Craig Jalbert, in his Capacity as Trustee for F2 L v. Miranyan

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF DELAWARE

Tn re: Chapter 11

F-Squared Investment Management, LLC, et Case No. 15-11469 (LSS)

Debtors.

Craig Jalbert, in his Capacity as Trustee for

F2 Liquidating Trust,

VS,

Adrienne Souza, Ady. No. 17-50716

Agnes Carol McClelland, Adv. No. 17-50718

Ann Aghababian, Adv. No. 17-50719 □

Charles Hart, Adv. No. 17-50722

Christine Martin, Adv. No. 17-50723

David Souza, Ady. No. 17-50725

Carlos Oliveira, Adv. No, 17-50741

David Alan Dunaway, Adv. No, 17-50749

F. Warren McEarlan, Adv. No, 17-50752

Geordie McClelland, Adv. No. 17-50755

George McClelland, Adv. No. 17-50758

Graham Hart, | Adv, No, 17-50767

Hazel McClelland, Adv. No. 17-50772

Joseph Miskel, . Adv. No. 17-50776

Jacquelyn McClelland, Adv. No. 17-50786

Kimberly Collins, Adv. No. 17-50787

John Chu, Adv. No. 17-50791

Leonard. Gurevich, Adv. No. 17-50793

John M. Weyand 2005 Trust, Adv. No. 17-50797

Luiza Miranyan, Adv. No. 17-50798

John F, Holsteen Declaration of Trust, Adv. No. 17-50799

Jonathan Stern, Adv. No. 17-50802

Rodrigo Franco Toso, Adv. No. 17-50819

Zhenyu Yuan, Ady. No. 17-50841

Keith Jarrett, Adv. No. 17-50848

Lindsay Hart, Adv. No. 17-50849

Lindsay McClelland, Ady. No. 17-50850.

McClelland Irrevocabie Grantor Trust, Adv. No, 17-50854

Millennium Trust Company, LLC, Adv. No. 17-50855

MME-NH LLC, Adv. No. 17-50856

Paul Martin, Adv. No. 17-50858

Quinn McClelland Hart, Adv. No, 17-50859

Revocable Trust of Charles E. Jacobs, Adv. No. 17-50861

Roberts Family 1998 Exempt Trust, Adv. No. 17-50863

Sea View Investments LLC, Adv. No. 17-50865

Thomas Roberts, Adv. No. 17-50866

Thomas Littauer, Adv. No. 17-50870

Tina Eng, . Adv. No. 17-50873 .

William Weyand. Adv. No. 17-50877

. OPINION

This is the second opinion addressing motions to dismiss complaints filed by the

trustee of the F2 Liquidating Trust (the “Trustee” or “Plaintiff’). In the one hundred plus

adversary proceedings filed by the Trustee, he seeks to avoid as fraudulent conveyances

and/or preferential transfers bonus payments made by F-Squared Investment Inc. and/or

tax and profit distributions made by F-Squared Management, LLC.

In my first opinion, I addressed the Trustee’s per se theory of liability with respect to

discretionary bonus payments. L rejected the Trustee’s argument that discretionary bonuses

_ without previously-enunciated metrics could never provide “value” for purposes of

fraudulent conveyance laws and therefore granted the motions to dismiss challenging that

theory. But I found the Trustee’s allegations sufficient as to the insider status of certain

Defendants, and permitted the preference counts, which otherwise went unchallenged by

those defendants, to proceed.

In this opinion, I address a separate subset of motions to dismiss. Here, Defendants

ask me to review the sufficiency of the allegations in the complaints regarding Debtors’

financial condition relative to the challenged transfers. This opinion calls upon me to

decide what reasonable inferences can be drawn from the complaints. It also requires me to

address the sufficiency of a novel and largely undeveloped theory: that F-Squared was

“insolvent since its inception” because of violations of the securities law associated with the

advertising of its AlphaSector Indexes. □

I find the allegations in the complaints insufficient to support the requisite financial

condition. And, I will not permit the excessive liberty taken in the Trustee’s answering brief

and unwarranted reply brief to add facts nowhere found in the complaints. Accordingly, □ -

will grant the motions to dismiss. Whether the ‘Trustee will be able to amend the complaints

will await a properly-filed motion to amend.

Background’

F-Squared Management, LLC and its subsidiaries (collectively, “Debtors”’) were

investment management and research firms whose primary business was selling Debtors’

portfolio model services to investment advisors in the advisory, institutional, retail and

retirement markets. In order to provide products and services, Debtors created and licensed

a series of specialty indexes (the “AlphaSector Indexes”), covering a range of asset classes.

‘The AlphaSector Indexes were based on sector rotation strategies that used quantitative

models, programmed to measure the volatility and price movements of exchange-traded

funds as criteria for inclusion and weighting in the indexes. As of June 30, 2014, there were

1 As required on a motion to dismiss the facts recited herein are taken from the complaints and

documents appropriately considered. Pension Benefit Guar. Corp, v. White Consol. Indus., Inc., 998 □□□□

1192, 1196 (3d Cir. 1993). A court is not required to make findings of fact or conclusions of law on

a motion to dismiss under Fed. R. Civ. P. 12, made applicable by Fed. R. Bankr. P. 7012, and I

none. See Fed. R. Civ. P. 52(a)(3), made applicable by Fed. R. Bankr. P. 7052,

2 The debtors in these cases are: F-Squared Investment Management, LLC, F-Squared Investments,

Inc., F-Squared Retirement Solutions, LLC, F-Squared Alternative Investments, LLC, F-Squared.

Solutions, LLC, F-Squared Institutional Advisors, LLC, F-Squared Capital, LLC, AlphaSector LLS

GP 1, LLC, and Active Index Solutions, LLC.

‘approximately $28.5 billion in assets under advisement invested by Debtors’ clients using

the AlphaSector Indexes, including $13 billion in mutual fund assets sub-advised by

Debtors.

F-Squared was organized as a limited liability company that paid no income taxes of

its own.’ Income taxes associated with F-Squared were instead paid on a ratable basis by

individual or entity with an ownership interest in F-Squared. In 2013, the Securities &

Exchange Commission (the “SEC”) began an investigation into potential violations of

federal securities laws related to Debtors’ advertising of the AlphaSector Indexes’

performance track record between April 2001 and September 2008. On December 22,

2014, Debtors agreed to a settlement (the “Transfer Order”) of an administrative cease-and-

desist proceeding with the SEC that, among other things, required Debtors to admit to false

advertising during the relevant time period, pay a $5 million penalty to the SEC, disgorge

$30 million in related profits and adhere to certain future reporting and compliance

requirements.

Following the entry of the Transfer Order, Debtors encountered various financial

difficulties as a result of the negative publicity and the payment of the $35 million. A

number of clients terminated their business relationships with Debtors, creating a sharp

decrease in revenues. In response to the loss of business, Debtors instituted several cost-

cutting measures, including a 30% reduction in Debtors’ workforce. Specifically, in March

2015, Debtors reduced their workforce from 162 to 117 employees. As a result of the

3 At least one of the F-Squared entities is organized as a corporation. Since no Defendant has

moved to dismiss the Complaints because the Trrustee’s allegations fail to distinguish among debtor

entities, I will accept as true that the relevant Debtor is a limited liability company for purposes of

this Opinion. And, I will accept the parties’ convention and refer to Debtors as F-Squared

throughout this Opinion except when identifying the transferee of the challenged transfers.

. 4 .

reduction in workforce, Debtors incurred approximately $1.3 million in severance

obligations. Also, as a direct result of the SEC investigation, and in furtherance of the

eventual settlement under the Transfer Order, Debtors incurred an estimated. $17.2 million

in direct legal fees, of which approximately $10 million was recovered through Debtors’

available insurance. The Trustee alleges that “millions more” were advanced to Debtors’

directors and officers for payment of legal fees related to the investigation.

The Transfers

Prior to the execution of the Transfer Order and in the two years leading up to the

filing of its bankruptcy petition, F-Squared Investment Management LLC made periodic

‘payments to Defendants so that each Defendant could pay income taxes on its F-Squared

equity interest (the “Tax Distributions”). Specifically, Tax Distributions were made on ot

about August 29, 2013, December 5, 2013, March 27, 2014, April 8, 2014, June 5, 2014,

September 9, 2014 and March 30, 2015.* A “profit distribution” on account of an equity

4 The majority of the listed dates for the Tax Distributions were taken from the Complaint filed

against George McClelland in Adv. No. 17-50758, with the exception of the March 30, 2015 date

that is taken from the Complaint against Leonard Gurevich in Adv. No. in 17-50793, The dates of

distributions to other Defendants may vary by a day or two, but any discrepancy does not affect the

outcome of these Motions to Dismiss. Defendants who received Tax Distributions are: Adrienne

Souza (Adv. No. 17-50716), Agnes Carol McClelland (Adv. No. 17-50718), Ann Aghababian (Adv.

No. 17-50719), Charles Hart (Adv. No. 17-50722), Christine Martin (Adv. No. 17-50723), David

Souza (Adv. No. 17-50725), F. Warren McFarlan (Adv. No. 17-50752), Geordie McClelland (Adv.

No. 17-50755), George McClelland (Adv. No. 17-50758), Graham Hart (Adv. No. 17-50767), Hazel

McClelland (Ady. No. 17-50772), Jacquelyn McClelland (Adv. No. 17-50786), John Chu (Adv. No.

17-50791), John F, Holsteen Declaration of Trust (Adv. No. 17-50799), John M. Weyand 2005

Trust (Ady. No. 17-50797), Jonathan Stern (Adv. No. 17-50802), Joseph Miskel (Adv. No. 17-

50776), Keith Jarrett (Adv. No. 17-50848), Leonard Gurevich (Adv. No. 17-50793), Lindsay Hart

(Adv. No. 17-50849), Lindsay McClelland (Adv. No. 17-50850), Luiza Miranyan (Adv, No. 17-

50498), McClelland Irrevocable Grantor Trust (Adv. No. 17-50854), Millennium Trust Company,

LLC (Adv. No. 17-50855), MMF-NH LLC (Ady. No. 17-50856), Paul Martin (Adv. No. 17-50858),

Quinn McClelland Hart (Adv. No. 17-50859), Revocable Trust of Charles E. Jacobs (Adv. No. 17-

50861), Roberts Family 1998 Exempt Trust (Adv. No. 17-50863), Rodrigo Franco Toso (Adv. No.

17-50819), Sea View Investments LLC (Adv. No. 17-50865), Thomas Littauer (Adv. No. 17-50870),

Thomas Roberts (Adv. No. 17-50866), Tina Eng (Adv. No. 17-50873), and William Weyand (Adv.

No. 17-50877).

interest was also made to certain Defendants on or about January 16, 2014 (“Profits

Distributions”).> Also, on or about February 6, 2014, December 29, 2014, February 13,

2015 and April 15, 2015, F-Squared Investments Inc. paid certain Defendants bonuses’ (the

“Bonus Payments” and, with the Tax Distributions and the Profit Distributions,.

collectively, the “Transfers”). The Trustee contends that, as a result of Debtors’ admitted

securities law violations, Debtors were insolvent “since inception” and thus were insolvent

on each day a transfer was made to any Defendant.

Procedural Background

On July 8, 2015, Debtors filed voluntary petitions under chapter 11 of title 11 of the

United States Bankruptcy Code. Plaintiff Craig Jalbert was appointed the trustee for the F2

Liquidating Trust effective January 22, 2016, pursuant to Debtors’ Joint Plan of

Liquidation.

