The extraterritorial jurisdiction of securities law originates in U.S., and U.S. also has a long and rich history in securities development and regulation. Therefore, this article studies the practice of extraterritorial jurisdiction in securities law by U.S. Federal Courts, and understands development history, and analysis of recent years of practice, with a view to providing relevant reference recommendations for the extraterritorial jurisdiction of Chinese securities laws.
Part one is an overview of extraterritorial jurisdiction in U.S. securities laws. This part first clarifies the definition of extraterritorial jurisdiction, that is, the power of a country to formulate norms for people and affairs outside its jurisdiction and to implement them through domestic judicial and administrative organs. Then, the classification of extraterritorial jurisdiction is discussed. Secondly, in order to better understand the connotation of extraterritorial jurisdiction, the two groups of related concepts of legislative jurisdiction and subject matter jurisdiction, extraterritorial jurisdiction, extraterritorial validity, and extraterritorial application are analyzed to clarify the connections and differences between concepts. Finally, this chapter also analyzes the legal basis of extraterritorial jurisdiction in U.S. securities law, and discusses it from two perspectives: the basis of international law and the basis of domestic law.
Part two is the development and evolution of extraterritorial jurisdiction in U.S. securities laws. This part focuses on a detailed analysis of typical cases and their applicable standards in the development of extraterritorial jurisdiction in U.S. The Schoenbaum case establishes effect test and sets a precedent for judging whether securities cases have jurisdiction over matters by “effects”. The Bersch case clarifies the “effects”, according to the standards of the investor’s nationality and residence, and combines whether a substantive and significant act occurs in U.S. and other situations summarizes a set of rules. The Leasco case established conduct test, “as long as a significant portion of the fraud occurred in U.S., even if it did not affect U.S., U.S. has jurisdiction.” In the Itoba case, the court did not consider it necessary to apply the two standards separately. The combination of the two can better explain whether U.S. has enough intervention factors to justify the court’s exercise of jurisdiction, thereby establishing the effect- conduct test. Until the Morrison case, the Federal Supreme Court held that the focus of securities law was not on the origin of fraud, but on securities trading in U.S., which rejected previous standards and established transactional test. The Dodd-Frank Act, which was quickly promulgated, appeared to be a subversion of the Morrison judgment, but due to its ambiguity in semantics, the academic and judicial circles debated it.
Part three is the practice of federal courts over the jurisdiction of securities law after the Dodd-Frank Act. This part searches and analyzes relevant U.S. securities cases from 2011 to 2020, and shows which standards the U.S. courts have relied on in cases involving jurisdiction outside the securities jurisdiction since the Dodd-Frank Act was enacted, and summarize the characteristics of federal courts’ practice of extraterritorial jurisdiction over securities law. In terms of applicable standards, the Federal Court favors the transactional test established by the Supreme Court in the Morrison case; in terms of the types of plaintiffs, the litigation cases filed by the SEC account for almost half of the cases studied, and the court’s always support the claims of SEC. According to the year of the case, although the transactional test are generally applicable, the relevant cases are basically judged three years after the establishment of the transactional test. In recent years, cases where the effect-conduct test has been applied have begun to appear.
Part four is the inspiration to China of U.S. federal court’s practice of extraterritorial jurisdiction of securities law. This part analyzes the inspiration to China from three aspects. The first is the response to extraterritorial jurisdiction of U.S. securities law. For the response of federal court jurisdiction, investors must pay attention to the relief of U.S. domestic law and grasp the effect-conduct test and transactional test. For the enforcement jurisdiction of SEC, Chinese courts can take a non-cooperative approach and, if necessary, legislative organs can implement counteract legislation. Secondly, in terms of extraterritorial jurisdiction over Chinese securities laws, based on the differences in litigation systems between China and U.S., it is not possible to simply imitate its extraterritorial jurisdiction model in securities laws. At the same time, extraterritorial jurisdiction may affect the sovereignty of other countries, so it needs to be treated with caution. Finally, when Chinese courts deal with cross-border securities litigation cases, they must strictly implement the jurisdiction of the case in accordance with existing laws, and be alert to inappropriate expansion of jurisdiction; at the same time, when dealing with related cases, they must pay attention to relevant decisions or rules made by the China Securities Regulatory Commission.
