Dept. of Economic Dev. v. Arthur Andersen & Co.

• Decision Date: 05 April 1988
• Docket Number: No. 85 Civ. 1292(CES).,85 Civ. 1292(CES).
• Citation: 683 F. Supp. 1463
• Parties: DEPARTMENT OF ECONOMIC DEVELOPMENT, Plaintiff, v. ARTHUR ANDERSEN & CO. (U.S.A.), Arthur Andersen & Co. (Republic of Ireland) and Arthur Andersen & Co. (United Kingdom), Defendants.
• Court: U.S. District Court — Southern District of New York

683 F. Supp. 1463

DEPARTMENT OF ECONOMIC DEVELOPMENT, Plaintiff, v. ARTHUR ANDERSEN & CO. (U.S.A.), Arthur Andersen & Co. (Republic of Ireland) and Arthur Andersen & Co. (United Kingdom), Defendants.

No. 85 Civ. 1292(CES).

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

March 8, 1988.

On Motion to Certify for Interlocutory Appeal April 5, 1988.

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Mudge, Rose, Guthrie, Alexander & Ferdon, New York City, for plaintiff; Malcolm R. Schade, Robert Sidorsky, of counsel.

Breed, Abbot and Morgan, New York City, for defendants; James D. Zirin, James J. Sabella, Adrian V. White, Alan J. Sorkowitz, of counsel.

MEMORANDUM DECISION

STEWART, District Judge:

Plaintiff Department of Economic Development ("DED"), an agency of the British government operating principally in Northern Ireland, brings this securities fraud action against defendants Arthur Andersen & Co. (USA) ("AA-US"), Arthur Andersen & Co. (Republic of Ireland) ("AA-Ireland") and Arthur Andersen & Co. (United Kingdom) ("AA-UK"). Defendants are affiliated accounting firms.¹ Plaintiff alleges that defendants certified fraudulent financial statements of various corporations controlled by John Z. DeLorean ("DeLorean"), and thereby committed primary violations and aided and abetted violations of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Plaintiff also asserts various common law fraud and breach of contract claims, as well as a claim based on civil RICO, 18 U.S.C. § 1964. Defendants now move to dismiss the complaint on several grounds.

I. BACKGROUND

DED's predecessors in interest, the Northern Ireland Development Agency ("NIDA") and the Department of Commerce ("DOC") were agencies of the British government empowered to extend loans and grants to businesses for the purpose of promoting industrial development in Northern Ireland.² On July 28, 1978, NIDA and DOC entered into a contract with the DeLorean entities³ entitled "Master Agreement," which spelled out the contracting parties' rights and obligations with respect to the development and manufacture of the DMC-12 sports car. See Plaintiff's Exhibit 1 (hereinafter "Master Agreement"). The car was to be manufactured in Dunmurry, an economically depressed area in Northern Ireland. The principal DeLorean entities and their respective roles will be briefly summarized here. The DeLorean Motor Company ("DMC") was incorporated in 1975 under the laws of Michigan for the purpose of developing, manufacturing, and marketing the DMC-12 sports car. John Z. DeLorean was Chairman of the Board and Chief Executive Officer of DMC. The manufacturing work on the car was performed at the plant of DeLorean Motor Cars Limited ("DMCL") the Northern Ireland Subsidiary of DMC. The common stock of DMCL was owned by DMC, and the preferred stock was owned by NIDA. After the Master Agreement was signed, another entity, DeLorean Research Limited Partnership ("DRLP"), was formed on September 22, 1978, to raise money for research and development of the car. DMC was the sole general partner of DRLP.

In the Master Agreement NIDA and DOC agreed, inter alia, to purchase all of the 17,757,000 preferred shares of DMCL stock at one British pound per share. As discussed at greater length in section III(B) below, the certificates of this stock were delivered at the closing of the Master Agreement, although NIDA was to pay for the shares in a series of "calls" to be made at DMCL's discretion. NIDA and DOC also agreed to extend a variety of grants, loans, and loan guaranties to DMCL up to a maximum of £44,936,000. Master Agreement at 12-13, 15; Appendix F to the Master Agreement, § 1. To protect these investments, the Master Agreement provided that NIDA would appoint DMCL's financial comptroller, and that DMC would "use its best endeavors" to insure that the boards of directors of DMCL and DMC each included two NIDA appointees. Master Agreement at 7, 11. In addition, NIDA was given the right under certain circumstances to compel DMC to purchase NIDA's DMCL stock. In March 1980, this latter right was replaced by an amendment to the Master Agreement which gave NIDA the right to convert its DMCL preferred stock into seven million shares of DMC common stock.

