Terra Sec. Asa Konkursbo v. Citigroup, Inc.
| Decision Date | 16 August 2010 |
| Docket Number | No. 09 Civ. 7058 (VM),09 Civ. 7058 (VM) |
| Citation | 740 F.Supp.2d 441 |
| Parties | TERRA SECURITIES ASA KONKURSBO, et al., Plaintiffs, v. CITIGROUP, INC., et al., Defendants. Banca Carige S.P.A.—Casa Di Risparmio Di Genova E Imperia, et al., Plaintiffs, v. Citigroup Inc., et al., Defendants. |
| Court | U.S. District Court — Southern District of New York |
Marc E. Kasowitz, Charles Matthew Miller, John Charles Canoni, Michael Matthew Fay, Kasowitz, Benson, Torres & Friedman LLP, New York, NY, for Plaintiffs.
Brad Scott Karp, John Frederick Baughman, Susanna Michele Buergel, Daniel H. Levi, Paul, Weiss, Rifkind, Wharton & Garrison LLP, Alastair Wood, Paul, Hastings, Janofsky & Walker LLP, New York, NY, for Defendants.
DECISION AND ORDER
Plaintiffs Terra Securities ASA Konkursbo ("Terra") and seven Norwegian municipalities—Bremanger, Hattfjelldal, Hemnes, Kvinesdal, Narvik, Rana and Vik (the "Municipalities")—filed an amended complaint in this action, dated March 15, 2010 (the "Terra Complaint"), naming as defendants Citigroup, Inc., Citigroup Global Markets, Inc., Citigroup Alternative InvestmentsLLC, and Citigroup Financial Products, Inc. (collectively, "Defendants"). Terra and the Municipalities 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 ("§ 20(a)"), 15 U.S.C. § 78t(a), as well as common law fraud and negligent misrepresentation claims.
On April 20, 2010, Banca Carige S.P.A.—Cassa Di Risparmio Di Genova E Imperia, Carige Vita Nuova S.P.A., and Carige Assicurazioni S.P.A. (collectively, "Banca Carige", together with Terra and the Municipalities, "Plaintiffs"), filed a complaint (the "Banca Carige Complaint") asserting nearly identical securities and common law fraud claims against Defendants arising out of underlying events and operative facts substantially similar to those asserted in the Terra Complaint.
Defendants now move to dismiss the Terra and Banca Carige Complaints pursuant to Federal Rule of Civil Procedure 12(b)(6) ("Rule 12(b)(6)"), asserting that Plaintiffs fail to state a claim upon which relief can be granted.
For the reasons stated below, Defendants' motion to dismiss the Terra Complaint is GRANTED in part and DENIED in part, and the motion to dismiss the Banca Carige Complaint is GRANTED.
Terra and the Municipalities filed this action in August 2009. In October 2009, Defendants moved to dismiss the original complaint on subject matter jurisdiction and forum non conveniens grounds. By Decision and Order dated February 16, 2010 (the "February 2010 Decision"), the Court denied Defendants' motion.2 Thereafter, Terra and the Municipalities filed the amended Terra Complaint, dated March 15, 2010.
As noted above, the Banca Carige Complaint was filed in April 2010, alleging claims substantially similar to those brought in the Terra Complaint. By Order dated May 4, 2010, the Court consolidated the two actions, and Defendants now move to dismiss both the Terra and Banca Carige Complaints for failure to state a claim under Rule 12(b)(6).
The operative facts and events underlying the Terra Complaint are largely set forth in the February 2010 Decision, familiarity with which is assumed. Here, the Court will briefly review additional facts relevant to this motion to dismiss, as well as factual background and allegations derived from the Banca Carige Complaint.
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 fund-linked notes ("FLNs") linked to theCiti Tender Option Bond Fund (the "Citi TOB Fund"). The FLNs were arranged by Defendants, issued by Banque AIG and Starling Finance, PLC, and purchased by Terra "for the benefit of the investing Municipalities." (Terra Complaint ¶ 58.)
Similarly, in or around January 2007, Defendants sold 10 million euros worth of FLNs linked to Defendants' Offshore Tender Option Bond Fund (the "Offshore TOB Fund," together with the Citi TOB Fund, the "Funds") to Banca Carige, and entered into a fund-linked "Total Return Swap" (the "TRS") agreement with Banca Carige.
