One of the special rules that applies to fraud claims is a more generous statute of limitations. The time by which a lawsuit alleging fraud must be brought is judged by two standards – the one resulting in the longer period applying: (1) six years from the date the fraud was committed or (2) two years from when the fraud was discovered or could have been discovered with due diligence. See CPLR 213(8)(“ the time within which the [fraud] action must be commenced shall be the greater of six years from the date the cause of action accrued or two years from the time the plaintiff or the person under whom the plaintiff claims discovered the fraud, or could with reasonable diligence have discovered it.”).
Thus, depending on when the fraud was actually discovered or could have reasonably been discovered, the statute of limitations could run long past the date that the fraud was actually committed. The more forgiving standard recognizes that it would be unfair to shut the courthouse doors on the victim of fraud if the very nature of the deceptive conduct prevents the victim from even knowing it was defrauded.
The key to preserving the right to sue for fraud is taking timely and prudent action not only to prevent the fraud, but to detect it as soon as possible. The cases show that parties must be vigilant in investigating suspicious circumstances, and that engaging knowledgeable legal counsel from the earliest moment is critical in preserving rights and obtaining the full scope of legal remedies for fraud.
First Department Sheds Light on Inquiry Notice
The New York Appellate Division First Department has recently shed light on the circumstances considered in judging whether the fraud in question could have been discovered within the two-year statute of limitations. These cases arose out of claims relating to the worldwide financial crisis that began in 2007. The subject fraud claims were brought by Aozora Bank, Ltd., (“Aozora”), a Japanese commercial bank with its principal offices in Tokyo. Aozora invested in complex financial products backed by mortgages, including $430 million in collateralized debt obligations (“CDOs”) by the end of 2007.
In both cases — Aozora Bank, Ltd. v Deutsche Bank Sec. Inc., 2016 NY Slip Op 02511 [137 AD3d 685] (1st Dep’t 2016) and Aozora Bank, Ltd. v. Credit Suisse Group, 2016 NY Slip Op 07259 (1st Dep’t Nov. 3, 2016) — the First Department concluded that Aozora could have discovered the alleged fraud more than two years before it brought the claims, and was therefore barred under the statute of limitations from suing.
In Aozora v. Deutche, defendants Deutsche Bank Securities Inc. and Deutsche Bank AG (“Deutsche”) structured and sold the CDO. Aozora alleged that although Deutsche selected the securities that were to be included in the CDO, Deutsche actually secretly held negative views about those securities. In marketing, selling, and offering the CDOs to investors, Deutsche created, drafted, and disseminated marketing and offering documents that Aozora alleged contained material misrepresentations, misleading statements and omissions.
In its complaint in January 2014, Aozora asserted causes of action for common law fraud, aiding and abetting fraud, breach of the implied covenant of good faith and fair dealing, negligent misrepresentation, and unjust enrichment. With respect to the claims for common law fraud and negligent misrepresentation, Aozora asserted that it reasonably relied on Deutsche’s misrepresentations and omissions by conducting its own due diligence and risk analysis, scrutinizing, among other things, the collateral portfolio and its structural protections against collateral losses. Aozora stated that it also reviewed the marketing materials and concluded that the investment, as represented by Deutsche, was appropriate.
Aozora insisted, however, that it did not know, and could not have known, that the marketing materials and offering documents contained material misrepresentations and omissions, that the portfolio was filled with securities that defendants internally disparaged, or that Deutsche had understated the degree to which the CDOs were collateralized by higher-risk, lower-quality assets.
Deutsche moved to dismiss the complaint arguing, among other things, that all of Aozora’s claims were time-barred because Aozora filed its action more than six years after it bought the CDOs and more than two years after it should have discovered the alleged fraud in the exercise of reasonable diligence. To support this argument, Deutsche attached details of numerous publications, testimony, and lawsuits regarding the financial crisis; the earliest of this material was dated from March 2007—nearly seven years before Aozora commenced the action in January 2014. Deutsche noted that beginning in early 2008, it was well publicized that banks, including Deutsche, were under investigation for their involvement in creating defective mortgage products. Deutsche also attached excerpts from an April 13, 2011 report of the Permanent Subcommittee on Investigations of the United States Senate entitled “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse” (“Senate Report”). Finally, Deutsche attached proof that Moody’s had downgraded the CDOs to junk status in June 2008. Deutsche argued that all this information put Aozora on notice of its claims years before it commenced the action.
