On March 27, 2012, the Appellate Division, First Department issued its opinion in HSH Nordbank AG v. UBS AG, which reversed the lower court’s denial of a motion to dismiss the fraud claim. HSH Nordbank alleged that UBS induced it to enter a credit default swap transaction by misrepresenting the risk HSH Nordbank would assume – the risk of default in a $3 billion securities portfolio “comprised predominantly of assets linked to the United States real estate market (for example, mortgage-backed securities and instruments issued by real estate investment trusts).”   The Appellate Division found that HSH Nordbank, as a sophisticated party, could not plead justifiable reliance because it had failed to “exercise ordinary diligence” and “conduct an independent appraisal of the risk [it was] assuming.”  The court wrote:

By no means do we suggest that UBS, if it engaged in the sharp dealing alleged by HSH, is to be commended; such practices are indeed troubling. Still, however much UBS’s alleged conduct leaves to be desired as a matter of business ethics, the undisputed documentary evidence and HSH’s own allegations eliminate, as a matter of law, any reasonable inference that HSH justifiably relied on the representations of which it now complains. To sustain HSH’s fraud cause of action, we would have to ignore the fact that the amended complaint—assuming the truth of its allegations—does not allege that UBS misrepresented any material existing fact as to which HSH could not have learned the truth had it conducted (or hired a consultant to conduct on its behalf) an independent appraisal of the risks of the NS4 transaction. We would also have to close our eyes to HSH’s sophistication; to HSH’s disclaimer of reliance on UBS for advice or on any extracontractual representations; to the detailed and specific disclosures of risk and conflict of interest in the transactional documents; to HSH’s ability to protect itself through the exercise of due diligence; and to the availability to HSH of appropriate relief (if any) under the rubric of its claim for breach of contract. Indeed, if we were to affirm the denial of the motion to dismiss this fraud claim, we would be judging the sufficiency of a claim asserted by a € 140 billion commercial bank by a standard more lenient than the one by which this Court has judged similar claims made by individual investors against their retail brokers (see e.g. Matter of Dean Witter Managed Futures Ltd. Partnership Litig., 282 A.D.2d 271 [2001] ). Such a result would put in question whether any set of disclaimers and disclosures, no matter how detailed and specific, affords protection against a fraud claim—even a claim by a commercial entity of a high degree of sophistication, and with the resources to hire any outside help it needs—concerning matters subject to discovery through due diligence, and as to which the claimant agreed that it was not relying on the party sitting across the table.

This decision is an important one for fraud jurisprudence in the post-financial crisis world.  Many of the cases winding their way through the courts involve claims by sophisticated parties, such as monoline insurers, that they were duped into investing in or insuring risky mortgage-backed securities.  Many of these complaints rely on sampling to illustrate the poor performance of the mortgages in the pools.  The HSH Nordbank decision suggests that sampling and other diligence should take place before entering into the deal.  On May 1, 2012,  a decision from Justice O. Peter Sherwood held that a monoline insurer wishing to plead fraud must do just that.

In CIFG Assurance North America v. Goldman Sachs & Co., plaintiff CIFG alleged that Goldman Sachs induced it to insure a securitization created by Goldman.  Defendant M&T Bank was the underwriter for the mortgages backing the securitization.   The court dismissed fraud claims against both defendants on the ground that plaintiff CIFG failed to show justifiable reliance.  The court held, as to M&T, that

Because CIFG cannot show detrimental reliance, its fraud-related claim against M&T Bank must fail. CIFG acknowledges in its complaint that while it conducted due diligence as to certain aspects of the transaction, it made a decision not to conduct a review of the underlying loans as a cost avoidance measure. However, as M&T Bank notes, if the misrepresentations in such loans was as pervasive as CIFG asserts, then CIFG would have discovered the misrepresentations had it conducted a review of sample loans, similar to what CIFG later hired Opus to do.


As a sophisticated party involved in an arms length transaction, CIFG had a duty to undertake an independent due diligence review of the risks associated with the guaranty it sold, including, at the very least, a review of a sample of the underlying mortgage loans which would have revealed the problems in such loans. Having failed to do so, CIFG cannot now be heard to claim that it justifiably relied to its detriment on M&T Bank’s representations.

The court dismissed the fraud claim against Goldman Sachs under the same theory, holding that”[h]ad CIFG conducted proper due diligence prior to writing the insurance, it would have uncovered the alleged misrepresentations about which it now complains.”

Interestingly, Justice Sherwood reached this result without citation to HSH Nordbank, which had been decided during the briefing of CIFG v. Goldman Sachs. In a footnote, the court acknowledge that counsel had submitted the HSH Nordbank decision to the court via letters, but that under Commercial Division Rule 19, sur-reply papers – including correspondence – require advance permission, which was not sought in this case.  Thus, the court did not consider the submissions on HSH Nordbank.  Otherwise, Justice Sherwood allowed contract claims to proceed against Goldman, and dismissed M&T Bank from the action.

For further discussion regarding these decisions, please see NY appeals court raises bar for sophisticated investors; UBS Wins Dismissal of Fraud Claim in HSH Nordbank Suit; Goldman Sachs Wins Dismissal of Some Claims in CIFG Suit.