Sec. & Exch. Comm'n v. Gruss
| Decision Date | 09 May 2012 |
| Docket Number | No. 11 Civ. 2420.,11 Civ. 2420. |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Perry A. GRUSS, Defendant. |
| Court | U.S. District Court — Southern District of New York |
OPINION TEXT STARTS HERE
George S. Canellos, Esq., Todd D. Brody, Esq., Securities & Exchange Commission, New York, NY, for Plaintiff.
Nathaniel H. Akerman, Esq., Thomas O. Gorman, Esq., Cecilie Howard, Esq., Dorsey & Whitney LLP, New York, NY, for Defendant.
Defendant Perry Gruss (“Gruss” or the “Defendant”) has moved to dismiss the amended complaint (the “Complaint”) brought by the plaintiff U.S. Securities and Exchange Commission (the “SEC” or the “Plaintiff”) for failure to state a claim under Fed.R.Civ.P. 12(b)(6) and for failure to set forth a plausible cause of action pursuant to Fed.R.Civ.P. 8(a) and 9(b).
Upon the facts and conclusions set forth below, the Defendant's motion is denied.
The SEC filed its initial complaint on April 8, 2011 seeking enforcement of the Investment Advisers Act of 1940 (the “IAA”), 15 U.S.C. § 80b–6. On June 10, 2011, the SEC amended and filed its Complaint. The Complaint sets forth a claim for relief against Gruss consisting of four separate alleged frauds, charged as aiding and abetting violations of Sections 206(1) and (2) of the IAA.
The four separate frauds alleged in the Complaint are (1) the misappropriation of cash belonging to an offshore fund for onshore fund investments, (2) the misappropriation of cash belonging to an offshore fund for the repayment of a credit facility for an onshore fund, (3) the early withdrawal of management fees from unspecified managed client funds, and (4) funds taken from an onshore fund and an unidentified managed client fund for the purchase of an airplane. The Complaint seeks injunctive relief, disgorgement and civil penalties against Gruss pursuant to Section 209(e) of the IAA.
Invoking Rules 12(b)(6), 8(a) and 9(b) of the Federal Rules of Civil Procedure, Gruss moved to dismiss the Complaint on July 15, 2011.
The instant motion was heard and marked fully submitted on September 28, 2011.
The following factual background is drawn from the Complaint and from documents referenced in or integral to the Complaint. The allegations of the Complaint are accepted as true for the purposes of this motion, see Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir.2002), and do not constitute findings of fact by the Court.
D.B. Zwirn & Co. L.P. (“DBZCO”), now defunct, was a New York-based limited partnership and unregistered investment adviser. From 2 002 through 2009, DB2CO managed five hedge funds, including the D.B. Zwirn Special Opportunities Fund, Ltd. (the “Offshore Fund”) and the D.B. Zwirn Special Opportunities Fund, L.P. (the “Onshore Fund”). The Offshore Fund and the Onshore Fund were separate entities with largely distinct pools of investors. The Onshore Fund faced a chronic cash shortage because its investment opportunities exceeded its available funds. In contrast, the Offshore Fund had more cash than investment opportunities due to its inability to make investments or loans to U.S. businesses without being subject to tax liability.
From March 1, 2004 through October 4, 2006, DBZCO had no written accounting policies or procedures. Instead, the de facto policy was that all transfers of cash of any size had to be expressly approved by Gruss, the Chief Financial Officer (“CFO”) of DBZCO. Gruss' approval was effectuated by his affirmative response to email requests sent to him or through his personal signing or authorizing his signature to be affixed to hard copy wire transfer requests.
During this period, Gruss used the signatory and approval authority he had over the funds to authorize more than $870 million in improper transfers of client cash. The cash was transferred both between client funds and from client funds to DBZCO and third parties. More specifically, these transfers included: (i) at least 85 transfers totaling $576 million from the Offshore Fund to the Onshore Fund or directed to third parties to fund Onshore Fund investments; and (ii) $273 million in transfers from the Offshore Fund to repay the Onshore Fund's revolving credit facility.
Gruss personally approved transfers from the Offshore Fund to the Onshore Fund to offset the Onshore Fund's cash shortage. The transfers typically involved the movement of cash from the Offshore Fund's U.S. bank account into a third party's U.S. bank account. The third party, the company receiving the loan or investment, was in many cases a U.S. entity. Similarly, to repay the Onshore Fund's revolving credit facility, Gruss approved the transfer of cash between the accounts for each of the funds at U.S. banks and then on to the U.S. bank account of the provider of the credit facility.
