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Investors That Agree to Rely on Their Own Due Diligence May Be Held to That Promise

The Southern District of Ohio recently reached an interesting decision that may be relevant to institutional investors in Pharos Capital Partners, L.P. v. Touche, L.L.P. (In re Nat’l Century Fin. Enters.), 905 F. Supp. 2d 814 (S.D. Ohio 2012). There, the plaintiff – a limited partnership which made private equity investments for its limited partner investors – allegedly reached out to defendant Credit Suisse Securities LLC (“Credit Suisse”) in search of an investment opportunity in the healthcare sector. Id. at 817-818. Credit Suisse had previously entered into an engagement letter with National Century Financial Enterprises, Inc. (“National Century”) – one of the largest healthcare finance companies in the United States at the time – whereby Credit Suisse agreed to use reasonable efforts to arrange for the private placement of equity securities in National Century. Id. at 818. Pursuant to the plaintiff’s request, Credit Suisse sent the plaintiff a private placement memorandum for the preferred stock offering and a “data room” of due diligence materials. Id. The plaintiff reviewed the materials and had follow up conversations with Credit Suisse – which vouched for the profitability of National Century – and National Century itself. Id. at 818-819.

Credit Suisse sent the plaintiff a “standard” letter agreement, which stated that the plaintiff was relying exclusively on its own due diligence and would bear the risk of an entire loss, and that Credit Suisse had made no representations as to National Century or the credit quality of the securities and had no duty to disclose non-public information to the plaintiff. Id. at 820. After a few revisions and “extensive due diligence,” the plaintiff signed a letter agreement which retained the language regarding reliance, risk, representation, and disclosures, as well as its status as a sophisticated institutional investor. Id. National Century and the plaintiff entered into a preferred stock purchase agreement for $12 million worth of National Century Series B Convertible Preferred Stock. Id. at 821. Four months later, National Century declared bankruptcy and the stock fully lost its value. Id. It was undisputed that National Century committed a massive fraud in the offering of its stock. Id.

The plaintiff initially filed suit against Credit Suisse and other defendants in 2003, before its action was consolidated with the many other actions brought as part of the multidistrict litigation involving National Century’s fraudulent activity. Id. Eventually, Credit Suisse was the only defendant remaining in the plaintiff’s original action. Id. The plaintiff alleged that: (1) Credit Suisse was aware of National Century’s fraud; (2) Credit Suisse misrepresented the manner in which National Century ran its operations in the offering materials and conversations between Credit Suisse and the plaintiff; and 3) Credit Suisse should have disclosed known facts about National Century’s fraud when the plaintiff conducted its due diligence investigation. Id. It also claimed that Credit Suisse violated Ohio Revised Code Section 1707.41, which forbids the offer of any security for sale based on a material misrepresentation. Id. at 827-828.

The court concluded that the plaintiff could not establish justifiable reliance on the representations of Credit Suisse, which necessarily defeated its claims of fraud, negligent misrepresentation, and material misrepresentation. Id. at 823. By its own admission, the plaintiff was a private equity fund with about $160 million in capital. Id. It represented that it knew a good deal about the healthcare sector, and that it was a sophisticated investor that was skilled in due diligence. Id. at 823-824. Most importantly, it agreed – in writing – to rely exclusively on its own due diligence. Id. at 820. Essentially, the court held that an institutional investor which explicitly holds itself out to be sophisticated and reliant exclusively upon its own due diligence cannot later claim it relied on the representations of a defendant in choosing to invest in a private placement offering. As a result, it granted summary judgment in favor of the defendants.

The plaintiff appealed the Court’s decision to the United States Court of Appeals for the Sixth Circuit. In 2013, the Sixth Circuit affirmed the District Court’s decision without a full opinion.

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