CIVIL ACTION NO. Plaintiffs CLASS ACTION COMPLAINT JURY TRIAL DEMANDED

Transcription

1 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK EILEEN S. SILVERS and RICHARD J. BRONSTEIN, individually and on behalf of all others similarly situated, CIVIL ACTION NO. V. Plaintiffs CLASS ACTION COMPLAINT TREMONT GROUP HOLDINGS, INC., TREMONT PARTNERS, INC., RYE INVESTMENT MANAGEMENT, INC., OPPENHEIMER ACQUISITION CORPORATION, MASSACHUSETTS MUTUAL LIFE INSURANCE CO., RYE SELECT BROAD MARKET FUND, L.P., f/k/a AMERICAN MASTERS BROAD MARKET FUND, L.P., RYE SELECT BROAD MARKET PRIME FUND, L.P., f/k/a/ AMERICAN MASTERS BROAD MARKET PRIME FUND, L.P., RYE SELECT BROAD MARKET XL FUND, L.P., ERNST & YOUNG, LLP, and KPMG LLP, JURY TRIAL DEMANDED Defendants, GRANT & EISENHOFER P.A. 485 Lexington Avenue 29t' Floor New York, New York Telephone: Fax: Attorneys for Plaintiffs

2 Plaintiffs, Eileen S. Silvers and Richard J. Bronstein, individually and on behalf of all other persons similarly situated (the "Class"), by Plaintiffs' undersigned attorneys, make the following allegations based upon the investigation of counsel, except as to the allegations pertaining specifically to Plaintiffs and Plaintiffs' counsel that are based on personal knowledge. The investigation Plaintiffs' counsel conducted included, inter alia, a review and analysis of publicly available information, including but not limited to news articles and reports and filings in court proceedings related to the Ponzi scheme perpetrated by Bernard L. Madoff ("Madoff'), including complaints filed by the United States Government and Securities and Exchange Commission (the "SEC") against Madoff and his investment firm, Bernard L. Madoff Investment Securities, LLC ("BMIS"), and proceedings relating to the bankruptcy of BMIS, as follows: BACKGROUND 1. This suit is a class action brought on behalf of all persons, other than defendants, who purchased a limited partnership interest in the Rye Select Broad Market Fund, L.P.; or the Rye Select Broad Market Prime Fund, L.P.; or the Rye Select Broad Market XL Fund, L.P. (collectively, the "Rye Funds"), between December 21, 2003 through December 21, 2008 for claims arising under the Securities Exchange Act of 1934 (the "Exchange Act") and for claims arising under the Investment Advisers Act of 1940 (the "Advisers Act") (the "Exchange Act and Advisers Act Class Period"); and between May 10, 1994 through December 21, 2008 for claims arising under state law (the "State Claims Class Period"; collectively, the Exchange Act and Advisers Act Class Period and State Claims Class Period are the "Class Period"), to recover damages caused by defendants' violations of the federal securities laws and common law. 2. Plaintiffs and other limited partners in the Rye Funds entrusted their assets to these funds' managers at Tremont Partners, Inc. ("Tremont"), the General Partner of each of the 2

3 Rye Funds, who, in turn, invested the funds' assets with Madoff, through BMIS. The Rye Funds had an estimated value of $3.1 billion, as of December On December 10, 2008, Madoff confessed to senior employees that he had been operating a Ponzi scheme, and that the accounts at BMIS were essentially worthless. Madoff explained that for years he paid returns to certain investors out of the principal received from other, different investors. Madoff stated that the business was insolvent and that it had been for years. Madoff also stated that he estimated the losses from this fraud to be approximately $50 billion. 4. On December 11, 2008, the U. S. Attorney brought criminal charges against Madoff and the SEC filed a civil suit, alleging securities fraud by Madoff and BMIS. The Securities Investor Protection Corporation ("SIPC") moved to protect the assets of Madoff and BMIS, and commenced proceedings in the bankruptcy court. A court-appointed trustee is overseeing the liquidation of BMIS' s assets and processing claims of customers who held brokerage accounts at BMIS. 5. Like those individuals who invested directly with Madoff, investors in the Rye Funds have seen their assets vanish as a result of Tremont's conduct and breaches of duty set forth herein. Tremont promised investors it would provide careful due diligence and portfolio management, yet did nothing of the kind. 6. Various red flags tipped off other investment professionals to the risks of investing with Madoff, but Tremont ignored these warning signs. Tremont conducted no due diligence or due diligence that was negligent and/or reckless. Tremont then failed to monitor Madoff' s investment activities and did not ensure that proper controls were implemented to guard against fraud, given the multiple roles Madoff and BMIS performed for the Rye Funds. 3

