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Sanford Gould, Individually, and On Behalf of All Others Similarly Situated v. Winstar Communications


July 19, 2012


The opinion of the court was delivered by: Lohier, Circuit Judge:

10-4028-cv(L), 10-4280-cv(CON)

BIM Intermobiliare SGR v. Grant Thornton LLP

Argued: November 2, 2011

Before: SACK, HALL, and LOHIER, Circuit Judges.

8 Plaintiffs-Appellants appeal from a judgment of the United States District Court for the 9 Southern District of New York (Daniels, J.) granting the motion for summary judgment of 10 Defendant-Appellee Grant Thornton LLP ("GT") and dismissing the Plaintiffs' claims under 11 Sections 10(b) and 18 of the Securities Exchange Act of 1934. Those claims related to GT's 12 auditing of the financial statements of Winstar Communications, Inc. ("Winstar"). Because 13 triable questions of fact exist as to (1) whether GT acted with scienter in making alleged 14 misrepresentations in its audit opinion letter, (2) whether the Plaintiffs purchased Winstar's stock 15 in actual reliance on those representations, and (3) whether the Plaintiffs suffered losses as a 16 result, we VACATE the judgment of the District Court and REMAND for further proceedings.

17 Plaintiffs-Appellants appeal from a September 2010 judgment of the United States 18 District Court for the Southern District of New York (Daniels, J.) granting the summary 19 judgment motion of Defendant-Appellee Grant Thornton LLP ("GT") and dismissing the 20 Plaintiffs' claims arising from GT's audit of the financial statements of its client, Winstar 21 Communications, Inc. ("Winstar"). The Plaintiffs claimed that GT committed securities fraud in 22 violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (the "Act" 23 or the "Exchange Act"), and 17 C.F.R. § 240.10b-5, and made false and misleading statements in 24 an audit opinion letter in violation of Section 18 of the Act, 15 U.S.C. § 78r. We conclude that 25 genuine issues of material fact exist as to each of these claims. We therefore VACATE the 26 District Court's grant of summary judgment and REMAND for further proceedings.


1. Facts

3 Reviewing the District Court's grant of summary judgment in favor of GT, "we construe 4 the evidence in the light most favorable to the [Plaintiffs], drawing all reasonable inferences and 5 resolving all ambiguities in [their] favor."*fn2 In re Omnicom Grp., Inc. Sec. Litig., 597 F.3d 501, 6 504 (2d Cir. 2010) (quotation marks omitted).

7 Winstar was a broadband communications company whose core business was to provide 8 wireless Internet connectivity to various businesses. GT served as Winstar's independent auditor 9 from 1994 until Winstar filed for bankruptcy in April 2001, and GT regarded Winstar as "one of 10 [its] largest and most important clients."*fn3

11 In 1999, however, the relationship deteriorated. Winstar warned GT that it would likely 12 terminate the relationship if GT's performance on unrelated international tax planning and other 13 accounting matters proved unsatisfactory. In March 1999 at least one member of Winstar's 14 board of directors openly urged during a board meeting that the GT partner overseeing the audit 15 of Winstar be removed from the Winstar account. GT eventually re-staffed the Winstar account 16 so that the 1999 audit was managed by a partner, Gary Goldman, and a senior manager, Patricia 1 Cummings, neither of whom had previously reviewed or audited the financial records of a 2 telecommunications company.

3 As relevant to this appeal, GT's audit for 1999 included several "large account" 4 transactions that Winstar consummated in an attempt to conceal a decrease in revenue associated 5 with Winstar's core business. Most of the large account transactions involved Lucent 6 Technologies, Inc. ("Lucent"), Winstar's strategic partner, and all of them were consummated at 7 the end of Winstar's fiscal quarters in 1999. Together, the transactions accounted for $114.5 8 million in revenue, or approximately 26 percent of Winstar's reported 1999 operating revenues 9 and 32 percent of its "core" revenues that year. At the time, GT considered these transactions to 10 be "red flags," warranting the accounting firm's "heightened scrutiny."*fn4 However, GT 11 ultimately approved Winstar's recognition of revenue in connection with each of these 12 transactions.

