RS Investments Ltd. v. RSM US, LLP

2019 IL App (1st) 172410

FOURTH DIVISION
February 28, 2019

No. 1-17-2410

______________________________________________________________________________

IN THE APPELLATE COURT OF ILLINOIS
FIRST JUDICIAL DISTRICT
______________________________________________________________________________

RS INVESTMENTS LIMITED, CORRADO INVESTMENTS )
LIMITED, EDEN ROCK FINANCE MASTER LIMITED, EDEN )
ROCK ASSET BASED LENDING MASTER LIMITED, EDEN ) Appeal from
ROCK UNLEVERAGED FINANCE MASTER LIMITED, and ) the Circuit Court
SOLID ROCK SPECIAL SITUATIONS 2 LIMITED D, ) of Cook County
)
Plaintiffs-Appellants, ) 2016-L-11459
)
v. ) Honorable
) Raymond W. Mitchell,
RSM US, LLP; RSM CAYMAN, LTD.; and SIMON LESSER, ) Judge Presiding
)
Defendants-Appellees. )

PRESIDING JUSTICE McBRIDE delivered the judgment of the court, with opinion.
Justices Gordon and Reyes concurred in the judgment and opinion.

OPINION

¶1 The plaintiffs are certain shareholders of Lancelot Investors Fund (Lancelot Offshore), a

hedge fund that was incorporated in the Cayman Islands in 2002 and collapsed in 2008 upon the

revelation that substantially all of its assets were invested in a Ponzi scheme. The fund filed for

bankruptcy protection in Illinois federal court and is not a party to suit. In this action, the

shareholders sued the fund’s auditors 1 for apparently performing no real audits while issuing

1
All of the defendants dispute liability for the audit opinions. Defendants RSM US, LLP, and
Simon Lesser contend they assisted the fund’s Cayman Islands audit firm but did not themselves issue
any audit opinion of the fund’s financial records. Defendant RSM Cayman, Ltd., disputes that it is the
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unqualified annual opinions upon which the plaintiffs relied when they initially invested $1.25

million in the fund in November 2004, increased their shares in each subsequent year, and

maintained their $79 million holdings until the fund’s downfall in 2008. The shareholders

alleged that auditing in conformance with generally accepted accounting principles in the United

States would have readily detected that the fund was lending money to a business that was

conducting entirely fictitious transactions. The shareholders sought the return of their invested

dollars and punitive damages due to the accountants’ common law fraud and fraudulent

inducement in issuing “clean” audit reports (count I), as well as negligent misrepresentations

(count II), and professional negligence (count III). The trial judge, however, was persuaded by

the accountants’ arguments for dismissal pursuant to section 2-619 of the Code of Civil

Procedure (Code) (735 ILCS 5/2-619 (West 2016)). The judge found that the suit concerned an

issue of corporate governance of a Cayman Islands’ entity, the plaintiffs’ standing was governed

by Cayman Islands’ reflective loss doctrine, and they lacked standing to sue for an injury that

was merely derivative or reflective of the company’s injury. The shareholders argue for reversal

on grounds that they sued for their own direct injuries from financial statements that portrayed

the fabricated enterprise as a legitimate business, were addressed to them, and were foreseeably

relied upon by potential and existing investors. They also contend that in a choice of law

analysis, Illinois, not Cayman Islands, has the most significant relationship to the parties and the

dispute because the principal auditors were in Illinois and their fraudulent reporting also

occurred in this jurisdiction.

¶2 A section 2-619(a)(9) motion to dismiss admits all well-pled allegations in the complaint,

successor to the fund’s Cayman Islands audit firm and asserted this argument in a separate section 2-615
motion to dismiss, which the trial court did not reach. 735 ILCS 5/2-615 (West 2016). In this order, we
have referred to the three defendants as the auditors.

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and in this appeal, we also take those allegations as true. Doe v. University of Chicago Medical

Center, 2015 IL App (1st) 133735, ¶ 4, 31 N.E.3d 323, 325; Village of Bloomingdale v. CDG

Enterprises, Inc., 196 Ill. 2d 484, 486, 752 N.E.2d 1090, 1094 (2001). A section 2-619 motion is

similar to a motion for summary judgment, in that it admits the legal sufficiency of the complaint

and the intention is to dispose of easily proven issues of fact or issues of law. Advocate Health &

Hospitals Corp. v. Bank One, N.A., 348 Ill. App. 3d 755, 759, 810 N.E.2d 500, 504 (2004). A

section 2-619 motion, however, is usually presented early in a case, before discovery. Advocate

Health, 348 Ill. App. 3d at 759. Provided there is no genuine issue of material fact and the

defendant is entitled to judgment as a matter of law, the motion is properly granted. Advocate

Health, 348 Ill. App. 3d at 759. We address the ruling de novo and construe the pleadings and

supporting matter in the light most favorable to the plaintiff. Advocate Health, 348 Ill. App. 3d at

759. Whether a party has standing to sue is also a question of law that is subject to the de novo

standard. Cashman v. Coopers & Lybrand, 251 Ill. App. 3d 730, 733, 623 N.E.2d 907, 909

(1993).

¶3 We begin by summarizing the shareholders’ 83-page complaint and its numerous

attachments and then recap the procedural history that culminated in the dismissal order.

¶4 The business of the fund, Lancelot Offshore, was to make short-term loans by purchasing

commercial notes issued by Thousand Lakes, LLC (Thousand Lakes). Thousand Lakes,

however, was part of a multi-layered Ponzi scheme run by Thomas J. Petters. Between 2002 and

2008, the defendants were the fund’s outside auditors but failed to discover that Petters and his

key associates had criminal backgrounds and were falsifying most of their transactions.

Thousand Lakes purported to use the money it borrowed from Lancelot Offshore to buy flat

screen televisions and other high-end home electronics that it supplied to Costco, Sam’s Club,

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and other United States retail chain stores. Thousand Lakes routinely wired money to purchase

electronic goods, but the auditors failed to discover that Thousand Lakes sent the money to other

entities in the Ponzi scheme, those entities almost immediately returned most of the funds to

Thousand Lakes, and Thousand Lakes falsely recorded the receipts as loan payments. The

auditors also failed to discover there was no merchandise, there was no transportation or

warehousing of goods, and there were no transactions with the well-known retailers. Thousand

Lakes created the illusion of a profitable enterprise through its “round trip” wire transactions,

phony purchase orders, Petters’s personal guarantees, other falsified transactions, and the support

of the auditors’ annual opinions. Conversations secretly recorded by law enforcement revealed

that “Petters and his co-conspirators knew that the basic auditing step of observing inventory and

seeking written third party confirmation was a weakness of their scheme and discussed it

amongst themselves, at one point admitting that ‘the scheme would implode’ as soon as

‘investors send auditors out to visit warehouses where the merchandise is located.’ ” The scheme

unraveled in 2008, not because of an audit, but because a key figure confessed. The Federal

Bureau of Investigation easily corroborated the informant’s allegations by contacting one of the

purported retailers, which recognized that the purchase order numbers were fabricated and that

the orders had been manually created despite the retailer’s exclusive use of an electronic

inventory system. By then, Lancelot Offshore, which required a minimum initial investment of

$1 million, had attracted at least 20 shareholders, and had lent $1.5 billion to Thousand Lakes. In

all, Petters’s Ponzi scheme netted $3.5 billion. By December 2009, he and his coconspirators

were convicted and imprisoned for the federal crimes of mail fraud, wire fraud, money

laundering, and conspiracy.

