TERRA SECURITIES ASA KONKURSBO v. Citigroup, Inc., 09 Civ. 7058(VM).

• Decision Date: 17 February 2010
• Docket Number: No. 09 Civ. 7058(VM).,09 Civ. 7058(VM).
• Citation: 688 F. Supp.2d 303
• Parties: TERRA SECURITIES ASA KONKURSBO, et al., Plaintiffs, v. CITIGROUP, INC., et al., Defendants.
• Court: U.S. District Court — Southern District of New York

688 F.Supp.2d 303

TERRA SECURITIES ASA KONKURSBO, et al., Plaintiffs, v. CITIGROUP, INC., et al., Defendants.

No. 09 Civ. 7058(VM).

United States District Court, S.D. New York.

February 17, 2010.

Marc E. Kasowitz, John Charles Canoni, Michael Matthew Fay, Charles Matthew Miller, Kasowitz, Benson, Torres & Friedman LLP, New York, NY, for Plaintiffs.

Brad Scott Karp, John Frederick Baughman, Susanna Michele Buergel, Alastair Wood, Daniel H. Levi, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, NY, for Defendants.

DECISION AND ORDER

VICTOR MARRERO, District Judge.

Plaintiffs Terra Securities ASA Konkursbo ("Terra") and seven Norwegian municipalities—Bremanger, Hattfjelldal, Hemnes, Kvinesdal, Narvik, Rana and Vik (the "Municipalities") (collectively, "Plaintiffs") filed a complaint in this action, dated August 10, 2009 (the "Complaint"), naming as defendants Citigroup, Inc. ("Citigroup"), Citigroup Global Markets, Inc. ("CGM New York") and Citigroup Alternative Investments LLC ("CAI")—(collectively, "Defendants"). Plaintiffs assert securities fraud claims under § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) ("§ 10(b)"), Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), as well as common law fraud and negligent misrepresentation claims. Defendants now move to dismiss Plaintiffs' claims, asserting that the Court lacks subject matter jurisdiction pursuant to Federal Rule of Civil Procedure 12(b)(1) ("Rule 12(b)(1)") or, alternatively, that New York is not a convenient forum for the litigation of this matter.¹

For the reasons stated below, Defendants' motion to dismiss is DENIED.

I. BACKGROUND²

In May and June of 2007, Defendants sold over $115 million in securities to the Municipalities through Terra, a Norwegian securities firm. The securities constituted notes linked to the Citi Tender Option Bond Fund (the "Fund"), a Cayman Island fund managed by CAI, a unit of CGM New York. Plaintiffs assert that the fund-linked notes ("FLNs") were structured and arranged by CGM New York and managed by CAI, and the FLNs were issued by two different European entities, Starling Finance P.L.C. and Banque AIG, for trading on the Irish Stock Exchange.

Beginning in or about April 2007, Defendants marketed the FLNs to the Municipalities. Plaintiffs allege that Defendants, through its affiliate Citigroup Capital Markets Ltd. ("CGM London"), materially misrepresented that the FLNs were safe, conservative investments. Plaintiffs point primarily to a presentation entitled "Citigroup Municipal Investors: TOB Capital Municipal Portfolio" ("Presentation I"), prepared by CGM New York in New York, and distributed to Terra for presentation to the Municipalities by CGM London or another Europe-based Citigroup entity.³ Presentation I contains the CAI logo on every page, represents that two New York-based Citigroup employees, Craig Henick ("Henick") and Edward Sun, are the "Senior Portfolio Managers" of the Fund, and states that the Fund would be managed by a "highly experienced team spinning out of Citigroup's proprietary municipal bond trading desk to establish a fund within CAI." (Complaint ¶ 31; Declaration of Jon E. Skjorshammer ("Skjorshammer"), dated October 14, 2009 ("Skjorshammer Decl."), Ex. D.) Plaintiffs assert that Defendants insisted that Terra provide Presentation I to the Municipalities and that Terra did so at their insistence.

Presentation I marketed the Fund to municipal investors by describing the Fund's investment strategy, detailing its structure, and purporting to demonstrate the historical performance of municipal yields hedged with interest rate swap agreements. Presentation I described the Fund's investment strategy as an arbitrage opportunity for investors, whereby the Fund takes advantage of the relative steepness of the long-term municipal yield curve—the spread between long-term and short-term rates on municipal bonds. Specifically, Presentation I represented that the net amount long-term municipal bonds pay over the cost of lending short term (the "Arbitrage") was consistent over time. The Arbitrage would accumulate in the Fund and be distributed to investors.

