Arnlund v. Deloitte & Touche Llp

Decision Date08 May 2002
Docket NumberNo. Civ. 3:01CV353.,Civ. 3:01CV353.
Citation199 F.Supp.2d 461
CourtU.S. District Court — Eastern District of Virginia
PartiesBert E. ARNLUND, et al., Plaintiffs, v. DELOITTE & TOUCHE LLP, Defendant.

Steven S. Biss, Richmond, VA, for Plaintiffs.

Michael D. Warden, Griffith L. Green, Richard D. Bernstein, Sidley Austin Brown & Wood, Washington, DC, James T. Williams, Jr., Brooks, Pierce, McLendon, Humphrey & Leonard, LLP, Greensboro, NC, for Defendants.

MEMORANDUM OPINION

PAYNE, District Judge.

Pursuant to Fed.R.Civ.P 12(b)(6), Deloitte & Touche, L.L.P. ("Deloitte") has moved for the dismissal of the Amended Complaint in which Plaintiffs allege that Deloitte committed securities fraud under Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b)) (the "1934 Act") and Securities Exchange Commission Rule 10(b)(5) ("Rule 10(b)(5)"), and actual and constructive common law fraud. The grounds on which dismissal is urged are that: (1) Plaintiffs have failed to state a claim under the 1934 Act and Rule 10(b)(5) because five of the seven Plaintiffs did not allege that they purchased or sold stock of Heilig-Meyers Company ("HM" or the "Company") subsequent to Deloitte's alleged misrepresentation; (2) the Amended Complaint fails to state with particularity facts giving rise to a strong inference of scienter, as required by the Private Securities Litigation Reform Act of 1995 (the "PSLRA"); (3) Cullather, the only Plaintiff who bought his HM shares after the alleged misrepresentations and in reliance upon them, made the purchases after he knew of the Company's "true financial picture," thereby foreclosing, as a matter of law, the adequate pleading of the elements of causation, justifiable reliance and material misrepresentation, which are the sine qua non of a valid claim under Section 10(b) and Rule 10(b)(5). Deloitte seeks dismissal of the constructive and actual common law fraud claims based on: (1) failure to adequately allege causation, and actual and reasonable reliance; and (2) the precept that constructive fraud cannot be premised on alleged negligent misrepresentation.

Finally, Deloitte asserts that all of the Plaintiffs' claims for punitive damages are unfounded because such damages are not recoverable under Section 10(b) or Rule 10(b)(5), and because Plaintiffs cannot show an injury caused by detrimental reliance on the fraud, or any element of wantonness, malice or overreaching.

STATEMENT OF FACTS

In this action, seven shareholders of HM, a home furnishings retailer, assert claims for securities fraud and common law fraud arising out of misrepresentations and omissions alleged to have been made by HM's outside auditor, Deloitte, in connection with HM's Annual Report issued on May 30, 2000. The facts, as alleged in the Amended Complaint, are recited below. Of course, for purposes of this motion the alleged facts must be taken as true and all favorable inferences that reasonably can be drawn from those facts must be extended to the Plaintiffs.

Deloitte performed an audit of the financial statements of HM as of the fiscal year ending on February 29, 2000. The audit report was incorporated in full in HM's Annual Report (Form 10-K) for that fiscal year issued on May 30, 2000.

On March 22, 2000, Deloitte presented its unqualified audit report to the HM Board of Directors. On May 29, 2000, the HM Board of Directors approved the Annual Report and it was filed with the Securities and Exchange Commission ("SEC") on May 30, 2000.

The Annual Report included an audit opinion wherein Deloitte represented that: (1) Deloitte had audited the balance sheets, consolidated statements of operations and stockholders' equity of HM; (2) HM's financial statements "present fairly, in all material respects, the financial position" of HM as of February 29, 2000; and (3) the audit was in conformity with accounting principles generally accepted in the United States. Deloitte's unqualified audit opinion also represented that, as of February 29, 2000, and May 30, 2000, HM was solvent; that it had almost $535 million in shareholder equity; and a book value of $8.81 per share. Amended Complaint, ¶ 14.

It also is alleged that Deloitte knew that its unqualified opinion was to be used in HM's Annual Report and that, as of May 30, 2000, when the Annual Report was issued, Deloitte knew that HM was not solvent; that the shareholder equity was not $535 million; that the book value was not $8.81 per share; and that the audited financial statements did not in most material respects fairly present HM's financial position either as of February 29, 2000, or as of May 30, 2000. Amended Complaint, ¶ 127, 141.

