Cavello Bay Reinsurance Limited v. Stein

Background

Cavello Bay Reinsurance Limited alleged that Kenneth Shubin Stein, Spencer Capital Limited, and Spencer Capital Holdings Ltd. engaged in securities fraud when soliciting Cavello’s purchase of Spencer shares. Cavello alleged that a February 2015 presentation represented that Spencer Management’s incentive fee was based on profits after an 8% increase in book value per share, without including capital raised through the stock offering. Cavello later learned that Spencer Management allegedly calculated performance fees using increases in book value attributable to offering proceeds.

Cavello bought 250,000 shares for $5 million under a 2015 subscription agreement. It asserted claims under Section 10(b) of the Securities Exchange Act and Securities and Exchange Commission Rule 10b-5, sought rescission under Section 29(b), and asserted control-person liability against Stein under Section 20(a). Cavello requested rescission of the subscription agreement or compensatory damages.

Motions and legal standards

Stein and the Spencer entities moved to dismiss under Federal Rules of Civil Procedure 9(b) and 12(b)(6). Rule 12(b)(6) tests whether a complaint states a legally sufficient claim, while Rule 9(b) requires fraud to be pleaded with particularity. The court accepted the complaint’s factual allegations as true for purposes of the motions.

For a Section 10(b) and Rule 10b-5 claim, the court explained that a plaintiff must adequately allege a material misstatement or omission, fraudulent intent, a connection with the purchase or sale of securities, reliance, and loss caused by the reliance. A Section 20(a) control-person claim also requires a primary securities-law violation. Section 29(b) allows rescission of a contract involving a prohibited transaction under the Act, but the plaintiff must satisfy the requirements for that remedy.

Extraterritoriality ruling

The defendants argued that the federal securities laws did not apply because the transaction was foreign. The court applied the Supreme Court’s rule that Section 10(b) generally does not apply outside the United States and the Second Circuit’s test for determining whether an unlisted-security transaction is domestic. Under that test, a transaction may be domestic if irrevocable liability was incurred or title passed in the United States.

The court concluded that the allegations did not show that irrevocable liability arose in the United States. Cavello signed the agreement in Bermuda and sent it to Spencer. Although Stein allegedly countersigned in New York, the agreement stated that Spencer could accept or reject the subscription in its sole discretion and that its obligations depended on additional conditions. The agreement also contemplated payment and delivery of title to Cavello in Bermuda. The court therefore found that the transaction appeared not to be domestic.

The court further held that, even assuming the transaction was domestic, the claims were impermissibly extraterritorial because the transaction was predominantly foreign. Cavello and Spencer were Bermudan entities, the relevant securities interests were connected to Bermuda, the alleged misrepresentation was directed to and affected Cavello’s governing entity in Bermuda, and Cavello signed the agreement and received title in Bermuda. The court found that the New York connections—including Stein’s alleged location when making the statement and signing the agreement—did not overcome the transaction’s predominantly foreign character.

Other claims and disposition

Because the court found no viable Section 10(b) claim, it dismissed the Section 20(a) control-person claim against Stein. It also dismissed the Section 29(b) claim because the transaction was outside the reach of the Securities Exchange Act, meaning Cavello was not within the class of persons the Act was designed to protect. The court rejected Cavello’s argument that Section 29(b) created an independent claim that could avoid the pleading requirements for the underlying securities violation.

The court did not decide the defendants’ additional arguments about whether Cavello adequately pleaded materiality, fraudulent intent, reliance, or other specific elements of the Section 10(b) claim. It granted both motions to dismiss, dismissed all claims with prejudice, terminated the motions, and directed the Clerk of Court to close the case.