New York Law Review

Tag: Securities Law

  • Guice v. Charles Schwab & Co., 89 N.Y.2d 32 (1996): Federal Law Preempts State Common Law Regarding Disclosure of Order Flow Payments

    89 N.Y.2d 32 (1996)

    Federal securities regulations preempt state common law claims that impose stricter disclosure requirements on broker-dealers regarding order flow payments than those mandated by the SEC, to ensure a uniform national market system.

    Summary

    Former customers sued Charles Schwab & Co. and Fidelity Brokerage Services, alleging breach of fiduciary duty and conversion due to the brokerages’ receipt of order flow payments without adequate disclosure. The New York Court of Appeals held that federal securities laws and SEC regulations preempt state common law claims imposing stricter disclosure standards. The Court reasoned that allowing state common law claims would undermine the SEC’s authority to regulate the national securities market uniformly, potentially disrupting the balance Congress intended to achieve with the 1975 amendments to the Securities Exchange Act.

    Facts

    Plaintiffs, former retail customers of discount brokerage firms Charles Schwab & Co. and Fidelity Brokerage Services, filed class-action lawsuits. They alleged that the brokerages breached their fiduciary duty by accepting “order flow payments” without fully disclosing the practice to customers. Order flow payments are remuneration paid to brokers for directing customer orders to specific market makers. The plaintiffs argued that the brokerages’ disclosures were inadequate, violating common-law agency principles that require full and frank disclosure of conflicts of interest.

    Procedural History

    The Supreme Court dismissed the complaints, finding the claims preempted by federal law. The Appellate Division modified, reinstating the causes of action except for the Martin Act claim, arguing that the claims were not preempted if based on inadequate disclosure. The Court of Appeals reversed the Appellate Division, dismissing the complaints and holding that the plaintiffs’ common-law causes of action, even as limited to claims based on inadequate disclosure, are preempted by federal law.

    Issue(s)

    Whether state common-law claims imposing stricter disclosure requirements on broker-dealers regarding order flow payments than those mandated by the SEC are preempted by federal securities laws and regulations.

    Holding

    No, because permitting state common-law claims would undermine the SEC’s authority to regulate the national securities market uniformly and disrupt the balance Congress intended to achieve with the 1975 amendments to the Securities Exchange Act.

    Court’s Reasoning

    The Court’s reasoning focused on the Supremacy Clause and the intent of Congress in enacting the 1975 amendments to the Securities Exchange Act, as well as the SEC’s role in regulating the securities industry. The Court stated, “The preemption question is ultimately one of congressional intent.” It found that Congress intended the SEC to have broad authority to regulate the national market system, including disclosure requirements for securities transactions.

    The Court emphasized that the SEC had specifically addressed the issue of order flow payments, conducting cost-benefit analyses to determine the appropriate level of disclosure. The SEC permitted the practice and established specific disclosure requirements, aiming to balance investor protection with the need for efficient market operations. Allowing state common law claims to impose stricter disclosure standards would disrupt this balance, forcing broker-dealers to comply with varying state laws and potentially undermining the SEC’s uniform regulatory structure.

    The Court cited the legislative history of the 1975 amendments, stating that Congress wanted the SEC to develop a “coherent and rational regulatory structure” for the national market system. Permitting state courts to impose civil liability based on common-law agency standards would defeat this purpose.

    The Court distinguished this case from situations where federal and state laws have the same goals, noting that even if the goals are similar, a state law is preempted if it interferes with the methods by which the federal statute was designed to reach that goal, quoting International Paper Co. v. Ouellette, 479 U.S. 481 (1987). The Court also rejected the argument that Section 28(a) of the Securities Exchange Act, a “savings clause,” negated preemption, stating that such clauses typically negate implied field preemption, but not conflict preemption.

    The Court concluded that enforcing state common-law duties of disclosure would inevitably undermine the federal regulatory structure. “It would be extraordinary for Congress, after devising an elaborate [balanced regulatory] system that sets clear standards, to tolerate common-law suits that have the potential to undermine this regulatory structure” (quoting International Paper Co. v. Ouellette, 479 U.S. at 497).

  • People v. Landes, 84 N.Y.2d 655 (1994): Determining Public vs. Private Offering of Securities

    People v. Landes, 84 N.Y.2d 655 (1994)

    Whether a securities offering is “public” versus “private” under New York’s Martin Act (General Business Law § 359-e (3)) depends on factors like the number and relationship of offerees, the number of units offered, the size of the offering, and the manner of the offering, with the crucial inquiry being whether the offerees have access to the kind of information a registration would provide.

