Opinion
650144/2020
07-27-2020
Bruce BULLEN et al., Plaintiffs, v. COHNREZNICK LLP, Defendant.
Plaintiffs were represented by Glen Lenihan and Judith Schwartz, Oved & Oved LLP, 401 Greenwich Street, New York, NY 10013 (212) 226-2379 glenihan@ovedlaw.com Defendant was represented by James Heyworth, Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019 (212) 839-6785 jheyworth@sidley.com
Plaintiffs were represented by Glen Lenihan and Judith Schwartz, Oved & Oved LLP, 401 Greenwich Street, New York, NY 10013 (212) 226-2379 glenihan@ovedlaw.com
Defendant was represented by James Heyworth, Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019 (212) 839-6785 jheyworth@sidley.com
Barry Ostrager, J.
Before the Court is a motion by defendant CohnReznick LLP ("CohnReznick") for an order, pursuant to CPLR 3211(a)(7), dismissing the Complaint filed by plaintiff Bruce Bullen and 48 other investors ("plaintiffs") for failure to state a cause of action. Extensive oral argument was held on the record on July 8, 2020 (NYSCEF Doc. No. 67, hereafter "TR"). For the reasons stated below, the motion is denied without prejudice to a motion for summary judgment following the completion of discovery.
Background Facts
According to the Complaint (NYSCEF Doc. No. 17), plaintiffs are individuals, retirement plans, trusts, limited liability companies, and corporations, which collectively invested about $63 million in the now defunct hedge fund Platinum Partners Credit Opportunities Fund ("PPCO"). Defendant CohnReznick annually audited PPCO's financial statements and issued audit reports (the "Audit Reports") for the calendar years 2012, 2013 and 2014, with the last Audit Report having been issued in April 2015, and also performed some tax work. CohnReznick attested in the Audit Reports that, after reviewing the financial statements of PPCO, "which comprise the statement of assets, liabilities and members' equity as of [year end], and the related statements of operations, changes in members' equity and cash flows for the year then ended, and the related notes to the financial statements," it concluded that "the audit evidence [CohnReznick] obtained is sufficient and appropriate to provide a basis for [its] audit opinion [that] the financial statements present fairly, in all material respects, the financial position of [PPCO] ." (See, e.g., 2014 Audit Report, Doc. No. 29, pp 2-3, emphasis added). Plaintiffs assert that CohnReznick made these certifications with knowledge of missing material documentation and questionable transactions, which ultimately confirmed that PPCO assets were grossly overvalued. PPCO suffered from liquidity issues at least as of 2014 and collapsed in December 2016 when, among other things, the Securities and Exchange Commission commenced an action alleging a broad scheme by Platinum to defraud its investors.
PPCO is one of the funds managed by Platinum Partners. The second major fund is Platinum Partners Value Arbitrage Fund ("PPVA"). Plaintiffs were investors in PPCO only, not PPVA.
Plaintiffs assert CohnReznick ignored numerous "red flags" and confirmed in its Audit Reports material misstatements by Platinum unsupported by documentation, aware that investors like plaintiffs would be relying on the Audit Reports when determining to invest because of the otherwise opaque nature of the hedge funds. The Complaint asserts claims of: (1) fraud; (2) aiding and abetting fraud; and (3) aiding and abetting breach of fiduciary duty. CohnReznick seeks to dismiss all three claims and attempts to distinguish this action from the related action Bullen et al., v. Sterling Valuation Group, Inc., wherein this Court on June 5, 2020 -- five days before the instant motion was filed -- denied a similar pre-Answer motion to dismiss (Index No. 650050/19, NYSCEF Doc. No. 101). CohnReznick claims that, as the auditor, it is in a different position than Sterling, which acted as the valuation consultant As explained below, the Court is not persuaded by CohnReznick's arguments and, as in Sterling , denies dismissal at the pleading stage.
Discussion
Under CPLR § 3211(a)(7), the Court must determine whether, after affording the pleadings a liberal construction and accepting the allegations in the Complaint as true, "the facts as alleged fit within any cognizable legal theory ...." Leon v. Martinez , 84 NY2d 83, 87-88 (1994) (citations omitted). Based on the pleadings and supporting documents, the Court finds plaintiffs have adequately stated all three causes of action for fraud, aiding and abetting fraud, and breach of fiduciary duty to defeat defendant's 3211 motion and allow discovery to proceed.
