Securities and Exchange Commission v. Gruss

Filing 71

OPINION re: 54 MOTION for Summary Judgment Notice. filed by Perry A. Gruss, 49 MOTION for Summary Judgment filed by Securities and Exchange Commission: Based upon the findings and conclusions set forth above, Defendant's motion for summary judgment is granted in part and denied in part, and Plaintiff's motion for summary judgment is granted in part and denied in part. (Signed by Judge Robert W. Sweet on 3/28/2017) (jwh)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK

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SECURITIES AND EXCHANGE COMMISSION,
Plaintiff,

11 Civ. 2420
OPINION

-againstPERRY A. GRUSS,
Defendant.

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A P P E A RA N C E S:

Attorneys for Plaintiff
SECURITIES AND EXCHANGE COMMISSION
New York Regional Off ice
Brookfield Place
200 Vesey Street
New York, NY 10281-1022
By:
Todd D. Brody, Esq.
Peter Altenbach III, Esq.

Attorneys for Defendant

DORSEY & WHITNEY LLP
51 West 52 ~ Street
New York, NY 10019
By:
Nathaniel H. Ackerman, Esq.
Thomas 0. Gorman, Esq.

usncsnNY

uocurv1E1'1l

ELECTRO: , CALLY FILED
DOC#: ____,,:;::>rn.,,.~OATE FILED:

Table of Contents
Prior Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Defendant and the Funds Involved . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Operating Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
The U.S. Tax Exemption for the Offshore Fund . . . . . . . . . . . . . . . . . 23
The Offshore Fund Loans to the Onshore Fund . . . . . . . . . . . . . . . . . . 33
The Offshore Fund Loans to Pay Revolver Obligations . . . . . . . . . . 91
The Payment by the Off shore Fund of Onshore Fund Management
Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
The Payment by the Off shore Fund for the Purchase of an
Airplane . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
Materiality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134
CONCLUSIONS OF LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
The Applicable Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
The SEC's Motion for Summary Judgment that Section 206(2) Was
Violated is Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160
Section 206(2) Is Applicable Because DBZCO Was an Investment
Advisor under Section 206(2) of the Advisers Act Owing
Fiduciary Duties to Its Investors and Used Instrumentalities of
Interstate Commerce . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160
DBZCO Violated Its Fiduciary Duty by Transferring Funds from
the Offshore Funds to Meet the Onshore Fund's Obligations ... 161
The Offshore Fund Was Prohibited from Making Investments in or
Loaning Money to US Companies (Including the Onshore Fund) .. 162
The Offshore Fund Was Prohibited from Making Payments to the
Onshore Fund (or Directly to Its Creditors) for Its Revolving
Credit Facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
The Breaches of the Fiduciary Duty by Making Loans from the
Off shore Fund to the Onshore Fund for Investments and the
Revolver Were Material . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

i

Gruss acted with a Negligent Intent When He Authorized the
Off shore Fund Transfers to Fund Onshore Investments and the
Revolver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181
Gruss Aided and Abetted DBZCO's Violation of Section 206(2) of
the Advisers Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 4
The Advance Payment of Management Fees Were Appropriate InterCompany Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 6
The Motion for an Injunction Based Upon the Payment by The
Off shore Fund to Purchase an Airplane is Denied as Presenting a
Contested Issue of Fact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 6
The Motion for the Imposition of a Civil Penalty is Granted. 191
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195

ii

The plaintiff the Securities and Exchange Cormnission
("SEC" or the "Plaintiff") has moved pursuant to Rule 56(a) F.
R. Civ. P. for surmnary judgment enjoining the defendant Perry A.
Gruss

("Gruss" or the "Defendant") from violating Sections

206(1) and (2) of the Investment Advisers Act of 1940 (the
"Advisers Act") and for disgorgement and civil penalties. Gruss
has also moved for surmnary judgment pursuant to Rule 56(a) to
dismiss the SEC complaint against him. Upon the facts and
conclusions set forth below, both motions are granted in part
and denied in part.

The principal dispute between the parties arises from
the interpretation of the documents controlling the operations
of the funds involved relative to the actions taken by Gruss.
Central to this controversy is the bar against engaging in a
U.S. trade or business under which the Offshore Fund was
exempted from U.S. taxes and whether or not that bar was
breached .

The SEC has advanced four grounds on which it urges
the issuance of an injunction based on violations of Sections
206(1) and (2) of the Advisers Act by D.B. Zwirn & Co .
("DBZCO"), aided and abetted by Gruss. The first is based upon
the sixty-six interfund transfers from the Offshore Fund to the
1

Onshore Fund to fund Onshore investment between May 2004 and
July 2006 , fourteen of which were real estate investments. The
second ground relates to the four payments of the Onshore
revolver credit between June 2005 and May 2006, and the third
and fourth grounds arise out of the payment by the Off shore Fund
of DBZCO management fees and to purchase an airplane for DBZCO's
managing partner. Because the payments for funding the Onshore
Fund investment and repaying the Onshore revolving credit
facility violate the Advisers Act, the SEC motion for injunctive
relief and penalties will be granted, and the Gruss motion for
summary judgment denied. Because the intercompany payment of
management fees does not violate the Advisers Act, that portion
of the SEC motion is denied and that portion of Gruss' summary
judgment is granted. Because there is a factual issue as to
Gruss' knowledge with respect to the payments to purchase the
airplane, the SEC summary judgment motion on that basis is
denied.

Prior Proceedings

The SEC filed this action on April 8, 2011 alleging
that Gruss, the Chief Financial Officer of DBZCO, a hedge fund
aided and abetted violations of the Advisers Act by using funds
of the Off shore Fund to fund investments by the Onshore Fund and
2

to pay Onshore Fund loan commitments as well as a revolving 75 day credit facility and management fees and payments to purchase
an airplane.

Discovery proceeded, the motion of Gruss to dismiss
the complaint was denied on May 9 , 2012

(859 F.Supp.2d 653

(S.D . N.Y. 2012), and the instant motions were heard and marked
fully submitted on October 6, 2016.

The Facts

The facts in these fact-rich motions are set forth in
the parties' respective Rule 56.1 Statements of Material Fact
and are not in dispute except as noted below.

The Defendant and the Funds Involved

1.

DBZCO was an investment adviser to and manager of

certain hedge funds and managed accounts.

2.

DBZCO no longer performs any business functions.

3.

At different times, DBZCO had offices in numerous

locations, including New York, London, Hong Kong, Houston,
3

Milan, Frankfurt, Tokyo, Seoul, Beijing, Singapore, Melbourne,
and Luxembourg. DBZCO also had offices in Connecticut, Mexico,
New Delhi, Warsaw, Tel Aviv, and Taipei.

4.

Daniel B. Zwirn ("Zwirn") was the founder and

managing partner of DBZCO.

5.

The Chief Financial Officer ("CFO") and Chief

Administrative Officer for DBZCO was Gruss. In January 2006,
Gruss became a partner of DBZCO and at various times held the
title of Senior Vice President Managing Director. Prior to
becoming the CFO of DBZCO, Gruss had never served as a CFO,
although he did work in the finance departments at Nomura
Holdings America, where he prepared profit and loss statements,
and at American International Group.

6.

In 2004, Gruss' compensation at DBZCO was either

$800,000 or $1.2 million. In 2005, his compensation at DBZCO was
$1.8 million. In 2006, his compensation at DBZCO was
$1,657,718.00.

7.

Gruss' bonus comprised the vast majority of his

compensation. In 2005, his base salary from DBZCO was $160,000.

4

In 2006, in connection with his promotion to partner, Gruss'
base salary was increased to $225,000.

8.

In 2007, Gruss was hired as a "marketer" for

Babcock & Brown, LP, a global merchant/investment bank. As of
the date of his deposition in this case, Gruss was still
employed by Babcock & Brown.

Gruss admitted the statement in part and denied it in
part, noting Babcock & Brown ("B&B") did hire Gruss in 2007 as a
marketer, but he has never worked in that role at B&B, that B&B
has been in liquidation after being delisted on the Australian
Stock Exchange in June 2009, that since that time his
responsibility at B&B has been to assist in the company's
liquidation, and that he has not worked for an investment
advisor since he left DBZCO in September-October 2006 and at the
present time has no plans to work for an investment advisor.

9.

During the time period of 2002 through 2009,

DBZCO managed several "hedge funds," including the D.B. Zwirn
Special Opportunities Fund, L.P.

("the Onshore Fund") and the

D.B. Zwirn Special Opportunities Fund, Ltd.

(the "Offshore

Fund"), and added a third fund in March 2003 and a fourth fund

5

in May 2005, in addition to several separately managed private
accounts.

PriceWaterhouseCoopers ("PWC " ) audited each of these
funds annually.

10.

The Onshore Fund was a Delaware limited

partnership founded in April 2 002 to operate as a private
investment fund . The Onshore Fund commenced investment
operations in May 2002.

The Off shore Fund was a Cayman Island exempted company
incorporated on April 12 , 2002 to operate as a private
investment fund. The Offshore Fund commenced investment
operations in May 2002.

11 .

While there was some overlap in the investors in

the Onshore and Offshore Funds, the majority of investors in the
two funds were different . Gruss knew that the investors in the
Onshore Fund were separate and distinct from the investors in
the Offshore Fund. The Offshore Fund was open to both non - U. S.
investors and permitted U. S . investors, and both groups of
investors were required to be accredited investors and qualified
purchasers. A significant proportion of the investors in both
6

funds were themselves registered investment advisors . The SEC
has noted that Gruss ' only citation for this statement is the
report of Dr . Richard Bergin ("Dr. Bergin"), his expert, and
that Dr. Bergin cannot testify about purely factual information
where the expert has no first-hand knowledge and because Gruss
has not provided an admissible source for this assertion , the
SEC has not responded.

The SEC has cited listings of investors for the
Onshore Fund and the Offshore Fund for the period of January 1,
2006 to March 4, 2008. The relevant period of the inter-fund
transfers alleged in the complaint and claimed on the SEC's
summary judgment motion is March 2004 through July 2006. The
evidence as to the relative proportion of the same investors in
both funds has not been established .

12 .

The Offshore Fund was an exempted company under

Cayman Islands law; as such, it had received an undertaking as
to tax concessions that provided that , for a period of 20 years
from the date of issue of the undertaking, no law thereafter
enacted in the Cayman Islands imposing any taxes or duty to be
levied on income or capital assets, gains or appreciation would
apply to any income or property of the Offshore Fund. Gruss
asserts that the next paragraph of the exhibit cited states :
7

"There can be no assurance that the ... Cayman Islands tax laws
will not be changed adversely with respect to the Fund

or

. that the Funds income tax status will not be successfully
challenged."

13.

The 2002, 2003 and 2005 Offshore Fund Offering

Memoranda disclosed that "these securities [shares in the
Offshore Fund] are suitable for sophisticated investors" who
"fully understand and are willing to assume the risks involved
in the portfolio's investment program." Ex. Lat DBZ 0009680;
Ex. Mat DBZ 0009823; Ex. 0 at DBZ 0009747.

The Offering Memoranda further disclosed that "Shares
will only be offered to non-U.S. or permitted U.S. investors"
who had to be '"accredited investors,' as defined in Rule 501(a)
under Regulation D of the United States Security Act of 1933,"
as well as '"qualified purchasers', as defined by Section 2(a)
(51) of the United States Investment Company Act of 1940." Ex. L
at p. 12

(DBZ 009688); Ex. M at p. 15

(DBZ 0009841); Ex. 0 at p.

6 (DBZ 0009755).

The investors of the fund 1) were a bank, insurance
company or investment company or had investments of at least $5
million, or had a net worth of at least $1 million (as an
8

accredited investor) and 2) owned at least $5 million in
investments (as a qualified purchaser) .

14.

The Offshore Fund had Assets under Management

("AUM") of (1) $877,000,000;

(2) $1,500,000,000; and (3)

$2,400,000,000 respectively as of December 31, 2004 , December
31, 2005, and December 31, 2006 . At the end of February 2006 ,
the Offshore Fund's AUM were $1,500,000,000. The Onshore Fund
and Off shore Fund experienced substantial and rapid growth in
AUM from inception in May of 2002 to the end of 2006: the
Onshore Fund's AUM was approximately $525 million on December
31, 2004 .

15.

The DBZCO investment approach yielded for the

investors of the Offshore Fund and the Onshore Fund "superi or
annual returns relative to S&P 500 or other multi-strategy hedge
funds" from 2004 to 2006 . The SEC denies this statement as based
upon the expert report of Dr. Bergin about purely factual
information where the expert has no first-hand knowledge. The
SEC further notes that the Bergin report provides, in 2006 , the
Offshore Fund was significantly outperformed by both the
CS/Tremont Multi-Strategy sub-index and by the S&P 500. The SEC
also has disputed use of the term "superior", which is not
defined, noting that when over the three year period identified,
9

the annual difference between the performance of the Off shore
Fund and the CS/Tremont Multi-Strategy sub-index was 34 basis
points and the charts provided by Dr. Bergin demonstrate that in
sixteen of the twenty-four months presented for the period 2004
to 2005, the S&P 500 and/or the CS/Tremont Multi-Strategy subindex outperformed the Offshore Fund. In fact the SEC asserts
that over the twenty-nine month period (January 2004 - May 2006)
analyzed in Dr. Bergin's report, a $100 January 2004 investment
in the Offshore Fund would have grown to $125.11 by May 2006,
and the same $100 investment in the C/S Tremont Multi-Strategy
sub-index growing to $124.03 and in the S&P 500 to $122.81.
Finally, the SEC has noted the Bergin report does not provide
any explanation why it would be appropriate to compare the
performance of the Onshore and Off shore Funds to the S&P 500 or
to the CS/Tremont Multi-Strategy sub-index (as opposed to other
funds whose investment strategy was actually similar to that of
the Onshore and Offshore Funds).

16.

Zwirn made all investment decisions for the funds

managed by DBZCO. Gruss was not authorized to make any
investment decisions. Zwirn has acknowledged that Gruss and
later the DBZCO Chief Operating Officer, Harold Kahn ("Kahn"),
managed the non-investment portion of the firm.

10

The Operating Documents

17.

The Offshore Fund and Onshore Fund were governed

by their operating documents. Those include the Offshore Fund
Shareholder Agreement and Onshore Fund Limited Partnership
Agreement

(collectively "formation documents"), the Offering

Memoranda for each fund furnished to each investor (Exhs . K, L,
M, O, T, U), and the Management Agreement executed by each fund
with DBZCO.

(Exhs. V , W, MM, NN, SS)

(the "Operating

Documents"). Collective ly the Operating Documents created
essentially the same governance structure, although there were
certain differences.

The SEC has noted that "the Offering Memoranda
explained that the Offshore Fund was subject to regulation and
supervision by the Cayman Island authorities and that it was
obligated to adhere to Cayman Islands law"

(SEC v. Gruss,

859

F.Supp.2d at 657) and that DBZCO, the investment advisor for
both Offshore and Onshore Funds, was subject to the federal
securities laws even though it was unregistered. See, e.g.,

SEC

v. Rabinovich & Assocs., Onshore Fund, 07 Civ. 104547, 2008 U.S.
Dist. LEXIS 93595

(S.D.N.Y. Nov. 18, 2008).

11

18.

The Onshore Fund Limited Partnership Agreement

vested broad powers in the General Partner, DBZCO:

management, operation and control .
. [vests]
exclusively in the General Partner, which shall
have the Power by itself on behalf and in the
name of the Partnership to carry out any and all
of the purposes of the Partnership and to perform
all acts and enter into and perform all contracts
and other undertakings that it may deem necessary
or advisable or incidental. Ex. TT at p. 5, §3.1.

The SEC has noted that the agreement does not use the
term "broad powers."

19.

Similarly, the Offshore Fund Memorandum of

Association specifies the reasons for the formation of the term
- "investments":

The objects for which the company is established
are unrestricted and shall include, but without
limitation .
(e) to undertake and carry on
and execute all kinds of investment, financial,
commercial, mercantile trading and other
operations .
(iii) To purchase or otherwise
acquire, to sell, exchange, surrender, lease,
mortgage, charge, convert, turn to account
dispose of and deal with real and personal
property and rights of all kinds .
(v) To
stand surety for or to guarantee, support or
secure the performance of all and any of the
obligations of any person, firm or company
whether or not related or affiliated to the
Company in any manner.

12

Ex. S at pp. 1-3 (MAXAM00000929 - 931). To implement these
goals the Offshore Fund could "advance, deposit, or lend
money, securities and/or property to or with such [other]
persons, and on such terms as may seem expedient ." Ex. S at
p . 2 (MAXAM00000930) , '(d).

The SEC has noted the memorandum does not define
the term "investments" and , as Gruss concedes in '39 of his
56 .1 Statement , the Offshore Fund " was prohibited" from
participating in certain investments because of tax
considerations.

20.

The Offering Memoranda or Private Placement

Memoranda for each fund was uti li zed to solicit investors to
purchase the securities of either the Onshore Fund or the
Offshore Fund under "Section 4(2) of the Securities Act of
1933", Regulation D, which provided an exemption from the
registration provisions of Section 5 of the Securities Act of
1933. See e.g . Ex . K at DBZ 0009448 . There were multiple
Offering Memoranda, but each was essentially similar including
those for the Onshore Fund and Offshore Fund. Each defined the
type of investments the fund would make on behalf of its

13

shareholders in broad, general terms which gave the investment
adviser or Manager the broadest possible discretion.

The SEC did not deny the first sentence in this
statement but noted the lack of citation for the remainder of
the statement, and further noted that the Offshore Fund "was
prohibited" from participating in certain investments because of
tax considerations, that the Offshore Fund was restricted and
that consequently the investment adviser or Manager did not have
the "broadest possible discretion."

21.

The Offshore Fund Memoranda represented that it

"focuses on multiple strategies, including but not limited to"
corporate debt investments, assets, public equity, and that
Onshore Fund and other funds "are managed using strategies
generally similar to those the Manager used for the [Offshore
Fund] Fund." Ex. Mat pp . 18-20 (DBZ 0009844-9846). Compare e.g.
Ex. Tat pp.14-16 (DBZ 0009601-9603) . The SEC has noted that the
financial statements for the Offshore Fund demonstrates that the
fund overwhelmingly invested in Corporate Bonds (44 .1 3 % [Br ody
Deel. Ex. 96 at p. 4)) and Loans (30.17 % [Id. at p. 6)) .

22 .

Investments selected by the Manager for both the

Onshore Fund and Offshore Fund could be highly speculative. As
14

the Offering Memoranda for the Offshore Fund specified, "The
Fund (and including for the avoidance of doubt, any managed
accounts or investment vehicles advised or managed by the
Manager or any of its affiliates in which a portion of the
Fund's assets may be invested) will utilize highly speculative
investment techniques." Ex. Mat p. 34

(DBZ 0009860). Compare

e.g. Ex. Tat p . 30 (DBZ 0009617).

23.

Co-investments with third parties were

specifically authorized by the Offshore Fund Offering Memoranda.
Ex. M at p. 42

(DBZ 0009868)

("co-investment with third parties

through joint ventures"). Assignments of investments from the
Onshore Fund were also specifically authorized for the Off shore
Fund . Ex. Mat p. 20 (DBZ 0009846).

("[A]n assignment of, or

participating in, a loan from the U.S. Fund at a price approved
by an independent third party."). The Offshore Fund could also
invest directly in other funds managed by DBZCO: Alternatively
the investments for the Off shore Fund and others managed by
DBZCO could also include investments in affiliated funds.

The SEC has noted that the Offering Memoranda also
provided that "the [Offshore] Fund ... will generally not invest
in . . . other assets such as real estate or make direct loans to
or otherwise engage in the active management of a U.S. company ."
15

(Brody Deel. Ex. 3 at 19-20.) The SEC also noted that DBZCO and
Gruss repeatedly represented this limitation on the Offshore
Fund's ability to invest to the auditors, investors and
potential investors. Likewise the SEC noted that Gruss has
conceded that the Onshore Fund was a U.S. company, and that he
told lawyers from the law firm Gibson, Dunn & Crutcher, and
Albert Lilienfeld from Deloitte Financial Advisory Services,
which conducted the internal investigation for DBZCO in 2006 and
2007, that money from the Offshore Fund needed to be kept
separate from the money from the Onshore Fund to avoid ECI
issues. The SEC also notes that Gruss conceded it was well-known
that a transfer from the Off shore Fund to the Onshore Fund would
raise Effectively Connected Income ("ECI") and "trade or
business concerns" (Brody Deel. Ex. 182; Ex. 57 at 111:10-24,
113:16-23) and that an arrangement where the Offshore Fund would
loan money to the Onshore Fund to pay its debts, fund its
investments or operate its business would raise ECI issues and
would not be permitted under the funds'

offering documents. ECI

is the acronym for "effectively connected income," which is the
income when a foreign person engages in a trade or business in
the United States, connected with the conduct of that trade or
business.

16

Gruss has denied this and objects to this statement
noting that as the interview memoranda state in the beginning
paragraph, "Gruss has not read, reviewed, or adopted the
contents of this memorandum." Brody Deel, Ex . 182 at 1, and that
whoever wrote up Gruss' alleged interv iew statement did not
understand how the Onshore Fund and Off shore Fund funds worked
and why they were established or that "mone y from the Off shore
Fund needed to be kept separate from the Onshore Fund t o avoid
ECI issues" was the entire purpose of establishing a U.S. fund
and a non-U.S. fund and that the advances were recorded as such
on the books and records of the Onshore Fund and Offshore Fund
and not as interest bearing l oans , Ex. BBB at p. 174, so there
would be no ECI issues. Gruss has fur the r noted that in
connection with Gruss' alleged statement, Lilienfeld testified
that Deloitte "never found loan documentation, so when we
referred to the CDC or other transfers of monies being loans,
that is not the proper terminology because a loan implies that
there is a documentation surrounding it. It is more of a
transfer, an advance or something along th ose lines, but not
raising it to the level o f a loan," Ex. UUU at p. 11 3 , and that
this did n ot mean that the Off shore Fund could not advance funds
to the Onshore Fund that the Onshore Fund could use to buy
investments. Gruss further has noted that he had told Jason
Pecora, DZBCO's Treasurer, that the monies advanced from the
17

Offshore Fund to the Onshore Fund were not booked as a "l oan in
the portfolio accounting system" and "papered as a loan"
precisely to avoid "tax issues," Ex. EEE at pp. 67 - 69 , and that
this practice of the Off shore Fund advancing money to the
Onshore Fund was permitted by the funds' and Operat ing
Documents .

Gruss has further noted that Dr. Bergin stated that:
"[a]n aspect of DBZCO's strategy, as detailed in the pertinent
fund materials, was for the Offshore Fund and the Onshore Fund
to operate symbiotically in order to enhance investment
opportunities , facilitate largely parallel strategies and
bolster returns for both funds and that the Onshore Fund was
frequently utilized as a sourcing agent to acquire select
investments for the fund complex, and often these investments
were not immediately available to the Offshore Fund and that
this process required a treasury approach which facilitated the
movement of funds among fund complex members." Ex. D at p. 8 .
Gruss further has contended that the Onshore Fund located
investments for the Off shore Fund and often restructured them in
a manner that fit within the tax limitations of the Offshore
Fund and that this arrangement benefited both funds - the
Onshore Fund because, although uncompensated for its task, was
able to effectively leverage its assets, which enhanced the
18

Onshore Fund's rate of return; the Offshore Fund because it was
able to expand its investments beyond the limitations imposed by
the tax code as a result of the sourcing and restructuring
efforts of the Onshore Fund.

24 .

The Offering Memoranda acknowledged that at times

working for a group of funds and making investments for each and
for the group not only required the Manager to allocate its time
but created potential conf licts that investors had to consider
in investing in the Onshore Fund or the Offshore Fund: "inherent
or potential conflicts o f int erest in the structure and
operation of the Fund's business should be considered by
prospective investors before subscribing for Shares." Ex. Mat
p. 50 (DBZ 0009876) ; Ex. 0 at p. 28

(DBZ 0009777); Ex. Lat p.

28 (DBZ 0009704); Ex. T at p. 46 (DBZ 0009633); Ex. U at p. 29
(DBZ 0009561); Ex. K at p. 23 (DBZ 0009473). See also Ex. B at
pp. 8 -10 (SEC Gruss 001015-17)

(DBZCO also provided a similar

conf li cts of interest disclosure in due diligence materials for
potential investors.) A conflict can arise from the practice of
'cross trading,' i.e., the Manager effects a trade or a loan
between the Fund and another investment fund or account that it
or its affiliates manage." Ex. M at p. 52
at p. 29 (DBZ 0009705); Ex. T at p. 47
p. 30 (DBZ 0009562); Ex. K at p. 24
19

(DBZ 0009878); Ex. L

(DBZ 0009634); Ex. U at

(DBZ 0009474). Thus, the

Offering Memoranda granted DBZCO the right to engage in
transactions between the funds, while simultaneously disclosing
that such a transaction could create a conflict of interest. The
Offering Memoranda also disclosed that "notwithstanding the
potential conflicts of interest resulting from these multiple
relationships , the Manager is expressly permitted to enter into
contracts and transactions with its affiliates on behalf of the
Fund . " Id.; Ex. Kat p. 25 (DBZ 0009475). Similar disclosures
appeared in the due diligence materials provided to investors.

The SEC has admitted the quoted language appears in
the Offering Memorandum , but has noted that this statement is
incomplete as the Offering Memorandum also provided that "the
[Offshore] Fund . . . will generally not invest in ... other
assets such as real estate or make direct loans to or otherwise
engage in the active management of a U.S. company" (Brody Deel.
Ex. 3 at 19-20) and repeatedly represented this limitation on
the Offshore Fund's ability to invest to the auditors, investors
and potential investors . The SEC did not contest that the
Offering Memoranda specifically stated that the Off shore Fund
might "accept an assignment of , or participation in, a loan from
the [Onshore Fund] at a price approved by an independent third
party" [Brody Deel. Ex . 3 at 201) , and has noted that Gruss made
statements as noted in the Findings of Fact ("FOF") above.
20

25.

In such instances "the Manager and Zwirn may have

a conf l ict of interest between acting in the best interests of
the Fund and such other accounts and funds . " Ex . M at p . 51
0009877) ; Ex. 0 at p . 28

(DBZ 0009777); Ex . L at p . 28

(DBZ

(DBZ

0009704) ; Ex. T at p. 46 (DBZ 0009633) ; Ex . u at p . 29 (DBZ
0009561); Ex. K at p . 23 (DBZ 0009473) . Those conflicts were to
be resolved by the Manager in its sole discretion: "When the
Fund and one or more other clients of the manager have available
funds for investments , investments

.

. will be allocated

substantially pro rata on an overall basis . . . to the extent
possible , unless the Manager believes , in good faith, that
another method would be more fair and equitable . " Ex . Mat pp.
51 - 52 (DBZ 0009877-78) ; Ex. 0 at p. 29 (DBZ 0009778); Ex . L at
p . 29 (DBZ 0009705) ; Ex. T at pp . 46-47

(DBZ 0009633-34) ; Ex. U

at pp. 29-30 (DBZ 0009561-62); Ex . K at p. 24

(DBZ 0009474). The

Offering Memoranda stated that the Manager can "engage in
investment techniques and strategies not described" in the
Offshore Fund's Offering Memoranda "that the Manager considers
appropriate under the circumstances" Ex. M at p. 27

(DBZ

0009853) and "to perform all acts and enter into and perform all
contracts and other undertakings that it may deem necessary or
advisable or incidental" for the Onshore Fund. Ex. K at p . 5
(DBZ 0009502).
21

The SEC has admitted the quoted language appears in
the Offering Memoranda, but noted that these statements are
incomplete because the Offering Memorandum explicitly provided
that "the [Offshore] Fund ... will generally not invest in ...
other assets such as real estate or make direct loans to or
otherwise engage in the active management of a U.S. company,"
(Brody Deel. Ex. 3 at 19-20), that DBZCO and Gruss represented
this limitation on the Offshore Fund's ability to invest to the
auditors , investors and potential investors and that Gruss made
statements as notes in the FOF.

26.

The Management Agreements with the Funds, under

which DBZCO was retained as investment adviser by each fund,
stated authority of the Manager in the Offering Memoranda. The
2005 version of the Offshore Fund Management Agreement stated
that:

The Fund desires to employ its capital by
investing and reinvesting in securities and other
instruments and investments as specified in the
Memorandum [Offering Documents]
. The Manager
is authorized as attorney-in-fact of the Fund to
take all such actions .
. on behalf of the Fund
that it deems, in its sole discretion, necessary
or appropriate to perform its obligations under
this Agreement.

22

Ex. V at

~1

(BS00000220).

The SEC has noted that the Management Agreement
specifically states that the Off shore Fund "desires to employ
its capital by investing and reinvesting in securities and other
instruments as specified in the [Offering Memorandum]

"

(Brody Deel. Ex. 139 at 1), and the Offering Memorandum included
the limitation that "the [Offshore] Fund . .. will generally not
invest in . . . other assets such as real estate or make direct
loans to or otherwise engage in the active management of a U. S.
company . "

(Brody Deel . Ex . 3 at 19-20).

27 .

The agreement for the Onshore Fund is virtually

identical. Ex. W at

~1

(DBZ0040972) see also Exhs. MM , NN, SS at

~1.

The U.S. Tax Exemption for the Offshore Fund

28.

The purpose of the Offshore Fund, a Cayman Island

company, was to create an investment vehicle that would not be
subject to U.S . taxes.

