Aris Multi-Strategy Offshore Fund, Ltd. v Devaney
Decided on December 14, 2009
Supreme Court, New York County
Aris Multi-Strategy Offshore Fund, Ltd. and ARIS MULTI-STRATEGY FUND, LP, Plaintiffs,
Dennis John Devaney, HORIZON FUND, L.P., HORIZON ABS FUND, LTD., HORIZON FUND INVESTORS, LLC, UNITED CAPITAL MARKETS, INC. and UNITED CAPITAL ASSET MANAGEMENT LLC, Defendants.
Brian A. Herman, Esq., of Morgan, Lewis & Bockius LLP (for Defendants/movants) and Steven Shiffman, Esq., of Katten Muchin Rosenman LLP (for the Plaintiffs/opponents to the motion).
Eileen Bransten, J.
Plaintiffs Aris Multi-Strategy Fund, LP ("Aris LP") and Aris Multi-Strategy Offshore Fund, Ltd. ("Aris Ltd." and together with Aris LP, collectively, "Aris") seek to recover over $5.13 million in damages that they allegedly suffered in connection with their investments in hedge funds (collectively "the Horizon Funds"), controlled by defendants Dennis John Devaney ("Devaney"), Horizon Fund L.P. ("Horizon Domestic"), Horizon ABS Fund, Ltd. ("Horizon Offshore"), Horizon Fund Investors, LLC ("Horizon Investors"), United Capital Markets Inc. ("UCM"), and United Capital Asset Management LLC ("UCAM") (collectively "defendants"). Plaintiffs allege that, during the second half of 2006 and the first half of 2007, when the asset-backed securities ("ABS") and mortgage-backed securities ("MBS") markets in which the Horizon Funds were invested were becoming increasingly negative, defendants engaged in a fraudulent scheme to induce Aris to remain invested in the Horizon Funds so that defendants could reap substantial management and performance fees.
According to Aris, as part of this fraudulent scheme, defendants made misrepresentations concerning, among other things: (1) the measures they had taken to protect the Horizon Funds against market risks; (2) their ability to profit from a downturn in the ABS and MBS markets and, in particular, from problems in the sub-prime sector; and (3) the liquidity of the Horizon Funds' portfolio. In addition, Aris contend, defendants provided Aris with false performance data that misrepresented profits during April 2007, when the ABS and MBS markets were experiencing a severe downturn. Aris further contends that, but for defendants' misrepresentations, Aris' [*2]investments would have been redeemed no later than the end of April 2007, before the Horizon Funds suspended redemptions on June 29, 2007. Aris asserts causes of action for fraud, breach of fiduciary duty, gross negligence/recklessness, negligence, negligent representation and breach of contract.
Defendants now move, pursuant to C.P.L.R. 3211 (a) (1) and (7), for an order dismissing the tort claims set forth in the complaint. Defendants do not move to dismiss the breach of contract claim.
The plaintiffs in this case are two funds, which consist of one offshore and one domestic private investment fund that invests in other private investment funds. (Compl. ¶1). Aris Capital Management, LLC ("Aris Capital") is the investment manager of the two funds. Id. Beginning in June 2006, Aris Ltd. and Aris LP invested approximately $5.13 million in the Horizon Funds, which are hedge funds indirectly controlled by Devaney that invested primarily in ABS and MBS, including MBS invested in sub-prime mortgages. Id. Devaney is the sole indirect owner of UCAM, the investment manager of the Horizon Funds, and of Horizon Investors, the general partner of Horizon Domestic. Id. Devaney is also the sole indirect owner of UCM, a broker dealer that handles transactions in fixed-income and asset-based securities, including those made by Devaney and the Horizon Funds. Id. at ¶13.In June 2006, Aris Offshore invested $1,750,000 in Horizon Offshore. (Compl. ¶32; Compl. Ex. A, Schedule of Investment ["Compl. Ex. A"]). On June 30, 2006, Aris Offshore invested an additional $500,000 in Horizon Offshore. (Compl. Ex. A). Aris does not raise any claim with respect to this initial investment.
In September 2006, Aris Ltd. became concerned about how a downturn in the ABS and MBS markets, as well as in the sub-prime portion of the MBS market, would affect its investment. (Compl. ¶ 34). Based on that concern, Aris Ltd. submitted, on 90 days' notice, a redemption request to withdraw its entire investment in Horizon Offshore, effective December 31, 2006. (Compl. ¶34).