The first cause of action sounds in fraud. "The elements of a cause of action for fraud require a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance by the plaintiff and damages ..." Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 NY3d 553, 559 (2009). While the Court of Appeals in Eurycleia did acknowledge, as CohnReznick urges, that CPLR 3016(b) requires that plaintiffs plead fraud with particularity, that Court also noted, as plaintiffs argue, that "there is certainly no requirement of ‘unassailable proof’ at the pleading stage" and " CPLR 3016(b) is satisfied when the facts suffice to permit a ‘reasonable inference’ of the alleged misconduct" id. (citations omitted).
The pleadings meet this standard, as reasonable inferences can readily be drawn from plaintiffs' allegations to state a fraud claim. As CohnReznick acknowledged in its Memorandum of Law (NYSCEF Doc. No. 15, pp 4-5) and during oral argument (TR 5-6), plaintiffs specifically plead that CohnReznick had access to a substantial amount of information. Platinum provided CohnReznick with "valuations generated by Sterling" and CohnReznick and Platinum directly corresponded about the supporting valuation models. (Compl. ¶116). In addition, CohnReznick spoke directly to Sterling (TR 14). Further, in conducting audits of PPCO's financial statements, CohnReznick "regularly met, spoke and corresponded with PPCO concerning operations, transactions, business structures, accounting policies, and other issues relevant to PPCO's financial statements." (NYSCEF Doc. No. 30, FAC (Mass. 2/14/2019), ¶83). CohnReznick also "reviewed PPCO allocation schedules" and "confirm[ed] capital contributions to and withdrawals from PPCO." (Compl. ¶198). Further, the Audit Reports themselves, quoted above, confirmed CohnReznick's access to, and consideration of, PPCO financials.
The Audit Reports themselves also provide a basis to infer CohnReznick's knowledge that Platinum's representations in its financial statements were dubious. For example, the Reports emphasized that a significant portion of PPCO's assets were difficult-to-value Level 3 assets, the value of which had been estimated by management "using inputs that are unobservable." (NYSCEF Doc. Nos. 21-29, emphasis added). The 2014 Audit Report indicated that these Level 3 assets made up 97.7% of PPCO's assets, and "103.2% of partners' capital." (Doc. 28 at 3, 16). Consistent with Eurycleia , one can reasonably infer CohnReznick's knowledge of Platinum's highly questionable representations from these facts and statements in the Reports that, for example, the "estimated values may not necessarily represent amounts that will be ultimately realized in the near term and the differences could be material."
Plaintiffs' allegations are further particularized by reference to the 28-page Declaration by Melanie L. Cyganowski, the court-appointed Receiver in the SEC Action (NYSCEF Doc. No. 43). While not mentioning CohnReznick, the Declaration identifies significant evidence of misrepresentations by Platinum that plaintiffs contend were either actually considered by CohnReznick or could not reasonably have escaped the auditor's attention in the course of its work. For example, the Receiver states that she concluded in her investigation that the PPCO Funds were "systematically and grossly overvalued by over 300% or $500 million" (¶36). She details (at ¶37) several investments and states: "Investments in portfolio companies with no track record, no demonstrated prospects and substantial unfunded capital requirements routinely were being carried on PPCO Master's books for tens of millions of dollars or more per investment."
Additionally, the Receiver notes (at ¶38) her observation that "Platinum investor funds effectively were commingled. Beginning in or about 2014, and continuing through the commencement of the Receivership, the Platinum Insiders effectuated repeat transfers of cash, booked as loans, from PPCO and PPLO [Platinum Partners Liquid Opportunities Master Fund, a separate Platinum Fund] to PPVA in order to assuage growing liquidity issues developing at PPVA. The loans were recorded as being partly, but not fully, paid down by virtue of subsequent asset transfers, mostly of distressed private equity or debt positions held by PPVA to PPCO at inflated valuations, as well as, from time to time, cash from PPVA to PPCO and PPLO. By the commencement of the Receivership, PPCO had transferred to PPVA a total of over $60 million in cash ... The flow of funds from investors into PPCO and/or PPLO, from PPCO and PPLO to PPVA, and then from PPVA back to PPCO and PPLO, had the effect of commingling investor contributions amongst the three funds." The Receiver further describes (at ¶39) various complex transactions "in which the Platinum Insiders had an interest on both sides of the transactions" to the detriment of the Fund and causing harm to PPCO in excess of $57M.
CohnReznick's characterization of the Receiver Declaration as being limited to valuation issues is belied by the above-cited declarations directly relating to books and records that the auditor claims it reviewed along with the financial statements. Nor can the auditor hide behind the Sterling valuation report, as many of the suspect activities noted by plaintiffs and the Receiver directly related to documentation available to CohnReznick during its 2014 audit and raised issues such as commingling of investor funds beyond Sterling's valuation of assets. What is more, CohnReznick asserts it did not merely accept the Sterling reports at face value but instead, "those Sterling Valuation Reports as part of CohnReznick's audits were discussed between CohnReznick and PPCO's management, and CohnReznick discussed them as well with Sterling." (TR 14). An inference of knowledge is justified.
