ACA Financial Guaranty Corp., Appellant,v.Goldman, Sachs & Co., Respondent, Paulson & Co., Inc. et al., Defendants.BriefN.Y.March 26, 2015To be Argued by: MARC E. KASOWITZ (Time Requested: 30 Minutes) APL 2014-00114 New York County Clerk’s Index No. 650027/11 Court of Appeals of the State of New York ACA FINANCIAL GUARANTY CORP., Plaintiff-Appellant, – against – GOLDMAN, SACHS & CO., Defendant-Respondent. BRIEF FOR PLAINTIFF-APPELLANT KASOWITZ, BENSON, TORRES & FRIEDMAN LLP Attorneys for Plaintiff-Appellant 1633 Broadway New York, New York 10019 Tel.: (212) 506-1700 Fax: (212) 506-1800 Dated: June 30, 2014 DISCLOSURE STATEMENT PURSUANT TO § 500.1(f) OF THE RULES OF THE COURT OF APPEALS Plaintiff-appellant ACA Financial Guaranty Corp. states that (a) ACA Capital Holdings, Inc. is its parent, (b) ACA Management, L.L.C. is its inactive subsidiary, and (c) it has no other affiliates. i TABLE OF CONTENTS Page PRELIMINARY STATEMENT ............................................................................... 1 QUESTIONS PRESENTED ...................................................................................... 8 STATEMENT OF JURISDICTION........................................................................ 10 STATEMENT OF THE NATURE OF THE CASE ............................................... 10 I. BACKGROUND ............................................................................................... 10 A. The Nature Of The Financial Instruments At Issue ............................ 10 B. Goldman Sachs Agreed To Orchestrate ABACUS For Paulson ................................................................................................ 11 C. Goldman Sachs Could Not Enlist A Portfolio Selection Agent Or Insurer Which Knew The Truth That Paulson Intended To Short ABACUS ................................................................................... 13 D. Goldman Sachs Misrepresented That Paulson Was The Transaction Sponsor And Equity Investor .......................................... 14 E. Paulson Manipulated The Portfolio Selection Process To The Detriment Every Long Investor In ABACUS, Including ACA .......... 16 F. Goldman Sachs’ Mispresentations Induced ACA To Enter Into The Financial Guarantee ..................................................................... 18 G. Agreements And Documents At Issue ................................................ 19 1. The Financial Guaranty ............................................................. 19 2. The Offering Circular ............................................................... 20 3. The Trade Confirmations .......................................................... 21 II. PROCEEDINGS BELOW ............................................................................ 22 A. The First Amended Complaint ............................................................ 22 ii B. The Trial Court’s Decision .................................................................. 22 C. The Second Amended Complaint ....................................................... 23 D. The Appellate Division’s Decisions .................................................... 23 III. The SEC v Tourre Case ................................................................................ 23 ARGUMENT ........................................................................................................... 26 I. LEGAL STANDARD ON A MOTION TO DISMISS ............................... 26 II. THE COMPLAINT AMPLY PLEADS REASONABLE RELIANCE ....... 27 A. The Complaint Alleges That ACA Took Reasonable Steps To Protect Itself Against Deception ......................................................... 27 B. The Allegations Of The Complaint Do Not Establish That ACA Had A Duty To Make Further Inquiries .............................................. 29 III. THE APPELLATE DIVISION ERRED IN HOLDING THAT THE COMPLAINT FAILS TO PLEAD REASONABLE RELIANCE AS A MATTER OF LAW .................................................................................. 32 A. The “Prophylactic Provision” Requirement Is Contrary To Court of Appeals Authority ................................................................. 32 B. The Offering Circular Does Not Even Hint, Much Less “Expressly Disclose,” That Paulson Was Not The Equity Investor ................................................................................................ 35 C. Whether Paulson Would Have Disclosed The Truth If Asked Is A Factual Issue That Cannot Be Resolved On A Motion To Dismiss ................................................................................................ 39 D. The Disclaimers Do Not Bar ACA’s Fraud Claims ............................ 41 CONCLUSION ........................................................................................................ 44 iii TABLE OF AUTHORITIES Page(s) Cases ACA Fin. Guar. Corp. v Goldman, Sachs & Co., 22 NY3d 909 [2013] ........................................................................................... 10 Allstate Ins. Co. v Credit Suisse Sec. (USA) LLC, 42 Misc 3d 1220(A), 2014 N.Y. Misc. LEXIS 428 [Sup Ct, New York County Jan. 24, 2014] ......................................................... 30 Arfa v Zamir, 17 NY3d 737 [2011] ........................................................................................... 30 Basis Yield Alpha Fund (Master) v Goldman Sachs Group, Inc., 115 AD3d 128 [1st Dept 2014] .......................................................................... 42 Black v Chittenden, 69 NY2d 665 [1986] ................................................................................. 7, 28, 41 Centro Empresarial Cempresa S.A. v América Móvil, S.A.B. de C.V., 17 NY3d 269 [2011] ....................................................................................passim Chimart Associates v Paul, 66 NY2d 570 [1986] ........................................................................................... 38 Danann Realty Corp. v Harris, 5 NY2d 317 [1959] ......................................................................................passim DDJ Mgmt., LLC v Rhone Group L.L.C., 15 NY3d 147 [2010] ....................................................................................passim Global Mins. & Metals Corp. v Holme, 35 AD3d 93 [1st Dept 2006]............................................................................... 34 Goshen v Mut. Life Ins. Co., 98 NY2d 314 [2002] ........................................................................... 6, 27, 36, 37 Graham Packaging Co., L.P. v Owens-Illinois, Inc., 67 AD3d 465 [1st Dept 2009] ...................................................................... 34, 35 iv HSH Nordbank AG v UBS AG, 95 AD3d 185 [1st Dept 2012] ............................................................................ 30 J.P. Morgan Sec. Inc. v Vigilant Ins. Co., 21 NY3d 324 [2013] ............................................................................... 26, 39, 40 JP Morgan Chase Bank v Winnick, 350 F Supp 2d 393 [SD NY 2004] ............................................................... 30, 31 Loreley Fin. (Jersey) No. 3 Ltd. v Citigroup Global Mkts. Inc., 2014 N.Y. App. Div. LEXIS 3300 [1st Dept, Index No. 650212/12, May 8, 2014] ................................................................... 42 Nat’l Conversion Corp. v Cedar Bldg. Corp., 23 NY2d 621 [1969] ........................................................................................... 34 Nat’l Union Fire Ins. Co. v Robert Christopher Assocs., 257 AD2d 1 [1st Dept 1999] .............................................................................. 43 Pappas v Tzolis, 20 NY3d 228 [2012] ........................................................................................... 30 Permasteelisa, S.p.A. v Lincolnshire Mgt., Inc., 16 AD3d 352 [1st Dept 2005] ............................................................................ 35 Richman v Goldman Sachs Group, Inc., 868 F Supp 2d 261 [SD NY 2012] ..................................................................... 25 Rodas v Manitaras, 159 AD2d 341 [1st Dept 1990] .......................................................................... 34 Rovello v Orofino Realty Co., 40 NY2d 633 [1976] ........................................................................................... 27 Sargiss v Magarelli, 12 NY3d 527 [2009] ........................................................................................... 27 SEC v Goldman Sachs & Co., 790 F Supp 2d 147 [SD NY 2011] ..................................................................... 15 SEC v Tourre, 2014 U.S. Dist. LEXIS 1570 [SD NY, Index No. 10 Civ. 3229, Jan. 7, 2014] .........................................................passim v SEC v Tourre, 2014 U.S. Dist. LEXIS 32817 [SD NY, Index No. 10 Civ. 3229, Mar. 12, 2014]......................................................passim Steinhardt Group, Inc. v Citicorp, 272 AD2d 255 [1st Dept 2000] .......................................................................... 43 Swersky v Dreyer & Traub, 219 AD2d 321 [1st Dept 1996] .......................................................................... 41 Syncora Guar. Inc. v Alinda Capital Partners LLC, 2013 N.Y. Misc. LEXIS 2943 [Sup Ct, New York County, Index No. 651258/2012, July 1, 2013] ............................................................... 