Aris alleges that defendants did not want any withdrawals from Horizon Offshore because it would mean a diminution of fees, reduction of the amount of capital under their management, and could cause other investors to follow suit and redeem. (Compl. ¶35). Plaintiffs further allege that, as a result, defendants, "led by Devaney, embarked on a fraudulent scheme to retain Aris Ltd.'s investments in the funds they managed by misrepresenting the exposure of those funds to a downturn in the ABS and MBS markets in which those funds focused." Id. at ¶36. According to Aris, Devaney personally made, and directed other representatives of defendants to make, misrepresentations regarding, among other things, the Horizon Funds' portfolios, their performance, the liquidity and the stability of Aris' investments, the risk management techniques employed by Horizon, and the exposure of the Horizon Funds in the ABS and MBS markets. Id. at ¶ 37.
Thus, Devaney, acting on his own behalf and on behalf of the other defendants, as well as other representatives of defendants, including Sam Barron-Fox, an officer and portfolio manager of UCAM, and Wesley Pritchett, UCAM's Chief Operating Officer, communicated with Aris on several occasions in late 2006 and early 2007 in an attempt to convince Aris to remain invested in the Horizon Funds. (Compl. ¶¶28-31; 37-50; 57-58). First, Devaney, along with Barron-Fox and [*3]Pritchett, traveled to New York on November 15, 2006 to meet with Aris Ltd. to try to induce it to withdraw its initial redemption request. (Compl. ¶38). Aris alleges that, in reliance on the representations made at the November meetings, as detailed below, Aris Ltd. withdrew its initial redemption request by reinvesting the funds that were to be withdrawn from Horizon Offshore into Horizon Domestic. (Compl. ¶43). In addition, in reliance on these representations, Aris LP, which was also managed by Aris Capital, decided to invest $2 million in Horizon Domestic. (Compl. ¶43; Compl. Ex. A). Aris alleges that, but for these statements, they would not have made their investments in the Horizon Funds in December 2006 and January 2007.
Plaintiffs further allege that, on February 14th and 15th, 2007, after the ABS and MBS markets started to exhibit clear signs of distress, defendants' representatives met with principals from Aris to discuss how Horizon Domestic was positioned for a continued downturn in these markets. (Compl. ¶¶46-50).
According to Aris, during the November 15, 2006 and February 14 & 15, 2007 meetings, defendants made the following representations:
As a broker/dealer (UCM), in addition to an investment manager (UCAM), in a market that Devaney claimed to have developed personally, Horizon had unique access to market information, allowing Devaney to know who was buying and selling, and providing him with other "informational advantages";
Horizon had the "best liquidity" in the ABS market since it could use the broker/dealer side of its operations (UCM) to sell bonds to hundreds of customers, while other players in the ABS market would only have a limited number of counterparties with whom to trade, and because, even if the market were frozen, Devaney could liquidate his entire portfolio in a few days; and
Horizon had fail-safe risk management techniques for insuring positive returns in any
market, and in the event of a "perfect storm" involving a terrorist attack, a tsunami and the
Federal Reserve significantly raising interest rates, the Horizon Funds could still make money.
(Compl. ¶¶38-41, 48-50).
Aris contends that the they specifically questioned defendants on the positions in the portfolio, how the portfolio had changed to prepare for the anticipated downturn, the steps that the Horizon Funds were taking to minimize risk, how the Horizon Funds would fare if there were a severe downturn in the ABS and MBS markets and the sub-prime sector of the MBS market, and Horizon Domestic's maximum downside exposure. (Compl. ¶¶40, 47, 49, 50, 52). According to plaintiffs, defendants assured Aris that the Horizon Funds were positioned to do well in such a downturn because defendants: (1) anticipated a downturn but "would have greater liquidity and greater ability to profit from such a downturn" due to their superior knowledge; (2) were reducing risk by steadily decreasing the Horizon Fund's leverage; (3) changed the balance of the portfolio to higher quality instruments, such as those rated higher by credit agencies; (4) over-collateralized their "Repo" borrowing, reducing exposure to margin calls; (5) were going to hedge against loss by [*4]shorting an instrument keyed to indices for the ABS and MBS markets; (6) had sophisticated computer models to monitor and reduce risk; and (7) even in a worst case scenario, would not lose more than 10%-20% of its market value. (Compl. ¶¶38-41; 48-50).
Aris alleges that they relied on defendants' representations because of Devaney's reported experience and reputation as the pre-eminent trader in the MBS and ABS markets. (Compl. ¶ 41), and that, but for these statements, Aris would have withdrawn its investment in Horizon Domestic. Id. at ¶¶48-53.
