Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-azd-4_07-cv-00319/USCOURTS-azd-4_07-cv-00319-0/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 28:1441 - Petition for Removal: SEC Act

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WO

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF ARIZONA

MITCHELL POZEZ and NEIL

KLEINMAN, 

Plaintiffs/Counterdefendants, 

vs.

ETHANOL CAPITAL

MANAGEMENT, L.L.C., a Delaware

limited liability company; SCOTT

BRITTENHAM and JANE DOE

BRITTENHAM; GARY

SCHWENDIMAN and JANE DOE

SCHWENDIMAN; ABC

CORPORATIONS I-V; XYZ

PARTNERSHIP I-X; JOHN DOES I-V,

Defendants/Counterclaimants. 

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No. 07-CV-00319-TUC-CKJ

ORDER

ETHANOL CAPITAL

MANAGEMENT, L.L.C., as general

partner of and on behalf of, ETHANOL

CAPITAL PARTNERS, L.P., SERIES

G.,

Third Party Plaintiff,

vs.

NOK & MTP, L.L.C.,

Third Party Defendant

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/ / /

Case 4:07-cv-00319-CKJ Document 110 Filed 07/21/09 Page 1 of 20
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1

Also pending before the Court is Plaintiffs’ Motion to Compel Disclosure or

Discovery [Doc. #83]; however, the Parties have requested the Court set this motion aside

until resolution of the dispositive motions.

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Pending before the Court are Defendants’ Motion for Summary Judgment [Doc. #90]

and Motion to Preclude Opinion Testimony of Roger S. Brown [Doc. #91] and Plaintiffs’

Motion for Partial Summary Judgment [Doc. #94].1

I. FACTUAL BACKGROUND

Ethanol Capital Partners, L.P., Series G (“ECP”) is a Delaware limited partnership

formed to invest in ethanol production plants. Ethanol Capital Management (“ECM”) is the

general partner of ECP. ECM is a Delaware limited liability company, authorized to conduct

business in Arizona. Defendant Scott Brittenham (“Brittenham”) is the chief manager of

ECM, and held this position at all times relevant to this case. Defendant Schwendiman

(“Schwendiman”) is a former manager of ECM and its current Chairman. ECM registered

as an investment adviser with the Securities and Exchange Commission (“SEC”) on or about

August 28, 2007.

Plaintiffs Pozez and Kleinman are two (2) of the twenty (20) limited partners of ECP.

Pozez held a Series 7 and Series 63 securities license from 1987 to some time in 1991, after

which he no longer held a securities license. Kleinman is a real estate appraiser, who at one

time represented clients in tax appeals. Kleinman has invested in approximately twenty (20)

limited partnerships, mostly in real estate. Brittenham and Schwendiman met Pozez and

Kleinman in September 2005 when the latter pair were looking for an opportunity to invest

in the ethanol production business. Over the course of several conversations, Brittenham and

Schwendiman suggested that Pozez and Kleinman might invest in ECP’s ethanol production

efforts. Further, Brittenham and Schwendiman suggested that Pozez and Kleinman could

assist the business by identifying other potential investors for ECP’s ethanol production

business.

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As such, Pozez and Kleinman became responsible for identifying additional investors.

Defendants claim that it was Plaintiffs’ responsibility to secure those investors as well;

however, Plaintiffs urge that they played no role in securing those investments. Rather,

Plaintiffs claim, Defendants made presentations to the potential investors and provided a

solicitation letter originally drafted by Pozez and edited by Schwendiman. Pozez and

Kleinman introduced potential investors, comprised of relatives and personal friends, to

Brittenham and Schwendiman during the latter’s sales presentations. Ultimately, some of

the potential investors did invest in Brittenham and Schwendiman’s business, contributing

approximately six million dollars ($ 6,000,000.00) to the ethanol production business. 

Pozez and Kleinman were designated Program Monitors to ensure that the other

limited partners were given a degree of comfort knowing that someone they knew was

monitoring their investments. The Program Monitor designation also provided Pozez and

Kleinman an opportunity for additional return on their investment. The Private Placement

Memorandum (“PPM”) for ECP describes the role of Program Monitor as follows:

[O]bserve the Partnership and the General Partner to monitor that the activities

of the Partnership are generally proceeding as described in the memorandum

and the Partnership Agreement, as the same may be amended from time to

time.

The General Partner will cooperate fully and in good faith with the Partnership

Series G Monitors by among other things, providing the Monitors with reports,

memoranda, correspondence, financial information or other information

concerning the General Partner or the Partnership. The General Partner agrees

to make itself and its officers and agents reasonable [sic] available to answer

questions and otherwise communicate with the Partnership Series G Monitors.

The Monitors shall have reasonable access to books, records, reports, data and

other information relevant to the Limited Partners or the Partnership for

purposes of review and report. The Program Monitors will communicate to

the General Partner any information from the Monitors or that the Monitors

receive from Partners that may be helpful to Fund operations.

