G THE B IN EN V C R H E S

A N 8 D 8 B 8 A E 1 R SINC Web address: http://www.law.com/ny

VOLUME 229—NO. 57 TUESDAY, APRIL 1, 2003 WHITE-COLLAR CRIME

BY ROBERT G. MORVILLO AND ROBERT J. ANELLO Securities, Investigations and Prosecutions Under the Martin Act

HERE WAS a time, when a Martin Act against three former party whose attorney success- executives of Tyco International Ltd., fully had persuaded a federal alleging that they defrauded investors prosecutor to forego a securi- by failing to disclose millions of dollars T in loans, bonuses and gifts received ties fraud prosecution, could breath a sigh of relief and put concern over criminal by company executives and by misrep- liability behind. But no longer. In recent resenting information concerning their months, Manhattan District Attorney Robert G. Morvillo Robert J. Anello sales of Tyco stock. Although these Robert Morgenthau and New York defendants face other serious charges, Attorney General Eliot Spitzer, as well as including grand larceny and enterprise as the Martin Act,1 widely is considered state prosecutors from other jurisdictions, corruption, the Martin Act felony one of the toughest securities laws in have let it be known that the federal charges alone carry a penalty of up to the country. Although occasionally in government does not have a monopoly on four years in prison. the past2 prosecutors employed it to securities law enforcement. In fact, if the The Martin Act contains a far fight large-scale securities fraud, until past year is any indication, potential broader definition of fraud than do securities fraud defendants may have as recently, it had been used primarily the federal securities statutes. It much to worry about from state prosecu- in boiler-room prosecutions and indi- enumerates a litany of behavior that tors as they do from the United States vidual cases of fraud. Starting last comes within its definition of fraudu- Attorney’s Office or the Securities year however, state prosecutors have lent practices, including deceptions, Exchange Commission. The New York made aggressive use of the Martin Act misrepresentations and representations State securities law, with its unique set of in their investigations of corporate beyond reasonable expectation in procedural mechanisms, gives state accounting scandals and charges of connection with the issuance, pur- prosecutors a number of tools that federal investment banking conflicts of inter- chase, exchange, investment advice or prosecutors do not have and with which ests. Among the recent high-profile sale of securities.3 New York federal and the defense bar must now be familiar. uses of the Martin Act are Attorney state courts alike have construed its Moreover, this emerging pattern of General Spitzer’s investigation into coverage broadly, finding that the multi-jurisdictional enforcement has whether stock analysts were operating terms fraud and fraudulent practices resulted in what some government offi- under conflicts of interest when they embrace all deceitful practices contrary cials have criticized as the “balkanization” issued reports on companies that were to plain rules of honesty.4 of securities laws and raises serious double also clients of their firm’s investment The most striking aspect of jeopardy concerns. banking business, and his lawsuit the Martin Act, and that which filed in September against executives sets it apart from most other securities Recent Martin Act Investigations of five communications companies laws, is that liability under the act and Cases alleging that they had received lucra- does not depend on the purchase tive initial public offering shares from or sale of any security. Nor does New York’s “blue sky” statute, known brokerage firms in exchange for their the act contain a requirement of Robert G. Morvillo and Robert J. firms’ underwriting business. The Man- scienter, intent, reliance or damages Anello are partners at Morvillo, Abramowitz, hattan district attorney’s office recently for either civil or criminal misde- Grand, Iason & Silberberg. brought criminal charges under the meanor liability. NEW YORK LAW JOURNAL TUESDAY, APRIL 1, 2003

