412 F.Supp.3d 392
S.D.N.Y.2019 USEC SDNY
UNITED STATES DISTRICT COURT | DOCUMENT SOUTHERN DISTRICT OF NEW YORK i MLEOPR 6 MICAL LY }
LORELEY FINANCING (JERSEY) NO, 3 : i Peay vos Sorte LIMITED; LORELEY FINANCING Shap: WIDT19 |
(JERSEY) NO. 5 LIMITED; LORELEY ren co inmates ff
FINANCING (JERSEY) NO. 15 LIMITED; : LORELEY FINANCING (JERSEY) NO. 28 — :
LIMITED; and LORELEY FINANCING :
(JERSEY) NO. 30 LIMITED, : 12 Civ. 3723 (PAC)
Plaintiffs, :
: OPINION & ORDER
-against- :
WELLS FARGO SECURITIES, LLC; :
WELLS FARGO BANK, N.A.; HARDING :
ADVISORY LLC; and STRUCTURED :
ASSET INVESTORS, LLC, :
Defendants. :
wenn ene cence ee eee ne eee nner
HONORABLE PAUL A. CROTTY, United States District Judge:
More than a decade ago, Plaintiffs invested in three collateral debt obligations
(“CDOs”)—Octans II (“Octans”), Sagittarius, and Longshore-—-which were comprised primarily
of residential mortgage-backed securities. As we all know now, those investments turned upside
down in 2007 and 2008. The CDOs defaulted and Plaintiffs lost their entire investment.
Plaintiffs allege that Defendants, who created the three CDOs, failed to disclose conflicts of
interest and that the CDOs were set up to fail. Specifically, Plaintiffs allege that an important
hedge fund client of Defendants’, Magnetar, exerted improper influence over and selected
inferior collateral for Octans and Sagittarius to advance Magnetar’s strategy to bet against or
“short” the CDOs. Plaintiffs also allege that Defendants dumped toxic assets from their own
warehouse into Longshore in an effort to offload their risk onto unknowing investors who
believed they were investing in a vehicle intended to produce returns to long investors.
Plaintiffs filed suit in New York State Supreme Court on November 1, 2011, alleging
fraud, rescission, conspiracy, aiding and abetting, fraudulent conveyance and unjust enrichment.
(Dkt. 1 Ff 3, 13.) Defendants removed the action to federal court on May 10, 2012 pursuant to
the Edge Act, 12 U.S.C. § 632, Ud. § 1.) This Court dismissed Plaintiffs’ claims in their entirety
in 2013. Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Secs., LLC, No. 12 Civ. 3723, 2013 WL
1294668 (S.D.N.Y. Mar. 28, 2013) (“Loreley PF’). Plaintiffs appealed the determination, (Dkt.
71), and the Second Circuit reversed in part and vacated in part, 797 F.3d 160 (2d Cir. 2015)
(“Loreley IP’), remanding the action back to this Court on August 17, 2015, (Dkt. 74).
Plaintiffs filed their First Amended Complaint (“FAC”) on September 11, 2015, (Dkt.
84), and Defendants moved to dismiss on December 2, 2015, (Dkt. 106). Wells Fargo and
Harding filed a third party complaint against IKB Deutsche Industriebank AG on February 16,
2016. (Dkt, 123.) The CDO Defendants—Octans IT CDO Ltd., Octans I CDO LLC, Sagittarius
CDO I Ltd., Sagittarius CDO I LLC, Longshore CDO Funding 2007-3, Litd., and Longshore
CDO Funding 2007-3, LLC—were voluntarily dismissed without prejudice on May 12, 2016.
(Dkt. 140.) On September 26, 2016, the Court granted in part and denied in part Defendants’
motion to dismiss. (Dkt. 180.) The third party complaint was voluntarily dismissed with
prejudice on October 23, 2018. (Dkt. 365.)' The remaining Defendants then moved for
summary judgment and to exclude Plaintiffs’ experts on December 14, 2018. Oral argument was
held on May 29, 2019.
The Court DENIES Defendants’ motion to exclude Plaintiffs’ experts, with one limited
exception, and GRANTS Defendants’ motion for summary judgment.
This case was reassigned from the Hon. Richard J. Sullivan to the Hon. Paul A. Crotty on October 24, 2018.
FACTUAL BACKGROUND
I The Parties
Plaintiffs” are five special purpose entities organized under the laws of the Bailiwick of
Jersey and formed to invest in CDOs. (FAC □□□ 9-13, 28; Tambe Ex. 38 { 2.)
IKB Deutsche Industriebank AG and IKB Credit Asset Management GmbH (collectively
“IKB”) created Plaintiffs and served as their investment advisor. (FAC { 32.) IKB is a German
banking company that was Plaintiffs’ investment advisor for Octans, Sagittarius, and Longshore,
which were part of a larger investment program called the “Rhineland Program.” (Tambe Ex. 39
q 10, Ex. 138 at LOR-WF-IKB 00060800, Ex. 167 at 16.)
Defendants are banks and collateral managers. The banks are (1) Wells Fargo Securities,
LLC (successor by merger to Wachovia Capital Markets, LLC (“WCM”)) and (2) Wells Fargo
Bank, N.A. (successor by merger to Wachovia Bank, N.A.) (collectively, “Wachovia”). (FAC {If
20-21; Tambe Ex. 36 fff 20-21.) The collateral managers are Harding Advisory LLC
(“Harding”) and Structured Asset Investors LLC (“SAI”). (FAC 22-23; Tambe Ex. 36 {fj 22-
23.) SAL is a Delaware limited liability company that was a wholly-owned subsidiary of WCM.
(Tambe Ex. 36 | 23.) Harding, now a Florida limited liability company, was established by
Wing Chau as an investment advisory firm. (Tambe Ex. | at LORWFS0006989, Ex. 21 at
33:21-23; Ex. 20 at 21:10-13; Ex. 37 22.)
Set forth below are the roles played, positions taken, and relevant actions of the parties.
(See infra at 3-17).
i. IKB’s Investment Recommendations
2 Loreley Financing (Jersey) No. 3 Ltd., Loreley Financing (Jersey) No. 5 Ltd., Loreley Financing (Jersey) No.
15 Ltd., Loreley Financing (Jersey) No. 28 Ltd., and Loreley Financing (Jersey) No. 30 Ltd.
IKB assessed potential investments for the Rhineland Program to ensure they met
eligibility criteria (e.g. assets were required to be rated at least BBB-/Baa3), before evaluating
the deal’s structure, asset manager, and portfolio and writing up an analysis of the deal for
Plaintiffs. (Tambe Ex. 25 at 66:10-67:4, Ex. 112 at LOR-WFS0003511.) Plaintiffs did not
review offering memoranda before or after approving an investment decision, (id. Ex. 23 at
78:20-79:8), and did not independently confirm whether or not investments conformed to IKB’s
investment criteria, but rather relied on recommendations received from IKB, (id. 79:23-80:11.)
IKB was “an independent contractor and not a general agent of” Plaintiffs. (id. Ex. 109
at LOR-WFS0003425.) IKB did “not have authority to act for or represent” Plaintiffs. (/d. Ex.
112 at LOR-WFS0003490.)
Octans
A. Assets
Octans was a $1.575 billion collateralized debt obligation backed primarily by a portfolio
of residential mortgage-backed securities (“RMBS”), which closed on October 12, 2006. (See
id. Ex. 1.) Harding was the collateral manager for Octans. (/d. Ex. 2 at WF_LOR_000898907,
Ex. 3 at WF_LOR_000895544.) SAI was the warehouse manager, and was responsible for
approving assets selected by Harding. (/d. Ex. 14 at 126:7-17.)
