Loreley v. Wells Fargo

19-3304
Loreley v. Wells Fargo

In the
United States Court of Appeals
FOR THE SECOND CIRCUIT

AUGUST TERM 2020
No. 19-3304

LORELEY FINANCING (JERSEY) NO. 3 LIMITED, LORELEY FINANCING
(JERSEY) NO. 5 LIMITED, LORELEY FINANCING (JERSEY) NO. 15
LIMITED, LORELEY FINANCING (JERSEY) NO. 28 LIMITED, AND
LORELEY FINANCING (JERSEY) NO. 30 LIMITED,
Plaintiffs-Appellants,

v.

WELLS FARGO SECURITIES, LLC, WELLS FARGO BANK, N.A.,
HARDING ADVISORY LLC, AND STRUCTURED ASSET INVESTORS,
LLC,
Defendants-Appellees. *

On Appeal from the United States District Court
for the Southern District of New York

ARGUED: APRIL 7, 2021
DECIDED: SEPTEMBER 13, 2021

* The Clerk of Court is directed to amend the caption as set forth above.
Before: CALABRESI and MENASHI, Circuit Judges, and KOELTL,
District Judge. †

The plaintiffs invested in three collateralized debt obligations
(“CDOs”) created and offered by predecessors-in-interest to certain
defendants. Assets for the CDOs were selected according to stringent
eligibility criteria by collateral managers who are also defendants
here. When the financial crisis hit in 2008, the collateral underlying
the CDOs defaulted and the CDOs became worthless. The plaintiffs
brought suit for fraud, rescission, conspiracy, aiding and abetting,
fraudulent conveyance, and unjust enrichment alleging that the
defendants had misrepresented that the collateral managers would
exercise independence in selecting assets for the CDOs. The district
court granted summary judgment to the defendants. On appeal, the
plaintiffs claim to have detrimentally relied on the defendants’
misrepresentations that the collateral managers would exercise
independence in selecting assets for the CDOs.
We disagree. The plaintiffs based their investment decisions
solely on the investment proposals their investment advisor
developed. The advisor developed these detailed investment
proposals based on offering materials the defendants provided and
on the advisor’s own due diligence, which included conducting its
own risk analyses and asset valuations and vetting the collateral
managers. The plaintiffs, who did not directly communicate with the
defendants, therefore premise their fraud claims on the advisor’s
reliance on the defendants’ representations. Yet New York law does
not support this theory of third-party reliance. Accordingly, we hold

†Judge John G. Koeltl of the United States District Court for the Southern
District of New York, sitting by designation.

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that the plaintiffs have failed to establish, by clear and convincing
evidence, reliance on the defendants’ representations.

We also hold that the plaintiffs have failed to establish that the
defendants misrepresented or omitted material information for two
of the three CDO deals at issue—the Octans II CDO and the
Sagittarius CDO I. The defendants’ representations that the collateral
managers would exercise independence in selecting assets were not
misrepresentations at all; the plaintiffs have identified no evidence
that the collateral managers ceded control of asset selection to a non-
party hedge fund that was also an investor in the CDOs. Moreover,
the evidence indicates that the hedge fund’s involvement in asset
selection was known to the advisor. The defendants did not have a
duty to disclose their knowledge of the hedge fund’s investment
strategy because this information could have been discovered
through the exercise of due care. For these reasons, we AFFIRM the
judgment of the district court.

SHERON KORPUS, Kasowitz Benson Torres LLP, New
York, New York (David M. Max, Kasowitz Benson
Torres LLP, New York, New York; James M. Ringer,
Meister Seelig & Fein LLP, New York, New York;
Stephen M. Plotnick, Alexander Malyshev, Carter
Ledyard & Milburn LLP, New York, New York, on the
brief), for Plaintiffs-Appellants.

JAYANT W. TAMBE (Laura Washington Sawyer, Rajeev
Muttreja, James M. Gross, Amanda L. Dollinger, on the
brief), Jones Day, New York, New York, for Defendants-
Appellees.

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MENASHI, Circuit Judge:

In 2006 and 2007, Plaintiffs-Appellants Loreley Financing
(Jersey) No. 3 Limited, Loreley Financing (Jersey) No. 5 Limited,
Loreley Financing (Jersey) No. 15 Limited, Loreley Financing (Jersey)
No. 28 Limited, and Loreley Financing (Jersey) No. 30 Limited
(collectively, “Loreley”)—five special purpose entities formed for the
specific purpose of investing in securities known as collateralized
debt obligations (“CDOs”)—invested in three CDOs created and
offered by Wachovia subsidiaries (collectively, “Wachovia”) that
were the predecessors-in-interest to Defendants-Appellees Wells
Fargo Securities, LLC, Wells Fargo Bank, N.A., and Structured Asset
Investors, LLC (“SAI”). The collateral managers for these CDOs—
Defendants-Appellees Harding Advisory LLC (“Harding”) and
SAI—selected assets that met the CDOs’ eligibility criteria. When the
financial crisis hit in 2008, cash flow into the CDOs ceased and the
CDOs became worthless. Loreley sued the defendants for fraud,
rescission, conspiracy, aiding and abetting, fraudulent conveyance,
and unjust enrichment—alleging that the defendants had
misrepresented the collateral managers’ independence in selecting
assets for the CDOs.

Loreley now appeals to this court, for the second time, from a
judgment granting summary judgment to the defendants. Loreley
claims to have detrimentally relied on the defendants’
misrepresentations that the collateral managers would exercise
independence in selecting assets for the CDOs. We disagree. Loreley
based its investment decisions solely on the investment proposals
developed by its investment advisor, IKB Deutsche Industriebank AG
and IKB Credit Asset Management GmbH (collectively, “IKB”). IKB

4
developed these detailed investment proposals based on the
defendants’ offering materials and on IKB’s own due diligence, which
included conducting its own risk analyses and asset valuations and
vetting the collateral managers. For this reason, Loreley—which did
not communicate directly with the defendants—bases its fraud claims
on IKB’s reliance. Yet New York law does not support such a theory
of third-party reliance. See Pasternack v. Lab. Corp. of Am. Holdings, 807
F.3d 14 (2d Cir. 2015), certified question answered, 27 N.Y.3d 817, 829
(2016) (holding that misrepresentations that are not communicated to
a plaintiff cannot form the basis of a plaintiff’s reasonable reliance).
Accordingly, we hold that Loreley fails to establish by clear and
convincing evidence that it relied on the defendants’ representations.

