IN THE UNITED STATES DISTRICT COURT FOR THE...

IN THE UNITED STATES DISTRICT COURT FOR THE MIDDLE DISTRICT OF NORTH CAROLINA

SJK ABSOLUTE RETURN FUND, LLC and SJK ABSOLUTE RETURN FUND, LTD.,

Plaintiffs,

v. EISNERAMPER LLP f/k/a EISNER LLP and EISNERAMPER (CAYMAN) LTD. f/k/a EISNER (CAYMAN) LTD.,

Defendants.

Case No. 1:13-CV-000432-TDS-JEP

PLAINTIFFS’ RESPONSE IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS

TROUTMAN SANDERS LLP Gary S. Parsons (N.C. State Bar No. 7955) D. Martin Warf (N.C. State Bar No. 32982) Post Office Drawer 1389 Raleigh, North Carolina 27602-1389 Telephone: (919) 835-4107 Facsimile: (919) 829-8715 [email protected] [email protected] J. David Dantzler, Jr. (GA Bar No. 205125) Thomas B. Bosch (GA Bar No. 068740) Mary M. Weeks (GA Bar No. 559181) 600 Peachtree Street, Suite 5200 Atlanta, GA 30308 Phone: (404) 885-3591 Facsimile: (404) 962-6727 [email protected] [email protected] [email protected]

Case 1:13-cv-00432-TDS-JEP Document 24 Filed 08/26/13 Page 1 of 28

mailto:[email protected]





TABLE OF CONTENTS

Page

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PRELIMINARY STATEMENT .........................................................................................1

STATEMENT OF FACTS .................................................................................................2

STANDARD OF REVIEW UNDER RULE 12(B)(6) .......................................................6

ARGUMENT AND CITATION OF AUTHORITY ..........................................................7

I. EISNER HAS NOT DEMONSTRATED THAT THE ALLEGATIONS IN THE COMPLAINT ESTABLISH UNEQUIVOCALLY THAT IN PARI DELICTO BARS THE FUNDS’ CLAIMS .............................................................8 A. The Funds Were Not “Equally At Fault” for Their Losses ..........................8 B. The Authority Relied Upon By Eisner Does Not Support the

Application of In Pari Delicto to the Funds’ Claims ..................................11 II. EISNER CANNOT DEMONSTRATE THAT, AS A MATTER OF LAW,

THE ALLEGATIONS IN THE COMPLAINT PRECLUDE THE FUNDS FROM INVOKING THE ADVERSE INTEREST EXCEPTION TO THE DEFENSE OF IN PARI DELICTO ......................................................................14 A. The Complaint Alleges That the Funds Were the Victims of, And

Did Not Benefit From, Kowalewski’s And SJK’s Wrongful Conduct ......14 B. North Carolina Has Not Adopted the Sole Actor Exception And It

Does Not Apply Based Upon the Allegations of the Complaint ................16 III. PUBLIC POLICY DICTATES THAT THE FUNDS SHOULD BE

PERMITTED TO PURSUE THEIR CLAIMS......................................................19

CONCLUSION .................................................................................................................20


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TABLE OF AUTHORITIES

Page(s) CASES

Allegheny Official Comm. of Unsecured Creditors of Allegheny Health Educ. & Research Found. v. Pricewaterhousecoopers, LLP 989 A.2d 313, 335-36 (Pa. 2010) ................................................................................. 12

Bechtle v. Master, Sidlow & Assocs., P.A., 766 F. Supp. 2d 547 (E.D. Pa. 2011) .............................................................................. 7

Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) ....................................................................................................... 7

Blackburn v. Trs. of Guilford Tech. Cmty. Coll., 822 F. Supp. 2d 539 (M.D.N.C. 2011) ........................................................................... 7

Bowden v. Agnew, 2013 U.S. Dist. LEXIS 97593 (M.D.N.C. July 11, 2013) .............................................. 7

Buckley v. Deloitte & Touche USA LLP, 2007 U.S. Dist. LEXIS 37107 (S.D.N.Y. May 21, 2007) .............................................. 8

Cauble v. Trexler, 42 S.E.2d 77 (N.C. 1947) ............................................................................................. 19

Cenco Inc. v. Seidman & Seidman, 686 F.2d 449 (7th Cir. 1982) ........................................................................................ 14

Chaikovska v. Ernst & Young, LLP, 78 A.D.3d 1661 (N.Y. App. Div. 2010) ....................................................................... 13

Comeau v. Rupp, 810 F. Supp. 1127 (D. Kan. 1992) ......................................................................... 14, 17

FDIC v. Ernst & Young, 967 F.2d 166 (5th Cir. 1992) ........................................................................................ 17

Hays v. Paul Hastings, Janofsky & Walker LLP, 2006 U.S. Dist. LEXIS 95849 (N.D. Ga. Sept. 14, 2006) ............................................ 13

Hice v. Hi-Mil, Inc., 273 S.E.2d 268 (N.C. 1981) ......................................................................................... 14


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In re Adelphia Commc’ns Corp., 365 B.R. 24 (Bankr. S.D.N.Y. 2007) ........................................................................... 18

In re AMERCO Derivative Litig., 252 P.3d 681 (Nev. 2011) ............................................................................................. 18

In re Cree, Inc. Sec. Litig., 333 F. Supp. 2d 461 (M.D.N.C. 2004) ........................................................................... 4

In re Friedman’s Inc., 394 B.R. 623 (S.D. Ga. 2008) .......................................................................... 14, 18, 20

In re Jack Greenberg, Inc., 212 B.R. 76 (Bankr. E.D. Pa. 1997) ............................................................................. 17

In re Mediators, Inc., 105 F.3d 822 (2d Cir. 1997) ......................................................................................... 17

In re Hoang, 449 B.R. 850 (Bankr. Md. 2011), rev’d on other grounds, 2013 U.S. Dist. LEXIS 38478 (D. Md. Mar. 15, 2013) ......................................................................... 16

In re Neri Bros. Constr. Corp., 323 B.R. 540 (Bankr. D. Conn. 2005) .......................................................................... 17

In re NM Holdings Co., 622 F.3d 613 (6th Cir. 2010) .................................................................................. 16, 18

In re Parmalat Sec. Litig., 383 F. Supp. 2d 587 (S.D.N.Y. 2005) .......................................................................... 14

