Article 23-A of New York’s General Business Law, commonly referred to as the Martin Act, is a powerful statute, one that has been used time and again by New York’s Office of the Attorney General to prosecute a wide range of alleged securities-related offenses, from purported conflicts of interest between equity research and investment banking in the late 1990s, to Wall Street practices that supposedly contributed to the financial crisis of 2008. The Act’s potency derives in large part from Section 352-c, which prohibits “any person, partnership, corporation, company, trust or association, or any agent or employee thereof,” from engaging in a variety of fraudulent practices in connection with the “issuance, distribution, exchange, sale, negotiation or purchase within or from [New York] of any securities or commodities.” 1
23-A N.Y. Gen. Bus. Law §352-c.
Significantly, although directed at activities sounding in fraud, Section 352-c does not require the Attorney General to plead or prove that an alleged violator acted with scienter. 2
A separate part of the Martin Act, Section 352-e, grants the Attorney General authority to regulate another area of commerce – offers and sales of interests in cooperative and condominium apartment buildings. Among other things, Section 352-e and its corresponding regulations require the sponsors of cooperatives and condominiums to issue offering statements or prospectuses with specified disclosures about different aspects of the project. See 23-A N.Y. Gen. Bus. Law §352-e.
While the Martin Act vests the Attorney General with broad powers, it provides no recourse for private claimants. Unlike the blue sky laws in other states, legislators never promulgated an express private right of action under the Act. And in 1987, the New York Court of Appeals held in CPC International Inc. v. McKesson Corp.
3
70 N.Y.2d 268 (1987).
that there was no implied right of action either. McKesson did not deter private plaintiffs from asserting state law claims in the securities context, however. It simply forced them to pursue alternative, non-statutory theories of liability. Barred from bringing direct claims under the Martin Act, many plaintiffs tried to achieve the same result indirectly by filing common law claims based on the same underlying misconduct. This development, in turn, raised an important question that courts have wrestled with ever since: to what extent does the Martin Act preempt efforts by private litigants to bring non-fraud common law claims in the securities context — i.e., claims that may sound in fraud but, like the Martin Act itself, do not require proof of scienter?
As discussed below, McKesson arguably did not provide a clear answer to this question, thereby facilitating a split among courts that continues to this day. At one end of the spectrum, most federal courts have held that the Martin Act preempts not only private claims brought under the statute itself (as per McKesson), but also non-fraud common law claims. Recently, however, several decisions have questioned this prevailing view, arguing that there is no basis in the Martin Act’s text or legislative history to support such an expansive approach to preemption. Below, we trace these competing holdings back to McKesson and the ambiguities that arguably emerged from the Court’s opinion. We then discuss the evolution of case law after McKesson, with a particular emphasis on how a broad formulation of Martin Act preemption became the majority view in the Southern District of New York. We then turn to a number of recent decisions, including two – Anwar v. Fairfield Greenwich Limited from the Southern District of New York and Assured
Guaranty (UK) Ltd. v. J
.P. Morgan Investment Management Inc. from New York’s Appellate Division – that have reinvigorated the debate by advocating a more narrowly circumscribed preemption rule. We conclude by examining the practical impact that these divergent positions might have on securities law practitioners.
Section 352-c was added to the Martin Act in 1955. The New York Court of Appeals, however, did not consider whether private citizens could sue under the Act until McKesson was heard in 1987. The dispute stemmed from efforts by McKesson to sell plaintiff the stock of a wholly-owned subsidiary, C.F. Mueller Corporation. According to plaintiff, defendants had artificially inflated C.F. Mueller Corporation’s stock by “deliberately and fraudulently prepar[ing] false projections of revenues, operating expenses and profits.” Plaintiff’s complaint asserted claims against McKesson, its investment advisor and two C.F. Mueller Corporation employees based on breaches of warranty; common law fraud; Section 17(a) of the Securities Act of 1933 ; and Section 352-c of the Martin Act. In modifying the trial court’s decision, the Appellate Division had granted defendants’ motions to dismiss the statutory claims while sustaining both common law causes of action. 4
One of the principal issues on appeal (and the one for which McKesson gained notoriety) was whether plaintiff, as a private entity, could prosecute a cause of action under Section 352-c of the Martin Act. In answering this question, the Court acknowledged at the outset what was apparent from the statutory language: New York’s legislature had not expressly provided for a private right of action under Section 352-c. By necessity, then, the Court’s analysis shifted to whether it should recognize an implied right of action from the Martin Act’s text and legislative history. For purposes of this inquiry, the Court noted that a private cause of action generally is not implied unless each of two conditions exist: one, “’plaintiff belongs to the class of legislatively intended beneficiaries’”; and two, a “‘right of action would be clearly in furtherance of the legislative purpose.’” 5
Id. at 276 (citing Burns Jackson Miller Summit & Spitzer v. Lindner , 59 N.Y.2d 314 (1983)).
