The opinion of the court was delivered by: LEWIS KAPLAN, District Judge
MEMORANDUM OPINION (Corrected)
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
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
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
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
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 ...