failed to assert legally viable claims against Ernst & Young, that defendant is entitled to a dismissal at this time, and questions of the fairness of the proposed order barring Ernst & Young's claims against the settling defendants do not arise.
Evaluating plaintiffs' claims against Ernst & Young by the lenient criteria required by Rule 12(b)(6), I conclude that plaintiffs assert viable claims for securities fraud against the accounting firm, with a particularity sufficient to satisfy Rule 9(b).
The seminal case of Ernst & Ernst v. Hochfelder, 425 U.S. 185, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976), involved charges against an accounting firm that it had violated § 10(b) and Rule 10b-5 by failing to conduct proper audits of a brokerage firm which perpetrated a fraudulent scheme upon the brokerage customers. The Supreme Court held, in the context of the accountants' asserted liability, that scienter was a required element of the implied cause of action under the statute and the rule. The Court expressly left open the question whether reckless behavior constituted intentional conduct sufficient to impose civil liability, but noted that "in certain areas of the law recklessness is considered to be a form of intentional conduct for purposes of imposing liability for some acts." Id. at 193 n.12.
Since Ernst & Ernst, the Second Circuit has repeatedly held that for primary § 10(b) violations, an allegation of recklessness is sufficient. See, e.g., Sirota v. Solitron Devices, Inc., 673 F.2d 566, 575 (2d Cir.), cert. denied, 459 U.S. 838, 74 L. Ed. 2d 80, 103 S. Ct. 86 (1982); IIT, an International Investment Trust v. Cornfeld, 619 F.2d 909, 923 (2d Cir. 1980); Lanza v. Drexel & Co., 479 F.2d 1277, 1305 (2d Cir. 1973) (en banc). The Second Circuit has characterized recklessness as "at the least, conduct which is 'highly unreasonable' and which represents '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.'" Rolf v. Blyth Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir.) (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir. 1977)), cert. denied, 439 U.S. 1039 (1978).
It is now well settled that an accountant's recklessness is sufficient to give rise to primary liability. See, e.g., CL-Alexanders Laing & Cruickshank v. Goldfeld, 739 F. Supp. 158, 163 (S.D.N.Y. 1990); Fund of Funds, Ltd. v. Arthur Andersen & Co., 545 F. Supp. 1314, 1356 (S.D.N.Y. 1982); see also Akin v. Q-L Investments, Inc., 959 F.2d 521, 525-26 (5th Cir. 1992) ("There are three routes by which an accountant may be held liable under [Rule 10b-5]. First, an accountant is directly liable for intentional or reckless misrepresentations if he knows his statements will be communicated to third parties.") (footnote omitted).
As noted, plaintiffs also charge Ernst & Young as an aider and abettor of the primary liability of other defendants. The Second Circuit has held "that recklessness satisfies the scienter requirement where 'the alleged aider and abettor owes a fiduciary duty to the defrauded party,'" Sirota at 575 (quoting Rolf at 570 F.2d at 44). The Second Circuit left open in Sirota whether recklessness is sufficient for secondary liability in the absence of such a relationship. I need not address that question in the case at bar because Ernst & Young's undertaking to furnish a comfort letter to plaintiffs created a fiduciary relationship between those parties.
Accordingly, plaintiffs state viable § 10(b) claims against Ernst & Young. It therefore becomes necessary to consider the viability of Ernst & Young's claims against the settling defendants.
It is well settled that Ernst & Young would not be entitled to indemnity from another with respect to liability based upon its own intentional or reckless conduct. See Globus v. Law Research Service,Inc., 418 F.2d 1276, 1288 (2d Cir. 1969); Department of Economic Development v. Arthur Andersen & Co., 747 F. Supp. 922, 931 (S.D.N.Y. 1990); In re Citisource Securities Litigation, 694 F. Supp. 1069, 1078-9 n.15 (S.D.N.Y. 1988); Odette v. Shearson, Hammill & Co., 394 F. Supp. 946, 956 (S.D.N.Y. 1975).
However, the Supreme Court has recently held that "those charged with liability in a 10b-5 action have a right to contribution against other parties who have joint responsibility for the violation." Musick Peeler & Garrett v. Employers Insurance of Wausau, 124 L. Ed. 2d 194, 113 S. Ct. 2085, 2092 (1993). In the first sentence of his opinion for the Court, Justice Kennedy posed the pertinent inquiry:
Where there is joint responsibility for tortious conduct, the question often arises whether those who compensate the injured party may seek contribution from other joint tortfeasors who have paid no damages or paid less than their fair share.
Id. at 2086.
The Court concluded in Musick that § 10(b) and Rule 10b-5 imply a private right of action for contribution.
If plaintiffs at bar prove their allegations against Ernst & Young, they will have shown Ernst & Young to be a joint tortfeasor with the settling defendants. In the present posture of the case, plaintiffs and the settling defendants prefer to stress Ernst & Young's discrete and separate obligations arising out of the comfort letter Ernst & Young gave to plaintiffs. If Ernst & Young's liability arises from the comfort letter, plaintiffs and the settling defendants argue, the accounting firm cannot be regarded as acting in concert with the settling defendants, so that no right to contribution exists, and Ernst & Young loses nothing through the barring of claims against the settling defendants.
For tactical reasons the proponents of the settlement characterize plaintiffs' claims against Ernst & Young too narrowly. Those claims are based in significant measure upon the accounting firm's conduct as auditor of Cortec's financial statements, quite apart from Ernst & Young's obligations to plaintiffs in connection with the comfort letter. Thus plaintiffs argued in opposing Ernst & Young's motion to dismiss the amended complaint:
Despite knowing Cortec's historical use of these improper practices and giving a specific instruction on the accruals, Ernst & Young's management letter, issued in March 1989 as part of its year end audit in 1988, did not identify the accrual or reserve procedures as ones that needed to be changed. Had it done so, Ernst & Young would have tipped plaintiffs off to Cortec's misconduct and misleading financials.