Bell v. Kaplan
Filing
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ORDER granting in part and denying in part 9 Motion to Dismiss and Plaintiffs Second Claim for Relief is hereby dismissed.. Signed by Senior Judge Graham Mullen on 2/29/16. (ssh)
IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF NORTH CAROLINA
CHARLOTTE DIVISION
3:14CV352
KENNETH D. BELL, in his capacity as a
court-appointed Receiver for Rex Venture Group,
LLC d/b/a ZeekRewards.com,
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Plaintiff,
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v.
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HOWARD N. KAPLAN,
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Defendant.
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ORDER
This matter is before the Court upon Defendant Howard N. Kaplan’s Motion to Dismiss.
(Doc. No. 9). For the reasons stated herein, the motion is granted in part and denied in part.
I.
FACTUAL BACKGROUND
This “clawback” litigation was initiated by the Receiver of Rex Venture Group, LLC
(“RVG”). The Complaint alleges as follows: Paul Burks, the owner and former top executive of
RVG, and other management insiders used RVG in their operation of a massive Ponzi and
pyramid scheme through ZeekRewards from at least January 2011 until August 2012. (Compl. at
6 n. 1) (incorporating by reference the Complaint in Bell v. Burks, et al., No. 3:14CV89
(W.D.N.C. filed February 28, 2014)). On August 17, 2012, the Securities and Exchange
Commission filed an action in this Court, Securities and Exchange Commission v. Rex Venture
Group, LLC d/b/a ZeekRewards.com and Paul Burks, Civil Action No. 3:12-cv-519 (the “SEC
Action”), to obtain injunctive and monetary relief against Paul Burks, shut down the
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ZeekRewards Ponzi and pyramid scheme, freeze RVG’s assets, and seek appointment of a
Receiver for RVG. (Compl. at ¶ 6).
That same date, in an Agreed Order Appointing Temporary Receiver and Freezing Assets
of Defendant Rex Venture Group, LLC (the “Agreed Order”), this Court appointed Kenneth D.
Bell as the Receiver over the assets, rights, and all other interests of the estate of Rex Venture
Group, LLC, d/b/a www.ZeekRewards.com and its subsidiaries and any businesses or business
names under which it does business (the “Receivership Entities”). (Id. at ¶ 7). The Order further
directed Mr. Bell as RVG’s Receiver to institute actions and legal proceedings seeking the
avoidance of fraudulent transfers, disgorgement of profits, imposition of constructive trusts and
any other legal and equitable relief that the Receiver deems necessary and appropriate to
preserve and recover RVG’s assets for the benefit of the Receivership Estate. (Id.)
Howard Kaplan (“Kaplan”) served as legal counsel to RVG from roughly January 2012
until August 2012, when RVG was placed into receivership. (Id. at ¶ 1). The financial essence of
the ZeekRewards scheme – to buy bids to receive a profit share and get paid for recruiting others
to the scheme – was or should have been clear to Kaplan. (Id. at ¶ 25). Kaplan knew that
participants in the ZeekRewards scheme invested money in the scheme expecting that they
would receive profits from the Zeekler penny auction or other ZeekRewards efforts. (Id. at ¶ 35).
Despite his knowledge of the scheme and that ZeekRewards’ compensation plan faced potential
security issues, Kaplan misled affiliates into believing that they need not report their
ZeekRewards income as investment income, giving them a false impression that ZeekRewards
was a legitimate enterprise and prolonging the life of the scheme. (Id. at ¶¶ 43-47). Moreover,
Kaplan deliberately turned a blind eye to ZeekRewards’s implausible income claims, including
average returns of 1.4% per day. (Id. at ¶ 34).
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With all this significant information indicating that he was representing an unlawful
scheme, Kaplan nonetheless assisted the Insiders in promoting and legitimizing the public
perception of this scheme. (Id. at ¶¶ 35, 40). Kaplan appeared on at least two Affiliate
“Leadership Calls” with Dawn Wright-Olivares to promote ZeekRewards. (Id. at ¶ 41). He
provided a “frequently asked questions” document (“FAQ”) for use on ZeekRewards’ website
and made himself available to affiliates for follow-up tax questions via email. (Id. at ¶ 42). In
addition, Kaplan allowed ZeekRewards to use his name in promoting the scheme, deepening
RVG’s insolvency and causing significantly more loss to RVG than it otherwise would have
incurred, including the financial claims of the victims of the ZeekRewards Ponzi and/or pyramid
scheme against RVG. (Id. at ¶¶ 48, 60).
The Receiver filed this action against Kaplan on June 25, 2014. The Complaint alleges
claims for legal malpractice/negligence/breach of fiduciary duty (Claim I), aiding and abetting
breach of fiduciary duty (Claim II), and Constructive Trust (Claim III). Kaplan moves to dismiss
pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.
II.
