2/7/2011

By Sarah Kelly-Kilgore

It’s shaping up to be quite a busy year for New York’s Martin Act, the state’s increasingly notorious “blue sky law” designed to combat financial fraud. See N.Y. GEN. BUS. LAW§§ 352-59 (McKinney 2010). For that matter, though, it’s been a busy decade. The Martin Act, which celebrates its 90th birthday this year, gives New York’s attorney general broad powers in both investigating and prosecuting financial fraud. Id.

Although the statute remained largely unused for seventy-five years, Eliot Spitzer began dusting it off in 2001 when he was told about the statute by his new staffer, Eric Dinallo. Since then, the Martin Act has been used aggressively – and successfully – against the banking industry, the hedge fund industry, and finally, the mutual fund industry. See Ashby Jones, Cuomo to E&Y: Let Me Introduce You to My Good Friend, Martin, WALLST. J. (Dec. 21, 2010 4:39 PM), http://blogs.wsj.com/law/2010/12/21/cuomo-to-ey-let-me-introduce-you-to-my-good-friend-martin/. Although there was speculation even during Spitzer’s term as attorney general (and gleeful assumptions after his rapid fall from grace – and the governorship) that the Martin Act would be substantially weakened, if not altogether rescinded, the aging statute remains among the most powerful prosecutorial tools in securities regulation today. Robert J. Anello, The Martin Act: New York State securities fraud statutein 4C N.Y. PRAC., COM.LITIG.INN.Y.STATECOURTS§ 90:17 (Robert L. Haig ed., 3d ed. 2010); Nicholas Thompson, The Sword of Spitzer, LEGALAFFAIRS(May/June 2004),http://www.legalaffairs.org/issues/May-June-2004/feature_thompson_mayjun04.msp. Spitzer’s immediate successor, Andrew Cuomo, used the Martin Act to subpoena entities connected to the subprime mortgage crisis, and it is expected that the new attorney general, Eric Schneiderman, will use the Act’s broad powers during his term. See Jones, suprasee also Kate Kelly et al., State Subprime Probe Takes a New Tack, WALLST. J. (Jan. 31, 2008), available at http://online.wsj.com/article/SB120173938230430417.html?mod=googlenews_wsj.

The Martin Act, widely regarded as the most expansive anti-fraud statute in the country, allows New York’s attorney general to combat financial fraud by initiating civil or criminal investigations – or both – against persons or companies suspected of engaging in some fraudulent practice. N.Y. GEN. BUS. LAW§ 352. In contrast to other anti-fraud statutes, however, the Martin Act allows the attorney general to subpoena witnesses to appear for an interview, or to provide written statements or documents, without going before a grand jury. 4C N.Y. PRAC. § 90:17. Extremely controversial, these provisions grant expansive powers which are only heightened by the fact that the degree of confidentiality afforded the documents or information obtained by any such subpoena is at the sole discretion of the attorney general.See id. Even more striking, because subpoenas issued under section 352 are purely investigatory, witnesses subpoenaed by the attorney general can claim neither the right to counsel nor the right against self-incrimination. Id.

In addition to the Martin Act’s broad investigatory powers, the Act gives the attorney general the power to bring an action against any person or company believed to be engaged in fraudulent practices in the name and on behalf of the people of New York. N.Y. GEN. BUS. LAW§ 353. In another departure from usual security fraud prosecutions, the Martin Act requires no finding of intent to defraud for conviction. People v. Barysh, 408 N.Y.S.2d 190, 193 (Sup. Ct. N.Y. County 1978), cited in DECHERT LLP, FIN. SERVS., New York State’s Martin Act: A Primer (Jan. 18, 2004), http://www.dechert.com/library/FS_2004-04.pdf. Instead, convictions under the Martin Act – which may be comprised of either misdemeanor or felony charges – require only a finding that some defrauding act was committed. N.Y. GEN. BUS. LAW§ 353; see also Jones, supra (“[T]he Martin Act includes all deceitful practices contrary to the plain rules of common honesty and all acts tending to deceive or mislead the public, whether or not the product of scienter or intent to defraud.”) (internal citations omitted); cf.DECHERT(“It is well settled that fraud exists not only where there has been an affirmative misstatement of a material fact, but also where there has been an omission of a material fact.”) (internal citations omitted).

