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Newman v. Family Management Corp.

October 20, 2010

DAVID B. NEWMAN, ET AL. PLAINTIFFS,
v.
FAMILY MANAGEMENT CORPORATION, ET AL. DEFENDANTS.



The opinion of the court was delivered by: Sand, J.

OPINION & ORDER

Plaintiffs in this case are investors in the FM Low Volatility Fund ("FM Fund"), a "sub-feeder" fund, the assets of which were invested in "Feeder Funds" that in turn invested in Bernard L. Madoff Securities LLC ("BMIS"). Plaintiffs bring claims against Defendants associated with the FM Fund and against the Feeder Funds in which the FM Fund invested.*fn1 All Defendants have moved to dismiss the Second Amended Complaint ("SAC"). For the following reasons, the motions are granted.

I. Background

a. Madoff's Fraud

The basic facts surrounding Madoff's historic Ponzi scheme are now well known. Madoff was a prominent and respected member of the investing community, whose investment company, BMIS, had operated since approximately 1960. Madoff claimed he utilized a "split-strike conversion strategy" to produce consistently high rates of return on investment. This strategy supposedly involved buying a basket of stocks listed on the Standard & Poor's 100 Index and hedging through the use of options.

Since at least the early 1990s, Madoff did not actually engage in any trading activity. Instead, he generated false paper account statements and trading records. If a client asked to withdraw her money, Madoff would pay her with funds invested by other clients. Madoff deceived countless investors and professionals, as well as his primary regulators, the Securities and Exchange Commission ("SEC") and the Financial Industry Regulatory Authority ("FINRA").

On December 11, 2008, Madoff was arrested by federal authorities for operating a multi-billion dollar Ponzi scheme. On March 12, 2009, Madoff pleaded guilty to securities fraud and related offenses arising out of his Ponzi scheme. On March 18, 2009, the United States Attorney's Office indicted BMIS's accountant, David Friehling of Friehling & Horowitz, CPAs, P.C., on charges of securities fraud, filing false audit reports, and related offenses. On August 11, 2009, BMIS's Chief Financial Officer, Frank DiPascali, pleaded guilty to conspiracy to commit securities fraud and related offenses. On November 13, 2009, the United States Attorney's Office charged two computer programmers with aiding Madoff's scheme by developing software to generate false trading data. On May 11, 2010, the Attorney General of the State of New York filed a civil complaint against Defendant Ivy in the Supreme Court of the State of New York, alleging that Ivy and individuals related to it committed fraud and related offenses.

b. The FMC Defendants and Plaintiffs' Investment in the FM Fund

Defendant Family Management Corporation ("FMC") is a registered investment adviser that provides wealth management and investment advisory services to its clients. As of May 31, 2008, FMC had approximately $1.3 billion in assets under management. Defendant Seymour Zises is FMC's President and Chief Executive Officer, and Defendant Andrea Tessler is FMC's Managing Director and Chief Operating Officer (collectively with FMC and Zises, the "FMC Defendants").

Nominal Defendant the FM Fund is a Delaware limited partnership. Defendant FMC serves as general partner of the FM Fund. During the relevant time period, Defendants Zises and Tessler were co-heads of the FM Fund's Investment Committee and were charged with monitoring the performance of the FM Fund's investments on an ongoing basis and for reviewing relevant market conditions and economic trends. They made all investment, trading, and allocation decisions for the Fund, including the decision to invest in the Andover, Beacon, and Maxam Funds.

Participation in the FM Fund was offered through an Offering Memorandum dated April 2008 ("FM OM") and attached Form ADV dated May 2008 ("Form ADV"). Investment in the FM Fund was open only to sophisticated, accredited investors. Lebersfeld Decl. Ex. B ("FM OM"), at (i). Plaintiffs are limited partners in the FM Fund who invested $610,000 in limited partnership interests between April 8, 2008 and December 11, 2008. The limited partners paid an annual investment management fee of 1.4% of assets to the FM Fund and were liable for management fees and performance fees charged by the Feeder Fund Defendants.*fn2 The limited partners were "not . . . able to readily participate in the management of the Fund, and [had] limited voting rights including no right to remove the general partner." FM OM at 17. Redemption was only available on the 31st of December each year or on different terms at FMC's discretion.

The OM disclosed that the Fund would invest through other "Investment Vehicles," such as hedge funds and hedge "funds-of-funds" rather than trading on its own. FM OM at (i). According to the offering materials, including Form ADV, Defendant FMC would conduct "initial and ongoing due diligence on all Third Party Managers and their investment vehicles." Basar Decl. Ex. C ("Form ADV"), at Schedule F. FMC lists various sources of investment information, including annual reports, SEC filings, financial publications, research materials, and on-site due diligence. However, the FM OM stated that the Investment Vehicles would be controlled by outside Managers, and that "the General Partner must ultimately rely on each Manager to operate in accordance with the investment strategy . . . and the accuracy of the information provided to the Fund by such Manager." Thus, the Fund might sustain losses if "a Manager does not operate in accordance with its investments strategy . . . or if the information furnished by a Manager is not accurate." FM OM at 9.

