Securities Law - Does Rule 10(b)(5) Have An Extraterritorial Effect?

Respondent, National Australia Bank Ltd. (“National”), the largest bank in Australia, has its shares traded on the Australian Stock Exchange and on other foreign securities exchanges but not on any exchange in the United States. National bought the stock of HomeSide and operated it as a subsidiary. HomeSide’s business was to receipt fees for servicing mortgages. These services are a valuable asset and the more valuable it is, is a function of period in which the fees will be paid. HomeSide calculates the present value of the mortgage servicing rights by using a valuation model designed to take the likelihood of prepayment into account. In other words, if mortgages are prepaid, the service fees stop to the extent of such repayment.

From the allegations in the Complaint, it is alleged that National’s Managing Director and Chief Directing Officer plotted the benefits of National but it also alleged that they did not take into account the write-downs necessary because of prepayments.

In July 2001, National wrote down HomeSide’s assets by $450,000 million and then again on September 3, 2001 by another $1.75 billion. The shares dropped in value. These plaintiffs alleged that the executives manipulated HomeSide’s financial models to make the rates of early repayment unrealistically low in order to cause the mortgaging servicing rights to appear more valuable than they actually were. Two Australians purchased ordinary shares in 2000 and 2001 before the write-downs. They sued National and HomeSide in the United States District Court for the Southern District of New York for violations of §10(b) and §20(a) of the Securities Exchange Act of 1934, and Rule 10(b)(5). They sought to represent a class of foreign purchasers of National’s ordinary shares up to the September write-downs.
Plaintiffs, the Australians, according to the Complaint, invested based on false information. The Second Circuit held that the specific language of §30(b) does not show Congressional intent to preclude application of the Exchange Act to transactions regarding stock traded in the United States which are affected outside the United States.

The Supreme Court in an opinion by Justice Scalia stated that there is no affirmative indication in the Exchange Act that §10(b) applies extra-territorially and that “we, therefore, conclude that it does not.”

The Court further stated that it is our view that only transactions of securities listed under domestic exchanges and domestic transactions and other securities to which §10(b) applies. Thus, §10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed an American stock exchange and the purchase or sale of any such security in the United States.

Justice Stevens, with whom Justice Ginsberg joined, concurred in the judgment.

Justice Stevens stated that he took exception to the statements in the majority opinion that the decision rested on the construction of the statutory text. “I happen to agree with the result the court reaches in this case. But, ‘I respectfully dissent,’ once again from the Court’s continuing campaign to render the private cause of action under Section 10(b) toothless.

Edward X. Clinton, Sr.