¶5 The plaintiffs further alleged that Lancelot Offshore had been incorporated in Cayman

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Islands but headquartered in Northbrook, Illinois. It was managed by Illinois resident

Gregory M. Bell and his solely-owned investment firm, Lancelot Investment Management,

which was also headquartered in Northbrook. Between 2002 and 2008, Lancelot Offshore

attracted investors through confidential information memoranda (CIMs) that outlined the fund’s

activities and the extensive “protections” and “monitoring efforts” that the fund’s management

(Bell) supposedly employed to protect the fund’s assets and investors. The fund was nearly two

years old when the plaintiffs first invested. The CIMs listed the defendants as independent

auditors. Subscription agreements annexed to the CIMs and signed by plaintiffs provided: “This

Subscription Agreement is governed by the laws of the State of Illinois, United States. The

parties hereto consent to the jurisdiction of the courts in the State of Illinois, United States with

respect to any proceeding or claim arising hereunder or in respect of the Fund.” One of the

purported protections set out in the CIMs was that Lancelot Offshore purchased notes only where

Thousand Lakes had preexisting contracts to sell goods to retailers, meaning that the fund would

“assume little or no inventory risk with respect to the Underlying Goods.” The CIMs also stated

that each note Lancelot Offshore purchased would be secured by collateral equal to 150% of the

value of the note and that Lancelot Offshore would have a “lock-box” arrangement with

Thousand Lakes in which the retailers would remit their payments into a bank account that

Lancelot Offshore could control. As part of a plea agreement, Bell testified that he was not

involved in the Ponzi scheme, but he pled guilty and was imprisoned for covering up

delinquencies in the fund’s commercial notes as early as 2007 (when the Ponzi scheme was no

longer taking in enough cash from new investors to pay its existing investors). Bell admitted that

he knew from the outset that the funds lent to the Petters enterprise were not secured by Costco’s

inventory or a “lockbox” payment arrangement with Costco because he knew the payments came

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from a Petters’s entity and that there was no assurance Petters would continue paying. Because

of the fabricated nature of the transactions and related documents, the representations in the

CIMs were materially false and misleading.

¶6 It was alleged that the firm of Altschuler, Melvoin & Glasser, LLP (AMG), with its

principal offices in Chicago and its affiliate in Cayman Islands, had served as the auditors of

Lancelot Offshore between 2002 to at least 2007 and was acquired by McGladrey & Pullen

(M&P) and its Cayman Island affiliate, which took over the auditing responsibilities. Neither

AMG nor M&P were sued, however. The defendants included RSM US, LLP (RSM US), and

RSM Cayman, Ltd. (RSM Cayman), as successors to the offshore fund’s auditors. The third

defendant, Simon Lesser, was an Illinois resident, a partner of AMG and later a partner of M&P,

worked out of their Chicago offices, and was the partner in charge of the audits. The

accountants’ written engagement letters with the fund provided that “[a]ny claim arising out of

services rendered pursuant to this agreement shall be resolved in accordance with the laws of

Illinois.”

¶7 The plaintiffs alleged that each of the audit opinions was addressed to “Shareholders of

Lancelot Investors Fund, Ltd.,” which at all relevant times included the plaintiffs. In addition, the

plaintiffs alleged that based on the auditors’ years of experience with hedge funds, they knew

that their audit opinions were being used by potential investors to evaluate the fund’s business

and financial performance and the strength of its management and that existing investors were

also using the audit opinions to evaluate the fund’s performance and determine whether to

redeem, retain, or increase their investments in the fund. Each of the audit opinions at issue

represented without qualification that the accountants conducted their audits “in accordance with

auditing standards generally accepted in the United States.” The audit opinions further

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represented that Lancelot Offshore’s “financial statements present fairly, in all material respects,

the financial position” of the fund as of January 5, 2004, and for each succeeding fiscal year. In

addition, the fund’s financial statements purportedly presented “the results of [the offshore

fund’s] operations, changes in shareholders’ capital and its cash flows for the year then ended in

conformity with accounting principles generally accepted in the United States.” The auditors

were supposed to work with professional skepticism and awareness that fraud may have occurred

and thus gather and objectively evaluate appropriate evidence that the various financial

statements were true. Because the merchandise transactions were entirely fabricated, it is

inconceivable that the accountants obtained reasonable assurances of their legitimacy. The

auditors, instead, apparently blindly accepted that Thousand Lakes engaged in the purchase and

sale of high-end electronic products, did not confirm with any of the purported retail customers

that they were transacting business with Thousand Lakes, failed to confirm that the retailers were

depositing their payments into the “lock-box” account controlled by the fund, did not vet Petters

or his associates, failed to detect that some of the Thousand Lakes notes became delinquent, and

failed to require that the fund maintain a bad debt reserve.

¶8 The plaintiffs alleged they were injured by audit opinions that were supposed to be

independent assessments of the fund’s value and were relied upon, as the auditors knew or

should have known, by potential and existing investors. Had the audit statements been accurate,

these plaintiffs would have never invested in Lancelot Offshore and would have avoided any

loss. Their losses were separate and distinct from any injuries purportedly sustained by Lancelot

Offshore, and Lancelot Offshore had actually benefitted from the shareholders’

losses/investments by receiving additional capital that it used to perpetuate the Ponzi scheme.

The plaintiffs’ losses were also separate and distinct from any injuries sustained by investors

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who were able to withdraw their funds prior to the exposure of the Ponzi scheme.

¶9 This suit, filed in 2016, was one of many stemming from the fund’s collapse in 2008. It

came after a substantially similar suit filed in the circuit court in 2010, Tradex Global Master

Fund SPC Ltd. v. Lancelot Investment Management, LLC, No. 10-CH-13264 (Cir. Ct. Cook

County), in which other shareholders sought to represent the claims of all Lancelot Offshore

investors. As we noted at the outset of this opinion, one of the other actions was Lancelot

Offshore’s bankruptcy filing in Illinois federal court. The bankruptcy trustee responsible for the

fund asked the circuit court to stay the Tradex class action pending the fund’s own claims against

the auditors. The bankruptcy trustee then sued the auditors in Illinois federal court, on the

grounds of professional negligence, seeking the $1.5 billion that Lancelot Offshore loaned to the

Ponzi scheme. The federal district court, however, granted the auditors’ motion to dismiss the

fund’s claims under the doctrine of in pari delicto, which precludes liability where the plaintiff

(the fund) is as culpable as the defendant (the fund’s auditors). Peterson v. McGladrey LLP, 792

F.3d 785, 787 (7th Cir. 2015). The fund had raised money through deceit, but the auditors had

failed to do their job of detecting that fraud. Under the doctrine, neither party is considered to

have a superior claim and courts decline to become involved in disputes between wrongdoers.

Peterson, 792 F.3d at 788. The in pari delicto dismissal was affirmed by the Seventh Circuit in

2015, which remarked on the subsequent viability of the investors’ direct claims against the

auditors in state court:

“Foreclosing all liability when two parties commit distinct wrongs might seem to

allow the failure of one safeguard to knock out the other. Corporate and securities laws

rely on both managers and accountants to protect investors’ interests. There would be a

major gap in those bodies of law if, when one turns out to be a scamp, then the other is

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excused from performing his own duties, and investors were left unprotected. But that’s

not the outcome of applying the [in] pari delicto doctrine to the Trustee’s suit. The

Trustee stepped into the shoes of [Lancelot Offshore], not the shoes of the investors.

People who put up money have their own claims.

[Investor claims] against Bell [(the fund’s manager)] may not be worth much (he’s in

prison) and securities-law claims against [Lancelot Offshore] for misstatements in the

offering documents aren’t worth much either ([it’s] bankrupt), but a claim against [the

fund’s auditing firm] may offer some recompense, if the auditor was indeed negligent or

willfully blind. See 225 ILCS 450/30.1(2) [(West 2014)]; Tricontinental Industries, Ltd.

v. PricewaterhouseCoopers, LLP, 475 F.3d 824, 837-38 (7th Cir. 2007) (Illinois law);

Kopka v. Kamensky & Rubenstein, 354 Ill. App. 3d 930, 935, 821 N.E.2d 719 (2004);

Builders Bank v. Barry Finkel & Associates, 339 Ill. App. 3d 1, 7, 790 N.E.2d 30 (2003)

[(Illinois statute and cases regarding liability for accountant fraud)]. Proceedings on the

investors’ claims [in the Illinois circuit court] have been stayed pending resolution of the

Trustee’s suit. It is time to bring the investors’ claims to the fore.” Peterson, 792 F.3d at

788-89.

¶ 10 With that ruling, the circuit court lifted its stay and resumed the Tradex claims. The

accountants, however, sought dismissal by arguing that the shareholders lacked standing due to

Cayman Islands’ reflective loss doctrine. Just before the trial judge ruled on the motion, the

current plaintiffs opted out of the Tradex class and filed the instant, similar action that was

assigned to a different circuit court judge. The first judge rejected the accountants’ argument that

the shareholders lacked standing and presided over additional issues, which culminated in a

settlement between the shareholders and the accountants in late 2018.

