Nisselson v. Lernout

United States Court of Appeals
For the First Circuit

No. 05-1774

ALAN NISSELSON, TRUSTEE OF THE DICTAPHONE
LITIGATION TRUST,

Plaintiff, Appellant,

v.

JO LERNOUT ET AL.

Defendants, Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Patti B. Saris, U.S. District Judge]

Before

Selya, Lipez and Howard,
Circuit Judges.

Max Folkenflik and Regina Griffin, with whom Folkenflik &
McGerity, Brauner Baron Rosenzweig & Klein, Karen D. Hurvitz, and
Law Offices of Karen D. Hurvitz were on brief, for appellant.
George A. Zimmerman, with whom Matthew J. Matule and Skadden,
Arps, Slate, Meagher & Flom LLP were on brief, for appellee SG
Cowen and Company, LLC.
Janet B. Fierman, with whom Thomas W. Evans, Robert M. Cohen,
and Cohen & Fierman, LLP were on brief, for appellee Mercator
Assurances, S.A.
Robert J. Kaler, with whom Eric Neyman and Gadsby Hannah LLP
were on brief, for appellees Flanders Language Valley Fund et al.
Michael P. Carroll, with whom Michael S. Flynn, Sean C.
Knowles, Phineas E. Leahey, Davis Polk & Wardwell, Kevin J.
Lesinski, William J. Hanlon, Kristin G. McGurn, and Seyfarth Shaw
LLP were on brief, for appellee KPMG LLP.
Thomas J. Gallitano, Conn, Kavanagh, Rosenthal Peisch & Ford
LLP, John B. Missing, Ada Fernandez Johnson, and Debevoise &
Plimpton LLP on brief for appellee GIMV, N.V.
Michael J. Stone, Peabody & Arnold LLP, George A. Salter,
Nicholas W.C. Corson, and Hogan & Hartson LLP on brief for appellee
Klynveld Peat Marwick Goerdeler Bedrijfsrevisoren.
Robert P. Trout, John Thorpe Richards, Jr. and Trout Cacheris,
PLLC on brief for appellee Lessius Management Consulting, N.V.
Andrew Good, Good & Cormier, Roger E. Zuckerman, Steven M.
Salky, P. Andrew Torrez, and Zuckerman Spaeder LLP on brief for
appellee Louis-H. Verbeke.

November 8, 2006
 SELYA, Circuit Judge. This appeal requires us to explore

an arcane corner of the world of corporate finance. In the

underlying series of events, a corporate shark, using fraudulent

means, induced an allegedly innocent target corporation to enter

into an ill-advised merger. After both the shark and the merged

entity drowned in red ink, plaintiff-appellant Alan Nisselson (the

trustee), appointed by the bankruptcy court to prosecute any causes

of action that the merged entity might possess, attempted to mount

various claims arising out of the innocent target's legal rights.

Those rights, of course, were twice removed from the damages that

formed the basis of the suit: they were passed along once to the

surviving corporation (at the time of the merger) and again to the

trustee (during the bankruptcy proceedings).

Emphasizing this genealogy, the district court dismissed

the action on two grounds; it determined that the trustee lacked

standing to pursue the claims and that, in all events, the rascality

of the shark was as a matter of law imputed to the surviving entity

in the merger (and that, therefore, the hoary in pari delicto

doctrine barred the suit). See Nisselson v. Lernout, No. 03-10843,

2004 U.S. Dist. LEXIS 28655, at *20-21 (D. Mass. Aug. 9, 2004).

Concluding, as we do, that the second of these determinations

withstands scrutiny — the trustee's claims are incurably tainted

because they derive from the itself-complicit surviving corporation

— we affirm the judgment below.

-3-
I. BACKGROUND

We glean the pertinent facts from the amended complaint,

supplementing those facts as needed by documents fairly incorporated

therein and matters susceptible to judicial notice. See Centro

Medico del Turabo, Inc. v. Feliciano de Melecio, 406 F.3d 1, 5 (1st

Cir. 2005); In re Colonial Mortg. Bankers Corp., 324 F.3d 12, 15-16

(1st Cir. 2003). While the scheme that lies at the center of this

case comprises a complex tale of sophisticated financial chicanery,

we rehearse here only those features essential to an understanding

of the present proceeding. We urge the reader who thirsts for

greater knowledge to consult the array of published opinions

emanating from related litigation. See, e.g., Baena v. KPMG LLP, 453

F.3d 1 (1st Cir. 2006); Quaak v. Klynveld Peat Marwick Goerdeler

Bedrijfsrevisoren, 361 F.3d 11 (1st Cir. 2004); Bamberg v. SG Cowen,

236 F. Supp. 2d 79 (D. Mass. 2002); Filler v. Lernout, 230 F. Supp.

2d 152 (D. Mass. 2002); In re Lernout & Hauspie Sec. Litig., 208 F.

Supp. 2d 74 (D. Mass. 2002).

By the time the new millennium dawned, Dictaphone

Corporation (Old Dictaphone), a company chartered under the laws of

Delaware, had established itself as a force in the healthcare speech

and language applications market. Lernout & Hauspie, N.V. (L&H), a

Belgian corporation that ran its United States operations from

headquarters in Massachusetts, was itself an international leader in

various speech and language sectors. In hopes of swallowing up its

-4-
competitor, L&H began courting Old Dictaphone; it described in

glowing terms its financial stability and the profitable synergies

that a merger could generate. Negotiations ensued.

