Securities and Exchange Commission v. Trabulse et al

MOTION to Dismiss

N.D. Cal.November 1, 2007

404602.07 1 KEKER& VANNEST, LLP MICHAL D. CELIO - #197998 2 CLEMENT S. ROBERTS - #209203 JO F. WEINGARTEN - #246224 3 710 Sansome Street San Francisco, CA 94111-1704 4 Telephone: (415) 391-5400 Facsimile: (415) 397-7188 5 Email: mcelio~kv.com croberts~kvn.com 6 iweingaren~kv.com 7 Attorneys for Defendants ALEXADER JAMES TRAULSE, 8 FAHEY FUND, L.P., FAHEY FINANCIAL GROUP, INC., INTERNATIONAL TRADE 9 & DATA, and ITD TRADING 10 11 UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF CALIFORNIA SAN FRACISCO DIVISION 12 13 14 15 16 17 18 19 20 21 SECURITIES AND EXCHAGE COMMISSION Case No. C-07-4975 WH Plaintiff, v. ALEXADER JAMES TRAULSE Defendant, and FAHEY FUND, L.P., FAHEY FINANCIAL 22 GROUP, INC., INTERNATIONAL TRADE & DATA, and ITD TRAING, 23 24 25 26 27 28 Relief Defendants. DEFENDANT ALEXADER JAMES TRAULSE'S NOTICE OF MOTION; MOTION TO DISMISS THE FIRST, SECOND, AND THIRD CAUSES OF ACTION OR, IN THE ALTERNATIVE, FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORADUM OF POINTS AND AUTHORITIES Date: December 6, 2007 Time: 8:00 a.m. Couroom: 9 Judge: Hon. Wiliam H. Alsup Date Action Filed: September 26, 2007 DEF.'S NTC. OF MTN., MTN. TO DISMISS i SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WHA Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 1 of 30 404602.07 1 TABLE OF CONTENTS2 Pa2e 3 NOTICE OF MOTION AN MOTION .........................................................................................1 4 ISSUE TO BE DECIDED...............................................................................................................1 5 MEMORADUM OF POINTS AN AUTHORITIES .................................................................1 6 i. 7 II. 8 III. 9 10 11 12 13 14 15 16 17 18 19 20 INTRODUCTION ...............................................................................................................1 FACTUAL BACKGROUND..............................................................................................3 ARGUMENT.................................................................................................................... ...5 A. The Cour should dismiss the first and second causes of action. .............................6 1. The SEC has not identified the allegedly false statements with paricularty. .......................................................................................... .:..... 7 The SEC has not met its obligation to say why and how any alleged statements were false or misleading...............................................8 The SEC has failed to meet its obligation to allege specific facts demonstrating the materiality of any allegedly false statements. ..............10 The SEC has not met its obligation to allege specific facts showing that any allegedly false statement was made "in connection with the purchase or sale of a securty." ..................................12 2. 3. 4. B. The SEC's Investment Advisers Act claim also lacks the necessary paricularity. .......................................................................................................... .13 C. The Cour should, at a minimum, requie a more definite statement of the charges. .......................................................................................................... ..17 IV . CONCLUSION....................................................................................... ......................... ..18 21 22 23 24 25 26 27 28 1 DEF.'S NTC. OF MTN., MTN. TO DISMISS i ,2 & 3 CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 2 of 30 404602.07 TABLE OF AUTHORITIES 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Pa2e FEDERA CASES Basic Inc. v. Levinson, 485 U.S. 224 (1988) ............... ..................... ....... ....................................................................10 Branch v. Tunnell, 14 F .3d 449 (9th Cir. 1994) .................................................................................................. .15 In re GlenFed Sec. Litigation, 42 F.3d 1541 (9th Cir. 1994) .................................................................................................17 Glen Holly Entertainment, Inc. v. Tektonix, Inc., 100 F. Supp. 2d 1086 (C.D. CaL. 1999) ............................................................................5, 14 Goldstein v. SEC, 451 F .3d 873 (D.C. Cir. 2006).............................................................. .............................. ...13 Kaplan v. Rose, 49 F .3d 1363 (9t Cir. 1994) ............................................................................................... ..16 Livid Holdings LTD. v. Salomon Smith Barney, Inc., 416 F 3d 940 (9th Cir. 2005) ..........................................................................................1 0, 11 Neubronner v. Milken, 6 F .3d 666 (9th Cir. 1993) .......................................................................................................5 Parrino v. FHP, Inc., 146 F .3d 699 (9th Cir. 1998) .............................................................................................. ...14 SEC v. Baxter, 2007 WL. 2013958 (N.D. CaL. Jul. 11,2007) ..............................................................5, 7, 8 SEC v. Merril Scott & Associates, Ltd., 505 F. Supp. 2d 1993 (D. Uta 2007) ...................................................................................13 SEC v. Phan, 500 F.3d 895, 2007 WL. 2429365 ..........................................................................................6 SEC v. Rauscher Pierce Refines, Inc., 17 F. Supp. 2d 985 (D. Arz. 1998) .......................................................................................13 SEC v. Yuen, 221 F .R.D. 631 (C.D. CaL. 2004) .............................................................................................5 SEC v. Zandford, 53 5 U.S. 813 (2002)......................................................................................,............,........ ...12 Semegar v. Weidner, 780 F .2d 727 (9th Cir. 1985) .............. ................................. ........ ........ ........,.,....................., ..,5 11 DEF.'S NTC. OF MTN., MTN. TO DISMISS i si, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 3 of 30 404602.07 TABLE OF AUTHORITIES 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Pa2e Simpson v. AOL Time Warner Inc., 452 F .3d 1040 (9th Cir~ 2006) ..................... .............. ................... ....................... ................ ....4 Vernazza v. SEC, 327 F .3d 851 (9t Cir. 2003) .. .................. ........ ...... ......................................................... ......13 Vess v. Ciba-Geigy Corp., 317 F .3d 1097 (9th Cir. 2003) ...........................................................................................5, 8 W Mining Council v. Watt, 643 F .2d 618 (9th Cir. 1981) ............................................................................... ................5, 9 Wenger v. Lumisys, 2 F. Supp. 2d 1231 (N.D. CaL. 1998) .....................................................................................17 FEDERA STATUTES 15 U. S. C. § 77 q( a) .........................................................................................................................6 15 U.S. C. § 78j (b) ....................................................................................................................,.....6 15 U.S. C. § 80b-6(1 )-(2)...... ................ .......................... ........................................................,;.. .,13 17 C.F .R. § 240.1 Ob-5.......................... ........... ........................ .............................. ....................,.,..6 Fed. R. Civ. P. 9(b) ............................................................. ............................ ............. ........ passim Fed. R. Civ. P. 12(b)( 6)........................ ............................................................................. ........ .2, 6 Fed. R. Civ. P. 12(e) .................. ............. .............................................................................. ...1, 17 Fed. R. Evid. 201 ......... ........................................................................ ................. .......................14 Rule 12(b)( 6) .............................. ...................................................................... ................... passim 11 DEF.'S NTC. OF MTN., MTN. TO DISMISS i SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 4 of 30 1 NOTICE OF MOTION AND MOTION 2 PLEASE TAK NOTICE that at 8:00 a.m. on December 6,2007, or at such other date 3 and time ordered by this Cour, in Couroom 9 of the above-referenced cour, before Honorable 4 Wiliam H. Alsup, Defendant Alexander James Trabulse and Relief Defendants Fahey Fund, 5 L.P., Fahey Financial Group, Inc., International Trade & Data, and ITD Trading (collectively, 6 "Fahey Fund") will, and hereby do, move this Cour to grant ths motion to dismiss or, in the 7 alternative, grant ths motion for more definite statement. This motion to dismiss is brought 8 pursuant to Federal Rules of Civil Procedure 12(b)(6), and 9(b), to dismiss the Complaint for its 9 failure to state a claim upon which relief may be granted and failure to plead its allegations with 10 sufficient paricularty. In the alternative, Defendant moves under Rule 12(e) for a more definite 11 statement of the charges. 12 This motion seeks entr of an Order Granting Trabulse's Motion to Dismiss and is based 13 on this Notice of Motion and Motion, the Memorandum of Points and Authorities that follows, ;- 14 the request for judicial notice and the documents attached thereto submitted herewith, the 15 declaration of Clement S. Roberts submitted herewith, the pleadings on file with the Cour, and 16 any oral arguent heard by the Cour on December 6, 2007. 17 ISSUE TO BE DECIDED 18 Whether the SEC has pleaded its first, second, and third causes of action for securties 19 fraud with the requisite degree of paricularty, under Rules 12(b)(6), 9(b), and 12(e) of the 20 Federal Rules of Civil Procedure. 21 MEMORADUM OF POINTS AND AUTHORITIES 22 I. INTRODUCTION 23 Although you might not know it from the Complait's hyperbolic language, ths is a case 24 in which the paries agree that no investor lost money. Ths case is solely and exclusively a 25 dispute about how much money the Fahey Fund's investors made. If one examines the numbers 26 in the SEC's Complaint closely, it becomes clear that even under the SEC's math-which is 27 flawed-the Fund's investors outperformed the stock market durng the period covered by the 28 404602.07 1 DEF.'S NTC. OFMTN., MTN. TO DISMISS ISI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 5 of 30 1 Complaint. 1 To put it another way, the central dispute here is whether the Fahey Fund's 2 investors became slightly wealther or became much wealthier. Ths case is not a "fraud" case as 3 that term is tyically understood; because economic loss is an essential element of any fraud 4 claim, no investor could sue the Fund for fraud under these circumstaces. 5 As a result, the SEC is not intending to prove fraud, at least not in the traditional sense. 6 Instead, the SEC bases its Complaint on its special power to vindicate the securties laws by 7 bringing complaints even where no one has been harmed, in order to recover from defendants 8 who have been unjustly enrched. But in ths case the SEC's Complaint lacks both a coherent 9 theory of unjust enrchment and paricular facts that could support such a theory. Instead, the 10 SEC alleges a series of disjointed facts and conclusory allegations, and then incorporates all of 11 those statements, by reference, into each cause of action. The SEC's hope is that the 12 defendant-and the Cour-will pick though the varous allegations and piece together a viable 13 theory for each cause of action. But, leaving aside the fact that this "puzzle-piece" style of 14 pleading has been repeatedly condemned, the SEC's Complaint must be dismissed because the 15 necessary puzzle pieces are either missing or simply do not fit. 16 For example, although the SEC generally alleges that Mr. Trabluse took "too much" 17 money from the Fund, the Complaint says nothng about how much he was entitled to tae nor 18 about how much he allegedly took. The Parership Agreement at issue in this case2 permits Mr. 19 Trabluse to take up to 25% of the Fund's profits and requires him to pay Fund expenses using 20 that money. Thus, so long as Mr. Trabluse's personal and business expenses are. (together) less 21 than 25% ofthe Fund's appreciation, Mr. Trabulse did not commit any act of misappropriation. 22 23 24 25 26 27 28 1 Indeed, one of the SEC's tral lawyers (whose name appears on the complaint) admitted to the press that the SEC's Complaint in ths case has "not alleged that (the defendant's investors) lost money." Kathleen Pender, Net Worth: Hedge Funds Need a CarefUl Look, S.F. Chron., Sept. 27, 2007, at C 1 (quoting SEC staff attorney Erin Schneider), attached hereto as Exhbit 2 to the Declaration of Clement S. Roberts. 2 The Fahey Fund (Limited) Parnership Agreement is attched to the Declaration of Clement S. Roberts in Support of the Motion to Dismiss, as Exhbit 1. Mr. Trabulse seeks judicial notice of the Parnership Agreement in his concurently filed Request for Judicial Notice, on the ground that the Agreement is effectively incorporated into the SEC's Complaint. See n.15, infra. 404602.07 2 DEF.'S NTC. OF MTN., MTN. TO DISMISS I SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 6 of 30 1 But nothing in the Complaint says how much the Fund appreciated or how much of that 2 money Mr. Trabluse used for personal and business expenses. Instead, the Complaint alleges a 3 few specific instaces of Mr. Trabulse spending Fund money for personal expenses while 4 recording the expenditues as business expenses. But, even if those allegations are tre, they are 5 irrelevant. Again, the Fund documents require Mr. Trabulse to treat business expenses as a 6 subset of his personal expenses and to pay for both from the same pool of money. From the 7 Fund's perspective, it simply does not matter whether a given expense was a personal expense or 8 a business expense, and/or how the expense was characterized-the only relevant questions are 9 what the total (business + personal) expenses were, and whether those expenses were less than 10 25% ofthe Fund's profits. But the SEC has made no factual allegations on either score. 11 As discussed in more detail below, the SEC's other theories are equally flawed. For 12 example, the SEC claims that investors were misled by false statements about the value of their 13 accounts, but ignores the fact that these statements were allegedly made after the investments to 14 which they pertin. The SEC tries to plug this hole in its theory by alleging that (undentified) 15 later investors decided to invest based on (unspecified) conversatións with (undentified) existing 16 investors who supposedly passed along (undentified) allegedly false statements. But the SEC 17 has utterly failed to identify any specific conversations, investors, or false statements to support 18 this allegation. 19 For these reasons, and as discussed in more detail below, the first, second and third 20 causes of action should be dismissed and the SEC should be required to replead (if it can) with 21 paricularty and in a clear, logical order that does not require a puzzle-piece deciphering. 22 II. FACTUAL BACKGROUND 23 Defendant Jim Trabulse is the General Parer ofthe hedge fud known as the Fahey 24 Fund, L.P. See Plaintiffs Complaint ("Complt.") (Docket No. 1) ~ 8. He is also the President 25 and Chief Executive Offcer of Fahey Financial Group, Inc., the "sole parer" of International 26 Trade & Data, and a founding general parter of ITD Trading - all of which are relief defendants 27 in this litigation. See id. ~~ 9-11. 28 404602.07 3 DEF.'S NTC. OF MTN., MTN. TO DISMISS I SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 7 of 30 1 The SEC's Complaint avers generally that for the past seven years, Mr. Trabulse has 2 systematically "defrauded investors." Id. ~ 1. Yet, as the SEC publicly confrmed to the press,3 3 its Complaint nowhere alleges that the investors lost money by investing in the Fund. Indeed, 4 according to the allegations in the Complaint; the Fund made a lot of money for its investors. 5 The Complaint alleges that investors put almost $10 millon in capital into the Fund since 6 inception and that the curent value of the Fund's brokerage accounts is approximately $13 7 milion. Id. ~~ 12, 15. Thus, ignoring money already retued to investors and the value of the 8 assets held by the Fund outside its brokerage accounts, and assuming that the SEC's (disputed) 9 valuation is correct, the Fund would have retued just about 5% a year net of costs and fees - a 10 period durng which the Dow Jones Industrial Average had a compound average anual retu of 11 just 1.2%. Of course, as soon as the more than $7 milion in distrbutions are factored back in 12 (and again using the SEC's disputed curent valuation while ignoring the Fund's non-brokerage 13 account assets) the Fund's compound average anual retu jumps to over 14%. Thus, even 14 using the SEC's figues-the accuracy of which Mr. Trabulse disputes-the investors were 15 enriched enormously by virte of their investment in the Fund. There was, as a matter of law, 16 simply no fraud against the investors, notwthstanding the SEe's hyperbolic, press-release- 17 seeking statements to the contrar. See Simpson v. AOL Time Warner Inc., 452 F.3d 1040, 1047 18 (9th Cir. 2006) (economic loss and loss causation are both required elements of an investor's 19 claim for fraud). 