Opinion
00 CIV. 2284 (DLC), 00 CIV. 2498 (DLC).
September 19, 2001
Steven S. Honigman, Richard P. Swanson, Jonathan E. Polonsky, Veronica E. Rendon, Thelen Reid Priest LLP, New York, NY Attorneys for Plaintiffs Cromer et al.
Jeffrey H. Squire, Richard L. Stone, Mark A. Strauss, Kirby, Mclnerney Squire, LLP, New York, NY, Attorneys for Plaintiffs Cromer et al.
Steven E. Greenbaum, Scott M. Berman, Berlack, Israels Liberman LLP, New York, NY, Attorneys for Plaintiffs Argos et al.
Michael J. Dell, David S. Frankel, Timothy J. Helwick, Kramer Levin Naftalis Frankel LLP, New York, NY, Attorney for defendant Deloitte Touche Bermuda.
Robert E. Juceam, Gregg L. Weiner, Fried, Frank, Harris, Shriver Jacobson, New York, NY, Attorneys for defendants Ernst Young Bermuda, Fund Administration Services (Bermuda) Ltd., and Kempe Whittle Associates Limited.
Martin I. Kaminsky, Pollack Kaminsky, New York, NY, Attorneys for defendant Financial Asset Management, Inc.
Michael Berger, pro se, West Hampton Beach, NY
OPINION ORDER
This Opinion addresses a third round of motions to dismiss filed in these two federal securities fraud actions. Each of these actions is brought by investors in the Manhattan Investment Fund, Ltd. (the "Fund"), an off-shore investment fund that traded United States securities. By Opinion and Order dated April 17, 2001 ("April 17 Opinion"), this Court, among other things, denied in their entirety the motions to dismiss brought by defendant Deloitte Touche Bermuda ("ETB"), Fund Administration Services (Bermuda) Ltd. ("FASB") and Ernst Young Bermuda ("EYB"), and denied in part the motion to dismiss brought by defendant Kempe Whittle Associates Limited ("KW") against the First Amended Complaint. Cromer Finance Ltd. v. Berger, 137 F. Supp.2d 452 (S.D.N.Y. 2001). The April 17 Opinion granted the motions made by FASB, EYB, and KW for a more definite statement pursuant to Rule 12(e), Fed.R.Civ.P. Familiarity with the April 17 Opinion is assumed, and defined terms have the meanings given them therein. By Opinion and Order dated August 16, 2001, this Court denied motions made by these same defendants to dismiss these actions on the ground of forum non conveniens.
By Opinion and Order dated May 14, 2001, the Court denied the motions for reconsideration brought by DTB and FASB. Cromer Finance Ltd. v. Berger, Nos. 00 Civ. 2284, 00 Civ. 2498 (DLC), 2001 WL 506908 (S.D.N.Y. May 14, 2001).
Following the April 17 Opinion, Second Amended Complaints were filed in both the Cromer and Argos actions. The Cromer plaintiffs bring 21 causes of action. As against DTB, EYB, FASB, and KW, they allege the same causes of action as in their First Amended Complaint. Namely, the Cromer plaintiffs allege violation of Section 10(b) of the Securities Exchange Act ("Exchange Act"), violation of Rule 10b-5, common law fraud, aiding and abetting common law fraud, aiding and abetting breach of fiduciary duty, negligence, gross negligence, and professional malpractice. As against EYB, FASB, and KW, the Cromer plaintiffs additionally allege negligent misrepresentation. As against EYB, the Cromer plaintiffs additionally allege violation of Section 20(a) of the Exchange Act under a "controlling person" theory.
The Argos plaintiffs bring eleven causes of action. As against DTB and FASB they allege the same causes of action as in their First Amended Complaint but additionally include several causes of action not previously asserted. Specifically, they re-allege violation of Section 10(b) of the Exchange Act, violation of Rule 10b-5, common law fraud, aiding and abetting common law fraud, and aiding and abetting breach of fiduciary duty. As against FASB, the Argos plaintiffs additionally re-allege breach of fiduciary duty, negligence and negligent misrepresentation. The Argos plaintiffs include two new causes of action against both DTB and FASB: gross negligence and professional malpractice. As against DTB, the Argos plaintiffs further add a claim of negligence.