CohnReznick counters that the claims at most plead malpractice, which plaintiffs, as non-clients, cannot assert under New York law due to a lack of privity, but they do not state a claim of fraud against an auditor, which is more "demanding". Israel Disc. Bank of New York v. EisnerAmper LLP, 45 Misc 3d 1218(A) (NY Sup. Ct. 2014), aff'd, 137 AD3d 638 (2016), quoting Meridian Horizon Fund, LP v. Tremont Group Holdings, Inc., 747 F. Supp. 2d 406, 412 (SDNY 2010) ; see also CRT Invs. Ltd. v. BDO Seidman, LLP., 85 AD2d 470, 472 (1st Dep't 2011) ("Plaintiffs' allegations of GAAS [Generally Accepted Accounting Standards] violations ‘without corresponding fraudulent intent’ are insufficient to state a securities fraud claim against an independent accountant") (internal citations omitted).
Citing various cases, but mostly federal court cases related to securities fraud, CohnReznick attacks plaintiffs' claim of scienter. For example, citing Stephenson v. PricewaterhouseCoopers, LLP , 482 F. App'x 618, 622-23 (2d Cir. 2012), CohnReznick argues that for plaintiffs to adequately allege scienter, they must plead specific facts demonstrating that CohnReznick's conduct was so reckless as to amount to "no audit at all". CohnReznick then recounts for the Court the various documents it reviewed and communications it had with Platinum, Sterling, and fund investors, as detailed earlier, to argue that the facts belie a claim of "no audit at all." The auditor adds that plaintiffs' own pleadings (detailed above) confirm that CohnReznick reviewed the PPCO financial statements and conducted other investigation as part of its audit.
But even accepting, without deciding, that plaintiffs' allegations do not rise to the level of "no audit at all" if the phrase is construed literally with the words given their plain meaning, the inquiry does not end there, as various courts have offered alternative interpretations that are more directly supported by the allegations here. For example, in the well-known case of In re Bear Stearns Companies, Inc. Sec., Derivative, & ERISA Litig. , 763 F. Supp. 2d 423, 511 (SDNY 2011), on reconsideration, 2011 WL 4072027 and 2011 WL 4357166 (SDNY. Sept. 13, 2011), District Court Judge Sweet stated (with emphasis added):
In the context of an accounting firm's audits, the scienter requirement for a Section 10(b) claim is satisfied by alleging that "[t]he accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts." In re Scottish Re Group Sec. Litig., 524 F. Supp. 2d 370, 386 (SDNY 2007) (citation omitted) ... Moreover, "[a]llegations of ‘red flags,’ when coupled with allegations of GAAP [Generally Accepted Accounting Principles] and GAAS [Generally Accepted Auditing Standards] violations, are sufficient to support a strong inference of scienter." In re Scottish Re, 524 F. Supp. 2d at 385, citing In re AOL Time Warner, Inc. Sec. and "ERISA" Litig., 381 F. Supp. 2d 192, 240 (SDNY 2004). "A complaint might reach this ‘no audit at all’ threshold by alleging that the auditor disregarded specific ‘red flags’ that ‘would place a reasonable auditor on notice that the audited company was engaged in wrongdoing to the detriment of its investors.’ " In re IMAX Sec. Litig., 587 F. Supp. 2d 471, 483 (citation omitted).
Judge Sweet went on to find plaintiffs' allegations sufficient to survive dismissal, stating that:
The Securities Complaint adequately alleges Deloitte's recklessness, if not actual knowledge, based on its awareness of red flags and its duty to investigate. McCurdy v. SEC, 396 F.3d 1258, 1261 (D.C. Cir. 2005) ( "[P]rofessional auditing standards have come to recognize, through decades of experience, particular factors that arouse suspicion and call for focused investigation. These factors are the so called ‘red flags’ for which all auditors are trained to remain alert."). See also AOL Time Warner, 381 F. Supp. 2d at 240 n. 51 (" ‘Red Flags,’ or audit risks, are the various ‘risk factors’ that auditors must consider under GAAS when performing an audit").
New York State courts have used similar language and have effectively adopted the "red flag" test. See, e.g., Israel Discount Bank of NY v. EisnerAmper LLP, 45 Misc 3d 1218(a) (Sup. Ct. NY 2014), aff'd 137 AD3d 638 (1st Dep't 2016), lv. denied, 27 NY3d 910 ; CRT Investments, Ltd. v. Merkin, 29 Misc 3d 1218(A) (Sup. Ct. NY 2010), aff'd sub nom. CRT Investments, Ltd. v. BDO Seidman, LLP , 85 AD3d 470 (1st Dep't 2011).
