Opinion
No. 603755/08.
2010-01-28
ASSURED GUARANTY (UK) LTD., in its own right and in the right of Orkney Re II PLC, Plaintiff, v. J.P. MORGAN INVESTMENT MANAGEMENT, INC., Defendant.
William A. Maher, Esq., Wollmuth Maher & Deutsch LLP, New York, for Plaintiff. Richard A. Rosen, Esq., Paul Weiss Rifkind Wharton & Garrison, LLP, New York, for Defendant.
William A. Maher, Esq., Wollmuth Maher & Deutsch LLP, New York, for Plaintiff. Richard A. Rosen, Esq., Paul Weiss Rifkind Wharton & Garrison, LLP, New York, for Defendant.
BARBARA R. KAPNICK, J.
Plaintiff Assured Guaranty (UK) Ltd. (“Assured Guaranty”), which is the financial guarantor of certain notes issued by Orkney Re II plc (“Orkney”), brings this action in its own right and in the right of Orkney against defendant J.P. Morgan Investment Management Inc. (“JPMIM”), the investment manager of approximately $553 million in assets for Orkney which have substantially decreased in value, for breach of fiduciary duty (first cause of action), gross negligence (second cause of action), and breach of contract (third cause of action).
The First Amended Complaint dated May 13, 2009 (the “Complaint”) alleges that Orkney is a special purpose reinsurance company created by Scottish Re (U.S.) Inc. (“Scottish Re”) to obtain capital through the issuance of bonds and preference shares having an aggregate initial value of approximately $553 million. Of such securities, the most senior Series A Notes (comprised of Series A–1 and Series A–2) were to have an initial value of $425 million.
The capital was raised to fund, among other things, statutorily required “excess reserves” or “Triple–X reserves” ensuring Orkney's ability to meet projected potential payments under certain term life insurance policies reinsured by Scottish Re.
The Complaint alleges that as of the Fall of 2005, Scottish Re, which is a U.S. based life reinsurance company, had reinsured a substantial volume of term life insurance policies having policy issue dates in 2004 with an aggregate insured amount of approximately $36.7 billion.
Because the policies had guaranteed level premiums, Scottish Re was subject to National Association of Insurance Commissioners (NAIC) Model Regulation XXX, which requires life reinsurers to maintain “excess reserves,” or “Triple–X reserves,” above and beyond the capital reserves (“economic reserves”).
Scottish Re, desiring to move the liabilities for its reinsured pool of 2004 life insurance policies off of its balance sheet and to transfer the related “excess reserve” funding requirements, formed Orkney, an Irish domiciled company with which Scottish Re entered into a 100% quota share reinsurance agreement, and ceded substantially all of its 2004 term life reinsurance liabilities to it.
In or about August 2005, representatives of Scottish Re approached Assured Guaranty regarding its providing a financial guarantee of the principal and interest payments on the Series A–1 Notes which had an initial value of $382.5 million. Plaintiff alleges that without such a financial guarantee to back the Notes, prospective investors would have perceived a greater risk in purchasing bonds from Orkney, a newly-created issuer with no operating history.
In December 2005, Orkney entered into an Investment Management Agreement (the “IMA”), and annexed Investment Guidelines, with JPMIM. At the same time, Assured Guaranty, which had participated in the negotiation of the terms of the IMA and Investment Guidelines, agreed to provide the financial guarantee on the Notes. The IMA provides that Assured Guaranty was an intended third-party beneficiary of the IMA.
Section 19 of the IMA provides in relevant part that, “the parties hereto acknowledge and agree that [Assured Guaranty] shall be entitled to enforce [Orkney]'s rights and remedies under this Agreement, as an express third-party beneficiary, against [JPMIM] (or its assignee) to the same extent as if [Assured Guaranty] were a party hereto ...”
Pursuant to the IMA, the proceeds from Orkney's issuance of the bonds and preference shares
were used to initially fund four separate accounts maintained at and managed by JPMIM, namely: the Economic Reserve and Excess Reserve ( i.e., “Triple–X reserve”) sub-accounts;
As well as an initial reinsurance premium that Orkney was to receive from Scottish Re.
the Surplus Account, to be used to make quarterly interest and ultimate principal payments to Noteholders, as well as to pay Orkney's operating expenses; and the Additional Funding Account, to be used to meet future increases of Orkney's “Triple–X reserve” requirements. (All four accounts are collectively referred to herein as the “Accounts.”)
