New York Law Journal, January 13, 2012.*
Clear Path to Pursuing Common Law Securities
Claims Not ‘Assured’
By James Goldfarb and Hannah Berkowitz
For more than 20 years, courts routinely dismissed common law claims brought
by investors and other securities market participants under New York law. The courts relied on a
line of cases holding that New York’s blue sky statute, the Martin Act, preempted those claims.
But last month, the Court of Appeals rejected that line of cases. See Assured Guaranty (UK) Ltd.
v. J.P. Morgan Inv. Mgmt. Inc., No. 227, — N.E.2d —, 2011 WL 6338898 (N.Y. Dec. 20, 2011).
Some observers see Assured as clearing the path to the courthouse for plaintiffs pursuing
negligent misrepresentation, breach of fiduciary, and other common law claims arising from
securities transactions. But that view gives short shrift to significant substantive and procedural
protections—unaffected by Assured—that will continue to provide robust defenses to issuers,
underwriters, and other defendants in securities-related actions.
Rise of Martin Act Preemption
The Martin Act authorizes New York’s Attorney General to investigate and
remediate fraud in the securities markets. It does not provide a private right of action for
violations of the act. See CPC Int’l Inc. v. McKesson Corp., 514 N.E.2d 116 (N.Y. 1987). In
CPC, the Court of Appeals dismissed a Martin Act claim brought by a company that acquired the
stock of another company’s subsidiary. The Court observed that the Martin Act did not
expressly provide a private right of action, and held that an implied private right of action was
inconsistent with the Legislature’s intent to provide to the attorney general broad powers to
police the securities markets.
After CPC, a majority of federal and lower state courts relied on the Court’s
ruling to dismiss common law claims, except fraud, arising from securities transactions. Those
courts reasoned that, because the attorney general does not have to prove fraudulent intent when
prosecuting Martin Act violations, permitting investors to pursue common law claims that do not
require fraudulent intent would be tantamount to permitting private actions under the Martin Act
and inconsistent with the attorney general’s broad mandate under the act. See, e.g., Granite
Partners, L.P. v. Bear Stearns & Co., 17 F. Supp. 2d 275 (S.D.N.Y. 1998). A minority of courts
did not read CPC to preempt common law claims. See, e.g., Nanopierce Techs. Inc. v.
Southridge Capital Mgmt. LLC, No. 02-cv-0767(LBS), 2003 WL 22052894 (S.D.N.Y. Sept. 2,
2003) (discussing cases).
In 2009, the Court of Appeals appeared to reinforce the majority view when it
dismissed a common law fraud claim on preemption grounds. See Kerusa Co. LLC v. W10Z/515
Real Estate Ltd. P’ship, 906 N.E.2d 1049 (N.Y. 2009). In Kerusa, the plaintiff’s claim arose
from the alleged omission of material information from a condominium’s offering plan
amendments—information the Martin Act and its implementing regulations required to be
*
Reprinted with permission. Copyright 2012 ALM Properties, LLC. Further duplication without permission is prohibited.
disclosed. The Court held that permitting a claim based entirely on disclosure obligations
created by the act and its regulations “would invite a backdoor private cause of action to enforce
the Martin Act in contradiction to our holding in CPC Intl. that no private right to enforce that
statute exists.” Id. at 1054.
Fall of Martin Act Preemption
Courts continued to dismiss common law claims on preemption grounds after
Kerusa. But an increasing number of courts questioned that approach. See, e.g., Anwar v.
Fairfield Greenwich Ltd., 728 F. Supp. 2d 354 (S.D.N.Y. 2010). In Assured, the Court of
Appeals sided with those courts and rejected the argument that the Martin Act preempted
common law claims.
Assured arose from a dispute between a financial guarantor, plaintiff Assured, and
an investment manager, defendant J.P. Morgan Investment Management. Assured alleged that
J.P. Morgan mismanaged an investment portfolio that backed obligations Assured had
guaranteed. Assured allegedly suffered losses when it honored its financial guaranty and sought
damages from J.P. Morgan for common law gross negligence and breach of fiduciary duty. A
lower court dismissed those claims as preempted by the Martin Act. The Appellate Division,
First Department, reinstated the claims on the ground that the Martin Act did not preempt them.