13 We discuss the evidence relating to each category of transaction in turn.

14 A. Questionable Sales

15 The first category of questionable transactions involved a series of six end-of-quarter and 16 end-of-year transactions, primarily reported as equipment sales, for which there was little 17 evidence that any goods or services were ordered and delivered. For example, for the third 18 quarter of 1999 Winstar recognized $15 million in revenue for the sale of Lucent equipment to 19 Anixter Brothers, Inc. ("Anixter"), a wire and cable distributor. There were several unusual 1 aspects of this sale. First, Anixter ordinarily purchased equipment directly from Lucent, not 2 Winstar. Second, equipment sales were not part of Winstar's core business of creating and 3 operating wireless networks. Third, during GT's audit Cummings noted that the Anixter 4 transaction was "apparently" completed on September 30, 1999, the last day of Winstar's fiscal 5 quarter, but GT's work papers included no documents reflecting the sale's completion beyond a 6 purchase order from Winstar to Lucent and an invoice from Lucent to Winstar. Moreover, 7 neither the purchase order nor the invoice included an itemized list of the goods sold or indicated 8 the shipping terms, even though the items were to be shipped on September 30, 1999, and 9 delivered on October 4, 1999.*fn5 Absent too was any document evidencing Anixter's agreement to 10 purchase the items. Lastly, not a single employee of Lucent, Winstar, or Anixter who was asked 11 about the equipment sale could recall it.

12 Five other transactions that were not part of Winstar's core business were consummated 13 at the end of one of Winstar's fiscal quarters and were barely documented. Winstar nevertheless 14 recognized a total of $49.7 million in revenue associated with these five transactions. First, 15 Winstar recognized $5 million in revenue in the first quarter of 1999 for a "feasibility study" that 16 Winstar was scheduled to conduct for Lucent, but which had not been delivered by at least 2000. 17 Second, Winstar recognized $21.1 million in revenue in the first and second quarters of 1999 in 1 connection with the sale of Lucent equipment to Williams Communications, Inc. ("Williams").

2 The equipment was shipped by Lucent, not Winstar, on the last business day of the first and 3 second quarters (March 31, 1999 and June 30, 1999, respectively), with no written agreement. 4 Third, Winstar recognized $9.1 million in revenue in the second quarter of 1999 in connection 5 with the sale of Lucent equipment to VoCall Communications Corporation ("VoCall") on June 6 30, 1999. Although the sale was referenced in a series of non-numbered purchase orders, it was 7 not referenced in any executed, final agreement or shipping document. Fourth, Winstar 8 recognized $4.5 million in revenue in the third quarter of 1999 in connection with the sale of 9 unspecified "WinStar Equipment" to Cignal Global Communications ("Cignal"), which was 10 contracted for on September 30, 1999, the last day of that quarter. However, GT was unable to 11 produce a document evidencing that the equipment had been shipped to Cignal during that 12 quarter. Fifth, Winstar recognized $10 million in revenue in the fourth quarter of 1999 in 13 connection with the sale of wireless radio equipment ("radios") to Lucent under an agreement 14 dated December 30, 1999. GT endorsed the recognition of revenue even though its work papers 15 included shipping documents with conflicting dates, no document specified the goods purchased, 16 and Lucent, not Winstar, was in the business of manufacturing and selling radios. The same 17 agreement also involved a $2 million "promotional credit" purchased by Lucent for services that 18 had not yet been rendered by Winstar. Although GT specifically advised Winstar that 19 recognizing and recording the amount of the credit as revenue was improper and in violation of 1 generally accepted accounting principles ("GAAP"),*fn6 Winstar nevertheless recognized the full 2 $2 million in revenue.

3 Each of these transactions appears to have violated the provisions of Staff Accounting 4 Bulletin No. 101 ("SAB 101"), issued by the Securities and Exchange Commission ("SEC"), 5 which states that four conditions must be satisfied before revenue can be recognized: (1) 6 "Persuasive evidence of an arrangement [for the sale of goods or services] exists," (2) "Delivery 7 has occurred or services have been rendered," (3) "The seller's price to the buyer is fixed or 8 determinable," and (4) "Collectibility is reasonably assured." SAB 101 at 3.*fn7

1 GT requested that Winstar's counterparties provide additional documentary evidence of 2 the relevant sales underlying each questionable transaction. By doing so, consistent with SAB 3 101, GT sought to obtain independent support for Winstar's recognition of revenue for each 4 transaction - in other words, support from documents that were not generated by Winstar itself.

