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Leland Eaves and Cando Consultant Services, Inc., Individually and For v. Designs For Finance

March 30, 2011


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


Before the Court are Defendants' Motions to Dismiss Plaintiffs' Second Amended Complaint. (Docs. 53, 56, 59.)



For the purposes of the instant motions, the Court assumes the facts, although not the legal conclusions, in the Second Amended Complaint to be true. Plaintiff Leland Eaves is a Colorado resident and the owner of Plaintiff Cando Consultant Services, Inc. ("Cando"), a Florida-based construction services company. (SAC ¶¶ 8--9.)*fn1 Plaintiffs allege that in the late 1990s and early 2000s, Defendants Designs for Finance, Inc. ("Designs"), Moritt, Hock, Hamroff & Horowitz LLP ("Moritt"), and Prusky Law Associates, P.C. ("Prusky") devised a scheme to market and sell illegal tax shelters, including, and most notably for the purposes of this case, the BETA Multiple Employer Death Benefit Plan (the "BETA Plan"). (Id. ¶¶ 1, 31.) Despite knowing it to be an illegal tax shelter, Defendants represented the BETA Plan as a legitimate multiple-employer welfare benefit plan under Section 419A(f)(6) of the Internal Review Code ("IRC"). (Id. ¶ 2.) Such plans are funded through the purchase of life insurance and annuities, and their purpose is to fund the insurance needs of the small businesses that buy into them. (Id. ¶ 32.) As such, the Internal Revenue Service ("IRS") permits participating businesses to take tax deductions for contributions to the plan-but only to the extent that such contributions are for legitimate insurance needs, not as a form of deferred compensation. (Id.)

Designs acted as the BETA Plan Sponsor and, in that capacity, created and "primarily advocated" for the plan. (Id. ¶¶ 2, 36a.) Knowing that the IRS considered plans structured similarly to the BETA Plan to be illegal tax shelters, Designs opted not to obtain a private letter ruling from the IRS regarding the plan; instead, it sought legal analysis from Defendant Moritt, a New York--based law firm. (Id. ¶¶ 6, 12.) Despite knowing that, as Plaintiffs allege, "IRS laws were not strong and that it was skating on thin ice by approving the BETA Plan," Moritt endorsed the plan in a 54-page opinion letter to Designs dated September 24, 2000-a letter, Plaintiffs allege, that contained "questionable analysis of IRS code and case law." (Id. ¶¶ 6, 36b.)

In July 2001, Plaintiffs' accountant Jack Winebrenner suggested to Eaves that he look into the BETA Plan for use with his small business, Cando. (Id. ¶ 37.) Winebrenner had received information regarding the plan from John Rau, an agent of CNA, one of the plan's marketers and funders, who himself had received information from Designs. (Id. ¶ 38.) Winebrenner prepared a packet of information for Plaintiffs (the "BETA Plan Sales Packet"), which included a letter from Rau, an overview of the plan, questions and answers regarding the plan, cost information, and Moritt's September 24, 2000 opinion letter to Designs. (Id. ¶¶ 38--39, Ex. B.) After reading through the BETA Plan Sales Packet, which Plaintiffs allege was "endorsed" by both Designs and Moritt, Plaintiffs decided to enroll in the BETA Plan in October 2001. (Id. ¶ 40.)

Starting in 2001, and continuing through 2007, Plaintiffs made annual contributions of $40,000 to the BETA Plan and, "as advised by Rau and Defendants Moritt . . . and Designs," claimed the same amount as annual tax deductions. (Id. ¶¶ 40--41.) In 2003, the IRS issued stricter regulations on multiple-employer benefit plans under Section 419A(f)(6) of the IRC. (Id. ¶ 34.) In response to those regulations, Designs signed a BETA Plan Severance Agreement, effective January 1, 2003, that effectively transformed the BETA Plan from one multiple-employer plan ("MEP") into several single-employer plans ("SEP"). (Id. ¶¶ 34, 43.) This change in plan structure resulted in a split-dollar life insurance arrangement for plan participants, pursuant to which plan benefits would be separated between employers and shareholder-employees. (Id. ¶ 34.)

