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Levey v. Brownstone Asset Management, LP

Court of Chancery of Delaware

August 1, 2014


Date Submitted: June 5, 2014





The plaintiff and the three individual defendants worked together as principals in a financial services boutique. On January 26, 2006, the plaintiff quit. He claims he resigned from his employment, but did not withdraw from certain entities through which the boutique operated. In this action, he seeks a declaration that he continues to own equity stakes in two of the entities—a limited liability company and a limited partnership. If he remains an owner, then he demands his pro rata share of all distributions made by those entities since January 2006, and he wants the defendants to account for any undisclosed profits.

The evidence at trial established the plaintiff withdrew from the two entities as of January 26, 2006. Under the applicable entity statutes, the plaintiff became entitled upon withdrawal to the fair value of his interests in the entities. There were no written agreements governing the entities at the time of the plaintiff's withdrawal, and this decision need not resolve the defendants' argument that an unwritten agreement limited the plaintiff to the value of his capital accounts. Because the plaintiff only presented evidence at trial sufficient for the court to determine the value of his capital accounts and did not present any evidence of the fair value of his interests, the most the plaintiff can receive is the value of his capital accounts. The convergence of the parties' positions renders unnecessary any ruling on the existence of an unwritten agreement.

This decision awards the plaintiff $35, 042.67, representing the value of his capital accounts on the date of his withdrawal. Pre- and post-judgment interest is due on this amount at the legal rate, compounded quarterly, from January 26, 2006, until the date of payment.


The case was tried over three days. The plaintiff and the three defendants testified live. Each has a personal interest in the outcome of the litigation, and none gave wholly credible testimony. This decision finds that the following facts were proven by a preponderance of the evidence.

A. The Broker/Dealer

The plaintiff, Gordon Levey, and two of the individual defendants, Douglas Lowey and Barrett Naylor, met while working at Mabon Nugent & Co., a New York investment firm. Lowey traded bonds, Naylor sold bonds, and Levey provided technical support for the bond trading operation. Because Levey and Lowey have similar names, this decision refers to Levey as Gordon. The parties frequently used first names in their testimony, and no disrespect is intended.

In 1994, Lowey and Naylor moved to Bear Stearns. There they met the third individual defendant, Oren Cohen, who was an analyst focusing on high-yield securities.

In 1997, Lowey decided to form a new firm that would specialize in trading high-yield bonds. The firm eventually was named Brownstone Investment Group, LLC. The parties refer to this non-party entity as "BIG, " and they refer to the four defendant entities as "BIP, " "BAM, " "PIP, " and "PAM." For those immersed in the case, these terms trip poetically off the tongue. For those less intimately involved, like the author of this decision and any readers other than the parties and their lawyers, the terms breed confusion. This decision refers to Brownstone Investment Group as the "Broker/Dealer." The other entities are introduced later.

Lowey testified that he initially formed the Broker/Dealer as a Delaware limited liability company, then talked to Naylor and Gordon about joining him. In 1998, they did. The three thought of themselves as partners. No one drafted formal documentation for the firm.

Lowey explained at trial that the partners did not prepare formal documentation because they were friends who trusted one another, and they prioritized their day-to-day jobs over the less compelling details of entity-level paperwork. Their informal approach largely continued until Gordon left and litigation ensued. Before then, what motivated the partners to prepare any type of documentation appears to have been the need to make tax filings or comply with regulatory requirements. When doing so, the partners treated their internal relationships as sufficiently malleable to enable them to achieve the most favorable economic result.

Everyone agrees that Naylor received a 20% equity interest in the Broker/Dealer and Gordon received a 10% equity interest. Lowey owned the rest.

B. The Hedge Fund

In 2002, Cohen joined Trilogy Capital, LLC, where he managed a hedge fund. Lowey had kept in touch with Cohen, and in late 2003, Lowey and Cohen began discussing forming a hedge fund of their own.

In early 2004, Cohen left Trilogy and began working with Lowey to set up the new fund. Lowey and Cohen hired a law firm and a prime broker, worked with counsel to set up the necessary entities, and raised capital from investors.

