EDWARD J. LODGE, District Judge.
On May 9, 2013, United States Magistrate Judge Mikel H. Williams issued a Report and Recommendation in this matter, Dkt. 31. Pursuant to 28 U.S.C. § 636(b)(1), the parties had fourteen days in which to file written objections to the Report and Recommendation. Plaintiff filed his limited objection on May 23, 3013, Dkt. 32. No objections or response to Plaintiff's limited objection was filed by Defendant. The matter is now ripe for the Court's consideration.
Pursuant to 28 U.S.C. § 636(b)(1)(C), this Court may accept, reject, or modify, in whole or in part, the findings and recommendations made by the magistrate judge. Where the parties object to a report and recommendation, this Court shall make a de novo determination of those portions of the report which objection is made. Id. Where, however, no objections are filed the district court need not conduct a de novo review. In United States v. Reyna-Tapia, 328 F.3d 1114, 1121 (9th Cir.2003), the court interpreted the requirements of 28 U.S.C. § 636(b)(1)(C):
See also Wang v. Masaitis, 416 F.3d 992, 1000 & n. 13 (9th Cir.2005). Furthermore, to the extent that no objections are made, arguments to the contrary are waived. See Fed.R.Civ.P. 72; 28 U.S.C. § 636(b)(1) (objections are waived if they are not filed within fourteen days of service of the Report and Recommendation). In this case, an objection was filed so the Court is required to conduct a de novo determination of the portion of the Report and Recommendation objected to.
The Court adopts and incorporates by reference the factual background from the Report and Recommendation on pages 1-5.
Judge Williams recommends that the negligent misrepresentation claim contained in Count 15 be dismissed without leave to amend as Idaho law does not allow such a claim except between an accountant and his client. Judge Williams indicates the Trustee has argued in favor of Idaho law applying to the other state law claims and the court should be consistent and dismiss a claim that is not allowed under Idaho law. The Trustee argues that it is premature to dismiss the claim as the alleged negligent misrepresentations by Ellison
The Court finds the most prudent course of action at this time is to grant the motion to dismiss Count 15 but grant Plaintiff leave to amend the allegations in the Complaint with specificity as to what states (for which a claim for negligent misrepresentation is recognized as a cause of action under the facts of this case) the Defendant made alleged negligent misrepresentations. Any alleged negligent misrepresentations that occurred in Idaho towards Idaho investors will not be allowed to proceed as Idaho does not recognize such a claim under the facts of this case and those facts should not be included in the amended allegations.
MIKEL H. WILLIAMS, United States Magistrate Judge.
Pending before the Court is a motion to dismiss filed on behalf of Defendant Mark Ellison. (Dkt. 13). This case was referred to the undersigned United States Magistrate Judge for all dispositive and non-dispositive matters on October 16, 2012. (Dkt. 10, p. 2). Having reviewed the pleadings and affidavits pertinent to the motion (Dkts. 13, 13-1, 13-2, 19, & 23), and having entertained oral argument on February 5, 2013, the Court hereby enters the following Report and Recommendation.
This is another case arising from the collapse of DBSI, Inc, for many years a large and successful real estate company located in Boise Idaho.
The events giving rise to this lawsuit are complex and are set forth in more than five hundred paragraphs of factual allegations. With some emendations, these allegations largely tell the same story as does the complaint in the Zazzali v. Swenson matter. Rather than entering into a detailed factual discussion here, the Court will incorporate by reference the background discussion in its January 25, 2013 Report and Recommendation in that case. (See Case No. 12-00224, Dkt. 256, at 3-8). As in Zazzali v. Swenson, the overarching questions are not so much whether the Complaint describes the over-all fraud in sufficient detail, but whether Ellison's role in it has been pled with sufficient particularity to satisfy the standards of Rule 8(a), Rule 9(b), and the Private Securities Litigation Reform Act ("PSLRA"). Therefore, the Court will focus its factual discussion on those allegations that address Ellison's individual actions, rather than those allegations that simply lump him together with the rest of the defendants alleged to have played a role in the fraud.
Ellison was one of DBSI's original principals who set up the company along with his colleague, Douglas Swenson, in the late 1970s. He left DBSI in 1992 to work in a private law firm but maintained his relationship with DBSI as its outside counsel. Twelve years later, he returned as inside counsel in October of 2004, which is when the Trustee alleges that DBSI had begun to take on characteristics of a Ponzi scheme. (Complaint, ¶¶ 4 & 15-18, Dkt. 1).
