Summary
holding risk disclosures "indicating the possibility of decline cannot be used to shield [defendants] from [p]laintiffs' allegations that [defendants] had custom-built [the securities] to intensify the normal risk of principal loss"
Summary of this case from Y-GAR Capital LLC v. Credit Suisse Grp. AGOpinion
10 Civ. 8086 (LBS)
10-31-2011
DANDONG, et al., Plaintiffs, v. PINNACLE PERFORMANCE LIMITED, et al., Defendants.
MEMORANDUM & ORDER
In this action, a group of Singapore investors ("Plaintiffs") assert various claims against Morgan Stanley & Co. ("Morgan Stanley") and certain of its affiliates (collectively, "Defendants"). Plaintiffs allege that Defendants violated New York State law by engaging in, inter alia, fraud, negligent misrepresentation, and breach of fiduciary duty in relation to credit-linked notes ("Notes") issued by Pinnacle Performance Limited ("Pinnacle") and purchased by Plaintiffs.
Defendants have moved to dismiss Plaintiff's Complaint ("Complaint"). For the following reasons Defendants' motion to dismiss is granted in part and denied in part.
I. Background
Between 2006 and 2007, a group of Singapore investors, including Plaintiffs, bought the Notes from various independent distributors based in Singapore, Hong Kong, and elsewhere in Asia. "Credit-linked notes" ("CLNs") are a type of credit derivative that shifts credit risk onto investors in return for a higher yield than can be attained through typical bonds. The "redemption value" of the CLNs upon maturity is linked not only to the creditworthiness of the issuer, but more importantly to the creditworthiness of certain otherwise unrelated third parties—the "reference entities" ("REs"). McNeela Decl. Ex. 3, at 67. CLNs are, in essence, a bet on the creditworthiness of the REs.
Over ten different independent distributors appear to have sold the Pinnacle Notes to Singapore investors, including Kim Eng Securities Pte. Ltd., Hong Leong Finance Limited, OCBC Securities Private Limited, and RHB Bank Berhad. Plaintiffs assert no claims against the distributors. --------
CLNs of the kind in question are typically created as follows. McNeela Decl. Exs. 1-6. First, the bank arranging the CLNs creates a Special Purpose Vehicle ("SPV") to issue the CLNs. The SPV is generally, but not always, an "orphan company owned by a trustee [that] will not appear on the balance sheet of any party to the transaction." McNeela Decl. Ex. 5, at 32. The bank then buys protection from the SPV in the amount of the CLNs that will be issued to investors insuring it against the possibility that REs' would experience a "credit event," such as default. The name given to this particular transaction is "credit default swap" and this is, in effect, a derivative contract that functions like insurance. Second, the SPV sells the CLNs to the investors and uses the principle it receives therefrom to purchase highly-rated securities, or "underlying assets," which serve as collateral in the event that the REs default. In Morgan Stanley's own words, "the proceeds of the funded note issuance are invested in low-risk 'eligible collateral,'" which "mainly consists of investments in cash or government bonds or guaranteed investment contracts (GICs) issued by highly rated insurance companies." McNeela Decl. Ex. 2, at 29 & n.1. Third, in return for assuming the risk, investors receive interest in the form of (i) credit protection payments from the sponsoring bank and (ii) any interest generated by the underlying assets. Assuming that no credit events occurs, investors will receive the redemption value of the Note. If a credit event does occur, however, they will be paid a value less than par. McNeela Decl. Ex. 3, at 67.
Generally, therefore, from the perspective of the investor, "the single most important risk exposure in a CLN is . . . the credit risk associated with the reference entit[ies]." McNeela Decl. Ex. 1, at 126. But that was not the case here—or so Plaintiffs contend. Rather than invest Plaintiffs' principal in low-risk underlying assets, the SVP Pinnacle, at the behest of Morgan Stanley International ("MS International"), invested in high-risk synthetic collateralized debt obligations ("CDOs") of Morgan Stanley Capital ("MS Capital")'s own making.
The synthetic CDOs at issue here are yet another example of a credit default swap. In this case, "[t]he SPV sells protection on [a] collateral pool of assets to the sponsoring financial institution . . . and receives a premium for the risk being assumed." McNeela Decl. Ex. 2, at 29. The protection-selling SPV takes a "long" position on the risk, while the protection-buying counterparty takes a "short" position on the risk. "When a credit event occurs with respect to any asset in the collateral pool, the SPV pays the protection buyer an amount linked to the loss incurred on the asset." Id. Usually the CDOs are divided into tranches, with riskier tranches yielding greater returns. Some banks, however, offer "single-tranche" CDOs that allow purchasers to bet on a particular band of risk in the overall portfolio. From the perspective of the investor, CDOs—much like CLNs—are bets on the creditworthiness of the collateral pool of assets in any given tranche.
Plaintiffs allege that MS International deliberately invested their principal not in high-grade collateral, but in highly risky single-tranche CDOs created by MS Capital. While the REs linked to the CLNs were mostly sovereign nations, MS Capital chose CDOs that were linked to a collateral pool of assets that posed a high risk of default—subprime mortgage lenders, companies tied to the U.S. housing market, and risky Icelandic banks. Plaintiffs further assert that MS Capital organized the particular tranches of debt to be highly susceptible to total impairment in the event of even a modest default. In other words, Plaintiffs claim that MS Capital designed these CDOs to fail.
Plaintiffs allege that MS Capital profited from this uncommon arrangement because it had taken a short position with respect to the collateral pool of assets underlying the CDOs that it had itself created. In other words, MS Capital stood to profit in the event that the pool of assets performed poorly, while the investors in the Notes suffered losses. Plaintiffs allege, among other things, that this setup was fraudulent, that Defendants engaged in negligent misrepresentation, and that they breached their fiduciary duty.
