The elements of a cause of action for fraud are well known and often cited: “a misrepresentation or a material omission of fact which was false and known to be false by [the] defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury.’ ” Mandarin Trading Ltd. v Wildenstein, 16 NY3d 173, 178 (2011), quoting Lama Holding Co. v Smith Barney, 88 NY2d 413, 421 (1996). It is not frequent, however, for courts to drill down into the issue of “causation” in fraud cases. When they do, the courts analyze the two elements of causation in fraud cases: “transaction” causation and “loss” causation. A new Appellate Division, First Department, decision delves into these issues.
In Basis PAC-Rim Opportunity Fund (Master) v TCW Asset Mgt. Co., 2017 NY Slip Op 01644 (1st Dep’t March 2, 2017), the First Department reversed the court below and granted summary judgment dismissing fraud claims based upon plaintiffs’ failure to establish loss causation.
In Basis, plaintiffs were two Australian-based Cayman Islands hedge funds that relied upon the investment management services of defendant in connection with investment notes based upon collateral debt obligations (CDOs) — residential mortgaged-back securities (RMBS). Defendant “marketed itself as having the ability to identify which risky RMBS were likely to succeed and which were likely to fail. In other words, [defendant] marketed itself as having the ability to select the less risky RMBS from what was then known to be the risky RMBS market.” As a result, plaintiffs purchased $27 million of the RMBS recommended by defendant.
In the midst of the housing market crisis, the RMBS that plaintiffs acquired relying upon defendant lost most of their value. Plaintiffs commenced this action asserting causes of action for fraudulent inducement, fraudulent concealment, negligent misrepresentation, breach of contract – third party beneficiary, and unjust enrichment. Plaintiffs then filed an amended complaint asserting only the fraud claims. Defendant moved for summary judgment, arguing that plaintiffs were unable to meet their burden of proving loss causation, an element of fraud. The motion court denied defendant’s motion for summary judgment, finding issues of fact as to loss causation.
Transaction and Loss Causation
The First Department summarized the concepts of transaction and loss causation as relate to the elements of fraud:
A fraud claim requires “proof by clear and convincing evidence” as to each element of the claim (Gaidon v Guardian Life Ins. Co. of Am., 94 NY2d 330, 350 ). One such element is causation, and to establish causation, plaintiffs must prove both that “defendant’s misrepresentation induced plaintiff[s] to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiff[s] complain (loss causation)” (Laub v Faessel, 297 AD2d 28, 31 [1st Dept 2002]). “Transaction causation is akin to reliance, and requires only an allegation that but for the claimed misrepresentations or omissions, the plaintiff would not have entered into the detrimental [*3]securities transaction'” (Lentell v Merrill Lynch & Co., 396 F3d 161, 172 [2d Cir 2005], cert denied 546 US 935 ).
“Loss causation is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff'” (id. at 172). To establish loss causation a plaintiff must prove that the “subject of the fraudulent statement or omission was the cause of the actual loss suffered'”(id. at 173). Moreover, “when the plaintiff’s loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospect that the plaintiff’s loss was caused by the fraud decreases’, and a plaintiff’s claim fails when it has not . . . proven . . . that its loss was caused by the alleged misstatements as opposed to intervening events'” (id. at 174, quoting First National Bank v Gelt Funding Corp., 27 F3d 763, 772 [2d Cir 1994]). Indeed, when an investor suffers an investment loss due to a “market crash  of such dramatic proportions that [the] losses would have occurred at the same time and to the same extent regardless of the alleged fraud,” loss causation is lacking (see Loreley Fin. [Jersey] No. 3 Ltd. v Wells Fargo Sec., LLC, 797 F3d 160, 186-187 [2d Cir 2015]). Although the Loreley case concerned a motion to dismiss and thus focused on pleading requirements for loss causation, that court did note that “[w]hether [p]laintiffs can prove [their] allegations – and whether defendants in turn can proffer evidence that the CDOs would have collapsed regardless, due to the larger crash in the [mortgage-backed securities] market – are evidentiary matters for later phases of this lawsuit” (id. at 188).
