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Readers of this Blog know that, as a general matter, New York courts will not permit a tort claim to survive a motion to dismiss when the claim arises from a breach of contract. here).=">here)."> Indeed, courts routinely dismiss a tort claim where “ he existence of a valid and enforceable written contract govern a particular subject matter” and the recovery sought arises out of the same facts and circumstances. Clark-Fitzpatrick v. Long Is. , 70 N.Y.2d 382 (1987). However, where “a legal duty independent of the contract itself has been violated<,> ” or where the misrepresentation is “collateral or extraneous to the terms of the parties’ agreement,” a fraudulent inducement claim can stand side-by-side with “a simple breach of contract” claim.  Dormitory Auth. v. Samson Constr. Co. , 30 N.Y.3d 704 (2018) (citation omitted). See also Cronos Grp. v. Xcomip, LLC , 156 A.D.3d 54, 62-63 (1st Dept. 2017); McKernin v. Fanny Farmer Candy Shops, Inc. , 176 A.D.2d 233, 234 (2d Dept. 1991).  This is arguably so even when the damages sought in the tort action overlap with the contract action. ( Financial Structures Ltd. v. UBS A.G. , 77 A.D.3d 417, 419 (1st Dept. 2010) (requiring each of the following elements to be present to find duplication: a tort is “based on the same facts that underl the contract cause of action, not collateral to the contract, and d not seek damages that would not be recoverable under a contract measure of damages.”). In the Southern District of New York, the courts are split on the impact of overlapping damages. Compare Blackrock Core Bond Portfolio v. U.S. Bank Nat’l Ass’n , 165 F. Supp. 3d 80, 106 (S.D.N.Y. 2016) and Triaxx Prime CDO 2006-1, Ltd. v. Bank of New York Mellon , No. 16-cv-1597, 2018 WL 1417850, at **6-7 (S.D.N.Y. Mar. 8, 2018), aff’d sub nom ., Triaxx Prime CDO 2006-1, Ltd. v. U.S. Bank Nat’l Ass’n , 741 F. App’x 857 (2d Cir. 2018) (summary order) (dismissing tort claims as barred by the economic loss doctrine) with Ambac Assurance Corp. v. U.S. Bank Nat’l Ass’n , 328 F. Supp. 3d 141, 157-60 (S.D.N.Y. 2018); Phoenix Light SF Ltd. v. Deutsche Bank Nat’l Tr. Co. , 172 F. Supp. 3d 700, 719 (S.D.N.Y. 2016) (“ Phoenix Light/DB ”); Commerzbank AG v. U.S. Bank Nat’l Ass’n , 277 F. Supp. 3d 483, 496-97 (S.D.N.Y. 2017) (“ Commerzbank/U.S. Bank ”) (allowing tort claims to proceed).  “This schism centers on whether a defendant’s alleged breach of extra-contractual legal duties is independently sufficient to foreclose application of the economic loss rule, or whether a plaintiff must also allege damages flowing from the tort claims that are independent of the damages flowing from the contract claims.” Ambac Assurance Corp. , 328 F. Supp. 3d at 158.  The district courts dismissing tort claims that arise from collateral facts or independent duties do so under the economic loss doctrine – e.g. , courts dismiss claims even where the plaintiff alleged an extra-contractual duty because the damages alleged “in connection with the breach of fiduciary duty claims arise entirely from defendants’ obligations under the .” Phoenix Light SF Ltd. v. U.S. Bank Nat’l Ass’n , No. 14-cv-10116, 2016 WL 1169515, at *9 (S.D.N.Y. Mar. 22, 2016) (“ Phoenix Light/U.S. Bank ”). Under the economic loss doctrine, “ plaintiff cannot seek damages by bringing a tort claim when the injury alleged is primarily the result of economic injury for which a breach of contract claim is available.” Phoenix Light/DB , 172 F. Supp. 3d at 718-19 (citing BNP Paribas Mortg. Corp. v. Bank of Am., N.A. , 949 F. Supp. 2d 486, 505 (S.D.N.Y. 2013)). Significantly, “Plaintiffs’ allegations that Defendant breached duties independent of its contracts do not, themselves, ‘allow evasion of the economic loss rule, which presents a second, distinct barrier’ to tort claims stemming from contractual relationships.” BlackRock Allocation Target Shares: Series S. Portfolio v. Wells Fargo Bank, Nat’l Ass’n , 247 F. Supp. 3d 377, 399 (S.D.N.Y. 2017) (“ Wells Fargo I ”) (quoting Royal Park Invs. SA/NV v. HSBC Bank USA, Nat’l Ass’n , 109 F. Supp. 3d 587, 599 (S.D.N.Y. 2015)). “The economic-loss rule provides that ‘a contracting party seeking only a benefit of the bargain recovery may not sue in tort notwithstanding the use of familiar tort language in its pleadings.’” Wells Fargo I , 247 F. Supp. 3d at 399 (quoting Phoenix Light/U.S. Bank , 2016 WL 1169515, at *9). In National Credit Union Admin. Bd. v. Deutsche Bank Nat’l Trust Co. , 14-cv-8919 (SHS) (S.D.N.Y. Oct. 15, 2019) ( here ), Judge Sidney H. Stein sided with the courts that applied the economic loss doctrine to dismiss negligence/gross negligence and breach of fiduciary duty claims seeking damages that overlapped with those sought by the plaintiff’s contract claims. National Credit Union Administration Board v. Deutsche Bank National Trust Co. Background The National Credit Union Administration Board (“NCUA”) is an independent federal agency that regulates federal credit unions. Among NCUA’s powers is the authority to place failed credit unions into liquidation. Upon liquidation, NCUA succeeds to “all rights, titles, powers, and privileges of the credit union, and of any member, accountholder, officer, or director of such credit union with respect to the credit union and the assets of the credit union.” 12 U.S.C. § 1787(b)(2)(A)(i). According to NCUA, in 2009 and 2010, in the aftermath of the financial crisis, it placed several failed corporate credit unions into liquidation and thus succeeded those entities. The failed corporate credit unions had assets that included residential mortgage-backed securities (“RMBS”) in trusts for which Deutsche Bank served as trustee. Each trust consisted of hundreds of individual residential mortgage loans that were pooled together and securitized for sale to investors. The trusts were governed by agreements called Pooling and Servicing Agreements (“PSAs”). Plaintiff filed suit against Deutsche Bank in connection with its duties as Trustee to the RMBS trusts. According to the complaint, Deutsche Bank had both common law and contractual duties as Trustee to, inter alia , (1) review the underlying mortgage files for completeness and accuracy, (2) notify appropriate parties and take various actions should it discover breaches of representations and warranties (“R&Ws”) concerning the mortgage loans, and (3) take similar protective actions upon learning of events of default concerning the trust. NCUA alleged that Deutsche Bank was derelict in its duties and failed to perform its obligations. According to NCUA, reports of systemic problems with the mortgages and the trusts, as well as Deutsche Bank’s own involvement in the RMBS market, supported the likelihood that Deutsche Bank had notice of the issues with the underlying mortgages, and yet it allegedly took no remedial action. Plaintiff asserted claims for: (1) breach of contract related to Deutsche Bank’s alleged breaches of the PSAs; (2) negligence and gross negligence related to Deutsche Bank’s alleged neglect of its duties as trustee; (3) breach of fiduciary duty; (4) declaratory judgment that Deutsche Bank was not permitted to use trust funds to pay its litigation costs; and (5) breach of contract for Deutsche Bank’s alleged unlawful withdrawals from the trust funds to pay its litigation costs. The contract claims stemmed from Deutsche Bank’s contractual duties as Trustee under the PSAs. Among the duties alleged to have been breached include: (1) pre-Event of Default (“EOD”) obligations, such as taking possession of and reviewing mortgage files conveyed to the trust and notifying relevant parties of any defects as well as providing notice of and enforcing repurchase rights with respect to mortgages that were found to be in breach of the R&Ws, and (2) post-EOD obligations where, after Deutsche Bank had notice of an EOD, it was required to provide notice to all certificateholders and act prudently in managing the EOD. The negligence/gross negligence claims stemmed from Deutsche Bank’s alleged duty to “administer the trusts without negligence” which it purportedly violated though the “fail to avoid conflicts of interest” and thus “protect the interests of the certificateholders,” specifically by not “(1) acting in good faith; (2) providing notice to certificateholders when appropriate ... and (3) acting with undivided loyalty to certificateholders.” The breach of fiduciary duty claim stemmed from Deutsche Bank’s alleged fiduciary duty “following Events of Default to act in good faith, with due care and undivided loyalty, and without conflicts of interest, when performing the obligations set forth in the PSAs,” which NCUA alleged that Deutsche Bank failed to do. On October 5, 2018, NCUA filed a motion for leave to file a proposed second amended complaint. Deutsche Bank opposed the amendment and moved to dismiss the amended allegations on the merits. With regard to the negligence/gross negligence and breach of fiduciary duty claims, Deutsche Bank argued that those claims should be dismissed because: (1) they were barred by the economic loss doctrine; (2) they were duplicative of plaintiff’s contract claims; (3) there was no fiduciary duty and the allegations of conflicts of interest were conclusory; and (4) there could be no negligence because Deutsche Bank’s duties were limited under the PSAs. Among other things, the Court denied the motion to dismiss Plaintiff’s contract claims and granted the motion to dismiss the negligence/gross negligence and breach of fiduciary duty claims. The Court’s Decision a) The Economic Loss Doctrine The Court agreed with the courts within the Southern District of New York that found the economic loss doctrine to apply to tort claims asserted against RMBS trustees. The Court rejected NCUA’s assertion that the economic loss doctrine did not apply because it pleaded “a legal duty separate from the contract claim,” holding that “even if true, the economic loss doctrine ‘presents a second, distinct barrier’ to the tort claims.” Slip Op. at 26, quoting Wells Fargo I , 247 F. Supp. 3d at 399. See also Nat’l Credit Union Admin. Bd. v. U.S. Bank Nat’l Ass’n , No. 14-cv-9928, 2016 WL 796850, at *11 (S.D.N.Y. Feb. 25, 2016) (even where a claim “may arise from common law duties and not from the PSA, ‘the injury’ and ‘the manner in which the injury occurred and the damages sought persuade us that plaintiff’s remedy lies in the enforcement of contract obligations,’ and are barred by the economic loss doctrine.”) (quoting Bellevue S. Assocs. v. HRH Const. Corp. , 78 N.Y.2d 282, 293 (1991)). The Court held that “the basis for plaintiff’s damages sound in Deutsche Bank’s failures to take actions under the PSAs, for which the asserted contractual remedies would be appropriate.” Slip Op. at *26.  The Court found support in its decision in the Second Circuit’s summary affirmance of Triaxx and the Appellate Division, First Department’s decision in Blackrock Balanced Capital Portfolio in which the court affirmed the dismissal of the plaintiff’s tort claims against the RMBS trustee, finding that “‘the court correctly determined that the tort claims barred by the economic loss doctrine.’” Id. , quoting Blackrock Balanced Capital Portfolio (FI) v. U.S. Bank Nat’l Ass’n , 165 A.D.3d 526, 528 (1st Dept. 2018). The Court took issue with NCUA’s argument that it had “actually asserted separate duty owed by Deutsche Bank,” noting that “although the contain the proper words to make out an independent tort claim, the pleading quite hollow on substance.” Id . at *27. Citing to the language of the proposed complaint, the Court stated: “The fact that Deutsche Bank’s alleged duty stems from the PSAs is revealed by the glaring oxymoron nestled within the PSAC’s negligence allegations: ‘Defendant owed the certificateholders, including Plaintiffs, extracontractual duties under the PSAs.’” Id . The Court rejected NCUA’s explanation that the use of the quoted language was intended to “to demonstrate that there were ‘extracontractual duties’, viewing such language as a mere label “to somehow transmogrify them into extracontractual claims.” Id ., quoting Triaxx , 2018 WL 1417850, at *6. The Court also found that the fiduciary duty claim suffered from the same infirmity. Id . “Less conspicuous but also consistent the reference to the PSAs in the fiduciary duty count.” Id . The Court concluded that “ ecause, among other indicators, the consistent references to the PSAs reveal how reliant NCUA’s tort claims are on the contracts at issue, the Court grant defendant’s motion to dismiss plainitff’s tort claims on economic loss grounds.” Id . b) NCUA’s Tort Claims Were Deemed to Be Largely Duplicative of Its Contract Claims “Independently”, the Court granted Deutsche Bank’s motion to dismiss NCUA’s tort claims because they were “duplicative of the contract claims - with one exception.” Id ., citing Bayerische Landesbank, N. Y. Branch v. Aladdin Capital Mgmt. LLC , 692 F.3d 42, 58 (2d Cir. 2012) (where “the basis of a party’s claim is a breach of solely contractual obligations, such that the plaintiff is merely seeking to obtain the benefit of the contractual bargain through an action in tort, the claim is precluded as duplicative.”); Bakal v. U.S. Bank Nat’l Ass’n , No. 15-cv-6976, 2018 WL 1726053 (S.D.N.Y. Apr. 2, 2018), aff’d , 747 F. App’x 32 (2d Cir. 2019). With respect to the negligence claim as it related to pre-EOD duties, the Court held that Deutsche Bank owed NCUA a duty to avoid conflicts of interest. Slip Op. at *28.  “Allegations of breach of an independent duty to avoid conflicts of interest,” said the Court, “are properly pled as negligence claims, not as breaches of any fiduciary duty.” Id ., citing Phoenix Light SF Ltd. v. Bank of New York Mellon , No. 14-cv-10104, 2015 WL 5710645, at *7 (S.D.N.Y. Sept. 29, 2015). “Therefore,” concluded the Court, “solely to the extent that plaintiff’s negligence claim in Count Two alleges a breach of duty to avoid conflicts of interest, that claim is not duplicative.” Id ., citing Commerzebank/BNYM , 2017 WL 1157278, at *6 (dismissing all tort claims as duplicative save for claims relating to trustee's conflict of interest); Fixed Income Shares: £Series M v. Citibank N.A. , 130 F. Supp. 3d 842, 857-58 (S.D.N.Y. 2015) (same). However, the Court dismissed the claim “because of the economic loss doctrine.” Id . Takeaway The economic loss doctrine preserves the distinction between claims sounding in contract and those sounding in tort and protects defendants from disproportionate damages awards that a judgment in tort may impose. Though originated in the context of product liability and construction cases, the economic loss doctrine has been applied in a wide variety of cases having nothing to do with their forerunners. Consequently, what was a straightforward way to achieve the goals of the doctrine has become a principle of law with no standard application.   Given the split in authority within the Southern District of New York, the question remains whether the economic loss doctrine can truly be applied outside the products liability and construction law context.   National Credit Union answers this question by adding to the uncertainty surrounding application of the doctrine.

