Second Circuit Applies Morrison To Criminal Prosecution Under Section 10(B) And Rule 10b-5

In United States v. Vilar, Case Nos. 10-521(L), 10-580(CON), 10-4639(CON), 2013 WL 4608948 (2d Cir. Aug. 30, 2013), the United States Court of Appeals for the Second Circuit held that Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, do not apply to extraterritorial conduct in both the civil and criminal context. In so holding, the Second Circuit made clear that the United States Supreme Court's ruling in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010) [blog article here], that civil liability under Section 10(b) does not apply extraterritorially, extends to criminal conduct as well. In light of that ruling, a criminal conviction for securities fraud can only be found if the defendant "engaged in fraud in connection with (1) a security listed on a U.S. exchange, or (2) a security purchased or sold in the United States." While this holding did not disturb the defendants' convictions in this case, the ruling provides guidance for future prosecutions under Section 10(b), which now require proof of a domestic sale or listing as a necessary element for conviction.

From the mid-1980s through their arrest in 2005, defendants Alberto Vilar and Gary Alan Tanaka worked as investment managers and advisors using a number of domestic and off-shore companies as vehicles for the investments that they managed. Vilar and Tanaka's troubles began after the technology bubble burst in late 2000. Over the prior decade, Vilar and Tanaka had been offering investors the opportunity to invest in "Guaranteed Fixed Rate Deposit Accounts" ("GFARDAs"), which purportedly consisted of high-quality, short-term deposits, such as U.S. Treasury bills, with no more than 25% of the accounts to be invested in emerging growth stocks. However, the GFARDAs were not, in fact, secure investments and were instead fully invested in highly volatile technology and biotechnology stocks.

After the precipitous decline in technology securities of the early 2000s, Vilar and Tanaka struggled to sustain their business. In June 2002, they approached a long-standing client, Lilly Cates, and sought to sell her on a new investment that would purportedly invest in small businesses and obtain matching funds from the federal government. However, Vilar and Tanaka had never been approved for such matching funds, and the investment did not exist. Cates...