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Alexander J.

Nicas

Alexander J. Nicas

THE MARTIN ACT: POWERFUL, EXPANSIVE, AND POTENTIALLY


CONSTRAINED BY FUNDING. WHY THE LEGISLATURE MUST DECIDE WHO
DESERVES PROTECTION IN THE 21ST CENTURY.

I. Introduction

Ninety years ago, in 1921, the New York Legislature enacted Article 23-A of the

General Business Law, entitling it: “Fraudulent Practices in Respect to Stock, Bonds and

Other Securities.”1 This law, commonly referred to as the “Martin Act,” has become one of

the most powerful prosecutorial tools in the entire country.2 Powerful yes, but only for the

Attorney General of the State of New York. He3 has the sole right to prosecute under the

Martin Act’s disclosure and antifraud provisions.4 Within the last 13 months, nine cases in

the Southern District of New York have also held that the Martin Act preempts certain

common-law causes of action brought by an investor.5 The federal district court looked at

an unsettled landscape of case law and came down on the side of preemption.6 The

preemption question is a complex but important issue. If a private right of action is

unavailable, and the Martin Act preempts common-law remedies, what protection does an

investor have? Under these circumstances (no private right of action + common-law

1
N.Y. GEN. BUS. LAW, Art. 23-A (McKinney’s 2011).
2
Barry Kamins, The Martin Act: A Sleeping Giant, N.Y. L.J., Dec. 13, 2007, at 1.
3
The current Attorney General is Eric Schneiderman (January 1, 2011 – present). Throughout this paper I will
sometimes refer to the Attorney General as “he.”
4
Kerusa v. W10Z/515 Real Estate Ltd. P’ship, 12 N.Y.3d 236, 247 (2009); CPC Int’l v. McKesson Corp., 70
N.Y.2d 268, 275 (1987).
5
See Barron v. Igolnikov, No. 09 Civ 4471(TPG) 2010 WL 882890 (S.D.N.Y. Mar. 10, 2010), In re Tremont
Sec. Law, State Law and Insur. Litig., 703 F.Supp.2d 362 (S.D.N.Y. Mar. 30, 2010), Meridian Horizon Fund v.
Tremont Group Holdings, Inc., 747 F.Supp.2d 406 (S.D.N.Y. Mar. 31, 2010), Stephenson v. Citco Group Ltd.,
700 F.Supp.2d 599 (S.D.N.Y. Apr. 1, 2010), In re Beacon Assoc. Litig., No. 09 Civ. 777(LBS), 2010 WL
3895582 (S.D.N.Y. Oct. 5, 2010), In re Jeanneret Assoc., Inc., No. 09 Civ. 3907(CM), 2011 WL 33594
(S.D.N.Y. Jan. 31, 2011), In re Merrill Lynch Auction Rate Sec. Litig., No. 09 MD 2010(LAP), 2011 WL
536437 (S.D.N.Y. Feb. 9, 2011), In re Kingate Mgmt. Ltd. Litig., No. 09 Civ. 5386(DAB), 2011 WL 1362106
(S.D.N.Y. Mar. 30, 2011), In re Wachovia Equity Sec. Litig., Nos. 08 Civ. 6171(RJS), 09 Civ. 4472(RJS), 09
Civ. 5466(RJS), 09 Civ. 6351 (RJS), 2011 WL 1343027 (S.D.N.Y. Mar. 31, 2011).
6
See infra notes 91-113.

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remedies preempted), an investor is left to rely on the Attorney General’s discretionary

power to prosecute.

This paper explores the protection question from a policy, legislative intent and

common sense perspective. New York is arguably the epicenter of the financial world. For

this reason, New York must have state securities laws that facilitate its powerful position

while balancing the protections afforded to investors. The New York Legislature has

amended the Martin Act multiple times, but now the Legislature may need to step in once

again to clarify investors’ rights under the law. Alternatively, the New York Court of

Appeals could take up the issue. Multiple federal opinions mention this possibility, but the

Court of Appeals has no case on its docket that discusses the Martin Act preemption

question.7

This paper focuses on two main issues. Is there, or should there be, a private right of

action under the Martin Act? Even if the answer to that question is NO, as New York’s

highest court has said, are common-law causes of action completely preempted by the

Martin Act? I posit that the hybrid nature of the Martin Act – serving both the securities and

real estate markets – makes the preemption question extremely difficult. These two markets

are vitally important to the long-run health of New York; the Martin Act should therefore

regulate in the most efficient way – with clarity.

I posit that the Legislature must step in and clarify the law. We are in an age of

fiscal austerity. If the Legislature steps in and cuts the Attorney General’s budget, some

investors will likely be left with no right of redress. A read-through of a couple recent

7
See Joseph De Simone & S. Christopher Provenzano, Latest Guidance On This Uncertain Subject Breaks
With Well-Settled Federal Precedent, N.Y. L.J., Apr. 18, 2011, at 4 (mentioning that an important case –
Assured Guaranty (UK) Ltd. v. J.P. Morgan Inv. Mgmt. Inc. – has been appealed to the New York Court of
Appeals, but that the motion was granted with respect to an issue relating to the statute of limitations).

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amicus briefs filed by the Attorney General indicate that he believes preemption is not

warranted.8 I agree with now Governor Andrew Cuomo; state law does not support

preemption.