Loreley also fails to establish by clear and convincing evidence
that the defendants misrepresented or omitted material information
for two of the three CDO deals at issue—the Octans II CDO and the
Sagittarius CDO I. The defendants’ representations that the collateral
managers would exercise independence in selecting assets were not
misrepresentations at all; Loreley has identified no evidence that the
collateral managers ceded control of asset selection to a non-party
hedge fund, Magnetar Capital LLC (“Magnetar”), which was also an
investor in the CDOs. Moreover, the evidence indicates that
Magnetar’s involvement in asset selection was known to IKB. The
defendants did not have a duty to disclose their knowledge of
Magnetar’s strategy because, based on what was already known to
IKB and the high level of access IKB had to relevant information to
conduct due diligence, this was information that could have been
discovered through the exercise of due care.

For these reasons, we affirm the judgment of the district court.

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 BACKGROUND

This appeal is the second time that this matter has come before
this court. We assume some familiarity with the subject matter
covered in our earlier opinion. See Loreley Fin. (Jersey) No. 3 Ltd. v.
Wells Fargo Sec., LLC (Loreley I), 797 F.3d 160, 164-69 (2d Cir. 2015).

I

This case concerns three CDOs—Octans II CDO (“Octans”),
Sagittarius CDO I (“Sagittarius”), and Longshore CDO Funding
2007-3 (“Longshore”)—that were sold to sophisticated investors,
including Loreley, by Wachovia subsidiaries, the predecessors-in-
interest to Wells Fargo Securities, LLC, Wells Fargo Bank, N.A., and
SAI. The CDOs were managed portfolios of assets. The CDOs’ assets
were selected and managed by collateral managers Harding, an
independent company, and SAI, a Wachovia subsidiary at the time.
Harding was the collateral manager for Octans, and SAI was the
collateral manager for Sagittarius and Longshore.

Loreley alleges that the defendants perpetrated two different
fraudulent schemes. Loreley’s allegations involve a non-party to this
litigation: Magnetar, a hedge fund that invested in the equity tranches
of the CDOs and simultaneously invested in the short-side of credit-
default swaps (“CDS”), positioning itself against the senior tranches
of those same CDOs. Loreley alleges that Magnetar coerced Harding
and SAI into accepting poor-quality assets for Octans and Sagittarius.
This coercion allegedly contradicted the defendants’ representations
in their offering materials that the collateral managers would exercise
independence when selecting “high quality assets with stable
returns” and would “minimize losses through rigorous upfront credit
and structural analysis, as well as ongoing monitoring of asset quality

6
and performance.” Loreley I, 797 F.3d at 167. Loreley invested $94
million into Octans in October 2006 and $10 million in Sagittarius
Class A and B notes in March 2007. Octans and Sagittarius defaulted
in May 2008 and October 2007, respectively.

Loreley’s fraud allegations regarding the Longshore CDO do
not involve Magnetar. As was the case with Octans and Sagittarius,
the Longshore offering materials emphasized that the collateral
manager, SAI, would exercise independence when selecting assets for
Longshore and would acquire assets from Wachovia through
arm’s-length transactions. Contrary to these representations,
Wachovia allegedly pressured SAI to accept assets for Longshore
from Wachovia’s warehouse at above-market prices so that Wachovia
could avoid losses from another, canceled CDO deal. 1 In April 2007,
Loreley bought notes of various Longshore tranches with a total face
value of $59.1 million. These notes went into default by February
2008.

II

In April 2012, Loreley filed suit in state court alleging state law
claims for fraud, rescission, conspiracy, aiding and abetting,
fraudulent conveyance, and unjust enrichment. See Am. Compl.,
Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC, 412 F. Supp. 3d
392 (S.D.N.Y. 2019) (No. 12-CV-3723), ECF No. 84. The suit was later

1 A warehouse is a bank account that acquires collateral in anticipation of
doing some type of securitization—in this case, creating collateralized debt
obligations. If a securitization deal falls through, the bank continues to keep
warehouse assets on its books and bears the market risk—gains and
losses—on those assets.

7
removed to federal court pursuant to the Edge Act. See 12 U.S.C. § 632;
28 U.S.C. § 1441(a).

In March 2013, the district court (Sullivan, J.) dismissed the
complaint with prejudice. Among other things, the district court held
that Loreley had failed to meet the heightened pleading standard set
forth in Federal Rule of Civil Procedure 9(b) for its fraud claims, and
the district court also dismissed its related claims of aiding and
abetting fraud, conspiracy to defraud, and rescission based on fraud.
Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC, No. 12-CV-3723,
2013 WL 1294668, at *7-15 (S.D.N.Y. Mar. 28, 2013). Loreley appealed.

This court disagreed with the district court. As for the fraud
claim relating to Octans and Sagittarius, we held that “[i]t is not for
us to say at this stage whether Plaintiffs’ account of Magnetar’s role
and of Defendants’ sleights of hand regarding that role is true, nor is
it for us to say whether, at a later stage, a judge or jury might find that
such misrepresentations were immaterial to sophisticated investors
like Plaintiffs.” Loreley I, 797 F.3d at 174-75. With regard to the fraud
claim relating to Longshore, this court held that Loreley had pleaded
sufficient facts to survive the defendants’ motion to dismiss but that
“the complaint could be more detailed as to the timeline and
valuation of the securities in question.” Id. at 180. Our court also noted
that because Loreley’s losses on all three CDOs coincided with the
financial crisis, there would need to be further inquiry at “later phases
of this lawsuit” with respect to whether Loreley’s claims would fail if
“the CDOs would have collapsed regardless [of the alleged fraud],
due to the larger crash in the MBS market.” Id. at 188. Accordingly,
we reversed in part, vacated in part, and remanded the case back to
the district court.