In re Sharp Int’l Corp., 319 B.R. 782 (Bankr. E.D.N.Y. 2005) ................................................................... 16, 18

In re Sunpoint Sec., Inc., 377 B.R. 513 (Bank. E.D. Tex. 2007) ........................................................ 10, 14, 17, 20

In re Vendsouth, Inc., 2003 Bankr. LEXIS 1437 (Bankr. M.D.N.C. Oct. 9, 2003) ..................................... 8, 14

In re Wedtech Corp., 81 B.R. 240 (S.D.N.Y. 1987) ....................................................................................... 15


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Kirschner v. KPMG LLP 938 N.E.2d 941, 946 (N.Y. 2010) .................................................................... 12, 14, 16

Latta v. Rainey, 689 S.E.2d 898 (N.C. Ct. App. 2010) ......................................................................... 8, 9

Mosier v. Stonefield Josephson, Inc., 2011 U.S. Dist. LEXIS 124058 (C.D. Cal. Oct. 25, 2011) .......................................... 13

NCP Litig. Trust v. KPMG LLP, 901 A.2d 871 (N.J. 2006) ............................................................................................. 20

Nisselson v. Lernout, 469 F.3d 143 (1st Cir. 2006) ........................................................................................ 13

Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Coopers & Lybrand, LLP, 322 F.3d 147 (2d Cir. 2003) ................................................................................... 13, 17

Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) ................................................................................... 16, 17

Picard v. JPMorgan Chase Bank & Co. (In re Bernard L. Madoff Inv. Sec. LLC), 2013 U.S. App. LEXIS 12551 (2d Cir. June 20, 2013) ........................................ passim

PNC Bank Ky., Inc. v. Hous. Mortg. Corp., 899 F. Supp. 1399 (W.D. Pa. 1994) ............................................................................. 17

Republican Party of N.C. v. Martin, 980 F.2d 943 (4th Cir. 1992) .......................................................................................... 7

Royster v. McNamara, 723 S.E.2d 122 (N.C. Ct. App. 2012) ............................................................................. 9

In re Sharp Int’l Corp., 319 B.R. 782 (Bankr. E.D.N.Y. 2005) ................................................................... 16, 18

Shell Trademark Mgmt. BV v. Ray Thomas Petroleum Co., 642 F. Supp. 2d 493 (W.D.N.C. 2009) ........................................................................... 8

Skinner v. E.F. Hutton & Co., 333 S.E.2d 236 (N.C. 1985) ....................................................................................... 7, 9


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Smith v. Arthur Anderson L.L.P, 175 F. Supp. 2d 1180 (D. Ariz. 2001) .......................................................................... 18

Thabault v. Chait, 541 F.3d 512 (3d Cir. 2008) ......................................................................................... 17

USACM Liquidating Trust v. Deloitte & Touche, LLP, 764 F. Supp. 2d 1210 (D. Nev. 2011) .......................................................................... 13

Wechsler v. Squadron, Ellenoff, Plesent & Sheinfeld, LLP, 212 B.R. 34 (S.D.N.Y. 1997) ....................................................................................... 17


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PRELIMINARY STATEMENT

From December 2009 until January 2011, Stanley J. Kowalewski (“Kowalewski”)

and SJK Investment Management, LLC (“SJK”) looted millions of dollars from

Plaintiffs, the SJK Absolute Return Fund, LLC (the “Onshore Fund”) and the SJK

Absolute Return Fund, Ltd. (the “Offshore Fund”) (collectively, the “Funds”), for

Kowalewski’s own personal benefit. Specifically, Kowalewski and SJK caused the

Funds to transfer millions of dollars to the SJK Special Opportunities Fund, LP (the

“Special Opportunities Fund”), a sham hedge fund created by Kowalewski to paper over

his misappropriations from the Funds. Kowalewski used the money he diverted from the

Funds to, among other things, purchase his personal residence for $2.8 million (at

approximately $1 million over market value), purchase a beach house on Pawley’s Island,

South Carolina for $3.9 million, and pay for hundreds of meal, travel, and entertainment

expenditures. The Funds were the victims of Kowalewski’s and SJK’s conduct and

obtained no benefit from their misappropriations.

Defendants EisnerAmper LLP f/k/a Eisner LLP and EisnerAmper (Cayman) Ltd.

f/k/a Eisner (Cayman) Ltd. (collectively “Eisner”) audited the Funds’ 2009 year-end

financial statements. Because the day-to-day operations of the Funds were managed by

Kowalewski and SJK, Eisner’s audits provided the Funds’ independent director,

members, and shareholders with critically important, independent verification of the

Funds’ financial health. In conducting its audits, Eisner failed to adhere to Generally

Accepted Auditing Standards (“GAAS”) by, among other things, failing to properly audit

the Funds’ transfers to the Special Opportunities Fund.

Ultimately, on June 1, 2010, Eisner issued an unqualified audit opinion for each

Fund, which falsely attested to the veracity of the Fund’s financial statements. As a


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result of Eisner’s professional malpractice, SJK’s and Kowalewski’s fraud against the

Funds went undetected, Kowalewski was able to continue stealing from the Funds, and

the Funds incurred millions of dollars in additional losses.

Eisner does not contend that the Complaint fails to state prima facie claims for

accounting malpractice and breach of contract. Rather, Eisner attempts to hide behind

the affirmative defense of in pari delicto to avoid liability for its clear professional

malpractice.

Eisner bears the burden of demonstrating that in pari delicto, which requires a

fact-intensive inquiry, bars the Funds’ claims. As demonstrated herein, Eisner cannot

meet its burden. Initially, in pari delicto applies to prevent one wrongdoer from

recovering from another wrongdoer. Here, the Complaint alleges unequivocally that the

Funds were the victims of, and did not benefit in any way from, Kowalewski’s and SJK’s

wrongful conduct. Simply put, because the Funds were not wrongdoers, in pari delicto

cannot apply to their claims. Moreover, even if in pari delicto could apply in the first

instance, the Complaint alleges facts sufficient to invoke the “adverse interest” exception

– i.e., that Kowalewski’s interests were not aligned with, and his acts did not benefit, the

Funds. Finally, public policy dictates that Eisner should not invoke in pari delicto to

shield itself from liability for its clear professional malpractice. Therefore, Eisner’s

motion should be denied.