4 Tremont essentially turned over the entire operation to Madoff and BMIS and collected fees from the limited partners for providing virtually no services of value. 7. The Rye Funds' losses were also facilitated by the failure of the funds' auditors to perform adequate audits in conformance with generally accepted auditing standards. 8. Plaintiffs seek to recover damages caused to the Class by defendants' violation of Section 10(b) and 20(a) of the Exchange Act, as well as for common law fraud, negligent misrepresentation and breach of fiduciary duty, and for rescission under the Advisers Act. JURISDICTION AND VENUE 9. The claims asserted herein arise under Sections 10(b) and 20(a) of the Securities Exchange Act, 15 U.S.C. 78j and 78t(a), and Rule lob-5, 17 C.F.R b-5, promulgated thereunder by the SEC, the Investment Advisers Act, 15 U.S.C. 80b-1 et seq. as well as under the laws of the State of New York. 10. This Court has jurisdiction in this action pursuant to 28 U.S. C. 1331, 1667 and Section 27 of the Exchange Act, 15 U. S.C. 78aa. 11. Venue is proper in this judicial district pursuant to Section 22(a) of the Securities Act, 15 U.S.C. 77v( a), Section 27 of the Exchange Act, 15 U. S.C. 78aa, and 28 U.S.C. 1391(b). Many of the alleged acts, transactions, and conduct occurred, at least in part, in this District. Additionally, the Tremont Defendants, at all relevant times, resided, maintained their headquarters or conducted substantial business in this District at 555 Theodore Fremd Avenue, Rye, New York Defendant Ernst & Young LLP maintains its U. S. headquarters in this District at 5 Times Square, New York, New York Defendant KPMG LLP maintains its U.S. headquarters this District, with offices at 757 Third Avenue, New York, New York In connection with the acts alleged in this Complaint, defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including, but not 4

5 limited to, the mails, interstate telephone communications and the facilities of the national securities markets. PARTIES 13. Plaintiffs Eileen S. Silvers and Richard J. Bronstein, as tenants in common, own a Limited Partnership interest in the Rye Select Broad Market Prime Fund, L.P. Plaintiffs invested $ 580,000 with the Rye Select Broad Market Prime Fund, L.P. and their partnership interest was valued at $ as of October 31, Defendant Rye Select Broad Market Fund, L.P., f/k/a American Masters Broad Market Fund, L.P. ("Rye Broad Market"), is a Delaware limited investment partnership organized on or about May 10, Defendant Rye Select Broad Market Prime Fund, L.P., f/k/a/ American Masters Broad Market Prime Fund, L.P. ("Rye Prime") is a Delaware limited investment partnership organized on or about May 23, Rye Prime is a leveraged version of Rye Broad Market, using access to a credit facility to leverage the investment in Rye Broad Market. 16. Defendant Rye Select Broad Market XL Fund, L.P. ("Rye XL") is Delaware limited investment partnership organized on or about September 1, Rye XL is a fund linked to three times leveraged exposure to Rye Broad Market. (Collectively, Rye Broad Market, Rye Prime, and Rye XL are referred to as the "Rye Funds.") 17. Defendant Tremont Partners, Inc. ("Tremont") is an investment management firm and is the General Partner of each of the Rye Funds. (Tremont is also referred to as the General Partner of the Rye Funds.) Tremont has offices at 555 Theodore Fremd Avenue, Rye, New York Tremont is registered with the SEC as an investment adviser under the Advisers Act. 18. Defendant Tremont Group Holdings, Inc. ("Tremont Group") is the corporate parent of Tremont, and has offices at 555 Theodore Fremd Avenue, Rye, New York

6 19. Defendant Rye Investment Management, Inc. ("Rye") is the division within Tremont Group that manages, sells, and administers the Rye Funds. Rye has offices at 555 Theodore Fremd Avenue, Rye, New York (Defendants Tremont, Tremont Group, and Rye are referred to collectively as the "Tremont Entities.") 20. Defendant Oppenheimer Acquisition Corporation ("Oppenheimer") is a business that specializes in investment advisory services. Oppenheimer's headquarters are located at 2 World Financial Center, New York, New York Tremont Group is a wholly-owned subsidiary of Oppenheimer, which acquired it in Defendant Massachusetts Mutual Life Insurance Co. ("MassMutual") is a mutually owned financial protection, accumulation and income management company and is a member of FINRA and SIPC. MassMutual is located at 1295 State Street, Springfield, Massachusetts Oppenheimer is a wholly-owned subsidiary of MassMutual Holding LLC, which is a subsidiary of MassMutual. 22. Defendant Ernst & Young LLP ("E&Y) is one of the largest professional services firms in the world and one of the " Big Four" auditors. E&Y maintains its U. S. headquarters at 5 Times Square, New York, New York, E&Y conducted audits of the financial statements of the Rye Funds until Defendant KPMG LLP ("KPMG") is part of an international network of member firms offering audit, tax and advisory services and is one of the Big Four auditing firms. KPMG is the U.S. member firm of KPMG International, a Swiss cooperative. KPMG maintains its U.S. headquarters at 757 Third Avenue, New York, New York KPMG replaced E&Y as auditor for the Rye Funds in 2004, and first audited the Rye Funds' financial statements for the fiscal year ended December 31, 2005 and issued unqualified opinions thereon on March 6,

