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In re Tremont Securities Law, State Law and Insurance Litigation

United States District Court, Second Circuit

May 23, 2013

IN RE TREMONT SECURITIES LAW, STATE LAW, AND INSURANCE LITIGATION
v.
TREMONT OPPORTUNITY FUND III, L.P., ET AL., Defendants. CAYMAN NATIONAL TRUST COMPANY, LTD., as trustee of THE INTERNATIONAL DAD TRUST, Plaintiff, No. 11 Civ. 1687

OPINION

THOMAS P. GRIESA, District Judge.

This is an action brought by the Cayman National Trust Company in its capacity as trustee of the International DAD Trust. The Trust alleges that, through various misrepresentations about the due diligence performed by Tremont on its fund managers, defendants induced it to invest in excess of $4 million in two Tremont funds - Tremont Opportunity and Tremont International. Of this $4 million, approximately $1.5 million was lost when it was revealed that the ultimate manager of these assets, Bernard Madoff, was using the assets to fund his Ponzi scheme instead of investing them.

The complaint frequently uses the term "Tremont" and defines it to refer collectively to Tremont Opportunity Fund III, L.P.; Tremont International Insurance Fund L.P.; Tremont Partners, Inc.; Tremont Group Holdings, Inc.; and Rye Investment Management. The court will adopt this terminology as well. Certain allegations in the complaint are only plausible to the extent that they refer to a subset of these entities. But, for the purpose of this motion, it is not the court's prerogative to gainsay plaintiff's allegations. The court anticipates, however, that further proceedings will serve to clarify which allegations and claims are truly relevant to each particular defendant.

The action was originally brought in Texas state court. It was removed to federal court in the Northern District of Texas and then transferred to this court as a part of the multidistrict case In re Tremont Group Holdings, Inc., 09 M.D. 2052, for pretrial case management. Here, it was consolidated with the case In re Tremont Securities Law, State Law, and Insurance Litigation, 08 Civ. 11117.

Defendant moves to dismiss the complaint, which is the second amended complaint filed in this action. The motion is denied.

The Complaint

The Trust is the policyholder of a variable universal life insurance policy, or "VUL, " issued by Scottish Annuity & Life Insurance Company (Bermuda) Ltd. A VUL is a type of life insurance that, in essence, permits the policyholder to engage in some degree of investment activity while enjoying the tax advantages afforded a life insurance policy. On one hand, this policy allows the policyholder to direct, among the options provided by the insurance carrier, how the funds paid into that account are to be invested. The proceeds from those investments are paid out through the policy's eventual death benefit and also, in the meantime, may be borrowed against and used to fund the policy premiums and other ongoing policy expenses. On the other hand, however, this arrangement is structured such that the assets held in the policy are considered to be those of the insurance carrier and not of the policyholder. This ensures that the transactions carried on within the VUL benefit from the relatively generous tax advantages afforded life insurance benefits.

In deciding how to invest these VUL assets, representatives of the Trust's "protector" took certain steps. The protector of a Cayman Islands trust serves a role similar and parallel to that of the trustee under Cayman Islands and United States law. A trust's protector is typically tasked with overseeing or approving the actions of the trustee. The protector's representatives met with representatives of Tremont in Dallas, Texas. At that meeting, the Tremont representatives stated that, if the Trust invested with Tremont, the Trust's assets would be invested in a multi-manager "fund of funds." They stated that Tremont conducted extensive "specialist" due diligence on the "market and credit risk management" and "operating and business risk management" of any fund in which Tremont invested. Based upon these representations, the complaint alleges, the Trust directed that a portion of its VUL assets be invested with Tremont. These investments occurred in February and November of 2005.

Subsequently, the complaint alleges, Tremont representatives met with representatives of the Trust's protector in Dallas, Texas on an annual basis. At these meetings, Tremont representatives continued to make representations about the due diligence that it performed on the funds in which it invested. They represented that Tremont had a dedicated "Manager Research Group" focused specifically on ensuring the "operational integrity" of the funds' managers. This allowed Tremont, it claimed, to "uniquely understand how manager returns are generated." Tremont also provided written materials which contained additional details about Tremont's due diligence practices. The materials stated that Tremont also conducted "initial operational risk due diligence" which focused on, among other things, an investment's cash controls, trade execution and settlement, and its third-party service providers.

In reliance on these representations, the complaint alleges, the Trust made additional investments with Tremont in 2006.

On December 12, 2008, however, the day after Madoff was charged with securities fraud in connection with his ponzi scheme, Tremont sent a letter to the Trust informing it that a substantial portion of its investment had been managed by Madoff. Prior to this communication, however, the Trust alleges that a great deal of information had become available that would have caused a reasonable and prudent investment advisor - particularly one that conducted all of the due diligence that Tremont represented it would conduct - to become suspicious of Madoff's operation and avoid financial exposure to it. That Tremont did not identify or heed these red flags, the complaint alleges, suggests that Tremont's representations about its due diligence practices were false and that, in fact, Tremont did not conduct the due diligence that should have been conducted.

Discussion

To survive a motion to dismiss under Rule 12(b)(6) of the Federal Rules of Civil

Procedure, a complaint must plead sufficient facts to state a claim for relief that is plausible on its face. Ashcroft v. Iqbal , 556 U.S. 662, 677-78 (2009); Bell Atl. Corp. v. Twombly , 550 U.S. 544, 570 (2007). In deciding a motion under Rule 12(b)(6), a court must accept as true the facts alleged in the complaint, drawing all reasonable inferences in the plaintiff's favor, and may consider legally required public disclosures as well as documents attached to the complaint, incorporated by reference into the complaint, or known to and relied on by the plaintiff in bringing the suit. ATSI Commc'ns, Inc. v. Shaar Fund, Ltd. , 493 F.3d 87, 98 (2d Cir. 2007).

In this connection, Tremont contends that its Private Placement Memorandum, Limited Partnership Agreement, and other documents should be considered by the court. These documents purport to prohibit Tremont from communicating with insurance policyholders such as the Trust, emphasize that policyholders were not limited partners in the fund, and provide that defendants owed no duties to policyholders. But the present motion is addressed to the complaint, and these documents are not referred to in the complaint. The court declines to turn the motion into one for summary judgment dealing, in part, with these documents.

It is far from established, however, that plaintiff relied on or even was aware of these documents in preparing its complaint. Indeed, defendants only appear to contend that the documents were provided to Scottish Annuity and Life, not plaintiff. Therefore, these documents can have no bearing on the resolution of this motion.

CHOICE OF LAW

This court, as the transferee court of a diversity action commenced out of state, but transferred here for pre-trial purposes, applies the substantive law of the state in which the action was originally filed. This includes that state's choice-of-law rules. Menowitz v. Brown , 991 F.2d 36, 40 (2d Cir. 1993). In this case, therefore, the court applies the choice of law rules and the other substantive law of Texas.

In deciding which jurisdiction's laws govern a given issue, Texas courts apply the "most significant relationship" test articulated in the ...


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