Rosenbach v Diversified Group, Inc.

[*1] Rosenbach v Diversified Group, Inc. 2006 NY Slip Op 50856(U) [12 Misc 3d 1152(A)] Decided on May 10, 2006 Supreme Court, New York County Moskowitz, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on May 10, 2006
Supreme Court, New York County

Gary Rosenbach, Susan Rosenbach, Raj Rajaratnam, and Asha Pabla Rajaratnam, Plaintiffs,

against

Diversified Group, Inc., a Delaware corporation, KPMG, LLP, a Delaware limited liability partnership, James Haber and John Schrier, Defendants.



602463/2005

Karla Moskowitz, J.

In motion sequence number 001, this court granted the request of defendant Diversified Group, Inc. (DGI) to stay these proceedings and compel arbitration (See Transcript of Proceedings dated December 1, 2005 [Tr.] Pg.12). In motion sequence 002, defendant KPMG, LLP (KPMG) moved and in motion sequence 003, defendant John Schrier (Schrier) also moved, pursuant to CPLR 7503, to stay these proceedings and compel arbitration. However, I denied these requests on the record (See Tr. Pgs. 30-32). I took on submission the alternative request of defendants KPMG and Schrier to dismiss the complaint pursuant to CPLR 3211 (a) (5) [statute of limitations] and CPLR 3211 (a) (7) [failure to state a claim]. Accordingly, this decision addresses only those parts of the motions of defendants KPMG and Schrier that seek dismissal of the complaint on those grounds.

The complaint alleges claims against KPMG and Schrier for fraud (count I), conspiracy to commit fraud (count II), aiding and abetting fraud (count III), negligent misrepresentation (count IV), breach of fiduciary duty (count V), violation of General Business Law § 349 (count VI), violation of General Business Law § 350 (count VII), promissory estoppel (count VIII), unjust enrichment/constructive trust (count IX), and fraudulent inducement (count X).

Plaintiffs allege that, defendants marketed, promoted and sold what defendants represented was a legitimate low-risk investment strategy but really was an illegal tax shelter. The tax shelter involved a series of purchases and sales of offsetting options called the Option Partnership Strategy or "OPS".

Plaintiffs allege that, in 1999, defendants Diversified Group, Inc. (DGI), its president James Haber (collectively, the DGI Defendants), KPMG and Schrier steered plaintiffs into the OPS. KPMG allegedly conspired with the DGI Defendants to induce plaintiffs to participate in the OPS transaction through AD FX Global Fund LLC (ADFX), a limited liability corporation that the DGI Defendants established.

To carry out the OPS transaction through ADFX, on September 29, 1999, DGI and [*2]Galleon Management, L.P. (Galleon) entered into the Operating Agreement of ADFX Global Fund LLC (the Operating Agreement). Galleon was a limited partnership whose general partners were plaintiffs Gary Rosenbach and Raj Rajaratnam. According to the Operating Agreement, the parties formed ADFX: to acquire, own, invest in, sell, assign, transfer and trade United States and foreign currencies, futures contracts relating to currencies and other options and related contracts and obligations, including put options, call options, repurchase agreements and other similar securities ...

(Operating Agreement, ¶ 2.4).

According to the complaint, in 1997, KPMG, one of the four largest accounting firms in the United States, began to enter into joint venture alliances with investment firms such as DGI and law firms in order to develop and market a series of generic tax shelter products to high-net-worth individuals. Plaintiffs allege that KPMG usually did not bill its clients for any services that it provided, but rather it received commissions from DGI based upon KPMG's level of responsibility in generating sales.

Plaintiffs maintain that KPMG acted as DGI's sales force in marketing and promoting the OPS tax shelter strategy. According to plaintiffs, DGI devised the strategy, but needed the services of a prominent accounting firm such as KPMG to assist in marketing. Plaintiffs assert that defendant Schrier was a tax attorney working at KPMG in 1999 when he targeted plaintiffs as potential participants in the OPS strategy. Plaintiffs state that Schrier repeatedly assured them that the strategy was legal and would generate large tax savings. Plaintiffs maintain that Schrier guaranteed them that there was no possibility the IRS would assess penalties against them, even in the unlikely event of an audit.