Harding’s Wing Chau, the collateral manager for Octans, testified that “all the securities
that went into Octans Il warehouse or CDO [were] fully vetted by my analysts and myself, and
met all the investment criteria.” (/d. Ex. 21 at 238:16-20.)
B. Magnetar’s Involvement with Octans
Octans was initiated by Magnetar, and Magnetar imposed conditions on the deal. (See
Korpus Ex. 96.) In Octans’ early stages, Magnetar’s James Prusko sent an email to Harding’s
Wing Chau and Wachovia’s Brian Farrell, stating:
Here’s what will work for us. As Wing knows, we have our deal and it is what it is. As far
as the structure, there can be no diversions of cash flow from the equity during the first five
years whatsoever. The loss test is not acceptable... .
Also, the CDO exposure will be primarily from mezz ABS deals and Magnetar will buy the
protection from the deal.
(id.) At Magnetar’s request, Octans did not contain an interest coverage test (“IC Test”) and
delayed application of the overcollateralization test (“OC Test”). (id. Ex. 147 at
WF_LOR_000870587, Ex. 148.)
Magnetar expressed a preference to Harding, who passed on to Wachovia, that some of
the Octans collateral portfolio be chosen from bonds listed on particular ABX indices? (id. Ex.
98.) Ultimately, 25 percent of the Octans portfolio was comprised of names drawn from the
ABX indices. (/d. Ex. 36 (“JN Rep.”) 92.) A Wachovia employee discussing collateral for
Octans commented that “we had to pick the lesser of evils when we were looking at the index”
and “we knew we had to pick the less worse.” (Tambe Ex. 117.)
After Octans closed and Plaintiffs had purchased their notes, four other Constellation
CDOs-—Auriga, Carina, Pyxis, and Vela—were added to the Octans portfolio. (id. Ex. 144, Ex.
118 at HALLC00038831-38; Korpus Ex. 66, Ex. 68, Ex. 86 at WF_LOR_000406439, Ex. 166 at
WF_LOR_000841246, Ex. 97.)
Magnetar took short positions against Octans CDO notes; its short position was more
than double its long position. (See id. Ex. 176.) In a 2006 email from Magnetar’s Prusko to
Wachovia’s Farrell and Harding’s Chau and Tony Huang, Prusko said “we should also discuss
CDO exposure as I will source the CDO CDS.” (Tambe Ex. 144.)
C. Defendants’ Representations
3 The ABX indices each referenced a small subset of the universe of available RMBS, (Korpus Decl. Ex. 36
qq] 31, 92.)
Wachovia provided IKB with term sheets and a marketing book for Octans. (Korpus
Exs. 1-2.) The term sheet and marketing book stated that Harding’s investment objectives
included “[i]nvestling] in high quality assets with stable returns and superior capital preservation
profiles” and “[m|aximiz{ing] returns and minimiz[ing] losses through rigorous upfront credit
and structural analysis, as well as ongoing monitoring of asset quality and performance.” (Id.
Ex. | at LOR-WF-IKB 00002117, Ex. 2 at LOR-WF-IKB 00023431.)
Wachovia provided IKB with drafts of and a final offering circular for Octans. (Id. Exs.
3, 118, 201; Tambe Ex. 73 at LOR-WF-IKB 00000223.) The offering circular identified
Harding as the collateral manager, and stated:
The performance of the portfolio of Collateral Debt Securities depends heavily on the skills
of the Collateral Manager in analyzing and selecting the Collateral Debt Securities. Asa
result, the Issuer will be highly dependent on the financial and managerial experience of the
Collateral Manager. .. .
(d.) The offering circular provided that an investment in Octans is “intended for sale only to
sophisticated investors who are capable of understanding and assuming the risks involved,”
(Tambe Ex, 1 at LOR WFS0006843), the purchaser is making an independent judgment and “is
not relying on the advice or recommendations of any of the Initial Purchaser, the Issuer, the Co-
Issuer, the Collateral Manager or any of their respective affiliates (or any representative of any of
the foregoing),” (id. at LOR-WFS0007017), and the purchaser may not rely on any prospector
investor presentations, (id. at LOR-WFS000688 1.)
None of the term sheet, marketing book or offering circular mentioned Magnetar or its
role in Octans. The offering circular did not disclose that the Octans portfolio would consist
largely of ABX index assets, or that Octans’ collateral would include notes from four other
Magnetar transactions.
D. IKB’s Recommendation
IKB drafted a risk analysis of Octans, (id. Ex. 45), which it did not provide to Plaintiffs,
(id. Ex. 23 at 96:20-97:8.) The risk analysis stated that “OC test and IC tests do not exist,” but
“(Jn return the rating agencies demanded a thicker equity tranche and therefore a higher
subordination for the rated notes.” Ud. Ex, 45 at LOR-WF-IKB 00234613.)
In an investment proposal, IKB recommended an investment in Octans based on four
factors, one of which was “[t]he quality of the manager.” (Cd. Ex. 41 at LOR-WFS0000024.)
IKB’s Investment Advisory Board approved the proposal. (Ud. at LOR-WFS0000025.)
On or about October 13, 2006, Plaintiff LFJ 3 bought $94 million in Octans notes: $41
million in Class A-2 notes, $30 million in Class B notes, and $23 million in Class C-1 notes.
(id.; Hollywood Decl. { 15.) Octans suffered an event of default on May 8, 2008, and
subsequently the notes became worthless. (Korpus Ex. 208.)
IV. Sagittarius
A. Assets
Sagittarius was a $1.030 billion collateralized debt obligation backed primarily by a
portfolio of RMBS, which closed on March 15, 2007. (Tambe Ex. 4 at LOR-WFS0002224, 54-
60.) SAI was the collateral manager for Sagittarius and was responsible for asset selection and
management. (Jd. at LOR-WFS0002362, Ex. 6 at WF_LOR_000480072.)
SAI’s James Burke, the collateral manager for Sagittarius, testified that SAI vetted every
asset that went into the Sagittarius portfolio. (Tambe Ex. 14 at 390:17-391:14.) He also stated
that SAI only selected assets that they “were comfortable with” for Sagittarius. (id. at 391:4-18.)
B. Defendants’ Representations
Wachovia provided IKB a term sheet and marketing book for Sagittarius. (Korpus Ex.
5.) The term sheet indicated that Sagittarius would be managed by SAI and stated: “A key
market advantage for SAI is its ability to leverage off of the resources and infrastructure of Wachovia, while maintaining strict separation from the trading and sales side of the
broker/dealer,” (Id. Ex. 5 at LOR-WF-IKB 00023199.) It also described that “SAI’s investment
approach is to maximize returns and minimize losses through rigorous upfront credit and
structural analysis as well as ongoing monitoring of asset quality and performance.” (/d.) The
marketing book contained similar representations. (/d. at LOR-WF-IKB 00023135.)
Wachovia also provided drafts of and a final offering circular for Sagittarius to IKB,
which identified SAI as the collateral manager, responsible for selecting Sagittarius’ collateral
portfolio, and stated that “[t]he performance of the Collateral will be highly dependent on the
financial and managerial expertise of the Collateral Manager.” (Korpus Exs. 90, 120, 175, Ex. 6
at LOR-WF-IKB 00513380, Ex. 120 at WF_LOR_000222231.)
