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STEED FINANCE LDC v. LASER ADVISERS

April 15, 2003

STEED FINANCE LDC, SHETLAND FUND LTD., REPUBLIC MULTI-ADVISER ARBITRAGE, INVESTMENTS LIMITED AND REPUBLIC GLOBAL HEDGE INVESTMENTS LIMITED, AND CREDITANSTALT A.G., PLAINTIFFS
v.
LASER ADVISERS, INC., MICHAEL SMIRLOCK, AND MELANIE KATZMAN, DEFENDANTS APPALOOSA MANAGEMENT L.P. AND DAVID TEPPER, DEFENDANTS AND THIRD-PARTY PLAINTIFFS V. JAMES RIVER CAPITAL CORP., JAMES RIVER OFFSHORE MANAGEMENT CORP., KEVIN M. BRANDT, AND PAUL H. SAUNDERS, THIRD-PARTY, DEFENDANTS



The opinion of the court was delivered by: Barbara S. Jones, United States District Judge

OPINION AND ORDER

This securities action is presently before the Court on the motion of the third-party defendants, James River Capital Corp., James River Offshore Management Corp., Kevin M. Brandt, and Paul H. Saunders, (collectively, the "James River Defendants"), to dismiss the third-party complaint against them for failure to state a claim upon which relief can be granted pursuant to Fed. R. Civ. P. 12(b)(6), and for failure to plead fraud with particularity pursuant to Fed.R.Civ.P. 9(b). The third-party complaint was filed by defendants Appaloosa Management L.P. and David Tepper (hereinafter "Appaloosa and Tepper") seeking contribution from the James River Defendants in the event that they are ultimately found liable in the main action.*fn1 For the reasons appearing hereafter, third-party defendants' motion to dismiss is granted.

I. BACKGROUND*fn2

This case arises from the mispricing of Plaintiffs' investment portfolios by defendants Michael Smirlock and LASER Advisers, Inc. between December 1997 and June 1998, allegedly designed to conceal the true performance of Plaintiffs' investments.

Plaintiffs are investors in certain hedge funds to which defendant Appaloosa, and later LASER Advisers, Inc. ("LASER") acted as investment advisor, with defendant Michael Smirlock acting as lead portfoho manager. Defendant and third-party plaintiff Appaloosa is a Delaware limited partnership registered with the Commodity Futures Trading Commission as a commodity pool operator and a commodity trading advisor. Its general partner is Appaloosa Partners Inc., of which defendant and third-party plaintiff David Tepper is President and sole shareholder. Tepper is also one of Appaloosa's limited partners. (TPC ¶ 4). Third-party defendants James River Capital Corporation ("James River") acted as the sponsor of the hedge fund in which plaintiffs invested, and was primarily responsible for organizing the funds and marketing them to investors. Individual third-party defendants James M. Brandt and Paul H. Saunders are principals of James River and served on the Board of Directors of Steed and Shetland, as did Smirlock.

The underlying litigation began when plaintiffs' Steed Finance Ltd. ("Steed"), an offshore hedge fund formed to serve as a "hub" fund to invest on behalf of other funds, Shetland Fund Ltd., ("Shetland") and three other entities that are alleged to be shareholders of Shetland brought suit against five defendants, LASER, Appaloosa, Michael Smirlock, David Tepper, and Melanie Katzmann, who is Michael Smirlock's wife, alleging that Smirlock, as lead portfolio manager of the hedge funds, mispriced the funds in December 1997 and from February 1998 through May 1998, causing damages to the plaintiffs. Plaintiffs' amended complaint, filed against the same five defendants, contained twenty-four claims alleging violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, common law fraud, negligent misrepresentation, fraud in the inducement, breach of contract, and breach of fiduciary duty.

Defendants Appaloosa and Tepper then moved to dismiss the first amended complaint against them, which the Court denied on January 4, 2001. Appaloosa and Tepper filed their third-party complaint approximately three months later, on April 5, 2001, for contribution from the James River Defendants should Appaloosa and Tepper be found liable to the plaintiffs, and Tepper brought a claim for damages, on behalf of LASER, for aiding and abetting fraud and breach of fiduciary duties by Smirlock. In their third-party complaint, Appaloosa and Tepper allege that the James River Defendants are liable for violations of Federal securities laws and rules promulgated thereunder, as well as for common law fraud, negligence and breach of fiduciary duties.