The resulting fund structure involved three entities. First, there was Brownstone Partners Catalyst Fund, the actual hedge fund that owned securities and made trades. This decision refers to this entity as the "Hedge Fund." Second, there was Brownstone Investment Partners LLC, which the parties call "BIP." It technically managed the Hedge Fund and owned a 20% carried interest in the fund. To ensure that amounts generated by the carried interest would receive favorable tax treatment, it was essential that BIP remain passive and hire an active manager to do the actual managing. This decision therefore refers to BIP as the "Passive Manager." Third, there was Brownstone Asset Management, LP, which the parties call "BAM." It was the entity that the Passive Manager hired to do the active managing, so this decision refers to it as the "Active Manager." In return for its services, the Active Manager received a management fee from the Hedge Fund, payable quarterly in advance, equal to 1.5% of assets under management.

Lowey and Cohen decided to run the Hedge Fund out of the Broker/Dealer's offices. This plan enabled Lowey to split his time easily between the Broker/Dealer and the Hedge Fund, and it allowed the Hedge Fund to benefit from the Broker/Dealer's resources, including its trading relationships and technology infrastructure.

In the first quarter of 2004, Lowey decided that he needed to offer interests in the fund to Naylor and Gordon. Cohen resisted. After discussing matters, Lowey and Cohen agreed that Naylor and Gordon would each receive a 2.5% interest.

The 2.5% offer failed to inspire gratitude. Naylor compared it to his 20% interest in the Broker/Dealer and became upset with Lowey. Gordon did not like the idea of the Hedge Fund in the first place. He was the Chief Compliance Officer for the Broker/Dealer, and he thought it was risky for a hedge fund and a broker/dealer to operate out of the same office through a single trader. Given that Lowey is a human with only one brain, Gordon worried that a regulator might think that Lowey had access in his capacity as the principal trader of the Hedge Fund to non-public information in his head about what he was trading in his capacity as the principal trader of the Broker/Dealer. Gordon proposed to limit his own involvement to the Broker/Dealer, and he countered that instead of giving him an interest in the new fund, Lowey should increase his share of the equity in the Broker/Dealer to 33%. According to Gordon, when Lowey first enticed Naylor and Gordon to join the Broker/Dealer, he promised them each one third of the business, but he later reneged and forced Naylor and Gordon to take less. Gordon told Lowey to give him what he believed he was originally promised.

Lowey went back to Cohen and told him they needed to sweeten their offer. After some tense discussions, Lowey and Cohen agreed that Naylor and Gordon would each receive a 5% interest.

At trial, the individual defendants testified that Lowey and Cohen extracted two agreements from Naylor and Gordon in return for their 5% stakes. First, they claimed that Naylor and Gordon had to perform work for the Hedge Fund and that to satisfy this requirement, Naylor helped market and raise capital for the fund, and Gordon became CFO and provided technical support. Second, they claimed that Naylor and Gordon agreed to forfeit their equity interests in the Passive Manager and the Active Manager if they ever left the Broker/Dealer. Gordon disputed that there were any agreements regarding his interests in the Passive Manager and the Active Manager.

C. Gordon Forgoes Income In The Active Manager For 2004.

In early 2005, as part of his administrative responsibilities, Gordon was working with Brownstone's accountant to prepare the various tax filings necessary for 2004. In March, the accountant provided Gordon with a draft tax return that allocated the Active Manager's net income according to the members' equity interests.

The accountant's proposed tax treatment, however straightforward, risked inviting regulatory scrutiny from the City of New York. Lowey, Naylor, and Gordon had structured their affairs at the Broker/Dealer so that only Lowey filed taxes with the City. Naylor and Gordon paid taxes on their respective shares of the income from the Broker/Dealer in the jurisdictions where they lived. If the Active Manager's net income were allocated as the accountant proposed, then each of its owners would receive a Schedule K-1 reflecting income generated in the City of New York. Gordon was concerned that Gotham tax ...

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