Cotter v. Gwyn

PATRICK C. COTTER v. BRUCE A. GWYN ET AL.

CIVIL ACTION No. 15-4823 SECTION H

UNITED STATES DISTRICT COURT EASTERN DISTRICT OF LOUISIANA

August 25, 2016

ORDER AND REASONS

Before the Court are Defendants Turn Key Hedge Funds, Inc. ("Turn Key") and Michael Lapat's ("Lapat") (collectively "TK&L") Motion to Dismiss (Doc. 10); Defendant Anne Marie Gwyn's ("A. Gwyn") Motion to Dismiss (Doc. 17); Defendant Treaty Energy Corporation's ("Treaty") Motion to Dismiss (Doc. 18); and TK&L's Motion to Dismiss Cross-Claims (Doc. 37). For the following reasons, TK&L's Motion to Dismiss Cross-Claims is GRANTED. The remaining motions are DENIED.

BACKGROUND

I. General factual and procedural background

This matter arises out of the failure of a "commodity pool," a type of hedge fund that trades in commodities futures contracts. "Commodities futures contracts are instruments that allow parties to agree to buy and sell a particular commodity at a future date."¹ "A commodity pool is the commodity-futures equivalent of a mutual fund; the investor buys shares in the pool and the operator of the pool invests the proceeds in commodity futures."² "They are vehicles through which investors can aggregate their funds, allowing a commodity pool operator to invest them for a fee."³

Level III Trading Partners, L.P. ("Level III" or "the Fund") was a commodity pool created in February 2007 by Defendant Bruce A. Gwyn ("Gwyn"). According to the Complaint, the Fund attracted approximately $ 2.7 million in investments from its inception in 2007 to its filing for bankruptcy in 2013. From 2007 to 2010, the fund successfully and profitably operated as a commodity pool.

Beginning in 2010, however, Gwyn allegedly began divesting the fund of commodities futures and investing its assets in companies controlled by Gwyn and his close business associate, Defendant Andrew V. Reid ("Reid"). The Complaint claims that "[t]his scheme involved [transfers] in the guise of loans, purchases of stock, and purchases of limited liability company membership interests."⁴ These transfers were allegedly part of a larger fraudulent scheme to artificially inflate the stock prices of two public companies, Defendants Treaty and Orpheum Properties, Inc. ("Orpheum"). Gwyn and Reid were officers and directors of Treaty and Orpheum, and they maintained substantialfinancial interests in both companies. The Complaint also claims that Gwyn misappropriated money from the fund by diverting cash for his own personal use and by improperly charging the fund for fictitious administrative services purportedly performed by Gwyn and his wife, defendant A. Gwyn.

In order to hide his self-dealing and the depletion of the fund's assets from its investors, the Complaint alleges that Gwyn disclosed false investment performance reports, false asset values, and fraudulent account statements to the fund's investors. Many of these reports to investors were allegedly prepared and sent by Defendants TK&L. In addition to hiding Level III's value and the nature of its investments from current investors, Gwyn allegedly continued to accept additional investments from current investors, as well as limited partner subscriptions to the Fund from new investors looking to invest in a commodity pool.

After Level III's investors learned of the scheme, they filed an involuntary petition for relief under Chapter 7 of the Bankruptcy Code on August 2, 2013.⁵ The bankruptcy court later converted the matter into a voluntary petition for bankruptcy pursuant to Chapter 11.⁶ On July 11, 2014, the bankruptcy court confirmed a Chapter 11 plan for reorganization and established a "Litigation Trust." It appointed Plaintiff, Patrick C. Cotter ("Cotter" or "the Trustee") as the "Trustee of the Litigation Trust created by the plan."⁷ The litigation trustee represents the bankruptcy estate by assuming the obligation to prosecute the bankruptcy estate's claims for the benefit of creditors.⁸ The Chapter 11 plan in this case authorizes the trustee to bring all claims on behalf of the bankrupt debtor's estate.⁹

On September 28, 2015, Cotter filed the above-captioned action in this Court in his capacity as trustee of the Level III Trading Partners, L.P. Litigation Trust. The Trustee's Complaint asserts seventeen claims for relief against eleven defendants, and he seeks to avoid various pre-petition transactions on behalf of the debtor. The matter was initially referred to the bankruptcy court, but the referral was withdrawn on March 9, 2016. Defendants TK&L, A. Gwyn, and Treaty have filed motions to dismiss the claims against them. After a more detailed review of the facts of the Complaint, this Court will address each motion in turn.

