The opinion of the court was delivered by: MICHAEL MUKASEY, Chief Judge, District
This opinion and order treats two motions to dismiss a consolidated
class action. The action arises out of an announcement of losses and
restatement of earnings by Philip Services Corporation ("Philip"), a
Canadian metal processing company.
Plaintiffs represent an uncertified class of investors who purchased
Philip stock or call options during the proposed class period, or
former shareholders of companies whose stock was exchanged for Philip
stock. The gravamen of their complaint is that Philip perpetrated a
massive fraud upon its shareholders by making various fraudulent
misrepresentations concerning the income and value of the company during
a three-year period between 1995 and 1998. Plaintiffs have sued, among
others, Philip's outside auditor Deloitte & Touche LLP ("Deloitte"),
alleging violations of Section 10(b) of the Securities Exchange Act of
1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) (2000), and Rule 10b-5
promulgated thereunder, and Section 11 of the Securities Act of 1933 (the
"Securities Act"), 15 U.S.C. § 77k (2000); and Philip directors William
Haynes and Robert Knauss, alleging violations of Section 20(a) of the
Exchange Act, 15 U.S.C. § 78t(a) (2000), Section 11 of the Securities
Act, and Section 15 of the Securities Act, 15 U.S.C. § 77o (2000).
All of the defendants named in the action previously moved to dismiss
on forum non conveniens grounds. In addition, Deloitte, Haynes and Knauss moved to dismiss the claims asserted against
them under Fed.R.Civ.P. 12(b)(6) for failure to state a claim. By
previous order, I dismissed the action on forum non conveniens grounds.
See In re Philip Servs. Corp. Sec. Litig., 49 F. Supp.2d 629 (S.D.N.Y.
1999). On appeal, the Court of Appeals reversed and remanded for
consideration of the motions to dismiss for failure to state a claim.
This opinion resolves those motions.
For the reasons set forth below, the motions to dismiss are denied as
to all claims, except that Haynes' and Knauss' motion to dismiss the
Section 20(a) claim is granted in part.
Many of the facts underlying this action are set forth in prior
opinions issued by the Second Circuit and this court. See DiRienzo v.
Philip Servs. Corp., 294 F.3d 21 (2d Cir. 2002); DiRienzo v. Philip
Servs. Corp., 232 F.3d 49 (2d Cir. 2000); In re Philip Servs. Corp. Sec.
Litig., 49 F. Supp.2d 629 (S.D.N.Y. 1999). Familiarity with those
opinions is assumed for current purposes, and what follows are only those
facts relevant to the motions presently under consideration.*fn1 The
facts are either undisputed or presented in the light most favorable to
plaintiffs. Between 1992 and 1997, Philip sought to expand its revenue base, range
of services and network of facilities throughout North America. To the
extent relevant here, Philip's expansion effort assumed two forms.
First, in July 1997, Philip acquired two companies Allwaste, Inc.
("Allwaste") and Serv-Tech, Inc. ("Serv-Tech") in stock-for-stock deals
worth approximately $560 million. Second, in November 1997, Philip placed
secondary stock offerings in the U.S. and Canada (the "November 1997
public offerings"), raising from investors approximately $380 million.
On January 26, 1998, Philip announced it would take charges to earnings
for fiscal year 1997 of between $250 and $275 million. Over the next
several months, this figure was increased to over $381 million. In
addition, Philip restated its financial statements for fiscal years 1995,
1996, and 1997. The restatements showed that Philip had overstated its
1995 earnings by $22.5 million and its 1996 earnings by $48.3 million.
After these announcements, Philip's share price dropped from $13 1/8 on
January 16, 1998 to $2 9/16 in July 1998, a loss of approximately 80
Philip's announcements and the drop in its share price loosed a torrent
of litigation in the United States and Canada. In the United States, more
than 20 class action lawsuits were commenced in various jurisdictions.
The Judicial Panel on Multi-District Litigation transferred the cases to this court for coordinated pre-trial
proceedings.*fn2 Plaintiffs filed a 157-page, 453-paragraph Consolidated
and Amended Class Action Complaint ("Complaint"), alleging numerous
fraudulent misrepresentations regarding Philip's financial condition and
financial results. The Complaint names as defendants, among others,
Deloitte, Haynes and Knauss.
