Chatham Asset Mgmt. v. Adviser Compliance Assocs.

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CHATHAM ASSET MANAGEMENT, LLC Plaintiff, v. ADVISER COMPLIANCE ASSOCIATES, LLC D/B/A ACA COMPLIANCE GROUP, Defendant.

Civil Action No. 23-2677

United States District Court, D. New Jersey

December 1, 2023

NOT FOR PUBLICATION

OPINION

ARLEO UNITED STATES DISTRICT JUDGE

THIS MATTER comes before the Court by way of the Motion to Dismiss (the “Motion”) filed by Defendant Adviser Compliance Associates, LLC (“ACA”). ECF No. 13. Plaintiff Chatham Asset Management, LLC (“Chatham”) opposes the Motion. ECF No. 20. For the reasons set forth herein, the Motion is GRANTED in part and DENIED in part.

I. Background

Chatham is a hedge fund manager organized in Delaware. ECF No. 1.1 (“Compl.”) ¶ 9. ACA is a governance, risk and compliance advisor organized in the District and Columbia. Id. ¶ 10. As an aspiring registered investment advisor, Chatham sought to ensure compliance with the regulations promulgated under the Investment Advisers Act. Id. ¶ 14. Chatham therefore retained ACA, which was founded by former SEC and state regulators to provide expert guidance on regulations, including compliance solutions. Id. ¶ 15.

Two agreements governed the relationship between ACA and Chatham. Id. ¶ 16. First, ACA and Chatham entered into a “non-privileged agreement” that required ACA to provide SEC filing assistance and compliance support, including telephone consulting for trading questions. Id. ¶ 17. Second, ACA entered into a “privileged agreement” with Chatham's counsel, which required ACA to conduct reviews of annual compliance, policies, procedures, and documents, with Chatham as a third-party beneficiary. Id. ¶¶ 18-20, 22, 24. ACA touted this service on its website, where it described a “mock exam” that would allow clients to “know what to expect” and “address any deficiencies.” Id. ¶ 19. ACA also agreed to draft and revise policies and procedures and provide SEC examination support, including assistance for staff presentations and preparation for employee interviews. Id. ¶¶ 18, 21, 23.

Since 2003, Chatham has acquired concentrated positions in credits offered by distressed companies and managed these assets through privately held high-yield funds. Id. ¶¶ 25-26. In 2013, Chatham expanded operations by managing assets through publicly registered liquid alternative funds, which imposed more stringent requirements, such as restrictive issuer and industry concentration limits. Id. ¶¶ 26-27. In response to these restrictions, Chatham decided to spread a concentrated investment in American Media, Inc. among different funds that it managed (the “Rebalancing Trades”). Id. ¶¶ 28-29. However, Chatham recognized that the Rebalancing Trades posed compliance challenges because the Investment Company Act prohibits transactions between registered investment companies and affiliated persons. Id. ¶¶ 30-31. Chatham's Chief Operating and Compliance Officer therefore turned to ACA's Lead Engagement Partner, who suggested that the interposition of broker-dealers would circumvent this prohibition. Id. ¶¶ 31-32. ACA's Lead Engagement Partner was a co-founder who had extensive experience at the SEC and then ACA, which held itself out as the leading compliance expert for investment advisory firms. Id. ¶¶ 31, 35, 38. Thus, Chatham's Managing Partner relied on his advice to execute the Rebalancing Trades. Id. ¶¶ 33, 37-38.

Ultimately, Chatham learned that ACA's advice contradicted past and then-current SEC precedents, which made clear that the interposition of broker-dealers could not cleanse transactions between registered investment companies and affiliated persons. Id. ¶¶ 34-36. According to Chatham, ACA had numerous opportunities to detect and correct its error but failed to do so. For example, ACA conducted annual compliance program reviews and mock audits, which were intended to identify compliance issues with respect to the Investment Advisers Act, the Investment Company Act, internal policies and procedures, best practices, and regulatory expectations. Id. ¶ 39. In conducting these reviews, ACA interviewed employees and reviewed Chatham's books and records, policies and procedures, and compliance documents. Id. ¶ 40. ACA also had access to Chatham's trading system, electronic communications, Bloomberg chats, and all information it requested. Id. Although ACA conducted these reviews in 2017 and 2018, it failed to flag the hundreds of Rebalancing Trades that occurred after 2016. Id. ¶¶ 41-50.

