Securities & Exchange Commission v. Gruss
2012 U.S. Dist. LEXIS 66052
S.D.N.Y.2012Background
- SEC filed initial complaint April 8, 2011 and amended June 10, 2011 seeking enforcement under the Investment Advisers Act (IAA) against Grass for four alleged frauds (aiding and abetting).
- Allegations include: misappropriation of offshore fund cash for onshore fund investments, misappropriation to repay a credit facility, early withdrawals of management fees, and funding an aircraft with fund assets.
- Gruss/Grass allegedly had signatory authority over all transfers; transfers between Offshore and Onshore funds and to third parties totaled hundreds of millions of dollars without formal loan agreements or interest.
- Inter-fund transfers were to offset offshore fund cash shortages and were not documented investments or loans; concerns were raised by accountants who resigned after continued transfers.
- Offering Memoranda and audited financial statements described Cayman Islands structure and foreign administration, but alleged operational decisions occurred largely in New York and with U.S. investor involvement.
- SEC seeks injunction, disgorgement, and civil penalties; Grass moves to dismiss arguing Morrison v. NAB limit extraterritorial reach and pleading standards.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Extraterritorial reach of the IAA post-Morrison | SEC argues Morrison does not bar IAA claims; focus remains on adviser, not just where fraud occurred. | Grass contends Morrison bars extraterritorial application since offshore Cayman Islands fund victims and conduct outside U.S. | Morrison does not bar the SEC’s IAA claims. |
| Application of Morrison to IAA claims versus Exchange Act | IAA focus on adviser, not client location; Section 929P(b) suggests extraterritorial enforcement possible. | Morrison-like analysis should limit IAA claims if conduct occurred outside the U.S. and clients are abroad. | IAA claims survive; distinct purposes of IAA support extraterritorial enforcement where conduct occurs in U.S. or substantially affects U.S. investors. |
| Adequacy of pleading under Rule 8 and Rule 9(b) | Complaint provides sufficient facts to state plausible claims and to meet particularity for fraud. | Complaint contains inconsistencies with Offering Memoranda and financials; insufficient to plead with Rule 9(b) particularity. | Complaint adequate under Rule 8 and 9(b); provides plausible claims and strong inference standards. |
| Sufficiency of scienter or recklessness for aiding-and-abetting under 206(1)-(2) | Gruss had motive and opportunity; accountants warned, yet transfers continued, showing recklessness/conscious misbehavior. | No explicit intent; some transactions authorized by offering documents; alleged damages not required for 206 claims. | Complaint pleads a strong inference of scienter or recklessness sufficient to survive dismissal. |
Key Cases Cited
- Chambers v. Time Warner, Inc., 282 F.3d 147 (2d Cir. 2002) (claimant-friendly standard for considering motion to dismiss; accept the allegations as true)
- Ashcroft v. Iqbal, 556 U.S. 662 (Supreme Court 2009) (plausibility standard; not entitled to rely on mere legal conclusions)
- Bell Atl. Corp. v. Twombly, 550 U.S. 544 (Supreme Court 2007) (stricter plausibility standard; allegations must move beyond speculative)
- Capital Gains Research Bureau, Inc. v. SEC, 375 U.S. 180 (Supreme Court 1963) (remedial purposes of IAA and broad disclosure duties)
- Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (U.S. 2010) (transactional focus; extraterritorial reach limited unless domestic conduct involved)
- Kalnit v. Eichler, 264 F.3d 131 (2d Cir. 2001) (strong inference standard for scienter)
- ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase, 553 F.3d 187 (2d Cir. 2009) (recklessness suffices for securities fraud pleading)
- In re Bayou Hedge Fund Litig., 534 F. Supp. 2d 405 (S.D.N.Y. 2007) (statutory focus on adviser-related conduct and fiduciary duties)