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Trustees of the Masonic Hall and Asylum Fund v. Pricewaterhousecoopers LLP

February 5, 2009

THE TRUSTEES OF THE MASONIC HALL AND ASYLUM FUND, PLAINTIFF,
v.
PRICEWATERHOUSECOOPERS LLP, DEFENDANT.
INDEX RECOVERY COMPANY, LP F/K/A SPHINX MANAGED FUTURES INDEX FUND, LP, PLAINTIFF,
v.
PRICEWATERHOUSECOOPERS LLP, DEFENDANT.



The opinion of the court was delivered by: Gerard E. Lynch, District Judge

OPINION AND ORDER

Plaintiffs, the Trustees of the Masonic Hall and Asylum Fund ("Trustees") and the Index Recovery Company, LP f/k/a SPhinX Managed Futures Index Fund, LP ("Index Recovery") (collectively, the "Index Recovery Plaintiffs"),*fn1 initially brought independent actions for negligence and professional malpractice in the Supreme Court of the State of New York, County of Oneida (the "New York State Court").*fn2 The actions, filed approximately twelve months apart, contain substantially similar allegations, namely that the audits performed by Pricewaterhousecoopers LLP ("PwC") failed to disclose that the Index Fund's assets -- which included the assets of the Trustees -- were improperly diverted into unprotected, non-regulated accounts at Refco Capital Markets, Ltd. ("RCM"), exposing those assets to the risk -- and in October 2005 the reality -- of RCM's insolvency. The Index Recovery Plaintiffs now move this Court to abstain from asserting jurisdiction and to remand these actions to the New York State Court. In addition, the Trustees seek a remand to the New York State Court on the basis that PwC's removal of the Trustees' action more than a year after the action was filed was untimely, and that accordingly, they are entitled to costs, expenses, and fees pursuant to 28 U.S.C. § 1447(c). For the reasons set forth below, the motions will be denied.

BACKGROUND

The facts set forth below are those alleged in the complaints filed by the Trustees and Index Recovery in the New York State Court.*fn3 The allegations are assumed to be true for purposes of this motion. See Merritt v. Shuttle, Inc., 245 F.3d 182, 186 (2d Cir. 2001).

I. Events Leading up to the Bankruptcy of the Index Fund

The Trustees constitute the governing board of the Masonic Hall and Asylum Fund (the "Masonic Hall and Home"), a not-for-profit corporation formed by an act of the New York State Legislature and located in Oneida County. (Trustees' Compl. ¶ 1.) In May 2004, the Masonic Hall and Home entered into a Subscription Agreement for the purchase of limited partnership interests in the SPhinX Managed Futures Index Fund, LP ("Index Fund"), the post-bankruptcy shell of which is the Index Recovery Company, LP. (Id. ¶ 5). The Trustees initially invested $12,750,000 in the Index Fund and several months later, in September 2004, made an additional investment of $17,850,000. (Id.)

The Index Fund debuted in 2001 as one of several SPhinX Funds. The SPhinX Funds were a platform of funds organized as Cayman Islands Exempted Segregated Portfolio Companies ("SPCs") and designed to track the performance of the Standard & Poor's Hedge Fund Index.*fn4 (Index Recovery's Compl. ¶¶ 4, 6, 47.) The purpose of the SPCs was to preserve and protect assets invested in any one portfolio from cross-liability in the event of the insolvency of other segregated portfolios or of the custodian or prime broker. (Id. ¶ 8.) Retaining customer-segregated assets in SPCs was essential to the structure of the SPhinX funds. (Id. ¶ 15.)

The purpose of the Index Fund was to issue subscriptions to qualified investors and then allocate substantially all of its assets, via the SPhinX Managed Futures LP, to the SPhinX Managed Futures Fund SPC ("SMFF"). (Id. ¶¶ 7, 10.) The Index Fund, however, had no employees of its own. (Id. ¶ 11.) Rather, Refco Securities, LLC ("Refco LLC") offered the limited partnership interests in the Index Fund (id. ¶ 6), and those interests were subsequently managed by Refco Alternative Investments, LLC ("RAI"), the prime broker for many of the SPhinX Funds, including SMFF and the Index Fund (id. ¶ 11).

On RAI's watch, however, and despite the fact that according to the SPC structure assets of each segregated portfolio were to be held separately from every other segregated portfolio, assets from SMFF were swept on a regular basis from their proper customer-segregated accounts at Refco LLC into accounts of an unregulated offshore Refco affiliate, RCM, where the assets were co-mingled with assets belonging to RCM and to other RCM customers. (Id. ¶¶ 16-20.)

