"low risk" securities that could be modeled and utilized to create market-neutral portfolios. The Brokers allegedly knew that ACM's touted analytical models did not exist, and the Brokers' belief that the securities could not be modeled supports an inference that they knew that ACM misrepresented its analytical capacity.
The Brokers allegedly induced their sales forces to market unmodelable securities to ACM by multiplying several-fold the commissions paid on such transactions. Complaint P 64-66. These sales were financed by the Brokers themselves on terms that were allegedly created specifically for ACM and that caused ACM to become excessively leveraged and illiquid. As the Second Circuit has noted, "substantial assistance might include . . . executing transactions or investing proceeds, or perhaps . . . financing transactions." Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 48 (2d Cir. 1978) (quoting 2 A. Bromberg, Securities Law, § 8.5 at 515 (1974)). Participation in the financing of a fraudulent scheme, particularly where, as here, it is alleged that the financing was not routine, constitutes substantial assistance. See, e.g., Monsen v. Consolidated Dressed Beef Co., 579 F.2d 793, 800-04 (3d Cir. 1978) (bank's atypical financing transactions constituted substantial assistance); Bruce v. Martin, 1990 U.S. Dist. LEXIS 4198, 1990 WL 52180, at *5 (Sweet, J.) (upholding substantial assistance allegation that amounted to a "suggestion . . . that the Sureties were not operating from only the ordinary economic motivation of collecting the premium"); In re Gas Reclamation, Inc. Sec. Litig., 659 F. Supp. at 504 (participation in "atypical financing transactions" supports aider and abetter liability). Finally, the Brokers are alleged to have helped perpetuate ACM's fraud by providing to ACM false and inflated "performance marks" for ultimate dissemination to the Investors.
These Broker practices encouraged and facilitated the ongoing fraudulent scheme, and thus constitute substantial assistance. See Bruce v. Martin, 1990 U.S. Dist. LEXIS 4198, 1990 WL 52180 at *5.
The Brokers contend that their dealings with ACM amounted to nothing more than ordinary-course transactions, and thus their silence and inaction in failing to inform Plaintiffs of ACM's fraud is not actionable as aiding and abetting. See Woodward v. Metro Bank of Dallas, 522 F.2d 84, 95-96 (5th Cir. 1975). However, the Brokers were active participants in the symbiotic fraudulent scheme alleged by Plaintiffs. Unlike the typical relationship between brokers and customers, ACM and the Funds relied on the Brokers to create new CMOs, to finance CMO purchases and to maintain a general market for such securities. In turn, many Brokers relied on the Funds -- which were among their largest and most important CMO customers -- to purchase a large proportion of the Brokers' most "toxic," "deal-driving" CMO tranches. Given the esoteric nature of CMOs and the fact that the Brokers created and maintained a market for such instruments, the assistance they provided in directing millions of dollars worth of exotic securities to ACM can be regarded as unusual, rather than routine, in character and degree. The allegations that the Brokers engaged in these activities and did so to prop up ACM and their multi-billion dollar market in CMOs, see Complaint P 65 (Kidder representative stating that "we are in bed with [ACM]"), adequately supports the claim that the Brokers substantially assisted ACM's fraud.
Moreover, as recognized in National Union, 892 F.2d at 207 (2d Cir. 1989), even silence or inaction that is designed to aid a primary fraud, particularly where there is a heightened economic motivation to do so, IIT, 619 F.2d at 921, may constitute substantial assistance. Here, even if the Brokers had merely executed "ordinary course" trades and remained silent about ACM's misrepresentations, allegations of their extraordinary economic motivation to aid in the fraud would suffice at the pleading stage with respect to the substantial assistance element.
Finally, Defendants contend that Plaintiffs have not adequately alleged scienter. To adequately plead scienter in an aiding and abetting fraud claim, Plaintiffs must allege sufficient facts to support a "strong inference" of fraudulent intent. Beck, 820 F.2d at 50; Dreick Finanz Ag v. Sun, No. 89 Civ. 4347, 1990 WL 11537, at *12 (S.D.N.Y. Feb. 9, 1990). Plaintiffs may raise such an inference in one of two ways: (1) by alleging facts showing a motive for participating in a fraudulent scheme and a clear opportunity to do so; or (2) by identifying circumstances indicative of conscious behavior. Dreieck, 1990 WL 11537 at *12. Plaintiffs have alleged both "motive and opportunity" and circumstances indicative of conscious behavior.
