FILED: NEW YORK COUNTY CLERK 10/30/ :42 PM INDEX NO /2015 NYSCEF DOC. NO. 28 RECEIVED NYSCEF: 10/30/2015

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1 FILED NEW YORK COUNTY CLERK 10/30/ PM INDEX NO /2015 NYSCEF DOC. NO. 28 RECEIVED NYSCEF 10/30/2015 SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK X JAY DEUTSCH, AS MANAGING GENERAL PARTNER OF THE DEUTSCH FAMILY INVESTMENT PARTNERSHIP AND TODD DEUTSCH, -against- Plaintiffs, LIQUID HOLDINGS GROUP, INC. F/K/A LIQUID HOLDINGS GROUP, LLC, BRIAN FERDINAND, RICHARD SCHAEFFER, FERDINAND HOLDINGS, LLC, SCHAEFFER HOLDINGS, LLC, BRIAN STORMS, AND JOHN DOES I-X, Defendants X Index No /2015 DEFENDANT LIQUID HOLDINGS GROUP S REPLY MEMORANDUM OF LAW IN SUPPORT OF MOTION TO DISMISS BLANK ROME LLP Robert Kenney Michael D. Silberfarb Martin S. Krezalek 405 Lexington Avenue New York, New York (212) Attorneys for Liquid Holdings Group, Inc / v.2

2 TABLE OF CONTENTS Page INTRODUCTION...1 ARGUMENT...2 I. Plaintiffs Opposition Does Not Address the Deficiencies of its Fraud Claim...2 A. Plaintiffs have not Sufficiently Pleaded the Misrepresentation Element of their Fraud Claim Plaintiffs do not Sufficiently Allege that Liquid Made Affirmative Material Misrepresentations The Omissions Cited by Plaintiffs are Insufficient to Salvage Their Fraud Claim...4 (a) The Alleged Omissions do not Absolutely Qualify the Statements Relied upon by Plaintiffs...4 (b) The Special Facts Doctrine is Inapplicable...6 B. Plaintiffs Reliance was not Justifiable...9 C. Plaintiffs Group Pleadings are Insufficient...11 D. Liquid is not Responsible for the Acts of the Individual Defendants...11 II. The Aiding and Abetting Claim Must be Dismissed...12 CONCLUSION...12 i

3 TABLE OF AUTHORITIES Page(s) Cases Abrahami v. UPC Const. Co., 224 A.D.2d 231 (1st Dep t 1996)...9, 10 AHT Corp. v. Bioshield Technologies, Inc. (In re AHT Acquisition Corp.), 292 B.R. 734 (S.D.N.Y. 2003)...10 Andre Strishak & Associates, P.C., No. 4332/01(N.Y. Sup. Ct. July 13, 2001)...3, 4 Barnes v. Hodge, 118 A.D.3d 633 (1st Dep t 2014)...3 Black v. Chittenden, 511 N.Y.2d 665 (1986)...8 Braddock v. Braddock, 60 A.D.3d 84 (1st Dep t 2009)...9 Brass v. Am. Firm Tech., Inc., 987 F.2d 142 (2d Cir. 1993)...7 Coral Gables, Inc. v. Mayer, 241 A.D. 340 (1st Dep t 1934)...4, 5 CPC Intl. v. McKesson Corp., 514 N.E.2d 116 (N.Y. 1987)...8 Elghanian v. Harvey, 249 A.D.2d 206 (1st Dep t 1998)...5 Jana L. v West 129th St. Realty Corp., 22 A.D.3d 274 (1st Dep t 2005)...6, 9 Junius Const. v. Cohen, 257 NY 393 (1931)...4 Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. P ship, 12 N.Y.3d 236 N.E.2d 1049 (N.Y. 2009)...8 Matter of Barby Land Corp. v. Ziegner, 65 A.D.2d 793 (2d Dep t 1978)...10 ii