29.

A representation letter to the auditors for all

of the Offshore Funds managed by DBZCO , signed by Gruss and

23

Zwirn stated: "[t]he Funds have structured their operation in
order that it will not be deemed to be engaged in a trade or
business within the U.S. for purposes of U.S. federal tax laws."
(Brody Deel. Ex. 21).

30 .

DBZCO made similar representations to the

investors in the Offshore Fund. The Offering Memorandum
explained that "[a] non-U.S. corporation engaged in a U.S. trade
or business is generally subject to U.S. corporate income tax on
income and gain earned in the U.S. which is connected to such
trade or business, in the same manner as a U.S. corporation. In
addition, a non-U.S. corporation engaged in a U.S. trade o r
business is subject to a

'branch profits' tax equal to 30 % of

the amount of its U.S. earning which are not reinvested in U.S.
assets." In order to avoid these taxes, "the [Offshore]

Fund

intends to operate and structure its investments in a manner
such that it should not be deemed to be engaged in a U.S. trade
or business." (Brody Deel. Ex. 3 at 66; 15 "[t]he manager
intends to conduct the business of the [Offshore]

Fund

(including investments in loans originated by the U.S. Fund or
its affiliates)

in a manner such that the fund should not be

engaged in a U.S. trade or business " ).

24

The same section of the July 2006 Offering Memoranda
stated:
The Manager intends to conduct the business of the
Fund in a manner so as to meet the requirements of the
Safe Harbor, and believes that the transactions under
its investment program, including investments in loans
originated by the U.S. Fund or its affiliates, should
qualify for the Safe Harbor. There can be no
assurance, however, that the Service will agree that
each of such transactions qualifies for the Safe
Harbor. If certain of the Fund's activities were
determined not to be of the type described in the Safe
Harbor, the Fund's activities may constitute a U.S.
trade or business, in which case the Fund would be
subject to U.S. income and branch profits tax on its
share of the income and gain from those activities and
related activities, if any, and the Fund may have to
file a U.S. tax return. In addition, if any credit
default swap is characterized as a contract of
insurance or a guarantee, payments to the Fund under
such credit default swap may be subject to an excise
tax or a withholding tax.
The Safe Harbor, however, may not apply to the trade
or business of actively originating loans within the
U.S. The Manager believes that the transactions under
its investment program, including investments in
loans, should qualify for the Safe Harbor, although
there can be no assurance that the Service will agree.
Moreover, as indicated above, the Fund may acquire
interests in loans (including leases treated as
financings for U.S. Federal income tax purposes),
revolvers and letters of credit originated by the U.S.
Fund or its affiliates and may make such investments
through subsidiary vehicles. The Fund believes that
these activities should qualify for the Safe Harbor
terms are agreed upon and will not in any event be
obligated to make any purchases until after the loans
are made. Furthermore, the Fund will not be permitted
to purchase interests in loans originated by the U.S.
Fund or its affiliates unless an independent party
approves the purchase. Nevertheless, there can be no
assurance that the Service will not assert that the
Fund is engaged in a trade or business within the U.S.
by virtue of such purchase of interests in loans from
25

the U.S. Fund or its affiliates. If the Service is
successful in such an assertion, the Fund's or its
subsidiary's income from these activities and related
activities , if any, may be subject to U.S. income and
branch profits tax and the Fund or its subsidiary may
have to file a U.S. tax return.

Ex. Mat p. 67.

31 .

The Offering Memorandum stated that "actively

originating loans within the U.S. " might create adverse tax
consequences and that "certain investments by the [Offshore]
Fund could result in the [Offshore]

Fund being deemed engaged in

a U.S. trade or business, including direct investments by the
[Offshore]Fund in U.S. real estate." Id. at pp. 67, 69. As such,
the offering memorandum noted that "the [Offshore] Fund ... will
generally not invest in leased equipment and other assets such
as real estate or make direct loans to or otherwise engage in
the active management of a U. S. company." Id. at pp. 19-2 0 .

The July 2005 Offering Memoranda stated:

The U.S. Fund, the Parallel Cayman Fund and the TE
Fund are managed using strategies generally similar to
those the Manager uses for the Fund. Even though their
strategies are generally similar, performance of the
U.S. Fund, the Parallel Cayman Fund and the TE Fund
will not be the same as the Fund's performance as a
result of, among other things, different legal,
regulatory, tax, liquidity, structuring and investment
26

constraints on the U.S. Fund, the Parallel Ca yma n Fund
and the TE Fund. These constraints include adverse tax
consequences to the Fund and the Parallel Cayman Fund
of certain investments made by the U.S. Fund as well
as differences in the timing of inves tments,
limitations on size of investments, nature of
investments , and governmental regulation of
investments . For example, the Fund and the Parallel
Cayman Fund will generally n o t invest in leased
equipment and other assets such as real estate or make
direct loans to or otherwise engage in the active
management of U.S. company. The Fund or a subsidiary
of the Fund may, however, accept an assignment of, o r
participation in, a loan from the U.S. Fund at a price
approved by an independent third party (see "Confli cts
of Interest"). The TE Fund is managed using strategies
generally similar to th ose the Manager uses for the
U.S. Fund, except that the TE Fund generally does not
engage in investment activities that would generate
UBTI for U.S. tax purposes. As a consequence of these
and other differences, the Fund's performance will
differ from the performance of the U.S. Fund, the
Parallel Cayman Fund and the TE Fund. In the future,
the Fund may carry out its investment objectives by
investing all or a portion of its capital thr ough a
master-feeder structure along with other funds and
accounts managed by the Manager. The offering
memorandum exp lained that instead of making a direct
investment, "[t]he [Offshore] Fund or a subsidiary of
the [Offshore] Fund may, h owever , accept an assignment
or, or participation in, a loan from the U.S. Fund at
a price approved by an independent third party .... "
Id. at pp. 19-20. "The [Offshore] Fund believes that
these activities should qualify for the Safe Harbor
since it will only be committing to buy the interests
in the l oans after the loan terms are agreed upon and
will not in any event be ob ligated to make any
purchases until after the loans are made. Furthermore,
the Fund will not be permitted to purchase interests
in l oans originated by the U.S. Fund or its affiliates
unless an independent party approves the purchase."
Id. at p. 67.

27

32.

The Offering Memorandum stated that instead of

making a direct investment, "[t]he [Offshore] Fund or a
subsidiary of the [Offshore] Fund may, however , accept an
assignment or, or participation in , a loan from the U.S . Fund at
a price approved by an independent third party . " Id. at p . 20 .
"The [Offshore] Fund believes that these activities should
qualify for the Safe Harbor since it will only be committing to
buy the interests in the loans after the loan terms are agreed
upon and will not in any event be obligated to make any
purchases until after the loans are made . Furthermore , the Fund
will not be permitted to purchase interests in loans originated
by the U.S . Fund or its affiliates unless an independent party
approves the purchase . " Id. at p. 67 .

33.

The Offering Memorandum stated that the inability

for the Off shore Fund to participate in certain transactions for
tax reasons could result in a disparity of performance between
the Offshore Fund and other investment vehicles managed by
Zwirn . In a 2005 internal email, Gruss noted that a recently
disparity in performance was because "there have been severa l
pops on a few assets that cannot go offshore be of ECI" ,
including "Oil/Gas Overides . Resi Platforms . "
22).

28

(Brody Deel . Ex .

Gruss has noted that Brody Deel. Ex. 22 is an email
exchange between Gruss/Kahn and a member of the DBZCO staff in
the London office , that there are many different causes for a
potential disparity in returns between the Onshore Fund and the
Offshore Fund, including most significantly, the leverage
attributed to the Onshore Fund's Col laterali zed Loan Obligations
("CLOs") .

34 .

As a result of tax laws , the Offshore Fund could

not "buy certain investments for itself," and the Onshore Fund
would have to buy and "season" the investments for anywhere
between 30 to 90 days before it could sell those investments to
the Offshore Fund. Ex. Z at pp. 31-33 ; Ex. R at pp. 9 7-1 00 , 14243; Ex. CC at pp. 72-74. The SEC has noted that this was not
only because of the tax laws but also because the Offshore Fund
Offering Memorandum specifically stated that it would not engage
in such investments, and that none of the evidence cited by
Gruss states that the investments were "seasoned" for a period
of 30 to 90 days and that Gruss told one investor that "[a]ll
loans will be seasoned a minimum of 90 days sometimes 110 days."
(Brody Deel. Ex. 32); see also (Brody Op. Deel., Ex. J at 24 :1423)

(90 days),

(Brody Op . Deel., Ex.Kat 98:21-24)

29

(90 days).

35.

Quarterly i nvestor letters sent from DBZCO to

offshore investors also noted that the offshore entities ,
i ncluding the Offshore Fund "do not expect to orig i nate loans . "
(Brody Deel . Ex . 23 at p. 5) . In response to a question from a
prospective investor about this language in the quarterly letter
and "does the offshore [fund] eventually participate via a
seasoning vehicle or does it never participate at all ," DBZCO
responded " [w]e are extremely sensitive to trade or business
issues related to our lending and assets business . Yes, while
the onshore fund originates the loans , for the majority of the
loans we can season them and then the Off shore Fund can
participate as well." (Brody Deel . Ex. 24) . Likewise, DBZCO said
that "[t]he fund is mindful of [sic.] Offshore Fund can ' t be in
the business of originating to US companies otherwise it would
be subject to 54 . 5 % US tax rate." (Brody Dee l . Ex . 25) .

This tax issue was regularly discussed with investors
and potential investors . In 2004, one investor emailed DBZCO as
part of its due di l igence and asked "does the manager generate
any Effectively Connected Income . "

36 .

(Brody Deel . Ex . 26) .

In 2005, Gruss told one investor doing due

diligence that "DB Zwirn seasons their loans in the onshore
[fund] for 90 days before they contemplate participating in the
30

loans by the offshore [fund].

[W]hen a loan is ready to be

sold to the offshore [fund], the loan is priced at fair market
value . . . . Prior to every sale to the offshore, DB Zwirn
utilizes an independent trading manager that determines if a
loan is 'offshorable' and the trading manager also opines on the
transaction price. The independent trading manager they use is
called the Taylor Group and they are based in Chicago."

(Brody

Deel. Ex. 27).

In another 2005 due diligence meeting with an
investor, Gruss said that the tax/ECI issue "is a focus of Perry
[Gruss] . They [DBZCO] have structured every deal in order to
avoid it. If needed, the offshore does not participate and deals
are held for 90 days. The lawyers told h1m deals should be held
30-60 [days] to avoid it [ECI] but practice may hit 90 days
eventually and they use 90 days for all deals going forward."
(Brody Deel. Ex. 28). Approximately a month after this meeting,
the same investor emailed Gruss and stated "ECI is become a
priority issue for us in many of our products and I was telling
[our CFO] of your dealings in this area and she would like to
speak to you at your convenience."

(Brody Deel. Ex. 29).

In a 2006 due diligence meeting between Gruss and a
potential investor, Gruss informed the investor that "[b]ecause
31

of tax issues associated with loan origination the Offshore Fund
does not participate in all trades" and that "[t]he Offshore
Fund historically underperforms the on shore due to tax issues
associated with loan origination." (Brody Deel. Ex. 30).

37 .

In response to an email from one investor about

whether offshore investors were invol v ed in loan origination ,
Gruss responded that they were not involved in loan origination
because of ECI issues.

38.

One investor had a specific call with Gruss about

whether the Offshore Fund was in the domestic lending business .
In this call , Gruss stated that "[a]ll loans will be seasoned a
minimum of 90 days sometimes 110 days . In addition to the
seasoning term all loans purchased by the Off shore Fund from the
onshore fund will have an independent 3rd party valuation group
price the loan . " Gruss also told the investor that he was
"confident enough portfolio statistics will be generated to
support a strong case that the Offshore Fund is not solely a
domestic lender." The investor noted that "[i]f an Offshore Fund
was found to be a domestic lender by the IRS the implications
would be very serious and could cause a very material impact . "
(Br o dy Deel. Ex. 3 2 ) .

32

39.

Gruss understood that the Offshore Fund could not

make certain investments because of "limitations" including that
it could not be deemed to be involved in a U.S. trade or
business because that would have "adverse tax implications" for
the Offshore Fund.

(Brody Deel. Ex. 4 at 77:14 - 78:3). Gruss

reviewed transactions to try and find ways to allow the Offshore
Fund to participate in investments "without incurring ECI."
(Brody Deel. Ex. 33)

40 .

Gruss candidly stated that ECI "scares the

[expletive] out of me." (Brody Deel. Ex. 34). Gruss may have
been scared about ECI because of its complexity and because it
would cause issues for the investors in the Off shore Fund if the
Offshore Fund was found to have engaged in a U.S. trade or
business. Gruss told Sylvia Wu ("Wu" ), the controller for the
funds, that because of tax reasons, the Onshore Fund could
orig inate loans while the Offshore Fund could not.

41.

Other members of the accounting department also

understood that if loan originations would come out of the
Offshore Fund, it would open the Offshore Fund to tax li ability .

The Off shore Fund Loans to the Onshore Fund

33

42.

The individuals in the accounting and finance

departments who reported to Gruss included Wu, Li Anne Law
("Law"), Robert Racusin ("Racusin"), Michelle O'Hara ("O'Hara"),
and Jason Pecora ("Pecora"). Josh Karotkin ("Karotkin") was also
in a line that reported to Gruss.

43.

The funds had various bank accounts. The main

bank account for the Offshore Fund was account ***600 at ABN
Amro . The main account for the Onshore Fund was account ***559
at ABN Amro . The SEC asserts that everyone in the accounting
department knew which account was which. When Law spoke with
Gruss about the accounts, they would refer to them by their
account numbers. Gruss knew that Ltd . Account #***600 was for
the Offshore Fund because it was one of the accounts most
frequently used at the custodian bank and was the shorthand way
the accountants referred to the account.

Gruss, however, asserts that he was not aware of the
identity of the account numbers for each account . Law testified
that when she spoke to Gruss about the Onshore Fund and Off shore
accounts, she used both the account number and the name of the
fund. Ex. BBB at p. 142 .

34

44.
Bear Stearns.

Each of the funds also had a brokerage account at
(Brody Deel. Ex. 17 at 52:9-12) The Offshore Fund

was referred to in shorthand as "Ltd" and the Onshore Fund was
referred to in shorthand as "LP." Id. at 53:3-6.

45.

During all relevant time periods, Zwirn and Gruss

were the two individuals at DBZCO who were authorized to
transfer cash from the funds.

(Brody Deel. Ex. 2 at 262:17-21).

Only one of their signatures was required to transfer money.
(Brody Deel. Ex. 17 at 55:19 - 56:6).

46.

DBZCO had no written manual of accounting

policies or procedures dur ing the relevant period of time. Nor
were there any written policies at DBZCO concerning the movement
of cash, however, the accounting departmen t

knew that Gruss was

the signatory on all fund accounts.

47.

The procedure for requesting that wires be made

from the funds accounts at ABN Amro was that "the account ing
team would send out the instructions [to the bank] and say
'Please do this wire' and th en [Gruss] would have to send an email reply back to al l that says okay to go. And then that wire
would go out." (Brody Deel. Ex. 16 at 55:13-18).

35

48.

There was a photocopy of Gruss' signature that

was used to fax wire requests to Bear Stearns when Gruss was not
available.

Id. at 47:1-3, 48:25 - 49:2. Most of the accounting

and operations team had a copy of the signature.

49.

Because money needed to be sent quickly and Gruss

was sometimes not available, the accountants would "take the
signature and take it to a photocopy and take it on the sheet
that we created, instruction that we created, and photocopy it
and to make it look like it was signed by Perry, and then fax it
to Bear Stearns." (Brody Deel. Ex. 16 at 48:20-24).

50.

Using Gruss' signature under these circumstan ces

was standard operating procedure at DBZCO. People talked about
using the photocopied signature since this was a standard
practice.

Gruss' signature was used "when he was out of the
office", Ex. ZZ at p. 50, or he "could not be located to sign a
wire." Ex. BBB at p. 47.

51.

Gruss was aware of this practice, approved the

practice, and joked about the practice saying "[h]ey, lo o k, here
is my fake signature." (Brody Deel. Ex. 16 at 49:3-13, 50:824;
36

Ex. 17 at 48:1-7 "joking atmosphere"). Gruss never complained
that his signature had been used in an unauthorized fashion.
Gruss even praised accountants after they used his copied
signature to get a wire out.

52.

(Brody Deel. Ex. 16 at 49:13-18).

The Onshore Fund consistently suffered from a

lack of available cash.

(Brody Deel. Ex. 1 at

<JI

14; Ex. 3 6 "we

are extremely tight right now"; Ex. 37 "pls don't

t~ll

me we're

out of cash"; Ex. 199; Ex. 38; Ex. 39 "we have negative really
big $$$$ - Wu is freakin. How do we avoid this in the future?";
Ex. 40 "Wu is losing it over the whole money thing"; Ex. 41 "US
=BROKE"; Ex. 42 "we owe at least $11M in cash we don't have
right now and that is a very conservative number"; Ex. 43; Ex.
44; Ex. 45; Ex. 46 "Onshore Fund is tight on cash"; Ex. 47
"tight"; Ex. 48; Ex. 49 "we should discuss our current funding
availability situation sometime today"; Ex. 50 "we need to start
exploring the idea of maintaining a min cash available amount
for each fund"; Ex. 51 "Onshore Fund is just about tapped"; Ex.
5 2 "not good. Onshore Fund is getting extremely tight"; Ex. 53
"we have no cash in Onshore Fund"; Ex. 54 "Do we need the money
today ... " "Not today, last Wednesday.") According to Gruss, the
use of the adverb "consistently" is an overstatement and that
whether the Onshore Fund at times had a lack of cash is
irrelevant.
37

53.

The Offshore Fund often did not have sufficient

cash on hand to fund new investments to which it had committed
capital.

(Brody Deel. Ex. 1 at

~

14; Ex. 55 at 85:4-8; Ex. 17 at

124:1-4 "Not enough subscriptions, investor subscriptions to
match the investments that were going out the door"). According
to Gruss, "often" is an overstatement.

54.

The Offshore Fund, however, "had more cash than

investment opportunities due to its inability to make
investments or loans directly in a U.S. trade or business
without being subject to a U.S. tax liability."
1 at

~

(Brody Deel. Ex.

15). Gruss has denied this statement.

55.

At times the funds had at their disposal many

sources of capital available to draw on for investments. These
sources included prime brokers, banks, affiliated funds, managed
accounts, structured vehicles such as the Offshore Fund and
Onshore Fund CLOs and other financing sources. These sources of
capital were continually evolving and expanding over time.
Depending on the type of investment and cash availability at
each of the sources, certain borrowing sources were preferred
over others. However, several factors influenced the Manager's
decision to use one funding source over another, including
38

investment type, financing vehicle constraints, cash
availability and differing tax consequences . Above all, the
Manager's goal , when determining its funding source, was to
maximize investor returns whenever possible .

The SEC has noted that the Offering Memorandum for the
Offshore Fund further provided that "the [Offshore]

Fund

will generally not invest in . . . other assets such as real
estate or make direct loans to or otherwise engage in the active
management of a U.S. company" (Brody Deel . Ex. 3 at 19-20) and
DBZCO and Gruss represented this limitation on the Offshore
Fund's ability to invest to the auditors , investors and
potential investors , and that Gruss made the statements referred
to in the FOF above.

56 .

In 2004 , a practice started where Gruss and the

accountants would take cash that was sitting in the Offshore
Fund and use that money to pay for Onshore Fund investments. As
described by Wu , the controller for the funds :

[W]e didn ' t have the money [in the US Fund] . We
received an email from the analyst , but we didn ' t have
the money to send the money out from the onshore fund .
And at that time, Bob [Racusin] and I were sitting to
next together and we want to figure out what to do and
we don ' t know what to do , and we go into Perry ' s
off ice and the three of us will have a -- the three of
39

us had a powwow and trying to figure out how to deal
with the situation. Perry asked me how much there is
in the onshore fund, how much there is in the Off shore
Fund, and how much the fund -- the analyst want to
send out , and we will come up with suggestions. I said
to him before that , like, he could -- can we lend the
money that we have excess sitting at the Offshore Fund
and lend it to the onshore fund, and we create like an
intercompany loan and charge interest, and once the
onshore fund has money, it can pay back. And he said
no, you cannot do that because of some tax reason,
that the Off shore Fund cannot lend to the onshore
fund. I didn't remember the exact details of it, but
it's just a "Nou answer. And then I also said can we
lend money directly from the Off shore Fund to the
borrower so we have enough money, since we have enough
money in the Offshore Fund. And he said no, the loan
cannot be originated from the Offshore Fund. And then
he said that since we will have money coming in, you
know, next week or so for the new subscriptions of the
onshore fund, we can send the money out from the
Off shore Fund now and then we can repay -- when the
subscription money comes in, we can repay the Offshore
Fund. And since that was the only alternative that we
had, and so that's what we did.

Brody Deel. Ex. 16 at 63:4 - 64:13 .

According to Gruss, on cross-examination in her
deposition, Wu stated that she was confused as to what she was
told by Gruss, did not understand that the tax reason as to why
the Onshore Fund could not lend money to the Offshore Fund with
interest was because the act of lending money with interest
could arguably place the Off shore Fund in engaging in the trade
or business of loaning money. Wu also confused "loan
originationu by the Onshore Fund with the Offshore Fund

40

advancing funds to the Onshore Fund so it could originate the
loans that were the investments that the Onshore Fund would
season and later provide to the Offshore Fund.

57.

It was Gruss' idea to use the money from the

Offsh ore Fund to fund the U.S. Fund's investments. Id. at p.
64 :14-1 8. Wu recalled that the initial conversation was
essent iall y "[b]asically we are screwed; what are we going to
do. We have no money. That dude back there wants the money out .
What are we going to do." Brody Deel. Ex. 16 at p. 65 :1 0 -14.

Gruss has denied this statement asserting that the
answer was to a leading question by the SEC that should be
suppressed as a violation of Fed. R. Evd. 611(c) because Wu was
a witness for the SEC, had entered into a cooperation agreement
with the SEC (Ex . AAA), the question was asked on direct
examination and the witness was not hostile to the SEC or
identified with Gruss and the remaining statements are
inadmissible hearsay in which Wu relates a conversation she had
with Racusin.

58.

Wu was un comfortab le with the practice of moving

"money from the Offshore Fund in order to fund the onshore fund
obligations ," Brody Deel. Ex. 16 at 33:20 - 34 :1 2 , because she
41

was "told that we were not supposed to lend money from the
Offshore Fund to the onshore fund. So since I was told that, so
I

thought we had - as a hedge fund manager, you are supposed to

have fiduciary duty to your investors, so we're doing something
that wasn't beneficial to the investors." Id. at 72:25 - 73:5.

Gruss has denied this statement as inadmissible as the
operation of Wu's mind, and has noted she did not explain her
"reasoning to him [Gruss]," did not know what the funds could or
could not legally do under their Offering Memoranda and
formation documents, that she had never read any of the fund
Offering Memoranda to determine whether the Off shore Fund could
advance funds to the Onshore Fund and had the title of
"Controller," but stated she was "essentially a bookkeeper at
D.B. Zwirn." Id. at pp. 21 , 232.

59.

Wu told Gruss that she was un6omfortable with the

practice "and we really need to find some solutions to this
I

asked him if Dan Zwirn knows about what we are doing, and

basically tell him that this is causing me a lot of stress." Id.
at 72:5-13.

Gruss has noted that Law testified that "[n]o one
acted like it [the LTD advancing funds to the Onshore Fund] was
42

wrong" and "nobody told

[her] that this was illegal" and

that it was "stressful" because it was "an accounting headache
that we needed to clear as soon as we could" and that "it was
creating a l ot of accounting work and responsibilities." Ex. BBB
at pp. 174, 198-99. "[T]he monies that went from the Offshore to
the Onshore , this all had to be done the last minute, and the
money had to be moved in and it was extremely stressful." Id. at
p. 263. Gruss testified that Wu attempted to resign 5 times
before she actually left because of stress.

60 .

Wu told Gruss numerous times that she was

uncomfortable with the practice because "we're not supposed to
do this , so we need to do something." Brody Deel. Ex. 16 at
73:8-13. Wu even joked with Gruss that the y were going to go to
jail because of the interfund transfers.

Id. at 97 :10-1 7 . When

Wu had thes e co n versations with Gruss, at no point did Gruss say
that this practice was allowed under the offering documents.

Id.

at 75:25 - 76:4.

According to Gruss, Wu's statement about "going to go
to jail because of the interfund transfers "in fairness ought to
be cons idered " along with Wu's admission that "she did not know
if it [t he LTD advancing funds t o the Onshore Fund] could be
legal," Ex. ZZ at p. 12 2 .
43

61.

Wu threatened to quit numerous times over the

interfund transfers and each time would have discussions with
Gruss about the practice. Brody Deel. Ex. 16 at 74:10-12. The
gist of the conversations was that she felt "very uncomfortable.
We cannot do this, and this thing just keeps snowballing and
it's not getting any smaller and we just cannot do this, it's
not right, and I feel very uncomfortable." Id. at 74:17-24.
Gruss' response to Wu's concerns was "we will figure out
something." Id. at 74:25 - 76:1.

According to Gruss, Wu's statements must be considered
in light of Gruss' and Law's testimony that the concern was not
about the legality of the practice but rather the stressful
accounting work it created and Gruss' testimony that Wu's
concern was also about the size of the receivable from the
Onshore Fund to the Offshore Fund.

62.

Gruss admitted in words or substance that Law

and Wu both raised concerns to him regarding the interfund
transfers and Pecora raised concerns about the CDC-related
interfund transfers. Gruss admitted that Wu and Law both quit
over the interfund transfer practice.

44

(Brody Deel. Ex. 184).

Gruss admitted the statement in part and denied it in
part noting that as referenced above, Law and Wu were concerned
not about the legality of the practice but about the stress it
placed on them to accomplish the accounting and bookkeeping that
resulted from the Offshore Fund advances to the Onshore Fund and
that Pecora's concern was that the advances from the Offshore
Fund to the Onshore Fund were not booked in the sub-ledger as
formal interest bearing loans as opposed to advances, Ex. EEE at
pp. 67 - 69 , and that the statement that "Gruss admitted that Wu
and Law both quit over the interfund practice" is not accurate.
Gruss further notes that while Wu testified that the "burden" of
the inter-fund transfers were the main reason she resigned, Ex.
ZZ at pp. 74, 117, Law testified that Wu "tried to resign a
number of times" because of "stress in general," which did not
help her depression for which she was consulting with a
physician, Ex. BBB at pp. 302 - 04, and Law also admitted that one
of the reasons she resigned was because of DBZCO's internal
investigation into the purchase of the airplane and the early
payment of management fees,

Id. at pp. 212 -17, and that it was

the investigation of the airplane and management fees that
"pushed" her into "action." Id. at pp. 212-13. Gruss further
notes that Law testified that one of the reasons she explained
to Gruss as to why she was resigning "was the aggressive growth
of the firm, and .

[she] basically felt that there was a lot
45

of extra workload coming down to the back office. It was like
expanding too much of the top, without giving any thought to
whether the back off ice was structurally ready to accept that
increased workload. So it was very crippling and that was very
frustrating as well".

63.

Id. at pp. 172-3.

