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IN RE PHILIP SERVICES CORP.

May 19, 2004.

IN RE PHILIP SERVICES CORP. SECURITIES LITIGATION; THIS DOCUMENT RELATES TO: ALL ACTIONS


The opinion of the court was delivered by: MICHAEL MUKASEY, Chief Judge, District

OPINION AND ORDER

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.

  I.

  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 percent.

  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.

 Claims Against Deloitte

  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.

  II.

  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.

 1. Pleading Scienter

  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 ...


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