Repex Ventures S.A v. Madoff et al Doc. 259 Att. 2. Exhibit B. Dockets.Justia.com

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1 Repex Ventures S.A v. Madoff et al Doc. 259 Att. 2 Exhibit B Dockets.Justia.com

2 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK In Re HERALD, PRIME and THEMA ) Civil Action No. 09 CIV 289 (RMG) (HBP) FUNDS SECURITIES LITIGATION ) (Consolidated with 09 CIV 2032 and ) 09 CIV 2568) DECLARATION OF GRAHAM FRASER RITCHIE QC I, Graham Fraser Ritchie QC, of Charles Adams Ritchie & Duckworth, attorneys-at-law, Zephyr House, Mary Street, Grand Cayman, Cayman Islands, declare, under penalty of perjury under the laws of the United States of America that the foregoing is true and correct:- INTRODUCTION I am the senior litigation partner with Charles Adams Ritchie & Duckworth ("CARD"). I was enrolled as a solicitor of the Senior Court of England and Wales in 1979 and admitted to the Bar of the Cayman Islands as an attorney-at-law in I was appointed Queen's Counsel in 2004, 2. I have extensive experience in commercial litigation including professional negligence claims and in particular claims involving auditors 3. My background, qualifications and experience are set out at Appendix A. PURPOSE OF THIS DECLARATION 4. I have been requested by Hughes Hubbard & Reed LLP of New York, counsel for the defendant, Ernst & Young Ltd (Cayman Islands) ("EY Cayman"), in this action to provide an opinion on issues of Cayman law. 5. By way of full disclosure I have not acted for EY Cayman in the past. I have not had any role in this litigation other than to provide this opinion on Cayman law. 6. This declaration is based on my personal knowledge and over 26 years experience practicing Cayman Islands law and on my review of the following documents:- (i) The Second Consolidated Amended Complaint dated 1 April 2011 filed in these proceedings (the "Proposed Prime Complaint"); 1

3 (ii) The [Proposed] Third Amended Class Action Complaint dated 1 April 2011 filed in these proceedings (the "Proposed Herald Complaint"), (together the "Consolidated Complaints"); (iii)the Amended and Restated Memorandum and Articles of Association of Prime Fund dated 24 April 2006 (the 'Prime Articles"), and 25 April 2007 (the "Amended Prime Articles"); (iv)the Articles of Association of the Herald Fund SPC dated 24 March 2004 (the "Herald Articles"); (v) The Prime Fund Offering Memorandum dated July 2006 (the "Primeo OM"); (vi)the Herald Fund SPC Offering Memorandum dated 31 July 2005 (the "Herald OM"); (vii)the Herald Fund SPC Supplement to the Offering Memorandum dated 1 May 2006 (the "Herald Fund Supplement"); (viii) The Amended Class Action Complaint dated 11 February 2010 (the "Herald Complaint"); and (ix)the Consolidated Amended Complaint dated 11 February, 2010 (the "Prime Complaint"). 7. The opinions I express in relation to the Consolidated Complaints are equally applicable to the existing complaints referred to at paragraph 6(viii) and (ix) above, Upon the request of the Court, I can provide copies of all legal authorities referred to herein CAYMAN ISLANDS LAW 8. I have read the declaration of William James Tyre Bagnall dated 29 June 2011, ("Mr. Bagnall's Declaration") including paragraphs 6 to 10 inclusive. I confirm that I agree with Mr. Bagnall's summary of the sources of Cayman Islands law and their effect and application. AUDITOR'S DUTY OF CARE TO THIRD PARTIES 9. Under Cayman Islands law, accountants like other professionals owe duties of care to their clients but do not owe them to third parties in the absence of some "special factor" or 'extra ingredienr, the effect of which is to create a special relationship between the accountant and the third party. Thus in the context of a corporate audit, the auditor of a company will owe contractual duties and duties of care in tort to the company itself. Paragraph Jackson & Powell on Professional Liability Edition. 2

