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December 14, 2004.

VTECH HOLDINGS LIMITED, et ano., Plaintiffs,

The opinion of the court was delivered by: LEWIS KAPLAN, District Judge


Plaintiffs VTech Holdings, Ltd. and VTech Europe B.V. (collectively "VTech") claim that defendant PricewaterhouseCoopers ("PwC") is partly to blame for its unsuccessful acquisition of the consumer telephone business of Lucent Technologies, Inc. and Lucent Technologies Consumer Products, LP (collectively "Lucent"). Plaintiffs seek recovery on theories of accounting malpractice, breach of contract, breach of fiduciary duty, aiding and abetting the fraudulent activities of Lucent, fraud and fraudulent concealment. PwC moves to dismiss the Second Amended Complaint on the ground that it fails to state a claim upon which relief may be granted and fails to plead fraud with particularity.


  A. The Independent Auditor Agreement

  In late 1999, VTech proposed to acquire Lucent's consumer telephone division, known as the "Wired Business."*fn1 To complete the acquisition, VTech sought the approval of its shareholders and hired PricewaterhouseCoopers of Hong Kong ("PwC Hong Kong") in connection with the preparation of a Circular describing the deal. The Circular, which was required by the London and Hong Kong stock exchanges, consisted of a letter from the board of VTech recommending the purchase, an accountant's report by PwC Hong Kong on the Wired Business, and general and financial information relating to VTech.*fn2

  According to the plaintiff, in early January 2000, VTech and PwC (as distinguished from PwC Hong Kong) entered into an oral agreement that PwC would assist in preparing the Circular and that it would serve as VTech's independent auditor in connection with the proposed acquisition.*fn3 VTech alleges that PwC was supposed to "prepare and provide VTech with financial records pertaining to the Lucent Business which were necessary for inclusion in the Circular."*fn4 Prior to entering into its oral agreement with VTech, PwC had disclosed that it was Lucent's auditor and assured VTech that this conflict would not be a problem.*fn5

  PwC subsequently told VTech that it could not conduct a full audit of the Wired Business because Lucent had not prepared separate accounts on a standalone basis.*fn6 PwC Hong Kong encountered this problem as well and disclosed it in its accountant's report in the Circular.*fn7 As they could not analyze the accounts independently, PwC and PwC Hong Kong relied on a representation letter of Lucent management dated March 1, 2000, which stated that:
"[t]o the best of our knowledge and belief, no events have occurred subsequent to 30th September, 1999 and through the date of this letter that would require adjustment to or disclosure in the combined financial information, except for the US $2.2 million adjustment to the warranty provision which has been reflected in the combined financial information and the sale of the Wired Business to VTech."*fn8
  Although PwC Hong Kong prepared the Circular as a whole and signed the accountant's report in it, VTech alleges that PwC caused an excerpt from Lucent's letter to appear in footnote eleven of that report.*fn9 The footnote stated that: "[i]n the opinion of Management of LTCP [Lucent], no significant events have taken place subsequent to 30th September, 1999."*fn10

  VTech alleges that PwC neglected and refused to investigate the accuracy Lucent's opinion and that, had it done so, it would have found that Lucent management did not in fact hold this opinion.*fn11 Moreover, it alleges that PwC could have evaluated the accounts of the Wired Business and that this data had been extracted from Lucent's books for another prospective buyer in 1999.*fn12

  VTech now alleges that significant adverse events regarding Lucent's consumer telephone products had occurred between September 30, 1999 and January 19, 2000. During that period, the Wired Business had accumulated more than two hundred thousand Falcon and Osprey telephone products that it was unable to sell.*fn13 Moreover, its sales and production forecasts had declined, and independent testing had established that the Falcon telephone product was so faulty as to be unmarketable.*fn14

  PwC allegedly knew about these problems in its capacityas auditor for Lucent. VTech claims that PwC concealed these adverse events so as not to jeopardize its relationship with Lucent.*fn15

  B. The Business Advisory Agreement

  In order to integrate the soon to be acquired Wired Business into the company, VTech sought to hire PwC as its business advisor. In December of 1999, PwC told VTech that one of the people working on the proposed business advisory project would be Steven Smith, a PwC partner who had been in charge of the Lucent audit.*fn16

