New York's Highest Court Decides Important Martin Act Preemption Question

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...