Court Limits NY Attorney General’s Reach

New York State Attorney General                  Barbara D. Underwood

Bloomberg quoted me in Credit Suisse Wins Narrowing of $11 Billion Suit, Martin Act. It opens,

New York’s powerful anti-fraud weapon known as the Martin Act was crimped by the state’s highest court, which scaled back what was an $11 billion lawsuit against Credit Suisse Group AG over mortgage-securities practices in the run-up to the financial crisis.

The New York Court of Appeals found that many of the claims were too old, trimming the statute-of-limitations of the law to three years from six years. The Martin Act has been used by the state’s attorney general to police the securities markets since the 1920s, so the ruling may limit the prosecution of fraud in stock and bond sales and some other financial transactions.

“Anything that reduces a statute of limitations will have a big impact on enforcement,” said David Reiss, a professor at Brooklyn Law School, noting that it can take many years to develop complex financial cases. “This case reflects a significant curtailment of the New York attorney general’s ability to go after alleged financial wrongdoing.”

Prior to the legal battle against Credit Suisse, the Martin Act, one of the country’s oldest and toughest anti-fraud tools, faced relatively few tests in court. The law can be used by the state attorney general to file both civil suits and criminal charges, and requires a lower standard of proof for civil cases than other anti-fraud statutes. It can also be used to launch investigations, which can help extract settlements.

Legal Tool

Through the specter of the Martin Act, New York state has been able to collect billions of dollars in fines from investment banks, insurance companies and mutual funds over a wide variety of alleged fraud. It has also been used to charge individuals, including executives at Tyco International Ltd., accused of looting the company, and former officials at the law firm Dewey & LeBoeuf.

Amy Spitalnick, a spokeswoman for Attorney General Barbara Underwood, said she pursues cases quickly and will continue to do so.

“This decision will have no impact on our efforts to vigorously pursue financial fraud wherever it exists in New York,” Spitalnick said. “That includes continuing our case against Credit Suisse.”

In recent years, the Martin Act has been used against Barclays Plc and other banks to pursue claims they misled customers about the role of high-frequency traders in dark pools, to win a settlement from the Bank of New York Mellon Corp. over foreign-currency trading, and to start an investigation into Exxon Mobil Corp. about whether it misled investors about the impact of climate change.

The case against Zurich-based Credit Suisse came as the office started probes into allegations of wrongdoing related to the financial crisis. The lawsuit, filed by former Attorney General Eric Schneiderman in November 2012, claimed the bank ignored warning signs about the quality of loans it was packaging and selling in 2006 and 2007.

Reiss in Bloomberg on CS Lawsuit

Bloomberg quoted me in Credit Suisse Waits for $11 Billion Answer in N.Y. Fraud Suit.  It reads in part,

As Credit Suisse Group AG (CSGN) sees it, time has run out on New York Attorney General Eric Schneiderman’s pursuit of Wall Street banks for mortgage fraud that helped trigger the financial crisis.

Schneiderman sued Credit Suisse in 2012 as part of a wide-ranging probe into mortgage bonds. He claimed Switzerland’s second-largest bank misrepresented the risks associated with $93.8 billion in mortgage-backed securities issued in 2006 and 2007.

Credit Suisse asked a Manhattan judge in December to dismiss Schneiderman’s case, as well as his demand for as much as $11.2 billion in damages. The bank argued that New York, by waiting so long to file the lawsuit, missed a three-year legal deadline for suing. The state countered that it had six years to file its complaint.

If the bank wins, Schneiderman will face a new roadblock as he considers similar multibillion-dollar claims against a dozen other Wall Street firms. The judge in New York State Supreme Court could rule at any time.

“It would obviously tilt everything in the favor of Credit Suisse and similarly situated financial institutions,” said David Reiss, a professor at Brooklyn Law School, hindering New York’s remaining efforts to hold banks accountable for mistakes that spurred a recession.

*     *     *

Since the latest bonds cited in Schneiderman’s suit originated in 2006 and 2007, if the judge chooses the bank’s argument, the lawsuit may be dismissed. If the judge takes Schneiderman’s more expansive view, most or all of the suspect bonds may still be covered by the litigation.

“The entire case is time-barred,” Richard Clary, a lawyer for the bank, told Friedman at the December hearing. Lawyers for the state argued that such limits weren’t intended to apply to the attorney general.

“We’ve successfully resolved cases filed within six years,” Deputy Attorney General Virginia Chavez Romano said, citing last year’s JPMorgan accord. “It has been our decades-long practice.”

So far, New York’s courts have broadly interpreted the statute in finding a six-year period, Brooklyn Law School’s Reiss said. That may be changing as legal scholars and financial industry lawyers question its propriety.

“Having these incredibly long and ambiguous statutes of limitations is not particularly fair,” he said.

*     *     *

Friedman’s ruling in the Credit Suisse case may be crucial to Schneiderman’s probe of close to a dozen other banks, and whether he can sue them successfully.

New York agreed with the firms in October 2012 that any legal deadline for bringing fraud claims against them would be suspended while he continues his investigation, a person familiar with the matter said.

Such tolling agreements stopped the clock on any statute of limitations and ensured Schneiderman can bring fraud claims against banks for conduct going as far back as 2006, said the person.

Brooklyn Law School’s Reiss said the banks may have agreed to the delay to avoid forcing Schneiderman to file a “kitchen sink complaint with every possible allegation in it” just to beat the clock. Doing so also builds good will with regulators and may also facilitate a favorable settlement.

