Summary
rejecting argument that a New York law requires a court to conduct a conflict of laws analysis on an "issue-by-issue basis, a principle known as depacage"
Summary of this case from ICP Strategic Credit Income Fund, Ltd. v. Piper (In re ICP Strategic Credit Income Fund Ltd.)Opinion
No. 651217/2015.
01-19-2016
FIA LEVERAGED FUND LTD. and Fletcher Income Arbitrage Fund Ltd., Plaintiffs, v. GRANT THORNTON LLP, Eisneramper LLP and Eisneramper (Cayman) Ltd., Defendants.
Jeffrey E. Gross of Reid Collins & Tsai LLP for Plaintiffs. Grant J. Esposito and Daniel Matza–Brown of Morrison & Foerster LLP, for Defendant Grant Thornton, LLP. Brian P. Morgan of Drinker Biddle & Reath LLP, for Defendants EisnerAmper, LLP and EisnerAmper (Cayman) Ltd.
Jeffrey E. Gross of Reid Collins & Tsai LLP for Plaintiffs.
Grant J. Esposito and Daniel Matza–Brown of Morrison & Foerster LLP, for Defendant Grant Thornton, LLP.
Brian P. Morgan of Drinker Biddle & Reath LLP, for Defendants EisnerAmper, LLP and EisnerAmper (Cayman) Ltd.
EILEEN BRANSTEN, J.
Plaintiffs FIA Leveraged Fund, Ltd. (“Leveraged”) and Fletcher Income Arbitrage Fund, Ltd. (“Arbitrage,” collectively the “Fletcher Funds” or the “Funds”) bring this action against Defendants Grant Thornton, LLP (“Thornton”), EisnerAmper, LLP and EisnerAmper (Cayman), Ltd. (together, “Eisner”) to recover approximately $47 million in damages for the allegedly deficient auditing services Defendants provided the Funds. Plaintiffs assert causes of action for negligence and accounting malpractice, arguing that Defendants failed to exercise reasonable and professional care in accordance with U.S. auditing standards. Defendants Thornton and Eisner have filed separate motions to dismiss, each based on the doctrine of in pari delicto, arguing that the Funds cannot succeed on claims against their auditors for failing to detect the Funds' own misconduct.
For the reasons that follow, Defendants' motions to dismiss are granted.
I. Background
a. The Fletcher Structure
In 1991, Alphonse Fletcher (“Fletcher”) founded Fletcher Asset Management (“FAM”). (Complaint (“Compl.”) ¶ 25.) In 1995, Fletcher and FAM created a multi-level structure of private investment funds (the “Fletcher Structure”), organized under a “master” fund, Fletcher International, Ltd. (“FILB”). Id. at ¶¶ 9, 25, 26. Arbitrage was the largest feeder fund in the Fletcher Structure and an “intermediate” fund, since it was wholly financed by the investments of Leveraged and non-party Fletcher Fixed Income Alpha Fund, Ltd (“Alpha”). Id. at ¶¶ 11, 28. Fletcher and FAM managed each fund in the Fletcher Structure. Id. at ¶ 25.
Alpha was established solely to invest in Arbitrage, and the Massachusetts Bay Transportation Retirement Fund (“MBTARF”) was the sole investor in Alpha. (Compl.¶ 14.) Alpha has been in liquidation proceedings since May 2012. Id. at ¶ 13.
FAM's investment strategy was to identify public companies that were closed out of traditional markets for financing and offer those companies capital infusion. Id. at ¶ 30. FAM's investments—held by the Funds—typically involved common stock, preferred stock or warrants, and were “highly illiquid.” Id. For these services, FAM charged management fees, and, in the case of Arbitrage, incentive fees. Id. at ¶ 31.