Plaintiffs have alleged a powerful motivation for the Brokers' participation in the fraudulent scheme. The Brokers assert that ordinary economic motives are insufficient to support the scienter element of an aiding and abetting claim. See Shields, 25 F.3d at 1130. Here, however, the Brokers' "economic motives" were extraordinary. They allegedly earned extremely high fees, including special commissions, on the sale of "toxic" securities to ACM. They needed to make these sales to ACM, because ACM was one of the few buyers of these risky instruments, and their sale was essential to making a profit on any given CMO offering. The Brokers' needed ACM to continue purchasing these securities to perpetuate the Brokers' multi-billion-dollar market for CMOs. ACM would not have been able to continue purchasing these instruments if the investors had been told the truth about them, so the Brokers had a motive to assist in the perpetration of the fraud. Such allegations of motive are sufficient to infer not only knowledge of fraud, but an intent that the fraud continue.
Moreover, Plaintiffs allege circumstances indicative of conscious behavior. Plaintiffs allege that each Broker knowingly provided inflated marks to ACM, increasing original valuations after negotiation, to allow ACM to report false valuations and returns to its investors. Complaint PP 121-29.
This allegation of negotiation strongly suggests that the Brokers knew the marks were fictional. It also suggests that the Brokers knew that any purported "quantitative" model for analyzing the securities was fictional.
Accordingly, scienter has been properly pleaded.
VI. The Breach of Fiduciary Duty Claim and Aiding and Abetting Breach of Fiduciary Duty Claim Will Be Dismissed
The Bankruptcy Court has determined that plaintiffs in the Primavera action did not have standing to assert breach of fiduciary duty claims against ACM, because such claims belonged solely to the trustee. In re Granite Partners, L.P., 194 Bankr. 318, 327-28 (Bkrptcy S.D.N.Y. 1996). Moreover, this Court has held that the plaintiffs in the Primavera action did not have standing to assert their claims of aiding and abetting breach of fiduciary duty against the Broker defendants, because such claims are derivative, not direct, under the law of the Cayman Islands and Delaware, where the Funds were incorporated. 1996 U.S. Dist. LEXIS 12683, 1996 WL 494904 at *12-17. Since the analysis in those cases applies equally here, the breach of fiduciary duty and aiding and abetting breach of fiduciary duty claims will be dismissed.
Under the law of the Cayman Islands -- where both Granite Corp. and Quartz are incorporated -- claims based on breach of fiduciary duty, corporate mismanagement or third party action that result in the diminution of share value belong to the corporation and can only be brought by it or a shareholder suing derivatively. See Affidavit of Angus John Elliot Foster, dated May 30, 1996 PP 6-10 and P 11. The same is true under Delaware law (Granite Partners is a Delaware limited partnership): "When an injury to corporate stock falls equally upon all stockholders, then an individual stockholder may not recover for the injury to his stock alone, but must seek to recover derivatively in behalf of the corporation." Bokat v. Getty Oil Co., 262 A.2d 246, 249 (Del. 1970); In re Ionosphere Clubs, Inc., 17 F.3d 600, 604 (2d Cir. 1994) ("a shareholder asserting a direct action against a third party must allege 'special injury'") (citation omitted) (applying Delaware law); Moran v. Household Int'l, Inc., 490 A.2d 1059, 1070 (Del. Ch.) (a shareholder may sue individually only if it has alleged "an injury which is separate and distinct from that suffered by other shareholders" or a wrong involving a contractual right of a shareholder, such as the right to vote, or assert majority control, which exists independently of any right of the corporation) (citation omitted), aff'd, 500 A.2d 1346 (Del. 1985). Once the entity goes into bankruptcy, these claims become the property of the estate, and the trustee alone can assert them. In re Granite Partners, L.P., 194 Bankr. 318, 328 (Bkrptcy S.D.N.Y. 1996).
Because Plaintiffs allege no injury to themselves distinct from the injury to the Funds, they have no standing to assert the breach of fiduciary duty claim against ACM. As in Kagan v. Edison Brothers Stores, Inc., 907 F.2d 690 (7th Cir. 1990), "the nub of the problem is that the investors' injury flows not from what happened to them . . . but from what happened to [the debtor corporation] (it failed, making their stock worthless)." Id. at 692.
Plaintiffs contend that Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 119-20 (2d Cir. 1991), and Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1094 (2d Cir. 1995) compel a different result.
