Lehman Brothers Inc.

NOT FOR PUBLICATION
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
In re
LEHMAN BROTHERS INC.,
Debtor.
Chapter 11
Case No. 08-01420 (SCC)
MEMORANDUM DECISION SUSTAINING TRUSTEE’S OBJECTION TO PROOF OF
CLAIM NUMBER 8002386 FILED BY RALPH HARARY
A P P E A R A N C E S:
HUGHES HUBBARD & REED, LLP
One Battery Park Plaza
New York, NY 10004
By: 	Stuart N. Mitchell, Esq.
Karen M. Chau, Esq.
Erin E. Diers, Esq.
Attorneys for James W. Giddens, as
Trustee for the SIPA Liquidation of Lehman Brothers Inc.
LLOYD S. CLAREMAN, ATTORNEY AT LAW
121 East 61 st Street
New York, NY 10065
By: 	Lloyd S. Clareman, Esq.
Attorney for Ralph Harary
SHELLEY C. CHAPMAN
UNITED STATES BANKRUPTCY JUDGE
Before the Court is the objection (the “Objection”) of James W. Giddens (the “Trustee”),
as trustee for the liquidation of Lehman Brothers Inc. (“LBI”) under the Securities Investor
Protection Act of 1970, as amended, 15 U.S.C. §§ 78aaa et seq. (“SIPA”) seeking entry of an
order, pursuant to section 502(b) of title 11 of the United States Code (the “Bankruptcy Code”),
as made applicable to this proceeding pursuant to sections 78fff(b) and 78fff-1(a) of SIPA,
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seeking to disallow and expunge the general creditor claim represented by number 8002386 (the
“Claim”) filed by Ralph Harary [ECF No. 10142].
The Claim arises out of a portfolio of securities and interest rate swaps assembled for Mr.
Harary in 2002 and 2003 (the “Portfolio”), allegedly by Allen Reichman, an employee of LBI, to
constitute qualified replacement property (“QRP”) for tax purposes. In late 2007, following a
margin call, Mr. Harary terminated the swaps in the Portfolio and made a $3.8 million payment
to LBI in respect of the termination. In the Claim, Mr. Harary alleges that LBI 1 made unsuitable,
negligent, and fraudulent recommendations and representations regarding the Portfolio and
contends that, as a result of such recommendations and representations, he has claims for
negligence and common-law fraud against LBI and is entitled to damages of not less than $3.8
million. The Trustee argues that because (i) Mr. Harary’s claim for negligence is time-barred
and (ii) his claim for common-law fraud is insufficient as a matter of law, the Claim should be
disallowed and expunged.
In response to the Objection, Mr. Harary filed the Memorandum of General Creditor
Ralph Harary in Response to Trustee’s Objection to Proof of Claim No. 8002386 [ECF No.
10439]. The Trustee filed a further reply in support of the Objection [ECF No. 11689] and the
Court heard oral argument on the Objection on April 8, 2015.
BACKGROUND
In August 2002, claimant Ralph Harary sold stock in Jacques Moret Inc. to Jacques
Moret Inc.’s employee stock ownership plan. First Claim Letter2 at 1. Pursuant to 26 U.S.C. §
1 Mr. Harary does not precisely specify which Lehman entity he is referring to in his Claim; instead he refers to
“Lehman” and “Lehman Brothers.” Presumably Mr. Harary and the Trustee were able to agree that these references
to “Lehman” and “Lehman Brothers” were meant to refer to LBI, the broker-dealer in the Lehman family of entities.
Accordingly, the Court will treat references to “Lehman” and to “Lehman Brothers” in the Claim as references to
LBI unless context dictates otherwise.
2 Capitalized terms not defined herein shall have the meanings ascribed to them in the Objection. The First Claim
Letter was filed contemporaneously with the Claim, on January 29, 2009. At the Trustee’s request for additional
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1042, taxpayers who sell stock to employee stock plans are permitted to defer recognition of gain
on such sale if, amongst other requirements, the taxpayer purchases QRP (as defined in 26
U.S.C. § 1042(c)(4)) within the “replacement period” defined in 26 U.S.C. § 1042(c)(3). See 26
U.S.C. § 1042(a). Mr. Harary alleges that, following the sale of his stock, he entered into a
transaction structure implemented by UBS that was suitable for meeting the requirements to
defer gain on the sale of such stock under 26 U.S.C. § 1042, which structure included investment
into a portfolio of securities qualifying as QRP; such portfolio allegedly consisted chiefly of
long-term floating-rate notes (the “UBS Portfolio”).3
In October 2002, Allen Reichman of LBI 4 allegedly recommended the Portfolio to Mr.
