Investors Could “Occupy” American Courts

The conclusion of most of the occupy camps across North America this fall was largely peaceful, with some notable exceptions involving pepper spray and excess force. But the protesters for the most part were non-violent, and in my exposure in Toronto, largely respectful of the legal system.

Although skepticism abounded when police announcements were shared or news stories circulated, judicial decisions appeared to have much more impartiality and credibility to the protesters. If the courts can be used as an alternative to police excess and fiascoes like the G20, I interpret it as a small success for our judicial system.

A recent American decision could see protesters, some of them backed with union support, bringing their own actions to address wrongs that they see as the heart of the occupy movement. On December 20, 2011, the New York Court of Appeals unanimously ruled in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management Inc. that the New York General Business Law article 23-A, sections 352-353, also known as the “Martin Act,” does not preempt common law securities claims for breach of fiduciary duty and gross negligence.

Background

The Martin Act was passed in 1921, and gives the Attorney General extremely broad enforcement authority to regulate, investigate, and bring civil and criminal actions for securities fraud, including the power to seek equitable and monetary relief. The only elements necessary to demonstrate a violation under the Martin Act is a misrepresentation or omission of material fact when inducing or promoting securities trading, without a need to show intent, reliance or damages.

In Assured, the defendant claimed that the Martin Act precluded private investors from initiating their own common law claims, a strategy that has been used extensively to preempt non-fraud common law claims otherwise covered by the statute. More recent court judgments have rejected this approach.

The plaintiff claimed that the defendant had mismanaged a $500 million investment portfolio of an entity by investing in high-risk securities such as subprime mortgage-backed securities, without diversifying the portfolio or advising the the entity of the true level of risk. The plaintiff also claimed that the defendant improperly invested in a nonparty client rather than benefit the portfolio or the plaintiff, causing a 86 per cent financial loss to the portfolio from $360 million on June 30, 2006 to $50 million on Feb. 28, 2009, and triggering a the plaintiff’s guaranteed obligation to pay.

The Supreme Court granted the defendant’s motion and dismissed the claim in its entirety under CPLR 3211, holding that breach of fiduciary duty and gross negligence 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.

The Appellate Division reinstated two tort claim for breach of fiduciary duty and gross negligence and a contract claim, stating,

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”

The Appellate Division granted the defence’s leave to appeal on a certified question,

…plaintiff’s common-law breach of fiduciary duty and gross negligence claims must be dismissed because they are preempted by the Martin Act. Contending that the Martin Act vests the Attorney General with exclusive authority over fraudulent securities and investment practices addressed by the statute, J.P. Morgan asserts that it would be inconsistent to allow private investors to bring overlapping common-law claims. J.P.

Analysis

Graffeo J. rejected the defendants submissions that CPC Intl. v. McKesson Corp. and Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. Partnership abrogated all nonfraud common-law claims. She indicated that legislative intent was integral here, and noted that the Act had been amended a number of times to broaden its powers. She cited Hechter v. New York Life Ins. Co. and ABN AMRO Bank, N.V. v. MBIA Inc. to emphasize that an unambiguous legislative intent to override the common law would be necessary for abrogation, and pointed to Burns Jackson v. Lindner,

…when the common law gives a remedy, and another remedy is provided by statute, the latter is cumulative, unless made exclusive by the statute…

Although the Martin Act did not create a private right of action to enforce its provisions, the defendant was unable to demonstrate anything in the legislative history of any of the amendments demonstrating a mandate that would abolish private common-law claims.

The cases relied on by the defendant were distinguished from Assured. In the first, the plaintiff brought a private action under the Martin Act, as opposed to a private action independent of the Act. In the second case, the plaintiff’s entire claim was based on a Martin Act disclosure violation that did not have an independent cause of action, and private parties do not have a right to enforce the Martin Act. Graffeo J. concluded that a mere overlap between the common law and the Martin Act and its regulations is not enough to extinguish the remedies in common law, as long as it is not entirely dependent on the Martin Act for viability.

The court also considered policy implications regarding expansive preemption in securities and real estate, but concluded,

…we believe that policy concerns militate in favor of allowing plaintiff’s common-law claims to proceed. 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 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” (Anwar v. Fairfield Greenwich Ltd., 728 F Supp 2d 354, 371 [SD NY 2010]).

Implications

The defendant has noted that the decision relates to the adequacy of the pleadings and not the merits of the claim, and intend to continue to vigorously dispute the claim as they consider their management of the client’s accounts appropriate. The case did not disturb the general rule that securities fraud claims by classes of 50 or more are precluded by the Securities Litigation Uniform Standards Act (SLUSA).

Robert A. Wallner of Milberg LLP, who filed an amicus brief for labor organizations, called the decision “a landmark change in the law,” and said that “the ramifications of this decision are quite extraordinary.”

There has been quite a bit of commentary about the union ties to the occupy movement, and in some ways they have been the biggest victims of the economic crisis. The largest security investors in the United States are union members, largely through pension plans. This decision is expected to open the doors to more actions by unions out of events during the economic recession. It may also demonstrate some of the future relevance of unions, in an era of transition to a service economy and declining unionization rates.

For disgruntled investors, or workers who have invested through a pension or labour group, these types of actions may finally provide the type of relief that many were expecting, instead of the bonuses that were often observed. Occupiers are expected to head out to the parks again once the weather warms up, and maybe this time some of them will turn to the courts instead.

 

Comments are closed.