In February 2004, Rau sent a letter to Winebrenner (who presumably forwarded the letter to Plaintiffs, as they have attached the letter to their Second Amended Complaint) stating that the IRS regulations had made the BETA Plan strategy "stronger than ever." (Id. ¶ 42, Ex. C.) Plaintiffs allege, instead, that the changes made the plan strategy riskier, and that Designs should have been aware of the risks associated with the regulations and alerted Plaintiffs to such risks. (Id. ¶ 42.) In December 2004, the BETA Plan Administrator sent plan participants a letter notifying them of the plan's re-characterization as a SEP, as described above. (Id. ¶ 45.) The letter informed Plaintiffs that the changes did not affect them and were made for compliance purposes only. (Id.) Plaintiffs allege, however, that such changes "solidified the [BETA] Plan as a deferred compensation plan rather than the legitimate welfare benefit plan it was marketed to be," (id. ¶ 35); that, under the new plan structure, plan participants' contributions were subject to funding limitations that rendered Plaintiffs' contributions no longer tax-deductible, (id. ¶¶ 34, 43); and that, had they been properly informed of how to comply with the IRS regulations, they would not have claimed plan contributions as deductions, and would have paid the necessary taxes on such contributions, (id. ¶ 46).

In December 2007, Designs sent a letter to plan participants alerting them to other, new IRS rulings and "attempt[ing] to reassure" them that the plan was still valid. (Id. ¶¶ 47, 49, Ex. E.) Designs included with that letter a December 7, 2007 memorandum from Defendant Prusky, a Philadelphia-based law firm, to Designs that "further advocated for the legality of the BETA Plan in spite of the IRS revisions." (Id. ¶ 48, Ex. E.) The Prusky memo also recommended that plan participants file a Form 8886 with the IRS disclosing contributions to the BETA Plan and associated tax deductions, and warned participants that even if the IRS found the deductions to be appropriate, it could nonetheless opt to impose penalties for a failure to file a Form 8886. (Id. ¶ 50, Ex. E.)*fn2 Eaves filed his Form 8886 shortly thereafter. (Id. ¶ 53, Ex. G.) Eaves did not trust Prusky's evaluation of the BETA Plan and therefore opted not to claim as a tax deduction his $40,000 contribution to the BETA Plan for the 2007 tax year. (Id. ¶ 57.)

Eaves received a letter from the IRS dated March 26, 2008, notifying him that he would be audited due to his participation in the BETA Plan for the years 2005, 2006, and 2007. (Id. ¶ 54, Ex. A.) He received another letter from the IRS on February 26, 2010, analyzing his involvement in the BETA Plan as an employee-shareholder and stating that he owed approximately $250,000. (Id. ¶ 54, Ex. D.)*fn3 Cando also received a letter from the IRS on February 26, 2010, detailing the taxes, interest, and penalties owed to the IRS for its involvement in the BETA Plan for tax years 2004 through 2008. (Id. ¶ 56, Ex. H.) Because Eaves did not claim a tax deduction for his 2007 contribution to the plan, Cando suffered no fines for that year. (Id. ¶ 57.) Nonetheless, the letter specified that Cando owed $4,422.47 in penalties, and a total of $33,620.80 to the IRS. (Id. ¶ 57, Ex. H.) Eaves's IRS letters stated that contributions to the BETA Plan were not deductible, as the plan "was not created or designed as, nor does it operate as, an employee welfare benefit fund." (Id. ¶ 58, Exs. A, D.) The letters further stated that the BETA Plan was a deferred compensation plan-that is, it was "simply a means of distributing corporate earning[s] and profits to the shareholder-employee(s) [Eaves] in the guise of providing employee benefits," and plan contributions were "made for the personal benefit of the Shareholder-Employee to fund an investment in a cash value life insurance policy as an alternative means of distributing earning and profits." (Id. ¶ 58 (second alteration in original) (internal quotation marks omitted).) Plaintiffs' contributions to the BETA Plan totaled over $300,000 (including fees to Designs and others), and they allege ongoing audits that will cost them that same amount. (Id. ¶ 64.)

