Matter of Ikon Office Solutions Inc.

• Decision Date: 15 October 1997
• Citation: 277 F.3d 658
• Parties: (3rd Cir. 2002) IN RE: IKON OFFICE SOLUTIONS, INC., SECURITIES LITIGATION CITY OF PHILADELPHIA, THROUGH ITS BOARD OF PENSIONS AND RETIREMENT, OLIVER SCOFIELD AND LAWRENCE PORTER, AS REPRESENTATIVES OF A CERTIFIED CLASS CONSISTING OF ALL PERSONS WHO PURCHASED THE COMMON STOCK, CONVERTIBLE PREFERRED STOCK, AND/OR CALL OPTIONS OF IKON OFFICE SOLUTIONS, INC. DURING THE PERIOD FROM
• Court: U.S. Court of Appeals — Third Circuit

Page 658

277 F.3d 658 (3rd Cir. 2002)

IN RE: IKON OFFICE SOLUTIONS, INC., SECURITIES LITIGATION

CITY OF PHILADELPHIA, THROUGH ITS BOARD OF PENSIONS AND RETIREMENT, OLIVER SCOFIELD AND LAWRENCE PORTER, AS REPRESENTATIVES OF A CERTIFIED CLASS CONSISTING

OF ALL PERSONS WHO PURCHASED THE COMMON STOCK, CONVERTIBLE PREFERRED STOCK, AND/OR CALL OPTIONS OF IKON OFFICE SOLUTIONS, INC. DURING THE PERIOD FROM OCTOBER 15, 1997, THROUGH AND INCLUDING AUGUST 13, 1998, APPELLANTS

No. 01-1553

UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT

Argued October 11, 2001

January 11, 2002

On Appeal from the United States District Court for the Eastern District of Pennsylvania (MDL No. 1318) District Judge: Honorable Marvin Katz

[Copyrighted Material Omitted] Todd S. Collins (Argued), Merrill G. Davidoff, Jacob A. Goldberg, Douglas M. Risen, Berger & Montague, 1622 Locust Street Philadelphia, PA 19103, Jared Specthrie (Argued), Justin C. Frankel, Milberg Weiss Bershad Hynes & Lerach, One Pennsylvania Plaza New York, NY 10119-0165, Lynn Lincoln Sarko, Britt L. Tinglum, Keller Rohrback, 1201 Third Avenue, Suite 3200 Seattle, WA 98101-3052, and Stuart H. Savett, Savett Frutkin Podell & Ryan, 325 Chestnut Street, Suite 700 Philadelphia, PA 19106-2614, for Appellants.

Lawrence S. Robbins (Argued), Gary A. Orseck, Kathryn S. Zecca, Robbins, Russell, Englert, Orseck & Untereiner, 1801 K Street, Suite 411 Washington, DC 20006, Edward M. Posner, William M. Connolly, Drinker Biddle & Reath, One Logan Square 18th & Cherry Streets Philadelphia, PA 19103 Jonathan C. Medow, Brian J. Massengill, Mayer, Brown & Platt, 190 South LaSalle Street Chicago, IL 60603, and Kathryn A. Oberly, Patricia A. McGovern, Ernst & Young Llp, 787 Seventh Avenue New York, NY 10019, for Appellee.

Before: Becker, Chief Judge, Scirica and Greenberg, Circuit Judges

OPINION OF THE COURT

Greenberg, Circuit Judge.

This shareholders' class action case comes on before this court on plaintiffs-appellants' appeal from a February 6, 2001 order of the district court granting summary judgment to the defendant-appellee Ernst & Young LLP ("Ernst"). See In re IKON Office Solutions Sec. Litig., 131 F. Supp. 2d 680 (E.D. Pa. 2001). Appellants are representatives of a certified class consisting of all persons who purchased common stock, convertible preferred stock, and/or call options of IKON Office Solutions, Inc. ("IKON") from October 15, 1997, through August 13, 1998. In their complaint they alleged that Ernst, IKON's accounting firm, violated section 10(b) of the Securities Exchange Act, 15 U.S.C. S 78j(b), and Rule 10b-5, 17 C.F.R.S 240.10b-5, promulgated thereunder, by issuing an unqualified audit report approving IKON's financial statements for fiscal year 1997 knowing that they overstated IKON's pre-tax income or, even if Ernst did not have actual knowledge of the overstatement, by recklessly performing its audit.

The district court granted Ernst's motion for summary judgment on the grounds that the appellants failed to raise a genuine issue of material fact with respect to two elements of a prima facie section 10(b) claim: scienter (that Ernst harbored an intent to deceive or acted with reckless disregard for the truth and accuracy of IKON's financial disclosures) and causation (that the inflated value of IKON's stock price dropped when the market reevaluated the security after a corrective disclosure). In addition, and in the alternative, the court granted Ernst's motion for partial summary judgment, ruling that it could not be liable to certain members of the class under section 10(b) by reason of an October 15, 1997 press release IKON issued because Ernst itself did not communicate misrepresentations to investors in the press release -- the only activity proscribed by the statute.

