Amorosa v. Llp

• Decision Date: 20 January 2010
• Docket Number: No. 03 Civ. 3902(CM),03 Civ. 3902(CM)
• Citation: 682 F.Supp.2d 351
• Parties: Dominic F. AMOROSA, Plaintiff, v. ERNST & YOUNG LLP, Defendant
• Court: U.S. District Court — Southern District of New York

682 F.Supp.2d 351

Dominic F. AMOROSA, Plaintiff,

v.ERNST & YOUNG LLP, Defendant

No. 03 Civ. 3902(CM)

United States District Court

S.D. New York

Decided: Jan. 20, 2010

Christopher J. Gray, Law Office of Christopher J. Gray, P.C, New York, NY.

Jeremy Neil Kudon, Heller Ehrman, LLP, New York, NY, Robert Byron Hub-bell, Gibson, Dunn & Crutcher, LLP, Los Angeles, CA, for Defendant.

[CORRECTED] DECISION AND ORDER GRANTING DEFENDANT'S MOTION TO DISMISS THE COMPLAINT IN ITS ENTIRETY

McMAHON, District Judge:

INTRODUCTION

Dominic F. Amorosa was a private investor who purchased common stock of America Online, Inc. ("AOL") prior to its merger with Time Warner, Inc. ("Time Warner"). As a pre-merger stockholder, Amorosa voted in favor of the merger, and on January 11, 2001, exchanged his shares at a one-to-one ratio for shares in the successor corporation, AOL Time Warner, Inc. ("AOLTW").

More than a year and a half after the merger, the Washington Post published a two-part series of articles exposing widespread fraud at AOL and its successor corporation. Shortly thereafter, AOLTW, its executives and auditors found themselves facing hundreds of lawsuits arising from some of the same accounting practices the Washington Post had detailed. Amorosa commenced this action, the last of those suits, on May 29, 2003, naming as defendants AOL, Time Warner, AOLTW, eleven individual executives, Bertelsmann AG and auditor Ernst & Young LLP ("Ernst & Young"). Presently, only one defendant (Ernst & Young) remains in his suit. Amorosa's complaint as amended alleges that Ernst & Young as auditor to AOL, Time Warner and AOLTW engaged in fraud in violation of federal and state law when it issued audited financial statements approving of the company's faulty accounting, and that the auditor aided and abetted the company's fraud in violation of state laws. Ernst & Young has responded by filing the motions sub judice: a 12(b)(6) motion to dismiss Amorosa's complaint and a motion for sanctions under Rule 11 alleging that Amorosa's claims are frivolous.

For the reasons set forth below, Ernst & Young's motion to dismiss is granted in its entirety. Its motion for sanctions is neither granted nor denied; however, Ernst & Young is directed to produce a reasonable estimate of the attorneys' fees it seeks in connection with its motion, and plaintiff's attorney is ordered to show cause why sanctions should not be imposed.

FACTS

Amorosa's Stock Purchases

AOL and Time Warner announced their intent to merge on January 10, 2000. (Second Am. Compl. ("SAC"), Nov. 14, 2007, ¶¶12, 70.) Over the next three days, Amorosa purchased 16, 000 shares of premerger AOL common stock at allegedly inflated prices ranging from $61.89 to $65.88 per share. (Id. ¶ 5.)

Then, on May 19, 2000, AOL and Time Warner took the next step toward consum mating a merger between the two companies by jointly filing a Merger Registration Statement ("MRS") with the Securities and Exchange Commission ("SEC"). (Id, ¶¶13-14, 86.) The MRS contained selected historical financial data and AOL's previous SEC filings for shareholders to review in determining whether to support the merger, including inter alia:

(1) AOL's 10-K for the fiscal year ended 06/30/99;

(2) AOL's 10-Qs for the quarterly periods ended 09/30/99, 12/31/99 and 03/31/00;

(3) AOL's 8-Ks dated 12/01/99, 12/21/99, 01/10/00, 01/19/00, 03/17/00, 04/03/00, and 04/18/00.

(Id. ¶¶15, 17, 21.) AOL's 06/30/99 10-K (the "June 1999 Opinion" or "06/30/99 Opinion") was the only audited financial statement incorporated into the MRS; the others were "reviewed and approved" but never "certified" by AOL's auditor, Ernst & Young. (See id. ¶18.) Additionally, between the filing of the MRS and the consummation of the merger, Ernst & Young approved two additional audited financial statements on June 30, 2000 (the "June 2000" or "06/30/2000 Opinion") and December 31, 2000 (the "December 2000 Opinion" or "12/31/2000 Opinion"). (See Ernst & Young Mem. of Law in Supp. of Mot. to Dismiss ("E & Y MTD"), Jan. 18, 2008, at 5 (citation omitted).) The fourth and final audited statement prepared by the auditor was released on December 31,-2001 (the "December 2001 Opinion" or "12/31/2001 Opinion"). (Id.)

Four months after AOL and Time Warner had first filed the MRS with the SEC, Amorosa purchased an additional 330 shares of pre-merger AOL common stock at $54.56. (SAC ¶ 5.) One week later, on June 23, 2000, AOL and Time Warner shareholders approved the merger (id. ¶ 12), and approximately seven months la- ter, in January 2001, Amorosa exchanged his shares of AOL common stock for 16,-330 shares of AOLTW common stock (id. ¶5). Since that transaction, he has neither purchased nor sold any AOLTW stock. (Id.)

