White Paper on the Martin Act

for the Partnership for New York City

I.

Executive Summary

More than ninety years ago, when New Yorkers first considered state
legislation to regulate the securities markets, Governor Alfred E. Smith cautioned that
New York is the financial center of the world, and that, [i]n framing laws and in
administering government, it is therefore of prime importance that legitimate business
should be safeguarded, protected and encouraged, to the end that we maintain our
financial, commercial and industrial supremacy. 1
This central concern animated the States enactment in 1921 of New
Yorks first statutory regulation of securities fraud, popularly known as the Martin Act.
The policymakers who drafted the statute understood that fraud undermines the integrity
of the market to the detriment of all investors, not only those investors that are actually
defrauded. These policymakers understood also, however, that any regulatory regime
risks tarring the honest broker with the stain of the swindler, and that too broad a brush
could irreparably damage the primacy of New York as the world financial capital.
Mindful of this danger, the architects of the Martin Act sought to strike a balance. They
empowered the State Attorney General to take civil action against speculators who
preyed on retail investors with promises of lavish returns from oil fields, mining projects,
land developments and new companies that were worthless or fake. At the same time,
they explicitly refrained from creating the kind of all-encompassing disclosure and
regulatory regime at the state level that would overburden legitimate securities firms and
companies looking to raise capital. The drafters considered this restraint vital to assure
that undue state regulation would not cause these legitimate firms to take their business
elsewhere to the detriment of the state economy.
Amid the Great Depression, the U.S. Congress recognized the need for
nation-wide regulation of these matters and enacted the Securities Act of 1933 and the
Securities Exchange Act of 1934, which, as amended, continue to govern the national
securities markets today. At the same time, New York policymakers remained
committed to the Martin Acts original balance at the state level, while investing the
Attorney General with more weapons to battle truly fraudulent activity in boiler rooms
and Ponzi schemes.
The Partnership for New York City is concerned that in recent years
when both New York and the United States need to be more competitive than ever the
use of the Martin Act has made it more challenging for New York to remain competitive
as a global financial center. In particular, three key features of the Martin Act have
effectively allowed the New York Attorney General to regulate the securities markets on

Governors Message to the Legislature Transmitting Report of the Special Committee Appointed by the
Governor to Provide Proper Supervision and Regulation in Connection with Securities Offered to the
Public Investment, LEGIS. DOC. NO. 81, at 8 (1920) (available from New York Legislative Service)
[hereinafter Governors Message].

a national level with powers that exceed those available to federal regulators at the
Securities and Exchange Commission (SEC).
First: The Martin Act is untethered to its original purpose: deterring and
punishing fraudulent schemes. The statute does not require the Attorney General to
prove that a defendant acted with the intent to defraud in order to establish that the
defendant is either guilty of a criminal misdemeanor or liable in a civil action. The
Martin Act does not recognize any defense premised on the defendants good faith or
reasonable diligence, even an affirmative defense on which the defendant would bear the
burden of proof.
Second: The Martin Act applies to almost any transaction in securities
made on an exchange located in New York. This territorial scope permits the New York
Attorney General to prosecute conduct on a nationwide level, which makes enforcement
unpredictable for firms that list their securities on New York exchanges but conduct their
business elsewhere.
Third: The Martin Act gives the Attorney General what the courts have
called inquisitorial investigative powers, which may be used to investigate conduct
prior to the filing of a lawsuit. The Attorney General has virtually absolute discretion
over how to use these powers including over whether an investigation is secret or
public. Further, those at whom the Attorney General directs these powers do not have
some of the protections that are afforded them in other proceedings. As such, companies
targeted by the Attorney General have very little leverage to defend themselves in the
face of what is often a well-publicized investigation that precedes the filing of any actual
lawsuit in a court of law.
These three features of the Martin Act permit the Attorney General of
New York to regulate the securities markets on a nationwide basis using investigative
powers that exceed those of the SEC, and to do so without having to marshal the same
proof required by the federal securities laws. Unlike the applicable federal securities
laws, a company (or individual) may be guilty of or liable for fraud under the Martin
Act even if the company (or person) can prove no intent to deceive. All too often, this
results in companies agreeing to pay out-sized settlements and to accept restrictive
regulatory burdens even when no evidence exists that their employees acted with
fraudulent intent.
This shadow regime conflicts with national priorities. Over the last two
decades, confronting growing competitive pressures from other global financial centers,
Congress has repeatedly tried to streamline and balance American securities laws.
Recognizing, for example, that the crushing costs of discovery in private securities cases
may coerce defendants into punitively expensive settlements even when they have strong
defenses, Congress enacted several protections for defendants, including raising the
pleading requirements to allege fraudulent intent, an element that the Attorney General
does not have to allege or prove at all in a Martin Act proceeding.
Likewise,
recognizing the costs of overlapping, at times duplicative, multi-jurisdictional regulation,
Congress on two occasions has limited the states power to regulate securities

transactions, largely confining them to investigating the kinds of fictitious or worthless

securities at which the Martin Act was originally targeted.
The Partnership for New York City believes that the Martin Act in its
current form undermines the competitiveness of New York (and thus the United States)
as a global financial center, and thus threatens the engine of our state economy. Data
confirm this view. For example, a 2007 report issued by Mayor Bloomberg and Senator
Schumer found that financial industry leaders concerns about a fragmented,
unpredictable and unbalanced U.S. securities regulation regime undermined New Yorks
competitiveness as a financial center. 2 Explaining why London was a more attractive
location for their business, these industry leaders cited the problems with securities
enforcement that are part and parcel of the current Martin Act enforcement regime. 3
Since then, the competition has grown stiffer still. New Yorks advantage
in the Global Financial Centers Index over its nearest competitors Hong Kong and
Singapore has been more than halved in the past five years alone. 4 Financial
professionals expect emerging financial centers not just Singapore and Hong Kong but
also Shanghai, Sao Paulo, Beijing, and Mumbai, among others to grow more than New
York in the years ahead.
The potential costs of these trends are enormous. New Yorks securities
industry contributes 1 of every 12 jobs in New York State, and 1 of every 7 jobs in New
York City, as well as $2.8 billion, or 7 percent, of state tax revenues and $8.7 billion, or
14 percent, of city tax revenues. New York State also has more than double the securities
industry jobs than any other state. 5
To protect our state and national economy, the Partnership for New York
City recommends that the Attorney General restore balance to the Martin Act by bringing
actions only when: (1) the Attorney General can prove that the defendant acted with an
intent to defraud or recklessly; and (2) a significant part of the allegedly fraudulent
conduct took place in New York or the conduct has caused substantial harm to New York
residents or companies. This will harmonize the Martin Act with securities regulatory
regimes nationwide, and will focus the Attorney Generals resources where they belong,
namely, on truly fraudulent activity in this State.

See generally Sustaining New Yorks and the US Global Financial Services Leadership, available at
http://www.nyc.gov/html/om/pdf/ny_report_final.pdf, at 73-94 (Jan. 22, 2007) [hereinafter Sustaining New
York].
3
See id.
4
Compare
id.,
with
The
Global
Financial
Centres
Index
1,
available
at
http://217.154.230.218/NR/rdonlyres/0C0332C0-4CE5-4012-9AF72CF98A32E618/0/BC_RS_GFCI07_FR.pdf, at 7 (Mar. 2007) [hereinafter Global Financial Centres Index
1],
with
The
Global
Financial
Centres
Index
12,
available
at
http://www.longfinance.net/Publications/GFCI%2012.pdf, at 11 (Sept. 2012) [hereinafter Global Financial
Centres Index 12].
5
THOMAS P. DINAPOLI, NEW YORK STATE COMPTROLLER, REPORT 9-2013, THE SECURITIES INDUSTRY IN
NEW YORK CITY (Oct. 2012), available at https://www.osc.state.ny.us/osdc/rpt9-2013.pdf.

The Office of the Attorney General should also use its discretion to bring
Martin Act cases only when federal regulators have not already commenced an
investigation or filed a lawsuit. Where the Attorney General learns through investigatory
cooperation that the SEC is pursuing an investigation or enforcement action, the Attorney
General should let these efforts take their course before continuing its own investigation
or filing its own action under the Martin Act. At the very least, the Attorney General
should not file a Martin Act case where the SEC has already filed a civil enforcement
action. This will avoid duplicative regulatory proceedings that waste resources and
taxpayer dollars that could be used to investigate other activity, and that multiply costs
for companies already responding to a regulatory inquiry into the very same conduct.
Finally, the Partnership for New York City recommends that the State
Legislature consider amending the Martin Act to require the Attorney General, in seeking
to establish criminal or civil liability, to prove that a defendant acted with intent to
defraud investors, thereby bringing the Martin Act into line with national policies aimed
at the very same balance that the Acts authors sought to strike.
II.

History of the Martin Act

In order to understand the problems with the way the Martin Act is being
used today, it is critical to understand what problems the Acts authors were trying to
combat and why they believed the Act was the best way to solve them. The elected
officials and legal advisors who drafted and enacted the Act shared a central goal:
deterring the sale of essentially worthless or fictitious securities and other predatory
investment opportunities while preserving New Yorks status as a global financial capital.
Though the securities markets of 1921 may bear little resemblance to our highly
globalized and automated financial markets, this balance remains relevant and should
continue to guide the Acts application today.
A.