    Summary

    Landes was convicted of fraud and unregistered sale of securities under the Martin Act for soliciting investments in a health food product venture. He orally promised investors their money would be secure and used solely to purchase the product, but instead, he commingled and spent the funds on personal expenses. The key issue was whether the offering was “public,” requiring dealer registration. The New York Court of Appeals affirmed the conviction, holding that the offering was public because the investors lacked sufficient knowledge of Landes and the venture to substitute for the information a registration would have provided. The court considered the four factors from Doran v. Petroleum Mgt. Corp., adapting them to focus on the availability of information about the seller, not just the security itself.

    Facts

    Landes, owner of a health food store, sought investors for Nutri-King, a health food product. He orally assured potential investors that funds would be held in escrow and used solely for purchasing the product, and that they would receive stock in a new corporation. Twelve individuals invested a total of $100,000, but the written agreements did not include the oral promises.

    Procedural History

    Landes was indicted on multiple charges, including grand larceny and violations of the Martin Act. Following a jury trial, he was convicted of fraud (General Business Law § 352-c (1)) and unregistered sale of securities (General Business Law § 359-e (3)). The Appellate Division modified the sentence but sustained the convictions. The New York Court of Appeals granted leave to appeal to determine if the offering was public or private.

    Issue(s)

    Whether the transactions at issue constituted a public offering or personal sales of stock in a private corporation exempt from the registration requirements of General Business Law § 359-e (3)?

    Holding

    Yes, because the evidence supported the finding that the offering was public, as most investors knew little about Landes, the securities, or each other, and lacked access to information that a registration would have provided.

    Court’s Reasoning

    The court analyzed whether the offering was public or private, applying the framework from Securities & Exch. Commn. v Ralston Purina Co., 346 U.S. 119 (1953) and Doran v. Petroleum Mgt. Corp., 545 F.2d 893 (5th Cir. 1977), focusing on the number of offerees and their relationship to the issuer, the number of units offered, the size of the offering, and the manner of the offering. The court noted that New York law, unlike federal law, does not require securities registration except in specific areas. Since registration of the securities was not required, but dealer registration was if the offering was public, the court focused on the availability of information. The court adapted the Ralston Purina and Doran tests to consider information about the seller, as well as the security. The court noted, “[T]he relationship of many investors was far from intimate, and few if any had sufficient knowledge or access to information of defendant’s background and experience to substitute for what could have been learned about defendant from a State registration, or what could have been learned about the securities under the requirements of Federal law.” Furthermore, the court found that Landes evaded investors’ inquiries when they sought material information. The Court concluded that the investors had to rely completely upon Landes to learn the financial prospects of the new enterprise and that their relationship with him was not close enough to obviate the need for Martin Act protection.

  • All Seasons Resorts, Inc. v. Abrams, 68 N.Y.2d 81 (1986): Defining ‘Securities’ Under New York’s Martin Act

    All Seasons Resorts, Inc. v. Abrams, 68 N.Y.2d 81 (1986)

    An interest is a security under New York’s Martin Act if it constitutes a participation interest or investment in real estate with the expectation of financial profit or return or meets the broader definition of a security as an investment of money in a common enterprise with profits to come solely from the efforts of others.

    Summary

    All Seasons Resorts, Inc. (ASR) sought a declaratory judgment to prevent the New York Attorney General from applying the Martin Act’s registration requirements to its campground memberships. ASR argued that these memberships, which grant non-exclusive use of recreational facilities, are not securities. The Court of Appeals held that ASR memberships are not securities under the Martin Act because they do not offer financial profit, an ownership interest, or control over ASR’s management, and are sold for personal recreational use, not investment purposes.

    Facts

    ASR, a Washington corporation, owns and operates campgrounds in several states. It markets memberships in these campgrounds, offering members the non-exclusive right to use recreational facilities. Members pay an initial fee and annual dues. The membership agreement specifies that members acquire no ownership interest in ASR or its assets, no right to income or distributions, and no voting rights. Members represent they are buying the memberships for personal use, not for resale or profit. Transfer of memberships is restricted to prevent speculative investment.

    Procedural History

    ASR filed a declaratory judgment action against the Attorney General, seeking a determination that its memberships are not securities and an injunction against enforcement of the Martin Act. Special Term granted summary judgment to ASR, holding that the memberships are not securities. The Appellate Division reversed, finding the memberships to be participation interests in real estate. The Court of Appeals reversed the Appellate Division and reinstated the Special Term’s judgment.

    Issue(s)

    Whether ASR’s campground memberships are securities under General Business Law § 352-e, requiring registration under the Martin Act.

    Holding

    No, because ASR memberships do not constitute participation interests or investments in real estate, nor do they fall within the general definition of securities under the Martin Act.