5 As with the dates listed for the Tax Distributions, this date may vary by a day or two depending on

the Defendant. Defendants who received a Profit Distribution are: Adrienne Souza (Adv. No. 17-

50716), Agnes Carol McClelland (Adv. No. 17-50718), Ann Aghababian (Ady. No. 17-50719),

Charles Hart (Adv. No. 17-50722), Christine Martin (Adv. No, 17-50723), David Souza (Adv. No.

17-50725), F. Warren McFarlan (Adv. No. 17-50752), Geordie McClelland (Adv, No. 17-50755),

George McClelland (Adv. No. 17-50758), Graham Hart (Adv. No, 17-50767), Hazel McClelland.

(Ady. No. 17-50772), Jacquelyn McClelland (Adv. No. 17-50786), John Chu (Adv. No. 17-50791),

John F. Hoisteen Declaration of Trust (Adv, No. 17-50799), John M. Weyand 2005 Trust (Adv. No.

17-50797), Jonathan Stern (Adv. No. 17-50802), Joseph Miskel (Adv. No. 17-50776), Keith Jarrett

(Adv. No. 17-50848), Lindsay Hart (Adv. No. 17-50849), Lindsay McClelland (Ady. No, 17-50850),

McClelland frrevocable Grantor Trust (Adv. No. 17-50854), Millennium Trust Company, LLC

(Ady. No. 17-50855), MME-NH LLC (Adv. No. 17-50856), Paul Martin (Adv. No. 17-50858),

Quinn McClelland Hart (Adv. No. 17-50859), Revocabie Trust of Charles E. Jacobs (Adv. No, 17-

50861), Sea View Investments LLC (Adv. No. 17-50865), Thomas Littauer (Adv. No. 17-50870),

Tina Eng (Adv. No. 17-50873), William Weyand (Adv. No. 17-50877) and Kimberly Collins (Adv.

No. 17-50787). Additionally, on October 30, 2014, F-Squared Investment Management, LLC also

repurchased its own stock from George McClelland in exchange for $86,184.

6 These dates, too, may vary by a couple of days, depending on the Defendant. Defendants who

received Bonus Payments are: Carlos Oliveira (Adv. No. 17-50741), David Alan Dunaway (Adv.

No, 17-50749), Leonard Gurevich (Adv. No. 17-50793), George McClelland (Adv. No. 17-50758),

Joseph Miskel (Adv. No. 17-50776), Luiza Miranyan (Adv. No. 17-50498), Rodrigo Franco Toso

(Adv. No. 17-50819), Zhenyu Yuan (Adv. No. 17-50841) and Kimberly Collins (Adv. No.

17- 50787).

6

On July 17, 2017, the Trustee filed complaints (the “Complaints”) against each

Defendant seeking recovery of Bonus Payments, Tax Distributions and/or Profit -

Distributions as constructive fraudulent transfers and/or preferential transfers.

The McClelland Defendants

On November 7, 2017, Defendants Agnes Carol McClelland, Ann Aghababian,

Charles Hart, Geordie McClelland, George McClelland, Graham Hart, Hazel McClelland,

Jacquelyn McClelland, Lindsay Hart, Lindsay McClelland, the McClelland Irrevocable

Grantor Trust and Quinn McClelland Hart (the “McClelland Defendants”) jointly filed

their Motion to Dismiss, together with their opening brief.’ On December 22, 2017, the

Trustee filed an answering brief.2 The McClelland Defendants’ reply brief was filed on

January 19, 2018.? On January 25, 2018, the Trustee filed a motion for leave to file a sur-

reply accompanied by his sur-reply brief." ‘The McClelland Defendants did not oppose the

? Motion to Dismiss Adversary Proceeding & Memorandum in Support of Motion to Dismiss, Adv.

No. 17-50718, D.I. 13, 14; Adv. No. 17-50719, D.I. 13, 14; Adv. No. 17-50722, D.I. 13, 14; Adv.

No. 17-50755, D.J. 13, 14; Adv. No. 17-50758, D.L. 13, 14; Adv. No. 17-50767, D.1. 13, 14; Adv.

No. 17-50772, D.I. 13, 14; Adv. No. 17-50786, D.T. 13, 14; Adv. No. 17-50849, D.I. 13, 14; Adv.

No. 17-50850, D.I. 13, 14; Adv. No. 17-50854, D.I. 13, 14; Adv. No, 17-50859, DI. 13, 14 (the

“McClelland Opening Brief’).

§ Trustee’s Memorandum in Opposition to Defendants’ Motion to Dismiss, Adv. No, 17-50718,

D.I. 30; Adv. No. 17-50719, D.T. 30; Adv. No. 17-50722, D.I. 30; Adv. No. 17-50755, D.I. 30; Adv.

No. 17-50758, D.1. 30; Adv. No. 17-50767, D.L 29; Adv. No, 17-50772, D.I. 30; Ady. No. 17-

50786, D.I. 30; Adv. No. 17-50849, D.I. 30; Adv. No. 17-50850, D.I. 30; Adv. No. 17-50854, D.I.

_ 30; Adv. No. 17-50859, D.1. 30, In each of Defendants’ cases, the ‘Trustee filed substantially similar

answering briefs. I will refer to all of these (across all groups of Defendants) as the “Answering

Brief,” collectively. —

? Reply in Support of Motion to Dismiss, Adv. No. 17-50718, D.I. 35; Adv. No. 17-50719, D.L. 35;

Adv. No. 17-50722, D.I. 35; Adv. No, 17-50755, D.I. 35; Adv. No. 17-50758, D.I. 35; Adv. No. 17-

50767, D.I. 34; Ady. No. 17-50772, D.I. 35; Adv. No. 17-50786, D.I. 35; Adv. No. 17-50849, D.I.

35; Adv. No. 17-50850, D.I. 35; Adv. No. 17-50854, D.I. 35; Adv. No. 17-50859, D.I. 34 (the

“McClelland Reply Brief’).

0 Motion for Leave to File Sur-Reply to Defendants' Reply in Support of Their Motion to Dismiss

Complaint, Adv. No. 17-50718, D.1. 36; Adv. No. 17-50719, D.I. 36; Adv. No. 17-50722, D.L. 36;

Adv. No. 17-50755, D.I. 36; Adv. No. 17-50758, D.I. 36; Adv, No, 17-50767, D.I. 35; Adv. No. □□□□

50772, D.1. 36; Adv. No. 17-50786, D.1. 36; Adv. No. 17-50849, D.I. 36; Adv. No. 17-50850, D.I.

36; Adv. No. 17-50854, D.I. 36; Adv. No. 17-50859, D.T. 36.

motion for leave to file a sur-reply, and the motion was granted upon filing of a certification

of counsel.!! The sur-reply was filed on March 9, 2018.”

The Passive Investor Defendants

On November 13, 2017, Defendants Adrienne Souza, Christine Martin, David

Souza, F. Warren McFarlan, John M. Weyand 2005 Trust, John F. Holsteen Declaration of

Trust, Jonathan Stern, Keith Jarrett, Millennium Trust Company, LLC, MMF-NH LLC,

Paul Martin, Revocable Trust of Charles E. Jacobs, Roberts Family 1998 Exempt Trust, Sea

View Investments LLC, Thomas Roberts, Thomas Littauer, and William Weyand (the

“Passive Investor Defendants”) jointly filed their Motion to Dismiss, together with their

opening brief.'? On December 22, 2017, the Trustee filed an answering brief."4 The Passive

Investor Defendants’ reply brief was filed on January 18, 2018," On January 25, 2018, the

Order Granting Motion of Craig Jalbert for Leave to File Sur-Reply to Defendants’ Reply in

Support of Their Motion to Dismiss Complaint, Adv. No. 17-50718, D.I. 40; Adv. No. 17-50719,

D.1. 40; Adv. No. 17-50722, D.1. 40; Adv. No. 17-50755, D.I. 40; Adv. No. 17-50758, D.1. 40; Adv.

No. 17-50767, D.I. 39; Adv. No. 17-50772, D.L. 40; Adv. No. 17-50786, D.1. 40; Adv. No. 17-

50849, D.I. 40; Adv. No. 17-50850, D.I. 40; Adv. No. 17-50854, D.I. 40; Adv. No. 17-50859, D.I.

39.

12 Trustee’s Sur-Reply in Opposition to Motion to Dismiss, Adv. No. 17-50718, D.I. 41; Adv. No,

17-50719, D.I. 41; Adv. No. 17-50722, D.I. 41; Adv. No. 17-50755, 41; Adv. No. 17-50758,

D.I. 41; Adv. No. 17-50767, D.I. 40; Adv. No. 17-50772, □□□ 41; Adv. No. 17-50786, D.I. 41; Adv.

No. 17-50849, D.1. 41; Adv. No. 17-50850, D.I. 41; Adv. No. 17-50854, D.I. 41; Adv. No, 17-

50859, D.I. 40,

8 Defendants’ Motion to Dismiss Complaint & Joint Memorandum in Support of Defendants’

Motion to Dismiss, Adv. No. 17-50716, D.I. 18, 19; Adv. No. 17-50723, D.L 17, 18; Adv. No. '17-

50725, D.1. 17, 18; Adv. No. 17-50752, D.I. 17, £8; Adv. No. 17-50797, D.1. 17, 18; Adv. No. 17-

50799, D.I. 17, 18; Adv. No, 17-50802, D.I. 17, 18; Adv. No. 17-50848, D.I. 17, 18; Adv. No. 17-

50855, D.I. 17, 18; Adv. No. 17-50856, D.I. 17, 18; Adv. No. 17-50858, D.1. 17, 18; Adv. No. 17-

50861, D.I. 17, 18; Adv. No. 17-50863, DL. 17, 18; Adv. No. 17-50865, D.I. 17, 18; Adv. No, 17-

50866, D.I. 17, 18; Adv. No. 17-50870, D.1. 17, 18; Adv. No. 17-50877, D.I. 17, 18.

“4 'Trustee’s Memorandum in Opposition to Defendant’s Motion to Dismiss, Adv. No. 17-50716,

33; Adv. No. 17-50723, D.1. 33; Adv. No. 17-50725, D.I. 33; Adv. No. 17-50752, D.I. 33; Adv.

No. 17-50797, D.I. 33; Adv. No. 17-50799, D.L. 33; Adv. No. 17-50802, D.I. 33; Adv. No, 17-

50848, D.I. 33; Adv. No. 17-50855, D.1. 33; Adv. No. 17-50856, D.I. 33; Adv. No. 17-50858, D.I.

33; Adv, No. 17-50861, D.I. 33; Adv. No. 17-50863, D.I. 33; Adv. No. 17-50865, D.I, 33; Adv. No.

17-50866, D.1. 33; Adv. No. 17-50870, D.I. 33; Adv. No. 17-50877, D.I. 33.

‘5 Defendants' Reply in Support of Their Motion to Dismiss Complaint, Adv. No. 17-50716, D_L.

36; Adv. No. 17-50723, D.I. 36; Adv. No, 17-50725, D.1. 37; Adv. No. 17-50752, D.I. 37; Adv. No.

Trustee filed a motion for leave to file a sur-reply accompanied by his sur-reply brief.’° The

Passive Investor Defendants opposed the motion to file a sur-reply."’ The opposition will be

sustained, □

The New Jersey Defendants

On November 17, 2017, Defendants Dunaway, Gurevich, Miranyan, Miskel,

Oliveira, Toso and Yuan (the “New Jersey Defendants”) jointly filed their Motion to

17-50797, D.I. 37; Adv. No. 17-50799, D.I. 37; Adv. No. 17-50802, D.I. 37; Adv. No. 17-50848,

D.I. 37; Adv. No. 17-50855, D1. 37; Adv. No. 17-50856, D.I. 37; Adv. No. 17-50858, D.1. 37; Adv.