Plaintiffs explain that, once they agreed to participate in the OPS strategy, Schrier instructed them about the mechanics of the strategy and advised them to carry out certain put and call option transactions in foreign currencies. Defendants then advised plaintiffs as to how to dispose of their option positions in order to generate losses for tax purposes. Plaintiffs state that they paid $2 million to DGI for investment advisory services, but that DGI split this fee with KPMG on a commission or finder's fee basis.

In October 2004, the IRS notified plaintiffs that they had participated in an illegal tax shelter. In January 2005, plaintiffs settled the IRS's claims, sustaining over $15 million in losses, allegedly because of defendants' fraudulent misrepresentations.

Plaintiffs point out that 17 former KPMG executives have been indicted in connection with KPMG's tax shelter activities. Plaintiffs state that, to avoid being indicted as a firm, KPMG admitted to certain unlawful and fraudulent conduct of former KPMG partners, agreed to a deferred prosecution agreement, agreed to eliminate its tax shelter practice and agreed to pay $456 million in fines, penalties and restitution to the federal government.

In this motion, KPMG argues that this court should dismiss counts one through five and ten because they are time-barred and that counts six through nine fail to state a claim. KPMG argues that, although plaintiffs did not denominate any claim against KPMG as accounting malpractice, in essence the complaint alleges only accounting malpractice against KPMG. According to KPMG, plaintiffs did not label any cause of action this way, so as to avoid the three-year accounting malpractice statute of limitations in CPLR 214 (6). KPMG argues that, as [*3]a matter of law, what KPMG refers to as "the tort causes of action" in the complaint (counts one through five and ten) merge into an accounting malpractice cause of action, and are, therefore, similarly time-barred.

KPMG states that, in order to allege accounting malpractice, a plaintiff must plead that a defendant departed from accepted standards of practice and that this departure proximately caused injury. The cause of action accrues when the client receives the work product from the accountant. KPMG points out that plaintiffs do not allege that KPMG delivered any work product, performed any service for them or made any representation to them after 1999. Plaintiffs filed the complaint on July 7, 2005. Thus, KPMG argues that the accounting malpractice claim is time-barred.

KPMG argues that the sixth and seventh causes of action, for violations of GBL §§ 349 and 350 respectively, fail as a matter of law because the conduct in question is not consumer-oriented and because a tax strategy is not actionable under GBL § 349. According to KPMG, section 350 similarly does not apply to the OPS tax strategy.

KPMG asserts that this court must also dismiss the eighth cause of action, for promissory estoppel, because the complaint contains only a single, conclusory allegation that plaintiffs suffered "unconscionable" injury. In addition, KPMG argues that the ninth cause of action, sounding in unjust enrichment, also fails to state a claim, because plaintiffs cannot maintain an equitable cause of action for unjust enrichment when they have an adequate remedy at law. Finally, KPMG asserts that the court should strike plaintiffs' demand for the interest that they allegedly paid to the IRS, because such interest is not recoverable under New York law.

In motion sequence 003, Schrier, who states that he is a former partner at KPMG, moves to dismiss the complaint, also pursuant to CPLR 3211 (a) (5) and (7). Schrier states that plaintiffs are sophisticated business people who regularly engage in high-value, complex transactions worth billions of dollars, who sought to avoid paying tens of millions of dollars worth of taxes through an elaborate tax shelter. According to Schrier, after the scheme ultimately failed and plaintiffs had to pay taxes, interest and penalties to the IRS, plaintiffs sought to cut their losses by shifting responsibility for the tax shelter's failure onto the defendants. Schrier adopts and incorporates KPMG's legal arguments.

Plaintiffs disagree with KPMG's argument that the tort claims in the complaint are time-barred because they merge into an accounting malpractice claim. According to plaintiffs, the law does not support defendants' attempt to merge and dismiss the tort claims. Plaintiffs assert that KPMG's other arguments for dismissal are also flawed because KPMG again attempts to recast the complaint and draw inferences from that recasting that are impermissible at this stage in the proceedings. Plaintiffs then argue that their claims are not predicated upon accounting malpractice, so that the three-year statute of limitations does not apply.

Plaintiffs argue that their fraud claims do not merge into a single malpractice claim. They argue that malpractice is a negligence-based theory of liability that requires factual circumstances, duties, and conduct specific to the cause of action that are not present here. They state that there is no authority in New York for merging otherwise legally sufficient causes of action premised upon intentional or fraudulent conduct into a single malpractice claim for purposes of the statute of limitations. Plaintiffs also challenge defendants' arguments concerning the GBL, promissory estoppel, unjust enrichment and interest paid to the IRS.