Not surprisingly, Old Dictaphone conducted extensive due

diligence investigations into L&H's fiscal health. During the course

of that review, L&H's senior officers, investment bankers, attorneys,

and auditors touted its financial prowess. Against this rose-colored

backdrop, Old Dictaphone agreed to a stock-for-stock merger. The

parties memorialized the terms in a merger agreement dated March 7,

2000.

The merger took place less than two months thereafter: L&H

acquired all the outstanding stock of Old Dictaphone in exchange for

approximately 9,400,000 shares of L&H common stock. Based on the

trading price of L&H stock at the time of the closing, the exchange

corresponded to a merger price of roughly $930,000,000.

As part and parcel of the transaction, Old Dictaphone

merged into Dark Acquisition Corp. (Dark), a wholly-owned subsidiary

of L&H created under Delaware law for the express purpose of

effectuating the merger. L&H's chief executive officer, defendant-

appellee Gaston Bastiaens, doubled in brass as Dark's chief executive

and lone director. He also signed the merger agreement on its

behalf.

Under the terms of the merger agreement, Dark inherited Old

Dictaphone's assets (including any existing legal claims) and assumed

-5-
Old Dictaphone's liabilities. This arrangement corresponded to the

dictates of Delaware law. See Del. Code Ann. tit. 8, § 259(a). Dark

survived the merger and Old Dictaphone ceased to exist. Dark then

changed its name to Dictaphone Corporation (New Dictaphone).

The honeymoon was brief. Shortly after the merger had been

consummated, L&H announced that the financial picture it had painted

and displayed was not an accurate portrayal. As matters turned out,

nearly two-thirds of L&H's reported revenue from 1998 through mid-

2000 had been improperly recorded, so that an apparent $70,000,000

net profit for that period was in fact a net loss of a similar

magnitude. The price of L&H shares plummeted and, on November 29,

2000, L&H and New Dictaphone filed voluntary petitions for relief

under Chapter 11 of the Bankruptcy Code.

We fast-forward to New Dictaphone's approved plan of

reorganization. As part of that plan, the corporation conveyed its

interest in any claims arising out of the merger to the Dictaphone

Litigation Trust (the Trust). That assignment galvanized this suit:

acting on behalf of the Trust, the trustee filed a civil action in

federal district court seeking damages to compensate for the "loss

or diminution of [Old Dictaphone's] value as a going concern."

The trustee's amended complaint characterizes the gross

misstatments of earnings as the mainspring of a fraudulent scheme

designed to inflate the value of L&H's stock. As the trustee

envisions it, this scheme, which played out over a four-year period,

-6-
was concocted and executed by the defendants in this case (who

include the officers, directors, investment bankers, attorneys, and

auditors of L&H, and divers entities related to them). The fallout

from it rendered worthless the consideration that Old Dictaphone and

its shareholders received (assumption of Old Dictaphone's debt and

shares of L&H stock).

In his amended complaint, the trustee asserts federal

securities and racketeering claims, see 15 U.S.C. §§ 78j(b), 78t(a);

18 U.S.C. § 1962(c); 17 C.F.R. § 240.10b-5, as well as supplemental

state-law claims for fraud, unfair trade practices, negligent

misrepresentation, and conspiracy. The theory underlying each and

all of these initiatives is that L&H, through its senior management,

knowingly engaged in a scheme to classify research and development

expenditures as fictional revenue in order to inflate the value of

the company's stock. Then, knowing that they were selling a lie,

L&H's hierarchs flaunted the company's ever-increasing stock price

and used its apocryphal earnings to persuade Old Dictaphone and its

shareholders to enter into a stock-for-stock merger. L&H relied on

its investment bankers, attorneys, accountants, and related entities

to substantiate its false claims; those parties, the trustee

contends, knew that L&H was spinning a yarn, yet assisted it in

perpetrating the fraud.1

1
This suit comprised one of many filed in the wake of L&H's
revenue restatement. In one such related action, Stonington
Partners, Inc., which had owned ninety-six percent of Old

-7-
 Various defendants, led by SG Cowen (an investment banking

house), filed motions to dismiss. See Fed. R. Civ. P. 12(b)(6). All

of these motions argued, in relevant part, that the trustee lacked

standing and that his claims were barred under the in pari delicto

doctrine. Some of the motions advanced additional grounds for

dismissing particular claims. The trustee vigorously opposed the

motions.

In due course, the district court granted Cowen's motion

and dismissed the trustee's federal claims against Cowen with

prejudice. See Nisselson, 2004 U.S. Dist. LEXIS 28655, at *20-21.