II. Introduction + History of the Martin Act

A. The Early 20th Century, a Financial Wild West.

Enacted in 1921, and named after its sponsor Assemblyman Louis M. Martin (R-

Clinton), the original law was viewed as weak.9 “Remedial in its character,” the Martin Act

only provided “for the investigation by the Attorney General of the fraudulent practices …

in respect to the sale of bonds, stocks, and other securities.”10 Weak or not, it was common

knowledge at the time that securities dealers openly pursued fraudulent practices.11 The

need to prevent this type of evil was very strong, and by 1925 all but two states had enacted

similar statues – known as “blue sky laws.”12 Blue sky laws filled a gaping regulatory hole

in the early 20th Century and generally protected against acts “[having] a tendency to

deceive or mislead the purchasing public.”13 To put it in perspective, federal securities

regulations (Securities Act of 1933 & Securities Exchange Act of 1934) were enacted more

than a decade, and in some cases more than two decades after states began regulating

8
Brief for the Attorney General of the State of New York as Amicus Curiae, Barron v. Igolnikov, No. 10-
1387-cv, 2010 WL 330648 (2nd Cir. 2010); Brief for the Attorney General of the State of New York as
Amicus Curiae, CMMF LLC v. J.P. Morgan Investment Management, Inc., No. 2009061924, 2009 NY App Ct.
Briefs 1924 (2010).
9
Kamins, supra note 2.
10
People v. Federated Radio Corp., 244 N.Y. 33, 37-38 (1926).
11
Orestes J. Mihaly & David J. Kaufman, Practice Commentaries, Art. 23-A, GEN. BUS. LAW, McKinney’s
Consolidated Laws, 413 [hereinafter Art. 23-A Practice Commentary]
12
Id.; see Hall v. Geiger-Jones Co., 37 S.Ct 217 (1917) (indicating that evil the laws aimed to curtail were
speculative schemes grounded in nothing more than “so many feet of blue sky); see also Kamins, supra note 2
(stating that New York was actually one of the last states to pass a blue sky law).
13
Federated Radio Corp., 244 N.Y. at 39.

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fraudulent securities practices.14 Today, blue sky laws such as the Martin Act are in place in

all fifty states and work in conjunction with federal securities regulations.

Prior to enactment in 1921, the New York Legislature considered two types of

statues. The first type required the obtaining of a license as a prerequisite to the sale of

securities, with the forfeiture of the license as punishment for engaging in fraudulent

practices.15 The second type did not require a license yet punished by removing the right to

issue securities once fraudulent practices were engaged in.16 Considerable debate between a

commission of bankers, securities dealers, and investors ensued, resulting in the original

statute being structured as the latter type – no license was required.17 Legislative documents

indicate the commission recommended: “[t]he Attorney General should be fully empowered

and under the duty … to investigate any transaction … [and] can pursue whom [he] will

with [his] investigation, and [he] can obtain more information in respect to the issuance and

negotiation of securities than anyone could be required to give under any statute which has

been enacted or contemplated.”18

Becoming a law on May 7, 1921, the legislation gave the Attorney General

significant power.19 First, the power to investigate allowed the Attorney General to request

information when “it shall appear … either upon complaint, or otherwise” that there are

“fraudulent practices.”20 Although not defined in the statute, fraudulent practices were

14
See Kamins, supra note 2 (noting that Kansas enacted the first blue sky law in 1911); see also Art. 23-A
Practice Commentary, supra note 7 at 416 (discussing how the Martin Act and Securities Acts of 1933 and
1934 are virtually identical in their design and scope, and the purpose for which they were enacted).
15
Art. 23-A Practice Commentary, supra note 7 at 414.
16
Id.
17
Id. It is clear that the original intent was not to create a licensing system, but as will be discussed later, a
portion of the statute now requires some registration in the form of an offering statement. See infra notes 46-61
and accompanying test.
18
Id. (citing Legislative Document #81 of 1920).
19
L. 1921, c. 649
20
Id.

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“given a wide meaning, so as to include all acts, although not originating in any actual evil

design or contrivance to perpetrate fraud or injury upon others, which do by their tendency

to deceive or mislead the purchasing public come within the purpose of the law.”21 Under

this standard, the Attorney General need not prove actual or intentional fraud.22 Second, the

power to enjoin allowed the Attorney General to bring an action against anyone that “has

engaged in, is engaged or is about to engage in” fraudulent practices.23 Section 352 (the

power to investigate) & §353 (the power to enjoin) bestow great power upon the New York

Attorney General. Although great, this power is discretionary.

B. Giving the Martin Act Some “Teeth” (§352-c)

The first major amendment to the Martin Act occurred in 1955.24 Creating §352-c of

N.Y. General Business Law, the Martin Act now provided an additional deterrent to fraud

when it predicated culpability on mere conduct, without the need to prove intent.25 Section

352-c also defined certain acts as criminal, punishable as a misdemeanor. 26 The removal of

scienter greatly expanded the statute’s capability; the Martin Act became, in part, a strict

liability criminal statute.27 The imposition of criminal liability coupled with the removal of

scienter (as an element of the crime) makes the Martin Act one of the strongest blue sky

laws in the country.28

21
People v. Federated Radio Corp., 244 N.Y. 33, 38-39 (1926).
22
See id. at 41.
23
N.Y. GEN. BUS. LAW § 353; see also L. 1921, c. 649, §1 (enabling the Attorney General to enjoin persons
from participating in, or about to participate in fraudulent practices).
24
L.1955, c. 553, § 2.
25
Art. 23-A Practice Commentary, supra note 7 at 415.
26
N.Y. GEN. BUS. LAW § 352-c(4) (McKinney’s 2011).
27
See Kamins, supra note 2.
28
See Art. 23-A Practice Commentary, supra note 7.