There was no dispute that plaintiff satisfied the first element, so the Court focused instead on defining the Martin Act’s “legislative purpose,” an inquiry that produced a 4-2 split among the judges. 6
The seventh member of the panel, Judge Judith Kaye, took no part in the decision or its deliberations.
In an interesting twist, Judge Stewart Hancock, Jr. was tasked with writing the Opinion of the Court, even though he was in the minority. At the outset, Judge Hancock laid out the Court’s divergent views on legislative intent. Along with his colleague, Judge Richard Simons, Judge Hancock believed that the “ultimate aim” of the Martin Act was “the deterrence of fraudulent practices in the sale of securities and the protection of investors damaged by such practices.” Thus, the minority would have ruled “that an implied private cause of action furthers that broader statutory purpose.” The majority, however, disagreed, holding that an implied private right of action under Section 352-c would not be “consistent with the [Martin Act’s] legislative scheme.” Underlying this determination was a more narrowly tailored interpretation of the statute’s objectives. As the majority explained:
[T]he specific purpose of the statute was to create a statutory mechanism in which the Attorney-General would have broad regulatory and remedial powers to prevent fraudulent securities practices by investigating and intervening at the first indication of possible securities fraud on the public and, thereafter, if appropriate, to commence civil or criminal prosecution.
Somewhat cryptically, the majority added that “consistency of purpose with the statute includes consistency with this enforcement mechanism.” Having espoused the Court’s competing interpretations, Judge Hancock concluded in summary fashion, stating that “further elaboration of our respective positions … is unnecessary.” 7
70 N.Y.2d at 275-77.
With the benefit of hindsight, one could argue that the Court’s truncated analysis left important questions unanswered. For instance, while the Court barred private litigants from asserting statutory claims under the Martin Act’s anti-fraud provisions, it did not specifically discuss a question of profound significance: whether private litigants can bring non-fraud common law claims – e.g., negligent misrepresentation, breach of fiduciary duty, unjust enrichment, etc. – based on the same underlying facts. As discussed below, courts have since disagreed over how broadly to interpret this holding. For some, McKesson’s preemptive scope is not limited to claims that specifically implicate the Martin Act; it also includes any effort to sidestep this prohibition by artfully pleading non-fraud common law claims. Under this line of reasoning, the Court of Appeals could not have intended to issue an opinion that took away statutory rights of action, yet preserved the right to assert common law claims that, in effect, would achieve the same practical objective and, in so doing, render the Court’s holding meaningless. 8
McKesson does provide some ammunition for the advocates of broad preemption. For instance, the Court invites legislators to “consider the merits of a statutorily expressed cause of action,” declaring that it “would act as a further deterrent” by “reducing the expectancy of reaping illicit profits from fraudulent securities practices” while, at the same time, creating “a remedy for defrauded investors in those cases where none exists in common-law fraud” or under federal law. 70 N.Y.2d at 277-78. In other words, the Court was asking the legislature to consider undoing McKesson so that private plaintiffs would have a remedy if fraud-based claims, under either federal or common law, were unavailable. This seems to suggest, albeit implicitly, that the Court believed it was barring explicit statutory claims and non-fraud common law claims. Otherwise, the Court’s request for legislative intervention makes little sense. For instance, let’s assume for the sake of argument that non-fraud common law claims survived McKesson. Under this scenario, it is hard to see how the Court’s request for a statutory right of action would, in its words, “act as a further deterrent.” On the contrary, in a world where non-fraud common law claims are still viable, this “new” remedy would be cumulative at best.