Deloitte is a member of Deloitte Touche Tohmatsu, a federation of
affiliated accountants headquartered in New York City. Deloitte served as
Philip's outside auditor beginning in 1990 and for the entirety of the
proposed class period. (Compl. ¶¶ 83, 282) It staffed and performed the
audit of Philip's financial statements from its Mississauga, Ontario,
Canada office. (Id. ¶ 284) According to the Complaint, the Philip audit
engagement was "one of the largest accounts (if not the largest account)
handled by the Mississauga office of Deloitte." (Id. ¶ 291)
Deloitte issued unqualified or "clean" audit opinions on Philip's
financial statements for fiscal years 1995 and 1996. (Id. ¶ 286) In both
opinions, Deloitte stated that it had conducted the audit "in accordance
with auditing standards generally accepted in Canada" and that, in Deloitte's opinion, the
financial statements "present fairly, in all material respects, the
financial position of the Company" as at year-end, "in accordance with
accounting principles generally accepted in Canada." (Id. ¶¶ 287, 288;
1995 Philip Annual Report, Serio Decl. Ex. A ("1995 Report"), at 36; 1996
Philip Annual Report, Serio Decl. Ex. B ("1996 Report"), at 38) Philip
included the audit opinions in its Form 40-Fs annual reports that
certain Canadian issuers file with the Securities and Exchange Commission
("SEC") pursuant to Section 13(b) or 15(d) of the Exchange Act of 1934
for fiscal years 1995 and 1996. (Compl. ¶¶ 100, 287, 288; 1995 Report at
36; 1996 Report at 38) Moreover, Deloitte agreed to the inclusion of its
1996 audit opinion in the registration statements accompanying the
Allwaste and Serv-Tech mergers and the November 1997 public offerings.*fn3
(Id. ¶¶ 125, 286, 386, 411, 433) In connection with the November
1997-registration statement, Deloitte updated its 1996 audit opinion to
reflect Philip's compliance, in all material respects, with accounting
principles generally accepted in the United States, and confirmed this information as of a week before the November 1997 public offerings.
(Id. ¶ 289)
The Complaint alleges that the 1995 and 1996 audit opinions were false
and misleading because, contrary to its representations, Deloitte
knowingly or recklessly failed to disclose Philip's multiple violations
of U.S. and Canadian Generally Accepted Accounting Principles ("GAAP")
and, in preparing the audit opinions, failed to comply with U.S. and
Canadian Generally Accepted Accounting Standards ("GAAS").*fn4 (Id. ¶¶
4, 167, 230, 270-336) The Complaint asserts claims against Deloitte
pursuant to Section 10(b) of the Exchange Act, and Rule 10b-5 promulgated
thereunder, and Section 11 of the Securities Act of 1933.
Claims Against Haynes and Knauss
Haynes and Knauss were directors of Allwaste before its acquisition by
Philip in July 1997, and were appointed directors of Philip on August 6,
1997. (Id. ¶¶ 60, 61) Knauss was appointed Chairman of Philip's Board on
May 6, 1998. (Id. ¶ 60) The Complaint alleges that Haynes and Knauss
attended a board of directors meeting at which the participants discussed Philip's improperly
recorded earnings for the third quarter of 1997, and then signed the
November 1997 registration statement, which made no disclosure that the
earnings therein reported were fraudulent. (Id. ¶¶ 60-61, 236-238) The
Complaint asserts claims against Haynes and Knauss pursuant to Section
20(a) of the Exchange Act and Sections 11 and 15 of the Securities Act.
For purposes of a motion to dismiss, the court must accept as true all
allegations in the complaint and draw all reasonable inferences in the
plaintiffs' favor. Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 534 (2d
Cir. 1999). Also, for purposes of a Rule 12(b)(6) motion in a securities
case, a complaint is deemed to include any statements or documents
incorporated in it by reference, as well as publicly disclosed documents
required by law to be, and that actually have been, filed with the SEC,
and documents the plaintiffs either possessed or knew about and upon
which they relied in bringing suit. Rothman v. Gregor, 220 F.3d 81, 88
(2d Cir. 2000) (citations omitted). III.
