FILED: NEW YORK COUNTY CLERK 03/08/2012

INDEX NO. 603271/2008

NYSCEF DOC. NO. 12 RECEIVED NYSCEF: 03/08/2012
SUPREME COURT OF THE STATE OF NEW YORK
COUNTY OF NEW YORK
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NORTHERN GROUP INCORPORATED and
ALTITUDE PARTNERS, LLC,
Plaintiffs,
-against-
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED and MERRILL LYNCH
GOVERNMENT SECURITIES, INC,
Defendants.
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Amended Complaint
Index No. 603271/08
Plaintiffs Northern Group Incorporated ("Northern") and Altitude Partners, LLC
("Altitude") (collectively, the "Companies" or "plaintiffs"), by their attorneys Hinman,
Howard & Kattell, LLP, allege as follows:
PRELIMINARY STATEMENT
JURISDICTION
1. This Court has jurisdiction over defendants Merrill Lynch, Pierce, Fenner &
Smith Incorporated and Merrill Lyneh Government Securities, Inc. (colleetively, "Merrill"
or "defendants") pursuant to CPLR 302 (a)(l) because each defendant has its principal
place of business within the State of New York.
PARTIES
2. PlaintifI Northern Group Incorporated is a Delaware company and has an
office located in New York, New York.
3. Plaintiff Altitude Partners, LLC is a Delaware company and has an ofliee
loeated in New York, New York.
4. Defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated ("ML") is a
Delaware corporation with its principal place of business in New York, New York.
5. Defendant Merrill Lynch Government Securities, Inc. ("MLGS") IS a
Delaware corporation with its principal place of business in New York, New York.
FACTUAL BACKGROUND
6. NOlthern was formed in 1990 and Altitude was !(ll"lued in 2007.
7. Jacqueline Fried ("Fried") and Alexander Dembitzer ("Dembitzer") are the
sole shareholders of Northern and sole members of Altitude.
8. Northern is a management company managed by Fried and Dembitzer to
manage real property which is owned by Fried and Dembitzer through various special
purpose entities.
9. Altitude is an entity managed by Fried and Dembitzer.
10. Altitude's sole business purpose is to hold liquid assets (derived 1\'om the
operation of real property or the sale of real property) until such time as Fried and
Dembitzer need such assets to acquire or improve real property.
11. Northern and Altitude each hold their assets separate \'om one another and
neither one is: (i) a Qualified Institutional Buyer ("QIB") or an (ii) institutional investor
that is an accredited investor within the meaning of 501(A),(I), (2), (3), or (7) of
Regulation D under the Securities Act of 1933 ("Securities Act").
MERRILL'S SOLICITATION OF' PLAINTIFF TO INVEST IN COMMERCIAL
MORTGAGE-BACKED SECURITIES
12. In May, 2008, Northern entered into a consulting agreement with Irwin
Boris ("Boris"). Boris's initial responsibility was to assist in obtaining financing as well
as assist in the management of properties managed by Northern.
13. Prior to consulting for Northern, Boris was contacted by John Mulligan
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("Mulligan"), a Merrill Managing Director, regarding various investments for his then
employer, El Ad.
14. When Boris began working j{)r Norlhern, Boris injurmed Mulligan of his
new position.
15. On April 16, 2008, Mulligan, on behalf of defeudants, met with Fried,
Dembitzer and Boris. Mulligan touted Merrill's expertise in the flnaneial analysis of
companies fur the purpose of providing honest opinions and recommendations on whether
Merrill clients should buy, hold or sell securities. Defendants represented themselves as
the premier llnll in the f,nance industry, adhering to all ethical and regulatory standards,
complying with the 2004 analyst consent agreement, and maintaining their clients'
accounts in accordance with applicable standards within the industry.
16. At the meeting, Fried, Dembitzer, and Boris inf{lrI11ed Mulligan that neither
they nor the plaintiffs had ever invested in commercial mortgage backed securities
("MBS").
17. Fried and Dembitzer also advised Mulligan that: (i) they were not
experienced investors in securities; (ii) Altitude's sale flmction was to hold funds for
Dembitzer and Fried until such time as they were needed to invest in real estate; (iii)
plaintiffs' primary objective was to maintain principal and liquidity so that the funds
would be available to invest in real estate on short notice; (iv) they had a conservative
investment strategy; and (v) if they chose to proceed they would be relying on Merrill's
selection of securities in order to provide the Companies' safety, liquidity and principal
protection.
18. Mulligan then presented plaintiffs with a high pressure sales pitch in an
effort to convince them to invest in MBS and/or collateralized mortgage obligations
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("CMO," collectively referred to with MBS as "CMBS"). More specifically:
a. Mulligau advised plaintim (via Dembitzer and Fried) that CMBS
are liquid bonds ("Bonds").
b. Mulligan advised plaintiffs that the Bonds traded in an active
market and were prieed by a mark to market system.
e. Merrill advised plaintiffs that it made a market in the Bonds so that
they will always be saleable;
d. Mulligan informed plaintiffs that the Bonds were secured by loans
on eommercial property.
e. Mulligan advised plaintiffs that Merrill was the
originator/underwriter/syndicator of many Bonds ("Merrill Originated Bonds") and that
the underwriting standards used by Merrill in originating such bonds were the most
stringent in the industry;
f Mulligan represented to plaintiffs that the Bonds arc "money good,"
conservative, safe and highly liquid investments and that the safety of the investments arc
reflected by the high ratings from S&P, Moodys and Fitch.
g. Mulligan assured Fried, Dembitzer and Boris that if the plaintiffs
invested in Bonds rated A or higher, the principal risk would be comparable to that of a
similarly rated government security. More specifically, a Bond rated AAA was
comparable in risk to a United States Treasury Bond, while a Bond rated AA was
eomparable to an Israeli Treasury Bond.
h. Mulligan failed to advise plaintiffs that 88% of the Bonds were
rated A or higher, and that seventy pereent of the Bonds were considered "super senior".