Blue Sky Laws

Between 1897 and 1913, rising incomes among a rapidly expanding

middle class, along with a strong agricultural sector, quadrupled the American publics
savings, a new source of capital that could be tapped effectively by means of public
securities issuance. 6 In the early years of the twentieth century, access to the securities
markets thus expanded from professional investors to retail investors with far less
experience. 7
Many of these new investors purchased traditionally safe so-called blue
chip securities with low but reliable returns, such as railroad and municipal bonds.
Many others, uninitiated and unsophisticated, became prime targets for promises of far
greater returns from investments, typically in natural resources and land development,
that were particularly attractive at a time of high inflation. Unlike traditional securities
6

Jonathan R. Macey & Geoffrey P. Miller, Origin of the Blue Sky Laws, 70 TEX. L. REV. 347, 353-354 &
n.22 (1991).
7
See id.

issued by large financial institutions and traded on major securities exchanges, these getrich-quick prospects were sold using the tools of a burgeoning mass marketing industry:
face-to-face solicitation, newspaper advertisements, and mass mailings. 8 They were
hyped by sales puffery to anyone on a mailing list in exciting, vibrant tones,
stimulating the imaginations of wishful investors with tales of earth-shaking inventions,
new projects, and vast wealth. 9
The publics growing appetite for speculative securities sparked intense
public concern about fraudulent promotions. 10 Financial industry authorities and public
figures alike became alarmed that retail investors were committing their savings to
investments in oil fields, mining projects, and land developments that were either
fictitious or so speculative as to be worthless. 11 In popular parlance, many of these
securities were said to have no more basis than so many feet of blue sky. 12
At the time, no state or federal statutes specifically governed the sale of
securities. As public reports of losses from bogus securities mounted, so, too, did calls
for legislation to stop the sale of stock in fly-by-night concerns, visionary oil wells,
distant gold mines, and other like fraudulent exploitations. 13 These statutes became
known as Blue Sky laws because they were aimed at promoters who would sell
building lots in the blue sky in fee simple. 14
Kansas passed the first of these Blue Sky laws in 1911. The Kansas law
required any firm selling securities in Kansas to obtain a license and file with the
Banking Department copies of the securities, any contracts for their sale, descriptions of
expected returns, and reports of the firms financial condition. Based on these
submissions, the banking commissioner had discretion to prohibit the sale of any
securities that he concluded were unfair, unjust, inequitable or oppressive, did not
represent honest business, or did not promise a fair return. As such, the Kansas law
became the model for so-called merit regulation. 15
Reports of the Kansas legislation quickly sparked efforts to regulate the
sale of speculative securities in other states. 16 In 1912, Arizona and Vermont adopted
laws modeled on the Kansas statute, and nine more states followed the next year. Nearly
a dozen other states enacted Blue Sky laws that required licensing and registration with
state regulators but did not empower them to reject securities on the merits. 17 In 1917,
8

Id., at 353-54.
Id.
10
Id. at 355-59.
11
Id.
12
Hall v. Geiger-Jones Co., 242 U.S. 539, 550 (1916).
13
Id.
14
1 L. LOSS & J. SELIGMAN, SECURITIES REGULATION 36, 31-43 (3d ed.1998) (quoting Mulvey, Blue Sky
Law, 36 CAN. L. TIMES 37 (1916)).
15
See generally Rick A. Fleming, 100 Years of Securities Laws: Examining a Foundation Laid in the
Kansas Blue Sky Law, 50 WASHBURN L.J. 583 (2011); see also Origin of the Blue Sky Laws, supra note 6,
at 359-64; 1 L. LOSS, J. SELIGMAN, & T. PAREDES, SECURITIES REGULATION, at 53-54 (4th ed. 2006).
16
Origin of the Blue Sky Laws, supra note 6, at 377.
17
Id. at 377-380; LOSS, ET AL., supra note 15, at 54.
9

the U.S. Supreme Court upheld several Blue Sky laws against constitutional challenge. 18
By 1920, some 33 states had enacted Blue Sky laws, 19 and by 1934, 47 of the 48 states,
plus the territory of Hawaii had Blue Sky laws on the books. 20
B.

Origins of the Martin Act

New York approached legislation somewhat more deliberately because of

its unique place in the American financial landscape. While New York shared other
states concerns about fictitious securities and bogus schemes, unlike most other states,
New York was equally concerned that anti-fraud measures could inhibit legitimate
investment activity that powered the states economy.
On September 25, 1919, Governor Smith appointed a Special Committee
to Provide Proper Supervision and Regulation in Connection with Securities Offered to
the Public Investment to study the issue and make recommendations. The Special
Committee was comprised of prominent figures in private banking, the legal profession,
and representatives of the investing public. 21 In his letter appointing the Special
Committee, Smith made clear that any legislation should be directed to a prevention of
the evil of issuing and offering for sale to the investing public, of worthless securities and
securities of doubtful value. 22
The Special Committee found that the evils at issue fell into two
classes:
1. The initial issuance of securities to the public in this or
some other State, which are either worthless or have so
little value that those purchasing them at the prices for
which they are offered immediately sustain a severe loss.
2. The negotiation and sale by swindlers of worthless
securities to individuals. 23
After studying the Blue Sky laws of other states, corresponding with
officials in these states, and holding hearings with the New York District Attorneys
Office and various industry associations, the Special Committee issued its report in
December 1919. Despite some disagreement in approach three members of the Special
Committee issued a minority report 24 the members of the Special Committee agreed
that any legislative solution needed to deter fraud without compromising New Yorks
preeminent position as a financial center.
18

See Merrick v. Halsey & Co., 242 U.S. 568 (1917); Caldwell v. Sioux Falls Stock Yards Co., 242 U.S.
559 (1917); Hall, supra note 12, 242 U.S. 539.
19
See State v. Gopher Tire & Rubber Co., 177 N.W. 937, 938 (Minn. 1920).
20
LOSS, ET AL., supra note 15, at 58.
21
Governors Message, supra note 1, at 5.
22
Id.
23
See id. at 5.
24
Id. at 5-6, 17-18.

Echoing Governor Smith, the majority wrote that New York is today the
financial center of the world and that, [i]n framing laws and in administering
government, it is therefore of prime importance that legitimate business should be
safeguarded, protected and encouraged, to the end that we maintain our financial,
commercial and industrial supremacy. 25 In a similar vein, the majority found that, [i]n
adopting any legislation which frankly will tend to restrict legitimate business in the hope
of preventing fraud, New York State must proceed intelligently and should not adopt any
legislation in which the restriction upon business is out of proportion to the benefit which
might thereby be attained. 26 The minority agreed that legislation should be framed . . .
with a view to preserving as much freedom as possible for legitimate business
enterprises, and that this was especially important in the case of New York State which
is the center where capital is mainly mobilized for service in all parts of the country. 27
The members of the Special Committee disagreed on how to strike this
balance. The minority proposed a licensing and disclosure regime similar to the British
Company Act and to regulatory schemes enacted by many Western states. Draft
legislation appended to the minority report became the basis for a bill in the
Legislature. 28 The Committees majority opposed the licensing and disclosure proposal,
rejecting the British model. England, they wrote, is a country with a single financial
centre, whereas New York State is one State of a union, and can neither legislate as to the
issuance of securities in other States, nor afford to drive capital into other States. 29 To
avoid that result, the Committee recommended legislation granting the Banking
Department and the Attorney General concurrent jurisdiction to investigate fraudulent
securities. 30
Opposing the minority view, the Association of the Bar of the City of New
York elaborated on the risk that legislation would undermine New Yorks supremacy as a
financial center:
The United States, if not the whole world looks to New
York State for capital and the development of national
resources, industries and inventions. New York State has
become a great financial centre of the World . . . . The
capitalist who is urged to advance large sums of money is
not likely to invest his money in New York if such
investment is made burdensome, while other States and
countries afford more favorable opportunities for
investment. Any law which places oppressive burdens on
those who are asked to invest their capital tends to drive
capital, from the State enacting such a law, into other States
and countries. The Legislature should be scrupulously
25

Id. at 8.
Id.
27
Id. at 20.
28
Id. at 20-24.
29
Governors Message, supra note 1, at 12.
30
Id. at 12-14.
26

careful in attempting a remedy for an alleged evil not to

create thereby a greater evil. 31
The majority view prevailed in the Legislature, and its proposal became
the basis for legislation introduced by Assemblyman Louis H. Martin, whose name
became associated with the Act. The core of the Martin Act was its majestic, one
sentence sweep empowering the Attorney General to investigate fraud, broadly
defined. 32 The Acts opening sentence provided that, [w]henever it shall appear to the
attorney-general that any person or company is employing or is about to employ any
device, scheme or artifice to defraud or for obtaining money or property by means of any
false pretense, representation or promise in connection with any transaction in securities,
the Attorney General could require the person or company to testify in his office under
oath. 33 The Act also empowered the Attorney General to bring a civil action for an
injunction barring a person or company from engaging in practices the Attorney General
believed operated as a fraud. 34
Recognizing that the Martin Act embodied the balance that animated the
Special Committees work, the City Bar Association called the law an excellent remedy
for the evils which it has been attempted to meet by means of so-called blue-sky laws, but
which, unfortunately, have been so framed as to give rise to abuses as serious as those
sought to be obviated. 35
C.