A. The Funds' Beginnings

David Tepper, formerly of Goldman Sachs & Co.'s high yield group, formed Appaloosa as a hedge fund manager. In early 1994, Michael Smirlock was hired by Tepper to establish new hedge funds to trade mortgage-related securities. Smirlock was previously Chief Investment Officer for Goldman Sachs Asset Management. Smirlock created plaintiff Shetland, an offshore hedge fund, as a limited liability corporation incorporated under the laws of the British Virgin Islands.*fn3 According to its Offering Memorandum, Shetland was formed to invest in "high quality U.S. fixed-income securities, primarily private-label mortgage-securities and governmental agency mortgage-based securities as well as other securities and derivative instruments." (Shetland Offering Mem. at 4).*fn4 On July 1, 1994, the effective date of its formation, Shetland entered into an Investment Advisory Agreement with Appaloosa and until July 1995, Appaloosa conducted Shetland's investment and trading operations and acted as Shetland's sponsor.

B. The Entrance of James River

In an effort to expand their hedge fund operations, Tepper and Smirlock began looking for an outside sponsor to market the funds through private placements. (Am. Compl. ¶ 26, TPC ¶ 18). In July 1995, James River Capital Corporation ("James River") became Shetland's sponsor.*fn5 Pursuant to an Amended and Restated Sponsor Agreement dated July 21, 1995, James River was to receive a management fee "with respect to the Company's Class A Shares equal to 1/6 of 1% (a 2% annual rate) of the month-end Net Asset Value (as defined in the Offering Memorandum) of the Company's Class A Shares" in addition to "an annual incentive fee equal to 5% of any cumulative New Profit with respect to the Company's Class A Shares determined as of the end of each calendar year." (TPC ¶ 16). Prior to July 1995, Shetland had conducted all of its investment and trading operations directly. (Shetland Offering Mem. at 4). However, as of July 1, 1995, Shetland was scheduled to begin conducting its investment and trading activities indirectly through an investment in Steed, a Cayman Islands corporation formed to serve as a "hub" fund to conduct investment trading activities on behalf of certain investment funds advised by Appaloosa. Pursuant to an Amended and Restated Investment Advisory Agreement with Appaloosa effective July 1, 1995, Appaloosa served as the investment advisor to Steed and Shetland, and Smirlock acted as the portfoho manager and executed the trading methods and policies for both Steed and Shetland in exchange for advisory fees. The Board of Directors for Shetland and Steed were identical. Two of James River's principals, Paul Saunders and James Brandt, served on the Board of Directors of Shetland and Steed.

There were several other funds under the "hub" fund, Steed. One such fund was Trakehner Fund L.P. ("Trakehner"), a Delaware limited partnership hedge fund. Trakehner invested all or substantially all of its assets indirectly into Steed. James River served as the General Partner and commodity pool operator of Trakehner, and Appaloosa served as the investment advisor and commodity trading advisor. (Trakehner Offering Mem. at 4). Trakehner limited partnership units were offered through a private placement memorandum starting on August 28, 1995, which was updated on April 5, 1996. Appaloosa was paid a management fee and an incentive fee linked to Trakehner's cumulative "new" profit for each year over the life of the Advisory Agreement. The Trakehner Offering Memorandum stated that the partnership's trading policies were to be executed by Smirlock through Thoroughbred Finance Ltd. and ultimately through Steed, the hub fund.*fn6

C. Tracking the Funds' Progress

The Investment Advisor, Appaloosa, through Smirlock, provided monthly unaudited and annual audited financial statements of Shetland and Steed, as well as the monthly composition of Shetland's portfolio to each shareholder of Shetland. The Trakehner portfolio was similarly valued monthly by Appaloosa, through Smirlock. The Investment Advisory Agreements required Appaloosa to adhere to valuation provisions contained in the Agreements, including the requirement that Appaloosa "value each portfoho security based on quotations received from at least one independent dealer in the security involved." (Steed Advisory Agmt. at ΒΆ 13). According to plaintiffs' amended complaint, adherence to the valuation provisions was important to Steed, Shetland, and investors in Shetland and Trakehner because ...


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