17-50861, D.L 37; Adv. No. 17-50863, D.I. 37; Adv. No. 17-50865, D.I. 37; Adv. No. 17-

50866, D.I. 37; Adv. No, 17-50870, 37; Adv. No. 17-50877, D.I. 37.

- Motion for Leave to File Sur-Reply to Defendants’ Reply in Support of Their Motion to Dismiss

Complaint, Adv. No. 17-50716, D.I. 40; Adv. No, 17-50723, D.I. 40; Ady. No. 17-50725, D.I. 40;

Adv. No. 17-50752, D.I. 40; Adv. No. 17-50797, DI. 40; Adv. No. 17-50799, D.I. 40; Adv. No. 17-

50802, D.I. 40; Adv. No. 17-50848, D.L. 40; Adv. No. 17-50855, D.I. 40; Adv. No. 17-50856, D.I.

40; Adv. No. 17-50858, D.I. 40; Adv. No. 17-50861, D.I. 40; Adv. No. 17-50863, D.I. 40; Adv. No.

17-50865, D.I. 40; Adv. No. 17-50866, D.I. 40; Adv. No. 17-50870, D.I. 40; Adv. No. 17-50877,

D.I. 40. .

17 Objection to Plaintiff's Motion for Leave to File Sur-Reply, Adv. No. 17-50716, D.I. 42; Adv. No.

17-50723, D.I. 42; Adv. No. 17-50725, D.1. 42; Adv. No. 17-50752, D.I. 42; Adv. No. 17-50797,

D.I. 42; Adv. No. 17-50799, D.I. 42; Adv. No, 17-50802, D.I. 42; Adv. No. 17-50848, D.I, 42; Adv.

No. 17-50855, D.I, 42; Adv. No. 17-50856, D.I. 42; Adv. No. 17-50858, D.I. 42; Adv. No. 17-

50861, D.1. 42; Adv. No. 17-50863, D.I. 42; Adv. No. 17-50865, D.I. 42; Adv. No. 17-50866, D.I.

42: Adv. No. 17-50870, D.1. 42; Ady, No. 17-50877, D.I. 42.

Dismiss, together with their opening brief.'* On December 22, 2017, the Trustee filed an

answering brief.'? The New Jersey Defendants’ reply brief was filed on January 19, 2018.”

Defendant Chu

On November 17, 2017, Defendant John Chu filed his Motion to Dismiss together

with an opening brief”! On December 22, 2017, the Trustee filed his answering brief” Mr.

Chu filed his reply brief on January 19, 2018.% On January 25, 2018, the Trustee filed a

motion for leave to file a sur-reply accompanied by a sur-reply brief.“ Mr. Chu did not

oppose the motion for leave to file a sur-teply, and the motion was granted upon filing of a

certification of counsel. The sur-reply was filed on March 9, 2018.”

‘8 Motion to Dismiss Complaints for Failure to State a Claim Pursuant to Federal Rule of

Bankruptcy Procedure, Rule 7012 and Federal Rule of Procedure 12(b)(6) of David Alan Dunaway,

Leonard Gurevich, Luiza Miranyan, Joseph Miskel, Carlos Oliveria, Rodrigo Franco Toso, And

Zhenyu Yuan, Adv. No, 17-50749, D.I. 18; Adv. No. 17-50793, D.I. 18; Adv. No. 17-50798, D.1.

18; Adv. No. 17-50776, D.I. 18; Adv. No. 17-50741, D.L. 18; Adv, No. 17-50819, D.I. 18; Adv. No.

17-50841, D.J. 18. Opening Brief of David Alan Dunaway, Leonard Gurevich, Luiza Miranyan,

Joseph Miskel, Carlos Oliveria, Rodrigo Franco Toso, And Zhenyu Yuan in Support of Motion to

Dismiss Complaints for Failure to State a Claim Pursuant to Federal Rule of Bankruptcy Procedure,

Rule 7012 and Federal Rule of Procedure 12(b)(6), Adv. No. 17-50749, D.I. 19; Ady. No. 17-50793, □

D.L. 19; Adv. No. 17-50798, D.1. 19; Adv. No. 17-50776, D.I. 19; Adv. No. 17-50741, D.I. 19; Adv.

No. 17-50819, D.I. 19; Adv. No. 17-50841, D.I. 19 (the “New Jersey Defendants Opening Brief”).

‘Trustee’s Memorandum in Opposition to Defendants’ Motion to Dismiss, Adv. No. 17-50749,

D.I. 39; Adv. No. 17-50793, D.1. 38; Adv. No. 17-50798, D.I. 39; Adv. No. 17-50776, D.I. 39; Adv.

No. 17-50741, D.I. 39; Adv. No. 17-50839, D.1. 39; Adv. No. [7-50841, D.I. 39.

20 Reply to Trustee's Memorandum in Opposition to Defendants’ Motion to Dismiss Filed on Behaif

of David Alan Dunaway, Leonard Gurevich, Luiza Mitanyan, Joseph Miskel, Rodrigo Franco

Toso, Carlos Oliveira and Zhenyu Yuan, Adv. No. 17-50749, D.I. 43; Adv. No. 17-50793, D.L 42;

Adv. No, 17-50798, D.I. 43; Adv. No. 17-50776, D.I. 43; Adv. No. 17-50741, D.I. 43; Adv. No. 17-

50839, D.I. 43; Adv. No, 17-50841, D.1. 43.

Defendant’s Motion to Dismiss, Adv. No. 17-50791, D.I. 14; Opening Brief in Support of

Defendant’s Motion to Dismiss, Adv. No. 17-50791, D.L. 15.

2 Trustee’s Memorandum in Opposition to Defendant’s Motion to Dismiss, Adv. No. 17-50873,

DAT. 30.

Reply Brief in Support of Defendant’s Motion to Dismiss, Adv. No. 17-5079], D.1. 35.

24 Motion for Leave to File Sur-Reply to Defendants' Reply in Support of Their Motion to Dismiss

Complaint, Adv. No. 17-50791, D.1. 36.

* Order Granting Motion of Plaintiff Craig Jalbert, Trustee of the F2 Liquidation Trust, for Leave

to File Sut-Reply to Defendants' Reply in Support of Their Motion to Dismiss Complaint, Adv. No.

17-50791, D.L. 40.

6 Trustee's Sur-Reply in Opposition to Motion to Dismiss, Adv. No. 17-50873, D.I. 41.

10

Defendant Eng .

On November 17, 2017, Defendant Tina Eng filed her Motion to Dismiss together

with an opening brief.27 On December 22, 2017, the Trustee filed his answering brief.* Ms.

Eng filed her reply brief on January 19, 2018.” On January 25, 2018, the Trustee filed a

motion for leave to file a sur-reply accompanied by a sur-reply brief.°° Ms. Eng did not

oppose the motion for leave to file a sur-reply, and the motion was granted upon filing of a

certification of counsel.*! The sur-reply was filed on March 9, 2018.”

Defendant Collins

On November 30, 2017, Defendant Kimberly Collins filed her Motion to Dismiss

together with an opening brief.’ On December 22, 2017, the Trustee filed his answering

brief.*4 Ms. Collins filed her reply brief on January 19, 2018. On January 25, 2018, the

Trustee filed a motion for leave to file a sur-reply accompanied by a sur-reply brief.**

27 Defendant’s Motion to Dismiss, Adv. No. 17-50873, D.I. 14; Opening Brief in Support of □

Defendant’s Motion to Dismiss, Adv. No, 17-50873, D.L 15.

8 ‘I'rustee’s Memorandum in Opposition to Defendant’s Motion to Dismiss, Adv. No. 17-50873,

DI. 30.

29 Reply Brief in Support of Defendant’s Motion to Dismiss, Adv. No. 17-50873, D.I. 34.

30 Motion for Leave to File Sur-Reply to Defendants' Reply in Support of Their Motion to Dismiss

Complaint, Adv. No. 17-50873, D.L 35.

Order Granting Motion of Plaintiff Craig Jalbert, Trustee of the 2 Liquidation Trust, for Leave

to File Sut-Reply to Defendants’ Reply in Support of Their Motion to Dismiss Complaint, Ady, No.

17-50873, D.I. 39.

Trustee's Sur-Reply in Opposition to Motion to Dismiss, Adv. No. 17-50873, D.I. 40.

33 Motion to Dismiss, Adv. No. 17-50787, D.I. 15; Memorandum in Support of Motion to Dismiss,

Ady. No. 17-50787, D.I. 15-1.

34 Trustee’s Memorandum of Law in Opposition to Defendant’s Motion to Dismiss, Adv. No. 17-

50787, D.1. 32.

35 Defendant’s Reply to Plaintiff's Opposition to Motion to Dismiss, Adv. No. 17-50787, D.L. 36.

36 Motion of Plaintiff Craig Jalbert, Trustee of the F2 Liquidating Trust, for Leave to file Sur-Reply

to Reply Brief in Support of Defendants’ Motion to Dismiss, Adv. No, 17-50787, D.I. 37.

11

Ms. Collins did not oppose the motion for leave to file a sur-reply, and the motion was

granted upon filing of a certification of counsel.*’ The sur-reply was filed on April 3, 2018.¥

Oral Argument

T heard oral argument on March 12, 2019. Defendants coordinated their argument

on F-Squared’s financial condition and each Defendant adopted thé contentions proffered

by counsel who took the laboring oar at the hearing.” Further, the parties used the

Complaint filed against George McClelland” when referring to allegations in the .

Complaints. Accordingly, except where otherwise indicated, I will do the same.” At the

conclusion of the argument, I took the matter under advisement.

Jurisdiction

Subject matter jurisdiction exists over these adversary proceedings pursuant to 28

U.S.C. § 1334(b). Adversary proceedings seeking to avoid fraudulent conveyances and

preferences are statutorily core matters.

As to my entry of final judgments in these Adversary Proceedings, Plaintiff

consents.“ Defendants take varying positions. The New Jersey Defendants consent to my

entry of final orders.* The McClelland Defendants do not consent to the entry of final

7 Order Granting Motion of Plaintiff Craig Jalbert, Trustee of the F2 Liquidating Trust, for Leave

to file Sur-Reply to Reply Brief in Support of Defendants’ Motion to Dismiss, Adv, No, 17-50787,

DVT. 40.

8 Trustee’s Sut-Reply in Opposition to Motion to Dismiss, Adv. No, 17-50787, D.I. 42.

3 See Hr’g Tr., Mar. 12, 2019, No. 15-11469, D.I. 1262.

Trg Tr, 23:25-24:1, 24:10-12, 26:12-14, 26:18-19. :

4. “Adv. No. 17-50758.

“ While the paragraph numbering in the Complaints or other responsive briefing in the other

adversary proceedings may differ slightly, except where otherwise specified, each of the ‘Trustee’s

filings against the various Defendants contains paragraphs with identical wording.

8 28 U.S.C. §157(b)(2\F), (HD.

Complaint 4. -

45 New Jersey Defendants Opening Brief 4.

12 □

orders or judgments if it is determined that, absent consent of the parties, the bankruptcy

court cannot enter final orders or judgments consistent with Article III of the Constitution.”

The Passive Investor Defendants take an intermediate position, stating that they consent to

the entry of final orders or judgments “in connection with this Motion but reserve their right

to seek a jury trial before an Article IIT judge.””” So, too, both Mr. Chu and Ms. Eng

consent to the entry of final orders or judgments in connection “with this Motion.” Ms.

Collins did not make a statement regarding final judgments, accordingly (unless otherwise

ordered by the court) she has waived the right to contest my authority to enter final orders.” -

Accordingly, I may enter final orders on these Motions to Dismiss consistent with

the Constitution with respect to the Plaintiff, the New Jersey Defendants, the Passive

Investor Defendants, Mr. Chu, Ms. Eng and Ms. Collins. Whether I may do so with

respect to the McClelland Defendants is an open issue, and one that has not been briefed.

