| IKB Intl. S.A. v Morgan Stanley |
| 2016 NY Slip Op 05779 [142 AD3d 447] |
| August 11, 2016 |
| Appellate Division, First Department |
[*1]
| IKB International S.A., in Liquidation, et al.,Respondents, v Morgan Stanley et al., Appellants. |
Davis Polk & Wardwell LLP, New York (James P. Rouhandeh of counsel), forappellants.
Schlam Stone & Dolan LLP, New York (Richard H. Dolan of counsel), forrespondents.
Order, Supreme Court, New York County (Marcy S. Friedman, J.), entered October29, 2014, which, insofar as appealed from, denied defendants' motion to dismiss thecauses of action for fraud and aiding and abetting fraud except as related to the fourcertificates purchased before November 16, 2005, and, as related to all other certificates,except to the extent they are based on alleged misrepresentations regarding transfer ofnotes and mortgages to the trusts, unanimously affirmed, without costs.
This fraud action arises out of the significant financial losses plaintiffs incurred as aresult of defendants' allegedly fraudulent conduct in connection with the offer, sale,structure, and marketing of $132,665,000 in residential mortgage backed securities(RMBS). Primarily, this appeal concerns whether plaintiffs adequately pleaded theelements of justifiable reliance and scienter necessary for fraud claims, both as to theRMBS that defendants sold directly to them and as to four RMBS for which defendantsonly acted as the underwriter. We hold, as more fully explained below, that plaintiffsadequately pleaded these elements by alleging that defendants knew that the offeringdocuments misrepresented critical characteristics of the underlying mortgage loans, thatthey fraudulently concealed the inferior quality of those loans by means of misstatements,misrepresentations, and omissions of material fact in the offering documents, and thatplaintiffs undertook appropriate due diligence before purchasing the RMBS. The fraudclaims concerning defendants' role as an underwriter are also sufficiently pleaded, basedupon plaintiffs' allegations that defendants participated in or had knowledge of thefraud.
Plaintiff IKB International S.A. (IKB SA), a Luxembourg incorporated financialinstitution, is a subsidiary of plaintiff IKB Deutsche Industriebank AG (IKB AG), aGerman corporation. Between June 2005 and April 2007, IKB SA purchased a total of25 RMBS certificates in connection with 18 securitizations that defendants sponsored,arranged, marketed, underwrote, and/or sold. In 2008, IKB SA sold all 25 RMBS at amassive financial loss. Two of the RMBS were sold to a nonparty buyer and the other 23RMBS were sold to IKB AG. In November 2008, IKB AG sold the 23 RMBS it washolding to Rio Debt Holdings (Ireland) Limited (Rio). In December 2008, both IKB SAand IKB AG assigned all of their claims arising from the purchase of the RMBS,including claims against the issuers, underwriters, and sellers of the securities, to Rio. InNovember 2011, plaintiffs, defendants, and Rio entered into a tolling and forbearanceagreement concerning claims related to the RMBS (the statute of limitations was due toexpire on May 15, 2012). On May 9, 2012, Rio reassigned all claims arising from theRMBS to IKB AG, but did not physically deliver the securities themselves. This actionwas commenced on November 16, 2012 and a complaint was filed May 17, 2013. Thisseries of events forms the backbone of defendants' additional arguments, that this actionviolates the champerty statute because plaintiffs purchased the claims for the solepurpose of bringing an action (Judiciary Law § 489), plaintiffs lackstanding, and in any event, it is time barred. We agree with the motion court thatdefendants failed to show, as a matter of law, that the [*2]reassignment of claims from Rio to IKB SA violated thechamperty statute. The defendants also failed to show, as a matter of law, that the claimsare subject to the three-year German statute of limitations, as opposed to the 30-yearLuxembourg statute of limitations.
To establish a prima facie claim of fraud, a complaint must allege misrepresentationor concealment of a material fact, falsity, scienter on the part of the wrongdoer,justifiable reliance, and resulting injury (Dembeck v 220 Cent. Park S., LLC, 33 AD3d 491, 492[1st Dept 2006]). Defendants argue that plaintiffs are sophisticated investors and havenot adequately alleged the justifiable reliance element of their claims, because they madea substantial investment without conducting any due diligence of their own toindependently appraise the risks attendant to the RMBS in which they invested.
Where a plaintiff is a sophisticated entity, "if the facts represented are not matterspeculiarly within the [defendant's] knowledge, and the [plaintiff] has the means availableto [it] of knowing, by the exercise of ordinary intelligence, the truth or the real quality ofthe subject of the representation, [the plaintiff] must make use of those means, or [it] willnot be heard to complain that [it] was induced to enter into the transaction bymisrepresentations" (ACA Fin.Guar. Corp. v Goldman, Sachs & Co., 25 NY3d 1043, 1044 [2015][internal quotation marks omitted]; MP Cool Invs. Ltd. v Forkosh, 141 AD3d 111, 117 [1stDept 2016]). In other words, a sophisticated investor claiming that it has been defraudedhas to allege that it took reasonable steps to protect itself against deception by, forinstance, examining available financial information to ascertain the true nature of aparticular transaction or facts averred (see e.g. DDJ Mgt., LLC v Rhone Group L.L.C., 15 NY3d147, 154-155 [2010]).
