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February 24, 1986

OPPENHEIM, APPEL, DIXON & CO., a partnership, Defendant

The opinion of the court was delivered by: LASKER


Defendant Oppenheim, Appel, Dixon & Co. moves pursuant to Federal Rules of Civil Procedure 12(b)(6) and 9(b) to dismiss the complaint in this action for failure to state a claim upon which relief can be granted and for failure to plead the fraud claims with sufficient particularity. For the reasons explained below, the motion is granted in part and denied in part.


 The present action arises out of the complex of facts which formed the basis of a previous litigation before this court, Wichita Federal Savings and Loan Association v. Comark, No. 82 Civ. 4703(MEL) (S.D.N.Y.). In that action five savings and loan associations and a municipality sued Comark, a dealer in government securities, and Marine Midland Bank, N.A. ("Marine"), Comark's clearing agent, for losses of $17 million in government securities sustained in June 1982.

 The plaintiffs in the Wichita action were former customers of Comark who alleged

 that Comark represented to the plaintiffs that securities which they had purchased from Comark would be segregated in safekeeping accounts; that the securities were instead deposited and integrated in a Marine account with other securities owned either by Comark or by other customers; that Comark used the plaintiffs' securities as collateral for a loan from Marine; and that Marine sold the plaintiffs' securities to satisfy debts owed by Comark.

 Wichita Federal Savings and Loan Association v. Comark, 586 F. Supp. 940, 942 (S.D.N.Y. 1984). The Wichita action was tried to a jury in the spring of 1985, with the jury returning a verdict for fraud and the court directing a verdict for conversion against Comark. Plaintiffs settled their claims against Marine during the trial.

 The plaintiffs in the present action are four of the five savings and loan associations or their successors in interest who were plaintiffs in the Wichita action and the City of Farmington, New Mexico. *fn1" In this action the plaintiffs seek to hold Comark's accountants, Oppenheim, Appel & Dixon & Co. ("OAD"), liable on a variety of legal theories for the losses they incurred. *fn2"

 The amended complaint, the factual averments of which must be accepted as true on this motion to dismiss, alleges that between July 1981 and May 1982 the plaintiffs purchased *fn3" securities through Comark which were left on deposit for safekeeping and deposited other securities for safekeeping with Comark. As part of its role as Comark's clearing agent during this period, Marine regularly made overnight loans to Comark to finance Comark's inventory positions in government securities. These overnight loans were covered by a security agreement under which Comark granted Marine a floating security interest in all securities in Comark's account at Marine that Comark owned or in which it had an interest. Although Comark had represented to plaintiff customers that their securities would be held in safekeeping, Comark deposited the plaintiffs' securities in an account at Marine with securities that Comark owned, thereby pledging or hypothecating plaintiffs' securities as collateral for the overnight clearance loans. From June 1981 forward Comark's overnight loans almost always exceeded the value of the securities held by Marine that were owned by Comark itself. From August 1981 forward Comark continued its operations insolvent, with its liabilities exceeding its assets. On June 3, 1982 Comark informed Marine of itse financial problems and its pledging of customer-owned securities. Marine responded by foreclosing on its loans to Comark and on June 4, 1982 liquidated plaintiffs' securities, among others, in order to satisfy Comark's then outstanding overnight loan. Those securities had a value at the time of liquidation of over $16 million.

 The amended complaint also alleges that as early as the summer of 1981 Comark informed OAD and Stephen Rubenstein, the OAD partner in charge of the Comark account, about its financial problems and its pledging of customer-owned securities. Subsequently, Rubenstein together with employees of OAD and Comark engaged in an attempt (known as the Board Room Project) to reconcile Comark's records. The Board Room Project also specifically reviewed the accounts of Richard Tisdale, a Comark salesman whose customers included all but one of the plaintiffs. In late October 1981 Rubenstein prepared a memorandum (the "Illegal Acts Memo") (attached to Amended Complaint as Exhibits A & B) for OAD's national management committee in which he detailed Comark's difficulties and discussed OAD's disclosure obligations.

 The amended complaint alleges three distinct instances of OAD's involvement in Comark's fraud and conversion:

 Throughout September and October, 1981 and . . . continuously thereafter, Rubenstein and OAD advised Comark that Comark did not need to disclose to anyone that customer-owned securities were commingled or hypothecated with Comark's securities in one account at Marine.

 In December, 1981, Rubenstein met with Tisdale at Comark's offices in California and informed Tisdale that there would be no material problems with Comark's financial statement for the year ending December 31, 1981.

 [D]uring the course of its audit of Comark in January and February, 1982, OAD drafted, issued and mailed to plaintiffs, or caused to be drafted, issued and mailed to plaintiffs, letters on Comark stationery [representing] that Comark was holding their securities in safekeeping, and request[ing] that plaintiffs confirm directly to OAD their understanding that such securities were being held in safekeeping.

