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SUPREME COURT OF THE STATE OF NEW YORKCOUNTY OF NEW YORK
Index No. 601832/09Part 60(Fried, J.)
COOPERATIVIEVE CENTRALERAIFFEISEN-BOERENLEENBANK, B.A.,
Plaintiff,
-against-
MERRILL LYNCH & CO., INC.,
Defendant.
PLAINTIFF'S MEMORANDUM OF LAW IN OPPOSITION TODEFENDANT'S MOTION TO DISMISS THE COMPLAINT
QUINN EMANUEL URQUHART OLIVER &HEDGES, LLP
Michael B. CarlinskyJonathan E. PickhardtBrendan N. SnodgrassJordan Fletcher51 Madison Avenue, 22nd FloorNew York, New York 10010-1601(212) 849-7000
Attorneys for Plaintiff
TABLE OF CONTENTS
Page
INTRODUCTION 1
FACTUAL BACKGROUND 3
A. Merrill Lynch Adopts A Fraudulent De-Risking Scheme To AvoidSubstantial Losses On Accumulated Inventory Of Subprime Securities 3
B. Merrill Lynch Creates The Norma CDO As Part Of Its De-RiskingScheme 4
C. Merrill Lynch Fraudulently Induces Rabobank To Loan Money To Norma 7
ARGUMENT 8
I. STANDARD OF REVIEW 8
II. RABOBANK HAS SUFFICIENTLY PLED FRAUD 9
A. Rabobank Adequately Alleges Intent 10
B. Rabobank Adequately Alleges Actionable Misrepresentations andOmissions 13
1. Merrill Lynch's Misrepresentations and Omissions Regarding theLegitimacy and Security of Norma as an Investment Vehicle 13
2. Merrill Lynch's Misrepresentations and Omissions Regarding theExperience, Independence and Integrity of NIR 17
3. Merrill Lynch's Misrepresentations and Omissions Regarding theValidity of Norma's Credit Ratings 20
4. Merrill Lynch's Misrepresentations and Omissions RegardingOpaque Structural Protections for Merrill Lynch Built into theNorma Structure 22
C. Rabobank Adequately Alleges Reliance On Merrill Lynch'sMisrepresentations 23
1. Rabobank Did Not "Disclaim" Reliance on Merrill Lynch'sStatements 25
2. Merrill Lynch Has Not Established that Rabobank "Failed to MakeUse of Means of Verification that Were Available to It" 26
3. Warnings in the Transactions Documents Do Not Preclude FraudClaims 29
III. RABOBANK HAS SUFFICIENTLY PLED NEGLIGENTMISREPRESENTATION 30
IV. RABOBANK HAS SUFFICIENTLY PLED FRAUDULENT CONVEYANCE 32
V. RABOBANK HAS SUFFICIENTLY PLED UNJUST ENRICHMENT/CONSTRUCTIVE TRUST 34
VI. RABOBANK HAS SUFFICIENTLY PLED CONVERSION 35
VII. IN THE ALTERNATIVE, LEAVE TO AMEND SHOULD BE GRANTED 35
CONCLUSION 35
11
TABLE OF AUTHORITIES
Page
Cases
511 W. 232nd Owners Corp. v. Jennifer Realty Co.,98 N.Y.2d 144 (2002) 8
Abu Dhabi Commercial Bank v. Morgan Stanley & Co.,---F. Supp.2d---, 2009 WL 2828018 (S.D.N.Y. Sep. 2, 2009) 21, 28
Andres v. LeRoy Adventures, Inc.,201 A.D.2d 262 (1st Dep't 1994) 32
Appleton Acquisition, LLC v. Nat'l Housing P'ship,10 N.Y.3d 250 (2008) 3
Apthorp Assocs., LLC v. 390 W. End Assocs. L.L.C.,22 Misc.3d 1132, 2009 WL 613606 (Sup. Ct. N.Y. County March 6, 2009) 28
Atkins Nutritional v. Ernst & Young, LLP,301 A.D.2d 547 (2d Dep't 2003) 32
Barrett v. Freifeld,64 A.D.3d 736 (2d Dep't 2009) 10
Brass v. Am. Film Tech., Inc.,987 F.2d 142 (2d Cir. 1993) 19
Caiola v. Citibank, NA., NY.,295 F.3d 312 (2d Cir. 2002) 30
CDO Plus Master Fund Ltd. v. Wachovia Bank, NA.,07 Civ. 11078(LTS)(AJP), 2009 WL 2033048 (S.D.N.Y. July 13, 2009) 25
City of New York v. Corwen,565 N.Y.S.2d 457 (1st Dep't 1990) 23, 24
City of New York v. Keene Corp.,756 N.Y.S.2d 536 (1st Dep't 2003) 23, 24
Cresser v. Am. Tobacco Co.,662 N.Y.S.2d 374, 174 Misc. 2d 1 (Sup. Ct. Kings County 1997) 16
Daly v. Kochanowicz,884 N.Y.S.2d 144 (2d Dep't 2009) 9
Donovan v. Aeolian Co.,270 N.Y. 267 (1936) 19
DynCorp v. GTE Corp.,215 F. Supp. 2d 308 (S.D.N.Y. 2002) 32
ECA & Local 134 IBEW Joint Pension Trust of Chicago v. JP. Morgan Chase Co.,553 F.3d 187 (2d Cir. 2009) 12, 13
E*Trade Fin. Corp. v. Deutsche Bank AG,420 F. Supp. 2d 290 (S.D.N.Y. 2006) 31
Elkind v. Liggett & Myers, Inc.,635 F.2d 156 (2d Cir. 1980) 15
Emigrant Bank v. UBS Real Estate Secs.,49 A.D.3d 382 (1st Dep't 2008) 32
Eternity Global Master Fund Limited v. Morgan Guar. Trust,No. 02 Civ. 1312(LMM), 2002 WL 31426310 (S.D.N.Y. Oct. 29, 2002) 30
Fraternity Fund Ltd. v. Beacon Hill Asset Mgt. LLC,376 F. Supp. 2d 385 (S.D.N.Y. 2005) 32
Guggenheimer v. Bernstein Litowitz Berger & Grossman LLP,810 N.Y.S.2d 880, 11 Misc. 3d 926 (Sup. Ct. N.Y. County 2006) 24, 35
Heller v. Goldin Restructuring Fund, L.P.,590 F. Supp. 2d 603 (S.D.N.Y. 2008) 19
Hershfcmg v. Citicorp.,767 F. Supp. 1251 (S.D.N.Y. 1991) 11
Hiliel v. Motor Haulage Co., Inc.,140 N.Y.S.2d 51 (Sup. Ct. Kings Co. 1955), affd, 1 A.D.2d 782 (2d Dep't 1956) 23
Hornett v. Leather,145 A.D.2d 814 (3d Dep't 1988) 34
Houbigant, Inc. v. Deloitte & Touche, LLP,303 A.D.2d 92 (1st Dep't 2003) 10
HSH Norbank v. UBS AG,600562/08 (Sup. Ct. N.Y. County Oct. 1, 2009) 11, 29
Huang v. Sy,859 N.Y.S.2d 903, 2008 WL 553646 (Sup. Ct. Queens County Feb. 28, 2008) 10
Hunt v. Alliance N Am. Gov. Income Trust Inc.,159 F.3d 723 (2d Cir. 1998) 30
IDC (Queens) Corp. v. Illuminating Experiences, Inc.,220 A.D.2d 337 (1st Dep't 1995) 33
IUE AFL-CIO Pension Fund v. Herrmann,9 F.3d 1049 (2d Cir. 1993) 16
Israel Discount Bank of NY. v. NCC Sportswear, Corp.,18 Misc. 3d 1140A, 2008 WL 518151 (Sup. Ct. N.Y. County 2008) 19
iv
Kimmell v. Schaefer,89 N.Y.2d 257 (1996) 30, 31
L & L Auto Distribs. & Suppliers Inc. v. Auto Collection, Inc.,23 Misc.3d 1139, 2009 WL 1652852 (Sup. Ct. Kings County June 12, 2009) 8
Lanzi v. Brooks,43 N.Y.2d 778 (1977) 9
Loblaw, Inc. v. Wylie,50 A.D.2d 4 (4th Dep't 1975) 33
M&T Bank Corp. v. Gemstone CDO VII, Ltd,23 Misc.3d 1105, 2009 WL 921381 (Sup. Ct. Erie County April 7, 2009) passim
Mallis v. Banker's Trust Co.,615 F.2d 68 (1980) 28
Mandarin Trading Ltd. v. Wildenstein,17 Misc.3d 1118, 2007 WL 3101235 (Sup. Ct. N.Y. County Sept. 4, 2007) 17
MBIA Ins. Corp. v. Countrywide Home Loans, Inc.,No. 602825/08, 2009 WL 2135167 (Trial Order) (Sup. Ct. N.Y. County July 8, 2009) 28
Menaker v. Alstaedter,134 A.D.2d 412 (2d Dep't 1987) 33
Merrill Lynch & Co. Inc v. Allegheny Energy,500 F.3d 171 (2d Cir. 2007) 24, 27
Mfrs. Hanover Trust Co. v. Drysdale Secs. Corp.,801 F.2d 13 (2d Cir. 1986), cert. denied, 479 U.S. 1066 (1987) 28, 35
Milman v. Box Hill Sys. Corp.,72 F. Supp. 2d 220 (S.D.N.Y. 1999) 15
Morgan, Olmstead, Kennedy & Gardner, Inc. v. Schipa,585 F. Supp. 245 (S.D.N.Y. 1984) 24
Olkey v. Hyperion 1999 Term Trust, Inc.,98 F.3d 2 (2d Cir. 1996) 15
P. T. Bank Central Asia v. ABN Amro Bank N.75 N.Y.S.2d 245 (1st Dep't 2003) 16
Pludeman v. N. Leasing Sys., Inc.,10 N.Y.3d 486 (2008) 9, 16
In re Prudential Sec. Inc. P'ships Litig.,930 F. Supp. 68 (S.D.N.Y. 1996) 15
Republic of Haiti v. Duvalier,211 A.D.2d 379 (1st Dep't 1995) 35
Roldan v. Allstate Ins. Co.,149 A.D.2d 20 (2d Dep't 1989) 16
Rovello v. Orofino Realty Co., Inc.,40 N.Y.2d 633 (1976) 9
Sakoloff v. Harriman Estates Dev. Corp.,96 N.Y.2d 409 (2001) 8
School Dist. Of the City of Erie v. J.P. Morgan Chase Bank,No. 08 CV 07688LAP, 2009 WL 234128 (S.D.N.Y. Jan. 30, 2009) 17
Segal v. Cooper,856 N.Y.S.2d 12 (1st Dep't 2008) 23
Sheridan v. Tr. of Columbia Univ. in the City ofX Y,296 A.D.2d 314 (1st Dep't 2002) 32
Sierra Rutile Ltd. v. Katz,No. 90 Civ. 4913(JFK), 1992 WL 236208 (S.D.N.Y. Sept. 8, 1992) 21
Societe Nationale d'Exploitation v. Salomon Bros. Int?,268 A.D.2d 373, 702 N.Y.S.2d 258 (1st Dep't 2000) 30
Sterling Interiors Group, Inc. v. Haworth, Inc.,No. 94 Civ. 9216(CSH), 1996 WL 426379 (S.D.N.Y. July 30, 1996) 21
Suez Equity Investors, L.P. v. Toronto-Dominion Bank,250 F.3d 87 (2d Cir. 2001) 32
UBS Real Estate Secs. Inc. v. Fairmont Funding Ltd.,862 N.Y.S.2d 818, 2008 WL 1821875 (Sup. Ct. N.Y. County April 21, 2008) 10
UST Private Equity Invs. Fund, Inc. v. Solomon Smith Barney,733 N.Y.S.2d 385 (1st Dep't 2001) 30
United States v. Zagari,111 F.3d 307 (2d Cir. 1997) 10
Valassis Comm 's, Inc. v. Weimer,304 A.D.2d 448 (1st Dep't 2003) 29
Wildman & Bernhardt Const., Inc. v. BPM Assocs., L.P.,708 N.Y.S.2d 653 (1st Dep't 1997) 34
Williams v. Sidley Austin Brown & Wood L.L.P,38 A.D.3d 219 (1st Dep't 2007) 19
Yang v. Morgan Stanley Dean Witter,724 N.Y.S.2d 149 (1st Dep't 2001) 30
Statutes
N.Y. Debt. & Cred. § 203 33
vi
Plaintiff CoOperatieve Centrale Raiffeisen-Boerenleenbank, ("Rabobank") respectfully
submits this memorandum of law in opposition to the motion to dismiss by Defendant Merrill
Lynch & Co., Inc. ("Merrill Lynch").
