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Media Source: www.nyfraudclaims.com

CPLR 3016(b) requires the circumstances of fraud to be alleged in detail.  The one element of the cause of action for fraud for which courts afford more flexibility and less scrutiny under the heightened pleading standard is establishing fraudulent intent, or that the defendant intended to commit the fraud.  The courts recognize that because “intent” is uniquely within the possession of the defendant, a pleading need not allege details supporting that element, and it may be alleged through fair inferences.

As the First Department recently recognized in IKB International S.A. v. Morgan Stanley, 2016 N.Y.Slip.Op. 05779, Aug. 11, 2016:  “The element of scienter, that is, the requirement that the defendant knew of the falsity of the representation being made to the plaintiff, is, of course, the element most likely to be within the sole knowledge of the defendant and the least amenable to direct proof.”  The court continued:  “All that is required to defeat a motion to dismiss a fraud claim for lack of scienter is ‘a rational inference of actual knowledge.’”  Id.

In IKB, plaintiff was an international financial institution that had purchased over $132 million in residential mortgage backed securities.  The First Department ultimately ruled that the plaintiff had adequately pleaded the elements of fraud by alleging that “defendants knew that the offering documents misrepresented critical characteristics of the underlying mortgage loans, and that they fraudulently concealed the inferior quality of those loans by means of misstatements, misrepresentations, and omissions of material fact in the offering documents, and that plaintiffs undertook appropriate due diligence before purchasing the securities.”

Defendants moved to dismiss the complaint by arguing that plaintiff had not adequately alleged the circumstances establishing that defendant had intended to defraud plaintiff.  At the pleadings stage, it is highly unlikely for a defendant to succeed in dismissing a complaint by arguing that the plaintiff had not adequately pleaded in sufficient detail the element of fraudulent intent, or scienter.  The defendants in IKB fared no better than most defendants.

The Appellate Division, First Department observed what the courts long recognize:  “The element of scienter, that is, the requirement that the defendant knew of the falsity of the representation being made to the plaintiff, is, of course, the element most likely to be within the sole knowledge of the defendant and least amenable to direct proof.”  As a result, the Court noted:  “All that is required to defeat a motion to dismiss a fraud claim for lack of scienter is ‘a rational inference of actual knowledge.’”

Applying the foregoing analysis to the facts before it, the Court found that the “allegations that defendants were informed about defects in the loans that they were securitizing because they obtained this information through their own due diligence are sufficient to plead scienter.”  The Court continued:  “The due diligence reports prepared during the securitization process suggest that almost 39% of the loan files reviewed for defendants were defective; yet defendants included 56% of the nonconforming loans in its [securities], often making deals that allowed them to obtain the loans at steep discounts.  The complaint also alleges that defendants were uniquely positioned to know that the originators had abandoned their underwriting guidelines.  These allegations satisfy the element of scienter for pleading purposes.”

Although CPLR 3016(b) does require the allegations of fraud to be stated in detail, the element of fraudulent intent, or scienter, receives the least amount of scrutiny by the courts.