20 The Cour should not, therefore, be misled by the Complaint's rhetoric into believing that 21 ths case concerns some kind of massive theft from the Fund's investors. Indeed, in its 22 previously fied motion for preliminar relief, the SEC effectively asked the Cour to keep Mr. 23 Trabluse in charge of managing investors' accounts durg the pendency of the litigation - 24 something it would not have done if Mr. Trabluse had been stealing from his clients. Although 25 the SEC's Complaint shouts fraud from the rooftops, the alleged foundation is far more modest- 26 27 28 3 The SEC has "not alleged that (the defendant's investors) lost money." Kathleen Pender, Net Worth: Hedge Funds Need a Careful Look, S.F. Chron., Sept. 27, 2007, at Cl (quoting SEC staff attorney Erin Schneider), attached hereto as Exhbit 2 to the Declaration of Clement S. Roberts. 4 DEF.'S NTC. OF MTN.,MTN. TO DISMISS ISI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 8 of 30 1 namely the allegation that the Fund's accounting improperly valued its assets over time and, as a 2 result, somehow unjustly enrched Mr. Trabluse. 3 III. ARGUMENT 4 The Cour should dismiss the first, second, and thid causes of action because they lack 5 the specificity required by Federal Rules of Civil Procedure 12(b)(6) and 9(b). Under Rule 9(b), 6 "(i)n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be 7 stated with paricularty." Ths heightened pleading standard applies "to fraud actions brought 8 under the federal securties laws(.)" SEC v. Yuen, 221 F.R.D. 631,634 (C.D. CaL. 2004) 9 (dismissing SEC complaint for failure to plead fraud with paricularty). Because the first three 10 claims all allege fraud, each must meet the heightened pleading requirements of Rule 9(b). 11 The purose of this heightened pleading stadard is "to give defendants notice ofthe 12 paricular misconduct which is alleged to constitute the fraud charged so that they can defend 13 against the charge and not just deny that they have done anytng wrong." Neubronner v. 14 Milken, 6 F.3d 666,671 (9th Cir. 1993) (citing Semegar v. Weidner, 780 F.2d 727, 731 (9th Cir. 15 1985)). To meet the Rule 9(b) standard, a "complaint must specify such facts as the times, dates, 16 places, and benefits received, and other details of the alleged fraudulent activity." Glen Holly 17 Entm't, Inc. v. Tektonix, Inc., 100 F. Supp. 2d 1086, 1094 (C.D. Cal. 1999) (citing Neubronner, 18 6 F.3d at 672) (internal citations omitted). Once the SEC has identified a paricular statement, its 19 allegations "must be accompaned by 'the who, what, when, where, and how' of the misconduct 20 charged." Vess v. Ciba-Geigy Corp., 317 F.3d 1097, 1106 (9th Cir. 2003). See also SEC v. 21 Baxter, 2007 WL 2013958, at *3 (N.D. Cal. Jul. 11,2007) ('''(A) plaintiff must set forth more 22 than the neutral facts necessary to identify the transaction. The plaintiff must set fort what is 23 false or misleading about a statement, and why it is false."') (quoting Vess, 317 F.3d at 1106) 24 (emphasis added). 25 In evaluating whether the SEC has met this heightened pleading stadard, the Cour is not 26 required to accept uneasonable inferences, unwaranted deductions of fact, or conclusory legal 27 allegations cast in the form of factual allegations. See W Mining Council v. Watt, 643 F.2d 618, 28 404602.07 5 DEF.'S NTC. OF MTN., MTN. TO DISMISS ISI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 9 of 30 404602.07 1 624 (9th Cir. 1981); Yuen, 221 F.R.D. at 634. As discussed in more detail below, however, this 2 is all the SEC has offered. 3 A. The Court should dismiss the first and second causes of action. 4 The SEC's first and second claims for relief do not meet the required pleading stadards. 5. In paricular, the SEC has: (1) failed to identify allegedly false or misleading statements with 6 paricularty; (2) failed to specify how and why it contends those statements were wrong; and (c) 7 failed to allege any specific facts showing that any such misinformation was materiaL. 8 The first and second claims for relief rise and fall together because they require the SEC 9 to plead the same elements. Specifically, each of Section 17(a) of the Securties Act,4 Section 10 1O(b) ofthe Exchange Act,S and Rule 1Ob-5,6 require the SEC to allege specific facts showing 11 that a defendant made "'(1) a material misstatement or omission (2) in connection with the offer 12 or sale of a securty (3) by means of interstate commerce. ", SEC v. Phan, 500 F.3d 895, _, 13 2007 WL 2429365, at *8 (quoting SEC v. Dain Rauscher, Inc., 254 F.3d 852,856 (9th Cir. 14 2001)).7 Thus, uness the SEC has pled each ofthese thee elements with particularty, the first 15 and second claims for relief must be dismissed. As discussed in more detail below, the SEC has 16 failed to shoulder its burden. 17 18 19 20 21 22 23 24 25 26 27 28 4 15 U.S.C. § 77q(a). This section forbids any person in the offer or sale of any securties by means of interstate commerce "(1) to employ any device, scheme, or arifice to defraud, or (2) to obtain money or property by means of any untre statement of a material fact or any omission to state a material fact necessar in order to make the statements made, in the light of the circumstaces under which they were made, not misleading; or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser." Id. S 15 U.S.C. § 78j(b). Ths section makes it unawfl for any person by means of interstate commerce "(t)o use or employ, in connection with the purchase or sale of any securty. . . any manpulative or deceptive device or contrvance in contravention of such rules and regulations as the Commission may prescribe(.)" Id. 6 17 C.F.R. § 240. lOb-5. Rule lOb-5 provides that it shall be unawf for any person "(a) (t)o employ any device, scheme, or arifice to defraud, (b) (t)o make any untre statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstaces under which they were made, not misleading, or (c) (t)o engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any securty." Id. 7 In addition, violations Section 17(a)(I), Section 10(b), and Rule lOb-5 require scienter, while violations of Sections 17(a)(2) and (3) require a showing of negligence. See id 6 DEF.'S NTC. OF MTN., MTN. TO DISMISS I SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 10 of 30 1 1. The SEC has not identified the allegedly false statements with particularity. 2 The SEC fails to state with paricularty each of the statements that it believes to be 3 materially inaccurate. Whle the SEC generally avers that Trabulse made materially misleading 4 statements in his newsletter and quarerly reports, it måkes only fleeting attempts to identify 5 what the alleged misstatements were, identifying what it terms a few "examples" of the 6 statements in question. See Complt. ~~ 12-18. Yet, in order to meet the pleading requirements 7 '''the allegations should include the misrepresentations themselves with paricularty(.)'" Baxter, 8 2007 WL 2013958, at *6 (quoting Moore v. Kayport Package Exp., Inc., 885 F.2d 531,540 (9th 9 Cir. 1989)). Thus, only these purorted "examples" can be relied on to resist the present motion 10 to dismiss; everyg else is, by force of logic, not a paricularzed allegation. 11 But even these so-called "examples" fail to point to specific statements. For example, in 12 paragraph 14 of the Complaint, the SEC alleges (as an "example") that "in the second quarer of 13 2005 Trabulse reported to investors collective gains of approximately $2.5 milion. In reality the 14 Fund realized a net loss in its brokerage accounts of more than $200,000." Complt. ~ 14. But 15 the SEC canot meet the requirement of specifcally identifing allegedly false statements by 16 pointing to "collective gains" - because there is no allegation that any investor ever saw any 17 discussion of the Fund's "collective gains." The SEC is pointing to an entire set of quarerly 18 reports-with each report being different for each shareholder-while generally alleging that 19 varous undentified statements in those reports were cumulatively misleading. The SEC must 20 identify what the paricular misleading statements were. It has not done so. 21 Yet ths is the most specifc allegation of its kind in the Complaint. For example, in 22 attempting to offer a second "example" of a misleading statement in the latter par of paragraph 23 14, the SEC wrtes that "Trabulse fraudulently reported to investors durng the period from 1998 24 though 2006 that they collectively eared gains totaling approximately $30 milion." Complt. ~ 25 14. Yet nothig in the Complaint identifies which of the hundreds or thousands of emails, phone 26 calls, and other communcations that took place during the referenced eight-year period are the 27 "reports" to which the SEC is referrng - much less what specific statements in those reports are 28 7 DEF.'S NTC. OF MTN., MTN. TO DISMISS isi. 