 Amended Complaint at PP 58, 61, 66.

 The plaintiffs claim that as a result of this course of conduct OAD is liable for negligent misrepresentation (count II); fraudulent misrepresentation (count I); violation of the federal and New Mexico securities fraud statutes (counts III & IX); aiding and abetting and conspiracy to commit Comark's fraudulent misrepresentation, conversion and violation of the federal and New Mexico securities fraud statutes (counts VI, VII, IV, & X); and violation of the federal and New Mexico racketeering statutes (counts VIII & XI). *fn4" The plaintiffs seek in the aggregate compensatory damages of over $16 million (or treble damages on the racketeering causes of action) as well as punitive damages of $20 million. OAD moves to dismiss the entire complaint for failure to state any claim upon which relief can be granted.

 II.Negligent Misrepresentation

 OAD argues that the complaint fails to state a claim for negligent misrepresentation by OAD because OAD owed plaintiffs no duty of care under the law of either New York or California. OAD adds that even if plaintiffs were owed a duty of care by OAD, OAD owed Comark a higher legal duty not to disclose without Comark's consent any information learned by OAD in the course of the accountant/client relationship.

 The leading case in New York on the subject of accountants' liability for negligence to third parties absent privity of contract is Credit Alliance Corporation v. Arthur Andersen & Co., 65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110 (1985). In Credit Alliance the Court of Appeals refined the privity rule of Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931) (Cardozo, C.J.), stating:

 Before accountants may be held liable in negligence to noncontractual parties who rely to their detriment on inaccurate financial reports, certain prerequisites must be satisfied: (1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to reply; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants' understanding of that party or parties' reliance.

 Credit Alliance, 65 N.Y.2d at 551, 493 N.Y.S.2d at 443, 483 N.E.2d at 118. The Credit Alliance opinion decided two cases. In the first, the court found that even though the accountants knew or should have known that their client was showing their financial reports to plaintiffs, creditors of the client, in order to induce their reliance on them, the complaint did not allege either a particular purpose for the reports' preparation or any word or action on the part of the accountants directed at the plaintiffs. Id. at 553-54, 493 N.Y.S.2d at 444, 483 N.E.2d at 119. In the second case, in contrast, the court found that the accountants were aware that the primary, if not exclusive, purpose of their audit of the client was to provide the plaintiff bank with the financial information it required, and that the accountants communicated with the bank orally and in writing and in person on numerous occasions. Id. at 554, 493 N.Y.S.2d at 445, 483 N.E.2d at 120. The court dismissed the negligence cause of action in the first case and found the complaint sufficient in the second.

 Applying the Credit Alliance criteria to the facts in the case at hand, the motion to dismiss is denied. The financial reports in this case were the oral representations made by Rubenstein to Tisdale in December 1981 and the audit confirmation letters mailed to the plaintiffs in January and February of 1982. As to the conversation with Tisdale, the amended complaint alleges that Rubenstein knew or should have known that his statements were going to be relied on by Tisdale's customers -- plaintiffs herein -- and the complaint's allegations of Rubenstein's awareness of who Tisdale's customers were sufficiently pleads conduct by the accountant which evinces his understanding of the customers' reliance. Similarly, OAD was charged with the knowledge that Comark intended that the plaintiff customers to whom OAD mailed the audit reports would rely on the representations rcgarding safekeeping contained therein, and the act of sending such letters directly to the plaintiffs satisfies the conduct requirement. Thus, although the conduct linking OAD to the plaintiffs may not have been as direct as in the second Credit Alliance case decided by the New York Court of Appeals, the allegations of the amended complaint are sufficient to fulfill the second and third Credit Alliance criteria.

 As to the first criterion -- the accountants' awareness that their financial reports were to be used for a specific purpose -- the amended complaint alleges that OAD was well aware of the purpose of its audit activities, namely, to investigate and rectify if possible Comark's insolvency and hypothecation of customer-owned securities. Moreover, in view of the complaint's allegation that by the end of October 1981 OAD knew that Comark's problems had not been solved, it is reasonable to conclude that the plaintiffs have adequately pleaded that OAD knew the particular purposes to which its reports were to be put. Consequently, the allegations in the amended complaint meet the first Credit Alliance criterion as well, and the plaintiffs have established that OAD was under a duty of care under New York law not to render negligent financial reports to them. *fn5"

 The parties appear to agree that the fraudulent misrepresentation claim is governed by either New York or California law, in view of the fact that they devote virtually all of their briefs to a discussion of the law of those two jurisdictions. Because we read the New York law as imposing requirements for a negligence cause of action against accountants at least as stringent as the corresponding California law on the duty of care owed by a professional to a third party absent contractual privity, *fn6" an extended treatment of the California case law is not warranted. It suffices to state that by passing muster under the Credit Alliance standards, the plaintiffs' claim for negligent misrepresentation also states a cause of action against OAD under California law.