1. Mulligan also stated that a portfolio of CMBS in different
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geographic areas and different propClty elassitlcations (i.e. retail, industrial, otlice, hotels
...) would provide diversification and thus, additional security far superior to municipal
bonds.
J. Mulligan fililed to advise plaintiffs that many of the loans
underlying the Bonds would have been in default but for funds escrowed at closing.
k. Mulligan failed to advise plaintiffs of the decline in underwriting
metries used to generate both the bonds and their underlying loans. To wit: (i) in greater
loan to value ratios; (ii) greater percentage of loan interest only; (iii) use of j(llward
looking rather than actual tlnaneials in determining debt service coverage.
I. Mulligan fi.uther advised plaintiffS that Merrill would provide the
plaintifls with repurchase tlnaneing ("Repo Financing") on the Merrill Bonds. Mulligan
also reassured them that Merrill has always in the past provided, and would continue to
provide, Repo Financing on securities bought ji'om Men'ill's trading inventory ("Inventory
Bonds").
m. Mulligan stated that the llnaneing offered on Bonds varied based
on the ratings of these securities. The higher the rating on the Inventory Bonds, the
greater the amount of tlnancing Merrill would provide. Merrill otIered the Inventory
Bonds with a repurehase roll-over period ("Repo Roll"). This means that after 30 days the
interest rate for the Bonds would be reset in accordance with the current L1BOR pricing.
Thc tlnancing Merrill offered the plaintiffs on Bonds with a 30-day rcpo roll was as
follows:
AAA 85%
AA 75%
A 65%
BBB 50%
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n. Apparently anticipating concerns about the heavy leverage,
Mulligan then repeated his assurances about the safety and liquidity of the investments
and that the leverage would create a nominal risk. In this vein, Mulligan stated: (i) if
plaintiffs purchased short term Bonds, the price fluctuations were meaningless because
the Bond would payoff in ftl!l within that time frame; and (ii) the strength of the collateral
underlying the Bonds would minimize any l1uctuation.
o. Mulligan then recommended certain Inventory Bonds.
19. The plaintiffs left the meeting believing that investing in Bonds was
in line with their business objectives.
MERRILL'S OPENING AND OPERAnON OF THE
INVESTMENTS ACCOUNTS
20. On April 18, 2007, Max Baker, Director of CMBS Trading at Merrill,
emailed the plaintiffs an offering of some Bonds.
21. On April 21,2008, Merrill assigned Matthew LoVecchio, CLoVecehio"),
hom Merrill's Global Markets and Investment Banking (GMI) ._.. NY Fixed Income Sales
Group, to act as the plaintiffs' registered representative and sales consultant.
22. That same day, LoVecchio emailed the plaintiffs an introduction, offered
his assistance and outlined the required doeUli1entation to open an account with Merrill:
specifically, a Master Repurchase Agreement ("MRA") with Merrill, an Investment
Management Agreement ("IMA"), an offering memorandum or prospectus for the
plaintiffs, a certificate of formation or articles of incorporation, and a tax ID form.
23. This was the only detailed documentation Merrill requested Ii'om the
plaintiffs for Merrill to open and maintain the accounts.
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24. The plaintiffs reviewed such requests and advised Merrill that they had no
offering memorandum or prospectus.
25. On April 28, 2008, LoVecchio emailed the plaintiffs to notify them that
Merrill had set up accounts n no IMA was ever submitted. In that same email, LoVeeehio
offered the plaintiffs two Bonds that were eaeh rated A.
26. Shortly thereafter, LoVeeehio requested a Enaneial statement for Merrill's
credit department to review to approve plaintiffs' creditworthiness for the purchase and
financing of Bonds.
27. On or about May 2, 2008, Northern providcd a statement of assets it
managed, whieh were constructively owned by Dembitzer and Fried. The flnaneial
statement was unaudited, unexecuted and was a merely a two page statement, with the
Erst page listing cash and real estate owned by Dembitzer and Fried through special
purpose entities while the second page listed mortgages and a net value - - i.e. assets
luinus lTIOltgages.
28. No Enaneial statement was providcd by Altitude.
29. LoVecchio and his group continued the sophisticated hard-sell methods
that Merrill employed throughout Merrill's relationship with the plaintiffs. Beginning on
April 22, 2008, LoVecchio called plaintiffs on almost a daily basis, in an effort to
convince them to purchase Inventory Bonds. LoVecchio also sent the plaintiffs emails
praetieally every day eontaining an offering ofInventory Bonds. At no time, however, did
Merrill send the plaintiffs any kind of account analysis or market analysis of the
InventOlY Bonds that adequately disclosed the risks of investing in CMBS. To wit:
degradation of underwriting metries, rapid decline of the eollateral underlying eertain
segments of CMBS, laek ofliqnidity in CMBS, and the inability to have an aeeurate mark
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to market price due to the lack of liquidity in the CMBS market.
30. Boris asked LoVechhio for information regarding the Bonds and was told
that the only information required was that contained on the Trepp Sheets.
31. The Trepp Sheets providcd a snapshot of the performance of the loans
underlying the Bonds. To wit: Loan: Amount of Loan; Loan Balance; ldentitleation of
Property; Term of Loan; Amortization Term; lntercst Only Period; Status of Loan --
current, delinquent or default; and a summary of each category.
32. In this regard, LoVecchio gavc plaintifh his password so tlicy could acccss
the Trepp Sheets.
33. Plaintiffs were never provided with any offering memorandums,
prospectus' or private placement memorandums ("Offering Memorandums") for any of
the Bonds which they purchased.