Plaintiffs allege that defendants knowingly misrepresented the credit quality andcharacteristics of the pool of residential mortgage loans that comprised thesecuritizations. For instance, defendants represented that rigorous loan underwritingstandards had been employed in the loan origination process, and that if a particular loandid not comply, there were other compensating factors, when in fact the originators hadsystematically abandoned their underwriting standards, selling loans that they knew weredefective. There were also misrepresentations about loan to value ratios, the appraisedvalues of the underlying loans, owner occupancy of the mortgaged properties, and creditratings.
Specifically on the issue of justifiable reliance, the complaint alleges that plaintiffs'investment advisors analyzed the RMBS based upon information in the prospectuses,prospective supplements and other offering documents and that plaintiffs lacked accessto the underlying mortgage loan files. They further claim that they would not havereceived the loan files even if they had been requested because of applicable regulationsprotecting the borrowers' personal information (see 17 CFR 248.1 [SEC Privacyof Consumer Financial Information]). Plaintiffs further allege that defendants cautionedinvestors to rely only on the offering documents and expressly warned that anyoneoffering conflicting information about the investment was unauthorized to do so. Theseallegations are sufficient to allege justifiable reliance under the circumstances of thiscase.
Defendants argue that in order to establish justifiable reliance, plaintiffs wererequired to allege that they sought additional information from defendants about thetruthfulness of the representations made in the offering documents or that they requestedthe loan files for the loans underlying the RMBS. The level of due diligence advocatedby defendants requires a prospective purchaser to assume that the credit ratings assignedto the securities were fraudulent and to verify them through a detailed retracing of thesteps undertaken by the underwriter and credit rating agency. We do not require thisheightened due diligence standard to support justifiable reliance in a pleading concerningsuch sales of securities by prospectus (see Basis Yield Alpha Fund Master v Morgan Stanley, 136AD3d 136, 142-143, 144 [1st Dept 2015]; CIFG Assur. N. Am., Inc. v Goldman, Sachs & Co., 106AD3d 437 [1st Dept 2013]).
Defendants also argue that the motion court erred in failing to dismiss plaintiffs'fraud claims because the element of scienter is only based on generalized allegations thatdefendants knew of the falsity of their representations. "The element of scienter, that is,the requirement that [*3]the defendant knew of the falsityof the representation being made to the plaintiff, is, of course, the element most likely tobe within the sole knowledge of the defendant and least amenable to direct proof"(Houbigant, Inc. v Deloitte & Touche, 303 AD2d 92, 98 [1st Dept 2003]).All that is required to defeat a motion to dismiss a fraud claim for lack of scienter is "arational inference of actual knowledge" (see AIG Fin. Prods. Corp. v ICP Asset Mgt., LLC, 108 AD3d444, 446 [1st Dept 2013]). The allegations that defendants were informed aboutdefects in the loans they were securitizing because they obtained this information throughtheir own due diligence are sufficient to plead scienter (see e.g. Basis Yield AlphaFund Master, 136 AD3d at 145). The due diligence reports prepared during thesecuritization process suggest that almost 39% of the loan files reviewed for defendantswere defective; yet defendants included 56% of the nonconforming loans in its RMBS,often making deals that allowed them to obtain the loans at steep discounts. Thecomplaint also alleges that defendants were uniquely positioned to know that theoriginators had abandoned their underwriting guidelines. These allegations satisfy theelement of scienter for pleading purposes. Defendants' argument, that they also sufferedfinancial losses and that it defies logic that they would have invested as heavily as theydid (almost $543 million) in securities expected to fail, does not render the pleadinglegally infirm.
Defendants separately urge the dismissal of the fraud claims concerning the ACCR2004-3, ACCR 2006-1, NCHET 2005-C, and NCHET 2005-D securitizations. Theyargue that they acted exclusively as underwriter with respect to these securitizations,whose issuers are not parties to this action, and that the allegations in the complaint donot support a claim that they made any of the material misrepresentations in the offeringmaterials for these securitizations (see Eurycleia Partners, LP v Seward & Kissel, LLP, 46AD3d 400 [1st Dept 2007], affd 12 NY3d 553 [2009]). Although an underwriter doesnot usually "make" statements in offering documents, it constructively represents thatstatements made in an offering document are complete and accurate (see e.g. In reMTC Elec. Tech. Shareholder Litig., 993 F Supp 160, 162 [ED NY 1997]). Thecomplaint in this case alleges that defendants' role as an underwriter was significant,active and not passive, because among other responsibilities it purchased bonds,identified potential investors, and provided them with the offering documents in order tosolicit their investment. Moreover, as underwriter, defendants were privy to and hadactual knowledge of the issuers' fraud, given their active involvement in the entiresecuritization process. Defendants worked closely with the sponsor, rating agencies, andoriginators in structuring the transaction. Two of the prospectus supplements disclosed alending relationship between defendants as underwriter and the depositor. Defendants'name was on the offering documents, and for at least one of the securitizationsdefendants were identified as the "lead manager." These alleged facts permit a reasonableinference that defendants, in their underwriter role, had a significant presence in manyaspects of the securitization process and that they not only knew of the substandardquality of the loans being securitized, they actively participated in it (see Pludeman vNorthern Leasing Sys., Inc., 10 NY3d 486 [2008]). Unassailable proof ofthese facts is not necessary at the pleading stage to withstand a dismissal motion(Eurycleia Partners, LP v Seward & Kissel, LLP, 12 NY3d 553 [2009]).Concur—Sweeny, J.P., Saxe, Moskowitz, Gische and Webber, JJ. [Prior CaseHistory: 45 Misc 3d 1212(A), 2014 NY Slip Op 51548(U).]