INTRODUCTION
At issue in this litigation are Rabobank's allegations that, in the months leading up to the
mid-2007 collapse of the subprime mortgage market, Merrill Lynch embarked on a fraudulent
scheme to avoid losses on its massive inventory of deteriorating mortgage securities. Merrill
Lynch accomplished this by unloading those assets at above-market prices on its own
collateralized debt obligations ("CDOs") — such as the "Norma" CDO at the center of this
dispute — thereby passing along the losses to the investors in those CDOs. This "de-risking"
strategy is hardly Rabobank's concoction, having also been exposed in an April 2008 front page
Wall Street Journal article and effectively conceded by Merrill Lynch's then-CEO.
Rabobank brings claims to recover the amounts it lost on a near $60 million senior
secured loan that it provided to Norma in March 2007 at Merrill Lynch's behest. As alleged in
the Complaint, unbeknownst to Rabobank at the time, Merrill Lynch had not structured Norma
as the legitimate investment vehicle it was purported to be, but rather had hijacked it to further
Merrill Lynch's own "de-risking" agenda. In so doing, Merrill Lynch variously misrepresented
or omitted material facts about Norma, including, among others, that:
• Many of Norma's assets were distressed securities that Norma's supposedlyindependent collateral manager (now under criminal investigation) had agreed topurchase at or near face value (Compl. 35-37);
• Merrill Lynch had teamed with Norma's key equity investor to create Norma as away to "short" the mortgage-backed securities market (Compl. 41-42);
• Merrill Lynch marketed Norma almost exclusively to "captive" investors thatwere beholden to Merrill Lynch for substantial business and would not questionNorma's bona fides (Compl. IN 43-46);
• Merrill Lynch brought Norma to market by procuring false credit ratings for theclasses of notes that Norma issued (Compl. IN 48-49); and
• Merrill Lynch had surreptitiously subordinated the repayment of Rabobank'ssenior loan to Merrill Lynch's own positions in the structure (Compl. 54-56).
On the basis of these allegations and others, Rabobank seeks recovery on claims of fraud,
negligent misrepresentation, fraudulent conveyance, unjust enrichment and conversion.
Merrill Lynch's efforts to obtain dismissal of these claims at the pleading stage falls short for
numerous reasons.
First, Merrill Lynch's claim that Rabobank failed to allege adequately fraudulent intent
(Mem. at 27-30) is easily dispatched in light of the Complaint's coherent allegations that Merrill
Lynch employed a fraudulent scheme to "de-risk" its distressed inventory through Norma.
Second, Merrill Lynch's tired refrain that Rabobank's fraud allegations are "conclusory"
and "lacking in specificity" (Mem. at 17-27) is belied by the multitude of specific allegations in
Rabobank's Complaint setting forth Merrill Lynch's misrepresentations and omissions. These
allegations easily meet the requirements that fraud be plead with detail and particularity.
Third, Merrill Lynch's argument that Rabobank could not, as a matter of law, have
reasonably relied upon Merrill Lynch's representations in light of purported disclaimers,
warnings and theoretical additional due diligence efforts (Mem. at 12-17) is also easily dispelled.
Indeed, the primary disclaimer that Merrill Lynch invokes (quoted on page 1 of its motion and
repeated throughout) is in a contract to which Merrill Lynch is not a party and had nothing to do
with Merrill Lynch's representations. The other disclaimers and warnings cited by Merrill
Lynch have been routinely regarded by courts as too general to preclude the type of fraud claims
asserted here. Nor are Merrill Lynch's contentions about what additional due diligence might
have shown — a clear fact-based inquiry — sufficient to support dismissal on the pleadings.
Finally, Merrill Lynch also fails to assert any basis for this Court's dismissal of
Rabobank's other claims. Most glaringly, Merrill Lynch provides zero justification for dismissal
of Rabobank's fraudulent conveyance claim, which requires nothing more than allegations that
Merrill Lynch sold assets to Norma for less than fair consideration and that Norma was either
already insolvent or rendered insolvent thereby. Rabobank's allegations easily meet that
standard.
2
For those reasons and the others described herein, Merrill Lynch's motion to dismiss the
Complaint should be denied.
FACTUAL BACKGROUND
The following facts alleged in Rabobank's Complaint must, for purposes of this motion,
be accepted as true with every possible inference drawn in Rabobank's favor. See Appleton
Acquisition, LLC v. Nat'l Housing P 'ship, 10 N.Y.3d 250, 261 (2008).
A. Merrill Lynch Adopts A Fraudulent De-Risking Scheme To AvoidSubstantial Losses On Accumulated Inventory Of Subprime Securities
During the height of the subprime mortgage boom, Merrill Lynch was the world's
leading underwriter of CDOs — the now infamous financial instruments through which Wall
Street banks repackaged securities backed by subprime mortgages into purportedly secure
investments. (Compl. If 13.) Between 2004 and 2007, Merrill Lynch generated hundreds of
millions of dollars in fees from assembling and marketing such CDOs. (Compl. 'II 13.)
By early 2007, however, Merrill Lynch had observed a material drop in the prices at
which it was able to sell mortgage-backed securities in the market. (Comp1.11 33.) At the same
time, Merrill Lynch faced massive exposure to this market, having amassed over $30 billion of
mortgage-backed securities as a product of its securitization business and for use in its CDO
production business. (Compl. 1133.)
To mitigate its financial exposure to the softening market, Merrill Lynch embarked on a
fraudulent scheme to use new CDOs as captive "customers" that would be willing to overpay for
Merrill Lynch's deteriorating assets — a strategy Merrill Lynch internally referred to as "de-
risking." (Compl. I 34.) Had Merrill Lynch sold its inventory of mortgage-backed securities to
any arm's-length buyer, it would have suffered a substantial loss; instead, Merrill Lynch
exercised its de facto control over the CDOs it was creating to force those structures to purchase
Merrill Lynch's deteriorated assets for prices that were at or very near "par" values. (Compl.
(ft 34.) Through these off-market sales, Merrill Lynch mitigated the losses that it otherwise would
have suffered from the drop in market values. (Compl. II 34.)
3
Although secret at the time, the existence of Merrill Lynch's "de-risking" strategy is not
in dispute. Indeed, the practice garnered front-page headlines in an April 2008 expose in the
Wall Street Journal entitled "Merrill Upped Ante as Boom In Mortgage Bonds Fizzled." As that
article described:
Pressures rose in early 2007 as the housing bubble lost air. Merrill set out toreduce its exposure, in an effort referred to innocuously as "de-risking." It couldhave sold off billions of dollars' worth of mortgage-backed bonds that it hadstockpiled with the intention of packaging them into more CDOs. But with themarket for such bonds slipping, Merrill would have had to record losses of $1.5 to$3 billion on the bonds .... Instead, Merrill Lynch tried a different strategy:quickly turn the bonds into more CDOs.... [E]xecutives believed that so long asall they retained on their books were super-senior tranches, they would beshielded from falls in the prices of mortgage securities. And they wouldn't haveto sell their mortgage bonds at a loss.
(Compl. 1134.) In fact, Merrill Lynch's own Chairman and CEO had obliquely referred to the
practice himself in public statements he made in late 2007, explaining that "[a]s the market for
[CDO] securities began to deteriorate in the first quarter [of 2007], [Merrill Lynch] began
substantially reducing its warehouse risk by constructing CDOs." (Compl. 1133.) Nor does
Merrill Lynch in this lawsuit even try to contest the existence of its de-risking strategy,
conceding instead that "Merrill's problem is that it didn't `de-risk' enough." (Mem. at 29.)
B. Merrill Lynch Creates The Norma CDO As Part Of Its De-Risking Scheme
The CDO at the heart of this case — Norma CDO I Ltd. — was born in the midst of
Merrill Lynch's undisclosed de-risking efforts. And, while Merrill Lynch would market Norma
as a legitimate investment vehicle, the reality was that virtually every attribute of Norma was
selected or structured to further Merrill Lynch's de-risking strategy, not to benefit its investors.
For example, for Norma's "collateral manager" — the purportedly independent entity
retained to compile Norma's asset portfolio — Merrill Lynch selected a small firm called NIR
Capital Management, LLC ("NIR") that it knew would allow Norma to pay near full price for
deteriorated assets, in furtherance of Merrill Lynch's de-risking agenda. (Compl. 50.) While
Merrill Lynch touted NIR's independence and expertise, the reality was that NIR's collateral
management business had been hatched over a round of golf between a Merrill Lynch executive
and Corey Ribotsky, NIR's founder, with the idea of NIR doing Merrill Lynch's bidding.
(Compl. IE 51.) In addition to an undisclosed history of lawsuits against Ribotsky's hedge funds
alleging fraud, insider trading and price manipulation (Compl. 1152), it has recently come to light
that NIR and Ribotsky are under federal criminal investigation for defrauding investors.1
The other key player in Merrill Lynch's efforts to create Norma as a "de-risking" vehicle
was Norma's linchpin equity investor — Magnetar Capital, LLC — a hedge fund and cozy
Merrill Lynch trading partner. Finding a CDO equity investor for a CDO doomed for failure —
such as Norma — would usually be difficult since the equity investor assumes the first loss
position and would usually evaluate rigorously the CDO's collateral to confirm a minimal risk of
loss. (Compl. 41.) Magnetar, however, was the perfect partner to help Merrill Lynch create a
CDO that was intended to incur massive losses, because Magnetar itself had embarked on a
strategy of hedging its CDO equity investments with much larger short positions in the same
structures — essentially making huge bets that the CDOs in which it invested would fail.
(Compl. 42.) This practice was later exposed in another Wall Street Journal article singling out
Magnetar as having made a "tidy profit" during the subprime market collapse. (Compl. if 42.)
Having recruited both a corrupted collateral manager and an equity investor that would
benefit if the deal lost money, Merrill Lynch was free to use Norma's collateral portfolio to "de-
risk" its exposure to the deteriorated assets held elsewhere on its books.
First, Merrill Lynch arranged to have Norma (via NIR) pay Merrill Lynch near par value
for a pool of "cash" securities that had declined in value by 27%, on average, at the time of
purchase. (Compl. 36.) Relative to the rest of the portfolio, these assets included a
disproportionate number of Merrill Lynch's own deteriorating CDO securities. (Compl. II 36.)
Second, Merrill Lynch arranged both to have itself serve as Norma's counterparty on the
credit default swap that created Norma's "synthetic" portfolio and to reference at full value
securities that had already, on average, declined in value by 15% at the time the swap was
I See Affirmation of Jonathan E. Pickhardt ("Pickhardt Aff."), Ex. A, "Hedge Fund Manager InvestigatedFor Fraud," Wall Street Journal (July 24, 2009).
5
executed. (Compl. 1135.) Through this, Merrill Lynch was able to use Norma as a means to
effectively take a $1.41 billion "short" position on the referenced assets in Norma's synthetic
portfolio — a short position that was 15% in the money on day one. (Compl. 15.)
