UED ON411412005 K ! m SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK X ____________---___________r_____l___ HARCH INTERNATIONAL LIMITED, a foreign : corporation, Plaintiff, -against- HARCH CAPITAL MANAGEMENT, INC., a : Florida corporation, and HARCH CLO I LIMITED, : a foreign corporation, Defendants. TO THE ABOVE-NAMED DEFENDANTS: Index No. Date Purchased: Plaintiff designates New York County as the place of trial. The basis of the venue is contractual provisions. SUMMONS YOU HEREBY SUMMONED to answer the Complaint in this action and to serve a copy of your Answer, or, if the Complaint is not served with this Summons, to serve a Notice of Appearance, on the Plaintiff‘s attorneys within twenty (20) days after the service of this Summons, exclusive of the day of service (or within thirty (30) days after the service is complete if this Summons is not personally delivered to you within the State of New York). In case of failure to appear or answer, judgment will be taken against you by default for the relief demanded in the Complaint. Dated: New York, New York April 13,2005 HERRICK, FEINSTEIN LLP Attobeys For Plaintiff”’ 2 Park Avenue ,‘ New York, New York 10016 (212) 592-1400 TO: Harch Capital Management Inc. Harch CLO I Limited HFNYZ: #824220 v.1 #113754001 04/13/2005
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UED ON411412005 K ! m
SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK
HARCH INTERNATIONAL LIMITED, a foreign : corporation,
Plaintiff,
-against-
HARCH CAPITAL MANAGEMENT, INC., a : Florida corporation, and HARCH CLO I LIMITED, : a foreign corporation,
Defendants.
TO THE ABOVE-NAMED DEFENDANTS:
Index No. Date Purchased:
Plaintiff designates New York County as the place of trial. The basis of the venue is contractual provisions.
SUMMONS
YOU HEREBY SUMMONED to answer the Complaint in this action and to
serve a copy of your Answer, or, if the Complaint is not served with this Summons, to serve a
Notice of Appearance, on the Plaintiff‘s attorneys within twenty (20) days after the service of
this Summons, exclusive of the day of service (or within thirty (30) days after the service is
complete if this Summons is not personally delivered to you within the State of New York). In
case of failure to appear or answer, judgment will be taken against you by default for the relief
demanded in the Complaint.
Dated: New York, New York April 13,2005 HERRICK, FEINSTEIN LLP
Attobeys For Plaintiff”’ 2 Park Avenue ,‘ New York, New York 10016 (212) 592-1400
TO: Harch Capital Management Inc. Harch CLO I Limited
HFNYZ: #824220 v.1 #113754001 04/13/2005
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SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK
HARCH INTERNATIONAL LIMITED, a foreign : corporation,
: IndexNo.
X _ _ _ _ _ _ I _ _ c r _ r - _ _ _ _ _ _ _ I _ _ _ _ _ _ _ _ c _ _ _ I I
Plaintiff,
-against- : COMPLAINT
HARCH CAPITAL MANAGEMENT, INC., a :
05Gc)1=512 Florida corporation, and HARCH CLO I LIMITED, : a foreign corporation,
Defendants.
Herrick, Feinstein LLP, sues Defendants Harch Capital Management, Inc. (“Harch Advisor”)
and Harch CLO I Limited (“Harch CLO”) and alleges as follows:
NATURE OF THE ACTION
1. This is an action for breach of contract, conversion, breach of fiduciary
duty, fraud and a demand for an accounting arising out of Defendants’ failure to honor the terms
of a Collateral Management Agreement and a Trust Indenture governing the allocation of monies
upon redemption of outstanding note securities issued by Harch CEO, and also arising out of
Harch Advisor’s abuse of its fiduciary obligations to Harch Fund and its shareholders, as
evidenced by a series of investments on behalf of Harch Fund which served only to enrich Harch
Advisor at the expense of Harch Fund and its shareholders.
THE PARTIES
2. Harch Fund is a corporation organized under the laws of the Cayman
Islands. Heretofore, Harch Fund has operated as a hedge fund with its principal place of
business in Hamilton, Bermuda.
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3. Upon information and belief, Harch Advisor is a corporation organized
under the laws of Florida, with its principal place of business in Boca Raton, Florida. Harch
Advisor is an investment advisor registered with the Securities and Exchange Commission under
the U.S. Investment Advisers Act of 1940.
4. Upon information and belief, Harch CLO is an exempted company with
limited liability organized under the laws of the Cayman Islands to act as a collateralized loan
obligation entity, or “CLO”; i.e. a special purpose entity organized for the purpose of (i)
investing in a portfolio of corporate loan obligations and other corporate debt instruments (the
“Portfolio”) and (ii) issuing note securities (the ‘Votes”) collateralized by the Portfolio.
JURISDICTION AND VENUE
5. This Court has jurisdiction over Harch Advisor and Harch CLO based on
contractual provisions whereby they have submitted to the jurisdiction of New York state and
federal courts in the Borough of Manhattan. Venue of this action is proper pursuant to CPLR 5
501.
FACT ALLEGATIONS , .
Harch Advisor Sponsors Harch Fund And Becomes Its Investment Advisor
6. Upon information and belief, in 1997 Harch Advisor sponsored the
formation of Harch Fund and arranged for the private offering of its common shares to
sophisticated investors seeking hedge fund investment returns with periodic redemption rights.
7. Hedge fund sponsors such a s Harch Advisor generally manage the
formation of the hedge fund entities, arrange for the retention of hedge fund service-providers
and prepare the hedge fund disclosure documents.
8. Upon information and belief, in connection with the formation of Harch
Fund, Harch Advisor arranged for the election of the following four individuals as Directors to 2
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Hard Fund: Oskar Lewnowski, Gerald Rokoff, Alan Brown, and Paul Schreiber (the “Original
Directors”).
9. Upon information and belief, in connection with the formation of Harch
Fund, Harch Advisor and the Original Directors arranged for Harch Fund to retain Blue Highway
Management Limited (“Blue Highway”) as Manager for Harch Fund.
10. Oskar Lewnowski, one of Harch Fund’s Original Directors, was also the
President of Blue Highway.
11. Upon information and belief, in connection with the formation of Harch
Fund, Harch Advisor and the Original Directors arranged for Blue Highway to retain Olympia
Capital (Cayman) Limited (“Olympia Capital”) as Administrator for Harch Fund.
12. Upon information and belief, in connection with the formation of Harch
Fund, Harch Advisor and the Original Directors arranged for Harch Fund to retain Shearman &
Sterling as counsel to Harch Fund.
13. One of Harch Fund’s Original Directors, Oskar Lewnowski, was the
Another Chairman of Olympia Capital International, Olympia Capital’s parent company.
Original Director, Paul Schreiber, was a director of Olympia Capital International, while a third
Original Director, Alan Brown, was an employee of Olympia Capital (Bermuda) Limited, an
affiliate of Olympia Capital. The fourth Original Director, Gerald Rokoff, was the director of
international investment companies related to Olympia Capital International.
14. Upon information and belief, two of Harch Fund’s Original Directors,
Paul Schreiber and Gerald Rokoff, were partners of Shearman & Sterling.
