KDH Consulting Grp. LLC v. Iterative Capital Mgmt. L.P.

528 F.Supp.3d 192

KDH CONSULTING GROUP LLC, Plaintiff,

v.ITERATIVE CAPITAL MANAGEMENT L.P., et al., Defendants.

20 Civ. 3274

United States District Court, S.D. New York.

Signed March 23, 2021

I. Rika Khurdayan, Khurdayan PLLC, New York, NY, for Plaintiff.

Julia Rossi Livingston, Robert James Boller, Lawrence Gerschwer, Barnes & Thornburg LLP, New York, NY, for Defendants Iterative Capital Management L.P., Iterative Capital GP, LLC, Brandon Buchanan, Christopher Dannen.

DECISION AND ORDER

VICTOR MARRERO, United States District Judge.

Plaintiff KDH Consulting Group LLC ("KDH") brings this action against Iterative Capital Management L.P. ("Iterative Capital Management"), Iterative Capital GP, LLC ("Iterative Capital"), Iterative OTC, LLC ("Iterative OTC"), Iterative Mining, LLC ("Iterative Mining"), Brandon Buchanan ("Buchanan"), and Christopher Dannen ("Dannen," and together with Buchanan, "Individual Defendants") (collectively, "Defendants"). The initial complaint alleged twelve counts. (See "Complaint," Dkt. No. 20.) Counts One through Four alleged violations of the federal securities laws, while Counts Five through Twelve brought claims under state and common law. (Complaint ¶¶ 102-86.) This Court subsequently granted in part and denied in part Defendants’ motion to dismiss the Complaint. (See Dkt. No. 37.)

On July 20, 2020, KDH filed a First Amended Complaint (the "FAC"), alleging two counts of violations of federal securities laws. (See FAC, Dkt. No. 40.) Count One alleges that Defendants had violated Section 10(b) of the Securities Exchange Act of 1934 and the related Rule 10b-5. (FAC ¶¶ 113-28.) Count Two alleges that the Individual Defendants violated Section 20(a) of the Securities Exchange Act. (Id. ¶¶ 129-38.)

Now before the Court are the premotion letters filed by the parties regarding Defendants’ contemplated motion to dismiss the FAC. Defendants notified KDH of their intent to seek permission to file a motion to dismiss the Complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) (" Rule 12(b)(6)") on August 10, 2020. (See "Letter Motion," Dkt. No. 47.) By letter dated August 17, 2020, KDH responded to the Letter Motion, arguing that the Complaint sufficiently states violations of Section 10(b), Rule 10b-5, and Section 20(a) of the Securities Exchange Act. (See "Opposition," Dkt. No. 48.)

The Court now construes Defendants’ Letter Motion as a motion by Defendants to dismiss the Complaint pursuant to Rule 12(b)(6).¹ For the reasons set forth below, the Letter Motion is GRANTED IN PART and DENIED IN PART.

I. BACKGROUND

A. FACTUAL BACKGROUND ²

KDH became a limited partner in Iterative Capital, L.P. (the "Partnership," and together with Iterative Capital Master, L.P. and Iterative Mining Master, L.P., the "Fund Complex") in January 2018 with a $1,000,000 investment. KDH's investment is generally governed by three documents:

• The Subscription Agreement ("Subscription Agreement"), signed by KDH on January 5, 2018 (see "Hatami Decl.," Dkt. No. 27 ¶ 7 & Ex. A);

• The Limited Partnership Agreement ("LPA"), signed by Iterative Capital Management L.P. on January 12, 2018 (see Hatami Decl. ¶ 8 & Ex. B); and

• The Private Placement Memorandum ("PPM"), dated December 2017 (see Hatami Decl. ¶ 10 & Ex. C).

1. The Initial Investment

KDH alleges that Defendants fraudulently induced it to invest in a cryptocurrency investment and trading fund by misrepresenting the purpose of the fund, its prior performance history, and the liquidity options. For instance, Dannen, who along with Buchanan is a principal of Iterative Capital Management, allegedly promised a highly liquid fund with quarterly withdrawal rights. Dannen also represented that "Iterative had a continuous successful history managing similar investments in different funds," but the Individual Defendants knew that cryptocurrency investment was no longer a viable strategy and that the prior investments had failed for this reason, resulting in Defendants having to return prior investments. (FAC ¶ 115.) At the time funds were being raised, "Individual Defendants and Iterative already knew that [token generation events] and cryptocurrency trading was no longer a viable investment strategy and planned to use Plaintiff's funds for highly illiquid mining operations." (FAC ¶ 3.)