To reduce fraud, the Sarbanes-Oxley Act of 2002 requires audits of every U.S.-traded firm to be inspected by the Public Company Accounting Oversight Board. But U.S.-traded firms based in China, whose market capitalizations collectively exceed $1 trillion, refuse to comply. They and Beijing say PCAOB inspection of China-based audit records would violate state-secrecy laws.
In May 2020, the Senate unanimously passed a bill—the Holding Foreign Companies Accountable Act—requiring the Securities and Exchange Commission (SEC) to ban trading in the shares of any firm whose audits go three consecutive years without PCAOB inspection. In August 2020, a task force set up by President Trump recommended that the SEC put in place similar rules.
These efforts are motivated by outrage over U.S.-listed China-based firms not playing by the same rules as well as other firms, as well as the relatively high frequency of fraud at these firms. The apparent goal is to force China to agree to inspections, which would make it harder for insiders of China-based firms to defraud American investors. And if China does not agree, future American investors in these companies cannot be defrauded—because the trading ban and subsequent delisting will ensure there are no such investors.
But would U.S. investors be safe if China does agree to allow inspections? Hardly. Even if the quality of audits improves, that by itself does not prevent China-based insiders of China- based firms plundering their firms; they will still be “law-proof” – legally unreachable by those attempting to enforce corporate and securities claims against them. The main problem is that almost every person or thing required to enforce the law—the insiders, the insiders’ assets, the firms’ records, and the firms’ assets—is behind China’s “Great Legal Wall” and out of reach both for private plaintiffs and for public prosecutors in the United States. China cannot be expected to extradite defendants, enforce foreign judgments, allow foreigners’ claims to be filed in its courts, or even permit litigation-critical information to be shared with foreign authorities or plaintiffs’ lawyers. Thus, China-based insiders cannot easily be deterred from expropriating large amounts of value.
The unparalleled economic growth of the People’s Republic of China has resulted in a paradigm shift in its legal regime. Once a closed market to the world, China now faces an unprecedented surge in international business and inflow of global capital into its domestic market as a result of its immense economic growth in the past 40 years. Consequently, the internationalization of businesses in China has given rise to the need for the domestic courts to update their private international law practices such as allowing, to a greater extent, foreign judgments to be recognized and enforced in domestic courts. Such is a clear indicator of globalization and the rapid development of China’s economy.
An important step China has taken in the past few years is to improve efficiency in recognizing and enforcing foreign judgments. Specifically, the salient shift to a more liberal application of the reciprocity principle, the signing of the 2005 Hague Choice of Court Convention (2005 Hague Convention) and the growing number of bilateral treaties on judicial assistance are clear indicators of China’s recent willingness to provide greater commercial certainty for the parties involved, to promote fairness for both domestic and foreign litigants, and to ensure the global circulation of judgments. All these measures have contributed to greater investor confidence and further economic growth in China.
In this presentation, the current theory and practice with respect to the recognition and enforcement of foreign civil and commercial judgments in China will be analyzed. There are two aspects that will be discussed: first, the various legal regimes under which Chinese courts recognize and enforce foreign judgments, including the existing Sino-bilateral judicial assistance treaties on civil and commercial matters, the principle of ‘reciprocity’ in the absence of a bilateral treaty, the potential impact of the 2005 Hague Convention signed by the Chinese government in September 2017, etc. Second, a survey of cases decided by Chinese courts which reveals, empirically, that considerable progress has been made in promoting wider recognition and enforcement of foreign judgments in China.