In a March 21, 2007 letter from UCAM to all investors in Horizon Domestic, Devaney continued to assure plaintiffs that Horizon Domestic was positioned to profit from a downturn in the markets. However, on March 23, 2007, growing concern about the downturn in the markets led Aris to submit redemption requests for the second time for the full amount of Aris' investments, effective April 30, 2007. (Compl. ¶56).
After receiving Aris' second redemption requests, Devaney and the other defendants again tried to convince Aris to rescind its redemption requests. (Compl. ¶57). Throughout the month of April 2007, defendants repeatedly contacted Aris by telephone in an attempt to convince Aris to remain invested. Id. On April 24, 2007, defendants disclosed interim results for the Horizon Funds for April 2007. Id. at ¶58. Plaintiffs contend that the interim results provided by defendants fraudulently represented that the Horizon Funds' performance was up 3.2% for the month, when, in reality, the Horizon Funds' performance for April was down 2.15%. (Compl. ¶57). Aris alleges that, but for these statements, it would not have withdrawn its March 23, 2007 redemption request. (Compl. ¶59).
Soon after learning that the Horizon Funds' performance for April was actually down 2.15%, Aris submitted redemption requests in May 2007, which, according to plaintiffs, should have entitled them to have their redemptions paid as of June 30, 2007. (Compl. ¶ 60). On June 29, 2007, the day before the redemption date, UCAM and Horizon Investors suspended redemptions in the Horizon Funds. (Compl. ¶61). Throughout the remainder of 2007 and the first half of 2008, no redemptions were paid. Id. at ¶69. By the end of the first week of July 2008, the Horizon Funds had no remaining assets, and the Horizon Funds informed their investors that the Horizon Funds would be closing. Id. at ¶71. To date, Aris has received no payments from either Devaney or the Horizon Funds. Id. at ¶72.
The complaint alleges six causes of action: (1) fraud against all defendants; (2) negligent
misrepresentation against all defendants; (3) breach of fiduciary duty against all defendants; (4)
recklessness/gross negligence against all defendants; (5) negligence against all defendants; and
(6) breach of contract against Horizon Domestic and Horizon Investors.
"The scope of a
court's inquiry on a motion to dismiss under C.P.L.R. 3211 is narrowly circumscribed." P.T.
Bank Cent. Asia v ABN AMRO Bank N.V., 301 AD2d 373, 375 (NY App. Div. 1st Dept.
2003). Thus, it is well established that, on "a motion to dismiss pursuant to C.P.L.R. 3211, the
pleading is to be afforded a liberal construction." Leon v Martinez, 638 NE2d 511, 513
(NY 1994). The court "must accept as true the facts as alleged in the complaint and submissions
in [*5]opposition to the motion, accord plaintiffs the benefit of
every possible favorable inference and determine only whether the facts as alleged fit within any
cognizable legal theory." Sokoloff v Harriman Estates Dev. Corp., 754 NE2d 184, 187
(NY 2001). Under C.P.L.R. 3211 (a) (7), the "criterion is whether the proponent of the pleading
has a cause of action, not whether he has stated one." Guggenheimer v Ginzburg, 372
NE2d 17, 20 (NY 1977). Moreover, the court's role is to determine if the allegations give rise to
a cause of action, not to determine "whether there is evidentiary support for the complaint."
Bernstein v Kelso & Co., Inc., 231 AD2d 314, 318 (NY App. Div 1st Dept. 1997).
To properly plead a common-law fraud claim, a plaintiff must allege misrepresentation of a material fact, falsity of the misrepresentation, scienter, plaintiff's reasonable reliance on the alleged misrepresentation, and injury resulting from the reliance. Small v Lorillard Tobacco Co., 720 NE2d 892, 898 (NY 1999); see also P.T. Bank v Central Asia v ABN AMRO Bank N.V., 301 AD2d 373 (NY App. Div. 1st Dept. 2003).
While New York law requires that fraud claims be pled with specificity, see C.P.L.R. 3016(b) (McKinney 1991) ("the circumstances constituting the wrong shall be stated in detail"), C.P.L.R. 3016(b) "requires only that the misconduct complained of be set forth in sufficient detail to clearly inform a defendant with respect to the incidents complained of and is not to be interpreted so strictly as to prevent an otherwise valid cause of action where it may be impossible to state in detail the circumstances constituting a fraud.'" (P.T. Bank v Central Asia v ABN AMRO Bank N.V., 301 AD2d 373, 377 (NY App. Div. 1st Dept. 2003) (quoting Jered Constr. Corp. v New York City Tr. Auth., 239 NE2d 197, 201 (NY 1968); Kaufman v Cohen, 307 AD2d 113 (NY App. Div. 1st Dept. 2003) ("plaintiff need only provide sufficient detail to inform defendants of the substance of the claims'" [citation omitted]). As set forth below, the complaint's allegations clearly satisfy C.P.L.R. 3016 (b).