5 As of February 10, 2000, GT still had not received responsive documents from four of these 6 customers. Nonetheless, it issued an audit opinion letter opining that Winstar's 1999 financial 7 statements accurately reflected its financial condition and complied with GAAP.

8 B. Bifurcated Accounting

9 In connection with at least three other transactions, Winstar employed a bifurcated 10 accounting scheme that GT ultimately approved prior to its audit of Winstar's financial 11 statements. Two of these transactions involved leasing or subleasing fiber optic network 12 capacity in units called indefeasible rights of use ("IRUs"). Winstar accounted for these IRUs 13 using a dubious bifurcated accounting method, pursuant to which it recognized as much as 94 14 percent of the revenue from the leases upon execution of the lease, reflecting the cost of optical 15 equipment ("optronics") that transmitted data over fiber optic cable ("cable" or "fiber").


16 then would recognize the balance of the revenue in later quarters, as payments were received

17 over the span of the lease, representing the customer's actual use of the network. In other words,

18 Winstar split the value of the leases so that the revenue associated with the optronics was process is not complete." Id. (footnotes omitted). In its Form 10-K, Winstar stated, "Revenues from equipment sales are recognized when the equipment is delivered to the customer. Professional services revenues are recognized under the percentage of completion method." Joint App. at 538.

1 reported separately from revenue associated with the cable. By employing this accounting 2 method, Winstar was able to recognize $30.9 million in revenue up front in 1999. 3 During discovery, a forensic accountant retained by the Plaintiffs opined that the rules of 4 the Financial Accounting Standards Board and interpretive rules of the SEC prohibited the 5 division of leases for fiber optic networks because both the cable and the optronics were 6 essential to the network. Winstar conceded that the fiber and the optronics were not separable, 7 and that no other company previously had employed this bifurcated method in accounting for 8 IRUs. Indeed, Winstar specifically advised GT that the bifurcated approach had been criticized 9 by the accounting firm Deloitte & Touche LLP ("Deloitte").

10 GT was in any event aware that revenue associated with an IRU contract could be 11 recognized only if the leased circuit was operational, or "lit," in the language of the fiber optics 12 field. In the third and fourth quarters of 1999, however, Winstar had failed to "light" many of its 13 IRU circuits, a fact that should have precluded the company from recognizing revenue associated 14 with those IRUs.

15 In the midst of GT's audit, Winstar sent form letters dated December 30, 1999, and 16 December 31, 1999, to the counterparties to the two IRU transactions, Wam!Net, Inc. and 17 Cignal, respectively, to confirm that the IRU circuits had been "deliver[ed]" and "accept[ed].'"

18 A representative of Cignal signed a form letter confirming delivery and acceptance of the 19 circuits. By contrast, Wam!Net's Senior Vice President of Finance responded to a letter from 20 Winstar as follows: "To our knowledge [the circuits] are not currently in place." A subsequent 21 amended letter from a different Wam!Net employee, which does not appear in the record but 22 which Cummings referenced in an email, purported to "accept" the circuits but did not address 23 the earlier letter response. After receiving the amended letter, GT did not further review whether 1 the circuits were installed and operational. Even though it appears not to have received the 2 amended letter until after February 11, 2000, GT approved Winstar's recognition of revenue for 3 the Wam!Net IRU circuit sale on February 10, 2000.

4 While GT appears to have neglected to verify that Wam!Net's IRU circuits were 5 operational, there was evidence that GT actually knew that the leased Cignal IRU circuits were 6 inoperative. GT nevertheless approved Winstar's recognition of revenue for the Cignal IRUs in 7 the third quarter of 1999.

8 Winstar employed a similar bifurcated accounting method in the fourth quarter of 1999 9 for its sale of radios to Lucent. The agreement between the two companies provided for Winstar 10 to install the radios, but Winstar recognized revenue for the transaction immediately, upon 11 delivering them to Lucent.*fn8 GT expressed doubt that the radios and installation services were 12 separable,*fn9 but it nevertheless approved of Winstar's recognition of $10 million in revenue in 13 connection with the transaction.