4 10.As a general rule and in the absence of such a "special factor" or "extra ingredient" a shareholder in a company is not owed a free-standing duty of care by the auditor of a company with respect to investment losses arising from a diminution of the value of the shares in the company or for investment decisions taken in reliance upon the audited financial statements. 11. This principle was established in the paradigm English case of Capam Industries plc v Dickman [ AC 605, ("Caparo") a decision of the House of Lords (now the Supreme Court but for convenience referred to in this declaration as the House of Lords). Although the judgment in that case considered English statutory provisions that are not reflected in the statutes of the Cayman Islands, the relevant principles to be extracted from this decision (which will be discussed in more detail below), have been cited with approval by Smellie CJ in the Cayman case of In Re Omni Securities Limited (No. 3) 1998 CILR 275 ("Omni Securities"). 12.Caper recognised the need for courts to impose limits on the situations which can give rise to a duty of care, particularly in the field of economic loss. In order to keep the tort of negligence within reasonable bounds, the courts require some extra ingredient beyond mere foreseeability of loss If there were no extra ingredient, then there would in the words of Cardozo CJ in Ultramares Corp v Touche (1931) 174 N. E. 441 at be the risk of imposing "a liability in an indeterminate amount for an indeterminate time to an indeterminate class". The need for constraint is particularly acute in the case of accountants, since the range in number of persons who may claim loss consequent upon negligent performance of an audit report are potentially very large. 3 In Caper, the House of Lords held that liability for economic loss for negligent misstatement was confined to cases where the statement or advice had been given to a known recipient "for a specific purpose" of which the maker was aware and upon which the recipient had relied and acted to his detriment. 13. Over the years, various tests or approaches had been formulated in order to determine whether on particular facts the defendant owed to the plaintiff a duty of care in tort. This has included the three-fold test which was adopted in Caparo based on:- z Cited by Lord Bridge of Harwich at page 621-D of his judgment in Caporo; see paragraph 17 below. 3 Lord Oliver in Caparo recognised at pages 632/633 the need to keep the law of negligence "within the bounds of common sense and practicality'. 3

5 (i) foreseeability of loss; (ii) proximity of relationship; and (iii) whether it would be just and reasonable to impose a duty In my opinion, it is clear from Caper, that to succeed in pleading a "special factor" or "extra ingredient", the plaintiff would need to establish that the accountant has undertaken a specific responsibility to a particular shareholder or defined group of shareholders and that:- (i) the accountant was aware of the nature of the particular transaction or transactions of a particular kind which, the particular shareholder or defined group of shareholders had in mind; (ii) the accountant knew or ought to have known that his statement would be communicated to the particular shareholder or defined group of shareholders; (iii) the accountant knew or ought to have known that the particular shareholder or defined group of shareholders was/were likely to rely on the statement in deciding whether or not to proceed with the particular transaction or the transactions of a particular kind; and (iv) the particular shareholder or defined group of shareholders did rely on the statement in question to his/their detriment Lord Bridge, in his judgment in Caper, analysed two decisions of the House of Lords following the seminal decision in Hedley Byrne and Co Ltd. v Heller and Partners Ltd. (1964) AC 465 ("Hedley Byrne'), namely Smith v. Eric S. Bush and Harris v Wyre Forest District Council (two appeals which were heard together) [ AC 831, where the surveyors in both cases were held liable for negligent valuations of properties which the plaintiffs purchased in reliance on the valuation reports. Following that analysis Lord Bridge said this at page 620h:- ' The other two tests are known as the "assumption of responsibility" test and the "incremental approach". Smellie CJ in Omni Securities preferred the three-fold test describing it at page 281 as the 'tripartite test knowledge, reliance, detriment'. 5 And see also paragraph Jackson & Powell on Professional Liability 6'h Edition. 4

