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Louis C. Bechtle, In His Capacity As Receiver For Acorn Ii, L.P., Acorn Capital v. Master

February 7, 2011

LOUIS C. BECHTLE, IN HIS CAPACITY AS RECEIVER FOR ACORN II, L.P., ACORN CAPITAL
MANAGEMENT, LLC AND ANY ENTITIES THAT ACORN II, L.P., OR ACORN CAPITAL MANAGEMENT,
LLC OWN OR CONTROL OR IN WHICH ANY OF THEM HAVE AN INTEREST
v.
MASTER, SIDLOW & ASSOCIATES, P.A., ET AL.



The opinion of the court was delivered by: Padova, J.

MEMORANDUM

Louis C. Bechtle, the Court-appointed Receiver for Acorn II, L.P., Acorn Capital Management, LLC (collectively, the "Acorn Entities"), and other related entities, filed this professional negligence action against Defendants Master, Sidlow & Associates, P.A. ("Master Sidlow"), William Master, Frank Sidlow, Michael McCuddon, and Juan Pablo Vasquez, in connection with accounting and auditing services that Defendants provided to the Acorn Entities. Defendants have filed a Motion to Dismiss the Complaint pursuant to Fed. R. Civ. P. 12(b)(6), arguing that the doctrine of in pari delicto bars the Receiver's claims because the Acorn Entities are at least equally responsible for the wrongs alleged. For the reasons that follow, we deny Defendants' Motion.

I. BACKGROUND

The Complaint alleges that, at all relevant times, Master Sidlow acted as auditor for Acorn II, L.P. ("Acorn II"). (Compl. ¶ 9.) Also at all relevant times, Defendants William Master, Frank Sidlow, and Michael McCuddon were licensed accountants with Master Sidlow, and Juan Pablo Vasquez was an employee of firm, under the supervision of McCuddon. (Id. ¶¶ 10-13.) Both Acorn II and Acorn Capital Management II, Limited Partnership ("ACM II") (collectively, the "Limited Partnerships") were created to invest in securities and other instruments of the United States. (Id. ¶ 18.) The General Partner of each of the two Limited Partnerships was Acorn Capital Management, LLC ("Acorn Capital") and, in that capacity, Acorn Capital served as the Limited Partnerships' investment advisor. (Id. ¶¶ 18-19.) Donald Young was the managing member of Acorn Capital, and a partner of that firm. (Id. at ¶ 18.) Young controlled Acorn Capital, with the company acting by and through him. (Id. ¶ 19.) In 2005, R. Stewart Strawbridge, who had worked for Acorn Capital since 2001, acquired a 20% interest in the company, thereby becoming partners with Young. (Id. ¶ 20.)

In the course of their operations, the Limited Partnerships solicited and accepted funds from investors, who then served as the partnerships' limited partners. (Id. ¶ 22.) However, instead of properly investing those funds, Young conducted a Ponzi scheme whereby he used investments from new limited partners to pay previous investors. (Id.) Young also diverted investor funds to his own personal accounts, and used the funds for his and his family's benefit and to pay their personal expenses. (Id. ¶ 24.) Indeed, from November 1999, when ACM II was formed, through June 25, 2009, substantially all of Young's income was derived from Acorn Capital, ACM II and/or Acorn II. (Id. ¶ 25.)

In March of 2003, Young, on behalf of Acorn II, engaged Master Sidlow and McCudden to perform an audit of Acorn II's balance sheet and related statements of income as of December 31, 2001 and 2002, and to prepare Acorn II's federal and state tax returns. (Id. ¶¶ 29-30.) Master Sidlow subsequently was engaged to perform the same audit and tax services for Acorn II for the years 2003 through 2007, and to perform similar audit and tax services for ACM II for the years 2006 and 2007. (Id. ¶ 32.) Master Sidlow issued an "unqualified audit opinion" in connection with each year's auditing services, concluding that the financial statements were fairly presented in all material respects and were in conformity with Generally Accepted Accounting Principles. (Id. ¶ 33.) In addition to the audit and tax services, Master Sidlow provided additional services for Acorn II and Acorn Capital, including but not limited to, maintenance of books and records, expense and fee calculations, and review and authorization of wire disbursements. (Id. ¶ 36.) When performing bookkeeping and compilation services, Master Sidlow primarily relied on monthly account statements from CRESAP, a company that was Acorn II's custodian and which maintained the brokerage account for Acorn II's investments. (Id. ¶¶ 37-38.)

