Zazzali v. Eide Bailly LLP et al

Filing 125

ORDER ADOPTING REPORT AND RECOMMENDATION ON MOTIONS TO DISMISS re 107 Report and Recommendation re 80 Motion to Dismiss Claims Asserted by DBSI for Lack of Standing and 81 Motion to Dismiss Pursuant to Rule 12(b)(6).. Signed by Judge Marsha J Pechman. (caused to be mailed to non Registered Participants at the addresses listed on the Notice of Electronic Filing (NEF) by (st) Modified on 11/14/2013 to link to Report and Recommendation(st).

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF IDAHO
JAMES R. ZAZZALI, as Trustee for the
DBSI Estate Litigation Trust and as
Trustee for the DBSI Private Actions
Trust,
Plaintiff,

Case No. 1:12-CV-349-S-MJP
ORDER ADOPTING REPORT AND
RECOMMENDATION ON MOTIONS
TO DISMISS

v.
EIDE BAILLY LLP, JOHN DOES 1-50
and ABC ENTITIES 1-50,
Defendants.

This matter is before the Court on the Report and Recommendation (“R&R”) of
the Honorable Magistrate Judge Ronald E. Bush (Dkt. No. 107), the objections of
Plaintiff James R. Zazzali (Dkt. No. 114), and the objections of Defendant Eide Bailly
LLP (Dkt. No. 113). The Court considered the R&R, the objections, Eide Bailly’s
response to Zazzali’s objections (Dkt. No. 122), Zazzali’s response to Eide Bailly’s
objections (Dkt. No. 123) and all related documents. The R&R addresses two motions:
(1) Eide Bailly’s motion to dismiss for lack of standing, and (2) Eide Bailly’s motion to
dismiss pursuant to Fed. R. Civ. P. 12(b)(6), for failure to state a claim upon which relief
can be granted. The Court ADOPTS the Report and Recommendations.
Background
DBSI, Inc. and its related entities filed for bankruptcy in the United States District
Court of Delaware in 2008. (Dkt. No. 1 at 5.) The Bankruptcy Court confirmed a plan
Order - 1

which created four trusts, including the Estate Litigation Trust (“ELT”) and the DBSI
Private Action Trust (“PAT”). (Id. at 6.) Plaintiff James R. Zazzali is the court approved
Trustee for the PAT and ELT trusts. (Id.)
Zazzali claims DBSI was engaged in an elaborate Ponzi scheme, where guaranteed
returns to earlier investors could only be satisfied by the flow of funds from newlydeceived investors. (Dkt. No. 1 at 17.) Zazzali asserts Eide Bailly was engaged to and did
audit financial statements for DBSI, and Eide Bailly auditors facilitated DBSI’s Ponzi
scheme by purposefully failing to perform audits in accordance with applicable
professional standards, certifying fraudulent financial statements, and issuing deceptive
audit opinions, all while knowing their statements would be used in DBSI offering
materials and relied upon by the investing public. (Id. at 18.)
Zazzali brought 16 claims against Eide Bailly on behalf of one or both trusts, and Eide
Bailly moved to dismiss the claims, bringing one motion to dismiss for lack of standing
and one motion to dismiss for failure to state a claim upon which relief can be granted.
(Dkt. Nos. 80 and 81.) The R&R recommended denying the motion to dismiss for lack of
standing, and granting in part and denying in part the motion to dismiss for failure to state
a claim. (Dkt. No. 107.) Both parties objected, and each objection is addressed below.

I.

Lack of Standing

Defendant argued in its motion to dismiss for lack of standing that Zazzali purports to
bring claims on behalf of individual investors and creditors who have assigned their
claims to the PAT, and this exceeds Zazzali’s authority under the Bankruptcy code. (Dkt.
Order - 2

