A long-standing question under New York law is whether the state’s Martin Act preempts private claimants’ efforts to bring non-fraud common law claims in the securities context. A well-developed body of case law has generally held that it does, although recently some judges questioned this conclusion.
In a December 20, 2011 opinion (here), the New York’s highest court held that the Martin Act does not preclude private claimants from bringing common law causes of action. As discussed below, this ruling not only clarifies a long-standing question but also has important implications. It could represent a big win for securities plaintiffs.
Background: The Martin Act
The Martin Act has been a potent weapon in the New York Attorney General’s toolkit. The Act prohibits fraudulent securities practices, but it does not require the NYAG to plead or prove scienter. The Act does not, however, provide for a private right of action and New York’s courts have declined to imply one. Claimants unable to pursue private rights of action under the Martin Act have sought to plead alternative non-statutory liability theories. These efforts have run afoul of case law suggesting that the Martin Act preempts these alternative theories as well.
A 1987 New York Court of Appeals decision, CPC International, Inc. v. McKesson Corp., has been interpreted by most later courts as having held that the Martin Act precludes not only private actions brought under the Act itself but also alternative common law claims. This view of the McKesson opinion has been, until recently, the generally prevailing view in the Southern District of New York. As a result, investors asserting claims of common law negligence and breach of fiduciary duty have generally had their claims dismissed. However, more recently, some courts and commentators have questioned whether McKesson definitively answered the question, and more to the point, whether the Martin Act does preclude common law claims. A split in decisions has been emerging in the trial courts.
The Assured Guaranty Case
J.P. Morgan Investment Management managed the investment portfolio of Orkney Re II PLC, whose obligations Assured Guaranty guaranteed. In its complaint, Assured Guaranty, as an express third-party beneficiary of J.P. Morgan’s investment management agreement with Orkney, alleged that J.P. Morgan invested Orkney’s assets in risky subprime mortgage-backed securities, as a result of which Orkney suffered financial losses that triggered Assured Guaranty’s payment obligations.
J.P Morgan moved to dismiss Assured Guaranty’s complaint, arguing that the Martin Act precluded Assured Guaranty’s claims for breach of fiduciary duty and gross negligence. The trial court granted J.P. Morgan’s motion to dismiss, but the intermediate appellate court reinstated Assured Guaranty’s claims. The intermediate appellate court granted J.P. Morgan leave to appeal to the New York Court of Appeals on certified questions.
The December 20 Opinion
In a December 20, 2011 opinion written by Judge Victoria Graffeo, the New York Court of Appeals held that the Martin Act does not preempt Assured Guaranty’s common law causes of action for breach of fiduciary duty and gross negligence.
The court state that the “plain text” of the Martin Act “does not expressly mention or otherwise contemplate the elimination of common law claims,” adding that J.P. Morgan “cannot point to anything in the legislative history” demonstrating a legislative “mandate to abolish preexisting common-law claims that private parties would otherwise posses.” Accordingly, the court agreed with Assured Guaranty that “the Martin Act does not preclude a private litigant from brining a non-fraud common law cause of action.”
The court distinguished claims “premised on a violation of the Martin Act” that “would not have existed absent the statute.” By contrast, however, “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.”
If for no other reason than the fact that the decision of the New York Court of Appeals sets aside a generally accepted, conventional view of New York law, the decision will have a significant impact. It also clears up what was becoming a vexing situation, where some judges were holding that the common law claims were not preempted, while most others were holding that they were.
The decision would seem to be an enormous boost for claimants seeking recoveries for alleged wrongdoing involving securities. In his December 20, 2011 Am Law Litigation Daily article about the decision (here), Nate Raymond quotes a leading plaintiffs’ attorney who had filed an amicus brief in the case on behalf of a group of unions as saying that “this decision will tremendously enhance plaintiffs’ ability to vindicate their rights under New York law.” The December 20, 2011 New York Law Journal article about the decision says that "the decision is likely to have a wide impact as it resolves an issue that arises with some frequency, and shatters the long-held assumptions of lower state and federal courts."
