131 Main Street Associates v. Manko

• Decision Date: 14 January 2002
• Docket Number: No. 93 Civ. 800(LBS).,93 Civ. 800(LBS).
• Citation: 179 F.Supp.2d 339
• Parties: 131 MAIN STREET ASSOCIATES, et al., Plaintiffs, v. Bernhard F. MANKO, et al., Defendants.
• Court: U.S. District Court — Southern District of New York

179 F.Supp.2d 339

131 MAIN STREET ASSOCIATES, et al., Plaintiffs, v. Bernhard F. MANKO, et al., Defendants.

No. 93 Civ. 800(LBS).

United States District Court, S.D. New York.

January 14, 2002.

COPYRIGHT MATERIAL OMITTED

Nicholas M. De Feis, De Feis O'Connell & Rose, P.C., New York City, Philip A. Kantor, Law Offices of Philip A. Kantor, P.C., Las Vegas, NV, for Plaintiff.

Stephen E. Kesselman, Brief, Justice, Carmen, Kesselman & Kleiman, LLP, New York City, for Defendant.

OPINION AND ORDER

SAND, District Judge.

In this long-lived action, Plaintiffs allege civil violations of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq. While the charged financial chicanery is technical and complex, in essence, Plaintiffs allege that the Defendant Jon Edelman ("Defendant") fraudulently induced Plaintiffs to invest in limited partnership tax shelter investments that Defendant looted by passing off false tax losses and by awarding himself and his co-conspirators commissions and fees for bogus securities trades.¹ See Plaintiffs' Memorandum in Support of Renewed Motion to Amend and for Reconsideration at 1-2 ("Plaintiffs' Memo"). The specific details of this scheme can be found in United States v. Manko, 979 F.2d 900, 901-05 (2d Cir.1992), cert. denied, 509 U.S. 903, 113 S.Ct. 2993, 125 L.Ed.2d 687 (1993), and Greenwald v. Manko, 840 F.Supp. 198, 199-201 (E.D.N.Y.1993). Plaintiffs present two motions: to amend the amended complaint and to have us reconsider the issue of notice of injury. Defendant's cross motion seeks to dismiss the amended complaint. We reject Plaintiffs' motion and grant summary judgment in favor of the Defendant.

I. Background

A. Statement of Facts

At the outset, we outline the structure of the fraudulent scheme, the response of the investors (including Plaintiffs) and Internal Revenue Service ("IRS") to the scheme, and the role of Defendant in planning and carrying out the scheme. Beginning in 1977 Defendant Edelman, along with several others, organized and managed limited partnerships through Arbitrage Management Company ("Arbitrage Management"). See Second Amended Complaint (Proposed) at ¶ 37. Plaintiffs were investors in one or more of these limited partnerships, including Government Arbitrage Partnership, The Arbitrage Group, Sectra Limited Partnership, Conarbco, and Midipco (collectively "the partnerships"). Plaintiffs allege Defendants represented to investors that these partnerships would allow investors to obtain tax-advantaged investments, usually through some form of income deferral. Id. at ¶ 38. Defendants allegedly represented to Plaintiffs, in order to solicit their investment, that the partnerships were "profit-motivated, and not risk-free, tax-motivated trades," which otherwise may have violated the various tax laws. Id. Defendants also allegedly failed to mention that most of the tax losses passed through to Plaintiffs would be pursuant to fictitious trades, sometimes amounting to billions of dollars, that were devoid of the possibility for profit. Id. at ¶ 38, 58. The fictitious trades eliminated any possibility for the investors to achieve economic gain. Id. at ¶ 42. Beginning in 1979, defendants allegedly supplied the investment partnerships' outside auditors with incomplete information to prepare the partnerships' tax returns and financial statements for the prior year. Id. at ¶ 52. Beginning in 1982, defendants allegedly entered the partnerships into prearranged and bogus repurchase transactions with an inactive corporation controlled by Manko "to purportedly finance certain trades in U.S. Government-backed securities." Id. at ¶ 53.

The injuries suffered by Plaintiffs included "the loss of [P]laintiffs' investment; the loss of any profit opportunity on their investment; liability to federal, state and/or local tax authorities; and expenses for the defense of their interests." Id. at ¶ 73.