EYB and KW are not named as defendants in the Argos action.
DTB now moves to dismiss the Second Amended Complaints pursuant to Rules 9(b) and 12(b)(6), Fed.R.Civ.P. EYB, FASB, and KW (collectively, "the Ernst Young Defendants") move to dismiss the Second Amended Complaints pursuant to Rules 9(b), 12(b)(1), (2), and (6), Fed.R.Civ.P., or alternatively move for a more definite statement pursuant to Rule 12(e) and to strike certain statements pursuant to Rule 12(f). With respect to the motions by DTB, the Court addresses primarily the allegations in the Cromer action and, for the reasons discussed below, denies the motions. The parties shall have seven days in which to notify the Court why the analysis in this Opinion does not resolve the motions made by DTB to dismiss the claims in the Argos action as well. Further, for the reasons discussed below, the Ernst Young Defendants' motion in the Cromer action is denied. The motion by FASB in the Argos action is denied in part and granted in part.
DISCUSSION
The standards f or motions made pursuant to Rules 9(b), 12(b)(1), (2), and (6) are described in the April 17 Opinion and will not be repeated here. Cromer, 137 F. Supp. 2d at 467-69.
I. DTB
DTB, the auditor for the Fund, moves to dismiss the Second Amended Complaints for several reasons. Because each of the arguments could have been made by DTB in its first motion to dismiss, which the Court addressed comprehensively in its April 17 Opinion, the Court shall address them in summary form.
A motion to dismiss for failure to state a claim is a nonwaivable defense and can be brought even after the close of the pleadings. Patel v. Contemporary Classics of Beverly Hills, 259 F.3d 123, 126 (2d Cir. 2001).
A. Securities Fraud and Common Law Fraud Claims
First, DTB argues that the plaintiffs have failed to state a cause of action for securities and common law fraud because "each Plaintiff must allege (and prove) its actual justifiable reliance on a misrepresentation by DTB." In particular, DTB argues that the plaintiffs were not justified in relying on the audit reports because the information in each audit was at least three months old and therefore not as current as the monthly net asset value ("NAV") statements sent by the Fund administrators. In support of this argument, DTB cites a letter by plaintiffs' counsel indicating that investors' decisions were based on the integrity and accuracy of the NAV statements.
The bulk of DTB's arguments are not appropriate for a motion to dismiss. They are in essence an attempt to get each investor to identify in the pleadings when it received DTB audits and how exactly it relied on them. There is, however, no Rule 9(b) requirement for pleading reliance and, as noted below, the facts supporting justifiable reliance are, under the applicable standards, more than adequately pled. DTB has more appropriately included its arguments regarding reliance in its opposition to the Cromer plaintiffs' motion for class certification. Accordingly, these arguments will be addressed at more length in that context.
The April 17 Opinion details the elements necessary to state claim for securities fraud, Cromer, 137 F. Supp. 2d at 468-69, 481, and for common law fraud, id. at 494. The plaintiffs have alleged reliance adequately to survive the liberal pleading standard of Rule 12(b)(6), which focuses on the allegations of the complaint. Specifically, the plaintiffs allege that DTB "issued materially false and misleading audit reports to Plaintiffs and other members of the class, specifically addressing such reports to the shareholders of the Fund" and that the audit reports were "the principal means by which investors were induced to purchase shares of the Fund in that there was no other purportedly independently-verified information available to investors upon which they could rely." Plaintiffs further allege that they "would not have purchased the securities of the Fund at the prices they paid, or at all, if they had known" that the audits were materially false, and that they "relied on Deloitte's misrepresentations in deciding to purchase shares in the Fund, to increase their investments in the Fund, and/or not to redeem them." These allegations are sufficient to allege reliance.