4 Reich v. Mitrani Plasterers Co., 268 A.D.2d 256 (1st Dep t 2000)...3, 4 Shareholder Representative Services LLC v. Sandoz, 9 N.Y.S.3d 595 (N.Y. Cty. Sup. 2015)...6, 7, 10 Stuart Silver Associates, Inc. v. Baco Dev. Corp., 245 A.D.2d 96 (1st Dep t 1997)...9 UST Private Equity Invs. Fund v. Salomon Smith Barney, 288 A.D.2d 87 (1st Dep t 2001)...11 Zanett Lombardier, Ltd. v. Maslow, 29 A.D.3d 495 (2006)...5, 9 Statutes Martin Act...8 Other Authorities Memo of Law, pp. 2, Memo of Law, p Memo of Law, p Memo of Law, p iii

5 INTRODUCTION 1 Plaintiffs Opposition fails to defeat any of the arguments raised in Defendants Motion. For example, as described in the Memo of Law, the Complaint does not detail, with the requisite specificity, the alleged false statements that Plaintiffs allegedly relied. In Opposition, Plaintiffs do not, because they cannot, argue that they sufficiently pleaded these statements. Instead, Plaintiffs cite to alleged false statements contained in Liquid s SEC stock registration statement. But those statements cannot be the basis of Plaintiffs fraud claim because, according to the Complaint, Plaintiffs never relied on them. Indeed, the Complaint makes clear that three of the four transactions at issue took place before the registration statement was even filed. Likewise, Plaintiffs fail to provide any valid basis for their argument that Defendants had a duty to disclose allegedly omitted facts. As detailed below, even under the outlier case law cited by Plaintiffs, Defendants had no duty to disclose such information. In addition, Plaintiffs fail to explain how their reliance on Defendants statements about Liquid was justifiable in light of the fact that they did not ask a single question, or request a single document, about those statements. Plaintiffs failure to perform reasonable diligence with respect to the arms length transactions at issue -- by definition -- renders Plaintiffs alleged reliance unjustifiable. Plaintiffs also fail to identify any valid basis for the Court to reject Liquid s argument that Plaintiffs group pleadings mandate dismissal of the fraud claim. Nor have Plaintiffs provided a valid reason for why Liquid should be held liable for the purported acts of the 1 Capitalized terms used herein but defined are ascribed the meaning given to them in Liquid s Memorandum of Law in Support of its Motion to Dismiss (the Memo of Law ). 1

6 Individual Defendants. And, Plaintiffs do not provide any support for their argument that their aiding and abetting claim could survive if the Court dismisses the underlying fraud claim. 2 As detailed more fully below and in the Memo of Law, Defendants have failed to state claims against Liquid -- or the other Defendants -- for fraud or aiding and abetting. Accordingly, the Court should reject the arguments in the Opposition and grant Liquid s Motion to Dismiss. ARGUMENT I. PLAINTIFFS OPPOSITION DOES NOT CURE THE DEFICIENCIES OF THEIR FRAUD CLAIM A. Plaintiffs have not Sufficiently Pleaded the Misrepresentation Element of their Fraud Claim Plaintiffs argue that they have sufficiently alleged both affirmative representations and omissions to satisfy the misrepresentation element of their fraud claim. (See Opposition, pp ). But, as detailed below, Plaintiffs allegations are insufficient, as a matter of law, to satisfy the pleading requirements of a fraud claim. 1. Plaintiffs do not Sufficiently Allege that Liquid Made Affirmative Material Misrepresentations The Complaint alleges that Plaintiffs collectively invested $1.25 million in Liquid solely in reliance on the information and data provided by Liquid at the February 12, 2013 meeting with the Individual Defendants. (Complaint 20-24). In its Memo of Law, Liquid argued that Plaintiffs allegations regarding the information and data provided at the February 2013 meeting lacked the requisite specificity to sustain a fraud claim. (Memo of Law, p. 4). In Opposition, Plaintiffs do not disagree. Instead, they argue that their fraud claim is based on six 2 Plaintiffs also fail to address Defendants argument that the Complaint must be dismissed (in part) because Plaintiffs fail to allege that they actually purchased Liquid stock in two of the four transactions at issue. (See Memo of Law, pp. 2, 11). 2