STATEMENT OF FACTS

The Funds. The Funds were formed in July 2009 by SJK, a small investment

advisor based in North Carolina and owned by Kowalewski. (¶¶ 9, 29.)1 The Funds were

1 Unless otherwise indicated, paragraph references (“¶ __” or “¶¶ __”) are to the Complaint.


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structured as “fund-of-funds” hedge funds, into which third parties invested money,

which money was then pooled together and reinvested by the Funds into other hedge

funds. (¶ 2.) Between July 6, 2009 and January 6, 2011, several investors invested a

total of $21 million in the Onshore Fund and $48.8 million in the Offshore Fund. (¶¶ 7,

30.) Except for the monies pilfered from the Funds by Kowalewski, investors’ monies

were invested with other hedge funds in accordance with the Funds’ “fund-of-funds”

structure. (¶¶ 2, 28.)

At all times relevant to the Funds’ claims, SJK acted as the Managing Member to

the Onshore Fund and the Investment Adviser to the Offshore Fund, subject to the

restrictions of each Fund’s governing documents and the control of its non-managing

members/shareholders. (¶¶ 31-38.) Kowalewski also served as one of two directors of

the Offshore Fund. (¶ 39.) The other director, David Bree, was independent and not

affiliated in any way with SJK or Kowalewski. (Id.)

SJK’s and Kowalewski’s power to control the Funds was subject to various

limitations. For example, the governing documents of the Funds provided, among other

things, that the Funds were expected to invest “substantially all” of their assets into

investment funds sponsored by “unaffiliated investment managers” and allocate no more

than 15% of their capital to a single investment fund. (¶¶ 32, 36.) In addition, the

Onshore Fund’s non-managing members and the Offshore Fund’s shareholders had

numerous rights, including the ability to terminate Kowalewski’s authority as Director,

Investment Adviser, or Managing Member and the right to redeem their investments.

(¶¶ 94, 104; see Defs.’ Br., Ex. A §§ 4.2(a), 6.6; Defs.’ Br., Ex. B ¶¶ 35, 104.)2 Finally,

2 As also recognized by Defendants, in considering the foregoing, the court may consider documents extraneous to the Complaint if they are “integral to and explicitly relied on in


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Kowalewski’s authority to manage the Offshore Fund required the consent of David

Bree, the Offshore Fund’s independent director. (¶ 104.)

Misappropriation by SJK and Kowalewski from the Funds. On November 30,

2009, Kowalewski formed the Special Opportunities Fund. (¶ 40.) Subsequently,

beginning in late 2009, SJK, acting primarily through Kowalewski, misappropriated

millions of dollars from the Funds to fund SJK’s business operations and to support

Kowalewski’s extravagant lifestyle. (¶¶ 3, 50, 54.) More specifically, from December

31, 2009 through June 1, 2010, Kowalewski diverted in excess of $8.5 million from the

Funds to the Special Opportunities Fund. (¶¶ 3, 50.)

To paper over his misappropriations, Kowalewski signed Subscription

Agreements on behalf of each Fund and the Special Opportunities Fund. (¶¶ 67-68.)

SJK and Kowalewski never informed the Funds’ investors or the Offshore Fund’s

independent director of these misappropriations. (¶ 105.)

Shortly after the Funds’ first transfers to the Special Opportunities Fund,

Kowalewski began using substantial amounts of the Funds’ money for his own personal

benefit or the benefit of SJK. (¶¶ 51, 78.) For example:

• On February 2, 2010, Kowalewski caused the Special Opportunities Fund to purchase Kowalewski’s residence for a purchase price of $2.8 million, which allowed Kowalewski to pay off mortgages totaling $2.2 million and retain almost $600,000 for personal use. (¶ 51(c).)

• On May 6, 2010, the Special Opportunities Fund purchased a beach house on Pawley’s Island, South Carolina for $3.9 million. (¶ 51(e).)

• From December 31, 2009 through May 31, 2010, Kowalewski used thousands of dollars of the Funds’ money for personal expenditures, including meals, travel, and entertainment. (¶¶ 51, 54.)

the complaint” and if the authenticity of the documents is not at issue. In re Cree, Inc. Sec. Litig., 333 F. Supp. 2d 461, 469 (M.D.N.C. 2004).


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None of the transfers from the Funds to the Special Opportunities Fund or the subsequent

use of the transferred monies by SJK and Kowalewski benefitted the Funds. (¶ 53.)

Rather, the Funds were the victims of SJK’s and Kowalewski’s wrongful conduct. (Id.)

Eisner’s Audits of the Funds. On October 29, 2009, each Fund engaged Eisner to

serve as its auditor for the year-ending December 31, 2009. (¶ 55.) During the course of

the audits, Eisner learned of millions of dollars in transfers from the Funds to the Special

Opportunities Fund. (¶¶ 4, 65, 67-69, 72.) Eisner knew that Kowalewski stood on both

sides of these transfers. (¶¶ 66-68.) Eisner also was provided with all of the information

and documents it requested and was not denied access to any records of the Funds, SJK,

or the Special Opportunities Fund. (¶¶ 64, 66, 71, 73.)

Based on its audit work, Eisner concluded that the Special Opportunities Fund was

a subsidiary of the Funds. (¶ 75.) Despite this conclusion and its knowledge that

Kowalewski stood on both sides of the transactions, Eisner failed to comply with GAAS

in conducting the audits. (¶¶ 117-25.) Among other failures, Eisner did not review the

Special Opportunities Fund’s 2010 bank statements and interim financial statements and

did not otherwise subject the Special Opportunities Fund to any further testing. (¶ 121.)

Had it reviewed this information, Eisner would have learned that Kowalewski was using

the monies he had misappropriated from the Funds to pay SJK’s expenses and to bankroll

his lavish lifestyle. (¶¶ 78, 90, 100, 121.) Making matters worse, Eisner did not even

require that the Funds’ financial statements reflect the Funds’ transfers to the Special

Opportunities Fund as related party transactions or material subsequent events. (¶¶ 80,

83-84, 87-89, 91, 97-99, 101, 124(d).)

Ultimately, on June 1, 2010, Eisner issued unqualified audit opinions for each

Fund, in which it attested that the Fund’s “financial statements and financial highlights . .


