In re Meridian Funds Group Securities & Employee Retirement Income Security Act (ERISA) Litigation

Citations: 917 F. Supp. 2d 231; 55 Employee Benefits Cas. (BNA) 2920; 2013 U.S. Dist. LEXIS 2806; 2013 WL 76188Docket: No. 09 M.D.2082

Court: District Court, S.D. New York; January 6, 2013; Federal District Court

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The legal action is a putative class action stemming from the Ponzi scheme led by Bernard Madoff, initiated by the Pension Trust Fund for Operating Engineers, an ERISA-governed multi-employer pension plan. The fund invested in the Meridian Diversified ERISA Fund, Ltd., which in turn invested in the Rye Select Broad Market XL Portfolio Ltd., a feeder fund that directed assets to Madoff’s firm. Following the revelation of Madoff's fraud, the investments were lost. The complaint cites violations of multiple securities laws, ERISA, breach of contract, fiduciary duty, unjust enrichment, gross negligence, fraud, and negligent misrepresentation, prompting defendants to file a motion to dismiss. The court granted this motion in part and denied it in part.

The Operating Engineers held shares worth $125 million in the Meridian Diversified ERISA Fund during the specified class period from March 24, 2004, to December 11, 2008. F.G. Crossthwaite, acting as fiduciary, asserts ERISA claims on behalf of the Operating Engineers. The action seeks to represent all similarly situated individuals who invested in funds managed by Meridian Corporate Defendants, which include various entities under the Meridian umbrella. However, since Operating Engineers only invested in the ERISA Fund, they lack standing to pursue claims related to the other seven funds mentioned in the complaint, resulting in the dismissal of those claims affecting only the class composition and not the named parties. Individual defendants associated with Meridian Management and Meridian Capital are also included in the lawsuit.

Operating Engineers lacks standing to assert state-law claims on behalf of non-ERISA class members, as these plaintiffs invested in funds different from the ERISA Fund in which Operating Engineers invested. Consequently, claims including breach of fiduciary duty, fraud, unjust enrichment, breach of contract, negligent misrepresentation, and gross negligence (counts 11-16) are dismissed. Regarding the securities fraud claim, Operating Engineers allege that they were misled into believing due diligence was performed on the Rye Portfolio Fund manager, Tremont Partners, Inc. However, funds were actually managed by Madoff, who operated a Ponzi scheme. While the complaint acknowledges Madoff as the true manager and cites interviews from Meridian executives, it fails to adequately plead the necessary elements of fraud, particularly scienter. The complaint primarily alleges a lack of due diligence by Meridian without demonstrating knowledge of Madoff’s fraudulent activities at the time of investment. The allegations of failing to fulfill a promise regarding due diligence do not constitute fraud, as no fraudulent intent is asserted.

Representations made to investors highlighted the dependency of the ERISA fund on the expertise of underlying Fund Managers, whose investment decisions could negatively impact the fund's results. The court determined that the complaint failed to sufficiently allege the elements of securities fraud, leading to the dismissal of Count 1 and, consequently, the dismissal of Count 2 regarding control person liability under section 20(a). Count 3, alleging a violation of § 12(a)(2) of the Securities Act, was dismissed because it pertains only to public offerings, whereas the offerings by Austin Capital were private.

Operating Engineers, an ERISA plan, asserts that the ERISA fund's assets were transformed into "plan assets" under ERISA due to sufficient investment from ERISA plans. Meridian Management, as the investment manager, is identified as a fiduciary under ERISA, with duties including prudent management of plan assets and avoidance of prohibited self-dealing transactions. Operating Engineers claims that all defendants are fiduciaries due to their control or investment advice roles and allege breaches of fiduciary duties.

Defendants contest the sufficiency of the allegations regarding their status as fiduciaries and any breaches. Additionally, they argue that ERISA's application to the Cayman Islands-based ERISA Fund would constitute an extraterritorial application of the law, which is generally disallowed unless explicitly stated in the statute. The Morrison ruling clarified that federal statutes, including the Exchange Act, do not have extraterritorial reach, though an exception exists for securities transactions occurring on U.S. exchanges or within the U.S. jurisdiction. The court noted that while the ERISA Fund is organized in the Cayman Islands, there is no indication that any significant part of the sale occurred outside the United States.

