A recent Southern District of New York decision issued by Judge Gregory H. Woods is the first in the Second Circuit since Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010), to hold that the Securities Exchange Act’s (Exchange Act) antifraud provisions apply to extraterritorial conduct that is the subject of an SEC enforcement action. In United States Sec. & Exch. Comm’n v. Passos, 1:22-cv-3156-GHW, 2024 WL 5203022 (S.D.N.Y. Dec. 21, 2024), the defendant, Fernando Passos (Passos), a former executive at a Brazilian reinsurance company whose stock traded on a Brazilian exchange, moved to dismiss an SEC enforcement action on the basis that the SEC was seeking to regulate extraterritorial conduct. Applying Section 929P of the Dodd-Frank Act, the Court denied Passos’s motion, holding that Section 10(b) of the Exchange Act reaches extraterritorial transactions and that the SEC adequately alleged a violation. This holding reinforces the SEC’s expansive view of its enforcement authority and increases the risk of SEC enforcement actions against non-U.S. public companies, especially those with a substantial base of U.S. shareholders or officers conducting significant business in the United States.
Morrison v. National Australia Bank and its Aftermath
Before the Supreme Court’s ruling in Morrison, courts in the Second Circuit applied “conduct” and “effects” tests, under which Section 10(b) applied to extraterritorial transactions involving conduct that “occurred in the United States” or “had a substantial effect in the United States or upon United States Citizens.” SEC v. Berger, 322 F.3d 187, 192-93 (2d Cir. 2003).
Morrison rejected the conduct and effects tests, holding that Section 10(b) reached “only transactions in securities listed on domestic exchange, and domestic transactions in other securities.” 561 U.S. at 267. Within weeks of the Supreme Court’s decision in Morrison, Congress passed the Dodd-Frank Act, Section 929P of which amended the Exchange Act by adding to Section 27 a part (b) titled “Extraterritorial Jurisdiction.” Pub. L. No. 111-203, 124 Stat. 1376, 1862 (2010). This subsection provides that U.S. courts shall have jurisdiction over actions initiated by the SEC or the United States alleging violations of the Exchange Act’s antifraud provisions that involve “conduct occurring within the United States” or “conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” Id. In short, the Dodd-Frank Act revived the conduct and effects tests for assessing jurisdiction over actions brought by the SEC.
Because Dodd-Frank amended the Exchange Act’s jurisdictional provision rather than Section 10(b) itself, which Morrison held was limited to “domestic transactions,” [Morrison at 267], it was an open question in the Second Circuit whether SEC enforcement of Section 10(b) was limited to domestic transactions. It remains to be seen whether courts in the Second Circuit and elsewhere will follow the reasoning in Passos and whether Passos will prompt an increase in extraterritorial enforcement actions during the Trump Administration or thereafter.
Factual Background
IRB Brasil Ressegurous S.A. (IRB) is a public Brazilian reinsurance company whose stock trades on a Brazilian exchange. Passos served as IRB’s Executive Vice President of Finance and Investor Relations and was responsible for the company’s communications with investors. In February 2020, a short seller of IRB stock published a letter questioning IRB’s financial stability. The letter included commentary on the general health of the reinsurance industry from Warren Buffet, the Chairman and CEO of Berkshire Hathaway (“Berkshire”)—a major investor in the industry.
After the letter was published, IRB’s stock price declined. To counteract the drop in price, Passos allegedly concocted a false story that Berkshire had made “substantial purchases of IRB stock.” Passos, at *2. Passos allegedly created fake documents in support of this story and enlisted the company’s communications manager and public relations firm to share it with journalists. Some of this conduct allegedly occurred in the United States. For example, Passos allegedly sent IRB’s communications manager text messages with instructions on how to contact journalists, and, in response to one journalist’s query, circulated false documents, including a fake Shareholder Schedule, allegedly corroborating Berkshire’s investment. Two days later, Passos allegedly implied in conversations with U.S. investors that Berkshire was heavily invested in IRB. After this story spread, IRB’s stock price rose until Berkshire issued a press release denying it, after which IRB’s stock price declined by 40%.
The SEC brought an action against Passos under Section 10(b) of the Securities and Exchange Act in April 2022, alleging that Passos knowingly engaged in a scheme to defraud IRB investors. Specifically, while in the United States, Passos allegedly took deliberate steps to spread the false Berkshire story to convince investors of IRBs financial health and encourage them to purchase stock. According to the complaint, certain U.S.-based investors bought IRB shares while the fake story was circulating, and, during that time, IRB’s stock price was artificially inflated. The SEC also claimed, in the alternative, that Passos’s actions violated Section 20(e) of the Exchange Act by aiding and abetting IRB’s alleged violations of Section 10(b).
