Opinion ID: 769835
Heading Depth: 2
Heading Rank: 3

Heading: The SIPC's claims on its own behalf

Text: 39 Having affirmed the district court's dismissal of all claims on behalf of Baron's customers, we now consider the SIPC's claims for losses sustained in its own right. The success or failure of the SIPC's fraud claim depends on the precise extent of New York's reliance requirement, specifically whether the SIPC can establish reliance on Seidman's audit reports despite never having received or read those reports. Similarly, the SIPC's negligence claim turns on the stringency of the known party and linking conduct requirements under New York law. To assess this claim, we must determine: 1) whether the SIPC qualifies as a known party for purposes of negligence liability; and 2) whether the SIPC can show linking conduct despite its lack of any substantial direct contact with Seidman. Because New York caselaw indicates some uncertainty as to the contours of these limitations on liability, and because resolution of these issues requires a delicate balancing of state policy concerns, we certify these questions to the New York Court of Appeals. See Joblon v. Solow, 135 F.3d 261, 264 (2d Cir. 1998) (finding certification appropriate where the state court decisions do not yield a clear answer and the state has an interest in deciding the question itself rather than having [it] decided by a federal court, which may be mistaken) (quoting Home Ins. Co. v. American Home Prods. Corp., 873 F.2d 520, 522 (2d Cir. 1989)).
40 As noted above, see supraII.A, to recover in New York for misrepresentations made to a third party, the plaintiff must establish that he or she relied to his or her detriment on the misrepresentations and that the defendant intended those misrepresentations to be communicated to the plaintiff. See Rosen, 894 F.2d at 33; Ultramares, 255 N.Y. at 187. 41 Although it dismissed the SIPC's claims on its own behalf for lack of standing, the district court also observed that the SIPC's fraud claim on its own behalf suffered from the same defect as its fraud claim on behalf of Baron's customers: the SIPC could not prove reliance because it could not show that it had ever read any of Seidman's allegedly false financial statements. See Seidman, 49 F. Supp. 2d at 653 n.4. As the district court noted, the SIPC alleges that Seidman sent its financial reports to the SEC and the NASD, the industry self-regulating body for Baron, but it does not claim that the SIPC itself received those materials. See id.at 656. In response, the SIPC argues that it relied nonetheless on the information contained in Seidman's reports because, under the SIPA regulatory scheme, it relies on the SEC and the NASD to alert it regarding any impending financial difficulties a broker-dealer may be facing. Thus, the SIPC maintains, by remaining silent about a particular broker-dealer's financial condition, the SEC and the NASD essentially transmit the audit report's message that the government has no cause for concern. 42 This no news is good news theory of reliance finds some support in New York law. Analyzing the reliance element in third-party fraud cases, several decisions have suggested that a plaintiff may demonstrate reliance where the third party does not directly repeat the defendant's misrepresentations to the plaintiff, but rather communicates them in a repackaged or summary form, on which the plaintiff then relied. In Tindle v. Birkett, 171 N.Y. 520 (1902), for example, the New York Court of Appeals permitted recovery for misrepresentations made by the defendants to a credit rating agency for purposes of receiving a favorable rating. The plaintiffs never received those misrepresentations directly, but rather relied on the favorable credit rating the agency had formulated using the defendants' misinformation. See id.at 522-23. The Court of Appeals found that because the plaintiffs extended credit to the defendants in reliance on the correctness of the rating, without any other knowledge [of the defendant's financial situation], they had established the reliance necessary to sustain a fraud claim against the defendant. Id. at 523. More recently, in Caramante v. Barton, 494 N.Y.S.2d 498 (3d Dep't 1985), the Appellate Division found reliance where the defendant homeowners fraudulently certified to the bank that their septic system was in working order, the bank extended credit based on that assurance, and plaintiffs - without speaking to the defendants directly - relied on the bank's decision to extend credit in assuming that the system was serviceable. See id. at 500. 