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Phoenix Four, Inc. v. Strategic Resources Corporation

February 21, 2005

PHOENIX FOUR, INC., PLAINTIFF,
v.
STRATEGIC RESOURCES CORPORATION, PAUL SCHACK, CHRISTIAN M. VAN PELT, JAMES J. HOPKINS III, ROBERT H. ARNOLD, R.H. ARNOLD & CO. INCORPORATED, JOEL G. SHAPIRO, AND JGS ADVISORS LLC, DEFENDANTS.



The opinion of the court was delivered by: Hon. Harold Baer, Jr., District Judge:

OPINION & ORDER

Plaintiff Phoenix Four, Inc. ("Phoenix") brought this action against defendants Strategic Resources Corporation ("SRC"), Paul Schack ("Schack"), Christian M. Van Pelt ("Van Pelt"), James J. Hopkins III ("Hopkins"), Robert H. Arnold ("Arnold"), R.H. Arnold & Company, Inc. ("RHAC"), Joel G. Shapiro ("Shapiro"), and JGS Advisors LLC ("JGS") alleging: (i) violations of the Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 et seq. (against SRC and RHAC only); (ii) violations of the Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-1 et seq.; (iii) breach of fiduciary duty; (iv) common law fraud; (v) negligent misrepresentation; (vi) breach of contract (against SRC, RHAC, and JGS only); (vii) negligence; and (viii) declaratory relief. This Court has jurisdiction pursuant to 28 U.S.C. Sections 1331 and 1332(a)(4). All defendants except for Shapiro and JGS now move to dismiss the complaint pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure. For the reasons set forth below, the defendants' motion to dismiss is GRANTED in part and DENIED in part.

I. BACKGROUND

The following facts are taken from the allegations in the complaint unless otherwise stated.

A. The Parties

Phoenix is an investment company incorporated in the Commonwealth of the Bahamas ("The Bahamas") in 1993 and licensed as a mutual fund under Bahamian law in 1997.

Complaint ("Compl.") ¶ 23. Its principal place of business is in Nassau, The Bahamas. Id. ¶ 9.

SRC served as Phoenix's investment adviser and provided other services to it. Id. ¶ 10. SRC is incorporated under the laws of New York with its principal place of business in New York City. Id.

Schack and Van Pelt were managing directors of Phoenix and members of its Board of Directors (the "Board") from 1994 until about April 21, 2004. Id. ¶¶ 11, 12. Both Schack and Van Pelt are, and at all relevant times were, principal shareholders, senior officers, and directors of SRC and in those capacities transacted business in New York City and continue to do so. Id. Schack is a citizen of the State of New York and resides in New York City. Id. ¶ 11. Van Pelt is a citizen of the State of New Jersey. Id. ¶ 12.

Hopkins was a member of Phoenix's Board of Directors from April 2004 through August 2004. Id. ¶ 13. He is also, and at all relevant times was, a principal shareholder, senior officer, and director of SRC and transacted business in New York City and continues to do so. Id. Hopkins is a citizen of the State of New Jersey. Id.

Arnold was a managing director of Phoenix and a member of its Board of Directors from at least October 1995 until about April 21, 2004. Id. ¶ 14. He is a citizen of the State of New York and transacted business in New York City and continues to do so. Id.

RHAC is a corporation organized and existing under the laws of the State of New York, with its principal place of business in New York City. Id. ¶ 15. Arnold is, and at all relevant times was, the senior officer and director of RHAC. Id. ¶¶ 15, 16.

JGS is a limited liability company organized under the laws of the State of New York and has its principal place of business in New York City. Id. ¶ 17. The company was established by Shapiro, and performed a broad range of services for SRC and Phoenix beginning some time after July 2000. Id. Shapiro is a citizen of the State of New York, resides in New York City, and transacted business in New York City and continues to do so. Id. ¶ 18.

B. Relationship Between Phoenix, SRC, and RHAC

Schack, Van Pelt, and Hopkins founded and owned SRC, which was established to act as an adviser to an investment or mutual fund that they would form. Id. ¶ 25. These three defendants then provided assistance in establishing Phoenix, and solicited investors for the fund. Id. ¶¶ 26, 27. On November 5, 1993, Phoenix entered into an Investment Advisory Agreement with SRC ("Advisory Agreement") pursuant to which SRC agreed to serve as the investment adviser for Phoenix for an "indefinite period" and provide advice on the trading of securities. Advisory Agreement, Ex. 1 to Compl., art. II, V. In return for its services, SRC would earn a management fee based on the value of Phoenix's gross assets, and a performance fee based on Phoenix's net asset value per share. See id. art. III. In December 2002, after two Board members pressed SRC to decrease its fees, an amended advisory agreement was negotiated ("Amended Agreement"). Compl. ¶¶ 68, 70. SRC never signed that agreement despite language in the original Advisory Agreement that it could "not be altered or amended except in a writing signed by both parties." Id. ¶ 210; Advisory Agreement, Ex. 1 to Compl., art XI. In October 2003, SRC proposed yet a different fee schedule that was approved by a vote of six directors. Compl. ¶ 73.