In 2007, the accounting firm Deloitte Onshore

Fund ("Deloitte") reviewed the books and records of DBZCO and
determined that in at least the following instances, the
Offshore Fund funded an investment for another entity managed by
DBZCO (including the Onshore Fund) where the Offshore Fund did
not initially participate or where its initial participation was
less than the amount it funded:

46

Name of Investment

Funding Date

LFG

26 - Mar - 04

Suncruz

Funding F r om
Of f shore
Fund

Initia l
Participa t i o
n by
Offsho r e
Fund

$377 ' 715

0%

9- Apr - 04

$10 , 000 , 000

9- Jun - 04

$3,266 , 252

0%

L Group

9-Jun- 04

$5 , 400 , 000

0%

Cornerstone

14 - Jun - 04

$414 , 417

Levitz

1 8 - Jun - 04

$6 , 000 , 000

svs First

28 - Jun - 04

$990 , 000

Genutrec

4- Ju l- 04

I nterim Saddleback

x

0%

Comcap

Transfer
Repaid
Entirely
in Cash

x

Investment
in U.S.
Real
Estate

Cash
Trans f er
from
Offshore
Fund
Directly
to
Investment

x
x
x

x

x

50 %
($207 ' 706)
50 %
($3 , 000 , 000)
0%

x

$3 , 540 , 500

0%

x

16 - Ju l- 04

$6 , 051 , 500

0%

Northlake

29 - Jul - 04

$17 , 500 , 000

0%

x

JPMX X

16- Aug - 04

$999 , 990

0%

x

Priority

30 - Aug - 04

$975 , 000

0%

x

LFG

30 - Aug - 04

$447 , 500

0%

x

x

LFG

12-0ct - 04

$268 , 518

0%

x

x

Cornerstone

14 - 0ct - 04

$410 , 022

x

Quantum

25 - 0ct - 04

$16 , 800 , 000

50 %
($205 , 50 1 )
0%

Kimco

26- 0ct-04

$2 , 055 , 290

0%

x

GP E

23 - Nov- 04

$15 , 000 , 000

x

NCC

29 - Nov - 04

$14 , 690 , 385

40 %
($6 , 000 , 000)
0%

Brantley

20 - Dec- 04

$3 ,1 07 , 815

0%

Schilling

27 - Jan - 05

$999 , 014

Davidson

28 -Jan - 05

TLC

x
x

x

x

x

x

x
x

x

x

0%

x

x

$18 , 596 , 150

0%

x

x

ll - Feb- 05

$27 , 500,000

0%

x

x

HeOnshore Fund

15 - Feb- 05

$16 , 273,485

0%

x

Heon shore Fund

18 - Feb-05

$12 , 805 , 000

0%

x

Tremont

4- Mar - 05

$19 , 000 , 000

0%

Malara

8 - Mar - 05

$27 , 918 , 485

0%

47

x

x
x

x

x

x

Markley

22 - Mar - 05

$20 , 920 , 380

0%

Lifesource

14 - Apr - 05

$1 , 005 , 774

0%

x

x

Sununitbridge

15-Apr - 05

$4 , 190 , 000

0%

x

x

LS Reo

18 - Apr - 05

$3 , 000 , 000

0%

RIH Investment

19 - Apr - 05

$5 , 000 , 000

0%

x

x

x

Hudson Spokane

27 - Apr-05

$3 , 358 , 055

0%

x

x

x

River Island

5 - May-05

$25,000 , 000

0%

x

LLJ Precis

16-Jun - 05

$7,849,808

0%

Marquette

14 - Jul - 05

$14 , 422,470

0%

Lotus

25 - Jul - 05

$8,250,000

0%

x

Copper Canyon

25 - Jul - 05

$27 , 529,057

0%

x

Port Cardig

23 - Aug - 05

$14 , 850 , 000

0%

x

Latam

24 - Aug - 05

$2 , 307,337

x

Vision Bozeman

24 - Aug - 05

$4 , 400 , 000

70 %
($1 , 615 , 136)
0%

Tremont

25 - Aug - 05

$6 , 192 , 263

0%

SWB

9- SeI? - 05

$1 , 177 , 200

Petro Edge

15 - Sep- 05

$330 , 080

Chesapeake/Shelly

15 - Sep- 05

$2 , 227 , 500

65 %
($765 , 180)
76 %
($252,294)
0%

Ext ell

12-0ct- 05

$5 , 064,006

0%

Solana

17 - 0ct - 05

$26,000 , 000

0%

Ireo

21 - 0ct - 05

$3,212 , 000

25 %
($803,000)

x

Vanguard

l-Nov- 05

$7 , 839 , 393

0%

x

x

Project Taka

10 - Nov- 05

$4 , 783,126

0%

x

x

DPH

21 - Nov - 05

$2 , 500,000

x

MBW

1 - Dec-05

$17 , 379 , 295

53 %
($1,325,000)
0%

INT Ventana

l - Dec - 05

$3,349,344

x

Longroad HOP

9- Dec - 05

$5,987 , 224

Davidson

9- Dec - 05

$391 , 879

95 %
($3 , 181, 877)
50 %
($2 , 993 , 612)
0%

Sununitbridge

22 - Dec- 05

$2,450 , 000

0%

x

x

Kaufman

ll - Jan - 06

$7 , 692,760

0%

x

x

Plant

30 - Jan - 06

$12,610,000

Pilot Barrington
Broad

30 - Jan - 06

$5 , 060 , 556

Davidson

31 - Jan - 06

Da Vinci

6- Feb - 06

x

x
x

x

x
x

x
x

x
x
x

x

x

x

x

x

x

x

x
x

x

43 %
($5 , 399,414)
50 %
($2 , 519 , 948)

x

$16 , 600 , 000

0%

x

$25,000 , 000

50 %

x

48

x

x

($ 1 2 ,5 00 , 000)
0%

I nterim Apex

28 -Fe b - 06

$6 , 745 , 000

Ve rmilli on

10 - Mar - 06

$10 , 000 , 000

Summitbridge

13 - Apr-06

$2,930 , 000

80 %
($8 , 000 , 000)
0%

Interim Mt. Lau

17-Apr-06

$6 , 650 , 000

0%

Ire o

25 - May- 06

$3,400,000

x

82 %
($2 ,7 97 , 829)
($ 51, 566, 4 97)

Total Funding

$559,041 , 545

Le ss Ini t i al
Part icipation

x
x
x

x
x

($51 , 566 ,4 97)

Total Advance s

x

$507 , 475 , 048

Gruss has objected to the chart and i t s use on the
grounds that this chart changes the SEC ' s theory and factual
al l egations from the amended complaint where it is alleged that
there were "$576 mil l i on i n [ 85 ] t ransfe r s between March 2004
and Ju l y 2006 .

. to fund Onshore Investments" " for the

benefit of the Onshore Fund ." According to Gruss , these factual
allegations were supported by the Delo i tte work papers that
showed that the 85 transfers amounting to $576 million was
derived from a chart prepared by Deloitte and represent 66
investments purchased , i n whole or in part , from funds advanced
to the Onshore Fund by the Of f shore Fund. Ex. AA at pp . 5 1- 52 ;
Gruss Dec . Ex. A; Gruss Dec . Ex . B and the above chart expands
and changes the a l lega ti on beyond t h e Of f shore Fu nd advancing
funds to the Onshore Fund for investments to any " entity managed
by DBZCO " to those instances where "t he Offshore Fund funded an
investment for another entity managed by DBZCO (i ncluding the

49

x

Onshore Fund) where the Offshore Fund did not initially
participate or where its initial participation was less than the
amount it funded."

According to Gruss, the transactions reflected on this
chart representing the advancement of funds from the Off shore
Fund to the Onshore Fund and other DBZCO managed funds were
permitted by the funds' Offering Memoranda and operating
documents. Gruss further has asserted that the c hart's emphasis
on "Initial Participation by Offshore Fund" is misleading and
contrary to the Offshore Fund's Offering Memoranda that provides
that "the Fund may acquire interests in loans

(including leases

treated as financings for U.S . Federal income tax purposes) ,
revolvers and letters of credit originated by the U. S. Fund or
its affiliates and may make such investments through subsidiary
vehicles," Ex. Mat p. 67, and that in certain instances, the
Onshore Fund regularly "seasoned" those interests in loans
between 30 to 90 days before they were transf erred to the
Offshore Fund . Ex. CCC at pp. 3 1-3 2 ; Ex. UU at p . 97 ; Gruss
Declaration,

~

8 . Further , Gruss asserted that the Chart fails

to reflect that the Offshore Fund subsequent to its advance of
funds t o the Onshore Fund was later provided ownership interests
in the following investments : Suncruz, Comcap, L Group, SVS
First, Interim Saddleback, Northlake, NCC, Copper Canyon, Port
50

Cardig, and Solana. The Onshore Fund also later provided the
Offshore Fund with an ownership interest in Bantley, DT 1892,
1914; Latam, DT 1896-7, 1921 and Interim Apex, DT 1795, 1892,
1854. Gruss further has asserted that the Chart omits to
acknowledge that the Offshore Fund received interests in the
following investments, portions of which were transferred to the
Offshore Fund's CLO , Bernard Global: Priority, Schilling,
Davidson, TLC, HeOnshore Fund, Malara, River Island, LLJ Precis,
Extell, Davidson, and Plant, see Ex . C at B01801, and further
omitted to acknowledge that the Offshore Fund received interests
in the following investments through its mezzanine investment in
the Onshore Fund's CLO: Priority, Quantum , Davidson , TLC,
Malara, and Markley. Ex. FF at p. 50.

64 .

In some cases, the Offshore Fund received a

combination of cash and a portion of the investment as
reimbursement for the money that it had advanced. In certain
instances, however, the Offshore Fund did not participate in the
investment at all and only received cash as its reimbursement.

According to Gruss, these advances were permitted by
the Operating Documents and were part of the investment process
among the DBZCO managed funds and that the SEC can only prove in
its allegation of "$57 6 million" in the amended complaint that
51

"the LTD had not advanced .

$126,896,039 to the Onshore Fund

for the purchase of investments for which it does not appear the
LTD ever received any participation" and "without the complete
records of DBZCO," Gruss is "unable to identify which portions
of the investments represented by the remaining $126,896,039 out
of the $576,124,932 in cash transfers from the LTD to the
Onshore Fund were ultimately transferred to the LTD." Gruss
Declaration,

65.

~

9.

As of the time that Deloitte completed its

review, the Offshore Fund had not yet been reimbursed for some
of the advances that it had made. In March 2007 when DBZCO
informed the investors about the interfund transfers, it stated
that the Onshore Fund at that time owed in excess of $100
million to the Offshore Fund and to a managed account.

66.

In some cases, the Offshore Fund sent the money

to the Onshore Fund, which then funded the investment (in most
cases a loan). Mostly, however, the Offshore Fund sent the money
directly to the borrower.

According to Gruss, whether the Offshore Fund sent the
advance to the Onshore Fund directly to the investment is
irrelevant because DBZCO had the right under the Operating
52

Document to arrange for the Off shore Fund to advance cash to the
Onshore Fund reflected on the funds' books and records as a
receivable and payable on each of the funds' corresponding
balance sheets.

67 .

Certain of the Onshore Fund's investments that

were funded by the Off shore Fund were real estate investments in
the United States . According to Gruss, the Chart does not
reflect which investments are real estate investments.

68 .

The 85 transfers amounting to $576 million was

derived from the chart prepared by Deloitte and represent 66
investments purchased, in whole or in part, from funds advanced
to the Onshore Fund by the Offshore Fund.

The SEC notes that it used additional detail provided
by the Deloitte documents to revise the interfund transfer
amount from $576 million to $507 million.

68 .

Of those 66 investments, in the regular course of

DBZCO's management of its investment process, the Offshore Fund
participated in 45 of those investments through direct
assignments from the Onshore Fund to the Offshore Fund or
indirectly through its subsidiary Le Moyne Avenue Investors,
53

LLC, and/or to the Offshore Fund's CLO [Collateralized Loan
Obligation], Bernard Global.

The SEC has noted that the Off shore Fund may have
ultimately participated in some fashion was not linked to the
initial advancement of cash and in Comcap, the Offshore Fund
advanced the money for the Onshore Fund to make its $3,266,252
investment, which was repaid in full by the Onshore Fund more
than 5 months before any of the investment was transferred to Le
Moyne, and in 32 instances identified by Deloitte, the advance
made by the Offshore Fund was repaid in cash.

70.

As a way to invest in other Onshore Fund assets ,

the Offshore Fund made several direct investments in the
Mezzanine Tranche of the Onshore Fund, Bernard National, which
totaled $141 ,0 00 , 000 as of December 31 , 2006. Approximately $449
million of the approximate $576 million cash from the Offshore
Fund alleged in the complaint was not used to make investments
for the benefit of the Onshore Fund but was in fact used to make
investments for both the Onshore Fund and Off shore Fund, and at
most, approximately $127 million of Offshore Fund funds were
used only to "fund Onshore Fund investments." Gruss Dec., i

54

3.

The SEC has disputed the statement and has noted that
in 32 instances identified by Deloitte (including in cases where
the Offshore Fund ultimately participated in the investment),
the Off shore Fund was repaid entirely in cash and that the
Offering Memorandum stated that the Offshore Fund:

(1) could not

purchase interests in the loans to United States companies until
after the loans had been made;

(2) could not even be obligated

to make purchases until after the loans were made; and (3) could
not purchase interests in such loans until an independent party
approved such purchase.

(Brody Deel. Ex. 3 at 20 , 67) The SEC

also asserts that Gruss told one investor that "DB Zwirn seasons
their loans in the onshore [fund] for 90 days before the y
contemp late participating in the loans by the offshore [fund]."
(Brody Deel. Ex. 36) . According to the SEC, the fact that the
Offshore Fund might have participated in the investment at some
later point in time does not make it appropriate for the
Offshore Fund to have advanced the money.

71 .

Certain of the investments at issue ultimately

acquired by the Offshore Fund could not initial ly be assigned to
the Offshore Fund because of the U.S. tax laws that prohibited
the Off shore Fund from engaging in a trade or business i n the
U.S. Before any investment was made, DBZCO included in its
investment analysis whether or not an investment was eligible to
55

be made by the Offshore Fund , whether at the time of initial
funding or at a later date , via a transfer from the Onshore Fund
to either the Offshore Fund directly or through its subsidiary
or CLO. This analysis included making certain it was an
investment that fit into the tax parameters spelled out in the
Off shore Fund Offering Memorandum.

The SEC did not dispute the first sentence of this
statement but disputes the remainder of the statement supp o rted
only by the declaration of Gruss, noting that with respect to
the Vanguard investment (one of the investments where the
Off shore Fund provided the money for the funding and never
participated in the investment), there was no discussion in the
investment analysis as to whether or not the investment could be
made by the Offshore Fund , and Gruss told an investor that "DB
Zwirn seasons their loans in the onshore [fund]

for 90 days

before they contemplate participating in the loans by the
offshore [fund] . "

72 .

(Brody Deel. Ex. 36.)

DBZCO invested in a number of joint ventures such

as Horizon where the Offshore Fund could not initially
participate in the investment because the joint venture was
engaged in a U.S. trade or business. However, it was always the
intention from the outset of the investment in these joint
56

ventures that DBZCO would restr u cture these joint ventures so
portions of the investments cou l d be assigned to the Off shore
Fund. In connection with that intent , DBZCO hired a full-time on
staff attorney who was charged with the task of restructuring
these joint ventures so portions of these investments would be
eligible for assignment to the Offshore Fund .

The SEC did not dispute the first sentence of this
statement but denies the remainder of the statement as not
supported by the evidence cited since the emails do not state
anywhere that it was the intention from the onset that the
Horizon joint venture be restructured so that portions could be
reassigned , and that DBZCO hired an attorney to restructure the
joint ventures . The SEC further has asserted that the
declaration of Gruss is contradicted by his statement to an
investor that "DB Zwirn seasons their l oans in the onshore
[fund] for 90 days before they contemplate participating in the
loans by the offshore [fund] . "

(Brody Deel. Ex . 36 . ) The Gruss

declaration is further contradicted by the language in the
Offshore Funds ' Offering Memorandum that the Offshore Fund:

(1)

could not purchase interests in the loans to United States
companies until after the loans had been made ;

(2) could not

even be obligated to make purchases until after the loans were
made; and (3) could not purchase interests in such loans until
57

an independent party approved such purchase.

(Brody Deel. Ex. 3

at 20 , 67).

73.

Certain joint ventures were restructured and

portions of the underlying investments were transferred to the
Offshore Fund. However, without the complete records of DBZCO,
there is no way to identify which portions of the investments
represented by the remaining $126,896,039 out of the
$576,124,932 in cash transfers from the Offshore Fund to the
Onshore Fund were ultimately transferred to the Offshore Fund.
That the Onshore Fund initially purchased the investments and
subsequently provided a portion of the investments to the
Offshore Fund was consistent with the Onshore Fund's undisputed
role as the sourcing agent for investments for the Off shore Fund
and other funds managed by DBZCO. See Ex. D at p. 8 (The Onshore
Fund "was frequently utilized as a sourcing agent to acquire
select investments for the fund complex , and often these
investments were not immediately available to the Off shore
Fund."), Ex. Z at pp. 22-25, Ex. Y at pp. 121-22, Gruss Dec .,

~

6.

The SEC did not dispute that in certain instances the
Onshore Fund purchased an investment and subsequently sold a
portion of that investment to the Off shore Fund but has noted
58

that with respect to the assertion that the Onshore Fund was the
"sourcing agent " for investments for the Offshore Fund and the
other funds managed by DBZCO, the source for this statement is
the expert report of Dr . Bergin and is not the proper subject
for expert testimony and that the testimony of Scott Sulzberger
("Sulzberger") stated only that "there are occasions" where the
Onshore Fund acted as agent on behalf of the other funds.

(Gruss

Ex. Z at 22:24 - 23:3) and that the testimony of Li Anne Tan
("Tan" also known as Li Anne Law or "Law") was that the Onshore
Fund was not acting as an agent with respect to the investments
that were "seasoned" and sold.

(Gruss Ex. Y at 121:13-21). The

SEC further notes that the Gruss declaration at

~6

similarly

does not state that the Onshore Fund was a "sourcing agent."

74.

Even though there is no provision in any of the

Funds' Offering Memoranda to conclude that the Onshore Fund owed
the Offshore Fund interest for the use of its funds for
investments solely for the Onshore Fund or to pay down the
credit line of the Onshore Fund, PWC used the interest not paid
to the Offshore Fund for the use of its money to determine the
materiality of these transactions.

The SEC did not dispute this statement but noted that
such transfers were not allowed and would not have been
59

contemplated and Gruss repeatedly told the attorneys conducting
the internal investigation for DBZCO that money from the
Off shore Fund needed to be kept separate from the money from the
Onshore Fund to avoid ECI issues and that it was well-known that
a transfer from the Off shore Fund to the Onshore Fund would
raise ECI and "trade or business concerns "

(Brody Deel. Ex. 182;

Ex. 57 at 111:10-24 , 113:16-23) and that an arrangement where
the Off shore Fund would loan money to the Onshore Fund to pay
its debts, fund its investments or operate its business would
raise ECI issues and would not be permitted under the funds'
offering documents.

75 .

(Brody Deel. Ex. 184; Ex. 57 at 117:14-20)

Deloitte did not find any evidence that the

Offshore Fund received any interest on the money that it
advanced. Deloitte did not find any l oan documentation for any
of these advances that would show when the money needed to be
paid back.

According to Gruss, the money the Offshore Fund
advanced to the Onshore Fund "were really more advances than
anything else or monies transferred" reflected on the Annual
Financial Statements not as loan but as "Due to affiliates" or
"Due from affiliates ." Ex. E at 2 , Ex. Fat 2, Ex. G at 2 , Ex H
at 2 , Ex. I at 2 , Ex. J at 2 and all the amounts due between and
60

among all of the funds were recorded and tracked on a daily
basis in DBZCO's accounting system in an account known as
DZPRIV. Ex. BBB at pp. 277 -7 8.

76.

The SEC asserts that Gruss authorized ABN Amro to

transfer the money from the Offshore Fund's accounts to fund
these investments.

(Brody Deel. Ex. 58). According to Gruss, the

emails (Brody Deel. Ex. 58) show that Gruss authorized ABN Amro
to transfer the money from the Offshore Fund's account to fund
the following investments: IREO, Vermil li on , Pilot Group,
Kaufman , Longroad Hop, Chesapeake , Tremont, Vision - Bozeman, LLJ
Precis, River Island, Hudson-Spokane, Barrett, and Markley.
Certain of the emails in Brody Deel. Ex. 58 reflect transactions
between certain funds managed by DBZCO and unrelated third party
funds and were unrelated to any inter-fund transfers and Gruss
understood these wires were to fund investments and knew which
investments were being funded.

(Brody Deel. Ex. 16 at 56:1-4 "he

is very well aware of all the deals in the pipeline; Ex. 55 at
37 :1 0-18). He regularly received a "pipeline report" that
"showed all of the upcoming ... fundings and repayments that
were happening at the firm."

(Brody Deel. Ex. 35 at 30:12-16)

All private investments appeared on the pipeline report.
30 :1 7 - 23.

61

Id. at

77.

Gruss also attended a meeting every Monday with

Zwirn to discuss "what we called the pipeline of new deals that
were coming down. So in that meeting ... we would discuss which
deal and that they were loan originations , and in knowing that
they were loan originations, that they were to come out of the
onshore fund."

(Brody Deel. Ex. 18 at 39:3 -10; 41:2-4). The

pipeline report was reviewed in detail at these meetings.

(Brody

Deel . Ex. 35 at 35 :1 6-1 9) .

78 .

While Gruss may not have been aware of subsequent

drawdowns if there was a revolving credit facility and the
borrower did not immediately draw down the entire amount, "the
bigger ones or the initial closing of a deal, he would
definitely, obviously know." (Brody Deel . Ex. 16 at 56:5-17)

Without specificity as to the identity of the "bigger
ones," Gruss declined to respond to this paragraph.

79.

Gruss would regularly receive emails prior to an

investment being funded that explained exactly where and how
much money was going to be wired.

80.

On March 26 , 2004 , at 1:01 pm, Gruss and Wu

received an email stating that $877,744.15 needed to be wired in
62

order to fund the LFG investment.

(Brody Deel. Ex. 59). The

email instruction also included the principal amount, the
interest rate, and the loan maturity. The email also stated that
"[t]he loan should be booked as follows -LawFinance 03/04 Berry-Microsoft." Id. At 1:40 pm, Wu sent an email to the bank
providing wiring instructions, including that $377,714.55 should
come from the "HZLTD #***600 account, i.e. the Offshore Fund
bank account, "upon Perry's approval." (Brody Deel. Ex. 60). At
6:45 pm, Gruss sent an email to the bank approving the
instructions to wire money from the Offshore Fund account.

Id.

The email in question .(Brody Deel. Ex 59) appears to show
Zwirn's approval since prior to the word "approval" is a "Z"
with the previous letters blocked out by a paper punch hole.
(Brody Deel. Ex. 59).

On June 28 , 2004 , Gruss received an email concerning
the funding for an investment called "Service First." The email
stated: "We are funding Bridge Funding - Service First today.
DZ's approval is attached below, and I have also attached wiring
instructions/escrow letter from Bridge Funding's counsel , along
with signed docs from Bridge Funding. The total loan amount is
$1,100,000 and our loan amount is 90% of the total

(10 % part to

Bridge) or $990,000." (Brody Deel. Ex. 61). Several hours later,
Law sent an email to the bank instructing "[p]lease wire
63

$990,000 from the Ltd account #***600 to the following
instructions. PG ' s approval to follow. Thanks." (Brody Deel. Ex.
62). Later that evening , Gruss emailed his approval of the wire
transfer to the bank .

On July 14, 2004 , Gruss , Wu, and Law were emailed
instructions concerning a $3 , 540 , 500 investment called the
" Genutec Funding." (Brody Deel . Ex . 63). The email stated
"attached please find the settlement statement and participation
agreement for the GenuTec funding. Please send the $3 ,5 40,500 . 00
to the standing wire instructions below ." Id. Later that day ,
Law emailed the bankers an email stating : "Please transfer
$3 , 450,500 from the Ltd account# ***600 .... PG ' s approval to
follow. Thanks. "

(Brody Deel . Ex. 64) . Gruss subsequently

approved the transfer from the Offshore Fund account .

On February 23, 2005, Gruss received an email
concerning an investment called "Tremont/Bloomfield" stating :
"PG - reminder that we will be funding this deal early next week
(Monday or Tuesday). I t ' s a $35 mill i on deal but we will only be
funding approx . $21 million at closing. "

(Brody Deel . Ex. 65) .

On March 3, Gruss , Law and Wu received another emai l providing a
closing statement for the Tremont/Bloomfield investment, which
was now approximately $24 million .
64

(Brody Deel. Ex. 66) . On

March 4, Gruss, Law and Wu received the wiring instructions for
the Tremont/Bloomfield investment with the instruction "[w]ill
let you know when to send - will be very soon." (Brody Deel . Ex.
67). Approximately an hour later, Gruss, Law and Wu received the
final approval to send the money as per the instructions. Five
minutes lat er , Law sent the email to the bank asking it to
process several wires for Tremont/Bloomfield, including to wire
$19 million "from the LTD account # ***600 to the Onshore Fund
acct # ***599 ." (Brody Deel. Ex. 69) . Thirtee n minutes later,
Gruss sent an email to the bank approving the wires, including
the wire from the Offshore Fund .

81 .

After numerous transfers from the Offshore Fund

in order to fund Onshore Fund investments , the accountants who
worked under Gruss expressed their displeasure with this
practice. In April 2005 , DBZCO decided to invest money in
certain real estate assets being sold by Hudson Advisors Taiwan
(the "REO portfolio").

(Brody Deel. Ex. 70.) After receiving the

instruction to fund this investment, Law emailed Gruss asking
"should we fund this from Ltd???" Id. After Gruss responded
"[y]es p l s" Law wrote back "[j]ust curious - is there a game
plan? Or is this something that the DBZ backoffice must 'learn
to accept.'" Id. When Gruss responded "what's our alternatives
[sic.]", Law stated: "Get all the partners/top mgmt in the loop
65

(i.e. REALITY) and then have them make a joint mgmt decision."

Id. According to Gruss, mail was sent by Law but at her
deposition, she admitted she was simply trying to solve the
stressful accounting issue.

82.

Notwithstanding the criticism of the practice

from his subordinates, Gruss continued to fund Onshore Fund
investments from the Offshore Fund. At the pipeline meetings,
Gruss did not tell Zwirn that the Offshore Fund was funding an
Onshore Fund investment.

(Brody Deel. Ex. 71 at 115:2-6). Gruss

did not tell Zwirn that the Onshore Fund did not have sufficient
cash to make investments, or that the only way that the Onshore
Fund could make an investment would be if Zwirn raised
additional funds for the Onshore Fund.

(Id. at 111:3 -112:16;

Brody Deel. Ex. 35 at 42:25 - 43:12). Gruss did not review the
cash positions of the Onshore and Offshore Funds at the pipeline
meetings.

(Brody Deel. Ex. 71 at 112:19-22).

According to Gruss, the so-called "criticism from his
[Gruss'] subordinates" was not, as stated above, directed at the
legality of the Offshore Fund advancing funds to the Onshore
Fund. Gruss has asserted that none of these subordinates had
read the Offering Memoranda or the fund operating documents, and
that Gruss did review the cash position of the Offshore Fund and
66

Onshore Fund at the pipeline meetings. Ex. FFF at p. 389; see
also Ex. YY at p. 129; Ex. XX at pp. 89 , 126-27. Further, Gruss
asserts that the Pecora testimony relied upon by the SEC only
reflects that Pecora did not recall Gruss going "through the
cash position of the Onshore Fund and Offshore Fund funds."
(Brody Deel. Ex. 71 at 112:19-22).

83.

Indeed, the day after receiving the email from

Law concerning the REO portfolio, Gruss received a funding
request for RIH Co-Investment Partners concerning "project grand
slam." (Brody Deel. Ex. 86). The email to Gruss attaching the
instructions to wire $5 million stated: "This is ok to fund. RF
sent the capital call request from Colony Capital (lead
sponsor). We executed dox several weeks ago." Id. At 2 : 23 pm , a
member of the accounting department sent an email to the bank
stating "[p]lease wire $5,000,000 from Offshore Fund account
#***600 to the following account .
follow."

. PG's approval will

(Brody Deel. Ex. 203) . Five minutes later, Gruss sent

his email to the bank approving the transfer from the Off shore
Fund.

84.

In September 2005 , Gruss was told that DBZCO was

purchasing 270 , 000 shares of a company called SWB in a PIPE
transaction.

(Brody Deel. Ex. 72). The investment was for
67

$1,177,200. On September 7, 2005, Gruss decided to allocate this
investment between the various funds in the following fashion
Offshore Fund (65 %) , Onshore Fund (15 %), LLC (15 %) , TE (5 %).
(Brody Deel. Ex. 73). On September 9, 2005, Law emailed the ABN
Amro bankers "please wire $1,177 , 200 from the Offshore Fund
account ***600 to the following instructions. PG's approval to
follow . "

(Brody Deel . Ex . 74) . Notwithstanding that Gruss only

allocated 65 % of the investment to the Off shore Fund, Gruss
approved the Offshore Fund funding the entire $1 , 177 , 200
investment .

According to Gruss , under the firms' Offering
Memoranda, the Manager had the right to allocate investments.
Per the funds' Offering Memoranda, such conflicts were to be
resolved by the Manager in its sole discretion: "When the Fund
and one or more other clients of the manager have available
funds for investments , investments .

. will be allocated

substantially pro rata on an overall basis .

to the extent

possible , unless the Manager believes , in good faith , that
another method would be more fair and equitable." Ex . Mat pp.
51-52 (DBZ 0009877 - 78); Ex. 0 at p. 29 (DBZ 0009778) ; Ex . L at
p . 29 (DBZ 0009705); Ex. T at pp . 46-47

(DBZ 0009633-34) ; Ex . U

at pp. 29 - 30 (DBZ 0009561 - 62) ; Ex. Kat p. 24

68

(DBZ 0009474).

85.

In June 2005, Wu resigned from DBZCO.

(Brody

Deel. Ex. 75). It was the interfund transfers "that made me
cannot stay at this company anymore. Make me want to
disassociate myself with this company." (Brody Deel. Ex. 1 6 at
117:20 - 118:4). Wu also testified that her issue with the
inter-fund transfers was not its legality, but "the burden." Ex.
ZZ at p. 117, 24:25.

Gruss asked Law to speak to Wu about why she wanted to
leave and to try and persuade her to stay.

(Brody Deel. Ex. 17

at 130:17-21). Law reported on her conversation with Wu to
Gruss: "Just spoke with her[.] She's v[ery] clear-headed and
calm about it[.] She says that the proposed remedies i.e. ltd
metis and stopping offshore investor $$

(if that even ever

happens) are just remedies for going forward purposes[.]
order to get us out of the current

In

(v[ery] deep) hole, will need

at least 2 years ' worth of new onshore $$ assuming that no more
onshore fundings occur which we all know is not going to happen
[ a]nd in the meantime there are the audits happening .
[c]an[']t talk her out of it cos I kinda agree with her."

(Brody

Deel. Ex. 76).

As noted by Gruss, neither Wu nor Law had any
knowledge about what was permitted by the Operating Documents
69

and their concern , as best expressed by Law, was the accounting
burden and stress created by this accounting burden .