Because I will allow the Trustee to file a motion for leave to amend, however, the order

entered with respect to the McClelland Defendants on this motion will not be a final order.°*°

Parties’ Positions .

Defendants move to dismiss the Complaints for failure to sufficiently allege (@)

insolvency, (ii) unreasonably small capital or (iii) intent to incur debts that F-Squared could

not pay.

46 McClelland Motion to Dismiss 2.

47 Passive Investor Motion to Dismiss 2.

48 Chu Motion to Dismiss 2; Eng Motion to Dismiss 2.

® Del. Bankr. L.R. 7012-1.

50 Unless a non-consenting entity briefs the issue of authority to enter a final order on a given

matter, a statement that a party does not consent if the court cannot enter final orders absent consent

of the parties is of little value. If the McClelland Defendants believe that I cannot enter a final order

in their respective Adversary Proceedings, they should brief the issue in a future filing.

13

As to insolvency, all Defendants argue that the relevant standard is balance sheet

insolvency, that the Trustee has not pled any information on Debtors’ assets and liabilities

at the time of the transfers, or at any time, and so the Complaints should be dismissed.

Defendants further assert that the Trustee’s theory that Debtors are “insolvent from the

inception” of the AlphaSector Index products is conclusory and contradicted by other

allegations in the Complaints or First Day Declaration.” Further, Defendants assert that

“insolvency from the inception” is not a valid legal theory, and mischaracterizes even the

minimal facts pled. ‘The Trustee responds first that insolvency is a factual question that is

inappropriate for resolution on a motion to dismiss. He contends that the facts in the

Complaints, in particular the allegations of fraud, are sufficient to plead insolvency. He also

contends that Debtors’ December 2014 admission of securities law violations can be used to

show that Debtors were insolvent on the date of each transfer. Defendants respond that to

do so would be employing impermissible hindsight.

As to “unreasonably small capital,” Defendants generally assert that the allegations

in the Complaints supporting this contention are few and far between. For those allegations

that may be read to support a theory of undercapitalization, Defendants contend that the

Trustee cannot meet the standard of “reasonable foreseeability” without relying on

impermissible hindsight. In response, the Trustee argues first that F-Squared was “always

undercapitalized” because “[e]ven though F-Squared. generated large quantities of cash

_ during and after its fraudulent advertising campaign, this cash flow slowed to a trickle once

F-Squared admitted to its fraud, and the company used much of the cash it had. its coffers

51 Declaration of David N. Phelps in Support of Chapter 11 Petitions and First Day Motions, Jul. 8,

2015, No. 15-11469, D.L. 3.

14

to make the Transfers.”°? Additionally, the Trustee asserts that he has not relied on

impermissible hindsight, and that Defendants have conflated “hindsight” with permissible

use of subsequently-acquired information.

As to F-Squared’s intent to incur debts it cannot pay, Defendants generally note that

there are not facts to support this claim in the Complaints beyond the Trustee’s recitation of

the statute. Certain Defendants also point out that the First Day Declaration (which the

Trustee purports to incorporate by reference into the Complaints) indicates Debtors held an

ongoing belief that the company would continue on after the Transfer Order without the

need to file for bankruptcy, and therefore no intent or belief of inability to pay debts exists.

The Trustee’s responsive briefing does not address Defendants’ arguments.

Legal Standard

A Rule 12(b)(6) motion is a challenge to the sufficiency of factual allegations in a

complaint.~ In reviewing a complaint under Rule 12(b)(6), the Third Circuit has instructed

that the factual and legal elements of a claim should first be separated.** The court must

accept all of the complaint’s well-pled facts as true but may disregard legal conclusions.* -A

court must then determine whether the facts alleged in the complaint are sufficient to show

that the plaintiff has a “plausible claim for relief.”

A plausible claim requires more than allegations of the plaintiff's entitlement to relief,

a complaint has to “show” such an entitlement with its facts.” It is insufficient to provide

Answering Brief {| 53.

533 In ve Amcad Holdings, LLC, 579 B.R. 33, 37 (Bankr. D. Del. 2017) (citing to Kost v. Kozakiewicz, 1

F.3d 176, 183 Gd Cir. 1993)).

34 Fowler v, UPMC Shadyside, 578 F.3d 203, 210-11 Gd Cir. 2009).

55 Id. (citing Ashcroft v. Igbal, 556 U.S. 662, 677 (2009)).

Sve In ve THO, Inc., No. 12-13398, 2016 WL 1599798, at *2 (Bankr. D, Del. Apr. 18, 2016).

37 Howler, 578 F.3d at 210 (citing Iqbal, 556 U.S. at 677 (2009).

i5

“threadbare recitals of a cause of action's elements, supported by mere conclusory

statements[.]”°> Instead, a complaint “must contain either direct or inferential allegations

respecting all the material elements necessary to sustain recovery under some viable legal

theory.” This allows the court to “draw the reasonable inference that the defendant is

liable for the misconduct alleged.” The plausibility determination will be “a context-

specific task that requires the reviewing court to draw on its judicial experience and

common sense.”*! A court must draw all reasonable inferences from the facts in the light

most favorable to the plaintiff.

Discussion

I. On These Motions to Dismiss, I Will Consider Only the Facts Alleged in the

Complaints and the Transfer Order.

Before examining the substance of the Motions to Dismiss, it is important to

determine what facts and documents I will consider—or, more importantly, not consider—

in examining the sufficiency of the Trustee’s allegations.

First, I will not consider the numerous new facts the Trustee alleges in his Answering

Brief. As each Defendant argues, “it is axiomatic that the complaint may not be amended

by the briefs in opposition to a motion to dismiss.” Accordingly, a court must not

“consider after-the-fact allegations in determining the sufficiency” of a complaint under □

% THO Inc., 2016 WL 1599798, at *2 (citing Jgbal, 556 U.S. at 677).

59 Bell Atl. Corp. v. Twombly, 550 U.S. 544, 562 (2007).

Fowler, 578 F.3d at 210 (citing Igbal, 556 U.S. at 677 (2009)).

® Phillips v. Cty. of Allegheny, 515 F.3d 224, 228 (3d Cir, 2008).

8 Com. of Pa. ex rel. Zimmerman v. PepsiCo, Inc., 836 F.2d 173, 181 (3d Cir. 1988).

16

Rule 12(b)(6).% Attempting to preempt the argument that the Answering Brief added new

_ facts, the Trustee states:.

The great majority of the facts below [in the Answering Brief]

can be found in the Complaints, in the Declaration of David N.

Phelps in Support of Chapter 11 Petitions and First Day Motions

. incorporated into the Complaints by reference at § 11, the

‘Transfer Order referenced in the Complaints at | 15, and the SEC

complaint referenced in the Complaints at {| 16 (of which the

Court can take judicial notice). Some additional facts were

derived from additional information obtained by the Trustee.”

Looking to the listed sources (assuming J should even do so), try as I might, I could not find

the new facts relevant to F-Squared’s financial condition in any of them. Rather, the

Answering Brief reads like an entirely new complaint, complete with new factual

allegations.

In his Answering Brief, the Trustee for the first time alleges: G) aggregate and yearly

fees received for the use and licensing of the AlphaSector Indexes; (ii) statutory penalties

that the SEC may assess for each violation of the securities laws; (iii) allegations regarding

F-Squared’s contracts with clients which allegedly include indemnification clauses; and (iv)

a discussion of the proofs of claims filed against F-Squared together with a thirteen-page

chart listing 94 proofs of claim (“Proof of Claim Chart”). °’ The Trustee asserts that the

“ In re Washington Mut., Inc., 418 B.R. 107, 113 (Bankr. D. Del. 2009) (quoting Frederico v. Home

Depot, 507 F.3d. 188, 201-02 (3d Cir.2007)).

6 Answering Brief {7 n.5.

6 Perhaps some of this information is in the “SEC complaint.” See Complaint 16. Paragraph 16

states in its entirety: “On the same day, the SEC also commenced a civil action against Howard.

Present, who had been the CEO of F-Squared until his departure in November 2014.” The “SEC

complaint” was not attached as an exhibit to the Complaints, nor relied on in the Complaints in any

sense — as Paragraph 16 seems to be the only reference to the action against Mr. Present. And, as no.

party to these adversary proceedings provided me with a copy of the “SEC complaint” in connection

with the Motions to Dismiss, I have not reviewed it.

6? See Answering Brief Ex. A.

Proof of Claim Chart reflects claims against F-Squared based on indemnification obligations

and liabilities arising under tort or contract because of F-Squared’s fraud.

As became clear during oral argument, these newly-identified potential SEC fines as

well as the indemnification claims are at the heart of the Trustee’s arguments. But there is □

no mention in the Complaints of any such indemnification claims arising from F-Squared’s

contracts with its clients. While the Trustee suggested at argument that I may be able to

infer the existence of such obligations, such an inference is not reasonable.” Thus, I will not

8 At oral argument, the Trustee conceded that the indemnification claims are not mentioned.

specifically in the Complaints, although it was initially suggested that such claims could be inferred

from the facts.

MR. MOXLEY: So, we talk at paragraph 20, Judge, about how the

SEC opened investigation into the clients. We don’t say in the

complaint specifically that those investigations led to indemnification

claims. We don’t say that specifically, Judge, but it ts a fair inference

that the court can make.

THE COURT: Why can I make an inference about what someone’s

indemnification obligations are to another party?

MR. MOXLEY: It’s one piece, Judge. It’s just one piece of the overall.

The cases speak to the fact that the complaint is to be and the financial

situation of the company is to be looked at in its totality. This is just

one aspect. I have more I’m going through, but this is just one aspect

of the liability that F-Squared was facing. We know it faced the

securities violation.

THE COURT: Where in this paragraph do you say that F-Squared

faced liability from indemnification obligations?

MR. MOXLEY: Your Honor, we don’t expressly say it in that

paragraph.

Tr. 35:16-36:11. The Trustee later conceded that the facts did not compel an inference of

the existence of such indemnification agreements.

MR. MOXLEY: Yeah what you can infer from those facts is that there

were multiple clients which, of course, would have had to have been

contacted and provided with information about the indexes. I think

that’s a fair inference. And each and every time that happened, there

was a securities fraud violation. And an indemnification claim

obligation and breach of contract.

THE COURT: Why should I assume there’s an indemnification

obligation from that?

MR. MOXLEY: I apologize. I don’t you have to assume the

indemnification piece, but you do have, I think, the court respectfully

does have to infer that there were multiple clients who were contacted

18

consider any indemnification obligations to F-Squared’s clients on these Motions to

Dismiss.

Additionally, the Trustee and certain Defendants ask me to consider various

documents attached as exhibits to a filing or referenced in a filing. As for the Trustee’s

requests, the only exhibits attached to the Complaints relating to F -Squared’s financial

condition are the exhibits detailing the individual transfers.” I will consider these as they

detail relevant facts and are simply an extension of the Complaints, I will not consider the

- Proof of Claim Chart as it is submitted to support the new facts alleged in the Trustee’s

Answering Brief.

Neither will I consider the First Day Declaration. In the Background section of the

Complaints, I am apprised that some information in the Complaints is “discussed more

fully” in the First Day Declaration which is “incorporated herein by reference.” Assuming

one should incorporate another document in a complaint, it is unhelpful to incorporate the

entire document rather than the specific relevant paragraphs. Here, fully half of the First

Day Declaration is devoted to facts related to first day motions that do not appear to be

on multiple occasions and to the point where billions of dollars were

invested in the company.