Third, to further de-risk its own portfolio, Merrill Lynch arranged to have more than half
of the subprime and midprime mortgage-backed securities in Norma's synthetic portfolio track
the constituents in the ABX, an asset-backed security market index that was commonly used as a
means of hedging against overall market movements. (Compl. if 38.) Since many bank trading
partners sought to short the ABX as a means of hedging, it was common for banks to accumulate
corresponding long positions in the index. Building "long" ABX positions into Norma's
synthetic portfolio created a "short" ABX position for Merrill Lynch, as Norma's swap
counterparty, that allowed Merrill Lynch to hedge its long exposures.
Through these undisclosed machinations, Norma thus became an integral part of Merrill
Lynch's efforts to "de-risk" its portfolio in the early months of 2007. In order for these efforts to
succeed, however, Merrill Lynch both needed Norma to come to market and needed investors to
purchase Norma's notes, so that Merrill Lynch's risks would be passed onto others.
As a condition to closing under Norma's indenture, Merrill Lynch needed Standard &
Poor's Ratings Service ("S&P"), Moody's Investor Services ("Moody's") and Fitch Ratings Inc.
("Fitch") (together, the "Ratings Agencies") to issue certain investment grade ratings on the
various tranches of notes issued by Norma. (Compl. II 23.) Those required ratings, however,
were inconsistent with the substantial market deterioration in Norma's asset pool. (Compl.T48.)
Therefore, to ensure that Norma received its requisite ratings, Merrill Lynch either
misrepresented or withheld material information about Norma's asset pool, resulting in Norma's
notes receiving ratings that mischaracterize their true credit quality. (Compl. 1[ 49.)
And further, to ensure that there would be purchasers for the securities issued by Norma,
Merrill Lynch marketed a disproportionate amount of Norma's notes — comprising over 80% of
the subordinated securities in the Norma structure — to collateral managers that were beholden
to Merrill Lynch for business. (Compl. 43-46.) Indeed, nine of the twelve initial purchasers
6
of Norma's notes were managing — and earning fees on — over $42 billion of assets across a
combined 46 other Merrill Lynch deals. (Compl. If 45.) These "captive" investors provided a
ready market to which Merrill Lynch could pawn off Norma's securities without the value or
integrity of those securities being substantially tested or challenged. (Compl. dij 43.)
C. Merrill Lynch Fraudulently Induces Rabobank To Loan Money To Norma
Against this backdrop, Merrill Lynch approached Rabobank in early 2007 about
providing a $57.7 million loan to Norma through a type of agreement called a "Proceeds Swap."
(Compl. 19.) Securing the Proceeds Swap was critically important to Merrill Lynch's ability to
the close the Norma transaction since the proceeds were needed to fund upfront costs for
Norma's formation, including some of Merrill Lynch's own fees. To satisfy Rabobank's highly
conservative risk profile, Merrill Lynch committed that Rabobank's upfront loan to Norma
would be secured by Norma's purported $1.5 billion in portfolio assets and be senior in
repayment priority to all of Norma's noteholders, including even the "super senior" tranche of
notes that Merrill Lynch itself had committed to initially purchase. (Compl. II 24.)
In deciding to enter into the Proceeds Swap, Rabobank reasonably relied upon numerous
representations by Merrill Lynch with regard to Norma and the protections that Rabobank would
have securing the repayment of its upfront loan. (Compl. IR 19.) Those representations were
included in, among other sources, an 80-page detailed marketing book (the "Pitchbook")
provided by Merrill Lynch to Rabobank on February 5, 2007, an offering memorandum (the
"Offering Memorandum") that was first provided to Rabobank in draft on February 15, 2007,
and an indenture (the "Indenture") between Norma and its trustee, that was also first provided to
Rabobank in draft on February 15, 2007. (Compl. 1120.)
Unbeknownst to Rabobank, however, many of Merrill Lynch's representations upon
which Rabobank relied were materially false, misleading and/or incomplete. These included —
as described in the Complaint and below — misrepresentations or omissions with regard to:
• Merrill Lynch's use of Norma to "de-risk" its mortgage-backed securityinventory. (Compl. TT 34-35.)
7
• Merrill Lynch's effective control over NIR, as well as NIR's record ofquestionable integrity and its abdication of its duties to select each of Norma'sassets after making an independent judgment as to credit quality and value.(Compl. irf 50-53.)
• Merrill Lynch's collaboration with Norma's equity investor, Magnetar, to createNorma as a shorting vehicle. (Compl. TT 41-42.)
• Merrill Lynch's sale of distressed assets, including a disproportionately highpercentage of CDO securities underwritten by Merrill Lynch, to Norma at fullvalue. (Compl. TT 35-37.)
• Merrill Lynch's use of a portion of Norma's portfolio as a tracking instrument forthe ABX index. (Compl. If 38.)
• Merrill Lynch's procurement of inaccurate credit ratings from S&P, Moody's andFitch on the basis of misrepresentations and/or omissions with regard todeterioration in Norma's asset portfolio. (Compl. 48-49.)
• Merrill Lynch's disproportionate placement of securities issued by Norma withcaptive investors that managed other Merrill Lynch deals. (Compl. ■ffil 43-46)
• Merrill Lynch's failure to provide Rabobank with the promised structuralprotections that would secure its loan against all of Norma's assets. (Compl.TT 54-57.)
As a result of Merrill Lynch's wrongful conduct, upon Norma's default and liquidation,
Rabobank was left with more than $45 million of its senior priority loan unpaid. Rabobank
therefore filed suit for fraud, negligent misrepresentation, fraudulent conveyance, unjust
enrichment, and conversion. Merrill Lynch subsequently moved to dismiss, which Rabobank
hereby opposes.
ARGUMENT
I. STANDARD OF REVIEW
In considering Merrill Lynch's motion to dismiss under CPLR 3211, the Court must
"liberally construe the complaint ... and accept as true the facts alleged in the complaint." L & L
Auto Distribs. & Suppliers Inc. v. Auto Collection, Inc., 23 Misc.3d 1139(A), 2009 WL 1652852,
*4 (Sup. Ct. Kings County June 12, 2009) (quoting 511 W. 232nd Owners Corp. v. Jennifer
Realty Co., 98 N.Y.2d 144, 152 (2002)); see also Sakoloff v. Harriman Estates Dev. Corp., 96
N.Y.2d 409, 414 (2001). "[A] complaint should not be dismissed on a pleading motion so long
as, when the plaintiff is given the benefit of every possible favorable inference, a cause of action
exists." Rovello v. Orofino Realty Co., Inc., 40 N.Y.2d 633, 634 (1976). The "rules are
designed to focus attention on whether the pleader has a cause of action rather than on whether
he has properly stated one." Id. at 36 (quotations omitted).
Merrill Lynch's motion to dismiss pursuant to CPLR 3211(a)(1) "will fail unless the
documentary evidence that forms the basis of the defense resolves all factual issues as a matter of
law, and conclusively disposes of the plaintiff's claim." Daly v. Kochanowicz, 884 N.Y.S.2d
144, 151 (2d Dep't 2009) (citation omitted). Likewise, Merrill Lynch's motion to dismiss
pursuant to CPLR 3211(a)(7) "will fail if, taking all facts alleged as true and according them
every possible inference favorable to the plaintiff, the complaint states in some recognizable
form any cause of action known to our law." Id. at 151-152 (citation omitted). Applying these
standards, Rabobank's allegations are more than sufficient to survive Merrill Lynch's motion to
dismiss.
II. RABOBANK HAS SUFFICIENTLY PLED FRAUD
Merrill Lynch fails to identify any basis upon which Rabobank's claims for fraud should
be dismissed. To state a claim for fraudulent misrepresentation, a plaintiff need only allege a
"representation of a material existing fact, falsity, scienter, deception and injury." Daly, 884
N.Y.S.2d at 152. Courts do not require a plaintiff to include "unassailable proof of fraud" in its
complaint, understanding that facts supporting the plaintiff's claim that are uniquely in the
defendant's knowledge may be "unavailable prior to discovery." Pludeman v. N. Leasing Sys.,
Inc., 10 N.Y.3d 486, 492-93 (2008). Rather, a plaintiff need only include "sufficient detail to
clearly inform a defendant with respect to the incidents complained of." Lanzi v. Brooks, 43
N.Y.2d 778, 780 (1977).
Fraud may also arise by omission where, in addition to the aforementioned factors, a
defendant had a duty to disclose material information and failed to do so. Such a duty arises in
any of the following situations: (i) where "there is a need to complete or clarify one party's
partial or ambiguous statement"; (ii) if "there exists a fiduciary or confidential relationship
between the parties"; or (iii) where "one party has superior knowledge of facts which are not
9
available or discoverable with reasonable diligence by the other party and the first party knows
that the second party is acting on the basis of mistaken or inadequate knowledge." Huang v. Sy,
859 N.Y.S.2d 903 (Table), 2008 WL 553646, *6 (Sup. Ct. Queens County Feb. 28, 2008); see
also Barrett v. Freifdd, 64 A.D.3d 736, 738 (2d Dep't 2009) ("[e]ven in the absence of a
fiduciary relationship, a duty to disclose may arise when one party's superior knowledge of
essential facts renders nondisclosure inherently unfair."). 2 As detailed below, Rabobank has
made sufficient allegations to support its fraud by omission claims on the basis of Merrill
Lynch's partial or ambiguous statements and/or its superior knowledge of facts not available to
or discoverable by Rabobank.
Merrill Lynch argues for dismissal of Rabobank's fraud claims on the basis that
Rabobank: (1) failed to plead adequately fraudulent intent; (2) failed to plead any actionable
misrepresentation or omission; and (3) failed to plead adequately justifiable reliance. As
described below, Merrill Lynch is wrong on all counts.
A. Rabobank Adequately Alleges Intent
As a preliminary matter, Merrill Lynch's argument that "Rabobank fails to sufficiently
plead intentional wrongdoing" (Mem. at 27) is premature as "Nntent to defraud ... 'is ordinarily
a question of fact which cannot be resolved on a ... motion to dismiss." UBS Real Estate Secs.
Inc. v. Fairmont Funding Ltd., 862 N.Y.S.2d 818 (Table), 2008 WL 1821875, *3 (Sup. Ct. N.Y.
County April 21, 2008) (Fried, J.) (citation omitted). Rather, a defendant's intent need not be
proven at the pleading stage, and it is sufficient if intent can be inferred "from the defendant's
actions and through other circumstantial evidence." United States v. Zagari, 111 F.3d 307, 327
(2d Cir. 1997) (citation omitted); see also Houbigant, Inc. v. Deloitte & Touche, LLP, 303
A.D.2d 92, 100 (1st Dep't 2003) (plaintiff may establish intent from "facts from which it may be
inferred that the defendant was aware that its misrepresentations would be reasonably relied
upon by the plaintiff").
2 Merrill misstates the law as requiring fraudulent omission claims to allege "either a fiduciary duty orconfidential relationship between the parties." (Mem. at 18.)
10
Rabobank has pled, in more than sufficient detail, that Merrill Lynch secretly developed a
scheme in early 2007 to "de-risk" its exposure to mortgage-backed securities and had a strong
financial motivation to commit fraud. In fact, this type of "undisclosed economic motivation"
was recently upheld by Justice Lowe as supporting a fraud claim alleging that a CDO
underwriter had "structured the deal from day one with only its own benefit in mind, with the
intent to thwart [plaintiff's] expectation for a low-level, but reliable, risk investment." HSH
Norbank v. UBS AG, 600562/08, at 4 (Sup. Ct. N.Y. County Oct. 1, 2009). Here, Rabobank has
similarly alleged that Merrill Lynch's de-risking scheme was an undisclosed economic
motivation and that for Merrill Lynch structured Norma from day one with Merrill Lynch's own
benefit in mind, with the intent of thwarting Rabobanles expectation for a low-risk, but reliable,
investment through the Proceeds Swap.