7 statements, which they refer to as affirmative misrepresentations. (Opposition, p. 11). But, as a matter of law, these six statements cannot be the basis of Plaintiffs fraud claim. For example, one of the statements -- that Defendants failed to indicate that Liquid was a sham company created for the enrichment of its founders, directors, and senior executives -- is conclusory and, therefore, is insufficient to satisfy the misrepresentation element of a fraud claim. See Barnes v. Hodge, 118 A.D.3d 633 (1st Dep t 2014) ( [C]onclusory allegations claims consisting of bare legal conclusions with no factual specificity are insufficient to survive a motion to dismiss. ) (citation omitted). In addition, even if this allegation was not conclusory, it is an omission -- not an affirmative misrepresentation -- and as alleged cannot be the basis a fraud claim. See infra, at 4. The five remaining affirmative misrepresentations that Plaintiffs allege are based on statements in Liquid s SEC Form S-1 registration (the S-1 Statement ). (Opposition p. 11, citing to Complaint 26, 28). But, these statements cannot be the basis of Plaintiffs fraud claim because Plaintiffs do not allege that they relied on these statements when they engaged in the transactions at issue. See Reich v. Mitrani Plasterers Co., 268 A.D.2d 256, 256 (1st Dep t 2000) (dismissing fraud claim where court found that plaintiffs had not seen brochures that contained the alleged misrepresentations until after the alleged reliance.); see also Andre Strishak & Associates, P.C., No. 4332/01, 2001 WL , at *2 (N.Y. Sup. Ct. July 13, 2001) ( A plaintiff cannot justifiably rely on an alleged misrepresentation that was not observed until the complained-of damage was discovered. ). Moreover, for three of the four transactions at issue, Plaintiffs purchased Liquid stock before the S-1 was even issued. (Complaint 25) (stating that S-1 Statement was issued on April 11, 2013); (Complaint 20-23) (acknowledging that all 3

8 previous transactions occurred prior to April 11, 2013). Reliance on representations in the S-1 Statement was not even possible. Thus, Plaintiffs argument that they relied on the S-1 Statement is nothing more than an after the fact -- and meritless -- attempt to salvage an insufficiently pleaded fraud claim. The Court should reject the argument. See Reich, 268 A.D.2d at 256; Andre Strishak & Associates, P.C, 2001 WL , at *2. 2. The Omissions Cited by Plaintiffs are Insufficient to Salvage their Fraud Claim Plaintiffs also contend that their fraud claim can be based on alleged fraudulent omissions made by Defendants. As detailed in Defendants Memo of Law, fraudulent omissions can only be the basis of a fraud claim where the party accused of fraud had a duty to disclose the omitted information. (Memo of Law, p. 5). Plaintiffs argue that Defendants were required to disclose the omitted information because (i) Defendants told Plaintiffs half-truths about Liquid s customers and financials; and (ii) Defendants had a duty to disclose the information under the special facts doctrine. (See Opposition pp ). The Court should reject both of these arguments. (a) The Alleged Omissions do not Absolutely Qualify the Statements Relied upon by Plaintiffs In support of the first argument -- that Defendants were required to disclose the alleged omitted information because Defendants told half-truths to Plaintiffs -- Plaintiffs cite two cases. (See Opposition pp (citing Junius Const. v. Cohen, 257 NY 393, 400 (1931) (involving claims for rescission and false representations not common law fraud); Coral Gables, Inc. v. Mayer, 241 A.D. 340, 342 (1st Dep t 1934)). Yet these cases, stand for the unremarkable proposition that a court may imply a misrepresentation where an alleged fraudster makes a material representation but leave[s] out something which, absolutely qualifies [the 4

9 representation]. Coral Gables, 241 A.D. at 342 (internal citations omitted). In other words, these cases stand only for the proposition that an omission can be considered a misrepresentation if the omission directly contradicts a material affirmative statement. Contrary to Plaintiffs implication, however, these cases do not mandate that a seller is under an obligation to reveal each and every detail about any topic he discloses to a buyer. See id. None of the alleged omissions here absolutely qualify the statements allegedly made by Defendants. For example, Plaintiffs argue that Defendants demonstration of Liquid s software required Defendants to disclose problems that Liquid allegedly encountered in trying to implement the software with one of its customers. (See Opposition, p. 14). But Plaintiffs fail to explain how one customer s dissatisfaction with a Liquid product contradicts what Plaintiffs learned from Liquid s demonstration of the software. (See id.) 3 Plaintiffs also claim that by describing the software as leading edge, Defendants had a duty to disclose that the product lacked a competitive advantage and that Liquid was a sham, designed to enrich the founders. (See Opposition, p. 14). But, Defendants description of the software as leading edge amounted to mere puffery, which can hardly establish a duty to disclose more information. See Elghanian v. Harvey, 249 A.D.2d 206, 206 (1st Dep t 1998) (holding that defendant s statements and omissions amounted to nothing more than puffery and thus were not actionable fraud). To the contrary, such a broad description of the product only suggests that Plaintiffs should have inquired more about Liquid s product. But, according to their own allegations, they failed to do so. 3 This alleged omission also cannot be the basis of Plaintiffs fraud claim because Plaintiffs fail to allege that any of Defendants knew about the customer dissatisfaction at the time they touted their customer relationships. See Zanett Lombardier, Ltd. v. Maslow, 29 A.D.3d 495 (2006) (to sustain cause of action for fraud plaintiff must allege scienter by wrongdoer.) 5