These two sub-accounts contained assets in an amount equal to Orkney's statutory reserve requirements, and were held by a reinsurance trust formed by Scottish Re, Orkney and the Bank of New York as Trustee.
Plaintiff alleges in the Complaint that all parties to the transaction were fully aware that the interest income from the Accounts was expected to cover interest payments to Noteholders, as well as to fund a portion of the growth in economic reserves. The principal amount of the assets in the Excess Reserve sub-account was to be used to cover principal repayments on the senior Class A Notes. Any diminution in value of the assets increased the probability that the Accounts would not contain sufficient funds to make timely interest and principal payments on all classes of Notes.
The Complaint also alleges that pursuant to section 4(a) of the IMA, JPMIM assumed the “Discretionary Authority” to “review the assets held in the [Accounts]” and exercise its “complete discretion and authority ... to make such sales, exchanges, investments or reinvestments or to take any action that it deems necessary or desirable in connection with [such assets].”
Plaintiff further alleges that JPMIM was bound by the Investment Guidelines which provided that the goal of the investment policy for the assets held in the Excess Reserve sub-account and the Additional Funding Account was to obtain reasonable income while providing a “high level of safety of capital.” The Investment Guidelines also required diversification of the investments made in each Account and provided tables which specify percentage limitations on the amounts JPMIM could invest into certain asset-backed securities classified by sector and rating.
Further, plaintiff alleges that JPMIM was obligated to comply with certain provisions of Chapter 13 of the Delaware Insurance Code (“Delaware Code” or “18 Del. C.”), incorporated by reference in section 4(d) of the IMA, providing for a cap on the amount of mortgage-related securities that JPMIM could place in the Economic Reserve and Excess Reserve sub-accounts.
Specifically, Plaintiff alleges that JPMIM was bound by section 1305(4) of the Delaware Code, which provides that, “an insurer shall not at anytime have more than 50% of its assets invested in obligations under [18 Del. C.] § 1323.” Section 1323(a) states that an insurer may invest in “bonds, notes or other evidences of indebtedness secured by first or second mortgages or deeds of trust ...”
The Complaint alleges that instead of providing a “high level of safety of capital” for Orkney's investments, JPMIM breached its fiduciary duties as discretionary investment manager to Orkney and plaintiff, carelessly, recklessly and in a grossly negligent manner failed to exercise the degree of skill, care and competence expected of competent members of the investment advisory profession performing similar work, and breached its contractual obligations under the IMA by plunging Ornkey's assets into undiversified, highly risky subprime mortgage-backed securities and maintaining such imprudent investments despite its fundamental obligation to preserve capital and its knowledge that such investments posed unreasonably high risk.
Specifically, plaintiff alleges that JPMIM invested approximately 85% of the assets in the Excess Reserve sub-account and the Additional Funding Account in highly risky subprime and Alt–A mortgage-backed securities.
Plaintiff further alleges that even as JPMIM's internal knowledge of the riskiness of subprime mortgage-backed securities grew during 2006 and early 2007, due to the fact that companies affiliated with JPMIM were themselves ridding their investment portfolios of the same risky securities, JPMIM failed to divest its investments, causing a dramatic decline in the value of the assets.
Plaintiff claims that as of June 30, 2006, the par value of the assets in the Excess Reserve sub-account and the Additional Funding Account totaled approximately $360 million, but on February 29, 2009 those assets had suffered an approximately 86% loss in mark-to-market value, becoming valued at approximately $50 million, for a total dollar loss of approximately $310 million.
According to plaintiff, JPMIM inexplicably concealed the risks associated with subprime and Alt–A mortgage-backed securities from, and failed to disclose them to, Orkney and Assured Guaranty. Specifically, paragraph 58 of the Complaint alleges that:
[u]pon information and belief, JPMIM also withheld from Orkney and Assured Guaranty material information regarding fraud, delinquency, default and other problems with the subprime and Alt–A loan-backed portfolios of its affiliates and other lenders and servicers and the fact that subprime originators were refusing to stand behind their contractual warranties relating to such loans. Upon information and belief, if this information had been disclosed to the rating agencies initially, the collateral in the Orkney portfolio would have received lower ratings prior to the transaction, Orkney would not have issued the Notes and Assured Guaranty would not have guaranteed the A–1 Notes.
Plaintiff goes on to allege that although JPMIM issued monthly statements for the investment portfolios that described the categories of mortgage-backed securities in which defendant had invested the assets, those statements did not disclose to Orkney or plaintiff the high risk of such investments that had been and/or had become known to JPMIM internally.
