STATE OF NEW YORK OFFICE OF THE ATTORNEY GENERAL

ERIC T. SCHNEIDERMAN
ATTORNEY GENERAL

BARBARA D. UNDERWOOD
SOLICITOR GENERAL

January 13, 2014

Mylan Denerstein Counsel to the Governor State of New York Executive Chamber The Capitol Albany, New York 12224 Dear Ms. Denerstein: You have asked for an explanation of the legal basis for the terms of the Attorney Generals recent settlement with JP Morgan Chase in connection with the misconduct that caused the collapse of the residential mortgage backed securities market in 2008. The settlement agreement requires JP Morgan Chase to deposit a substantial sum in an escrow account, from which at least 85% shall be used by the Attorney General for purposes intended to avoid preventable foreclosures, to ameliorate the effects of the foreclosure crisis, to enhance law enforcement efforts to prevent and prosecute financial fraud or unfair or deceptive acts or practices, and to otherwise promote the interests of the investing public and from which up to 15% may be paid to the state treasury. As set forth more fully below, the settlement is entirely consistent with the types of relief that could have been ordered by a court if the case had been adjudicated instead of settled. Moreover, a settlement may of course include terms that would not have been ordered by a court. Finally, the Attorney General has unreviewable discretion to decide whether and how to settle a case in the best interest of the public. We have identified at least eighteen other cases since 1999 where that discretion has been used to settle cases in excess of $1 million in similar fashionwith settlement money obtained by the Attorney General distributed for indirect relief.

120 BROADWAY, NEW YORK N.Y. 10271-0332 PHONE (212) 416-8020 FAX (212) 416-8962 *NOT FOR SERVICE OF PAPERS http://www.ag.ny.gov

Page 2 This includes several cases settled by Governor Cuomos administration as Attorney General, including with various health insurance providers ($90 million in 2009 to fund a program established by the Attorney General) and with various student loan providers (more than $13 million in 2007 to create a discretionary fund, administered by the Attorney General, to educate and assist families with the financial aid process). It also includes the National Mortgage Settlement ($136 million in 2012, to be used for purposes similar to the JP Morgan Chase settlement funds). The Attorney General worked with the Division of the Budget to direct a portion of that settlement fund to state programs consistent with permitted purposes under the settlement agreement, including $7.5 million to fund civil legal services contracts and $6 million to fund the Neighborhood Preservation Program and Rural Preservation Program (NPP/RPP) and is in the process of distributing the remainder of the funds to the purposes set forth in the settlement agreement, including to fund the Homeowner Protection Program, land banks, and Hurricane Sandy-related counseling. No objections have ever been raised by the Executive or the Division of the Budget to the terms of that settlement agreement or our execution thereof. I. The Settlement Was Plainly Authorized By Law On October 1, 2012, after extensive investigation, the Attorney General filed a complaint against JP Morgan Chase pursuant to the Martin Act and Executive Law 63(12), alleging fraud in connection with the sale of residential-mortgage-backed securities. The complaint alleged that defendants fail[ed] to abide by their representations that they took a variety of steps to ensure the quality of the loans underlying their RMBS. Compl. 2, State of New York v. JP Morgan Chase, No. 451556/2012 (N.Y. Sup. Ct. Oct. 1, 2012). The complaint further alleged that by not conducting the due diligence they had promised, defendants acquired and securitized loans without ensuring loan quality or adequately assessing the borrowers ability to repay, id. 59, and that as a result, investors were deceived about the fundamentally defective character of the mortgages underlying the RMBS they purchased and [m]ortgagors defaulted on their loans in exceedingly large numbers. Id. 6. Both the Martin Act and Executive Law 63(12) had as their original and primary purpose the prevention of fraud and the provision of equitable remedies, including injunctive relief and receiverships, all designed to protect the public going forward. See GBL 352 & 353; Exec. Law 63(12). Both statutes vest the Attorney General with authority to direct the distribution of any money or property that may be available as restitution. GBL 353(3); Exec. Law 63(12). And the Martin Act, in particular, repeatedly confers express authority on the Attorney General: to investigate whenever he believes it to be in the public interest that an

