In short, Central Bank has generated a fair amount of confusion in the lower courts both in identifying the line between primary and secondary liability and in determining whether that distinction should be implemented on a motion to dismiss or on a motion for summary judgment. After considering these approaches, I conclude that if Central Bank is to have any real meaning, a defendant must actually make a false or misleading statement in order to be held liable under Section 10(b). Anything short of such conduct is merely aiding and abetting, and no matter how substantial that aid may be, it is not enough to trigger liability under Section 10(b).
2. The Claim Based On The 1991 Prospectus
Plaintiffs have alleged that H. J. Meyers participated in drafting and circulating the prospectus for MTC's November 1991 public offering. There is no allegation that H. J. Meyers made any of the allegedly fraudulent representations in that prospectus. Indeed, there is no allegation that it did anything that is not done by lead underwriters with respect to all such public offerings. Again, I conclude that this is precisely the sort of role in an alleged 10(b) violation that, according to Central Bank, is no longer actionable. Accordingly, to the extent that Count One seeks to impose liability on H. J. Meyers based on its role in preparing and disseminating the November 1991 prospectus, it is hereby dismissed.
H. J. Meyers' motion to strike those allegations, however, is denied. As set forth below, the complaint does allege a primary violation of Section 10(b) against H. J. Meyers, and the factual allegations relating to the 1991 prospectus may properly be proved in support of that claim.
3. The Claim Based On The Research Report
The plaintiffs also seek to hold H. J. Meyers liable for its dissemination of a research report about MTC on May 29, 1992, three months before the beginning of the class period. The allegedly fraudulent statements in the report (which relate to the purported joint ventures in China and the revenues those joint ventures were expected to generate) are statements by H. J. Meyers itself, and thus may support an allegation of primary liability.
H.J. Meyers challenges the plaintiffs' claim that the misleading report was a cause in the rise in MTC stock during the class period. Under normal circumstances, plaintiffs in securities cases do not have to make precise allegations of causation in order to plead a primary violation under Section 10(b). In re Crazy Eddie Securities Litigation, 817 F. Supp. 306, 312 (E.D.N.Y. 1993). However, H.J. Meyers points out that shortly after the release of its research report, the price of MTC's stock declined for several months. Because plaintiff's fraud on the market theory is premised on an efficient market, Basic, 108 U.S. at 246, H. J. Meyers argues that its research report could not, as a matter of law, have caused the "spike" in MTC's stock price during the class period. The plaintiffs vigorously dispute this assertion, arguing that the research report contributed to the "totality of the circumstances" which caused the market price of MTC stock to rise.
This dispute strikes me as particularly unsuited for resolution on a motion to dismiss. What role, if any, H. J. Meyers' research report played in the rise of MTC's stock price is an issue of fact. Accordingly, the motion to dismiss this claim is denied.
4. H.J. Meyers' Failure To Correct False Statements.
Finally, H. J. Meyers argues that it cannot be held liable for failing to correct the allegedly false and misleading statements contained in MTC's prospectus and H.J. Meyer's research report. Since H. J. Meyers cannot be held liable as a primary violator for statements contained in MTC's 1991 prospectus, logic dictates that it cannot be held liable for failing to correct those statements.
The plaintiffs also claim, however, that H.J. Meyers had a duty to correct the statements it knew to be false in its 1991 research report.
As a general matter, courts have held that underwriters do not have a duty to correct statements made by an issuer in a prospectus which the underwriter learns to be false and misleading after the underwriter's involvement with the issuing company has ceased. See In re Chaus Securities Litigation, 1990 U.S. Dist. LEXIS 15810 at *35,Fed Sec. L. Rep. (CCH) P 95, 646 (S.D.N.Y. Nov. 20, 1990); Hudson v. Capital Management Int'l, Inc., 565 F. Supp. 615, 623 (N.D. Cal. 1983). However, an issuer has a duty to correct its own statements which become materially false or misleading. IIT v. Cornfeld, 619 F.2d 909, 927 (2d Cir. 1980); In re Phillips Petroleum Sec. Litigation, 881 F.2d 1236 (3d Cir. 1989); Roeder v. Alpha Industries, Inc., 814 F.2d 22, 26-27 (1st Cir. 1987). Courts have also held that professionals such as accountants may have a duty to correct their own statements which later become false or misleading. Rudolph v. Arthur Andersen & Co., 800 F.2d 1040 (11th Cir. 1986); Sharp v. Coopers & Lybrand, 83 F.R.D. 343, 345 (E.D. Pa. 1979).
Here, H.J. Meyers had underwritten an MTC public offering, held warrants of MTC stock, issued a research report praising the company and was quoted in a Business Week article lauding MTC during the class period. Under these circumstances, H.J. Meyers may be held liable as a primary violator for failing to correct its own statements which became materially false and misleading.
G. The Motion of BDO Dunwoody.
Dunwoody moves to dismiss the complaint on the ground that it does not properly allege that Dunwoody is a primary violator of Section 10(b). Specifically, Dunwoody asserts that the plaintiffs have not alleged facts sufficient to establish either its scienter or the existence of any material misstatements by Dunwoody.
