Irrefutable Claims of Fraud and Misrepresentation May be Precluded Under the Securities Litigation Uniform Standards Act

In In re Harbinger Capital Partners Funds Investor Litig., 2015 BL 88340 (S.D.N.Y. Mar. 30, 2015), the District Court for the Southern District of New York granted a motion to dismiss for failure to state a claim in favor of Harbinger Capital Partners, LLC (“HCP”) and Philip A. Falcone (collectively “Defendants”) in a class action lawsuit filed by Lili Schad, Anil Bhardwaj, The Edward M. Armfield Sr. Foundation, Inc., and The Randall Lang, Klein Family Partnership L.P., (collectively “Plaintiffs”). The court held The Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) precluded the claims because the class action involved misrepresentations made in connection with the sale of covered securities.  The court further declined to exercise supplemental jurisdiction as to Plaintiff’s remaining state law claims.

According to the complaint, the Defendants in 2006 acquired SkyTerra and renamed the company Light-Squared, immediately taking the company private. Light-Squared was attempting to establish a 4G network but faced problems with GPS interference and opposition from the Pentagon, NASA, and the Department of Transportation. Nonetheless, the Federal Communications Commission (“FCC”) eventually granted conditional approval. Upon receipt of a report concluding that Light-Squared’s technology “could not operate without interfering with the GPS network”, the FCC revoked its approval and Falcone filed for bankruptcy. 

Thereafter, according to the allegations, Falcone and HCP settled a case brought by the Securities and Exchange Commission (SEC) “admitting that they made the personal loan to Falcone without disclosing it for five months, and granted favorable redemption terms to investors in Fund I exchange for investors' votes to impose more restrictive terms without informing Fund I's board of directors or other investors. “ (For a discussion of the settlement, go here).  

Plaintiffs were investors in a family of hedge funds managed by Defendants.  According to the complaint, they claimed that the Defendants made misrepresentations and fraudulent statements after acquiring SkyTerra. The Plaintiffs further alleged that Defendants breached their fiduciary duties in connection with the personal loan to Falcone and "side agreements" granting large investors more favorable redemption terms than the Plaintiffs. Finally, the Plaintiffs brought state-law derivative claims against Defendants.

The court considered the dismissal of Plaintiff’s sixth amended complaint under the Securities Litigation Uniform Standards Act (“SLUSA”).  SLUSA provides that “[A]llegations of misrepresentations and omissions related to covered securities will not trigger SLUSA preclusion if they are extraneous to the bases for liability alleged in the complaint.” 15 U.S.C. § 78bb(f).  Although the Plaintiffs’ sixth amended complaint provided more limited allegations than prior complaints, pertaining only to Defendants’ misrepresentations after acquiring SkyTerra, the court found Plaintiffs’ claims nevertheless triggered SLUSA preclusion because the claims could not be separated from the Defendants’ acquisition of covered SkyTerra securities.

The court also granted Defendants’ motion to dismiss the Plaintiffs’ breach of fiduciary duty claims. The court found that the failure to disclose claims were appropriately raised as direct rather than derivative.  Under Rule 9(b), false disclosure claims must be alleged with particularity.  A plaintiff must "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent."

The Court found the Plaintiff’s did not indicate "where and when" any of the statements attributed to Defendants were made, did not state whether Falcone, Harbinger, or some other entity was responsible for informing them about the fraudulent loan, or exactly "when" the omissions occurred, and failed to identify any particular speakers with particular statements. Furthermore the Court found that Plaintiffs did not demonstrate any fraudulent statements were made to investors. Because the Plaintiffs failed to state with particularity the circumstances which constituted the fraud or mistake, the court also dismissed the Plaintiffs’ aiding and abetting the breach of fiduciary duty claims.

Finally, the court declined to exercise supplemental jurisdiction over the Plaintiffs’ state-law derivative claims.  Under 28 U.S.C. § 1367, “a district court may decline to exercise supplemental jurisdiction if it has dismissed all claims over which it has original jurisdiction.” Because the court dismissed Plaintiffs’ claims as to misrepresentation, fraud, and breach of fiduciary duty, the court also dismissed Plaintiffs’ derivative claims without prejudice.

The primary materials for this post can be found at the DU Corporate Governance website.

Jason Haubenreiser