united states district court southern...

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff, - against - ICP ASSET MANAGEMENT, LLC, et al.,

Defendants.

No. 10 Civ. 4791 (LAK) (JCF) ECF Case

PLAINTIFF’S MEMORANDUM OF LAW IN OPPOSITION TO DEFENDANTS’ MOTIONS TO DISMISS THE COMPLAINT

Case 1:10-cv-04791-LAK Document 30 Filed 09/29/10 of 57

i

TABLE OF CONTENTS INTRODUCTION......................................................................................................................... 1

THE ALLEGATIONS OF THE COMPLAINT ........................................................................ 3

A. The Defendants’ Duties and Incentives ........................................................................ 3

B. Misconduct Related To The Bear Stearns Bonds ......................................................... 5

C. Swaps of Bonds to Make Undisclosed Profits at the CDOs’ Expense ......................... 7

D. Systematic Mispricing of Cross-Trades ........................................................................ 7

E. Misrepresented Cash Transfers From SCIF .................................................................. 9

F. Numerous Other Deceptions and Misrepresentations ................................................... 9

G. Compliance and Books and Records Violations ......................................................... 11

H. The Alleged Violations of Law ................................................................................... 11

ARGUMENT ............................................................................................................................... 12

I. THE PLEADING STANDARDS GOVERNING THE COMPLAINT ........................ 12

A. Pleading Under The Federal Rules of Civil Procedure .............................................. 12

B. The Fraud Claims Against The Defendants ............................................................... 13

C. The Commission Is Not Subject To A Special Pleading Standard............................. 16

II. THE COMPLAINT PLEADS FRAUD WITH PARTICULARITY ............................ 17

A. The Allegations of ICP’s and Priore’s Repeated Undisclosed Breaches Of Their Fiduciary Obligations State A Claim For Fraud ............................................... 18

1. The misappropriation of $14 million from the CDOs by ICP, ICPS, ICP Holdco, and Priore ...................................................................................... 19

2. Systematic mispricing of trades by ICP and Priore ........................................... 22

3. The “swapping” of bonds by ICP, ICPS, and Priore ......................................... 25

4. Undisclosed and willful violations of the CDOs’ investment criteria constitute fraud................................................................................................... 27


ii

B. The Complaint Alleges Material Misstatements And Omissions By ICP And Priore................................................................................................................... 28

1. Concealment of unauthorized trades .................................................................. 28

2. Repeated lies to investors about the CDOs’ investments .................................. 31

3. Repeated misstatements to the CDOs’ trustee about trades ............................... 32

4. Misrepresentations about SCIF’s cash transfers ................................................ 33

C. The Complaint Alleges The Scienter Of All Four Defendants .................................. 34

1. The Complaint alleges the defendants’ deliberate misconduct .......................... 35

2. The Complaint alleges the defendants’ motive and opportunity to defraud ICP’s clients .......................................................................................... 37

D. The Complaint Alleges Aiding And Abetting Fraud By ICP, ICPS, ICP Holdco, And Priore.............................................................................................. 42

E. Defendants’ Motions Impermissibly Rely On Disputed Facts Wholly Outside The Complaint ............................................................................................................ 43

III. THE COMPLAINT SUFFICIENTLY ALLEGES NON-FRAUD CLAIMS AGAINST ICP AND PRIORE ......................................................................................... 45

A. The Complaint’s Non-Fraud Claims .......................................................................... 45

B. The Non-Fraud Claims Satisfy Fed. R. Civ. P. 8(a) ................................................... 46

CONCLUSION ........................................................................................................................... 48


iii

TABLE OF AUTHORITIES

Cases

Aaron v. SEC, 446 U.S. 680, 100 S. Ct. 1945 (1980) ............................................................ 15, 34

ABKCO Music, Inc. v LaVere, 217 F.3d 684 (9th Cir. 2000) ..................................................... 42

Armstrong v. McAlpin, 699 F.2d 79 (2d Cir. 1983) ............................................................... 23, 43

Ashcroft v. Iqbal, 556 U.S. ---, 129 S. Ct. 1937 (2009)................................................................ 12

ATSI Commc’n, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007) ............................ 13, 35, 43

AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202 (2d Cir. 2000) .......................................... 37

Bell Atl. Corp. v. Twombly, 550 U.S. 544, 127 S. Ct. 1955 (2007) ............................................ 12

Billard v. Rockwell Int’l Co., 683 F.2d 51 (2d Cir. 1982)............................................................ 16

Brown v. Thompson, 374 F.3d 253 (4th Cir. 2004) ..................................................................... 42

Caiola v. Citibank, N.A., 295 F.3d 312 (2d Cir. 2002)................................................................. 29

Cruse v. Equitable Sec. of New York, Inc., 678 F. Supp. 1023 (S.D.N.Y. 1987) ........................ 29

Defer LP v. Raymond James Fin., Inc., 654 F. Supp. 2d 204 (S.D.N.Y. 2009) ........................... 33

DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242 (2d Cir. 1987) ............................ 13

Edison Fund v. Cogent Inv. Strategies Fund, Ltd., 551 F. Supp. 2d 210 (S.D.N.Y. 2008) ........................................................................................................................ 39

F.B. Horner & Assocs., Inc. v. SEC, 994 F.2d 61 (2d Cir. 1993) ................................................ 41

Fraternity Fund Ltd. v. Beacon Hill Asset Mgmt. LLC, 376 F. Supp. 2d 385 (S.D.N.Y. 2005) .................................................................................................................. 24, 37

Fraternity Fund Ltd. v. Beacon Hill Asset Mgmt., LLC, 479 F. Supp. 2d 349 (S.D.N.Y. 2007) ........................................................................................................................ 32

Ganino v. Citizens Utils. Co., 228 F.3d 154 (2d Cir. 2000) ................................................... 12, 35

Goldman v. Belden, 754 F.2d 1059 (2d Cir. 1985) .......................................................... 12, 18, 32

Heller v. Goldin Restructuring Fund, L.P., 590 F. Supp. 2d 603 (S.D.N.Y. 2008) ...................... 38

IDC Holdings S.A. v. Frankel, 976 F. Supp. 234 (S.D.N.Y. 1997) .............................................. 39

In re Atlas Air Worldwide Sec. Litig., 324 F. Supp. 2d 474 (S.D.N.Y. 2004) ....................... 36, 46


iv

In re BISYS Sec. Litig., 397 F. Supp. 2d 430 (S.D.N.Y. 2005) ................................................... 37

In re Global Crossing, Ltd. Sec. Litig., 322 F. Supp. 2d 319 (S.D.N.Y. 2004) ............................ 20

In re Int’l Bus. Machs. Corp. Sec. Litig., 163 F.3d 102 (2d Cir. 1998) ........................................ 32

In re Marsh & McLennan Cos., Inc. Sec. Litig., 501 F. Supp. 2d 452 (S.D.N.Y. 2006) .................................................................................................................. 37, 39

In re NTL, Inc. Sec. Litig., 347 F. Supp. 2d 15 (S.D.N.Y. 2004) ................................................. 32

In re Parmalat Sec. Litig., 375 F. Supp. 2d 278 (S.D.N.Y. 2005) ................................................ 46

In re Parmalat Sec. Litig., 594 F. Supp. 2d 444 (S.D.N.Y. 2009) .......................................... 45, 47

In re Refco Capital Mkts., Ltd. Brokerage Customer Sec. Litig., No. 06 Civ. 643 (GEL), 2007 WL 2694469 (S.D.N.Y. Sept. 13, 2007) ................. 17, 18, 19, 26

JP Morgan Chase Bank v. Winnick, 406 F. Supp. 2d 247 (S.D.N.Y. 2005) ................................ 42

Kalnit v. Eichler, 264 F.3d 131 (2d Cir. 2001) ....................................................................... 35, 39

Leberman v. John Blair & Co., 880 F.2d 1555 (2d Cir. 1989) ..................................................... 34

Lerner v. Fleet Bank, N.A., 459 F.3d 273 (2d Cir. 2006) ....................................................... 15, 42

M’Baye v. N.J. Sports Prod., Inc., No. 06 Civ. 3439 (DC), 2007 WL 431881 (S.D.N.Y. 2007) ........................................................................................... 46

Manela v. Garantia Banking, Ltd., 5 F. Supp. 2d 165 (S.D.N.Y. 1998) ....................................... 31

Nelson v. Stahl, 173 F. Supp. 2d 153 (S.D.N.Y. 2001) .............................................. 29, 32, 33, 34

Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266 (3d Cir. 1998) ...................................................................................................................... 22, 26

Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000) ..................................................................... passim

Ouaknine v. MacFarlane, 897 F.2d 75 (2d Cir. 1990) .................................................................. 12

Pension Committee of the Univ. of Montreal Pens. Plan v. Banc of America Sec., 446 F. Supp. 2d 163 (S.D.N.Y. 2006) ....................................................................................... 38

Piamba Cortes v. Am. Airlines, Inc., 177 F.3d 1272 (11th Cir. 1999) ......................................... 42

Pollack v. Laidlaw Holdings, Inc., No. 90 Civ. 5788 (DLC), 1995 WL 261518 (S.D.N.Y. May 3, 1995) .............................................................................. 33

Press v. Chemical Inv. Servs. Corp., 988 F. Supp. 375 (S.D.N.Y. 1997) ..................................... 41


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Primavera Familienstifung v. Askin, 130 F. Supp. 2d 450 (S.D.N.Y.2001) ................................ 42

Rivera v. Clark Melvin Sec. Corp., 59 F. Supp. 2d 280 (D. Puerto Rico. 1999) .......................... 30

Rolf v. Blyth, Eastman Dillon & Co., Inc., 570 F.2d 38 (2d Cir. 1978) ....................................... 43

Rombach v. Chang, 355 F.3d 164 (2d Cir. 2004) ......................................................................... 46

Roth v. Jennings, 489 F.3d 499 (2d Cir. 2007) ............................................................................. 12

Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 97 S. Ct. 1292 (1977) ........................................... 18

SEC v. Ballesteros Franco, 253 F. Supp. 2d 720 (S.D.N.Y. 2003) ........................................ 37, 39

SEC v. Battenberg, No. 06 Civ. 14891, 2010 WL 1416981 (E.D. Mich. Apr. 8, 2010) ......................................................................................................... 21

SEC v. Bremont, 954 F. Supp. 726 (S.D.N.Y. 1997) ................................................................... 37

SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 84 S. Ct. 275 (1963) ......................................................................... 15, 22, 29, 41

SEC v. Cavanagh, No. 98 Civ. 1818 (DLC), 1998 WL 440029 (S.D.N.Y. July 27, 1998) .................................................................................................... 36, 40

SEC v. Collins & Aikman Corp., 524 F. Supp. 2d 477 (S.D.N.Y. 2007) ................... 30, 33, 35, 42

SEC v. Credit Bancorp, Ltd., 195 F. Supp. 2d 475 (S.D.N.Y. 2002) ........................................... 13

SEC v. DiBella, No. 304 Civ. 1342 (EBB), 2005 WL 3215899 (D. Conn. Nov. 29, 2005) ......................................................................................................... 40

SEC v. DiBella, 587 F.3d 553 (2d Cir. 2009) ................................................................... 15, 29, 42

SEC v. Dunn, 587 F. Supp. 2d 486 (S.D.N.Y. 2008) ....................................................... 12, 35, 36

SEC v. Espuelas, 579 F. Supp. 2d 461 (S.D.N.Y. 2008) .............................................................. 42

SEC v. First Jersey Sec., Inc., 101 F.3d 1450 (2d Cir. 1996) ................................................. 13, 20

SEC v. Fraser, No. 09 Civ. 443, 2009 WL 2450508 (D. Ariz. Aug. 11, 2009) ............................ 21

SEC v. Gann, No. 05 Civ. 63, 2008 WL 857633 (N.D. Tex. Mar. 31, 2008) .............................. 36

SEC v. George, 426 F.3d 786 (6th Cir. 2005) .............................................................................. 14

SEC v. Hasho, 784 F. Supp. 1059 (S.D.N.Y. 1992) ..................................................................... 29

SEC v. Kelly, 663 F. Supp. 2d 276 (S.D.N.Y. 2009) ................................................................... 40


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SEC v. KPMG LLP, 412 F. Supp. 2d 349 (S.D.N.Y. 2006) ......................................................... 33

SEC v. Monarch Funding Corp., 192 F.3d 296 (2d Cir. 1999) .................................................... 13

SEC v. North Am. Research & Dev. Corp., 424 F.2d 63 (2d Cir.1970) ...................................... 13

SEC v. Pentagon Capital Mgmt., PLC, 612 F. Supp. 2d 241 (S.D.N.Y. 2009) ................ 12, 20, 40

SEC v. Power, 525 F. Supp. 2d 415 (S.D.N.Y. 2007) ...................................................... 12, 42, 44

SEC v. Reserve Mgmt. Co., Inc., No. 09 Civ. 4346 (PGG), 2010 WL 685013 (S.D.N.Y. Feb. 24, 2010) ................................................................. 35, 37, 39

SEC v. Saul, 133 F.R.D. 115 (N.D. Ill. 1990) .............................................................................. 16

SEC v. Simpson Capital Mgmt., Inc., 586 F. Supp. 2d 196 (S.D.N.Y. 2008) ............ 12, 13, 20, 21

SEC v. Steadman, 967 F.2d 636 (D.C. Cir. 1992) ........................................................................ 34

SEC v. Trabulse, 526 F. Supp. 2d 1001 (N.D. Cal. 2007) ............................................................ 24

SEC v. Treadway, 430 F. Supp. 2d 293 (S.D.N.Y. 2006) ...................................................... 15, 39

SEC v. Zandford, 535 U.S. 813, 122 S. Ct. 1899 (2002)....................................................... passim

Sinclair v. SEC, 444 F.2d 399 (2d Cir. 1971) ................................................................... 22, 24, 26

Steed Fin. LDC v. Laser Advisers, Inc., 258 F. Supp. 2d 272 (S.D.N.Y. 2003) .......................... 39

Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 128 S. Ct. 761 (2008) ......................................................................................... 20

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S. Ct. 2499 (2007) ................................................................................. 34, 35

Transamerica Mortg. Advisors, Inc. v. Lewis, 444 U.S. 11, 100 S. Ct. 242 (1979) ........................................................................................... 15

U.S. ex rel Dhawan v. N.Y. City Health & Hosp. Corp., No. 95 Civ. 7649, 2000 WL 1610802 (S.D.N.Y. Oct. 27, 2000) ........................................................................... 16

U.S. v. Falcone, 257 F.3d 226 (2d Cir. 2001) ............................................................................... 19