Dunwoody's claim that the plaintiffs have not alleged that it made any materially false and misleading statements is incorrect. In fact, the complaint alleges that Dunwoody issued unqualified audit opinions on MTC's 1991 and 1992 financial statements and consented to the inclusion of these opinions in MTC's 1992 10-K statement, a registration statement and six prospectuses filed during the class period. It is further alleged that Dunwoody materially misstated MTC's results of operations and net income, outstanding shares and options and the nature and extent of its business, and that Dunwoody materially misrepresented that it had performed its audit in accordance with generally accepted auditing standards. These allegations are sufficient to state a claim against Dunwoody as a primary violator. See Vosgerichian, 862 F. Supp. 1371, 1378 (E.D. Pa. 1994) (dismissing claims against accountant based on misrepresentations made by client, but holding that accountant's unqualified opinion could be the basis of primary liability); In re Kendall Square, 868 F. Supp. at 28-29 (same).
Dunwoody's second argument is that, in light of Central Bank, the plaintiffs have failed to properly plead scienter. As noted above, in order to properly allege scienter under Section 10(b), a plaintiff must allege facts that either show that the defendant had motive and opportunity to commit fraud or constitute strong circumstantial evidence that the defendant acted knowingly or recklessly. Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128-30 (2d. Cir. 1994).
Dunwoody argues, however, that Central Bank's strict textual reading of Section 10(b) compels the conclusion that the scienter element can no longer be established by a showing of mere recklessness. This is particularly true, Dunwoody adds, with respect to secondary actors, such as accountants. Dunwoody contends that "the clear message of Central Bank was to narrow the liability against such secondary actors, not expand it through concepts like 'recklessness' which are not even in the statute." Dunwoody Mem. at 19-20.
It is true that Central Bank signals a general unwillingness to interpret Section 10(b) expansively. However, Central Bank did not address the scienter requirement, and the Second Circuit -- in a decision postdating Central Bank -- has reaffirmed recklessness as a means of establishing scienter. Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128-29 (2d Cir. 1994).
The plaintiffs have alleged both a motive and an opportunity for Dunwoody to commit fraud, as well as circumstantial evidence which points to recklessness on the part of Dunwoody. First, the plaintiffs allege that Dunwoody's conduct must have been intentional or willfully blind because of Dunwoody's (a) apparent failure to detect the massive stock embezzlement scheme of the Leungs despite its audit of MTC's stock option program; (b) statement indicating that MTC had exclusive contracts with the Chinese government, and (c) repeated correction of its auditing statements covering the class period.
Second, the plaintiffs allege that Dunwoody had a motive to turn a blind eye to the fraud going on around it: aiding the firm in raising capital for its Chinese joint venture and the promise of future profits. There is disagreement over whether motive may be established by a professional's alleged desire for future fees. Compare Bernstein, 702 F. Supp. at 977 (finding that accountant "gained from its alleged role in the preparation of the misleading statements the continued patronage and goodwill of its client"), with Friedman v. Arizona World Nurseries, Ltd., 730 F. Supp. 521, 532 (S.D.N.Y. 1990) (motive may not be established merely from alleging that the firm was compensated for its professional services).
However, considering that the plaintiffs have alleged fraud of such an enormous scope and degree at MTC, I need not address the sufficiency of the allegations of motive. Instead, I find that the allegations of fraud, if proven, are alone sufficient to permit the jury to infer that Dunwoody was at least willfully blind to the fraud. As the court stated in In re Leslie Fay Companies, Inc., 835 F. Supp. 167 (S.D.N.Y. 1993), "when tidal waves of accounting fraud are alleged, it may be determined that the accountant's failure to discover his client's fraud raises an inference of scienter on the face of the pleading." Id. Accordingly, Dunwoody's motion to dismiss is denied.
For the reasons stated above, and in accordance with this Court's ruling of April 10, 1995:
(a) the motion by Edilberto Pozon and Peter Jensen to dismiss the complaint for failure to plead fraud with particularity is DENIED;
(b) the motion by Robert Farr and Goodwin Wang to dismiss Count One for failure to state a claim against them is DENIED;
(c) the motion by MTC, Robert Farr, Peter Jensen, Goodwin Wang, Thomas Lenagh, Edilberto Pozon and David Wong to dismiss Count One for failure to state a claim is GRANTED to the extent that it alleges a conspiracy to violate Section 10(b) of the Securities Act of 1933;
(d) the motion by Miko Leung and Sit Wa Leung to dismiss Count Three for failure to state a claim is DENIED;
(e) the motion by Alan Leung to dismiss the complaint for failure to plead fraud with particularity is DENIED;
(f) the motion by H.J. Meyers to dismiss Count One of the complaint for failure to state a claim is GRANTED only to the extent that Count One is based on H.J. Meyers' preparation or drafting of MTC's November 1991 prospectus. In all other respects, H.J. Meyers' motion to dismiss is DENIED; and
(g) the motion by BDO Dunwoody to dismiss the complaint for failure to state a claim and for failure to plead fraud with particularity is DENIED.
United States District Judge
Dated: September 7, 1995
Brooklyn, New York