Petition for Writ of Certiorari — Nisselson v. Lernout, 127 S. Ct. 2131 (2007) (No. 06-1160)

05-1774 061160 FEB23 2007

OFFICE OF THE CLERK

Supreme Court of the United States

ALAN NISSELSON, Trustee of the Dictaphone Litigation Trust,

successor-in-interest to claims of Dictaphone Corporation,

Petitioner,

JO LERNOUT, et al.,

Respondents.

ON PETITION FOR WRIT OF CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE FIRST CIRCUIT

PETITION FOR WRIT OF CERTIORARI

MAX FOLKENFLIK

Counsel of Record

FOLKENFLIK & MCGERITY

1500 Broadway, 21st Floor

New York, New York 10036

(212) 757-0400

Attorneys for Petitioner

QUESTIONS PRESENTED

. Where an acquiring company succeeds in fraudulently

merging with its target, and the target’s securities fraud

claims pass first to the defrauding acquirer’s subsidiary

as a matter of law, and thereafter to a bankruptcy estate

and a litigation trustee, may the trustee be denied recov-

ery on the ground of in pari delicto only if the two-

part test adopted by this Court in Bateman Eichler, Hill

Richards, Inc. v. Berner, 472 U.S. 299 (1985) is met?

. Does a trustee or receiver “bear at least substantially

equal responsibility for the violations he seeks to

redress” as “a direct result of his own actions” thereby

satisfying the first prong of the Bateman Eichler test

whenever. principles of imputation make him respon-

sible for the wrongs of a “guilty” predecessor?

. Does Section 541 of the Bankruptcy Code require a

finding that a trustee acquiring the claims of a debtor

bears “equal responsibility” as “a direct result of his

own actions” for the wrongs underlying those claims

whenever the debtor would have been found to have

“equal responsibility”?

. Does arule of law denying recovery to all trustee suc-

cessors for all defrauded merger targets “significantly

interfere with the effective enforcement of the securi-

ties laws and protection of the investing public” under

the second prong of the Bateman Eichler test, thereby

requiring the defense to be denied?

. Does Section 541 of the Bankruptcy Code create a fed-

eral rule of imputation consistant with this Court’s rul-

ing in O’Melveny & Myers v. FDIC, 512 U.S. 79

(1994), thereby requiring all trustees obtaining rights to

claims in bankruptcy to be found in pari delicto on all

state law causes of action whenever the debtor would

have been so found, irrespective of the provisions of

state law otherwise governing the claim and defense?

LIST OF PARTIES — Rules 14.1(b) and 29.6

A. Parties Originally Named in the District Court.

Jo Lernout; Pol Hauspie; Nico Willaert; Gaston Bas-

tiaens; Carl Dammekens; Ellen Spooren; Ju-Chul Seo:

Erwin Vandendriessche; RVD Securities N.V.; Dick

Cauwelier; Mare G.H. DePauw; Francis Vanderhoy-

donck; Gerard van Acker; S.AI.L. Trust V.Z.W., Flan-

ders Language Valley Fund; Flanders Language Valley

Fund Management; Lessius Management Consulting,

N.V.; Gewestelijke Investeringsmaatschapp1) Vlaanderen

N.V.; L&H Investment Company, N.V.; Language Invest-

ment Company: Language Development Services: Mer-

cator and Noordstar N.V.; Language Development Fund;

Velstra Pte Ltd., Louis H. Verbeke; Willem Hardeman;

Tony Snauwaert: Klynveld Peat Marwick Goerdeler

Bedrijfsrevisoven; KPMG LLP; Paul Behets; SG Cowen

Securities Corporation: Chase Securities, Inc., as suc-

cessor to Hambrecht & Quist: Deloitte & Touche; Ston-

ington Partners, Inc.: Stonington Capital Appreciation

1994 Fund L.P.; Stonington Holdings, LLC; John H.

Duerden; Albert J. Fitzgibbons, III]; Emil F. Jachmann;

Alexis P. Michas; Scott M. Shaw: Joseph D. Skrzypczak;

and Peter P. Tong.

B. Changes of Parties in the District Court.

The District Court entered judgment solely as to Jo

Lernout; Pol Hauspic; Nico Willaert: Gaston Bastiaens;

Carl Dammekens; Ellen Spooren; Ju-Chul Seo; Erwin

Vandendriessche; RVD Securities N.V.; Dick Cauwelier:

Marc G.H. DePauw; Francis Vanderhoydonck; Gerard

van Acker: S.AI.L. Trust V.Z.W., Flanders Language

Valley Fund, Flanders Language Valley Fund Manage-

ment; Lessius Management Consulting, N.V.; Gewest-

clijke Investeringsmaatschappij Vlaanderen N.V.; L&H

ill

Investment Company, N.V.; Language Investment Com-

pany; Language Development Services: Mercator and

Noordstar N.V.; Language Development Fund; Velstra

Pte Ltd., Louis H. Verbeke; Willem Hardeman; Tony

Snauwaert; Klynveld Peat Marwick Goerdeler Bedrijf-

srevisoven; KPMG LLP; Paul Behets; SG Cowen Secu-

rities Corporation. Chase Securities, Inc. and Deloitte &

Touche are no longer parties to the action. The case to

the remaining parties is pending.

C. Changes of Parties in the Court of Appeals.

None

CORPORATE DISCLOSURE STATEMENT

The Dictaphone Litigation Trust is a trust, without

shareholders, parents or subsidiaries. KBC Bank, N.V.

and Fortis Bank, N.V. each have a beneficial interest in

the Trust exceeding 10%.

TABLE OF CONTENTS

CIEE See. F PUREST EAD oj nccedaxs siuseantewen

LIST OF PARTIES—Rules 14.1(b) and 29.6 ....

CORPORATE DISCLOSURE STATEMENT.....

SPE EP PLATI Ee TORSO bs crab da Means cesta ncbenaens

FURR NEG TF NGIT OES 5 ccs tka bec baxnaboWhkesk beret

PERTINENT CONSTITUTIONAL AND

STATUTORY PROVISIONS ....... 5.5.62: hee

PRE NCIS MPP Leh Cees ees veep sa eyavnsents

PRs SHEE ee Oa. © RAE eras oh pucae rece uekaeons

5. STATEMENT OF THE FACTS. ...¢. 6.5:

C. THE DISTRICT COURT DECISION...

. THE COURS OF APPEAL oi iss vcckans-

THE REASONS FOR GRANTING THE WRIT .

1. The Question of Whether a Trustee

May Be Held “Jn Pari Delicto”

on Federal Claims because of his

Predecessor’s Fault is an Important

Issue Left Open by this Court in

Bateman Eichler, which has Split

LUNE et Ta Se ar canes Mee S ie ey a a Le er

A. Under General Equitable Principles

and with regard to the Limited

Role of Jn Pari Delicto Defense

in Federal Claims, a Trustee is

Not “of Equal Fault” with the

Wrongdoer..... lok Rea canecunee beau

B. The Trustee Here Asserting a Claim

Originally Held by anInnocent —

Victim of Fraud was Not of

Equal Fault with Defendants.......

C. Bankruptcy Code §541 Neither

Prohibits Consideration of Equities

Presented by a Trustee Suit Nor —

Trumps this Cov *’s Bateman

Eichler Test in Determining the

Proper Application of Jn Pari

BE icacsoecuascostaensuedcasiness

Allowing In Pari Delicto to Defeat

Claims of Defrauded Merger

Targets Substantially Interferes

with the Policies of the Federal

ENG RI cn vr xvceaesscessausvoaneee

Allowing Bankruptcy Code Section 541

to Federalize the Application of State

Law Claims of Jn Pari Delicto Violates

this Court’s Holding in O'Melveny &

Myers v. FDIC and is also an Important

Issue Meriting Review by this Court...

RRP ROUES . evn ndcensayetVoutebsceuriuabencases

15

18

19

23

30

TABLE OF AUTHORITIES

Federal Cases: PAGE

Adelphia Communs. Corp. v. Bank of America

(In re Adelphia Communs. Corp.),

Bae ae, Oe COR, oo co bbb coco bdekcbanenceds 29

Baena v. KPMG, LLP. 453 F.3d |

CERES Sy SP bivcinbae keene hocks eciaabactuue }?