86 .

On October 12, 2005 , Gruss received the closing

documents for an investment called Extell .

(Brody Deel . Ex . 77)

The closing documents indicated that this was a real estate deal
for a property at 356-366 Tenth Avenue in New York.
wiring instructions sent to ABN Amro

Id. The

(which Gruss approved)

initially requested that the necessary $5,064,006 come from the
Onshore Fund ' s account.

(Brody Deel. Ex. 78). Later that same

day, the accountant sent a second email to the bank requesting
that the wire come from the Offshore Fund account #***600 i.e. , the Offshore Fund account.

Id . Gruss approved this second

transfer. The clear inference is that there were insufficient
funds in the Onshore Fund's account so money was just taken from
the Off shore Fund even though the Offshore Fund should not have
participated in this loan origination because it was a United
States-based real estate transaction .

According to Gruss, there is nothing in Brody Deel .
Ex . 77 to reflect that this was a real estate deal and no
admissible evidence to support this so-called "clear inference"
and that it was always the intention from the outset of the
purchase of investments in which the Off shore Fund could not
70

initially be a participant because of ECI issues that DBZCO
would restructure those investments so portions of the
investments could be assigned to the Offshore Fund.

87 .

On Friday, October 14, 2005, Gruss received an

email concerning an approximate $30 million investment called
Solana.

(Brody Deel. Ex. 79). The wiring instructions, which

were to a title company, indicated that this was a Texas real
estate deal. Law, who was also a recipient on the email
responded "Late in the day for such a large funding. So this is
not funding from Bernard? If not when can we assign. Need to be
ASAP." (Brody Deel. Ex. 80) . In sum, Law was indicating that the
Onshore Fund did not have sufficient funds in hand to make this
investment and that it needed to be assigned to the other funds
managed by DBZCO as soon as possible. In the response to her
email (which was also sent to Gruss), Law was informed that the
investment "[h] as to fund through Onshore Fund ... . "Id. That
even ing, one of the DBZCO accountants sent an email to the ABN
Arnro bankers (cc'ed to Gruss) stating that $3.7 million should
be transferred from the Onshore Fund's account to the Offshore
Fund's account and that $27 million should then be wired from
the Offshore Fund's account in order to fund the investment.
(Brody Deel. Ex. 81) . That evening Gruss emailed the DBZCO
employees who were working on the funding "[s]o are we good
71

here." (Brody Deel. Ex. 82). In response, Gruss was informed
that the deal had not yet closed but that it would close the
following Monday. Id. Late that night, Racusin emailed Gruss
that "we have no money on Monday once the Solana deal cl o ses."
(Brody Deel. Ex. 83). On Monday, one of the DBZCO accountants
emailed the ABN Amro bankers "[p]lease wire $29,538,514.72 from
the Offshore Fund account #***600 to the following instructions.
PG's approval to follow."

(Brody Deel. Ex. 84). Notwithstanding

that this was a Texas real estate investment, Gruss approved the
transfer of Funds from the Offshore Fund Account.

Gruss has noted that the fact that the Wire
Instructions, were from a Title Company does not establish this
"was a Texas real estate deal" and whether or not it was a real
estate deal is irrelevant and this statement omitted "[h]as to
fund though Onshore Fund but I assume you can move it postclosing" and that the undisputed evidence shows that the
Offshore Fund did receive a share of this investment and there
is nothing in Brody Deel. Ex. 80 from which it can be inferred
that "Law was indicating that the Onshore Fund did not have
sufficient funds in hand to make this investment."

88.

There were "occasions where the Onshore Fund"

acted as "the agent on behalf of the other funds . . . where it
72

would purchase the entire investment in its name and in turn
provide each of the other funds its percentage participation in
that investment ." Ex . Z at pp. 22 - 23, Ex . Y at pp . 121 - 22.

The SEC has disputed this statement as unsupported by
the citations and noted that the testimony of Sulzberger,
provides only that there were occasions when the Onshore Fund
wou l d act "as agent on behalf of the other funds " while , the
remainder of this quote does not appear in his testimony and
notes that Law ' s testimony states that there was an " agenting
process" where the Onshore Fund might make a loan to a private
party but would not want to bear the risk of the entire amo unt
so they might apportion out bits of the loan to other interested
parties which could include the Offshore Fund or it could
include some other hedge fund that might be interested. Tan
testified that this "agenting process " was different than the
"seasoning " or "tailoring" process and therefore the statement
is not relevant to this litigation.

89 .

When the Onshore Fund purchased investments for

the Offshore Fund , "the title to those investments was just in
the Onshore Fund . " Ex. Z at p. 28, Ex. Y at p. 122 . The SEC
notes that Sulzberger ' s testimony (Ex. Z) concerns the "agenting
process" which Law testified was d i fferent from the "seasoning
73

or "tailoring" process and therefore this statement is not
relevant to this litigation.

90 .

The cash used to purchase these investments would

come from the Onshore Fund or the Offshore Fund or both.

The SEC has disputed this statement as unsupported and
notes Law's testimony, cited as Ex. Y did not concern the
"agenting process" but it concerned the separate situation where
"a lot of the onshore investments . . . were being funded by the
offshore , because the o nshore entity had not enough funds,"
"there are certain investments that only the Onshore fund can
participate in, and - so they would close the deal, and the
funds would have to come from the Off shore Fund because that is
the entity that's making the investment. But oftentimes, this
onshore entity does not have sufficient funds to fund this
investment, and so money from the Offshore Fund would be used to
finance these purchases." (Gruss Ex . Y at 123:16-23). The SEC
further notes Sulzberger's testimony likewise concerned the
situation (of which he was previously unaware), where funds from
the Offshore Fund were used to pay for the Onshore Fund's
investments.

( Gruss Ex. Z at 2 5: 3 - 7) .

74

91.

The analysis by Deloitte Financial Services LLP

("Deloitte Financial") shows that cash was advanced between and
among all of the funds to purchase investments that, for the
most part, were provided to all of the funds.

The SEC has disputed this statement as unsupported and
noted the cited testimony provides that "it came to our
attention that certain of the initial investments made, that is
of financing and cash made with respect to certain investments,
had come from Offshore Fund on behalf of Onshore Fund." (Gruss
Ex. AA at 18: 11-15).

92.

The status of the funds owed from the Onshore

Fund to the Offshore Fund was reported on the annual financials
of each of the funds for 2004 through 2006.

The SEC has denied that the "status of the funds owed
fr om the Onshore Fund to the Offshore Fund" was accurately
reported in the annual financial report for each of the funds
and has noted that the notes to the financial statements, which
were an "integral part of the financial statements" did not
disclose that the Off shore Fund had advanced money to allow the
Onshore Fund to fund its investment obligations or to repay the
Onshore Fund's obl igati ons under the loan facility and further
75

noted that Law testified that she did not believe that the notes
addressed the fact that money from the Offshore Fund was being
used to fund Onshore Fund investments." (Brody Deel . Ex. 17 at
175:20 - 176:16). Further, the SEC disputes that PWC did not
understand that the due to affiliates line on the financial
statements included money that the Off shore Fund provided to the
Onshore Fund to repay the loan facility and to fund investments
where the offshore fund was not going to be a participant.
(Brody Deel. Ex. 98 at 140:20 - 141:3.) Instead, the SEC
believes that was not PWC 's understanding of how the funds
operated.

(Brody Deel. Ex. 98 at 140:17-19).

93 .

All of the outstanding balances from these

advances from the Off shore Fund to the Onshore Fund were
continuously and accurately tracked such that at any point "you
could basically say how much the Onshore Fund owed to the
Offshore Fund." Ex. Y at pp. 238 -4 2. The SEC has disputed this
statement and noted that Law testified that the "intercompany
receivable and payable" was accurately tracked and that she
could say how much the Onshore Fund owed to the Off shore Fund
and did not testify in the cited testimony about the "advances "
(which were a subset of the overall intercompany receivable and
payable)

from the Offshore Fund.

76

94.

The balances were also conta ined on the 2004 and

2005 Financial Statement s for both the Onshore Fund and Offshore
Fund in each funds' Consolidated Statement of Assets and
Liabilities that were disclosed to the investors. Ex . Y at p.
238, Ex. F; Ex. Z at pp. 41- 44. The SEC has noted that 2004 and
2005 Financial Statements for the Ons h ore Fund included a line
item on the balance sheet for liabilities called "due to
affiliates" and that the 2004 and 2005 Financial Statements for
the Offshore Fund in c luded a li ne item on the balance sheet for
assets called "due from affiliates" and that these line items
represented monies due to and from all affiliates, not just the
balance owed between the Onshore and Off shore Fund. The SEC has
further noted that the balances in the Financial Statements do
not only concern the monies owed by the Onshore Fund to the
Offshore Fund because the Off shore Fund had advanced money to
the Onshore Fund and include any monies owed between the two.
The SEC also has denied the statement because the Financial
Statements provide the balance only as of a given date December 31, 2004 and 2005 and the money the Offshore Fund
advanced in June 2005 to allow the Onshore Fund to repay its
credit line was returned by December 23, 2005 and the 2005
financial statements did not disclose that this transfer had
taken place at all.

77

95 .

PWC understood at the time that the due to/from

affiliates amounts represented the situation where the Onshore
Fund would loan money and would subsequently transfer of portion
of that loan or other investment to the other funds .

(Brody

Deel. Ex . 98 at 139 : 16-25). No one at PWC had the understanding
that the "related party note" indicated that the Offshore Fund
had provided money to the Onshore Fund to fund investments where
the Offshore Fund was not going to be a participant. Id. at
140:20 - 141 : 3 . Indeed , that was not PWC ' s understanding of how
the funds operated . Id. at 140:17-19 .

Gruss admitted in part, denied in part and objected to
the statement presuming that PWC was aware of what was permitted
under the Operating Documents asserting that PWC was never asked
to nor did it ever provide to DBZCO any guidance as to what it
could do under the funds ' Operating Documents , Ex . CCC at pp .
243 - 46 , and that DBZCO accountants testified that spreadsheets
listing the inter - fund transfers were g i ven to PWC . Ex. ZZ at p .
159 , Ex . BBB at pp . 226-227 .

96 .

In August 2006 , after the 2005 audited

Consolidated Financial Statements were issued , one of the
accountants at DBZCO emailed Gruss: "One of the investors asked
me about the due to affiliates .. . what do you normally tell
78

them ... I'm sure you aren't 100 % forthcoming on the actual
answer. Loans t o other funds that have been promptly repaid
after year end ... is that saying too much?" (Brody Deel. Ex. 99) .

Gruss has denied this statement and notes Alisa
Butchkowski ("Butchkowski"), the author of the email, had no
recollection of the email and no recollection of ever discussing
the subject matter with Gruss, Ex. JJJ at pp. 80 -8 9, and Gruss
had no recollection of this email and testified he was always
"100 percent forthcoming" with investors, Ex. VV at pp. 249-53 ,
and there is no evidence that Gruss ever read or responded to
this email .

97 .

Deloitte confirmed the efficacy of the accounting

system and traced the funds from DBZCO's bank statements to the
VPM and DZPRIV. The SEC notes that Deloitte ide ntified various
errors in the DZ PRIV system.

98 .

The tax restrictions on the Offshore Fund also

meant that the Off shore Fund was dependent on the Onshore Fund
to source its investments. The Offering Memoranda for the
Offshore Fund stated that because of these tax restrictions, it
"will not regularly acquire loans from issuers, although it will
acquire loans from the U.S. Fund [the Onshore Fund] after the
79

loans are acquired from the issuer by the U.S. Fund."
p. 35 (DBZ 0009711) , see also, Ex. 0 at p. 35
M at p. 20

Ex~

L at

(DBZ 0009784), Ex.

(DBZ 0009846). This practice was consistent with the

representation in the Off shore Fund Offering Memoranda that the
Offshore Fund will be "managed using trading strategies
generally similar to those the Trading Manager [DBZCO] uses for
the U.S . Fund." Ex. L at p. 8 (DBZ 0009684) , see also Ex. 0 at
p. 8 (DBZ 0009757), Ex.Mat p. 19 (DBZ 0009845).

The SEC has noted that the Offering Memorandum for the
Offshore Fund does not contain a blanket requirement that the
Onshore Fund source every investment made by the Off shore Fund
and there was no restriction on the Offshore Fund even sourcing
loans in jurisdictions outside of the United States.

99 .

In addition to purchasing investments from the

Onshore Fund, the Off shore Fund had what was known as a
"mezzanine investment in the Onshore CLO." Ex. R at pp. 125-27.
As of December 31, 2004, the Offshore Fund had a $25M investment
in the Onshore CLO , Bernard National. Ex. E at p. 16. As of
December 31 , 2006, this mezzanine investment had grown to $141
million. Ex. G at p. 30 .

80

100.

Gruss discussed the interfund transfers with

other accountants at DBZCO and had several discussions with one
of the accountants where they discussed the balance owed by the
Onshore Fund to the Off shore Fund and how the Onshore Fund was
going to repay that amount.

(Brody Deel. Ex. 18 at 61: 8 - 62 :1 1) .

When this accountant first raised the issue, Gruss was not
surprised. He knew exactly what she was talking about and she
did not have to provide any background. Id. at 64 : 2 1 - 65:10.
DBZCO's treasurer also asked Gruss whether the Onshore Fund
borrowed money or utilized money from the Offshore Fund to fund
deals. Gruss responded yes, but stated that it was disclosed in
the financial statements.

(Brody Deel. Ex. 35 at 1 33 :16 -

134:14). When the Treasurer asked why he didn't see the
transfers from the Of f shore Fund booked as a loan, Gruss
responded that it couldn't be treated as a loan because of the
tax issues around it. Id. at 135:1822. Gruss also spoke with
Racusin, who reported to Gruss, about the practice. During none
of his conversat i ons with Racusin did Gruss say that the
transfers were allowed under the funds' offer ing documents.
(Brody Deel. Ex . 55 at 119:4-8).

According to Gruss, the last statement in the
statement is misleading because Racusin did not testify that no
such conversat i ons occurred , only that he did not recall.
81

101 .

Gruss never to l d Zwirn about the fact that the

Off shore Fund was advancing money to fund the investments of the
other funds and accounts managed by DBZCO . Gruss has noted that
whether or not Gruss had told Zwirn about the Off shore Fund
adv ancing funds to the Onshore Fund is irrelevant to the fact
that the practice was permitted under the funds' Operating
Documents . Zwirn admitted to an investor , Eric Dillon of Silver
Creek Capital Management LLC , that the inter - fund transfers were
a " common business practice that is clarified in the offer
memo . " See Ex . GGG .

102.

Initially Law viewed the interfund transfers as

an "operational headache[] . "

(Brody Dee l . Ex . 17 at 132 : 19 - 22) .

After Wu resigned and Law became the control l er for t h e funds ,
h owever , " it really h i t me that every dollar that ... an
off shore investor puts into the Fund , into his Offshore Fund , is
not being put to work for his benefit . And - in that i nstead i t
was being put to work for another i nvestor ' s benefit in another
fund . And that on l y became apparent when . .. you run the NAV ."
Id . at 135 : 14 : 20. Moreover , the investors in the onshore fund

were getting a benefit for which they hadn ' t invested . Law was
also concerned that if the monies owed to the Offshore Fund were
not repaid by year - end 2005 , this would cause red f l ags for the
82

auditors that could cause problems for the company and she
conveyed this to Gruss. Gruss has admitted that in his meetings
with Law, Law expressed her concern that the interfund transfers
constituted comingling of funds, were not documented, and did
not involve payment of interest to the Offshore Fund for the use
of the money at that time.

According to Gruss, the statement that "Gruss admits
that in his meetings with Law, Law expressed her concern that
the interfund transfers constituted comingling of funds, were
not documented, and did not involve payment of interest to the
Offshore Fund for the use of the money at that time" is not
supported by Brody Deel. Ex. 1 at

103.

~

25.

On June 5, 2006 , Law resigned from DBZCO. There

were several reasons for her resignation, including "the
overwhelming frustration

about the inter-fund transfers, and

that nothing was being done about it." (Brody Deel. Ex. 17 at
173:16-18). Law told Gruss at the time about her frustration
with the interfund transfers that were "getti ng too stressful to
handle, and the fact that it ... didn't seem like it was getting
anywhere near getting fixed." Id. at 173:11-15. Law also did not
want to have to lie to the auditors, PricewaterhouseCoopers
("PWC") about what the interfund transfers were for.
83

Gruss has asserted that the first sentence of this
statement about "overwhelming frustration" and the last sentence
that "Law also did not want to have to lie to the auditors" are
inadmissible and notes that these statements about what she
thought some seven years prior to her deposition testimony was
not articulated or stated to Gruss or anyone else. Ex. BBB at p.
180, 18:21. 115.

104.

Gruss designated Dr. Bergin as his expert

witness on these issues. Dr. Bergin is a principal with KPMG 's
Forensic Services practice and co-head of KPMG 's U.S. Economic &
Regulation practice, Ex. D at p. 4 and has testified in
significant complex matters involving hedge funds on behalf of
private parties and the government, including the SEC. The SEC
has noted that Dr. Bergin nothing in his testimonial experience
suggests that he has any background relevant to the instant
matter.

Dr. Bergin "served as a board director for six years
for Aquamarine Fund, Inc.
Aquamarine Value Fund L.P.

(an off shore hedge fund)

and

(an on -s hore hedge fund)." Id. The

SEC has noted that Dr. Bergin served as board director but that
there was nothing in his experience at Aquamarine relevant to
84

his engagement in this action and that the Aquamarine Fund was a
small fund and the investors were larg ely the portfolio
manager's family and friends.

Further, the SEC asserted that

during the time period that Dr. Bergin was a director and Dr.
Bergin cou l d not recall any loans that the Aquamarine Fund made
to small cap companies or to any companies in the United States
the only fixed income investments that Dr. Bergin that were
made by the Aquamarine Fund were bonds to support the tunnel
between the UK and France. Finall y , the Aquamarine Funds had no
involvement in the seasoning of loans.

105.

Dr. Bergin has Doctorate and MBA degrees with

highest distinction from Harvard Business School.

Dr. Bergin summarized his opinion as follows:

DBZCO operated a rapidly expanding hedge fund complex
which generated above-average investment returns for a
group of sophisticated investors by successfully
implementing a complex, broad, and multi-faceted
investment strategy. The fund complex was larg ely
unregulated, as was typical of hedge funds at the
time, and thus not subject to many of the constraints
of mutual funds which are highly regulated under the
federal security laws.
DBZCO was given a broad mandate under the pertinent
operating documents to select investments, manage the
funds, and resolve conflicts among the fund complex
members as necessary to facilitate implementation of
its strategy and in crease risk-adjusted returns.

85

An aspect of DBZCO's strategy, as detailed in the
pertinent fund materials, was for the Offshore Fund
and the Onshore Fund to operate symbiotically in order
to enhance investment opportunities, facilitate
largely parallel strategies and bolster returns for
both funds. The Onshore Fund was frequently utilized
as a sourcing agent to acquire select investments for
the fund complex, and often these investments were not
immediately available to the Offshore Fund. This
process required a treasury approach which facilitated
the movement of funds among fund complex members.
The movement of funds amongst fund complex members 1)
was authorized by the offering memoranda and other
fund documents; 2) was documented in the funds' books
and records that were available for investor review;
3) was reflected in the funds' audited financial
statements; and 4) created substantial benefits for
investors of both funds.
The SEC's claims that select advances of funds from
the Offshore Fund to the Onshore Fund constituted
improper activity contradict the investment authority
of the manager and the manner in which the fund
complex could and did operate. It is thus incorrect to
claim that in effecting the transactions to fund the
investment selections of the manager that former CFO
Gruss did not act in accord with the pertinent fund
materials and documents furnished to investors. It is
also incorrect to claim that the cash transfers were
not disclosed to investors.

Ex. D at p. 8.

The SEC has not disputed that this is a summary of the
opinions of Dr. Bergin but has disputed that these opinions are
admissible as recitations of facts from the record and as
interpretations of the Offshore Fund's Offering Memoranda and
Gruss' conduct and has further noted that Dr. Bergin's

86

conclusion that the interfund transfers did not violate the
terms of the Offering Memorandum should be excluded as he is
drawing a legal conclusion and are not admissible as contrary to
the record, including the statement of Gruss set forth in the
FOF above.

106.

Gruss stated in words and substance that an

arrangement where the Off shore Fund would loan money to the
Onshore Fund to pay its debts , fund its investments, or operate
its business would raise ECI issues and would not be permitted
under the funds offering documents.

Gruss has denied and objected to this statement
asserting as set forth above , there is a significant difference
between the Offshore Fund "loaning" money and advancing funds to
the Onshore Fund. Gruss has further contended that his statement
was with respect to the Offshore Fund formally loaning funds to
the Onshore Fund and that the full statement in the interview
memorandum is as follows : "When asked , Gruss said he was not
aware of any loans between Onshore Fund and Off shore Fund,
except to the extent one view any delay in 'settling up '

to be

' the essence of a loan . ' Offshore Fund did not loan money to
Onshore Fund to allow Onshore Fund to pay its debts , fund its
investments, or operate its business. Any such arrangement would
87

raise ECI issues and would not be permitted by DBZ ' s offering
documents . u Brody Deel ., Ex. 183 , p . DBZCO 00025 .

Gruss further has noted that Lilienfeld on crossexamination admitted that he had no recol l ection of Gruss saying
anything about the "funds' Offering Memoranda, u not permitting
the inter-fund transfers .

107 .

Gruss further stated in words or substance

that the Onshore Fund and the Off shore Fund were responsible for
paying their own borrowings and that there was no mechanism
through which one fund cou l d repay another fund ' s indebtedness
directly or indirectly unless either (a) the repayment was a
loan which would require documentation; or (b) there was
consideration for some other debt/transfer for value.

Gruss has admi tted the first portion of the statement
and objected to the remainder.

108.

Gruss admitted in words or substance that he

transferred cash from the Off shore Fund to the Onshore fund
because the Onshore Fund otherwise lacked the abi l ity to fund
certain investments that had to originate onshore (Brody Deel .
Ex. 57 at 115 : 3 - 12) , and recalled approving interfund transfers
88

to repay the CDC . Id. at 116:13-22. Gruss further asserted that
he saw no substantive distinction between these interfund
transfers - all were intended to address the Onshore Fund's
inability to fund investments.

(Brody Deel. Ex. 184; Ex. 57 at

116:23-117:3).

109.

Gruss admitted in words or substance that he , Wu

and a junior accountant devised the practice as a temporary
"bandaid" to address the Onshore Fund's liquidity concerns.
(Brody Deel. Ex. 184; Ex. 57 at 117:8-13).

110.

Gruss admitted in words or substance that he

"knew you shouldn't be going there" - that is, should not be
using Offshore Fund cash to fund Onshore Fund obligations given
the tax concerns.

(Brody Deel. Ex. 184; Ex. 57 at 117:14-20).

Gruss has admitted this statement in part, has denied
it in part and objected to it noting the objections raised above
and that this statement, like Gruss ' other statements recited by
the SEC, does not reference the scope of the Manager's authority
under the funds' operating, offering or management documents,
that Gruss was differentiating between formal loans and advances
from the Off shore Fund to the Onshore Fund, explained above as
well as Gruss '

statement allegedly made immediately thereafter
89

that these "transfers

'were not the favored approach' to

funding investments." Brody Deel. Ex. 184, DBZC0_00040. As set
forth above, Gruss explained to the SEC why the advances from
the Off shore Fund to the Onshore Fund were not the favored
approach to fund Onshore Fund's obligations or investments.
According to Gruss, the non-recourse methods of raising capital
for the Onshore Fund to purchase investments were the swing
line, both CLOs, a senior tranche CLO with Deutsch Bank, an
Asian facility with Asian Development Bank, a Euro facility
known as IXIS, an ABS facility and a BA facility with a Belgian
bank.

111.

Gruss admitted in words or substance that he

hoped the loans could be paid down relatively quickly and that
there was always an event on the horizon,

such as an upsize of

the Revolver, that Gruss believed might enable him to repay the
loans.

(Brody Deel. Ex. 184; Ex. 57 at 118:4-13).

Gruss has admitted the statement in part and denied it
in part noting that the interv iew report incorrectly refers to
the advances from the Off shore Fund to the Onshore Fund as
"loans," even though at the beginning of the paragraph of the
interview report the advances from the Off shore Fund to the
Onshore Fund are referred to as "transfers." Brody Deel. Ex.
90

184, DBZCO 00039. Gruss noted that the recording of the Gruss
interview reflects a misunderstanding between formal loans and
the advancing of funds that was part of the investing process.

112 .

In a July 31, 2007 telephone call with an

investor, Gruss stated that he was truthful in his meetings with
Gibson Dunn & Crutcher .

(Brody Deel. Ex. 185). Gruss objects to

that statement as inadmissible hearsay.

The Offshore Fund Loans to Pay Revolver Obligations

113. During 2005 and 2006 , the Onshore Fund and the
Offshore Fund were parties to a Revolving Credit and Security
Agreement as amended and restated (collectively "the Revolver").

114.

Under the terms of the Revolver, "Borrower Group "

was defined as meaning "either (i) the U.S. Fund, or (ii)

the

Off - Shore Borrowers." (Brody Deel ., Ex. 87 at 938920). The
Revolver defined the "U.S. Fund" as the D.B. Zwirn Special
Opportunities Fund, L.P.

Id. at 938937. The Revolver defined

"Off-Shore Borrowers" as the "Off-Shore Fund" and the "Off-Shore
Subsidiary Fund." Id. at 938931. The Revolver defined "Off-Shore
Fund" as the D.B. Zwirn Special Opportunities Fund, Offshore

91

Fund and the "Off-Shore Subsidiary Fund" the Lemoyne Avenue
Investors, LLC. Id.

115.

As stated in the Revolver, the obligations of

each "Borrower Group" were several, and not joint and several.
(Id. at 938917; Brody Deel . Ex. 88 at 5919) . The Revolver did
not specify the source of the funds used to repay outstanding
balances nor did it preclude a third party from paying the
amounts due .

116.

The Maturity Date for advances could not be

more than seventy-five days after the Borrowing Date.

(Brody

Deel. Ex. 87 at 938930).

117.

Similar to how the Onshore Fund did not have

sufficient cash on hand to fund its investments, it also did not
have sufficient cash on hand to repay its obligations under the
Revolver as they came due . As Law testified : "Basically the CDC
line expires or matures every set amount of time,

I can ' t

remember, but maybe , for example , we say every three months . And
then at the end of the three months , the whole amount has to be
repaid to the CDC, and then CDC would immediately re-lend it
back to us again . So there were some times where the Onshore
Fund did not have the - enough funds to pay that amount to the
92

... CDC, so the Off shore Fund would pay for the 50 million or
whatever was outstanding at the time." (Brody Deel. Ex. 17 at
137:6-19).

Gruss has noted that the SEC cites the testimony of
Karotkin , Brody Deel. Ex. 71 at 55:19-56-9, for the proposition
that "[s]imilar to how the Onshore Fund did not have sufficient
cash on hand to fund its investments (as described above), it
also did not have sufficient cash on hand to repay its
obligations under the Revolver as they came due" and that
Karotk in also testified that he did not remember if "we didn't
have money when it was due." Gruss has further noted that while
the funds may have come fr om the Off shore Fund to pay the
Onshore Fund's outstanding balance, this amount was reflected on
the financial statements of both the Onshore Fund and Off shore
Fund as an advance of funds from the Offshore Fund to the
Onshore Fund. Ex. BBB at pp. 240 -4 2 , Ex. UU at p. 403. According
to Gruss, the Offshore Fund was permitted to advance cash to the
Onshore Fund pursuant to the Operating Documents.

118.

On June 13, 2005 at 08:20 a.m., Wu sent an

emai l to ABN Amro with the subject line "Wire from #***599 -CDC. " The email conta ined instructions to ABN Amro to transfer
$78 ,000, 000 from "# ***600 " to "# ***599 " and then to wire
93

$80,000,0000 from "#***599" to Citibank New York.

(Brody Deel.

Ex. 89). The subject of the email was "Wire from #***599 -CDC ."
Id. The email referred to Gruss by initials "PAG" and noted that

his approval was to follow.

Id. At 08:21 a.m., Gruss emailed "Ok

pag", expressing his approval of the transfer of the money from
the Off shore Fund to the Onshore Fund and from the Onshore Fund
to CDC.

(Id.; Brody Deel. Ex. 4 at 392:15-18) .

119.

On November 22 , 2005 , Law emailed Gruss a

spreadsheet with the filename "cash consolidation 11-15-05.xls."
(Brody Deel. Ex. 90). The spreadsheet contained an entry labeled
"CDC" under the column "Onshore Fund to Offshore Fund" in the
amount of $77,845,541 . 65.

Id.

Gruss has noted that this document was prepared on a
daily basis and saved on the share drive and accessible to the
entire accounting team and operations team.

120.

This spreadsheet was a "payable and receivable

schedule showing all of the cash advances . . . at a point in
time " made by the Offshore Fund to the Onshore Fund and that as
of November 15, 2005, the Onshore Fund owed the Offshore Fund
approximately $312 million (Brody Deel. Ex. 4 at 402:11-20).
Gruss has noted that the reference to the CDC on this
94

spreadsheet represented money that the Off shore Fund advanced to
the Onshore Fund to allow the Onshore Fund repay the Revolver.
(Id . at 403:17-24).

121.