U.S. v. O’Hagan, 521 U.S. 642, 117 S. Ct. 2199 (1977) .............................................................. 18

U.S. v. Santoro, 302 F.3d 76 (2d Cir. 2002) ................................................................................. 41

Village of Arlington Heights v. Poder, 712 F. Supp. 680 (N.D. Ill. 1989) ................................... 30

Village Pond, Inc. v. Town of Darien, 56 F.3d 375 (2d Cir. 1995) .............................................. 44


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Statutes

Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) ............................................................................................................... 11, 13

Section 101(b)(2) of the Public Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b)(2) ............................................................................................................ 35

Section 15(c)(1)(A) of the Securities Exchange Act of 1934, 15 U.S.C. § 78o(c)(1)(A) .................................................................................................... 11, 14

Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) ........................................................................................................ 11, 13, 34

Section 20(a) of the Securities Exchange Act of 1934 ..................................................... 11, 45, 47

Section 204 of the Investment Advisers Act of 1940, 15 U.S.C. § 78b-4 ................................................................................................... 11, 45, 46, 47

Section 206 of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6 ............................................................................................................... 11, 14

Section 3(c)(1) of the Investment Company Act of 1940, 15 U.S.C. § 80a-3(c)(1)............................................................................................................. 14

Section 929O of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203 (H.R. 2173) .......................................................... 42

Rules

Federal Rule of Civil Procedure 8 .................................................................................... 12, 45, 46

Federal Rule of Civil Procedure 9 ......................................................................................... passim

Exchange Act Rule 10b-3, 17 C.F.R. 240.10b-3 .................................................................... 11, 14

Exchange Act Rule 10b-5, 17 C.F.R. 240.10b-5 .................................................................... 11, 13

Advisers Act Rule 204-2, 17 C.F.R. 275.204-2 .......................................................... 11, 45, 46, 47

Advisers Act Rule 206(4)-7, 17 C.F.R. 275.206(4)-7 ...................................................... 11, 45, 46

Advisers Act Rule 206(4)-8, 17 C.F.R. 275.206(4)-8 ...................................................... 11, 13, 14

Other Authorities

Compliance Programs of Investment Companies and Investment Advisers, Advisers Act Rel. No. 2204, 68 F.R. 74714 (Dec. 24, 2003) ................................................... 45


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House Conference Report on Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, H.R. Conf. Rep. 111-517 (2010)....................................... 42

Interpretation of Section 206(3) of the Advisers Act, Advisers Act Rel. No. 1732, 1998 WL 400409, at *1 n.3 (July 17, 1998) ............................... 14

Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Advisers Act Rel. No. 2628, 2007 WL 2239114 (Aug. 3, 2007) ............................................. 14

Restatement (Third) Agency § 8.01 (2006) .................................................................................. 27


1

Plaintiff Securities and Exchange Commission (“Commission” or “SEC”) respectfully

submits this Memorandum of Law in Opposition to (1) the Joint Motion to Dismiss the

Complaint of defendants ICP Asset Management, LLC (“ICP”), Institutional Credit Partners,

LLC (“ICP Holdco”), and Thomas C. Priore, and (2) the Motion to Dismiss the Complaint of

defendant ICP Securities, LLC (“ICPS”), each made under Federal Rules of Civil Procedure 9(b)

and 12(b)(6). For the reasons set forth below, the defendants’ motions should be denied.

INTRODUCTION

The Commission brings this action against Thomas Priore and a complex of companies

that he founded, owns, and controls for misconduct in the management of several collateralized

debt obligations (“CDOs”) and other investment vehicles. It charges them with securities fraud

based on deliberate breaches of the duties they owed their clients and affirmative

misrepresentations they made to their clients and investors. The Commission also charges Priore

and ICP, his asset management firm, with record-keeping and compliance violations.

The defendants argue that, while their alleged mismanagement might constitute breaches

of their fiduciary duties, they cannot support fraud claims. As the Supreme Court and Second

Circuit have recognized, however, undisclosed breaches of fiduciary duties constitute a form of

deception; such breaches are deceptive because they contradict the implied representation that

the fiduciary will act in accordance with his fiduciary obligations. Here, the Complaint describes

various ways in which ICP and Priore acted contrary to their fiduciary duties while continuing to

pretend loyalty to their clients’ best interests and fidelity to the various restrictions governing

their investment authority. Such conduct constitutes fraud under the securities laws, apart from

the many material misrepresentations that ICP and Priore are alleged to have made.

The defendants next argue that all claims should be dismissed for failure to plead

scienter. However, not only does the Complaint assert numerous claims for which scienter is not


2

an element, it also clearly alleges that Priore (and, by extension, the companies he controlled and

directed) acted willfully to defraud ICP’s clients. Among other forms of conscious misbehavior,

the defendants are alleged to have misappropriated profitable trades from their clients,

knowingly mispriced and backdated investments, purchased securities without approval, and lied

to clients and investors to conceal their wrongdoing. These allegations, which cover dozens of

transactions over a two-year period, are more than sufficient to allege scienter.

Defendants also contend that the Complaint fails for lack of particularity. But the

Complaint identifies fraudulent transactions by specifying their dates, the securities and prices

involved, and the clients who were defrauded. It also describes defendants’ misstatements by

specifying their content, who made them, the timeframe, and why they were deceptive. For

example, the Complaint quotes representations to investors that trades by the CDOs had been

made at “significant discounts” in the “current market” when in fact the trades at issue had been

made many months before, without disclosure or authorization, and at deliberately inflated

prices. Similarly, the Complaint describes how, in June 2007, all defendants participated in

cancelling and rebooking a profitable investment in Bear Stearns bonds that their CDO clients

had made in order to misappropriate $14 million. The Complaint’s detailed allegations about

these and other transactions and misstatements easily meet Federal Rule of Civil Procedure 9(b).

Finally, while defendants attempt to distance ICPS, Priore’s broker-dealer firm, from the

fraud, the Complaint adequately alleges its participation. ICPS is alleged to have interjected

itself in trades whose sole purpose it knew was to defraud ICP’s clients and to misappropriate

their trading profits. And since Priore is the owner and senior officer of ICPS and directed the

company’s affairs, his scienter is properly imputed to ICPS under the law. Defendants’ assertion

that ICPS acted “innocently” and just like “any broker-dealer” is unfounded.


3

THE ALLEGATIONS OF THE COMPLAINT

Since 2006, ICP, an SEC-registered investment adviser, and Priore, its most senior officer

and controlling shareholder, served as investment advisers to four collateralized debt obligations

known as Triaxx 1, 2, and 3 and Triaxx Funding. (Compl. ¶ 18.)1 These CDOs issued billions

of dollars in notes and obligations to investors and primarily invested the proceeds in mortgage-

backed securities. (Id.) ICP and Priore also served as investment advisers to a hedge fund

named ICP Strategic Credit Income Fund (“SCIF”) and an investment account (“Managed

Account”) owned by an important ICP client (“Client A”). (Id. ¶¶ 17, 21.) For managing the

assets of the CDOs and SCIF, ICP received advisory fees. (Id. ¶¶ 19-21, 60.) For advising the

Managed Account, it received a portion of the account’s net profits. (Id. ¶ 21.)

The Complaint recounts an array of fraudulent transactions conducted by ICP and Priore

in advising these clients, often with the participation of their affiliated broker-dealer, ICPS, and

(in at least one instance) ICP Holdco, the parent company of ICP and ICPS. Some of the

misconduct generated undisclosed and improper fees and markups for the defendants at the

Triaxx CDOs’ expense. Other fraud shifted investment losses from Triaxx Funding and the

Managed Account to Triaxx 1, 2, and 3 — the principal victims of defendants’ misconduct. In

all, the Complaint alleges that the defendants defrauded Triaxx 1, 2, and 3 of tens of millions of

dollars. A summary of these allegations follows.

A. The Defendants’ Duties and Incentives

As investment advisers, ICP and Priore owed fiduciary obligations to their CDO clients

to act in the best interests of each. (Id. ¶ 27.) To reinforce these obligations, the CDOs’ offering

1 “Joint Br.” refers to the brief in support of the joint motion (Docket No. 18); “ICPS Br.” refers to the brief in support of ICPS’s motion (Docket No. 21); and “Compl.” refers to the SEC’s Complaint, filed June 21, 2010 (Docket No. 1).


4

circulars and advisory agreements with ICP (called “collateral management agreements”)

provided that ICP shall act at all times with the same “skill and attention” used by “institutional

managers of national standing” or the care it “exercise[d] for . . . itself.” (Id. ¶ 22.) The circulars

and advisory agreements further stated that, in managing the CDOs’ assets, ICP shall strictly

follow the terms of the CDOs’ indentures, the documents governing their obligations to

investors. (Id.) As is typical of CDOs, therefore, the investment restrictions contained in the

indentures governed both the CDOs’ obligations to their noteholders and ICP’s relationship with

the CDOs. Those restrictions explicitly limited ICP’s fiduciary discretion to manage the CDOs’

assets and were designed for the protection of both the CDOs and their investors. (Id. ¶¶ 22-26.)

To assure investors that ICP would responsibly exercise its investment authority, it was

subject to further restrictions. First, ICP could only cause a CDO to invest on an arm’s length

basis (i.e., on terms at which unaffiliated parties would freely trade) and with best execution (i.e.,

at the best price reasonably available). (Id. ¶ 23.) Next, before ICP could sell a security from a

CDO to another ICP client, it had to obtain bona fide bids for that security from two independent

dealers. (Id.) Third, before causing Triaxx 1, 2, or 3 to make any investment, ICP had to obtain

the prior written approval of AIG Financial Products Corporation (“AIG”) or Financial Guaranty

Insurance Company (“FGIC”), the investors who insured the CDOs’ senior notes and therefore

bore the economic risk on them. (Id. ¶¶ 25, 61.) Finally, to ensure compliance with these

restrictions, ICP could not cause a CDO to make a trade unless ICP first certified to the CDOs’

trustee — the representative of the CDOs’ investors — that all criteria had been met. (Id. ¶ 26.)

The restrictions on ICP’s investment authority were designed to address potential

conflicts of interest between ICP and the CDOs. For example, ICP’s fee for managing the CDOs

was payable quarterly — but only if the CDOs met certain governing tests, such as the

overcollateralization test (which measures the protection afforded to investors by the value of the


5

CDOs’ assets). (Id. ¶ 60.) ICP’s obligations to trade on an arms’ length basis, with best

execution, and with prior approval from AIG or FGIC were, in part, aimed at preventing it from

engaging in sham or improper investments designed to manipulate the CDOs’ tests in order to

improperly prolong the payments of its fees. (Id. ¶ 23.) Other restrictions mitigated the potential

conflict resulting from ICP’s ownership interest in the CDOs. Although it had contributed no

capital, ICP held the residual interests in Triaxx 1, 2, and 3 — which meant that it was entitled to

any surplus if and when all investor capital was returned. (Id. ¶¶ 19-20.) This gave ICP an

incentive to invest in risky securities since potential losses would be borne by capital-

contributing investors, while profits in excess of what investors were owed would go to ICP.

(Id.) The documents governing ICP’s management of the CDOs’ assets mitigated this conflict

by requiring it to obtain approval from AIG or FGIC, the most senior and risk-averse investors,

for all investments and by placing other restrictions on its authority (such as prohibiting it from

purchasing heavily-discounted bonds priced at below $75). (Id. ¶¶ 22-26, 41.)

B. Misconduct Related To The Bear Stearns Bonds

The Complaint alleges that in June 2007 all four defendants secretly usurped a $14

million profit to themselves from a trade that the CDOs had made. (Id. ¶¶ 28-34.) On June 14,

Priore committed the CDOs to forward purchase $1.3 billion in mortgage bonds that originated

from Bear Stearns.2 (Id. ¶ 29.) By late June, however, Priore had convinced Client A to acquire

the very same bonds into the Managed Account at a higher price. (Id. ¶ 31.) Rather than sell the

bonds from the CDOs to the Managed Account, Priore contrived to secure the profit for himself

and his entities. He cancelled and rebooked the CDOs’ June 14 trade so that ICP, ICPS, and ICP

2 A forward purchase is an agreement to buy an asset, at a pre-determined price, on a specified date in the future. (Compl. ¶ 24.)


6

Holdco could purchase the bonds, sell them to the Managed Account at the higher price, and

retain a $14 million profit. (Id. ¶¶ 32-33.) Neither the initial trade nor the rebooking —

together, a blatant breach of ICP’s and Priore’s duty of loyalty to the CDOs — were disclosed to

the CDOs, their trustee, or to investors. (Id. ¶¶ 30, 34, 62.)

Two months later, Priore caused the CDOs to overpay for these same bonds. In August

2007, after Client A expressed anxiety about the declining mortgage market, Priore caused

Triaxx 1, 2, and 3 to forward purchase all of the Bear Stearns bonds from the Managed Account.

(Id. ¶ 36.) However, to prevent the Managed Account from sustaining losses, Priore backdated

the trades by using the June 2007 prices that the Managed Account had paid for the bonds —

which were higher than August prices — thereby shifting the losses to the CDOs. (Id.) ICP and

Priore neither sought nor obtained AIG’s or FGIC’s approval for the $1.3 billion forward-

purchase arrangement with the Managed Account and concealed it from the CDOs’ trustee,

despite knowing that the trustee’s reports to investors would omit this investment. (Id. ¶¶ 30, 34,

62.) In December 2007, after the mortgage markets had declined further, Priore caused the

CDOs to forward purchase from the Managed Account additional bonds, once again using higher

June 2007 prices. (Id. ¶ 39.) These willfully mispriced investments caused the CDOs to overpay

for bonds by at least $53.5 million — a favor to an important ICP client, and a profit in which

ICP was entitled to share under its arrangement with the Managed Account. (Id. ¶¶ 21, 36, 39.)

The Complaint alleges that, in carrying out these forward purchases, ICP and Priore

breached their duties to Triaxx 1, 2, and 3 in other ways as well. When one CDO could not

consummate a forward purchase, ICP and Priore caused another CDO to acquire the bonds at

June 2007 prices, even though the latter had never committed to purchase the bonds and could

have acquired them, or similar bonds, for much less in the open market. (Id. ¶ 38.) Because

each CDO was a separate entity with distinct investors, there was no proper basis for shifting the


7

obligations of one CDO to another, thereby inflicting on the second CDO a massive loss (i.e., the

difference between the purchase price and the prevailing market price of the bonds). (Id. ¶ 18.)