Later Amendments

Since 1921, the State Legislature has amended the Martin Act several
times to give the Attorney General additional powers to prosecute fraud, 36 some of which
are germane to how the law operates today.
In 1932, the Legislature augmented the Attorney Generals power to bring
a civil action for an injunction against a person or company that had violated the Act. As
originally enacted, the Act permitted the Attorney General to seek an injunction against
only the specific practices alleged to be misleading. The 1932 amendment authorized the
Attorney General to bar the violator from selling any securities of any kind in the state,
not only the securities involved in the violation. 37

31

Committee on the Amendment of the Law of the Association of the Bar of the City of New York,
Memorandum on Senate Bill, Pr. No. 140, Int. No. 138 & Assembly Bill, Pr. No. 9, Int. 9 (available from
New York Legislative Service), at 107-108.
32
LOSS, ET AL., supra note 15, at 164.
33
Martin Act, ch. 649, 352 (1921) (current version at N.Y. GEN. BUS. LAW. 352 (2012)).
34
Id., 353.
35
Committee on the Amendment of the Law of the Association of the Bar of the City of New York,
Memorandum on Assembly Bill, Pr. No. 1932, Int. No. 1540 (available from New York Legislative
Service), at 360-61 [hereinafter Memorandum on Assembly Bill].
36
See L. 1923, c. 600; L. 1925, c. 239; L. 1926, c. 617; L. 1927, c. 365; L. 1932, c.213; L. 1935 c.271; L.
49, c. 525; L. 1955, c. 553; L. 1958, c. 750; L. 1959, c. 692; L. 1960, c. 961r; L. 1980, c. 316; L. 1982, c.
146.
37
Martin Act, ch. 213 533 (1932) (current version at N.Y. GEN. BUS. LAW. 352 et seq. (2012)).

In 1955, on the recommendation of Attorney General Jacob K. Javits, the

Legislature made its most significant amendments to the Martin Act. In a letter to
Governor W. Averell Harriman and the states legislative leadership, Javits reported that
the sale of fictitious and highly speculative securities to retail investors continued despite
the Attorney Generals powers under the Martin Act:
In the last year the number of firms specializing in the retail
distribution of such speculative securities has mushroomed.
Most of them do their selling on the telephone out of what
are familiarly known in the trade as Boiler Rooms. They
employ salesmen of dubious reputation who resort to gross
misrepresentations, false promises and other fraudulent and
deceptive practices in order to sell their gullible prospects.
They concentrate their efforts in the sale of issues of
securities which are exempt from registration under the
Securities and Exchange Act.
In particular, Javits described schemes very similar to the sales of blue sky that
Governor Smith and his Special Committee had targeted three decades earlier:
speculators touting the development of oil and the future economic prospects of
uranium. 38
Javitss proposal led to two major changes to the Act. First, the
amendments made it a criminal misdemeanor to violate the Martin Act. Previously, the
Act had merely empowered the Attorney General to file a civil action for an injunction.
Second, the amendments clarified that the definition of fraudulent conduct prohibited
by the Act included [a]ny representation or statement which is false even where the
person who made such representation or statement . . . did not have knowledge
concerning the representation or statement made. 39 This amendment codified prior
judicial rulings (discussed below) that the Act did not require the Attorney General to
prove that a defendant acted with fraudulent intent.
In 1976, the Legislature amended the Act again to enable the Attorney
General, in a civil action, not only to enjoin alleged wrongdoing but also to obtain
restitution of any moneys or property obtained directly or indirectly by an such
fraudulent practice that violated the Act. 40
In 1982, the Legislature strengthened the Acts criminal penalties for
intentional and egregious violations. The 1982 amendment made it a class E felony to
engage in an intentional ongoing scheme to defraud or to intentionally defraud ten or
more persons. 41 Although a felony conviction would thus require proof of fraudulent
38

Jacob K. Javits, N.Y. State Attorney General, Memorandum to the Governor on Assembly Int. 3448 Pr.
3734 (Apr. 7, 1955), in 1955 Amendment Bill Jacket (available from New York Legislative Service).
39
L. 1955, c.533, 532-c (1955) (current version at N.Y. GEN. BUS. LAW. 352 et seq. (2012)).
40
L. 1976, c.559 1 (current version at N.Y. GEN. BUS. LAW. 352 et seq. (2012)).
41
L. 1982, c. 146 (1982) (current version at N.Y. GEN. BUS. LAW. 352 et seq. (2012)).

intent, the Attorney General retained the earlier-provided power to bring misdemeanor
charges without proving such fraudulent intent. 42
In writing to Governor Hugh L. Carey in support of this amendment,
Attorney General Robert Abrams noted that it would help protect the investing public
from the same evils targeted by the Martin Act and Javitss 1955 amendments, namely,
boiler rooms, Ponzi schemes, insider trading, pyramid schemes, fictitious transactions
and other artifices to defraud the investing public. 43
III.

The Martin Act Today

History, then, teaches that the architects of the Martin Act and its key
amendments intended for the Act to be used primarily to deter schemes involving
fictitious or essentially worthless securities that prey on unsophisticated retail investors.
Equally clear from the Acts history is that the Legislature, Governors, Attorneys
General, and leading members of the bar took great care to assure that anti-fraud
measures did not impede the markets for legitimate securities.
Unfortunately, adherence to this objective has been uneven. In recent
times, the expanded use of the Martin Act has undermined the delicate balance that the
architects of the Martin Act intended and created an uncertain and unpredictable
regulatory regime that imposes enormous costs on businesses and firms. Indeed, several
key features of the Martin Act have permitted the Attorney General to establish a more
unpredictable and less balanced securities regulatory regime in New York than exists at
the federal level or in some of the emerging financial centers with which this State must
compete. To understand why this is so, it is necessary to analyze three key features of the
Act, especially in comparison to national policy on securities regulation.
A.

The Martin Act Punishes Unintentional Conduct

The potential effects of an Attorney Generals decision to file a Martin Act

claim are of no small severity. If the Attorney General concludes that a sufficient basis
exists to allege a violation of the Martin Act, the Attorney General may file a civil action
seeking an award of restitution, monetary damages, an award of attorneys fees, and an
injunction barring the defendant from continuing the practice that allegedly violates the
Act as well as from selling any securities in the state. 44 Misdemeanor charges, carrying
a prison term of up to a year, are also an option. 45 Not only are these penalties stiff, but
defendants face the prospect of damaging reputational injury.
At the same time, however, the requirements for the Attorney General to
impose these consequences are minimal. The Attorney General need prove only two
meaningful elements to prove a violation: that the person or company made a false or
42

Letter from Attorney General Robert Abrams to Governor Hugh L. Carey, May 25, 1982 (available from
New York Legislative Service).
43
Id.
44
N.Y. GEN. BUS. L. 353.
45
N.Y. GEN. BUS. L. 352-c (4); N.Y. GEN. BUS. L. 359-g(2)

10

misleading statement 46 and that the statement was material. 47 The Attorney General need
not demonstrate that a defendant intended to deceive or mislead any investor in order to
prove civil or misdemeanor charges. In fact, the Attorney General does not have to prove
anything at all about the defendants intent. Nor does the law recognize a defense that a
defendant acted in complete good faith or upon due diligence, including any affirmative
defense as to which the defendant would bear the burden of proof.
Since the Acts inception, the New York courts have held that, as used in
the Act, [t]he words fraud and fraudulent practices should be given a wide
meaning so as to include all acts, although not originating in any actual evil design or
contrivance to perpetuate fraud or injury upon others, which do by their tendency to
deceive or mislead the purchasing public come within the purpose of the law. 48
The New York courts continued to cite and follow this interpretation even
after the Legislature made it a crime to violate the Martin Act. As the leading
commentator on the Martin Act has noted, a long line of cases has consistently
established the principle that neither scienter nor intent need to be alleged or proven to
sustain civil liability in general, or misdemeanor criminal culpability under the Martin
Act. 49 Former Attorney General Abrams and numerous commentators have uniformly
understood this case law to mean that the Martin Act contains no intent requirement at
all. 50 The Martin Act creates a strict liability crime.
Further, not only does the Attorney General not have to prove that a
defendant intended to defraud any investor, but the Attorney General also does not have
to prove that anyone was, in fact, defrauded. 51 By its express terms, the Martin Act
provides that it is a crime to make a misleading statement regardless of whether the
issuance, distribution, exchange, sale, negotiation or purchase [of a security] resulted. 52

46

N.Y. GEN. BUS. L. 352-c.