In today’s commercial world, businesses claiming breach of an agreement often seek lost profits resulting from the breach. The hurdle that the plaintiff must overcome when seeking such relief, however, can be high. As discussed below, the reason has to do with the type of damages sought and the applicable standard of proof. There are two types of damages recoverable as lost profits: (1) lost profits that are general damages; and (2) lost profits that are consequential or special damages. As the New York Court of Appeals has noted: “The distinction between general and special contract damages is well defined but its application to specific contracts and controversies is usually more elusive.” Biotronik A.G. v. Conor Medsys. Ireland, Ltd. , 22 N.Y.3d 799, 805-806 (2014) (internal quotation marks and citation omitted). Lost profits as general damages “are the natural and probable consequence of the breach” of a contract. Biotronik , 22 N.Y.3d at 805, citing American List Corp. v. U.S. News & World Report , 75 N.Y.2d 38, 43 (1989); Kenford Co. v County of Erie , 73 N.Y.2d 312, 319 (1989). General damages include “money that the breaching party agreed to pay under the contract.” Tractebel Energy Mktg., Inc. v. AEP Power Mktg., Inc. , 487 F.3d 89, 109 (2d. Cir 2007), citing American List Corp. , 75 N.Y.2d at 44. In other words, “a claim for general damages” exists where the plaintiff “seeks only what it bargained for—the amount it would have profited on the payments promised to make.” Tractebel , 487 F.3d at 110; see also Biotronik , 22 N.Y.3d at 806 (the “direct and immediate fruits” of a contract are general damages) (quoting Tractebel , 487 F.3d at 109 n.20). Lost profits may be recovered as general damages if there is a “stable foundation for a reasonable estimate.” Tractebel , 487 F.3d at 110 (internal quotation and citations omitted). To plead a stable foundation, a plaintiff must show that “ here are some facts upon which a jury could base a judgment, not certain nor strictly accurate, but sufficiently so for the administration of justice.” Wakeman v. Wheeler & Wilson Mfg. Co. , 101 N.Y. 205, 216 (1886); accord Plant Planners, Inc. v. Pollock , 60 N.Y.2d 779, 780–81 (1983) (lost profits are “recoverable where plaintiff has supplied some adequate basis for computing the amount.”). This standard flows from the principle that a party who breaches “his contract should not be permitted entirely to escape liability because the amount of the damage which he has caused is uncertain.” Tractebel , 487 F.3d at 110 (quoting Wakeman , 101 N.Y. at 209).  Under the stable foundation standard, therefore, general damages may be awarded for lost profits even where they are uncertain and difficult to estimate. See Randall-Smith, Inc. v. 43rd St. Estates Corp. , 17 N.Y.2d 99, 105 (1966) (“The rule to be applied is a flexible one”); see also Tractebel , 487 F.3d at 112 (“New York courts have significant flexibility in estimating general damages once the fact of liability is established.”). Lost profits as consequential, or special damages, do not “directly flow from the breach.” American List Corp. , 75 N.Y.2d at 43. Where the damages were the result of a separate agreement with a nonparty, they are consequential damages. Typically, consequential damages involve a breach of contract that interferes with “the ability of the non-breaching party to operate his business, and thereby generate profits on collateral transactions” such that “profits from potential collateral exchanges are ‘lost.’” Tractebel , 487 F.3d at 109. Lost profits as consequential or special damages “are only recoverable when ‘(1) it is demonstrated with certainty that the damages have been caused by the breach, (2) the extent of the loss is capable of proof with reasonable certainty, and (3) it is established that the damages were fairly within the contemplation of the parties.’” Biotronik , 22 N.Y.2d at 806, quoting Tractebel , 487 F.3d at 109, citing Kenford Co. v. County of Erie , 67 N.Y.2d 257, 261 (1986). As to the second requirement, the damages must be capable of measurement based upon known reliable factors. Ashland Mgt. Inc. v. Janien , 82 N.Y.2d 395, 403 (1993). They cannot be “speculative, possible or imaginary, but must be reasonably certain and directly traceable to the breach.” Id . Finally, the damages cannot be “remote or the result of other intervening causes.” Id . Notably, if a new business is seeking to recover for the loss of future profits, the courts impose “a stricter standard … for the obvious reason that there does not exist a reasonable basis of experience upon which to estimate lost profits with the requisite degree of reasonable certainty.” Id. , citing Cramer v. Grand Rapids Show Case Co. , 223 N.Y. 63 (1918); 25 CJS, Damages, § 42(b). In Electron Trading LLC v. Perkins Coie LLP , 2019 N.Y. Slip Op. 33019(U) (Sup. Ct., N.Y. County Oct. 9, 2019) ( here ), Justice O. Peter Sherwood of the Supreme Court, New York County, Commercial Division, addressed the foregoing principles in dismissing the plaintiff’s claim for lost profits. electron trading llc v. morgan stanley & co. llc, 157 a.d.3d 579 (1st dept. 2018), as well as the factual recitation by justice sherwood.> electron trading llc v. morgan stanley & co. llc, 157 a.d.3d 579 (1st dept. 2018), as well as the factual recitation by justice sherwood.> Plaintiff, Electron Trading LLC (“Electron”), a developer of intellectual property relating to “spread” trading, a type of electronic securities trading, entered into two agreements with Morgan Stanley & Co. LLC (“Morgan Stanley”): an Exclusive License Agreement (“ELA”) whereby it granted Morgan Stanley an exclusive license for its alternative trading system (“ATS”) and a Consulting Services Agreement (“CSA”) whereby it agreed to perform related consulting services. The ELA required Morgan Stanley to use commercially reasonable efforts to develop and implement necessary software and systems, to operate and market the ATS, and to launch the ATS by a defined deadline. Morgan Stanley conceded, for the sake of argument, that it breached the ELA by not performing any of its obligations. The parties disputed whether Electron’s damages were limited by the ELA’s limitation of liability provision. Morgan Stanley moved to dismiss.  The Court (Saliann Scarpulla, J.) granted Morgan Stanley’s motion with regard to, inter alia , Electron’s breach of contract claim but only to the extent that Electron sought damages above the amount allowed under the contractual limitation of liability clause in the ELA. The Appellate Division, First Department, unanimously affirmed. Thereafter, Electron commenced a legal malpractice action against defendants Perkins Coie, LLP and Bracewell LLP. Both firms represented Electron in negotiating the ELA and CSA. Plaintiff claimed that defendants failed to properly advise it as to the limitation of liability provision set forth in the ELA. Among other damages, Electron sought the lost profits it would have received if Morgan Stanley had developed the system and third parties using the system had generated revenue to cover costs. Defendants moved to dismiss the claim for lost profits, arguing that such damages were inherently speculative and not within the parties’ contemplation when plaintiff and Morgan Stanley signed the ELA. Defendants also claimed that any diminution in value of the intellectual property due to Morgan Stanley’s breach was not caused by defendants and in any event, such claim was precluded by the Appellate Division’s decision. Justice Sherwood granted the motion. First, Justice Sherwood held that Electron failed to demonstrate that its lost profit damages were consequential or special damages. In fact, noted the Court, “ he complaint not allege that the parties ever discussed lost profits damages in the event of breach of the License Agreement.” Slip Op. at *3. Thus, concluded the Court, plaintiff failed to meet “the foreseeability branch of the applicable standard.…” Id . Second, the Court held that Electron failed to demonstrate that its lost profit damages were general damages. Justice Sherwood rejected the notion that Electron’s alleged damages were “quintessential general damages”. Id . (internal quotation marks and citation to briefing omitted). Electron claimed that under the License Agreement, it was owed royalties as a consequence of Morgan Stanley’s breach. However, said the Court, there was no mechanism in the ELA or the CSA “for calculating the amount of royalties to be paid.” Id . The Court explained: No comparable formula can be found in the parties’ agreements here. There is no provision for any specific payments to be used in the Spread Trading System. Morgan Stanley was not required to pay Electron any fixed amount. There was no minimum volume of trades acquired or commission amounts provided. In fact, there were no metrics by which the parties could project future receivables and therefore on which lost profits might be calculated. Id . The Court further explained: The License Agreement only required Morgan Stanley to provide Electron 25% of the Net Revenue generated by the Spread Trading System if the parties were successful in fully developing it…. Thus, for Electron to receive any payment, third parties would have had to elect to use the system to execute spread trades; Morgan Stanley and Electron would then have to set a competitive amount of commissions to charge third parties for use of the system; and those commissions would have to generate revenues that exceed various expenses before Morgan Stanley would owe Electron the type of profit payments Electron might seek to recover. Id . at **3-4. Based upon the foregoing, the Court found that whether or how the system would have been received by third parties was “entirely speculative” – a conclusion, noted the Court, both Justice Scarpulla and the First Department reached. Id . at *4. Accordingly, the Court granted defendants’ motion and dismissed plaintiff’s claims for lost profits and diminution-in-value damages. Takeaway As discussed above, the distinction between general and special or consequential damages is meaningful, especially given the standard of proof that attaches to each one. While the standard of proof applicable to general damages is less demanding than that which is applicable to consequential damages, it nevertheless requires a stable foundation upon which the trier of fact can base an award. In Electron Trading , the Court held that the plaintiff could not satisfy the less demanding standard of proof because there was no formula or metric by which the parties could project future receivables and, therefore, calculate the amount of lost profits that flowed from Morgan Stanley’s breach.

