Does someone defrauded into not selling (“holding”) an asset have a claim against the fraudster?  Intuitively, one might think “of course!” if not for the fraud, the holder would have sold the asset and made a profit.  Why should someone else’s bad acts prevent the asset owner from recovering her would-be profits?  Recent New York state court decisions, however, confirmed the answer in New York is a flat “no,” at least where the asset holder is seeking to recover lost profits.  What happens if a holder is not seeking lost profits, but instead to recover for a complete loss of investment?  The question remains unsettled in New York.

Defrauded holders are in a tough spot.  The securities fraud section of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated by the U.S. Securities and Exchange Commission require a purchase or sale for a fraud claim and do not provide relief for an owner defrauded into holding.  Aggrieved holders are left with potential common law (i.e. court created rather than statutory) fraud claims.  Common law fraudulent inducement claims in New York are generally limited to “out of pocket” losses and require damages that are not speculative.  In Starr Found. v. Am. Int’l Grp., Inc., 76 A.D.3d 25, 901 N.Y.S.2d 246 (1st Dep’t 2010), the First Department, the appellate court covering Manhattan and the Bronx, confirmed that a defrauded holder may not recover for potential lost profits.  In Starr, plaintiff-charity alleged defendant AIG fraudulently misrepresented the degree of risk attached to AIG’s credit default swap portfolio, which induced plaintiff to hold and not sell its publicly traded AIG shares.  Months later, AIG publicly reported billions of dollars of losses caused by its credit default swap portfolio and its share price plummeted.  Plaintiff sought to recover the loss in value of its shares from Summer 2007 – when it claims it would have sold the shares – to early 2008 after AIG reported its losses.  The First Department dismissed the claim as violative of New York’s “out-of-pocket” rule – a plaintiff is only entitled to recover what it actually lost because of the fraud, not what it might have gained.  The court held holder claims seeking lost profits are impermissible because they require an untenable degree of speculation, including (1) whether the holder would have sold absent the fraud; (2) when the sale would have occurred; (3) the amount of shares the holder would have sold; and (4) the effect truthful disclosure would have had on the market price.

Recently, the New York County Commercial Division, perhaps the most sophisticated commercial state trial court in the country, applied the bar against lost profit holder claims.  In Q China Holdings, LTD. v. TZG Capital Limited, 2018 NY Slip Op 30779(U) (Sup. Ct. N.Y. Co. Apr. 23, 2018), Plaintiff claimed it abandoned a sale of shares to defendant when plaintiff learned defendant lied about the company’s earlier sale of a subsidiary.  Plaintiff sought to recover the profits it would have received had defendant been honest and plaintiff sold to defendant.  Citing Starr, the court dismissed the claim as a prohibited speculative holder claim seeking lost profits.

It is clear that New York courts reject claims seeking lost profits due to a fraud that causes an investor to hold and not sell.  What is not clear is the viability of a holder claim where the investment becomes worthless once the fraud is revealed.  In a decision nearly one century old, Continental Ins. Co. v. Mercadante, 22 A.D. 181, 225 N.Y.S. 488 (1st Dep’t 1927), defendants fraudulently induced the plaintiffs to not sell bonds by conveying false information as to the earnings and solvency of the bond issuer.  Shortly thereafter, the bonds plaintiff did not sell became “substantially worthless.”  The court held plaintiffs stated a claim for recovery against defendants for plaintiffs’ loss.  Eighty years later, the same court in Starr questioned whether Mercadante still represented good law, but assuming it did, distinguished it because the Starr plaintiff was seeking lost profits, not to recover the loss of investment, i.e. an out-of-pocket loss – perhaps a dubious distinction.  More recently, in AHW Inv. P’ship, MFS, Inc. v. Citigroup Inc., 661 F. App’x 2 (2d Cir. 2016), the Second Circuit Court of Appeals, the appellate Federal court covering New York State, noted the contrary decisions by New York courts and acknowledged that whether a holder can recover damages for loss of investment remains an unsettled question in New York.

If you have any questions about potential fraudulent conduct that affected an investment you have made, please do not hesitate to contact us.


You may have had a friend try to introduce you to a company looking for investors for a private offering or a PIPE transaction (private investment in public equity).  Maybe you were even the person doing the introducing.  If so, the issuer might have promised to pay you a commission.  What happens when your prospect invests and the company does not pay?  Based on the way New York courts have interpreted the law, the company could be entirely in the right, and you could be subject to a claim of violation of the securities laws.

A person acting as a “broker” must be with the Financial Industry Regulatory Authority (“FINRA”).  While somewhat underutilized defense, FLLC and other security litigators have successfully defended issuers against claims for commissions because the plaintiff acted as an unregistered “broker.”  A person acting as a “finder,” however, does not act as a “broker” and need not be registered.  While also infrequently litigated, FLLC and other lawyers have succeeded in getting clients paid because they fell under the “finder’s exemption.”

The Securities Exchange Act of 1934 (the “Exchange Act”) is part of an extensive series of legislation designed “to protect investors … through regulation of transactions upon securities exchanges and in over-the-counter markets.”  Section 15 of the Exchange Actspecifically prohibits an unregistered person from acting as a “broker,” while section 29(b) of the Exchange Act makes void any contract that violates the Exchange Act.  The question then is “who is a broker?”  The Exchange Act defines a “broker” as “any person engaged in the business of effecting transactions in securities for the accounts of others.”  Unhelpfully, the Exchange Act does not define either “effecting transactions” or “engaged in the business.”  Knowing whether you are engaged in the business of effecting transactions is incredibly important, because if you are instead acting as a “finder,” you may be entitled to payment.  Courts have held that distinguishing between a broker and finder “involves an evaluation of the quality and quantity of services rendered.”  A finder “is required to introduce and bring the parties together, without any obligation or power to negotiate the transaction, in order to earn the finder’s fee.”  A broker, on the other hand, will perform that same introduction, but “ordinarily also bring the parties to an agreement.”

Courts have generally agreed that “merely bringing together the parties to transactions, even those involving the purchase and sale of securities, is not enough” to find a person acted as a broker.  Rather, the person must have been involved at “key points in the chain of distribution,” such as participating in the negotiation, analyzing the issuer’s financial needs, discussing the details of the transaction and recommending an investment.  A finder generally has far less involvement in the ultimate transaction quantitatively and qualitatively than a broker.  Each case is different and courts in New York and elsewhere will take an in-depth look at the facts to determine whether a person was a broker or a finder.  Beyond the scope here, but further complicating matters, each state has its own “Blue Sky Law” regulating securities that could come into play.

Unfortunately, the Exchange Act’s vague definitions create fact issues and uncertainty for finders, brokers and issuers alike.  While the safest course is registration for a broker, the cost and administrative burden makes registration untenable for most.  If you have questions about the broker/finder distinction or the right to payment for broker/finder services, please do not hesitate to contact us.