The opinion of the court was delivered by: LASKER
In this action alleging violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78(j) and Rule 10b-5, 17 C.F.R. 204.10b-5, Arthur Andersen & Co. (Andersen) moves pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure to dismiss the amended complaint for failure to state a claim upon which relief can be granted and for failure to state a claim with the particularity required by Federal Rule of Civil Procedure 9(b).
While we agree with Andersen that the complaint is poorly pleaded, we nevertheless find both that it states a claim and that, with one minor qualification, it complies with Rule 9(b). Moreover, even if we were to conclude that the complaint falls shy of the requirements of Rule 9(b) there would be no justification for granting Andersen's request that it be dismissed without the right to replead. Finally, we note that whatever deficiency exists because of the opacity of the complaint is remedied by the massive detail of plaintiffs' papers on this motion, in particular by the affidavit of plaintiffs' accountant, Ralph Rehmet.
On March 5, 1971, Lawrence and Theodore Oleck (the Olecks) sold their stock in Blue Circle Telephone Answering Service, Inc. (Blue Circle) to Sherwood Diversified Services, Inc. (Sherwood). Only $98,000 of the $728,000 purchase price was paid in cash, the remainder consisting of Sherwood's promissory notes payable over a period generally of five years. In March, 1973, with $400,000 still unpaid on the Oleck's notes, Sherwood filed a petition under Chapter XI of the Bankruptcy Act.
The purchase agreement provided that:
"[Sherwood] has furnished [the Olecks] with a true copy of the annual report of [Sherwood] audited by Arthur Andersen & Co., dated October 30, 1970, which includes a balance sheet as of February 28, 1970."
(Complaint, para. 20; Affidavit of Lawrence Oleck para. 4). The Olecks contend that they relied upon Andersen's certification of the February 28, 1970 financial statement (1970 statement) and that the statement was materially false and misleading. Specifically, it is asserted that the 1970 statement failed fairly to portray the financial consequences of Sherwood's acquisition and subsequent resale of the U.S. Media International Corporation (U.S. Media) and that at the time Andersen prepared the statement it "knew, or in the exercise of reasonable diligence should have known" that the statement was misleading. (para. 26(a)) Since the adequacy of the allegations as to Andersen is the subject of this motion, they are set forth in full in the margin.
The Particularity Requirement
Andersen argues that the complaint fails to meet the standards of particularity required by Rule 9(b) in three respects. The "most prominent" of these (Defendant's Memorandum, at 3) is asserted to be that the allegations against Andersen are made on information and belief. However, this factor does not automatically render a complaint inadequate. Allegations on information and belief can meet the standards of Rule 9(b) so long as the pleading includes a statement of the facts on which the belief is founded. Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 379 (2d Cir. 1974); 5 C. Wright & A. Miller, Federal Practice and Procedure: Civil § 1298, at 416 (1969). The Olecks' complaint, particularly in paragraphs 25 and 26, sets forth the factual basis for their claim in sufficient particularity to meet the Rule's requirements. In Schlick v. Penn-Dixie Cement Corp., supra, the complaint had been dismissed for failure to meet the requirements of Rule 9(b). The Court of Appeals reversed because, in addition to a conclusory allegation of fraud and deceit, the complaint specified the transactions alleged to have been fraudulent and the manner in which they were alleged to be fraudulent. The allegations here pass the Penn-Dixie test. In addition to identifying the alleged misrepresentations (para. 25), the complaint specifies various respects in which the statements are alleged to be misleading. (para. 26) In contrast, the complaint dismissed by the court in Goldberg v. Shapiro, CCH FED. SEC. L. REP. para. 94,813 (S.D.N.Y. October 1, 1974), on which Andersen relies, contained no more than a bare assertion that the defendant violated Rule 10b-5 by "materially understating" and "substantially [overstating]" various items in the financial statement there at issue. Goldberg v. Shapiro, supra at 96,717.
Andersen next argues that even assuming a basis for the Olecks' allegations on information and belief, their complaint fails under Rule 9(b) because "it is not possible to deduce either the operative facts or a theory upon which plaintiffs seek recovery." (Defendant's Memorandum at 6) The contention is without merit. Theories of recovery need not be pleaded, 5 C. Wright & A. Miller, Federal Practice and Procedure, Civil § 1219 (1969) and the complaint sufficiently alleges the facts on which the action is based. The complaint states a 10b-5 claim centering on an allegation that the 1970 statement misrepresented the facts surrounding Sherwood's U.S. Media transactions and obscured Sherwood's resultant exposure to severe losses. It specifies a statement alleged to be misleading, the manner in which it is alleged to be misleading and the categories of information it misrepresented. More than this is not required. Schlick v. Penn-Dixie Cement Corp., supra, 507 F.2d at 379.
As in Felton v. Walston and Co., Inc., 508 F.2d 577 (2d Cir. 1974), in which the Second Circuit recently reversed a finding that the complaint against an accounting firm failed to particularize the allegations adequately, so here:
"While the allegations are not as specific as might be desired . . . they cannot be characterized as merely conclusory since they are clearly much more than a bald assertion that the defendant engaged in fraudulent acts. It may well be that plaintiffs have no claim against the defendant but the proper manner in which to determine whether a claim exists is to require an answer, and, if necessary, a trial of those issues. This result is especially appropriate since in applying rule 9(b) we ...