7 KPMG performed additional audits of the Rye Funds' financial statements for the fiscal years ended December 31, 2006 and December 31, 2007, and issued unqualified opinions thereon on March 26, 2007, and March 24, 2008, respectively. 24. Defendants the Rye Funds, the Tremont Entities, Oppenheimer, MassMutual, E&Y, and KPMG are sometimes referred to herein collectively as the "Defendants." PLAINTIFFS' CLASS ACTION ALLEGATIONS 25. Plaintiffs bring this action as a class action pursuant to Federal Rules of Civil Procedure 23(a) and (b)(3) on behalf of all those persons who, between December 21, 2003 through December 21, 2008 for claims arising under the Exchange Act and for claims arising under the Advisers Act (the "Exchange Act and Advisers Act Class Period"); and between May 10, 1994 through December 21, 2008 for claims arising under state law (the "State Claims Class Period"; collectively, the Exchange Act and Advisers Act Class Period, and State Claims Class Period are the "Class Period"), purchased limited partnership interests in any of the Rye Funds and who were injured thereby (the "Class"). Excluded from the Class are Defendants, the officers and directors of the Defendants, members of their immediate families and their legal representatives, heirs, successors, or assigns, and any entity in which Defendants have or had a controlling interest. 26. The members of the Class are so numerous that joinder of all members is impracticable. The precise number of Class members is unknown to Plaintiffs at this time but is believed to be in the hundreds or thousands, and will be ascertained through appropriate discovery. Additionally, the names and addresses of the Class members can be ascertained from the books and records maintained by the Rye Funds or its General Partner. Notice can be provided to such Class members by a combination of published notice and first-class mail, using techniques and a form of notice similar to those customarily used in securities class actions. 7

8 27. Plaintiffs will fairly and adequately represent and protect the interests of the members of the Class and have retained competent counsel experienced in class action litigation to further ensure such protection. 28. Plaintiffs' claims are typical of the claims of the members of the Class because all of the Class members' damages arise from and were caused by the same wrongful conduct of Defendants that is complained of herein. Plaintiffs do not have any interests antagonistic to, or in conflict with, the Class. 29. A class action is superior to other available methods for the fair and efficient adjudication of this controversy. Since the damages suffered by individual Class members may be relatively small, the expense and burden of individual litigation make it virtually impossibly for the Class members individually to seek redress for the wrongful conduct alleged. Further the sheer number of Class members would make it impracticable and cost ineffective for each limited partner in any of the Rye Funds to bring individual claims. Plaintiffs cannot foresee any difficulty in the management of this litigation that would preclude its maintenance as a class action. 30. Common questions of law and fact exist as to all members of the Class and predominate over any questions solely affecting individual members of the Class. Among the questions of law and fact common to the Class are: a. Whether Defendants owed Plaintiffs and other class members any fiduciary duties; b. Whether Defendants breached any fiduciary duties owed to Plaintiffs and other class members; 8

9 c. Whether statements made by Defendants to investors in the Rye Funds during the Class Period misrepresented material facts about the business, operations, and financial condition of the Rye Funds; d. Whether statements made by Defendants to investors in the Rye Funds during the Class Period misrepresented material facts about the extent of due diligence and monitoring undertaken to protect the assets of the Rye Funds; e. Whether Defendants acted knowingly or recklessly in making materially false and misleading statements during the Class Period; f. Whether the federal securities laws were violated by Defendants' acts as alleged herein; g. Whether Defendants' conduct alleged herein was intentional, reckless, or grossly negligent and therefore violated the common law of New York; and h. The extent of injuries sustained by the Class and the appropriate measure of damages. The Madoff Ponzi Scheme FACTUAL ALLEGATIONS PERTINENT TO CLAIMS FOR BREACH OF FIDUCIARY DUTY 31. Madoff had operated BMIS since Madoff and BMIS were well-known and respected among the Wall Street community for his trading activities and role as a market maker. However, a separate arm of the business - operated on another floor, in offices to which few other employees had access - engaged in money management and advisory services. Through this arm, Madoff managed investments for wealthy individuals, non-profits, and funds invested through hedge funds. 9

10 32. Madoff offered impressive results - solid gains of 10-12%, quarter after quarter (even when the rest of the market was down), year after year, with little fluctuation. He claimed that these results were achieved through the "split-strike" conversion strategy, which purportedly allowed him to profit even when overall indexes were down. In reality, however, Madoff was operating an enormous Ponzi scheme, using funds from new investors to pay the prior investors. In order to sustain this fraud, Madoff generated fraudulent client statements, documents supplied to auditors, and other documents. 33. Madoff was able to sustain the scheme until the recent downtown in the stock market, which caused many of his investors to cash out their investments. With this dramatic increase in redemption requests, Madoff ran out of money and could not solicit new investors fast enough. Thus, in early December, he was forced to reveal the longstanding fraud he had been committing. 34. The news of Madoff's downfall took most investors by surprise, yet many analysts and hedge fund managers had long been suspicious of Madoff's surprising results. The numerous "red flags" that led these analysts and fund managers to steer clear of investing with Madoff should have alerted Defendants that Madoff was operating some kind of fraud. For example: a. Madoff s returns were simply too good to be true. Several traders and hedge fund operators used the same split-strike conversion strategy, and did not achieve the same stellar results. Moreover, some professionals specifically tried to replicate his results using the same strategy, and were unable to do so. b. Given the volume of assets under Madoff's management, there were simply not enough index options on the market to support the levels of his trading. And even 10