With the intensifying economic and social dynamics between Hong Kong and Mainland China since the handover in 1997, a comprehensive and effective cross-border judgment recognition and enforcement mechanism is imperative in order for Hong Kong to reinforce its role as a dispute resolution center in the perspective of judgments, in the context of the Belt and Road Initiative, and in the Greater Bay Area. This Article examines in detail the achievements and inadequacies in the current Hong Kong statutory and common law regimes, particularly the Mainland Judgment (Reciprocal Enforcement) Ordinance (Cap. 597) (“MJO”), and reveals their tensions and inconsistencies with Mainland regimes and the 2005 Hague Convention on Choice of Court Agreements. Then, the Article provides an exhaustive statistical analysis on cases involving the MJO and explains the evolution to a more pro-enforcement judicial approach towards Mainland judgments in Hong Kong recently. It concludes by looking at the breakthroughs and outstanding issues of the new 2019 Arrangement between Hong Kong and the Mainland, as well as the prospects of Hong Kong in acceding to the 2005 and 2019 Hague Conventions and developing an interregional judgment recognition and enforcement framework.
The newly amended Securities Law came into effect in March 2020, and the authority was introduced for Chinese regulators to cover the defined extraterritorial securities activities. In order to flesh it out in a proper way, experiences and lessons might well be drawn from the overseas practices. Amongst the others, the Morrison case decided by the U.S. Supreme Court in 2010 favored the transaction test instead of the plausible conduct test and effects test when interpreting the scope of Securities Exchange Act§10(b). In the years followed, Morrison has been largely followed and revisited also by the Dodd-Frank Act, notwithstanding controversies. How to balance and enhance the public enforcement and the private adjudication, remains as a key issue for both countries, as demonstrated by the recent cases like Luckin Coffee. Strengthening the international securities regulatory cooperation, including carrying out joint inspections over the auditor’s working papers, will ease up the possible tension.
Two audit issues highly relevant to China underscore the need for international cooperation—a dispute over access to audit work papers currently playing out between U.S. and Chinese regulators, and under-development of an emerging field of auditing: social compliance audits.
Financial Audits: For years, the U.S. government has complained about lack of access to audit work papers of Chinese companies listed on U.S. securities markets. Accounting firms that sign audit reports for companies listed on U.S. securities markets must register with the Public Company Accounting Oversight Board (PCAOB) and subject themselves to PCAOB inspections to ensure compliance with U.S. laws. However, the PCAOB claims that China has prevented it from completing inspections of PCAOB-registered accounting firms located in mainland China and Hong Kong. Jointly, these uninspected accounting firms signed audit reports for 202 public companies with a combined market capitalization of $1.8 trillion.[Note 1] These accounting firms also perform audit work in China and Hong Kong for hundreds of well-known U.S. multinational companies (e.g., Walmart and Sotheby’s) on behalf of affiliated U.S. accounting firms.[Note 2] In the absence of progress on the dispute over inspections, the U.S. is threatening to delist Chinese firms that refuse to comply with its domestic audit requirements.
Social Compliance Audits: Meaningful public disclosures on “environmental, social and governance” (ESG) issues depend upon third-party verification of compliance with domestic laws and international standards. But this emerging field has been described by one prominent practitioner as the “Wild West”—characterized by a lack of universally accepted benchmarks, uneven quality of auditors, and audit assurance letters of questionable value to stakeholders. Although auditors face difficulty auditing many types of ESG disclosures, we highlight one prominent area that could benefit from greater international regulatory cooperation: supply chain audits. At present, supply chain auditors may face physical hazards in carrying out their work and/or lack access to facilities or employees necessary to complete their inspections.
Our presentation will explore the need for greater international regulatory cooperation in these two fields of auditing—one longstanding and prominent; the other, novel and poorly understood.
Notes:
[1] These figures are determined using the eighteen-month period ended on June 30, 2020. PCAOB, China-Related Access Challenges. Available at https://pcaobus.org/International/Pages/China-Related-Access-Challenges.aspx
[2] Id. Please find a list of all U.S. issuers that rely on Chinese or Hong Kong-based accounting firms for a portion of their audit here: https://pcaobus.org/International/Pages/China-Referred-Work.aspx
In contrast to other countries, the United States regulates insider trading as a construct derived from the law of fraud. That separates into distinct inquiries into marketplace disclosure, misappropriation, and a unique administrative prohibition related solely to tender offer-related information. In turn both courts and Congress have addressed extraterritorial jurisdiction, which interacts in puzzling ways with these distinctive theories of insider trading. My talk will address the extraterritorial scope of U.S. insider trading enforcement and some of the challenges posed by its common law style of development.