Through early 2007, Fletcher and FAM maintained that they were earning high returns on behalf of the Funds, though, in reality, the Funds were losing money. Id. at ¶¶ 32–33. Fletcher and FAM were using newly acquired investors to pay returns in order to preserve the appearance of steady profits. Id. By mid–2007, the combined cash assets of the Funds were approximately $2.6 million, “far from enough to satisfy redemptions and the cash needs of the various entities.” Id. Thereafter, Fletcher and FAM increasingly relied on fraudulent schemes to keep the Funds afloat. Id.
b. MBTARF and Louisiana Pension Funds' Investments in the Fletcher Structure
i. MBTARF's Investment in Alpha
In March 2007, FAM approached MBTARF with an investment pitch. Id. at ¶ 35. On June 7, 2007, MBTARF invested $25 million in Alpha, in accordance with the Alpha Offering Memorandum (the “Alpha Memorandum”). Id. at ¶¶ 36–37. MBTARF also required that FAM and Alpha enter into a side letter agreement (the “MBTARF Side Letter Agreement”), which placed a limitation on FAMS's ability to alter its investment strategy. Id. at ¶ 37. Alpha and FAM agreed that if a “material change” were made to FAM's investment strategy, they had to provide MBTARF sufficient advance notice so that MBTARF could place a redemption order. Id. Pursuant to the Alpha Memorandum, MBTARF could redeem its investment after one year, and, thereafter, quarterly, with 60 days' notice. Id. at ¶ 38.
Despite the parties' agreement, which stipulated that no more than $8 million of MBTARF's $25 million investment could be used for new investments, FAM used most of the $25 million to satisfy redemptions and pay margin calls. Id. at ¶ 39. FAM also made numerous changes to the investment strategy over the course of the parties' relationship without providing MBTARF the required advance notice. Id.
ii. Louisiana Pension Funds' Investment in Leveraged
Between March 31 and April 1, 2008, three Louisiana state pension funds—the Firefighters' Retirement System, the Municipal Employees' Retirement System of New Orleans and the New Orleans Firefighters' Pension and Relief Fund (collectively, the “Louisiana Funds”)—invested a combined $100 million in Leveraged. Id. at ¶ 41. Specifically, the Louisiana Funds invested in, and were the only holders of, Leveraged's “Series N” stock. Id. at ¶ 43. The investments were subject to a two-year lock-up provision, at which point the stocks could be redeemed at the end of the month with 60 days' advance notice. Id.
Additionally, the Louisiana Funds' investment was subject to mandatory redemption upon the occurrence of one of two events: (1) if a Series 4, 5 or 6 investor redeemed, the Series N stock had to be redeemed one day earlier; and (2) if the value of the non-Series N capital accounts fell below 20% of the Series N accounts, the Series N stock had to be redeemed. Id. at ¶ 44. Thus, the Fletcher Structure's survival depended on keeping the non-Series N shareholders at or above 20% of the Louisiana Funds' capital accounts because a redemption of the Series N stock would cause Leveraged, then Arbitrage, to collapse. Id. at ¶ 46. Accordingly, Fletcher and FAM had an incentive to “prop up” Leveraged through fraudulent means. Id.
c. The Fletcher Structure and Valuation
In 2000, FAM hired non-party Quantal as a valuation agent for the Fletcher Structure. Id. at ¶ 48. Quantal, however, was a risk management firm and lacked experience in the field of valuation. Id. at ¶¶ 48–50. In fact, Fletcher and FAM were Quantal's only valuation clients. Id. at ¶ 50. From 2006 to 2012, Quantal received, in total, approximately $3.3 million from Fletcher and FAM for the services it provided. Id. at ¶ 52.
d. Grant Thornton's 2007 and 2008 Audits of Arbitrage and Leveraged
In an engagement letter dated December 14, 2007, Defendant Thornton agreed to audit the December 31, 2007, financial statements for Arbitrage, Leveraged and FILB in conformance with U.S. auditing standards. Id. at ¶ 55. On April 14, 2006, Thornton agreed to an amendment (together with the Engagement Letter, the “2007 Thornton Engagement”), which provided that Thornton would work with non-party Grant Thornton Cayman on the audits. Id. at ¶ 56. Non-party Grant Thornton Cayman's only role was to review and sign Thornton's final audit reports. Id. at ¶ 57. After signing the reports, Grant Thornton Cayman sent them, along with invoices for its work, to Thornton in New York, which sent the documents, plus its own invoice, to FAM, also located in New York. Id. at ¶ 58. On April 22, 2008, Thornton issued Leveraged, Arbitrage and FILB's audit reports for 2007, each of which contained material misstatements. Id. at ¶ 59.