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AN SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 11 of 30 1 alleged to be false or misleading. This kind of vague gestue towards hundreds of different 2 undentified communcations canot meet the specificity requirements of Rule 9(b). 3 Nor are these problems limited to anyone paragraph of the Complait - they apply to 4 every attempt the SEC has made to identify an allegedly false statement. For ease of reference, 5 those failings are sumarized in the char attched hereto as Exhbit A. As set fort therein, the 6 SEC nowhere points to a paricular statement that is misleading. 7 8 2. The SEC has not met its obligation to say why and how any alleged statements were false or misleading 9 It is black letter law that, in order to meet the specificity requirement of 9(b) the SEC 10 must not merely specifically identif any allegedly false statements, but must specifically say 11 why and how those statements are alleged to be false and misleading. See Baxter, 2007 WL 12 2013958, at *3 ("'(A) plaintiff must set forth more than the neutral facts necessar to identify the 13 transaction. The plaintiff must set fort what is false or misleading about a statement, and why it 14 is false."') (quoting Vess, 317 F.3d at 1106) (emphasis added). The SEC has failed to meet this 15 obligation. 16 First, the SEC repeatedly premises its assertion that Mr. Trabulse's (undentified) 17 statements to his investors were false on a logical fallacy. Retung to the previous example, in 18 paragraph 14 the SEC contends that Mr. Trabluse misled investors when "in the second quarer 19 of2005 (he) reported to investors collective gains of approximately $2.5 milion." According to 20 the SEC, these (unspecified) statements were cumulatively misleading because "In reality the 21 Fund realized a net loss in its brokerage accounts of more than $200,000." Complt. ~ 14 22 But ths allegation makes absolutely no sense. As the SEC well knows, and has alleged 23 elsewhere in the Complaint, Mr. Trabulse invested a "signficant portion" of the Fund's capital in 24 a wide varety of assets that are not held in brokerage accounts, such as real estate, antique rugs, 25 and a sta-up golf company.8 Thus, the fact that the brokerage accounts saw a net decrease 26 durng a paricular period says nothing about whether the overall value of the Fund's assets were 27 28 8 See, e.g,. ~ 28 404602.07 8 DEF.'S NTC. OF MTN., MTN. TO DISMISS ISl, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 12 of 30 1 up or down. It is like claiming that a person must be lying when he says that he ate more than 2 usual yesterday and pointing as proof to the fact that he ate a modest breakast. Again, even 3 accepting the SEC' s allegations as true for the purposes of ths motion, the fact that part of the 4 Fund declined in value does not logically imply that the whole Fund did so. 5 As noted previously, the Cour should not accept nonsensical logical inferences in 6 deciding a motion to dismiss. See W Mining Council, 643 F.2d at 624. The SEC therefore 7 canot satisfy its obligation to explain why a statement is allegedly false with an obvious logical 8 fallacy. Yet, if the Cour carefully reads the Complaint (or reviews Exhbit A hereto) it will see 9 that the SEC has premised its entire case for the falsity of the Fund's account statements on this 10 same ilogical and obviously deficient premise. 11 Nor is this the only instance where the SEC's allegations of "falsity" are premised on a 12 demonstrably incorrect basis. For example, the SEC alleges that Mr. Trabulse misled his 13 investors by tellng them, "in both verbal and wrtten communcations, that the Fahey Fund 14 invested (in) financial instrents like stocks, options, derivatives, futues and foreign 15 curency(,)" and then actually invested in "gems and other jewelry, real property, and rugs(,)" 16 and using the money "to fud a star-up golf company and purchase a BMW for the golf 17 company's owner." Complt. ~ 28. 18 Leaving to one side (for the moment) the fact that nothng in this paragraph identifies a 19 specific statement that is alleged to be false,9 the allegation of falsity is also demonstrably wrong. 20 In its Complaint, the SEC repeatedly cites to the Fund's Parership Agreement-effectively 21 incorporating it as a reference and allowig the Cour to review it on a motion to dismiss. Yet 22 the Parership Agreement clearly states that "capital may be invested in other businesses" and 23 that the Fund's mission will be to invest in "publicly listed opportties, natual resources, and 24 any other investment of a unique long-term character(.)" Declaration of Clement S. Roberts 25 ("Roberts Decl."), Ex. 1 (Fahey Fund (Limited) Parership Agreement ("Parnership 26 Agreement")) § 6.09 and § 2.01 (emphasis added). Thus, the Fund's investment in the golf 27 28 9 Because the allegations do not identify what the alleged statements were, when they were 9 DEF.'S NTC. OF MTN., MTN. TO DISMISS I si, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 13 of 30 404602.07 1 company, and in other appreciating assets like a warehouse full of antique rugs, real-estate and 2 rare gems are all fairly within the set of investments that Mr; Trabulse agreed to with his limited 3 parers. The SEC's allegation that Mr. Trabulse misrepresented the scope of the Fund's 4 investments is, therefore, not merely vague, but also wrong. Those allegations canot, therefore, 5 satisfy the requirements of Rule 9(b).10 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 The SEC has failed to meet its obligation to allege specifc facts demonstrating the materiality of any allegedly false statements. Even if the Complaint had identified paricular misleading statements-which it does 3. not-and even if the Complaint had explained why those statements are misleading-which it has not-the Complaint would stil fail because it does not specifically allege that the (unidentified) statements were material. A misrepresentation "is material if there is a substatial likelihood that a reasonable investor would have acted differently if the misrepresentation had not been made or the trth had been disclosed." Livid Holdings LTD. v. Salomon Smith Barney, Inc., 416 F.3d 940, 946 (9th Cir. 2005) (citation omitted). See also Basic Inc. v. Levinson, 485 U.S. 224,231-232 (1988) ("'(T)here must be a substantial likelihood that the disclosure ofthe omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available.''') (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). But the SEC does not allege any specific facts regarding materiality. The vast bulk of the statements to which the SEC vaguely gestues were clearly made after people who received the statements invested in the Fund. Thus, in order to adequately allege materiality the SEC would have to allege with paricularty that specific investors would have divested from (or not increased their investment in) the Fund had they received the specifically identified information. made, or to whom they canot form a basis for sustaining the first and second causes of action. 10 Indeed, it is somewhat surrising (and disappointing) that the SEC made this mistae because defense counsel explicitly pointed out the mistake before the SEC fied the Complaint. Specifically, after a meeting in which the SEC's tral counsel said it could not find any authorization in the Fund documents for this kind of investment, the defendant's counsel wrote and pointed the SEC to this authorization in the Fund documents. See Roberts Decl., Ex. 3 (Celio letter of July 17, 2007). Apparently the SEC either did not read, or chose to ignore, the letter. 10 DEF.'S NTC. OF MTN., MTN. TO DISMISS I SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 14 of 30 1 The SEC simply has not made any such allegation. Indeed, the only place in which the 2 Complaint even attempts to make such an allegation are in paragraphs 16, 17 and 20. But these 3 paragraphs do not contan any specific information whatsoever, and therefore fall far short of 4 what is required under 9(b). Paragraph sixteen, for example, only says that "many (undentified) 5 investors decided to invest in Fahey Fund because they heard (undentified statements) from 6 (undentified) frends or colleagues already invested in the fud ( . J" Complt. ~ 16. 