The Partnership Series G Monitors will be compensated by the General Partner

or its Affiliates in the form of assignment of a portion of the carried interest of

the General Partner and compensation for certain expenses incurred. In

addition, the Partnership will pay the Monitors together for providing Program

Monitor services to the Fund a total fee annually of 1% of the capital

contributions to the Partnership secured for the Partnership by the Program

Monitors.

[PPM at 21-2.]

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2

ECG refers to Ethanol Capital Partnership, Series G – the partnership in which

Plaintiffs invested.

3

ECM is defined as the “Management Company” pursuant to the LPA. [LPA at 9.]

4

The LPA defines “Related Person” as “any Person serving, directly or indirectly, as

an officer, director, stockholder, member, partner, employee, Partnership Series Program

Monitor, agent or assign of any Portfolio Company at the written request of the General

Partner or any Person who was, at the time of the act or omission in question, such a person.”

[LPA at 17 § 3.2(a).]

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In the course of the current litigation, Defendants have produced the following records

to Plaintiffs: ECP’s 2005, 2006, and 2007 tax returns; ECG’s 2007 tax return; ECP’s 2005,

2006, 2007 financial statements; ECP’s General Ledger; ECG’s General Ledger; ECP and

ECG’s account listings; and ECG and ECP’s Profit and Loss Statement and Balance Sheets.2

The PPM and Agreement of Limited Partnership (“LPA”) provide that the limited

partners agree that the Partnership will pay a quarterly Management Fee to ECM equal to

one-half of 1% of the Partners’ total capital.3

 The PPM broadly defines Partnership

“Operational Expenses” to include all business related expenses. [PPM at 23-4.] The LPA

expands this definition to include without limitation: (a) all expenses incurred in connection

with Partnership Operations including due diligence, research, travel, development,

marketing, office and other related expenses and costs; (b) all costs related to litigation. [LPA

at 36-7.] Pozez admitted that he did not expect that the Management Fee would pay all

operational expenses, but that, in addition, the Partnership would pay accounting fees,

allocation to office overhead, postage, travel to the plants, and legal fees.

The LPA establishes that a General Partner may be liable for “[d]amages resulting

from acts or omissions of such Related Person which were taken or omitted in bad faith or

constituted gross negligence, intentional misconduct, a breach of this Agreement or a

knowing violation of law (or a violation of law that reasonably should have been known), as

determined by a court of final jurisdiction, not by a regulatory agency.”4

 [LPA at 18.]

Further, the LPA requires the General Partner “not . . . do any act in contravention of any

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5

Defendants argue that these e-mails were regarding a broker-dealer inquiry, not an

investment adviser inquiry.

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applicable law or regulation, or provision of this Agreement (including the Investment

Guidelines).” The LPA also contains the following Choice of Law agreement:

This Agreement and the rights of the parties hereunder shall be governed by

and interpreted in accordance with the laws of the State of Delaware and,

without limitation thereof, the Partnership Act as now adopted or as may be

hereafter amended shall govern the partnership aspects of the Agreement.

[LPA at 53 § 15.3.]

Neither the PPM nor the LPA contain any provision requiring Pozez and Kleinman

to be registered investment advisers pursuant to SEC regulations. In June 2006, Pozez and

Kleinman began to make requests for access to partnership books and records. The following

month, the State of Maryland’s securities division inquired of ECM whether Pozez was a

licensed investment adviser.5

 ECM’s Chief Administrative Officer Patricia Black confirmed

with Pozez that he was not registered anywhere. Schwendiman contacted Pozez and

informed him that there had been a mistake, and that Pozez was a placement agent, who did

not need to be registered. In September 2006, Schwendiman contacted Pozez and Kleinman

about additional business opportunities. There was no further mention of the licensing issue.

By February 2007, Pozez and Kleinman were still seeking information regarding the Series

G investments. At this point communications between Pozez and Kleinman and Brittenham

and Schwendiman deteriorated and all further discussions took place between representatives

of the two parties, culminating in the current lawsuit.

During this litigation, Pozez and Kleinman have retained Roger S. Brown, CPA as

their forensic accounting expert. Brown opines that the types of documents Plaintiffs have

requested as part of the accounting they seek are those kept by business entities such as the

ECP in the ordinary course of business. Moreover, Brown asserts that Defendants should

already have records allocating expenses and demonstrating the method for such allocation

kept in the normal course of business. Prior to issuing his report, Brown had not spoken with

either Pozez or Kleinman.

