Questions regarding the extraterritorial reach of Exchange Act section 10(b) have typically presented the courts with difficult factual and legal issues. The Supreme Court’s seminal decision in Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010) on the extraterritorial reach of that section added to the complexities. There the Court held that the federal courts have the power, the jurisdiction, to hear cases involving international matters under the Exchange Act. Nevertheless, the Court concluded that section 10(b) did not reach fraudulent conduct where the securities transaction did not take place either on a U.S. exchange or within the country. That conclusion was based on the presumption that statutes do not have extraterritorial reach absent an indication in the statutory text that Congress intended to confer that authority and the text of section 10(b). That intent is not evident from the text of section 10(b).
Shortly after the High Court handed down Morrison, Dodd-Frank was signed into law. Section 929(p) of that Act amended the jurisdictional sections of the securities laws to indicate that the antifraud provisions applied extraterritorially when a version of the conduct-and-effects test is met. That test had been used by the Circuit Courts prior to Morrison to determine if the courts had jurisdiction to consider an extraterritorial transaction. Its application was rejected as unnecessary in Morrison.
Recently the Tenth Circuit sought to harmonize Section 929(p) in SEC v. Scoville, No. 17-4059 (10th Cir. Jan. 14, 2019). There the Court concluded that the Dodd-Frank provision extended the reach of section 10(b) based on an application of the traditional conduct-and-effects test.
Factual background
Scoville centers on what is alleged to have been a Ponzi scheme operated by Defendants Charles Scoville and Traffic Monsoon, LLC, his controlled entity. Traffic Monsoon offered investors two ways to make money. Through its website, maintained on several U.S. based servers, would-be investors could become a member of Traffic Monsoon by paying a small fee and then purchase several different advertising services. Alternatively, the potential investor could purchase an Adpack which entitled the member to receive 1,000 visits to the website and twenty clicks on an internet advertisement, supposedly a $10.95 value. In return the investor obtained the opportunity to share in the ad revenue up to a maximum amount of $55. There was no limit to the number of Adpacks that could be purchased. About 99% of the purchasers qualified to obtain some of Traffic Monsoon’s revenue. Alternatively, members could earn money by recruiting other members.
Adpacks were very popular. Over a two year period, beginning in October 2014, Traffic Monsoon was paid $173 million in new money to purchase about 14 million Adpacks. Members were paid about $2.9 million during the period. About 90% of the members who purchased Adpacks lived outside the United States, generally in poor countries such as Bangladesh, Venezuela and Morocco.
The district court initially entered an asset freeze order and appointed a receiver at the request of the SEC. Following an evidentiary hearing the court entered a preliminary injunction and rejected a claim that the receivership be set aside. The central question on appeal was the extraterritorial reach of section 10(b). The Tenth Circuit affirmed the ruling of the district court.
The opinion
The Circuit Court used a two-prong analysis to reach its conclusion. Extraterritorial reach is in the first instance a question of Congressional intent, the Court noted. In Morrison the Supreme Court stated that the statute only applies within the United States unless there is affirmative and unmistakable evidence that Congress intended otherwise. Stated differently, if there is no clear indication of extraterritorial reach, there is none.
In this case Congress has spoken. Section 929(p) states that “The district courts of the United States . . . shall have jurisdiction of an action or proceeding brought or instituted by the Commission. . . alleging a violation of ” Exchange Act section 10(b). The language of the section is clear.
The fact that Congress intended to extend the reach of the two antifraud provisions in certain circumstances is bolstered by considering the context. Morrison rejected the conclusion that section 10(b) could have extraterritorial effect based on the application of a conduct-and-effects test because “Congress, in originally enacting section 10(b) did not address whether that provision applied extraterritorially.” Other provisions addressed the jurisdictional question. “But Congress, in the Dodd-Frank Act, amended only the jurisdictional sections of the securities laws to indicate that the antifraud provisions applied extraterritorially when a version of the conduct-and effects test is met,” the Scoville Court stated.
