In re Tremont Securities Law, State Law, and Insurance Litigation (Elendow Fund, LLC v. Rye Select Broad Market XL Fund): The Heightened Pleading Standards for Securities Fraud Claims under the PSLRA
In In re Tremont Sec. Law., State Law, & Ins. Litig. (Elendow Fund, LLC v. Rye Select Broad Mkt. XL Fund), Master File No. 08 Civ. 1117, 10 Civ. 9061, 2013 BL 249529 (S.D.N.Y. Sept. 16, 2013), Plaintiff Elendow Fund, a small investment fund, filed suit against Rye Select Broad Market XL Fund (“XL Fund”), Rye Investment Management, Tremont Partners (“Tremont”), and other entities alleged to be directly and indirectly involved in the exchange of XL Fund investments (collectively, the “Defendants”) in an effort to recover assets lost as a result of the Bernard Madoff Ponzi scheme. Elendow Fund’s complaint made several allegations including securities fraud, control-person liability, and violations of various state-law provisions. The Defendants moved to dismiss and the United States District Court for the Southern District of New York granted the motion.
According to the allegations, XL Fund engaged in an investment strategy that entailed, among other things, investments in a fund managed by Bernard Madoff. Tremont allegedly “induced” Elendow Fund to invest in XL Fund through misrepresentations. Tremont’s alleged misrepresentations included statements about the investment strategy of the XL Fund. Tremont also allegedly misrepresented the due diligence that it performed on fund managers. Elendow Fund also brought claims for control-person liability.
Actions for securities fraud allegations are subject to the heightened pleading standards set out in the Private Securities Litigation Reform Act and Rule 9(b) of the Federal Rules of Civil Procedure. To meet these requirements, a complaint must identify “each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” § 78u-4(b)(1). Furthermore, plaintiffs must also allege a “strong inference” of scienter. This requires allegations: “(1) showing that the defendants had both motive and opportunity to commit the fraud or (2) constituting strong circumstantial evidence of conscious misbehavior or recklessness.”
Elendow Fund argued that its complaint met the heightened pleading standard for securities fraud. The court, however, disagreed. The complaint did not “specifically and plausibly allege that Tremont actually knew that Madoff’s operation was a fraud.” With respect to the allegation that Tremont recklessly disregarded red flags, the court found that the complaint failed to sufficiently allege facts to establish that “the dangers posed by Madoff were so unmistakable that Tremont must have known that its representations were false.” The court further noted that Tremont recognized the risks and benefits associated with investing with Madoff, but nonetheless chose to continue doing so.
The court also found that Elendow Fund’s allegations about Tremont’s due diligence were insufficient to plead securities fraud. Specifically, the court highlighted the fact that the complaint failed to sufficiently allege that some of the statements (the promise to perform “careful” due diligence posted on the Internet) were false. More specific representations about the level of due diligence in Tremont’s Form ADV failed because of the vagueness of the allegations. As the court reasoned:
This allegation might have been sufficient if, in context, it clearly referred to any specific representations. But this allegation appears, not alongside any allegations of actual representations, but in the formulaic recitation of the elements of count I of the complaint. In that context it is not clear what “statements described above” the allegation refers to. When an allegation couched in such generic language is completely separated from the substantive, factual allegations of the complaint, it is simply too vague to support an action for securities fraud under the applicable heightened pleading standards. Elendow Fund’s generic allegation that it relied upon such representations as those described in the complaint is simply not adequate to push its reliance allegation over the line from conceivable to plausible.
Accordingly, the court dismissed the securities fraud claim. In absence of a primary violation, the court also dismissed Elendow Fund’s claim for control-person liability. Additionally, the court dismissed all of Elendow Fund’s state-law claims.
Therefore, the United States District Court for the Southern District of New York granted Defendants’ motion dismissing Elendow Fund’s complaint in its entirety.
The primary materials for this case may be found on the DU Corporate Governance website.