No. 80-1 at 5.) Eide Bailly asserts the Court must dismiss claims on behalf of PAT for
lack of subject matter jurisdiction because Zazzali lacks standing. (Id.) Eide Bailly argues
bankruptcy laws do not authorize a trustee to assert claims for the benefit of third parties
rather than the estate as a whole. (Id. at 6.)
The R&R rejected Eide Bailly’s argument, finding that the cases relied upon by Eide
Bailly do not apply because they address the standing of bankruptcy trustees and not
post-conformation trustees like Zazzali. (Dkt. No. 107 at 17.) The R&R said, because
Zazzali is not a bankruptcy trustee the Bankruptcy Code and cases bearing on the Code
do not apply, the matter is governed by the mandates of the Plan and/or the PAT
Agreement. (Id. at 18.) Judge Bush found there was no apparent legal authority or policy
impediment to preclude creditors assigning their claims to a private right of action trust
pursuant to a plan of liquidation, or to the private action trustee pursuing those claims,
and thus Zazzali has standing. (Id. at 20.)
Eide Bailly relies on Williams v. California 1st Bank for the proposition that, in the
Ninth Circuit, a trustee cannot pursue claims of third parties even when the claims are
assigned. 859 F.2d 664, 666 (9th Cir. 1988). The R&R rejects the reliance on Williams,
pointing out, like the Supreme Court case it relies upon, Williams addresses the standing
of a trustee in bankruptcy, and at issue here is a post-confirmation trustee. (Dkt. No. 107
at 17, discussing Caplin v. Marine Midland Grace Trust Co. of N.Y., 406 U.S. 416
(1972)). Judge Bush instead relies on Grede v. Bank of NY Mellon, 598 F.3d 899, 902
(7th Cir. 2010),where the Seventh Circuit expressly addressed the issue of permissible
duties of a trustee after bankruptcy. (Dkt. No. 107 at 17.)
Order - 3

In its Objections, Eide Bailly argues there is a circuit split, and the Seventh Circuit’s
decision in Grede expressly distinguished Williams. (Dkt. No. 113 at 5.) It is true that
Grede uses the phrase, “We must choose between the second circuit’s holding and the
ninth’s.” 598 F.3d at 901. However, this is both dicta and an overgeneralization of
Williams, which has been rejected in other cases. In fact, Williams does not address the
bankruptcy/post-bankruptcy issue at all; Williams stands for the proposition that a trustee
in bankruptcy does not have standing to pursue claims on behalf of third parties even
when those claims are assigned. Williams, 859 F.2d at 665, 666.
Contrary to Eide Bailly’s suggestions, at least one opinion in the Ninth Circuit has
followed Grede and held a post-confirmation trustee has standing to pursue the assigned
claims of third parties. In Calvert v. Zions Bancorporation, the United States Bankruptcy
Court for the Western District of Washington specifically found Caplin and Williams do
not apply to a post-confirmation trustee, because once there is a confirmed plan the
liquidating trustee is bound by the terms of the new contract and contract principles
apply. 485 B.R. 604, 611 (W.D. Wash. 2013.) Calvert clearly states a post-confirmation
trustee, like Zazzali, has standing to pursue assigned claims. Id. at 612.
Calvert relies on a Delaware case, Zazzali v. Hirschler Fleischer, P.C. 482 B.R.
495 (Del. 2012), which is extremely factually similar to the case presented here. Hirschler
stems from the same alleged DBSI Ponszi scheme, and was brought against DBSI’s legal
counsel. In that case, the defendants raised the same standing arguments as Eide Bailly
presents here. The court in Hirschler found, on factual circumstances almost identical to
those presented here, the post-confirmation trustee in that case had standing. Id. at 510Order - 4

11. That court rejected nearly identical arguments about the applicability of Caplin and
Williams. Id. at 509-10. Likewise, Defendant’s objections here are unfounded and the
Court adopts the R&R’s finding that Plaintiff does have standing to pursue claims on
behalf of PET.

II.

Dismissal for Failure to State a Claim

Defendant’s motion to dismiss for failure to state a claim brings forth multiple
arguments with respect to each claim brought by Plaintiff. The R&R recommends
granting the motion as to some claims and not to others, and both parties filed objections.
Each objection is addressed below, by party.