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6

Defendants assert that this Court determined this issue in its November 28, 2007

Order [Doc. #14]. This assertion is without merit. The matter before the Court at that time

was a Motion to Dismiss Pursuant to 28 U.S.C. § 1406(a) or Alternatively, Motion to

Transfer Pursuant to 28 U.S.C. §§ 1406(a) and/or 1404(a) [Doc. #4]. In considering the

propriety of transfer, this Court recognized federal question jurisdiction in light of the federal

securities law at issue. That discussion included acknowledgment of registration and/or

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II. STANDARD OF REVIEW

Summary judgment is appropriate when, viewing the facts in the light most favorable

to the nonmoving party, Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255 (1986), “there

is no genuine issue as to any material fact and [] the moving party is entitled to a judgment

as a matter of law.” Fed. R. Civ. P. 56(c). A fact is “material” if it “might affect the outcome

of the suit under the governing law,” and a dispute is “genuine” if “the evidence is such that

a reasonable jury could return a verdict for the nonmoving party.” Anderson, 477 U.S. at

248. Thus, factual disputes that have no bearing on the outcome of a suit are irrelevant to the

consideration of a motion for summary judgment. Id. In order to withstand a motion for

summary judgment, the nonmoving party must show “specific facts showing that there is a

genuine issue for trial,” Celotex Corp. v. Catrett, 477 U.S. 317, 324 (1986). Moreover, a

“mere scintilla of evidence” does not preclude the entry of summary judgment. Anderson,

477 U.S. at 252. The United States Supreme Court also recognized that “[w]hen opposing

parties tell two different stories, one of which is blatantly contradicted by the record, so that

no reasonable jury could believe it, a court should not adopt that version of the facts for

purposes of ruling on a motion for summary judgment.” Scott v. Harris, 550 U.S. 372, 380,

127 S.Ct. 1769, 1776, 167 L.Ed.2d 686 (2007).

III. ANALYSIS

A. Pozez and Kleinman were not Investment Advisers requiring registration

pursuant to the Investment Advisers Act of 1940, 15 U.S.C. § 80b-2.

Defendants argue that Pozez and Kleinman were acting as investment advisers in their

roles as Program Monitors thereby requiring registration pursuant to SEC regulations.6

 Title

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licensing of Program Monitors as an issue, but did so as part of the analysis. The Court

considers this reference dicta. As such, Defendants argument is misplaced.

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15 U.S.C. § 80b-2(a)(11) of the Investment Advisers Act of 1940 defines an “Investment

Adviser” as:

Any person who, for compensation, engages in the business of advising others,

either directly or through publications or writings, as to the value of securities

or as to the advisability of investing in, purchasing, or selling securities, or

who for compensation and as part of a regular business, issues or promulgates

analyses or reports concerning securities.

In an interpretive release regarding the applicability of the Investment Adviser Act, the SEC

stated:

Whether a person providing financially related services of the type discussed

in this release is an investment adviser within the meaning of the Advisers Act

depends upon all the relevant facts and circumstances. . . . A determination as

to whether a person providing financial planning, pension consulting, or other

integrated advisory services is an investment adviser will depend on whether

such person: (1) Provides advice, or issues reports or analyses, regarding

securities; (2) is in the business of providing such services; and (3) provides

such services for compensation.

Applicability of the Investment Advisers Act to Financial Planners, Pension Consultants, and

Other Persons Who Provide Investment Advisory Services as a Component of Other

Financial Services, INVESTMENT ADVISERS ACT RELEASE NO. 1A-1092, 52 Fed.Reg. 38400,

38401-02 (Oct. 8, 1987) [hereinafter SEC Release]; See also U.S. v. Elliott, 62 F.3d 1304,

1309-10 (11th Cir. 1996).

The Second, Seventh, Eleventh and District of Columbia Circuits have considered the

applicability of § 80b-2(a)(11) to individuals and their qualification of investment advisers.

Abrahamson v. Fleschner, 568 F.2d 862 (2d Cir. 1977), cert. denied, 436 U.S. 905, 98 S.Ct.

2236, 56 L.Ed.2d 403, and cert. denied, 436 U.S. 913, 98 S.Ct. 2253, 56 L.Ed.2d 414 (1978)

(holding general partners who “received substantial compensation for managing the limited

partners’ investments” and who engaged “in the business of advising others” were

investment advisers under the Act. Id. at 870); Zinn v. Parrish, 644 F.2d 360 (7th Cir. 1981)

(professional athlete’s manager did not qualify as investment adviser, where manager did not

hold himself out as an investment adviser and advice was limited to isolated transactions);

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Wang v. Gordon, 715 F.2d 1187 (7th Cir. 1983) (general partner who “received a 5%

brokerage commission on the gross sales price of partnership property” was not an

investment adviser under the Act. Id. at 1188.); U.S. v. Elliott, 62 F.3d 1304 (11th Cir. 1996)

(holding managers of several investment companies and who were operating a Ponzi scheme

qualified as investment advisers under the Act); SEC v. Washington Investment Network and

Robert Radano, 475 F.3d 392 (D.C. Cir. 2007) (affirming lower court’s determination that

defendants were investment advisers in light of their ongoing duties to clients who had set

up accounts with third-party firm based on defendants’ recommendations).

Defendants rely on Elliot, 62 F.3d 1304, and Washington Investment Network, 475

F.3d 392, in support of their contention that Pozez and Kleinman qualify as investment

advisers and were required to register pursuant to SEC regulations. Washington Investment

Network involved the business dealings of two individuals, Steven Bolla and Robert Radano,

and their company Washington Investment Network (“WIN”). 475 F.3d 392. Bolla was

under investigation by the SEC prior to the formation of WIN, and Radano was aware of this

situation. Id. at 396. As such, when WIN was formed Radano and Bolla’s wife were

designated owners of the corporation. Id. Despite this ownership arrangement, Bolla was

the principal director of WIN activities. Id. “Radano and Bolla’s business involved locating

investors and referring them to Lockwood Financial Services.” Id. Investment advisers like

WIN would “determine[] the individual investor’s specific investment priorities and direct[]

the investor to the Lockwood money managers best suited to the investor’s objectives.”

