Economic Dev. v. Arthur Andersen & Co.

• Decision Date: 02 April 1996
• Docket Number: No. 85 Civ. 1292 (MBM).,85 Civ. 1292 (MBM).
• Citation: 924 F. Supp. 449
• Parties: DEPARTMENT OF ECONOMIC DEVELOPMENT, Plaintiff, v. ARTHUR ANDERSEN & CO. (U.S.A.), Arthur Andersen & Co. (Republic of Ireland), Arthur Andersen & Co. (United Kingdom), Richard E. Beckman, Richard L. Measelle, and Edward A. Massura, Defendants-Third-Party Plaintiffs, v. Alex H. FETHERSTON, C. Shaun Harte, Ronald J. Henderson, Anthony S. Hopkins and James Sim, Third-Party Defendants.
• Court: U.S. District Court — Southern District of New York

924 F. Supp. 449

DEPARTMENT OF ECONOMIC DEVELOPMENT, Plaintiff, v. ARTHUR ANDERSEN & CO. (U.S.A.), Arthur Andersen & Co. (Republic of Ireland), Arthur Andersen & Co. (United Kingdom), Richard E. Beckman, Richard L. Measelle, and Edward A. Massura, Defendants-Third-Party Plaintiffs, v. Alex H. FETHERSTON, C. Shaun Harte, Ronald J. Henderson, Anthony S. Hopkins and James Sim, Third-Party Defendants.

No. 85 Civ. 1292 (MBM).

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

April 2, 1996.

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Malcolm R. Schade, Robert Sidorsky, Mark D. Beckett, Kathleen E. McKay, Jack V. Valinoti, James Whelan, Nicole S. Polley, Mudge, Rose, Guthrie, Alexander & Ferdon, New York City, for Plaintiff.

James D. Zirin, James J. Sabella, Brenda F. Szydlo, William C. Rand, Brown & Wood, New York City, for Defendants.

MUKASEY, District Judge.

The Department of Economic Development ("DED"), an agency of the British government operating principally in Northern Ireland, brings this securities fraud action against the accounting firm Arthur Andersen & Co. ("AA") and three of its partners, Richard L. Measelle, Edward A. Massura, and Richard E. Beckman. Defendants have moved for summary judgment on all claims on various grounds. For the reasons that follow, the motion is granted in part and denied in part as explained below.

I.

A. A Brief Summary of the DeLorean Motor Co. Debacle¹ (1978-1983)

DED's predecessors, the Northern Ireland Development Agency ("NIDA") and the Department of Commerce ("DOC"), were agencies of the British government empowered to extend financial assistance to businesses to promote industrial development in Northern Ireland. On July 28, 1978, NIDA and DOC entered into a "Master Agreement" with several entities controlled by John Z. DeLorean ("the DeLorean entities"). The Master Agreement spelled out the contracting parties' rights and obligations with respect to the development and manufacture of the DMC-12, a sports car with distinctive gull wing-shaped doors and a rust-proof stainless steel body. (Zirin Aff.Ex. 49) The car was to be manufactured in Dunmurry, an economically depressed, predominantly Catholic area near the Northern Ireland capital of Belfast.

The principal DeLorean entities and their respective roles will be summarized briefly 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 car was manufactured at the plant of DeLorean Motor Cars Limited ("DMCL"), a subsidiary of DMC based in Northern Ireland. DMCL's common stock was owned by DMC, and DMCL's 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 for the venture. DMC was the sole general partner of DRLP. The DRLP limited partners were a group of individual American investors including several Hollywood celebrities. See generally Rudolph v. Arthur Andersen & Co., 800 F.2d 1040 (11th Cir.) (vacating district court's dismissal of securities fraud claims against AA by DRLP limited partners and DRLP liquidating trustee), reh'g denied, 806 F.2d 1070 (11th Cir.1986), cert. denied, 480 U.S. 946, 107 S.Ct. 1604, 94 L.Ed.2d 790 (1987); Judith Cummings, An Audit Under Fire, N.Y. Times, Mar. 16, 1986, § 3 at 4.

