On March 27, 2012, Germany’s HSH Nordbank AG („HSH“) was left with no hope to recover from a $500 million loss when a New York Appellate Court dismissed its last standing claim against UBS. The loss stemmed from a credit default swap transaction, in which, HSH, in exchange for a stream of premium payments, assumed the risk of the first half billion dollars on a $3 billion portfolio of securities …
composed mainly of mortgage-backed securities and instruments from real estate investment trusts that collapsed after the U.S. housing bubble burst in 2008.
HSH sued UBS in New York County Supreme Court, stating numerous claims, including negligent misrepresention and fraud. HSH alleged UBS misled it by using credit rating agencies and models to assess the portfolio’s risk that UBS rejected for its own use in addition to engaging in a form of „ratings arbitratge“ by selecting securities for the portfolio that were mispriced relative to their ratings, and then used its own superior knowledge to profit from those discrepencies.
The New York County Supreme Court dismissed HSH’s negligent misrepresentation and punitive damages claims, but denyed the motion to dismiss fraud in the inducement claims, and both parties appealed.
The Appellate Court dismissed the fraud claim against HSH due to the German bank’s lack of due diligence before entering into a risky $500 million credit-linked transaction provided the fatal link to its fraud suit against UBS AG.
Justice David Friedman wrote following for the panel: „However much UBS’s alleged conduct leaves to be desired as a matter of business ethics, the undisputed documentary evidence and HSH’s own allegations eliminate, as a matter of law, any reasonable inference that HSH justifiably relied on the representations of which it now complains.“
Additionally, Justice David Friedman pointed out the following reasons for dismising HSH’s fraud claim: 1) the deal documents explicitly stated HSH was not relying on UBS’S advice, disclosed UBS’s connection to the reference portfolio and warned there were risks in undertaking a highly leveraged transaction; 2) HSH’s own complaint acknowledged that the deal documents contained disclaimes warning about the risks of the investments; 3) HSH is a large commerical bank, sophisticated enough to uncover any misrepresentation of the deal’s risk by conducting reasonable due diligence; and 4) HSH’s complaint did not allege that UBS misrepresented any material existing fact as to which HSH could not have learned the truth if it had conducted (or hired a consultant to conduct on its own behlaf) an independent appraisal of the risks of the transaction.