Extraterritorial Application of the Securities Fraud Statute

Vilar and Tanaka were charged with 12 counts, including conspiracy, securities fraud, investment adviser fraud, mail fraud, wire fraud, money laundering and making false statements to the Securities Exchange Commission (SEC). After a jury trial, Vilar was convicted on all 12 counts and Tanaka was convicted of conspiracy, securities fraud related to the GFRDA scheme and investment adviser fraud. On appeal, the defendants argued that their securities fraud convictions should be reversed because their conduct occurred outside the United States, or “extraterritorially.”'

Section 10(b) and Rule 10b-5 proscribe the use of fraudulent schemes “in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.” In Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), the U.S. Supreme Court held that the SEC could bring a civil action under Section 10(b) and Rule 10b-5 only if the alleged fraud had a clear transactional connection to the United States. The decision effectively did away with the “conducts and effects test” previously relied upon by courts to determine whether Section 10(b) and Rule 10b-5 could apply to foreign conduct; that test focused on whether the wrongful conduct occurred in the United States or had a “substantial effect” in the United States or upon its citizens. See Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 65 (2d Cir. 2012) (reviewing the development of the law on this issue). In Morrison, the Supreme Court substituted the conducts and effects test with the requirement that the fraud be committed in connection with “transactions in securities listed on domestic exchanges [or] domestic transactions in other securities.”

In Vilar, the Second Circuit held that Morrison's limitation on the scope of the securities fraud statute extended to criminal prosecutions, recognizing the longstanding presumption against the extraterritorial application of United States laws absent a clear statement of contrary intent by Congress, noting an exception only in instances where the criminal statute was aimed at prohibiting crimes against the United States government itself. As there was no claim that Vilar and Tanaka sold securities listed on an American exchange, the court turned to the question of whether the defendants engaged in fraud in connection with a domestic purchase or sale of securities. To answer this question, the Second Circuit relied on the test set forth in its previous decision in Absolute Activist Value Master Fund Ltd. v. Ficeto: “a securities transaction is domestic when the parties incur irrevocable liability to carry out the transactions within the United States or when title is passed within the United States.” Id. at 69. Relevant to this determination are facts concerning the formation of the contracts, the placement of purchase orders, and the exchange of money.'

The Second Circuit determined that the transactions in which Vilar and Tanaka engaged were domestic in nature despite the fact that the defendants frequently operated from abroad and ran two of their funds through entities organized under the laws of Panama and the United Kingdom. In reaching this conclusion, the court relied on several facts, including that investors entered into and renewed investment agreements related to the GFRDAs in the United States and Puerto Rico (the default rule presumes the applicability of federal laws to Puerto Rico, a territory of the United States); that documents related to the transactions were executed and transmitted in the United States; and that investors were located in the United States when they transmitted money to Vilar and Tanaka for investment.

Accordingly, the test articulated in Morrison was met and the securities fraud convictions were upheld. In November, both defendants filed a petition for rehearing en banc in the Second Circuit. The defendants argue that they were denied their right to a fair trial because the factual issues raised by Morrison, rendered after the verdict in the case, were never resolved by a jury. Further, Vilar argues that the court should rule on whether the element of reliance, imposed in civil securities fraud cases, also is an element of a securities fraud prosecution.

Open Questions

While the Second Circuit's decision in Vilar is notable because of its proclamation that United States criminal laws do not reach foreign conduct unless the statute specifically contemplates such a reach, the decision also leaves open a number of issues.'

Application to Other Criminal Statutes

Perhaps the biggest question is how this analysis will be applied outside the securities fraud context to other white-collar crimes, such as mail or wire fraud or money laundering, where Congress has not specifically addressed the laws' application to foreign conduct. Historically, the extraterritorial application of criminal laws generally has been limited to crimes committed aboard a ship or airplane, condemned by international treaty, or relating to government employees or property overseas. Chris Doyle, “Extraterritorial Application of American Criminal Law,” Congressional Research Service (Feb. 15, 2012). To the extent the government seeks to expand beyond these scenarios, which increasingly is likely given the expanding global business market, they must contend with the now clear presumption established in Morrison and Vilar that criminal statutes that are silent as to their territorial reach have no extraterritorial application.

Despite this presumption, the reality is that the majority of white-collar activities being investigated by the government today have both a foreign and domestic component, and to the extent the government seeks to wrap foreign conduct into the case, the Second Circuit's application of Morrison arguably sets a relatively low hurdle for the government to clear. Evidence of communications in the United States or the transfer of payments from or to the United States may be sufficient to transform foreign activity into domestic
conduct prosecutable by statute ' a way of getting foreign conduct in through the back door. The clear presumption against extraterritorial application of criminal statutes therefore may be of little effect at times.'