Likewise, ACA failed to address the Rebalancing Trades in connection with the SEC examination that occurred in 2018. Id. ¶¶ 51-61. In May 2018, the SEC notified Chatham that it would conduct an onsite examination, and in June 2018, Chatham's Chief Operating and Compliance Officer participated in a “pre-exam” call with the SEC. Id. ¶¶ 51, 53. In these communications, the SEC not only requested information and documents, but also inquired into whether Chatham conducted cross trades among the funds its managed. Id. The previous year, the SEC had announced that controls over cross trading was a priority for the agency. Id. ¶ 55. Despite this development-and despite its involvement from the outset and its participation in the pre-exam call-ACA did not flag the Rebalancing Trades. Id. ¶¶ 52-55. Nor did ACA address the Rebalancing Trades during the onsite examination, which ACA's Lead Engagement Partner attended. Id. ¶¶ 56, 58. Instead, ACA only began to scrutinize the Rebalancing Trades after the SEC requested information about these transactions and indicated that it would return for another onsite examination. Id. ¶ 57. Specifically, ACA used proprietary software to scrutinize the Rebalancing Trades but failed to find any issues. Id. ¶ 59. Thus, ACA failed to prepare Chatham for the subsequent onsite examination, which took place October 2018. Id. ¶¶ 60-61.

By 2019, Chatham suffered consequences as a result the SEC examination. First, the SEC inquiry was leaked to the public, and investors responded by redeeming existing investments and refraining from making further investments. Id. ¶ 62. Second, Chatham received a deficiency letter from the SEC, which proceeded to initiate an investigation despite explanations of ACA's advice and reviews. Id. ¶¶ 63-66. The investigation culminated in a settlement agreement that Chatham and the SEC executed on April 3, 2023. Id. ¶ 67. Due to the settlement, Chatham suffered reputational and monetary harm, as the public terms of the agreement required payment of $11 million in disgorgement, $3.375 million in interest, and $4.4 million in penalties. Id. ¶¶ 67-69.

On April 17, 2023, Chatham filed this lawsuit against ACA for breach of the non-privileged agreement, breach of the privileged agreement, gross negligence, negligent misrepresentation, and breach of fiduciary duty. Id. ¶¶ 70-102. ACA moved to dismiss, ECF No. 13, and Chatham opposed the Motion, ECF No. 20.

II. Legal Standards

Under Federal Rule of Civil Procedure 12(b)(6), a party may move to dismiss a complaint for failure to state a claim to relief. Fed.R.Civ.P. 12(b)(6). For purposes of a motion to dismiss, the district court accepts the facts alleged in the complaint as true and draws all reasonable inferences in favor of the non-moving party. N.J. Carpenters & the Trustees Thereof v. Tishman Const. Corp. of N.J., 760 F.3d 297, 302 (3d Cir. 2014). While the complaint need not contain detailed factual allegations, Fed.R.Civ.P. 8(a), it must contain “enough facts to state a claim to relief that is plausible on its face,” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). The complaint is facially plausible if it “allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Thus, “conclusory or bare-bones allegations will no longer survive a motion to dismiss.” Fowler v. UPMC Shadyside, 578 F.3d 203, 210 (3d Cir. 2009) (citations omitted).

III. Analysis

A. Breach of Contract

As a preliminary matter, ACA argues that the claims for breach of contract are barred by the Delaware statute of limitations. ECF No. 13.1 at 23-26. Chatham responds that New Jersey law applies and that the Delaware statute of limitations is subject to equitable tolling. ECF No. 20 at 24-28, 30-32.^[1]

The Court agrees with ACA that the claims for breach of contract are untimely. “Statutes of limitations are substantive,” Dixon Ticonderoga Co. v. Estate of O'Connor, 248 F.3d 151, 16061 (3d Cir. 2001), and federal courts with diversity jurisdiction must “apply the relevant state's substantive law, which includes its statute of limitations,” Jaworowski v Ciasulli, 490 F.3d 331, 333 (3d Cir. 2007). To determine the relevant state for an area of substantive law, “a court sitting in diversity will apply the choice-of-law principles of the forum state (here, New Jersey).” Zydus Worldwide DMCC v. Teva API Inc., 461 F.Supp.3d 119, 131 (D.N.J. 2020). Under principles of New Jersey law, “when parties to a contract have agreed to be governed by the laws of a particular state, New Jersey courts will uphold the contractual choice if it does not violate New Jersey's public policy.” Instructional Sys., Inc. v. Computer Curriculum Corp., 614 A.2d 124, 133 (N.J. 1992). Here, Chatham and ACA agreed that the non-privileged and privileged agreements would be “governed by, and construed in accordance with, the laws of the State of Delaware,” Compl. at Exs. A, B ¶ 8, and there is no indication that this choice contravenes New Jersey's public policy. Therefore, Delaware law applies to the contract claims, including the statute of limitations,^[2] which requires a “contract action [to] be brought within three years from the date that the cause of action accrued.” Levey v. Brownstone Asset Mgmt., LP, 76 A.3d 764, 768 ...