The U.S. Supreme Court’s decision in Morrison v. National Australia Bank Ltd. (561 U.S. 247 (2010)) signaled a sea change in the extraterritorial application of Rule 10b-5 issued under the Securities Exchange Act of 1934, and a bright line-oriented rejection of the prior and far more uncertain tests justifying extraterritorial application of Rule 10b-5, the “conduct” and “effects” tests. This presentation will touch on the impact and continuing implications of the Morrison opinion for U.S. securities law over the decade after it was issued, but focus on the lessons the United States’ uncertain course has for the PRC’s own proposed extraterritorial (including in the Hong Kong SAR) application and enforcement of Chinese securities law norms designed to combat fraud and market manipulation in the still-globalized securities markets.
This presentation will try to digest the causes and potential consequences of the current deadlock in cross-border coordination between the US and Chinese securities regulators on combating serious disclosure breaches and accounting frauds by Chinese companies listed in the US markets. Particularly, difficulties arising from investigating, as well as punishing, the misbehavior in disclosure and corporate governance practices of the so-called “China-Dimension Stocks,” with their essential and identifying business characteristics closely associated with mainland China except for incorporating places, will be highlighted to reveal the paradox of the extraterritorial exercise of enforcement powers by US regulators.
I will argue that the attempts at applying “long-arm” enforcement jurisdiction in mainland China over US-listed Chinese companies and their senior management faced with accusations of securities fraud would still encounter practical difficulties which would compromise their expected goals, even if the two sides would have signed a new MOU to wider the on-site access of the US regulators to the original operating and accounting documents of those Chinese issuers and their auditors. The main factors impacting, or curtailing, the exercise of the extraterritorial jurisdiction of the US regulators, namely the Securities Exchange Commission (SEC) and the Public Companies Accounting Oversight Board (PCAOB), over Chinese companies and their auditors and senior management not only point to the hesitation of the Chinese government in recognizing and assisting with domestic enforcement of overseas regulatory authorities, but also concern the current ownership and industrial structures of US-listed Chinese companies as well as of their business partners and clients.
Lastly, I would add that excluding the impact of the dramatic turns in US-China relations of recent times which had displayed trends of politicization in US securities regulation targeting Chinese companies, highlighted by the passing of the Holding Foreign Companies Accountable Act, the key factors mentioned above which had constrained further progress in cross-border coordination between China and the US, would sustain for extended periods of time for the foreseeable future. Looking forward, dramatic prospects of either a landscape, wholesale-type, retreat of Chinese issuers from the US markets (including options of delisting), or a reshape of China’s domestic regulatory framework for overseas listing of Chinese companies which would distinguish among issuers on the basis of ownership structures and industrial affiliations, may arise in the horizon.
Sino-US cooperation in audit supervision has been a hot topic in recent years. Even with the memorandum of law enforcement cooperation between the CSRC/MOF and the PCAOB on May 7, 2013, Chinese authorities repeatedly rejected PCAOB’s requests for inspection or auditors’ working papers of Chinese-concept Companies (CCCs), on the basis that those working papers concerning state secrets. While the importance of information disclosure and transparency to the capital market and investor protection cannot be exaggerated; the Chinese side has reasons to worry about the national security. The issue is more realistic nowadays than before when many new listing companies base their business model on big data. Moreover, in recent years, the US sanctions against Chinese enterprises have been increasingly intensified, and people feel afraid that the audit working papers may provide information of certain clients who fall into the US sanctions list, thus implicating Chinese enterprises with which they do business. The author is to propose solving the dilemma by (1) delisting those CCCs in sensitive fields; (2) a routine coordination mechanism among the CSRC, the MoF and the State Security Bureau for the state secret related supervision of overseas listed CCCs, allowing the hand-over to foreign regulatory authorities of audit working paper not involving state secrets; (3) strengthened investigation and punishment on financial forgery of CCCs by Chinese authorities; and (4) a joint inspection mechanism between regulatory authorities of China and US.