Thus, the question was whether plaintiffs sustained damages due to the misrepresentations of defendant about its ability to select the least risky RBMSs or because the entire RBMS market was doomed and collapsed.
The First Department found that “both the motion court’s decision and [plaintiffs’] argument on appeal conflate the concept of loss causation with materiality, falsity and reasonable reliance – other elements of fraud. Once [defendant] made a prima facie showing that [plaintiffs’] loss was not due to any fraudulent statements or omissions by [defendant], the burden then shifted to [plaintiffs] to raise an issue of fact. [Plaintiffs] did not meet [their] burden and [defendant’s] summary judgment motion should have been granted.”
The First Department then gave an interesting account of how defendant proved the absence of loss causation through expert opinion:
[Defendant] has proffered evidence that [investment fund] would have collapsed regardless of the assets selected by [defendant] due to the housing market crash – a “marketwide phenomenon causing comparable losses to other investors” (Lentell v Merril Lynch & Co., Inc., 396 F3d at 174). [Defendant] submitted an expert affidavit in which the expert opined that even if [defendant] had selected assets that complied with the [investment fund] model and comported with [defendant’s] representations to [plaintiffs], [plaintiffs] would still have suffered a loss due to an external and intervening cause – namely, the housing market crash. The expert conducted a common form of regression analysis to “analyze the effect that macroeconomic factors had on pools of collateral consistent with [investment fund’s] core asset portfolio . . . in order to create a benchmark against which to compare the performance of the loan pools analyzing the collateral in [investment fund].” The [defendant] expert found that “any CDO backed by pools of loans consistent with [investment fund’s] core asset portfolio would have suffered losses as a consequence of the general market downturn . . .” Ultimately, the expert concluded that [plaintiffs’] “economic losses were caused by unforeseeable macroeconomic events . . .”
After finding that defendant’s expert adequately established the absence of loss causation, the First Department found that plaintiffs failed to rebut that evidence by raising any issue of fact:
In response, [plaintiffs] failed to raise an issue of fact. Despite having pleaded in its amended complaint that [defendant] allowed [investment fund] to contain “toxic securities” that “performed significantly worse than a benchmark portfolio comprised of similar mortgage-backed bonds,” [plaintiffs] failed to produce any evidence that under the circumstances here involving the collapse of the RMBS market, it was [defendant’s] misrepresentations, rather than market forces, that caused the investment losses (see e.g. Laub v Faessel, 297 AD2d at 30-32). Instead, [plaintiffs’] expert, in response, provided a general overview of the role of various players involved in CDO transactions as well as his opinion and interpretation of internal [defendant] emails discussing the investment vehicle at issue and the health of the market. However, [plaintiffs’] expert failed to address or even discuss [plaintiffs’] argument that no suitable collateral then existed and that [defendant] lied about its existence, and that this misrepresentation caused [plaintiffs] to lose their entire investment. [Plaintiffs’] expert did not analyze the quality or performance of the assets purchased by [defendant]. [Plaintiffs’] expert’s conclusory assessment of the economic damages suffered by [plaintiffs] addressed only transaction causation, stating that “[i]n the absence of  fraudulent inducement and concealment, [p]laintiffs aver that [plaintiffs] would not have invested [$27,000,000 plus] . . . and would therefore not have suffered this total loss.” This was insufficient to raise an issue of fact as to loss causation.
It is not common that courts delve into the deeper issues of causation in fraud cases. In certain circumstances, there is a question whether the plaintiff would have sustained the alleged damages even apart from relying upon the alleged misrepresentations. In such circumstances “loss” causation is relevant in addition to “transaction” causation. The First Department’s decision in Basis is a good explanation and implementation of the applicable law.