Eide Bailly’s Objections

1. Lack of additional allegations as to investors specific damages not fatal

Judge Bush recommended dismissal of PAT Counts 1,2,5,6,7 and 8 for failure to
allege the identify of each assigning investor, and thereby failing to state a claim upon
which relief can be granted. (Dkt. No. 107 at 57-58.) Judge Bush found the deficiency
could be cured by properly incorporating, in an amended complaint, a list of investor
names. (Id. at 57.) The R&R noted, however, it is not necessary for Zazzali to make
specific allegations in the Complaint detailing each assigning investor’s specific

Order - 5

damages, because this information can be gleaned through discovery and tested on
summary judgment. (Id.)
Eide Bailly, while agreeing with Judge Bush’s conclusion all claims on behalf of the
PAT should be dismissed due to Plaintiff’s failure to specifically identify each assigning
investor, “objects to Judge Bush’s statements that ‘the absence of additional allegations
detailing the assigning investors’ specific damages and how Eide Bailly caused those
damages is not fatal to Zazzali’s Complaint’ and that ‘such information can be gleaned
through discovery.’” (Dkt. No. 113 at 8.) Defendant argues this transfers the burden of
uncovering facts from the Plaintiff to the Defendant, and Zazzali should be required to set
forth each investor claim just as the individual investor would if they brought a separate
fraud-based lawsuit. (Id. at 8.) Eide Bailly argues Judge Bush’s conclusion is not
consistent with Fed. R. Civ. P. 9(b)’s particularity requirement for fraud claims. (Id.)
Zazzali counters the objection lacks merit because the Trustee takes the position “that
had Eide Bailly come anywhere near satisfying its professional and contractual
obligations in conducting its audits, the entire DBSI fraud would have been revealed
years earlier.”(Dkt. No. 123 at 7.) Zazzali argues taking this position means information
concerning damages is the same for each PAT member, and they need not have read a
single Eide Bailly audit report to have sustained damages proximately caused by
violations Eide Bailly facilitated. (Id. at 8.) Because the claims against Eide Bailly are for
aiding and abetting fraud and breaches of fiduciary duties, Zazzali argues the reliance on
Rule 9(b) is misplaced, and the Trustee need only prove Eide Bailly’s knowing
participation in those violations. (Id.)
Order - 6

Defendant’s objections on this point are not well taken. Even under the Rule 9(b)
standard, a complaint does not fail for not specifying an amount of damages. Rather, if
the existence, and not the amount, of damages alleged in a fraud pleading is too remote,
speculative or uncertain, then the pleading cannot state a claim for relief. See, Alimena v.
Vericrest Fin., Inc., 2013 U.S. Dist. LEXIS 112814, *25 (E.D. Cal., Aug. 9, 2013).
Plaintiff sufficiently alleges the investors suffered damages, and details of those damages
can be fleshed out upon discovery. The Court agrees with the R&R’s conclusion and
adopts the R&R on this point.

2. Remaining objections

Eide Bailly acknowledges its remaining objections need not be addressed unless the
Court rejects the R&R’s other recommendations on dismissing the RICO counts. (Dkt.
No. 113 at 9, 11, 12.) Because the Court adopts the R&R in full, the remaining objections
are not addressed.

Zazzali’s Objections

1. ELT’s causes of action should not be dismissed on grounds of in pari delicto

The R&R recommends dismissal with prejudice of counts 1,2,3,4, 9 and 16 of
Plaintiff’s claims on behalf of ELT based on the doctrine of in pari delicto, which stands
Order - 7

for the proposition that when plaintiff is as culpable as the defendant (if not more so), the
law will let losses rest where they fall. (Dkt. No. 107 at 22, 31.) Zazzali objects to the
conclusion the doctrine should be applied here because such application would be
inequitable in light of (1) the innocence of the victims of the DBSI fraud who are the
beneficiaries of the ELT, (2) the safeguards put in place to ensure no wrongdoer will
receive any portion of a judgment in favor of the ELT, (3) Eide Bailly’s express
contractual commitment to detect fraud, and (4) Eide Bailly’s degree of culpability
relative to the beneficiaries of the ELT. (Dkt. No. 114 at 4.)
Plaintiff’s objections are not well taken. Zazzali raises no argument in his objections
militating against the application of in pari delicto to this case. In the very similar
Hirschler case, discussed above, in pari delicto was applied. 482 B.R. at 514. That case
involved the same ELT, the same DBSI, and the same basic Ponzi scheme scenario
presented here. The application of the doctrine in Hirschler is instructive and addresses
many of Plaintiff’s objections. The Court in Hirschler found that under Idaho law and on
the facts of the DBSI fraud allegations, the alleged wrongful conduct of officers and
directors of DBSI is imputed to DBSI, and the court rejected equitable arguments against
applying the doctrine. Id. at 513. Plaintiff’s first, second and fourth arguments fail for the
same reasons they failed in Hirschler.
Plaintiff’s third argument, that Eide Bailly was contractually bound to detect fraud, is
also not persuasive. (Dkt. No. 114 at 9.) As Defendant notes in its reply to Plaintiff’s
objections, Eide Bailly’s agreement to provide “reasonable assurances” against fraud and