33 Whitebox Concentrated Convertible Arbitrage Partners, L.P. v Superior Well Servs., Inc., 20 NY3d 59 [2012] ............................................................................. 6, 27, 36, 38 Other Authorities CPLR 3211 ................................................................................................... 25, 26, 28 Plaintiff-appellant ACA Financial Guaranty Corp. (“ACA”) respectfully submits this brief in support of its appeal from the decision and order of the Appellate Division, First Department, entered May 14, 2013 (the “Decision”), which reversed the trial court and dismissed fraud claims asserted by ACA against defendant-respondent Goldman, Sachs & Co. in the first amended complaint (“complaint” or “Compl.”). PRELIMINARY STATEMENT ACA was the principal victim of Goldman Sachs’s infamous ABACUS fraud -- which resulted in Goldman Sachs paying the largest SEC fine in history, while admitting that it made misrepresentations, and in a federal jury verdict against the Goldman Sachs employee principally responsible for the fraud, a verdict upheld by the district court. It would be anomalous, to say the least, and contrary to settled New York law, for ACA to be deprived of its right to recover the damages it suffered as a result of that fraud. In the Decision, the majority found that ACA “adequately pleaded all of the requisite elements comprising a fraud claim” against Goldman Sachs, but held that the complaint “fails to establish justifiable reliance as a matter of law.” (Decision at 2 [R. at 817]).1 The two dissenting justices would have upheld the fraud claims 1 Citations to the record on appeal are to “R. at __.” 2 and stated that they were “compelled to disagree” because the Decision “neither comports with the factual record nor the law on this issue.” (Decision at 16 [R. at 831]). As shown below, the dissent is correct; indeed, that the majority departed from settled law under this Court’s decisions already has been noted and has had repercussions in other cases. As ACA alleges, and as the federal jury and court found, Goldman Sachs, a prominent investment bank, fraudulently induced ACA, a monoline bond insurance company now operating in runoff, to provide financial guaranty insurance for a structured finance product that was conceived and marketed by Goldman Sachs based on a portfolio of investment securities selected largely by its hedge fund client, Paulson & Co., Inc. (“Paulson”). Unbeknownst to ACA, the product was designed to fail from the start, so that Paulson could reap huge profits by shorting the portfolio. In inducing ACA to provide insurance for the product, a synthetic collateralized debt obligation (“CDO”) Goldman Sachs called ABACUS 2007- AC1 (“ABACUS”), Goldman Sachs deceived ACA into believing that Paulson was to be the “equity” investor in ABACUS -- i.e., a long investor whose interest was in its success. However, as Goldman Sachs knew but concealed from ACA, Paulson instead intended to take an enormous short position in ABACUS -- an economic position precisely contrary to ACA’s position as insurer. Indeed, 3 Goldman Sachs repeatedly and unequivocally misrepresented Paulson’s role to ACA, both orally and in emails. Had Paulson’s true role as a short investor selecting the portfolio been disclosed, neither ACA nor anyone else would have provided financial guaranty insurance for ABACUS. Because of Goldman Sachs’s deceit -- which led ACA to reasonably believe that ABACUS was a valuable product selected largely by the equity investor -- ACA insured a financial product that was doomed to fail. Goldman Sachs engaged in this egregious misconduct, notwithstanding that it expressly acknowledged at the time that its participation presented “reputational risk” and after at least one other major investment bank declined to participate for that very reason. Indeed, Goldman Sachs has all but admitted its fraud. In settling civil charges brought by the SEC arising out of this fraudulent conduct, Goldman Sachs agreed to pay a $550 million fine and expressly admitted that it was a “mistake” not to disclose, among other things, that Paulson’s “economic interests were adverse” to other investors in ABACUS, including ACA. The SEC action went to trial against the Goldman Sachs employee principally responsible for ABACUS, Fabrice Tourre. In a verdict upheld by the district court, the jury found him “liable for participating in a scheme to defraud ACA.” SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *6 [SD NY, Index No. 10 Civ. 3229, Mar. 12, 2014]. In denying Tourre’s motion for a new trial, the district 4 court held that the SEC had proved a fraudulent scheme “designed and geared in a myriad of ways to support (or not undercut) ACA’s mistaken belief that Paulson was a long investor in [ABACUS]” and that the evidence adduced at trial was “fully supportive” of Goldman Sachs’s involvement in that scheme. SEC v Tourre, 2014 U.S. Dist. LEXIS 1570, *15-16, *20-21 [SD NY, Index No. 10 Civ. 3229, Jan. 7, 2014]. The majority below nonetheless held that the complaint fails, as a matter of law, to establish justifiable reliance. Each of the majority’s reasons for reaching this conclusion is erroneous. First, the majority held that, as a matter of law, a sophisticated party’s reliance on a misrepresentation is not justifiable unless it “insert[s]” a “prophylactic provision” in a written agreement warranting the truth of that representation. (Decision at 2 [R. at 817]). Such an inflexible approach to the context-dependent question of whether reliance is justifiable is a departure from established law and contrary to this Court’s decisions, including Centro Empresarial Cempresa S.A. v América Móvil, S.A.B. de C.V., 17 NY3d 269 [2011]. Centro Empresarial makes clear that inserting a “prophylactic provision” in a written agreement is one way, but not the exclusive way, for a sophisticated party to establish that its reliance was reasonable. Id. at 279. As the dissent pointed out and even the majority acknowledged, ACA did obtain “prophylactic” 5 representations from Goldman Sachs in recorded telephone conversations and emails. (Decision at 20 [R. at 835]; Decision at 6 [R. at 821]). Moreover, there are extensive factual allegations in the complaint establishing that ACA had no reason to doubt the veracity of Goldman Sachs’s “assurances,” including, among other things, as the dissent noted, allegations that those assurances “conformed to the industry standard for this type of transaction.” (Decision at 19 [R. at 834]). ACA, therefore, had no reason, much less a duty, to require a contractual “prophylactic provision.” DDJ Mgmt., LLC v Rhone Group L.L.C., 15 NY3d 147, 155-56 [2010]. Indeed, the relationship between ACA and Goldman Sachs was not embodied in a formal written agreement in which such a provision could have been “inserted.” Accordingly, ACA did take “reasonable steps to protect itself against deception” and, at a minimum, whether it did so is a “question to be resolved by the trier of fact.” DDG Mgmt., 15 NY3d at 154. Second, the majority held that, as a matter of law, ACA’s reliance on Goldman Sachs’s repeated misrepresentations was unreasonable because ACA possessed a securities offering circular for ABACUS that, the majority stated, “expressly disclose[s]” that the defendant’s representations were false. In fact, the offering circular in no way “expressly” disclosed the falsity of Goldman Sachs’s representations; it more nearly expressly confirmed those 6 misrepresentations. See infra Argument, Section III.B. In any event, at a minimum, the offering circular was ambiguous -- as evidenced by the conflicting interpretation of the offering circular by the dissent, as well as by the jury and district court in SEC v Tourre. Accordingly, the offering circular is not documentary evidence that “utterly refutes plaintiff’s factual allegations,” and therefore is not a proper basis for dismissal. Goshen v Mut. Life Ins. Co., 98 NY2d 314, 326 [2002]; Whitebox Concentrated Convertible Arbitrage Partners, L.P. v Superior Well Servs., Inc., 20 NY3d 59, 64 [2012] [dismissal improper if there is any “ambiguity in the interpretation and effect” of the documentary evidence]. ACA should be permitted the opportunity to prove (as the SEC was permitted to and did prove in the SEC v Tourre trial) that the offering circular does not even hint, much less “expressly disclos[e],” that Goldman Sachs’s representations were false. Third, the majority held that, as a matter of law, ACA’s reliance was unreasonable because ACA “could have, upon further inquiry, uncovered [Paulson’s] actual position, but apparently chose not to [ask Paulson].” (Decision at 6 [R. at 821]). Even assuming arguendo that ACA had any reason or duty to make further inquiries (and it did not), it is at best entirely speculative to conclude without any factual basis -- as the majority did -- that Paulson “would have likely” disclosed the truth if asked. (Decision at 7 [R. at 822]). The allegations of the 7 complaint are to the contrary -- including, among others, the allegations that the economic interests of ACA and Paulson in the transaction were “exactly opposite.” Those allegations and the