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. present fairly, in all material respects, the financial position of [the Funds] as of

December 31, 2009.” (¶¶ 4, 86, 96.) After Eisner issued the clean audits, Kowalewski

and SJK continued to misappropriate money from the Funds and use the misappropriated

money for their own benefit. (¶¶ 105-06.) Had Eisner properly conducted the audits, it

would not have issued unqualified audits, and the Offshore Fund’s outside director and

shareholders and the Onshore Fund’s innocent members could have prevented

Kowalewski from continuing to steal from the Funds and from spending the money that

he previously misappropriated under Eisner’s watch. (¶¶ 94, 104-05.) Thus, Eisner’s

professional malpractice caused the Funds to incur millions of dollars in losses. (¶ 106.)

The SEC Enforcement Action and the Receivership. SJK’s and Kowalewski’s

looting of the Funds continued until the Securities and Exchange Commission filed an

enforcement action against them on January 6, 2011 (the “SEC Enforcement Action”).

(¶ 107.) Neither of the Funds was named as a defendant in the SEC Enforcement Action,

and they are not alleged to have engaged in any wrongdoing. (¶¶ 107-08.)

On February 2, 2011, S. Gregory Hays (the “Receiver”) was appointed as

Receiver for Kowalewski3 and SJK, and, on March 8, 2011, he was appointed as

Receiver for the Special Opportunities Fund. (¶ 108.) The Funds, which are not in

receivership, and not the Receiver, are the Plaintiffs in this action. No claims are asserted

on behalf of SJK or Kowalewski – i.e., the wrongdoers. (¶¶ 9, 107-08.)

STANDARD OF REVIEW UNDER RULE 12(b)(6)

To survive a motion to dismiss, a complaint need only allege sufficient factual

matter to “state a claim to relief that is plausible on its face” by including “factual content

that allows the court to draw the reasonable inference that the defendant is liable for the 3 The receivership over Kowalewski was terminated on September 30, 2011. (¶ 108.)


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misconduct alleged.” Bowden v. Agnew, 2013 U.S. Dist. LEXIS 97593, at *12-13

(M.D.N.C. July 11, 2013) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570

(2007)). In considering a motion to dismiss, the Court “must accept as true all of the

factual allegations contained in the complaint, and all reasonable inferences must be

drawn in the plaintiff’s favor.” Blackburn v. Trs. of Guilford Tech. Cmty. Coll., 822 F.

Supp. 2d 539, 549 (M.D.N.C. 2011) (quoting Republican Party of N.C. v. Martin, 980

F.2d 943, 952 (4th Cir. 1992)).

The purpose of a motion to dismiss pursuant to Federal Rule of Civil Procedure

12(b)(6) is to “‘test[] the sufficiency of a complaint’ and not to ‘resolve contests

surrounding the facts, the merits of a claim, or the applicability of defenses.’” Id. See

Bowden, 2013 U.S. Dist. LEXIS 97593, at *13-14. Consequently, a motion to dismiss

based on an affirmative defense must be denied unless the allegations in the complaint

“disclose[] an unconditional affirmative defense which defeats the asserted claim.”

Skinner v. E.F. Hutton & Co., 333 S.E.2d 236, 238 (N.C. 1985).

ARGUMENT AND CITATION OF AUTHORITY

The sole basis for Eisner’s motion to dismiss is its argument that the Funds’ claims

are barred by the doctrine of in pari delicto. Because in pari delicto is an affirmative

defense, Eisner bears the burden of establishing its applicability to the Funds’ claims.

See id. Similar to other affirmative defenses, the application of in pari delicto requires a

fact intensive analysis that generally cannot be conducted on a motion to dismiss. See

Bechtle v. Master, Sidlow & Assocs., P.A., 766 F. Supp. 2d 547, 555 (E.D. Pa. 2011)

(denying motion to dismiss where in pari delicto defense not clear from allegations of the

complaint and defendants’ argument otherwise “rests on underdeveloped legal arguments

and oversimplifications of the legal requirements for the application of that defense”);


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Buckley v. Deloitte & Touche USA LLP, 2007 U.S. Dist. LEXIS 37107, at *14-15

(S.D.N.Y. May 21, 2007) (denying motion to dismiss to the extent based on the defense

of in pari delicto and collecting cases); cf. In re Vendsouth, Inc., 2003 Bankr. LEXIS

1437, at *45-47 (Bankr. M.D.N.C. Oct. 9, 2003) (denying defendants’ motion for

summary judgment where application of in pari delicto depended on resolution of

disputed issues of material fact).

To succeed on its motion, Eisner must make two distinct showings. First, it must

establish that the allegations in the Complaint establish unequivocally that in pari delicto

should be applied to bar the Funds’ claims. Second, even if Eisner can establish that in

pari delicto applies to the Funds’ claims in the first instance, it must also show that the

allegations in the Complaint preclude the Funds from invoking the “adverse interest”

exception to the defense. Eisner fails to make either showing.

I. EISNER HAS NOT DEMONSTRATED THAT THE ALLEGATIONS IN THE COMPLAINT ESTABLISH UNEQUIVOCALLY THAT IN PARI DELICTO BARS THE FUNDS’ CLAIMS.

A. The Funds Were Not “Equally At Fault” for Their Losses.

In pari delicto, which means “equally at fault,” provides that, where both parties to

a cause of action are equally at fault, neither can recover from the other. Latta v. Rainey,

689 S.E.2d 898, 910 (N.C. Ct. App. 2010).4 Further, as recognized by Eisner’s principal

authority, “[i]n pari delicto does not apply to all wrongdoers; the doctrine targets those

who actively participate in the illegal scheme and who are substantially at fault.” Picard

4 In its brief, Eisner concedes that North Carolina law should apply based upon the engagement of Eisner and the direction of Kowalewski’s misconduct within the State. (Defs.’ Br. at 4 n.2.) For purposes of the resolution of Eisner’s motion only, the Funds do not object to the application of North Carolina law. See Shell Trademark Mgmt. BV v. Ray Thomas Petroleum Co., 642 F. Supp. 2d 493, 503 n.3 (W.D.N.C. 2009).


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v. JPMorgan Chase Bank & Co. (In re Bernard L. Madoff Inv. Sec. LLC), 2013 U.S.

