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

Heading: The Trustee's claims and the SIPC's claims on behalf of Baron's customers

Text: 22 Because both the Trustee and the SIPC in their capacities as subrogees assert claims on behalf of Baron's customers, the claims can survive dismissal only if the customers would have had a cause of action against Seidman for either fraudulent or negligent misrepresentation. The district court found that the plaintiffs were unable to meet this requirement with respect to their fraud claim because they could not show that Baron's customers had ever relied on Seidman's alleged misrepresentations. It further found that the plaintiffs' negligence claim failed because they had not established any privity-like relationship between the customers and the defendant. We agree with both conclusions and affirm the district court's dismissal of these claims.
23 Under New York law, 3 a plaintiff may state a claim for fraudulent misrepresentation made to a third party if he alleges that he relied to his detriment on the defendant's misrepresentation and that the defendant intended the misrepresentation to be conveyed to him. See Rosen v. Spanierman, 894 F.2d 28, 33 (2d Cir. 1990); Peerless Mills, Inc. v. AT&T, 527 F.2d 445, 450 (2d Cir. 1975); Ultramares Corp. v. Touche, 255 N.Y. 170, 187 (1931). In this case, the plaintiffs argue that they may recover, on the customers' behalf, for misrepresentations contained in the financial statements that Seidman submitted to the SEC and the NASD. 24 The district court correctly rejected this claim. Crucially, the plaintiffs concede that Baron's customers never received or reviewed any of the financial statements certified by Seidman. See Seidman, 49 F. Supp. 2d at 655. Moreover, the plaintiffs do not allege that the SEC or the NASD ever conveyed the information contained in those statements to the customers, nor do they allege that they were entitled to receive any materials or information prepared for purposes of complying with the SIPA. 4 Because Baron's customers never received Seidman's alleged misrepresentations in any form, therefore, the plaintiffs cannot establish that the customers relied to their detriment on that misinformation. 25 The plaintiffs here argue, however, that they need not establish direct reliance by Baron's customers on Seidman's representations. Rather, they contend that they are entitled to a presumption of reliance because the customers depended on the regulatory process as a whole to ensure that Baron's financial condition was stable. In making this claim, the plaintiffs rely on a theory of fraud on the regulatory process, an extension of the fraud on the market theory applicable in the federal securities context. 5 Fraud on the regulatory process rests on the notion that in making investment decisions, an investor relies, at least indirectly, on the integrity of the regulatory process and the truth of any representations made to the appropriate agencies and the investors. In re Towers Fin. Corp. Noteholder Litig., No. 93 Civ. 0810, 1995 WL 571888, at  (S.D.N.Y. Sept. 20, 1995); see alsoMishkin v. Peat, Marwick, Mitchell & Co., 658 F. Supp. 271, 274-75 (S.D.N.Y. 1987) (Weinfeld, J.) (applying fraud on the regulatory process theory to presume reliance by a securities broker-dealer's investors). The plaintiffs argue that the fraud on the regulatory process theory should give rise to a presumption of reliance in this case because Baron's customers, when deciding to invest with Baron, relied on the SIPA broker-dealer regulation scheme to alert them of any impending financial difficulties with the firm. Cf.Mishkin, 658 F. Supp. at 276 (An investor does and should be able to rely on the regulatory process' regulation of a broker-dealer to assure the broker-dealer's solvency and legitimacy . . . .). Because Seidman made misrepresentations in its reports to regulators, however, the process was unable to monitor Baron properly, causing customers to lose their investments when the alleged fraud came to light. 26 Whatever the merits of the fraud on the regulatory process theory - which the Second Circuit has never recognized, see Seidman, 49 F. Supp. 2d at 655 n.8; In re Towers, 1995 WL 571888, at  - it does not assist the plaintiffs in this case. To the extent that the federal courts have adopted this concept, it has applied only in the context of the federal securities laws. SeeArthur Young & Co. v. United States District Court, 549 F.2d 686, 695 (9th Cir. 1977); Mishkin, 658 F. Supp. at 274. As the district court recognized, common-law fraud claims require a different analysis than those brought under the federal securities regulation scheme. See Basic Inc. v. Levinson, 485 U.S. 224, 244 n.22 (1988) (Actions under Rule 10b-5 are distinct from common-law deceit and misrepresentation claims and are in part designed to add to the protections provided investors by the common law.) (citations omitted). Relying on this distinction, federal courts repeatedly have refused to apply the fraud on the market theory to state common law cases despite its wide acceptance in the federal securities fraud context. SeeIn Re Motel 6 Sec. Litig. 