Public Employees' Retirement v. Deloitte & Touche, 07-1704.

Decision Date05 January 2009
Docket NumberNo. 07-1704.,07-1704.
PartiesPUBLIC EMPLOYEES' RETIREMENT ASSOCIATION OF COLORADO; Generic Trading of Philadelphia, L.L.C., Plaintiffs-Appellants, v. DELOITTE & TOUCHE LLP; Deloitte & Touche Accountants, Defendants-Appellees.
CourtU.S. Court of Appeals — Fourth Circuit

ARGUED: Andrew John Entwistle, Entwistle & Cappucci, L.L.P., New York, New York, for Appellants. Daniel F. Kolb, Davis, Polk & Wardwell, New York, New York; John T. Behrendt, Gibson, Dunn & Crutcher, L.L.P., New York, New York, for Appellees. ON BRIEF: Johnston de F. Whitman, Jr., Richard W. Gonnello, Jordan A. Cortez, Entwistle & Cappucci, L.L.P., New York, New York; Adelberg, Rudow, Dorf & Hendler, L.L.C., Baltimore, Maryland, for Appellants. Marshall R. King, Lee G. Dunst, LaShann M. DeArcy, Gibson, Dunn & Crutcher, L.L.P., New York, New York, Daniel F. Goldstein, Brown, Goldstein & Levy, L.L.P., Baltimore, Maryland, for Appellee Deloitte & Touche Accountants; Sharon Katz, Jane Alexandra Small, Joshua D. Liston, Davis, Polk & Wardwell, New York, New York, Max H. Lauten, Kramon & Graham, P.A., Baltimore, Maryland, for Appellee Deloitte & Touche LLP.

Before WILKINSON and AGEE, Circuit Judges, and JOHN T. COPENHAVER, JR., United States District Judge for the Southern District of West Virginia, sitting by designation.

Affirmed by published opinion. Judge WILKINSON wrote the opinion, in which Judge AGEE and Judge COPENHAVER joined.

OPINION

WILKINSON, Circuit Judge:

This class action securities fraud lawsuit arises out of improper accounting by Royal Ahold, N.V., a Dutch corporation, and U.S. Foodservice, Inc. ("USF"), a Maryland-based Ahold subsidiary. The misconduct of Ahold and USF is not disputed in this appeal; at issue is the liability of Ahold's accountants, Deloitte & Touche LLP ("Deloitte U.S.") and Deloitte & Touche Accountants ("Deloitte Netherlands"), for their alleged role in the fraud perpetrated by Ahold and USF. Under the Private Securities Litigation Reform Act ("PSLRA"), Pub.L. No. 104-67, 109 Stat. 737, plaintiffs must plead facts alleging a "strong inference" that the defendants acted with the required scienter. As recently explained by the Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007), a strong inference "must be more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of non-fraudulent intent." Id. at 2504-05. Because we find the inference that the Deloitte defendants lacked the necessary scienter more compelling than any competing inference that they knowingly or recklessly perpetrated a fraud on Ahold's investors, we affirm the district court's judgment that plaintiffs' motion for leave to file a second proposed amended complaint was futile.

I.

Ahold owns and operates grocery stores and food service companies in the United States and other countries. Deloitte U.S. is an American accounting firm that audited Ahold's American subsidiaries and acted as a filing reviewer for Ahold's filings with the Securities and Exchange Commission ("SEC"). Deloitte Netherlands is a Dutch accounting firm that served as Ahold's outside auditor. Although they work closely together, the two Deloittes are legally distinct entities.

Beginning in the 1990s, and continuing until 2003, Ahold perpetrated two frauds that led it to significantly overstate its earnings on financial reports. First, Ahold improperly "consolidated" the revenue from a number of joint ventures with supermarket operators in Europe and Latin America ("the JV fraud"). That is, for accounting purposes Ahold treated these joint ventures as if it fully controlled them—and thus treated all revenue from the ventures as revenue to Ahold—when in fact Ahold did not have a controlling stake. Under Dutch and U.S. generally accepted accounting principles (GAAP), Ahold should only have consolidated the revenue proportionally to Ahold's stake in the ventures.

Second, USF falsely reported its income from promotional allowances ("the PA fraud"). Also known as vendor rebates, promotional allowances ("PAs") are payments or discounts that manufacturers and vendors provide to retailers like USF in order to encourage the retailers to promote the manufacturers' products. In order to increase its stated income, USF prematurely recognized income from PAs and inflated its reported PA income beyond amounts actually received.

