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HOFFMAN v. DELOITTE & TOUCHE

June 1, 2001

DAVID HOFFMAN AND HOFFMAN VESTMENT, INC., PLAINTIFFS,
v.
DELOITTE & TOUCHE, LLP. AND JEFFERIES & COMPANY, INC., DEFENDANTS. JAMES HOLDEN AND CHRISTINE HOLDEN, PLAINTIFFS, V. DELOITTE & TOUCHE, LLP. AND JEFFERIES & COMPANY, INC.; JEFFREY WEINHUFF; CHRISTOPHER P. MASSEY; DAVID M. EHLEN; ERIK R. WATTS; WALTER L. SCHINDLER; MARK C. COLEMAN; EPS SOLUTIONS CORP.; ENTERPRISE PROFIT SOLUTIONS CORP., DEFENDANTS.



The opinion of the court was delivered by: Robert W. Gettleman, U.S. District Judge.

MEMORANDUM OPINION AND ORDER

In these related cases, plaintiffs David Hoffman and Hoffman Investment Company. Inc. ("Hoffman"), and James and Christen Holden ("Holdens") have filed separate lawsuits alleging that they were fraudulently induced to sell their companies as part of a large "roll-up" to a newly created company called EPS Solutions Corp. ("EPS"). Hoffman has named as defendants Deloitte & Touche, LLP ("D&T"), a national and international public accounting limited liability partnership, and Jefferies & Company, Inc. ("Jefferies"), an investment banking firm. In addition to D&T and Jefferies, the Holdens have named Jeffery Weinhuff, Executive Vice President of Jefferies and later an officer of EPS; Christopher P. Massey, until December 14, 1998, Senior Partner at D&T and thereafter CEO of EPS; David H. Ehlen, Senior Partner and National Director of D&T until December 14, 1998, and thereafter an employee and officer of EPS; Erik R. Watts, an associate of Massey and starting in December 1998 an officer and director of EPS; Walter L. Schindler, a Senior Partner at the law firm of Gibson, Dunn & Crutcher, LLC. until January 10, 1999, and thereafter General Counsel and Vice President of EPS; Mark C. Coleman, a partner at D&T until December 14, 1998, and thereafter Senior Vice President and CFO of EPS; EPS, and its operating company Enterprise Profit Solutions Corp.

D&T and Jefferies have moved in both cases to dismiss or stay the proceedings and compel arbitration. Massey and Watts have adopted D&T's motion in the Holden case. For the reasons set forth below, the motions are granted.

Background

The complaints in these cases allege a complex fraudulent scheme conducted by D&T and Jefferies, and others acting in concert with them, to form and operate EPS, a company comprised of numerous entities that are or were engaged in various business service fields including: disbursement management services; corporate training; health care claims recovery; outsourcing; recruiting; and benefit consulting. Because an understanding of the basic scheme as well as each defendant's individual role is necessary for resolution of the pending motions, the court provides both a general description of the scheme as well as an abbreviated version of the extensive allegations regarding its creation and the plaintiffs' involvement.

Facts*fn1

In 1995 D&T formed a division called Integrated Cost Reduction Strategies Group ("ICRS") to provide business services to its audit clients. Massey, a D&T partner, was made Managing Partner of ICRS, and reported to an advisory board consisting of the managing partner of D&T as well as the function heads and other top D&T partners. Coleman was made CFO and National Director of ICRS's health care service group.

Because the Security and Exchange Commission and American Institute of Certified Public Accountant regulations prohibited D&T from receiving performance-based or "contingency" fees, D&T contracted with an intermediary firm, National Benefits Consultants, LLC. ("NBC"), which then contracted with separate companies called "Alliance Members" to perform a majority of the services at ICRS's direction. NBC received a portion of the contingency fees for the services provided by the Alliance Members, and then itself paid most of that fee, ostensibly as payment for "time and materials," to ICRS. These "time and materials" fees were then passed on to the local D&T office that had referred the audit client. In fact, neither ICRS nor D&T provided any time or material; they simply used D&T referrals to channel contingent fee work to third party companies.