The offering circular provided that an investment in Sagittarius is “intended for sale only
to sophisticated investors who are capable of understanding and assuming the risks involved,”
(Tambe Ex. 4 at LOR-WFS6002241), and the purchaser is making an independent judgment and
“is not relying on the advice or recommendations of any of the Initial Purchaser, the Issuer, the
Co-Issuer, the Collateral Manager or any of their respective affiliates.” Gd. at LOR-
WEFS0002384-2385).
None of the term sheet, marketing book or offering circular mentioned Magnetar or its
role in Sagittarius.
C. Magnetar’s Involvement with Sagittarius
Sagittarius was initiated by Magnetar, and Magnetar imposed conditions on the deal.
(Korpus Ex. 114 at WF_LOR_000205808, Ex. 77 at WF_LOR_000917411.) At Magnetar’s
request, Sagittarius did not contain an IC test and delayed application of the OC Test. (id. Ex.
133 at WF_LOR_000673884, Ex. 127 at WF_LOR_000870587, Ex. 5, Ex. 120.) Wachovia
traders were aware that Sagittarius involved the “creation” of debt tranches “for Magnetar to short” and of “Magnetar’s desire to hedge their equity position by taking a short position.” (Jd.
Ex. 77 at WF_LOR_000917411.)
Magnetar encouraged SAI to source credit risk for Sagittarius from the ABX index.
(Tambe Ex, 120 at WF_LOR_000801086, Ex. 122; Korpus Ex. 76.) The ABX indices made up
almost a quarter of the entire Sagittarius portfolio. (JN Rep. at 57.)
In a February 2007 email, Wachovia’s Michael Thompson told SAT’s James Burke: “We
never explicitly disclosed Magnetar is purchasing the equity in Sag[ittarius].” (Korpus Ex. 131.)
D. IKB’s Recommendation
In an investment proposal, IKB recommended that Plaintiffs invest in Sagittarius, stating:
From a credit perspective, SAI can be characterized as an above average Manager according
to the criteria crucial to us. They do have a conservative view on the RMBS products as they
feel uncomfortable with affordability products and above average risk characteristics in the
pools they do consider for investments. A fact which clearly could be observed in the
portfolio selection. ... They are also aware of the structural risks incorporated in RMBS
structures. Their CDO Management component seems to be prudent and they should be
aware of the main things to focus on dependent of the different CDO type (HG vs. Mezz).
However, as this transactions lacks most of the classic CDO features which were considered
as being challenging within a CDO beside the collateral performance, this is not such an
important fact for this transaction. .. .
(Tambe Ex. 42 at LOR-WFS0002662-2663.) IKB’s investment committee approved the
proposal. (/d. at LORWFS0002658.)
On or about March 15, 2007, LFJ 15 bought $5 million of Sagittarius Class A notes, and
LFJ 28 bought $5 million of Sagittarius Class B notes. (Hollywood Decl. 17.) Sagittarius
suffered an event of default on November 6, 2007, and subsequently the notes became worthless.
(Korpus Ex. 208.)
Longshore
A. Assets
Longshore was a $1.30 billion collateralized debt obligation backed primarily by a
portfolio of RMBS, which closed on or about April 26, 2007. (Tambe Ex. 7 at LOR-
WFS0006085-86.) SAI was the collateral manager for Longshore, and was responsible for
selecting and managing the assets for Longshore. (fd. at LOR-WFS0006253, Ex. 8.)
B. Defendants’ Representations
Wachovia provided IKB with a term sheet for Longshore, which stated that SAI would be
the collateral manager for the transaction, (Korpus Ex. 7 at LOR-WF-IKB 00142658), and a
marketing book stating:
SATis a wholly-owned subsidiary of Wachovia Corporation whose investment approach is to
_ maximize returns and minimize losses through rigorous upfront credit and structural analysis
as well as ongoing monitoring of asset quality and performance.
(id. Ex. 8 at LOR-WF-IKB 00023211.) The marketing book also touted SAI’s access to
Wachovia’s “vast resources and infrastructure” while “maintaining strict separation from the
broker/dealer.” (id. at LOR-WF-IKB 00023218.)
Wachovia provided IKB drafts of and a final offering circular for Longshore, stating:
Because the composition of the Collateral Assets will vary over time, the performance of the
Offered Securities will depend heavily on the skills of the Collateral Manager in analyzing,
selecting and managing the Collateral Assets. As a result, the Issuer, which has no
employees, will be highly dependent on the financial and managerial experience of certain
individuals associated with the Collateral Manager.
(Korpus Ex. 9 at LOR-WFS0006134, Ex. 122 at WF_LOR_000624346, Ex. 231 at LORWF-
IKB00020198.)
The offering circular also said that collateral would be selected by SAI and would be
acquired “on an arm’s length basis” and “at fair market prices.” (Korpus Ex. 122 at
WF_LOR_000624377, Ex. 9 at LOR-WFS0006167, Ex. 231 at LOR-WF-IKB00020231.)
10
None of the term sheet, marketing book or offering circular mentioned that Wachovia had
instructed SAI to transfer assets into Longshore from the warehouses of other CDOs, and that
such assets were transferred at non-market prices.
C. Wachovia’s Strategy for Longshore
On February 2007, Wachovia stated: “Due to the market volatility in ABS and feared
contagion and/or disappearance of liquidity in CDO market, let’s do everything we can to push
out all our inventories and pending new issues.” (Korpus Ex. 48.) One “deal of focus” in this
effort was Longshore. (Id.)
In March 2007, Wachovia’s Michael Thompson sent an email out to his colleagues with
the subject line “Risk Management Discipline,” stating “[w]e are very clearly in risk mgmt/loss
mitigation/profit preservation mode,” and instructed Wachovia’s Dash Robinson, to “sell
[Longshore] debt and equity. Get the roadshow going — come up with a target list, specific
marketing plan. Then do the same for GA3.” (Id. Ex. 82.) “GA3” was a reference to Grand
Avenue III (“Grand Avenue”), another CDO which Wachovia was in the process of ramping.
(Korpus Ex, 29 at 81:6-25.) The collateral manager of Grand Avenue was TCW, a manager that
was on IKB’s “no go” list because of a negative previous experience. (Bauknecht Decl. { 19;
Korpus Ex. 11 at 60:13-61:13.)
Thompson stated during his deposition that Wachovia:
[Was trying to minimize our risk, which we were thinking of, frankly as mark-to-market
volatility by selling collateral, selling warehouses. ... So we had an idea of taking the TCW
warehouse, which was — I don’t remember, but 30, 40 percent ramped, and the Longshore
warehouse, which was the same or maybe even a little more ramped. And rather than have
two half-baked things, you have something that’s pretty close to fully baked and ready to go.
(Korpus Ex. 32 at 342:12-343:2.)
In February 2007, when James Burke of SAI heard that Wachovia would be transferring
assets from Grand Avenue’s warehouse to Longshore’s, he sent an email stating:
11
Iam VERY sensitive to where SAI might take down bonds from the TCW warehouse, Ido
not want anymone [sic] in market to think we were stuffed with bonds at above-market
prices. So -- if TCW is still doing a deal, SAI should only take whatever bonds it wants at
MARKET prices.