10 In addition, Plaintiffs claim that by touting its customer relationships and software revenues, Liquid and its agents were also required to disclose that some or all of those revenues were from clients who were paying for a product that did not work. (See Opposition, p. 14). The Court should reject this argument because there is no allegation in the Complaint that Plaintiffs ever relied on Defendants statements about customer revenues. See supra at 3. The purported affirmative statements did not create a duty to disclose the allegedly omitted facts. (b) The Special Facts Doctrine is Inapplicable Plaintiffs also argue that pursuant to the special facts doctrine, Defendants had a duty to disclose the alleged omissions. (Opposition, p. 14). That claim is incorrect. As detailed in the Memo of Law, the special facts doctrine provides that an omission may be considered to be a misrepresentation for purposes of a common law fraud complaint only where, the material fact was information peculiarly within the knowledge of [defendant], and that information was not such that could have been discovered by [plaintiff] through the exercise of ordinary intelligence. Jana L. v West 129 th St. Realty Corp., 22 A.D.3d 274, 277 (1st Dep t 2005). Plaintiffs argue that inquiries under the special facts doctrine are typically not resolvable on a motion to dismiss. (See Opposition at, p. 15). They, again, are incorrect. New York courts routinely find that determinations regarding the special facts doctrine may be addressed on a motion to dismiss. See, e.g., Shareholder Representative Services LLC v. Sandoz, 9 N.Y.S.3d 595, 599 (N.Y. Cty. Sup. 2015) (dismissal based on failure to show that plaintiffs exercised reasonable due diligence); Jana L., 22 A.D.3d at 278. Thus, the Court should look at the facts pleaded in the Complaint to determine whether the special facts doctrine could possibly apply here. And those facts make clear that it could not. To rely on the special facts doctrine, Plaintiffs must allege that they could not have discovered the alleged omissions by engaging in reasonable diligence. See Memo of Law, p. 6 6

11 (citing Sandoz, 9 N.Y.S.3d at 599). Plaintiffs fail to make that allegation. Instead, they argue that, regardless of what reasonable diligence might have revealed, the Court should assume that the alleged omissions were not discoverable because the transaction involved the purchase of stock. (See Opposition, pp (citing Brass v. Am. Firm Tech., Inc., 987 F.2d 142, 151 (2d Cir. 1993); Black v. Chittenden, 511 N.Y.2d 665, 669 (1986)). Plaintiffs again are simply wrong and the cases that they cite are inapposite. For example, Brass is not about the special facts doctrine, and it does not address whether, through reasonable diligence, the purchaser could have discovered the alleged omission. Id. Rather, Brass is akin to the line of cases discussed above, in which a seller, in making a true statement, is found to have made a misrepresentation by its failure to reveal facts that absolutely qualify the statement. In Brass, the Second Circuit held that a corporate officer who sold stock to an outside investor after two years of representations that the stock price could rise had a duty to disclose that the stock could not be traded on the open market. See Brass, 987 F.2d at The Court based its holding on the officer s overall conduct, especially his representations [to the investor] about the upward potential of [the stock] on the open market strongly implied that the stock... could be freely traded. See id. at 152. In these very limited circumstances, the Court found that because the alleged omission defeated the very purpose of the transaction at issue, the corporate officer had a duty to disclose. See id. This case is inapplicable here. As detailed above, this line of cases is inapplicable here. See supra, at Likewise, the Black case, is distinguishable. Black involved the purchase of a bowling alley -- not stock. See Black, 511 N.Y.2d at 669. The plaintiff in Black presented facts showing 4 The Second Circuit in Brass also acknowledged that the case was somewhat unusual and that it does not fit comfortably within [New York State] cases establishing a duty to disclose certain facts. Id. at 151. Thus, even if similarities exist between this case and Brass, the case lacks precedential value. 7