C. Swaps of Bonds to Make Undisclosed Profits at the CDOs’ Expense

The Complaint describes how, in early 2008, Priore, ICP, and ICPS caused multiple

“swaps” of bonds in the Managed Account in order to pocket undisclosed profits at their CDO

clients’ expense. (Id. ¶¶ 43-47.) Each swap had three steps: First, bonds in the Managed

Account were sold in the market, even though a Triaxx CDO had previously been committed to

forward purchase them; next, ICP, ICPS, and Priore purchased cheaper bonds in the market into

the Managed Account; finally, ICP and Priore caused a Triaxx CDO to acquire the newly-

purchased bonds from the Managed Account using the much higher June 2007 price assigned to

the original bonds. (Id. ¶¶ 44-45.) ICPS retained the difference in market price between the

original bonds and the cheaper bonds that were bought to replace them. (Id. ¶ 46.)

To take one of the swaps detailed in the Complaint, in mid-2008 ICPS acquired CMALT

2006 mortgage bonds in the market at a price of $81.13 per bond, which it immediately sold to

the Managed Account at a price of $82.63 per bond; the bonds were then sold from the Managed

Account to Triaxx 1 using a June 2007 forward-purchase price of $97.84 per bond (i.e., a price

that had been assigned to a different bond a year earlier). (Id.) This caused Triaxx 1 to acquire

the CMALT bonds at June 2007 prices even though it had never committed to forward purchase

those bonds and could have acquired them for much less directly in the market (as ICPS had

done). (Id. ¶ 47.) The swaps allowed Priore, ICP, and ICPS to generate undisclosed profits at

the CDOs’ expense — once again putting their own interests ahead of their clients. (Id.)

D. Systematic Mispricing Of Cross-Trades

The Complaint also describes how ICP and Priore systematically defrauded Triaxx 1, 2,

and 3 by causing them to acquire bonds from Triaxx Funding, and to buy and sell bonds from


8

and to one another, at deliberately inflated prices. In 2008, as the mortgage market continued its

precipitous decline, Triaxx Funding received margin calls from its lender, which Priore knew

could not be satisfied by selling its assets in the market because prices were too depressed.3 (Id.

¶¶ 48, 52.) Instead, on nineteen occasions between March and October 2008, ICP and Priore

caused Triaxx 1, 2, and 3 to acquire bonds from Triaxx Funding at above-market prices, causing

an overpayment of approximately $38 million. (Id. ¶¶ 49-50.)

Throughout 2007 and 2008, ICP and Priore also deliberately used above-market prices

for dozens of cross-trades between Triaxx 1, 2, and 3. (Id. ¶¶ 57-60.) In one of several examples

from the Complaint, they caused two Triaxx CDOs to cross-trade mortgage bonds at a price of

$99.20 per bond, even though ICP had acquired the same bonds on the same day in the market

for only $85.16 per bond. (Id. ¶ 59.) These cross trades often were done at a price of exactly

$92 per bond to manipulate (to the greatest extent possible) the CDOs’ overcollateralization test:

In calculating overcollateralization, the CDOs’ indentures permitted a bond’s value to be

considered as par (i.e., $100) if it had been purchased at $92 or above. (Id. ¶ 60.) Through this

manipulation, the mispriced cross-trades deceptively averted the failure of the CDOs’

overcollateralization test for months, thereby allowing ICP to collect substantial management

fees that it would not have received had the cross-trades been priced at market levels. (Id.)

ICP and Priore set the prices for the bond sales from Triaxx Funding, and for the cross-

trades between Triaxx 1, 2, and 3, in breach of their obligations to trade solely on an arms’

3 Triaxx 1, 2, and 3 were “cash-flow” CDOs, while Triaxx Funding was a “market value” CDO. (Compl. ¶ 18.) As the Complaint explains, in a cash-flow CDO, changes in the market value of the CDO’s assets usually do not require any of the assets to be sold. By contrast, under the financing arrangements used by a market-value CDO, the CDO is typically subject to margin calls when the market value of its assets declines. To meet the calls, the CDO has to sell assets and, if it cannot do so at sufficiently high prices, liquidate its portfolio to satisfy obligations to lenders and investors. (Id.)


9

length basis, at the best price reasonably available, subject to prior approval from AIG or FGIC,

and only after obtaining bona fide dealer bids. (Id. ¶¶ 23, 25.) Yet for each improper trade, ICP

affirmatively represented to the CDOs’ trustee that it was in conformity with these criteria. (Id.

¶¶ 50, 59.) Each of these representations was false. (Id.)

E. Misrepresented Cash Transfers From SCIF

In another deception, as alleged in the Complaint, in October 2008 Priore began causing

the hedge fund SCIF to make cash transfers totaling $36.5 million to pay for Triaxx Funding’s

margin calls. (Id. ¶¶ 52-55.) Priore knew that no party had agreed to repay SCIF and that no

assets were securing the transfers. (Id. ¶ 55.) To hide this from SCIF investors, in letters to the

hedge fund’s administrator Priore misrepresented the payments as “collateralized loans” and as

“ownership” interests in Triaxx Funding, and ICP accounted for them on SCIF’s books at full

value (as if repayment were assured) despite an admonition from its legal counsel that SCIF’s

repayment prospects were far from certain. (Id. ¶¶ 53-55.)

F. Numerous Other Deceptions and Misrepresentations

The Complaint chronicles other deceptions by ICP and Priore. In August 2008, after

consulting Priore, an ICP employee caused the Managed Account to purchase mortgage bonds in

the market at a price of $63.50 per bond and immediately to sell them to Triaxx 2 at $75 per

bond. (Id. ¶¶ 41-42.) This trade was intended to evade a prohibition on the purchase of heavily-

discounted bonds priced below $75, and it generated a risk-free profit of $2.5 million for the

Managed Account (which ICP was entitled to share in) at the expense of Triaxx 2. (Id.)

Separately, ICP and Priore caused the CDOs to purchase ineligible bonds that had been

“repackaged” by ICPS, while allowing SCIF to retain large, undisclosed, risk-free profits in

creating those securities. (Id. ¶ 66.) Instead of acting as fiduciaries to the CDOs, the Complaint


10

describes how time and again ICP and Priore misappropriated millions of dollars in undisclosed

profits and fees for themselves or other clients.

To hide their misconduct, ICP and Priore repeatedly deceived investors about the CDOs’

trading activity. They did not obtain AIG’s or FGIC’s approval for trades — violating a critical

form of protection for the CDOs and their investors. (Id. ¶¶ 37, 50, 59, 62-65). They also

affirmatively misrepresented to the CDOs’ trustee that all investments complied with the CDOs’

investment criteria and restrictions on ICP’s authority. (Id. ¶¶ 50, 59.) Throughout the period

described in the Complaint, ICP and Priore collected substantial management fees while falsely

pretending fidelity to their fiduciary obligations and the restrictions on their investment

authority. (Id. ¶¶ 60, 63-65.)

In late 2007, when AIG complained about unauthorized purchases of bonds from the

Managed Account (which, unbeknownst to AIG, were made pursuant to the undisclosed August

2007 forward-purchase arrangement), ICP told AIG that the “current market allows us to buy

these securities at significant discounts.” (Id. ¶¶ 63-64.) This was false because the purchases

had in fact been priced at higher June 2007 levels and did not reflect “significant discounts” in

the “current” market. (Id.) After AIG rejected the purchases, ICP kept them in the CDO anyway

and made other unauthorized investments. (Id. ¶ 63.) When AIG again inquired in the fall of

2008 about the prices of other unauthorized purchases from the Managed Account, Priore

directed an ICP employee to lie to AIG that the purchases were made at “market prices.” (Id.

¶ 65.) To another investor who questioned inflated prices paid by a CDO, Priore directed an

employee to suggest that the purchases were contemporaneous trades of “discount securities”

and “earlier vintage securities.” (Id.) This was misleading because the purchases had been made

under an unauthorized forward-purchase commitment made a year earlier. (Id.)


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G. Compliance and Books and Records Violations

Separately from the fraud, the Complaint alleges that ICP failed to implement appropriate

compliance policies and procedures and to maintain accurate books and records, as required. (Id.

¶ 67.) The firm did not hold a single brokerage committee meeting to oversee compliance with

its best execution obligation, and failed to follow compliance procedures regarding third-party

approvals for investments and disclosures for principal trades. (Id. ¶¶ 67-68.) The Complaint

further alleges that ICP failed to maintain accurate and complete securities trading blotters and

proper memoranda of all orders for the purchase and sale of securities. (Id. ¶ 69.)

H. The Alleged Violations of Law

Based on these allegations, the Complaint asserts the following claims: (1) violations of

Section 17(a) of the Securities Act of 1933 (“Securities Act”) (against all defendants);

(2) violations of, and aiding and abetting violations of, Section 10(b) of the Securities Exchange

Act of 1934 (“Exchange Act”) and Rule 10b-5 (against all defendants); (3) violations of, and

aiding and abetting violations of, Section 15(c)(1)(A) of the Exchange Act and Rule 10b-3

(against ICPS, ICP, and Priore); (4) violations of, and aiding and abetting violations of, Sections

206(1) and 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”) (against all

defendants); (5) violations of, and aiding and abetting violations of, Section 206(4) of the

Advisers Act and Rule 206(4)-8 (against all defendants); (6) violations of, and aiding and

abetting violations of, Section 206(3) of the Advisers Act (against ICP and Priore); (7) violations

of Section 204 of the Advisers Act and Rule 204-2 (against ICP); (8) violations of Section 206(4)

of the Advisers Act and Rule 206(4)-7 (against ICP); and (9) control person liability under

Section 20(a) of the Exchange Act (against Priore).


12

ARGUMENT

I. THE PLEADING STANDARDS GOVERNING THE COMPLAINT

A. Pleading Under The Federal Rules of Civil Procedure.

Federal Rule of Civil Procedure 8(a)(2) requires a complaint to contain “a short and plain

statement of the claim showing that the pleader is entitled to relief.” This standard “does not

require detailed factual allegations,” Ashcroft v. Iqbal, 556 U.S. ---, 129 S. Ct. 1937, 1949

(2009), but a complaint must describe sufficient facts to “raise a right to relief above the

speculative level.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 127 S. Ct. 1955, 1965

(2007). On a motion to dismiss, the Court may consider “documents attached to the complaint or

incorporated in it by reference” or documents that are “integral to the complaint.” Roth v.

Jennings, 489 F.3d 499, 509 (2d Cir. 2007). The Court’s function, however, is “not to weigh the

evidence that might be presented at trial” but merely to “determine whether the complaint itself

is legally sufficient.” SEC v. Simpson Capital Mgmt., Inc., 586 F. Supp. 2d 196, 199 (S.D.N.Y.

2008) (quoting Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985)). It must construe the

complaint “liberally, accepting all factual allegations . . . as true, and drawing all reasonable

inferences in the plaintiff’s favor.” SEC v. Pentagon Capital Mgmt., PLC, 612 F. Supp. 2d 241,

257 (S.D.N.Y. 2009); accord Ganino v. Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000).

In fraud cases, Federal Rule of Civil Procedure 9(b) requires a complaint to “state with

particularity the circumstances constituting [the] fraud.” This requirement is not meant “to act as

an insurmountable hurdle.” SEC v. Dunn, 587 F. Supp. 2d 486, 505 (S.D.N.Y. 2008) (quotation

omitted); see also SEC v. Power, 525 F. Supp. 2d 415, 423 (S.D.N.Y. 2007). Rule 9(b) “must be

read together with Rule 8(a), which requires only a ‘short and plain statement’ of the claims for

relief.” Ouaknine v. MacFarlane, 897 F.2d 75, 79 (2d Cir. 1990). To meet its particularity

requirement, the complaint must describe the fraudulent misrepresentation or omission, identify


13

who made it, indicate when and where it was made, and explain why it was fraudulent. ATSI

Commc’n, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007); Novak v. Kasaks, 216 F.3d

300, 306 (2d Cir. 2000). When charging multiple defendants with fraud, the Complaint must

inform “each . . . of the nature of his alleged participation.” DiVittorio v. Equidyne Extractive

Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987).

B. The Fraud Claims Against The Defendants.

The Complaint asserts fraud claims against the defendants under Section 17(a) of the

Securities Act, Sections 10(b) and 15(c)(1)(A) of the Exchange Act and Rules 10b-3 and 10b-5

thereunder, and Section 206 of the Advisers Act and Rule 206(4)-8 thereunder. (Compl. ¶¶ 70-

91.) As an alternative theory of liability, the Complaint asserts aiding and abetting charges

against the defendants. (Id.)

To state a claim under Section 10(b) of the Exchange Act and Rule 10b-5, the Complaint

must allege that the defendants, with scienter and in connection with the purchase or sale of

securities, made materially false statements or omitted material facts. SEC v. Monarch Funding

Corp., 192 F.3d 296, 308 (2d Cir. 1999); SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1467 (2d

Cir. 1996).4 Alternatively, the Complaint can allege that the defendants participated in a

deceptive act or course of business, with scienter, in furtherance of a scheme to defraud.

Simpson, 586 F. Supp. 2d at 201. Section 17(a) of the Securities Act requires “[e]ssentially the 4 Defendants argue that the Complaint is insufficient because it fails to allege harm to investors. (Joint Br. at 5 (claiming allegations that “investors have suffered any actual injury” are “notably absent”); id. at 24 (claiming absence of allegations that a “single bond . . . has defaulted”); id. at 28 (same); id. at 34 (same).) In fact, the Complaint alleges that the defendants misappropriated millions of dollars from their CDO clients and subjected investors in Triaxx 1, 2, and 3 to substantial risks of further losses. (Compl. ¶¶ 1, 5, 32-33, 36, 39, 42, 47, 49, 60.) Regardless, it is settled that “[u]nlike private litigants, the SEC is not required to prove investor reliance, loss causation, or damages in an action for securities fraud.” Simpson, 586 F. Supp. 2d at 201; accord SEC v. KPMG, LLP, 412 F. Supp. 2d 349, 375 (S.D.N.Y. 2006); SEC v. Credit Bancorp, Ltd., 195 F. Supp. 2d 475, 490-91 (S.D.N.Y. 2002) (citing SEC v. North Am. Research & Dev. Corp., 424 F.2d 63, 84 (2d Cir.1970)).


14

same elements” in connection with the “offer or sale” of securities, except that “no showing of

scienter is required . . . under subsection (a)(2) or (a)(3).” Monarch, 192 F.3d at 308. Section

15(c)(1)(A) of the Exchange Act and Rule 10b-3 contain a parallel prohibition on fraud in the

purchase or sale of securities, or inducement thereof, by a broker or dealer. See SEC v. George,

426 F.3d 786, 792 (6th Cir. 2005) (elements of Section 15(c)(1) violation “are the same” as

Section 10(b) and Rule 10b-5).