Ernst & Young's Involvement in the AOLTW Merger

Ernst & Young was the independent auditor for AOL, Time Warner and AOLTW at all relevant times prior to the AOLTW merger. (Id. ¶6.) As the independent auditor, Ernst & Young "audited and issued audit reports on the companies' year-end financial statements," including audit opinions for the years 1999-2001. (E & Y MTD at 5 (citation omitted).)

Amorosa alleges that Ernst & Young's wrongdoing stems from the auditor's role in approving certain false and misleading financial statements that were incorporated by reference into the MRS. Specifically, Amorosa alleges that AOL's June 1999 Opinion was audited and certified as "clean" by Ernst & Young, and AOL's interim results were reviewed and approved by the auditor. (SAC ¶¶18, 21.) A "clean unqualified opinion" indicates that the auditor has reviewed a company's financial statements in keeping with Generally Accepted Auditing Standards ("GAAS") and that the financial statements themselves comport with Generally Accepted Accounting Principles ("GAAP"). (Id. ¶¶21.) However, Amorosa alleges that no financial statement prepared and reviewed by Ernst & Young should ever have been certified as "clean" because Ernst & Young knew that AOL was actually relying upon non-GAAP accounting methods to fraudulently book certain revenues and conceal losses. (Id. ¶ 37.) Specifically, Amorosa alleges that Ernst & Young ignored certain "red flags" between 1999 and 2001 (id. ¶¶32, 45) and that Ernst & Young's "audit workpapers" dem onstrate that it "knew" of fraud and helped to conceal it by advising the company to "keep the percentage of barter revenue under 10% of total advertising revenue." (Id. ¶ 33.) Amorosa further alleges that Ernst & Young "failed to challenge" the company's accounting for a series of transactions (id. ¶34), even though the auditor "reviewed at least twelve transactions where the impropriety of revenue recognition was readily apparent" (id. ¶ 36).

Reports of the Fraud at AOL

According to Amorosa, throughout 2001 and 2002, scattered news reports began to expose AOL's improper accounting practices. Some—but not all—were directly related specifically to the company's booking of online advertising revenue. (Id. ¶¶ 22, 359.) The examples cited by Amorosa can be divided into four categories and include the following:

Reports Regarding AOL/'AOLTW's Financial Health

SPECIAL_CHARS_DOT A January 12, 2001 Bloomberg article that stated: "some on Wall Street have grown skeptical that the new company [AOLTW] will be able to meet its own projected growth rates." (Id. ¶ 359(a) (internal quotations omitted).)

SPECIAL_CHARS_DOT A February 1, 2001 Wall Street Journal article reporting concerns that AOLTW might not meet its "aggressive '01 financial targets following disappointing 4Q '00 results." (Id. ¶359(b).)

SPECIAL_CHARS_DOT A July 18, 2001, J.P. Morgan analyst report questioning AOLTW's ability to meet its "aggressive post-Merger financial targets." (Id.¶359(d) (internal quotations omitted).)

SPECIAL_CHARS_DOT On August 14, 2001, the Washington Post reported that AOLTW was "expected to announce a round of substantial layoffs at its online unit [AOL]soon." That same day, "Morgan Stanley reduced its financial targets for the company." (Id. ¶ 859(e) (internal quotations omitted).)

SPECIAL_CHARS_DOT A September 7, 2001 Lehman Brothers forecast for AOLTW that cut revenue projections in part due to "a softer environment and more tempered top line growth at AOL." (Id. 11 359(f) (internal quotations omitted).)

SPECIAL_CHARS_DOT An October 8, 2001 Barron's article addressing "AOLTW's inability to accelerate its growth and meet its aggressive financial targets." (Id. ¶ 359(g).)

SPECIAL_CHARS_DOT An October 17, 2001 Merrill Lynch downgrade of AOLTW stock "due to concerns about future advertising revenue and subscriber growth." (Id. ¶ 359(h).)

SPECIAL_CHARS_DOT A December 6, 2001 Bloomberg report speculating that AOL CEO Gerald Levin's resignation "may signal weakness." (Id. ¶359(i).)

SPECIAL_CHARS_DOT A December 7, 2001 Merrill Lynch report stating that AOLTW "may be hampered by slowing subscriber and advertising growth at its America Online unit." (Id. ¶359(j) (internal quotations omitted).)

SPECIAL_CHARS_DOT A December 10, 2001 analyst report revising downward estimates for the AOLTW segment, because "the AOL segment is at risk of continuing margin erosion, driven primarily by declining ad and commerce revenue." (Id. ¶ 359(k) (internal quotations omitted).)

SPECIAL_CHARS_DOT A February 20, 2002 Lehman Brothers downgrade of AOLTW stock, which cited as "key concerns" "declining subscriber revenues and online advertising." (Id. ¶359(1).)

SPECIAL_CHARS_DOT A June 4, 2002 Lehman Brothers downward revision of AOL advertising revenue forecasts. (Id. ¶359(o).)

Reports of SEC Investigations

SPECIAL_CHARS_DOT A May 21, 2002 USA Today article that Amorosa alleges reported on an SEC investigation of AOL's accounting practices, including the SEC's inquiry into the company's "bartering" transactions. (Id. ¶359(n).)

SPECIAL_CHARS_DOT The July 25, 2002 "disclosure" of an SEC investigation regarding AOL's accounting practices, which Amorosa did not attribute to any source. (Id. ¶359(r).)

Repoiis of General Accounting "Problems"

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