11 if those options had existed, the market would have been impacted by and reacted to such a large volume of options trades. c. Madoff had physical custody of clients' assets, whereas typically an investment manager makes trades on his clients ' behalf but the assets are actually held by a third party financial institution, so the manager cannot withdraw the clients' funds. itself, Because Madoff held the assets, his firm generated the monthly statements rather than a third party that could have provided independent verification of the results he was reporting. d. Madoff s auditor was a three-person firm, which would not have had the sophistication or expertise to audit an advisor in charge of a reported $17 billion in assets. The accounting firm's employees include a 78-year-old living in Florida and a secretary, and Madoff was its only client. e. The form of the BMIS statements was itself a red flag. In the age of internet access to financial data, customers typically can view and track their holdings on line, but Madoff s clients did not have this access. Further, the statements were prepared in an outdated format, in terms of both the bookkeeping format used and extent of account detail. Additionally, one accountant has noted that the statements appeared to have been printed using a computer printer that was virtually antique - a type used before the dot matrix printers used in the 1990s. f. Press accounts indicate that a cursory analysis of the stock trades reported on an account statement with the actual trading prices on the relevant date would have shown that the prices did not match. 11

12 g. Other investment managers noted inconsistencies between customer account statements and the audited BMIS financial statements filed with the SEC. In particular, the stock holdings reported in the quarterly statements of BMIS filed with the SEC appeared too small to support the size of the assets Madoff claimed to be managing. h. Madoff insisted on an unusual degree of secrecy, regarding both his clientele and his investment strategy. His role was also concealed from investors in the feeder funds. His refusal to provide transparent information on his strategy caused several cautious fund managers and advisors to shy away from dealing with him. i. In addition to those on Wall Street who privately questioned the legitimacy of Madoff's methods, at least two publications aired concerns in In the May 7, 2001 edition of Barron's, an article entitled "Don't Ask, Don't Tell" raised questions regarding his business. The author noted that some of Madoff s billiondollar funds had never had a down year and reported on speculation on Wall Street that Madoff was using his market-making business to subsidize and smooth out the returns on the funds. The author suggested that investors should seek greater transparency in an investment strategy than Madoff was providing. The article also quoted one former investor who had pulled out his money when Madoff could not explain how a particular month's results were generated. Also in May 2001, Michael Ocrant raised many of the same concerns in an article that appeared in Institutional Investor and the MAR/Hedge report (an industry publication). In this article, Ocrant referred to over a dozen hedge fund 12

13 professionals who questioned why no one else using the split-strike conversion strategy had similarly impressive results. The Rye Funds' Investments with Madoff 35. Despite these warning signs, Tremont invested 100% of the Rye Broad Market assets with Madoff. Similarly, Rye Prime and Rye XL were leveraged versions of Rye Broad Market, and thus were equally exposed to the risk of investing all the funds' assets with Madoff. 36. Ignoring its fiduciary duties, Tremont failed to conduct even the most rudimentary due diligence on Madoff. Instead Tremont relied on the "reputation" of Madoff without conducting any investigation of Madoff and his operation, and/or an analysis of the trading strategies and investment returns reported by Madoff, which remained suspiciously and consistently high even during adverse market conditions. 37. Unlike Tremont, other investment advisors who conducted due diligence on Madoff and ran even the most simplistic models testing the validity of Madoff' s results recognized the fraudulent irregularities with Madoff s investments. 38. Had Tremont conducted adequate due diligence - if indeed any due diligence was conducted at all - Tremont would have discovered the red flags that other managers saw and would not have invested the Rye Funds with Madoff. The failure to conduct such due diligence was a reckless breach of Tremont's fiduciary duty to Plaintiffs and the Rye Funds' other limited partners. 39. Tremont also failed to supervise, monitor and manage the investments of the Rye Funds, in violation of its fiduciary duties as set forth in the offering memoranda issued to prospective investors, and under the laws of both New York and Delaware. If Tremont had 13

14 applied the appropriate degree of scrutiny of Madoff's operations, it would have discovered material irregularities in the investments, operations and financial reporting of Madoff. 40. For example, Tremont should not have allowed Madoff to operate as the investment advisor while BMIS functioned as the asset custodian, without verification that appropriate internal controls were in place to ensure the separation of these two functions. Yet Tremont took no steps to safeguard the Rye Funds' assets and it was this very overlap in duties that enabled Madoff to perpetuate the fraud. 41. Tremont's own faith in Madoff diminished at some point in 2007, yet it, together with Rye, continued to solicit new investors. The audited financial statements for the Rye Broad Market Fund indicate that Tremont withdrew 92% of its investment during 2007, and the audited financial statements for the Rye Prime Fund indicate that Tremont withdrew 94% of its investment the same year. Tremont sought to protect its own capital, yet took no steps to diversify the holdings of the Rye Funds or otherwise alter the investment strategy, in breach of its duty of due care. COUNT I For Breach of Fiduciary Duty (Against Tremont) 42. Plaintiffs repeat and reallege each and every allegation contained in the foregoing paragraphs as if fully set forth herein. 43. As General Partner of the Rye Funds, Defendant Tremont owes a fiduciary duty to Plaintiffs and the other Class members. 44. Defendant Tremont has breached its fiduciary duty to Plaintiffs and other Class members, by failing to use due care in the investment and management of the assets of the Rye Funds. 14