App. LEXIS 12551, at *22 n.12 (2d Cir. June 20, 2013) (“Madoff”) (internal quotations

and citations omitted). Lastly, in pari delicto, by definition, does not apply where the

plaintiffs do not share at least equal fault with the defendants from which recovery is

sought. See Royster v. McNamara, 723 S.E.2d 122, 128-29 (N.C. Ct. App. 2012) (in pari

delicto does not apply to professional malpractice claim where evidence did not establish

that the plaintiff was “in the wrong about the same matter whereof he complain[ed]”);

Skinner, 333 S.E.2d at 239; Latta, 689 S.E.2d at 910.

The Complaint’s allegations plainly establish that the Funds were not wrongdoers.

To the contrary, the Funds were the victims of Kowalewski’s and SJK’s fraudulent acts.

(¶¶ 53, 105.) Among other things, the Complaint alleges:

• The Funds were formed in July 2009 as “fund-of-funds” hedge funds and raised nearly $70 million from third party investors. (¶¶ 28, 30.)

• Kowalewski formed the Special Opportunities Fund in November 2009. (¶ 40.)

• From late 2009 through June 1, 2010 – i.e., the date that Eisner issued its unqualified audits – Kowalewski misappropriated in excess of $8.5 million from the Funds through a series of transfers to the Special Opportunities Fund. (¶¶ 3, 50.)

• Kowalewski used the misappropriated money to fund SJK and to bankroll his own extravagant lifestyle. (¶ 54.)

• After Eisner issued its unqualified audits, Kowalewski misappropriated millions of additional dollars from the Funds via transfers and continued to use misappropriated funds for his own benefit, including paying SJK’s operating expenses, purchasing additional family residences at inflated prices, and purchasing various boats and other watercraft for personal use. (¶ 106.)


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• The transfers from the Funds to the Special Opportunities Fund and the subsequent uses of the transferred money were not intended to benefit and, in fact, did not benefit the Funds. (¶ 53.)

Because the Funds were not wrongdoers – let alone active participants in Kowalewski’s

illegal scheme who are substantially at fault for their own losses – in pari delicto does not

apply.

Eisner’s argument that it “was itself an innocent victim of the fraud,” (Defs.’ Br.

at 2), does not change the analysis and is belied by the allegations of the Complaint.

Eisner was engaged to perform accounting services and issue an audit opinion regarding

each Fund’s year-end financial statements through December 31, 2009. (¶ 55.) During

the course of its audit, Eisner learned of the existence of the Special Opportunities Fund,

discovered the transfer of millions of dollars from the Funds to the Special Opportunities

Fund, and reviewed information and documents requested from the Funds and SJK – all

of which were promptly provided to Eisner upon request. (¶¶ 4, 64-69, 71-73.) Despite

its knowledge of the key facts surrounding the transfers from the Funds to the Special

Opportunities Fund, Eisner failed to perform any of the follow-up testing that it was

required to do in order to fulfill its duties to the Funds. (¶¶ 76-77.) See In re Sunpoint

Sec., Inc., 377 B.R. 513, 555 (Bank. E.D. Tex. 2007) (“The idea that fraud by a

company’s management is not reasonably foreseeable to an auditor is, of course,

preposterous.”). Ultimately, Eisner’s professional malpractice allowed Kowalewski’s

fraud against the Funds to go undetected and caused the Funds to incur millions of dollars

in additional losses. (¶¶ 105-06.) See In re Sunpoint Sec., Inc., 377 B.R. at 555 (“An

auditor should not escape liability for the harm which his negligence proximately caused

merely because a condition he was hired to detect was actually present (and went

undetected).”).


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B. The Authority Relied Upon By Eisner Does Not Support the Application of In Pari Delicto to the Funds’ Claims.

In support of its argument that in pari delicto bars the Funds’ claims, Eisner relies

primarily on three recent decisions, which it claims “are based on facts that are closely

analogous to those alleged by [the Funds]” and call for dismissal here. (Defs.’ Br. at 9-

14.) Eisner’s reliance on these and other similarly decided cases, none of which apply

North Carolina law, is misplaced and none of Eisner’s cases support dismissal here.

Madoff. This decision involved claims by the court-appointed trustee for Bernard

Madoff and his brokerage firm, Bernard L. Madoff Investment Securities, LLC

(“BMLIS”) against several financial institutions. 2013 U.S. App. LEXIS 12551, at *6-8.

There was no question that Madoff and BLMIS – i.e., the individual and entity on whose

behalf the claims were asserted – had perpetrated and benefited from a massive Ponzi

scheme. Id. at* 6. Therefore, the court in Madoff was presented with two issues:

(1) whether Madoff’s and BLMIS’s bad acts that occurred before the appointment of the

trustee could be imputed to the trustee and support the application of in pari delicto to bar

the trustee’s claims; and (2) whether the adverse interest exception to in pari delicto,

which applies when an agent acts adversely to the principal’s interests, could save the

trustee’s claims. Id. at *18-22.

On the first issue, the court concluded that in pari delicto could bar the trustee’s

claims because the trustee stood in the shoes of Madoff and BLMIS and, thus, could not

recover for a wrong that “he himself essentially took part in.” Id. at *19-20 (citations

omitted). Only after concluding that in pari delicto applied in the first instance did the

court in Madoff analyze whether the adverse interest exception could save the trustee’s

claims. The court concluded that the adverse interest exception did not apply because the


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complaint made clear that Madoff and BLMIS benefitted from, and were not the victims

of, the fraudulent scheme. Id.

Kirschner. Likewise, Kirschner v. KPMG LLP involved claims asserted by a

bankruptcy litigation trustee on behalf of Refco, Inc. and affiliated entities (“Refco”) –

i.e., the entities that had engaged in and benefited from the underlying fraudulent scheme.

938 N.E.2d 941, 946 (N.Y. 2010). Because the trustee stood in the shoes of the entities

that had committed the fraud, there was no dispute regarding the application of in pari

delicto to his claims. Id. at 947. Instead, the court in Kirschner addressed only the

application of the adverse interest exception. As in Madoff, the court concluded that the

exception did not save the trustee’s claims because the complaint’s allegations made clear

that Refco received “substantial benefits” from the wrongdoing. Id. at 951.

