Motion to Dismiss; In Pari Delicto; Adverse Interest Exception to In Pari Delicto; Negligence; Innocent Insiders; Choice of Law; Accounting Malpractice; Fraud
By: Judith Balasubramaniam | Senior Staff Writer
Plaintiffs are Cayman-Island-based feeder funds for the investment firm of Alphonse Fletcher and Fletcher Asset Management (together, “FAM”), and are organized under FAM’s master fund. . FAM relied on fraudulent schemes in its management of the Funds to preserve the appearance of steady profits and high returns, when in fact the Funds were losing money. FAM also employed a risk management firm as a valuation agent, despite the firm having no valuation experience. FAM hired Defendants Grant Thornton, LLP, EisnerAmper, LLP and EisnerAmper, Ltd. to provide audit reports for the Funds for three fiscal years. Unfortunately, Defendants’ reports overstated the value of the Funds based on inaccurate calculations provided by the risk management firm’s valuation of the Funds and its assets.
Plaintiffs brought a breach of fiduciary duty suit against Defendants for accounting malpractice based on the premise that Defendant: (1) failed to detect FAM’s misconduct and (2) were negligent in failing to exercise reasonable and professional care in preparing audit reports for Plaintiffs. Additionally, Plaintiffs argued that since the Funds were incorporated in the Cayman Islands, Cayman Island law, should have controlling effect on the case. Defendants filed motions to dismiss under the doctrine of in pari delicto, arguing that Plaintiffs’ claims should fail because their own managers committed fraud to keep the Funds afloat. Indeed, Defendants contended that they should not be charged with malpractice for failing to detect illegal activity because FAM provided them with false and misleading information to perform their audits. In opposition, Plaintiffs argued that (1) the adverse interest exception to in pari delicto applies here because the misconduct of FAM was for its personal benefit and not attributable to the Funds; and (2) the Funds should be considered innocent insiders because they would have stopped FAM’s misconduct if Defendants reported it.
The Court granted Defendants’ motions to dismiss. First, the Court held that New York law had controlling effect on this case. Although the Funds were incorporated in the Cayman Islands, and Cayman Island law does not impute an agent’s misconduct to the corporation, where conflicting laws regulate conduct, the law of the jurisdiction having the greatest concern with the specific issue raised in the litigation is applied. Here, the only acts performed in the Cayman Islands were the signing of the final audit reports while all other work took place in New York. Therefore, New York had the greatest interest in the outcome of the litigation.
Second, the Court held that the doctrine of in pari delicto applies here. In pari delicto mandates courts to refrain from interceding to resolve disputes between two wrongdoers, to prevent a wrongdoer from profiting from his own misconduct. Here, FAM was an authorized agent of Plaintiffs. FAM used fraudulent schemes to prop up Plaintiffs’ Funds. Its actions fell squarely within its managerial scope of authority. Therefore, the fraud and overstated value of the Funds that Plaintiffs charge Defendants with failing to detect could be imputed to Plaintiffs themselves. Thus, in pari delicto refrained the Court from interceding to resolve a dispute between FAM and Plaintiffs. The Court granted Defendants’ motion as to this point. Third, the Court rejected the Plaintiffs’ adverse interest exception argument. The adverse interest exception is a very narrow exception in which the misconduct of an agent, when committed entirely for himself or a third party, is not imputed to the corporation. Here, FAM did not completely abandon Plaintiff’s interest. On the contrary, the misconduct was committed, at least in part, to benefit Plaintiffs’ Funds. As FAM’s misconduct was not committed in total abandonment of the interests of the Plaintiffs, the adverse interest exception did not apply here. Therefore, the Court granted the motion as to this point. Fourth, the Court found Plaintiffs’ argument regarding innocent insiders irrelevant. The existence of innocent insiders is immaterial unless the adverse interest exception applies. Here, the exception did not apply because Plaintiffs failed to show that FAM completely abandoned Plaintiffs’ interests and were acting entirely for its own purpose. And since the adverse interest exception did not apply, the existence of innocent insiders was immaterial.
FIA Leveraged Fund Ltd. v. Grant Thornton LLP, Index No. 651217/2015, 1/19/2015 (Bransten, J.).