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¶ 11 While the Tradex class action was proceeding to a successful resolution for the

shareholders, the accountants (RSM US, RSM Cayman, and their principal, Lesser) were seeking

dismissal of this nearly identical action. RSM US and Lesser recast the standing argument, which

had been rejected in Tradex class action, and sought dismissal of this separate suit on that basis,

pursuant to section 2-619 of the Code (735 ILCS 5/2-619 (West 2016)). The other defendant,

RSM Cayman, contended the complaint should be dismissed as factually deficient pursuant to

section 2-615 of the Code (735 ILCS 5/2-615 (West 2016)). The judge granted the section 2-619

motion and found it unnecessary to reach the section 2-615 argument. The judge was persuaded

the suit involved a matter of corporate governance (Lancelot Offshore’s “internal affairs”) that

was subject to Cayman Islands law, engaged in extensive analysis of that jurisdiction’s authority,

and concluded that Cayman Islands’ reflective loss doctrine barred shareholder claims regarding

the auditors’ reports when those losses were merely reflective of the fund’s own losses. The

judge also found that the suit duplicated the bankruptcy trustee’s action against the accountants,

which had been dismissed from federal court on the basis of the in pari delicto. Because the

judge considered the suit to be duplicative, rather than the distinct suit against the auditors that

was described by the Seventh Circuit (“It is time to bring the investors’ claims to the fore.”

Peterson, 792 F.3d at 788-89), the judge also concluded that a dismissal was not inconsistent

with the federal court’s analysis.

¶ 12 On appeal from the section 2-619 dismissal, the plaintiff shareholders now argue that the

trial court erred in applying the internal affairs doctrine and, thus, Cayman Islands law, to a suit

that does not concern misconduct or negligence of the offshore hedge fund. The plaintiffs

emphasize that they did not complain of general corporate mismanagement at Lancelot Offshore,

waste of corporate assets, or diminution in the value of their shares. Furthermore, they did not

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seek damages (on behalf of the corporation) based on their pro rata losses as shareholders when

the price of Lancelot Offshore’s shares plummeted in 2008. Instead of taking issue with the

fund’s corporate governance, these shareholders brought direct claims against the fund’s outside

accountants on grounds that their fraud and misrepresentation about the fund is what led the

investors to turn money over to a Ponzi scheme. Instead of attempting to restore the fund’s

coffers, the plaintiffs sought the dollars they were fraudulently induced to invest and keep

invested in reliance on the Illinois accountants’ series of materially false and misleading audit

opinions regarding the fund. Those opinions were addressed and mailed directly to the plaintiffs.

They contend the auditors’ tortious conduct took place in Northbrook, Illinois, at the

accountants’ headquarters and that two contracts relevant to the dispute contained Illinois

governing-law and/or consent-to-jurisdiction clauses. The plaintiffs also specified that their

losses over the years were separate and distinct from the fund’s loss in 2008 and that the fund

was a participant in the fraudulent financial statements that were issued in 2004 and onward. For

these reasons, it makes no sense to treat the shareholders’ losses as reflective of the fund’s losses

or deem the claims to be duplicative of the fund’s claims that were dismissed from federal court

on the basis of in pari delicto. The shareholders also contend that, instead of the internal affairs

doctrine, the trial court should have employed the “most significant relationship” test set out in

the Restatement (Second) of Conflict of Laws § 302 (1971) to resolve the Illinois-Cayman

Islands conflict-of-law question and that, based on the facts pled and proper application of the

test, Illinois law is controlling. They contend the complaint indicates Cayman Islands has no

significant interest in application of its corporate governance rules to this dispute. They also

contend that even if Cayman Islands law is controlling, that jurisdiction’s reflective loss doctrine

was misconstrued by the trial court. The plaintiffs conclude that their claims are viable in Illinois

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court, under Illinois law.

¶ 13 In response, RSM US and Lesser argue the shareholders did seek their pro rata share of

the fund’s Ponzi-scheme losses and, thus, their suit concerns the internal affairs of Lancelot

Offshore and is subject to Cayman Islands law. The accountants argue the trial court followed

hornbook law and a uniform line of Illinois cases in deciding that matters pertaining to the

internal affairs of a corporation are, almost without exception, to be determined by the law of the

state of incorporation. They contend that only in the “unusual case” will a court disregard the

doctrine and apply local law rather than the law of the place where the company was initially

incorporated and that this suit does not qualify as that “extremely rare” instance. They argue that

applying the law of the place of incorporation, rather than the law where the plaintiffs chose to

file suit, results in uniform treatment of the competing claims of the company, its shareholders,

and its creditors, particularly when Lancelot Offshore is bankrupt. They argue that Illinois has no

interest whatsoever in applying its own law to the issue of standing and that Cayman Islands has

a much deeper connection to the dispute than only being the place of the fund’s initial

incorporation because this suit is about audit reports issued by McGladrey’s affiliate in Cayman

Islands. In addition, none of the plaintiffs reside in Illinois and “many” of Lancelot Offshore’s

shareholders are Cayman Islands’ entities themselves. The accountants urge us to find that

Cayman Islands’ reflective loss doctrine bars the shareholders’ suit for lack of standing, as the

trial court correctly ruled.

¶ 14 The third defendant, RSM Cayman, joins in the lack-of-standing argument and has filed a

separate brief urging us to affirm on the alternate grounds presented in its section 2-615 motion

to dismiss for lack of factually sufficient allegations.

¶ 15 Thus, the threshold issue is whether the substantive law of Illinois or Cayman Islands is

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controlling of the plaintiffs’ standing. This is an issue we address de novo. Townsend v. Sears,

Roebuck & Co., 227 Ill. 2d 147, 153, 879 N.E.2d 893, 897 (2007).

¶ 16 A choice-of-law analysis presupposes there is a conflict in the relevant law of two

jurisdictions. Gleim v. Roberts, 395 Ill. App. 3d 638, 641, 919 N.E.2d 367, 369 (2009).

Therefore, before engaging in the analysis, a court must be assured that a conflict exists. Gleim,

395 Ill. App. 3d at 641. The accountants, as the litigants seeking a choice-of-law determination,

had the burden of demonstrating to the trial court that a difference between the laws of Illinois

and the laws of Cayman Islands would have made a difference in the outcome of the complaint

against them. Bridgeview Health Care Center, Ltd. v. State Farm Fire & Casualty Co., 2014 IL

116389, ¶ 14, 10 N.E.3d 902. That is, unless the accountants demonstrated that the laws of the

two jurisdictions conflicted, then it would not be appropriate for the court to perform a choice-of-

law analysis. Townsend, 227 Ill. 2d at 155 (courts should not engage in a choice-of-law analysis

unless a difference in law will make a difference in outcome); Barron v. Ford Motor Co. of

Canada, Ltd., 965 F.2d 195, 197 (7th Cir. 1992) (federal appeals court for Illinois, Indiana, and

Wisconsin applied Florida law after stating “before entangling itself in messy issues of conflict

of laws a court ought to satisfy itself that there actually is a difference between the relevant laws

of the different [places]”); Banks v. Ribco, Inc., 403 Ill. App. 3d 646, 649, 933 N.E.2d 867, 870

(2010) (“Since a real conflict has been identified, it is necessary to apply Illinois choice-of-law

rules to determine whether Illinois or Iowa law applies to this action.”).

¶ 17 The accountants ultimately argue, however, that shareholders who claim a devaluation of

their shares lack standing under the laws of both jurisdictions. Thus, instead of demonstrating

there was a conflict of laws that required judicial resolution, the accountants have argued that

judicial analysis would be pointless. Accordingly, we need not delve into the parties’

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disagreement as to whether the “most significant relationship” test is the appropriate test in this

conflict-of-laws dispute, and we will not examine the contacts in the two jurisdictions in order to

determine whether Cayman Islands law should be invoked instead of our own forum’s principles.

¶ 18 We find that the accountants’ failure to demonstrate a choice-of-law issue means that

Illinois law is controlling. SBC Holdings, Inc. v. Travelers Casualty & Surety Co., 374 Ill. App.

3d 1, 13, 872 N.E.2d 10, 21 (2007) (“In the absence of a conflict, Illinois law applies as the law

of the forum.”); Dearborn Insurance Co. v. International Surplus Lines Insurance Co., 308 Ill.