Harary as a replacement for the UBS Portfolio. The Portfolio, which qualified as QRP, consisted
of fixed-rate bonds paired with interest rate swaps and was meant to mimic the performance of
floating-rate notes.5 Mr. Reichman allegedly represented that the Portfolio would “perform
identically to a floating rate note, but would enhance the interest rate return sufficiently to
eliminate the ‘negative carry’.”6 Mr. Reichman also allegedly represented that, “because
Lehman Brothers had a bank subsidiary,” Mr. Harary would have the ability to borrow on
margin against 95% of the value of the Portfolio, allegedly a higher margin percentage than UBS
was offering.7 Despite the fact that, Mr. Harary, relying in part on a report of Prairie Capital
Advisors, Inc., attached to the First Claim Letter, now characterizes the Portfolio’s composition
of securities consisting of fixed-rate notes and interest rate swaps as “unconventional” and
information on the Claim, Mr. Harary’s attorney, Lloyd S. Clareman, sent the Second Claim Letter to the Trustee on
June 23, 2014.
3 See First Claim Letter at 1-2; Response at 1-2.
4 The Claim does not specify precisely which Lehman entity Mr. Reichman worked for; presumably it was LBI.
5 See Second Claim Letter at 2; Response at 2.
6 Second Claim Letter at 2.
7 Id.
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containing “an unsuitably high level of risk,”8 Mr. Harary opted to invest in the Portfolio.
Between November 2002 and July 2003, Mr. Reichman purchased more than $40 million worth
of securities comprising the Portfolio on Mr. Harary’s behalf. 9 In connection with investing in
the Portfolio, Mr. Harary signed client agreements for each of two accounts set up for the
Portfolio.10 Mr. Harary also took out a margin loan, in the amount of 95% of the value of the
Portfolio (the “Margin Loan”), from “Lehman Bank” (presumably Lehman Brothers Bank,
FSB).11
The Claim alleges that there were no issues with the Portfolio until October 2007, when
LBI informed Mr. Harary that significant problems had developed with respect to the Portfolio
and the Margin Loan.12 In October 2007, LBI allegedly informed Mr. Harary that:
 	The Margin Loan would have to be moved from Lehman Bank to LBI because (i)
Lehman Bank lacked the internal controls to monitor the collateral for the Margin Loan
(i.e., the Portfolio) and (ii) one of the issuers of the securities comprising the Portfolio
was not Sarbanes-Oxley compliant;
 	LBI could offer a margin loan in the amount of only 80% of the value of the Portfolio, as
opposed to the 95% offered by Lehman Bank; and
 	The value of the fixed-rate bonds in the Portfolio had fallen and the interest rate swaps in
the portfolio were working against Mr. Harary.
See Second Claim Letter at 3-4.
Allegedly as a result of these developments, LBI informed Mr. Harary that it was
making a margin call in excess of $5 million on his accounts. 13 In “Late 2007” Mr. Harary met
the margin call, and avoided a sale of the Portfolio, which would have had adverse tax
consequences for Mr. Harary, by adding approximately $5 million worth of additional securities
8 Second Claim Letter at 3.
9 Id.
10 Objection Ex. B (Pace Declaration), Ex. 3-4.
11 Second Claim Letter at 3.
12 Id.
13 Second Claim Letter at 4.
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to his LBI account and obtaining guarantees from family members.14 The Claim alleges that the
additional securities were ultimately liquidated; $3.8 million of the proceeds were used to
terminate the interest rate swaps in the Portfolio and the balance of the proceeds was credited
against the Margin Loan.15 In March 2008, allegedly under threat of further margin calls, Mr.
Harary transferred the Portfolio to UBS. 16
STANDARD
The Objection triggered a “Sufficiency Hearing,” as defined in the Court’s September 26,
2013 Order Establishing Claims Hearing Procedures and Alternative Dispute Resolution
Procedures for General Creditor Claims Pursuant to Section 105 of the Bankruptcy Code,
Bankruptcy Rule 9014, and General Order M-452 [ECF No. 7351]. Pursuant to that order, all
hearings “to address the legal sufficiency of [a] particular Contested Claim and whether the
Contested Claim states a claim against the asserted Debtor under Bankruptcy Rule 7012” shall be
“Sufficiency Hearings,” unless the Trustee serves the holder of a contested claim with (a) a
Notice of ADR Procedure or Notice of Consolidated ADR Procedures or (b) a Notice of Merits
Hearing. Id. Ex. A, ¶ 5(a). The standard of review for a Sufficiency Hearing is equivalent to the
standard applied by the Court upon a motion to dismiss for failure to state a claim.