In Pari Delicto, the Adverse Interest Exception and the Alleged Failure to Uncover Fraudulent Activity The doctrine of in pari delicto has been a part of the common law for at least two centuries. Kirschner v. KPMG LLP , 15 N.Y.3d 446 (2010), citing  Woodworth v. Janes , 2 Johns Cas 417, 423 (N.Y. 1800) (parties in equal fault have no rights in equity); Sebring v. Rathbun , 1 Johns Cas 331, 332 (N.Y. 1800) (where both parties are equally culpable, courts will not “interpose in favour of either”). It requires the court to refrain from resolving a dispute between two wrongdoers. As the Court of Appeals explained more than 70 years ago: o court should be required to serve as paymaster of the wages of crime, or referee between thieves. Therefore, the law will not extend its aid to either of the parties or listen to their complaints against each other, but will leave them where their own acts have placed them. Stone v. Freeman , 298 N.Y. 268, 271 (1948) (internal quotation marks omitted). The doctrine ( i.e. , that a wrongdoer should not profit from his own misconduct) “is so strong in New York” that the Court of Appeals has held that it “applies even in difficult cases and should not be ‘weakened by exceptions.’” Kirschner , 15 N.Y.3d at 464, quoting McConnell v. Commonwealth Pictures Corp. , 7 N.Y.2d 465, 470 (1960); see also Saratoga County Bank v. King , 44 N.Y. 87, 94 (1870) (characterizing the doctrine as “inflexible”). Agency Law and the Principle of Imputation “Traditional agency principles play an important role in an in pari delicto analysis.” Kirschner , 15 N.Y.3d at 465. In this regard, “of particular importance” is the principle of imputation – that is, “the acts of agents, and the knowledge they acquire while acting within the scope of their authority are presumptively imputed to their principals.” Id . (citations omitted). Thus, the law “presumes imputation even where the agent acts less than admirably, exhibits poor business judgment, or commits fraud.” Id . (citation omitted). The foregoing applies equally to corporations. Corporations act through their officers or other duly authorized agents. Id . (citation omitted). Thus, although corporations are not natural persons, they are, nonetheless, responsible for the acts of their authorized agents even if the acts were unauthorized. Id . (citation omitted). As the Court of Appeals “explained long ago, a corporation ‘is represented by its officers and agents, and their fraud in the course of the corporate dealings[ ] is in law the fraud of the corporation.’” Id ., quoting Cragie v. Hadley , 99 N.Y. 131, 134 (1885). See also Wight v. BankAmerica Corp. , 219 F.3d 79, 86-87 (2d Cir. 2000) (under “fundamental principle(s) of agency,” managers’ misconduct within the scope of their employment is imputed and “bars a trustee from suing to recover for a wrong that he himself essentially took part in”). Likewise, “ hen corporate officers carry out the everyday activities central to any company’s operation and well-being—such as issuing financial statements, accessing capital markets, handling customer accounts, moving assets between corporate entities, and entering into contracts—their conduct falls within the scope of their corporate authority.” Kirschner , 15 N.Y.3d at 465-66 (citation omitted). “And where conduct falls within the scope of the agents’ authority, everything they know or do is imputed to their principals.” Id . at 466. In every case, the law presumes that agents “communicate information to their principals.” Id . This is so “except where the corporation is actually the agent’s intended victim.” Id ., quoting Center v. Hampton Affiliates , 66 N.Y.2d 782, 784 (1985) (“when an agent is engaged in a scheme to defraud his principal . . . he cannot be presumed to have disclosed that which would expose and defeat his fraudulent purpose”). However, “ here the agent is defrauding someone else on the corporation’s behalf, the presumption of full communication remains in full force and effect. Id . (citations omitted). Adverse Interest Exception to Imputation As with most rules, there are exceptions. With the in pari delicto doctrine, the Court of Appeals has recognized “adverse interest” to be an exception to the rule. “‘To come within the exception, the agent must have totally abandoned his principal’s interests and be acting entirely for his own or another’s purposes. It cannot be invoked merely because he has a conflict of interest or because he is not acting primarily for his principal.” Kirschner , 15 N.Y.3d at 466, quoting Center , 66 N.Y.2d at 784-785 (emphasis added). The exception “avoids ambiguity where there is a benefit to both the insider and the corporation, and reserves this most narrow of exceptions for those cases—outright theft or looting or embezzlement—where the insider’s misconduct benefits only himself or a third party; i.e. , where the fraud is committed against a corporation rather than on its behalf.” Id . at 466-67. Thus, where “the agent is perpetrating a fraud that will benefit his principal,” as opposed to himself/herself (which is “adverse” to the principal), the exception will not apply. Id . at 467. In the context of fraud, therefore, the exception will not be invoked where the fraud benefits the corporation, because “ fraud that by its nature will benefit the corporation is not ‘adverse’ to the corporation’s interests.” Id . This is so “even if was actually motivated by the agent’s desire for personal gain.” Id . (citations omitted). In Kirschner , the Court of Appeals underscored the point that the exception requires adversity: Again, because the exception requires adversity, it cannot apply unless the scheme that benefitted the insider operated at the corporation’s expense. The crucial distinction is between conduct that defrauds the corporation and conduct that defrauds others for the corporation’s benefit. “Fraud on behalf of a corporation is not the same thing as fraud against it” ( Cenco Inc. v Seidman & Seidman , 686 F2d 449, 456 <7th cir 1982> ), and when insiders defraud third parties for the corporation, the adverse interest exception is not pertinent. Thus, as we emphasized in Center , for the adverse interest exception to apply, the agent “must have totally abandoned his principal’s interests and be acting entirely for his own or another’s purposes,” not the corporation’s ( Center , 66 NY2d at 784-785 ). So long as the corporate wrongdoer’s fraudulent conduct enables the business to survive—to attract investors and customers and raise funds for corporate purposes—this test is not met ( Baena , 453 F3d at 7 <“a fraud by top management to overstate earnings, and so facilitate stock sales or acquisitions, is not in the long-term interest of the company; but, like price-fixing, it profits the company in the first instance”> ). Kirschner , 15 N.Y.3d at 467-68. Notably, “any harm from the discovery of the fraud—rather than from the fraud itself—does not bear on whether the adverse interest exception applies.” Id . at 468.  The Court of Appeals reasoned that “ he disclosure of corporate fraud nearly always injures the corporation. If that harm could be taken into account, a corporation would be able to invoke the adverse interest exception and disclaim virtually every corporate fraud—even a fraud undertaken for the corporation’s benefit—as soon as it was discovered and no longer helping the company.” Id . at 468. The foregoing principles were recently considered by the Appellate Division, First Department in Conway v. Marcum & Kliegman LLP , 2019 N.Y. Slip Op. 07338 (1st Oct. 10, 2019) ( here ). There, the Court held that issues of fact surrounding application of the adverse interest exception precluded dismissal of the action on summary judgment grounds. Conway involved an accounting malpractice action in which the plaintiffs, the liquidators of several hedge funds, alleged that the defendants failed to uncover fraudulent activity by the funds’ investment managers. The issue before the Court was whether “the adverse interest exception to the equitable defense of in pari delicto bar the defense in th case.” Slip Op. at *1. The motion court held that the exception did not apply and granted summary judgment to the defendants.  The First Department reversed, holding that “plaintiffs raised issues of fact as to the adverse nature of their interests vis-a-vis those of their agents, the funds’ investment managers,” sufficient to “preclude summary dismissal of the complaint on the ground of the in pari delicto defense.” In the motion court, defendants argued, among other things, that the adverse interest exception did not apply because the fraudulent activities of the funds’ investment managers benefited the funds. Defendants maintained that their audits of the funds’ financial statements allowed the funds to remain a going concern much longer than if no audit was performed. According to defendants, the audits allowed the investment managers to restructure the funds, thereby allowing investors to move their investments into another fund and limit their ability to redeem their money. As such, the audits allowed the funds the opportunity to survive, even for a short period of time, which, defendants claimed, was a benefit that made the adverse interest exception inapplicable. The First Department rejected this argument: Moreover, reliance on speculation about the benefits to be derived from the continued existence of an entity is inconsistent with the analysis of the adverse interest exception in Kirschner . It may be possible in every case to construct a hypothetical scenario where the company teetering on the brink of insolvency because of its agent’s fraud meets with an opportune circumstance that allows it to resume legitimate business operations. Permitting such speculation would render the adverse interest exception meaningless. Further, an ongoing fraud and a continued corporate existence may harm a corporate entity: The agent may prolong the company’s legal existence so that he can continue to loot from it, as appears to have been the case here. Slip Op. at *1. The Court also found that “ he other purported ‘benefits’ cited by defendants also insufficient to show that the adverse interest exception inapplicable, there factual questions as to whether the funds were beneficiaries, rather than victims, of the investment managers’ fraud.” Id . Takeaway The in pari delicto doctrine serves two important public policy purposes. First, it deters illegal activity by denying judicial relief to an admitted wrongdoer. Second, it conserves judicial resources because it avoids entangling courts in disputes between wrongdoers. Kirschner , 15 N.Y.3d at 464. Notwithstanding, the doctrine will not bar an action when an agent totally abandons his/her principal’s interests and acts entirely for his/her own purposes or those of another ( i.e. , the agent’s acts are “totally” adverse to the principal). Id . at 466. In Conway , Defendants were unable to persuade the Court that the investment managers acted solely for the funds’ benefit. As such, denial of summary judgment was deemed appropriate.

Specific Performance is an equitable remedy used to compel a party to perform under a contract.  McGinnis v. Cowhey , 24 A.D.3d 629 (2 nd Dep’t 2005).  Specific Performance is frequently used to enforce a party’s rights under real estate contracts.  In EMF General Contracting Corp. v. Bisbee , 6 A.D.3d 45 (2004), the First Department set forth the elements of a specific performance claim: The elements of a cause of action for specific performance of a contract are that the plaintiff substantially performed its contractual obligations and was willing and able to perform its remaining obligations, that defendant was able to convey the property, and that there was no adequate remedy at law. *     *     * Generally, the equitable remedy of specific performance is routinely awarded in contract actions involving real property, on the premise that each parcel of real property is unique. EMF , 774 N.Y.S.2d at 44 (citations omitted). The Second Department, in Utica Builders, LLC v. Collins (October 9, 2019), affirmed Supreme Court’s dismissal of a complaint in which the plaintiff, a potential purchaser of real property, sought specific performance of a contract of the sale. As a result of the Utica parties’ negotiations for a purchase/sale of real property in Brooklyn, the plaintiff sent defendant a purchase proposal in which it offered to purchase the property for $590,000 and delivered a $29,500 deposit.  In response, the defendant forwarded to the plaintiff an unexecuted contract of sale that, among other things, was consistent with plaintiff’s price terms and which provided that the property was being sold “as is.”  The plaintiff, in turn, returned to defendant executed contracts and an additional deposit check in the amount of $29,000.  Plaintiff, however, included on the contract executed by it, handwritten amendments in the form of representations by the defendant that the property was improved with a legal two-family dwelling.  Defendant’s attorney returned to plaintiff fully executed contracts after modifying plaintiff’s changes from “two family” to “one family.” Despite defendant’s attempts to schedule a closing, plaintiff refused to close without “a certificate of occupancy designating the premises as a two-family dwelling or a letter of no objection to that effect.”  Plaintiff advised that without proof that the property could be used as a legal two-family dwelling, plaintiff would deem the contract cancelled and seek the return of the $59,000 deposit.  Subsequently, defendant declared a default and indicated that plaintiff could cure by closing on or before June 8, 2015.  In response, the plaintiff urged that the parties did not have a binding contract and sought the return of the deposit.  In correspondence between the parties on June 2, 2015, defendant continued to argue that the parties had a binding contract and the plaintiff again demanded the return of its deposit. Almost a year later, in May of 2016, plaintiff commenced an action for specific performance.  Supreme Court granted defendant’s motion for summary judgment dismissing the complaint, finding that the parties “never entered into an enforceable contract for the sale of the subject property” and the Second Department affirmed. The Second Department found that the parties never had a “meeting of the minds” as to material terms of the purchase/sale contract and that “specific performance may be awarded only where there is a valid existing contract for which to compel performance.”  (Citations omitted.) The Second Department’s decision was based on the fact that the: … documentary evidence established that the parties were never truly in agreement with respect to all material terms, because the plaintiff did not intend to pay the proposed contract price for a one-family dwelling, and the defendant could not or would not represent that the subject property was a legal two-family dwelling. The plaintiff's signing of the proposed contract did not create a binding agreement between the parties, as the plaintiff's acceptance was conditioned on material changes to the contract and, thus, constituted a counteroffer, which the defendant did not accept. Because the parties never came to a meeting of the minds regarding essential terms of the agreement, there was no binding and enforceable contract between the parties. (Citations omitted.) In Utica , while the Court determined that the remedy of specific performance is unavailable absent an enforceable contract, it should be noted that there was a lengthy delay before plaintiff commenced its action for specific performance.  Because specific performance is an equitable remedy, the “available defenses include serious unfairness, undue hardship, and laches, or unreasonable prejudicial delay.”  EMF , 6 A.D.3d at 52 (citations omitted).  In this regard, specific performance will not be granted where speculation related delay is a factor.  Thus, “where it is established that the buyer has made excuses in order to delay closing on the contract, with an actual purpose of waiting to see whether to enforce the contract depending upon whether the market value of the subject property increases or decreases, the courts will not grant specific performance.”  EMF , 6 A.D.3d at 53 (citations omitted). While it is not suggested that the delay present in Utica would have vitiated plaintiff’s claim for specific performance had there been an enforceable contract between the parties, it is important to consider the impact of the delay in exercising one’s rights to, inter alia , this equitable remedy.

