Tecku v. YieldStreet Inc.

Background

Michael Tecku, David Finkelstein, and Lawrence Tjok sued Yieldstreet Inc., Yieldstreet Management LLC, YS ALTNOTES I LLC, YS ALTNOTES II LLC, and Michael Weisz. They brought the action for themselves and other similarly situated investors, alleging seven causes of action arising from investments in Yieldstreet products.

The products included borrower payment dependent notes, which were debt obligations tied to loans made through special-purpose entities. Plaintiffs alleged that Yieldstreet’s private placement memoranda and series note supplements made misleading statements or omitted important information about the investments. Their allegations included a statement that earlier investments had suffered no principal loss, inaccurate information about oil-and-gas production, and misleading descriptions of Yieldstreet’s review process for vessel-deconstruction investments.

Plaintiffs alleged that Yieldstreet changed from longer-term industry lending practices to a riskier short-term model, despite warnings from Global Marine Transport Capital. They also alleged that Weisz approved transactions involving North Star Group without the promised independent review by a multi-party credit committee. Plaintiffs claimed that several investments later went into default. Defendants disputed that the vessel-deconstruction investments were in default.

Motion and claims

Defendants moved to dismiss the Corrected Amended Complaint under Federal Rule of Civil Procedure 12(b)(6), which asks whether the complaint contains enough factual allegations to state a legally plausible claim. Because the complaint included fraud allegations, the Court also applied heightened requirements requiring the circumstances of the alleged fraud to be stated in detail, along with the securities-law requirement to plead facts supporting a strong inference that defendants acted with the required state of mind.

The seven counts were: fraudulent inducement; aiding and abetting fraud as an alternative theory; violations of Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5; control-person liability under Section 20(a) of the Exchange Act against Weisz; breach of fiduciary duty; aiding and abetting breach of fiduciary duty; and negligent misrepresentation.

Court’s analysis

For the Section 10(b) and Rule 10b-5 claim, the Court found that Plaintiffs plausibly alleged two actionable categories: the “principal loss” statement in the private placement memoranda and omissions about the diligence process in the vessel-deconstruction offering documents. The Court concluded that outstanding principal on a defaulted loan could plausibly constitute “principal loss” at the pleading stage. It rejected the oil-and-gas production allegation because the complaint did not adequately allege that Defendants knew the production figure was incorrect when the offering document was issued.

The Court also concluded that the alleged October 2018 events plausibly made the previously described diligence process misleading. Because the offering documents represented that Global Marine and a multi-party credit committee would perform particular review functions, Plaintiffs plausibly alleged that Defendants had a duty to update the documents after the process allegedly changed.

The Court found that Plaintiffs adequately pleaded scienter, meaning a state of mind involving an intent to deceive or reckless disregard for the truth. The alleged prior default information supported an inference that the principal-loss statement was knowingly misleading, while the allegations about Weisz’s conduct and the changed diligence process supported an inference that Defendants knew later offering documents were misleading.

The Court also found that Plaintiffs adequately pleaded reliance and causation. It rejected Defendants’ argument that general cautionary language in the offering documents prevented reliance because the warnings did not specifically disclose the alleged prior principal loss or the departure from the represented diligence process.

The Court held that Plaintiffs plausibly alleged that Yieldstreet Inc., Yieldstreet Management, and the ALTNOTES entities had control over the offering documents and could be treated at this stage as the parties that made the alleged statements. The Court separately stated that the complaint did not adequately allege that Weisz personally made the statements in the offering documents; to that extent, the claim against Weisz personally was dismissed.

For the Section 20(a) claim, the Court held that Plaintiffs adequately alleged a primary securities-law violation, Weisz’s control over the relevant Yieldstreet entities, and Weisz’s culpable participation. The Court relied on allegations that Weisz was president and co-founder, exercised complete control over investment decisions, personally approved the North Star transaction, and ignored Global Marine’s advice. The motion to dismiss Count Four was denied.

The Court again denied dismissal of the breach-of-fiduciary-duty claim against Yieldstreet Management and allowed the claim against Yieldstreet Inc. to proceed at this stage. It denied dismissal of the aiding-and-abetting claim against Weisz because Plaintiffs plausibly alleged that he knew of the wrongful conduct, controlled Yieldstreet, and substantially assisted the conduct at issue. The Court also denied dismissal of the negligent-misrepresentation claim, finding that the allegations supporting a possible fiduciary relationship also plausibly supported the less demanding special-relationship requirement for that claim.

The Court stated that the motion to dismiss the fraudulent-inducement claim was denied as to the Yieldstreet Defendants. It did not address the alternative aiding-and-abetting-fraud claim at that stage. The final order states that Defendants’ motion to dismiss the Corrected Amended Complaint was DENIED.