Defendants contend that the fraud claims fail for three independent reasons: (1) the
statements at issue constitute non-actionable forward-looking statements of opinion or "puffery";
(2) the terms of the investment were limited to those set forth in the various offering documents,
and Aris could not, as a matter of law, reasonably rely on statements made outside those
documents; and (3) Aris fails to plead scienter. None of these contentions has any merit.
(a) Statements of Opinion
First, defendants contend that, under New York law, optimistic statements about performance and risk, and boastful statements of opinion — commonly known as "puffery" — will not support an action for fraud. Defs.' Mem. 13 (citing Jacobs v Lewis, 261 AD2d 127 (NY App. Div. 1st Dept. 1999). Defendants point out that in order for a misstatement to be actionable, it "must be one of existing fact, and not merely an expression of opinion, expectation or declaration of [intent]." Defs.' Mem. 14 (quoting In re Duane Reade Inc. Sec. Litig., 2003 WL 22801416, *4 (S.D.NY 2003)).
Defendants, however, mischaracterize the alleged misrepresentations set forth in the complaint. Defendants' assertion that their alleged statements were mere "chest-beating statements" that "may have proved overly optimistic" and not representations that were "known to be incorrect' when made," Defs.' Mem. 15, ignores the primary allegations in the complaint that defendants misrepresented: (1) the Horizon Funds' April 2007 performance; (2) specific facts about the nature of the Horizon Funds' investments; and (3) how the Horizon Funds were minimizing their exposure [*6]to risk.
For example, Aris alleges that, after they submitted a redemption request in March 2007 for their full investment, defendants provided Aris with performance data for April that materially misstated the Horizon Funds' performance. This alleged misrepresentation can be characterized as a pure statement of present fact that defendants allegedly knew to be false when made. Contrary to defendants' assertion, Defs.' Mem. 14, the complaint's allegation is not that the interim results were used to forecast future earnings, and those earnings forecasts turned out to be incorrect, but rather, that the interim results themselves were false. (See Compl. ¶ 58) ("the interim results provided ... on April 24th fraudulently represented that the [Horizon Funds'] performance was up 3.2% for the month ... [when] [i]n actuality, the [Horizon Funds'] performance for April was down 2.15%, a substantial difference"). This allegation, which must be accepted as true on this motion, is clearly a misrepresentation of an existing fact that can be the basis of a fraud claim. See e.g. Houbigant, Inc. v Deloitte & Touche LLP,303 AD2d 92 (NY App. Div. 1st Dept. 2003) (allegations that financial statements were inaccurate and that defendants knew of their inaccuracy deemed sufficient to withstand motion to dismiss despite the fact that defendants asserted that the statements were accurate); P.T. Bank v Central Asia v ABN AMRO Bank N.V., 301 AD2d 373 (NY App. Div. 1st Dept. 2003) (sustaining fraud claim based on allegations that defendants misrepresented value of collateral, and noting that plaintiff need not produce evidence that defendants knew the true value of the collateral).
There are many other allegations in the complaint concerning the nature of the Horizon Funds' investments, and the measures that defendants were supposedly taking to mitigate the risk of those investments, that can also be viewed as false statements of existing fact. Among the misrepresentations defendants allegedly made during late 2006 and early 2007, including at the November 2006 and February 2007 meetings, were the following:
That defendants were taking steps to hedge against a continued downturn in the ABS/MBS markets when, in fact, they were not doing so, (Compl. ¶¶39, 44, 48, 50, 53, 65-66);
That the Horizon Funds had only minimal exposure in the sub-prime sector, when, in fact, they had significant exposure, (id. at ¶¶48, 50, 53, 65-67);
That defendants were using sophisticated software models to mitigate risk, when they did not have such models in place, (id. at ¶¶39-40; 44, 48, 53, 67);
That defendants had the ability to liquidate their portfolio quickly, when, in fact, their holdings were illiquid, (id. at ¶¶39-40, 44, 48, 53, 67);
That defendants had reduced the Horizon Funds' leverage, when, in fact, they had not, (id. at ¶¶48, 53, 67); and
That the Horizon Funds were positioned to profit from a continued downturn in the ABS and MBS markets when, in fact, they were positioned to experience significant losses, (id. at ¶¶38-40; 44, 48-50; 53, 57-58; 65-67).