In combination, the Martin Act’s tools for the investigation and prosecution of financial fraud allow the Attorney General of New York to subpoena persons and documents without oversight, interrogate investigatory targets in the absence of any right to counsel or against self-incrimination, publicize information obtained in criminal or civil investigations at his own discretion, and ultimately secure convictions without showing the accused ever intended to defraud the public. With these extreme provisions already in place, how could the Martin Act possibly gain strength ninety years after its enactment?

If – like me – you’d rather be building snowmen or watching the so-far phenomenal defense of Clay Matthews, A.J. Hawk, and Charles Woodson in post-season action (don’t get me wrong, I’m a Rodgers/Driver fan, too, but McCarthy’s play-calling sometimes makes the Pack’s offense hard for me to watch) than digging through the seemingly-endless snow-related news articles recently, you probably missed the Wall Street Journal’s last few write-ups on the Martin Act. In its most recent article, which can be found in blog form here, the Wall Street Journal reported that Manhattan District Attorney Cyrus R. Vance, Jr. plans to ask the New York legislature to amend the statute to include mandatory jail-time for some violators. Michael Rothfeld, D.A. Urges Tougher Martin Act, WALLST. J., Jan. 26, 2011, at C3. Vance will apparently propose sentences of up to twenty-five years for large-scale fraud, with a mandatory minimum term of one to three years for lesser violations. Id. Given the Act’s broad scope, however, mandatory jail-time for Martin violations could prove disastrous for the New York corporate world. Indeed, the Act, which covers “[a]ll acts tending to deceive or mislead the public,” see People v. Cadplaz Sponsors, Inc., 330 N.Y.S.2d 430, 432 (Sup. Ct. N.Y. County 1972), is already considered by some “the legal equivalent of a weapon of mass destruction” because of the unlimited damage it is capable of creating. SeeThompson, supra.

In addition to the Martin Act’s harsher penalties under Vance’s proposal, the Act’s application may be broadened by a recent court decision that calls into doubt more than twenty years of case law and suggests the Martin Act does not preempt certain private common-law claims. See Joseph De Simone et al., First Department Rejects Martin Act Preemption, MONDAQ, Jan. 18, 2011. Assured Guar. (UK) Ltd. v. J.P. Morgan Inv. Mgmt. Inc., 2010 WL 4721590 (N.Y.A.D. Nov. 23, 2010). As reported by Mondaq Business Briefing in January, the New York Supreme Court, Appellate Division found that the Martin Act does not preempt private common-law claims of breach of fiduciary duty, breach of contract, or gross negligence. Previously, defendants had successfully argued that CPCInt’l, Inc. v. McKesson Corp., 514 N.E.2d 116 (N.Y. 1987) and its progeny extend to completely preempt certain private common-law claims. See De Simone, suprasee also McKesson, 514 N.E.2d at 118-19. AlthoughMcKesson held only that the Martin Act did not permit individual litigants to sue for violation of the Act, the majority of state and federal courts – including the Second Circuit Court of Appeals – have been persuaded by the argument that Martin preempts even non-fraud common-law claims arising from actions that could be covered under the Act. De Simone, supra.

In its recent decision, the Appellate Division discussed both the Act’s legislative history, and the line of cases extending from McKesson before ultimately deciding that “many courts, particularly federal courts, have misinterpreted [McKesson] to find such preemption of common-law causes of action arising from facts which would support a Martin Act claim.” Assured Guar., 2010 WL 4721590, at *4. The court then concluded “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 [sic] preempts otherwise validly pleaded common-law cause of action.” Id. at *6.

Though the court’s decision is perhaps far from extraordinary in light of its finding that New York state courts seem to be moving away from a finding of preemption, see id., it does indicate that the Martin Act may now be used more extensively by the Attorney General, who will no longer need to be concerned about what private claims are being preempted. Additionally, although an appeal has been filed with the state’s highest court, the New York Court of Appeals – which has never made a decision on the Martin Act preemption issue – the decision in Assured Guaranty combined with the proposal made by District Attorney Vance suggests that a large segment of the corporate world could ultimately be facing both jail-time and private suits under the Martin Act.

Are these changes to the Act good for business? Good for New York? If the Martin Act continues to gain strength and exposure as it has in the last decade, these changes could arguably lead to the Act’s own demise as greater numbers of investigatory targets and legal commentators realize its almost unlimited power. See Thompson,supra. For the moment, though, it’s good to be Martin…even at ninety.