The Court of Appeals affirmed the First Department’s ruling. The Court held that
statutory remedies—such as the antifraud enforcement powers provided to the attorney general
under the Martin Act—do not extinguish preexisting common law remedies absent clear
legislative intent. The Court found that neither the Martin Act nor its legislative history reflects
any intent to extinguish common law claims arising from securities transactions. Therefore, it
held that the act “does not preclude a private litigant from bringing a nonfraud common-law
cause of action.” Id., slip op. at 7.
Next, the Court addressed and rejected the argument that CPC and Kerusa
precluded such claims. The Court held that its earlier decisions do not prevent an injured
investor from bringing “a common-law claim (for fraud or otherwise) that is not entirely
dependent on the Martin Act for its viability.” Id. at 10. Rather, the decisions “stand for the
proposition 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.” Id. Assured’s claims were not predicated solely on a violation of
the Martin Act or its implementing regulations and, therefore, were not preempted.
Finally, the Court addressed and rejected the argument that permitting common
law claims by private litigants is inconsistent with the attorney general’s broad mandate under
the Martin Act. The Court held that so long as the claims have a “legal basis independent of the
statute,” the private litigant and the attorney general are pursuing the “same goal—combating
fraud and deception in securities transactions.” Id.
No Clear Path
By rejecting Martin Act preemption, Assured removed one obstacle to private,
securities-related common law claims under New York law. But others remain.
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For example, to prevail on a negligent misrepresentation claim under New York
law, a plaintiff must plead and prove “a special or privity-like relationship” with the defendant.
Mandarin Trading Ltd. v. Wildenstein, 944 N.E.2d 1104, 1109 (N.Y. 2011). An even stiffer
standard applies to a negligent misrepresentation claim by a non-client against an accountant or
other outside professional. To prevail on that claim, the plaintiff must plead and prove “actual
privity” or “a relationship so close as to approach that of privity.” Parrott v. Coopers &
Lybrand, LLP, 741 N.E.2d 506, 508 (N.Y. 2000).
Claims for aiding and abetting a breach of fiduciary duty, which investors
typically assert against financial institutions or outside professionals, are also hard to prosecute.
To prevail, the plaintiff must plead and prove that the defendant had “actual knowledge” of the
underlying breach of fiduciary duty and “knowingly induced or participated in the breach” by
providing “substantial assistance.” Kaufman v. Cohen, 760 N.Y.S.2d 157, 169-170 (1st Dept.
2003). Common law actions by a bankruptcy trustee or a litigation trust to recover securitiesrelated losses from a debtor’s officers, directors, or outside professionals face similar challenges.
The in pari delicto doctrine under New York law bars those actions unless the plaintiff pleads
and proves that the defendant totally abandoned the debtor’s interests and acted entirely for its
own or another’s benefit. See Kirschner v. KPMG LLP, 938 N.E.2d 941 (N.Y. 2010).
Stringent pleading standards are another obstacle to common law actions by
private litigants. For example, under New York law, a plaintiff must plead with specificity the
facts supporting each element of a misrepresentation, as well as a fraud, claim. See N.Y.
C.P.L.R. 3016(b). Under federal law, a plaintiff must plead with specificity the facts supporting
non-fraud claims when those claims sound in fraud (see Fed. R. Civ. P. 9(b)), which typically is
the case when investors assert non-fraud claims along with fraud claims. Courts routinely
dismiss securities-related common law claims that fail to meet these pleading standards.
Finally, a plaintiff must be mindful of the Securities Litigation Uniform Standards
Act of 1998 (SLUSA), the federal statute designed to ensure that securities class action lawsuits
are heard in federal court. See 15 U.S.C. § 78bb(f)(1). If a plaintiff seeks class action status
under New York law for non-fraud claims based on misrepresentations or omissions in
connection with exchange-listed securities, SLUSA permits the defendant to remove the action
to federal court, where it can be dismissed. See Romano v. Kazacos, 609 F.3d 512 (2d Cir.
2010).
Conclusion
Assured bars defendants from arguing that the Martin Act preempts common law
claims under New York law. But it hardly clears the path to the courthouse. Significant
substantive and procedural protections embedded in New York and federal law will continue to
pose formidable challenges to investors and other securities market participants seeking common
law relief for securities-related wrongs.
Mr. Goldfarb and Ms. Berkowitz, partners in the New York office of Murphy & McGonigle, represent financial
institutions, financial services firms, and their executives in securities and complex commercial litigation and
regulatory and compliance counseling. For more information, please contact them at [email protected] and
[email protected].
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