GOLDENSON et al v. STEFFENS et al
ORDER granting in part and denying in part 26 Motion to Dismiss By JUDGE JOHN A. WOODCOCK, JR. (MFS)
UNITED STATES DISTRICT COURT
DISTRICT OF MAINE
DANIEL R. GOLDENSON, et al.,
JOHN L. STEFFENS, et al.,
ORDER ON MOTION TO DISMISS
On October 27, 2010, Daniel and Suzanne Goldenson; SKG Partners, L.P.;
and SKG General Corp. (Plaintiffs) filed a complaint against John L. Steffens;
Gregory P. Ho; Spring Mountain Capital GP, LLC; Spring Mountain Capital LP;
and Spring Mountain Capital, LLC, (Defendants) alleging under a variety of legal
theories that the Defendants committed fraud against them by recommending that
they invest their money in the Ascot Fund, a hedge fund with a complex proprietary
strategy that stabilized investment returns and protected against market
fluctuations when in fact, as the Defendants knew, the Ascot Fund was merely a
feeder fund for the notorious Bernard Madoff, the infamous and now convicted
perpetrator of the largest investment fraud in history. The Plaintiffs also claim
that the Defendants committed a similar fraud by convincing them to invest in a
Spring Mountain hedge fund called QP1 Fund, which itself was substantially
invested in the Ascot Fund. The Defendants moved to dismiss the Complaint. The
Court dismisses one count of the Complaint but concludes that all other counts
withstand the motion.
STATEMENT OF FACTS
On October 27, 2010, the Plaintiffs filed their Complaint against the
Defendants. Compl. (Docket # 1). The parties engaged in an initial skirmish about
whether the Court should decide a choice of law issue before the Defendants filed a
motion to dismiss; by Order dated December 8, 2010, the Magistrate Judge resolved
this issue, noting that the choice of law issue could be raised in the contemplated
motion to dismiss. Defs.’ Mot. for Ruling on Choice of Law (Docket # 14); Pls.’
Objection to Defs.’ Mot. for Ruling on Choice of Law (Docket # 18); Defs.’ Reply in
Support of Mot. for Ruling on Choice of Law (Docket # 19); Memorandum Decision
on Mot. for Ruling on Choice of Law (Docket # 20).
On December 20, 2010, the Defendants filed a motion to dismiss. Defs.’ Mot.
to Dismiss the Compl. (Docket # 26) (Defs.’ Mot.).
On February 1, 2011, the
Pls.’ Consolidated Objections to Defs.’ Mot. for Ruling on
Choice of Law and Defs.’ Mot. to Dismiss the Compl. (Docket # 27) (Pls.’ Opp’n). On
February 17, 2011, the Defendants replied. Defs.’ Reply Mem. in Further Support of
Their Mot. to Dismiss the Compl. (Docket # 31).
On February 22, 2011, the
Defendants‘ moved for oral argument. Defs.’ Req. for Oral Arg. (Docket # 32). On
February 23, 2011, the Court granted the request for oral argument.
Granting Mot. for Oral Arg. (Docket # 33).
On March 31, 2011, the Plaintiffs moved to amend their Complaint and on
April 19, 2011, the Court granted the motion without objection. Pls.’ Mot. for Leave
to File an Am. Compl. (Docket # 34); Defs.’ Resp. to Pls.’ Mot. for Leave to File Am.
Comp. (Docket # 35); Order Granting Mot. to Am. (Docket # 37). In their response
to the motion to amend complaint, the Defendants emphasized that the amended
allegations did not alter the merits of their motion to dismiss. Defs.’ Resp. to Pls.’
Mot. for Leave to File Am. Compl. at 1-6. The Plaintiffs filed the First Amended
Complaint on April 21, 2011. First Am. Compl. (Docket # 38) (Am. Compl.).
Daniel and Suzanne Goldenson are married residents of the state of Maine.
Am. Compl. ¶ 9.
Ms. Goldenson is the President of SKG General Corporation
(SKGGC), a Maine corporation, the general partner of SKG Partners, L.P. (SKG), a
Delaware limited partnership. Id. ¶ 10.
Spring Mountain Capital GP, LLC (SMCGP or with other Spring Mountain
entities Spring Mountain) is a Delaware limited liability company and the general
partner of the Spring Mountain Partners QP1, LP (QP1 Fund), a private
investment instrument that functions as a so-called hedge fund. SMCGP has a
principal place of business in the city of New York, state of New York. Id. ¶ 11.
Spring Mountain Capital LP (SMCLP or collectively with other Spring Mountain
entities Spring Mountain) is a Delaware limited partnership and the management
company for QP1 Fund. Its principal place of business is in the city of New York,
state of New York. Id. ¶ 12. Spring Mountain Capital, LLC (SM or collectively with
other Spring Mountain entities Spring Mountain) is the general partner of the
Management Company. Id. ¶ 13. Its principal place of business is in the city of
New York, state of New York. SMCGP, SMCLP and SM were investment advisers
within the meaning of the securities laws of the United States and the state of
Maine. Id. ¶ 14.
John L. Steffens is the sole managing member of SMCGP, the Managing
Director of SMCLP, and the sole managing member of SM.
Id. ¶ 15. He is a
resident of the state of New Jersey and was an Investment Advisor (or was
associated with an Investment Advisor) within the meaning of the securities laws of
the United States and the state of Maine. Id.
Gregory P. Ho is the President and Chief Operating Officer of SMCLP and is
a resident of the city of New York, state of New York. Id. ¶ 16. Mr. Ho was an
Investment Advisor (or was associated with an Investment Advisor) within the
meaning of the securities laws of the United States and the state of Maine. Id. The
Plaintiffs claim that Mr. Steffens and Mr. Ho were the controlling persons of Spring
Mountain. Id. ¶ 17.
Before Spring Mountain
Before December 2001, when Mr. Steffens established Spring Mountain, Mr.
Steffens had been Vice Chairman of Merrill Lynch, an institution upon which the
Goldensons relied on for investment advice and the Goldensons had both a personal
and business relationship with Mr. Steffens and reposed great trust and confidence
in him and his investment advice. Id. ¶ 28. The Goldensons were high net worth
individuals who had never invested in hedge funds; instead, over 90% of their
investments were in AAA municipal bonds to ensure a safe and steady rate of
return upon which they relied as their fixed income and for their retirement. Id. ¶¶
24-26. The Goldensons made known to their investment advisers their preference
for predictable and stable rates of return and the risk averse nature of their longterm investment strategies. Id. ¶ 27.
In June 2001, Mr. Steffens resigned from Merrill Lynch and established
Spring Mountain, which he promoted as an investment management venture for
the ―ultra-high end net worth market.‖ Id. ¶ 29. By November 2001, the municipal
bond rates had diminished and the Goldensons considered other investment
options. Id. ¶ 30.
The Plaintiffs, Mr. Steffens, QP1 Fund, Ascot Fund, and
In the fall of 2001, the Goldensons learned about Mr. Steffens‘ Spring
Mountain venture over dinner at a restaurant in Princeton, New Jersey. Id. ¶ 31.
Mr. Steffens described Spring Mountain as a well-diversified ―fund of funds‖ that
employed numerous ―sub-managers‖, who in turn used various investment
strategies to generate earnings. Id. The Goldensons and Mr. Steffens met on a
number of occasions and Mr. Steffens described how he and Spring Mountain
carefully selected these sub-managers and monitored their trading strategies and
performance. Id. ¶ 32. Mr. Steffens encouraged them to dispense with municipal
bonds and invest instead in the QP1 Fund, a hedge fund. Id. ¶¶ 21, 32. QP1 Fund
has two components, a portfolio of underlying hedge funds and a private equity
fund, collectively referred to as ―Portfolio Funds.‖ Id. ¶ 22. Despite the fact that
the Goldensons had never invested in hedge funds, id. ¶ 24, Mr. Steffens
encouraged them to invest in Spring Mountain because the QP1 Fund would
simultaneously provide them with consistently superior rates of return and reduced
risk. Id. ¶ 32.
On or about December 14, 2001, Mr. Goldenson met with Mr. Steffens at Mr.
Steffens‘ Manhattan office and further discussed an investment in QP1 Fund. Id. ¶
33. During this meeting, Mr. Goldenson inquired about investing additional money
in another secure, well-managed hedge fund and Mr. Steffens immediately
recommended the Ascot Fund, which he said was well managed by his friend and
business associate Ezra Merkin. Id. ¶¶ 1, 33. Mr. Merkin was an Investment
Adviser within the meaning of federal securities laws and an investment consultant
to Spring Mountain; he was also an investor and limited partner in Spring
Mountain and entitled to nearly half its profits. Id. ¶¶ 34-35.
Mr. Steffens told Mr. Goldenson that the Ascot Fund would provide the
Goldensons with consistently better rates of return than municipal bonds as well as
Id. ¶ 36.
He said that the Ascot Fund employed a proprietary
investment strategy even more conservative than QP1 Fund and therefore the
Goldensons would likely see a somewhat lower rate of return on the Ascot Fund
investments than from Spring Mountain. Id. ¶ 37. At the same time, Mr. Steffens
thought Ascot Fund was well-managed and reliable and a good complement to the
Goldensons‘ investment in QP1 Fund.
He informed Mr. Goldenson that a
portion of QP1 Fund was invested in the Ascot Fund so that a portion of their
investment would, in any event, be invested in Ascot Fund. Id.
During this December 14, 2001 conversation, Mr. Steffens offered to
introduce Mr. Goldenson to Mr. Merkin, whose office was in the same Manhattan
building as Mr. Steffens‘ office. Id. ¶ 39. In fact, the same day, Mr. Steffens did
introduce Mr. Goldenson to Mr. Merkin at Mr. Merkin‘s Manhattan office. Id. ¶ 39.
Mr. Steffens said that Mr. Merkin was a new investor in the Spring Mountain QP1
The three men met for approximately one hour.
meeting, Mr. Steffens and Mr. Merkin described the Ascot Fund as Mr. Steffens had
previously described it—a fund that employed a proprietary strategy of put and call
options on selected securities in order to hedge against market fluctuations, thereby
generating consistent annual returns of 8% to 10%. Id. ¶ 42. They further told Mr.
Goldenson that the Ascot Fund employed a ―split-strike‖ trading strategy whereby
the fund ensured its investments were equally long and short at all times, a
strategy that worked better for unclear reasons in a high interest environment. Id.
¶ 43. Mr. Steffens again told Mr. Goldenson that his own QP1 Fund held a position
in the Ascot Fund as a stable core investment. Id. When the three men met, Mr.
Merkin was a limited partner in SMCLP and a consultant to SMCLP and/or
SMCGP and during this time, QP1 invested heavily in the Ascot Fund and in
Gabriel Capital, LP (Gabriel Fund), another Merkin fund. Id. ¶¶ 40-41, 43.
The Goldensons’ Investments
On or about January 1, 2002, through SKG, the Goldensons, acting on Mr.
Steffens‘ advice, invested $2,000,000 in Spring Mountain‘s QP1 Fund. Id. ¶ 45. In
addition, on or about January 1, 2002, through SKG, the Goldensons, acting on
representations of both Mr. Steffens and Mr. Merkin, invested $2,250,000 in the
Ascot Fund. Id. ¶ 46. In or about September 2002, Mr. Goldenson transferred his
Individual Retirement Account (IRA) in the amount of $250,000 and in or about
October 2006, he transferred $40,000 from another IRA to the Ascot Fund. Id. ¶¶
In or about November 2006, Ms. Goldenson transferred her IRA in the
amount of $90,706.55 to the Ascot Fund. Id. ¶ 73. Finally, in or about December
2006, through SKF, they transferred an additional $250,000 to the Ascot Fund. Id.
