The Starr Found. v. Am. Int'l Group Inc.

• Decision Date: 27 May 2010
• Citation: 2010 N.Y. Slip Op. 04526,76 A.D.3d 25,901 N.Y.S.2d 246
• Parties: The STARR FOUNDATION, Plaintiff–Appellant,v.AMERICAN INTERNATIONAL GROUP, INC., et al., Defendants–Respondents.
• Court: New York Supreme Court — Appellate Division

76 A.D.3d 25

901 N.Y.S.2d 246

2010 N.Y. Slip Op. 04526

The STARR FOUNDATION, Plaintiff–Appellant,

v.AMERICAN INTERNATIONAL GROUP, INC., et al., Defendants–Respondents.

Supreme Court, Appellate Division, First Department, New York.

May 27, 2010.

Plaintiff appeals from orders of the Supreme Court, New York County (Charles E. Ramos, J.), entered December 3 and 19, 2008, which granted defendants' motion to dismiss the complaint.Schindler Cohen & Hochman LLP, New York (Rebecca L. Fine, Steven R. Schindler, Lisa C. Cohen, Scott W. Bulcao and Karen M. Zakrzewski of counsel), for appellant.Weil, Gotshal & Manges LLP, New York (Joseph S. Allerhand, Stacy Nettleton, Robert F. Carangelo and Brant Duncan Kuehn of counsel), for respondents.LUIS A. GONZALEZ, P.J., DAVID FRIEDMAN, KARLA MOSKOWITZ, DIANNE T. RENWICK, HELEN E. FREEDMAN, JJ.FRIEDMAN, J.

At issue on this appeal is the legal sufficiency under New York law of a claim for fraudulent inducement to continue to hold, rather than sell, a large block of the common stock of defendant American International Group, Inc. (AIG), a publicly traded security. In a nutshell, the theory of the complaint (as amplified by affidavits and testimony offered in response to the motion to dismiss) is that plaintiff Starr Foundation (the Foundation), which was seeking to divest itself of most of the AIG stock that formed its original endowment, was induced to set an excessively high “floor price” ($65 per share) for the sale of the stock by public statements defendants made beginning in August 2007 that allegedly misrepresented (by minimizing) the degree of risk attached to AIG's large credit default swap (CDS) portfolio. Allegedly in reliance on these statements, the Foundation suspended its sales of the stock in October 2007, when AIG's share price fell below $65. But for defendants' misrepresentations, the Foundation claims, it would have set a lower floor price for selling its AIG stock and, as a result, would have accelerated its divestiture plan and sold all of its remaining AIG stock within two weeks.¹ In fact, however, the Foundation ceased selling its AIG stock in October 2007, and therefore still held approximately 15.5 million AIG shares in February and March of 2008, when the value of AIG stock declined substantially as AIG reported billions in CDS losses due to the mounting number of defaults on real estate mortgages.

In this action, the Foundation apparently seeks to recover the value it hypothetically would have realized for its 15.5 million shares of AIG stock in the late summer or fall of 2007 had defendants at that time accurately disclosed the risk of AIG's CDS portfolio, less the stock's value after the alleged fraud ceased to be operative in early 2008. If the case were to go to trial, to establish liability and damages the Foundation would be required (in addition to proving the fraudulent nature of the statements complained of) somehow to come forward with a nonspeculative basis for determining how accurate disclosure of the risk of the CDS portfolio beginning in August 2007—and such disclosure's hypothetical effect on the market at that time—would have affected the Foundation's decision to sell or retain its AIG stock and the amount it would have received for the stock it hypothetically would have sold. However, the Foundation's “holder” claim fails, as a matter of law, because it violates the “out-of-pocket” rule governing damages recoverable for fraud. Accordingly, we affirm the dismissal of the complaint.²

As should be evident from the foregoing summary of the allegations on which the claim is based, the Foundation is seeking to recover the value it would have realized by selling its AIG shares before the stock's price sharply declined in early 2008 due to the reporting of its CDS losses. Manifestly, such a recovery would violate New York's longstanding out-of-pocket rule, under which “ ‘[t]he true measure of damages [for fraud] is indemnity for the actual pecuniary loss sustained as the direct result of the wrong’ ” ( Lama Holding Co. v. Smith Barney, 88 N.Y.2d 413, 421, 646 N.Y.S.2d 76, 668 N.E.2d 1370 [1996], quoting Reno v. Bull, 226 N.Y. 546, 553, 124 N.E. 144 [1919] ). Such damages “are to be calculated to compensate plaintiffs for what they lost because of the fraud, not to compensate them for what they might have gained,” and “there can be no recovery of profits which would have been realized in the absence of fraud” ( Lama, 88 N.Y.2d at 421, 646 N.Y.S.2d 76, 668 N.E.2d 1370; see also Reno v. Bull, 226 N.Y. at 553, 124 N.E. 144 [“The purpose of an action for deceit is to indemnify the party injured,” and “(a)ll elements of profit are excluded”] ).

