The opinion of the court was delivered by: EUGENE H. NICKERSON
NICKERSON, District Judge:
Numerous memoranda and orders of this court have recounted the facts of this litigation. The court assumes familiarity with its previous published memoranda and orders dated December 30, 1988, Bernstein v. Crazy Eddie, Inc., 702 F. Supp. 962 (E.D.N.Y. 1988); June 16, 1989, In re Crazy Eddie Sec. Litig., 714 F. Supp. 1285 (E.D.N.Y. 1989); June 19, 1990, In re Crazy Eddie Sec. Litig., 740 F. Supp. 149 (E.D.N.Y. 1990); September 19, 1990, In re Crazy Eddie Sec. Litig., 747 F. Supp. 850 (E.D.N.Y. 1990); March 6, 1991, In re Crazy Eddie Sec. Litig., 135 F.R.D. 39 (E.D.N.Y. 1991); May 1, 1992, In re Crazy Eddie Sec. Litig., 792 F. Supp. 197 (E.D.N.Y. 1992); September 4, 1992, In re Crazy Eddie Sec. Litig., 802 F. Supp. 804 (E.D.N.Y. 1992) (the "September 1992 Order"); and January 20, 1993, In re Crazy Eddie Sec. Litig., 812 F. Supp. 338 (E.D.N.Y. 1993).
Defendants Wertheim Schroder & Co. ("Wertheim"), Bear, Stearns & Co. Inc. ("Bear Stearns") and Salomon Brothers Inc ("Salomon") move for summary judgment with respect to claims against them under section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. § 78j(b), and claims based on common law fraud and negligence. Because the common law fraud and negligence claims against them were dismissed by this court in its September 1992 Order, 802 F. Supp. at 812-13, this opinion addresses only the section 10(b) claims.
The critical facts may be quickly summarized. Wertheim, Bear Stearns and Salomon (collectively, the "Underwriters") underwrote public offerings of Crazy Eddie stock on March 7, 1986 and debentures on June 24, 1986.
The Class Plaintiffs' Fourth Supplemental Amended and Consolidated Complaint alleges that prior to, in the course of, and subsequent to, these two offerings, Crazy Eddie management engaged in a series of fraudulent schemes designed falsely to portray Crazy Eddie as a thriving, well-managed and profitable enterprise, positioned to grow in the years to come, when in fact the company was losing money in part due to looting by Crazy Eddie management.
The complaint alleges, for example, that (1) Crazy Eddie founder Eddie Antar and other officers skimmed cash from store receipts prior to Crazy Eddie's initial public offering in September 1984 causing post-offering gross sales falsely to suggest extraordinary growth; (2) they later placed some of this skimmed cash into the cash registers of selected stores in order to inflate the growth rate of "same store" sales, a trend that was closely watched by investment analysts; (3) they over-reported company inventory and underreported accounts payable by tens of millions of dollars; and (4) they looted Crazy Eddie inventory through a series of sham transactions.
In late 1987, after Crazy Eddie had been acquired through a tender offer, new management discovered and announced that Crazy Eddie had overstated its inventory by some $ 65 million. As a result of new management's discovery that former management had consistently overstated company profits and had looted receipts and inventory, the value of Crazy Eddie securities collapsed. Its common stock is now worthless, and its debentures have little value.
Plaintiffs, a class of Crazy Eddie securities purchasers, contend that the Underwriters violated section 10(b) and Rule 10b-5 promulgated thereunder by intentionally or recklessly misleading investors in disseminating the prospectuses in connection with the March and June 1986 public offerings, thereby causing losses to plaintiffs.
Section 10(b) makes it "unlawful for any person, . . . to use or employ . . . any manipulative or deceptive device or contrivance" in contravention of rules and regulations issued by the Securities and Exchange Commission. 15 U.S.C. § 78j(b). Rule 10b-5, promulgated under that section prohibits, in addition to nondisclosure and misrepresentation, any "artifice to defraud" or any act "which operates or would operate as a fraud or deceit." 17 C.F.R. § 240.10b-5.
