Second Circuit Endorses Extraterritorial Limitation for Criminal Securities Fraud Prosecutions


On August 30, 2013, the United States Court of Appeals for the Second Circuit handed down its decision in United States v. Vilar, which unequivocally limits the U.S. government’s ability to use Section 10(b) of the Securities Exchange Act of 1934 in criminal prosecutions involving extraterritorial conduct. No. 10-521-CR (2d Cir. Aug. 30, 2013). In so doing, the court made clear that the Supreme Court’s territorial limitation on private securities fraud actions, originally set forth in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), also applies to criminal prosecutions. While the Dodd-Frank Act may affect the scope and impact of the Vilar decision, Vilar restricts the pursuit of criminal actions for alleged securities fraud where the purchase or sale of securities occurred outside the U.S.

The Morrison Decision

In Morrison, the Supreme Court rejected the extraterritorial application of Section 10(b) and Rule 10b-5 in a case involving only private parties. The Court put an end to the widely used "conduct" and "effects" tests, which focused on where the wrongful conduct occurred and whether it had a substantial effect on the U.S. or its citizens. Id. at 2879-81; Vilar, slip op. at 11. Instead, Morrison held that Section 10(b) reaches conduct "only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States." 130 S. Ct. at 2888. Using the so-called transactional test, the Court, in affirming dismissal of the complaint at issue, focused on the fact that the securities at issue were not listed on a U.S. exchange and "all aspects of the purchases complained of . . . occurred outside the United States." Id.

The Vilar Decision

While lower courts have applied Morrison to civil enforcement actions, such as those brought by the Securities and Exchange Commission, its applicability to criminal matters had not yet been expressly addressed. In Vilar, the Second Circuit was definitive: "(1) the presumption against extraterritoriality applies to criminal statutes, and (2) the presumption against extraterritoriality applies to Section 10(b)." Vilar, slip op. at 11-12. Through its decision, the court sent a clear message: "United States law governs domestically but does not rule the world." Id. at 12 (internal citation omitted). According to the Vilar court, the securities laws are no exception. Id. at 15.

According to the Second Circuit, the evidence presented at trial, viewed in the light most favorable to the government, showed that Alberto Vilar and Gary Alan Tanaka were investment managers and advisers for approximately twenty years. Id. at 5. In 1986, they began offering certain clients the opportunity to invest in Guaranteed Fixed Rate Deposit Accounts. Id. According to Vilar and Tanaka, most of the funds would be invested in high-quality deposits with "guaranteed" rates of return and the rest would be invested in "emerging growth" stocks. Id. at 5. Contrary to their promise, Vilar and Tanaka allegedly invested all of the capital in technology and biotechnology stocks; these investors lost millions of dollars when the dot-com bubble burst. Id. at 6. In the wake of the loss, Vilar and Tanaka allegedly offered a false investment opportunity to a long-standing client. Id. Vilar and Tanaka actually used the client’s funds for their own personal expenses, including repaying a victim of their previous investment scheme, making a mortgage payment, and donating to a charity. Id. at 6-7. The client ultimately reported Vilar and Tanaka to the SEC, which brought a civil enforcement action in 2005. See SEC v. Amerindo Inv. Advisors, Inc., No. 05-5231, 2013 WL1385013 (S.D.N.Y. filed June 1, 2005); Vilar, slip op. at 7.

The Department of Justice followed suit and charged Vilar and Tanaka with a number of crimes, including securities fraud in violation of Section 10(b) and Rule 10b-5. See Vilar, slip op. at 7. While Vilar was convicted on all counts and Tanaka only on some, both were convicted of securities fraud in 2008 and sentenced in 2010. Id. at 7-8. On appeal, Vilar and Tanaka argued—among other things—that their conduct was extraterritorial and, therefore, Section 10(b) and Rule 10b-5 did not apply. Id. at 8.

The Vilar court explained at great length that the fact that a matter is criminal, as opposed to civil, does not impact the Section 10(b) analysis from an extraterritoriality standpoint. The proper test in both contexts, the Second Circuit held, is the Morrison transactional test. The Vilar court first reiterated that unless a statute has a "clear indication of an extraterritorial application, it has none." Vilar, slip op. at 12 (internal citation omitted). It next made clear that the presumption against extraterritoriality generally applies to criminal statutes, especially statutes proscribing "crimes against private individuals or their property." Id. at 12-13 (internal citation omitted). The exception lies in instances where a statute’s underlying purpose involves the government’s right to defend itself, a circumstance the court held was not present in Vilar. Id. at 12-13. According to the court, Section 10(b) is an example of the rule rather than the exception. The Vilar court next emphasized that "a statute either applies extraterritorially or it does not," and rejected the government’s argument that Section 10(b) should be interpreted differently in criminal matters and civil matters. Id. at 16.