Yet this interpretation is not universally shared. Other courts, including authors of several more recent Martin Act decisions, have adhered to a more narrow, literal reading of McKesson.
McKesson also left future courts to speculate about another one of its holdings: the decision to leave in place plaintiff’s common law fraud claim. From the standpoint of Martin Act preemption, what message, if any, was the Court trying to send here? The Court did not attempt to reconcile this holding with its preemption analysis, thereby creating an ambiguity from which courts have drawn different conclusions. For some, it is confirmation that McKesson did not intend to preempt common law claims unless they are derived solely from rights created by the Martin Act (such as the detailed rules and regulations for co-op and condominium offerings); while for others (i.e., advocates of broad preemption), the Court of Appeals was simply drawing a sharp, albeit unstated, distinction – namely, that common law fraud claims are not preempted because they contain an element, scienter, that is not required in the Martin Act context.
In the final analysis, the Court’s decision to abstain from a more detailed “elaboration of [its] respective positions” created a vacuum, one which, as discussed below, forced later courts to reach their own conclusions about the scope of Martin Act preemption. Some courts tried to derive meaning from McKesson through inference and implication; while others sought guidance from tersely-worded decisions by New York’s four appellate divisions; while still others began to mechanically cite prior decisions without contributing their own independent analysis. Collectively, over time, these efforts have created a body of Martin Act jurisprudence that is replete with conflicting and seemingly irreconcilable decisions.
Since McKesson was decided nearly twenty-four years ago, Martin Act preemption in the securities law realm has been shaped largely by federal district court decisions. Historically, “the overwhelming majority” of these courts have concluded that “non-fraud common law” theories (e.g., negligent misrepresentation, breach of fiduciary duty and other claims that do not have a scienter element) are preempted by the Martin Act. 9
In re Beacon Assocs. Litig. , No. 09 Civ. 777 (LBS), 2010 WL 3895582 , at *35 (S.D.N.Y. Oct. 5, 2010) (Sand, J.); see also, e.g., Stephenson v. Citco Grp. Ltd. , 700 F. Supp. 2d 599 , 620-21 (S.D.N.Y. 2010) (Holwell, J.) (dismissing breach of fiduciary duty, negligence, gross negligence, and aiding and abetting breach of fiduciary duty claims); Abu Dhabi Commercial Bank v. Morgan Stanley & Co. , 651 F. Supp. 2d 155 , 181-83 (S.D.N.Y. 2009) (Scheindlin, J.) (“[T]he Second Circuit has adopted the … rule that the Martin Act preempts common law tort claims in the securities context.”); Kassover v. UBS AG , 619 F. Supp. 2d 28 , 36 (S.D.N.Y. 2008) (McKenna, J.) (negligent misrepresentation claim based on securities transactions is preempted by the Martin Act); In re Bayou Hedge Fund Litig. , 534 F. Supp. 2d 405 , 421 (S.D.N.Y. 2007) (McMahon, J.) (“The vast majority of state and federal courts have found that causes of action related to a plaintiff’s securities fraud claim that do not include scienter as an essential element are typically preempted by the Martin Act.”), aff’d sub nom, South Cherry St., LLC v. Hennessee Group LLC , 573 F.3d 98 (2d Cir. 2009); Pro Bono Invs., Inc. v. Gerry , No. 03 Civ. 4347 (JGK), 2005 WL 2429787 , at *16 (S.D.N.Y. Sept. 30, 2005) (Koeltl, J.) (noting that New York courts and federal courts “almost without exception” have held that the Martin Act precludes common law claims).
Emblematic of this approach is the Second Circuit Court of Appeals’ decision in Castellano v. Young & Rubicam, Inc. , which dismissed a breach of fiduciary duty claim on Martin Act preemption grounds. 10
257 F.3d 171 (2d Cir. 2001).
In its only direct ruling on the subject, Castellano afforded substantial deference to several rulings from New York’s Appellate Division. These rulings, according to the Second Circuit, had “determined that sustaining a cause of action for breach of fiduciary duty in the context of securities fraud ‘would effectively permit a private action under the Martin Act, which would be inconsistent with the Attorney General’s exclusive enforcement powers thereunder.’” 11
Id. at 190 (quoting Eagle Tenants Corp. v. Fishbein , 582 N.Y.S.2d 218 , 219 (2d Dep’t 1992)).