Bateman Eichler, Hill Richards, Inc. v. Berner.

GSE i ROT ORE Koso bin bad hhc tka epivewns passim

A. C. Frost & Co. v. Coeur D'Alene Mines

OO ie Oe er PT ickcxcckpiwsnccnetes 24

Caplin v. Marine Midland Grace Trust Co..,

og ee 1 EE 2 37-8 Bee ee een Comrie 16, 27

Consolidated Rock Products Co. v. Du bois,

REZ Oy POR EOD oes esend ccabedodwaxbewds 2?

ELF. Hutton & Co. v. Hadley, 901 F.2d 979

Cy ee Oe Go re ieee ek OS ee ae 9

FDIC v. O'Melveny & Myers, 61 F.3d i7

CPPS SO OAED 5 dhasneadededseis ites passim

Grassmueck v. America Shorthorn Association,

GE? Fi 3G BS9. (BU Cis, FOSS oe nv.cvcwdivenccsess 5

In re: Hedged-Investments Associates, Inc.,

BO F506 F205. CUR CH, FON cia cievncncncss 6

Hirsch v. Arthur Andersen & Co., 72 F.3d 1085—

Ce a Se BED core cate ecu redecaiewodwad sowie: 6,9

Keystone Driller Co. v. General Excavator

CO ce a Ae Psa c,h eae bodes 20

Vii

PAGE

McCandless v. Furlaud, 296 U.S. 140 (1935).... 16, 17

Mediators, Inc. v. Manney (in re Mediators,

Inc.), 105 F.3d 822 (2d Cir. 1997) .......... 6, 9, 11

Northern Pacific R. Co. v. Boyd, 228 U.S. 482

CIES ine kkccd candiesavussdsass si eie ate 22

O’Melveny & Myers v. FDIC, 512 U.S. 79

CP yaks Co oad bo as ed cs Ca passim

Official Committee of Unsecured Creditors

of PSA, Inc. v. Edwards, 437 F.3d 1145

(2006), cert. denied sub nom Laddin v.

Reliance Trust Co., 2006 U.S. LEXIS

5711) (Octoter Z, 2006) 6.0.6cccces 4, 15, 20, 23, 29

Official Committee of Unsecured Creditors

v. R.F. Lafferty & Co., 267 F.3d 340

CoG S56 Seeks osc cen 5, 15, 29

Perina Life Mufflers v. International Parts

as Pee, ES MK LG) | Bree ya 14, 24

Pinter v. Dahl, 486 U.S. 622 (1988)...9, 13, 23, 24, 25

SEC v. North American Research &

Development Corp., 280 F.Supp. 106

CBee, 2a CE oon danhbewis dhe oo eas 24

Scholes v. Lehmann, 56 F.3d 750

CFU SL Sik io dettectc ise, 5, 14, 17, 18

Shearson Lehman Hutton, Inc. v. Wagoner,

O64 F206 134 (206 Cit, 1998) uns cadets ccciwec 6,9

Talz v. Proskauer Rose LLP (In re Fuzion

Tech. Group, Inc.), 332 B.R. 225

C52 Pa aD nk bbc kaddseasnivadathiasescdhs 20

vill

PAGE

In re Telegroup, Inc. v. Telegroup, Inc.,

en Oe Gry RED ces isecencceeeves 22

Terlecky v. Hurd (In re Dublin Sec),

133 F.3d 377 (6th Cir. 1997),

cert. denied, 1998 U.S. LEXIS 4792 ........ 5

In re The Personal and Business Insurance

Agency v. McNamara, 334 F.3d 239

See eae cick nye tevaceeyerccssvesde @° Ua

McNamara vy. PFS (In re Personal &

Bus. Ins. Agency), 334 F.3d at 246

er du vacseesaeceyeees 17

Waslow v Grant Thornton LLP (in re

Jack Greenberg, Inc.), 240 B.R. 486

er Ba Cv awae vice sevaesuceters 29

Williams v. California Ist Bank, 859 F.2d 664

ee. ese poe dywac ese etees 9

Woolf v. S. D. Cohn & Co., 515 F.2d 591

rls ive pve tes eestsceseceen 13

State Cases:

Albers v. Continental Illinois Bank & Trust

Be Bie PR. OHO CUDIE) . i... cece cee oee 18

Brooke v. Kennedy, 172 Ga. 461 (1931).......... 29

Camerer v. California Say. & Commercial

eS er Ee Be eo ks 18

Choquette v. lsacoff, 836 N.E.2d 329

SS ra 28

iX =

PAGE

ISP.com, LLC v. Theising, 805 N.E.2d 767

CR; DE cdi osendcdeieccen eeawinedevetsaiesuee 17-18

Peregrine Funding, Inc. v. Sheppard Mullin

Richter & Hampton LLP,

133 Cal. App. 4th 658 (2005) ................ 29

Tooley v. Donaldson, Lufkin, & Jenrette, Inc.,

845 A.2d 1031 (Del. 2004).................-. 10

Universal Builders, Inc. v. Moon Motor Lodge,

Bae. BOS FO, Sa CIM sv avdavyeneccqetyeauss 18, 29

Statutes:

DE a i hav ein eco enedasasdond osuatande 19

EE See WEE cncchccupacodsscncuxouturenese ceases passim

EE EA. Peete Me oh vin ca vicesbenecusaereasesans 27

RS UR © RR sive i ee cds ccs ceciice 28

ED ic B FOe vii heii evdeniedsavecadeensweeieces 12

BS Sites Oe PRs svi Sandvetasitiettikeecee 2

BO Wierd O BGO os vncicsinticcd saneerkstesGeatanere l

Ge Ra OE nhac i incke de cnessiseveaweWacctnens ]

1S U.S. OG 1967 OO8 TFGG onc cscseescceissevas oe

ee Oe EE ee PR Rae eer 2

Financial Institutions Reform, Recovery,

and Enforcement Act of 1989 (FIRREA),

Pen... LATS, CS BAA, Beas cvescvvasceevess 28

Det: O03. 620 ai insincere 6, 19

PAGE

Miscellaneous

Slain & Kripke, The Interface between Securities

Regulation and Bankruptcy—Allocating

the Risk of Illegal Securities Issuance

Between Securities Holders and the

Issuer's Creditors, 48 N.Y.U.L.Rev. 261.... yd.

Warren, Bankruptcy Policy,

Pe Aree EN FIG TOE soced cckoeshcswapees 22

Gerald L. Baldwin, /n Pari Delicto Should

Not Bar a Trustee's Recovery,

ra Se "Be ee Re Se ee mes pone 20

Jeffrey Davis, Ending the Nonsense:

The In Pari Delicto Doctrine Has

Nothing to Do with What is § 541

Property of the Bankruptcy Estate,

Bt Mey TOOT. FAW; FL DTF oo kc di cre ccc cectss 20, 21

Making Sense of the In Pari Delicto

Defense: “Who's Zoomin’ Who?”

23 No. 11 Bankr. Law Letter |

GPR eR so ooo dk Cheeks coh adi ed 64 dak Pee bes 20

Robert T. Kugler, The Role of Imputation

and In Pari Delicto in Barring

Claims Against Third Parties,

| No. 14 Andrews Bankr. Lit. Rep. 13

ER i cient akuns Sass ouee Muanareciaueebiion 20

Tanvir Alalm, Fraudulent Advisors Exploit

Confusion in the Bankruptcy Code: How

In Pari Delicto Has Been Perverted to

Prevent Recovery for Innocent Creditors,

77 Am Bannkr. L.J. 305 (Summer 2003).... 20

OPINIONS BELOW

The opinion of the Court of Appeals is reported at 469

F.3d 143 (Ist Cir. 2006) and is reprinted in the Appendix

hereto at 1a to 25a.

-\ The opinion of the District Court granting the Motion

to Dismiss the Amended Complaint filed by SG Cowen

Securities Corporation (“Cowen”) is reported at 2004

U.S. Dist. LEXIS 13648 (D. Mass., July 21, 2004) and is

reprinted at 26a to 40a. A further Memorandum and

Order allowing the motions to dismiss of various other

defendants is not reported and is reprinted at 41a to 42a.