The scheme allegedly operated in the following manner. A trader would purchase a U.S. Treasury Bill on the open market, and to pay for it, the trader would enter into a separate financing transaction called a repurchase agreement with the seller. Id. at ¶ 54. This repurchase agreement gives title of the Treasury bill to the borrower; however, the Treasury bill is sold to the lender pursuant to an agreement entered into with the borrower to repurchase the bill at a specified time and price.² Id. When the repurchase agreement's term ends, the borrower pays the lender the agreed upon repurchase price of the Treasury bill, including finance charges. Id. at ¶ 55. For the borrower to make a profit, the borrower has to sell the Treasury bill to the lender or on the open market at a sufficiently appreciated price. Id. Legitimate traders can take advantage of the tax implications of these transaction. Id. at ¶ 56. "By positioning a repurchase agreement to terminate after year end, the borrower's hoped-for profit on final sale of the underlying security can be realized in the following year. However, accrued finance charges up to year end may be accrued for tax purposes as deductible investment interest expense." Id. Plaintiffs assert that Defendants' Treasury bill purchases and the attendant repurchase transactions used to finance them were fictitious and illusory. Id. at 57. How the Defendants more specifically carried out these transactions can be found in the Second Amended Complaint (Proposed). Id. at ¶ 58-81.

In its proposed Second Amended Complaint, Plaintiffs now allege that defendants, including Edelman, engaged in fraudulent concealment of the scheme. Id. at ¶ 82. Defendants maintained a trading room to give the appearance of a legitimate government securities dealer. Id. at ¶ 83. Legitimate traders conducted regular and legitimate transactions with well-known securities, and when the defendants conducted bogus trades, only a small group of traders was used and the transaction was kept secret from the legitimate traders. Id. Defendants further told their accounting staff that the bogus trades were bona fide and at arms length. Id. at ¶ 86. Defendants used an organization of its creation, T.S.M. Holding Corp. (TSM), with which to trade, and the paperwork generated by TSM led the auditors to believe that "they had confirmed trades done between defendants and TSM, and that such trades were bona fide and at arms length." Id. at ¶ 87.

From the beginning of the investment partnership until February 18, 1988, the limited partner investors, including Plaintiffs, allegedly sought to monitor the integrity of the defendants' operations "by establishing an infrastructure of investor and administrative services representatives to serve as intermediaries between investors and the general partners and as paid `watchdogs' or `snoops' ...." Id. at ¶ 89. These representatives included Barry Lyman and the accounting firm Berk & Michaels. Id. Defendants, however, allegedly engaged in acts designed to throw the watchdogs off the trail, including giving the watchdogs trading documents showing trades with recognizable securities firms but never with TSM. Id. at ¶ 90. According to Plaintiffs, Lyman represented not just the investors that he put into the deal, but all investors. Id. at ¶ 92. Moreover, the IRS investigated the partnerships throughout the 1980s, and Plaintiffs were sent (a) copies of the reports and (b) the response of Defendant and its counsel to such reports. See, e.g., Kesselman Aff. Ex. 5 (1985 IRS Report of The Arbitrage Group), Ex. 6 (1988 IRS Report of Conarbco), Ex. 7 (1988 IRS Report of Midopco), Ex. 7 (1987 IRS Report of Sectra Limited). In response to the IRS challenge to the partnerships' tax position, Defendants hired the law firm Saltzman & Holloran "to defend the investment partnerships' federal tax position."³ Second Amended Complaint (Proposed) at ¶ 94.

Plaintiffs allege that Defendants prevented them from learning of the fraud. For instance, on May 7, 1986, Edelman wrote to the partners of Midopco that the losses facing the partnerships were the result of accounting errors by the IRS. Id. at ¶ 96. Lyman and Berk & Michaels' investigation into the Defendants' operations revealed (a) high commissions and (b) high overhead. Id. at ¶ 97. Defendants offered a reasonable explanation for the cost of commission and overhead — an explanation that did not reveal that the commissions were for bogus securities trades. Id. at ¶ 99. Moreover, a number of outside auditors certified the partnerships' accounts (e.g., those of Sectra, Midopco, Conarbco) because the auditors had not been told that TSM was not an independent entity trading at arms length with defendants. Id.

Plaintiffs' also allege that their failure to attribute their tax-related losses to Defendants' scheme was not due to their own lack of reasonable diligence. Id. at ¶ 106. Defendants encouraged the limited partners to retain the firms already hired by management, and about 150 of them did so. Id. Defendants point out that the IRS summary reports issued in the 1980s contained several errors indicating that the preliminary disallowance of partnership items could be successfully defended. Id. at ¶ 107. Defendants allegedly hid from Plaintiffs the trading with TSM and asserted primary control over the response to the tax audits, pushing for their early resolution. Id. at ¶ 109. Some time in late 1987 to early 1988, an agreement was reached to settle the audits. Id. at ¶ 110.

On February 8, 1989 Edelman and Manko were indicted on charges of "conspiracy to commit tax fraud, subscription to knowingly false tax returns, and of aiding and abetting the (unwitting) filing of false tax returns by limited partnership investors such as [P]laintiffs." Id. at ¶ 43. Both were convicted on all counts in the indictment, and the convictions have been affirmed on appeal. See United States v. Manko, 979 F.2d 900 (2d Cir.1992). On February 8, 1993, Plaintiffs brought suit against Defendants, exactly...