The Enabling of the Hedge Fund Fraudsters, Part II

The Enabling of the Hedge Fund Fraudsters, Part II

On Sept. 1, we posted here our notes on the case of Rizack et al v. Signature Bank et al. This, a lawsuit filed in Broward County, Florida, constitutes fall-out from a fraud perpetrated by William Landberg in 2005-08, as he converted West End Financial Advisers and West End Capital Management from genuine (though poorly run) investment entities into the mere shells of a textbook Ponzi scheme.

Here we will update developments in that lawsuit. As of early December, there is a motion to dismiss pending, and the court is expected to rule on it before the end of the year.

The Principal and the Enablers

What is of interest in this case isn’t the question of Landberg’s guilt. That has long been settled. He pleaded guilty to criminal charges in a New York federal court in 2011. More of interest is the way this civil case seeks compensation for his victims from his enablers: a director of Century Bank., Barry Florescue, among them.

On July 20, 2015, Florescue’s lawyers filed a motion to dismiss. They added a memorandum stating their view of the pertinent law on October 28.

A motion to dismiss entails the argument that, even if everything the plaintiff alleges is true, the complaint nonetheless fails to state a claim on which relief can be granted. It must not be confused with a motion for summary judgment (which implies that, after both parties have had the benefit of discovery proceedings, there is such a decisive imbalance of the evidence at hand that no rational trier of fact could find for the plaintiff, so no trial is called for). Both types of motion would give the defendant a win without trial, but the motion to dismiss contests legal issues by finessing any dispute over the facts, whereas the motion for summary judgment requires a deep dive into the facts.

Or at least, that’s the theory. In the reality of legal practice, the memoranda supporting or opposing motion to dismiss usually do end up arguing the facts as well as the law.

This case displays something of the range of walls and protections that enablers have available to them under existing law, although it is as yet possible that given this specific pattern of facts all of these walls will fall and liability will attach.

Insolvency  

Florescue relies in large part on a 2009 case by the Fifth Circuit Court of Appeals, Torch Liquidating Trust v. Stockstill. The fifth circuit there found that “the filing of a chapter 11 petition creates an estate comprised of all the debtor’s property [which estate] includes causes of action belonging to the debtor.” Thus, (on Florescue’s reasoning) since Landberg’s West End entities filed for bankruptcy, only the resultant estate may bring actions against the directors of the bankrupt company. This excludes the individuals in the position of the individual plaintiffs in the Signature Bank case.

Several individual plaintiffs filed a response to Florescue’s motion and memo on November 4th.   They respond to this argument by saying that the Torch precedent doesn’t help Florescue at all, because he wasn’t a director of the bankrupt entity involved in this case. He was a director of a third-party enabler, Century Bank. Further, the individual plaintiffs aren’t suing on behalf of a bankrupt estate or “even purporting to.”

The Passage of Time

Florescue also involves Florida’s statute of limitations. Or, rather, “statutes” because there are several that may be thought to apply.

The plaintiffs reason that the pertinent provision is Fla. Stat. 95.031, which provides that actions founded on fraud must be brought within four years of the time when “the cause of action was discovered or should have been discovered with the exercise of due diligence.”

Plaintiffs argue, further, that Florescue’s role could not have been discovered until the completion of the forensic audit, in August 2011. This action, filed in December 2014, comes well within the four-year limit so understood.

Yet to protect against the possibility that the court will adopt an earlier time to start the limitations-clock ticking, plaintiffs also invoke the doctrine of equitable estoppel. That is: a plaintiff is in general prohibited from benefitting from the bad acts with which he is charged. In this case, Florescue’s actions allegedly impaired the ability of the plaintiffs to determine who they ought to sue, and in trying to evoke the statute of limitations he is trying to benefit from that consequence of his own fraud.

Money and Conversion

The pleadings also raise an issue about the scope “conversion.” The tort of conversion, one of the claims in this lawsuit, is usually understood as the unlawful turning of the personal goods of one person to the benefit of another. It is typically used in connection with the theft of “chattels,” not the misappropriation of investment funds. Florescue moves to dismissal of the charges of conversion on that basis.

The plaintiffs maintain, though, that Florida’s law does allow the application of the tort to money, so long as (in the words of a 2008 precedent), there was “an obligation to keep intact or deliver the specific money in question, so that money can be identified.”

What does a phrase like “specific money” mean in this context? A specific bank account? Specific serial numbers on the bills? There will likely be further arguments over “specificity” if the lawsuit proceeds.

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