The court rested its decision on two alternative grounds. First, it

concluded that the in pari delicto doctrine barred the claims because

the trustee had inherited them from New Dictaphone, an entity itself

implicated in the alleged fraud. See id. at *12-15. Second,

interpreting and applying the Delaware standard for distinguishing

direct and derivative claims, it concluded that the trustee lacked

standing because the claims asserted belonged to Old Dictaphone's

former shareholders, not to Old Dictaphone itself. See id. at *15-20

(discussing, inter alia, Tooley v. Donaldson, Lufkin & Jenrette,

Dictaphone prior to the merger, sued for damages allegedly incurred
when it traded its once-valuable interest for what ended up being
worthless paper.
For his part, the trustee has brought separate actions for
breach of fiduciary duty against Old Dictaphone's former directors
and controlling shareholders and for breach of contract and
negligence against the accountants and investment bankers who
counseled Old Dictaphone during the merger negotiations.

-8-
Inc., 845 A.2d 1031, 1033 (Del. 2004)). For the same reasons, the

court, in a series of subsequent orders, granted the other appellees'

motions to dismiss.2 This timely appeal followed.

II. ANALYSIS

We review Rule 12(b)(6) dismissal orders de novo, assuming

the truth of all well-pleaded facts contained in the operative

version of the complaint and indulging all reasonable inferences in

the plaintiff's favor. See McCloskey v. Mueller, 446 F.3d 262, 266

(1st Cir. 2006). Facts distilled in that fashion may be augmented

by reference to (i) documents annexed to it or fairly incorporated

into it, and (ii) matters susceptible to judicial notice. See Centro

Medico del Turabo, 406 F.3d at 5; Rodi v. S. New Engl. Sch. of Law,

389 F.3d 5, 12 (1st Cir. 2004). Where, as here, a district court

rests its decision on alternative grounds, an appellate court need

not explore both; if it determines that one such ground fully

supports the order of dismissal, the court may end its deliberations

at that point. See Feinstein v. Resolution Trust Corp., 942 F.2d 34,

41 n.7 (1st Cir. 1991).

This case presents an idiosyncratic procedural feature.

While most Rule 12(b)(6) motions are premised on a plaintiff's

putative failure to state an actionable claim, such a motion may

2
The lower court did not reach any of the additional arguments
proffered by the defendants, nor do we.

-9-
sometimes be premised on the inevitable success of an affirmative

defense. See, e.g., In re Colonial Mortg. Bankers, 324 F.3d at 16;

Blackstone Realty v. FDIC, 244 F.3d 193, 197 (1st Cir. 2001); Keene

Lumber Co. v. Leventhal, 165 F.2d 815, 820 (1st Cir. 1948).

Dismissing a case under Rule 12(b)(6) on the basis of an affirmative

defense requires that "(i) the facts establishing the defense are

definitively ascertainable from the complaint and the other allowable

sources of information, and (ii) those facts suffice to establish the

affirmative defense with certitude." Rodi, 389 F.3d at 12.

A. Standing.

The district court characterized both the in pari delicto

doctrine and the absence of cognizable injury as evincing a lack of

standing. See Nisselson, 2004 U.S. Dist. LEXIS 28655, at *12-13.

Part of this characterization is inapt: the in pari delicto doctrine

does not implicate a plaintiff's standing to sue but, rather,

constitutes an affirmative defense. See Official Comm. of Unsecured

Creditors of PSA, Inc. v. Edwards, 437 F.3d 1145, 1149-50 (11th Cir.

2006); Official Comm. of Unsecured Creditors of Color Tile, Inc. v.

Coopers & Lybrand, LLP, 322 F.3d 147, 157 (2d Cir. 2003); see also

Baena, 453 F.3d at 6 (noting that the doctrine is, on occasion,

"dubiously" referred to as implicating standing).

This does not mean, however, that we must grapple with the

district court's alternative "distinct injury" holding first. Even

though challenges to a plaintiff's standing are often considered

-10-
threshold issues in federal cases, see, e.g., Pagán v. Calderón, 448

F.3d 16, 26 (1st Cir. 2006); Eulitt v. Me. Dep't of Educ., 386 F.3d

344, 351 (1st Cir. 2004), such challenges must be addressed first

only if they call into question a federal court's Article III power

to hear the case. See Steel Co. v. Citizens for a Better Env't, 523

U.S. 83, 94-95 (1998). The constitutional prerequisites for Article

III standing are satisfied so long as a plaintiff colorably alleges

an actual injury that is both traceable to the defendant's conduct

and redressable by a favorable decision. See Lujan v. Defenders of

Wildlife, 504 U.S. 555, 560-62 (1992); Ramírez v. Sánchez Ramos, 438

F.3d 92, 97 (1st Cir. 2006).

In this case, those prerequisites have been fulfilled. For

purposes of their motions to dismiss, the defendants wisely choose

not to contest the trustee's assertion that the conduct attributed

to them resulted in a redressable injury; instead, they posit that

the trustee is seeking to prosecute claims that, although cognizable

in a federal court, belong exclusively to Old Dictaphone's former

shareholders. The determination of who may maintain an otherwise

cognizable claim turns on a question of prudential standing, not one

of Article III standing. See Baena, 453 F.3d at 5; see also Ramírez,

438 F.3d at 98.

That frees our hands: Steel Co.'s ban on hypothetical

jurisdiction extends only to issues involving Article III

jurisdiction and, hence, Article III standing. There is no

-11-
counterpart rule that demands the resolution of objections based on

prudential concerns before other issues can be adjudicated. See

Baena, 453 F.3d at 5; McBee v. Delica Co., 417 F.3d 107, 127 (1st

Cir. 2005).