Washington Investment Network, 475 F.3d at 396. Lockwood would contract with the

investor and begin paying fees to the investment adviser. Id. “Investment advisers [were]

also obligated to remain in regular contact with the investor and to monitor the investor’s

account, ensuring the investor’s portfolio remain[ed] consistent with his or her investment

objectives.” Id. Defendants argued that they were simply a referral service and as such not

investment advisers under the rule; however, the court held that because of their “obligation

to advise new clients regarding various investment options and a continuing obligation to

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monitor each client’s investment account” and give ongoing investment advice, WIN

qualified as an investment adviser.

In Elliott, defendants “managed a collection of investment companies.” 62 F.3d at

1306. They operated a Ponzi scheme soliciting new investments to cover interest payments

that were coming due. Id. Relying on the SEC Release, the Elliott court determined that

defendants unequivocally “provided investment advice to their customers, both by advising

them in their choice among Elliott Enterprise investment vehicles and by controlling the

investments underlying those investment vehicles.” Id. at 1310 (citations omitted).

Additionally, defendants advertised that one of them was a registered investment adviser,

both “received ‘transaction-based compensation’ whenever a customer implemented their

advice by purchasing an Elliott Enterprises investment product,” both gave regular

investment advice, and were “responsible for selecting, purchasing, and selling the

underlying investments for Elliott enterprises.” Id. at 1310-11. As such, the court

determined that defendants were “in the business” of advising others. Id. at 1311.

Plaintiffs argue that rather than support Defendants’ positions, these cases underscore

how Pozez and Kleinman were not acting as investment advisers in their positions as

Program Monitors. Unlike the defendants in Elliott, Pozez and Kleinman did not direct

customers among choices of investment vehicles nor did they have any control of the

investments underlying the investment vehicles. Here, Defendants had sole control of the

investments. Similarly, unlike the defendants in Washington Investment Network, Pozez and

Kleinman did not advise clients in choosing amongst a selection of potential investments, and

they had no obligation to monitor individual investor accounts to ensure that these accounts

continued to meet the client’s long term goals. Rather, Plaintiffs attracted friends and

relatives to join them in investing in Defendants’ venture.

The Seventh Circuit Court of Appeals opinion in Zinn v. Parrish, 644 F.2d 360 (7th

Cir. 1981) is instructive. There an agent sought to recover fees owed under a personal

management contract with a football player. Id. at 360. In the course of performing his

agent duties he was responsible for soliciting investment advice, screening those

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recommendations and transmitting them to his football player client Parrish. The Investment

Advisers Act was enacted as “the last in a series of Acts designed to eliminate certain abuses

in the securities industry, abuses which were found to have contributed to the stock market

crash of 1929 and the depression of the 1930’s.” SEC v. Capital Gains Research Bureau,

Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 280, 11 L.Ed.2d 237 (1963). “As a remedial statute,

it must be read broadly in order to effectuate its purpose of ‘protect(ing) the public and

investors against malpractices by persons paid for advising others about securities.’” Zinn,

644 F.2d at 363 (quoting SEC v. Wall Street Transcript Corp., 422 F.2d 1371, 1376 (2d.

Cir.), cert denied, 398 U.S. 958, 90 S.Ct. 2170, 26 L.Ed.2d 542 (1970), quoting (1960) U.S.

Code Cong. & Admin. News 3503). This mandate must be balanced by interpreting the

definitional requirements of the statute “so as not to sweep in persons whose activities

Congress did not intend to regulate on the theory that they posed no national concern.” Zinn,

644 F.2d at 363.

In considering whether Zinn’s personal agent status made him an investment adviser

requiring registration, the court noted that “isolated transactions with a client as an incident

to the main purpose of his management contract to negotiate football contracts do not

constitute engaging in the business of advising others on investment securities.” Zinn, 644

F.2d at 364 (citations omitted). The court acknowledged that if Zinn made a business of

screening securities recommendations of others prior to passing them on to clients,

registration would be required; however, such was not the case. Zinn’s “advice to clients on

securities [was] ‘solely incidental to his duty as a professional trustee.’” Id. (quoting In re

Augustus P. Loring, Jr., 11 SEC 885, 886-87, 41-45 Dec. P 75,299 (1942)). Moreover, Zinn

did not “hold himself out as being engaged in the business of giving advice to others as to

securities.” Zinn, 644 F.2d at 364. As such, the court held that Zinn was not an investment

adviser requiring registration under the Act. Id.

