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Sapirstein-Stone-Weiss Found. v. Merkin

United States District Court, S.D. New York

June 11, 2013


Page 622

For Sapirstein-Stone-Weiss Foundation, a charitable foundation, Irving I. Stone Foundation, a charitable foundation, Plaintiffs: David Edgar Bamberger, Brickman & Bamberger, New York, NY.

For J. Ezra Merkin, Gabriel Capital Corporation, Defendants: Kristina Arlene Moon, Dechert, LLP (NYC), New York, NY.

Page 623


VICTOR MARRERO, United States District Judge.

Plaintiffs Sapirstein-Stone-Weiss Foundation (" SSWF" ) and Irving I. Stone Foundation (" IISF," and collectively with SSWF the " Plaintiffs" ) filed the complaint in this action against Defendants J. Ezra Merkin (" Merkin" ) and Gabriel Capital Corporation (" GCC," and collectively with Merkin the " Defendants" ) alleging a variety of claims under New York common law including Breach of Fiduciary Duty, Fraud, Negligent Misrepresentation, Breach of Contract, Breach of Implied Obligation of Good Faith and Fair Dealing, Negligence, and Unjust Enrichment (the " Complaint" ). (Dkt. No. 1.) Defendants filed a timely Motion to Dismiss the Complaint. (Dkt. Nos. 7-8.) Plaintiffs filed their response (Dkt. Nos. 11-18) and Defendants filed a reply. (Dkt. No. 21.) For the reasons discussed below, Defendants' motion to dismiss is GRANTED in part and DENIED in part.


This case arises out of Plaintiffs' investments in Ariel Fund Limited (" Ariel" ), a Cayman Islands hedge fund. GCC is a Delaware corporation that serves as Ariel's investment advisor. Merkin is the sole shareholder and sole director of GCC.

Page 624


In 2001, SSWF invested $1 million in shares of Ariel. In 2006, IISF invested $750,000 in shares of Ariel. Over the ensuing years, Defendants invested an increasing percentage of Plaintiffs' investments in Ariel in the Ponzi scheme operated by Bernard Madoff (" Madoff" ) under the auspices of Bernard L. Madoff Investment Securities, Inc. (" BMIS" ). On December 10, 2008, Madoff admitted to running the largest Ponzi scheme in history and was sentenced to 150 years in prison in June 2009 following his guilty plea. See United States v. Madoff, No. 09 Cr. 213 (S.D.N.Y. June 29, 2009). At the time that the Madoff fraud was revealed, Defendants had entrusted to Madoff at least twenty-five percent of the investment capital of the Ariel Fund.


The Complaint alleges that Defendants made various materially false and misleading statements and/or omissions relating to Plaintiffs' investments in Ariel. Specifically, Plaintiffs claim that Defendants improperly misrepresented and/or failed to disclose Merkin's role in managing Ariel, Ariel's investments in Madoff, and the true nature of Ariel's investment strategy. Plaintiffs point to the Offering Memoranda, Subscription Agreements, and related documents (collectively, the " Governing Documents" ) distributed by Defendants, in addition to quarterly performance letters (" Quarterly Letters" ) and various other representations or statements made by Defendants to Plaintiffs.

For example, Plaintiffs allege that the Governing Documents and Quarterly Letters contained various omissions and misrepresentations relating to the nature of Ariel's investments and strategies. According to the 1996 Offering Memorandum, Ariel represented that its investment strategies consisted of risk arbitrage and investments in distressed securities. In the 2006 Offering Memorandum, Ariel represented that its investment strategies consisted of risk arbitrage, investments in distressed securities, and private equity. The 2006 Offering Memorandum further represented that Morgan Stanley was Ariel's sole broker and that Morgan Stanley cleared all transactions for Ariel placed by other brokers. In the Quarterly Letters, Defendants also listed the various asset classes in which Ariel was invested.

