Opinion
No. X05 CV10-6008473S
September 13, 2011
MEMORANDUM OF DECISION ON THE DEFENDANT CALLAHAN'S MOTION TO STRIKE (#103)
Introduction
Before the court is the individual defendant's motion to strike a claim of professional negligence. It is a motion that hinges on whether or not a cognizable duty on the part of that defendant exists in these allegations. This litigation is part of the fallout from the enormous securities fraud perpetrated by Bernard L. Madoff and his firm, Bernard L. Madoff Investment Securities, LLC (Madoff). In December 2008, in connection with criminal charges for which he is currently incarcerated, Madoff admitted that he had orchestrated a massive Ponzi scheme. Essentially, Madoff admitted that funds which were entrusted to him were not actually invested, but, rather, were utilized to pay other investors' requests for the redemption of principal and profits, and to fund his extravagant lifestyle.
A Ponzi scheme has been described as "a pyramid scheme where earlier investors are paid from the investments of more recent investors, rather than from any underlying business concern, until the scheme ceases to attract new investors and the pyramid collapses." (Citation omitted.) Retirement Program for Employees v. Madoff, 130 Conn.App. 710, n. 3 (2011).
The plaintiff Orthopaedic Specialty Group, P.C. (OSG), is a Fairfield, Connecticut-based musculoskeletal medical practice that maintains a qualified retirement plan (Plan). The employees of OSG have participated in the Plan for more than twenty years. Other plaintiffs here include five doctors who are members of the OSG group practice and who also acted as trustees of the Plan during the relevant time frame. The individual defendant is Michael E. Callahan (Callahan), whose motion to strike is the subject of this memorandum of decision. Callahan is a pension professional with over thirty years of experience in the pension advisory field. During the time of these allegations, Callahan was the owner and President of the co-defendant Pentec, Inc. (Pentec), a Connecticut corporation which had been retained by the plaintiff trustees in connection with their management of the Plan.
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The Allegations
The allegations in the complaint may be summarized as follows: Starting in or about March 2003, the plaintiffs retained the defendants to provide comprehensive advisory and consulting services regarding the design, structure and ongoing administration of the Plan. During the course of their relationship, the defendants undertook to provide professional advice and guidance as to a wide array of pension-related topics for the Plan, including the issue of insurance coverage for the trustees. The plaintiffs claim that while the defendants advised the trustees as to their fiduciary obligations to the Plan and its participants, and offered to secure insurance coverage, the defendants never explained that the trustees could limit their personal exposure by securing fiduciary liability insurance coverage and/or changing the Plan to a self-directed structure pursuant to § 404(c) of the Employee Retirement Income Security Act of 1974, as amended, 29 U.S.C. § 1000 et seq. (ERISA).The plaintiffs claim that until approximately July 2009, the defendants continued to provide a wide array of pension advisory services to the plaintiffs. Throughout this more than six-year period from 2003 to 2009, the defendants met regularly with the trustees to discuss the design and operation of the Plan. The trustees relied on the defendants' advice and guidance, and the defendants were aware of this reliance. By way of background, for nearly twenty years prior to December 2008, OSG and the Plan's trustees had used Madoff's investment advisory services, and the defendants were fully aware of this. Through the trustees, the Plan participants had invested a total of $10,094,855.19 of their collective earnings with Madoff in order to fund their respective retirements. As of November 30, 2008, OSG's total Plan value, according to account statements issued by Madoff, was reported at over three times that principal amount at around $33 million. On or about December 12, 2008, the trustees learned that Madoff was under arrest for perpetrating a massive multi-billion dollar fraud on all of his investors, and that his firm had been taken over by federal regulators. The plaintiffs and the other Plan participants learned very soon thereafter that virtually all of the investment returns that Madoff had reported to them over the years were fabricated, and that all of the money OSG had invested in the Plan had been stolen.
The plaintiffs allege that shortly after the Madoff fraud came to light and the losses to the Plan became apparent, the defendants advised the plaintiffs that they should restructure the Plan. Among other recommendations, the Plan would become a program with participant-directed investments which were valued daily. Rather than having OSG doctors serve as Plan trustees, the plaintiffs also would hire an independent, institutional Plan trustee, one with a proven high quality fiduciary track record according to outside rating agencies. The defendants further recommended that the plaintiff trustees review their fidelity bond and fiduciary liability insurance policies.