34. On April 18, 2008, Merrill attempted to send plaintiffs two offering
memorandums via email. Apparently due to the tremendous size of the attachments,
neither document was received. Altitude did ultimately purchase Bonds reflected in one
of the offering memorandums.
35. Other than the futile attempt to provide plaintifls with Offering
Memorandums on April 18, 2008 (see paragraph 33 above), plaintiffs never received any
Offering Memorandums until they were provided in discovely in this action.
36. On or around May 5, 2008, in reliance on Merrill's representations set fortb
above, Northern and Altitnde each entered into a Master Repurchase Agreement ("Repo
Agreement) with Merrill, dated April 28, 2008, and provided Merrill with Northern's
Certificate of Incorporation and Altitude's Certificate of Formation. No IMA was
provided or even requested.
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37. Upon information and belief, an IMA is required pursuant to Merrill's
internal compliance manual, and the Know Your Client Rules contained in FINRA Rule
2090.
38. Northern did not make any investments or conduct any trading activities
with Merrill. Only Altitude purchased Bonds fi'om Menill.
39. Altitude would never have invested in Bonds if Merrill had not represented
to the plaintiffs that the Bonds were "money good," conservative, safe, sound, highly
rated, highly liquid investments, and if Menill had not assured it of the safety of making
these investments with the levels of financing Merrill agreed to provide.
THE INITIAL CMBS PURCHASES IN PLAINTIFFS' ACCOUNTS
40. On or about May 12,2008, Altitude purchased eight inventory Bonds with
a face value of $23,626,000, for $16,985,945 ("Purchase 1") with Merrill Providing 30-
day Repo Financing as follows: (i) ML Commercial CMO 2006 4 Crated AA for
$3,981,138.28; (ii) Waehovia Bank CMO 2006 C29 Crated AA for $2,779,605.70; (iii)
ML Commercial CMO 2007 6E rated A- for $2,623,880.16; (iv) ML Commercial TR
CMO 2007 Cl B rated AA tor $ 105,710.94; (v) Waehovia Bank CMO 2007 C31 AJ
rated AAA telr $2,841,222.66; (vi) Waehovia Bank CMO 2007 C31 F rated Ate)]'
$4,077,656.25; (vii) ML Commercial CMO 2007 5 D rated Ate)]' $272,544.18; and (viii)
ML Commercial CMO 2007 8 Crated AA for $304,187.50.
41. Plaintiffs were never given an Offering Memorandnm for any of sueh
Bonds and thus were not privy to the numerous risk tiletors detailed therein.
42. Plaintiffs were never provided with the updated financials t,)r any of such
Bonds.
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43. On May 12, 2008, the settlement date for these purchases, Altitude paid for
the Bonds in cash by wiring $4,700,792 to Merrill, with $12,326,000 in financing hom
Menill.
44. On May 19, 2008, Altitude purchased two additional Bonds with a
combined $2,964,000 filce value for $2,810,425 with Merrill providing 30 day Repo
Financing of $2,389,000 ("Purchase 2") as follows: (i).lP Morgan Chase CMO 2006
FL2A A2 rated AAA for $365,929.69;and (ii) Greenwich Capital CMO 2006 FL4A A2
rated AAA for $2,444,495.63.
45. PlaintiiTs were never provided with offering memorandum for either Bond and
thus were not privy to the numerous risk factors detailed therein.
46. On June 4, 2008, Altitude purchased another two bonds with a combined
face value of $7,020,000 for $6,387,661 with Merrill providing 30 day Repo Financing in
the amount of $4,754,000 ("Purchase 3") as follows: (i) Bank of America Large Loan
2007 BMB1 Crated AA for $4,505,273.44; and (ii) Citigroup CMT 2007 FL3A A2 Rated
AAA for $1,882,387.50.
47. Merrill never provided plaintiffs with any Offering Memorandums !{ll' any
of those Bonds, and thus plaintiffs were not privy to any of the risk factors detailed
therein.
48. Merrill never provided plaintiffs with any updated !inancials !{)r any of
such Bonds.
49. On June II, 2008, the Repo Financing for Purchase 1 came due. Merrill
sent the Companies notification that for Altitude to roll Purchase I for another repo
period, Altitude had to pay an additional $112,000 to cover market valuations.
50. As of June II, 2008, Altitude had purchased a total of $33,61 0,000.00 face
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amount of Inventory Bonds hom Merrill f'lr purchase prices totaling $26, 184,03 I .00 with
Repo Financing totaling $19,469,000.
5I. On June 16, 2008, LoVecchio advised Northern that it must execute and
return a QIBLlST Application ("QIB Form").
52. The QIB Form is a representation that the buyer of securities is a qualillcd
institutional investor and therefore, eligible to purchase unregistered securities (such as
Bonds) pursuant to an excmption in the Securities Act of 1933 ("Securities Act").
53. According to Part 230.144A of the General Rules and Regulations of the
Securities Act, to be effective, a QIB Form must be exeeuted by a company's Chief
Financial Officer, a person lulfilling an equivalent funetion, or other exeeutive offieer of
the purehaser.
54. On June 16, 2008, Boris exeeuted the QIB Form and returned same to
LoVeeehio.
55. Boris was never the Chief Financial Offker, a person fulfilling an
equivalent fi.lIlction or other executive officcr of any of the plaintiffs. Merrill was awarc
that plaintiffs were a mother, son operation and that Boris was a new hire and Merrill
should have looked to one of the principals of plaintiffs for such signature.
56. Merrill's failure to have the QIB form executed prior to the purchase or by
an authorized person, is yet an other example (no IMA) of how its desperation to unload
the InventOly Bonds took precedenec over following proper proecdure.