Contrary to defendants' arguments, these statements cannot be characterized as "mere puffery," but rather, they are statements concerning the Horizon Funds' composition and abilities at the time the statements were made. Such statements can serve as the basis for a fraud claim. For instance, in Hunt v Alliance North American Govt. Income Trust, Inc., 159 F3d 723 (2d Cir. 1998), the Court upheld fraud claims based upon similar allegations concerning a mutual fund's representation about its intention to use hedging techniques. In Hunt, the defendant funds stated that they intended to use hedging techniques to reduce the risk from currency fluctuations, but did not actually do so because it was too costly. Reversing dismissal of the fraud claims, the Second Circuit Court of Appeals determined that the alleged misrepresentations concerning the intended use of hedging techniques constituted "an actionable claim for misrepresentation." Hunt v Alliance North American Govt. Income Trust, Inc., 159 F3d 723, 728 (2d Cir. 1998); see also Cohen v Koenig, 25 F3d 1168, 1172 (2d Cir. 1994) (holding that a "relatively concrete representation as to a company's future performance, if made at a time when the speaker knows that the represented level of performance cannot be achieved, may ground a claim of fraud"); Elkind v Liggett & Myers, Inc., 635 F2d 156, 164 (2d Cir. 1980) (fraud claim stated if "management intentionally fosters a mistaken belief concerning a material fact, such as its evaluation of the company's progress and earnings prospects in the current year").
Similarly, the statements concerning the Horizon Funds' ability to prosper during a
continued downturn, as well as the statements concerning the measures defendants had in place
to reduce risk, also are actionable because the defendants allegedly did not have the measures in
place to reduce the risk that they claimed they had. See e.g. CPC Intl., Inc. v McKesson
Corp., 514 NE2d 116 (NY 1987) (financial projections were actionable as fraud where they
were alleged to be false and unreasonable based upon company's financial condition when the
statements were made); Channel Master Corp. v Aluminum Ltd. Sales, 151 NE2d 833
(NY 1958) (statements concerning company's capacity to make sale actionable as fraud where
the statements were rendered false by company's commitments to other customers);
Cristallina S.A. v Christie, Manson & Woods Intl., Inc., 117 AD2d 284 (NY App. Div.
1st Dept. 1986) ("expression or prediction as to some future event" can support a fraud claim if it
is alleged that the author knew it to be false when the statement was made); EED Holdings v
Palmer Johnson Acquisition Corp., 387 F Supp2d 265 (S.D.NY 2004) (statements
concerning company's wherewithal and ability to perform project were actionable as fraud
because company's financial difficulties, including fact that it was undercapitalized, revealed that
the statements were calculated to deceive).
(b) Reasonable Reliance
Next, defendants argue that Aris has not sufficiently alleged reasonable reliance. However,
issues of reasonable reliance "are not subject to summary disposition" and should not be
disposed of on a motion to dismiss. See e.g. E*Trade Fin. Corp. v Deutsche Bank AG,
2008 WL 2428225, *21-*23 (S.D.NY 2008) (reasonableness of reliance on misrepresentations is
a fact-specific inquiry not usually suitable to resolution on a motion to dismiss); see also
Brunetti v Musallam, 11 AD3d [*7]280, 281 (NY App. Div.
1st Dept. 2004) (issue of "reasonable reliance, [an] essential element of a fraud claim, [is] not
subject to summary disposition").
(c) Fiduciary Duty
Moreover, as the general partner and investment manager of funds in which plaintiffs
invested, as well as the principals of those entities, the funds themselves and parties in whom
plaintiffs placed their trust, defendants owed fiduciary duties to Aris. See Blue Chip Emerald
LLC v Allied Partners Inc., 299 AD2d 278 (NY App. Div. 1st Dept. 2002); see also
Fraternity Fund Ltd. v Beacon Hill Asset Mgt. LLC, 376 F.Supp.2d 385 (S.D.NY 2005).
Reliance on a fiduciary's representation is generally justified. See Blue Chip Emerald LLC v
Allied Partners, Inc., 750 NYS2d 291, 294-295 (NY App. Div. 1st Dept. 2002) (although
plaintiffs had opportunity to conduct their own due diligence, and disclaimed, in writing, any
reliance on defendants' representations, the disclaimers were ineffective because defendants were
fiduciaries). In addition, where, as here, the parties are in a fiduciary relationship, whether the
plaintiffs could reasonably rely on the defendants' misrepresentations generally raises an issue of
fact precluding summary disposition. See Kimmell v Schaefer, 675 NE2d 450 (NY
(d) Defense of Disclaiming Reliance
Defendants also argue that Aris could not have relied upon their misrepresentations because the offering documents specifically disclaimed reliance on any representations other than those in the written documents, and because plaintiffs are sophisticated investors. There is no merit to either argument.