14 C. Round-Trip Transactions

15 Several of the transactions discussed above involved "round-trip" transactions with 16 Cignal and Wam!Net at a time when the two customers were struggling financially. "'Round- 17 tripping' typically refers to reciprocal agreements, involving the same products or services, that 18 lack economic substance but permit [both] parties to book revenue and improve their financial 19 statements." Teachers' Ret. Sys. of LA v. Hunter, 477 F.3d 162, 169 (7th Cir. 2007). The two 1 principal round-trip transactions that were the focus of discovery involved a scheme pursuant to 2 which Winstar overpaid both companies for purportedly unrelated goods and services in 3 exchange for their purchase of IRUs, equipment, and services from Winstar by the end of 4 Winstar's third fiscal quarter of 1999 (Cignal), and the end of the fourth quarter of 1999 5 (Wam!Net).

6 Both round-trip transactions were material to Winstar's financial performance in 1999. 7 In the larger of the two transactions, Winstar recognized approximately $39 million in revenue in 8 the third and fourth quarters of 1999 in connection with sales to Cignal while it paid Cignal 9 $29.5 million under a separate agreement during the same time period and an additional $4.8 10 million in the first quarter of 2000. Similarly, Winstar recognized $19.6 million in revenue in 11 connection with sales to Wam!Net in the fourth quarter of 1999, even as it paid Wam!Net $25 12 million in the same quarter for "prepaid marketing" and the lease of a "data service center." In 13 February 2000 GT questioned the "[a]rms length nature of the [round-trip] transactions." It later 14 acknowledged that the transactions "raise[d] a concern" within GT "as to whether or not absent 15 Winstar's payment . . . collectability [sic] was reasonably assured." Nevertheless, GT approved 16 Winstar's recognition of the full amount of revenue for both transactions.

17 D. The Audit Opinion Letter

18 By letter dated February 10, 2000, GT issued an unqualified audit opinion letter stating 19 that Winstar's annual Form 10-K report for fiscal year 1999 complied with GAAP and fairly 20 represented Winstar's financial condition at the end of that year: 21 We have audited the accompanying consolidated balance 22 sheets of Winstar Communications, Inc. . .

23 We conducted our audits in accordance with auditing 1 standards generally accepted in the United States. Those standards 2 require that we plan and perform the audit to obtain reasonable 3 assurance about whether the financial statements are free of material 4 misstatement. . . . We believe that our audits provide a reasonable 5 basis for our opinion.

6 In our opinion, the consolidated financial statements referred 7 to above present fairly, in all material respects, the consolidated 8 financial position of Winstar Communications, Inc. and Subsidiaries 9 as of December 31, 1999 . . . in conformity with accounting 10 principles generally accepted in the United States.

12 Joint App. at 529.

13 E. Investment by the Jefferson Plaintiffs

14 From December 1998 to February 2001, the Jefferson Plaintiffs purchased over $200 15 million worth of Winstar stock. The investment portfolios of most of the Jefferson Plaintiffs 16 were managed by Ronald Clark, the Chief Investment Officer for Allianz of America 17 ("Allianz"). The remaining entities deferred to Clark to select their investments in United States 18 securities. Although Clark enjoyed ultimate authority for these investment decisions, he relied 19 on recommendations from a team of analysts, including Livia Asher, who recommended that 20 Allianz purchase Winstar stock. Based on Asher's recommendation, Clark caused Allianz and 21 the other Jefferson Plaintiffs to invest in Winstar.

22 Clark, it appears, did not personally review Winstar's financial statements prior to 23 making the decision to invest in Winstar. Instead, he relied on Asher to review the statements as 24 part of her job. During discovery, however, Asher acknowledged that she was uncertain of the 25 date of, or reason for, her recommendation that Allianz purchase Winstar stock. Nor could she 26 specifically recall reading Winstar's 1999 Form 10-K report. However, Asher testified that she 27 "probably flipped through every single page" of the report, based on her practice. She explained, 1 "I can't imagine any reason why I would not have looked at this, . . . given our position in the 2 stock and given what I would normally do." Asher added that she habitually read auditors' 3 opinion letters included in Forms 10-K to make sure that auditors believed that an issuer's 4 reports were "kosher," but she did not specifically recall reviewing GT's audit report.