(Tambe Ex. 145.) Subsequently, Burke wrote to Dash Robinson of Wachovia that “The marks
you provided for the bonds to be transferred over to [Longshore] (from TCW) are not
defensible.” (Korpus Ex. 153.) Burke also emailed his superior, Darrell Baber, and wrote:
The difference between the banking team’s suggested transfer prices and where the bonds are
actually marked by the traders in the system is negative $5mm. The difference between the
banking team’s suggested transfer prices and where . . . the bonds the individual SAI p.m.’s
[portfolio managers] feel ‘comfortable’ with the bonds is negative $7.8mm.
(Tambe Ex. 152.)
On March 13, 2007, Wachovia’s chief compliance officer, David Hunt, sent Burke,
Baber, and others an email summarizing SAI’s “fiduciary responsibility [which] extends to each
of its clients” to obtain the “best execution” possible. (Korpus Ex. 52.) Burke responded to the
group, airing his concern that “[i]nvestors commit to buy [Longshore] and subsequently learn
that SAI took down $300m of collateral from another warehouse from Wachovia post-pricing []
at above market prices.” (/d.) To alleviate that concern, Burke suggested that SAI “send the full
list of assets (including the $300mm from the TCW warehouse) out to prospective investors
(along with transfer prices) before they give a verbal commitment on [Longshore] and before the
deal prices.” (d.)
Also on March 13, 2007, James Burke of SAI emailed his wife: “I’m having a very bad
day. I’m being asked/told to do something that I believe is improper/unethical.” (Id. Ex. 191.)
Ultimately, SAI transferred certain assets from Grand Avenue to Longshore. (/d, Ex. 42,
Ex. 27 at 274:3-275:14, Ex. 12 at 327:19-328:2, 328:17-22, 332:21-333:9, 334:4-335:1.) SAI’s
James Burke testified that SAI only accepted into the Longshore portfolio the Grand Avenue
assets that he and his team were comfortable with from a credit perspective, (Tambe Ex. 14 at
12
336:21-338:7, 343:22-344:8, 357:22-358:9.), though he “had made it very clear that these were
not assets that I had purchased into my warehouse, and if I were going to take those assets into
my warehouse today, I would want them to happen at the current market price.” (Korpus Ex. 12
at 334:4-23.)
The Grand Avenue assets were transferred to Longshore at the prices at which they were
originally acquired by TCW for Grand Avenue, not the lower current market prices. (Korpus
Decl. Exs. 52, 136, 152-55, Ex. 12 at 362:18-363:2, 365:11-19, Ex. 27 at 275:12-23, 283:13-21,)
IKB was advised of a slight decline in the value of the Longshore assets since they were
acquired; specifically, that “the current weighted average price of the Longshore 3 portfolio is
just under 99.” (Tambe Ex. 55 at WF_LOR_000744280.) When IKB requested current “marks”
of the portfolio, Wachovia sent a spreadsheet in which the current market prices of the
transferred assets had been deleted. (id. Ex. 144, 147-49, 153.)
D. JKB’s Recommendation
In an investment proposal, IKB recommended that Plaintiffs invest in Longshore, in part
because of IKB’s “positive judgment of the collateral manager” and the transaction’s “strict
eligibility criteria.” (Tambe Ex. 52 at LORWFS0028818.) The proposal contained an evaluation
of SAI based on in-person meetings with “James Burke and key staff of his team,” and noted that
the “close relationship to Wachovia gives SAI a somehow unique position in the market of ABS
Managers.” (/d. at LOR-WFS0028815.) The proposal characterized SAI as “an above average
Manager according to the criteria crucial to us,” noting that SAI had “a conservative view on the
RMBS products” and a “critical opinion towards current market developments, which could
affect their management possibilities.” (/d.) In addition, it noted that Burke “seemed to be well
aware of all the factors possibly influencing RMBS performance” and that SAI “recognize
potential dangers, which they cannot gauge explicitly [but] they try to stay away from them.”
13
(id.) The proposal also included quantitative analysis of the portfolio that had been ramped to
date, (id. at LOR-WFS0028817-18), but did not contain any disclosure regarding the slight
decline in the value of the Longshore assets, as that information had not yet been sent from
Wachovia to IKB, (id. Ex. 25 at 239:17-21). TIKB’s Investment Committee approved the
investment proposal. (Ud. Ex. 52 at LOR-WFS0028809.)
On April 26, 2007, LFJ 30 purchased $13.5 million in Longshore Class A-2 notes, LFJ 5
purchased $37.6 million in Longshore Class B notes, and LFJ 3 purchased $8 million in
Longshore Class C notes. (Tambe Ex. 100; Hollywood Decl. § 20.) Longshore suffered an
event of default on February 8, 2008, and subsequently the notes became worthless. (Korpus Ex.
208 at 5.)
VI = Magnetar’s Strategy
In 2006 and 2007, the hedge fund Magnetar purchased the equity in a number of CDOs,
including Octans and Sagittarius, and implemented a hedging strategy on those same
investments. (Korpus Ex. 25 at 29:7-30:20.) According to Magnetar’s James Prusko,
Magnetar’s goal on a portfolio-wide basis was to be $2 short mezzanine for every $1 long equity.
(id. at 128:11-22) Wachovia’s Michael Thompson testified that Magnetar’s willingness to
purchase the equity of CDOs gave it leverage or negotiating ability with banks. (fd. Ex. 32 at
85:18-86:6.)
Magnetar pushed for structural terms in the CDOs it sponsored, including the suspension
or elimination of certain tests (i.e. the OC Test and the IC Test) to ensure cash would continue to
flow to its equity positions if returns slowed. (Korpus Ex. 25 at 40:25-42:2, 155:11-20.) As
Prusko explained, “in order to buy the equity, we were very clear that the CDO had to have
certain structural features and certain economic terms that would make it attractive.” (Ud. at
155:9-20.)
14
Magnetar invested a substantial amount in its overall CDO strategy (of which Octans and
Sagittarius were just a part). The collapse of the U.S. housing market in 2007-2008 triggered
massive losses in the type of collateral backing the CDOs. (See Tambe Ex. 166 at 148.) Octans,
Sagittarius, and Longshore defaulted in the wake of the financial crisis. (FAC ¶¶ 119, 163, 191.)
Magnetar achieved a return commensurate with its investment from its strategy when the
financial markets collapsed. (Korpus Ex. 25 at 197:9-198:6.)
A. Magnetar’s Relationship with Wachovia
Wachovia personnel considered Magnetar a “huge account” and believed that Magnetar
was “single-handedly driving the market” for CDOs in 2007. (Id. Ex. 130, Ex. 32 at 119:19- 120:20, 218:5-14, 465:11-22, Ex. 27 at 146:16-147:9.)
Some Wachovia employees were aware that Magnetar had executed short trades in the
collateral portfolios of CDOs that Wachovia arranged, (id. Ex. 97 at WF_LOR_000408253;
Tambe Ex. 144), and facilitated for Magnetar at least two credit default swap trades (shorts) on
Octans and two on Sagittarius, (Korpus Ex. 109 at WF_LOR_000413229, Ex. 110 at
MAG_WACH 0024887, Exs. 162-65, 167, 185, 190, Ex. 77 at WF_LOR_000917410-11,
Korpus Ex. 85 at WF_LOR_000455815).
B. Magnetar’s Relationship with Harding
Harding had a good working relationship with Magnetar prior to the Octans and
Sagittarius CDOs. According to Wachovia’s Brian Farrell, Harding’s Wing Chau had “5 of the
Octans deals planed [sic] with Magnetar and they are obviously very comfortable and impressed
with his skills.” (Korpus Ex. 86 at WF_LOR_000406439.)
