Keren Matana v. Merkin et al

Filing 67

OPINION & ORDER re: 52 MOTION to Dismiss the Amended Complaint filed by Gabriel Capital Corporation, J. Ezra Merkin. For the foregoing reasons, defendants' motion to dismiss the Amended Complaint is granted. The Clerk of Court is directed to terminate the motion pending at docket number 52, and to close this case. (Signed by Judge Paul A. Engelmayer on 11/22/2013) (lmb)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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:
KEREN MATANA,
:
:
Plaintiff,
:
:
-v:
:
J. EZRA MERKIN and GABRIEL CAPITAL
:
CORPORATION,
:
:
Defendants.
:
:
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13 Civ. 1534 (PAE)
OPINION & ORDER

PAUL A. ENGELMAYER, District Judge:
Plaintiff Keren Matana (“KM”), an Israeli charity, brings this action against J. Ezra
Merkin and Gabriel Capital Corporation (“GCC”) (collectively, “defendants”). KM invested
$1.5 million in Ascot Fund Limited (“Ascot Fund”), an off-shore hedge fund managed by
Merkin and GCC. Ascot Fund, in turn, invested substantially all of its assets with Bernard
Madoff. KM’s investment was wiped out following the revelation that Madoff was operating an
epic Ponzi scheme. This Court dismissed KM’s original Complaint, but granted KM narrowly
limited leave to amend. KM now brings state law claims of fraud and of a breach of the duty of
good faith and fair dealing. Defendants move to dismiss. For the reasons that follow, the motion
to dismiss is granted.
I.

Background
On July 30, 2013, the Court granted defendants’ motion to dismiss the original Complaint

See Matana v. Merkin, No. 13 Civ. 1534 (PAE), 2013 WL 3940825 (S.D.N.Y. July 30, 2013)
(“Matana I”) reconsideration denied, No. 13 Civ. 1534, 2013 WL 4010280 (S.D.N.Y. Aug. 6,

2013) (Matana II). This Opinion assumes familiarity with that decision and provides factual
background only as necessary to address the current motion.
A. The Parties and the Investment
On October 1, 2002, KM, an Israeli charity then managed by Benjamin Jesselson,
invested $1 million in Ascot Fund. Am. Compl. ¶ 2. On January 1, 2003, Ascot Fund became a
limited partner in Ascot Partners, L.P. (“Ascot Partners”), such that KM’s sole investment was in
Ascot Partners. Id. ¶ 1. On January 1, 2004, KM invested another $500,000 in Ascot Fund. Id.
¶ 2. In 2008, when Madoff’s fraud was exposed, the value of Ascot Partners’, and thus Ascot
Fund’s, investments with Madoff were wiped out; KM lost its $1.5 million investment. Matana
I, 2013 WL 3940825, at *2.
B. Procedural Background to the Amended Complaint
On March 7, 2013, KM filed suit, bringing state-law claims of fraud, breach of fiduciary
duty, breach of the duty of good faith and fair dealing, gross negligence, and unjust enrichment.
Dkt. 1.
On July 30, 2013, the Court granted defendants’ motion to dismiss. Matana I, 2013 WL
3940825, at *16. The Court denied KM leave to amend the three claims as to which amendment
would be futile: breach of fiduciary duty and gross negligence, which were barred by the statute
of limitations; and unjust enrichment, which was precluded as a matter of law by the presence of
a contract. Id. at *12–16. The Court similarly denied KM leave to amend the main part of its
fraud claim, which alleged fraudulent misrepresentations or omissions in defendants’ offering
documents, because that part of the fraud claim was barred by the statute of limitations. Id. at
*7–11, 16.

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The Court granted KM leave to amend two claims. First, as to the fraud claim, the Court
granted KM leave to amend to cure the aspect of that claim that articulated a “holder” theory of
fraud, i.e., that alleged defendants had made fraudulent misrepresentations that induced KM to
retain, or hold, its investment. Id. at *16. A holder claim, as opposed to a claim of fraud at the
inception of the investment, was potentially timely. However, the timely holder-claim
allegations in the original Complaint were deficient because KM had failed to plead them with
particularity, as required by Federal Rule of Civil Procedure 9(b), in that “the only allegations in
the Complaint that would form the basis of a timely holder claim [were] three paltry
parenthetical references to excerpts of letters allegedly sent to Ascot Fund investors.” Id. at *12.
The Court was doubtful that these statements were material; KM had also failed to adequately
allege that it “reasonably relied on these snippets as a basis for retaining its investment in Ascot
Fund.” Id. But, because it was “conceivable that KM may be able to remedy that deficiency in
an amended complaint,” the Court granted KM leave to amend. Id. at *16. The Court noted
that, in moving to dismiss, defendants, while primarily attacking deficiencies specific to KM’s
complaint, had also argued that New York law no longer recognized any form of holder claim.
The Court stated that, were defendants to renew that argument on a new motion to dismiss, it
“would expect and invite thorough briefing on that point.” Id. at *12.
Second, the Court granted KM leave to amend its claim for breach of an implied
contractual duty, on one condition. Counsel had been unable “to locate the original subscription
agreement executed by KM.” Id. at *16. As a result, KM had argued, see Dkt. 36, and
defendants had stipulated, see Dkt. 37, that the documents that governed KM’s investments in
Ascot Fund were the two subscription applications that KM had executed. Matana I, 2013 WL
3940825, at *14. However, those agreements could not support an implied contractual duty on