Impact on Sentencing

Another important issue is how losses attributable to foreign conduct, which cannot be used to establish criminal liability under the securities laws, will impact a defendant's sentence in cases involving both domestic and foreign activity. In Vilar, the court ordered the recalculation of the defendants' sentences that were premised in part on losses attributed to foreign conduct, finding that such losses could not be considered in calculating the defendants' sentences. However, the Second Circuit also noted that the question of whether such losses may constitute “relevant conduct” and, therefore, be included in the offense level calculation under the Sentencing Guidelines, remained open. Under the Guidelines, a sentencing court is required to consider the entirety of a defendant's “relevant conduct,” including “all acts and omissions ' that were part of the same course of conduct or common scheme or plan as the offense of conviction.” United States Sentencing Guidelines (U.S.S.G.) ” 1B1.3.

Because the Guideline sentencing ranges are calculated based on the amount of loss resulting from the crime, if it is determined that foreign conduct is includable as relevant conduct, a defendant's sentence is likely to be as high as it would be if losses attributable to foreign activity were included in the underlying calculation. The court also ordered the recalculation of restitution amounts to be paid by the defendants since losses caused by conduct other than that which forms the basis of the offense conviction cannot be included. The Second Circuit remanded the sentencing issues back to the district court, but resentencing currently is on hold while the defendants seek a rehearing en banc.

Interaction with Dodd-Frank Act

Another open question is whether the Second Circuit's decision in Vilar has been rendered irrelevant in the securities fraud context by the Dodd-Frank Act. Although the argument was not raised in Vilar, other courts have grappled with the validity of the Supreme Court's decision in Morrison since the enactment of the Dodd-Frank Act. Section 929P(b) of that Act, entitled “Extraterritorial Jurisdiction of the Antifraud Provisions of the Federal Securities Laws,” added the following language to both the Securities Act and Exchange Act: “district courts ' shall have jurisdiction over an action or proceeding brought or instituted by the [SEC] or the United States 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.”

The applicability of this provision and its relationship to the Supreme Court's decision in Morrison recently was raised in a civil securities fraud lawsuit initiated by the SEC in the United States District Court for the Northern District of Illinois. The defendants brought a motion to dismiss, arguing that the transactions at issue were not “domestic” as required by Morrison. The SEC contended that Section 929P(b) supersedes Morrison and revived the previously applied “conducts and effects” test. The defendants responded that the provision relates only to subject matter jurisdiction and did not “even attempt to address” what constitutes a substantive cause of action. SEC v. A Chicago Convention Center, LLC, ___ F. Supp.2d ___, 2013 WL 4012638, *4 (N.D.Ill. Aug. 6, 2013).

Reviewing the legislative history of Section 929P(b), the district court observed that “[t]he plain language of Section 929P(b) and its placement in the jurisdictional section of the Exchange Act indicate that it may be jurisdictional. It is unclear, however, whether the Court's analysis should stop there because it is possible that this interpretation would create superfluity or contradict the legislative intent.” Finding that the conduct at issue satisfied both the “transactional” inquiry under Morrison and the “conducts and effects” test, the court declined further inquiry to resolve the tension between the Dodd-Frank provision and Morrison. The court noted, however, a number of other decisions in which Section 929P(b) was assumed, without analysis, to supersede Morrison. Id. at *4 n.1.

Conclusion

The Second Circuit's extension of Morrison to criminal cases is significant. Arguably, the court's analysis of the extraterritorial application of criminal laws is not confined to the securities fraud statutes, but generally embraces the “presumption that United States law governs domestically but does not rule the world” in holding that absent clear indication to the contrary, criminal statutes have no extraterritorial application. Even if Section 929P(b) is determined to supersede Morrison's holding, it applies only to securities laws and does not negate the Second Circuit's holding vis-'-vis other criminal statutes. Nevertheless, it remains to be seen whether this holding will be embraced in other contexts or other federal circuit courts.'

Jodi Misher Peikin ([email protected]), a member of this newsletter's Board of Editors, is a partner at Morvillo Abramowitz Grand Iason & Anello PC, New York.

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In the era of global and relatively borderless business transactions, the federal government's reach in pursuing wrongdoing that occurs outside the United States is particularly relevant to white-collar practitioners. A recent decision from the U.S. Court of Appeals for the Second Circuit limits the government's ability to prosecute securities fraud to those cases involving a domestic security, defined as a security listed on an American exchange or purchased or sold in the United States. Although the defense bar undoubtedly welcomed the decision, it has spawned a number of significant questions, including whether the rule against the presumption of extraterritoriality applies to other criminal statutes; whether and how foreign conduct can be considered at sentencing; and whether recent legislation preempts the decision.'