Two unreported orders of the District Court granting the

motions by certain defendants for an order pursuant to

Rule 54(b) to enter a separate judgment of dismissal are

reprinted at 43a to 45a, and 46a to 48a. A further unre-

ported order of the District Court amending the prior

judgment to correctly specify the parties against whom

all claims were dismissed is reprinted at 49a to 50a. An

unreported order of the Court of Appeals pursuant to

Rule 60(a), allowing the District Court to enter the cor-

rected judgment is reprinted at 5la to 53a.

JURISDICTION

The District Court had subject matter jurisdiction of

this action pursuant to Section 27 of the Exchange Act,

15 U.S.C. § 78aa, 28 U.S.C. §§ 1331 and 1337, and the

principles of supplemental jurisdiction under 28 U.S.C.

§ 1367. The Court of Appeals affirmed the District

Court’s dismissal of the claims against certain named

defendants on November 8, 2006. Pursuant to the Order

of Justice Souter dated February 2, 2007, this petition is

due to be filed on February 23, 2007. This Court has

jurisdiction pursuant to 28 U.S.C. § 1254.

tJ

PERTINENT CONSTITUTIONAL

AND STATUTORY PROVISIONS

-Section 541 of the Bankruptcy Code, II U.S.C. § 54],

Section 10(b) of the Securities Exchange Act, 15 U.S.C.

§ 78j(b), Rule 10(b)(5), 17 C.F.R. § 240. 10b-5( 2000), and

the pertinent provisions of the Racketeer Influence and

Corrupt Organization Act, 18 U.S.C. §§ 1962 and 1964

ure reprinted in the appendix hereto at App. 54a to 63a.

STATEMENT OF THE CASE

A. INTRODUCTION

This case involves the proper scope of the in pari

delicto defense when it is asserted against a claim by a

Trustee or receiver who has inherited the claim from a

wrongdoer. Both logic and experience indicates that this

is the context in which the defense its most likely to be

raised since a corporate wrongdoer is most likely to suc

its confederates after those in charge of the wrongful

acts have lost corporate control.

Absent clear guidance from this Court on the issue,

and there has been none, itt is perhaps not surprising that

the issue of whether a Trustee is continued to be bur-

dened with the in pari delicto defense to the same extent

as his predecessor-in-interest is one which has deeply

split the circuits. What is surprising, however, is how

frequently the circuits have decided the issue without

reference to the governing precedents from this Court,

und that even those who did address this Court's require-

ments applied them inconsistently.

The application of the in pari delicto detense in fed-

eral courts is governed by two decisions of this Court,

both of which were misapplied by the First Circuit

below. In the first, Bateman Eichler, Hill Richards, Ince.

v. Berner, 472 U.S. 299 (1985) this Court held that a pri-

vate securities fraud suit for damages, or other like cases

involving federal law claims implicating the public

interest, “may be barred on the grounds of the plaintiff’s

own culpability only where”

(1) as a direct result of his ow. actions, the plaintiff

bears at least substantially equal responsibility for

the violations he seeks to redress, and (2) preclusion

of suit would not significantly interfere with the

effective enforcement of the securities laws and pro-

tection of the investing public.

Id. at 310-11, emphasis supplied.

In the second, O’Melveny & Myers v. FDIC, 512 U.S.

79 (1994), this Court held that in contrast to those strict

requirements for allowing the defense in cases arising

under federal law, where the claims asserted arise under

State law, then, state law principals alone govern the

application of the defense to those state law claims.

In determining the critical issue under the first prong

of the Bateman Eichler test, whether the Trustee’s lia-

bility in this case is “substantially equal” to that of the

defendants, the First Circuit ignored Bateman Eichler

and the policies behind it. Instead, the court of appeals

focused exclusively on the “genealogy” of the Trustee’s

claim, as having passed through the hands of a wrong-

doer. Although the claim rose in innocence as a claim of

a defrauded merger target, and was asserted by an inno-

cent trustee, acting for the benefit of the innocent cred-

itors, the First Circuit applied a mechanical test. It held

that a bankruptcy trustee, and therefore the Trustee in

this case, “stands in the shoes” of his predecessor, and is

barred by in pari delicto if his predecessor would have

been. As we show below in Point 1.A, this approach is

/

ed

4

contrary to the Bateman Eichler rule and long standing

concepts of equity jurisprudence.

The second prong of the Bateman Eichler test was

misapplied following the same mechanical approach.

Since the Trustee was found by the court of appeals to

be a “guilty” participant (by imputation), the policies of

the securities laws were not interfered with since those

laws do not exist to give wrongdocrs a “second bite at

the cherry.” App. at 23a. Allowing the resolution of the

Bateman Eichler “equal guilt” prong (particularly when

guilt is solely through imputation) to determine the

result of the “significant interference” prong, effectively

nullifies the second prong of the Bateman Eichler test.

Further, as we show in Point 2 below, a rule of law that

insulates from suit those who participate in fraudulent

corporate acquisitions clearly does interfere with the

effective enforcement of the securities laws and pro-

tection of the investing public,” and for that reason alone

the decision below merits reversal.

The court of appeals also dismissed the state law

claims using its court devised federal law of imputation

which, as we show below in Point 3, is contrary to this

Court's holding in O'Melveny and contrary to governing

Massachusetts law.

This case calls for review by this Court, however, not

merely because of the errors of the First Circuit below,

however serious, but because those similar failures to

apply this Court’s rulings in Bateman Eichler and

O'Melveny have occurred in case after case, and in

growing numbers, and will continue to occur until this

Court clarifies the issues. The First Circuit decision in

this case below followed the Eleventh Circuit in Official

Committee of Unsecured Creditors of PSA, Inc. v.

Edwards, 437 F.3d 1145 (2006) which contained the

same errors.

The Third Circuit in Official Comm. of Unsecured

Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 357 (3d

Cir. 2001) applied in pari delicto to bar federal and state

law claims of a creditors’ committee without even citing

Bateman Eichler, and by applying a federal standard of

imputation, contrary to the command of O’Melveny and

of Pennsylvania law which governed the state law

claims. See Point 3, infra. In In re The Personal and

Business Insurance Agency v. McNamara, 334 F.3d 239

(3d Cir. 2003), the same circuit, again without citation to

Bateman Eichler, held a bankruptcy trustee was not pro-

hibited from recovering fraudulent conveyance based on

the debtor’s participation in pre-petition fraudulent con-

veyances.

The Seventh Circuit reached the conclusion in Scholes

v. Lehmann, 56 F.3d 750, 754 (7th Cir. 1995) that “the

defense of in pari delicto loses its sting when the person

who is in pari delicto is eliminated.” Citing [llinois

cases and Supreme Court precedent, but notably not the

Bateman Eichler decision, the defense was rejected for

both federal securities and state law claims. '

Similarly, the Eighth, Sixth and Tenth Circuits have

held a bankruptcy trustee’s state law claims is barred by

in pari delicto if his predecessor would have been using

federal court made imputation law in violation of the

rule in O’Melveny.* The Second Circuit has followed its

| Accord FDIC v. O'Melveny & Myers, 61 F.3d 17, 19 (9th Cir.

1995) (“While a party may itself be denied a right or defense on

account of its misdeeds, there is little reason to impose the same pun-

ishment on. . . [an] innocent entity that steps into the party’s shoes

pursuant to court order or operation of law.”)

2 E.g., Grassmueck v. Am. Shorthorn Ass'n, 402 F.3d 833, 836

(8th Cir. 2005) (applying in pari delicto to bar state law claims of

bankruptcy trustee based on federal court made imputation rule); Ter-

lecky v. Hurd (In re Dublin Sec), 133 F.3d 377 (6th Cir. 1997), cert.

denied, 1998 U.S. LEXIS 4792 (October 5, 1998) (same); Jn re:

6

own drummer and held that a bankruptcy trustee loses

standing to assert claims where the debtor has partict-

pated in the wrongdoing.’

This large and growing list of circuit court cases dis-

regarding or conflicting with this Court’s governing

opinions and the still larger number of district court and

Bankruptcy Court cases containing the same defects,

have undermined the continuing vitality of both Bateman

Eichler and O'Melveny. There can be little doubt that

this case, presenting errors in application of both of

those precedents, merits review by this Court to

clarify the proper application of Bateman Eichler and

O'Melveny to suit by trustees and receivers.

