ORDER AND REASONS
JANE TRICHE MILAZZO, District Judge.
Before the Court is Defendant Kaplan & Company's Motion to Dismiss (Doc. 45). For the following reasons, the Motion is GRANTED IN PART.
I. General factual and procedural background
This matter arises out of the failure of a "commodity pool," a type of hedge fund that trades in commodities futures contracts. Level III Trading Partners, L.P. ("Level III" or "the Fund") was a commodity pool created in February 2007 by Defendant Bruce A. Gwyn ("Gwyn"). According to the Complaint, the Fund attracted approximately $2.7 million in investments from its inception in 2007 to its filing for bankruptcy in 2013. From 2007 to 2010, the fund successfully and profitably operated as a commodity pool. Beginning in 2010, however, Gwyn allegedly began divesting the fund of commodities futures and investing its assets in companies controlled by Gwyn and his close business associate, Defendant Andrew V. Reid. The Complaint claims that "[t]his scheme involved [transfers] in the guise of loans, purchases of stock, and purchases of limited liability company membership interests."
In order to hide his self-dealing and the depletion of the fund's assets from its investors, the Complaint alleges that Gwyn disclosed false investment performance reports, false asset values, and fraudulent account statements to the fund's investors. Many of these reports to investors were allegedly prepared and sent by Defendants Turn Key Hedge Funds, Inc. ("Turn Key") and Michael Lapat. In addition to hiding Level III's value and the nature of its investments from current investors, Gwyn allegedly continued to accept additional investments from current investors, as well as limited partner subscriptions to the Fund from new investors looking to invest in a commodity pool.
After Level III's investors learned of the scheme, they filed an involuntary petition for relief under Chapter 7 of the Bankruptcy Code on August 2, 2013.
On September 28, 2015, Cotter filed this action in this Court in his capacity as trustee of the Level III Trading Partners, L.P. Litigation Trust. The Trustee's Complaint asserts seventeen claims for relief against eleven defendants, and he seeks to avoid various pre-petition transactions on behalf of the debtor. The matter was initially referred to the bankruptcy court, but the referral was withdrawn on March 9, 2016. Defendant Kaplan & Company ("Kaplan") has filed the instant Motion to Dismiss the claims against it. Prior to addressing the merits of this Motion, this Court will discuss the Complaint's allegations involving Kaplan.
II. Specific allegations against Kaplan & Company
The Complaint alleges that Kaplan, a CPA firm, was retained by Gwyn at the recommendation of Defendant Turn Key to provide accounting and auditing work for the Fund. Kaplan was responsible for preparing monthly capital and performance reports that were provided to the fund's investors. It also audited financial statements and prepared partnership tax information. The Complaint alleges that beginning in 2010, Kaplan had frequent problems completing its monthly reports "because of untimely, problematic, and inconsistent information and documentation" provided to it by Gwyn. Despite these ongoing issues, Kaplan allegedly "never disclosed any of the problems, irregularities, or inconsistencies to the partnership or its limited partners."
According to the Complaint, Kaplan's responsibilities included confirming the accuracy of Turn Key's calculations of the Fund's net asset value. In doing so, it reviewed documents relating to the entities in which the Fund had invested and therefore allegedly knew that Gwyn held an interest in or was otherwise affiliated with those entities and that the entities had no appreciable assets or performed no real business. The Complaint alleges that Kaplan was aware of Gwyn's self-dealing and fraud. In addition, it alleges that Kaplan knew that Gwyn was using the Fund for personal expenses.
By late 2010, Kaplan had stopped preparing monthly reports or verifying monthly partner capital account statements because it was unable to verify the value of the fund's private investments. It sought supporting documentation from Gwyn and Turn Key to verify the Fund's net asset value but never received such. In addition, it had difficulty preparing the annual statement for 2010 for the same reasons. Kaplan allegedly did not at that time explain to the limited partners the reason for the delay or relay its belief that the Fund's private investments were actually worthless.
Kaplan ultimately issued the financial statements for 2009 and 2010 on October 13, 2011, stating that it was unable to verify the valuation of the investments. These statements were not provided to the limited partners.