Merrill Lynch's argument that Rabobanles intent allegations impermissibly rely upon
newspaper articles is both misplaced and mistaken. None of the authority cited by Merrill Lynch
stands for the proposition that intentional conduct exposed by investigative journalism cannot
support fraud allegations. 3 Nor is Merrill Lynch even slightly persuasive in claiming that "there
is nothing wrong with [the] `de-risking" strategy exposed by the Wall Street Journal. (Mem. at
29.) Rather, the Journal uncovered that Merrill Lynch was forcing CDOs to overpay for Merrill
Lynch's deteriorating assets. According to the Journal, had Merrill Lynch sold the mortgage-
backed bonds it had stockpiled in the open market, it "would have to record losses of $1.5 to $3
billion" whereas by selling those same assets to its own CD0s, Merrill Lynch "wouldn't have to
sell their mortgage bonds at a loss." (Compl. II 34.) Far from an innocuous risk mitigation
strategy, the Journal described exactly what Rabobank alleges here — that Merrill Lynch
knowingly sold impaired assets to Norma at above-market prices in order to maximize its returns
3 Hers hfang v. Citicorp., 767 F.Supp. 1251 (S.D.N.Y. 1991), cited by Merrill Lynch, has no applicationwhere, as here, the investigative journalism exposes the facts constituting the fraud. In contrast, Hershfang involveda plaintiff attempting to state a claim for securities fraud based on statements made by the defendant in various newsarticles.
11
and minimize its losses. Indeed, by admitting in its papers that it engaged in "de-risking" (Mem.
at 29), Merrill Lynch effectively concedes the basis for Rabobank's intent allegations.
In any event, while the fraudulent conduct exposed by the Wall Street Journal is
sufficient to support Rabobank's intent allegations, it is not the sole basis for those allegations.
For example, Rabobank additionally relies upon allegations that Merrill Lynch intentionally
procured false credit ratings for Norma's notes, knowingly misrepresented the experience of NIR
and the process it employed to select Norma's assets, intentionally placed Norma's notes with
captive investors, and failed to disclose that a significant portion of Norma's assets had been
selected to create a de facto ABX index hedge for Merrill Lynch. These allegations, which were
not sourced from newspapers articles, are also sufficient to demonstrate a clear intent to defraud.
Further, Merrill Lynch is simply mistaken in contending that Rabobank's theory "cannot
be reconciled with the fact that Merrill Lynch took the biggest 'long' position of any investor in
the Transaction." (Mem. at 28.) As a preliminary matter, while Rabobank alleges that Merrill
Lynch committed to purchase $975 million of Norma's "super-senior" Class A-1 Notes, it is
entirely possible that Merrill Lynch subsequently offloaded that financial risk onto a third party.4
Yet, even if Merrill Lynch retained that "long" position in Norma, what Merrill Lynch
conspicuously fails to mention is that it simultaneously took a much larger "short" position
through its role as Norma's swap counterparty on the $1.41 billion of synthetic collateral
acquired by Norma. Through this role, Merrill Lynch fully hedged its long position and created
hundreds of millions of dollars worth of short exposure to Norma's synthetic collateral. Thus, it
is hardly clear that Norma's deterioration was the "spectacular failure" for Merrill Lynch that it
claims (Mem. at 28) — indeed, it very well may have profited handsomely.
Merrill Lynch's attempt to equate this case to ECA & Local 134 IBEW Joint Pension
Trust of Chicago v. J.P. Morgan Chase Co., 553 F.3d 187 (2d Cir. 2009) misses the mark since
4 The Wall Street Journal's April 2008 article describes Men-ill's active efforts during 2007 to "mitigate"risks by hedging exposure to the super-senior tranches it held on its books — such as with Norma — through dealswith a number of bond insurers. (Musoff Aff., Ex 10.)
12
there, the plaintiff's complaint embodied two contradictory theories: "an intent to earn excessive
fees for the corporation and also an intent to defraud Plaintiffs by losing vast sums of money."
Id. at 203. Since those internally contradictory results made no rational sense, the court
dismissed the claims. In this case, however, Rabobank's claims contain no such contradictory
theories; rather it makes consistent allegations that Merrill Lynch enhanced its financial position
at the expense of Rabobank and Norma's investors by dumping unsellable assets in Norma,
giving itself priority repayment status and hedging against falling values.
B. Rabobank Adequately Alleges Actionable Misrepresentations andOmissions
In support of its contention that Rabobank has failed to allege actionable
misrepresentations or omissions, Merrill Lynch argues that Rabobank's claims lack "sufficient
particularity," are "conclusory," or are "refuted by the Transaction Documents." 5 (Mem. at 19-
20). These assertions are completely devoid of merit in light of the fact that the Complaint sets
forth a cogent and coherent fraudulent scheme through which Merrill Lynch sought to
"maximize its own revenues and mask its losses during the last gasp of the subprime mortgage
boom." (Compl. 41131.) Specifically, the Complaint details how Merrill Lynch, in furtherance of
that scheme, misrepresented and omitted material facts as to: (1) the legitimacy and security of
Norma as an investment vehicle; (2) the experience, independence and integrity of NIR in
selecting Norma's assets; (3) the validity of Norma's credit ratings; and (4) the opaque structural
protections Merrill Lynch created for itself in the deal. These allegations are set forth in
sufficient particularity and detail and are entirely consistent with — if not, indeed, supported by
— the Transaction Documents. Merrill Lynch's arguments to the contrary must fail.
1. Merrill Lynch's Misrepresentations and Omissions Regarding the Legitimacy and Security of Norma as an Investment Vehicle
The Complaint alleges numerous specific misrepresentations by Merrill Lynch that
Norma was established as a legitimate and secure investment vehicle for investors intending to
5 The "Transaction Documents" include the Pitchbook, the Offering Memorandum, the Indenture and theProceeds Swap. (Mem. at 5.)
13
take a "long" position in the mortgage backed securities market. (Compl. 21.) These include
representations in the Pitchbook prepared by Merrill Lynch, which touted that:
(a) there were seven classes of carefully structured notes comprising $1.5 billionof securities that would be available to investors interested in investing in astructure with a "portfolio of Synthetic Securities of which the referenceobligations are predominantly Residential Mortgage Backed Securities(`RMBS') and CDO Securities as well as cash ABS, RMBS, CDO Securities,and CMBS Securities" (Pitchbook at 6);
(b) the RMBS securities that Norma would be purchasing "have historicallyexhibited lower default rates, higher recovery upon default and better ratingstability that comparably rated corporate bonds" (Pitchbook at 6);
(c) the primary classes of securities in Norma's collateral pool had an historical 1-year weighted default rate of less than 1% (Pitchbook at 13); and
(d) the type of debt securities that were being issued by Norma exhibited highstability and low volatility relative to corporate obligations, and thus were asecure long-term investment. (Pitchbook at 16-18.) (Compl. 20-21.)
The Complaint also alleges in detail both how and why these representations were false,
misleading and/or incomplete. Specifically, the Complaint describes how Merrill Lynch never
intended Norma to be secure investment vehicle, but had rather used it in its "de-risking" scheme
to transfer billions of dollars of Merrill Lynch's distressed assets to unsuspecting investors at
inflated prices. (Compl. 32-38.) Indeed, as alleged in the Complaint, the 'synthetic assets' in
Norma's portfolio had undisclosed deterioration of 15% at the time of Norma's closing, and
Norma's 'cash assets' — which included a disproportionately high percentage of Merrill Lynch's
own CDO securities — had even greater undisclosed deterioration of 27% by closing. (Compl.
35-36.) Merrill Lynch not only concealed this deterioration but also arranged to have Norma
pay at or near par value for the deteriorated securities, thus transferring the market losses on the
assets to Norma's investors. (Compl. IT 37.)
Rabobank's assertion that Merrill Lynch did not intend Norma as a legitimate investment
vehicle is further supported by Rabobank's allegations that Merrill Lynch teamed up with
Norma's linchpin equity investor, Magnetar Capital LLC, to create Norma as a short position on
the mortgage-backed securities market and that the other investors in Norma came almost
14
exclusively from Merrill Lynch's stable of captive collateral managers that were managing other
Merrill Lynch CDOs and thus beholden to it for business. (Comp!. 11[39-47.)
Merrill Lynch's characterization of these allegations as mere "fraud by hindsight" are
unavailing. (Mem. at 20.) Rabobank does not claim fraud on the basis of a subsequent drop in
value of securities; rather, Rabobank alleges that Merrill Lynch knew — and, indeed, intended
— that Norma's collateral would include assets that had already deteriorated in order to further
Merrill Lynch's "de-risking" strategy. Merrill Lynch's significant reliance on the Second
Circuit's decision in Olkey v. Hyperion 1999 Term Trust, Inc., 98 F.3d 2, 8 (2d Cir. 1996), is thus
misplaced, as the fraud claims dismissed in that case — unlike here — alleged only that fund
manager defendants made unskillful investment decisions which caused subsequent losses.
Nor are Merrill Lynch's attempts to invalidate Rabobank's misrepresentation claims that
involve statements about historical performance any more convincing. (Mem. at 21.) As
Rabobank has alleged, Merrill Lynch knew, at the time it made the statements about historical
performance in the Pitchbook, that Norma's collateral included a substantial number of
distressed assets and that reference to the historical performance measures for non-distressed
assets was thus grossly misleading. See, e.g., Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 164
(2d Cir. 1980) ("Liability may follow where management intentionally fosters a mistaken belief
concerning a material fact ...."); Milman v. Box Hill Sys. Corp., 72 F. Supp. 2d 220, 230-31
(S.D.N.Y. 1999) (claim based on failure to disclose actual and known — as opposed to
hypothetical — risks was not barred by the "bespeaks caution" doctrine); In re Prudential Sec.
Inc. P 'ships Litig., 930 F. Supp. 68, 72 (S.D.N.Y. 1996) ("[C]autionary language does not
protect material misrepresentations or omissions when defendants knew they were false when
made."). Furthermore, even assuming arguendo that the statements regarding historical
performance in the Pitchbook were not actionable as affirmative misrepresentations, that would
not preclude Rabobank's claims that Merrill Lynch fraudulently omitted material information
regarding the distressed nature of Norma's collateral that was peculiarly in Merrill Lynch's
possession and necessary to render the Pitchbook's disclosures not misleading.
15
Similarly, Merrill Lynch's argument that the Court should disregard Rabobank's
allegations of impairment in Norma's assets simply because Rabobank does not allege the source
of its information fails under established legal precedent. (Mem. at 22.) It is axiomatic that a
plaintiff need not plead the evidence supporting its claim in order to survive a motion to dismiss,
as even facts plead "upon information and belief' must be accepted as true. See Roldan v.
Allstate Ins. Co., 149 A.D.2d 20, 40 (2d Dep't 1989); see also Cresser v. Am. Tobacco Co., 662
N.Y.S.2d 374, 174 Misc.2d 1, 4, 9 (Sup. Ct. Kings County 1997). A plaintiff need not provide
"proof" in its complaint, especially where the facts supporting its allegations are peculiarly in the
defendant's possession and thus "unavailable prior to discovery." Pludeman, 10 N.Y.3d at 493;
see also IUE AFL-CIO Pension Fund v. Herrmann, 9 F.3d 1049, 1057 (2d Cir. 1993) ("[fraud]
allegations may be based on information and belief when facts are peculiarly within the opposing
party's knowledge") (citation omitted). Indeed, Merrill Lynch acknowledged as much in seeking
to uphold its own fraud claims in Merrill Lynch v. Young, where it asserted that its own fraud
allegations based on "information and belief' were sufficient because "facts relating to the fraud
are peculiarly in the opposing parties' possession." (Pickhardt Aff., Ex B at 10-11.)