To state a claim under Sections 206(1), (2), and (4) of the Advisers Act, the Complaint

must allege that the defendants, acting as investment advisers, employed a “device, scheme, or

artifice to defraud,” or engaged in a “transaction, practice, or course of business which operate[d]

as a fraud or deceit upon any client or prospective client” or which was “fraudulent, deceptive, or

manipulative.” 15 U.S.C. §§ 80b-6(1), (2) and (4). Rule 206(4)-8 prohibits advisers to “pooled

investment vehicles” from engaging in fraudulent acts or making material misrepresentations to

any investor or prospective investor.5 17 C.F.R. 275.206(4)-8. Section 206(3) prohibits an

investment adviser from effecting a transaction for a client while acting as principal for its own

account, or as broker for another, without disclosing the adviser’s role and obtaining the client’s

written consent. 15 U.S.C. § 80b-6(3).6

5 “Pooled investment vehicles” include hedge funds, CDOs, and other pooled funds that invest in securities. See Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Advisers Act Rel. No. 2628, 2007 WL 2239114, at *3 (Aug. 3, 2007). Under Rule 206(4)-8, a “pooled investment vehicle” is defined, inter alia, as “any company that would be an investment company under section 3(a) [of the Investment Company Act of 1940] . . . but for the exclusion provided from that definition by either section 3(c)(1) or section 3(c)(7) of that Act.” The exclusion under Section 3(c)(1) extends to an “issuer whose outstanding securities . . . are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of its securities.” This applies to the Triaxx CDOs and SCIF, and defendants have not suggested otherwise. 6 Client consent is required even when, as was done here, an investment adviser transacts through an affiliated broker-dealer. See Interpretation of Section 206(3) of the Advisers Act, Advisers Act Rel. No. 1732, 1998 WL 400409, at *1 n.3 (July 17, 1998).


15

As the Supreme Court has recognized, Section 206 of the Advisers Act “establishes

federal fiduciary standards to govern the conduct of investment advisers.” Transamerica Mortg.

Advisors, Inc. v. Lewis, 444 U.S. 11, 17, 100 S. Ct. 242, 246 (1979) (“Congress intended to

impose enforceable fiduciary obligations”). Given the “delicate fiduciary nature of . . . [the]

investment advisory relationship,” Section 206 places “an affirmative duty” on investment

advisers of “utmost good faith, and full and fair disclosure of all material facts, as well as an

affirmative obligation to employ reasonable care to avoid misleading.” SEC v. Capital Gains

Research Bureau, Inc., 375 U.S. 180, 194, 84 S. Ct. 275, 284 (1963); see also SEC v. Moran, 922

F. Supp. 867, 895-96 (S.D.N.Y. 1996) (investment advisers must “act for the benefit of their

clients” and with “utmost good faith”). Under Section 206, it is “not necessary . . . to establish

all the elements of fraud that would be required in a suit against a party to an arm’s length

transaction,” Aaron v. SEC, 446 U.S. 680, 693, 100 S. Ct. 1945, 1954 (1980), since the Advisers

Act prohibits fraud “in the ‘equitable’ sense of the term . . . premised on [the] recognition that

Congress intended . . . to establish federal fiduciary standards for investment advisers.” Santa Fe

Indus., Inc. v. Green, 430 U.S. 462, 472 n.11, 97 S. Ct. 1292, 1300 n.11 (1977); see also SEC v.

Treadway, 430 F. Supp. 2d 293, 338 (S.D.N.Y. 2006) (“Conduct subject to liability under the

Advisers Act is broad.”).

Finally, for the aiding and abetting claims, the Complaint must allege “(1) the existence

of a fraud; (2) defendant’s knowledge of the fraud; and (3) that the defendant provided

substantial assistance to advance the fraud’s commission.” Lerner v. Fleet Bank, N.A., 459 F.3d

273, 292 (2d Cir. 2006); accord SEC v. DiBella, 587 F.3d 553, 566 (2d Cir. 2009).


16

C. The Commission Is Not Subject To A Special Pleading Standard.

Defendants contend that the Commission must meet a uniquely heightened pleading

burden because it conducted a pre-litigation investigation. (Joint Br. at 14.) As is common, the

Commission filed the Complaint based on information gathered over several months. But this

does not mean that the Commission’s investigative file is a “full discovery [record] of all

documents,” as was the case in the authority defendants cite. See Billard v. Rockwell Int’l Co.,

683 F.2d 51, 57 (2d Cir. 1982). Indeed, courts have recognized that the Commission should not

be restricted in litigation because of its pre-filing investigation as this would threaten to

“transform[] regulatory investigations into trials.” SEC v. Saul, 133 F.R.D. 115, 119 (N.D. Ill.

1990) (denying motion to preclude deposition because of prior investigative testimony, noting

“there is no authority which suggests that it is appropriate to limit the SEC’s right to take

discovery based upon the extent of its previous investigation”); see also SEC v. Softpoint, Inc.,

958 F. Supp. 846, 857 (S.D.N.Y. 1997). The Commission is not aware of any decision holding

the government to a more exacting pleading standard as a result of a prior investigation.7 Nor is

there any support for such a special rule in the text of Rule 9(b) or its accompanying Advisory

Committee Notes.

7 The two cases defendants rely on are inapposite. In Billard, the court noted the danger of “strike suits” and found that the plaintiffs failed to produce “any supporting detail for their general allegation of fraud” despite having taken “full discovery” in prior “extensive litigation” of the same transaction. 683 F.2d at 53, 57. In U.S. ex rel Dhawan v. N.Y. City Health & Hosp. Corp., No. 95 Civ. 7649, 2000 WL 1610802, at *2-3 (S.D.N.Y. Oct. 27, 2000), the court found that fraud against two defendants was properly alleged. It dismissed other fraud claims because they were based on no more than “an unjustified quantum leap,” unsupported by any facts, that some defendants must have committed fraud because their business activities were similar. Neither case supports the sweeping suggestion that a prior administrative investigation alters the pleading standard under Rule 9(b).


17

II. THE COMPLAINT PLEADS FRAUD WITH PARTICULARITY

The federal securities laws recognize several kinds of deception. Perhaps the most

common form involves a false or misleading statement or material omission. But, as Judge

Lynch has succinctly explained, another type of securities fraud arises from “conduct that is

deceptive because it is inconsistent with a fiduciary duty”:

In claims of this kind, the fiduciary duty serves as a sort of standing false representation by the fraudster, who deceives the victim by violating the commitment associated with her fiduciary duty. Acceptance of a fiduciary duty creates an understanding that the fiduciary will behave in certain ways; if the fiduciary allows this understanding to continue while acting inconsistently with her obligations, she has deceived the victim.

In re Refco Capital Mkts., Ltd. Brokerage Customer Sec. Litig., No. 06 Civ. 643 (GEL), 2007

WL 2694469, at *7 (S.D.N.Y. Sept. 13, 2007).

Here, the Complaint alleges both kinds of deception with specificity. It alleges that ICP

and Priore repeatedly breached their fiduciary obligations by knowingly violating the CDOs’

investment criteria, engaging in unauthorized trades, usurping profits from the CDOs,

intentionally mispricing investments, and engaging in cross trades to benefit one client at the

expense of another — all while continuing to feign loyalty to each CDO and compliance with the

undertakings governing its fiduciary authority to manage investments on behalf of the CDO.

Separate from these undisclosed fiduciary abuses, the Complaint alleges that ICP and Priore

made affirmative misstatements and omissions to investors, the CDOs’ trustee, and others. By

describing the misconduct defendants engaged in, specifying multiple examples, explaining each

defendant’s role, and alleging facts showing the defendants’ scienter, the Complaint more than

meets Rule 9(b).


18

A. The Allegations of ICP’s and Priore’s Repeated Undisclosed Breaches Of Their Fiduciary Obligations State A Claim For Fraud.

An undisclosed breach of a fiduciary duty can constitute fraud under the federal securities

laws. Refco, 2007 WL 2694469, at *7. The Supreme Court’s decision in Santa Fe, much relied

upon by the defendants, is not to the contrary. It holds only that a fiduciary breach, absent

deception, is not fraud. 430 U.S. at 472-74, 97 S. Ct. at 1300-01; see also Goldman, 754 F.2d at

1067 (Santa Fe “was concerned with whether conduct that involved neither misrepresentation

nor nondisclosure . . . was the proper subject of a claim under Rule 10b-5.”). The deception that

transforms a fiduciary abuse into securities fraud consists, as the Supreme Court has recognized

elsewhere, in undisclosed conduct that is inconsistent with a fiduciary obligation.

In SEC v. Zandford, for example, the Supreme Court held that a broker defrauded his

client by secretly selling the client’s securities for his own profit in breach of his fiduciary duty.

535 U.S. 813, 820-21, 122 S. Ct. 1899, 1903-04 (2002). Each sale, the Court held, “was

deceptive . . . because it was neither authorized by, nor disclosed to” the client. 535 U.S. at 820-

21, 825 n.4, 122 S. Ct. at 1904, 1906 n.4 (“[I]f the broker told his client he was stealing the

client’s assets, that breach of fiduciary duty . . . would not involve a deceptive device or fraud.”).

By not disclosing his conduct, the broker “duped” his clients into believing that “any transactions

made on their behalf would be for their benefit for the ‘safety of principal and income,’” as the

broker had represented when becoming a fiduciary. 535 U.S. at 822, 122 S. Ct. at 1904.

Similarly, in U.S. v. O’Hagan, the Supreme Court held that an attorney committed

securities fraud when he traded on the basis of confidential information gleaned from his client

in breach of a fiduciary duty. 521 U.S. 642, 653-55, 117 S. Ct. 2199, 2208-09 (1977). Such

conduct was deceptive because the defendant “pretend[ed] loyalty to the principal while secretly

converting the principal’s information for personal gain.” Id. (distinguishing Santa Fe on ground


19

that, in Santa Fe, “all pertinent facts were disclosed”); U.S. v. Falcone, 257 F.3d 226, 232 (2d

Cir. 2001) (“Because the lawyer O’Hagan had breached the fiduciary duty he owed both to his

law firm and to the firm’s client to keep their information confidential and not appropriate such

information to his own use, he had engaged in deception within the meaning of section 10(b).”).

The Complaint alleges that ICP and Priore engaged in a host of fiduciary abuses while

feigning loyalty to their clients and compliance with the terms of ICP’s investment advisory

agreements, thereby “allowing the understanding to continue” that they were serving their

clients’ best interests. Refco, 2007 WL 2694469, at *7. Contrary to defendants’ arguments,

such allegations establish securities fraud.

1. The misappropriation of $14 million from the CDOs by ICP, ICPS, ICP Holdco, and Priore.

The Complaint alleges that the defendants misappropriated a trade from the CDOs in

order to pocket a $14 million profit. After committing the CDOs to forward purchase $1.3

billion in Bear Stearns bonds, Priore located another client willing to pay a higher price.

(Compl. ¶¶ 29, 31.) Instead of selling the bonds from the CDOs to this client, Priore rebooked

the trade so that ICP, ICPS, and ICP Holdco could purchase the bonds and sell them at the higher

price to misappropriate the $14 million gain. (Id. ¶¶ 32-33.) None of this was disclosed to the

CDOs, their trustee, or investors. (Id. ¶¶ 34, 62.) Instead, Priore and his entities collected the

profit while continuing to feign loyalty to the CDOs — precisely the kind of undisclosed

fiduciary breach recognized as fraud in Zandford.

The Complaint describes each defendant’s participation. Priore, who owned, controlled,

and directed ICP, ICPS, and ICP Holdco (id. ¶¶ 12-15), initiated and orchestrated the fraud by

persuading Client A to purchase the bonds at a higher price, directing the rebooking of the

CDOs’ trade, and interposing his entities to misappropriate the profit. These allegations easily


20

meet Rule 9(b). See Pentagon, 612 F. Supp. 2d at 260 (allegations of defendants’ role as

“creators, directors, and chief beneficiaries” of alleged fraud “are sufficient to allege [fraud] with

particularity”); Simpson, 586 F. Supp. 2d at 208 (SEC pleaded fraud by stating facts showing

defendants “orchestrated the fraudulent scheme”); In re Global Crossing, Ltd. Sec. Litig., 322 F.

Supp. 2d 319, 336-337 (S.D.N.Y. 2004) (allegations that defendant “masterminded” fraudulent

transactions sufficient to plead fraud with particularity).

ICPS claims that the Complaint “does not allege that [it] played any role” in this fraud.

(ICPS Br. at 15.) In fact, the Complaint alleges that both ICPS and ICP Holdco participated by

interjecting themselves in the trade to replace the CDOs, immediately selling the bonds to the

Managed Account, and misappropriating what they knew (because Priore, who owned and

controlled them, knew) to be a profit opportunity of the CDOs. (Compl. ¶¶ 32-33.) ICPS’s

suggestion that a broker-dealer may interpose itself to willfully misappropriate a client’s trading

profit has no support in the case law. By executing a trade whose sole purpose it knew was to

usurp a profit from the CDOs, ICPS participated in the fraud. First Jersey, 101 F.3d at 1471

(primary liability attaches not only to “persons who made fraudulent misrepresentations but also

[to] those who had knowledge of the fraud and assisted in its perpetration”); Simpson, 586 F.

Supp. 2d at 207 (liability for fraudulent scheme “supports a participation standard, at least in

actions brought by the SEC”); Global Crossing, 322 F. Supp. 2d at 336 (primary liability alleged

where accounting firm masterminded “sham swap transactions” used by their clients to

“circumvent GAAP and inflate . . . revenues”).8

8 Although the Supreme Court in Stoneridge rejected private claims based on participation in a fraudulent scheme on the ground that reliance is lacking, this does not apply to SEC actions where reliance is not an element. See Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 161, 128 S. Ct. 761, 770 (2008) (“[I]f business operations are used . . . to affect securities markets, the SEC

(footnote continued on the next page)


21

Defendants contend that the CDOs’ offering circulars permitted them to cancel and

rebook the CDOs’ June 14 trade because they disclosed that ICP need not present every

investment opportunity to the CDOs. (Joint Br. at 21.) However, this trade was not merely an

opportunity that ICP came across but failed to present to the CDOs. Instead, the Complaint

alleges that ICP and Priore first committed the CDOs to the trade (putting them at risk of loss),

and then deprived them of what turned out to be a profit on the trade by canceling and rebooking

it. (Compl. ¶ 33.) Nothing in the offering circulars permitted ICP to wager its clients’ money on

a trade and, once the wager was winning, seize the profits for itself.