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In 1982, the Legislature enhanced the criminal penalties when they added two felony

provisions.29 The first provision made it a class E felony to intentionally defraud ten or

more people.30 The second provision made it a class E felony to “intentionally engag[e] in

fraud, deception, concealment, suppression, false pretense or fictitious or pretended

purchase or sale, or who makes any material false representation or statement with intent to

deceive or defraud.”31 The latter provision provides the Attorney General with considerable

leeway to punish intentional fraud. Different than the misdemeanor section of the statute,

scienter is reintroduced under the felony provisions.32 Therefore, a class E felony,

punishable by up to four years in prison, requires the Attorney General to prove intent. The

Legislature also added a “repeat offender” provision, raising the penalty to a class E felony

for those who have already committed a misdemeanor under the Martin Act within the

preceding five years.33 Shortly thereafter, the Legislature deemed a violation under the

Martin Act a “criminal act” pursuant to the Enterprise Corruption Statute, and added a

Martin Act felony as a “designated offense” for which a prosecutor could now apply for an

eavesdropping warrant.34

Making the Martin Act a criminal statute strengthened it considerably. Although the

felony sections require intent, the absence of scienter for misdemeanors is the hallmark of

the Attorney General’s power. It is also clear that if the Attorney General chooses to begin

an investigation, the offending party must comply and disclose its activities. But, what if the

Attorney General chooses not to pursue an action?

29
L.1982, c. 146, § 3.
30
N.Y. GEN. BUS. LAW § 352-c(5).
31
Id. at § 352-c(6).
32
Id. at § 352(c)(6).
33
L.1982, c. 825, § 1.
34
N.Y. PENAL LAW 460.10(1)(b) & N.Y. PENAL LAW 700.05(8)(m); see also Kamins, supra note 2.

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III. Current Scope of the Martin Act

The Attorney General has wide discretion to determine when an inquiry is warranted,

and can choose not to bring an action.35 This is an important point to highlight once again.

If the Attorney General chooses not to bring an action, those harmed by fraudulent practices

have no option but to bring a private cause of action. As will be discussed later, this private

action could take two forms: (1) a suit under the Martin Act or (2) a common-law cause of

action such as breach of fiduciary duty or negligent misrepresentation.

If the Attorney General begins an investigation, he has “exceedingly broad” –

indeed, “inquisitorial” – powers under the Martin Act.”36 The Attorney General is

empowered to: conduct a confidential investigative hearing, subpoena books and records,

issue a subpoena to compel witness testimony, or require a written statement under oath.37

Failure to comply with any of the aforementioned subpoenas constitutes a misdemeanor

under the statute and the Attorney General can prosecute without a court order.38 The

Martin Act is the only statute of its kind that vests criminal and civil enforcement authority

in one agency.39

A. Bifurcated – One Martin Act, Two Regulations40

The Martin Act is also unique because it governs two distinct and critical areas of the

economy – the securities and real estate markets.41 Securities regulation is an area that most

people have some understanding of. We need look no further than the recent financial crisis

to understand how vitally important the stock market and Wall Street is to our economic

35
See Charles H. Greenthal & Co., Inc. v. Lefkowitz, 41 A.D.2d 818 (1st Dep’t 1973).
36
Gonkjur Assoc. v Abrams, 88 AD2d 854, 855-56 (1st Dep’t 1982).
37
See Art. 23-A Practice Commentary, supra note 7; see also Kamins, supra note 2.
38
Id.
39
Kamins, supra note 2.
40
An additional section of the Martin Act that I will not be discussing – §352-b – deals with the regulation of
“non-resident brokers, dealers, salesman and investment advisors….” See N.Y. GEN. BUS. LAW § 352-b.
41
See Art. 23-A Practice Commentaries, supra note 7.

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well-being. Just as intended in 1921, the Martin Act of today protects New Yorkers from

the fraudulent sale of securities – i.e. stocks, bonds, commodities or other investment

vehicles.42 The Martin Act’s regulation of the real estate market is something that most

people know nothing about. This area focuses on the sale of a security interest in real estate,

sometimes called a real estate syndication.43 To put it a different way, a developer buys a

building, rehabilitates it, and sells the condo or cooperative apartments as an interest in real

estate. In this context, the Martin Act protects a unit purchaser from fraudulent practices in

the offering, or sale of their unit. Especially in New York City, where the sale of condo or

cooperative apartments is big business, this protection is also vitally important. Drawing a

distinction between “how” the Martin Act regulates these markets is not difficult. The

statute requires the filing of an “offering statement” prior to the sale of an interest in real

estate.44 In contrast, no such “offering statement” is required prior to the sale of securities.45

The purpose of this paper is not to dissect this difference, but to show that this difference

confuses courts when applying the law. To illustrate in the best way possible, some

understanding of the bifurcated regulation is necessary.

B. Real Estate Syndications, Cooperative and Condominium Offerings

Section 352-e of the N.Y. General Business Law requires the filing of an offering

statement or prospectus with the New York Attorney General’s office.46 The filing must:

“afford potential investors, purchasers and participants an adequate basis upon which to

found their judgment and shall not omit any material fact or contain any untrue statement of

42
Id.
43
N.Y. GEN. BUS. LAW § 352-e.; See also Christine Gimeno et al, New York Jurisprudence §220 (2d. ed.
2011).
44
N.Y. GEN. BUS. LAW § 352-e
45
See Art. 23-A Practice Commentary, supra note 7 (stating that 48 states require securities registration prior
to the offer or sale of securities, but in New York there is no requirement except in three specific areas, one of
which being real estate securities, including the sale of cooperative and condominiums).
46
Id.