It is not uncommon for a client to claim that he/she had an agreement with another based on oral representations that were not memorialized in the writing between them. The question for practitioners and the courts is whether the oral assurances constitute a binding agreement. In LiTrenta v. Chappaqua Cent. Sch. Dist. , 2019 N.Y. Slip Op. 51556(U) (Sup. Ct., Westchester County Oct. 4, 2019) ( here ), the Court answered the question in the negative. LiTrenta involved an action to recover damages for breach of contract. Plaintiff, Marie LiTrenta (“Plaintiff” or “LiTrenta”), claimed that her employer, Defendant Chappaqua Central School District (“Defendant” or the “District”), owed her medical benefits pursuant to an oral agreement following her retirement as an administrator of the District. LiTrenta began her employment with the District on August 1, 2000, as Assistant Superintendent for Curriculum and Technology. At the time, the District provided retirees with lifetime health benefits on the District’s group health plan. Pursuant to the District’s Handbook on Personnel Practices and Procedures (the “Handbook”), however, those benefits were available only to retirees with a minimum District service of five years. On January 10, 2002, the then Superintendent of Schools, James F. Donovan (“Donovan”), issued a memo to the benefits clerk stating that Plaintiff was entitled to the administrator’s benefit package as a vested employee upon her retirement, which included medical, dental, vision, and life insurance as per the current administrator’s contract. Thereafter, Plaintiff advised Superintendent Donovan that she would be retiring effective February 2, 2003. Although Plaintiff retired with less than five years of service, the District paid her medical benefits through 2019. In May 2019, Plaintiff was notified by the District that she was not eligible for health insurance through the school district and that such coverage would terminate after June 30, 2019. She was further advised that the District would no longer contribute to reimbursement of the cost of Medicare Part B. As a result, Plaintiff commenced the action for breach of contract. Plaintiff sought a temporary restraining order to restrain Defendant from taking any action to terminate her current medical coverage which the Court granted on the record pending the resolution of a motion for a preliminary injunction. Thereafter, Plaintiff moved for a preliminary injunction to enjoin Defendant from taking any action to terminate her medical coverage. The Court held a preliminary injunction hearing on June 17, 2019. Plaintiff testified that upon accepting employment with the District, the then Superintendent, Dr. Donald Parker (“Parker”), assured her that upon retirement, the District would pay her lifetime benefits for medical coverage. She testified that she would not have taken the position with the District without that assurance since she was eligible for lifetime medical benefits with her prior school district. Plaintiff further testified that she retired from the District in 2003 to work in private schools in Miami and in Manhattan. According to Plaintiff, upon her retirement, she was assured by Superintendent Donovan that the District would provide her with lifetime medical benefits even though she had less than five years of service with the District. Plaintiff admitted during the hearing that she was aware that for a school district to contract with an employee, the terms of the contract must be authorized by the district’s Board of Education. John Chow (“Chow”) testified for the District. As the Assistant Superintendent for Business for the Chappaqua Central School District, Chow was responsible for the District’s finances, including salaries, benefits, and operations. Chow confirmed that under the Handbook, retirement benefits, such as continued medical coverage, were available to retirees who had at least five years of service with the District. Chow also referenced the Board of Education meeting minutes of November 5, 2002, which reflected Plaintiff’s resignation for purpose of retiring as effective on February 2, 2003. Chow testified that he found no employment contract between the District and Plaintiff. Notably, Chow testified that there was nothing in the minutes from the November 5th meeting reflecting a decision by the Board of Education to waive the Handbook requirement of minimum service to the District in connection with Plaintiff’s retirement. Chow further testified that Plaintiff was not a vested employee because she had less than five years of service with the District. Chow explained that the reason the Board of Education was unaware that Plaintiff received the medical benefits was because the budget it received only included a budget line for health insurance and all retirees and current employees were collectively on that one line represented by a dollar figure. Following the hearing and post-hearing briefing, the Court denied the motion, holding that Plaintiff failed to satisfy the elements required to obtain a preliminary injunction – that is, a probability of success on the merits, danger of irreparable injury ( i.e. , injury for which money damages are insufficient) in the absence of an injunction and a balance of equities in its favor. Slip Op. at *3, citing Nobu Next Door, LLC v. Fine Arts Hous., Inc. , 4 N.Y.3d 839 (2005); CPLR 6301. First, the Court held that Plaintiff failed to demonstrate a likelihood of success on her breach of contract claim. Under the Handbook, lifetime medical benefits were funded by the District for certain employees with a minimum district service requirement of five years. To obtain such benefits with less than the required minimum, an employee needed a waiver of the requirement from the Board of Education. “The plaintiff has not presented any contract with the Board of Education waiving the five-year requirement,” observed the Court. Slip Op. at *4. The Court explained that the minutes of the July 11, 2000, Board of Education meeting, when Plaintiff was hired, were devoid of any resolution by the Board approving a waiver of the five-year minimum service requirement for Plaintiff to receive lifetime benefits. Id . Similarly devoid of such a waiver was the July 13, 2000 letter from Superintendent Parker wherein he advised Plaintiff that the Board accepted his recommendation for her employment. Id . The Court explained that pursuant to the Education Law, only a board of education is vested with the power to enter into employment contracts and, therefore, issue a waiver. Id ., citing Kight v. Wyandanch Union Free Sch. Dist. , 84 A.D.2d 749 (2d Dept. 1981); Education Law, § 1709<16> ). “Thus,” said the Court, “the plaintiff’s reliance on Superintendent Parker’s oral assurance upon her hiring that she would be provided with lifetime medical benefits and the January 2002 internal correspondence from Superintendent Donovan to the benefits clerk that plaintiff is entitled to the administrator’s benefit package upon her retirement as a vested employee, i.e. an employee with at least five years of service, does not avail plaintiff of entitlement to a preliminary injunction.” Id . The Court explained that “ he superintendents did not have the power or authority to enter into any contract with the plaintiff to waive the five-year employment requirement for lifetime medical benefits.” Id . Since “ either the verbal assurance of the superintendent nor the correspondence came from the Board of Education,” there could be no enforceable contract. Id . Simply stated, “ here has been no evidence submitted nor testimony elicited at the hearing establishing that the District’s Board of Education waived the five-years of service requirement so that plaintiff would be entitled to lifetime health insurance.” Id . The Court rejected Plaintiff’s argument that the Board ratified the oral assurances by paying the benefits since she retired in 2003. The Court found “no evidence … that the Board of Education knew that plaintiff was being treated as vested even though she had less than five years of service with the District.…” Id . Finally, the Court held that Plaintiff “failed to allege damages of a noneconomic nature and therefore, not demonstrate[ ] irreparable injury.” Id ., citing DiFabio v. Omnipoint Communications, Inc. , 66 A.D.3d 635 (2d Dept. 2009). Takeaway “It is well settled that unless an employment is for a specified period, it is presumed to be an employment at will, and that, ‘absent a constitutionally impermissible purpose, a statutory proscription, or an express limitation in the individual contract of employment, an employer’s right at any time to terminate an employment at will remains unimpaired.’” Collins v. Hoselton Datsun, Inc. , 120 A.D.2d 952, 952 (4th Dept. 1986), quoting Murphy v. American Home Prods. Corp. , 58 N.Y.2d 293, 305 (1983); see also Lobosco v. NY Tel. Co./Nynex , 96 N.Y.2d 312, 316 (2001). New York “does not recognize the tort of wrongful discharge” upon which an employee at will may base a cause of action.   Id . Nevertheless, New York courts have held that provisions in an employee handbook or policy manual may constitute an employment contract on which a breach of contract action may be based. Lobosco , 96 N.Y.2d at 316 citing Weiner v. McGraw-Hill, Inc. , 57 N.Y.2d 458 (1982). In LiTrenta , though not explicitly stated, the Court found that the Handbook constituted a binding contract between the parties. As such, it spoke to the issue of lifetime healthcare benefits and the requirements necessary to receive such benefits. Since Plaintiff could not demonstrate a waiver of those requirements ( e.g. , minimum service of five years to the District), she could not demonstrate a breach of the Handbook. Thus, Plaintiff’s reliance on the assurances of those without the statutory authority to make them simply was not enough to support her claim.

The Foreign Corrupt Practices Act (“FCPA”) requires issuers to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that” all transactions are “executed” and “recorded … to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and … to maintain accountability for assets.” 15 U.S.C. §§ 78m(b)(2)(B). As discussed below, compliance with this requirement has been a continued focus of the Securities and Exchange Commission (“SEC” or the “Commission”) for many years. ( Here .) The internal controls provisions of the FCPA apply to all issuers ( i.e. , entities that register their securities pursuant to Section 12 of the Securities Exchange Act of 1934 (“Exchange Act”) or file reports (periodic or otherwise) pursuant to Section 15(d) of the Exchange Act) whether they are publicly traded or based in the United States. Under the FCPA, issuers are responsible for their internal controls as well as those of their subsidiaries. However, the FCPA limits the obligations of the parent corporation when the parent owns less than 50% of the subsidiary. Under that circumstance, the parent need only demonstrate a good faith effort to ensure the sufficiency of the subsidiary’s internal controls. 15 U.S.C. § 78m(b)(6). Compliance with the internal controls provisions of the FCPA requires issuers to give “reasonable assurance” that transactions are executed, and assets are accounted for in accordance with management’s authorization and recorded as necessary to permit the preparation of financial statements in conformity with generally accepted accounting principles. The FCPA defines “reasonable assurances” as “such level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs.” 15 U.S.C. § 78m(b)(7). Courts interpret the “reasonable assurance” standard as follows: The definition of accounting controls does comprehend reasonable, but not absolute, assurances that the objectives expressed in it will be accomplished by the system. The concept of “reasonable assurances” . . . recognizes that the costs of internal controls should not exceed the benefits expected to be derived.”  It does not appear that either the SEC or Congress . . . intended that the statute should require that each affected issuer install a fail-safe accounting control system at all costs. It appears that Congress was fully cognizant of the cost-effective considerations which confront companies. . . and of the subjective elements which may lead reasonable individuals to arrive at different conclusions. Congress has demanded only that judgment be exercised in applying the standard of reasonableness.… It is also true that the internal accounting controls provisions contemplate the financial principle of proportionality—what is material to a small company is not necessarily material to a large company.” SEC v. World-Wide Coin Invs., Ltd. , 567 F. Supp. 724, 751 (N.D. Ga. 1983). Since compliance with the FCPA’s internal controls provision is a fact-dependent, analysis, courts and the Commission look at several factors to determine whether the issuer has established and maintained an effective internal accounting controls system. Among the factors considered are the “size of the business, diversity of operations, degree of centralization of financial and operating management, amount of contact by top management with day-to-day operations.