3

the part of defendants, because the defendants were not parties to them. Id. They were instead
between KM and Ascot Fund. Id. The Court found it “conceivable that KM can identify a
contract between it and defendants that would imply such [an implied contractual] duty,” and
therefore gave KM leave to “include a claim of breach of an implied contractual duty claim if it
can locate such a contract.” Id. at *16 (emphasis in original).
The Court emphasized that “leave to amend applies to these two claims alone. The Court
does not invite KM to relitigate the claims that have already been dismissed with prejudice, or to
add new claims.” Id.1
On August 2, 2013, KM filed a motion for reconsideration of Matana I, on the ground
that the Court erred in denying equitable tolling. Dkt. 42–46. On August 5, 2013, KM submitted
a letter “seek[ing] guidance” from the Court on the preparation of its amended complaint. On
August 6, 2013, the Court denied KM’s motion for reconsideration. Matana II, 2013 WL
4010280, at *3. The Court separately responded to KM’s August 5, 2013 letter. Dkt. 47. The
Court declined to give KM guidance as to its forthcoming Amended Complaint, because “[i]t is
not the proper role of the Court to render an advisory opinion with specific outcomes as to the
matters raised by plaintiff.” Id. The Court, however, reminded counsel that, in granting leave to
amend, “the Court did not invite, or intend to invite, plaintiff to bring claims or articulate legal
theories that could have been brought earlier in this litigation,” but instead had “offered plaintiff

1

KM had foregone its amendment as of right under Federal Rule Civil Procedure 15(a)(1)(B)
because, in response to defendant’s motion to dismiss, it had elected not to amend its pleading,
but instead to oppose the motion to dismiss. Dkt. 58. The Court’s Individual Rules then in
effect stated that: “If a motion to dismiss is filed, the plaintiff has a right to amend its pleading,
pursuant to Federal Rule of Civil Procedure 15(a)(1)(B), within twenty-one days. If the nonmoving party elects not to amend its pleading, no further opportunity to amend will be granted
and the motion to dismiss will proceed in the normal course.”
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an opportunity to correct the specific failings noted by the Court in granting the motion to
dismiss those claims.” Id.
C. The Amended Complaint
On August 6, 2013, KM filed its Amended Complaint. As to the fraud claim, the
Amended Complaint adds allegations that defendants (1) in Ascot Fund’s financial statements
for fiscal years 2006 and 2007, falsely characterized Merkin’s investments advisory fees and
Ascot’s brokerage agreements, Am. Compl. ¶¶ 6, 67–70, (2) in a series of “Quarterly Letters”
sent to Jesselson and other investors in Gabriel Capital, L.P. (“Gabriel”), a separate hedge fund
that Merkin managed, misleadingly painted Merkin as “a true portfolio manager,” and omitted to
mention investments with Madoff, id. ¶¶ 7, 72–86; and (3) omitted to report information that
Merkin learned, or should have learned, about Madoff in 2007 and 2008, id. ¶¶ 90–98. As to the
claim of a breach of an implied duty of good faith, the Amended Complaint identifies one
written contract and one oral agreement which, it alleges, give rise to such a duty.
On September 12, 2013, defendants moved to dismiss the Amended Complaint. Dkt. 53
(“Merkin Br.”). On October 3, 2013, KM opposed the motion to dismiss, Dkt. 58, and later that
day amended its opposition, Dkt. 60 (“KM Br.”). On October 18, 2013, defendants replied. Dkt.
64 (“Merkin Reply Br.”). On November 7, 2013, the Court heard argument.
II.

Applicable Legal Standards
In resolving a motion to dismiss, the Court must “construe the Complaint liberally,

accepting all factual allegations in the Complaint as true, and drawing all reasonable inferences
in plaintiff[’s] favor.” Galiano v. Fid. Nat’l Title Ins. Co., 684 F.3d 309, 311 (2d Cir. 2012).
Nevertheless, the “[f]actual allegations must be enough to raise a right to relief above the
speculative level,” and the complaint must plead “enough fact[s] to raise a reasonable

5

expectation that discovery will reveal evidence of [plaintiff’s claim].” Bell Atl. Corp. v.
Twombly, 550 U.S. 544, 555–56 (2007). Put differently, “[t]o survive a motion to dismiss, a
complaint must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is
plausible on its face.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Twombly, 550 U.S.
at 570).
“The plausibility standard is not akin to a ‘probability requirement,’ but it asks for more
than a sheer possibility that a defendant has acted unlawfully.” Iqbal, 556 U.S. at 678 (quoting
Twombly, 550 U.S. at 556). “A pleading that offers ‘labels and conclusions’ or ‘a formulaic
recitation of the elements of a cause of action will not do.’ Nor does a complaint suffice if it
tenders ‘naked assertion[s]’ devoid of ‘further factual enhancement.’” Id. (quoting Twombly,
550 U.S. at 555). “Where a complaint pleads facts that are ‘merely consistent with’ a
defendant’s liability, it ‘stops short of the line between possibility and plausibility of entitlement
to relief.’” Id. (quoting Twombly, 550 U.S. at 557).
In addition, a claim for common law fraud under New York law must satisfy the
requirements of the heightened pleading standard under Federal Rule of Civil Procedure 9(b).
See Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co. of N.Y., 375 F.3d 168, 187 (2d
Cir. 2004); Dover Ltd. v. A.B. Watley, Inc., 423 F. Supp. 2d 303, 327 (S.D.N.Y. 2006). Rule 9(b)
provides: “In alleging fraud or mistake, a party must state with particularity the circumstances
constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person’s
mind may be alleged generally.” Fed. R. Civ. P. 9(b). The Second Circuit has clarified that
although intent may be alleged generally, “we must not mistake the relaxation of Rule 9(b)’s
specificity requirement regarding condition of mind for a license to base claims of fraud on
speculation and conclusory allegations.” Lerner v. Fleet Bank, 459 F.3d 273, 290 (2d Cir. 2006)

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(citation omitted). Rather, plaintiffs must allege facts that “give rise to a strong inference of
fraudulent intent.” Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994).
III.