Page 3 investigation be made, GLB 352(1), and to obtain such other and further relief as may be proper. Id. 353-a. Given these provisions, on a finding of liability in a fraud case under these statutes, the Attorney General could request and a court could order the defendant to make payments to existing not-for-profit institutions, or to fund the establishment of new ones, to be used for the purpose of preventing and remedying fraud. See, e.g., New York v. Coal. Against Breast Cancer, Inc., No. 20432-2011 (Suffolk Sup. Ct. June 11, 2013) (appropriate remedy for defendants fraudulent fundraising includes restitution to be distributed cy pres to breast cancer charities).1 And it follows that the Attorney General can, in the settlement of such a case, obtain the defendants agreement to do the same thing, i.e., pay money into a fund dedicated to the specific purpose of preventing and remedying the effects of the fraud alleged in the case that is being settled. E.g., State of New York v. McLeod, 45 A.D.3d 282, 283 (1st Dept 2007) (affirming Attorney Generals unreviewable authority to settle Martin Act and Executive Law 63(12) claims in agreement that called for settlement amount to be distributed to New York law schools and/or not-for-profit entities selected by the Attorney General). That is precisely what has occurred in this settlement. JP Morgan Chase has agreed to pay a sum of money to be deposited into an escrow account, to be distributed over at least the next four years, and to be used largely for preventing and remedying the mortgage-related frauds that were alleged in this complaint. In particular, the Attorney General shall direct the use of the funds as follows: The New York Attorney General shall use at least 85% of such funds for purposes intended to avoid preventable foreclosures, to ameliorate the effects of the foreclosure crisis, to enhance law enforcement efforts to prevent and prosecute financial fraud or unfair or deceptive acts or practices, and to otherwise promote the interests of the investing public. Such permissible purposes for allocation of the funds include, but are not limited to, providing funding for housing counselors, state and local foreclosure assistance hotlines, state and local foreclosure mediation programs, legal assistance, housing remediation and anti-blight projects, and for the training and staffing of, and capital expenditures required by, financial fraud and consumer protection efforts. The remaining funds described in this paragraph may be paid by the New York Attorney General to the state treasury as compensation to the State of New York for harms to the State of New York, and its agencies and political subdivisions, purportedly caused by the allegedly unlawful conduct of Defendants.

Available at http://www.ag.ny.gov/pdfs/Decision_June11.pdf.

Page 4 Settlement Agreement at 3, State of New York v. JP Morgan Chase, No. 451556/2013 (N.Y. Sup. Ct. Nov. 17, 2013) (the Settlement Agreement) (attached hereto). You have asked whether any money received by the Attorney General pursuant to this settlement is necessarily money received for or on behalf of the state, and whether it must therefore be deposited in the state treasury pursuant to State Finance Law 121(1), and paid out of the treasury only pursuant to the legislative appropriation process, pursuant to Constitution art. VII, 7 and State Finance Law 4(1). But the settlement funds at issue here are not money received for or on behalf of the state. Instead, they are held by the Attorney General for the benefit of others, namely the people who were or will be harmed, directly and indirectly, by the fraud, or by similar frauds. Accordingly, those funds are exempt from transfer to the state treasury, as [m]oney which has not been given, granted, or bequeathed to the state. State Finance Law 121(2). And for the same reason the funds are exempt from the requirement of an appropriation. State Finance Law 4(4). E.g., Saratoga Harness Racing Assn v. Agric. & N.Y. State Horse Breeding Dev. Fund, 22 N.Y.2d 119, 123-23 (1968) (Section 7 of the Constitution does not apply to money that is not property of the State and is not deposited in the treasury, but is held in a separate fund for distribution by a public benefit corporation); Schulz v. Pataki, 272 A.D.2d 758 (3d Dept 2000) (Section 7 of the Constitution does not apply to distribution of complimentary ski lift tickets to disaster relief volunteers). The New York Attorney General has frequently settled enforcement actions on terms that require the defendant to pay a sum of money into a fund dedicated to activities designed to prevent or remedy the type of fraud alleged in the action. For example: In 2009, Attorney General Cuomo settled a series of consumer fraud cases against UnitedHealth Group and other health insurance companies for $90 million. None of that settlement amount went to the state treasury. Rather, that money was to be given to a not-for-profit company selected by the Office of the Attorney General (OAG) and with a representative board of directors approved by the OAG, to establish and operate a health care reimbursement database, as well as consumer education efforts.2 In 2007, Attorney General Cuomo settled a series of consumer fraud cases against student loan providers for approximately $13.5 million. The Attorney General labeled that money the National Education Funda fund

