Article

Note: Following a judicial finding that the STABL Fund (Fraudster) was a Ponzi scheme, the court appointed a Receivership Estate (Receiver) to recover assets for the benefit of defrauded investors. Receiver sued Morningstar Inc. (Research Firm) for contributing to the scheme and for aiding and abetting a breach of fiduciary duty and fraud. The United States District Court for the Eastern District of Pennsylvania, Schiller, J., ruled that Research Firm was not liable to Receiver for contribution as it was not a party to Fraudster's Ponzi scheme.

Research Firm operated a hedge fund database that included information about Fraudster's hedge fund. All of the information Research Firm had about Fraudster was supplied by Fraudster and was not independently verified by Research Firm. Fraudster's fund received a five-star rating on Research Firm's investor advising website that was generated by Research Firm's algorithm operating off of information supplied by Fraudster. The data provided by Fraudster triggered three "risk flags" on Research Firm's website, alerting investors to possible fraud. However two of these warnings was not made available to investors who did not purchase a subscription to Research Firm. Approximately half of all hedge funds reported by Research Flag triggered three or four risk flags.

Research Firm repeatedly noted in its materials that all information was reported by hedge fund managers, and cautioned potential investors that "hedge fund data are generally self-reported and not subject to independent verification..." There was no evidence that Research Firm was aware that the information it received from Fraudster was fraudulent. The Judge ruled that Research Firm's disclaimer that it had not verified data received from Fraudster should have warned investors that they ought to do their own research into a fund before investing, and reliance on Research Firm's statements was unreasonable.

The Judge evaluated eight statements about Fraudster's fund made by Research Firm to determine whether they supported Research Firm's liability under Rule 10b-5 of the SEC Act. The Judge ruled that Research Firm had a duty to disclose to investors that Fraudster's fund had triggered three risk flags in its database, and that the failure to disclose was a material omission. However, the Judge also ruled that Research Firm did not omit the risk flags with an, "intent to deceive, manipulate, or defraud." None of the information that Research Firm received was obviously false, and the court received no evidence suggesting that Research Firm intended to defraud investors. The court concluded that because Research Firm did not intentionally provide false or misleading information and because any reliance investors placed on Research Firm's statements was unreasonable, Research Firm was not liable to Receiver as a party to Fraudster's Ponzi scheme.

[MJS]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.