These cases, however, do not support Plaintiffs' novel contention that breach of fiduciary duty claims predicated on an injury that is general to corporate shareholders may be brought by individual investors.
Hirsch held that where management was complicit with third party accountants in defrauding a debtor corporation, the bankruptcy trustee was barred by the doctrine of in pari delicto from bringing a claim against the accountants on behalf of the corporation. 72 F.3d at 1094. While Hirsch did recognize that investors had standing to assert claims based on the distribution of fraudulent PPMs that induced their individual, personal investments, id., the Court did not hold that an investor has standing to assert claims of breach of fiduciary duty where the injury is to the corporation and affects investors equally according to their proportionate shares.
Wagoner similarly held that a bankruptcy trustee did not have standing to assert claims against a third party for defrauding a corporation with the cooperation of management, because such a claim accrues to the defrauded creditors, nor the guilty corporation. 944 F.2d at 120. Because Wagoner involved the standing of a creditor, rather than an equity investor, it did not address the question of standing to bring derivative claims at issue in this case. Here, Plaintiffs are not individually defrauded creditors, but equity investors whose injury is general to all investors, and thus must be vindicated, if at all, by the trustee.
Plaintiffs' also appear to read Hirsch and Wagoner to confer standing on an investor when the corporation is barred by the in pari delicto doctrine from asserting the claim itself. However, this Court rejected just such an argument in Primavera. 1996 U.S. Dist. LEXIS 12683, 1996 WL 494904 at *12. Standing is a constitutional requirement. Allen v. Wright, 468 U.S. 737, 751, 82 L. Ed. 2d 556, 104 S. Ct. 3315 (1984). The application of in pari delicto to bar the trustee can neither confer constitutional standing upon Plaintiffs nor transform the nature of its alleged injury from a derivative one into a direct and personal one. Primavera, 1996 U.S. Dist. LEXIS 12683, 1996 WL 494904 at *12.
Only when a plaintiff alleges a "special injury" or the breach of a duty owed uniquely to him (rather than a duty to shareholders generally) may he or she bring a direct action. Cowin v. Bresler, 239 U.S. App. D.C. 188, 741 F.2d 410, 415 (D.C. Cir. 1984); Manson v. Stacescu, 11 F.3d 1127, 1131 (2d Cir. 1993) (shareholders lack standing unless they are owed some "special duty"). Plaintiffs here do not allege that they suffered any unique injury apart from the loss of investment in the Funds, an injury shared by all investors. Any of the duties owed to Plaintiffs (and allegedly breached by Defendants) were owed to all investors generally as shareholders. The breach of such a general duty is insufficient to confer standing to bring a direct claim for breach of fiduciary duty against ACM or the Brokers.
VII. The Negligent Misrepresentation Claim Against ACM Will Be Dismissed
Under New York law, to state a claim for negligent misrepresentation, a plaintiff must allege:
(1) carelessness in imparting words (2) upon which others were expected to rely (3) upon which they did act or failed to act (4) to their damage; further, (5) the author must express the words directly, with knowledge they will be acted upon, to one whom the author is bound to by some relation [of] duty or care.
The Pits, Ltd. v. American Express Bank Int'l, 911 F. Supp. 710, 720 (S.D.N.Y. 1996).
"Under New York law, it is well established that '[a] defendant is not liable . . . for negligent misrepresentation unless a prior relationship existed between the defendant and plaintiff.'" Toto v. McMahan, Brafman, Morgan & Co., 1995 U.S. Dist. LEXIS 1399, No. 93 Civ. 5894, 1995 WL 46691 at *12 (S.D.N.Y. Feb. 7, 1995) (quoting Schwartz v. Michaels, [1992 Transfer Binder] Fed. Sec. L. Rep. (CCH) P I 96,920, at 93,852, 1992 WL 184527 (S.D.N.Y. July 22, 1992); see also Village on Canon v. Bankers Trust Co., 920 F. Supp. 520, 531 (S.D.N.Y. 1996) ("Under New York law, there is no action for negligent misrepresentation of a promise of future conduct unless there is a special relationship between the parties.").
