The opinion of the court was delivered by: Richard J. Holwell, District Judge
MEMORANDUM OPINION AND ORDER
The parties are individuals and entities who, like most of the country, were unaware until December 2008 that Bernie Madoff was operating a Ponzi scheme.*fn1, *fn2
Unlike most of the country however, the parties had the misfortune of being directly involved.
The plaintiff is G. Philip Stephenson, the trustee and namesake of the Philip Stephenson Revocable Living Trust, which invested $60 million as a limited partner in a fund called Greenwich Sentry. Greenwich Sentry in turn invested most of its assets with Bernie Madoff Investment Securities (BMIS), the fake fund through which Madoff perpetrated his multi-billion dollar fraud. Greenwich Sentry is not a party to this action, but as one of a number of so-called "feeder funds" provided a vehicle for plaintiff (among others) to invest with BMIS. Greenwich Sentry had as its administrator defendant Citco (Canada) Inc., and as its sub-administrator defendant Citco Fund Services (Europe) Inc.*fn3 Finally, defendant PricewaterhouseCoopers Canada ("PWC") was Greenwich Sentry's independent auditor.*fn4
Plaintiff has never received back a penny of the $60 million that his trust invested in BMIS through Greenwich Sentry. As a result of that loss he has brought this direct action against Greenwich Sentry's administrators and its independent auditor.*fn5 The Complaint*fn6 features seven state law claims: (I) breach of fiduciary duty against Citco, (II) gross negligence against Citco, (III) negligence/professional malpractice against PWC, (IV) fraud against PWC, (V) breach of contract (third party beneficiary) against Citco, (VI) breach of contract (third party beneficiary) against PWC, and (VII) aiding and abetting breach of fiduciary duty, against Citco and PWC.
The defendants have filed three separate motions seeking to dismiss the complaint in its entirety. (, , and .) With respect to plaintiff's breach of fiduciary duty, gross negligence, negligence, and aiding and abetting breach of fiduciary duty claims, defendants assert preemption by the Martin Act, New York's blue sky law. With respect to plaintiff's fraud claim, PWC contends that the Complaint does not plead fraud with particularity as required by Federal Rule of Civil Procedure 9(b). With respect to all claims, defendants assert that (1) they are derivative and cannot be brought directly by Stephenson, and (2) they are not adequately plead and should be dismissed pursuant to Federal Rule of Civil Procedure 12(b)(6).
For the reasons that follow the Court finds that plaintiff's first, second, third, and seventh causes of action are preempted by the Martin Act, and that his first, second, third, fifth, sixth, and seventh causes of action are derivative and cannot be brought directly. The Court also finds that plaintiff's fourth claim, alleging fraud against PWC, has not been plead with an adequate allegation of scienter. Accordingly the Court dismisses plaintiff's complaint in its entirety.
The factual allegations in the Complaint are as follows:
1. The Parties and Other Relevant Entities
Several non-parties (other than, of course, BMIS) had important roles in the facts underlying the complaint. Most central among them is Greenwich Sentry, the Madoff feeder fund that connects plaintiff to the defendants. Greenwich Sentry operates principally out of New York, where its offices are located. (Cl. ¶ 6.) Greenwich Sentry was set up by Fairfield Greenwich Group, a Delaware limited liability company that operates principally out of New York, and which also set up a number of Madoff feeder funds similar to Greenwich Sentry. (Cl. ¶¶ 6-7.) Fairfield Greenwich's "core product business model is the investment management and oversight of the split strike conversion strategy, implemented through [the feeder funds]," and Fairfield Greenwich made substantial representations as to the extent and quality of its due diligence in that capacity. (Cl. ¶¶ 31-38.)
Greenwich Sentry operated as a "feeder fund," placing substantially all of its Limited Partners' investments into a brokerage account in the custody of Madoff, who acted as trader, broker, and custodian of all funds and securities in the account. (Cl. ¶ 26.) Madoff reported account data and trading results back to Greenwich Sentry, which were in turn handed over to Greenwich Sentry's administrator and auditor to process reports. (Cl. ¶ 26.)
The limited partners bought shares of Greenwich Sentry, which in turn invested in BMIS. They could withdraw funds monthly by placing requests directly with Greenwich Sentry, which would either pay them out of a separate account that it maintained for the purpose of monthly adjustments, (Cl. ¶ 27), or forward the requests to BMIS which would send back the funds for distribution. In December 2008 when the Ponzi scheme was disclosed, Greenwich Sentry ceased honoring withdrawal requests. (Cl. ¶ 29.)