The FM OM stated the FM Fund would invest in no fewer than three Investment Vehicles, with no more than 35% invested in any one Investment Vehicle. FM OM at 4. It warned investors that this division is no way guaranteed diversification, as the Managers "at times may take positions on behalf of the Fund which are the same, or opposite from, the positions taken by other Managers." FM OM at 9. The FM OM also advised that "a significant portion of the overall portfolio of the Investment Vehicles invested in by the Fund" would likely be invested in a strategy focused on "the purchase of [large capitalization] equity securities and the concurrent use of equity or index options in order to hedge the equity portfolio," the split-strike conversion strategy purportedly used by Madoff. FM OM at 4--5.

Under the Limited Partnership Agreement ("FM LPA"), Plaintiff investors agreed to exculpate Defendant FMC and its officers and directors from any liability to the Fund or its limited partners for any act or omission except those that "constitute[] bad faith, gross negligence, fraud or willful misconduct." Lebersfeld Decl. Ex. D ("FM LPA") § 5.5.1.

The FMC Defendants invested the FM Fund's assets*fn3 in three funds: Andover, Beacon, and Maxam. These funds invested with Madoff to varying degrees, leading the FM Fund and the Plaintiffs as limited partners to lose a large portion of its investments. Shortly after Madoff's arrest, FMC informed the Fund's investors that it would dissolve the Fund.

c. The Maxam Defendants

Defendant Maxam Absolute Return Fund, L.P. ("Maxam Fund") was created in or about July 2006 and invested exclusively with Madoff. Maxam Capital GP, a Delaware limited liability corporation, was the general partner of the Maxam Fund. Defendant Maxam Capital Management Limited ("MCM") is an investment management and consulting firm, which served as the administrator of the Maxam Fund, and Defendant Maxam Capital Management LLC ("Maxam Capital") is the investment manager of the Maxam Fund.*fn4 Defendant Sandra Manzke is the founder, principal and Chief Executive Officer of Maxam GP and MCM.

The Maxam Fund was offered to investors through a Private Placement Memorandum. Tendler Decl. Ex. A ("Maxam PPM"). The Maxam PPM indicated that there was "only one Broker Dealer trading [the Maxam Fund's] assets on a discretionary basis," and that "it is likely that only the services of the present Broker Dealer will be used." Maxam PPM at 1. This Broker Dealer was BMIS. The Maxam PPM indicated that Maxam would perform due diligence, but that it was entitled to rely on information supplied by the Broker Dealer and was "not required to undertake any due diligence to confirm the accuracy" of such information. Maxam PPM at 17. The Maxam Defendants received management and administration fees calculated as a percentage of the investments of the limited partners in Maxam, including the FM Fund. Maxam PPM at 10. The Fund lost virtually all of its value when Madoff's Ponzi scheme collapsed.

d. The Andover Beacon Defendants

Defendants Andover Associates LLC ("Andover Fund") and Beacon Associates LLC I ("Beacon Fund") are hedge "funds of funds" that grouped smaller investors together to meet the minimum net worth requirements for investing directly with BMIS. The Funds were formed by Defendants Joel Danziger and Harris Markhoff in conjunction with Larry Simon, president and CEO of Ivy Asset Management, who had personal relationships with Madoff, Danziger, and Markhoff. Defendant Andover Associates Management Corp. ("AAMC"), a New York corporation, is the manager of the Andover Fund, and Defendant Beacon Associates Management Corp. ("BAMC") is the manager of the Beacon Fund. Defendant Danzinger served as President and Director of Andover Associates and BAMC. Defendant Markhoff served as Vice President, Secretary, Treasure, and Director of the same.

In February 1995, BAMC and Ivy Asset Management entered into a "consultant agreement" under which Ivy Asset Management was compensated for introducing BAMC to Madoff and was to receive 50% of the management fees collected by BAMC for investing the Beacon Fund's assets with Madoff. On January 1, 2006, BAMC and Ivy executed a new advisory contract, which was not disclosed to Plaintiffs. This contract explicitly excluded Madoff from the managers Ivy agreed to research, monitor, meet with, and evaluate. The contract stated that "[BAMC] has expressly requested that Ivy not monitor or evaluate or meet with any representatives of Madoff including Bernard L. Madoff." Liman Decl. Ex. B, C § 3(d).

Participation in the Andover and Beacon Funds was offered to investors through confidential Offering Memoranda ("OMs"). The Beacon OM was released in 2004, followed by the Andover OM in 2008 (together the "Andover Beacon OMs"). Plaintiffs allege the two OMs are "substantially the same in all relevant respects." SAC ¶ 143. The Andover Beacon OMs represented that BAMC and AAMC retained sole discretion to invest and reallocate the Funds' assets, and would do so after consultation with Ivy. The managing members were responsible for selecting investment managers, such as BMIS, and for "monitoring the Managers' performance and their adherence to their stated investment strategies and objectives." Rosenfeld Decl. Ex. C ("2004 OM"), at 10. The Andover Beacon OMs contained extensive cautionary language about the risks of investing with the Andover and Beacon Funds. The OMs explained that the investments would not be diversified, but notified investors that a "significant portion of the Company's assets are allocated to a strategy adopted by the Managing Member involving a portfolio of Large Cap Stocks hedged with options ('Large Cap Strategy')." 2004 OM at 1.

The Beacon and Andover Defendants received management fees at an annual rate of 1.5% of the value of each member's capital account and 1% of each year's net profits. The Andover and Beacon Funds had approximately 23% ...


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