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 III

After remand, Loreley amended its complaint and removed the
non-fraud claims, and the district court dismissed its conspiracy
claim. Discovery was thereafter conducted between 2016 and 2018.

A

Discovery revealed the following details about asset selection
for Octans and Sagittarius.

Collateral manager Harding selected assets for Octans.
Harding’s founder, Wing Chau, testified that Harding would “source
the CDO CDS exposure to the market,” Harding’s analysts would
review those securities, and “to the extent that [the assets] met
[Harding’s] criteria and spread requirements, [Harding] would
execute those transactions.” App’x 579. Chau testified that “all the
securities that went into the Octans” warehouse or CDO were “fully
vetted by my analysts and myself.” App’x 580. Harding analyzed
each security to ensure that it met stringent eligibility criteria.
Sometimes that analysis was formalized in a document sent to
potential investors, including Loreley’s investment advisor, IKB.

Collateral manager SAI selected assets for Sagittarius. SAI’s
James Burke testified that a team of analysts, organized with respect
to each financial product, would consider each asset, model various
scenarios, scrutinize the originator and the servicer of the assets, and
generally “look at everything possible” before accepting the asset for
placement in Sagittarius. App’x 508. He further testified that every
asset that was accepted for Sagittarius was vetted by his team and that
he accepted assets only with which he was comfortable from a credit
perspective.

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 Magnetar, a hedge fund that purchased the equity tranches in
a number of CDOs including Octans and Sagittarius, was also
involved in suggesting assets for Octans and Sagittarius. As the
equity tranche investor in these CDOs, Magnetar had considerable
negotiating leverage with the banks. Magnetar’s senior vice
president, James Prusko, testified that Magnetar made “very clear
that the CDO had to have certain structural features and certain
economic terms that would make it attractive” for Magnetar to buy
into the equity tranches. Confidential App’x 53. These structural
features included suspending or eliminating certain cash-flow
triggers—including tests such as the overcollateralization and interest
coverage tests—that would have diverted cash flows from equity
investors to more senior note holders if the value of a CDO’s collateral
fell below a certain level or if interest payments declined by a
specified amount. This ensured that cash would continue to flow to
Magnetar through its equity positions (positions that are usually
subordinated to senior notes) even if returns to the more senior notes
slowed or stopped altogether.

Simultaneously, Magnetar bought protection against defaults
in the senior notes of both Octans and Sagittarius by taking short-side
positions in credit default swaps on the same CDOs in which
Magnetar held long equity positions. Prusko testified that Magnetar’s
goal on a portfolio-wide basis was to be “$2 of … shorts on [the senior
notes] against every $1 of long equity exposure.” App’x 3125. This
strategy achieved a return of about $1 billion when the financial
markets collapsed.

At Octans’s inception, Prusko asked Wachovia and Harding to
“discuss CDO exposure as I will source the CDO CDS.” App’x 1970.
Wachovia personnel considered Magnetar a “huge acc[oun]t,” App’x
10
4132, believed that Magnetar was “single-handedly driving the
market” for CDOs in 2007, App’x 3260, and characterized Magnetar
as “the darling of Wall Street, the popular girl that everyone wanted
to take to the prom,” App’x 3145. Chau also testified that he knew
Magnetar was hedging its position in Octans’s equity tranche by
buying protection on the senior tranches of Octans and on the senior
tranches of other CDOs in which it owned equity. He noted that
hedge funds, as part of their hedging strategy, generally purchase
hedging instruments that correlate with the underlying assets. Chau
testified that he “knew that [Magnetar] would hedge” in the same or
a similar way. App’x 3051. However, Chau maintained in his
testimony that “all the securities that went into the Octans II
warehouse or CDO [were] fully vetted by my analysts and myself”
and that those securities “met all the investment criteria.” App’x 580.
Chau repeatedly denied that any asset had been accepted for Octans
that had not been vetted and approved by his team.

Unlike Chau, Burke testified that he “had no reason to suspect”
that Magnetar was taking short positions against the CDOs in which
Magnetar had long positions in the equity tranches; he affirmed that
he was “shocked” when he learned of Magnetar’s strategy because he
had “[n]ever heard of anyone doing that.” App’x 2994. Burke testified
that he did not allow Prusko to source assets for Sagittarius. On at
least one occasion, Burke informed Prusko that he “would not accept
assignment of … trades,” App’x 1632, and complained to Wachovia
that “Prusko is under the impression that he can source credit risk …
for this deal at whatever levels he wants. I specifically [do] not want
this to occur,” App’x 1635. Although Burke characterized Prusko as
an “extremely important client,” App’x 3580, he testified that
Magnetar did not have the authority to select assets for Sagittarius.

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Burke even rejected on principle assets that Magnetar suggested, but
he later relented and accepted the assets because he felt “okay with
the credit risk.” App’x 511-12.

B

Discovery revealed the following details about asset selection
for Longshore.

SAI was the collateral manager for Longshore. Beginning in
February 2007, Wachovia noted “market volatility” and “feared
contagion and/or disappearance of liquidity in [the] CDO market”
and sought to unload its inventory and to accelerate pending deals.
App’x 3439. Wachovia identified Longshore as one of the “[d]eals of
focus” that Wachovia wanted to accelerate before liquidity
“disappear[ed].” App’x 3439.

Wachovia sought to transfer assets into Longshore from the
warehouse of a canceled CDO deal at the original prices rather than
at the then-current market prices. When Burke learned that Wachovia
would be transferring assets to Longshore from the canceled CDO’s
warehouse—the “Grand Avenue” warehouse, managed by a
collateral manager named TCW—he informed Wachovia by email:

I am VERY sensitive to where SAI might take down bonds from
the TCW warehouse. I do not want anymone [sic] in the market
to think we were stuffed with bonds at above-market prices. So
– if TCW is still doing a deal, SAI should only take whatever
bonds it wants at MARKET prices.