7 Similarly, the most detailed allegation in paragraph seventeen says that "(0 )ne 8 (undentified) investor, who with his wife invested more than $2 milion in 2006, called several 9 (undentified) individuals on the list before investing and based his investment, in par, on 1 0 (undentified) material misstatements about the fund ( . J" Id. ~ 17.11 11 And paragraph 20 suffers from the same deficiencies. In paricular it does not 12 specifically identify any allegedly false information, does not even attempt to identify any person 13 who purortedly received that information, and does not contain any allegation whatsoever that 14 anyone took any action based on that information or considered that information as importt in 15 any way. 16 In other words, the SEC ha not identified any investor who allegedly would have 17 divested, any investor who would not have invested additional amounts or any first time investor 18 who would not have put money in "if the misrepresentation had not been made or the trth had 19 been disclosed." Livid, 416 F.3d at 946. Because the Complaint does not identify any specific 20 investor, nor any specific statement allegedly relied on by that (undentified) investor, it has not 21 plead materiality with the requisite specificity. 22 Indeed, assuming the SEC's numbers are correct (for the purose ofthis motion only) 23 and assuming therefore that the Fund retued an anual average of more than 14% (as compared 24 with an overall market retu of about 1.2% 12) it is hard to tae seriously the notion that investors 25 26 27 28 11 Again, the SEC canot meet the paricularty requirement by alleging that one undentified person had a conversation with another undentified person in which unown and undentified things were said and then invested based on unidentified misstatements. Yet ths is precisely the set of allegations upon which the SEC is attempting to rely. 12 Ths figue is derived from the Dow Jones Industrial Average anual retus for the years 11 DEF.'S NTC. OF MTN., MTN. TO DISMISS I SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 15 of 30 1 would have gone elsewhere had they had different inormation. Indeed, the SEC's failure to 2 allege materiality with specificity is probably a fuction of the fact that none of the Fund's 3 investors would have wanted to give up a retu of at least 5% per year-more likely 14o/o-in 4 order to invest elsewhere in an otherwise sluggish market. 5 In considerig ths proposition, the Cour should keep in mind the fact that the SEC 6 already has deposed nearly 30 of the Fund's investors. If the lack of specificity in the Complaint 7 is any indication, apparently none of them were willng to go on record saying that they would 8 have acted differently had they known what the SEC contends to be the Funds "actual" retu. 9 10 4. The SEC has not met its obligation to allege specifc facts showing that any allegedly false statement was made "in connection with the purchase or sale of a security." 11 Finally, the SEC has failed to meet its pleading burden under this requirement for the 12 same reason it has failed to meet its burden of pleading materiality with paricularity - namely 13 the SEC has totaly failed to identify even a single person who made an investment decision in 14 connection with the receipt of any of the (unspecified) statements about which the governent 15 complains. Indeed, given that the allegedly false statements in this case were supposedly 16 (somewhere) withi the statements that went to actual investors, the only way they could be in 17 connection with the purchase or sale of a securty is if someone put money into the fund based on 18 such a statement. But, again, the SEC' s simply has not identified a single specific instace in 19 which ths supposedly happened. 20 Indeed, even if the SEC were to identify the people who purortedly invested afer 21 taking to existing investors, and specified the contents of the conversations between them, the 22 allegations would stil be inadequate because any allegedly false statement in that conversation 23 was not made by Mr. Trabulse. In other words, the SEC's theory here appears to be that Mr. 24 Trabulse can be liable for makng a material misstatement in connection with the purchase or 25 sale of a sec~ty, even if he did not make the statement, or exercise control over what was said. 26 The case law does not support such an expansive reading of the securties law. As the Supreme 27 28 404602.07 2000-2006. See Roberts DecL, Ex. 4 (Dow Jones Industrial Average anual retus report). 12 DEF.'S NTC. OF MTN., MTN. TO DISMISS I SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07~4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 16 of 30 1 Cour has put it, the statute "must not be constred so broadly as to convert every common-law 2 fraud that happens to involve securties into a violation of § 1 O(b )." SEC v. Zandford, 535 U.S. 3 813,820 (2002). Thus, even if the SEC were to say which investors allegedly invested based on 4 which alleged misstatements, it might very well fail to satisfy the connectivity requirement. But, 5 as pleaded, we canot know-which is precisely why the Complaint violates Rule 9(b). 6 B. The SEC's Investment Advisers Act claim also lacks the necessary particularity. 7 The SEC's third cause of action - for violating § 206 of the Investment Advisers Actl3_ 8 also fails under Rule 9(b). The "Advisers Act § 206 prohibits advisers from, directly or 9 indirectly, employing a scheme to defraud clients or engaging in practices which operate as a 10 fraud upon clients." Vernazza v. SEC, 327 F.3d 851,858 (9th Cir. 2003) (citing 15 U.S.C. § 11 80b-6(1)-(2)). Specifically, to successfully plead a cause of action under section 206(1), the SEC 12 must allege with paricularty that: (1) Mr. Trabulse was an investment adviser; (2) he utilzed 13 the mails or instrentalities of interstate commerce to employ a device, scheme or artifice; 14 (3) the device, scheme or arifice violated Mr. Trabluse's fiduciary duty to his clients; and 15 (4) Mr. Trabluse acted with scienter. See SEC v. Merril Scott & Associates, Ltd., 505 F. Supp. 16 2d 1993,2005 (D. Utah 2007) (listing elements of the claim); SEC v. Rauscher Pierce Refines, 17 Inc., 17 F. Supp. 2d 985,988-90 (D. Arz. 1998) (applying Rule 9(b)'s paricularty requirements 18 to the claims under Section 206).14 19 Importantly, the only allegations that can form a basis for a claim under ths section are 20 allegations regarding conduct directed towards the Fund and not conduct or statements directed 21 to the Fund's investors. This is because the SEC must allege a breach of fiduciar duty to state a 22 viable cause of action, and because the only fiduciary duties a hedge fud general parer has are 23 those he owes to the Fund itself. Indeed, ths precise question was addressed in Goldstein v. 24 SEC, 451 F.3d 873 (D.C. Cir. 2006). In that case, the Cour of Appeals invalidated the SEC's 25 "hedge fud rue" and held that hedge fud general parers, under the Advisers Act, owe 26 27 28 13 15 U.S.C. § 80b-6(1) and (2). 14 The same elements apply for Section 206(2), except that the SEC need not allege scienter. Id. 13 DEF.'S NTC. OF MTN., MTN. TO DISMISS isi. 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 17 of 30 1 "fiduciary duties only to the fud, notto the fud's investors." Id. at 881 (emphasis added). 2 The SEC has made only one set of allegations that could form a basis for its Investment 3 Advisors Act claim - namely the allegations contaied in paragraphs 22 though 27 ofthe 4 Complait. Generally speakng, these paragraphs allege that Mr. Trabluse violated his duties to 5 the Fund by failing to maintain accurate accounting records, by failng to segregate his assets and 6 by using Fund assets for personal expenses. See Complt. ~~ 22-27. But these allegations are not 7 sufficient. 8 First, the allegation that Mr. Trabulse "failed to maintain accurate accounting records" 9 appears only in paragraph 26, and with no more detail than what was just quoted. Thus, ths 10 statement canot satisfy the paricularty requirements of Rule 9(b). See Glen Holly, 100 F. 11 Supp. 2d at 1094 (holding that "a complaint must specify such facts as the times, dates, places, 12 and benefits received, and other details of the alleged fraudulent activity" in order to meet the 13 Rule 9(b) stadard). 