15. Upon information and belief, Shearman & Sterling acted as counsel to
Harch Advisor as well as counsel to Harch Fund.
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16. Upon information and belief, in connection with the formation of Harch
Fund, Harch Advisor and the Original Directors arranged for Blue Highway to retain Harch
Advisor as investment advisor for Harch Fund.
17. Blue Highway and Harch Advisor entered into a Subadvisory Agreement
(the “Subadvisory Agreement”; Exhibit A) which entitled Harch Advisor to receive two types of
fees for managing Harch Fund: i) an annual management fee of no less than 0.5% of the net asset
value of Harch Fund’s assets at the end of each month; and ii) an annual performance fee of no
less than 10% of the amount by which the annual increase in the net asset value of Harch Fund’s
assets exceeded 5%.
18. The Subadvisory Agreement gave Harch Advisor investment discretion
with respect to all of Harch Fund’s investments.
19. The Subadvisory Agreement also required that Harch Advisor act at all
times in accordance with Harch Fund’s investment objectives.
20. Under the terms of the Subadvisory Agreement, Harch Advisor owed its
fiduciary duties directly to Harch Fund.
21. Harch Fund was the intended third party beneficiary of the Subadvisory
Agreement.
22. Further or alternatively, there was a collateral contract between Harch
Fund and Harch Advisor (made n consideration of the indemnity contained in section 3 of the
Subadvisory Agreement) under which Harch Advisor owed its fiduciary duties and duties of care
as investment advisor directly to Harch Fund. The terms of the Subadvisory Agreement were
continually considered and approved by the Directors of Harch Fund.
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23. Upon information and belief, in September 1997, Harch Advisor prepared
a confidential offering memorandum (the “Offering Memorandum”; Exhibit B) in connection
with the private offering of common shares of Harch Fund.
24. The Offering Memorandum promised shareholders that Harch Fund would
pursue the following investment objective and strategy:
The investment objective of [Harch Fund] is to provide investors with attractive risk-adjusted rates of return through a portfolio that generally has the following characteristics: (a) low volatility; (b) a short duration (generally less than two (2) years, measured retrospectively); and (c) an overall high degree of liquidity in the underlying securities. [Harch Fund] will attempt to achieve this objective through a two-pronged investment strategy: (x) an emphasis on non-investment grade fixed income and equity financial instruments (including bonds and bank loans) that, in [Harch Advisor’s] judgment, are likely to be repurchased, redeemed or retired by the issuer at a premium within twelve (12) . to eighteen (18) months as the result of the occurrence of a corporate event such as an initial public offering, asset sale, merger or rehancing; and (y) active trading of the portfolio.
25. The Offering Memorandum promised that shareholders would, ‘in general,
be able to redeem their shares on a quarterly basis. The Offering Memorandum also warned
shareholders that redemptions might be suspended upon the occurrence of any of the.following
circumstances:
(i) when any exchange, board of trade or organized interdealer market on which a significant portion of [Harch Fund’s] assets is regularly quoted or traded is closed (other than for holidays) or trading thereon has been restricted or suspended; (ii) whenever, as a result of events, conditions or circumstances beyond the control or responsibility of [Harch Fund], disposal of the assets of [Harch Fund’s] business involving the sale, transfer, delivery or withdrawal of funds is not reasonably practicable without being detrimental to the interests of [Harch Fund] or the Shareholders; (iii) if it is not reasonably practical to determine the Net Asset Value per Share on an accurate and timely basis or the Board of Directors otherwise determines that such action is in the best interest of [Harch Fund]; or (iv) [Harch Fund] has adopted a resolution calling for the liquidation and dissolution of [Harch
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Fund 3.
Harch Advisor Sponsors Harch CLO And Becomes Its Collateral Manaver
26. In 2000, Harch Advisor sponsored the formation of Harch CLO and the
private offering of Notes of Harch CLO to institutional investors seeking CLO investment
returns.
27, Investment managers such as Harch Advisor generally participate in the
formation of the CLO entities, the retention of CEO service-providers and the preparation of the
CLO disclosure documents.
28. Upon information and belief, in connection with the formation of Harch
CLOY Harch Advisor arranged for Harch CLO to appoint Harch Advisor as its Collateral
Manager pursuant to the terms of a Collateral Management Agreement (the “Collateral
Management Agreement”; Exhibit C).
29. Pursuant to Section 28 of the Collateral Management Agreement, Harch
Advisor and Harch CLO agreed that “the Trustee on behalf of the Noteholders shall be a third
party beneficiary” of the Collateral Management Agreement. , .
30. Upon Harch CLO’s successful launching, Harch Advisor would act as an
agent for Harch CLO and would be responsible for discharging many of the obligations of Harch
CLO under the terms of a Trust Indenture (the “Trust Indenture”; Exhibit D) pursuant to which
Harch CLO’s Notes would be issued.
31. Upon information and belief, in February of 2000, Harch Advisor
promoted a private offering of Notes of Harch CLO to institutional investors. The offering,
which closed on March 15,2000, raised gross proceeds of approximately $425 million for Harch
CLO.
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32. As a result of the offering, four classes of Notes were issued by Harch
CLO: Class A Notes, Class B Notes, Class C Notes and Class D Subordinated Notes. Harch
CLO issued the Notes pursuant to the Trust Indenture, with JP Morgan Chase as trustee (the
“Trustee”) for the Noteholders.
33. Pursuant to the Granting Clause of the Trust Indenture, Harch CLO
granted the Trustee “all of its right, title and interest in” all of the property of Harch CLO for the
benefit and security of the Harch CLO Noteholders. The Trustee, therefore, acted as
representative of the Harch CLO Noteholders under the terms of the Trust Indenture.
34. Harch CLO issued $327 million aggregate principal amount Class A
Notes, which received an “Am” rating by Moody’s Investors Service, Inc. (“Moody’s’’); $35
million aggregate principal amount Class B Notes, which received an “A3” Moody’s rating; and
$33 million aggregate principal amount Class C Notes, which received a “Baa2” Moody’s rating.
These Class A, Class B and Class C Notes had investment grade ratings; were fixed obligations
of Harch CLO and could be resold by their investors pursuant to Rule 144A of the U.S.
Securities Act of 1933, as amended (the “Securities Act”). . .
35. Institutional investors generally regard CLO Notes with the attributes of
the Class A, Class B and Class C Notes as being liquid securities.
36. By contrast, the Class D Subordinated Notes of Harch CLO were offered
without an investment grade rating; were subordinated in right of payment to the payment o f the
Class A, Class B, and Class C Notes of Harch CLO; constituted claims on the residual value of
the Harch CLO Portfolio after payment of all fixed claims; and were completely restricted for
purposes of resale under the private placement rules of the Securities Act.
37. Institutional investors generally regard CLO Notes with the attributes of
the Class D Subordinated Notes as being highly illiquid securities.
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38. Because of the high degree of illiquidity and subordination risk of CLO
Notes with the attributes of the Class D Subordinated Notes (generally, “Residual Notes”),
sponsors of CLOs often find Residual Notes difficult to promote. However, the successful
formation and private offering of a CLO, and the related arrangements with its collateral
manager, require that the CLO issue a class of Residual Notes.
