As we noted at the time, it stood out as an anomaly last spring when a New York judge refused to dismiss the bond insurer ACA Financial Guaranty’s fraud suit against Goldman Sachs. ACA, which claims it was duped into providing financial guaranty insurance for Goldman’s notorious ABACUS 2007-ACI collateralized debt obligation, managed to survive the bank’s defense that ACA was a big, sophisticated investor that should have known the risks it faced in the CDO deal. Other plaintiffs in similar cases, meanwhile, kept running aground on the same defense.
Fortunately for Goldman and its lawyers at Sullivan & Cromwell, ACA’s claims didn’t hold up so well on appeal. In a divided ruling issued Tuesday, New York’s Appellate Division, First Department ordered the case dismissed, concluding that ACA could have ferreted out the facts about ABACUS on its own. The ruling reverses an April 2012 decision from New York Supreme Court Justice Barbara Kapnick.
The decision is a big setback for ACA, which claims that Goldman Sachs should have disclosed that Goldman hedge fund client Paulson & Co. was not only selecting assets for the CDO but also shorting the same assets. In ACA’s complaint, Marc Kasowitz of Kasowitz Benson Torres & Friedman accused Goldman of fraudulently inducing his client to insure ABACUS, "which was designed to fail so that Paulson could reap huge profits by shorting the portfolio and Goldman Sachs could reap huge fees."
Sullivan & Cromwell’s Richard Klapper countered in Goldman’s motion to dismiss that ACA could have simply asked Paulson what kind of position it was taking in the deal. In her ruling last year, Justice Kapnick rejected that argument partly because Goldman had already admitted in a $550 million settlement with the Securities and Exchange Commission that it should have disclosed Paulson’s role in constructing ABACUS.
The argument went over better with the appellate court, which ruled 5-2 Tuesday that Kapnick should have dismissed the fraud claims. "[P]laintiff could have, upon further inquiry, uncovered the nonparty hedge fund’s actual position, but apparently chose not to," the majority noted. "[P]laintiff should have questioned defendant or the non-party hedge fund; such an inquiry would have likely informed plaintiff that the nonparty hedge fund was taking a short rather than a long equity position represented."
Sullivan & Cromwell’s Klapper referred a request for comment to Goldman Sachs, which said in a statement that it was pleased with the ruling. ACA said that it would move for a reconsideration or pursue an appeal to the New York State Court of Appeals.
Kasowitz, for his part, told us the decision could wreak havoc if it’s allowed to stand. "Under the majority’s reasoning, any party in the position of investing or guaranteeing an investment would have an intolerably burdensome obligation to figure out in advance when every and any representation being made to it was a lie, and then procure in a contract a specific representation that such representation was untrue," he said. He added that the majority was wrong on the facts, since "indeed the allegations were that ACA did inquire of Paulson what its position was and then was lied to."
ACA amended its complaint in January to include Paulson as a defendant. Paulson’s lawyers at Willkie Farr & Gallgher have moved to dismiss, but Kapnick hasn’t yet issued a decision.
Read more about Tuesday’s decision from our affiliate the New York Law Journal.