Discussion[*4]

Defendants argue the statute of limitations bars counts I-V and X because: (1) although plaintiffs have been very careful not to assert an accounting malpractice claim, accounting malpractice is the essence of their claims, (2) the tort and equitable causes of action merge into the accounting malpractice claim and (3) accounting malpractice is time barred.

I. Applicable Statute of Limitations

Plaintiffs argue that their claims are not, in essence, professional malpractice claims. They assert, however, that even if their claims were professional malpractice claims, the six-year breach of contract statute of limitations would apply. This argument is not persuasive. Plaintiffs did not bring a claim labeled as either accounting malpractice or breach of contract. While defendants can attempt to argue that certain claims have been incorrectly labeled, plaintiffs cannot respond in an effort to circumvent a shorter statute of limitations by arguing that their claims are actually breach of contract claims, when it is plaintiffs who drafted the complaint and chose not to include any breach of contract claim. The cases that plaintiffs cite to, indicating that, in certain instances, a malpractice claim could "theoretically also rest on breach of contract to obtain a particular bargained-for result" (Chase Scientific Research, Inc. v NIA Group, Inc., 96 NY2d 20, 25 [2001]) are cases in which the plaintiffs specifically designated a cause of action sounding in breach of contract. The issue before the courts in those cases was whether the breach of contract claim was duplicative of the professional malpractice claim. None of the cases plaintiffs cite resemble what is before this court, in which plaintiffs, in response to a defendants' attempt to re-label certain claims as accounting malpractice, thereafter attempt to themselves re-label those same claims as sounding in breach of contract. Thus, the breach of contract argument is not applicable in this case.

II. Negligent Misrepresentation

"[W]hen applying a Statute of Limitations, courts look to the essence of the stated claim and not the label by which a plaintiff chooses to identify it." (Meyer v Shearson Lehman Bros., Inc., 211 AD2d 541, 542 [1st Dept 1995], citing Brick v Cohn-Hall-Marx Co., 276 NY 259, 264 [1937]).

Although plaintiffs did not label any of the claims in the complaint as accounting malpractice, their negligent misrepresentation claim against KPMG and Schrier would be duplicative of that claim and would arise from the same alleged actions of the movants. Plaintiffs allege that the defendants breached their duty to act with skill and care in providing plaintiffs with investment, accounting, tax or legal advice related to the OPS (Complaint ¶¶ 115, 116, 123, 124). The claim, in essence, asserts that defendants provided poor advice to plaintiffs in matters related to the OPS tax strategy. These allegations are basically those of a malpractice action, and therefore, the negligent misrepresentation claim is untimely, based on the 3-year statute of limitations for malpractice claims. Thus, count IV is dismissed. (See Gaslow v KPMG LLP, Sup Ct, NY County, Feb. 24, 2005, Lowe, J., Index No. 600771/04, at 11-12, affd. to the extent appealed 19 AD3d 264 [1st Dept 2005]).

III. Fraud and Breach of Fiduciary Duty

However, plaintiffs' tort claims alleging intentional, fraudulent conduct, are not disguised accounting malpractice claims. The First Department has stated that a fraud action can remain "viable irrespective of whether some of the alleged acts and misrepresentations were mentioned in connection with the untimely causes of action sounding in professional malpractice." (Serio v PriceWaterhouseCoopers LLP, 9 AD3d 330, 331 [1st Dept 2004]). Therefore, the court declines [*5]to dismiss the first through third, fifth and tenth causes of action.

"The elements of a cause of action for fraud are a misrepresentation, that is material, known to be false and made with the intent of inducing reliance, upon which the victim actually relies and, as a result of which, sustains damages." (Ross v Louise Wise Servs., Inc., __ AD2d __, 812 NYS2d 325, 337 [1st Dept 2006]). A significant distinction between negligence-based claims and those based on theories of fraud is the element of scienter. In allegations in support of their first, second, third and tenth causes of action, plaintiffs plead scienter. Plaintiffs allege that Schrier, then an employee of KPMG, repeatedly assured them that the shelter was legal under the tax laws and that it would be fully supported by a legal opinion letter from a prominent law firm. Schrier guaranteed and repeatedly assured plaintiffs that this letter would eliminate any possibility that the IRS would assess penalties if plaintiffs were ever audited. (Complaint ¶ 35) . According to the complaint, Schrier assured plaintiffs that KPMG was backing and promoting the OPS shelter. (Id. ¶ 36).