In June 2024, Passos moved to dismiss the SEC’s complaint arguing, inter alia, that it was barred by the presumption against the extraterritorial application of law as set forth in Morisson. Passos contended that his conduct fell outside of the scope of Section 10(b) because IRB traded its stocks exclusively on a Brazilian exchange and that, because the SEC did not allege related U.S. transactions, it did not have authority to bring an enforcement action against him.
The District Court’s Decision
The district court denied Passos’s motion to dismiss, holding that Section 10(b) reached Passos’s conduct even though the relevant transactions were extraterritorial. The Court found, first, that the text of the Exchange Act was broad enough to encompass extraterritorial misconduct, and second, that Congress’s amendment of the Exchange Act in Dodd-Frank provided the “affirmative indication” of extraterritorial application that did not exist when the Supreme Court decided Morrison. [1]
The Text of Section 10(b) Encompasses Extraterritorial Misconduct
The Court began its analysis with the language of the Exchange Act. Citing “broad language” in the text of Section 10(b), the Court reasoned that the provision “encompasses extraterritorial conduct” because it requires only the use of “an instrumentality of interstate commerce or of the mails.” Id. at *12. The Court interpreted this language to include instrumentalities used between the U.S. and Brazil “to manipulate investors in connection with IRB stock,” regardless of whether the stock is registered on a U.S. Exchange. Furthermore, the Court reasoned that Section 10(b) can reach extraterritorial transactions because the definition of “interstate commerce” within the Exchange Act is “trade, commerce, transportation, or communication…between any foreign country and any State.” Id.
Congress’s Amendment of the Exchange Act in Dodd-Frank Rebuts the Presumption against Extraterritoriality
After finding that Section 10(b) was on its face broad enough to encompass extraterritorial transactions, the Court next considered whether Section 27 of the Exchange Act, as revised by Dodd-Frank, “provides the ‘affirmative indication’ of extraterritorial application that did not exist when the [Supreme] Court decided Morrison.” Id. at *13.
The Court held that the “grant of jurisdiction over Section 10(b) enforcement actions involving specific extraterritorial conduct [in Section 27(b)] is a clear, affirmative indication that Section 10(b)’s broad language may be applied to that conduct in an enforcement action brought by the SEC.” (internal quotations omitted). Id. at *14. First, the Court noted that the language of Section 27(b), (titled “Extraterritorial Jurisdiction”), which revives the pre-Morrison conduct and effects test, is convincing evidence of Congressional intent to permit the SEC to bring enforcement actions related to extraterritorial transactions. Second, the Court found that “if there were any doubt” about the meaning of Section 27(b), the title, “STRENGTHENING ENFORCEMENT BY THE COMMISSION,” also “suggests that Section 10(b) applies extraterritorially where Section 27(b)’s conduct or effects test is met.” Id. Finally, adopting a holistic view of the Exchange Act, the Court ruled that Congress intended Section 27(b) to expand the substantive reach of the SEC, notwithstanding that it is a jurisdictional provision because it “would have been pointless for Congress” to define these tests “for jurisdiction over Section 10(b) enforcement actions if the scope of Section 10(b) never reached that conduct.” Id. at *13.
Application to Passos
The Court then applied Section 10(b) to Passos’s alleged conduct and held the SEC had adequately pleaded that the conducts test was met. The conduct the SEC alleged within the United States included sending several text messages to an IRB communications manager instructing her to spread the story regarding Berkshire’s purported investment in IRB, coordinating with IRB’s public relations firm concerning communication with journalists, and forwarding for public dissemination allegedly false documents ostensibly corroborating Berkshire’s purported investment. Viewing Passos’s conduct collectively, and drawing all reasonable inferences in the SEC’s favor, the Court determined that Passos’s conduct in the United States “constituted significant steps in furtherance of his Section 10(b) violations . . . and thus that his conduct falls within the ambit of Section 10(b).” Id. at *14. (internal quotation marks omitted).
Implications
Passos clarifies the SEC’s ability to bring enforcement actions related to extraterritorial transactions, buttressing the Commission’s expansive view of its reach. Whether, as a policy matter, the Trump-era SEC will continue to investigate extraterritorial transactions or will instead take a narrower approach to extraterritoriality remains to be seen. Nonetheless, non-U.S. public companies, including those listed on non-U.S. exchanges, should be cognizant of the increased risk of SEC enforcement, take steps to ensure their conduct complies with antifraud provisions of the Exchange Act, and include potential enforcement actions in their legal risk management plans. This is particularly true of companies whose executives conduct business while in the United States or who have a broad base of U.S. shareholders, either of which might, under the right circumstances, permit the SEC to pursue an enforcement action concerning conduct related to a wholly extraterritorial transaction.
[1] Passos also moved to dismiss for lack of personal jurisdiction. The Court concluded it had personal jurisdiction over Passos because he allegedly took significant steps in the United States to plant and disseminate the allegedly false story and because his alleged actions had a direct and foreseeable effect in the United States. Passos, at *5.