  Relying on the promise that the engagement would be staffed with people knowledgeable about Lucent, VTech hired PwC as its business advisor on January 27, 2000 pursuant to a written agreement.*fn17 As VTech's business advisor, PwC stated it would:
"[a]ssess the relative financial impact and probability of success of key management actions[;] * * *
"[c]onduct focus group meetings with a sampling of employees . . . to capture feedback on their understanding of the reasons for the changes";*fn18 and
"combine the information we obtain from these interviews with financial data and other company information to build a detailed, interactive model of the important post-deal actions."*fn19 The agreement provided also that PwC would create transition teams, identify and work through organizational and cultural obstacles to integration,*fn20 and "staff the engagement to ensure continuity and incorporation of our knowledge of VTech/Lucent Wired operations."*fn21 PwC warranted that "the Services will be performed and supervised by qualified personnel."*fn22
  In February of 2000, PwC participated on behalf of VTech in an audit of inventory in Lucent's warehouse in Guadalajara, Mexico.*fn23 PwC personnel at the audit saw that the warehouse contained excessive inventory. VTech claims that the PwC people knew that this inventory build up was due to the poor sales of the Falcon and Osprey systems.*fn24 Steven Smith of PwC and the other personnel involved with the business advisory engagement for VTech did not inform it that the inventory in Mexico would not be merchantable. Instead, on April 4, 2000, Jeff Dufty of PwC told VTech that the products could be sold in the ordinary course of business using pricing incentives and promotional programs.*fn25 C. The Purchase Price Audit Agreement

  On March 31, 2000, the deal between VTech and Lucent closed, and VTech acquired the Wired Business for approximately $121,266,000.*fn26 VTech then hired PwC to audit Lucent's final net current account statement ("NCAS"), which was defined in the Purchase Agreement between Lucent and VTech.*fn27 The NCAS was to be prepared on the basis of the estimated net current account statement ("ENCAS") and in accordance with generally accepted United States accounting principles ("GAAP").*fn28 The agreement obliged PwC to perform the audit so as to "obtain reasonable assurance about whether the NCAS is free of material misstatement."*fn29 This assurance was limited, however, as PwC stated that it could not "ensure that errors, fraud or other illegal acts, if present, will be detected."*fn30

  VTech asserts that the PwC's audit was faulty with respect to the value of certain of the inventory of the Wired Business. GAAP generally require a reduction in the valuation of inventory when its utility is no longer as great as its cost.*fn31 This devaluation is known as the reduction to fair market value ("RFMV") or "lower of cost or market" because it reduces the value of inventory to the cost at which it could be replaced at market value, not its production cost. Lucent used this method to value its inventory and had a formula for determining the reserve required for each product.*fn32 It also had guidelines that provided that the reserve calculations could be overridden by management in order to hold inventory without devaluing it when there were changes in sales forecasts, spot deals, or seasonal inventory build up.*fn33

  In the ENCAS, Lucent overrode the RFMV reserve calculation for five telephone models, including the Falcon and Osprey products.*fn34 There was evidence in litigation between VTech and Lucent suggesting that Lucent did so improperly to overvalue its inventory by $20 million and protect the purchase price of the deal.*fn35 PwC did not test the legitimacy of this override in the audit and apparently relied only on the opinion of executives of the Wired Business that it was appropriate.*fn36 Accordingly, on June 30, 2000, PwC opined to VTech that the override had been proper and done in accordance with Lucent's guidelines.*fn37 II

  In resolving a motion to dismiss, the Court accepts as true the factual allegations set forth in the complaint and draws all reasonable inferences in the plaintiff's favor.*fn38 "[D]ismissal is appropriate if the plaintiff can prove no set of facts that would entitle him to relief."*fn39 The issue is not whether the plaintiff ultimately will prevail but whether the plaintiff is entitled to offer evidence to support its claims.*fn40

  Although Rule 12(b) motions are addressed to the pleadings,*fn41 PwC attached the Circular and the relevant engagement letters to its motion. This Court advised counsel that it intended to consider the three engagement letters and, to that limited extent, might convert the motion into one for summary judgment.*fn42 It then invited VTech's counsel to "submit any evidence they contend raise a genuine issue of material fact with respect to the authenticity of or terms of the relevant engagements."*fn43 Plaintiffs do not dispute the authenticity of these documents and therefore summary judgment is granted as to their authenticity.*fn44

  The Circular also was attached to PwC's motion. The Second Amended Complaint quotes from and refers to it, thereby incorporating it by reference.*fn45 There is no dispute as to its authenticity.*fn46 The Court therefore considers it for the purposes of this motion.*fn47

  A. Accountant Malpractice

  VTech's first claim is for accountant malpractice based on PwC's statement in footnote eleven of the March 2, 2000 Circular produced by PwC Hong Kong. VTech alleges that PwC failed to exercise the requisite care in gathering information about Lucent and the validity of its opinion that there had been no significant changes since September 30, 1999 that would alter the financial picture of the Wired Business. VTech claims that it relied on this statement and, as a result, suffered damages. PwC moves to dismiss this claim, arguing that VTech on several grounds has failed to state a claim.

  To state a claim of professional malpractice under New York law,*fn48 VTech must allege a departure from accepted standards of practice and that the departure was the proximate cause of its injury.*fn49 VTech must allege also that it was in privity with PwC or had a bond "`so close as to approach that of privity.'"*fn50

  PwC first asserts that VTech's claim fails because there was no contract between it and VTech with regard to the Circular. It contends that PwC Hong Kong, a separate legal entity, produced the Circular and all statements in it.*fn51 It argues that the existence of the written contract between VTech and PwC ...

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