15 45. Defendant Tremont has failed to fulfill its fiduciary duty owed to Plaintiffs and other members of the Class by acting in bad faith, with gross negligence and in utter disregard for due care and reasonable and prudent investment standards. 46. As a proximate result of Tremont's bad faith breach of fiduciary duty, Plaintiffs and other Class members have sustained damages and have lost most, if not all, of their respective investments in an amount yet to be determined, and to be proven at trial. 47. By reason of the foregoing, Defendant Tremont is liable to Plaintiffs and other limited partners of the Rye Funds who continue to own their interests in the Rye Funds. FACTUAL ALLEGATIONS PERTINENT TO OTHER CLAIMS FOR RELIEF The Rye Funds Solicited Investors Using False, Misleading Information 48. Prior to and during the Class Period, Tremont, Rye, and the Rye Funds offered participation in Limited Partnerships in the Rye Funds to qualified investors such as Plaintiffs. Participation was offered primarily through offering memoranda, such as the Rye Prime Fund's Amended and Restated Confidential Private Placement Memorandum, dated July 1, 2006 (the "Offering Memorandum "). While the Offering Memorandum may have been amended or revised from time to time, it remained the same in all relevant, material respects. 49. Specifically, the Offering Memorandum remained consistent with respect to the material misrepresentations and omissions contained therein. Neither the Offering Memorandum nor any other offering material used to solicit investments in the Rye Funds disclosed that the majority of the Fund' s assets were invested with Madoff, BMIS, or other Madoff-controlled entities. 50. Nor does the Offering Memorandum disclose the fact that Madoff and BMIS were fulfilling three roles generally filled by three separate companies: Madoff was the investment advisor, and BMIS was both the custodian for the Rye Funds' account and the broker/dealer for 15

16 the trades that were purportedly made on the Funds' behalf. The risk posed by having related parties perform all three functions was not disclosed to investors. 51. Tremont, Rye, and the Rye Funds knew that this was a material risk yet recklessly omitted the information from the Offering Memorandum. 52. Tremont, the General Partner, boasted on its website of its "thorough manager research, careful due diligence, advanced risk allocation and time-tested portfolio management." In truth, Tremont and Rye provided virtually no due diligence or management expertise and did not properly assess the risk to the Rye Funds' limited partners of having all the assets invested with and managed by Madoff. 53. The Offering Memorandum also describes defendant Tremont as being "responsible for the day-to-day administration and operation of the Partnership." Tremont "ha[d] primary responsibility for monitoring the ongoing activities of [Madoff]," and its duties included "review[ing] the confirmations of the Partnership's trading activity for purposes of tracking the current status of the Partnership's accounts." However, Tremont could not have been monitoring the trades as represented because had it done so, Tremont would have discovered that the confirmations did not support the investment strategy Madoff purportedly used or the returns supposedly generated. 54. Tremont, Rye, and the Rye Funds knew that the Offering Memorandum misrepresented the extent of oversight and monitoring Tremont provided for the Rye Funds. 55. The statements of Tremont, Rye, and the Rye Funds were also materially false and misleading in conveying the impression that Rye and Tremont maintained a system of internal controls to provide ongoing due diligence, oversight and portfolio management. In 16

17 reality, Tremont and Rye abdicated their responsibility and entrusted the assets of the Rye Funds to Madoff and BMIS. 56. The Offering Memorandum and Rye Funds fact sheets described the Rye Funds' investment strategy as one seeking long-term growth, entrusting the assets to advisors with "conservative investment styles [who] have demonstrated, over a prolonged period of time and under all economic and market conditions, their ability to achieve consistent returns." 57. In making these misleading statements, Tremont, Rye, and the Rye Funds falsely implied that Rye and Tremont were investing the Rye Funds' assets prudently by using managers with conservative approaches, when all the funds were invested with Madoff, who would not explain his investment strategy and took the unusual approach of having his related firm act as broker/dealer and custodian. Further, the statements implied that Rye and Tremont had undertaken extensive due diligence before deciding to invest with Madoff, when no such due diligence had been conducted. 58. Rye and Tremont acted recklessly in not thoroughly investigating Madoff's strategy, not verifying that the necessary controls were in place, and not pursuing the many red flags that existed. 59. Tremont, Rye, and the Rye Funds knew that they had not conducted adequate due diligence or imposed proper controls, and that the representations in the Offering Memorandum regarding their due diligence and oversight were misleading. The Rye Funds' Auditors 60. Defendants E&Y and KPMG performed their work as auditors of the Rye Funds' annual financial statements in a reckless manner inconsistent with the standards of the auditing profession and as required by Generally Accepted Auditing Standards ("GAAS") 17

