Commercial Division Blog
Court of Appeals Accepts Certified Questions Regarding Fraud and Assignability of Fraud Claims
On November 20, 2014, the Court of Appeals accepted certified questions from the Second Circuit, in Commonwealth of Pennsylvania Public School Employees’ Retirement System v. Morgan Stanley & Co. Incorporated, on two issues: (1) the standard for determining whether the transfer of a note includes a transfer of the transferor's right to sue for fraud; (2) whether a defendant can be liable for fraud based on a misrepresentation of a third party where the defendant knew about (and perhaps took steps to procure) the third party's statement.
The lawsuit arose out of the collapse of an investment structured by Morgan Stanley. At issue on that portion of the appeal now before the Court of Appeals are the claims of Commerzbank AG, a subsequent holder of notes issued in connection with the investment. The federal district court ruled that Commerzbank lacked standing to bring a fraud claim, holding that "for a subsequent holder of a note to have standing to sue entities involved in the issuance of the note for torts committed in the issuance, the prior holder of a note must assign its tort claims at the time of the transfer, and that a simple transfer of the note did not assign those claims." The Second Circuit found that there was no controlling precedent from the Court of Appeals on this issue, and lower court authority was inconclusive:
On the one hand, New York law is clear that specific incantations of "assignment" are unnecessary to perfect a transfer. Moreover, we have elsewhere noted a general trend in New York toward adopting principles of free assignability of claims, including those of fraud. However, there is also a strain of New York law that treats tort and contractual claims in a particular instrument separately.
We believe these jurisprudential trends present an as-yet unresolved issue when applied to this case. Specifically, it is unclear whether the intent of parties to transfer a whole interest, combined with the absence of limiting language, suffices to transfer an assignor's tort claims, or whether an additional, more specific statement of an intent to transfer tort claims is required. We certify that issue to the New York Court of Appeals.
Another issue in the case concerned whether Morgan Stanley could be liable for fraud, given that the alleged misrepresentations were not made by Morgan Stanley, but by ratings agencies that gave the investment high ratings that were allegedly based on unreliable and outmoded data. The Second Circuit certified this issue to the Court of Appeals, as well:
The district court held that, as a matter of New York law, the allegedly fraudulent ratings could be attributed only to the ratings agencies themselves. Because Morgan Stanley did not issue the ratings, the district court held that it could not be directly liable and that there was no claim of aiding-and-abetting liability. Appellants argue that Morgan Stanley is nonetheless liable because it exerted pressure on the ratings agencies to obtain the fraudulently high ratings, even participating in a "scheme" to do so. Indeed, the district court noted that appellants had presented some evidence that Morgan Stanley had "manipulated the Cheyne SIV modeling process to create the ratings it desired," and had otherwise influenced the process beyond simply hiring the agencies. This would suffice under some New York decisions to impose liability on parties who make, authorize or cause a fraudulent representation to be made. Other New York decisions, however, which were discussed extensively by the district court, seem to foreclose suits against third parties based on the misrepresentations of another, even where that party was alleged to have known about the misstatement.