The Complaint does not contain a lot of detail regarding Ellison's overall role at DBSI from 2004 onward, other than to state generally that he was tasked with "respondfing] to any legal questions or issues presented to him by Douglas Swenson or other members of the management team." (Id., 18). However, the Complaint does discuss in some detail his alleged role in drafting and/or signing off on various Private Placement Memoranda ("PPMs"). The PPMs were a series of offering documents distributed to potential investors in connection with various DBSI real estate and securities offerings. The PPMs are central to the Trustee's claims and are
The Complaint also contains a number of allegations which attempt to show that Ellison was aware of the DBSI's dire financial picture in the years leading up to its bankruptcy. For example, it alleges that Ellison attended accounting and finance presentations where he was informed of the company's financial problems and short-term cash needs. It also alleges these issues were also raised at board meetings, which Ellison attended and for which he prepared minutes. (Id. at ¶¶ 19, 20, 112, 175, & 497). The Complaint also points to the fact that Ellison prepared term sheets for note offerings as evidence that he was aware of DBSI's ever-growing debt. (Id. ¶ 114, 177). It also asserts that Ellison was responsible for instituting the "Loan Committee" which oversaw the disbursement of loans by various Internal Funding Programs as a cover for the Insiders' fraudulent scheme. (¶¶ 113, 176, 424-426). It asserts that Ellison was responsible for supervising in-house attorneys who worked on the financial statements, and that in June of 2008, he himself prepared certain "footnotes" to financial statements, though the nature of these footnotes is not explained. (¶ 498). Finally, the Trustee asserts that two DBSI accounting employees, Paris Cole and Matt Duckett, informed Ellison that DBSI's financial statements did not conform to Generally Accepted Accounting Principles ("GAAP"). (¶ 502). The Complaint also alleges that Ellison admitted in his interview with the Bankruptcy Examiner that he was aware that the Accountable Reserve funds — which were supposed to have been used only for certain limited purposes, such as capital improvements, leasing commissions, taxes and insurance — were not segregated. (Id., ¶ 378). The Trustee also asserts, on information and belief, that Ellison would have been responsible for drafting or reviewing the "Accountable Reserve" language contained in all or most of the PPMs. (Id. ¶ 307).
The present motions are governed by the standards of Rule 8(a) and Rule 9(b) of the Federal Rules of Civil Procedure. Federal Rule of Civil Procedure 9(b) requires that, when fraud is alleged, "a party must state with particularity the circumstances constituting fraud." Gibson v. Credit Suisse AG, 2012 WL 1253007 *1 (D.Idaho 2012) (quoting Kearns v. Ford
Beyond that, Rule 8(a)(2) requires only "a short and plain statement of the claim showing that the pleader is entitled to relief," in order to "give the defendant fair notice of what the ... claim is and the grounds upon which it rests." Fed. R.Civ.P. 8(a); Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). To survive a motion to dismiss, a complaint must contain sufficient factual matter, which, if accepted as true, would "state a claim to relief that is plausible on its face." Id. at 570, 127 S.Ct. 1955. See also, Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009). A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged. Twombly, 550 U.S. at 556, 127 S.Ct. 1955. The plausibility standard is not akin to a "probability requirement," but it asks for more than a sheer possibility that a defendant has acted unlawfully. Id. Where a complaint pleads facts that are "merely consistent with" a defendant's liability, it "stops short of the line between possibility and plausibility of entitlement to relief." Id, at 557, 127 S.Ct. 1955.
Thus, in considering the present motions, the Court will apply the standards of both Rule 8(a) and 9(b) apply to all fraud-based causes of action, and the standards of Rule 8(a) to everything else.
The Court will first address Ellison's argument that the Complaint violates Rule 8(a)(2). That rule, of course, provides that "a pleading that states a claim for relief must contain ... a short and plain statement of the claim showing that the pleader is entitled to relief." Fed. R. Civ. Pro. 8(a)(2). Ellison argues that the Trustee's
This argument has considerable merit. At least as to its length, the Trustee's Complaint approaches Tolstoyan proportions. It also, indisputably, engages in "group pleading" in that many, if not most, of the factual allegations do not address Ellison's conduct individually, but lump him together with the rest of the parties alleged to be "Insiders." A number of allegations are also made upon "information and belief," with no supporting facts-a practice that is not permissible under either the heightened pleading standards of Rule 9(b) or the PSLRA. See, 15 U.S.C. § 78u-4(b)(1); Neubronner v. Milken, 6 F.3d 666, 672 (9th Cir.1993). Compared to a number of the defendants in the companion case, Ellison's role in the overall structure of DBSI seems somewhat more limited. The Complaint also contains a number of allegations that are of so unspecific a nature that the Court is left wondering if the Trustee simply crammed the Complaint with every known fact about Ellison, whether significant or not, in order to bolster its credibility. To name just a couple of examples, the Trustee emphasizes that Ellison was involved with DBSI from 1979 onwards, but this is of little relevance to determining whether he played a role in a fraudulent scheme that is not alleged to have gotten underway until twenty-five years later. The Trustee also makes much of the fact that Ellison instituted the Loan Committee and selected its members, and that he prepared term sheets for note offerings. Allegations like this do nothing more than point out types of tasks that it would be common for an in-house attorney to perform, and do nothing to explain how Ellison knowingly furthered the alleged fraud.
