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ROSS v. WARNER

November 28, 1979

MARCUS ROSS and RUTH ROSS, on behalf of themselves and all others similarly situated, Plaintiffs, against LESLIE H. WARNER, et al., Defendants.


The opinion of the court was delivered by: TENNEY

In the Second Amended Complaint of this still uncertified class action, shareholders of General Telephone & Electronics Corporation ("GT&E") allege violations of sections 10(b) and 18 of the Securities Exchange Act, 15 U.S.C. §§ 78j(b), 78r(a), rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5, section 11 of the Securities Act of 1933, 15 U.S.C. § 77k ("1933 Act"), and the common law by GT&E, its officers, directors and accountants. *fn1" Plaintiffs seek to maintain this action as class representatives on behalf of all persons who purchased common stock of GT&E through the corporation's various automatic dividend reinvestment services from January 1, 1972 through January 17, 1977.

The instant motion, made individually by defendant Arthur Andersen & Co. ("Andersen"), seeks dismissal pursuant to Federal Rule of Civil Procedure 12(b) ("Rules") for failure to state a claim upon which relief can be granted. Alternatively, Andersen seeks an order pursuant to Rule 9(b) dismissing the complaint for failure to state "the circumstances constituting fraud . . . with particularity." *fn2" For the reasons given below, the motion is granted in part and denied in part.

Background

 This action follows several derivative suits commenced subsequent to GT&E's disclosure, in a March 1976 proxy statement, of the contents of a special investigative report of the Audit Committee of the GT&E Board of Directors. See Cramer v. General Telephone & Electronics Corp., 582 F.2d 259 (3d Cir. 1978), Cert. denied, 439 U.S. 1129, 99 S. Ct. 1048, 59 L. Ed. 2d 90 (1979). The first cause of action of the Second Amended Complaint, asserting causes of action under sections 10(b) and 18, states that the Audit Committee Report, and two SEC civil complaints, revealed that substantial improper payments, kickbacks, rebates and bribes had been made directly and indirectly to officials of foreign customers. On "information and belief," plaintiffs recite these transactions and add the allegation that in concealing their actions, defendants "caused false and erroneous reports, including annual reports, proxy and registration statements, 8-k and 10-k reports and false financial statements, with the knowledge and consent of Andersen, to be submitted and filed with the SEC for the last ten years." Second Amended Complaint P 21. Plaintiffs allege that Andersen, as accountant and auditor of GT&E, had knowledge of the improper transactions, the lack of disclosure and the inaccurate accounting entries, yet certified the corporation's SEC filings with the "purpose and effect of misleading and defrauding plaintiff(s) and others similarly situated." Id. P 43.

 Andersen argues that the first cause of action fails to meet the requirements of Rule 9(b) because it fails to identify particular false documents and to specify how they are false or misleading and because it lacks specific facts showing that Andersen acted with scienter. Second, Andersen claims that insofar as the Second Amended Complaint asserts a claim under section 18, it is fatally defective because it fails to affirmatively plead compliance with that section's statute of limitations. Third, defendant reasons that since some of the allegedly improper transactions took place after plaintiffs became subscribers to the reinvestment plan, the complaint must, in order to state a valid claim under section 10(b), allege a sale of the stock subsequent to the fraudulent activities. Finally, Andersen asserts that the second cause of action does not properly state a claim under section 11 of the 1933 Act because plaintiffs fail to aver explicitly both the dates of their participation in the reinvestment plan and that the stock they purchased was registered under one of the registration statements allegedly lacking material information. Because a finding that the Second Amended Complaint fails to meet the requirements of Rule 9(b) would be dispositive of the section 10(b) cause of action as it applies to Andersen, the Court will address the Rule 9(b) issue first.

 Discussion

 Rule 9(b) provides: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally." The Second Circuit has recognized several purposes underlying the requirement that allegations of fraud be pleaded with particularity. The rule ensures that defendants in fraud actions will be given sufficient notice of the claims against them to prepare defenses to charges of misconduct. Felton v. Walston and Co., 508 F.2d 577, 581 (2d Cir. 1974); Rich v. Touche Ross & Co., 68 F.R.D. 243, 245 (S.D.N.Y.1975). The requirement "inhibit(s) the filing of a complaint as a pretext for discovery of unknown wrongs." Gross v. Diversified Mortgage Investors, 431 F. Supp. 1080, 1087 (S.D.N.Y.1977); Segal v. Gordon, 467 F.2d 602, 608 (2d Cir. 1972). The specificity requirement also serves to discourage lightly made allegations of conduct involving moral turpitude, which is particularly important to "professionals whose reputations . . . are most sensitive to slander." Rich v. Touche Ross & Co., supra, 68 F.R.D. at 245.