6 "The salient feature of all these cases is that the defendant giving advice or information was fully aware of the nature of the transaction which the plaintiff had in contemplation, knew that the advice or information would be communicated to him directly or indirectly and knew that it was very likely that the plaintiff would rely on that advice or information in deciding whether or not to engage in the transaction in contemplation." He distinguished this from the situation where: "a statement is put into more or less general circulation and may foreseeably be relied on by strangers to the maker of the statement for any one of a variety of different purposes which the maker of the statement has no specific reason to anticipate. To hold the maker of the statement to be under a duty of care in respect of the accuracy of the statement to all and sundry for any purpose for which they may choose to rely on it is [not only] to subject him, in the classic words of Carriozo CJ, to liability in an indeterminate amount for an indeterminate time to an indeterminate class; see Ultramares Corporation v Touche (1931) 174 N.E. 441, " 16 In a similar vane Lord Roskill had this to say beginning at page 628g of his judgment:- "The submission that there is virtually unlimited and unrestricted duty of care in relation to the performance of an auditor's statutory duty to certify a company's accounts, a duty extending to anyone who may use those accounts for any purpose such as investing in the company or lending the company money, seems to me untenable. No doubt it can be said to be foreseeable that those accounts may find their way into the hands of persons who may use them for such purposes or indeed other purposes and lose money as a result. But to impose a liability in those circumstances is to hold, contrary to all the recent authorities, that foreseeability alone is sufficient, and to ignore the statutory duty which enjoins the preparation of and certification of those accounts." 17. Caparo established that unless there are special factors to the contrary, an auditor's duty does not give rise to specific duties to individual or specific shareholders. Given that the interests of the shareholders as a body in the proper management of the company's affairs is indistinguishable from the interests of the company itself any loss suffered by the shareholders, sustained by virtue of a negligent audit will be recouped by a claim brought by the company itself not by the shareholders. As Lord Bridge observed at page 626e, of his judgment:- "1 find it difficult to visualise a situation arising in the real world in which the individual shareholder could claim to have sustained a loss in respect of his existing shareholding referable to the negligence of the auditor which could not be recouped by the company." 18. Similarly, Lord Oliver at page 654c of his judgment had this to say:-

7 "In my judgment, accordingly, the purpose of which the auditors' certificate is made and published is that of providing those entitled to receive the report with information to enable them to exercise in conjunction those powers which their respective proprietary interests confer upon them and not for the purposes of individual speculation with a view to profit. The same considerations as limit the existence of a duty of care also, in my judgment, limit the scope of the duty and I agree with O'Connor L.J. that the duty of care is one owed to the shareholders as a body and not to individual shareholders." 19. Here, the common theme in the Consolidated Complaints with respect to the negligence based counts against EY Cayman is that EY Cayman had a "special relationship" with the plaintiffs and the Class that gave rise to a duty of care. It appears that the only pleaded fact relied on by the plaintiffs in seeking to establish this special relationship is that the audit opinions allegedly were issued directly to the plaintiffs and the Class as investors and shareholders. It is then asserted that EY Cayman knew that the audited opinions would be relied on by the plaintiffs and the Class in deciding to make or retain their investments in the Funds. 8 It is worth looking at the relevant corporate documents with respect to the Primeo and Herald Funds by virtue of which the shareholders were to be provided with the audited accounts. These documents are discussed below. 20. Under the Amended Prime Articles it is a matter for the directors to determine whether and to what extent and under what conditions or regulations the accounts and books of the company or any of them shall be open to the inspection of members not being directors. "No member (not being a Director) shall have any right of inspecting any account or book or document of the Company except as conferred by Statute, or authorised by the Directors or by the Company in general meeting:. 21. The Herald Articles incorporate similar regulations The Amended Primeo Articles provide that the auditors shall, if so required by the directors, make a report on the accounts of the company at the next annual general meeting following their appointment in the case of a company registered as an ordinary company and at the next extraordinary general meeting in the case of a company which is an exempt company and at any other time during their term of 6 Paragraphs 260 and 268 of the Proposed Prime Complaint, Counts 8 and 9 respectively; and paragraphs 713 and 721 of the Proposed Herald Complaint, Counts 10 and 11 respectively. 'Regulation 189 of the Amended Prime Articles. Regulation 144 of the Herald Articles. 6

8 office upon request of the directors at any general meeting of the members. 9 The Herald Articles contain a provision which is very similar In the Herald OM dated 31 st July 2005, it is recorded that in each year the directors shall cause to be prepared an annual report and annual audited accounts for the Fund. These were to be forwarded to the shareholders within 4 months after the end of each financial year. A copy of the audited financial reports shall be posted to each shareholder at his registered address and will also be made available at the offices of the administrator In the Prime OM there is similar provision. Here it is stated that the annual report and audited statements of the Fund were to be sent to shareholders within 120 days of the end of each fiscal year or as soon thereafter as possible and in any event within 6 months of the end of the fiscal year, There are two important observations to make with respect to the arrangement which had been put in place for the delivery of the audited accounts to the shareholders of the Prime Fund and the Herald Fund:- (i) firstly, the audited accounts were to be provided to the shareholders of the two Funds as a general body; and (ii) secondly, the audited accounts were not being provided for the purpose of any particular transaction or transactions of a particular kind under contemplation by the shareholders or any of them. Put another way, the audited accounts were not being provided to the shareholders for a specific purpose. 26. In my opinion, the mechanism which was put in place by the Funds for the provision of financial information to the shareholders is analogous to the mechanism contained in the statutory provisions under the English Companies Act which fell for consideration in Caparo. In my view, in both instances the central and primary purpose was to provide information regarding the financial affairs of the company in question to 5 Regulation 193 of the Amended Prime Articles. 1 Regulation 149 of the Herald Articles. 11 Page 19 of the Herald OM. 12 Page 24 of the Prime OM. 7

