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Beacon Associates Management Corp. v. Beacon Associates LLC I

July 27, 2010

BEACON ASSOCIATES MANAGEMENT CORP., PLAINTIFF,
v.
BEACON ASSOCIATES LLC I, DEFENDANT.



The opinion of the court was delivered by: Andrew J. Peck, United States Magistrate Judge

OPINION AND ORDER

Beacon Associates LLC I ("Beacon" or the "Fund"), is a private investment fund decimated by the Ponzi scheme perpetrated by Bernard L. Madoff. (Dkt. No. 1: Compl. ¶ 1.) Plaintiff Beacon Associates Management Corp. ("Management") is the Managing Member of Beacon and brings this action, pursuant to 28 U.S.C. § 2201, seeking a declaratory judgment that it distribute the Fund's remaining assets, and that in making such distribution, the current value of the capital accounts of each of Beacon's members should be calculated based on the positive balances reflected on Beacon's books as of December 11, 2008, as adjusted by the allocation to each member of their respective distributive share of Beacon's [Madoff] theft loss. (Compl. ¶¶ 1-4, 23, 43 & Wherefore Clause.)

Presently before the Court is the motion of David Fastenberg and 161 other intervening Fund members (the "Fastenberg Intervenors"), seeking a mandatory injunction compelling Management to distribute Beacon's remaining assets "proportionately in accordance with the capital accounts of the investors less a write-down for the Madoff theft losses on the date of the discovery of those losses." (Dkt. No. 24: Notice of Motion; Dkt. No. 25: Fastenberg Br. at 2; Dkt. No. 18: Fastenberg Intervenor Compl. ¶¶ 5, 31 & Wherefore ¶ 2.) The parties have consented to decision of this motion by a Magistrate Judge pursuant to 28 U.S.C. § 636(c). (Dkt. Nos. 21, 48 & 49.)*fn1

For the reasons set forth below, the Fastenberg Intervenors' motion is GRANTED, and Management is directed to distribute Beacon's assets (less certain hold-backs identified below) by August 31, 2010 to Beacon's members using the Valuation Method.

FACTS

The Beacon Fund

Beacon is a New York limited liability company, formed in 1995 and comprised of numerous entities and individuals who each own a membership interest in the Fund. (Dkt. No. 1: Compl. ¶ 6; Dkt. No. 25: Fastenberg Br. at 3.) At all times relevant to this case, Beacon's affairs, including the relationship between and among its members, were governed by the terms of the Amended and Restated Operating Agreement,*fn2 dated as of April 1, 2004 (Operating Agmt.), as modified by a Confidential Offering Memorandum dated August 9, 2004 (Dkt. No. 51: Jordan Intervenor Compl. Ex. 1: Offering Mem.) and a Supplemental Confidential Offering Memorandum dated November 28, 2005 (Compl. Ex. A: Supp. Offering Mem.) (collectively, "the Agreement"). Beacon's stated purpose was to invest member capital in "securities and financial instruments of every kind and description," including other investment funds. (Compl. ¶ 6; Operating Agmt. Art. III ¶ 1; Offering Mem. at 1-2, 25; Fastenberg Br. at 3.)

To become a member of Beacon required an initial "Capital Contribution" exceeding $500,000, "unless the Managing Member, in its discretion, determine[d] that a lower amount is acceptable." (Offering Mem. at 4, 30; Operating Agmt. Art. VIII ¶ 1.)*fn3 Once accepted, members were assigned a "Capital Account" that was "equal to [their] proportionate share of the Net Worth of the Company." (Offering Mem. at 34-35; Operating Agmt. Art. VIII ¶ 2.)*fn4 Capital accounts were:

increased by (1) the amount of any Money... contributed by the Member to the capital of the Company, and (2) the Member's share of Net Profits.... [and are] decreased by (1) the amount of any Money actually distributed by the Company to the Member, (2) the fair market value of any non-cash [p]roperty distributed to the Member..., and (3) the Member's share of Net Losses.... (Operating Agmt. Art. VIII ¶ 2.)

Member capital was pooled together and invested at the Managing Member's discretion. (Operating Agmt. Art. VII ¶ 6 & Art. III ¶ 1; Offering Mem. at 1, 5, 30.) Funds not immediately invested in securities or other financial instruments were "deposited in a bank or money market account maintained by the Managing Member... in the name of and for the benefit of" Beacon. (Operating Agmt. Art. VIII ¶ 6.3; see Offering Mem. at 13.) Beacon's profits and losses are allocated among its members in accordance with each member's "Sharing Ratio," or "the proportion that [an individual member's] Capital Account bears to all other Capital Accounts on the last day of each applicable accounting period." (Operating Agmt. Art. I ¶ 43 & Art. IX ¶ 1.1; Offering Mem. at 5, 34-35.) Profits allocated to a member's capital account "constitute[s] an additional Capital Contribution by it to the Company." (Operating Agmt. Art. 9 ¶ 5.1.) Sharing Ratios are adjusted when: a new Member is admitted, when the Company accepts an additional Capital Contribution from an Existing Member,*fn5 when any Member makes a withdrawal of any part of his or its Capital Account*fn6 or when the Company makes a distribution to less than all the [M]embers (other than in complete liquidation of their Membership Interests).