Th e Offshore Fund was not fully reimbursed for

the money it had advanced on June 13, 2005 to repay the Revolver
until December 23, 2005.

Gruss has noted that Wu testified that "it was always
the intention for the Onshore Fund to pay back the Off shore
Fund" f or the advances, Ex ZZ at p. 178, that "there was a
continual process of paying back on" the advances from the
Offshore Fund to the Onshore Fund.

Id. at pp. 128-29 and that

while the Off shore Fund may not have been fully reimbursed for
the money it had advanced on June 13 , 2005 to repay the Revolver
until December 23 , 2005 , PWC always had access to these records
reflecting the advances from the Off shore Fund and the amounts
being paid back by the Onshore Fund.

Id. at p. 179. Gruss

further notes that the Offshore Fund's Consolidated Financial
Statement for the year ended December 31 , 2005 , shows the sum of
$220,788,666 "Due from affiliates" and a corresponding entry
"Due to affiliates" on the Onshore Fund's balance sheet. 56.1
Statement , Ex. F, p. 2 , Ex. I, p. 2. Gruss further notes that
the Offshore Fund's Consolidated Financial Statement for the
95

year ended December 31, 2004, shows the sum of $6,383,050 "Due
from affiliates" and a corresponding entry "Due to affiliates"
on the Onshore Fund's balance sheet, 56.1 Statement, Ex . E, p.
2 , Ex. H, p. 2, and Offshore Fund's Consolidated Financial
Statement for the year ended December 31, 2006, shows the sum of
$189,019,591 "Due from affiliates" and a corresponding entry
"Due to affiliates" on the Onshore Fund's balance sheet. 56.1
Statement, Ex. G, p. 2, Ex. J, p. 2. Gruss further notes that if
an investor had questions about any of the numbers in either the
Offshore Fund's or the Onshore Fund's financial statement, an
investor was free to meet with Gruss or anyone else at DBZCO.
Ex. UU at p. 81 ("If an investor wanted to meet with the CFO or
any other individual they were free to do so"). Thus, "if the
investors came in to review the funds, they could see anything
they wanted." Ex. ZZ at p. 179.

122.

On January 9, 2006 at 4:37 p.m., a DBZCO

accountant emailed instructions to ABN Amro to transfer
$125,000,000 from "Offshore Fund# ***600" (the Offshore Fund's
account) to "Onshore Fund# ***599 "

(the Onshore Fund's account)

and then t o wire a t ota l of $125,000,000 from "Onshore Fund
#***599" to the accounts of the two banks providing the c redit
facility - $27,777,777.78 to Citibank and $97,222,222.22 to KBC
Bank N.V. New York.

(Brody Deel. Ex. 92). The subject of the
96

email was " CDC repayment." Id. The email referred to Gruss by
initials "PG" and noted that his approval was to follow.

Id. at

4:48 p.m., Gruss emailed "Ok pag." Id.

123.

A few minutes later, DBZCO's treasurer

forwarded the emails with the transfer instruct i ons and the " Ok
pag" to Gruss and wrote "what is this?" (Brody Deel. Ex. 92).
Gruss responded "Repayment of 75day swingline revolver." Id.
Gruss was, therefore, fully aware that money from the Offshore
Fund was going to repay the obl igati ons of the Onshore Fund
under the Revolver . The Offshore Fund was not fully reimbursed
for the money it had advanced in January to repay the Revolver
until November 6, 2006.

124.

(Brody Deel. Ex. 91 at 19).

On March 3, 2006 , a DBZCO accountant emailed

instructions to ABN Amro to transfer $50,000,000 from the
"Offshore Fund# ***600 "

(the Offshore Fund's account) to

"#***599" (the Onshore Fund's account) and then a total of
$50 ,0 00,000 from the " Onshore Fund# ***599" (the Onshore Fund's
account) to the accounts of the two banks providing the credit
facility - $38,888,888.89 to KBC N.V. New York Branch and
$11,111 ,1 11.11 to Bank of New York.

(Brody Deel. Ex. 94). The

subject of the email was "CDC Repayment." Id. The email
referenced Gruss by initials "PG" and noted that his approval
97

was to f ollow . Id. Gruss responded " ok pag." Id. The Offshore
Fund was not fully reimbursed for the money it had advanced in
March t o repay the Revolver until November 27, 2006.

(Brody

Deel . Ex. 91 at p.19).

125.

On May 26, 2006 , at 8 :1 3 a.m., a DBZCO

accountant emailed instructions to ABN Amro to transfer
$20,000,000 from "# ***600 "

(the Offshore Fund's account) to

"# ***599" (the Onshore Fund's account).

(Brody Deel. Ex. 95).

The subject of the email was "Various." Id. The email referred
to Gruss by initials "PG" and noted that his approval was to
follow.

Id. At 8: 15 a.m., Gruss emailed "Ok pag." Id.

On May 26 , 2006, at 8 :41 a.m., a DBZCO accountant
emai led instructions to ABN Amro to transfer a tota l of
$20,000,000 from "Onshore Fund# ***599" (the Onshore Fund's
account) to the accounts of the two banks providing the c redit
facility - $15 , 555 , 555 .5 6 to KBC Bank N.V. New York and
$4,444,444.44 to Bank o f New York.

(Brody Dee l. Ex. 200). The

subject of the email was " CDC ." Id. The email referred to Gruss
by initials "PG" and noted that his approval was to follow.
At 1:42 p.m., Gruss emailed "Ok pag." Id.

98

Id.

The Off shore Fund was not fully reimbursed for the
money it had advanced in May to repay the Revolver until
November 27 , 2006.

126.

(Brody Deel. Ex. 91 at 19).

The balance owed to the Offshore Fund by the

Onshore Fund because of the transfers to repay the Revolver was
$175 million in March 2006.

127.

In total, the Offshore Fund transferred $273

million to the Onshore Fund (in four transfers : $78 million
(Brody Deel. Ex. 33); $125 million (Brody Deel. Ex. 92); $50
million (Brody Deel. Ex. 94); $20 million (Brody Deel. Ex. 95))
in order to allow the Onshore Fund to repay its loan obligations
under the Revolver .

128.

The SEC asserts that without the transfers from

the Off shore Fund, the Onshore Fund would not have been able to
make the required periodic repayments of the Revolver.

129.

The interfund transfers continued t hrough at

least May 2006 .

130.

On April 19, 2006, PWC, the auditors for the

Offshore Fund, issued the Consolidated Financial Statements for
99

the year ended December 31, 2005.

(Brody Deel. Ex.

96 at 1). The

Financial Statements for the year ended December 31, 2005,
listed $220,788,666 under the assets of the Offshore Fund as
"[d]ue from affiliates." Id. at 2. The Financial Statements
state that "[t]he accompanying notes are an integral part of
these consolidated financial statements." Id.

131.

The notes, which were written by DBZCO, provide

in the section captioned "related party transactions," "[i]n
connection with certain investments entered into by an affiliate
(primarily corporate loans), the Company may purchase a portion
of such loans from such affiliates at the current estimated fair
value as determined by the Trading Manager. Such transactions
are subject to review by an independent third party. At December
31, 2005, the Company is due $223,049,505 from affiliates for
certain investment transactions and their related cash flow, and
owes $2,260,839 to the Trading Manager for expenses incurred on
behalf of the Company. Such amounts are included net in due from
affiliates on the consolidated statement of assets and
liabilities." Id. at 26.

132.

There was no mention in this note or anywhere in

the Financial Statements that the "due from affiliates line"
included money that the Offshore Fund had advanced on behalf of
100

the Onshore Fund to pay for the Onshore Fund's investments.

Id.

at 26 - 27.

Gruss has denied this statement noting that Law stated
that the phrase in the note, "and their related cashflow" could
refer to "the money that flows from the Offshore Fund to the
Onshore Fund for investments that the Onshore Fund might make
for itself" and, that she was unable to provide "any reason" why
such interpretation was not correct , Ex. BBB at pp. 284-86, and
that there was also no statement in the note that states that
the "due from affiliate line" does not include the advancement
of funds from the Off shore Fund to the Onshore Fund for the
purchase of assets that would be used for the Onshore Fund to
purchase investments.

(Gruss Rule 56.1, Ex. E, p. 16; Ex. F, p.

26; Ex G, p. 28) . Gruss has further stated that the Offshore
Fund's Offering Memoranda that the Offshore Fund "may acquire
interests in loans .

originated by the U.S. Fund," Ex. Mat

p. 67, when coupled with this note, led to the inference by the
Offshore Fund's sophisticated investors that this "related cash
flow" relates to the symbiotic investing process that existed
between and among the DBZCO managed funds. Ex. D at pp. 28 - 30 .

137.

Law, who saw the notes for the 2005 audited

Consolidated Financial Statements , did not believe that the
101

notes address the fact that money from the Off shore Fund was
"being used to fund Onshore Fund investments." (Brody Deel. Ex.
17 at 175:20 - 176:16). Gruss has denied this statement and
noted that Law provided this testimony on direct examination
without being shown the note in the financial statement, that
she was questioned totally on her "recollection," Ex. BBB at p.
176, and that when Law was shown the actual note on cross examination and questioned about it,

Id. at pp. 281 - 83 , she

stated, that the "Due from affiliates" number , would "typically
be items arising from the agenting relationship between the
Onshore , the Offshore and the other Funds, and it would also
include all the funds that were sent by the Off shore for Onshore
investments."

138.

Id. at 283:6-10.

In connection with the 2005 audit for the

Onshore and Offshore Funds, no one at DBZCO told PWC that the
amounts shown as due to affiliates and due from affiliates
included money from the Offshore Fund that was being used to
fund Onshore Fund investments.

(Brody Deel. Ex. 98 at 137:21 -

138:13; Ex. 17 at 136:9-16).

Gruss has noted that most of the back office staff
knew about the inter-funds transfers and no one was ever told
"to keep quiet about these transfers" , Ex. BBB at pp. 274 -77,
102

Ex. ZZ at pp. 186-88, that all of the inter-fund transfers were
accounted for in the books and records of DBZCO, that each
advance from the Off shore Fund to the Onshore Fund was
accurately accounted for with corresponding entries on the
records of the Off shore Fund and Onshore Fund and were not
"hidden off the books," Ex. BBB at pp. 193-94, 232-42, 273-74,
Ex. ZZ at pp. 123-24, 168-80, PWC had "full access to DZPRIV,"
Ex. BBB at pp. 197, 226-27, and "the DZPRIV schedule [in
"spreadsheet format" was] given to PWC to be used as the basis
for the presentation of the payable-receivable balances for" the
funds, Ex. ZZ at p. 159, Ex. BB at pp. 226-27.

Gruss further notes that the inter-fund transfers were
related party transactions requiring specific disclosures. See,
e.g., Financial Accounting Standard No. 57
transactions)

(related party

("FAS 57"), and were reflected in the balance

sheet, the statement of cash flows and the notes to the
financial statements, all of which were prepared by DBZCO and
audited by the external audit firm PWC. See, e.g. PCAOB Auditing
Standard No. 18 (auditing standards for related party
transactions). The audited financial statements for the Onshore
Fund for the fiscal year ended December 31, 2005 in the balance
sheet disclosed "Due to affiliates: $308,839,745." Ex. I at p.
2. Similarly, the notes to the financial statements fully
103

disclosed the transactions as required by FAS 57 under the
heading "Related Party Transactions":

In connection with certain investments (primarily
corporate loans), the Fund may sell or
participate a portion of such loans to affiliates
at the current estimated fair value as determined
by the Trading Manager. Such transactions are
subject to review by an independent third party.
At December 31, 2005, the Fund owes $308,839,745
to affiliates for certain investment transactions
and their relate cash flows.

Ex. I at p. 28.

According to Gruss, Investors had full access to the
underlying documents for these transactions and all of the
investments were recorded in DBZCO's Virtual Portfolio
Management ("VPM") system, Ex. ZZ at p. 162, and then reconciled
as to which fund owned which percentage of the investments in
DZPRIV. Ex. CCC at pp. 25-26. DZPRIV "showed how much was owed
between the Funds," Ex. BBB at p. 239, and the VPM contained the
separate accounting records for each of the funds. Ex. ZZ at p.
167. DZPRIV also recorded "every dime that was owed from the
onshore fund to the Offshore Fund," id. at p. 186, Ex. BBB at
pp. 273-74, and Law would provide PWC with records reflecting
"subsequent repayment[s]" from the Onshore Fund to the Offshore
Fund. Id. at p. 198.

104

The Payment by the Off shore Fund of Onshore Fund Management Fees

139 .

The Onshore Fund and DBZCO were parties to a

Management Agreement dated May 1, 2002 amended as October 1 ,
2004 , and further amended on January 1, 2006 . The management
agreement provides that "[e]ach of the parties hereto shall bear
its own expenses with respect to all matters contemplated
hereunder .

(Brody Deel. Ex . 102 at 2).

140 .

With respect to who was responsible for which

expenses , the confidential memorandum for the Onshore Fund
states : "The Fund bears its o perating expenses , including all
direct expenses of the Fund , investment expenses

(e . g. expenses

which the General Partner determines to be related to the
investment of the Fund ' s assets such as brokerage commissions ,
interest expenses , borrowing costs, clearing and settlement
charges , loan servicing fees,

custodial fees , bank servi c e fees ,

extraordinary expenses and all other transaction costs) , legal
expenses , professional fees

(including , without limitation ,

expense of consultants , experts , and third- party appraisers)
relating to investments , accounting expenses, auditing and tax
preparation expenses , entity level taxes, inc l uding New York
City unincorporated business taxes , printing and mailing
105

expenses, and fees and out - of -pocket expenses of any service
company retained to provide certain accounting, bookkeeping,
asset management, appraisal and administrative services. The
Fund also pays its ongoing offering , legal, filing, accounting
and reporting fees as well as other operating expenses and
expenses incurred in connection with the sale of Interests."
(Brody Deel. Ex. 6 at 27) .

141.

The Onshore Fund and DBZCO were parties to a

Management Agreement dated May 1, 2002, amended as October 1,
2004, and further amended on January 1, 2006.

(Brody Deel. Exs .

100-102). Pursuant to this agreement, DBZCO was to be paid a
monthly management fee which was to be "accrued monthly and
payable quarterly."

142.

The Off shore Fund and DBZCO similarly were

parties to a Management Agreement dated May 1, 2002 , amended as
of August 19, 2005 , and further amended on January 6 , 2006.
(Brody Deel. Exs . 138-140). Pursuant to this agreement, DBZCO
was to be paid a monthly management fee which was to be "a ccrued
monthly and payable quarterly."

143.

D.B. Zwirn Special Opportunit i es Fund (TE), L.P.

(the "TE Fund") and DBZCO were parties to a Management Agreement
106

dated May 29, 2003, amended as of October 1, 2004 , and further
amended as of January 1, 2006 .

(Brody Deel. Exs. 141-143).

Pursuant to this agreement, DBZCO was to be paid a monthly
management fee which was to be "accrued monthly and payable
quarterly."

144.
Offshore Fund.

D.B. Zwirn Special Opportunities Fund II,
(the "Offshore Fund II Fund") and DBZCO were

parties to a Management Agreement as of June 1, 2005.

(Brody

Deel. Ex. 144). Pursuant to this agreement, DBZCO was to be paid
a monthly management fee which was to be "accrued monthly and
payable quarterly."

145.

The meaning of the "a ccrued monthly and payable

quarterly" language was that the fee was calcu la ted on a monthly
basis, but it would not be paid until the end of the quarter.
(Brody Deel. Ex. 17 at 60:4 -11 ).

146.

DBZCO was "always short on cash." (Brody Deel.

Ex. 17 at 63 : 9-11 ). As Gruss explained: "The management company
was always tight on cash . .

. It was always tight on cash

because ... Dan Zwirn grew the firm way too quickly. Way too
quickly. The growth exceeded the amount of operational expenses
a firm of that size could bear." (Brody Deel. Ex. 4 at 267 : 817).
107

During most of 2005 , DBZCO had little liquidity and had invoices
coming down that were close to or exceeding the amount of cash
available to it. By the end of each quarter it was hard for
DBZCO to pay invoices.

147.

(Brody Deel. Ex. 104 at 29 : 24 - 31 :5 ) .

In order to pay DBZCO's expenses, a practice

developed where management fees were collected early.

(Brody

Deel. Ex. 145 at 66 : 25 - 67:6). Because DBZCO needed to pay rent
or salary, "it collected the management fees earned by the Fund
but not yet payable." Id. at 67:23 - 68:4. Gruss was aware of
this practice as of the summer of 2004, knew and approved for
management fees to be paid early without any authority to do so.
(Brody Deel. Ex. 9 at 256:25 - 257:18).

Gruss objected to this statement noting that on June
21 , 2004 , when Wu first asked Gruss to approve the early payment
of management fees via an email, Gruss sought Wu's guidance, and
in the email response from Gruss to Wu, Gruss specifically asked
Wu whether a loan had to be documented, stating "We need to
paper a l oan to mgmt co don't we?" to which Wu replied, "no ...
just prepaying mgmt fee ahead of schedule." Ex. YY at pp. 201 09, Ex. ZZ at pp. 21,113-14, 219 - 20 ; Ex. SSS.

108

148.

The process was on a "needs basis." (Brody Deel.

Ex. 17 at 86:10). The trigger point for sending management fees
from the funds to DBZCO "was always when Michelle O'Hara came to
us saying 'Look, we have a cash crunch.'" Id. at 86:12-15.

149.

DBZCO would not have been able to pay its bills

if the management fees had not been paid early by the Funds.
(Brody Deel. Ex. 17 at 94:14-18; Ex. 105 at 20:24 - 21:6 "We
didn't have enough cash to stay current on our bills. So during
that period I would talk to Perry [Gruss] regularly about cash
issues"). As Gruss admits, "[i]f we didn't collect the
management fees, people would not have been paid, period."
(Brody Deel. Ex. 145 at 74:23 - 75:11).

Zwirn was not aware of this practice while it was
going on.

(Brody Deel. Ex. 145 at 75:14-15; Affidavit of Daniel

B. Zwirn at

~

150.

9).

The SEC asserts that Gruss knew that the early

collection of management fees would violate the agreements
between the funds and the management company and also understood
that taking investor funds in ways not permitted by the legal
agreements was a serious matter.

109

15 1 .

As demo nstrated in the c hart bel ow, there were

twent y- three in s t a nces where DBZC O withdrew ac c rued mo n t hl y
management fees bef o re the end of the quarter.
Number of
Days
W thdrawn
i
Before End
of
Quarter
35

Amount
$450 , 595

Fee Acc r ued
Fo r Mo n th
Ended
4 /30/04

End of
Quarter
6 ' 30/04

6/21/04

394 I 710

5/3 1 /04

6/30/04

9

3

6/25/04

497 , 178

5/31/04

6/30/04

5

4

8/23/04

557 , 557

7 /31/04

9/30/0 4

38

5

9/7 /04

91 , 945

7 /31/04

9/30/04

23

6

9/7 /04

484 , 935

7 /31/04

9/30/04

23

7

8/5/05

1 , 183 , 786

7 /31/05

9/30/05

56

8

9/1/05

304 ' 114

7 /31/05

9/30/05

29

9

9/1/05

379 , 257

7/31/05

9/30/0 5

29

10

9/14/05

1 , 265 , 424

8/31/05

9/30/05

16

11

9/1 4 /05

323 , 932

8/31/05

9/30/05

16

12

11/22/05

1 , 440 , 254

10/31/05

12/31/05

39

13

11/30/05

427 , 498

10/3 1 /05

12/3 1 /05

31

14

12/14/05

355 , 648

10/31/05

1 2/3 1 /05

17

15

12/19/05

1 , 506 , 720

11/30/05

12/31/05

12

16

12/19/05

433 , 373

11 /30/05

12/31/05

12

17

12/20/05

357 , 844

11/30/05

12/31/05

11

18

12/29/0 5

1 , 500 , 000

1 2/31/05

12/31/05

2

19

12/30/05

450 , 000

1 2/31/05

12/31/05

1

20

3/1/06

5 , 200 , 000

l/30&2/28/06

3/31/06

30

21

3/1/06

3 , 400 , 000

l/30&2/28/06

3/3 1 /06

30

22

3/1/06

770 , 000

l/30&2/28/06

3/31/06

30

23

3/7 /06

760 , 000

l/30&2/28/06

3/31/06

24

1

Date of
Withdrawal
5/26/04

2

No .

$22 , 534 , 770

Gr u ss h as denied this statement.
110

15 2 .

These early withdrawals of management fees were

memorialized in emails and requests for wire transfers, each
showing that Gruss approved the early withdrawal of management
fees. On May 26 , 2004 at 3:16 p.m., DBZCO's controller emai l ed
the Onshore Fund's bank instructions to "wire $450,595 from the
Onshore Fund's account to DBZCO's operating account at Citibank .
(Brody Deel. Ex. 146). The subject of the email referenced "wire
from #** * 599 - Mgmt Fee. " Id. Gruss was copied on the email.

Id.

At 4:48 p.m., Gruss emailed the Onshore Fund's bank stating
"[o]nce aga i n , pls take this email as authorization for [DBZCO 's
controller] to sign on my behalf through Friday the 28 th of
May." (Brody Deel. Ex. 147).

153.

DBZCO's auditors PWC, did not test the timing of

management fee payments as part of its audit.

The Payment by the Offshore Fund for the Purchase of an Airplane

154.

As early as March 2005 , Zwirn began discussing

with Gruss and others at the company, including its Chief
Operating Officer , Harold Kahn ("Kahn "), and the purchase of a
private plane for his business travel. Zw irn wanted the
management company to purchase the airplane.
111

155.

Gruss was against the purchase of the plane

because the management company "was always short on cash,
constantly ," (Brody Deel. Ex. 9 at 420:10-13), and when people
in the accounting department found out about the plane purchase ,
they were surprised because "[t]he management company had at
that time been having ... liquidity issues. Our payments of
regular invoices for the management company was becoming an
issue. And then to find out that we were also going to be
funding the purchase of a plane, it really

it didn't make

sense to some of us." (Brody Deel. Ex. 104 at 29:2 - 11) . Gruss
admits the statement in part and objected to on the grounds that
other people were inadmissible hearsay.

156.

From April through July 2005 , Gruss met with an

airplane broker, PrivatAir, as well as with an aviation attorney
and an accountant who would be involved in structuring the plane
purchase .

Gruss has denied this statement stating there is no
admissible evidence that Gruss actually ever met with an
airplane broker, PrivatAir, an aviation attorney or an attorney
regarding the purchase of an airplane.

112

157.

In response to a June 14 email from Zwirn

stating that he was "even more convinced that I need a s o lution"
to his travel issues, Gruss stated: "[a]t this stage it's really
about whether or not you want to deal with $. Tax folks are
finalizing structure for holding Plane to maximize cost savings
for DZ. "

(Brody Deel. Ex. 111).

158.

On July 1, 2005, Kahn reported to Gruss that

PrivatAir had just provided an initial list of acceptable planes
so there was a "need to get our structuring ready to go." Gruss
responded "Ok good. Let's review." (Brody Deel. Ex. 110).

Gruss has denied this statement in part noting that
Zwirn had tasked Kahn , not Gruss, with the job of "find[ing] out
what potential options were available and to the Onshore Fund
identify sources of financing for such a purchase." Ex. KKK at
p. 19. As such, Kahn identified "[t]ypes of planes, who were
sellers o f planes,

[and] who were intermediaries that would be

involved in the purchase process." Id. at 19. "Gruss had a role
in the purchase of the plane simply based on his position as CFO
of the company ." Id. at 27.

159.

On August 25 , 2005, PrivatAir informed Kahn that

they had a " verbal confirmation " from the seller of a Gulfstream
113

G-IV that he would accept $19.95 million for the plane.

(Brody

Deel. Ex. 112). Kahn forwarded that information to Gruss and
stated "[u]pon offer acceptance we need to be prepared to wire
$250K as a deposit ... could be as soon as tomorrow. Upon
c l osing (say around 9/30), we will need to structure a loan from
the mgmt co to ZH for about $2MM until DZ gets 4th qtr. Mgmt
fees payment and thus may have to be prepared to borrow as you
noted the other day." Id. Gruss responded "[n] o problem re
tomorrow. I'll spark some interest in the working capital loan
for 9/30 ." Id.

160.

On August 31, 2005, Kahn emailed Law and O'Hara

details to wire $250,000 to an escrow account with instructions
that the "[a]mount should be treated as a mgmt co. prepaid
expense .

[a]pproved per PG and me." (Brody Dec. Ex. 198).

Gruss responded "[c]orrect. Ok pag." Id. Consistent with the
emails from Kahn and Gruss, the $250,000 was paid out of the
management company 's operating account on August 31, 2005.
(Brody Deel. Ex . 114).

Gruss has denied that the email, Brody Dec. Ex. 198,
contains a response from Gruss, "[c] orrect . Ok pag."

114

161.

Kahn and Gruss sought financing for the plane

purchase. On September 2 , Merrill Lynch sent a financing
proposal to Kahn for the 1991 Gulfstream G-IV.

(Brody Deel. Ex .

115). The proposal was based on a purchase price of $17.9
million.

Id. at 4. In order to offer nonrecourse financing

(as

Zwirn had requested), the bank required additional collateral in
the form of a $1.9 million letter of credit. Id. Kahn provided
the letter to Gruss and Zwirn and stated "s o far this is the
only one [proposal] that is truly non-recourse and gives us
decent flexibility re use of cash of LC or combination thereof."
Id.

Gruss has denied that he sought financing for the
plane purchase.

162.

On September 9 , Kahn emailed Gruss saying "the

LC [letter of credit] we've talked about ... probably around $2
MM plus or minus representing 10 % of the purchase price ... who
do you think would be the best guys to set it up? ... Think we
can get away w/not having it fully cash collateralized." (Brody
Deel. Ex. 116). Gruss responded: "[w]e should do citi. Timings
perfect. I had them in earlier this week and [expletive] slapped
them." Id.

115

163.

Shortly thereafter, Gruss and Kahn contacted

Citigroup about providing a letter of credit for the airplane
purchase as well as a working capital loan for the management
company. On September 19, after not receiving a term sheet,
Gruss again reached out to Citigroup asking that the term sheet
be provided "asap. You now have more than enough information. I
want to review quickly as we are in the process of reviewing
other 3rd Party term sheets." (Brody Deel. Ex. 117). That same
day, Citigroup sent the term sheet to Gruss for a $10 million
loan facility, which included the $2 million letter of credit.

According to Gruss, the admissible evidence only shows
that Kahn, not Kahn and Gruss, contacted Citigroup about
providing a letter of credit for the airplane purchase as well
as a working capital loan for the management company and the
term sheet was sent to Kahn, and Gruss was copied on the email.

164.

In order to obtain the letter of credit from

Citigroup, the management company was required to wire $1.9
million in cash collateral to Citigroup.

165.

On September 26, 2005, Gruss wrote Citigroup

asking where they stood with respect to the management company
loan.

(Brody Deel., Ex. 120 at 731856). Citgroup responded that
116

the letter of credit would be ready for issuance most likely by
September 27 . Id. at 731855. When Gruss forwarded this
information to one of the internal accountants for the
management company who was involved in the transfer of funds,
she asked "[a]ny eta on the cash ." Id. at 731854. Gruss
responded "possibly on Friday." Id.

166.

In addition to the $1.9 million that needed to

be transferred to Citigroup, the company needed to wire
$1,681,350 to the seller , $112,575 to PrivatAir (the broker) and
$80,250 in closing costs to Merrill Lynch. As such, including
the cash collateral for the letter of credit, DBZCO needed to
come up with $3,774,175 to close the airplane purchase.

167.

While the initial intention may have been t o use

money from the Citigroup loan facility to pay the $3 ,774,175 to
close on the airplane purchase, that loan facility did not
become available until November. In October, 2005 , one of the
accountants asked Gruss to approve wiring $163,267.50 for
airplane expenses.

(Brody Deel. Ex. 121) The accountant also

wrote : "FYI, I am now completely out of cash. Is the Citibank
loan ever actually happening? I have about 2MM of invoices
holding on my desk waiting to be paid." Id. Gruss approved the

117

expenses and wrote "Pls move $ from Offshore Fund.

[the Offshore

Fund]". Id.

Gruss has denied in part and objected in part to the
statement, noting that the initial sentence is inadmissible
speculation and that there is no admissible evidence that Gruss
was ever aware of how much money the management company had at
any one time, Ex. UU at pp. 223-25 , or that there was any
intention to use the money from the Citigroup loan facility to
pay the $3 , 774,175 to close on the airplane purchase. Gruss
further notes that O'Hara, the accountant in charge of the
Management Company account, testified that the purpose of the
Citibank loan was "to normalize processes" in paying Management
Company expenses on a monthly basis as opposed to paying
expenses on an ad hoc basis by withdrawing money from the funds
to reimburse fund expenses, whenever the Management Company had
to pay such expenses. "[T]he Citibank loan would have alleviated
the need to pay expenses and be reimbursed immediately from the
funds," Ex. LLL at pp . 161-63, and that Gruss also testified
that the Citibank revolver was not needed "in order to effect
the purchase of the plane," but for "operating expenses." Ex. VV
at pp. 107-8. According to Gruss, the statement in the October
25, 2005 email, "Pls move $ from Offshore Fund" is misleading
and improperly implies that Gruss approved $163,267 . 50 for
118

airplane expenses to be paid by the Off shore Fund and that the
$163,267.50 was taken from the Offshore Fund as a reimbursement
to the DBZCO, the management company, for expenses, which the
Offshore Fund owed to DBZCO, Ex. LLL at pp. 156-62; Ex. UU at
pp. 361-65, and that in the normal course of operations of the
funds, the management company paid expenses on behalf of the
funds, and the funds in turn reimbursed the management company
at various times. Ex. LLL at pp. 157-58.