Rule 7012(b) of the Federal Rules of Bankruptcy Procedure, which incorporates Federal
Rule of Civil Procedure 12(b)(6) (“Rule 12(b)(6)”), permits a bankruptcy court to dismiss an
adversary proceeding if a plaintiff’s complaint fails to state a claim upon which relief may be
granted. In reviewing a motion to dismiss under Rule 12(b)(6), the Court accepts the factual
allegations of the complaint as true and draws all reasonable inferences in the plaintiff’s favor.
Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009); Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555-
14 Id.
15 Id.
16 Id.
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56 (2007); E.E.O.C. v. Staten Island Sav. Bank, 207 F.3d 144, 148 (2d Cir. 2000). To survive a
challenge to the adequacy of a complaint under Rule 12(b)(6), the factual allegations in a
complaint must be supported by more than mere conclusory statements. Twombly, 550 U.S. at
555. The allegations must be sufficient “to raise a right to relief above the speculative level” and
provide more than a “formulaic recitation of the elements of a cause of action.” Id. (citations
omitted).
A court may dismiss a complaint unless a plaintiff pleads “enough facts to state a claim to
relief that is plausible on its face.” Twombly, 550 U.S. at 570. “[O]nly a complaint that states a
plausible claim for relief survives a motion to dismiss.” Iqbal, 556 U.S. at 679 (citing Twombly,
550 U.S. at 556). Therefore, the appropriate inquiry “is not whether a plaintiff is likely to
prevail, but whether [he] is entitled to offer evidence to support [his] claims.” Chance v.
Armstrong, 143 F.3d 698, 701 (2d Cir. 1998) (citations omitted).
DISCUSSION
As described in this Memorandum Decision, the Court sustains the Objection. Even after
accepting the truth of all assertions of fact in the proofs of claim and drawing all reasonable
inferences in Mr. Harary’s favor, Mr. Harary is unable to support claims based on theories of
negligence and common-law fraud. Mr. Harary’s negligence claim, if he has one, is time-barred
and he fails to state a claim for common-law fraud. Accordingly, the Claim fails to state a claim
upon which relief may be granted under the applicable standard.
The Negligence Claim
Mr. Harary contends that Mr. Reichman’s alleged recommendation, in 2002, to exchange
the UBS Portfolio, which contained conventional floating-rate notes, for the Portfolio, which
contained securities consisting of fixed-rate notes and interest rate swaps designed to mimic the
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performance of floating-rate notes, was a departure from securities industry practice. Response
at 11. Mr. Harary further asserts that, under Trimarco v. Klein, 436 N.E.2d 502 (N.Y. 1982), a
departure from industry practice is evidence of negligence.
The Trustee does not attack the merits of Mr. Harary’s negligence claim but contends
that, even if Mr. Harary has a claim for negligence, such claim is time-barred under New York’s
three-year statute of limitations for negligence claims. N.Y. C.P.L.R. § 214(4). The parties
agree that a claim for negligence accrues at the date of injury but disagree as to when an injury
occurs in the context of a negligence claim based on the purchase and receipt of allegedly
unsuitable securities. The Trustee argues that the injury is sustained at the time the securities are
purchased and that, accordingly, Mr. Harary’s claim for negligence, if he has one, accrued
between November 2002 and July 2003, when LBI purchased the securities comprising the
Portfolio for Mr. Harary’s accounts. Mr. Harary contends that his claim for negligence only
accrued in October 2007, when LBI informed him of the problems with the Portfolio and
pending margin call.
In support of his position that the injury, and thus the claim for negligence, accrues at the
time of the purchase and receipt of allegedly unsuitable securities, the Trustee cites to Coleman
& Co. Securities, Inc. v. Giaquinto Family Trust, 236 F. Supp. 2d 288 (S.D.N.Y. 2002) and
Butala v. Agashiwala, 916 F. Supp. 314 (S.D.N.Y. 1996). In each case, the court, applying New
York law, found that the claim for negligence accrued on the date the allegedly unsuitable
securities were purchased. Coleman & Co, 236 F. Supp. 2d at 303 (“Respondents were injured
as of the dates of purchase…when they received shares in private, start-up companies that were
risky and illiquid instead of investments that were safe and secure”) (citation omitted); Butala,
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916 F. Supp. at 317 (“…the plaintiffs’ injuries occurred at the time the limited partnership
interests were purchased”).