12 that the allegedly omitted information (about the bowling alley s condition) was not discernable to the untrained eye. See id. Unlike Plaintiffs here, the purchaser in Black solicited and received assurances from the seller about the allegedly omitted information. Id. Because the sellers assurances prevented the purchaser from discovering the allegedly omitted information, the court held that the special facts doctrine was applicable. Here, Plaintiffs do not allege that they solicited or received assurances about any of the alleged omissions regarding Liquid or Liquid s stock. To the contrary, according to Plaintiffs allegations, they did not ask any questions or conduct any due diligence. As a result, Black is inapposite. Plaintiffs attempt to use federal laws to implicate the special facts doctrine also fails. (See Opposition, p. 16). Plaintiffs made the strategic decision -- likely to avoid satisfying federal procedural requirements -- to pursue their action only under a state common-law fraud claim. They cannot now benefit from obligations to disclose that arise under the federal securities laws. Likewise, Plaintiffs cannot benefit from duties to disclose under the Martin Act because the Martin Act does not create a private cause of action, and therefore cannot be the basis of a common-law fraud claim. See Kerusa Co. LLC v. W10Z/515 Real Estate Ltd. P'ship, 12 N.Y.3d 236, 245, 906 N.E.2d 1049 (N.Y. 2009) (dismissing fraud claim where to accept [plaintiff s] pleading as valid would invite a backdoor private cause of action to enforce the Martin Act in contradiction to our holding in [CPC Intl. v. McKesson Corp., 514 N.E.2d 116 (N.Y. 1987)] that no private right to enforce that statute exists. ). The Court can ignore Plaintiffs the federal-law based arguments. In sum, Plaintiffs have failed to allege that they could not have performed reasonable diligence that would have allowed them to discover the alleged omissions. Instead, they ask this Court to extend the special facts doctrine to every case involving the purchase of stock, even 8

13 where a plaintiff has failed to allege that he could not have discovered the alleged omissions through reasonable diligence. (Opposition, at p. 14). Such broad application of the special facts doctrine is inconsistent with every case that has decided the issue, and it would effectively swallow the general rule. See, e.g., Jana L., 22 A.D.3d at 274. The Court should reject Plaintiffs argument. B. Plaintiffs Reliance was not Justifiable Plaintiffs argument that they justifiably relied on the information provided by Defendants also fails. Black letter law mandates that a party asserting a fraud claim allege that it justifiably relied on the alleged misrepresentations. See Braddock v. Braddock, 60 A.D.3d 84, 86 (1st Dep t 2009). Courts applying this standard have uniformly held that reliance is only justifiable where a party of ordinary intelligence would have relied on the statements. See Zanett Lombardier, Ltd. v. Maslow, 29 A.D.3d 495,496 (2006) (holding that plaintiffs could not claim justifiable reliance on alleged misrepresentations made in connection with their investment in two companies where they could have discovered the underlying condition and true nature of both companies with due diligence); Stuart Silver Associates, Inc. v. Baco Dev. Corp., 245 A.D.2d 96, 98 (1st Dep t 1997) (holding that plaintiff s reliance on figures presented in defendants offering materials for real estate venture was not justifiable because plaintiff failed to conduct due diligence). Under this standard, individual purchasers engaged in a private arms length transaction must perform reasonable diligence in order to satisfy the reliance prong of a fraud claim. See Abrahami v. UPC Const. Co., 224 A.D.2d 231, 234 (1st Dep t 1996) ( [W]here a party has means available to him for discovering, by the exercise of ordinary intelligence, the true nature of a transaction he is about to enter into, he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations ) (internal quotations and citations omitted); Sandoz, 9 N.Y.S.3d at 599 9