Significantly, in Merrill Lynch v. Young, Merrill Lynch further argued — contrary to the
standards by which it seeks to have Rabobank's claims judged here — that the pleading of
"detailed evidentiary matter," (id. at 9) is not required to sustain a fraud claim.
Rabobank has satisfied — and indeed, exceeded — the very standards Merrill Lynch
itself advanced in Young, as the mark-to-market valuation of Merrill Lynch's own assets is
precisely the kind of information that is "peculiarly in [Merrill Lynch's] possession." (ML Opp.
at. 11.) See P.T. Bank Central Asia v. ABN Amro Bank IV.V, 75 N.Y.S.2d 245 (1st Dep't 2003)
(reversing dismissal where plaintiff alleged that defendant possessed specific knowledge and
information that the value of the collateral for a loan had been significantly overstated, and
16
holding that plaintiff need not plead "how or when [defendant] assertedly obtained information
demonstrating that the appraised value was overstated" to comply with CPLR 3016(b)).6
Moreover, Merrill Lynch's claim that Rabobank's allegations regarding the
disproportionately high number of Merrill Lynch's own CDOs in Norma's cash portfolio should
be disregarded, because that information was disclosed in the Offering Circular, is simply wrong.
(Mem. at 22-23.) The only disclosures that Merrill Lynch cites concern general disclaimers that
some of Norma's collateral may have been sourced from Merrill Lynch. Rabobank's allegations,
however, concern something entirely different, which is the relative concentration of Merrill
Lynch's own CDO securities in the cash portfolio as compared to the synthetic portfolio.
(Compl.T 36.) The Offering Circular did not disclose — nor does Merrill Lynch even attempt to
provide any non-fraudulent explanation for — this gross discrepancy in Norma's synthetic and
cash assets, which were both purportedly selected on the basis of the same selection criteria.
2. Merrill Lynch's Misrepresentations and Omissions Regarding theExperience, Independence and Integrity of NIR
The Complaint also alleges numerous specific misrepresentations by Merrill Lynch
regarding the experience, independence and integrity of NIR as Norma's collateral manager.
Indeed, almost 20 pages of the Pitchbook were dedicated to describing NIR's experience and
investment selection process. (Pitchbook at 45-62.) The Pitchbook extolled NIR's principals as
having a "depth of investment expertise [that] spans all major sectors of structured finance" and
a "strong record of portfolio management." (Compl. If 22.) It further asserted that NIR would
apply an independent and rigorous evaluation process to select "products that offer superior risk
adjusted returns" and employ a "long term return on equity approach ... to the investment
6 Defendant's reliance on School Dist. of the City of Erie v. J.P. Morgan Chase Bank, No. 08 CV07688LAP, 2009 WL 234128 (S.D.N.Y. Jan. 30, 2009) and Mandarin Trading Ltd. v. Wildenstein, 17 Misc.3d1118(A), 2007 WL 3101235 (Sup. Ct. N.Y. County Sept. 4, 2007), is misplaced. Significantly, in City of Erie, thedismissed claims were based upon bare allegations regarding the subjective "fairness" of a fee or market spread thatthe Court found required some enumeration; in contrast, Rabobank's allegations about the market value of Norma'sassets concern objective facts about the "mark to market" — or prices at which Merrill Lynch was clearing trades —for assets for which Merrill Lynch made a market. Similarly, the dismissed claims in Mandarin involved an artappraisal that the court concluded was mere "opinion" and thus could not support fraud claims. Here, the mark-to-market value of Norma's assets was not "opinion" but facts that Merrill Lynch misrepresented.
17
selection process" through the use of "proprietary CDO modeling" that "forecasted collateral
performance ... from a base of historical loan/bond level data." (Id.) Merrill Lynch further
touted NIR's "bottom-up analysis" that would involve, among other factors, an evaluation of
"collateral profiles," "performance statistics," and the "latest performance trends" for each of the
potential individual portfolio assets that NIR selected for Norma's portfolio. (Id.)
The Complaint further details exactly how and why these representations were false,
misleading or incomplete. For example, it alleges that Merrill Lynch failed to disclose that NIR
had been created by Merrill Lynch as a captive collateral manager that was completely beholden
to Merrill Lynch for business. (Comp1.1[ 51.) It further alleges that Merrill Lynch's touting of
NIR as a reputable manager was refuted by undisclosed information about the checkered past of
Corey Ribotsky, NIR' s founder and chief executive, who had a long history of lawsuits alleging
stock price manipulation and shorting of companies in which NIR had invested. (Compl. 1152.)
Indeed, since the Complaint was filed, it has come to light that Mr. Ribotsky and NIR — the
very parties that Merrill Lynch put in charge of selecting Norma's collateral — are now under
criminal investigation by the Federal Bureau of Investigation and the Securities and Exchange
Commission for defrauding investors. See Pickhardt Aff., Ex. A. Having made certain
statements regarding NIR's expertise, independence and competency, Merrill Lynch was
obligated to disclose countervailing facts that would have provided a fuller picture of NIR and
corrected misperceptions created by false information and/or half-truths.
The Complaint furthermore alleges that, as Merrill Lynch was aware and intended, NIR
never implemented the rigorous asset selection process described in the Pitchbook. For example,
it alleges that over half of the subprime and midprime RMBS in Norma's collateral pool were
simply lifted from the ABX index, an asset-backed securities index commonly used to hedge
against overall market movements. (Compl. 38.) This correlation — which was far too high to
have occurred by coincidence — was patently inconsistent with the supposed individualized
"bottom-up analysis" that Merrill Lynch represented NIR would use to select Norma's portfolio.
(Compl. TT 38, 50.) Furthermore, the Complaint alleges that Merrill Lynch knew and intended
18
that NIR would abdicate its responsibility to rigorously assess Norma's collateral and permit
Merrill Lynch to hijack the portfolio — especially the cash asset portion — to dump deteriorated
assets from its own books as part of its efforts to "de risk." (Compl. 53).
Merrill Lynch's half-hearted attempt to rebut these allegations by asserting that
Rabobank fails to allege any statements that Norma's portfolio "would differ substantially from
the ABX index" misses the point. (Mem. at 24-25.) The clear and irrefutable point is that
Merrill Lynch's hyping of NIR as employing the "bottom-up" asset-by-asset selection process is
undercut by the fact that NIR selected a significant component of the portfolio to track the ABX
index in order to create a hedge for Merrill Lynch. Even without an affirmative representation
that Norma's portfolio would not track the ABX, these allegations are sufficient to support a
fraud claim. See Donovan v. Aeolian Co., 270 N.Y. 267, 270-71 (1936) (piano salesman who
placed a used and refurbished piano on the showroom floor was liable for fraud even though
"there ha[d] not been a direct affirmation by the seller that the goods were new and unused");
Williams v. Sidley Austin Brown & Wood L.L.P., 38 A.D.3d 219, 220 (1st Dep't 2007)
(misleading partial disclosures by financial services provider found actionable).
Nor does Merrill Lynch do any better in seeking to characterize its representation that
NIR had a "strong record" as mere opinion. (Mem. at 25.) Such a representation can plainly
support a fraud claim when stated — as Merrill Lynch is adequately alleged to have done here —
with knowledge of its falsity or where the statement was material to an investment decision and
created a misleading impression or half-truth. See, e.g., M&T Bank Corp. v. Gemstone CDO VII,
Ltd., 23 Misc.3d 1105(A), 2009 WL 921381, at *9 (Sup. Ct. Erie County April 7, 2009) (finding
statement that CDO structure was "fully rock solid" sufficient to support a fraud claim). 7 In any
7 Merrill Lynch's reliance on Israel Discount Bank of NY. v. NCC Sportswear, Corp., 18 Misc. 3d 1140A,2008 WL 518151, *4 (Sup. Ct. N.Y. County 2008), is unavailing since that case involved only casual comments,unlike the detailed representations about NIR by Merrill Lynch in this case. Moreover, having provided someinformation regarding NIR's record, Merrill Lynch was obligated to disclose competing facts that contradicted oraltered that picture. See Brass v. Am. Film Tech., Inc., 987 F.2d 142, 150 (2d Cir. 1993) (finding that when a "partyhas made a partial or ambiguous statement," a duty to disclose arises "on the theory that once a party has undertakento mention a relevant fact to the other party it cannot give only half of the truth."). Such information would have"altered the 'total mix' of information available," and thus was a material omission. Heller v. Goldin RestructuringFund, L.P., 590 F. Supp. 2d 603, 614 (S.D.N.Y. 2008) (citation omitted).
19
event, Merrill Lynch's description of NIR as having a "strong record" is but one of many false
representations alleged in the Complaint; the rest Merrill Lynch does not even seek to challenge.
3. Merrill Lynch's Misrepresentations and Omissions Regarding the Validity of Norma's Credit Ratings
The Complaint also alleges numerous specific misrepresentations regarding the
independent credit ratings for Norma's notes that were intended to confirm the overall secure
nature of Norma as an investment. Specifically, the Complaint alleges that the Pitchbook, the
Offering Circular, and the Indenture each included representations by Merrill Lynch that
Norma's issuance of notes would be conditioned upon Norma's nine tranches of notes receiving
legitimate investment-grade ratings from S&P, Moody's and Fitch Ratings, with the top 75% of
the structure receiving each of the Ratings Agencies' highest ratings (e.g., AAA). (Compl. 23.)
The Complaint then details why and how these representations were false, misleading or
incomplete. Specifically, the Complaint alleges that Merrill Lynch knew that the notes issued by
Norma did not warrant the requisite investment-grade ratings on account of the distressed nature
of the assets, which equated to expected losses on the overall collateral pool of $225 million at
closing. (Compl. IT 48.) Merrill Lynch nonetheless arranged for Norma to obtain the requisite
ratings through either providing false information to, or withholding information from, the
Ratings Agencies. (Compl. II 49.) Merrill Lynch thus knew that the credit ratings it procured
from the Ratings Agencies were inaccurate, since the degraded quality of the collateral
underlying the notes made the likelihood of default much greater, and the likelihood of recovery
far lower, than the ratings actually reflected. (Compl. IT 49.)
Merrill Lynch's contention that Rabobank's allegations lack sufficient specificity
regarding the misrepresentations or omissions Merrill Lynch made to the Ratings Agencies
misses the mark. Rabobank does not predicate its claims on Merrill Lynch's misrepresentations
to the Ratings Agencies, but rather predicates them on Merrill Lynch's misrepresentations to
Rabobank regarding the legitimate credit ratings that Norma's notes would be required to receive
as a condition to closing. The Complaint sets forth the details of those misrepresentations with
20
all the particularity required and, indeed, Merrill Lynch does not claim otherwise. In any event,
even if Rabobank were required to describe Merrill Lynch's misrepresentations to the Ratings
Agencies with particularity, its allegations that Merrill Lynch obtained credit ratings that were
irreconcilable with the information that Merrill Lynch knew about deterioration in Norma's
collateral pool is sufficient at the pleading stage, where information as to Merrill Lynch's
specific communications with the Ratings Agencies will be unavailable to Rabobank until
discovery. See Sierra Rutile Ltd. v. Katz, No. 90 Civ. 4913(JFK), 1992 WL 236208, *6
(S.D.N.Y. Sept. 8, 1992) ("Because Plaintiff has based its allegations of fraud upon information
from third parties, its information-and-belief allegations are acceptable ... given that Plaintiff
cannot be expected to have direct knowledge of [defendant's] allegedly fraudulent conduct");
Sterling Interiors Group, Inc. v. Haworth, Inc., No. 94 Civ. 9216(CSH), 1996 WL 426379, *7
(S.D.N.Y. July 30, 1996) (finding fraud allegations regarding price-fixing information supplied
by defendant was sufficient without identifying the agent who supplied the information or the
date it was supplied where that information was "peculiarly in the opposing party's knowledge").
