At the end of 2011, the New York Court of Appeals handed down Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, Inc., an important decision that could have a broad impact on securities litigation in New York state and federal courts.1 The case presented New York's highest court with an opportunity to resolve a significant and unsettled issue in New York securities law—whether the Martin Act, New York's securities statute, preempts private common-law tort claims arising from securities transactions. On December 20, 2011, the Court of Appeals held that the Martin Act does not preempt common-law claims, contrary to numerous federal and state court decisions that had held such claims were precluded.
The Martin Act
The Martin Act (the "Act") is New York's
"blue sky" law, so called because these laws were
designed to stop schemes involving fraudulent securities
"which have no more basis than so many feet of 'blue
sky.'"2 The Act prohibits "[a]ny fraud,
deception, concealment, suppression, false pretense or fictitious
or pretended purchase or sale" in "the issuance,
distribution, exchange, sale, negotiation or purchase ... of any
securities or commodities."3 In 1960, the Act was
amended to also cover fraudulent practices in the offering of
condominiums and cooperatives.4
Widely considered the most severe blue sky law in the country, the
Martin Act grants the New York Attorney General extraordinarily
broad power to investigate and prosecute suspected violators of its
antifraud provisions. The Act, for instance, contains no scienter
requirement. The Attorney General need not prove a defendant's
intent to defraud or deceive to recover civil damages. The Act was
used to great effect by former New York Attorney General Eliot
Spitzer in a series of lawsuits against banks and investment firms.
New York Governor Andrew Cuomo continued to use the Martin Act
against financial institutions during his tenure as New York
Attorney General.
Private Securities Claims and the Martin Act
The Martin Act does not expressly provide a private right of action for claims that fall within the Attorney General's enforcement authority. Some courts initially allowed private litigants to bring claims pursuant to the Act.5 That practice stopped when the New York Court of Appeals held, in CPC International Inc. v. McKesson Corp.,6 that only the Attorney General can bring an action under the Act, because "an implied private action is not consistent with the legislative scheme underlying the ... Act." The CPC decision set the Martin Act apart from other states' blue sky laws, the majority of which had been held to provide an implied private right of action.7 While dealing with private actions under the Martin Act itself, the CPC decision left open the question of the extent to which the Martin Act, under the doctrine of preemption, precluded common law claims asserted in New York securities cases.
Martin Act Preemption
Following CPC, many state and federal courts in New
York held that the Martin Act preempts private common law claims
based on facts that would also allow the New York Attorney General
to bring an action under the Act. An exception was made for common
law fraud, which requires proof of deceitful intent, an additional
element not required by the Act.
For example, a line of condominium and cooperative cases in New
York state court found that common law negligence, breach of
fiduciary duty, and constructive fraud claims were preempted by the
Martin Act, because allowing the claims "would effectively
permit a private action under the ... Act, which would be
inconsistent with the Attorney-General's exclusive enforcement
powers thereunder."8
In Independent Order of Foresters v. Donaldson, Lufkin &
Jenrett, the Southern District of New York applied these real
estate cases to the securities context, holding that "[a]ny
claim that is covered by the Martin Act is ... not actionable by a
private party," and dismissed common law claims for negligence
and breach of fiduciary duty.9 The Second Circuit
reached a similar result in Castellano v. Young & Rubicam
Inc.,10 relying on the New York state court real
estate cases to dismiss a common law breach of fiduciary duty
claim. Although the courts were not uniform on the issue, the
majority of federal courts within the Second Circuit have followed
Foresters and Castellano in finding Martin Act
preemption of nonfraud tort claims.11
Until this past December, the New York Court of Appeals had not
directly addressed the issue. The closest it came was in Kerusa
Co. LLC v. W10Z/515 Real Estate LP,12 where the
court dismissed a common law fraud claim involving a condo
development because it was based entirely on disclosure
requirements imposed solely by the Martin Act. The Kerusa
court held that, on those facts, a common law fraud claim based on
a defendant's failure to comply with the Martin Act cannot be
meaningfully distinguished from a private right of action under the
Act.13 However, the Court of Appeals did not address the
question of whether plaintiffs could bring a common law cause of
action that was premised on facts that would support a valid Martin
Act claim by the Attorney General, but whose elements were not
based on the particular requirements of the Act itself. Certain
decisions by the New York Appellate Division, New York's
intermediate appellate court, had rejected arguments for such broad
preemption, finding that private common law claims "may rest
upon the same facts that would support a Martin Act violation ...