Investigative Authority the witness cannot be used again him or business damage of having a criminal her in a subsequent criminal proceeding. investigation conducted in public gives Both the attorney general and the The statute provides no right to counsel the attorney general awesome power. local district attorney offices may ins- at a Martin Act hearing, and, because titute prosecutions alleging criminal these proceedings are considered inves- Criminal and Civil Remedies violations of the Martin Act. Under the tigative rather than adjudicative, at least No private right of action exists Martin Act, however, the attorney one court has held that no constitution- under the Martin Act,12 leaving the general has been afforded two separate al right to counsel exists.7 Nevertheless, attorney general as the sole individual methods of investigation. He may the attorney general’s practice has been who can invoke the statute’s remedial conduct a confidential investigation, to permit witnesses to be represented at provisions. Under §353 the attorney pursuant to §352, or a public investiga- Martin Act hearings, and courts have general may seek to enjoin any frau- tion under §354. He may pursue both held that the attorney general may dulent act in which he believes types of investigations simultaneously.5 not interfere with the choice of counsel any person or entity has engaged or Under §352, the attorney general can once a witness has been accorded the threatens to engage. He also may seek conduct a private investigation upon privilege of representation.8 Martin Act restitution of any funds or property suspicion that there has been or threat- hearings are confidential. In contrast obtained either directly or indirectly by ens to be some fraudulent practice in to state and federal grand jury any fraudulent practice. connection with a security or if he proceedings, the statute prohibits even The criminal provisions of the statute “believes it to be in the public interest the witnesses from disclosing questions are set forth in §352-c, which makes it that an investigation be made.” That asked, answers given or persons present section authorizes him to require the illegal for any person or entity, engaged submission of sworn written statements ------in the promotion, issuance, distribution, from an entity or anyone associated with Corporate reformers and exchange, sale, negotiation or purchase it, but its primary mechanism is a proce- others have referred to of a security to employ any fraud, de- dure known as a Martin Act hearing. the recent spate of state ception, concealment, suppression, false pretense, promise or representation as securities regulation efforts Martin Act Hearing to the future that is beyond reasonable as the “balkanization” of expectation or unwarranted by existing Under §352(2), the attorney general securities law. circumstances. The statute distinguishes can subpoena witnesses, compel their ------between misdemeanor and felony liabil- attendance, examine them under oath ity based solely on the intent of the and require the production of any at the hearing. Any such disclosure is defendant. No scienter is required for a relevant books or papers. The statute punishable as a misdemeanor.9 A Martin misdemeanor conviction,13 whereas a provides that anyone who fails to comply Act witness has no right to a transcript defendant who commits one of the with a Martin Act subpoena, whether by of the proceeding.10 proscribed acts with the intent to failing to appear, produce requested The attorney general also can proceed deceive or defraud can be found guilty of records or answer questions posed at the by way of a public investigation under a Class E felony.14 In the federal system, hearing is guilty of a misdemeanor. §354, by seeking an order from a state the regulators and prosecutors are, for Moreover, the failure of a potential Supreme Court Justice directing that the most part, separated. Giving a single defendant or an officer of a potential witnesses appear before the court or agency civil, regulatory and criminal defendant to comply with a Martin Act produce documents. The attorney power creates the potential that the subpoena constitutes prima facie proof general may file such a request before criminal power will be exploited to that the defendant has engaged in the commencing an action and may include achieve civil or regulatory settlements. suspected fraudulent practices and, with the request an application for a standing alone, provides the basis for preliminary injunction or stay, which Tension, Federal Enforcers entry of a permanent injunction.6 the court may grant if it finds it “proper Parties may invoke the Fifth Amend- or expedient.” Attorney General Spitzer If Wall Street is taken aback by the ment right against self-incrimination recently proceeded under this provision, aggressiveness with which the states are at a Martin Act hearing. If the attorney obtaining an injunction against a pursuing securities fraud violations, general directs a party who has invoked brokerage firm based on allegations to so too are the federal securities law the Fifth Amendment to respond, which the firm was given no chance to enforcers, who have long dominated the answers given or documents produced by respond.11 The shock value and potential field. Several lawmakers have been NEW YORK LAW JOURNAL TUESDAY, APRIL 1, 2003 outspoken in their criticism of such enacted however, precisely because the close overlap between the federal and state activism. Corporate reformer federal Double Jeopardy Clause does not state securities schemes and the poten- Representative Michael G. Oxley, bar successive federal and state prosecu- tial for fierce competition between fed- R-Ohio, and recently appointed SEC tions.18 The Supreme Court repeatedly eral and state prosecutors, fairness dic- Chairman William H. Donaldson both has held that “two identical offenses are tates that defendants not be whipsawed have referred to the recent