The New York courts have adopted a standard formulated by the United States Supreme Court as to
when information is material, namely, if there was a substantial likelihood that the information would
have been viewed by the reasonable investor as having significantly altered the total mix of information
made available. State of New York v. Rachmani Corp., 71 N.Y.2d 718, 726 (1988).
48
People v. Federated Radio Corp., 244 N.Y. 33, 38-39 (1926).
49
ORESTES J. MIHALY & DAVID J. KAUFMANN, MCKINNEYS CONSOLIDATED LAWS OF NEW YORK
ANNOTATED (1996); see also, e.g., Rachmani Corp., 71 N.Y.2d at 725 n.6; People v. Lexington Sixty-First
Assocs., 38 N.Y.2d 588, 595 (1976); People ex rel. Cuomo v. Greenberg, 95 A.D.3d 474, 484 (1st Dept.
2012); People v. Am. Motor Club, 179 A.D.2d 277, 283 (1st Dept. 1992); People ex rel. Cuomo v. Charles
Schwab & Co., Inc., No. 453388/2009, 2011 WL 5515434, at *7 (N.Y. Sup. Ct. Oct. 24, 2011); People v.
Morris, No. 0025/09, 2010 WL 2977151, at *22 (N.Y. Sup. Ct. July 29, 2010); State v. Justin, 779
N.Y.S.2d 717, 739 (Sup. Ct. 2003).
50
Letter from Attorney General Robert Abrams to Governor Hugh L. Carey, May 25, 1982 (available from
New York Legislative Service); ROBERT J. ANNELLO, 4C N.Y. PRAC., COM. LITIG. IN NEW YORK STATE
COURTS 90:17 (3d ed.); Frank C. Razzano, The Martin Act: An Overview, 1 J. BUS. & TECH. L. 125, 128
n. 21, 129 (2006); Robert A. McTamaney, New Yorks Martin Act: Expanding Enforcement in an Era of
Federal Securities Regulation, 18(5) WASHINGTON LEGAL FOUNDATION, LEGAL BACKGROUNDER, at 3
(2003).
51
Razzano, supra note 50, The Martin Act: An Overview, at 125.
52
N.Y. GEN. BUS. L. 352-c(1).
47

11

Thus, the Attorney General does not have to prove that any investor relied on the alleged
misstatement. 53
In sum, while the Martin Act was enacted to prevent swindlers from
cheating retail investors out of their savings with bogus promises about fictitious
securities, the Martin Act, in its current form and application, punishes innocent mistakes
and malicious frauds alike.
B.

The Reach of the Act Is National

The second key feature of the Martin Act is that it essentially applies

nationwide.
By its terms, the Act applies to the issuance, exchange, purchase, sale,
promotion, negotiation, advertisement, investment advice or distribution within or from
this state, of any . . . securities. 54 Accordingly, so long as some nexus exists between a
securities transaction and New York, the Martin Act applies. 55 The mere involvement
of a New York broker has been held sufficient to trigger application of the Act. 56 And
the Act can be invoked in connection with transactions involving investors who have no
connection to New York, so long as the securities were sold within or from the state.57
Thus, as one commentator has noted, the Acts territorial reach is arguably satisfied in
virtually every case involving a publicly traded security because the New York Stock
Exchange is located in New York, the [NASDAQ] is headquartered in New York, and
business transactions are routinely negotiated and financed in New York. 58
In sum, a statute that the Legislature intended to protect the primacy of
New Yorks financial markets creates a disincentive for companies and businesses to take
advantage of New Yorks financial markets, and arguably of the United States financial
markets.
C.

The Act Gives the Attorney General Unbridled Inquisitorial Power

The third key feature of the Act is that it gives the Attorney General broad
inquisitorial investigative powers. 59
The extremely broad investigative power conferred upon the Attorney
General by the Martin Act is evidenced by the fact that the statute affords him not one but
53

See People ex rel. Cuomo v. Merkin, 907 N.Y.S.2d 439 (Sup. Ct. 2010); State of New York v. Sonifer
Realty Corp., 212 A.D.2d 366, 367 (1st Dept 1995).
54
N.Y. GEN. BUS. L. 352(1).
55
Charles Schwab & Co., Inc., 2011 WL 5515434, at *6.
56
State v. Samaritan Asset Mgmt. Serv., Inc., 874 N.Y.S.2d 698, 704 (Sup. Ct. 2008).
57
See People ex rel. Cuomo v. H&R Block, Inc., 58 A.D.3d 415, 416 (1st Dept 2009); People ex rel.
Spitzer v. Telehublink Corp., 301 A.D.2d 1006 (3d Dept 2003).
58
Wendy Gerwick Couture, White Collar Crimes Gray Area: The Anomaly of Criminalizing Conduct Not
Civilly Actionable, 72 ALB. L. REV. 1, 20-21 (2009).
59
In re Am. Res. Council, Inc., 10 N.Y.2d 108, 113 (1961); see also Gonkjur Assocs. v. Abrams, 88 A.D.2d
854, 856 (1st Dept 1982).

12

two means of pursuing his investigative goals: confidential investigations conducted

under compulsion of subpoena (352) and public investigations conducted pursuant to
court order ( 354 and 355). 60
Under Section 352, whenever it appears to the Attorney General that any
person has engaged or is about to engage in any violation of the Act, the Attorney
General can require the suspected defendant to file with him a statement in writing
under oath as to the relevant facts. 61 And some courts have held that the Attorney
General has this subpoena power even after an action has been commenced. 62
The Attorney General also has great leverage to enforce subpoenas under
Section 352. The Attorney General does not have to move any court to compel any
response to such a subpoena. Rather, the Attorney General may prosecute the failure to
obey the command of a subpoena as a misdemeanor. 63 Further, if the Attorney General
decides to pursue a civil action to enjoin a defendant from selling securities in the state,
the failure to respond to a subpoena to the Attorney Generals satisfaction is prima facie
evidence that a target has engaged in the alleged fraudulent practices, which alone,
without more, supplies a court with a basis to bar the alleged wrongdoer from selling
securities in the state. 64
That is not all. A witness testifying in response to a Section 352 subpoena
does not have a right to the assistance of counsel while testifying before the Attorney
General. 65 Nor does the witness have a right to a transcript or recording of the
testimony. 66 To the contrary, it is a crime for the witness to divulge to anyone other than
an attorney what transpired during the testimony. In fact, one commentator has observed
that [t]he secrecy of confidential hearings conducted by the Attorney General pursuant
to the Martin Act has . . . been held to be absolute in its entirety. 67 But the street is oneway only: the case law uniformly holds that the Attorney General has the authority to
decide whether the information he gathers as part of his investigation should be kept
secret or public. 68 The choice is for the Attorney General alone to make; the Attorney
General may opt to keep some or all of the evidence a secret, 69 or he may elect to
disclose the information at a time, place, and manner of his own choosing. 70

60

MIHALY & KAUFMANN, supra note 49, at 36.

N.Y. GEN. BUS. L. 352.
62
MIHALY & KAUFMANN, supra note 49, at 36; see also Grandview Dairy, Inc., 76 A.D.2d 776, 777 (1st
Dept 1980).
63
N.Y. GEN. BUS. L. 352; see also MIHALY & KAUFMANN, supra note 49, at 37.
64
N.Y. GEN. BUS. L. 353(1).
65
See First Energy Leasing Corp. v. Attorney-General, 68 N.Y.2d 59, 64 (1986).
66
See, e.g., Abrams v. Alliance for Progress, Inc., 519 N.Y.S.2d 533 (Sup. Ct. 1987); Gutterman v.
Lefkowitz, 400 N.Y.S.2d 667 (Sup. Ct. 1977).
67
N.Y. GEN. BUS. L. 352(5); see also MIHALY & KAUFMANN, supra note 49, at 38.
68
People v. Thain, 874 N.Y.S.2d 896, 901 (Sup. Ct. 2009); see also In re Marcus, 248 N.Y.S. 291 (Sup Ct.
1931, affd, 232 A.D. 731 (1st Dept 1931).
69
Thain, 874 N.Y.S.2d at 920.
70
Sittniewski v. Decker, 134 Misc.2d 177, 178, 509 N.Y.S.2d 1019 (Sup. Ct. 1986), affd, 140 A.D.2d 965,
529 N.Y.S.2d 639 (4th Dept 1988).
61

13

Further, Section 354 empowers the Attorney General to conduct his entire
investigation in public. Under this Section, the Attorney General may obtain, without
notice to the witness or to a defendant, a judicial order requiring a witness to testify under
oath at a public hearing. The Attorney General may obtain such an order upon no
weightier a showing than his information and belief that the testimony of such person or
persons is material and necessary to a Martin Act investigation. 71
The Attorney Generals power to conduct a public pre-suit investigation is
daunting. The injury alone, in the absence of any claims being filed in a court of law, can
have severe consequences, even if the Attorney General never pursues legal action or
proves a violation. As one commentator has explained, [t]he shock value and potential
business damage of having a criminal investigation conducted in public gives the
Attorney General awesome power. 72 It affords vast tactical advantages and all but
guarantees that sufficient evidence is available before the decision is taken formally to
initiate the proceedings, and guarantees that maximum public relations pressures will be
imposed on potential defendants, resulting in settlements which have been secured not
only pre-judgment, but pre-filing. 73
Magnifying this concentration of power is that the Attorney General is the
only securities regulator in the United Statesstate or federalwith exclusive authority
to bring both civil and criminal actions for violations of the securities laws. 74 Every other
state has a securities commissioner that is independent from the states Attorney General
and has primary if not exclusive authority to enforce Blue Sky laws. 75 Likewise, on the
71

