Foreign Regulation of Corporate Governance: Extraterritorial Application of Securities Laws

1. Foreign Regulation of Corporate Governance: Extraterritorial Application of Securities Laws By Baiba Tora Simonetta Simmons Brandon Taylor

2. Overview • Main Issues • Morrison v. National Australia Bank • Dodd-Frank Act • Policy Proposal

3. Securities Laws • Securities Act (1933) • Securities Exchange Act (1934) • Investment Company Act (1940) • Investment Advisor Act (1940) • Sarbanes-Oxley Act (2002) • Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

4. Main Issues • Congressional action regarding extraterritorial reach vs. court interpretation • Application of U.S. law to foreign actors and foreign transactions • Transparency and fairness in the financial markets across sovereign territories • Affect on foreign investment in the U.S., and harm to U.S. investors from foreign actions

5. Importance of Securities Regulations • Growing number of foreign IPOs in the U.S. • Increasing value of IPOs globally • Investor confidence in U.S. markets • Confidence in companies (domestic or foreign) listed on U.S. stock exchanges • Complex financial innovations • Interconnections between international markets

6. Source: www.renaissancecapital.com

7. Source: www.renaissancecapital.com

8. Source: Financial Times, 12/28/11

9. Court Interpretation of Extraterritoriality (1) For cases with foreign actors and foreign transactions, (2) And if Congress is silent or vague about extraterritorial jurisdiction for a particular statute. First test applied: “presumption of territoriality” • the court assumes the statue is limited to domestic matters • “rooted in principles of comity, non-intervention, and sovereign equality” (Desautels-Stein) • in many cases, successful arguments can be made w/o invoking extraterritorial transactions, but by focusing on domestic activity. • exceptions to the principle rely on the “subject matter” of the case, e.g. cases dealing with fraud

10. Beyond the Presumption of Territoriality In the past, If courts recognized extraterritorial jurisdiction for a vague or silent statute, certain tests were applied: • Conduct Test – “whether the wrongful conduct occurred in the U.S.” • Effects Test – “whether the wrongful conduct had a substantial effect in the U.S.” • Reasonableness Test – component of international law that defines “reasonable” factors that should be confirmed Taken together, the use or interpretation of any of these principles was “unpredictable.”

11. Morrison v. National Australia Bank (2010) • Was a significant departure from previous interpretation of extraterritorial jurisdiction. • Most prominent example of a “foreign-cubed” class-action case. This case involved: • Foreign plaintiffs (Morrison) • Foreign company (NAB) • Foreign Stock Exchange transactions (Australian Stock Exchange)

12. Morrison v. NAB: the Plaintiff’s Claim Note: HomeSide was the U.S. Mortgage Servicer for National Australia Bank

13. Morrison v. NAB: Ruling • Southern District of New York found no “subject matter” to establish jurisdiction under Section 10(b) of the Exchange Act • Second Circuit Court agreed • Supreme Court agreed, but on different grounds: • “no clear indication” that the statute applies extraterritorially • The “conduct” and “effect” tests are too vague • Claims ought to depend on the locality of the “transaction”

14. Morrison v NAB: Consequences • Fraud committed by HomeSide was effectively overlooked • The Supreme Court has made a “clear intention to limit the extraterritoriality of section 10(b).” And lower courts have followed this ruling • The once vague tests applied to securities fraud cases involving foreign actors and foreign transactions are now more limiting • Any prior intent in the law to have extraterritorial jurisdiction will need to be addressed by Congress

15. Dodd-FrankAct • Signed July 21, 2010 • Purposes of law • “To promote the financial stability of the United States by improving accountability and transparency in the financial system • To end ‘too big to fail’ • To protect the American taxpayer by ending bailouts • To protect consumers from abusive financial services practices and for other purposes.”

16. Dodd-Frank Act (cont.) • Financial Stability Oversight Council • provide, for the first time, comprehensive monitoring to ensure the stability of our nation's financial system. The Council is charged with identifying threats to the financial stability of the United States; promoting market discipline; and responding to emerging risks to the stability of the United States financial system. • Securities and Exchange Commission Whistleblower Program • Assistance and information from a whistleblower who knows of possible securities law violations can be among the most powerful weapons in the law enforcement arsenal of the SEC. Through their knowledge of the circumstances and individuals involved, whistleblowers can help the Commission identify possible fraud and other violations much earlier than might otherwise have been possible. • Consumer Financial Protection Bureau • Supervision Program” over “larger participants” within markets for consumer financial products or services • Ultimate goal: “CFPB will have the authority to supervise non-depository institutions identified as larger participants in certain markets – including by requiring reports and conducting examinations – to ensure” their compliance with Federal consumer financial law.(This is in addition to applicable federal and state law)

17. Dodd-Frank - Extraterritoriality • Dodd Frank reversed in part Morrison v. National Australia Bank Ltd., and confirmed Congress’ intent that in proceedings brought by SEC or United States government the securities laws will have extraterritorial effect. • Extraterritorial scope – financial regulations to restore transparency and stability to the global derivatives market. • Dodd-Frank applies across jurisdictions so long as the U.S. has a vested interest in the derivatives transactions. Section 722(d)