The QP1 Fund and Ascot Fund Confidential Offering
Before investing in the QP1 Fund and the Ascot Fund, the Goldensons relied
not only on advice from Mr. Steffens and Mr. Merkin, but also on Confidential
Offering Memoranda (COMs) that QP1 Fund and Ascot Fund both issued, which
were false or misleading. Id. ¶ 47. The QP1 Fund provided investors, including the
Goldensons, with a COM dated October 2001 (the QP1 COM), which described QP1
Fund‘s investment strategies and risks; QP1 amended the October 2001 COM from
time to time, but it remained essentially unchanged.
Id. ¶ 48.
objective was to achieve 15% per annum growth, the QP1 Fund told investors it
would employ a ―five-step, top-down investment process‖ whereby it would, among
other things, identify, evaluate, and select managers for proposed strategies and
would construct ―a high-performing and truly diversified portfolio.‖ Id. ¶¶ 49-50.
The QP1 Fund COM and Spring Mountain filed a registration application with the
United States Securities and Exchange Commission that promised to test the
portfolio by ―monitoring the portfolio and its underlying managers and making
required adjustments.‖ Id. ¶ 50.
The QP1 COM told its prospective and existing investors that its success
depended ―upon the ability of the Management Company and [the Fund‘s]
Submanagers to develop and implement investment strategies that achieve the
Fund‘s investment objectives.‖ Id. ¶ 53. As it pertained to the Ascot Fund, this
representation was false because the submanager, namely Mr. Merkin, did not
develop and implement strategies, but instead relied exclusively on the ability and
trustworthiness of Bernard Madoff. Id. ¶ 53. All of the Defendants either knew or
should have known that it was Bernard Madoff, not Mr. Merkin, who managed QP1
Fund‘s investment in Ascot Fund. Id. ¶ 54.
The QP1 COM invited prospective investors ―to meet with the General
Partner to ask questions of, and receive answers from, the General Partner
concerning the terms and conditions of this offering of the interests, and to obtain
any additional information, to the extent that the General Partner possesses such
information or can acquire it without unreasonable effort or expense, necessary to
verify the information contained herein.‖ Id. ¶ 51. Mr. Goldenson availed himself
of this invitation and spoke repeatedly to Mr. Steffens and to Mr. Ho concerning
their investments in QP1 Fund and its underlying Portfolio Funds, including Ascot
Fund. Id. ¶ 52.
The QP1 COM contained broad exculpation and indemnification clauses for
its General Partner, the Management Company, and their respective partners,
managers, consultants, and agents, including Messrs. Steffens, Ho, and Merkin,
and for Spring Mountain‘s key personnel, including Messrs. Steffens, Ho, and
Merkin. Id. ¶¶ 55-56. However, the clauses do not apply to mistakes of judgment,
gross negligence, willful misconduct, and bad faith and only apply to acts committed
by agents or brokers if an indemnified party ―selected, engaged and retained‖ the
agents or brokers in accordance with the standard of care in the QP1. Id.
The Defendants knew or should have known about the representations that
Mr. Merkin had made about the Ascot Fund. Id. ¶ 57. Furthermore, Mr. Merkin
made statements to the Goldensons regarding the Ascot Fund with the Defendants‘
knowledge, endorsement, or acquiescence. Id. The Ascot Fund issued a series of
COMs in 1992, 1996, 2002 and 2006 in which the Ascot Fund and Mr. Merkin
consistently misrepresented Mr. Merkin‘s role in the management of the Ascot
Fund and concealed Bernard Madoff‘s role as the repository of virtually all the
money in Ascot Fund. Id. ¶ 58. The Defendant knew or should have been aware of
Ascot Fund‘s misrepresentations including that the Ascot Fund had an active
investment strategy, that Mr. Merkin was involved in the Ascot Fund‘s day-to-day
management, that Mr. Merkin was devoting substantially all his time to the Ascot
Fund, that the Ascot Fund employed multiple money managers, that the Ascot
Fund was using multiple unaffiliated brokerage firms as custodians and to execute
and clear trades, and that Morgan Stanley and MIS were ―principal prime brokers
and custodians.‖ Id. ¶ 59.
Omissions and Concealments
After January 1, 2002, Mr. Goldenson communicated regularly with Mr.
Steffens, Mr. Ho, and other Spring Mountain personnel about the Goldenson
investments in QP1 Fund and in the Ascot and Gabriel Funds, which Spring
Mountain supposedly managed.
Id. ¶ 62.
All the Defendants gave continual
reassurances about the stability and soundness of the Goldensons‘ investments with
QP1 and Ascot Funds and about their monitoring and adjusting of their
investments and the submanagers. Id. ¶ 63. The Defendants represented to the
Goldensons that the Ascot Fund used a more conservative investment approach
than QP1 Fund and that Mr. Merkin carefully supervised its proprietary trading
strategy. Id. ¶ 75. The Goldensons placed particular credence in the Defendants‘
representations about the Ascot Fund because they knew that the QP1 Fund, a socalled ―fund of funds,‖ made its own substantial investment in Ascot Fund. Id. ¶ 64.
Spring Mountain provided the Goldensons with monthly account statements and
performance overviews for the QP1 Fund but these documents provided no
information about the individual underlying Portfolio Funds in which Spring
Mountain had invested and only discussed in general terms the performance and
earnings of the Portfolio Funds. Id. ¶ 65.
From January 1, 2002 onward, Mr. Goldenson also communicated regularly
with Mr. Merkin and other personnel at the Ascot Fund. Id. ¶ 66. The Ascot Fund
sent the Goldensons statements reflecting the purported value of their Ascot Fund
investments. Id. ¶ 67. However none of these statements disclosed that the Ascot
Fund was not investing the Goldensons‘ money according to a proprietary
investment strategy and instead had turned over complete custody and control of
their Ascot Fund investment to Mr. Madoff. Id. ¶ 68.
The Defendants and Ezra Merkin
The Defendants and Mr. Merkin enjoyed a symbiotic business relationship.
Id. ¶ 76. The QP1 Fund was a substantial investor in Mr. Merkin‘s Ascot and
Gabriel Funds and Mr. Merkin received substantial performance-based fees for
purportedly managing those Funds. Id. ¶ 76. At the same time, Mr. Merkin had a
substantial limited property interest in SMCLP, the management company for QP1
Fund, received nearly half of its profits, served as a consultant for QP1 Fund, and
QP1 Fund advertised Mr. Merkin‘s expertise to prospective investors. Id. ¶ 77. The
Defendants and Mr. Merkin shared other business relationships, including 1) Mr.
Steffens served on the Board of Directors of Aozora Bank of Japan and was
instrumental in the creation of a joint venture between Aozora and Spring
Mountain relating to hedge fund investments; 2) Cerberus Capital Management in
which Mr. Merkin was a substantial investor was a major shareholder in Aozora; 3)
Aozora was a major shareholder in General Motors Acceptance Corporation (GMAC)
for which Mr. Merkin served as Chairman; and 4) Spring Mountain engaged in a
hedge fund joint venture with Bank Leumi of Israel and Mr. Merkin, whose funds
had a substantial interest in Bank Leumi, was instrumental in establishing this
joint venture. Id. ¶ 78. Because of their numerous interlocking investments, the
Defendants and Mr. Merkin were interdependent and the Defendants were
motivated to promote and protect him, not to view him critically or expose him to
criticism. Id. ¶ 79.
The Goldensons Seek to Redeem the Hedge Fund Portion
of QP1 Fund But Not The Ascot Fund
By 2007, market conditions had adversely affected the Goldensons‘
investment in QP1 Fund and Mr. Goldenson spoke to Mr. Steffens and Mr. Ho
about their intention to liquidate their hedge fund portion of their QP1 Fund assets.
Id. ¶¶ 83-84. The Goldensons narrowly missed the 2007 redemption deadline but
the Defendants were well aware that the Goldensons wanted to withdraw from QP1
as early as September 2007 and in September 2008, the Goldensons timely sought a
redemption of their interest in the hedge fund portion of QP1. Id. ¶¶ 85-86. The
Goldensons expected to receive their liquidated investment from the hedge fund
portion of QP1 by the end of 2008. Id. ¶ 86.
The Goldensons did not seek to redeem their interest in the Ascot Fund
before 2007 because the fund continued to report high yields. Id. ¶ 87. By 2007 and
2008, there had been numerous warning signs about Bernard Madoff. Id. ¶ 80.
Other investors could not model Mr. Madoff‘s purported investment strategy and
reported it could not be duplicated. Id. The mainstream financial media reported
these warning signs and there was widespread concern about Mr. Madoff‘s secretive
approach to the details of his trading strategy. Id. ¶¶ 81-82. These warning signs
about Mr. Madoff did not concern the Goldensons because they had no knowledge or
suspicion that a large portion of their own assets was in his care and custody. Id. ¶
Bernard Madoff Is Exposed and Arrested
On December 11, 2008, federal authorities arrested Bernard Madoff for
perpetrating the largest investment fraud in history and Mr. Madoff was ultimately
convicted of his crimes. Id. ¶¶ 88-89. When the Goldensons learned about Mr.
Madoff, they had no knowledge or suspicion that their own investments in the QP1
Fund and the Ascot Fund were at risk because of Mr. Madoff‘s massive Ponzi
scheme. Id. ¶ 89.
The Defendants React
On December 12, 2008, the Defendants sent the Goldensons a letter signed
by Mr. Steffens and Mr. Ho, which advised them that the Defendants were ―actively
investigating what our potential exposure is to Madoff Securities and related
entities‖ and represented that they had no ―direct investments with Madoff
Securities‖ but that some of their ―underlying managers do have exposure.‖ Id. ¶¶
90-91. On December 15, 2008, the Defendants sent the Goldensons a follow-up
letter describing their efforts to ―quantify‖ the exposure of the QP1 Fund‘s
submanagers to Madoff Securities and reported that only two funds had direct
exposure to Madoff Securities—the Ascot Fund and Gabriel Capital. Id. ¶¶ 92-93.
The December 15, 2008 letter stated that ―substantially all of the Ascot investment‖
and ―approximately 29% of the Gabriel investment‖ were exposed to Madoff
Securities and that the QP1 Fund ―had approximately 9.89% of its assets exposed to
Madoff Securities as of November 30, 2008.‖ Id. ¶ 93. The December 15, 2008
letter also informed the Goldensons that the Defendants had taken ―affirmative
steps‖ to protect their interests including the retention of ―one of the nation‘s most
highly regarded and sophisticated law firms.‖ Id. The December 15, 2008 letter
failed to mention that a substantial portion of QP1‘s assets was invested in
Cerberus even though the Defendants knew that Cerebrus was a substantial
investor in Aozora Bank, which was heavily invested in the Ascot and Gabriel
funds. Id. ¶¶ 94-95.
On December 21, 2008, the Defendants sent the Goldensons a letter
informing them that all redemptions from the QP1 Fund were suspended
immediately. Id. ¶ 96. On December 22, 2008, the Defendants sent the Goldensons
another letter, announcing a ―dramatic change in the way we manage money,‖
saying that they ―now believe the correct strategy is a complete disengagement from
pooled investment vehicles and a movement to . . . actively managed accounts . . . .‖
Id. ¶ 97. They declared that this strategic choice was ―the responsible thing to do as
fiduciaries of the assets which you have placed under our care.‖ Id.
The Goldensons Respond and the Defendants Dissemble
After receiving the December 12, 2008 correspondence, the Goldensons
immediately contacted Mr. Steffens and Mr. Ho about their investments in the QP1
Fund and the Ascot Fund. Id. ¶ 99. On December 17, 2008, they emailed Mr.