All of these factors have led the Court to seriously consider ordering the Trustee to submit a much shorter complaint focusing specifically on Ellison's individual actions and his individual role in the overall scheme. It is not the job of district courts to stitch together cognizable claims from a wholly deficient pleading. See, Mann v. Boativright, 477 F.3d 1140, 1148 (10th Cir.2007). Dismissal under Rule 8(a) may be warranted where it is impossible to "separate the wheat from the chaff." Id. As one district court within the Ninth Circuit has observed:
Levine v. McDonald's Corp., 1979 WL 1648 (D.Ariz.1979).
What the Trustee appeal's to have done, in this case as well as in several others the Court has now had an opportunity to review, is to take the same basic complaint and adjust it slightly to address the individual defendant or defendants being sued. This was, to put the matter bluntly, a risky approach. A two hundred-page complaint might have been justifiable in Zazzali v. Swenson, considering that the Trustee had to 1) delineate a highly complex scheme of alleged fraud, 2) explain the role of at least eight different defendants, and 3) meet the heightened pleading standards applicable to various fraud claims. Taking the same approach in a
However, this is not the first DBSI case the Court has addressed. Prior to hearing the motion in this case, the Court had the opportunity to prepare a Report and Recommendation for similar motions brought by various defendants in the Zazzali v. Swenson matter. Having established an analytical framework for analyzing the various fraud-based claims in that case, it is somewhat less burdensome to simply apply that same logic to the factual allegations made here. The Ninth Circuit has held that verbosity and length are not, by themselves, sufficient bases for dismissing a complaint based upon Rule 8(a). See, Reams v. San Bernardino Police Dept., 530 F.3d 1124-1132 (9th Cir.2008). In this case, the Complaint, though admittedly of excessive length considering that only a single defendant is being sued, nonetheless meets minimal standards of intelligibility and organization identified in the Hearns case.
Despite this, if the Court were convinced that requiring the Trustee to narrow the complaint would in any way make the parties' task of litigating this case more manageable, it would do so. But the presence of several conspiracy-based claims convinces the Court that ultimately, such an exercise would probably not help turn an unwieldy case into a tidier one. Where a conspiracy is alleged, all members of a conspiracy are jointly and severally liable for the acts of their co-conspirators, even if they are unaware of the overall scope of the conspiracy. This rule has an unimpeachable pedigree in American jurisprudence. See, e.g., Beltz Travel Service, Inc. v. International Air Transport Ass'n, 620 F.2d 1360 (C.A.Cal.1980) (antitrust case); Securities Investor Protection Corp. v. Vigman, 908 F.2d 1461 (9th Cir.1990) (securities fraud case); Oki Semiconductor Co. v. Wells Fargo Bank, Nat. Ass'n, 298 F.3d 768 (9th Cir.2002); Aetna Cas. Sur. Co. v. P & B Autobody, 43 F.3d 1546, 1562 (1st Cir. 1994); Chubb & Son Inc. v. Kelleher, 2010 WL 5978913 at *6 (E.D.N.Y.2010) (civil RICO, collecting cases). The numerous allegations that do not address Ellison specifically do serve a purpose, in that they place him on knowledge of the scope of the conspiracy with which he is alleged to have played a role. Thus, though it is not without sympathy for the task Ellison and his attorneys face in responding to the Complaint, the Court concludes that requiring the Trustee to re-plead would probably not serve to make this case proceed in a smoother fashion.
The Court will next take up the question of whether the Complaint states valid claims for RICO and common law fraud, and in particular, whether these claims are pled with the particularity required by Rule 9(b). The Court will address the claims for securities fraud separately, because those claims are subject to an even more stringent pleading standard than that imposed by the Federal Rules of Civil Procedure.
The Report and Recommendation in Zazzali v. Swenson contained an extensive discussion of the legal background of RICO claims and the specific elements a plaintiff must plead in order to survive a motion to dismiss. The Court will not repeat that discussion here, but will instead incorporate it by reference and summarize those aspects of it that are most critical to the issues herein. (Zazzali v. Swenson R & R, p. 12-14).