Discussion
A. Breach of the Duty of Good Faith and Fair Dealing
In Matana I, the Court granted KM leave to amend its claim for breach of an implied

contractual duty of good faith and fair dealing if it could “locate . . . a contract” between the
parties “that would imply such a duty” on the part of defendants. 2013 WL 3940825 at *16.
KM has not “locate[d]” such a contract. Instead, the Amended Complaint bases its
renewed claim of a breach of implied duty of good faith and fair dealing on two other asserted
agreements. First, KM asserts, it was an intended third-party beneficiary of the 2002 Ascot
Partners Limited Partnership Agreement (“LPA”). Am. Compl. ¶¶ 44–46, 109. Second, KM
asserts, there was a previously undiscovered oral contract between Merkin and Jesselson. Id.
¶ 110.
The Amended Complaint does not comply with the Court’s directive in Matana I. KM
was not a party to the asserted written contract. And, as to both asserted contracts, the Amended
Complaint runs afoul of the Court’s August 6, 2013 admonition that, in granting leave to amend,
“the Court did not invite, or intend to invite, plaintiff to bring claims or articulate legal theories
that could have been brought earlier in this litigation.” Dkt. 47. KM’s new claims that it was a
third-party beneficiary of an Ascot Partners Agreement, and that Merkin and Jesselson had an
oral agreement, could each just as easily “have been brought earlier in this litigation,” and KM

7

has not endeavored to explain why it did not do so.2 KM’s new contract claim merits dismissal
on this ground alone.
In any event, even if KM’s newly articulated claim of a breach of a contractually-implied
duty of good faith and fair dealing was properly within the scope of its leave to amend, KM’s
claim would still require dismissal, because it fails to state a claim.
KM first seeks to situate such a duty in the fact that it was a shareholder of Ascot Fund,
and Ascot Fund was a party to the LPA with Ascot Partners. On this basis, KM asserts, it was a
third-party beneficiary of the LPA. But it is black-letter law that shareholders of a corporation or
partnership are not third-party beneficiaries of contracts entered into by that corporation or
partnership. See, e.g., ASR Levensverzekering v. Breithorn ABS, 958 N.Y.S.2d 380, 381 (1st
Dep’t 2013); Freeford Ltd. v. Pendleton, 857 N.Y.S.2d 62, 67 (1st Dep’t 2008); Bordereaux v.
Salomon Smith Barney Holdings, Inc., 703 N.Y.S.2d 112 (1st Dep’t 2000). KM has cited no law
to the contrary.
KM next alleges an oral agreement between Jesselson, its manager, and Merkin. But this
thin claim is inadequately pled. The Amended Complaint does not specifically allege any such
oral agreement; at best, paragraph 110 alleges that Merkin made an oral promise upon which KM
relied, but the Amended Complaint does not anywhere allege an exchange of promises or other
consideration, nor does it allege the date on which the contract was entered. See Fuji Photo Film
U.S.A., Inc. v. McNulty, 669 F. Supp. 2d 405, 412 (S.D.N.Y. 2009) (“To show that an
enforceable contract existed, the claimant must plead facts surrounding the formation of the
contract such as the date the parties entered into the contract, the major terms of the contract, the

2

Questioned on this point at argument, KM’s counsel stated that he had became aware of the
supposed oral contract after this Court’s decision in Matana I, because he had not, prior to that
point, taken the trouble to ask his client about that subject.
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parties to the contract, and that the party to be bound assented to the contract.”); Berman v. Sugo
LLC, 580 F. Supp. 2d 191, 202 (S.D.N.Y. 2008) (“a claim that fails to allege facts sufficient to
show that an enforceable contract existed between the parties is subject to dismissal”) (citations
omitted).
Indeed, the first time KM explicitly referred to a supposed oral contract was in its
memorandum of law opposing the motion to dismiss the Amended Complaint. See KM Br. 17.
Notably, in reciting the oral agreement’s ostensible terms in that memorandum of law, id., KM
revealingly cites to paragraph 35 of the Amended Complaint. That paragraph discusses only
written representations.
In any event, any such oral agreement would be precluded as a matter of law. That is
because, in investing in Ascot Fund, KM disclaimed any reliance on representations outside “the
Fund Documents and independent investigations made by the Investor.” Princ Decl. Ex. 1
(Ascot Fund Limited Subscription Agreement), at 2. See Cobalt Partners, L.P. v. GSC Capital
Corp., 944 N.Y.S.2d 30, 35 (1st Dep’t 2012) (“The subscription agreement states that in making
the decision to purchase the Common Stock, plaintiffs relied solely on the information set forth
in the Offering Memorandum and any other information obtained by plaintiffs directly from the
Fund. Accordingly, plaintiffs expressly disclaimed reliance on any representations other than
those they received from the Fund alone and cannot now complain that Group made them some
sort of independent promise.”) (citations omitted).
Furthermore, any such purported oral agreement would likely fail under the Statute of
Frauds. See S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 106 (2d Cir. 2009)
(holding, in a due diligence suit against an investment advisor for recommending that his
advisees invest in what turned out to be a Ponzi scheme, that “under New York law, an oral

9

agreement that is not by its terms to be fully performed within one year falls within the Statute of
Frauds if the option to terminate rests with the plaintiff alone”); Zaitsev v. Salomon Bros., 60
F.3d 1001, 1003 (2d Cir. 1995) (“if performance within one year depends upon an act solely
within the control of the party seeking to enforce the oral agreement, the Statute of Frauds
remains applicable”).
Defendants’ motion to dismiss KM’s claim of a breach of a contractually implied duty of
good faith and fair dealing is, therefore, granted.
B. Fraud
KM’s Amended Complaint alleges that defendants made fraudulent representations, or
omitted required disclosures, that fraudulently induced KM to maintain its investment in Ascot
Fund. In their motion to dismiss, defendants argue that, as a categorical matter, New York fraud
law no longer recognizes such “holder claims.” Alternatively, defendants argue, even if some
form of holder claims are cognizable in New York, the Amended Complaint does not adequately
allege any materially false statements or omissions or otherwise fails to state a claim. For the
reasons that follow, the Court agrees with KM that New York law appears still to recognize a
limited class of holder claims of fraud, but holds, with defendants, that the Amended Complaint
does not state a claim for common-law fraud.
1. The Status of Holder Claims Under New York Law
In Matana I, the Court canvassed the evolution of the New York common law of fraud as
applied to holder claims, including the decision of the Appellate Division, First Department, in
Starr Foundation v. American International Group., Inc., 901 N.Y.S.2d 246 (1st Dep’t 2010),
which held that holder claims are not available to the extent the plaintiff holder seeks to recover
lost profits, as opposed to recoup losses. See Matana I, 2013 WL 3940825, at *11. But, as the

