On June 13, 2014, Justice Ramos of the New York County Commercial Division issued a decision in Phoenix Light SF Ltd. v. Goldman Sachs Group, Inc., 2014 NY Slip Op. 50917(U), dismissing a fraud claim brought by sophisticated investors who alleged misrepresentations in the offering documents for a mortgage-backed securities investment.
In Phoenix Light, the court noted that “[u]nder New York law, there is an affirmative duty imposed on sophisticated investors, such as plaintiffs, to protect themselves from misrepresentations made during business acquisitions by investigating the details of the transactions”:
It has been held that as a matter of law, a sophisticated plaintiff cannot establish that it entered into an arm’s length transaction in justifiable reliance on alleged misrepresentations if that plaintiff failed to make use of the means of verification that were available to it
Nonetheless, a fraud claim may proceed where a plaintiff has sufficiently alleged that defendant possessed peculiar knowledge of the facts underlying the fraud, and the circumstances present would preclude any investigation by plaintiff conducted with due diligence. Thus, if the facts represented are not matters peculiarly within the party’s knowledge, and the other party has the means available to him of knowing, by the exercise of ordinary intelligence, the truth or the real quality of the subject of the representation, he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.
(Citations and internal quotation marks omitted.)
Justice Ramos found that the defendants in Phoenix Light did have “peculiar knowledge about the misrepresentations and omissions.” However, he nevertheless found that the complaint did not state a cause of action for fraud because “the allegations of the complaint, itself, actually establish that plaintiffs could have uncovered defendants’ alleged misrepresentations and omissions if they had exercised due diligence by asking for the loan files, which plaintiffs admit was information available at the time they bought the Certificates”:
[P]laintiffs and their external asset and investor managers reviewed only the data presented by defendants in the Offering Documents, despite having the ability to ask to review the loan files. The complaint alleges that defendants “did not share” the loan files, but there are no allegations that plaintiffs sought this pertinent information and that defendants denied access to it. It does not matter if the failure to seek this information was because of blind faith in the process of origination and/or securitization, or if it was attributable to the desire to quickly get on board of what the investors thought was a profitable bandwagon, the obligation of a sophisticated investor to inquire cannot be merely excused.
This decision illustrates the high burden that a sophisticated investor must satisfy to state a fraud claim arising from a commercial transaction. If the plaintiff could have availed itself of information from which it could reasonably have discovered the alleged misrepresentation, it will not be able to plead reasonable reliance, even if it did in fact rely on the misrepresentation.