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RESNICK v. TOUCHE ROSS & CO.

April 25, 1979

Raymond RESNICK, Plaintiff,
v.
TOUCHE ROSS & CO., Defendant. Warren SPACHNER, Plaintiff, v. TOUCHE ROSS & CO., Defendant



The opinion of the court was delivered by: KNAPP

MEMORANDUM AND ORDER

This action presents another chapter in the "Weis debacle" the collapse of Weis Securities, Inc. ("Weis") in May of 1973. Plaintiffs are purchasers of various classes of Weis stock. Their claim arises as security holders, and not as customers of that brokerage firm. Defendant Touche Ross was Weis' auditor at all times relevant to this action.

In 1972 defendant certified several statements relating to the Weis financial condition. In certifying those statements Touche Ross opined that the figures therein contained fairly presented the Weis financial position in accordance with generally accepted auditing practices. Plaintiffs' claim is that the statements so certified by defendant contained several misstatements upon which they relied in purchasing their securities.

 Plaintiffs allege in four separate counts: violations of section 10(b) of the Securities Exchange Act of 1934 ("1934 Act"), Rule 10b-5 and Section 17(a) of the Securities Act of 1933 ("1933 Act"); violations of Section 18(a) of the 1934 Act; common law negligence and gross negligence; and the aiding and abetting by Touche Ross of securities law violations committed by Weis. Subject matter jurisdiction is predicated upon Section 22 of the 1933 Act, Section 27 of the 1934 Act and pendant jurisdiction.

 Defendant moves to dismiss the complaint under Fed.R.Civ.P. 12(b) for failure to state a claim, and for lack of subject matter jurisdiction.

 Scienter and the 10(b) and 17(a) claims:

 Defendants argue that plaintiffs' claims under 10(b) and 17(a) should be dismissed because they fail to satisfy the Scienter standard enunciated by the Supreme Court in Ernst & Ernst v. Hochfelder (1976) 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668. Although that decision held that negligent action or inaction was not sufficient to support a 10b-5 claim, in a footnote the Court left open the question of whether recklessness would suffice, Supra n. 12, at 193. Prior to Hochfelder, it was established in this Circuit that the standard of Scienter required in an action under Rule 10b-5 was "willful or reckless disregard for the truth." Lanza v. Drexel (2d Cir. 1973) 479 F.2d 1277, 1306 n. 98 (en banc). Several recent cases have confirmed that, in the absence of further word from the Supreme Court, reckless conduct will continue to meet the requirements of Scienter for 10b-5 actions. Rolf v. Blyth, Eastman, Dillon & Co. (2d Cir. 1978) 570 F.2d 38; U. S. v. Chiarella (2d Cir. 1978) 588 F.2d 1358; Edwards & Hanly v. Wells Fargo Securities Clearance Corp. (S.D.N.Y.1978) 458 F. Supp. 1110, 1122-23. Thus, the Scienter standard we will apply is one of recklessness.

 The amended complaint alleges that the statements certified by defendant were "materially false and misleading" in twenty-four specified respects, and that "defendant knew, should have known or was on notice of or recklessly disregarded" facts relating to these misstatements. The amended complaint further alleges that "the defendant obtained actual knowledge of the materially false and misleading entries . . . or, in the alternative conducted its examination and audit with reckless disregard for the truth." Finally, the amended complaint sets forth the circumstances, with respect to each alleged misstatement, that are said to constitute "defendant's knowing and/or reckless conduct."

 Defendant argues, with some force, that the amended complaint in essence alleges no more than several instances of negligent conduct. However, we cannot say as a matter of law that if plaintiffs prove all their allegations the recklessness standard will not be met. As we thus cannot say as a matter of law that the Scienter requirement has not been satisfied, plaintiff's claim under Rule 10b-5 must survive this motion to dismiss. *fn1"

 Sections 17(a) and 18(a) of the 1934 Act

 Plaintiffs assert that the recent Second Circuit decision in Reddington v. Touche Ross & Co. (2d Cir. 1978) Fed.Sec.L.Rep. (CCH) P 96,404, has established a private right of action in their favor under Section 17(a) of the 1934 Act. Plaintiffs' reliance on that case is misplaced. While Reddington did allow a private cause of action under Section 17(a), the right of action was only said to run in favor of the Customers of a brokerage firm. Fed.Sec.L.Rep. (CCH) P 96,404 at 93,433. Implied private rights of action, when found, should be strictly limited to that class of "beneficiaries" whom Congress intended to protect in enacting the section involved. Piper v. Chris-Craft Industries, Inc. (1977) 430 U.S. 1, 37, 97 S. Ct. 926, 51 L. Ed. 2d 124; Cort v. Ash (1975) 422 U.S. 66, 95 S. Ct. 2080, 45 L. Ed. 2d 26. Section 17(a), which requires broker-dealers such as Weis to keep records and to make prescribed reports, is intended to protect customers rather than security holders of the broker-dealer. Investors in the securities of a broker-dealer are amply protected by other more germane provisions in the securities laws. Under the test enunciated by the Supreme Court in Cort v. Ash, supra, any implied right of action under 17(a) must be limited to those the section was designed to protect, the customers of broker-dealer firms. *fn2" The defendant's motion to dismiss the section 17(a) claim must therefore be granted.

 Since plaintiffs have conceded that their claims under Section 18(a) of the 1934 Act are barred by the time limitations of that section, defendant's motion to dismiss the claims under Section 17(a) and 18(a) of the 1934 Act is granted.

 Aiding and Abetting

 In addition to their allegations of primary violations under the securities laws by defendant, plaintiffs argue that the defendant is secondarily liable as an aider and abettor of the violations of Weis. In this Circuit, Section 10(b) and Rule 10b-5 may give rise to aiding and abetting liability. Rolf v. Blyth, Eastman, Dillon & Co., supra, 570 F.2d at 47; Hirsh v. DuPont (2d Cir. 1977) 553 F.2d 750, 759. Three elements must be established in order to impose such liability. First, it must be shown that the primary party (Weis), as distinguished from the alleged aider and abettor (Touche Ross), violated the securities laws. Second, it must be established that the aider and abettor knew of ...


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