93 Civ. 2183, 1997 WL 154011, at  (S.D.N.Y. Apr. 2, 1997); Banque Arabe Et Internationale D'Investissement v. Maryland Nat'l Bank, 850 F. Supp. 1199, 1221 (S.D.N.Y. 1994), aff'd, 57 F.3d 146 (2d Cir. 1995); Turtur v. Rothschild Registry Int'l Inc., No. 92 Civ. 8710, 1993 WL 338205, at  (S.D.N.Y. Aug. 27, 1993); Schultz v. Commercial Programming Unlimited Inc., No. 91 Civ. 7924, 1992 WL 396434, at  (S.D.N.Y. Dec. 23, 1992). New York courts have also recognized this difference. See Strauss v. Long Island Sports, Inc., 401 N.Y.S.2d 233, 237 (2d Dep't 1978) (Other 10b 5 cases . . . do dispense with a showing of reliance provided the misrepresentation is material. But it appears from these decisions that 10b 5 cases are very much distinguishable from common law fraud cases.); Stellema v. Vantage Press Inc., 470 N.Y.S.2d 507, 510 (Sup. Ct. 1983) (While reliance need not be proved in [a Rule 10b-5] case, the requirement of a showing of reliance has not been removed in common law fraud cases . . . .). 27 Given that New York has not adopted even the well-recognized fraud on the market theory to allow a presumption of reliance in common-law fraud cases, we see no basis for applying the fraud on the regulatory process theory to achieve that end in this state-law case. Contrary to the plaintiffs' contention, therefore, we will not presume that Baron's customers relied on Seidman's misrepresentations. Rather, the plaintiffs must show that the customers actually relied on Seidman's certified statements to the SEC and the NASD regarding Baron's financial health. See Rosen, 894 F.2d at 34. Because the plaintiffs' complaints are devoid of any allegation that Baron's customers ever received this information in any form, they cannot establish reliance under New York law. Cf. Strauss, 401 N.Y.S.2d at 235-36 (finding no class-wide reliance in fraud class action because the plaintiffs could not establish that every class member had seen the alleged misrepresentations). We thus affirm the dismissal of the plaintiffs' claim for fraudulent misrepresentation.
28 In New York, a plaintiff claiming negligent misrepresentation against an accountant with whom he has no contractual relationship faces a heavy burden. To prevail, the plaintiff must establish three elements: 1) the accountant must have been aware that the reports would be used for a particular purpose; 2) in furtherance of which a known party was intended to rely; and 3) some conduct by the accountant linking him or her to that known party. See Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 551 (1985). The New York Court of Appeals has described these three factors as establishing a relationship approach[ing] that of privity between the accountant and the third party claiming negligence. Id. at 550 (quoting Ultramares, 255 N.Y. at 182-83). This strict limitation on the class of potential plaintiffs represents a policy determination by the New York courts that accountants will not, merely by contracting with a particular client, expose themselves to a liability in an indeterminate amount for an indeterminate time to an indeterminate class. Ultramares, 255 N.Y. at 179. 29 Like the district court, we find that the plaintiffs have failed to satisfy both the second and third elements of the Credit Alliance test. 6 See Seidman, 49 F. Supp. 2d at 657. We consequently affirm the district court's dismissal of the plaintiffs' negligence claims on behalf of Baron's customers. 30
31 To qualify as known parties under New York law, plaintiffs must be members of a known group possessed of vested rights, marked by a definable limit and made up of certain components. White v. Guarente, 43 N.Y.2d 356, 361 (1977). Applying this standard, the New York Court of Appeals in White deemed the plaintiff a known party because the defendant accounting firm knew, when it agreed to perform an audit, that a group of limited partners, including the plaintiff, would rely on that audit in preparing their tax returns. See id. Because the plaintiff thus was part of an identifiable, particularized group rather than a faceless or unresolved class of persons, the court found that the accountant owed him a duty of care with respect to services performed for purposes of that group's reliance. See id.at 361, 363; see also Duke v. Touche Ross & Co., 765 F. Supp. 69, 77 (S.D.N.Y. 1991) (granting known-party status under New York law where the accountant's report was disseminated to a select group of qualified investors). 32 By contrast, absent some evidence that he or she comprises part of such a specific class, a plaintiff generally will be unable to satisfy the known party requirement. In Westpac Banking Corp. v. Deschamps, 66 N.Y.2d 16 (1985), for example, the Court of Appeals found that the plaintiff, a creditor, could not maintain a negligence action against an accountant for a false audit report prepared on behalf of the debtor, even though the plaintiff had relied on that report in agreeing to extend credit. The court noted that the accountant had not prepared the report specifically for the plaintiff, but rather for the debtor for the purpose of supplying it generally to creditors in an attempt to obtain a loan. Because the plaintiff thus was only one of a class of 'potential . . . lenders,' it could not qualify as a specific, known party for purposes of a negligence action. See id.at 19. Similarly, in Ultramares, a seminal New York case on accountant negligence, the court declined to hold the accountant liable where the plaintiff, a creditor, was merely one of the indeterminate class of persons who, presently or in the future, might deal with [the debtor] in reliance on the audit. 