The Second Circuit ultimately affirmed the convictions on the basis that Vilar and Tanaka had engaged in fraud in connection with a "domestic" purchase or sale of securities. Id. at 52-53. The court explained that a transaction is domestic "when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States." Id. at 19 (citing Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 69 (2d Cir. 2012)). Key to the Second Circuit in Vilar was that—although the securities were not listed on an American exchange and the defendants engaged in various foreign conduct in connection with the alleged fraud—one set of victims signed and renewed an agreement with Vilar and Tanaka in Puerto Rico, another did so in New York, and a third executed certain documents necessary for the investment in New York as well. Id. at 19-21.

Although dealing with the same set of facts, the Second Circuit and the district judge charged with the SEC’s parallel civil enforcement differed in their analysis of the evidence against Vilar and Tanaka. Id. at 20, n. 11. The district judge, in applying Morrison, granted summary judgment to the SEC as to the New York transaction, but denied summary judgment on the securities fraud claims as to the Puerto Rico transaction because Vilar may have sent an offer letter from abroad and, under Puerto Rico law, a contract agreed to by mail might be considered to be executed at the place where the offer was made. Vilar, slip op. at 20, n. 11 (citing Amerindo, 2013 WL 1385013, at 6-8). The Second Circuit disagreed, holding that "territoriality under Morrison concerns where, physically, the purchaser or seller committed him or herself, not where, as a matter of law, a contract is said to have been executed." Vilar, slip op. at 20, n.11.

The Impact of the Dodd-Frank Act on Section 10(b) and Extraterritoriality

The Vilar court did not consider the Dodd-Frank Act in its decision. Section 929P of the Dodd-Frank Act amended the Exchange Act by adding a new section entitled "Extraterritorial Jurisdiction." This addition states that federal district courts shall have jurisdiction over actions brought by the SEC or the United States alleging a violation of the antifraud provisions of the Exchange Act 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." Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 § 929P(b)(1), Pub. L. No. 111-203, 124 Stat. 1376, 1864 (2010) (codified at 15 U.S.C. § 77v(c)). This new provision was signed into law shortly after the Supreme Court handed down the Morrison decision; the Vilar defendants’ alleged misconduct and criminal convictions predated the Dodd-Frank Act.

Questions abound as to the meaning and scope of Section 929P, which will be worked out in the courts. One recent example where the parties directly pitted Morrison against the Dodd-Frank provision is SEC. v. Chicago Convention Ctr., LLC, Case No. 13 C 982, 2013 WL 4012638 (N.D. Ill. Aug. 6, 2013). The defendants argued that, "under the ‘transactional’ test set forth in Morrison, the SEC cannot assert a claim against them because the transactions at issue here were not ‘domestic transactions’"; the SEC, on the other hand, argued that Dodd-Frank "superseded Morrison and revived the previously applied ‘conducts and effects’ test for SEC actions." Id. at 2. The district court—noting that "whether the ‘transactional’ test or the ‘conducts and effects’ test governs this suit" was "a complicated question"—concluded that it did not need to resolve it "because the SEC has stated a claim under either inquiry." Id.


Despite the frank language of the Vilar decision, much remains to be seen. The extent to which it will impact other cases and its interplay with Dodd-Frank will be especially interesting. The petitioners have indicated that they intend to continue fighting their convictions, recently filing a motion requesting an extension of time to file their petition for rehearing.1 In the meantime, the Vilar decision unquestionably circumscribes the pursuit of criminal actions under Section 10(b) and Rule 10b-5 where extraterritorial conduct is involved.

1Petitioners requested an additional month (until October 11, 2013) to file their petition for rehearing, apparently intending to argue that, among other things, the underlying indictments should have been dismissed because they did not address the "domestic transaction" element of the criminal charges. See Decl. Supp. Extension for Reh’g and Stay 3-5, Vilar, No. 10-521-CR (2d Cir. Sept. 5, 2013).