OPINION & ORDER
Table of Contents
I. BACKGROUND.........................................................515
II. DISCUSSION...........................................................516
A. The Claims are Direct, not Derivative...................................516
B. New York Substantive Law Governs the Fraud and Negligent Misrepresentation Claims............................................518
1. New York and Florida Law Conflict.................................519
a. Negligent Misrepresentation...................................519
b. Common Law Fraud..........................................519
2. New York has a Greater Interest in the Litigation than Florida......522
C. New York Law Requires Dismissal of the Action..........................524
1. Plaintiffs’ Negligent Misrepresentation Claim Fails Because they have Not Alleged a “Special Relationship.”.........................524
2. Plaintiffs’ Common Law Fraud Claim Fails Because they have Not Alleged Cognizable Damages Proximately Caused by the Fraud......525
III. CONCLUSION..........................................................527
Plaintiffs raise common law claims of negligent misrepresentation and fraud that take the form of what are referred to as “holder” claims: i.e., they allege that they would have sold their Citigroup stock but instead held it to their detriment in reliance on defendants’ misleading statements. Specifically, plaintiffs allege that they planned to sell 16.6 million shares of Citigroup stock in May 2007. However, believing defendants’ misrepresentations that minimized Citigroup’s exposure to its risk from holding residential mortgage-backed securities, they instead held the stock until March 2009 as its price fell by 95%. Defendants have moved to dismiss the action pursuant to Federal Rule of Civil Procedure 12(b)(6).
Defendants principally assert that plaintiffs cannot state a valid claim based on an injury that derives from a contemplated sale in hypothetical market conditions. The motion presents a choice between New York law—which largely prohibits fraud claims by holders of publicly traded securities alleging such an injury—and Florida law—which likely permits those claims. Defendants contend, first, that New York law applies to plaintiffs’ claims and, second, that New York law bars recovery here because the alleged damages are speculative and not proximately caused by the misrepresentations. See Starr Found, v. Am. Int’l Grp., Inc.,
Because New York state has the greater interest in applying its law to govern suits regarding misrepresentations made in New York about stock in a New York-based corporation that is traded on a New York exchange, New York law applies to these claims. Applying New York law, the Court finds that plaintiffs have failed to allege cognizable damages proximately caused by the alleged misrepresentations, and thus dismisses the action.
1. Background
According to the Amended Complaint (the “Complaint”),
In May 2007, Williams developed a plan “to sell out his entire Citigroup position.” (Id. ¶ 5.) In forming this plan, Williams and his financial advisors thoroughly “combed through Citigroup’s filings and statements” (id. ¶ 170), examining information that included “conference calls, investor slideshows, earnings releases, public filings and statements from senior officers” (id. ¶ 169). Williams investigated “whether [Citigroup] had meaningful exposure to the subprime mortgage assets that were beginning to drag down other major players in the financial services sector.” (Id. ¶ 170.) Although Citigroup had substantial exposure to risky subprime assets throughout 2007, it failed to disclose that exposure until November 2007. (See, e.g., id. ¶¶ 64-74, 103-09.) Although Williams thus believed that Citigroup’s balance sheet was healthy, he nonetheless sold 1 million shares on May 17, 2007 at $55 per share. (Id. ¶ 170.) However, “[t]rusting that [Citigroup]’s public pronouncements were forthright and that it had no exposure to those ‘toxic’ assets, Williams reversed course [on his plan to fully liquidate] and decided to hold the remainder of his shares.” (Id. ¶ 170.)
Williams “continually” reconsidered selling the remaining 16.6 million shares “[o]ver the next seventeen months,” only to be deceived into holding them each time. (Id. ¶ 177.) He reconsidered the sale in July 2007, for example, but decided against it after listening to an earnings call and reviewing “earnings releases and materials downloaded from [Citigroup]’s website.” (Id. ¶ 209.) Similarly, in January 2008, Williams decided not to sell in reliance on an earnings call in which executives explained further write-downs, but assured investors that “they had a complete understanding of their exposure, and that it was contained and under control.” (Id. ¶ 223.) The price of Citigroup stock steadily fell as market conditions worsened and news of its exposure to toxic assets, with associated accounting and liquidity issues, trickled out. (See, e.g., id. ¶235 (discussing the effect of “enormous turmoil and uncertainty in the markets”.) “It was not until the end of 2008 that Citigroup’s full exposure during the subprime crisis, and the consequences [of] its exposure,
Although plaintiffs cite multiple instances of detrimental reliance on defendants’ misstatements after May 2007, they allege that their losses stem in full from their having not sold 16.6 million shares at some time after the executed sale of 1 million shares on May 17, 2007. But plaintiffs claim as damages the price they would have received for all 16.6 million shares on May 17, 2007—the estimated “fraud-free price” of $51.59—less the $3.09 per share they actually received in 2009. (Id. ¶ 171-72.) Alternatively, they claim out-of-pocket damages based on the $35 value of Citigroup shares at the time of the Travelers merger, not on the estimated May 2007 price. (Id. ¶ 173.)