Plaintiffs assert that the Fund, no matter the value of the Arbitrage, posed a risk for any investor and thus Defendants also used Presentation I to explain the Fund's hedging strategy. Presentation I explained how the Fund hedged against a drop in municipal bond values with interest rate swap agreements. Defendants represented that if the long-term municipal bonds dropped in value, the swap agreements would increase in value by an equal amount, thereby keeping the market value of the Fund stable. To market this hedging strategy, Presentation I contained graphs demonstrating the historically strong relationship between municipal bond rates and the London Interbank Offered Rate ("LIBOR"), the benchmark rate used for the interest rate swap agreements. Presentation I represented that the municipal bond and LIBOR rates had a near perfect correlation and that this correlation held even during periods of economic downturn, when short-term instruments typically pay more than long-term instruments.

Plaintiffs allege that Defendants' representations in Presentation I regarding the historically high correlation between municipal and LIBOR rates were material misstatements upon which they relied in deciding to invest in the FLNs. Plaintiffs contend that Defendants intentionally or recklessly focused on the relationship between levels of municipal and LIBOR interest rates instead of on the rates of change in those interest rates, and also ignored fundamental rules of statistical analysis. Defendants thereby misrepresented the statistical relationship between the rates and the riskiness of investment in the FLNs.

Within a few months after the Municipalities invested in the FLNs, the FLNs lost significant value. In August 2007, when the value of the FLNs was collapsing, Terra requested a meeting with Henick. In September and October 2007, Terra representatives met with Henick, among others, in New York.

Further, in late 2007 or 2008, CGM New York prepared a presentation addressing information requested by Terra entitled "Citigroup Municipal Investors, Customer-Requested Information for Terra" ("Presentation II"). Plaintiffs assert that Presentation II revealed that, prior to Plaintiffs' investment in the FLNs, Defendants had fraudulently withheld information showing the Fund's pro forma mark-to-market valuation from 2000 to 2007. Presentation II contained a graph showing the Fund's putative mark-to-market valuation before the Fund's inception in May 2006. The graph showed that the Fund would have suffered significant asset-value volatility over that time period, and Plaintiffs allege that this variation should not have occurred if the municipal and LIBOR rates were as highly correlated as represented in Presentation I. Plaintiffs assert that based on the data contained in Presentation II, the value of an investment in the Fund would have dropped by ten or more percent on six occasions between 2000 to 2007.

Plaintiffs acknowledge that Presentation I included the caveat that municipal bonds may underperform or outperform LIBOR hedges for several reasons and thus cause mark-to-market volatility, but nonetheless assert that Presentation I misrepresented the risk inherent in a Fund investment. Plaintiffs rely on the following statement, which directly followed the caveat described above: "These dislocations can cause mark-to-market volatility in a hedged municipal position, but they can also present relative value opportunities for skilled value managers." (Complaint ¶ 42.) Plaintiffs allege that Defendants' failure to provide an accurate portrayal of the pro forma mark-to-market volatility of the Fund prior to their investment in the FLNs constituted a material omission of fact.

Lastly, Plaintiffs allege that Presentation I fraudulently omitted the credit risk inherent in an FLN investment. Plaintiffs assert that municipal bonds are subject to credit risk, both related to the performance of the municipalities themselves and the possibility that the insurers of municipal debt offerings falter. Because Presentation I contains only boilerplate risk factors, Plaintiffs assert that Defendants also materially misrepresented this risk component of investment in the FLNs.

II. DISCUSSION

A. SUBJECT MATTER JURISDICTION

In reviewing the motion to dismiss, the Court will first address grounds that challenge its subject matter jurisdiction because, absent authority to adjudicate, the Court lacks a legal basis to grant any relief, or even consider the action further. See Makarova v. United States, 201 F.3d 110, 113 (2d Cir.2000); Can v. United States, 14 F.3d 160, 162 n. 1 (2d Cir.1994) ("In most instances the question whether a court has subject-matter jurisdiction is, conventionally and properly, the first question a court is called on to consider.").

1. Legal Standard

The inquiry on a motion to dismiss for lack of subject matter jurisdiction under Rule 12(b)(1) concerns whether the district court has the statutory or constitutional power to adjudicate the case. See Makarova, 201 F.3d at 113. "Jurisdiction must be shown affirmatively, and that showing is not made by drawing from the pleadings inferences favorable to the party asserting it." Shipping Fin. Servs. Corp. v. Drakos, 140 F.3d 129, 131 (2d Cir.1998). "A plaintiff asserting subject matter jurisdiction has the burden of proving by a preponderance of the evidence that it exists." Makarova, 201 F.3d at 113. The preliminary showing that must be made by the plaintiff, however, is not meant to be overly burdensome, "allowing for subject matter jurisdiction so long as the `the federal claim is colorable.'" Cromer Fin. v. Berger, 137 F.Supp.2d 452, 467 (S.D.N.Y. 2001) (quoting Savoie v. Merchants Bank,...