According to Plaintiffs, the Governing Documents and Quarterly Letters were false and/or misleading because, while they purported to set forth the nature and strategies of Ariel's investments, they never disclosed either that Ariel was invested in Madoff or that a portion of the assets were being invested pursuant to the " split strike conversion" strategy employed by Madoff. Plaintiffs claim that, regardless of whether the Governing Documents permitted Defendants to delegate funds to third-party managers such as Madoff, Defendants' alleged failure to disclose Ariel's investments with Madoff, in addition to various affirmative misrepresentations - such as the fact that Morgan Stanley cleared all transactions, which Plaintiffs assert was a conscious misrepresentation because Madoff infamously self-cleared all transactions - violated the contractual and common law duties Defendants owed to Plaintiffs.


Plaintiffs also claim that Defendants' failure to conduct due diligence on Ariel's investments with Madoff was unreasonable and violated the contractual and common law duties Defendants owed to Plaintiffs.

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Specifically, Plaintiffs point to Defendants' admitted failure to conduct any formal due diligence on Ariel's investments with Madoff despite a number of alleged " red flags" that Plaintiffs assert should have put Defendants on notice of Madoff's fraud, or at the least, prompted Defendants to disclose the nature of Ariel's investments in Madoff.


" 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, 556 U.S. 662, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009) (quoting Bell A. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). This standard is met " 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. A court should not dismiss a complaint for failure to state a claim if the factual allegations sufficiently " raise a right to relief above the speculative level." Twombly, 550 U.S. at 555. The task of the court in ruling on a motion to dismiss is to " assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof." In re Initial Pub. Offering Sec. Litig., 383 F.Supp.2d 566, 574 (S.D.N.Y. 2005) (internal quotation marks omitted). The Court must accept all well-pleaded factual allegations in the complaint as true, and draw all reasonable inferences in the plaintiff's favor. See Chambers v. Time Warner, 282 F.3d 147, 152 (2d Cir. 2002).



Defendants assert that the relevant statutes of limitations for Plaintiffs' claims began to run at the time of the investments in 2001 and 2006 and therefore are time-barred. Plaintiffs counter that Defendants actively concealed Ariel's investment in Madoff, had continuing obligations and duties to disclose Ariel's investments and conduct due diligence, and therefore the statutes of limitation did not begin to run until Madoff's fraud, and consequently Ariel's investments in Madoff, was uncovered in December 2008. Further, Plaintiffs argue that the applicable statutes of limitation were tolled pursuant to American Pipe & Constr. Co. v. Utah, 414 U.S. 538, 94 S.Ct. 756, 38 L.Ed.2d 713 (1974) by the filing of a currently pending opt-out federal class action brought on behalf of investors in Ariel and two other funds managed by Merkin - Ascot Partners, L.P. (" Ascot" ) and Gabriel Partners, L.P. (" Gabriel" ). See In re Merkin, 817 F.Supp.2d 346, 349 (S.D.N.Y. 2011). Defendants counter that the tolling pursuant to American Pipe is inapplicable because Plaintiffs allege only state-law claims and that New York courts would not recognize such tolling.

1. Tolling

As Defendants correctly note, a determination as to whether or not the filing of a class action tolls related state law claims is " properly understood to be a question of state law." Casey v. Merck & Co., 653 F.3d 95, 100 (2d Cir. 2011). Therefore, " a federal court evaluating the timeliness of state law claims must look to the law of the relevant state to determine whether, and to what extent, the statute of limitations should be tolled by the filing of a putative class action." Id. However, " New York courts have, in the interest of avoiding 'court congestion, wasted paperwork and expense,' long embraced the principles of American Pipe." Cullen v. Margiotta, 811 F.2d 698, 719-20 (2d Cir. 1987) (quoting Yollin v. Holland America Cruises, Inc., 97 A.D.2d 720, 720, 468 N.Y.S.2d 873, 875

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(1st Dep't 1983) (" We . . . hold that the timely commencement of the action by plaintiff herein satisfied the purpose of the contractual limitation period as to all persons who might subsequently participate in the same suit as members of the class. See American Pipe . . . ." )); see also Clifton Knolls Sewerage Disposal Co. v. Aulenbach, 88 A.D.2d 1024, 1025, 451 N.Y.S.2d 907, 908 (3d Dep't 1982) (" [T]he Statute of Limitations on each of plaintiff's claims was tolled during the pendency of [a prior] class action" ) (internal citations omitted); 1 McLaughlin on Class Actions § 3:15 (9th ed.) (" [T]he majority of state courts to consider the question have adopted the American Pipe tolling rule." ). Therefore, the filing of the In re Merkin class action served to toll the statute of limitations for Plaintiffs' claims.

