Internet Securities and the Jurisdiction Reach of Securities Laws

Page 9
Denis T. Rice, July 1998

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V. Internet Securities and the Jurisdiction Reach of Securities Laws.

A. Background: Basic Jurisdictional Principles under the U.S. Constitution and under International Law.

In exploring the new jurisdictional issues posed by issuing and trading of securities on the Internet, it is useful to review briefly the principles of personal jurisdiction that antedate this new medium. Traditionally, there have been two types of personal jurisdiction under U.S. law, “general” and “specific.” General jurisdiction is of less immediate importance to Internet transactions and involves a nonresident defendant whose contacts with the forum state are unrelated to the particular dispute in issue. The criteria for application of general jurisdiction under constitutional due process limitations are very strict; such jurisdiction can apply only if the defendant’s contacts with the forum are “systematic” and “continuous” enough that the defendant might anticipate defending any type of claim there. Given the strict requirements, it is not surprising that to date no finding of general jurisdiction has been based solely on advertising on the Internet.

Specific jurisdiction applies where the defendant’s contacts with the forum state are related to the particular dispute in issues. As stated in 1945 by the U.S. Supreme Court, personal jurisdiction over a non-resident defendant by a forum state requires only that “he have certain minimum contacts with it, such that the maintenance of the suit does not offend `traditional notions of fair play and substantial justice.'” Existence of the required “minimum contacts” is determined by a three-part test: (1) the defendant must purposefully direct his activities or consummate some transaction with the forum state or a resident thereof; or perform some act by which he purposefully avails himself of the privilege of conducting activities in the forum and thereby invokes the benefits and protections of its laws; (2) the claim must be one arising out of or relating to the defendant’s forum-related activities; and (3) the exercise of jurisdiction must comport with “fair play and substantial justice,” i.e., it must be reasonable.

An example of “purposeful direction” in the context of more traditional media was found where Florida residents wrote and edited an article in the National Enquirer which defamed a California resident. The Enquirer had its largest circulation in California and was the focal point of both the story and the harm suffered. These factors led the U.S. Supreme Court to conclude that there was sufficient evidence that the defendants’ actions were “aimed at California” and would be expected to have a potentially devastating effect on the California resident, hence the defendants could have reasonably foreseen being brought into court in California.

The test of “purposefully availing” oneself of the privilege of conducting business in the forum can be met if a party reaches beyond one state to “create continuing relationships and obligations with citizens of another state.” For example, taken alone, a contract between a resident of the forum state and an out-of-state party may not establish sufficient minimum contacts to support personal jurisdiction, but added contacts such as telephone calls and mail into the forum state can collectively form a basis for jurisdiction over the nonresident.

International law similarly limits a country’s authority to exercise jurisdiction in cases that involve interests or activities of non-residents. First, there must exist “jurisdiction to prescribe.” If jurisdiction to prescribe exists, “jurisdiction to adjudicate” and, “jurisdiction to enforce” will be examined. The foregoing three types of jurisdiction are often interdependent and based on similar considerations.

“Jurisdiction to prescribe” means that the substantive laws of the forum country are applicable to the particular persons and circumstances. Simply stated, a country has jurisdiction to prescribe law with respect to: (1) conduct that, wholly or in substantial part, takes place within its territory; (2) the status of persons, or interests in things, present within its territory; (3) conduct outside its territory that has or is intended to have substantial effect within its territory; (4) the activities, interests, status, or relations of its nationals outside as well as within its territory; and (5) certain conduct outside its territory by persons who are not its nationals that is directed against the security of the country or against a limited class of other national interests.

Overarching the foregoing criteria is a general requirement of reasonableness. Thus, even when one of the foregoing bases of jurisdiction is present, a country may not exercise jurisdiction to prescribe law with respect to a person or activity having connection with another country if the exercise of jurisdiction is unreasonable. The net effect of the reasonableness standard is to require more close contact between a foreign defendant and the forum country than is required under constitutional due process.