Because the record fails to establish a triable issue with respect to scienter, we will affirm the judgment of the district court without addressing loss causation or whether Ernst can be held liable under section 10(b) for IKON's October 15, 1997 press release.

I. BACKGROUND

A. Factual History

IKON, which is headquartered in Malvern, Pennsylvania, supplies copiers, printing systems, and related services throughout the United States, Canada, and Europe. Its shares are traded publicly on the New York Stock Exchange. Between 1995 and 1998, IKON embarked on a "transformation" business plan in which it acquired and consolidated close to 200 independent copier, technology-services, and outsourcing and imaging companies. See J.A. 1331 (Jarrell Report). IKON intended to become an international provider of "office technology solutions," serving as a single source for networking services, office technology, and software needs, rather than simply distributing and servicing office products in domestic markets. See J.A. 1330-31 (Jarrell Report).

Ernst, a "Big Five" accounting firm,¹ served as the independent, outside auditor of IKON's September 30 fiscal year-end financial statements for a number of years, including the time encompassing the audit of IKON's 1997 consolidated financial statements. See J.A. 113-14 (2d Am. Cplt. at P 101). Ernst designed its year-end audits to evaluate whether IKON's financial statements accurately and fairly reflected its financial position in accordance with Generally Accepted Accounting Principles ("GAAP").² In addition, Ernst performed certain internal audit functions for IKON, such as monitoring and evaluating its compliance with its own internal accounting policies and procedures. See J.A. 115 (2d Am. Cplt. at P 105).

This dispute focuses on the soundness of Ernst's audit for fiscal year 1997. On October 15, 1997, after Ernst had completed the bulk of its audit work,³ IKON issued a press release discussing fourth-quarter and year-end results. See J.A. 5150-55. The release reported income from continuing operations totaling $204.9 million for fiscal 1997, a 15 percent increase from fiscal 1996. See J.A. 5151. Ernst reviewed the press release before it was issued without proposing any modifications. See J.A. 3523 (Dillon Dep. 26-27).

On December 24, 1997, Ernst publicly issued its unqualified, or "clean," audit opinion,⁴ stating that it had conducted its audit in accordance with Generally Accepted Auditing Principles ("GAAS"),⁵ and concluding that IKON's 1997 financial statements fairly reflected its financial position. See J.A. 4701 (Graham Report). Relevant portions of that unqualified audit opinion, which appeared in IKON's 1997 Annual Report to the Securities and Exchange Commission on Form 10-k, follow:

We have audited the accompanying consolidated balance sheets of IKON Office Solutions, Inc... and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended September 30, 1997.... We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of IKON Office Solutions, Inc., and subsidiaries at September 30, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1997, in conformity with generally accepted accounting principles.

See J.A. 117 (2d Am. Cplt. at P 109).

Following the release of the audit opinion and IKON's contemporaneous December 24, 1997 10-k filing with the SEC, share values of IKON common stock experienced a net gain. See J.A. 1371 (Chart Common 1). Within a matter of months, however, IKON's prospects soured. On April 22, 1998, before the stock market opened, IKON announced that its second quarter earnings for fiscal year 1998 would be $0.35 per share, instead of $0.38 as expected by analysts. IKON also warned that third and fourth quarter earnings would fall below expectations. See J.A. 1624-25 (PR Newswire). IKON cited several reasons for the earnings shortfall, including issues related to its transformation process, competitive pressures, and costs associated with product rationalization. IKON, however, did not mention accounting charges to rectify discrepancies in its 1997 financial statements.

Later that morning the investment banking firm of Goldman, Sachs & Co. downgraded IKON to "market perform" from "recommend list," while Prudential Securities downgraded IKON from "buy" to "hold." See J.A. 1340 (Jarrell Report). As a result, the price of IKON common stock dropped precipitously from $34.625 a share on April 21, 1998, to close at $25.25 a share on April 22, 1998 --a one-day decline of 27.08 percent. See J.A. 1371 (Chart Common 1).

IKON's stock continued to decline over the remainder of the spring and summer of 1998. On June 26, 1998, after the market closed, IKON announced that it would miss its earnings estimate for the third quarter of 1998. See J.A. 1341 (Jarrell Report). The following trading day, June 29, 1998, shares of its common stock declined $6.75 to close at $15.31. See J.A. 1371 (Chart Common 1). On July 9, 1998, IKON CEO John Stuart resigned and was replaced by IKON Vice-President James Forese. See J.A. 1342 (Jarrell Report).

With its market performance and economic prospects deteriorating, IKON engaged Ernst to review the books of each of its North American and United Kingdom business services, a project known as the "Special Procedures." See J.A. 1131-32 ...