II. Specific allegations against TK&L

The Complaint devotes five-and-a-half pages specifically to allegations against TK&L, in addition to other scattered references throughout. It states that "Turn Key was the fund's third-party administrator and professional consultant from the fund's inception in 2007 through March of 2012."¹⁰ It alleges that Lapat "is an attorney licensed to practice law in Florida," "[is] the president and principal of [Turn Key]," and that he "provided legal services and advice to the fund through Turn Key and/or his law firm."¹¹

The Complaint alleges that Gwyn hired TK&L in February 2007 to provide all of the necessary hedge fund start-up services, including the preparation of offering and subscription documents and the partnership agreement. "Thereafter, pursuant to its contract with Level III, Turn Key provided hedge fund administration services, investor management services, accounting management services, and compliance management services to Level III."¹² These services included "analyzing Level III's financial information and performance, communicating with [Defendant Kaplan &Company ("Kaplan"), a CPA firm,] regarding financial statements, calculating the fund's net asset value, and calculating each investor's capital account value."¹³ TK&L were then allegedly responsible for distributing much of this information to the fund's investors. The Complaint claims that Level III also engaged the legal services of Turn Key's president and principal, Lapat, who provided guidance regarding regulatory compliance and Level III's purchases of interests and stock in the companies discussed in the Complaint.

The Complaint states that in late 2009, when Gwyn decided to divest the fund of commodities futures and make private investments, TK&L advised Gwyn that Level III's offering documents did not authorize such investments and instead limited the fund to commodities futures products. Accordingly, in order to permit such private investments, "in December 2009, Turn Key revised the Executive Summary that was provided to potential investors to state that, in addition to trading futures contracts and options, the fund [could] also invest 0% to 10% of its assets in private securities and privately held micro-cap companies."¹⁴ The Complaint alleges, however, that by the end of 2011 Gwyn had, "with the knowledge and assistance of [TK&L]," used nearly 100% of the Fund's assets to either invest in small, closely-held companies that he and Reid owned or controlled or to buy stock in Orpheum and Treaty. Although the Fund allegedly derived no value from the self-interested investments and, indeed, the Fund's value was depleted because of them, "Turn Key continued to report to the partnership and its investors in 2010 and 2011 that the fund's net asset value was in the range of $1.3 to $1.6 million, based on unsupported and inflated values assigned to the fund's holdings and interests in these companies."¹⁵

According to the Complaint, TK&L's agreement with Level III obligated them to render a number of services for the fund, the performance of which gave TK&L a thorough understanding of the affairs of Level III.¹⁶ The Complaint states that TK&L "regularly reviewed Level III's bank statements and expense receipts and frequently noted and questioned Gwyn regarding charges that were unrelated to the fund, issues with the amount of incentive allocation that was withdrawn by [Level III Management, LLC ("L3M")]¹⁷ and/or Gwyn, and issues with loans that were made to Gwyn's affiliates."¹⁸ TK&L also allegedly reviewed the operating agreements of the companies in which Level III invested, revised correspondence that Gwyn prepared for the Fund's investors and potential investors, reviewed potential stock purchases, and acted as a liaison between Level III and auditors or regulatory agencies.¹⁹

The Trustee alleges that, as a result of their services, TK&L were aware of Gwyn's self-dealing investments, his collection of fraudulent management fees, his regular use of the Fund's cash for personal expenses, and the unsecured and under-collateralized loans to his affiliates. The Trustee also claims that "[TK&L] knew that the value of the fund's investments and the fund's investment performance were fraudulently inflated and misrepresented in financial statements that were provided to the partnership and its investors."²⁰ The Trustee alleges that TK&L assisted Gwyn in the self-dealing transactions on multiple occasions by preparing, reviewing, commenting on, and editing purchase and loan agreements.²¹

The Complaint further alleges that during this period Gwyn and/or his wife charged the fund $3,000 per month for administrative services that were never actually provided. "[TK&L] not only expressly authorized these expenditures despite knowing that they were providing all of the fund's necessary administrative services but, at the request of Gwyn, they revised the partnership agreement specifically to allow for L3M to be reimbursed for additional alleged administrative costs."²² The Complaint states that TK&L "knew about and authorized" charges to the fund from 2010 through June 2012 of $1,000 per month by Gwyn and/or his wife for rent of their residence. This amount was allegedly excessive and/or unnecessary, provided...