The jurisdiction of U.S. economic sanctions is far greater than many financial institutions realize. After 2008, the Dodd-Frank Act gave the Securities and exchange Commission broad authority to combat fraud and corruption in the financial markets. Over the next several years, the federal agency concluded dozens of investigations and levied billions in fines using that new power. Those inquiries and penalties weren’t limited to U.S. based firms—they extended to EU firms as well.
For years, U.S. courts had tempered the extraterritorial reach of U.S. securities law until Dodd-Frank undid all of that. With a stroke of the pen, the SEC attained jurisdiction over "conduct occurring outside the United States that has a foreseeable substantial effect within the United States." Since that time, the SEC has shown an ever-increasing willingness to pursue insider trading enforcement actions with substantial international dimensions. In the words of former SEC Enforcement Chief Robert Khuzami, “offshore trading is not off-limits to U.S. law enforcement.”
U.S. regulators’ reach into EMEA firm. It turns out these words weren’t "all bark and no bite." For example, SEC v. Tiger Asia Management et al., involved a firm which was trading Chinese bank stocks executed on the Hong Kong Stock Exchange (HKSE). Tiger Asia allegedly submitted losing trades in securities of Chinese bank stocks on the HKSE, in order to manipulate the price, which artificially inflated the management fees. The SEC claimed it had jurisdiction since the sole principal of the firm resided in New Jersey, and placed and received telephone calls (related to the charges) from his residence. The HK Firm ultimately agreed to pay a combined $60 million in disgorgement and penalties, including $44 million to settle the SEC’s civil action and $16 million forfeited in connection with the criminal action.
A few months later the SEC filed another case, this time with the improbable name of SEC v. Certain Unknown Traders in the Securities of H.J. Heinz Company. Acting without knowledge of any material link to conduct within the United States, and without knowing the identities or nationalities of the traders involved, the SEC was able to affect an account freeze in Switzerland.
“For companies to make money, they need to trade through the U.S. financial system. It is therefore a matter of global economic power. In addition, a key to understanding what makes the U.S. so influential is the use of dollars. The dollar is the main world currency and is dominant economically.”
Matteo Winkler, Professor of Law, HEC Paris
These may sound like extreme examples, but they are by no means outliers. More importantly, they illustrate a disturbing trend: As the securities environment becomes increasingly intertwined, and cross border trading becomes far more common, the SEC (and by extension the United States) may have designed a playbook for foreign regulators of competent jurisdictions to impose their will within the U.S. markets.
MiFID II turns the table. In years past, the U.S. was shielded from such an unthinkable outcome. Matteo Winkler, professor of law at HEC Paris stated, “For companies to make money, they need to trade through the U.S. financial system. It is therefore a matter of global economic power. In addition, a key to understanding what makes the U.S. so influential is the use of dollars. The dollar is the main world currency and is dominant economically.”
Having oversight for the security and stability of the largest financial system in the world, U.S. regulatory entities can certainly justify extreme measures. As a result, some financial institutions in EMEA and APAC were forced to avoid trades and business decisions that ran afoul of DFA. But now, the European Union is borrowing a page from the U.S. playbook.
Today, Markets in Financial Instruments Directive, better known as MiFID II, has everyone’s attention in much the same way that Dodd-Frank did back in 2010. Slated to take effect on January 3, 2018, this sweeping EU regulation will redraw the rules for trading stocks, bonds, derivatives, and commodities within the European Union. It has been reported as a bold new law that will reshape Europe’s capital markets, the magnitude of which cannot be underestimated. Although enforcement questions remain, a lot of guidance has been published and stern warnings issued for market participants not in compliance. Firms within the European Union continue to prepare for the January 3 implementation date at a feverish pace, with many fearing they will not be ready in time.
Still, firms in the United States are by and large ignoring MiFID II altogether. If your firm is one of those taking a wait-and-see attitude, consider the following.
Come January, the European Union will have a regulation that is as large, complex, and as far reaching as Dodd-Frank. ESMA, the independent EU authority, has the capacity to issue guidance that competent authorities of member states have the ability to conduct investigations outside the European Union. Taking a page from the U.S. playbook, ESMA could conceivably require any firms with substantial ties to the EU markets to comply with MiFID II.
Using the collective size of the EU markets, the European Commission has all the leverage needed to force compliance. The adjusted GDP of the 28 EU member nations is larger than both China and the US. In an interview, Joseph P. Quinlan, chief market strategist for U.S. Trust stated “in nominal U.S. dollar terms, the European Union (plus Norway, Switzerland, Iceland) accounted for 25.4 percent of world output in 2014 according to data from the International Monetary Fund.” Should the European Union decide to pursue this course of action, how many firms would be willing to endanger access to the largest collective economy in the world? Furthermore, diplomatically the United States would find itself hard pressed to defend actions that they themselves developed.
Time for action is now. In sum, the issue of MiFID II’s applicability to U.S. firms is far from settled. Should the European Union decide that MiFID II non-compliance by U.S. firms represents a systemic danger to EU markets, it’s not so farfetched to think they wouldn’t borrow a page from the very same extraterritorial playbook the U.S. created for the Dodd-Frank Act.
The expansion of the scope under MiFID II will make it far likelier for market participants to be caught within EU regulators’ crosshairs without even realizing it. Even if legal ramifications may seem defensible, the mere prospect of an ESMA investigation could cause internationally active firms to incur significant legal costs and corresponding reputational damage. If that does not provide a strong enough spur to comply with MiFID II, and fast, then nothing will.
David T. Ackerman holds the position of SME, Communications Compliance Line of Business for Hoboken-based NICE.