App. 3d 368, 373, 719 N.E.2d 1092, 1096 (1999). We also find, as we explain later, that the trial

court erred by assuming that the issue of standing was governed by the internal affairs doctrine

and then choosing to apply Cayman Islands law.

¶ 19 Further, if the accountants are correct that the shareholders are claiming a devaluation of

their share price in 2008, then we see no meaningful difference between applying the shareholder

standing rule followed in Illinois and applying the reflective loss doctrine, which controls

shareholder standing in Cayman Islands suits. Under the laws of both jurisdictions, when a

wrong is done to a company, generally, the company’s management, not its shareholders, has the

autonomous right to recover the company’s losses, and both jurisdictions would bar a

shareholder from suing for his or her indirect, proportionate share of the company’s losses.

¶ 20 More specifically, the shareholder standing rule followed in the United States “ ‘is a

longstanding equitable restriction that generally prohibits shareholders from initiating actions to

enforce the rights of the corporation unless the corporation’s management has refused to pursue

the same action for reasons other than good-faith business judgment.’ ” Cashman, 251 Ill. App.

3d at 733 (quoting Franchise Tax Board v. Alcan Aluminum Ltd., 493 U.S. 331, 336 (1990));

Kramer v. Western Pacific Industries, Inc., 546 A.2d 348, 351 (Del. 1988) (indicating an

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exception to the shareholder standing rule is a shareholder’s derivative suit in which the

shareholder is permitted to sue on behalf of the corporation for harm done to the corporation, and

if successful, obtain a damage award for the corporation); Mann v. Kemper Financial Cos., 247

Ill. App. 3d 966, 975-76, 618 N.E.2d 317, 324 (1992) (in a shareholder’s derivative suit, the

alleged harm and compensation to the shareholder is only indirect; an indirect injury is an injury

inflicted directly on the corporation and felt by the shareholder only because he or she owns

shares of the company). For purposes of our analysis, the shareholder standing rule has the same

effect as the reflective loss doctrine followed in Cayman Islands and other jurisdictions that

adhere to the legal principles of the United Kingdom. 2 Under the English common law doctrine

of reflective loss, generally, a shareholder cannot claim a loss that is merely reflective of the

company’s own losses:

“What [a shareholder] cannot do is to recover damages merely because the company in

which he is interested has suffered damage. He cannot recover a sum equal to the

diminution in the market value of his shares, or equal to the likely diminution in

dividend, because such a ‘loss’ is merely a reflection of the loss suffered by the company.

The shareholder does not suffer any personal loss. His only ‘loss’ is through the

company, in the diminution in the value of the net assets of the company, in which he has

(say) a 3 per cent shareholding.” Prudential Assurance v. Newman [1982] 1 Ch 204 at

210.

Lord Bingham summarized the reflective loss concept in the leading English case of Johnson v.

2
Our discussion and application of foreign law is based in part upon three affidavits prepared by
the parties’ experts in Cayman Islands law. See Bianchi v. Savino Del Bene International Freight
Forwarders, Inc., 329 Ill. App. 3d 908, 922, 770 N.E.2d 684, 695 (2002) (indicating that because Illinois
courts are not permitted to take judicial notice of the laws of foreign countries, parties are required to
present admissible evidence of such laws).

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Gore Wood & Co.: “A claim will not lie by a shareholder to make good a loss which would be

made good if the company’s assets were replenished through action against the party responsible

for the loss, even if the company, acting through its constitutional organs, has declined or failed

to make good that loss.” Johnson v. Gore Wood & Co. [2000] UKHL 65, [2002] 2 AC 1 [35F]

(Lord Bingham of Cornhill ). The reflective loss rule was developed to prevent double recovery

and to provide protection for the company’s creditors and other shareholders, who might be

prejudiced if a shareholder’s claim were to succeed:

“If the shareholder is allowed to recover in respect of [reflective] loss, then either

there will be double recovery at the expense of the defendant or the shareholder will

recover at the expense of the company and its creditors and other shareholders. Neither

course can be permitted. This is a matter of principle; there is no discretion involved.

Justice to the defendant requires the exclusion of one claim or the other; protection of the

interests of the company’s creditors requires that it is the company which is allowed to

recover to the exclusion of the shareholder.” Johnson [2000] UKHL 65, [2002] 2 AC 1

[62].

The prohibition on a shareholder recouping reflective losses applies even where the facts

preclude double recovery, such as when the company has compromised its claim or chosen not to

pursue the claim or where there is a defense to the company’s claim, such as a limitation defense

or estoppel defense, which does not apply to the shareholder’s claim. Day v. Cook [2001] EWCA

(Civ) 592 [38] (Eng.) (“It is not simply the case that double recovery will not be allowed so that,

for instance, if the company’s claim is not pursued or there is some defence to the company’s

claim, the shareholder can pursue his claim. The company’s claim, if it exists, will always trump

that of the shareholder.”) The reflective loss doctrine is an absolute bar to a shareholder claim

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even if the claimant gives credit in his claim for damages that the company might have recovered

or if the court enters an award to that effect. Day [2001] EWCA (Civ) 592 [39] (“Accordingly

the court has no discretion. The claim cannot be entertained.”) “[I]f the company chooses not to

exercise its remedy, the loss to the shareholder is caused by the company’s decision not to pursue

its remedy and not by the defendant’s wrongdoing. By parity of reasoning, the same applies if

the company settles for less than it might have done.” Johnson, [2000] UKHL 65, [2002] AC 1

[66D] (Lord Millet).

¶ 21 Thus, under both Illinois law and Cayman Islands law, shareholders generally lack

standing to bring merely reflective or indirect claims regarding a diminution in the value of their

company shares.

¶ 22 A shareholder, however, who has a direct and personal interest in a cause of action has

standing to sue in Illinois in an individual capacity, even if the corporation’s rights are also

implicated. “ ‘A suit brought by a stockholder upon a personal claim is by its nature

distinguishable from a proceeding to recover damages or other relief for the corporation.’ ”

Cashman, 251 Ill. App. 3d at 733 (quoting Zokoych v. Spalding, 36 Ill. App. 3d 654, 664, 344

N.E.2d 805, 813 (1976)); Sterling Radio Stations, Inc. v. Weinstine, 328 Ill. App. 3d 58, 62, 756

N.E.2d 56, 60 (2002); Mann, 247 Ill. App. 3d at 975-76. In order to proceed in any individual

capacity, a shareholder “must allege something more than wrong to the corporate body” (Davis

v. Dyson, 387 Ill. App. 3d 676, 689, 900 N.E.2d 698, 710 (2008)), and this injury must be

“separate and distinct from that suffered by other shareholders.” (Internal quotation marks

omitted.) Spillyards v. Abboud, 278 Ill. App. 3d 663, 671, 662 N.E.2d 1358, 1363 (1996).

Zokoych indicates that when evaluating whether an action is direct (permitted) or indirect (not

permitted), “a court must preliminarily determine if the ‘gravamen’ of the pleadings states injury

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to the plaintiff upon an individual claim as distinguished from an injury which indirectly affects

the shareholders or affects them as a whole.” Zokoych, 36 Ill. App. 3d at 663. In determining the

nature of the wrong alleged, a court is to consider “the body of the complaint, not to the

plaintiff’s designation or stated intention.” (Internal quotation marks omitted.) Kramer, 546 A.2d

at 352; Sterling Radio Stations, 328 Ill. App. 3d at 62 (determining whether an action is direct

requires “a strict focus on the nature of the alleged injury, i.e., whether it is to the corporation or

to the individual shareholder that injury has been done”).

¶ 23 The English reflective loss rule has similar boundaries:

“On the one hand the court must respect the principle of company autonomy, ensure that

the company’s creditors are not prejudiced by the action of individual shareholders and

ensure that a party does not recover compensation for a loss which another party has

suffered. On the other, the court must be astute to ensure that the party who has in fact

suffered loss is not arbitrarily denied fair compensation. The problem can be resolved

only by close scrutiny of the pleadings at the strike-out stage and all the proven facts at

the trial stage: the object is to ascertain whether the loss claimed appears to be or is one

which would be made good if the company had enforced its full rights against the party

responsible, and whether (to use the language of Prudential at page 223) the loss claimed

is ‘merely a reflection of the loss suffered by the company.’ In some cases the answer

will be clear, as where the shareholder claims the loss of dividend or a diminution in the

value of a shareholding attributable solely to depletion of the company’s assets, or a loss

unrelated to the business of the company. In other cases, inevitably, a finer judgment will

be called for. At the strike-out stage any reasonable doubt must be resolved in favour of

the claimant.” Johnson [2000] UKHL 65, [2002] 2 AC 1.

