Hedge funds dodge Morrison in state-court case against Porsche
In what appears to be the first example of securities plaintiffs getting a green light to litigate in state court after their federal court case was bounced under the U.S. Supreme Court ruling in Morrison v. National Australia Bank, New York State Supreme Court Justice Charles Ramos ruled Wednesday that several hedge funds can proceed with claims that they lost more than $1 billion as a result of Porsche’s allegedly deceptive manipulation of the market for Volkswagen shares in 2008. But the 22-page opinion isn’t just good news for investors with fraud claims against foreign defendants. It’s also a rare judicial boost for so-called sophisticated investors, who’ve been smacked down this year by New York state and federal appeals courts.
The hedge funds originally sued Porsche in federal court in Manhattan, claiming that Porsche deceived them and the rest of the market when it denied intentions to buy up more than a simple majority of Volkswagen shares. Based on those reports – and significant additional due diligence – the hedge funds shorted Volkswagen, believing its share price to be inflated. When Porsche subsequently announced its intention to buy up essentially all of the Volkswagen shares on the open market in a takeover bid, the price skyrocketed and the short-sellers were squeezed. Their lawyers – including Bartlit Beck Herman Palenchar & Scott; Kleinberg, Kaplan, Wolff & Cohen; Dowd Bennett; and Quinn Emanuel Urquhart & Sullivan – asserted state-law fraud as well as federal securities claims, but when U.S. District Judge Harold Baer ruled in 2010 that the securities claims were barred by Morrison, he dismissed the entire case.
The hedge funds then refiled the fraud claims in state court, blazing a path that other Morrison refugees have since traveled. J.B. Heaton of Bartlit Beck, who represents Glenhill Capital, Greenlight Capital, Royal Capital and Tiger Global in this case, said that the state-court route doesn’t make sense for every securities plaintiff bounced out of federal court, since, generally speaking, investors can’t band together in a securities class action in state court. But for investors like his clients, who have sizable damages claims and the resources to litigate them, state court presented a viable alternative forum.
Porsche’s lawyers at Sullivan & Cromwell disagreed, but to no avail. In Porsche’s original motion to dismiss the hedge funds’ case, the company argued that New York state court was not the appropriate forum to litigate claims involving a German defendant’s purchases of German-listed stock. Those facts may have been enough to persuade Baer in federal court to invoke Morrison, but they didn’t convince Ramos in state court. In Wednesday’s ruling, Ramos focused instead on the hedge funds’ ties to New York and their New York-based due diligence on Porsche’s representations.
The state judge, in fact, adopted parochial reasoning that’s quite a contrast to the U.S. Supreme Court’s hands-off approach in Morrison. “The court rejects Porsche’s characterization of the issues in this action as the manipulation of the German stock market and the trade of German securities,” Ramos wrote. “At the core of plaintiffs’ claims [is] whether New York courts may hold responsible a foreign entity, who conducts business globally, for fraudulent misrepresentations purportedly aimed at New York plaintiffs. New York clearly has a vested interest in such an action.” (You can expect to see that language crop up in briefs by other Morrison refugees in state court.)
Ramos’s analysis didn’t end with the forum question, though. He had invited Porsche to brief the issue of whether the hedge funds, which are the very epitome of sophisticated investors, could reasonably claim that they relied on Porsche’s alleged misstatements about its Volkswagen intentions. As you probably recall, the New York state appeals court sent a loud message in March that to proceed with fraud claims, sophisticated investors can’t claim to have been misled by public statements and must show that they undertook their own investigation. (The hedge funds in the Porsche case were surely familiar with the state appellate ruling, since one of their counsel, Quinn Emanuel, lost the case.)
Porsche asserted in a supplemental brief and at oral argument last August that the hedge funds knew full well that Porsche was buying VW stock. They made an informed bet that the shares were overpriced, Porsche counsel Robert Giuffra of S&C told Ramos, and lost the bet. “They made it with their eyes wide open,” Giuffra said. “There were many contingencies that they were aware of: They knew about the public statements that Porsche had made; they knew about the fact that Porsche had cash settled options; they knew that the option holders on the other side of those cash settled options might well have hedged those options with owning stock; they knew there was a limited supply of stock.” If anyone was deceptive, Giuffra said at oral argument, it was one of the hedge funds, which pumped Porsche for inside information under the pretense that it was contemplating an investment in the company.
Ramos, however, was persuaded by the hedge funds’ evidence that a Porsche investor relations official actively deceived them. The hedge funds presented affidavits detailing several phone conversations in which fund managers asked the Porsche official whether the company’s statements about not wanting to snap up VW shares were true, and he said they were. Only after receiving those assurances, the funds alleged, did they short VW. The hedge funds also hired German legal and accounting experts and otherwise took care to educate themselves about their short position, Ramos said. So while it’s true that sophisticated investors must meet a higher standard of proof, the judge wrote, only Porsche actually knew that it intended to buy up the shares, and Porsche allegedly lied about it.
“Where the facts allegedly misrepresented were within the exclusive knowledge of the defendant, or where one party’s superior knowledge of essential facts renders the transaction without disclosure inherently unfair, a sophisticated plaintiff’s reliance on the defendant’s representations is not unreasonable as a matter of law,” Ramos wrote.
Hedge fund counsel Heaton of Bartlit Beck said the ruling stands for the proposition that defendants can be liable for duping even sophisticated investors. “You don’t get a free pass to defraud sophisticated investors just because they’re sophisticated,” he told me. Porsche counsel Giuffra said the company intends to appeal Ramos’s decision.
The hedge funds’ green light to proceed with discovery in state court raises some fascinating jurisdictional questions. Some short-sellers have brought claims against Porsche in Germany. Many hedge funds, including some that are not in the state case, have appealed Baer’s dismissal of the federal case and are awaiting a decision from the 2nd Circuit Court of Appeals. If the 2nd Circuit revives the federal case, there’s a chance that Porsche will face overlapping claims in three jurisdictions.
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