…” Id . See also Foreign Corrupt Practices Act of 1977: Statement of Policy, SEC Release No. 34-17500 (Jan. 29, 1981) (46 F.R. 11544). ( Here at Appendix L.) Notably, the materiality of the transaction is not a factor considered by the courts or the Commission. As noted, enforcement of the FCPA remains “a high priority area for the SEC.” ( Here .) In 2010, the SEC’s Enforcement Division created a specialized unit to enhance its enforcement of the FCPA ( here ). Since that time, the SEC has commenced and/or settled numerous enforcement proceedings involving the anti-bribery and/or internal controls provisions of the FCPA. Today, this Blog examines In the Matter of Westport Fuel Systems, Inc. et al. , Administrative Proceeding File No. 3-19543 (Sept. 27, 2019), which involved alleged violations of the anti-bribery, books and records, and internal controls provisions of the FCPA. According to the SEC, Westport Fuels Systems, Inc. (“Westport”), a Canadian clean fuel technology company headquartered in Vancouver, Canada, and its former chief executive officer (“CEO”), Nancy Gougarty (“Gougarty”), of Leesville, South Carolina, violated the anti-bribery, books and records, and internal controls provisions of the FCPA by paying bribes to a foreign government official in China. Westport registers its common stock with the SEC pursuant to Section 12(b) of the Exchange Act and trades its securities on the NASDAQ and the Toronto Stock Exchange. The proceeding arose from a joint venture (“JV” or “Joint Venture”) between Westport and a Chinese state-owned entity (“SOE-1”). In March of 2013, at the direction of a Chinese Government Official, SOE-1 proposed taking the JV public in China through an initial public offering (“IPO”). The JV’s manager, appointed by SOE-1, falsely represented to Westport that Chinese law required SOE-1 to have a majority interest in the Joint Venture to qualify for an IPO. Accordingly, the manager of the JV advised Westport that a preliminary step in the IPO process would involve restructuring the Joint Venture so that a portion of the shares held by Westport and a privately held Hong Kong conglomerate would have to be transferred to SOE-1 and a Chinese private equity fund (in which the Government Official held a financial interest). Although the shares were transferred to the private equity fund, the contemplated IPO never took place. Once the proposed restructuring was complete, SOE-1 would own 51% of JV’s shares, Westport would own 23.33% through its Hong Kong subsidiary, the Hong Kong conglomerate would own 16.67%, and the Chinese private equity fund would own 9%. On February 11, 2014, the JV board of directors approved the proposed share transfer. Gougarty, who at the time was Westport’s Chief Operating Officer, led the Westport team in the negotiations with SOE-1. In April 2014, Gougarty recruited and hired a Chinese national to head Westport’s Asia Pacific regional office (the “Asia Pacific GM”). The Asia Pacific GM played a central role in the negotiations with SOE-1 and the Chinese private equity fund. Early in the negotiations, the Asia Pacific GM reported that the Government Official had a significant but undisclosed financial interest in the Chinese private equity fund that was to receive the JV shares from Westport and the Hong Kong conglomerate. He also reported that it was the Government Official’s personal financial interest, not Chinese law, which was motivating the transfer of shares to the private equity fund. According to the SEC, the Government Official’s personal interest became a central part of Westport’s negotiation strategy. Gougarty recommended alternatives that included seeking a supply agreement in exchange for a transfer of shares to the private equity fund. No later than March 2015, Westport explicitly conditioned the share transfer on obtaining a long-term sales agreement. Having acknowledged Westport’s position of “no component sales contract, no share transfer,” Gougarty instructed Westport employees working for her on the transaction in March 2016 that the component supply agreement was a necessary element to complete the deal. The negotiations progressed slowly as the Government Official and Westport disagreed on the share transfer price, a figure derived from the valuation of the Joint Venture. In March 2015, after meeting with executives at the private equity fund, the Asia Pacific GM reported that the Government Official was seeking a low valuation in order to “make quick and big money” outside the scrutiny of Chinese regulators. At the same time, Westport was seeking to maximize its value in order to alleviate its deteriorating financial condition and cash needs. However, as oil prices declined in 2014 and 2015, increasing the market for gasoline-powered car engines and reducing the market for Westport’s alternative fuel products, Westport became more willing to accept a lower valuation in order to close the deal and obtain the much-needed, albeit smaller, infusion of cash. On June 29, 2015, Westport’s Board of Directors (the “Board”) authorized Westport’s management to complete the negotiations and execute the share transfer. Gougarty did not disclose to the Board what the Asia Pacific GM had told her about the Government Official’s personal financial interest in the private equity fund or that the Government Official had requested a discount in the share transfer price. In fact, alleged the SEC, approximately nine months before obtaining the Board’s approval, Gougarty withheld this information from the Board, deleting a sentence in a September 2014 draft letter to the Board prepared by the Asia Pacific GM that described the proposed transfer. If Gougarty had not redacted the sentence, the SEC maintained, it would have reported to the Board that the Government Official had a financial interest in the Chinese private equity fund. By early December 2015, Westport and the Government Official, negotiating through SOE-1 and the private equity fund, struck a deal. They agreed on a valuation of $70 million for the JV, and Westport agreed to transfer shares to SOE-1 and the private equity fund in exchange for a long-term framework supply agreement and a cash dividend of 30% of undistributed profits – 20% more than what was provided for under the joint venture agreement and more than Westport had received in the past. Westport also agreed, as Gougarty explained earlier in November 2015, that the public announcement of the deal would be limited to “talk about the transfer of share to and unidentified Chinese company.” On August 20, 2016, Gougarty, by then Westport’s CEO, executed the share transfer agreements with the Chinese private equity fund and with SOE-1. That same day, the JV and Westport entered into a framework supply agreement pursuant to which the JV eventually would purchase approximately $500,000 of engine components from Westport. By separate resolution, executed on the same day, the JV authorized the distribution of a 30% dividend to all of the shareholders. On September 29, 2016, as reflected in bank records maintained as source documents in Westport’s files, the private equity fund wired a payment of approximately $3 million to Westport’s bank in Vancouver, Canada, from its bank in China through a correspondent bank in the United States. However, even though Westport’s accounting controls required the comparison of source documents with journal entries, Westport’s books and records accounting for the transaction falsely reflected the identity of the counterparty in the transaction as SOE-2, an entity related to SOE-1, rather than the true counterparty, the private equity fund. In October 2016, Westport received approximately $3.5 million, representing the increased dividend approved by the JV board of directors on August 20, 2016, the same day that Westport executed the share transfer agreements to the private equity fund and SOE-1. The $3.5 million dividend was credited to Westport’s bank account in Vancouver, Canada, having been sent from a bank in China through a correspondent bank in the United States. On November 9, 2016, Westport filed its Form 6-K with the SEC which, according to the Commission, falsely described the identity of the counterparty in the share transfer as SOE-2 instead of the Chinese private equity fund. Even though Westport’s internal accounting controls purported to establish a process to reconcile public filings with source documents to provide reasonable assurance with respect to the accuracy and consistency of its filings, it failed to follow this process, alleged the SEC. On March 31, 2017, Westport filed its annual report on Form 40-F for the year ended December 31, 2016. According to the SEC, the Management Discussion & Analysis and financial statements attached to the Form 40-F falsely reported the identity of the counterparty in the share transfer as SOE-2 instead of the Chinese private equity fund. In connection with the filing of the Form 40-F, Gougarty executed a certification attesting that Westport had disclosed all significant deficiencies and material weaknesses in the design and operation of its internal controls to the outside auditors. However, said the SEC, the certification was knowingly false because Gougarty failed to disclose the deficiencies and weaknesses in the internal controls that she had exploited in carrying out the transaction in circumvention of Westport’s anti-bribery policies and its key accounting controls. Westport and Gougarty agreed to settle the SEC’s charges for $4.1 million without admitting or denying the SEC’s findings. In that regard, Westport agreed to pay $2,546,000 in disgorgement and prejudgment interest and a civil penalty of $1,500,000, and Gougarty agreed to pay a civil penalty of $120,000. In determining to accept Westport’s offer, the SEC considered remedial actions undertaken by Westport concerning its anti-corruption and financial reporting compliance programs, and its cooperation with the SEC’s investigation. “A company’s commitment to compliance is only as strong as the effort put in by senior management,” said Charles Cain, Chief of the SEC Enforcement Division’s FCPA Unit. “Here, the chief executive exploited weaknesses in the company’s controls to engage in bribery, undermining shareholder interests.” A copy of the September 27, 2019 press release announcing the settlement can be found here . A copy of the Order can be found here .

In New York, to plead (and prove) a fraud claim, a plaintiff must demonstrate the following: “a misrepresentation or a material omission of fact which was false and known to be false by the defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury.” Pasternack v. Laboratory Corp. of Am. Holdings , 27 N.Y.3d 817, 827 (2016) (internal citations and quotation marks omitted). Today, this Blog looks at the injury element of a fraud claim; in particular, whether the injury was proximately caused by the alleged fraud. It is well settled that loss causation or proximate causation is “ n essential element” of a fraud claim. Laub v. Faessel , 297 A.D.2d 28, 31 (1st Dept. 2002). Therefore, a plaintiff alleging a fraud claim must “demonstrate that a defendant’s misrepresentations were the direct and proximate cause of the claimed losses.” Ambac Assur. Corp. v. Countrywide Home Loans, Inc. , 151 A.D.3d 83, 86 (1st Dept. 2017), aff’d , 31 N.Y.3d 569 (2018), quoting Vandashield Ltd. v. Isaacson , 146 A.D.3d 552, 553 (1st Dept. 2017) (internal quotation marks omitted). To do so, “ plaintiff must show both that defendant’s misrepresentation induced plaintiff to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiff complains (loss causation).” Id. , quoting Laub , 297 A.D.2d at 31. Notably, “ here may be more than one proximate cause of a plaintiff’s injuries.” Santaiti v. Town of Ramapo , 162 A.D.3d 921, 926 (2d Dept. 2018). For this reason, a plaintiff asserting a fraud cause of action must “show that the was a substantial cause of the events which produced the injury.” Derdiarian v. Felix Contr. Corp. , 51 N.Y.2d 308, 315 (1980). “Where the acts of a third person intervene between the defendant’s conduct and the plaintiff’s injury, the causal connection is not automatically severed.” Id . at 315. “In such a case, liability turns upon whether the intervening act is a normal or foreseeable consequence of the situation created by the defendant’s .” Id .; Turturro v. City of New York , 28 N.Y.3d 469, 484 (2016). “This is true even where the intervening acts of a third party may be characterized as intentional, reckless, or criminal.” Id .; Nallan v. Helmsley-Spear, Inc. , 50 N.Y.2d 507, 520-521 (1980). Accordingly, although “an intervening intentional or criminal act will generally sever the liability of the original tort-feasor,” the principle “has no application when the intentional or criminal intervention of a third party or parties is reasonably foreseeable.” Kush v. City of Buffalo , 59 N.Y.2d 26, 33 (1983); Turturro , 28 N.Y.3d at 484. More generally, “ n intervening act may not serve as a superseding cause, and relieve an actor of responsibility, where the risk of the intervening act occurring is the very same risk which renders the actor” liable for fraud. Derdiarian , 51 N.Y.2d at 316; Hain v. Jamison , 28 N.Y.3d 524, 531 (2016). On the other hand, “ f the intervening act is extraordinary under the circumstances, not foreseeable in the normal course of events, or independent of or far removed from the defendant’s conduct, it may well be a superseding act which breaks the causal nexus.” Derdiarian , 51 N.Y.2d at 315. “As with determinations regarding proximate cause generally, ‘ ecause questions concerning what is foreseeable and what is normal may be the subject of varying inferences,’ whether an intervening act is foreseeable or extraordinary under the circumstances ‘generally for the fact finder to resolve.’” Turturro , 28 N.Y.3d at 484, quoting Derdiarian , 51 N.Y.2d at 315. With the foregoing principles in mind, this Blog looks at Designer Limousine, Inc. v. Authority Transp., Inc. , 2019 N.Y. Slip Op. 07049 (2d Dept. Oct. 2, 2019) ( here ). Designer Limousine, Inc. v. Authority Transp., Inc. Plaintiff, Designer Limousine, Inc. (“Designer”), is a limousine company that operated a fleet of buses and other vehicles for hire in New York. Plaintiff, Kenneth Caldwell (“Caldwell”), was Designer’s principal. On several occasions in late 2011 and early 2012, Defendant, Michael Cassano (“Cassano”), who was in the business of conducting automobile damage appraisals, appraised damage to and the cost of repairing certain of Designer’s vehicles in connection with claims for coverage Designer made to its insurer. In March 2016, Plaintiffs commenced the action alleging, inter alia , that Cassano had falsely inflated the damage amounts he reported in his appraisals as part of a scheme to defraud Designer’s insurer. Plaintiffs alleged that Cassano’s fraudulent conduct caused Designer’s insurance premiums to increase exponentially and, in turn, forced the company to discontinue operations. Cassano moved for summary judgment dismissing, inter alia , the fraud cause of action against him. Cassano argued, among other things, that his alleged fraudulent conduct was not a proximate cause of Plaintiffs’ claimed losses, and that an August 2012 fatal accident involving one of Designer’s buses and the impact of the accident on the business constituted superseding causes of Plaintiffs’ claimed losses, thereby relieving him of any liability. The motion court denied the portion of Cassano’s motion for summary judgment dismissing the fraud cause of action asserted against him. Cassano appealed. The Second Department affirmed, holding that the motion court correctly found issues of fact surrounding the issue of proximate causation. Slip Op. at *1. In that regard, the Court held that Cassano “failed to demonstrate that the events subsequent to the alleged fraud relating to the August 2012 accident constituted superseding causes relieving him of liability for the plaintiffs’ claimed losses.” Id . The Court also rejected Cassano’s contention that Plaintiffs failed to “adequately alleg definite, measurable out-of-pocket damages resulting from his alleged fraud.” Id . Takeaway Loss causation is a well-established requirement of a common-law fraud claim for damages. Ambac Assur. Corp. v. Countrywide Home Loans, Inc. , 31 N.Y.3d 569, 580-581 (2018). “Central to the notion of proximate cause is the idea that a person is not liable to all those who may have been injured by his conduct, but only to those with respect to whom his acts were ‘a substantial factor in the sequence of responsible causation,’ and whose injury was ‘reasonably foreseeable or anticipated as a natural consequence.’” First Nationwide Bank v. Gett Funding Corp. , 27 F.3d 763, 769 (2d Cir. 1994). Thus, if the fraud causes no loss ( e.g. , the loss was not reasonably foreseeable or was the result of a superseding event), then the plaintiff suffered no damages. Ambac Assur. , 31 N.Y.3d at 580-581.   Since the determination of loss causation turns upon questions of foreseeability and “what is foreseeable and what is normal may be the subject of varying inferences,” the issue is left for the fact finder to resolve. Kriz v. Schum , 75 N.Y.2d 25, 34 (1989), quoting Derdiarian , supra at 315. In Designer Limousine , the Second Department held that proximate causation should be left for the jury to decide because Cassano failed to establish, as a matter of law, that Plaintiffs’ damages were unforeseeable or that Plaintiffs’ damages were the result of superseding causes that severed any nexus between Cassano’s alleged fraud and Plaintiffs’ damages.

