Martin Act Applies to Claims About Trading Venue as Well as Securities Traded in that Venue

On February 13, 2015, Justice Kornreich of the New York County Commercial division issued a decision in People v. Barclays Capital Inc., 2015 NY Slip Op. 25043, discussing the standard for a Martin Act claim.

In Barclays Capital, the New York Attorney General brought a Martin Act claim against the defendant relating to "allegedly false and misleading statements made about its dark pool," which "is a private securities trading platform used to execute securities trades anonymously, unlike public exchanges, such as the New York Stock Exchange." The defendant moved to dismiss. The court denied the motion, explaining:

[I]t should go without saying that a Martin Act claim cannot be based on representations on which no reasonable sophisticated investor (the only investors who trade in dark pools) would rely. Drafts of power point marketing decks and charts labeled "sample" are not actionable. Moreover, though Barclays may have colloquially referred to certain high frequency traders with seemingly derogatory words such as "toxic", that is a meaningless term. A valid fraud claim, for instance, must be based on representations about types of trading counterparties that include enough of a degree of specificity about the characteristics of the traders for the representations to be actionable, as opposed to impermissibly vague descriptions and sheer puffery. The focus is on what a reasonable, sophisticated trader, trading millions of dollars, actually would consider material. The court, however, will not assess the pleading sufficiency of the AC until the parties have fully briefed the forthcoming motion to dismiss it.

. . .

The Martin Act—New York's blue sky law—authorizes the Attorney General to investigate and enjoin fraudulent practices in the marketing of stocks, bonds and other securities within or from New York. The purpose of the Martin Act was to create a statutory mechanism in which the Attorney-General would have broad regulatory and remedial powers to prevent fraudulent securities practices by investigating and intervening at the first indication of possible securities fraud on the public and, thereafter, if appropriate, to commence civil or criminal prosecution.

The Martin Act is not a narrow statute. Rather, the Court of Appeals has long held that the Martin Act should be liberally construed to give effect to its remedial purpose of protecting the public from fraudulent exploitation in the offer and sale of securities. Moreover, though a cause of action under the Martin Act is a fraud claim, it is well settled that the Attorney General need not prove scienter or intent to defraud. Nor need reliance be proved.

Despite the Martin Act's exceedingly broad scope and its limited elements, materiality is an essential element of a Martin Act claim. That is, just as with common law fraud claims, representations that are immaterial to an investment decision are not actionable and, thus, cannot give rise to liability under the Martin Act. Under New York law, the test for materiality is whether defendants' representations, taken together and in context, would have misled a reasonable investor about the nature of the investment.

(Internal quotations and citations omitted) (emphasis added). The court went on to address the "novel issue" of whether the defendants' alleged misrepresentations, which related to the venue for the trading (the dark pool), not the securities traded there, were actionable under the Martin Act. The court ruled that they were, explaining:

Given the reality of how modern securities trading actually occurs — that is, how trading decisions are really made — the notion that the decision about where to execute a trade is not an investment decision is unpersuasive because the choice of trading platform can have a significant impact on the outcome of the trade. [A] substantial percentage of all securities trading is conducted by computer algorithms. HFT trades are executed in milliseconds by algorithms programmed to implement previously determined trading strategies. The profitability of algorithmic trading often has nothing to do with anything classically understood to impact corporate value. Instead, much of the profitability of algorithmic trading is predicated on finding opportunities to profit on short term market fluctuations in different venues, with the short term often being milliseconds in duration. Consequently, trading decisions can be inexorably linked to the venue in which the trade occurs, because that venue will impact the profitability of a trade based on timing and counterparty.

. . .

[T]o the extent the applicability of the Martin Act to representations about trading venues can be considered a close call — and, for what it's worth, [the defendant's] arguments are not entirely unreasonable — this court views the Court of Appeals' guidance on the Martin Act to be that doubts in favor of the Martin Act's applicability should be resolved in the NYAG's favor. In other words, if it is a close call, the Martin Act should be held to apply. New York, the center of the financial universe, benefits greatly from having powerful blue sky laws.

(Internal quotations and citations omitted) (emphasis added).