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material fact.”47 The filing must be done prior to any offering of interest, and the Attorney

General must approve the prospectus.48 The required elements of the prospectus have been

laid out in regulations issued by the Attorney General.49 If the Attorney General rejects the

prospectus at the outset, the plan sponsor has the opportunity to correct the deficiencies.50

The Attorney General may also require an inspection to be made in the connection with a

real estate syndication, cooperative, or condominium offering.51

To the learned investor, a real estate syndication resembles an investment contract.52

This class of “securities” fits within the guise of state securities regulation, but why

cooperative and condominium offerings? Basically, the New York Legislature chose to slip

them into the Martin Act, and did so without much debate. A review of the legislative

history indicates that cooperative offerings were only included as an afterthought by one

policy advocate.53 Inclusion was not without reason though; a cooperative offering is an

offering of stock plus a proprietary lease.54 The inclusion of condominium offerings is more

peculiar. There is no offering of stock with condominiums; the transaction constitutes an

ownership in real estate.55 As with cooperatives, there was no debate as to whether

47
N.Y. GEN. BUS. LAW § 352-e(1)(b)
48
See Vincent Di Lorenzo, N.Y. Condominium and Cooperative Law § 2:11 (2d ed. 2010).
49
13 N.Y.C.R.R. § 18, 20, 21, 22, 23, 24.
50
N.Y. GEN. BUS. LAW § 352-c(2).
51
Id. at § 352-e(7)(b).
52
Vincent Di Lorenzo, Disclosure as Consumer Protection: Unit Purchasers’ Need For Additional
Protections, 73 St. John’s L. Rev. 43, 47 (1999). See also Art. 23-A Practice Commentary, supra note 7 at
486.
53
Di Lorenzo, supra note 52 (discussing how cooperative unit offerings were added to the list of covered
securities at the behest of the Chief of the Securities and Real Estate Financing Bureau, and therefore not a
deliberated choice by legislature).
54
Id. at 48 (stating that while not deliberated by the legislative body, full disclosure of risk by plan sponsors
could have been viewed in the 1960’s as an effective mechanism to protect unit purchasers against abuses in
unit offerings).
55
Id.

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regulation of condominiums should be incorporated into the Martin Act. Instead, the only

discussion related to the structure of the condominium and the condominium association.56

There are other parts of §352-e that also deal with real estate – §§ 352-ee, 352-eee,

352-eeee. These sections regulate the conversion of non-residential property to residential

cooperative ownership57, and residential property conversion to cooperative or

condominium ownership in Nassau, Westchester, and Rockland Counties58, or in the City of

New York.59 The core requirement under §§ 352-ee, 352-eee, and 352-eeee is full disclosure

through the offering statement.60 But, the regulation of conversions deviates from the norm

because it provides substantive protections to certain constituencies: non-purchasing tenants,

senior citizens and disabled persons who live in premises being converted to cooperative or

condominium ownership. This is the only section in the entire Martin Act that provides

substantive protections to a defined constituency.61

C. Securities Offerings

Besides the last few paragraphs, this paper has generally referred to securities

offerings as the sale of stocks, bonds, commodities or other investment vehicles. In New

York, there is no requirement to file, use or gain approval for a prospectus prior to an

offering or sale of securities.62 This is in-line with the original legislative intent from 1921,

but to put this in perspective, forty-eight states require securities registration prior to initial

or secondary offerings or sales.63 Without a registration requirement, courts have broadly

56
Id. at 49 (stating also that there was no discussion regarding the usefulness of the disclosure approach to the
newly emerging condominium market).
57
See N.Y. GEN. BUS. LAW §352-ee
58
See id. § 352-eee
59
See id. § 352-eeee
60
See Art. 23-A Practice Commentary, supra note 7 at 472-73.
61
Id.
62
See Art. 23-A Practice Commentary, supra note 7 at 413.
63
Id.

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defined the terms of the Martin Act and liberally constructed its provisions.64 One court

stated that Martin Act regulations “must not be strictly interpreted but should be given a

pliable yet resilient construction enabling them to be applied to individual situations in a

manner which best fulfills their beneficial purpose.”65 The beneficial purpose this court was

talking about was to “provide a remedy to those who have fallen prey to the exploitation of

the public by unscrupulous individuals.”66

To fall within the purview of the Martin Act’s regulation of securities offerings,

there must be a “public offering” of a “security,” and disclosures to investors must include

all “material” information.67 If one of the elements is not satisfied, the Attorney General

may not have jurisdiction because the potential fraud may not constitute a violation of the

Martin Act. A security generally refers to instruments for payment of money or evidencing

title or equity, with or without collateral obligation.68 The judiciary in New York has also

incorporated the Howey test, which is the primary test employed by federal courts when

looking at investment contracts.69 To be a public offering, multiple factors are important:

“(1) the number of offerees involved (not just the number of actual purchasers; (2) the

number of units offered; (3) the size of the offering; and, (4) the manner of the offering.”70

The final element – materiality – advances the purpose of the Martin Act (i.e. to insure

prospective purchasers are furnished with sufficient, non-fraudulent information).71 If a fact

64
Id.
65
Gardner v. Leftkowitz, 97 Misc.2d 806, 813 (Sup. Ct. New York County Dec. 14, 1978).
66
Id. at 812.
67
See Art. 23-A Practice Commentary, supra note 7 at 416.
68
Id. at 417.
69
SEC v. W.J. Howey Co., 328 U.S. 293 (1946). The court defined an investment contract as “a contract,
transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits
solely from the efforts of the promoter or a third party.” See Art. 23-A Practice Commentary, supra note 7 at
418.
70
People v. Landes, 192 A.D.2d 1, 4, 600 N.Y.S.2d 292, 294 (3d Dep’t 1993).
71
See Art. 23-A Practice Commentary, supra note 7 at 423.

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is material, and omitted from any disclosure, the Attorney General will be able to investigate

the fraudulent practice. Ironically, the standard for materiality was defined by the Court of

Appeals in a case dealing with the conversion of a cooperative apartment building.72 The

Court stated: “there must be a substantial likelihood that the disclosure of the omitted fact

would have been viewed by a reasonable investor as having significantly altered the total

mix of information made available.”73

The bifurcated, or hybrid regulation of the Martin Act allows the Attorney General to

police a wide spectrum of economic activity. The question is, is the scope of the Martin Act

too large for one man or one office to handle? The Attorney General thinks so.74

IV. Private Right of Action – CPC & Kerusa

If he Attorney General chooses not to bring an action, does an investor have access

to an implied private right of action for possible violations of the Martin Act? In short, the

answer is no. The New York Court of Appeals has spoken with distinction twice; first

discussing the antifraud provisions (§352-c), and second discussing the disclosure

requirements (§352-e) of the Martin Act.

