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January 14, 2002


The opinion of the court was delivered by: Bernard B. Sand, United States District Judge.


In this long-lived action, Plaintiffs allege civil violations of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq. While the charged financial chicanery is technical and complex, in essence, Plaintiffs allege that the Defendant Jon Edelman ("Defendant") fraudulently induced Plaintiffs to invest in limited partnership tax shelter investments that Defendant looted by passing off false tax losses and by awarding himself and his co-conspirators commissions and fees for bogus securities trades.*fn1 See Plaintiffs' Memorandum in Support of Renewed Motion to Amend and for Reconsideration at 1-2 ("Plaintiffs' Memo"). The specific details of this scheme can be found in United States v. Manko, 979 F.2d 900, 901-05 (2d Cir. 1992), cert. denied, 509 U.S. 903 (1993), and Greenwald v. Manko, 840 F. Supp. 198, 199-201 (E.D.N.Y. 1993). Plaintiffs present two motions: to amend the amended complaint and to have us reconsider the issue of notice of injury. Defendant's cross motion seeks to dismiss the amended complaint. We reject Plaintiffs' motion and grant summary judgment in favor of the Defendant.

I. Background

A. Statement of Facts

At the outset, we outline the structure of the fraudulent scheme, the response of the investors (including Plaintiffs) and Internal Revenue Service ("IRS") to the scheme, and the role of Defendant in planning and carrying out the scheme. Beginning in 1977 Defendant Edelman, along with several others, organized and managed limited partnerships through Arbitrage Management Company ("Arbitrage Management"). See Second Amended Complaint (Proposed) at ¶ 37. Plaintiffs were investors in one or more of these limited partnerships, including Government Arbitrage Partnership, The Arbitrage Group, Sectra Limited Partnership, Conarbco, and Midipco (collectively "the partnerships"). Plaintiffs allege Defendants represented to investors that these partnerships would allow investors to obtain tax-advantaged investments, usually through some form of income deferral. Id. at ¶ 38. Defendants allegedly represented to Plaintiffs, in order to solicit their investment, that the partnerships were "profit-motivated, and not risk-free, tax-motivated trades," which otherwise may have violated the various tax laws. Id. Defendants also allegedly failed to mention that most of the tax losses passed through to Plaintiffs would be pursuant to fictitious trades, sometimes amounting to billions of dollars, that were devoid of the possibility for profit. Id. at ¶ 38, 58. The fictitious trades eliminated any possibility for the investors to achieve economic gain. Id. at ¶ 42. Beginning in 1979, defendants allegedly supplied the investment partnerships' outside auditors with incomplete information to prepare the partnerships' tax returns and financial statements for the prior year. Id. at ¶ 52. Beginning in 1982, defendants allegedly entered the partnerships into prearranged and bogus repurchase transactions with an inactive corporation controlled by Manko "to purportedly finance certain trades in U.S. Government-backed securities." Id. at ¶ 53.

The injuries suffered by Plaintiffs included "the loss of [P]laintiffs' investment; the loss of any profit opportunity on their investment; liability to federal, state and/or local tax authorities; and expenses for the defense of their interests." Id. at ¶ 73.

The scheme allegedly operated in the following manner. A trader would purchase a U.S. Treasury Bill on the open market, and to pay for it, the trader would enter into a separate financing transaction called a repurchase agreement with the seller. Id. at ¶ 54. This repurchase agreement gives title of the Treasury bill to the borrower; however, the Treasury bill is sold to the lender pursuant to an agreement entered into with the borrower to repurchase the bill at a specified time and price.*fn2 Id. When the repurchase agreement's term ends, the borrower pays the lender the agreed upon repurchase price of the Treasury bill, including finance charges. Id. at ¶ 55. For the borrower to make a profit, the borrower has to sell the Treasury bill to the lender or on the open market at a sufficiently appreciated price. Id. Legitimate traders can take advantage of the tax implications of these transaction. Id. at ¶ 56. "By positioning a repurchase agreement to terminate after year end, the borrower's hoped-for profit on final sale of the underlying security can be realized in the following year. However, accrued finance charges up to year end may be accrued for tax purposes as deductible investment interest expense." Id. Plaintiffs assert that Defendants' Treasury bill purchases and the attendant repurchase transactions used to finance them were fictitious and illusory. Id. at 57. How the Defendants more specifically carried out these transactions can be found in the Second Amended Complaint (Proposed). Id. at ¶ 58-81.

In its proposed Second Amended Complaint, Plaintiffs now allege that defendants, including Edelman, engaged in fraudulent concealment of the scheme. Id. at ¶ 82. Defendants maintained a trading room to give the appearance of a legitimate government securities dealer. Id. at ¶ 83. Legitimate traders conducted regular and legitimate transactions with well-known securities, and when the defendants conducted bogus trades, only a small group of traders was used and the transaction was kept secret from the legitimate traders. Id. Defendants further told their accounting staff that the bogus trades were bona fide and at arms length. Id. at ¶ 86. Defendants used an organization of its creation, T.S.M. Holding Corp. (TSM), with which to trade, and the paperwork generated by TSM led the auditors to believe that "they had confirmed trades done between defendants and TSM, and that such trades were bona fide and at arms length." Id. at ¶ 87.