II. Discussion
The Court first analyzes whether plaintiffs’ claims are actually shareholder derivative claims that they lack shareholder standing to assert on behalf of the corporation. The Court finds the claims are direct and determines that New York law applies to both claims. Finally, the Court finds that New York law requires dismissal of the claims as a matter of law.
A. The Claims are Direct, not Derivative.
The Court rejects defendants’ contention that these claims are in reality derivative claims brought on behalf of Citigroup.
Conveniently ignoring the second question entirely, defendants contend that because all shareholders suffered when the price of Citigroup stock fell subsequent to the contemplated May 2007 sale, any claim seeking redress for that loss in value is necessarily derivative. This reasoning invokes the bright-line test that Tooley “expressly disapprove^],” id. at 1039: that “a suit must be maintained derivatively if the injury falls equally upon all stockholders,” id. at 1037 (abrogating Bokat v. Getty Oil Co.,
Defendants’ contentions to the contrary ignore Tooley’s instruction that “a court should look to the nature of the wrong and to whom the relief should go.” Id. at 1039. In sum, the relevant considerations for the Tooley test are the following: According to plaintiffs’ allegations, “the duty breached was owed to” them and other investors directly, not to Citigroup and indirectly to shareholders. See id
The Court recognizes a tension in Delaware law between two lines of cases applying the Tooley test to holder claims—one line finds that misrepresentations and omissions generally give rise to direct claims and the other line finds that injuries that result from the diminution of stock value are generally derivative. Compare Albert v. Alex. Brown Mgmt. Servs., Inc., No. Civ.A.762-N,
Following the latter line, the U.S. Court of Appeals for the Fifth Circuit has held that holder claims such as plaintiffs’ claims are necessarily derivative because the alleged misstatements “only injured [the plaintiffs] indirectly as a result of their ownership of’ stock. See Smith v. Waste Mgmt., Inc.,
In both Delaware cases on which defendants rely, the derivative claims were premised on an insider’s breach of a duty owed to the corporation. In Feldman, the allegations concerned board members’ breaches of their fiduciary duties that diluted the plaintiffs ownership stake. See id. at 732. In Manzo v. Rite Aid Corp., meanwhile, the Court of the Chancery dismissed the fraud claims because plaintiff had not pled reliance or cognizable damages, not because they were derivative. See No. Civ.A. 18451-NC,
B. New York Substantive Law Governs the Fraud and Negligent Misrepresentation Claims.
“[F]ederal courts must follow conflict of laws rules prevailing in the states in which they sit.” Klaxon Co. v. Stentor Elec. Mfg. Co.,
New York applies the law of the state with the most significant interest in the litigation. In weighing interests, New York distinguishes between “conduct regulating” and “loss allocating” rules. If conduct regulating rules are in conflict, New York law usually applies the law of the place of the tort (“lex loci delicti”). However, if loss allocating rules conflict, the choice of law analysis is governed by the so-called Neumeier*519 [v. Kuehner,31 N.Y.2d 121 ,335 N.Y.S.2d 64 ,286 N.E.2d 454 (1972)] rules.
Lee v. Bankers Trust Co.,
1. New York and Florida Law Conñict.
a. Negligent Misrepresentation
The parties agree that the elements of negligent misrepresentation pursuant to New York and Florida law differ materially. New York requires a “special relationship” between the parties; Florida does not. Compare Mandarin Trading Ltd. v. Wildenstein,
b. Common Law Fraud
The parties agree that the basic elements of common law fraud in New York and Florida are substantially equivalent.