255 N.Y. at 183; see alsoSecurity Pacific Bus. Credit, Inc. v. Peat Marwick Main & Co., 79 N.Y.2d 695, 708 (1992), (finding no third-party negligence claim where the accountant's audit work was clearly for the benefit of its client . . . and 'only incidentally or collaterally for the use of those to whom [the client] might exhibit it thereafter.') (quoting Ultramares, 255 N.Y. at 183). 33 These cases strongly resemble the one before us. In this case, the plaintiffs do not allege that Seidman prepared its audit reports for Baron's customers; rather, Seidman prepared those statements for filing with the SEC and the NASD, as required under the SIPA. Even if Baron's customers relied indirectly on the material contained in those reports - specifically, information indicating that Baron was financially healthy - in deciding to invest or maintain accounts with Baron, the complaint does not allege that Seidman ever knew those investors' identities, or even of the number of customers Baron had at any one time. At best, therefore, the plaintiffs can establish that Baron's customers constitute an unknown class of investors, each of whom potentially would rely on Seidman's representations. These circumstances are insufficient to render the customers known parties under New York law. 34 The plaintiffs nonetheless urge this Court to find that Baron's customers meet this requirement on the ground that any accountant knows, when contracting for services with a broker-dealer, that customers will rely on its audit reports to ensure the financial viability of the dealers with whom they invest. See Redington, 592 F.2d at 623 ([S]ection 17 imposes a duty on accountants in favor of brokers' customers. . . . [T]he broker's customers must rely on the certification by the accountants.); Mishkin, 658 F. Supp. at 275 ([A]n accountant engaged in [auditing] activities can reasonably foresee that not only the regulatory agency but also the purchasing public will rely upon the audit.). We reject this contention. Under New York law, the mere knowledge that some customers will rely on an accountant's work does not establish negligence liability. Rather, the accountant must have known when preparing the audit that the particular plaintiffs bringing the action would rely on its representations. SeeWestpac, 66 N.Y.2d at 19 (noting that plaintiff's status as a prime candidate for a loan is not . . . the equivalent of knowledge of 'the identity of the specific nonprivy party who would be relying upon the audit reports') (quoting Credit Alliance, 65 N.Y.2d at 554). Because the plaintiffs here have not alleged that Seidman knew of any particular customers who would rely on its work for Baron, they have not satisfied the known party element of their negligent misrepresentation claim. 35
36 The plaintiffs also fail to allege linking conduct between Seidman and Baron's customers sufficient to impose negligence liability on Seidman. To demonstrate linking conduct, a plaintiff generally must show some form of direct contact between the accountant and the plaintiff, such as a face-to-face conversation, the sharing of documents, or other substantive communication between the parties. See, e.g., Prudential Ins. Co. v. Dewey, Ballantine, Bushby, Palmer & Wood, 80 N.Y.2d 377, 385 (1992) (finding linking conduct where accountant sent its financial opinion letter directly to the plaintiff); Credit Alliance, 65 N.Y.2d at 554 (finding linking conduct where the parties communicated repeatedly to discuss the financial situation of the entity being audited). 37 Where direct contact between the accountant and the plaintiff has been nonexistent or even minimal, however, the plaintiff cannot recover for negligence. In Security Pacific, for example, the New York Court of Appeals found linking conduct absent because the accountant had never provided or agreed to provide a copy of the audit report directly to the plaintiff, had not mentioned the plaintiff in its audit engagement letter with its client, and had shown no awareness that the audit would benefit primarily the plaintiff. See Security Pacific,79 N.Y.2d at 706. The court noted that the plaintiff, a lender, did in fact speak to the accountant by telephone on one occasion to discuss the audit report. Nonetheless, the court found this contact insufficient to establish liability, reasoning that the plaintiff could not, with one phone call, create such an extraordinary obligation on the defendant's part. Id. at 705; see also CMNY Capital, L.P. v. Deloitte & Touche, 821 F. Supp. 152, 161 (S.D.N.Y. 1993) (finding no linking conduct where the accountant's client had made one phone call informing the accountant that the plaintiffs, investors in the client corporation, would be relying on the audit report);cf. Westpac, 66 N.Y.2d at 19 ([T]here is simply no allegation of any word or action on the part of the accountants directed to [the plaintiff, a lender], or anything contained in [the accountants'] retainer agreement . . . which provided the necessary link between them.). 38 Given this high standard for establishing linking conduct, we have little difficulty concluding that the plaintiffs have not shown such a link between Seidman and Baron's customers. The complaint in this case alleges no direct contact whatsoever between the customers and the defendant. At best, it alleges contact between Seidman and the SIPC regulators, who themselves operate at least one step removed from Baron's investors. The plaintiffs therefore cannot establish the direct nexus necessary to give the customers - or, by extension, the SIPC and the Trustee suing on their behalf - a cause of action against Seidman for negligent misrepresentation. 7