Mandatory rules aside, courts should not rush to rely on

hypothetical jurisdiction. See Berner v. Delahanty, 129 F.3d 20, 23

(1st Cir. 1997). Nevertheless, one situation in which hypothetical

jurisdiction, if otherwise proper, may be invoked is when doing so

would avoid the need to sort out thorny jurisdictional tangles. See,

e.g., McBee, 417 F.3d at 127; Parella v. Ret. Bd. of R.I. Employees'

Ret. Sys., 173 F.3d 46, 56 (1st Cir. 1999). As we explain briefly,

just such a tangle exists here.

Although the decision in Tooley may have helped to clarify

the often elusive distinction between direct and derivative claims,

that distinction remains tenebrous. See Richard Montgomery

Donaldson, Mapping Delaware's Elusive Divide: Clarification and

Further Movement Toward a Merits-Based Analysis for Distinguishing

Derivative and Direct Claims in Agostino v. Hick and Tooley v.

Donaldson, Lufkin & Jenrette, Inc., 30 Del. J. Corp. L. 389, 404

(2005) (listing the "determination of who suffered the harm — the

corporation or the shareholder(s)" as one of the potentially

confusing issues left open under Tooley). More to the point, it is

not immediately apparent how the Delaware court's newly announced

two-part test, 845 A.2d at 1033, should apply to the unique facts of

-12-
this stock-for-stock merger. Because the record reflects a clear and

sufficient basis apart from standing for affirming the district

court's judgment, we bypass these uncharted waters.

B. The In Pari Delicto Doctrine.

In pari delicto is both an affirmative defense and an

equitable defense. Broadly speaking, the defense prohibits

plaintiffs from recovering damages resulting from their own

wrongdoing. See Terlecky v. Hurd (In re Dublin Sec.), 133 F. 3d 377,

380 (6th Cir. 1997). The label derives from the Latin phrase in pari

delicto potior est conditio possidentis, which admonishes that "[i]n

a case of equal or mutual fault . . . the condition of the [defending

party] is the better one." Black's Law Dictionary 791 (6th ed.

1990).

The doctrine is grounded on twin premises. The first is

that "courts should not lend their good offices to mediating disputes

among wrongdoers." Bateman Eichler, Hill Richards, Inc. v. Berner,

472 U.S. 299, 306 (1985). The second is that "denying judicial

relief to an admitted wrongdoer is an effective means of deterring

illegality." Id.

The in pari delicto defense has long been woven into the

fabric of federal law. See id. at 307 (discussing the doctrine's

historical development); see also Fleming v. Lind-Waldock & Co., 922

F.2d 20, 28 (1st Cir. 1990); Duncan v. Me. Cent. R. Co., 113 F. 508,

509 (C.C.D. Me. 1902). It does not make a difference that some of

-13-
the trustee's claims are premised on state law. Those claims invoke

the law of Massachusetts — and the Massachusetts courts, like the

federal courts, have warmly embraced the in pari delicto defense.

See, e.g., Council v. Cohen, 21 N.E.2d 967, 970 (Mass. 1939);

Choquette v. Isacoff, 836 N.E.2d 329, 332 (Mass. App. Ct. 2005).

As originally conceived, the in pari delicto doctrine

forged a defense of limited utility. Over time, however, courts

expanded the doctrine's sweep, deploying it as a basis for dismissing

suits whenever a plaintiff had played any role — no matter how modest

— in the harm-producing activity. See Bateman Eichler, 472 U.S. at

307. Deploring this overly commodious construction, the Supreme

Court later reined in the doctrine and returned it to its classic

contours. See Pinter v. Dahl, 486 U.S. 622, 635 (1988); Bateman

Eichler, 472 U.S. at 310-11. This retrenchment, which governs here,

restricts the application of the in pari delicto doctrine to those

situations in which (i) the plaintiff, as compared to the defendant,

bears at least substantially equal responsibility for the wrong he

seeks to redress and (ii) preclusion of the suit would not interfere

with the purposes of the underlying law or otherwise contravene the

public interest. See Bateman Eichler, 472 U.S. at 311 (discussing

the doctrine's application to federal securities laws); see also

Edwards, 437 F.3d at 1154. Recent Massachusetts case law mirrors

these refinements. See, e.g., Choquette, 836 N.E.2d at 332-33.

-14-
 While the application of this binary paradigm may vary

slightly depending on the nature of the particular claim asserted,

courts nonetheless speak of a single doctrine. This is because the

analysis ordinarily will be the same across a spectrum of different

causes of action. See Official Comm. of Unsecured Creditors v. R.F.

Lafferty & Co., 267 F.3d 340, 345-46 (3d Cir. 2001); see also Coopers

& Lybrand, 322 F.3d at 160.

The court below adopted this one-size-fits-all approach in

addressing the in pari delicto defense; it neither distinguished

among the various counts nor differentiated between federal and state

law. The trustee has not objected to this approach, so he has waived

any argument either that a claim-by-claim analysis is obligatory or

that some material differences exist between applicable federal and

state law. See Domegan v. Fair, 859 F.2d 1059, 1065 (1st Cir. 1988)

("It is too familiar to warrant string citation that we will not

consider arguments which could have been, but were not, advanced

below."). Consequently, we employ the same generic strain of the in

pari delicto doctrine throughout our review.