Although the Horizon Domestic offering documents specifically preclude reliance on statements not contained in the offering documents as a condition of investment, that disclaimer has no effect on subsequent representations (see e.g. P.T. Bank v Central Asia v ABN AMRO Bank N.V., 301 AD2d 373 (NY App. Div. 1st Dept. 2003); Suez Equity Investors, L.P. v Toronto-Dominion Bank, 250 F.3d 87, 104 (2d Cir. 2001).
Here, the statements prohibiting reliance on statements other than those contained in the offering memorandum are irrelevant because, as defendants acknowledge, Defs.' Mem. 4, plaintiffs not claim that they were defrauded into making the initial investment with the Fund. Rather, plaintiffs claim that, after they made their investments, they were defrauded into keeping their investments in the Horizon Funds (and into withdrawing their redemption requests). (Compl. ¶¶42, 43, 53, 59, 79). The disclaimer language cited by defendants in the Offering Memorandum and Subscription Documents is only applicable to the initial decision to invest in the Fund. See e.g. Offering Mem. 1-3 (stating that "in making an investment decision investors must rely on their own examination of the partnership and the terms of the offering" and that "no person has been authorized in connection with this offering to give any information or make any representation other than as contained in this memorandum" [emphasis added]); Subscription Doc. B-1 to B-2, ¶ 4 ("In deciding to invest in the Partnership, Subscriber has relied solely on the information in the Memorandum and has not relied on any oral misrepresentations or warranties" [emphases added]). There is no disclaimer as to future representations.
As a result, the disclaimers are not applicable to the fraudulent statements that form the basis
for the complaint here, which were all made well after the initial investment. See e.g. P.T.
Bank v Central Asia v ABN AMRO Bank N.V., 301 AD2d 373 (NY App. Div. 1st Dept.
2003) (disclaimer precluding reliance on misstatements in loan documents did not preclude
reliance on oral [*8]representations concerning value of
collateral); Delano v Umbreit, 809 NYS2d 481(Table), *1 (NY Sup. Ct., Suffolk Cty.
2005) (disclaimer in of pre-contract representations does not preclude reliance on representations
made post-contract/pre-closing); Suez Equity Investors, L.P. v Toronto-Dominion Bank,
250 F.3d 87, 104 (2d Cir. 2001) (disclaimer precluding reliance on representations concerning
the accuracy or completeness of evaluation materials did not cover subsequent conversations
concerning the same subjects).
(e) Defense of Sophistication of Plaintiffs as Investors
Defendants also contend that plaintiffs are sophisticated investors who face a particularly
high bar when alleging reasonable reliance. However, even if plaintiffs may be characterized as
sophisticated investors, they could still have justifiably relied upon defendants' alleged
misrepresentations (see National Western Life Ins. Co. v Merrill Lynch, Pierce, Fenner &
Smith, Inc., 89 F. App'x 287, 294-295 (2d Cir. 2004) (" Sophisticated' entities can justifiably
rely on fraudulent statements," and whether such entities did so in particular case "is a genuine
issue of material fact"). Moreover, the complaint contains allegations that Aris did not have the
expertise in the ABS and MBS markets in which the Horizon Funds invested, and relied on the
statements made by defendants because of Devaney's "reported experience and reputation as the
pre-eminent trader in the MBS and ABS markets." (See Compl. ¶¶27, 41).
Accepting these allegations as true, such reliance, particularly where defendants were in
exclusive possession of the details of how they were minimizing risk, see id. at
¶52, can be characterized as reasonable. See e.g. Fraternity Fund Ltd. v Beacon Hill
Asset Mgt. LLC, 376 F.Supp.2d 385, 411 (S.D.NY 2005) (hedge fund investor could
reasonably rely on information provided concerning the fund's performance because the
defendants were "uniquely positioned to know" the fund's value and because, as limited partners,
their relationship with the defendants was fiduciary in nature).
Defendants' argument that the complaint does not adequately allege scienter because it does nothing more than allege that "the motivation or intent for the fraud was to increase Defendants' corporate profitability," Defs.' Mem. 21, is rejected.