Order - 8

specified DBSI was ultimately responsible for the design and implementation of fraud
prevention programs. (Dkt. No. 90-1 at 25.)
The two cases primarily relied upon by Plaintiff, NCP Litigation Trust v. KPMG LLP,
901 A.2d 871 (N.J. 2006) and Freeman v. BDO Seidman LLP, 2010 WL 1417732
(Bankr. S.D. Fla. Apr. 6, 2010), are not applicable for several reasons. First, Plaintiff
acknowledges neither of these opinions are binding precedent for this Court. (Dkt. No.
114 at 12.) Second, the only Court outside of New Jersey to adopt the NCP analysis is
Freeman, the unpublished Florida bankruptcy court decision. Judge Bush properly chose
to rely on alternative precedent. (Dkt. No. 107 at 26.) Third, there are important factual
differences between the NCP case and the case at hand. NCP involved a situation where
certain officers were making fraudulent filings, where Plaintiff alleges DBSI was in its
entirety an elaborate Ponzi scheme. 187 N.J. at 358. Plaintiff’s objections are not
persuasive and fail to cite binding precedent militating a departure from Judge Bush’s
analysis, and the Court adopts Judge Bush’s analysis on the application of in pari delicto.

2. ELT’s actions for negligence/accounting malpractice should not be dismissed

This objection goes to ELT’s third cause of action, which is dismissed with prejudice
for the reasons discussed above in the in pari delicto section, and this objection need not
be addressed.

Order - 9

3. ELT and PAT’s RICO causes of action should not be dismissed

Plaintiff objects to the recommendation in the R&R that civil RICO claims be
dismissed for failure to state a claim, arguing the claims are pled with sufficient
particularity. Plaintiff contends proximate cause was sufficiently alleged because the
Complaint claims the fraudulent offering materials in which Defendant was involved
were the mechanism by which the DBSI fraud was perpetuated. (Dkt. No. 114 at 17.)
Plaintiff goes on to dispute Judge Bush’s finding that each actionable misrepresentation
alleged by Plaintiff is barred by the securities fraud exemption to the applicable RICO
claims. Plaintiff argues at least some of the misrepresentations constitute RICO predicate
acts and cannot be actionable in securities fraud, or at least necessitate an intensive fact
inquiry to determine if they do constitute securities fraud. (Id. at 18.)
Plaintiff’s objections on this point fail to raise arguments not addressed in the R&R,
and the Court agrees with the R&R’s analysis. (See, e.g., Dkt. No. 107 at 41.)
Importantly, the Hirschler decision also found, on extremely similar facts, RICO claims
were barred by the securities fraud exemption. 482 B.R. at 515. The Court finds, and
Plaintiff presents, no reason to deviate from the Hirschler decision and Judge Bush’s well
reasoned conclusions on the RICO claims. The findings of the R&R are adopted on this
point.

Order - 10

4. ELT’s unjust enrichment claim should not be dismissed

This objection goes to ELT’s 16th cause of action, which is dismissed with prejudice
for the reasons discussed above in the in pari delicto section, and this objection need not
be addressed.

