In re Optimal U.S. Litigation: S.D.N.Y. Applies Janus

In In re Optimal U.S. Litigation, 10 Civ. 4095, (S.D.N.Y., Oct. 14, 2011), the court granted in part and denied in part the defendants’ motion to dismiss federal securities fraud claims brought by Plaintiffs in a class action. 

The plaintiffs are investors in Optimal Strategic U.S. Equity Fund (“Fund”), which invested all of its assets with Bernard Madoff.  The defendants include the Fund’s investment manager, Optimal Investment Management Services, S.A. (“OIS”), and OIS’s parent company, Banco Santander.  The plaintiffs allege defendants ignored red flags concerning Madoff, failed to conduct reasonable due diligence, and made material misstatements and omissions regarding the Fund.  The plaintiffs further allege that because of defendant’s actions, plaintiffs lost their investment and that the defendants improperly collected management fees. 

Rule 10(b)-5 permits actions for fraudulent disclosure in connection with the purchase or sale of a security.   17 CFR 240.10b-5.  Under the provision, however, an action can only be brought by a person who “make[s]’ the untrue statement.   In Janus Capital Group v. First Derivative Traders, the Supreme Court held that the maker of a statement is the person with “ultimate authority” over its contents. 

The defendants brought the motion to dismiss based on Janus Capital Group v. First Derivative Traders.  Defendants asserted that allegedly fraudulent statements made in Explanatory Memoranda (documents described in the opinion as “Bahamian equivalents of prospectuses”) that issued by Optimal Multiadvisors (OM), not the defendants.    

The plaintiffs argued that OIS exercised control and had “ultimate authority” over OM.  According to the complaint, OIS owned 100% of OM’s voting shares,  had authority to remove and add directors of OM, and its  CEO was one of OM’s directors.  Plaintiffs asserted that OIS exercised control over OM and that the “relevant statements are attributable to OIS.”    

The court held OM made the misstatements for purposes of Rule 10b-5.  The court concluded that OM’s Board of Directors had the ultimate authority over issuance of the prospectuses and made the statements.  The court further noted that under Janus, a statement is made by the entity that delivers it rather than the entity that drafts it.  The court also noted that under Janus, the affiliation of one OM director with OIS was not enough to impose liability on OIS under Rule 10(b)-5. 

Plaintiffs also argued that OIS was liable under a theory of “corporate veil-piercing”.   The court applied the law of the Bahamas, OM’s place of incorporation.  Under Bahamian law, a defendant “incurs liability to [P]laintiffs before creating a fraudulent shell entity.”  The court held that Plaintiff’s corporate veil-piercing claim failed under Bahamian law.  Because OM was founded in 1995 and the misstatements occurred between 2001 and 2008, the defendants could not have created OM to avoid liability. 

Lastly, the defendants argued that claims under §20(a) of the Exchange Act must be dismissed because the plaintiffs did not adequately show scienter.  Section 20(a) provides that any person who directly or indirectly controls any person is jointly and severally liable.  The court relied on a previous ruling from May 10, 2011 to hold that the plaintiffs adequately pled scienter with respect to OIS and OM and sustained the §20(a) claims against these two defendants.  The court dismissed the §20(a) claims against Banco Santander based on its control of OIS since OIS did not make the misstatements. 

Although the court dismissed the 20(a) claims against Banco Santander, the court sustained other claims of federal securities fraud against OIS and Banco Santander.  The court did not address the remaining claims of common law fraud, gross negligence, negligent misrepresentation, and aiding and abetting fraud in this action. 

The primary materials for this case may be found on the DU Corporate Governance website.