In an opinion issued just before the Christmas and Hanukah holidays by the New York Court Appeals, the Court gave private investors and the New York Attorney General a fine present: a decision that New York’s Martin Act, New York Gen. Bus. Law art. 23-A, §§ 352-53 (2011), does not preclude common-law tort claims arising out of the sale of securities. This decision, discussed in this alert, gives new freedom to private investors to patrol Wall Street in ways almost everyone had previously assumed was denied to them.
In an opinion issued just before the Christmas and Hanukah holidays by the New York Court Appeals, the Court gave private investors and the New York Attorney General a fine present: a decision that New York’s Martin Act, New York Gen. Bus. Law art. 23-A, §§ 352-53 (2011), does not preclude common-law tort claims arising out of the sale of securities. This decision gives new freedom to private investors to patrol Wall Street in ways almost everyone had previously assumed was denied to them.
The opinion in question was written in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, 2011 N.Y. Slip Op. 9162, 2011 N.Y. LEXIS 3658 (N.Y. Dec. 20, 2011). The underlying lawsuit was commenced by a reinsurance company, Assured Guaranty (UK) Ltd. (“Assured”), which had guaranteed the obligations of Orkney Re II PLC (“Orkney”). J.P. Morgan Investment Management, Inc. (“J.P. Morgan”) had been managing the investment portfolio of Orkney. As a guarantor of Orkney’s portfolio, Assured was an express third-party beneficiary of the investment management agreement between J.P. Morgan and Orkney.
Orkney’s portfolio did not do well. As a result, Assured faced a call on its guaranty. Assured then sued J.P. Morgan, alleging that J.P. Morgan had improperly invested Orkney’s assets in high-risk vehicles such as subprime mortgage-backed securities, had failed to diversify the Orkney portfolio, and had failed to advise Orkney of the true level of risk it was carrying. Furthermore, J.P. Morgan’s investment decisions supposedly favored nonparty Scottish Re Group Ltd., a client of J.P. Morgan and Orkney’s largest equity holder, rather than Orkney itself (or Assured as its guarantor). Together, J.P. Morgan’s actions supposedly constituted a breach of fiduciary duty, gross negligence, and breach of contract.
The trial court hearing Assured’s claims, consistent with prior judicial precedent, dismissed the lawsuit in its entirety on grounds that the claims were preempted by the Martin Act. On appeal, the First Department reversed, finding “nothing in the plain language of the Martin Act, its legislative history or appellate level decisions in this State that support defendant’s argument that the [Martin Act] preempts otherwise validly pleaded common-law causes of action.” Assured Guaranty (UK) Ltd. v. J.P. Morgan Inv. Mgmt., 80 A.D.3d 293, 304 (1st Dep’t 2010). Based on this holding, the First Department then reinstated Assured’s claims for breach of fiduciary duty and gross negligence, as well as part of its contract claim.
On further appeal, the Court of Appeals affirmed the First Department’s decision in a unanimous opinion by Judge Victoria A. Graffeo. Looking first to legislative intent, the Court agreed with the First Department that nothing in the Martin Act, either as originally enacted in 1921 or in numerous amendments, demonstrated an intent to abolish preexisting common law claims that would otherwise exist in favor of an investor. To override the common law, there must be, according to the Court, evidence of a clear and specific legislative intent to do so. Assured Guaranty, 2011 N.Y. LEXIS 3658 at *6-7. And while the Martin Act gives the New York Attorney General special investigatory and civil and criminal enforcement powers, it “does not expressly mention or otherwise contemplate the elimination of common-law claims.” Id. at *6.
As additional support for the Court’s decision rejecting preemption of private tort claims, Judge Graffeo also cited to public policy goals, noting that “proceedings by the Attorney General and private actions further the same goal- combating fraud and deception in securities transactions.” Id. at *10. If common law claims were to be pre-empted, this would weaken, rather than strengthen, such protections in the marketplace. Id. at *10-11 (citing Anwar v. Fairfield Greenwich Ltd., 728 F. Supp. 354, 371 (S.D.N.Y. 2010)).
In reaching this result, Judge Graffeo took pains to distinguish the Court’s previous holdings in CPC Int’l. v. McKesson Corp., 70 N.Y.2d 268 (N.Y. 1987), and Kerusa Co. LLC v. W10Z/515 Real Estate Ltd., 12 N.Y.3d 236 (N.Y. 2009), both of them decisions that had been cited by state and federal courts to support a pre-emption rationale. In Assured Guaranty, however, she described those decisions as holding merely that no private right of action exists to enforce the Martin Act itself, without squarely addressing whether the Act preempted otherwise viable common law claims. See 2011 N.Y. LEXIS 3658 at *10.
The bottom line for the Court’s decision is that it is now clear that “an injured investor may bring a common-law claim (for fraud or otherwise) that is not entirely dependent on the Martin Act for its viability.” Id. at *10. This also resolves what was threatening to become a split of authority in the courts. The Second Circuit, for example, had a decade ago held in Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 190 (2d Cir. 2001), that the Martin Act would preempt private securities claims based on common law. Even after the First Department issued its opinion in Assured Guaranty, District Court Judge Colleen McMahon had noted in In re J.P. Jeanneret Assocs., 769 F. Supp. 2d 340, 378 (S.D.N.Y. 2011), that the interim Assured Guaranty decision was inconsistent with precedent and “not the last word.”
The Assured Guaranty decision has already been widely hailed as a victory both for investors and for the New York State Attorney General. It is, in fact, likely to open wider the door to using state law theories for claims related to the purchase and sale of securities. In this respect it is part of a possibly emerging trend against preemption in the financial industry (a trend also expressed, for example, in the Dodd-Frank Wall Street Reform and Consumer Protection Act’s limits on preemption of claims against national banks, see 12 U.S.C. § 25b (2011) ). At a minimum, financial institutions will now need to become even more aware of New York state law theories than in the past, and may find themselves more often dragged into New York state court than before by private investors now freed to assert claims previously considered to be preempted.
- Common law fraud claims involving the sale of securities will, however, continue to be limited or in some instances completely preempted by the Securities Litigation Uniform Standards Act of 1998. See Securities Litigation Uniform Standards Act of 1998, Pub. L. No. 105-353, 112 Stat. 3227 (1998) (codified as amended in part at 15 U.S.C. §§ 77p & 78bb(f) (2011)).
[Back to reference]