In the instant case, Pozez and Kleinman do not hold themselves out to be investment

advisers nor are they in the business of providing investment advice. Although Pozez and

Kleinman receive compensation for their roles as Program Monitors, these duties arose after

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7

Defendants argue pursuant to Section 215 of the Act that because Pozez and

Kleinman were required to be registered as investment advisers any and all contracts with

them are void. Section 215 provides in relevant part:

(a) Waiver of compliance as void.

Any condition, stipulation, or provision binding any person to waive

compliance with any provision of this subchapter or with any rule, regulation,

or order thereunder shall be void.

(b) Rights affected by invalidity.

Every contract made in violation of any provision of this subchapter and every

contract heretofore or hereafter made, the performance of which involves the

violation of, or the continuance of any relationship or practice in violation of

any provision of this subchapter, or any rule, regulation , or order thereunder

shall be void

(1) as regards the rights of any person who, in violation of any such

provision, rule, regulation, or order, shall have made or engaged in the

performance of any such contract, and

(2) as regards the rights of any person who, not being a party to such

contract, shall have acquired any right thereunder with actual knowledge of the

facts by reason of which the making or performance of such contract was in

violation of any such provision.

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the investments were made. Furthermore, Pozez and Kleinman were investors in the

partnership. It was this investment that provided them the position of Program Monitor, they

were not simply hired by the partnership to perform this duty as disinterested monitors.

Defendants assert that because the duties of Program Monitor required them to monitor and

report “with some regularity,” they were ipso facto “in the business” as contemplated by the

court in Elliott. There is no evidence before this Court that Pozez and Kleinman produced

any reports “with regularity” or that this was their “business.” Moreover, neither the PPM

or LPA contained any requirement that the Program Monitors needed to be licensed or

otherwise registered with the SEC. In fact, Defendants admit that the “Program Monitor”

moniker was a marketing tool, and that the idea that Plaintiffs should be licensed did not arise

until Plaintiff Pozez became dissatisfied. [Mot. Hearing Tr. 6/22/09 at 23:6-14.] As such,

Defendants’ argument is without merit. Therefore, this Court finds as a matter of law that

Pozez and Kleinman were not investment advisers requiring registration under the

Investment Advisers Act of 1940, 15 U.S.C. § 80b-2.7

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15 U.S.C. § 80b-15. Because this Court finds that Pozez and Kleinman were not investment

advisers as a matter of law, Defendants argument that all contracts are void pursuant to

Section 215 must fail.

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Defendants also argue that the Solicitation Rule applies here. See 17 C.F.R. § 275-

206(4)-3. The Solicitation Rule provides in relevant part:

(a) It shall be unlawful for any investment adviser required to be registered

pursuant to section 203 of the Act to pay a cash fee, directly or indirectly, to

a solicitor with respect to solicitation activities unless:

(1) (i) The investment adviser is registered under the Act; 

(ii) The solicitor is not a person (A) subject to a Commission

order issued under section 203(f) of the Act, or (B) convicted within the

previous ten years of any felony or misdemeanor involving conduct described

in section 203(e)(2)(A) through (D) of the Act, or (C) who has been found by

the Commission to have engaged, or has been convicted of engaging, in any

of the conduct specified in paragraphs (1), (5) or (6) of section 203(e) of the

Act, or (D) is subject to an order, judgment or decree described in section

203(e)(4) of the Act; and 

(iii) Such cash fee is paid pursuant to a written agreement to

which the adviser is a party; and 

(2) Such cash fee is paid to a solicitor: 

(i) With respect to solicitation activities for the provision of

impersonal advisory services only; or 

(ii) Who is (A) a partner, officer, director or employee of such

investment adviser or (B) a partner, officer, director or employee of a person

which controls, is controlled by, or is under common control with such

investment adviser: Provided, That the status of such solicitor as a partner,

officer, director or employee of such investment adviser or other person, and

any affiliation between the investment adviser and such other person, is

disclosed to the client at the time of the solicitation or referral; or 

(iii) Other than a solicitor specified in paragraph (a)(2)(i) or (ii)

of this section if all of the following conditions are met: 

(A) The written agreement required by paragraph (a)(1)(iii) of

this section: (1) Describes the solicitation activities to be engaged in by the

solicitor on behalf of the investment adviser and the compensation to be

received therefor; (2) contains an undertaking by the solicitor to perform his

duties under the agreement in a manner consistent with the instructions of the

investment adviser and the provisions of the Act and the rules thereunder; (3)

requires that the solicitor, at the time of any solicitation activities for which

compensation is paid or to be paid by the investment adviser, provide the client

with a current copy of the investment adviser's written disclosure statement

required by § 275.204-3 of this chapter (“brochure rule”) and a separate

written disclosure document described in paragraph (b) of this rule. 

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(B) The investment adviser receives from the client, prior to, or

at the time of, entering into any written or oral investment advisory contract

with such client, a signed and dated acknowledgment of receipt of the

investment adviser's written disclosure statement and the solicitor's written

disclosure document. 

(C) The investment adviser makes a bona fide effort to ascertain

whether the solicitor has complied with the agreement, and has a reasonable

basis for believing that the solicitor has so complied.

