CMNY CAPITAL, LP v. Deloitte & Touche

• Decision Date: 20 May 1993
• Docket Number: No. 91 Civ. 0670 (MJL).,91 Civ. 0670 (MJL).
• Citation: 821 F. Supp. 152
• Court: U.S. District Court — Southern District of New York
• Parties: CMNY CAPITAL, L.P. and Permal Capital Partners, L.P., Plaintiffs, v. DELOITTE & TOUCHE, Defendant.

821 F. Supp. 152

CMNY CAPITAL, L.P. and Permal Capital Partners, L.P., Plaintiffs, v. DELOITTE & TOUCHE, Defendant.

No. 91 Civ. 0670 (MJL).

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

April 1, 1993.

Order Denying Reargument May 20, 1993.

COPYRIGHT MATERIAL OMITTED

Spengler Carlson Gubar Brodsky & Frischling by Herbert B. Max, Norman M. Block, New York City, for plaintiffs.

Shea & Gould by Leon P. Gold, Richard L. Spinogatti, Merrye Piltz Schindler, Alyson M. Weiss, New York City, for defendant.

OPINION AND ORDER

LOWE, District Judge.

Before this Court is the motion filed July 12, 1991 by Deloitte & Touche ("D & T") to dismiss for failure to state a claim and for failure to plead fraud with particularity. Fed.R.Civ.P. 12(b)(6), 9(b). For the following reasons, D & T's motion to dismiss is denied with respect to plaintiffs' federal securities claim, but granted with respect to plaintiffs' state law negligence claim.

BACKGROUND

Defendant's motion was referred to Magistrate Judge Naomi Reice Buchwald, who issued a Report and Recommendation ("R & R") on May 29, 1992. Plaintiffs filed objections to the R & R pursuant to 28 U.S.C. § 636(b)(1), and defendants filed a reply to plaintiffs' objections.

The R & R's detailed account of the facts is adopted for purposes of this opinion. A brief recital of the most salient points will suffice. Plaintiffs CMNY Capital, L.P. ("CMNY") and Permal Capital Partners, L.P. ("Permal") brought this suit to recover $6.054 million they invested in Collectors Guild, Inc. ("Guild") between January 1989 and March 1990. Guild went bankrupt in 1990, but its accountant Touche Ross & Co. ("Touche") remains solvent in the guise of successor D & T. During the relevant time period, two of plaintiffs' principals served as directors of Guild.

Plaintiffs allege that Guild fraudulently misrepresented its financial condition to induce their investments.¹ They claim that Touche is liable for their losses because of its conduct in issuing a certified financial statement on or about December 23, 1988 for Guild's 1988 fiscal year, which ended September 30, 1988. Specifically, plaintiffs advance two theories of liability against Touche: (1) liability as an aider and abettor of securities fraud violations under § 10(b) of the Securities Exchange Act of 1934; and (2) liability for negligence under New York State law.

DISCUSSION

The standards for deciding a motion under rule 12(b)(6) are well-settled. A court's task

is necessarily a limited one. The issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims. Indeed it may appear on the face of the pleadings that a recovery is very remote and unlikely but that is not the test. Moreover, ... the allegations of the complaint should be construed favorably to the pleader.

Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974). A complaint "should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 101-102, 2 L.Ed.2d 80 (1957).

In addition to the usual requirements of rule 12(b)(6), a plaintiff bringing a claim under § 10(b) must state with particularity the circumstances of the alleged fraud. Fed. R.Civ.P. 9(b); Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 115 (2d Cir.1982). Rule 9(b) has been interpreted to require that a plaintiff allege facts that give rise to a "strong inference" of fraudulent intent. Kramer v. Time Warner, Inc., 937 F.2d 767, 776 (2d Cir.1991); Ouaknine v. MacFarlane, 897 F.2d 75, 80 (2d Cir.1990); Cosmas v. Hassett, 886 F.2d 8, 13 (2d Cir.1989); Connecticut Nat'l Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir.1987).

A. § 10(b) Aider and Abettor Liability

1. Scienter

Plaintiffs' first claim is that Touche violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and rule 10b-5 of the associated Securities and Exchange Commission regulations. 17 C.F.R. § 240.10b-5. Plaintiffs do not allege direct violations by Touche; rather, they allege that Touche is liable as an "aider and abettor" of Guild's violations. Liability under § 10(b) and rule 10b-5 requires proof that the defendant acted with scienter. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 96 S.Ct. 1375, 1380, 47 L.Ed.2d 668 (1976). For purposes of rule 12(b)(6), a complaint sufficiently pleads an accountant's liability as an aider and abettor if it charges:

(1) A violation of section 10(b) by the accountant's client;

(2) Knowledge of the client's violation on the part of the accountant; and

(3) Substantial assistance by the accountant in the accomplishment of the violation.