Martin Act preemption and the heightened pleading standards under the PSLRA together represented significant barriers for investors seeking to recover their losses. The heightened pleading standards often knocked out the federal securities law claims and the Martin Act preemption generally knocked out the common law claims – indeed, in many instances, claimants often omitted the common law claims altogether, in recognition of the Martin Act preemption.
Now, in light of the Court of Appeals ruling, most claimants will now likely include common law claims along with their federal securities claims – or simply assert common law claims alone, as Assured Guaranty did. Without the preemption argument, defendants will find it more difficult to knock out the common law claims at the initial pleading stage, particularly given that many of common law claims do not require the claimant to plead fraud. Without having to satisfy the heightened pleading requirement under the federal securities laws, aggrieved investors may be able to overcome the initial pleading hurdles, at least with respect to their common law claims.
This development may be most useful for claimants proceeding individually. In light of SLUSA as well as constraints in pleading common law claims on behalf of a class of claimants, the decision of the Court of Appeals may have less impact in class actions. At a minimum, the Court of Appeals decision seems likely to have a significant impact in the way that aggrieved investors plead their claims, and it potentially could have a significant impact on the numbers of cases, like that of Assured Guaranty, surviving the preliminary motions stage. The Court of Appeals decision in this case could potentially represent a significant development for securities claimants proceeding under New York law.
About That Big Fee Award in Delaware: Judging by the number of comments I received, Chancellor Leo Strine Jr.’s $285 million plaintiffs’ fee award in the Southern Peru case, has quite a few people really stirred up. (Actually, as Nate Raymond noted in his December 19, 2011 Am Law Litigation Daily article, here, due to an increase in the amount of the underlying judgment, the value of the fee award is actually closer to $300 million.)
One particularly provocative question about the award is whether or not it has anything to do with the concerns some have raised about whether Delaware is losing corporate litigation “market share,” as plaintiffs’ attorneys’ increasingly resort to the courts of other jurisdictions they regard as more plaintiff friendly. In her December 20, 2011 article on Thomson Reuters News & Insight, Alison Frankel suggests that the fee award in the Southern Peru case was a “message…to the entire securities class action plaintiffs bar.” Frankel reports that at the hearing on the fee award, Strine made it clear that he wants certain kinds of cases to remain in Delaware, and that plaintiffs resort to Delaware courts with the kinds of cases in which they are taking risks will be well compensated for their efforts.
As I have previously noted, it is a serious concern if Delaware’s judges feel obliged — in order remain competitive in the jurisdictional competition and to try to preserve declining market share — to prove that plaintiffs’ lawyers will be rewarded for resorting to the state’s courts.
A Negative Take on the SEC’s Lawsuit Against Fannie and Freddie: The SEC made quite a splash with the lawsuit it filed last week against several former officers of Fannie Mae and Freddie Mac. New York Times columnist Joe Nocera is unimpressed. In his December 19, 2011 column (here), Nocera describes the complaint as “extraordinarily weak.”
The complaint alleges that the organizations misled investors about their exposure to subprime mortgages. Nocera contends that in order to make its case, the SEC lumps together all kinds of mortgages as subprime. He also notes that there are no damning emails and no allegations of insider stock sales. In addition, he contends that in their regulatory filings the firms “clearly laid out the credit characteristics of their mortgage loan portfolios,” noting in that regard that the federal judge presiding over the Fannie Mae lawsuit threw out their complaint because the company’s disclosures were adequate. His final point is that Fannie and Freddie’s mortgage loan default rate is actually well below the national average. Fannie and Freddie, Nocera suggests, are not to blame for the entire crisis.
A December 20, 2011 column on the Bank Think blog (here), challenges Nocera’s conclusions, referencing earlier New York Times articles about the moral hazards of the policy Fannie and Freddie adopted in the 90s (as a result of political pressure) to ease mortgage lending standards. The earlier articles quoted commentators as saying that looser standards could lead to increased defaults and even bank failures that could in a time of crisis require a government bailout. The institutionalized imprudent lending caused the crisis, the author contends.
Whatever else might be said about the lending policies, it should be noted that the lawsuits are not about the policies, but about Fannie and Freddie’s disclosures. Nocera’s point is not that Fannie and Freddie are beyond reproach; to the contrary, his concern is that these organizations “real sins” are being “largely overlooked in favor of imagined ones.”