5 F. Winstar's Decline

6 Winstar's stock reached a price per share of over $60 in March 2000. In May 2000 7 Lucent provided Winstar with financing in the form of a renewed credit facility in the aggregate 8 amount of $2 billion. Almost a year later, however, in March 2001, Asensio & Company 9 ("Asensio"), an investment firm, issued a press release criticizing Winstar's ability to pay its 10 debts and explaining that certain measurements of Winstar's financial performance were 11 "questionable" due in part to Winstar's "revenue recognition from non-core businesses and sales 12 of equipment and services to related parties." Joint App. at 2412. The same press release 13 warned that "[a]ny adjustment to Winstar's aggressive revenue accounting and capitalization of 14 cash expenditures would negatively and materially impact Winstar's reported [earnings] and 15 analyst's [sic] opinions of its operations." Id. at 2413. On March 19, 2001, Asensio issued 16 another press release reporting on Winstar's "debt collapse," again criticizing its revenue 17 accounting practices and noting, "Winstar has recognized revenues that created a slew of 18 uncollected items . . . . Its revenues include sales to related parties and non-core items such as 19 equipment sales and installation services." Id. at 2414.

20 The Asensio press releases preceded a significant downgrade in Winstar's credit rating 21 on April 3, 2001. Moreover, on April 16, 2001, Winstar announced that Lucent was canceling 1 Winstar's credit facility, that Winstar would delay filing its Form 10-K report for 2000, and that 2 Winstar was considering a reorganization under Chapter 11 of the Bankruptcy Code. 3 By the time of the Asensio press releases, Winstar's revenues and its stock price had 4 decreased significantly during a marketwide decline in the prices of technology stocks. 5 However, the press releases, coupled with the subsequent announcements of Winstar's financial 6 troubles, were followed almost immediately by an additional steep decline in Winstar's stock 7 price, from over $10 per share before March 2001 to $0.14 per share by mid-April 2001. On 8 April 18, 2001, Winstar filed for bankruptcy.

9 During discovery, an economist retained by the Plaintiffs as an expert witness attributed 10 the decline in Winstar's stock price to, among other causes, the partial disclosure of Winstar's 11 alleged fraud by Asensio. The economist calculated that members of the putative class who had 12 purchased Winstar common stock lost as much as $974 million, that class members who 13 purchased Winstar notes lost up to $197 million, and that the Jefferson Plaintiffs lost over $96 14 million by investing in Winstar stock.

15 2. Procedural History

16 On April 10, 2001, the Lead Plaintiffs filed a putative class action complaint in the 17 Southern District of New York against Winstar, GT, Lucent, and certain Winstar executives 18 alleging securities fraud under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b). In 19 December 2001 the Jefferson Plaintiffs filed a separate complaint in the District Court against 20 GT, claiming violations of both Section 10(b) and Section 18 of the Exchange Act, 15 U.S.C. § 21 78r(a).*fn10 As a result of various settlements among the parties, the claims against GT were all that 1 remained by 2008. After discovery, GT moved for summary judgment to dismiss the Plaintiffs' 2 claims and also moved unsuccessfully to preclude the Plaintiffs' expert loss causation analysis.

3 In September 2010 the District Court granted GT's motion for summary judgment, 4 concluding that (1) the Plaintiffs had failed to demonstrate that a genuine dispute of material fact 5 existed as to whether GT acted intentionally or recklessly, as required under Section 10(b) of the 6 Exchange Act, and (2) the Jefferson Plaintiffs had failed to demonstrate that such a dispute 7 existed as to whether they actually relied on GT's audit opinion letter, as required under Section 8 18 of the Exchange Act. In re Winstar Commc'ns Sec. Litig., No. 01 CV 11522 (GBD), 2010 9 WL 3910322, at *5-6 (S.D.N.Y. Sept. 29, 2010).

