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Eurycleia Partners, LP v. Seward & Kissel

June 4, 2009


The opinion of the court was delivered by: Graffeo, J.

This opinion is uncorrected and subject to revision before publication in the New York Reports.

Following the collapse of a hedge fund, certain limited partners brought this action sounding in fraud and breach of fiduciary duty against the fund's attorneys based on the law firm's failure to disclose improper fund activities and its misrepresentations in the offering memoranda. For the reasons that follow, we affirm the Appellate Division order dismissing the complaint.

In February 2003, John Whittier launched Wood River Partners, LP, a hedge fund in the form of a limited partnership. Whittier was the sole principal and managing member of Wood River Associates, LLC, the hedge fund's general partner.*fn1 According to Wood River's offering memorandum, the fund sought "to achieve capital appreciation through the combination of long and short equity investments in a diversified number of industries, with a particular emphasis in media and communications, technology and technology-related companies." The offering memorandum also represented that American Express Tax and Business Services, Inc. (TBS) was Wood River's auditor and that, to ensure adequate investment diversification, individual holdings in the fund's portfolio would be capped at 10% of the total assets at any given time, based on the original cost of the stock. As Wood River's legal counsel, defendant Seward & Kissel, LLP (S&K) drafted the original offering memorandum as well as periodic updates.*fn2

Plaintiffs are 16 of Wood River's limited partners who invested in the fund between 2003 and 2005.*fn3 Unbeknownst to plaintiffs, in 2004 or early 2005, Wood River -- at Whittier's direction -- began to invest heavily in the stock of Endwave Corporation. By the summer of 2005, Wood River's investment in Endwave shares represented approximately 65% of the fund's total assets and over 35% of Endwave's outstanding shares. After peaking at $54 per share in mid-July, Endwave's share price gradually declined until it plummeted to $14 in late September. As a result, Whittier was unable to meet plaintiffs' redemption requests. S&K resigned as Wood River's counsel on September 30, 2005.

In October 2005, the Securities and Exchange Commission (SEC) brought an action in federal court against Whittier and the Wood River entities seeking to enjoin them from violating various securities laws and to impose civil penalties. At the SEC's request, the United States District Court for the Southern District of New York appointed a receiver for the Wood River entities and issued an injunction preventing any lawsuits against Wood River absent the court's permission.*fn4 A federal grand jury subsequently indicted Whittier for securities fraud and he pleaded guilty to three counts in May 2007. During his allocution, Whittier admitted that he intentionally concealed the extent of Wood River's position in Endwave.

Plaintiffs commenced this action against S&K, TBS and a third entity in March 2006, alleging causes of action against S&K for, among other things, fraud, aiding and abetting fraud, gross negligence and breach of fiduciary duty. They seek $200 million in damages.

The July 2007 amended complaint presents three main allegations against S&K. First, plaintiffs assert S&K learned at some point in 2005 that Wood River invested more than 10% of its assets in Endwave stock in violation of the 10% restriction contained in the offering memoranda. According to plaintiffs, S&K nonetheless persisted in drafting offering memoranda falsely representing that Wood River was adhering to the 10% cap as part of its investment policy. Second, plaintiffs claim that S&K falsely stated in the offering memoranda that TBS was Wood River's auditor even though S&K knew from the inception that TBS had not been retained to perform any auditing work. Third, plaintiffs allege S&K learned in January 2005 that Wood River had violated securities laws by failing to file required notices when Wood River obtained 5% and, later, 10% of Endwave's stock.*fn5

Plaintiffs maintain that S&K breached fiduciary duties owed to them, as limited partners, by failing to disclose the SEC violations to them.

S&K and TBS each moved to dismiss the complaint pursuant to CPLR 3211. Supreme Court denied the motions. The Appellate Division reversed, granted the motions and dismissed the complaint as against them (46 AD3d 400 [1st Dept 2007]).*fn6 We granted plaintiffs leave to appeal (11 NY3d 705 [2008]).

Plaintiffs principally argue that the Appellate Division erred in dismissing their fraud and aiding and abetting fraud claims against S&K. They contend that the complaint adequately pleads these claims because it alleges that S&K drafted offering memoranda falsely representing that a 10% investment cap was in place and that TBS was Wood River's auditor, despite knowing that these representations were false. S&K counters that, even under CPLR 3211's liberal pleading requirements, the fraud and aiding and abetting fraud claims fail because plaintiffs' allegations relating to S&K's knowledge of falsity are too conclusory and without a factual basis.

The elements of a cause of action for fraud require a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance by the plaintiff and damages (see Ross v Louise Wise Servs., Inc., 8 NY3d 478, 488 [2007]; Lama Holding Co. v Smith Barney, 88 NY2d 413, 421 [1996]). A claim rooted in fraud must be pleaded with the requisite particularity under CPLR 3016 (b).

We recently explored the pleading requirements of CPLR 3016 (b) in Pludeman v Northern Leasing Sys., Inc. (10 NY3d 486 [2008]). In that case, we noted that the purpose underlying the statute is to inform a defendant of the complained-of incidents. We cautioned that the statute "should not be so strictly interpreted as to prevent an otherwise valid cause of action in situations where it may be impossible to state in detail the circumstances constituting a fraud" (id. at 491 [internal quotation marks and citations omitted]). Although there is certainly no requirement of "unassailable proof" at the pleading stage, the complaint must "allege the basic facts to establish the elements of the cause of action" (id. at 492). We therefore held that CPLR 3016 (b) is satisfied when the facts suffice to permit a "reasonable inference" of the alleged misconduct. And, "in certain cases, less than plainly observable facts may be supplemented by the circumstances surrounding the alleged fraud" (id. at 493).

Here, whether the claim is labeled fraud or aiding and abetting fraud, we conclude that neither the allegations in the complaint nor the surrounding circumstances give rise to a reasonable inference that S&K participated in a scheme to defraud or knew about the falsity of the two contested statements in the offering memoranda. The amended complaint conclusorily alleges that at some unspecified point in 2005 S&K became aware that more than 10% of Wood River's holdings were invested with Endwave but, nonetheless, S&K continued to issue offering memoranda falsely representing that Wood River would not invest more than 10% of its assets in any given security.*fn7 In support of this allegation, plaintiffs assert that S&K was informed in January 2005 that Wood River had purchased 10% of Endwave's stock. But the fact that S&K may have been aware that Wood River owned 10% of Endwave's stock is not material to whether Wood River invested more than 10% of its total assets in Endwave, particularly where there is no indication that S&K was ever informed of Wood River's overall asset levels or the cost basis of the Endwave shares. Plaintiffs' reliance on a 2002 letter -- predating the existence of Wood River by nearly a year -- from a S&K attorney to Whittier discussing the performance of a separate fund is similarly unavailing.

Nor do the surrounding circumstances breathe life into plaintiffs' fraud claim premised on the 10% cap representation. Unlike the individual corporate officer defendants in Pludeman, each of whom managed a company implicated in a nationwide fraudulent scheme covering a span of years, S&K was outside counsel to Wood River, whose manager -- Whittier -- was convicted of securities fraud. Notably, plaintiffs do not dispute S&K's assertion that they secured Whittier's assistance in drafting the amended complaint. The absence of any firm factual pleadings relevant to S&K's knowledge that Wood River ...

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