Defendants also argue that the Complaint “concedes that the Triaxx CDOs did not have

the means to purchase the Bear Stearns portfolio,” and therefore the misappropriated $14 million

profit never was an opportunity of the CDOs. (Joint Br. at 21.) This both misconstrues the

Complaint and is irrelevant. What the Complaint alleges is that, when the June 14 trade was

made, the CDOs could not “immediately” settle the bonds — hence ICP arranged for forward

settlements in August and September. (Compl. ¶¶ 28-29.) In any event, even if the CDOs could

not have settled the bonds, nothing prevented them from selling their right to buy them to the

Managed Account and receiving the profit. And if, as the defendants appear to suggest, the

CDOs “did not have the means to purchase” the bonds, then ICP and Priore, as fiduciaries,

obviously had no business committing them to the trade (and placing them at risk of loss) in the

first place.

enforcement power may reach the culpable actors”); see also SEC v. Battenberg, No. 06 Civ. 14891, 2010 WL 1416981, at *4 (E.D. Mich. Apr. 8, 2010) (“Stoneridge . . . did not reject or abandon scheme liability in SEC enforcement actions.”); SEC v. Fraser, No. 09 Civ. 443, 2009 WL 2450508, at *9 (D. Ariz. Aug. 11, 2009) (same); Simpson, 586 F. Supp. 2d at 207-08 n.4 (same).


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2. Systematic mispricing of trades by ICP and Priore.

The Complaint alleges that ICP and Priore systematically mispriced trades by the CDOs

in order to manipulate the overcollateralization test (so that they could continue to collect

advisory fees) or to benefit Triaxx Funding and the Managed Account over Triaxx 1, 2, and 3.

The Complaint first describes how in August 2007, Priore used higher June 2007 prices

when committing the CDOs to forward purchase the Bear Stearns bonds from the Managed

Account. (Id. ¶ 36.) Later, when the mortgage market declined even further, Priore once more

used June 2007 prices for additional bond purchases by the CDOs from the Managed Account.

(Id. ¶ 39.) This willful and undisclosed mispricing violated ICP’s and Priore’s fiduciary duty to

act with the “utmost good faith,” Capital Gains, 375 U.S. at 194, 84 S. Ct. at 284, and to seek the

most favorable price reasonably available for the CDOs. See Newton v. Merrill, Lynch, Pierce,

Fenner & Smith, Inc., 135 F.3d 266, 270-73 (3d Cir. 1998) (en banc) (broker’s failure to obtain

best execution constituted securities fraud; best execution duty requires seeking “best reasonably

available price” and entails “implied representation . . . that [trades would] maximize the

[client’s] economic gain”); see also Sinclair v. SEC, 444 F.2d 399, 400 (2d Cir. 1971) (“as a

matter of fiduciary duty,” broker had to “use due diligence to obtain the best available price . . .

upon execution”).

The Complaint also alleges that between March and October 2008, ICP and Priore

directed nineteen sales of bonds from Triaxx Funding to Triaxx 1, 2, and 3, at what they knew

were above-market prices, in order to allow Triaxx Funding to meet margin demands. (Id. ¶¶ 48-

51.) And it further describes recurrent cross-trading between Triaxx 1, 2, and 3, throughout 2007

and 2008 and at above-market prices, to manipulate the CDOs’ overcollateralization test so that

ICP would continue to receive management fees. (Id. ¶¶ 57-60.) Although ICP owned the

residual interest in the CDOs (which meant that it might theoretically benefit, in the distant


23

future, if the CDOs bought securities cheaply), this willful, undisclosed mispricing ensured that

ICP received immediate payments of millions of dollars in fees. (Id. ¶ 60.) In addition to

blatantly violating ICP’s and Priore’s duty to obtain the most favorable prices, these mispriced

trades were therefore analogous to “churning,” i.e., the fraudulent practice of “‘overtrading’ . . . a

controlled account for the purpose of increasing the amount of commissions.” Armstrong v.

McAlpin, 699 F.2d 79, 90 (2d Cir. 1983).

Defendants assert that the Complaint contains only “generalized allegations of

overcharges.” (Joint Br. at 30.) However, the Complaint details numerous facts alleging that

trades were systematically mispriced:

• Contemporaneous trades of the very same bonds were made at markedly different prices, with Triaxx 1, 2, and 3 always paying the higher price. (Compl. ¶¶ 41-42 (same-day trade at $63.50 and $75); id. ¶ 59 (same-day trade at $85.16 and $99.20); id. (same-day trades ranging from $78 to $99.86); id. (same day trade at $92 and $96).)

• Many of the bond sales from Triaxx Funding to Triaxx 1, 2, and 3, and the cross-trades between the CDOs, were priced at exactly $92 per bond, the threshold for maximum overcollateralization credit under the CDOs’ indentures. (Id. ¶ 60.) This price was used throughout 2008, irrespective of the sharp decline in the mortgage market during that period. (Id. ¶ 50 (mid-2008 cross-trades at $92); id. (sale from Triaxx Funding in 2008 at $92).)

• Cross-trades between Triaxx 1, 2, and 3 were done at substantially higher prices than what ICP paid in the market at the time for very similar bonds. (Id. ¶ 50 (purchase of CMALT 2007-A6 at $92 shortly after market purchase of CMALT 2007-A5 at $78.63).)

• In the period between March and October 2008, when Triaxx Funding was under regular margin demands and the mortgage markets were depressed, it did not sell a single bond in the market and instead sold only to the other CDOs. (Id. ¶ 50.)

• The forward-purchase agreement between the CDOs and the Managed Account was made in August 2007 but used June 2007 prices, which were higher. (Id. ¶ 36.) June 2007 prices also were used for subsequent purchases of tens of millions of dollars worth of BAFC 2007 and RALI 2007 bonds by the CDOs from the Managed Account. (Id. ¶ 39.)


24

• All purchases by the CDOs of “swapped” bonds were, once again, done at June 2007 prices and substantially in excess of what ICP or ICPS paid for the bonds shortly before the CDOs purchased them. (Id. ¶ 45 (bond purchased by ICPS at $78.63 and sold to CDO at $99.22); id. ¶ 46 (bond purchased by ICPS at $81.13 and sold to CDO at $97.84).)

• Not a single sale from a Triaxx CDO to another ICP client was done using bona fide bids from independent dealers. (Id. ¶¶ 50, 59.)

As in Zandford, ICP and Priore committed fraud each time they engaged in a mispriced,

undisclosed, and unauthorized trade while continuing to pretend to be serving their clients’ best

interests. Zandford, 535 U.S. at 820-21, 122 S. Ct. at 1903-04. The Complaint’s detailed

allegations are sufficient to state securities fraud with particularity. See Fraternity Fund Ltd. v.

Beacon Hill Asset Mgmt. LLC, 376 F. Supp. 2d 385, 396-97 (S.D.N.Y. 2005) (“Fraternity I”)

(complaint pleaded fraud by alleging that defendants valuation of fund’s assets substantially

diverged from independent marks and prices used for contemporaneous trades).9

The defendants criticize what they say is the Complaint’s “exclusive focus on price,” on

the ground that other factors could affect investment decisions. (Joint Br. at 27, 30, 34.) But the

Complaint does not merely allege that ICP selected more costly bonds over cheaper ones. It

alleges that ICP intentionally mispriced investments that the CDOs could — and, consistent with

ICP’s and Priore’s fiduciary duty, should — have made at a better price for the client. See

Sinclair, 444 F.2d at 400-01 (broker committed fraud by causing customers “to pay higher prices

for securities purchased by them, or to receive lower prices for securities sold by them”).10

9 The Complaint identifies multiple mispriced trades by specifying bond names, principal amounts, dates, and trade prices. (Compl. ¶¶ 39, 41-42, 45-46, 50, 59.) This level of detail is sufficient to put the defendants on notice of their alleged fraud. See SEC v. Trabulse, 526 F. Supp. 2d 1001, 1004-05 (N.D. Cal. 2007) (SEC “has pleaded sufficient detail” by identifying “examples” of misstatements, even though other allegedly fraudulent misstatements remained “unidentified” in the complaint). 10 With respect to the same-day markup on bonds from $63.50 to $75, defendants argue that the Complaint does not allege that the bonds “were worth less than the $75 price paid by Triaxx 2.” (Joint

(footnote continued on the next page)


25

Finally, the defendants suggest that the mispricing of trades was not fraudulent because

ICP and Priore only did it to ensure that the CDOs remained in “compliance” with their

governing tests. (Joint Br. at 34.) The CDOs’ tests, however, were supposed to function as

objective measures of the financial health of the CDOs. They were designed to protect investors

by ensuring that certain safeguards — such as diversion of cash flows to senior investors and

suspension of the payment of ICP’s investment advisory fee — would be adopted whenever the

CDO fell out of compliance with these tests. (Compl. ¶ 60.) The failure of such a test, therefore,

was not a harm to be avoided by any means possible. To the extent that defendants mispriced

cross-trades to avoid failure of these tests, they doubly harmed investors: They not only inflicted

upon investors the immediate loss of a mispriced trade (i.e., the purchase of a security at a price

above the prevailing market price), they also fraudulently deprived them of the protections that

would have been triggered by an accurately and fairly priced trade.

3. The “swapping” of bonds by ICP, ICPS, and Priore.

Finally, the Complaint alleges another undisclosed fiduciary abuse by ICP, ICPS, and

Priore: the “swapping” of bonds in the Managed Account to evade AIG’s oversight and generate

undisclosed profits. (Id. ¶¶ 43-44 (describing the three steps involved in the swaps).) The

Complaint recounts several swaps in detail (id. ¶¶ 45-46) and identifies the role of each

defendant. Priore proposed the swaps and caused ICPS and ICP to locate the cheaper securities,

replace the bonds in the Managed Account with these securities, sell them to the CDOs at the

higher June 2007 price, and retain the resulting profit. (Id. ¶ 46.) ICPS and ICP knew (because

Br. at 26.) This claim cannot be squared with ICP’s fiduciary obligations, which included the duty not to purchase bonds priced below $75 and to ensure that all purchases were made on an arms’ length basis and at the best reasonably available price. There is no support for defendants’ suggestion that ICP can substitute its own assessment of “worth” to negate express restrictions on its investment authority.


26

Priore knew) that the swaps were inherently deceptive, i.e., that their object was to sell cheaper

securities to the CDOs, using higher June 2007 prices, as if they had been forward purchased

months before at those prices. (Id.) Although the swaps were inconsistent with ICP’s and

Priore’s fiduciary duties, ICP did not disclose this, and in fact falsely certified that these trades

complied with all of their obligations. (Id. ¶¶ 26, 43.)

Defendants argue that the swaps were only meant to find high-quality bonds for the

CDOs and to “uphold” the forward purchases at “better economics.” (Joint Br. at 28-29.) But

the swaps are alleged to have caused the CDOs, in mid-2008, to pay inflated year-old prices for

bonds they had no obligation to purchase at any price. (Id. ¶ 47.) If ICP and Priore believed in

good faith that the CDOs’ would prosper by owning these bonds, they could (and should) have

caused them to purchase the bonds in the open market for much less. Thus, even assuming that

the replacement bonds were of better quality (a fact nowhere alleged in the Complaint), ICP and

Priore still engaged in an undisclosed breach of their fiduciary duty by favoring another client

(the Managed Account) over the CDOs and by failing to obtain best execution for these trades.

Sinclair, 444 F.2d at 400; Newton, 135 F.3d at 270-73.

Defendants further suggest that Priore’s email to Client A about the swaps, which the

Complaint quotes and which they attach to their papers, shows that Priore was pursuing the

CDOs’ best interests. (Joint Br. at 28-29). It does not. The email demonstrates, instead, that

Priore’s motive was to profit (“make some dough”) at the CDOs’ expense — by directing the

swaps, ICP, ICPS, and Priore were able to generate additional profits for themselves on the

CDOs’ purchases from the Managed Account. That Priore self-servingly claimed that the swaps

would “uphold” the purchases at “better economics” is irrelevant. The swaps were undisclosed

and inconsistent with ICP’s and Priore’s fiduciary duty, which suffices to state a fraud claim.

Zandford, 535 U.S. at 820-21, 122 S. Ct. at 1903-04; Refco, 2007 WL 2694469, at *7.


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4. Undisclosed and willful violations of the CDOs’ investment criteria constitute fraud.

Defendants separately argue that the Complaint alleges nothing more than breaches of

contract. (Joint Br. at 15, 25.) But the systematic and deliberate failures by ICP and Priore to

follow the express restrictions on their investment authority were breaches of their fiduciary

obligations and, since they were undisclosed, are actionable as fraud. Several of these

restrictions, such as the duty to trade on an arms’ length basis and with best execution, were set

out in their advisory agreements with the CDOs, while others were contained in the CDOs’

indentures and incorporated by reference in the advisory agreements. (Compl. ¶¶ 22-23.)

Together, these express restrictions on ICP’s and Priore’s authority to invest on behalf of the

CDOs defined the scope of their fiduciary discretion. The Supreme Court in Zandford held a

broker liable for fraud where he failed, without disclosure and in breach of a fiduciary duty, to

follow his client’s stated investment criteria. 535 U.S. at 815, 822, 122 S. Ct. at 1901, 1904.

ICP’s and Priore’s repeated and undisclosed violations of the CDOs’ express restrictions on their

investment authority also are actionable as fraud.

In any event, many of the duties that ICP and Priore are alleged to have flouted (such as

the duty to seek best execution and only invest with approval) are core fiduciary obligations of

an investment adviser, as ICP appears to have recognized when it codified several of these

protections in its compliance manual. (Compl. ¶¶ 67-68.) These obligations stem from the

adviser’s overriding duty to act “for the benefit” of his clients, Moran, 922 F. Supp. at 895-96,

and with “utmost good faith.” Capital Gains, 375 U.S. at 194, 84 S. Ct. at 284; see also

Restatement (Third) Agency § 8.01 (2006) (“An agent has a fiduciary duty to act loyally for the

principal’s benefit.”). Thus, because they never disclosed an intent not to comply with these


28

fiduciary duties, ICP’s and Priore’s alleged misconduct would be actionable as fraud even if their

advisory agreements with the CDOs had not explicitly spelled out those duties.

B. The Complaint Alleges Material Misstatements And Omissions By ICP And Priore.

In addition to systemic, undisclosed abuses of their fiduciary positions, the Complaint

describes repeated misstatements that ICP and Priore made to investors, the CDOs’ trustee, and

SCIF’s administrator. Some misrepresentations were affirmative lies; others were deliberate

omissions. Each gives rise to a fraud claim, and for each the Complaint alleges who made the

misrepresentation, when, in what context, and why it was fraudulent.