For allegedly knowingly misrepresenting and/or endorsing the BETA Plan as a legal welfare benefit plan, when it was instead a disguised deferred compensation plan under which tax deductions were not permitted, Plaintiffs assert the following causes of action: (1) fraudulent inducement, as against Designs; (2) breach of contract, as against Designs, (3) breach of the implied duty of good faith and fair dealing, as against Designs; (4) fraud, as against Moritt and Prusky; (5) breach of fiduciary and co-fiduciary duties under the Employee Retirement Income Security Act ("ERISA"), as against all Defendants; (6) violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), as against all Defendants; (7) violation of New York General Business Law Section 349, as against all Defendants; (8) conversion, as against all Defendants; (9) negligent misrepresentation, as against all Defendants; and (10) civil conspiracy, as against all Defendants. (Id. ¶¶ 81--161.)

As to the fraud claims, Plaintiffs point to the following instances of fraud: Designs' "marketing strategy and the letters it continued to send to Plaintiffs and Class Members"; Moritt's September 24, 2000 opinion letter to Designs, as well as "letters written by Steven Horowitz in December 2002, and August 12, 2003," in which it "misrepresented the legality of the Plan"; and Prusky's December 7, 2007 memorandum to Designs and "a legal opinion on July 13, 2005 further affirming the legitimacy of the BETA Plan." (Id. ¶ 70.)

B.Procedural History

Plaintiff Eaves filed the original Complaint in this case on April 21, 2009, (Doc. 1), against Designs, as well as Pointe Benefit Consultants LLC, North Fork Bank, Capital One Bank, CNA, Sun Life Financial, and Valley Forge Insurance Co.-entities Eaves alleged to have been the administrator, trustee, and various marketers and/or funders of the BETA Plan, respectively, (id. ¶ 34).*fn4 Eaves voluntarily dismissed the remaining defendants in July and August 2009, (Docs. 14, 21, 22, 23, 24), pursuant to confidential settlement agreements, (see SAC ¶ 38 n.1; Doc. 49). Eaves filed an Amended Complaint on October 7, 2009, naming Designs, Moritt, Prusky, and Rau as defendants. (Doc. 28.) The parties appeared before this Court on December 18, 2009 for a pre-motion conference to discuss Defendants' requests to file motions to dismiss. On December 23, 2009, the parties were referred to mediation, (Doc. 39), which proved unsuccessful, (see Doc. 49). Pursuant to a stipulation and order dated April 12, 2010, (Doc. 50), Eaves filed a Second Amended Complaint on May 20, 2010, in which he joined Cando as a plaintiff and dropped Rau as a defendant, (Doc. 51). Pursuant to a stipulation and order dated May 19, 2010, (Doc. 52), Defendants moved to dismiss the Second Amended Complaint on June 9, 2010, (Docs. 53, 56, 59).


A.Motion to Dismiss Standard

"To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009)(quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Id. "While a complaint attacked by a Rule 12(b)(6) motion to dismiss does not need detailed factual allegations, a plaintiff's obligation to provide the grounds of his entitlement]to relief requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Twombly, 550 U.S. at 555 (alteration, citations, and internal quotation marks omitted). While Federal Rule of Civil Procedure 8 "marks a notable and generous departure from the hyper-technical, code-pleading regime of a prior era, . . . it does not unlock the doors of discovery for a plaintiff armed with nothing more than conclusions." Iqbal, 129 S. Ct. at 1950.