II. Standard of Review
On a motion to dismiss, a court reviewing a complaint will consider all material factual allegations as true and draw all reasonable inferences in favor of the plaintiff. Lee v. Bankers Trust Co., 166 F.3d 540, 543 (2d Cir. 1999). "To survive dismissal, the plaintiff must provide the grounds upon which his claims rests through 'factual allegations sufficient to raise a right to relief above the speculative level.'" ATSI Commc'ns Inc. v. The Shar Fund, Ltd., 493 F.3d 87, 93 (2d Cir. 2007) (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007)). "Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice." Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009). Rather, the plaintiff's complaint must include "enough facts to state a claim of relief that is plausible on its face." Id. at 1940 (citing Twombly, 550 U.S. at 570). Plausibility, in turn, requires that the allegations in the complaint "raise a reasonable expectation that discovery will reveal evidence" in support of the claim. Twombly, 550 U.S. at 556.
Allegations of fraud must, however, meet the heightened pleading standard of Rule 9(b), which requires that the plaintiff "state with particularity the circumstances constituting fraud." Fed. R. Civ. P. 9(b). The complaint must "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir 1994). "[W]hile Rule 9(b) permits scienter to be demonstrated by inference, this must not be mistaken for license to base claims of fraud on speculation and conclusory allegations. An ample factual basis must be supplied to support the charges." O'Brien v. Nat'l Prop. Analysts Partners, 936 F.2d 674, 676 (2d Cir. 1991) (internal citations omitted). As such, "plaintiffs [must] allege facts that give rise to a strong inference of fraudulent intent," Mills v. Polar Molecular Corp., 12 F.3d 1170, 1176 (2d Cir. 1993), which may be shown by "alleging facts to show ... motive and opportunity [or] facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Shields, 25 F.3d at 1128 (2d Cir. 1994).
On a motion to dismiss, a court is not limited to the four corners of the complaint. A court may also consider "documents attached to the complaint as an exhibit or incorporated in it by reference, ... matters of which judicial notice may be taken, or ... documents either in the plaintiffs' possession or of which plaintiffs had knowledge and relied on in bringing suit." Brass v. Am. Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993).
III. Discussion
A. Jurisdiction
1. Forum Selection and Choice of Law
Defendants argue that Plaintiffs agreed to litigate matters related to the Notes in Singapore. To support this argument, Defendants cite forum selection clauses contained in the various Pricing Statements, all of which state that "[b]y completing and delivering the Notes Application Form, you[, the investors,] agree that ... all applications, acceptances or contracts resulting therefrom shall be governed by and construed in accordance with the laws of Singapore and that you irrevocably submit to the exclusive jurisdiction of the Singapore courts." Youngwood Decl. Ex. 2, at 18; Ex. 3, at 19; Ex. 4, at 19; Ex. 5, at 19; Ex. 6, at 37; and Ex. 7, at 36. Plaintiffs argue, in response, that this clause only applies to contracts resulting from the application process to purchase the Notes and not to the Notes themselves. In other words, it only applies to contracts and applications between a prospective investor and an independent distributor, not to disputes between an investor and Pinnacle or Morgan Stanley, from whom the Notes could not be directly purchased. To bolster their argument, Plaintiffs point to other forum selection clauses in the Base Prospectus specifying other fora. Most importantly, one clause reads that "The Notes are governed by English law and the courts of England will have non-exclusive jurisdiction in respect of disputes involving the Notes." Youngwood Decl. Ex. 8, at 14. Another clause for the Swap Guarantee and Forward Guarantee specifies New York law and New York non-exclusive jurisdiction. Id. at 14-15.
It is clear that the Singapore forum selection clause was "reasonably communicated" to Plaintiffs. In addition, by using the word "shall," the clause is mandatory, not permissive. Phillips v. Audio Active Ltd., 494 F.3d 378, 383 (2d Cir. 2007). The issue, then, is whether "the claims and parties involved in the suit are subject to the forum selection clause." Id. That is, are Plaintiffs' claims properly understood as falling under the contracts resulting from their application to purchase the Notes or are they best understood as involving some other document—the Notes themselves, the Base Prospectus, or the Pricing Statements?
Defendants' reading of the Singapore clause is implausibly broad, for it provides no intelligible means to distinguish the other forum selections clauses found in the Base Prospectus. Defendants deal with this by claiming that the Singapore clause trumps the others, but this assumes that these provisions are contradictory, when there is no need to construe them as such. See Seabury Const. Corp. v. Jeffrey Chain Corp., 289 F.3d 63, 69 (noting that "where two seemingly conflicting contract provisions reasonably can be reconciled, a court is required to so and to give both effect."). Giving the clauses their "plain meaning," Krumme v. Westpoint Stevens Inc., 238 F.3d 133, 140 (2d Cir. 2000), we find the following. The Singapore forum selection clause governs the Notes Application Form. Youngwood Decl. Ex. 2, at 18; Ex. 3, at 19; Ex. 4, at 19; Ex. 5, at 19; Ex. 6, at 37; and Ex. 7, at 36 ("By completing and delivering the Notes Application Form, you agree that ... all applications, acceptances or contracts resulting therefrom shall be governed by and construed in accordance with the laws of Singapore and that you irrevocably submit to the exclusive jurisdiction of the Singapore courts."). The England forum selection clause governs the Notes themselves. Youngwood Decl. Ex. 8, at 14 ("The Notes are governed by English law and the courts of England will have non-exclusive jurisdiction in respect of disputes involving the Notes."). Last, the New York forum selection clause governs the Swap Guarantee and the Forward Guarantee. Id. at 14-15 ("The Swap Guarantee and the Forward Guarantee are governed by New York law and the courts of New York will have non-exclusive jurisdiction in respect of disputes involving the Swap Guarantee or the Forward Guarantee as the case may be."). The inevitable conclusion is that the Base Prospectus and Pricing Statements—which contain the omissions and misstatements that underlie Plaintiffs' claims—are governed by no forum selection clause.