18 61. Defendants E&Y and KPMG either knew of or recklessly disregarded: (a) the concentration of the Rye Funds' investments in a single third party investment manager, Madoff; (b) the materially heightened risk to the Rye Funds' assets from such reliance on Madoff, particularly given the lack of transparency of Madoff's operations; (c) the abnormally high and stable positive investment results reportedly obtained by Madoff; (d) the inconsistency between BMIS' publicly available financial information concerning its assets and the purported amounts that Madoff managed for clients such as Tremont; and (e) the fact that BMIS itself was audited by a small, obscure accounting firm, Friehling & Horowitz, which has its offices in Rockland County, New York and had no experience auditing entities of the apparent size and complexity of BMIS. 62. KPMG, in its annual audit reports, represented to the limited partners of the Rye Funds that it had performed its audits in accordance with GAAS and that the financial statements were prepared in conformity with Generally Accepted Accounting Principles (GAAP). The American Institute of Certified Public Accountants (AICPA) through the Auditing Standards Board has developed and codified Statements on Auditing Standards (hereinafter referred to as AU Section #) which interpret GAAS. 63. In its annual audit reports, KPMG represented that it examined evidence supporting the amounts and disclosures in the financial statements and that its audits provided it with a reasonable basis to conclude that the financial statements were not materially misstated. 64. These statements were false, as KPMG' s audits did not conform to GAAS. Had KPMG not recklessly violated GAAS, it would have discovered the fraudulent information underlying the Rye Funds' false and misleading financial statements. 18

19 65. GAAS requires that an auditor exercise due professional care in performing an audit and in preparing the audit report. GAAS also requires that each audit be planned and performed with an attitude of professional skepticism. KPMG failed to exercise due professional care in the performance of its audits of the Rye Funds' financial statements during the relevant time period. KPMG failed to adhere to professional auditing standards by: a. failing to understand Rye's internal control structure sufficiently; b. failing to obtain sufficient competent evidential matter; c. failing to amend their audit procedures to take into consideration related party transactions; d. failing to conduct an effective confirmation process; and e. failing to extend its audit procedures in light of the warning signs of fraud. 66. KPMG failed to assess internal controls: GAAS required KPMG to assess the Rye Funds' internal accounting and reporting controls as an integral part of performing their audits of the Rye Funds. AU Section 319, Consideration of Internal Control in a Financial Statement Audit and, for audits after 2006, AU Section 314, Understanding the Entity and its Environment and Assessing the Risk of Material Misstatement, require an auditor to obtain an understanding of internal controls sufficient to plan an effective audit. KPMG knew that the amounts and disclosures in the Rye Funds' financial statements were reliant on internal accounting and reporting controls being carried out by entities other than the Rye Funds. 67. For example, the Rye Funds were relying on the following internal controls being in place and operating effectively, among others, at various other entities: a. the internal controls designed and implemented by the General Partner in monitoring the ongoing activities of the investment advisor (i.e., Madoff); 19

20 b. the internal controls designed and implemented by the General Partner to confirm the Rye Funds' trading activity; c. the internal controls designed and implemented by its investment advisor (Madoff) over the purchase and sale of securities; d. the internal controls designed and implemented by its custodian (i.e., BMIS) to confirm trading activity, the receipt and disbursement of cash and security positions, and the physical security of cash and portfolio positions; and e. the internal controls designed and implemented by its administrator (Tremont Partners, which was then replaced with BNY Alternative Investment Services) over cash, portfolio positions and general ledger account reconciliations and certain custodial services. 68. Therefore, in order for KPMG to perform an audit in accordance with GAAS it was required to obtain an understanding of the internal controls not only at the Rye Funds but also at the General Partner, the investment advisor, the custodian and the administrator. 69. Under AU Section 332, Auditing Derivative Instruments, Hedging Activities, and Investment in Securities, KPMG needed to assess the part of Rye Funds' accounting done by Madoff as the investment advisor, including the following: a. the purchase and sale of securities; b. collection and distribution of income; c. maintenance of security records; and d. the pricing of securities. 20

21 70. To assess Madoff's accounting, KPMG should have reviewed reports issued by independent auditors, internal auditors and regulatory authorities regarding the information systems and internal controls Madoff had implemented. 71. KPMG was obligated to assess the internal controls of Madoff, BMIS, Tremont, and BNY Alternative Investment Services, all of which are considered service organizations. A service organization is an entity that designs and implements internal controls over financial information on which another entity relies. 72. AU Section 324, Service Organizations, governs the audit procedures KPMG should have performed on the internal controls designed and implemented by the service organizations at issue here. KPMG should have obtained audit evidence that the service organizations' controls were in place and operating effectively by performing one of or several of the following audit procedures: a. testing the Rye Funds' internal controls over the activities of the service organizations; b. testing the controls at the service organizations; and/or c. obtaining the service organizations' auditors' reports on controls placed in operation and the related tests of operating effectiveness. Such a report is usually referred to as a SAS 70 Report, which would tell KPMG whether the tests and results of the service organizations' auditors are relevant to the assertions made in the Rye Funds' financial statements. 73. In determining if the service organizations' auditors' reports could be relied on KPMG should have considered the guidance in AU Section 543, Part of Audit Performed by Other Independent Auditors, which obligates the auditor to make inquiries of the professional 21