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¶ 24 Based on our reading of the two jurisdictions’ legal principles, if the plaintiff

shareholders alleged an indirect or reflective claim regarding a loss suffered by Lancelot

Offshore, then under both Illinois and Cayman Islands law, the plaintiffs lack standing to sue.

However, if they have alleged a claim that is direct and different from the fund’s claims, then

under the laws of both jurisdictions, the plaintiffs have standing to sue. We concluded above that

Illinois law is controlling because the accountants failed to show there was a conflict between the

laws of Illinois and Cayman Islands, but based upon our de novo review, we also conclude there

is no conflict between the shareholder standing principles of the two jurisdictions.

¶ 25 We have also considered whether the accountants’ depiction of the suit is accurate. In our

opinion, this suit is fairly characterized as a direct action against Lancelot Offshore’s outside

accountants regarding the financial losses the individual shareholders suffered when they first

invested in the fraudulent offshore fund and when they increased their shares and maintained

their holdings, rather than as a derivative or reflective loss action concerning the fund’s corporate

governance and conduct that subsequently diminished the value of the shares. We agree with the

plaintiffs’ characterization of their suit as a direct claim involving accountant fraud and

misrepresentation that occurred in Illinois and reject the defendants’ characterization of the suit

as an indirect claim implicating the internal affairs of the Cayman Islands’ hedge fund.

¶ 26 The internal affairs doctrine, which the accountants have relied upon and the trial court

found was applicable, “is a conflict of laws principle which recognizes that only one State should

have the authority to regulate a corporation’s internal affairs—matters peculiar to the

relationships among or between the corporation and its current officers, directors, and

shareholders—because otherwise a corporation could be faced with conflicting demands.” Edgar

v. MITE Corp., 457 U.S. 624, 645 (1982) (citing Restatement (Second) of Conflict of Laws

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1-17-2410
§ 302 cmt. b, at 307-08 (1971)). “The internal affairs doctrine developed on the premise that, in

order to prevent corporations from being subjected to inconsistent legal standards, the authority

to regulate a corporation’s internal affairs should not rest with multiple jurisdictions.”

VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108, 1112 (Del. 2005). “By

providing certainty and predictability, the internal affairs doctrine protects the justified

expectations of the parties with interests in the corporation.” VantagePoint, 871 A.2d at 1113.

Examples of the internal affairs of a corporation include “steps taken in the course of the original

incorporation, the election or appointment of directors and officers, the adoption of by-laws, the

issuance of corporate shares, preemptive rights, the holding of directors, and shareholders’

meetings, methods of voting ***, shareholders’ rights to examine corporate records, charter and

by-law amendments, mergers, consolidations and reorganizations and the reclassification of

shares.” Restatement (Second) of Conflict of Laws § 302 cmt. a, at 307 (1971).

¶ 27 In other words, internal affairs litigation is about compensating shareholders for

infringements of their rights or for losses they suffered to the value of their shares as a result of

negligent behavior by corporate management or by third party interaction with corporate

management. However, the dispute here cannot be found in this list of examples, and it is not

analogous to any conduct on the list because it does not concern a corporate decision at Lancelot

Offshore or the rights and liabilities of Lancelot Offshore that indirectly affected the company’s

shareholders.

¶ 28 In determining whether the suit is indirect and impermissible because it concerns the

internal affairs of Lancelot Offshore or is direct and permissible, we have focused on the body of

the complaint (Spillyards, 278 Ill. App. 3d at 671), assessed the gravamen of the pleading

(Zokoych, 36 Ill. App. 3d at 663), and asked who suffered the alleged harm and who would

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1-17-2410
receive the claimed relief (Spillyards, 278 Ill. App. 3d at 670 (citing Kramer, 546 A.2d at 352)).

Lancelot Offshore’s conduct and rights have not been put at issue. Furthermore, Lancelot

Offshore is not a party, and it could not step into the shoes of the plaintiffs and pursue the same

claims asserted here. Thus, applying the internal affairs doctrine would not further the goal of the

doctrine by protecting Lancelot Offshore from being subjected to possibly inconsistent legal

standards of various jurisdictions where plaintiffs might be located. And, applying the internal

affairs doctrine would not ensure that claims involving the current officers, directors, and

shareholders of Lancelot Offshore, or its creditors, for that matter, are treated uniformly under

the laws of a single jurisdiction. This suit is not about the actions or inactions of the Cayman

Islands’ hedge fund, it is about the actions or inactions of the fund’s outside accountants.

¶ 29 The accountants’ section 2-619 motion to dismiss hinged on the allegations in paragraph

11 of the complaint. In that paragraph, the plaintiffs alleged that they “invested tens of millions

of dollars in the Fund” and became “the beneficial owners of 37,484.94 shares of Lancelot

Offshore, which represent claims aggregating $79,047,685.80 (based on last reported NAV [or

value per share] in 2008).” Plaintiffs also alleged in paragraph 11, “As a result of Defendants’

actions and omissions, Plaintiffs are entitled to lost profits in an amount in excess of $79 million,

exclusive of pre-judgment interest and any other relief at law or in equity to which Plaintiffs may

prove themselves entitled.” On appeal, the defendant accountants have again cited paragraph 11

of the complaint in support of their contention that the plaintiffs’ losses are measured solely by

the diminution in the value of their shares and, thus, the plaintiffs brought indirect claims that

concern the internal affairs of Lancelot Offshore, are governed by Cayman Islands law, and are

barred by the reflective loss doctrine for lack of standing.

¶ 30 The trial court found that the complaint concerned “issues related to [the] corporate

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governance [of Lancelot Offshore]” and, from this starting point, proceeded to apply Cayman

Islands law.

¶ 31 The brief statements in paragraph 11 regarding the extent of the plaintiffs’ investment in

Lancelot Offshore appear in the introductory paragraphs of an 83-page complaint. The

immediately preceding paragraph, paragraph 10, indicates the plaintiffs were fraudulently

induced by the accountants’ unqualified opinions to initially purchase shares and subsequently

buy more shares. In other words, in paragraph 10, the plaintiffs indicate that their suit concerns

the money they were induced to invest in what was then a two-year-old, seemingly successful

investment vehicle, and the additional money they contributed to the fund over the next four

years. In paragraph 12, there are express allegations that the investors’ losses are “separate and

distinct from Lancelot Offshore” and “directly attributable to the Defendants’ failure to properly

audit the Fund, and not to any losses that the Fund itself suffered.” Thus, reading paragraph 11 in

context, it does not appear that the suit concerns the diminution of the value of the fund’s share

price in 2008, that is, the suit is not about an injury to the fund in 2008 that was suffered only

indirectly by the fund’s shareholders. In context, the language in paragraph 11 that the

defendants quote is a description of the magnitude of these shareholders’ purchases/direct losses

in what turned out to be a Ponzi scheme. In paragraphs 10 through 12, the plaintiffs allege they

were fraudulently induced by the accountants’ material misrepresentations and omissions to

purchase shares in Lancelot Offshore; through their various transactions over a number of years,

the plaintiffs became “the beneficial owners of 37,484.94 shares of Lancelot Offshore, which

represent claims aggregating $79,047,685.80 (based on last reported NAV [or value per share] in

2008)”; and that these losses are not reflective of the fund’s losses.