57. On Junc 23, 2008, Northern rewarded Boris by making him its Chief
Investmcnt Officer ("CIa") a title which is not traditionally considered to be an actual
officer but rather a mere job title. Tellingly, Boris was not cIa of Altitude, and he
I 1
gained such title with Northern after he executed the QIB Form.
58. Merrill was precluded Ii'om selling any of the Bonds to the plaintiffs
because they did not qualify to use any of the exemptions fi'om registration under tbe
Securities Act of 1933
PLAINTIFFS SUCCUMB TO ADDITIONAL SALES PRESSURE FROM
MERRILL
59. On June 13, 2008, Dembitzer and Boris, met with Merrill to discuss
investing in Bonds. Those present from Merrill werc Matthew LoVecchio, Roger Lehman
CLehman"), Max Baker ("Baker"), and Julia Tcherkassova ("Tcherkassova"). At that
meeting, LoVecchio, Baker and Tcherkassova reiterated that CMBS are strong, secure,
liquid investments and that Bonds are rated A and above are "money good." This
meeting induced Altitude to retain its existing positions regarding the Bonds Altitude had
already purchased and to purchase additional Bonds. At such mccting, Lchman
vigorously stated that the higher rated Bonds held almost no principal risk because they
were in a senior position to the lower rated Bonds. What Lebman and Merrill Lynch f ~ t i l e d
to disclose at such meeting was that close to ninety percent of all the Bonds were in this
senior position, thereby making this statement almost meaningless -- the senior Bonds
were effectively not senior to any other bonds. In addition, Lehman failed to disclose the
degeneration of underwriting metries that had occurred since 2003, thereby weakening the
value of the underlying collateral. To wit: loan to value ratio increased; the cash How to
debt service coverage decreased; loans were written on pro-forma financials rather than
actual financials; the methods of appraisal were loosened allowing for higher valuations.
60. During that conversation, LoVecchio informed Boris that Altitude had
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initial approval for $50 million of Repo Financing, and that, if needed after quarter-end,
the plaintiffs could discuss increasing their Repo Financing amounts based on their past
performance, Boris also asked LoVecchio if the plaintifls could extend their repo periods
for 90 days or morc. LoVecchio answcred that he spoke with Merrill's rcpurchase
tlnancing group and they suggested repeating this request after quarter-end.
61. On .June 20, 2008, the Repo Financing from Purchasc 2 expired and
LoVecchio stated that in order to roll the tlnancials ovcr for another period, Altitude must
invcst an additional $14,000, which Altitude then did.
THE EARLY MARGIN CALLS
62. On .June 24, 2008, Merrill sent Altitude a notice of a margin call with an
exposure of $464,468, which Merrill claimed was duc to a decrease in markct value for all
the Bonds purchased by Altitude. Altitude covered the margin call.
63. On June 30, 2008, Merrill sent Altitude noticc of a second margin call for
$396,452, which Merrill once again claimed was due to the decreasc in market value for
all thc Bonds purchased by Altitude. Altitude covercd the margin call.
64. On July 7, 2008, the Repo Financing camc due. Paul Caputo, another
representative at Merrill who was handling the Companies' accounts at Merrill while
LoVecchio was away, told Altitude that it would have to invest an additional $100,000 in
cash to roll the financials over for another 30-day period, which Altitude did.
65. When Dembitzer and Boris asked LoVecchio why Altitude was recclvmg
all these margin calls, LoVecchio responded that it was due to the fact that it was the end
of the current qumier. He said there is always volatility at the end of the quarter, but that
the prices would readjust in a few days. LoVecchio further assured Dembitzer and Boris
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that these were just paper losses and that the Bonds were good investments.
MORE SALES PRESSURE, MORE PURCHASES
66. With that reassurance in mind, on July 9, 2008, in response to the daily
offering sheet provided by LoVecchio ofInventory Bonds, Altitude purchased two Bonds
with a combined IIlce value of $10,000,000 jix $9,140,625 with Merrill providing 30 day
Repo Financing of $7,770,000 ("Purchase 4") as follows: (i) ML CMO 2006 1 A2 rated
AAA for $4,603,125; and (ii) ML CMO 20061 B ratcd AAA fi)r $4,537,500.
67. P l a i n t i n ~ were never given an Offering Memorandum fi)r either of such
Bonds, and thus were not privy to any of the risk factors detailed therein.
68. From July 11, 2008 to July 24, 2008, the Repo Financing expired and was
rolled for 30 days. This time, Merrill did not request any additional funds Ii'om Altitude.
69. On July 18, 2008, Altitude purchased two Inventory Bonds with a
combined face value of $2,000,000 for $1,177,031 with Merrill providing 30 day Rcpo
Financing of $880,000 ("Purchase 5") as follows: (i) CW Capital Cabal CMO 2006 CI G
rated BBB fi)r $402,187.50; and (ii) ML Commercial CMO 2007 7 AJ rated AAA lill"
$774,843.75.
70. Plaintiffs were never given an Offering Memorandum for either of sucb
Bonds, and thus were not privy to any of the risk factors detailed therein.
71. On July 21, 2008, Altitnde purchased one Inventory Bond with a face
value of $5,000,000 face for $4,097,656 with Merrill providing 30 day Repo Financing in
the amount of $3,483,000 ("Purchase 6") as follows: ML Commercial CMO 2006 3 AI
rated AAA.
72. PlaintiilS were never given an Olfering Memorandnm for snch Bond, and
thus were not privy to any of the risk factors detailed therein.
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MOUNTING MARGIN CALLS IN JULY AND AUGUST Z008
73. On July 30, 2008, Merrill sent Altitude notice of a margin call for
$1, I05,110, which Merrill, once again, claimed was due to decrease in market value for
all the Bonds Altitude purchased. Altitude covered the margin call.
