Criminal Prosecution Under New York State's Martin Act

Yet by the 1930s, virtually all of the states already had “blue-sky laws” for exactly that purpose. A dozen years before the federal initiative, in 1921, NY Assemblyman Louis M. Martin sponsored the law that still bears his name. The Martin Act at first empowered only the N.Y. Attorney General to investigate ' civilly ' securities fraud in the already important NY markets. The attorney general was granted subpoena power to call people in for questioning. He decided if the investigation was to be secret or public.

From the outset, the Martin Act's breadth was recognized and upheld by NY courts. Only five years after its enactment, New York's highest court declared:

The purpose of the law is to prevent all kinds of fraud in connection with the sale of securities and commodities and to defeat all unsubstantial and visionary schemes in relation thereto whereby the public is fraudulently exploited. The words 'fraud' and 'fraudulent practice,' in this connection should therefore, be given a wide meaning so as to include all acts, although not originating in any actual evil design or contrivance to perpetrate fraud or injury upon others, which do by their tendency to deceive or mislead the purchasing public come within the purpose of law.

People v. Federated Radio Corp., 244 N.Y. 33, 38-39 (1926).

In the decades following the Great Depression, the Martin Act became a powerful tool for civil protection against fraud. Of particular importance was that it broadly prohibited certain acts and practices in the sale of securities and commodities, making such conduct civilly actionable by the state attorney general without the need to prove intent to defraud. Nor did the state attorney general need to prove that an investor relied on the prohibited acts or even lost money. In broad strokes, all that was needed was a misrepresentation or omission made while inducing or promoting the issuance, distribution, exchange, sale, negotiation or purchase of securities or commodities.

Criminal Provisions

The evolving Martin Act did not include penal sanctions until 1955, and did not include felony sanctions until 1982. At the same time, the authority to enforce the criminal provisions was expanded beyond the attorney general to district attorneys throughout the state. With these changes, by the early 1990s, the Martin Act was regularly employed against larger institutions as well as smaller fraudulent schemes. The Act's primary penal provisions are found in General Business Law (GBL) ' 352-c. Significantly, whereas the felony provision requires the intentional performance of acts “illegal and prohibited,” neither felony nor misdemeanor prosecutions require a specific intent to defraud victims, and the misdemeanor provision requires no mens rea at all.

A felony prosecution under the Martin Act exposes the wrongdoer to up to four years in jail, under one of two different prohibitions. The first requires an ongoing scheme to defraud at least ten people using false or fraudulent pretenses, representations or promises in connection with the issuance, distribution, exchange, sale, negotiation or purchase of any securities or commodities, in which the wrongdoers obtain any amount of property from at least one victim. GBL ' 352-c(5). Notwithstanding the reference to a “scheme to defraud,” NY courts do not require an intent to defraud or scienter to prove a felony Martin Act violation. See People v. Sala, 258 A.D.2d 182, 193 (3rd Dept. 1999) (statute only requires “deceitful practices ' tending to deceive or mislead the public.”). This, together with the lack of a reliance requirement, distinguishes the Martin Act from common-law fraud and many federal anti-fraud statutes.

The second felony Martin Act provision requires that the wrongdoer obtain more than $250 through either: 1) intentional deception in the sale or purchase of securities; or 2) an intentionally false representation made with the specific intent to defraud, in connection with issuance, distribution, exchange, sale, negotiation or purchase of securities. Of course, the misrepresentation or omission must be material, that is, there must be a “substantial likelihood” that a reasonable investor would have considered the matter “important” or as “having significantly altered the 'total mix' of information made available.” People v. Rachmani, 71 N.Y.2d 718, 725-726 (1988).

The misdemeanor violation, which carries maximum penalties of up to one year in jail for individuals and up to a $5,000 fine for each violation by a corporation, catches an even broader range of misconduct. To effectuate this broad purpose, the statute contains a laundry list of “illegal and prohibited” acts that would constitute a misdemeanor under GBL ' 352-c, which can be fairly summarized as prohibiting any act that is fraudulent in the sale of securities or commodities, any unreasonable future promise, any false statement in issuance, distribution, exchange, sale, negotiation or purchase of securities or commodities whether intentional, recklessly, or negligently made, and any use of a prohibited act to obtain property.

Crucially, liability for the misdemeanor is triggered by the acts, defined as criminal, that are used to promote the securities ' not whether the person committing those acts intended to obtain property or was even successful in doing so. In other words, the Martin Act imposes a high duty of care on those involved in the sale and issuance of securities and commodities. Although misdemeanor prosecutions may be less serious than felonies, for companies in regulated industries or for those who would face grave collateral consequences from a conviction, any criminal action is a serious matter.

State Prosecutors

In recent years, beginning long before the Martin Act became a household name on Wall Street in the late 1990s, the Manhattan District Attorney's Office used its felony provisions to prosecute boiler rooms and Ponzi schemes, private-placement investment fraud, violations of customer confidences, and corrupt trading practices by brokers, floor traders and clerks. The misdemeanor provisions have not been used as frequently, but they remain an important tool in the state prosecutor's arsenal, particularly in cases where the public interest requires holding corporate actors responsible even absent proof of intent by any particular officer or agent.

