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In Re Austin Capital Management

December 21, 2012

IN RE AUSTIN CAPITAL MANAGEMENT, LTD, SECURITIES & EMPLOYEE RETIREMENT INCOME SECURITY ACT (ERISA) LITIGATION


OPINION

This putative class action arises out of the massive Ponzi scheme orchestrated by Bernard Madoff. Plaintiffs are investors in hedge funds controlled by Austin Capital Management Ltd. A portion of these funds' assets was invested in the Rye Select Broad Market Prime Fund, LP ("Rye Select Prime Fund"), managed by Tremont Partners, Inc. The Rye Select Prime Fund, in turn, paid its assets over to Madoff and his investment firm, Bernard L. Madoff Investment Securities LLC. When Madoff's fraud was discovered, Austin Capital's entire investment in the Rye Select Prime Fund was lost.

The consolidated second amended class action complaint alleges, against numerous defendants, violations of the Securities Act of 1933 ("Securities Act"), the Securities Exchange Act of 1934 ("Exchange Act"), the Employee Retirement Income Security Act of 1974 ("ERISA"), breach of contract, breach of fiduciary duty, unjust enrichment, gross negligence, common law fraud, negligent misrepresentation, and violations of state blue sky laws. Defendants move to dismiss all of plaintiffs' claims.

Defendants' motion is granted in part and denied in part.

The Complaint

The following allegations are taken from the complaint and the documents on which it relies. For the purpose of this motion, the allegations in the complaint are assumed to be true.

PARTIES

Lead Plaintiffs include Pension Trust Fund for Operating Engineers ("Operating Engineers"), International Brotherhood of Teamsters Local 705 Pension Fund ("Local 705"), and Sheet Metal Workers' National Pension Fund ("Sheet Metal Workers"). Other named plaintiffs include Laborers Local 17 Pension Plan ("Local 17 Pension Plan"), New Mexico Educational Retirement Board ("New Mexico ERB"), and Texas Treasury Safekeeping Trust Company ("Texas Safekeeping"). The trustees or fiduciaries of these entities are also named as plaintiffs: Russell Burns, John Witt, Michael Sullivan and Ronald Palmerick, and Daniel Jackson, respectively. This action is brought on their behalf and also on behalf of all persons similarly situated who purchased shares in funds controlled by Austin Capital or a related entity and who suffered losses as a result of the events described below. The putative class action covers shares purchased between January 2, 2005 and December 11, 2008.

For purposes of the standing discussion below, it is important to summarize the shares purchased by the plaintiffs. During the class period, Operating Engineers purchased and held $164.3 million of shares in Austin Capital Safe Harbor ERISA Dedicated Fund, Ltd. ("ERISA Fund"); Local 705 purchased and held $25 million of shares in Austin Capital Safe Harbor Portable Alpha Offshore Fund One, Ltd. ("Portable Alpha One"); Sheet Metal Workers purchased and held $50 million of shares in Austin Capital All Seasons Offshore Fund, Ltd. ("All Seasons"); Local 17 purchased and held $4 million worth of shares in the ERISA Fund; New Mexico ERB purchased and held $130 million worth of shares in Austin Capital Safe Harbor QP Fund ("Domestic Fund"); and, finally, Texas Trust purchased $287.5 million worth of shares in Austin Capital Safe Harbor Offshore Fund ("Safe Harbor Offshore Fund").

Plaintiffs assert claims not only related to the Austin Capital funds they invested in - ERISA Fund, Safe Harbor Offshore Fund, Domestic Fund, All Seasons, and Portable Alpha One - but also on behalf of investors in any Austin Capital fund that invested in any Madoff-related entity.*fn1

Defendant Austin Capital is a limited partnership, based in Austin, Texas, that oversees hedge fund investment portfolios for individuals and institutional clients. Austin Capital placed and controlled investments with various funds, including the Rye Select Prime Fund, which plaintiffs allege was nominally managed by Tremont but actually managed by Madoff.

Plaintiffs have also sued various other companies that they assert were involved with the management of Austin Capital's investments. These include Austin Capital Management GP Corp. ("ACM-GP"), Victory Capital Management, Inc., and KeyCorp. ACM-GP is the sole general partner of Austin Capital. KeyCorp is the corporate parent and sole limited partner of Austin Capital, as well as the corporate parent of ACM-GP. Victory, another KeyCorp subsidiary, managed the assets of Austin Capital's funds since Victory acquired Austin Capital in 2006.

The individual defendants include people who occupied management positions with Austin Capital, KeyCorp, and Victory. These include Charles W. Riley, Brent A. Martin, James P. Owen, Robert Wagner, David C. Brown, David E. Friedman, Kyle McDaniel, Montgomery Green, Jay W. Van Ert, and Ronald J. Dugas. Plaintiffs have also sued various Doe Defendants whose identities are not yet known, but who they assert may be liable.

There are 15 counts in the complaint. Count 1 alleges violation of § 10(b) of the Exchange Act and rule 10(b)(5). Count 2 is against certain defendants, alleging violation of § 20(a) of the Exchange Act. Count 3 is brought under § 12(a)(2) of the Securities Act. Counts 4 through 8 are brought under ERISA. Counts 9 through 15 are brought under various state law theories.

Standing

To bring a claim even "named plaintiffs who represent a class must allege that they personally have been injured. . . ." Lewis v. Casey, 518 U.S. 343, 357 (1996). As described above, the complaint alleges violations by defendants with respect to 17 funds controlled by Austin Capital. But of these 17 funds the named plaintiffs only invested in five. Thus, the named plaintiffs have suffered no injury traceable to the remaining 12 funds.

Plaintiffs are only permitted to pursue claims relating to investments in the ERISA Fund, Safe Harbor Offshore Fund, Domestic Fund, All Seasons, and Portable Alpha One, the Austin Capital funds in which named plaintiffs actually invested. All claims not relating to investments in these five funds are dismissed. However, because these claims are brought only on behalf of putative class members, it has no impact on the parties named in this lawsuit. It only affects the composition of the putative class and, accordingly, the number of potential claims against defendants.

Securities Fraud

Paragraphs 63 through 66 of the complaint purport to describe the investments of the Austin Capital funds leading to the losses in this case. It is alleged that Austin Capital invested in the Rye Select Prime Fund, and that Rye was managed by Tremont entities. However, the main point made is that Tremont was merely a "nominal investment manager" to Rye and that all investment decisions and all trades were made by Madoff. The complaint goes on to allege that Austin Capital was "knowingly investing with Madoff," but failed to conduct "meaningful due diligence investigation into Madoff or his company BMIS." The complaint alleges that all funds invested with Rye were turned over to Madoff.

The allegations of wrongdoing commence with paragraph 67 and are under the heading:

False and Misleading Statements Concerning Austin Capital's Purported Due Diligence, Risk Management Practices and Financial Performance The complaint quotes at length from various materials disseminated to investors by Austin Capital describing the due diligence which would be undertaken by Austin. These materials, as quoted, stated over and over the numerous steps which would be taken to scrutinize the "manager," or "hedge fund managers." Certain of the materials describe what a proper "hedge fund manager" would do such as putting some of his own money into the investment, making his compensation depend on profits, having a reputable auditor, and so forth.

Beginning with paragraph 70, there are allegations about how the due diligence, as promised above, was not performed and how there were numerous failures to live up to the qualifications which were described as attending a proper manager. However, this portion of the complaint is all about Madoff. The failures of scrutiny and investigation are said to be failures with respect to Madoff. The ...


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