DISCUSSION
A. Standard of Review
“To survive a motion to dismiss, a complaint must contain sufficient factual matter,
accepted as true, to state a claim to relief that is plausible on its face.” Ashcroft v. Iqbal, 556
U.S. 662, 663 (2009). “A claim has facial plausibility when the plaintiff pleads factual content
that allows the court to draw the reasonable inference that the defendant is liable for the
misconduct alleged.” Id. at 678 (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 556
(2007). “The plausibility standard is not akin to a ‘probability requirement,’ but it asks for more
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than a sheer possibility” that the defendant is liable for the alleged harm. Id. (quoting Twombly,
550 U.S. at 556).
B. In Pari Delicto Defense
Kaplan’s primary argument in support of his motion to dismiss is based upon the doctrine
of in pari delicto. In pari delicto is an equitable common law defense and stands for the idea that
when two parties are in equal fault, the plaintiff’s wrongdoing is a full bar to recovery. However,
there are important “limitations and exceptions” to the doctrine, including the specific
requirement that “public policy implications” be considered. See Bateman Eichler, Hill Richards,
Inc. v. Berner, 472 U.S. 299, 310 (1985) (“the classic formulation of the in pari delicto doctrine
itself require[s] a careful consideration of such [public policy] implications before allowing the
defense.”); Jones v. Wells Fargo Bank, N.A., 666 F.3d 955, 966–67 (5th Cir. 2012) (“the in pari
delicto doctrine is not for the benefit of either party and not to punish either of them, but for the
benefit of the public” and “application of the doctrine depends upon the peculiar facts and
equities of the case, and the answer usually given is that which is thought would better serve
public policy.”) In Bateman, the Supreme Court considered such public policy implications in
refusing to apply the in pari delicto defense to an action under the federal securities laws
between a “tipper” and a “tippee” in which the “tipper” sought to avoid claims by the “tippee”
based on the “tippee’s” unlawful use of the inside information provided by the defendant.
Indeed, the court held that the “tippee’s” private action for damages could only be barred if (in
addition to other requirements) “preclusion of suit would not significantly interfere with the
effective enforcement of the securities laws and protection of the investing public.” Id. at 31011. Moreover, the North Carolina Supreme Court has recognized that “[e]ven where the
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contracting parties are in pari delicto, the courts may interfere from motives of public policy.”
Cauble v. Trexler, 227 N.C. 307, 312 (1947).
The application of the in pari delicto defense becomes more complex where, as here, a
receiver stands in the shoes of the wrongdoer. While neither North Carolina courts nor the
Fourth Circuit have considered its application in such a case, the Seventh Circuit declined to
apply the doctrine to a receivership in Scholes v. Lehman, 56 F.3d 750 (7th Cir. 1995). Scholes
was a Ponzi scheme case and the receiver sued certain outsiders with fraudulent conveyance
claims. The court allowed the claims to proceed despite the in pari delicto defense, reasoning
that the receivership entities were not the wrongdoers, but the controlling principal. Once the
receiver was appointed and the wrongdoer was removed, the corporate entities were entitled to a
return of the money fraudulently transferred. This Court has relied upon Scholes in Quilling v.
Cristell, 2006 U.S. Dist. LEXIS 8480 (W.D.N.C., Feb. 9, 2006), deciding that a receiver had
standing to pursue a fraudulent conveyance claim in view of an in pari delicto defense.
Kaplan relies upon a subsequent Seventh Circuit case to support application of the
doctrine to the claims herein. In Knauer v. Jonathon Roberts Fin. Group, Inc., 348 F.3d 230 (7th
Cir. 2003), the receiver of two entities used to conduct a Ponzi scheme sued two broker dealer
entities. Fraudulent transfers were not at issue, rather defendants were accused of being active in
the scheme by failing to properly supervise or maintain proper control of the individual
employees who perpetrated the scheme. The broker dealers moved to dismiss on the grounds of
in pari delicto. The Seventh Circuit affirmed dismissal under the doctrine, discussing Scholes,
but reasoning as follows:
The key difference, for purposes of equity, between fraudulent conveyance
cases such as Scholes and the instant case is the identities of the defendants.
The receiver here is not seeking to recover the diverted funds from the
beneficiaries of the diversions (e.g., the recipients of Douglas’s transfers in
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Scholes). Rather, this is a claim for tort damages from entities that derived no
benefit from embezzlements, but that were allegedly partly to blame for their
occurrence. In the equitable balancing before us, we find Scholes less
pertinent than the general Indiana rule that the receiver stands precisely in the
shoes of the corporations for which he has been appointed.
Knauer, 348 F. 3d at 236.
Kaplan argues that like the defendants in Knauer, he received no fraudulently
transferred funds from Rex, and should thus be allowed to assert the in pari delicto
defense.