14 Second, the allegation that Mr. Trabulse failed to segregate his personal expenses from 15 those of the Fund canot form a basis for the Investment Advisors Act claim because Mr. 16 Trabulse had no duty to distinguish between personal expenses and Fund expenses. As noted at 17 the outset, the Parnership Agreement that governs the operation of the Fund requires Trabulse to 18 pay for all Fund expenses from the 25% of the Fund's profits that make up his personal 19 compensation. See Roberts Decl., Ex. 1 (Parership Agreement) at §§ 5.14, 6.06.1S From the 20 perspective of the Fund, it makes no difference at all how or for what purose Mr. Trabulse 21 withdraws money from the fud, or how he characterizes the expenditue. At the end of the day, 22 is Even on a motion to dismiss, the Cour can tae judicial notice of a document which, like this 23 agreement, is referenced in the Complaint. See Fed. R. Evid. 201; Branch v. Tunnell, 14 F.3d 449,454 (9th Cir. 1994), overruled on other grounds by Galbraith v. County of Santa Clara, 307 24 F.3d 1119 (9th Cir. 2002) ("documents whose contents are alleged in a complaint and whose authenticity no pary questions, but which are not physically attched to the pleading, may be 25 considered in ruling on a Rule 12(b)(6) motion to dismiss."). When ruling on a motion to dismiss, the cour may consider the facts alleged in the complaint, documents attched to the 26 complait, documents relied upon but not attched to the complaint when authenticity is not contested, and matters of which the cour taes judicial notice. See Parrino v. FHP, Inc., 146 27 F.3d 699, 705-06 (9th Cir. 1998) (superseded by statute on other grounds). The arguents in support of the Cour's taking judicial notice of the Parnership Agreement is included in Mr. 28 14 DEF.'S NTC. OFMTN., MTN. TO DISMISS ISI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINTE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 18 of 30 1 Mr. Trabulse's fiduciar obligation to the Fund is to withdraw no more than 25% of the Fund's 2 profits-from which he must both tae his own compensation and pay the Fund's expenses. 3 Whle ths is, admittedly, an innovative arangement, it is designed to and does 4 substantially benefit the Fund's investors. Under the Fund's governance structue the investors 5 do not need to worry about whether the Fund manager is minmizing expenses or whether there 6 are any hidden fees. Thus, for example, when Mr. Trabulse rents a car, the investors need not 7 worry or keep track of how much of the time he is using it for business puroses. Similarly, 8 neither the investors nor the Fund need be concerned about whether, when Mr. Trabulse flies 9 first class to Pars, he is really incurng a business expense or takng a vacation. The Fund's 10 governance strctue avoids all of those questions by treating business expenses and personal 11 expenses as the same with respect to the Fund's capital, and requiring, instead, that all expenses 12 (business expenses and personal compensation) together be restricted to 25% of the Fund's 13 operating profits. 14 Because of ths strctue, the allegation that Mr. Trabulse "mislabeled" personal expenses 15 as business expenses canot constitute a breach of Mr. Trabulse's duties to the Fund. For 16 example, in paragraph 24, the SEC alleges that Mr. Trabulse wired $500,000 to an account in 17 France and spent the money for personal expenses, while simultaeously recording the wire 18 transfer as being for "business expenses." See Complt. ~ 24. But, so what? From the Fund's 19 perspective nothing tus on how the transaction was described-the only thing that matters is 20 whether Mr. Trabulse withdrew more or less than 25% of the Fund's profits. To put it another 21 way, under the Parership Agreement, Mr. Trabulse was required to pay business expenses out 22 of his personal stae in the Fund's profits. Thus, Mr. Trabulse's alleged failure to clearly 23 delineate what was a personal expense and what was a business expense canot constitute a 24 breach of his fiduciar duty to the Fund and, therefore, canot form a basis for a claim under 25 §206 of the Investment Advisors Act. 26 Third, the allegation that Mr. Trabulse misused Fund assets fails for the same reason. As 27 28 404602.07 Trabulse's Request for Judicial Notice, filed concurently with ths motion to dismiss. 15 DEF.'S NTC. OF MTN., MTN. TO DISMISS isi. 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 19 of 30 1 noted previously, the only way to determine whether or not Mr. Trabulse misused Fund assets 2 for personal puroses is to look at the total profits of the Fund and the total amount of money 3 that Mr. Trabulse withdrew for business and personal expenses combined. Lookig at individual 4 expenses--r the accounts from which those expenses were paid-tells you nothing because Mr. 5 Trabulse had a right to use up to 25% of the Fund's profits to pay personal expenses. 6 Yet, the SEC seems unwilling or unable to understand this fudamental point. Thus, 7 instead of alleging anything about how much the Fund made in profits or how much of those 8 profits Mr. Trabulse used for the combination of business expenses and personal compensation, 9 the SEC makes a series of flamboyant and irrelevant allegations about conspicuous personal 10 spending. For example, the SEC alleges that Mr. Trabulse "used Fahey Fund ban accounts to 11 pay for a wide varety of personal, and unauthorized, expenses." Complt. at ~ 22. Ths statement 12 is both misleading and irrelevant. First, the SEC's use of the word "unauthorized" is just 13 grandstading. There is no clause in the Parnership Agreement regarding what expenses are 14 authorized or unauthorized. There is no' requirement that Mr. Trabulse record exactly what he 15 did with his 25% of the net profits. And it is irrelevant to the health of the Fund whether Mr. 16 Trabulse used his share of the profits to pay his ex-wife's mortgage, see id. ~ 23, or whether he 17 allowed his daughter to draw on the account using a debit card, see id. ~ 25. Mr. Trabulse's 18 fiduciary duty was, instead, only to ru the Fund without spending more than 25% of its profits 19 on the combination of business and personal expenses. 20 The only time the SEC says anything about totals is in paragraph 22, where it nakedly 21 alleges that Mr. Trabulse spent "more than he was entitled to under the terms of the Fund's 22 limited parership agreement." Id. ~ 22. But the SEC fails to provide any paricularzed 23 allegation regarding what the profits of the Fund were, what 25% of that amount would have 24 been at any moment in time, what amount Mr. Trabulse withdrew from the Fund and over what 25 period, how that amount exceeded his 25% share, or any paricularzed facts whatsoever to guide 26 Mr. Trabulse in responding to the Complaint. See Kaplan v. Rose, 49 F.3d 1363, 1370 (9th Cir. 27 1994) ("(A) pleading is suffcient under Rule 9(b) if it identifies the circumstances of the alleged 28 16 DEF.'S NTC. OF MTN., MTN. TO DISMISS isi. 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 20 of 30 1 fraud so that the defendant can prepare an adequate answer."). 2 Indeed, from (1) the SEC's exclusive reliance on the Fund's brokerage accounts; (2) the 3 fact that the SEC has ignored the value of the Fund's numerous other investments; and (3) the 4 fact that the SEC has ignored the impact of distributions and new investments in its 5 "calculations" of the Fund's profitability - it appears that the SEC did not conduct an adequate 6 prefiling investigation and therefore does not know what the fud was worth over time. In other 7 words, the reason the SEC has not alleged either the Fund's profits nor that the combination of 8 Mr. Trabulse's business and personal expenditues was more than 25% of those profits is 9 because the SEe does not know if it is true. In a word, the SEC is just guessing - which it 10 plainly is not permitted to do under 9(b). 11 C. The Court should, at a minimum, require a more definite statement of the charges. 12 In the alternative to his motion to dismiss under Rule 12(b)(6), Mr. Trabulse moves under 13 Rule 12(e), for a more definite statement. See Fed. R. Civ. P. 12(e). All of the defects in the 14 allegations of the Complaint, discussed above, have created a pleading that is "so vague or 15 ambiguous that (Mr. Trabulse) canot reasonably be required to frame a responsive pleading." 16 Id. Thus, for example, as the Complaint is curently strctued, Mr. Trabulse canot tell which 17 of the various allegations are alleged to constitute a violation of each cause of action. 18 Under Rule 12(e) the defendant may move for an order requiring a more definite 19 statement by pointing out "the defects complained of and the detals desired." Id. Mr. Trabulse 20 hereby incorporates all of the arguents lodged above, in support of his motion to dismiss and 21 requests a more definite statement on all the defects complained of and the detals that are 22 missing from the Complaint. 23 As numerous cours in the Ninth Circuit and tIs District have held, responding to a 24 complaint is nota treasure hunt and defendants are not required to excavate the allegedly false 25 statements from amongst a mass of allegations. See In re GlenFed Sec. Litig., 42 F.3d 1541, 26 1554 (9th Cir. 1994) (en banc) ("A complaint is not a puzzle. . . and we are loathe to allow 27 plaintiffs to tax defendants. . . with the burden of solving puzzles in addition to the burden of 28 404602.07 17 DEF.'S NTC. OF MTN., MTN. TO DISMISS I si. 