KDH also alleges that the PPM made misrepresentations. The PPM indicates that the primary investment strategy was to purchase and hold cryptocurrencies, with 70% of the assets invested in trading cryptocurrencies and network tokens and the remaining 30% invested in cryptocurrency mining operations, including cryptocurrency mining equipment.³ KDH alleges that this investment plan did not hold true. According to KDH, although Defendants knew that cryptocurrency mining, not trading, would ultimately be the primary investment objective, Defendants’ offering documents failed to disclose this objective and strategy, failed to reflect accurately their prior performance, and failed to include adequate information on the risks relating to mining.

KDH alleges that based on these representations and following "constant and increasing pressure from Individual Defendants to subscribe," KDH was formed and signed the subscription documents on or about January 5, 2018. (FAC ¶ 58.) KDH "and its principals completely relied on Defendants’ experience and representations, did not have other financial advisers in relation to this investment but for Dannen and Buchanan, and pooled funds from several individuals to form Plaintiff specifically for the investment." (FAC ¶ 12.) KDH had no experience investing in cryptocurrencies or a private fund, which the Individual Defendants knew. Ultimately, KDH invested $1,000,000 in exchange for a limited partner interest in the Partnership.

2. The Withdrawal Request

KDH also alleges that Defendants misrepresented the liquidity of their investment. When the cryptocurrency market (in particular, Bitcoin) declined shortly after the initial investment was made, KDH requested immediate withdrawal. Buchanan assured KDH that their funds had not yet been invested, that the Fund Complex would not invest heavily in Bitcoin, and that KDH would be able to withdraw at any time. KDH alleges these representations were made to induce it to retain the investment rather than withdraw its funds. Then Defendants allegedly quickly turned the portfolio illiquid by deviating from the stated investment strategy and turning to mining, including spending $6.5 million of the remaining assets on "rapidly depreciating mining equipment." (FAC ¶ 17.) Although Defendants continued to make promises of immediate liquidity and withdrawal opportunities, "Defendants locked most of the funds in the mining ‘side-pocket’ not subject to withdrawal." (FAC ¶ 19.)

KDH claims that Defendants had a conflict of interest and engaged in self-dealing with Iterative OTC (Defendants’ related over-the-counter trading business) and Iterative Mining (Defendants’ mining business). KDH contends that Defendants had planned all along to make the mining objective, which was "disclosed as a minor ancillary strategy," the primary focus of the Fund Complex in order to profit separately through Iterative OTC to the exclusion of KDH and the other investors. (Id. ¶ 90.)

3. Conversion to a Mining Operation

On December 20, 2019, Defendants wrote to KDH to inform it that "during Q1 2020, we will embark on an effort to convert the Fund [Complex] from an investment fund structure to a corporate structure and consolidate it with our other flagship business," Iterative OTC. (FAC ¶ 21.) It was only on March 1, 2020 that Defendants provided new disclosures relating to mining and therein admitted that mining is very different and much riskier than the investment objective contained in the PPM.

As part of the restructuring, Defendants presented a take-it-or-leave-it offer to KDH and other investors highlighting three options: (1) sign an "exiting investor" consent approving the restructuring and withdrawing from the Fund Complex in exchange for a minor portion of KDH's investment based on the undisclosed value of the remaining assets after deduction of significant restructuring expenses; (2) sign a "continuing investor" consent approving restructuring and receiving a de minimis illiquid stake in Defendants’ new mining operation based on the undisclosed value of the remaining assets after deduction of significant restructuring expenses; or (3) receive a pro rata share of the Fund's assets in-kind, such as digital assets and outdated mining equipment, minus shipping expenses and be forced out of the Fund Complex prior to restructuring.

Defendants failed to provide a definitive figure of the proposed refund or contribution into the new venture and also failed to provide any information on the two businesses with which the fund would be consolidated and/or continue doing business. Buchanan did not respond to KDH's very basic questions about the restructuring.

On May 8, 2020, Defendants informed KDH that it had been forcibly removed from the Partnership and returned to it $126,352.42 and unvalued mining equipment. KDH then commenced this action.

B. PROCEDURAL HISTORY

KDH brought suit, initially alleging twelve counts. Count One alleges violations of Section 10(b) ("Section 10(b)") of the Securities Exchange Act of 1934 (the "Exchange Act") and Securities Exchange Commission ("SEC") Rule 10b-5 ("Rule 10b-5"). See 15 U.S.C. § 78j(b) ; 17 C.F.R. § 240.10b-5. Count Two, brought against the Individual Defendants only, alleges violations of Section 20(a) ("Section 20(a)") of the Exchange Act. See 15 U.S.C. § 78t(a). Count Three, brought against Iterative Capital Management L.P. only, alleges violations of fiduciary duty under Section 206 ("Section 206") of the Investment Advisers Act ("IAA"). See 15 U.S.C. § 80b-6. Count Four, brought against the Individual Defendants only, alleges that the Individual Defendants aided and abetted violations of Section 206. The remaining...