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Court in Matana I noted, the New York courts have not clearly resolved the status of holder
claims under New York law. Where, as here, “the law of New York on this issue is not yet
authoritatively articulated, this Court must carefully ‘predict’ how the highest court of New York
would resolve the uncertainty.” In re WorldCom, Inc. Sec. Litig., 382 F. Supp. 2d 549, 559
(S.D.N.Y. 2005) (quoting Phansalkar v. Andersen Weinroth & Co., 344 F.3d 184, 199 (2d Cir.
2003)).
The Court’s analysis begins with the elements of common-law fraud. “Proof of fraud
under New York law requires a showing that (1) the defendant made a material false
representation, (2) the defendant intended to defraud the plaintiff thereby, (3) the plaintiff
reasonably relied upon the representation, and (4) the plaintiff suffered damage as a result of
such reliance.” Matana I, 2013 WL 3940825, at *12 (quoting Wall v. CSX Transp., Inc., 471
F.3d 410, 415–16 (2d Cir. 2006)). Those elements do not, by their terms, exclude claims of
fraud by persons alleging that they were fraudulently induced to retain securities or other
holdings. The cause of action for fraud in New York thus differs from the cause of action for
securities fraud under federal law, the elements of which are found in Rule 10b-5 of the
Securities and Exchange Commission, 17 C.F.R. § 240.10b-5, which in turn implements § 10-b
of the Securities Exchange Act of 1934. Under federal law, the fraudulent misrepresentation or
omission must have been “in connection with” a “purchase or sale,” 17 C.F.R. § 240.10b-5,
language which the Supreme Court has held does not permit claims of fraud brought by mere
holders. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975).
Recently, in Starr, as noted, the First Department held that holder claims cannot proceed
to the extent they seek lost profits. 901 N.Y.S.2d 246. “A federal court will only decline to
follow such an intermediate appellate court decision if it ‘find[s] persuasive evidence that the

11

New York Court of Appeals, which has not ruled on this issue, would reach a different
conclusion,’” AHW Inv. P’ship v. Citigroup Inc., No. 09 MD 2070 (SHS), 2013 WL 5827643, at
*7 (S.D.N.Y. Oct. 30, 2013) (quoting 10 Ellicott Square Court Corp. v. Mountain Valley Indem.
Co., 634 F.3d 112, 120 (2d Cir. 2011)). There is no persuasive evidence that the New York
Court of Appeals would depart from the thoughtful reasoning in Starr. The question, here,
however, is not Starr’s validity, but its reach, i.e., whether Starr reveals that the New York
courts would also refuse to recognize holder claims seeking to recoup losses. That question is
central here, because KM’s claim, at least in substantial measure, seeks to recover the value of its
investment in Ascot Fund that disappeared upon revelation of the Madoff fraud.
As to that question, a close analysis of Starr is instructive. The plaintiff there was a
charitable foundation, The Starr Foundation (“the Foundation”), whose original endowment was
comprised entirely of stock in American International Group, Inc. (AIG), a publicly traded
company. 901 N.Y.S.2d at 248. The Foundation alleged that, in 2007, it determined to sell off
most of its AIG stock, but as a result of fraudulent statements by AIG, which minimized the
degree of risk attached to AIG’s credit default swap portfolio, the Foundation set a higher floor
price for such sales ($65 per share) than it would have absent AIG’s unduly rosy statements. Id.
As a result, the Foundation ceased selling its shares when AIG’s share price fell below $65,
leaving it holding approximately 15.5 million AIG shares when AIG later reported billions of
dollars in credit default swap losses and its stock plummeted. Id. The Foundation then sued
AIG “to recover the value it hypothetically would have realized for its 15.5 million shares of
AIG stock in the late summer or fall of 2007 had defendants at that time accurately disclosed the
risk of AIG’s CDS portfolio, less the stock’s value after the alleged fraud ceased to be operative
in early 2008.” Id. Inasmuch as the Foundation’s “original cost basis was just over 7.4 cents per

12

share,” id. at 253 (Moskowitz, J., dissenting), almost all of the value that the Foundation sought
to recoup in its lawsuit would have represented profit.
Starr dismissed the Foundation’s holder lawsuit “for three distinct but related reasons.”
AHW, 2013 WL 5827643, at *6. First, under New York’s “longstanding” out-of-pocket rule,
damages for fraud “‘are to be calculated to compensate plaintiffs for what they lost because of
the fraud, not to compensate them for what they might have gained,’ and ‘there can be no
recovery of profits which would have been realized in the absence of fraud.’” Starr, 901
N.Y.S.2d at 249 (quoting Lama Holding Co. v. Smith Barney, 88 N.Y.2d 413, 421(1996)).
Second, “the value to the claimant of a hypothetical lost bargain is too undeterminable and
speculative to constitute a cognizable basis for damages.” Id. at 250 (citation omitted). Third, in
the case at hand, the decline in AIG’s stock value had not been caused by AIG’s alleged
misrepresentations, but by its underlying business decisions which the stock market only
belatedly came to appreciate, and these “paper losses” would have ensued regardless of when
AIG’s exposure to credit default swaps came to light. Id. at 249–250. In other words, had AIG
been forthright about its exposure from the start, its stock price would have declined sooner, and
the Foundation would not have been in any better position than the one in which it ultimately
found itself.
Defendants read Starr as barring all holder claims, not just those for lost profits. But
Starr cannot be read so broadly. The First Department in Starr contrasted the facts before it
from those in Continental Insurance Co. v. Mercadante, 225 N.Y.S. 488 (1st Dep’t 1927).
There, a holder’s fraud claim was sustained where the plaintiffs “alleged that as a result of being
fraudulently induced to refrain from selling their bonds, they were ultimately left with
instruments that were substantially worthless,” and thus “did suffer an out-of-pocket loss,