Allegheny. Official Comm. of Unsecured Creditors of Allegheny Health Educ. &

Research Found. v. Pricewaterhousecoopers, LLP (“Allegheny”) was decided on

summary judgment, not at the motion to dismiss stage. 989 A.2d 313, 335-36 (Pa. 2010).

Like Madoff and Kirschner, Allegheny addressed a claim brought by a successor-in-

interest on behalf of a bankrupt corporation. And, consistent with the application of in

pari delicto by other courts, the court in Allegheny held that in pari delicto can apply as a

bar to an auditor malpractice claim grounded in negligence where corporate agents “acted

for the benefit of the corporation with culpability exceeding that of the [auditor].” Id.

Unlike Madoff, Kirschner, and Allegheny, the claims here are not asserted by the

Receiver as successor-in-interest to the bad actors – i.e., Kowalewski and SJK. Rather,

the claims are asserted by the Funds, entities which are not in receivership and which are

the victims of Kowalewski’s and SJK’s fraud. Under these circumstances, whether the

Receiver stands in the shoes of SJK and Kowalewski and would be subject to in pari


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delicto if he asserted claims on their behalf is irrelevant.5 Consequently, the decisions in

Madoff, Kirschner, and Allegheny are inapposite and do not support the application of in

pari delicto, in the first instance, to the Funds’ claims.6

* * *

In sum, because the allegations in the Complaint do not establish unequivocally

that the Funds actively participated in Kowalewski’s illegal scheme and are substantially

at fault for their own losses, Eisner’s motion should be denied.

5 While not relevant to their claims, the Funds note that several courts have held that in pari delicto does not bar claims asserted by a receiver after the removal of company management. See, e.g., Hays v. Paul Hastings, Janofsky & Walker LLP, 2006 U.S. Dist. LEXIS 95849, at *31-32 (N.D. Ga. Sept. 14, 2006); Mosier v. Stonefield Josephson, Inc., 2011 U.S. Dist. LEXIS 124058, at *17 (C.D. Cal. Oct. 25, 2011). 6 The other cases relied upon by Eisner, none of which were decided under North Carolina law, also are inapposite. (See Defs.’ Br. at 13-14.) See Nisselson v. Lernout, 469 F.3d 143, 157 (1st Cir. 2006) (applying in pari delicto to bar claims of bankruptcy trustee who stood in the shoes of the fraudster); Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Coopers & Lybrand, LLP, 322 F.3d 147, 166 (2d Cir. 2003) (“Color Tile”) (claims brought by committee of unsecured creditors on behalf of bankrupt entity against financial advisors in connection with corporate acquisition barred by in pari delicto where complaint established that entity’s disinterested decisionmakers approved transaction with full knowledge of the risks involved); USACM Liquidating Trust v. Deloitte & Touche, LLP, 764 F. Supp. 2d 1210 (D. Nev. 2011) (trustee’s claims barred by in pari delicto on summary judgment based on undisputed material facts presented after full discovery); Chaikovska v. Ernst & Young, LLP, 78 A.D.3d 1661, 1663 (N.Y. App. Div. 2010) (bankruptcy trustee’s and former CEO’s claims barred by in pari delicto on summary judgment where evidence was not in dispute that CEO and others perpetrated fraud on behalf of entity “to obtain funding for [entity]”).


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II. EISNER CANNOT DEMONSTRATE THAT, AS A MATTER OF LAW, THE ALLEGATIONS IN THE COMPLAINT PRECLUDE THE FUNDS FROM INVOKING THE ADVERSE INTEREST EXCEPTION TO THE DEFENSE OF IN PARI DELICTO.

A. The Complaint Alleges That the Funds Were the Victims of, And Did Not Benefit From, Kowalewski’s And SJK’s Wrongful Conduct.

Under North Carolina law, the adverse interest exception provides that the acts of

an agent cannot be imputed to his or her principal for purposes of in pari delicto if the

agent is acting on his or her own behalf and his or her actions did not provide a benefit to

the principal. In re Vendsouth, Inc. 2003 Bank. LEXIS 1437, at *44-45 (citing Hice v.

Hi-Mil, Inc., 273 S.E.2d 268 (N.C. 1981)).7 As recognized by Eisner’s own authority, the

touchstone of the adverse interest analysis is whether the wrongdoers were engaged in

fraud for the entity or against the entity. See Kirschner, 938 N.E.2d at 952. Moreover,

“[b]y any standard, theft from a corporation by insiders is self dealing by the insiders and

not in any sense in the interest of the entity” and precludes the application of in pari

delicto. In re Parmalat Sec. Litig., 383 F. Supp. 2d 587, 599 (S.D.N.Y. 2005) (applying

North Carolina law).

7 Courts in other jurisdictions apply a similar analysis. See, e.g., In re Friedman’s Inc., 394 B.R. 623, 632 (S.D. Ga. 2008) (adverse interest exception applies where “entire theory of the . . . case is that [corporate agents] were acting against the interests of the corporation and solely for their own personal interests and the interests of [a related entity]”); Comeau v. Rupp, 810 F. Supp. 1127, 1140 (D. Kan. 1992) (adverse interest exception applied because “disaster, not benefit, accrued to the association through the malfeasance of its officers”); In re Sunpoint Sec., Inc., 377 B.R. at 564 (“[W]hether an employee’s fraud is imputed to the corporation depends upon whether the fraud was on behalf of the corporation or against it.”); Cenco Inc. v. Seidman & Seidman, 686 F.2d 449, 456 (7th Cir. 1982) (“Fraud on behalf of a corporation is not the same thing as fraud against it.”). Even the cases relied upon by Eisner recognize that the adverse interest exception applies where the principal is the victim, and not the beneficiary, of the agent’s wrongful conduct. See, e.g., Kirschner, 938 N.E.2d at 952 (crucial distinction in analyzing adverse interest exception “is between conduct that defrauds the corporation and conduct that defrauds others for the corporation’s benefit”); Madoff, 2013 U.S. App.