as long as they are sufficient to satisfy traditional rules of
pleading and proof."14
Assured Guaranty
In Assured Guaranty, the plaintiff brought negligence
and breach of fiduciary duty claims against an investment manager
for investing funds in mortgage-backed securities. The trial court
dismissed the claims, finding that they were preempted by the
Martin Act. The Appellate Division, First Department, reversed.
Construing Kerusa narrowly, the Appellate Division held
that a private common law claim is not preempted by the Act unless
it also "cast[s] what is clearly an obligation under the ...
Act as a common-law cause of action."15 The court
was persuaded by the New York Attorney General's amicus brief,
which asserted that "there is nothing in the act or its
legislative history, despite a number of amendments, that indicates
any intention [by] the Legislature to replace common-law causes of
action," and that allowing common law claims furthers the
purpose of the Act, which is to combat fraud in securities
transactions.16 The court also cited as persuasive
Anwar v. Fairfield, a decision by Southern District of New
York Judge Marrero, which criticized the Foresters and
Castellano decisions for reading the early state court
real estate cases too broadly.17
The Appellate Division applied the same reasoning in CMMF, LLC
v. J.P. Morgan Investment Management Inc.,18
decided the same day as Assured Guaranty. In
CMMF, the trial court declined to find common law
negligence and breach of fiduciary duty claims preempted by the
Martin Act, and the Appellate Division affirmed, voicing its
opposition to the majority federal court view. These cases appeared
to settle the issue, at least in the New York state courts. Even
after the Appellate Division's decision in Assured
Guaranty was handed down, however, the dissonance continued in
the federal courts. In one case, another judge in the Southern
District found that common law claims were still preempted by the
Martin Act.19 In doing so, the court followed
Castellano without addressing the comprehensive analysis
of this issue in Anwar, and noted that the Appellate
Division's decision in Assured Guaranty was not the
"last word" on the subject because the New York Court of
Appeals had not addressed the issue.20
Meanwhile, the bank defendant moved for leave to further appeal the
First Department's decision in Assured Guaranty to the
New York Court of Appeals, noting this conflict among the state and
federal courts on Martin Act preemption, and the Court of
Appeals' failure to address the issue directly. The Appellate
Division granted the bank defendant leave to further appeal,
setting the preemption question up for decision by New York's
highest court.
The Court of Appeals' Opinion
In a unanimous opinion, the Court of Appeals rejected the
argument that the Martin Act preempts nonfraud common-law claims.
Relying on CPC and Kerusa, as well as the
court's prior cases on common law preemption, the court held
that, as a general rule, the Martin Act does not preclude a private
litigant from bringing a nonfraud common-law cause of action. The
court stated that, read together, CPC and Kerusa
stand only for the proposition that a private litigant may not
pursue a common-law cause of action where the claim is based on a
violation of the Martin Act itself and would not exist but for the
statute. Hence, the court held, there is no "preemption"
based merely on the fact that the common-law claim brought by a
private litigant could also be styled as a Martin Act claim. As the
court put it, "mere overlap between the common law and the
Martin Act is not enough to extinguish common-law
remedies."21
The Court of Appeals stated that its conclusion was supported by
the plain text of the Act, as well as the legislative intent,
legislative history, and policy considerations underlying the Act.