Steffens about their concern, following a conversation with Mr. Ho, about their
pending redemption request. Id. ¶ 100. On December 19, 2008, they wrote to Mr.
Steffens thanking him for his efforts in arranging for a partial redemption of their
interest in the hedge fund portion of the QP1 Fund. Id. ¶ 102. Mr. Goldenson
followed up with Mr. Steffens and Mr. Ho on December 22, 2008 but they never
revealed to him that they were aware that the Goldensons‘ investments in the Ascot
Fund either directly or through the QP1 had been funneled to Mr. Madoff, that the
Ascot Fund was a ―feeder fund‖ for Madoff Securities, or that the Ascot Fund did not
engage in any trading at all much less the proprietary trading strategy Mr.
Steffens, Mr. Merkin, and the various Ascot COMs had described. Id. ¶ 106. Nor
did the Defendants reveal to QP1 Fund investors that the QP1 Fund losses went
well beyond the Fund‘s investments in the Ascot and Gabriel Funds and included
losses sustained by its other funds, including Cerberus. Id. ¶ 108. Despite their
representations of affirmative action, the Defendants took no action against their
business partner Ezra Merkin or against the Ascot Fund to protect the interests of
the Goldensons and other investors. Id. ¶ 110.
The Goldensons Discover the Truth
On or about January 6, 2009, Mr. Goldenson read an article in The
Dartmouth, the Dartmouth College newspaper.
alumnus of Dartmouth.
Id. ¶ 111.
Mr. Steffens is an
The article, Alumni Interests Hurt By Madoff,
recounted how various non-profit organizations had been adversely affected by Mr.
Madoff‘s fraud and how one, New York Law School, had sued Mr. Merkin, Ascot
Partners, and its auditor for failing to inform the school about the extent to which
the Fund had invested in Madoff Securities. Id. The article quoted Mr. Ho as
saying that Spring Mountain did not intend to initiate a similar legal action against
Mr. Merkin because Spring Mountain was ―fully aware‖ of the Ascot Fund‘s
investment in Madoff Securities and that ―we asked and were given the
information.‖ Id. ¶ 112.
By reading the article, the Goldensons learned for the first time that the
Defendants were fully aware the money they had invested in the Ascot Fund had
simply been funneled to Mr. Madoff, that the Ascot Fund was a mere ―feeder fund,‖
and that it engaged in no trading whatsoever. Id. ¶ 113. Mr. Goldenson asked
Spring Mountain personnel whether it intended to initiate a legal action against
Mr. Merkin or Ascot Fund and was informed that no such action was anticipated
because Mr. Merkin was Mr. Steffens‘ business partner and the Defendants were
aware of Mr. Madoff‘s role as the repository of Ascot Fund money. Id. ¶ 114.
In effect, the Goldensons learned that the Defendants had known but
concealed from them highly material information about their investments in the
Ascot Fund, which would have been critically important to the Goldensons‘ initial
decision to invest in the Ascot Fund.
Id. ¶ 115.
With that information, the
Goldensons would have been aware that the media reports about Mr. Madoff
involved their own personal investments and would have known that nearly half of
their assets were in the hands of Mr. Madoff. Id. ¶ 116.
THE LEGAL CONTENTIONS1
The Legal Theories
The Goldensons‘ multi-count Amended Complaint sets forth the following
causes of action: Count One—Breach of Fiduciary Duty under Maine common law;
Count Two—Fraudulent Misrepresentation/Deceit under Maine common law; Count
Three—Aiding and Abetting Tortious Conduct under Maine common law; Count
Four—Intentional Infliction of Emotional Distress under Maine common law; Count
Five—Civil Conspiracy under Maine common law; Count Six—Securities Fraud
under 15 U.S.C. § 78(j)(b) and SEC Rule 10b-5; Count Seven—Securities Fraud:
Controlling Persons Liability under 15 U.S.C. § 78t(a); Count Eight—Maine
Securities Fraud under 32 M.R.S. § 16509(6); Count Nine—Maine Joint and Several
Liability for Securities Fraud under 32 M.R.S. § 16509(7); Count Ten—Punitive
Enrichment/Constructive Trust under Maine law of equitable remedy.
The Defendants’ Position
The Defendants initially argued that choice of law principles establish that New York law should
apply to the Plaintiffs‘ state law claims. Defs.’ Mot. for Ruling on Choice of Law (Docket # 14) (Defs.’
Choice of Law Mot.). Acknowledging that the initial task of a choice of law analysis is to determine
whether there is an actual conflict between the substantive law of the interested jurisdictions, the
Defendants argued that New York‘s Martin Act, N.Y. Gen. Bus. Law, Art. 23-A §§ 352-59 preempts
common law causes of action for securities fraud, breach of fiduciary duty, aiding and abetting
breach of tortious conduct, and unjust enrichment. Id. at 5-6. However, recent opinions from the
Appellate Division of the New York Supreme Court and the District Court for the Southern District
of New York question whether the Martin Act preempts other causes of action. Assured Guar. (UK)
Ltd. v. J.P. Morgan Inv. Mgmt. Inc., 915 N.Y.S.2d 7, 14 (1st Dep‘t 2010); Anwar v. Fairfield
Greenwich Ltd., 728 F. Supp. 2d 354, 357 (S.D.N.Y. 2010). At oral argument, the Defendants
conceded that the preemption rule in New York is unsettled and declined to press their choice of law
contentions for purposes of the motion. Consistent with Roc-Century Assocs. v. Giunta, 658 A.2d 223
(Me. 1995), the Court applies Maine law. Id. at 226 (―Consequently, New York law on this issue is
unsettled and the court erred in failing to apply Maine law‖).
Noting that two of the Plaintiffs‘ causes of action allege violations of federal
securities statutes, two allege violations of Maine securities statutes, and seven
allege violations of Maine common law, the Defendants claim that ―[a]ll these
claims are legally insufficient.‖ Defs.’ Mot. at 6.
The Federal Statutory Claims
The Defendants observe that in Count Six, the Plaintiffs are proceeding
under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule
10b-5, 17 C.F.R. § 240.10b-5 for alleged misstatements and omissions to the
Plaintiffs in connection with their purchase of interests in Spring Mountain‘s QP1
Fund and in Ezra Merkin‘s Ascot Fund, and that in Count Seven, they are
proceeding under § 20(a) of the 1934 Act, 15 U.S.C. § 78t(a), on the theory that the
Defendants are controlling persons of each other and of Mr. Merkin. Id. at 7. The
Defendants address each statutory provision separately.
Section 10(b) and Rule 10b-5
The Defendants make two overriding points in their motion to dismiss the §
10(b) and Rule 10b-5 claims: 1) the vast majority of the investments occurred
outside the applicable statute of limitations; and 2) what remains is inadequate
under the heightened pleading standards for such claims. Id.
Turning to the statute of limitations issue, the Defendants note that a private
right of action for a claim of fraud under federal securities law must be brought no
later than ―5 years after such violation.‖ Id. at 8 (citing 28 U.S.C. § 1658(b)). They
say that the statute of limitations starts to run from the date the buyer purchased
the security. Id. at 8-9. Thus, the Defendants say that any federal securities law
claims for purchases before October 27, 2005, five years before the Plaintiffs filed
their Complaint, are time-barred. Id. at 9. The Defendants claim the statute of
limitations eliminates all § 10b-5 claims relating to the Plaintiffs‘ January 2002
QP1 Fund purchase ($2 million), the January 2002 Ascot Fund purchase ($2.25
million), and their September 2002 Ascot Fund purchase ($250,000). Id. According
to the Defendants, the Plaintiffs‘ cognizable claims melt to their three timely Ascot
Fund purchases, totaling $380,000. Id.
Turning to the timely claims against Mr. Merkin and Ascot Fund, the
Defendants say the statutory cause of action is fatally flawed because there is no
allegation that the Defendants wrote or published the Ascot Fund COM. Id. The
Defendants assert they cannot be held responsible for misstatements or omissions
by third parties.
In other words, Rule 10b-5 applies only to primary, not
secondary violations. Id. at 10.
The Defendants next address the direct claims against them.
claims, they observe that there is a heightened pleading requirement and that the
allegations fail to meet that standard. Id. For example, general allegations that the
Defendants made assurances does not, in Defendants‘ view, meet the time, place
and content specificity requirements under Rule 9(b) and under § 78u-4 of the
Private Securities Litigation Reform Act of 1995 (PSLRA). Id. Referring to the QP1
Fund‘s 2001 COM, they assert that the Plaintiffs have engaged in wordplay and
twisted the meaning of a section that conveys the risks of this type of investment
into an affirmative performance promise. Id. at 10-12. They turn next to the claim
that when Mr. Steffens met with Mr. Goldenson in December 2001, he misled him
by act and by omission when Mr. Steffens described Mr. Merkin‘s investment
strategy and failed to mention that Mr. Merkin‘s fund was purely a feeder fund for
Id. at 12.
Even assuming the truth of these allegations, the
Defendants point to the legal requirement of scienter and say that the Plaintiffs
failed to allege that Mr. Steffens intended to deceive, manipulate or defraud. Id. at
12-16. Finally, the Defendants say that the Plaintiffs have failed to allege that a
disclosure that Ascot Fund had invested some or all of its capital with Mr. Madoff
would have been material. Id. at 17-18.
To start, the Defendants observe that § 20(a) creates only a derivative
liability, requiring first that a person be liable for an underlying violation. If, as the
Defendants claim, there is no liability under Rule 10b-5, there is no liability under §
20(a). Id. at 18. If the Plaintiffs survive this challenge, the Defendants claim that
the Amended Complaint must be dismissed because the Plaintiffs fail to allege
control to generate a § 20(a) cause of action. Id. at 18-19.
The Maine Statutory Claims
The Defendants say that the jurisdictional provision of the Maine Uniform
Securities Act, 32 M.R.S. § 16610, limits its reach to acts occurring in Maine and
there is no allegation that the Defendants ever entered the state of Maine or that
any sales took place in Maine. Id. at 20-21.
Common Law Claims Asserting Primary Liability
The Plaintiffs‘ Maine common law claims asserting primary liability include
breach of fiduciary duty, fraudulent misrepresentation/deceit, and intentional
infliction of emotional distress. Id. at 21. Since fraud is the lynchpin of these
causes of action, the Defendants say that Rule 9(b)‘s heightened pleading
requirements apply. Id. Turning first to the breach of fiduciary duty claim, the
Defendants assert it must fail because the Plaintiffs have failed to allege a fiduciary
relationship between the Plaintiffs and the Defendants.
Id. at 23-25.
Plaintiffs have stated a fiduciary relationship, they have not alleged facts sufficient
to extend the relationship to their investments in Ascot Fund. Id. at 26.
As regards the fraudulent misrepresentation/deceit claim, the Defendants
contend that if the Rule 10b-5 claim fails for lack of specificity, the fraudulent
misrepresentation/deceit claim must fail as well since the standards for the federal
and state causes of action are similar. Id. at 26-27.
The Defendants describe the intentional infliction of emotional distress claim
as baseless and urge its dismissal. Id. at 27-28. Citing caselaw, the Defendants say
that the type of actions the Plaintiffs have alleged do not rise to the extreme level to
sustain an intentional infliction of emotional distress claim and that courts have not
allowed similar allegations to proceed in securities fraud cases. Id. at 29-30.
Common Law Derivative Claims
Count Three claims that the Defendants aided and abetted tortious conduct
by each other and by Mr. Merkin. Id. at 30. Count Five alleges a civil conspiracy.
Id. The Defendants say that these claims are derivative claims and depend upon
the existence of an underlying tort.
Id. at 30-31. Since there is no cognizable
underlying tort, the Defendants assert these derivative claims must fail as well. Id.