Through May 19, 2005, SRC regularly furnished Phoenix with advice regarding the investment in, purchase, sale, or disposal of securities or other properties and, together with the Phoenix Board of Directors, conducted Phoenix's business. Compl. ¶ 29. Phoenix was SRC's sole client. Id. ¶ 30. From 1997 to December 2, 2002 and then again from May 1, 2003, SRC also served as Phoenix's administrator as defined by the Mutual Fund Regulations and Investment Funds Regulation of the Commonwealth of the Bahamas. Id. ¶ 31.

Arnold and RHAC had a business association with SRC, Schack, Van Pelt, and Hopkins. Id. ¶ 37. As a result of that association, SRC, Schack, and Van Pelt caused Phoenix to make Arnold a Director of Phoenix in or around 1995, and to employ RHAC as a financial adviser. Id. In or around April 1996, SRC caused Phoenix to enter into an investment advisory agreement with RHAC, but this agreement was never submitted to the Board or its members for approval.

Id. ¶ 86. From at least early 2000, RHAC assisted in calculating the value of Phoenix's assets and net asset value per share. Id. ¶ 39.

C. The Alleged Wrongdoing

Phoenix alleges that Schack, Van Pelt, Hopkins, Arnold, and the other Directors they caused to be appointed to the Board treated Phoenix as their "personal candy store" and incurred unwarranted expenses for their own benefit. Id. ¶ 4. The Directors routinely approved transactions in which they were self-interested: they invested Phoenix's money in assets in which they had financial interests and paid fees to third parties to whom they were related. Id. ¶ 94. In order to justify such transactions and increase SRC's fees under the Advisory Agreement, the defendants inflated the value of Phoenix's assets and those of its subsidiaries that were under SRC management. Id. ¶ 109. Further, Schack, Van Pelt, and Arnold caused Phoenix's Articles of Association to provide indemnification to its directors and officers except for willful default or gross negligence in contravention of Bahamian law. Id. ¶ 322.

The defendants inflated Phoenix's asset values by listing yet to be acquired assets in Phoenix's financial statements. For example, the transaction by which Phoenix was to acquire its interest in a start-up insurance company known as Insurent did not close until after March 18, 2002. Id. ¶¶ 110, 116, 118. Nonetheless, the defendants caused Phoenix's Consolidated Financial Statements for the Year Ending December 31, 2001 to list the value of Phoenix's interest in Insurent as $26.7 million. Id. ¶ 120.

The defendants also assigned inflated values to Phoenix's assets. For example, on December 14, 2002, an outside entity called Houlihan Valuation Advisers ("Houlihan") valued Insurent at $63 million. Id. ¶¶ 124, 130, 134. The defendants listed the value of Phoenix's then 51.38% interest in Insurent, however, as $57 million as of December 31, 2002. Id. ¶ 131. For that figure to be accurate, the total value of Insurent would have had to increase from $63 million to $110.9 million-a 76% increase-in seventeen days. Id. In addition, the defendants assigned values to other Phoenix assets-Shoppes@IV, Seacourt Pavilion, Westminster Mall-that exceeded the values reported by third party appraisers.

On February 5, 2003, the Board unanimously approved a $57 million number to Phoenix's interest in Insurent. Id. ¶ 133. The directors' vote was based on representations by Schack that this was the value Houlihan and BDO International ("BDO"), Phoenix's outside accountant and auditor, had assigned to this asset. Id. ¶ 134. On January 14, 2003, just a few weeks earlier, Schack had reported to the Board that Houlihan had valued Insurent at $70 million.*fn1 Id. Further, by the end of April 2003, BDO insisted that a statement be inserted in Phoenix's Consolidated Financial Statements for the Year Ending December 31, 2002 to the effect that the value assigned to Insurent was excessive. Id. ¶ 135. Although BDO's position was disclosed to the entire Board on April 29, 2003, the Board failed to decrease the net value assigned to Insurent. Id.

The Insurent agreements stated that at the same time Phoenix was to acquire its interest in Insurent, an SRC subsidiary and RHAC were also to acquire interests in Insurent. Id. ¶ 113.

Despite these statements, Phoenix alleges that the defendants never disclosed that SRC and RHAC intended to acquire an interest in Insurent prior to causing Phoenix to enter into contracts to acquire an interest in the same entity. Id. ΒΆ 115. Further, SRC has refused to produce a complete set of the minutes of Phoenix's Board meetings, including the ...


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