168.

On October 25, 2005, Gruss wrote Citigroup

asking for the status of the loan facility. "What is the holdup?
We're now going on the 4th week of the 'we'll turn this around
in a week' loan." (Brody Deel. Ex. 122). In fact, the money from
the Citigroup loan was not credited to the company's account
until November 4, 2005 - more than a month after the money was
necessary to pay for the closing costs for the airplane
purchase.

(Brody Deel. Ex. 123). As one accountant testified:

"it was supposed to be a quick process and it turned out to be
much longer than I expected." (Brody Deel. Ex. 105 at 41:18-20)
"My expectation was that it was coming when they told me it was
coming. In a week, in two weeks, in three days. So, every time
that deadline passed, I would again be,

'What's going on? Where

is the loan?' I -- at some point, in my recollection,

I stopped

assuming knowing when the loan was coming." Id. at 58:17-24.
119

Gruss denied the statement in part noting the phrase
"More than a month after the money was necessary to pay for the
closing costs for the airplane" is contrary to O' Hara ' s
testimony that the purpose of the Citibank loan was "to
normalize processes" in paying Management Company expenses on a
monthly basis as opposed to paying expenses on an ad hoc basis
by withdrawing money from the funds to reimburse fund expenses,
whenever the Management Company had to pay such expenses. "[T]he
Citibank loan would have alleviated the need to pay expenses and
be reimbursed immediately from the funds ." Ex . LLL at pp . 16163.

169 .

Without the money from the Citigroup loan

facility , a decision was made to take the money from the
investors' funds to pay the closing costs. The SEC asserts that
Law participated in a meeting in Gruss' office with Kahn where
it was decided to use investor money to pay the closing costs
since the loan had not come through .
97:20 -

(Brody Deel. Ex. 17 at

98:10) . Law recalled that during the meeting, Gruss was

bouncing a ball off the wall of his office.

Gruss has denied the statement in part and stated that
the Citigroup loan had nothing to do with the closing costs for
120

the airplane, that there is no admissible evidence that at the
meeting in Gruss ' office with Kahn and Law it was decided to use
investor money to pay the closing costs for the plane, that Law
testified in her deposition that she has no recollection what
anybody said at that meeting, and she "had no recollection of
any discussions about the transfers from the Onshore Fund or
HCMZ for plane related expenses," Ex. BBB at pp. 258-59, and
that the only direction she received from anybody about using
fund money to pay for the airplane expenses was an email she
received from Kahn asking her to fund the airplane expenses and
that "was an indication of moving the money from the Funds." Id.
at p. 258. Gruss further stated that the email in question from
Kahn to Law stated, "Can you pls arrange to have the $ 1. 9MM
wired to Citi asap for the issuance of the LC. This will only be
a short-term deposit in that once the Citi revolver is in place
(should be w/n a week) we will credit the amount against the
line. Thx." Id. at pp. 289 - 90 , Ex. MMM. Gruss has denied that he
ever authorized or had knowledge of these payments being made
from the Funds.

170.

Law was only involved in this meeting, because

she was the accountant for the funds and the money was corning
from the funds.

If the money had come from the management

company ' s account, she would not have been involved at all. Law
121

was the person "responsible f or fund expenses so if there were
any expenses directly related to the fund or f or deals, they
would have gone to [Law]." (Brody Deel. Ex . 104 at 33 :2-5 ) .

Gruss has denied and objected to this statement noting
that the Law testimony cited at 97:20 - 98:2 is inadmissible
speculation about an unidentified conversation, that the
statement about "any expense directly related to the fund
would have gone to [Law]" is directly refuted by Law who
testified she cou ld approve the expenditure of funds from the
Management Company , Ex. BBB at p. 55, and Kahn who testified
that even though Law "was more responsible for the fund
accounting" and "O'Hara was more responsible for the management
company accounting," this split in responsibilities was "not
exclusive ." Ex. KKK at pp. 38 - 9 and that as Controller of DBZCO,
Law had responsibility for paying management company expenses.
Ex. VV at p. 87 .

171.

At the time, Law was " ve r y used to this kind of

situation whereby if something needed to get funded and there
was not enough money, then we would take it from an entity that
had the money." In this case, the management company was in a
" very tight cash situation" and could not pay for the plane. Law

122

understood that Gruss knew that the money was going to come from
the fund.

(Brody Deel. Ex. 17 at 110:6-11).

Gruss has denied and objected to this statement noting
that the statement that Law was "very used to this kind of
situation whereby if something needed to get funded and there
was not enough money , then we would take from an entity that had
the money," was elicited improperly over Gruss' objection as a
leading question in violation of Fed.R.Evd.611(c). Gruss
believes that the statement was a leading question because Law
was a witness for the SEC , had entered into a cooperation
agreement with the SEC, the question was asked on direct
examination by the SEC, and the witness was not hostile or
identified with Gruss. Gruss further notes that the second
statement that "Law understood that Gruss knew that the money
was going to come from the fund" is inadmissible and not based
on any statement made to her by Gruss. Finally, Law admitted
that prior to the fund money being used to pay for the airplane,
she could not recall any specific conversation with Gruss about
the airplane being paid with the fund money. Ex. BBB at pp . 30507 .

According to Gruss, as to the two September 28, 2005
payments for the airplane closing costs, Law testified that she
123

had created two approval forms for the two payments using wire
requests with photocopies of Gruss' signature at the bottom of
the wire requests, Ex. BBB at pp. 253 -5 4 ; Exhs. PP-QQ, and Law
took " one of" the "old wire approvals" and "fold[ed] it at the
part where the signature is shown up, put it on the blank that
we just printed out and then photocopied it." Id. at p. 2 53.
Further, Gruss notes that Law has no recollection of speaking to
Gruss to obtain his approval for these two wires prior to
sending out these two wires on September 28th , id. at pp. 255-56 ,
and that Law stated that what prompted her to pay the amounts
from the two managed accounts was an email she had received from
Kahn requesting her to fund the two amounts -- to her "it was an
indication of moving the money from the Funds." Id. at pp. 258 ,
289 - 90 ; Ex. MMM.

According to Gruss, both the September 29th and 30th
payments for the airplane closing costs were sent from the funds
after Gruss had emai led his approvals "Ok pag" in response to
emails from Law. Exhs. RR, KK. Law stated that DBZCO did a
number of "investments that related to airplanes including
Priority Air, that "she "wouldn't know" whether Gruss actually
knew he was approving payments from the funds for Zwirn 's
airplane and that she could not "recall" any such conversations
with Gruss about these payments. Ex. BBB at pp. 294-300 .
124

172.

At the time Gruss was very cognizant of keeping

track, or seeing every payment related to the plane so all
invoices specifically required Gruss' separate approval .

Gruss has denied this statement noting that O' Hara did
not testify that Gruss was very cognizant of keeping track, or
seeing every payment related to the plane and testified that "I
don ' t have a specific recollection of him actually approving any
particular invoice," Ex. LLL at p. 150, and that there is no
evidence that "Gruss was very cognizant of keeping track," or
seeing every payment related to the plane .

173.

Gruss knew that the use of investor funds to

purchase an airplane for the management company would be a
violation of the agreements between the funds and the management
company.

174.

On September 27, 2005 , Kahn sent Law and email

with a copy to Gruss requesting that Law "arrange to have the
$1.9MM wired to Citi asap for the [i]ssuance of the LC [letter
of credit] ." (Brody Deel . Ex. 124).

125

175.

A wire transfer instruction to Bear Stearns

dated September 28 , 2005 requested the transfer of $1,900,000
from the HCM/Z Account to DBZCO's cash collateral account at
Citibank .

(Brody Deel. Ex 125). A signature appeared on the

Perry Gruss signature line.

Gruss denied the statement in part noting that Law
stated, as set forth above, that she had created the signature
on the wire approval by photocopying Gruss' signature on to the
wire instructions without Gruss '

176.

knowledge.

On September 27 , 2005, Kahn sent Gruss and Law

an email stating that a "facility fee" in the amount of $80,250
needed to be paid to Merrill Lynch.

(Brody Deel. Ex. 126).

According to Gruss, Kahn sent the email to Law and copied Gruss
on the email.

177.

A wire transfer instruction to Bear Stearns

dated September 28 , 2005 requested the transfer of $80,250 from
the HCM/Z Account to Merrill Lyn ch .

(Brody Deel. Ex. 127). A

signature appeared on the Perry Gruss signature line.

126

According to Gruss, Law admits that she created the
signature on the wire approval by photocopying Gruss' signature
on to the wire instructions without Gruss'

178.

knowledge.

On September 28 , 2005 , Kahn forwarded to Law and

copied to Gruss the wire instructions for the plane deposit to
be sent to the escrow agent, Insured Aircraft Title Service
("IATS") .

(Brody Deel. Ex. 128). On September 29 , Kahn sent Law

and copied to Gruss the final amount for the wire that needed to
be paid to IATS.

(Brody Deel . Ex. 129). On that same date, the

accountant sent an email -- cc'ed to Gruss -- stating: "Please
wire $1,681,350 from the L.P. acct# ***599 to the following
instructions. PG's [Perry Gruss'] approval to follow. Thanks."
(Brody Deel. Ex. 130).

179.

Gruss approved the transfer from the Onshore

Fund's account to pay the deposit on the airplane.

Gruss has denied the statement in part noting that as
to the September 29th and 30th payments for closing costs for
the airplane for which Gruss approved the email requests for the
transfer of the funds , these approvals were a "protocol for
LaSalle" bank , which Gruss was required to perform in order to
release funds from the bank, Ex. VV at p. 17, and Gruss' purpose
127

in approving the transfer was "[t]o make sure the wire was
actually sent" because "[w]ithout an authorization that wire
does not get sent," Id. at 27, that Gruss received "hundreds of
e-mail approval requests," Id. at 17, that in the month of
"September alone " he "had received over 250 such requests" and
that on September 29th and 30th Gruss received numerous email
requests for authorizations t o send moneys from the funds and
approved the two emails at issue at the same time he approved
other email requests for approval. Ex. BBB at pp. 293-94, 299300; Exhs. NNN-000. "[T]he control that made sure that the wire
was for an appropriate purpose" was the "Finance [personnel] who
were actually authorizing the wires and

[the] people in

the back office the next day that were reconciling the wires."
Id. at Exhs. RR, KK.

According to Gruss, at the time he approved the
September 29th and 30th email requests, he did not know he was
approving payments for Zwirn's airplane. Ex. VV at p. 17. As a
general practice Gruss "wou ld read the "To" line and the "From"
line and most likely the subject." Id. The subject on th e
September 29th and 30th emails was "RE: IATS." By itself this
subject did not reference the purchase of Zwirn's airplane. If
Gruss had read further into the email, he would have seen on the
September 29th email the phrase "CREDIT: INSURED AIRCRAFT TITLE
128

SERVICES , INC . ," Ex . RR, and on the September 30th email the
phrase, "Acct : FSG Privatair, Inc. " Ex. KK. Prior to September
30th the Zwirn funds had been investing in aircraft , one of
which investments was known as "Priority Air, " "quite similar to
Private Air." Ex. BBB at p. 295 ; Ex. UU at pp . 344-46, Ex . PPP .
Gruss further notes as recently as September 6th, Gruss had
approved an email relating to "Priority Air." Id. , and because
the airplane was supposed to be paid out of the Management
Company, Gruss was not expecting to be given an approval for
payment from any of the funds . Ex . UU at pp . 232 , 355; Ex . XX at
pp. 204 - 05 .

Gruss further noted that he sent an email to DBZCO
partner Christopher Suan ("Suan") about a week after the
completion of the four airplane transactions in which Suan asked
Gruss if Zwirn had bought "Glenn's [Dubin] plane . " Gruss
replied, "No his own" and that the funds to pay for the plane
came out of the "Mgmt co be its 95pct mgmt . co related. " Ex .
QQQ . The remaining 5% of the 95 % of the plane that would be used
for the management company was for Zwirn ' s personal use of the
plane . Ex . VV at pp . 95 - 96 .

180 .

On September 28 , PrivatAir sent Kahn its invoice

for the balance of the acquisition fee.
129

(Brody Deel. Ex . 131).

On September 30, Kahn forwarded the invoice to Gruss and the
accountants, stating: "[o]ne more wire to go this am as per
attached -- $112 ,5 75 ." Id. According to Gruss, the September 30
email was sent to the accountants and copied to Gruss .

181.

On September 30 , the accountant sent an email --

cc'ed to Gruss -- stating: "Please wire $112,575 from the L.P.
acct #***599 to the following instructions. PG's approval to
follow. Thanks." (Brody Deel. Ex. 132).

182.

On that same day, Gruss approved the transfer

from the Onshore Fund's account to pay PrivatAir for its
brokerage services for the plane acquisition.

(Brody Deel. Ex.

132). Gruss has denied the statement it in part as set forth
above.

183.

During this entire time , Gruss was aware that

the management company did not have sufficient funds to pay the
$3,774,175 required to close the airplane purchase. Indeed, the
tone of the discussion in the office was that it was " odd" that
the company was purchasing the plane while it was going through
liquidity issues.

(Brody Deel. Ex. 105 at 69:13 -17 ) .

130

Gruss has denied and objected to this statement and
testified that he was not aware that the management company did
not have sufficient funds to pay the $3,774,175. Ex. VV at pp.
107-08, Ex. UU at pp. 274 , 278 -7 9 , and the statement about the
"tone of the discussionu is inadmissible hearsay pursuant to
Fed . R. Evd. 801 and that O'Hara testified in regard to the
"general toneu that she did "not recall any specific
conversat i ons .u Ex. RRR at p. 69 .

184 .

During the period from September 28 , 2005

through September 30 , 2005 , the management company did not have
more than $827,000 in its operating account.

185.

On September 23, 2005 , one of the accountants

sent Gruss an email stating that the management company was
"s craping the barrelu (Brody Deel. Ex. 202) , meaning that the
funds were very low in the management company's account.

(Brody

Deel. Ex. 105 at 37:17 -1 9) . On September 23 , the management
company 's operating account balance declined from $207,000 to
just below $178 , 000 .

(Brody Deel. Ex. 1 33 at 66)

Gruss denied the statement in part and objected in
part noting the additional testimony of O'Hara that the SEC does
not c it e or include is her testimony that the funds would
131

reimburse expenses to the Management Company "on an as-needed
basis," Ex. RRR at pp. 38-41, as well her immediately subsequent
testimony about how the Management Company would meet upcoming
expenses by obtaining reimbursement from the funds for expenses
the Management Company had spent on behalf of the funds.

186.

On October 26, 2005 after the airplane deal

closed, one of the accountants sent Gruss a spreadsheet
specifically stating that the money to the seller ($1,681,350),
to Citgroup ($1,900,000), to Merrill Lynch ($80,250), and to
PrivatAir ($112,575) had not come from DBZCO.

(Brody Deel. Ex.

135). The term "FUND" was used in the "Bank" column of the
spreadsheet to indicate that payment "was made by somebody from
the fund account, from one of the fund accounts" as
distinguished from DBZCO's operating account at Citibank.

(Brody

Deel. 105 at 64:19 - 65:4).

Gruss has denied the statement in part noting that
there is no evidence he ever reviewed the chart or responded to
the October 26 email.

187.

On November 9, 2005, one of the accountants sent

Gruss an email describing how much cash was available to the
management company.

(Brody Deel. Ex. 136). The first liability
132

listed was $3 . 8 million to "repay Onshore Fund for airplane
wires." Id. On November 10, the accountant sent Gruss a second
email stating: "PG - we need to send $3 .77mm from the new
account where we received the 8.1 mm loan back to the Onshore
Fund for reimbursement of the airplane wires." (Brody Deel. Ex.
137) .

188. After the plane purchase was comp leted, Gruss and
Law continuously talked about when the Citigroup l oan was going
to come through so that the funds could be repaid for the money
that had been used for the plane.

(Brody Deel. Ex. 1 7 at 96: 13 -

97: 7) .

Gruss has denied the statement in part noting the only
conversations Law recalls with Gruss were "after the fact" of
the payments from the funds about repaying the two managed
accounts and the funds from a loan from Citibank. Law did not
recall any conversation with Gruss "pri or to November 9th
[ 2005 ], where .

[she] actually spoke to him about the fact

that the monies had to be repaid for the

. airplane wires."

Ex. BBB at pp. 305 -07. Further, Gruss deined that that on
November 9 , 2005 , Gruss was in Hong Kong . Ex. UU at pp. 373 -7 4 ,
and that on cross-examination Law testified that she talked to
Gruss "[s] everal times,

(as opposed to "co ntinu ous l y talked")
133

but nothing specific," and she could not say if those
conversations occurred in " October or November." Ex. BBB at p.
307 .

Materiality

189.

Sulzberger of PWC, testified that the "impact

on the financial statements" for 2004 and 2005 of the inter-fund
transfers, the early payment of management fees, the use of fund
money for the purchase of the airplane, "certain opera ti onal
expenses overcharged by the investment manager to the fund" and
other items " were quantitatively and qualitatively immaterial
both individually and in aggregate with respect to all impa cted
periods," and that DBZCO was "not required to restate the 2004
or 2005 financial statements" for the funds.

(Ex. Z at pp. 8 -11,

72-73, 75, 92 , 103, 127, Ex. GG and HH).

The SEC has d isputed this statement noting that no
analysis was done to determine whether or not the monthly or
quarterly information provided to investors was materially
impacted by the interfund transfers or any of Gruss' acts, that
PWC's analysis was limited to the annual financial statements,
and that DBZCO's analysis did not only concern the adjustments
relating to the interest due to the Off shore Fund for amounts
134

advanced for the purchases of investments for other funds, the
money advanced for repayment of the credit facility and the
early management fee withdrawals but concerned "all adjustments
the Company is aware of as of the date of this memorandum"
(Gruss Ex. HH at p . 1) and the "all adjustments" included the
net effect of some seventeen individual adjustments, which
included many issues unrelated.

(Brody Op . Deel. Ex. E) While

the adjustments for 2005 relating to the interest due to the
Off shore Fund for amounts advanced for the purchases of
investments for other funds, the money advanced for repayment of
the credit facility and the early management fee withdrawals
exceeded $8 million. Further, the net of all of seventeen
adjustments was approximately $6 mill i on and that there was no
separate consideration of the materiality of the adjustments
related to interest due to the Offshore Fund for amounts
advanced for purchases of investments for other funds nor for
the money advanced for repayment of the credit facility and the
early management fee withdrawals. The SEC further noted that
Sulzberger also testified that PWC did not analyze, and did not
have the capability to analyze, whether the Offshore Fund was
materially harmed by the fact that its cash was being used for
the benefit of another fund and, as such, did not have the
ability to use that money to fund its own investments.

(Brody

Op. Deel ., Ex. Fat 186:8 -2 3) Further, in connection with the
1 35

2006 audit, PWC sent SAS 112 letters to DBZCO for both the
Onshore and Off shore Fund identifying material control
weaknesses.

(Brody Deel. Exs. 189-90).

190.

Sulzberger testified that none of the financial

statements for 2004 and 2005 for the Onshore Fund and Off shore
Fund were restated.

The SEC notes that in addition to the issues
identified above, Sulzberger conceded that PWC determined that
there were quantitatively large misstatements in the 2005
financial statements (concerning the transfers between the
Offshore and Onshore Funds), but in light of the fact that
remediation had taken place and in light of the fact that
significant disclosures had been made by the company as to what
misstatements had taken place, no restatement of the financial
statements was necessary.

191.

PWC determined that the inter-fund transfers,

the early payment of management fees and the use of fund money
to purchase the airplane, even when aggregated with other
operational expenses that were allegedly overcharged, were not
material.

136

The SEC has disputed the statement that many of the
"other operational expenses" that PWC considered, in fact,
reduced the overall impact to the Fund; as described above, that
while the adjustments for 2005 relating to the interest due to
the Offshore Fund for amounts advanced for the purchases of
investments for other funds, the money advanced for repayment of
the credit facility and the early management fee withdrawals
exceeded $8 million, the net of all of seventeen adjustments was
approximately $6 million.

(Brody Op . Deel. Ex. E). The SEC

further noted in connection with the 2006 audit, PWC sent SAS
112 letters to DZBCO identifying material control weaknesses at
the management company (Brody Dec. Exs. 1 89 -1 90) stating that:
the Investment Manager did not maintain and tone and
control consciousness to prevent or detect certain
instances of inappropriate conduct, and to maintain
sufficient accounting records and other documentation
to support the fair presentation of the Fund's
consolidated financial statements in accordance with
... GAAP and that the letters described how the
Investment Manager did not maintain effect i ve controls
over certain disclosures in the Fund's consolidated
financial statements, including the due to/from
affiliates, managements fees , expenses and income tax
accounts and PWC concluded that the controls were not
designed to ensure the prevention or detection of
certain issues, including: (1) improper cash and
investment transfers among the funds; (2) premature
payment of management fees to the Investment Manager;
and (3) the short term use of the Fund's assets for
non -Fund related purposes.

192.

PWC reviewed DBZCO's analyses of the Onshore

Fund and Offshore Fund funds in accordance with the SEC's Staff
137

Accounting Bulletin "No. 99 - Materiality "

("SAB 99") and agreed

with DBZCO that the adjustments made to the financial statements
for 2004 and 2005 were not quantitatively or qualitatively
material and that the financial statements for 2004 and 2005 did
not have to be restated . Ex . Z at pp . 68 - 69 and 103 - 105.

The SEC has noted that the materiality analysis
concerned seventeen separate adjustments, including many
unrelated adjustments and there was no separate consideration of
the impact to the Off shore Fund relating solely to the interfund
transfers, the management fees, and the airplane purchase and
with respect to the interfund transfers , which totaled
approx i mately $775 million . Further , the SEC asserted that the
only issue that PWC looked at with respect to quantitative
materiality was whether the interest that DBZCO determined
should have been paid on the interfund transfers would have had
a material impact on the Offshore or Onshore Fund.

(Brody Op.

Deel., Ex. Fat 183:9-184:15). The SEC further noted that
Sulzberger testified that PWC did not analyze (and did not have
the capability to analyze) whether the Offshore Fund was
materially harmed by the fact that its cash was being used for
the benefit of another fund and , as such, did not have the
ability to use that money to fund its own investments (Id. at
186:8-23), and the SAB 99 analysis concerned the 2004 and 2005
138

audits; in connection with the 2006 audits, PWC sent SAS 112
letters to DBZCO identifying material control weaknesses at the
management company (Brody Dec. Exs. 189-190), which referred to
the "inappropriate conduct" that took place at the funds,

and

containing the statements referred to above and the letters
stated that these were "material weaknesses," which were defined
in the letter as "a control deficiency, or combination of
control deficiencies, that results in more than a remote
likelihood that a material misstatement of the financial
statements will not be prevented or detected." The SEC further
noted i nvestors requested the SAS 112 letters as support for
potential redemption actions.

193.

(Brody Deel. Ex. 187).

Sulzberger testified, "SAB 99 represents the

best authoritative literature available for addressing the issue
of materiality and prior period adjustment." Ex. Z at pp. 76-77.

The SEC noted that on its face, SAB 99 relates to
misstatements in financial statements , and provides that the
factors listed therein are "not an exhaustive list of the
circumstances that may affect the materiality of a
quantitatively small misstatement. Among other factors, the
demonstrated volatility of the price of a registrant's
securities in response to certain types of disclosures may
139

provide guidance as to whether investors regard quantitatively
small misstatements as material." (SAB 99, Topic 1: Financial
Statements , Section M. Materiality , Subsection 1. Assessing
Materiality.) Further, from September 2007 to November 2007, as
a result of the disclosures made to the SEC, the investors, and
the auditors by DBZCO and the delay in the audit that resulted,
there were $1.4 billion in investor redemptions from the funds.

194.

Sulzberger also agreed with DBZCO "that its

investors are primarily focused on bottom line fund
performance," (Ex. Z at pp. 72-89; 220; Ex. HH at p. 2) and that
the threshold of "5 to 10 percent was in line with industry
standards and norms for evaluating the quantitative impact on
net income and total return" of each fund.

(Ex . Z at pp. 80-81,

217, see Ex. GG.) Dr. Bergin compared the funds'

returns to

standard industry indices - and showed that the DBZCO "hedge
fund complex . . . generated above-average investment returns for
a group of sophisticated investors." Ex. D at p. 8, see also,
pp. 30-32 and Bergin stated that "one reason that the flow of
funds was so strong into the off shore account" "year after year "
was because the Off shore Fund repeatedly earned these above
average returns. Exhibit II at p. 294.

140

The SEC noted that Sulzberger testified that he agreed
with DBZCO's view that its investors were focused on bottom-line
performance but also testified that he would not be surprised if
other entities or accounting groups used different thresholds
for hedge funds to determine the materiality of adjustments to
net income and total return. The SEC also noted Dr. Bergin's
report contradicts his assertion that the Off shore fund
" repeatedly earned these above average returns" in that sixteen
of the twenty-four months presented for the period 2004 to 2005 ,
the S&P 500 and/or the CS/Tremont Multi -Stra tegy sub-index
outperformed the Offshore Fund (Gruss Ex. D at 33) , and over the
twenty-seven month period (January 2004 - May 2006) analyzed in
Dr. Bergin 's report, a $100 investment in the Offshore Fund
would have grown to $ 1 25 .11 and that the same $100 investment
growing to $124 .0 3 in the C/S Tremont Multi-Strategy sub-index
and $122.81 in the S&P 500 (Gruss Ex. D at 40), and that Dr.
Bergin 's report stated the Offshore Fund returned only 1 % more
than the CS/Tremont Mult i-Strateg y sub-index and 2 % more than
the S&P 500 .

195.

As to the qualitative analysis using the

standards of SAB 99, PWC agreed with DBZCO that

(1) "most of the

errors are subject to reasonably precise measurement," (2) "the
errors in question had v irtually no impact on the trend of any
141

of the relevant measures," (3) "the errors in question do not
impact whether the fund's performance was greater than or less
than the performance' of various [market] indices that "certain
of its invest ors could" have used,

( 4) "none of the

misstatements individually or in aggregate changes a l oss int o
income or vice versa for any annual period," (5) each "fund has
been assessed on a standalone basis and that there are no
segments within the fund,"

(6) the "adjustments are not

concentrated in any individual significant strategies utilized
by the management company," (7) "there are no regulatory
thresholds that were affected by the recording of these
misstatements and the fund's financial statements," (8) "the
misstatements in question do not affect the company 's compliance
with loan covenants or other contractual requir ements ," (9) "the
impact on the management incentive fees overall is a $233,000
decrease in compensation ," (10) "insufficient evidence exists to
conclude that these matters and the errors in question were the
result of an attempt to conceal unlawful transa ctions, "

(11)

"the related party e lements of these adjustments [did not]
result in any of these adjustments being qualitatively
material," and ( 1 2) that "there are no other qualitative aspects
of these adjustments that would make them material in any of the
financial statements for any of the periods in questions." Ex . Z
at pp. 89 -10 2 ; Ex. GG and HH.
142

The SEC has noted that SAB 99 relates to misstatements
in financial statements and provides that the factors listed
therein are "not an exhaustive list of the circumstances that
may affect the materiality of a quantitatively small
misstatement" and that, among other factors, the demonstrated
volatility of the price of a registrant's securities in response
to certain types of disclosures may provide guidance as to
whether investors regard quantitatively small misstatements as
material." The SEC further noted that from September 2007 to
November 2007, as a result of the disclosures made to the SEC,
the investors, and the auditors by DBZCO (concerning the issues
alleged in the SEC's complaint), and the delay in the audit that
resulted, there would be $1.4 billion in investor redemptions
from the funds

(Zwirn Affiavit at

~14)

and that in connection

with the 2006 audits, PWC sent SAS 112 letters to DBZCO
identifying material control weaknesses at the management
company and the letters repeatedly referred to the
"inappropriate conduct" that took place at the funds,

explicitly

stating that "the lack of an effective control environment
allowed the Investment Manager's former Chief Financial Officer
[Gruss] to engage in inappropriate conduct that resulted in
certain transactions not being properly reflected on the Fund's
consolidated financial statements." (Brody Deel. Ex. 189-190).
143

196.

PWC's worksheets identified numerous material

weaknesses, including:

(1) controls, policies and procedures may

not have been sufficiently designed or in operation regarding
the movement/use of cash between the funds and the proper
accounting treatment for these transactions;

(2)

"tone at the

top" - the former CFO did not appear to have focused on ensuring
adequate design and operating effectiveness of internal control
over financial reporting. Also the former CFO appeared to lack
the willingness to deliver "bad news" to the managing partner.
This led to a control environment in which accounting
adjustments were viewed at times as an acceptable device to
compensate for operational shortfalls wh ich, in certain
instances, led to inappropriate accounting decisions and entries
that appear to have been largely motivated to achieve desired
accounting results, as well as management override of controls;
and (3) management override and inadequate antifraud programs
and controls, there were various instances of the former CFO
performing inappropriate transactions to "manage" liquidity
concerns and,

in some instances, accounting irregularities were

brought to his attention and he did not take appropriate action
to investigate and correct for them.

144

(Brody Deel. Ex. 1 88).