 The entire Second Amended Complaint is alleged on "information and belief." Only those matters peculiarly within the knowledge of the adverse party may be pleaded in this manner, and then, in order to satisfy Rule 9(b), the allegations must be accompanied by a statement of the facts on which plaintiffs' belief is founded. Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 379 (2d Cir. 1974), Cert. denied, 421 U.S. 976, 95 S. Ct. 1976, 44 L. Ed. 2d 467 (1975); Segal v. Gordon, supra; Morgan v. Prudential Group, Inc., 81 F.R.D. 418, 423 (S.D.N.Y.1978).

 The Section 10(b) Claim

 A successful section 10(b) action requires, Inter alia, a showing that defendants had intended to deceive, manipulate or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976). To meet the particularity requirement, a complaint must state facts giving rise to the inference of fraudulent conduct by a particular defendant. Jacobson v. Peat, Marwick, Mitchell & Co., 445 F. Supp. 518, 522 (S.D.N.Y.1977). Assuming Arguendo that plaintiffs have adequately identified improper transactions engaged in by GT&E, they have failed to identify adequately the misleading documents involved or state facts sufficient to give rise to an inference of fraud by the corporation's accountant.

 At a minimum, a plaintiff alleging securities fraud should be able to identify the misleading documents on which he has relied to his detriment. Plaintiffs cannot logically claim inability to do this without leaving the impression that they are using the suit as a device to search for fraud. "The familiar plaint that the details of an alleged fraud lie in the defendant's ken has no convincing ring when the details at issue are the identities of documents that have been widely disseminated to and assimilated by the investing public." Denny v. Barber, 73 F.R.D. 6, 9 (S.D.N.Y.1976), Aff'd, 576 F.2d 465 (2d Cir. 1978); Accord, Morgan v. Prudential Group, Inc., supra, 81 F.R.D. at 423; Gross v. Diversified Mortgage Investors, supra, 431 F. Supp. at 1087; Rich v. Touche Ross & Co., supra, 68 F.R.D. at 246. The Second Amended Complaint should have identified specific documents that were certified by Andersen and the manner in which those documents were materially false or misleading. Andersen may have neither certified nor even viewed the documents in question. See Rich v. Touche Ross & Co., 415 F. Supp. 95, 98 (S.D.N.Y.1976). Rule 9(b) requires their identification so that Andersen might frame an appropriate response. See Todd v. Oppenheimer & Co., Inc., 78 F.R.D. 415, 420 (S.D.N.Y.1978); Denny v. Barber, supra. *fn3"

 Even if the misleading reports had been identified, and had been certified by Andersen, the Second Amended Complaint would still fail to meet the particularity requirement. Plaintiffs claim to rely on evidence of fraud by GT&E and on Andersen's position as the corporation's accountant and auditor as the basis for allegations of fraud by Andersen. These facts are insufficient support for claims of fraud. An inference of fraud does not arise from the mere fact that an auditor "certified" an inaccurate report. See Weinberger v. Kendrick, 451 F. Supp. 79, 83 (S.D.N.Y.1978). Plaintiffs must allege circumstances giving rise to an inference of a breach of generally accepted auditing standards amounting to a "fraudulent breach of duty," Jacobson v. Peat, Marwick, Mitchell & Co., supra, 445 F. Supp. at 523; Gross v. Diversified Mortgage Investors, supra, 431 F. Supp. at 1089, or the events on which the information and belief pleading is based. See Ross v. A. H. Robins Co., Inc., 607 F.2d 545 at 558-559, No. 79-7106 (2d Cir. 1979). In Robins, the Court of Appeals for the Second Circuit stated that even though plaintiffs cannot be expected to "plead defendants' actual knowledge" in the complaint, they

 
can be required to supply a factual basis for their conclusory allegations regarding that knowledge. It is reasonable to require that the plaintiffs specifically plead those events which they assert give rise to a strong inference that the defendants had knowledge of the facts . . . or recklessly disregarded their existence. ...

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