reasonable inferences to be drawn from them -- i.e., that Paulson would not have told the truth -- must be viewed in the light most favorable to ACA on a motion to dismiss. Moreover, the majority made precisely the type of “hindsight” assessment that it “might have been possible to detect the fraud” that this Court has cautioned courts not to make. DDJ Mgmt., LLC, 15 NY3d at 154. At the very least, whether ACA “could have discovered the truth [] through the exercise of ordinary intelligence” is a question of fact that cannot be resolved as a matter of law. Black v Chittenden, 69 NY2d 665, 669 [1986]. Fourth, the majority held that, as a matter of law, disclaimers in the offering circular bar reasonable reliance here. However, those disclaimers have nothing to do with and do not disclaim the specific misrepresentations at issue. The Decision is thus contrary to more than fifty years of precedent establishing that, only where a “plaintiff has in the plainest language announced and stipulated that it is not relying on any representations as to the very matter as to which it now claims it was defrauded” will a disclaimer bar a fraud claim. Danann Realty Corp. v Harris, 5 NY2d 317, 320 [1959].2 Moreover, and in any event, the disclaimers 2 The majority’s departure from Court of Appeals authority establishing the standard for dismissal of fraud claims based on a disclaimer already has caused, as 8 expressly applied only to purchasers of a “beneficial interest” in the ABACUS securities; and ACA was not such a purchaser. Accordingly, the Decision should be reversed and ACA’s fraud claims against Goldman Sachs reinstated. QUESTIONS PRESENTED 1. Is a sophisticated plaintiff’s reliance on the defendant’s fraudulent misrepresentation unreasonable as a matter of law, if the plaintiff failed to insist that the misrepresentation be inserted in a formal written agreement with the defendant, even where the plaintiff had sought and obtained the misrepresentation in emails and recorded telephone conversations? The Appellate Division majority incorrectly answered this question in the affirmative. Supreme Court Justice Oing put it, “quite a stir” in the trial courts. (Transcript of June 20, 2013 Hearing in Loreley Financing (Jersey) No. 28, Ltd. v Morgan Stanley & Co., Index No. 653316/2012 (Sup Ct, New York County) (“Loreley Financing”) [Dkt. No. 52] at 71). During an oral argument on a motion to dismiss in Loreley Financing, Justice Oing observed that: the Decision is “really a change of the senior landscape” concerning the impact of disclaimers on fraud claims (id. at 74); whereas, prior to the Decision, the trial courts had “a lot of playroom” in deciding whether disclaimers preclude reliance in any given case, the Decision requires dismissal based on “general no reliance” clauses (id. at 42); and the Decision “change[d] the dynamics [on a motion to dismiss] substantially” (id. at 74). See also id. at 28-29, 41-45, 65-76. 9 2. May claims be dismissed based on documentary evidence, where the document is, at a minimum, ambiguous, including, as indicated by, among other things, the differing interpretations of the document proffered by the majority and dissenting opinions of the Appellate Division? The Appellate Division majority incorrectly answered this question in the affirmative. 3. Is a sophisticated plaintiff’s reliance on the defendant’s fraudulent misrepresentation unreasonable as a matter of law, if the plaintiff did not inquire of a potential third-party source of information whether the misrepresentation was true, even where there are, at a minimum, issues of fact as to whether there was any reason for the plaintiff to doubt the truth of the misrepresentation and whether the third-party would have told the truth? The Appellate Division majority incorrectly answered this question in the affirmative. 4. Is a sophisticated plaintiff’s reliance on the defendant’s fraudulent misrepresentation unreasonable as a matter of law, if the plaintiff had in its possession a document containing the defendant’s general disclaimers, even where the disclaimers did not at all address the subject of the misrepresentation and, by their terms, did not apply to the plaintiff? 10 The Appellate Division majority incorrectly answered this question in the affirmative. STATEMENT OF JURISDICTION On May 1, 2014, the Appellate Division granted ACA’s motion for leave to appeal from the Decision to this Court. (R. at 815).3 All arguments raised on this appeal have been made to the courts below and, therefore, are preserved for this Court’s review. STATEMENT OF THE NATURE OF THE CASE I. BACKGROUND A. The Nature Of The Financial Instruments At Issue ABACUS was a synthetic CDO, which is a structured finance product through which investors take indirect economic exposure to the financial performance of a portfolio of asset-backed securities (the “reference portfolio”). (Compl. ¶¶ 11-19 [R. at 136-138]). Investors take short or long positions in the CDO by purchasing notes issued by the CDO, or by entering into credit default swaps with respect to certain tranches of risk. (Compl. ¶ 18 [R. at 138]). 3 On October 15, 2013, the Court dismissed ACA’s initial appeal, filed as of right, “upon the ground that the order appealed from does not finally determine the action within the meaning of the Constitution.” ACA Fin. Guar. Corp. v Goldman, Sachs & Co., 22 NY3d 909 [2013]. 11 In a CDO, the so-called equity investor agrees to suffer the first loss if the reference portfolio performs poorly, so the equity investor has the strongest economic incentive of any participant in the CDO to have a high quality reference portfolio. (Compl. ¶ 13 [R. at 136]). For this reason, it is common practice in the industry for the transaction sponsor -- i.e., the investor that approaches the investment bank and proposes a reference portfolio with specified characteristics -- to pre-commit to invest in the equity of the CDO. (Compl. ¶ 21 [R. at 139]). So-called protection sellers also take long positions -- i.e., they profit if the reference portfolio performs well -- and protection buyers take short positions -- i.e., they profit if the reference portfolio performs poorly. (Compl. ¶ 17 [R. at 138]). The portfolio selection agent typically selects the collateral to be included in the reference portfolio within the parameters established by the transaction sponsor. (Compl. ¶ 22 [R. at 139]). The financial guaranty insurer “wraps” the CDO, that is, issues a financial guaranty policy effectively insuring the performance of the reference portfolio with specified conditions and limitations. (Compl. ¶ 14 [R. at 137]). The investment bank orchestrates the overall transaction and markets the CDO to investors. (Compl. ¶ 20 [R. at 139]). B. Goldman Sachs Agreed To Orchestrate ABACUS For Paulson In late 2006, Paulson approached Goldman Sachs seeking a way to take a massive short position on subprime residential mortgage backed securities 12 (“RMBS”). (Compl. ¶ 10 [R. at 135-136]). Paulson did not want to take the short position in just any portfolio of RMBS but in a portfolio of RMBS that it had selected and believed was most likely to default. (Compl. ¶ 28 [R. at 141]). Goldman Sachs enabled Paulson to do precisely that. At least one investment bank that Paulson approached before approaching Goldman Sachs, Bear Stearns, declined to structure such a transaction out of concern for its reputation, comparing Paulson to “a bettor asking a football owner to bench a star quarterback to improve the odds of his wager against the team.” (Compl. ¶ 30 [R. at 141-142]). Like Bear Stearns, Goldman Sachs knew that acting as the investment bank for the transaction Paulson proposed entailed what Goldman Sachs itself acknowledged was a “reputational risk,” but that did not stop Goldman Sachs from agreeing to underwrite the transaction on behalf of Paulson -- an important client with which Goldman Sachs had done $7 billion in transactions before ABACUS. (Compl. ¶¶ 31, 32 [R. at 142]). Goldman Sachs agreed to do so, believing that it would position Goldman Sachs “to compete more aggressively in the growing market for synthetics written on structured products,” a huge and enormously profitable market for Goldman Sachs. (Compl. ¶¶ 34, 65 [R. at 143, 153]). 