The court agreed with the New York Attorney General's position
that the purpose of the Martin Act is not impaired by private
common-law actions that have a legal basis independent of the
statute, because "proceedings by the Attorney General and
private actions further the same goal—combating fraud and
deception in securities transactions."22
The court cited approvingly to Southern District of New York Judge
Marrero's opinion in Anwar when discussing the
legislative intent and policy considerations underlying its
interpretation of the Martin Act. The court stated that a finding
that the Martin Act precludes properly pleaded common-law actions
would leave the marketplace "less protected than it was before
the Martin Act's passage, which can hardly have been the goal
of its drafters."23 For these reasons, the court
concluded that the plaintiff's common-law claims of breach of
fiduciary duty and gross negligence were not barred by the Martin
Act and should be permitted to go forward.
The Implications of Assured Guaranty for Securities Litigation in New York
The impact of this opinion on securities litigation in New York,
in both the state and federal courts, is significant. Some
commentators have already predicted that Assured Guaranty
will result in a substantial increase in consumer fraud suits, as
well as suits for negligence and breach of fiduciary duty, in
connection with the purchase and sale of securities.24
It remains to be seen whether a greater number of suits will be
filed, but at the very least, more actions are likely to survive
motions to dismiss. Assured Guaranty opens the door for
private litigants asserting federal securities law claims to plead
state common-law claims that might previously have been considered
preempted by the Martin Act.
While presenting a new opportunity for plaintiffs in securities
litigation, Assured Guaranty ushers in new burdens for
defendants. The decision will require financial institutions
jurisdictionally connected to New York and their counsel to become
more aware of New York common-law theories of recovery. To be sure,
although Martin Act preemption is no longer one of them, viable
defenses to such claims remain, which can be asserted in a motion
to dismiss. For example, a plaintiff asserting a negligent
misrepresentation claim must under New York law plead a special or
privity-like relationship with the defendant. But Assured
Guaranty eliminates a preemption defense to common-law claims
that had given significant protection to defendants in the New York
federal courts.
As noted in an amicus brief from the Securities Industry
and Financial Markets Association, the overall effect of the New
York Court of Appeals' decision may be to impose substantial
new regulatory burdens, resulting in "higher costs, reduced
returns, and narrower investment choices for
investors."25 Moreover, some legislators have
interpreted this decision as a signal to the New York legislature
that the Martin Act should itself be expanded to permit a private
right of action.26 In fact, one bill authorizing such a
right has already been introduced in the State
Assembly.27
New York remains a hub for the securities industry, and investment
decisions worth billions of dollars are frequently governed by
transactions and contracts controlled by New York law. For decades,
securities professionals have had the comfort that these
transactions and contracts would not be second guessed by common
law negligence claims or other common-law claims should a wise
investment perform poorly through no fault of the securities
professional involved, unless plaintiffs were also prepared to
assert that there was intentional misconduct. Based on the Court of
Appeals' Assured Guaranty decision, the landscape
appears to have changed, and the range of available causes of
action has broadened.
Footnotes
1. Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, Inc., No. 227, 2011 N.Y. LEXIS 3658 (December 20, 2011).
2. Hall v. Geiger-Jones Co., 242 U.S. 539 (1917).
3. N.Y. Gen. Bus. Law § 352-c.
4. N.Y. Gen. Bus. Law § 352-e.
5. See, e.g., Lupardo v. I.N.M. Indus. Corp., 36 F.R.D. 438, 439 (S.D.N.Y. 1965).
6. CPC Intern. Inc. v. McKesson Corp., 70 N.Y.2d 268, 277 (1987).
7. Id. at 276 (discussing the antifraud provisions of the Martin Act, and noting that "[i]n all the other states, except one, the Legislature has expressly recognized a private civil action for violations of the corresponding provision.").
8. Eagle Tenants Corp. v. Fishbein, 182 A.D.2d 610, 611 (2d Dep't 1992). See also Horn v. 440 East 57th Co., 151 A.D.2d 112 (1st Dep't 1989); Rego Park Gardens Owners, Inc. v. Rego Park Gardens Assoc., 191 A.D.2d 621, 595 N.Y.S.2d 492, 494 (2d Dep't 1993).
