As shown by the recent decision in Rostami v. Open Props, Inc., No. 22-CV-3326 (RA) (U.S.D.C. SDNY Jan. 9, 2023), courts apply particular scrutiny to fraud claims attempted to be asserted by what the courts deem are “sophisticated investors,” especially involving investments that carry great recognized risks. In Rostami, the plaintiff-investor could not scale the uphill legal terrane sufficiently to clear the pleadings stage of the case.
For some context and background, see my post Dismissal of Sophisticated Investor’s Attempted Fraud Claim Affirmed by First Department For Lack of Due Diligence.
Rostami
In Rostami, the individual plaintiff responded to “an initial coin offering” – the “‘cryptocurrency industry’s equivalent to an initial public offering for stocks’” – in which the defendants were selling a new cryptocurrency called “Props Tokens,” which allegedly would power a new video platform. The essential foundation of the new video platform and the viability of the Prop Tokens were apparently dependent upon the ability to create a “decentralized” digital media system that enabled an open-ended user pool, rather than “controlled by a few actors.” Ultimately, the decentralization effort failed, and plaintiff’s investment went kaput.
Plaintiff brought suit in the federal court for the Southern District of New York, alleging fraudulent inducement, unjust enrichment and breach of implied covenant of good faith and fair dealing. The Court granted the defendants’ motion to dismiss pursuant to Federal Rule of Civil Procedure (FRCP) 12(b)(6).
In dismissing the fraud claim, the Court focused on some well-established principles that have exposed the weaknesses in vulnerable fraud claims: One, the Court found that the complaint did not adequately identify actual misrepresentations of fact made by defendants, instead relying upon what the Court found was mere “puffery” or “promissory” statements during the promotions of the investment. Two, the Court found that even if there were sufficient factual misrepresentations, plaintiff could not have reasonably relied upon those statements because of the information available showing the risky nature of the investment. Three, the Court found plaintiff had not sufficiently alleged the basis of fraudulent intent.
Noting that the plaintiff himself was an acknowledged “accredited investor,”[1] the Court repeatedly emphasized that plaintiff was a “sophisticated investor” and that there was plenty of information available to him that identified the risks of the investment. This foundation clearly contributed to the Court’s overall view of the case.
Misrepresentations
After noting that a claim for fraudulent inducement requires plaintiff to identify specifically the statement(s) that plaintiff contends are fraudulent, the Court found that plaintiff failed to meet the heightened pleadings requirements of FRCP 9(b). The Court cited authority finding statements were mere puffery and the like:
First, while it is true that the Complaint lists numerous representations made by Defendants during the promotional phase for the Props Tokens, see Compl. ¶¶ 34-45, most of these statements are either promissory in nature or constitute mere puffery, neither of which can form the basis of a fraudulent inducement claim. See, e.g., Blanton v. Educ. Affiliates, Inc., No. 21-1221-cv, 2022 WL 1505124, at *4 (2d Cir. May 12, 2022) (quoting Brown v. Lockwood, 432 N.Y.S.2d 186, 194 (App. Div. 1980)) (“[F]raud cannot be predicated upon statements which are promissory in nature at the time they are made and which relate to future actions or conduct.”3); EED Holdings v. Palmer Johnson Acquisition Corp., 387 F. Supp. 2d 265, 276 (S.D.N.Y. 2004) (quoting 60A William H. Danne, Jr., N. Y. Juris. § 34 (2d ed. 2003)) (“It is well established in New York that `a seller’s mere general commendations of the product sought to be sold, commonly known as “dealer’s talk,” “sales talk,” or “puffery,” do not amount to actionable misrepresentations.'”); President Container Grp. II, LLC v. Systec Corp., 467 F. Supp. 3d 158, 166 (S.D.N.Y. 2020) (quoting Time Warner Cable, Inc. v. DIRECTV, Inc., 497 F.3d 144, 159 (2d Cir. 2007)) (“The Second Circuit has described puffery as `an exaggeration or overstatement expressed in broad, vague, and commendatory language’ or ‘ [s]ubjective claims about products, which cannot be proven either true or false.”).
