For Foreign Stock Sales to Foreign Investors, a Domestic Escrow Agent Is Insufficient to Establish a Domestic Transaction Even If the Bulk of the Fraudulent Activity Occurred in the U.S.

The World in U.S. Courts: Spring 2013 - Securities | February.15.2013

Securities & Exchange Commission v. Benger (U.S. District Court, N.D. Ill., Feb. 15, 2013)

A district court in Chicago concludes that, even though the bulk of the fraudulent activity occurred in the U.S. and the escrow agents were located in the U.S., stock sales of a foreign corporation to foreign investors did not constitute domestic transactions and thus were outside the reach of Section 10(b) of the Securities Exchange Act.

Facts

The Securities and Exchange Commission (“SEC”) filed an enforcement action against defendants, alleging that they were engaged in an international “boiler room” scheme to defraud some 1,400 foreign individuals that reaped approximately $44 million through the sale of penny stocks to the foreign investors. The fraud was largely conceived of and directed in the U.S.

Defendants moved for summary judgment in connection with one stock in particular, which was never traded on a U.S. exchange and which was only purchased by non-U.S. citizens/residents. Offers to purchase the stock were set forth in stock purchase agreements (“SPAs”). The SPAs stated that the transaction was “an offshore transaction to be consummated and closed outside the U.S.” All offers to purchase were submitted to an escrow agent, which did not have authority to accept or reject an offer. Rather, all offers were subject to acceptance by the penny stock company in Brazil.

Analysis

The court held that a transaction is domestic if: (1) the purchaser incurred irrevocable liability in the U.S.; (2) the seller incurred irrevocable liability in the U.S.; or (3) the title is transferred in the U.S. The court found that, in this case, the answers to these questions were determined by the SPAs. Because the SPAs instructed investors that their offers were subject to acceptance by the penny stock corporation, which occurred in Brazil, irrevocable liability occurred outside the U.S. The fact that domestic escrow agents were an intermediary between the investors and the corporation was irrelevant because they escrow agents did not have any authority to act on the corporation’s behalf. The court also held that the title passed abroad because the escrow agents did not have authority to take possession of the certificates on behalf of the investors; rather, they were intermediaries delivering certificates to the investors on behalf of the penny stock company.

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