Secs. Investor Protection v. R.D. Kushnir & Co., Adversary No. 99 A 858 SIPA.

Citation274 B.R. 768
Decision Date12 March 2002
Docket NumberAdversary No. 01 A 00485.,Adversary No. 99 A 858 SIPA.
CourtUnited States Bankruptcy Courts. Seventh Circuit. U.S. Bankruptcy Court — Northern District of Illinois
PartiesIn the Matter of SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff, v. R.D. KUSHNIR & CO., Defendant. Securities Investor Protection Corporation, as Trustee for the Liquidation of R.D. Kushnir & Co., Plaintiff, v. Adler Drobny Fischer LLC, Larry D. Adler, and Aaron J. Fischer, Defendants.

Melanie Rovner Cohen, Tracy L. Treger, Altheimer & Gray, Chicago, IL, Stephen P. Harbeck, Karen A. Caplan, Securities Investor Protection Corporation, Chicago, IL, for Plaintiff.

Fred R. Harbecke, Ronald LePinskas, Joseph J. Border, Lord Bissell & Brook, Chicago, IL, for Defendants.

MEMORANDUM OPINION ON DEFENDANTS' MOTION TO DISMISS

JACK B. SCHMETTERER, Bankruptcy Judge.

Plaintiff Securities Investment Protection Corporation ("SIPC") filed this Adversary Complaint on May 22, 2001, as trustee for R.D. Kushnir & Co. ("RDK"), an Illinois Corporation. SIPC's Complaint charges the accountant firm Adler Drobny Fischer, LLC ("ADF") and two of its members Larry D. Adler ("Adler") and Aaron J. Fischer ("Fischer") (collectively "Defendants") with negligence (Count I), breach of contract (Count II), negligent misrepresentation (Count IV), and fraudulent conveyance (Count V and VI). SIPC also charges Adler and Fischer with inducement of breach of contract (Count III).

Defendants have moved to dismiss the complaint pursuant to Fed.R.Civ.P. 12(b)(6) [Rule 7012 Fed.R.Bankr.P.]. For reasons discussed below, Defendants' motion to dismiss is denied as to all Counts except Count III. However, unless amended Count II, III, V, and VI are filed in accord with standards set forth, the individual Defendants will be dismissed from those Counts and Count III will be dismissed.

JURISDICTION

This case was referred here by District Court order after SIPC initiated a liquidation proceeding against RDK pursuant to Section 78eee(b)(1) of the Securities Investor Protection Act of 1970, 15 U.S.C. § 78aaa, et seq. ("SIPA"). District Judge Shadur appointed SIPC as trustee to oversee the liquidation of RDK pursuant to SIPA § 78eee(b)(3) and removed the case to this court pursuant to SIPA § 78eee(b)(4). Section 78eee(b)(4) commands that after issuance of a protective order and appointment of a trustee, the district court shall remove the entire case to the bankruptcy court for that district, which will then have "all of the jurisdiction, powers, and duties conferred by this chapter" upon the district court. Thus, this court has jurisdiction to hear this matter, and venue lies here pursuant to 15 U.S.C. § 78eee(b)(4).

FACTS ALLEGED

RDK was an "introducing broker" which introduced investors wishing to buy securities to a "clearing broker" which carried out the actual trade. RDK transmitted orders from its customers to Wexford Services Corporation ("Wexford"), the clearing broker, which bought the ordered stock with funds on deposit in customer accounts at Wexford. RDK earned a commission on each order it channeled to Wexford.

Although the customer accounts were maintained on Wexford's computer system, employees at RDK allegedly had access to the accounts, as well as to an RDK error account. SIPC asserts that between the summer of 1997 and May of 1998 an RDK employee named Paul Carney ("Carney") used this access to make unauthorized trades on customer accounts held by Wexford. Carney allegedly caused more than $2,000,000 in losses to RDK and its customers by engaging in "highly speculative" options trades. Carney was purportedly able to conceal his activity by deleting the losses incurred from these trades from one customer's account and transferring the losses to another customer's account or to the RDK error account. Thus, customers would allegedly receive falsified account statements from Wexford. In May of 1998 Carney assertedly confessed his misconduct to his superiors at RDK and resigned.

SIPC alleges that ADF provided accounting services to RDK for the years 1996 and 1997. During this time, Adler was the engagement partner primarily responsible for the 1996 and 1997 audits of RDK. Fischer was the reviewing audit partner for both audits. SIPC asserts inter alia that all Defendants failed to follow Generally Accepted Accounting Standards ("GAAS") and SEC rules governing financial audits. Consequently, the audits conducted by Defendants failed to disclose Carney's fraudulent activity and failed to disclose the absence of internal controls at RDK that might otherwise have thwarted Carney's scheme. SIPC contends that a "major part" of the losses sustained by RDK could have been prevented if Defendants had properly performed the 1997 audit which was completed in February of 1998. SIPC avers that it has paid $252,715.52 in cash payments to customers of RDK, $437,661.94 to buy securities to replace securities of RDK customers, and over $1,000,000 in administrative and professional fees. SIPC also contends that after Carney's activities were revealed, RDK paid ADF an additional $25,000 for a special audit to investigate the matter. However, SIPC contends that no audit report was ever produced by ADF. Therefore, SIPC argues that RDK did not receive any value in return for the special audit payment.