¶ 32 Paragraphs 10 through 12 are only a small portion of the introductory statements in this

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lengthy and detailed pleading and the plaintiffs’ ”Summary of Action” continues on through

paragraph 30 of the complaint. In their summary, the plaintiffs relate the factual and procedural

history of their dispute with the accountants, in even greater detail than the summary we

provided at the outset of this opinion. The plaintiffs’ comprehensive summary even includes a

description of the Tradex class action, the stay obtained by the bankruptcy trustee, and the

plaintiffs’ decision to opt out of the Tradex class and file this separate action. The plaintiffs also

recap the Seventh Circuit’s conclusion that the bankruptcy trustee’s claims against the auditors

were barred by in pari delicto, but the investors’ direct claims would not be affected. The

plaintiffs then pled, as part of their 83-page complaint, that they were “asserting those very

claims” and that the “claims herein are not precluded by the so-called ‘reflective loss’ doctrine

under Cayman Islands’ law” because they are the “direct claims” that resulted from the auditors’

misrepresentations and omissions to them and caused injuries that are “distinct and separate from

those suffered by the Fund.” Thus, the summary section of the complaint makes clear that the

plaintiffs are not asserting derivative, reflective, or indirect claims as disgruntled shareholders

but direct claims as investors who were misled by the accountants’ opinions.

¶ 33 After the summary section, the plaintiffs detail the standards that governed the auditors’

work and also allege the auditors made deliberately false or grossly reckless misrepresentations

and omissions. Later, the allegations in paragraphs 174 through 186, subtitled “Proximate Cause

and Injury,” make clear that “every dollar invested *** was done so in express reliance on

Defendants’ false and misleading Audit Opinions and was promptly diverted into a vast Ponzi

scheme” but had the audit opinions been accurate, the plaintiffs “would not have invested in the

Fund at all, and would thus have been spared any loss.” Based on these allegations, in paragraphs

197 through 227, the plaintiffs claim damages “in excess of $79 million.” The plaintiffs claim

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these damages for themselves—they do not claim damages on behalf of Lancelot Offshore in

order to indirectly benefit the fund’s shareholders and creditors.

¶ 34 Thus, the gravamen or essence of this complaint is that the plaintiffs were injured as early

as 2004 because they invested and continued to invest in a Ponzi scheme between 2004 and 2008

in direct reliance on the defendants’ audit opinions. These are allegations that the plaintiffs’

funds were lost when they were transmitted to Lancelot Offshore between 2004 and 2008, as the

inevitable fate of a Ponzi scheme is its implosion. At the risk of stating the obvious, Ponzi

schemes are “ ‘phony investment plan[s] in which monies paid by later investors are used to pay

artificially high returns to the initial investors, with the goal of attracting more investors.’ ” In re

Slatkin, 525 F.3d 805, 809 n.1 (9th Cir. 2008) (quoting Alexander v. Compton (In re Bonham),

229 F.3d 750, 759 n.1 (9th Cir. 2000)). Ponzi schemes have also been described as “any sort of

fraudulent arrangement that uses later acquired funds or products to pay off previous investors.”

Danning v. Bozek (In re Bullion Reserve of North America), 836 F.2d 1214, 1219 n.8 (9th Cir.

1988). “The term ‘Ponzi scheme’ is derived from Charles Ponzi, a famous Boston swindler. With

a capital of $150, Ponzi began to borrow money on his own promissory notes at a 50% rate of

interest payable in 90 days. Ponzi collected nearly $10 million in 8 months beginning in 1919,

using the funds of new investors to pay off those whose notes had come due.” (Internal quotation

marks omitted.) United States v. Masten, 170 F.3d 790, 797 n.9 (7th Cir. 1999). Furthermore,

“An enterprise engaged in a Ponzi scheme is insolvent from its inception and becomes

increasingly insolvent as the scheme progresses.” In re Ramirez Rodriguez, 209 B.R. 424, 432

(Bankr. S.D. Tex. 1997); Scholes v. Lehmann, 56 F.3d 750, 755 (7th Cir. 1995) (Ponzi schemes

are insolvent from the outset and investors are considered tort creditors of the scheme).

“[A Ponzi scheme is] ‘a scheme whereby a corporation operates and continues to operate

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at a loss. The corporation gives the appearance of being profitable by obtaining new

investors and using those investments to pay for the high premiums promised to earlier

investors. The effect of such a scheme is to put the corporation farther and farther into

debt by incurring more and more liability and to give the corporation the false appearance

of profitability in order to obtain new investors.’ ” Hirsch v. Arthur Andersen & Co., 72

F.3d 1085, 1088 (2d Cir. 1995) (quoting McHale v. Huff (In re Huff), 109 B.R. 506, 512

(Bankr. S.D. Fla. 1989)).

¶ 35 Allegations that the plaintiffs were misled by the defendants’ opinions to give money to a

Ponzi scheme between 2004 and 2008 are not allegations that implicate any decisions in the

hedge fund’s corporate governance. When this court considers who suffered the alleged harm

and who would receive the benefit of any recovery or other remedy (Spillyards, 278 Ill. App. 3d

at 670 (citing Kramer, 546 A.2d at 352)), the answers to both questions are the shareholders and

not Lancelot Offshore. Accordingly, the suit is not fairly characterized as a shareholders’ claim

for indirect or reflective losses resulting from losses the fund incurred when it eventually

collapsed in 2008. Regardless of the language the defendant auditors focus upon in paragraph 11

of the pleading, the complaint does not indicate the plaintiffs were attempting to recover the

company’s losses that occurred in 2008 or that their claims were indirect claims regarding a

diminution of the value of their shares in 2008.

¶ 36 Based on our reading of the complaint in light of the concepts of the internal affairs

doctrine and the standing rule that generally prevents shareholders from bringing claims that are

merely indirect or reflective of the company’s own losses, we find that the trial court erroneously

concluded that the complaint presented “issues related to [the] corporate governance [of Lancelot

Offshore].”

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1-17-2410
¶ 37 Because the internal affairs doctrine is not relevant in this context, the accountants’

reliance on internal affairs cases is unpersuasive. For instance, we see no relevance in Lipman v.

Batterson, 316 Ill. App. 3d 1211, 1215, 738 N.E.2d 623, 627 (2000), in which shareholders of a

Delaware corporation were suing the corporation and its board of directors regarding a financial

decision that depressed the price of the company’s common stock. A claim that mismanagement

has caused corporate waste is a claim of a direct wrong to the corporation that is only indirectly

experienced by all the shareholders. Kramer, 546 A.2d at 353. Under Delaware law, actions

alleging corporate mismanagement which depress stock value are allegations of a wrong to the

corporation and can be brought only as a derivative action. Lipman, 316 Ill. App. 3d at 1215

(citing Kramer, 546 A.2d at 353). Thus, the shareholders’ action was derivative in nature,

controlled by Delaware law, and properly dismissed for lack of standing under Delaware law.

Lipman, 316 Ill. App. 3d at 1216. We also see no relevance in Seinfield v. Bays, 230 Ill. App. 3d

412, 595 N.E.2d 69 (1992) (law of incorporation state, Delaware, controlled derivative and

individual claims of shareholders of Delaware corporation alleging director mismanagement and

self-dealing in corporate merger and stock swap which necessitated wasteful payment of $150

million fee to terminate merger); Spillyards, 278 Ill. App. 3d at 667 (applying law of

incorporation state, Delaware, to shareholder’s individual and derivative claims that directors

should not have issued new shares to new shareholder with conditions that favored directors);

Housman v. Albright, 368 Ill. App. 3d 214, 857 N.E.2d 724 (2006) (applying Delaware law and

finding employee stock ownership plan participants were not shareholders of Delaware

corporation who could bring derivative action against board alleging self-dealing and waste

diminished the value of the corporation’s stock); Smith v. Waste Management, Inc., 407 F.3d 381

(5th Cir. 2005) (applying Delaware law to former shareholder’s claims that corporate fraud and

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1-17-2410
negligent misrepresentation caused 60% drop in share price and led to personal bankruptcy); or

Kreindler v. Marx, 85 F.R.D. 612 (N.D. Ill. 1979) (applying Delaware law to shareholder

derivative suit alleging directors breached fiduciary duties by approving lease payments). The

accountants’ citation to these cases highlights that the current plaintiffs are not suing Lancelot

Offshore or the fund’s board of directors for mismanagement and that this suit does not concern

the internal affairs of the corporation. The shareholders are suing third-party auditors for direct

harm allegedly caused by misrepresentations and omissions in a series of audit reports that were

expressly addressed to the plaintiffs and which are alleged to have led the shareholders to invest

in a Ponzi scheme, and the fund’s claims against the auditors regarding those same reports have

been rejected on the basis of the in pari delicto doctrine.