In considering whether a complaint states a claim upon which relief can be granted, the court may "begin by identifying pleadings that, because they are no more than conclusions, are not entitled to the assumption of truth," and then determine whether the remaining well-pleaded factual allegations, accepted as true, "plausibly give rise to an entitlement to relief." Id. Deciding whether a complaint states a plausible claim for relief is "a context-specific task that requires the reviewing court to draw on its judicial experience and common sense." Id. "[W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged-but has not 'show[n]'-'that the pleader is entitled to relief.'" Id. (quoting Fed. R. Civ. P. 8(a)(2)).

B.Documents the Court May Consider on a Motion to Dismiss

When deciding a motion to dismiss, the Court is entitled to consider the following:

(1) facts alleged in the complaint and documents attached to it or incorporated in it by reference, (2) documents "integral" to the complaint and relied upon in it, even if not attached or incorporated by reference, (3) documents or information contained in [a] defendant's motion papers if plaintiff has knowledge or possession of the material and relied on it in framing the complaint, (4) public disclosure documents required by law to be, and that have been, filed with the Securities and Exchange Commission, and (5) facts of which judicial notice may properly be taken under Rule 201 of the Federal Rules of Evidence.

Weiss v. Inc. Vill. of Sag Harbor, No. 10-2603, 2011 WL 222480, at *4 (E.D.N.Y. Jan. 24, 2011) (citation omitted); accord Chambers v. Time Warner, Inc., 282 F.3d 147, 152--53 (2d Cir. 2002). A document is considered "integral" to the complaint where the plaintiff has "reli[ed] on the terms and effect of [the] document in drafting the complaint." Chambers, 282 F.3d at 153 (emphasis omitted). Such reliance "is a necessary prerequisite to the court's consideration of the document on a dismissal motion; mere notice or possession is not enough." Id.; see Faulkner v. Beer, 463 F.3d 130, 134 (2d Cir. 2006) (integral documents may include documents partially quoted in complaint or on which plaintiff relied in drafting complaint). If a document outside of the complaint is to form the basis for dismissal, however, two requirements must be met in addition to the requirement that the document be "integral" to the complaint: (1) "it must be clear on the record that no dispute exists regarding the authenticity or accuracy of the document"; and (2) "[i]t must also be clear that there exist no material disputed issues of fact regarding the relevance of the document." Faulkner, 463 F.3d at 134.

Both Designs and Plaintiffs have submitted with their briefing various documents outside the Second Amended Complaint. First, Designs has submitted both the original Complaint in this action, as well as the First Amended Complaint. (Richan Decl. Exs. C, F.)*fn5 The Court may take judicial notice of these documents as matters of public record. See, e.g., Reisner v. Stoller, 51 F. Supp. 2d 430, 440 (S.D.N.Y. 1999) ("The court may . . . take judicial notice of matters of public record, such as pleadings and court orders from prior litigation between the parties."). Designs also has submitted the BETA Multiple Employer Death Benefit Plan and Trust, the operative document establishing the plan and setting forth its details. (Richan Decl. Ex. E)*fn6 The Court may consider this document, as Plaintiffs reference the BETA Plan repeatedly throughout the Second Amended Complaint, and, at the very least, relied heavily upon it in drafting the Second Amended Complaint. See, e.g., Munno v. Town of Orangetown, 391 F. Supp. 2d 263, 269 (S.D.N.Y. 2005) (collective bargaining agreement upon which plaintiff relied is integral to complaint). Designs has also submitted an "Adoption Agreement for the BETA Individual Employer Welfare Benefit Plan," signed by Eaves on December 24, 2004. (Richan Decl. Ex. A.)*fn7 The agreement, pursuant to which Eaves adopted the BETA Plan for Cando after the plan had been converted to a SEP, specifies that it was effective January 1, 2003. (Id. Ex. A, at 2.) Though Plaintiffs do not specifically reference the Adoption Agreement in their Second Amended Complaint, they discuss the financial ramifications of their having adopted the SEP version of the BETA Plan, and it is clear that they relied heavily upon the "terms and effect" of the Adoption Agreement in filing their Second Amended Complaint. The Court may therefore consider it.