In order to state a claim for a substantive RICO violation under either 18 U.S.C. § 1962(b) or (c), a plaintiff must plead the following elements: 1) conduct 2) of an enterprise 3) through a pattern 4) of racketeering activity. See, e.g. Odom v. Microsoft Corp., 486 F.3d 541, 547 (9th Cir.2007). Though sections 1962(b) and (c) have some distinct elements, the touchstone of both is that each individual defendant must be shown to have personally participated in a pattern of racketeering activity. "Racketeering activity," which is often referred to as the "predicate acts" requirement, may consist of "any act indictable under one of several provisions of Title 18 of the United States Code, including wire fraud, 18 U.S.C. § 1343, and mail fraud, 18 U.S.C. § 1961(1)(B)." Savage v. MTF Relocation Inc., 2012 WL 822954 (N.D.Cal.2012). A defendant need not personally have mailed the offending letter or made the offending telephone call in order to be liable for a substantive RICO violation. Rather, "the offense may be established where one acts with the knowledge that the prohibited actions will follow in the ordinary course of business or where the prohibited acts can reasonably be foreseen." U.S. v. Lothian, 976 F.2d 1257, 1262 (9th Cir. 1992) (citing Pereira v. United States, 347 U.S. 1, 9, 74 S.Ct. 358, 98 L.Ed. 435 (1954)). Though RICO violations are fraud-based claims that must conform to the strictures of Rule 9(b), Edwards v. Marin Park, Inc., 356 F.3d 1058, 1065-66 (9th Cir.2004), "malice, intent, knowledge, and other conditions of a person's mind may be alleged generally." Fed. R. Civ. Pro. 9(b); See also Odom v. Microsoft Corp., 486 F.3d 541, 553-54 (9th Cir.2006).
Like many of the Defendants in Zazzali v. Swenson, Ellison is alleged to have played a role in approving or "signing off on" the PPMs prior to their issuance. Though PPM work was apparently handled by DBSI's outside counsel during some of the relevant time frame, the Complaint specifically alleges that from about
For these reasons, the Court recommends that the federal RICO claims (Counts 1, 2, and 3) not be dismissed at this juncture. Since Idaho's racketeering statute closely tracks the federal statute, Counts 4, 5, and 6 should also not be dismissed.
The Court will next address whether the Plaintiffs federal RICO claims are barred by 18 U.S.C. § 1964(c). That statute provides that no RICO plaintiff "may rely upon any conduct that would have been actionable as fraud in the purchase and sale of securities to establish a violation of section 1962." 18 U.S.C. S 1964(c). This is true even if the acts that form the basis of liability would independently qualify as mail fraud or wire fraud under the federal criminal law. See, Bald Eagle Area Sch, Did. v. Keystone Fin., Inc., 189 F.3d 321, 327 (3rd Cir.1999) (holding that a plaintiff cannot avoid the securities fraud exception by pleading mail fraud or wire fraud "if the conduct giving rise to those offenses [also] amounts to securities fraud"); Armstrong v. American Pallet Leasing, Inc., 678 F.Supp.2d 827, 855-56 (N.D.Iowa 2009) (same); Ling v. Deutsche Bank, 2005 WL 1244689 at *3 (S.D.N.Y. May 26, 2005) (same); cf., Howard v. America Online, 208 F.3d 741, 749 (9th Cir.2000) (holding that the securities fraud exception in section 1964(c) is conduct-based). Thus, if the TIC investments are properly considered securities, any offering documents made in connection with them effectively do not "count" for purposes of establishing RICO liability.
The Trustee does not contest this legal proposition, but instead, argues that the characterization of the TIC investments is a factual question not amenable to resolution on a motion to dismiss. Contrary to the Defendant's assertions, it does not appear that the Complaint unequivocally characterizes the TIC investments as securities. Rather, it appears that the Trustee has attempted to differentiate types of investments involved so as to preserve both RICO and securities fraud claims. Specifically, the Trustee's RICO clauses of action reference a "common design and purpose of fraudulently marketing securities
Just because the TIC investments involved real estate does not obviate the possibility that they were structured in such a way that they meet the definition of securities under federal law.
The above analysis does not affect the Idaho racketeering claims, because Idaho's statute has a broader definition of predicate acts, which specifically includes securities fraud. See, I.C. § 18-7803(a)(13) & (16).
For all the foregoing reasons, the Court recommends that the federal RICO causes of action not be dismissed on the basis of the securities fraud exception at this time.
Ellison also argues that RICO proximate cause is not pled with particularity. The Court disagrees. The Complaint establishes a very direct theory of causation: that the claimants were induced to invest in DBSI based upon false representations, and, as a result, lost money. Cf. Hemi Group LLC v. City of New York, NY, 559 U.S. 1, 130 S.Ct. 983, 175 L.Ed.2d 943 (2010) (holding that RICO proximate cause should be evaluated in light of its common law foundations). The Complaint also alleges numerous misstatements that misled investors, and also alleges that each investor had to certify that in making the decision to invest, he or she relied upon the offering document at issue. (Complaint, ¶ 47). For pleading purposes, this is sufficient to establish proximate cause.