13 C. Goldman Sachs Could Not Enlist A Portfolio Selection Agent Or Insurer Which Knew The Truth That Paulson Intended To Short ABACUS Goldman Sachs soon learned it could not find a portfolio selection agent for ABACUS -- much less a financial guaranty insurer to wrap the CDO, or any other long investor in ABACUS -- if Goldman Sachs disclosed that Paulson, the purported transaction sponsor proposing the reference portfolio, in fact intended to take an enormous short position against that portfolio. (Compl. ¶ 36 [R. at 143- 144]). Indeed, GSC Partners (“GSC”), an institutional investment manager, declined to act as the portfolio selection agent for that very reason, later admonishing Goldman Sachs: “I do not have to say how bad it is that you guys are pushing this thing.” (Compl. ¶ 37 [R. at 144]). Thus, when Goldman Sachs subsequently approached ACA about acting as the portfolio selection agent for a CDO proposed by Paulson, Goldman Sachs misrepresented to ACA that Paulson had pre-committed to take a long position in ABACUS -- i.e., that Paulson had an economic incentive to select reference obligations that would perform. (Compl. ¶ 59 [R. at 151]). In fact, through an undisclosed credit default swap between Goldman Sachs and Paulson, Paulson became the ultimate and undisclosed protection buyer (i.e., the short investor) in ABACUS. (Compl. ¶ 56 [R. at 150]). Thus, contrary to Goldman Sachs’s representations, and ACA’s reasonable understanding based on those 14 representations and customary practice in the industry, Paulson in fact had an economic incentive to select reference obligations that would default. (Compl. ¶ 25 [R. at 140]); see also Compl. ¶¶ 49, 81 [R. at 148-49, 157]). D. Goldman Sachs Misrepresented That Paulson Was The Transaction Sponsor And Equity Investor On January 8, 2007, ACA Management, LLC (“ACAM”), a subsidiary of ACA, met with Paulson at Paulson’s offices in New York City, where they discussed the proposed transaction, including, among other things, the RMBS to be included in the reference portfolio. In contrast to the candid disclosure to GSC of Paulson’s short interest in ABACUS, Paulson did not disclose that it intended to short the reference portfolio. (Compl. ¶ 39 [R. at 144-45]). Goldman Sachs knew that Paulson had not disclosed to ACAM that Paulson intended to short the reference portfolio. (Compl. ¶ 40 [R. at 145]). In an email sent later that same day, ACAM advised Goldman Sachs that “we didn’t know exactly how [Paulson] want[s] to participate in the space” and asked Goldman Sachs to “get us some feedback.” (Id.) Although Goldman Sachs responded to the e-mail, it did not disclose the truth -- that Paulson intended to participate in ABACUS by shorting the reference portfolio. (Id.) Instead, Goldman Sachs responded in Tourre’s January 10, 2007 email (the “January 10 email” [R. at 806-807]) purporting to provide a “Transaction Summary,” which not 15 only failed to disclose Paulson’s short interest in ABACUS, but affirmatively misrepresented that Paulson had pre-committed to take a long position in ABACUS. (Compl. ¶ 25 [R. at 140]). In the January 10 email, Goldman Sachs expressly identified -- indeed, defined -- Paulson as the purported “Transaction Sponsor,” which is typically the equity investor. (Compl. ¶ 41 [R. at 145]). Goldman Sachs also affirmatively misrepresented to ACAM in the January 10 email that the economic interests of Paulson and ACAM in ABACUS were “align[ed].” (Compl. ¶¶ 41, 43 [R. at 145- 146]). Moreover, in summarizing the capital structure, Goldman Sachs described the 0-9% tranche -- i.e., the equity tranche -- as “pre-committed first loss.” (Compl. ¶ 43 [R. at 146]). Because the CDO had not even been launched, let alone marketed to prospective investors, the only entity that could have “pre-committed” to invest in the equity tranche was Paulson. Goldman Sachs thus misrepresented to ACA that Paulson had pre-committed to take a long position in ABACUS.4 As the district court in SEC v Tourre noted, “Tourre admitted at trial that [the January 10] 4 In denying Tourre’s motion to dismiss in SEC v Tourre, the district court held, correctly, that “Tourre’s January 10 email to ACA, which included a “Transaction Summary” describing Paulson as the “Transaction Sponsor” with a pre-committed position to ABACUS’s equity tranche, sufficiently alleges a material misrepresentation regarding Paulson’s investment interest.” SEC v Goldman Sachs & Co., 790 F Supp 2d 147, 162 [SD NY 2011]. 16 email he sent to ACA “was not accurate.”” SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *38-39 [SD NY Mar. 12, 2014]. On February 23, 2007, Goldman Sachs repeated and confirmed its misrepresentation that Paulson had agreed to be the equity investor in ABACUS. Contemporaneous notes memorializing a telephone conversation between ACAM and Goldman Sachs state: 2/23 Call w/ [Goldman Sachs] -- Counterparty motivation -- reverse inquiry from Paulson who interviewed several collateral management teams – one being ACA. Paulson looking 0-10%. [emphasis supplied]. (Compl. ¶ 47 [R. at 148]). By “reverse inquiry,” Goldman Sachs meant that Paulson had approached Goldman Sachs to propose that it structure and market ABACUS. (Id.). By “Paulson looking 0-10%,” Goldman Sachs meant that Paulson intended to invest in the equity tranche of ABACUS. (Compl. ¶ 43 [R. at 146]). Goldman Sachs thus reiterated to ACA that Paulson intended to take a long position in ABACUS. E. Paulson Manipulated The Portfolio Selection Process To The Detriment Of Every Long Investor In ABACUS, Including ACA Relying on Goldman Sachs’s misrepresentations, ACAM agreed to act as the portfolio selection agent for ABACUS and -- as was customary in the financial industry (Compl. ¶¶ 20, 21 [R. at 139]) -- permitted Paulson, as the purported 17 “Transaction Sponsor,” to play an influential role in selecting the reference portfolio. (Compl. ¶ 63 [R. at 152]); see also Compl. ¶¶ 4, 50-56, 68, 76 [R. at 134, 149-150, 154, 156]).5 Paulson manipulated the portfolio selection process to the detriment of every long position in ABACUS, including ACA’s. (Compl. ¶ 56 [R. at 150]). While ACA believed that Paulson shared its economic incentive to select reference obligations that would perform, Paulson in fact had an economic incentive to select reference obligations that would default. (Compl. ¶ 25 [R. at 140]). A representative of Paulson has since testified, ACAM’s and Paulson’s incentives in the portfolio selection process were “exactly opposite.” (Compl. ¶ 41 [R. at 145]). Goldman Sachs was acutely aware of this perverse dynamic. On February 2, 2007, while sitting in a meeting between Paulson and ACAM to discuss the RMBS to be included in the reference portfolio, Tourre sent an e-mail to a Goldman Sachs colleague, stating, “I am at this ACA Paulson meeting, this is surreal.” What Tourre meant by “surreal” was that, at the meeting, Paulson proposed RMBS, ostensibly in a good faith effort to select those that it considered least likely to default, when in fact -- as Goldman Sachs knew and ACAM did not know -- 5 “The evidence at trial [in SEC v Tourre] showed that Tourre misrepresented Paulson’s role in the [ABACUS] transaction to ACA so that ACA would agree to work with Paulson to select a portfolio.” SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *38. 18 Paulson proposed RMBS that it considered most likely to default. (Compl. ¶ 53 [R. at 149-50]). Ultimately, more than half of the RMBS in the final reference portfolio were originally proposed by Paulson, and all of the RMBS in the final reference portfolio met criteria specified by Paulson, which was more than enough to ensure that Paulson (as the ultimate and undisclosed protection buyer) would receive enormous contingent payments under any financial guaranty policy referencing the super senior tranche of ABACUS. (Compl. ¶ 56 [R. at 150]).6 F. Goldman Sachs’s Misrepresentations Induced ACA To Enter Into The Financial Guarantee Relying on Goldman Sachs’s misrepresentations, and unaware that the ultimate and undisclosed short investor in ABACUS had played an influential role in the portfolio selection process, ACA agreed to issue a financial guarantee (defined infra Section G) referencing the super senior tranche of ABACUS. (Compl. ¶¶ 48, 49 [R. at 148-49]; see also Compl. ¶¶ 58, 59 [R. at 151]). Knowledge of Paulson’s true economic interests would have raised a red flag and 6 In imposing civil penalties on Tourre, the district court in SEC v Tourre found that Goldman Sachs had “received initial trading revenues of $15 million and more than $1 billion in payments from long investors, which were then passed along to Paulson [] through a series of credit default swaps.” SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *4. 19 caused ACA to decline any participation in ABACUS. (Compl. ¶ 63 [R. at 152]).7 As a former managing director of Moody’s Investors Services, Inc., the rating agency that rated ABACUS notes, testified before the United States Senate: “[i]t just changes the whole dynamic of the structure where the person who is putting [the transaction] together, choosing [the reference portfolio], wants it to blow up.” (Compl. ¶ 42 [R. at 145-46]). G. Agreements And Documents At Issue The ABACUS transaction involves a series of agreements and documents, including (i) the financial guaranty, (ii) the offering circular, and (iii) the trade confirmations, which are defined and summarized below. 1. The Financial Guaranty At Goldman Sachs’s request, there was no contractual relationship between Goldman Sachs and ACA. (Compl. ¶ 61 [R. at 158]). Rather, ABN AMRO Bank N.V. (“ABN”) “intermediated” ACA’s financial guaranty policy. (Id.). Thus, ABN issued to Goldman Sachs a financial guaranty policy referencing the super senior tranche of ABACUS; and ACA in turn issued to ABN a financial guaranty policy referencing the super senior tranche of ABACUS. (Id.). In effect, ACA 7 “ACA witnesses testified [at trial in SEC v Tourre] that they would never have agreed to serve as the collateral manager for [ABACUS] if they had known Paulson was a purely short investor.” SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *39. 