i. Florida Holder-Claim Law
There are few clues in Florida law to its treatment of holder claims, but the weight of authority supports the conclusion that Florida would permit holder claims with heightened pleading standards. There is one case in which a Florida intermediate appellate court reversed the grant of summary judgment to a defendant that had allegedly dissuaded a plaintiff from selling stock. See Ward v. Atl. Sec. Bank, 777 So.2d 1144, 1146 (Fla.Dist.Ct.App.2001). Indeed, the plaintiff in Ward had actually placed an order to sell her stock but was persuaded to abandon it in a telephone call that a representative of the bank initiated to the stockholder. Id. at 1145. She had “properly alleged common law fraud” despite that she had not purchased or sold shares in reliance on the
Federal courts have predicted that Florida would permit holder claims, subject to heightened pleading requirements for the reliance element. See, e.g., Hunt v. Enzo Biochem, Inc.,
that if the plaintiff had read a truthful account of the corporation’s financial status, the plaintiff would have sold the stock, how many shares the plaintiff would have sold, and when the sale would have taken place. The plaintiff must allege actions, as distinguished from unspoken and unrecorded thoughts and decisions, that would indicate that the plaintiff actually relied upon the misrepresentations.
Small,
ii. New York Holder-Claim Law
New York courts have not explicitly defined distinct pleading requirements applicable to holder claims, but the Appellate Division, First Department, has significantly narrowed the scope of cognizable damages for holder claims in Starr Foundation v. American International Group, Inc.,
Second, the court characterized “the value [the plaintiff] might have realized from selling its shares during a period when it chose to hold, under hypothetical market conditions” in which the concealed facts were widely known, as the “undeterminable and speculative” proceeds of “an alternative contractual bargain.” Id. at 28,
Third, the court characterized the claimed damages—the decline in the stock price after revelation of the truth in worse market conditions—as a mere “paper ‘loss’ ” that the alleged misrepresentations did not proximately cause. Id. at 29,
As noted above, the decision in Starr was rendered by an intermediate appellate court. A federal court will only decline to follow such an intermediate appellate court decision if it “find[s] persuasive evidence that the New York Court of Appeals, which has not ruled on this issue, would reach a different conclusion.” 10 Ellicott Square Court Corp. v. Mountain Valley Indem. Co.,
On the first question, plaintiffs point to another First Department decision: Continental Insurance Co. v. Mercadante,
On the second question, plaintiffs point to the decisions of courts in other states that permit certain holder claims as evidence that the New York Court of Appeals would reject Starr. But the fact that some courts in other states may not follow Starr is no reason to disregard a recent First Department decision quite squarely addressing the viability of claims by holders of publicly traded securities.
In sum, New York’s appellate courts are the best predictors of how the New York Court of Appeals would decide such a contentious issue. Accordingly, the Court adopts Starr as the law governing holder claims in New York. New York law thus diverges from Florida law on whether a holder’s losses on a publicly traded security are legally cognizable.
Having found that the law of New York conflicts with that of Florida, the Court must now determine “which of two competing jurisdictions has the greater interest in having its law applied in the litigation. The greater interest is determined by an evaluation of the facts or contacts which relate to the purpose of the particular law in conflict.” Padula v. Lilarn Props. Corp.,
Plaintiffs contend that the only relevant difference is a loss-allocating rule governing the calculation of damages. Defendants contend that Starr sets forth conduct-regulating rules because it concerns not the calculation of damages but whether a holder’s losses are legally cognizable at all. The parties also dispute the significance of New York’s and Florida’s contacts with this case; plaintiffs emphasize that the place of the loss determines the location of a tort, and defendants emphasize that the conduct to be regulated occurred in New York.
i. Conduct-Regulating or Loss-Allocating Rules
As in Padula, the Court finds that the rules at issue here are “are primarily conduct-regulating rules.”