The plaintiffs allege that the defendants were professionally negligent, and breached their duty to the plaintiffs to act in a professional and competent manner consistent with the applicable standard of care of a reasonably prudent pension advisor. This breach allegedly occurred when the defendants failed to advise the plaintiffs at any time during the approximately five and one-half years of their pension adviser relationship before the Madoff Ponzi came to light in December 2008 of certain options available to the plaintiffs. The plaintiffs could have chosen to modify the Plan structure to a participant-directed plan. Such a plan provides a broad array of investment options better suited to each individual participant's risk tolerance. Rather than having the Plan remain as a single investment account with Madoff, this change would also have allowed Plan participants to make their own investment decisions, rather than the trustees. The defendants also failed to advise the plaintiffs as to the risks inherent in keeping all of the Plan's assets invested in a single account with Madoff. The defendants further failed to advise the plaintiff trustees to obtain fiduciary liability insurance coverage in order to protect themselves from personal liability in connection with their administration of the Plan.
The complaint alleges that as a direct and proximate result of the defendants' negligent conduct, the plaintiffs are now subject to the claims of all OSG Plan participants for their individual losses, losses for which the Trustees may be held personally liable, as the Plan has lost substantially all of its value. While the phrase "proximate cause" is not used in the complaint in this context, the term "proximate result" is. The defendant Callahan now moves to strike the negligence count directed against him on the grounds that he owed no duty to the plaintiffs in his personal capacity under Connecticut law. Absent such a duty of care, the defendant argues that a negligence count cannot be maintained. The court will first set forth the applicable standard, followed by an analysis of the allegations.
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Motion to Strike: Legal Standard
"The purpose of a motion to strike is to contest . . . the legal sufficiency of the allegations of any complaint . . . to state a claim upon which relief can be granted." (Internal quotation marks omitted.) Fort Trumbull Conservancy, LLC v. Alves, 262 Conn. 480, 498, (2003). "[A] motion to strike challenges the legal sufficiency of a pleading and, consequently, requires no factual findings by the trial court . . ." (Internal quotation marks omitted.) Connecticut Coalition for Justice in Education Funding, Inc. v. Rell, 295 Conn. 240, 252, (2010). "It is well established that a motion to strike must be considered within the confines of the pleadings and not external documents . . . We are limited . . . to a consideration of the facts alleged in the complaint." (Internal quotation marks omitted.) Zirinsky v. Zirinsky, 87 Conn.App. 257, 268 n. 9, cert. denied, 273 Conn. 916 (2005). "A speaking motion to strike is one improperly importing facts from outside the pleadings." Mercer v. Cosley, 110 Conn.App. 283, 292 n. 7 (2008). "Where the legal grounds for . . . a motion [to strike] are dependent upon underlying facts not alleged in the plaintiff's pleadings, the defendant must await the evidence which may be adduced at trial, and the motion should be denied." (Internal quotation marks omitted.) Commissioner of Labor v. C.J. M Services, Inc., 268 Conn. 283, 293 (2004).This court takes "the facts to be those alleged in the complaint . . . and . . . construe[s] the complaint in the manner most favorable to sustaining its legal sufficiency . . . Thus [i]f facts provable in the complaint would support a cause of action, the motion to strike must be denied . . . Moreover, [the court notes] that [w]hat is necessarily implied [in an allegation] need not be expressly alleged . . . It is fundamental that in determining the sufficiency of a complaint challenged by a defendant's motion to strike, all well-pleaded facts and those facts necessarily implied from the allegations are taken as admitted . . . Indeed, pleadings must be construed broadly and realistically, rather than narrowly and technically." (Internal quotation marks omitted.) Connecticut Coalition for Justice in Education Funding, Inc. v. Rell, 295 Conn. 240, 252-53 (2010). "If any facts provable under the express and implied allegations in the plaintiff's complaint support a cause of action . . . the complaint is not vulnerable to a motion to strike." Bouchard v. People's Bank, 219 Conn. 465, 471 (1991). "[I]f facts provable in the complaint would support a cause of action, the motion to strike must be denied." (Internal quotation marks omitted.) American Progressive Life Health Ins. Co. of New York v. Better Benefits, LLC, 292 Conn. 111, 120 (2009).