13

specifically, the loss of their investment in the bonds.” Starr, 901 N.Y.S.2d at 252 (citing
Mercadante). Starr “[a]ssum[ed] the continued vitality of Mercadante,” and indicated that, as in
Mercadante, a plaintiff who brought a holder claim to recoup “the loss of [an] investment” could
potentially obtain relief. Id. In such a situation, the concern that the First Department articulated
in Starr about compliance with the out-of-pocket limitation would be respected. And the court’s
second concern, that plaintiffs not seek speculative damages, would be significantly alleviated
because recovery would be capped at the plaintiff’s original investment. To be sure, the First
Department’s final concern—that it will a dissatisfied holder’s after-the-fact claim that it would
have sold its holdings but for a disclosure or non-disclosure will often be conjectural—exists
whether the holder claims out-of-pocket damages or lost profits. But the Starr court did not state
that that consideration was dispositive in its analysis. Instead, it was merely an additional reason
not to allow holder claims for lost profits. And, in some circumstances, as courts have
recognized, including in connection with Madoff-related lawsuits, a claim by a holder to recoup
the out-of-pocket cost basis of an investment vaporized by an undisclosed fraud may present
more reliable means of proving causation. See, e.g., Anwar v. Fairfield Greenwich Ltd., 728 F.
Supp. 2d 372, 445 (2010) (distinguishing Starr on the grounds that “[t]he loss at issue in this
litigation—the fall-out from Madoff’s Ponzi scheme—cannot be easily compared to the facts
present in a more typical securities fraud action”); cf. AHW, 2013 WL 5827643, at *7 n.7
(distinguishing Starr, which “addressed the specific issue of the viability of claims by holders of
publicly traded securities,” from cases in which “the New York Court of Appeals has recognized
that common law fraud claims extend to plaintiffs who were fraudulently induced to refrain from
acting”); Prime Mover Capital Partners, L.P. v. Elixir Gaming Technologies, Inc., 793 F. Supp.
2d 651, 672 n.108 (S.D.N.Y. 2011) (Kaplan, J.) (holding, after Starr, that “[u]nlike federal

14

securities law, New York common law in certain circumstances allows a plaintiff to recover on a
fraud claim where the plaintiff was injured because he or she held, rather than bought or sold,
securities in reliance on defendants' misrepresentations. . . . Plaintiffs, however, have neither
argued nor pleaded such a ‘holder’ claim.”).
In light of Starr’s explicit distinction between lost profits and out-of-pocket losses, at
argument, defendants conceded that Starr does not, by itself, bar all holder claims. Defendants
instead argued that a later decision, Tradex Global Master Fund SPC LTD v. Titan Capital
Group III, LP, 944 N.Y.S.2d 527 (1st Dep’t 2012), extended Starr to bar all holder claims. The
Court does not so read Tradex. Tradex instead is faithful to Starr’s distinction between lost
profits and out-of-pocket losses: “[U]nder New York law, such a ‘holder claim’ would be
precluded under the out-of-pocket rule by which the true measure of damages for fraud is
indemnity for the actual pecuniary loss sustained as a direct result of the wrong. Under the rule
there can be no recovery of profits which would have been realized in the absence of fraud.” Id.
at 529 (citing Starr).
Defendants also rely on Irvin v. Jones, 966 N.Y.S.2d 346, 2012 WL 6634476 (Sup Ct.
Suffolk Cnty. Dec. 13, 2012). There, plaintiff Barbara Irvin alleged that, after her husband died,
the defendant accountants, who “controlled every aspect of [her] finances,” used her money to
benefit themselves, including through a self-dealing investment in an office building in
Cincinnati, Ohio. Id. at *1. Irvin sued these accountants for out-of-pocket losses and lost
investment opportunities. Id. at *2. The Supreme Court, Suffolk County, dismissed Irvin’s New
York fraud claim “to the extent that such cause of action may be read as asserting ‘holder’
claims, i.e., that the plaintiffs’ were wrongfully induced by the defendants to hold rather than sell
the [Cincinnati office building] and other investments, [because] such claims are not actionable

15

under New York law.” Id. at *11. Defendants read this as a categorical bar on holder claims.
Merkin Br. 14; Merkin Reply Br. 10–11. But Irvin does not squarely so hold. First, it is not
clear whether the court’s phrase “such claims are not actionable” referred to holder claims in
general, or just those at issue in that case. The court’s one-sentence explanation for dismissing
the holder claim, focused entirely on the out-of-pocket rule, suggests the latter interpretation. Id.
at *11 (“The ‘out-of-pocket rule’ limits the recovery of damages for fraud to the actual pecuniary
loss sustained as a direct result of the wrong and precludes recovery of profits which might have
been realized but for the wrongful conduct.”) (citing Starr and Tradex). Second, the court’s
treatment of the issue is too cursory to merit deference as to the path of New York fraud law.
Third, Irvin was decided by a state trial court. The “proper regard” this Court owes it is less than
that due to rulings by a higher court. See Phansalkar v. Andersen Weinroth & Co., L.P., 344
F.3d 184, 199 (2d Cir. 2003) (in predicting state law, “we must give ‘fullest weight’ to the
decisions of a state’s highest court, and we must give ‘proper regard’ to the decisions of a state’s
lower courts”) (quoting Travelers Ins. Co. v. 633 Third Assocs., 14 F.3d 114, 119 (2d Cir.
1994)); AHW, 2013 WL 5827643, at *7 (“A federal court will only decline to follow such an
intermediate appellate court decision if it ‘find[s] persuasive evidence that the New York Court
of Appeals, which has not ruled on this issue, would reach a different conclusion’”) (quoting 10
Ellicott Square Court Corp. v. Mountain Valley Indem. Co., 634 F.3d 112, 120 (2d Cir. 2011)).
On the present state of the case law, therefore, this Court cannot predict that the New
York Court of Appeals would preclude holder claims altogether. No New York state court has
so held, or even so stated in dicta. The Court instead is compelled to predict, consistent with
Starr, that the New York Court Appeals today would still recognize a limited set of holder
claims, specifically, those in which plaintiffs seek to recover out-of-pocket losses, and perhaps,