App’x 1972. Subsequently, Burke wrote to Dash Robinson, a director
in Wachovia’s Asset Repackaging Group, stating that “[t]he marks
you provided for the bonds to be transferred over to [Longshore] …

12
are not defensible” and that “the difference between your marks and
the trading system (on the cash bonds alone) is over $1 mm” and the
“difference on the CDS will be much larger.” App’x 4206. 2

On March 13, 2007, Wachovia’s chief compliance officer, David
Hunt, defended the asset transfer at the above-market prices by
explaining that SAI’s “fiduciary responsibility extends to each of its
clients” and requires SAI to obtain the “best execution” possible.
App’x 3450. Burke responded by suggesting that the full list of assets
and the prices at which those assets were transferred be disclosed to
prospective investors before Longshore was priced and before
prospective investors committed. He was concerned that investors
would object if they committed to Longshore and subsequently
learned that Longshore had accepted $300 million of collateral at
above-market prices. That same day, Burke emailed his wife that “I’m
having a very bad day. I’m being asked/told to do something that I
believe is improper/unethical.” App’x 4952.

Over Burke’s objection, the Grand Avenue assets were
transferred to Longshore at the original purchase prices rather than at
the current market prices. Burke’s team “review[ed] all the bonds in
the warehouse” and told him “exactly which bonds they were
comfortable with from a credit perspective.” App’x 529. Burke
testified that only those bonds that met the eligibility criteria from a
risk perspective were taken into Longshore. SAI ultimately accepted
all but two bonds for Longshore.

2 “Marks” refers to the assets’ “mark to market,” which is the value of each
asset at the market price at the time of each inventory. Mark to market,
Wolters Kluwer Bouvier Law Dictionary (2012).

13
 However, Burke “made it very clear that these were not assets
that [he] had purchased into [Longshore’s] warehouse, and if [he was]
going to take those assets into [the] warehouse today, [he] would
want them to happen at the current market price.” App’x 3009. Burke
believed the “marks” were inaccurate and “should have been marked
lower.” App’x 3020. He also testified that he “made it very clear” that
all investors were to have information about the purchases and was
told that they in fact received that information. App’x 3021.

Wachovia advised IKB of a slight decline in the value of the
Longshore assets since those assets were acquired—specifically, that
“the current weighted average price of the Longshore 3 portfolio is
just under 99” and that there were mark-to-market losses for the deal
on closing. App’x 1296, 1299. IKB subsequently requested the current
marks of the Longshore portfolio. Wachovia sent a spreadsheet that
did not contain the current market prices of the transferred assets and
from which the current marks may have been deleted. However,
emails between Wachovia’s Robinson and IKB appear to indicate that
a spreadsheet containing the current marks may have been sent to IKB
on or around March 4, 2007.

C

Offering materials for Octans, Sagittarius, and Longshore were
distributed to potential investors, including IKB. For Octans, the
materials included term sheets, a marketing book, and an offering
circular. Octans’s offering memorandum identified Harding as the
collateral manager and explained that the “performance of the
portfolio … depends heavily on the skills of the Collateral Manager
in analyzing and selecting the Collateral Debt Securities.” App’x 5020.
It also specified that Octans is a “complex instrument[] … involv[ing]

14
a high degree of risk and [is] intended for sale only to sophisticated
investors who are capable of understanding and assuming the risks
involved.” App’x 2178.

Wachovia also provided term sheets, a marketing book, and an
offering memorandum for Sagittarius. The term sheet noted that
SAI’s relationship with Wachovia provided “[a] key market
advantage for SAI” because SAI could “leverage off of the resources
and infrastructure of Wachovia, while maintaining strict separation
from the trading and sales side of the broker/dealer.” App’x 2551.
SAI’s investment approach was described as “maximiz[ing] returns
and minimiz[ing] losses through rigorous upfront credit and
structural analysis as well as ongoing monitoring of asset quality and
performance.” App’x 2551. Just like the offering memorandum for
Octans, the offering memorandum for Sagittarius stated that
Sagittarius’s performance would be “highly dependent” on SAI’s
financial and managerial expertise, App’x 2585, and that Sagittarius
is a “complex instrument[] … intended for sale only to sophisticated
investors who are capable of understanding and assuming the risks
involved,” App’x 395. The offering memorandum also cautioned that
any investor in Sagittarius should have the knowledge and
experience to evaluate the merits and risks of this investment and
should exercise independent judgment in its decision to invest in
Sagittarius.

Finally, Wachovia provided term sheets, a marketing book, and
an offering memorandum for Longshore, all of which made similar
representations as those in the offering materials for Octans and
Sagittarius. Longshore’s marketing book also promoted SAI’s
relationship with Wachovia, explaining that the relationship gave SAI
“vast resources and infrastructure” while “maintaining strict
15
separation from the broker/dealer.” App’x 2696. Just as in Octans’s
and Sagittarius’s offering materials, the memorandum explained the
importance of the collateral manager’s skills in analyzing, selecting,
and managing collateral and explained that Longshore’s performance
would be “highly dependent” on SAI’s expertise. App’x 2796. The
circular also warned potential investors that even though SAI was a
subsidiary of Wachovia, SAI may nevertheless engage in securities
transactions with Wachovia that might result in conflicts of interest.
In those circumstances, the circular guaranteed that SAI would
acquire collateral “on an arm’s-length basis” and “at fair market
prices” but could take advantage of other benefits of the relationship
such as “obtaining favorable commissions.” App’x 4013.

D

Discovery also revealed IKB’s prominent role in Loreley’s
decision to invest in the CDOs. IKB was a German banking company
that created the Loreley entities and served as the investment advisor
for those entities’ investment into Octans, Sagittarius, and Longshore.
These investments were part of a larger investment program called
the Rhineland Program. IKB advised Loreley, but it did not invest
directly on Loreley’s behalf because it did “not have authority to act
for or represent” Loreley or the authority to “incur any obligation or
liability on behalf of” Loreley. App’x 1571.