3 There is an exception to this general rule, in that “[a] promise relating to a future event may be actionable . . . when made with a preconceived and undisclosed intention of not performing it.” President Container Grp. II, LLC v. Systec Corp., 467 F. Supp. 3d 158, 166-67 (S.D.N.Y. 2020) (internal quotation marks omitted). As discussed below, however, Plaintiff does not plausibly allege that Defendants acted with fraudulent intent when promoting the Props Tokens, so this exception is inapplicable.
I have chronicled numerous cases in which statements were considered mere puffery or non-actionable sales talk. See posts here.
The Court cited a number of examples of non-actionable statements in the complaint, such as “[i]n our view, the world needs a decentralized digital media ecosystem,” which the Court viewed as a “statement [that] makes a representation about Defendants’ expectations and opinions, “‘which cannot be proven either true or false.’”
Reasonable Reliance
The Court did recognize that plaintiff’s allegation that defendants falsely misrepresented that their system was indeed an existing “decentralized digital media ecosystem” could be deemed to have alleged an actionable misrepresentation. The Court nevertheless found that plaintiff had not adequately alleged he reasonably relied on such alleged misrepresentation. The Court cited some applicable cases:
“In evaluating justifiable reliance, courts consider `the entire context of the transaction, including factors such as its complexity and magnitude, the sophistication of the parties, and the content of any agreements between them,’ as well as `the investor’s access to information and whether that investor engaged in due diligence before investing.'” DNV Inv. P’ship v. Field, No. 15-cv-1255 (PAC), 2020 WL 2539029, at *8 (S.D.N.Y. May 19, 2020) (internal citations omitted) (quoting Century Pac., Inc. v. Hilton Hotels Corp., 354 F. App’x 496, 498 (2d Cir. 2009)); Abbey v. 3F Therapeutics, Inc., No. 06-cv-409, 2011 WL 651416, at *7 (S.D.N.Y. Feb. 22, 2011)); see also Crigger v. Fahnestock & Co., Inc., 443 F.3d 230, 234 (2d Cir. 2006) (“Reasonable reliance entails a duty to investigate the legitimacy of an investment opportunity where [the] plaintiff was placed on guard or practically faced with the facts.” (internal quotation marks omitted)).
The Court observed that there was plenty of publicly-available information that plaintiff could have reviewed to assess the reliability of the statements made by defendants, and thus, he could not have reasonably relied solely on defendants’ statements in choosing to invest.
Intent to Defraud
Finally, the Court found that plaintiff had not adequately alleged the necessary foundation for pleading “fraudulent intent”:
Plaintiff alleges that “Defendants made these [allegedly false] representations with the intent of never creating a decentralized network and blockchain where the Props tokens could be used and planned to exit the venture under the guise of non-commercial viability leaving investors with worthless tokens.” Compl. ¶ 31. This allegation, however, is entirely conclusory, and Plaintiff provides no factual basis for the assertion that Defendants never intended to create a functioning Props network. See Greene v. Gerber Prods. Co., 262 F. Supp. 3d 38, 73 (E.D.N.Y. 2017) (quoting Glidepath Holding B. V. v. Spherion Corp., 590 F. Supp. 2d 435, 453 (S.D.N.Y. 2007)) (“Although ‘ [g]reat specificity as to scienter is not required,’ plaintiffs `have the burden of pleading circumstances that provide at least a minimal factual basis for their conclusory allegations of scienter.'”); see also Acito v. IMCERA Grp., Inc., 47 F.3d 47, 52 (2d Cir. 1995) (explaining that fraudulent intent cannot be based “on speculation and conclusory allegations” (internal quotation marks omitted)).
Plaintiff did allege that defendants themselves intentionally caused the entire investment facility to fail by filing with the SEC because, as defendants themselves admitted, registering the Props Tokens as a qualified security actually made it infeasible to make the necessary public filings and get regulatory approval. But the Court found that the Props Tokens did have to be so registered and simply doing so did not create a sufficient inference of fraudulent intent.
Commentary
When Courts view a plaintiff as a “sophisticated investor,” it is particularly more difficult to allege the necessary foundation for any type of fraud claim relating to the failed investment. Courts often rely upon well-established authority piling up a number of doctrines cutting against such claims, as set out in the Rostami decision discussed above.