In a decision with far reaching implications for both private investors and the business community, New York’s highest court recently ruled that an individual plaintiff’s common-law causes of action for breach of fiduciary duty and negligence stemming from a bank’s purported mismanagement of the plaintiff’s investment account were not pre-empted by New York’s “blue sky” law, the Martin Act. The unanimous decision in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment, Management, Inc., 2011 WL 6338898, 2011 N.Y. Slip Op. 09162, settles a longstanding dispute among New York courts as to whether a private litigant may pursue claims that overlap with the enforcement powers granted to the New York Attorney General by the Martin Act. The Court of Appeals noted that allowing individual investors to pursue common law claims alongside those brought by the New York Attorney General provides greater protection for both individual investors and the marketplace and, in doing so, furthers the goals of the Martin Act.

The Martin Act, codified as New York General Business Law article 23-A, sections 352-353, was passed in 1921 and sought to afford the New York Attorney General greater powers to combat securities fraud. It “authorizes the Attorney General to investigate and enjoin fraudulent practices in the marketing of stocks, bonds and other securities within or from New York” Assured Guaranty, No. 227 at *4 (quoting Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. P’ship, 12 N.Y.3d 236, 243 (2009)). Prior to the passage of the Martin Act, “the primary weapon afforded the Attorney General to combat securities fraud was that of injunctive relief.” Id. at *4-5 (citing Mihaly and Kaufmann, Securities, Commodities and Other Investments, McKinney’s Cons Laws of NY, Book 19, General Business Law art 23-A, at 13). To remedy this deficiency, the Act provided the Attorney General with the power to “investigat[e] and interven[e] at the first indication of possible securities fraud on the public and, thereafter, if appropriate, to commence civil or criminal prosecution.” Id. (citing CPC Int’l v. McKesson Corp., 70 N.Y.2d 268, 277 (1987); Kralik v. 239 E. 79th St. Owners Corp., 5 N.Y.3d 54, 58-59 (2005)).  

Over the past 85 years, the Legislature has repeatedly expanded the Attorney General’s powers under the Act. In 1955 the Legislature added section 352-c, which broadened the Attorney General’s powers by allowing for criminal charges to be brought against those engaging in fraudulent practices “even absent proof of scienter or intent.” Slip Op. at *5 (citing People v. Landes, 84 N.Y.2d 655, 660 (1994)). Five years later, the Martin Act was again expanded to cover the real estate industry through the addition of section 352-e, which is aimed at preventing fraud in the sale of condominiums and cooperative apartments. This amendment made it “‘illegal for a person to make or take part in a public offering of securities consisting of participation interests in real estate unless an offering statement is filed with the Attorney General’ and numerous disclosures are made pursuant to the statute and its implementing regulations.” Id. (citing Kerusa, 12 N.Y.3d at 243). The Martin Act was expanded again in 1976 when the Attorney General received authorization to seek monetary restitution on behalf of investors injured as a result of fraud.

Courts have long held that the Martin Act does not preempt fraud claims as the statue itself contains no requirement of deceitful intent. However, prior to the Assured Guaranty decision there was a distinct lack of clarity in how courts should treat the convergence of an individual plaintiff’s common-law causes of action with the powers granted to the Attorney General under the Martin Act. In cases like CPC International and Kerusa, both relied upon by J.P. Morgan in Assured Guaranty, the Court of Appeals found claims to be preempted by the Martin Act. However, more recently courts began to trend against preemption. In cases like CMMF LLC v. J.P. Morgan Investment Management, 78 A.D.3d 562 (1st Dep’t 2010), and Anwar v. Fairfied Greenwich, Ltd., 728 F. Supp. 2d 354 (S.D.N.Y.), plaintiffs (including CMMF, represented by Quinn Emanuel) successfully argued that the Martin Act does not preclude non-fraud tort claims. The Assured Guaranty decision expressly acknowledged this divide and stated that latter cases such as CMMF and Anwar “represent the more accurate view” of the Martin Act’s role. Assured Guaranty, at n.2.

The decision in Assured Guaranty stems from J.P. Morgan’s purported mismanagement of funds belonging to its client, Orkney Re II p.l.c. (“Orkney”). Orkney retained J.P. Morgan as its investment manager for approximately $553 million of assets. The complaint alleges that rather than manage the account pursuant to the guidelines set forth in the parties’ investment management agreement, J.P. Morgan heavily invested Orkney’s assets in high-risk securities like subprime mortgage-backed securities. The complaint further alleges that J.P. Morgan failed to properly diversify the portfolio, failed to adequately advise Orkney of the true level of risk in the account and improperly made investment decisions in favor of J.P. Morgan’s own client—and Orkney’s largest equity holder—Scottish Re Group Ltd., rather than for the benefit of Orkney. As a result of this alleged mismanagement, Orkney suffered substantial financial loss. As guarantor of Orkney’s investment and express third party beneficiary of the investment management agreement between Orkney and J.P. Morgan, Assured Guaranty was forced to pay for the loss. Assured Guaranty subsequently brought claims in New York state court against J.P. Morgan for breach of fiduciary duty, gross negligence and breach of contract.

J.P. Morgan moved to dismiss the complaint, arguing that the breach of fiduciary duty and gross negligence claims were preempted by the Martin Act. J.P. Morgan argued that the Martin Act vests the Attorney General with exclusive authority over fraudulent securities and investment practices addressed by the statute and it would be inconsistent to allow private investors to bring overlapping common-law claims.

The trial court granted the motion to dismiss, holding that the fiduciary duty and gross negligence claims fell “within the purview of the Martin Act and their prosecution by plaintiff would be inconsistent with the Attorney General’s exclusive enforcement powers under the Act.” On appeal, the First Department rejected the Supreme Court’s ruling, holding that “there is nothing in the plain language of the Martin Act, its legislative history or appellate level decisions in this state that supports defendant’s argument that the Act preempts otherwise validly pleaded common-law causes of action.” 80 A.D.3d 292, 304 (1st Dep’t 2010). In so holding, the Appellate Division reinstated Defendant’s breach of fiduciary duty and gross negligence causes of action and part of its contract claim. Id.

Upon review, the Court of Appeals upheld the First Department’s ruling and, for the first time, expressly held that private causes of action are not preempted by the Martin Act. In doing so, the Court of Appeals relied heavily on the plain language and legislative history of the Act. The Court noted that nothing in the language of the statute itself “expressly mention[s] or otherwise contemplate[s] the elimination of common-law claims….Certainly the Martin Act, as it was originally conceived in 1921 with its limited relief, did not evince any intent to displace all common-law claims in the securities field.” Slip. Op. at *6. The Court also noted that nothing in the legislative history supports “a ‘clear and specific’ legislative mandate to abolish preexisting common-law claims that private parties would otherwise possess.” Id. at *7. Moreover, the Court noted that the purpose of the Martin Act was best advanced through the permission of private claims alongside those brought by the Attorney General. “We agree with the Attorney General 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. Moreover, as [S.D.N.Y. District Court] Judge Marrero observed recently, to hold 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.’” Id. at 10-11(citing Anwar, 728 F. Supp. 2d at 371).

The Assured Guaranty decision opens a significant door for private litigants’ New York common-law securities claims, the validity of which was previously in doubt. In addition to widening the range of claims a private litigant can bring, the Assured Guaranty decision also increases the chances of obtaining settlements. As these common-law claims do not require the heightened pleading standards of fraud claims, defendants will have a more difficult time eliminating investors’ claims at the pleading stage.