9 those entitled to receive the audit report to enable the informed exercise of those powers which their respective proprietary interest confer upon them." 27. The information contained in the audited accounts could be used by the shareholders for all sorts of purposes. In my opinion it cannot legitimately be asserted that EY Cayman had assumed responsibility to each and all of the shareholders of the Funds for all and any losses arising from whatever use they made of the audited accounts including any decision to buy or sell shares in the Funds. In this context, it is worth noting that the Class of shareholders referred to in the Consolidated Complaints appears from the plaintiffs own case to be quite significant in size In my opinion the facts of this case appear to fall squarely within the general bar against shareholder actions of this type as established in Capara The plaintiffs are unable, in my opinion, to establish a sufficient proximity of relationship between themselves and EY Cayman to give rise to a duty of care owed to them and in the circumstances of this case, in my view, it would be inconceivable that a court would consider it just and reasonable to impose a duty on EY Cayman with respect to any losses which may be incurred by the shareholders with respect to any and all transactions that they may enter into in reliance upon the audited accounts delivered to the general body of shareholders. APPLICATION OF CAYMAN LAW TO PLAINTIFFS' CLAIMS Negligence-based claims Counts 8, 9 and 22 in the Proposed Prime Complaint; Counts 10 and 11 in the Proposed Herald Complaint 29. In view of my statements at paragraphs 9 to 28 inclusive above, there is no direct duty of care owed by EY Cayman to the plaintiffs which would give rise to any claim based in negligence against EY Cayman. 30. With respect to the claim for negligent misrepresentation, under Cayman Islands law a misrepresentation of fact can give rise to liability in the tort of negligence as established by the principles laid down in the Hedley Byrne case, to which I have 13. Lord Oliver In Collar at page 631E-F and 654C. 14 See for example paragraph 641 of the Proposed Herald Complaint which states that "the Class is so numerous that joinder of all members is impracticable' and the exact number is unknown to the plaintiffs but they believe the numbers are in the hundreds and perhaps the thousands." 8

10 already referred at paragraph 15 above. The House of Lords held that a person who made a negligent statement could owe a duty of care to a person who suffered loss through reliance upon that statement, but that in the absence of a contractual relationship, in order for a duty of care to be owed there must be a "special relationship" between the plaintiff and defendant. In his judgment Lord Reid stated that a special relationship would arise where:- "the party seeking the information and advice was trusting the other to exercise such a degree as to the circumstances required, where it was reasonable for him to do that and where the other gave the information or advice when he knew or ought to have known that the inquirer was relying on him." 31. I refer to paragraphs 53 and 54 of Mr. Bagnalt's Declaration. I agree with his opinion; there is no tort of "gross negligence" distinct from negligence in the Cayman Islands, 32. I refer to paragraphs 24 to 28 inclusive of Mr. Bagnalle Declaration which deal with the principle of reflective loss. I confirm that I agree with his opinion. 33. In the circumstances based upon the facts pleaded in the Consolidated Complaints, in my opinion, a Cayman court would not allow the plaintiffs to bring a claim against EY Cayman in view of the reflective loss principle even if the plaintiffs were able to establish that EY Cayman owed them a direct duty of care. Aiding and Abetting Claims Count 10 in the Proposed Prime Complaint and Counts 3, 18 and 19 In the Proposed Herald Complaint 34. I refer to paragraphs 91 to 92 and paragraphs 105 to 107 of Mr. Bagnall's Declaration and confirm that I agree with his opinion. Claims for aiding and abetting conversion, aiding and abetting breach of fiduciary duty and aiding and abetting fraud are not actionable under Cayman Islands law. 35. Furthem-tore, the facts as pleaded in the Consolidated Complaints do not establish any dishonesty on the part of EY Cayman which is the key element to be able to establish "dishonest assistance" in breach of fiduciary duty, which is a cause of action recognised by the Cayman court's 15 See Royal Brunei Airlines v Tan [ AC 378, Privy Council and Grupo Torras v AI Sabah [20001 ALL ER (D)