This Blog has previously addressed issues surrounding various evidentiary issues faced by foreclosing mortgage lenders, among others, in proving their prima facie case on summary judgment. < HERE =">HERE"> , < HERE =">HERE"> , < HERE =">HERE"> and < HERE =">HERE"> . On September 25, 2019, the Appellate Division, Second Department, in JPMorgan Chase Bank v. Grennan , yet again analyzed the sufficiency of the foreclosing lender’s evidence submitted on its motion for summary judgment. One of the defendants in JPMorgan , defaulted on the repayment of a note (that was secured by a mortgage encumbering her home) in the amount of $280,000 and made payable to CTX Mortgage Company, LLC.  As a result of the defaults, JPMorgan Chase commenced a foreclosure action by the filing of a summons and verified complaint, annexed to which was a copy of the note.  In their answer, the defendants asserted among other defenses, lack of standing and failure to comply with RPAPL 1304 .  (This Blog has previously treated the standing issue < HERE ,=">HERE," HERE=">HERE" and="and"> and the RPAPL 1304 issue < HERE ,=">HERE," HERE=">HERE" and="and"> .) Plaintiff’s motion for, inter alia , summary judgment and to appoint a referee to compute was granted over defendants’ opposition.  Thereafter, plaintiff’s motion to confirm the referee’s report and for a judgment of foreclosure and sale was granted; again, over defendants’ objection.  On the JPMorgan Defendants’ appeal, the Second Department reversed the Judgment of Foreclosure and Sale and denied plaintiff’s motion for summary judgment and for an order of reference. The JPMorgan Court noted that a foreclosing plaintiff makes its prima facie case by “producing the mortgage, the unpaid note, and evidence of default. (Citations omitted.)  Also, when a standing defense is raised, a foreclosing plaintiff “must prove its standing as part of its prima facie showing on a motion for summary judgment” (citations omitted), which is done by “demonstrating that, when the action was commenced, it was either the holder or assignee of the underlying note” (citations omitted).  A “written assignment” or “physical delivery of the note” sufficiently transfers the obligation (citations omitted).  According to the JPMorgan Court, standing as the holder of the note may be established by “demonstrating that a copy of the note, including an endorsement in blank, was among the exhibits annexed to the complaint at the time the action was commenced” (citations omitted). A promissory note is a negotiable instrument within the meaning of the Uniform Commercial Code ( see UCC 3-104<2> ). A "holder" is "the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession" ( UCC 1-201 <21> ; see UCC 3-301 ). Where an instrument is endorsed in blank, it may be negotiated by delivery ( see UCC 3-202<1> ; 3-204[2) . "An indorsement must be . . . on the instrument or on a paper so firmly affixed thereto as to become a part thereof" ( UCC 3-202<2> ).  (Some citations, internal quotation marks and brackets omitted.) The JPMorgan Court found that the plaintiff failed to establish its standing as a matter of law because “it cannot be ascertained from the copy of the note annexed to the complaint whether the separate page that bears the endorsement in blank was stamped on the back of the note, as alleged by the plaintiff, or on an allonge, in which case the plaintiff would have to prove that the endorsement was ‘so firmly affixed thereto as to become a part thereof,’ as required under UCC 3-202(2).” The JPMorgan Court also found that the lender failed to establish the borrower’s default as a matter of law due to the insufficiency of the affidavit of lender’s vice president.  A lender’s prima facie case can be based on a variety of business records “so long as the plaintiff satisfies the admissibility requirements of CPLR 4518(a) , and the records themselves actually evince the facts for which they are relied upon.”  (Citations and internal quotation marks omitted.)  The Court found that although the bank officer’s affidavit “sufficient establish a proper foundation for the admission of a business record pursuant to CPLR 4518(a), the plaintiff failed to submit copies of the business records themselves.”  (Some citations omitted.)  Citing Bank of N. Y. Melon v. Gordon , 171 A.D.3d 197, 205 (2 nd Dep’t 2019), the JPMorgan Court stated that “ he business record exception to the hearsay rule applies to a writing or record and it is the record itself, not the foundational affidavit, that serves as proof of the matter asserted.”  (Some citations, internal quotation marks, brackets and ellipses omitted.) Because the bank officer failed to annex copies of the records on which he relied in attempting to establish the borrower’s default in his affidavit, the narrative descriptions about those records in the affidavit were “inadmissible hearsay.”  (Citations omitted.)  Thus, the JPMorgan Court stated: While "a witness may always testify as to matters which are within his or her personal knowledge through personal observation" (Bank of N.Y. Mellon v Gordon, 171 AD3d 197, citing Jerome Prince, Richardson on Evidence §§ 4-301, 6-210 ), did not attest to such personal knowledge. Contrary to the plaintiff's assertion, a review of records maintained in the normal course of business does not vest an affiant with personal knowledge. Since affidavit was the only evidence of default proffered in support of the motion, the plaintiff failed to establish its prima facie entitlement to summary judgment on the complaint on this additional ground.” The JPMorgan Court also found that lender failed to meet its burden of demonstrating compliance with the mailings required by RPAPL 1304 because the affiant bank officer “did not have personal knowledge of the purported mailing by first-class mail, and failed to attest that he was familiar with the plaintiff’s mailing practices and procedures.”

The title of this post comes from the observation Justice Saliann Scarpulla made in Jobar Holding Corp. v. Halio , 2019 N.Y. Slip Op. 32813(U) (Sup. Ct., N.Y. County Sept. 23, 2019) ( here ), wherein she was asked to decide a motion to dismiss a complaint that asserted both direct and derivative claims.  As discussed below, because, among other things, the complaint “mingled” the direct and derivative claims and otherwise failed to differentiate between the causes of action, the Court dismissed the complaint with leave to replead. The Law: Direct vs. Derivative Claims It is well-settled that a plaintiff asserting a derivative claim seeks to recover for injury to the business entity. A plaintiff asserting a direct claim seeks redress for injury to himself/herself individually. Sometimes, the distinction between the two types of actions is not readily apparent. Yudell v. Gilbert , 99 A.D.3d 108, 113 (1st Dept. 2012). In considering whether a claim is direct or derivative, courts look to the nature of the wrong and the person or entity to whom the relief should go. Tooley v. Donaldson, Lufkin & Jenrette, Inc. , 845 A2d 1031, 1039 (Del. 2004). See also Yudell , 99 A.D.3d at 114; Higgins v. New York Stock Exch., Inc. , 10 Misc. 3d 257, 264 (Sup. Ct. N.Y. County 2005) (citation omitted). Thus, for a shareholder’s injury to be direct it must be independent of any alleged injury to the corporation. The shareholder must demonstrate that the duty breached was owed to the stockholder and that he/she can prevail without showing an injury to the corporation. Tooley , 845 A2d at 1039. “The pertinent inquiry is whether the thrust of the plaintiff’s action is to vindicate his personal rights as an individual and not as a stockholder on behalf of the corporation.” Maldonado v. DiBre , 140 A.D.3d 1501, 1504 (3d Dept. 2016). Therefore, the plaintiff must show that the duty allegedly breached was owed to the shareholder, and that he/she can prevail without showing an injury to the corporation. Yudell , 99 A.D.3d at 114. If the individual claim of harm is “confused with or embedded” within the harm to the corporation, then it must be dismissed. Serino v. Lipper , 123 A.D.3d 34, 40 (1st Dept. 2014); Patterson v. Calogero , 150 A.D.3d 1131, 1133 (2d Dept. 2017) (even where individual harm is claimed, if it is confused with or embedded in the harm to corporation, it cannot stand separately). Jobar Holding Corp. v. Halio Background Plaintiff, Jobar Holding Corp. (“Jobar” or the “Company”), is a small family-run corporation organized in 1958 under the laws of the State of New York. Jobar was owned and managed by Otto and Kitty Buck, the parents of Defendant, Barbara Halio (“Halio”) and Joan Buck. Until the 1980s, the Buck family operated Cake Masters, a bakery located on the property. After the bakery closed, Jobar continued to operate the property. Upon Kitty Buck’s death in 2001, Halio and Joan Buck served as co-presidents of Jobar until Joan Buck’s death in 2005, when Halio became the Company’s sole president. In May 2006, Jobar sold the property for $22,000,000, and began winding down its operations under Halio’s supervision. At the time of the sale, Plaintiff, Robert Buck (“Buck”), in his personal and executory capacities, owned 38 shares of Jobar common stock, equal to a 38% ownership interest in the Company. Buck alleged that, following the sale, Halio embezzled $1,500,000 from Jobar’s bank accounts, by misappropriating funds in a variety of ways, including disguising the embezzlement as “bogus management fees, officer compensation, or as fake loans which were never intended to be repaid.” Halio maintained that the withdrawals were used for proper purposes, including the recoupment of loans made to Jobar by Halio from her husband’s pension and a home equity loan, payment of fees for the loans, executory and management fees, deferred salary, and payment of other post-closing fees. According to Buck, in March 2007, Halio and Yeskoo Hogan & Tamblyn (“Yeskoo”) arranged for the $1,500,000 sale proceeds to be held in a “reserve”, which Halio then used for her personal use. Buck alleged that, as holders of 38% of Jobar’s interest, he and Joan Buck’s estate were owed $570,000 from the reserve. On July 26, 2016, Buck filed a petition pursuant to Business Corporation Law (“BCL”) § 624 to inspect the Company’s books and records. According to Plaintiffs, although the records were incomplete, they revealed that Halio fraudulently transferred at least $1.5 million of the Company’s funds to herself. Plaintiffs maintained that by the time her fraud was discovered in mid-2017, Halio had stolen all of Jobar’s funds that had remained after the property was sold in 2006. Plaintiffs commenced the action in 2017 against Halio, her accountants, Turman & Eimer LLP (“Turman”), and her attorneys. Against Halio, plaintiffs alleged causes of action for fraudulent conveyance, conversion, unjust enrichment, breach of fiduciary duty and accounting. Plaintiffs alleged aiding and abetting claims against her accountants. Turman moved to dismiss the complaint, arguing that the claims asserted against it were time barred and otherwise failed to state a claim for which relief could be granted. According to Turman, Halio’s theft purportedly began in 2006 with the sale of the property. As such, because the action was commenced in 2017, the statute of limitations barred all the claims asserted against it. In opposition, Plaintiffs argued that the statute of limitations did not bar their causes of action because they only discovered Halio’s alleged wrongdoing and Turman’s claimed involvement when the Company’s books and records were obtained in 2017. Plaintiffs also claimed that the statute of limitations did not begin to run until the last unlawful act under the continuous wrong doctrine. In addition to the statute of limitations, Turman contended that Plaintiffs failed to plead any individual injury apart from the alleged injury to Jobar. Turman also claimed that the derivative allegations in the complaint were improperly interspersed with the non-derivative allegations. Thus, because Plaintiffs’ individual claims were “confused with or embedded” within the harm to the Company, the entire complaint should be dismissed as against it. Plaintiffs maintained that the derivative claims alleged in the complaint were only asserted against Halio and that “Buck, as an individual, not seeking to pursue any derivative claims” against Turman. The Court granted the motion without prejudice. The Court’s Decision As an initial matter, the Court observed that the complaint lacked clarity about whether the claims asserted against Turman were direct or derivative: Although the complaint is rife with allegations that a serious wrong was committed, the drafting of the pleading makes it difficult to determine the precise causes of action that are being pled. Plaintiffs state in their opposition papers that derivative claims are only being asserted against Halio, however, some of the allegations stated in the causes of action asserted against Turman support derivative causes of action as well. In addition, while the causes of action asserted against Turman are stated as being on behalf of Buck individually, some of those causes of action would be inappropriate or unsustainable as causes of action on behalf of an individual. Slip Op. at *5. With regard to Turman’s statute of limitations arguments, the Court held that “the complaint not clearly state when the claims accrued” and that “ urther information s needed to determine whether the statute of limitations causes of action against Turman.” Id . at *7 n.3. For example, explained the Court, the BCL § 624 proceeding on which Buck relied did not provide the clarity needed to make a determination:  “It appears that Buck did not obtain certain documents until 2016 pursuant to the BCL § 624 proceeding, while others were allegedly obtained before then.” Id .  Additional information was also needed to determine whether there was privity or a fiduciary duty sufficient to toll the statute of limitations. Id . Turning to the claims asserted against Turman, Justice Scarpulla held that they were “an unclear mix of Buck’s personal claims, derivative claims on behalf of Jobar, and other claims that not sustainable to any of the plaintiffs.” Id . at *7. Although the complaint explicitly sets forth a cause of action based on BCL § 626 (shareholders’ derivative action) against Halio and does not do the same against Turman, it is not clear from the complaint that derivative allegations are not also being asserted against Turman. For example, the aiding and abetting breach of fiduciary duty cause of action is based on the allegation that Turman aided and abetted Halio’s wrongs against Jobar, not against Buck individually. Regarding plaintiffs’ allegations that Turman caused Buck individual harm, the complaint states that Turman consistently delayed delivery of K-1s to Buck and many times intentionally interfered with Buck’s attempts to obtain financial information for Jobar. The complaint alleges that Buck relied on the allegedly falsified tax forms prepared by Turman to prepare his own and his mother's estate's taxes. These are not derivative claims, as Buck, not Jobar, suffered the alleged harm and would receive the benefit of any recovery. However, plaintiffs do not allege a clear injury to Buck or damages sustained by him resulting from this alleged misconduct. Id . at **6-7. Finally, the Court found that because the direct and derivative claims were “based on the same operative facts<, they could not> be interspersed in the same action.” Id . at *7 (citing Abrams v. Donati , 66 N.Y.2d 951 (1985); Barbour v. Knecht , 296 A.D.2d 218, 228 (1st Dept 2002)). Consequently, the Court dismissed the complaint as against Turman with leave to replead. Id . (“Because of the mixing of derivative and individual claims, and the unclear nature of the allegations being asserted against Turman, the complaint is dismissed insofar as asserted against Turman without prejudice to bring properly pled causes of action against this defendant.”). Takeaway The theme that runs throughout Jobar is the importance of filing a well pled complaint. As indicated by the Court, allegations of serious wrongdoing may get lost in a pleading that does not identify the precise claims being asserted: “Although the complaint is rife with allegations that a serious wrong was committed, the drafting of the pleading makes it difficult to determine the precise causes of action that are being pled.” In Jobar , the absence of such clarity affected the Court’s consideration of the claims asserted against Turman – that is, whether the claims asserted were direct or derivative. To be sure, the difference between a direct and derivative claim is not always easy to discern. In fact, the distinction between the two types of claims can be elusive. Nuance and subtlety often rule the day, leading to confusion and uncertainty. For this reason, as Plaintiffs learned in Jobar , it is important to present direct and derivative causes of action in a clear way to avoid the dismissal of the claims (even if the dismissal is without prejudice, as in Jobar ).