ii. Interest in Regulating the Conduct at Issue
The default rule for conduct-regulating tort rules is lex loci delicti—to apply the law of the place of the tort. The logic of the rule is straightforward: generally, “that jurisdiction has the greatest interest
“However, where the loss was suffered is not conclusive and does not trump a full interest analysis.” Thomas H. Lee Equity Fund V, L.P. v. Mayer Brown, Rowe & Maw LLP,
Courts considering claims of fraud and negligent misrepresentation have instead focused on the place where the fraud was centered and where misrepresentations were made. See In re Refco Inc. Sec. Litig.,
Moreover, in Sack and the other cases on which plaintiffs rely, courts rigidly followed the location of the loss to determine the statute of limitations pursuant to New York’s borrowing statute, not to determine governing law pursuant to a comprehem sive interest analysis. See Sack,
In New York’s flexible interest analysis, by contrast, courts look to all the “facts or contacts ... which relate to the purpose of the particular law in conflict.” Schultz,
If statements that defendants disseminated to the investing public were subject to the fraud laws of any jurisdiction in which a Citigroup investor lived at the time the statements were made, defendants would be subject to liability pursuant to the laws of all fifty states and an unknown number of foreign nations. That approach would paralyze actors in the securities markets, not regulate their conduct. Even here—despite plaintiffs’ attempts to disregard the trust and corporate forms that non-party Arthur Williams chose for his investments by treating Williams himself as the sole plaintiff—at least one of the actual plaintiffs is a Nevada resident, not a Florida resident. (See Compl. ¶ 28 (“Plaintiff MFS Inc. [ ] is a corporation incorporated under the laws of Nevada, with a principal place of business in Nevada.”).) Because most defendants are New York residents (see Compl. ¶¶ 17-25) and most plaintiffs are Florida residents (see Compl. ¶¶ 14-16), the parties’ domiciles do not favor either jurisdiction.
Furthermore, plaintiffs allege they were injured only when they sold the stock at a loss. If so, holders of a stock that has fallen in value could establish residence in a state with holder-friendly laws before selling. That change in residence, according to plaintiffs’ view, would ensure that the stockholder’s chosen state’s law applied to his fraud claims in state and federal courts in New York, regardless of which state (or foreign nation) he had chosen as his new residence. Fortunately, the flexibility of New York’s interest analysis prevents the forum shopping that plaintiffs’ rigidly formalist reasoning would permit.
Wherever the loss was felt, New York is the jurisdiction with the greatest interest in litigation over claims regarding conduct based in New York. Accordingly, New York law governs these claims.
C. New York Law Requires Dismissal of the Action.
1. Plaintiffs’ Negligent Misrepresentation Claim Fails because They Have Not Alleged a “Special Relationship.”
New York law requires “the existence of a special or privity-like relationship” between the plaintiff and defendant for a successful negligent misrepresentation claim. See Mandarin Trading Ltd. v. Wildenstein,
Here, because Citigroup is an issuer of shares to public investors, defendants are not in a special privity-like relationship with the investing public, or with actual purchasers (Compl. ¶ 256). See Int’l Fund Mgmt. S.A., 822 F.Supp.2d at
2. Plaintiffs’ Common Law Fraud Claim Fails because They Have Not Alleged Cognizable Damages Proximately Caused by the Fraud.
New York law, as applied to plaintiffs’ allegations, also requires dismissal of the fraud claims. As in Starr, the premise of plaintiffs’ injuries is the “undeterminable and speculative” proceeds of an alternative bargain reached in “hypothetical market conditions.” See Starr,
Plaintiffs contend that the Court should distinguish Starr for three reasons. First, the Starr plaintiff had never sold its AIG shares; plaintiffs, by contrast, sold the Citigroup shares at issue here for $3.09. (Compl. ¶¶ 9, 172-73.) Second, the Starr plaintiff also did not realize a trading loss because AIG stock was still trading at a higher price than his acquisition price; here, Arthur Williams acquired these shares for roughly $32 more per share than the price at which plaintiffs sold them. (Id. ¶¶ 3, 173.) And third, the Starr plaintiff had not alleged precisely the time and terms of the sale it would have made absent the misstatements; plaintiffs, however, have alleged that in “May 2007” they would have sold “16.6 million shares” (Id. ¶¶ 48) at the “fraud-free price” of “$51.59” (Id. ¶ 171)—their estimate of what the price would have been on May 17, 2007 if defendants had not misled investors. Thus, plaintiffs have indeed pled facts different from those in Starr, but these distinctions do not yield a different outcome.
As to the first and second points, even assuming that Williams’s 1998 acquisition price is imputed to plaintiffs,
As to the third point, plaintiffs misunderstand the Starr court’s concerns about the speculation required to assess holder, claims; Starr relied on obstacles to proving the specifics of a claim in court, not obstacles to alleging the specifics in a complaint.