IKB assessed potential investments for the Rhineland Program
to ensure those investments met IKB’s criteria. A potential investment
would go through several levels of review. When approached with an
investment opportunity, IKB would commence due diligence. This
process included analyzing the CDO’s risk, evaluating the investment
in terms of its financial structure, and vetting the experience and

16
expertise of the collateral manager. IKB’s chief investment officer and
the investment committee would then “sign off” on the investment
proposal before it was given to Loreley. App’x 743. SAI’s James Burke
testified that IKB “conducted the most thorough due diligences of any
investor [he] had ever met with.” App’x 507.

Consistent with its general practice, IKB conducted a risk
analysis on Octans. IKB noted that because of “increasing pressure
from equity investors,” Octans did not have overcollateralization and
interest coverage tests and “[i]n return the rating agencies demanded
a thicker equity tranche and therefore a higher subordination for the
rated notes.” App’x 1097-98. However, IKB noted that Octans did
have a net loss test, effective five years after the closing date, that
triggered cash diversion from subordinate tranches if the loss in the
portfolio “correspond[ed] to the amount of the nominal volume of the
preferred shares.” App’x 1097. The net loss test and relatively high
subordination were “demanded by the rating agencies to balance out
the weaker structure,” which IKB saw as a “positive.” App’x 1098.

IKB performed various stress tests on the Octans portfolio and
concluded that the portfolio withstood the “IKB worst case scenario.”
App’x 1099. IKB also “emphasized positively” the “experience and
long-time collaboration of the key persons of the [Harding] team.”
App’x 1098. IKB had more than one in-person meeting with
representatives from Harding during which it performed “on-site due
diligence” and vetted the collateral manager. App’x 1098.

IKB then created an investment proposal for IKB’s Investment
Advisory Board. In this proposal, IKB noted Wing Chau’s experience
and the experience of Harding’s senior managers, who had spent over
twelve years in structured finance and related fixed income sectors.

17
App’x 1014. IKB explained the various stress tests it had performed
and concluded that in a worst-case scenario, the portfolio loss would
be only about 3.68 percent. App’x 1024. IKB based its final
recommendation on four factors: the “quality of the Manager,” the
results of the stress tests, the structural features of the portfolio, and
other “credit enhancement[s].” App’x 1028. IKB ultimately
recommended that Loreley invest in Octans and provided its
investment proposal to IKB’s Advisory Board. IKB’s internal risk
analysis was not included.

IKB also created an investment proposal recommending
investment in Sagittarius. IKB favorably described SAI’s “rather
conservative investment approach,” about which IKB had learned
during its meetings with “James Burke and key staff of his team.”
App’x 1039, 1043. IKB performed various stress tests and other risk
analysis and noted that “there are very rare issues which can be
categorized as being totally clean from a risk perspective at this point
in time.” App’x 1042. IKB also observed that “uncertainty exists
around the question” of whether the portfolio’s conservative asset
selection and structural enhancements would be “sufficient to
completely immunize [the] bonds in a further deteriorating
environment against defaults.” App’x 1042. As with Octans, IKB
identified the absence of overcollateralization and interest coverage
tests but noted that the CDO’s structural features showed “adequate
protection for the Noteholders despite the innovative financing
structure.” App’x 1045. IKB explained that the “[e]quity investor
[was] the driving force” behind the structure and therefore “any
beneficial change to this was not negotiable,” but “real shortfalls will
be unlikely due to the structure of the transaction’s liabilities.” App’x
1046. IKB also observed that “systemic deterioration is expected” and

18
that the unproven depth of the synthetic market could limit SAI’s
ability to react proactively to unfavorable market events. App’x 1047.
Finally, IKB commended SAI’s “close relationship to Wachovia,”
noting the flexibility that the relationship provided SAI. App’x 1043.
IKB characterized SAI as an “above average Manager,” with a
“prudent” management style, that was “uncomfortable with … above
average risk characteristics in the pools they … consider for
investments.” App’x 1043.

Based on these considerations, IKB recommended investment
in Sagittarius. In making its recommendation, IKB highlighted two
major factors: the “high quality of the manager” and the structure of
the transaction. App’x 1048. IKB conveyed the recommendation to
Loreley through a letter that accompanied IKB’s investment proposal.

IKB additionally created an investment proposal for
Longshore. IKB recommended investment into Longshore based on
the “good quality of the underlying portfolio” as well as SAI’s good
judgment, strict eligibility criteria, and tight overcollateralization test
levels that would divert cash flows into senior tranches if the portfolio
collateral deteriorated. App’x 1213. IKB based its evaluation on
several in-person meetings between members of IKB and key
members of SAI, including Burke. Just as IKB noted in the investment
proposal for Sagittarius, IKB favorably described SAI’s “close
relationship to Wachovia” and the flexibility it gave SAI to react to
market developments. App’x 1218. IKB also emphasized SAI’s
conservative approach to choosing collateral and characterized SAI as
an “above average Manager.” App’x 1218. IKB observed that SAI’s
conservative asset selection process was in part based on SAI’s
concern about reduced liquidity in the credit markets. IKB identified
no weaknesses in the investment into Longshore. IKB’s final
19
investment proposal did not include Burke’s disclosure regarding the
slight decline in the value of the Longshore assets from collateral
taken from the canceled Grand Avenue CDO. IKB’s investment
proposal recommended investment into Longshore and was
approved by IKB’s Investment Committee before it was given to
Loreley.

Loreley based its investment decisions solely on these
investment proposals. Loreley did not receive any other materials—
including any of the offering materials—prior to investing into
Octans, Sagittarius, and Longshore. Loreley also did not
independently confirm whether the investments conformed to IKB’s
investment criteria.

IV

On September 17, 2019, the district court (Crotty, J.) granted
summary judgment to the defendants on several independent
grounds. Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC (Loreley
II), 412 F. Supp. 3d 392 (S.D.N.Y. 2019). The district court held that
Loreley had failed to provide clear and convincing evidence that
(1) Loreley had detrimentally relied on the defendants’
representations, id. at 409, 411, or (2) the defendants had made any
material misrepresentations or omissions concerning the collateral
managers’ independence or Magnetar’s role in the Octans and
Sagittarius deals, id. at 407-08. 3

3 Because we affirm the district court on these grounds, we need not decide
other questions that the district court considered, such as whether Loreley
established loss causation. See Loreley II, 412 F. Supp. 3d at 412.