B. STATEMENT OF THE FACTS

On May 5, 2000, in a merger pursuant to Section 259

of the Delaware General Corporate Law, Dictaphone

Corporation (“Dictaphone™ or sometimes “Old Dicta-

phone”) transferred all its assets and its business, then

valued at approximately $900,000,000, to Dark Acqui-

sition Corp. (“Dark™ and subsequent to the merger, “New

Dictaphone”), a newly-created wholly-owned subsidiary

of L&H.

The Merger Agreement, which was executed on March

7, 2000, contains representations and warranties from

L&H to Dictaphone in Article IV. including representa-

lions concerning the accuracy of filed financial state-

ments. Those representations were the subject of extensive

“due diligence” by Dictaphone and in the course of

Hedged-Investments Assocs., Inc., 84 F.3d 1281 (10th Cir. 1996)

(same).

3

See, e.g... Shearson Lehman Hutton, Inc. v. Wagoner, 944 12d

114 (2d Cir. 1991): Mediators, Inc. v. Manney (In re Mediators, Inc.).

10S F.3d 822. 825-26 (2d Cir. 1997): and Hirsch v. Arthur Andersen

& Co., 72 F.3d 1085. 1094 (2d Cir. 1995).

which defendants made face-to-face representations to

Dictaphone, upon which Dictaphone relied. Dictaphone

itself hired professional advisors, who were also sub-

jected to misrepresentations from defendants in per-

forming their work for Dictaphone.

Unknown to Dictaphone, the consideration it received

for its transfer of $900,000,000 in business and assets,

including (but not limited to) stock of L&H and the

assumption of Dictaphone’s liabilities, was essentially

worthless due to the existence of a massive fraudulent

scheme to artificially inflate L&H’s reported revenues

and profits which L&H had been engaged in since at

least 1996. As a result, within months of the merger,

both L&H and Dictaphone were forced into bankruptcy

and Dictaphone lost nearly its entire net worth.

The L&H scheme involved the use of related or con-

trolled companies through which L&H would funnel

loans or venture capital, or sometimes its own money,

which would then be given to L&H and fraudulently

recorded by L&H as revenue. Initially, the scheme

involved two corporations called Dictation Consortium

and the Brussels Translation Group (“BTG”). The

scheme was later expanded to a series of twenty so-

called Language Development Companies (“LDCs”) and

Cross-Language Development Companies (“CLDCs”)

(the “LDC/CLDC Fraud”). Like the Dictation Consor-

tium and BTG, the LDCs and CLDCs were effectively

controlled by L&H, but that relationship was concealed.

Following the acquisition by L&H of a Korean

telecommunications company, Bumil, in September

1999, L&H also embarked on a related fraud to enter

into sales contracts at wildly inflated prices with a series

of essentially shell companies, and to fraudulently book

the revenues from these contracts, even though the pur-

chasers had not—and could not—pay the contract price

(the “Korean Revenue Fraud”).

L&H ultimately admitted that various fraudulent

schemes inflated L&H revenues in the period 1998

through June 2000 by $373 million, nearly two-thirds of

the total, and the profits of L&H, reported to Dictaphone

at the time of the merger as $70 million, in actuality was

a $70 million loss. L&H, which had boasted a market

capitalization of $8 billion, was essentially worthless.

Defendants were all alleged to have directly participated

in the L&H scheme. Absent the fraud, Dictaphone never

would have agreed to the merger.

Upon discovery of the fraud, L&H and its fraudu-

lently-acquired subsidiary Dictaphone were compelled

to file for protection under the United States Bankruptcy

Code. Pursuant to Dictaphone’s plan of reorganization,

Dictaphone’s claims were assigned to the “Dictaphone

Litigation Trust,” of which Plaintiff-Appellant, Alan

Nisselson, is the Trustee. Plaintiff-Appellant, by this

action, secks to recover the “damages suffered by Dic-

taphone as a result of the fraudulent course of conduct.”

The damages alleged in the Amended Complaint are

identified generally as “including, but not limited to,

loss or diminution of its value as a going concern and

consequential damages in an amount to be proven at

trial, but no less than $900,000,000.” The $900,000,000

number corresponds to the value of Dictaphone business

and assets which it surrendered in the merger. The

Amended Complaint does not assert any claim or cause

of action premised on any injury, other than injuries to

Dictaphone.

C. THE DISTRICT COURT DECISION

The District Court addressed the issues presented by

the dismissal motions as sub-categories of the issue of

9

standing. The Court found that the case was “much com-

plicated by the fact that the bankrupt corporation was

wholly-owned by the alleged perpetrator of the fraud.”

App. at 34a. The Court first addressed the issue of in

pari delicto. Significantly, although federal securities

fraud and RICO claims were asserted, the District Court

did not even mention, let alone address, the standards

governing the application of the in pari delicto defense

to Federal claims as set forth by this Court in Bateman

Eichler, Hill Richards, Inc. v. Berner et al,, 477 U.S. 299

(1985); and Pinter v. Dahl, 486 U.S. 622 (1988). Nor did

the District Court evaluate the state law claims applying

Massachusetts state law principals‘* as required by this

Court’s decision in O’Melveny & Myers v. FDIC, 512

U.S. 79 (1994).

Instead, the District Court, relying primarily on the

Second Circuit’s decision in Shearson Lehman Hutton,

Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991) and its

progeny,° the District Court held that “Courts have con-

sistently held that claims for fraud or misrepresentation

perpetrated on investors belong exclusively to those

investors to the exclusion of the corporation or its suc-

cessor in interest, where the corporation itself was

4 While the district court did not discuss choice of law issues

Massachusetts, the state where the merger was consummated, L&H

and Dark existed and many of the fraudulent misrepresentations

occurred was the state whose law would apply to the dispute.

? Mediators, Inc. v. Manney (In re Mediators, Inc.), 105 F.3d

822, 825-26 (2d Cir. 1997); and Hirsch v. Arthur Andersen & Co., 72

F.3d 1085, 1094 (2d Cir. 1995). The district court also relied on E. F-

Hutton & Co. v. Hadley, 901 F.2d 979, 987 (11th Cir. 1990), where a

trustee for the perpetrator of a Ponzi scheme, GIC, had no standing to

on claims belonging only to GIC customer creditors, and Williams v.

California 1st Bank, 859 F.2d 664, 666-67 (9th Cir. 1988), where a

bankruptcy trustee was held not to have standing to pursue creditors

claims which the trustee had received by way of assignment.

10

involved in the wrongdoing.” App. at 35a. The court dis-

missed the Trustee’s argument that “Old Dictaphone”

was the victim of the fraud holding: “Old Dictaphone

cannot arise Phoenix-like to assert pre-merger claims

against third parties that New Dictaphone could not

assert.” App. at 36a.

As an alternative ground for its holding that the

Trustee had no standing, the District Court held that the

loss of value resulting from a stock for stock merger was

injury either directly to the shareholders, or directly to

the creditors. App. at 39a-40a. The court found any sep-

arate harm to the “value of the corporation as a going

concern” to be “speculative.” App. 40a. Applying the

test established by the Delaware Supreme Court in the

then-recently decided case of Tooley v. Donaldson,

Lufkin, & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), the

District Court found no standing on that ground as well.

Id.

D. THE COURT OF APPEALS

While the Court of Appeals affirmed the District

Court, it did so under very different reasoning. The

Court rejected entirely the standing conclusions of the

district court. It held that the in pari delicto defense is an

“affirmative defense,” not a matter of “standing.” App.

at 9a. It also held that the issue of who has the right to

assert a claim (in this case the shareholders, as held by

the District Court, or the Trustee ) turns on a question of

prudential standing not Article III standing, and there-

fore need not be resolved as a threshhold matter. App. at

10a. The court declined to address what it considered an

unsettled matter of Delaware law. App. at Ila.

In addressing the in pari delicto defense, the court of

appeals found that Massachusetts law paralleled federal

law as set forth in Bateman Eichler. App. at 12a-13a. It

11

also held that the application of the defense need not be

separately analyzed claim by claim because “the analy-

sis ordinarily will be the same across a spectrum of dif-

ferent causes of action,” App. at 13a, citations omitted,

and any argument that analysis differed claim by claim

or between state and federal law had been “waived.”