The law of this Circuit holds that a plaintiff's "choice of forum in bringing his suit in federal court in New York will not be disregarded unless the contract evinces agreement by the parties that his claims cannot be heard there." Phillips, 494 F.3d at 387 (2d Cir. 2007). Drawing all inferences in favor of Plaintiffs, Defendants have not shown that the forum selection clauses preclude suit in New York.
2. Forum Non Conveniens
Defendants ask this Court to dismiss the Complaint on the ground of forum non conveniens ("FNC"). This is a "discretionary device permitting a court in rare instances to dismiss a claim even if the court is a permissible venue with proper jurisdiction over the claim." Wiwa v. Royal Dutch Petroleum Co., 226 F.3d 88 (2d Cir. 2000). "[D]ismissal will ordinarily be appropriate where trial in the plaintiff's chosen forum imposes a heavy burden on the defendant or the court, and where the plaintiff is unable to offer any specific reasons of convenience supporting his choice." Piper Aircraft Co. v. Reyno, 454 U.S. 235, 249 (1981). FNC motions in this Circuit are reviewed under the three-part test outlined in Norex Petroleum Ltd. v. Access Indus. Inc., 416 F.3d 146, 154 (2d Cir. 2005). First, the "court determines the degree of deference properly accorded the plaintiff's choice of forum." Second, "it considers whether the alternative forum proposed by the defendants is adequate to adjudicate the parties' dispute." And finally, it "balances the private and public interests implicated in the choice of forum." Id. at 153.
i. Plaintiff's Choice of Forum
Generally speaking, there is a "strong presumption in favor of the plaintiff's choice of forum." Piper Aircraft, 454 U.S. at 255 (1981). Therefore, "unless the balance is strongly in favor of the defendant, the plaintiff's choice of forum should rarely be disturbed." Gulf Oil Corp. v. Gilbert, 330 U.S. 501, 508 (1947). While it is true that "great deference is generally accorded a plaintiff's choice of its home forum," this is not a hard and fast rule. Norex, 416 F.3d at 154 (2d Cir. 2005). Rather, the Court must make a case-by-case determination, analyzing such factors as the "convenience of the plaintiff's residence ..., the availability of witnesses or evidence ..., the defendant's amenability to suit ..., the availability of appropriate legal assistance, and ... other reasons relating to convenience and expense." Id. at 155. Having considered both sides' arguments, we find that none of the factors are dispositive except the availability of witnesses and evidence. Resolving this, in turn, depends upon determining where the alleged fraud was devised, since that will likely be the site of critical documents and witnesses.
Defendants assert that the "core allegations in the Complaint make clear that this is a dispute centered on activities that occurred in Singapore." Mem. Supp. Defs.' Mot. Dismiss 18. Plaintiffs dispute this characterization—and we agree. The Complaint is quite clear that the vast majority of actions that Plaintiffs' allege were fraudulent occurred in New York and London. MS Capital's creation of single-tranche CDOs created to match each series of Notes occurred in New York. Compl. ¶128. MS Capital's selection of the assets underlying the CDOs also occurred in New York. Pl. Mem. Opp. Defs.' Mot. Dismiss 11. MS International's selection of the underlying assets for the CLNs was done in London. Compl. ¶ 147. The parties, of course, dispute who actually drafted the offering materials, but taking Plaintiffs' factual allegations as true, we must assume at this stage of the proceeding that it was MS Capital in New York.
In this regard, Defendants' appeal to Acosta v. JPMorgan Chase & Co., No. 05 Civ. 977 (NRB), 2006 WL 229196 (S.D.N.Y. Jan. 30, 2006), is inapposite. Acosta involved actions committed by foreign banks, whereas Plaintiffs' claims focus first and foremost on the activities of MS Capital, which is headquartered in New York. Indeed, in Acosta, Plaintiffs had "conceded ... that they [did] not claim that the [U.S.] defendants ... actively participated in the underlying fraud," id. at *5, while Plaintiffs here assert precisely that. For that reason we find that the availability of evidence and witnesses favors New York.
There remains the issue of the independent distributors, all of whom are in or around Singapore, and whether they will be necessary as witnesses to conduct this action. As noted, Plaintiffs have pled that the misstatements and omissions at issue were made by Morgan Stanley in its offering materials, and that the alleged conduct in furtherance of the fraud—the arrangement of the synthetic CDOs—took place in New York and London. Defendants claim that the independent distributors are essential to this action. But given that the independent distributors did not create the CDOs but merely sold the Notes, we do not see—nor have Defendants told us—why the independent distributors' statements would be material to rebutting Plaintiffs' claims.
Having found that most of the activity alleged to be fraudulent occurred not in Singapore but in New York (and to a lesser extent in London), we find that the availability of evidence and witnesses—not to mention issues of expense and convenience—favor Plaintiffs' choice of a New York forum.
ii. Adequate Alternate Forum
Defendants assert, and Plaintiffs contest, that Singapore is an adequate alternate forum. We would agree with Defendants—were it not for the issue of ex-employees of Morgan Stanley and MS Capital whose testimony Plaintiffs believe is critical to exposing the alleged fraud. Having found, supra, that Plaintiffs' Complaint asserts causes of action that appear to be connected more strongly to New York than to Singapore, we are faced with the question of whether, were this case to proceed in Singapore, Singaporean courts could subpoena ex-employees of Morgan Stanley and MS Capital. We are convinced that they could not. See Furmston Decl. ¶ 44 (citing Singapore Order 38 rule 18, which forbids the serving of a subpoena on anyone that is outside of Singapore's jurisdiction).