C. Establishing the Appropriate Benchmark.

To apply the requisite two-part paradigm in the

circumstances of this case, we must answer a threshold question: Who,

exactly, are the proper parties for the purpose of determining

relative blame? The trustee's answer to this query is

straightforward. Because his claims originate with Old Dictaphone,

-15-
he asseverates that this indisputably innocent party is the relevant

entity for purposes of the comparison required by the binary in pari

delicto test. Since Old Dictaphone was the victim rather than a

perpetrator of the alleged fraud, the trustee's thesis runs, it bears

less responsibility than any of the defendants and, therefore, the

defendants fail to satisfy the first precondition for use of the in

pari delicto defense. On that basis, the trustee claims an

entitlement to recover for the injury that Old Dictaphone suffered

when it was duped into proceeding with the merger.

We assume, for argument's sake, that Old Dictaphone would

have been a proper party to sue for the asserted injury. See supra

Part II (A). Even so, the trustee's reasoning is flawed; his

analysis entirely overlooks that, pursuant to both the merger

agreement and the governing law, see Del. Code Ann. tit. 8, § 259(a),

upon the consummation of the merger Old Dictaphone vanished into thin

air and New Dictaphone inherited all of Old Dictaphone's choses in

action. Under the approved plan of reorganization incident to New

Dictaphone's bankruptcy, those litigation rights were passed along

once more — this time to the Trust (and, thus, to the trustee). See

11 U.S.C. § 541(a)(1). Because the lineage of the trustee's claims

passes directly through New Dictaphone, any right that the trustee

may have to assert those claims derives directly from New Dictaphone.

This chain of descent means that the trustee — despite his

protestations to the contrary — is not acting in the place and stead

-16-
of Old Dictaphone but, rather, in the place and stead of New

Dictaphone.

This genealogy is important. Giving effect to it, the

trustee may assert only those claims that New Dictaphone could have

asserted prior to seeking the protection of the bankruptcy court.

See Mediators, Inc. v. Manney (In re Mediators, Inc.), 105 F.3d 822,

826 (2d Cir. 1997); see also 11 U.S.C. § 541. After all, a trustee

in bankruptcy cannot and does not acquire rights or interests

superior to, or greater than, those possessed by the debtor. See

Edwards, 437 F.3d at 1150; 5 Collier on Bankruptcy § 541.04 (15th ed.

2006) (noting that "nothing in section 541 [of the Bankruptcy Code,

defining property of the estate] can revest a debtor with property

lost prepetition" and describing property of the estate as including

"causes of action").

Given the line of descent delineated by operation of the

corporation and bankruptcy laws, we think that the in pari delicto

defense must be available to a defendant in an action by a bankruptcy

trustee whenever that defense would have been available in an action

by the debtor. See Edwards, 437 F.3d at 1152; see also Baena, 453

F.3d at 7 (assessing the debtor's culpability to determine whether

the in pari delicto doctrine barred a bankruptcy trustee's claims).

As a necessary corollary of that proposition, there is no "innocent

successor" exception available to a bankruptcy trustee in a case in

which the defendant successfully could have mounted an in pari

-17-
delicto defense against the debtor. See R.F. Lafferty, 267 F.3d at

356-57.

The explication of these principles suffices to answer the

threshold question here. Consistent with both precedent and

analytic rigor, we hold that New Dictaphone is the relevant

comparator vis-á-vis the defendants for the purpose of determining

the viability of the latter's in pari delicto defense. Old

Dictaphone's innocence is irrelevant to that inquiry.

D. Applying the Paradigm.

Having determined that New Dictaphone is the entity of

interest for purposes of the required comparison, we move to the

question of what actions can, at this stage of the proceedings, be

imputed to it (and, thus, to the trustee). See Baena, 453 F.3d at

7. In an effort to mount a preemptive strike, the trustee posits

that because all imputation inquiries entail fact-specific

determinations, an in pari delicto defense that relies on imputed

conduct cannot be adjudicated on a motion to dismiss. Although the

trustee's premise is partially correct — the extent to which

fraudulent conduct can be implied depends heavily on the specific

facts of a given case — he casts the net too wide.

The reporters are replete with examples of fact-dominated

questions, normally grist for the jury's mill, that may

appropriately be resolved by a motion filed pursuant to Rule

12(b)(6). See, e.g., Epstein v. C.R. Bard, Inc., 460 F.3d 183, 188

-18-
(1st Cir. 2006); Rodi, 389 F.3d at 16. The key is whether the

factual scenario, as pleaded, is clear enough to permit peremptory

resolution of the dispositive issue. See Rodi, 389 F.3d at 16

(explaining that when the facts alleged in the complaint preclude

a finding in the plaintiff's favor on a particular claim or defense,

"a court may enter an order of dismissal under Rule 12(b)(6)").