Indeed, even accepting the allegations that Starr deems impermissibly speculative, the Complaint itself belies plaintiffs’ assertion that no speculation is required here. Plaintiffs allege that “Williams decided to liquidate his entire 17.6 million share position” in mid-May 2007 and began with “the sale on May 17, 2007 of one million shares” for $55 per share. (Id. ¶ 170.) “Thereafter, he canceled the remainder of the planned sale in reliance on” the alleged misstatements. (Id. (emphasis added).) Plaintiffs do not allege how long “thereafter” Williams cancelled the remaining sales, nor when he had planned to execute the sales before the alleged misstatements caused him to “reverse course.” (Id.) Plaintiffs also claim as damages the difference between the price they estimate would have prevailed on May 17, 2007 and the price they received in March 2009. (Id. ¶ 171-72.) And yet, by plaintiffs’ own telling, they would have sold the 16.6 million shares at issue here at some point after May 17, 2007.
III. Conclusion
Having found that New York has a greater interest than Florida in regulating the conduct at issue here, the Court applies New York law. Concluding that the reasoning of the Appellate Division, First Department, in Starr Foundation v. American International Group, Inc.,
SO ORDERED.
Notes
. The alleged misstatements largely match those that the Court previously found were a valid basis for federal statutory securities fraud claims in two related class actions. See In re Citigroup Inc. Bond Litig.,
. In evaluating a motion to dismiss pursuant to Rule 12(b)(6), the Court accepts the truth of the facts alleged in the complaint and draws all reasonable inferences in the plaintiffs' favor. Wilson v. Merrill Lynch & Co., Inc.,
. If plaintiffs lack shareholder standing to assert the claims because they are derivative, then the Court is arguably without jurisdiction to hear the case. The U.S. Supreme Court views the shareholder standing rule— which "generally prohibits shareholders from initiating actions to enforce the rights of the corporation unless the corporation's management has refused to pursue the same action”—as relevant to "the prudential requirements of the standing doctrine.” Franchise Tax Bd. of Cal. v. Alcan Aluminium Ltd..,
. Defendants’ reliance on Stephenson v. PricewaterhouseCoopers, LLP, a summary order, is misplaced. See
. Defendants contend that Tooley presents the only circumstance that justifies that court’s rejection of the bright-line rule on which defendants rely. They argue that Tooley was unique because claims for the lost time-value of an asset do not allege depreciation of that asset. (Reply Mem. at 14 n. 32.) In other words, they contend that the Tooley plaintiffs' injury, and thus claim, was unique because their alleged loss did not take the form of a drop in stock price. But that distinction elevates form over substance. There, as here, the plaintiffs alleged damage tied to lost value of their shares resulting from defendants' breach of a duty owed to plaintiffs, not to the corporation. That the lost value took the form of the loss of the ability to use the value of the stock during a certain period of time rather than a price with a falling numeric value is a distinction without an economic difference for these purposes.
. New York's elements include the following: "(1) the defendant made a material false representation, (2) the defendant intended to defraud the plaintiff thereby, (3) the plaintiff reasonably relied upon the representation, and (4) the plaintiff suffered damage as a result of such reliance.'' Wall v. CSX Transp., Inc.,
. It is true that the New York Court of Appeals has recognized that common law fraud claims extend to plaintiffs who were fraudulently induced to refrain from acting. See, e.g., Hadden v. Consol. Edison Co.,
. The Court need not address defendants’ contention that plaintiffs have not pled any price at which they, as opposed to Arthur Williams, acquired the shares at issue. That contention, which relies on facts outside the complaint, takes two forms: First, the price Williams effectively paid to acquire Citigroup stock as part of the 1998 Citicorp-Travelers Group merger is immaterial because plaintiffs did not acquire Citigroup stock then. Second, in any event, Williams himself never actually paid $35 for his shares because the nature of the reverse-triangular merger between Citicorp and Travelers was such that Williams never exchanged his Travelers shares for Citigroup shares; Williams simply retained his share in Travelers, which was then renamed Citigroup. Whatever the force of these contentions, Starr compels the dismissal of plaintiffs’ claims. The possibility that the technicalities of the 1998 TravelersCiticorp merger might defeat a common law fraud claim regarding misstatements beginning in 2007 only confirms the Court’s view that the New York Court of Appeals would agree with the Starr court that these purported out-of-pocket damages are not cognizable pursuant to New York law.
. The Court recognizes that Stair extends the reasoning of Lama. In Lama, the "undeterminable and speculative” contractual bargain at issue was an alternative to one that the plaintiff actually accepted in alleged reliance on a fraud. Lama,
. Plaintiffs contend that they are not speculating about the price they would have received because they rely on an expert who used an event study to determine the effect of the misstatements on the market. But this response is inapposite because the proffered event study addresses at most only one of the several layers of speculation that the Starr court bemoaned. See