Scienter is adequately pleaded if "the complaint contains some rational basis for inferring that the alleged misrepresentation was knowingly made." Houbigant Inc. v Deloitte & Touche LLP, 303 AD2d 92, 93 (NY App. Div. 1st Dept. 2003). Unlike the Second Circuit test which requires a "strong inference" of fraudulent behavior, all that is required under C.P.L.R. 3016 (b) is that the facts alleged "permit a reasonable inference of" fraud. Pludeman v Northern Leasing Sys. Inc., 890 NE2d 184, 187 (NY 2008). Thus, to establish scienter, a plaintiff does not have to demonstrate the truth of its allegations, but "need only allege specific facts from which it is possible to infer defendant's knowledge of the falsity of its statements." Houbigant Inc. v Deloitte & Touche LLP, 753 NYS2d 493, 499 (NY App. Div. 1st Dept. 2003). Moreover, because the element of scienter is "most likely to be within the sole knowledge of the defendant and least amenable to direct proof," the requirement of C.P.L.R. 3016 (b) should not be interpreted strictly when analyzing the scienter allegations in a complaint. Houbigant, Inc. v Deloitte & Touche LLP, 753 NYS2d 493, 498 (NY App. Div. 1st Dept. 2003); P.S. Auctions, Inc. v Exchange Mut. Ins. Co., 105 AD2d 473 (NY App. Div. 3d Dept. 1984).
Defendants' assertion that the complaint fails to adequately allege scienter because it merely [*9]alleges a motive — corporate profits — that is common to "every corporation in the world," Defs.' Mem. 22, mischaracterizes the complaint's allegations. Aris' allegations that defendants made statements they knew were false to induce Aris to maintain its investments, and revoke its redemption requests, (Compl. ¶¶ 35, 37, 44, 53, 58-59, 74-75, 77), clearly set forth conscious misbehavior. Specifically, Aris' allegations concerning the April 24th call where, allegedly, defendants knowingly provided false performance data in order to convince Aris to revoke its redemption requests are sufficient to set forth the element of scienter. See e.g. Houbigant, Inc. v Deloitte & Touche LLP, 753 NYS2d 493, 497 (NY App. Div. 1st Dept. 2003) (allegations that defendants knew of, but failed to acknowledge, irregularities in financial statements sufficient to plead scienter); Cosmas v Hassett, 886 F.2d 8, 13 (2d Cir. 1989) (statement concerning income projections made with knowledge of import restrictions that could undercut those projections sufficient to allege scienter).
Accordingly, defendants' motion to dismiss the fraud cause of action is denied.
Claims Against United Capital Market ("UCM") and Horizon Offshore
Defendants contend that the fraud claims must be dismissed against United Capital Market ("UCM") because "there is no allegation that [UCM] made a single statement, much less a misrepresentation, either knowingly or unknowingly, to any representative or agent of [Aris]." Defs.' Mem. 10. However, the complaint alleges that Devaney, a principal of UCM, made numerous statements to Aris concerning the Horizon Funds' ability to profit during a downturn in the ABS, MBS and sub-prime markets because of UCM. (See Compl. ¶¶2-3, 28, 31, 39-41, 48, 77). Moreover, the complaint specifically alleges that defendants' allegations concerning the unique access to market information and its ability to liquidate holdings quickly were made on behalf of UCM . (See Compl. ¶31) (defendants would use UCM's "unique market knowledge"); (Compl. ¶40) (Devaney represented that "through UCM he had a unique network"). Plaintiffs also allege that the defendants, including UCM as a broker-dealer for the Horizon Funds, stood to profit from the allegedly fraudulent scheme "by the substantial management and performance fees charged by defendants." (See Compl. ¶2; see also Compl. ¶¶ 36, 45, 59, 73-75). Such allegations, at this early stage, are clearly sufficient to state a claim for fraud against UCM. See e.g. Pludeman v Northern Leasing Sys. Inc., 890 NE2d 184, 190 (NY 2008) (unnecessary to allege specific details of each defendant's conduct where a fraudulent scheme is alleged); CPC Intl., Inc. v McKesson Corp., 514 NE2d 116, 125 (NY 1987) (allegations of a scheme involving all defendants sufficient to state a fraud claim); Tompkins PLC v Bangor Punta Consol. Corp., 194 AD2d 493, 493 (NY App. Div. 1st Dept. 1993) (fraud properly pleaded against multiple defendants where "complaint sets forth the interlocking relationship of the various defendants, and when that relationship and the other allegations in the complaint are read in the light most favorable to plaintiffs, plaintiffs have adequately alleged that the [defendants] authorized the various misrepresentations"); Board of Mgrs. of 411 E. 53rd St. Condominium v Dylan Carpet, Inc., 182 AD2d 551, 552 (NY App. Div. 1st Dept. 1992) ("that the fraud allegations do not identify and distinguish between the two individual defendants is of no consequence since the complaint as a whole adequately alleges a scheme involving both defendants").