Hr’g Tr. 57:24-58:5.

6 Fach Complaint attached a document as Exhibit A that detailed the challenged transfers for each

_ Defendant, including the nature, amount and source of the payment as well as the date of payment.

See Complaint Ex. A.

7” Complaint { 11. In like fashion, I am informed that I can find “more information” on the

Debtors’ cash management system in the Debtors’ Motion () to Continue to Use Existing Cash

Management System, Including Maintenance of Existing Investment Accounts, Bank Accounts,

Checks and Business Form, (ID) Waiver of Certain Requirements of the United States Trustee, and.

(III) for Extension of Time to Comply with Section 345 of the Bankruptcy Code. Complaint § 2 n.2.

I have not considered this motion either.

19

germane to these adversary proceedings. Moreover, wholesale incorporation can also lead

to the incorporation of facts that contradict allegations in the body of the Complaints.”

Lalso decline to consider the voluntary petition.” The Trustee first requested that I

take judicial notice of the petition at oral argument.” The Trustee argued that I could take

71 For instance, contrary to assertions in the Complaints that F-Squared was “no longer a viable

business” or any argument that F-Squared’s business was itself illegal, the First Day Declaration

clearly contemplates that the company expected to continue its business and provide uninterrupted

service to its clients. See, ¢.g., First Day Declaration { 6; 138. Similarly, the First Day Declaration

states that Debtors’ most significant categories of claims are (1) an indemnification claim of Howard

Present, (ii) Debtors’ lease obligations of $2.7 million per year; and (iii) severance obligations of $1.3

million. Jd. at 9919, 21, 22. There is no mention of customer indemnification claims based on F-

Squated’s fraud. The First Day Declaration, thus, suggests such liabilities, to the extent they exist

(which is not suggested), are not significant, and certainly not “massive.”

I am not sure what reasonable inferences I should draw from contradictory facts.

Trustee’s counsel essentially suggested that I must ignore any “bad” facts, as I must draw all

reasonable inferences in favor of the Trustee.

MR. MOXLEY: No, Judge, you just have -- the court has ~ —

respectfully, the court just has to read all of those allegations and all of

- those pieces of information in a light most favorable to the trustee.

That’s what the stand[ard] is, Tudge.

THE COURT: I don’t -- maybe I don’t understand how I can apply

that standard when -- if the trustee pled in its complaint the sky is blue

in patagraph three and then in paragraph four, he pled the sky is red.

What inference do I draw from those facts?

MR. MOXLEY: Well, the -- what the Hornbook law ts, is that you

would read those allegations in the light most favorable on that

particular motion. And so if there are contradictory allegations and

one of the allegation allows the trustee to survive the motion and

another allegation allows the trustee to not survive the motion, I would

submit to you that you’d have to read the allegations together in a light

most favorable and so, you would read them in a way that allows the

complaimt to survive.

Hr’g Tr. 70:10-71:3. This is clearly not the case. For example, the Third Circuit has instructed that

where a document attached to or relied upon in a complaint contradicts the allegations therein, the

document controls. Vorchheimer v. Philadelphian Owners Ass'n, 903 F.3d 100, 111-12 Gd Cir. 2018)

(“As exhibits to her own complaint, these materials were appropriate to consider on a motion to

dismiss. They do not require going ‘outside the pleadings.’ And if her own exhibits contradict her

allegations in the complaint, the exhibits control.”) (internal citations omitted). Contradictory

allegations in a complaint, therefore, may mean I can draw no reasonable inference.

% See Hr’g Tr. 53:16-18, 61:18-22. At argument, J suggested that I would consider the petition as no

one objected. Hr’g Tr. 127:13-17. Upon reflection, as I write this section of the Opinion, I do not

think this is appropriate for the multiple reasons discussed in the text. But, even if I were to consider

it, it would not change my conclusions. See discussion iafra note 129.

3 See Hr’g Tr. 36:25-37:23. A court can take judicial notice of adjudicative facts pursuant to Federal

Rule of Evidence 201. Query whether a petition contains adjudicative facts?

20

judicial notice of the petition because “the petition is a document that’s filed in the

bankruptcy proceedings.” While it is true that in considering a motion to dismiss, a court

can take judicial notice of public documents,” including filings in a bankruptcy case, the

request cannot be made during argument on the motion to dismiss. While Federal Rule of

Evidence 201 does not specify any formal requirements for a request for judicial notice,

general considerations of due process suggest that the request should be in writing, or made

in some way so as to give the adverse party notice and an opportunity to challenge the

propriety of the request.” Further, the Trustee did not supply me with a copy of the

petition, or even indicate which of Debtors’ nine petitions he was referring to, an important

consideration given there are transfers from two separate Debtors and the Trustee is using

the term “F-Squared” collectively to mean all filing entities.”

As for Defendants, the Passive Investors attached the Transfer Order to their Motion

to Dismiss. I will consider the Transfer Order as it was referenced and relied upon by the

Trustee in the Complaints.” But, I will consider it only with respect to statements a party

has called to my attention in the briefing or at argument. The New Jersey Defendants ask

me to consider Debtors’ objections to certain of the proofs of claims on the Proof of Claim

Chart.” Similarly, the McClelland Defendants ask me to consider the dismissals of certain

74 EKO Corp. v. United States Dep't of Homeland Sec., 369 F. Supp. 34.577 (D, Del. 2019) (quoting

Mayer v. Belichick, 605 F.3d 223, 230 (3d Cir. 2010) (emphasis added)) (“In deciding a Rule 12(b)(6)

motion, a court must consider only the complaint, exhibits attached. to the complaint, matters of

public record, as well as undisputed authentic documents if the complainant's claims are based upon

these documents.”).

® 1 Weinstein’s Federal Evidence § 201.30 [3].

76 See, e.g., Federal Rule of Evidence 201 (c)(2), which provides that a court “must take judicial

notice if a party requests it and the court is supplied with the necessary information.” Fed, R. Evid. 201

(emphasis added).

7 Complaint 4¥f 15, 18, 22.

New Jersey Defendants Opening Brief { 13 n.3.

21

of the proofs of claims on the Proof of Claim Chart,” Because I am not considering the

Proof of Claim Chart, or any reference to claims filed against the estate, I need not consider

Debtors’ objections to, or the dismissal of, those proofs of claim.

In summary, I will consider the facts alleged in the Complaints, Exhibit A to each

Complaint and the Transfer Order. I will not consider any other documents, whether

specifically discussed above or not. Having determined the scope of the documents I will

consider on these Motions to Dismiss, I turn to the substantive arguments.

H. The Trustee Has Not Sufficiently Pled Facts Related to Debtors’ Financial

Condition on the Dates of the Relevant Transfers.

In the Complaints, the Trustee asserts that the Transfers are constructive fraudulent

conveyances. A prepetition transfer by a debtor can be avoided and recovered when the

transfer occurred within two years of filing for bankruptcy, the debtor received less than

reasonably equivalent value in exchange for the transfer, and one of the following

- conditions is satisfied: (1) the debtor was insolvent at the time of the transfer, or became

insolvent as a result of the transfer, (ii) the debtor had unreasonably small capital at the time

of transfer or as a result of the transfer, or (iii) the debtor intended to incur, or believed it

would incur, debts beyond its ability to pay as those debts become due. As discussed

below, the Trustee has not pled facts sufficient to show that any of these three conditions is

satisfied.

7” McClelland Reply Brief 4-6.

11 U.S.C. § 548 (a)(1)(B).

□ 22

A. The Trustee Has Not Sufficiently Pled Insolvency for Purposes of Section

548 (a)(1)(B)@).

The Bankruptcy Code defines insolvency as “the financial condition such that the

sum of such entity’s debts is greater than all of such entity’s property, at fair valuation.”®

This standard is commonly called the balance sheet test.” Insolvency is determined at the

time of conveyance.® Notwithstanding this definition, the Complaints do not contain any

specific allegations regarding Debtors’ assets or liabilities at the time of each transfer. At

argument, the ‘Trustee acknowledged as much.” To compensate, the Trustee makes

multiple arguments, each of which fail.

As a preliminary matter, the Trustee argues that insolvency is a factual inquiry and

therefore inappropriate for consideration on a motion to dismiss. While it is true that

insolvency is a factual inquiry, the Trustee is still required to plead facts from which a court

can infer that the debtor was insolvent on the date of each transfer. That this element of a □

constructive fraudulent conveyance is a factual question does not excuse a plaintiff from

pleading facts; to so conclude would effectively permit a plaintiff to evade the pleading

standard. As Judge Carey recently stated, a complaint’s “recitation of the word ‘insolvency’

is not enough to support a plausible claim under the Twombly standard.”*’ To the extent

8 11 U.S.C. § 10132).

82 In re Opus Fast, LLC, 528 B.R. 30, 50 (Bankr. D. Del. 2015), aff'd sub nom, In re; Opus East, LLC,

No. 09-12261, 2016 WL 1298965 (D. Del. Mar. 31, 2016), affd sub nom. In re Opus East LLC, 698 F.

711 (3d Cir. 2017).

83 Mellon Bank, N.A. v, Metro Comme'ns, Inc., 945 F.2d 635, 648 (3d Cir. 1991), as amended (Oct. 28,

Hr’g Tr. 50:8-12. See also Hr’g Tr. 50:19-21; Hr’g Tr. 52:4-21.

8 Answering Brief { 38.

86 In re United Tax Grp., LLC, No. 14-10486 (LSS), 2016 WL 7235622, at *3 (Bankr. D. Del. Dec. 13,

2016).

8? Tn re Draw Another Circle., No. 16-11452 (KIC), 2019 WL 2489654, at *13 (Bankr. D. Del. June 13,

2019).

23

any cases cited by Plaintiff actually stand for the proposition that a conclusory statement

parroting the statute is sufficient to plead insolvency, I respectfully disagree.®

Next, the Trustee argues in its Answering Brief that insolvency can be pled without

providing balance sheet specifics. This may be true. For example, the Trustee cites cases in

which certain courts have cited to facts other than “balance sheet specifics” in denying a

motion to dismiss.*? But, the common thread in those cases is that the complaint states facts

that allow the court to draw a reasonable inference of insolvency when read in the light

most favorable to the plaintiff.” That is not the case here.

8 The Trustee cites several cases in support of this proposition. These decisions do not particularly □

support the notion that I should not consider whether insolvency has been sufficiently pled. Several

of these courts spend time reviewing the factual allegations surrounding insolvency and making a

sufficiency determination. See, e.g, Inre DBSI, Inc., 445 B.R. 344, 349 (Bankr, D, Del. 2011) (finding

that an allegation that the enterprise was a “Ponzi scheme” that was “by definition insolvent during

that time, as it was dependent on constant infusions of cash from new investors to satisfy obligations

owed to prior ones[]” was sufficient to meet the pleading standard); Jn re Green Field Energy Servs.,

2015 WL 5146161, at *7 (Bankr. D, Del. Aug. 31, 2015).

See, e.g., In re Amcad Holdings, LLC, 579 BR. 33, 39 Bankr. D. Del. 2017); Official Comm. of

Unsecured Creditors v. The CIT Grp./ Bus. Credit, Inc. (in re Jevic Holding Corp,), Adv. No. 08-51903,

2011 WL 4345204, at *9 (Bankr. D. Del. Sept. 15, 2011); Official Comm. of Unsecured Creditors v. DVI

Bus. Credit, Inc. (in ve DVI, Inc.), 326 B.R. 301, 306-07 (Bankr. D. Del. 2005).