The Court may not consider, however, the document Designs submits entitled "BETA Individual Employer Welfare Benefit Plan Waiver and Representation Agreement." (Id. Ex. B.) Though Eaves signed the document and presumably either had notice or possession of it, this is not enough for the Court to consider it. While Designs would certainly prefer the Court to consider the document-it contains liability waivers and representations regarding risk and reliance that Designs argues bar some of Plaintiffs' claims-nothing in the document or Second Amended Complaint suggests that Plaintiffs relied on the terms or effect of the document in drafting their Second Amended Complaint. Such a document is more properly considered on summary judgment. See, e.g., In re Bausch & Lomb, Inc. Sec. Litig., No. 01-6190, 2003 WL 23101782, at *17 (W.D.N.Y. Mar. 28, 2003) (declining to consider transcript of conference call because "while plaintiffs may have possessed a recording of the conference call, they did not 'rely' upon it in preparing the Complaint").

Plaintiffs have also submitted documents outside the Second Amended Complaint in connection with their Opposition papers to Moritt's motion to dismiss and Prusky's motion to dismiss. In response to Moritt's motion, Plaintiffs have submitted a December 16, 2002 letter from Moritt to BETA Plan participants, (Balla Decl. ISO Moritt Opp'n Ex. A),*fn8 a December 17, 2002 letter from Moritt to Designs, (id. Ex. B), and an August 12, 2003 letter from Moritt to Designs, (id. Ex. C). Because, as noted above, Plaintiffs refer in their Second Amended Complaint to "letters written by Steven Horowitz in December 2002, and August 12, 2003," in which Moritt "misrepresented the legality of the Plan," (SAC ¶ 70), the letters are incorporated by reference in the Second Amended Complaint, and the Court may therefore consider them.

Finally, in connection with their Opposition papers to Prusky's motion, Plaintiffs have submitted a November 13, 2007 Prusky "sponsor memo," (Balla Decl. ISO Prusky Opp'n Ex. A),*fn9 although it is unclear from the face of the document to whom the memo was sent (e.g., Designs, or the BETA Plan participants). Plaintiffs never refer to this document in their Second Amended Complaint, and instead premise their allegations regarding Prusky's allegedly fraudulent conduct on a December 7, 2007 sponsor memo to Designs and a July 13, 2005 legal opinion. (See, e.g., SAC ¶¶ 36c, 47--51, 57, 66--67, 70, Ex. E). It cannot be said that Plaintiffs relied on the terms and effect of the November 13, 2007 sponsor memo in drafting the Second Amended Complaint, and therefore the document cannot be considered integral to it. The Court will therefore not consider it.

C.Plaintiffs' Claims

1.Fraudulent Inducement (Claim 1)

Plaintiffs assert a claim for fraudulent inducement against Designs. To state a claim for fraudulent inducement under New York law,*fn10 Plaintiffs must allege the following elements: "'(1) that the defendant made a representation, (2) as to a material fact, (3) which was false, (4) and known to be false by the defendant, (5) that the representation was made for the purpose of inducing the other party to rely upon it, (6) that the other party rightfully did so rely, (7) in ignorance of its falsity (8) to his injury.'" Computerized Radiological Servs. v. Syntex Corp., 786 F.2d 72, 76 (2d Cir. 1986) (quoting Brown v. Lockwood, 432 N.Y.S.2d 186, 193 (2d Dep't 1980)).

