Goldenson v. Steffens
802 F.Supp.2d 240, 2011 U.S. Dist. LEXIS 85855, 2011 WL 3424246 (2011)
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Rule of Law:
A complaint alleging securities fraud under § 10(b) and Rule 10b-5 survives a motion to dismiss if it pleads with particularity facts giving rise to a strong, cogent, and compelling inference of scienter. Under the "continuing fraudulent scheme theory," claims based on misrepresentations outside the five-year statute of repose may not be time-barred if they are part of a common scheme with at least one fraudulent statement made within the repose period.
Facts:
- Prior to 2001, Daniel and Suzanne Goldenson had a long-standing personal and business relationship with John L. Steffens at Merrill Lynch, relying on his investment advice and maintaining a risk-averse strategy focused on municipal bonds.
- In 2001, Steffens founded Spring Mountain Capital and persuaded the Goldensons to invest in its QP1 Fund, representing it as a diversified 'fund of funds' offering superior returns with reduced risk.
- On December 14, 2001, Steffens recommended the Goldensons also invest in the Ascot Fund, managed by his associate Ezra Merkin, falsely describing it as having a conservative, proprietary 'split-strike' trading strategy.
- On the same day, Steffens introduced Daniel Goldenson to Merkin, and both men repeated the false claims about Ascot's proprietary strategy, concealing that it was merely a 'feeder fund' that gave all its capital to Bernard Madoff.
- Relying on these representations, the Goldensons invested $2 million in the QP1 Fund and $2.25 million in the Ascot Fund in January 2002, making several additional investments in Ascot through 2006.
- Over the subsequent years, Steffens and his colleague Gregory P. Ho provided the Goldensons with ongoing reassurances about the stability of their investments, claiming they were actively monitoring the funds and sub-managers.
- On December 11, 2008, Bernard Madoff's Ponzi scheme was exposed, resulting in the total loss of the Goldensons' investments in both the QP1 Fund and the Ascot Fund.
- On January 6, 2009, Daniel Goldenson read a newspaper article in which Ho was quoted admitting that Spring Mountain was 'fully aware' of the Ascot Fund's investments with Madoff, revealing to the Goldensons for the first time that the defendants had known Ascot was a feeder fund.
Procedural Posture:
- Daniel and Suzanne Goldenson and their related entities (Plaintiffs) filed a complaint against John L. Steffens, Gregory P. Ho, and their related entities (Defendants) in the U.S. District Court for the District of Maine, the court of first instance.
- The Defendants filed a motion to dismiss the complaint for failure to state a claim.
- The court granted the Plaintiffs' unopposed motion for leave to file a First Amended Complaint.
- The Defendants confirmed that their motion to dismiss should apply to the First Amended Complaint.
- The District Court held oral arguments on the Defendants' motion to dismiss.
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Issue:
Do the plaintiffs' allegations of fraud against their investment advisers, which include specific misrepresentations about investment strategy and the concealment of a fund's nature as a feeder for a Ponzi scheme, satisfy the heightened pleading standards of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act (PSLRA) to survive a motion to dismiss?
Opinions:
Majority - Chief Judge John A. Woodcock, Jr.
Yes. The plaintiffs' allegations are sufficient to state a plausible claim for relief and survive the motion to dismiss. The court found that the complaint met the heightened pleading standards for fraud by alleging specific misrepresentations and facts supporting a strong inference of scienter. The court reasoned that under the 'continuing fraudulent scheme theory,' the claims were not time-barred by the five-year statute of repose because the defendants' ongoing misrepresentations connected earlier investments to fraudulent acts within the limitations period. The complaint properly alleged primary, not secondary, liability because it focused on the defendants' own false statements and endorsements of the fraudulent scheme. Furthermore, the allegations, including a defendant's admission of prior knowledge, created a 'cogent and compelling' inference of scienter that was at least as strong as any non-culpable explanation. Finally, the court concluded that the misrepresentations were material, as a reasonable investor would consider it important to know their funds were being managed by an unknown third party (Madoff) rather than by the adviser they had met and trusted.
Analysis:
This decision illustrates the practical application of the heightened pleading standards for scienter under the PSLRA and the Supreme Court's Tellabs decision. It shows how specific allegations, particularly a defendant's own admission of knowledge, can create a 'cogent and compelling' inference of fraud sufficient to defeat a motion to dismiss. The court's adoption of the 'continuing fraudulent scheme theory' is also significant, as it prevents defendants from using the statute of repose to shield themselves from liability for earlier acts in a prolonged, unified fraudulent enterprise. This case serves as a strong precedent for holding investment advisers directly liable for their own misrepresentations, even when a third party (like Madoff) is the ultimate perpetrator of the underlying scheme.
