Securities Investor Protection v. Bdo Seidman, Llp

• Decision Date: 14 May 1999
• Docket Number: No. 98 Civ. 2266(LAP).,98 Civ. 2266(LAP).
• Citation: 49 F.Supp.2d 644
• Parties: SECURITIES INVESTOR PROTECTION CORPORATION and James W. Giddens, as Trustee for the liquidation of the business of A.R. Baron & Co., Inc., Plaintiffs, v. BDO SEIDMAN, LLP, Defendant.
• Court: U.S. District Court — Southern District of New York

49 F.Supp.2d 644

SECURITIES INVESTOR PROTECTION CORPORATION and James W. Giddens, as Trustee for the liquidation of the business of A.R. Baron & Co., Inc., Plaintiffs, v. BDO SEIDMAN, LLP, Defendant.

No. 98 Civ. 2266(LAP).

United States District Court, S.D. New York.

May 14, 1999.

COPYRIGHT MATERIAL OMITTED

Stephen P. Harbeck, Securities Investor Protection Corp., Washington, DC, for Securities Investor Protection Corp.

Daniel Haym Weiner, Hughes Hubbard & Reed, New York City, for James W. Giddens.

Michael R. Young, Willkie Farr & Gallagher, New York City, for BDO Seidman, LLP.

OPINION

PRESKA, District Judge.

Plaintiffs, the Securities Investor Protection Corporation ("SIPC") and James W. Giddens as Trustee (the "Trustee") for the liquidation of the business of securities broker-dealer A.R. Baron & Co., Inc. ("Baron"), brought this action against defendant BDO Seidman, LLP ("Seidman") seeking damages for various state law causes of action, such as negligence, fraud and breach of contract. In essence, the action is one seeking recovery for an accountant's misrepresentations. Defendant has now moved to dismiss the complaint pursuant to Federal Rules of Civil Procedure 12(b)(1) and 12(b)(6) on grounds of standing and the failure to state a claim. For the reasons set forth below, defendant's motion is granted.¹

BACKGROUND

For purposes of this motion, the facts alleged in plaintiffs' complaint (the "Complaint") are presumed to be true. Seidman is a national accounting firm which served as the independent certified public accountant for Baron, a securities broker-dealer, and which also audited Baron's financial statements for the years 1992 through 1995. (See Complaint ¶ 1). Baron achieved notoriety in the 1990's, when the excesses and illicit activities of its management (the "Bressman Team") became widely known. The "Bressman Team," as defined in the Complaint, consisted of such members of Baron's senior management as chief executive officer Andrew Bressman, chief financial officers Mark Goldman and John McAndris, and brokers Roman Okin and Brett Hirsch. (See id. ¶ 9). The Bressman Team's illegal activities included the following: (1) fraudulent sales of securities; (2) manipulation of initial public offerings of securities; (3) manipulation of trading in the after-market of those securities for which Baron was the sole or dominant market maker and creation of artificially inflated values for those securities; and (4) frenzied purchases on corporate credit cards for personal expenses that totalled several million dollars. (See id. ¶¶ 9, 12). The Complaint alleges that the Bressman Team acted with the express purpose of enriching themselves, their friends and other insiders to the detriment of Baron. (See id. ¶ 9). To that end, the Bressman Team "caused Baron to issue false and misleading financial reports, including those audited by Seidman, in order to prolong their fraudulent scheme and increase their personal gain." (Id. ¶ 13).

When the unlawful activities at Baron were revealed, criminal indictments were brought against Baron employees. In total, thirteen Baron employees pleaded guilty or were convicted for their participation in fraudulent activity and other criminal wrongdoing at Baron. (See id. ¶ 10). Baron itself entered into a guilty plea on one count of enterprise corruption. (See id. ¶ 11). Although the complaint asserts that no evidence exists that all employees engaged in or assisted the illegitimate activities of the Bressman team, (see id.), it does not allege that any individual member of Baron's management was innocent of those activities and could have put a halt to the fraudulent activities.

Plaintiffs contend that Seidman is liable for its failure to audit adequately Baron's financial statements for the years 1992 through 1995. (See id. ¶¶ 19, 21, 23, 25). Generally, plaintiffs seek to recover for: (1) Seidman's alleged multiple misrepresentations as Baron's certified public accountant; (2) Seidman's failure to conduct year-end audits of Baron in accordance with generally accepted auditing standards ("GAAS"); (3) Seidman's failure to disclose that Baron did not present fairly its year-end financial statements in accordance with generally accepted accounting principles ("GAAP"); and (4) Seidman's failure to comply with the rules and regulations of the Securities and Exchange Commission ("SEC") governing the practice of independent certified public accountants for SEC registrants. (See id. ¶ 1).