On February 24, 2003, Ahold announced that its earnings for fiscal years 2001 and 2002 had been overstated by at least $500 million as a result of the fraudulent accounting for promotional allowances at USF and that Ahold would be restating revenues because it would cease treating the joint ventures as fully consolidated. After this announcement, Ahold common stock trading on the Euronext stock exchange and Ahold American Depository Receipts trading on the New York Stock Exchange lost more than 60% of their value. Subsequent to the February 2003 announcement, Ahold made further restatements to its earnings totaling $24.8 billion in revenues and approximately $1.1 billion in net income.

As a result of the frauds, the SEC filed civil enforcement actions against Ahold and several individual defendants. Separately, twenty-one private class action securities and ERISA actions were filed against Ahold, both Deloittes, and other defendants. On June 18, 2003, the Judicial Panel on Multidistrict Litigation transferred them to the U.S. District Court for the District of Maryland. In re Royal Ahold N.V. Securities & "ERISA" Litig., 269 F.Supp.2d 1362 (J.P.M.L.2003). Subsequently, several more related actions were also transferred to the District of Maryland.

On November 4, 2003, the district court consolidated all the actions and designated plaintiffs Public Employees' Retirement Association of Colorado and Generic Trading of Philadelphia, LLC as Lead Plaintiffs. In re Royal Ahold N.V. Securities and ERISA Litig., 219 F.R.D. 343 (D.Md. 2003). On February 18, 2004, the Lead Plaintiffs filed a Consolidated Amended Securities Class Action Complaint ("CAC") against Ahold, several Ahold subsidiaries, both Deloittes, and some of Ahold's underwriters, officers, and directors. The CAC charged Ahold, its subsidiaries, the Deloittes, and the individual defendants with violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5(b), as well as 10b-5(a) and (c), 17 C.F.R. § 240.10b, promulgated thereunder, and also charged some defendants with other violations of the securities laws not relevant here.

Both Deloittes moved to dismiss the CAC on several grounds. The district court on December 21, 2004, dismissed all of the claims against both Deloitte defendants for failure to state a claim, and held that with respect to the § 10(b) claims the complaint did not plead facts alleging a strong inference of scienter as required by the PSLRA. In re Royal Ahold N.V. Securities & ERISA Litig., 351 F.Supp.2d 334, 385-96 (D.Md.2004). The district court also dismissed some but not all of the claims against the other defendants on various grounds.1 See id. at 411. The plaintiffs continued the litigation on the remaining claims and proceeded with discovery. On November 28, 2005, Ahold and the Lead Plaintiffs announced a $1.1 billion settlement resolving the Class's claims against all the defendants other than Deloitte U.S. and Deloitte Netherlands.

On March 6, 2006, the Lead Plaintiffs filed a motion to amend the original complaint accompanied by a proposed Second Consolidated Amended Securities Class Action Complaint ("SAC"). The SAC alleged two causes of action: one under Rule 10b-5(b), and one under both 10b-5(a) and (c). After briefing and oral argument, the district court denied the motion on the basis of futility, for it determined that the amended motion still did not meet the PSLRA's requirement that it allege a strong inference of scienter against the Deloittes. Plaintiffs timely appealed.

II.

This appeal turns on Ahold's accountants' alleged role in the JV and PA frauds. Accordingly, we shall review the frauds and the Deloittes' roles in them as indicated by the record. Although Ahold began consolidating its joint ventures in 1992, the purported class period did not begin until July 30, 1999. Our discussion of events before that date serves only to provide background for later events.

A.

With respect to the JV fraud, both Deloittes advised Ahold on the consolidation of the joint ventures. Five joint ventures are at issue in this litigation: JMR, formed in August 1992; Bompreço, formed in November 1996; DAIH, formed in January 1998; Paiz-Ahold, formed in December 1999; and ICA, formed in February 2000. Ahold had a 49% stake in JMR and a 50% share of each of the other ventures at their respective times of formation.

Prior to Ahold's entering into the first joint venture, Deloitte Netherlands and Deloitte U.S. gave Ahold advice about revenue consolidation under Dutch and U.S. GAAP. For example, several months before the first joint venture was formed, Deloitte U.S. partner David Herskovits sent Ahold Senior Vice President Cor Sterk a memorandum providing details on the consolidation of joint venture revenue. It explained that control of a joint venture is required for consolidation of the venture's revenue and discussed what situations are sufficient to demonstrate control. The memo indicated that control could be shown by a majority voting interest, a large minority voting interest under certain circumstances, or by a contractual arrangement.

Ahold began consolidating the joint ventures as they were formed. The various Joint Venture Agreements ("JVAs") did not indicate that Ahold controlled the ventures. For example, the JMR joint venture agreement specified that decisions would be made by a board of directors, "deciding unanimously," and that the board would consist of three...

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