Chau testified that he “knew that [Magnetar] would hedge. Hedge funds hedge. And
part of their hedging strategy would include this, as well as other hedging instruments that were
correlated for the underlying asset.” (Id. Ex. 13 at 158:17-22.) Harding was aware that
Magnetar’s hedging strategy included buying protection on senior tranches of the same CDOs
that Magnetar was buying equity from, (éd. at 158:12-159:3), and that it involved buying
protection on constellation CDOs generally, (id. 265:6-25). Still, Chau testified that Magnetar’s
strategy was intended to be market neutral. (See id. 151:9-13.)
C. SAI’s Relationship with Magnetar
Before Sagittarius closed, its collateral manager James Burke of SAI thought Magnetar
was “just a long-only equity investor” and “had no reason to suspect anything else.” (/d. Ex. 40
at 140:5-141:16, Ex. 12 at 180:8-12.) Burke testified that he was “shocked” when he learned,
after Sagittarius closed, that Magnetar was taking short positions in CDOs in which it was
sponsoring the equity, as Burke had “[nJever heard of anyone doing that.” Ud. Ex. 12 at 180:8-
12, 183:16-25, 194:19-195:22, 271:12-21, 195:17-22, Ex. 40 at 140:5-141:16.)
At one point, Burke informed Magnetar’s Prusko that Wachovia would not “accept
assignment of . . . trades” from Magnetar and communicated this refusal to others at Wachovia.
(Tambe Ex, 121.) On the same day, Burke complained to Wachovia’s Michael Thompson and
Dash Robinson that: “Pruske is under the impression that he can source credit risk (from names
in the ABX) for this deal at whatever levels he wants. I specifically did not want this to occur.”
(Id, Ex. 122; Korpus Ex. 188.) Prusko of Magnetar expressed to Farrell of Wachovia
“discomfort in dealing with Jim Burke and SAI.” (Korpus Ex. 86.)
A few days later, Prusko wrote to Thompson, Burke, and others, saying “[t]hanks for the
lunch, feel like we are now ready for action.” (Tambe Ex. 120 at WF_LOR_000801086.)
Prusko then stated that he wanted to buy protection from Sagittarius on the two original bonds
that Burke had initially rejected, and indicated two additional bonds that he wanted to execute
“cross” on with Sagittarius. Ud.) Burke responded to Prusko, copying Thompson, “For the
avoidance doubt, all 4 CDS are approved,” and asked Prusko to provide “full trade details and
16
counterparty info.” Ud.) Subsequently, Burke instructed SAI employees to “treat Jim Prusko
like royalty. He is an extremely important client.” (Xorpus Ex. 73 at WF_LOR_000526285.)
DISCUSSION
I. Motions to Exclude Proffered Expert Opinions‘
A. Legal Standard
On a motion for summary judgment, it is appropriate for the Court to decide questions
regarding the admissibility of expert opinion evidence. Raskin v. Wyatt Co., 125 F.3d 55 , 66 (2d
Cir.1997). The admissibility of expert testimony is governed by Rule 702 of the Federal Rules
of Evidence. Under Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 , 596 (1993),
trial courts must act as gatekeepers to ensure that proposed expert testimony conforms to the
requirements of Rule 702. “The objective .. . is to ensure the reliability and relevancy of expert
testimony.” Kumho Tire Co. v. Carmichael, 526 U.S. 137 , 152 (1999). Plaintiff has the burden
to prove by a preponderance of the evidence that their expert’s testimony is admissible. See
United States v. Williams, 506 F.3d 151 , 160 (2d Cir. 2007).
Asa preliminary matter, the Court first examines whether the proposed witness qualifies
as an expert. See Fed. R. Evid. 702 (requiring a witness to be “qualified as an expert by
knowledge, skill, experience, training or education”); Baker v. Urban Outfitters, Inc., 254 F.
Supp. 2d 346, 352 (S.D.N.Y. 2003). Plaintiffs must also demonstrate that the expert’s testimony
is “based on sufficient facts or data,” and “the product of reliable principles and methods,” and
that the expert has “reliably applied the principles and methods to the facts of the case.” Fed, R.
4 Dr. Jonathan Neuberger’s May 29, 2018 expert report will be cited as “JN Rep.”, his February 14, 2019
declaration will be cited as “FN Decl.”, and the transcript of his September 25, 2018 deposition will be cited as
“TN Tr.” Mark Adelson’s May 29, 2018 expert report will be cited as “MA Rep.” and his February 14, 2019
declaration will be cited as “MA Deci.”
17
Evid. 702. Finally, the expert’s opinions must be relevant to the issues in the case and assist the
trier of fact. See Fed. R. Evid. 702(a); Raskin, 125 F.3d at 55 n.5.
B. Dr. Jonathan Neuberger
The Court determines that Dr. Jonathan Neuberger qualifies as an expert financial
economist. Dr. Neuberger has over thirty years’ experience evaluating market structure,
corporate conduct and financial performance. (JN Rep. {ff 1, 6-11.) He holds a Ph.D. in
economics, has taught courses in economics and finance, and spent six years as an economist at
the Federal Reserve Bank of San Francisco. (/d. 7-8.) Dr. Neuberger has also held various
private sector positions as an economist, and has been qualified multiple times as an expert
economist in legal matters involving financial products and markets, including mortgage backed
securities and CDOs. Ud. J 11; JN Decl. 5-8.) Indeed, Dr. Neuberger was qualified as an expert
witness for the SEC in a case in this district, and testified regarding the selection of RMBS assets
for a CDO created by Citibank. SEC v. Stoker, 11 CV 07388 (JSR). Dr. Neuberger is not being
offered as an industry expert on CDOs, but his knowledge and experience allow him to testify on
the general background of RMBS and CDO markets.
Dr. Neuberger devotes much of his report to general factual discussion of the Magnetar
trade, (JN Rep. {{] 45-57), and the collateral selection process for Octans, Sagittarius, and
Longshore, (id. Jf 58-69). The report, however, does not purport to present the factual
allegations the Court must take into consideration in deciding the summary judgment motion.
Instead, it properly sets forth the facts on which his opinions are based. The Court will consider
Dr, Neuberger’s factual statements as background for his expert analysis, but will rely on the
evidence referenced in the parties’ Rule 56.1 statements for the relevant facts.
The Court will also consider Dr. Neuberger’s testimony regarding the materiality of the
collateral selection process to investors of the CDOs as background only, as determinations
18
about the materiality of the alleged fraud are for the factfinder, not the Plaintiffs’ expert. See
SEC v. Tourre, 950 F. Supp. 2d 666 , 678 (S.D.N.Y. 2013); Highland Capital Mgmt., L.P. v.
Schneider, 379 F. Supp. 2d 461 , 471 (S.D.N.Y. 2005) (expert testimony on legal conclusions
including materiality inadmissible); United States v. Tomasetta, No. 10-CR-1205(PAC), 2012
WL 1080293, at *4 (S.D.N.Y. Mar. 30, 2012) (“[T]estimony regarding whether the analysts
thought that the disclosures would have been material to an investor... invades the province of
the jury.”). Plaintiffs conceded at oral argument that Dr. Neuberger’s testimony is not necessary
for proving materiality. (Dkt. 434 at 61:8-24.)
Defendants seek to strike Dr. Neuberger’s testimony about what the ratings agencies
would have done had certain information been disclosed, which is used to support Dr.