When a case hinges on imputation and the pleaded facts, construed

in the light most flattering to the resisting party, dictate

imputation, a court is free to decide that question on a motion to

dismiss. See, e.g., Baena, 453 F.3d at 8 (affirming dismissal on

in pari delicto grounds after imputing fraudulent conduct to debtor

corporation); Coopers & Lybrand, 322 F.3d at 164; (noting that the

court historically "has affirmed the dismissal of . . . claims on

the pleadings upon findings that in pari delicto had been

established in the complaints"); Terlecky, 133 F.3d at 380

(affirming dismissal when the debtor "admit[ted] in his complaint

that the debtor's own actions were instrumental in perpetrating the

fraud").

We look to state law to ascertain when wrongful conduct

should be imputed to a corporation. See O'Melveny & Myers v. FDIC,

512 U.S. 79, 84 (1994); Merrill Lynch, Pierce, Fenner & Smith, Inc.

v. Nickless (In re Advanced RISC Corp.), 324 B.R. 10, 14 (D. Mass.

-19-
2005).3 Here, the case law leaves little doubt that Massachusetts

law governs the imputation calculus. See O'Melveny & Myers, 512

U.S. at 83-85 (emphasizing the importance of the substantive law of

the state in which the causes of action arose, rather than the law

of the state of incorporation, to determine imputation).

Under Massachusetts law, a parent and its wholly-owned

subsidiary are generally regarded as separate and distinct entities.

See United Elec., Radio & Mach. Workers v. 163 Pleasant St. Corp.,

960 F.2d 1080, 1091 (1st Cir. 1992); Berger v. H.P. Hood, Inc., 624

N.E.2d 947, 950 (Mass. 1993). Courts may, however, disregard the

corporate form when doing so will defeat a fraud practiced by those

who control the subsidiary corporation. See My Bread Baking Co. v.

Cumberland Farms, Inc., 233 N.E.2d 748, 751 (Mass. 1968).

Relatedly, the fraudulent conduct of persons or entities who

exercise complete control over a corporation may be imputed to the

corporation when those actors have used the corporation as a vehicle

for facilitation of the fraud. See, e.g., Consove v. Cohen (In re

3
To the extent that the trustee's claims are premised on
federal statutes, we arguably have discretion to use federal common
law, as opposed to state law. See O'Melveny & Myers, 512 U.S. at 84
(explaining that where a particular cause of action arises under a
federal statute, a federal court, for this purpose, writes on a
pristine page). Even so, license to apply a uniquely federal test
is not tantamount to mandating such a test. Mindful that two of
our sister circuits recently have opted for state-law tests of
imputation in connection with federal claims, see Edwards, 437 F.3d
at 1149; R.F. Lafferty, 267 F.3d at 358, and that no party to this
litigation has requested us to fashion federal common law, we use
Massachusetts jurisprudence as the yardstick for measuring
imputation across the board.

-20-
Roco Corp.), 701 F.2d 978, 984 (1st Cir. 1983) (applying

Massachusetts law and imputing fraudulent conduct of individual who,

"as the company's president, director, and sole shareholder, . . .

was in a position to control the disposition of its property");

Merrill Lynch, 324 B.R. at 14-15 (applying Massachusetts law and

imputing principals' fraudulent conduct to debtor corporation where

the relationship was "one of complete control"); Demoulas v.

Demoulas, 703 N.E.2d 1149, 1171 (Mass. 1998) (applying Massachusetts

law and denying bona fide purchaser status to a corporation, under

an imputation theory, when the "sole voting trustee of 100 percent

of the [corporation's] stock" had actual knowledge of adverse claims

against the purchased property).

With this backdrop in place, the trustee's remaining

arguments against imputing L&H's fraudulent conduct to its wholly-

owned subsidiary lack force. The trustee himself has observed that

in pari delicto cases often result in imputation of fraudulent

conduct to a corporation when those responsible for the scheme are

"the sole decision-maker[s] for such entity, exercising complete

control over its management." Appellant's Br. at 43 n.21. This

observation accurately reflects the case law. See, e.g., Coopers

& Lybrand, 322 F.3d at 164-65 (imputing fraudulent conduct to debtor

when complaint established that its controlling shareholders

"dominat[ed] and controll[ed] the corporation" and were responsible

for "orchestrat[ing] the fraudulent conduct"); R.F. Lafferty, 267

-21-
F.3d at 359-60 (imputing fraudulent conduct to debtor corporation

and dismissing trustee's case on in pari delicto grounds where the

individuals masterminding the fraud were the debtor's sole

shareholders); Merrill Lynch, 324 B.R. at 14-16 (dismissing

trustee's action on in pari delicto grounds when debtor corporation

was formed by the defrauders for the express purpose of carrying out

the fraudulent plan). Since New Dictaphone, not Old Dictaphone, is

the proper focal point of our imputation inquiry, see supra Part II

(C), this case fits snugly within that integument. We explain

briefly.

Here, the amended complaint leaves no doubt but that L&H

played the primary role in contriving the scheme to acquire Old

Dictaphone under false pretenses. The amended complaint also

establishes that L&H created New Dictaphone (née Dark) for the

express purpose of furthering this artifice. L&H's control over New

Dictaphone during the course of the scheme is indisputable. In

addition to owning all of New Dictaphone's stock, L&H installed its

president, Bastiaens, as New Dictaphone's chief executive officer

and sole director. Bastiaens, in turn, ensured New Dictaphone's

complicity in the fraud's climactic event when he executed the

merger agreement on its behalf.

