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FRATERNITY FUND LTD. v. BEACON HILL ASSET MANAGEMENT LLC.

United States District Court, S.D. New York


July 11, 2005.

FRATERNITY FUND LTD., et al., Plaintiffs,
v.
BEACON HILL ASSET MANAGEMENT LLC, et al., Defendants.

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

MEMORANDUM OPINION

The case is before the Court on motions by defendants ATC Fund Services (Cayman) Limited ("ATC") and Amsterdam Trust Corp., B.V. ("ATC BV") (collectively the "ATC Defendants") to dismiss the amended complaint ("Complaint").

Facts

  At the center of this case is an alleged valuation fraud involving hedge funds that invested in mortgage-backed and related securities.*fn1 The two funds at issue here are Bristol Fund, Ltd. ("Bristol") and Safe Harbor, L.P. ("Safe Harbor") (collectively the "Funds"). They were created and managed by defendants 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").*fn2 ATC was the administrator of the Funds.*fn3

  From March 2000 through September 2002, the Beacon Hill Defendants allegedly misrepresented in offering memoranda and elsewhere that the Funds' net asset values ("NAVs") would be calculated in good faith using independent prices.*fn4 Contrary to those representations, they allegedly overpriced the securities in the Funds' portfolios for purposes of reporting NAVs in audited financial statements and month-end reports.*fn5

  ATC allegedly is liable on the theory that it calculated the Funds' NAVs using the Beacon Hill Defendants' inflated prices without verifying the accuracy of those prices.*fn6 It then disseminated the NAVs to plaintiffs in month-end reports.*fn7 Plaintiffs assert that Beacon Hill's prime broker, Bear Stearns, independently valued the securities in the Funds' portfolios and arrived at prices that would have resulted in portfolio valuations that were lower than those based upon the Beacon Hill prices.*fn8 Although ATC allegedly received the Bear Stearns prices, it "slavishly used the Beacon [Hill] Defendants' marks . . . without verifying that the marks reflected market value."*fn9

  The Complaint asserts claims against ATC under Section 10(b) of the Securities and Exchange Act of 1934 ("Exchange Act"),*fn10 and Rule 10b-5 thereunder,*fn11 and on state law theories.*fn12 It makes a claim against ATC BV for control person liability under Section 20(a) of the Exchange Act.*fn13

  The ATC Defendants move to dismiss on various grounds, including, primarily, that the Complaint fails to satisfy Fed.R.Civ.P. 9(b) and/or the Private Securities Litigation Reform Act ("PSLRA").*fn14 Discussion

  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.*fn15 A district court may consider the full text of documents attached as exhibits to the complaint, incorporated in it by reference, or "integral" to the complaint.*fn16

  A. Scienter

  Plaintiffs must "state with particularity facts giving rise to a strong inference that the defendant acted with the requisite state of mind."*fn17 This may be done "either (a) by alleging facts that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness."*fn18 "[T]he inference may arise where the complaint sufficiently alleges that the defendants: (1) benefitted in a concrete and personal way from the purported fraud, (2) engaged in deliberately illegal behavior, (3) knew facts or had access to information suggesting that their public statements were not accurate, or (4) failed to check information they had a duty to monitor."*fn19

  Plaintiffs rely upon the conscious misbehavior or recklessness approach.*fn20 They contend that "ATC knew facts or had access to information suggesting that their public statements and those of the Beacon Defendants were not accurate."*fn21 In particular, they allege that ATC routinely received prices of the securities in the Funds' portfolios from Bear Stearns and that those prices would have resulted in portfolio valuations that were lower than the valuations published by the Beacon Hill Defendants.*fn22 Valuations based on Bear Stearns prices would have been lower than those based on Beacon Hill prices by 10 to 15 percent in March 2000 and March 2001, 16.32 percent in March 2002, 24.46 percent in April 2002, 12.45 percent in May 2002, 15.08 percent in June 2002, 31.43 percent in July 2002, and 37.62 percent in August 2002.*fn23 ATC allegedly stated in a due diligence questionnaire for Bristol that it received "position statements" from Bear Stearns, as well as from the fund's managers, and that non-public securities were valued "from the Prime Brokers, and underwriters; and verified with Bloomberg."*fn24 Plaintiffs have not alleged facts sufficient to justify their assertion that the Bear Stearns/Beacon Hill valuation disparity created a red flag. As explained in the July 6 Opinion, "[t]he defendants' hedge funds involved non-exchange listed securities, the valuation of which may differ depending on the model used in the calculations. In other words, valuation of such securities was not a matter of looking up closing prices in the Wall Street Journal, but involved the exercise of judgment."*fn25 Plaintiffs do not allege that the models used or the judgments made by Bear Stearns were superior to those used or made by Beacon Hill. They do not allege that the differences in valuations were outside the range of what was considered normal in the industry. Certainly they do not allege that the ATC Defendants had any reason to think that Bear Stearns figures were any better than those of the Beacon Hill Defendants.*fn26

  Plaintiffs' theory of scienter appears to be based also upon the mistaken assumption that ATC had the expertise or duty "to conduct an independent valuation" of the securities in the Funds' portfolios.*fn27 Although ATC allegedly was responsible for computing the NAV of the Funds, that task is different from the task of valuing the securities in the Funds' portfolios.*fn28 Fund documents delegated responsibility for the former task to ATC and the latter to Bristol's investment manager and Safe Harbor's general partner.

  One such document was the Bristol offering memorandum. It repeatedly stated that the fund's investment manager, Beacon Hill, was responsible for valuing the fund's securities and cautioned that this delegation of responsibility to the investment manager created a potential conflict of interest insofar as the investment manager's compensation was based upon NAV.*fn29 In contrast, when describing ATC's responsibilities as administrator, the offering memorandum nowhere indicated that one of ATC's responsibilities was the valuation of the securities in the fund.*fn30 Instead, it cited to the administration agreement between ATC and the Fund, which lists one of ATC's "duties and functions" as including responsibility for "computing the Net Asset Value of the Company's shares . . ."*fn31 Safe Harbor's offering memoranda also provided that the general partner, Safe Harbor Asset Management, was responsible for valuing the securities in the fund's portfolio, whereas its administration agreement with ATC provided that the latter was responsible for computing the partnership's NAV.*fn32 Plaintiffs do not allege facts to show that, contrary to these documents, ATC had an obligation to independently calculate or verify the Beacon Hill prices.*fn33 Accordingly, plaintiffs fail to plead facts giving rise to a strong inference of scienter.

  B. Control Person Liability

  The Complaint alleges control person liability against ATC BV based on the alleged primary violation by ATC. As plaintiff has failed adequately to allege a primary violation, its Section 20(a) claims are dismissed.*fn34

  C. State Law Claims

  Plaintiffs allege various state law claims against ATC. However, for the reasons addressed in the July 6 Opinion, the Court lacks supplemental jurisdiction over those claims.*fn35

  Conclusion

  As the Complaint fails to satisfy either the PSLRA or Rule 9(b) as to the moving defendants, the Court does not address defendants' remaining arguments for dismissal of the federal securities law claims. The motions of defendants ATC Fund Services (Cayman) Limited and Amsterdam Trust Corp., B.V. to dismiss the federal securities law claims [docket items 50 and 71, respectively] are granted. As plaintiffs already have had an opportunity to amend, dismissal is with prejudice.*fn36 There being no independent basis of federal jurisdiction over the state law claims, they are dismissed for lack of subject matter jurisdiction.

  SO ORDERED.


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