16

but not necessarily, further limited to those in which there is a non-conjectural evidentiary basis
for asserting causation and tabulating damages. The Court, accordingly, rejects defendants’
argument that KM’s fraud claims are non-cognizable on the ground that the New York Court of
Appeals would not recognize any holder claim.
2. KM Has Not Adequately Alleged Fraud
The Court turns, next, to defendants’ alternative argument for dismissal—that the claims
of fraud in the Amended Complaint do not state a claim under Rule 12(b)(6). “Proof of fraud
under New York law requires a showing that (1) the defendant made a material false
representation, (2) the defendant intended to defraud the plaintiff thereby, (3) the plaintiff
reasonably relied upon the representation, and (4) the plaintiff suffered damage as a result of
such reliance.’” Matana I, 2013 WL 3940825, at *12 (quoting Wall, 471 F.3d at 415–16). As
noted, the Amended Complaint alleges that defendants made three sets of statements that
fraudulently caused KM to maintain its investment in Ascot Fund. The Court considers these in
turn.
a. Ascot Fund’s Financial Statements
The Amended Complaint alleges that KM retained its investment in Ascot Fund based on
a series of false statements in Ascot Fund’s financial statements for fiscal years 2006 and 2007,
which were delivered to KM in April 2007 and April 2008, respectively. Am. Compl. ¶¶ 6, 64.
First, the financial statements represented that Merkin earned “investment advisory fees” of $26
million in 2006 and $28 million in 2008. Id. ¶¶ 6, 67. In fact, the Amended Complaint alleges,
that representation was false because Merkin did not provide investment advisory services to
Ascot Fund, but instead funneled the money to Madoff. Id. ¶ 67. Second, the statements
represented that Ascot Partners “has a prime brokerage agreement along with clearing

17

agreements with brokerage firms to carry its account as a customer,” id. ¶¶ 6, 68; in fact, the
Amended Complaint alleges, Madoff did not function as prime broker, id. ¶ 69. Third, the
statements represented that Ascot Partners’ “brokers have custody of the Partnership’s
securities.” Id. ¶ 70. The Amended Complaint alleges that this was false, because there were not
“brokers,” but only one broker, Madoff, who had custody of substantially all of Ascot Partners’
assets. Id.
The Amended Complaint does not state facts upon which a factfinder could plausibly
infer that KM relied upon any of these statements in its decision to hold, rather than seek to
redeem, its investment in the Ascot Fund. Reasonable “[r]eliance provides the requisite causal
connection between the defendant’s misrepresentation and the plaintiff’s injury.” Ackerman v.
Price Waterhouse, 683 N.Y.S.2d 179, 191 (1st Dep’t 1998)). This is not a “fraud-on-themarket” case in which reliance is presumed. See Basic Inc. v. Levinson, 485 U.S. 224 (1988).
To survive a motion to dismiss, the Amended Complaint must instead plausibly plead that
defendants’ specific representations caused its injury, i.e., its decision to maintain its investment,
such that had those representations not been made, KM would have redeemed its investment in
Ascot Fund.
The Amended Complaint fails to do so. It offers only a conclusory assertion that KM
would have redeemed its Ascot Fund position absent these three statements. But, this ipse dixit
aside, the Amended Complaint does not plead facts that supply a plausible basis from which a
factfinder could infer that, but for these representations, KM would have initiated a redemption.
The Amended Complaint does not, for example, allege that KM had in place a specific
investment philosophy and standards, that the representations whose accuracy the Amended
Complaint now challenges were necessary to cause KM to believe that the Ascot Fund met those

18

standards, and that financial statements that lacked these representations would have triggered a
decision within KM to exit that Fund. The Amended Complaint does not allege that there were
meetings or discussions within KM as to whether to retain the Ascot Fund position, and that the
challenged representations factored into KM’s decision to continue to hold. There are, in fact, no
concrete allegations as to KM’s investment history that would give a factfinder a non-speculative
basis on which to conclude that, but for the challenged representations, KM would have
abandoned the Ascot Fund.
Importantly, this not an instance in which plaintiffs can invoke the principle of res ipsa
loquitur, i.e., where the inherent nature of a fund’s representations makes it obvious that, without
such representations, a rational investor would have redeemed his stake. Far from it: It is not
plausible that KM would have redeemed its investment if defendants had reformulated, or
omitted, these three technical, narrow statements. The Amended Complaint presupposes that,
had the Fund called the money paid to Merkin “fees” rather than “investment advisory fees,” or
dropped the reference to the Ascot Fund’s “prime brokerage agreement along with clearing
agreements with brokerage firms,” or used the singular word “broker” rather than “brokers,” it
would have taken a U-turn so as to veer from the Ascot Fund.3 But the Amended Complaint
pleads no facts to suggest that these subtleties would have been material to an investment holder,
let alone that KM actually relied on them in deciding to retain its investments. In sum, without
more, the alternative history that the Amended Complaint conjures is not plausible. In Rule

3

Nor does the Amended Complaint allege concrete facts as to when KM would have sought to
make such a redemption, how much of its investment it would have sought to redeem, and how
much of that investment it would have reclaimed given that, as is known now, Madoff would
have absconded with the Fund’s money. A factfinder would be forced to guess in hindsight at
these questions—the very concern about unguided conjecture that troubled the Starr court.
19