Neuberger’s calculation of out-of-pocket losses, because he lacks a background in ratings. But
Plaintiffs are not relying on Dr. Neuberger’s opinion for expert analysis on ratings—they have a
ratings expert, Mr. Adelson, for that.
Defendants are free to challenge the accuracy of Dr. Neuberger’s assumptions underlying
his opinion on loss causation, but his testimony does not contain bare conclusions, relies on
legitimate sources, and is admissible. Cf Malletier v. Dooney & Bourke, Inc., 525 F. Supp. 2d
558, 642 (S.D.N.Y. 2007) (expert’s bare conclusions on probability excluded where he did not
explain statistical significance); see Vuitton Malletier S.A. v. Sunny Merch. Corp., 97 F, Supp. 3d
485, 505 (S.D.N.Y. 2015) (allowing expert testimony that relied on articles and deposition
testimony without performing any analysis of her own, where those sources were “clearly within
the universe of those on which [she] could permissibly rely”). Critiques of the data supporting
Dr. Neuberger’s assumptions go to weight, not admissibility. See In re: N. Sea Brent Crude Oil
Futures Litig., No. 1:13-MD-02475(ALC), 2016 WL 1271063 , at *7 (S.D.N.Y. Mar. 29, 2016)
19
(“To the extent that [the expert’s] conclusions are broader than supported by the data . . . that
goes to weight rather than admissibility.”).
Accordingly, the Court DENIES Defendants’ motion to strike Dr. Neuberger’s testimony,
with one limited exception. Because rebuttal expert reports were not contemplated by the
scheduling order, the motion to strike Dr. Neuberger’s supplemental declaration is GRANTED.
C. Mr. Mark Adelson
Mr. Adelson is a qualified expert on ratings agencies. He has dozens of years of
experience in structured finance and specifically with ratings agencies and their methodologies
rating CDOs. (MA Rep. {ff 13-22; MA Decl. fff 4-5, 18-26.) Mr. Adelson spent ten years as a
senior analyst and managing director at Moody’s, where he was involved with ratings of asset-
backed security CDOs, (MA Rep. § 17; MA Decl. § 20), and was brought in as Chief Credit
Officer of S&P following the financial crisis to overhaul their CDO rating criteria, (MA Rep.
19; MA Decl. § 22). He has written and presented extensively on CDOs, and was involved with
the investigation of the causes of the financial crisis by the Financial Crisis Inquiry Commission,
a commission created by the United States Congress. (See MA Decl. { 24-26, MA Rep. [ 22.)
Mr. Adelson’s expert report is wholly admissible. It is limited to an assessment of what
the ratings agencies would have done had there been full disclosure of relevant conflicts, based
on a review of the ratings agencies’ published criteria and Mr. Adelson’s expertise in the field.
Accordingly, Adelson’s expert report will be considered by the Court.
5 On July 24, 2018, the Court allowed Plaintiffs to submit a brief supplemental! expert report to address a late
document production that occurred after the initial expert report had been served. (See Dkt. 337.) Dr.
Neuberger recognized that pursuant to that order, he was not permitted to serve as a rebuttal expert, but still
attempted to rebut the claims of Defendants’ expert report. (See JN Decl. 8.) Plaintiffs’ deadline to serve all
expert reports, other than the supplement that was permitted by the Court, was May 29, 2018. See Advanced
Analytics, Inc. v, Citigroup Glob. Markets, Inc., 301 F.R.D. 31 ,42 (S.D.N.Y.), ebjections overruled, 301 F.R.D.
47 (S.D.N.Y. 2014) (recognizing that declarations containing merits-related expert testimony filed after
disclosures were due pursuant to a court’s scheduling order and/or Rule 26(a)(2) would lead to unjust results).
20
I. Summary Judgment Standard
Summary judgment shall be granted where “the movant shows that there is no genuine
dispute as to any material fact and that the movant is entitled to judgment as a matter of law.”
Fed. R. Civ. P, 56(a). A fact is material if it “might affect the outcome of the suit under
governing law.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242 , 248 (1986).
The moving party bears the initial burden of producing evidence on each material
element of its claim or defense demonstrating that it is entitled to relief. See Celotex Corp. v.
Catrett, 477 U.S. 317 , 323 (1986). The Court resolves all ambiguities and draws all factual
inferences in favor of the nonmovant, but “only if there is a ‘genuine’ dispute as to those facts.”
Scott v. Harris, 550 U.S. 372 , 380 (2007) (citing Fed. R. Civ. P. 56(c)).
IE. Fraud Claim
In New York, the five elements of fraud are: “(1) a material misrepresentation or
omission of fact (2) made by defendant with knowledge of its falsity (3) an intent to defraud,
(4) reasonable reliance on the part of the plaintiff; and (5) resulting damage to the plaintiff”
Crigger v. Fahnestock & Co., 443 F.3d 230 , 234 (2d Cir. 2006). “At the summary judgment
stage, a party must proffer enough proof to allow a reasonable jury to find by clear and
convincing evidence the existence of each of the elements necessary to make out a claim for
fraud in the inducement.” Waran v. Christie’s Inc., 315 F. Supp. 3d 713 , 718 (S.D.N.Y. 2018).
The elements of material misrepresentations or omissions and reliance are dispositive of
the present motion for summary judgment.
A. Material Misrepresentations or Omissions
Octans and Sagittarius
Plaintiffs allege that Defendants made material representations and omissions in their
marketing and offering materials for Octans and Sagittarius by representing that the assets for
21
these CDOs would be selected by their respective collateral managers, Harding and SAI, to
“maximize returns and minimize losses” for noteholders. In particular, Plaintiffs point to the
term sheet, marketing book, and offering circular for Octans and its representations that Harding,
a skilled collateral manager, would invest in high quality assets, maximize returns, and monitor
asset quality and performance. (See Korpus Ex. 1 at LOR-WF-IKB00002117, Ex. 2 at LOR-
WE-IKB 00023431, Ex. 3, Ex. 118, Ex. 201.) Plaintiffs also note that the term sheet, marketing
book, and offering circular for Sagittarius emphasized the expertise of collateral manager SAI,
(Korpus Ex. 6 at LOR-WF-IKB 00513380, Ex. 120 at WF_LOR_000222231), SAI’s close
relationship with Wachovia “while maintaining strict separation from the trading and sales side
of the broker/dealer,” and SAI’s approach to maximize returns and monitor asset quality and
performance, (id. Ex. 5 at LOR-WF-IKB 00023199, 23135). According to Plaintiffs, it was not
disclosed anywhere that another actor with materially different investment objectives (Magnetar)
had substantial influence over the collateral selection process for Octans and Sagittarius.
Plaintiffs have not shown by clear and convincing evidence that these statements were
misrepresentations. The Second Circuit previously found that Plaintiffs’ pleadings were
adequate to state a claim for fraud, see Loreley IH, 797 F.3d at 178 , but a review of the full record
at the summary judgment phase shows that Plaintiffs’ allegations are unsupported. On the
contrary, representatives of Harding and SAI testified that they vetted all securities that went into
Octans and Sagittarius, ensured that they met investment criteria, and monitored their
performance. While the head of SAI, James Burke, testified that he objected to including certain
bonds proposed by Magnetar in Sagittarius initially “on principle,” because he thought that
Magnetar was “asking to do something [he] didn’t think [Magnetar] had any ability to do,” he
also admitted that a selection of the bonds were accepted when his team reviewed them and
decided they were “okay with the credit risk.” (Tambe Ex. 14 at 282:9-283:17.) Furthermore,
22
Harding’s Wing Chau testified that all of Octans’ collateral met the CDO’s eligibility criteria.