As described above, the Complaint alleges multiple claims against
Deloitte, Haynes and Knauss under various provisions of the federal
securities laws. Each claim will be addressed in turn.
A. Section 10(b) of the Exchange Act
The first claim in the Complaint alleges that Deloitte committed
securities fraud in violation of Section 10(b) and Rule 10b-5 promulgated
thereunder. Section 10(b) makes it unlawful "[t]o use or employ, in
connection with the purchase or sale of any security . . ., any
manipulative or deceptive device or contrivance in contravention of such
rules and regulations as the Commission may prescribe as necessary or
appropriate in the public interest or for the protection of investors."
15 U.S.C. § 78j(b). Rule 10b-5 lists the following among the acts
proscribed by Section 10(b): "To make any untrue statement of a material
fact or to omit to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they were
made, not misleading." 17 C.F.R. § 240.10b-5(b). The Second Circuit has
held that to state a claim under Section 10(b) and Rule 10b-5, a
plaintiff must allege that the defendant: "(1) made misstatements or
omissions of material fact; (2) with scienter; (3) in connection with the
purchase or sale of securities; (4) upon which plaintiffs relied; and (5) that plaintiffs'
reliance was the proximate cause of their injury." In re IBM Corp. Sec.
Litig., 163 F.3d 102, 106 (2d Cir. 1998) (citations omitted).
Deloitte moves to dismiss the Section 10(b) claim on the grounds that
the Complaint (1) fails sufficiently to allege scienter; and (2) fails to
allege fraud with sufficient particularity.
In order to state a Section 10(b) claim, a plaintiff must allege that
defendants acted with scienter, i.e., fraudulent intent. See Ernst &
Ernst v. Hochfelder, 425 U.S. 185, 193 (1976) (finding that the Exchange
Act "clearly connotes intentional misconduct" and thus a plaintiff must
plead scienter). The Private Securities Litigation Reform Act of 1995
("PSLRA") codified the scienter requirement and established a pleading
standard. Pursuant to that statute, a complaint alleging a Section 10(b)
claim must "state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of mind."
15 U.S.C. § 78u-4(b)(2).
Even before passage of the PSLRA, the Second Circuit interpreted Fed.
R. Civ. P. 9(b), which governs fraud claims generally, to require
securities fraud plaintiffs to allege facts giving rise to "a strong inference of fraudulent intent." See, e.g.,
Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1127-28 (2d Cir.
1994). See also Sec. & Exch. Comm'n v. KPMG LLP, 03 Civ. 671 (DLC), 2003
U.S. Dist. LEXIS 14521, at *10-11 (S.D.N.Y. Aug. 22, 2003) (noting that
securities fraud plaintiffs have "long been required to state with
particularity `facts that give rise to a strong inference of fraudulent
intent.'") (quoting Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir.
1995.)). Accordingly, the Second Circuit has ruled that the PSLRA
heightened the nationwide pleading standard to the level already used by
the Second Circuit. See Levitt v. Bear Stearns & Co., 340 F.3d 94, 104
(2d Cir. 2003); Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir. 2001).
Because the PSLRA effectively codified the existing Second Circuit
pleading standard for scienter, I may look to the Circuit's pre-PSLRA body
of case law to determine whether plaintiffs sufficiently allege scienter
in this case. See Novak v. Kasaks, 216 F.3d 300, 311 (2d Cir. 2000)
("[W]e hold that the PSLRA adopted our "strong inference' standard. . . .
Therefore, in applying this standard, district courts should look to
the cases and factors . . ." already established by the Circuit.); Hart
v. Internet Wire, Inc., 145 F. Supp.2d 360, 366 (S.D.N.Y. 2001) (noting
that "we may apply the standards for scienter that have been developed in
this Circuit" in weighing sufficiency of scienter allegations). In the Second Circuit, a plaintiff can generate the requisite ...