2. The Weiss Arbitration

Defendants further argue that tolling based on the pendency of the federal class action is plainly inapplicable because Plaintiffs manifested their intent to opt out of In re Merkin when members of the Weiss family commenced an arbitration for their individual claims related to investments in two separate funds managed by Merkin - Ascot and Gabriel (the " Arbitration" ). See Weiss, et al. v. Merkin, AAA No. 13 148 Y 01803 10. Plaintiffs filed the instant action in January 2013, less than three years after the Arbitration began in July 2010. Therefore, Plaintiffs' claims would not be time-barred even assuming the limitations period began to run at the commencement of arbitration.

Furthermore, as Defendants note in their attempt to bar the instant action on collateral estoppel grounds, the Arbitration did not include the claims at issue in the instant action - the Plaintiffs' investments in Ariel. In fact, the Arbitration did not include investments in Ariel because the Defendants declined to consent to the arbitration of these claims. (Decl. of David E. Bamberger, dated Apr. 28, 2013 (" Bamberger Decl." ) ¶ 4, Ex. W.) Therefore, even if the limitations period regarding Plaintiffs' investments in Ascot and Gabriel began to run upon commencement of the Arbitration, it did not affect the current claims relating to investments in Ariel that were not adjudicated in the Arbitration.[2]

For these reasons, Plaintiffs' claims are not barred by the applicable statutes of limitations.


" The elements of common law fraud under New York law are: (1) a material representation or omission of fact; (2) made with knowledge of its falsity; (3) with scienter or an intent to defraud; (4) upon which the plaintiff reasonably relied; and (5) such reliance caused damage to the plaintiff." (quotation marks and citations omitted). Trinity Bui v. Indus. Enters. of Am., 594 F.Supp.2d 364, 371 (S.D.N.Y. 2009).

1. Actionable Misrepresentations and/or Omissions

Defendants' argue that Plaintiffs fail to identify any actionable misrepresentation or omission made by Defendants because the Governing Documents explicitly warn that investment discretion could be delegated to outside money managers and that the Defendants might not have custody of such assets. (Defs.' Mot. at 17-18.) Furthermore, Defendants assert that the Governing Documents did not require the disclosure of the identities of outside money managers, that Defendants disclosed the relevant Madoff investment

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strategy of purchasing " equity and debt securities and options," and that Plaintiffs' claims that Defendants failed to perform sufficient due diligence on Madoff fail as a matter of law. (Id. at 18-19.)

While Defendants are correct that the Governing Documents granted the Defendants the authority to delegate certain decisions to outside money managers, such authority in the abstract does not in and of itself insulate Defendants from possible liability. Assuming the facts as alleged by Plaintiffs, regardless of any obligation to disclose certain money managers and investment strategies embedded in the Governing Documents, Defendants chose of their own volition to provide Quarterly Letters to Plaintiffs explicitly setting forth the " Categories of Investments" in Ariel's portfolio, which they described, in at least one instance, as a " tapestry of six threads . . . established in tandem with our friend Steve Feinberg and the Cerberus Group." (Bamberger Decl., Ex. D at 3.) However, according to Plaintiffs, all of these Quarterly Letters failed to mention the one loose thread that, as of 2006, constituted approximately twenty-five percent of Defendants' artful weaving: Madoff and the " split strike conversion" strategy. (Pls.' Opp'n at 2.) [3]