The Citco defendants acted in various capacities as Greenwich Sentry's hedge fund administrators. According to the complaint, Citco Group Limited (CGL) is an integrated financial services holding company that includes among its subsidiaries Citco (Canada), Inc. and Citco Fund Services (Europe) BV. (Cl. ¶ 8.) Operating solely through its subsidiaries, CGL represents itself and its subsidiaries as the world's top providers of hedge fund administration services. (Cl. ¶ 11.) CGL explains these services on its web site:
Our Hedge Fund Service offering includes fund accounting and net asset value calculations, investor relations services, anti-money laundering compliance, corporate & legal services, . tax reporting and financial statement preparation. Citco's online reporting tools, . offer both investment managers and investors an extensive suite of online reports to provide them with the tools they need to operate efficiently and effectively. Citco also offers a complete front-to-back offering for single manager funds, combining portfolio capture and real-time position monitoring technology . with middle and back office operations support. (Cl. ¶ 12.) Citco (Europe) Inc. is a Netherlands limited liability company and wholly owned subsidiary of CGL that operates principally out of Amsterdam. (Cl. ¶ 9.) It has been Greenwich Sentry's fund administrator since September 1, 2006. (Cl. ¶ 9.) Citco (Europe) was primarily responsible for: communicating with limited partners, maintaining a record of accounts, processing subscriptions and withdrawals, preparing and maintaining financial and accounting records and statements, calculating account balances, arranging for the provision of accounting, clerical, and administrative services, and maintaining corporate records. (Cl. ¶ 49.) Citco (Canada) Inc. is a Canadian corporation and wholly owned subsidiary of CGL that operates principally out of Ontario, Canada. (Cl. ¶ 9.) Citco (Canada) was delegated by Citco (Europe) to function as sub-administrator of Greenwich Sentry. (Cl. ¶ 10.) It has done so since September 2006. (Id.)
The Citco entities issued reports as to Greenwich Sentry's portfolio and limited partners' NAV valuations, which they represented they would verify and investigate through due diligence applying their substantial expertise in that area. (Cl. ¶ 45.) They held themselves out as a fiduciary to the investors of the funds they administered. (Cl. ¶ 46.) According to their website:
By providing fully independent services, we act as a reliable fiduciary to safeguard the interests of investors. We train our staff to provide specialist accounting and valuation support, investor relations, corporate services, and day to day management. (Cl. ¶ 46.)
PricewaterhouseCoopers, LLP (PWC) is an Ontario limited liability partnership, (Cl. ¶ 14), and a member firm of PricewaterhouseCoopers International, which operates a network of inter-connected member firms providing auditing, accounting and other investment and advisory services across an international platform, maintaining centralized control over information, training, standards of care, marketing, and quality of work. (Cl. ¶ 15.) The network of PricewaterhouseCoopers entities hold themselves out and operate as a unified business entity comprising a leading accounting and auditing firm with specialized expertise in hedge funds and investment vehicles. (Cl. ¶ 15; Cl. ¶ 60.) Defendant PWC was the auditor of Greenwich Sentry from 2006 through 2008. (Cl. ¶ 16.) It conducted an annual audit of Greenwich Sentry, (Cl. ¶ 63), for the purposes of which it was given complete access to Greenwich Sentry's records. (Cl. ¶ 65.) It annually issued an unqualified audit report, with the salutation "To the Partners of Greenwich Sentry, L.P." attesting to the accuracy of Greenwich Sentry's financial statements. (Cl. ¶ 63.) In preparing this report PWC undertook to "prepare an annual audited financial report setting forth a balance sheet of Greenwich Sentry, a profit and loss statement showing the results of operations of Greenwich Sentry and its net capital appreciation or net capital depreciations, a statement of such Partner's closing capital account and the manner of its calculation and the Partner's opening capital account and partnership percentage for the then current fiscal year." (Cl. ¶ 98.)
Plaintiff decided to invest with Greenwich Sentry (and in turn BMIS) in early 2008. On February 20, 2008, Stephenson received documents about one of Greenwich Sentry's sister funds, Fairfield Sentry, and was told that the documents for Greenwich Sentry were similar but not then available. The documents he received included a Fairfield Sentry Private Placement Memorandum, a powerpoint presentation, two "tearsheets" of initial performance data for Fairfield Sentry, and a due diligence questionnaire that described the roles of Citco and PWC in Fairfield's funds. (Cl. ¶ 106.) On February 27, 2008, plaintiff received a "return attribution analysis" showing net profits for Fairfield Sentry of 9.38% in 2006 and 7.34% in 2007, with the understanding that the figures would be applicable to Greenwich Sentry because they represented the returns generated by BMIS. (Cl. ¶ 107.)