In light of these facts, the Trustee alleges that Kaplan aided Gwyn in misappropriating investor funds and misleading investors regarding the value of their investments. It failed to communicate to the limited partners its assessment of the value of the Fund's investments and thus assisted Gwyn in perpetuating the scheme. The Trustee brings claims against Kaplan for (1) violation of § 10 of the 1934 Securities Exchange Act, (2) violation of state securities laws, (3) professional malpractices and negligence, (4) aiding and abetting Gwyn, (5) breach of contract, (6) civil conspiracy, and (7) misrepresentation and omission. In its Motion, Kaplan seeks the dismissal of each of these claims.
To survive a Rule 12(b)(6) motion to dismiss, a plaintiff must plead enough facts "to state a claim for relief that is plausible on its face."
LAW AND ANALYSIS
This Court will consider each of Kaplan's arguments in turn.
I. Breach of Contract
At the outset, Kaplan argues that the Trustee cannot succeed on its breach of contract claim. It argues that Louisiana law applies to this claim and that under Louisiana law allegations that an accountant breached its duties sounds in tort, not contract. The Trustee rebuts that it is impossible for the Court to engage in a fact-intensive choice of law analysis at this stage.
While the parties dispute which choice of law provision applies to this claim, this Court agrees with the Trustee that Louisiana Civil Code article 3537, which specifically addresses which law applies to issues of conventional obligations, applies here.
This Court agrees with the Trustee that such a determination at this stage would be premature. This Court has not been provided with sufficient facts to engage in the analysis mandated by article 3537. For instance, the Complaint does not provide any information regarding the negotiation or formation of the contract between Kaplan and Level III, nor has the contract been provided to this Court for consideration. For these reasons, Kaplan's request for dismissal of the Trustee's breach of contract claim is denied.
II. Peremption of Tort Claims
Kaplan next argues that the Trustee's claims sounding in tort, such as those for malpractice, misrepresentations, and breach of fiduciary duty, are perempted. It argues that Louisiana law applies, and under Louisiana law, claims against accountants are subject to two peremptive periods set forth in Louisiana Revised Statutes § 9:5604, which states that:
Applicability of Louisiana law aside, this Court is unable to make a determination regarding the passing of peremption without a factual determination regarding when the claim arose. Even Kaplan points out that "Plaintiff's Complaint fails to point to a specific action or date on which Kaplan allegedly committed an action or omission which would form the basis of Plaintiff's" claims. In addition, it is not clear when Plaintiff should have been aware of the claim. Kaplan argues that certainly the Plaintiff should have been on notice of its claim against Kaplan by June 12, 2012 when the National Futures Association ("NFA") took emergency action against Level III and Gwyn. The Trustee points out, however, that nothing in the NFA's notice suggests that Kaplan was engaged in any wrongful conduct. Regardless, a finding of when Plaintiff should have discovered his claim against Kaplan is a factual determination inappropriate for resolution at this stage. Accordingly, this Court cannot say that Plaintiff's claims are perempted by Louisiana's one-year peremptive period.
Likewise, this Court does not find that Plaintiff's claims are perempted by the three-year period. As Kaplan points out, the Complaint alleges that Kaplan stopped providing accounting services for the Fund in June of 2012. The bankruptcy proceeding began on August 2, 2013, and, on October 1, 2013, the Trustee was given an additional two years within which to bring any claims that were actionable at the time of the filing of the bankruptcy.
III. Accountant Review Panel
Kaplan next argues that the claims alleging that it breached its duties of professional care are premature because they have not yet been submitted to a public accountant review panel. Louisiana Revised Statutes § 37:105(a) states that:
Kaplan argues that this law is procedural and this Court must therefore apply it to this matter regardless of which state's substantive law applies. The Trustee rebuts on two grounds. First, he argues that the law is substantive, not procedural, and that since Illinois substantive law applies to this dispute, it is inapplicable here. Second, he argues that even if Louisiana law applies, he is not required to comply with this statute because Kaplan is licensed in Illinois, not Louisiana.
At the outset, this Court agrees with the Trustee that the accountant review panel requirement is a substantive law.
