United States: Tenth Circuit Affirms Extraterritorial Reach Of SEC Enforcement Of The Federal Securities Laws

In the Traffic Monsoon litigation, the U.S. Court of Appeals for the Tenth Circuit held that the enforcement provisions of the Securities Act and the Exchange Act reach Traffic Monsoon's sales to customers outside of the United States. The implications of this decision are significant. This is the first Circuit Court decision to interpret Section 929P(b) of Dodd-Frank, and the first to adopt the position that Dodd-Frank limited Morrison's application to allow for the enforcement provisions of the 1933 and 1934 Acts to apply extraterritorially. As a result, the decision may result in future decisions by the SEC to allow for holders of common shares to be eligible for recovery in connection with fair funds, rather than limiting eligible parties to holders of shares of American Depositary Shares or Receipts (ADR's), a limitation the SEC imposed in the Fair Fund established for investors in BP. Recently, Traffic Monsoon has requested a stay of the Tenth Circuit's mandate while it prepares a writ of certiorari to the Supreme Court.

Traffic Monsoon is an internet traffic exchange business. Businesses like Traffic Monsoon allow companies to purchase "visits" to their websites in order to make their websites appear more popular on search engines such as Google. In order to utilize Traffic Monsoon's services, users had to become a member by creating an account; members could then purchase various services. Members could also purchase an "Adpack" for $50. An Adpack would allow a member to receive 1,000 visits to his website, and 20 clicks on his internet ad. Further, the purchase of an Adpack allowed the member to share in Traffic Monsoon's revenue every day, up to a maximum of $55, by clicking on a certain number of internet ads for other Traffic Monsoon customers. Traffic Monsoon facilitated the process by presenting rotating ads, on which the members could click, through the Traffic Monsoon website. This processes allowed members to complete 50 clicks in just over 4 minutes. Each day that the member completed the requisite number of clicks, he qualified to share in Traffic Monsoon's revenue earned during the preceding 24 hours. Typically, an Adpack purchaser would earn $1 in shared revenue for each day that he made the requisite number of clicks; therefore the purchaser would receive a 10% return on his initial investment in 55 days. Further, a member could purchase an indefinite number of Adpacks, and some purchased in quantities in the thousands. Regardless of how many Adpacks a member purchased, he could qualify to share in Traffic Monsoon's revenue on all of them just by spending four minutes clicking on other members' ads. In addition, Traffic Monsoon allowed members to recruit other members, and receive a 10% commission on every service purchased by the recruited member. It became apparent that, while some individuals initially purchased Adpacks as a way to promote their online businesses, many others viewed Adpacks merely as an investment opportunity. Between October 2014 and July 2016, members had paid Traffic Monsoon $173 million to purchase 3.4 million Adpacks, and had purchased approximately 14 million additional Adpacks for $700 million. Notably, 90% of the Adpacks were purchased by individuals outside the United States.

The SEC initiated a civil enforcement action on July 26, 2016, alleging that the Defendants had violated § 17(a)(1) and (a)(3) of the Securities Act of 1933 and § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5(a) and (c).The district court entered orders (1) freezing Traffic Monsoon's assets, (2) appointing a receiver over the assets and business, and (3) entering a temporary restraining order prohibiting the defendants from continuing to operate their business. Traffic Monsoon appealed the preliminary injunction and receivership arguing, among other things, that under Morrison, the antifraud provisions of the federal securities acts do not apply to offers to sell, and sales of, Adpacks to Traffic Monsoon members located outside the United States.

The majority of the Tenth Circuit panel held that Congress, in enacting Dodd-Frank, clearly abrogated Morrison, as applied to SEC actions under Section 17(a) of the Securities Act and the antifraud provisions of the Exchange Act. Specifically, Section 929P(b) of the 2010 Dodd-Frank Act amended the jurisdictional provisions of the Securities Act and the Exchange Act to state that the U.S. District Court "shall have jurisdiction" for proceedings "brought or instituted by the Commission" 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.

While Morrison rejected this so-called "conduct and effect" approach for private actions under Section 10(b) and Rule 10b-5, the Tenth Circuit majority concluded that it was "clear ... that Congress undoubtedly intended that the substantive antifraud provisions should apply extraterritorially when the statutory conduct-and-effects test is satisfied." The court emphasized that the Morrison decision came down on the very last day that a joint congressional committee was ironing out differences between the House and Senate versions of the Dodd-Frank bill, and that, given that context, it was clear that Congress had intended the conduct-and-effects test to be applied to SEC enforcement provisions. Because Traffic Monsoon engaged in conduct within the United States that was likely to have violated securities law, the court concluded that the conduct-and-effects test had been satisfied, and that, as a result, the district court had jurisdiction over the enforcement action aimed at Traffic Monsoon's sale of Adpacks outside the United States.

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Authors
Joel D. Rothman
 
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