In or about April 2007, Defendants began marketing the FLNs to the Municipalities through Terra. In May and June of 2007, Terra entered into distribution agreements (the "Distribution Agreements") with Defendants, which governed the terms of their FLN distribution, and mandated distribution of marketing materials, including the presentation (the "Presentation") that Plaintiffs allege contained material misstatements and omissions of fact. On two separate occasions, Defendants allegedly provided the Presentation to Terra with full knowledge and intention that it would be transmitted to the Municipalities and/or would serve as the basis for Terra's advice to the Municipalities with respect to their investment in the FLNs.
Similarly, Banca Carige alleges that Defendants provided it with the Presentation along with other materials marketing the Offshore TOB Fund beginning in or around November 2006.
The Presentation marketed the Funds by describing the Funds' investment strategy, detailing their structure, and purporting to demonstrate the historical performance of municipal yields hedged with interest rate swap agreements. The Presentation described the Funds' investment strategy as an arbitrage opportunity for investors, whereby the Funds take advantage of the relative steepness of the long-term, nontaxable, municipal curve as against a taxable London Interbank Offered Rate ("LIBOR") curve (the "Hedging Strategy"). The Funds purported to hedge against a drop in municipal bond values with LIBOR swap agreements that traded a fixed interest rate for a floating rate, and Defendants represented that the net amount long-term municipal bonds pay over the cost of short-term LIBOR loans (the "Arbitrage") was consistent over time.
Both the Terra and Banca Carige Complaints rely primarily on allegations that Defendants materially misrepresented the Hedging Strategy by portraying the correlation between long-term municipal bond rates and LIBOR swap rates as "virtually perfect, with a factor of almost .97 out of a possible 1." (Terra Complaint ¶ 5; Banca Carige Complaint ¶ 5.) Specifically, Plaintiffs rely on a graph contained in the Presentation entitled "Correlation Between Municipal and LIBOR rates" (the "Graph"), which purports to represent a regression analysis of the taxable and non-taxable rates over the last thirty years. (Terra Complaint ¶ 40; Banca Carige Complaint ¶ 36.) Defendants represented that the Arbitrage was the result of "market inefficiency due to investor preference for shorter term municipal maturities, the risk of changes in tax law, and the lack of any short market on municipal bonds." (Terra Complaint ¶ 34.)
Plaintiffs allege that the correlation presented in the Graph was "blatantly false and misleading." (Terra Complaint ¶ 6; Banca Carige Complaint ¶ 6.) The Graph incorrectly compared levels of interest rates and not rates of change, and thereby generated the misrepresentative, near-perfectcorrelation. Plaintiffs also condemn statistical flaws that led to the misrepresentative Graph, including an unacceptable standard error. By contrast to the Graph's representation, Plaintiffs allege that if more accurate correlation analyses for the hedging strategy were employed, the result would have been a significantly lower correlation factor—as low as .562 or .27 out of a possible 1, depending on the municipal benchmark used. As a result, Plaintiffs allege that Defendants misrepresented the risk associated with the FLNs and the TRS, and that they relied on these misrepresentations to their financial detriment.
Plaintiffs allege that the Presentation materially omitted to disclose two additional risk factors: (1) credit risk—the risk that municipal borrowers may become less creditworthy; and (2) liquidity risk—the risk that investors may become increasingly concerned about the liquidity of their long-term municipal bonds.3 Plaintiffs assert that the risk that insurers to the municipal debt offerings would falter could not be effectively hedged with interest rate swap agreements and thus should have been disclosed in the Presentation.
Six weeks after the Municipalities' purchase of the FLNs, Defendants' representations regarding the high correlation between municipal and LIBOR rates were proven "demonstrably false, and those rates began to dramatically diverge." (Terra Complaint ¶ 72.) As the rates diverged, the Citi TOB Fund's assets, and thus correspondingly the Municipalities' FLNs, lost value. Municipal bond yields increased, causing the value of long-term municipal bonds to fall, but the Funds' taxable LIBOR swap agreements did not offset the non-taxable losses. Instead, "as investors worried about credit and liquidity risk," yields fell on taxable instruments, and thus both assets held by the Citi TOB Fund fell in value. ( Id. ¶ 73.)
Ultimately, at the request of Defendants and Terra, the Municipalities sold their FLNs in late 2007 and early 2008. Combined, the Municipalities lost approximately $90 million, and these investment losses also allegedly resulted in Terra's financial ruin. Following the precipitous decline of the FLNs, Norway's Financial Supervisory Agency launched an investigation into Terra, which forced Terra to cease operations and declare bankruptcy.
For its part, Banca Carige alleges damages in excess of $47 million resulting from Defendants' alleged fraud. In or about the spring of 2008, after their fund-linked investments had suffered losses, Defendants contacted Banca Carige and assured them that the Offshore TOB Fund was...
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