"A motion to strike admits all facts well pleaded; it does not admit legal conclusions or the truth or accuracy of opinions stated in the pleadings." (Emphasis in original; internal quotation marks omitted.) Faulkner v. United Technologies Corp., 240 Conn. 576, 588 (1997). "A motion to strike is properly granted if the complaint alleges mere conclusions of law that are unsupported by the facts alleged." (Internal quotation marks omitted.) Fort Trumbull Conservancy, LLC v. Alves, 262 Conn. 480, 498 (2003). The court must "construe the complaint in the manner most favorable to sustaining its legal sufficiency." (Internal quotation marks omitted.) American Progressive Life Health Ins. Co. of New York v. Better Benefits, LLC, supra, 292 Conn. 120. While a complaint also includes any document attached as an exhibit to the complaint, Tracy v. New Milford Public Schools, 101 Conn.App. 560, 566, cert. denied, 284 Conn. 910 (2007), in this case there are no agreements attached to the complaint spelling out the exact terms of the relationship between the parties, or between Callahan and Pentec on the one hand, and the Plan and the trustees on the other. It would therefore be improper for the court to consider any material outside of the complaint that is being challenged by the motion to strike. The purpose and scope of a motion to strike are identical to those of a demurrer under the old rules of practice." (Internal quotation marks omitted.) Brennan v. Fairfield, 255 Conn. 693, 699 n. 4 (2001). The "takeaway" from the foregoing recitation of precedent is that the negligence count against the defendant Callahan in this complaint should not be stricken unless it appears certain that the OSG plaintiffs are entitled to no relief under any state of facts which could be proved in support of their claim. Conley v. Gibson, 335 U.S. 41 (1957).
Discussion
The history of this litigation is as follows. On August 16, 2010, the plaintiffs filed this action in Superior Court in two counts against Pentec and Callahan alleging professional negligence and breach of contract under Connecticut law. On September 15, 2010, the defendants removed the case to federal court based on a question of federal jurisdiction pursuant to 28 U.S.C. § 1331. The plaintiffs filed a motion to remand the case back to Superior Court, and the defendants filed a motion to dismiss. The United States District Court for the District of Connecticut, Droney, J., granted the plaintiffs' motion and remanded the case. It denied the defendants' motion to dismiss without prejudice to reasserting it before this court. Prior to this action being remanded, the plaintiffs advised the federal court that they were withdrawing the second count of the complaint as to Callahan, recognizing that he was not a party to any contract between the corporate defendant Pentec and the plaintiffs. The sole remaining count directed against Callahan is a count of negligence, which he argues is also fatally flawed, as he did not owe a duty of care to the plaintiffs in his personal capacity.
Orthopedic Speciality Group, P.C. v. Pentec, Inc., United States District Court, Docket No. 3:10-CV-1470 (CDF) (D.Conn. December 14, 2010).
Callahan's argument starts by pointing out that OSG and the trustees had a relationship with Madoff that predated any association by the defendants with the Plan by a number of years. Rather than accept responsibility for their own decision to invest with Madoff, the OSG plaintiffs have now filed a series of lawsuits premised on the basic theory that someone should have saved them from themselves. As the Plan was designed to provide retirement benefits to OSG employees in conformance with the requirements of ERISA, the trustees of the Plan were subject to the following fiduciary duties: (i) to act prudently; (ii) to act solely in the interest of the participants and for the exclusive purpose of providing benefits to the participants; (iii) to diversify the Plan's investments so as to minimize the risk of large losses; and (iv) to act in accordance with the terms of the Plan. 29 U.S.C. § 1104(a)(1)(A)-(D). ERISA's fiduciary duties have been described as "the highest known to the law." Donovan v. Bierwirth, 680 F.2d 263, 272 n. 8 (2d Cir. 1982).