N.Y. GEN. BUS. L. 354; First Energy Leasing Corp., 68 N.Y.2d at 64. In this regard, [t]he courts have
given Section 354 of the Martin Act the widest possible application. Kaufmann, McKinneys
Consolidated Laws of New York Annotated, at 39; see also Razzano, supra note 50, at 130. In fact, Justice
Cardozo recognized decades ago that the Attorney General can require a public hearing almost upon mere
request. Matter of Ottinger v. State Civ. Serv. Commn, 240 N.Y.435, 439 (1925); see also In re Am. Res.
Council, Inc., 10 N.Y.2d at 111. And, even after the Attorney General has commenced a public proceeding
and required the testimony of witnesses, the Attorney General can continue to investigate in secret by
subpoenaing other witnesses under Section 352. See Matter of Abrams, 611 N.Y.S.2d 422, 425 (Sup. Ct.
1994).
72
ANNELLO, supra note 50, at 90:17.
73
McTamaney, supra note 50, at 3.
74
MIHALY & KAUFMANN, supra note 49, at 11.
75
See, e.g., ALA. CODE 8-6-15 (2012); ALASKA V STAT. 45.55.905 (2012); ARIZ. REV. STAT. ANN
44-1822 (2012); ARK. CODE. ANN. 23-42-201 (2012); CAL. CORP. CODE 25531 (2012); COLO. REV.
STAT. 11-51-601 (2012); CONN. GEN. STAT. 26b-26, 36b-27 (2012); DEL. CODE. ANN. 73-401, 73403 (2012); D.C. CODE 31-5606.01 (2012); FLA. STAT. 517.201 (2012); GA. CODE. ANN. 10-5-70
(2012); HAW. REV. STAT. 485A-602 (2012); IDAHO CODE ANN. 30-14-602 (2012); 815 Ill. COMP. STAT.
ANN. 5/11 (2012); IND. CODE 23-19-6-3 (2012); IOWA CODE 502.602 (2012); KAN. STAT. ANN. 1712a602 (2012); KY. REV. STAT. ANN. 292.460 (2012); LA. REV. STAT. ANN. 51:711 (2012); ME. REV.
STAT. 16602, 16603 (2012); MD. REV. STAT. 11-701 (2012); MASS. GEN. LAWS ch. 110A 407
(2012); MICH. COMP. LAWS 451.2602 (2012); MINN. STAT. 80A.79 (2012); MISS. CODE ANN. 7571-602 (2012); MO. REV. STAT. 409.6-602 (2012); MONT. CODE. ANN 30-10-304 (2012); NEB. REV.
STAT. 8-1115 (2012); NEV. REV. STAT. 90.620(1) (2012); N.H. REV. STAT. 421-B:22(1) (2012); N.J.
STAT. ANN. 49:3-68(a) (2012); N.M. STAT. ANN. 58-13C-602(a) (2012); N.C. GEN. STAT. ANN. 78A57(b) (2012); N.D. CODE. 10-04-16.1 (2012); OHIO REV. CODE. 1707.23 (2012); OKLA. STAT. ANN.
1-602(A)(1) (2012); OR. REV. STAT. 59.245 (2012); PA. STAT. 1-509 (2012); R.I. GEN. STAT. 7-11601(a) (2012); S.C. CODE 35-1-602 (2012); S.D. CODE 47-31B-602 (2012); TENN. CODE. ANN. 48-2-

14

federal level, the SEC cannot bring criminal charges. While the SEC can share
information and work with the Department of Justice, the Department cannot use an SEC
civil investigation as a stalking horse for a criminal investigation and the Department has
independent authority over whether to file criminal charges. 76 In contrast, the Attorney
General need not consult with any other agency before openly invoking the possibility of
criminal charges to exert leverage in a nominally civil investigation.
The Martin Act thus gives a single state official enormous discretion to
regulate securities firms precisely the state of affairs under the original Kansas Blue
Sky law that New York sought to avoid.
IV.

These Features Give the Attorney General Unparalleled Power

These features of the Act give the Attorney General unparalleled power to
regulate the national securities markets. Indeed, the Act has had far more punitive
consequences than its architects intended. Whereas Attorney General Javits envisioned
that the 1955 amendments would conform our statutes with similar provisions contained
in the laws of the more progressive States and the Federal Government, the reality today
is that the Attorney General may prosecute conduct that the federal securities laws do not
prohibit and that our system of justice has not permitted the law to punish.
A.

The American Legal System Generally Disfavors Unintentional

Criminal Liability

The Attorney Generals power to prosecute conduct as criminal fraud,

even when the defendant did not intend to mislead anyone, is inconsistent with
foundational principles of our legal system. While the Attorney Generals Office
generally forbears from using this power to charge individuals or companies with
misdemeanor violations, the specter that the Attorney General could do so casts a shadow
over civil actions and investigations. By invoking the possibility that defendants in civil
actions or subjects of investigations could face criminal charges as well, the Attorney
General can exert leverage over defendants who assert an aggressive defense. As such,
notwithstanding the fact that the Attorney Generals power to prosecute violations of the
Martin Act as strict liability crimes is more often recognized than exercised, that power
has tremendous consequences for those the Attorney General elects to pursue.
Our system of law has long frowned on the existence of such power. The
principle that a defendant should not be punished criminally for an unintentional act was
well-established at English common law in the eighteenth century. 77 From its
beginnings, American jurisprudence, too, has recognized that the prosecution of good
faith defendants under strict liability laws appears to conflict with the most fundamental
118 (2012); TEX. ANN. STAT 581-28 (Vernon 2012); UTAH CODE ANN. 61-1-19 (2012); VT. STAT. ANN.
9 5602 (West 2012); VA. CODE ANN. 13.1-518) (2012); WASH. REV. CODE 12.20.370 (West 2012);
W. VA. CODE 32-4-407 (2012); WIS. STAT. ANN. 551.602 (2012); WYO. STAT. 17-4-119(a) (2012).
76
See, e.g., United States v. Scrushy, 366 F. Supp. 2d 1134 (N.D. Ala. 2005); United States v. Parrott, 248
F. Supp. 196 (D.D.C. 1965).
77
4 WILLIAM BLACKSTONE, COMMENTARIES *21.

15

principles of just punishment. 78 Indeed, the U.S. Supreme Court has consistently
required evidence of some culpable intent even when a criminal statute is silent on the
question. 79 The Court has permitted convictions without a showing of intent only for
violations of statutes intended to protect the public from severe physical danger, such as
laws regulating narcotics, prescription drugs, contaminated food, and highly toxic acids. 80
Lawyers assessing the 1955 amendment criminalizing violations of the
Martin Act recognized the danger of extending the Acts criminal proscriptions to
unintentional misstatements. The New York City Bar Association said at the time that
the amendment may give rise to unease because it does not contain the usual statutory
requirement that criminal acts be willfully or knowingly committed. 81 For these
reasons, the City Bar expressed concern that [t]he result could be that one forecasts at
his peril and that a securities salesman might find himself saddled with criminal
liability for a careless but innocent misstatement of an immaterial fact. 82
The City Bar, however, believed this risk was minimal because, in its
view, the intent of the bill appears to sanction criminal liability only for obviously
intentional or irresponsible acts. 83 The City Bar was confident that the courts would
effectuate this intent by invoking the well-established principle strongly disfavoring
prosecution of unintentional acts. This belief that courts will generally construe
criminal statutes strictly persuaded the City Bar to conclude that these objections are
not sufficient to . . . to disapprove the bill. 84 Instead, the City Bar observed that,
whereas other states have much more restrictive and far reaching Blue Sky or
securities laws than New York, the bill provides an additional measure of public
protection by creating higher standards of conduct for those dealing in securities and
commodities without imposing the sweeping regulation which in some states reduces the
flexibility of the securities distribution system. 85
As set forth above, however, the courts did not interpret the Act as the
City Bar anticipated. Accordingly, as the law currently stands, the Attorney General has
the power to prosecute violations of the Martin Act as criminal misdemeanors even if the
violators did not act with any intent to defraud. And even if the Attorney General rarely
(if ever) invokes his power to prosecute unintentional violations of the Martin Act as
criminal violations, his authority to do so gives him enormous leverage to dictate terms to
those parties under civil investigation.

78

Laurie L. Levinson, Good Faith Defenses: Reshaping Strict Liability Crimes, 78 CORNELL L. REV. 401,
427 (1993).
79
See, e.g., Staples v. United States, 511 U.S. 600 (1994); United States v. U.S. Gypsum Co., 438 U.S. 422
(1978); Morissette v. United States, 243 U.S. 246 (1952).
80
See United States v. Park, 421 U.S. 658 (1975); United States v. Intl Minerals & Chem. Corp., 402 U.S.
558 (1971); United States v. Dotterweich, 320 U.S. 277 (1943); United States v. Balint, 258, 250 (1922).
81
Comm. On State Legislation, Memo. No. 124, 7 N.Y. City B.A. Bull. 421, 423 (Apr. 21, 1955).
82
Id.
83
Id.
84
Id.
85
Id.

16

B.