This action is virtually the paradigm of the kind of claim that is barred by the out-of-pocket rule. As the Court of Appeals noted in Lama, under the out-of-pocket rule “the loss of an alternative contractual bargain ... cannot serve as a basis for fraud or misrepresentation damages because the loss of the bargain was ‘undeterminable and speculative’ ” (88 N.Y.2d at 422, 646 N.Y.S.2d 76, 668 N.E.2d 1370, quoting Dress Shirt Sales v. Hotel Martinique Assoc., 12 N.Y.2d 339, 344, 239 N.Y.S.2d 660, 190 N.E.2d 10 [1963]; see also Rather v. CBS Corp., 68 A.D.3d 49, 58, 886 N.Y.S.2d 121 [2009], lv. denied 13 N.Y.3d 715, 895 N.Y.S.2d 314, 922 N.E.2d 903 [2010]; Geary v. Hunton & Williams, 257 A.D.2d 482, 684 N.Y.S.2d 207 [1999]; Alpert v. Shea Gould Climenko & Casey, 160 A.D.2d 67, 72, 559 N.Y.S.2d 312 [1990] ). Here, the Foundation seeks to recover the value it might have realized from selling its shares during a period when it chose to hold, under hypothetical market conditions for AIG stock (assuming disclosures different from those actually made) that never existed. A lost bargain more “undeterminable and speculative” than this is difficult to imagine.³

The inconsistency of the Foundation's claim with the out-of-pocket rule emerges fully when one considers that the measure of damages under the rule is “the difference between the value of what was given up and what was received in exchange” ( Mihalakis v. Cabrini Med. Ctr. (CMC), 151 A.D.2d 345, 346, 542 N.Y.S.2d 988 [1989], lv. dismissed in part, denied in part 75 N.Y.2d 790, 552 N.Y.S.2d 98, 551 N.E.2d 591 [1990], citing Reno v. Bull, 226 N.Y. at 553, 124 N.E. 144). The Foundation does not allege any transaction in which it gave up anything in exchange for anything else. On the contrary, the Foundation complains that it was induced to continue holding its AIG stock for a certain period of time. In holding its stock, the Foundation did not lose or give up any value; rather, it remained in possession of the true value of the stock, whatever that value may have been at any given time. Thus, the Foundation did not suffer any out-of-pocket loss as a result of retaining its AIG stock. Further, the decline in AIG's share price for which recovery is sought was caused by the reporting of the company's massive CDS losses. Since the CDS losses would have been incurred regardless of any earlier misrepresentations AIG made concerning the risk of the CDS portfolio, such alleged misrepresentations could not have been the cause of the decline of AIG's stock price. In other words, the paper “loss” the Foundation seeks to recover in this action was caused by the underlying business decision of AIG's management to build up the CDS portfolio on which the losses reported in early 2008 were sustained, not by the earlier alleged misrepresentations forming the basis of the Foundation's complaint.⁴

As noted, the rationale of the out-of-pocket rule is that the value to the claimant of a hypothetical lost bargain is too “undeterminable and speculative” ( Lama, 88 N.Y.2d at 422, 646 N.Y.S.2d 76, 668 N.E.2d 1370 [internal quotation marks and citation omitted] ) to constitute a cognizable basis for damages. In this regard, the impermissibly speculative nature of the recovery sought in this action emerges from a comparison of the Foundation's holder claim against AIG with a more typical claim for fraud in the inducement of an actual purchase or sale of a publicly traded security. In the latter case, the claim is based on a transaction involving a particular quantity of the security at a particular time, and, to determine damages, the factfinder need determine only the effect of an accurate disclosure on the price of the security at the particular time the transaction actually occurred. In the case of a holder claim seeking damages based on the value that would have been realized in a hypothetical sale, however, the degree of speculation in determining damages is essentially quadrupled, in that the factfinder must determine (1) whether the claimant would have engaged in a transaction at all if there had been accurate disclosure of the relevant information, (2) the time frame within which the hypothetical transaction or series of transactions would have occurred, (3) the quantity of the security the claimant would have sold, and (4) the effect truthful disclosure would have had on the price of the security within the relevant time frame. These cumulative layers of uncertainty amount to a difference in the quality, not just the quantity, of speculation, and take the claim out of the realm of cognizable damages.

In fact, this case well illustrates the speculative nature of the holder claimant's allegation that it was injured at all. Specifically, after the alleged fraud was exposed upon the reporting of AIG's massive CDS losses in February and March of 2008, the Foundation continued to hold its remaining AIG stock through all the ensuing drops in share price. The speculative nature of the claim is underscored by the following testimony given by the Foundation's president, Florence A. Davis, under questioning by defense counsel at a hearing before the motion court:

“[DEFENSE COUNSEL]: ... If the exact same disclosures that were made in February 2008 had been moved up...