In Exhibit B to the Complaint, the Trustee has identified the various PAT assignors and also purports to identify the offerings in which they invested. (See, Trustee's Opposition Brief, p. 17 & Dkt. 1, Exh. B). Though it may be somewhat difficult for a person not familiar with the Trustee's designations to understand which particular offering each claimant invested in, it appears that there has at least been an attempt to provide this information. This is not a critical issue at
In Idaho, fraud consists of "(1) a statement or a representation of fact, (2) its falsity, (3) its materiality, (4) the speaker's knowledge of its falsity, (5) the speaker's intent that there be reliance, (6) the hearer's ignorance of the falsity of the statement, (7) reliance by the hearer, (8) justifiable reliance, and (9) resultant injury." Washington Federal Sav. v. Van Engelen, 153 Idaho 648, 289 P.3d 50, 2012 WL 5665109 (Idaho 2012.) Other than the requirements that the defendant must knowingly make a false statement, there is no specific "scienter" requirement for fraud in Idaho. See, e.g., Staff of Idaho Real Estate Comm'n v. Nordling, 135 Idaho 630, 635, 22 P.3d 105 (2001). As discussed above, Ellison is linked with numerous allegedly false statements in the PPMs by virtue of his having "signed off on them. The state of mind for common lawT fraud may be averred generally. See, McCoy v. Lyons, 120 Idaho 765, 820 P.2d 360 (1991). Therefore, the Complaint states valid common law fraud claims.
Since alternative pleading is possible, the Court recommends that the claims for aiding and abetting fraud also not be dismissed at this juncture. The Court assumes for purposes of this motion that Idaho would recognize such a cause of action. See, O'Banion v. Select Portfolio Services, Inc., 2010 WL 3834055 at *5 (D.Idaho 2010). Read in a light most favorable to the Plaintiff, the Complaint alleges that Ellison was aware of at least certain aspects of the alleged fraud, particularly the way the use of Accountable Reserve funds were being used, and that he provided substantial assistance to the other Insider Defendants in carrying out this scheme. Id. Consistent with the Court's earlier recommendation in Zazzali v. Swenson, the Court will recommend that Count 22 (fraudulent concealment) be dismissed as a stand-alone theory of recovery. Such a ruling, however, would not preclude Plaintiff from asserting a theory of fraudulent concealment as a rebuttal to affirmative defenses such as the statute of limitations.
Though Trustee has brought securitiesrelated claims arising both under federal and Idaho law, the parties focus their briefing on the question of whether the Complaint meets the pleading requirements of the PSLRA. Accordingly, the Court will focus its discussion on that issue as well.
A claim under Rule 10b-5 requires a demonstration of the following elements: 1) a misrepresentation or omission of materia] fact; 2) scienter 3) reliance; 4) causation and 5) damages, as well as a demonstration that the misrepresentations were made in connection with the sale of securities. See, e.g.. Livid Holdings, Inc. v. Solomon Smith Barney, Ltd., 416 F.3d 940, 946 (9th Cir.2005) & 15 U.S.C. § 78j(b). "[T]he enactment of the Private Securities Litigation Reform Act ("PSLRA") in 1995 significantly altered pleading requirements in private securities
In order to survive a motion to dismiss, a securities fraud complaint must state facts which give rise to an inference of scienter that is "cogent and at least as compelling as any other non-fraudulent inference." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 314, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). In order to prove the required state of mind in a securities fraud action, "the plaintiffs must show that defendants engaged in knowing or intentional conduct.... [R]eckless conduct can also meet this standard to the extent that it reflects some degree of intentional or conscious misconduct." South Ferry LP, No. 2 v. Killinger, 542 F.3d 776, 782 (9th Cir.2008). Tellabs further instructs that the allegations in a securities fraud complaint are to be read "holistically," rather than in a segmented fashion that separately analyzes different types of scienter allegations. See, Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 991-92 (9th Cir.2009).