20 insured the super senior tranche of ABACUS and ABN insured Goldman Sachs against the possibility of a default by ACA on that financial guaranty. (Id.). On May 31, 2007, ACA issued to ABN a financial guaranty policy referencing the super senior tranche of ABACUS for up to $909 million, pursuant to: (i) the Credit Default Swap Insurance Policy, effective May 31, 2007; (ii) the 1992 ISDA Master Agreement, dated as of May 31, 2007, between ABN and ACA Credit Products - ABN AMRO, LLC; (iii) the Schedule to the Master Agreement, dated as of May 31, 2007; and (iv) the Confirmation of Credit Default Swap Transaction, between ABN and ACA Credit Products, dated May 31, 2007 (collectively, the “financial guaranty”). (Compl. ¶ 62 [R. at 152]). 2. The Offering Circular On April 26, 2007, Goldman Sachs offered ABACUS notes for sale through an offering circular (the “offering circular” [R. at 316-512]). The offering circular provides that “each purchaser of a beneficial interest in [an ABACUS] Note will be deemed to have provided and agreed with the Issuer”8 (Offering circular at 115 [R.. at 437] (emphasis supplied)) that, “[i]n connection with the purchase of the Notes”: 8 The Issuer is the special purpose vehicle established to issue ABACUS notes, not Goldman Sachs. (Offering circular at 2 [R. at 324]). 21 (A) “none of [Goldman Sachs, ACAM, or other specified entities] is acting as a fiduciary or financial or investment adviser for the purchaser,” (B) “the purchaser is not relying (for the purposes of making any investment decision or otherwise) upon any advice, counsel of representations (whether written or oral) or [Goldman Sachs, ACAM or other specified entities] other than in the final offering circular for such Notes . . .,” and (E) “the purchaser has evaluated the terms and conditions of the purchase and sale of the Notes with a full understanding of all of the risks thereof (economic or otherwise) . . . .” (Offering circular at 117, Transfer Restrictions, Rule 144A Global Notes, Section (vi)(A), (B) and (E) [R. at 439] (emphasis supplied)). 3. The Trade Confirmations On April 26, 2007, ACAM purchased $42 million in ABACUS notes on behalf of three CDOs that it managed, specifically, Zenith Funding, Ltd., Grenadier Funding, Ltd., and ACA ABS 2003-2, Ltd. (the “trade confirmations” [R. at 601-603]; see also ACA’s 2007 Form 10-K at 12 [R. at 194-95] (identifying Zenith Funding, Ltd., Grenadier Funding, Ltd., and ACA ABS 2003-2, Ltd. as CDOs managed by ACAM)). 22 II. PROCEEDINGS BELOW A. The First Amended Complaint On April 25, 2011, ACA filed the first amended complaint (R. at 133-159), alleging that Goldman Sachs fraudulently induced ACA to issue the financial guarantee by affirmatively misrepresenting that Paulson was taking a long position in ABACUS (Compl. ¶¶ 79-80 [R. at 156-57]) and by fraudulently concealing that Paulson was in fact taking a short position in ABACUS (Compl. ¶¶ 85-86 [R. at 157-58]). B. The Trial Court’s Decision On April 23, 2012, the Supreme Court, New York County, Commercial Division denied Goldman Sachs’s motion to dismiss ACA’s claims and rejected Goldman Sachs’s argument, among others, that the complaint failed, as a matter of law, to plead reasonable reliance (the “Comm. Div. Order” at 20-30 [R. at 28-38]).9 On May 29, 2012, Goldman Sachs filed its notice of appeal of the trial court’s decision insofar as it denied Goldman Sachs’s motion to dismiss ACA’s fraud claims. (R. at 5-7). 9 The trial court granted Goldman Sachs’s motion to dismiss ACA’s unjust enrichment claim (Comm. Div. Order at 38-39 [R. at 46-47]), a decision ACA did not appeal. 23 C. The Second Amended Complaint On January 30, 2013, while Goldman Sachs’s appeal of the trial court’s denial of its motion to dismiss ACA’s fraud claims was sub judice, ACA, with leave of the trial court, filed the second amended complaint (“SAC”) asserting additional allegations against Goldman Sachs and asserting causes of action against Paulson and its affiliate Paulson Credit Opportunities Master II, Ltd.10 The SAC alleges that Paulson conspired with and aided and abetted Goldman Sachs in carrying out and concealing their fraud on ACA. (SAC ¶¶ 129-131). Among other things, the SAC alleges that Paulson agreed, in its own words, to “stick to the script” and “play the role” of equity investor in ABACUS (SAC ¶ 44) and that, through a secret “Side Letter Agreement,” Goldman Sachs and Paulson agreed not to disclose Paulson’s true role in ABACUS. (SAC ¶¶ 50-56). On April 17, 2013, Goldman Sachs answered the SAC.11 D. The Appellate Division’s Decisions On May 14, 2013, the Appellate Division reversed, 3 to 2, the Commercial Division’s denial of Goldman Sachs’s motion to dismiss. While recognizing that 10 On August 21, 2014, at the direction of the clerk, ACA submitted to this Court the SAC and the trial court’s decision and order granting ACA’s motion to file the SAC. 11 Goldman Sachs also asserted counterclaims against ACA and third-party claims against ACAM, which ACA and ACAM moved to dismiss. On June 6, 2013, after the Decision issued, the trial court so-ordered a stipulation among the parties staying all proceedings below pending further appellate proceedings. ACA and ACAM’s motion to dismiss was withdrawn without prejudice. 24 ACA had “adequately pleaded all of the requisite elements comprising a fraud claim,” the majority nevertheless held that the complaint “fails to establish justifiable reliance as a matter of law” and dismissed ACA’s fraud claims. (Decision at 2-3 [R. at 817-18]).12 In dissent, Justices Manzanet-Daniels and Clark were “compelled to disagree” because the Decision “neither comports with the factual record nor the law on this issue.” (Decision at 16 [R. at 831]).13 III. THE SEC v TOURRE CASE On April 16, 2010, the SEC asserted securities fraud claims against Goldman Sachs and Fabrice Tourre -- “the deal captain of [ABACUS], and [] the person primarily responsible for the transaction at Goldman [Sachs]”14 -- based on precisely the same operative facts at issue in this action. SEC v Goldman, Sachs & Co., No. 10-CV-3229 [SD NY], Docket No. 1 (“SEC v Tourre”). On July 20, 12 On January 31, 2013, ACA sent a copy of the SAC to the Appellate Division. On February 4, 2013, at the direction of the clerk of the Appellate Division, ACA also submitted the trial court’s decision and order granting ACA’s motion to file the SAC to the Appellate Division. Nevertheless, the Decision refers only to the “amended complaint” and makes no reference to the SAC or to the fact that the trial court granted ACA leave to file the SAC. 13 On December 17, 2013, the Appellate Division denied ACA’s motion for reargument. On May 1, 2014, the Appellate Division granted ACA’s motion for leave to appeal to this Court. (R. at 815). ACA submitted the SAC to the Appellate Division in support of both its motion to reargue and its motion for leave to appeal. 14 SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *15. 25 2010, the SEC filed the Consent of Defendant Goldman, Sachs & Co. (the “Consent” [R. at 783-796]). In the Consent, Goldman Sachs admitted that: the marketing materials for the ABACUS 2007-AC1 transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was “selected by” ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson’s economic interests were adverse to CDO investors. Goldman regrets that the marketing materials did not contain that disclosure. (Consent ¶ 3 [R. at 784]). Goldman Sachs also consented to entry of a Final Judgment Against Defendant Goldman, Sachs & Co. [R. at 797-805], providing that Goldman Sachs “is liable for disgorgement of $15,000,000 and a civil penalty in the amount of $535,000,000” (Judgment at 2 [R. at 798]). Goldman Sachs thus paid the “largest SEC penalty in history -- because of the “mistake” it admitted. Richman v Goldman Sachs Group, Inc., 868 F Supp 2d 261, 278 [SD NY 2012]. As the court in Richman noted, Goldman Sachs’s admission was tantamount to an admission of fraud. The Judgment against Goldman Sachs did not resolve the SEC’s fraud claims against Tourre, which proceeded to trial. On August 1, 2013, after eleven days of testimony, the “jury found Tourre liable for participating in a scheme to defraud ACA.” SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *6 [imposing civil penalties on Tourre]. In denying Tourre’s motion for a new trial, the district court 26 held that the evidence adduced at trial was “more than clear” that Tourre and Goldman Sachs’s conduct was “designed and geared in a myriad of ways to support (or not undercut) ACA’s mistaken belief that Paulson was a long investor in the [ABACUS] transaction.” SEC v Tourre, 2014 U.S. Dist. LEXIS 1570, *15 [SD NY, Index No. 10 Civ. 3229, Jan. 7, 2014].15 The district court further held that the evidence adduced at trial was “fully supportive” of Goldman Sachs’s involvement in the scheme to defraud ACA.16 On March 27, 2014, the district court entered final judgment against Tourre. Tourre did not appeal.17 ARGUMENT I. LEGAL STANDARD ON A MOTION TO DISMISS In assessing whether a complaint states a cause of action under CPLR 3211[a][7], “the court must give the pleading a liberal construction, accept the facts alleged in the complaint to be true and afford the plaintiff the benefit of every possible favorable inference.” J.P. Morgan Sec. Inc. v Vigilant Ins. Co., 21 NY3d 15 See also SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *38-40 [summarizing the evidence adduced at trial establishing the scheme to defraud ACA]. 