20
 The district court held that Loreley failed to establish the
reliance element of fraud because the defendants’ purported
misstatements in the offering materials were “not ultimately
transmitted to Plaintiffs in IKB’s written investment proposals.” Id. at
411. The district court also held that even if Loreley had relied on the
defendants’ representations pertaining to Octans and Sagittarius,
those representations were true and not misleading. Id. at 410. The
district court also concluded that there was no material omission
regarding Magnetar’s role in those deals because Magnetar’s role was
known to IKB, which decided not to make further inquiries about
Magnetar’s strategy. Id. at 409. Having dismissed Loreley’s claims of
fraud, the district court dismissed its related claims—conspiracy to
defraud, aiding and abetting fraud, and rescission based on fraud. Id.
at 412.

Loreley timely appealed.

STANDARD OF REVIEW

We review a district court’s grant of summary judgment de novo
and will affirm if “the movant shows that there is no genuine dispute
as to any material fact” and the “movant is entitled to judgment as a
matter of law.” Lehman XS Trust, Series 2006-GP2 v. GreenPoint Mortg.
Funding, Inc., 916 F.3d 116, 123 (2d Cir. 2019) (quoting Fed. R. Civ. P.
56(a)). We consider the record in the light most favorable to the non-
movant, Jackson v. Fed. Exp., 766 F.3d 189, 192 (2d Cir. 2014), and we
resolve all ambiguities and draw all factual inferences in favor of the
non-movant “if there is a ‘genuine’ dispute as to those facts.” Scott v.
Harris, 550 U.S. 372, 380 (2007) (citing Fed. R. Civ. P. 56(c)). A fact is
material if it “might affect the outcome of the suit under the governing
law.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).

21
 DISCUSSION

On appeal, Loreley argues that the district court erred in
granting summary judgment to the defendants on Loreley’s fraud
claim. We disagree and affirm the judgment of the district court.
Loreley has failed to establish by clear and convincing evidence that
it reasonably relied on the defendants’ representations or, for the
Octans and Sagittarius deals, that the defendants materially
misrepresented or concealed the collateral managers’ independence
or Magnetar’s role in asset selection and investment strategy.

I

Under New York law, the five elements of fraud are “(1) a
material misrepresentation or omission of fact (2) made by [a]
defendant with knowledge of its falsity (3) and intent to defraud;
(4) reasonable reliance on the part of the plaintiff; and (5) resulting
damage to the plaintiff.” Crigger v. Fahnestock & Co., 443 F.3d 230, 234
(2d Cir. 2006); Pasternack, 27 N.Y.3d at 827. Each element “must be
shown by clear and convincing evidence.” Banque Arabe et
Internationale D’Investissement v. Maryland Nat’l Bank, 57 F.3d 146, 153
(2d Cir. 1995). At the summary judgment stage, a plaintiff must offer
enough evidence to allow a reasonable jury to find by clear and
convincing evidence that each of the elements is met. Merrill Lynch &
Co. v. Allegheny Energy, Inc., 500 F.3d 171, 181 (2d Cir. 2007) (citing
Crigger, 443 F.3d at 234, and Jo Ann Homes at Bellmore, Inc. v. Dworetz,
25 N.Y.2d 112, 119 (1969)); see also Banque Franco-Hellenique de
Commerce Int’l et Maritime, S.A. v. Christophides, 106 F.3d 22, 25 n.2 (2d
Cir. 1997). “Clear and convincing evidence is evidence that satisfies
the factfinder that it is highly probable that what is claimed actually
happened and it is evidence that is neither equivocal nor open to

22
opposing presumptions.” Seon v. N.Y. State Dep’t of Motor Vehicles, 74
N.Y.S.3d 20, 25 (N.Y. App. Div. 1st Dep’t 2018) (alteration omitted)
(quoting In re Gail R., 891 N.Y.S.2d 411, 414 (N.Y. App. Div. 2d Dep’t
2009)), rev’d on other grounds, 35 N.Y.3d 1032 (2020).

Loreley’s claim for fraud fails because Loreley has not
established reliance. Loreley has not identified any evidence, much
less clear and convincing evidence, that it received any
communications from the defendants. Misrepresentations that were
not communicated to a plaintiff cannot form the basis of a plaintiff’s
reasonable reliance. Pasternack, 27 N.Y.3d at 829. It remains
undisputed in this appeal that the defendants did not communicate
directly with Loreley. Compare Loreley II, 412 F. Supp. 3d at 410, with
Appellants’ Br. 50-55. It is also undisputed that Loreley’s investment
decisions were based solely on IKB’s advice and proprietary
investment proposals. IKB did not give Loreley the offering materials
that were created and distributed by the defendants or even IKB’s
internal risk analyses that IKB had conducted during its due
diligence. Because Loreley cannot show that the defendants’
purported misrepresentations actually reached Loreley, it cannot
show that it relied on these purported misrepresentations.

To avoid this problem, Loreley argues that it reasonably relied
on the defendants’ indirect communications because IKB
“summarized” the defendants’ alleged misrepresentations for
Loreley. Appellants’ Br. 49. This theory of reliance is not viable under
New York law. The reliance element of fraud cannot be based on
indirect communications through a third party unless the third party
acted as a mere conduit in passing on the misrepresentations to a
plaintiff. Pasternack, 27 N.Y.3d at 828-29.

23
 Here, the record does not create a disputed issue of material
fact as to whether IKB acted as a mere conduit. Reliance on an
intermediate third party can form the basis of a claim for fraud when
the third party acts as a scrivener by transcribing and distributing a
defendant’s representations without filtering or modification.
Pasternack, 27 N.Y.3d at 828 (citing Eaton Cole & Burnham Co. v. Avery,
83 N.Y. 31, 35 (1880), and Bruff v. Mali, 36 N.Y. 200, 206 (1867)). Such
a theory of third-party reliance is limited. When the defendants’
misrepresentations are “filtered through” a third party’s “own
process of evaluation” or the third party plays “a significant role in
choosing what information it wanted to receive and, in addition, what
it deemed worthy of communicating,” the third party has not acted
as a mere conduit and the theory is not viable. Sec. Investor Prot. Corp.
v. BDO Seidman, 95 N.Y.2d 702, 710-11 (2001).

