UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK
April 5, 1978
WILLIAM B. WEINBERGER, ROBERT SMITH, STEIN FAMILY FOUNDATION, INC. and EDITH CITRON, Plaintiffs,
JAMES C. KENDRICK, HARRY E. PIERSON, A. RICHARD BUTLER, ROBERT H. ANDERSON, JOHN E. SUNDMAN, RICHARD M. SCARLATA, JOSEPH W. CHINN, JR., RAYMOND H. FOGLER, JOSEPH HINSEY, JOHN D. GRAY, DEWITT PETERKIN, JR., LOUIS LUSTENBERGER, CHARLES PHILLIPS, ASA T. SPAULDING, C. W. SPANGLE, E. ROBERT KINSEY, RICHARD W. MAYER, MORGAN GUARANTY TRUST COMPANY OF NEW YORK, Individually and as Agent for a Group of Twenty-Seven Lending Banks described herein, CHASE MANHATTAN BANK, N.A., CITIBANK N.A., THE BANK OF NEW YORK, BANKERS TRUST COMPANY, CHEMICAL BANK, IRVING TRUST COMPANY, MARINE MIDLAND BANK, SANWA BANK LTD., MANUFACTURERS HANOVER TRUST COMPANY, ERNST & ERNST and W. T. GRANT CO., Defendants
The opinion of the court was delivered by: DUFFY
OPINION AND ORDER
KEVIN THOMAS DUFFY, D.J.
By opinion and order dated January 24, 1977, I granted the motions of defendants Morgan Guaranty Trust Company of New York, Ernst & Ernst, and the officers and directors of W. T. Grant Company, also a defendant herein, to dismiss this shareholders' complaint, alleging violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), Rule 106-5 promulgated thereunder and common law fraud, for failure to state a claim upon which relief can be granted under Rule 12(b)(6), F.R.Civ.P., and allowed plaintiffs leave to replead. 432 F. Supp. 316 (S.D.N.Y. 1977). Plaintiffs have done so. Defendant Ernst and Ernst, the accounting firm for W. T. Grant Company at the time of the occurrence of the acts of which plaintiff complains, now challenges the sufficiency of the second amended complaint as to it for failure to plead the circumstances constituting the fraud with sufficient particularity as required by Rule 9(b), F.R.Civ.P.
In my previous opinion I determined that the original complaint, which contained allegations "upon information and belief," was fatally devoid of facts upon which to base the belief that Ernst & Ernst practiced securities and common law fraud upon plaintiffs. 432 F. Supp. at 321. See Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 379 (2d Cir. 1974), cert. denied 421 U.S. 976, 44 L. Ed. 2d 467, 95 S. Ct. 1976 (1975); Segal v. Gordon, 467 F.2d 602, 608 (2d Cir. 1972). I noted that only neutral facts and conclusions had been pleaded and that the complaint failed to "give notice of which figures contained in which financial statements were made by Ernst & Ernst with an intent to deceive." 432 F. Supp. at 321.
The second amended complaint has attempted to cure these deficiencies. However, it is clear as to those allegations which group Ernst & Ernst with all other defendants in failing to make timely disclosure of certain information purportedly evidencing W. T. Grant Company's deteriorating financial condition (paras. 31, 32) and in disseminating public statements concerning that Company's actual or anticipated profits and loss (para. 33), there is lacking the requisite factual specificity from which an inference of fraud on the part of Ernst & Ernst may be drawn with regard to Ernst & Ernst. These allegations merely restate those originally pleaded (compare first Complaint, paras. 12, 13, 14,) and found wanting. 432 F. Supp. at 321.
The thrust of plaintiffs' endeavor to cast liability on Ernst & Ernst for its "knowingly or recklessly certifying false financial statements of Grant" (Plaintiffs' Memorandum in Opposition, p. 3) is purportedly reflected in the amended allegations set forth in the margin,
and it is to a consideration of the sufficiency of those allegations in light of Rule 9(b), F.R.Civ.P., that I now turn. These amended allegations sufficiently identify the figures and statements claimed to be false, as well as the financial statements certified by Ernst & Ernst in which that information appeared. However, the mere designation of this information, the glaring omission of which was highlighted in my previous opinion, does not in and of itself satisfy the strictures of Rule 9(b). The complaint must particularize not only the errors or omissions made by the accounting firm but also the manner in which the firm acted improperly. Gross v. Diversified Mortgage Investors, et al., 431 F. Supp. 1080 [1977-78 Transfer Binder] C.C.H. Fed. Sec. L. Rep. P96, 137 at 92, 109 (S.D.N.Y. 1927). Moreover, since the amended allegations, like those originally pleaded, are rooted in "information and belief," it is incumbent upon plaintiffs to have laid a sufficient factual foundation for their assertion.
Segal v. Gordon, 467 F.2d at 608.