Defendants, to their credit, have taken steps to identify employees—both current and former—who may have knowledge of the Singapore side of the transaction, see Jackson Decl., but they have not made similar efforts with respect to the New York side. Thus Defendants' claim that they have identified persons with knowledge is helpful, but neither conclusory nor exhaustive. We therefore find Plaintiffs' ability to effect compulsory process on ex-employees of MS Capital to be dispositive, which renders the Singapore forum inadequate.
iii. Gilbert Factors
The final step in assessing convenience is to balance the public and private interest factors articulated in Gulf Oil Corp. v. Gilbert, 330 U.S. 501 (1947). Defendants bear the burden of demonstrating that Plaintiffs' choice of forum is not convenient. Wiwa, 226 F.3d at 100 (2d Cir. 2000). The private interest factors include the ease of access to evidence, the availability of compulsory process, the cost for cooperative witnesses to attend, and other practical matters related to the cost and duration of trial. The public factors include court congestion, imposing jury duty on citizens of the selected forum, having local disputes settled locally, and avoiding the problems associated with the application of foreign law. Gilbert, 330 U.S. at 508-509 (1947).
The private interest factors are substantially similar to what we considered in III.A.2, supra, and favor Plaintiffs' choice of forum. The public interest factors, however, require analysis.
Working backwards, this court finds that Defendants have not indicated any particular conflicts or difficulties likely to arise from the application of Singaporean law. Loebig v. Larucci, 572 F.2d 81, 85 (2d Cir. 1978) (holding that under New York choice of law rules, a party wishing to apply the law of a foreign state must show how that law differs from the forum state's laws). To the contrary, Defendants have gone out of their way to suggest that Singaporean law is at the very least equal to New York law with respect to procedural rights and not materially different in substance. See Tan Decl. ¶¶ 8-45. While Singapore courts would obviously be better able to apply Singapore law, Anwar v. Fairfield Greenwich Ltd., 2010 WL 3910197, at *9 (S.D.N.Y. Sept. 14, 2010), Singapore law would not likely present this court with too great a difficulty, particularly in light of the presumption that "in cases involving the law of common law countries, New York courts generally assume that the foreign law is the same as New York law." Loebig, 572 F.2d at 85 (2d Cir. 1978).
Plaintiffs argue, and we agree, that given the situs of the alleged fraud, New York has a significant interest in this dispute. Defendants counter by citing Pollux Holding Ltd. v. Chase Manhattan Bank, 329 F.3d 64 (2d Cir. 2003), for the proposition that a "New York court's 'generalized interest' in overseeing [a] bank ... headquartered in New York [does not] create[] any strong local interest." Id. at 76. But Defendants omit a critical distinguishing characteristic—namely, that the plaintiffs in Pollux alleged that the fraud and misrepresentation occurred not in New York but in London. Id. Here, on the other hand, the allegations center on New York, not Singapore, and therefore Pollux does not control.
Finally, while this court is well aware of the Southern District of New York's formidable caseload, this alone is insufficient to tip the balance in favor of Defendants. Taken together, then, the Gilbert factors favor Plaintiffs. Defendants' motion to dismiss on the grounds of forum non conveniens is denied.
3. International Comity
Defendants ask this court to dismiss the case on the grounds of international comity, generally defined by the federal courts as "the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience." Hilton v. Guyot, 159 U.S. 113, 164 (1895). It is, in short, a "discretionary rule of practice, convenience, and expediency." JP Morgan Chase Bank v. Altos Hornos de Mex., S.A. de C.V., 412 F.3d 418, 423 (2d Cir. 2005) (internal quotation marks and citation omitted).
Specifically, Defendants argue (i) that international comity is warranted because of the existence of parallel actions in Singapore and (ii) that this court should defer to the specially-created Singapore Monetary Authority's dispute resolution system.
i. Parallel Actions
Defendants assert that several Singaporean investors in the Notes have either threatened legal action in Singapore or have initiated pre-action discovery. Mem. Supp. Defs.' Mot. Dismiss 26-27. While foreign bankruptcy actions generally warrant dismissal of parallel domestic actions, JP Morgan Chase Bank, 412 F.3d at 424 (2d Cir. 2005), in all other cases a court must weigh, inter alia, the "similarity of parties, the similarity of issues, the order in which actions were filed, the adequacy of the alternate forum, the potential prejudice to either party, the convenience of the parties, the connections between the litigation and the United States, and the connection between the litigation and the foreign jurisdiction." Royal & Sun Alliance Ins. Co. of Can. v. Century Int'l Arms, Inc., 466 F.3d 88, 94 (2d Cir. 2006). Which is to say, a court must examine the "totality of the circumstances," id., to "determine whether exceptional circumstances exist that justify the surrender of that jurisdiction" all the while bearing in mind "district courts' virtually unflagging obligation ... to exercise the jurisdiction given them." Id. at 92-93.
In Royal & Sun Alliance, the Second Circuit found that a district court abused its discretion by dismissing an action based on international comity where there was a pending parallel proceeding in Canada, the defendant had consented to jurisdiction in Canada, the defendant had an affiliate in Canada, and Canada provided an adequate forum for the plaintiff's claims. Id. at 94. If dismissal was improper there, then a fortiori it is improper here where, first, no action has been filed, only "threatened," Mem. Supp. Defs.' Mot. Dismiss 26-27, let alone finally adjudicated. Id. at 92 (noting that "parallel proceedings ... should ordinarily be allowed to proceed simultaneously, at least until a judgement is reached in one which can be pled as res judicata in the other."). Second, whereas in Royal & Sun Alliance Canada was deemed an adequate forum, id. at 94, it is hardly certain that Singapore would provide an appropriate forum for Plaintiffs' claims, see III.A.2.ii, supra.