That is the case here. The defendants’ representations were
“filtered through” IKB’s “own process of evaluation”; IKB played “a
significant role in choosing what information it wanted to receive
and, in addition, what it deemed worthy of communicating.” Id. IKB
did not simply transmit the defendants’ representations regarding the
expertise and independence of the collateral managers. Rather, IKB
vetted the managers, often meeting with the collateral managers in
person, and drew its own conclusions about the strengths and
weaknesses of the managers’ investment philosophies. For example,
IKB examined SAI’s conservative investment philosophy and
concluded that its approach would aid Sagittarius’s and Longshore’s
future performance. IKB was also aware of abnormal structural
features built into Octans and Sagittarius at Magnetar’s insistence and
factored those features into its analysis. Ultimately, IKB concluded
that the features would be balanced by other, protective structural

24
features such as the net loss test. Moreover, despite the concerning
structural features, IKB’s stress tests revealed that shortfalls would be
“unlikely.” App’x 1046; see also App’x 1098.

IKB’s filtering and evaluation process was extensive. IKB’s due
diligence involved conducting its own risk analyses, performing
stress tests, and exercising independent judgment in determining the
benefits and risks of investment in the CDOs. IKB’s vetting process
involved a multi-level review of the investment opportunities. IKB
independently analyzed the risk, conducted stress tests, and created
detailed investment proposals spanning hundreds of pages. Each
proposal received approval from the chief investment officer and the
investment committee before being presented to Loreley. In order to
conduct its due diligence, IKB requested further information, as
evidenced by the email exchanges between IKB and the defendants.
IKB also met in person with the collateral managers for the purpose
of vetting the collateral managers and collecting other information
about the investment opportunities.

IKB played “a significant role in choosing what information it
wanted to receive and, in addition, what it deemed worthy of
communicating.” BDO Seidman, 95 N.Y.2d at 710. Loreley did not
receive offering materials created by the defendants. Loreley did not
receive IKB’s risk reports beyond what was summarized in IKB’s
proposals. In one instance, although the defendants’ offering
materials stated that Longshore assets would be acquired at fair
market value, that representation was not included in IKB’s written
investment proposal—the only document provided to Loreley in
support of IKB’s recommendation. When SAI later informed IKB of
the slight decline in the value of the Longshore assets from collateral
taken from the canceled CDO, IKB requested and received further
25
information from the defendants. IKB, however, decided not to relay
this information to Loreley because the information did not affect
IKB’s recommendation.

In fact, contrary to Loreley’s argument, the evidence here
indicates that the defendants did not intend for their representations
to be passed to Loreley without filtering and modification. 4 Rather,
the defendants expected that IKB would conduct its own due
diligence on the deals. The offering materials caution that investing
in the CDOs is appropriate only for investors with the expertise to
assess complex instruments and encouraged prospective investors to
conduct due diligence and to exercise independent judgment. The
offering materials provided to prospective investors, including IKB,
included hundreds of pages detailing valuations of the structured
notes, risk analyses on various aspects of each CDO’s portfolio, and

4 The district court relied on In re LIBOR-Based Fin. Instruments Antitrust
Litig., No. 11-MDL-2262, 2015 WL 6243526, at *63 (S.D.N.Y. Oct. 20, 2015),
for the proposition that “for Plaintiffs to have reasonably relied on
statements communicated through a third party, Defendants must have
intended for the misrepresentations to be communicated by the third party,
IKB, to Plaintiffs.” Loreley II, 412 F. Supp. 3d at 411-12. Under New York
law, however, reliance on communications from a third party cannot form
the basis of a fraud claim, regardless of the defendant’s intent, unless the
third party was a mere conduit. Pasternack, 27 N.Y.3d at 828-29; see also id.
at 834-35 (Fahey, J., dissenting) (disagreeing with the majority that reliance
cannot be established through evidence that a third party relied on the
alleged misrepresentation even when the misrepresentation was made with
the intent of influencing the plaintiff and causing injury). Even if intent
were relevant, the evidence in this record is neither clear nor convincing
that the defendants intended for IKB to transmit its representations to
Loreley without substantial filtering, evaluation, and modification; rather,
the evidence indicates that the defendants knew IKB was conducting due
diligence and that it would not act as a mere conduit.

26
complex contractual conditions triggered by various stress scenarios.
See, e.g., App’x 2194-97. These materials called for the application of
expertise and analysis. Additionally, IKB was known to be a
sophisticated investment advisor. As noted above, according to SAI’s
Burke, IKB “conducted the most thorough due diligences of any
investor [he] had ever met.” App’x 507.

For these reasons, Loreley has not established reliance by clear
and convincing evidence.

II

Loreley also fails to show by clear and convincing evidence that
defendants misrepresented that the collateral managers would

27
exercise independence 5 in selecting assets for Octans and
Sagittarius. 6

Loreley argues that the defendants ceded control of asset
selection to Magnetar. Yet even if Magnetar exerted pressure over the
asset selection process, the evidence does not show that either
Harding or SAI allowed Magnetar to control the process. Both Chau
and Burke testified that each security considered for Octans and
Sagittarius was vetted by their teams and accepted only if the security

5 The defendants correctly note that the offering materials did not expressly
represent that the collateral managers would exercise independence.
Appellees’ Br. 39-41. The only express representation in the offering
materials regarding independence is Wachovia’s representation that SAI
would acquire collateral “on an arm’s-length basis” and “at fair market
prices,” App’x 4013, in transactions with Wachovia. This representation
does not implicate the defendants’ relationship to Magnetar. However, to
the extent that the offering materials emphasized that the collateral
managers’ expertise would be important to the CDOs’ performance, and
those statements implied that the managers would exercise independent
judgment in asset selection, the fact that a third party with possibly adverse
economic interests was dictating asset selection would be inconsistent with
that representation and material to an investor’s decision to invest. See
Moore v. PaineWebber, Inc., 189 F.3d 165, 170 (2d Cir. 1999) (noting that a
material fact is one “significant to a reasonable person considering whether
to enter into the transaction”).
6 We cannot reach the same conclusion with respect to Longshore because
Loreley has offered sufficient evidence—including that the then-current
marks of the Longshore portfolio may have been withheld from IKB—for a
factfinder to find by clear and convincing evidence that Wachovia and SAI
misrepresented that assets for Longshore would be acquired in arm’s-
length transactions. As explained above, however, because those
misrepresentations were never communicated to Loreley, Loreley’s fraud
claim pertaining to Longshore fails for lack of reliance.