If the claims survive, the Defendants contend that they still fail: the aiding and
abetting count because it fails to allege Defendants‘ knowledge of a breach of duty,
which is essential for an aiding and abetting claim, and the civil conspiracy count
because it fails to allege an agreement among the Defendants. Id. at 31.
The Defendants urge the Court to dismiss the punitive damages count
because it is a remedy rather than an independent cause of action. Id. at 32. They
urge the Court to dismiss the constructive trust/unjust enrichment count because
the Plaintiffs have failed to establish a fiduciary relationship necessary to impose
such a remedy and none of the Plaintiffs‘ alleged damages is the type of damage
susceptible to the imposition of a constructive trust. Id. at 32-34.
The Plaintiffs’ Response
The Federal Statutory Claims
Responding first to the statute of limitations question, the Plaintiffs point out
that even by the Defendants‘ account, some of the transactions in Counts Six and
Seven fall within the five-year statute of limitations, the Counts are not subject to
wholesale dismissal and the determination of what falls within and outside the
applicable statute requires a factual determination not appropriate for a motion to
dismiss. Pls.’ Opp’n. at 25-26. Next, the Plaintiffs contend that under 28 U.S.C. §
1658(b)(1), the applicable statute of limitations is ―2 years after the discovery of the
facts constituting the violation‖ and they contend that they fit within that exception
to the five year provision. Id. at 25-26.
They then address the Defendants‘ contention that the Amended Complaint
fails to meet the heightened pleading standards under Rule 9(b) and the PSLRA.
Id. at 26-33. After reviewing the necessary elements of a Rule 10b-5 violation, the
Plaintiffs address the Defendants‘ contention that the Plaintiffs have pleaded
secondary rather than primary liability. Id. at 27-28. The Plaintiffs note that they
have alleged that Mr. Steffens, Mr. Merkin, and Mr. Ho each gave Mr. Goldenson a
detailed and false description of Ascot Fund, expressly assuring him that Ascot
Fund had an elaborate trading strategy, which was undertaken under their
watchful eyes. Id. at 27. None of this, according to the Plaintiffs, was true. Id.
The Plaintiffs emphasize that the Goldensons are not seeking to hold the
Defendants responsible for Bernard Madoff‘s misdeeds; instead, they are trying only
to hold the Defendants to their own misrepresentations and omissions. Id. As to
the scienter requirement, the Plaintiffs contend they can demonstrate scienter by
showing that the Defendants either ―consciously intended to defraud, or that they
acted with a high degree of recklessness.‖ Id. at 28. (quoting Aldridge v. A.T. Cross
Corp., 284 F.3d 72, 82 (1st Cir. 2002)).
Citing Tellabs, Inc. v. Makor Issues &
Rights, Ltd., 551 U.S. 308, 324 (2007), the Plaintiffs say that their Amended
Complaint when viewed in its entirety fits within the requirement that the
inference of scienter be cogent and compelling or strong in light of other
Pls.’ Opp’n. at 29.
In particular, the Plaintiffs dismiss the
Defendants‘ assertion that the Amended Complaint failed to establish that Mr.
Steffens knew about Mr. Merkin‘s action, noting that it was Mr. Steffens who
introduced Mr. Goldenson to Mr. Merkin and who participated in the glowing but
false description of his vaunted trading strategy. Id. at 30. Furthermore, they
point out that Mr. Ho admitted that the Defendants knew all along about the feeder
fund nature of the Ascot Fund and its capitulation of any investment strategy to
Mr. Madoff, which is why they refused to take any action against Mr. Merkin even
after Mr. Madoff was exposed. Id. In addition, the Plaintiffs say that the Amended
Complaint alleges that the Defendants actively misled them about QP1 Fund‘s
exposure to Mr. Madoff‘s Ponzi scheme. Id. at 31.
The Plaintiffs observe that materiality is generally a jury question. Id. at 31.
Citing case law, they state that they need not prove they relied on the
misstatements or omissions; they must merely ―demonstrate that a reasonable
investor would have considered the applicable facts important to his investment
decision-making process.‖ Id. at 32. Addressing the Defendant‘s contention that
the Defendants‘ statements were not material because Mr. Madoff used the same
investment strategy purportedly used by Ascot, the Plaintiffs emphasize that the
Defendants‘ repeatedly touted the unique acumen of themselves and Mr. Merkin.
The Plaintiffs make precisely the obverse argument to the Defendants‘ §
20(a) argument: they say that since they have established underlying violations, the
§ 20(a) cause of action remains viable.
Id. at 33.
Regarding the allegation of
―control,‖ the Plaintiffs clarify that they have not claimed that the Defendants
controlled Mr. Merkin, but they have claimed that they controlled each other. Id.
The Maine Statutory Claims
In response to the Defendants‘ claim that Maine law restricts its
jurisdictional reach, the Plaintiffs say that ―the Defendants generate a
jurisdictional limitation . . . where none exists.‖ Id. at 33. The Plaintiffs assert that
section 16610(1)-(5) limits Maine jurisdiction only for actions involving ―sales and
offers to sell‖ and ―purchases and offers to purchase‖ when neither party is located
in the state of Maine. Id. at 34. Since the Plaintiffs have alleged that they were
domiciled and present in Maine in 2006, they say that they acted in reliance on the
Defendants‘ misrepresentations and omissions to purchase Ascot Fund securities
and Counts Eight and Nine should therefore survive. Id. at 34-35.
Common Law Claims Asserting Primary Liability
Turning to their common law claims, the Plaintiffs first address the
Defendants‘ contention that they failed to plead a breach of fiduciary duty. Id. at
12. They acknowledge that the Defendants articulated the proper legal standard
but argue that they misapplied it by ―ignoring the most inculpatory allegations
against them and by drawing inferences that are, at best, palpably biased in their
favor.‖ Id. Specifically, the Plaintiffs contend that the Defendants were acting as
investment advisers even though they were not registered as such, and their failure
to register as investment advisers ―does not extricate them from a fiduciary status
with the Plaintiffs.‖
Id. at 13-14.
Similarly, the Plaintiffs dismiss as a
mischaracterization of the law the Defendants‘ categorical assertion that hedge
funds managers have no fiduciary duties to their individual investors. Id. at 14-15.
They argue that a fiduciary relationship was formed because they placed trust and
confidence in the Defendants through their long personal and professional
relationship with Mr. Steffens, their reliance on the Defendants‘ investment counsel
over the course of a decade, and the Defendants‘ repeated representations that the
Plaintiffs‘ investments were being carefully managed. Id. at 18.
With regard to their fraudulent misrepresentation/deceit claim, the Plaintiffs
do not dispute that the heightened pleading requirements of Rule 9(b) and the
PSLRA apply. Id. at 19. But they assert that Count Two should not be dismissed
for the same reasons their federal securities fraud claim should not be dismissed.
The Plaintiffs maintain that the Defendants‘ conduct was so ―extreme or
outrageous‖ as to countenance a claim for intentional infliction of emotional
distress. Id. at 19-21. The Plaintiffs direct the Court to other cases that have
allowed intentional infliction of emotional distress claims to proceed in the context
of securities fraud. Id. at 20. Against that backdrop, they emphasize the special
relationship they had with the Defendants and the amount of money invested and
lost, and they argue they should be allowed to proceed with discovery. Id. at 20-21.
Common Law Derivative Claims
Regarding the aiding and abetting and conspiracy claims, the Plaintiffs say
their pleadings speak for themselves. They assert that the allegations regarding
the Defendants‘ collaboration with Mr. Merkin in making and perpetuating
relationships with Mr. Merkin, and their mutual concealments and omissions are
sufficient for the claims to survive. Id. at 22.
The Plaintiffs do not dispute that punitive damages are a remedy, not an
independent cause of action. Id. They clarify that the punitive damages count ―is
merely notice pleading that the Plaintiffs are alleging that the Defendants‘ conduct
was extreme, outrageous and marked by malice or implied malice.‖ Id.
With regard to the constructive trust/unjust enrichment claim, the Plaintiffs
dispute the Defendants‘ assertion that the claim is barred by written contract. Id.
at 22-23. They assert that a written contract to pay fees is meaningless if the fees
were earned dishonestly or in breach of a fiduciary duty as alleged. Id. Moreover,
the Plaintiffs emphasize that Count Eleven is based not only on the fees the
Plaintiffs paid to the Defendants but also on consideration the Defendants received
from Mr. Merkin in exchange for their referral of investors to his fund. Id. at 23.
The Defendants’ Reply
Regarding the statute of limitations question, the Defendants respond that
whether the Plaintiffs made their investments in 2002 in Ascot Fund and QP1 Fund
does not present a factual issue; rather, it is an ―inescapable legal bar.‖ Defs.’ Reply
at 2. Turning to the misstatements and omissions by Mr. Merkin, the Defendants
characterize the Plaintiffs‘ argument as premised on the ―substantial participation‖
doctrine, which the Defendants point out the First Circuit has not adopted. Id. at 3.
As to the Defendants‘ own misstatements and omissions, they insist that the factual
allegations do not meet Rule 9(b) specificity requirements. Id. The Defendants also
dispute whether the Court may draw the Plaintiffs‘ requested inference about what
Mr. Steffens knew when he made his representations regarding Ascot Fund. Id.
They reassert their contention that at most, the Plaintiffs have alleged fraud by
hindsight. Id. Regarding the Maine Securities Act, the Defendants dispute the
contention that section 16610 only applies to administrative actions. Id. at 4. They
observe that it expressly cross-references private causes of action. Id.
As to the Plaintiffs‘ fiduciary duty argument, the Defendants say that the
Plaintiffs have failed to plead special circumstances to transform an otherwise
arms-length business transaction into a fiduciary-based transaction.
Id. at 5-6.
The lack of specificity, according to the Defendants, becomes more pronounced as
the allegations seep from the Plaintiffs‘ direct relationships with the Defendants
into their indirect relationships with Ascot Funds. Id. at 6-7. As to the intentional
infliction of emotional distress claim, the Defendants reiterate their position that,
even though such a claim can be made, the Plaintiffs have failed to allege it with
Id. at 7-8. Finally, the Defendants dispute the Plaintiffs‘
efforts to distinguish the unjust enrichment caselaw, noting that courts have
dismissed unjust enrichment claims where the enrichment was the subject of a
written contract between the parties. Id.
The Legal Standard
In Securities and Exchange Commission v. Tambone, 597 F.3d 436, 441 (1st
Cir. 2010) (en banc) the First Circuit set forth the legal standards applicable to a
securities fraud case. In ruling on a motion to dismiss, a court is required to ―accept
as true all the well-pleaded facts set out in the complaint and indulge all reasonable
inferences in favor of the pleader.‖ Id. at 441. ―As a general proposition, a complaint
must contain no more than ‗a short and plain statement of the claim showing that
the pleader is entitled to relief.‘‖ Id. at 442 (quoting FED. R. CIV. P. 8(a)(2)). To
survive a motion to dismiss, a plaintiff must allege ―sufficient factual matter,
accepted as true, to state a claim to relief that is plausible on its face.‖ Id. (quoting
Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009)). ―In other words, the complaint
must include ‗factual content that allows the court to draw the reasonable inference
that the defendant is liable for the misconduct alleged.‘‖ Id. (quoting Iqbal, 129 S.
Ct. at 1949). ―If the factual allegations in the complaint are too meager, vague, or
conclusory to remove the possibility of relief from the realm of mere conjecture, the
complaint is open to dismissal.‖ Id.
―Because the complaint in this case contains allegations of fraud, an
additional hurdle must be surmounted: the pleader . . . must ‗state with
particularity the circumstances constituting [the] fraud.‘‖ Id. (quoting FED. R. CIV.