Gruss has ob je cted to the statement noting that any
alleged material weaknesses are irrelevant and inadmissible
hearsay and that after concluding its 2006 audit, which included
reviewing the funds'

financial statements for 2004 and 2005, PWC

did not find any fraud and concluded there was no reason to
restate the financial statements of the Onshore Fund and
Offshore Fund for 2004 and 2005. Ex. CCC at pp. 68 -70.

197.

Using the interest rate relied upon by Deloitte

("Greater of (i) short term monthly applicable funds rate or
(ii) the fed fund rate plus 25 basis points" Ex. JJ at p. 11),
Gruss asserted that if the Offshore Fund had not advanced the
$126,896 , 039 to the Onshore Fund for the purchase of investments
for which it does not appear the Offshore Fund ever received any
participation , the Offshore Fund's Net Profit in 2004 would have
increased by 0.01 %, the Offshore Fund's Net Profit in 2005 would
have increased by 0.43 %, and the Offshore Fund's net profit in
2006 would have increased by 0.18 %. Annexed as Gruss Dec . Ex. F
is a spreadsheet showing the interest calculated for the 27 cash
transfers from the Off shore Fund to the Onshore Fund amounting
to $126,896,039 and representing transfers for the purchase of
21 investments for which there is no evidence of Offshore Fund
participation in the 21 investments associated with those 27

145

cash transfers. Gruss Dec.,

~~

12 - 14; Gruss Dec. Ex. G; Gruss

Dec. Ex . H.

The SEC has noted that the underlying assumption that
it is correct to limit the interfund transfers to approximately
$127 million is baseless. The SEC does not claim that the
"interest" that was not paid on the interfund transfers is not
in and of itself why the interfund transfers were material .
Instead , the SEC noted that the Interfund Transfers were
material for numerous reasons , including: the total volume of
the interfund transfers relating to the funding of the Onshore
Fund ' s investments exceeded $500 million, and the transfers to
allow the Onshore Fund to repay its credit facility totaled $273
million so that amounts outstanding at various dates were
material (as an example, the Offshore Fund had AUM of $1.6
billion in March 2006 (Brody Deel., Ex. 10) , and the $175
million balance owed to the Off shore Fund for transfers related
to the credit facility (Brody Deel . Ex. 91 at 19) amounted to
more than 10 % of AUM.

The money that was transferred to the Onshore Fund or
directly to the investment could have been used for the direct
benefit of the Offshore Fund; the transfer of this money to the
Onshore Fund or directly to the investment (which included US
146

real estate investments and other US businesses) exposed the
Offshore Fund investors to US tax liability which PWC estimated
would be approximately $250 million and while DBZCO's managing
director of tax believed that the amount would be closer to $100
million even he thought that "it would still be devastating"
(Brody Deel. Ex . 191 at 463); PWC be li eved that these transfers
resulted from material control weaknesses at the management
company (Brody Deel. Exs . 189-190); and (5)

investor reaction,

including mass redemption requests demonstrated the materiality
of these transfers, $1.4 billion in investor redemptions between
September 2006 and November 2007 and eventually redemptions in
excess of $2 billion.

198.

(Affidavit of Daniel Zwirn at

~14).

The second group of inter-fund transfers

charged in the complaint were the "$273 million in transfers
between March 2004 and July 2006 from the Offshore Fund to repay
the revolving credit facility of the Onshore Fund ." Ex. N at

~3.

Applying the same interest rate used by Deloitte to the funds
the Off shore Fund advanced to the Onshore Fund for the payment
of Onshore Fund's obligation to the revolving credit account, if
the Off shore Fund had not advanced those funds to the Onshore
Fund to repay the revolving credit facility, the net profit in
2005 for the Offshore Fund would have increased by 0.92 %, and
the net profit in 2006 would have increased by 1.83 %.
147

The SEC has noted that the Interfund Transfers were
material for numerous reasons, including:

(1) the total volume

of the interfund transfers relating to the repayment of the
revolving credit facility was more than $270 million, which was
a material amount;

(2) the money that was transferred to the

Onshore Fund to repay the revolving credit facility could have
been used for the direct benefit of the Offshore Fund;

(3) the

transfer of this money to the Onshore Fund exposed the Offshore
Fund investors to US tax liability which PWC estimated would be
approximately $250 million and while DBZCO's managing director
of tax believed that the amount would be closer to $100 million
even he thought that "it would still be devastating"
Deel. Ex. 191 at 463);

(4)

(Brody

PWC be lie ved that these transfers

resulted from material control weaknesses at the management
company (Brody Deel. Exs. 189-190);

(5) in the absence of this

money being transferred to the Onshore Fund, the Onshore Fund
would not have been able to repay the revolving credit facility
(Brody Op . Deel., Ex. Cat 147:4-9); and (6) investor reaction,
including mass redemption requests after DBZCO's disclosures to
the investors, the SEC, and the auditors as well as the delay in
the audit which resulted from such disclosures.

148

199.

At the end of October 2006, DBZCO reached out to

investors to inform them of certain of the improper actions that
had taken place at the funds. These calls were followed up with
a November 3 , 2006 memorandum to investors that explained that
DBZCO was conducting an internal review. Gruss has objected to
the statement on the ground that the November 3, 2006, memo from
DBZCO to investors is inadmissible hearsay and the results of
DBZCO's internal investigation consist of hearsay upon hearsay
and are inadmissible, U.S. Reyes, 239 F.R.D. 591, 600

(N.D. Ca.

2006) , and what the investors were told is irrelevant.

200.

In its Q4 2006 letters to the Offshore and

Onshore Fund investors, DBZCO stated "[a]s you know, we
communicated with you in Q4 2006 regarding certain issues
affecting our Firm. At that time, we informed you that we were
taking significant, carefully-coordinated steps to resolve these
issues, including an internal review in consultation with
external lawyers and an external review by independent lawyers
and accountants ('the Independent Review'). We also inf ormed you
that we took the additional step of informing the S.E.C. of
these issues, as well as the actions the Firm was taking to
address them, including the Independent Review."

(Brody Deel.

Ex. 175 at 8865; Ex. 176 at 86). Gruss has objected to the
statement noting that the Q4 2006 letters to the Off shore and
149

Onshore investors are inadmissible hearsay and what the
investors were told is irrelevant to any of the issues in this
case .

201.

On March 27 , 2007 , DBZCO sent a memorandum to

investors reporting the completion of the independent review.
Gruss has objected to the statement on the ground that the March
27 , 2007 memorandum to investors is inadmissible and what the
investors were told is irrelevant to any of the issues in this
case.

202 .

The memorandum explained that the "e xhaustive "

review had cost the management company over $20 million in
professional fees to date .

(Brody Deel. Ex. 177). Gruss has

objected to this statement as the March 27, 2007 memorandum to
investors is inadmissible hearsay, and on the ground that what
the investors were told are irrelevant.

203 .

The memorandum reported that there were

"numerous inter-fund transfers" where the Offshore Fund and
another managed account "frequently made advances" to the other
funds and managed accounts "and those advances were used to fund
investments. These inter-fund transfers were not properly
accounted for and documented."

(Brody Deel. Ex . 177). Gruss has
150

objected to the statement asserting that the March 27, 2007
memorandum to investors as inadmissible hearsay, that the
advances from the Off shore Fund to the Onshore Fund were
accounted for to the penny in DZPRIV and the funds' balance
sheets, see

~~

41 - 46 of Defendant Gruss' Statement of Undisputed

Material Facts Pursuant to Local Civil Rule 56.1, and that what
the investors were told is irrelevant.

204 .

The memorandum further reported that the amounts

currently due fr om the Onshore Fund to the Off shore Fund and a
managed account "are in excess of $100 million."

(Brody Deel.

Ex. 177). Gruss has objected to the statement on the ground that
the March 27 , 2007 memorandum to investors as inadmissible
hearsay and that what the investors were told is irrelevant to
any of the issues in this case .

205.

Investors believed that these disclosures were

material. One investor wrote following a November 7, 2006
conference call with DBZCO: "DB Zwirn have verbally advised us
. . . of a number of accounting errors that they have identified
prior & subsequent to the departure of their CFO in early
October 2006 . The errors involve the transfer of an asset from
one fund to an o ther without $8 million of associated interest, a
management fee drawn down before its due date and some expenses
151

incorrectly booked.

. This disclosure does , of course , raise

questions as to the overall integrity of their accounting .
Given the circumstances , we have reduced our Competence
operational rating to a D, and would recommend that clients do
not consider new or additional investments until these issues
are resolved. "

(Brody Deel. Ex. 178).

Gruss has denied and has objected asserting that the
investor documents are irrelevant and are inadmissible hearsay
and that as to redemption, the full statement in Zwirn ' s
Affidavit is that "[a]s a result of the disclosure that the
DBZCO made to the SEC , investors in the funds, and auditors, as
well as the significant delay in the audit, there were $1.4
billion in investor redemptions from the Funds between September
2006 and November 2007." Zwirn Affidavit ,

~

14. Gruss further

has noted that in a press report from the Financial Times of
February 22 , 2008 , Zwirn is reported as saying that only "the
delayed audit drove the redemptions , " Ex . TTT , further confirmed
by his statement reported in a July 9, 2007 , DZBCO Memo of a
Status Meeting with Dan Zwirn , Senator Rudman , and Other Members
of Senior Management that " DZ [Daniel Zwirn] has heard from
several investors who have stated their wish to invest more
money once the 2006 financial statements are issued." Brody
Deel, Ex. 192 at p . 6.
152

206.

On January 26 , 2007 , DBZCO received a letter

from HCM/Z terminating the advisory agreement for its managed
account. An April 11, 2007 follow-up letter confirmed that HCM/Z
"had terminated [DBZCO] for improper activities .

."

(Brody

Deel. Ex . 180). Gruss has objected to the statement noting that
the investor letters are irrel evant and inadmissible hearsay.

207 .

On November 3 , 2006 , DBZCO received a letter

from an investor stating that a $5 million investment made on
October 1, 2006 should be immediately rescinded. "[ S]imply
stated,

[the investor ] would not have made the $5 million

investment in the Fund on October 1, 2006 had the Fund disclosed
to [the investor]

(i) the recent termination of the Chief

Financial Officer and the reasons therefor, as expressed t o me
during my telephone conversat i on with a representative of the
Fun d o n Sunday evening, October 29 , 2006 .... "

(Brody Deel. Ex.

181) . Gruss has objected to the statement as in admiss ibl e
hearsay and irrelevant.

208 .

During the summer of 2007, DBZCO had several

meetings with PWC concerning the potential tax liability
resulting from the interfund transfers.

153

Gruss has denied this statement and objected to it
noting that any meetings between PWC and DBZCO concerning the
potential tax liability resulting from the inter-fund transfers
are irrelevant.

209.

In June 2007 , PWC held a conference call with

one of the directors of the Offshore Fund as well as with
several individuals from DBZCO during which they discussed the
potential tax liability to the Offshore Fund because of the
interfund transfers.

Gruss has denied this statement and objected to it
noting that the conference ca ll in question is irrel evant and
the discussions referenced in the conference call are
inadmissible hearsay.

210 .

One of the tax partners from PWC expressed that

"ta xes were 'a significant issue' and that certain transactions
could possibly give rise to making the Offs h o re Fund a

'taxable

business .'" (Brody Deel. Ex. 191 at 463). This partner estimated
that the tax liability that would result would be about $250
million. DBZCO's managing director of tax thought that the
amount would be c loser to $100 million "but it wou ld still be
'de vastat ing.'" Id.
154

Gruss has denied this statement and objected to it
noting that the statements by the PWC partners are inadmissible
hearsay, and are contrary to the subsequent testimony of PWC.
Further Gruss asserted that PWC ultimately "rec ognized" that the
taxability of the inter-fund transfers "was an issue" but it
"concluded that it met the accounting criteria for not being
rec ogn ized in the financial statements based upon all the work
we [PWC] did , which included an opinion of [the law firm of]
Clifford Chance ." (Ex. CCC at pp . 235 - 36 . ) As a result of the
Clifford Chance tax opinion , Gruss asserted that PWC did not do
"anything" "to change any of the accounting for the Onshore Fund
or Offshore Fund for the years 2004 to 2006 " or create "any
restatements of the financial statements for the Onshore Fund or
the Offshore Fund from 2004 to 2005 ," Id. at pp. 106-111, and
that PWC's review of the Clifford Chance opinion did not "have
any impact on the financial statements for the Onshore Fund or
the Offshore Fund for 2006. " Id. at 110.

211.

In July 2007 , PWC he ld another meeting with

personnel from DBZCO, including Zwirn and other members of
senior management, during which it was discussed that Schulte
Roth & Zabel, DBZCO's main corporate law firm, was not willing

155

to provide an opinion letter that it was more likely than not
that there would not be any tax liability.

Gruss has denied this statement and objected to it
noting that the meeting in question is irrele vant in light of
PWC's that Clifford Chance 's opinions referenced in the
memorandum and it is inadmissible hearsay and the memorandum
does not state "that Schulte Roth & Zabel,

DBZCO's main

corporate law firm, was not willing to provide an opinion
letter," rather it recites the triple hearsay statement of an
individual not present at the meeting that Schulte "continues to
be unwilling to provide a

'more likely than not' written

opinion " and speculation that "Schulte may not be willing to
provide even an oral 'view' on the ECI tax issue" and recites
the hearsay statement of an unidentified PWC person who
" confirmed that, in our experience, it is not uncommon for
corporations to obtain more than one opinion on a significant
complex tax matter such as this."

212.

On April 10, 2008, counsel for DBZCO informed

the Commission that DBZCO obtained an opinion letter from the
law firm Clifford Chance on the issue of whether it was more
likely that not that the interfund transfers would cause the
Offshore Fund to be treated as engaged in a U.S. federal or
156

state and local trade or business activity. DBZCO , however ,
asserted the work - product privilege with respect to this opinion
letter and withheld it from production .

Gruss has objected to the statement on the grounds
that the conversation in question between counsel for DBZCO and
the SEC is irrelevant to the issues in this case and is
inadmissible .

CONCLUSIONS OF LAW

The Applicable Standards

Summary judgment is appropriate only where "there is
no genuine issue as to any material fact and . . . the moving
party is entitled to a judgment as a matter of law."
Civ. P. 56(c).

Fed. R .

A dispute is "genuine" if "the evidence is such

that a reasonable jury could return a verdict for the nonmoving
party . "

Anderson v. Liberty Lobby, Inc ., 477 U. S . 242 , 248

(1986).

The relevant inquiry on application for summary

judgment is "whether the evidence presents a sufficient
disagreement to require submission to a jury or whether it is so
one - sided that one party must prevail as a matter of law. "
at 251 - 52 .

Id.

A court is not charged with weighing the evidence
157

and determining its truth , but with determining whether there is
a genu i ne issue for tr i a l.

Westinghouse El ec . Corp . v . N.Y .

City Transit Auth ., 735 F. Supp . 1205 , 12 1 2 (S . D. N. Y. 1 990)

(quoting Anderson, 477 U.S. at 249) .

" [T ] he mere existence of

some alleged factual dispute between the parties will not defeat
an otherwise properly supported motion for summary judgment ; the
requ i rement is that the r e be no genuine issue of material fact ."
Anderson , 477 U. S. at 247 - 48

(emphasis in original) .

Section 206(1) of the Adv i sers Act makes it unlawfu l
for an investment adviser to employ "any dev i ce, scheme , or
artifice to defraud any c li ent or prospective client ," and
Section 206(2) further prohibits an investment adviser from
engaging i n any "transaction , practice, or course of business
which operates as a fraud or deceit upon any client or
prospective cl i ent . " U. S . C.

§§

80b - 6(1) ,

(2). These provis i ons

"establ i sh[] federal f i duciary standards to govern the conduct
of investment advisers. " Transamerica Mortg . Advisers, Inc. v .
Lewis , 444 U. S . 11, 17

nature of ...

(1979). Given the " delicate fiduciary

[the] investment advisory relationship ," Section

206 p l aces " an affirmat i ve duty " on advisers to act with the
"utmost good faith , and [with ] fu l l and fair disclosure of all
material facts, as well as an affirmative obligation to employ
reasonable care to avoid misleading . " SEC v . Capital Gains
158

Research Bureau, Inc ., 375 U. S. 180, 194

(1963); Bullmore v .

Bank of Am . Sec., LLC, 485 F. Supp. 2d 464 , 470-71

2007)

(S.D.N.Y.

("[I]nvestment advisers owe fiduciary duties to their

clients" arising from "discretion to manage the client's
investment") . Thus, under Section 206 "it is not necessary
to establish all the elements of fraud that would be required in
a suit against a party to an arm's length transaction." Aaron v.
SEC , 446 U.S . 680, 693 (1980); see also Capital Gains, 375 U. S .

at 194 ("Congress ... did not intend to require proof of ...
actual injury to the client.").

The elements of a primary violation of Section 206(1)
and (2) "have been interpreted as substantively
indistinguishable from Section 17(a) of the Securities Act." SEC
v. Meltzewrco Advisers Fund Mgmt . LLC, 341 F.Supp.2d 454, 470

(S . D.N.Y . 2004)

(citing SEC v . Moran,

922 F. Supp . 867 , 896 - 97

(S . D. N.Y. 1996)), with one exception. While Section 206(1)
requires proof of fraudulent intent, negligence is sufficient to
establish a violation of Section 206(2). Aaron v. SEC,

446 U.S .

680 , 691 - 93 , 100 S . Ct . 1945, 64 L . Ed.2d 611 (1980); SEC v .
DiBella, 587 F . 3d 553 , 569 (2d Cir. 2009) .

159

The SEC 's Motion for Summary Judgment that Section 206(2) Was
Violated is Granted

Section 206(2) Is Applicable Because DBZCO Was an Investment
Advisor under Section 206(2) of the Advisers Act Owing Fiduciary
Duties to Its I nvestors and Used Instrumentalities of Interstate
Commerce

Section 206 applies "t o all investment advisers,
whether or not such advisers were required to register under
§

203 of the Act ." Transamerica Mortg . Advisers, Inc.

Lewis,

(TAMA)

v .

444 U.S . 11 (1979) ; SEC v . Gruss , 859 F. Supp. 2d 653 ,

663 (S .D.N. Y. 2012) . Section 202(a) (1 1 ) o f the Investment
Advisers Act defines an "Investment Adv iser" as "any person who,
for compensation , engaged in the business of advising others
as to the value of securities or as to the advisability of
investing in, purchasing , or selling securities .... "

Gruss admits in his answer to the SEC ' s complaint that
DBZCO was an investment advisor .

(56 . 1 at

~

1). DBZCO was an

investment advisor because it received fees from the Offshore
and Onshore Fund pursuant to the management agreement . The
management agreements between the funds and DBZCO exp li c itl y
appointed DBZCO as the "investment adviser " to make all
investment decisions in exchange for the management fee .
at

~~

56 - 59) .
160

(56 .1

Second , DBZCO "used the mails or any other means or
instrumentality of interstate commerce, directly or indirectly."
S.E.C. v. Bolla , 401 F . Supp . 2d 43, 67

(D .D. C. 2005) . DBZCO used

instrumentalities of interstate commerce when making
investments, paying the revolver, and communicating with
investors. For example, some investments owned by the Onshore
Fund, but ultimately paid for by the Offshore Fund were loans
that included 11 U.S. real estate deals. Purchasing these
properties involved instrumentalities of interstate commerce, as
was communication with Offshore investors about loan origination
and tax issues.

DBZCO Vi o lat ed Its Fiduciary Duty by Transferring Funds from the
Offshore Funds to Meet the Onshore Fund's Obligat i ons

Section 206(2) "establishes federal fiduciary
standards to govern the conduct of investment advisers ."
Transamerica Mortg . Advisers, Inc. v . Lewis, 444 U.S. 11, 1 7

(1979). Given the "delicate fiduciary nature of ...

[the]

investment advisory relationship," Section 206 places "an
affirmative duty" on advisers to act with the "utmost good
faith, and [with] full and fair disclosure of al l material
facts, as well as an affirmative obligation to employ reasonable

161

care to avoid misleading." SEC v . Capital Gains Research Bureau,
Inc.,

375 U.S. 180, 1 94

(1963) ; Bullmore v. Bank of Am. Sec.,

LLC, 485 F. Supp . 2d 464, 470-71 (S.D .N.Y. 2007)

("[I]nvestment

advisers owe fiduciary duties to their clients " arising from
"discretion to manage the client 's investment").

While DBZCO had wide discretion and great authority in
making invest decisions , it was not permitted to l oan material
sums in excess of 5 % of Assets Under Management from the
Off shore Fund to the Onshore Fund absent approval of an
independent third party. Gruss does not argue that 66 transfers
he authorized from the Off shore to the Onshore Fund were proper
loans with the required approvals. Instead , Gruss argues that
these transactions were not loans because they were inter -fund
transfers . Despite this attempt to re-characterize the
transactions, they were loans and therefore violated the
Offering Documents and DBZCO's fiduciary duties.

1) The Offshore Fund Was Prohibited from Making Investments in
or Loaning Money to US Companies ( Includin g the Onshore
Fund)

The Offering Memorandum stated that "the [Offshore]
Fund int ends to operate and structure its investments in a
manner such that it should not be deemed to be engaged in a U.S.
162

trade or business" that "actively originating loans within the
U. S." might create adverse tax consequences and that "certain
investments by the [Offshore]

Fund could result in the

[Offshore] Fund being deemed engaged in a U.S. trade or
business, including direct investments by the [Offshore]

Fund in

U.S. real estate" and that "the [Offshore] Fund ... will
generally not invest in leased equipment and other assets such
as real estate or make direct loans to or otherwise engage in
the active management of a U. S. company ." (FOF at

~23.)

The Off shore Fund could not invest in or make direct
loans to a US company because the purpose of the Offshore Fund
was to create an investment vehicle that would not be subject to
U. S . taxes. A representation letter to the auditors for all of
the Offshore Funds managed by DBZCO , signed by Gruss and Zwirn
stated: "[t]he Funds have structured their operation in order
that it will not be deemed to be engaged in a trade or business
within the U.S. for purposes of U.S. federal tax laws ." (FOF at
~29.)

Further, the Offering Memorandum explained "a non-U . S.

corporation engaged in a U.S. trade or business is subject to a
' branch profits ' tax equal to 30 % of the amount of its U.S .
earning which are not reinvested in U.S . assets."
In order to avoid these taxes, "the [Offshore]

(FOF at

~30.)

Fund intends to

operate and structure its investments in a manner such that it
163

should not be deemed to be engaged in a U. S. trade or business."
Id .

Gruss conceded it was well - known that a transfer from
the Off shore Fund to the Onshore Fund would raise ECI and "trade
or business concerns" because they could be construed as a
foreign entity engaging in a trade or business in the US.
at

(FOF

~23 . )

The Operating Documents presented a conflict : while
inter-company transfers were permitted, loans to U.S. companies
were not permitted. Gruss seeks to avoid liability by
characterizing the transfers as permitted inter - company
transfers rather than loans to the Onshore Fund . Yet in 14
instances these transfers included commitments for direct
investment in U.S. real estate investments and the other
transactions also put the Offshore Fund at risk for ECI
consequences in violation of the Offering Memorandum. Despite
Gruss ' attempt to characterize these transactions as interfund
transfers , the reality of the practice was that they were loans
from the Off shore Fund to the Onshore Fund to be paid back at a
later date in violation of DBZCO ' s fiduciary duties to its
investors .

164

Gruss has cited the Offering Memorandum that described
certain conflicts that can arise from the practice of cross
trading - "i.e. the Manager effects a trade or a loan between
the Fund and another investment fund or account that it or its
affiliates manage"

(FO F at

~24)

but omits the remainder of the

paragraph, which continues: "The U.S. Fund may assign or
participate out ce rtain of the l oans that it makes, or portions
thereof, to other entities, including to the Fund or to its
affiliates. Assignments of participations to the Fund or its
affiliates will be at fair market value and will be subject to
approval by an independent third party, and will be made
sometime after the initial date of the debt investment."
at p. 52

(Ex . M

(DBZ 0009878) .) Gruss also cited language from t he

Management Agreement to show that the DBZCO had broad discretion
concern in g what investments it would make for the Offshore Fund.
The Management Agreement specifically states, however, that the
Offshore Fund "desires to employ its cap ital by investing and
reinvesting in securities and other instruments as specified in
the [Offering Memorandum]." (FOF at

~26. )

The provisions with

respect to conflicts and investment discretion do not overcome
the bar against investment in a U.S. company.

Since the Of fsh ore Fund was prohibited from engaging
in a specific type of transaction - lending money to a U.S.
165

company - Gruss '

inter - company transfer characterization renders

this prohibition meaningless . As a general rule , an
interpretation should be avoided that would result in an
inconsistency between provisions or that wou l d render a
particular provision superfluous. See ABN Amro Verzekeringen EV
v . Geologistics Americas, Inc ., 485 F . 3d 85 , 102

cert . den. , 522 U. S . 1295 (2008)

(2d Cir. 2007) ,

("no provision of a contract

should be left without force and effect"). Moreover , a basic
principle of construction is that particular language prevails
over general language in determining the meaning of a provision.
See Sompo Japan Ins . Co. of Am . , v . Norfolk S. Ry . Co ., 762 F . 3d
165, 179 (2d Cir . 2014)

("a specific contract provision should

prevai l over a genera l one") ; United States v. Local 6A, Cement
& Concrete Works, Laborers Int ' l Union of N. America , 832 F.
Supp. 674 , 679 - 80 (S . D. NY. 1993). The specific l i mitat i on that
the Offshore Fund would not loan money to a U.S. company
prevails over the general provisions that the funds might
transact with each other.

In the Gruss motion for summary judgment, he relies on
expert opinions of Dr. Bergin. However , " the question of
interpretation of the contract is for the jury and the question
of legal effect is for the judge. In neither case do we permit
expert testimony ." Marx & Co . v. Diners ' Club, Inc ., 550 F . 2d
166

505 (2d Cir.) , cert . den . 434 U.S. 861 (1977) . Dr. Bergin's
opinion that the interfund transfers did not violate the
Operating Documents is a legal conclusion and is excluded. U. S .
v . Duncan,

42 F.3d 97 , 101 (2d Cir. 1994)

("thi s Court requires

the exclusion of testimony which states a legal conclusion").

2) The Offshore Fund Was Prohibited from Making Payments to
the Onshore Fund (or Directly to Its Creditors) for Its
Revolving Credit Facility

As set forth in the facts above, the Offshore Fund
transferred money to the Onshore Fund so that the Onshore Fund
could repay its obligations under a 75-day revolving credit line
(the "Revolver").

(FOF at

~116.)

The four transfers to pay the

Revolver vio l ated the prohibition in the Offering Documents
against making loans to US companies .

On four occasions (June 13 , 2005 , January 9 , 2006 ,
March 3 , 2006 , and May 26 , 2006), Gruss caused money from the
Off shore Fund to be transferred to the Onshore Fund to repay the
Onshore Fund's Revolver.

(SEC's Rule 56.1 Statement at

~~88 ,

93 ,

96 , 98 . ) The June 13, 2005 transfer was not fully repaid until
December 23 , 2005.

(SEC 56.1 at

~92.)

The January 9 , 2006

transfer was not fully repaid until November 6 , 2006.

167

(SEC 56.1

at ! 95 . ) The March 3 and May 26 , 2006 transfers were not fully
repaid until November 27 , 2006 .

(SEC 56.1 at !!97 , 100 . )

DBZCO witnesses test i fied that the Offshore Fund
transferred money to the Onshore Fund for the Revolver because
of the cash problems described above. As Law testified:
"Basically the CDC line expires or matures every set amount of
time , I can ' t remember , but maybe , for example , we say every
three months . And then at the end of the three months , the whole
amount has to be repaid to the CDC , and then CDC would
immediately re - lend it back to us again. So there we r e some
times where the Onshore Fund d i d not have the - enough funds to
pay that amount to the .. . CDC , so the Offshore Fund would pay
for the 50 million or whatever was outstanding at the time . "
(FOF at ! 117 . )

Each of these transactions violated the Offering
Documents because they provided that " the [Offshore]

Fund . . .

will genera ll y not invest in . . . other assets such as real
estate or make direct l oans t o or otherwise engage in the active
management of a U.S . company. "

(FOF at !23 . ) Yet on June 13 ,

2005 at 08 : 20 a . m., Wu sent an email to ABN Amro with the
subject line "Wire from #***599 - - CDC ." (FOF at !1 1 8 . ) The
email contained instruct i ons to ABN Amro to transfer $78 , 000 , 000
168

from "#***600" to "#***599" and then to wire $80 , 000 , 0000 from
"#***599" to Citibank New York .

(FOF at !118.) When Gruss

approved this transaction, he authorized making a direct loan
from the Offshore Fund to the Onshore Fund for $78 , 000 , 000 . Law
sent Gruss a spreadsheet on November 22, 2005 showing that the
Onshore Fund owed the Offshore Fund $77 , 845 , 541.65, which is
further evidence that functionally this was a loan, particularly
because these "transfers" were not repaid for many months.

(FOF

at !119.)

Further, treating these four loans from the Offshore
Fund to the Onshore Fund to pay down the Revolver as loans, they
were not approved by a third party as required by the Offering
Documents. The Offering Memorandum provided that "the Fund will
not be permitted to purchase interests in loans originated by
the U.S. Fund or its affiliates unless an independent party
approves the purchase ." (FOF at !32.) Yet Gruss did not obtain
third party approval for these four loans in violation of this
requirement.