For somewhat different reasons than those discussed in Zazzali v. Swenson, the Court concludes that the Complaint states valid claims for securities fraud. It does not appear that Ellison was as integrated into the overall structure and management of the various DBSI companies as some of the defendants in the companion case. This is apparent from a glance at Exhibit "A," which lists Ellison only twice, as a member of the Board of Directors of DBSI, Inc. and of DBSI Reality, Inc. This is in contrast to the defendants in Zazzali v. Sivenson, many of whom were officers and/or directors of numerous DBSI entities. (Complaint, Exh. A). For these reasons, the "core operations" inference, which the Court concluded was permissible as to several of the defendants in the Swenson case, falls short in this context. Cf. City of Marysville v. NightHawk Radiology, Holdings, Inc., 2011 WL 4584778 at *21 (D.Idaho 2011) (holding that the core operations inference, standing alone,
In its briefing, the Trustee points to a number of facts that allegedly support an inference of scienter to support all fraudbased causes of action, including securities fraud. Specifically, the Trustee cites 1) Ellison's longstanding relationship with Douglas Swenson 2) the fact that he was a founding member of DBSI; 3) his status as general counsel during the relevant time frames; 4) his attendance at board meetings and accounting and finance presentations where DBSI's financial difficulties were discussed; 5) his role in drafting and/or approving PPMs and DDBs for certain TIC and funding entity offerings; 6) the fact that he spearheaded the FOR 1031 concept, instituted the Loan Committee, and prepared term sheets for note offerings; and 7) his awareness that DBSI's financial statements did not conform to GAAP. (Trustee's Brief at p. 13, Dkt. 19, Complaint 1502). Finally, the
Many of these facts are, at best, equivocal. As discussed above, certain factsfor example, Ellison's longstanding relationship with Douglas Swenson, the bare fact that he instituted the Loan Committee, and the unexplained reference to "footnotes" to financial statements that he supposedly drafted, do not, without any contextual support, seem to have much bearing on Ellison's state of mind.
Other allegations, however, are more to the point. One of the Trustee's primary theories of liability has to do with the "Accountable Reserve" language found in most, if not all, of the PPMs. According to the Trustee, the Accountable Reserves were funds routinely designated by DBSI to be set aside to pay costs and expenses in connection with TIC investment properties over the terms of the master lease. Per the terms of various PPMs, these funds had certain, quite limited, authorized uses. (Id,, p. 2). The Trustee asserts that the Accountable Reserve language in various PPMs misled investors into believing that these monies would be segregated, when in fact, they were commingled with company funds, used to pay existing debts, and used to fund payments to Insiders. (Id., ¶ 310, 316, 322, 329, 334, 341, 346, & 349). Critically, the Trustee alleges that in an interview with the Bankruptcy Examiner in August of 2009, Ellison admitted that the Accountable Reserve funds were not segregated into separate accounts. (Id., ¶ 378). It also alleges that Ellison drafted or reviewed the Accountable Reserves language found in many, if not all, of the PPMs. Although this allegation is made on information and belief, there is a vague factual hint that this task would have fallen to Ellison as DBSI's general counsel. (Id,, ¶ 307).
Though the issue is a close one, the Court concludes that these allegations create a strong inference of scienter at least as to those aspects of the claims arising from the commingling of the Accountable Reserve Funds. Publication of false information may itself be indicative of scienter "where it is combined with allegations regarding a management's role in the company that are particular and suggest that the defendant had actual access to the disputed information," or when such allegations "are buttressed with detailed and specific allegations about management's exposure to factual information within the company." Zucco Partner's, LLC v. Digimarc Corp., 552 F.3d 981, 1000 (9th Cir. 2009).
By his own admission, Ellison was aware that the Accountable Reserve monies were not being segregated. Given the extensive involvement of Ellison and the legal department in PPM work, it is fair to infer that Ellison was generally aware of the contents of those PPMs, including the Accountable Reseive language that was allegedly misleading to investors. The Complaint alleges that from 2006 onwards,
Certain other allegations of the complaint serve to buttress the inference of scienter. In particular, the Complaint alleges that Ellison was informed by Paris Cole and Matthew Duckett that DBSI's financial statements did not conform to generally accepted accounting principles ("GAAP") and that DBSI was not keeping up with changes in accounting standards. (Complaint, ¶ 502). Violations of GAAP may be a factor in the scienter calculus where they are significant and obvious. See, e.g. In re Daou Systems, Inc., 411 F.3d 1006 (9th Cir.2005) ("violations of GAAP can also provide evidence of scienter when significant violations are described with particularity"); see, also, In re MicroStrategy Inc., Securities Litigation, 115 F.Supp.2d 620 (E.D.Va.2000) (collecting cases and holding that "when the number, size, timing, nature, frequency, and context of the misapplication or restatement are taken into account, the balance of the inferences to be drawn from such allegations may shift significantly in favor of scienter."). Here, the Trustee has alleged a number of specific violations of accounting standards that enabled DBSI to conceal its insolvency. These violations are described in paragraphs 503 to 517 of the Complaint. For example, the Complaint alleges that DBSI failed to record several hundred million dollars' worth of liabilities it had guaranteed. These could not accurately be described as contingent liabilities, because DBSI was continually disbursing funds to support TIC entities that could not generate sufficient income to meet their rent and loan obligations. (Id. ¶ 504). According to the Complaint, guarantee liability on the TIC portfolio alone was in excess of several hundred million dollars. (Id., ¶ 505). It also alleges that DBSI was able to mask its insolvency by overstating assets in the form of receivables from affiliates, by failing to account for the near total insolvency of some of these affiliates. In particular, as recently as June 30, 2008, DBSI listed Stellar and the Technology Companies as having a value of $235,000,000. (Id., ¶¶ 506-507). The Trustee alleges that un-collectable debts from affiliates were also used to offset "hard" debts with a defined maturity date, thus creating an impression of solvency. (Id., ¶ 508). These allegations describe significant departures from accepted accounting standards that overstated DBSI's net worth by very large amounts, sometimes hundreds of millions of dollars. Thus, the Complaint identifies significant violations of accounting standards and describes them with particularity sufficient to meet the standards articulated by the Ninth Circuit In re Daou Systems, Inc.