1. Concealment of unauthorized trades.

The Complaint describes numerous trades that ICP and Priore made on behalf of the

CDOs without disclosure or authorization. ICP and Priore did not even tell AIG or FGIC of —

let alone obtain their approval for — the CDOs’ forward purchase of $1.3 billion in Bear Stearns

bonds, either in June 2007 (when the initial investment was made) or in August 2007 (when the

second, backdated investment was made). (Comp. ¶¶ 30, 36, 62.) They concealed this, as the

Complaint explains, because the investment exceeded ICP’s investment authority. (Id. ¶ 24.)

Moreover, if ICP and Priore had disclosed the June 2007 investment, they would not have been

able to rebook it to misappropriate $14 million from the CDOs. (Id. ¶ 33.) And by failing to

disclose the August 2007 investment, ICP and Priore could conceal the fact that it was done with

June 2007 prices, which were higher. (Id. ¶ 36.) The Complaint also alleges that ICP and Priore

concealed from AIG and FGIC many of the bond purchases from Triaxx Funding and the cross-

trades between Triaxx 1, 2, and 3, which also were deliberately mispriced. (Id. ¶¶ 61-65.)

Defendants argue that allegations of failure to obtain approval for trades cannot “rise to

the level of fraud.” (Joint Br. at 37.) But the Second Circuit considers it “well-settled” that


29

securities fraud claims can be based on “unauthorized trading, which occurs when a broker

intentionally places trades without obtaining the customer’s approval.” Caiola v. Citibank, N.A.,

295 F.3d 312, 323 (2d Cir. 2002). ICP and Priore told their clients and investors that they would

not trade without first obtaining AIG’s or FGIC’s written approval, and then proceeded to do just

that repeatedly. This is actionable as fraud. See Caiola, 295 F.3d at 323; see also SEC v. Hasho,

784 F. Supp. 1059, 1110 (S.D.N.Y. 1992) (brokers committed fraud through unauthorized trades

and seeking after-the-fact ratification by misrepresenting prices); Cruse v. Equitable Sec. of New

York, Inc., 678 F. Supp. 1023, 1028 (S.D.N.Y. 1987) (securities fraud claim may be based on

allegations that defendant executed trades “without first obtaining the requisite authority”).

Moreover, as fiduciaries, ICP and Priore had a duty to disclose these trades so that AIG

and FGIC could determine whether to approve them (among other reasons). Capital Gains, 375

U.S. 180 at 194, 84 S. Ct. 275 at 284 (investment advisers have “affirmative duty of full and fair

disclosure of all material facts”); DiBella, 587 F.3d at 568 (“[A]n investment adviser can avoid

committing fraud on its clients by disclosing material information to them.”). The Complaint’s

allegations of their failure to do so satisfy Rule 9(b). See Nelson v. Stahl, 173 F. Supp. 2d 153,

168 (S.D.N.Y. 2001) (complaint sufficiently alleged fraud by omission by identifying “what

Defendants allegedly failed to disclose and why they were required to disclose”).

Defendants find it “difficult to comprehend” how investors were misled by concealment

of the $1.3 billion purchase of the Bear Stearns bonds. (Joint Br. at 19.) But it is no mystery:

Investors expected ICP and Priore, as fiduciaries, to serve the CDOs’ best interests and invest

solely in conformity with the criteria and procedures ICP had represented it would follow. They

were “duped into believing that . . . any transactions made on their behalf would be for their

benefit.” Zandford, 535 U.S. at 822, 122 S. Ct. at 1905. Investors were unaware that ICP and

Priore usurped profit opportunities from the CDOs, failed to obtain favorable prices, and


30

repeatedly concealed trades and failed to obtain approvals for them. As one court has put it,

“failure to inform an investor of transactions made on his or her account is . . . a material

omission” under the securities laws “and, in fact, no omission could be more material than that.”

Rivera v. Clark Melvin Sec. Corp., 59 F. Supp. 2d 280, 292 (D. Puerto Rico. 1999) (quoting

Village of Arlington Heights v. Poder, 712 F. Supp. 680, 683 (N.D. Ill. 1989)).11

Next, in claiming that no investors were misled, defendants point to a disclosure in the

CDOs’ offering circulars that ICP and its affiliates may make investment decisions “that may be

the same as or different from those made” for the CDOs, or may seek to conduct trades between

the CDOs and other ICP clients. (Joint Br. at 12 n.8.) But all that this disclosure provides is that

ICP may apply different investment strategies to different vehicles or accounts under its

management. No one reading this provision would understand it to permit ICP to systematically

disadvantage a CDO by causing it to purchase assets at above-market prices from another ICP

client, or to engage in unauthorized investments.

Finally, defendants contend that nothing prohibited the $1.3 billion forward purchase

arrangement. (Id. at 15-18.) However, the Complaint alleges that the arrangement was:

(1) intentionally mispriced using backdated June 2007 prices; (2) never disclosed to AIG or

FGIC for approval; (3) never mentioned to the CDOs’ trustee; (4) carried out by shifting losses

from one CDO to another; and (5) fraudulently modified by directing the “swapping” of bonds,

using June 2007 prices, that were never part of the arrangement. (Compl. ¶¶ 43-47.) Thus, the

11 Regardless, the extent to which investors were misled, which goes to the materiality of defendants’ nondisclosures, is not suitable for resolution at the pleading stage. See SEC v. Reserve Mgmt. Co., Inc., No. 09 Civ. 4346 (PGG), 2010 WL 685013, at *14 (S.D.N.Y. Feb. 24, 2010) (complaint may not be dismissed unless misrepresentations were “so obviously unimportant . . . that reasonable minds could not differ on the question of their importance”); SEC v. Collins & Aikman Corp., 524 F. Supp. 2d 477, 496 (S.D.N.Y. 2007) (“Materiality is a mixed question of law and fact and is thus not generally suitable for treatment on a motion to dismiss.”).


31

Complaint pleads fraud regardless of whether the forward purchase arrangement was in principle

permissible (which it was not).12 Similarly, defendants’ claim that the forward-purchase

arrangement was merely designed to supply the CDOs with eligible bonds (Joint Br. at 18-19)

does not excuse ICP’s backdating of prices, repeated failure to obtain approval, and causing one

CDO to take another CDO’s loss.

2. Repeated lies to investors about the CDOs’ investments.

The Complaint also describes how ICP and Priore affirmatively lied to AIG when it

inquired about unapproved bond purchases from the Managed Account. More than once in late

2007, ICP told AIG that the “current market allows us to buy these securities at significant

discounts” or that ICP was “targeting” the bonds for “sound underwriting and performance.”

(Compl. ¶¶ 63, 64.) In 2008, Priore directed an ICP employee to tell AIG that purchases from

the Managed Account were done at “market prices.” (Id. ¶ 65.) These statements were false

because the purchases in fact had been priced at June 2007 levels that did not reflect “significant

discounts” in the “current” market. See Manela v. Garantia Banking, Ltd., 5 F. Supp. 2d 165,

176 (S.D.N.Y. 1998) (denying summary judgment on fraud claim based on mischaracterization

of bond prices as “market prices,” noting that “it is reasonable to infer that the price of the bonds

12 The CDOs’ investment guidelines precluded ICP from holding the CDOs out “as being willing to enter into . . . or to offer to enter into” any forward contracts. (Compl. ¶ 24.) Defendants point to three exceptions to this, yet none are relevant or applicable here — namely, an exception for the “warehouse” period (i.e., before a CDO closes when it cannot take delivery of securities), an exception for the “ramp up period” (i.e., immediately after a CDO closes), and an exception for short-term forward purchases (up to 30 days for ordinary bonds, or 45 days for new issue bonds). (Joint Br. at 16-17.) Alternatively, defendants contend that the prohibition in the investment guidelines was merely “intended to prevent the issuer from being a ‘dealer’” and subjecting it to U.S. tax. (Id. at 15). This reading, however, is unpersuasive as it renders another paragraph of the guidelines superfluous. (See Declaration of Nathan P. Kitchens, submitted in support of defendants’ joint motion, Exhibit 3, at ICP 0269883 ¶ 2 (prohibiting ICP from “caus[ing a CDO] to take any action that would cause [the CDO] to be required to register as . . . [a] broker-dealer” or to “be treated as . . . broker dealer for purposes of . . . any tax”). Further, defendants’ suggested interpretation relies entirely on the purported “intent” behind the guidelines — a factual matter that is inappropriate for resolution at this stage.


32

would have made a significant difference”); In re NTL, Inc. Sec. Litig., 347 F. Supp. 2d 15, 27

(S.D.N.Y. 2004) (when company “speaks on a subject, it must speak truthfully and

completely.”). Nor was ICP “targeting” the bonds in late 2007, because it had committed the

CDOs to these purchases months before. (Compl. ¶ 36.)

As the Complaint alleges, these misstatements concealed the truth from AIG, namely,

that the trades were undisclosed forward purchases made without its approval and at backdated

prices. (Id. ¶¶ 62-65.) These allegations satisfy Rule 9(b): They identify the misstatement, who

made it, indicate the approximate date, and establish why they were deceptive. Goldman, 754

F.2d at 1070; Nelson, 173 F. Supp. 2d at 168 (complaint satisfied Rule 9(b) “by identifying . . .

the dates of the misrepresentations, what form they took, the exact content . . . and why the

statements were false or misleading.”).13

3. Repeated misstatements to the CDOs’ trustee about trades.

The Complaint also describes recurrent misstatements to the CDOs’ trustee — the agent

of the CDOs’ investors whose approval was required for each purchase and sale of securities.

ICP and Priore affirmatively lied to the trustee about each of the bond sales from Triaxx Funding

to the other CDOs, cross-trades between Triaxx 1, 2, and 3, and bond purchases from the

13 Defendants argue that representations of future performance, like those made in the CDOs’ offering circulars and advisory agreements, can only give rise to fraud where the speaker never intended to honor them. (Joint Br. at 11.) As this Court has noted, however, “a duty to update past representations arises when a statement of future intention, ‘reasonable at the time it is made, becomes misleading because of a subsequent event.’” Fraternity Fund Ltd. v. Beacon Hill Asset Mgmt., 479 F. Supp. 2d 349, 363 n.70 (S.D.N.Y. 2007) (fund managers’ failure to disclose change in how they valued assets “could constitute fraud, regardless of their intentions at the time” of initial representation) (quoting In re Int’l Bus. Machs. Corp. Sec. Litig., 163 F.3d 102, 110 (2d Cir. 1998)). Here, investors were entitled to rely on the representations in the CDOs’ offering circulars and governing documents that ICP would manage the CDOs’ assets consistent with the various restrictions governing its investment authority, especially since the governing documents also represented that ICP could not trade unless it certified its continuing compliance to the CDOs’ trustee. (Compl. ¶ 26.) ICP’s failure to correct these representations is actionable as fraud.


33

Managed Account described in the Complaint. To induce the trustee to accept each of these

trades, ICP and Priore falsely certified that they conformed with several criteria, including that it

was made on an arms’ length basis, with best execution, with approval from AIG or FGIC, and

only after bona fide bids had been obtained. (Compl. ¶¶ 26, 50, 59.) In truth, the trades in

question were willfully mispriced, done without approval, and made without obtaining bona fide

dealer bids. (Id. ¶¶ 41-42, 49-50, 59.) The allegations of ICP’s and Priore’s false certifications

to the trustee satisfy Rule 9(b). Novak, 216 F.3d at 306, 311; Nelson, 173 F. Supp. 2d at 168.14

ICP and Priore also concealed the $1.3 billion forward-purchase arrangement from the

trustee, who relied on them for such information, knowing that monthly reports to investors

would omit it. (Compl. ¶¶ 30, 36, 62.) That neither ICP nor Priore provided these reports

directly to investors is immaterial. See SEC v. Collins & Aikman Corp., 524 F. Supp. 2d 477,

488 (S.D.N.Y. 2007) (defendant “need not have communicated the statement . . . directly to

investors” if he “kn[ew] or should have known that [it] would be communicated to investors”);

SEC v. KPMG LLP, 412 F. Supp. 2d 349, 375-76 (S.D.N.Y. 2006) (same).

4. Misrepresentations about SCIF’s cash transfers.

The Complaint describes misstatements Priore made in an effort to conceal the true

nature of $36.5 million in cash transfers that he caused SCIF to make to meet Triaxx Funding’s

margin calls. (Compl. ¶¶ 52-53.) In letters to SCIF’s administrator, Priore reported the transfers

as “collateralized loans” with fixed terms, implying there were means of repayment and assets

14 The Complaint identifies the date of several of these misstatements by specifying when the trade occurred (which is also when ICP made the certification to the trustee), while for others it indicates the general timeframe. No greater particularity is necessary. See Defer LP v. Raymond James Fin., Inc., 654 F. Supp. 2d 204, 212 (S.D.N.Y. 2009) (allegations of statements made “repeatedly over the course of five years” sufficiently particularized); Pollack v. Laidlaw Holdings, Inc., No. 90 Civ. 5788 (DLC), 1995 WL 261518, at *9 (S.D.N.Y. May 3, 1995) (alleging “general time frame” is sufficient).


34

securing the transfers — facts that he knew were untrue. (Id. ¶¶ 53, 55.) ICP and Priore also

accounted for the transfers on SCIF’s books at par (again representing that repayment was near

certain) despite their counsel’s written opinion concluding that SCIF’s repayment prospects were

far from certain. (Id. ¶ 55.)15 These allegations, too, satisfy Rule 9(b): They identify the

misstatement, the speaker, and the approximate date, and establish why they were deceptive. See

Novak, 216 F.3d 300, 311; Nelson, 173 F. Supp. 2d at 168.

C. The Complaint Alleges The Scienter Of All Four Defendants.

Defendants argue that the entire Complaint should be dismissed for failing to allege

scienter. (Joint Br. at 1, 8-13; ICPS Br. at 11-13.) Scienter, however, is an element of only some

of the Commission’s fraud claims — those brought under Sections 10(b) and 15(c)(1)(A) of the

Exchange Act and Rules 10b-3 and 10b-5, Section 17(a)(1) of the Securities Act, and Section

206(1) of the Advisers Act. Negligence is sufficient for the remaining fraud claims. Aaron, 446

U.S. at 691-93, 697, 100 S. Ct. at 1953, 1956 (Sections 17(a)(2) and (3) and Section 206(2) do

not require scienter); SEC v. Steadman, 967 F.2d 636, 646-47 (D.C. Cir. 1992) (“[S]cienter is not

required under Section 206(4).”). Nor is scienter an element of the books and records,

compliance, or control person claims.