Ud. Ex. 21 at 253:24-254:4.)
In other words, the collateral managers for Harding and SAI acted independently and did
what Wachovia represented they would. That SAI sometimes pushed back when Magnetar
requested that Sagittarius include certain collateral is further evidence that SAI conducted
rigorous analysis of collateral and maintained proper separation and independence in managing
Sagittarius. Harding and Magnetar may have had a close relationship, but there is no evidence
that Harding improperly caved into any demands by Magnetar. Rather, the evidence shows that
Harding approved of collateral based on its compliance with Octans’ investment criteria.
In addition, the structure of the Octans and Sagittarius CDOs was disclosed to IKB, and
the fact that Magnetar sought certain structural modifications to these CDOs—such as the
absence of triggers——was not a material omission. In fact, IKB factored in the absence of
triggers into its modeling of Octans. In the risk analysis of Octans (which IKB did not share
with Plaintiffs), IKB stated that “OC test and IC tests do not exist,” but “[i]n return the rating
agencies demanded a thicker equity tranche and therefore a higher subordination for the rated
notes.” (Tambe Ex. 45 at LOR-WF-IKB 00234613.)
Moreover, Defendants did not have a duty to disclose Magnetar’s role in Octans and
Sagittarius to Plaintiffs. See First Hill Partners, LLC v. BlueCrest Capital Mgmt, Ltd., 52 F.
Supp. 3d 625, 637 (S.D.N.Y. 2014) (to succeed under a material omission theory, a plaintiff must
allege that “the defendant had a duty to disclose material information”). The parties were not in
a fiduciary relationship, Plaintiffs were not acting on the basis of mistaken knowledge, and
Defendants did not make any statements to Plaintiffs, let alone partial or ambiguous statements
requiring “complete disclosure.” See id.; see also Dodona I v. Goldman Sachs & Co,, 132 F.
Supp. 3d 505, 517 (S.D.N.Y. 2015) (granting summary judgment because there was no duty to
. 23
disclose when defendants did not structure the CDO to fail or knew some “inside information”
regarding the quality of the collateral).
In its claims relating to Octans and Sagittarius, Plaintiffs seek to pin blame for the
financial crisis on Magnetar because of its CDO strategy. (See JN Rep. J 154.) But Plaintiffs
have not sued Magnetar, and are not bringing a class action or seeking a remedy to alleviate the
vast losses suffered during the financial crisis. Plaintiffs sued Wachovia, a bank that engaged
minimally with Magnetar in the grand scheme of Magnetar’s overall strategy. The two CDOs
Wachovia created are the focus here. With respect to those two CDOs, the Court finds that there
is simply not evidence that Wachovia misrepresented the CDOs at issue or omitted a material
fact to Plaintiffs, since the structural features of the CDOs were disclosed to IKB and the
collateral managers fulfilled their duties in selecting collateral that satisfied the CDOs’
investment criteria.
Longshore
Plaintiffs claim that the marketing materials for Longshore contained false
representations, such as: (1) Longshore’s collateral would be selected by SAI to “maximize
returns and minimize losses” for noteholders; (2) SAI would “maintain[] strict separation from
the broker/dealer” side of its corporate parent, Wachovia; and (3) SAI would acquire assets “on
an arm’s length basis” and “at fair market prices.” (Korpus Ex. 8 at LOR-WF-IKB 00023211,
218, Ex, 9 at LOR-WFS0006167, Ex. 122 at WF_LOR_000624377, Ex. 231 at LOR-WF-
IKB00020231.) Plaintiffs assert that no version of the term sheet, marketing book, or offering
circular mentioned that approximately one-third of Longshore’s portfolio was comprised of
assets transferred from the warehouses of other Wachovia-held CDOs, where the collateral had
been selected by other collateral managers, and that the transfers took place at non-market prices.
24
SAI’s unwillingness to transfer the assets from Grand Avenue to Longshore wholesale
indicates that SAI persisted in maintaining independence and only approved the assets it felt
comfortable with from a risk perspective. Even though Burke expressed to his wife that he felt
he was “being asked/told to do something that [he] believe[d] is improper/unethical,” (Korpus
Ex. 191), Burke made clear in his deposition that he only accepted assets into Longshore that his
“team was comfortable taking in from a credit perspective,” (id. Ex. 12 at 334:4-23.)
The fact that the assets were not transferred from Longshore at current market prices,
however, contradicts the marketing materials that IKB reviewed for Longshore. IKB was
advised of a slight decline in the value of the Longshore assets since they were acquired. But
that does not excuse Wachovia’s transmission to IKB of a spreadsheet for the current “marks” of
the portfolio that deleted the current market prices of the transferred assets. (id. Ex. 144, 147-49,
153.) This act suggests that there could be a triable issue of fact regarding whether Wachovia
made material misrepresentations or omissions with respect to Longshore. Still, for the reasons
stated below, see infra Sect. ILB., Plaintiffs could not have reasonably relied on these statements.
B. Reliance
“Justifiable reliance is a ‘fundamental precept’ of a fraud cause of action.” Ambac
Assurance Corp. v. Countrywide Home Loans, Inc., 31 N.Y.3d 569 , 579 (2018). In evaluating
justifiable reliance, courts consider “the entire context of the transaction, including factors such
as its complexity and magnitude, the sophistication of the parties, and the content of any
agreements between them,” Century Pacific, Inc. v. Hilton Hotels Corp., 354 F. App’x 496 , 498
(2d Cir, 2009), as well as “the investor’s access to information and whether that investor engaged
in due diligence before investing,” Abbey v. 3F Therapeutics, Inc., No. 06 CV 409, 2011 WL
651416, at *7 (S.D.N.Y. Feb. 22, 2011).
25
New York courts have historically disagreed on whether a defendant is liable for an
injury suffered by a plaintiff who relied on misrepresentations provided by a third party
associated with the defendant. Some courts have held that a plaintiff cannot make a common
law fraud claim against a defendant under New York law based on allegations of third-party
reliance, see, e.g., Shaw v. Rolex Watch, U.S.A., Inc., 673 F. Supp. 674 , 682 (S.D.N.Y. 1987);
Escoett & Co. v. Alexander & Alexander, Inc., 296 N.Y.S.2d 929 , 929 (1st Dep’t 1969), and
others have recognized that “[wJhile the plaintiff alleging fraud must normally show that it
reasonably relied upon a misrepresentation made by the defendant to its detriment, the doctrine
of third-party reliance permits the plaintiff to show that a third-party relied upon a
misrepresentation by the defendant, which resulted in injury to the plaintiff,” Prestige Builder &
Mamt. LLC vy. Safeco Ins. Co. of Am., 896 F, Supp. 2d 198, 203 (E.D.N.Y. 2012); see also
Ruffing v. Union Carbide Corp., 764 N.Y.S8.2d 462, 465 (2d Dep’t 2003).