39. In some instances an investment adviser will use its own capital to invest
in Residual Notes so that the CLO may be successfully offered, and so that the investment
advisor may be retained as collateral manager to the CLO and be in a position to receive
significant base management and incentive fees from the CLO.
40. In connection with the formation and private offering of Harch CLO,
Harch Advisor, in its capacity as discretionary investment advisor to Harch Fund, invested $30
million of Harch Fund’s capital in 100% of the Class D Subordinated Notes.
41. The investment in the Class D Subordinated Notes did not comply with
the investment objectives and strategies which Harch Advisor had promised to the Harch Fund
investors in the Offering Memorandum. Specifically, the Class D Subordinated Notes did not
have low volatility, did not have a short duration and did not have a high degree of liquidity.
Moreover, an investment manager such as Harch Advisor could not reasonably expect that
Residual Notes such as the Class D Subordinated Notes would be likely to be repurchased,
redeemed or retired within 12 to 18 months of issuance, or that such Notes could be actively
traded.
42. The investment in the Class D Subordinated Notes created a significant
conflict of interest for Harch Advisor. By investing a substantial portion of the assets of Harch
Fund in Harch CLO, Harch Advisor positioned itself to earn two asset-based fees on the same
assets of Harch Fund, and potentially, two incentive fees relating to the performance of the same
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assets of Harch Fund. Moreover, as Collateral Manager to Harch CLO, Harch Advisor owed
fiduciary duties to a broader range of Note investors whose interests would likely conflict with
those of Harch Fund in the event of a deterioration in the performance of Harch CLO.
Specifically, the holders of the Class A, Class B and Class C Notes would expect an acceleration
of the paydown of their investments in the event of a deterioration in the performance of Harch
CLO, which could terminate distributions on the Class D Subordinated Notes, and would reduce
the value of the Class D Subordinated Notes, By contrast, the investors in Harch Fund would
expect the portfolio investments of Harch Fund, including the Class D Subordinated Notes, to be
liquid and retrievable at their carried value.
43. Upon information and belief, Harch Advisor never sought (i) approval
from the Board of Directors of Harch Fund for the investment of $30 million of Harch Fund’s
capital in the Class D Subordinated Notes; or (ii) a waiver from the Directors of Harch Fund for
the violation of the investment objectives of Harch Fund which such investment entailed; or (iii)
the consent of the Directors of Harch Fund to the conflict of interest created for Harch Advisor
as a result of the investment.
44. The private offering of Harch CLO was successfully closed on March 15,
2000.
45. As provided under the terms of the Collateral Management Agreement, in
Section 8, Harch Advisor was to be paid a “base collateral management fee” equal to 0.375% per
annum of the Aggregate Principal Balance of the Collateral Portfolio.
46. In addition, as provided under the terms of the Collateral Management
Agreement, in Section 8, after the internal rate of return on the original principal amount o f the
Class D Subordinated Notes exceeded 10% on an annualized basis, Harch Advisor was t o be
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paid an “incentive collateral management fee” equal to 0.375% per annum of the Aggregate
Principal Balance of the Collateral Portfolio.
47. The Collateral Management Agreement, in Section 9, stated that Harch
Advisor’s obligations were for the direct benefit of Harch CLO Noteholders:
(a) The Collateral Manager [Harch Advisor] shall perfom its obligations hereunder in accordance with the terms of this Agreement and the terms of the Indenture applicable to it and shall use all reasonable endeavors, in the course of carrying out such obligations, to act in the best interests of the holders of the Notes.
48. Both Harch Advisor and Harch CLO agreed, pursuant to Section 22(a) of
the Collateral Management Agreement and Section 14.10 of the Trust Indenture, to submit to the
jurisdiction of the New York state or federal courts in the Borough of Manhattan for m y action
or proceeding arising out of or relating to the Harch CLO Notes, the Trust Indenture or the
Collateral Management Agreement.
Harch Advisor’s Investment Of Harch Fund’s Capital In Harch CLO’s Class D Subordinated Notes Creates Liquidity And Valuation Problems For Harch Fund
, . 49. Upon information and belief, the investment by Harch Advisor of Harch
Fund’s $30 million on March 15,2000 in Hnrch CLO’s Class D Subordinated Notes precipitated
a severe and prolonged liquidity problem for Harch Fund and its shareholders which coincided
with a significant deterioration in the US. corporate credit markets.
50. Upon information and belief, many institutional investors reacted to the
deterioration of the US. corporate credit markets in the year 2000 by liquidating credit-sensitive
investments in favor of more liquid, higher rated investments.
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5 1. The ability of shareholders of Harch Fund to pursue this defensive strategy
was severely impaired by the extraordinary limitations imposed upon the redemption of shares of
Harch Fund.
52. For the first quarter following the investment, ending June 30, 2000,
Harch Fund was able to honor only 90% of each redemption request submitted by its
shareholders because it lacked sufficient liquid assets to honor 100%.
53. For the second quarter following the investment, ending September 30,
2000, redemptions of Harch Fund shares were suspended in their entirety,
54. For the quarter ended December 3 1,2000, redemptions of shares of Harch
Fund were limited to 38% of requested amounts and paid part in cash and part in kind.
55.
were suspended in their entirety.
56.
For the year ended December 3 1,2001, redemptions of Harch Fund shares
At the meeting of the Directors of Harch Fund held on June 7, 2000, the
Directors reviewed the letter dated April 26, 2000 (the “Management Letter”) of
PriceWaterhouseCoopers, auditor of the financial statements of Harch Fund (the “Auditor”),
submitted to the Board with respect to its audit of Harch Fund’s financial statements for fiscal
year ended December 3 1, 1999. The Directors cited portions of the Management Letter stating
that the Auditor was “unable to obtain independent verification of a number of the [Hmch]
Fund’s assets which had been valued by Harch [Advisor] on a ‘fair value’ basis and that in
certain cases where independent values had been obtained by [the Auditor], these prices differed
from Harch [Advisor’s] valuations by amounts in excess of $200,000 per position.” The
Directors further noted the Auditor’s statement that “an inherent conflict of interest arose in
relation to the reliance on Harch [Advisor] for asset valuations in light of the fact that Harch
[Advisor] receives management and incentive fees from the [Harch] Fund based on the net asset
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value and the annual performance of the [Harch] Fund and also that Harch [Advisor] has a
significant financial interest in Premier Holding Limited.. ., the issuer of a number of debt and
equity instruments held by the [Harch] Fund.” In the Management Letter, the Auditor requested
the Directors to confirm the valuations made by Harch Advisor of Harch Fund investments.
57. At the same meeting, the Directors also reviewed memoranda produced by
Harch Advisor to justify its valuations. In connection with such review, the Board noted that
Joseph Harch and Michael Lewitt, two principals of Harch Advisor, also served as two of the
five Directors of Premier Holding Limited and “exercise effective control over the company”.
The Board also recorded that it had discussed the foregoing with Michael Lewitt and other
personnel of Harch Advisor responsible for Liaising with the Harch Fund Directors.
