A New York State trial court recently dismissed claims by the holders of variable life insurance policies, some of whose excess cash value was invested with Bernard Madoff’s securities firm, against various investment advisors and hedge fund managers.  The decision is SSR II, LLC v. John Hancock Life Insurance Company, et al., No. 652793/2011 (N.Y. Sup. Ct. – N.Y. Co. – Sept. 28, 2012).  A copy is available here.

Given the total lack of privity between the plaintiffs, on the one hand, and the investment advisors and fund managers, on the other, the court’s decision appears correct with respect to the claims for negligence and breach of fiduciary duty.  The policyholders dealt with the life insurers who issued the variable life policies, and the life insurers in turn dealt the advisers and fund managers, strictly in accordance with directions they received from the policyholders.

With respect to both common law and statutory fraud claims, the court held that the policyholders had failed to plead scienter – that is, the requisite intent to defraud.  The investment advisors and fund managers had an incentive to earn a profit; but, the court affirmed, that alone was insufficient to prove an intent to defraud.  Citing the similar case of Prickett v. New York Life Insurance Company, No. 09-cv- 3137 (S.D.N.Y. Sept. 11, 2012), the court held that the policyholders’ claims were essentially an example of impermissible “allegations of fraud by hindsight.”  Many of the so-called “red flags” identified by the policyholders were plainly disclosed in the relevant offering materials.

Accordingly, the court concluded that it would be improper to hold the investment advisors and fund managers liable for their failure to detect Madoff’s fraud.  Citing favorably to dicta in another Madoff case recently decided by the Second Circuit, the New York court noted that the more compelling inference as to why Madoff’s fraud went undetected for two decades was Madoff’s “proficiency in covering up his scheme and deceiving the SEC and other financial professionals.”

The New York decision is welcome news to carriers who insure investment advisors and fund managers.