74. On August 6, 2008, the Repo Financing for the purchases came due and
Merrill permitted Altitude to roll it over. The cash remaining from the rollover was
applied to the account.
75. On August II, 2008, Merrill sent Altitude notice of a margin call for
$533,000 which Merrill once again claimed was due to dccrease in market value for all
the Bonds purchased by Altitudc. Altitude covered the margin call.
76. On August 15, 2008, Merrill sent Altitude notice of a margin call for
$392,000 which Merrill once again claimed was due to decrease in market value It)r all
the Bonds purehased by Altitude. Altitude covered the margin call.
77. On August 19, 2008, Merrill sent Altitude notice of a margm call It)r
$607,000 which Merrill once again claimed was duc to decrease in market value for all
the Bonds purchased by Altitude.
78. Prior to covering certain of the margm calls, plaintiffs inquired as to
whether it could sell the Bonds. Defendants responded that there was a limited market for
the Bonds and that, although Merrill would pnrchase them from plaintiffs, it would be at a
mark approximately forty percent less than the one used to determine the margin call. As
a result, Altitude had no option but to cover the margin calls.
79. Despite the margin calls during that period, LoVecchio repeatedly advised
the plaintiffs via telephone calls and emails that the Bonds the plaintiffs purchased were
highly attractive, safe, highly rated, "money good" investments with long term value, a
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nice upside and high payoffs. In this regard, Merrill provided plaintiffs with daily market
color from its trading desk as well as weekly CMBS research reports.
80. The weekly CMBS Rcsearch would, as a general rule, discuss a negative
occurrence in the commercial rcal estate market but then disingenuously minimize its
impact. For instance, when discussing Stuyvesant Town ("Stuy Town") and Peter Cooper
Village, Lehman wrotc that although at its present rate, Stuy Town would not have
enough funds to satisfy its debt in 4 months, it was immaterial over the next twelve
months; and (ii) when discussing a failing borrower, such as: Riverton; Mervins; West
Oak Mall; Feldman Mall; Goody,; Steve & Barrys'; Linens and Things; Boseows; Lillian
Vernon; Shatver Image; Bombay Company or Borders, Lehman would state that the size
of default was immaterial as it was only a miniscule percentage of the bonds -- tellingly
Lehman never aggregated the exposure created in a segment ie. retail.
CONSOLIDAnON OF THE ACCOUNTS
8I. On August 22, 2008, the Repo Financings for all the purchases were
consolidated ("Consolidated Repo") and Altitude had a surplus of $2.4MM of margin
cash. To roll these consolidated purchases, $2.4MM of the margin cash was applied to
Altitude's account at Merrill.
82. Through late Angust 2008, the net result of the purchases, the margin calls
and the Consolidated Repo was that Northern and Altitude had purchased $50,610,000.00
face amount of Bonds for $8,997,334.00 cash plus roll-over and margin payments of
$3,427,483.00 for total payments of $12,424,827.00 with total remaining margin of
$28,480,000.
83. Throughout September 2008, Merrill made numerous telephone calls to the
plaintiffs and sent the plaintiffs numerous emails containing market reports (CMBS
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Weekly and Daily Color) (i-om Merrill stating that the Bonds were highly attractivc, safe,
highly rated, "money good" investments with high payoffs.
LATE SEMPTEMBER: THE MOUNTING D 1 S A S n ~ R ANn EXPANDING LIES
OF MERRILL
84. On September 22, 2008, the Consolidated Rcpo came duc and, without any
notice, Merrill reduecd Altitude's levcrage by flve percent. Thus, Altitude had to invcst
an additional $772,000 to cover reduced leverage. Altitude wired the additional $772,000
to Merrill.
85. That same day, Dembitzer and Boris on behalf of Altitude, had a
conversation with LoVccchio. During that conversation, LoVecchio stated that Mcrrill
would continue providing Repo Financing for Altitude. LoVecchio also assured
Dembitzer and Boris that Menill is in the business of buying and selling Bonds and
providing flnancing to facilitate transactions. He said that Merrill had reduced the
flnancing amounts and therefore, their exposure on a temporaIy basis bccause of market
conditions and balance sheet concerns with the pending acquisition of Merrill by Bank of
Amcrica. He also reassured Dembitzer and Boris that the fundamentals were sound and
that Altitude's investments were liquid, safe and secure.
86. Later that day, Boris contacted LoVecchio to discuss Repo Financing.
LoVecchio then called the repo desk at Merrill with Boris in the background. Boris then
heard the person LoVecchio was speaking with at the repo desk state that Merrill would
continue to provide Repo Financing for Merrill Bonds.
87. On October 1, 2008, Merrill sent Altitude notice of a margin call for
$1,063,000, which Merrill once again claimed was due to decrease in market value for all
the Bonds purchased by Altitude. Altitude covered the margin call.
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88. On October 2, 2008, Merrill sent Altitnde notice of a margin call for
$9 I4,000, which Men'ill once again claimed was due to decrease in market value for all
the Bonds purchased by Altitude. Altitude covered the margin call.
89. On October 10, 2008, Merrill sent Altitude notice of a margin call for
$3 I9,000, which Merrill once again claimed was due to dccreasc in market value for all
the Bonds purchased by Altitude. Altitude covered the margin call.
90. On October 16, 2008, Merrill sent Altitude notice of a margin call for
$1,828,000, which Merrill once again claimed was due to decrease in market value for all
the Merrill Bonds purchased by Altitude.
91. On Oetober 20, 2008, Merrill fired more than SOO employees.
92. On October 22, 2008, the Consolidated Repo came due. Merrill informed
Altitude that to roll the Consolidated Repo, in addition to applying the entire margin cash,
Altitude had to invest an additional $100,000 to cover reduced leverage. Altitude wired
the additional $772,000 to Merrill.