22 reputation of the service organizations' auditors. Such inquiries would have been directed to the AICPA and applicable state society of certified public accountants and other practitioners. In addition, KPMG should have obtained a representation from the auditors of the service organizations confirming that they are independent under the requirements of the AICPA, and should have informed the auditors of the service organizations that their reports were being relied upon in KPMG's audit of the Rye Funds. KPMG also should have ascertained that the auditors of the service organizations are familiar with GAAP and have conducted their review of the servicing organizations ' internal controls in accordance with GAAS. 74. Additionally, in accordance with AU Section 543, KPMG should have visited the service organizations' auditors to discuss procedures performed and results thereof, reviewed the internal control review programs used by the service organizations' auditors or issued specific instructions outlining work that KPMG would have wanted the service organizations' auditors to perform; and reviewed the working papers of the service organizations ' auditors. 75. Had KPMG performed these audit procedures as required by GAAS in connection with understanding the Rye Funds' internal accounting and reporting controls it would have discovered the following: a. the auditor of the General Partner did not opine on the controls that were relevant to the assertions made by Rye Funds in their financial statements including those related to the purchase and sale of securities; b. the auditor for Madoff and BMIS was unqualified to perform audits or issue reports on the processing of transactions and the related design and effectiveness of internal controls on behalf of Madoff as the investment advisor or BMIS as the custodian; and 22

23 c. the auditor of the administrator did not opine on the controls that were relevant to the assertions made by the Rye Funds in their financial statements including those related to purchase and sale of security transactions and the physical security of portfolio positions. 76. Had KPMG performed these audit procedures as required by GAAS it would have led KPMG to perform the actual tests of internal accounting and reporting controls at the various service organizations, which would have easily unraveled the fraud. 77. KPMG ignored related party warning signs: GAAS, specifically, AU Section 334, Related Parties, says that an audit should identify related parties and the auditor should examine and fully understand related party transactions. GAAS defines a related party as an entity that can control or significantly influence the management or operating policies of another entity to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interest. GAAS warns the auditor to be aware that the substance of a related-party transaction may be significantly different from its form and that financial statements should recognize the substance of transactions rather than merely their legal form. 78. In connection with the audit of the Rye Funds, KPMG was aware of related party transactions. The most prevalent of these was the concentration of multiple roles in entities controlled by Madoff, which is disclosed in the footnotes to the financial statements as follows: The Partnership's assets are currently managed by a single portfolio manager who has investment discretion with respect to such assets.... This manager, through an affiliated registered broker/dealer, also acts as custodian for the Partnership assets it manages. 79. This seemingly innocuous disclosure does not convey that this related-party arrangement, whereby the manager controls the custodian, is akin to allowing the proverbial fox to guard the hen house. Had KPMG properly analyzed this relationship, it would have been 23

24 required to amend the nature, timing and extent of its audit procedures. But KPMG neither obtained an understanding of the business purpose of the relationship nor inspected evidence in possession of the custodian, BMIS. Had KPMG complied with AU Section 334, it would have easily uncovered the fraud. 80. Although the related party relationship was disclosed, this disclosure did not negate KPMG's responsibility under GAAS to probe further and did not remedy the fact that the financial statements were not prepared in accordance with GAAP. 81. Additionally, one of the fundamental internal accounting controls is the segregation of non-compatible duties. Thus, the portfolio manager who initiated the security transactions (Madoff) should have been separate from the custodian, who is responsible for the delivery and receipt of securities, the collection of income, and the holding and safekeeping of Rye's assets (BMIS). Had this basic internal control been operating, KPMG could have relied on the information received from the custodian as representing a complete record of the Rye Fund' security transactions. But without the effective operation of this essential internal control, KPMG was merely receiving a carbon copy of the information from Madoff as both the portfolio manager and the custodian about the Rye Funds' security transactions. 82. KPMG was therefore unable to accomplish the audit objective of determining the completeness and accuracy of the security transactions and the physical security of the resulting positions. 83. The conflict of interest inherent in the overlapping roles of Madoff and BMIS should have been a warning sign to KPMG, yet KPMG recklessly disregarded the risk of fraud. 84. KPMG Relied on Invalid Evidence, Which Was Not Properly Confirmed: KPMG did not verify the assertions in the financial statements with sufficient supporting evidential 24

25 documentation. Claims made in the financial statements about the amount of purchase and sale transactions, dividends, interest and realized gains and investment assets were not supported by persuasive audit evidence, in violation of AU Section 326, Evidential Matter. Although the particular circumstances of each audit dictate the amount and type of evidence that is persuasive, the general principles regarding evidential matter require the auditor to obtain evidence from independent sources, where there are effective internal controls or based on the auditor's direct knowledge. KPMG should have known that the audit evidence it was relying on to support its audit reports was insufficient insofar as: a. It was inadequate because the Rye Funds were incapable of implementing effective monitoring of the investment manager who initiated, executed, and accounted for the transactions; b. It was irrelevant to the assertions made by the Rye Funds in their financial statements because the evidence was obtained from a custodian (BMIS) who was not independent of the investment adviser (Madoff); and/or c. It was insufficient because it was received from unqualified auditors, which KPMG would have realized had it obtained SAS 70 reports from the custodian (BMIS) and the investment adviser (Madoff). 85. KPMG's inability to obtain sufficient and competent evidential matter should have caused KPMG to extend its audit procedures by assessing the internal controls at the service organizations, which would have directed KPMG to discover the fraud or, at the very least, would have caused KPMG to issue a disclaimer audit report in light of the limitation of the audit scope. 25