% See, e.g., Inve Amcad Holdings, LLC, 579 B.R. at 40 (“[]Complaint relies on the declaration of the

Debtor's president that proper accounting practices would have shown that the Debtor was insolvent

during the relevant period. ... Viewed in the light most favorable to the Liquidating Trustee,

testimony regarding insolvency from an officer of the Debtor with direct knowledge of its financial

position and. an explanation of the transactions that led to insolvency are facts that, if taken as true,

would demonstrate insolvency.”) (internal citations omitted); in re.Troll Comme'ns, LLC, 385 BR.

110, 124 (Bankr. D, Del. 2008) (“According to Troll's internal financial statements, as of June 30,

2002, Communications' accounts payable and other liabilities were $12.8 million. The tangible net

worth of Communications was valued at a negative $13.1 million. The going concern business □

qualification given by PWC rendered the company’s goodwill valueless, making tangible net worth

the guidepost for determining the company's insolvency. By this standard, and by the standard of

the company's cash flow, Troll was insolvent on June 30, 2002....”); Inve DVI, Inc., 326 B.R. at 307

(“The allegations in the Amended Complaint of REC IT's insolvency are sufficiently specific: that

REC III did not have sufficient assets to provide equity to DVI BC, that REC II did not have

sufficient capital to contribute to the Cash Collateral Accounts as required, and that payments to the

Noteholders were made while REC Il was insolvent.”).

24

In his Answering Brief, the Trustee sets forth in bold-type print his summary of the

relevant allegations in the Complaints: ”!

e F-Squared’s revenues were earned predominantly on account of the

AlphaSector Indexes (citing to paragraph 17);”

e F-Squared had enormous unliquidated liabilities at all relevant times (citing to

paragraph 17);

e F-Squared was charged with and admitted to securities fraud (citing to

paragraph 15);”

e F-Squared paid $35 million to the SEC in December 2014 (citing to

paragraphs 15 and17);

® The SEC also opened investigations into F-Squared clients (citing to

paragraph 20);

Answering Brief at ff 15-16.

% Paragraph 17 reads in full:

F-Squared’s ability to make its payroll and pay its debts as they came

due following the transfer of $35 million to the SEC was limited and

depended on continued payment of asset management fees by

clients. By 2014, a substantial majority of F-Squared’s revenues,

however, were on account of fees paid by F-Squared’s clients to F-

Squared to permit them to manage their client investments based on

the AlphaSector Indexes. Thus, at all relevant times, F-Squared

generated a great majority of its revenue by means of illegal activity

almost certain to give rise, at some point, to massive liabilities on

account of that activity, and so F-Squared was insolvent from the

inception of its use of the AlphaSector Index strategy.

Paragraph 15 reads in full:

The Securities and Exchange Commission (the “SEC”) began an

investigation of F-Squared in 2013. On December 22, 2014, F-Squared

agreed to resolve an administrative cease-and-desist proceeding

brought by the SEC pursuant to Section 203(k) of the Investment

Advisers Act (“IAA”) and Sections 9(b) and 9(f) of the Investment

Company Act (“ICA”). Under the terms of the order enacting this

resolution (the “Transfer Order”), the SEC charged, and I’-Squared

agreed to admit, that F-Squared’s performance track record for the

period between April 2001 and September 2008 was materially

inflated, hypothetical and back-tested. ‘The Transfer Order required F-

Squared to pay $30 million in disgorgement to the SEC, as well as a $5

million fine.

Paragraph 20 reads in full:

The SEC also opened investigations into certain of the Debtors’ clients

for securities fraud related to their use of the AiphaSector strategy,

which gave further incentives for these clients to leave F-Squared. For

example, in early May 2015, Virtus Investment Partners, Inc.

(“Virtus”) terminated its relationship with F-Squared, which had been

25

e Due to F-Squared’s fraud, and because many of them were facing their own

SEC investigations and penalties for false advertising, F-Squared’s clients fled

(citing to paragraphs 18, 19).”

The Trustee’s summary is accurate. In the cited paragraphs, the Trustee details the

securities fraud and certain results from it—namely, the payment of $35 million to the SEC

and the loss of clients. But all of these events occurred from December 2014 forward, after

almost all of the Transfers were made. More importantly, these allegations do not permit

me to draw a reasonable inference that Debtors were insolvent at the time of each transfer.

Simply facing liability for securities fraud does not make a company insolvent, And uses of

words such as “massive” and “enormous” to describe a company’s liabilities are conclusory

a sub-advisor on several popular mutual funds from Virtus. Virtus was

itself investigated by the SEC, and entered into a settlement with the

SEC on November 16, 2015. In August 2016, the SEC announced

penalties against another thirteen of F-Squared’s clients, including

_ AssetMark, Inc., BB&T Securities, and Ladenburg Thalmann Asset

Management. See U.S. Sec. and Exch. Comm'n, Investment Advisers .

Paying Penalties for Advertising False Performance Claims (Aug. 25,

2016), https://www.sec.gov/news/ presstelease/2016-167.html.

% Paragraph 18 reads in full:

Following entry of the Transfer Order, F-Squared’s clients stopped

using F- Squared’s algorithms to manage their assets for several

reasons, including:

e The negative publicity resulting from the Transfer Order,

e I-Squared’s payment of $35 million to the SEC;

e -Squared’s admission that it had conducted business illegally

for many years, including especially the AlphaSector Index,

which F-Squared had been selling to substantially all of its

clients for years;

* The realization of clients using the AlphaSector Index that they

themselves might incur liability to their own clients if they

continued doing business with F- Squared; and

e The SEC’s commencement of investigative enforcement

proceedings against several F-Squared clients relating to their

business dealings with F-Squared.

Paragraph 19 reads in full:

As a result, F-Squared’s revenues dropped precipitously. For example, by

Match 31, 2015, four of its largest clients notified F-Squared that they were

terminating their relationships, representing a loss of $4.3 billion, more than

25% of assets under management. Thereafter, F-Squared’s clients continued

to flee.

26

in nature and say nothing regarding the actual magnitude of the liabilities much less the

goagnitude relative to the company’s assets. □

The Trustee’s primary argument in response to the Motions to Dismiss is that the

Complaints contain sufficient allegations from which I can conclude that Debtors were

“insolvent from inception” and therefore insolvent on the date of each transfer.”° In

paragraph 17 of the Complaints, the Trustee specifically alleges that: “at all relevant times,

F-Squared generated. a great majority of its revenue by means of illegal activity almost

certain to give rise, at some point, to massive liabilities on account of that activity, and so F-

Squared was insolvent form the inception of its use of the AlphaSector Index strategy.”

Many Defendants argue in their Motions to Dismiss that this language invokes the pleading

standard applied by some courts in addressing complaints alleging Ponzi schemes (i.e., a

presumption of fraud)?” In his Answering Brief, the Trustee acknowledges both that his

theory applies in Ponzi scheme cases, and that he is not alleging that F’-Squared was

engaged in a Ponzi scheme. Nonetheless, he argues that “even where a debtor does not

operate a Ponzi scheme, a debtor’s pervasive illegal activity can result in a debtor's

insolvency due to substantial liabilities on account of that illegal activity.”"> The Trustee

further contends that the fact that the fraud was the advertising of the product—as opposed

_ to illegal operations—makes no difference. He states: the “use of [the AlphaSector]

technology constituted securities fraud because of how it had chosen to advertise it.””

Applying the Ponzi scheme theory here, the Trustee reasons that because Debtors engaged

Complaint | 17. At argument, the Trustee explained his position is that Debtors were insolvent

since 2008 when they started using the AlphaSector Index. Hr’g Tr. 85:16-23.

See, e.g., McClelland Opening Brief 9-11.

Answering Brief {51 n. 9.

® Answering Brief 51, citing to the Complaint { 14.

27

in securities fraud, Debtors were accruing liabilities due to that fraud at the time the fraud

occurred (i.e., each time it advertised), and that these liabilities were large enough (i.e.

“massive”) so that they outweighed Debtors’ assets.’

This case is sufficiently distinct from a Ponzi scheme case that I will not import any

Ponzi scheme standard into this decision on the Motions to Dismiss." A Ponzi scheme

presents a very specific scenario: guaranteed returns to existing investors can only be paid

with funds from new investors.’ Certain courts conclude that an allegation that a business □

constitutes a Ponzi scheme sufficiently alleges insolvency under the balance sheet test and

section 548, as “[t]he promised rate of return renders a Ponzi scheme operator insolvent

from the scheme's inception, because the returns exceed any legitimate investments.”'

Here, there is no allegation that Debtors’ operations (as opposed to its advertising) were

illegal, that Debtors (or their clients using the AlphaSector Indexes) were placing

customers’ funds in illegitimate investment vehicles or even that persons using the

AlphaSector Indexes strategy were making losing investments. As Defendants contend,

Debtors operated an otherwise legitimate business. Indeed, the SEC found that although

F- Squared’s investment strategy underperformed advertised results, it outperformed the

S&P 500 Index for the period of April 1, 2001 through August 24, 2008.'" And, the SEC

did not shut down F-Squared. Rather, it imposed a fine and certain undertakings, mcluding

100 Id.

10f also make no comment on whether the presumption of insolvency is appropriately applied in

Ponzi scheme cases.

02 See Cunningham v. Brown, 265 U.S. 1, 8 (1924) (describing Charles Ponzi as “always insolvent,

and became daily more so, the more his business succeeded. He made no investments of any kind,

so that all the money he had at any time was solely the result of loans by his dupes.”).

3 See In ve Taubman, 160 B.R. 964, 978 (Bankr.S.D.Ohio 1993) (citing Cunningham v. Brown, 265

U.S. 1, 7 (1924) (“The promised rate of return renders a Ponzi scheme operator insolvent from the

scheme's inception, because the returns exceed any legitimate investments.”).

14 Transfer Order 2.

28

that F-Squared continue to retain an independent compliance consultant with a period of

engagement of not less than two years.’ .

Even assuming, therefore, that the existence of a Ponzi scheme is sufficient to infer

the insolvency of the operator of that scheme, it is not sufficient on the facts alleged in the

Complaints. Rather, the degree to which business activities constitute illegal activities, or

the type of activity itself, determines the factual allegations that are required to make a

plausible claim of “Insolvency from inception.” Such allegations are not present here, and a

Ponzi scheme cannot be pled here.

Further, the Trustee’s reliance on Coated Sales! and Antar‘”’ do not otherwise

persuade me that the Trustee has alleged sufficient facts in the Complaints to permit me to

draw a reasonable inference that Debtors were insolvent on the date of each transfer. In

Coated Sales, the debtor’s officers perpetrated a “massive fraud involving fictitious invoice

billings, false account receivable, false customer audit confirmations and nonexisting

inventory records” for which these officers were subsequently indicted on charges of bank □

fraud, securities fraud, racketeering and money laundering.' Among the litigation brought

in the ensuring bankruptcy case were various preference actions which necessitated a

determination of whether Coated Sales was insolvent on the applicable transfer dates. At

trial, the court heard competing valuation testimony. As a preliminary matter the court

considered whether it should value the company as a going concern or on a liquidation

basis.'° In this context, the court said it could consider information (i.e., the fraud) learned

106 Ty ve Coated Sales, Inc., 144 B.R. 663 (Bankr. S.D.N.Y. 1992).

B.C. y, Antar, 120 F. Supp. 2d 431 (D.N.J. 2000), aff'd 44 F. App'x 548 (3d Cir, 2002).

Coated Sales, 144 B.R. at 665.

109 Td. at 667.

10 Fd. at 667-8. .

29

after the challenged transfers to determine whether the company was insolvent on the .

transfer dates."' The Coated Sales court explained that a court may use such after-the-fact

information if it “tends to shed light on a fair and accurate assessment of the asset or liability

as of the pertinent date... .”"? Ultimately, the court did not need to choose between a

liquidation and a going concern valuation methodology because after adjustments to the

balance shect the debtor was insolvent under either methodology.'” Thus, to the extent the

court even considered the fraud in its decision, the court considered it in the context of □

assets and liabilities and the adjustments to the debtor’s balance sheet.