Nor does Merrill Lynch's argument with regard to statements in the Offering Circular
and Pitchbook that credit ratings "are not a guarantee of quality" fare any better. (Mem. at 26).
As the court explained in M&T Bank Corp. in rejecting a motion to dismiss claims with regard to
false credit ratings on the basis of similar arguments:
The ratings by Moody's and S&P are facts constituting the actual evaluation byreputable independent entities concerning the creditworthiness of the Notes.Plaintiff alleges that these ratings were false because the Defendants providedfalse information to the ratings agencies. The ratings by Moody's and S&P arenot just predictions of future valuation but a present analysis of current valuation.Such ratings have been highly regarded and eagerly sought for years. Tocharacterize them merely as predictions or opinions would undercut the necessaryreliability such ratings furnish to the work of credit.
2009 WL 921381, at *11; see also Abu Dhabi Commercial Bank v. Morgan Stanley & Co., ---
F.Supp.2d ----, 2009 WL 2828018, *13 (S.D.N.Y. Sept. 02, 2009) (upholding fraud claims based
on the procurement of inflated ratings notwithstanding disclaimers that ratings are not a
guarantee of performance on finding that "the market at large, including sophisticated investors,
21
have come to rely on the accuracy of credit ratings and the independence of rating agencies ...
[and] the Rating Agencies' access to non-public information that even sophisticated investors
cannot obtain."). Thus, even if a credit rating is not a "guarantee," procuring false ratings
constitutes an actionable fraud since credit ratings are widely understood to be predicated on
present analysis by an independent entity. Merrill Lynch's arguments to contrary fail.
4. Merrill Lynch's Misrepresentations and Omissions Regarding OpaqueStructural Protections for Merrill Lynch Built into the Norma Structure
Finally, the Complaint also alleges numerous misrepresentations regarding the structural
attributes of the transaction that would protect Rabobank's right to priority repayment of its loan
prior to all of Norma's noteholders. For example:
• The Pitchbook included among the "Transaction Highlights" a chartshowing payments to Rabobank (identified as the 'Senior HedgeCounterparty' in the chart) as senior to payments made to any of Norma'snoteholders, including the AAA-rated Class Al Notes. (Compl. 'II 24.)
• In e-mail communications on February 15, 2007, Merrill Lynch confirmedthat Rabobank's position would be senior to the notes, and made revisionsto the Indenture's "Priority of Payments," placing Rabobank above all ofNorma's noteholders, and even above Merrill Lynch itself as the CDSCounterparty. (Compl. 25.)
• The Indenture's subordination provision expressly provided that "theNotes ... shall be subordinate and junior to the rights of the HedgeCounterparties [e.g., Rabobank] ... with respect to payments to be made tothe Hedge Counterparties." (Compl. IR 26.)
• The Offering Circular included a list showing the order in which "losseswill be borne," which included the nine classes of noteholders and theholders of preference shares (i.e., equity). Notably, Rabobank, as a"Hedge Counterparty," was not included on that list. (Compl. 1127.)
The Complaint further alleges in detail how and why these representations were false,
misleading or incomplete. Specifically, notwithstanding that Rabobank was listed above the
CDS Counterparty in order of preference in the Indenture's Priority of Payments — thus
demonstrating its entitlement to payments before the CDS Counterparty — Merrill Lynch
inserted provisions in other places in the Indenture that funneled monies to the CDS
Counterparty before Rabobank. (Compl. 56(a).) Merrill Lynch similarly preferenced itself as
the committed purchaser of the Class A-1 Notes by requiring that sources of cash that could
22
otherwise be used to pay Rabobank be depleted before any monies were drawn on the Class A-1
Notes. (Comp!. 56(b).) And, it also engineered the structure so that no Class A-1 Notes
funding would ever be used to pay Rabobank, effectively subordinating Rabobank to Merrill
Lynch as the committed purchaser of the Class A-1 Notes. (Compl. 56(c).)
Merrill Lynch's attempt to divert attention from its own misconduct by characterizing
Rabobank as having simply "overlooked -the terms of the contracts" is unavailing. Merrill Lynch
made numerous specific representations that were intended and expected to mislead Rabobank
into believing that it was being provided with the senior-most structural protections in the deal.
Indeed, it was even reflected in Rabobank's fees for making such a senior loan, which equated to
an interest rate that was lower than the rate paid on any of the notes that Norma issued. (Compl.
1128.) Having intentionally misled Rabobank — including through short changing it for the risk
that it was assuming — Merrill Lynch cannot now escape liability for its fraudulent conduct by
claiming that Rabobank should have had the wherewithal to ignore Merrill Lynch's
misrepresentations. See, e.g., Hiliel v. Motor Haulage Co., Inc., 140 N.Y.S.2d 51, 54 (Sup. Ct.
Kings Co. 1955), affd, 1 A.D.2d 782 (2d Dep't 1956) ("The law does not ordinarily impose
upon a defrauded person the duty of investigating fraudulent claims .... Even negligence in
ascertaining the true facts has been held not to bar the right of recovery."); City of New York v.
Corwen, 565 N.Y.S.2d 457, 460 (1st Dep't 1990), abrogated as to other issues, City of New York
v. Keene Corp., 756 N.Y.S.2d 536 (1st Dep't 2003).
C. Rabobank Adequately Alleges Reliance On Merrill Lynch'sMisrepresentations
Faced with Rabobank's clear allegations that it relied upon Merrill Lynch's false
statements and omissions — which must be presumed true for purposes of this motion — Merrill
Lynch contends that Rabobank's reliance was unreasonable as a matter of law. (Mem. at 12-17.)
As an initial matter, Merrill Lynch's arguments are premature since "whether plaintiff's reliance
upon defendants' alleged misrepresentations was reasonable is a factual issue not to be resolved
on a motion directed at the pleadings." Segal v. Cooper, 856 N.Y.S.2d 12, 13 (1st Dep't 2008);
23
see also Guggenheimer v. Bernstein Litowitz Berger & Grossman LLP, 810 N.Y.S.2d 880, 11
Misc. 3d 926, 933 (Sup. Ct. N.Y. County 2006) (Fried, J.) ("[a] plaintiff need only plead that he
relied on misrepresentations made by the defendant since the reasonableness of his reliance
generally implicates factual issues whose resolution would be inappropriate" on a motion to
dismiss) (internal quotation marks, citations, and alterations omitted).
In any event, even setting aside the impermissibility of raising such issues on a motion to
dismiss, Merrill Lynch should not be permitted to defend against its own fraudulent conduct by
blaming Rabobank, as the victim, for not having uncovered the fraud. Indeed, the Second
Circuit rejected Merrill Lynch's prior attempt at this very same strategy in Merrill Lynch & Co.
Inc v. Allegheny Energy, 500 F.3d 171 (2d Cir. 2007), explaining that a defrauded party — even
if sophisticated — may prevail on a fraud claim so long as "its reliance on the alleged
misrepresentations was not so utterly unreasonable, foolish or knowingly blind as to compel the
conclusion that whatever injury it suffered was its own responsibility." Id at 182 (reversing
lower court's factual finding that plaintiff's reliance was unreasonable because it "could have
discovered the truths that Merrill Lynch obscured or omitted had it pursued its diligence 'with a
little more pizzazz"). Merrill Lynch's argument further runs afoul of the well-settled rule that a
plaintiff's purported negligence is not a defense to intentional torts. Corwen, 565 N.Y.S.2d at
460; Keene Corp., 756 N.Y.S.2d 536 (1st Dep't 2003). As the court explained in Morgan,
Olmstead, Kennedy & Gardner, Inc. v. Schipa, 585 F. Supp. 245 (S.D.N.Y. 1984):
[Tin all intentional frauds, one party has knowingly deceived the other party, andpurposely exploited a weakness in the other's method of operation for his owngain. No social value would be served by allowing a defendant to assert the veryweakness he has exploited as a ground for limiting the defrauded party's claimagainst him for damages. Instead, it would merely insulate one who hascommitted an intentional, antisocial act from accounting to the person he hasinjured for all of the consequences flowing from that act, and thus might have theundesired secondary effect of promoting fraudulent activity.
Id at 249.
Merrill Lynch seeks to overcome such well-settled authority by arguing that Rabobank
disclaimed reliance on Merrill Lynch's fraudulent statements, Rabobank failed to make use of
24
information it could have uncovered about Merrill Lynch's fraud, and warnings in the
Transaction Documents preclude fraud claims. Merrill Lynch's arguments fall short of the mark.
1. Rabobank Did Not "Disclaim" Reliance on Merrill Lynch's Statements
Merrill Lynch predicates its primary argument that Rabobank's reliance on Merrill
Lynch's statements was unreasonable on identical, boilerplate "non-reliance" disclaimers that
were included in both the Schedule and Confirmation to the Proceeds Swap. (Mem. at 1, 12-14.)
Merrill Lynch's arguments regarding these disclaimers are, true to form, misleading.
First, Merrill Lynch fails to mention that the Proceeds Swap is an agreement between
Rabobank and Norma CDO I Ltd — the special purpose CDO vehicle — and that Merrill Lynch
is neither a party nor third party beneficiary under that agreement. The disclaimers upon which
Merrill Lynch now purports to rely were thus representations made to Norma — not to Merrill
Lynch — and Merrill Lynch has no basis upon which to rely upon them in its defense.
Second, even if Merrill Lynch was entitled to rely on the disclaimers — which it was not
— the only statements for which the disclaimers purportedly disclaim reliance are
"communications (written or oral) of the other party." (Affirmation of Scott D. Musoff, Ex 2, p.
3) (emphasis added.) Since Merrill Lynch is not the "other party" to Rabobank under the
Proceeds Swap, Rabobank did not disclaim reliance upon Merrill Lynch's statements. These
disclaimers thus do nothing to insulate Merrill Lynch from liability for its fraudulent statements.
Third, Merrill Lynch's heavy reliance on CDO Plus Master Fund Ltd. v. Wachovia Bank,
NA., 07 Civ. 11078(LTS)(AJP), 2009 WL 2033048 (S.D.N.Y. July 13, 2009), is misplaced in
light of critical differences in the contractual provision at issue in that case. As Merrill Lynch
concedes, in CDO Plus, the plaintiff represented that it "was relying solely upon its own
evaluation of the .... consequences, risks, and benefits [of the Trade]." (Mem. at 13 and 14;
emphasis added). In essence, the plaintiff in CDO Plus agreed that there was a limited universe
of information on which it had relied in entering the transaction. By contrast, Rabobank
represented here that it was "... not relying on any communication (written or oral) of the other
25
party." (Ex p. 3.) Therefore, unlike in CDO Plus, Rabobank's representation to Norma only
designates a universe of information on which Rabobank did not rely. Notably absent from that
universe of information are representations made by Merrill Lynch.
Last, it is clear from the context and history of the disclaimers that they were intended
solely to prevent the creation of a financial advisor relationship (and the concomitant fiduciary
duties) and not to preclude fraud claims based on factual misrepresentations. The disclaimers
are, in fact, verbatim recitations of standard disclaimers that were first promulgated by the
International Swap Dealers Association ("ISDA") in 1996 as a way for swap parties to
"document their understanding of the nature of their relationship." (See Pickhardt Aff., Ex C.)
Portions of these standard disclaimers that Merrill Lynch artfully excludes from its quotations
make clear their intent to prevent the creation of a financial advisor relationship: "[Rabobank] is
not relying on any communication (written or oral) of the other party as investment advice"; and
"information and explanations relating to the terms and conditions of a Transaction shall not be
considered investment advice." Furthermore, the committee that promulgated the principles
upon which this ISDA provision was drafted explained that it was never intended to preclude
fraud claims, as Merrill Lynch claims it now does:
Several commentators interpreted this provision broadly to disclaim responsibilityeven for the factual statements made to a counterparty. The drafting committeedid not intend for Section 4.2.2 to be interpreted in this manner. . .. It was notintended to protect or condone inaccurate or intentionally misleading factualstatements. Furthermore, the Principles do not and could not modify the commonlaw rules of fraud.