The auditing standards—divided into: general standards, field work standards and reporting standards-are promulgated by the Auditing Standards Board, a division of the American Institute of Certified Public Accountants. (Compl.¶ 81.) For example, among the numerous general standards outlined, General Standard No. 3 requires the auditor to exercise “due and professional care in the performance of the audit and the preparation of the report.” Id. at ¶ 83.
On February 2, 2009, Thornton and Grant Thornton Cayman entered into separate engagement letters for Leveraged, Arbitrage and FILB's 2008 audits (the “2008 Thornton Engagement”), and were to conduct the audits in accordance with U.S. auditing standards. Id. at ¶ 60. Pursuant to the 2008 Thornton Engagement, Thornton agreed to be 7F'responsible for communicating to the board of directors or others of equivalent authority or responsibility significant deficiencies and material weaknesses in internal control over financial reporting that come to [their] attention Id. at ¶ 61.
In addition, Thornton was required to disclose to the board any “fraud involving senior management and fraud, whether cause by senior management or other employees, that causes a material misstatement of the financial statements.” Id. As in 2007, Thornton conducted the field work and Grant Thornton Cayman signed the financial reports after review. Id. at ¶¶ 62, 63. In May and June 2009, Thornton issued its reports for Leveraged, Arbitrage and FILB, each of which were materially misleading. Id. at ¶ 64.
In early 2010, after the SEC questioned the Funds about the accounting treatment of two $80 million “cashless-notes” exchanged in the Fletcher Structure, Thornton considered whether to withdraw the 2007 and 2008 audit reports. Id. at ¶ 65. In Arbitrage's audited financial statements, the notes were treated as bona fide assets, even though, Plaintiffs allege, Thornton knew that money had not been exchanged. Id. In March 2010, Thornton notified FAM that it was withdrawing the 2007 and 2008 reports, and directed FAM to notify “persons who are known to be relying, or who are likely to [rely]” on the reports. Id. at ¶ 66.
Thereafter, Thornton performed additional services for the Fletcher Structure, namely, by providing restatements of the 2007 and 2008 audit reports, and producing documents to the SEC in connection with a 2009 investigation of the Funds. Id. at ¶¶ 67, 70.
On January 24, 2011, Thornton released the restated audit reports for 2007 and 2008, which no longer listed the cashless notes as assets of Arbitrage. (Compl.¶ 71.)
e. Eisner's 2009 Audits of Arbitrage and Leveraged
After Thornton withdrew the 2007 and 2008 audit opinions, FAM approached Defendant Eisner to take over auditing the Funds. Id. at ¶ 72. On March 24, 2010, Eisner negotiated and entered into an engagement letter with FAM in New York (the “Eisner Engagement”). Id. at ¶ 73. The letter confirmed the terms of Eisner's retention, including the requirement that Eisner's auditing conform to U.S. standards. Id. at ¶ 74. The Eisner Engagement also provided that U.S. personnel would conduct the Funds' audits, but Eisner Cayman would sign the audit reports. Id . at ¶ 76. FAM's payments were deposited directly into Eisner's bank account in New York. Id. at ¶ 77.
Peter Testaverde, an Eisner partner based in New York City, executed the agreement. Id. at ¶ 75.
On February 8, 2011, Eisner issued Arbitrage's 2009 audit report, which included by reference, FILB's financial statements. Id. at ¶ 79. Although FAM also engaged Eisner to audit Leveraged, Eisner never issued an audit opinion for Leveraged because the parties could not agree on the value of an asset. Id. at ¶ 80. The value of the asset was “pivotal to the survival of Arbitrage because a lower valuation would have caused the demise of Arbitrage.” Id.
f. The Bankruptcy Proceedings
In 2012, the Grand Court of the Cayman Islands appointed Robin Lee McMahon and Roy Bailey, as Joint Official Liquidators of both Leveraged and Arbitrage. Id. at ¶¶ 9, 11. In 2014, the United States Bankruptcy Court for the Southern District of New York recognized Leveraged and Arbitrage's foreign liquidation proceedings as a foreign main proceedings pursuant to 11 U.S.C. § 1517(b)(1). Id. at ¶ 10.