Section 929(p) was intended to give the antifraud provisions extraterritorial effect according to the Tenth Circuit: “Notwithstanding the placement of the Dodd-Frank amendments in the jurisdictional provisions of the securities acts, given the context and historical background surrounding Congress’s enactment of those amendments, it is clear to us that Congress undoubtedly intended that the substantive antifraud provisions should apply extraterritorially when the statutory conduct-and effects test [in Dodd-Frank] is satisfied,” the Court held. The point is bolstered by the fact that the title of the provision states it is intended to strengthen the authority of the SEC.
Under the circumstances of the this case the Court found that the statutory test had been satisfied. That test requires that “(1) the conduct within the United States constitutes significant steps in furtherance of the violation . . . [and] (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” Here Mr. Scoville conceived and created Traffic Monsoon in the U.S. The servers were also in this country. The district court concluded this conduct was sufficient to meet the requirements of section 929. The Circuit Court agreed.
Comment
The critical question presented by Scoville is the impact of section 929(p) on the antifraud provision. Two points are clear. First, Morrison held that the existing jurisdictional provisions were sufficient to reach extraterritorial conduct — no statutory amendment was necessary. The Court also held that section 10(b) did not reach that type of conduct. The Supreme Court took care to separate the question of jurisdiction from the merits of a claim when discussing these points: “But to ask what conduct Section 10(b) reaches is to ask what conduct Section 10(b) prohibits which is a merits question. Subject-matter jurisdiction presents a question quite separate from the question of whether the allegations the plaintiff makes entitle him to relief.” (Internal citations omitted).
Second, the key statutory text has not changed. Section 929 did not amend Section 10(b). Rather, it amended the jurisdictional section of the statute. The section 929 amendment thus confirmed Morison – the courts had the judicial power to consider cases that might reach beyond the shores of the United States. Stated differently, the addition of the conduct-and-effect test did nothing to change the reach of the original jurisdictional provisions, although it may have added clarity regarding the applicable test.
Dodd-Frank failed to address the critical question regarding extraterritorial reach of the antifraud provisions – the purchase/sale requirement Morrison called the “solicitude” of the statute. Morrison held that this requirement delimited the reach of the antifraud provisions to either a U.S. exchange or a transaction in the U.S. It is understandable, as Scoville notes, that Congress did not address this point in crafting Dodd-Frank which cleared Congress just days after the Supreme Court handed down its decision – a fact that effectively negates the typical presumption that legislation is passed with knowledge of High Court decisions. This does not, however, change the fact that the text of the antifraud provision remains the same.
Ultimately, the question presented by Scoville becomes what impact the amendment to the jurisdictional section has on the reach of the antifraud provision. Scoville concluded that the clear intent of Congress, evident from a review of legislative materials, dictates that the Dodd-Frank be read to extend the reach of the antifraud provision. While that seems consistent with Congressional intent, the reading is not supported by the plain text of the statute or the standard rules of construction. Indeed, as the Scoville Court acknowledged Congressional action regarding a jurisdictional section is not typically read as impacting other sections of the statute.
Ultimately the impact of Dodd-Frank and the reach of Section 10(b) should be addressed by the Supreme Court. An increasingly conservative Court will no doubt be troubled by the decision in Scoville. In recent securities cases Justices Thomas, Alito and Gorsuch have been critical of majority opinions which cited legislative materials to support a reading of statutory text, arguing that only the text should be considered. See, e.g., Digital Realty Trust, Inc. v. Sommers, 138 S.Ct. 767 (2018)(Thomas, J. concurring in result). At the same time if those materials are ignored Dodd-Frank section 929(p) will be rendered meaningless, a conclusion which is not favored by standard tenants of statutory construction. In the end, the Court might just direct Congress to go back to work and redraft the statute. See, e.g., McNally v. U.S., 483 U.S. 350 (1987)(vague honest services fraud statute required Congressional clarification).
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