A possible parallel action is not among the "exceptional circumstances" that would direct deferment to a foreign court.
ii. Singapore Monetary Authority's Dispute Resolution System
The Singapore Monetary Authority ("SMA") has established a "special dispute resolution system for investors who wish to file claims against Distributors in connection with their purchase of Singapore structured financial products." Mem. Supp. Defs.' Mot. Dismiss 26 (emphasis added). Defendants argue that because "Singapore['s] government has made special policy decisions in connection with Singapore structured financial products," this court should defer to the SMA. Id. This argument fails to persuade, however, for—as Defendants themselves state—the SMA's system only covers claims by investors against independent distributors, id., who are not defendants in, nor essential to, this action. See III.A.2.i, supra. Consequently, it does not appear that the SMA would entertain Plaintiffs' claims against Morgan Stanley or its affiliates—claims, Plaintiffs' argue, that are at the very heart of the Complaint.
Defendants' appeal to international comity is without merit. Defendants' motion to dismiss on grounds of international comity is denied.
4. Pinnacle as Necessary Party
The parties do not dispute that New York law governs the personal jurisdiction analysis. They also do not dispute the fact that Pinnacle does not do business in New York, or that it does not have common ownership with the other Defendants. Rather, the pith of the argument is whether Pinnacle is an "indispensable" party under Fed. R. Civ. P. 19(b). If it is, and if we cannot assert personal jurisdiction over it, Defendants argue that this case ought to be dismissed.
Assuming—but, we emphasize, not deciding—that Pinnacle is a "necessary" party under 19(a), we must determine whether it is "indispensable" under 19(b). If it is not, then whether this court can or cannot exercise personal jurisdiction becomes irrelevant because this "court could, in equity and good conscience, proceed in [Pinnacle]'s absence." Ente Nazionale Idrocarburi v. Prudential Sec. Group, Inc., 744 F. Supp. 450, 456 (S.D.N.Y. 1990).
In Provident Tradesmens Bank & Trust Co. v. Patterson, the Supreme Court considered the four factors that underlie a Rule 19(b) determination of indispensability. 390 U.S. 102, 109-111 (1968). First, there is the plaintiff's interest in its chosen forum, which often depends on whether an adequate alternate forum exists. Second, the court looks at the defendant's interest in avoiding multiple litigation or inconsistent relief. Third, there is the interest of the party that cannot be joined, which requires that a court evaluate the extent to which a "judgement may as a practical matter impair or impede [the non-party's] ability to protect his interest in the subject matter." Id. at 110. Fourth and last, "the interests of the courts and the public in complete, consistent, and efficient settlement of controversies." Id. at 111.
In evaluating these factors, a district court's approach is a flexible one. Clarkson Co. v. Shaheen, 544 F.2d 624, 628 (2d Cir. 1976). "The rule allows courts ... to determine the emphasis to be placed on each consideration according to 'the facts of [the] given case and in light of the governing equity-and-good-conscience test.'" Associated Dry Goods Corp. v. Towers Financial Corp., 920 F.2d 1121, 1124 (2d Cir. 1990) (quoting 7 C. Wright & A. Miller, Federal Practice & Procedure § 1608, at 91-92). Put differently, a court ought not make a "mechanical determination of who is an independent party." Prescription Plan Service Corp. v. Franco, 552 F.2d 493, 496 (2d Cir. 1977).
Turning to factor one, there is an alternate forum, but as we noted above in III.A.2.ii, it is not an adequate one given the lack of subpoena power over MS Capital and Morgan Stanley. With regard to the second factor, Defendants have stated only that some injured parties have "threatened" litigation. Mem. Supp. Defs.' Mot. Dismiss 26-27; see also Youngwood Decl. Exs. 10, 11. At this point, then, we must abide by Health-Chem, which holds that the "speculative possibility of future litigation ... furnishes no basis for compulsory joinder." Health-Chem Corp. v. Baker, 915 F.2d 805, 810 (2d Cir. 1990). With regard to the third factor, we find this carries little weight since Pinnacle could voluntarily appear in this action were it held in New York. See Staten Island Rapid Transit Ry. Co. v. S.T.G. Construction Co., 421 F.2d 53, 58 n.6 (2d Cir. 1970); Arthur v. Starrett City Assocs., 89 F.R.D. 542, 547-548 (E.D.N.Y. 1981); 7 C. Wright & A. Miller, Federal Practice & Procedure § 1608, at 112-114 ("The absent person ... may protect his interest by voluntarily appearing in the action or intervening. Certainly there is no obstacle to the absentee voluntarily appearing when joinder is not feasible because of a defect in personal jurisdiction or venue, both of which can be waived; the major difficulty ... is when the intervenor's presence would create a subject-matter jurisdiction defect."). Finally, the last factor is essentially in equipoise, since both parties argue—from opposing perspectives, of course—that neither forum is ideal. Taken together, then, Pinnacle is not "indispensable" to this action. As a consequence, even if there were a defect in personal jurisdiction over Pinnacle, it would not be grounds for dismissal.
Defendants' argument is meritless, and we deny Defendants' motion to dismiss on the ground that this Court lacks personal jurisdiction over a necessary party.
B. Merits
1. Choice of Law
Having found, supra III.A.1, that no forum selection clause nor any choice of law clause governs, the issue is what law should be applied. "In New York, it is required that a party wishing to apply the law of a foreign state show how that law differs from the forum state's law. Failure to do so results in the application of New York law." Independent Order of Foresters v. Donaldson, Lufkin & Jenrette, Inc., 919 F. Supp. 149, 152 (S.D.N.Y. 1996). Defendants have not demonstrated that Singapore law differs from New York law. Indeed, Defendants have argued that New York and Singapore law are neither materially different nor, when applied to the facts at hand, likely to result in different outcomes. See Tan Decl. ¶¶ 8-45; Mem. Supp. Defs.' Mot. Dismiss 28-29. Defendants' motion to dismiss will be analyzed, accordingly, under New York law.