43 These cases suggest that so long as the plaintiff receives the substance of a defendant's misstatements, he or she may establish reliance on that information even if the defendant did not communicate with the plaintiff directly. See Tindle, 171 N.Y. at 524 ([I]t cannot be doubted that the defendant spoke false and deceitful words to the plaintiffs through the agency just as effectually as if they had met face to face, and the statements had been made directly and personally.); cf. John Blair Comm., Inc. v. Reliance Capital Group, L.P., 549 N.Y.S.2d 678, 680 (1st Dep't 1990) ([A] party who commits intentional fraud is liable to any person who is intended to rely on the misrepresentation or omission and who does in fact so rely to his detriment.). This principle speaks in favor of permitting the SIPC's fraud claim in this case, on the theory that due to the structure of the regulatory scheme, the substance of any misrepresentations Seidman made to the SEC and the NASD were transmitted through those entities to the SIPC itself. In particular, we could find that, because the SIPA provides that the SEC and the NASD only communicate with the SIPC when a broker-dealer's accounting reports exhibit a problem, their silence regarding Baron conveyed the message - drawn directly from the misrepresentations in Seidman's certified audit reports - that Baron was in good financial health. The effect of such a message would be analogous to a case in which the SEC repeated the audit reports verbatim to the SIPC, which then relied on that misinformation in deciding whether any action was necessary. Because we almost certainly would find reliance in that situation, we similarly might find reliance here, where the SEC and NASD effectively communicated through silence rather than affirmative transmittal of the information. 44 To find reliance in this situation, however, would involve expanding New York fraud law in a manner best entrusted to the Court of Appeals. Although New York law is fairly clear that a plaintiff may establish reliance on misrepresentations it receives from a third party in a repackaged form, such as a credit rating or a financial report, New York courts have not extended this rule to cover a third party's failure to convey information at all. As the district court correctly noted, the SIPC's theory of reliance rests on the absence of any activity by [the SEC and the NASD], . . . rather than on any subsequent communication of Seidman's misrepresentation. Seidman, 49 F. Supp. 2d at 656. This absence of action distinguishes the case before us from the decisions on which the SIPC relies, all of which involve some affirmative activity by a third party based on the defendant's misrepresentations. See, e.g., Tindle, 171 N.Y. at 523 (plaintiff relied on credit rating); John Blair, 549 N.Y.S.2d at 680 (plaintiff relied on defendant's certified financial statements); Caramante, 494 N.Y.S.2d at 500 (plaintiffs relied on bank's extension of credit); see also Hyosung Am., Inc. v. Sumagh Textile Co., 25 F. Supp. 2d 376, 384 (S.D.N.Y. 1998) (finding reliance where bank made payments pursuant to letters of credit, for which plaintiff was liable, based on defendant's misrepresentations). 45 Whether fraud liability encompasses reliance on the absence of communication, rather than on communication itself, is thus currently unclear under New York law. Resolving this issue will involve a detailed analysis of the policy concerns underlying New York's fraud rules, including the sometimes difficult balance between deterring fraud in accounting transactions and protecting accountants against far-flung liability for inchoate or unintended injuries. Union Carbide Corp. v. Montell N.V., 9 F. Supp. 2d 405, 412 (S.D.N.Y. 1998). Because the state's highest court is the most appropriate forum for considering these issues, we certify this question to the New York Court of Appeals.