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Here, even if the Court determines that in pari delicto could apply to the Funds’

claims against Eisner, the Complaint’s allegations are sufficient to invoke the adverse

interest exception and prevent dismissal of the Complaint. See, e.g., In re Wedtech

Corp., 81 B.R. 240, 241 (S.D.N.Y. 1987) (denying motion to dismiss based on in pari

delicto because allegations that “former managers were acting in their own personal

interest, and not in the interests of the corporation,” were sufficient to invoke the adverse

interest exception). The Complaint alleges unequivocally that the Funds were the victims

of, and did not benefit in any way from, Kowalewski’s and SJK’s misappropriation of

their assets. Among other things, the Complaint alleges that Kowalewski transferred in

excess of $8.5 million out of the Funds and used the funds to bankroll his own

extravagant lifestyle, to purchase his personal home and a beach house, and to cover his

personal expenses. (¶¶ 3, 51, 54.)8 The Complaint further alleges that Kowalewski’s and

SJK’s fraud was “not intended to benefit and, in fact, did not benefit the Funds.” (¶ 53.)

LEXIS 12551, at *21-22 (adverse interest exception applies where “fraud is committed against a corporation rather than on its behalf”). 8 Defendants incorrectly claim that the Complaint “makes it clear that both the challenged transfers from the Funds and the Special Opportunities Fund’s subsequent investments were within the ordinary course of Plaintiffs’ business” and “that real estate investments made by the SOF were within the scope of permitted investment under the Funds’ governing documents, and hence were designed to benefit the Funds.” (Defs.’ Br. at 15 n.11.) To the contrary, the Complaint alleges the “investments” made by the Special Opportunities Fund, a “sham hedge fund,” were not within the Special Opportunities Fund’s ordinary course of business and that “Kowalewski misappropriated money from the Funds to cover [SJK’s] expenses, to pay for hundreds of meal, travel, and entertainment expenditures, and to otherwise fund Kowalewski’s lavish lifestyle.” (¶¶ 3, 54, 78.) the Complaint also alleges that the Special Opportunities Fund’s subsequent uses of the misappropriated assets were made in contravention of the terms of its governing documents. (¶ 52.)


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The Complaint’s allegations establish that Kowalewski’s and SJK’s acts:

(a) completely abandoned the Funds’ interests; (b) were intended to and did, in fact,

benefit only Kowalewski and SJK; and (c) were perpetrated against, and not on behalf of,

the Funds. These allegations are far afield from those at issue in the cases relied upon by

Eisner in support of its motion and are sufficient to invoke the adverse interest exception.

Compare, e.g., Kirschner, 938 N.E.2d at 947 (finding adverse interest exception did not

apply where “under the Trustee’s own allegations, the Refco insiders stole for Refco, not

from it” (emphasis added)) with In re Vendsouth, Inc., 2003 Bank. LEXIS 1437, at *46-

47 (holding evidence that corporation did not benefit from acts of agent raised triable

issue of fact regarding application of the adverse interest exception and precluded

summary judgment for defendants on in pari delicto defense). Therefore, Eisner’s

motion should be denied.

B. North Carolina Has Not Adopted the Sole Actor Exception And It Does Not Apply Based Upon the Allegations of the Complaint.

The “sole actor” exception is a narrow exception to the adverse interest exception.

It has not been adopted by North Carolina courts and, in any event, is not applicable to

the Funds’ claims. The sole actor exception provides that “if an agent is the sole

representative of a principal, then that agent’s fraudulent conduct is imputable to the

principal regardless of whether the agent’s conduct was adverse to the principal’s

interests.” Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340,

359 (3d Cir. 2001). The exception “has its roots in cases where the agent and the

principal are literally the same person.” In re NM Holdings Co., 622 F.3d 613, 621 (6th

Cir. 2010); see In re Sharp Int’l Corp., 319 B.R. 782, 787 (Bankr. E.D.N.Y. 2005)

(exception applies “where the principal and agent are one and the same”); In re Hoang,


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449 B.R. 850, 858 (Bankr. Md. 2011) (exception applies where “the party that should

have been informed was the agent itself albeit in its capacity as principal”), rev’d on

other grounds, 2013 U.S. Dist. LEXIS 38478 (D. Md. Mar. 15, 2013).

Consistent with its origin and purpose, the sole actor exception is most often

applied in sole shareholder cases or in cases where all shareholders participated in or

knew of the wrong. See In re Jack Greenberg, Inc., 212 B.R. 76, 86 (Bankr. E.D. Pa.

1997) (noting that, in auditor malpractice cases, “the ‘sole actor’ doctrine has been

applied where the agent who committed the misconduct was the sole shareholder of the

corporation”); Lafferty, 267 F.3d. at 359-60 (sole shareholder and representatives); In re

Mediators, Inc., 105 F.3d 822, 827 (2d Cir. 1997) (sole shareholder and decisionmaker);

FDIC v. Ernst & Young, 967 F.2d 166, 168 (5th Cir. 1992) (agent was sole owner,

chairman, CEO, and COO); Color Tile, 322 F.3d at 153 (company was “portfolio

company” of primary wrongdoer); PNC Bank Ky., Inc. v. Hous. Mortg. Corp., 899 F.

Supp. 1399, 1405 (W.D. Pa. 1994) (sole owners); Wechsler v. Squadron, Ellenoff, Plesent

& Sheinfeld, LLP, 212 B.R. 34, 36 (S.D.N.Y. 1997) (all relevant shareholders and/or

decisionmakers must be involved in fraud). Indeed, several courts have declined to apply

the exception where the agent was not the sole shareholder. See, e.g., Comeau, 810 F.

Supp. at 1141 n.5 (70% ownership insufficient); In re Sunpoint Sec., Inc., 377 B.R. at 566

(largest shareholder, sole member of board, and “predominant position of control”

insufficient); In re Neri Bros. Constr. Corp., 323 B.R. 540, 543 (Bankr. D. Conn. 2005)

(participation of two of three director-shareholders insufficient); Thabault v. Chait, 541

F.3d 512, 529 (3d Cir. 2008) (65% ownership insufficient).