28
met the CDOs’ stringent eligibility criteria. 7 In fact, Burke and Prusko
appear to have had a tense relationship because Burke insisted on
maintaining his independence during this process. Burke would not
allow Prusko to originate assets for Sagittarius. On one occasion,
Burke informed Prusko that he “would not accept assignment of …
trades,” App’x 1632, and complained to Wachovia that “Prusko is
under the impression that he can source credit risk … for this deal at
whatever levels he wants. I specifically [do] not want this to occur,”
App’x 1635. Burke maintained that Magnetar did not have the
authority to select bonds for Sagittarius, and he even rejected on
principle several bonds suggested by Magnetar, later relenting
because those bonds met Burke’s risk criteria.

Moreover, Magnetar’s role in structuring both deals was
known to IKB. IKB’s investment proposals for both Octans and
Sagittarius observed that an “[e]quity investor [was] the driving
force” for the deal, App’x 1046, and that several abnormal structural
features had been added to Octans and Sagittarius “[o]n the basis of
the increasing pressure from equity investors,” App’x 1098. IKB
accounted for Magnetar’s demands in its analysis. IKB’s investment
proposals for both Octans and Sagittarius noted that these abnormal
structural features created risks—even though IKB determined that
the risks did not outweigh the benefits of investment.

7 Chau could not remember the specific characteristics and selection
process for each bond that was vetted and accepted for Octans by his team,
but that alone does not establish “that it is highly probable” that Chau did
not exercise independent judgment when selecting assets for Octans. In re
Gail R., 891 N.Y.S.2d at 414; Seon, 74 N.Y.S.3d at 25.

29
 The defendants did not have a duty to disclose Magnetar’s
investment strategy beyond what was already known about
Magnetar’s involvement in the deals. To establish a material
omission, Loreley must proffer clear and convincing evidence
establishing that the defendants had a duty to disclose the material
information. See Banque Arabe, 57 F.3d at 153. “[A] duty to disclose
may arise in two situations: first, where the parties enjoy a fiduciary
relationship, and second, where one party possesses superior
knowledge, not readily available to the other, and knows that the
other is acting on the basis of mistaken knowledge.” Lerner v. Fleet
Bank, N.A., 459 F.3d 273, 292 (2d Cir. 2006); see Mariano v. CVI Invs.
Inc., 809 F. App’x 23, 27 (2d Cir. 2020). It is undisputed that Loreley
cannot establish material concealment under the former theory
because the parties were not in a fiduciary relationship.

Loreley also cannot establish material concealment under the
latter theory because “the [undisclosed] information” was of the kind
“that could have been discovered … through the ‘exercise of ordinary
intelligence.’” Mariano, 809 F. App’x at 27 (quoting Jana L. v. W. 129th
St. Realty Corp., 802 N.Y.S.2d 132, 135 (N.Y. App. Div. 1st Dep’t 2005)).
Magnetar’s role was known to IKB. 8 Despite knowing that an equity
investor was exerting “pressure” to include certain structural features
that increased the risk of investing in the CDOs—and indication that
the investor at least had mixed motives—IKB did not inquire further
about the identity or strategies of that investor. It would not have been

8 At oral argument, the defendants’ counsel emphasized that “IKB had
direct contact with Magnetar in other contexts, knew Magnetar was
investing in CDOs in the equity tranches … but never inquired further.”
Oral Argument Audio Recording at 27:03-27:13; Transcript of Oral
Argument at 20. Loreley did not dispute that characterization on rebuttal.

30
difficult for a sophisticated investment advisor such as IKB—which
conducted thorough due diligence and which had extensive access to
relevant information—to have made that inquiry. IKB’s failure to ask
Wachovia about other investors’ identities or strategies precludes
finding that the defendants had a duty of disclosure based on superior
knowledge. 9

Loreley has therefore failed to establish a material
misrepresentation or omission with respect to Octans and Sagittarius.

CONCLUSION

For the foregoing reasons, we conclude that Loreley has failed
to offer clear and convincing evidence supporting its claim of fraud.
Because we hold that Loreley has failed to establish a fraud claim, we
also conclude that Loreley has failed to establish its related claims of
conspiracy to defraud, aiding and abetting fraud, and rescission

9 Additionally, the record does not indicate that SAI even possessed
superior knowledge of Magnetar’s strategies. Burke testified that he was
not aware that Magnetar was taking short positions against the CDOs in
which Magnetar had long positions in the equity tranches; he affirmed that
he was “shocked” when he learned of Magnetar’s strategy. App’x 2994.
Chau appears to have been aware of Magnetar’s strategy, but he had no
reason to believe that IKB was acting “on the basis of mistaken knowledge.”
Lerner, 459 F.3d at 292. Chau did not consider Magnetar’s strategy
remarkable but testified that hedge funds generally purchase hedging
instruments that correlate to the underlying assets. Because “[h]edge funds
hedge,” Chau testified that he “knew that [Magnetar] would hedge” and
did not consider it remarkable that Magnetar had done so. App’x 3051.

31
based on fraud. Because summary judgment was appropriate on
these claims, we AFFIRM the judgment of the district court. 10

10 We do not address whether the district court erred by excluding an
untimely expert report submitted by Loreley. The report concerned loss
causation and therefore does not change the disposition of this appeal.

32