10 This appeal followed.


12 We review a district court's grant of summary judgment de novo, viewing the evidence in 13 the light most favorable to the non-moving party and drawing all reasonable inferences and 14 resolving all ambiguities in its favor. E.g., Grain Traders, Inc. v. Citibank, N.A., 160 F.3d 97, 15 100 (2d Cir. 1998). We will affirm the judgment "only if there is no genuine dispute as to any 16 material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a). 17 "There is no genuine issue of material fact where the record taken as a whole could not lead a 18 rational trier of fact to find for the non-moving party."

Durakovic v. Bldg. Servs. 32 BJ Pension 19 Fund, 609 F.3d 133, 137 (2d Cir. 2010) (quotation marks and brackets omitted). Put another 20 way, "[a]n issue of fact is genuine if the evidence is such that a reasonable jury could return a 21 verdict for the nonmoving party." Omnicom, 597 F.3d at 509 (quotation marks omitted).

1 To sustain a claim under Section 10(b) of the Exchange Act and Rule 10b-5, the 2 Plaintiffs must show "(i) a material misrepresentation or omission; (ii) scienter; (iii) 'a 3 connection with the purchase or sale of a security[;]' (iv) reliance by the plaintiff(s); (v) 4 economic loss; and (vi) loss causation." Id. (quoting Dura Pharms., Inc. v. Broudo, 544 U.S. 5 336, 341-42 (2005)).

6 1. Scienter

7 Plaintiffs may satisfy the scienter requirement by producing "evidence of conscious 8 misbehavior or recklessness." See ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP 9 Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009). Scienter based on conscious misbehavior, 10 in turn, requires a showing of "deliberate illegal behavior," Novak v. Kasaks, 216 F.3d 300, 308 11 (2d Cir. 2000), a standard met "when it is clear that a scheme, viewed broadly, is necessarily 12 going to injure," AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202, 221 (2d Cir. 2000) 13 (alterations omitted).

14 In AUSA Life, we applied this standard to representations by the accounting firm Ernst 15 & Young ("E & Y"), which, as plaintiffs allege with respect to GT, "consistently noticed, 16 protested, and then acquiesced in" the financial misrepresentations of an audit client under 17 pressure from the client's management. Id. at 205. We held that by issuing an unqualified audit 18 report despite its knowledge of accounting improprieties by the client, E & Y "intentionally 19 engaged in manipulative conduct," id. at 221 (quotation marks omitted), in violation of Section 20 10(b). We explained that 21 E & Y is not an accounting dilettante. It knows well that its opinions 22 and certifications are afforded great weight, and it must have known 1 that its financial certifications with regard to [its client] would be 2 compelling to the investors. . . [I]t is sufficient [for the purposes of 3 showing scienter] for a plaintiff to allege and prove that a defendant 4 could have foreseen the consequences of his actions but forged ahead 5 nonetheless . . .

7 Id.; see also SEC v. KPMG LLP, 412 F. Supp. 2d 349, 379 (S.D.N.Y. 2006) (triable issue as to 8 conscious fraud existed when accountant was "[a]ware of [the client's] earnings pressures" but 9 allowed aggressive accounting policies "without any serious study to determine that these 10 unusual, indeed unique, accounting treatments would result in financial statements that fairly 11 represented [the client's] financial condition").

12 Scienter based on recklessness may be demonstrated where a defendant has engaged in 13 conduct that was "highly unreasonable, representing an extreme departure from the standards of 14 ordinary care . . . to the extent that the danger was either known to the defendant or so obvious 15 that the defendant must have been aware of it." Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir. 16 2000) (quotation marks omitted). Recklessness may be established where a defendant "failed to 17 review or check information that [it] had a duty to monitor, or ignored obvious signs of fraud." 18 Novak, 216 F.3d at 308.

19 The District Court concluded that Winstar engaged in "dubious accounting practices," 20 that "[m]uch of the supporting documentation that Winstar supplied to GT was a mere 21 contrivance meant to paper the transactions and create the appearance of legitimacy," and that 22 GT "failed to uncover the accounting fraud being perpetuated by the Winstar defendants." 23 Winstar, 2010 WL 3910322, at *3, *5. GT does not seriously dispute these conclusions, which 24 are in any event supported by the record before us. The District Court concluded, however, that 1 the evidence demonstrated only that GT was "performing its role as [Winstar's] independent 2 auditor" and fell short of demonstrating scienter in the form of either conscious misbehavior or 3 recklessness. Id. at *3. We disagree.