While the Second Circuit acknowledged that New York’s highest court had not explicitly addressed the preemption question, it nonetheless concluded that “principles of federalism and respect for state courts’ interpretation of their own laws counsel[ed] against ignoring the rulings of [the aforementioned intermediate] New York courts.” 12
Recently, in Stephenson v. Citco Group Ltd. , District Judge Richard Holwell characterized the Second Circuit’s holding in Castellano as a straightforward application of the overarching policy announced in McKesson – to wit, “that private causes of action which impinge on the Attorney General’s authority under the Martin Act are preempted in order to maintain the exclusivity of that authority.” 13
700 F. Supp. 2d 599 , 615 (S.D.N.Y. 2010).
Under this line of reasoning, if a common law claim pleads violations that might also be prosecuted under the Martin Act, allowing that claim to continue would effectively – although not literally – permit private litigants to assert claims under the Martin Act, thereby intruding upon the Attorney General’s statutory authority.
Despite the holding in Castellano, a minority position among federal district courts has slowly emerged. Prior to 2010, the principal dissenting voice was Judge Denise Cote’s opinion in Cromer Finance Ltd. v. Berger . 14
No. 00 CIV 2498 (DLC), 2001 WL 1112548 (S.D.N.Y. Sept. 19, 2001).
In Cromer Finance, Judge Cote observed that while the New York Court of Appeals had barred private rights of action under the Martin Act, it had not yet determined “whether the [statute] preempts claims made under the common law.” This silence, Judge Cote added, was significant, since there was “nothing … in the text of the Martin Act itself to indicate an intention to abrogate common law causes of action.” 15
While acknowledging that she was bound by Second Circuit precedent, Judge Cote argued that the panel in Castellano had overlooked a “split among the New York Appellate Divisions” on the issue of preemption. 16
Id. at *4 & n.6 (citing Scalp & Blade, Inc. v. Advest, Inc. , 722 N.Y.S.2d 639 , 640 (4th Dep’t 2001) (sustaining claim for negligent misrepresentation and noting that “[n]othing in the Martin Act, or in the Court of Appeals cases construing it, precludes a plaintiff from maintaining common-law causes of action based on such facts as might give the Attorney-General a basis for proceeding civilly or criminally against a defendant under the Martin Act”)).
Judge Cote also distinguished Castellano by pointing to another Second Circuit decision from 2001, Suez Equity Investors, L.P. v. Toronto-Dominion Bank . In that case, a different three-judge panel had expressed doubt – albeit in dicta – that the New York Court of Appeals “would follow the[] lead” of the appellate division cases that had found preemption, noting that these lower court decisions had not explored the issue with any “level of depth.” 17
250 F.3d 87 , 104 (2d Cir. 2001).
In 2003, Judge Leonard Sand argued in Nanopierce Technologies, Inc. v. Southridge Capital Management LLC that Cromer Finance and the principal New York State decision upon which it relied, Scalp & Blade, Inc. v. Advest, Inc. , 18
722 N.Y.S.2d 639 , 640 (4th Dep’t 2001).
were outliers or, as he put it, “solitary islands in a stream of contrary opinion.” 19
Nanopierce Techs., Inc. v. Southridge Capital Mgmt. LLC , No. 02 Civ. 0767 (LBS), 2003 WL 22052894, at *4 (S.D.N.Y. Sept. 2, 2003).
Whether accurate or not in 2003, this critique needs to be reassessed in light of Anwar v. Fairfield Greenwich Ltd. , a 2010 ruling by Judge Victor Marrero that emphatically rejected the preemption of common law claims under Section 352-c of the Martin Act and, in so doing, called into question the entire “stream of contrary opinion” that had surrounded Judge Cote’s holding in Cromer Finance. 20
No. 09 Civ. 0118 (VM), 2010 WL 3022848 (S.D.N.Y. July 29, 2010).