An examination of the amended allegations in light of the above requirements reveals insufficient particularization, despite the identification of the purported false figures and reports. Although plaintiffs have alleged the manner in which this information was false or misleading, they have omitted assertions crucial to the vitality of the claim against Ernst & Ernst. For example, plaintiffs complain that the stated dollar amounts of net customer accounts receivable and of merchandise inventory, contained in the consolidated financial statements certified by Ernst & Ernst and included in Grant's 1973 and 1974 Annual Reports were "grossly overstated" for various asserted reasons. (para. 34A, B, D, E).
Yet nowhere do the pleadings provide the approximate amount of the overstatement, notice of which defendant is entitled.
Jacobson v. Peat, Marwick, Mitchell & Co., et al., 445 F. Supp. 518, slip op. 1, 5-6 (S.D.N.Y. 1977); Goldberg v. Shapiro, [1974-75 Transfer Binder] C.C.H. Fed. Sec. L. Rep. para. 94,813 at 96,717 (S.D.N.Y. 1974).
More crucial, however, is the omission of allegations which would give rise to an inference of actionable wrongdoing by Ernst & Ernst. This defendant is charged with certifying financial statements at a time when it knew, recklessly disregarded, or should have known, by virtue of its audit of Grant's operations, that the amounts included for net customer accounts receivables and merchandise inventory figures were overstated. (para. 38 incorporating para. 34 A, B, D, E).
Additionally, plaintiffs seek to hold Ernst & Ernst liable for the inclusion in Grant's 1974 Annual Report of certain purportedly false statements (para. 38 incorporating para. 34C).
This latter claim, however, is devoid of any asserted linkage between Ernst & Ernst and the examination, preparation, certification, making or dissemination of these statements. Without some factual indication of the extent of the accountants' knowledge of these purportedly false statements or their participation in their dissemination, this portion of plaintiffs' claim must fail. See Rich v. Touche Ross & Co., 68 F.R.D. 243, 246-47 (S.D.N.Y. 1975).
Nor can an inference of fraud be drawn from Ernst & Ernst's certification of the allegedly overstated figures in the absence of some factual indication that Ernst & Ernst was remiss in conducting the audit or was otherwise possessed of information indicating the true financial picture at the time of the certification. Jacobson v. Peat, Marwick, Mitchell & Co., supra; Rich v. Touche & Co., supra. Compare Kamens v. Horizon Corp., 432 F. Supp. 322 (S.D.N.Y. 1977); Lewis v. Black, [1976-77 Transfer Binder] C.C.H. Fed. Sec. L. Rep. para. 95,638 (E.D.N.Y. 1976). The claims concerning the overstated net customer accounts receivable figures are devoid of any assertions of improper auditing or accounting treatment or of any support for the proposition that Ernst & Ernst was aware of the write-off policy on which the overstatements were based at the time of the certification. While plaintiffs have alleged, with respect to the merchandise inventory figures, that the overstatements resulted from, inter alia, "the fact that . . . the calculation of inventory did not conform to standard auditing procedures[,]" this assertion is meaningless without some particularization of the manner in which the calculation did not so conform, what procedures Ernst & Ernst was under a duty to perform, and how non-performance rendered the certifications false. Jacobson v. Peat, Marwick, Mitchell & Co., et al., slip op. at 7-8. This allegation is not saved by plaintiffs' assertions of mark-ups not reflected on the store's books and of calculating inventory by netting mark-ups and mark-downs rather than the "retail inventory method, as represented." (para. 34B(ii), (iii), D).
The former assertion fails to reflect Ernst & Ernst's knowledge or use of or participation in this practice, and the latter fails to imply wrongdoing in light of plaintiffs' allegation that the merchandise inventory figures were represented to have been determined "at the lower of cost or market, determined principally by the retail method." Indeed, it is difficult, if not impossible, to discern the meaning of this claim.
Plaintiffs argue that allegations of factual support for the accountants' knowledge at the time of the certification are unnecessary. While plaintiffs are correct in contending that the state of mind with which the accountants acted can be generally averred under Rule 9(b), Heit v. Amrep Corp., et al., [1975-76 Transfer Binder] C.C.H. Fed. Sec. L. Rep. P 95,406 at 99,076 (S.D.N.Y. 1975); Oleck v. Fisher [1975-76 Transfer Binder] C.C.H. Fed. Sec. L. Rep. para. 95,322 at 98,672 (S.D.N.Y. 1975), simply coupling conclusory allegations of wrongful intent with neutral assertions of false information does not effectively substitute for the particularization of the circumstances constituting the accountants' fraud as required by that rule. Jacobson v. Peat, Marwick, Mitchell & Co., et al., supra; Schmeidler v. Lazard Frere & Co., Inc., et al., 74 Civ. 2206 (CBM) (S.D.N.Y. January 5, 1977).
Accordingly, defendant Ernst & Ernst's motion to dismiss the second amended complaint as to them for failure to allege fraud with particularity is granted.
IT IS SO ORDERED.