P. 9(b)). ―To satisfy this particularity requirement, the pleader must set out the
‗time, place, and content of the alleged misrepresentation with specificity.‖
(quoting Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (1st Cir. 1999)).
Section 10(b) and Rule 10b-5
The Statute of Limitations
The statute of limitations for causes of action under § 10b-5, 15 U.S.C. §
78j(b), is found in 28 U.S.C. § 1658(b):
[A] private right of action that involves a claim of fraud, deceit,
manipulation, or contrivance in contravention of a regulatory
requirement concerning the securities laws . . . may be brought not
later than the earlier of - (1) 2 years after the discovery of the facts constituting the
(2) 5 years after such violation.
The Plaintiffs filed their Complaint on October 27, 2010 and therefore by operation
of the five-year statute of limitations, violations before October 27, 2005 are timebarred.
The Rule 10b-5 statute of limitations provides two periods: 1) within two
years ―after the discovery of the facts constituting the violation,‖ and 2) within five
years ―after such violation.‖
Young v. Lepone, 305 F.3d 1, 8 (1st Cir. 2002)
(addressing the predecessor statute with one and three year statutes of limitation
The five-year period of repose serves ―as a cutoff‖ and ―tolling
As part of the Sarbanes-Oxley Act of 2002, Congress amended the securities fraud statute of
limitations in 28 U.S.C. § 1658 by increasing the discovery period from one to two years and the
repose period from three to five years. Public Company Accounting Reform and Investor Protection
Act of 2002, Pub. L. 107-204 § 804, 116 Stat. 745, 801 (2002), codified in part at 28 U.S.C. § 1658(b);
Quaak v. Dexia, S.A., 357 F. Supp. 2d 330, 334 (D. Mass. 2005).
principles do not apply.‖ Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson,
501 U.S. 350, 363 (1991) (addressing predecessor three year statute of limitations).
This leaves only the question of when the ―violation‖ in this case occurred for
purposes of the commencement of the five-year statute of limitations. Courts are
generally in agreement that the repose period runs from the date of the alleged
fraudulent statements. In In re Exxon Mobil Corp. Securities Litig., 500 F.3d 189,
200-01 (3d Cir. 2007), the Third Circuit distinguished between accrual for purposes
of a typical statute of limitations and for purposes of a statute of repose like §
1658(b)(2). According to the Third Circuit, ―[u]nlike statutes of limitations, which
traditionally do not begin to run until a cause of action has accrued (or when a
reasonable person should have discovered it), statutes of repose start upon the
occurrence of a specific event and may expire before a plaintiff discovers he has
been wronged or even before damages have been suffered at all.‖ Id. at 199. The
Third Circuit observed that though statutes of repose are similar to statutes of
limitations, the former are more ―defendant-friendly‖ in that they set a time when
―allowing people to put their wrongful conduct behind them—and out of the law‘s
reach—becomes more important than providing those wronged with a legal
remedy.‖ Id. In the context of a § 10(b) claim, the Exxon Mobil Court reasoned:
[W]hile it is true that for a § 10(b) claim to ‗accrue‘ there must be an
exchange of securities . . . ,the specific acts targeted by a § 10(b) cause
of action are fraudulent statements themselves. It is therefore more
consonant with the traditional understanding of how a statute of
repose functions for the repose period of . . .§ 1658(b)(2) to begin from
the date of Exxon‘s alleged misrepresentation.
Id. at 200. More recently, the Second Circuit in City of Pontiac General Employees’
Retirement System v. MBIA, Inc., 637 F.3d 169, 176 (2d Cir. 2011), employed similar
reasoning in distinguishing between the two-year limitation period in § 1658(b)(1)
and a statute of repose. It observed that a period of repose begins to run from the
date of a defendant‘s violation while a limitations period ―cannot begin to run until
the plaintiff‘s claim has accrued.‖ City of Pontiac, 637 F.3d at 176. Consistent with
Exxon Mobil and City of Pontiac, district courts have held that securities fraud
violations occur and the repose period begins to run at the time of a defendant‘s
misrepresentation. In re iBasis, Inc. Derivative Litig., 532 F. Supp. 2d 214, 221
(D.N.H. 2007) (holding that the statute of repose applies to each individual proxy
statement); Quaak v. Dexia S.A., 357 F. Supp. 2d 330, 337 (D. Mass. 2005)
(considering a limited exception to the consensus that the period of repose ―begins to
run when the alleged misrepresentations is made‖); Take-Two Interactive Software,
Inc. v. Brant, No. 06 Civ 05279 (LTS), 2010 WL 1257351, at *5 (S.D.N.Y. Mar. 31,
2010) (―The statute of repose for claims based upon misrepresentations begin to run
on the date of the alleged misrepresentation‖); In re Silicon Storage Tech. Inc.,
Shareholder Derivative Litig., No. C 06-4310 JF, 2009 U.S. Dist. LEXIS 58705, *12
(N.D. Cal. Jul. 7, 2009) (―Each false representation constitutes a separate violation
of § 10(b), such that the five-year period begins to run with respect to each violation
when it occurs‖); Plymouth Cnty Ret. Ass’n v. Schroeder, 578 F. Supp. 2d 360, 378
(E.D.N.Y. 2008) (―the weight of authority, including in this Circuit, dictates that the
five year statute of repose first runs from the date of the last alleged
misrepresentation regarding related subject matter‖). Accordingly, in calculating
when a period of repose began, the focus is on the Defendants‘ alleged fraudulent
There is some authority that softens the application of the five-year statute of
repose in cases of ―ongoing and continuing fraudulent schemes that relate to the
very core of each company‘s business.‖ In re iBasis, 532 F. Supp. 2d at 221 (D.N.H.
2007). In Quaak v. Dexia, S.A., 357 F. Supp. 2d at 338, a district court concluded
that ―the statute of repose runs from the date of the last fraudulent
Similarly, the Southern District of New York, while
recognizing that this is an unsettled area of law, has declined to dismiss securities
claims related to misrepresentations outside of the repose period where the same
defendant made at least one similar fraudulent statement within the repose period.
Take-Two Interactive Software, Inc. v. Brant, 2010 WL 1257351, at *6; In re Dynex
Capital, Inc. Sec. Litig., No. 05 Civ. 1897(HB), 2009 WL 3380621, at *18 (S.D.N.Y.
Oct. 19, 2009). A district court in the Eastern District of New York applied the
same theory where ―statements made within the repose period likely [bore] a
factual nexus to statements made outside of the repose period.‖ Plymouth Cnty Ret.
Ass’n v. Schroeder, 578 F. Supp. 2d 360, 378 (E.D.N.Y. 2008).
fraudulent scheme theory‖ does not violate the Lampf Court‘s conclusion that
principles of equitable tolling do not apply to § 1658(b). The theory does not allow a
claim to go forward more than five years after a defendant‘s final violation. Rather,
when a defendant has committed a violation within the repose period, it allows a
plaintiff to hold the defendant accountable for previous violations that are part of
the same scheme.
Because the alleged misrepresentations in this case came from a common
group of defendants in pursuit of a common scheme, the Court concludes that none
of the misrepresentations is time-barred if any of them occurred within the period of
repose. The Plaintiffs allege that they received a QP1 COM every year that touted
the investment strategy of QP1 and the stability of its portfolio funds. Because the
COMs were delivered after October 27, 2005, the Plaintiffs claims are not timebarred.
Heightened Pleading Requirements
The Defendants next contend that the remaining claims should be dismissed
because they fail to meet the heightened pleading standards under Rule 9(b) and
the PSLRA. Defs.’ Mot. at 9.
Primary v. Secondary Violators
First, the Defendants say that the Plaintiffs are attempting to hold them
legally responsible for the actions of a third party, namely, Mr. Merkin, and that ―a
defendant cannot be liable under Rule 10b-5 based on misstatements or omissions
made by third parties.‖
They cite Central Bank of Denver, N.A. v. First
Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) for the proposition that Rule
10b-5 does not extend to aiding and abetting; they quote Tambone: ―[The Rule‘s]
private right of action extends only to primary violations, not to secondary
violations.‖ Defs.’ Mot. at 9-10 (quoting Tambone, 597 F.3d at 446).
In response, the Plaintiffs stress that they are not attempting to hold the
Defendants responsible for another‘s actions; rather, they are attempting to hold
the Defendants responsible for their own actions.
Pls.’ Resp. at 27-28.
reiterate that Mr. Steffens and Mr. Ho knowingly made false statements about the
Ascot Fund, its purported trading strategy, and Mr. Merkin‘s supervisory role. Id.
They quote Tambone as observing that ―liability inheres when ‗defendants have
expressly or impliedly adopted statements, placed their imprimatur on the
statements, or have otherwise entangled themselves with the [statements] to a
significant degree.‘‖ 597 F.3d at 449 (quoting In re Cabletron Sys., Inc., 311 F.3d 11,
37-38 (1st Cir. 2002)).
The parties correctly identify the applicable law.
In Tambone, the First
Circuit reviewed the Supreme Court‘s holding in Central Bank that although the
Exchange Act provides for a private cause of action for a Rule 10b-5 violation, the
―right of action is not unbridled: private plaintiffs are permitted to bring suit under
Rule 10b-5 against only ‗primary‘ violators.‖
Tambone, 597 F.3d at 445.
Tambone, the First Circuit set forth the ―two divergent strains of authority‖ that
have evolved to test the line between primary and secondary violations. Id. at 447.
One is the ―substantial participation‖ test under which a person‘s ―substantial
participation or intricate involvement in the preparation of fraudulent statements‖
is enough to establish a primary violation. Id. (quoting Howard v. Everex Sys., Inc.,
228 F.3d 1057, 1061 n.5 (9th Cir. 2000)). The second adheres to the ―bright line‖
test under which a primary violation requires proof both that the defendant actually
made a false or misleading statement and that it was attributable to him at the
time of public dissemination. Id. (citing Wright v. Ernst & Young, 152 F.3d 169, 175
(2d Cir. 1998)). The First Circuit declined to choose between the two but observed
that ―[b]oth tests focus, albeit to different degrees on the actual role that a
defendant played in creating, composing, or causing the existence of an untrue
statement of material fact.‖ Id. Accordingly, the Court focuses on the Defendants‘
role in making the fraudulent statements, not Mr. Merkin‘s.
For purposes of the motion to dismiss, the question is whether the Plaintiffs‘
Amended Complaint has successfully alleged a cause of action for primary liability
under either the ―substantial participation‖ or ―bright line‖ test.
carefully reviewed the allegations in the Amended Complaint and it readily
concludes that the Amended Complaint survives this challenge.
Plaintiffs are successful in convincing a properly instructed jury that the
Defendants are primarily liable remains to be seen; however, they have made
sufficiently detailed allegations of the Defendants‘ own asserted misconduct, as
opposed to the actions of third parties, to survive the motion to dismiss.
The Amended Complaint alleges a number of fraudulent statements made by
the Defendants themselves. It alleges that Mr. Steffens personally made repeated
assertions about the reliability of the Ascot Fund, its conservative trading strategy,
its ―reduced risk of exposure to adverse market trends,‖ the effectiveness of its splitstrike strategy in high interest trading environments, and its performance as a
portfolio fund of QP1.
Am. Compl. ¶¶ 32-33, 36-37, 43. Similarly, QP1‘s COM,
which remained ―largely unchanged in all substantive respects,‖ Am. Compl. ¶ 48,
emphasized QP1‘s reliance on the investment strategies of its submanagers. Id. ¶
Moreover, Messrs. Steffens and Ho, in conversations with Mr. Goldenson,
assured him of the ―stability and soundness‖ of his investments in the QP1 Fund
and the Ascot Fund and maintained that the portfolio funds and their submanagers were being monitored and adjusted as required. Id. ¶ 63. Finally, in
their December 15, 2008 correspondence to the Goldensons, the Defendants
underrepresented QP1‘s exposure to Madoff Securities. Id. ¶¶ 92-95.