The agreements don’t necessarily mean that suits will be filed, the person said. If Schneiderman sues any of the banks, they may then assert the statute of limitations is three years, and not six, just as Credit Suisse has done.

*     *     *

This may be a more potent argument if Friedman rules for the Swiss bank in the pending case.

A three-year statute-of-limitations would mean they can’t be held responsible for transactions before 2009, while a six-year deadline would allow Schneiderman to reach back to 2006.

There’s “great uncertainty” about whether Schneiderman can move forward with the Credit Suisse case in light of the statute of limitations arguments, said James Cox, a corporate law professor at Duke University in Durham, North Carolina.

Reiss said that any ruling would probably be challenged all the way to the Court of Appeals in Albany, the state’s highest court.

The Devil is in the Statute of Limitations

NY Supreme Court Justice Kornreich (N.Y. County) issued an opinion ACE Securities Corp. v. DB Structured Products Inc., No. 650980/2012 (May 13, 2013) that diverges in approach from an earlier SDNY opinion as to whether the statute of limitations runs “from the execution of the contract.” (5) The case concerns allegations that an MBS securitizer made false representations about the loans that underlay the MBS.

Kornreich held that the statute of limitations begins to run when the MBS securitizer (a Deutsche Bank affiliate) “improperly rejected the Trustee’s repurchase demand” so long as the Trustee did not “wait an unreasonable time to make the demand.” (7) (On a side note, Kornreich also held that the plaintiff in such a case is not required “to set forth which of the specific loans are affected by false” representations in a breach of contract claim. (7))

This really opens up the statute of limitations under NY law. There has been a lot of speculation that the flood of lawsuits arising from the Subprime Boom would have to come to an end because the statute of limitations covering many of the claims was six years.  A variety of developments has extended the possibility of filing a suit.  There is FIRREA‘s ten year statute of limitations. There is NY’s Martin Act, with its lengthy statutes of limitation. And now there is this expansive reading of NY’s statute of limitations for breach of contract actions.

Although one might think that all of the good cases have been filed already, you never know. And with the ACE Securities Corp. case, we can see how a case can be filed more than six years after the contract was entered into, under certain circumstances.


Martin-et Act?

I am on the record in favor of greater prosecutorial attention to the events that led to the financial crisis, but I also believe that any prosecutions that result from such investigations should arise from laws that clearly outline potential liability.  Jeff Izant, a 3L at Columbia, has written a Note on an important, related topic:  Mens Rea and The Martin Act: A Weapon of Choice for Securities Fraud Prosecutions?

In particular, Izant argues

that the mental state requirements for Martin Act Section 352-c misdemeanor and felony liability need to be clarified and more thoroughly supported, because the statutory text and legislative history are somewhat ambiguous, and the subsequent jurisprudence has failed to provide a coherent explanation for the current state of the doctrine. Nonetheless, the Martin Act’s text, history and underlying policy rationale can be interpreted to support strict liability prosecutions for misdemeanor securities fraud, and to impose felony liability only for reckless violations of the statute. (919)

I have already noted that the Martin Act is in need of a thorough review, but Izant makes a strong case that strict liability under the act is on shaky grounds both as a legal and policy matter.

Izent notes that the Martin Act is a powerful club for the NY Attorney General to wield. Because those under investigation fear it so and typically choose to settle, there is little case law to guide our understanding of its reach.  Indeed, the New York Court of Appeals has never directly addressed the mens rea element of a Martin Act violation and Izant argues that lower courts have also not addressed it satisfactorily.  Because of this, Izant concludes that the Martin Act  poses dangers to the rule of law, particularly when the citizenry is calling for blood after a financial crisis.

Jean Martinet came to be a symbol of one “who demands absolute adherence to forms and rules.”  The Martin Act poses a greater danger:  in the wrong hands, it can demand absolute adherence to ambiguous rules that are only clearly articulated after the fact.  The Martin Act is in need of legislative attention.  Let us hope that some in the NY State Assembly or Senate agree.

Before The Next Crisis: Now’s The Time to Rethink The Martin Act

The Martin Act, New York State’s far-reaching securities fraud statute, has been a powerful tool for New York law enforcement officials to pursue wrongdoing by financial institutions.  It has a broad definition of fraud and a long statute of limitations. NY Attorneys General like Spitzer, Cuomo and Schneiderman have used it to bring whole industries in line.

The act has faced criticism from the financial sector for being farther reaching than federal securities laws and comparable statutes in other states.  Because it is such a powerful too, various groups have promoted various amendments to increase its potency.  The financial sector has opposed these attempts (and here) over the last few years to expand its reach by, for instance, creating a private right of action.  Manhattan District Attorney Vance has also called for the Martin Act’s statute of limitations (currently six years or two years from when the injured party discovered or could have reasonably discovered fraudulent behavior) to be extended.  The financial sector would not welcome such a move either, of course.

With the six year statute of limitations soon to run out on actions from the Subprime Boom, we should ask ourselves — how broad should the Martin Act be?  On the one hand, New York must treat businesses fairly for fairness’ sake but also to maintain its dominant position as a global capital of capital.  On the other hand, fairness demands that wrongdoers be punished and fraud be deterred by vigorous enforcement.

Now that we are about to have a breather between the last crisis and the next, we should try to come up with a principled balance between those two goals.  That balance should be struck while our cooler heads are prevailing.