Particularly persuasive is the case of Houbigant, Inc. v. Deloitte & Touche , 303 AD2d 92 (1st Dep't 2003) cited by plaintiffs. There the Appellate Division reversed the trial court's dismissal of fraud and aiding and abetting fraud asserted by non-clients against Deloitte related to audited financial statements for a company in which plaintiffs had invested. While noting that dismissal of the malpractice claim was compelled by the lack of privity, the court held a claim had been stated for fraud, noting that the dismissal of malpractice claims under privity rules "does not emancipate accountants from the consequences of fraud." Id. At 95. As in this case, plaintiffs in Houbigant alleged that Deloitte had "materially misrepresented [the net worth] each year, in view of the absence of competent support for the values set forth in the financial statements " The basis for this conclusion was Deloitte's alleged failure to mention in its audit reports significant deficiencies or to take action to verify the information called into question by the deficiencies, along with the affirmative representation in the audit reports [like the reports here] that the financial statements "present[ed] fairly, in all material respects, the financial position of [the company being audited]." Id. at 95-96. The court concluded the allegations sufficiently stated a claim at the pleading stage and that issues relating to materiality and actual knowledge could be further explored at trial.
This Court finds that the allegations in this case, similar to those in Houbigant and Bear Stearns, suffice at the pleading stage to establish the required element of scienter, as they allow a reasonable inference of CohnReznick's "egregious refusal to see the obvious, or to investigate the doubtful." Plaintiffs here have specifically alleged numerous red flags which include that:
• [Platinum's Chief Investment Officer] Nordlicht exercised carte blanche authority over the valuation of PPCO's Level 3 assets, which comprised nearly the entirety of the Fund (Compl. ¶ 67);
• Most PPCO investments lacked basic documents or analyses, and Platinum otherwise lacked materials to corroborate PPCO's asset values (id. ¶ 215);
• Another auditor BDO concluded that a "material weakness" existed in Platinum's Level 3 asset valuation process for the related PPVA Fund, which increased the possibility of material misstatement and called into question PPCO's asset valuations (id. ¶¶ 112-13, 180); • Platinum lacked a written valuation policy for oil, gas, and mining investments, which comprised a significant portion of PPCO's holdings (id. ¶¶ 162, 165);
• Platinum's valuation committee failed to maintain meeting minutes, calling into question whether any such meetings actually occurred (id. ¶ 165);
• PPCO carried on its books tens of millions of dollars of distressed, unprofitable, and cash-dependent assets like Buffalo Lake, Cleveland Mining, Arabella, American Patriot, and LC Energy that had no track record or demonstrated financial viability (id. ¶¶ 71, 76-82, 166, and Receiver Declaration);
• Platinum effectuated improper loans between PPCO and PPVA that were used to ease PPVA's liquidity crisis and were paid back, in part, with distressed debt and private equity (Compl. ¶¶ 182, 210 and Receiver Declaration);
• Platinum facilitated related-party transactions that were injurious to PPCO (Receiver Declaration ¶ 39); and
• The Funds made preferential redemption payments and cashless transfers of limited partnership interests between the Funds (Compl. ¶ 90).
Plaintiffs further allege GAAS violations, including CohnReznick's failure to:
• Test the reasonableness of assumptions and estimates employed by Platinum to determine asset values (id. ¶ 102);
• Obtain reasonable assurance that PPCO's financial statements were free from material misstatement (id. ¶¶ 161, 178);
• Perform sufficient risk assessment procedures to provide a basis for the identification and assessment of risks of material misstatement in the financial statements, despite the fact that nearly all of PPCO's assets were Level 3 assets with no observable market inputs (id. ¶¶ 178, 226);
• Perform any procedures to identify related party transactions between PPCO and PPVA, including the inter-company loans and asset purchases used to prop-up the Funds (id. ¶¶ 101-02, 182); and
• Investigate information provided by an investor suggesting that CohnReznick's 2014 PPVA Audit Report was materially inaccurate in violation of GAAS (id. ¶¶ 150-52).