12(b)(6) terms, the Amended Complaint fails to plausibly plead the element of reliance (and,
relatedly, the element of materiality).
b. Gabriel’s Quarterly Letters
KM next alleges that it retained its investments in Ascot Fund as a result of a series
Quarterly Letters that another Merkin fund, Gabriel, sent to its investors, including KM’s
Jesselson. Id. ¶¶ 7, 72–86.
Before delving into the specifics, the Court notes that these alleged representations were
not made to KM and did not concern Ascot Fund, or even Ascot Partners, in which Ascot Fund
had invested. The Court previously noted this problem in dismissing the original complaint.
Matana I, 2013 WL 3940825, at *12 n.9. (“At argument, defense counsel represented that the
letters referenced [which were not attached as exhibits] were sent to investors in Gabriel Fund,
not Ascot Fund. Tr. 47. In the event of an Amended Complaint citing these letters, the Court
expects that KM would attach these letters and would amplify its theories of materiality and
reliance.”). But the Amended Complaint does not explain any better than its predecessor how
letters that were not sent to KM and did not address the fund in which KM had invested are ones
on which KM could have reasonably relied in deciding to maintain its investment in Ascot Fund.
For this reason alone, the Amended Complaint, to the extent based on the Gabriel Quarterly
Letters, does not state a claim for common-law fraud.
Even if KM could have reasonably relied on the Gabriel Quarterly Letters, the Amended
Complaint does not adequately allege statements in them that were actionable in fraud. First, the
Amended Complaint alleges that the letters were materially misleading because certain letters
(sent outside of the statute of limitations) stated that many of the fund’s investment opportunities
had come through Steve Feinberg and his Cerberus Group, Am. Compl. Ex. G at 3 (April 20,

20

2005), Ex. H at 5 (October 20, 2005), and Ex. I at 3 (July 20, 2006), and subsequent letters (sent
within the statute of limitations) emphasized Gabriel’s “sourcing advantage,” id. Ex. J at 7
(January 20, 2007), “sourcing network,” id. Ex. K at 8 (July 20, 2007), and “sourcing networks,”
id. Ex. L at 8 (January 20, 2008), whereas none of the letters disclosed to Gabriel’s investors that
Gabriel had invested in Madoff. Id. ¶ 76–77. But the letters never purported to identify all of
Gabriel’s sources, so the non-identification of one source, Madoff, was not inherently
misleading. Nor does the Amended Complaint allege that these statements were false; after all,
Gabriel invested 20 to 30 percent of its assets with Madoff, and there is no specific pleading that
it lacked the sourcing network the letters describe. Id. ¶ 7. Finally, the letters’ vague statements
about Gabriel’s “sourcing advantage” are classic puffery. They are “optimistic generalizations . .
. ‘too general to cause a reasonable investor to rely upon them.’” In re Australia & New Zealand
Banking Grp. Ltd. Sec. Litig., No. 08 Civ.11278 (DLC), 2009 WL 4823923, at *11 (S.D.N.Y.
Dec. 14, 2009) (quoting ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan
Chase Co., 553 F.3d 187, 206 (2d Cir. 2009)).
The Amended Complaint next alleges that the Quarterly Letters were materially false and
misleading because, “despite repeatedly emphasizing the centrality of diversification,” they did
not “reveal[] or even suggest[] the material role played by Madoff in all four (4) Merkin funds,”
such that investing in multiple Merkin funds increased exposure to Madoff. Id. ¶ 78 (emphases
in original). But even if that statement to Gabriel’s investors was a potential basis for claiming
fraud directed at KM, and even if it could be viewed as non-puffery, that statement as alleged
was not misleading as applied to Gabriel, which was the subject of the letters. Gabriel invested
only 20 to 30 percent of its funds with Madoff, id. ¶ 7, and, as KM acknowledged at argument on
the first motion to dismiss, Merkin did not actually know that Madoff was engaged in a Ponzi

21

scheme, 7/8/2013 Tr. at 39–40. KM argues that the statement to Gabriel’s investors was
misleading because other funds that Merkin advised also invested in Madoff. Thus, KM argues,
based on the non-identification of Madoff, investors in those other funds might unwittingly
increase their exposure to Madoff by investing in Gabriel and those other funds. But this
argument, too, does not withstand analysis. The letters were addressed solely to investors in
Gabriel; they do not purport to address the circumstance in which an investor invested in both
Gabriel and other Madoff-invested funds; and there is no allegation that KM invested in Gabriel
and thus could stand to be harmed by the negative synergy of investing in both Gabriel and the
Ascot Fund.
Finally, the Amended Complaint alleges that these Quarterly Letters “created and
reinforced the impression that Merkin was a true portfolio manager, entitled to be paid as one,
when all he was [sic] a financial intermediary.” Id. ¶ 86. But, as to Gabriel, which unlike Ascot
Fund did not invest most of its funds with Madoff, the Amended Complaint does not explain
why it was false for Merkin to suggest that he “was a true portfolio manager” rather than a mere
“financial intermediary.”
As to other statements to Gabriel investors which the Amended Complaint quotes, in an
April 20, 2007 letter, Merkin assured investors that Gabriel is “always playing defense, defense,
defense, till the moment comes to shift direction and head up the ice.” Id. Ex. M at 7; see also
id. ¶ 82. In a January 20, 2008 letter, Merkin characterized Gabriel’s work as “combin[ing]
some feel for the markets with research, hard work, and pounding the pavement” and explained
that “[t]he combination of some talent and a lot of diligence got us through a rocky 2007, and we
hope to employ the same formula to good if not better effect in calmer years ahead.” Id. Ex. L at
9; see also id. ¶ 83. And in a July 21, 2008 quarterly letter, Merkin assured investors that “we