18. Dodd-Frank Extraterritoriality (cont.) • Section 722(d) aligns with the U.S. Constitution and satisfies the due process under the 5th and 14th amendments of the U.S. Constitution. • 722 (d) provides that the provisions of the Act shall not apply to activities outside the United States unless those activities: • Have a direct and significant connection with activities in, or effect on, commerce of the U.S. • contravene such rules or regulations as the Commission may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision of this Act. • Asahi Metal industry Co. v. Superior Court of Californiaand International Shoe Co. v. Washington

19. Dodd-Frank Extraterritoriality (cont.) • Section 929P of Dodd-Frank amends the following regulations: • Section 22 of the Securities Act of 1933 (15 U.S.C. 77v(a)) • Section 27 of the Securities Exchange Act of 1934 (15 U.S.C. 78aa) • Section 214 of the Investment Advisers Act of 1940 (15 U.S.C. 80b– 14) by adding at the end the following new subsection:‘‘(b) EXTRATERRITORIAL JURISDICTION —The district courts of the United States and the United States courts of any Territory shall have jurisdiction of an action or proceeding brought or instituted by the Commission or the United States alleging a violation of the antifraud provisions of this title involving— ‘‘(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or ‘‘(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.’’.

20. Whistleblowers - Extraterritoriality • Under Dodd-Frank, whistleblowers are entitled to anywhere from 10% to 30% if the monetary sanctions recovered in eligible SEC or related actions arising from the information provided by the whistleblower. The information need not be related to illegal practices within the US by US entities; it can pertain to any activities of the US entity or its business partners anywhere in the world. • Dodd-Frank also expands the existing Sarbanes-Oxley Act (SOX) whistleblower anti-retaliation provision. • However - there is no evidence that Congress intended to broaden whistleblower retaliation protections either under SOX or under the new Dodd- Frank anti-retaliation causes of action to individuals employed by overseas subsidiaries of U.S. companies. To the contrary, the text and structure of the Act suggest the opposite.

21. Policy Proposal • Congress should pass, and the President should sign, legislation that clarifies the extraterritorial jurisdiction of securities laws and the extent to which regulators can apply that reach to existing and future rules. The legislation should be thorough, addressing any gaps or vagueness in the existing statutes. • Statutes must show clear Congress' intent to give the statute extraterritorial scope (as argued under Morrison ) • Provisions of statute shouldn't be ambiguous left for Court's interpretation

22. Pros & Cons • Pros: • Constitutional authority to regulate foreign commerce returned to the Congress • Clarity of extraterritorial reach will reduce uncertainty and bolster confidence for investors • Stability in securities regulations will encourage foreign issuers to deal more with U.S. markets

23. Pros & Cons (cont.) • Cons: • Despite the attempt to clarify extraterritorial reach, the added and modified provisions could make securities law more complicated • Chamber of Commerce refers to the SEC as a “disclosure regime that is burdensome and difficult to comply with” • If improperly applied, the fear of “Shangri-la of class action” may become true, leading to foreign nationals exploiting the more favorable U.S. laws • Current bilateral agreements may be sufficient to handle cross-border transactions, and do not challenge a countries sovereignty • Reduces competition for U.S. financial institutions

24. Impacts on Foreign Securities Policies • So far, foreign regulators have not suggested that they would apply their domestic restrictions on U.S. banks operating in the U.S. • The European Investment Bank (EIB) and ECB have threatened to cease trading OTC swaps if subject to Dodd-Franks clearing and collateral requirements. • E.U. Financial Services Commissioner argued that “it is not acceptable that U.S. rules have such a wide effect on other nations.”

25. Counterarguments • The increasing complexity and interconnectedness of financial markets requires that U.S. legislation be updated to handle new challenges. • The expansion of bilateral and multilateral agreements among nations makes the financial system all the more complex. A unified message from the U.S. would help. • As the largest economy, the world will still want to do business with the U.S., and will appreciate the clarity and transparency of its regulations.

26. Sources • De Pue, John. “Fundamental Principles Governing Extraterritorial Prosecutions–Jurisdiction and Venue.” United States Attorneys’ Bulletin. United States Department of Justice. Vol. 55, No. 2. March, 2007. • Frankel, David et al. “Dodd-Frank’s Impact on Securities Enforcement and Litigation.” The Metropolitan Corporate Counsel. October, 2010.Page 12. • Giuffra, Robert Jr. et al. “The Territorial Reach of U.S. Securities Laws After Morrison v. National Australia Bank.” The Harvard Law School Forum on Corporate Governance and Financial Regulation. October 13, 2011. • Greenberger, Michael. “The Extraterritorial Application of the Dodd-Frank Act Protects U.S. Taxpayers from Worldwide Bailouts.” University of Maryland Francis King Carey School of Law. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2029063 • Noked, Nome. “The Dodd-Frank Extraterritorial Jurisdiction Provision.” The Harvard Law School Forum on Corporate Governance and Financial Regulation. August 5, 2011.

27. Sources (cont.) • Protess, Ben. “Unearthing Exotic Provisions Buried in Dodd-Frank.” The New York Times. July 13, 2011. • “SEC and CSRC Announce Terms of Reference for Enhanced Dialogue.” Securities Exchange Commission. May 2, 2006. www.sec.gov/news/press/2006/2006-63.htm • Schwartz, Jason et al. “The Extraterritorial Application of the Dodd-Frank Whistleblower Provisions.” Employment Law Strategist, Volume 19, Number 4, August 2011, http://gibsondunn.com/publications/Documents/SchwartzJohnson-ExtraterritorialApplicationofDodd-Frank.pdf