Plaintiff further alleges that even in the late summer of 2007, JPMIM continued to advise plaintiff that the assets in the Accounts provided a high level of safety, were “money good” and that Orkney should retain the assets rather than sell them.
Allegedly, JPMIM projected in September 2007 that the deal would lose only $12 million, or approximately 3% on its subprime and Atl–A investments.
Plaintiff also alleges that JPMIM disregarded its fiduciary duties to Orkney and plaintiff by improperly taking direction from Scottish Re in determining the composition and risk levels of investments placed in the Accounts, rather than exercising its own independent judgment.
According to the Complaint, as of early May 2009, the value of the assets had become insufficient to allow Orkney to meet its quarterly interest payment obligation on the Notes. Consequently, on May 11, 2009 plaintiff made its first payment pursuant to its financial guarantee in the net amount of approximately $1.2 million.
JPMIM now moves for an Order, pursuant to CPLR §§ 3211(a)(1) and (a)(7), dismissing the Complaint in its entirety.
I. Breach of Fiduciary Duty and Gross Negligence Claims
JPMIM contends that the breach of fiduciary duty and gross negligence claims should be dismissed for failure to state a claim because they are preempted by New York General Business Law (“GBL”), Art. 23–A, § 352, et seq. (“the Martin Act” or “the Act”).
As additional grounds for dismissal of the tort claims, JPMIM contends that defendant owed no duty to plaintiff, the claims are duplicative of plaintiff's breach of contract claim and the economic loss doctrine bars tort claims based only on economic harm.
Section 352–c(1) of the GBL (the Martin Act) provides that:
1. It shall be illegal and prohibited for any person, partnership, corporation, company ... to use or employ any of the following acts or practices:
(a) Any fraud, deception, concealment, suppression, false pretense ...;
(b) Any promise or representation as to the future which is beyond reasonable expectation or unwarranted by existing circumstances;
(c) Any representation or statement which is false, where the person who made such representation or statement: (i) knew the truth; or (ii) with reasonable effort could have known the truth; or (iii) made no reasonable effort to ascertain the truth; or (iv) did not have knowledge concerning the representation or statement made;
where engaged in to induce or promote the issuance, distribution, exchange, sale, negotiation or purchase within or from this state of any securities ..., regardless of whether issuance, distribution, exchange, sale, negotiation or purchase resulted.
The Court of Appeals has held that there is no implied private right of action under the Martin Act as the purpose of the statute was:
to create a statutory mechanism in which the Attorney–General would have broad regulatory and remedial powers to prevent fraudulent securities practices by investigating and intervening at the first indication of possible securities fraud on the public and, thereafter, if appropriate, to commence civil or criminal prosecution; ...”
CPC Intl. v. McKesson Corp., 70 N.Y.2d 268, 277 (1987).
Plaintiff relies on the case of Hamlet on Olde Oyster Bay Home Owners Assn., Inc. v. Holiday Org. Inc., 59 AD3d 673, 677 (2d Dep't 2009), for the proposition that the Martin Act does not preempt common law causes of action arising from conduct prohibited under the Act. However, that decision, dated February 24, 2009, was recalled and vacated by the Court upon reargument, which substituted therefor a decision rendered on September 29, 2009 (the “Substituted Decision”), which held the alleged claims for fraudulent inducement and negligent misrepresentation which arose under the Martin Act were properly dismissed by the trial court as preempted. See Hamlet on Olde Oyster Bay Home Owners Assn., Inc. v. Holiday Org. Inc., 65 AD3d 1284, 1287 (2d Dep't 2009).
The Court based its holding in the Substituted Decision on the case of Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. Partnership, 12 NY3d 236, 247 (2009), which dealt with omissions in disclosures required by the Martin Act and held that the fact “[t]hat [plaintiff] alleged the elements of common-law fraud does not transmute a prohibited private cause of action to enforce Martin Act disclosure into an independent common-law tort.”
It should be noted that the Substituted Decision was rendered after this Court heard oral argument on the instant motion on August 4th, 2009.
Plaintiff also cites to the case of Nanopierce Techs., Inc. v. Southridge Cap. Mgmt., 2003 WL 22052894 at *3–4 (SDNY 2003). However, in that case the Court actually explained very clearly that claims such as breach of fiduciary duty and negligent misrepresentation which, unlike common law fraud, do not require proof of deceitful intent and therefore “essentially mimic” the Martin Act, are preempted by the Act.