To the extent DTB is arguing that, as a matter of law, its audit reports cannot be the basis for reliance since they confirmed the accuracy of the year-end NAV calculations, which were several months old at the time the audits were issued, the argument is of no avail. An annual audit report is the kind of document on which investors are entitled to rely even though the information contained in it is necessarily historical. Annual certified audits are a principal means through which corporations and investment funds provide investors with assurance that more frequently released financial information is reliable.
DTB further argues that the plaintiffs have failed to allege the scienter/intent prongs of the fraud claims with respect to initial Fund purchases because the audit reports were addressed "to the shareholders of the Fund" rather than to prospective shareholders, and plaintiffs therefore fail to show that DTB intended to defraud first-time investors. The plaintiffs have adequately alleged scienter with respect to both the securities fraud and common law fraud claims. By way of example, in addition to the allegations detailed in the April 17 Opinion regarding DTB's access to information which contradicted the false financial information upon which it based its audit reports, the plaintiffs allege that DTB "knew or recklessly disregarded that the audit reports it issued were the principal means by which investors were induced to purchase shares of the Fund, to increase their shares in the Fund and/or to retain their existing shares in the Fund in that there was no other purportedly independently-verified information available to investors upon which they could rely." DTB's motion to dismiss the fraud claims is denied.
DTB argues generally that any claims based on trading prior to May 27, 1997, the date of DTB's first audit report, must be dismissed for failure to plead reliance. DTB also argues that the securities claims must be dismissed for those individual plaintiffs who relied on an audit report only with respect to a decision to maintain or not redeem shares for failure to meet the "in connection with" requirement. The plaintiffs have, however, adequately pled their claims, and these arguments are more appropriately made in a motion for summary judgment.
B. Negligence and Gross Negligence
The standards for stating a claim of negligence and gross negligence are detailed in the April 17 Opinion. Cromer, 137 F. Supp. 2d at 495. DTB argues both that these claims are barred by the Martin Act, N.Y. Gen. Bus. Law, Art. 23-A, § § 352 et seq. (McKinney 1996), New York's blue sky law governing securities fraud, and that the plaintiffs fail to state a claim under Rule 12(b)(6). DTB further argues that New York law does not recognize an independent cause of action for gross negligence against an accountant.
The Martin Act "prohibits various fraudulent and deceitful practices in the distribution, exchange, sale and purchase of securities," Castellano v. Young Rubicam, Inc., 257 F.3d 171, 190 (2d Cir. 2001), "but does not require proof of intent to defraud or scienter," Granite Partners. L.P. v. Bear, Stearns Co., Inc., 17 F. Supp.2d 275, 291 (S.D.N.Y. 1998) (citing CPC Int'l Inc. v. McKesson Corp., 514 N.E.2d 116 (N.Y. 1987)). It provides in pertinent part that
1. It shall be illegal and prohibited for any person, partnership, corporation, company, trust or association, or any agent or employee thereof, to use or employ any of the following acts or practices:
(c) Any representation or statement which is false, where the person who made such representation or statement: (i) knew the truth; or (ii) with reasonable effort could have known the truth; or (iii) made no reasonable effort to ascertain the truth; or (iv) did not have knowledge concerning the representation or statement made;
where engaged in to induce or promote the issuance, distribution, exchange, sale, negotiation or purchase within or from this state of any securities or commodities . . . regardless of whether issuance, distribution, exchange, sale, negotiation or purchase resulted.
