United States: First Department Rejects Martin Act Preemption

Originally published January 18, 2011

Keywords: Martin Act, New York, blue sky law, sellers, securities

The Martin Act—New York's "blue sky" law—prohibits various fraudulent and deceitful practices in the distribution, exchange, sale and purchase of securities. Long dormant, the Martin Act was famously dusted off and put to vigorous use by former New York Attorney General (later governor) Eliot Spitzer in his campaign to "clean up" Wall Street. The Martin Act provides the New York Attorney General with powerful investigative tools and statutory remedies with respect to dishonest or deceptive activities by sellers of securities. 

According to the NY Court of Appeals, one thing the Act does not do is create a private right of action. In CPC Int'l v. McKesson Corp.,¹ New York's highest court concluded that the Martin Act did not permit individual litigants to sue for violation of that Act—only the Attorney General may do so. Enterprising defendants have used that decision to argue not only that the Martin Act did not create a private right of action, but that it had the effect of preempting certain private common-law claims arising from the conduct covered by the Act.

The majority of state and federal courts have been persuaded by this argument with respect to non-fraud claims, such as breach of fiduciary duty, negligent misrepresentation and related claims. Although this proposition has not been uniformly applied, defendants have often succeeded in having non-fraud common-law claims dismissed on the ground that they are preempted by the Martin Act. This has been especially true in the federal courts' construction of New York law. A recent decision by the Appellate Division of the Supreme Court, First Department, however, cuts against this trend.

In Assured Guaranty (UK) Ltd. v. J.P. Morgan Inv. Mgt. Inc.,² the plaintiff brought claims in state court for (among other things) breach of fiduciary duty and negligence in connection with a securities transaction. The trial court granted the defendant's motion to dismiss those claims on the ground that they were preempted by the Martin Act, citing state and federal court cases.

The Appellate Division, however, reversed. In a unanimous decision, Justice John Sweeney, Jr., wrote that "there is nothing in the plain language of the Martin Act, its legislative history or appellate level decisions in this State that supports defendant's argument that the [Martin Act] preempts otherwise validly pleaded common-law causes of action."

Looking at the statutory text, the court relied on two rules of statutory construction: "when common law gives a remedy and another remedy is provided by statute, the latter is cumulative, unless made exclusive by statute" and "clear and specific legislative intent is required to override common law." Employing these rules, the court determined that because the plain language of the Act does not explicitly preempt common-law claims, and because nothing in the legislative history suggests an intent to do so, nothing in the Martin Act preempts common law claims.

Consistent with his position in other civil cases, the Attorney General filed an amicus brief in this action urging that the Martin Act not be construed to preempt private civil remedies. In his amicus, the Attorney General argued that "the purpose or design of the Martin Act is in no way impaired by private common-law claims that exist independently of the statute, since statutory actions by the Attorney General and private common-law actions both further the same goal, namely, combating fraud and deception in securities transactions." If anything, the Attorney General continued, "the Martin Act was intended to supplement, rather than supplant existing causes of action."

Having concluded that the plaintiffs' common-law claims were neither expressly nor implicitly preempted by the Act, and that such litigation does not impair the Attorney General's ability to perform his duties under the Act, the court found that "it flies in the face of logic to preclude other valid common law causes of action in the securities area, most of which would rely on the same facts and documents for a successful fraud action."

The Appellate Division noted that previous New York cases had barred "artful" pleading, in which a plaintiff had attempted "to cast what is clearly an obligation under the Martin Act as a common-law cause of action." These cases did so because to allow such a claim "would constitute, in effect, a prohibited private action based upon the provisions of the Martin Act and are preempted by the statute." The First Department concluded, however, that "these decisions neither held nor implied that the Martin Act preempts properly pleaded common-law causes of action."

This decision is of particular interest not only because it potentially forecloses a valuable defense, but because the First Department reached a conclusion contrary to that reached by several federal courts construing New York law, including the Second Circuit Court of Appeals.³ The Appellate Division took special note of the apparent federal-state disparity: "[w]e are mindful of the fact that, in recent years, a majority of the federal courts in the Southern District of New York have held that, except for fraud, the Martin Act forecloses any private common-law causes of action." It further indicated, however, that "not all courts in the Southern District have a similar view," and specifically identified a recent Southern District decision by Judge Marrero that "meticulously traces the decisional journey" that led to the current state of the law.⁴

The Appellate Division also applied this holding in CMMF, LLC v J.P. Morgan Inv. Mgt. Inc.,⁵ decided the same day. Thus, the First Department has rejected the majority federal view.

The New York Court of Appeals has never expressly addressed this specific issue. A motion for leave to appeal in the Assured Guaranty case was filed with the First Department on December 28, 2010. That motion remains undecided as of the date of this Legal Update.

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Footnotes

1. 70 N.Y.2d 268 (1987).

2. 3053M 2455, 2010 NY Slip Op 8644 (N.Y. App. Div. 1st Dep't Nov. 23, 2010).

3. See, e.g., Castellano v. Young & Rubicam, Inc. 257 F.3d 171, 190 (2nd Cir. 2001).

4. See Anwar v. Fairfield Greenwich Ltd., 09 Civ. 0118, 2010 U.S. LEXIS 78425 (S.D.N.Y. July 29, 2010) (Marrero, J.). 

5. 2010 NY Slip Op 08628 (App. Div. 1st Dep't Nov. 23. 2010).

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