In 1987, the Court in CPC Int’l Inc. v. McKesson Corp. held that there was no

implied right of action under the antifraud provisions (§352-c) of the Martin Act.75 In a 6-2

decision (Justice Kaye took no part), the majority stated: “the purpose of the statute was to

create a statutory mechanism in which the Attorney General would have broad … powers to

prevent [fraud] by investigating and intervening at the first indication.”76 Because the

72
State v. Rachmani Corp., 71 N.Y.2d 718, 525 N.E.2d 704 (1988).
73
Id. at 726 (looking to Supreme Court decisions involving Federal securities statutes for guidance, the Court
determined that the objective test for materiality of an omission is equally appropriate in the conversion of a
cooperative apartment).
74
See supra note 8.
75
70 N.Y.2d 268 (1987).
76
Id. at 277.

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statute only granted one individual power, “an implied private action is not consistent with

the legislative scheme underlying the Martin Act.”77 Ironically, the author of the majority

opinion dissented on this specific issue, and was able to weave his dissent into the majority

opinion.78 Judge Hancock Jr. and Judge Simons believed the underlying purpose of the

statute was not to grant power to the Attorney General, but rather to deter fraudulent

practices.79 The dissenting justices believed that the majority was wrong when it found that

“plaintiff[s] [did not] belong to the class of legislatively intended beneficiaries.”80 The

majority opinion went on to suggest that there are reasons the “Legislature [might] consider

the merits of a statutorily expressed cause of action.”81 They explained why it would offer a

remedy to defrauded investors, and how legislative action would be “consistent with blue

sky laws of the other States which, except for Rhode Island, all expressly provide some form

of civil liability.”82 Nevertheless, the majority determination that there is no implied private

right of action under §352-c is widely held as binding precedent.83

The Court of Appeals returned to the issue in 2009 and discussed a private right of

action utilizing the disclosure requirements of §352-e.84 In Kerusa, the Court held that

plaintiff’s cause of action relied entirely on alleged omissions from required filings, and that

“common-law fraud does not transmute a prohibited cause of action to enforce Martin Act

77
Id. (citing Burns Jackson Miller Summit & Spitzer v. Lidner, 59N.Y.2d 314, 329 (1983)).
78
Id.; see also Art. 23-A Practice Commentary, supra note 7 (stating that the Court of Appeals invoked the
“political question” doctrine because they stated that an implied private right of action is not consistent with
the legislative theme while unanimously recognizing that there are reasons for the Legislature’s review of the
issue.)
79
Id.
80
Id. Justice Hancock Jr. cited the Attorney General’s Memorandum in support of amendments to the law in
1955 and other pieces of legislative history to bolster the two-man dissent. Id.
81
Id.
82
CPC Int’l Inc., 70 N.Y.2d at 278.
83
See Art. 23-A Practice Commentary, supra note 7 at 441 (mentioning how every decision since CPC has
followed its dictates).
84
Kerusa v. W10Z/515 Real Estate Ltd. P’ship, 12 N.Y.3d 236, 245 (2009). The Legislature had not taken the
advice of the Court in CPC, and at the time of the Kerusa decision, there had been no statutory changes to the
Martin Act.

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disclosure requirements into an independent common-law tort.”85 The Court did not

determine whether an alleged misrepresentation could be the basis of a suit, just that an

alleged omission from required disclosure was insufficient.86 Allowing an omission claim

“would invite a backdoor private cause of action to enforce the Martin Act in contradiction

to [our] holding in CPC Int’l.”87 In effect, the Court believed that omission was a slippery

slope in real estate cases governed by §352-e.88

In light of CPC and now Kerusa, “both state and federal courts have consistently and

properly held that where a pleading is drafted in such a way to cast what is clearly an

obligation under the Martin Act as a common-law cause of action, that complaint would

constitute, in effect, a prohibited cause of action based upon the provisions of the Martin

Act.”89 Looking back to the bifurcated nature of the Martin Act, each case speaks for a

different section (§352-c vs. §352-e) yet comes to the same result – there is no implied

private right of action based upon the provisions of the Martin Act. However, neither case

held nor implied that the Martin Act preempts properly pleaded common-law causes of

action.90

85
Id. at 247.
86
See id. at n. 5. The Court did discuss Kerusa’s claim of fraudulent concealment, but determined that nothing
in the complaint supported active concealment unrelated to alleged omissions from Martin Act disclosures. Id.
at 246.
87
Id. at 245.
88
See generally id. at 245-46 (agreeing with the Real Estate Board of New York who pointed out that
expanding the already detailed disclosure requirements by forcing parties to disclose normal problems
encountered in the course of construction would transform every potential latent construction defect case into a
claim for common-law fraud based on alleged omissions.)
89
Assured Guaranty (UK) Ltd. V. JP Morgan Inv. Mgmt. Inc., 2010 WL 4721590, at *4 (1st Dep’t 2010)
(citing a number of Court of Appeals cases and one Second Circuit decision).
90
Id.