Section 1517 provides, in relevant part, that a foreign proceeding shall be recognized “as a foreign main proceeding if it is pending in the country where the debtor has the center of its main interests.” 11 U.S.C. § 1517(b)(1).
Currently, FILB, the Fletcher Structure's “master” fund, is being managed by a bankruptcy trustee appointed by the United States Bankruptcy Court for the Southern District of New York (the “FILB Trustee”). See In re Fletcher International, Ltd., Case No. 12–12796 (Bankr.S.D.NY March. 24, 2014). The FILB Trustee entered into a settlement with Leveraged and Arbitrage whereby Plaintiffs agreed to pool their respective rights, title and interest in their claims and to cooperate with the FILB Trustee in the prosecution of the claims. See id.
g. The Instant Action
On April 13, 2015, Leveraged and Arbitrage filed this action against Thornton and Eisner, asserting causes of action for accounting malpractice and negligence based on Defendants' alleged failures to exercise reasonable and professional care in preparing audit reports for Leveraged and Arbitrage. Plaintiffs contend that Defendants committed malpractice by failing to detect various misconduct by the Funds' managers, Fletcher and FAM, including, but not limited to, the following: (1) overstating the value of the Funds in the Fletcher Structure, (2) failing to disclose related-party transactions, and (3) misusing investor funds.
Specifically, Plaintiffs allege that Defendants failed to detect the overstated value of the Funds and the improper calculations of assets under management, numbers which were provided by Quantal, an inexperienced valuator hired by Fletcher and FAM. Plaintiffs also allege that Defendants failed to detect the improper transfer of cashless notes, apparently arranged by Fletcher and FAM, between Leveraged and Arbitrage. Finally, Plaintiffs allege that Defendants failed to detect Fletcher and FAM's improper use of MBTARF and Louisiana Funds' investments—namely, by using the investments to pay redemptions and to maintain the appearance of the Fletcher Structure's profitability.
II. Discussion
Defendants Thornton and Eisner have filed motions to dismiss based on the doctrine of in pari delicto, i.e., “unclean hands.” Defendants argue that Plaintiffs Leveraged and Arbitrage cannot succeed on their claims because Fletcher and FAM, who managed the Funds, committed fraud in order to keep the Fletcher Structure afloat. Accordingly, Defendants argue, they cannot be charged with malpractice on the grounds that they failed to detect the illegal activity when they were provided false and misleading information with which to perform their audits. In response, Plaintiffs maintain that Fletcher and FAM's misconduct was for their personal benefit and, as a result, their actions cannot be attributed to the Funds.
Before reaching the merits of Defendants' motions, the Court must first conduct a choice of law analysis to decide whether New York or Cayman Island law governs Plaintiffs' claims. Pursuant to the reasoning below, New York law applies, as does in pari delicto.
A. Choice of Law
In tort cases, New York courts have adopted the “interest analysis” in resolving choice of law issues, “under which the law of the jurisdiction having the greatest interest in resolving the particular issue' is given controlling effect.” Shaw v. Carolina Coach, 82 A.D.3d 98, 101, 918 N.Y.S.2d 120 (2d Dep't 2011) (citing Cooney v. Osgood Mach., 81 N.Y.2d 66, 72, 595 N.Y.S.2d 919, 612 N.E.2d 277 (1993) ). There is a distinction made in this approach “between laws that regulate primary conduct (such as standards of care) and those that allocate losses after the tort occurs.” Cooney, 81 N.Y.2d at 72, 595 N.Y.S.2d 919, 612 N.E.2d 277. Where the conflicting laws regulate conduct, courts apply “the law of the jurisdiction which, because of its relationship or contact with the occurrence or the parties, has the greatest concern with the specific issue raised in the litigation.” Id. The law where the tort occurred “almost invariably” applies because “that jurisdiction has the greatest interest in regulating behavior within its borders.” Id.
