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“Self-Styled ‘Long-Established and Well-Regarded’ Commodities Futures Commission Merchant” Loses Fraud Claim On Justifiable Reliance Grounds

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  • Posted on: Dec 16 2020

To plead a claim for fraud in the inducement or fraudulent concealment, a plaintiff must allege facts to support the claim that it justifiably relied on the alleged misrepresentations.

A sophisticated party, like the plaintiff in MBF Clearing Corp. v. JPMorgan Chase Bank, N.A., 2020 N.Y. Slip Op. 07504 (1st Dept. Dec. 15, 2020) (here), must allege that it exercised due diligence and took affirmative steps “to protect itself against deception.” DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 154 (2010). This means, for example, that a sophisticated party must employ whatever “means of verification were available at the time” of the alleged misrepresentations. VisionChina Media, Inc. v. Shareholder Representative Servs., LLC, 109 A.D.3d 49, 57 (1st Dept. 2013) (citation omitted). One way to do so is by obtaining a prophylactic provision in a contract or other writing or exercising due diligence to make an additional inquiry into the truth of the representation. ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043, 1045 (2015); DDJ, 15 N.Y.3d at 154 (holding that in contract negotiations between sophisticated parties, justifiable reliance element sufficiently alleged where plaintiff “has gone to the trouble” of insisting on warranties in the written agreement that certain facts were true). Thus, a sophisticated party cannot “argue justifiable reliance on defendants’ misrepresentation or omission where [it] had the means available to ascertain the status of the [transaction]” at issue and did not avail itself of those means. ACA Fin. Guar., 25 N.Y.3d at 1044; HSH Nordbank AG v. UBS AG, 95 A.D.3d 185, 194-195 (1st Dept. 2012).

[Ed. Note: we have addressed the justifiable element of a fraudulent inducement claim viz-a-viz a sophisticated party here and here, for example.]

MBF Clearing involved a “self-styled ‘long-established and well-regarded’ commodities futures commission merchant” that claimed, among other things, the defendants fraudulently induced it to invest its customer segregated assets in defendant’s J.P. Morgan U.S. Government Money Market Fund (“USG Fund”). 

In particular, plaintiff, MBF Clearing Corp. (“MBF”), alleged that the defendants, JPMorgan Chase Bank N.A (“JPMC Bank”), J.P. Morgan Investment Management Inc. and Kevin T. Murphy (“Murphy”), an employee of JPMC Bank, and a futures commission merchant, fraudulently induced MBF to invest its customer segregated assets by opening a new segregated customer account (“Account x2069”) and invest those assets in the USG Fund. It also alleged that defendants fraudulently changed the title of Account x2069 to remove “commodity customer segregated bank account” in violation of the Federal Commodity Exchange Act and rules and regulations of the United States Commodities Futures Trading Commission. 

MBF filed its first complaint on September 16, 2014. Thereafter, MBF filed two more complaints, an amended complaint and a second amended complaint (“SAC”). In the SAC, MBF alleged claims for fraudulent inducement to invest in USG Fund and open Account x2069, fraudulent misrepresentation as to the USG Fund, fraudulent misrepresentation as to Account x2069, fraud in changing the name on Account x2069, fraudulent concealment as to Account x2069, negligent misrepresentation as the USG Fund, negligent misrepresentation as to Account x2069, aiding and abetting in fraud, deceptive conduct, and contribution and indemnity.

On January 28, 2016, the motion court dismissed the SAC without prejudice. As to the fraud-based claims and negligence claims involving both Account x2069 and the USG Fund, the motion court dismissed them because MBF failed to allege justifiable reliance. The motion court found that the investment in the USG Fund ran afoul of applicable rules and that MBF did not do its due diligence in making the investment, noting that it simply relied on the documents sent in connection with opening the account (that is, “in terms of setting up the account and opening the account … there [was] an acknowledgement … by … the CFO as well as the principles [sic] of plaintiff saying they read all the prospectus related to that opening of the account”).