Applicable Standards for A Motion to Dismiss under Rule 12(b)(6)

Fed.R.Civ.P. 12(b)(6) [Rule 7012 Fed.R.Bankr.P.] allows a defendant to test the legal sufficiency of a complaint. Triad Associates, Inc. v. Chicago Hous. Auth., 892 F.2d 583, 586 (7th Cir.1989). The court ruling on a motion to dismiss must determine whether there is a basis for the case to go forward. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974). A motion to dismiss should only be granted if it appears that there is no set of facts under which the plaintiff could prevail. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). All well-plead facts alleged in the complaint are taken as true, and all reasonable inferences derived therefrom are construed in favor of the plaintiff. Bontkowski v. First Nat'l Bank of Cicero, 998 F.2d 459, 461 (7th Cir.1993). To survive a motion to dismiss, a complaint must set forth a short plain statement that informs a defendant of the charges and basis of charges contained in the complaint. Fed.R.Civ.P. 8(a)(2) [Rule 7008 Fed.R.Bankr.P.]; Leatherman v. Tarrant County Narcotics Intelligence and Coordination Unit, 507 U.S. 163, 168, 113 S.Ct. 1160, 122 L.Ed.2d 517 (1993). However, even under the liberal pleading standard of Fed.R.Civ.P. 8(a)(2), the plaintiff cannot rest on mere conclusory statements. Ryan v. Mary Immaculate Queen Ctr., 188 F.3d 857, 859 (7th Cir.1999). The complaint must provide facts from which the conclusions averred in the complaint are derived. Palda v. General Dynamics Corp., 47 F.3d 872, 874-75 (7th Cir.1995).

DISCUSSION
CountI — Negligence

Count I essentially alleges that ADF and the individual Defendants committed professional malpractice through negligence. SIPC avers that all Defendants owed a duty to RDK to perform audits with due care in accordance with GAAS and Securities Exchange Commission ("SEC") rule 17 CFR § 240.17a-5 and pursuant to the Securities Exchange Act of 1934, 15 U.S.C. § 78q(a)(1)(2). SIPC further alleges that all Defendants breached that duty by failing to perform audits with skill, thoroughness, diligence, and professional competence. As a result of Defendants' asserted malpractice, RDK claims that it sustained damages. SIPC seeks to hold all Defendants jointly and severally liable for these damages.

ADF and RDK dealt with each other in Illinois, so the contract and tort law of that state applies. In Illinois, to prevail on an action for contract breach or negligence, Plaintiff must show that Defendants owed it a duty under contract or a duty of care but breached that duty, and an injury to Plaintiff was proximately caused by the breach. Hills v. Bridgeview Little League Assoc., 195 Ill.2d 210, 253 Ill.Dec. 632, 745 N.E.2d 1166, 1178 (2001). SIPC asserts that Defendant ADF owed a contractual duty to RDK to perform the audits for the years 1996 and 1997 with due care and competence as prescribed by SEC 17 CFR § 240.17a-5 and GAAS accounting procedures. It also claims that the individual Defendants also owed a duty of due care and competence that they breached in their work.

The Supreme Court of Illinois has held that individual accountants, like lawyers, owe their clients a professional duty outside of contractual obligations to observe reasonable professional competence. Congregation of the Passion, Holy Cross Province v. Touche Ross & Co., 159 Ill.2d 137, 201 Ill.Dec. 71, 636 N.E.2d 503, 515 (1994) ("This duty to observe reasonable professional competence exists independently of any contract."). Thus, in addition to the contractual obligation between RDK and ADF and the duty of care owed by ADF thereunder, Defendants Adler and Fischer each had an independent professional duty to perform competently the audits done by them for RDK. SIPC contends that the individual Defendants as well as RDF as a firm breached their respective professional duties by failing to perform their work on the audits in accordance with SEC 17 CFR § 240.17a-5 or GAAS accounting procedures. It avers that as a result of the negligent work by all Defendants, RDK lacked sufficient internal controls to detect Carney's fraudulent conduct which resulted in RDK being rendered insolvent and caused losses in excess of $2,000,000. As trustee for RDK, SPIC has thereby alleged facts under Count I that entitle it to survive Defendants' motion to dismiss.

Count II — Breach of Contract

Count II alleges that ADF entered into a valid and enforceable contract to provide auditing services for RDK. SIPC avers that the same facts asserted in Count I constitute breach of...

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