spate of state not the ‘same offense’ within the mean- between the two sovereigns. Few would securities regulation efforts as the ing of the Double Jeopardy Clause, object to any branch of law enforce- “balkanization” of securities law,15 and if they are prosecuted by different ment rooting out those who commit Representative Richard Baker, R-La., sovereigns.”19 Although dissenters have securities fraud. However, a legitimate called for Mr. Spitzer to step aside and argued that the “safeguard against double concern exists that aggressive local let the SEC handle the inquiry into jeopardy was intended to establish a prosecutors will preempt national secu- analysts conflicts of interests “because of broad national policy against federal rities law policy in a manner that is the need for uniformity in our national courts trying or punishing a man a injurious to the stability of our markets securities markets.” Mr. Spitzer has fired second time after acquittal or conviction and financial institutions back at the feds, accusing Mr. Oxley of in any court,”20 the Court’s majority con- undercutting his own purported goal of sistently has reasoned that federal law ••••••••••••••••••••••••••••••• defending our system of “capital forma- enforcement efforts would be hindered if (1) N.Y. Gen. Bus. Law §352, et seq. (2) See Tamara Loomis, “The New York Securities tion” by opposing strong state laws and an initial state prosecution could serve as Statute has made Headlines Before,” New York Law Journal 21 Nov. 14, 2002. aggressive enforcement. He also has a bar to subsequent federal action. (3) People v. Lexington Sixty-First Associates, 38 NY2d issued a press release observing that the The Justice Department has adopted 588, 595 (1976) (“[T]he terms ‘fraud’ and ‘fraudulent prac- tices’ [are] to be given a wide meaning so as to embrace all congressional subcommittee chaired by an internal policy, known as the “Petite deceitful practices contrary to the plain rules of common Mr. Baker had failed to elicit any of the Policy,” which precludes federal charges honesty.” (4) See, e.g., People v. Federated Radio Corp., 244 NY2d evidence necessary to bring about following a prior state prosecution 33 (1926); Bishop v. Commodity Exchange, Inc., 564 FSupp reform and that “no other regulatory based on substantially the same acts or 1557 (SDNY 1983). (5) In the Matter of Abrams, 160 Misc2d. 824 (Sup. Ct. body stepped forward to prevent the transactions, unless the matter involves N.Y. Co. 1994). (6) §353 abuse from occurring.” a substantial federal interest that was (7) In the Matter of Kanterman, 76 Misc2d. 743 (Sup. Ct. The Martin Act has existed side by left demonstrably not vindicated by the N.Y. Co. 1973). (8) See, e.g., Hentz & Co. v. Lefkowitz, 256 NYS2d 724 side with the federal securities laws since prior prosecution and an assistant attor- (1965). their passage. As the court in State v. ney general approves the subsequent (9) §352(5); Kanterman, 76 Misc2d 743. (10) Gutterman v. Lefkowitz, 92 Misc2d 583 (Sup. Ct. 16 22 Justin recently observed, “in fine federal prosecution. One of the stated N.Y. Co. 1977) federalist fashion, the 1934 Act was purposes of this policy is to “protect (11) That injunction was obtained against the brokerage firm of Merrill Lynch and required the firm to provide its designed to supplement rights and duties persons charged with criminal conduct customers with disclosure of any actual or anticipated investment banking links between Merrill Lynch and the created by state ‘blue sky’ laws, not from the burdens associated with companies covered by its analysts. supercede them.” But with the state of multiple prosecutions and punishments (12) CPC International Inc. v. McKesson Corp., 70 N.Y.2d 268 (1987). New York taking a more active role in for substantially the same act(s) or (13) §352-c(4) securities law enforcement, the overlap transaction(s).” Although this policy (14) §352-c(6) (15) See James Toedtman, “A Pledge to Clean Up of federal and state regulation subjects provides some measure of protection Mess,” Newsday, Feb. 6, 2003; Wendy Davis, “Up Against actors in the securities world to two sets against a federal prosecution following Wall Street,” ABA Journal, September 2002. (16) 237 FSupp2d (WDNY 2002). of rules and two different masters. New state criminal charges, it offers no (17) See Kaplan v. Ritter, 71 NY2d 222 (1987). York State’s statutory double jeopardy guarantees. As an internal policy, the (18) People v. Rivera, 60 NY2d 110 (1983). (19) Heath v. Alabama, 474 US 82(1985); United States provision protects against the assertion Petite Policy confers no substantive v. Lanza, 260 US 377 (1922). 23 (20) Abbate v. United States, 359 US 187 (1959) (Black, of Martin Act charges against a defen- rights on a defendant. Moreover if J., dissenting). dant who already has been prosecuted on state prosecutors continue to bring (21) United States v. Lanza, 260 US 377. (22) United States Attorneys’ Manual, Chapter 9-2.031. federal securities charges arising out of Martin Act charges in cases where (23) See United States v. Williams, 181 F Supp 2d 267 the same transaction.17 CPL §40.20 federal regulators perceive a strong (S.D.N.Y. 2001). provides that a person may not be twice federal interest, federal prosecutors may This article is reprinted with permission from the prosecuted for the same crime nor conclude that federal interests are not April 1, 2003 edition of the NEW YORK LAW separately prosecuted for two offenses sufficiently vindicated by the state JOURNAL. © 2003 ALM Properties, Inc. All rights based upon the same act or criminal prosecutions, particularly in light of the reserved. Further duplication without permission is prohibited. For information contact, American Lawyer transaction except under certain limited relatively light prison sentences avail- Media, Reprint Department at 800-888-8300 x6111. circumstances. That provision was able under the Martin Act. With such a #070-04-03-0007