App. at 13a.°

Having disposed of the preliminaries, the court of

appeals proceeded to analyze the applicability of the

defense to the Trustee here without regard to the Bate-

man Eichler rule or the parallel state law. Instead, the

court emphasized that any claim for Old Dictaphone for

fraud committed upon it passed through New Dictaphone

before being acquired by the Trustee. The court con-

cluded that

Because the lineage of the trustee’s claims passes

directly through New Dictaphone, any right that the

trustee may have to assert those claims derives

directly from New Dictaphone. . . . The trustee

may assert only those claims that New Dictaphone

could have asserted prior to seeking the protection

‘of the bankruptcy court.

App at 14a.

The court relied on Bankruptcy Code Section 541,

Mediators, Inc., Edwards, and Lafferty to support its

conclusion.

Once having reached that conclusion, the court of

appeals completely disregarded the equities and com-

plexities of the case which Bateman Eichler and paral-

lel state law required it to consider. Instead, the

imputation of guilt to the Trustee effectively resolved

6

The Trustee had argued, with citations to authority, that bar-

ring the claim was inequitable under both federal and state law.

every other issue and overcame every other equity and

policy.

That the Trustee was of equal fault was dictated by the

fact that the Trustee was in effect New Dictaphone, and

the equities arising from the genesis of the claim or the

replacement of Old Dictaphone were disregarded. App.

at 16a-22a. The allowance of the defense would not

interfere with the purposes of the securities law because

the Trustee was guilty (by imputation) and the law ts not

designed to protect the guilty. App. at 23a.

The court found it “preferable” that the creditors sue

individually, rather than through a trustee, because it

speculated that L&H “may well” be a beneficiary of the

trust. App. at 23a.’ It noted that the creditors could still

sue former directors, controlling shareholders and out-

side accounting professionals, without noting the serious

policy implications of allowing direct participants tn

fraud to escape liability while holding merely negligent

parties to account. See App. at 24a.

THE REASONS FOR GRANTING THE WRIT

1. The Question of Whether a Trustee May Be Held

“In Pari Delicto” on Federal Claims because of

his Predecessor’s Fault is an Important Issue

Left Open by this Court in Bateman Eichler,

which has Split the Circuits

The language of Bateman Eichler allows for no excep-

tion. The in pari delicto defense may be applied to a suit

by a trustee or receiver “only” if the two prongs of the

Bateman Eichler test are met. The courts of appeals have

~~»

/

Any concern on that front should have been resolved by the

fact that L&H had been through its own bankruptcy and its creditors.

not its guilty principals, would benefit in that event. See, Buena v.

KPMG LLP. 453 F. 3d 1 (ist Cir. 2005).

13

discussed whether a trustee or receiver should be con-

sidered to be of “substantially equal” guilt. But like the

First Circuit below, they have not analyzed that issue

addressing the language used or the policies behind the

Bateman Eichler decision.

The first prong of the Bateman Eichler test was

framed in a way that suggested only the fault of the lit-

igant appearing before the Court is to be considered. As

the this Court held, an in pari delicto defense could

apply in federal securities fraud cases “where. . . asa

direct result of his own actions” there is “at least sub-

Stantially equal responsibility” for the violations he

seeks to redress.” Bateman Eichler, Hill Richards, Inc. v.

Berner, 472 U.S. at 310-11 (emphasis supplied).

The emphasis by this Court on the “direct result” and

the parties’ “own actions” would seem to preclude the

use of the defense when the parties’ liability for wrong-

ful conduct is a result of vicarious liability, principles of

agency, or imputation, rather than direct participation in

the wrongful conduct alleged. The need to show the

plaintiff’s direct personal involvement in the wrong was

re-emphasized in Pinter v. Dahl, 486 U.S. 622 (1988),

where this Court held:

Under the first prong of the Bateman Eichler test, as

we have noted above, a defendant cannot escape lia-

bility unless, as a direct result of the plaintiff's own

actions, the plaintiff bears at least substantially

equal responsibility for the underlying illegality.

The plaintiff must be an active, voluntary partici-

pant in the unlawful activity that is the subject of

the suit. See Woolf v. §. D. Cohn & Co., 515 F.2d

591, 604 (CAS 1975), vacated and remanded on

other grounds, 426 U.S. 944 (1976). . .”

Id. at 635-636 (emphasis added).

14

A similar formulation also appears in Justice Harlen’s

concurrence and dissent in Perma Life Mufflers v. Inter-

national Parts Corp., 392 U.S. 134 (1968): “Plaintiffs

who are truly in pari delicto are those who have them-

selves violated the law in cooperation with the defen-

dant.” /d. at 153. (emphasis supplicd).

lt is true that these cases did not address the question

presented here, whether a trustee who succeeds to the

rights of a corporate wrongdoer ts considered guilty to

the same extent as his predecessor. However, the least

that can be said about that issue is that the language of

the cases leaves it open to be resolved. That conclusion

is buttressed by the fact that the Bateman Eichler Court

declined to resolve the argument raised by an amicus

Securities Industry Association (“SIA”) as to whether a

lability of a “controlling person” of the defrauding party

has a better ground for asserting the defense when the

controlling person’s liability was only ‘vicarious’ and

‘secondary’.” Bateman Eichler, Hill Richards, Inc. vy.

Berner, 472 U.S. at 314.

The circuit court opinions have addressed the issue of

the application of in pari delicto to trustees or receivers

have deeply split. Those courts which have addressed

the issues in terms of general equitable principles or

specific state law have found that the Trustee is not

barred by his predecessor's wrongs. See, e.g., Scholes v.

Lehmann, 56 F.3d 750, 754 (7th Cir. 1995) (“the defense

of in pari delicto loses its sting when the person who is

in pari delicto is eliminated.”); FDIC v. O'Melveny &

Myers, 61 F.3d 17, 19 (9th Cir. 1995) (holding under

California law “While a party may itself be denied a

right or defense on account of its misdeeds, there ts lit-

tle reason to impose the same punishmenton. . . [an]

innocent entity that steps into the party's shows pursuant

to court order or operation of law”); /n re The Personal

15

and Business Insurance Agency v. McNamara, 334 F.3d

239 (3d Cir. 2003) (same).

Those courts to have allowed the defense against a

Trustee have generally followed a more mechanical

approach, concluding that a trustee “steps into the

shoes” of his predecessor and has no defenses that the

predecessor did not have. Those courts, including the

First Circuit below, have relied upon Bankruptcy Code

Section 541 as the basis for their assertion and have not

tried to reconcile that provision with Bateman Eichler.

See, App. at 14a-15a; Official Committee of Unsecured

Creditors of PSA, Inc. v. Edwards, 437 F.3d 1145 (2006);

Official Comm. of Unsecured Creditors v. R.F. Lafferty

& Co., 267 F.3d 340, 357 (3d Cir. 2001).

Under the general principles which underlie Bateman

Eichler, the defense should not be allowed unless the

particular equities of the case demand otherwise. Section

541 does not require that the important public policy

concern for enforcement of federally-protected rights

should be disregarded when a bankruptcy trustee pursues

those claims.

A. Under General Equitable Principles and with

regard to the Limited Role of Jn Pari Delicto

Defense in Federal Claims, a Trustee is Not

“of Equal Fault” with the Wrongdoer

The place to begin the analysis is with Bateman Eich-

ler itself. It is beyond question that allowing trustees to

pursue suits will advance the purposes of enforcement of

federal law. That result shall only be thwarted if there

are strong reasons to require it. But review of the equi-

table underpinnings of the rule supports barring the

defense, not enforcing it.

As this Court noted in Bateman Eichler, the in pari

delicto defense st ds on two grounds: “First, that the

16

Court should not lend their good offices to mediating

disputes among wrongdoers, and second, that denying

judicial relief to an admitted wrongdoer is an affective

means of deterring illegality.” 472 U.S. at 306. Neither

of these grounds for the defense is truly implicated when

u trustee is suing wrongdoers to obtain assets for credi-

tors of a debtor.

As to the first ground, allowing an innocent Trustee to

pursue claims against guilty parties for the benefit of

innocent creditors can hardly be said to compromise the

integrity of the courts. This Court has recognized the

propriety of proceeding on behalf of a receiver even

where the receiver's predecessor would have been barred

by fraud. In McCandless v. Furlaud, 296 U.S. 140

(1935), a suit was initiated by a receiver of an insolvent

corporation to compel the corporate promoters, their

confederates, to restore property that would be diverted

from the corporation as a result of a fraudulent scheme.