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 21 of 30 1 formulating an answer to their complaint"); see also Wenger v. Lumisys, 2 F. Supp. 2d 1231, 2 1243-44 (N.D. Cal. 1998) (dismissing complaint where "(p)laintiffmerely thows the statements 3 and the alleged 'tre facts' together in an undifferentiated clump and apparently expects the 4 reader to sort out and pair each statement with a supposedly relevant 'true fact.' The predictable 5 demands of reviewing such a complaint abuse judicial resources."). Here, the Complaint 6 generally refers to varous alleged misrepresentations made over the course of eight years. But 7 the Complaint nowhere explains how these allegations fit together to form a cognizable legal 8 claim. 9 Accordingly, in the event that the Cour denies his motion to dismiss, Mr. Trabulse 10 requests that the Cour grant his motion for a more definite statement. 11 iv. CONCLUSION 12 The SEC has extraordinar investigative powers. Using those powers in ths case it 13 deposed literally dozens of witnesses, and reviewed hundreds if not thousands of documents 14 prior to filing suit. Yet, despite all of that apparent activity, the SEC has failed to plead a 15 cognzable theory of this case. The SEC has utterly failed to allege specific facts about how 16 much money the Fund made, or how much Mr. Trabluse allegedly spent on the combination of 17 business and personal expenses. Instead, it chose to attack Mr. Trabluse personally - accusing 18 him of lavish personal spending without in any way indicating how that spending supports a 19 conclusion that he violated a duty to the Fund. 20 Elsewhere, the Complaint gestues broadly towards allegedly false documents without 21 specifying the statements within those documents that are alleged to be false, alleges falsity 22 based on inference that are demonstrably incorrect, if not downght sily, and have utterly fails 23 to identify anyone who did anything based on those undentified statements. For these reasons, 24 / / / 25 / / / 26 27 28 18 DEF.'S NTC. OF MTN., MTN. TO DISMISS I si. 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH404602.07 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 22 of 30 1 and for all the reasons set forth above, the first though thrd causes of action should be 2 dismissed. 3 4 Dated: November 1,2007 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 404602.07 KEKER & VAN NEST, LLP By: sf Clement S. Roberts CLEMENT S. ROBERTS Attorneys for Defendants ALEXANDER JAMES TRAULSE, FAHEY FUND, L.P., FAHEY FINANCIAL GROUP, INC., INTERNATIONAL TRAE & DATA, and ITD TRAING 19 DEF.'S NTC. OF MTN., MTN. TO DISMISS I SI, 2ND & 3KU CAUSES OF ACTION OR, IN THE ALT., FOR MORE DEFINITE STATEMENT; AND SUPPORTING MEMORANDUM OF POINTS AND AUTH. CASE NO. C-07-4975 WH Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 23 of 30 EXHIBIT A Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 24 of 30 EXHIBIT A Aile ations Trabulse operated Fahey Fund, L.P. and Fahey 12. Financial Group, Inc. as a single hedge fund (collectively, "Fahey Fund"). In 1998, Fahey Fund had approximately 11 investors. By the end of 2006, the fund had grown to more than 100 investors. Trabulse described the fund to investors in oral conversations and written materials as a conservative fund that invested in financial instruments like stocks, options, derivatives, futures, indexes, and foreign currency. Since its inception, Fahey Fund has collected at least $10 million from investors. At the end of each calendar quarter, Trabulse 13. prepared and sent to investors an account statement that purported to account for the changes in an investor's account balance from one quarter to the next. The statements purported to identify each investor's beginning balance, gains and/or losses earned during the period, and ending balance. Typically, the account statements were accompanied by a newsletter prepared and signed by Trabulse that summarized the fund's performance during the quarter and described current market conditions and what he expected markets to do in u coming quarters. The quarterly account statements Trabulse sent to 14. investors were materially false and misleading. They bore no relation to the fund's actual performance during the quarter. For example, in the second quarter of2005, Trabulse reported to investors collective gains of approximately $2.5 million. In reality, the fund realized a net loss in its brokerage accounts of more than $200,000. Moreover, Trabulse fraudulently reported to investors during the period from 1998 through 2006 that they collectively earned gains totaling approximately $30 milion, based on investments in stocks, derivatives, and foreign 405531.01 Deficienc This paragraph alleges background facts and does not allege that any of the statements referenced therein are false. This paragraph describes (in general) a hoast ofvergited material including account statements and newsletters. No specific statements are identified or alleged to be false. This allegation does not identify any specific statement but points to an undifferentiated mass of materials that spanned many years. The value of one component of the Fund does not render false a statement about the Fund's overall value. ¡. This allegation suffers from both of the problems identifed above - no specific statement is identified and the assertion fails as a matter of logicaL. Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 25 of 30 currency. However, the fund's brokerage account records show the fund's profits during this time were less than $10 million. Similarly, Trabulse also overstated the funds' This allegation does not identify any 15. assets in the quarterly statements he sent to specific statement but points to an investors. undifferentiated mass of materials that spanned many years. As of December 3 1,2006, Trabulse reported to The value of one component of the Fund investors that their collective assets, which were (the brokerage accounts) does not render composed of investor contributions and gains false a statement about the Fund's overall purportedly earned on investments in stocks, value. derivatives, and foreign currency, totaled more than $45 milion. In reality, the fund's brokerage account records and bank statements show the fund's value was less than $13 million. Trabulse used the false and misleading account This allegation does not identify who the . 16. statements to encourage existing investors to new investors were, what was said to them, recruit new investors and increase their own who said it to them, or when those investments in Fahey Fund. Indeed, many conversations took place. investors decided to invest in Fahey Fund because they heard from friends or colleagues already invested in the fund that the fund achieved spectacular returns. Trabulse also touted the fund's positive performance when soliciting new investors. Trabulse gave certain prospective investors a list This allegation does not identify who 17. of existing investors who would act as received the alleged list nor who was on it. references. The investors identified as references had This allegation rests upon the SEC's flawed received materially false and misleading assertion that the account statements were account statements with grossly overstated false as noted above. The value of one profits and account balances. component ofthe fund does not render false a statement about the Fund's overall value. One investor, who with his wife invested more This allegation does not identify the than $2 milion in 2006, called several of the investor, who he spoke with, what was said individuals on the list before investing and or what alleged misstatemens he relied on. based his investment, in part, on material misstatements about the fund's performance. In addition, certain investors made multiple This allegation does not identify which contributions into the fund based on the false investors made these contrabutions, when and misleading representations about the fund's the statements or contrabutions were made, 405531.01 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 26 of 30 performance in the account statements they or which statements they allegedly relied received from Trabulse. on. In addition this allegation rests upon the SEC's flawed assertion that the account statements were false as noted above. Trabulse knew or was reckless in not knowing No identification of a materially false and 18. that the account statements provided to investors misleading statement. were false and misleading. Trabulse prepared and disseminated to investors This is simply a conclusory allegation and 19. other materials containing materially false and does not identify any statements. misleading claims about the fund's performance, all designed to increase the money he managed or to solicit investments from the general