One of the six essential elements of a § 10(b) and Rule 10b-5 complaint is an
allegation of scienter.3 ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 58 (1st
Cir. 2008). ―Scienter is ‗a mental state embracing intent to deceive, manipulate, or
defraud.‖ Id. at 58 (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12
(1976)). The First Circuit has held ―that a plaintiff can demonstrate scienter by
showing that defendants either ‗consciously intended to defraud, or that they acted
with a high degree of recklessness.‘‖
Mississippi Public Employees’ Retirement
System v. Boston Scientific Corp., 523 F.3d 75, 85 (1st Cir. 2008) (quoting Aldridge
v. A.T. Cross Corp., 284 F.3d 72, 82 (1st Cir. 2002)). In a securities fraud case, the
Plaintiff‘s obligation to clearly state the grounds for his complaint is encouraged by
the confluence of three strands of law: for scienter as well as the other required
The six PSLRA elements are 1) a material misrepresentation or omission, 2) scienter, or a wrongful
state of mind, 3) a connection with the purchase or sale of a security, 4) reliance, 5) economic loss
and 6) loss causation. ACA Fin., 512 F.3d at 58 (citing Dura Pharm., Inc. v. Broudo, 544 U.S. 336,
elements, a plaintiff must state ―a plausible entitlement to relief‖ under Twombly,
550 U.S. at 559, must meet the heightened pleading requirements of Rule 9(b) for
fraud, ACA Fin., 512 F.3d at 58 n.7, and must satisfy the ―exacting pleading
requirements‖ of the PSLRA, Tellabs, 551 U.S. at 313; ACA Fin., 512 F.3d at 56 n.
5. Under the PSLRA, the complaint
shall specify each statement alleged to have been misleading, the
reason or reasons why the statement is misleading, and, if an
allegation regarding the statement or omission is made on information
and belief, the complaint shall state with particularity all facts on
which that belief is formed.
15 U.S.C. § 78u-4(b)(1).
Specifically, as regards scienter, the PSLRA mandates that ―the complaint
shall, with respect to each act or omission alleged to violate this chapter, state with
particularity facts giving rise to a strong inference that the defendant acted with
the required state of mind.‖ 15 U.S.C. § 78u-4(b)(2). In Tellabs, the Supreme Court
directed the courts in evaluating this statutory requirement to engage in a
[I]t must consider, not only inferences urged by the plaintiff . . . but
also competing inferences rationally drawn from the facts alleged. An
inference of fraudulent intent may be plausible, yet less cogent than
other, nonculpable explanations for the defendant‘s conduct. To
qualify as ―strong‖ within the intendment of [§ 78u-4(b)(2)], we hold, an
inference of scienter must be more than merely plausible or
reasonable—it must be cogent and at least as compelling as any
opposing inference of nonfraudulent intent.
551 U.S. at 314.4
In support of their position, the Defendants cite Greebel v. FTP Software, Inc., 194 F.3d 185, 193
(1st Cir. 1999) and its statement that the PSLRA standard has been viewed in the First Circuit as
―notably strict and rigorous.‖ Defs’ Mot. at 8. The Plaintiffs counter that in Mississippi Public
Armed with this array of procedural, statutory and decisional law, the
Defendants vigorously attack the sufficiency of the allegations in the Amended
Complaint, which they dismiss as ―a transparent exercise in wordplay and
obfuscation‖ and ―fraud by hindsight.‖ Defs.’ Mot. at 11; Defs.’ Reply at 4.
Plaintiffs respond by saying that the fraud allegation rests upon a ―schism between
what was said and written to the Plaintiffs by the Defendants and the truth.‖ Pls.’
Opp’n. at 29.
The Court has carefully reviewed the allegations in the Amended Complaint
and concludes that they survive dismissal. The first premise of the Plaintiffs‘ cause
of action is that the Defendants were partners with Mr. Merkin, that they shunted
the Plaintiffs‘ funds to him on the fraudulent pitch that Mr. Merkin had a highly
sophisticated investment strategy whereby his fund generated consistently high
investment returns with minimal risk, when in fact the Defendants knew all along
that Mr. Merkin had no such strategy but operated only a feeder fund, which
supplied capital to Bernard Madoff‘s notorious Ponzi scheme. The second premise is
that the Defendants affirmatively represented to the Plaintiffs that they would
assume an active monitoring role over their investments with Mr. Merkin. For both
aspects of this alleged fraud, the Plaintiffs have alleged specific instances of the
Defendants‘ representations by date and content sufficient to survive the higher
pleading standard. See ACA Fin., 512 F.3d at 65 (―[T]he fact that a defendant
Employees Retirement System v. Boston Scientific Corp., 523 F.3d 75, 89 (1st Cir. 2008) the First
Circuit observed that in Tellabs, the Supreme Court ―reversed a higher standard for scienter
imposed by the prior law of this circuit.‖ Pls’ Opp’n at 29 n.25. However described, the Court views
the Tellabs standard, as applied in Boston Scientific, as specific and binding.
knowingly made a false statement is ‗classic evidence of scienter‘‖) (quoting
Aldridge, 284 F.3d at 83). The Plaintiffs have alleged that the Defendants had close
business and personal ties to Mr. Merkin.
They have further alleged Mr. Ho‘s
admission that the Defendants were aware of Ascot‘s exposure to Madoff Securities.
representations regarding the responsible management of Ascot and their active
and strategic monitoring of QP1‘s portfolio funds, the Court finds that the inference
of fraudulent intent is cogent and compelling.
In drawing this conclusion, the Court is mindful of the First Circuit‘s
admonition in Boston Scientific that courts must be cautious about dismissal at the
Rule 12(b)(6) stage. 523 F.3d at 90. As the First Circuit explained, at the pleadings
stage, ―we cannot hold plaintiffs to a standard that would effectively require them,
pre-discovery, to plead evidence.‖ Id. (quoting Shaw v. Digital Equip. Corp., 82 F.3d
1194, 1225 (1st Cir.
―The law ‗proscribes the pleading of ―fraud by
hindsight,‖ but neither can plaintiffs be expected to plead fraud with complete
insight.‘‖ Id. (quoting Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978)).
The Defendants also claim that the Amended Complaint fails to sufficiently
allege the necessary element of materiality.
The First Circuit has defined
―materiality‖ in the securities context:
The mere fact that an investor might find information interesting or
desirable is not sufficient to satisfy the materiality requirement.
Rather, information is ‗material‘ only if its disclosure would alter the
‗total mix‘ of facts available to the investor and ‗if there is a substantial
likelihood that a reasonable shareholder would consider it important‘
to the investment decision.
Lucia v. Prospect St. High Income Portfolio, Inc., 36 F.3d 170, 175 (1st Cir. 1994)
(citations omitted). The appellate court has also stated that ―[t]he existence of a
material omission is usually a question for the trier of fact.‖ Boston Scientific, 523
F.3d at 87.
The Defendants characterize as ―both disingenuous and grandiose‖ the
Plaintiffs‘ allegation that if they had known that Mr. Merkin was investing in
Madoff Securities, they would not have invested with Mr. Merkin. Defs.’ Mot. at 17.
The Defendants say that Mr. Merkin‘s purported investment strategy was ―exactly
like the investment strategy that Madoff claimed to employ.‖ Id. In response, the
Plaintiffs point out that the standard is not whether they personally relied on these
facts but whether a reasonable investor would have considered the facts important
to an investment decision-making process. Pls.’ Resp. at 32.
Here, the Court readily concludes that the Plaintiffs have alleged sufficient
facts to avoid dismissal on the materiality element. The Plaintiffs allege that the
Defendants introduced Mr. Goldenson to Mr. Merkin and represented that he, not
some other person, would be handling the Goldensons‘ investments and using a
unique and proprietary investment strategy. It is one thing to place millions of
dollars in the care of someone the investor has been introduced to, has taken the
personal stock of, and has been assured by; it is another to entrust investments to
an unknown third party.5 The Court concludes that the allegations in the Amended
Complaint are sufficient to create an issue of fact on materiality that must be
resolved by a jury.
In addition to their claims under § 10(b) and Rule 10b-5, the Plaintiffs have
pleaded a claim under § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §
78t, against Mr. Steffens and Mr. Ho in their corporate capacities as ―controlling
persons‖ of the Spring Mountain entities. Section 20(a) imposes joint and several
liability on ―[e]very person who, directly or indirectly, controls any person liable‖ for
a securities fraud violation. Id. at § 78t(a); ACA Fin., 512 F.3d at 67. Because a §
20(a) claim is a derivative cause of action, to state a viable § 20(a) claim a plaintiff
must also state a viable § 10b-5 violation. ACA Fin., 512 F.3d at 67-68. As the
Court concluded that the § 10b-5 claim survives dismissal, the § 20(a) claim
survives dismissal on the same basis.
The Defendants further claim that the Plaintiffs have failed to allege
sufficient actual control of each other and of Mr. Merkin or that they actually
exercised such control. Defs.’ Mot. at 18-19. ―[T]o meet the control element, the
alleged controlling person must not only have the general power to control the
[person primarily liable], but must also actually exercise control over the [person].‖
Aldridge, 284 F.3d at 85.
Evidence that the defendants are controlling
shareholders, for example, is insufficient; the test is not ―some potential ability to
It is unknowable whether Mr. Goldenson, had he met Mr. Madoff, would have succumbed to Mr.
Madoff‘s legendary charm. What is known is that he did meet Mr. Merkin and was convinced to
place millions of dollars under his care.
control‖ but the ―exercise of control over the entity primarily liable.‖ Id. Before
―controlling person liability can be imposed,‖ the Plaintiffs must allege ―facts that
indicate that the controlling shareholders were actively participating in the
decisionmaking processes of the corporation.‖ Id.
The allegations in the Amended Complaint place Mr. Steffens and Mr. Ho as
executives and managers in a much more active role than a shareholder regarding
the activities of the Spring Mountain Defendants. The Amended Complaint alleges
that Mr. Steffens has been the ―sole managing member‖ of Spring Mountain Capital
GP, the ―Managing Director‖ of Spring Mountain Capital LP, and the ―sole
managing member‖ of Spring Mountain Capital, LLC; it alleges that Mr. Ho has
been ―the President and Chief Operating Officer of Spring Mountain Capital LP.‖
Am. Compl. ¶¶ 15-16. Spring Mountain Capital LP is alleged to have been the
―management company for the QP1 Fund;‖ Spring Mountain Capital GP is alleged
to have been the General Partner of the QP1 Fund; and Spring Mountain Capital,
LLC is alleged to have been the General Partner of Spring Mountain Capital LP.
Id. ¶¶ 11-13.
The allegations against Mr. Steffens are sufficient to meet the
requirements of control and the exercise of control for each Defendant entity and
the allegations against Mr. Ho are similarly sufficient for Spring Mountain LP,
since the titles alone convey the active participation in the decisionmaking process.
Whether the interrelationship among Spring Mountain Capital GP, Spring
Mountain Capital LLC, and Spring Mountain Capital LP allow Mr. Ho‘s authority
over Spring Mountain LP to be exercised in Spring Mountain Capital GP and
Spring Mountain LLC is less clear. However, the Court will not assume to the
contrary given the allegations in the Amended Complaint. The Court concludes
that the allegations in the Amended Complaint state a claim under § 20(a).
Maine Uniform Securities Act: Counts Eight and Nine
The Defendants raise a jurisdictional defense to the Plaintiffs‘ statutory
causes of action under Maine‘s Blue Sky Law, 32 M.R.S. § 16509(6) and (7).6 Defs.’