United States v. Vilar

In United States v. Vilar , 729 F.3d 62 (2d Cir. 2013), the Second Circuit considered the appeals of Alberto Vilar and Gary Alan Tanaka, investment managers and advisers who were convicted of securities fraud for lying to clients about the nature and quality of certain investments. From 1986 through 2005, Vilar and Tanaka offered clients the opportunity to invest in “Guaranteed Fixed Rate Deposit Accounts” (GFRDAs), promising investment in high-quality, short-term deposits. In fact, Vilar and Tanaka invested all of the GFRDA funds received from clients in emerging growth stocks in the technology and biotechnology sectors, which dropped dramatically when the dot-com bubble burst in the fall of 2000. The defendants subsequently misappropriated client money to cover losses and to meet various personal and corporate obligations.'

Vilar and Tanaka were charged with 12 counts, including conspiracy, securities fraud, investment adviser fraud, mail fraud, wire fraud, money laundering and making false statements to the Securities Exchange Commission (SEC). After a jury trial, Vilar was convicted on all 12 counts and Tanaka was convicted of conspiracy, securities fraud related to the GFRDA scheme and investment adviser fraud. On appeal, the defendants argued that their securities fraud convictions should be reversed because their conduct occurred outside the United States, or “extraterritorially.”'

Section 10(b) and Rule 10b-5 proscribe the use of fraudulent schemes “in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.” In Morrison v. National Australia Bank , 130 S. Ct. 2869 (2010), the U.S. Supreme Court held that the SEC could bring a civil action under Section 10(b) and Rule 10b-5 only if the alleged fraud had a clear transactional connection to the United States. The decision effectively did away with the “conducts and effects test” previously relied upon by courts to determine whether Section 10(b) and Rule 10b-5 could apply to foreign conduct; that test focused on whether the wrongful conduct occurred in the United States or had a “substantial effect” in the United States or upon its citizens. See Absolute Activist Value Master Fund Ltd. v. Ficeto , 677 F.3d 60, 65 (2d Cir. 2012) (reviewing the development of the law on this issue). In Morrison, the Supreme Court substituted the conducts and effects test with the requirement that the fraud be committed in connection with “transactions in securities listed on domestic exchanges [or] domestic transactions in other securities.”

In Vilar, the Second Circuit held that Morrison's limitation on the scope of the securities fraud statute extended to criminal prosecutions, recognizing the longstanding presumption against the extraterritorial application of United States laws absent a clear statement of contrary intent by Congress, noting an exception only in instances where the criminal statute was aimed at prohibiting crimes against the United States government itself. As there was no claim that Vilar and Tanaka sold securities listed on an American exchange, the court turned to the question of whether the defendants engaged in fraud in connection with a domestic purchase or sale of securities. To answer this question, the Second Circuit relied on the test set forth in its previous decision in Absolute Activist Value Master Fund Ltd. v. Ficeto: “a securities transaction is domestic when the parties incur irrevocable liability to carry out the transactions within the United States or when title is passed within the United States.” Id. at 69. Relevant to this determination are facts concerning the formation of the contracts, the placement of purchase orders, and the exchange of money.'

The Second Circuit determined that the transactions in which Vilar and Tanaka engaged were domestic in nature despite the fact that the defendants frequently operated from abroad and ran two of their funds through entities organized under the laws of Panama and the United Kingdom. In reaching this conclusion, the court relied on several facts, including that investors entered into and renewed investment agreements related to the GFRDAs in the United States and Puerto Rico (the default rule presumes the applicability of federal laws to Puerto Rico, a territory of the United States); that documents related to the transactions were executed and transmitted in the United States; and that investors were located in the United States when they transmitted money to Vilar and Tanaka for investment.

Accordingly, the test articulated in Morrison was met and the securities fraud convictions were upheld. In November, both defendants filed a petition for rehearing en banc in the Second Circuit. The defendants argue that they were denied their right to a fair trial because the factual issues raised by Morrison, rendered after the verdict in the case, were never resolved by a jury. Further, Vilar argues that the court should rule on whether the element of reliance, imposed in civil securities fraud cases, also is an element of a securities fraud prosecution.

Open Questions

While the Second Circuit's decision in Vilar is notable because of its proclamation that United States criminal laws do not reach foreign conduct unless the statute specifically contemplates such a reach, the decision also leaves open a number of issues.'

Application to Other Criminal Statutes

Perhaps the biggest question is how this analysis will be applied outside the securities fraud context to other white-collar crimes, such as mail or wire fraud or money laundering, where Congress has not specifically addressed the laws' application to foreign conduct. Historically, the extraterritorial application of criminal laws generally has been limited to crimes committed aboard a ship or airplane, condemned by international treaty, or relating to government employees or property overseas. Chris Doyle, “Extraterritorial Application of American Criminal Law,” Congressional Research Service (Feb. 15, 2012). To the extent the government seeks to expand beyond these scenarios, which increasingly is likely given the expanding global business market, they must contend with the now clear presumption established in Morrison and Vilar that criminal statutes that are silent as to their territorial reach have no extraterritorial application.

