Gva Market Neutral v. Veras Capital Partners, 07 Civ. 0519.

• Citation: 580 F.Supp.2d 321
• Decision Date: 29 September 2008
• Docket Number: No. 07 Civ. 0519.,07 Civ. 0519.
• Parties: GVA MARKET NEUTRAL MASTER LIMITED, Plaintiff, v. VERAS CAPITAL PARTNERS OFFSHORE FUND, LTD., Veras Investment Partners, LLC, Veras Investment Group, LP, Kevin D. Larson, and James R. McBride, Defendants, and Veras Capital Partners Offshore Fund, Ltd., and Veras Capital Master Fund, Nominal Defendants.
• Court: U.S. District Court — Southern District of New York

Page 321

580 F.Supp.2d 321

GVA MARKET NEUTRAL MASTER LIMITED, Plaintiff, v. VERAS CAPITAL PARTNERS OFFSHORE FUND, LTD., Veras Investment Partners, LLC, Veras Investment Group, LP, Kevin D. Larson, and James R. McBride, Defendants, and Veras Capital Partners Offshore Fund, Ltd., and Veras Capital Master Fund, Nominal Defendants.

No. 07 Civ. 0519.

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

September 29, 2008.

COPYRIGHT MATERIAL OMITTED

Nixon, Peabody LLP, by: Adam B. Gilbert, Esq., New York, NY, Nixon, Peabody LLP, by: George Skelly, Esq., Andrew Hachey, Esq., Boston, MA, for Plaintiffs.

Spears & Imes LLP, by: David Spears, Esq., New York, NY, Richards Kibbe & Orbe LLP, by: Paul A. Leder, Esq., David W.T. Daniels, Esq., Washington, DC, for Defendants and Nominal Defendants.

OPINION

SWEET, District Judge.

Defendants and Nominal Defendants Veras Capital Partners Offshore Fund, Limited ("VCP Offshore" or the "Fund"), Veras Capital Master Fund (the "Master Fund"), Veras Investment Partners, LLC ("VIP"), Veras Investment Group, LP ("VIG" or, collectively with the other entity defendants, "Veras"), Kevin D. Larson ("Larson"), and James R. McBride ("McBride") (collectively, the "Defendants") have moved pursuant to Fed. R.Civ.P. 12(b)(6) to dismiss with prejudice the Amended Complaint filed by Plaintiff GVA Market Neutral Master Limited ("Gottex"). For the reasons set forth below, the motion is granted.

This case arises out of investments of $25 million in VCP Offshore, a Cayman Islands hedge fund, by Gottex, a sophisticated British Virgin Islands hedge fund.

Gottex invested in VCP Offshore in August and September of 2003, based upon the Fund's investment strategy, which involved market timing of mutual funds. VCP Offshore closed its operations shortly after Gottex made its investment, in the wake of announcements of industry-wide investigations into market timing by the Office of the New York Attorney General ("NYAG") and the U.S. Securities and Exchange Commission ("SEC"). VCP Offshore is alleged to have held back, at that time, a portion of Gottex's investment to pay any fines or sanctions in connection with these investigations. The regulatory investigations involving Veras were ultimately resolved through settlement in December 2005, when Veras and certain affiliated entities and individuals paid $36,2 million (the "Settlement Expense"). Though most of Gottex's investment was returned, a portion of that Settlement Expense was allocated to Gottex. The essence of the dispute concerns the allocation of the Settlement Expense and the propriety of the holdback of part of the Gottex investment pending the Fund's windup.

I. Prior Proceedings

Gottex filed its complaint on January 23, 2007. The Defendants filed a motion to dismiss the complaint on April 26, 2007. Gottex filed an amended complaint on June 18, 2007. The Defendants again moved to dismiss and the motion was heard and marked fully submitted on November 28, 2007.

II. The Amended Complaint

The Amended Complaint makes the following allegations:

VCP Offshore is a hedge fund organized as a Cayman Islands Exempted Company with its offices on Grand Cayman Island. Am. Compl. ¶ 13. VCP Offshore is a socalled "feeder fund" which sold shares to offshore subscribers but invested its assets through the Master Fund, a Texas general partnership. Id. ¶¶ 14, 21. VCP Offshore was managed by an investment manager, VIG, a Texas limited partnership, which, in turn, allegedly has a general partner, VIP, and two limited partners, Larson and McBride. Id. ¶ 12.

Gottex is a British Virgin Islands entity whose sole beneficial shareholder is Gottex Value Added Fund Limited ("Gottex VAF"), a hedge fund that invests assets in other hedge funds (i.e., a "fund of funds"). Id. ¶ 8. Gottex VAF alleges that at the time of its investment in VCP Offshore, Gottex VAF was managed by a Bermuda company, Gottex America Limited, and that a New York-based corporation, Gottex Fund Management Limited, "supported" Gottex America Limited with its investment-related activities on behalf of Gottex and Gottex VAF. Id.