Fraudulent inducement claims are subject to the heightened pleading standards of Federal Rule of Civil Procedure 9(b), which provides that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." Fed. R. Civ. P. 9(b); see Ebusinessware, Inc. v. Tech. Servs. Grp. Wealth Mgmt. Solutions, LLC, No. 08-9101, 2009 WL 5179535, at *11 (S.D.N.Y. Dec. 29, 2009) (applying Rule 9(b) to fraudulent inducement claim). "[I]n order to comply with Rule 9(b), 'the complaint must: (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.'" Lerner v. Fleet Bank, N.A., 459 F.3d 273, 290 (2d Cir. 2006) (quoting Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)). While the fraud alleged must be stated with particularity, Rule 9(b) specifies that "[m]alice, intent, knowledge, and other conditions of a person's mind may be alleged generally." Fed. R. Civ. P. 9(b). Therefore, "the requisite intent of the alleged speaker of the fraud need not be alleged with great specificity." Chill v. Gen. Elec. Co., 101 F.3d 263, 267 (2d Cir.1996). This is because "'a plaintiff realistically cannot be expected to plead a defendant's actual state of mind.'" Id. (quoting Conn. Nat'l Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir. 1987)). Nonetheless, a plaintiff "'must allege facts that give rise to a strong inference of fraudulent intent.'" Lerner, 459 F.3d at 290 (quoting Acito v. IMCERA Grp., Inc., 47 F.3d 47, 52 (2d Cir. 1995)). "The requisite 'strong inference' of fraud may be established either (a) by alleging facts to show 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." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994). Finally, a plaintiff "may not lump separate defendants together in vague and collective fraud allegations but must inform each defendant of the nature of his alleged participation in the fraud." Alki Partners, L.P. v. Vatas Holding GmbH, No. 09-8125, 2011 WL 651056, at *9 (S.D.N.Y. Feb. 17, 2011).

In support of their fraudulent misrepresentation claim, Plaintiffs allege that "Designs knowingly made material misrepresentations to Plaintiffs and Class Members regarding the BETA Plan . . . . in order to induce Plaintiffs and Class Members into participating in the BETA Plan." (SAC ¶¶ 82--83.) The Second Amended Complaint, however, contains scant allegations of misrepresentations made by Designs prior to the time when Plaintiffs actually started participating in the plan in October 2001. Plaintiffs attempt to frame the BETA Plan Sales Packet as a representation by Designs, but that packet contains no documents authored by Designs or any agent thereof. As Designs points out, the sales packet explicitly advertises that it was prepared by Jack Winebrenner, (id. Ex. B, at 1), and it contains an introductory letter and other summary materials from John Rau, (id. Ex. B, at 3--23)-indeed, Rau states in his letter, "Enclosed, you will find a [welfare benefit trust] overview, questions and answers, plan legal opinion and all costs associated with implantation [sic]," (id. Ex. B, at 3)-as well as the September 24, 2000 sponsor memo authored by Moritt, (id. Ex. B, at 24--77), and a March 8, 1999 letter from Steven A. Horowitz and Horowitz, Mencher, Klosowski & Nestler, P.C. (presumably a predecessor firm to Moritt) to a company called Tan Oriented Plans, Inc., noting that the firm will provide assistance to BETA Plan participants, (id. Ex. B, at 78). Plaintiffs allege only that Designs "endorsed" the sales packet. (Id. ¶ 40.) Whether this is a reference to Designs' sponsorship of the plan in general, or their endorsement of the sales packet in particular, is unclear. If the latter is intended, no facts are provided explaining how or in what context Designs "endorsed" the packet, or even what Plaintiffs mean by "endorsed." Such allegations are insufficient to adequately allege a misrepresentation, and, at the very least, they fail the heightened pleading standards of Rule 9(b).

Similarly falling short of Rule 9(b) are Plaintiffs' allegations regarding Designs' marketing of the BETA Plan. Indeed, despite titling a section of their Second Amended Complaint as "Specific Allegations of Fraud," Plaintiffs make only general, repetitive allegations as to Designs' marketing of the BETA Plan: ...

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