In March 2008 plaintiff received an estimated monthly fund report for Greenwich Sentry showing a gain in February 2008, a Greenwich Sentry Limited Partnership Agreement, its PPM, and a Subscription Agreement. (Cl. ¶ 108.) The Greenwich Sentry PPM, dated August 2006, described how the Limited Partners' funds would be invested: it described the split strike conversion strategy, and explained that the strategy was "implemented by Benard L. Madoff Investment Securities LLC.through accounts maintained by the Partnership at that firm..The services of BLM and its personnel are essential to the continued operation of the Partnership, and its profitability, if any." (Cl. ¶ 28.) Plaintiff decided to invest in the funds, knowing and relying on the strength of Citco's approval as administrator and PWC's approval as auditor because he had learned as an experienced investor that the administration and auditing of hedge funds was vital to their security. (Cl. ¶¶ 109-115.)
Plaintiff individually executed his first subscription and deposited $60 million in Greenwich Sentry's New York bank accounts on or about April 1, 2008. (See Subscription Documents, Citco Fund Services Ex. A.) He subsequently executed a new subscription on June 1, 2008 transferring the partnership assets into his trust. (Cl. ¶¶ 115-117.) Although he never withdrew funds from the account, he received monthly updates on his investment detailing his "gains." By October 31, 2008, plaintiff had received seven monthly NAV sheets from Citco demonstrating that his $60 million had risen in value to $62,540,565. (Cl. ¶ 120.) According to the NAVs, by the end of November 2008 he had totaled gains of 6.59% in just seven months, while the Dow Jones Industrial Average had lost 33.44% and the S&P 500 had lost 37.65%. (Cl. ¶ 121.) However by December 11, 2008, those numbers had been called into doubt: upon learning of the Madoff scheme, Stephenson requested withdrawal of the entirety of his account, but his requests were ignored. (Cl. ¶ 129.) His investment had been wiped out.*fn7 (Cl. ¶ 130.)
2. Suspicious Facts Surrounding BMIS
The Complaint describes a number of red flags surrounding BMIS "during the time that Citco and PWC provided services to Greenwich Sentry" that it alleges should have "placed them on notice of the Ponzi Scheme." (Cl. ¶ 134.)
First, plaintiff alleges that operational risk was high because BMIS had complete control over all aspects of the trades: it held the securities, executed the trading strategy, and reported results. "As a result there was no segregation of duties among independent reporters and thus a lack of internal control which resulted in a lack of investment transparency such that risk management was materially compromised." (Cl. ¶¶ 135-136.)
Second, the complaint alleges that BMIS' transactions were at variance with market evidence. In several cases, the positions that BMIS claimed to have placed using the split-strike conversion methodology were actually in excess of the actual open interest in the S&P 100 Put & Call market in those securities. (Cl. ¶ 138.) Furthermore, the complaint alleges that BMIS' over-the-counter option agreements would have been more expensive than similar trades made over the S&P 100 Put & Call market, and that this would have "materially reduced profits" because of the higher transaction costs. The decision to engage in more expensive over-the-counter trades, then, was supicious. (Cl. ¶¶ 137-141.)
Third, the Complaint generally alleges that a red flag was created by the fact that BMIS used manual trades despite Madoff's reputation "as an early and enthusiastic proponent of electronic trading," that Madoff refused to permit any "due diligence reviews" or "performance audits" of those manual trades, and that such a review would have revealed the Ponzi scheme. (Cl. ¶¶ 142-146.)
Fourth, because BMIS' account statements were fake, the cash in Greenwich Sentry's accounts did not actually exist. Accordingly, the Complaint alleges that cash and position reconciliations between Greenwich Sentry's books and the results reported by BMIS would have necessarily revealed material discrepancies. (Cl. ¶¶ 147-149.)
Fifth, the Complaint alleges that the PPM permits BMIS to engage in securities lending of the securities in its portfolio. Because BMIS did not actually own securities, however, it did not engage in securities lending. A review of securities lending practices would have raised a red flag because it would have been irrational for BMIS to forego the investment income that securities lending would have provided. (Cl. ¶¶ 150-151.) Similarly, because BMIS did not take out commercial bank loans in order to re-invest in itself (despite higher rates of return than prevailing interest rates), the Complaint alleges that its operations were irrational and suspicious. (Cl. ¶ 161-163.)
Sixth, the reported results of BMIS were much higher and more stable than other firms using the same ...