The corporation shareholders, promoters and directors

were all involved. The Court of Appeals had dismissed

the receiver's case on the ground that the consent of the

shareholders to the fraudulent transaction bound the cor-

poration and the receiver stood in no better position.

This Court reversed in an opinion by Justice Cardozo

holding:*

There is no occasion to consider whether the cor-

poration itself at the instance of new sharcholders

would be permitted to disaffirm the fraud and main-

‘4 McCandless was distinguished by this Court in Caplin vy.

Maurine Midland Grace Trust Co., 406 U.S. 416, 429 (1972). Caplin

held that under the applicable bankruptcy statutes a bankruptcy trustee

was not entitied to pursue causes of action which belong to creditors.

In McCandless, the Court noted, the receiver was “suing on behalf of

the corporation, not third parties.” /d. The Trustee in this case ts like-

wise suing on behalf of the corporation, Dictaphone, for its own

losses.

17

tain a suit in equity for appropriate relief. We put

that question by. Enough that the receiver has the

requisite capacity. /d., at 160-161.

Relying on McCandless and general equitable princi-

pals, in Scholes v. Lehmann, 56 F.3d 750, 754 (7th Cir.

1995) Judge Posner explained the reason and the policy

behind denying the in pari delicto defense when a suit is

brought by a receiver or trustee.

Now that the corporations created and initially con-

trolled by Douglas are controlled by a receiver

whose only object is to maximize the value of the

corporations for the benefit of their investors and

any creditors, we cannot see an objection to the

receiver’s bringing suit to recover corporate assets

unlawfully dissipated by Douglas.

Scholes v. Lehmann, 56 F.3d at 754-755.

Similar conclusions about the equity of allowing

trustees or receivers to pursue claims free of the in pari

delicto defense have been reached by other circuit courts

applying general equitable principals. McNamara v. PFS

(In re Personal & Bus. Ins. Agency), 334 F.3d at 246

(“as the bad actor, Kesselring, has been eliminated and

the trustee comes to us with clean hand, representing the

interests of innocent creditors. If the doctrine of impu-

tation were applied to bar PBI’s recovery, that applica-

tion would lead to an inequitable result (loss to innocent

creditors).”). FDIC v. O'Melveny & Myers, 61 F.3d 17,

19 (9th Cir. 1995) (“While a party may itself be denied

a right or defense on account of its misdeeds, there is lit-

tle reason to impose the same punishment on... . [an]

innocent entity that steps into the party’s shoes pursuant

to court order or operation of law.”) (applying Califor-

nia law). Similar rulings have been made by state courts

applying general equitable principals. See, e.g. 1SP.com,

18

LLC v. Theising, 805 N.E.2d 767, 772-773 (Ind. 2004);

Universal Builders, Inc. v. Moon Motor Lodge, Inc., 430

Pa. 550 (Pa. 1968): Albers v. Continental Illinois Bank &

Trust Co., 296 Ill. App. 596. 599 (Il. App: Ct. 1938);

Camerer v. California Say. & Commercial Bank, 4 Cal.

2d 159, 170 (Cal. 1935). |

There is no case of which we are aware which articu-

lates a principled basis for denying the creditors recov-

ery through a trustee or receiver and allowing wrongdoers

to escape liability.

In addition, there are practical benefits of allowing

such recoveries, as Judge Posner also observed.

The conceivable alternatives to these suits for get-

ting the money back into the pockets of its rightful

Owners are a series of individual suits by the

investors, which, even if successful, would multiply

litigation: a class action by the investors — and class

actions are clumsy devices: or, most plausibly, an

adversary action, in bankruptcy, brought by the

trustee in bankruptcy of the corporations if they

were forced into bankruptcy.

Scholes v. Lehmann, 56 F.3d at 755.

For all of these reasons, denying application of the

defense to a Trustee furthers the policies behind the

Bateman Eichler rule.

B. The Trustee Here, Asserting a Claim Origi-

nally Held by an Innocent Victim of Fraud,

was Not of Equal Fault with Defendants

In addition to the equities of allowing a trustee gen-

erally to be free of the burden of the in pari delicto

defense. there is a further reason to deny the defense

here because the wrongdoer, New Dictaphone, only

acquired the claim for fraud on Old Dictaphone as a

19

result of the success of the wrongful merger. Because of

the merger, the creditors of Old Dictaphone, became

creditors of New Dictaphone. See Del. G.C.L. § 259.

In effect, the merger was a fraud on the creditors of

Old Dictaphone and it destroyed the entire enterprise

value of the entity the creditors were entitled to look to

for recovery. Where the Trustee is seeking to obtain rec-

ompense from the participants in the fraud for the ben-

efit of creditors who were the target of the fraud, barring

that action is particularly inequitable.

C. Bankruptcy Code § 541 Neither Prohibits

Consideration of Equities Presented by a

Trustee Suit Nor Trumps this Court’s Bate-

man Eichler Test in Determining the Proper

Application of In Pari Delicto

The First Circuit below and the other circuits applying

in pari delicto to defeat federal law based claims

asserted by a bankruptcy trustee rely on their reading of

Bankruptcy Code Section 541. As the Eleventh Circuit

stated in Edwards, in language which best articulates the

argument:

Under the plain meaning of section 541(a), the

debtor estate includes all “legal or equitable inter-

ests of the debtor as of the commencement of the

case.” 11 U.S.C. §541(a) (emphasis added). “A

bankruptcy trustee stands in the shoes of the debtor

and has standing to bring any suit that the debtor

could have instituted” when the debtor filed for

bankruptcy, and there is no suggestion in the text of

the Bankruptcy Code that the trustee acquires rights

and interests greater than those of the debtor.

O'Halloran, 350 F.3d at 1202; see also 11 U.S.C.

§ 362(a). If a claim of ETS would have been subject

to the defense of in pari delicto at the commence-

20

ment of the bankruptcy, then the same claim, when

usserted by the trustee, is subject to the same affir-

mative defense.

Official Comm. of Unsecured Creditors of PSA, Inc. v.

Edwards, 437 F.3d at 1150.

However, the argument has been expressly rejected by

numerous commentators” and at least one Bankruptcy

court,'’ and is unsound for several reasons. First, Section

541 does not address the rights of trustees or the appli-

cation of defenses at all, it merely identifies what is

“property of the debtor.” 11 U.S.C. § 541(a). Nothing in

that section would seem to place any restriction on the

discretion of a court of equity to apply equitable

defenses in a manner which was equitable. Indeed, the

discretion of the court in applying equitable defenses

was a settled law at the time the section was enacted.

See, Keystone Driller Co. v. General Excavator Co., 290

U.S. 240, 245-246 (1933) (“courts of equity do not make

the quality of suitors the test. They are not bound by for-

mula or restrained by any limitation that tends to tram-

mel the free and just exercise of discretion.”); | Story,

Commentaries on Equity Jurisprudence § 423, at 399-

' See Jeffrey Davis. Ending the Nonsense: The In Pari Delicto

Doctrine Has Nothing to Do with What is § 541 Property of the

Bankruptcy Estate, 21 Emory Bankr. Dv. J. 519 (Summer 2005); Tan-

vir Alatm., Fraudulent Advisors Exploit Confusion in the Bankruptcy

Code: How In Part Delicto Has Been Perverted to Prevent Recovery

for Innocent Creditors, 77 Am Bannkr. L.J. 305 (Summer 2003): Ger-

ald L. Baldwin, Jn Pari Delicto Should Not Bar a Trustee's Recovery,

23 Am. Bankr. Inst. J. 8 (Oct. 2004): Making Sense of the In Pari

Delicto Defense: “Who's Zoomin’ Who?” 23 No. 11 Bankr. Law Let-

ter | (Nov. 2003): Robert T. Kugler. The Role of imputation and In

Part Delicto in Barring Claims Against Third Parties. 1 No. 14

Andrews Bankr. Lit. Rep. 13 (2004).

Talz v. Proskauer Rose LLP (lr re Fuzion Tech. Group, Inc. ).