17 C.F.R. § 275-206(4)-3. As an initial matter, the payor must be a registered investment

adviser. It is undisputed that ECM did not become a registered investment adviser until some

time after August 2007. This is well after the PPM and LPA between the Parties were

created. Furthermore, as Plaintiffs point out, unless Defendants are embracing securities

fraud, any payment paid to Plaintiffs cannot be construed as solicitation fees. The Court

agrees with Plaintiffs that the Solicitation Rule has no connection with the current litigation.

B. Whether Defendants Are Obligated to Pay Program Monitor Fees.

The LPA contains an express choice of law agreement which provides:

This Agreement and the rights of the parties hereunder shall be governed by

and interpreted in accordance with the laws of the State of Delaware and,

without limitation thereof, the Partnership Act as now adopted or as may be

hereafter amended shall govern the partnership aspects of the Agreement.

Arizona law recognizes choice of law agreements should be given effect. Swanson v. Image

Bank, Inc., 206 Ariz. 264, 268 ¶ 12, 77 P.3d 439, 443 (2003). Defendants point to Delaware

law arguing that a general partner cannot be held jointly and severally liable for a partnership

obligation. See 6 Del.C. § 17-403. Conversely, Plaintiffs rely on the Arizona statute

delineating partnership choice of law urging the application of Arizona law. Section 29-348

of the Arizona Revised Statute provides in relevant part:

The laws of the state or other jurisdiction under which a foreign limited

partnership is organized govern its organization and internal affairs and the

liability of its limited partners.

Plaintiffs assert that because the statute is silent with regard to the general partners, this

means Arizona law should apply as to them. Therefore, a general partner could be held

jointly and severally liable for partnership debts. Catalina Mortgage Co., Inc. v. Monier, 166

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Ariz. 71, 800 P.2d 574 (1990) (adopting the minority rule allowing joint and several liability

against partners).

The Arizona statutes also provide, however, that “[e]xcept as provided in this chapter

or in the partnership agreement, a general partner of a limited partnership has the liabilities

of a partner in a partnership without limited partners to the partnership and the other

partners.” A.R.S. § 29-324(C). Section 29-324(B) mirrors this rule with regard to a general

partners’ liability “to persons other than the partnership and the other partners.” A.R.S. § 29-

324(B). “Statutory construction requires that the provisions of a statute be read and

construed in context with the related provisions and in light of its place in the statutory

scheme.” Grant v. Board of Regents of Universities and State, 133 Ariz. 527, 529, 652, P.2d

1374, 1376 (1982). In light of the additional statutory sections regarding the liabilities of

general partners and the express choice of law provision as delineated in the LPA, this Court

finds that the choice of law agreement should control. As such, Delaware law should apply

to this cause of action.

Defendants assert that the General Partner is not responsible for payment of the

Partnership’s obligations regarding Program Monitor compensation. The PPM provides in

relevant part:

The Partnership Series G Monitors will be compensated by the General Partner

or its Affiliates in the form of assignment of a portion of the carried interest of

the General Partner and compensation for certain expenses incurred. In

addition, the Partnership will pay the Monitors together for providing Program

Monitor services to the Fund a total fee annually of 1% of the capital

contributions to the Partnership secured for the Partnership by the Program

Monitors.

[PPM at 22.] By its terms the PPA contemplates that ECP will pay the Program Monitors

fees, not ECM; however, it would seem that the Monitor fees may be otherwise recoverable

as “damages” as contemplated by the LPA.

The LPA also provides a General Partner may be liable for “[d]amages resulting from

acts or omissions of such Related Person which were taken or omitted in bad faith or

constituted gross negligence, intentional misconduct, a breach of this Agreement or a

knowing violation of law (or a violation of law that reasonably should have been known), as

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determined by a court of final jurisdiction, not by a regulatory agency.” [LPA at 18.]

Moreover, Delaware law provides that individual defendants may be held “jointly and

severally liable with the General Partner for aiding and abetting the General Partner’s breach

of fiduciary duties created by the Partnership Agreement. ‘The elements of a claim for

aiding and abetting a breach of a fiduciary duty are: (1) the existence of a fiduciary

relationship, (2) the fiduciary breached its duty, (3) a defendant, who is not a fiduciary,

knowingly participated in a breach and (4) damages to the plaintiff resulted from the

concerted action of the fiduciary and the non-fiduciary.’” Gotham Partners, L.P. v.

Hallwood Realty Partners, L.P., 817 A.2d 160, 172 (Del. 2002). In Gotham Partners, the

Delaware Supreme Court noted “that ‘where a corporate General Partner fails to comply with

a contractual standard [of fiduciary duty] that supplants traditional fiduciary duties and the

General Partner’s failure is caused by its directors and controlling stockholder, the directors

and controlling stockholders remain liable.’” Id. at 173.

In light of the foregoing, including the choice of law agreement in the LPA, Delaware

law is applicable to this cause of action. Furthermore, this Court denies summary judgment

as to payment of program monitor compensation in light of genuine residual questions of

material fact surrounding the actions of the general partner and related persons Schwenidman

and Brittenham.