See, e.g., Assurance of Discontinuance Under Executive Law 63(15) 20-22, 26, Matter of UnitedHealth Group Incorporated, Investigation No. 2008-161 (Jan. 13, 2009), available at http://www.ag.ny.gov/sites/default/files/pdfs/bureaus/health_care/United%20Health.pdf.

Page 5 controlled by the Attorney General in his discretionto educate and assist families with the financial aid process. Much of that fund was awarded by Attorney General Cuomo on his last day in office, giving the money to the New York State Higher Education Services Corporation and the New York Public Interest Research Group to operate a call center and website and to start a public service campaign.3 In 2006, Attorney General Eliot Spitzer settled Martin Act and 63(12) claims against Clark McLeod for $4.4 million. According to the settlement agreement, the settlement amount would be paid to the Attorney General to be distributed to New York law schools and/or not-for profit entities, selected exclusively by the Attorney General or his designee, which promote the interests of investors residing in the State of New York.4 That settlement was ultimately upheld against a claim that part of the fund should be paid as restitution to the victims of McLeods fraud. State of New York v. McLeod, 45 A.D.3d 282, 283 (1st Dept 2007). Also in 2006, Attorney General Eliot Spitzer settled the Payola cases antitrust claims against music industry companiesfor $36.5 million. Under the terms of the settlement agreements, payments made to the Attorney General were delivered to the Rockefeller Philanthropy Advisors who will distribute these funds to New York State not-for-profit corporations, to insure the benefit of the residents of the State of New York by funding programs aimed at music education and appreciation.5

These funds have sometimes been described as cy pres funds, borrowing the term from the law of charities. The term originated in the law of trusts, describing a use of estate funds for a purpose similar to that intended by the testator, in circumstances when it was impossible to fulfill the testators precise intent. Restatement (Third) of Trusts 67 cmt. a (the cy pres doctrine is the principle that, when the exact intention of the settlor is not to be carried out, the intention will be
See, e.g., Assurance of Discontinuance 33, Matter of SLM Corp. (Apr. 11, 2007) (agreeing to donate $2 million to the New York Attorney Generals national fund for educating high school seniors and their parents regarding the financial aid process), available at http://www.ag.ny.gov/ sites/default/files/press-releases/archived/SLM%20Corporation%20Assurance.pdf; Kareem Fahim, Cuomo Names Developers of a Student Loan Center, N.Y. Times, Dec. 31, 2010 (describing distribution of fund).
3 4 Settlement Agreement at 2, State of New York v. McLeod, No. 02/403855 (N.Y. Sup. Ct. July 27, 2006), unexecuted copy available at http://www.ag.ny.gov/sites/default/files/press-releases/archived/ McLeod%20Settlement%20Stipulation.pdf.