The facts in Anwar, a putative securities class action, stemmed from the admitted Ponzi scheme perpetrated by Bernard L. Madoff. Plaintiffs, who had invested with Madoff through hedge funds run by Fairfield Greenwich Group, alleged claims under both the federal securities laws and various common law tort, breach of contract and quasi-contract theories. Defendants moved to dismiss all of the common law causes of action other than fraud, arguing that they were preempted by the Martin Act. In denying defendants’ motion, Judge Marrero examined the Martin Act’s text and legislative history, retraced the evolution of case law post-McKesson and made his case for how a broad preemption doctrine subverts – rather than supports – the Act’s underlying goals.
Judge Marrero observed, as an initial matter, that “[t]he plain language of the Martin Act, while granting the Attorney General investigatory and enforcement powers and prescribing various penalties, nowhere mentions or contemplates erasing common law causes of action.” After looking at the Martin Act’s legislative history, from its original enactment in 1921 through its subsequent amendments, Judge Marrero also could detect no “desire on the part of the legislature to preempt common law actions.” These facts, in the district court’s judgment, weighed heavily against preemption. That is because, under traditional principles of statutory construction, “‘a clear and specific legislative intent is required to override the common law.’” In the absence of such clear direction, “‘when the common law gives a remedy, and another remedy is provided by statute, the latter is cumulative.’” 21
Id. at *3-4 (citations omitted).
McKesson, moreover, was not to the contrary. While acknowledging the Court of Appeals’ prohibition against private rights of action, Judge Marrero opined that McKesson was “equally important for what it did not decide,” namely, “whether [the statute] broadly preempted common law causes of action arising out of the same facts that would support a Martin Act proceeding.” 22
Unlike the Second Circuit in Castellano or the district court in Stephenson, Judge Marrero found the lack of explicit direction on this point dispositive.
Judge Marrero was also troubled by the decisional law that had followed in McKesson’s wake. Many of these courts, he explained, had not formed an independent view of the Martin Act’s text or legislative history, nor had they performed anything more than a superficial analysis of the Court of Appeals decision in McKesson. Instead, these courts had reached their respective conclusions largely “by citing to other decisions that ha[d] found preemption, without examining whether the doctrine was warranted in the first place.” 23
This casual and uncritical adoption of prior opinions, in turn, had led to an “unwitting perpetuation of … error.” One error, according to Judge Marrero, was the widely held belief that state court authority strongly supported the broad preemption of non-fraud common law claims in the securities context. In fact, Judge Marrero asserted, a number of these precedents had arisen in a completely different setting (i.e., real estate syndication offerings) and thus implicated an entirely separate part of the Martin Act, Section 352-e. The plaintiffs in these cases, Judge Marrero stated, were seeking to vindicate rights (based on disclosure violations, etc.) that had been created by – and would not have existed but for – the Martin Act and its underlying regulations. It therefore was “not surprising that the state courts summarily and uniformly dismissed causes of action that merely embodied Martin Act violations cloaked in the language of the common law.” 24
In a typical case involving securities or commodities, by contrast, the fact pattern is different: plaintiffs are attempting to plead common law claims that are covered by – but not derived from – the Martin Act, and would exist even in the statute’s absence. According to Judge Marrero, the state court decisions frequently cited by federal courts had not expanded preemption to reach this broader category of claims. 25
Id. (“These decisions did not hold that the Martin Act sweepingly preempted common law causes of action – they merely barred claims that relied on the Martin Act as the source of authority to frame and sustain a cause of action.”).
Judge Marrero also cited as support several recent state court decisions – decisions which supposedly clarified the distinction between common law claims that are “created by” the Martin Act (and thus are preempted) and claims that exist independent of the Martin Act (and thus, in his view, are not preempted). As an example, Judge Marrero cited Caboara v. Babylon Cove Development, LLC , a Second Department decision from 2008 which reversed a preemption-based dismissal of common law fraud and breach of contract claims. 26