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Alexander J. Nicas

V. Preemption

If a private right of action is unavailable, are common-law remedies available to an

alleged defrauded investor? Nine federal cases (all S.D.N.Y) decided within the last 13

months convincingly say NO – negligent misrepresentation, breach of fiduciary duty, gross

negligence, and even common-law fraud are all preempted by the Martin Act.91 Four of

these cases were decided since the beginning of 2011.92 Many of the recent decisions

explicitly relied on one Second Circuit decision from 2001: Castellano v. Young & Rubicam,

Inc. 93

Before I go further, it is worth noting that one month prior to the decision in

Castellano, the Second Circuit declined to decide the same issue in Suez Equity Investors,

L.P. v. Toronto-Dominion Bank.94 The court stated: “[w]e do not reach the Martin Act

[preemption] question. The New York Court of Appeals has not yet addressed this issue, and

91
See Barron v. Igolnikov, No. 09 Civ 4471(TPG) 2010 WL 882890, at *6 (S.D.N.Y. Mar. 10, 2010)
(dismissing common-law claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty,
gross negligence, and unjust enrichment), In re Tremont Sec. Law, State Law and Insur. Litig., 703 F.Supp.2d
362, 373 (S.D.N.Y. Mar. 30, 2010) (dismissing all non-fraud common-law claims), Meridian Horizon Fund v.
Tremont Group Holdings, Inc., 747 F.Supp.2d 406, 415 (S.D.N.Y. Mar. 31, 2010) (dismissing all non-fraud
common-law claims), Stephenson v. Citco Group Ltd., 700 F.Supp.2d 599 (S.D.N.Y. Apr. 1, 2010) (finding
that the overwhelming weight of authority supports Martin Act preemption of negligence and breach of
fiduciary duty claims), In re Beacon Assoc. Litig., No. 09 Civ. 777(LBS), 2010 WL 3895582 (S.D.N.Y. Oct. 5,
2010) (dismissing breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligent
misrepresentation, gross negligence and unjust enrichment claims because they all fall within the purview of
the Martin Act), In re Jeanneret Assoc., Inc., No. 09 Civ. 3907(CM), 2011 WL 33594 (S.D.N.Y. Jan. 31, 2011)
(dismissing a number of claims, including common-law fraud, as preempted by the Martin Act), In re Merrill
Lynch Auction Rate Sec. Litig., No. 09 MD 2010(LAP), 2011 WL 536437, at n.6 (S.D.N.Y. Feb. 9, 2011)
(stating that a negligent misrepresentation claim is preempted by the Martin Act), In re Kingate Mgmt. Ltd.
Litigation, No. 09 Civ. 5386(DAB), 2011 WL 1362106, at *10-12 (S.D.N.Y. Mar. 30, 2011) (dismissing
negligent misrepresentation, gross negligence, negligence, breach of fiduciary duty claims as preempted by the
Martin Act), In re Wachovia Equity Secur. Litig., Nos. 08 Civ. 6171(RJS), 09 Civ. 4472(RJS), 09 Civ.
5466(RJS), 09 Civ. 6351 (RJS), 2011 WL 1343027, at *37 (S.D.N.Y. Mar. 31, 2011) (dismissing negligent
misrepresentation claim). But see Anwar v. Fairfield Greenwich, 728 F.Supp.2d 354, 371 (S.D.N.Y. July 29,
2010).
92
See In re Jeanneret Assoc., 2011 WL 33594, In re Merrill Lynch Auction Rate Sec. Litig., 2011 WL 536437,
In re Kingate Mgmt. Ltd. Litig., 2011 WL 1362106, In re Wachovia Equity Sec. Litig., 2011 WL 1343027.
93
257 F.3d 171 (2d Cir. 2001) (dismissing a breach of fiduciary duty claim); see also Nanopierce Tech., Inc. v.
Southridge Capital Mgmt., No. 02 Civ. 0767(LBS), 2003 WL 22052894 (S.D.N.Y. Sept. 2, 2003), Pro Bono
Inv., Inc. v. Gerry, No. 03 Civ 4347(JGK), 2005 WL 2429787 (S.D.N.Y. Sept. 20, 2005). But see Cromer
Finance Ltd. v. Berger, No. 00 CIV 2498, 2001 WL 1112548 (S.D.N.Y. Sept. 19, 2001)
94
250 F.3d 87, 104 (2d Cir. 2001).

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Alexander J. Nicas

the lower court cases cited by defendant do not explore the issue with the level of depth that

would justify a ruling by us in the first instance.”95

Nonetheless, the Second Circuit took up the issue in Castellano, stating: “principles

of federalism and respect for state courts’ interpretation of their own laws counsel against

ignoring the rulings of those New York courts that have taken up the issue [of

preemption].”96 Citing two Appellate Division cases, decided in 1992 and 1989

respectively, the court “determined that sustaining a cause of action for breach of fiduciary

duty in the context of securities fraud would ‘effectively permit a private action under the

Martin Act, which would be inconsistent with the Attorney-General’s exclusive power

thereunder.’”97 The two cases – Eagle Tenants & Horn – are not only distinguishable

because they deal with the Martin Act’s regulation of real estate (pursuant to disclosure

requirements in §352-e), they have been superseded by subsequent case law in all four

Appellate Divisions.98 It is clear that the Second Circuit’s decision in Suez Equity was the

appropriate one; history has proven Castellano wrong.

Just after Castellano, the Fourth Department decided Scalp & Blade Inc. v. Advest

Inc.99 Scalp & Blade held that “[n]othing in the Martin Act, or in the Court of Appeals cases

construing it, precludes a plaintiff from maintaining common-law causes of action based on

95
Id. The Second Circuit in Suez explicitly stated: “We are not immediately persuaded that the Court of
Appeals would follow their lead, nor have the parties referred us to any apposite federal precedent.” Id.
“Their” was referring to the same cases relied on in Castellano, as well as an additional real estate disclosure
case – Rego Park Gardens Owners, Inc. v. Rego Park Gardens Assoc., 191 A.D2d 621, 622 (2d Dep’t 1993).
Id.
96
Castellano, 257 F.3d at 190.
97
Id. (citing Eagle Tenants Corp. v. Fishbein, 182 A.D.2d 610, 611 (2d Dep’t 1992)); see also Horn v. 440
East 57th Co., 151 A.D2d 112 (1st Dep’t 1989). A review of Eagle Tenants Corp, 182 A.D.2d at 611 indicates
that the court cited CPC Intl., 70 NY2d at 276-277 and Horn 151 A.D.2d at 120.
98
See infra notes 98-109 and accompanying text.
99
182 A.D.3d 882 (4th Dep’t 2001).

