Remember U.S. District Judge Victor Marrero's opus last month in
a hedge fund case against Goldman Sachs? The Manhattan federal
judge refused to dismiss claims that Goldman duped the fund,
Dodona, into investing in doomed-to-fail Hudson collateralized
debt obligations. In 64 vivid pages, Marrero detailed the fund's
allegations that Goldman engaged in a sweeping effort, initiated
by CFO David Viniar, to shed its exposure to subprime mortgages
-- and simultaneously to take advantage of clients who were
slower to perceive the looming collapse of the mortgage-backed
securities market. Marrero described the alleged scheme as "not
only reckless, but bordering on cynical."
What a difference a judge makes. Last September, in a
parallel case involving Goldman's Davis Square CDOs, U.S.
District Judge William Pauley, also of Manhattan, needed only 19
pages to dismiss fraud and negligent misrepresentation claims by
Germany's Landesbank Baden-Wuerttemberg. On Thursday, without
even bothering to write a precedential opinion, a three-judge
panel of the 2nd Circuit Court of Appeals upheld the dismissal.
Chief Judge Dennis Jacobs and Judges Rosemary Pooler and Susan
Carney agreed with Pauley that the German bank was a
sophisticated investor and received plenty of warnings about the
risk of investing in the Davis CDOs.
"The relationship between Landesbank and the defendants was
that of buyer and seller in a standard arm's length transaction;
and by its own representations Landesbank possessed sufficient
expertise to evaluate the risks of its investment," the 2nd
Circuit wrote in a summary order. "The complaint therefore fails
to plead justifiable reliance." Landesbank's counsel at Motley
Rice had notified the 2nd Circuit of Marrero's ruling, in a
letter spelling out the judge's conclusion that even if Dodona
was a sophisticated investor, its reasonable reliance on
Goldman's representations isn't precluded as a matter of law. By
giving Landesbank's argument such short shrift, the federal
appeals court clearly believes the contrary.
The 2nd Circuit didn't cite a New York state appeals court's
dismissal last month of HSH Nordbank's $500 million fraud claim against UBS, even though Goldman's lawyers at Sullivan &
Cromwell notified the federal court of the state appeals ruling
right after it came down. But there are distinct similarities in
the two appellate decisions. Both the Landesbank and HSH
Nordbank cases involved German banks investing in subprime
mortgage-linked CDOs -- and in both, the appeals courts held
that sophisticated investors have an independent duty to assess
the risks of their investments, particularly when offering
documents disclaim the issuer's responsibility.
Taken together, the state and federal rulings add up to very
bad news for sophisticated investors who lost money in complex
financial instruments. Big boys, the courts are saying,
shouldn't cry when they fall, even if Goldman Sachs or UBS stuck
out a leg to trip them.
We're still in the relatively early stages of
mortgage-backed securities litigation, in which all kinds of
foreign banks and sophisticated U.S. investors have sued for
fraud. As Reuters noted in its coverage of the 2nd Circuit ruling Thursday, not many of these cases have reached appellate
courts. So the state and federal precedent in the Goldman and
UBS cases should surely embolden defendants.
(Reporting by Alison Frankel)
Follow us on Twitter: @AlisonFrankel, @ReutersLegal