93. Instead of providing a thirty day roll over period, Merrill decreased the
Consolidated Repo period to seven days without any notice to Altitude. LoVecchio
claimed that on account of the layoffs that occurred on October 20, 2008, of more than
SOO people at Merrill, LoVecchio could not obtain credit approval for a repo period of 30
days. LoVecchio stated that he would work on extending the repo period for the next
time the Consolidated Repo came due.
94. On October 29, 2008, the Consolidated Repo period expired and was
rolled for 30 days. Nevertheless, that same day, Merrill demanded from Altitude a IS%
principal paydown on all the Merrill Securities in Altitude's account. Merrill claimed that
this was being done to all bond issues and claims on all its accounts. Merrill demanded
18
$4,721,991.87 hom Altitude on account of the "repo roll," $1,218,991.87 of which was
immediately paid by Altitude.
95. On Halloween, October 31, 2008, Merrill sent Altitude a margin call of
$1,774,054.42. Merrill claimed that Altitude had to pay the margin call and the
outstanding balance from the repo roll of $3,503,000, a total of $5,477,054.42, by
November 4, 2008, or else Altitude's account would be liquidated.
96. Altitude made repeated requests to Merrill to explain their unrcasonable
dcmand on such a short notice. Dembitzer informed Merrill that the funds werc
immediately available, but that, without admitting that Merrill is entitled to demand this
kind of money, Altitude wanted to simply place the funds in escrow until Altitude
received an explanation for Merrill's most recent demand for an additional
$5,477,054.42.
97. However, Merrill rejected Altitudc's proposal and thrcatened to liquidate
the account immediately - at an additional loss of tens of millions of dollars -- if
Altitude did not hand over nearly $5.5 million immediately.
98. On November 4, 2008, Dembitzer arranged for Altitude to pay
$5,477,054.42 cash to Mcrrill.
99. Altitude made this payment on November 4, 2008, under protest. If
Altitude did not make this payment, Merrill would have immediately liquidated Altitude's
account at Merrill and would have done so without regard for the prices Merrill could
obtain for the securities in Altitude's account. Therefore, Altitude's account at Merrill
would have incurred extremc and unreasonable losses.
100. On November 21, 2008, Altitude paid Merrill the sum of$13,383,183.29, in
full satisfaction of plaintiffs' elebt to Merrill Lynch.
19
101. In January 2009, Altitude transferred Bonds 111 exchange for
$I6, 194,953.17 credit fi'om Moselle Developments, LTD.
AS AND FOR A FIRST CAUSE OF ACTION
Fraud
102. Plaintiffs repeat and reallege the allegations set forth in the paragraphs "I"
through "101" above as if liIlIy set fOlih herein.
103. In April 2008, Merrill made material representations to plaintiffs as set
forth in paragraphs 17 above, and summarized below:
a. The Bonds are "money good," conservative, safe and highly liquid
investments and that the Bonds have high ratings from the principal rating agencies.
b. Investing in the Bonds would provide the plaintiffs' safety,
liquidity, principal protection and diversilication.
c. If the plaintiffs' invested 111 the Bonds they would realize high
returns.
d. Merrill would provide the plaintiffs with continued Repo Financing
on the Bonds.
e. That the Bonds rated A or higher were as secure as similar
government bonds because such Bonds were senior to the other bonds on the same debt.
f. Based upon the liquidity and safety of these Bonds, Northern and
Altitude could buy the Bonds in large quantities with full leverage as stated above and
nominal risk.
104. If Merrill had not made the misrepresentations set forth in paragraph
"102" above, then plaintiffs would not have invested in the Bonds.
I05. Plaintiffs did, in fact, rely on the information diselosed by Merrill.
20
106. Merrill intended that plaintiffs rely on such information when it disclosed
it to plaintills.
107. Such bonds were unsuitable for plaintiffs needs -- a safe secure investment
which could be easily liquidated to investment in real estate -- and plaintiffs knew such
investment was not suitable fix plaintiffs.
108. At the time of the account opening and plaintills' signing of the MRAs,
Merrill induced plaintiffs to do so by intentionally omitting vital and material information.
109. Merrill failed to follow its proper procedures when opening plaintiffs'
accounts -- to wit: no IMA and minimal effort to follow the Know Your Customer
regulations contained in FINRA Rnle 2090.
110. If Merrill had followed the regulations contained in FINRA Rule 2090, it
would have known the Bonds were not suitable for plaintills needs.
111. Merrill never infonned plaintills or anyone else affiliated with the
Companies the true value and risks of the investments they put plaintiffs into.
112. Merrill knowingly concealed from the Companies that:
(a) it had a liquidity crisis caused in large part by its inability to sell the
Bonds it originated and it was desperately trying to unload its inventories of commercial
and residential mortgage-backed securities during the very months it was pushing many of
those securities into plaintiffS' accounts;
(b) it had offered substantial financial iucentives (.5% paper commission)
to its registered representatives in the event they were able to sell any Inventory Bonds.
(c) that it was considering, and then cffectuating, the sale of a large part of
its own inventory of mortgage-backed securities to a third party at a 78 percent discount at
the same time it was selling such securities to the Companies at only a 20 percent
21
discount;
(d) its own flnancial instability - leaving its sales people and advisors in
a desperate need to "pnsh product" 'and maximize sales and commissions if they were to
have any chance of salvaging their jobs and avoiding the fate of tens of thousands of their
peers;
(e) it had stopped originating Bonds in 2007, because it was unable to
place a substantial percentage (more than ten billion dollars) of the Bonds it had already
originated;
(1) its liquidity crisis was caused by its inability to liquidate its InventOly
of Bonds;
(g) its poliey to pay higher bonuses to its registered representatives for the
sale of any Inventory Bonds;
(h) of the lack of transparency in the CMBS market and that the marks
utilized by Merrill for both the sales and margin calls were generated by tertiary forms of
mark to market because there were no comparable sales;
(i) in an effort to generate profits through the origination of CMBS, Merrill
had abandoned longstanding underwriting principals, To wit: (a) the loan to value ratios
increased; (b) loans were underwritten on 'pro-forma flnancials rather than actual
performance; and (c) cash flow to debt service ratio's decreased;
(j) institutional traders were aware of such dcgradation in thc underwriting
metrics which was contributing to the laek of liquidity in the CMBS market;
(k) eighty eight percent of all the Bonds were rated A or higher thereby
minimizing any protections that might be allorded the higher rated classes.
