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.
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 ¶
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.
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
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.
A. Motion to Amend Complaint and Motion for Summary Judgment