While CohnReznick disputes many of these allegations or their timing, the Court's role on a pre-Answer motion to dismiss is not to determine the facts but rather to determine whether, accepting the allegations as true, a claim has been stated. The answer to that question on the element of scienter is yes. Indeed, one can reasonably infer scienter from even the single item that Platinum repeatedly effectuated improper cash transfers, booked as loans, between PPCO and PPVA that were used to ease PPVA's liquidity crisis and were paid back, in part, with distressed debt and private equity of little to no value. These transfers were presumably reflected in PPCO's financial statements, which CohnReznick improperly certified as presenting " fairly, in all material respects, the financial position of [PPCO] ." The commingling of investor funds among the various Platinum Funds was another glaring red flag supporting the inference of scienter. These two items, certainly within the scope of a proper audit, support an inference of scienter based on " an egregious refusal to see the obvious, or to investigate the doubtful," within the meaning of Bear Stearns and the state court cases cited above.
The Court also rejects CohnReznick's argument that the allegations fail to support the required element of plaintiffs' justifiable reliance on the Audit Reports. CohnReznick acknowledges it contacted plaintiffs directly to confirm certain investments (TR 13) and it in no way disputes plaintiffs' allegation that many investors spoke with CohnReznick's managing partner Mr. Levy about their investments (Compl ¶ 196-198, TR 31-32). And despite general disclaimers in the Reports and plaintiffs' sophistication, plaintiffs were entitled to rely on the information in the Reports as being factually correct and to use those facts to make their own investment decisions. At a minimum, the pleadings raise issues of fact on these points that cannot be determined at the pleading stage. See Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 115 AD3d 128, 137 (1st Dep't 2014) (general disclaimer did not require pre-answer dismissal as a matter of law); ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 NY3d 1043, 1045 (2015) (reasonable reliance is not generally a question to be resolved as a matter of law on a motion to dismiss). As to causation of damages, plaintiffs have alleged the Audit Reports were a proximate cause of their damages (i.e., their lost investments); the Reports need not be the sole proximate cause of damages.
The second cause of action, that CohnReznick aided and abetted Platinum's fraud, also survives dismissal. To plead a claim of aiding and abetting fraud, the complaint must allege: "(1) the existence of an underlying fraud; (2) knowledge of this fraud on the part of the aider and abettor; and (3) substantial assistance by the aider and abettor in achievement of the fraud." Stanfield Offshore Leveraged Assets, Ltd. v. Metro. Life Ins. Co., 64 AD3d 472, 476 (1st Dep't 2009). As demonstrated above, sufficient knowledge of Platinum's fraud was averred more than generally, and plaintiffs alleged "substantial assistance" at a minimum by virtue of CohnReznick's failure to act when required to do so, which enabled the fraud to proceed and proximately caused plaintiffs harm. Particularly instructive on both the fraud and the aiding abetting claim is the First Department's statement in Houbigant, 303 AD2d at 98- 99 : "Keeping in mind the difficulty of establishing in a pleading exactly what the [auditor] knew when certifying its client's financial statements, it should be sufficient that the complaint contains some rational basis for inferring that the alleged misrepresentation was knowingly made."
The third cause of action for aiding and abetting Platinum's breach of fiduciary duty also survives dismissal. The Platinum Managing Member indisputably owed fiduciary duties to plaintiffs as fellow members in a close corporation, and plaintiffs entrusted their investments to Platinum, which had substantial discretion and control over PPCO's investment activities and assets. CohnReznick was aware of this fiduciary duty and provided substantial assistance to Platinum in its breach of fiduciary duties to plaintiffs by issuing unqualified Audit Reports that it knew or should have known would be used to mislead plaintiffs and by failing to conduct proper independent valuations of the Fund in light of the deficient documentation and questionable transactions. The Court rejects the claim that the third cause of action must be dismissed on the ground it is derivative in nature, as it cannot reasonably be disputed that plaintiffs are seeking to recover damages equivalent to their individual investments; they do not seek to restore the now defunct hedge fund.
Similarly without merit is CohnReznick's argument that plaintiffs' claim they were induced "to continue to hold securities" is not actionable under New York law, as confirmed by the First Department in cases such as Varga v. McGraw Hill Fin., 147 AD3d 480 (1st Dep't 2017). As plaintiffs allege they invested in the PPCO Fund in the first instance in reliance on the Audit Reports, and not merely to maintain or "hold" the investment, the claims need not be dismissed as improper holder claims.
Accordingly, it is hereby
ORDERED that the motion to dismiss by defendant CohnReznick, Inc. is denied without prejudice to renewal as a summary judgment motion upon the completion of discovery. CohnReznick shall efile an Answer to the Complaint by August 7, 2020. The parties shall then meet and confer and complete the Preliminary Conference Order available on the Court's website. A preliminary conference is scheduled for September 10, 2020 at 2:15 p.m. at which time the Court will review the proposed Preliminary Conference Order and discuss early settlement and a plan for the expeditious resolution of this action.