46 We find New York law similarly uncertain with respect to the SIPC's claim for negligent misrepresentation. As described above, see supraII.B., New York courts have been extremely reluctant to permit recovery for negligent performance by an accountant absent some direct relationship between the plaintiff and defendant. Toward this end, the Credit Alliancefactors - that the accountant have prepared its audit for a particular purpose, that the plaintiff be a known party, and that he or she show linking conduct with the defendant - are designed to limit accountants' liability to only those potential plaintiffs to whom they have assumed some duty of care. SeeCredit Alliance, 65 N.Y.2d at 547-48, 551. 47 Even given these strict limitations, however, this case presents a close question as to whether the SIPC has established the necessary privity-like relationship between itself and Seidman. First, we have little trouble finding that the SIPC has satisfied the particular purpose requirement. The plaintiffs' complaint alleges, inter alia, that Seidman intended, knew or should have known that the SEC, the NASD and the SIPC would rely on [the audit reports] in carrying out their respective regulatory, supervisory and protective duties with respect to Baron, in determining whether Baron was in compliance with the applicable financial responsibility rules, and in determining whether Baron was in financial difficulty. Compl. para. 55. The complaint also references a letter accompanying the 1993 audit in which Seidman stated that the audit was made for the purpose of forming an opinion on [Baron's] financial statements, but that some of its analysis was supplementary information required by Rule 17a-5 of the Securities and Exchange Commission. 8 SeeCompl. para. 22. Moreover, the record contains a second letter, accompanying the 1992 audit, stating that the report was intended solely for the use of management, the Securities and Exchange Commission, the National Association of Securities Dealers, Inc. and other regulatory agencies which rely on Rule 17a-5(g). (emphasis added). These allegations are sufficient to suggest that Seidman prepared its audit reports for the particular purpose of satisfying Baron's obligations under the SIPA and its implementing regulations. 48 Second, whether the SIPC has met its burden of showing that it was a known party depends largely on how the Court of Appeals resolves the SIPC's claim for fraudulent misrepresentation. As discussed previously, the known party element of a negligence claim requires fulfillment of two distinct factors. A plaintiff must show 1) that he or she is one of a specific, identifiable class of persons; 2) whom the accountant knew would rely on its audit performance. See, e.g.,White, 43 N.Y.2d at 361; supra Part II.B.1. Regarding the first factor, there is little doubt that the SIPC was known to Seidman for purposes of this analysis, as the SIPC is not a member of the indeterminate class of persons whom the court in Ultramares deemed improper plaintiffs in a negligence action. SeeUltramares, 255 N.Y. at 173-74 (refusing to find liability where the accountant's client had requested an audit for general exhibition to banks, shareholders, creditors, and customers, according to the needs of the occasion, on the basis of financial dealings). Rather, as one of the regulatory bodies designated by the federal securities laws, the SIPC is part of a known group possessed of vested rights, marked by a definable limit and made up of certain components. White, 43 N.Y.2d at 361; see alsoAUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202, 223 (2d Cir. 2000) (finding that plaintiffs were known parties where defendants knew what the [documents] were for and . . . knew for whom [they] were intended). 49 That the SIPC was a known party, however, does not end our analysis. To satisfy the second Credit Alliancefactor, the plaintiff must show that Seidman knew the SIPC would rely on its audit performance. As detailed above, seesupra III.A, whether the SIPC in fact relied on Seidman's reports remains an open question under New York law. Should the Court of Appeals answer that question in the affirmative, we will be obliged to find that the SIPC has met its burden on this prong of the Credit Alliancetest. If, however, the court finds that the SIPC did not rely on Seidman's alleged misrepresentation, we will be unable to classify the SIPC as a known party for purposes of a negligence claim against Seidman. We therefore reserve decision on this issue until completion of the certification process. 