(I) many of the Bonds never or rarely traded;
22
(m) that the prices which it used to sell the Bonds, f{)r margin ealls were
not actually market prices but generated by its traders based on a review of: (i) sales of
identieal Bonds; (ii) sales of similar bonds; (iii) market activity in general; (iv) Markit
CMBX; and (v) conversations with other Merrill traders and clients;
(n) that the finaneial woes of: Riverton; Mervis; West Oak Mall; Feldman
Malls; Goodys; Steve & Barrys'; Linen and Things; Boseouns; Lilior Vernon; Sharper
Image; Bombay Company eolleetively had an impact on the performanee of CMBS; and
that the escrowing of funds masked the lack of finaneial viability of Stuyvesant Town;
Extended Stay and other borrowers directly impacting select Bonds as well as the CMBS
market;
(0) Merrill had net losscs of $2.6 billion m the third quarter of 2007
resulting primarily from completed and planned asset sales across residential and
commercial exposures; and
(p) that the projimnas included in the proxy statement dated September
27, 20 II stated that there were preliminary adjustments of 5.3 billion dollars to its loan
portfolio.
113. In its desperation to unload the Inventory Bonds, Merrill sold over thirty
million dollars of Bonds to plaintiffs without qualifying plaintiffs as either a QIB within
the meaning of Rule 144A under the Seeurities Act of 1933 ("Securities Act") or a
Purchaser in offshore transaction in reliance on Regulation S ("Reg S Purchaser") under
the Securities Act.
114. Merrill never provided plaintiffs with offering memorandums for any of
the Bonds they purchased.
115. If Merrill had provided plaintiffs with Offering Memorandums complete
23
with Risk Factors, plaintiffs would not havc invested in the Bonds.
J 16. Plaintiffs were not a QIB or Reg S Purchaser.
117. Menill knew or should have known that plaintiffs were not a QIB or Reg S
Purchaser.
118. In its desperation to unload the Inventory Bonds, Merrill negligently or
recklessly tiled to determine that the plaintiffs were not a QIB or Reg S Purchaser.
119. Pursuant to the statements contained in the Offering Memorandums, the
Bonds were unregistered securities and could only be sold to QIB's or a Reg S Purchaser.
120. If Merrill had disclosed the information set forth in paragraphs "106" to
"112" above, then p l a i n t i l l ~ would not have invested in the CMBS.
121. Plaintiffs did, in fact, rely on the information disclosed by Merrill m
making the decision to purchase the Bonds.
122. Merrill's acts were willful and exceeded the bounds of decency and would
be considered outrageous by our society as a whole.
123. By reason of such !iaud, plaintim seek actual damages of twenty five
million dollars, plus interest hom December I, 2008; as well as exemplary and punitive
damages in such amount as the jury deems appropriate to discourage such behavior.
AS FOR A SECOND CAUSE OF ACTION
Breach of Fiduciary Duty
124. Plaintiffs repeat and reallege the allegations set forth in the paragraphs" I"
through "123" above as iffully set forth herein.
24
125. As the brokerage finn for plaintiffs, Merrill owed plaintiffs fiducimy duties
of honesty, hdl disclosure and compliance with securities regulations and generally
accepted brokerage firm principles and standards.
126. Merrill had a flducimy duty to execute the sales to plaintiffs at the mark to
market price.
127. Merrill had a fiduciary duty to make its margin calls at the mark to market
pncc.
128. Merrill breached this fiduciary duty by selling the Bonds to Altitude at
grossly inflated prices.
129. Merrill breached this fiduciary duty by selling the Bonds to plaintiffs
without qualifying plaintiffs for an exemption fi'om registration under the Securities Act,
and therefore, if Merrill didn't breach this fiducimy duty, plaintiffs would not have been
able to purchase the Bonds.
130. Merrill did not use accurate pricing when making the margin calls, but
instead utilized numbers designed to increase Merrill's cash position.
131. Merrill's breach of flduciary duty has caused plaintifls to incur damages in
excess of twenty four million dollars.
132. By reason of the foregoing, plaintifls demands judgment in the amount
twenty-four million dollars, plus interest.
AS AND FOR A THIRD CAUSE OF ACTION
Reckless and Negligent Misrepresentation
133. Plaintiffs repeat and reallege the allegations set forth in the paragraphs" I"
through "132" above as if fully set fOith herein.
25
134. Defendants held out themselves as experts for the purpose of providing
honest opinions and recommendations on whether plaintiffs should huy, hold or sell
CMBS from Merrill Securities in plaintiffs' accounts with Merrill, as well as which
CMBS securities should be initially purchased. Merrill represented itself as a finn in the
finance induslIy that maintained its clients' accounts in accordance with applicable
standards within the industry.