For all these reasons, the Court recommends that the securities fraud claims not be dismissed. Consistent with its decision in Zazzali v. Sivenson, the Court will also recommend that the control person liability claims not be dismissed, on the basis that alternative pleading is possible, though again, the concept of control person liability seems conceptually ill-suited where primary violations are alleged. Zazzali v. Sivenson R & R, (Dkt., 256, p. 27). Because Defendants have offered no argum it as to the Idaho securities fraud
The Trustee has brought two negligence claims. The first (Count 7) is styled as a legal malpractice claim, and is brought on behalf of the Estate Litigation Trust. The second claim (Count Twelve) is styled as a simple negligence claim, but references "professional duties of care." Count Twelve is brought on behalf of both the Estate Litigation Trust and the Private Action Trust.
The Court recommends that Count Twelve be dismissed, without leave to amend. Under Idaho law, the Trustee does not have a viable negligence claim against Ellison on behalf of the investors or creditors who have assigned their claims to the PAT. See, Harrigfeld v. Hancock, 140 Idaho 134, 139, 90 P.3d 884, 889 (2004) (holding that a direct attorney-client relationship must exist between a plaintiff and an attorney-defendant except in the very narrow circumstance of beneficiaries under a will). While it is true that Count Twelve is not overtly styled as a legal malpractice claim, the only duties mentioned in this count are "professional duties of care." This appears to be a malpractice claim in disguise, and thus, as to the ELT, it overlaps with Count Seven. It should therefore be dismissed in its entirety.
Ellison's argument regarding Count Seven is twofold. He first argues that Idaho courts have never recognized claims by a corporation against an in-house attorney. In support of this proposition, he relies on an unpublished decision from California, 1538 Cahuenga Partners, LLC v. Fabe, 2012 WL 19519 (Cal.App.2012).
In Idaho, the elements of a legal malpractice claim are: 1) the existence of an attorney-client relationship; 2) the existence of a duty on the part of the lawyer; and 3) failure to perform the duty, and 4) proximate cause. Bishop v. Owens, 152 Idaho 616, 620, 272 P.3d 1247, 1251 (Idaho 2012). Case lawr on this issue is sparse, but a number of professional publications suggest that claims against inhouse counsel, though rare overall, are fairly common where a third party such as a trustee or receiver takes over management of a company. See, e.g., Blowing Whistles & Climbing Ladders, 23 No. 4 ACDKT 32 at *43 (April 2005); Business Counselor's Law and Compliance Practice Manual § 4:4 (March 2013). The Cahuenga Partners case notwithstanding, the present claim fits within the framework for legal malpractice established by Idaho courts, and the Court can discern no reason why in-house attorneys would be an exception to the general rule.
Ellison also argues that the Complaint does not adequately state a claim for legal malpractice arising from his duties as DBSI's outside attorney. (Response Brief, p. 18). This assertion has some merit. While Count Seven contains an adequate enough description of the allegedly negligent conduct, it also asserts that Ellison, "both as DBSI's outside counsel and inhouse counsel, including as general counsel, owed duties of care to DBSI." (Complaint, ¶ 635) (emphasis added). However, Ellison did not return to DBSI as in-house counsel until 2004, which is also when the Trustee has alleged that DBSI began to take on characteristics of a Ponzi scheme. Likewise, the PPMs referenced in the Complaint were all for offerings dating from 2005 or later. (Id,, ¶¶ 195-235). It is not at all clear what events dating from before Ellison's return to DBSI in 2004 have to do with the present lawsuit. However,
To summarize, the Court recommends that Count Twelve be dismissed in its entirety, and Count Seven be dismissed with leave to amend to clarify what, if any, role Ellison's pre-2004 conduct plays in the present context.
Consistent with its ruling in Zazzali v. Swenson, the Court will recommend that claims for breach of fiduciary duties be treated as fraud-based claims that must be pled with particularity. (Report & Recommendation, p. 28-29).