14 (reliance not justifiable where purchaser of company in arms length transaction failed to perform any due diligence); cf. Matter of Barby Land Corp. v. Ziegner, 65 A.D.2d 793, 794 (2d Dep t 1978) ( [t]he courts should not be placed in the position of having to guarantee the investments of a careless... buyer ). Plaintiffs argue that the court should ignore this well-established precedent and instead adopt a new standard under which reliance is justifiable so long as the statements relied upon were not preposterous on their face. (Id.) Plaintiffs warn that unless the Court adopts this extreme standard, self-interest would become a license to lie and cheat. (Id.) But, as detailed above, New York Courts have uniformly applied a far less strict standard -- and no moral hazard has resulted. Applying the appropriate standard, Plaintiffs purported reliance was unjustifiable. According to the Complaint, Plaintiffs and Defendants were engaged in four arms length transactions, pursuant to which certain Defendants agreed to sell Liquid stock to Plaintiffs. (Complaint 21-24). Prior to completion of these transactions, Plaintiffs attended a meeting during which certain Defendants allegedly made statements about Liquid s customers and products. (Complaint 17-19). Yet, the Complaint fails to allege that Plaintiffs asked even a single question about, or requested a single document supporting, the statements that allegedly were made. (Complaint 17-19). Instead, Plaintiffs, who were sophisticated investors, chose blindly to rely on Defendants vague statements when they engaged in the transactions at issue. Under these circumstances, Plaintiffs reliance was not justifiable. See Abrahami v. UPC Const. Co., 224 A.D.2d 231, 234 (blind reliance on unaudited financial statements not justifiable); AHT Corp. v. Bioshield Technologies, Inc. (In re AHT Acquisition Corp.), 292 B.R. 734, 736 (S.D.N.Y. 2003) (same); cf. UST Private Equity Invs. Fund v. Salomon Smith Barney,

15 A.D.2d 87, 88 (1st Dep t 2001) ( a sophisticated plaintiff cannot establish that it entered into an arm s length transaction in justifiable reliance on alleged misrepresentations if that plaintiff failed to make use of the means of verification that were available to it ). C. Plaintiffs Group Pleadings are Insufficient Plaintiffs also argue that the Court should not dismiss the Complaint based on the fact that it contains group pleadings. In support of their argument, Plaintiffs claim that they cannot be required to plead specifically which Defendant committed which act because that information will only become available during discovery. (Opposition, p ). That argument makes no sense. Plaintiffs attended the meeting where the alleged misrepresentations occurred -- and they knew who said what. Discovery is not necessary on this point. Still, the Complaint fails to make individualized pleadings with respect to these facts. (Complaint 19). Thus, contrary to Plaintiffs argument, group pleadings are not appropriate in these circumstances. The Court should dismiss the Complaint for this reason as well. D. Liquid is not Responsible for the Acts of the Individual Defendants Plaintiffs further argue that Liquid is responsible for the alleged fraudulent acts committed by the Individual Defendants. (Opposition, pp ). In support of this argument, Plaintiffs claim that the Individual Defendants were acting on behalf of Liquid because they had a dual motive to benefit both Liquid and themselves when they made the allegedly fraudulent statements. But that is simply not the case. With respect to three of the four transactions at issue, the Individual Defendants were acting solely for their own benefit -- and to the detriment of Liquid by selling their own stock instead of stock that Liquid owned. Liquid cannot be held responsible for these actions. 11

16 II. THE AIDING AND ABETTING CLAIM MUST BE DISMISSED Plaintiffs argue that, even if the fraud claim is dismissed, the aiding and abetting claim should not be dismissed because such claims can be pleaded alternatively. (Opposition, at p. 24). Plaintiffs again miss the point. As detailed in the Memo of Law, proof of the underlying fraud (against any defendant) is an element of an aiding and abetting claim. (Memo of Law, at p. 12). Thus, if the Court dismisses the fraud cause of action as to all Defendants, which it should, then the Court must also dismiss the aiding and abetting claim against Liquid. CONCLUSION For the foregoing reasons and the reasons set forth in the Memo of Law, Liquid s motion to dismiss should be granted and Plaintiffs complaint should be dismissed with prejudice. Dated New York, New York October 30, 2015 BLANK ROME LLP By /s/ Robert Kenney Robert Kenney Michael D. Silberfarb Martin S. Krezalek 405 Lexington Avenue New York, New York (212) Attorneys for Liquid Holdings Group, Inc. 12