9. Independent Order of Foresters v. Donaldson, Lufkin & Jenrett, 919 F.Supp. 149, 153 (S.D.N.Y. 1996).
10. Castellano v. Young & Rubicam, Inc., 257 F.3d 171 (2d Cir. 2001).
11. See, e.g., In re Beacon Associates Litig., 745 F.Supp.2d 386 (S.D.N.Y. Oct. 5, 2010); Stephenson v. Citco Group Ltd., 700 F.Supp.2d 599 (S.D.N.Y. 2010). But see, e.g., Cromer Finance Ltd. v. Berger, No. 00 CIV 2498., 2001 WL 1112548, at *4 (S.D.N.Y. Sept. 19, 2001) (finding plaintiff's negligence claims not precluded by the Martin Act); Anwar v. Fairfield Greenwich Ltd., 728 F.Supp.2d 354, 371 (S.D.N.Y. 2010) (predicting that Court of Appeals would hold that the Martin Act does not preclude state law causes of action that do not derive from or rely upon the Act to establish a required element of the claim).
12. Kerusa Co. LLC v. W10Z/515 Real Estate LP, 12 N.Y.3d 236, 906 N.E.2d 1049 (2009).
13. 12 N.Y.3d at 247 ("That Kerusa alleged the elements of common-law fraud does not transmute a prohibited private cause of action to enforce Martin Act disclosure requirements into an independent common-law tort.").
14. Caboara v. Babylon Cove. Dev., 862 N.Y.S.2d 535, 537 (2d Dep't 2008). See also Scalp & Blade, Inc. v. Advest, Inc., 281 A.D.2d 882 (4th Dep't 2001).
15. Assured Guar. (UK) Ltd. V. J.P. Morgan Inv. Management Inc., 915 N.Y.S.2d 7, 13 (1st Dep't Nov. 23, 2010).
16. Id. at 15.
17. Id. at 14. See also Anwar, 728 F.Supp.2d at 356-72 (S.D.N.Y. 2010) (declining to follow Castellano after fully examining the history and purpose of the Martin Act, and tracing the genesis of the split between the New York state and federal courts on the issue of preemption).
18. CMMF, LLC v. J.P. Morgan Investment Management Inc., 915 N.Y.S.2d 2 (1st Dep't 2010).
19. In re J.P. Jeanneret Assocs., 769 F.Supp.2d 340 (S.D.N.Y. 2011).
20. Id. at 378 (applying Castellano, after noting that the First Department is not "the last word" on the subject of Martin Act preemption and that the Court of Appeals had not squarely addressed the issue of whether nonfraud common law claims are preempted by the Act).
21. Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, Inc., No. 227, 2011 N.Y. LEXIS 3658, at *12 (December 20, 2011).
22. Id. 23. Id. at 10-11. 24. See Steven Mayerowitz, "Avalanche of Consumer Fraud Suits to Follow NY Court's Ruling," Financial Fraud Law (December 21, 2011) (last visited January 14, 2012). 25. Brief for Securities Industry and Financial Markets Association et al. as Amici Curiae Supporting Defendant-Respondent-Appellant, Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, Inc., No. 227, at 3 (December 20, 2011).
26. John Caher, "Private Actions Are Not Precluded Under Martin Act, Panel Decides," N.Y.L.J., Dec. 21, 2011, at 6. (reporting that Assemblyman Rory I. Lancman and Senator Thomas Libous are sponsoring a bill that would expand the Martin Act to permit public retirement systems and multiemployer health and welfare plans to bring actions, and quoting Assemblyman Lancman as reading the decision "as an invitation to the Legislature to expand the Martin Act itself and allow investors to recoup losses as a result of fraud or malfeasance.").
27. Id.
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