Despite this presumption, the reality is that the majority of white-collar activities being investigated by the government today have both a foreign and domestic component, and to the extent the government seeks to wrap foreign conduct into the case, the Second Circuit's application of Morrison arguably sets a relatively low hurdle for the government to clear. Evidence of communications in the United States or the transfer of payments from or to the United States may be sufficient to transform foreign activity into domestic
conduct prosecutable by statute ' a way of getting foreign conduct in through the back door. The clear presumption against extraterritorial application of criminal statutes therefore may be of little effect at times.'

Impact on Sentencing

Another important issue is how losses attributable to foreign conduct, which cannot be used to establish criminal liability under the securities laws, will impact a defendant's sentence in cases involving both domestic and foreign activity. In Vilar, the court ordered the recalculation of the defendants' sentences that were premised in part on losses attributed to foreign conduct, finding that such losses could not be considered in calculating the defendants' sentences. However, the Second Circuit also noted that the question of whether such losses may constitute “relevant conduct” and, therefore, be included in the offense level calculation under the Sentencing Guidelines, remained open. Under the Guidelines, a sentencing court is required to consider the entirety of a defendant's “relevant conduct,” including “all acts and omissions ' that were part of the same course of conduct or common scheme or plan as the offense of conviction.” United States Sentencing Guidelines (U.S.S.G.) ” 1B1.3.

Because the Guideline sentencing ranges are calculated based on the amount of loss resulting from the crime, if it is determined that foreign conduct is includable as relevant conduct, a defendant's sentence is likely to be as high as it would be if losses attributable to foreign activity were included in the underlying calculation. The court also ordered the recalculation of restitution amounts to be paid by the defendants since losses caused by conduct other than that which forms the basis of the offense conviction cannot be included. The Second Circuit remanded the sentencing issues back to the district court, but resentencing currently is on hold while the defendants seek a rehearing en banc.

Interaction with Dodd-Frank Act

Another open question is whether the Second Circuit's decision in Vilar has been rendered irrelevant in the securities fraud context by the Dodd-Frank Act. Although the argument was not raised in Vilar, other courts have grappled with the validity of the Supreme Court's decision in Morrison since the enactment of the Dodd-Frank Act. Section 929P(b) of that Act, entitled “Extraterritorial Jurisdiction of the Antifraud Provisions of the Federal Securities Laws,” added the following language to both the Securities Act and Exchange Act: “district courts ' shall have jurisdiction over an action or proceeding brought or instituted by the [SEC] or the United States 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.”

The applicability of this provision and its relationship to the Supreme Court's decision in Morrison recently was raised in a civil securities fraud lawsuit initiated by the SEC in the United States District Court for the Northern District of Illinois. The defendants brought a motion to dismiss, arguing that the transactions at issue were not “domestic” as required by Morrison. The SEC contended that Section 929P(b) supersedes Morrison and revived the previously applied “conducts and effects” test. The defendants responded that the provision relates only to subject matter jurisdiction and did not “even attempt to address” what constitutes a substantive cause of action. SEC v. A Chicago Convention Center, LLC , ___ F. Supp.2d ___, 2013 WL 4012638, *4 (N.D.Ill. Aug. 6, 2013).

Reviewing the legislative history of Section 929P(b), the district court observed that “[t]he plain language of Section 929P(b) and its placement in the jurisdictional section of the Exchange Act indicate that it may be jurisdictional. It is unclear, however, whether the Court's analysis should stop there because it is possible that this interpretation would create superfluity or contradict the legislative intent.” Finding that the conduct at issue satisfied both the “transactional” inquiry under Morrison and the “conducts and effects” test, the court declined further inquiry to resolve the tension between the Dodd-Frank provision and Morrison. The court noted, however, a number of other decisions in which Section 929P(b) was assumed, without analysis, to supersede Morrison. Id. at *4 n.1.

Conclusion

The Second Circuit's extension of Morrison to criminal cases is significant. Arguably, the court's analysis of the extraterritorial application of criminal laws is not confined to the securities fraud statutes, but generally embraces the “presumption that United States law governs domestically but does not rule the world” in holding that absent clear indication to the contrary, criminal statutes have no extraterritorial application. Even if Section 929P(b) is determined to supersede Morrison's holding, it applies only to securities laws and does not negate the Second Circuit's holding vis-'-vis other criminal statutes. Nevertheless, it remains to be seen whether this holding will be embraced in other contexts or other federal circuit courts.'

Jodi Misher Peikin ([email protected]), a member of this newsletter's Board of Editors, is a partner at Morvillo Abramowitz Grand Iason & Anello PC, New York.

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