The Complaint alleges that, in performing services for Acorn II, Master Sidlow failed to adhere to proper auditing standards and recklessly disregarded numerous indications that Young was running a Ponzi scheme. (Id. ¶ 39.) Among the Generally Accepted Auditing Standards ("GAAS") that Defendants allegedly violated were standards requiring that they (1) "exercise and maintain professional skepticism and independent mental attitude" when conducting an audit (id. ¶¶ 41-42; see also id. ¶ 69); (2) ascertain and implement alternative measures to test for fraud when the company being audited has no internal controls in place (id. ¶¶ 48, 65); (3) "prepare audit documentation that enables an experienced auditor, having no previous connection to the audit, to understand the work performed . . . , the audit evidence obtained, and results and conclusions" (id. ¶¶ 52-54); and (4) obtain sufficient competent evidence to afford a reasonable basis for an opinion regarding the financial statements under audit, including reliable information from independent sources (id. ¶¶ 41e, 42, 44-50).

The Complaint alleges, among other things, that Defendants relied heavily on CRESAP's monthly account statements, which listed contributions and withdrawals from investor accounts, but did not specify the partner who contributed or withdrew the funds in each instance. (Id. ¶ 43.) To ascertain what each partner contributed and withdrew, Defendants emailed Young, who provided Defendants with false information, which Defendants neither questioned nor verified but, rather, "blindly accepted." (Id. ¶¶ 44-45, 47.) Similarly, Defendants relied on Young to explain suspicious or questionable activity in the investor accounts, including situations in which investor accounts were overdrawn, and they accepted his explanations without question. (Id. ¶ 46.) By proceeding in this fashion, Defendants failed to rely on proper supporting documentation and failed to exercise professional skepticism and independence. (Id. ¶ 53.)

The Complaint further alleges that Defendants "willfully ignored, recklessly disregarded, or cast a blind eye to the numerous indications that Young was running a Ponzi scheme." (Id. ¶ 60.) For example, in a 9-month period, there were at least 36 transfers from an Acorn II account held at CRESAP to Young's personal account, "yet falsely attributed to various Acorn II investors." (Id. ¶ 61.) In addition. Defendants ignored "exponential, irregular increases in activity in the Acorn II account," such as numerous occasions in which money was being deposited and withdrawn from the same investor account in the same day; one occasion in which Young opened an account and withdrew 75 percent of it within three months; and one occasion in which Young opened an account and then withdrew more than the amount invested within six months. (Id. ¶ 63.) The Complaint alleges that, by failing to properly monitor such activity in accordance with their professional responsibilities, Defendants enabled Young's perpetration of the fraud. (Id. ¶ 64.)

The Complaint further alleges that Defendants did not act as an "independent" auditor as GAAS require, because it acted as both bookkeeper and auditor for Acorn II, thereby creating a conflict of interest. (Id. ¶¶ 67-68, 73.) The bookkeeping functions Defendants undertook included maintaining and preparing accounting records for Acorn II, preparing cash receipts and cash disbursement entries, preparing bank reconciliation, and calculating management fees. (Id. ¶¶ 71-72.) By performing these functions, while simultaneously acting as auditor, Defendants essentially put themselves in the position of reviewing their own work. (Id. ¶ 73.)

On April 17, 2009, the Securities and Exchange Commission filed a civil Complaint against Young and the Acorn Entities, which accused them of violating various securities laws by running a Ponzi scheme, and which requested a temporary restraining order and an order freezing the assets of the Acorn Entities. (Id. ¶ 1.) On June 25, 2009, this Court issued an order appointing Louis C. Bechtle as Receiver for the Acorn Entities (the "Receiver"). (Id. ¶ 2.) The Receiver was charged with "investigating, marshaling and preserving . . . the assets, monies, securities, choses in action and properties . . . of the Acorn Entities in order to maximize the recovery available to the investors defrauded during Young's operation of the Ponzi scheme." (Id. ¶ 3.) Young has since admitted to misappropriating funds invested with the Acorn Entities to, among other things, pay other investors in the entities and fund his family's personal expenditures. (Id. ¶ 4.) On July 20, 2010, Young also pled guilty to charges of mail fraud and money laundering in a related criminal action. (Id. ¶ 5.)

The Complaint in the instant case asserts five claims against Defendants, based on the theory that Defendants enabled and facilitated Young's wrongful conduct and caused harm to the Acorn Entities. The five Counts assert claims of professional negligence, aiding and abetting fraud, aiding and abetting breach of fiduciary duty, breach of contract, and unjust enrichment. Defendants argue in their Motion to Dismiss that all five claims are barred by the doctrine of in pari delicto.

II. STANDARD OF REVIEW

When considering a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6), we look primarily at the facts alleged in the complaint and its attachments. Jordan v. Fox, Rothschild, O'Brien & Frankel, 20 F.3d 1250, 1261 (3d Cir. 1994). We take the factual allegations of the complaint as true and draw all reasonable inferences in favor of the plaintiff. Phillips v. County of Allegheny, 515 F.3d 224, 233 (3d Cir. 2008) (citing Pinker v. Roche Holdings Ltd., 292 F.3d 361, 374 n.7 (3d Cir. 2002)). Legal conclusions, however, receive no deference, and the court is "not bound to accept as true a legal ...


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