(Article from Securities Law Alert, January 2015)
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In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court held that “Section 10(b) applies only to transactions in securities listed on domestic exchanges and domestic transactions in other securities.” On January 20, 2015, the Third Circuit ruled that “irrevocable liability establishes the location of a securities transaction” for purposes of determining whether a transaction is “domestic” within the meaning of the Morrison decision. United States v. Georgiou, 2015 WL 241438 (3d Cir. 2015) (Greenaway, Jr., J.). Applying the “irrevocable liability” test, the Third Circuit held “as a matter of first impression” that over-the-counter “purchases and sales of securities issued by U.S. companies through U.S. market makers acting as intermediaries for foreign entities constitute ‘domestic transactions’ under Morrison.”
Third Circuit Holds That Securities Listed on Either the OTC Bulletin Board or the Pink OTC Markets Are Not “Securities Listed on an American Stock Exchange” for Morrison Purposes
At issue in the case before the Third Circuit was a “stock fraud scheme … centered on manipulating the markets of four stocks” traded by foreign entities on two American over-the-counter stock markets, the OTC Bulletin Board (“OTCBB”) and the Pink OTC Markets Inc. (“Pink Sheets”). The Third Circuit noted that “[u]nder the first prong of Morrison, Section 10(b) applies to ‘the purchase or sale of a security listed on an American stock exchange.” The Third Circuit found that “[s]ecurities listed on the OTCBB and the Pink Sheets are not within these parameters” for several reasons.
First, the Third Circuit pointed out that “[a]ccording to the SEC, there are eighteen registered national security exchanges” but “the Pink Sheets and the OTCBB are not among them.” Second, the court observed that “the stated purpose of the [Securities Exchange] Act refers to ‘securities exchanges’ and ‘over-the-counter markets’ separately, which suggests that one is not inclusive of the other.” Georgiou, 2015 WL 241438 (citing 15 U.S.C. §78a et seq. (described as “[a]n Act [t]o provide for the regulation of securities exchanges and of over-the-counter markets …[and] to prevent inequitable and unfair practices on such exchanges and markets”) (emphasis added)). The Third Circuit therefore concluded that the OTCBB and the Pink Sheets “are not national securities exchanges within the scope of Morrison.”
Third Circuit Applies the “Irrevocable Liability” Test and Determines That the Over-the-Counter Transactions at Issue Were “Domestic Transactions” Under Morrison
The Third Circuit next considered whether the foreign entities’ over-the-counter transactions in domestic securities constituted “domestic transactions” for purposes of Morrison’s second prong. The court found that the case at hand was distinguishable from Morrison. While Morrison involved a foreign-cubed action in which “all aspects of the trades at issue occurred abroad,” the case before the Third Circuit “involve[d] stocks of U.S. companies” and transactions that “were executed through American market makers.”
The Third Circuit explained that in order “[t]o determine whether the transactions at issue were ‘domestic transactions,’ under Morrison,” it must “consider ‘not … the place where the deception originated, but [the place where] purchases and sales of securities’ occurred” (quoting Morrison, 561 U.S. 247). The court observed that several other circuits, including the Second Circuit, have held that “a securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States” (quoting Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012)). Agreeing with these circuits, the Third Circuit held “that irrevocable liability establishes the location of a securities transaction” for purposes of Morrison’s second prong. The court noted that “[f]acts that demonstrate irrevocable liability’ include the ‘formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.’”
Applying the “irrevocable liability” test to the case before it, the Third Circuit found that “at least one of the fraudulent transactions in each of [the stocks at issue] was bought and sold through U.S.-based market makers.” The court determined that “some of the relevant transactions required the involvement of a purchaser or seller working with a market maker and committing to a transaction in the United States, occurring irrevocable liability in the United States, or passing title in the United States.” The Third Circuit therefore held that the transactions at issue constituted “domestic transactions” within the meaning of the Morrison test, and affirmed the conviction under Section 10(b) and Rule 10b-5 of a Canadian stockbroker involved in the transactions.
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