In opposition to the motion to dismiss, Aozora claimed that when it began to experience CDO losses, it believed those losses were the result of the United States subprime mortgage crisis. In September 2012, a former employee of Aozora contacted it, advising that several other banks had recently brought successful claims against structured finance arrangers and inquiring whether Aozora wanted its portfolio reviewed to determine whether it might have viable claims. Thereafter, as part of Aozora’s due diligence in November and December 2012, it spoke with several United States-based law firms regarding its potential claims. In March 2013, Aozora retained its current counsel, who informed Aozora that Deutsche had been discussed in the April 2011 Senate Report, in which certain of the securities in question were mentioned. Aozora claimed it was only then that it realized that it might have actionable claims against defendants, and commenced the action.
The IAS court found that Aozora’s fraud claims were untimely under the two-year discovery rule, concluding that Aozora was on inquiry notice of the alleged fraud by no later than April 2011, when the Senate Report was released. The court also found that Aozora failed to raise an issue of fact as to whether it had exercised reasonable diligence in an effort to discover its fraud claims, ruling that the information publicly available by 2010 should have alerted Aozora that something was amiss with its investment.
In affirming the lower court’s dismissal of Aozora’s fraud claims, the First Department first noted “‘[W]here the circumstances are such as to suggest to a person of ordinary intelligence the probability that he has been defrauded, a duty of inquiry arises, and if he omits that inquiry when it would have developed the truth, and shuts his eyes to the facts which call for investigation, knowledge of the fraud will be imputed to him” (citing CIFG Assur. N. Am., Inc. v Credit Suisse Sec. [USA] LLC, 128 AD3d 607, 608 [1st Dept 2015]).
The First Department then ruled that Aozora failed to carry its burden of raising issues of fact in response to the prima facie proof of being on notice of the fraud, “as there was a wealth of public information that should have put it on inquiry notice of the alleged fraud” – (1) the securities were downgraded to junk status and plaintiff incurred substantial losses on its investment; (2) there was considerable publicity about the subprime mortgage crisis from news reports, investor lawsuits, and government investigations well before June 2011; and (3) the Senate Report and its associated emails disclosed critical information, which actually later formed the centerpiece of plaintiff’s complaint. Thus, the Frist Department affirmed the dismissal because the claims were time-barred.
In the most recent case, Aozora Bank, Ltd. v. Credit Suisse Group, 2016 NY Slip Op 07259 (1st Dep’t Nov. 3, 2016), the First Department followed the same analysis in affirming the lower court and dismissing similar claims that Aozora asserted against Credit Suisse.
The First Department ruled that the motion court properly dismissed the fraud and misrepresentation claims as time-barred because “the publicly available information identified by defendants, considered in its totality, established prima facie that Aozora was on inquiry notice more than two years before the June 2013 commencement of the action” – (1) Aozora sustained substantial investment losses in 2007 and 2008, and by August 2008, the subject notes had been downgraded from the highest possible Moody’s rating to the lowest; (2) in March 2009, a complaint was filed in the Southern District of New York alleging misconduct similar to that alleged in Aozora’s complaint; and (3) there were other published reports that should have put a “sophisticated financial investor like Aozora on notice of a possible fraud.”
The Court found it particularly damning that Aozora only later engaged legal counsel to help it investigate the underlying fraud, but could have done so earlier, within the two-year statutory limitations period, yet had not.
Victims of Fraud Must Protect Themselves Timely
While the victim of fraud does have available a more forgiving statute of limitations to extend its time to sue, as with other elements of the fraud claim, it must exercise reasonable diligence in an effort to protect itself and discover the fraud. Even in the face of clearly-documented fraudulent conduct, the defrauded party must show the court that it acted reasonably to protect itself before it will be permitted to seek redress for the wrong. Engaging legal counsel as soon as possible to investigate suspicious circumstances is key to preserving rights. As shown by these cases, this is especially true when sophisticated investors are involved.