16 See also SEC v Tourre, 2014 U.S. Dist. LEXIS 32817, *6-8 [imposing civil penalties on Tourre and prohibiting him from seeking reimbursement “from Goldman [Sachs], which the jury determined to be a co-violator of the securities laws with respect to ACA and, thus, necessarily, in the [ABACUS] transaction”]. 17 Although reliance is not an element of the federal securities fraud claims at issue in SEC v. Tourre, the jury verdict meant that the jury, and the district court in upholding the jury’s verdict, necessarily took a different view of the offering circular from that of the majority in the Decision. See infra, Argument, Section III.B. 27 324, 334 [2013] [quotations and citations omitted]. “Whether the plaintiff can ultimately establish its allegations is not part of the calculus in determining a motion to dismiss.” Id. [quotations and citations omitted]. Under CPLR 3211[a][1], dismissal based upon documentary evidence is “appropriately granted only where the documentary evidence utterly refutes plaintiff’s factual allegations, conclusively establishing a defense as a matter of law,” Goshen v Mut. Life Ins. Co., 98 NY2d 314, 326 [2002], and is improper if there is any “ambiguity in the interpretation and effect” of the documentary evidence, Whitebox Concentrated Convertible Arbitrage Partners, L.P. v Superior Well Servs., Inc., 20 NY3d 59, 64 [2012]. Documentary evidence ordinarily “merely raise[s] factual issues not properly decided on a motion to dismiss,” Sargiss v Magarelli, 12 NY3d 527, 531 [2009], and will “seldom if ever warrant” dismissal. Rovello v Orofino Realty Co., 40 NY2d 633, 636 [1976]. II. THE COMPLAINT PLEADS REASONABLE RELIANCE A. ACA Took Reasonable Steps To Protect Itself Against Deception Fraud plaintiffs have a duty to use the “means available to [them] of knowing, by the exercise of ordinary intelligence, the truth . . . .” DDJ Mgmt., LLC v Rhone Group L.L.C., 15 NY3d 147, 154 [2010] [quotation and citation omitted]. This Court has emphasized, however, that even a sophisticated plaintiff “should not be denied recovery merely because hindsight suggests that it might 28 have been possible to detect the fraud,” where, as here, the plaintiff took “reasonable steps to protect itself against deception.” DDJ Mgmt., LLC, 15 NY3d at 154 [reversing dismissal and reinstating a sophisticated plaintiff’s fraud claims]. Moreover, the “question of what constitutes reasonable reliance is always nettlesome because it is so fact-intensive.” Id. at 155 [citation and quotation omitted]. Accordingly, as the Court has held and reiterated, whether a plaintiff was justified in relying on a defendant’s misrepresentations is ordinarily a “question to be resolved by the trier of fact.” Id. at 156; see also Black v Chittenden, 69 NY2d 665, 669 [1986] [whether plaintiff “could have discovered the truth [] through the exercise of ordinary intelligence” cannot be resolved as a matter of law]. Here, the complaint alleges that ACA specifically asked Goldman Sachs how Paulson intended to “participate” in ABACUS. (Compl. ¶ 40 [R. at 145]). In response, Goldman Sachs affirmatively and unequivocally misrepresented to ACA in a written “Transaction Summary” (R. at 729-732) that Paulson was the “Transaction Sponsor,” that Paulson had “pre-committed” to invest in the equity, and that Paulson and ACA’s interests in the transaction were “aligned.” (Compl. ¶¶ 41, 43, 47 [R. at 145-146, 148]). In a follow-up telephone call, Goldman Sachs 29 orally repeated and confirmed its written representation that Paulson was the equity investor. (Compl. ¶ 47 [R. at 148]).18 As the dissent below points out, ACA sought to “protect its interest in the transaction by confirming Paulson’s role via email and telephone calls.” (Decision at 20 [R. at 835]). Even the majority acknowledges that ACA “sought assurances” from Goldman Sachs about Paulson’s “role and position” in ABACUS. (Decision at 6 [R. at 821]). There is thus no question that ACA in fact did take “steps to protect itself against deception” (DDJ Mgmt., 15 NY3d at 155-56); the only question is whether those steps were “reasonable.” Assuming the allegations of the complaint to be true, and drawing all inferences in ACA’s favor -- as the majority should have done but did not do -- the answer to that question is plainly yes. In any event, it is a “question to be resolved by the trier of fact,” not to be resolved as matter of law on a motion to dismiss. DDJ Mgmt., 15 NY3d at 155-56; Black, 69 NY2d at 669. B. ACA Had No Duty To Make Further Inquiries On a CPLR 3211[a][7] motion to dismiss for failure to state a cause of action, fraud claims cannot be dismissed based on a plaintiff’s diligence unless the 18 The SAC also includes the transcript of an audio recording of a January 17, 2007 telephone conversation in which Goldman Sachs unequivocally misrepresented to ACA that Paulson’s economic interest in the “capital structure” of ABACUS was “100% equity.” (SAC ¶ 64). 30 allegations of the complaint itself establish that the plaintiff had “actual knowledge that [defendants] [were] not being entirely forthright.” Centro Empresarial, 17 NY3d at 279 [“as alleged here, [plaintiffs] [had] actual knowledge that [defendants] [were] not being entirely forthright”] [emphasis supplied]; see also Pappas, 20 NY3d at 233 [“plaintiffs’ own allegations make it clear that … reliance on [defendant’s] representations as a fiduciary would not have been reasonable”]; Arfa v Zamir, 17 NY3d 737, 738 [2011] [“By their own admission, plaintiffs [] had ample indication [] that defendant was not trustworthy”] [emphasis supplied].19 Moreover, a duty to exercise a heightened degree of diligence is not “necessarily triggered as soon as a plaintiff has the slightest ‘hints’ of any ‘possibility’ of falsehood.” DDJ Mgt., 15 NY3d at 155 [quoting with approval JP Morgan Chase Bank v Winnick, 350 F Supp 2d 393, 408 [SD NY 2004]). Rather, the representations must be “so transparently false [] that no reasonable [plaintiff] would have [entered into the transaction at issue] without conducting further 19 Indeed, in affirming the denial of a motion to dismiss, the First Department recently distinguished its own prior decision in HSH Nordbank AG v UBS AG, 95 AD3d 185 [1st Dept 2012] precisely because, unlike in that case or in this case, “the allegations of the complaint itself established that HSH could have uncovered any misrepresentation.” Basis Yield Alpha Fund (Master) v Goldman Sachs Group, Inc., 115 AD3d 128, 140 [1st Dept 2014] [emphasis supplied]; see also Allstate Ins. Co. v Credit Suisse Sec. (USA) LLC, 42 Misc 3d 1220(A), 2014 N.Y. Misc. LEXIS 428, * 42 [Sup Ct, New York County Jan. 24, 2014] [denying motion to dismiss and distinguishing HSH Nordbank for the same reason]. 31 inquiry into their accuracy.” DDJ Mgt., 15 NY3d at 156 [quoting with approval JP Morgan Chase Bank, supra, at 411]. Here, nothing in the complaint suggests that ACA had any reason to doubt the veracity of Goldman Sachs’s repeated and unequivocal representations that Paulson was the equity investor in ABACUS.20 To the contrary, because Paulson was the transaction sponsor, which customarily takes the equity in a CDO (Compl. ¶ 21 [R. at 139]), ACA had every reason to believe that Goldman Sachs’s representations were true. Moreover, Paulson’s undisclosed short position in ABACUS was a stark departure from the “basic assumption” in the financial industry that the people “putting deals together [] want the deal to succeed.” (Compl. ¶ 42 [R. at 145-146]). And as Goldman Sachs knew, Paulson reinforced the false impression that Paulson shared ACA’s long economic interest by objecting to certain RMBS on the purported basis that they were “too risky.” (Compl. ¶ 55 [R. at 150]).21 20 The majority’s factual determination that the offering circular “should have alerted” ACA that Paulson was not taking an equity position in ABACUS (Decision at 6 [R. at 821]) is incorrect and, in any event, does not satisfy the exacting standard for dismissal based on documentary evidence. See infra Argument, Section III.B. 21 As the SAC further alleges (SAC ¶ 44), Paulson agreed, in its own words, to “play the role” of the equity investor in ABACUS. 