Mot. at 19-21.
Subsection 6 establishes liability for fraudulently providing
investment advice and subsection 7 imposes joint and several liability for—among
other things—a violation of subsection 6. 32 M.R.S. § 16509(6), (7). Under section
16610, Maine law sets forth the jurisdictional requirements for different violations
of Maine‘s Uniform Securities Act. For example, section 16610(1) requires that to
impose civil liability for sales and purchases of securities and offers of the same the
seller must make the offer to sell or the sale or the buyer must make the offer to
purchase or the purchase in the state of Maine.
32 M.R.S. §§ 16610(1)(I),
16610(2)(G). However, it sets out a different jurisdictional requirement for civil
liability regarding investment advice and misrepresentations.
32 M.R.S. §
16610(6). Subsection 6 reads:
The following sections apply to a person if the person engages in an
act, practice or course of business instrumental in effecting prohibited
or actionable conduct in this State, whether or not either party is then
present in this State: A) section 16403, subsection 1, B) section 15404,
subsection 1, C) section 16405, subsection 1, D) section 16502, E)
section 1605, and F) section 16506.
The Defendants‘ first basis for dismissal is that New York law applies. Defs.’ Mot. at 20. However,
the Defendants have since conceded that Maine not New York law applies.
32 M.R.S. § 16610(6)(A-F). Noting that this list of applicable sections does not
include section 16509, which is the only section under which the Plaintiffs have
brought the Blue Sky portion of this lawsuit, the Defendants claim there is no
While acknowledging that the statutory language is dense and that it is
difficult to glean the drafters‘ intent from the listed (and unlisted) affected sections,
the Court disagrees with the Defendants.7
Maine has adopted the Uniform
Securities Act of 2002 and the Court looks to the uniform act for guidance.8 Section
16502 prohibits fraud in providing investment advice. The commentary clarifies
that ―[t]here is no private cause of action, express or implied under Section 502‖
but that ―Section 509 provides for a private cause of action for prohibited
conduct in providing investment advice that could violate Section 502.‖ UNIF.
SECURITIES ACT § 502 cmt. 5 (2002). Indeed, sections 16509 and 16411 ―provide the
exclusive private causes of action under this Act.‖ Id. § 509 cmt. 17. Specifically,
section 16509(6) provides a private cause of action for fraudulent investment advice.
That leaves unanswered which subsection of 16610 determines the
jurisdiction for a section 16509(6) action.
Contrary to the Plaintiffs‘ position,
section 16610 is not limited to administrative proceedings. Instead, section 16610
There is a paucity of authority on this provision. The parties, who were otherwise able to research
and find ample authority for their respective positions, were unable to present any assistance—other
than their own opposing statutory constructions—on the correct meaning of these contested
8 The relevant sections of the uniform act are numbered consistently with the last three numerals of
the Maine sections. Moreover, the uniform act designates its subsections with letters while the
Maine Act uses numbers. For example, Uniform Securities Act sections 502(a) and 610(f) are
consistent with Maine Uniform Securities Act sections 16502(1) and 16610(6) respectively. To avoid
confusion, the Court refers to the numbering in the Maine Act.
―applies to all types of proceedings specified by the Act––administrative, civil, and
criminal.‖ Id. § 610 cmt. 1. The Court concludes that the action‘s jurisdiction is
determined by section 16610(6). Not only is section 16610(6) titled ―Investment
advice and misrepresentations,‖ the commentary to section 16610 states that
subsection 6 ―is a new provision that specifies jurisdiction in cases involving
investment advice and misrepresentations.‖ Id. § 610 cmt. 3. Moreover, subsection
6 expressly applies the substantive prohibitions of section 16502 to persons within
its jurisdictional reach.
Because section 16509(6) provides the private cause of
action for violations of section 16502, section 16610(6) specifies the jurisdictional
scope of the cause of action.
The only wrinkle in this seemingly compelled
conclusion is the inclusion of section 16509 in the more limited jurisdictional
provisions of 16610(1) and (2). However, those provisions only limit the application
of section 16509 to ―a person that sells or offers to sell‖ or ―a person that purchases
or offers to purchase‖ a security. In this case, the Plaintiffs‘ section 16509 claims
are limited to the Defendants‘ role as investment advisers, not as purchasers or
sellers of securities. Accordingly, the jurisdictional limitations in sections 16610(1)
and (2) do not apply.
Despite section 16610(6)‘s somewhat cryptic language and a dearth of case
law, the Court concludes that the statute grants the Court jurisdiction over the
Plaintiffs‘ statutory claims. Section 16610(6) assumes that there has been ―an act,
practice or course of business instrumental in effecting prohibited or actionable
conduct in this State.‖ (emphasis supplied). If so, section 16610(6) allows the Court
to assume jurisdiction for the listed sections ―whether or not either party is then
present in the State.‖
Here, the Goldensons had a residence in Maine at all
material times and were domiciled in Maine from 2006 onward. Therefore, the
Defendants‘ investment advice and misrepresentations effected prohibited conduct
in this state, namely a fraud on Maine residents. The Court concludes that Counts
Eight and Nine survive the motion to dismiss.
Common Law Claims Asserting Primary Liability: Counts One,
Two and Four
In the Amended Complaint, the Plaintiffs allege three primary liability
common law claims: Count One—Breach of Fiduciary Duty; Count Two—
Fraudulent Misrepresentation/Deceit; and Count Four—Intentional Infliction of
Emotional Distress. Am. Compl. ¶¶ 122-34, 140-44.
First the Defendants say that each of these counts is subject to the higher
pleading requirements of Rule 9(b). Defs.’ Mot. at 21-22. The Court agrees. Under
North America Catholic Educational Programming Foundation, Inc. v. Cardinale,
567 F.3d 8, 14 (1st Cir. 2009), Rule 9(b) pleading requirements apply whenever
―fraudulent misrepresentation is the lynchpin‖ of the cause of action. Here, Count
One alleges that the Defendants made ―[f]alse and misleading statements,‖ Am.
Compl. ¶ 127(I); Count Two sounds in fraudulent misrepresentation and deceit, id.
¶¶ 129-34; and, Count Four alleges that the Defendants ―defrauded them.‖ Id. ¶
Breach of Fiduciary Duty
In Count One, the Plaintiffs allege that the Defendants were acting as
fiduciaries for them and that they engaged in numerous breaches of their fiduciary
duty; the Plaintiffs reassert the existence and breach of a fiduciary duty throughout
the Amended Complaint. Am. Compl. ¶¶ 122-28, 130, 136-39, 142, 147-48, 182.
Meeting this contention head on, the Defendants flatly deny that any fiduciary
relationship existed between the Plaintiffs and themselves and describe any such
claim as ―meritless.‖ Defs.’ Mot. at 23. The Plaintiffs disagree, contending that they
have alleged sufficient facts to generate fiduciary obligations. Pls.’ Opp’n. at 12-18.
The Defendants make the blanket statement that ―there was no fiduciary
relationship based on the fact that any defendant was an investment adviser under
the federal securities laws.‖ Defs.’ Mot. at 23. The Defendants say that as of 2002,
―none of the defendants was a registered investment adviser under the Investment
Advisers Act of 1940‖ (IAA). Id. Therefore, they say, the Defendants ―did not owe
plaintiffs fiduciary duties as investment advisers under ‗the securities laws of the
United States.‘‖ Id. (quoting Am. Compl. ¶ 123)).
The Plaintiffs respond that
registration as an investment adviser is not a prerequisite for the assumption of
fiduciary duties under the IAA. Pls.’ Resp. at 12-13. In their reply, the Defendants
agree that ―[i]t is axiomatic that investment advisers can be fiduciaries.‖ Defs.’
Reply at 4. Instead, they assert that the Plaintiffs failed to ―plead [the] special
circumstances in order to transform an otherwise arms-length business relationship
into one in which a fiduciary duty arose that will support a common law cause of
action.‖ Id. at 4-5. Furthermore, the Defendants say that the federal and state
securities statutes do not create a fiduciary duty between investment adviser and
Reviewing the allegations in the Amended Complaint, the Court concludes
that the Plaintiffs have sufficiently pleaded the existence of a fiduciary relationship
to survive the Defendants‘ motion to dismiss. First, as the Defendants concede, as a
matter of law, an investment adviser can be a fiduciary. Security and Exchange
Comm’n v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-94 (1963).
Whether the Defendants were in fact fiduciaries is, therefore, largely an issue of
fact. It is true, as earlier discussed, that the pleading requirements of Rule 9(b)
require more than a mere assertion of fraud. Boston Scientific, 523 F.3d at 85 n.5;
15 U.S.C. § 78u-4(b)(1); FED. R. CIV. P. 9(b). But the allegations here include a long
course of dealing between the Goldensons and Mr. Steffens, a personal friendship, a
switch whereby they followed him when he changed investment firms, a request for
investment advice, a recommendation to invest in a relatively esoteric form of
investment concerning which he professed specialized knowledge, and repeated
assurances of his personal involvement with and monitoring of the investments.
The case against Mr. Ho as a fiduciary is not nearly as strong; nevertheless, the
Court concludes it is sufficient to withstand dismissal.
In other words, if the
In evaluating a motion to dismiss, the Court is usually restricted to the allegations in the four
corners of the Complaint. However, courts have made exceptions ―for documents the authenticity of
which are not disputed by the parties; for official public records; for documents central to the
plaintiffs‘ claim; [and] for documents sufficiently referred to in the complaint.‖ Boston Scientific, 523
F.3d at 86 (quoting Waterson v. Page, 987 F.2d 1, 3 (1st Cir. 1993)). Both the Plaintiffs and the
Defendants attached to their filings affidavits which authenticate documents central to the claims
and defenses here. In the absence of objection, the Court has considered the attached documents.
Defendants can be fiduciaries as a matter of law, whether they are fiduciaries is a
matter of fact.
The Defendants next contend that if they were investment advisers to the
QP1 Fund, they owed a fiduciary duty to the Fund, not to its investors. Defs.’ Mot.
at 23-24. Quoting Goldstein v. Security and Exchange Comm’n, 451 F.3d 873, 880
(D.C. Cir. 2006), the Defendants say that ―[t]he adviser [of a hedge fund] does not
tell the investor how to spend his money; the investor made that decision when he
invested in the fund.‖ But as the Sixth Circuit explained in United States v. Lay,
612 F.3d 440, 446-47 (6th Cir. 2010), ―Goldstein did not hold that no hedge fund
adviser could create a client relationship with an investor, but rather held only that
the SEC had ‗not justified treating all investors in hedge funds as clients.‘‖ (quoting
Goldstein, 451 F.3d at 883). The Court agrees with the Lay Court that Goldstein
did not create a categorical rule that hedge fund advisers can never have fiduciary
duties to their individual investors.
Whether a fiduciary relationship existed
remains a fact-specific inquiry. See Lay, 612 F.3d at 446 (holding that the ―jury
could . . . reasonably find, as a matter of fact‖ that a hedge fund had a fiduciary
duty to an individual investor). In Goldstein, the District of Columbia Circuit Court
quoted the SEC‘s distinction between an adviser-client and an adviser-fund
[A] client of an investment adviser typically is provided with
individualized advice that is based on the client‘s financial situation
and investment objectives. In contrast, the investment adviser of an
investment company need not consider the individual needs of the
company‘s shareholders when making investment decisions, and thus
has no obligation to ensure that each security purchased for the
company‘s portfolio is an appropriate investment for each shareholder.
Goldstein, 451 F.3d at 880 (quoting Status of Investment Advisory Programs Under
the Investment Company Act of 1940, 62 Fed. Reg. 15,098, 15,102 (Mar. 31, 1997)).