Comparison with Federal Enforcement

As white-collar practitioners know, federal enforcement of securities and commodities fraud also includes robust weapons. In addition to the regulatory powers of the SEC and Commodity Futures Trading Commission, federal prosecutors can seek criminal sanctions where intent to defraud or other proof of willful violation of the particular statutory scheme is present, and they can also use the broad mail, wire, and securities fraud statutes in Title 18 of the U.S. Code. But the Martin Act, by placing an
affirmative obligation of fair dealing on those who sell or promote securities and commodities, provides a weapon that the federal prosecutor does not possess: the ability to prosecute those who engage in deceptive, false and misleading practices, even if proof of willfulness is lacking.

Moreover, New York has long defined the term “securities” much more broadly than analogous decisions in federal court. Federally, a security is “an investment of money in a common enterprise with profits to come solely from the efforts of others.” SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946). New York's definition also includes “any form of instrument used for the purpose of financing and promoting enterprises, and which is designed for investment.” All Seasons Resorts, Inc. v. Abrams, 68 N.Y.2d 81 (1986).

Suggestion for the Future

As useful as the Act is, it would be more powerful and more equitable if its penalties were gradated according to the loss amount. Currently, whether the perpetrator steals $500 or $500 million, the felony penalty is the same ' that reserved for the lowest-level felonies in New York. More rational would be to harmonize the Martin Act with New York's grand-larceny statute, which was amended in 1986 to create a new level of “mega-larcenies” where the amount of the theft was greater than $1 million. Such crimes are punishable by up to 8 1/3 to 25 years in state prison. In these economic times, when securities fraudsters peddle ever more complex schemes to bilk money from the public, such a system makes sense for the Martin Act as well, and would do much to protect New York's markets and investors from deceptive practices.

Adam S. Kaufmann is Executive Assistant District Attorney and Chief of the Investigation Division in the Manhattan District Attorney's office. Marc Frazier Scholl is Counsel to the Investigation Division and is assigned to the Major Economic Crimes Bureau. The views expressed herein are their own.

“Short-sellers spread rumors to drive down stock prices.” “Promoters use misleading and exaggerated claims to sell investment opportunities in high-risk companies.”

Although these could be the headlines of today, they were the likes of headlines nearly a century ago. For then, as now, there was no shortage of efforts to dupe the public into investing in “schemes which have no more basis than so many feet of 'blue sky.'” Hall v. Geiger Jones Co. , 242 U.S. 539 (1917). Headlines like these eventually led the federal government, in the 1930s, to create the SEC and enact the first national anti-fraud protections.

Blue-Sky Laws and the Martin Act's Development

Yet by the 1930s, virtually all of the states already had “blue-sky laws” for exactly that purpose. A dozen years before the federal initiative, in 1921, NY Assemblyman Louis M. Martin sponsored the law that still bears his name. The Martin Act at first empowered only the N.Y. Attorney General to investigate ' civilly ' securities fraud in the already important NY markets. The attorney general was granted subpoena power to call people in for questioning. He decided if the investigation was to be secret or public.

From the outset, the Martin Act's breadth was recognized and upheld by NY courts. Only five years after its enactment, New York's highest court declared:

The purpose of the law is to prevent all kinds of fraud in connection with the sale of securities and commodities and to defeat all unsubstantial and visionary schemes in relation thereto whereby the public is fraudulently exploited. The words 'fraud' and 'fraudulent practice,' in this connection should therefore, be given a wide meaning so as to include all acts, although not originating in any actual evil design or contrivance to perpetrate fraud or injury upon others, which do by their tendency to deceive or mislead the purchasing public come within the purpose of law.

People v. Federated Radio Corp. , 244 N.Y. 33, 38-39 (1926).

In the decades following the Great Depression, the Martin Act became a powerful tool for civil protection against fraud. Of particular importance was that it broadly prohibited certain acts and practices in the sale of securities and commodities, making such conduct civilly actionable by the state attorney general without the need to prove intent to defraud. Nor did the state attorney general need to prove that an investor relied on the prohibited acts or even lost money. In broad strokes, all that was needed was a misrepresentation or omission made while inducing or promoting the issuance, distribution, exchange, sale, negotiation or purchase of securities or commodities.

Criminal Provisions

The evolving Martin Act did not include penal sanctions until 1955, and did not include felony sanctions until 1982. At the same time, the authority to enforce the criminal provisions was expanded beyond the attorney general to district attorneys throughout the state. With these changes, by the early 1990s, the Martin Act was regularly employed against larger institutions as well as smaller fraudulent schemes. The Act's primary penal provisions are found in General Business Law (GBL) ' 352-c. Significantly, whereas the felony provision requires the intentional performance of acts “illegal and prohibited,” neither felony nor misdemeanor prosecutions require a specific intent to defraud victims, and the misdemeanor provision requires no mens rea at all.