5 8 . The Directors determined at the conclusion of their deliberations in June,
2000 to confirm to the Auditor the valuations made by Harch Advisor which were reflected in
Harch Fund’s financial statements for the year ending on December 31, 1999. As a condition of
doing so, the Directors required personal indemnities from Harch Advisor.
59. At a meeting of the Directors held on September 15, 2000, Oskar
Lewnowski and Paul Schreiber, the only two remaining Directors of Harch Fund at that time,
acknowledged to each other that they each had interests in other entities which dealt with, or
were affiliated with other entities which dealt with, Harch Fund and would therefore have
differing interests in any matters concerning Harch Fund. Having declared their interests, the
interested Directors determined that each Director was nevertheless entitled to vote on any
matters in which he had such a differing interest.
60. The two Directors then elected a third Director, William Maycock, who
also disclosed interests in other entities which dealt with, or were affiliated with entities which
dealt with, Harch Fund. The interested Directors then determined that the differing interests of
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the newly elected Director would not disqualify him from voting on any matter in which he had
such a differing interest.
61. At the September 15,2000 meeting, the Directors took note of the “severe
liquidity problems” affecting Harch Fund’s portfolio and the “impact of these problems on the
[Harch Fund’s] ability to honor outstanding redemption requests” from its shareholders for June
30, 2000, as well as redemption requests received for September 30,2000. In their deliberations,
the Directors took into account the representations and advice they had been given by Hakh
Advisor’s Executive Vice-president, Michael Lewitt.
62. Michael Lewitt informed the Directors that as of June 30, 2000, Harch
Fund held a percentage of its investments in illiquid securities which it could not sell, or could
not sell without a substantial discount. Mr. Lewitt stated that as a result of these positions, Harch
Fund was not in a position to honor redemptions in full at June 30, 2000 without significant
adverse effects to remaining investors.
63. Michael Lewitt also explained that the liquidity problems of Harch‘Fund
persisted after June 30, 2000 as a result of the total loss of the investment made by Harch
Advisor for Harch Fund in convertible bonds issued by Premier Cruises.
64. Michael Lewitt represented, on behalf of Harch Advisor, that Harch
Advisor had addressed the liquidity situation with each shareholder of Harch Fund which had
been affected thereby, and had obtained the agreement of each such shareholder to limit
redemptions on June 30,2000 to 90% of the demanded redemption amount.
65. The Directors of Harch Fund ratified the withholding of 10% of each
amount demanded for redemption as of June 30, 2000, and approved the suspension of
redemptions for the calendar quarter ending September 30,2000.
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66. Paul Schreiber then reminded the other Directors that Sheaman &
Sterling, counsel to Harch Fund, also acted as counsel to Harch Advisor.
67. The Directors of Harch Fund then voted to approve the renewal of the
Subadvisory Agreement between Blue Highway and Harch Advisor, which was expiring at the
end of its initial three year term.
68. In October of 2000, the Directors of Harch Fund convened a special
meeting to consider the demands of a shareholder (the “First Dissenting Shareholder”) which
objected to the limitations on redemptions on June 30,2000 and denied that it had ever agreed to
the limitations on redemptions proposed by Harch Advisor.
69. Michael Lewitt, as representative of Harch Advisor, informed the
Directors through correspondence dated October 23, 2000, that there had been a
miscommunication between Hxch Advisor and the First Dissenting Shareholder and that it
would be appropriate to honor the redemption requests of the First Dissenting Shareholder in
full.
70. The Directors determined that Harch Fund would honor the redemption , .
requests of the First Dissenting Shareholder.
71. In November of 2000, the Directors of the Harch Fund convened a special
meeting to consider the demands of a second shareholder (the “Second Dissenting Shareholder”)
which objected to the limitations on redemptions on June 30, 2000 and also denied that it had
ever agreed to the limitations on redemptions proposed by Harch Advisor.
72. Michael Lewitt, as representative of Harch Advisor, informed the
Directors through correspondence dated November 15, 2000, that there had been a
miscommunication between Harch Advisor and the Second Dissenting Shareholder, that this
shareholder was the only shareholder, other than the First Dissenting Shareholder, which had not
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effectively agreed to the limitations and suspensions, and that it would be appropriate to honor
the redemption requests of the Second Dissenting Shareholder in full.
73. The Directors determined that Harch Fund would honor the redemption
requests of the Second Dissenting Shareholder.
74. On January 19, 2001, the Directors of Harch Fund convened a special
meeting to review the ongoing liquidity problems of Harch Fund and to determine what
restrictions should be placed upon the redemptions for December 3 1,2000, and what restrictions
should be placed upon redemptions throughout 2001.
75. The Directors noted that redemption requests for 61% of the outstanding
shares of Harch Fund, representing $56 million in net asset value of Harch Fund investments,
had been tendered for December 31,2000.
76. However, 62% of the Harch Fund assets consisted of bank loans, private
debt and other positions which had very burdensome transfer restrictions and could not
practically be transferred and therefore were characterized by Harch Advisor as illiquid.
77. The Directors also considered Harch Advisor’s M e r representations that
selling the majority of Harch Fund’s remaining marketable positions or applying all of Harch
Fund’s cash on hand to meet the outstanding redemption requests would not be possible without
having a very significant and disproportionately adverse effect on non-redeeming shareholders.
78. The Directors approved a partial redemption of redemption requests for
December 3 1, 2000, in which 26% of the amount of the redemption requests would be honored
in cash and 12% of the amount of the redemption requests would be honored by distribution of
liquid securities in kind. The Directors then approved the complete suspension of redemptions
for 200 1.
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79. In a meeting held March 27, 2001, the Directors took note of the
suggestion of Harch Advisor to replace PriceWaterhouseCoopers with Emst & Young as Auditor
for Harch Fund’s fiscal year ended December 3 1,2000. Mr. Maycock, acting as Chairman of the
meeting, noted that “there were no disputes with the current auditors.” The Directors then
approved the appointment of Ernst & Young as Auditor in place of PriceWaterhouseCoopers.
Harch Advisor Invests More Than $15.2 Million Of Additional Capital Of Harch Fund In Harch CLO
80. Upon information and belief, in the year 2001, Harch CLO experienced a
significant deterioration in the credit quality of its Portfolio investments.
81. Under the terms of the Trust Indenture, if Harch CLO failed certain
financial tests it would be required to begin the liquidation of its Portfolio in order to pay off the
investment grade-rated Class A, Class B and Class C Notes it had issued.
82. If‘Harch CLO began to liquidate its Portfolio, Harch Advisor would lose a
substantial portion of its base collateral management fee and would be at risk of losing all of its
fee.
83. If Harch CLO began to liquidate its Portfolio, the Class D Subordinated
Notes would begin to lose value, and would be exposed to extreme risk of loss.
84. An infusion of additional subordinated capital achieved by the issuance of
additional Class D Subordinated Notes would serve to provide Harch Advisor with the means to
improve the financial condition of Harch CLO and possibly to avoid liquidation of the Harch
CLO Portfolio.