2. Fraud
i. Scienter
Defendants argue that Plaintiffs have failed to meet the pleading standard established by Federal Rule of Civil Procedure 9(b), which requires that "the circumstances constituting fraud ... be stated with particularity." Under this rule, "scienter need not be alleged with great specificity, [but] plaintiffs are still required to plead the factual basis which gives rise to a 'strong inference' of fraudulent intent." Scienter, of course, "is generally a question of fact, appropriate for resolution by the trier of fact." Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 538 (2d Cir. 1999). We must, therefore, be "lenient in allowing scienter issues to withstand summary judgment based on fairly tenuous inferences." Meijer, Inc. v. Ferring B.V., 585 F.3d 677, 693 (2d Cir. 2009) (internal quotation marks and citation omitted). With this in mind, plaintiffs must "alleg[e] facts to show that defendants had both motive and opportunity to commit fraud, or ... alleg[e] facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Lerner v. Fleet Bank, N.A., 459 F.3d 273, 290-91 (2d Cir. 2006).
With respect to the "motive and opportunity" prong, the Second Circuit writes that opportunity "entails the means and likely prospect of achieving concrete benefits by the means alleged." Novak v. Kasaks, 216 F.3d 300, 307 (2d Cir. 2000) (internal citation omitted). Allegations of motive, in turn, are sufficient if they "entail concrete benefits that could be realized by one or more of the false statements or wrongful disclosures alleged." Kalnit v. Eichler, 264 F.3d 121, 138 (2d Cir. 2001) (internal quotation marks omitted). Both opportunity and motive are adequately pled. Plaintiffs have alleged particularized facts supporting a strong inference that "someone whose intent could be imputed to the corporation acted with the requisite scienter." Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital, Inc., 531 F.3d 190, 195 (2d Cir. 2008).
As to motive, the means alleged were as follows: Plaintiffs were enticed by relatively safe CLNs, secured by sovereign nations and highly-rated corporations. Contrary to standard practice endorsed in 2007 by Morgan Stanley itself, McNeela Decl. Ex. 2, at 29, Plaintiffs' principal was invested not in highly secure "underlying assets" but in custom-made synthetic CDOs that were at best risky and possibly rigged to fail. That they were custom-made is clear from the chronology. Exactly one day before a particular series of Notes was issued, Morgan Stanley issued an underlying synthetic CDO that precisely matched the amount of funds raised from a particular series. MS International then chose that newly made synthetic CDO as the underlying asset for the Notes. Compl. ¶ 161. That Morgan Stanley was aware of the riskiness of the CDOs is clear from public statements by Morgan Stanley's chief economist in 2006, id. ¶ 194, as well as from that fact that Morgan Stanley had itself created the CDOs. See In re Citigroup Inc. Sec. Litig., 753 F. Supp. 2d 206, 235 (S.D.N.Y. 2010) (finding that a CDOs underwriter "is in the best position to recognize the threats the [CDOs] faced...."). Thus both the means and the likely prospect of achieving concrete benefit were present in this case.
Moving onto motive, Plaintiffs have succeeded in pleading more than a "generalized motive, ... which could be imputed to any publicly-owned, for-profit endeavor." Chill, 101 F. 3d at 268. They have pled what amounts to self-dealing by Morgan Stanley, insofar as Morgan Stanley was betting against, or "shorting," the synthetic CDOs that it had itself created. The engineered frailty of the CDOs and Morgan Stanley's positions on both sides of the deal adequately alleges motive. See Fraternity Fund Lts. v. Beacon Hill Asset Mgmt. LLC, 376 F. Supp. 2d 385, 404 (S.D.N.Y. 2005) (self-dealing sufficient to establish motive).
ii. Misstatements and Omissions
Defendants argue that there were no misstatements or omissions in the offering materials. They cite cautionary language in the offering materials as evidence that they disclosed to Plaintiffs that "various entities [of Morgan Stanley] might be counterparties on various transactions related to the Pinnacle Notes." Mem. Supp. Defs.' Mot. Dismiss 33. The key language is as follows:
"The economic interests of Morgan Stanley and/or its subsidiaries and affiliates in each such capacity may be adverse to the interests of the Noteholders and potential and actual conflicts of interest may arise from the different roles played by Morgan Stanley and its subsidiaries and affiliates. As a result, Noteholders will be exposed not only to the credit risk of Morgan Stanley and/or its subsidiaries and affiliates, but also to the operational risks arising from the lack of independence of Morgan Stanley and/or its subsidiaries and affiliated in assuming their duties and obligations under the Notes and as potential provider of the hedging instrument." Youngwood Decl., Ex. 8, at 16.Defendants also point to language in the Base Prospectus that warns investors the synthetic CDOs were extremely risky. To wit:
"Where the Underlying Assets of a Series consist of Synthetic CDO Securities and/or CDO Squared Securities and/or Credit Commodity Linked Securities and/or Asset-Backed Securities, prospective investors in such Series should be aware that such debt securities are subject to a high degree of complex risks and prospective investors should appreciate that they may bear the risk that the market value of such securities may decline significantly, possibly to zero." Youngwood Decl., Ex. 8, at 11.The inquiry, then, is whether generalized warnings of risk and of the possibility of adverse interests between Morgan Stanley and the Plaintiffs are sufficient to inoculate Defendants against all allegations of fraud. We are guided in this inquiry by Halperin v. Ebanker Usa.com, 295 F. 3d 352 (2d Cir. 2002). There, the Second Circuit noted that "[c]autionary language in securities offerings is just about universal. Thus, the key question a district court must decide when determining whether to grant a motion to dismiss a securities fraud complaint is whether plaintiffs have overcome the existence of such language. Plaintiffs may do this by showing, for example, that the cautionary language did not expressly warn of or did not directly relate to the risk that brought about plaintiffs' loss. ... In all cases, ... the court must keep in mind that a complaint fails to state a claim of securities fraud if no reasonable investor could have been misled about the nature of the risks when he invested." Id. at 359.