public. For example, he prepared and sent to some This allegation does not identify either the 20. prospective investors documents containing documents or the alleged charts that they charts which depicted the fund's value as supposedly contained. The allegation also steadily increasing, or holding steady, each does not say which prospective investors quarter beginning in the fourth quarter of 1997 received the "charts" and nothing in this and continuing through the second quarter of paragraph or any other says that those 2002. unnamed investors relied on the charts. Similarly, from approximately April 1999 until The SEe does not specify which "charts" it 2007, Fahey Fund maintained a website at is referring to on the website. Instead it just "www.faheyfund.com" that contained refers to unspecified charts that are alleged materially false and misleading information. to have been posted on the Fund's website The website purported to describe Trabulse's at some (unspecified) time over an eight investment strategy and contained various charts year period. which depicted the fund's profits as consistently positive (or flat) each quarter beginning in the fourth quarter of 1997 and continuing through the second quarter of2004. These charts sent to prospective investors and This allegation rests upon the same logical on the fund's website were materially false and falicy reflected in the SEC's assertion about misleading. In reality, the fund's brokerage the account statements. Again, the value of account records. show the fund realized losses one component of the fund (i.e. the in 1998,2000 and 2003. brokerage accounts) does not render false a statement about the Fund's overall value. Trabulse knew or was reckless in not knowing This is simply a conclusory allegation and 21. that the materials he disseminated to investors does not identify any statements. were false and misleading. 405531.01 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 27 of 30 Trabulse used Fahey Fund bank accounts to pay No identification of what he was entitled to 22. for a wide variety of personal, and unauthorized, spend under the terms of the fund's limited expenses. As of the years ended December 3 i, partnership agreement or what he actually 2004, December 31, 2005, December 31, 2006, spent. and the three months ended March 31, 2007, Trabulse misappropriated fund assets by No statement or explanation of how or why spending more than he was entitled to under the the alleged behavior is alleged to violate his terms of the fund's limited partnership duty to the Fund. agreement. For example, he transferred over $650,000 to his No identification of what he was entitled to 23. now ex-wife's bank accounts that she spent on spend under the terms of the fund's limited living expenses, a shopping allowance in Paris, partnership agreement or what he actually France, and to pay her home mortgage after they spent. separated. He also used the fund's bank accounts to buy her a home theater system No statement or explanation of how or why costing in excess of $25,000. Moreover, he the alleged behavior is alleged to violate his used the fund's bank accounts to purchase for duty to the Fund. her several rugs that she currently uses in her home. In addition, Trabulse transferred more than No identification of what he was entitled to 24. $500,000 to an overseas bank account spend under the terms of the fund's limited maintained in his personal name (not the fund's partnership agreement or what he actually name) in Paris, France. He described certain of spent. these transfers in the fund's books and records as for "Paris Business Expenses." Yet, after he No statement or explanation of how or why transferred the money, Trabulse used his Paris the alleged behavior is alleged to violate his bank account to pay for personal expenses here duty to the Fund. in the United States, including groceries, meals and clothes. Trabulse also transferred from the fund's bank accounts over $400,000 to third parties not related to the business of the fund. Trabulse also allowed his daughter to use a debit No identification of what he was entitled to 25. card linked to one of Fahey Fund's bank spend under the terms of the fund's limited accounts to buy furniture, airline tickets, and to partnership agreement or what he actually pay for her 2007 honeymoon in Panama. In spent. addition, Trabulse used the fund's bank accounts to purchase for his daughter several No statement or explanation of how or why pieces of jewelry that she currently keeps in her the alleged behavior is alleged to violate his home. duty to the Fund. Trabulse routinely transferred money between No identification of what he was entitled to 26. Fahey Fund, L.P., Fahey Financial .Group, Inc., spend under the terms ofthe fund's limited International Trade & Data, and ITD Trading, partnership agreement or what he actually and authorized the withdrawal of money from spent. all entities for improper purposes. Trabulse failed to segregate his own assets from those of No statement or explanation of how or why the fund and failed to maintain accurate the alleged behavior is alleged to violate his 405531.01 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 28 of 30 accounting records, thus violating his fiduciary duty to the Fund. duties to the fund. Trabulse knew, or was reckless in not knowing, No identification of what he was entitled to 27. that he was misappropriating funds by spending spend under the terms of the fund's limited more than he was entitled to. partnership agreement or what he actually spent. Trabulse told investors, in both verbal and The allegations in this paragraph are in 28. written communications, that Fahey Fund direct conflct with the express terms ofthe invested financial instruments like stocks, Fund's limited partnership agreement and options, derivatives, futures and foreign must therefore be rejected. currency. In reality, Trabulse used a significant portion of investor money to purchase items that This allegation cannot support the fourth he and his family used, including gems and cause of action which requires a breach of other jewelry, real property, and rugs. Trabulse duty to the Fund and not conduct directed at even used investor money to fund a start-up the investors. golf company and purchase a BMW forthe golf company's owner. This allegation cannot support the first or second causes of action because it does not identify any specific statement, or provide any allegation that would support material ity. Trabulse failed to tell investors before they The allegations in this paragraph are in 29. invested money that Fahey Fund invested, or direct conflict with the express terms ofthe planned to invest in, such iliquid items, some Fund's limited partnership agreement and of which were used for personal consumption, must therefore be rejected. including real estate, jewelry, and rugs. He also concealed these purchases from investors by This allegation cannot support the fourth failing to identify them in account statements or cause of action which requires a breach of elsewhere in materials provided to investors. duty to the Fund and not conduct directed at the investors. This allegation cannot support the first or second causes of action because it does not identify any specific statement or omission, or provide any allegation that would support material ity. In addition, the SEC has identified nothing that would require Mr. Trabulse to notifY investors of the particularities of the Fund's holdings. Trabulse also gave several of the items The Court can take judicial notice of the 30. purchased with the fund's money to members of Fact that Trabulse was entitled to take as 405531.01 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 29 of 30 his family: telling them the items were theirs to compensation up to 25% ofthe Fund's keep. Trabulse did not inform investors that he profits. The SEe has not identified used investor funds to purchase jewelry and anything that would prevent him from rugs for his family. taking these profits by using Fund capital to buy physical items for his family. Noting in this allegation idetifies what he was entited to spend under the terms ofthe Fund's limited partnership agreement or what he actually spent. Trabulse knew, or was reckless in not knowing, This allegation cannot support the fourth 31. that he failed to accurately disclose how he used cause of action which requires a breach of investor money. duty to the Fund and not conduct directed at the investors. This allegation cannot support the first or second causes of action because it does not identify any specific statement or omission, or provide any allegation that would support materiality. 405531.01 Case 3:07-cv-04975-WHA Document 36 Filed 11/01/2007 Page 30 of 30