The Martin Act is Stricter than the Federal Securities Laws

Adopted at a time when no federal regulatory scheme existed and

amended at times when local boiler room practices often fell below the federal radar, the
Martin Act also imposes liability for conduct that is legal under the current federal
regulatory scheme. 86
1. Federal Regulation by the SEC
The SEC is empowered with enforcement of the federal securities laws,
including, among other provisions, Section 17(a) of the Securities Act and Section 10(b)
of the Exchange Act. 87 At a minimum, these laws require the SEC to prove that the
defendant acted negligently, and in many cases they require the SEC to prove that the
defendant acted either recklessly or with the intent to defraud.
Section 17(a) of the Securities Act makes it unlawful in the offer or sale
of any securities . . .
(1) to employ any device, scheme, or artifice to defraud, or
(2) to obtain money or property by means of any untrue statement of a
material fact or any omission to state a material fact necessary in order to
make the statements made, in light of the circumstances under which they
were made, not misleading; or
(3) to engage in any transaction, practice, or course of business which
operates or would operate as a fraud or deceit upon the purchaser. 88
To prove a violation of Section 17(a)(2) or 17(a)(3), the SEC must prove
that the defendant acted negligently. 89 To prove a violation of Section 17(a)(1), the SEC
must prove that the defendant acted with scienter. 90 This means that the SEC must
demonstrate that a defendant acted recklessly, with willful disregard of the truth, or with
an intent to defraud. 91

86

See, e.g., Samuel W. Buell, What is Securities Fraud? 61 DUKE L.J. 511, 559 n. 172 (2011); Razzano,
supra note 50, at 18.
87
See 15 U.S.C. 77t; 15 U.S.C. 78u.
88
15 U.S.C. 77q.
89
See Aaron v. SEC, 446 U.S. 680, 697 (1980); SEC v. Morgan Keegan & Co., Inc., 678 F.3d 1233, 1244
(11th Cir. 2012); SEC v. Shanahan, 646 F.3d 536, 545 (8th Cir. 2011); SEC v. Wolfson, 539 F.3d 1249,
1256 (10th Cir. 2008); SEC v. Seghers, 298 F.Appx 319, 327 (5th Cir. 2008); SEC v. Ficken, 546 F.3d 45,
47 (1st Cir. 2008); Weiss v. SEC, 468 F.3d 849, 855 (D.C. Cir. 2006); SEC v. Hughes Capital Corp., 124
F.3d 449, 453, 454 (3d Cir. 1997).
90
See Aaron, 446 U.S. at 697.
91
See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 318 n.3 (2007) (noting that [e]very
Court of Appeals that has considered the question has held that a plaintiff may meet the scienter
requirement by showing that the defendant acted intentionally or recklessly but continuing to reserve
decision on whether recklessness is sufficient).

17

Section 10(b) of the Exchange Act prohibits essentially the same conduct
in connection with securities traded on a national exchange. 92 To show a violation of
Section 10(b), the SEC must prove that the defendant acted with scienter. 93
Even if the SEC proves that the defendant acted negligently or with
scienter under Section 17(a) and/or Section 10(b), the SEC nonetheless may obtain only
an enumerated set of remedies and penalties. The SEC may obtain an injunction ordering
the defendant not to continue the alleged fraudulent or misleading practice; 94 an order
requiring the defendant to disgorge any profits from the violation; 95 and capped civil
penalties. 96 The SEC, however, cannot recover other types of damages or pursue
criminal penalties.
Contrasting these federal regulations with the Martin Act etches the
problem in sharp relief. Unlike the SEC, the Attorney General is not required to prove
even that the defendant acted negligently to impose the penalties of the Martin Act. Also
unlike the SEC, the Attorney General may obtain remedies that include not only an
injunction but damages and restitution of any investments in the securities at issue.97
And, unlike the SEC, which must refer its evidence to an independent government
agency, the Attorney General has the power to threaten and pursue criminal penalties at
its discretion.
2. Federal Class Actions
While it may be appropriate that regulators do not have to prove all of the
elements that private litigants do, federal law provides for remedies commensurate with
the level of proof required. Though SEC has to prove less than private litigants, it cannot
obtain the large damage awards that private litigants can if they can satisfy additional
requirements. But quite the opposite is true under the Martin Act: the Attorney General
has to prove less than federal law requires either the SEC or private litigants to prove, but
the Attorney General can obtain the same kinds of large damage awards that are only
available to private litigants who must make a more rigorous evidentiary showing.
Federal civil class actions brought under Section 10(b) of the Exchange
Act provide the best illustration. Plaintiffs in these class actions may typically obtain
monetary damages equal to the decline in the value of plaintiffs stock attributable to the
corrective disclosure of the defendants false statement. 98 Plaintiffs often claim billions
of dollars in such damages, and it is not uncommon for defendants to pay tens or
92

15 U.S.C. 78j.
Aaron, 446 U.S. at 691.
94
15 U.S.C. 77t(b); 15 U.S.C. 78u(a)(d)(1).
95
See, e.g., SEC v. Curshen, 372 F.Appx. 872, 883 (10th Cir. 2010) ([T]he SEC is entitled to
disgorgement upon producing a reasonable approximation of [Defendants] ill-gotten gains when
defendant violated 17(a) and 10(b).); SEC v. Calvo, 378 F.3d 1211, 1217 (11th Cir. 2004) (same).
96
15 U.S.C. 77t(d); 15 U.S.C. 78u(3).
97
See Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. PShip, 12 N.Y.3d 236, 244 (2009); Greenberg, 95
A.D.3d at 481; N.Y. GEN. BUS. L. 353(3); N.Y. EXEC. L. 63(12).
98
See generally In re Omnicom Grp., Inc. Sec. Litig., 597 F.3d 501 (2d Cir. 2010).
93

18

hundreds of millions of dollars to settle such claims. 99 However, plaintiffs face a high
hurdle in such cases and one that, as set forth below, Congress has made even higher
out of concern that securities litigation had become unbalanced.
To sustain a class action complaint under Section 10(b)(5), claimants must
plead with specificity, and then prove by a preponderance of the evidence, that in making
an allegedly material misleading statement of fact, or omitting material information:
(a)

defendants acted with scienter, that is, with the intent to defraud or
recklessly as to whether the statement was misleading;

(b)

the plaintiffs relied on the alleged misstatements; and

(c)

that this reliance caused them actual monetary damages. 100

Not so under the Martin Act. The Attorney General need not demonstrate
bad intent, reliance, or causation the rudimentary elements of any claim for fraud at
common law. Yet the Attorney General is nevertheless authorized to seek damages under
the Martin Act, and has done so, in amounts comparable to those sought by nationwide
private class plaintiffs.
Even the most stringent provisions of the federal securities laws impose
greater hurdles to proving liability than does the Martin Act. Under Section 11 and
Section 12 of the Securities Act, plaintiffs alleging claims for false statements in a
registration statement or prospectus in connection with the issuance of securities need not
prove either scienter or negligence. 101 Nevertheless, except for the issuer, others
involved in the registration statement or prospectus such as financial advisors and
accountants are not liable under these Sections if they can establish by a preponderance
of the evidence that they acted with reasonable care and due diligence and, despite these
good faith actions, could not have known that any statement was misleading. 102 This
defense at least gives many defendants an ability to defend against inadvertent disclosure
errors by establishing their reasonable efforts and good faith. No such defense exists
under the Martin Act. 103

99

See generally Ellen M. Ryan & Laura E. Simmons, Securities Class Action Settlements: 2011 Review
and
Analysis,
Cornerstone
Research
(2012),
available
at
http://securities.stanford.edu/Settlements/REVIEW_1995-2011/Settlements_Through_12_2011.pdf.
100
Erica P. John Fund, Inc. v. Halliburton Co., 131 S.Ct. 2179, 2184 (2011).
101
See, e.g., Herman & MacLean v. Huddleston, 459 U.S. 375, 382 (1983); Ernst & Ernst v. Hochfelder,
425 U.S. 185, 208 (1976); In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359-60 (2d Cir.
2010); Miller v. Thane Intl, 519 F.3d 879, 886 (9th Cir. 2008); In re Suprema Specialties, Inc. Sec. Litig.,
438 F.3d 256, 269-70 (3d Cir. 2006).
102
See 15 U.S.C. 77k(b); 15 U.S.C. 77l(a).
103
See Note 50, supra.

19

V.

The Attorney General Has Become a Shadow National Regulator With

Nationwide Post-Hoc Rule-Making Power

The tremendous breadth of the Martin Act, coupled with the

unprecedented inquisitorial powers of the New York Attorney General, permits the
Attorney General to act as a shadow national securities regulator. This system risks
undermining the uniformity, predictability, and balance essential to preserving the
competitiveness of American financial markets.
Given the minimal proof requirements under the Martin Act and the
potential threat of criminal prosecution for unintentional conduct, companies under
investigation often have few alternatives other than to agree to settlements of large dollar
amounts accompanied by broad-ranging conduct reforms. As the SECs former Director
of Enforcement has noted, the prospect of being charged with fraud, even civilly, creates
very high stakes for securities-industry participantsindeed, so high, that state regulators
may find themselves in a position to dictate dramatic changes in conduct to settling
parties. In short, they will have the leverage to effect rule changes through
enforcement. 104
The Martin Act enables the Attorney General to effect these post hoc rules
through settlements involving conduct legal under federal law and, in many instances,
with only a tenuous connection to New York. By imposing change through litigation, the
Attorney General re-writes after-the-fact and on a national level securities rules that
no regulatory body in New York State has the authority to otherwise impose in advance.
This kind of policy making through litigation discussed in a closed conference room is
not healthy for the U.S. capital markets, and not good for investors. 105 Indeed, for two
reasons, the Attorney Generals recent enforcement is not an ideal strategy for rulemaking. 106
A.