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Alexander J. Nicas

such facts as might give the Attorney General” a similar basis for prosecution.100 Plaintiff’s

negligent misrepresentation and breach of fiduciary duty claims were not preempted.101

Within a year, the Third Department agreed when it considered, on the merits, breach of

fiduciary duty and negligent misrepresentation claims against an investment advisor.102

Both cases set precedent, but Scalp & Blade is incredibly significant because it answered the

precise question asked in a few of the recent federal cases – is a non-scienter based

common-law claim involving investment securities preempted by the Martin Act?103

The Second Department has also addressed the issue of Martin Act preemption in

Caboara v. Babylon Cove Development LLC.104 The court in Caboara reversed the

dismissal of a complaint brought by purchasers of condominium units against the sponsor,

holding that “private causes of action sounding in common-law fraud and breach of contract

may rest upon the same facts that would support a Martin Act violation as long as they are

sufficient to satisfy traditional rules of pleading and proof.”105 The court went on to state

that nothing in the “clear import of the Martin Act” requires a conclusion that the

Legislature intended to abrogate the common-law.106

The First Department waited until November 2010 to weigh in, but has followed the

path laid out by the other Appellate Divisions when it decided that the Martin Act did not

preempt breach of fiduciary duty, breach of contract, or gross negligence claims against an

investment management company.107 In Assured Guaranty (UK) Ltd. v. J.P. Morgan

Investment Management, Inc., the court held that “there is nothing in the plain language of

100
Id. at 883.
101
Id.
102
See Rasmussen v. A.C.T. Envtl. Serv., Inc. 292 A.D.2d 710 (3d Dep’t 2002)
103
See supra note 8.
104
54 A.D.3d 79 (2d Dep’t 2008)
105
Id. at 80.
106
Id. at 83.
107
Assured Guaranty (UK) Ltd. V. JP Morgan Inv. Mgmt. Inc., 2010 WL 4721590, at *9 (1st Dep’t 2010).

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Alexander J. Nicas

the Martin Act, its legislative history or appellate level decision in this State that supports

defendant’s argument that the act preempts otherwise validly pleaded common-law causes

of action.”108 The court, looking to the Court of Appeals holding in CPC Int’l, emphasized

that just because there is “no private right of action under a statute does not automatically

mean that the statute preempts common-law causes of action”, and specifically highlighted

how the Court of Appeals permitted the plaintiff to proceed on its claim for common-law

fraud.109 The First Department has subsequently reaffirmed its decision in two cases:

CMMF, LLC v. J.P. Morgan Investment Management110 & Silver Oak Capital L.L.C. v. UBS

AG111.

It is without question that the First, Second, Third and Fourth Departments have all

held that the Martin Act does not preempt properly pleaded common-law causes of action.

A Southern District opinion two years after Castellano said that the few cases against

preemption “stand as solitary islands in a stream of contrary opinion,” and did not persuade

the court to abandon the Second Circuit in Castellano.112 The Second Circuit will once

again be able to survey the horizon and determine whether only solitary islands still exist –

the court docketed Barron v. Igolnikov and heard oral arguments on March 1, 2011.113 The

court’s decision is still outstanding, but absent a ruling from the New York Court of

Appeals, the Second Circuit will likely follow their precedent in Castellano.
108
Id. at *6 (stating further that the decision is consistent with the general rule of statutory construction that a
clear and specific legislative intent is required to override the common-law).
109
Id. at *4.
110
78 A.D.3d 562, 564 (1st Dep’t 2010) (stating that the court below correctly determined that plaintiff’s
causes of action for negligence and breach of fiduciary duty are not precluded by the Martin Act).
111
82 A.D.3d 666, *1 (1st Dep’t 2011) (stating that plaintiff’s claims of negligent misrepresentation and unjust
enrichment are not barred by the Martin Act).
112
See Nanopierce Tech., Inc. v. Southridge Capital Mgmt., No. 02 Civ. 0767(LBS), 2003 WL 22052894, at
*4 (S.D.N.Y. Sept. 2, 2003) (listing Scalp and Blade and Cromer (a Southern District case that relied on Scalp
when refusing to dismiss a negligence claim based on Martin Act preemption, infra note 97) as the solitary
islands).
113
United States Court of Appeals, Second Circuit, Docket #10-1387-cv, oral argument schedule available at
www.ca2.uscourts.gov/Docs/Calendar/feb/feb28.pdf.

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Alexander J. Nicas

VI. Why All The Confusion?

The Second Circuit relied exclusively on real estate cases when answering the

preemption question in Castellano.114 Another oft-cited decision, Nanopierce (“solitary

islands in a stream of contrary opinion”), also exclusively discussed real estate cases.115

But, both of these cases dealt with securities … how could they exclusively cite the Martin

Act’s real estate cases?