Kaplan also relies on two South Carolina cases, one state and one federal. In
Myatt v. RHBT Fin. Corp., 635 S.E.2d 545 (S.C. Ct. App. 2006), the receiver for
corporations used to conduct fraudulent investment schemes sued the bank that
facilitated the transactions for tort damages. As in Knauer, no diverted funds were
sought from the bank. Following Knauer, the South Carolina Court of Appeals held
that “in the absence of a fraudulent conveyance case, the receiver of a corporation used
to perpetrate fraud may not seek recovery against an alleged third-party co-conspirator
in the fraud.” Myatt, 635 S.E.2d at 548.
In Hays v. Pearlman, 2010 WL 4510956 (D.S.C. Nov. 2. 2010), the receiver
sued the attorney who helped create the corporate entities used to perpetrate a Ponzi
scheme. The receiver alleged claims of malpractice and breach of fiduciary duty and
the defendant argued that the claims should be dismissed under the doctrine of in pari
delicto. In an unpublished decision, Judge David Norton, relying on Myatt and
Knauer, and barred the claims, stating “[t]he instant case is in line with Knauer.
Plaintiff receiver seeks tort damages from defendant Pearlman who derived no alleged
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benefit from Parish’s Ponzi scheme; however, he is alleged to have been partly to
blame for the occurrence of the Ponzi scheme.” Id. at * 7.
While this Court has great respect for Judge Norton, the Court finds that the
application of the doctrine of in pari delicto in this particular case would result in a
great inequity. Judge Norton’s decision, as well as the Myatt case, rely heavily on
Knauer. While the Knauer court distinguished the case where a receiver is seeking to
recover a fraudulent conveyance from the defendant, the court failed to explain why
that distinction would make any difference in the equities because the money
recovered in both circumstances would go to the victims who were defrauded. Instead,
the real basis of the court’s equitable balancing can be found in its description of the
claims against the broker dealer defendants: “[i]n sum, all of the liability, according to
the complaint, arises from the employment or agency relationship between the broker
dealer defendants and [the wrongdoers].” Knauer, 348 F.3d at 237. That is, the claims
against the broker dealers were primarily passive and derivative of the wrongdoing of
the perpetrators of the scheme. Indeed, the court emphasized that, “there is no
allegation whatsoever that the defendants were directly involved in the embezzlement
…” (Id.) and specifically stated in a footnote, “had the broker dealers been directly
involved in the embezzlements … this would be a different case.” Id. at 237 n. 6. The
Myatt court, without independent analysis, appears to have simply applied the in pari
delicto doctrine pursuant to Knauer because of the lack of a fraudulent conveyance
claim in that case. However, in Myatt, as in Knauer, the court noted that there was no
direct connection between the defendant bank and the unlawful conduct.
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The case herein is precisely the type of case that the Knauer court
distinguished. Here, the Receiver’s claims against Kaplan are not merely passive,
derivative, or related to the supervision of others. The claims herein are based on
Kaplan’s direct involvement with the scheme, including his bad legal advice, active
assistance to the wrongdoers, and personal promotion of the scheme to potential
investors.
Considering the important public policy interests at stake, the Court finds that
the in pari delicto doctrine should not be applied to bar the Receiver herein from
attempting to obtain recovery for the victims of the Zeek scheme from a person
accused of directly participating in the illegal scheme. The only people who will be
hurt by the application of in pari delicto to bar third party actions other than for
fraudulent transfers are the victims of the RVG scheme. All the professionals,
advisors and others who helped make the scheme possible with their own wrongful
conduct will enjoy the windfall of avoiding liability for their misdeeds. Such a result in
is simply not equitable.
C. Malpractice claim
In addition to arguing that in pari delicto should preclude any claims against
him, Kaplan contends that the Receiver’s legal malpractice claim should be dismissed
because the Complaint fails to plead the elements of a plausible legal malpractice
claim. Under North Carolina law, a claim for legal malpractice requires a showing:
“(1) that the attorney breached the duties owed to his client . . . and that this
negligence (2) proximately caused (3) damage to the plaintiff.” Rorrer v. Cooke, 329
S.E.2d 355, 366 (N.C. 1985).
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The Complaint alleges multiple instances of Kaplan’s omission to use
reasonable care and diligence in his representation of RVG, summing up these
breaches as follows:
Defendant’s negligent acts and omissions, including generally promoting
the scheme, failing to provide material facts (including tax information)
during ZeekRewards promotional calls, and allowing his name to be used
to prop up ZeekRewards as a supposedly legitimate enterprise, breached
his duties to RVG.
(Compl. at ¶ 51). The Court finds that these allegations are sufficient to plausibly
establish the first element of a legal malpractice claim.
Kaplan further argues that the Receiver has failed to plead that his actions
proximately caused RVG’s damages, because in order to do so, the Receiver must
allege and prove that the loss would not have occurred but for Kaplan’s conduct. In
support of his argument, Kaplan cites Belk v. Cheshire, 583 S.E.2d 700, 704 (N.C. Ct.