On September 19, 2013, Andrew Ceresney, then Co-Director of the Division of Enforcement of the Securities and Exchange Commission (“SEC” or the “Commission”), told an audience attending a continuing legal education program at the American Law Institute in Washington, D.C. about the importance of pursuing those who commit financial and accounting fraud ( here ). Comprehensive, accurate and reliable financial reporting is the bedrock upon which our markets are based because false financial information saps investor confidence and erodes the integrity of the markets.  For our capital markets to thrive, investors must be able to receive an unvarnished assessment of a company’s financial condition.  Financial reports must provide transparency for investors, and must not obscure the truth, even if that truth is inconvenient. Ceresney’s words reflect the SEC’s vigilance in cracking down on accounting and auditing fraud. Indeed, since the end of the financial crisis, the SEC has turned its attention to, among other things, the circumstances that create accounting fraud. To that end, the SEC has established a financial reporting and audit task force, implemented an array of investigatory techniques (such as data mining), and relied on tips from whistleblowers to identify the circumstances that allow accounting fraud to occur ( here ). These efforts continue to show results: in fiscal year 2018, accounting and auditing fraud constituted 16% of the standalone actions ( i.e. , actions brought in federal court or as administrative proceedings) brought by the SEC. i.e., 16% of the cases), preventing and stopping accounting and auditing fraud remains an important priority of the commission.> i.e., 16% of the cases), preventing and stopping accounting and auditing fraud remains an important priority of the commission.> In today’s post, this Blog looks at two enforcement proceedings involving alleged accounting fraud. One involved accounting and disclosure fraud by Comscore, Inc., and its former Chief Executive Officer (“CEO”), and the other involved violations of the SEC’s auditor independence rules by PwC and one of its partners. Both actions resulted in settlements. In the Matter of Comscore, Inc. Comscore concerned a financial accounting and disclosure fraud allegedly committed by Comscore, Inc. (“Comscore” or the “Company”), a publicly-traded data services and measurement company, principally through the conduct of its former Chief Executive Officer (“CEO”), Serge Matta (“Matta” and, together with Comscore, the “Respondents”). According to the SEC, from February 2014 through February 2016 (the “Relevant Period”), Comscore materially overstated revenue by approximately $50 million as result of a scheme to manipulate non-monetary and monetary contracts. Respondents’ actions, claimed the SEC, enabled the Company to artificially exceed analysts’ consensus revenue target in seven consecutive quarters. In addition, said the SEC, from April 2014 through February 2016, Comscore and Matta made false and misleading statements about two important performance metrics. The Contracts at Issue Comscore allegedly entered into non-monetary transactions (“NMTs”) for the purpose of improperly increasing revenue recognition. According to the SEC, Comscore valued these NMTs, which involved the exchange of data between Comscore and a counterparty, by assessing the fair value of the data it surrendered in each transaction. In negotiating certain of these arrangements, however, Matta allegedly included certain data that the counterparty did not ask for, want, need, or use. In addition, in communications with internal accountants and the independent auditor regarding the NMTs, Matta and other Comscore employees allegedly made false or misleading statements about the true purpose of the agreements, the commercial substance of the transactions, and the fair value of the assets. As a result, said the SEC, Comscore’s revenue related to these transactions was overstated by over $34.5 million during the Relevant Period. Comscore also allegedly entered into certain monetary transactions that improperly increased revenue recognition. In two instances, said the SEC, Matta knew that contracts he negotiated were related and linked but he misrepresented or failed to disclose the true facts to Comscore’s internal accountants and its independent auditor, which had the impact of overstating revenue by approximately $12 million in 2015. In two other instances, noted the SEC, Matta agreed to deliver data to a counterparty by the end of a quarter and then entered into undisclosed side agreements to deliver additional data after the quarter closed. Placing future data delivery obligations into a side agreement, claimed the SEC, allowed Comscore to take the position that all data at issue had been delivered before the current quarter closed, thereby permitting Comscore to recognize all of the revenue associated with the transaction in that quarter rather than defer some or all of the revenue to subsequent quarters. Comscore’s Performance Metrics In addition, the SEC alleged that Comscore made false or misleading disclosures regarding two important performance metrics. In 2014 and 2015, Comscore disclosed customer totals that falsely conveyed a consistent increase in the number of net new customers added. In fact, said the SEC, the number of net new customers was declining. Comscore disclosed these overstated numbers in its periodic filings with the SEC and Matta highlighted them during earnings calls with investors. Also, in the third and fourth quarters of 2015, alleged the SEC, Comscore disclosed misstated revenue growth percentages concerning one of its flagship data analytic products. Matta described this purported revenue growth in earnings calls. In fact, contended the SEC, the product’s revenue had been declining. In both instances, said the SEC, Matta directed or approved incremental changes within Comscore to the methodology by which the disclosed figures were calculated without disclosing those changes to investors. The Restatement In February 2016, Comscore’s audit committee commenced an internal investigation. On March 23, 2018, Comscore, under new management, filed its Form 10-K for the year ended December 31, 2017, which included a restatement (the “Restatement”). The Restatement provided restated and corrected financial information for the years ended December 31, 2014 and 2013. The Restatement also provided that Comscore restated certain information for the quarters ended March 31, June 30, and September 30, 2015, and adjusted information previously furnished on Form 8-K for the year ended December 31, 2015. In total, Comscore reversed approximately $50 million in revenue due to Respondents’ improper conduct and accounting. The Restatement also identified various material weaknesses in Comscore’s internal control over financial reporting and acknowledged that prior senior management did not establish or maintain an acceptable corporate culture. The Settlement With the SEC The SEC charged Comscore with violating Section 17(a) of the Securities Act of 1933 (“Securities Act”) and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rules 10b-5, 12b-20, 13a-1, 13a-11, and 13a-13 promulgated thereunder. Respondents settled the charges without admitting or denying the SEC’s findings. In connection with the settlement, Comscore and Matta agreed to cease-and-desist from future violations of the antifraud provisions of the federal securities laws and to pay penalties of $5 million and $700,000, respectively. Matta also agreed to reimburse Comscore $2.1 million, representing profits from the sale of Comscore stock and incentive-based compensation pursuant to Section 304(a) of the Sarbanes-Oxley Act and to the entry of an order barring him from serving as an officer or director of a public company for 10 years. “As the SEC orders find, Comscore and its former CEO manipulated the accounting for non-monetary and other transactions in an effort to chase revenue targets and deceive investors about the performance of Comscore’s business,” said Melissa R. Hodgman, Associate Director in the SEC's Enforcement Division. “We will continue to hold issuers and executives accountable for such serious breaches of their fundamental duty to make accurate disclosures to the investing public while giving appropriate credit for a company’s prompt remedial acts and cooperation.” The press release announcing the settlement can be found here . The SEC Orders relating to Comscore and Matta can be found here and here . In the Matter of PricewaterhouseCoopers LLP The SEC charged PricewaterhouseCoopers LLP (“PwC”) with improper professional conduct in connection with 19 engagements on behalf of 15 SEC-registered issuers and violating auditor independence rules in connection with engagements for one issuer where the firm performed prohibited non-audit services. The SEC also charged PwC partner Brandon Sprankle (“Sprankle”) with causing the firm’s independence violations. Both respondents agreed to settle the charges; PwC agreed to pay over $7.9 million in monetary relief. The SEC found that PwC violated the SEC’s auditor independence rules by performing prohibited non-audit services during an audit engagement, including exercising decision-making authority in the design and implementation of software relating to an audit client’s financial reporting, and engaging in management functions. In connection with performing non-audit services for 15 SEC-registered audit clients, the SEC concluded that PwC violated Public Company Accounting Oversight Board Rule 3525, which requires an auditor to describe in writing to the audit committee of the company the scope of work, discuss with the audit committee the potential effects of the work on independence, and document the substance of the independence discussion. According to the SEC, PwC’s actions deprived numerous issuers’ audit committees of information necessary to assess PwC’s independence. As further detailed by the SEC, the alleged violations occurred due to breakdowns in PwC’s independence-related quality controls, which resulted in the firm’s failure to properly review and monitor whether non-audit services for audit clients were permissible and approved by clients’ audit committees. “Auditors play a fundamental role in protecting the reliability and integrity of financial reporting and must ensure that non-audit services do not come at the cost of their independence on audits of public companies,” said Anita B. Bandy, Associate Director of the SEC’s Division of Enforcement. “PwC repeatedly provided non-audit services without having effective quality controls in place for monitoring whether the services impaired its independence on audit engagements and were properly disclosed to audit committees.”    The SEC also found that PwC and Sprankle violated the auditor independence provisions of the federal securities laws and caused one audit client to violate its obligation to have its financial statements audited by independent public accountants. The SEC further found that PwC and Sprankle engaged in improper professional conduct within the meaning of Rule 102(e) of the SEC’s Rules of Practice. The press release announcing the settlement can be found here . The SEC Orders relating to PwC and Sprankle can be found here and here .