Taking Plaintiffs' allegations as true, we find that they have met their burden at this stage. For each and every series of Notes, MS International selected as underlying assets extremely risky synthetic CDOs specifically created by MS Capital for the transaction. This was done despite industry practice that investors' principal be invested in low-risk collateral. MS Capital then bet against those same CDOs. The cautionary language, general as it is, does not embrace the alleged fraud. Boilerplate language indicating that Morgan Stanley "may be adverse to the interest of the Noteholders" and "[p]otential and actual conflicts of interest may arise" is insufficient to put investors on notice of what Plaintiffs allege was the inevitable risk that Morgan Stanley would invest their principal in an instrument that was engineered to fail. Put differently, "[g]eneral risk disclosures in the face of specific known risks which border on certainties" are not sufficient to defeat a securities fraud claim. In re Prudential Sec. Ltd. Pshps. Litig., 930 F. Supp. 68, 72 (S.D.N.Y. 1996).
With respect to the language warning investors that the "market value of [CDOs] may decline significantly, possibly to zero," our conclusions are much the same. First, Plaintiffs have pled sufficient facts to raise the suspicion that MS International had no intention of selecting anything apart from the synthetic CDOs created by MS Capital as the underlying assets. Second, the language indicating the possibility of decline cannot be used to shield Morgan Stanley from Plaintiffs allegations that MS Capital had "custom-built [the CDOs] to intensify the normal risk of principal loss." Pls.' Mem. Opp. Defs.' Mot. Dismiss 44. In particular, Plaintiffs have alleged that despite ample evidence of a worsening subprime crisis in late-2007, MS Capital "increased the percentage of companies susceptible to a housing downturn in the CDO REs." Pls.' Mem. Opp. Defs.' Mot. Dismiss 44 (emphasis added). "[M]ay decline" is a misstatement when, assuming Plaintiffs are correct, the CDOs would almost certainly decline.
In sum, while there is little doubt that the cautionary language warned Plaintiffs that the Notes carried some risk, it is inadequate to have put the reasonable investor on notice of the alleged fraud.
iii. Reliance
Defendants maintain, next, that Plaintiffs have not pled reasonable reliance. Their argument, essentially, is that Defendants disclosed the risks and the possibility of adverse interests and that by accepting those warnings, Plaintiffs held themselves out to be sophisticated investors.
We note, at the outset, that "[w]hether or not reliance on alleged misrepresentations in reasonable in the context of a particular case is intensely fact-specific and generally considered inappropriate for determination on a motion to dismiss." Maloul v. Berkowitz, No. 07 Civ. 8525, 2008 U.S. Dist. LEXIS 56314, at *6 (S.D.N.Y. July 23, 2008). See also MTV Networks v. Curry, 867 F. Supp. 202, 207 (S.D.N.Y. 1996). Bearing this in mind, on the facts of the record before us, we find that Plaintiffs have pled justifiable reliance.
New York takes a "contextual view" in deciding whether reliance was reasonable, J.P. Morgan Chase Bank v. Winnick, 350 F. Supp. 2d 393, 406 (S.D.N.Y. 2004), looking at the parties' sophistication and the information that was available. Id. In this circuit, "cases that have been dismissed prior to trial for failure to satisfy the reasonable reliance prong generally are cases in which plaintiff was placed on guard or practically faced with the facts," Doehla v. Wathne Ltd., No. 98 Civ. 6087, 1999 U.S. Dist. LEXIS 11787, at *37 (S.D.N.Y. Aug. 2, 1999), or "where the evidence has established that a sophisticated plaintiff had indisputable access to truth-revealing information." Id. at *32. Defendants have proffered nothing to suggest that investors were "placed on guard" about anything approximating the alleged fraud, that they were "practically faced with the facts," or that they had "access to truth-revealing information." Rather, Defendants point to generalized warnings cautioning investors not to rely solely on the offering materials and to consult outside advisors. But even a sophisticated investor armed with a bevy of accountants, financial advisors, and lawyers could not have known that Morgan Stanley would select inherently risky underlying assets and short them. Plaintiffs have pled reasonable reliance.
Defendants' motion to dismiss Plaintiffs' fraud claim is denied.
3. Plaintiffs' Subordinate Claims
i. Martin Act Preemption
Defendants assert that all but Plaintiffs' fraud claims are preempted by New York's Martin Act, N.Y. Gen. Bus. L. § 352-c (2003). However, we find that the law in this Circuit is in a state of flux. Compare Schwartz v. Thinkstrategy Capital Mgmt. LLC, No. 09 Civ. 9346, 2011 U.S. Dist. LEXIS 75751, at *16-17 (S.D.N.Y. July 14, 2011) (Noting that "recent opinions have explained that the statutory language, legislative history, and purpose of the Act cut against preemption, [and that] the First and Second Departments, on whose earlier opinions [Castellano v. Young and Rubicam, Inc., 257 F.3d 171, 190 (2d Cir. 2001)] based its ruling, have overruled their previous precedents... .") and Anwar v. Fairfield Greenwich Ltd., 728 F. Supp. 2d 354, 357, passim (S.D.N.Y. 2010) (finding that the Martin Act does not preempt "common law causes of action that exist independent of the Martin Act but whose proof relies on the same facts that would support a Martin Act prosecution by the Attorney General.") with Wachovia Equity Sec. Litig. v. Wachovia Corp., 753 F. Supp. 2d 326, 380-381 (holding that until either the Second Circuit or the New York Court of Appeals speaks otherwise, trial courts must find that the Martin Act preempts common law claims featuring the same or similar elements).
