Suez Equity Inv. v. Toronto-Dominion Bank

Decision Date01 August 1999
Citation250 F.3d 87
CourtU.S. Court of Appeals — Second Circuit

Defendants persuaded plaintiffs to invest in enterprise in which defendants already had a large financial stake. The enterprise soon failed. Plaintiffs brought federal securities and state negligence and fraud claims against defendant, alleging that defendants had concealed various adverse facts concerning background of enterprise's CEO. The district court dismissed the complaint, holding that (1) plaintiffs had not alleged loss causation; (2) plaintiffs had not alleged scienter; (3) plaintiffs had not alleged a "special relationship" to support negligent misrepresentation claim; and (4) plaintiffs had not alleged elements of common law fraud.

Affirmed in part, vacated in part, and remanded.

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[Copyrighted Material Omitted] William F. McCARTHY, Boston, Massachusetts (Michele T. Perillo, D. Ross Martin, Ropes & Gray, Boston, Massachusetts, of counsel), for Plaintiffs-Appellants.

David J. Woll, New York, New York (Nancy L. Swift, Simpson Thacher & Bartlett, New York, New York, of counsel), for Defendants-Appellees The Toronto-Dominion Bank, Toronto Dominion (Texas), Inc., Toronto Dominion Capital (usa), Inc., Toronto Dominion Investments, Inc., Toronto Dominion Securities (usa), Inc., Toronto Dominion Holdings (usa), Inc., and Eric D. Rindahl.

Susan E. Brune, New York, New York (Laurie Edelstein, Nina M. Beattie, Brune & Richard LLP, New York, New York, of counsel), for Defendant-Appellee Philip DeRoziere.

Before: Walker, Chief Judge, Cardamone, and Miner, Circuit Judges.

Cardamone, Circuit Judge

This appeal arises out of defendants' invitation to plaintiffs to invest in the ill-fated SAM Group, a health-care financing venture. Plaintiffs allege that defendants discouraged them from inquiring into the background of SAM Group's principal, J. Christopher Mallick, and instead provided them with what was purportedly the report of an independent investigator who had performed a background check on Mallick, but was in fact a modified version of that report with adverse information deleted. Plaintiffs thereafter invested in SAM Group in reliance on the modified report. When SAM Group subsequently failed financially, this securities fraud litigation ensued.


SAM Group, whose securities are at the center of this suit, comprises seven business entities that purchase and finance the accounts receivable of health care providers. The Toronto-Dominion Bank invested $3.35 million in SAM Group in April 1996 through its affiliate Toronto Dominion Investments. Over the next several months, Toronto Dominion Investments and the Toronto-Dominion Bank, acting through another affiliate, Toronto Dominion (Texas) Inc., invested further in SAM Group, and by October 1996, their total investment had grown to over $11 million. The Toronto-Dominion Bank allegedly controlled both Toronto Dominion Investments and Toronto Dominion Texas through its subsidiary Toronto Dominion Holdings (USA) Inc., which is parent to both entities.

In October 1996 the Toronto-Dominion Bank approached plaintiffs, Suez Equity Investors, L.P. and SEI Associates, through its subsidiary Toronto Dominion Capital (USA) Inc. with the proposal that plaintiffs invest in SAM Group. We will not repeat the phrase "Toronto-Dominion" in front of each corporate entity throughout this opinion, but will instead refer to these separate corporations as "Bank," "Investments," "Texas," "Holdings," "Capital," and "Securities" (for Toronto Dominion Securities (USA), Inc.).

SAM Group retained Capital as its agent in selling securities to plaintiffs. Capital provided plaintiffs with information about SAM Group through, among others, its employee and co-defendant Eric D. Rindahl. Defendant Philip DeRoziere allegedly acted for the Bank in the sale. In late 1996 plaintiffs informed defendants that they would like to commission background reports on five SAM Group principals, including Mallick, who was SAM Group's founder, principal executive, and controlling shareholder. Mallick and the defendants, including Rindahl, objected to having such reports prepared as an unnecessary expense and proposed that plaintiffs instead accept a copy of a prior background check DeRoziere had obtained on behalf of the Bank (Original Bishops Report) in August 1995. Rather than providing plaintiffs with the Original Bishops Report, however, defendants furnished a modified version of it (Modified Report) with a cover memorandum describing the Modified Report as a "report of the result of investigations performed by Bishops Services, Inc. on SAM Group principals." 2d Am. Compl. ¶ 61. The Modified Report was delivered to plaintiffs between December 13, 1996 and January 2, 1997. DeRoziere had originally distributed the Modified Report to various entities in September 1995 after the receipt of the Original Bishops Report by a financial rating agency had prompted a request for more information about Mallick's bankruptcy and other events in his past.