A felony prosecution under the Martin Act exposes the wrongdoer to up to four years in jail, under one of two different prohibitions. The first requires an ongoing scheme to defraud at least ten people using false or fraudulent pretenses, representations or promises in connection with the issuance, distribution, exchange, sale, negotiation or purchase of any securities or commodities, in which the wrongdoers obtain any amount of property from at least one victim. GBL ' 352-c(5). Notwithstanding the reference to a “scheme to defraud,” NY courts do not require an intent to defraud or scienter to prove a felony Martin Act violation. See People v. Sala , 258 A.D.2d 182, 193 (3rd Dept. 1999) (statute only requires “deceitful practices ' tending to deceive or mislead the public.”). This, together with the lack of a reliance requirement, distinguishes the Martin Act from common-law fraud and many federal anti-fraud statutes.

The second felony Martin Act provision requires that the wrongdoer obtain more than $250 through either: 1) intentional deception in the sale or purchase of securities; or 2) an intentionally false representation made with the specific intent to defraud, in connection with issuance, distribution, exchange, sale, negotiation or purchase of securities. Of course, the misrepresentation or omission must be material, that is, there must be a “substantial likelihood” that a reasonable investor would have considered the matter “important” or as “having significantly altered the 'total mix' of information made available.” People v. Rachmani , 71 N.Y.2d 718, 725-726 (1988).

The misdemeanor violation, which carries maximum penalties of up to one year in jail for individuals and up to a $5,000 fine for each violation by a corporation, catches an even broader range of misconduct. To effectuate this broad purpose, the statute contains a laundry list of “illegal and prohibited” acts that would constitute a misdemeanor under GBL ' 352-c, which can be fairly summarized as prohibiting any act that is fraudulent in the sale of securities or commodities, any unreasonable future promise, any false statement in issuance, distribution, exchange, sale, negotiation or purchase of securities or commodities whether intentional, recklessly, or negligently made, and any use of a prohibited act to obtain property.

Crucially, liability for the misdemeanor is triggered by the acts, defined as criminal, that are used to promote the securities ' not whether the person committing those acts intended to obtain property or was even successful in doing so. In other words, the Martin Act imposes a high duty of care on those involved in the sale and issuance of securities and commodities. Although misdemeanor prosecutions may be less serious than felonies, for companies in regulated industries or for those who would face grave collateral consequences from a conviction, any criminal action is a serious matter.

State Prosecutors

In recent years, beginning long before the Martin Act became a household name on Wall Street in the late 1990s, the Manhattan District Attorney's Office used its felony provisions to prosecute boiler rooms and Ponzi schemes, private-placement investment fraud, violations of customer confidences, and corrupt trading practices by brokers, floor traders and clerks. The misdemeanor provisions have not been used as frequently, but they remain an important tool in the state prosecutor's arsenal, particularly in cases where the public interest requires holding corporate actors responsible even absent proof of intent by any particular officer or agent.

Comparison with Federal Enforcement

As white-collar practitioners know, federal enforcement of securities and commodities fraud also includes robust weapons. In addition to the regulatory powers of the SEC and Commodity Futures Trading Commission, federal prosecutors can seek criminal sanctions where intent to defraud or other proof of willful violation of the particular statutory scheme is present, and they can also use the broad mail, wire, and securities fraud statutes in Title 18 of the U.S. Code. But the Martin Act, by placing an
affirmative obligation of fair dealing on those who sell or promote securities and commodities, provides a weapon that the federal prosecutor does not possess: the ability to prosecute those who engage in deceptive, false and misleading practices, even if proof of willfulness is lacking.

Moreover, New York has long defined the term “securities” much more broadly than analogous decisions in federal court. Federally, a security is “an investment of money in a common enterprise with profits to come solely from the efforts of others.” SEC v. W.J. Howey Co. , 328 U.S. 293, 301 (1946). New York's definition also includes “any form of instrument used for the purpose of financing and promoting enterprises, and which is designed for investment.” All Seasons Resorts, Inc. v. Abrams , 68 N.Y.2d 81 (1986).

Suggestion for the Future

As useful as the Act is, it would be more powerful and more equitable if its penalties were gradated according to the loss amount. Currently, whether the perpetrator steals $500 or $500 million, the felony penalty is the same ' that reserved for the lowest-level felonies in New York. More rational would be to harmonize the Martin Act with New York's grand-larceny statute, which was amended in 1986 to create a new level of “mega-larcenies” where the amount of the theft was greater than $1 million. Such crimes are punishable by up to 8 1/3 to 25 years in state prison. In these economic times, when securities fraudsters peddle ever more complex schemes to bilk money from the public, such a system makes sense for the Martin Act as well, and would do much to protect New York's markets and investors from deceptive practices.

Adam S. Kaufmann is Executive Assistant District Attorney and Chief of the Investigation Division in the Manhattan District Attorney's office. Marc Frazier Scholl is Counsel to the Investigation Division and is assigned to the Major Economic Crimes Bureau. The views expressed herein are their own.