C. Action for Accounting is Not Complete.

Defendants argue that because they have provided Pozez and Kleinman with the

applicable financial statements, profit and loss statements, balance sheets, general ledger, and

tax returns of ECP, Plaintiffs’ action for accounting is moot. Delaware has adopted the

Revised Uniform Partnership Act (“RUPA”). See Fike v. Ruger, 754 A.2d 254 (Del. Ch.

1999). Section 405 provides that a partner “may maintain an action against the partnership

or another partner for legal or equitable relief, with or without an accounting as to partnership

business, to . . . enforce the rights and otherwise protect the interests of the partner, including

rights and interests arising independently of the partnership relationship.” RUPA § 405(b)

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& (b)(3). “An accounting action is designed to produce and evaluate all testimony relevant

to the various claims of the partners.” Seguin v. Boyd, 134 Ariz. 172, 175, 654 P.2d 808, 811

(Ct. App. 1982) (citing Weidlich v. Weidlich, 147 Conn. 160, 157 A.2d 910 (1960)).

Moreover, an accounting is “an equitable proceeding for comprehensive investigation of

transactions and adjudication of rights of the partners.” Id. (citing Crane and Bromberg, Law

of Partnerships § 72 (1968)).

Although Defendants have provided documentation to effectuate a comprehensive

investigation of transactions, that is just the first step in the accounting process. Plaintiffs’

pending motion to compel seeks additional information that may affect the adjudication of

the rights of the parties. As such, it is premature for this Court to issue any rulings in regard

the accounting. Therefore, Defendants’ motion for summary judgment regarding the

accounting is denied.

D. Plaintiffs’ Individual Right to Sue and Recover Expenses on 

Behalf of ECP.

Defendants claim that Plaintiffs have no individual right to sue and recover expenses

on behalf of ECP. The Delaware courts have directly addressed the issue of direct versus

derivative nature of claims in the partnership context, stating:

The test for distinguishing direct from derivative claims in the context of a

limited partnership is substantially the same as that used when the underlying

entity is a corporation. In both instances the determination is made by careful

application of a rather nuanced test. The test looks to the nature of the injury

and to the nature of remedy that could result if the plaintiffs are successful.

When a plaintiff alleges either an injury that is different from what is suffered

by other shareholders (or partners) or one that involves a contractual right of

shareholders (or partners) that is independent of the entity’s rights, the claim

is direct. If the injury is one that affects all partners proportionally to their pro

rata interests in the corporation, the claim is derivative. In a derivative action

the plaintiff sues for an injury done to the partnership and any recovery of

damages is paid to the partnership. Conversely, in a direct action the plaintiff

sues to redress an injury suffered by the individual plaintiff and damages

recovered are paid directly to the plaintiff who was injured.

Anglo American Security Fund, L.P. v. S.R. Global Int’l Fund, L.P., 829 A.2d 143, 149-50

(Del. Ch. 2003). Further, Delaware courts have “identified two discernable purposes for

classifying claims as derivative: (1) to ensure that any remedy accrues to the entity that

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sustained the injury but does not confer benefits on wrongdoers nor provide windfalls to the

uninjured and (2) to provide a gatekeeping function that will both promote corporate

resolution of internal problems and deter strike suits.” Id. at 152.

In considering plaintiffs’ claims regarding the diminution in the value of the Fund, the

Anglo American court noted that whenever the value of the Fund was reduced, “the injury

accrue[d] irrevocably and almost immediately to the current partners but [would] not harm

those who later become partners.” Id. As such, classifying the claim as a derivative action

would provide newly admitted limited partners with a windfall, with “the perverse effect of

denying standing (and therefore recovery) to parties who were actually injured by the

challenged transactions while granting ultimate recovery (and therefore a windfall) to parties

who were not.” Id. at 153. The Anglo American court also considered the misdisclosure of

a 1999 statement. Id. The court recognized that the limited partners had “absolutely no

control over the governance and management of the Fund.” Anglo American, 829 A.2d at

154. Ultimately, it held that plaintiffs made a direct claim stating:

The plaintiff limited partners each appear to be sophisticated parties that

understood and voluntarily accepted the terms of the Agreement and assumed

the risks of investing in the Fund in order potentially to reap the rewards of

undertaking such risks. As such, these sophisticated investors reasonably

expected that the general partner would fulfill at least the obligations it

voluntarily accepted under the Agreement and as a fiduciary. As the

defendants correctly point out, Section 12.05 of the Agreement specifies the

obligations of the general partner to report to the limited partners-unaudited

quarterly reports of the fund performance, an audited financial report annually,

and a year-end report to each partner indicating the necessary gain and loss

information for Federal income tax purposes. Thus, the 1999 Statement was

contractually required to be provided to the partners and any claims that it was

incomplete, or materially false or misleading would state a direct claim.

Id.

Defendants rely on Litman v. Prudential-Bache Properties, Inc., 611 A.2d 12 (Del.