Here, where the laws in question regulate conduct, i.e., the standard of care for auditors, the Court must determine which jurisdiction—New York or the Cayman Islands—has the greatest interest in the litigation. According to Plaintiffs' allegations, Thornton and Eisner were both required to conduct their auditing work for Leveraged and Arbitrage in accordance with generally accepted U.S. auditing standards of care. (Compl.¶¶ 55, 74.) The record also indicates that Thornton and Eisner were New York companies and performed all auditing work for the Funds in New York, not the Cayman Islands. Id. at ¶¶ 52, 62, 76, 595 N.Y.S.2d 919, 612 N.E.2d 277. The only work performed in the Cayman Islands was provided by non-party Grant Thornton Cayman and Defendant EisnerAmpner (Cayman) LLC, each of whom merely reviewed and signed the audit opinions provided by Defendants' U.S. auditors. Id. at ¶¶ 57, 62, 76, 595 N.Y.S.2d 919, 612 N.E.2d 277. Furthermore, the invoices for the auditing work were sent to Defendants' New York offices and payment for that work was received in New York. Id. at ¶¶ 58, 77, 595 N.Y.S.2d 919, 612 N.E.2d 277.
Accordingly, there is no doubt that New York has the greatest interest in the outcome of this litigation, and as such, New York law—in this case, the law of the place of the tort, the alleged malpractice—should be applied in this case. Contrary to Plaintiffs' arguments, and as explained in greater detail below, Cayman Island law has no bearing on the resolution of the issues before the Court today.
B. In Pari Delicto
In separate motions to dismiss, Defendants Thornton and Eisner have invoked the doctrine of in pari delicto. As explained by the Court of Appeals, the doctrine “mandates that courts will not intercede to resolve a dispute between two wrongdoers” because “a wrongdoer should not profit from his own misconduct.” Kirschner v. KPMG LLP, 15 N.Y.3d 446, 464, 912 N.Y.S.2d 508, 938 N.E.2d 941 (2010) (citing McConnell v. Commonwealth Pictures Corp., 7 N.Y.2d 465, 470, 199 N.Y.S.2d 483, 166 N.E.2d 494 (1960) ). Pursuant to the doctrine, the misconduct of an “authorized agent” is imputed to the corporation “even if [the] particular acts were unauthorized .” Id. at 465, 199 N.Y.S.2d 483, 166 N.E.2d 494. Moreover, as an affirmative defense, in pari delicto is properly “resolved on the pleadings.” Id. at 459 n. 3, 912 N.Y.S.2d 508, 938 N.E.2d 941 ; see also Buckley v. Deloitte & Touche USA LLP, 2007 WL 1491403, at *5 (S.D.N.Y. May 22, 2007) (“Courts may appropriately apply the doctrine of in pari delicto on a motion to dismiss on those occasions when issues of imputation are clearly established by the allegations on the face of the complaint.”).
In Kirschner, the Court explained that in traditional agency law, an agent's actions, if within the scope of his authority, “are presumptively imputed to [his principal]” because “[c]orporations are not natural persons” and so “act solely through the instrumentality of their officers or other duly authorized agents.” Kirschner, 15 N.Y.3d at 465, 912 N.Y.S.2d 508, 938 N.E.2d 941.
Here, the record indicates that Fletcher and FAM managed the Funds, as well as their investment activities, in accordance with separate management agreements. (Compl.¶¶ 25, 30.) Plaintiffs concede that Fletcher and FAM carried out “fraudulent schemes to prop up the funds [they] managed.” Id. at ¶ 33 (emphasis added). The schemes, again, include: (1) overstating the value of the Funds in the Fletcher Structure in their financial statements, (2) failing to disclose related-party transactions, and (3) misusing investor funds. Id. at ¶ 2. Notwithstanding the illegality of these actions, they are actions that nonetheless fall squarely within a manager's scope of authority. Thus, the Court concludes that Fletcher and FAM were authorized agents of the Funds, and as such, the aforementioned misconduct—the very same misconduct Defendants are charged with failing to detect—may be imputed to Leveraged and Arbitrage. See Kirschner, 15 N.Y.3d at 465, 912 N.Y.S.2d 508, 938 N.E.2d 941 (explaining that an agent's actions, if within the scope of his authority, “are presumptively imputed to [his principal] )”.
It should be noted that Plaintiffs do not dispute Defendants' assertion that Fletcher and FAM were acting within their scope of authority as managers.