The conduct that caused the alleged injury—Kaplan's malpractice and breach of professional duties—occurred at its offices in Illinois. The injury was felt by Level III and its investors in Louisiana. Therefore, the law of Illinois applies only if the law of Louisiana does not provide for a higher standard of conduct. "In Illinois, the established standard of care for all professionals is stated as the use of the same degree of knowledge, skill and ability as an ordinarily careful professional would exercise under similar circumstances."
IV. Aiding and Abetting
Plaintiff's Complaint alleges that Kaplan is liable for aiding and abetting the breaches of fiduciary duty, breaches of partnership agreement, and conversion of partnership property committed by Level III and Gwyn. Kaplan argues that there is no cause of action for aiding and abetting under Louisiana law, and these claims should therefore be dismissed. This Court agrees that Louisiana does not recognize an independent cause of action for aiding and abetting;
V. Securities Exchange Act Claims
In his Complaint, the Trustee alleges that Kaplan has violated § 10 of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5. "Congress enacted § 10(b) to insure honest securities markets and thereby promote investor confidence."
The SEC, pursuant to this section, promulgated Rule 10b-5, which provides:
"To state a claim based on conduct violating Rule 10b-5(a) and (c), [a] plaintiff must allege (1) that the defendant committed a deceptive or manipulative act, (2) in furtherance of the alleged scheme to defraud, (3) with scienter, and (4) reliance."
The Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C § 78u et seq., requires heightened pleading standard for plaintiffs bringing private securities fraud actions.
Kaplan argues that Plaintiff cannot succeed in its securities claims against it because he has failed to allege the misstatements or omissions with particularity, has failed to allege the requisite scienter, and has failed to allege reliance.
Kaplan argues that the Complaint fails to point to any specific misrepresentation or omission or allege which private placement memoranda contained the statement. The Trustee responds with numerous instances in the Complaint in which he points out specific misrepresentations made by Kaplan. For instance, the Complaint alleges that Kaplan misrepresented the value of the Fund to its investors in monthly statements, performance reports, and financial statements sent in 2010 and 2011. This Court agrees that these assertions are sufficient to satisfy the heightened pleading standard.
Next Kaplan argues that the Complaint fails to establish the requisite scienter. A plaintiff may satisfy the heightened scienter pleading requirement by alleging facts showing a motive to commit fraud and a clear opportunity to do so, or by identifying circumstances indicating conscious or reckless behavior, so long as the totality of allegations raises a strong inference of fraudulent intent.
Kaplan alleges that the only possible red flag identified by Plaintiff's Complaint is the Fund's 2010 shift from commodities trading to almost entirely private investments in light of the December 2009 disclosure statement which stated that only 0 to 10% of the fund assets would be invested in private companies. Kaplan points out that the disclosure statement also states that the 0 to 10 "percentage may be substantially more or less at the discretion of the Partnership's Investment Manager." Kaplan argues that it "cannot be said to have `disregarded' the `red flag' of Bruce Gwyn moving the [F]und toward a majority of private investments as such action was authorized" by the disclosures provided to investors.
Plaintiff's response, however, points to several other red flags identified by his Complaint. Namely, the Complaint describes "frequent and detailed questions relating to problems, inconsistencies, and irregularities" identified by Kaplan in auditing Level III's accounting and bank records; Kaplan's knowledge that Gywn had an interest in many of the entities in which the Fund invested and that many of those entities had no assets or performed no real business; Kaplan's knowledge that Gwyn regularly used the Fund's cash for personal expenses; Gwyn's inability to furnish sufficient documentation to explain expenses or answer Kaplan's questions; and Kaplan's knowledge that no side pockets had been established for the investments and that redemption requests were being met based on the inflated values assigned to the investments. Plaintiff alleges that these suspicious acts were sufficient to put Kaplan on notice of Gwyn's wrongdoing but that Kaplan failed to do anything to alert investors to these red flags. Instead, Plaintiff alleges, Kaplan continued to issue reports even if all of its questions had not been answered. Plaintiff identifies Kaplan's motive as its partnership with Defendant Turn Key. Plaintiff's allegations, which are outlined in significant detail in the Complaint, give rise to a strong inference of scienter that is at least as compelling as any opposing inference that one could draw from the facts alleged. Even if Kaplan did not intentionally engage in deceptive conduct, the allegations are sufficient to indicate reckless disregard in reporting false information to investors. Defendants' argument that the Trustee failed to meet the heightened pleading requirements for scienter therefore fails.