Plaintiffs allege that defendants intentionally failed to register the OPS tax shelter with the IRS, because they knew that the IRS would not allow the tax shelter upon closer examination. Plaintiffs state that defendants "knew the only way to continue to successfully market the OPS strategy was to minimize the chance that the IRS would detect the scheme." (Complaint ¶ 67). Plaintiffs assert that defendants failed to inform plaintiffs of the fact that the IRS was likely to conclude that the tax strategy was improper and failed to inform plaintiffs about how the IRS would treat the transactions if it disallowed the tax strategy. (Id. ¶ 69).

To the extent plaintiffs premise their breach of fiduciary duty claim on intentional conduct, the same analysis would apply.

The allegations in the complaint are sufficient to satisfy the pleading requirements of CPLR 3016 (b), and they are also distinct from the elements of an accounting malpractice action. Thus, they do not duplicate the untimely malpractice claim.

IV. GBL §§ 349 and 350

However, the court dismisses the GBL §§ 349 and 350 claims. Although plaintiffs maintain that GBL § 349 and § 350 apply not only to consumer goods but to services as well, the statutes do not cover these types of services, i.e., investment advice relating to the buying, swapping and selling of various securities. (See Gray v Seaboard Sec., Inc., 14 AD3d 852 [3d Dept 2005]; Fesseha v TD Waterhouse Inv. Servs., Inc., 305 AD2d 268, 268 [1st Dept 2003]; Gaslow v KPMG LLP, supra , at 21-22). Thus, the court dismisses the sixth and seventh causes of action.

V. Promissory Estoppel

The court also dismisses the eighth cause of action for promissory estoppel. "This doctrine applies to a limited class of cases in which the person to whom the promise is made, in reliance upon the promise, has suffered unconscionable injury." (Tutak v Tutak, 123 AD2d 758, 760 [2d Dept 1986]). Plaintiffs allege only that they "sustained and suffered unconscionable injuries totaling over $15 million" (Complaint ¶ 142). These conclusory allegations do not plead unconscionable injury. Therefore, the court dismisses this claim. (See e.g., Long Island Pen Corp. v Shatsky Metal Stamping Co., Inc., 94 AD2d 788, 789 [2d Dept 1983] [finding that plaintiffs did not allege injuries "so egregious as to render unconscionable the assertion of the Statute of Frauds"]).

VI. Unjust Enrichment [*6]

As to the unjust enrichment claim, at this stage in the action, the court cannot determine whether or not plaintiffs have an adequate remedy at law, and therefore, the court declines to dismiss it. Pursuant to CPLR 3014, plaintiffs at this stage may plead alternative causes of action.

VII. Demand for Interest

Finally, the court strikes plaintiffs' demand for interest they allegedly paid to the IRS and state taxing authorities. Interest paid to the IRS is not recoverable under New York law, because these interest payments generally are not "damages suffered by plaintiff but rather [are] a payment to the IRS for his use of the money during the period of time when he was not entitled to it." (Alpert v Shea Gould Climenko & Casey, 160 AD2d 67, 72 [1st Dept 1990]). Thus, reimbursement of interest payments would place plaintiffs in a position better than they would have been had they not participated in the OPS tax shelter. (Gaslow v KPMG LLP, 19 AD3d 264 [1st Dept 2005]).

Accordingly, it is

ORDERED that the motions to dismiss, motion sequences 002 and 003, are granted in part, to the extent that the court dismisses the fourth, sixth, seventh and eighth causes of action of the complaint as against defendants KPMG, LLP and John Schrier; and strikes that part of the complaint that seeks damages for interest paid to the IRS and otherwise denies the motions; and it is further

ORDERED, the complaint is deemed amended accordingly; and it is further

ORDERED that the court directs defendants KPMG, LLP and John Schrier to serve answers to the complaint within 10 days after service of a copy of this order with notice of entry; and it is further

ORDERED that the parties shall attend a compliance conference on May 18, 2006 in Part 03, courtroom 248, 60 Centre Street, New York, NY, and refrain from further motion practice without conferencing the issues first in Part 03.

Dated: May __, 2006

ENTER:

J.S.C.