54 A.D.3 d 79 (2d Dep’t 2008).
In Coboara, it was alleged that the Offering Plan for a condominium apartment building had advertised a supposed right for owners to sublet, even though the project’s zoning approval required all units to remain owner-occupied. Defendants argued that the Martin Act barred plaintiffs’ common law claims, but the court disagreed. It found “[n]o case from the Court of Appeals” to support the notion “that the Martin Act … abrogated or supplanted an otherwise viable cause of action whenever the allegations would support a Martin Act violation.” 27
The Second Department added that common law causes of action may rest upon facts that would support a Martin Act violation “as long as they are sufficient to satisfy traditional rules of pleading and proof,” and that any contrary ruling would be contrary to “basic tenets of statutory construction.” 28
Id. The Second Department expressed a similar view in Board of Managers of Marke Gardens Condominium v. 240/242 Franklin Ave., LLC , a case that stemmed from alleged misrepresentations by the sponsor of a condominium project. 71 A.D.3 d 935 (2d Dep’t 2010). In refusing to dismiss plaintiff’s common law claim on preemption grounds, the court emphasized that the allegations, which included oral misstatements, did not “’rel[y] entirely on alleged omissions from filings required by the Martin Act and the Attorney General’s implementing regulations.’” Id. at 936 (citation omitted).
Judge Marrero also pointed to Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. Partnership , a 2009 ruling in which the New York Court of Appeals considered Martin Act preemption under Section 352-e, the provision addressed to real estate syndication offerings. 29
12 N.Y.3d 236 (N.Y. 2009).
There, it was alleged that a defendant condominium sponsor had defrauded plaintiffs by inserting “false and fraudulent representations and material omissions in the sales brochures and advertisements.” The question, as framed by the Court, was “whether [plaintiff] Kerusa has any common-law claim for fraud, as distinct from a claim under the Martin Act, which only the Attorney-General may bring.” The Court concluded that no such independent claim existed. “But for the Martin Act and the Attorney General’s implementing regulations,” the Court explained, “the sponsor defendants did not have to make the disclosures” at issue. Thus, “to accept Kerusa’s pleading as valid would invite a backdoor private cause of action to enforce the Martin Act in contradiction to our holding in [McKesson] that no private right to enforce that statute exists.” 30
The “upshot of this jurisprudence,” Judge Marrero reasoned, “is that the Martin Act should rarely have relevance in federal securities litigation.” That is because, in the securities law context, plaintiffs are not seeking to vindicate statutory rights, like the Martin Act’s real estate syndication provisions, which “are more burdensome than the common law requires.” In the end, as Judge Marrero argued, the preemption inquiry turns on whether the common law cause of action has “a legal basis independent from the Martin Act.” 31
Anwar, 2010 WL 3022848 , at *11-12.
If the answer is no, as in Kerusa, then preemption applies; if the answer is yes, then preemption is inoperative. Perhaps not surprisingly, adherents to the “broad preemption approach” have resisted this interpretation. In Stephenson, discussed above, Judge Holwell asserted that Judge Marrero’s construction represented “an inverted reading” of Kerusa. According to Judge Holwell, “[n]othing in the opinion suggests that the Court of Appeals, in expanding Martin Act preemption into the fraud realm [for real estate syndication offerings,] intended to diminish it with respect to other types of claims.” In fact, Judge Holwell suggested that Kerusa supports an expansive view of preemption, since its holding applies “the policy expressed in McKesson that private causes of action which impinge on the Attorney General’s authority under the Martin Act are preempted in order to maintain the exclusivity of that authority.” 32
Stephenson, 700 F. Supp. 2d at 615.
In November 2010, the proponents of Judge Marrero’s interpretation received an added boost with the Appellate Division, First Department’s decision in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management