Among the most damaging of Seidman's alleged acts as Baron's certified independent accountant was its failure to disclose that Baron lacked adequate reporting systems and internal controls to detect or prevent fraud. (See id. ¶¶ 40-44). Plaintiffs allege that Seidman's failure to disclose this information permitted the Bressman Team to hide the true financial state of Baron. For example, the Bressman Team was able to create the illusion that Baron had sufficient net capital by reducing the inventory of "house stocks" through the placement of securities in retail customer accounts and with other broker-dealers, artificially inflating values of securities where Baron was the dominant or sole market maker and understating the amount of loss contingencies disclosed in Baron's year-end financial statements. (See id. ¶¶ 14-15).

Plaintiffs also allege that Seidman wrongfully failed to disclose the true financial condition of Baron in its audit reports, such as Seidman's failure to report that Baron was insolvent or in violation of minimum net capital requirements. Like the failure to disclose inadequate internal reporting systems, this failure permitted "Baron to remain in operation and (to) obtain additional property from customers, which would then be appropriated by the Bressman team." (Id. ¶ 13). In sum, plaintiffs allege that the direct result of Seidman's improprieties was that, "Baron, SIPC, and Baron's customers, creditors, and regulators were denied the opportunity to take action with respect to the deterioration of Baron's financial condition and its violations of financial responsibility rules." (Id. ¶ 45).

At the heart of the Complaint is plaintiffs' contention that Seidman's inadequate performance as Baron's independent auditor created a breach in the regulatory framework of federal securities laws which were designed to protect customers from the harm of broker-dealer failure. Plaintiffs do not state in the Complaint whether SIPC or Baron's customers actually received, read or reviewed the financial statements certified by Seidman. Plaintiffs claim reliance upon those certified financial statements because they were sent to "the SEC, NASD and others" and SIPC, Baron and Baron's customers relied on those entities to ensure Baron's compliance with the applicable regulatory rules. (See id. ¶ 54). In furtherance of that argument, plaintiffs contend that the certified financial statements and the independent auditors' report attached to those financial statements, which are required by the securities laws, are "crucial elements of the effective regulatory system." (Id. ¶ 17). The Complaint states that Seidman knew or should have known that the "end and aim of its engagement to audit the financial statements of Baron" was to ensure adherence with the regulatory guidelines set forth in SEC Rule 17a-5. (See id. ¶ 57).

SIPC brings this action on its own behalf and as the subrogee to the net equity claims of Baron's customers which have been paid by SIPC. (See id. ¶ 4). SIPC has provided over $5.5 million for the payment of claims submitted by these customers and administrative expenses of the liquidation. (See id. ¶ 47). The Trustee brings this action as (1) the bailee of the fund of customer property entrusted to Baron by customers; (2) as assignee of the rights and claims of customers whose net equity claims have been paid by the Trustee; and (3) as the representative of the estate of Baron in liquidation. (See id. ¶ 5). The Trustee was appointed as trustee for the liquidation of Baron pursuant to an order of this Court in SIPC v. A.R. Baron & Co., Inc., No. 96 Civ. 5171 (S.D.N.Y. July 11, 1996) (the "Protective Decree"). Since the establishment of the Protective Decree, the Trustee has paid over $2.5 million to customers and other creditors for which it has received assignments. (See id. ¶ 48).

DISCUSSION

I. Motion to Dismiss Standard

In deciding this motion to dismiss, I must view the complaint in the light most favorable to plaintiffs. Scheuer v. Rhodes, 416 U.S. 232, 237, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974); Yoder v. Orthomolecular Nutrition Institute, Inc., 751 F.2d 555, 562 (2d Cir.1985). I must accept as true the factual allegations stated in the complaint, Zinermon v. Burch, 494 U.S. 113, 118, 110 S.Ct. 975, 108 L.Ed.2d 100 (1990), and draw all reasonable inferences in favor of the plaintiffs. Haines v. Kerner, 404 U.S. 519, 520-21, 92 S.Ct. 594, 30 L.Ed.2d 652 (1972); Hertz Corp. v. City of New York, 1 F.3d 121, 125 (2d Cir.1993), cert. denied, 510 U.S. 1111, 114 S.Ct. 1055, 127 L.Ed.2d 375 (1994). A motion to dismiss can only be granted if it appears beyond doubt that the nonmoving party can prove no set of facts in support of its claim which would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). Even under this liberal standard, however, the plaintiffs' claims suffer from deficiencies that require their dismissal at this time.

II. Securities Investor Protection Act Generally

Congress enacted the Securities Investor Protection Act of 1970, as amended, 15 U.S.C. §§ 78aaa-78lll (1994) (the "Act" or "SIPA"), after a business contraction in the securities industry led to a rash of failures among brokerage firms. See SIPC v. Barbour, 421 U.S. 412, 415, 95 S.Ct. 1733, 44 L.Ed.2d 263 (1975). After that contraction, "customers of failed firms found their cash and securities on deposit either dissipated or tied up in lengthy bankruptcy...