Ch. 1992) in support of their argument that Plaintiffs’ claims are derivative. In Litman,

plaintiffs alleged that “the general partners breached their fiduciary duties by inadequately

investigating and monitoring investments and by placing their interest in fees above the

interests of the limited partners.” Id. at 16. Plaintiffs did “not make any argument that the

general partners breached a distribution agreement in their complaint. Rather, plaintiffs’ true

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8

This Court further recognizes that the Delaware Court of Chancery has dismissed on

summary judgment traditional fiduciary duty claims while sustaining the contractual

fiduciary duty claims “on the ground that the Partnership Agreement supplanted traditional

fiduciary duties and provided for contractual fiduciary duties by which the defendants’

conduct would be measured.” Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817

A.2d 160, 166 (Del. 2002). As such, even if this Court were to grant summary judgment in

favor of the Defendants on the traditional fiduciary duty claims, they would survive as part

of the breach of contract claims alleged by the Plaintiffs.

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argument is that the alleged misconduct resulted in diminished income to the Partnership,

diminished distribution to Unitholders and a diminished value of the Units.” Id. As such,

the court found that “defendants’ misconduct damaged plaintiffs only to the extent of their

proportionate interest in the Partnership. Clearly, this was not a direct injury to the limited

partners or one that existed independently of the Partnership.” Id.

Defendants’ reliance on Litman is misplaced. Here, Plaintiffs have alleged a breach

of contract claim in conjunction with the breach of fiduciary duty claim. Pursuant to the

PPM and LPA, Defendants agreed to fulfill certain obligations regarding reporting and

communication to not only the limited partners as a whole, but specifically the Program

Monitors (a.k.a. Plaintiffs). Any failure on the part of Defendants to perform as a general

partner and fiduciary, is a breach resulting in a direct harm to Plaintiffs. Furthermore, such

would affect Plaintiffs’ ability to perform their reporting duties and act as fiduciaries on

behalf of the investments made by other Series G limited partners. Because Plaintiffs have

potentially suffered an individualized harm, Defendants’ motion for summary judgment

regarding Plaintiffs’ individual right to sue is be denied.8

E. Admissibility of Plaintiffs’ Expert Witness Roger S. Brown, CPA.

Defendants seek to preclude the testimony of Plaintiffs’ forensic accounting expert,

Roger S. Brown. Rule 702, Federal Rules of Evidence, provides:

If scientific, technical, or other specialized knowledge will assist the trier of

fact to understand the evidence or to determine a fact in issue, a witness

qualified as an expert by knowledge, skill, experience, training, or education,

may testify thereto in the form of an opinion or otherwise, if (1) the testimony

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is based upon sufficient facts or data, (2) the testimony is the product of

reliable principles and methods, and (3) the witness has applied the principles

and methods reliably to the facts of the case.

Fed. R. Evid. 702. Plaintiffs have disclosed Roger S. Brown, CPA as their forensic

accounting expert witness. Mr. Brown has been licensed as a Certified Public Accountant

since October 24, 1983. Moreover, he is certified in Financial Forensics by the American

Institute of Certified Public Accountants. Mr. Brown possesses extensive accounting

experience and has been an expert accounting witness since 1983. Defendants do not dispute

his qualifications as an expert in the field of accounting.

First, Defendants take issue with Mr. Brown’s opinions which constitute legal

conclusions. It is well established that “the judge instructs the jury in the law.” U.S. v.

Weitzenhoff, 35 F.3d 1275, 1287 (9th Cir. 1993) (citations omitted). As such, it is improper

for an expert witness to testify regarding legal conclusions because it has the effect of

allowing the witness to instruct the jury on the law rather than the judge. See id. Defendants

objections are well-taken; however, it is unnecessary to preclude all of Mr. Brown’s

testimony. Rather, Mr. Brown’s opinions shall be limited to those based upon the facts and

data present in this case.

Next, Defendants object to the reliability of Mr. Brown’s opinions. An expert

witness’s opinion must be reliable. See Fed. R. Evid. 702; Kumho Tire Co., Ltd. v.

Carmichael, 119 S.Ct. 1167 (1999). Defendants primary issue regarding reliability is that

Mr. Brown assumed $732,454 of expenses in the first nine months of 2008. This figure was

derived from an un-audited Profit and Loss Statement (“P&L”). Looking at the P&L sheet

provided by Defendants (Exh. M), this number clearly correlates with the total expenses for

2006-2008. Based upon the evidence before this Court, it remains unclear whether

Defendants’ Exhibit “M” is the same P&L relied on by Mr. Brown. Therefore, this Court

finds that Defendants’ argument goes to weight, not admissibility, and declines to strike

Plaintiffs’ expert. As such, Defendants’ motion to preclude expert witness Roger Brown is

denied.

/ / /

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Accordingly, IT IS HEREBY ORDERED that:

1. Plaintiffs’ Motion for Partial Summary Judgment [Doc. #94] is GRANTED;

2. Defendants’ Motion for Summary Judgment [Doc. #90] is DENIED; and

3. Defendants’ Motion to Preclude Opinion Testimony of Roger S. Brown [Doc.

#91] is DENIED.

DATED this 20th day of July, 2009.

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