Whether or not Defendants had a pre-existing duty to disclose the identity of outside money managers and investment strategies, " upon choosing to speak, one must speak truthfully about material issues." Caiola v. Citibank, N.A., New York, 295 F.3d 312, 331 (2d Cir. 2002). Therefore, once the Defendants chose to disclose in the Quarterly Letters sent to Plaintiffs certain outside money managers, categories of investments, and overall " strategy, [they] had a duty to be both accurate and complete." Id. Moreover, the Defendants' decision not to disclose Ariel's investments in Madoff, while affirmatively choosing to disclose this fact to investors in Ascot, contributes to the suspect inference surrounding Defendants' alleged misrepresentations. Finally, Defendants' alleged misrepresentation in the Governing Documents that Morgan Stanley was " Ariel's sole prime broker and . . . cleared all transactions for Ariel placed by other brokers," despite allegedly knowing that Madoff cleared and settled his own trades, may in and of itself constitute an actionable misrepresentation at the motion to dismiss stage. (Pls.' Mot. at 3.)

2. Scienter

Scienter is a " mental state embracing intent to deceive, manipulate, or defraud." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007) (quotation marks and citations omitted). Plaintiffs plead a strong inference of scienter where the " complaint sufficiently alleges that the defendants (1) benefited in a concrete and personal way from the purported fraud . . .; (2) engaged in deliberately illegal behavior . . .; (3) knew facts or had access to information suggesting that their public

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statements were not accurate . . .; or (4) failed to check information that they had a duty to monitor . . . ." South Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 110 (2d Cir. 2009) (quoting Novak, 216 F.3d at 311).

Defendants claim that the Complaint fails to allege scienter because, among other reasons, (1) Merkin had more than $110 million of his own money invested in Madoff, (2) Merkin's annual management fees are insufficient to establish scienter, (3) and that Defendants' failure to heed purported " red flags" pertaining to Madoff's are insufficient as a matter of law to establish scienter. (Defs.' Mot. at 20.) As support, Defendants point to the holding in In re Merkin that " allegations of Madoff-related red flags do not adequately plead scienter." In re Merkin, 817 F.Supp.2d at 357.

However, Defendants ignore the full breadth of Plaintiffs' allegations. Plaintiffs do not merely allege that Defendants failed to heed various " red flags," an allegation that standing alone might be insufficient to plead scienter. Instead, Plaintiffs specifically allege that the Defendants knowingly and intentionally failed to " disclose Madoff's role in Ariel and deliberately misrepresented the 'tapestry' of Ariel's investment" in addition to the fact that Morgan Stanley was Ariel's sole custodian. (Pls.' Opp'n at 26.) Plaintiffs' claim that Defendants made these misrepresentations and omissions despite being fully aware that (1) Ariel's " tapestry" of investments included investments in Madoff and (2) Morgan Stanley was not serving - and indeed could not have served - as a custodian for Ariel's investments with Madoff because, as the Defendants were well aware, Madoff infamously " cleared and settled his own trades, and acted as his own custodian" for all transactions. (Id. at 3, 26.) Accordingly, Plaintiffs have adequately pleaded that Defendants " knew facts or had access to information suggesting that their public statements were not accurate" and therefore have satisfied the scienter requirement. South Cherry, 573 F.3d at 110.[4]

Accordingly, the Court finds that Plaintiffs have sufficiently alleged a cause of action for common law fraud against the Defendants.


Defendants set forth a number of arguments for dismissal of Plaintiffs' non-fraud breach of duty claims based on the exculpatory provisions in the Governing Documents and adherence to the purported duties of care owed by Defendants to Plaintiffs. Specifically, Defendants argue, among other things, that (1) the Governing Documents expressly bar all claims except for gross negligence, fraud, or intentional conduct; (2) Plaintiffs' claims as investors are derivative of those held by Ariel itself and therefore impermissible; (3) no fiduciary relationship exists between

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the parties; (4) the Governing Documents permitted Defendants to delegate investment authority to Madoff without disclosing this fact; and (5) Defendants did not breach their relevant duties of care because of Madoff's reputation as a leading market maker. (Defs.' Reply at 5-10.)

Plaintiffs dispute Defendants' interpretation of the Governing Documents and claim that the relationship between the parties gave rise to fiduciary obligations, and that Defendants breached those duties through statements and omissions inducing Plaintiffs to retain their investments in Ariel. Consequently, Plaintiffs argue that, even assuming the validity of any purportedly exculpatory language in the Governing Documents, the Complaint adequately alleges derelictions of duty sufficiently egregious to constitute gross negligence and bad faith, thereby overcoming any exculpatory language in the Governing Documents. (Pls.' Opp'n at 18-23.)