With respect to Horizon Offshore, defendants contend that the complaint must be dismissed as against Horizon Offshore because, at the time Aris allegedly suffered losses, Aris had already [*10]withdrawn its entire investment in Horizon Offshore, and thus no damages resulted from Aris' investment in Horizon Offshore. Because the complaint alleges that Horizon Offshore took part in the fraudulent scheme, and that plaintiffs were damaged as a result of that scheme, (see Compl. ¶¶ 2-3, 38-40, 77-80), it is irrelevant that the damage occurred at a time when plaintiffs' funds were actually deposited with Horizon Domestic rather than with Horizon Offshore.
Thus, the motion to dismiss as to UCM and Horizon Offshore is denied.
Negligent Misrepresentation, Breach of Fiduciary
Duty, Recklessness/Gross Negligence, and Negligence
Defendants contend that plaintiffs' claims for negligent misrepresentation, breach of fiduciary duty, recklessness/gross negligence, and negligence are preempted by the Martin Act, which is New York's blue sky law that prohibits a broad range of fraudulent and deceitful practices in advertising, distributing, exchanging, selling and purchasing securities within or from New York state. See NY Gen. Bus. Law §§ 352, 352-c, 353 (McKinney 1996).
The Court of Appeals has determined that there is no express or implied private right of action under the statute. CPC Intl. v McKesson Corp., 514 NE2d 116, 118 (NY 1987). Instead, exclusive enforcement power rests with the Attorney General with respect to claims which fall within the Martin Act. See Kerusa Co. LLC v W10Z/515 Real Estate Ltd. Partnership, 906 NE2d 1049, 1054 (NY 2009).
The vast majority of state and federal courts have found that claims relating to securities fraud that do not include scienter as an essential element, including negligence, gross negligence, negligent misrepresentation, and breach of fiduciary duty, are "typically preempted by the Martin Act, in contrast to a claim requiring intent, such as a claim for common law fraud" (Sedona Corp. v Ladenburg Thalmann & Co., Inc., 2005 WL 1902780, *22 (S.D.NY 2005); In re Bayou Hedge Fund Litigation, 534 F.Supp.2d 405, 421 (S.D.NY 2007) (breach of fiduciary claim preempted); see e.g. Rego Park Gardens Owners, Inc. v Rego Park Gardens Assocs., 191 AD2d 621 (NY App. Div. 2d Dept. 1993) (negligent misrepresentation preempted); Horn v 440 E. 57th Co., 151 AD2d 112 (NY App. Div. 1st Dept. 1989) (negligent misrepresentation and breach of fiduciary duty claims dismissed as preempted); Castellano v Young & Rubicam, Inc., 257 F.3d 171 (2d Cir. 2001) (breach of fiduciary duty claim preempted); Heller v Goldin Restructuring Fund, L.P., 590 F.Supp.2d 603 (S.D.NY 2008) (breach of fiduciary duty claim preempted); Gabriel Capital, L.P. v Natwest Fin., Inc., 137 F.Supp.2d 251 (S.D.NY 2000) (negligence claim preempted).
Here, Aris' claims for negligent misrepresentation, breach of fiduciary duty, recklessness/gross negligence, and negligence all arise in the securities context and do not require proof of deceitful intent. Therefore, they are covered by the Martin Act and are preempted, because "to sustain them would be, in effect, to recognize a private right of action under the Martin Act contrary to case law." Horn v 440 E. 57th Co.,151 AD2d 112, 120 (NY App. Div. 1st Dept. 1989) (citing CPC Intl. v McKesson Corp., 514 NE2d 116 (NY 1987).
In opposition to the motion, plaintiffs rely on a non-binding decision from the Second Department, Carboara v Babylon Cove Dev., LLC, 54 AD3d 79 (NY App. Div. 2d Dept. 2008), and a law journal article discussing that decision, to suggest that the Martin Act has no preclusive effect on common-law claims. However, in the face of binding Appellate Division, First Department [*11]precedent, plaintiffs' argument is unpersuasive.
Thus, plaintiffs' claims for negligent misrepresentation, breach of fiduciary duty, recklessness/gross negligence, and negligence are dismissed.
Accordingly, it is
ORDERED that the motion to dismiss is granted to the limited extent that plaintiffs' second cause of action for negligent misrepresentation, third cause of action for breach of fiduciary duty, fourth cause of action for recklessness/gross negligence, and fifth cause of action for negligence are hereby severed and dismissed; and it is further
ORDERED that the motion to dismiss plaintiffs' first cause of action for fraud is denied; and it is further
ORDERED that defendants are directed to serve an answer to the complaint within 10 days after service of a copy of this order with notice of entry.
This constitutes the Decision and Order of the Court.
Dated: New York, New York
December 14, 2009
Hon. Eileen Bransten