N Y Gen. Bus. Law, art. 23-A, § § 352-c(1)(c)
When interpreting a state statute, it is a federal court's "`job to predict how the forum state's highest court would decide the issues'" before it. Sprint PCS L.P. v. Connecticut Siting Council, 222 F.3d 113, 115 (2d Cir. 2000) (citation omitted) "[T]o the extent there is any ambiguity in the state statutes under consideration," the federal court must "`carefully predict how the highest court of the state would resolve the uncertainty or ambiguity.'" Id. at 115-16 (citation omitted). While the New York Court of Appeals has held that there is "no implied private right of action for violations of the antifraud provisions of the Martin Act," CPC Int'l, 514 N.E.2d at 118; see also Vermeer Owners. Inc. v. Guterman, 585 N.E.2d 377, 378 (N.Y. 1991), it has not determined whether the Martin Act preempts claims made under common law. See Castellano, 257 F.3d at 190; Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 104 (2d Cir. 2001). New York's lower courts are split. The court in Horn v. 440 East 57th Co., 547 N.Y.S.2d 1, 5 (1st Dep't 1989), upheld a common law fraud claim but dismissed claims for negligent misrepresentation and breach of fiduciary duty as barred by the Martin Act. See also Rego Park Gardens Owners, Inc. v. Rego Park Gardens Assocs., 595 N.Y.S.2d 492, 494 (2d Dep't 1993) (citing Horn to dismiss a negligent misrepresentation claim). More recently, the Fourth Department upheld common law claims, including negligent misrepresentation, noting that "[n]othing in the Martin Act, or in the Court of Appeals cases construing it, precludes a plaintiff from maintaining common-law causes of action based on such facts as might give the Attorney General a basis for proceeding civilly or criminally against a defendant under the Martin Act." Scalp Blade. Inc. v. Advest, Inc., 722 N.Y.S.2d 639, 640 (4th Dep't 2001).
While other federal courts have dismissed common law claims as precluded by the Martin Act, See Castellano, 257 F.3d at 190 (breach of fiduciary duty); Granite Partners, 17 F. Supp. 2d at 291-92; Gabriel Capital. L.P. v. Natwest Finance, Inc., 137 F. Supp.2d 251, 266-67 (S.D.N.Y. 2000) (negligence and breach of fiduciary duty); Spirit Partners, L.P. v. Audiohighway.Com, No. 99 Civ. 9020 (RJW), 2000 WL 685022, at *6 (S.D.N.Y. May 25, 2000) (negligent misrepresentation);Bibeault v. Advanced Health Corp., No. 97 Civ. 6026 (MJL) (RJW), 1999 WL 301691. at *10 (S.D.N Y May 12, 1999) (negligent misrepresentation and breach of fiduciary duty); Independent Order of Foresters v. Donaldson, Lufkin Jenrette Inc., 919 F. Supp. 149, 153 (S.D.N.Y. 1996) (same), there is nothing in either of the New York Court of Appeals cases cited above or in the text of the Martin Act itself to indicate an intention to abrogate common law causes of action. Moreover, the Horn court — on which many of these cases relied — failed to provide any reasoning for its decision to uphold the fraud claim while barring the negligence and breach of fiduciary duty claims. The Second Circuit observed in Suez Equity, 250 F.3d at 104, that it was "not immediately persuaded that the Court of Appeals would follow the lead" of the Rego Park and Horn decisions. It noted that those decisions "do not explore the issue with the level of depth" sufficient to justify a decision by the Circuit where the argument was made initially on appeal. Id. In particular, there does not appear to be any basis in the Martin Act's provisions for a distinction between claims of fraud and claims for negligent misrepresentation, and both New York Court of Appeals decisions allowed plaintiffs' common law fraud claims to proceed. Accordingly, the plaintiffs' negligence claims are not precluded by the Martin Act.
While this Court is, of course, bound by Second Circuit precedent, the Castellano court did not address the split among the New York Appellate Divisions on this issue. Given the skepticism expressed in Suez Equity of the Horn decision, this Court concludes that the Second Circuit will adopt the analysis in Scalp Blade when next confronted with the issue and the split in authority among the Appellate Divisions.
DTB argues that plaintiffs fail to state a claim for negligence and gross negligence because they lack a contractual relationship or privity with DTB and fail to meet the three-pronged standard, articulated in the April 17 Opinion, applicable when no such relationship exists. Cromer, 137 F. Supp. 2d at 495-96. DTB's chief argument is that the plaintiffs have failed to allege adequately that they relied on the audit reports or to allege any conduct by DTB linking it to the plaintiffs' losses. The plaintiffs have adequately alleged reliance for the reasons discussed above. Further, DTB's audit reports, addressed "to the shareholders," constitute "substantial communication" between DTB and the plaintiff-shareholders sufficient to satisfy the "linking conduct" requirement discussed in the April 17 Opinion. Cromer, 137 F. Supp. at 496.
