Plaintiffs, court-appointed joint official liquidators (JOLs) of a failed hedge fund, brought claims on behalf of the Fund against, among others, the Fund’s investment managers, who were responsible for the operation and management of the Fund (Investment Managers) and the Fund’s auditor. The JOLs alleged that the Investment Managers fraudulently inflated the value of the Fund’s mortgage-backed securities and that the auditor conducted a deficient audit and negligently failed to detect the Investment Managers’ fraudulent valuation.
After all defendants other than the auditor settled, the auditor moved for summary judgment, which the Court granted. The Court first ruled that the JOLs were subject to the same defenses that the Fund itself would be subject to if it were the plaintiff. The Court then held that the JOLs’ claims were barred because the wrongful actions of the Investment Managers were imputed to the Fund itself. In doing so, the Court synthesized the in pari delicto doctrine, which bars a plaintiff from recovering from a defendant where each is equally at fault, with the “Wagoner rule” (named after the Second Circuit case in which it was enunciated), which the Court described as establishing that a bankruptcy trustee (or other similar court-appointed professional) is deprived of standing to assert a claim against a third party for wrongdoing committed “with the cooperation of management” of the entity on whose behalf the Trustee files suit.
While recognizing that there are limited exceptions to the Wagoner rule, the Court determined that none applied. For example, the JOLs failed to provide evidence to support application of the “adverse interest” exception, which applies if the acts of management are so adverse to the corporation that the conduct cannot be attributed to the corporation under traditional agency principles. To the contrary, the Fund benefited from the Investment Managers’ alleged wrongdoing by receiving additional capital and retaining investors. Similarly, the JOLs failed to support application of the “innocent insider” exception to the Wagoner rule, which would apply if there were “innocent” members of management who would have been able to stop the wrongdoing if the auditors had alerted them to the Investment Managers’ wrongdoing. The Court found that the JOLs had failed to raise a triable issue that there were any such innocent decision-makers. Finally, the court rejected the JOLs assertion that they should nonetheless be permitted to pursue the claims because any recovery would solely benefit innocent investors. While recognizing that such an exception had been made in at least one prior decision, the Court rejected it, reasoning that an “innocent successor” exception would “fly in the face of the well-established agency principle[s].” (Bullmore, et al. v. Ernst & Young Cayman Islands, et al., 2008 WL 2572931 (N.Y. Sup. June 19, 2008))