4 Some evidence supports the Plaintiffs' contention that GT consciously ignored Winstar's 5 fraud when it approved Winstar's recognition of revenue for the suspicious 1999 transactions. 6 This evidence goes beyond a mere failure to uncover the accounting fraud and, in general, relates 7 to (1) Winstar's recognition of revenue for the sale of equipment or services without sufficient 8 indicia of delivery, (2) its recognition of all revenue associated with the incomplete sale of 9 telecommunications systems, and (3) its recognition of revenue for sales of IRUs, equipment, 10 and services to financially unstable companies to whom Winstar paid back large sums under 11 separate contractual obligations.

12 There is also evidence that GT failed to confirm Winstar's representations regarding 13 these transactions or to retain and review documents evidencing each transaction. Indeed, an 14 expert forensic accountant retained by the Plaintiffs testified that GT's failure to exercise due 15 professional care, gather reliable documents, and issue an adverse opinion in this regard 16 represented a violation of Generally Accepted Accounting Standards ("GAAS")*fn11 with regard to 17 all of the challenged transactions. Furthermore, the record evidence supports a conclusion that 18 GT knew, even under the terms of Winstar's bifurcated accounting method - a method that had 1 been criticized by Deloitte but reviewed and approved, with skepticism, by GT - that revenue 2 could not be properly recognized for IRUs unless the leased circuits were operational. During 3 discovery, Cummings acknowledged that GT knew the circuits for the Cignal IRUs were not 4 operational. Under these circumstances, GT's approval of Winstar's recognition of revenue for 5 the nonfunctional circuits presents a genuine issue of material fact as to whether GT acted with 6 the requisite scienter under Section 10(b).

7 We point to the IRU transactions only as one example of a transaction that suggests that 8 GT acted with scienter. Triable issues regarding GT's scienter exist for the other questionable 9 transactions as well. Broadly speaking, there was admissible evidence that in the course of its 10 audit GT learned of and advised against the use of indisputably deceptive accounting schemes, 11 but eventually acquiesced in the schemes by issuing an unqualified audit opinion. See AUSA 12 Life, 206 F.3d at 221. Based on this record, we cannot conclude that this and the other evidence 13 adduced by the Plaintiffs was insufficient to raise a genuine issue of material fact about whether, 14 in issuing an unqualified audit opinion letter, GT "agreed to [Winstar's] accounting abuses, 15 knowing . . . that [investors] and others would be receiving and relying upon the manipulated 16 financial reports." Id. At this stage, the Plaintiffs have proffered enough facts constituting 17 evidence of conscious misbehavior or recklessness to survive summary judgment. 18 We note that in granting summary judgment in GT's favor, the District Court placed 19 particular emphasis on the magnitude of GT's audit work, both in time spent and documents 20 reviewed. For example, it noted that GT "spent 1,928 hours of professional time," assembled 21 working papers spanning 3,000 pages, and reviewed "copies of contracts, Winstar business 22 plan[s], press releases, board minutes," and memos prepared by Winstar and GT addressing 1 accounting issues. Winstar, 2010 WL 3910322, at *2. The number of hours spent on an audit 2 cannot, standing alone, immunize an accountant from charges that it has violated the securities 3 laws. Here, the Plaintiffs adduced evidence that, notwithstanding the magnitude of its audit, GT 4 repeatedly failed to scrutinize serious signs of fraud by an important client, including: (1) 5 significant end-of-quarter transactions;*fn12 (2) the absence of documents confirming the goods or 6 services ordered by Winstar customers, the fact of delivery, or the existence of an underlying 7 agreement; (3) the repeated failure of Winstar or its clients timely to provide supporting 8 documentation requested by GT; (4) Winstar's transactions outside its core business; and (5) 9 round-trip transactions in which revenues were subsequently offset by Winstar's payments to 10 financially unstable customers under unrelated contractual obligations.