Consent Judgment at 1, State of New York v. Entercom Commcns Corp., No. 4010002/06 (N.Y. Sup. Ct. Dec. 9, 2006), available at http://www.ag.ny.gov/sites/default/files/press-releases/archived/ Entercom%20Consent%20Judgment.pdf.
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Page 6 given effect as nearly as may be); Blacks Law Dictionary (9th ed. 2009) (cy pres) (The equitable doctrine under which a court reforms a written instrument with a gift to charity as closely to the donors intention as possible, so that the gift does not fail.) The term has been borrowed to describe the use by an Attorney General of funds recovered in an antitrust enforcement action to fund actions beneficial to all consumers rather than distributing those funds to the widely dispersed group of victims. See Susan Beth Farmer, More Lessons from the Laboratories: Cy Pres Distributions in Parens Patriae Antitrust Actions Brought by State Attorneys General, 68 Fordham L. Rev. 361 (1999) (discussing, for example, State of New York v. Keds Corp., No. 93 Civ. 6708, 1994 WL 97201 (S.D.N.Y. Mar. 21, 1994) and New York v. Reebok Intl, Ltd., 96 F.3d 44, 49 (2d Cir. 1996)).6 The term is also used in the class action context to describe a distribution for the indirect prospective benefit of the class. E.g., Newberg on Class Actions 10:17 (4th ed. 2002). Key examples of cy pres remedies include . . . distribution to nonprofit organizations whose goals are related in some way to the subject of the litigation. Schwab v. Philip Morris USA, Inc., CV-04-1945, 2005 WL 3032556, at *3 (E.D.N.Y. Nov. 14, 2005); e.g., In re Agent Orange Prod. Liab. Litig., 818 F.2d 179, 186 (2d Cir.1987) (noting that a court-approved settlement may undertake to use portions of the fund for class assistance programs that are consistent with the nature of the underlying action and with the judicial function); Mexico Money Transfer Litig., 267 F.3d 743 (7th Cir. 2001) (approving settlement including cy pres relief in the form of payments to organizations that assist the MexicanAmerican community). And the term is now sometimes used more broadly to describe any use of funds recovered in an enforcement action to benefit victims and potential victims rather than identifying and distributing money to them. E.g., Order and Judgment at 24-25, State of New York v. Medco Health Solutions, Inc. (April 26, 2004) (settling claims for consumer fraud by requiring cy pres payment to be used by Attorney General to, inter alia, promote lower drug costs for residents of [the] State . . . or to fund other programs reasonably targeted to benefit a substantial number of persons affected by the Covered Conduct).7 Whether this use of recovered funds is described as cy pres or simply as appropriate preventive and remedial action constituting a form of the broad
6 Keds and Reebok are further examples, dating to 1994, of cy pres settlements by the Attorney General. In Keds, several states received $5.7 million to be distributed by the States to a charitable agency, so long as the sponsored program benefits women aged 15 to 44. 1994 WL 97201, at *1. The settlement of Reebok Intl called for a distribution to be used in providing and improving athletic equipment and facilities and related uses, areas in which Reebok equipment plays a substantial role. 96 F.3d at 49.

Undated version available at http://www.ag.ny.gov/sites/default/files/press-releases/archived/ apr26b_attach1.pdf.

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Page 7 equitable relief authorized by the Martin Act and Executive Law 63(12), funds paid to the Attorney General for this purpose are held by the Attorney General for the benefit of third parties; they are not funds of the State, and they are not subject to the statutory requirements of deposit in the State Treasury and legislative appropriation. In contrast to the Martin Act and Executive Law 63(12), other statutes clearly direct that certain funds be deposited in the State Treasury. See, e.g., Exec. Law 63(6) (all moneys received by [the Attorney General] for debts due or penalties forfeited to the people of the state); GBL 352-e(7)(a) (fees collected by the OAGs Real Estate Finance Bureau shall be paid . . . to the state comptroller). The Martin Act and Executive Law 63(12) include no similar language, but instead charges the Attorney General with the responsibility for enforcing the Martin Act and Executive Law 63(12), including devising and administering remedies obtained under those statutes. If any of the money were regarded as a penalty, it would indeed be subject to deposit in the state treasury. But the parties agreed that no portion of the settlement would be designated or otherwise classified by the State of New York as a civil penalty, fine or similar payment. Settlement Agreement at 2.8 And neither the Martin Act nor Executive Law 63(12) provides for penalties in the circumstances of this case.9 Nonetheless, the Internal Revenue Service does not always accept the parties characterization of a payment, see, e.g., Allied-Signal Inc. v. Commissioner, 63 TCM 2672, 2682 (Tax Ct. 1992) (treating a payment as a penalty despite the parties contrary characterization), affd 54 F.3d 767 (3d Cir. 1995), and may treat deposit of a payment in a State Treasury as one indicator that the payment is a penalty. Accordingly, because penalties generally are not tax deductible, while other settlement payments may be, 26 U.S.C. 162(f); 26 CFR 1.162-21, JP Morgan Chase may have a substantial reliance interest in the agreements treatment of the money, which makes it indisputable that the payment is not a penalty.