In Antar, the SEC sued Antar to set aside certain transfers under New Jersey’s

Uniform Fraudulent Transfer Act.'4 The transfers occurred in 1991 and 1997." In

determining whether Antar was insolvent at the time of the transfers the court considered its

previous decision, in which it ruled that Antar had committed securities fraud in the 1980s

and awarded the SEC $15 million based on illegal profits plus prejudgment interest in the

amount of $42 million.“° The court included the SEC’s claim as a debt in its solvency

analysis concluding that the SEC had an unliquidated claim for the securities fraud at the

time of the 1991 and 1997 transfers. ‘The court stated that the fact that the SEC’s claim had

not yet been reduced to judgment at as of the time of the transfers did not undermine the

determination of insolvency.’ Comparing Antar’s net worth of between $6 million to $8

at 668,

112 id.

3 7d, at 679 (“Taking into consideration the adjustments that the Court feels were necessary and

reasonable under the circumstances, the Court finds that, irrespective of the valuation method

applied, CSI was insolvent at the time of the transfer.”).

M4 Antar, 120 F. Supp. 2d at 436.

Td. at 442.

at 443.

NT Td.

30

million as of the date of the transfers to the amount of the subsequent $15 million award for □

securities fraud, the court easily concluded that Antar’s “debts dwarfed any conceivable

valuation of his assets in 1991 and 1997.”' Both the Antar court and the Coated Sales court

were willing, to some degree, to consider aftér-the-fact information in determining the

solvency of the debtor.'”

Defendants contend that in relying on Coated Sales and Antar, the Trustee is

confusing the use of later-learned information and employing impermissible hindsight.

Defendants contend that the Trustee’s arguments rely on many contingencies, which were

not certainties at the time of each transfer, including that F-Squared’s misconduct would

have been discovered and not timely corrected, that the SEC would use its discretion to

bring an enforcement action against F-Squared, that the SEC would then use its further

discretion to take action against F-Squared’s customers and that F-Squared’s customers

would have indemnification claims against F-Squared. Defendants cite to Edgewater Medical

Center to prove their point.

In Edgewater Medical, a chapter 11 debtor brought a fraudulent conveyance and

breach of fiduciary duty lawsuit against a landlord and their common principal.”" The

court had previously determined after trial that the debtor was engaged in Medicare fraud,

and the plaintiff argued that this fraud should be taken into account in the solvency

#18 Td. :

focus on Antar and Coated Sales, as these are the cases the parties focused on in argument. In his

Answering Brief, the Trustee spends considerabie time discussing W.K. Grace & Co,, 281 B.R. 852

(Bankr. D, Del. 2002). The WR. Grace decision spends significant time discussing the treatment of

contingent claims and. unknown claims in a solvency analysis, and also tries to reconcile and/or

distinguish the different and varying contexts in which courts consider and/or condenin the use of

hindsight. Nothing in W.R. Grace, however, supports the ‘Trustee’s position that a court should

inject into its analysis an unknown, massive figure in lieu of a liquidated debt.

20 Tn ve Edgewater Med. Ctr., 373 B.R. 845 (Bankr. N. D. Ill. 2007).

1) Td. at 852.

. 31 .

analysis.!”? At trial on the fraudulent conveyance action, the plaintiff adduced credible

expert testimony on the actions the Department of Heaith and Human Services would have

taken if it had discovered the fraud and the effect of those actions on the solvency of the

debtor." As the court stated, if the effect of the Medicare fraud was included in the

solvency analysis, the debtor was insolvent; if not, the debtor was solvent." The Edgewater

Medical court declined to speculate regarding what would have happened if the fraud had

been discovered prior to the transfers and concluded that the plaintiff had not met its burden

of proving insolvency,’ In so doing, it distinguished Coated Sales noting that in. Coated Sales,

the debtor was actually insolvent, but only appeared to be solvent because it was “cooking

the books.”"5 The court observed that in Coated Sales, the court did not need to incorporate

hypothetical fines, penalties or uncollectible accounts receivable due to fraud as the debtor

was actually insolvent without accounting for the fraud.”

Here, I need not decide whether the Trustee’s request asks me to employ

impermissible hindsight. Assuming, arguendo, I should consider events subsequent to .

22 Id. at 853-4. □

23 Id. at 854,

124 Td.

25 The Edgewater Court explained:

Had the government discovered the Medicare fraud that was occurring

and had the government completely ceased making payments to the

debtor, then perhaps the debtor would have been rendered insolvent.

Perhaps that is what would have happened; perhaps that is even what

likely would have happened. To reach a finding of insolvency,

however, the court would have to disregard the large amounts of cash

the debtor had on hand and speculate on what the Department of

Human Services would have done if it had discovered the Medicare

fraud. The court declines to engage in that type of speculation and

finds and conciudes that the plaintiff has not met its burden of proving

insolvency.

Id. at 855.

6 Td. at 854-5.

7 Td, (citing to Coated Sales, 144 B.R. at 679).

32

Squared’s transfers in connection with a solvency analysis, the reasonable inferences to

be drawn in the Trustee’s favor still do not result in a plausible case of insolvency. Applying

Antar and. Coated Sales here, I would draw a reasonable inference from the Complaints and

the Transfer Order that on the date of each transfer that occurred prior to the Transfer

Order, the SEC had a claim against F-Squared in the amount of $35 million on account of

F-Squared’s false advertising. But from this, I cannot draw the further requested inference

that F-Squared was insolvent on each of those dates, primarily because the Trustee did not

plead any facts regarding F-Squared’s assets on those dates. As Defendants point out, the

reasonable inference to draw from the facts pled in the Complaints is that: (i) F-Squared was

profitable as it was making tax and profit distributions through 2014; and (ii) as of June 20,

2014, there were $28.5 billion in assets under advisement.* From the facts pled, I cannot

make the inferential leap the Trustee seeks, namely that F-Squared’s “massive liabilities”

always outweighed its assets. The same holds true with respect to Transfers made after the

Transfer Order. Even though there is an established liability, I have no asset information to

compare it to.!”

Further, on the facts pled and the law cited, I reject the Trustee’s suggestion that I

accept Antar’s conclusion and consider later-learned facts, but ignore those facts to the

28 Complaint 14.

129 were to consider the petition as a reference point, I would not conclude any differently. The

‘Trustee argues that the petition shows assets of between $1 and $10 million as of the petition date

and I should therefore value F-Squared’s assets at $1 million as of the date of each transfer. Even

giving the Trustee every reasonable inference, the $1 million value is after the payment of the SEC

fine, disgorgement of profits and Joss of clients. Hi’g Tr. 36:23-38:17. Importing a $1 million asset

value (or fair market value?) appears more akin to employing impermissible hindsight than an after-

the-transfer fact which permits a court to better assess the true value of an asset or liability at a

previous point in time. Unlike F-Squared’s false advertising, the loss of clients is not an established

fact that existed at the date of each transfer. This argument requires predicting that the SEC would

not only investigate and threaten to prosecute Debtors, but that the SEC would choose to investigate

and threaten to prosecute Debtors’ customers.

33

extent they do not support the Trustee’s position. Here, the Trustee asks me to

acknowledge debt existing at the time of each transfer based on F-Squared’s entry into the

ransfer Order, but to ignore the liquidation of that debt at $35 million. The Trustee asks

that I conclude that F-Squared’s debt at the time of the transfer was some unknown, but

“massive” number presumably far in excess of $35 million.“ Nothing in Antar suggests that

in drawing reas onable inferences I should forego acknowledging a subsequently liquidated.

amount in favor of a wholly speculative or potential figure. The only reasonable inference I

can draw from the facts alleged seen through the prism of Anter is that F-Squared’s debt for

securities violations at the time of each Transfer was $35 million.

Finally, that F-Squared was insolvent from the first instance that it put out any

advertisement that violated securities laws is simply not a reasonable inference. ‘The Trustee

provides no facts that show that Debtors would be liable for the full amount of any debt to

the SEC at the instance of the first securities law violation in 2008, or that the AlphaSector

Index constituted the largest portion of Debtors’ revenue from the beginning. To the

contrary, the Transfer Order states that the violations occurred over a period of time between

2008 and 2013. Further, the only timing allegation in the Complaints is inconsistent with a

theory of “insolvency from the inception” as the Trustee alleges that “/a/s a result of the

Transfer Order, F-Squared was no longer a viable business and was no longer able to operate

with its remaining capital.” The T ransfer Order is dated December 22, 2014. Therefore,

“insolvency from inception” is not a plausible, viable theory of insolvency based on the .

allegations pled here and is insufficient to meet the pleading standard. .

130 Hp Tr, 34:11-45.

34

Because I can draw no reasonable inferences as to assets or the magnitude of

liabilities relative to assets from the facts alleged in the Complaints, and because I do not

find the “insolvency from inception” theory to be based in the facts alleged, I cannot

reasonably infer insolvency.

B. The Trustee Has Not Adequately Pled Unreasonably Small Capital.

Even if the Trustee has not sufficiently pled insolvency, he may defeat the Motions to

Dismiss if he has adequately pled that Debtors had unreasonably small capital at the time of

each Transfer. Count I of the Complaints asserts this action under the Bankruptcy Code.

‘Count IT of the Complaints asserts this action under both Massachusetts and Delaware state

law imported through § 544(b) of the Bankruptcy Code.

The briefing on undercapitalization was meager, to say the least. And, in many of

Defendants’ Opening Briefs and the Answering Brief, there is overlap between the

discussion of insolvency and the discussion of undercapitalization. Defendants’ arguments

can generally be classified in three categories: (i) the Trustee has simply not pled sufficient

facts to show that there was inadequate capitalization at any time; (ii) the Trustee has not

pled sufficient facts to show that the Transfers caused undercapitalization, or that the

Transfers were of a magnitude that could have caused inadequate capitalization; and (ii)

the Trustee has not, and cannot, plead undercapitalization without use of impermissible

hindsight.

The Trustee’s one sentence response in his Answering Brief points to three

paragtaphs of the Complaints,’ which the Trustee cites for the proposition that: “Even

though F-Squared generated large quantities of cash during and after its fraudulent

31 Complaint ff 19, 21, 28.

35

advertising campaign, this cash flow slowed to a trickle once F-Squared admitted to its

fraud, and the company used much of the cash it had in its coffers to make the Transfers.”'”

. The remainder of the Trustee’s briefing reprises his impermissible hindsight/later-learned

information distinction.”

The Bankruptcy Code test is whether the debtor was “engaged in business or a

transaction, or was about to engage in business or a transaction, for which any property

remaining with the debtor was an unreasonably small capital.” The state law standards

are similar to the bankruptcy law standard. Massachusetts General Law 109A, section 5

states, in relevant part, that a transfer is fraudulent where given “without receiving a

reasonably equivalent value in exchange for the transfer or obligation, atid the debtor: (i)

was engaged or was about to engage in a business or a transaction for which the remaining

assets of the debtor were unreasonably small in relation to the business or transaction[.]”'°

2 The full text of paragraph 19 is recited supra, in note 95. Paragraph 21 reads in full: □

In response to this substantial loss of business, in March 2015 the

Debtors reduced their workforce by nearly 30% - from 162 to 117

employees. The work force reduction resulted in the incurrence of an

additional approximately $1.3 million in severance costs. Moreover, in

connection with the SEC’s investigations, F-Squared incurred

approximately $17.2 million in direct legal costs, plus millions more

advanced to Directors and Officers pre-petition relating to the

investigation, of which only $10 million of which was recovered from

available insurance.