Further, the Amended Complaint charges that, before the Annual Report was issued on May 30, Deloitte knew, or should have known, based on the financial information to which it was privy and discussions with HM's management, that there were serious questions about the accuracy of HM's financial statements and that there was material uncertainty about the ability of HM to continue as a going concern. Amended Complaint, ¶ 16. Further, it is averred that, by May 30, Deloitte knew that HM's liquidity situation was not accurately portrayed in its audit opinion or in the Annual Report, having been so informed by HM's CEO at a meeting of the HM Board on May 17, and that the Company's liquidity situation was a matter of great concern both to HM's executives and its Board. Amended Complaint, ¶ 27. Deloitte is said to have known that, before the Annual Report was issued, the Board had directed management to position the Company to seek protection under the bankruptcy laws, (Amended Complaint, ¶¶ 28, 29); and that the Company had retained an investment banker to determine whether there existed a potential purchaser for HM, facts that were not disclosed in the Annual Report or mentioned in Deloitte's unqualified audit opinion.

The Plaintiffs further charge that Deloitte knew that the Company's financial position would be adversely affected by the termination of its Chief Executive, William DeRusha ("DeRusha"), because, as Deloitte knew, DeRusha's termination would trigger a default in the Company's revolving credit facility. According to the Amended Complaint, DeRusha, the Board and Deloitte all knew before May 30 that DeRusha's employment likely would be terminated shortly thereafter. See Amended Complaint, ¶¶ 43-47.

Plaintiffs also allege that, with Deloitte's knowledge, the Annual Report made several other misrepresentations of material fact:

• The Company had grown and was continuing to grow, with new and expansive remodeling plans and an enhanced advertising program;

• As part of a "selective growth strategy", HM planned to select new Heilig-Meyers locations and plans to expand the RoomStore format;

• The Company's competitive environment was comparable in all geographic regions in which it operates. There was no significant threat of competition that would materially affect HM's business;

• There were no significant factors affecting the business of the Company, including, the economy;

• The Board intended to continue its present policy of paying regular quarterly dividends when justified by the financial condition of the company;

• There were no problems with the Company's receivables;

• The allowance for doubtful accounts was adequate.

According to the Amended Complaint, all of these statements were false because the Company's liquidity was in jeopardy and because the Company was selling assets rather than remodeling and effecting a "selective growth strategy," all of which affected the Company's business, its ability to compete and its financial viability.

On November 27, 2000, HM filed its quarterly report with the SEC. The quarterly report revealed that by August 31, 2000:

1. HM's assets had shrunk over $611,474,000;

2. Total revenues for the quarter decreased 7.8%;

3. Operating expenses exceeded revenue by over $48 million;

4. The net loss increased $536,835,000;

5. Accounts payable increased by $27,313,000;

6. The loss per share was ($9.71); and

7. The total shareholder equity went from $534,748,000 in May 2000 to ($75,057), a decrease of $609,805,000.

That quarterly report also stated that over $142.9 million in goodwill and all of the previously stated book value was gone, Amended Complaint, ¶ 119; and that "the equity interests of the Company's shareholders may have no value". Amended Complaint, ¶ 120 (citing the Quarterly Report).

According to the Amended Complaint, all Plaintiffs, including Cullather, held onto the HM stock they owned as of May 30, rather than selling it because of their reliance on the material misrepresentations made by, and material facts deliberately not disclosed by, Deloitte. Also, Cullather claims to have bought additional HM Stock in reliance on representations made by Deloitte on May 30. The Plaintiffs assert that they sustained significant losses in the value of the stock that they bought, or onto which they held, after May 30.

DISCUSSION

Deloitte's motion to dismiss the Amended Complaint must be assessed in perspective of the foregoing allegations, taken as true. The assessment must be made in perspective of the following legal framework for judging the legal sufficiency of claims for securities fraud and common law fraud.

A. The Basic Standards For Assessing Motions To Dismiss Under Rule 12(b)(6)

In considering a motion to dismiss a complaint for "fail[ing] to state a claim upon which relief can be granted," a court must construe the complaint in the light most favorable to the plaintiffs, read the complaint as a whole, and take the facts asserted therein as true. Fed.R.Civ.P. 12(b)(6); see Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974); In re MicroStrategy, Inc. Securities Litigation, 115 F.Supp.2d 620, 627-28 (E.D.Va.2000); Higgins v. Medical College, 849...

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