(Operating Agmt. Art. I ¶ 43; see also Offering Mem. at 35 ("Net Worth and Net Worth per Interest will be calculated as of the closing of business on the last business day of each month in each year, on each Withdrawal Date, and such other date(s) as the Managing Member determines.").) Beacon's Madoff Investments

Since its inception in 1995, Beacon invested approximately seventy percent of its assets with Bernard L. Madoff Investment Securities LLC ("BLMIS"). (Dkt. No. 1: Compl. ¶ 15; Dkt. No. 25: Fastenberg Br. at 3-4.) Between 1995 and December 2008, BLMIS issued monthly financial statements reporting substantial gains on Beacon's investments. (Dkt. No. 18: Fastenberg Intervenor Compl. ¶ 13.) Beacon allocated those gains to its members in proportion to each member's interest in Beacon and reflected those gains in its financial statements. (Fastenberg Intervenor Compl. ¶¶ 12-14.)

On December 11, 2008, it was discovered that Madoff had been operating a massive "Ponzi" scheme, and that virtually all of the money invested with BLMIS was stolen. (Compl. ¶ 19; Fastenberg Intervenor Compl. ¶ 2.) Following Madoff's arrest, an action was commenced in the United States Bankruptcy Court for the Southern District of New York seeking liquidation of BLMIS. (Compl. ¶ 20.) An investigation by the Bankruptcy Court revealed that BLMIS had not purchased or sold any securities since 1996, but rather, used investor funds in furtherance of the Ponzi scheme. (Compl. ¶ 20.)

Beacon made its last investment with BLMIS in July 2008. (Dkt. No. 55: Jordan Br. at 1-2; Dkt. No. 53: H. 16-19.)

Liquidation of the Beacon Fund

On December 18, 2008, Management advised Beacon's members that, as a result of Madoff-related losses, "Beacon was commencing with the process of liquidation." (Dkt. No. 1: Compl. ¶ 21.) Management consulted Beacon's accountants, Citrin Cooperman & Company, who advised of several "valuation methodologies" that could be used to determine how Beacon's remaining assets should be distributed to its members. (Compl. ¶¶ 23-24.)

The first such method, referred to as the "Valuation Method," treats the Madoff losses as though they occurred due to "market fluctuations," that is, the Madoff-related losses are reported as having occurred in December 2008 (the date of discovery) and, pursuant to Beacon's Operating Agreement, allocated to each member on a pro-rata basis. (Dkt. No. 26: Folkenflik Aff. Ex. D: Citrin Mem. at 1-2.) Thus, if a member's "capital balance represented 1% of the fund as of December 1, 2008..., that [member] would be allocated 1% of the losses attributable to Madoff." (Citrin Mem. at 1-2.) Similarly, members who were "fully redeemed from the fund prior to December 1, 2008 were not allocated any losses." (Citrin Mem. at 2.)

An alternative methodology, referred to as the "Restatement Method," treats the Madoff losses as having occurred in the same month that each of Beacon's investments in BLMIS were made:

For instance, if the Fund invested $100,000 into Madoff in May 2005, then [the] restatement method will consider that $100,000 lost in May 2005, and allocate the $100,000 loss to each partner's capital account in the ratio which the capital account of such partner bears to the total of the capital accounts of all partners.

(Citrin Mem. at 2.) Thus, all "profits" made from the Madoff investments would be eliminated and each member's capital account balance recalculated to reflect the historical losses. (Citrin Mem. at 2.) Using this methodology, each member's capital account balance would become "negative upon full redemption of their capital balances....[and] many [members]' balances [would] become negative with partial redemptions." (Citrin Mem. at 3.) As this methodology contemplates that certain members withdrew more than they were entitled to, any loss resulting from negative balances would need to be "clawed-back" from the divested members or, alternatively, allocated among Beacon's remaining members. (Citrin Mem. at 3.)*fn7