Extraterritorial jurisdiction Under the PRC Securities Law is based on the “effects test”, and is supposed to protect both the “domestic market order” and the “legitimate rights and interests of domestic investors”. As to explanation, the effects in the related clause should be limited to “direct” effects in the private law suits, but in government enforcement actions, the effects should include both “direct” and “indirect” effects. The domestic investors should be explained to cover the professional institutional investors as well as the retail investors.
The financial fraud scandal at China’s largest domestic coffee chain, Nasdaq-listed Luckin Coffee, a “foreign” company which is domiciled in the Cayman Islands, has raised questions over whether the extraterritorial jurisdiction clause under the Securities Law can be applied, the paper argues the clause cannot be applied to Luckin Coffee in this case. Securities fraud cases alike, with trading of the securities offered by non-China firms and listed on abroad stock exchanges, may not be good cases to activate the securities law exterritorial application either.
Traditional theories suggest that cross-border securities offering and trading demand international cooperation in respect of standard setting and law enforcement. This presentation argues that cross-border securities activities may also lead to a market-opening model that relies on domestic law enforcement rather than international cooperation. Specifically, this presentation will argue that three distinct features of China’s market-opening model, namely, segregated domestic markets, fragmented regulatory authority and uncoordinated multi-ministry enforcement will likely cause China to heavily rely on a domestic law enforcement model rather than international cooperation when handling cross-border securities misconduct such as inaccurate or misleading information disclosure. This presentation also argues that China’s recent move from market segregation to market unification, from regulatory fragmentation to regulatory consolidation and from ministry incoordination to ministry coordination will not fundamentally change this domestic law enforcement model.
Comity has been perceived as the basis of the enforcement of foreign judgment since the US Supreme Court’s decision in Hilton v. Guyot back in 1895. The assumption has been that countries should make effort to allow more foreign judgments to be given effects locally in the name of comity. With the new Hague Judgments Convention concluded in 2019, conflict scholars around the world are positive of the prospect of worldwide mutual enforcement of judgments. However, this comity view of enforcement of foreign judgment may be too simple and fails to take into account of the self-serving national interest underlying the rules of enforcement of judgment in every country.
The reality is that enforcement of foreign judgment is driven by national interest. It has been the case at the time in Hilton v. Guyot when the US Supreme Court actually rejected the enforcement of French judgment due to the lack of reciprocity, and will continue to be the case after the conclusion of the Hague Judgments Convention. The US-China trade war offers the best testing ground for this national interest view when there are intense conflicts in national interests between the countries.
With a significant part of the economy being controlled by state-owned enterprises, China has arguably more interests in seeing US judgments not enforced against its companies in China. As an exporting economy, it is more likely for China’s companies to get sued in the United States than the other way round, resulting in more US judgments against Chinese companies than Chinese judgments against US companies. US judgments are also generally more sizeable due to US procedural rules such as jury trial and class action. Accordingly, an enforcement treaty that ensures mutual enforcement does not appear to be equal.
Through the review of recent enforcement cases in both the United States and China, it is argued that the enforcement practices between the countries will continue to be inconsistent, particularly on the part of enforcement of US judgments in China, given the national interest at stake. Taking a realist approach, it is further argued that the more protectionist position could be justified.
This study examines the public enforcement (PE) of securities law in China. We exploit the external positive shock to enforcement intensity due to the reform decentralizing the authority to impose administrative sanctions (AS) and show that shares in the pilot project experience statistically significant, but economically insignificant, abnormal returns (AR). Furthermore, we examine the market reactions to PE actions against informational misconduct and find that shares receiving AS suffer an average AR of approximately -12.03 % over the (-1,5) event window, whereas those receiving non-AS experience economically insignificant AR. Next, we investigate the impacts of PE actions on the external debt financing, and show a significant decrease in external debt financing associated with firms receiving AS compared to those receiving non-AS. Finally, for the subsample of shares sanctioned by ROs, we find that firm size significantly reduces the likelihood of receiving AS, but neither governmental ownership nor political participation appears to have an effect.