In any event, the Complaint amply pleads the defendants’ scienter, “a mental state

embracing intent to deceive, manipulate, or defraud.” Tellabs, Inc. v. Makor Issues & Rights,

Ltd., 551 U.S. 308, 319, 127 S. Ct. 2499, 2507 (2007). Whereas particularity is needed for the

15 Contrary to the defendants’ suggestion, the Complaint does not “acknowledge” that ICP relied in good faith on counsel in effecting SCIF’s cash transfers. (Joint Br. at 5, 32.) What the Complaint actually alleges is that ICP ignored counsel’s advice in misrepresenting the cash transfers and accounting for them at par on SCIF’s books. (Compl. ¶ 55.) In any event, whether ICP relied in good faith on counsel is a factual issue not suitable for resolution at the pleading stage. See Leberman v. John Blair & Co., 880 F.2d 1555, 1560-61 (2d Cir. 1989) (question of reliance on counsel is “notoriously inappropriate” for resolution by motion).


35

“circumstances constituting [the] fraud,” Rule 9(b) states that “[m]alice, intent, knowledge, and

other conditions of a person’s mind may be alleged generally.” See Ganino, 228 F.3d at 169

(“great specificity” not required for scienter); SEC v. Reserve Mgmt. Co., Inc., No. 09 Civ. 4346

(PGG), 2010 WL 685013, at *5 (S.D.N.Y. Feb. 24, 2010) (“Rule 9(b) represents a ‘relaxation’ of

the specificity requirement in pleading the scienter element.”).16 To meet this standard, the

Complaint must allege facts giving rise to a strong inference of scienter, which it can accomplish

by showing that the defendants had “motive and opportunity to commit the fraud” or “strong

circumstantial evidence of conscious misbehavior or recklessness.” ATSI, 493 F.3d at 99;

accord Novak, 216 F.3d at 307. The Court must examine “whether all of the facts alleged, taken

collectively, give rise to a strong inference of scienter, not whether any individual allegation,

scrutinized in isolation, meets that standard.” Tellabs, 551 U.S. at 310, 127 S. Ct. at 2502

(original emphasis).

1. The Complaint alleges the defendants’ deliberate misconduct.

A complaint can show “conscious misbehavior or recklessness” by alleging that the

defendants “had knowledge of facts or access to information” contradicting their statements.

Reserve Mgmt., 2010 WL 685013, at *9 (citing Kalnit v. Eichler, 264 F.3d 131, 142 (2d Cir.

2001)). Another way to meet this standard is to allege deliberate misconduct. Collins &

Aikman, 524 F. Supp. 2d at 487 (citing Suez Equity Inv. v. Toronto-Dominion Bank, 250 F.3d

87, 100 (2d Cir. 2001)). 16 Defendants claim that the Complaint must plead scienter “with specificity.” (Joint Br. at 2, 8.) But while private plaintiffs must establish scienter “with particularity” under the Public Securities Law Reform Act of 1995, 15 U.S.C. § 78u-4(b)(2), this does not apply to SEC actions. Reserve Mgmt., 2010 WL 685013, at *6 (“Those courts in this Circuit that have directly addressed the issue have declined to apply the PLSRA’s standard to Commission enforcement actions, and that is the approach this Court will adopt.”); Pentagon, 612 F. Supp. 2d at 263-64 (same); Dunn, 587 F. Supp. 2d at 501 (same); see also Tellabs, 551 U.S. at 320, 127 S. Ct. at 2508 (PSLRA was “[d]esigned to curb perceived abuses of the § 10(b) private action”).


36

Here, the Complaint alleges deliberate misconduct: The misappropriation of $14 million

from the CDOs (Compl. ¶¶ 31-34); the backdating of trade prices (id. ¶¶ 36, 39); the same-day

markup on bonds from $63.50 to $75 (id. ¶ 41-42); the mispricing of numerous other trades to

favor Triaxx Funding or prolong the payment of ICP’s fees (id. ¶¶ 48-51, 57-60); repeated

investments without AIG’s or FGIC’s approval (id. ¶¶ 61-64); and improper swaps in the

Managed Account (id. ¶¶ 43-46). Each course of conduct breached Priore’s and ICP’s fiduciary

duties, was undisclosed, and benefitted Priore and his entities, or Triaxx Funding and the

Managed Account, at the expense of Triaxx 1, 2, and 3. Such allegations are more than

sufficient to establish Priore’s scienter. See Dunn, 587 F. Supp. 2d at 502-05 (allegations of

conduct reflecting complete derogation of attendant legal and accounting duties sufficient to

establish scienter). Continuing to make investments after being told not to by AIG (Compl. ¶ 63-

64) also evidences scienter. Cf. SEC v. Gann, No. 05 Civ. 63, 2008 WL 857633, at *11 (N.D.

Tex. Mar. 31, 2008) (continuing to trade after receiving block notice constitutes securities fraud).

The Complaint also alleges that Priore made (or directed others to make) various

statements while having “knowledge of facts or access to information” that contradicted them:

The certifications to the CDOs’ trustee that trades were done at arms’ length, at the best price

reasonably available, with AIG’s or FGIC’s approval, and after collecting bona fide bids (id. ¶¶

26, 50, 59); the lies to investors that trades were made at “significant discounts” in the “current

market” (id. ¶¶ 63-64); and the misrepresentation of SCIF’s $36.5 million cash transfers as

“collateralized loans” (id. ¶¶ 54-55). As the owner, president, and chief investment officer of

ICP, Priore was “in a position to know that the statements . . . were false and/or misleading, and

yet he did nothing to cure them.” SEC v. Cavanagh, No. 98 Civ. 1818 (DLC), 1998 WL 440029,

at *9 (S.D.N.Y. July 27, 1998); see also In re Atlas Air Worldwide Sec. Litig., 324 F. Supp. 2d

474, 489 (S.D.N.Y. 2004) (when corporate officer makes false statements about core operations,


37

“an inference arises that [they] knew or should have known the statements were false when

made”). Given the substantial sums involved and the attendant risk to ICP’s clients, Priore, at

the very least, was extremely reckless. See SEC v. Bremont, 954 F. Supp. 726, 730 (S.D.N.Y.

1997) (“[R]epresentations . . . given without basis and in reckless disregard of their truth or

falsity” establish scienter, especially “[c]onsidering the sums involved and the risks to . . .

clients.”); see also AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202, 221 (2d Cir. 2000) (if

defendants “could have imagined that saddling the investors with an undisclosed risk would

harm the investors . . . [therefore] we can easily find that [they] possessed the requisite intent to

deceive, manipulate, or defraud.”).

Priore’s scienter, in turn, can be imputed to ICP, ICPS, and ICP Holdco, which he

controlled, majority-owned, and directed in the alleged fraud. See In re Marsh & McLennan

Cos., Inc. Sec. Litig., 501 F. Supp. 2d 452, 481 (S.D.N.Y. 2006) (“[C]ourts have readily

attributed the scienter of management-level employees to corporate defendants.”) (citing In re

BISYS Sec. Litig., 397 F. Supp. 2d 430, 442-43 (S.D.N.Y. 2005)); SEC v. Ballesteros Franco,

253 F. Supp. 2d 720, 728 (S.D.N.Y. 2003) (“[T]he Second Circuit has held that a person’s

knowledge can be attributed to a corporation in connection with actions which that person

through his control causes the corporation to take.”) (collecting cases).

2. The Complaint alleges the defendants’ motive and opportunity to defraud ICP’s clients.

The Complaint also alleges motive and opportunity. Opportunity is obvious from

Priore’s control over, and direct involvement in, the management of the assets of the CDOs,

SCIF, and the Managed Account. See Fraternity I, 376 F. Supp. 2d at 404 (opportunity existed

for principals of small firm “directly involved” in its management); Reserve Mgmt., 2010 WL


38

685013, at *7 n.5 (“Courts in this district have often assumed that . . . corporate officers . . . have

the opportunity to commit fraud”) (quotation and alteration marks omitted).

To show motive, the Complaint must allege “concrete benefits that could be realized by”

the fraud. Heller v. Goldin Restructuring Fund, L.P., 590 F. Supp. 2d 603, 620 (S.D.N.Y. 2008)

(quoting Novak, 216 F.3d 307). The Complaint does this and more by alleging that defendants

misappropriated profit opportunities from the CDOs, such as the $14 million from the rebooked

trade in June 2007, for which they provided no legitimate advisory service. (Compl. ¶¶ 32-33.)

The Complaint also establishes motive by alleging the enormous personal stake Priore

had in the income and success of ICP’s asset management business. Judge Gardephe’s recent

decision in Reserve Mangement is directly on point. The SEC charged investment advisers with

fraud relating to events that led their money market fund to “break the buck,” i.e., have its per-

share value drop below $1. 2010 WL 685013, at *1, 8-14. Denying a motion to dismiss, Judge

Gardephe observed that the “desire to generate additional fee income may provide a sufficient

motive . . . where the defendant possesses a personal stake in the business and the fee income.”

Id. at *8. Because the defendants had founded, managed, and owned substantial interests in their

advisory business and funds, they had “an enormous reputational [and] personal stake in the[ir]

success” that went “far beyond” that of typical corporate officers. Id. at *7 (finding motive to

commit fraud because, inter alia, “it is clear that the [defendants] . . . had much to gain from the

survival of the Fund even if that objective was accomplished through fraud”); see also Heller,

590 F. Supp. 2d at 621 (managers of “privately-owned investment fund in which they possessed

a personal financial stake” had “unique incentive”); Pension Committee of the Univ. of Montreal

Pens. Plan v. Banc of America Sec., 446 F. Supp. 2d 163, 187 (S.D.N.Y. 2006) (“Unlike a

motive to increase stock prices, shared by all corporate insiders, a motive to generate increased

fees based on inflated [fund value] figures would be a concrete and personal benefit to the


39

individual defendants.”).17 Similarly, Priore is the founder, majority owner, and principal of

each ICP entity and owns, through them, interests in the investment vehicles under ICP’s

management. (Compl. ¶¶ 1, 12-15, 20.) He, too, had an “enormous reputational and personal”

stake in his entities’ income and success, and his motive therefore sharply contrasts with

allegations “common to all corporate executives.” Kalnit, 264 F.3d at 139.

The Complaint also alleges that Priore willfully favored some advisory clients (Triaxx

Funding and the Managed Account) over others (Triaxx 1, 2, and 3). (Compl. ¶¶ 36, 39, 49, 52.)

Defendants assert that favoring one client over another does not evidence scienter. (Joint Br. at

10.) However, courts have held that allegations of intentional favoritism or cherry-picking

among advisory clients are sufficient to plead motive to defraud. See DiBella, 2005 WL

3215899, at *12 (scienter alleged where “SEC alleges that Silvester’s motive for including

DiBella in the scheme was to . . . reward him for his friendship and support”); see also Moran,

922 F. Supp. at 896 (applying Section 206 of Advisers Act to claim that adviser favored family

over other clients); Treadway, 430 F. Supp. 2d at 339 (noting that violations of Advisers Act

would turn on whether defendant “put one client’s interests ahead of another”). Priore’s motive

to commit fraud may, in turn, be imputed to ICP, ICPS, and ICP Holdco. Marsh & McLennan,

501 F. Supp. 2d at 481; Ballesteros Franco, 253 F. Supp. 2d at 728.

17 Ignoring Reserve Mgmt., the defendants instead rely on distinguishable case law. In IDC Holdings S.A. v. Frankel, the complaint made scienter allegations “on information and belief” and offered “no suggestion” of motive other than indicating a longstanding business relationship and the prior receipt of compensation. 976 F. Supp. 234, 244 (S.D.N.Y. 1997). Edison Fund v. Cogent Inv. Strategies Fund, Ltd. and Steed Fin. LDC v. Laser Advisers, Inc., in turn, involved similarly vague allegations of motive. In Edison, the complaint alleged only that a fund manager received high management fees under his contractual advisory agreement. 551 F. Supp. 2d 210, 227 (S.D.N.Y. 2008). In Steed, the complaint merely alleged that the defendants’ remuneration was tied to their funds’ performance and that they had a “desire” to continue to be remunerated. 258 F. Supp. 2d 272, 278-79 (S.D.N.Y. 2003).


40

Next, defendants suggest that allegations of pecuniary gain fail to establish motive.

(Joint Br. at 9-10.) However, courts in SEC actions regularly find improper gains to constitute

sufficient motive to commit fraud. See SEC v. DiBella, No. 304 Civ. 1342 (EBB), 2005 WL

3215899, at *12 (D. Conn. Nov. 29, 2005) (scienter alleged where defendant’s “motive,

allegedly, was to receive a substantial fee or fees without having to provide any meaningful

work”); see also SEC v. Kelly, 663 F. Supp. 2d 276, 285 (S.D.N.Y. 2009) (scienter alleged

where SEC’s complaint “offers the defendants’ pecuniary gain as motive for the underlying

scheme” in the form of bonuses and profits on stock sales); Pentagon, 612 F. Supp. 2d at 264

(scienter established where “both Defendants are alleged to have profited substantially” from the

fraud through unwarranted trading returns); Cavanagh, 1998 WL 440029, at *9 (finding “ample

motive” where complaint alleged that defendant profited by receiving proceeds of stock sales).

Defendants also argue that only two fraudulent transactions resulted in a “specific profit.”

(Joint Br. at 10.) Not so. The Complaint alleges that several transactions resulted in direct

profits for the defendants. (Compl. ¶ 32 ($14 million profit on rebooked trade); id. ¶¶ 21, 42

(right to share in $2.5 million profit on same-day marked-up trade); id. ¶¶ 21, 36, 39 (right to

share in $53.5 million in profits on forward purchases); id. ¶¶ 45-47 (profits on several swaps of

bonds).) It also describes how ICP systematically mispriced other trades to manipulate the

CDOs’ overcollateralization test so that ICP could continue to collect substantial management

fees. (Id. ¶¶ 57-60 (“tens of millions of dollars” in fees due to mispriced cross-trades)).

Defendants’ refrain that “with rare exception” they have not personally profited is baseless.

Defendants’ fourth argument is that their alleged profits and markups were insufficiently

“extraordinary.” (Joint Br. at 10.) This misses the point. An investment adviser may not

secretly take profits from his clients (whether it be 1 percent or 50 percent of a trade) for the

simple reason that he owes a fiduciary duty to act in his clients’ best interest, with full disclosure,


41

and with the “utmost good faith.” Capital Gains, 375 U.S. at 194, 84 S. Ct. at 284; Moran, 922

F. Supp. At 895-96. Defendants instead point to cases discussing the reasonableness of

brokerage commissions. (Joint Br. at 22; ICPS Br. at 6-8.) But these cases do not speak to the

conduct of ICP, an investment adviser and fiduciary. As for ICPS, none of these cases involved

a broker-dealer knowingly acting in concert with, and under the common direction and control

of, an investment adviser willfully breaching its fiduciary obligations to its clients. See U.S. v.