85. However, an investment in additional Class D Subordinated Notes at a
time in which the financial condition of Harch CLO had deteriorated would present extreme risks
to the investor. Such an investment would primarily benefit the Class A, Class B and Class C
16 HFNYZ: #826893 v.1 # I 13754001 04/13/2005
Qm 0 Q Q Qa m W
Noteholders, and the Collateral Manager. In such a circumstance, all of the outstanding Class D
Subordinated Notes, including the newly issued Class D Subordinated Notes, would be exposed
to a significant risk of diminution of value or loss.
86. On June 22, 2001, Harch CLO made a distribution of over $3.3 million to
Harch Fund as holder of its Class D Subordinated Notes. On or about that same day, Harch
Advisor reinvested this distribution in additional Class D Subordinated Notes.
87. On September 22, 2001, Hnrch CLO made a distribution of more than $1
million to Harch Fund as holder of its Class D Subordinated Notes, On or about that same day,
Harch Advisor reinvested the distribution in additional Clam D Subordinated Notes.
88. On December 22,2001, Harch CLO made a distribution of more than $1.6
million to Harch Fund as holder of its Class D Subordinated Notes. On or about that same day,
Harch Advisor reinvested the distribution in additional Class D Subordinated Notes.
89. On March 22, 2002, Harch CLO made a distribution of more than $1.8
million to Harch Fund as holder of its Class D Subordinated Notes. On or about that same day,
Harch Advisor reinvested the distribution in additional Class D Subordinated Notes.
90. On June 22, 2002, Harch CLO made a distribution of more than $2.5
million to Harch Fund as holder of its Class D Subordinated Notes. On or about that same day,
Harch Advisor reinvested the distribution in additional Class D Subordinated Notes.
91. On September 22, 2002, Harch CLO made a distribution of more than
$1.8 million to Harch Fund as holder of its Class D subordinated Notes. On or about that same
day, Harch Advisor reinvested the distribution in additional Class D Subordinated Notes.
92. On December 22,2002, Harch CLO made a distribution of more than $2.6
million to Harch Fund as holder of its Class D Subordinated Notes. On or about that same day,
17 M 2 : #826893 v.1 #11375-0001 04/13L!005
Harch Advisor reinvested more than $1.3 million of this distribution ip additional Class D
Subordinated Notes.
93. On March 22, 2003, Harch CLO made a distribution of more than $1.8
million to Harch Fund as holder of its Class D Subordinated Notes. On or about that same day,
Harch Advisor reinvested more than $900,000 of this distribution in additional Class D
Subordinated Notes.
94. On June 22, 2003, Harch CLO made a distribution of more than $2.4
million to Harch Fund as holder of its Class D Subordinated Notes. On or about that same day,
Harch Advisor reinvested more than $600,000 of this distribution in additional Class D
Subordinated Notes.
95. The total amount of monies distributed by Harch CLO to Harch Fund and
immediately reinvested by Harch Advisor in additional Class D Subordinated Notes exceeded
$15.2 million (the “Reinvestment”).
96. As a result of the Reinvestment, the aggregate capital’ of Harch Fund
invested by Harch Advisor in Class D Subordinated Notes exceeded $45.2 million. , .
97. Upon information and belief, Harch Advisor did not procure the issuance
of additional Class D Subordinated Notes to Harch Fund to evidence the Reinvestment. Harch
Advisor did not renegotiate any of the terms of the Trust Indenture or the Collateral Management
Agreement to provide Harch Fund with additional or improved claims against Harch CLO in
consideration of the Reinvestment. Harch Advisor did not make payment of a fee or transfer of
any asset of value to Harch Fund a condition of the Reinvestment. Harch Advisor did not obtain
consideration of any kind for Harch Fund in connection with the Reinvestment.
98. The Reinvestment did not comply with the investment objectives and
strategies which Harch Advisor had promised to the Harch Fund investors in the Offering
18 HFNYZ: #826893 v.1 #11375-0001 04/13/’22005
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Memorandum. Specifically, the Reinvestment did not have low volatility, did not have a short
duration and did not have a high degree of liquidity. Moreover, an investment manager such as
Harch Advisor could not reasonably expect that the Reinvestment would be likely to be
repurchased, redeemed or retired within 12 to 18 months of issuance, or that the Reinvestment
could be actively traded.
99. The Reinvestment was made by Harch Advisor at a time when Harch
Advisor was subject to a significant conflict of interest. By reinvesting a substantial portion of
the assets of Harch Fund in Harch CLO, Harch Advisor preserved its ongoing base collateral
management fee ftom Harch CLO. Moreover, the Reinvestment primarily benefited other Harch
CLO Noteholders to which Harch Advisor also owed fiduciary duties, at a time when the
interests of the other Note investors were in conflict with those of Harch Fund.
100. Upon information and belief, Harch Advisor never sought: (i) approval
from the Directors of Harch Fund for the Reinvestment; or (ii) a waiver horn the Directors of
Harch Fund for the violation of the investment objectives of Harch Fund which the Reinvestment
entailed; or (iii) the consent of the Directors of Harch Fund to the conflict of interest to which
Harch Advisor was subject at the time of the Reinvestment.
Harch Fund Demands Redemption Of Its Class D Subordinated Notes
, .
101. On June 11, 2004, Harch Fund notified its shareholders that it had
liquidated all of its investments except for the Class D Subordinated Notes, and had distributed
substantially all of the net proceeds of such investments to the shareholders of Harch Fund.
Harch Fund further stated that the Class D Subordinated Notes were illiquid and that the only
source of valuation for the investment was Harch Advisor, which employed a valuation model
developed with the assistance of Ernst & Young, the Auditor of Harch Fund’s fmancial
statements. Harch Fund then informed the shareholders that Ernst & Young had detected a 19
HFNY2: #E26893 v.1 # I 13754001 04/13/2005
mistake in the valuation by Harch Advisor of the Class D Subordinated Notes which resulted in
an overstatement of value in the range of $3 million. Harch Fund explained that it would
therefore be necessary to restate its financial statements for the year ended December 3 1, 2003
to reduce the recorded value of Harch Fund’s investment in the Class D Subordinated Notes
from approximately $21 million to approximately $18 million.
102. On June 30, 2004, Harch Advisor, in its capacity as Collateral Manager to
Harch CLO, reported to the Class A, Class €3, Class C and Class D Subordinated Noteholders of
Harch CEO on the performance of Harch CLO. While generally positive in tone, the June 2004
Report disclosed that “[wlhile the CLO is meeting all (original emphasis) of the most important
tests, it is failing several other less important tests including (1) the Minimum Par Value Test, (2)
the maximum allowable Caal or below collateral basket, (3) issuers located outside of the United
States or Canada, (4) the Weighted Average Fixed Rate Coupon Test and ( 5 ) the Weighted
Average Spread Test (other than senior secured loans).” Harch Advisor commented on the
reasons for failing each such financial test and the outlook for improving compliance in the
hture. . .