5. ELT’s avoidance actions should not be dismissed

Plaintiff objects to the R&R’s recommendation the ELT avoidance actions based
on constructive fraud (ELT claims 11, 13 and 14) be dismissed for lack of allegations as
to the value of each specific transfer at issue. (Dkt. No 114 at 19.) Plaintiff contends
transaction-specific allegations are not required because the Trustee alleges all transfers
at issue served only to deepen the insolvency of the Debtors. (Id. at 20.) At a minimum,
Plaintiff argues fact issues involved in these claims make them inappropriate for
resolution at the pleading stage. (Id.) Defendant counters the R&R’s recommendation of
dismissal should be adopted because Plaintiff’s claims are merely a recitation of the
elements of the claim, and provide facts insufficient to state a claim. (Dkt. No. 122 at 21.)
Defendant also notes the Hirschler court dismissed constructive fraud based claims for
the same reason. (Id.)
Plaintiff’s objections on this point are not persuasive. Plaintiff raises no issue not
already considered in the R&R. As the R&R noted, a recitation of the elements of a claim
does not satisfy requisite pleading standards; Plaintiff must plead some facts to support a
Order - 11

plausible claim. (Dkt. No. 107 at 55.) One of the elements of a constructive fraudulent
transfer claim is Plaintiff did not receive the reasonably equivalent value of property
transferred. See, In re Nat’l Consumer Mortg., LLC, 2013 U.S. Dist. LEXIS 5986, *3132 (D. Nev. Jan. 14, 2013). The failure to allege necessary facts going to reasonably
equivalent value does not create “issues of fact” such that dismissal at the pleading stage
is inappropriate. This issue here is not one where Plaintiff and Defendant argue a
different version of facts such that a factual conflict is created; instead, Plaintiff has failed
to allege sufficient facts to state a claim. “A claim has facial plausibility when the
plaintiff pleads factual content that allows the court to draw the reasonable inference that
the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678
(2009). Here, the R&R properly found the Complaint stated facts “merely consistent with
a defendant’s liability” and therefore failed to state a claim. Id. The R&R’s findings on
these claims are adopted.

6. PAT claims should not be dismissed for failure to identify beneficiaries

Plaintiff argues the PAT’s claims should not be dismissed for failure to identify
beneficiaries because this information is publically available, and Eide Bailly has access
to the information outside of this litigation. (Dkt. No. 114 at 20.) Plaintiff argues Judge
Bush’s recommendation on this point is inconsistent with the R&R’s other finding that
the Trustee’s damages allegations can be cured through discovery. (Id.)

Order - 12

Plaintiff’s objections are not persuasive. The need to allege exact amounts of damages
is analytically distinct from the need to allege beneficiary identity. The R&R successfully
makes this distinction. (Dkt. No. 107 at 57.) The R&R also addresses and rejects
Plaintiff’s argument disclosure is unnecessary because investor names are separately
published outside this litigation. (Id.) Plaintiff’s objections raise no new issues and the
R&R is adopted on this point.

7. PAT claims should not be dismissed for failure to plead insiders’ fraud

Plaintiff objects to the R&R’s finding that because Plaintiff failed to sufficiently plead
the predicate acts of fraud, the pleadings are insufficient to state a claim for aiding and
abetting fraud. (Dkt. No. 107 at 59.) Plaintiff argues this finding is inconsistent with
footnote 30 of the R&R, where Judge Bush did find Eide Bailly was aware of the alleged
DBSI Ponzi scheme and substantially assisted the Insiders in achieving it. (Dkt. No. 114
at 21.) Plaintiff further objects that the predicate acts were sufficiently pled. (Id.)
The Court first notes the R&R’s main finding and footnote 30 are not internally
inconsistent because they deal with separate elements of the claim. The finding that Eide
Bailly was aware of the alleged Ponzi scheme does not contradict the finding that fraud
elements were, separately, insufficiently pled. Fed. R. Civ. P. 9(b) requires fraud based
allegations to “state with particularity the circumstances constituting the fraud,” and as
discussed below, the Rule 9(b) standard applies here. Plaintiff’s objections do not raise

Order - 13

issues unaddressed by the R&R. This Court finds the reasoning in the R&R appropriate,
and adopts the R&R’s findings on this point.

