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Second Circuit Affirms Dismissal Of Fraud Claims For Hypothetical Lost Profits
08/15/2016On August 5, 2016, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of common law fraud and negligent misrepresentation claims against Citigroup, Inc. AHW Investment Partnership v. Citigroup, Inc., No. 13-4488 (2d Cir. Aug. 5, 2016). In a summary order, the Court held that plaintiffs may only recover for actual pecuniary losses sustained as the direct result of fraud, and not for hypothetical value plaintiffs may have realized by selling a stock before its price plummeted. Plaintiffs had alleged that Citigroup and its officers made numerous fraudulent and negligent misrepresentations about the quality of plaintiffs’ investment in Citigroup between May 2007 and March 2009, causing plaintiffs to hold their Citigroup shares and incur losses of $800 million when the company’s stock price subsequently declined.
The Court first weighed whether New York or Florida law should be used to determine the types of damages recoverable under a fraud claim, and whether, with respect to a negligent misrepresentation claim, plaintiffs must allege a “special relationship” to defendants. Finding that rules at issue for the fraud and negligent misrepresentation claims were “conduct-regulating,” the Court held that the law of the state where the allegedly wrongful conduct transpired governs—here, New York, where Citigroup is headquartered and the misrepresentations were allegedly made.
Addressing the merits of the underlying claims, the Court affirmed the District Court’s dismissal of the fraud claim, holding that “recovery is limited to the actual pecuniary loss sustained as the direct result of the wrong” and not “the value [plaintiff] might have realized from selling its shares during a period when it chose to hold” the securities. Relying on Starr Foundation v. American Int’l Grp, Inc.—a 2010 New York Appellate Division First Department decision holding that investors in AIG could only recover for actual losses, and not profits they may have realized by selling AIG shares, because the damages under the latter were “too undeterminable and speculative”—the Second Circuit ruled that plaintiffs’ allegations could not “sustain[] a fraud cause of action that . . . seeks recovery for the loss of the value that might have been realized in a hypothetical market exchange that never took place.”
The Court rejected plaintiffs’ attempt to side-step the effects of Starr through a damages calculation based on the “fraud-free price” for Citigroup shares in May 2007. Plaintiffs argued that the Court may calculate damages by looking to a hypothetical stock price for Citigroup in May 2007, which would reflect what Citigroup’s stock price would have been had it fully disclosed its financial troubles. Not persuaded by this argument, the Court found that plaintiffs’ fraud claims were barred under Starr and noted that plaintiffs “[c]loaking [their] arguments in the mantle of pricing expertise does not alter the fact that Plaintiffs’ use of the ‘fraud-free price’ is, in essence, still an effort to recover the value [they] might have realized from selling [their] shares . . . under hypothetical market conditions.” The Court also affirmed the dismissal of the negligent misrepresentation claim, noting that plaintiffs “conceded that they cannot successfully assert a negligent misrepresentation claim against Citigroup under New York law because they did not have a ‘special or fiduciary relationship’ with Citigroup.”
The Court did note, however, that it took “no position on whether other types of holder claims, such as those seeking damages other than lost profits, may be cognizable under New York law.”
