HOLDER CLAIMS NOT ALLOWED IN NEW YORK AS OUT-OF-POCKET RULE PREVAILS

HOLDER CLAIMS NOT ALLOWED IN NEW YORK AS OUT-OF-POCKET RULE PREVAILS

A New York Appellate Court recently decided Starr Foundation v. American International Group, Inc. 901 N.Y.W. 2d 246 (N.Y. App. Div. 2010) in which it barred individual shareholders claims as being inconsistent with the long standing Out-of-Pocket Rule for fraud recovery. Starr Foundation held a majority of its assets in AIG stock. In an attempt to diversify its portfolio, Starr began to slowly divest itself of those stocks in 2006. Starr claims that AIG fraudulently made public statements which misrepresented the degree of risk involved with AIG’s large credit default swap portfolio. In reliance on this misrepresentation, Starr “was induced to set an excessively high ‘floor price” and postponed its sale of AIG stock in October of 2007. 

Starr was left holding the approximately 15.5 million shares when AIG’s stock declined upon discovery of its financial condition. Starr claimed that if it had not been for the misrepresentations, it would have continued to sell 15.5 million shares. Starr sought “to recover the value it hypothetically would have realized for its 15.5 million shares of AIG stock in the late summer or fall of 2007 had defendants at that time accurately disclosed the risk of AIG's credit default swap portfolio, less the stock's value after the alleged fraud ceased to be operative in early 2008.” 

The New York court stated that “[m]anifestly, such a recovery would violate New York's longstanding out-of-pocket rule, under which ‘[t]he true measure of damages [for fraud] is indemnity for the actual pecuniary loss sustained as the direct result of the wrong’” (Lama Holding Co. v Smith Barney, 88 NY2d 413, 421 [1996], quoting Reno v Bull, 226 NY 546, 553 [1919]). Such damages ‘are to be calculated to compensate plaintiffs for what they lost because of the fraud, not to compensate them for what they might have gained,’ and ‘there can be no recovery of profits which would have been realized in the absence of fraud’ (Lama, 88 NY2d at 421; see also Reno v Bull, 226 NY at 553 [‘The purpose of an action for deceit is to indemnify the party injured," and "(a)ll elements of profit are excluded’]). The Court went on to note that “[t]his action is virtually the paradigm of the kind of claim that is barred by the out-of-pocket rule. . . . A lost bargain more ‘undeterminable and speculative’ than this is difficult to imagine.”