Inc. 33
2010 WL 4721590 (N.Y. App. Div. 1st Dep’t Nov. 23, 2010).
There it was alleged that an investment manager had failed to disclose “substantial risks” lurking in plaintiff’s portfolio, including securities backed by subprime and Alt-A mortgages. The trial court had dismissed plaintiff’s gross negligence and breach of fiduciary duty claims, finding that they were preempted by the Martin Act. The Appellate Division, however, reversed. As in Anwar, which was cited with approval, the court found “nothing in the plain language of the Martin Act, its legislative history or appellate level decisions in this State that supports defendant’s argument” – to wit, that “the act preempts otherwise validly pleaded common-law causes of action.” 34
The Appellate Division further held that McKesson did not compel a different result, since the Court of Appeals “did not explicitly address whether the Martin Act preempted common-law claims based on the same facts that would allow the Attorney General to bring an action.” 35
Id. at *4; accord Silver Oak Capital L.L.C. v. UBS AG , 2011 WL 1166291 , at *1 (N.Y. App. Div. 1st Dep’t Mar. 31, 2011) (citing Assured Guaranty and finding that “[p]laintiffs’ claims of negligent misrepresentation and unjust enrichment are not barred by the Martin Act”); CMMF, L
LC v. J.P. Morgan Inv. Mgt. Inc
., 78 A.D.3 d 562, 563–564 (1st Dep’t 2010) (refusing to dismiss common law claims as preempted by Martin Act based on reasoning from Assured Guaranty).
J.P. Morgan Investment Management Inc. (“JPM”) has since petitioned successfully to have the Court of Appeals review the First Department’s ruling. 36
See Assured Guar. (UK) Ltd. v. J.P. Morgan Inv. Mgmt. Inc. , 915 N.Y.S.2d 7 (N.Y. App. Div. 1st Dep’t 2010), appeal docketed No. 603755/08 (N.Y. Apr. 18, 2011).
The question presented on appeal – Does the Martin Act preempt non-fraud common-law tort claims asserted by private civil litigants in the securities context? – provides the best opportunity in years to settle the issues surrounding Martin Act preemption once and for all. 37
If Assured Guaranty does not reach a decision on the merits (because it is settled, etc.), there is a Second Circuit appeal that might raise the issue. Specifically, in Barron v. Igolnikov , a case arising from the Madoff affair, Defendants-Appellees have argued that the Martin Act preemption issue should be certified to the New York Court of Appeals. See
Barron v. Igolnikov , No. 10-1387-cv, Brief of Defendants-Appellees 40 (Dec. 6, 2010) (Dkt. 76).
In its recently-filed opening brief, JPM argues that contrary to the Appellate Division’s holding (and other recent decisions like Anwar), the Martin Act’s text and structure decisively support the notion that New York’s legislature intended to preempt non-fraud common law tort claims in the securities context. As evidence for this proposition, JPM focuses on what it describes as the Attorney General’s “exclusive enforcement powers” under the Act, including its right to seek restitution on behalf of aggrieved investors and its authority to enact supporting regulations. JPM also cites certain statutory omissions that it views as supportive, including the Act’s lack of a private right of action or even a clause explicitly saving common law claims from preemption. And on the subject of intent, JPM points to the legislature’s failure, over many decades, to overrule what JPM terms “the overwhelming authority supporting the preemption of non-fraud common-law claims.” 38
See
Assured Guar. (UK) Ltd. v. J.P. Morgan Inv. Mgmt. Inc. , No. 603755/08, Brief of Defendant-Respondent-Appellant 2-4 (Apr. 18, 2011).
As of the date hereof, the appeal is still being briefed.
Given recent developments in Martin Act jurisprudence, the need for definitive Court of Appeals guidance is greater than ever. Indeed, Anwar and the First Department’s decision in Assured Guaranty have done little to resolve the differences of opinion surrounding the preemption issue. Some courts, for instance, have expressly disagreed with Judge Marrero’s analysis from Anwar, including In re Beacon Associates Litigation , an October 2010 decision which held that common law claims arising from Bernard Madoff’s Ponzi scheme were preempted by the Martin Act. 39
No. 09 Civ. 777 (LBS), 2010 WL 3895582 (S.D.N.Y. Oct. 5, 2010).
In his opinion, Judge Leonard Sand reiterated a stance he had taken over seven years earlier in Nanopierce – that “to sustain a cause of action for common law claims covered by the Martin Act ‘would be, in effect, to recognize a private right of action under the Martin Act contrary to [McKesson].’” 40
Id. at *36 (citation omitted). Judge Daniels recently echoed this view. See Horvath v. Banco Comercial Portugues, S.A. , No. 10 Civ. 4697 (GBD), 2011 WL 666410 , at *7 (S.D.N.Y. Feb. 15, 2011) (holding that Martin Act preempts common law claims “because sustaining such common law actions would effectively create an end-run around the New York Attorney General’s exclusive enforcement authority”).