From the beginning of the investment partnership until February 18, 1988, the limited partner investors, including Plaintiffs, allegedly sought to monitor the integrity of the defendants' operations "by establishing an infrastructure of investor and administrative services representatives to serve as intermediaries between investors and the general partners and as paid 'watchdogs' or 'snoops' . . . ." Id. at ¶ 89. These representatives included Barry Lyman and the accounting firm Berk & Michaels. Id. Defendants, however, allegedly engaged in acts designed to throw the watchdogs off the trail, including giving the watchdogs trading documents showing trades with recognizable securities firms but never with TSM. Id. at ¶ 90. According to Plaintiffs, Lyman represented not just the investors that he put into the deal, but all investors. Id. at ¶ 92. Moreover, the IRS investigated the partnerships throughout the 1980s, and Plaintiffs were sent (a) copies of the reports and (b) the response of Defendant and its counsel to such reports. See, e.g., Kesselman Aff. Ex. 5 (1985 IRS Report of The Arbitrage Group), Ex. 6 (1988 IRS Report of Conarbco), Ex. 7 (1988 IRS Report of Midopco), Ex. 7 (1987 IRS Report of Sectra Limited). In response to the IRS challenge to the partnerships' tax position, Defendants hired the law firm Saltzman & Holloran "to defend the investment partnerships' federal tax position."*fn3 Second Amended Complaint (Proposed) at ¶ 94.

Plaintiffs allege that Defendants prevented them from learning of the fraud. For instance, on May 7, 1986, Edelman wrote to the partners of Midopco that the losses facing the partnerships were the result of accounting errors by the IRS. Id. at ¶ 96. Lyman and Berk & Michaels' investigation into the Defendants' operations revealed (a) high commissions and (b) high overhead. Id. at ¶ 97. Defendants offered a reasonable explanation for the cost of commission and overhead — an explanation that did not reveal that the commissions were for bogus securities trades. Id. at ¶ 99. Moreover, a number of outside auditors certified the partnerships' accounts (e.g., those of Sectra, Midopco, Conarbco) because the auditors had not been told that TSM was not an independent entity trading at arms length with defendants. Id.

Plaintiffs' also allege that their failure to attribute their tax-related losses to Defendants' scheme was not due to their own lack of reasonable diligence. Id. at ¶ 106. Defendants encouraged the limited partners to retain the firms already hired by management, and about 150 of them did so. Id. Defendants point out that the IRS summary reports issued in the 1980s contained several errors indicating that the preliminary disallowance of partnership items could be successfully defended. Id. at ¶ 107. Defendants allegedly hid from Plaintiffs the trading with TSM and asserted primary control over the response to the tax audits, pushing for their early resolution. Id. at ¶ 109. Some time in late 1987 to early 1988, an agreement was reached to settle the audits. Id. at ¶ 110.

On February 8, 1989 Edelman and Manko were indicted on charges of "conspiracy to commit tax fraud, subscription to knowingly false tax returns, and of aiding and abetting the (unwitting) filing of false tax returns by limited partnership investors such as [P]laintiffs." Id. at ¶ 43. Both were convicted on all counts in the indictment, and the convictions have been affirmed on appeal. See United States v. Manko, 979 F.2d 900 (2d Cir. 1992). On February 8, 1993, Plaintiffs brought suit against Defendants, exactly four years after the 1989 indictment. Plaintiffs allege civil violations of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et. seq.

B. Procedural History

This Court's February 28, 2001 Memorandum and Order serves as the procedural backdrop for the Plaintiffs' current motion to amend the amended complaint and for reconsideration of the notice of injury issue and for Defendant's cross-motion to dismiss the amended complaint. See 131 Main Street v. Manko, Memorandum and Order, February 28, 2001 ("Feb. 2001 Order"). There, we readdressed the question of timeliness after the United States Supreme Court in Rotella held that the Malley-Duff four-year statute of limitations period begins as soon as a plaintiff discovers his injury, regardless of when the fraud causing that injury is discovered. Id. at 2; Rotella v. Wood, 528 U.S. 549 (2000); Agency Holding Corp. v. Malley-Duff & Associates, Inc., 483 U.S. 143 (1987).*fn4 Thus, because Plaintiffs filed the RICO action on February 8, 1993 and knew of the injury before February 8, 1989, we held that the Plaintiffs' RICO action was barred by the statute of limitations. Feb. 2001 Order at 2.

However, in our Feb. 2001 Order we acknowledged the significance of Plaintiffs' argument that the doctrine of equitable tolling could preclude summary judgment of the RICO claim. Id. at 3. We noted that the motion for summary judgment and amending the amended complaint hinged on the viability of Plaintiffs' new fraudulent concealment claim.*fn5 Id. The inquiry is straightforward: "If the unchallenged facts of this case contradict any of the [] three elements [of fraudulent concealment] as a matter of law, Plaintiffs' RICO action will be barred and any amendment of the pleadings will be futile." Id. at 4. After briefing and oral argument, we were not prepared at that time to answer this question because of several outstanding factual issues that needed to be developed by the parties. Specifically, we directed the parties to engage in limited fact discovery to determine (1) whether Plaintiffs had a watchdog at all times prior to February 8, 1989, and what bearing this would have on the due diligence requirement, and (2) whether Barry Lyman,*fn6 while sewing as a watchdog for Plaintiffs, was aware of Defendant's fraud more than four years prior to the commencement of this suit, and what bearing this would have on the ignorance requirement. Id. at 4-5.

We now rule on these motions.

II. Discussion

A. Motion to Amend Complaint and Motion for Summary Judgment

Leave to file an amended complaint "shall be freely given when justice so requires." Fed.R.Civ.P. 15(a). Unless there is evidence of undue delay, bad faith, undue prejudice to the nonmovant, or futility, leave to file an amended complaint should not be denied. See Foman v. Davis, 371 U.S. 178, 182 (1962)*fn7 If the Plaintiffs' proposed amended complaint is futile, then the motion for leave to amend will be denied, which ...

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