Fraud and the Sale of An Annuity Policy

• Posted on: Mar 22 2021

Fraud in the sale of securities. Such an allegation is often governed by an arbitration clause, requiring the parties to resolve their dispute before a FINRA tribunal. Not all investment claims, however, require resolution in arbitration. Sometimes the dispute can be adjudicated in a court of law. Such was the case in Pottorff v. Centra Fin. Group, Inc., 2021 N.Y. Slip Op. 01645 (1st Dept. Mar. 19, 2021 (here).

Pottorff v. Centra Financial Group, Inc.

Background

[Ed. Note: The background discussion comes from the Fourth Department’s decision and the briefing before the motion court.]

Pottorff involved an annuity contract, which plaintiff claimed was unsuitable and inappropriate for him. Although suitability concerns are often addressed by claims of breach of fiduciary duty and/or negligence, it can also be addressed by fraud claims where, as in Pottorff, the alleged unsuitable investment is rooted in a false and misleading recommendation or omission. 

In Pottorff, Plaintiff sold a business and sought the assistance of defendants for an investment vehicle that would not be subject to the fluctuations of the stock market and would provide plaintiff and his wife with a dependable income. Plaintiff claimed that he was not a sophisticated investor and placed his trust in defendants for a secure investment vehicle. Defendants were trusted advisors and fiduciaries of the plaintiff and were treated as such by the motion court.

Defendants recommended a single premium immediate annuity joint and survivor life annuity, which would pay plaintiff and his wife $8,702.42 a month while they were both alive. The payment decreased to $4,351.21 upon the death of either one of them. Defendants sought to provide protection for plaintiff should one of them die. Plaintiff was given a physical examination and was found to be uninsurable for life insurance purposes. Plaintiff’s wife was insurable up to $250,000.00 for life insurance purposes. The initial policy premium that was paid on the annuity was $1,425,000.00. The amount of life insurance defendants was able to secure for plaintiff and his wife was inadequate to cover the cost of the annuity premium. Despite the inability to cover this shortfall, defendants recommended the annuity to plaintiff and his wife.

Plaintiff’s operative complaint contained five causes of action: fraud in the inducement, fraud, constructive fraud, unjust enrichment and recission.

Defendants moved to dismiss. Defendants argued that plaintiff merely alleged a claim for negligence, which was barred by the running of the three-year statute of limitations. Defendants maintained that, at best, plaintiff merely alleged a failure to make a suitable recommendation – a claim that does not rise to level of fraud in the absence of a special relationship, which was non-existent. 

Defendants also argued that plaintiff failed to plead scienter with particularity. The only paragraphs in the complaint supporting the scienter element, said defendants, concerned defendants acting with a commercial motive. Such a motive, defendants claimed, does not satisfy the scienter requirement of the cause of action.

In addition, defendants argued that plaintiff failed to plead damages. According to defendants, plaintiff did not claim that any of the defendants failed to pay the monthly annuity payments. Instead, said defendants, to the extent plaintiff was harm it was because he had to remain alive in order to earn his premium back through annuity payments. The life annuity in question, explained defendants, did not guarantee complete return of premium through annuity payments. 

Further, defendants contended that plaintiff impermissibly used group pleading to allege the fraud, rather than alleging facts that distinguished between the three defendants. Defendants argued that plaintiff failed to specify which defendant committed the alleged wrongful acts and how the actions of any one defendant could be imputed to all defendants.

[Ed. Note: “Group pleading” occurs where there are multiple defendants who are alleged to have collectively committed the wrong complained of. Rather than differentiate the conduct attributable to each defendant, the plaintiff lumps them together in the pleading. Group pleading runs afoul of the CPLR and the Federal Rules of Civil Procedure. This Blog examined the “group pleading” prohibition here.]

Finally, defendants maintained that the October 2017 Letter annexed to the operative complaint constituted documentary evidence sufficient to dismiss the complaint under CPLR § 3211(a)(1). Defendants maintained that the October 2017 Letter explained how plaintiff knew the effect that either annuitants’ early death would have on the income payments before he and his wife purchased the annuity and further stated how they sought to generate “maximum income without market exposure” by purchasing the annuity, along with a variable annuity, and life insurance policies to offset lost income from the early death of either annuitant. 

[Ed. Note: Under CPLR § 3211(a), a party may make a motion to dismiss on the “ground that . . . a defense is founded upon documentary evidence.” To qualify as “documentary,” the content of the document must be “essentially undeniable and …, assuming the verity of [the paper] and the validity of its execution, will itself support the ground on which the motion is based.” Amsterdam Hospitality Grp., LLC v. Marshall-Alan Assocs., Inc., 120 A.D.3d 431, 432 (1st Dept. 2014), quoting David D. Siegel, Practice Commentaries, McKinney’s Cons. Laws of N.Y., Book 7B, C.P.L.R. C3211:10 at 22. Materials that clearly qualify as “documentary evidence” include judicial records, such as judgments and orders, as well as documents reflecting out of-court transactions, such as contracts, deeds, wills, and mortgages. Fontanetta v. Doe, 73 A.D.3d 78, 84-85 (2d Dept. 2010) (citation omitted). Thus, in order for evidence to qualify as “documentary,” it must be unambiguous, authentic and undeniable.” Granada Condominium III Assn. v. Palomino, 78 A.D.3d 996, 996-997 (2d Dept. 2010).

In the Second and Fourth Departments, affidavits, deposition testimony, and letters are not considered documentary evidence “within the intendment of CPLR 3211(a)(1).” Nero v. Fiore, 165 A.D.3d 823, 826 (2d Dept. 2018). In the First Department, like the Second  and Fourh Departments, affidavits are not documentary evidence within the meaning of CPLR § 3211(a)(1). Tsimerman v. Janoff, 40 A.D.3d 242 (1st Dept. 2007).]