103. The June 2004 Report made the following specific statement with respect
to the performance of the Class D Subordinated Notes: “In the most recent quarter we
distributed $1,922,977.20 to holders of the Class D Notes. This is the fourth consecutive 100%
distribution to Class D Noteholders. We have now made a net distribution of $14,446,089.71 to
Class D Noteholders since inception. ” (emphasis supplied)
104. The disclosure to the Class A, Class €3 and Class C Noteholders of a “net
distribution of $14,446,089.71 to Class D Noteholders since inception” excluded more than
$15.2 million which was distributed to Harch Fund but concurrently reinvested by Harch
Advisor in additional Class D Subordinated Notes.
20 HFNYZ: #E26893 v.1 #11375-0001 04/13RM35
105. Upon information and belief, Harch Advisor never informed the Trustee
that more than $15.2 million recorded as distributions on the Class D Subordinated Notes were
in fact concurrently reinvested in additional Class D Subordinated Notes.
106. Upon information and belief, Harch Advisor never informed the Trustee
that more than $15.2 million recorded as distributions on the Class D Subordinated Notes were
not included in the performance data for the Class D Subordinated Notes which Harch Advisor
supplied to all of the Noteholders.
107. Upon information and belief, Harch Advisor never lnformed the Trustee
that the infusion of more than $15.2 million of subordinated capital into Harch CLO was a
reinvestment by Harch Fund in additional Class D Subordinated Notes.
108. Under the terms of the Trust Indenture for Harch CLO, the holders of
more than 66 2/3% of the Class D Subordinated Notes had the right at June 30, 2004 and
thereafter to demand the redemption of the Class D Subordinated Notes, thereby liquidating the
investment. Such a redemption would have required the prior liquidation of Harch CLO
Portfolio and the payment in full of all outstanding Notes of Harch CLO in order of priority.
Such a liquidation would have also terminated Harch CLO and the ongoing related fee income to
its collateral manager, Harch Advisor.
109. As holder of 100% of the Class D Subordinated Notes, either Harch Fund
or Harch Advisor, as discretionary investment advisor for Harch Fund, had the ability to demand
the redemption of the Class D Subordinated Notes.
110. On January 17, 2005, in an extraordinary general meeting of the
shareholders of Harch Fund, the existing Directors of Harch Fund were removed and replaced by
a new Board of Directors (the ‘‘New Board”).
21 HFNYZ: #826893 v.1 #11375-0001 04/13/2005
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11 1. On January 17, 2005, the New Board convened a special meeting of the
Board to reorganize itself and to review the remaining investments of Harch Fund. The New
Board considered, after careful reflection, that it would be in the best interests<of Harch Fund to
liquidate its investment of more than $45.2 million in the Class D Subordinated Notes.
112. The New Board approved the liquidation of Harch Fund’s investment in
the Class D Subordinated Notes and resolved to demand the redemption of the Class D
Subordinated Notes in order to liquidate the investment.
1 13. Upon the conclusion of the special meeting, Harch Fund made the demand
for redemption of the Class D Subordinated Notes to Harch CLO, to Harch Advisor in its
capacity as Collateral Manager to Harch CLO, and to JP Morgan Chase in its capacity as Trustee
under the Trust Indenture.
114. Upon information and belief, prior to March 22, 2005, Harch Advisor
arranged for the liquidation of the Harch CLO Portfolio in order to fund the redemptions of the
outstanding Notes of Harch CLO.
1 15. On March 22,2005, the interest proceeds in the Harch CLO Portfolio were
distributed to pay accrued interest on the Harch CLO Notes and accrued expenses of providers of
services for Harch CLO.
, .
116.
received approximately $1 million.
117.
In connection with the distribution of interest proceeds, Harch Fund
On March 22, 2005, the liquidation proceeds of Harch CLO were
distributed in redemption of its outstanding Class A, Class B, Class C and Class D Subordinated
Notes.
118. In connection with the distribution of liquidation proceeds, Harch Fund
received approximately $14.3 million.
22 HFNY2: #E26893 v.1 # I 13754001 04/13/2005
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119. After receipt of its distribution, Harch Fund obtained from the Trustee a
copy of the Note Valuation Report (the “Note Valuation Report”; Exhibit E), which purported to
show how the liquidation proceeds of the Harch CLO Portfolio were distributed in connection
with the redemption of March 22,2005.
120. The Note Valuation Report disclosed a principal balance of approximately
$41 8 million in the Harch CLO Portfolio as of March 22,2005.
121. According to the Note Valuation Report, aRer application of liquidation
proceeds to pay the outstanding principal of the Class A, Class B and Class C Notes, the residual
value of Harch CLO was approximately $23.1 million.
122. As holder of 100% of the Class D Subordinated Notes, Harch Fund was
entitled to and expected to receive 92.5% of the entire residual value of the Harch CLO, which
would approximate $21.3 million.
123. The holders of the Class C Notes were entitled to and expected to receive
7.5% of the entire residual value of Harch CLO in payment of a liquidation yield distribution
amount, which would approximate $1.8 million. 1 , .
124. The Note Valuation Report disclosed, however, that over $7.6 million of
the residual value of Harch CLO had been paid to Harch Advisor as an additional “collateral
management fee”.
125. The New Board of Harch Fund immediately demanded an explanation
from Harch Advisor as to this payment and Harch Advisor responded by characterizing the
approximately $7.6 million as an incentive fee owed to it under the terms of the Collateral
Management Agreement.
23 HpNy2: #826893 v.1 #113754001 04/13/2005
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126. In a five year period beginning March 15, 2000 and ending March 22,
2005, Harch Advisor invested more than $45.2 million of Harch Fund’s capital in Class D
Subordinated Notes.
127. In that same time period, Harch Fund received a total return on its
investment in Class D Subordinated Notes of approximately $47.7 million.
128. After giving effect to the redemption on March 22, 2005, the annualized
internal rate of return on the Class D Subordinated Notes was materially below the 10%
threshold required in order for such an incentive fee to be payable.
129. ARer giving effect to the redemption on March 22, 2005, Harch Advisor
was not entitled to payment of an incentive fee out of the residual value of Harch CLO.
130. Upon information and belief, Harch Advisor knew that it was not entitled
to payment of an incentive fee from the residual value of the Harch CLO as contemplated by the
Collateral Management Agreement. .
131. At the time that Harch Advisor received payment of the incentive fee,
Harch Advisor was subject to material conflicts of interest.
132. As Collateral Manager for the Harch CLO, Harch Advisor owed a
fiduciary duty to the Class D Subordinated Noteholders to maximize their recovery in connection
with the redemption of the outstanding Notes of Harch CLO.
133. As investment advisor to Harch Fund, Harch Advisor owed a fiduciary
duty to Harch Fund to maximize its recovery on its $45.2 million investment in Class D
Subordinated Notes.
134. The wrongful acceptance by Harch Advisor of a $7.6 million incentive fee
to which it was not entitled resulted in an immediate and substantial reduction in the return to
Harch Fund on its $45.2 million investment in Class D Subordinated Notes.
24 HFNYZ: #826893 v.1 #1137S-oOOl 04/13/2005
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135. In wrongfully accepting an incentive fee to which it was not entitled,
Harch Advisor placed its own self-interests ahead of its fiduciary obligations.