Callahan notes that in exercising their fiduciary duties under ERISA, it was the individual trustees, not the Plan participants or Callahan, who made the decision to invest all of the Plan's assets with Madoff. Because of that decision, the trustees themselves face personal exposure from Plan participants for the losses suffered by the Plan. Callahan argues that in this litigation, along with a companion action brought by the same plaintiffs against their former law firm, the Plan trustees now seek to shift responsibility to third parties for their own actions, as well as their corresponding liability to Plan participants. However, for purposes of this motion to strike, the focus is not on the duty owed by the plaintiff trustees to the Plan's participants under ERISA. Those duties are not in dispute. The focus, rather, is on the duty owed by the defendants to the plaintiff trustees.
See Orthopaedic Specialty Group, P.C., et al. v. Day Pitney, LLP, Complex Litigation Docket, Judicial District of Stamford-Norwalk, at Stamford, Docket No. X05-FST-CV10-6007313-S. Those allegations are not specifically discussed herein.
According to the complaint, the plaintiffs allege that Pentec and Callahan should have advised the plaintiffs of the "risk inherent in keeping all Plan assets invested in a single account with Madoff," and recommend that the plaintiffs "modify the Plan structure to a participant-directed plan containing a broad array of investment options suited to each individual participant's risk tolerance, rather than having it remain as a single investment account with Madoff." The plaintiffs also allege that Pentec and Callahan should have advised "the Trustees that they should obtain fiduciary liability insurance coverage to protect themselves from personal liability in connection with the administration of the Plan."
The breach of contract count recites that "the Defendants agreed to provide comprehensive advisory and consulting services regarding the design, structure and ongoing administration of the Plan, and the Plaintiffs agreed to compensate the Defendants for such services." Callahan argues that because he was not personally a party to any contract between the plaintiffs and Pentec, he had no duty arising from the contract. He argues that the complaint fails to identify the source of any other duty owed by Callahan in his individual capacity. The allegations do not identify a statute, a professional code, or other similar source that imposes a duty on Callahan. Nor is there any allegation in the complaint of any particular action taken by Callahan, let alone any particular action taken by him in a personal capacity. As such, Callahan maintains that there is no basis for concluding that he owed a legal duty to Plaintiffs, a duty he breached through negligence.
The plaintiffs counter that at all relevant times throughout their professional relationship with the plaintiffs, Callahan had a duty to act in a professional and competent manner consistent with the applicable standard of care of a reasonably prudent pension advisor. The complaint plainly alleges the existence of that duty. The complaint further alleges that Callahan was negligent and breached this duty by: (i) failing to advise the plaintiffs before December 2008 that they could modify the Plan structure to a participant-directed plan containing a broad array of investment options suited to each individual participant's risk tolerance, rather than having it remain as a single investment account with Madoff; (ii) failing to advise them as to the risk inherent in keeping all Plan assets invested in a single account with Madoff; and (iii) failing to advise the Trustees that they should obtain fiduciary liability insurance coverage to protect themselves from personal liability in connection with the administration of the Plan. The plaintiffs argue that Callahan was the plaintiffs' principal contact with Pentec, the one who managed the client relationship, and it was Callahan who rendered substantially all of the advice in connection with this client relationship. The plaintiffs argue that the nature of the parties' relationship, the conduct of Callahan and the topics upon which he undertook to provide advice and guidance throughout the course of their relationship gave rise to a duty on his part, a duty which was breached by Callahan's negligence.
"The essential elements of a cause of action in negligence are well established: duty; breach of that duty; causation; and actual injury . . . Contained within the first element, duty, there are two distinct considerations . . . First, it is necessary to determine the existence of a duty, and second, if one is found, it is necessary to evaluate the scope of that duty . . . Although it has been said that no universal test for duty has ever been formulated . . . our threshold inquiry has always been whether the specific harm alleged by the plaintiff was foreseeable to the defendant . . . Furthermore, a duty to use care may arise from a contract, from a statute, or from circumstances under which a reasonable person, knowing what he knew or should have known, would anticipate that harm of the general nature of that suffered was likely to result from his act or failure to act." (Citations omitted; emphasis added.) D'Angelo Development Construction Corp. v. Cordovano, 121 Conn.App. 165, 184 (2010), appeal denied, 297 Conn. 923 (2010).