Santoro, 302 F.3d 76, 80 (2d Cir. 2002) (affirming sentence enhancement against independent

broker); F.B. Horner & Assocs., Inc. v. SEC, 994 F.2d 61, 62-63 (2d Cir. 1993) (affirming

disciplinary action against independent brokerage firm); Press v. Chemical Inv. Servs. Corp.,

988 F. Supp. 375, 378-79, 390-91 (S.D.N.Y. 1997) (granting motion to dismiss claims against

independent securities broker-dealer).

Finally, defendants contend that their interests were “aligned” with the CDOs’ interests,

and that this negates any motive to defraud. (Joint Br. at 3.) However, defendants’ interests

diverged from those of the CDOs in critical respects, as the Complaint explains. ICP’s and

Priore’s advisory fees were payable only if the CDOs met their governing tests, which provided

ICP and Priore with an incentive to manipulate the tests (as the Complaint alleges they did).

(Compl. ¶ 60.) Further, because ICP did not invest any capital in the CDOs but was still entitled

to the residual profits (id. ¶ 20), any risky investments it made amounted to a “heads-I-win, tails-

you-lose” proposition for those who actually put capital at stake in the CDOs: If the CDOs’

investments succeeded, ICP would reap the gain; if they failed, investors would lose their capital.

Yet another conflict stemmed from investors’ right to remove ICP as investment adviser for

executing unauthorized investments or willfully breaching its obligations under the advisory

agreements, which provided ICP and Priore with an incentive to conceal their misconduct (as,

once again, the Complaint alleges they did). (Compl. ¶¶ 61-65.)


42

D. The Complaint Alleges Aiding And Abetting Fraud By ICP, ICPS, ICP Holdco, And Priore.

The Complaint asserts aiding and abetting claims against all defendants. To state these

claims, the Complaint must allege a fraud, defendants’ knowledge of it, and their substantial

assistance in advancing it. Lerner, 459 F.3d at 292; DiBella, 587 F.3d at 566. As discussed

above, the Complaint satisfies the first two requirements by alleging fraud and each defendant’s

knowing participation in it.18

ICP, ICP Holdco, and Priore do not address aiding and abetting (except to note that Rule

9(b) applies, see Joint Br. at 14 n.10). ICPS argues, however, that it did not substantially assist

the fraud since its “innocent” conduct was no different “than that expected of any broker-dealer.”

(ICPS Br. at 11, 14-16.) Substantial assistance, however, “can take many forms,” including

undertaking or executing “ordinary course transactions.” Primavera Familienstifung v. Askin,

130 F. Supp. 2d 450, 511 (S.D.N.Y.2001). As Judge Lynch has noted, “[t]he critical test is not

. . . whether the alleged aiding and abetting conduct was routine, but whether it made a

substantial contribution to the perpetration of the fraud.” JP Morgan Chase Bank v. Winnick,

406 F. Supp. 2d 247, 257 (S.D.N.Y. 2005).

18 Section 929O of the recent Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 (H.R. 2173) amended Section 20(e) of the Exchange Act to clarify that an aider and abettor is one who “knowingly or recklessly” provides substantial assistance, resolving a split in this District. Compare Collins & Aikman Corp., 524 F. Supp. 2d at 491 (recklessness sufficient for fiduciary); Power, 525 F. Supp. 2d 422 (same), with SEC v. Espuelas, 579 F. Supp. 2d 461, 470-71 (S.D.N.Y. 2008) (noting split and requiring actual knowledge). As the Conference Report accompanying the bill stated, the amendment was passed to “make clear that the intent standard in SEC enforcement actions for aiding and abetting is recklessness.” H.R. Conf. Rep. 111-517, 2010 WL 2671804, at *771 (June 29, 2010). Since the amendment clarified existing law, it applies here. See ABKCO Music, Inc. v LaVere, 217 F.3d 684, 689 (9th Cir. 2000) (“Normally, when an amendment is deemed clarifying, rather than substantive, it is applied retroactively.”); Piamba Cortes v. Am. Airlines, Inc., 177 F.3d 1272, 1283 (11th Cir. 1999) (“[C]oncerns about retroactive application are not implicated when an amendment that takes effect after the initiation of a lawsuit is deemed to clarify relevant law.”); Brown v. Thompson, 374 F.3d 253, 261 (4th Cir. 2004) (amendment clarifying existing law does not implicate retroactivity concerns). In any event, the Complaint alleges actual knowledge of the fraud by Priore and, in turn, his companies.


43

The Complaint alleges that ICPS was integral to several schemes to defraud the CDOs,

including the misappropriation of the $14 million in June 2007, the swaps of bonds in the

Managed Account, and the repackaging and selling of ineligible securities to the CDOs. (Compl.

¶¶ 31-33, 43-46, 66.) In each instance, ICPS interposed itself to retain the fraudulent profit, and

in each instance ICPS knew (because Priore knew) that its role served no legitimate purpose

other than to facilitate a fraud and retain the proceeds. This is not a case where an independent

broker-dealer executed trades that unwittingly furthered a fraudulent scheme or course of

business (and is named because it is a “deep pocket”). Indeed, the Second Circuit has held that a

broker can be liable for conducting trades whose nature it knew was fraudulent in order to

generate commissions for himself and others. See Armstrong, 699 F.2d at 91-92 (reversing

dismissal of aiding and abetting claim); see also Rolf v. Blyth, Eastman Dillon & Co., Inc., 570

F.2d 38, 48 (2d Cir. 1978) (“[S]ubstantial assistance might include . . . acting as conduits to

accumulate or distribute securities, by executing transactions.”) (quotation omitted).19

E. Defendants’ Motions Impermissibly Rely On Disputed Facts Wholly Outside The Complaint.

In considering a motion to dismiss, a court “is normally required to look only to the

allegations on the face of the complaint,” although it may consider documents attached to or

incorporated by reference into it as well as “public disclosure documents filed with the SEC.”

19 In addition to alleging ICPS’s substantial assistance, the Complaint pleads that ICP Holdco substantially assisted the misappropriation of $14 million from the CDOs in June 2007 (Compl. ¶ 32), and that ICP and Priore substantially assisted the primary violations, including by devising and orchestrating the rebooking of the June 14, 2007 forward-purchase agreement (id. ¶¶ 31-34), pricing forward sales using back-dated, higher prices (id. ¶¶ 36, 39), authorizing a $2.5 million same-day markup on the sale of bonds to a CDO to circumvent the indentures (id. ¶¶ 41-42), overseeing fraudulent swaps of bonds in the Managed Account (id. ¶¶ 43-47), causing Triaxx 1, 2, and 3 to overpay for bonds from Triaxx Funding (id. ¶¶ 48-51), directing numerous cross-trades at above-market prices so ICP could collect fees (id. ¶¶ 57-60), misrepresenting SCIF’s cash transfers as “collateralized loans” (id. ¶¶ 52-55), and directing employees to lie to investors about the CDOs’ trading activity (id. ¶ 65).


44

ATSI, 493 F.3d at 98. Defendants’ briefs rely on passages from a Triaxx CDO’s indenture,

offering circular, collateral management agreement, and one email quoted in the Complaint.

These documents may properly be considered.

However, the defendants also proffer numerous purported “factual” assertions in support

of their motions, whose consideration would be inappropriate at this stage. For example:

• Defendants aver the “important fact” that “losses from purchases” at above-market prices by the CDOs always were “counter-balanced by gains from sales.” (Joint Br. at 34-35). This purported “fact” is nowhere found in the Complaint or any other document referenced therein or relied upon by defendants.

• Defendants aver that bond swaps in the Managed Account were done to acquire “preapproved” bonds. (Id. at 4.) This purported “fact” contradicts the Complaint’s allegation that ICP was obligated to obtain trade-by-trade approval. (Compl. ¶¶ 25, 61).

• Defendants aver that it “clearly was not the investors’ intent when they elected to invest in the Triaxx CDOs” to forego any reinvestment opportunity, and that “ICP was expected” to reinvest all amortization. (Joint Br. at 2, 19.) This purported “intent” and “expectation” are nowhere alleged in the Complaint.

• Defendants aver that “the very purpose of the cross-trades” was to keep the CDOs in compliance with their governing tests. (Id. at 34.) Not only is this not found in the Complaint, it actually contradicts the allegations that cross-trades were done to make room in Triaxx 1, 2, and 3 for above-market purchases from Triaxx Funding and the Managed Account, and to manipulate the CDOs’ overcollateralization tests so that ICP could continue to receive management fees. (Compl. ¶¶ 58, 60.)

Whatever weight these or other purported “facts” might have at trial, should they be

established, they have no bearing on the present motions. Here, the only question is whether the

facts alleged in the Complaint, taken as true, constitute fraud. Power, 525 F. Supp. 2d at 419

(issue on motion to dismiss “is not whether a [plaintiff] will ultimately prevail but whether the

claimant is entitled to offer evidence to support the claims.”) (quoting Village Pond, Inc. v.

Town of Darien, 56 F.3d 375, 278 (2d Cir. 1995)).


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III. THE COMPLAINT SUFFICIENTLY ALLEGES NON-FRAUD CLAIMS AGAINST ICP AND PRIORE______________________________________

The defendants move to dismiss the Complaint “in its entirety” for failure to satisfy Rule

9(b)’s particularity requirement. (Joint Br. at 1, 6-8.) But because several of the claims against

ICP and Priore do not sound in fraud, the allegations supporting them need only satisfy Rule

8(a)(2)’s liberal pleading standard. This they do.

A. The Complaint’s Non-Fraud Claims.

The Complaint asserts claims against ICP and Priore for failing to maintain accurate

books and records and to implement compliance policies and procedures. (Compl. ¶¶ 92-105.)

In addition, the Complaint charges Priore with control person liability under the Exchange Act.

(Id. ¶¶ 106-08.)

Under Section 206(4) of the Advisers Act and Rule 206(4)-7, investment advisers must

adopt and implement “written policies and procedures reasonably designed to prevent violation”

of the Act. 15 C.F.R. 275.206(4)-7.20 Under Section 204 and Rule 204-2, investment advisers

must make and keep certain records, including all securities trade orders showing the order’s

terms and conditions, the person who recommended it, and the person who placed it. 15 U.S.C.

§ 80b-4 and 15 C.F.R. 275.204-2(a)(3). Under Section 20(a) of the Exchange Act, a defendant is

liable as a control person if he possessed the power, “through the ownership of voting securities,

by contract, or otherwise,” to “direct or cause the direction of the management and policies” of

entities who violated the Act. In re Parmalat Sec. Litig., 594 F. Supp. 2d 444, 455-56 (S.D.N.Y.

2009) (“Parmalat III”) (quotation omitted).

20 An investment adviser’s failure to have adequate compliance policies and procedures “constitute[s] a violation [of Rule 206(4)-7] . . . independent of any other securities law violation.” Compliance Programs of Inv. Cos. and Inv. Adv., Advisers Act Rel. No. 2204, 68 F.R. 74714, 74715 (Dec. 24, 2003).


46

B. The Non-Fraud Claims Satisfy Fed. R. Civ. P. 8(a).

Contrary to defendants’ argument (Joint Br. at 6-8), Rule 9(b)’s particularity standard has

no application to the allegations supporting the books and records and compliance violations. As

the Complaint alleges, these violations were done “[i]n addition to [ICP’s] defrauding of its

clients and investors” (Compl. ¶ 67) and stem from independent facts.21

For the claim under Rule 206(4)-7, the Complaint alleges that “ICP’s compliance

manual” required the holding of “quarterly Brokerage Committee meetings to oversee . . . best

execution,” but that “[i]n practice, no such committee ever met for that purpose.” (Id.) The

Complaint further alleges that ICP ignored its compliance procedures by not disclosing the price

it paid for the Bear Stearns bonds, and by failing to make written disclosures to clients of all

material terms of principal trades. (Id. ¶ 68.) Because these alleged violations existed

independently of any fraud, they need not be alleged with particularity. See Rombach v. Chang,

355 F.3d 164, 171-72 (2d Cir. 2004) (claims based on the same facts as those supporting fraud

claims were subject to Rule 9(b) but claims against underwriters under Sections 11 and 12(a)(2)

of the Securities Act were “not subject to the heightened pleading requirement of Rule 9(b),

because they sound in negligence”); M’Baye v. N.J. Sports Prod., Inc., No. 06 Civ. 3439 (DC),

2007 WL 431881, at *11 (S.D.N.Y. 2007) (rejecting suggestion that, under Rombach, allegations

of fraud preclude the application of a lower pleading standard to non-fraud claims); In re

Parmalat Sec. Litig., 375 F. Supp. 2d 278, 292 (S.D.N.Y. 2005) (while fraud allegations

governed by Rule 9(b), allegations relating to “domination and control elements of [alter ego

doctrine] . . . need comply only with Rule 8”); Atlas Air, 324 F. Supp. 2d at 503 (“Rule 9(b) does

21 Although defendants argue that the Section 204 and Rule 204-2 violations purportedly “sounds in fraud” (Joint Br. at 6-7 n. 5.), they t do not explain their claim that the Rule 206(4)-7 violation also is subject to Rule 9(b).


47

not apply” to claims for which plaintiffs “alleged facts independent of their scienter

allegations”).

Similarly, for the claim under Section 204 and Rule 204-2, the Complaint alleges that

ICP failed to maintain accurate memoranda for securities trades and recounts examples of such

incomplete records. (Id. ¶¶ 51 (failure to accurately record bond sales from Triaxx Funding to

Triaxx 1, 2, and 3), 69.) That the Complaint states that trade blotters were inaccurate “[a]s a

result of [ICP’s] fraudulent practices” is immaterial. The acts constituting the violation were

independent of the fraud that preceded them and the Complaint pleads them separately.

Moreover, unlike the allegations supporting the fraud claims, these alleged acts need not have

been deceptive.

Finally, in support of Priore’s control person liability, the Complaint alleges that he was

the founder, majority owner, principal, and manager of ICP, ICPS, and ICP Holdco, and thus had

the power to direct and control their management and operations. (Id. ¶¶ 12-15, 69). This is

sufficient to establish his potential liability under Section 20(a) of the Exchange Act. Parmalat

III, 594 F. Supp. 2d at 455-56.


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