22

remain focused on preserving principal and committed to managing risk.” Id. Ex. N at 7; see
also id. ¶ 84.
These statements are not actionable in fraud. The Court in fact previously rejected as
non-actionable allegations based on three of these statements, Matana I, 2013 WL 3940825, at
*12, and the new one, regarding Gabriel’s “feel for the markets,” is no less puffery. See ECA,
553 F.3d at 205–06 (statements that “risk management processes . . . are highly disciplined and
designed to preserve the integrity of the risk management process” were “merely generalizations
regarding [defendant’s] business practices” and inactionable puffery); cf. City of Austin Police
Ret. Sys. v. Kinross Gold Corp., No. 12 Civ. 1203 (PAE), 2013 WL 1174017, at *16 (S.D.N.Y.
Mar. 22, 2013) (“generalized statements touting the quality of a company’s risk management
process are puffery”).
c. Omissions Regarding Madoff
Finally, the Amended Complaint alleges that material omissions led KM to retain its
investments in Ascot Fund. Specifically, it alleges, Merkin had a fiduciary duty to KM, which
he breached by his non-disclosure of “disquieting facts” that, in 2007 and 2008, he learned or
should have learned about Madoff. Am. Compl. ¶¶ 87–98. These were that: (1) Madoff had
filed false and misleading Forms ADV with the SEC in 2006 to 2008, id. ¶¶ 90–91; (2) Madoff
conducted a substantial portion of his options activity on a registered, not regulated, market,
contrary to Merkin’s representation in the Ascot Fund offering materials that Ascot would
conduct its options activity solely in a regulated market, id. ¶¶ 92–94; (3) Madoff was not,
contrary to his representations to Merkin, conducting a nontrivial percentage of Ascot Fund’s
options business over the Chicago Board Options Exchange (CBOE), as revealed by the fact that
a high percentage of Ascot’s options trades, on a money-weighted basis, occurred on days when

23

Ascot’s trading alone represented more than 1000% of the CBOE volume for the contract traded,
id. ¶ 95; (4) Madoff’s claim that Ascot held accounts in its own name at the U.S. Treasury was
untrue, id. ¶ 96; (5) Madoff first transmitted to Merkin supposed confirmations of $60 million in
trades more than two weeks after the reported trade date, a suspicious practice that warranted
investigation, id. ¶ 97; and (6) Madoff’s transaction confirmations were otherwise incoherent and
suspicious, and warranted investigation, id. ¶ 98.
These allegations fail to state a claim. To begin with, the Amended Complaint alleges
that Merkin actually knew only one of these facts: that Madoff conducted a substantial portion
of his options activity over-the-counter (OTC), not on a regulated market. Id. ¶¶ 92–94. As to
the other five alleged omissions, the Amended Complaint alleges only that Merkin should have
been aware of these facts. See Merkin. Br. 21–22. But a pleading that a defendant should have
known certain facts does not allege scienter, because under New York law, a fraud claim
requires that the “defendant knew [his misrepresentation or omission] to be false.” Wynn v. AC
Rochester, 273 F.3d 153, 156 (2d Cir. 2001) (also holding that “conclusory allegations” of
knowledge are insufficient to state a claim for fraud).
The remaining allegation, to the effect that Merkin knew that Madoff’s reported trades
involved a much higher volume of OTC options activity than he had represented to Merkin, also
fails for deficient pleading of scienter. The Amended Complaint does not plead, in other than a
conclusory way, that Merkin’s failure to disclose this fact to investors was done with fraudulent
intent. See Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994) (plaintiffs must
allege facts that “give rise to a strong inference of fraudulent intent”). The Amended Complaint
does not articulate any coherent reason for Merkin to deliberately hide this information from
investors. Tellingly, counsel for KM has conceded that Merkin at no point prior to the revelation

24

of Madoff’s Ponzi scheme was aware that Madoff was engaged in a fraud. 7/8/2013 Tr. at 39–
40. Had Merkin been alleged to know of Madoff’s fraud, a deliberate attempt by him to hide that
fraud from his investors would presumably give rise to a plausible claim of fraud. But, absent
such knowledge, Merkin’s nondisclosure to investors of this particular deviation from Madoff’s
promised investment course does not, without more, bespeak fraudulent intent.
To be sure, such omissions might have been actionable if brought under a different cause
of action. But, as noted, KM’s inexplicable decision to defer filing its original Complaint until
2013 meant that such claims, e.g., for gross negligence, fell outside the statute of limitations. See
Matana I, 2013 WL 3940825, at *14. On the timely claim that remains, for a fraud aimed at
holders, these omissions fall short of stating a claim. See In re Merkin, 817 F. Supp. 2d 346, 357
(S.D.N.Y. 2011) (in a federal securities fraud suit against Merkin, holding that “allegations of
Madoff-related red flags do not adequately plead scienter”); In re Beacon Associates Litig., 745
F. Supp. 2d 386, 414 (S.D.N.Y. 2010) (in a federal securities fraud case, holding that “Plaintiffs’
red flag theory is essentially that rejected by the Court of Appeals for the Second Circuit in South
Cherry: had BAMC investigated Madoff, it would have uncovered that he was a fraud.”); SSR II,
LLC v. John Hancock Life Ins. Co. (U.S.A.), 964 N.Y.S.2d 63, 2012 WL 4513354, at *6 (Sup.
Ct. N.Y. Cnty. 2012) (“[I]n almost every case . . . courts have not held investment advisors liable
for failing to deduce that Madoff was running a Ponzi scheme.”); cf. Sapirstein-Stone-Weiss
Found. v. Merkin, No. 13 Civ. 415 (VM), 2013 WL 2495141, at *5 (S.D.N.Y. June 11, 2013)
(“Plaintiffs do not merely allege that Defendants failed to heed various ‘red flags,’ an allegation
that standing alone might be insufficient to plead scienter.”).4

4

Because the Court dismisses these allegations for failure to adequately plead scienter, it has no
occasion to reach defendants’ alternative challenge to KM’s omission-based theory of fraud:
that defendants did not have a fiduciary duty to KM, and therefore under New York law, there
25

CONCLUSION
For the foregoing reasons, defendants' motion to dismiss the Amended Complaint is
granted. The Clerk of Court is directed to terminate the motion pending at docket number 52,
and to close this case.

SO ORDERED.

Paul A. Engelmayer
United States District Judge

Dated: November 22, 2013
New York, New York

can be no liability for omissions because "an omission does not constitute fraud unless there is a
fiduciary relationship between the parties." Eurycleia Partners, LP v. Seward & Kissel, LLP,
849 N.Y.S.2d 510, 512 (1st Dep't 2007) aff'd, 12 N.Y.3d 553 (2009).
26