Similarly, in Horn v. 440 E. 57th Co., 151 A.D.2d 112, 119 (1st Dep't 1989), the Court dismissed claims for breach of fiduciary duty and negligent misrepresentation, holding that “to sustain them would be, in effect, to recognize a private right of action under the Martin Act contrary to [ CPC Intl.].” See also Heller v. Goldin Restructuring Fund, L.P., 590 F Supp 2d 603 (SDNY 2008); Kassover v. UBS AG & UBS Fin. Servs., Inc., 619 F Supp 2d 28 (SDNY 2008); Jana Master Fund, Ltd. v. JPMorgan Chase & Co., 19 Misc.3d 1106(A) (N.Y. Co., Sup.Ct.2008).
After full submission of this motion, the parties, pursuant to Commercial Division Rule 18, submitted a copy of a decision rendered by the Hon. Melvin L. Schweitzer in the case of CMMF, LLC v. J.P. Morgan Investment Management, Inc., et al., Index No. 601924/09, dated December 10, 2009, in which the Court, inter alia, declined to dismiss claims for negligence, breach of fiduciary duty and negligent misrepresentation as preempted by the Martin Act. This Court permitted the parties to submit five-page letters in late December of 2009 to address this decision.
In CMMF, the Court relied on Louros v. Kreicas, 367 F Supp 2d 572, 595–96 (SDNY 2005), which held that “[a] claim of breach of duty that involves securities but does not allege any kind of dishonesty or deception implicates neither the plain language of the statute nor its policies.” By contrast, here the breach of fiduciary duty and gross negligence claims are preempted by the Act because plaintiff has clearly alleged concealment and deception.
Plaintiff next contends that the Martin Act is inapplicable here because the securities at issue were purchased by JPMIM and not by the plaintiff. However, it is clear that a plaintiff need not have purchased the securities itself to have its claims preempted by the Act, and that the Martin Act preempts an investor's claims for negligence and breach of fiduciary duty against its financial advisor and/or investment banker. See Abu Dhabi Commercial Bank v. Morgan Stanley & Co., 2009 WL 2828018 (SDNY 2009); Sedona Corp. v. Ladenburg Thalmann & Co., Inc., 2005 WL 1902780 (SDNY 2005); Louros v. Kreicas, 367 F Supp 2d 572 (SDNY 2005).
Based on the above analysis, this Court finds that the claims for breach of fiduciary duty and gross negligence fall within the purview of the Martin Act and their prosecution by plaintiff would be inconsistent with the Attorney General's exclusive enforcement powers under the Act.
Accordingly, they are dismissed.
Since the tort claims are dismissed as preempted, this Court need not discuss defendant's additional grounds for dismissal.
II. Breach of Contract Claim
JPMIM contends that the breach of contract claim should be dismissed because JPMIM's investments for the Accounts complied fully with the Investment Guidelines, defendant did not act with gross negligence or willful misconduct in managing the Accounts and did not violate Chapter 13 of the Delaware Insurance Code.
First, JPMIM contends that the percentage of the alleged risky securities in the Accounts did not exceed the percentages negotiated and agreed upon by both parties in the Investment Guidelines, which provide that the assets in the Excess Reserve sub-account and the Additional Funding Account may be invested up to 60% in “Home Equity Loan Asset Backed Securities” and up to 50% in “Mortgage Backed Securities” including up to 30% in Alt–A mortgage-backed securities.
Plaintiff does not dispute that JPMIM's investments never exceeded said percentages but argues that defendant breached the Investment Guidelines by failing to manage the Accounts in a manner consistent with the contractual investment objective, i.e., to obtain reasonable income while providing a “high level of safety of capital.”
However, JPMIM contends that the IMA granted it broad discretion and that, in an unpredictable market, its decision not to sell the alleged risky securities cannot be equated with a failure to manage the portfolio. JPMIM relies on the case of Guerrand–Hermès v. J.P. Morgan & Co. Inc., 2 AD3d 235, 238 (1st Dep't 2003), in which the Court dismissed a breach of contract claim alleging that the investment advisor declined to follow its client's direction to sell certain securities, based on the rationale that the investment advisor had discretionary authority over the account and “was in compliance with the investment guidelines' diversification requirements.”
Similarly, in Vladimir v. Cowperthwait, 42 AD3d 413, 415 (1st Dep't 2007), the Court found that an investment manager with discretionary authority was not liable to an investor for failure to achieve an investment objective where the securities purchased complied with the contractual diversification requirements.