136. Upon information and belief, Harch Advisor did not inform the Trustee of
material facts essential to the correct calculation of the annualized internal rate of return on the
Class D Subordinated Notes.
137. Upon information and belief, Harch Advisor did not inform the Trustee
that it was not entitled to the incentive fee.
138. Harch Advisor did not return the incentive fee payment to the Trustee for
the benefit of Harch Advisor’s fiduciary client, Harch Fund.
139. Harch Advisor did not provide Harch Fund with an opportunity to object
to the payment of the incentive fee or to object to the basis of its calculation before Harch
Advisor received payment of the fee.
AS AND FOR ITS FIMT CAUSE OF ACTION (Breach of Contract - Harch Advisor and Harch CLO)
140. Harch Fund repeats and realleges each of the allegations contained in
paragraphs 1 through 139 hereof with the same force and effect as if fully set forth herein.
141. Harch Fund was entitled to 92.5% of the entire residual value of Harch
CLO leR after payment of priority claims.
142. The entire residual value of Harch CLO after satisfaction of priority
claims was approximately $23.1 million.
143. Harch Fund was therefore entitled to a distribution of more than $21.3
million of the entire residual value of Harch CLO, but received only approximately $14.3
million.
25 HFNY2: #826893 v.1 #I 13754001 04/13/2005
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0
6
144. In connection with the redemption on March 22, 2005, Harch CLO was
liged to pay 92.5% of its entire residual value to Harch Fund, and to direct the Trustee to make
the payment on its behalf.
145. In connection with the redemption on March 22,2005, Harch Advisor was
obliged to discharge the obligations of Harch CLO to pay 92.5% of the entire residual value of
Harch CLO to Harch Fund, and to direct the Trustee to make the payment on behalf of Harch
CLO.
146. Harch CLO and Harch Advisor breached the Collateral Management
Agreement by directing payment to Harch Advisor of an incentive fee of approximately $7.6
million out of the residual value of Harch CLO.
147. Harch CLO and Harch Advisor breached the Trust Indenture by directing
payment to Harch Fund of approximately $14.3 million of the residual value of Harch CLO,
which was an amount approximately $7 million less than the amount to which Harch Fund was
entitled.
148. Defendants Harch Advisor and Harch CLO have materially breached the
terms of the Collateral Management Agreement and Trust Indenture by paying Harch Advisor an
incentive fee in excess of $7.6 million to which Harch Advisor was not entitled, and by failing to
distribute 92.5% of the entire residual value of the Harch CLO to Harch Fund as holder of 100%
of the Class D Subordinated Notes.
149. By reason of the foregoing, Harch Fund has been damaged.
26 m Y 2 : #826893 v.1 #11375-0001 04/13/2005
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AS AND FOR ITS SECOND CAUSE OF ACTION (Conversion - Harch Advisor )
150. Harch Fund repeats and realleges each of the allegations contained in
paragraphs 1 through 149 hereof with the same force and effect as if fully set forth herein.
151. Upon information and belief, Harch Advisor wrongfully converted to its
own use and benefit money belonging to Harch Fund in excess of $7 million.
152. Upon infomation and belief, the conversion by Harch Advisor was
intentional.
153. By reason of the foregoing, Harch Fund has been damaged.
AS AND FOR ITS THIRD CAUSE OF ACTION (Breach Of Fiduciary Duty - Harch Advisor)
154. Harch Fund repeats and realleges each of the allegations contained in
paragraphs 1 through 153 hereof with the same force and effect as if fully set forth herein.
155. As collateral manager for Harch CLOY Harch Advisor owed a fiduciary
duty to Harch Fund as holder of the Class D Subordinated Notes.
156. Harch Advisor was under a duty to act with loyalty, care, skill and
diligence in fulfilling its fiduciary obligations to Harch Fund and Harch Fund relied on Harch
Advisor’s loyalty, care, skill and diligence.
157. Harch Advisor wrongfully and knowingly accepted an incentive fee of
$7.6 million to which it was not entitled, which resulted in an immediate and substantial
reductio11 in the return to Harch Fund on its $45.2 million investment in Class D Subordinated
Notes.
158. By engaging in the conduct alleged above, Harch Advisor’s actions
constituted bad faith, willful misconduct, gross negligence andor reckless disregard with respect
to its fiduciary obligations.
27 HFNYZ: #a26893 v , l # I 1375-0001 04/13/2005
159, Harch Advisor failed to act in accordance with the fiduciary duties it owed
Harch Fund and breached those duties.
160. By reason of the foregoing, Harch Fund has been damaged.
AS AND FOR ITS FOURTH CAUSE OF ACTION (Fraud - Harch Advisor)
161. Harch Fund repeats and realleges each of the allegations contained in
paragraphs 1 through 160 hereof with the same force and effect as if fully set forth herein.
162. Upon information and belief, at all relevant times, Harch Advisor
represented to the holders of Harch CLO’s Class D Subordinated Notes that it would collect an
incentive fee under the terns of the Collateral Management Agreement and Trust Indenture only
if the annuaIized internal rate of return on the original principal amount of the Class D
Subordinated Notes exceeded 10%.
163. Pursuant to the terms of the Trust Indenture, the Trustee was required to
act for the benefit and security of the Noteholders, including Harch Fund as holder of 100% of
the Class D Subordinated Notes.
164. Harch Advisor had a duty, .as a fiduciary to the Class D Noteholders and to
the Trustee as their representative, to disclose to the Trustee all material information concerning
investments in the Class D Subordinated Notes and distributions on the Class D Subordinated
Notes, so that the Trustee would be able to calculate the correct annualized internal rate of return
on the Class D Subordinated Notes and thereby determine whether Harch Advisor was entitled to
an incentive fee.
165, Upon information and belief, Harch Advisor intentionally withheld
material information from the Trustee concerning: i) distributions of approximately $15.2
million on the Class D Subordinated Notes; and ii) the aggregate subordinated capital infused in
the Harch CLO of approximately $ 15.2 million (the “Material Omission”). 28
HFNYZ: #E26893 v.1 #11375-0001 04/13/2005
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166. Upon information and belief, the Trustee relied on Harch Advisor to
provide it with all material information concerning the distributions on and investments in the
Class D Subordinated Notes. As a result of the Material Omission, the Trustee incorrectly
calculated an annualized internal rate of return on the Class D Subordinated Notes in excess of
10% and therefore distributed more than $7.6 million from the entire residual value of the Harch
CLO to Harch Advisor in payment of an incentive fee to which Harch Advisor was not entitled.
167. Upon information and belief, when Harch Advisor accepted payment of
the incentive fee, Harch Advisor knew that the annualized internal rate of return on the Class D
Subordinated Notes which the Trustee had used as a basis for calculating the incentive fee was
materially incorrect, as a result of the Material Omission.
168. Upon information and belief, Harch Advisor's conduct was, malicious,
willful and in reckless disregard of Harch Fund's rights.
169. By reason of the foregoing, Harch Fund has been damaged.
AS AND FOR ITS FIFTH CAUSE OF ACTION (Breach of Fiduciary Duty - Harch Advisor)
170, Harch Fund repeats and realleges each of the allegations contained in
paragraphs 1 through 169 hereof with the same force and effect as if fully set forth herein.
