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July 6, 2005.

FRATERNITY FUND LTD., et al., Plaintiffs,

The opinion of the court was delivered by: LEWIS KAPLAN, District Judge


This is a private securities action based on an alleged valuation fraud involving three hedge funds.

  Over the course of October and November 2002, the funds' managers made a series of disclosures revealing that the net asset values of the funds had declined from the values reported as of August 31, 2002. Each subsequent disclosure revealed that the decline was greater than previously thought, with the final disclosure revealing that the NAVs had declined by 61.22 percent. The announcements prompted grand jury and SEC investigations and a number of civil actions, including this one. Now before the Court are motions to dismiss the amended complaint ("Complaint") by (1) Beacon Hill Asset Management, LLC ("Beacon Hill"), Safe Harbor Asset Management, LLC ("Safe Harbor Asset Management"), and their four principals, defendants John D. Barry, Thomas Daniels, John Irwin, and Mark Miszkiewicz (collectively, the "Beacon Hill Defendants") and (2) Asset Alliance Corp. ("Asset Alliance").*fn1 I. Background

  A. The Complaint

  1. The Funds

  The three hedge funds at the center of this action are Bristol Fund, Ltd. ("Bristol"), Safe Harbor, L.P. ("Safe Harbor"), and Milestone Plus Partners, L.P. ("Milestone") (collectively, the "Funds").*fn2 They invested in mortgage-backed and related securities.*fn3

  Bristol and Safe Harbor were created and managed by the Beacon Hill Defendants.*fn4 Milestone was managed by Milestone Global Advisors, L.P. ("Milestone Global") and, pursuant to an agreement in 1998 with Milestone Global, the Beacon Hill Defendants.*fn5 In January 2002, Beacon Hill announced its adoption of a master feeder fund structure under which the Funds became "feeder funds" into Beacon Hill Master, Ltd. ("Beacon Hill Master").*fn6 Beacon Hill Master managed their trading.*fn7 2. The Alleged Fraud

  The Complaint alleges three categories of misstatements and omissions by the Beacon Hill Defendants.

  First, from March 2000 through September 2002, the defendants allegedly overstated the net asset values ("NAVs") of Bristol and Safe Harbor in audited financial statements and monthly performance reports ("MPRs").*fn8 These documents allegedly stated "that each Funds' [sic] NAV was steadily increasing with little volatility and virtually no negative months. . . . [when] [i]n fact the Funds were losing money . . ."*fn9 Allegedly, "[t]hese losses were exacerbated in the summer of 2002 after Beacon Hill accumulated for the Funds a significant short position in U.S. Treasuries on a highly leveraged basis — apparently betting on an increase in interest rates. When interest rates continued to fall, the value of the Funds' portfolio continued to drop."*fn10

  Second, defendants allegedly represented in offering memoranda, audited financial statements, due diligence questionnaires, and meetings with investors that the NAVs of Bristol and Safe Harbor had been or would be calculated using independent prices.*fn11 Rather than use independent prices, however, defendants used their own allegedly fraudulent valuations.*fn12

  Finally, defendants allegedly misrepresented in offering memoranda and audited financial statements that NAVs were calculated in good faith.*fn13

  3. The Collapse

  The Beacon Hill Defendants allegedly concealed the Funds' losses until they made three disclosures in October and November 2002 that revealed the extent of losses.

  First, "[o]n October 8, 2002, Beacon Hill disclosed to investors, including the plaintiffs, that the NAVs of the Funds declined by an estimated 25% in September. This disclosure was prompted by [its primary broker] Bear Stearns' refusal to provide additional financing due to the material over-valuation of the portfolios and Bear Stearns reporting this situation to the SEC."*fn14

  Second, "[o]n October 17, 2002, following inquiries from the SEC, Beacon Hill disclosed to investors, including the plaintiffs, that, as of September 30, 2002, the NAVs for the Funds actually declined by 54% from the reported NAVs as of August 31, 2002. In this disclosure, Beacon Hill admitted that a portion of the Funds' losses occurred prior to August 31, 2002."*fn15

  Finally, "[o]n November 27, 2002, Beacon Hill disclosed that the NAV of the Funds had actually declined by 61.22% from the NAV reported as of August 31, 2002."*fn16 The Complaint alleges that, "[i]n actuality, the NAVs of the Funds had been declining for years."*fn17

  4. The Defendants

  The Complaint alleges the following about the defendants.