The relevant factual question here is whether the relationship between the
Plaintiffs and the Defendants was more like the former or the latter.
allegations in the Plaintiffs‘ Amended Complaint sufficiently allege that the
Defendants had assumed the role of advisers to them as clients, meeting with them
individually, reviewing their personalized investment objectives, recommending
investments in funds tailored to their investment objectives, and promising to
monitor the funds in their personal interest. Indeed, in the Defendants‘ December
12, 2008 correspondence with the Plaintiffs, they seemed to contemplate a fiduciary
relationship with their investors, asserting that they would act ―with the greatest
emphasis on protecting our investors‘ assets‖ and ―continue to act in your best
interest during this trying time.‖ Am. Compl. ¶ 91.
The Defendants contend that because the Plaintiffs have failed to meet the
PSLRA‘s pleading standards, the same fate must befall their common law fraud
claims because they are subject to the same Rule 9(b) heightened pleading
Defs.’ Mot. at 26-27.
This argument fails, however, because the
Court has determined that the Plaintiffs have met the more rigorous pleading
standards of the PSLRA and Rule 9(b).
Intentional Infliction of Emotional Distress
The Defendants say that the Plaintiffs‘ claim of intentional infliction of
emotional distress is ―baseless and should be dismissed.‖ Defs.’ Mot. at 28. They
assert that the allegations fail to meet the requirement that the Defendants‘
conduct be outrageous or extreme and the requirement that the Defendants
intended to inflict emotional distress on the Plaintiffs. Id. at 28-30. Citing caselaw,
Defendants claim that ―[o]ther courts that have considered the question have found
allegations of securities fraud and related conduct insufficient to support an
intentional infliction of emotional distress claim.‖ Id. at 29.
The Plaintiffs respond that the Amended Complaint alleges a ―personal
history and special relationship with Defendant Steffens and the Defendants‘
fiduciary status as investment advisors,‖ that the Plaintiffs ―reposed great trust and
confidence in the Defendants,‖ that they ―entrusted a large portion of their worldly
wealth (including all of their IRA funds) to them and their partner, Merkin,‖ that
over the course of their relationship, the Defendants ―completely misled the
Plaintiffs about the true nature of their investment in the Ascot Fund,‖ and that the
Plaintiffs were ―emotionally devastated.‖ Pls.’ Opp’n. at 19-20. The Plaintiffs cite
separate caselaw in which courts have determined that intentional infliction of
emotional distress claims in the context of securities fraud survive dismissal. Id. at
The Court agrees with the Plaintiffs. In effect the Plaintiffs have alleged that
the Defendants were self-dealing and double dealing to the Plaintiffs‘ detriment and
that they suffered extreme emotional anguish as a result of losing virtually all their
personal investments. From the Court‘s perspective, the allegations, taken as a
whole, are sufficient to withstand a motion to dismiss. It is true that some courts
have dismissed intentional infliction of emotional distress claims in securities cases.
Whitley v. Taylor Bean & Whitacker Mortg. Corp., 607 F. Supp. 2d 885, 902-03 (N.D.
Ill. 2009) (allegations of stress and fear insufficient to support IIED claim); Prymak
v. Contemporary Fin. Solutions, Inc., No. 07-cv-00103-EWN-KLM, 2007 U.S. Dist.
LEXIS 87734, *59-61 (D. Col. Nov. 29, 2007) (acknowledging that damages are
available for outrageous conduct in the context of a securities suit but concluding
that the allegations in the complaint were insufficient); Mosko v. Defilippo, No. 9110675-Z, 1991 U.S. Dist. LEXIS 13501, *9-11 (Sept. 10, 1991) (allegation of stock
churning ―not sufficiently outrageous‖); Jacobson v. Merrill, Lynch, Pierce, Fenner &
Smith, Inc., 605 F. Supp. 510, 512-13 (W.D. Pa. 1984); LeCroy v. Dean Whitter
Reynolds, Inc., 585 F. Supp. 753, 763-65 (E.D. Ark. 1984).
Other courts have
allowed such claims to go forward at the preliminary motion stage. Malandris v.
Merrill, Lynch, Pierce, Fenner & Smith, Inc., 703 F.2d 1152, 1157-67 (10th Cir.
1981); Castro v. Paine, Webber, Jackson & Curtis, Inc., 99 F.R.D. 655, 657 (D.P.R.
1983); Emmons v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 532 F. Supp. 480,
485 (S.D. Ohio 1982).
In view of this split of authority and the allegations in the Amended
Complaint, the Court concludes the better approach is to allow the parties to engage
in discovery and revisit this issue in the event the Defendants file a motion for
Derivative Claims: Counts Three and Five
Count Three alleges that the Defendants aided and abetted the tortious
conduct of their partner and consultant Ezra Merkin and Count Five alleges that
they engaged in a civil conspiracy to breach their fiduciary duties toward the
plaintiffs, to defraud the plaintiffs, and to intentionally inflict emotional distress on
the plaintiffs. Am. Compl. ¶¶ 135-39, 145-50. The Defendants move to dismiss
these counts as derivative claims and they say that the derivative claims must fail
because the Plaintiffs failed to adequately plead an underlying tort. Defs.’ Mot. at
30-31. On this point, however, the Court concludes that the Defendants‘ motion
must fail because the Court has determined that the underlying tort claims have
survived the Defendants‘ motion to dismiss.
The Defendants still say that these derivative claims must be dismissed even
if the underlying tort claims remain.
Defs.’ Mot. at 31.
They claim that the
Plaintiffs failed to allege that the Defendants had ―knowledge of any breach of
fiduciary duty or fraud.‖ Id. at 31. The Plaintiffs disagree. Pls.’ Opp’n. at 22.
The Court agrees with the Plaintiffs.
In the Amended Complaint, they
alleged an extensive business relationship between Mr. Merkin and the Defendants,
Am. Compl. ¶¶ 75-79, and that Mr. Ho admitted in The Dartmouth that Spring
Count Five of the Plaintiff‘s Amended Complaint alleges the intentional infliction of emotional
distress on behalf of all Plaintiffs against all Defendants. Am. Compl. ¶¶ 140-45. Although
Defendants do not raise it, the Court assumes that the only Plaintiffs who could assert a viable
emotional distress claim would be the Goldensons, not their businesses.
Mountain would not pursue a legal action against Mr. Merkin because Spring
Mountain was ―fully aware‖ of Ascot Fund‘s investment in Madoff Securities and
that ―we asked and were given information.‖ Am. Compl. ¶ 112. These allegations
are sufficient to establish that the Defendants actually knew that the Plaintiffs‘
investments were not being invested by Mr. Merkin and instead that they were
being diverted to a third party in a fashion contrary to the Defendants‘ repeated
and explicit representations to the Plaintiffs.
Count Ten of the Amended Complaint states a separate demand for punitive
damages for the Defendants‘ alleged violations of Maine common law. Am. Compl.
¶177-80. The Defendants move to dismiss Count Ten on the ground that punitive
damages is a form of relief, not an independent cause of action. Defs.’ Mot. at 32.
The Plaintiffs concede this is so. Pls.’ Opp’n. at 22.
The parties are correct: a claim for punitive damages ―is not a separate and
distinct cause of action under Maine law. Rather, it is a type of remedy.‖ Frank v.
L.L. Bean, Inc., 352 F. Supp. 2d 8, 13 (D. Me. 2005). The Court therefore dismisses
However, the ―Plaintiff[s] may pursue a punitive damages remedy
against [Defendants] . . . if [they] can make the proper showing at trial‖ and they
―may still rely on the factual averments in [their] First Amended Complaint
regarding punitive damages.‖ Id. at 14.
In Count Eleven, the Plaintiffs have demanded that to prevent unjust
enrichment, the Court ―impose a constructive trust upon each of the Defendants in
an amount equal to any pecuniary benefits they have received, whether directly or
indirectly, by virtue of the Plaintiffs‘ investments in the Ascot Fund or other funds
controlled or managed by Merkin.‖ Am. Compl. ¶ 186. The Defendants move to
dismiss this Count on the assumption that the Court would conclude the Plaintiffs
had failed to adequately plead the existence of a fiduciary duty. Defs.’ Mot. at 32.
As the Court has concluded the opposite, this part of the Defendants‘ motion fails.
The Defendants next say that even if the Plaintiffs have alleged ―unjust‖
conduct on the Defendants‘ part, the Plaintiffs failed to adequately allege any
―enrichment.‖ Defs.’ Mot. at 33. They point out that the Plaintiffs alleged two types
of property unjustly retained by the Defendants: 1) management and performancebased fees, and 2) other valuable consideration they received from Mr. Merkin in
exchange for referrals. Id. (quoting Compl. ¶¶ 183, 184). The Defendants say that
because the management and performance fees were received in accordance with a
written contract, the law does not allow a claim for unjust enrichment.
Regarding the ―other valuable consideration‖ claim, the Defendants contend that
since the Plaintiffs have made this assertion on ―information and belief,‖ they have
not alleged sufficient facts to withstand a motion to dismiss. Id. at 33-34.
To support their claim that the law does not permit a claim for unjust
enrichment where there exists a written contract that governs the same subject
matter, the Defendants cite Feigen v. Advance Capital Mgmt. Corp., 541 N.Y.S.2d
797 (1st Dep. 1989). Although Feigen was later questioned, see Seiden Assoc., Inc. v.
ANC Holdings, Inc., 754 F. Supp. 37, 40 (S.D.N.Y. 1991), the trend in New York law
is that a claim for unjust enrichment may not proceed when there is a written
contract between the two parties governing the subject matter of the dispute. Air
Atlanta Aero Eng’g Ltd. v. SP Aircraft Owner I, LLC, 637 F. Supp. 2d 185, 195-96
(S.D.N.Y. 2009); Mid-Hudson Catskill Rural Migrant Ministry, Inc. v. Fine Host
Corp., 418 F.3d 168, 175 (2d Cir. 2005); Clark-Fitzpatrick, Inc. v. Long Island R.R.
Co., 516 N.E.2d 190, 193 (N.Y. 1987). Assuming the Defendants are correct on New
York law, the Defendants‘ argument faces two further hurdles. First, Maine law,
not New York law, applies to this case and the Defendants have cited no Maine law
on this point. Second, the gravamen of the Plaintiffs‘ constructive trust request is
that the Defendants profited from defrauding them. Although the Defendants claim
there is a written contract that covers the same subject matter, the Court remains
to be convinced that the written contract between the Plaintiffs and the Defendants
specified what would happen to management and performance-based fees that the
Plaintiffs paid to the Defendants if the Defendants defrauded the Plaintiffs.
Regarding the ―information and belief‖ question, the Court concludes it would be
wiser to allow the parties to engage in discovery on this issue and to allow the
Defendant to resurrect it in the event the allegation is unsupported by facts.
The Court rejects the Defendants‘ motion to dismiss Count Eleven, the
constructive trust count.
Upon motion of the Defendants, the Court deems the Defendants‘ Motion for
Ruling on Choice of Law (Docket # 14) WITHDRAWN.
The Court partially
GRANTS and partially DENIES the Defendants‘ Motion to Dismiss (Docket # 26).
The Court GRANTS, without prejudice, the Defendants‘ motion to dismiss Count
Ten because it states a remedy rather than a claim upon which relief can be
The Court DENIES the Defendants‘ motion to dismiss Counts One
through Nine and Count Eleven because each states a claim upon which relief can
be granted and the Court has jurisdiction over each count.
/s/ John A. Woodcock, Jr.
JOHN A. WOODCOCK, JR.
CHIEF UNITED STATES DISTRICT JUDGE
Dated this 4th day of August, 2011
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