Regulation by Settlement Undermines National Priorities

The first problem with the Attorney Generals power to regulate the
securities markets through settlements is that it supplants national efforts to re-balance
American securities regulation.
Enforcement of the securities laws on an equal basis and with a studied
appreciation of the impact on national and global markets is an important governmental
objective. As the Attorney Generals enforcement of the Martin Act has moved beyond
the mere pursuit of fraudulent conduct within the jurisdictional boundaries of the state of
New York, the Acts features have permitted the Attorney General to usurp the SECs
core regulatory function: dictating regulatory policy for the capital markets and
104

Remarks of Stephen M. Cutler, Director, Division of Enforcement, U.S. Securities and Exchange
Commission, at F. Hodge ONeal Corporate and Securities Law Symposium, in 81 WASH. U. L. Q. 545,
552 (2003) [hereinafter Remarks of Stephen M. Cutler].
105
Oxley, Who Should Police the Financial Markets?, N.Y. TIMES (June 9, 2002).
106
Jonathan R. Macey, Wall Street in Turmoil: State-Federal Relations Post-Eliot Spitzer, 70 BROOK. L.
REV. 117, 129 (2004).

20

replace[] the SEC as policy czar. 107 In the words of Representative Michael Oxley,
Chairman of the House Committee on Financial Services and a principal architect of the
2002 Sarbanes-Oxley Acts aggressive reforms, the enforcement approach that the
Attorney General began nearly a decade ago represents a regulatory coup. 108 Such
actions are strange in our federal system, for there is nothing democratic about allowing
one state to set national policy. 109 Because regulated parties will conform their
behavior to meet the demands of the strictest regulator with authority over them, a single
state, like New York, could single-handedly undermine the majority view by
intensifying its enforcement policies. 110
For these reasons, Congress has repeatedly emphasized the goals of
efficiency and competitiveness in our capital markets, and has concluded that uniformity
in regulation is a pre-requisite to achieving these goals. 111 For example, in 1995,
Congress recognized that the asymmetry of securities litigation that the costs of
defending securities actions far outpace the costs of pursuing them made such litigation
potentially unfair, even where intent to defraud is a required element. 112 Congress
recognized that exorbitant defense costs, including the threat that the time of key
employees will be spent responding to discovery requests such as demands for
testimony, often force[d] innocent parties to settle frivolous suits. 113 To prevent this,
Congress passed the Private Securities Litigation Reform Act (PSLRA) of 1995, which,
among other things, increased the pleading standards for scienter applicable to securities
class actions and barred plaintiffs from pursuing discovery while a court considers
whether to dismiss an action. 114 When, following passage of the PSLRA, civil litigants
sought to evade the statute by filing their cases in state courts instead of federal courts,
Congress acted swiftly to prevent any such attempt to avoid the stricter federal standards,
passing the Securities Litigation Uniform Standards Act in 1998, which requires most
securities class actions to be litigated in federal courts. 115
More recently, Congress has acknowledged that the system of dual
Federal and state securities regulation has resulted in a degree of duplicative and
unnecessary regulation which was redundant, costly, and ineffective. 116 Congress
found that this duplicative regulation tends to raise the cost of capital to American
issuers of securities without providing commensurate protection to investors or to our

107

Id. at 128.
Oxley, Who Should Police the Financial Markets?, supra note 105.
109
Amanda M. Rose, The Multienforcer Approach to Securities Fraud Deterrence: A Critical Analysis, 158
U. PA. L. REV. 2173, 2210 (2010).
110
Id.
111
Remarks of Stephen M. Cutler, supra note 104, at 549.
112
Though private litigants had to prove that defendants acted with scienter, under existing law, plaintiffs
could allege this element quite easily. As such, courts were reluctant to dismiss securities class actions
before trial and plaintiffs could proceed to discovery, with its enormous costs. H.R. Conf. Rep. 104-369,
P.L. 104-67 (1995).
113
Id.
114
See generally 15 U.S.C. 78u-4.
115
H.R. Conf. Rep. 105-803, P.L. 105-353 (1998).
116
H.R. Conf. Rep. 104-864, P.L. 104-290 (1996).
108

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markets. 117 Accordingly, Congress sought to eliminate duplicative and unnecessary

regulatory burdens while preserving important investor protections by reallocating
responsibility over the regulation of the nations securities markets in a more logical
fashion between the Federal government and the states. 118
Specifically, Congress tried to achieve this goal by, as a general rule,
designating the Federal government as the exclusive regulator of national offerings of
securities. 119 That made sense, because the SEC is able to bring to its consideration of
matters affecting our markets a broader perspective one informed by national economic
and international policy developments than can any one state. 120 To that end,
Congress passed the National Securities Markets Improvement Act (NSMIA) of 1996,
which preempted the states from regulating securities registrations and offerings made on
a national scale. 121 Congress explicitly preserved the authority of the states to protect
investors through application of state antifraud laws in order to permit state securities
regulators to continue to exercise their police power to prevent fraud and broker-dealer
sales practice abuses, such as churning accounts or misleading customers 122 i.e., the
evils that Governor Smith and Attorney General Javits intended to target. At the same
time, however, Congress intended NSMIA to apply both to direct and indirect State
action, thus precluding States from exercising indirect authority to regulate the matters
preempted by NSMIA. 123
Contrary to this intent, the Attorney Generals enforcement of the Martin
Act has only increased since the enactment of the PSLRA and NSMIA, even as to
conduct that has nothing to do with fictitious securities or Ponzi schemes.
The Attorney General further routinely investigates conduct that is also
under investigation by the SEC or another federal or state agency. Indeed, a review of
press releases on the New York Attorney Generals website revealed that, in over 80% of
the major securities fraud settlements that the Office announced over the past decade, the
SEC or another federal regulator has been involved at some level in the underlying
investigation or settlement negotiation. 124 Though we are unable to determine from this
information whether the investigation was commenced by the SEC or the Attorney
General, this duplication is significant, and demonstrates a troubling overlap in the use of
regulators resources and companies expenses in responding to inquiries.

117

Id.
Id.
119
H.R. Conf. Rep. 104-290, Pl. 104-290, at 30 (1996).
120
Remarks of Stephen M. Cutler, supra note 104, at 550.
121
See generally Kevin A. Jones, The National Securities Markets Improvement Act of 1996: A New Model
for Efficient Capital Formation, 53 ARK. L. REV. 153 (2000); Roberta S. Karmel, Reconciling Federal and
State Interests in Securities Regulation in the United States and Europe, 28 BROOK INTL L. REV. 495, 509511 (2003).
122
H.R. Conf. Rep. 104-864, P.L. 104-290.
123
H.R. Conf. Rep. 104-290, P.L. 104-290, at 30 (1996)
124
The Partnership reviewed information on the New York Attorney Generals website,
http://www.ag.ny.gov, regarding 48 settlements of Martin Act actions from 2002 to the present.
118

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While in theory regulatory competition should encourage more vigorous

enforcement, a former SEC Commissioner has noted that it more frequently is an
unseemly jurisdictional battle fueled by politics that can lead to disrespect for the law,
as one regulator undermines the laws and regulations of another regulator. 125 Indeed, a
contest to be the most responsive regulator could too easily become a contest to be the
most popular but most irresponsible regulator, which can have untold costs to
investors to issuers, to financial institutions, to the capital markets, to the justice system,
and, ultimately, to our credibility as regulators. 126
B.

Regulation by Litigation is Too Unpredictable

The second problem with the Attorney Generals power to regulate the
securities markets through settlements in enforcement actions is that it is too
unpredictable. Companies deciding whether to embark on new initiatives or to open new
lines of business want to know whether these activities are legal, and they employ or
retain lawyers to advise them on such questions. The overwhelming majority of law
enforcement in this country is implemented in the private corridors of business, in the
private exchanges between lawyers and their clients. The more certain a company and its
lawyers are about the law, the less likely the company is to forgo profitable activity that
turns out to be lawful or to expend resources on safeguards that are, in fact, unnecessary.
But two features of the Martin Act make it very difficult for companies and their advisors
to know the rules in advance.
First, the Attorney Generals enormous power under the Act gives him
great leverage to dictate terms beyond what a company expects. Perhaps most
disturbingly, when rulemaking takes place in the context of an enforcement action, the
regulator has such a power advantage over the regulated entity that unjust results are
likely to occur.127 This is especially true under the Martin Act owing to its extraordinary
breadth and the powerful threat that the Attorney General will conduct its investigation in
the public spotlight.
Second, regulation by enforcement action lacks the usual notice and
comment period associated with the promulgation of rules. It does not permit
participation by all, or even most affected parties. 128 Whereas the SEC makes rules
pursuant to a set of substantive and procedural rules that the aggrieved parties can enforce
in court, there is no such process employed under the Martin Act and the Attorney
General has nearly absolute discretion over investigations and settlements. This lack of
transparency is particularly problematic where regulation is entrusted to a single elected
official. 129

125

Karmel, supra note 121, at 544-45.