NBC, founded in 1995, was a shell corporation nominally owned by Watts, but Massey owned an undisclosed option to purchase a one-half ownership interest for $1. Because Massey was a D&T partner, the undisclosed option was intended to disguise D&T's financial interest in and control over NBC, to give the appearance to clients and regulators that NBC's contingent fee activities were unconnected to D&T.

Because the contract providing for the funneling of work and revenue between NBC and ICRS was scheduled to expire on December 31, 1998, and because D&T desired to distance itself further from the contingent fee and "money laundering" aspects of the ICRS/NBC relationship, Massey proposed that D&T engineer a "roll-up", combining numerous third party cost-recovery and consulting companies into a new enterprise (EPS), which would be used as a vehicle to borrow money from the Bank of America and other lenders. The money would then be used to purchase ICRS from D&T at an inflated price, and to purchase various cost-recovery and consulting companies. Alan Bernikow, Massey's direct supervisor at D&T, and the rest of D&T's management accepted Massey's proposal.

D&T provided virtually all of EPS's capital and funded its promotional, payroll and operating expenses both before and after EPS was created up until the date of the initial roll-up, December 14, 1998. D&T employees, including Massey, Ehlen, and Coleman, made up EPS's staff but remained employees of D&T until the date of the roll-up, at which time they became full time EPS employees.

D&T promoted and controlled EPS through Massey, Coleman, Ehlen, Bernikow and other senior partners as part of an advisory board. Massey reported directly to Bernikow and to other D&T senior partners regarding the method, procedure, and details of the roll-up. Although still employed by and working on behalf of D&T, Massey signed an employment agreement effective August 28, 1998, indicating that his role was also "CEO" of EPS Solutions Corp. As CEO, Massey was in charge of structuring the roll-up, supervising due diligence, and identifying prospects such as plaintiffs. Massey took the lead in recruiting principals of companies such as plaintiffs on behalf of D&T. On December 7, 1998, Massey was formally named CEO and Chairman of the Board of Directors of Enterprise Profit Solution Corporation. Ehlen and Coleman also became full time corporate officers of EPS.

To make the roll-up appear legitimate, D&T required an investment banker. D&T named Jefferies, described by the Holdens as "an otherwise reputable firm," to be a "Founder" of the roll-up and to handle the investment banking role. Jefferies acted as a financial advisor and investment banker for EPS from early 1998 through early 1999. The relationship between Jefferies and EPS was memorialized in a letter agreement dated October 2, 1998, between NBC and promoters Watts, Massey and Coleman, and Jefferies. Both before and during the time period covered by the engagement letter, Jefferies, one of the founders of EPS, acted as promoter of the roll-up through its employees. Weinhuff, Jefferies' Chief of the High Yield Bond Division, who was the primary agent on the account, took the most active roll in soliciting companies to join the roll-up through presentations to owners of potential acquisitions. Weinhuff was recruited into the scheme by promises of extremely high finders fees, to be paid in cash and stock of EPS (the "arbitrage shares").

During the summer of 1998 through mid-March 1999, D&T, Massey, Watts, Ehlen, Coleman, Weinhuff, Schindler, and Jefferies represented to owners of potential roll-up companies, including plaintiffs, that Jefferies's financial advice and due diligence was full, thorough, accurate, and complied with all professional and legal standards. According to plaintiffs, however, Jefferies's real due diligence checks were limited to the few bona fide companies involved in the roll-up, such as plaintiffs. Plaintiffs allege that Jefferies performed no due diligence on Massey's and Watts' sham and overvalued companies or on ICRS and NBC. Jefferies concealed the truth about those companies being included in the roll-up and concealed that Jefferies' officer, Weinhuff, had a ...


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