In opposition, plaintiff argued that he satisfied all the elements of a fraud claim. Plaintiff maintained that he provided the who, what, where, when and how of the alleged fraud and did so with the requisite particularity. To that end, plaintiff alleged that (a) defendants represented that the purchase of the annuity, without any backside protection, including, but not limited to, commensurate insurance, was an appropriate investment; (b) defendants knew plaintiff and his wife were unsophisticated investors and would rely on them for investing and planning advice; (c) defendants knew when the annuity was issued that it was not appropriate or suitable for the Pottorffs because it lacked backing and/or protection; (d) defendants knowingly and with the intent to deceive recommended the annuity and advised plaintiff and his wife that it was a suitable and appropriate investment; (e) plaintiff and his wife relied on defendants agents and purchased the recommended annuity; (f) plaintiff’s reliance on defendants was justifiable in light of their position of trust.

Plaintiff also claimed that he satisfied the scienter element of the fraud claim. Specifically, plaintiff alleged that (a) defendants knew that plaintiff and his wife were unsophisticated investors and were relying on defendants for advice and recommendations; (b) defendants knew the annuity was unsuitable because it lacked commensurate insurance or other backside protection but recommended the security anyway; and (c) defendants knew that the annuity had limitations and strictures that made the annuity inappropriate for plaintiff and his wife.

The motion court denied the motion as to the fraud claims (here). The Appellate Division, Fourth Department unanimously affirmed.

The Fourth Department’s Decision

The Court held that plaintiff “sufficiently stated a claim for fraud by alleging ‘a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance by the plaintiff and damages.’” Slip Op. at *1 (quoting Eurycleia Partners, LP v Seward & Kissel, LLP, 12 N.Y.3d 553, 559 (2009), other citation omitted)). The Court found that, inter alia, “defendants’ employees and agents, with intent to induce plaintiff’s reliance, falsely represented to plaintiff that the subject annuity was a sound and appropriate investment while knowing that, ‘without the corresponding life insurance or other risk protection[, the annuity] would almost certainly result in a loss to . . . [p]laintiff and [a] windfall to [d]efendants.’” Id.

The Court further concluded that plaintiff sufficiently stated a claim for fraudulent inducement. 

To state a claim for fraudulent inducement, “there must be a knowing misrepresentation of material present fact, which is intended to deceive another party and induce that party to act on it, resulting in injury.” GoSmile, Inc. v. Levine, 81 A.D.3d 77, 81 (1st Dept. 2010), lv. dismissed, 17 N.Y.3d 782 (2011). See also Wyle Inc. v. ITT Corp., 130 A.D.3d 438, 439–41 (1st Dept. 2015); MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 A.D.3d 287, 294 (1st Dept. 2011). 

The Court found that plaintiff “alleged detrimental reliance on a material representation known to be false,” which was alleged “with the requisite specificity” that resulted in damages. Slip Op. at *1 (citations omitted). 

The Court also held that plaintiff “sufficiently stated a claim for constructive fraud.” Id. 

To plead a cause of action for constructive fraud, a plaintiff must allege the same elements as those to recover for actual fraud, except that a cause of action for constructive fraud does not require proof of defendant’s knowledge of the falsity of his or her representations. Brown v. Lockwood, 76 A.D. 2d 721 (2d Dept. 1980). “The scienter element is replaced by a requirement that the plaintiff prove the existence of a fiduciary or confidential relationship warranting the trusting party to repose confidence in defendants and therefore to relax the care and vigilance that would ordinarily be exercised in the circumstances.” Motion court order; see also Callahan v. Callahan, 127 A.D. 2d 298 (3d Dept. 1987); Brown v. Lockwood, supra. 

Like the motion court, the Fourth Department found that plaintiff “alleged the existence of a fiduciary relationship between plaintiff and defendants.” Slip Op. at *1 (citations omitted). 

Finally, the Court held that October 2017 was not documentary evidence within CPLR § 3211(a)(1). Slip Op. at *1. The Court also held that even if the letter was permissible documentary evidence, it did not “‘establish conclusively that . . . plaintiff ha[d] no cause of action.’” Id. (quoting Jeanty v. State of New York, 175 A.D.3d 1073, 1074 (4th Dept. 2019), lv. denied, 34 N.Y.3d 912 (2020) (internal quotation marks omitted); other citation omitted).

Takeaway

Pottorff shows the interplay between a fiduciary relationship and the scienter element of a fraud claim. Where a fiduciary relationship exists, the fiduciary is charged with having special knowledge or information regarding the alleged fraud. In such a situation (e.g., where the details are peculiarly within the knowledge of the fiduciary), “the heightened pleading requirements of CPLR § 3016(b) may be met when the material facts alleged in the complaint, in light of the surrounding circumstances, ‘are sufficient to permit a reasonable inference of the alleged conduct’ including the adverse party’s knowledge of, or participation in the fraudulent scheme.” JP Morgan Chase Bank, N.A. v. Hall, 122 A.D.3d 576, 580 (2d Dept. 2014), quoting High Tides LLC v. DeMichele, 88 A.D.3d 954, 957 (2d Dept. 2011). In Pottorff, plaintiff benefited from the foregoing principle.

Pottorff also shows that group pleading will not be an impediment to the particularity requirement of CPLR § 3016(b) when the reference to “defendants” is specific to a limited group of persons acting for a corporate defendant, instead of a “diverse group of defendants to whom entirely different acts giving rise to the action may be attributed [.…]” 47-53 Chrystie Holdings LLC v. Thuan Tam Realty Corp., 167 AD3d 405 (1st Dept. 2018). We wrote about 47-53 Chrystie Holdings here.