The Court is persuaded that Plaintiffs have adequately pleaded claims under New York law for breach of duties owed by Defendants directly to Plaintiffs. See Anwar v. Fairfield Greenwich Ltd., 728 F.Supp.2d 372, 400-1 (S.D.N.Y. 2010) (" Under New York law, a shareholder may sue individually when the wrongdoer has breached a duty owed to the shareholder independent of any duty owing to the corporation wronged." ) (internal quotations omitted). Any determination relating to the relevant duty of care owed by Defendants, whether or not Defendants abided by those duties, and other issues raised by Defendants are necessarily linked to Defendants' state of mind and other factual determinations that make resolution of these issues inappropriate at the motion to dismiss phase. See, e.g., Musalli Factory for Gold & Jewellry v. JPMorgan Chase Bank, N.A., 261 F.R.D. 13, 26 (S.D.N.Y. 2009) (" New York courts generally avoid dismissing a claim of breach of fiduciary duty . . . because it usually involves a question of fact: whether someone reposed trust and confidence in another who thereby gains a resulting superiority or influence." ); Abercrombie v. Andrew Coll., 438 F.Supp.2d 243, 274 (S.D.N.Y. 2006) (holding that whether a fiduciary duty exists " normally depends on the facts of a particular relationship, [and] therefore a claim alleging the existence of a fiduciary duty is not subject to dismissal" ). For these reasons, the Court rejects Defendants' arguments related to Plaintiffs' non-fraud breach of duty claims.


" To state a claim for unjust enrichment in New York, a plaintiff must allege that (1) defendant was enriched; (2) the enrichment was at plaintiff's expense; and (3) the circumstances were such that equity and good conscience require defendants to make restitution." Kidz Cloz, Inc. v. Officially for Kids, Inc., 320 F.Supp.2d 164, 177 (S.D.N.Y. 2004) (internal quotation marks omitted). " The existence of a valid and enforceable written contract governing a particular subject matter ordinarily precludes recovery in quasi contract for events arising out of the same subject matter." Clark-Fitzpatrick, Inc. v. Long Island R. Co., 70 N.Y.2d 382, 388, 516 N.E.2d 190, 521 N.Y.S.2d 653 (1987); accord EBC I, Inc. v. Goldman Sachs & Co., 5 N.Y.3d 11, 23, 832 N.E.2d 26, 799 N.Y.S.2d 170 (2005).

There is no dispute that the various Governing Documents and the Investment Advisory Agreement are valid contracts governing the relationship between the parties. Accordingly, Plaintiffs' claim for unjust enrichment is DISMISSED.


Under New York law, " punitive damages are unavailable in breach of

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contract actions involving only private rights." Wolf v. Rand, 258 A.D.2d 401, 404, 685 N.Y.S.2d 708 (1999) (internal citations omitted). " Punitive damages are available in a tort action where the wrongdoing is intentional or deliberate, has circumstances of aggravation or outrage, has a fraudulent or evil motive, or is in such conscious disregard of the rights of another that it is deemed willful and wanton." Gray & Associates, LLC v. Speltz & Weis LLC, 22 Misc.3d 1124[A], 880 N.Y.S.2d 223, 2009 N.Y. Slip Op 50275[U] (N.Y. S.Ct. 2009) (internal quotation marks omitted).

At the motion to dismiss stage, Plaintiffs have failed to establish a factual record that would substantiate a request for punitive damages. Accordingly, the Court grants without prejudice Defendants' motion to dismiss Plaintiffs' claim for punitive damages.


Accordingly, it is hereby

ORDERED that the motion of defendants J. Ezra Merkin and Gabriel Capital Corporation to dismiss the complaint of plaintiffs Sapirstein-Stone-Weiss Foundation and Irving I. Stone Foundation (Dkt. No. 7) is GRANTED in part and DENIED in part.


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