January 30, 2015

Third Circuit Clarifies Extraterritorial Reach of Federal Securities Laws

By William L. Carr and Garrett D. Trego

The Third Circuit recently clarified the extraterritorial limits of the federal securities laws, as the U.S. Supreme Court defined in Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010). See United States v. Georgiou, Nos. 10-4774, 11-4587, 12-2077, __ F.3d __, 2015 WL 241438 (3d Cir. Jan. 20, 2015). George Georgiou and his co-conspirators made zero-sum trades between brokerage accounts in Canada, the Bahamas, and Turks and Caicos to artificially inflate the value of four “target stocks” that were available for trade in the U.S. through two interdealer quotation systems, the OTC Bulletin Board (“OTCBB”) and the Pink Sheets. Id. at *1. Georgiou used the fraudulently inflated value of his ownership interest in the target stocks as collateral to obtain loans that he would never repay, ultimately costing his creditors and the other stockholders of the target stocks millions of dollars. Id. On appeal, Georgiou argued that his convictions could not stand because they were based on the extraterritorial application of the federal securities laws. Id.

In Morrison, the Supreme Court limited Rule 10(b)’s application to two types of transactions: “(1) transactions involving ‘the purchase or sale of a security listed on an American stock exchange,’ and (2) transactions involving ‘the purchase or sale of any other security in the United States.’” Georgiou, 2015 WL 241438, at *4 (quoting Morrison, 561 U.S. at 273). The Third Circuit determined that Georgiou’s transactions were not of the first type, even though some of the purchases were executed by market makers operating within the United States, because the SEC does not consider the OTCBB and the Pink Sheets to be securities exchanges. Id. at *4–5.

The Third Circuit held, however, that Georgiou’s transactions were of the second type because they involved “the purchase or sale of any other security in the United States.” Id. at *4. Whether a transaction is domestic, the court observed, does not depend on “‘the place where the deception originated, but [the place where] purchases and sales of securities’ occurred.” Id. at *5 (quoting Morrison, 561 U.S. at 266). A purchase or sale of securities occurs “when the parties incur irrevocable liability to carry out the transaction,” such as “the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.” Id. at *5–6 (citations omitted) (internal quotation marks omitted). The Third Circuit held that at least one transaction in each of the target stocks involved the purchase or sale of a security in the United States because “all of the manipulative trades were ‘facilitate[d]’ by U.S.-based market makers, i.e., an American market maker bought the stock from the seller and sold it to the buyer.” Id. at *6. Accordingly, the court affirmed Georgiou’s conviction under Section 10(b).

The take away: would-be fraudsters who think they can escape federal securities laws by setting up shop outside the U.S. to manipulate domestic securities should think again.

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