Decker, 681 F.2d at 119; IIT, An Int'l Inv. Trust v. Cornfeld, 619 F.2d 909, 922 (2d Cir.1980). These elements are not sharply distinct from one another; the statutory scienter requirement is loosely interwoven among all three. See IIT, 619 F.2d at 922.

Magistrate Judge Buchwald concluded that plaintiffs' complaint does not sufficiently plead scienter on the part of Touche, and recommended that the § 10(b) claim be dismissed. R & R at 14-18. Plaintiffs object to Magistrate Judge Buchwald's conclusion on two grounds. First, they argue that Magistrate Judge Buchwald applied an incorrect standard for pleading scienter. Second, they argue that scienter is a question of fact that cannot be resolved on a rule 12(b)(6) motion.

Scienter, the operative mental state requirement of § 10(b) as that section is interpreted by the Supreme Court, is defined as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst, 425 U.S. at 194 n. 12, 96 S.Ct. at 1381 n. 12.² In this circuit, "reckless conduct will generally satisfy the scienter requirement," IIT, 619 F.2d at 923 (emphasis omitted), but "special considerations" apply where aiders and abettors are concerned. "If the alleged aider and abettor owes a fiduciary duty to the plaintiff, recklessness is enough. If there is no fiduciary duty ... the assistance rendered must be knowing and substantial." Armstrong v. McAlpin, 699 F.2d 79, 91 (2d Cir. 1983) (citations omitted).

Magistrate Judge Buchwald acknowledged that recklessness can satisfy the scienter requirement, but found that plaintiffs' complaint fails to allege recklessness in terms that can give rise to a "strong inference of intent." R & R at 16-17. As noted above, numerous cases in this circuit have recited the "strong inference of intent" language in deciding whether a complaint satisfies rule 9(b) in a § 10(b) action. Kramer, 937 F.2d at 776; Ouaknine, 897 F.2d at 80; Cosmas, 886 F.2d at 13; Connecticut Nat'l Bank, 808 F.2d at 962.

Rule 9(b) pretermits claims that cannot be supported by strong inferences from the allegations. But rule 9(b) cannot require that those inferences support more than is necessary to state the claims. Rule 9(b) demands a strong inference of "intent" in a § 10(b) case only in the sense that "intent" means "scienter." Scienter is a flexible standard, and rule 9(b) must flex in tandem. Thus, the Second Circuit has reasoned that "`allegations of scienter are sufficient if supported by facts giving rise to a `strong inference' of fraudulent intent.' For Rule 10(b)(5) purposes, scienter includes recklessness." Breard v. Sachnoff & Weaver, Ltd., 941 F.2d 142, 144 (2d Cir.1991) (quoting Ouaknine v. MacFarlane, 897 F.2d 75, 81 (2d Cir.1990)). The Court went on to find that the plaintiff's allegations established "a relatively strong inference that the defendant was reckless." Id. It follows that when an alleged aider and abettor is a nonfiduciary, rule 9(b) requires allegations that support a strong inference of assistance that is knowing and substantial. Armstrong, 699 F.2d at 91. When an alleged aider and abettor is a fiduciary, rule 9(b) is satisfied by allegations that support a strong inference of recklessness. Id.

It seems axiomatic to add that a complaint based on fiduciary recklessness must allege the existence of a fiduciary relationship. The existence of such a relationship, however, is not one of "the circumstances constituting fraud" that rule 9(b) requires to be "stated with particularity." Fed.R.Civ.P. 9(b). The complaint need not state the basis of the fiduciary relationship with the same particularity that rule 9(b) would require; it need meet only the usual requirements of rule 12(b)(6).

a. Non-fiduciary Aider and Abettor Liability: Knowing and Substantial Assistance

Plaintiffs must show that they have stated a claim of either knowing and substantial assistance (if Touche was a non-fiduciary), or recklessness combined with a fiduciary relationship. Magistrate Judge Buchwald found no strong inference of intent to defraud on the part of Touche. This Court agrees as far as non-fiduciary liability is concerned; the complaint fails to support a strong inference of assistance that is knowing and substantial.

The pertinent parts of the complaint aver as follows:

11. Max Munn, President of Guild, contacted Touche and notified it that CMNY and Permal were awaiting the audited financial statements and would rely upon them in deciding to provide this funding.

....

19. Touche, as an experienced public accounting firm, knew or should have known that the financial statement contained these misrepresentations since the financial records of Guild either contained information which should have led Touche to believe that the information was false or failed to contain necessary information to support the truth of the representations, the lack of which a reasonable accounting firm would have questioned and investigated further before rendering an unqualified opinion that the audited financial statement was properly prepared.

20. In its audit of the fiscal year 1988 statement, Touche also manifested gross negligence and recklessness by failing to

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