As in Primavera, Plaintiffs here have failed to allege the existence of a special relationship between them and ACM; therefore, Plaintiffs have failed to state a claim for negligent misrepresentation. 1996 U.S. Dist. LEXIS 12683, 1996 WL 494904, at *18-19. A special relationship has been held to exist where, for example, there was an extended negotiation period between the parties before purchase, Polycast Technology Corp. v. Uniroyal, Inc., 1988 U.S. Dist. LEXIS 9648, No. 87 Civ. 3297, 1988 WL 96586, at *12 (S.D.N.Y. August 31, 1988), or where plaintiffs, who owned shares in partnerships that merged to form the defendant corporation, asserted claims against the defendant related to the merger. Maywalt v. Parker & Parsley Petroleum Co., 808 F. Supp. 1037, 1044-45, 1060 (S.D.N.Y. 1992) No similar prior relationship existed between ACM and the Plaintiffs, and as such, the claim of negligent misrepresentation with regard to pre-investment statements cannot stand.
VIII. The Unjust Enrichment Claims Will Be Dismissed
Under an unjust enrichment theory, Plaintiffs seek the return of fees and charges received by each defendant, as well as the Brokers' proceeds from sales. Complaint P 174.
To state a claim for unjust enrichment, a plaintiff must allege that the defendant was enriched at the plaintiff's expense and that the circumstances are such that equity and good conscience require that defendant make restitution. Violette v. Armonk Assocs., L.P., 872 F. Supp. 1279, 1282 (S.D.N.Y. 1995). Unjust enrichment is a quasi-contractual remedy, so that such a claim is ordinarily unavailable when a valid and enforceable written contract governing the same subject matter exists. See Clark-Fitzpatrick, Inc. v. Long Island R.R. Co., 70 N.Y.2d 382, 388, 516 N.E.2d 190, 193, 521 N.Y.S.2d 653 (1987). This is true whether the contract is one between parties to the lawsuit, or where one party to the lawsuit is not a party to the contract. Graystone Materials, Inc. v. Pyramid Champlain Co., 198 A.D.2d 740, 604 N.Y.S.2d 295, 296 (N.Y. App. Div. 3d Dept. 1993); Metropolitan Elec. Mfg. Co. v. Herbert Constr. Co., 183 A.D.2d 758, 583 N.Y.S.2d 497, 498 (N.Y. App. Div. 2d Dept. 1992) (plaintiff manufacturer's contract with subcontractor precluded manufacturer from equitably recovering from owner or contractor).
As with the breach of fiduciary duty claims, the unjust enrichment claims against ACM and the Brokers belong to the Funds, not the individual investors. The fees that Plaintiffs seek to have returned were paid pursuant to investment advisory contracts between ACM and the Funds and agreements between the Funds and the Dealers. Plaintiffs do not cite any authority holding that shareholders may bring unjust enrichment claims against third parties, such as ACM and the Brokers, that transacted business with the corporate entity where, as here, the claims are based on the transactions between the corporation and the third party. Because ACM and the Brokers had valid contracts with the Funds governing the transactions in question, Plaintiffs may not assert the claims that belong to the funds. See Villar v. Ricetta's, Inc., 1996 U.S. Dist. LEXIS 3061, Civ. No. 95-73- P-H, 1996 WL 118519 at *2 (D. Me. Feb. 21, 1996) (unjust enrichment claim against corporate directors is derivative and cannot be asserted by shareholders); see also Fahlenbach v. Trans Pacific Capital (USA) Inc., 1996 U.S. Dist. LEXIS 385, No. 95 Civ. 8776, 1996 WL 22602 at *2 (S.D.N.Y. Jan. 19, 1996) (unjust enrichment claim against investment fund's law firm asserted derivatively). Plaintiffs' own lack of a contract with the Defendants does not provide the basis for creating a quasi-contractual cause of action, when the Funds have a contractual cause of action to pursue.
Accordingly, the unjust enrichment claims will be dismissed.
For the reasons set forth above, ACM's motion is granted in part and denied in part. Specifically, ACM's motion to dismiss the claim for common law fraud is hereby denied. The claims against ACM for RICO violations, breach of fiduciary duty, negligent misrepresentation and unjust enrichment are hereby dismissed.
The Broker Defendants' motions are also granted in part and denied in part. Specifically, the Broker Defendants' motions to dismiss the aiding and abetting fraud claim are hereby denied. The claims against the Brokers for RICO violations, aiding and abetting breach of fiduciary duty and unjust enrichment are hereby dismissed.
It is so ordered.
New York, N. Y.
January 22, 1997
ROBERT W. SWEET