¶ 38 The parties cite Askenazy v. Tremont Group Holdings, Inc., No. 2010-0481-BLS2, 2012

WL 440675 (Mass. Super. Ct. Jan. 26, 2012) (Askenazy I), aff’d sub nom. Askenazy v. KPMG

LLP, 988 N.E.2d 463 (Mass. App. Ct. 2013) (Askenazy II), and Stephenson v. Citgo Group, Ltd.,

700 F. Supp. 2d 599, 608 (S.D.N.Y. 2010), as instances in which courts have applied the internal

affairs doctrine to suits involving shareholders and third-party accountants. We typically

disregard citations to unreported, trial court orders, but given the dearth of authority and factual

similarity of Askenazy, we have considered the decision of the Massachusetts judge and find that

it does not support the accountants’ contention that the internal affairs doctrine is controlling, but

it does support the shareholders’ argument that their claim was erroneously dismissed. Askenazy

I, 2012 WL 440675. The plaintiffs in Askenazy were hedge fund investors who sued the general

partner of the fund for choosing to invest in the Madoff Ponzi scheme; the fund’s parent

companies for their ineffective oversight; and the fund’s independent accounting firm, KPMG

LLP, for issuing unqualified audit reports and individual K-1 tax statements based on phantom

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1-17-2410
income. Askenazy I, 2012 WL 440675, at *4. As we did here under Illinois law, the

Massachusetts court, applying Delaware law, scrutinized the complaint and indicated the court’s

determination of whether the claims were derivative or direct would be answered by two

questions, “1) who suffered the alleged harm; and 2) who would receive the benefit of any

recovery or other remedy.” Askenazy I, 2012 WL 440675, at *9. The parties agreed that the law

of the state of incorporation was controlling and the court had no need to analyze whether a

different jurisdiction’s laws were controlling. Askenazy I, 2012 WL 440675, at *9. The case,

therefore, does not support the accountants’ contention that courts from other jurisdictions

recognize that the internal affairs doctrine governs the type of claims now at issue or that we

should find Cayman Islands law controlling.

¶ 39 Furthermore, the court dismissed most of the claims against the corporate entities as

derivative but found that the investors could proceed with their direct claims against the outside

auditors:

“Certain of those claims [regarding the audit reports] are for negligence and

misrepresentation: specifically, the plaintiffs allege that, as a result of KPMG’s

misstatements and professional incompetence, they were induced to invest in the Rye

Funds, to stay invested, and in some cases to make additional investments in the Funds.

As such, these claims describe individualized harm *** and rest on a duty to each

plaintiff that is not merely derivative of KPMG’s fiduciary duties as the Rye Funds’

auditor.” Askenazy I, 2012 WL 440675, at *10.

In addition, the court found that the claims based on the tax statements were also direct and not

derivative because the hedge funds were pass-through entities, so the profits and losses were

allocated to the individual recipients. Askenazy I, 2012 WL 440675, at *11.

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¶ 40 The ruling was affirmed on appeal, and the claims against the outside auditors went

forward. Askenazy II, 988 N.E.2d 463. In its analysis, the appellate court cited the rationale and

conclusion in Stephenson, 700 F. Supp. 2d at 612, for the proposition that claims against the

accountants could go forward because the plaintiffs had alleged they were induced to invest in

the fund or increase their investments and alleged a harm that had not affected all of the investors

in proportion to their ownership interest. Askenazy II, 988 N.E.2d at 468 . Similar allegations are

at issue here. Accordingly, we find Askenazy and Stephenson support our conclusion that the

dismissal order was in error.

¶ 41 At appellate arguments, the accountants contended there are three foreign cases in which

the reflective loss doctrine was applied to bar shareholder claims against auditors who failed to

detect massive fraud: Primeo Fund (In Official Liquidation) v. Bank of Bermuda (Cayman), Ltd.,

No. FSD 30 of 2013 (AJJ) (Grand Ct. Cayman Is. Aug. 23, 2017); In re Kingate Management

Ltd. Litigation, No. 09-CV-5386 (DAB), 2016 WL 5339538 (S.D.N.Y. Sept. 21, 2016), aff’d No.

16-3450-cv, 2018 WL 3954217 (2d Cir. Aug. 17, 2018)); and Barings plc v. Coopers & Lybrand

[2002] 2 BCLC 364, 2001 WL 1422895. They contended this trio of cases shows that a Cayman

Islands court would dismiss the plaintiffs’ complaint for lack of standing. 3 We disagree.

¶ 42 The first case is merely a trial court order that is currently on appeal; however, it

concerns Primeo Fund (Primeo), which was an investment fund incorporated in Cayman Islands.

Primeo invested directly in the Madoff Ponzi scheme between 1993 and 2007 (Primeo, No. FSD

30 of 2013 (AJJ), ¶ 39) and then invested indirectly through two of Madoff’s feeder funds,

3
RSM US and Lesser’s expert in Cayman Islands law swore:
“Where there is no applicable Cayman Islands case law, the Cayman Islands Court will
generally follow English appellate authorities to the extent they are not inconsistent with
Cayman Islands statute or authority and do not relate to English statutory provisions that
have no equivalent in the Cayman Islands. Such authorities are persuasive but not binding
on the Cayman Islands Court. Similarly, decisions of the appellate courts of other
Commonwealth jurisdictions are also of persuasive, but not binding, authority.”

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1-17-2410
known as Herald and Alpha (Primeo No. FSD 30 of 2013 (AJJ),¶ 135), until the collapse of

Madoff’s entire enterprise in late 2008. Primeo’s liquidators (shareholders) brought a breach of

contract claim against the fund’s administrator and custodian, contending they had been grossly

negligent or in willful default of their duties and that this conduct caused the fund’s investors to

lose $2 billion. Primeo, No. FSD 30 of 2013 (AJJ), ¶¶ 3-4. Primeo’s theory of causation was that

the administrator and custodian ought to have concluded that they were unable to perform their

contractual duties, and upon informing the investors of the problem, the investors “would have

withdrawn the assets and reinvested elsewhere, thereby avoiding the eventual loss of [the]

investments.” Primeo, No. FSD 30 of 2013 (AJJ), ¶ 5. The trial court employed a merits test.

Primeo, No. FSD 30 of 2013 (AJJ), ¶ 299. The trial court ruled in part that because the feeder

funds known as Herald and Alpha were suing the defendants in Luxembourg, and evidence

showed a real prospect of succeeding and making good on Primeo’s loss through that other suit,

the reflective loss doctrine barred the claims in Cayman Islands. Primeo, No. FSD 30 of 2013

(AJJ), ¶¶ 299-300. In other words, the reflective loss doctrine was used to preclude a double

recovery. Primeo is not relevant here. First, Primeo was a dispute about a fund’s corporate

governance, and the present dispute is a direct claim that is not about Lancelot Offshore’s

mismanagement. Second, Primeo concerned the “eventual loss” of assets that occurred when that

fund collapsed, while the present dispute concerns dollars that are alleged to have been lost upon

their transfer to the fund as early as 2004, many years before the collapse of Lancelot Offshore in

2008. Despite the accountants’ contention that the losses did not manifest until 2008, we take the

plaintiffs’ factual allegations as true in a section 2-619 proceeding. Third, application of a merits

test also distinguishes Primeo and the present claim. Primeo employed the reflective loss

doctrine to prevent a double recovery, but because the trustee’s claim against the accountants in

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federal court was soundly rejected on the basis of in pari delicto and the trustee had no claim at

all (no claim existed), we know that the present suit cannot result in a double recovery. The

accountants would have us rule, however, that Primeo precludes the investors from recovering in

any forum.