DTB argues that it owes no duty to prospective investors — those who relied on an audit report prior to making an initial investment in the Fund. The plaintiffs, however, limit their allegations of negligence to existing shareholders. The plaintiffs allege that "[b]y addressing its reports to the shareholders of the Fund, Deloitte acknowledged that it had assumed a duty to the Fund's existing shareholders who had purchased shares of the Fund as of the date each Deloitte audit was signed" (emphasis supplied). Further, their memorandum of law in opposition to DTB's motion acknowledges that the negligence claims "are limited to claims by the Fund's existing shareholders."
Finally, DTB moves to dismiss the gross negligence claim arguing that New York law does not recognize an independent cause of action for gross negligence against accountants. Under the law established in Ultramares Corp. v. Touche, 174 N.E. 441, 448-49 (N.Y. 1931), and its progeny, gross negligence may serve "to sustain an inference of fraud." Id. at 449; see also In re CBI Holding Co., 247 B.R. 341, 367 (S.D.N.Y. 2000); Foothill Capital Corp. v. Grant Thornton LLP, 715 N.Y.S.2d 389, 390 (1st Dep't 2000). Plaintiffs assert in their motion papers that their gross negligence claim is pled as giving rise to an inference of fraud. With the understanding that the gross negligence claim is an alternative pleading of the fraud claim, it is not dismissed.
C. Aiding and Abetting Fraud and Breach of Fiduciary Duty
The standards for stating a claim of aiding and abetting fraud or breach of fiduciary duty are provided in detail in the April 17 Opinion.Cromer, 137 F. Supp. 2d at 470, 494-95. DTB argues that the plaintiffs have failed to allege the actual knowledge and substantial assistance/participation prongs of these claims. The plaintiffs have alleged the elements of these claims adequately to survive the motion to dismiss.
II. Ernst Young Defendants
The Ernst Young Defendants, who are sued as the Fund administrators, primarily move to dismiss the securities fraud claims brought by theCromer plaintiffs against EYB, arguing that the plaintiffs fail to provide sufficiently specific allegations against EYB and fail to allege scienter. The elements necessary for pleading a claim under the securities law are detailed in the April 17 Opinion. Cromer, 137 F. Supp. 2d at 481. The motion is denied.
These defendants also preserve their motions to dismiss for lack of personal and subject matter jurisdiction and their motion to dismiss the securities claims against FASB for scienter deficiencies. For the reasons provided in the April 17 Opinion. these renewed motions are denied.Cromer, 137 F. Supp. 2d at 474-82.
The Ernst Young Defendants in the Cromer action and FASB in theArgos action also move to strike certain statements from the Second Amended Complaint in both actions, pursuant to Rule 12(f). These requests are denied. FASB also moves for a more definite statement in the Argos action. Having reviewed these arguments and the allegations in the Argos complaint, its motion is granted. The Second Amended Complaint in theArgos action does not identify with sufficient particularity the conduct attributable to FASB. It includes allegations against Ernst Young International ("EYI") and directs that any allegations against EYI should be read to mean FASB as well. Similarly, it directs that all references to FASB include KW. The plaintiffs in the Argos action shall have ten days to cure these deficiencies.
CONCLUSION
For the reasons discussed above, the motion to dismiss brought by Deloitte Touche Bermuda in the Cromer action is denied. The parties shall have seven days in which to notify the Court why the analysis in this Opinion does not resolve the motion brought by Deloitte Touche Bermuda to dismiss the claims in the Argos action as well.
The motion to dismiss brought by Fund Administration Services (Bermuda) Ltd., Ernst Young Bermuda, and Kempe Whittle Associates Limited in the Cromer action is denied. The motion to dismiss brought by Fund Administration Services (Bermuda) Ltd. in the Argos action is denied in part and granted in part.