171. As Harch Fund's investment advisor, Harch Advisor was under a duty to
act with loyalty, care, skill and diligence in fulfilling its fiduciary obligations to Harch Fund, and
Harch Fund relied on Harch Advisor's loyalty, care, skill and diligence.
172. The initial investment by Harch Adviser of $30 million of Harch Fund's
capital in the Class D Subordinated Notes of Harch CLO violated the investment objectives set
forth in the Offering Memorandum.
29 HFNY2: #826893 v.1 #I 1375-0001 04/13/2005
C?
173. The initial investment by Harch Advisor of $30 million of Harch Fund’s
capital in the Class D Subordinated Notes of Harch CLO involved a conflict of interest which
Harch Advisor did not disclose to Harch Fund and to which Harch Fund did not consent.
174. Upon information and belief, the initial investment by Harch Advisor of
$30 million of Harch Fund’s capital into Harch CLO was intended not to benefit Harch Fund or
its shareholders, but rather to enable Harch Advisor as the sponsor of Harch CLO to complete
the successhl offering and closing of Harch CLO and thereby obtain a steady flow of fees from
Harch CLO in its capacity as collateral manager to Harch CLO.
175. Upon information and belief, Harch Advisor’s initial $30 million
investment of Harch Fund’s capital in Class D Subordinated Notes precipitated a severe and
prolonged liquidity crisis for Harch Fund and its shareholders, resulting in extraordinary
restrictions on the ability of the shareholders to redeem their investments in the Harch Fund.
176. Upon information and belief, Harch Advisor provided incorrect valuations
for illiquid portfolio investments of Harch Fund while subject to a conflict of interest.
177. Upon information and belief, the Reinvestxnent by Harch Advispr of more
than $15.2 million of Harch Fund’s capital in additional Class D Subordinated Notes was
intended not to benefit Harch Fund or its shareholders, but rather to preserve Harch CLO and the
stream of collateral management fee income received by Harch Advisor from the Harch CLO.
, .
178. Upon information and belief, Harch Advisor in its capacity as fiduciary for
Harch Fund executed the Reinvestment without procuring the issuance of additional Class D
Subordinated Notes for Harch Fund, and without bargaining for consideration or value of any
kind for the benefit of Harch Fund.
179. The Reinvestment violated the investment objectives set forth in the
Offering Memorandum.
30 HFNYZ: #E26893 v.1 #I 1375-0001 04/13R005
180. Harch Advisor had a conflict of interest in making the Reinvestment,
which served to preserve the substantial stream of base collateral management fees paid by
Harch CLO to Harch Adviser.
18 1. Harch Advisor’s actions were dishonest and constitute gross negligence,
fraud and willful andor reckless misconduct with respect to its fiduciary obligations.
182. By the actions alleged above, Harch Advisor failed to act in accordance
with the fiduciary duties it owed to Harch Fund, and breached its fiduciary duties to Harch Fund.
183. By reason of the foregoing, Harch Fund has been damaged.
AS AND FOR ITS SIXTH CAUSE OF ACTION (Fraud - Harch Advisor)
184. Harch Fund repeats and realleges each of the allegations contained in
paragraphs 1 through 183 hereof with the same force and effect as if fully set forth herein.
185. Upon information and belief, at all relevant times, Harch Advisor
represented to Harch Fund that it was reinvesting Harch Fund’s capital of more than $15.2
million in additional Class D Subordinated Notes in exchange for valuable consideration. Upon
information and belief, when these representations were made they were false and misleading
and Harch Advisor knew that Harch Fund was not receiving any valuable consideration for the
Reinvestment.
186. Upon information and belief, Harch Advisor made these representations
knowing they were false and misleading with the intent to deceive Harch Fund and to induce
Harch Fund to continue to entrust Harch Advisor with investment discretion over Harch Fund’s
investment portfolio, including additional reinvestments of Harch Fund capital in additional
Class D Subordinated Notes.
31 HFNY2: #826893 v.l#11375-0001 04/13/2005
188. As
resentations, more than $
W
entrust Harch Advisor with investment discretion over Harch Fund’s portfolio, including
reinvestments of Harch Fund capital in additional Class D Subordinated Notes.
a result of Harch Fund’s reliance upon Harch Advisor’s misrep-
5.2 million of Harch Fund capital was reinvested in additional Class D
Subordinated Notes without any inurement for the benefit of Harch Fund.
189. Harch Advisor’s conduct was malicious, willful and in reckless disregard
of Harch Fund’s rights.
190. By reason of the foregoing, Harch Fund has been damaged.
AS AND FOR ITS SEVENTH CAUSE OF ACTION (Demand for an Accounting- Harch Advisor)
191. Harch Fund repeats and realleges each of the allegations contained in
paragraphs 1 through 190 hereof with the same force and effect as if fully set forth herein.
192.
duty to Harch Fund.
193.
As Collateral Manager for Harch CLO, Harch Advisor owed a fiduciary
Harch Advisor was entrusted with the proper management of Harch
Fund’s investments in Harch CLO and With directing the proper distribution of Harch Fund’s
capital upon the redemption of its Class D Subordinated Notes.
194. Upon information and belief, Harch Advisor intentionally directed the
misapplication of Harch CLO’s residual value, to which Harch Advisor was entitled, in violation
of the Collateral Management Agreement and Trust Indenture and caused in excess of $7.6
million of Harch CLO’s residual value to be wrongfully diverted to itself as an improper
incentive fee.
195.
196.
HFNYZ: #a26893 v.1 # I 1375-0001 04/13/2005 32
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197. Harch Fund has demanded that Harch Advisor provide a full accounting as
to the distribution of funds to Harch Advisor in connection with the redemption of the
outstanding Notes of Harch CLO.
198.
199.
Harch Advisor has failed to provide such an accounting.
An accounting is necessary to determine the rights of the parties in regard
to the funds in excess of $7.6 million claimed by Harch Advisor as an incentive fee.
PRAYER FOR RELIEF
WHEREFORE, Harch Fund demands judgment as follows:
A. As to the First Cause of Action, a sum in excess of $7 million, plus
interest and costs.
B. As to the Second Cause of Action, a sum in excess of $7 million,
plus interest and costs and punitive damages in the amount of $50 million.
C. As to the Third Cause of Action, a sum in excess of $7 million,
plus interest and costs and punitive damages in the amount of $SO million.
D. As to the Fowth Cause of Action, a sum in excess of $7 million,
plus interest and costs and punitive damages in the amount of $50 million.
E. As to the Fifth Cause of Action, damages to be determined at trial,
plus interest and costs and punitive damages in the amount of $50 million.
F. As to the Sixth Cause of Action, damages to be determined at trial,
plus interest and costs, and punitive damages in the amount of $50 million.
33 HFNY2: #826893 v.1 #I 1375-0001 04/13/’2005
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G. As to the Seventh Cause of Action, an accounting for all monies
paid to larch Advisor as collateral management fees as set forth in the Note Valuation Report.
H. Granting Harch Fund such other and hrther relief as the Court