Remarks of Stephen M. Cutler, supra note 104, at 551. See also generally Jonathan R. Macey, Positive
Political Theory and Federal Usurpation of the Regulation of Corporate Governance: The Coming
Preemption of the Martin Act, 80 NOTRE DAME L. REV. 951 (2004).
127
Id.
128
Id.
129
Rose, supra note 109, at 2223.
126

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Without any guidance from the rule-making process, companies and their
lawyers can only speculate about the motives, politics, and goals of the Attorney
Generals Office and what the Attorney General will demand in a proceeding where he
has the upper hand. Running a business based on this uncertainty can cause significant
economic disruption if regulated companies are unfairly surprised when regulators
advance broad principles in novel ways through enforcement. 130 In fact, regulatory
unpredictability can have some of the very same social costs as securities fraud itself
for example, it can increase the cost of capital . . . if fear of liability causes companies to
overinvest in precautionary measures or causes financial intermediaries to charge more
for their services. 131
VI.

The Current Martin Act Enforcement Scheme Harms New York

These are not idle concerns. Evidence exists that the regulatory problems
that characterize the current Martin Act regime uncertainty, inconsistency, and
imbalance have undermined New Yorks competitiveness as a global financial center.
The 2007 report commissioned by Mayor Michael Bloomberg and U.S. Senator Charles
Schumer found that the second most important factor of competitiveness among the
financial industry leaders it surveyed was the quality of the legal system. These leaders
cited the unpredictable nature of the legal system in the United States as one of the
major factors undermining New Yorks competitiveness. 132 Chief among the major
issues they cited:
The U.S. legal system is multi-tiered and highly complex
because it is divided between state and federal courts and uses a
variety of enforcement mechanisms, including legal actions by
regulators, state and federal attorneys general, plaintiff classes, and
individuals. This fragmented US approach was seen as being
more punitive, more public, and more costly, with multiple
enforcement actions by national and state regulators and litigators
as well as the possibility of both criminal and civil penalties in
different jurisdictions. 133 This has the unfortunate side effect of
making it harder to manage legal risk in the US than in many other
jurisdictions. 134

The enforcement efforts and subsequent rulings in the financial

services industry have appeared to effectively criminalize conduct
that had until then been assumed to be permissible. This caused
many market participants to question their understanding of the

130

James J. Park, The Competing Paradigms of Securities Regulation, 57 DUKE L.J. 625, 630-32 (2007);
see also Karmel, supra note 121, at 546.
131
Rose, supra note 109, at 2184.
132
Sustaining New York, supra note 2, at 73.
133
Id. at 84.
134
Id. at 77.

24

scope of existing law, which in turn led them to adopt costly riskaverse behavior and bear the associated opportunity costs. 135
As Mayor Bloomberg and Senator Schumer concluded, the highly complex and
fragmented nature of our legal system has led to a perception that penalties are arbitrary
and unfair, which diminishes our attractiveness to international companies. 136
The consequences of this reduced competiveness are clear. Long ago, the
New York City Bar Association noted that a capitalist who is urged to advance large
sums of money is not likely to invest his money in New York if such investment is made
burdensome, while other States and countries afford more favorable opportunities for
investment. Any law which places oppressive burdens on those who are asked to invest
their capital tends to drive capital, from the State enacting such a law, into other States
and countries. 137 And this is even truer in todays ultra-competitive global
marketplace where more and more nations are challenging our position as the worlds
financial capital. 138
Indeed, there are signs that New York already suffers from reduced
competitiveness. The report commissioned by Mayor Bloomberg and Senator Schumer
concluded that, as early as 2006, initial public offerings (IPOs), exchange listings, and the
rapidly expanding market in derivatives, among other financial activity, had begun
migrating away from the United States, which means away from New York. 139 Financial
industry leaders reported that they viewed London, and the United Kingdoms more
efficient and predictable regulatory environment, as a more attractive location for their
business. 140 And New York continues to trail London in the Global Financial Centres
Index, a biennial survey of global financial center competitiveness. 141
The threat has not abated; it has spread. New Yorks advantage in the
Index over its nearest competitors Hong Kong and Singapore has been cut by more
than half in the past five years. 142 The most recent Index found that financial
professionals expected that Singapore, Shanghai, Hong Kong, Toronto, Sao Paulo,
Luxembourg, Beijing, Moscow, Mumbai, and London, not New York, were the ten
financial centers likely to become more significant in the years ahead. 143 And more
financial professionals expected financial firms to open new offices in Singapore, Hong
Kong, London, Shanghai, and Dubai than expected firms to open new offices in New

135

Id. at 78.
Id. at ii.
137
Committee on the Amendment of the Law of the Association of the Bar of the City of New York,
Memorandum on Assembly Bill, Pr. No. 1932, Int. No. 1540, at 107-108.
138
Sustaining New York, supra note 2, at i.
139
Id. at 40-59.
140
Id. at 73-78.
141
Global Financial Centres Index 12, supra note 4, at 11 (2012).
142
Compare id., with Global Financial Centres Index 1, supra note 4, at 7 (2007).
143
See Global Financial Centres Index 12, supra note 4, at 9.
136

25

York. 144 Thus, the Index warned that London and New York must not believe they are
untouchable, since the longer term trend of the leading Asian centres is upward.
The potential costs of reduced financial competitiveness are enormous.
New Yorks securities industry currently contributes to 1 of every 12 jobs in New York
State, and 1 of every 7 jobs in New York City, as well as $2.8 billion, or 7 percent, of
state tax revenues and $8.7 billion, or 14 percent, of city tax revenues. New York State
also has more than double the securities industry jobs than any other state. 145
Thus, what Governor Smith noted in proposing the Martin Act remains
true nearly a century later: because New York is today the financial center of the
world, it is of prime importance that legitimate business should be safeguarded,
protected and encouraged, to the end that we maintain our financial, commercial and
industrial supremacy. 146
VII.

Recommendations

The Partnership for New York City is committed to restoring the Martin
Acts intended balance between deterring frauds and preserving New Yorks competitive
advantage as a financial capital. To accomplish this objective, we must revisit the Martin
Acts roots: (1) the Act was intended to protect retail investors from swindlers selling
fictitious securities or securities based on worthless promises; and (2) New York
purposefully rejected a comprehensive system of regulation in favor of a more surgical
approach focused on fraudulent schemes.
Today, Congress has preempted New York from doing so, because
national legislative reform has placed a premium on a single, national system of
comprehensive regulation and has rejected a system of dual regulation. Congress has
thus limited the states to prosecuting the kinds of fraudulent schemes at which the Martin
Act was originally directed.
In recent times, however, the Attorney General has used its residual power
for the very purpose of regulating the national securities markets wholesale, even where
the conduct at issue has nothing to do with fictitious securities, boiler room operations, or
pyramid schemes. New York cannot afford this system any more than it could in 1921;
indeed, such a system would be even more costly for New York today given competition
from global financial centers in Asia and elsewhere that were hardly on the map nine
decades ago.
The Attorney General should enforce the Martin Act in a way that
supplements rather than supplants national regulation.

144

Id. at 12.
THOMAS P. DINAPOLI, NEW YORK STATE COMPTROLLER, REPORT 9-2013, THE SECURITIES INDUSTRY IN
NEW YORK CITY (Oct. 2012), available at https://www.osc.state.ny.us/osdc/rpt9-2013.pdf.
146
Governors Message, supra note 1, at 8.
145

26

First, the Attorney General should pursue claims under the Martin Act
only when the Attorney General can establish that the defendant acted with intent to
defraud or recklessly, which is the prevailing standard for federal cases under federal law
and which comports with the Martin Acts historical objectives.
Second, rather than pursuing claims against defendants nationwide, the
Attorney General should pursue claims under the Martin Act only when a significant part
of the allegedly fraudulent conduct took place in New York or when the conduct has
caused substantial harm to New York residents or companies. Only these changes can
harmonize the Martin Act with securities regulatory regimes nationwide, and focus the
Attorney Generals resources where they belong: on truly fraudulent activity in this state.
Third, rather than duplicating or piggybacking on federal enforcement,
the Attorney General should also use its discretion to bring Martin Act cases only where
federal regulators have not already commenced an investigation or filed a lawsuit. While
the Attorney General may not always know in the first instance whether federal
regulators are pursuing a given matter, the Attorney Generals record of working jointly
with federal regulators suggests that the Attorney General will usually learn when the
SEC is pursuing an investigation or enforcement action. At the very least, the Attorney
General should not file a Martin Act case where the SEC has already filed a civil
enforcement action. Duplicating the efforts of federal regulators serves no additional
deterrent effect, wastes taxpayer resources that could be used to investigate other activity,
and materially increases defense costs for companies who are already facing legal
consequences.
Finally, because restoring the Martin Acts balance is so important to New
Yorks competitiveness, the Partnership for New York City recommends that the
Legislature consider amending the Martin Act to require the Attorney General to prove
that a defendant acted with intent to defraud, or, at a minimum, to afford defendants some
defense premised on their use of reasonable diligence or good faith.

27