A federal district court has ruled that plaintiffs in a securities fraud action against an investment fund and its advisors sufficiently pleaded claims under Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5. The action arose out of an investment plaintiffs made in the defendant fund, which was organized to make loans to a property development company pursuant to a revolving line of credit. The property development company subsequently defaulted on the loans, causing the investment fund to sustain losses.  

In denying defendants’ motion to dismiss, the court held that plaintiffs’ allegations concerning the individual defendant’s “close familial ties” to the development company, as well as defendants’ receipt of a $300,000 placement fee, were sufficient to demonstrate a strong inference of scienter. Analyzing the complaint’s allegations under the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues and Rights, Ltd., 551 U.S. 308 (2007), the court found that the inference that the individual defendant knew of the precarious financial condition of the property development company at the time he solicited plaintiffs to invest was at least as compelling as any other inference that could be drawn.  

In addition, the court held that even if the allegations concerning the individual defendant’s familial ties and the placement fees defendants received did not give rise to a strong inference of scienter, plaintiffs’ allegations that defendants failed to do “any” due diligence with respect to the property development company prior to recommending the investment to plaintiffs were adequate to plead scienter. In support of their allegations, plaintiffs cited a letter in which defendants boasted “of a ‘high level’ of collateral” with respect to the loans, when, it was revealed just a few months later, that there was, in fact, “no collateral.” The court held that, under the circumstances, the alleged lack of collateral alone gave rise to a strong inference of scienter. (Kahn v. Ran, 2009 WL 1138504 (E.D. Mich. Apr. 27, 2009))