Plaintiffs disagree with this conclusion, arguing instead that the issue of imputation is governed by New York's internal affairs doctrine, which provides that a corporation's internal affairs are governed by the law of the place of incorporation. However, Plaintiffs fail to cite any cases where a court applied New York's internal affairs doctrine to determine whether in pari delicto applies. Instead, Plaintiffs ignore factually similar New York cases where courts have rejected this approach. See, e.g., Walker, Truesdell, Roth & Associates, Inc. v. Globeop Financial Services LLC, 2013 WL 8597474 (Sup.Ct. N.Y. Cty. May 27, 2013) ; Bullmore v. Ernst & Young Cayman Islands, 20 Misc.3d 667, 861 N.Y.S.2d 578 (Sup.Ct. N.Y. Cty. April 30, 2010) (plaintiff funds were barred from recovering against auditors based on in pari delicto).
Since the Funds were incorporated in the Cayman Islands, Plaintiffs argue that Cayman Island law should govern the issue of imputation, pursuant to which, an agent's misconduct is not imputed to the corporation.
For example, in Walker, the court rejected the plaintiff's argument that the internal affairs doctrine applied, which would have preserved the claims of the Delaware-based investment funds pursuant to Delaware law. 2013 WL 8597474 at *9. The court explained that the internal affairs doctrine “governs the choice of law determinations involving matters peculiar to corporations, that is, those activities concerning the relationships inter se of the corporation” and “does not apply where the rights of third parties external to the corporation are at issue, e.g., contracts and torts involving third parties.” Id. (emphasis omitted). As previously explained, those issues are determined by the law of the jurisdiction with the greatest interest in the litigation. Id; see Cooney v. Osgood Mach., 81 N.Y.2d 66, 72, 595 N.Y.S.2d 919, 612 N.E.2d 277 (1993) (explaining that the interest analysis is used in deciding choice of law issues for tort cases).
Separately, Plaintiffs urge the Court to apply New York law, relying on the Court of Appeals' decision in Babcock v. Jackson, but that reliance, however, is misplaced. See Babcock v. Jackson, 12 N.Y.2d 473, 240 N.Y.S.2d 743, 191 N.E.2d 279 (1963). In Babcock, the Court was asked to determine whether the law of the place of the tort occurs “invariably” governs the tort claim, or whether other factors should be considered. Id. at 477–78, 240 N.Y.S.2d 743, 191 N.E.2d 279. There, the plaintiff suffered serious injuries as a result of an automobile accident in Ontario, Canada, and sued the driver of her vehicle for negligence. Id. at 476–77, 240 N.Y.S.2d 743, 191 N.E.2d 279. The trial court granted the defendant's motion to dismiss on the grounds that Ontario's guest-statute barred a passenger from suing the driver of the vehicle for any injuries suffered and the Appellate Division affirmed. Id.
In reversing the Appellate Division, the Court of Appeals first noted that the parties were New York residents and their relationship, as guest and host, started and would end in New York, and that the vehicle was registered and insured in New York. Id. at 482, 240 N.Y.S.2d 743, 191 N.E.2d 279. In light of those facts, the Court found that Ontario's interest in the matter was “minimal” since its “sole relationship with the occurrence [was] the purely adventitious circumstance that the accident occurred there.” Id. at 482, 240 N.Y.S.2d 743, 191 N.E.2d 279. Since the “rights and liabilities of the parties which stem from their guest-host relationship should remain constant and not vary and shift as the automobile proceeds from place to place,” the Court held that New York law should apply. Id. at 483, 240 N.Y.S.2d 743, 191 N.E.2d 279.
In conclusion, the Babcock Court noted that “there is no reason why all issues arising out of a tort claim must be resolved by reference to the law of the same jurisdiction.” Id. at 484, 240 N.Y.S.2d 743, 191 N.E.2d 279. Plaintiffs understand this language to “mandate that the Court conduct a conflict-of-laws analysis on an issue-by-issue basis, a principle known as dépeXage.” See Arbitrage Mem. in Opp. at 11. In other words, Plaintiffs are asking this Court to apply New York law to Plaintiffs claims and Cayman Island law to Defendants' affirmative defense.