Count Eight is a breach of fiduciary duty claim filed on behalf of the ELT. The Court recommends that it be dismissed, subject to leave to amend. Not only does it fail to differentiate between Ellison and the other members of the "Control Group," it also fails to identify the specific fiduciary relationship at issue and the conduct that allegedly violated that relationship. As the Court observed in Zazzali v. Swenson, breach of fiduciary duty claims arise from specific types of relationships, which must be identified before any claim can lie. "Before a fiduciary duty can be breached, there must exist a fiduciary relationship. A fiduciary relation exists between two parties when one is under a duty to act or to give advice for the benefit of the other upon a matter within the scope of the relation." Podolan v. Idaho Legal Aid Services, Inc., 123 Idaho 937, 947, 854 P.2d 280 (Ct.App.1993). Simply because Ellison may have been a fiduciary of one or two of the DBSI entities does not mean that he was in a fiduciary relationship to all the Debtor Entities at all relevant times. Thus, the Court recommends that Count 8 be dismissed, subject to leave to amend. Any amendment must focus more specifically on Ellison and identify, at a minimum: 1) the specific relationship or facts alleged to give rise to fiduciary duties 2) the relevant Debtor entity or entities 3) the conduct that allegedly breached that relationship and 4) the dates of the conduct and the dates of the relationship.
Count 9 is a claim for Aiding and Abetting Breach of Fiduciary Duty on behalf of the Estate Litigation Trust and Count 18 is a similar claim on behalf of the Private Action Trust. In order to be liable for aiding and abetting a civil wrong, a plaintiff must allege 1) the existence of an underlying wrong 2) that there was knowledge of the wrong on the part of the aider and abettor; 3) substantial assistance by the aider and abettor, and 4) damages proximately caused thereby. O'Banion v. Select Portfolio Services, Inc., 2010 WL 3834055 *4 (D.Idaho 2010); Cf. State Dept. of Finance v. Tenney, 124 Idaho 243, 250, 858 P.2d 782, 789 (Ct.App.1993) (citing substantially similar elements for aiding and abetting securities fraud under Idaho law). The Court recommends dismissal of these Counts with leave to amend, for reasons similar to those stated for Count 8. Any amendment must specify the above described elements with the specificity required by Rule 9(b).
Count Seventeen is a Breach of fiduciary duty claim brought on behalf of the Private Action Trust. (Complaint, p. 129). The Court will recommend that this claim be retained, at least for the time being. The claim arises from the alleged commingling of the Accountable Reserve funds. Essentially, the Trustee asserts
"The question of whether to permit a claim for punitive damages is substantive in nature and accordingly is controlled by relevant Idaho [law]" for all claims and causes of action arising under state law. Bauer v. Metropolitan Life Ins. Co., 2010 WL 2595291 at *5 (D.Idaho 2010); See also, Wisdom v. Centerville Fire Dist, Inc., 2010 WL 468094 at *11 (D.Idaho 2010) ("a federal court exercising supplemental jurisdiction over state law claims is bound to apply the law of the forum state to the same extent as if it were exercising its diversity jurisdiction."). Accordingly, the claim for punitive damages should be dismissed, subject to leave to amend according to the procedures set forth in LC. § 6-1604. However, the Trustee is also correct that this logic would not apply to the treble damages provision of RICO, or to any other aspect of damages arising under a federal statute.
In Zazzali v. Swenson, the Court held that Idaho does not recognize a cause of action for negligent misrepresentation outside the narrow confines of an accountantclient relationship. The Court will adhere to that recommendation in this Report. The Trustee has accepted without argument, and has indeed argued in favor of, application of Idaho law to the state racketeering and securities fraud claims, the common law fraud claim, the malpractice claims, and the fiduciary duty claims. The Trustee offers no explanation as to why Idaho law would apply to some claims and not others. Thus, it appears to the Court that there is not a genuine choice of law issue here, but rather, a formalistic attempt to preserve a cause of action that is simply not recognized in this state.
Next, while civil conspiracy is not an independent tort, it can give rise to legal remedies "if there is an agreement between two or more [individuals] to accomplish an unlawful objective in an unlawful manner." See, e.g. Mannos v. Moss, 143 Idaho 927, 935, 155 P.3d 1166, 1174 (2007); Gibson v. Credit Suisse, 787 F.Supp.2d 1123, 1139 (D.Idaho 2011). The Court recommends that this claim be retained, for the same reasons as stated in the Zazzali v. Swenson Report and Recommendation.
As in Zazzali v. Swenson, the Court will recommend granting the motion to dismiss Counts 11 and 16 to the extent that they contain misappropriation claims. These claims arise from the alleged commingling of Accountable Reserve funds with general operating accounts. However, the very fact of the co-mingling forecloses an equitable
DATED: May 9th, 2013.