Given this state of legal flux, we are not persuaded that Defendants' invocation of the Martin Act is sufficient to defeat Plaintiffs' subordinate claims at the pleadings stage. We thus turn to Defendants' substantive arguments for dismissing Plaintiffs' remaining claims.
ii. Negligent Misrepresentation
Defendants argue that Plaintiffs' negligent misrepresentation claim cannot succeed because Plaintiffs have failed to plead the required "special relationship" under New York law. We agree. While Plaintiffs are correct to note that a "determination of whether a special relationship exists is highly fact specific and generally not susceptible to resolution at the pleadings stage," Century Pac. Inc. v. Hilton Hotels Corp., No. 03 Civ. 8258, 2004 U.S. Dist. LEXIS 6904, at *24-25 (S.D.N.Y. Apr. 21, 2004) (internal quotation marks and citation omitted), the relationship between Defendants and Plaintiffs was that of an ordinary buyer and seller, which is not "special" under New York law. St. Paul Fire & Marine Ins. Co. V. Health Fielding Ins. Broking, 976 F. Supp. 198, 203 (S.D.N.Y. 1996). The Second Circuit has found something beyond an ordinary arm's length transaction where "defendants initiated contact with plaintiffs, induced them to forbear from performing their due diligence, and repeatedly vouched for the veracity of the allegedly deceptive information." Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co., 375 F.3d 168, 188 (2d Cir. 2004). Plaintiffs' have not accused Defendants of engaging in any of the above in this case.
Defendants' motion to dismiss Plaintiffs' negligent misrepresentation claim is granted.
iii. Breach of Fiduciary Duty
Creative it may be, but we are not convinced by Plaintiffs' argument that MS International's role as the "determination agent" is akin to that of an "investment advisor with discretionary control over plaintiffs' funds." Pl. Mem. Opp. Defs.' Mot. Dismiss 50. An investment advisor stands in a very different relationship to investors than does MS International in this case. "The principal activity of an investment adviser," as defined by the U.S. Supreme Court in Bd. of Governors of Fed. Reserve Sys. v. Inv. Co. Inst., "is to manage the investment portfolio of its advisee—to invest and reinvest the funds of the client." 450 U.S. 46, 55 (1981). This is not what MS international was tasked to do. Plantiffs did not pay MS International to invest their principal in various investments in exchange for compensation from Plaintiffs. Rather, MS International selected the underlying assets that served as collateral for the credit default swap transaction. While it is true that MS International had the discretion to invest Plaintiffs funds in any assets that "me[]t the criteria set out in the Applicable Pricing Statement for the Notes of that Series," Youngwood Decl., Ex. 8, at 24, this discretion alone is not sufficient to transform MS International into what is commonly understood to be an investment adviser. As a consequence, this case is to be distinguished from the cases that Plaintiffs cite that find that investment advisors with discretion over their clients' funds are in a fiduciary relationship with those clients. E.g., Cuomo v. Merkin, No. 450879/09, 2010 WL 936208, at *10 (N.Y. Sup. Ct. Feb. 8, 2010).
Since there was no contractual language creating a fiduciary relationship among the parties, we grant Defendants' motion to dismiss Plaintiffs' claim of breach of fiduciary duty.
iv. Fraudulent Inducement
In light of the discussion in III.B.2, supra, in which we declined to dismiss Plaintiffs claim of fraud, we deny Defendants' motion to dismiss Plaintiffs' fraudulent inducement claim, the elements of which are, Defendants concede, the same for fraud under New York law. Mem. Supp. Defs.' Mot. Dismiss 41.
v. Breach of Implied Covenant of Good Faith and Fair Dealing
"Under New York law, a covenant of good faith and fair dealing is implied in all contracts." State St. Bank & Trust Co. v. Inversiones Errazuriz Limitada, 374 F.3d 158, 169 (2d Cir. 2004) (citation omitted). "This covenant embraces a pledge that neither party shall do anything which shall have the effect of destroying or injuring the right of the other party to receive the fruits of the contract." Id. Defendants claim that the principle, followed by New York courts, that "no obligation can be implied that would be inconsistent with other terms of the contractual relationship," Dalton v. Educational Testing Service, 87 N.Y.2d 384, 389 (1995), shields them from liability because of the cautionary language contained in the offering materials. For the reasons outlined in III.B.2.ii, supra, we are not convinced that the warnings encompassed the alleged fraud.
Defendants' motion to dismiss this claim is denied.
vi. Unjust Enrichment
We grant Defendants' motion to dismiss Plaintiffs' claim of unjust enrichment because, as Defendants correctly note, the offering materials cover the claims at issue thereby barring recovery for unjust enrichment. See, e.g., Ventromile v. JPI Partners, LLC, 706 F. Supp. 2d 442, 457 (S.D.N.Y. 2010) (no recovery for unjust enrichment when the contract covers the claims at issue).
v. Aiding and Abetting
In accordance with the foregoing discussion, we grant Defendants' motion to dismiss Plaintiffs' aiding and abetting allegations with respect to negligent misrepresentation and breach of fiduciary duty.
IV. Conclusion
For the foregoing reasons, Defendants' motion to dismiss is GRANTED with respect to Plaintiffs' claims of negligent misrepresentation, breach of fiduciary duty, unjust enrichment, aiding and abetting negligent misrepresentation, and aiding and abetting breach of fiduciary duty. Defendants' motion to dismiss Plaintiffs' remaining claims is DENIED.
SO ORDERED.
October 31, 2011
New York, N.Y.
/s/_________
U.S.D.J.