Mr. Harary attempts to distinguish these cases by arguing that in Coleman & Co. and
Butala the plaintiffs did not claim absence of injury at the time of the purchase, in contrast to the
situation here, where Mr. Harary has alleged no injury at the time of the purchase of the
securities comprising the Portfolio, and no injury at all until October 2007. See Response at 12-
13. In support of his own position, that his claim for negligence did not accrue until the Portfolio
lost value and the problems with the Margin Loan arose, Mr. Harary cites to Kronos, Inc. v. AVX
Corp., 612 N.E.2d 289 (N.Y. 1993).
Mr. Harary’s attempts to distinguish Coleman & Co. and Butala fail and Kronos, Inc.
does not support his position. The courts’ holdings in Coleman & Co. and Butala, that the
plaintiffs’ negligence claims accrued at the time of the purchase of securities, are not dependent
on the fact that the plaintiffs did not claim absence of injury at the time of sale. In Coleman &
Co., the statement quoted by Mr. Harary in the Response that “[r]espondents do not cite any
evidence of losses, nor do they suggest that they were injured until the securities lost value” is
followed by a citation to Butala with the explanatory parenthetical “(rejecting argument that
claim did not accrue until damages ‘crystallized’),” Coleman & Co., 236 F. Supp. at 303,
indicating that, even if the plaintiffs in Coleman & Co. had made the argument that Mr. Harary
makes here - that they were not injured until the securities lost value - it would have been
rejected by the court. In fact, as Coleman & Co. indicates, the court in Butala considered and
rejected just such an argument:
The plaintiffs' argument that their cause of action did not accrue until their
damages were ascertainable is premised on a misunderstanding of the difference
between when an injury occurs and when the damages resulting from that injury
are 	fully 	quantifiable… 	The 	plaintiffs 	allege 	that 	these 	investments 	were
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fraudulent from their inception. Consequently, the plaintiffs were injured when
they purchased them.
Butala, 916 F. Supp. at 317.
The Butala court’s reasoning is applicable here as well. Mr. Harary has alleged that the
securities comprising the Portfolio were unsuitable from the moment they were purchased.
Consequently, his alleged injury occurred, and thus his claim for negligence accrued, at the time
of the purchase of such securities, between November 2002 and July 2003. Kronos, Inc. does
not change this result. Kronos, Inc. involved a claim for interference with contractual relations.
As damages sustained by the plaintiff is an element of such claim, the court stated the general
proposition that “…the claim is not enforceable until damages are sustained. Thus, in its present
posture, this action is time-barred only if plaintiff’s complaint must be read to allege damages
arising prior to [three years before the complaint was filed].” Kronos, Inc., 612 N.E.2d at 292.
Unlike in an action for interference with contractual relations, in an action for negligence based
on unsuitability, injury is incurred at the time of the purchase of allegedly unsuitable securities
under New York law, even if damages are not ascertainable. See e.g., Butala, 916 F. Supp. at
317; Pautienis v. Legacy Capital Corp., 36 A.D.3d 462, 463 (N.Y. App. Div. 1st Dep’t 2007);
Cator v. Bauman, 39 A.D.3d 1263, 1264 (N.Y. App. Div. 4th Dep’t 2007). Here, Mr. Harary has
alleged that the securities comprising the Portfolio were unsuitable from the date of purchase.
Thus, Mr. Harary’s claim for negligence accrued at the date of the purchase of such securities,
between November 2002 and July 2003. The claim for negligence is therefore time-barred.
The Common-Law Fraud Claim
To state a claim for common-law fraud under New York law, a party must allege (1) a
misrepresentation or a material omission of fact which was false and known to be false by the
defendant, (2) such misrepresentation made for the purpose of inducing the other party to rely
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upon it, (3) justifiable reliance of the other party on the misrepresentation or material omission,
and (4) injury. Emps.’ Ret. Sys. of Gov’t of Virgin Islands v. Morgan Stanley & Co., 814 F.
Supp. 2d 344, 351 (S.D.N.Y. 2011). Even assuming, arguendo, that Mr. Harary’s allegations
satisfy the first, second, and fourth elements of a claim for common-law fraud, the allegations do
not satisfy the third element, justifiable reliance by Mr. Harary on the alleged misrepresentations
or material omissions allegedly made by Mr. Reichman in selling Mr. Harary the Portfolio, and
therefore fail.