¶ 43 Kingate comes from Bermuda, rather than Cayman Islands, but is another case that

involved losses due to Madoff’s fraud. The plaintiffs invested in feeder funds and subsequently

asserted various common law claims against managers, consultants, administrators, and auditors

of the two funds. Kingate, 2016 WL 5339538, at *1. The appellee-auditors cite the trial court’s

order (which has been affirmed), for the conclusion that claims that audit reports, which induced

the plaintiffs to purchase and maintain their shares, did not make their losses separate and

distinct for purposes of the reflective loss doctrine. 4 Kingate, 2016 WL 5339538, at *40. In

contrast, the complaint at issue here specifies that the losses were sustained at the time of

investing, not at the time of the fund’s collapse, and that the investors’ losses were separate and

independent from the fund’s losses. Again, despite the accountants’ contention that the investors’

losses did not manifest until 2008, we take the plaintiffs’ factual allegations as true in a section

2-619 proceeding. Furthermore, when Kingate was argued, the feeder funds had liquidation

claims pending in the British Virgin Islands and were also pursuing compensation through

special proceedings set up to handle claims on behalf of Madoff’s victims. Kingate, 2016 WL

5339538, at *40. The court expressed concern that allowing the investors to bypass those forums

could be “counterproductive,” might hamper the liquidators’ efforts, and would potentially result

in a double recovery for the investors. Kingate, 2016 WL 5339538, at *40. Here, however, we
4
We reiterate the third principle of reflective loss set out in Johnson v. Gore Wood & Co. [2002]
UKHL 65, [2002] 2 AC 1 [35F-36B]: where a company suffers loss caused by a breach of duty to it and a
shareholder suffers a loss separate and distinct from that suffered by the company caused by a breach of
duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the
duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other.

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already know from the in pari delicto ruling that the fund has never had a claim against the

accountants and that there is no possibility of a double recovery for these investors.

¶ 44 The third case, Barings, does not help the appellee-accountants because the dismissal

order was not based on the reflective loss doctrine. Barings Bank was a British entity that

collapsed under a debt of £850 million in 1995 due to the unauthorized, fraudulent activity of an

employee trading on the Singapore International Monetary Exchange. In Barings, parent

companies of Barings’ Singapore subsidiary brought claims against the Singapore subsidiary’s

accountants for failing to detect three years of increasing, massive losses that the employee was

hiding in an errors reconciliation account. The auditors argued for dismissal on grounds of the

reflective loss doctrine and the lack of a duty owed to the Singapore subsidiary’s parent

companies. The court chose to dismiss the case for lack of duty and then returned to address the

reflective loss doctrine only in dictum.

¶ 45 Thus, the three foreign cases the auditors identify as most helpful, are, in fact, not helpful

and do not indicate that the shareholders’ complaint should have been dismissed by the trial

court for lack of standing.

¶ 46 Furthermore, the auditors’ expert in foreign law specified that the reflective loss doctrine

would not apply if there was “a special relationship (in other words knowledge on the part of the

auditors that the accounts would be relied on for the specific transaction for which they were in

fact relied on), a loss that is not merely reflective of the company’s, and circumstances such that

it would be fair, just and reasonable for a duty of care to be imposed.” It appears that the

shareholders were aware of these parameters and intended to plead within them. In a section 2-

619 proceeding, we are to accept their factual allegations as true. In addition, despite his

thorough discussion of Cayman Islands legal principles, the auditors’ expert remarked that he

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had read the complaint at issue and was offering “no opinion as to whether Cayman Islands law

would apply to the claims made by the Plaintiffs in these proceedings.” That determination was

to be made by the Illinois trial court.

¶ 47 We have also concluded that the shareholders’ allegations appear to be the type outlined

by the Seventh Circuit when it found Lancelot Offshore’s false representations to investors

meant the fund had no claim against the auditors, affirmed the dismissal of Lancelot Offshore’s

suit, and concluded that it was “time to bring the investors’ claims to the fore.” Peterson, 792

F.3d at 788-89. The Seventh Circuit cited an Illinois statute (225 ILCS 450/30.1(2) (West 2016)),

and case law that provide for auditor liability where the primary purpose and intent of an

accountant-client relationship was to benefit or influence the third-party plaintiff. The statute

provides for public accountant liability as follows:

Ҥ 30.1. Liability. No person, partnership, corporation, or other entity licensed or

authorized to practice under this Act or any of its employees, partners, members, officers

or shareholders shall be liable to persons not in privity of contract with such person,

partnership, corporation, or other entity for civil damages resulting from acts, omissions,

decisions or other conduct in connection with professional services performed by such

person, partnership, corporation, or other entity, except for:

(1) such acts, omissions, decisions or conduct that constitute fraud or intentional

misrepresentations, or

(2) such other acts, omissions, decisions or conduct, if such person, partnership or

corporation was aware that a primary intent of the client was for the professional services

to benefit or influence the particular person bringing the action; provided, however, for

the purposes of this subparagraph (2), if such person, partnership, corporation, or other

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entity (i) identifies in writing to the client those persons who are intended to rely on the

services, and (ii) sends a copy of such writing or similar statement to those persons

identified in the writing or statement, then such person, partnership, corporation, or other

entity or any of its employees, partners, members, officers or shareholders may be held

liable only to such persons intended to so rely, in addition to those persons in privity of

contract with such person, partnership, corporation, or other entity.” 225 ILCS 450/30.1

(West 2016).

See Tricontinental Industries, Ltd. v. PricewaterhouseCoopers, LLP, 475 F.3d 824 (7th Cir.

2007) (discussing adequacy of third party’s tort allegations against auditor); Kopka v. Kamensky

& Rubenstein, 354 Ill. App. 3d 930, 821 N.E.2d 719 (2004) (same); Builders Bank v. Barry

Finkel & Associates, 339 Ill. App. 3d 1, 790 N.E.2d 30 (2003) (same).

¶ 48 For these reasons, we find that the trial court erred in dismissing the shareholders’

complaint with prejudice on the basis of section 2-619. The trial court granted the motion

without requiring the defendant accountants to demonstrate a conflict between the laws of

Illinois and Cayman Islands as to shareholder standing, and without properly assessing the

gravamen of the shareholders’ allegations. We reverse the dismissal order and remand for further

proceedings consistent with our reasoning.

¶ 49 Given that we are reversing the section 2-619 ruling, we must address the separate

arguments of defendant RSM Cayman that its section 2-615 motion was reason to nevertheless

dismiss RSM Cayman from the proceedings. See Weis v. State Farm Mutual Automobile

Insurance Co., 333 Ill. App. 3d 402, 406, 776 N.E.2d 309, 311 (2002) (a section 2-615 motion

should be granted if a complaint fails to factually state a cause of action).

¶ 50 RSM Cayman contends that it was sued only as the successor in interest to AMG

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Cayman and M&P Cayman, but the complaint failed to factually allege that successor

relationship. Under Illinois law, the general rule is that a successor who purchases a company’s

assets is not liable for the company’s debts and other obligations, unless one of four exceptions

applies. Pielet v. Pielet, 407 Ill. App. 3d 474, 508, 942 N.E.2d 606, 636 (2010), rev’d in part on

other grounds, 2012 IL 112064, ¶ 57; Vernon v. Schuster, 179 Ill. 2d 338, 344-45, 688 N.E.2d

1172, 1175 (1997) (“The well-settled general rule is that a corporation that purchases the assets

of another corporation is not liable for the debts or liabilities of the transferor corporation.”). The

four exceptions are (1) where there is an express or implied agreement to assume liability,

(2) where the transaction amounts to a consolidation or merger of the entities, (3) where the

purchaser is merely a continuation of the seller, and (4) where the transaction is for the

fraudulent purpose of escaping liability for the seller’s obligations. Pielet, 407 Ill. App. 3d at

508.

¶ 51 We agree that the complaint lacks specific factual allegations that sufficiently invoke one

of the four exceptions. Nevertheless, because the plaintiffs have not had the opportunity to

amend their pleading, it would be premature to dismiss this original complaint with prejudice.

See Hayes Mechanical, Inc. v. First Industrial, L.P., 351 Ill. App. 3d 1, 7, 812 N.E.2d 419, 424

(2004); Loyola Academy v. S&S Roof Maintenance, Inc., 146 Ill. 2d 263, 273, 586 N.E.2d 1211,

1215-16 (1992). Moreover, RSM Cayman acknowledged during appellate arguments that the

shareholders had not had an opportunity to revise the first version of their complaint.

Accordingly, we affirm the dismissal of RSM Cayman, under section 2-615 instead of section 2-

619, but without prejudice. We direct the trial court to allow the plaintiffs the opportunity to

replead as to RSM Cayman.

¶ 52 Based on the foregoing, we reverse the dismissal as to defendants RSM US and Lesser

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under section 2-619, affirm the dismissal without prejudice as to defendant RSM Cayman under

section 2-615, and remand for further proceedings consistent with this opinion.

¶ 53 Affirmed in part and reversed in part; cause remanded.

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