In order to prevail on a negligence claim against Callahan, the plaintiffs must prove that the pension adviser relationship existed, and that this relationship created a duty between the defendant and the plaintiffs. The plaintiffs must also prove that the defendant Callahan breached that duty, and the plaintiffs were injured as a result. As a threshold matter, a court must decide as a matter of law whether such a legal duty exists between the parties. In the absence of a finding that a legal duty exists, there cannot be liability for negligence. The Supreme Court has articulated a two-part test of the existence of a legal duty: (1) A determination of whether an ordinary person in the defendant's position, knowing what the defendant knew or should have known, would anticipate the harm of the general nature of that suffered was likely to result; and (2) a determination, on the basis of public policy analysis, of whether the defendant's responsibility for his negligent conduct should extend to the particular consequences or particular plaintiff in the case. Lodge v. Arett Sales Corp., 246 Conn. 563, 572 (1998). "The ultimate test of the existence of a duty to use care is found in the foreseeability that harm may result Wit is not exercised . . . By that is not meant that one charged with negligence must be found actually to have foreseen the probability of harm or that the particular injury which resulted was foreseeable, but the test is, would the ordinary man in the defendant's position, knowing what he knew or should have known, anticipate that harm of the general nature of that suffered was likely to result?" (Citation omitted.) Orlo v. Connecticut Co., 128 Conn. 231, 237, 21 A.2d 402 (1941). This language is now a central feature of the formal, two-part test of duty of care. Zamstein v. Marvasti, 240 Conn. 549, 558, 692 A.2d 781 (1997).
The court must accept the factual allegations set forth in the complaint as true and draw all reasonable inferences in favor of the plaintiff. To survive this motion, the complaint must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face. The complaint itself must provide the defendant and the Court with notice as to how the doctrine of negligence applies to the plaintiff's claims. While a complaint need not supply "detailed factual allegations," it must consist of more than "labels conclusions" or a "formulaic recitation of the elements of a cause of action." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). The allegations in this case differ somewhat from some of the other Madoff-related claims being litigated in this and other courts around the country. The defendants here are not charged with recommending an investment with Madoff to the plaintiffs, or with any inadequate investigation into Madoff's activities, or their willful ignorance of "red flags" surrounding Madoff's reported returns. These defendants were retained by the trustees of the OSG Plan well into (in fact, years after) the plaintiffs' separate, pre-existing and seemingly profitable investment relationship with Madoff had begun. The defendant Callahan stands accused of what he failed to do, not of what he did. More specifically, he is charged in the complaint with negligence for advice he failed to give the trustees, not for any advice he gave. Therefore, the facts in the complaint must warrant the application of negligence, bearing in mind that in hindsight, virtually all harms are literally foreseeable. RK Constructors, Inc. v. Fusco Corp., 231 Conn. 381, 386 (1994). For that reason, "[i]n every case in which a defendant's negligent conduct may be remotely related to a plaintiff's harm, the courts must draw a line, beyond which the law will not impose legal liability." Lodge v. Arett Sales Corp., 246 Conn. at 578. Otherwise, the imperfect vision of reasonable foreseeability would be converted into the perfect vision of hindsight. Id.
See, e.g., Levinson v. PSCC Services, Inc., United States District Court, Docket No. 3:09-CV-00269 (PCD) (D.Conn. December 19, 2010). Levinson is a class action brought by some pension fund plaintiffs who were also victims of the Madoff Ponzi. They sued a number of defendants, including their pension consulting firm PSCC Services, as well as the president of that firm. The complaint is based on a number of legal theories, including negligence, and it contains several allegations that the defendants failed to make proper inquiries of Madoff, despite the existence of numerous red flags contained in the documentation received from Madoff.