As this Blog has noted previously, the courts (in New York and Delaware) have refused to approve the settlement of shareholder litigation where class members receive no financial benefit and are asked to give broad releases to the defendants that are inimical to their rights. The latest court to follow this path is the Supreme Court, New York County, Commercial Division. In Matter of Xerox Corp. Consol. Shareholder Litig. , 2019 N.Y. Slip Op. 51467(U) (Sept. 10, 2019), Justice Barry Ostrager denied a motion, among others, to approve a shareholder class action settlement because the putative class received no financial benefit from the settlement and relinquished rights that they could have otherwise asserted in derivative litigation. As explained by Justice Ostrager, the proposed settlement would have released current and former corporate directors from potential liability for, among other things, giving control over the board of directors (the “Board”) of the Xerox Corporation (“Xerox”) to activist investors and potentially exposing Xerox to significant liability in a contract action brought by Fujifilm Holdings Corporation (“Fuji”) concerning termination of the potential merger of the two companies. Background On January 30, 2018, Xerox and Fuji agreed to a proposed transaction, whereby Fuji would receive a 50.1% controlling interest in Xerox in exchange for its 75% interest in Fuji-Xerox (the “Transaction”). Xerox shareholders would receive a “special dividend” funded by new company debt. Despite sitting on over $8 billion in cash reserves and getting most of the future benefits of the deal, Fuji would not pay out any cash in the Transaction. On February 13, 2018, Darwin Deason (“Deason”), the second-largest individual shareholder of Xerox, initiated an action to enjoin the Transaction. Deason v. Fujifilm Holdings , Index No. 650675/2018 (“Deason I”). On March 2, Deason filed a second lawsuit to enjoin Xerox from enforcing the advance notice bylaw deadline for the nomination of directors to be elected at the 2018 Annual Meeting. Deason v. Xerox Corp. , Index No. 650988/2018 (“Deason II”). At or about this same period of time, four putative class actions were filed on behalf of pension funds for the Asbestos Workers, the Iron Workers, and Carpenters, as well as by Robert Lowinger, each of which also sought to enjoin the Transaction on the ground that, by approving the Transaction, the Xerox Board had breached its fiduciary duties to the Xerox shareholders. On March 9, 2018, the Court consolidated the four putative class actions under the caption In Re Xerox Corporation Consolidated Shareholder Litigation . Following expedited discovery, on April 27, 2018, the Court held that the Xerox Board and Jeff Jacobson, the then CEO of Xerox, had breached their fiduciary duties in agreeing to the proposed Transaction. The Court also issued a mandatory injunction that directed the Xerox Board to waive its advance notice bylaw to allow Deason to run a competing slate of directors. On May 1, 2018, two business days after the Court issued the preliminary injunction, the parties advised the Court that they had reached a potential settlement. In connection with the potential settlement, the parties ( i.e. , the class plaintiffs, Deason and Xerox) presented the Court with a fully executed Memorandum of Understanding (“MOU”), setting forth the salient terms of their settlement in principle. On May 13, 2018, Deason and Xerox settled their dispute pursuant to which six directors of the Xerox Board resigned and were replaced by directors nominated by Deason and Carl Icahn (“Icahn”), thereby effectively giving Deason and Icahn control of the Xerox Board. Icahn had supported the Deason action and with Deason was waging a proxy contest to oust the Xerox directors. According to the Court, the language of the settlement agreement indicated that termination of the Transaction was a condition of the Deason/Icahn settlement with Xerox, though neither Deason nor Icahn could be held liable for the decision. The Deason/Icahn/Xerox settlement was private; no release of the class claims was included. Also, on May 13, 2018, counsel for the putative class resubmitted the Memorandum of Understanding pursuant to which class counsel agreed to the release of all Xerox directors in exchange for no consideration other than the terms of the private Deason settlement. In that regard, the Memorandum of Understanding contemplated the release of all resigning and continuing Xerox directors from any liability relating to the change in control of the Xerox Board and any liability arising out of the termination of the Transaction. The Memorandum of Understanding provided that neither Xerox nor Deason would oppose, and Xerox would fund, an award of attorney’s fees of $7.5 million to counsel for the class plaintiffs, provided the Court approved the class settlement. On May 24, 2018, Carmen Ribbe (“Ribbe”) commenced a derivative action against the resigning and continuing Xerox directors for breach of fiduciary duty because, among other things, of the possibility that Fuji might sue Xerox over termination of the Transaction. That action was dismissed on December 6, 2018, without prejudice based on issues related to demand futility. Ribbe initiated a second derivative action on April 11, 2019, and is awaiting a response from Xerox on its demand. On June 18, 2018, Fuji initiated an action against Xerox in the United States District Court for the Southern District of New York seeking $1 billion in damages for breach of the January 31, 2018 Transaction agreement. Fujifilm Holdings Corp. v. Xerox Corp. , 1:18-cv-05458. Xerox moved to dismiss the complaint, which was subsequently denied. The case is being actively litigated. On June 21, 2018, the Court discontinued the Deason I action “on the express condition that the discontinuance of the Deason action in no way, shape or form constitute approval of any elements of any settlement agreement among any parties,” thereby terminating all litigation between Deason and Xerox. The Court also denied class plaintiffs’ motion to stay the litigation as to the Xerox defendants only and to vacate the preliminary injunction as to the Xerox defendants only, notwithstanding class counsel’s representation that “part of the settlement between us and Xerox defendants was that we would move the Court for an order lifting the injunction....” Nevertheless, on July 13, 2018, the newly constituted Xerox Board approved the settlement of the class litigation on the same basis contemplated by the Memorandum of Understanding. Shortly after Fuji filed the federal court action, class plaintiffs moved for preliminary approval of the proposed settlement. At a July 16, 2018 hearing on class plaintiffs’ motion, the Court declined to preliminarily approve the proposed settlement. Instead, the Court directed counsel to send notice to the class to apprise them of the status of the proceedings. On May 23, 2019, the Court approved the form of notice, a finalized copy of which was filed with the Court on June 3, 2019. On September 6, 2019, the Court heard argument on three motions filed by counsel for the putative class. The motions sought certification of a class for settlement purposes and appointment of class representatives, approval of the class settlement, and an award of attorneys’ fees of $7.5 million. Ribbe opposed the motions and approximately 34 members of the putative class opted out of the settlement. Following extensive oral argument on the motions, the Court found that the class representatives were inadequate, and the proposed settlement was unreasonable and unfair to Xerox shareholders. The Court’s Decision The Court held that the proposed class representatives were not adequate representatives of the class because they bound the class to corporate actions that occurred before the settlement had been reached. Slip Op. at *6 (noting that “material terms of the settlement took effect on May 13, 2018, at least insofar as it called for the resignation of certain Board members and the designation of new Board members” notwithstanding the fact that the settlement was reached three months later on July 13, 2018).  “By agreeing to the Memorandum of Understanding, which contained broad releases for the resigning Board members,” said the Court, “the class representatives were potentially shielding the Xerox directors from any potential liability for the subsequently filed Fuji action.” Id . “Turning to the proposed settlement,” the Court concluded that it was not in the best interests of Xerox shareholders because “it achieve no material benefit for shareholders other than Icahn and Deason.” Id . “On the contrary,” continued the Court, “the proposed settlement releases any claims shareholders may have concerning the change of control orchestrated by Deason and Icahn and any liability for the subsequently filed Fuji case.” Id . In fact, said the Court, “ he benefit to Xerox as a company s also questionable in light of the $1 billion lawsuit by Fuji that remain pending. Id . The Court concluded as follows: The purported class members will “get” no financial benefit, and they are being asked to “give” broad releases of any derivative claims they may have. The Memorandum of Understanding contemplated full releases to the directors at a time when this Court had held the directors to be faithless fiduciaries, largely in exchange for fees to the purported class counsel of $7.5 million. There were no exigent circumstances requiring purported class counsel to enter into the Memorandum of Understanding other than the desire of Deason and Icahn to achieve control of the Xerox Board, which purported class counsel facilitated. The purported class counsel had no authority to settle on behalf of the class without having been appointed as counsel for the class, without a class having been certified, and without their clients having been designated as class representatives. The net result of the actions of the purported class representatives and purported class counsel was to transfer control of a public corporation to Messrs. Deason and Icahn via a private agreement that offered no tangible benefit to the interests of the class. Id . at **6-7. Finally, the Court denied the request for attorney’s fees, holding that “ ince … class counsel conferred no benefit on the Xerox shareholders, there is no basis for any award of counsel fees.” Id . at *7. Takeaway In Gordon v. Verizon Communications, Inc. , 148 A.D.3d 146 (1st Dept. 2017), on which Justice Ostrager relied, the First Department observed that “ uch has been written on the subjects of whether settlements of shareholder class action suits challenging corporate mergers and acquisitions should be rejected in the absence of monetary damage awards, and the propriety of the attorney fee awards attendant to such agreements.” Id . at 148. The use of nonmonetary settlements has become increasingly disfavored because they provide minimal benefits to shareholders and to their corporations. Id . at 154. The increasingly negative view of nonmonetary settlements was memorialized in recent decisions coming from the courts in both Delaware and New York in which the judges found such lawsuits to amount to “meritless lawsuits filed in order to raise a threat of enjoining or delaying closure of the transaction, and thereby incentivizing settlement.” Id. , citing Matter of Trulia, Inc. Stockholder Litig. , 129 A.3d 884, 887 (Del. Ch. 2016); Matter of Allied Healthcare Shareholder Litig. , 49 Misc. 3d 1210 , 2015 N.Y. Slip Op. 51552 , *2 (Sup. Ct., N.Y. County 2015). In Xerox , the Court followed in the footsteps of the foregoing courts.

This Blog has often noted that “securities fraud comes in all shapes and sizes.” ( E.g. , here .) Though the alleged fraudulent scheme may differ, the types of schemes implemented tend to fall into one of the following (non-exclusive) categories: financial statement/accounting fraud; pyramid schemes; Ponzi schemes; pump-and-dump schemes; affinity fraud; promissory note fraud; Internet fraud; “microcap” stock fraud; and fraud concerning information about a company, its operations and future prospects ( id .). Many of the techniques used by alleged wrongdoers are designed to persuade a target or victim into buying the security at issue. Some of these techniques include: (1) phantom riches representation – that is, the investment will yield “incredible gains,” is a “breakout stock pick” or has “huge upside and almost no risk”; (2) guaranteed returns – that is, high returns and low risk are “guaranteed” or “can’t miss”; (3) source credibility or “halo” effect – the fraudster tries to build credibility by claiming to be with a reputable firm or to have a special credential or experience; (4) “I believe in the company, so should you” assurance – the fraudster tries to assure the target that the investment is a sound one because he/she also invested in the company; (5) “everyone is buying it” representation – the fraudster stresses that other people are buying the security and, therefore, so should the target or victim; and (6) the reciprocity representation – the fraudster offers to do a small favor for the target or victim in return for a big favor: “I’ll give you a break on my commission if you buy now.” In today’s post, this Blog looks at SEC v. Mediatrix Capital Inc. , 1:19-cv-02594-RM (D. Colo. Sept. 12, 2019), an enforcement action brought by the U.S. Securities and Exchange Commission (“SEC” or the “Commission”) in which the defendants are alleged to have employed many of the foregoing techniques to place at risk more than $125 million of investors’ funds. According to the SEC, from March 2016 to the present (the “Relevant Period”), Michael S. Young (“Young”), Michael S. Stewart (“Stewart”), Bryant E. Sewall (“Sewall”) (collectively, the “Individual Defendants”), through  Mediatrix Capital Inc. (“Mediatrix Capital”), Blue Isle Markets Inc. (“Blue Isle 1”), and Blue Isle Markets Ltd. (“Blue Isle 2”) (collectively, the “Entity Defendants”), raised more than $125 million from investors in unregistered securities offerings by representing to investors that their money would be pooled and invested using Defendants’ successful and profitable algorithmic trading strategy. Defendants claimed that from December 2013 through at least March 2019, their trading strategy had never had an unprofitable month and had returned more than 1,600%. Defendants further claimed that their trading strategy had enabled Mediatrix Capital to accumulate assets under management of $225 million at the end of 2018. The SEC maintained that none of the foregoing representations were true. According to the SEC, since mid-2016, Defendants had misappropriated more than $35 million of investors’ money by transferring it out of the Entity Defendants’ bank and brokerage accounts instead of using the money for trading. Defendants purportedly used investors’ money to purchase luxury properties and vehicles and diverted more than $5 million of additional investors’ funds for other expenditures to perpetuate the alleged fraud. Even when Defendants used the remaining portion of investors’ money for trading, claimed the SEC, Defendants consistently lost money – losing more than $18 million from trading in 2018 alone. Because of Defendants’ alleged misappropriation and trading losses, maintained the Commission, Mediatrix Capital’s assets under management were nowhere near the amounts represented by Defendants. For example, said the SEC, at year-end 2018, Defendants represented that Mediatrix Capital had $225 million under management, when the firm actually had approximately $35.3 million in assets under management (less than 16% of the amount claimed). To induce investment into the trading strategy, alleged the SEC, Defendants repeatedly misrepresented the profitability of their trading, falsified investors’ account statements to show phantom profits, and made Ponzi-like payments to investors who opted to cash out their “profits” — all in order to prop-up the façade of profitable trading. The SEC alleged that Defendants made numerous additional, material misrepresentations and omissions to investors regarding the purported transparency of Mediatrix Capital’s trading, as well as third party involvement in verifying trading results. Defendants allegedly falsified investors’ account statements and manipulated trading results to reflect profits rather than the actual losses resulting from their trading. The SEC maintained that Defendants falsely claimed that Mediatrix Capital’s trading results had been audited. Defendants also allegedly made numerous misleading statements implying that Blue Isle 1 and Blue Isle 2 were independent, third-party administrators that received Mediatrix Capital’s trading data directly from brokerage firms before reporting it to investors, when in fact, said the SEC, Defendants owned and controlled the Blue Isle entities and manipulated the trading data they conveyed to investors. According to the SEC, Defendants’ misrepresentations, omissions, and other misconduct had the same goal and effect: provide investors with a false picture of trading profitability and a false sense of security to induce additional investment and to perpetuate the alleged fraud. As alleged, Defendants’ misappropriation and trading losses caused the collapse of the fraud. According to the SEC, Mediatrix Capital’s most recent bank and brokerage account records indicated that only a fraction of investors’ funds remained, causing investors to lose tens of millions of dollars of their money. As a result of the conduct described in the SEC’s complaint, the SEC alleged that Defendants violated Sections 5(a) and (c) and Section 17(a) of the Securities Act of 1933 (the “Securities Act”), 15 U.S.C. § 77e(a) and (c) and §77q(a), and Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. The Commission also alleged that Mediatrix Capital, Young, Stewart, and Sewall violated Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act 1940 (“Advisers Act”), 15 U.S.C. §§ 80b6(1), 80b-6(2), and 80b-6(4), and Rule 206(4)-8 promulgated thereunder, 17 C.F.R. § 275.206(4)-8, and, in the alternative, Defendants Young, Stewart, and Sewall aided and abetted Mediatrix Capital’s violations of Sections 206(1), 206(2), and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. The SEC also named numerous persons and entities as relief defendants because Defendants allegedly transferred millions of dollars of investors’ money to spouses, other relatives, friends, and shell companies they owned or controlled. The SEC claimed that each of the relief defendants received illicit proceeds from Defendants’ fraud to which they had no legitimate claim. The SEC is seeking permanent injunctions against each of the Defendants, enjoining them from future violations of the securities laws, disgorgement of all Defendants’ and relief defendants’ ill-gotten gains from the alleged unlawful activity, together with prejudgment interest, and civil penalties against Defendants under Section 20(d) of the Securities Act, 15 U.S.C. § 77t(d), Section 21(d)(3) of the Exchange Act, 15 U.S.C. §78u(d)(3), and Section 209(e) of the Advisers Act, 15 U.S.C. § 80b-9(e). Commenting on the allegations, Kurt L. Gottschall, Director of the SEC’s Denver Regional Office, said: “We allege that this scheme has resulted in tens of millions of dollars in investor losses, in part, to fund defendants’ luxurious lifestyle. The SEC will do all it can to hold these defendants accountable and ensure money is returned to those who were deceived.” The SEC press release announcing the commencement of the action can be found here . The SEC Complaint can be found here .