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KLEIN v. GOETZMANN

July 12, 1991

ALBERT M. KLEIN, BLANCHE TAVE AND DANIEL SLANE, PLAINTIFFS,
v.
HARRY E. GOETZMANN, JR., JOHN L. BARTOLO, LYNN H. SMITH, HENRY A. PANASCI, JR., CHRIS J. WITTING, ALVIN O. BEILING, ROBERT C. HAYMAN, THOMAS J. PRINZING AND JAMES J. MOSHER, DEFENDANTS.



The opinion of the court was delivered by: McCURN, Chief Judge.

MEMORANDUM-DECISION AND ORDER

This is a putative class action in which the plaintiffs, shareholders in Continental Information Systems, Inc. ("CIS"), allege that certain of the corporation's officers, directors, and an accounting firm, made material misrepresentations and omissions in information provided to the investing public, in violation of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b) and 78t; and Rule 10b-5, 17 C.F.R. § 240.10b-5.

The court issued a prior decision granting in part and denying in part motions by all the defendants to dismiss the first consolidated amended complaint. Klein v. Goetzmann, 745 F. Supp. 107 (N.D.N.Y. 1990). The plaintiffs then filed and served their second consolidated amended complaint (hereinafter referred to as "the complaint") in January 1991.

Defendants Smith, Panasci, Witting and Hayman have moved to dismiss the complaint pursuant to Fed.R.Civ.P. 12(b)(1) and (6) for failure to state a claim upon which relief can be granted, failure to plead fraud with particularity, and for lack of pendent jurisdiction. Specifically, these defendants, who refer to themselves as the "outside directors,"*fn1 contend that the plaintiffs have failed to adequately allege fraud, scienter and culpable participation by these defendants.

The outside directors also move to dismiss cross-claims for indemnification and contribution interposed by defendant Mosher, an executive officer of CIS, in his answer to the complaint. Mosher has not responded to this motion, and the court deems this failure to respond as defendant Mosher's consent to the granting of the outside directors' motion to dismiss the cross-claims, pursuant to Local Rule 10(g).

Defendant Deloitte and Touche, the accounting firm for CIS, was added as a party defendant in the complaint. Deloitte and Touche has moved to dismiss the complaint on the ground that the claims against it are barred by the statute of limitations for section 10(b) and Rule 10b-5 actions.

Discussion

I. OUTSIDE DIRECTORS

The outside directors contend that the complaint is deficient since it fails to allege that any of them made any specific misstatements in financial statements, nor that any of them "culpably participated" in the making of any specific misstatements by others. The plaintiffs argue that (1) the motion to dismiss should be precluded by the law of the case and collateral estoppel doctrines; and (2) that the complaint adequately describes the allegedly fraudulent acts and provides the outside directors with sufficient information to answer the allegations.

With respect to the plaintiffs' first contention, the law of the case and collateral estoppel doctrines do not apply here. As the outside directors correctly assert in their reply memorandum, the issue presented here, whether outside directors are subject to "culpable participation" or "controlling person" liability has not been reached by the court prior to the instant motion. In fact, the court specifically stated in its prior decision that it would not address the issue whether any of the defendants might be subject to "controlling person" liability, since that issue was not raised by the parties. Klein, 745 F. Supp. at 110-11, n. 3. In addition, with respect to collateral estoppel, there has been no final judgment to which collateral estoppel could be attached.

The court turns then to considering whether plaintiffs have adequately pleaded their fraud claims against the outside directors. As noted by the court previously in Klein, complaints alleging fraudulent violations of section 10(b) and Rule 10b-5 must satisfy the requirement in Fed. R.Civ.P. 9(b) that fraud must be stated with particularity. Klein, 745 F. Supp. at 111 (citing Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 114 (2d Cir. 1982)).

An outside director has no duty to insure that all material adverse information about a corporation is conveyed to prospective purchasers of the corporation's stock. Decker, 681 F.2d at 119. An outside director's liability must be that of an "'aider and abettor, a conspirator, or a substantial participant in fraud perpetrated by others.'" Id. (quoting Lanza v. Drexel & Co., 479 F.2d 1277, 1289 (2d Cir. 1973)). However, conclusional allegations that the defendants aided and abetted or conspired are not sufficient. Decker, 681 F.2d at 119. "The complaint must charge a violation of section 10(b) by the Company, knowledge of such violation by the director, and his substantial assistance in the accomplishment of the violation [citation omitted], or else the existence of an agreement between the director and one or more others to accomplish the wrongful purpose of violating section 10(b)." Id. In sum, as stated by the Second Circuit in Lanza:

  We recognize that participation by a director in
  the dissemination of false information reasonably
  calculated to influence the investing public may
  subject such a director to liability under [Rule
  10b-5]. But it is quite a different matter to hold
  a director liable in damages for failing to insure
  that all material, adverse information is conveyed
  to prospective purchasers of the company's stock
  absent substantial participation in the concealment
  or knowledge of it. Absent knowledge ...

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