50 Finally, turning to the linking conduct prong, we find that whether the SIPC has alleged a sufficient nexus between itself and Seidman to satisfy the third Credit Alliancefactor is also a close question under New York law. As noted above, this requirement ensures that a negligence action will go forward only where the plaintiff has had both direct and substantial contact with the defendant. The SIPC, however, has alleged almost no direct contact with Seidman. The only activity even approaching this threshold is Seidman's filing, as required by federal law, of an annual report with the SIPC regarding the status of Baron's membership in the SIPC. These supplemental reports did not address Baron's financial health, but rather analyzed whether the SIPC assessment had been calculated fairly and whether Baron had overpaid on its assessment during the previous year. See17 C.F.R. § 240.17a-5(e)(4). Otherwise, Seidman apparently dealt exclusively with the SEC and the NASD rather than the SIPC itself. Given that courts in New York have declined to find linking conduct based on a single instance of contact between the parties, seeSecurity Pacific, 79 N.Y.2d at 705; CMNY Capital, 821 F. Supp. at 161, the Court of Appeals might find that the limited contact the SIPC has alleged here does not support a negligent misrepresentation claim against Seidman. 51 On the other hand, a second line of caselaw suggests that in certain unique circumstances, where the plaintiff's reliance is the end and aim of the defendant's actions, the plaintiff need not establish a direct relationship between the parties to support liability. SeeDorking Genetics v. United States, 76 F.3d 1261, 1270-71 (2d Cir. 1996); Kidd v. Havens, 577 N.Y.S.2d 989, 992-93 (4th Dep't 1991). 9 In Dorking, we held that a buyer of cattle could state a claim for negligent health certification under New York law even though the defendant's sole contact had been with the seller of the cattle and not the plaintiff-buyer. Because the seller had hired the defendant specifically to certify the cattle for sale, we considered it enough [to support liability] if the complaint shows reliance by the plaintiff that was the 'end and aim' of the transaction. Dorking, 76 F.3d at 1271 (citations and additional internal quotation marks omitted). Similarly, in Kidd, the Appellate Division held that a buyer could sue a title company for negligence even though the company's only contact had been with the seller and not the buyer. See Kidd,577 N.Y.S.2d at 992. Although the court acknowledged the general requirement of linking conduct between the parties, it observed that the title insurance business was unique in that while the defendant was nominally performing services for the seller, the end and aim of the transaction was for the benefit of the buyer. Id.at 992-93. (internal quotation marks omitted). As a result, the custom and usage of [the] profession dictated a finding of sufficient linking conduct. Id.. 52 These cases carve out an exception to the direct-contact requirement that may support the SIPC's negligence claim here. As in Dorking and Kidd, Seidman's financial reports, while submitted to the SEC, were prepared primarily for the benefit of a third party - specifically, the SIPC. Furthermore, as in those cases, the industry here imposes unique duties on the defendant: federal law requires that a broker-dealers like Baron engage an independent accountant to prepare its audit reports, see17 C.F.R. § 240.17a-5, and evidence accompanying the SIPC's complaint indicates that Seidman tailored its reports to meet those regulations. Cf.Dorking, 76 F.3d at 1270 (recognizing a negligence claim if the contract for services was tailored to the plaintiffs' requirements (thus demonstrating that the defendant understood the plaintiffs' reliance) even if the plaintiffs had never interacted directly with the defendant). Finally, the defendant repeatedly evinced an awareness that federal law required such information. Reliance by the SIPC (along with other regulators) was, therefore, the end and aim of Seidman's transaction with Baron. 53 Although these cases support the SIPC's negligence claim, we note that neither the New York Court of Appeals nor the majority of departments in the Appellate Division have recognized this unique circumstances exception to the linking conduct requirement. Consequently, we are reluctant to rely on this exception in assessing whether the SIPC's claim can survive, and we instead certify this question to the Court of Appeals as well. As with the fraud claim, the New York Court of Appeals is the most appropriate forum to rule on this issue, particularly given the court's clearly expressed desire, as a matter of state policy, to limit accountant liability for negligence to a narrow class of plaintiffs. SeeUltramares, 255 N.Y. at 179-80 (If liability for negligence exists, a thoughtless slip or blunder, the failure to detect a theft or forgery beneath the cover of deceptive entries, may expose accountants to a liability in an indeterminate amount for an indeterminate time to an indeterminate class. The hazards of a business conducted on these terms are so extreme as to enkindle doubt whether a flaw may not exist in the implication of a duty that exposes to these consequences.). We leave it to the Court of Appeals to determine whether the SIPC falls within that group.