11 Fraud Count 21 in the Proposed Prime Complaint 36. I refer to paragraphs 72 and 73 of Mr. Bagnall's Declaration. I confirm that I agree with his opinions. The facts as pleaded in the Consolidated Complaints do not establish deceit or a lack of honest belief on the part of EY Cayman and therefore, I am of the opinion a Cayman court would not allow the plaintiffs to bring a claim for fraud against EY Cayman. Civil Conspiracy Count 1 in the Proposed Herald Complaint 37. I refer to paragraphs 84 to 89 inclusive of Mr. Bagnalrs Declaration. I confirm that I agree with his opinion. 38. Based upon the pleaded case in the Proposed Herald Complaint the key elements to prove the tort of conspiracy are not established. In the circumstances I am of the opinion that a claim for conspiracy against EY Cayman would not be actionable under Cayman Islands law. Dated this 'day of June 2011 GRAHAM FRASER RITCHIE Q.C. 10

12 APPENDIX A Graham Fraser Ritchie Q.C. Graham is the Senior Litigation Partner at Charles Adams Ritchie & Duckworth ("CARD"), being one of the founding partners of CARD in 1991 which is the successor firm to Charles Adams & Co, where he worked prior to that. Graham has over 26 years litigation experience in the Cayman Islands. Prior to joining Charles Adams & Co. in 1984, Graham trained and worked in England where he qualified. Graham was appointed Queen's Counsel in November Graham undertakes all types on commercial litigation but has particular expertise in professional negligence, particularly claims involving auditors, international asset tracing, trusts and funds litigation. He has appeared as both leading and junior counsel in many landmark cases in the Cayman Islands including the Omni Securities decisions, details of which are set out below, one of the leading auditor negligence cases in the Cayman Islands. The following are some examples of reported cases in which Graham has appeared: Attorney General v. Bank of Nova Scotia CILR 418 BNS v. Emerald Seas Ltd CILR 180 Balboa Atlantico SA v. Registrar of Lands CILR 304 Gee v Altridge 1987 CILR 342 Cayman Islands News Bureau v. Cohen CILR 475 Lemos v. Coutts CILR 460 CA Deutsch-Sildamerikanische Bank A. G. v. Code/co 1996 CILR 1 Svanstrom v Jonasson 1997 CILR 192* In re Cotorro Trust [1997] C1LR 1, In re Code/co 1999 CILR 42 Grupo Torras S.A. v. Bank of Butterfield 2000 C1LR 452 Omni Securities v. Deloitte Touche 2000 CILR 102 CA In the Matter of Omni Securities Limited (No. 4) 1999 C1LR 126, In the Matter of Omni Securities Limited (No. 5) 2000 CILR 201; and Omni Securities Limited v Deloitte and Touche et al 2000 CILR 102. In the matter of Al Sabah CILR 373 (P.C)*

13 APPENDIX A Information & Communication Technology Auth, V Cable & Wireless (C./.) Ltd 2008 CILR N [6] (C.A.) * (Did not appear as Counsel at the hearing but had overall responsibility as the Partner in charge) Graham has acted as an expert witness on Cayman Islands law in the state courts of Florida and New York. Papers/Publications Graham has presented many papers on matters of Cayman law relevant to, inter alia, the obtaining of evidence in the Cayman Islands for the purpose of foreign civil proceedings, the enforcement of foreign judgments and the tracing and recovery of assets misappropriated by fraud. He has co-authored the following: "International Tracing of Assets," published by F.T. Law & Tax; "Getting the Deal Through Dispute Resolution " (most recently published by Herbert Smith); "Getting the Deal Through Restructuring & Insolvency 2007, 2008, 2009 and 2010"; "International Fraud & Asset Tracing 2008" edited by Herbert Smith; "Cross-Border Handbook - Dispute Resolution Handbook 2009/10: Volume 1" edited by the Practical Law Company; and The Restructuring Review edited by Christopher Mallon, Memberships Member of the Cayman Islands Law Society; Member of the Caymanian Bar Association; Honorary Member of the Commercial Bar Association of England; Member of the Law Society of England & Wales; Member of the International Bar Association; and Member of the Rules Committee and the Insolvency Rules Committee of the Grand Court of the Cayman Islands.