169

3) The Breaches of the Fiduciary Duty by Making Loans from the
Off shore Fund to the Onshore Fund for Investments and the
Revolver Were Material

To be material , "information need not be such that a
reasonable investor would necessarily change his investment
decision based on the information, as long as a reasonable
investor would have viewed it as significantly altering to total
mix of information available." SEC v. Mayhew,
(2d Cir. 1997)

121 F.3d 44, 52

(internal citations omitted). From at least March

2004 through May 2006 , Gruss authorized the Offshore Fund to
transfer money to the Onshore Fund to fund sixty-six of the
Onshore Fund's investment commitments and four transfers to fund
required payments for the Onshore Fund's Revolver loan without
disclosing these loans to the Offshore Fund's investors .

The investors in the Offshore Fund were in a fiduciary
relationship with DBZCO, which places "an affirmative duty" on
advisers to act with the "utmost good faith, and [with] full and
fair disclosure of all material facts, as well as an affirmative
obligation to employ reasonable care to avoid mis lea ding ." SEC
v . Capital Gains Research Bureau, Inc.,

375 U.S. 180, 194

(1963); Bullmore v. Bank of Am. Sec., LLC, 485 F. Supp . 2d 464,
470 -71 (S.D .N. Y. 2007) . Under 206(2), "an investment advisor can
avoid committing fraud on its clients by disclosing material

170

information to them . " SEC v. DiBella , 587 F . 3d 553 , 568

(2d Cir .

2009) . Here, DBZCO violated those fiduciary duties when they did
not make full and fair disclosure of the material fact that
Off shore funds were being used to fund Onshore investment
commitments and the Revolver to compensate for the cash flow
issues the Onshore fund was experiencing . SEC v . Capital Gains
Research Bureau, Inc ., 375 U. S . at 194 .

Obviously such

disclosure would have been problematic .

DBZCO ' s disclosures were not fu l l and fair about how
the Onshore Fund investments were funded . I n some cases , the
money went from the Off shore Fund to the Onshore Fund , which
then sent the money to the investment and more often , however,
the money went directly from the Off shore Fund to the
investment . The practice started when Wu , the controller for the
funds, met with Gruss to discuss how to address the i nability of
the Onshore Fund to meets its commitments.

(FOF at

~56 . )

Gruss

told Wu that since the Onshore Fund would have new subscriptions
corning in over the following weeks, they could take the money
from the Off shore Fund and repay the Off shore Fund when the new
investor money came in.

Id .

The SEC has estab l ished that DBZCO ' s fai l ure to
disclose to the investors that using the Off shore account to
171

fund Onshore investments and the Revolver would be a material
fact to a reasonable investor. Other courts have found that "a
reasonable factfinder could conclude that it is material that
the advis ors of the Fund used Fund assets for purposes other
than for the benefit of the Fund." SEC v . Mannion,

789 F.

Supp.2d 1321, 1341 (N . D. Ga. 20 11). Here, Gruss was using
Offshore Funds for purposes other than the benefit of the
Offshore Fund and did not disclose it to the investors . In fact,
DBZCO represented to investors in the offering memorandum, in
quarterly investor letters, in due diligence meetings with
investors and potential investors, and in management
representation letters to its auditor, that the Offshore Fund
was not going to lend money to any U.S . company in order to
avoid the potential of being found to have engaged in a U.S.
trade or business, which would result in it being subject to
U.S. taxes. Had the investors known about these loans both for
investments and the Revolver, it would have had the effect of
"significantly altering to total mix of information available"
to the investors. SEC v. Mayhew, 121 F.3d at 52 .

Although Gruss notes that PWC, the auditors for the
funds , concluded that the impact of the loans were not material,
PWC did determine that there were material control weaknesses at
DBZCO and sent SAS 11 2 letters to DBZCO for each of the funds .
172

The SAS 112 letters repeatedly referred to the "inappropriate
conduct" that took place at the funds, explicitly stating that
"the lack of an effective control environment allowed the
Investment Manager's former Chief Financial Officer [Gruss] to
engage in inappropriate conduct that resulted in certain
transactions not being properly reflected on the Fund's
consol ida ted financial statements."

(FOF at

~195.)

The SAS 112

letters further stated that the controls "were not designed or
operating effectively to ensure the protection of or detection
of (i) improper cash and investment transfers among the Fund and
the Other Accounts,

(iii) the premature payment of

management fees to the Investment Manager,

(iv) the short term

use of an affiliated fund's assets for non-fund related
purposes,

and (iv) the improper reconciliation of cash ,

brokerage and inter-company accounts."

(FOF at

~191.)

The

letters stated that these were "material weaknesses," which were
defined in the letters as "a control deficiency , or combination
of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the financial
statements will not be prevented or detected. "

(FOF at

~192.)

.Investors requested the SAS 112 letters as support for potential
redemption actions .

(FOF at

~192.)

PWC did not opine on the

issue presented here, the effect of the l oans on the prohibition
against investment in U.S. companies.
173

Therefore the loans from the Offshore to the Onshore
Fund for investments and the Revolver were material because they
exposed the Offshore Fund and its investors to increased U.S.
tax risk. As one commentator has recently described: "[s]hort of
a tornado or cataclysmic earthquake obliterating midtown
Manhattan or Greenwich, CT, there is little that offshore fund
managers fear more than the specter of their funds being treated
as engaged in a United States trade or business. This fear is
well-grounded; the incremental tax that results from this
treatment may exceed 50 percent." John Kaufmann, Effectively
Connected Income: A Close Look At The Rules, Law 360

(September

11, 2015, 11: 45 AM),
https://www.law360.com/articles/701645/effectively-connectedincome-a-close-look-at-the-rules. In fact,

DBZCO understood this

fact well when it said that: "[t]he fund is mindful of [sic.]
Offshore Fund can't be in the business of originating to US
companies otherwise it would be subject to 54.5 % US tax rate."
( FO F at

<J[ 3 5

.)

In a June 22, 2007 meeting between DBZCO, its auditor
PWC, and a director for the Off shore Fund, Gina Biondo
("Biondo")

( PWC' s leader of its New York Asset Management Tax

Practice) provided a summary of the tax issues, telling the
174

Offshore Fund Director "that taxes were a 'significant issue'
and that certain transactions could possibly give rise to making
the [Offshore Fund] a 'taxable business.'

[Biondo] explained

that historically the Fund has not been subject to tax and this
issue could subject the Fund to an exposure of a 55 % tax rate."
(Brody Deel., Ex. 191 at PwC-DBZSAS112-00463.)
this tax liability to be $250 million.

PWC estimated

(FOF at !197.) While

DBZCO's own tax director suggested that the liability might only
be $100 million, even he concluded that the lower amount would
be "devastating" to the Offshore Fund.

(FOF at !197.)

These potential consequences to investors explain why
DBZCO emphasized in the offering materials for the Offshore Fund
(as well as in other communications with investors) that the
Offshore Fund would not engage in a U.S. trade or business also
demonstrates the materiality of the interfund transfers. These
transactions were material because a reasonable investor would
have thought their risk of adding a 54.5 % tax liability would
have "significantly alter[ed the] total mix of information
available" to investors. SEC v. Mayhew,

121 F.3d at 52.

The general rule is that materiality in the context of
a Section 206(2) claim is a fact-intensive inquiry that will be
left for the jury to determine. However, "the ultimate issue of
175

materiality [may be] appropriately resolved as a matter of law "
when "the established omi ssions are so obviously important to an
investor that reasonable minds cannot differ on the question of
materiality .... " TSC Industries, Inc. v . Northway, Inc.,
U.S. 438, 450, 96 S.Ct. 2126 , 48 L.Ed. 2d 757

426

(1976) ; see also

Goldman v . Belden, 754 F.2d 1059 , 1067 (2d Cir . 1985). For the
reasons that follow,

the omissions in this case were obviously

material to a reasonable investor.

DBZCO utilized Off shore Fund money at leas t

sixty-six

times to pay for commitments of the Onshore Fund to pay for
other funds managed by DBZCO and four times to pay down the
Onshore Fund's commitments through its Revolver. A reasonable
factfinder would find it material that "fund assets were being
used to purchase stock for others at the fund's expense, even if
that money was later repaid." I-Enterprise Co. LLC v. Draper
Fisher Jurvetson Management Co . V, LLC, No. C- 03 -15 61 MMC , 2005
WL 3590984 , at *22,

(N .D. Cal . Dec . 30 , 2005) . Similarly here,

Gruss argues that the Onshore Fund later repaid the Off shore
Fund negating any materiality of the transactions. However, it
would have been material to the Off shore Investors because any
of the commitments of Offshore Fund money to pay for Onshore
Fund investments cou ld have subjected the Offshore Fund to US

176

taxes. This was "obviously important" to the investors because
of the substantial potential tax consequences discussed above.

In addition to the nature of the transactions being
materia l to investors, the quantity of the l oans a l so wou l d have
been material to investors . The total amount of the sixty - six
loans for investments exceeded $500 mi llion . This may have been
a material fact to the investors because , "Any money used to
purchase assets for others is money that is not available for
the fund to invest on behalf of i ts own partners. " I-Enterprise
Co . LLC v. Draper Fisher Jurvetson Management Co . V, LLC, 2005
WL 3590984 , at *22 . During this time period , the Offshore Fund ' s
assets under management (" AUM " ) ranged from $877 million to $2 . 3
billion .

(Ex . Eat p . 2; Ex . G at p . 2.)

Amounts in excess of 5% of AUM are generally
considered material. See , e . g ., ECA and Local 134 IBEW Joint
Pension Trust of Chicago v . JP Morgan Chase Co ., 553 F.3d 187,

204

(2d Cir. 2009) ; Strougo v. Barclays PLC , 105 F. Supp . 3d 330 ,

348

(S . D.N . Y. 2015)

("The 'use of a percentage as a numerical

thresho l d , such as 5 % may provide the bas i s for determining
whether an alleged misstatement could be material); In re Gen .
Elec . Co. Sec . Litig ., 856 F. Supp . 2d 645 , 654

(same).
177

(S . D. N. Y. 2012)

The loans for investments and to pay down the Revolver
obligations both exceeded 5 % of AUM in 2005 and 2006 and would
have been material to a reasonable investor. The Offshore Fund
transferred a total of $273 million to the Onshore Fund to allow
the Onshore Fund to repay its loan obligations under the
revolving credit agreement. The snapshot of outstanding balances
as of November 15, 2005, shows a balance of more than $77
million concerning the CDC - i.e. the revolving credit agreement
- and $120 million for the transfers for Onshore Fund
investments. In fact, as of November 15, 2005, approximately
5.5 % of the fund's AUM had been sent to the Onshore Fund to
repay the revolving credit agreement and 8.5 % of the AUM had
been sent to the Onshore Fund to pay for Onshore Fund
investments. By March 2006 , the balance owed to the Offshore
Fund with respect to the Revolver was $175 million. In March
2006 , the Offshore Fund's AUM was $1.6 billion. Consequently, at
this time, the balance owed by the Onshore Fund as a result of
the Offshore Fund repaying its obligations under the revolving
credit agreement was more than 10% of the Offshore Fund's AUM.
(SEC Rule 56.1 Statement at

~~11,

101.)

Gruss disputes this calculation method arguing that
the 5 % threshold should be calculated as the interest that would
178

have been paid to the Offshore Fund if it had not transferred
the money to the Onshore Fund. Gruss argues that this interest
should have been calculated as the greater of the short term
monthly applicable funds rate or the fed fund rate plus 25 basis
points.

Ex. JJ at p. 11; Gruss Rule 56.1 Statement at

~

71.

However , that is not how this calculation has been envisioned by
SAB 99 and the Courts.

SAB 99 provides an example when

describing its 5 % guideline for materiality. The example
involves whether a misstatement of net income of 4 % could still
be material. SAB at Topic 1: Financial Statements, M.
Materiality , 1 . Assessing Materiality . The SEC's calculation
method finding that the loans from the Off shore Fund to the
Onshore Fund exceeded 5 % is a more reasonable interpretation
than whether the interest on that amount of money would exceed
5 % of AUM. SAB at Topic 1: Financial Statements, M. Materiality ,
1. Assessing Materiality; see also Strougo v . Barclays PLC, 105
F. Supp . 3d at 348

(calculatin g the 5 % threshold as the total

revenue of a potentially fraudulent risk program as a percentage
of Barclays total revenue); ECA and Local 134 IBEW Joint Pension
Trust of Chicago v . JP Morgan Chase Co. , 553 F.3d at 204
(calculating the 5 % threshold as the amount of the potentially
fraudulent trade/loans over total assets under management) .

179

Gruss argues that some of the investment amounts do
not take into account the amount of the loans that were used to
"season" assets that later were purchased as CLOs by the
Offshore Fund from the Onshore Fund . This was required,
according to Gruss, because tax laws prohibited the Offshore
Fund could from "bu y[ ing] certain investments for itself," and
the Onshore Fund would have to buy and "season" the investments
f or anywhere between 30 to 90 days before it could sell those
investments to the Offshore Fund.

(FOF at

~34.)

One investor was

skeptical that this process would insulate the Off shore Fund
from US tax liability . The investor noted that "[i]f an Offshore
Fund was found to be a domestic lender by the IRS the
implications would be very serious and could cause a very
material impact."

(FOF at

~38.)

Further, Gruss represented that

the law firm Schulte, Roth, and Zabel approved of this seasoning
plan . However, the investor said that they "would be surprised
if Schulte approved of the seasoning process . "

(Brody Deel. Ex.

32 . )

Even if the seasoning process would successfully
season the loans from US tax liability , that would not shield
the initial transfer from the Offshore Fund to the Onshore fund
to purchase the original loans . Under the seasoning plan , the
Offshore Fund would later purchase the CLOs from the Onshore
180

Fund. The Offshore Fund did not need to transfer money to the
Onshore Fund before the seasoning process had even taken place.
All transfers from the Off shore Fund to the Onshore Fund to pay
for loans associated with the seasoning practice are
appropriately included in any violations of Section 206(2).

4) Gruss acted with a Negligent Intent When He Authorized the
Offshore Fund Transfers to Fund Onshore Investments and the
Revolver

While Section 206(1) requires proof of fraudulent
intent, negligence is sufficient to establish a violation of
Section 206(2). Aaron, 446 U.S. at 691-93 , 697 . Gruss' state of
mind was at least negligent because Gruss knew the terms of the
Offshore Fund's Offering Memorandum and acknowledged that the
Offshore Fund would not loan money to U.S . companies in order to
avoid being deemed to have engaged in a U.S. trade or business .
(FOF at

~40 . )

Gruss knew that if the Offshore Fund engaged in a

U.S. trade, it could potentially subject the Offshore Fund to
adverse tax consequences.

(FOF at 39.)

Gruss stated to the attorneys conducting an internal
investigation for DBZCO that money from the Off shore Fund needed
to be kept separate from money from the Onshore Fund to avoid
ECI issues and that it was well known that a transfer from the
181

Off shore Fund to the Onshore Fund would raise ECI and "trade or
business" concerns. Gruss told investors that the Offshore Fund
was not involved in loan origination because of tax issues and
he knew that it was important that the Offshore Fund not make
certain investments because of adverse tax implications. He also
told the attorneys conducting the internal investigation that he
"knew you shouldn't be going there." (FOF at

~110. )

Negligence is also established by the concern
expressed by other DBZCO employees about the impact of these
transactions on the status of the Offshore Fund. For example, Wu
told Gruss that she was uncomfortable with the practice "we're
not supposed to do this, so we need to do something." (FOF at
~60.)

Wu even joked with Gruss that they were going to go to

jail because of the interfund transfers.

Id.

In April 2005 , when

Gruss instructed Law t o fund an investment from the Off shore
Fund, Law responded "is there a game plan? Or is this something
that the DBZ backoffice must learn to accept."

(FOF at

~ 81 . )

When Gruss responded "what are the alternatives", Law told him
to "get all of the partners and top management in the l oop (i .e.
REALITY) and have them make a joint management decision." Id.

Wu and Law both resigned over the interfund transfers.
A factual issue is presented as to whether the resignations
182

resulted from the practice of interfund transfers or simply the
pressures of accommodating the process at the last minut e . No
matter the ultimate reason for their resignations, they each
expressed reservations about the interfund transfers to Gruss
( FOF at

~~60-62.),

and it was negligent to not at least seek a

legal opinion about the propriety of the practice after two
members of the team left DBZCO at least in part over this issue.

Gruss argues that the operating documents allowed for
interfund transfers, making his conduct permissible and not
negligent. However, even if interfund transfers were permitted
as conc luded above, these provisions did not nullify the bar to
investment in a U.S. company since a purpose of the Offshore
Fund was to create an investment vehicle that would not be
subject to U.S. taxes.

As the facts above establish, Gruss was responsible
for sixty-six inter-company transfers granting l oans fr om the
Offshore Fund to fund the Onshore Fund commitment to invest by
granting loans and f our loans to repay the Onshore loans arising
out of the revolving credit facility. These violations were
negligent. There is no evidence that at the time of these
transfers Gruss considered the provisions of the Operating
Documents on which he now relies, or sought an op inion on the
183

legality of his acts. With full knowledge that the Offshore Fund
was prohibited from investing in a U.S. company, it was
negligent not to review these transactions in light of
prohibition, particularly given the concerns expressed by those
involved in the transfer process. Presumably, an opinion of
counse l would have reached the same conc lusi ons as are set forth
above.

In view of the importance of the prohibition against U.S.

investment to the Offshore Fund and its investors, Gruss'
conduct as Chief Financial Officer, though not fraudulent, was
negligent.

5) Gruss Aided and Abetted DBZCO's Violation of Section 206(2)
of the Advisers Act

In addition to the conduct attributed to the company
f or the Section 206(2) claims regarding both the transfers to
support Onshore investments and the f our Revolver payments, the
SEC has established that Gruss aided and abetted these
violat i ons.

To prove Gruss' liability under an aiding and

abetting theory, "the SEC must establish:

(1)

a primary or

independent securities violation committed by another party;

(2)

awareness or knowledge by the alleged aider and abettor that his
role was part of an overall activity that was improper; and (3)
the alleged aider and abetter knowingly and substantially

184

assisted the conduct that constitutes the primary violation."
S.E.C. v. Bolla, 401 F.Supp.2d at 58

(internal citations

omitted); see also Investors Research Corp. v. Sec.
Comm'n,

& Exch.

628 F.2d 168, 178 (D.C.Cir. 1980), cert. denied,

449

U.S. 919, 101 S.Ct. 317, 66 L.Ed.2d 146 (1980). Further, "The
SEC has the burden of proving each element of the aiding and
abetting claims by a preponderance of the evidence." S.E.C. v.
Bolla, 401 F.Supp.2d at 59; Decker v. Sec.

& Exch. Comm'n,

631

F.2d 1380, 1388 (10th Cir. 1980).

Here, the SEC has proven by a preponderance of the
evidence that DBZCO committed securities violations as discussed
above and Gruss was the one who authorized the transfers and was
responsible for the violations of securities laws. Finally, the
emails and testimony establish that Gruss "knowingly and
substantially assisted" the primary violation. Law and Wu's
emails serve as a caution that this conduc t would be material to
reasonable investors and that Gruss understood the great risks
this conduct posed to the Offshore Fund.

(FOF at

~~60-62,

81.)

Yet Gruss continued to engage in this conduct after the
resignations knowing at this point the risks of this conduct.

185

The Advance Payment of Management Fees Were Appropriate InterCompany Transfers

Each of the funds was ob ligated to pay DBCZO a
management fee that, according to their Management Agreements
with DBZCO, was to "be accrued monthly and payable quarterly."
The undisputed facts show that from May 2004 through March 2006 ,
DBZCO withdrew the management fees owed under the Management
Agreements from the Onshore Fund, the Offshore Fund, the TE Fund
and the Offshore Fund accounts anywhere between 1 to 31 days
before the fees were due to DBZCO at the end of the appropriate
quarters. There were also instances where the management fees
were paid after the end of the quarter when they were due.

The payment of management is not characterized as a
loan by t he SEC nor has an impropriety been claimed with respect
to this inter-company transfer relating to cash flow, nor has it
been contended by the SEC that the amounts involved are
material. The motion for an injunction based on payment of
management fees is denied.

The Motion for an Injunction Based Upon the Payment by The
Off shore Fund to Purchase an Airplane is Denied as Presenting a
Contested Issue of Fact

186

According to Gruss, there is no admissible proof that
Gruss ever approved or had advance knowledge of the two
September 28th payments for the airplane closing costs funded by
the Off shore Fund or that Gruss knowingly or negligently
approved the September 29th and 30th payments. Gruss has
categorically denied that he had ever authorized or had
knowledge of these payments being made from the Funds:
Whatever expenses related to the airplane were
management company expenses. At no time then, or
ever, did I ever authorize anybody to send it out
of a fund or a managed account.
Ex. UU at p. 327 ;

Response~

136.

Zwirn had tasked Harold Kahn ("Kahn") , the Chief
Operating Officer for DBZCO, not Gruss, with the job of
"find[ing] out what potential options were available and to help
identify sources of financing for such a purchase." Similarly,
according to Gruss , there is no admissible evidence that Gruss
actually ever met with an airplane broker, PrivatAir, an
aviation attorney or an attorney regarding the purchase of an
airplane.

(FOF at

~156.)

The issue is not whether Gruss was

involved in some fashion in events le ading up to the purchase of
the airplane but whether or not Gruss knowingly approved the use
of fund money to pay for the closing costs for the airplane.

187

As to the two September 28, 2005 payments, Law
testified that she had created two approval forms for the two
payments using wire requests with photocopies of Gruss'
signature at the bottom of the wire requests. Law took " one of"
the "old wire approvals" and "fold[ed] it at the part where the
signature is shown up, put it on the blank that we just printed
out and then photocopied it." (FOF at

~171.)

Law has no

recollection of speaking to Gruss to obtain his approval for
these two wires prior to sending them for payment on September
28th .

The SEC relies on "a meeting in Gruss' office where
this decision was made [t o use investor money for the
airplane]."

(SEC Memo in Support at p. 10.) However , Law

testified in her deposition that she has no recollection what
anybody said at that meeting, and she "had no recollection of
any discussions [w ith Gruss] about the transfers from t he LP or
HCMZ for plane-related expenses." (Ex. BBB at pp. 258 -5 9 . )

Law testified that the only "indi cation " she received
from anybody about using fund money t o pay for the airplane
expenses was an email she received from Kahn asking her to fund
the airplane closing costs. To her, that email "was an
indicat i on of moving the money from the Funds." The email in
188

question from Kahn to Law stated, "Can you pls arrange to have
the $1 . 9MM wired to Citi asap for the issuance of the LC . This
will only be a short-term deposit in that once the Citi revolver
is in place (should be win a week) we will credit the amount
against the line. Thx." (FOF at

~169.)

Both payments, the September 29th and 30th payments for
closing costs, were sent from the funds after Gruss had emailed
his approvals " Ok pag" in response to emails from Law. Law
admitted that she "wouldn't know" whether Gruss actually knew he
was approving payments from the funds for Zwirn's airplane, and
she could not "re ca ll" any such conversations with Gruss about
these payments. Law cannot recall any conversation with Gruss
"prior to November 9th [2005], where ...

[she] actually spoke to

him about the fact that the monies had to be repaid for the ...
airplane wires." (FOF at 188.)

According to Gruss, his approvals of the September 29th
and 30th email requests for the transfer of the funds were in
furtherance of a "protocol for LaSalle" bank, which Gruss was
required to perform in order to release funds from the bank.
Gruss' purpose in approving the transfer was "[t]o make sure the
wire was actually sent" because "[w]ithout an authorization that
wire does not get sent." (FOF at

~179.)

189

Gruss received "hundreds

of e-mail approval requests." (FOF at

~179.)

In the month of

"September alone" he "had received over 250 such requests."
at

~179.)

(FOF

On September 29th and 30th Gruss received numerous

email requests for authorizations to send moneys from the funds
and approved the two emails at issue at the same time he
approved other email requests for approval. "[T]he control that
made sure that the wire was for an appropriate purpose" was the
"Finance [personnel] who were actually authorizing the wires and
[the] people in the back office the next day that were
reconciling the wires."

(FOF at

~179.)

At the time Gruss approved the September 29th and 30th
email requests, he maintains that he did not know he was
approving payments for Zwirn's airplane. As a general practice,
Gruss "would read the "To" line and the "From" line and most
likely the subject." The subject on the September 29th and 30th
emails was "RE: IATS." By itself, this subject did not reference
the purchase of Zwirn's airplane. If Gruss had read further into
the email, he would have seen on the September 29th email the
phrase " CREDIT : INSURED AIRCRAFT TITLE SERVICES, INC. Prior to
September 30th, the Zwirn funds had been investing in aircraft
related assets, one of which investments was known as "Priority
Air," "quite similar to PrivatAir." As recently as September

190

6th , Gruss had approved an email relating to the "Priority Air"
fund investment asset.

(FOF at

~179.)

The SEC has referred to Gruss' effort to obtain a loan
from Citibank and the fact that "[f]r om September 28 through
September 30 , 2005 ,

DBZCO did not have more than $827,000 in

its accounts" to impute to Gruss that he knew fund money was to
be used to pay for the airplane closing costs.

(Memo in Support

at pp. 9-10 . ) However, no evidence has been established that
Gruss was ever aware of how much money the management company
had at any one time or that there was any intention to use the
money from the Citigroup loan facility to pay the $3,774,175 to
close on the airplane purchase. Gruss also testified that the
Citibank revolver was not needed "in order to effect the
purchase of the plane," but for "operating expenses." (FOF at
~167.)

Gruss' denial of knowledge concerning the aircraft
purchase has created a factual issue. The motion for an
injunction against Gruss on the basis of Offshore payments for
the airplane is therefore denied.

The Motion for the Imposition of a Civil Penalty is Granted

191

The federal securities laws provide for the imposition
of civil penalties for violations of the securities laws. 15
U.S.C.

§§

77t(d) , 78u(d) , 80b-9(e) . Civil penalties serve the

dual purpose of penalizing the defendant for past violations and
deterring him from future misconduct. Official Comm . of

Unsecured Creditors of WorldCom, Inc. v . SEC,

467 F.3d 73, 81

(2d Cir. 2006) ; SEC v . Ramoil Mgmt., Ltd., No. 01 - cv - 9057(SC) ,
2007 WL 3146943 , at *13 (S .D. N. Y. Oct. 25 , 2007)

(civil

penalties "fulfill a number of other [nonpunitive] purposes such
as ... deterrence, fostering public confidence in the securities
system, and promoting stability in the securities market").

The securities laws provide for three tiers of
penalt ies to be "determined by the court in light of the facts
and circumstances." Under each tier, the Court is authorized to
impose a penalty that is the greater of the defendant's
"pe cuniary gain" from the violation or the applicable tiered
amount. 15 U.S.C.

§§

77t(d) (2) (A) -( C) , 78u(d) (3) (B) (i) - (iii) ,

8 Ob-9 ( e) ( 2) (A) - ( C) . The penalty tiers for individuals are as
follows:

First tier: $6,500 for an individual per violation;

192

Second tie r: $65 , 000 for an individual per vio l ation
that " invo l ved fraud , deceit , manipulat i on , or deliberate
or reckless disregard of a regu l atory requirement "; or

Third tier : $ 1 30 , 000 for an ind i vidual per v i olation
that occurred through March 3 , 2009 , that " involved fraud ,
deceit , manipulation , or deliberate or reckless disregard
of a regulatory requirement" and "di rectly or indirectly
resulted in substantia l losses or created a significant
risk of substantial losses t o other persons. "

Id .; See 17 C . F . R

§§

201 .1 003 , 201 . 1004 , Table II I.

I n we i gh i ng the pena l ty amount , courts cons i der :
the egregiousness of defendant ' s conduct ;
defendant ' s scienter ;

(1 )

(2) the degree of

(3) whether defendant ' s conduct created

substantial losses or the risk of substantial losses to other
persons ;

(4) whether defendant ' s conduct was isolated or

recurrent ; and (5) whether the pena l ty should be reduced due to
defendant ' s demonstrated current and future financial condition .
SEC v . Haligiannis , 470 F . Supp . 2d 373 , 386 (S . D.N . Y. 2007).

Gruss ' neg l igence warrants First Tier pena l ties and
not "w i llful and intent i onal " conduct , which would result in
193

Second Tier or Third Tier penalties. S . E . C . v . Moran , 944
F.Supp . 286 , 297

(S . D. N.Y. 1996) . Second or Third Tier penalties

would be inappropriate because no evidence has been presented to
establish that Gruss received any personal financial benefit
from his conduct, an important consideration when determining
civil penalties . SEC v. Haligiannis,

470 F. Supp. 2d at 386.

In attempting to determine the amount of civil
penalties, the loss of investment opportunity for the Offshore
Fund has not been quantified by the SEC, although Gruss' conduct
was recurrent. Under the circumstances presented here , the
$6,500 penalty for the seventy violative transfers will be
reduced by 50% to provide sufficient deterrence in addition to
the injunctive relief , which is also granted .

194

Conclusion

Based upon the findings and conclusions set forth
above , Defendant ' s motion for summary judgment is granted in
part and denied in part , and Pla i nt i ff ' s motion for summary
judgment is granted in part and denied in part .

It is so ordered .

t

New York, NY
March
2017

J.? ,

ROBERT W. SWEET
U.S.D.J.

195