    Court’s Reasoning

    The Court analyzed whether ASR memberships fall within the specific categories listed in § 352-e (1)(a), specifically “participation interests or investments in one or more real estate ventures” and “cooperative interests in realty”, and also under the broader definition of “securities” under § 352. The Court applied a substance-over-form approach, emphasizing economic reality and looking to decisions construing federal securities laws as persuasive authority.

    The Court determined that ASR memberships are not investments because they lack the essential characteristic of an expectation of financial profit or return. Members receive no profit, share in no gain, and acquire no interest in ASR’s assets. The memberships also do not constitute “participation interests in real estate” because members obtain no rights to share in profits or gains.

    The Court also found that the memberships do not fit within the term “cooperative interests in realty” because members hold no stock in ASR and no ownership or leasehold interest in any of its property. The agreement specifies that a membership is “only a license for nonexclusive use of recreational facilities.”

    The Court then applied the Howey test, derived from Securities & Exch. Commn. v Howey Co., asking whether the transaction “involve[d] an investment of money in a common enterprise with profits to come solely from the efforts of others.” The Court found that the ASR membership did not satisfy the Howey test because there was no expectation of financial gain or profit. The Attorney General argued for a broader “risk capital” test, focusing on the risk of loss and expectation of future benefits. However, the Court found that even under this test, ASR memberships would not be considered securities because the business was already established, and members received immediate use of facilities.

    The court noted, “There is certainly nothing about the ASR membership which would whet the ‘foolish cupidity’ of the ‘inexperienced, confiding and credulous investor’” (quoting People v Smith Co., 230 App. Div. 268, 269).

  • Koenig v. Dunay, 59 N.Y.2d 27 (1983): Enforceability of NYSE Arbitration Clause Post-Membership

    Koenig v. Dunay, 59 N.Y.2d 27 (1983)

    An arbitration agreement in the New York Stock Exchange (NYSE) constitution applies to disputes between members, even if their membership periods don’t overlap, and to disputes between a member and non-member arising from the member’s business.

    Summary

    Koenig and Weisglass sought arbitration against Dunay regarding ownership of Ladenburg stock. Dunay, a former allied member of the NYSE, argued that the arbitration clause in the NYSE constitution didn’t apply because his membership had lapsed before Koenig and Weisglass became members. The court held that the arbitration clause applied, even without overlapping membership periods, because Dunay’s obligations as a former member extended to future members concerning business dealings during his membership. Furthermore, the dispute arose from Dunay’s business as president of Ladenburg, making it arbitrable under the member-nonmember clause as well.

    Facts

    Koenig and Weisglass formed a joint venture with Dunay in 1974 to establish a brokerage firm. The venture affiliated with Ladenburg, Thalmann & Co., a member of the NYSE. Dunay became president of Ladenburg and an allied member of the Exchange. In 1975, Dunay purchased Ladenburg stock in his name, with an agreement to share gains with Koenig and Weisglass. A 1977 agreement restricted the sale or transfer of Ladenburg shares. Dunay’s employment and Exchange membership ended in 1979. Subsequently, a dispute arose over the ownership of the stock, leading Koenig and Weisglass to demand arbitration.

    Procedural History

    Dunay initiated a proceeding to stay arbitration. Koenig and Weisglass cross-applied to compel arbitration. The Supreme Court dismissed Dunay’s application and directed arbitration. The Appellate Division reversed and granted the stay. Koenig and Weisglass appealed to the Court of Appeals.

    Issue(s)

    1. Whether the NYSE arbitration clause requires simultaneous membership for disputes between members to be arbitrable.
    2. Whether the dispute over stock ownership arose out of the business of the member (Dunay) for purposes of the member-nonmember arbitration clause.

    Holding

    1. No, because the arbitration agreement extends to future members regarding business dealings undertaken during the former member’s tenure.
    2. Yes, because Dunay held the stock in connection with his role as president of Ladenburg, influencing its management and control.

    Court’s Reasoning

    The court reasoned that the “are members” language of the NYSE arbitration provision doesn’t require mutual membership. Dunay’s obligation to arbitrate survived the termination of his membership regarding business engaged in while a member. The court cited Coenen v Pressprich & Co., which held that the NYSE arbitration clause applies to “any controversy” between members, regardless of when membership was attained. The court distinguished Isaacson v Hayden, Stone, where both parties’ memberships had lapsed. Even under the member-nonmember clause, the court found that the controversy arose from Dunay’s business, as he held the stock in connection with his efforts to manage and control Ladenburg. The court emphasized the broad scope of the NYSE arbitration provision and the policy favoring arbitration, quoting Mobil Oil Indonesia v Asamera Oil stating the court policy favoring arbitration.