On August 2, 2016, MBF filed a motion to amend the complaint and caption, which was denied by the motion court. MBF then filed a motion to reargue the motion court’s decision denying the amendment. The motion to reargue was granted and the Third Amended Complaint (“TAC”) was deemed served and the caption amended.

The TAC omitted all claims as to the USG Fund and focused on Account x2069. As before, MBF alleged several fraud-based claims involving Account x2069, negligent misrepresentation claims involving Account x2069, aiding and abetting, and contribution and indemnity. 

The motion court dismissed the TAC on law of the case grounds.

“The ‘law of the case’ doctrine is a rule of practice which provides that once an issue is judicially determined, either directly or by implication, it is not to be reconsidered by Judges or courts of co-ordinate jurisdiction in the course of the same litigation.” Holloway v. Cha Cha Laundry, Inc., 97 A.D.2d 385, 386 (1st Dept. 1983) (citations omitted). The motion court concluded that the claims brought in the TAC were virtually identical to those dismissed in the SAC. 

MBF appealed. 

The Appellate Division, First Department unanimously affirmed.

After concluding that the motion court correctly dismissed the action under the law of the case doctrine, the Court, undertaking its own “sufficiency review” of the claims, determined that plaintiff failed to state a cause of action for which relief could be granted. Slip Op. at *1.

With regard to the fraudulent inducement claims, the Court held that the claims “failed” because plaintiff did “not allege justifiable reliance on the alleged misrepresentations.” Id. (citing ACA Fin. Guar., 25 N.Y.3d at 1045; HSH Nordbank AG, 95 A.D.3d at 194-195). The Court found that plaintiff was a sophisticated party that “could readily have determined for itself whether the representations were false by exercising reasonable due diligence.” Id. 

As a self-styled “long-established and well-regarded” commodities future commission merchant, required by the Commodities Futures Trading Commission (CFTC) to hold its customers’ assets in customer segregated accounts, plaintiff is presumably familiar with the requirements related to such accounts. Plaintiff could have made inquiries when defendants represented to it that there was no need for a “customer segregation acknowledgment letter” for Account x2069 because it would be linked to, and a sub-account of, plaintiff’s existing Account X0253 for which a segregation letter had been obtained. However, rather than take simple measures to ensure its compliance with CFTC regulations, plaintiff relied on the representations that the segregation letter for Account X0253 would cover Account X2069.

Id. (citations omitted).


MBF Clearing is another example of a court dismissing a fraud claim because the plaintiff failed to avail himself/herself/itself of the means to discover the truth or falsity of the representations and omissions made by the alleged wrongdoer. Although the determination of whether reliance is justified is a fact sensitive one, the courts are clear that failing to conduct any investigation, as in MBF Clearing, into the veracity of a representation or omission when the aggrieved party has the ability to do so, suffices to dismiss a fraud claim. This is especially so when the plaintiff, like MBF, is a sophisticated party. 

After all, the rationale for requiring sophisticated parties to “show they used due diligence and took affirmative steps to protect themselves from misrepresentations” (VisionChina Media, 109 A.D.3d at 57) comports with the public policy behind the rule: it rids the courts “of cases in which the claim of reliance is likely to be hypocritical.” Ambac Assurance Corp. v. Countrywide Home Loans, Inc., 31 N.Y.3d 569, 580 (2018). As Judge Read explained in her dissenting opinion in ACA Financial Guaranty:

Our venerable rule requiring that the reliance necessary to establish fraud must be justifiable is designed to make sure that the courts “reject[] the claims of plaintiffs who have been so lax in protecting themselves that they cannot fairly ask for the law’s protection” and “may truly be said to have willingly assumed the business risk that the facts may not be as represented.” [Citation omitted.]

ACA Fin. Guar., 25 N.Y.3d at 1051.

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