The Underwriters contend that the plaintiffs have no evidence demonstrating that (i) the alleged misrepresentations and omissions were material; (ii) the Underwriters acted with scienter; or (iii) plaintiffs' losses can be attributed to material facts known to or recklessly disregarded by the Underwriters.
The parties agree, in substance, as to the legal standards defining materiality, scienter and loss causation.
The Supreme Court defined materiality in TSC Industries, Inc. v. Northway Inc., 426 U.S. 438, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (2d Cir. 1976), holding, in the context of a false proxy statement, that a fact is material:
if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.
The Second Circuit has adopted the TSC Industries standard in claims arising under section 10(b). See, e.g., Securities and Exch. Comm'n v. Bausch & Lomb, Inc., 565 F.2d 8, 14-15 (2d Cir. 1977).
In determining whether a prospectus is materially misleading, the court may examine the literal truth or materiality of each statement or omission, or the aggregate impression created by the disclosure. See State Teachers Retirement Bd. v. Fluor Corp., 566 F. Supp. 945, 949 (S.D.N.Y. 1983) ("it is not any particular item on the laundry list that counts, but rather, it is the totality of the list and its overall impact on potential buyers and sellers that must be considered").
In Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976), the Supreme Court held that, in a private action under section 10(b), plaintiff must show defendant acted with scienter, by which the Court meant "an intent to deceive, manipulate, or defraud." The Court reasoned that the term "manipulative" in section 10(b) "connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities." Id. at 199. The Court explicitly left undecided the question of "whether, in some circumstances, reckless behavior is sufficient for civil liability under § 10(b) and Rule 10b-5." Id. at 194 n.12.
Before and since Hochfelder, the Second Circuit has held that proof of reckless disregard for the truth satisfies the scienter element "in appropriate circumstances." See, e.g., Rolf v. Blyth, Eastman Dillon & Co., Inc., 570 F.2d 38, 47 (2d Cir.), cert. denied, 439 U.S. 1039, 58 L. Ed. 2d 698, 99 S. Ct. 642 (1978) (defining reckless conduct as "an extreme departure from the standards of ordinary care . . . to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it").
In re Fischbach Corp. Sec. Litig., No. 89-5826, 1992 U.S. Dist. LEXIS 373, at *15 (S.D.N.Y. Jan. 15, 1992), the court observed that "actions performed with deliberately cultivated ignorance are a form or intentional conduct" meeting the scienter requirement. The court further explained that:
Typically, the defendant enjoys a profitable association with another who is willfully committing a fraud. . . . The defendant is motivated not to 'open his eyes' to the underlying facts, since this would place him in a position of terminating his profitable financial situation and exposing his associate, or continuing his participation in the fraudulent activities, but now without his modicum of deniability. The combination of this motivation and an otherwise unlikely degree of carelessness gives rise to an inference of deliberate disregard for the facts.
Id. at *18-19. The Fischbach court concluded that "where the circumstances suggest an egregious failure to gather information, which in turn suggests the defendant deliberately shut his eyes to the truth, the scienter requirement is met." Id. at *19.
Plaintiffs must also show that their losses were caused by defendants' conduct. That is, in addition to proving that plaintiffs relied on material misrepresentations in purchasing Crazy Eddie securities (defendants do not raise here the issue of reliance), plaintiffs must show that the economic harm they suffered occurred as a result of the alleged material misrepresentation or omission. Citibank, N.A. v. K-H Corp., 968 F.2d 1489, 1495 (2d Cir. 1992). In order to establish loss causation, a plaintiff must prove that the damage suffered was a foreseeable consequence of the misleading disclosure. Id.
In Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 61-62 (2d Cir. 1985), for example, the Second Circuit held that Attorneys who assisted in the preparation of material false financial disclosures did not proximately cause plaintiff's losses when the proceeds from the sale of securities were subsequently funneled ...