The Second Circuit recognized this discrepancy in the law, and certified a question to the
New York Court of Appeals to resolve it. See Pasternack v. Lab. Corp. of Am. Holdings, 807
F.3d 14 (2d Cir.), as amended (Nov. 23, 2015), certified question accepted, 26 N.Y.3d 1074 , 44
N.E.3d 226 (2015), and certified question answered, 27 N.Y .3d 817, 59 N.E.3d 485 (2016). The
Court of Appeals “decline[d] to extend the reliance element of fraud to include a claim based on
the reliance of a third party, rather than the plaintiff,” where the third party did not act asa
conduit to relay the false statement to the plaintiff. 27 N.Y.3d at 828-29 .
Octans and Sagittarius
It is undisputed that Defendants never made any representations to Plaintiffs. Plaintiffs
did not view documents from or communicate with Defendants, Rather, Plaintiffs depended
only on the advice of IKB, their investment advisor, and the investment proposals sent to them
by IKB. Plaintiffs cannot sustain a claim of actual reliance against Defendants, who did not
26
communicate with Plaintiffs directly. Sec. Inv’r Prot. Corp. v. BDO Seidman, L.L.P.,95 N.Y.2d
702, 710 (2001) (Plaintiffs “cannot claim reliance on alleged misrepresentations of which it was
unaware even by implication.”).
IKB’s investment proposals did not communicate any misrepresentations to Plaintiffs.
See Sec. Inv’r Prot. Corp., 95 N.Y.2d at 709 (even where investment adviser invests on behalf of
institutional plaintiffs, “Plaintiff{s] cannot sustain a cause of action for fraud if [Defendants’]
misrepresentation did not form the basis of reliance”). The only representations Plaintiffs allege
were repeated in IKB’s investment proposals for Octans and Sagittarius were those regarding the
strength and independence of the collateral managers and collateral selection. As was discussed
supra, those statements were true,
Furthermore, for Plaintiffs to have reasonably relied on statements communicated
through a third party, Defendants must have intended for the misrepresentations to be
communicated by the third party, IKB, to Plaintiffs. In re LIBOR-Based Fin. Instruments
Antitrust Litig., 11 MDL 2262 (NRB, 2015 U.S. Dist. LEXIS 147561 , at *261 (S.D.N.Y. Oct.
19, 2015) (“[A] [defendant] is liable for fraud when it falsely represents its economic condition
to a [third party] in the expectation that [the plaintiffs] will rely on the [third party’s] opinion.”).
Of course Defendants knew IK B was acting as Plaintiffs’ investment advisor; but there is no
evidence that Defendants intended their representations to be passed along to Plaintiffs. Indeed,
the disclaimers of reliance contained in the draft and final marketing materials, term sheets, and
offering circulars for Octans and Sagittarius suggest that Defendants did not intend for Plaintiffs
to rely on their representations.°
These disclaimers are likely “so general that we cannot be confident they bear on [Defendants’ alleged]
misrepresentations,” Loreley Hf, 797 F.3d at 186 n. 19, but they still speak to Defendants’ expectation that an
investor with whom they never communicated could rely on them.
27
In the context of securities fraud, “courts may look to a non-party investment adviser’s
knowledge in determining reliance, where that investment adviser invests on behalf of
institutional plaintiffs.” Villella v. Chem. & Mining Co. of Chile Inc., No. 15 CIV. 2106 (ER),
2018 WL 2958361 , at *4 (S.D.N.Y. June 13, 2018). Even under that standard, reliance would be
unjustified here since IKB was “an independent contractor and not a general agent of”
Plaintiffs,” and did “not have authority to act for or represent” Plaintiffs. (Tambe Ex. 109 at
LOR-WFS0003425, Ex. 112 at LOR-WFS0003490.)
Whether Plaintiff could have conducted due diligence to discover Defendants’ alleged
misrepresentations and omissions is ixrelevant. Plaintiff cannot claim actual or justifiable
reliance on Defendants’ representations, because they were not communicated to Plaintiff, were
not intended to be communicated to Plaintiff, and were true.
Longshore
SAI maintained independence and only approved assets for Longshore that it felt
comfortable with from a risk perspective. The representations regarding the quality and
independence of the collateral manager that were communicated in IKB’s investment proposal to
Plaintiffs were accurate.
Defendants’ representations that the Longshore assets would be acquired at fair market
value were not ultimately transmitted to Plaintiffs in IKB’s written investment proposals. Thus,
these statements did not form the basis for Plaintiff's reliance. See See. Inv’r Prot. Corp., 95
N.Y.2d at 709. Plaintiffs were “unaware even by implication” of these alleged
misrepresentations, and cannot claim reliance on them. Id. at 710; see also Pasternack, 27
N.Y.3d at 829, Moreover, even under the securities fraud standard, reliance would be unjustified
since IKB was an independent contractor and had no authority to act for or represent Plaintiffs.
C. Scienter and Intent to Defraud
28
Under New York law, Plaintiffs must prove that Defendants had knowledge of their
statements’ falsity and intended to induce reliance. Loreley H, 797 F.3d at 176 . “As scienter is
generally a question of fact, ‘[t]he Second Circuit has been lenient in allowing scienter issues to
withstand summary judgement based on fairly tenuous inferences.”” Waran, 315 F.Supp.3d at
719, Courts may grant summary judgment for lack of scienter where a plaintiff has failed to
“present facts that are capable of supporting an inference of bad faith or an inference that
defendants acted in intent to deceive.” In re Columbia Securities Litigation, 155 F.R.D. 466
(S.D.N.Y. 1994).
Since Plaintiffs have not shown that there were any misrepresentations with respect to
Octans and Sagittarius, they cannot establish scienter. See Loreley I, 797 F.3d at 177
(recognizing that where plaintiffs did not allege a misrepresentation, scienter would be
inadequately pleaded).
The evidence suggesting that Wachovia deleted a spreadsheet column showing the
current market prices of the assets transferred from Grand Avenue to Longshore could create an
inference of scienter, but since Plaintiffs could not have relied on these statements, Plaintiffs
cannot establish that Defendants intended to defraud them. See id.
D. Damages
In order to prevail on a fraud claim under New York law, a plaintiff must establish loss
causation. See id. at 187 n.20. To prove loss causation, a plaintiff “must show that the economic
harm that is suffered occurred as a result of the alleged misrepresentations.” Shanahan v. Vallat,
No, 03 Civ. 3496 (PAC), 2008 WL 4525452 , at *4 (S.D.N.Y. Oct. 3, 2008). Plaintiffs cannot
establish loss causation, since they cannot prove any misrepresentations caused their losses. See
Basis PAC-Rim Opportunity Fund (Master) v. TCW Asset Management Co., 48 N.Y.S.3d 654 ,
656 (2017).
29
Ill. Rescission
Plaintiffs’ rescission claim fails, since they cannot prove the elements of common law
fraud. See Druck Corp. v. Macro Fund Ltd., 290 F. App’x 441 , 445 (2d Cir. 2008) (dismissing
rescission claim for failure to plead loss causation).
IV. Aiding and Abetting
Plaintiffs cannot sustain claims for aiding and abetting, since they have failed to establish
fraud. See Dodona I, 132 F. Supp. 3d at 517 (granting summary judgment on aiding and abetting
fraud claim for failure to show sufficient evidence of underlying fraud).
CONCLUSION
For the reasons stated, the Court DENIES Defendants’ motion to exclude Plaintiffs’
experts, with one limited exception, and GRANTS Defendants’ motion for summary judgment.
The Clerk of Court is directed to enter judgment in Defendants’ favor, close Dkts. 394 and 397,
and close this case.
Dated: sm vor New York SO ORDERED
eptember _, 2019 fo, .
PAULA.CROTTY
United States District Judge
30