When, on October 10, 2005, Refco Inc., the parent company of RAI and an affiliate of Refco LLC, announced that it had "discovered" a $430 million receivable owed to it by an entity controlled by Refco's CEO Phillip R. Bennett, RCM held approximately $312 million of SMFF's cash, including approximately $40 million in assets from the Index Fund, $30.6 million of which belonged to the Trustees.*fn5 (Index Recovery's Compl. ¶¶ 11, 14, 23, 30; Trustees' Compl. ¶ 14.) RCM and dozens of other Refco subsidiaries and affiliates subsequently filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code in the Southern District of New York. (Trustees' Compl. ¶ 22). Ultimately, the Index Fund -- like the other SPhinX entities*fn6 -- also filed for bankruptcy. See In re Index Recovery Co., LP, No. 07-63680 (jointly administered with No. 07-63679) (Bankr. N.D.N.Y. Oct. 19, 2007) ("Index Recovery Chapter 11 Case").

II. PwC's Audit Services to the Index Fund

Pursuant to the Index Fund's Agreement of Limited Partnership, RAI was required to furnish each Limited Partner the audited financial statements of the Index Fund. (Index Recovery's Compl. ¶ 38.) The Index Fund retained PwC to perform the audit and to issue its financial statements for the fiscal years ending December 31, 2003, and December 31, 2004. (Id. ¶¶ 35-38.) During this time, PwC also served as outside auditor of the other SPhinX funds, including SMFF (id. ¶¶ 35-37; Trustees' Compl. ¶ 31), and was a financial consultant to the Refco entities (Index Recovery's Compl. ¶ 36.)

As auditor of the Index Fund, PwC was responsible for reviewing the Index Fund's accounting practices and providing an opinion as to whether those practices complied with generally accepted accounting principles ("GAAP"). (Trustees' Compl. ¶¶ 23-27.) For the fiscal years ending in 2003 and 2004, PwC issued unqualified opinions that the financial statements of the Index Fund and SMFF, for those years "present fairly, in all material respects, the financial position" of the entity in conformity with GAAP. (Index Recovery's Compl. ¶¶ 41, 46.) In those audits, however, although PwC identified related party transactions between Refco LLC, RCM, and RAI, the audits did not reveal that a substantial quantity of the Index Fund's assets was, in fact, via SMFF, being held in non-segregated accounts at RCM. (Id. ¶¶ 42, 44.) Yet, from its audits of the SPhinX entities, PwC knew or should have known in the exercise of reasonable diligence that the Index Fund's assets were being held at RCM, where the assets were exposed to the claims of RCM's creditors in the event of insolvency. (Id. at ¶¶ 35-45.) PwC's failure to disclose that SMFF had multiple deficiencies in its internal controls -- controls that should have informed Index Fund's Limited Partners that SMFF's financial statements, and by extension the Index Fund's statements, were not in accordance with generally accepted accounting principles (id. ¶¶ 66-68, 89,104; Trustees' Compl. ¶ 44) -- led to the loss of the Index Fund's, and the Trustees', assets.

III. Procedural History of the Instant Actions

The Trustees commenced their action against PwC by filing a Summons With Notice in the Supreme Court of the State of New York for Oneida County on May 21, 2007. The Trustees of the Masonic Hall and Asylum Fund v. PricewaterhouseCoopers LLP, No. 2007-1353 (N.Y. Supr. Oneida County) (See Chelney Decl. Ex. A.) On October 24, 2007, after a demand for the complaint by PwC, the Trustees served PwC with the Complaint in this action. (Chelney Decl. Ex. D, Removal Notice (Trustees) ¶ 2.)*fn7 Just a few days earlier, on October 19, 2007, the Index Fund had filed for Chapter 11 relief in the United States Bankruptcy Court for the Northern District of New York. (See Chelney Decl. Ex. D, Removal Notice (Index Recovery) ¶ 7.) Index Recovery commenced its action against PwC on May 23, 2008. Index Recovery Co., L.P. f/k/a SPhinX Managed Futures Index Fund, L.P. v. PricewaterhouseCoopers LLP, No. 2008-1565 (N.Y. Supr. Oneida County) (See Chelney Decl. Ex. C.) On June 30, 2008, PwC removed both actions to the United States District Court for the Northern District of New York on the premise that the Index Recovery Chapter 11 proceeding established federal jurisdiction pursuant to 28 U.S.C. § 1334. The Index Recovery Plaintiffs moved to remand to state court, ...


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