(Pickhardt Aff., Ex. D at 3.)
2. Merrill Lynch Has Not Established that Rabobank "Failed to Make Use ofMeans of Verification that Were Available to It"
Merrill Lynch's argument that Rabobank's reliance allegations are insufficient because it
has failed to plead that it conducted proper due diligence turns the parties' respective obligations
at the pleadings stage on their head. Faced with Rabobank's prima facie allegations of reliance,
Merrill Lynch bears the burden to establish, based on evidence acceptable for consideration on a
26
motion to dismiss, that Rabobank's reliance was so "utterly unreasonable, foolish or knowingly
blind as to compel the conclusion that whatever injury it suffered was its own responsibility."
Merrill Lynch, 500 F.3d at 182. Merrill Lynch falls well short of this high threshold.
Indeed, the sole specific due diligence deficiency that Merrill Lynch purports to identify
is based on Rabobank's failure to allege that it requested "the identity of [the] securities" in
Norma's collateral. (Mem. at 23.) As a preliminary matter, Merrill Lynch's argument is
unconvincing since Merrill Lynch has not established as a matter of law that such information
about Norma's portfolio — which Merrill Lynch concedes was not publicly available — was
available to Rabobank. Merrill Lynch's reliance on the Offering Circular's statement that lain
investor or prospective investor in the Offered Notes may at any time and from time to time
request from the Trustee a list of Collateral Debt Securities which the Issuer has Acquired"
(Mem. at 19) is besides the point. Rabobank, as the Proceeds Swap counterparty, was neither an
"investor" nor "potential investor" in Norma and, in any event, Norma did not "Acquire" any
Collateral Debt Securities until the March 1, 2007 closing date of the Norma transaction — the
very same day on which the Proceeds Swap was executed. (Musoff Aff., Ex 3 at 5-6; Musoff
Ex. 2.) The statement in the Offering Circular thus does not establish that any information about
Norma's collateral pool was available to Rabobank during the negotiation of the Proceeds Swap.
More importantly, even assuming arguendo that the identity of the securities in Norma's
collateral pool had been available to Rabobank, Merrill Lynch fails to demonstrate that this
information would have made Merrill Lynch's fraud so readily apparent as to render Rabobank's
reliance "utterly unreasonable, foolish or knowingly blind." Merrill Lynch, 500 F.3d at 182.
Indeed, Merrill Lynch fails to explain how Rabobank could reasonably have been expected to
deduce from a list of securities the true information regarding any of Rabobank's central fraud
allegations, such as: (a) a significant component of Norma's portfolio included distressed assets
from Merrill Lynch's own inventory; (b) Merrill Lynch had collaborated with Magnetar to
establish Norma as a shorting vehicle; (c) NIR lacked experience and integrity and abdicated its
responsibility to carefully and independently select Norma's assets; (d) Merrill Lynch procured
27
false credit ratings for Norma's notes based upon false statements or omissions to the Ratings
Agencies; (e) the vast majority of Norma's notes were sold to captive investors; and (f) a
component of Norma's portfolio had been established as an ABX hedge. 8 See MBIA Ins. Corp.
v. Countrywide Home Loans, Inc., No. 602825/08, 2009 WL 2135167 (Trial Order) (Sup. Ct.
N.Y. County July 8, 2009) (rejecting argument that Countrywide's disclosure of "detailed loan
information" negated MBIA's justifiable reliance on Countrywide's representations as to its
underwriting practices where "[e]ven assuming MBIA conducted a full inquiry under the
circumstances ... it is not conclusive that MBIA could have discovered the alleged fraud").
The allegations of reliance in this case are thus virtually identical to those upheld by the
court in M&T Bank Corp., which found, in light of the "highly complex derivative form of
investment" at issue, the "means by which Plaintiff could have learned the truth about the alleged
deficient collateral, inadequate underwriting standards and independent credit ratings purportedly
procured on false information" were "far from evident." 2009 WL 921381 at *12; see also Abu
Dhabi Commercial Bank, 2009 WL 2828018, at *13 (denying motion to dismiss and holding that
plaintiffs had pled reasonable reliance because "the market at large, including large investors,
have come to rely on the accuracy of credit ratings and independence of ratings agencies").
Moreover, the cases upon which Merrill Lynch relies are readily distinguishable because
they involved situations where, unlike here, specific information that could have revealed the
fraud was self evident or readily available. For example, in Apthorp Assocs., LLC v. 390 W End
Assocs. L.L.C., 22 Misc.3d 1132(A), 2009 WL 613606 (Sup. Ct. N.Y. County March 6, 2009) —
heavily relied upon by Merrill Lynch — this Court rejected plaintiff's claimed reliance on
8 While it may have been theoretically possible to determine from a listing of the securities in Norma'sportfolio that there was a correlation with the ABX index, given the inappropriateness of using an index product in amanaged CDO, Rabobank cannot be expected to have uncovered that correlation through reasonable due diligenceefforts. See Mallis v. Banker's Trust Co., 615 F.2d 68, 81 (1980) (a plaintiff need not establish due diligence exceptin cases "in which plaintiff was placed on guard or practically faced with the facts"); accord Mfrs. Hanover TrustCo. v. Drysdale Secs. Corp., 801 F.2d 13, 18, 23-25 (2d Cir. 1986), cert. denied, 479 U.S. 1066 (1987) (plaintiffbank justifiably relied upon false statements made by defendant broker-dealer even though bank failed to monitoradequately its own risk exposure, failed to take steps other banks routinely engaged in and failed to heed warningsigns). In any event, whether such information would have been discovered is a question of fact that is not suitablefor resolution on a motion to dismiss.
28
representations regarding the soundness of a building's steelwork where any person walking past
the building would have observed scaffolding covering the building's deteriorating steelwork
and information about the deteriorated steelwork was publicly available through a New York
City building department report. Similarly, in Valassis Comm 's, Inc. v. Weimer, 304 A.D.2d
448, 448-49 (1st Dep't 2003), the court dismissed plaintiffs fraud claims where plaintiff could
have discovered the fraud through simply reviewing "financial information relevant to the
business purchase transaction [at issue], including a list of the company's existing advertising
contracts, customers and suppliers" that was in the plaintiffs possession.
3. Warnings in the Transactions Documents Do Not Preclude Fraud Claims
Finally, Merrill Lynch claims that Rabobank's reliance on Merrill Lynch's
misrepresentations and omissions was unreasonable due to numerous generalized "warnings in
the Transaction Documents advising investors to conduct their own investigation and not to rely
on representations." (Mem.at 16.) However, as none of the provisions cited by Merrill Lynch
provided any warning as to the specific fraud alleged by Rabobank — i.e., that Merrill Lynch
would stuff Norma's portfolio with assets that were already substantially deteriorated — they
cannot negate Rabobank's reasonable reliance on Merrill Lynch's statements or omissions.
Recent decisions have rejected attempts to dismiss fraud claims based on analogous
warnings and disclaimers. For example, in M&T Bank Corp., the court rejected a nearly
identical argument put forth by Deutsche Bank regarding general disclaimers in CDO offering
materials, finding that "riln the absence of specific language addressing the representations made
both orally and in writing, and specifically addressing the complaints by Plaintiff with respect to
the quality of the collateral and the adequacy of [structurer's] underwriting, the disclaimers in the
documents do not negate the reliance factor as a matter of law." 2009 WL 921381 at *11.
In HSH Nordbank v. UBS AG, 600562/08, at 3 (Sup. N.Y. Co. October 1, 2009), the court
considered allegations that: "UBS misrepresented to HSH that it was creating a stable
investment strategy for HSH, when, in fact, UBS knew it was creating a structure solely to
29
benefit itself' and "UBS claimed that the transaction was 'tailored to meet' HSH's needs, when
it was actually structured to enrich UBS at HSH's expense." The court rejected UBS's claim
that HSH's fraud claims were precluded by specific disclaimers, finding that "[a] defendant 'may
not invoke even specific disclaimer clauses in order to preclude evidence of ... misrepresentation
if the facts allegedly misrepresented are peculiarly within the [defendant's] knowledge.' Id.
(quoting Yurish v. Sportini, 123 A.D.2d 760, 761-62 (2d Dep't 1986)).
Similarly, in Caiola v. Citibank, NA., NY, 295 F.3d 312, 330 (2d Cir. 2002), the Second
Circuit rejected Citibank's claims that a swap agreement disclaimer which stated that plaintiff
Caiola "would not be relying on Citibank's advice or recommendations" negated justifiable
reliance, finding that the disclaimer fell "well short of tracking the particular misrepresentations
alleged by Caiola." Id.; see also Eternity Global Master Fund Limited, 2002 WL 31426310 at
*6 (denying motion to dismiss fraud claims because disclosures in an ISDA Master Agreement
were too general and unrelated to the specific allegations in the complaint to warrant dismissal.)9
III. RABOBANK HAS SUFFICIENTLY PLED NEGLIGENT MISREPRESENTATION
Notwithstanding Merrill Lynch's arguments to the contrary, Rabobank has plainly stated
a cause of action for negligent misrepresentation. To establish a claim for negligent
misrepresentation, a plaintiff must allege, among other elements, the existence of a relationship
giving rise to a duty to make correct disclosures, such as where the defendant "possess[es]
unique or specialized expertise" or is "in a special position of confidence and trust with the
injured party such that reliance on the negligent misrepresentation is justified." Kimmell v.
9 Nor does any of the authority cited by Merrill Lynch suggest a different conclusion. See Hunt v.Alliance N. Am. Gov. Income Trust Inc., 159 F.3d 723 (2d Cir. 1998) (upholding fraud allegations where prospectusstated that hedging techniques were available, but that the fund managers knew that such techniques were notavailable); UST Private Equity Invs. Fund, Inc. v. Solomon Smith Barney, 288 A.D.2d 87, 88, 733 N.Y.S.2d 385,386 (1st Dep't 2001) (finding that plaintiff could not justifiably rely on false statements where, prior to transactionwith defendant, plaintiff was provided with a chronology that referenced the "very documents that ultimatelyalerted him" to the fraud and had the ability to request those documents from a third-party); Societe NationaleD 'Exploitation v. Salomon Bros. Inel, 268 A.D.2d 373, 374-75, 702 N.Y.S.2d 258, 258, 259 (1st Dept 2000)(addressing, on summary judgment, situation where plaintiff could not prove that it was unable to acquire theinformation needed to assess risks and benefits of transaction); Yang v. Morgan Stanley Dean Witter, 282 A.D.2d271, 271, 724 N.Y.S 2d 149, 150 (1st Dep't 2001) (plaintiff s alleged oral misstatements were expresslycontradicted by written prospectus).
30
Schaefer, 89 N.Y.2d 257, 263 (1996) ("In the commercial context, a duty to speak with care
exists when the relationship of the parties, arising out of contract or otherwise, [is] such that in
morals and good conscience the one has the right to rely upon the other for information."
(internal citation omitted)). 1 ° Whether the nature and caliber of the relationship between the
parties is such that the injured party justifiably relied on a negligent misrepresentation is
generally an issue of fact, and thus is inappropriate for resolution on a motion to dismiss." Id. at
264; see also E*Trade Fin. Corp. v. Deutsche Bank AG, 420 F. Supp. 2d 290, 290-91 (S.D.N.Y.
2006) ("[Plaintiff] has alleged the existence of a special relationship, the existence of which has
been held to be a factual question not to be resolved [on a motion to dismiss].").