Gottex invested in VCP Offshore in two tranches: $17 million on August 1, 2003, and $8 million on September 1, 2003. Id. ¶¶ 70-71.¹ VCP Offshore pursued an investment strategy known as mutual fund market timing, in which traders seek to earn a profit through frequent purchases and sales of shares in a mutual fund company in order to benefit from stale prices or other pricing discrepancies. Id. ¶ 18, 22.

Gottex made its investment in VCP Offshore after receiving two documents: a January 1, 2003 Private Offering Memorandum ("Offering Memorandum") and written responses to Gottex's due diligence questionnaire ("Questionnaire Responses") that had been prepared by "Larson and McBride, on behalf of themselves, VIP, and [VCP] Offshore." Id. ¶¶ 45, 52. Gottex alleges that in the offering materials and during Gottex's due diligence, Defendants made a number of material misrepresentations and omissions to Gottex concerning their investment process. Id. ¶¶ 45-61. According to Gottex, Veras failed to disclose that it engaged in late trading, which the Amended Complaint defines as "the illegal practice whereby an order to purchase or sell mutual fund shares is submitted after the U.S. stock market close (4:00 [p.m.] Eastern Standard Time) is treated as eligible for and receives the [net asset value per share] computed as of the market close." Id. ¶¶ 26, 29, 53. Gottex alleges that Defendants also failed to disclose that Veras market timed through "deceptive acts" designed to avoid detection of its trades by mutual funds and thereby evade any trading restrictions. Id. ¶¶ 24, 53, 59. Gottex further alleges that Veras did not disclose the risk that its investment strategy might be found by regulators to involve unlawful conduct or its knowledge that the NYAG had been investigating late trading and market timing "well before" Gottex made its investment. Id. ¶¶ 30, 50-51.

According to Gottex, in early September 2003, Larson called J.P. Bailey, a Senior Investment Partner of Gottex America Limited, and Larson admitted that he had been aware for several months that an NYAG investigation of late trading and market timing had been pending and conceded that Defendants had not disclosed this information to Gottex prior to its investments in the Fund. Id. ¶¶ 30, 73. Larson allegedly told Bailey that the NYAG was investigating both late trading and "kickbacks to the [mutual] funds in order to secure `capacity' to receive preferential trading terms," id. ¶ 74, and denied that Veras engaged in either practice, id. ¶ 75. Also in September 2003, Defendants informed Gottex that Veras was cooperating with the NYAG and SEC investigations, and that such cooperation would include withholding certain assets of VCP Offshore from distribution back to investors. Id. ¶ 87. On or about September 25, 2003, Larson advised Bailey that the total amount of the hold-back would be an estimated $77 million. Id. ¶ 88.

Following its investigation into the Defendants' practices, in December 2005, the SEC made extensive findings, including that the Master Fund, VIP, Larson, and McBride had engaged in fraudulent market timing and illegal late trading, and that they had willfully violated the anti-fraud provisions of federal securities laws (Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), and Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5) and had aided and abetted and caused violations of the federal securities laws prohibiting late trading (Rule 22c-1(a) under the Investment Company Act of 1940, 17 C.F.R. § 270.22c-1). The SEC ordered the Master Fund, VIP, Larson and McBride (as well as another Veras fund), jointly and severally, to pay $35,554,903 in disgorgement and $645,585 in prejudgment interest. Larson and McBride were each ordered to pay a civil penalty of $750,000, and were barred from serving as investment advisers or working for mutual funds for eighteen months. Id. ¶¶ 33-34.

Gottex alleges that it was initially told that VCP Offshore would allocate the Settlement Expense based on profits earned by investors over the life of VCP Offshore, and was later told that the management company, not VCP Offshore, would likely bear the expense of any settlement. Id. ¶¶ 90, 93-94. In January 2006, despite assurances that were made through July 2005, id. ¶ 91-95, VCP Offshore decided to allocate the Settlement Expense among all investors pro rata based on the size of their account balances rather than an allocation based upon profits. Id. ¶ 96. This resulted in the withholding of approximately $1.5 million from Gottex, which had "paper profits" of only $94,500 from its investment in VCP Offshore. Id. Gottex asserts that it therefore paid a disproportionately large share of the Settlement Expense, and that the allocation was made to protect the personal investments of Larson and McBride. Id. ¶¶ 99-101.

In late September 2003, Gottex had sought to redeem its shares at full value, but its notice of redemption was not honored by Veras Offshore. Id. ¶ 103. In or about October 2003, Veras sought to compulsorily redeem all shares of VCP Offshore, id. ¶ 104, however, according to Plaintiffs, "Defendants continue to refuse to pay Gottex the full value to which Gottex is entitled for redemption of its shares," id. ¶ 105. According to Gottex, because of representations made on behalf of the Defendants, its injury occurred no earlier than January 2006, when Gottex learned of the pro rata allocation determination. Id. ¶¶ 107-114.²

In its Amended Complaint, filed on January 23, 2007, Gottex alleges three types of claims. First, in Counts One and Two, Gottex alleges claims under the federal securities laws, specifically Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5...