11 In short, regardless of the hours GT spent or the number of documents it reviewed in the 12 course of its 1999 audit of Winstar, a jury reasonably could determine that the audit was so 13 deficient as to be "highly unreasonable, representing an extreme departure from the standards of 14 ordinary care . . . to the extent that the danger was either known to [GT] or so obvious that [GT] 15 must have been aware of it." Rothman, 220 F.3d at 90 (quotation marks omitted).

1 2. Reliance

2 Section 18 of the Exchange Act, 15 U.S.C. § 78r(a), requires actual rather than 3 constructive reliance upon a materially false or misleading statement by one who has purchased 4 or sold a security. Heit v. Weitzen, 402 F.2d 909, 916 (2d Cir. 1968). The District Court 5 concluded that the Jefferson Plaintiffs failed to show reliance because they could not 6 demonstrate that they or their representatives "actually saw Winstar's 1999 Form 10-K filing, 7 much less read the included independent accountant report of GT." Winstar, 2010 WL 3910322, 8 at *6. Even assuming that such "eyeball" reliance is the sort of actual reliance required by our 9 precedents, the District Court's conclusion somewhat understates the record evidence on this 10 score. Ronald Clark and Livia Asher worked on behalf of the Jefferson Plaintiffs. Although 11 Asher was unable to recall specifically that she reviewed GT's audit opinion letter, there was 12 evidence that she actively reviewed such letters as a matter of practice in deciding whether to 13 recommend certain stocks. At this stage of the proceedings, Asher's testimony is enough; from 14 that evidence, a jury reasonably could infer that she actually reviewed the relevant documents. 15 See, e.g., Fed. R. Evid. 406. Accordingly, we conclude that the District Court erred in granting 16 summary judgment in GT's favor on the Jefferson Plaintiffs' Section 18 claims.

17 3. Causation

18 GT argues in the alternative that the District Court's grant of summary judgment should 19 be affirmed because the Plaintiffs failed to show loss causation. We have described loss 20 causation as "the causal link between the alleged misconduct and the economic harm ultimately 21 suffered by the plaintiff." Emergent Capital Inv. Mgmt., LLC v. Stonepath Grp., Inc., 343 F.3d 22 189, 197 (2d Cir. 2003). Among other things, the misconduct must be a "substantial factor in the 1 sequence of responsible causation." AUSA Life, 206 F.3d at 215 (quotation marks omitted).

2 With these principles in mind, however, we have also warned that "if the loss was caused by an 3 intervening event, like a general fall in the price of Internet stocks, the chain of causation will 4 not have been established[, b]ut such is a matter of proof at trial." Emergent Capital, 343 F.3d at 5 197; see also AUSA Life, 206 F.3d at 214-15 ("[W]hen the plaintiff's loss coincides with a 6 marketwide phenomenon causing comparable losses to other investors, the prospect that the 7 plaintiff's loss was caused by the fraud decreases.").

8 Relying largely on the deposition testimony of an expert witness economist, the Plaintiffs 9 argue that they have adduced proof of loss causation in the form of the press releases from 10 Asensio and Winstar's April 2001 announcements, which publicly exposed Winstar's substantial 11 financial weaknesses and together suggested for the first time that Winstar had engaged in 12 improper revenue recognition practices for a period of time that included 1999. Although a 13 much closer call, a jury could reasonably infer based on the expert testimony and other evidence 14 that the precipitous decline in Winstar's stock price in 2001 was attributable in part to the 15 alleged fraud.

16 GT counters that any decline in Winstar's stock price that was not caused by broader 17 market trends resulted not from the alleged fraud but from Lucent's cancellation of its credit 18 facility. This may be true for a portion of the collapse in Winstar's stock price. There is support 19 as well for the argument that the downgrade in Winstar's credit rating resulted in a substantial 20 decline in the stock price. But these facts, if established, hardly foreclose the reasonable 21 inference that some part of the decline was substantially caused by the disclosures about the 22 fraud itself. We therefore conclude that a jury reasonably could find the requisite "causal link 1 between [Winstar's] alleged misconduct and the economic harm ultimately suffered" by the 2 Plaintiffs. See Emergent Capital, 343 F.3d at 197.


4 We have considered GT's other arguments, and we conclude that they are without merit. 5 For the foregoing reasons, we VACATE the District Court's grant of summary judgment, and we 6 REMAND for further proceedings.

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