 OAD's second argument -- that it can not be liable for failing to disclose Comark's illegal activities to plaintiffs because it owed its client a higher legal duty not to disclose to its (Comark's) detriment information learned in the course of its accountant/client relationship without its client's consent -- misses the mark. The amended complaint alleges facts which establish, for the purposes of a motion to dismiss, that OAD made affirmative negligent misstatements of fact, not merely that it failed to disclose certain facts. Certainly, once OAD communicated with the plaintiffs, it owed them a duty to speak truthfully. *fn7"

 Accordingly, OAD's motion to dismiss the plaintiffs' claim of negligent misrepresentation is denied.

 B. Fraudulent Misrepresentation

 OAD makes a number of arguments in support of its motion to dismiss the plaintiffs' common law fraudulent misrepresentation claim. OAD first contends that the allegations as to fraudulent misrepresentations in the amended complaint fail adequately to establish misstatement, materiality, scienter, and reliance -- elements of common law fraud, and that the complaint fails in certain respects to state the circumstances of the alleged fraud with the particularity required by Fed. R. Civ. P. 9(b). With regard to the plaintiffs' allegations that OAD and Rubenstein advised Comark that it need not disclose the problems relating to the pledging of customer-owned securities. OAD's argument has merit.

 A claim for common law fraudulent misrepresentation is sufficiently pleaded if the complaint alleges the misrepresentation of a material fact made with scienter that induces reliance to the detriment of the party to whom the misrepresentation is directed. Fund of Funds, Limited v. Arthur Andersen & Co., 545 F. Supp. 1314, 1359 (S.D.N.Y. 1982); Van Alen v. Dominick & Dominick, Inc., 441 F. Supp. 389, 403 (S.D.N.Y. 1976), aff'd, 560 F.2d 547 (2d Cir. 1977). OAD points out that the advice regarding non-disclosure alleged to have been given by Rubenstein and OAD to Comark was not a misrepresentation of fact, but rather an opinion as to Comark's legal obligations, and that reliance upon advice as to legal matters is unreasonable where the person intended to rely is aware that the advice comes from one not licensed to practice law. OAD also points out that Rubenstein had specifically directed Comark to consult counsel about the commingling problem, see Illegal Acts Memo at 6 (attached to Amended Complaint as Exhibit B), and thus he could not, as a matter of law, be chargeable with either knowledge or intent that Comark would rely on his legal advice. These considerations are persuasive that the plaintiffs' allegations contained in paragraph 58 of the amended complaint fail to satisfy the scienter and reliance elements necessary to make out a claim of fraudulent misrepresentation, *fn8" and accordingly OAD's motion to dismiss is granted to the extent that it is based on the facts discussed immediately above.

 As to the allegations regarding Rubenstein's representations to Tisdale about Comark's financial statement, OAD argues that the representations were not material and that the complaint fails to plead with particularity the elements of scienter and reliance. The Court of Appeals for the Second Circuit has defined a material fact as one to which a reasonable person would attach importance in determining his choice of action in a given transaction. Securities and Exchange Commission v. Great American Industries, Inc., 407 F.2d 453, 459-60 (2d Cir. 1968), cert. denied sub nom. Pagnani v. Securities and Exchange Commission, 395 U.S. 920, 23 L. Ed. 2d 237, 89 S. Ct. 1770 (1969); cf. TSC Industries v. Northway, Inc., 426 U.S. 438, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (1976). It is difficult to imagine what would be of more importance to plaintiffs (who faced decisions about purchasing and depositing securities with Comark) than the information that an intensive audit had by December 1981 revealed Comark to be insolvent and to be engaged in the regular pledging of its customers' securities, or the converse of such information, i.e., that there were no problems. In any event, "materiality is a mixed question of law and fact . . . and a complaint may not properly be dismissed pursuant to Rule 12(b)(6) on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance." Goldman v. Belden, 754 F.2d 1059, 1067 (1985).

 OAD's contention that the allegations in the complaint are conclusory and incomplete and fail to satisfy the scienter and reliance elements is without merit. Rule 9(b) states that "intent, knowledge, and other condition of mind of a person may be averred generally," Fed. R. Civ. P. 9(b), and thus the allegations in the complaint suffice to establish for the purpose of a motion to dismiss that Rubenstein had reason to expect that Tisdale would inform his customers that there would be no problems with the financial statements. Reliance by the plaintiffs may be inferred from the allegations in the amended complaint that Tisdale was informed by Rubenstein, Comark's chief independent auditor, that there would be no problems with Comark's financial statement and that he informed his customers of the substance of the ...

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