332 B.R. 225 (S.D. Fla 2005).

21

400 (14th ed. 1918); Pomeroy’s Equity Jurisprudence,

4th Ed., Section 941, pp. 1998-9. There is no reason to

believe that in enacting the section Congress intended to

change that settled law.

Second, the defense of in pari delicto is one which is

historically based on personal fault. The legislative his-

tory of the Section 541 expressly states that defenses

that are “personal against the debtor” are not effective

against the estate:

Thus, as section 541(a)(1) clearly states, the estate

is comprised of all legal or equitable interests of the ,

debtor in property as of the commencement of the

case. To the extent such an interest is limited in the

hands of the debtor, it is equally limited in the

hands of the estate except to the extent that defenses

are personal against the estate.

11 U.S.C.A § 541 note (West 2004) Legislative State-

ments (emphasis added); 124 Cong. Rec. 32,399 (1978).

See, also, 5 Collier on Bankruptcy 9541.04 (15th rev.

ed. 2004) (“To the extent an interest is limited in the

hands of the debtor, it is equally limited as property of

the estate except to the extent that defenses which are

personal against the debtor are not effective against the

estate.” (emphasis added)); Jeffrey Davis, Ending the

Nonsense: The In Pari Delicto Doctrine Has Nothing to

Do with What is §541 Property of the Bankruptcy

Estate, 21 Emory Bankr. Dev. J. 519, 538-39 (Summer

2005) (same). See also In re Fuzion Tech., 332 B.R. at

231-232 (same).

Third, finding that the Trustee is not barred by in pari

delicto is consistent with by the rule of “absolute priority”

embodied in the Bankruptcy Act and underlying much of

American jurisprudence.'' Under “absolute priority” rule,

where there is a business failure, creditors should recover

prior to equity holders. The rule is abandoned by denying

a Trustee the right to pursue such claims, but allowing

sharcholders to proceed unencumbered by the defense.

Fourth, and most importantly, there is nothing in Sec-

tion 541 which would allow it to override the Bateman

Eichler rule in cases brought by bankruptcy trustees. Were

this Court to allow the broad interpretation of Section 54]

to prevail, than Bateman Eichler would become largely

irrelevant, applicable only in the exceptional cases where

the defense ts raised outside the bankruptcy context.

% The principles that creditors are paid in full before equity

recovers any return, known/as the “absolute priority” rule, has roots

going back to Northern Pacific R. Co. v. Boyd, 228 U.S. 482 (1913)

and has repeatedly been re-affirmed since. To allow equity holders to

elevate their claims through the back door of direct actions would

defeat the “absolute priority” rule. which underlies both bankruptcy

practice and much of American business law. Warren, Bankruptcy

Policy. 54 U. Chi. L. Rev. 775. 792 (1987) (*An almost axiomatic

principle of business law ts that, because equity Owners stand to gain

the most when a business succeeds. they should absorb the costs of

the business's collapse—up to the full amount of their investment.”).

See also Consol. Rock Prods. Co. v. Du bois, 342 U.S. 510. 520-21

(1941) (“stockholders seeking to recover their investments cannot be

paid before provable claims have been satisfied in full”); Slain &

Kripke, The Interface between Securities Regulation and Bankruptcy

—Allocating the Risk of legal Securities Issuance Between Securi-

ties Holders and the Issuer's Creditors, 48 N.Y.U.L. Rev. 261 (1973)

(hereinafter “Slain/Kripke”).

Accordingly. Section 510(b) of the Bankruptcy Code was enacted

to subordinate any claim for damages “arising from the purchase or

sale” of the securities of the debtor. That section was adopted as part

of the 1978 enactment of the Bankruptcy Code to prevent “disap-

pointed shareholders from recovering their investment loss by using

fraud and other securities claims to bootstrap their way to parity with

general unsecured creditors in a bankruptcy proceeding.” Jn re Tele-

group, Inc. v. Telegroup, Inc., 281 F.3d 133, 142 Gd Cir. 2002).

23

2. Allowing In Pari Delicto to Defeat Claims of

Defrauded Merger Targets Substantially Inter-

feres with the Policies of the Federal Securities

Law

The First Circuit’s fixed focus on the Trustee as a

wrongdoer by imputation also caused the court of

appeals to misapply the second prong of the Bateman

Eichler test. The First Circuit held:

As we have pointed out, the trustee is not bringing

claims on behalf of an innocent target of the fraud

but, rather, on behalf of a complicit party. Viewed in

that light, the trustee’s policy concerns ring hollow.

See Edwards, 437 F.3d at 1155 (finding public pol-

icy exception inapplicable in analogous circum-

stances) . . . To permit the trustee to proceed in

these circumstances would be equivalent to giving

New Dictaphone a second bite at the cherry, allow-

ing it first to reap the benefits of the fraud and then

to attack the defrauders.

App. at 23a, footnote omitted.

A similar approach was taken by the Eleventh Circuit

in Edwards to bar a suit by a Trustee under RICO. Offi-

cial Comm. of Unsecured Creditors of PSA, Inc. v.

Edwards, 437 F.3d at 1155.

It is, of course true, that, as the First Circuit held, that

“[t]he securities laws were enacted to protect investors

from deceptive practices, see Pinter, 486 U.S. at 638,

not to give the intended beneficiaries of deceptive prac-

tices a back-door means of ensuring a profit.” App. at

23a. Yet, if the second prong of the Bateman Eichler

were readily avoided by simply labeling the plaintiff a

wrongdoer, there would be no case where the court could

find that the plaintiff was “equally” culpable under Bate-

man Eichler’s prong one, yet application of the defense

24

could nonetheless be barred under prong two on the

ground that it “interfere[d] with the effective enforce-

ment of the securities laws.”

As this Court has noted, “labels, as often is the case,

merely state the conclusion reached, but do not aid in

solution of the problem. The ultimate issue is whether

the result in the particular case would effectuate or frus-

trate the purposes of the [Securities] Act.” 312 U.S., at

44. n. 2. Bateman Eichler, Hill Richards, Inc. v. Berner,

472 U.S. at 311, n. 20, citing A. C. Frost & Co. v. Coeur

D'Alene Mines Corp., 312 U.S. 38, 43 (1941)

Indeed, an argument that the First and Eleventh Cir-

cuits rely on was raised and rejected by this Court in

Pinter v. Dahl, 486 U.S. 622, 637 (1988). As the Court

there held, the “broad policies” of the securities laws are

“protection of investors as a group, not as individ-

uals, and the need for a healthy economy constantly

purged by full disclosure. See, e. g., SEC v. North

American Research & Development Corp., 280

F. Supp. 106, 121 (SDNY 1968) (purpose of § 5 is

to protect public investors through disclosure), aff'd

in part and vacated in part on other grounds, 424

F.2d 63 (CA2 1970).

Id. at 637, n. 14.

Allowing a relatively culpable party to recover may

therefore be allowed when that approach serves to pro-

tect “the unknowing and innocent investor.” See, id. at

637. As this Court held in Perma Life Mufflers v. Inter-

national Parts Corp., 392 U.S. 134 (1968):

The plaintiff who reaps the reward of treble dam-

ages may be no less morally reprehensible than the

defendant, but the law encourages his suit to further

the overriding public policy in favor of competition.

A more fastidious regard for the relative moral

25

worth of the parties would only result in seriously

undermining the usefulness of the private action as

a bulwark of anti-trust enforcement.

Id. at 139.

Such an approach would seem to be particularly

appropriate in this case where the “guilt” of the Trustee

is only by imputation, and the claim was acquired by the

“guilty” entity only because of the success of the fraud.

Applying the more searching analysis required by

Bateman Eichler and Pinter makes it clear that denying

recovery in this case would dramatically interfere with

the purposes of the securities laws under which the

Trustee seeks to recover. Here, Old Dictaphone was the

target of a fraud designed to cause the corporation to

surrender its business and assets for consideration that

was essentially worthless. Since the object of the fraud

was the acquisition of Old Dictaphone by L&H through

its subsidiary “New Dictaphone,” by definition, the

fraud only could succeed if, as occurred here, Old Dic-

taphone and its fraud claim were acquired by New Dic-

taphone. If the fact of that acquisition by itself is

sufficient to bar even an innocent successor Trustee from

pursuing claims against the participants in the fraud,

than fraud by an acquirer against a merger target would

always, a fortiori, be insulated from damage claims.

