Litigation: Martin Act doesn’t preclude all common-law claims

Common-law claims in New York preempted only if they are solely predicated on the Act

On Dec. 20, 2011, New York’s highest court held that the Martin Act (General Business Law art 23-A)—New York’s “blue sky” law—does not preempt a plaintiff’s common-law causes of action for breach of fiduciary duty and gross negligence regarding the alleged mismanagement of an entity’s portfolio, as long as such claims are not predicated solely on a violation of the Act (or its implementing regulations) and would exist separate from the Act. (See Assured Guaranty (U.K.) Ltd. v. J.P. Morgan Inv. Management Inc., ___ N.E. 2d ___, 2011 WL 6338898 (N.Y.), 2011 N.Y. Slip Op. 09162.)

The plaintiff, Assured Guaranty (UK) Ltd., was the third-party beneficiary of an investment management agreement between defendant J.P. Morgan Investment Management Inc. and an entity whose obligations plaintiff guaranteed. The plaintiff alleged that the assets were mismanaged due to:

  • Investments in high-risk securities, including subprime mortgage-backed securities
  • A failure to diversity the portfolio
  • A failure to advise about the true level of risk
  • Investment decisions made in favor of the defendant’s client, rather than for the benefit of the plaintiff

The Martin Act, originally adopted in 1921, was enacted “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.” 2011 WL 6338898 at *1.

The defendant moved to dismiss the complaint, arguing that the Martin Act preempted plaintiff’s claims. The New York Supreme Court dismissed the plaintiff’s complaint, holding that the breach of fiduciary duty and gross negligence claims fell within the purview of the Martin Act, and would be inconsistent with the attorney general’s exclusive enforcement powers under the Act. The appellate division reversed that ruling, holding that nothing in the plain language or legislative history of the Act or appellate-level decisions in New York supported preemption.

The court of appeals found that although the plain text of the Act grants the attorney general investigatory and enforcement powers and prescribes various penalties, it neither mentions nor contemplates the elimination of common-law claims. The court found that in arguing for preemption, the defendant overread the import of two of its prior cases, CPC Intl. v. McKesson Corp., 70 N.Y.2d 268 (1987) and Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. Partnership, 12 N.Y.3d 236 (2009). The court of appeals has previously held that the Martin Act did not create a private right of action to enforce its provisions, but it found no requirement to conclude that traditional forms of action are no longer available to redress injury.

The court concluded that “a private litigant may not pursue a common-law cause of action where the claim is predicated solely on a violation of the Martin Act or its implementing regulations and would not exist but for the statute. But 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 *4.

Additionally, the court determined that policy considerations favored allowing the plaintiff’s common-law claims to proceed because proceedings by the attorney general and private common-law actions further the same goal, and precluding 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.’” Id. at *5.

The court acknowledged that following its decision in CPC Intl., some courts held that the Martin Act preempts nonfraud common-law claims if the subject of the claim is “covered” by the statute. As the court explained, the typical rationale in those cases was that fraud necessitates evidence of deceitful intent—an element not required by the Martin Act—whereas other common-law claims (such as breach of fiduciary duty and gross negligence) do not require such proof. To recognize such claims, the court added, would be analogous to permitting a private right of action under the Act, in contravention of CPC Intl.

More recently, however, courts have rejected that approach, concluding that the Martin Act does not preclude nonfraud tort claims, and the court of appeals noted that it believes “these latter cases represent the more accurate view.” 2011 WL 6338898 at 5 n.2.

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Alex Romain

Alex G. Romain is a partner at Williams & Connolly LLP, where he concentrates his practice on securities litigation and professional liability defense. He can...

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