Finally, Kaplan argues that the Plaintiff has failed to adequately allege that investors relied on its misrepresentations or omissions in investing in Level III. This Court disagrees. As Plaintiff points out, his Complaint expressly alleges that Kaplan prepared financial reports and statements, private placement memoranda, and disclosure documents for the benefit of investors and potential investors and that Kaplan knew that investors would rely on that information in deciding whether to invest in Level III. These statements allegedly grossly inflated Level III's value, causing investors to rely on them to their detriment.
Accordingly, Kaplan's arguments seeking the dismissal of Plaintiff's claims under the Exchange Act fail.
VI. State Law Securities Claims
Kaplan next argues that Plaintiff's state securities law claims, under Louisiana, Florida, Alabama, and Illinois law, fail as a matter of law. Plaintiff does not oppose the dismissal of his claims under Florida or Illinois law. Accordingly, this Court will consider only the viability of his claims under Louisiana and Alabama law.
First, Kaplan argues that it is not a "seller" under the terms of Louisiana Revised Statutes § 51:712(a)(2), which states that:
Both parties rely on Solow v. Heard McElroy & Vestal LLP to support their position.
Kaplan argues that, like the accounting firm in Solow, it was not involved with the negotiations or sales of interests in Level III and therefore cannot be said to be a seller. Plaintiff rebuts that Solow indicates that in considering whether an accounting firm was a substantial factor in a sale, a court should look to "whether the auditor authorized use of its reports and statements in public filings and had contact with potential investors."
Kaplan next argues that it cannot be liable under Louisiana Revised Statutes § 51:714(b) because it is not a "control person." Section 714(b) states that:
For purposes of this statute, "control" is defined as "the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise."
Plaintiff argues that his allegations are sufficient to support a claim for control person liability in light of Heck v. Triche.
Kaplan next argues that Plaintiff cannot succeed on his claim under Alabama's securities law, which states that:
Kaplan argues that the Complaint does not support a claim that it materially aided in selling interests in Level III. The Alabama Supreme Court has established that the phrase "materially aids" expands "liability to groups of persons beyond the [actual] seller of the security."
VII. Civil Conspiracy Claims
Kaplan argues that Plaintiff cannot succeed on his civil conspiracy claims because he has not adequately plead an underlying tort or wrong. However, this Court has previously declined to dismiss Plaintiff's claims of professional malpractice and breach of contract. Accordingly, Plaintiff's claim of civil conspiracy is properly supported by those underlying claims.
VIII. Breach of Fiduciary Duty
Finally, Kaplan argues that Plaintiff's breach of fiduciary duty claim should fail because the law does not recognize a fiduciary relationship between an auditor and its client. This Court has already held that Illinois law applies to claims involving Kaplan's standard of conduct pursuant to Louisiana Civil Code article 3543 unless the law of Louisiana provides for a higher standard of conduct. The parties agree that Louisiana law does not recognize a fiduciary duty between an accountant and its client and therefore does not provide for a higher standard of conduct. Therefore, Illinois law applies to Plaintiff's breach of fiduciary claim.
Illinois law recognizes a fiduciary duty between an auditor and his client under some circumstances. While an auditor-client relationship typically does not establish a fiduciary duty, "fiduciary duties are sometimes imposed on an ad hoc basis."
For the foregoing reasons, Kaplan's Motion is GRANTED IN PART. Plaintiff's claims under Louisiana Revised Statutes § 51:714(b) and for breach of fiduciary duty are DISMISSED WITHOUT PREJUDICE. In addition, Plaintiff's claims under Florida and Illinois securities law are DISMISSED WITH PREJUDICE. Plaintiff shall amend his Complaint within 20 days of this Order to the extent that he can remedy the deficiencies identified herein.