32 Accordingly, having sought and received unequivocal and apparently truthful representations from Goldman Sachs, both orally and in writing, ACA had no reason, much less any duty, to make any further inquiries. III. THE APPELLATE DIVISION ERRED IN HOLDING THAT THE COMPLAINT FAILS TO PLEAD REASONABLE RELIANCE AS A MATTER OF LAW In the Decision, the majority held that ACA cannot establish reasonable reliance as a matter of law because (i) ACA did not insert a “prophylactic provision” in a written agreement with Goldman Sachs, (ii) the offering circular “should have alerted” ACA that Paulson was not an equity investor, (iii) ACA “could have, upon further inquiry, uncovered [Paulson’s] actual position,” and (iv) disclaimers in the offering circular bar ACA’s fraud claims. As shown below, the majority is wrong on all counts. A. The “Prophylactic Provision” Requirement Is Contrary To Court of Appeals Authority The majority held that ACA cannot establish reasonable reliance as a matter of law because it failed to plead that it had “inserted the appropriate prophylactic provision [in a written agreement between the parties] to ensure against the possibility of misrepresentation.” (Decision at 2 [R. at 817]). In announcing this unprecedented rule, the majority stated that if sophisticated parties do not insert such a “prophylactic provision,” they forfeit the anti-fraud protections of New York law: 33 [B]ecause parties can seldom be certain that the representations made by other contracting parties are indeed true, they must -- lest their cause of action for fraud be barred -- insert the requisite prophylactic provision to ensure against the possibility of misrepresentation. (Decision at 5 (emphasis supplied) [R. at 820]).22 The majority cited (Decision at 4 [R. 819]) this Court’s decision in Centro Empresarial, supra, but that case is contrary to their holding. In Centro Empresarial, the plaintiffs alleged that the defendants had fraudulently induced them to sell their interest in a company by misrepresenting the value of the company. This Court affirmed the dismissal of the plaintiffs’ fraud claims on the ground, among others, that the plaintiffs had failed to plead justifiable reliance because the plaintiffs sold their interest in the company to the defendant “without demanding either access to the information [necessary to properly value that 22 The per se prophylactic provision requirement announced by the majority is not only legally unprecedented but also contrary to the customary reliance of sophisticated parties on extra-contractual representations in many commercial transactions, including the one at issue here. See, e.g., Syncora Guar. Inc. v Alinda Capital Partners LLC, 2013 N.Y. Misc. LEXIS 2943 [Sup Ct, New York County, Index No. 651258/2012, July 1, 2013] [noting that requiring a “prophylactic provision” would be contrary to “customary project finance documentation protocol”]. The difficulties the majority’s decision is causing in the trial courts is exemplified in Syncora. There, the trial court denied a motion to dismiss, attempting to distinguish the Decision on the ground, among others, that the Decision requires “prophylactic representations [only] from transactors, sellers of securities or assets,” not from “consultants, accountants, or other experts.” Id. at *27. There is no basis for such a distinction in the Decision, and the trial court did not point to one. 34 interest] or assurances as to its accuracy in the form of representations and warranties.” Id., 17 NY3d at 278 [emphasis supplied]. The Court thus made clear that inserting a “prophylactic provision” in a written contract between the parties is one way, but not the exclusive way, for a sophisticated party to satisfy its duty to exercise due diligence. See also DDJ Mgt., 15 NY3d at 155 [noting that, in National Conversion Corp. v Cedar Bldg. Corp., 23 NY2d 621 [1969], “we held that it was reasonable for the plaintiff to rely on a written representation as a substitute for making an investigation of the facts represented”] [emphasis supplied].23 The majority also assumed, contrary to the Record and the allegations in the complaint, that there was some existing written “agreement between the parties” in which ACA could have “insert[ed] the requisite prophylactic provision.” (Decision at 5 [R. at 820]). There was no written agreement at all between ACA and Goldman Sachs (or Paulson) concerning ABACUS. The relevant transaction 23 See also, e.g., Graham Packaging Co., L.P. v Owens-Illinois, Inc., 67 AD3d 465, 465 [1st Dept 2009] [plaintiff “should have at least inquired about such valuation or inserted a prophylactic provision in the settlement agreement to limit their exposure”] [emphasis supplied]; Global Mins. & Metals Corp. v Holme, 35 AD3d 93, 100 [1st Dept 2006] [“When a party fails to make further inquiry or insert appropriate language in the agreement for its protection, it has willingly assumed the business risk that the facts may not be as represented”] [emphasis supplied]; Rodas v Manitaras, 159 AD2d 341, 343 [1st Dept 1990] [when a party is on notice that representations might be false, it is unreasonable to rely on those representations without “securing the available documentation or inserting appropriate language in the agreement for his protection”] [emphasis supplied]. 35 -- the transaction that ACA alleges Goldman Sachs fraudulently induced it to enter into -- was the financial guaranty. (Compl. ¶ 62 [R. at 152]). At Goldman Sachs’s request (Compl. ¶ 61 [R. at 152]), Goldman Sachs was not a party to the financial guaranty. To the extent the majority’s holding requires that parties, who otherwise have no written contractual relationship, to enter into new written contracts containing a “prophylactic provision,” such a holding would be completely without precedent and would, in effect, extinguish any common law fraud claim asserted by a sophisticated party based on representations not contained in a formal agreement.24 B. The Offering Circular Does Not Even Hint, Much Less “Expressly Disclose,” That Paulson Was Not The Equity Investor The majority held that ACA cannot establish reasonable reliance as a matter of law because, it believed the offering circular for ABACUS notes “expressly disclosed” that no one was investing in the equity and therefore “should have alerted” ACA that, “contrary to [Goldman Sachs’s] representations,” Paulson was not taking an equity position in the transaction. (Decision at 6-7 [R. 821-22]). The 24 The cases cited by the majority (Decision at 2-6 [R. at 816-21]) all involved existing contracts between the parties. Centro Empresarial Cempresa S.A. v America Movil, S.A.B. de C.V., 76 AD3d 310, 311 [1st Dept 2010] [“the parties entered into a number of related agreements”]; Graham Packaging Co., L.P., 67 AD3d at 465 [the parties entered into a “settlement agreement”]; Permasteelisa, S.p.A. v Lincolnshire Mgt., Inc., 16 AD3d 352, 352 [1st Dept 2005] [the parties entered into a “purchase agreement”]. 36 offering circular more nearly means the opposite and is, at a minimum, ambiguous -- as evidenced by the conflicting interpretations articulated by the majority and dissenting opinions in the Decision, and the jury’s rejection of the majority’s interpretation in SEC v Tourre. The Decision is therefore contrary to Court of Appeals authority establishing that dismissal is “appropriately granted only where the documentary evidence utterly refutes plaintiff’s factual allegations, conclusively establishing a defense as a matter of law,” Goshen, 98 NY2d at 326, and is, thus, improper if there is any “ambiguity in the interpretation and effect” of the documentary evidence, Whitebox Concentrated, 20 NY3d at 64. The majority’s interpretation of the offering circular is contradicted by the circular itself. The majority relied on an entry in a chart in the offering circular, entitled “Notes,” which indicates that “$0” in “FL” (first loss a/k/a equity) notes would be issued (R. at 325). The majority mistakenly concluded that that entry meant that “no one was investing in the first-loss tranche” (Decision at 16 [R. at 831]). However, in the very same chart, there was an entry indicating “$0” in “SS” (super senior) notes. Under the majority’s interpretation, that meant that “no one was investing” in the super senior tranche. But that, of course, was not the case -- ACA itself was taking a $909 million position in the super senior tranche through a credit default swap. (Compl. ¶ 62 [R. at 152]). 37 What the majority ignored is that there were two ways to take positions in these tranches -- by purchasing notes or entering into a credit default swap. Credit default swaps (including ACA’s) were not recorded in the note offering circular chart relied on by the majority. The offering circular does not, therefore, “conclusively establish[] a defense as a matter of law.” Goshen, 98 NY2d at 326. The dissent thus correctly rejected the majority’s interpretation of the offering circular, concluding that it “does not imply that there was no equity investor or that ‘no one was investing in the first loss [i.e., equity] tranche’” (Decision at 16 [R. 831] (quoting the majority (id. at 6 [R. 821]). Indeed, as the complaint itself alleges (Compl. ¶ 18 [R. 138]), investors could invest in the equity through a credit default swap, which would not be reflected in an offering circular for notes (Decision at 16-17 [R. 831-32]). The majority nonetheless “reject[ed]” the dissent’s conflicting interpretation of the offering circular on the premise that, even if Paulson was taking an equity position in ABACUS through a credit default swap, that “funding mechanism . . . should have been listed in the offering circular.” (Decision at 7 [R. 822]). The majority’s assertion is incorrect, finds no support in the Record and raises, at a minimum, an issue of fact as to, among other things, whether it was customary in the industry to list in a note offering circular a value for a tranche covered not by notes, but by a credit default swap. In any event, the fact that a 5-justice 38 panel could not agree on the “interpretation and effect” of the offering circular demonstrates that it is, at a minimum, ambiguous -- i.e., “reasonably susceptible of more than one