B. Conflict Between the Internet and Jurisdictional Boundaries.

The principles of jurisdiction just discussed are made more difficult to apply to jurisdictional issues on the Internet, despite its decentralized structure. Information over the Internet passes through a network of networks, some linked to other computers or networks, some not. Not only can messages between and among computers travel along much different routes, but “packet switching” communication protocols allow individual messages to be subdivided into smaller “packets” which are then sent independently to a destination where they are automatically reassembled by the receiving computer. Since the Internet is indifferent to the actual location of computers between which information is routed, there is no necessary connection between an Internet address and a physical jurisdiction. Moreover, Web sites can be interconnected, regardless of location, by the use of hyperlinks. Information that arrives on a Web site within a given jurisdiction may flow from a linked site entirely outside that jurisdiction. Finally, notwithstanding the Internet’s complex structure, the Internet is predominately a passive system. In other words, Internet communication only occurs when it is initiated by a user.

C. Applying U.S. Constitutional Principles to Internet Jurisdiction.

Precedents from print, telephone and radio media generate analogies that can be useful in determining whether jurisdiction over Internet activities offends constitutional due process. For example, if an Internet-based news service were to send a number of messages specifically addressed to residents of a forum, there would be “purposeful direction.” Such purposeful direction can exist even though, unlike the physical shipment of substantial numbers of copies of the National Enquirer into California, from which the newspaper may be deemed to foresee an effect in that forum, nothing is shipped physically on the Internet. E-mail over the Internet is similar to traditional postal mail and to phone calls in this respect.

However, bulletin boards and Web sites are a step removed from e-mail. A person posting a bulletin board message knows that the message can be resent by others elsewhere in the world, but cannot control such redistribution. A Web site is even more of a passive medium; it sends nothing specifically directed to the forum state, but posts general information so that viewers can log on to the site. An analogy to the size of the National Enquirer’s forum state circulation might be the number of hits on the Web site that emanate from the forum state. A site operator can identify the source of “hits” on his site; an operator of a Web site would therefore know whether a large proportion of the hits came from California. If information about a California resident were posted on the site, it could be argued under the National Enquirer rationale that the operator purposefully directed the information to California residents.

It is therefore unsurprising that decisions upholding the exercise of specific jurisdiction over a nonresident defendant by reason of using the Internet have typically been based on the defendant’s purposeful availment of the privilege of doing business in the forum jurisdiction or the defendant’s purposeful direction of electronic communications to the forum jurisdiction. When an Internet communication is directed into the forum for purposes of a transaction, personal jurisdiction based on more traditional means such as mail or telephone can be invoked to determine that the defendant is electing to do business there. By the same token, if the Web site operator intends to receive communications emanating from the forum state in response to a Web posting and actually does, he avails himself of the privilege of doing business there. In one case, for example, a non-resident of California allegedly operated a scheme consisting of registering exclusive Internet domain names for his own use that contained registered trademarks. The defendant allegedly demanded fees from a California resident and other businesses that asked him to discontinue his unauthorized use of their trademarks. A federal district court held that it had personal jurisdiction over the defendant by the defendant’s having committed a tort “expressly aimed” at California. It reasoned that the defendant could foresee the harm done in California and therefore satisfied the minimum contact requirement.

In another case, the defendant registered an Internet address, which contained the plaintiff’s trademark as its own. The plaintiff then sued for violation of his trademark. A Connecticut federal court found the out-of-state defendant subject to its jurisdiction because its Internet advertising could be accessed in Connecticut. The advertising on the Internet was found to be “solicitation of a sufficient[ly] repetitive nature to satisfy” the requirements of Connecticut’s long-arm statute, which confers jurisdiction over foreign corporations on a claim arising out of any business in Connecticut. The court also held that the minimum contact test of the due process clause of the Fourteenth Amendment was satisfied, because the defendant had purposefully “availed” himself of the privilege of doing business in Connecticut in directing its advertising and phone number to the state where some 10,000 subscribers could access the Web site.

Constitutional due process allows potential defendants to structure their conduct in a way to avoid the forum state. However, to assume that a Web site operator can entirely avoid a given jurisdiction is unrealistic. Because the Web overflows all boundaries, the only way to avoid any contact whatsoever with a specific jurisdiction would be to stay off the Internet. For that reason, mere accessibility of a Web site should not properly be deemed to satisfy the Fourteenth Amendment minimum contacts requirements. Site operators should be able to structure their site use to avoid a given state’s jurisdiction. As described below, this reality has been recognized by regulators in the United States under both state blue-sky statutes and federal securities laws.

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