Although some courts have indicated that it may be appropriate to extend the sole

actor exception outside of the sole owner/shareholder context, they generally have done


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so only where “all relevant shareholders and/or decisionmakers were involved in the

wrongful conduct or if there is otherwise sufficient unity between the corporation and

defendant to implicate the corporation itself, rather than just its agents.” Smith v. Arthur

Anderson L.L.P, 175 F. Supp. 2d 1180, 1199 (D. Ariz. 2001) (internal quotations and

citations omitted). Moreover, the vast majority of courts will not apply the sole actor

exception where innocent shareholders and/or other decisionmakers could have prevented

or put a stop to the wrongful conduct. See, e.g., In re Friedman’s Inc., 394 B.R. at 633

(“The sole actor rule simply does not apply when innocent insiders possessed authority to

stop the wrongdoing of the other directors or shareholder.”); In re Sharp Int’l Corp., 319

B.R. at 788 (sole actor exception applies “unless ‘at least one decision maker in a

management role or amongst the shareholders is innocent and could have stopped the

fraud’”) (citations omitted); In re NM Holdings Co., 622 F.3d at 622 (alleged “presence

of a person with the ability to bring an end to the fraudulent activity at issue” rendered

the sole actor exception inapplicable); In re AMERCO Derivative Litig., 252 P.3d 681,

696 (Nev. 2011) (sole actor exception does not apply where there are innocent

decisionmakers present); Smith, 175 F. Supp. 2d at 1200. Finally, outside of the sole

shareholder context, determining whether the sole actor exception applies and whether

the presence of innocent decisionmakers precludes its application present issues of fact

that should not be decided on the pleadings. See, e.g., In re Adelphia Commc’ns Corp.,

365 B.R. 24, 82 (Bankr. S.D.N.Y. 2007); Smith, 175 F. Supp. 2d at 1201.

Here, Kowalewski and SJK were not the sole (or even majority) owners or

shareholders of the Funds. To the contrary, they stole from the shareholders of the

Offshore Fund and the members of the Onshore Fund. Further, the Complaint alleges

that the independent director of the Offshore Fund, David Bree, several innocent non-


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managing members of the Onshore Fund, and the shareholders of the Offshore Fund were

in a position to, and would have, put a stop to the fraud had they known about it. (¶¶ 94,

104; Defs.’ Br., Ex. A §§ 4.2(a), 6.6; Defs.’ Br., Ex. B ¶¶ 35, 104.) Consequently, Eisner

cannot demonstrate that application of the sole actor exception is obvious based on the

face of the Complaint, and its motion should be denied.

III. PUBLIC POLICY DICTATES THAT THE FUNDS SHOULD BE PERMITTED TO PURSUE THEIR CLAIMS.

Under North Carolina law, even if in pari delicto would otherwise apply, courts

may allow claims to proceed where denying relief on the grounds of in pari delicto would

be contrary to public policy. Cauble v. Trexler, 42 S.E.2d 77, 81 (N.C. 1947). Here,

public policy concerns weigh heavily in favor of the Funds proceeding against Eisner free

from Eisner’s in pari delicto defense. As Eisner recognizes, Kowalewski had a

significant amount of control over the Funds’ day-to-day operations. (Defs.’ Br. at 3-4.)

In order to ensure that he exercised his authority consistent with the Funds’ governing

documents, and for the benefit of the Funds, the Funds were required to undergo an

annual audit and to distribute audited financial statements to their innocent members,

shareholders, and independent director. (¶¶ 33, 37.) The Funds engaged Eisner, one of

the largest auditing firms in the world, to provide these assurances, and Eisner knew that

its audit opinions would be relied upon by the Funds’ innocent members, shareholders,

and director. Indeed, Eisner addressed its unqualified audit opinion letters directly to the

Funds’ non-managing members and shareholders and the Offshore Fund’s directors.

(¶¶ 92-93, 102-03.)

Because of Eisner’s negligence, Kowalewski was able to continue stealing the

Funds’ assets for his own personal use and the Funds incurred millions of dollars in


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additional losses. Eisner should not now be permitted to shirk responsibility for its

professional malpractice by pointing to Kowalewski’s looting of the Funds – the precise

activity that it failed to detect. See In re Friedman’s, Inc., 394 B.R. at 632 (holding that it

would be inequitable to apply in pari delicto in professional malpractice action where

entity “basically gave away $85 million and [the] professional malpractice was a

substantial contributing factor in that result” because it would protect the professionals

and hurt the entity and its creditors, “who are alleged to be innocent of any

malfeasance”); In re Sunpoint Sec., Inc., 377 B.R. at 566-68 (declining to apply in pari

delicto because “it would exonerate these auditors from all liability for their miserable

failure to perform their audits according to the applicable standards of their profession”);

NCP Litig. Trust v. KPMG LLP, 901 A.2d 871 (N.J. 2006) (where corporate agents

defrauded corporation, auditor cannot rely on imputation of agents’ acts to corporation to

avoid liability for its negligence).

CONCLUSION

For the foregoing reasons, Plaintiffs respectfully request the Court deny

Defendants’ Motion to Dismiss the Complaint.

Respectfully submitted, this 26th day of August, 2013.

TROUTMAN SANDERS LLP By: /s/ D. Martin Warf Gary S. Parsons (N.C. State Bar No. 7955) D. Martin Warf (N.C. State Bar No. 32982) Post Office Drawer 1389 Raleigh, North Carolina 27602-1389 Telephone: (919) 835-4107 [email protected] [email protected]




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/s/ Thomas B. Bosch J. David Dantzler, Jr. (GA Bar No. 205125) Thomas B. Bosch (GA Bar No. 068740) Mary M. Weeks (GA Bar No. 559181) 600 Peachtree Street, Suite 5200 Atlanta, GA 30308 Phone: (404) 885-3591 Facsimile: (404) 962-6727 [email protected] [email protected] [email protected]

Attorneys for Plaintiffs





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CERTIFICATE OF SERVICE

The undersigned hereby certifies that the foregoing PLAINTIFFS’ RESPONSE IN

OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS was electronically filed with the Clerk of Court using the CM/ECF system, which serves notification of such filing to all CM/ECF participants, including:

Carl N. Patterson, Jr. ([email protected])

Claude M. Tusk ([email protected])

Donald Hugh Tucker, Jr. ([email protected])

Jang H. Jo ([email protected])

This the 26th day of August, 2013.

TROUTMAN SANDERS LLP

By: /s/ D. Martin Warf D. Martin Warf N.C. State Bar No. 32982 Post Office Drawer 1389 Raleigh, North Carolina 27602-1389 Telephone: (919) 835-4123 Facsimile: (919) 829-8721 [email protected]


mailto:([email protected])





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