Based on Citrin's advice, Management concluded that the method most consistent with Beacon's past practices and the terms of the [Operating] Agreement would employ the positive balances in the members' respective Capital Accounts as actually reflected on the books of Beacon as of December 11, 2008, and would adjust these balances based on an allocation to each member of their respective distributive share of Beacon's theft loss.... (Compl. ¶ 23.) Management also solicited an opinion from the law firm of Roberts & Holland regarding the proper methodology for determining capital account balances. (Compl. ¶ 25.) Roberts & Holland's opinion letter dated May 27, 2009 advised that the most reasonable reading of the [Operating] Agreement is that distributions in liquidation of Beacon should be made in proportion to the positive balances in the members' respective Capital Accounts, as actually reflected on the books of Beacon at December 11, 2008, and as further adjusted for the allocation to them, in accordance with such balances on that date, of their respective distributive shares of Beacon's theft loss deduction computed in accordance with the principles of Revenue Ruling 2009-9 and Revenue Procedure 2009-20 (and other items of income, gain, loss, and deduction from and after that date). (Compl. Ex. B: Roberts & Holland Op. Ltr. at 5.) Roberts & Holland further advised, however, that "notwithstanding [their] conclusion,... there is a risk that a court might conclude that distributions made in the manner set forth above did not comport with the members' respective rights" and that each member's account balance must be restated for each prior period to account for the Madoff loss as it occurred, not when it was discovered. (Roberts & Holland Op. Ltr. at 5-6.)

As a result of the Roberts & Holland opinion letter, Management directed Citrin to calculate each member's capital account balance using the Valuation and Restatement methodologies. (Compl. ¶ 28.) Not surprisingly, the different methodologies "provided dramatically different results." (Compl. ¶ 28.) By way of illustration, while the capital account of one member was calculated at $4,750,866 using the Valuation method, it had a balance of $2,735,636 under a Restatement method. (Compl. ¶ 29.) Conversely, another member's capital account was valued at $1,815,576 under the Valuation method, but exceeded $3,000,000 under a Restatement method. (Compl. ¶ 29.)*fn8

Beacon's counsel informed Management that it question[ed] Management's ability to make distributions which would result in preferential treatment of one class of investors verses another, and that, in the absence of a full consensus of Beacon investors (which Fund Counsel acknowledges is not feasible) or a Court Order, Management will be held accountable for any injury suffered by investors as a result of improper distribution. (Compl. ¶¶ 2, 36.)

Because Management's selection of "one valuation methodology over another" would invariably favor one class of members over another, any decision it made likely would create "extensive, resource-depleting and time-consuming litigation." (Compl. ¶¶ 33, 40.) Moreover, if Management's selection ultimately was deemed incorrect, "Fund members who received a distribution in excess of their allocable share would be required to return funds distributed to them.... result[ing] in additional, protracted litigation..." (Compl. ¶ 41.) Accordingly, Management decided that an "'independent determination as to the appropriate method of distribution'" was required. (Compl. ¶ 35.)

On September 25, 2009, Citrin issued audited financial statements for Beacon for the period January 1, 2008 through December 31, 2008. (Folkenflik Aff. Ex. B: Beacon Fin. Stmts.)*fn9

According to those statements, Beacon lost approximately $358,000,000 through investments with BLMIS, and had just $113,283,785 of remaining assets. (Beacon Fin. Stmts. at 2, 4.) With regard to the Madoff-related losses, the accountants noted that because Beacon is unable to determine when the loss actually incurred, the amount of the loss attributable to previous reporting periods cannot be quantified. Accordingly, the Company has recorded the entire loss of $358,710,309 in the period January 1, 2008 through December 17, 2008, and has not charged any portion of this loss to the Company's capital balances as of January 1, 2008. (Beacon Fin. Stmts. at 10 n.5.) Management prepared and issued Schedule K-1 forms*fn10 for each member, reporting partnership profits and losses for the year ended December 31, 2008. (Dkt. No. 18: Fastenberg Intervenor Compl. ¶ 18; Dkt. No. 25: Fastenberg Br. at 6.) In accordance with Beacon's audited financial statements, all member losses attributable to BLMIS investments were reported as having occurred in the 2008 tax year. (Fastenberg Compl. ¶ 18; Fastenberg Br. at 6.) The Present Action

On August 5, 2009, Management filed a complaint seeking a declaration that it may distribute "a significant portion of Beacon's remaining assets" and that in making such distribution, the current value of the capital accounts of each of Beacon's members should be calculated based on the positive balances reflected on Beacon's books as of the December 11, 2008, as adjusted by the allocation to each member of their respective distributive share of Beacon's theft loss. (Dkt. No. 1: Compl. ¶ 43 & Wherefore Clause.)*fn11

On January 6, 2010, Fastenberg intervened (Dkt. No. 18: Fastenberg Intervenor Compl.) and on March 4, 2010 filed the present motion seeking:

1. A declaratory judgment that... the proper method for computation of each investor's capital accounts and 'sharing ratio' in the profits and losses of Beacon I for each ...


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