In the summer of 2010, District Court Judge Victor Marrero authored a

groundbreaking opinion summarily dismissing Martin Act preemption in a federal securities

case. He carefully traced the issue’s entire history, focusing on one shift in language that

gave rise to broad federal preemption: “there is no implied private cause of action for

violation of the antifraud provisions of the statute”116 to “there is no private right of action

for claims covered by the Martin Act117.118 This simple change (“for violation of” to “for

claims covered by”) allowed Martin Act preemption to quickly go viral.119 The new

language “significantly expanded the rule from state courts, which had only dismissed

claims relying solely on [the Martin Act’s] real estate regulations … and had never

preempted any causes of action that existed independent of the Martin Act.”120 Federal

courts that have used this fortuitous language have done so “by relying on the mirage

created by state courts dismissing claims in real estate cases where the Martin Act, through

114
Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 190 (2nd Cir. 2001) (citing CPC Int’l for the
proposition that there is no private right of action under the Martin Act in New York, while focusing on Eagle
Tenants & Horn to discuss the preemption question).
115
Nanopierce, 2003 WL 22052894 at *4 (citing the two cases from Castellano, and two additional
116
Breakwaters Townhomes Ass’n of Buffalo, Inc. v. Breakwaters of Buffalo, Inc., 207 A.D.2d 963, 964 (4th
Dep’t 1994)
117
Indep. Order of Foresters v. Donaldson, Lufkin & Jenrette Inc., 919 F.Supp. 149, 153 (S.D.N.Y. Mar. 23,
1996).
118
Anwar v. Fairfield Greenwich Ltd., 728 F.Supp.2d 354, 364 (S.D.N.Y. July 29, 2010).
119
Id. (citing seven Southern District cases that utilized the “covered by” language).
120
Id.

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Alexander J. Nicas

the regulations promulgated by the Attorney General, imposes more burdens than the

common law.”121 Preemption is a complex issue, but the hybrid regulation of the Martin Act

– securities and real estate – has made it even more difficult for courts to apply the law.

Given the fact that the Second Circuit will soon decide the preemption question in Barron, a

second-look at the hybrid regulation may be in order.

VII. Implications – The Fight For Your Rights

If the Second Circuit follows its precedent in Castellano, common law causes of

action (i.e. breach of fiduciary duty, negligent misrepresentation and gross negligence) will

be unavailable in New York federal courts. This could lead to a large number of defrauded

investors going without justice in the cases the Attorney General does not or cannot

prosecute.

The age of fiscal austerity is upon us, and the ability to bring common-law causes of

action may actually make the Attorney General’s job easier. One policy argument for

preemption is that it is needed in order to protect the exclusive authority of the Attorney

General to enforce the Martin Act.122 But today, this argument holds no water. The New

York Court of Appeals has definitively said that there is no implied private right of action

under the Martin Act. This is settled law, and the Attorney General’s power is fully intact.

A properly pleaded common-law cause of action is independent of a private right of action

and is therefore not within the Attorney General’s authority under the Martin Act. By

allowing a private remedy, the Attorney General will work side-by-side with investors to

police the marketplace and eliminate fraudulent practices.123

121
Id.
122
Brief for the Attorney General of the State of New York as Amicus Curiae, Barron v. Igolnikov, No. 10-
1387-cv, 2010 WL 330648 (2nd Cir. 2010).
123
See id.

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Alexander J. Nicas

VIII. Conclusion

There are three main reasons to decide against preemption: (1) under Erie, state law

governs and there is enough uniformity in state courts to merit congruent treatment in the

Second Circuit; (2) efficient 21st Century regulation of the marketplace (real estate and

securities) should be comprised of a properly pleaded common-law cause of action and an

action by the Attorney General under his Martin Act powers; (3) preemption is a matter of

legislative intent, and there is nothing that suggests the legislature intended to preempt

common-law causes of action.

Until a New York Court of Appeals decision or a legislative change to the statute,

the Second Circuit will likely stick to its guns and approve preemption. The Erie doctrine

certainly warrants review of the Appellate Division cases, but their decision is not

determinative. Every federal case to say YES to preemption within the last 13 months dealt

with the Bernie Madoff ponzi scheme. The Second Circuit may see preemption as a way out

in the face of potentially voluminous litigation. I posit that this is the wrong decision, and is

not supported by state law.124

The reality is that we live in an increasingly complex financial world. Capital

markets are larger and more relevant than ever before. New York State is a global leader in

financial markets, and must regulate in a way that balances that position while providing

protection to those who invest here. New York is one of only five states that does not allow

an implied private right of action under its blue sky law.125 Because of the Martin Act’s

124
On the state-federal conflict of law issue, it goes without saying that there are other unexplored policy
issues at play. For one, without preemption, federal-state forum shopping could become prevalent. Second, a
cogent preemption argument could be made in regard to other federal securities regulations. If preemption is
denied and these cases go to trial on the merits, federal preemption arguments will heat up.
125
See Barbara J. Hart & Kesav Wable, New York’s Martin Act: Investor Shield or Fraudster
Shield?, N.Y. L.J., Dec. 11, 2009, at 4.

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Alexander J. Nicas

“inquisitorial” powers, this result is likely warranted.126 That leaves only common-law

causes of action, but who should decide: courts or the legislature?

“Preemption is a matter of legislative intent.”127 As the plain language of the Martin

Act does not explicitly preempt all common-law claims, the “general rule is and has long

been that when the common law gives a remedy, and another remedy is provided by the

statute, the latter is cumulative, unless made exclusive by the statute.”128 This principle

stands today, and preemption should be viewed within its lens.129 Looking back to the

available legislative history from 1921, 1955, or 1960 there is no suggestion that the New

York Legislature ever took up the issue of preemption. This is a far cry from “exclusivity”

as stated in the rule, and the schism between state and federal courts indicate that they

cannot harmoniously decide the “cumulative” question.

The New York Legislature should step in and decide this vitally important issue.

Although I believe they should protect individual investors, they may come to an alternate

conclusion. Either way, I hope that their decision is well reasoned … investors deserve as

much.

126
See supra note 36.
127
Brief for the Attorney General of the State of New York as Amicus Curiae, Barron v. Igolnikov, No. 10-
1387-cv, 2010 WL 330648 (2nd Cir. 2010).
128
Assured Guaranty (UK) Ltd. V. JP Morgan Inv. Mgmt. Inc., 2010 WL 4721590, at *3 (1st Dep’t 2010)
(citing Burns Jackson Miller Summit & Spitzer v. Lidner, 59N.Y.2d 314, 329 (1983)).
129
See id.

22