While Judge Sand acknowledged some “potential uncertainty in this area of the law,” he nonetheless concluded that “the weight of opposing authority, including Second Circuit Court of Appeals precedent [i.e., Castellano], compel[led] his reaffirmation of Martin Act preemption.” 41
Id. at *37. Judge Thomas Greisa has further reinforced this broad view of Martin Act preemption in several other recent cases arising from the Madoff affair. See
Meridian Horizon Fund LP v. Tremont Group Holdings, Inc. , No. 09 Civ. 3708 (TPG), 2010 WL 1257567 , at *9 (S.D.N.Y. Mar. 31, 2010) (dismissing common law claims for negligence as preempted); Barron v. Igolnikov , No. 09 Civ. 4471 (TPG), 2010 WL 882890 , at *6 (S.D.N.Y. Mar. 10, 2010) (dismissing claims of breach of fiduciary duty, aiding and abetting breach of fiduciary duty, gross negligence and unjust enrichment); In re Tremont Secs. Law, State Law and Ins. Litig. , 703 F. Supp. 2d 362 , 373 (S.D.N.Y. 2010) (dismissing breach of fiduciary duty, negligent misrepresentation and aiding and abetting breach of fiduciary duty claims).
Several other federal court decisions have also expressed reluctance to adopt Judge Marrero’s position in the absence of more explicit direction from the Second Circuit or the New York Court of Appeals. For instance, in a decision from January of this year, Judge Colleen McMahon held that until the Court of Appeals “squarely addresse[s] whether the Martin Act preempts securities-related non-fraud common law or equitable claims,” she will feel “bound to apply the result in” Castellano. 42
In re J.P., Jeanneret Assocs., Inc. , No. 09 Civ. 3907 (CM), 2011 WL 335594 , at *33 (S.D.N.Y. Jan. 31, 2011); In re Wachovia Equity Sec. Litig. , 2011 WL 1344027 , at *37 (S.D.N.Y. Mar. 31, 2011) (Sullivan, J.) (negligent misrepresentation claim was preempted and observing that “unless and until the New York Court of Appeals adopts such a rule [advocated in Anwar], this Court is bound to apply the result in the only Second Circuit case [Castellano] to address the subject of Martin Act preemption”); In re Kingate Mgmt. Ltd. Litig. , No. 09 Civ. 5386 (DAB), 2011 WL 1362106 , at *11 (S.D.N.Y. Mar. 30, 2011) (Batts, J.) (because “the New York Court of Appeals has not examined the issue,” it “remains bound to apply the result in the only Second Circuit case that has addressed the subject,” Castellano); Iroquois Master Fund, Ltd. v. CEL-SCI Corp. , No. 09 CV 8912 (HB)(THK), 2011 WL 1216688 , at *3 (S.D.N.Y. Mar. 28, 2011) (Baer, J.) (“[U]ntil the New York legislature or the Court of Appeals says otherwise, it is settled that the Act ’preempts common law securities claims sounding in fraud or deception that do not require pleading or proof of intent, and that are based on conduct that is ”within or from“ New York.’”) (citation omitted).
These decisions cry out for the Court of Appeals to decisively address the scope of Martin Act preemption in Assured Guaranty. If the recent opinions in Beacon Associates and Jeanneret are any guide, district court judges will be reluctant to endorse Judge Marrero’s reasoning without further guidance from the New York Court of Appeals or a decision from the Second Circuit disavowing its holding in Castellano. In the interim, the breadth of Martin Act preemption in federal court may depend more on which judge has been assigned to the case than it does on principles of statutory construction. To be sure, this uncertainty is mitigated somewhat in the class action context by the Securities Litigation Uniform Standards Act, or SLUSA, which generally bars plaintiffs in certain “covered class actions” from bringing, in state or federal court, misrepresentation or omission claims based on state law. SLUSA, however, does not cover all class actions, nor does it impact plaintiffs who choose to assert individual actions. So for practitioners litigating common law claims arising from the purchase or sale of securities, there is still a need for clarity. Hopefully, the New York Court of Appeals will deliver a ruling in Assured Guaranty that fills this void.