JPMIM also points to section 14 of the IMA, Discharge of Liability, which provides, in relevant part, that:
(a) [JPMIM] does not guarantee the future performance of the Accounts or any specific level of performance, the success of any investment decision or strategy that [JPMIM] may use, or the success of [JPMIM]'s overall management of the Accounts. [Assured Guaranty] understands that investment decisions made for the Accounts by [JPMIM] are subject to various market, currency, economic, political and business risks, and that those investment decisions will not always be profitable ...
Second, JPMIM contends that plaintiff failed to sufficiently allege that defendant managed the Accounts in a grossly negligent manner.
Plaintiff contends that JPMIM at some point knew that the alleged risky securities would decline in value and failed to sell while there was still a market for them or to otherwise diversify the portfolio.
Section 14(b) of the IMA provides that JPMIM shall not be liable for any losses “arising from any depreciation in the value of the Accounts ... except to the extent such Losses are judicially determined to be proximately caused by the gross negligence or willful misconduct of [JPMIM].”
In support of its assertions, plaintiff relies heavily on certain statements made by Jamie Dimon, Chief Executive Officer of JPMorgan Chase Bank N.A. (“JPMorgan Chase”) in a magazine article dated September 2, 2008, discussing JPMorgan Chase's strategic response to the credit crises. The article quotes Mr. Dimon as having stated “[t]his stuff could go up in smoke,” and having instructed subordinates, including the head of the division that runs JPMIM, to “watch out for subprime” and “sell a lot of our positions.”
The article cited by plaintiff is entitled: Jamie Dimon's Swat Team: How J.P. Morgan's CEO and his crew are helping the big bank beat the credit crunch, Fortune Magazine, Sept. 2, 2008.
However, as defendant points out, the securities discussed in the article are “CDOs” ( i.e., Collateralized Debt Obligations) and “SIVs” ( i.e., Structured Investment Vehicles) which were never purchased for plaintiff's Accounts. Thus, this article does not support plaintiff's assertions that JPMIM knew, through its parent or affiliate JPMorgan Chase, of facts that would allow it to anticipate a general market decline in the value of mortgage-backed securities.
This Court finds that plaintiff has not otherwise alleged facts which adequately support the allegation that JPMIM acted with gross negligence or willful misconduct in managing the Accounts. See Retty Financing, Inc. v. Morgan Stanley Dean Witter & Co., 293 A.D.2d 341, 341 (1st Dep't 2002) (affirming dismissal of breach of contract claim for gross negligence or willful misconduct where the Complaint failed to set forth actions by the defendant evincing “a reckless disregard for the rights of [plaintiff] or smack [ing]' of intentional wrongdoing ... [citation omitted]”).
Third, JPMIM contends that it did not violate Chapter 13 of the Delaware Insurance Code (the “Code”) which prescribes the types of securities that are eligible investments for insurers. JPMIM argues that the securities challenged by plaintiff in this case are not covered by § 1323 of the Code, which applies to residential and commercial mortgages and not to the rated instruments contemplated by the Investment Guidelines. Rather, they fall under § 1308, which covers “obligations” and does not impose any limitation on the amount of such securities that may be owned.
Section 1309(a)(1) defines “obligations” to include “bonds, debentures, notes and other evidences of indebtedness ... as well as participation interests in any of the foregoing.” Defendant contends that all the securities at issue here are “notes” or “participation interests' covered by section 1308 and satisfy the ratings requirement of that section.
Plaintiff counters that §§ 1323(a)(5) and (e) also cover “participations evidencing participating interests in bonds, notes or other evidences of indebtedness,” which would include the securities at issue. Plaintiff contends that even if JPMIM complied with § 1308, such compliance does not excuse its violation of § 1323.
However, defendant contends that an investment is not required to comply with both sections of the Code. In fact, § 1308(c) provides that, “[a]n insurer may also invest any of its funds in obligations other than those permitted in subsections (a) or (b) of [§ 1308] or those eligible for investment under § 1323 (real estate mortgages) of this title if they [meet the requirements of § 1308(c) ] (emphasis added).” Moreover, § 1302(c) provides in relevant part that an investment “may be qualified or requalified at the time of acquisition or at a later date, ... under any section of this chapter, if the relevant conditions contained in the section are satisfied at the time of qualification or requalification.” Thus, this Court finds that JPMIM did not breach the IMA as it complied with § 1308 of the Code which is applicable to the securities at issue.
Accordingly, this Court finds that plaintiff's breach of contract cause of action must be dismissed.
The motion is thus granted in its entirety and the action is dismissed, with prejudice and without costs or disbursements.
This constitutes the decision and judgment of this Court.