Unlike the Original Bishops Report, the Modified Report omitted negative events in Mallick's business and financial history. Specifically, the Modified Report stated that: (1) no bankruptcy filings were found for Mallick, while the Original Bishops Report had described in some detail his involuntary Chapter 7 bankruptcy arising out of personal guarantees on business debts; (2) no pending civil suits were found for any individual subjects being investigated, but the Original Report had identified three civil suits filed against Mallick; and, omitted mention: (3) of a 1993 suit brought against Mallick by a gemstone business, in which he had been a joint venturer, where plaintiff sought the repayment of $250,000 borrowed from the business; (4) of three tax liens against Mallick personally, including one in the sum of $30,475, as well as a $3,233 tax lien against SAM Group's predecessor, which derived from $78,000 of unpaid federal taxes in the 1980s and $400,000 in the 1990s; and (5) of (a) several lawsuits that had been decided against Mallick, (b) his delinquent credit accounts, and (c) a critical comment made about him by a third party.

In a conference call on January 2, 1997, the defendants, including DeRoziere, stated that the Bank had conducted extensive due diligence on Mallick before investing in SAM Group and that the investigation had yielded positive comments. Defendants did not reveal that the Modified Report plaintiffs received was not the original report prepared as part of due diligence. On February 14, 1997 plaintiffs purchased $3 million in SAM Group debt and equity securities.

Defendants' substantial loans to SAM Group reflected the Group's liquidity problems, which the complaint attributes to Mallick's inability to manage the Group's finances effectively. When plaintiffs invested in the Group, "Mallick had put SAM Group in a financial position in which SAM Group had no chance to succeed [because it] had no access to working capital." Id. ¶ 67. As a result, plaintiffs' SAM Group securities were at the time of acquisition -- and are today --worthless. Within seven weeks of plaintiffs' investment, SAM Group suffered a cash flow crisis from which it did not recover.

Plaintiffs attribute that failure to Mallick's lack of "sound business, financial management and organizational skills, sound judgment, character, honesty, commitment and diligence." Id. ¶ 86. They contend that the business of SAM Group was "one involving sophisticated manipulation and control of finances," requiring the "leadership of a person who knew how to manage a debt load." Id. ¶ 66. In support of the importance they attached to the attributes of the individual who was to lead the Group, they note that their investment agreement required the Group to obtain $10 million of "key-man" life insurance payable in the event of Mallick's death.

On January 23, 1998 plaintiffs filed the instant suit in the United States District Court for the Southern District of New York before Judge Kimba M. Wood. Later they filed an amended complaint, alleging violations of Securities Exchange Act § 10(b), 15 U.S.C. § 78j(b) (1994); Rule 10(b)(5), 17 C.F.R. § 240.10b-5 (2000); and Securities Exchange Act § 20, 15 U.S.C. § 78t (1994), and asserting state law causes of action for common law fraud and negligent misrepresentation. On January 15, 1999 the district court dismissed the amended complaint under Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995 (Litigation Reform Act), 15 U.S.C. § 77a et seq. (Supp. IV 1998), but granted plaintiffs leave to replead. Plaintiffs filed a second amended complaint, which was dismissed on August 5, 1999 on the same grounds as the amended complaint. From the dismissal of their second amended complaint, plaintiffs appeal.


Three major issues are presented. First, do the allegations that defendants misled plaintiffs as to the background of SAM Group's principal suffice to allege loss causation? Second, have the plaintiffs alleged scienter? Third, have the plaintiffs alleged a "special relationship" sufficient to support a negligent misrepresentation claim under New York law? We analyze these issues in order in the discussion that follows.

The district court's dismissal was based on its view that plaintiffs had failed to state a claim and had failed to plead fraud with particularity....

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