8 The agreement goes on to say that the payments reflect compensation to the State of New York and its communities as distinguished from penalties; the communities referenced in that provision are classes of victims who are the beneficiaries, consistent with the detailed provision, quoted and discussed supra at 3, of at least 85% of the fund, which shall be directed to provide permissible forms of relief for victims. The State of New York may receive up to 15% of the fund for harms to the State and its agencies and political subdivisions.

The Martin Act provides for civil penalties only for the violation of an injunction issued under the Martin Act. See GBL 359-g. And penalties are available under Executive Law 63(12) only when the claim is for illegality under a law that itself has penalties, e.g., GBL 350-d.
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Page 8 II. The Attorney General Has Unreviewable Discretion to Determine whether and on What Terms to Settle a Case Brought Under the Martin Act or Executive Law 63(12) Only the Attorney General may commence a civil enforcement action for fraud under the Martin Act or Executive Law 63(12). The Martin Act repeatedly emphasizes the Attorney Generals sole authority over such actions, including his sole authority to determine whether to commence an investigation, GBL 352(1), whether to disclose the results of a pre-complaint investigation to the public, GBL 352(5), and what relief to seek, GBL 353(1) & (3). This broad authority to commence and litigate a case necessarily includes the authority to settle it. The sole responsibility of suing in the name of the people rests upon [the Attorney General]. That subject is wholly in his keeping as the representative of the public interests. People v. Ballard, 134 N.Y. 269, 293 (1892). And the question as to what the public interests require is committed to the absolute discretion of the attorneygeneral. Id. Courts have concluded even in ordinary commercial litigation that the Attorney Generals authority to conduct litigation for the state, conferred by Executive Law 63(1), is sufficient to give the Attorney General authority to settle or release a cause of action. Section 63(1) vests the Attorney General with the authority to control all actions or proceedings in which [the State] has an interest, and [i]mplicit in this authorization is the power to release a viable cause of action that has accrued to the plaintiff prior to the commencement of formal litigation. State v. Upstate Storage, Inc., 145 A.D.2d 714, 715 (3d Dept 1988). And Executive Law 63(15), which authorizes the Attorney General to resolve a civil enforcement action with an Assurance of Discontinuance prior to the commencement of litigation, confirms the Attorney Generals broad settlement authority. See People v. Bunge Corp., 25 N.Y.2d 91, 98 (1969). The case for unreviewable Attorney General discretion is even stronger in this case, brought under the Martin Act and Exec Law 63(12), because the Attorney General has exclusive authority over civil enforcement proceedings under both of these statutes. Where, as here, a statute such as the Martin Act authorizes the Attorney General to commence a civil enforcement action, the Attorney Generals conduct and resolution of the litigation is generally beyond review. Thus, in Bunge Corp., the Court of Appeals refused to review the remedies accepted by the Attorney General in settlement of a Martin Act claim: We cannot agree that the Legislature intended to grant the courts the authority to judicially review the Attorney-Generals exercise of discretion in dealing with a Martin Act violation. Implicit in any authority to commence an action is power over its disposition by discontinuance or otherwise.