2019 IL App (1st) 172410
Ill. App. Ct.2019Background
- Plaintiffs are investors in Lancelot Investors Fund Ltd. (a Cayman Islands hedge fund headquartered/managed in Illinois) who invested between 2004–2008 and lost about $79M when the fund turned out to be a Ponzi scheme run by Petters.
- Plaintiffs sued the fund’s outside auditors (RSM US, RSM Cayman, and partner Simon Lesser) for common-law fraud/fraudulent inducement, negligent misrepresentation, and professional negligence based on repeated unqualified audit opinions the auditors issued and addressed to shareholders.
- The fund filed bankruptcy and its trustee sued the auditors in federal court; that trustee suit was dismissed under the in pari delicto doctrine (Seventh Circuit, Peterson). Plaintiffs then pursued direct investor claims in Illinois state court.
- Defendants moved to dismiss under section 2-619, arguing (a) the dispute concerns the fund’s internal affairs and is governed by Cayman Islands law (reflective-loss doctrine), and (b) plaintiffs’ losses are merely derivative/reflective of the fund’s losses; RSM Cayman also moved under section 2-615 asserting lack of factual pleading of successor liability.
- The trial court granted dismissal under section 2-619 applying the internal-affairs doctrine and Cayman reflective-loss law. The appellate court reversed as to RSM US and Lesser (section 2-619) and affirmed dismissal without prejudice as to RSM Cayman (section 2-615) to allow repleading.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Choice of law / whether Cayman law governs standing (internal affairs doctrine) | Plaintiffs: claims are direct investor claims against auditors (not corporate governance issues); Illinois law governs because alleged misconduct and reliance occurred in Illinois and contracts invoked Illinois law | Defendants: internal affairs doctrine applies; fund incorporated in Cayman Islands so Cayman law (including reflective-loss rule) governs and bars the suit | Court: Internal-affairs doctrine not applicable here; Illinois law controls because defendants failed to show a meaningful conflict and plaintiffs allege direct investor claims distinct from corporate governance issues |
| Standing / reflective-loss (derivative vs. direct claim) | Plaintiffs: losses are direct and personal — they were induced to invest and would not have invested but for the auditors’ reports; losses are separate from the fund’s losses | Defendants: plaintiffs seek pro rata recovery tied to diminution in share value — reflective/derivative and barred under Cayman reflective-loss (and same result under Illinois standing principles) | Court: Plaintiffs pleaded direct, separate injuries (losses at time of investment) and alleged individualized reliance; reflective-loss/derivative bar did not apply at pleadings stage — dismissal on that ground was erroneous |
| Effect of in pari delicto dismissal of the trustee's federal suit | Plaintiffs: trustee’s suit dismissal does not preclude investors’ direct claims; Seventh Circuit invited investors’ claims to proceed | Defendants: dismissal of fund’s claim signals investor claims are duplicative or should be barred | Held: In pari delicto dismissal of fund’s claims does not make investors’ direct claims duplicative; that prior dismissal does not justify dismissing investors’ direct claims here |
| RSM Cayman successor-liability pleading (section 2-615) | Plaintiffs: allege RSM Cayman is successor to prior Cayman audit firm; should be allowed to replead if needed | RSM Cayman: complaint lacks factual allegations to invoke successor-liability exceptions | Held: Appellate court affirmed dismissal of RSM Cayman for failure to plead successor exceptions but without prejudice — plaintiffs may amend and replead |
Key Cases Cited
- Peterson v. McGladrey LLP, 792 F.3d 785 (7th Cir. 2015) (trustee’s suit dismissed in pari delicto; Seventh Circuit recognized investors may bring direct claims against auditors)
- Tricontinental Industries, Ltd. v. PricewaterhouseCoopers, LLP, 475 F.3d 824 (7th Cir. 2007) (auditor liability to third parties where accountant knew primary intent was to benefit/influence particular third party)
- Cashman v. Coopers & Lybrand, 251 Ill. App. 3d 730 (Ill. App. Ct.) (describing shareholder standing rule and derivative-versus-direct distinctions)
- Kramer v. Western Pacific Industries, Inc., 546 A.2d 348 (Del. 1988) (tests for distinguishing derivative and direct shareholder claims)
- Johnson v. Gore Wood & Co., 2 A.C. 1 (U.K. H.L.) (explaining the reflective-loss doctrine and absolute bar where loss is merely a reflection of corporate loss)