interpretation” (Chimart Associates v Paul, 66 NY2d 570, 573 [1986]) -- and, therefore, not a proper basis to dismiss the complaint. Whitebox Concentrated, 20 NY3d at 64. So too, the jury in SEC v Tourre, in finding Tourre liable for defrauding ACA and the district court in upholding the verdict, necessarily rejected the majority’s interpretation of the offering circular. Like the majority, Tourre asserted that the offering circular should have alerted ACA that Goldman Sachs’s representations were false. (Transcript of the trial in SEC v Tourre [“Trial Tr.”] at 99-100 [Dkt. No. 441] [“The official offering circular in ABACUS 2007-AC1 [shows] zero for equity”]; see also Trial Tr. at 2698-99 [Dkt. No. 463] [“There is an offering circular that says no [equity]”).25 In response, the SEC directly addressed and “put [] to rest” Tourre’s argument (Trial Tr. at 2750 [Dkt. No. 463]) -- by proving at trial -- precisely what the dissent pointed out here (Decision at 16- 17 [R. at 831-32]): “[equity] could be sold by notes or it could be sold by swaps.” (Trial Tr. at 2752 [Dkt. No. 463]). Consequently, “the fact that no equity notes were issued did not mean that there could not have been equity.” (Trial Tr. at 2756 25 The referenced transcript pages are available on the docket in SEC v Tourre through PACER at the docket numbers indicated. Upon request, ACA will submit copies of the referenced pages for the Court’s convenience. 39 [Dkt. No. 463]). Moreover, given that the offering circular showed zero for the super senior tranche -- even though ACA took a $909 million long position in that tranche (Compl. ¶ 62 [R. at 152]) -- no reasonable reader, let alone ACA itself, would understand the offering circular to mean that no one was taking the equity tranche. (Trial Tr. at 2751-52 [Dkt. No. 463]).26 C. Whether Paulson Would Have Disclosed The Truth If Asked Is A Factual Issue That Cannot Be Resolved On A Motion To Dismiss The majority held that ACA cannot establish reasonable reliance as a matter of law because ACA supposedly “could have, upon further inquiry, uncovered [Paulson’s] actual position, but apparently chose not to [ask Paulson].” (Decision at 6 [R. at 821]). The majority concluded -- with no basis -- that, if asked, Paulson “would have likely informed [ACA] that [Paulson] was taking a short rather than a long equity position [as] represented.” (Decision at 7 [R. at 822]) (emphasis supplied). In doing so, the majority erroneously ignored the allegations in the complaint compelling the opposite conclusion, and resolved a disputed issue of fact against ACA. See J.P. Morgan Sec. Inc., 21 NY3d at 334 [“the court must . . . 26 While reliance is not an element of the federal securities fraud claims in SEC v Tourre, the jury’s verdict in that case, and the district court’s decision upholding the verdict, necessarily are directly contrary to an essential (and incorrect) factual predicate of the majority’s holding here -- i.e., that the offering circular disclosed that no one was investing in the equity. 40 accept the facts alleged in the complaint to be true and afford the plaintiff the benefit of every possible favorable inference”]. Assuming for the sake of argument that ACA did have a reason or duty to ask Paulson to confirm Goldman Sachs’s unequivocal and apparently truthful representations -- which it did not (see supra Argument, Section II.B) -- there are no facts suggesting that Paulson “would have likely” disclosed its true role if ACA had also inquired directly of Paulson. To the contrary, the complaint alleges that Goldman Sachs and Paulson were working closely together and decided, before approaching ACA, that they needed to misrepresent Paulson’s role in order to convince other institutions to participate in the transaction. (Compl. ¶¶ 36, 37 [R. at 143-144]).27 Moreover, the economic interests of ACA and Paulson in the transaction were not, contrary to Goldman Sachs’s misrepresentations, “align[ed]” (Compl. ¶ 41 [R. at 145]) but indeed “exactly opposite” (id.). Thus, the inference to be drawn from the facts alleged -- an inference to which ACA is entitled on a motion to dismiss -- is that Paulson would not have been any more candid with 27 In the SAC, ACA further alleges, based on evidence produced by Goldman Sachs, that Goldman Sachs and Paulson conspired to conceal the very fact (SAC ¶¶ 50-56, 129-131) that the majority found Paulson “would have likely” disclosed if asked (Decision at 7 [R. at 822]). 41 ACA than Goldman Sachs had been. Black, 69 NY2d at 669 [whether a plaintiff “could have discovered the truth” is a question of fact].28 D. The Disclaimers Do Not Bar ACA’s Fraud Claims In the Decision, the majority held that ACA’s reliance on Goldman Sachs’s misrepresentations was unreasonable as a matter of law because of disclaimers in the offering circular, which state that purchasers of a “beneficial interest” in ABACUS notes are deemed to have represented that they were: “not relying (for purposes of making any investment decision or otherwise) upon any advice, counsel or representations (whether written or oral) of [Goldman Sachs] . . . other than in the final offering circular for [the transaction] and any representations expressly set forth in a written agreement with such party,” and that [Goldman Sachs] was not “acting as a fiduciary or financial or investment adviser for the purchaser” (Decision at 8 [R. 823] (quoting the offering circular [R. at 439]). It has been settled law for more than 50 years that only where a “plaintiff has in the plainest language announced and stipulated that it is not relying on 28 In Swersky v Dreyer & Traub, 219 AD2d 321, 327 [1st Dept 1996], which correctly applied this Court’s decision in Black, supra, a sophisticated plaintiff had not inquired of a source of information, but the First Department reversed dismissal of his fraud claim on the ground that it was unclear how much information the source had and also on the ground -- dispositive here -- that it was unclear, “given the alignment of economic interests, how candid he would have been . . . .” Id. at 327. “Since these are issues which require resolution by the trier of fact, summary dismissal of the [fraud] cause was improper.” Id. [citing Black, supra]. 42 any representations as to the very matter as to which it now claims it was defrauded” will a disclaimer bar a fraud claim. Danann Realty Corp. v Harris, 5 NY2d 317, 320 [1959] [emphasis supplied].29 Here, the boilerplate disclaimers in the offering circular -- i.e., that note purchasers were not relying on Goldman Sachs as a “fiduciary” or for “investment advice” (R. at 439) -- do not bar ACA’s fraud claims because they do not “track[] the particular misrepresentations and omissions alleged by [ACA].” Basis Yield Alpha Fund (Master), 115 AD3d at 138. Indeed, the offering circular contains no reference to Paulson whatsoever, much less a disclosure that Paulson had an economic incentive to select reference obligations that would default. (Compl. ¶ 25 [R. at 140]). In any event, the disclaimers in the offering circular are, by their express terms, inapplicable to ACA because ACA never purchased or owned any “beneficial interest” in ABACUS notes. (Offering circular at 115 [R. at 437]). Rather, ACAM purchased notes not on behalf of itself or ACA, but on behalf of 29 See also Basis Yield Alpha Fund (Master), 115 AD3d at 137 [“The law is abundantly clear in this state that a buyer’s disclaimer of reliance cannot preclude a claim of justifiable reliance on the seller’s misrepresentations or omissions unless [] the disclaimer is made sufficiently specific to the particular type of fact misrepresented or undisclosed”] [citing Danann, supra]; Loreley Fin. (Jersey) No. 3 Ltd., 2014 N.Y. App. Div. LEXIS 3300, *13-14 [following Basis Yield Alpha Fund (Master)and affirming denial of motion to dismiss where disclaimers “[fell] well short of tracking the particular misrepresentations and omissions alleged by plaintiff”]. 43 three CDO’s it managed. (R. at 601-03).30 Thus, the disclaimers do not bind ACA at all, much less bar ACA’s fraud claims. Steinhardt Group, Inc. v Citicorp, 272 AD2d 255, 257 [1st Dept 2000] [non-party not “bound by disclaimer” in agreement].31 30 Thus, Tourre testified at trial in SEC v Tourre that trade confirmations proffered by Goldman Sachs (Compare R. at 603 with Dkt. 194-26 in SEC v Tourre) reflect the sale of ABACUS notes to “CDOs managed by ACA,” not ACA. (Trial Tr. at 2191 [Dkt. 457]; see also id. at 2194-95 (confirming that the “only purchasers of notes in [ABACUS] were ACA-managed CDOs and [a third party]”) (emphasis supplied)). 31 There are no such disclaimers in the financial guaranty (Compl. ¶ 62 [R. at 152]), which is a “distinct obligation.” National Union Fire Ins. Co. v Robert Christopher Assocs., 257 AD2d 1, 6 [1st Dept 1999]. 44 CONCLUSION For the foregoing reasons, the Decision should be reversed and ACA’s fraud claims against Goldman Sachs reinstated. Dated: New York, New York July 1, 2014 Respectfully submitted, KASOWITZ, BENSON, TORRES & FRIEDMAN LLP By: Marc E. Kasowitz Daniel R. Benson Andrew K. Glenn Trevor J. Welch Kara F. Headley 1633 Broadway New York, New York 10019 (212) 506-1700 (212) 506-1800 (fax) Attorneys for Plaintiff-Appellant ACA Financial Guaranty Corp.