135. In the rendering of investmcnt advice and sale of securities to plaintiffs,
defendants have obtained money or property by means of untrue statements of material
facts or by omissions to state material facts necessary in order to make the statements
made, in light of the circumstances under which they were made, not misleading,
including, but not limited to, those misrepresentations specifically described in the
sections above, including that:
a. the Bonds are liquid;
b. the Bonds traded in an active market and were priced by a mark to
market system.
c. Merrill made a market in the Bonds so that they will always be
saleable;
d. Merrill was the originator/underwriter/syndicator of many Bonds
and that the underwriting standards used by Merrill in originating such bonds were the
most stringent in the industry;
f. the Bonds are "money good," conservative, safe and highly liquid
investments and that thc safety of the investments are reflected by the high ratings from
0&13, Moodys and Fitch;
g. a Bond rated AAA was comparable 111 risk to a United States
26
Treasury Bond, while a Bond rated AA was comparable to an Israeli Treasury Bond;
h. 88% of the Bonds were rated A or higher, and that seventy percent
of the Bonds were considered "super senior";
1. a portfolio of CMBS in different geographic areas and different
property classifications (i.e. retail, industrial, office, hotels . .) would provide
diversifkation and thus, additional security hlr superior to municipal bonds;
J. if plaintiJTs purchased short term Bonds, the price fluctuations were
meaningless because the Bond would payoff in full within that time Ji'ame and the
strength of the collateral underlying the Bonds would minimize any fluctuation;
and material omissions specifically described in the sections above, including that:
a. Merrill had a liquidity crisis caused in large part by its inability to
sell the Bonds it originated and it was desperately trying to unload its inventories of
commcrcial and residcntial mortgage-backed securities during the very months it was
pushing many of those securities into plaintifTs' accounts;
b. Merrill had offered substantial financial incentives (.5% paper
commission) to its registered representatives in the event they werc able to sell any
Inventory Bonds;
e. Menill was considering, and then effectuating, the sale of a large
part of its own inventOly of mortgage-backed securities to a third party at a 78 percent
discount at the same time it was selling such securities to the Companies at only a 20
percent discount;
d. Merrill's own financial instability - leaving its sales people and
advisors in a desperate need to "push product" and maximize sales and commissions if
they were to have any chance of salvaging their jobs and avoiding the fate of tens of
27
thousands of their peers;
e. Merrill had stopped originating Bonds in 200?, because it was
unable to place a substantial percentage (more than ten billion dollars) of the Bonds it had
already originated;
f. Merrill's liquidity crisis was caused by its inability to liquidate its
Inventory of Bonds;
g. Merrill's policy to pay higher bonuses to its registered
representatives for the sale of any Inventory Bonds;
h. there was a lack of transparency in the CMBS market and that the
marks utilized by Merrill for both the sales and margin calls were gcnerated by tertiary
forms of mark to market becausc there were no comparable sales;
I. in an effort to generate profits through the origination of CMBS,
Merrill had abandoned longstanding underwriting principals. To wit: (a) the loan to value
ratios increased; (b) loans were underwritten on pro-forma financials rather than actual
performance; and (c) cash flow to debt service ratio's decreased;
.J. institutional traders were aware of such degradation in the
underwriting metrics which was contributing to the lack of liquidity in the CMBS market;
k. eighty eight percent of all the Bonds were rated A or higher thereby
minimizing any protections that might be afforded the higher rated classes.
l. many of the Bonds never or rarely traded;
m. the prices which it used to sell the Bonds, for margin calls were not
actually market prices but generated by its traders based on a review of: (i) sales of
identical Bonds; (ii) sales of similar bonds; (iii) market activity in general; (iv) Market
CMBS; and (v) conversations with other Merrill traders and clients;
28
n. the financial woes of Riverton; Mervis; West Oak Mall; Feldman
Malls; Goodys; Steve & Barrys'; Linen and Things; Boscouns; Lilior Vernon; Sharper
Image; Bombay Company collectively had an impact on the perfonuance of CMBS; and
that the escrowing of funds masked the lack of fInancial viability of Stuyvesant Town;
Extended Stay and other borrowers directly impacting select Bonds as well as the CMBS
market;
o. Merrill had net losses of $2.6 billion in the third quarter of 2007
resulting primarily jj'om completed and planned asset sales across residential and
commercial exposures; and
p. the included in the proxy statement dated September
27, 2011 stated that there were preliminary adjustments of 5.3 billion dollars to its loan
portfolio.
136. Plaintiffs recklessly and or negligently represented that the Bonds were
suitable for plaintifTs.
137. In making the foregoing misrepresentations and material omISSIons,
defendants acted with recklessness or with negligence with the direct consequence of
deceiving plaintiffs and inducing plaintiffs to act or refrain from acting bascd upon the
false disclosures and nondisclosures by defendants.
138. Plaintiffs relied on the representatiol1s made by defendants, and upon the
misinformation caused by defendants' material omissions, by placing their brokcrage
investments with Merrill, acquiring the CMBS from Merrill's inventory, and placing their
investment accounts with Merrill.
139. Plaintiffs suffered mJury and damages in the amount of $25 million,
proximately caused by and as a result of defendants' reckless or negligent
29
misrepresentations and Olnissions.
WHEREFORE, plaintiffs demand judgment as follows:
a. on its first cause of action for fi'aud in the amount of $24,000,000.00 plus
punitive dmnages and interest;
b. on its second cause of action fllr breach of fiduciary duty in the amount of
$24,000,000.00 plus punitive damages and interest;
c. on its third cause of action of negligent misinterpretation in the amount of
$24,000,000 plus interest;
d. An award to plaintiffs of attorneys' fees, costs and disbursements; and
e. An order and judgment granting such fllrthcr relief as may be just.
1
Dated: New York, New York
December 6, 20II
30
; / ~
'" y ~ '2 ~ J "'1)
.To cpl N. Pay (
l inman, Howard & Kattell, LLP
Attorneys for Plaintiffs
185 Madison Avenue, 7''' Floor
New York, New York 10016
(212) 725-4423