Pursuant to the Master Agreement, DMC and another DeLorean-controlled corporation, the John Z. DeLorean Corporation ("JZDC")⁴ undertook to furnish to NIDA and DOC "within 120 days following the end of DMC's fiscal year ... a consolidated balance sheet as of the end of such fiscal year and a consolidated statement of income for such year, together with notes thereto and the report thereon of DMC's auditors." Master Agreement at 9. These "Consolidated Financial Statements" encompassed DMC and its subsidiaries, including DMCL. Defendants, as DMC's auditors, prepared reports certifying the Consolidated Financial Statements. These reports were issued in this country by either AA-US's Detroit or New York offices. The first report, which certified the Consolidated Financial Statement covering the nine-month period ending August 31, 1978, was issued on November 20, 1978.⁵

The gravamen of the complaint is that DMC's Consolidated Financial Statements were false and misleading, and that by issuing reports certifying these statements, defendants substantially assisted DeLorean and others in the execution of a fraudulent securities scheme. According to plaintiff, defendants' reports misrepresented or failed to disclose various questionable business transactions involving the DeLorean entities. Principally, plaintiff alleges that defendants inadequately investigated a November 1, 1978 contract between several of the DeLorean entities and GPD Services, Inc. ("GPD"), a Panamanian corporation not related to any of the DeLorean entities. Plaintiff contends that GPD performed none of its obligations under this contract, and that GPD instead was used by DeLorean to siphon money from DRLP and DMCL.

Amid allegations of mismanagement and fraud, the DeLorean entities began to collapse in 1981-82. DMCL was placed in receivership on February 19, 1982. DMC filed a petition for reorganization under Chapter 11 of the Bankruptcy Code on October 25, 1982. In December 1983 this proceeding was converted into a liquidation case under Chapter 7 of the Bankruptcy Code. Plaintiff estimates that it suffered $80,000,000 in damages as a result of the DeLorean entities' demise.

Defendants now move to dismiss the complaint on three grounds: 1) lack of subject matter jurisdiction, Fed.R.Civ.P. 12(b)(1); 2) failure to state a claim upon which relief can be granted, Fed.R.Civ.P. 12(b)(6); 3) forum non conveniens. In the alternative, defendants move for an Order staying this action pending the resolution of plaintiff's action against defendants in the courts of the United Kingdom.

II. SUBJECT MATTER JURISDICTION

The parties agree that the purchase of securities in this case occurred abroad. Defendants claim that this court lacks subject matter jurisdiction under the federal securities laws because plaintiff has failed to show that defendants' acts (or culpable failures to act) in the United States directly caused plaintiff's alleged loss. In deciding this issue, we shall consider materials outside the pleadings submitted by the parties. See Kamen v. American Telephone & Telegraph Co., 791 F.2d 1006, 1011 (2d Cir.1986).

Neither the text nor the legislative history of the securities laws indicate when federal courts have jurisdiction over claims arising from extraterritorial transactions. Bersch v. Drexel Firestone, Inc., 519 F.2d 974, 993 (2d Cir.), cert. denied, 423 U.S. 1018, 96 S.Ct. 453, 46 L.Ed.2d 389 (1975); see also Zoelsch v. Arthur Andersen & Co., 824 F.2d 27, 29-30 (D.C.Cir.1987). In the absence of statutory guidance, the Second Circuit has formulated a broadly-worded standard for determining when domestic conduct that is alleged to have assisted in the perpetration of a securities fraud on investors outside this country will activate federal jurisdiction.

The Second Circuit has declined jurisdiction over alleged violations of the securities laws when the domestic conduct that was the ostensible basis of jurisdiction was "merely preparatory" to the alleged fraud, or amounted simply to a "failure to prevent fraudulent acts where the bulk of the fraudulent activity was performed in foreign countries". IIT v. Vencap, Ltd., 519 F.2d 1001, 1018 (2d Cir.1975); Bersch, 519 F.2d at 992-93. However, if conduct here "directly caused" losses to investors abroad, the Second Circuit has held that jurisdiction will lie in federal district court. See AVC Nederland B.V. v. Atrium Investment Partnership, 740 F.2d 148, 153-54 (2d Cir.1984). This standard requires a case-by-case analysis. IIT, an International Investment Trust v. Cornfeld, 619 F.2d 909, 918 (2d Cir.1980); Fund of Funds, Ltd. v. Arthur Andersen & Co., 545 F.Supp. 1314, 1350 (S.D.N.Y.1982).

As noted above, plaintiff bases its claim on the defendants' preparation of reports on the fiscal 1978, 1979, and 1980 Consolidated Financial Statements of DMC and its subsidiaries, including DMCL. Plaintiff claims that defendants' certification of these statements was a direct cause of its losses. We hold that actions taken in this country by AA-US with respect to the Consolidated Financial Statements, and the interdependent nature of the DeLorean entities, provide sufficient bases for our jurisdiction over this case.

While most of the field work performed for the audit of DMC and its subsidiaries was conducted in the United Kingdom and the Republic of Ireland by AA-UK and AA-Ireland, ultimate "engagement partner responsibility" for the audit of DMC and its subsidiaries resided first in AA-US's Detroit offices and later in its New York offices. See Plaintiff's Exhibit 102. Plaintiff has submitted...