Prior to the Morrison decision, some courts had applied a presumption against extraterritoriality, determining that ERISA does not apply to claims from foreign nationals, as evidenced in cases like Chong v. InFocus Corp. and Giles Maurais v. Snyder. However, the current case differs because it involves a domestic plaintiff participating in a domestic transaction to invest in a fund organized offshore, specifically the "Meridian Diversified ERISA Fund, Ltd." This fund was designed for American investors seeking to invest ERISA-covered funds, making it illogical for ERISA not to apply simply due to the fund's offshore organization.

Regarding fiduciary status under ERISA, liability for imprudence or prohibited transactions applies only to those who were ERISA fiduciaries at the relevant times. Therefore, plaintiffs must demonstrate that each defendant was an ERISA fiduciary. A fiduciary is defined by ERISA as someone who exercises authority over plan management or assets, provides investment advice for compensation, or has discretionary responsibility in plan administration. Defendants concede that Meridian Management is an ERISA fiduciary but argue that Operating Engineers has not adequately established Meridian Capital’s fiduciary status. The court finds that Operating Engineers has sufficiently alleged that Meridian Capital qualifies as an "investment manager" under 29 U.S.C. § 1002(38), as it controls investments made by Meridian Management and receives fees for investment advice.

Operating Engineers did not plead any facts regarding the fiduciary status of defendants Meridian Diversified Fund, LLC, and Meridian Diversified Fund, LP, and it appears they do not intend to pursue ERISA claims against them. If they had intended to assert fiduciary status against these defendants, they have failed to do so adequately. However, the complaint appropriately alleges that individual defendants are ERISA fiduciaries due to their roles as officers and directors of Meridian Management, supported by the offering documents which detail their involvement in investment management and oversight.

Operating Engineers’ claims based on ERISA fiduciary status (counts 4-9) are dismissed regarding Meridian Diversified Fund, L.P. and Meridian Diversified Fund, LLC, while other defendants are identified as fiduciaries under ERISA. The complaint alleges Meridian Management diverted assets from the ERISA Fund into a segregated portfolio to fund a lawsuit against Tremont entities to recover losses from Madoff's fraud, violating ERISA § 406(a) and § 406(b). Although defendants acknowledge the asset diversion, they argue it does not violate ERISA since it was not for the benefit of a "party in interest," and claim the recovery will benefit investors. The Second Circuit’s interpretation in State St. Bank & Trust v. Salovaara allows fiduciaries to use plan assets for legal costs incurred in duties related to the plan, provided the actions are intended to benefit the fund. Since the lawsuits aim to recover lost investments for Operating Engineers, count 7 is dismissed against all defendants.

Regarding prudence, the complaint asserts defendants failed to manage ERISA assets prudently, as required by ERISA § 404(a)(1)(B), by neglecting red flags surrounding Madoff's operation. The ERISA prudence standard imposes a high duty of care, requiring fiduciaries to conduct thorough investigations and exercise independent judgment similar to that of experienced investment professionals. The court must avoid judging defendants’ actions with hindsight, focusing instead on whether a prudent, sophisticated investment professional in the same situation would have acted similarly. Notably, the allegation that Madoff’s reported returns were mathematically impossible was recognized by other investment managers prior to the fraud's exposure.

Plaintiffs allege that defendants were aware that Madoff managed their investments and understood, at least generally, his purported strategy. As sophisticated investors, they should have recognized red flags that warranted further scrutiny of their investments. The prolonged investment in Madoff's funds through Tremont raised additional concerns about defendants' prudence. Consequently, the court found that Operating Engineers sufficiently alleged imprudence, resulting in the denial of the motion to dismiss counts 4, 5, and 6 against all defendants, except for Meridian Diversified Fund, L.P. and Meridian Diversified Fund, LLC, which had these counts dismissed.

Regarding co-fiduciary liability, the claims supporting breach of fiduciary duty also substantiate the claim for co-fiduciary liability. The motion to dismiss count 8 is granted only for Meridian Diversified Fund, L.P. and Meridian Diversified Fund, LLC, while it is denied for other defendants. 

For disgorgement claims, counts 9 (against fiduciaries) is dismissed as it duplicates counts 4-6, while count 10 (against non-fiduciaries) remains viable. In conclusion, the motion to dismiss is granted for all counts related to Meridian Diversified Fund, L.P. and Meridian Diversified Fund, LLC, and granted for other defendants on all counts except for 4, 5, 6, 8, and 10. The surviving defendants include the Meridian Horizon Fund, LP; Meridian Horizon Fund II, LP; Meridian Diversified Fund, LP; Meridian Diversified Fund, Ltd.; Meridian Diversified Compass Fund, Ltd.; Meridian Absolute Return ERISA Fund, Ltd.; and Kingate Global Fund, Ltd.