The inter-fund transfers were not investments made by the Offshore Fund in the Onshore Fund. All investment decisions were made by DBZCO's managing partner, who had approval over all potential investments. No approval was given for any inter-fund transfers between the Onshore Fund by the Offshore Fund, and Gruss did not inform DBZCO's managing partner or any of the other DBZCO partners of the practice of transferring money between the funds.
The inter-fund transfers seemingly functioned as loans, in that the money transferred was ultimately repaid. However, no loan agreements were drafted or documented. No interest was paid by the Onshore Fund to the Offshore Fund, even though these transfers were outstanding for an average of 66 days and ranged up to 285 days.
As the size of the transfers grew, two accountants, who worked under Gruss in DBZCO's New York office, repeatedly expressed their concerns over the practice of transferring cash between funds. They informed Gruss that the transfers were inappropriate and requested that he make the partners aware of these activities to facilitate a joint management decision. When Gruss refused and continued the practice of improperly transferring cash between the funds, both accountants resigned from DBZCO.
In addition to the inter-fund transfers, Gruss approved (i) $22 million of early withdrawals of management fees from the accounts of client funds in order to cover DBZCO's operating cash shortfalls; and (ii) a transfer of $3.8 million from the Onshore Fund to partly fund a Gulfstream IV aircraft purchased by DBZCO's managing partner.
Without the funds provided by the early withdrawal of management fees, DBZCO would have faced severe liquidity constraints and might have been unable to fund its cash disbursements for its operating expenses. According to the Complaint, but for the early management fee withdrawals, DBZCO would have overdrawn its operating account by $1.9 million by September 2005, $4.0 million by December 2005 and $9.5 million by March 2006. Gruss was aware of the payment terms in the management agreements and recognized that the early withdrawals amounted to loans of money to fund DBZCO.
In September 2005, DBZCO's managing partner purchased an aircraft costing $17.95 million. At the close of the purchase,DBZCO was faced with a $3.8 million shortfall in available funds. Gruss authorized the transfer of the funds needed to close on the aircraft purchase from the Onshore Fund and a managed account. Despite knowing that money had been misappropriated to purchase the aircraft, Gruss did not inform any of his supervisors or anyone outside of the accounting group that funds had been used for this purpose.
Facing termination, Gruss resigned in October 2006, when at least $108 million of the unauthorized transfers remained outstanding. All of the money improperly transferred was eventually repaid with interest, but only after an internal investigation.
Because the SEC references the Offering Memoranda and the financial disclosures in its Complaint, the documents are appropriate for consideration in connection with the Defendant's motion to dismiss.1
The three relevant Offering Memoranda for the Offshore Fund are attached to the Declaration of Perry A. Gruss, dated July 13, 2011, as Ex. A, dated April 2002; as Ex. B, dated July 2003; and as Ex. C, dated July 2005. The Audited Financial Statement for the Offshore Fund and the Onshore Fund for 2005 are attached to the Gruss Dec. as Ex. D and Ex. E respectively. The three relevant Offering Memoranda for the Onshore Fund are attached to the Gruss Dec. as Ex. F, dated April 2002; as Ex. G, dated May 2003; and as Ex. H, dated May 2005. The Audited Financial Statements for the Offshore Fund and Onshore Fund for 2004 are attached to the Gruss Dec. as Ex. I and Ex. J respectively.
Each of the Offering Memoranda for the Offshore Fund stated that the fund was incorporated, administered, registered, domiciled and regulated in the Cayman Islands. Specifically, “[t]he Fund was incorporated and registered as an exempted company in the Cayman Islands under the Companies Law (2001 Second Revision) of the Cayman Islands on April 12, 2002” and the Fund's registered office and legal counsel were located in “George Town, Grand Cayman, Cayman Islands, British West Indies.” (Ex. A at 30, 32; Ex. B at 32; Ex. C at 56). The Offering Memoranda also stated that the Offshore Fund's Administrator, Registrar and Transfer Agent was Goldman Sachs (Cayman) Trust ... a company incorporated under the laws of the Cayman Islands and licensed as a mutual funds administrator pursuant to the Mutual Fund Law (2001 Revision) of the Cayman Islands, and that the Offshore Fund's cash in U.S. banks was in the name of the Cayman Administrator. (Ex. A at 21; Ex. B at 20; Ex. C at 32).
In addition, the Offering Memoranda explained that the Offshore Fund was subject to regulation and supervision by the Cayman Islands authorities and that it was obligated to adhere to Cayman Islands law. (Ex. A at 39; Ex. B at 39; Ex. C at 81). It also provided that shares could...
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