8. PAT claims should not be dismissed for failure to plead fiduciary duty

Judge Bush concluded in order for Plaintiff to successfully plead a fiduciary duty
claim, Plaintiff must establish a fiduciary relationship between the Insiders and assigning
investors in the PAT. (Dkt. No. 107 at 60.) Plaintiff objects, arguing at this stage “it is too
early to be certain whether, in each case, the Insiders’ duties . . . to PAT members . . .
arose purely as a result of the language in [the] offering documents or as a result of a
fiduciary duty, separate from [the] offering documents[.]” (Dkt. No. 114 at 22.) Plaintiff
argues this claim is properly tested at the summary judgment stage, and not at this stage.
(Id.)
Establishing the existence of a fiduciary duty is essential to a claim for breach of
fiduciary duty. “To establish a claim for breach of fiduciary duty, plaintiff must establish
that defendants owed plaintiff a fiduciary duty and that the fiduciary duty was breached.”
Country Cove Dev., Inc. v. May, 143 Idaho 595, 601 (2006), quoting Sorenson v. Saint
Alphonsus Reg’l Med. Ctr., Inc., 141 Idaho 754, 760 (2005). As discussed above, failure
to raise any facts supporting a central element of the claim makes the claim insufficient.
Iqbal, 556 U.S. at 678. Plaintiff does not appear to argue a fiduciary duty does exist or
that a fiduciary duty has been demonstrated. The Court finds the reasoning presented in
the R&R appropriate and adopts the R&R on this point.
Order - 14

9. Trustee should be entitled to a relaxed pleading standard

Plaintiff argues the Trustee is entitled to a relaxed pleading standard, and objects to
Judge Bush’s conclusion that ordinary pleading standards should apply in light of the
Examiner’s reports and investigation. (Dkt. No. 114 at 22.) Plaintiff argues the reports are
inapposite because they focused on DBSI and not Eide Bailly. (Id.) Because evidence
going specifically to Eide Bailly will be essential in proving its case against Eide Bailly,
Plaintiff argues the Trustee should be afforded a relaxed pleading standard. (Id. at 23.)
Judge Bush referenced the Hirschler decision in reaching the conclusion a relaxed
pleading standard is inappropriate under the circumstances of this case, noting the
Trustee here had access to an extensive investigation into the DBSI fraud. (Dkt. No. 107
at 39, n. 22.) The Court agrees with Judge Bush’s reasoning and the reasoning in
Hirschler, and finds the circumstances of this case are not the kind which implicate the
need for a relaxed pleading standard. 482 B.R. at 511-12.

10. Findings on PAT standing

Plaintiff objects to Judge Bush’s rejections of Plaintiff’s standing arguments. (Dkt.
No. 114 at 23.) Because, as discussed above, the Court adopts the R&R’s finding that
Zazzali does have standing to bring the claims on behalf of PAT, this objection need not
be addressed.

Order - 15

Conclusion
The Court, having considered the objections and responses of all Parties and all
related documents, agrees with the findings and conclusions of the Honorable Magistrate
Judge Bush and ADOPTS the Report and Recommendation in full. A summary of each
claim and its status is presented in the chart below. Plaintiff has fifteen (15) days from
the date of this order to file an amended complaint.

ELT Claims:
Claim
Number
and
Abbreviated
Description
Status

1
RICO
violations

Dismissed Dismissed

Claim
Number
and
Abbreviated
Description

11
avoidance
fraudulent
transfers

12
avoidance
four year
transfers

Status

Dis.
without
prejudice

Active

Order - 16

2
consp. to
violate
RICO

3
prof.
negligence

9
breach of
contract

Dismissed

4
aiding
breach of
fiduciary
duty
Dismissed

10
avoidance
two year
transfers

13
avoidance
four year
const.
fraud
transfers
Dis.
without
prejudice

14
avoidance
four year
const.
fraud
transfers
Dis.
without
prejudice

15
16
transfers
unjust
in fraud of enrich.
creditors

Dismissed Active

Active

Dismissed

PAT Claims:
Claim
Number and
Abbreviated
Description

1
RICO
violations

2
conspiracy
to violate
RICO

Status

Dis.
without
prejudice

Dis.
without
prejudice

5
6
7
aiding fraud civil
aiding
conspiracy breach of
fiduciary
duty/
breach of
trust
Dis.
Dis.
Dis.
without
without
without
prejudice
prejudice prejudice

Dated this 14th day of November, 2013.

A

Marsha J. Pechman
Chief United States District Judge

Order - 17

8
aiding
breach
of
fiduciary
duty
Dis.
without
prejudice