  Beacon Hill is a Delaware limited liability company formed in 1997 by its four principals — Barry, Daniels, Irwin, and Miszkiewicz (collectively the "Individual Defendants") — to serve as an investment manager of hedge funds that invested in mortgage-backed and related securities.*fn18 As of 1998, Asset Alliance, through two wholly owned subsidiaries, allegedly owned 50 percent of Beacon Hill and the Individual Defendants the other 50 percent.*fn19

  The Individual Defendants were principals and directors of Beacon Hill.*fn20 Barry was president and director of marketing and "responsible for the daily management of the firm."*fn21 Daniels was chief investment officer and "direct[ed] the overall risk management of the firm."*fn22 Miszkiewicz was chief financial officer and Irwin a senior portfolio manager.*fn23

  Safe Harbor Asset Management is a New Jersey limited liability company and the general partner of Safe Harbor.*fn24 Beacon Hill owned 99 percent and Barry one percent of it.*fn25

  Milestone Global is a Delaware limited liability partnership and the general partner of Milestone.*fn26 Asset Alliance owned 99 percent.*fn27 In or around 1998, Milestone Global and Beacon Hill entered into an agreement pursuant to which Beacon Hill provided Milestone with investment management services.*fn28

  Asset Alliance is a Delaware corporation that acquired a 50 percent interest in Beacon Hill in 1998.*fn29 Its practice allegedly was to purchase 50 percent interests in investment managers such as Beacon Hill.*fn30 It then provided its affiliates with advice in "marketing and distribution services, strategic planning and administration, as well as back-office support and systems."*fn31 None of the Funds is a party to this action.

  5. The Plaintiffs and Their Claims

  Plaintiffs are 36 shareholders and/or limited partners of the Funds.*fn32 They invested, in aggregate, $106 million between September 1997 and September 2002.*fn33 All but two of the plaintiffs invested in Bristol and/or Safe Harbor, but not Milestone. Plaintiffs Balentine Global Hedge Fund, L.P. and Balentine Hedge Fund Select, L.P. ("Balentine Plaintiffs") invested only in Milestone.*fn34

  The Complaint asserts six claims against the Beacon Hill Defendants. Four claims are brought by all plaintiffs except for the Balentine Plaintiffs. These claims allege violations of Section 10(b) of the Securities and Exchange Act of 1934 (the "Exchange Act")*fn35 and state common law.*fn36 The remaining two claims are brought by the Balentine Plaintiffs on state law theories.*fn37

  The Complaint makes five claims against Asset Alliance. Three are brought by all of the plaintiffs and allege control person liability under Section 20(a) of the Exchange Act*fn38 and violations of state common law.*fn39 Two are brought by plaintiff Sanpaolo IMI Alternative Investments SGR SpA ("Sanpaolo") on state common law theories and relate to Sanpaolo's investments in Bristol.*fn40

  Finally, the plaintiffs who invested in Safe Harbor ("Safe Harbor Plaintiffs") assert a state law claim against Safe Harbor Asset Management.*fn41

  B. Proceedings

  The disclosures by Beacon Hill in the fall of 2002 prompted an action by the SEC.*fn42 Without admitting or denying liability, the Beacon Hill Defendants consented to entry of a final judgment and injunction pursuant to which they were obliged to pay $2.2 million in disgorgement and $2 million in civil penalties.*fn43

  Plaintiffs commenced this action on April 8, 2003. The Court subsequently granted motions by the Beacon Hill Defendants and Asset Alliance to dismiss the corrected and supplemental complaint for failure to satisfy the requirements of Rule 9(b) and the PSLRA.*fn44 The Complaint was filed on June 24, 2004.

  II. Standards Governing Motions to Dismiss

  In deciding a Rule 12(b)(6) motion, the Court accepts as true all well-pleaded factual allegations in the complaint and draws all reasonable inferences in the plaintiff's favor.*fn45 Dismissal is inappropriate "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief."*fn46 A district court may consider the full text of documents attached as exhibits to the complaint or incorporated by reference.*fn47

  As this is a securities fraud case, the Complaint must meet the heightened pleading requirements of Rule 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA").*fn48 The PSLRA requires that a complaint alleging misstatements or omissions "specify each statement alleged to have been misleading" and "the reason or reasons why the statement is misleading."*fn49 In addition, where allegations of misstatements and omissions are made on information and belief, the complaint must "state with particularity all facts on which that belief is formed."*fn50

  Three requirements of Rule 9(b) are relevant to this motion. First, Rule 9(b) requires that plaintiffs alleging fraud state "the circumstances constituting fraud . . . with particularity."*fn51 Allegations that are "conclusory" or "unsupported by assertions of fact" are insufficient.*fn52 Second, the rule requires that the complaint "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent."*fn53 Finally, Rule 9(b) generally does not permit information and belief allegations except for matters that are "peculiarly within the opposing party's knowledge,"*fn54 in which case the allegations must be "accompanied by a statement of facts upon which the belief is founded."*fn55 III. Section 10(b) Claims

  In order to state a claim under Section 10(b) of the Exchange Act and Rule 10b-5, "a plaintiff must plead that the defendant, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiff's reliance on the defendant's action caused injury to the plaintiff."*fn56 Scienter is "an intent to deceive, manipulate or defraud."*fn57

  Plaintiffs allege that the Beacon Hill Defendants misrepresented (1) the NAVs of Bristol, Safe Harbor and Beacon Hill Master, (2) that independent prices had been or would be used to calculate the NAVs of those funds, and (3) that the assets of those ...

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