In insurance terms and according to an insurance industry publication, "A financial loss is an unexpected decrease in value arising out of an event," with the event in this case being the Madoff fraud, and the loss being the unexpected decrease in the Plan's assets. Also in insurance terms, "A loss exposure is a condition of susceptibility or vulnerability to loss, that is, the possibility of loss. A loss exposure exists if there is a possibility of a loss occurring and if such an occurrence would cause a financial loss. It is the possibility (not certainty) of a financial loss that creates insecurity and the need for insurance." Id. The allegations are that the defendants never advised the plaintiffs about the risks concerning the structure of the Plan. Specifically, the defendants failed to advise the plaintiffs of the risk of maintaining a central-pooled investment account, as opposed to a participant-directed plan. The plaintiffs claim that it was only after the Madoff fraud came to light that Callahan gave the Plan trustees the advice that a reasonable pension advisor would have given them all along. Therefore, based on the allegations in this complaint, if there were any "red flags" ignored by the defendants in this case, they relate to the structure of the Plan itself and allegedly inadequate insurance coverage for the trustees of the Plan, not to the Plan's investments with Bernard Madoff per se. The court cannot say as a matter of law that the plaintiffs cannot allege that Callahan failed in his duty to adequately measure and advise the plaintiffs as to their loss exposure. Whether one is discussing an automobile policy in the property casualty area for a driver with a high net worth, or life insurance for a highly compensated executive with several young children, or as here, a pension fund with tens of millions in assets with non-pension professionals serving as trustees, the risks of a client being uninsured or underinsured are obvious (or should be obvious) to trained professionals in the applicable industries in advance of any losses. This is not entirely a matter of penalizing a defendant with 20-20 hindsight. Competent risk management offers a systematic approach to dealing with loss exposures. In terms of its sheer size, scope and duration, the Madoff fraud may be unprecedented, but the concept of negligent risk management is not. One of the primary methods by which such losses exposures are controlled and managed is through adequate insurance, as a policy of insurance transfers all or a portion of a loss exposure to an insurance company in exchange for a premium.
B. Smith, J. Treishmann E. Weining, Property and Liability Insurance Principles, p. 2, Insurance Institute of America (1987).
As to Callahan's argument that he was not personally a party to any contract between the trustees of the Plan and the corporate co-defendant Pentec, the plaintiffs cite to a line of cases in which corporate officers have been found liable. "Where, however, an agent or officer commits or participates in the commission of a tort, whether or not he acts on behalf of his principal or corporation, he is liable to third persons injured thereby . . . Thus, a director or officer who commits the tort or who directs the tortious act done, or participates or operates therein, is liable to third persons injured thereby, even though liability may also attach to the corporation for the tort . . . We explained that the right to hold corporate actors liable for personal torts, regardless of their corporate position is a common law right." (Citations omitted; internal quotation marks omitted.) Strum v. Harb Development, 298 Conn. 124, 132-37 (2010).
In their brief (#107) in opposition to the motion to strike, the plaintiffs state, "It is important to note that while all of the allegations in the Complaint are cast in terms of the conduct of "the Defendants," the reality is that Callahan was the Plaintiffs' principal contact with Pentec, he managed the relationship and substantially all of the advice rendered in connection with this relationship was rendered by him." The problem with the complaint as currently drafted is that it does not clearly comport with this "reality," as it conflates the negligence allegations against both defendants, Pentec and Callahan, into a single count. However, that is a proper basis for a request to revise, not grounds for a motion to strike. "It is true that the plaintiff's complaint is confusing because it combines, in a single count, separate causes of action against the individual defendant and [a co-defendant]. Since there was nothing to prevent those two possible causes of action from being joined in the same complaint, however, the proper way to cure any confusion in that regard is to file a motion to revise, not a motion to strike the entire complaint. Practice Book [§ 10-35(3)." Rowe v. Godou, 209 Conn. 273, 279 (1988).
Practice Book § 10-35(3), Request to Revise, provides in relevant part as follows: "Whenever any party desires to obtain (3) separation of causes of action which may be united in one complaint when they are improperly combined in one count . . . the party desiring any such amendment in an adverse party's pleading may file a timely request to revise that pleading."
Conclusion
Utilizing the tests and standards applicable to adjudications of motions to strike, the court finds that a duty on the part of the defendant Callahan as a pension advisor and consultant to the Plan trustees is properly alleged, even if this complaint might have been better drafted by the plaintiffs. In so ruling, the court is also sensitive to the danger recognized by the Supreme Court in Lodge v. Arett Sales Corp., infra, that the imperfect vision of reasonable foreseeability may be converted into the perfect vision of hindsight. However, whether or not Callahan may ultimately be held liable to the plaintiffs on this issue of negligent assessment of loss exposure is not a question that may be resolved at the pleading stage. In fact, it is completely irrelevant to the disposition of this motion.
For the reasons stated herein, the defendant Michael E. Callahan's motion to strike is DENIED.
IT IS SO ORDERED,