It is hard to see how protecting perpetrators of fraud

from the consequences of their actions would not inter-

fere the purposes of the securities laws, for “full dis-

closure.” By contrast, allowing suits, such as the suit by

the Trustee in this case, provides a strong incentive to

disclosure, which advances the purposes of the securities

laws. Such a rule serves to protect innocent investors in

other cases and to deter, rather than encourage, fraud in

connection with the merger transactions.

26

‘oa

Allowing Bankruptcy Code Section 541 to Fed-

eralize the Application of State Law Claims of /n

Pari Delicto Violates this Court’s Holding in

O’Melveny & Myers v. FDIC and is also an

Important Issue Meriting Review by this Court.

The effect of the approach adopted by the First Circuit

in this case and by the Lafferty and Edwards courts does

not merely interfere with the Federal policies on appli-

cation of the in pari delicto defense, it also overrides

state in pari delicto law in a manner which is in direct

conflict with this Court's decision in O'Melveny &

Myers v. FDIC, 512 U.S. 79 (1994).

In O'Melveny, the FDIC as a receiver for a failed bank

brought suit against the bank's attorneys for negligence

and breach of fiduciary duty arising out of the attorneys’

failure to discover the bank’s fraudulent conduct. The

district court dismissed based on the imputation of the

bank's knowledge to the receiver, but the 9th Circuit

reversed holding that finding “federal pre-emption not

over the law of imputation generally, but only over its

application to the FDIC suing as receiver.” /d. at 85. The

9th Circuit held the receiver was not barred from pro-

ceeding with claims that the bank could not itself assert.

This Court reversed finding that the creation of federal

law of imputation was inappropriate, and the rules

regarding whether receivers could or could not suc

where their predecessor corporation was barred from suit

must be decided as a matter of state law. /d. at 87-88.

Justice Stevens concurred, joined by Justices Black-

mun, O’Conner and Souter, to emphasize that “[ilt

would be entirely proper for a state court of general

jurisdiction to fashion a rule of agency law that would

protect creditors of an insolvent corporation from the

consequences of wrongdoing by corporate officers even

27

if the corporation itself, or its shareholders, would be

bound by the acts of its agents. /d. at 90.

Justice Stevens’ concurrence also noted that where the

state law is unclear “federal judges must do their best to

estimate how the relevant state courts would perform

their lawmaking task.” /d.

On remand, the 9th Circuit adhered to its prior ruling

as a matter of state law. FDIC v. O’Melveny & Myers, 61

F.3d 17, 19 (9th Cir. 1995).

While the First Circuit below did rely on state law of

imputation to determine whether “New Dictaphone”

would be held to be “of equal fault,” on the determina-

tive issue of whether the Trustee was barred by in pari

delicto if the defense was applicable to New Dictaphone,

the court of appeals ignored state law entirely. Instead,

citing only Federal law, Bankruptcy Code Section 541,

and Federal Cases, the court of appeals held that “the

trustee may assert only those claims that New Dicta-

phone could have asserted prior to seeking the protection

of the bankruptcy court.” App. at 14a. 2

The reasoning, however, is flawed. There is no more

basis for a federal rule of Trustee standing in this case

than there was in O’Melveny. Bankruptcy Code Section

541 does not address the standing of a Bankruptcy

Trustee (let alone a Litigation Trustee like plaintiff).

Instead it merely identifies property of the Estate.’

While the First Circuit and the cases on which it relies

interpret the language of Section 541 broadly to create

12 § 541. Property of the estate

(a) The commencement of a case under section 301, 302, or 303 of

this title [11 USCS § 301, 302, or 303} creates an estate. Such estate is

comprised of all the following property, wherever located and by

whomever held: (1) Except as provided in subsections (b) and (c)(2) of

this section, all legal or equitable interests of the debtor in property as

of the commencement of the case.

28

federal law regarding defenses available against a

bankruptcy trustee, this court was faced with similar lan-

guage in the Financial Institutions Reform, Recovery,

and Enforcement Act of 1989 (FIRREA), Pub. L. 101-

73, 103 Stat. 183, which established the right of the

FDIC as receiver in O'Melveny." Yet, in'O'Melveny,

FIRREA did not compel a federal rule of law denying

the FDIC receiver the right to pursue claims barred us to

its predecessor. For the same reasons, Section 541 does

not establish a federal rule denying bankruptcy trustees

the right to pursue claims which might be denied to the

debtor itself.

While this Court will leave the resolution of the state

law issue to the court of appeals on remand, there is

good reason to believe that under general equitable prin-

ciples, the Massachusetts courts would allow the Trustee

in this case to pursue the wrongdoers free of the in pari

delicto defense. See, Choquette v. Isacoff, 836 N.E.2d

329, 332-333 (Mass. App. Ct. 2005). Here, at the time

the claim arose, it was the claim of the innocent victim,

Dictaphone. It only briefly passed through the hands of

“New Dictaphone. Massachusetts law does recognize

limitations on the defense based on the equities of the

case. It could well be determined that Massachusetts law

would bar the defense of in pari delicto against the

Trustee under these facts.

Similarly, the other cases to have likewise applied

Section 541 to federalize the issue of defenses available

against the Trustee have done so without attempting to

analyze conflicting state law on the issue. Compare,

13

Section 1821d)(2 Ai). which ts part of a tithe captioned

“Powers and duties of [the FDIC] as . . . receiver.” states that

HN4“the [FDIC] shall. . . . by operation of law, succeed to—all

rights. tithes. powers. and privileges of the insured depository insti-

tution. . . 2” 12 USC. § T821(d 2 ANG) (1988 ed.. Supp. TV).

O'Melveny & Myers vy. FDIC, S12 U.S. at 86.

29

Official Comm. of Unsecured Creditors v. R.F. Lafferty

& Co., 267 F.3d 340, 356 (3d Cir. 2001) (applying in

pari delicto to Pennsylvania law claim by Creditors

Committee), with Universal Builders, Inc. v. Moon

Motor Lodge, Inc., 430 Pa. 550 (Pa. 1968) (holding

under Pennsylvania law that in pari delicto defense

should not be applied to deny a plaintiff bankruptcy

trustee recovery); Adelphia Communs. Corp. v. Bank of

Am. (In re Adelphia Communs. Corp.), 330 B.R. 364,

381 (Bankr. D.N.Y. 2005) (same); Waslow v Grant

Thornton LLP (In re Jack Greenberg, Inc.), 240 B.R. 486

(Bankr. E.D. Pa. 1999) (Sigmund, J.) (“Jack Greenberg”)

(rejecting in pari delicto defense in action brought

against accountants by chapter 7 trustee) and Official

Comm. of Unsecured Creditors of PSA, Inc. v. Edwards,

437 F.3d 1145, 1151 (11th Cir. 2006) (“the defense of in

pari delicto may be asserted against a bankruptcy

trustee”) with Brooke v. Kennedy, 172 Ga. 461, 463-464

(Ga. 1931) (rejecting the defense against a receiver

“These contracts were assets which came into the hands

of the receiver, and from which creditors should be paid.

It would require a strong case for a court of equity under

such circumstances to refuse the creditors protection

through a receiver. . .”).

Equally pernicious, the federalization of defenses to

State law causes of action by a Trustee has distorted the

application of the defense of in pari delicto in state

courts as well. See, Peregrine Funding, Inc. v. Sheppard

Mullin Richter & Hampton LLP, 133 Cal. App. 4th 658,

680 (Cal. Ct. App. 2005) (applying in pari delicto

defense to claims of bankruptcy trustee on the basis of

federal cases construing Section 541.)

Section 541 should not be used to federalize state law

of imputation in cases where state law governs the

defense. For this reason as well, this case merits review

by this Court.

30

CONCLUSION

For all of the above reasons, each of which is inde-

pendently sufficient, petitioner respectfully requests that

this Court issue a writ of certiorari.

Dated: New York, New York

February 22, 2007

Respectfully Submitted,

MAX FOLKENFLIK

Counsel of Record

FOLKENFLIK & MCGERITY

1500 Broadway, 21st Floor

New York, New York 10036

(212) 757-0400

Attorneys for Petitioner