Opinion ID: 773254
Heading Depth: 4
Heading Rank: 2

Heading: Adequacy of the Allegations

Text: 16 Plaintiffs have adequately alleged loss causation against the defendants. A liberal reading of the complaint reveals allegations that the misrepresentations in the Modified Report led plaintiffs to appraise the value of SAM Group securities incorrectly by assuming the competency of Mallick, the Group's principal. Plaintiffs assert that Mallick's ability to manage complex debt loads was essential to the success of a financing business like SAM Group, and that his importance to the venture's success, as well as their belief in his importance, was evidenced by the investment agreement's provision for a large amount of life insurance on Mallick. 17 The alleged deliberate concealment of the financial and business problems of the leader of SAM Group, the complaint goes on to allege, gave plaintiffs an inaccurate perspective from which to value the Group securities. If defendants had not provided the Modified Report, plaintiffs assert, they would have conducted their own due diligence investigation of Mallick, would have uncovered the various negative facts about his background, and would not have invested in SAM Group. Under this chain of factual allegations, it would have been foreseeable to defendants that facts concealed in the Modified Report would have indicated Mallick's inability to run the Group, and would have forecast its (eventually fatal) liquidity problems. These allegations in our view are adequate to survive a motion to dismiss on the ground of failure to sufficiently plead loss causation. 18 A comparison of Marbury Management, Inc. v. Kohn, 629 F.2d 705 (2d Cir. 1980), and Bennett v. United States Trust Co., 770 F.2d 308 (2d Cir. 1985), elucidates why the plaintiffs' allegations of loss causation are sufficiently particular. In Marbury Management, a trainee at a brokerage firm had falsely claimed that he was a stockbroker and portfolio management specialist, and persuaded several clients to invest in his recommended stocks, overcoming the clients' own reservations. 629 F.2d at 707. We affirmed the jury verdict for the plaintiffs, stating that only the loss that might reasonably be expected to result from action or inaction in reliance on a fraudulent misrepresentation is legally, that is, proximately, caused by the misrepresentation. Id. at 708. In Bennett, conversely, we affirmed the dismissal of a complaint that alleged that the defendants had misrepresented to the plaintiffs that the Federal Reserve's margin rules did not apply to public utility shares pledged to a bank as collateral. The plaintiffs had alleged that they would not have invested if they knew the rules did in fact apply, and thus defendants were responsible for their losses when the value of the stock declined. See 770 F.2d at 310, 314. 19 We distinguished Marbury Management on the grounds that in that case the misrepresentation related to the value of the shares --specifically, the reliability of the trainee's valuation -- while in Bennett, the misrepresentation related to rules extrinsic to the decline in the securities' value. Id. at 314. We went on to observe that had plaintiffs known the seller in Marbury Management was an inexperienced trainee without expertise they would not have accepted his recommendations to buy stock. Id. Such a misrepresentation, we thought, misled plaintiffs with respect to the investment quality of the stock, although the misrepresentation was not directly related to the stock's intrinsic investment characteristics. Id. Thus, because the misrepresentation in Marbury Management induced the purchase (transaction loss) and related to the stock's value (loss causation), it was causally related to the loss. In Bennett since the margin rules were extrinsic to the stock, the complaint failed to allege loss causation. See id.; see also Mfrs. Hanover Trust, 801 F.2d at 22 (holding that misrepresentations by defendant accounting firm about the financial status of its client -- a company trading in repurchase agreements -- proximately caused the plaintiff's loss, as those misrepresentations pertained to the investment quality of the repurchase agreements selected). 20 The rule derived from the holdings of Marbury Management and Bennett is that plaintiffs may allege transaction and loss causation by averring both that they would not have entered the transaction but for the misrepresentations and that the defendants' misrepresentations induced a disparity between the transaction price and the true investment quality of the securities at the time of transaction. 21 The allegations of loss causation are at least as strong in the present case as they were in Marbury Management. In Marbury Management, the misrepresentations pertained to the investment quality of the securities, as a reasonable investor would presumably accord less deference to a trainee than it would to a broker when valuating a recommended stock. 629 F.2d at 707. In the instant dispute the misrepresentations were similarly relevant to the investment quality of SAM Group securities, as the defendants allegedly concealed a lack of skills and expertise on the part of the company's principal that, if revealed, would directly affect the plaintiffs' valuation of their investment in the company. 22 The complaint thus alleges that plaintiffs suffered a loss at the time of purchase since the value of the securities was less than that represented by defendants. Plaintiffs have also adequately alleged a second, related, loss -- that Mallick's concealed lack of managerial ability induced SAM Group's failure. The complaint contends that the Group was involved in highly sophisticated financial transactions in which the expertise of a skilled executive officer was essential. See 2d Am. Compl. 23 ¶ 66. Plaintiffs allege that it was entirely foreseeable at the time of the misrepresentation that the Group would fail if guided by an individual who did not possess the requisite skill to manage complex debt loads. Since defendants reasonably could have foreseen that Mallick's concealed lack of skill would cause the company's eventual liquidity problems, defendants' misrepresentations may be the causal precursor to the Group's final failure. Cf. Mfrs. Hanover Trust, 801 F.2d at 20-21 (holding that defendants may be held liable for the foreseeable consequences of [their] misrepresentation). 1 24 The district court's reliance on Unterberg Harris Private Equity Partners, L.P. v. Xerox Corp., 995 F. Supp. 437 (S.D.N.Y. 1998), in granting the motion to dismiss is misplaced. In that case, the plaintiff sued Xerox, as financial backer of a company, Microlytics, in which the plaintiff had invested and which subsequently failed. Unterberg held that plaintiff's allegations that Xerox had neglected to disclose the gambling problems of the CEO of Microlytics were not sufficient to allege loss causation. See id. at 442. Rather than holding that a principal's failings could never suffice for loss causation, the district court simply found that the lack of investor interest in Microlytics was unrelated to the shortcomings of its CEO. See id. at 442-43. In the present action, conversely, plaintiffs have adequately alleged that Mallick's lack of business acumen proximately caused SAM Group's financial troubles. 25 Nor are we able to agree with the trial court's intimation that, as a matter of law, the Group's pre-existing liquidity problems caused its demise. On a motion to dismiss we draw all inferences in favor of the pleader. The complaint could reasonably be read as alleging that Mallick had himself caused the liquidity problems and that such could not be resolved so long as he remained at the company's helm.