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SECURITIES INVESTOR PROTECTION v. BDO SEIDMAN

May 14, 1999

SECURITIES INVESTOR PROTECTION CORPORATION AND JAMES W. GIDDENS, AS TRUSTEE FOR THE LIQUIDATION OF THE BUSINESS OF A.R. BARON & CO., INC., PLAINTIFFS,
v.
BDO SEIDMAN, LLP, DEFENDANT.



The opinion of the court was delivered by: Preska, District Judge.

  OPINION

Plaintiffs, the Securities Investor Protection Corporation ("SIPC") and James W. Giddens as Trustee (the "Trustee") for the liquidation of the business of securities broker-dealer AR. Baron & Co., Inc. ("Baron"), brought this action against defendant EDO Seidman, LLP ("Seidman") seeking damages for various state law causes of action, such as negligence, fraud and breach of contract. In essence, the action is one seeking recovery for an accountant's misrepresentations. Defendant has now moved to dismiss the complaint pursuant to Federal Rules of Civil Procedure 12(b)(1) and 12(b)(6) on grounds of standing and the failure to state a claim. For the reasons set forth below, defendant's motion is granted.*fn1

BACKGROUND

For purposes of this motion, the facts alleged in plaintiffs' complaint (the "Complaint") are presumed to be true. Seidman is a national accounting firm which served as the independent certified public accountant for Baron, a securities brokerdealer, and which also audited Baron's financial statements for the years 1992 through 1995. (See Complaint ¶ 1). Baron achieved notoriety in the 1990's, when the excesses and illicit activities of its management (the "Bressman Team") became widely known. The "Bressman Team," as defined in the Complaint, consisted of such members of Baron's senior management as chief executive officer Andrew Bressman, chief financial officers Mark Goldman and John McAndris, and brokers Roman Okin and Brett Hirsch. (See id. ¶ 9). The Bressman Team's illegal activities included the following: (1) fraudulent sales of securities; (2) manipulation of initial public offerings of securities; (3) manipulation of trading in the after-market of those securities for which Baron was the sole or dominant market maker and creation of artificially inflated values for those securities; and (4) frenzied purchases on corporate credit cards for personal expenses that totaled several million dollars. (See id. ¶¶ 9, 12). The Complaint alleges that the Bressman Team acted with the express purpose of enriching themselves, their friends and other insiders to the detriment of Baron. (See id. ¶ 9). To that end, the Bressman Team "caused Baron to issue false and misleading financial reports, including those audited by Seidman, in order to prolong their fraudulent scheme and increase their personal gain." (Id. ¶ 13).

When the unlawful activities at Baron were revealed, criminal indictments were brought against Baron employees. In total, thirteen Baron employees pleaded guilty or were convicted for their participation in fraudulent activity and other criminal wrongdoing at Baron. (See id. ¶ 10). Baron itself entered into a guilty plea on one count of enterprise corruption. (See id. ¶ 11). Although the complaint asserts that no evidence exists that all employees engaged in or assisted the illegitimate activities of the Bressman team, (see id.), it does not allege that any individual member of Baron's management was innocent of those activities and could have put a halt to the fraudulent activities.

Plaintiffs contend that Seidman is liable for its failure to audit adequately Baron's financial statements for the years 1992 through 1995. (See id. ¶¶ 19, 21, 23, 25). Generally, plaintiffs seek to recover for: (1) Seidman's alleged multiple misrepresentations as Baron's certified public accountant; (2) Seidman's failure to conduct year-end audits of Baron in accordance with generally accepted auditing standards ("GAAS"); (3) Seidman's failure to disclose that Baron did not present fairly its yearend financial statements in accordance with generally accepted accounting principles ("GAAP"); and (4) Seidman's failure to comply with the rules and regulations of the Securities and Exchange Commission ("SEC") governing the practice of independent certified public accountants for SEC registrants. (See id. ¶ 1).

Among the most damaging of Seidman's alleged acts as Baron's certified independent accountant was its failure to disclose that Baron lacked adequate reporting systems and internal controls to detect or prevent fraud. (See id. ¶¶ 40-44). Plaintiffs allege that Seidman's failure to disclose this information permitted the Bressman Team to hide the true financial state of Baron. For example, the Bressman Team was able to create the illusion that Baron had sufficient net capital by reducing the inventory of "house stocks" through the placement of securities in retail customer accounts and with other broker-dealers, artificially inflating values of securities where Baron was the dominant or sole market maker and understating the amount of loss contingencies disclosed in Baron's year-end financial statements. (See id. ¶¶ 14-15).

At the heart of the Complaint is plaintiffs' contention that Seidman's inadequate performance as Baron's independent auditor created a breach in the regulatory framework of federal securities laws which were designed to protect customers from the harm of broker-dealer failure. Plaintiffs do not state in the Complaint whether SIPC or Baron's customers actually received, read or reviewed the financial statements certified by Seidman. Plaintiffs claim reliance upon those certified financial statements because they were sent to "the SEC, NASD and others" and SIPC, Baron and Baron's customers relied on those entities to ensure Baron's compliance with the applicable regulatory rules. (See id. ¶ 54). In furtherance of that argument, plaintiffs contend that the certified financial statements and the independent auditors' report attached to those financial statements, which are required by the securities laws, are "crucial elements of the effective regulatory system." (Id. ¶ 17). The Complaint states that Seidman knew or should have known that the "end and aim of its engagement to audit the financial statements of Baron" was to ensure adherence with the regulatory guidelines set forth in SEC Rule 17a-5. (See id. ¶ 57).