26 86. Pursuant to AU Section 330, The Confirmation Process, third-party confirmation of amounts included in financial statements is critical for providing reliability for the purposes of an independent audit. KPMG should have obtained evidence directly from third parties about assertions made in the Rye Funds' financial statements, including, among others, the assertions regarding the existence of security purchases and sales, the amounts recorded for dividends, the interest and realized gains, and the investment assets held at year end. 87. GAAS also cautions the auditor that if the third party providing evidence is the custodian of a material amount of his client's assets, the auditor should exercise a heightened degree of professional skepticism. Given that BMIS held 100% of the Rye Funds' assets - and was affiliated with Madoff, the portfolio manager - KPMG should have realized that such skepticism was called for. Had KPMG applied the appropriate level of scrutiny, it would have discovered the substandard audit evidence they had received to support the amounts recorded in the financial statements for securities transactions, dividends, interest, realized gains and investment assets. 88. Without an effective confirmation process, KPMG failed to comply with GAAS and instead relied on evidence that was in essence generated internally and falsified by the single person, who functioned as both portfolio manager and, through BMIS, as the affiliated broker/dealer and custodian. 89. In short, KPMG conducted its audits in a reckless manner, ignoring the obvious areas that required further inquiry, which, had they been pursued, would have revealed the fraud that Madoff had been perpetrating. 26

27 Loss Causation 90. Plaintiffs invested $ 580,000 in the Rye Funds, and received periodic statements showing that his investment had increased in value. As of October 31, 2008, Plaintiffs' limited partnership interest in the Rye Prime Fund was valued at $ 685, As a result of Defendants' conduct, Plaintiffs invested principal in the Rye Prime Fund. This principal and the purported gains thereon were lost when Madoff revealed his fraud on December 11, Defendants' conduct, as alleged herein, proximately caused foreseeable losses to Plaintiffs and other members of the Class. COUNT II For Violation of Section 10(b) of the Exchange Act and Rule 10b-5 of the Securities and Exchange Commission (Against All Defendants) 93. Plaintiffs repeat and reallege each and every allegation contained in the foregoing paragraphs as if fully set forth herein. 94. This Count is asserted against all Defendants and is based upon Section 10(b) of the Exchange Act, 15 U.S.C. 78j(b), and Rule lob-5 promulgated thereunder. 95. During the Class Period, Defendants directly engaged in a common plan, scheme, and unlawful course of conduct, pursuant to which they knowingly or recklessly engaged in acts, practices, and courses of business which operated as a fraud and deceit upon Plaintiffs and the other members of the Class, and made various deceptive and untrue statements of material facts and omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading to Plaintiffs and the other members of the Class. The purpose and effect of said scheme, plan, and unlawful course of conduct was, 27

28 among other things, to induce Plaintiffs and the other members of the Class to purchase limited partnership investment interests in the Rye Funds. 96. During the Class Period, Defendants, pursuant to said scheme, plan, and unlawful course of conduct, knowingly and recklessly issued, caused to be issued, participated in the issuance of, the preparation and issuance of deceptive and materially false and misleading statements to Plaintiffs and the other class members as particularized above. 97. Defendants Rye, Tremont, the Rye Funds, Oppenheimer, and MassMutual knowingly misrepresented the extent and quality of due diligence and oversight that Rye and Tremont afforded the Rye Funds. 98. Defendants E&Y and KPMG knowingly misrepresented that they conducted their audits of the Rye Funds in compliance with GAAS. 99. In ignorance of the false and misleading nature of the statements described above and the deceptive and manipulative devices and contrivances employed by said Defendants, Plaintiffs and the other members of the Class relied, to their detriment, on such misleading statements and omissions in purchasing limited partnerships in the Rye Funds Plaintiffs and the other members of the Class have suffered substantial damages as a result of the wrongs alleged herein in an amount to be proved at trial By reason of the foregoing, Defendants directly violated Section 10(b) of the Exchange Act and Rule lob-5 promulgated thereunder in that they: (a) employed devices, schemes, and artifices to defraud; (b) made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (c) engaged in acts, practices, and a course of 28

29 business which operated as a fraud and deceit upon Plaintiffs and other members of the Class in connection with their acquisitions of limited partnership interests in the Rye Funds. COUNT III For Violation of Section 20(a) of the Exchange Act (Against Rye, Tremont, Oppenheimer, and MassMutual) 102. Plaintiffs repeat and reallege each and every allegation contained in the foregoing paragraphs as if fully set forth herein Defendants Rye and Tremont acted as a controlling person of the Rye Funds within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their positions, participation in and/or awareness of the Rye Funds' operations, and/or intimate knowledge of the Rye Funds' products, sales, accounting, plans and implementation thereof, they had the power to influence and control and did influence and control, directly or indirectly, the decision-making of the Rye Funds, including the content and dissemination of the various statements that Plaintiffs contend are false and misleading. Defendants Rye and Tremont had the ability to prevent the issuance of the statements or cause the statements to be corrected Defendant Oppenheimer acted as a controlling person of Tremont within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of its position, participation in and/or awareness of the Rye Funds' operations, and/or intimate knowledge of the Rye Funds' products, sales, accounting, plans and implementation thereof, Oppenheimer had the power to influence and control and did influence and control, directly or indirectly through Tremont, the decision-making of the Rye Funds, including the content and dissemination of the various statements that Plaintiffs contend are false and misleading. Defendant Oppenheimer had the ability to prevent the issuance of the statements or cause the statements to be corrected. 29