App. 2003). However, the standard set forth in Belk applies to criminal legal
malpractice actions, not the current case. See Dove v. Harvey, 608 S.E.2d 798, 801
(N.C. Ct. App. 2005) (“In Belk v. Cheshire, 159 N.C.App. 325, 332, 583 S.E.2d 700,
706 (2003), this Court explained that in a criminal legal malpractice action, the
plaintiff has a high burden of proof to show proximate causation.”) (emphasis added).
As the Dove opinion explains, “In Belk, this Court reviewed cases from other
jurisdictions and determined several public policy reasons supported a stricter standard
for criminal malpractice actions.” Id. at 801–02.
Rather than the inapplicable “stricter standard” of Belk, the Receiver herein
must prove proximate cause by merely showing that Kaplan’s actions were “a
substantial factor . . . of the particular injuries for which [the Receiver] seeks
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recovery.” Self v. Yelton, 688 S.E.2d 34, 38 (N.C. Ct. App. 2010) (quoting Brown v.
Neal, 197 S.E.2d 505, 509 (N.C. 1973)). The Court finds that the Receiver has alleged
sufficient facts to support the plausible conclusion that Kaplan’s breaches proximately
caused damages to RVG. As the Complaint sets forth, because of Kaplan’s negligent
omissions, “Affiliates were placated in their misguided belief that ZeekRewards was a
lawful program,” which prolonged the scheme and deepened its insolvency. (Compl.
at ¶¶ 47, 48). Further, the Receiver alleges that:
by allowing ZeekRewards to use his name in providing Affiliates the false
perception that ZeekRewards was a lawful enterprise and by serving as a
resource in answering Affiliates’ tax questions via email, Kaplan assisted
in prolonging the scheme, deepening RVG’s insolvency and causing
significantly more loss to RVG than it otherwise would have incurred.
(Id. at ¶ 48). These statements, taken as true, demonstrate that Kaplan’s omissions
were a substantial factor in the harm caused to RVG. The Receiver has pleaded
sufficient allegations to support a showing that Kaplan’s breaches of duty proximately
caused damages to RVG.
D. Aiding and Abetting Breach of Fiduciary Duty
Kaplan next argues that the Receiver’s claim for aiding and abetting breach of
fiduciary duty must be dismissed because North Carolina does not recognize such a
cause of action. It appears that the Defendant is correct that North Carolina has never
recognized this cause of action. See Tong v. Dunn, 2012 WL 944581 at *4 (N.C.
Super. Ct., March 19, 2012); Laws v. Priority Trustee Service of N.C., L.L.C., 610 F.
Supp. 2d 528, 532 (W.D.N.C. 2009). The Receiver contends, however, that Nevada
law applies to the Receiver’s claim because RVG was incorporated in Nevada and the
claim involves the “internal affairs” of RVG. “Under North Carolina law, the
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substantive law of a corporation's state of incorporation governs suits involving ‘[the]
corporation's internal affairs—matters peculiar to the relationships among or between
the corporation and its current officers, directors, and shareholders....’” Haberland v.
Bulkeley, 896 F.Supp. 2d 410, 420 (E.D.N.C. 2012) (quoting Bluebird Corp. v. Aubin,
188 N.C.App. 671, 680–81 (2008)) (emphasis added). Mr. Kaplan is neither an officer,
director, nor shareholder of RVG. Therefore, this claim does not invoke the internal
affairs doctrine and Nevada law is inapplicable. As North Carolina does not recognize
this claim, it must be dismissed.
E. Constructive Trust
Finally, Kaplan moves to dismiss the Receiver’s claim for constructive trust,
arguing that “constructive trust” is merely a remedy under North Carolina law, not a
cause of action. North Carolina law holds that a constructive trust may be requested as
a claim or in the prayer for relief. See, e.g., Variety Wholesalers, Inc. v. Salem
Logistics Traffic Servs., LLC, 723 S.E.2d 744 (N.C. 2012) (reversing denial of
constructive trust for further fact-finding where constructive trust was alleged as an
affirmative claim for relief); see also Cury v. Mitchell, 688 S.E.2d 825, 828 (N.C. Ct.
App. 2010) (“These allegations and the facts as presented in the complaint are
sufficient to state a claim for constructive trust, and the trial court erred by granting
defendant’s motion to dismiss for failure to state a claim.”). The Court finds that the
Receiver has properly requested a constructive trust, regardless of whether it is
technically considered a claim or a remedy.
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IT IS THEREFORE ORDERED that Defendant’s Motion to Dismiss is hereby
GRANTED IN PART AND DENIED IN PART, and Plaintiff’s Second Claim for
Relief is hereby dismissed.
Signed: February 29, 2016
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