SIPC brings this action on its own behalf and as the subrogee to the net equity claims of Baron's customers which have been paid by SIPC. (See id. ¶ 14). SIPC has provided over $5.5 million for the payment of claims submitted by these customers and administrative expenses of the liquidation. (See id. ¶ 47). The Trustee brings this action as (1) the bailee of the fund of customer property entrusted to Baron by customers; (2) as assignee of the rights and claims of customers whose net equity claims have been paid by the Trustee; and (3) as the representative of the estate of Baron in liquidation. (See id. ¶ 5). The Trustee was appointed as trustee for the liquidation of Baron pursuant to an order of this Court in SIPC v. A.R. Baron & Co., Inc., No. 96 Civ. 5171 (S.D.N.Y. July 11, 1996) (the "Protective Decree"). Since the establishment of the Protective Decree, the Trustee has paid over $2.5 million to customers and other creditors for which it has received assignments. (See id. ¶ 48).

DISCUSSION

I. Motion to Dismiss Standard

In deciding this motion to dismiss, I must view the complaint in the light most favorable to plaintiffs. Scheuer v. Rhodes, 416 U.S. 232, 237, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974); Yoder v. Orthomolecular Nutrition Institute, Inc., 751 F.2d 555, 562 (2d Cir. 1985). I must accept as true the factual allegations stated in the complaint, Zinermon v. Burch, 494 U.S. 113, 118, 110 S.Ct. 975, 108 L.Ed.2d 100 (1990), and draw all reasonable inferences in favor of the plaintiffs. Haines v. Kerner, 404 U.S. 519, 520-21, 92 S.Ct. 594, 30 L.Ed.2d 652 (1972); Hertz Corp. v. City of New York, 1 F.3d 121, 125 (2d Cir. 1993), cert. denied, 510 U.S. 1111, 114 S.Ct. 1055, 127 L.Ed.2d 375 (1994). A motion to dismiss can only be granted if it appears beyond doubt that the nonmoving party can prove no set of facts in support of its claim which would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). Even under this liberal standard, however, the plaintiffs' claims suffer from deficiencies that require their dismissal at this time.

II. Securities Investor Protection Act Generally

Congress enacted the Securities Investor Protection Act of 1970, as amended, 15 U.S.C. § 78aaa-78lll (1994) (the "Act" or "SIPA"), after a business contraction in the securities industry led to a rash of failures among brokerage firms. See SIPC v. Barbour, 421 U.S. 412, 415, 95 S.Ct. 1733, 44 L.Ed.2d 263 (1975). After that contraction, "customers of failed firms found their cash and securities on deposit either dissipated or tied up in lengthy bankruptcy proceedings." Id. SIPA was intended to "arrest this process, restore investor confidence in the capital markets, and upgrade the financial responsibility requirements for registered brokers and dealers." Id. SIPA created a new form of liquidation proceeding that was "applicable only to member firms, designed to accomplish the completion of open transactions and the speedy return of most customer property." Id. at 415-16, 95 S.Ct. 1733. Those investors who had left identifiable securities in their names with the brokerdealer or cash balances to be used for investment purposes (which collectively constitute "net equity claims") are entitled to receive such securities and cash from the liquidator before other creditors may share in the estate. See Mishkin v. Peat, Marwick, Mitchell & Co., 744 F. Supp. 531, 555 (S.D.N.Y. 1990). The Act contemplates that customers' claims will be satisfied to the greatest extent possible from the bankrupt brokerage firm. See Appleton v. First National Bank of Ohio, 62 F.3d 791, 794 (6th Cir. 1995).

The Act also created SIPC. SIPC is a nonprofit membership corporation to which most broker-dealers are required to belong. 15 U.S.C. § 78ccc(a). SIPC protects customers from broker-dealer insolvencies by insuring the "net equity" of customers' accounts up to $500,000. See §§ 78fff-3(a); 78lll(11). As defined by SIPA, "net equity" is the amount that the broker would have owed a customer had it liquidated all the customer's holdings on the date SIPC filed for a protective decree, less any outstanding debt the customer owed to the broker. See § 78lll(11). To encourage the prompt resolution of customer claims, SIPC may advance funds to brokerage customers or to an appointed trustee. See § 78fff-3 (a-c). To the extent SIPC advances funds, either to the trustee or directly to brokerage customers, it is subrogated to the customers' claims, See §§ 78fff-3(a), 78fff-4(c).

III. Standing

One of the issues before me involves the plaintiffs' standing to bring this action — either on behalf of themselves or on behalf of Baron's customers. The Constitution limits the judicial power of the federal courts to deciding cases or controversies. U.S. Const. art. III, § 2, cl. 1. To have standing, a plaintiff must allege personal injury that is fairly traceable to the defendant's allegedly unlawful conduct and which is likely to be redressed by the requested relief. See Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1091 (2d Cir. 1995) (citing Allen v. Wright, 468 U.S. 737, 751, 104 S.Ct. 3315, 82 L.Ed.2d 556 (1984)). A party must "assert his own legal rights and interests, and cannot rest his claim to relief on the legal rights or interests of third parties." Warth v. Seldin, 422 U.S. 490, 499, 95 S.Ct. 2197, 45 L.Ed.2d 343 (1975). Standing is a jurisdictional matter and the ...


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