Paragraph 28 reads in full:

During the two years prior to the Petition Date, F-Squared distributed certain

Dividends to Defendant in the amount set forth in Exhibit A to pay Defendant’s

personal income taxes related to Defendant’s equity interest in F-Squared and/or as

profit interests in F-Squared.” I note that none of these paragraphs contain an

allegation that supports the assertion that F-Squared used ‘much of the cash in its

coffers.

‘3 Answering Brief 4] 54 (citing to Adelphia Recovery Tr. v. FPL Grp. Un re Adelphia Comme'ns Corp.),

512 B.R. 447, 495 (Bankr. S.D.N.Y. 2014) (“Adelphia”). Itis unclear that this argument addresses □

undercapitalization as the Trustee uses the term insolvency during the entirety of this argument.

Regardless, I will treat it as such.

1411 U.S.C. § 548 (a)(1)(B\GDAD.

35 “Mass. Gen. Laws ch. 109A.

36

Delaware Uniform Fraudulent Transfer Act § 1304(a)(2) uses the same language.'*° No

party briefed the standard under state law or distinguished it from the § 548 standard. Like

the parties, I will cite to caselaw interpreting § 548. .

Undercapitalization is a distinct concept from insolvency. A debtor has

unreasonably small capital if it has an “inability to generate sufficient profits to sustain

operations|,]” at the time of or because of the challenged transfer’”’ or, in other words, □

where a debtor is “technically solvent but doomed to fail.” The standard is reasonable

foreseeability.? In applying this standard, courts have considered. debtor’s assets and

liabilities, cash flow, revenue generating assets, access to capital, debt to equity ratio and

capital cushion. To “strike a proper balance” under the “reasonable foreseeability” test,

courts must “take[ ] into account that ‘businesses fail for all sorts of reasons, and that

fraudulent [conveyance] laws are not a panacea for all such failures.”'”

- For similar reasons to those set forth above regarding insolvency, the Trustee fails to

plead unreasonably small capital. There are simply insufficient facts in the Complaints to

36 Del. Code Ann. tit. 6, § 1304 (a)(2).

Moody v. Sec. Pac. Bus. Credit, Inc., 971 F.2d 1056, 1070 (3d Cir, 1992).

MFS/Sun Life Tr—High Yield Series v. Van Dusen Airport Servs. Co., 910 F.Supp. 913, 944 (S.D.N.Y.

1995) (citing Moody, 971 F.2d at 1070 & n.22). .

39 Tn ve Semerude, L.P., 526 B.R. 556, 560 (D. Del. 2014) (citing to Moody, 971 F.2d at 1073), affd sub

Inve SemCrude L.P., 648 F. App'x 205 (3d Cir. 2016).

40 Tn ve 45 John Lofts, LLC, 599 B.R. 730, 746 (Bankr. S.D.N.Y. 2019). See also Adelphia, 512 B.R. at

495-6 (“Courts considering capital adequacy (under state law or Bankruptcy Code section 548,

which affords analogous rights of recovery in favor of estate representatives under federal law) have

generally considered whether, at the time of the transfer, the company was able to generate sufficient

profits or capital to sustain operations over a reasonable period of time. In doing so, they have

considered the reality of the debtor’s financial condition leading up to the transfer, looking to such

factors as the company’s ‘debt to equity ratio, its historical capital cushion, and the need for working

capital in the specific industry at issue,’ as well as ‘the debtor's present and prospective debts, and

whether the retained assets are sufficiently liquid to enable the debtor to pay such debts as they

become due.’ But ‘[w[hile a company must be adequately capitalized, it does not need resources

sufficient to withstand any and all setbacks.’”) (citations omitted).

141 Moody, 971 F.2d at 1073.

37

permit me to draw a reasonable inference that Debtors were undercapitalized at the time of

each transfer. The Trustee does not sufficiently allege facts regarding F-Squared’s overall

assets and liabilities. Neither does he allege facts regarding F-Squared’s access to capital,

debt to equity ratio or capital cushion. And, because he makes no allegations with respect

to the amount of F-Squared’s capital, a fortiori, the Trustee makes no allegations that F-

Squared’s assumptions regarding its available capital were unreasonable.

The Trustee does allege that following entry of the Transfer Order, and therefore the

payment of the amounts due thereunder, F-Squared lost certain clients. The Trustee pleads

that by March 15, 2015 four of F-Squared’s largest clients were terminating their relationship

with F-Squared resulting in a loss of more than 25% of assets under management, and that

F-Squared was taking measures to reduce its workforce. The Trustee also pleads that in

early May 2015 another client terminated its relationship with F-Squared, and that i# August

2016, the SEC announce penalties against thirteen of F-Squared’s clients. These allegations

provide sufficient detail to infer that F-Squared would experience a sharp and significant

drop in revenue after it lost these clients, but, without more, they are not sufficient to infer

undercapitalization at the time of the challenged transfers. First, the ttmeframe of the loss

of revenue is, at best, March 15, 2015 through August 2016. At most, two sets of transfers

were made during this time frame, the Tax Distribution made on March 30, 2015 and the

Bonus Payment made on April 15, 2015. All other ‘Transfers predate the ioss of clients,

some by more than one year. Second, there are no facts alleged regarding F-Squared’s

capital needs, its monthly liabilities or its outstanding debt to know at what point I’-

Squared’s loss of revenue turns into “an inability to generate sufficient profits to sustain

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operations.” Notably, there is no allegation that any clients ceased paying fees prior to

terminating their contracts.

In his Answering Brief, the Trustee states that “F-Squared was always

undercapitalized.”'” This is akin to the allegation F-Squared was insolvent “since the

inception,” and appears to invoke Antar and Coated Sales. But, these cases do not persuade

me that the Trustee has met the pleading standards. Preliminarily, courts appear to caution

even more strongly against the use of impermissible hindsight in an unreasonably small

capital analysis because the standard is one of “reasonable foresceability."" More

importantly, there is no comparative information against which to gauge the later-learned

“fact” of loss of clients and revenue steam. Again, there is no information in the

Complaints regarding funds necessary to sustain operations or the level of F-Squared’s

capital at any point in time.

Further, the Profit Distributions and the Tax Distributions are somewhat unique

transfers to evaluate, particularly in the context of an unreasonably small capital analysis.

The Profit Distributions and ‘Tax Distributions are made based on F-Squared’s profits. As

the Trustee observes, the Tax Distributions correspond to the income tax obligations of the

recipient on account of his ownership interest in F-Squared equity.' So, as revenues

decrease, any profit and or tax distributions would decrease as well. Placing revenue loss

Answering Brief § 53.

143 See Boyer v. Crown Stock Distribution, Inc., 587 F.3d 787, 794 (7th Cir. 2009) (“But one has to be

careful with a term like “unreasonably small.” It is fuzzy, and in danger of being interpreted under

the influence of hindsight bias. One is tempted to suppose that because a firm failed it must have

been inadequately capitalized. The temptation must be resisted.”), See also WR. Grace, 281 B.R. at

852 (comparing an insolvency analysis with an unreasonably small capital analysis and determining

that the significant difference between the two was a focus on “reasonableness” in the unreasonably

small capital analysis).

M4 See Complaint 9 9.

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back in time, therefore, could eliminate any such transfers. The Trustee does not discuss

how an adequate capitalization analysis accounts for this type of transfer.

Cc. The Trustee Has Not Adequately Pled That Debtors Intended to Incur

Debts They Could Not Pay.

Finally, to plead a constructive fraudulent conveyance, a plaintiff may allege that at

the time of the transfer, the debtor intended to incur or believed that it would incur debts

beyond its ability to pay as such debts matured.“ Count I of the Complaints makes this

assertion under the Bankruptcy Code. Count II of the Complaints makes this assertion

under Massachusetts and Delaware state law imported through § 544(b) of the Bankruptcy

Code. The language of the relevant Massachusetts and Delaware laws are substantially □

similar to language of § 548." No party briefed the relevant standard. And, the Answering

Brief does not even address this aspect of the Motions to Dismiss.

This prong of the constructive fraudulent conveyance standard can be met if it can be

shown that the debtor made the transfer “contemporaneous with an intent or belief that

subsequent creditors likely would not be paid as their claims matured.”!*’ Courts have held .

that intent or belief can be inferred from circumstances showing that the debtor could not

reasonably believe that it would be able to repay subsequent debts.“

Here, there is only one allegation in the Complaints that relates to this element. The

Trustee alleges: “F-Squared’s ability to make its payroll and pay debts as they became due

following the transfer of $35 million to the SEC was limited and depended on continued

M511 U.S.C. 548(a)(1)(B)GIID. :

46 Both require that the debtor “(ii) intended to incur, or believed or reasonably should have

believed that he would incur, debts beyond his ability to pay as they became due.” Mass. Gen.

Laws ch. 109A, § 5, Del. Code Ann. tit. 6, § 1304 (a)(2).

147 5 Collier on Bankruptcy { 548.05 (16" ed, 2019),

48

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payment of asset management fees by clients.”’” This allegation merely states that the

ability to pay debts was “limited” and dependent, and does not rise to the level of

“mability.” And, there are no allegations in the Complaints suggesting that the Debtors did

not intend to pay their debts as they came due. Moreover, certain allegations suggest the

opposite. The Trustee alleges that “in response to the loss of business, in March 2015, the

Debtors reduced their workforce by nearly 30%.” While the Trustee alleges that the

workforce reduction resuited in additional costs of $1.3 million, the reasonable inference to

draw from this allegation as it relates to this standard is that F-Squared recognized the loss

of revenue and was actively working to reduce its ongoing costs, and thus its future payroll

obligations (although the severance obligation was increased). Similarly, the Trustee alleges

in Complaints seeking avoidance of Bonus Payments that: “Minutes of F-Squared’s April 6

2015 meeting of the Board of Managers note that no bonuses for 2015 were likely to be paid

due to F-Squared’s poor financial performance. Nonetheless, F-Squared made the Bonus

Payments, even though it was in the midst of its death spiral.”'*’ The reasonable inference

from this allegation is that management was aware of the need to consider its profitability in

the decision making process; this allegation does not reflect an intent to incur debts that

F- Squared cannot pay.

No facts alleged create a reasonable inference that F-Squared was intending to create

debt it was unable to pay. And, once again, the timeframe alleged in the Complaints is

December 2014 to March 2015-April 6, 2015, after almost all ‘Transfers were made.

Accordingly, the Trustee has not met the pleading standard.

49 Complaint § 17. .

80 Oliveira Complaint 29, Adv. No. 17-50741,

Al

Conclusion

The ‘Trustee has not pled facts sufficient to support a reasonable inference that

F-Squared suffered from one of the three financial conditions necessary to plead a .

constructive fraudulent conveyance. So, the Motions to Dismiss will be granted as to these

grounds. I will, however, permit the Trustee to file motions to amend the Complaints with

respect to his allegations related to F-Squared’s financial condition if he believes it is

appropriate. .

Orders need to be entered in each adversary proceeding. But, Defendants Eng, Chu,

Collins, Dunaway, Gurevich, Miranyan, Miskel, Oliveria, Toso and Yuan raise arguments

in their Motions to Dismiss that I have not yet considered. Accordingly, I will be issuing a

separate Memorandum in each of those adversary proceedings addressing remaining issues.

Thereafter, a joint status conference will be held to address appropriate forms of order in all

of the captioned adversary proceedings consistent with my rulings in this Opinion, my

previous Opinion and any Memoranda.

Dated: September 6, 2019 if

Wilmington, Delaware £ ; b

Wl Ltt ho

Laurie Selber Silverstein

. United States Bankruptcy Judge

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