These uncontroverted facts are telling. Because the

amended complaint shows beyond hope of contradiction that L&H

created and controlled New Dictaphone in order to perpetrate the

-22-
harm-producing fraud, we have no principled choice but to impute its

conduct to New Dictaphone for the purpose of applying the in pari

delicto paradigm. See Merrill Lynch, 324 B.R. at 15; Demoulas, 703

N.E.2d at 1172; My Bread Baking, 233 N.E.2d at 751.

The trustee tries to find sanctuary by pointing out that,

after the merger, the directors of Old Dictaphone (presumably

innocent) became directors of New Dictaphone. This datum does not

alter our conclusion. The first prong of the in pari delicto

inquiry focuses on "the unlawful activity that is the subject of the

suit." Pinter, 486 U.S. at 636. Accordingly, a party's culpability

vel non must be based on its status at the time the alleged

illegality occurred. See Baena, 453 F.3d at 10 (finding no

Massachusetts case law supporting a theory that in pari delicto is

in any way modified when "prior management was at fault but the

claim [is] asserted on behalf of creditors or shareholders").

Here, of course, the fraud that underpins the trustee's

claims was complete at the moment the companies merged. Therefore,

any post-merger changes in New Dictaphone's corporate governance or

management are beside the point. Simply put, bankruptcy trustees

do not have access to an "innocent successor" exception as a way of

shielding themselves from the operation of an in pari delicto

defense. See R.F. Lafferty, 267 F.3d at 356-57; see also Baena, 453

F.3d at 10.

-23-
 The trustee's next attempt to elude the toils of the in

pari delicto doctrine involves the well-recognized adverse interest

exception. Generally, a wrongdoer's fraudulent acts will not be

imputed to a corporation when the wrongdoer is acting contrary to

the corporation's present interests. See, e.g., Baena, 453 F.3d at

8 (listing looting as a "classic example" of adverse conduct);

Sunrise Props., Inc. v. Bacon, Wilson, Ratner, Cohen, Salvage,

Fialky & Fitzgerald, P.C., 679 N.E.2d 540, 543 (Mass. 1997)

(concluding that "unauthorized acts [should] not [be] imputed to the

principal when the agent has acted fraudulently toward the

principal"). Endeavoring to squeeze within these narrow confines,

the trustee contends that L&H's scurrilous conduct is tantamount to

looting because L&H convinced Old Dictaphone to surrender its assets

for worthless paper.

This contention is ill-conceived, for the trustee's sights

are trained on the wrong entity. Accepting the allegations of the

amended complaint as true, L&H's actions were adverse to Old

Dictaphone and its shareholders — but they were not adverse to New

Dictaphone (a corporate shell which, in effect, was in league with

the defrauder and as a result received something for nothing).

Since we already have determined that New Dictaphone, not Old

Dictaphone, is the focal point of the imputation inquiry, see supra

Part II (C), the adverse interest exception does not apply.

-24-
 The trustee has yet another string to his bow. He argues

that even if New Dictaphone is the proper focal point of an in pari

delicto analysis, the adverse interest exception precludes us from

imputing L&H's fraud to its subsidiary because New Dictaphone was

"entirely indifferent" about whether Old Dictaphone received fair

value for its assets or whether L&H used skulduggery to effect the

acquisition. Appellant's Reply Br. at 19. We find this argument

unpersuasive. In our view, mere indifference is insufficient to

show adversity. The adverse interest exception applies only to

those whom the fraud has disadvantaged. See Restatement (Second)

of Agency § 282(1) (explaining that the exception attaches only when

an agent secretly acts adversely to his principal). In this

instance, the allegations of the amended complaint make manifest

that New Dictaphone benefitted from the fraud: it was the surviving

entity in a merger that netted it over $900,000,000. New

Dictaphone, as a beneficiary of L&H's chicanery at the time the

fraud was consummated,4 cannot rely on the adverse interest

exception to avoid imputation. After all, a party cannot accept the

avails of fraudulent conduct without also bearing responsibility for

4
Because the adverse interest exception turns on how the
alleged wrongdoing affected the immediate interests of the party
who seeks its shelter, New Dictaphone's subsequent implosion is of
no moment. See Baena, 453 F.3d at 7; accord Beck v. Deloitte &
Touche, Deloitte, Haskins & Sells, Ernst & Young, L.L.P., 144 F.3d
732, 736 (11th Cir. 1998) (applying Florida law); Cenco Inc. v.
Seidman & Seidman, 686 F.2d 449, 456 (7th Cir. 1982) (applying
Illinois law).

-25-
that conduct. See Tremont Trust Co. v. Noyes, 141 N.E. 93, 98

(Mass. 1923).

To summarize succinctly, L&H was the main player in the

alleged fraud and its parlous behavior must be imputed lock, stock,

and barrel to its offspring (New Dictaphone). It follows inexorably

that New Dictaphone, in contemplation of law, bears at least as much

responsibility for the asserted wrongdoing as any of the

defendants.5 Hence, the moving defendants have satisfied the first

requirement for establishing an in pari delicto defense.