Mr. Harary contends that his common-law fraud claim arises out of Mr. Reichman’s
alleged misrepresentations that (i) the securities in the Portfolio would replicate a floating-rate
note in all material respects and (ii) LBI would maintain a margin loan at or close to 95% of the
value of the Portfolio through Lehman Bank in perpetuity. See Second Claim Letter at 5. An
investor, even an unsophisticated investor,17 may not justifiably rely on a misrepresentation if,
through minimal diligence, the investor should have discovered the truth. Brown v. E.F. Hutton
Grp., Inc., 991 F.2d 1020, 1032 (2d Cir. 1993). An investor in securities cannot justifiably rely
on oral statements from a seller when such statements are contradicted in the written offering
materials for such securities. See e.g., Iconix Brand Grp. v. Merrill Lynch, Pierce, Fenner &
Smith, Inc., 505 F. App’x 14 (2d Cir. 2012); Brown, 991 F. 2d at 1032-33; Good Hill Partners
L.P. ex rel. Good Hill Master Fund, L.P. v. WM Asset Holdings Corp., 583 F. Supp. 517, 520
(S.D.N.Y. 2008).
Here, Mr. Harary could not have justifiably relied on either of Mr. Reichman’s alleged
misrepresentations. First, the alleged misrepresentation that the securities comprising the
17 It is not clear whether or not Mr. Harary is a sophisticated investor. While selling a successful business for
millions of dollars and investing millions of dollars of such proceeds in tax-advantaged property can be argued to
suggest sophistication, the Court has presumed that Mr. Harary is an unsophisticated investor for purposes of its
analysis.
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Portfolio would perform identically to floating-rate notes is contradicted by the written offering
prospectuses for such securities. For example, the prospectus supplement for the Series
Repackaged American General Floating Rate Trust Certificates, Series 2003-1 discloses that the
security consists of certificates in a trust that (i) holds 7.5% notes due 2025 issued by American
General Corporation and (ii) has entered into an interest rate swap with Lehman Brothers
Derivative Products Inc. Diers Decl. Ex. 1 at S-10. The prospectus supplement, under the
heading “RISK FACTORS” describes risks of holding a certificate, including how holding the
trust certificates is different than directly holding a note issued by a typical issuer and how the
inclusion of the interest rate swap may affect a certificateholder’s return as compared to the
return that a direct holder of a note issued by a typical issuer may receive. See Diers Decl. Ex. 1
at S-11-S-13. Accordingly, while the intention of the certificates may have been to mimic the
performance of a directly-held floating-rate note issued by a typical issuer, no reasonable
investor reviewing these offering materials, and others like them for the securities comprising the
Portfolio, could fail to appreciate that the certificates issued by the trusts were not identical to
floating-rate notes. Accordingly, Mr. Harary could not justifiably rely on Mr. Reichman’s
alleged representation that the securities comprising the Portfolio would perform identically to
floating-rate notes issued by a typical issuer. See Brown, 991 F.2d at 1033.
Second, the alleged misrepresentation that LBI would maintain a margin loan at or close
to 95% of the value of the Portfolio through Lehman Bank is contradicted by Mr. Harary’s client
agreement with LBI, which states “[t]he minimum and maximum amount of any particular loan
may be established by [LBI] in [its] discretion regardless of the amount of collateral delivered to
[LBI] and [LBI] may change such minimum and maximum amounts from time to time.” Pace
Decl. Ex. 5, Form of Client Agreement ¶ 16. Accordingly, LBI was simply exercising its
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contractual rights, which had been disclosed to Mr. Harary and to which Mr. Harary had agreed,
when it reduced the amount of the margin loan it was willing to extend to Mr. Harary below 95%
of the value of the Portfolio. Thus, Mr. Harary, with the minimal diligence of reading the LBI
customer agreement, could have discovered that Mr. Reichman’s alleged representation that LBI
would maintain a margin loan at or close to 95% of the value of the Portfolio through Lehman
Bank was not absolute and was instead subject to the continuing discretion of LBI. Accordingly,
Mr. Harary could not justifiably rely on Mr. Reichman’s alleged representation that LBI would
maintain a margin loan at or close to 95% of the value of the Portfolio through Lehman Bank in
perpetuity, see Brown, 991 F.2d at 1033, and he therefore fails to state a claim for common-law
fraud.
CONCLUSION
For the reasons stated, the Objection is sustained. The Trustee is directed to submit an
order consistent with this memorandum decision.
Dated: June 2, 2015
New York, New York
/S/ Shelley C. Chapman_________________
UNITED STATES BANKRUPTCY JUDGE
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