Although Plaintiffs cite a litany of cases in support of their position, none of these cases bear any similarity to the case at bar, factually or otherwise. See, e.g., Krentsel v. Loews Miami Beach Hotel Operating Co., Inc., 2010 WL 2023341 (Sup.Ct. N.Y. Cty. May 10, 2010) (utilizing the interest analysis in determining whether to apply in pari delicto); see also Feiger v. Pitney Bowes Credit Corp., 251 F.3d 386, 397 fn. 1 (2d Cir.2001) (explaining that New York courts may apply the law of several jurisdictions to resolve multiple claims). In fact, these cases stand for nothing other than the general proposition that New York courts may apply the laws of multiple jurisdictions to multiple claims where an interest analysis so dictates, and, therefore, do not require a different result here, where the Court has conducted the necessary interest analysis and found New York law to apply.
Therefore, unless an exception to in pari delicto applies, Fletcher and FAM's bad acts are imputed to Leveraged and Arbitrage.
C. Adverse Interest Exception
The “adverse interest” exception to imputation exists where the authorized agent has “totally abandoned his principal's interests and is acting entirely for his own or another's purposes.” Kirschner v. KPMG et al., LLP, 15 N.Y.3d 446, 466, 912 N.Y.S.2d 508, 938 N.E.2d 941 (2010) (internal emphasis omitted). Courts should reserve “this, most narrow of exceptions” for situations where “the insider's misconduct benefits only himself or a third party; i.e., where the fraud is committed against a corporation rather than on its behalf.” Id. at 466–67, 912 N.Y.S.2d 508, 938 N.E.2d 941 (emphasis in original); see also Bullmore v. Ernst & Young Cayman Islands, 20 Misc.3d 667, 672, 861 N.Y.S.2d 578 (Sup.Ct. N.Y. Cty. April 30, 2010) (noting the courts must ask whether the “corporation benefit[ed] to any extent from the alleged wrongful acts of its agents”).
Although Plaintiffs have invoked the exception, they fail to allege that Fletcher and FAM “totally abandoned” the Funds' interests and were acting “entirely” for their own purposes. Kirschner, 15 N.Y.3d at 466, 912 N.Y.S.2d 508, 938 N.E.2d 941. Indeed, the allegations in the complaint suggest just the opposite. For example, Plaintiffs allege that Fletcher and FAM's fraud “camouflaged the fact that the funds they managed were losing money and using new investors to pay redemptions and fees to maintain the false appearance of steady profits.” (Compl. at ¶ 33.) Plaintiffs further allege that Fletcher “desperately needed new cash to satisfy redemptions and pay fees, and increasingly, he used fraudulent schemes to prop up the funds he managed.” Id. It follows that Fletcher and FAM's misconduct was committed, at least in part, to benefit Leveraged and Arbitrage. As our Court of Appeals explained in Kirschner, “So long as the corporate wrongdoer's fraudulent conduct enables the business to survive this test is not met.” Kirschner, 15 N.Y.3d at 466, 912 N.Y.S.2d 508, 938 N.E.2d 941. Thus, the adverse interest exception does not apply.
Plaintiffs' remaining argument, that an “innocent director” or insider, existed at the Funds and would have stopped Fletcher and FAM's misconduct had Defendants reported it, is irrelevant, since the Court has already determined the adverse interest exception does not apply. See In re Lehr Constr. Corp., 528 B.R. 598, 610 (Bankr.S.D.N.Y.2015) (“Unless the adverse interest exception to the presumption of imputation applies, it is immaterial whether innocent insiders exist”) (citing In re CBI Holding Co., Inc., 311 B.R. 35 at 373 (Bankr.S.D.NY 2004), reversed on separate grounds, In re CBI Holding Co., Inc., 529 F.3d 432 (2d Cir.2008) ).
Plaintiffs argue that Lisa Alexander, who sat on the board of both Leveraged and Arbitrage, was the “innocent insider.” (Compl.¶ 224.)
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Since Plaintiffs have failed to show that an exception to the doctrine of in pari delicto applies in this case, Defendants' motions to dismiss are granted.
III. Conclusion
For the foregoing reasons, it is
ORDERED that Defendants' motions to dismiss are granted; and the complaint is dismissed with costs and disbursement to defendants as taxed by the Clerk of the Court, upon submission of an appropriate bill of costs; and it is further
ORDERED that the Clerk is directed to enter judgment accordingly.