Contrary to Merrill Lynch's assertions, Rabobank has pled numerous facts regarding
Merrill Lynch's unique special expertise which established a "special relationship" and duty of
disclosure to Rabobank. Specifically, Rabobank has alleged that Merrill Lynch:
possessed unique and special expertise in matters of CDO construction and riskassessment ... [and] was uniquely situated to understand the purpose for whichNorma was created, the impaired value of Norma's collateral portfolio, the natureof Norma's investors, the asset selection process employed by Norma's collateralmanager, the accuracy of the credit ratings for Norma's notes, and the details,attributes and conditions of the Proceeds Swap.
(Compl. 73,76.) Further, Rabobank has alleged that Merrill Lynch owed a duty to Rabobank
to disclose these material facts about Norma, particularly as Merrill Lynch knew that Rabobank
did not and could not, through reasonable due diligence efforts, know the truth behind Merrill
Lynch's misleading disclosures. (Compl. IN 78-79.)
Courts regularly find a duty to disclose where, as here, a defendant underwriter or
investment broker is uniquely situated and possesses key undisclosed knowledge regarding the
economics and structure of the complex financial investments it markets. See, e.g., M&T Bank,
1 ° Merrill Lynch's claim that Rabobank failed to allege the other elements of negligent misrepresentation,including actionable misrepresentation and reasonable reliance (Mem. at 30), is unavailing for the same reasonsdescribed in the prior section. See supra at Part II(B).
11 To determine whether this justifiable reliance exists "a fact finder should consider whether the personmaking the representation appeared to hold unique or special expertise; whether a special relationship of trust orconfidence existed between the parties; and whether the speaker was aware of the use to which the informationwould be put and supplied it for that purpose." Kimmell, 89 N.Y.2d at 264.
31
2009 WL 921381, at *13 (finding CDO underwriter and collateral manager could possess
"unique or special expertise" sufficient to support claim for negligent misrepresentation);
Kimmel, 89 N.Y.2d at 264 (duty to speak with care found where defendant was "uniquely
situated to evaluate the economics" of investment project and was experienced selling such
projects to investors); Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87,
102-04 (2d Cir. 2001) (negligent misrepresentation claim upheld where defendants were aware
of, and suppressed, negative facts when providing information to investor); Fraternity Fund Ltd.
v. Beacon Hill Asset Mgt. LLC, 376 F. Supp. 2d 385, 411 (S.D.N.Y. 2005) (duty of care arose
where defendants sent offering materials to induce prospective investors to invest and allegedly
"managed and determined the composition of [investment funds] and therefore were uniquely
positioned to know their overall value."). 12 Consequently, Merrill Lynch, as Norma's structurer,
underwriter and the broker that marketed the Proceeds Swap, owed a duty to Rabobank to
disclose all material information and to provide accurate information regarding the transaction
involved. Therefore, Rabobank has stated a cause of action for negligent misrepresentation.
IV. RABOBANK HAS SUFFICIENTLY PLED FRAUDULENT CONVEYANCE
Whatever conclusion the Court may reach with regard to Rabobank's other claims, there
can be zero doubt that Rabobank has alleged facts sufficient to support its claim for constructive
fraudulent conveyance. Indeed all that Rabobank must allege to support its constructive
fraudulent conveyance claim under New York law that: (1) Rabobank is a creditor of Norma; (2)
Norma made a conveyance to Merrill Lynch for less than fair consideration; and (3) Norma was
12 Not one of the cases cited by Merrill Lynch is relevant in the context of a structurer and marketer ofinvestments in a highly-complex financial product. Rather, each of Merrill Lynch's cases involved simple, arms'-length contract or commercial disputes in which the defendants were not alleged to possess any special or uniqueknowledge. See DynCorp v. GTE Corp., 215 F. Supp. 2d 308, 329 (S.D.N.Y. 2002) (dismissing negligentmisrepresentation claim against seller of telecommunications business where no special relationship alleged);Emigrant Bank v. UBS Real Estate Secs., 49 A.D.3d 382, 384-85 (1st Dep't 2008) (contract dispute stemming fromon-line auction); Atkins Nutritional v. Ernst & Young, LLP, 301 A.D.2d 547, 548-49 (2d Dep't 2003) (allegingprofessional malpractice by computer consultants); Sheridan v. Tr. of Columbia Univ. in the City of N. Y, 296 A.D.2d314, 316 (1st Dep't 2002) (involving university's refusal to forward plaintiff's college transcript to graduateschools); Andres v. LeRoy Adventures, Inc., 201 A.D.2d 262, 262 (1st Dep't 1994) (alleging misrepresentationsregarding wedding venue).
32
either insolvent at the time of conveyance or rendered insolvent by the conveyance. See N.Y.
Debt. & Cred. § 203. 13 Here, Rabobank plainly alleges all three elements.
First, Rabobank alleges that it is a creditor Norma in that Norma owes Rabobank unpaid
obligations under the Proceeds Swap. (Compl. 59-60.)
Second, Rabobank also alleges that Norma made conveyances to Merrill Lynch for less
than fair consideration, because Norma purchased impaired assets at inflated prices. (Compl.
19-30.) Specifically, Rabobank alleges that Merrill Lynch transferred a portfolio of cash assets
to Norma that were worth a mere 73 cents on the dollar for which Norma paid at or near face
value. (Compl. 37.) In addition, Rabobank alleges that at the time Merrill Lynch and Norma
entered into the credit default swap that created Norma's synthetic collateral, it referenced $1.4
billion in synthetic assets that were worth only 85 cents on the dollar, thereby conveying over
$200 in value to Merrill Lynch, without any offsetting consideration to Norma. (Compl. IT 35.)
Both of these exchanges resulted in Norma receiving less than "fair consideration."
Third, Rabobank alleges that Norma was rendered insolvent by these transfers.
Specifically, Rabobank alleges that the more than $225 million in liabilities that Norma incurred
through paying inflated prices for distressed cash assets and entering into the credit default swap
with Merrill Lynch that was out of the money at execution, rendered Norma insolvent since they
left Norma without sufficient assets to pay back its noteholders and Rabobank. (Compl. it 37.)
Merrill Lynch's argument that Rabobank's fraudulent conveyance allegations are
insufficient because they do not contain the detail required by CPLR 3016(b) is based on a flat
misstatement of law. (Mem. at 32) Rather, CPLR 3016(b) has no application to fraudulent
conveyance claims. See Menaker v. Alstaedter, 134 A.D.2d 412, 413 (2d Dep't 1987). 14
13 In lieu of showing that Norma was either insolvent or rendered insolvent by the conveyance, Rabobankcould also support its fraudulent conveyance claim by alleging: (1) Norma was left with unreasonably small capital;or (2) Merrill Lynch knew that Norma would incur debts beyond its ability to pay as they matured. See N.Y. Debt.& Cred. §§ 274-275. These provide alternative bases upon which Rabobank's allegations are sufficient.
14 The sparse summary order in IDC (Queens) Corp. v. Illuminating Experiences, Inc., 220 A.D.2d 337,337 (1st Dep't 1995), cited by Merrill Lynch, is readily distinguishable since, unlike here, the plaintiff made no"specific allegation concerning the value of the transferred property." See Loblaw, Inc. v. Wylie, 50 A.D. 2d 4, 7(4th Dep't 1975) (reversing dismissal of fraudulent conveyance claim where the complaint "clearly assert[ed] the
33
Nor is Merrill Lynch's claim that Rabobank has failed to allege insolvency any more
convincing. Specifically, Merrill Lynch's assertion that Norma "had more than $1.2 billion in
assets as of the closing" (Mem. at 33) relies on factual claims by Merrill Lynch that contradict
the Complaint. Rabobank has alleged that the value of Norma's assets at closing were far less
than its obligations. (Compl. IT 37.) In fact, as of the closing, the impairment of the synthetic
securities referenced in Norma's credit default swap with Merrill Lynch meant that agreement
had a negative value of over $200 million to Norma. Since Norma would have been unable at
closing to both pay off that negative value to Merrill Lynch under the credit default swap and
repay all of its noteholders, it was insolvent.
V. RABOBANK HAS SUFFICIENTLY PLED UNJUST ENRICHMENT/CONSTRUCTIVE TRUST
Rabobank's allegations also suffice to support its unjust enrichment/constructive trust
claim. The "essence of unjust enrichment is that one party has received money or a benefit at the
expense of another. . . and that it is against equity and good conscience to permit [the other
party] to retain what is sought to be recovered." Guggenheimer, 810 N.Y.S.2d at 887 (internal
citations omitted). While Rabobank need not demonstrate a wrongful act by Merrill Lynch to
preserve its claim, see Hornett v. Leather, 145 A.D.2d 814, 816 (3d Dep't 1988), Rabobank has
alleged a dispiriting range of unjust behavior that permitted Merrill Lynch to benefit wrongfully
at Rabobank's expense. Further, Rabobank has alleged that Merrill Lynch retained the profits it
made through this unjust conduct to the detriment of Rabobank, whose loan has not been repaid.
The arguments raised by Merrill Lynch are of no moment. First, for all the reasons
discussed above, Rabobank has more than satisfied its burden of pleading that Merrill Lynch's
acquisition of funds rightly owed to Rabobank was both unjust and contrary to "equity and good
conscience." Second, Merrill Lynch's contract-related arguments, (Mem. at 33), are inapposite
basic elements of a fraudulent conveyance claim, namely allegations ... that the conveyance was made at a time ofinsolvency on the part of the transferors ... [and] the allegation of the absence of fair consideration."). Wildman &Bernhardt Const., Inc. v. BPM Assocs., L.P., 708 N.Y.S.2d 653 (1st Dep't 1997), is similarly inapposite, sinceRabobank has clearly alleged in detail how the transfers at issue left Norma insolvënt.
34
since Rabobank and Merrill Lynch are not in contractual privity; as Merrill Lynch is not a party
to the Proceeds Swap. Therefore, Rabobank's unjust enrichment claim should proceed.
VI. RABOBANK HAS SUFFICIENTLY PLED CONVERSION
Finally, Rabobank has adequately pled conversion, which is established when "one who
owns and has a right to possession of personal property proves that the property is in the
unauthorized possession of another who has acted to exclude the rights of the owner." Republic
of Haiti v. Duvalier, 211 A.D.2d 379, 384 (1st Dep't 1995). Specifically, Rabobank has alleged
that it provided Norma with a $57.7 million loan specifically to fund the CDO's start-up costs,
which included, significantly, Merrill Lynch's own fees, and that Rabobank was entitled to have
that loan repaid through a specific series of payments from Norma. (Compl. 'II 19); see Mfrs.
Hanover Trust Co. v. Chemical Bank, 160 A.D.2d 113, 124 ("It is well settled that an action will
lie for the conversion of money where there is a specific, identifiable fund and an obligation to
return or otherwise treat in a particular manner the specific fund in question."). Further,
Rabobank has alleged that Merrill Lynch wrongfully converted these specific funds which were
to be repaid to Rabobank, and that, as a consequence, Rabobank has suffered a loss of tens of
millions of dollars. Consequently, Rabobank's claim for conversion is sufficient.
VII. IN THE ALTERNATIVE, LEAVE TO AMEND SHOULD BE GRANTED
For all the reasons stated above, Merrill Lynch's motion to dismiss should be denied.
However, to the extent that the Court grants any portion of Merrill Lynch's motion, Rabobank
respectfully requests leave to amend its Complaint, as Merrill Lynch has not raised any objection
which could not be addressed by Rabobank in a revised pleading. See, e.g., M&T Bank Corp.,
23 Misc.3d 1105(A), at *18.
CONCLUSION
For the foregoing reasons, Rabobank respectfully requests the Court to deny Merrill's
motion to dismiss.
35
DATED: New York, New YorkOctober 13, 2009 QUINN EMANUEL URQUHART OLIVER &
HEDGES, LLP
camagw-rumb.semescr.------el B. Carli skyan E. Pickhardt
Brendan N. SnodgrassJordan Fletcher
51 Madison Avenue, 22nd FloorNew York, New York 10010-1601(212) 849-7000
Attorneys for Plaintiff
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