We move next to the second requirement. As said, this

prong implicates public policy concerns. The trustee contends that

allowing the defendants to hide behind the in pari delicto doctrine

would frustrate the purpose of the securities laws because it would

allow participants in a fraudulent scheme to shield themselves from

liability. This contention is wide of the mark.

As we have pointed out, the trustee is not bringing claims

on behalf of an innocent target of the fraud but, rather, on behalf

5
As a fallback, the trustee suggests that the relevant
comparison entails matching New Dictaphone's culpability against
the culpability of L&H. That suggestion is faulty. When deciding
whether to recognize an in pari delicto defense, an inquiring court
must consider whether the party alleging injury (here, the trustee,
who stands in the shoes of New Dictaphone) bears substantially
equal (or greater) responsibility as the party or parties asserting
the defense (here, the defendants). See Bateman Eichler, 472 U.S.
at 306 (emphasizing the relative culpability of the "[defending]
party" as compared to the plaintiff (alteration in original)). L&H
is not a defendant in this action.

-26-
of a complicit party. Viewed in that light, the trustee's policy

concerns ring hollow.6 See Edwards, 437 F.3d at 1155 (finding

public policy exception inapplicable in analogous circumstances).

The trustee also asserts that withholding application of

the in pari delicto doctrine would promote the goal of

"discourag[ing] wrongdoers from engaging in future fraudulent

schemes and violations of the securities laws." Appellant's Br. at

38. That resupinate reasoning turns reality on its head. To permit

the trustee to proceed in these circumstances would be equivalent

to giving New Dictaphone a second bite at the cherry, allowing it

first to reap the benefits of the fraud and then to attack the

defrauders. The securities laws were enacted to protect investors

from deceptive practices, see Pinter, 486 U.S. at 638, not to give

the intended beneficiaries of deceptive practices a back-door means

of ensuring a profit.

Finally, the trustee strives to persuade us that we should

repel the defendants' in pari delicto defense because, in the

absence of that defense, the creditors of Old Dictaphone ultimately

would receive the fruits of any recovery. We find this argument

unconvincing; despite the interposition of the in pari delicto

6
In all events, dismissing the claims at issue here will not
allow the defendants to escape unscathed. The amended complaint
and matters susceptible to judicial notice reveal that many of the
defendants are facing or have faced not only criminal charges but
also a myriad of other civil suits relating to their respective
roles in the alleged fraud.

-27-
defense, the creditors remain free to proceed in their own right,

untainted by New Dictaphone's role in the alleged wrongdoing. See

Edwards, 437 F.3d at 1151; Terlecky, 133 F.3d at 380; Merrill Lynch,

324 B.R. at 16.

This arrangement is especially preferable because the

Trust beneficiaries may well include parties (most notably L&H) who

were themselves complicit in the underlying fraud. If we were to

suspend the operation of the in pari delicto defense in this case,

creditors with unclean hands would profit equally with innocents.

If, however, each creditor must proceed by individual suit, the

righteous may recover while the tainted, unable to circumvent the

in pari delicto bar, will be hoist by their own petard.

At oral argument, the trustee insisted that the

alternative of direct suits by creditors is illusory because

creditors lack contractual privity with the investment bankers,

lawyers, and accountants who comprise the trustee's targets. Thus,

the argument runs, if we afford these targets the safe haven of an

in pari delicto doctrine, creditors will be completely foreclosed

from accessing those pockets that are deep enough to compensate them

at anything higher than pennies on the dollar.

This jeremiad is unavailing. Even assuming that the

trustee's premise is true — and we have some doubt about its

validity — the equities are not nearly so clear-cut. First, the

creditors (or the trustee, on their behalf) may well succeed in

-28-
suits against Old Dictaphone's former directors, controlling

shareholder, and outside accounting professionals. See supra note

1. Second — and more important — our holding today breaks no new

ground. As such, the potential for default under these

circumstances is something about which creditors had notice —

something that should have been priced into their decisions to

extend credit. Equity does not require courts to provide a belt

when creditors had fair warning that they ought to have purchased

suspenders.

III. CONCLUSION

To summarize, we conclude that uncontroverted facts

sufficient to establish the in pari delicto defense are definitively

ascertainable from the amended complaint and other allowable sources

of information. These include L&H's creation of New Dictaphone for

the express purpose of effectuating the fraud-inspired merger and

its exercise of complete control over New Dictaphone until the fraud

was consummated. In these circumstances, L&H's conduct must be

imputed to New Dictaphone. Consequently, New Dictaphone shares the

culpability of the fraud's progenitor and, as such, bears as much

or more responsibility for the wrongdoing as any of the named

defendants. In the absence of any compelling public policy reason

to allow New Dictaphone to seek damages from those that assisted in

executing the fraudulent scheme — and the trustee has identified

none — the in pari delicto doctrine precludes New Dictaphone (and,

-29-
hence, the trustee) from advancing the type of claims that are at

issue here.

We need go no further. For the reasons elucidated above,

we hold that the district court did not err in dismissing the

trustee's amended complaint.

Affirmed.

-30-