In the Master Agreement NIDA agreed, inter alia, to purchase all of the 17,757,000 preferred shares of DMCL at a price of £1 per share. (Master Agreement ¶ 1.1, Zirin Aff.Ex. 49 at 128) Although the stock certificates were delivered at the closing of the Master Agreement, NIDA was to pay for the shares in a series of "calls" to be made at DMCL's discretion. (Id.) NIDA and DOC also agreed to extend a variety of grants, loans, and loan guarantees to DMCL up to a maximum of £44,936,000. (Master Agreement ¶¶ 7.1, 8.3.3 & Ex. F, Zirin Aff.Ex. 49 at 131, 133) To protect those 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 ¶¶ 5.1.6, 6.4, 6.5, Zirin Aff.Ex. 49 at 129, 131) In addition, DMC issued a "put" to NIDA. Under the terms of the put, after four years NIDA could force DMC to purchase NIDA's DMCL preferred shares for the cash value of 6.5 million shares of DMC common stock. After 10 years, NIDA could force DMC to buy its DMCL shares at a price of £1 per share plus a premium. (Master Agreement ¶ 9.2, Zirin Aff.Ex. 49 at 133-34) In March 1980, the parties renegotiated the put. NIDA relinquished its original put rights in exchange for the single right, effective after four years, to force DMC to tender the cash value of 7 million shares of DMC stock in payment for NIDA's DMCL shares. (Zirin Aff.Ex. 50)

Pursuant to the Master Agreement, DMC and another DeLorean-controlled corporation, the John Z. DeLorean Corporation, undertook to furnish to NIDA and DOC "within 120 days following the end of DMC's fiscal year ... a consolidated balance sheet at 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 ¶ 6.1.5(b), Zirin Aff.Ex. 49 at 130) Those "Consolidated Financial Statements" treated DMC and its subsidiaries, including DMCL. AA, as DMC's auditors, prepared reports certifying the Consolidated Financial Statements. Those reports were issued in this country by AA's Detroit and 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.

The gravamen of DED's complaint is that DMC's Consolidated Financial Statements were false and misleading, and that by issuing reports certifying these statements, AA substantially helped DeLorean and others to execute a securities fraud. According to DED, AA's reports misrepresented or failed to disclose various questionable business transactions involving the DeLorean entities. Principally, DED alleges that AA 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. (Schade Aff.Ex. 141) DED contends that GPD performed none of its obligations under the contract, and that GPD instead was used by DeLorean to siphon money from DRLP and DMCL. Funds paid to GPD allegedly were transferred to Swiss accounts of the Dutch bank Pierson, Heldring, Pierson, N.V., and then loaned back to DeLorean at below market interest rates. DeLorean allegedly used the proceeds of the Pierson loan to repay a debt to Continental Illinois Bank incurred in connection with DeLorean's acquisition of Logan Manufacturing Company, a manufacturer of snow-grooming equipment and tracked vehicles based in Utah. DED alleges that AA knew or should have known of those transactions, but neglected to disclose its knowledge or its suspicions in its audit reports.

In late 1981, the DeLorean entities began to collapse amid allegations of mismanagement and fraud. On February 19, 1982, DMCL was placed in receivership. On October 25, 1982, DMC filed a petition for reorganization under Chapter 11 of the Bankruptcy Code, and in December 1983 that proceeding was converted into a Chapter 7 liquidation. DED estimates that it suffered millions of dollars in damages as a result of the demise of the DeLorean entities. (Second Am. Compl. at 224)

B. DED's Original Complaint (1985)

On February 15, 1985, DED filed its initial complaint in this action, naming as defendants three branches of AA's worldwide partnership.² In that complaint, DED alleged that AA committed primary violations and aided and abetted violations of § 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. In addition, DED asserted civil claims under the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1964(a)-(d), as well as a claim for aiding and abetting DeLorean's RICO violations. Finally, DED included common law claims for negligence, breach of contract, fraud, and aiding and abetting fraud. The case was assigned to the late Judge Charles E. Stewart of this Court.

C. AA's Motion to Dismiss (March 1988)

AA moved to dismiss the claims in the original complaint on various grounds. Pursuant to Fed.R.Civ.P. 12(b), Judge Stewart partially converted the motion to a motion for summary judgment after both parties submitted materials outside the pleadings for the Court's consideration. Judge Stewart issued an opinion on the motion in March 1988. 683 F.Supp. 1463 (S.D.N.Y.1988).

First, he found that it was appropriate to apply the American securities laws in this action because a substantial part of the conduct giving rise to the fraud claims took place in the United States. Id. at 1471.

Second, he held that material issues of fact prevented a summary judgment as to whether the Master Agreement is a security for purposes of Rule 10b-5. Under Securities & Exch. Comm'n v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), a financial instrument will be deemed an investment contract and therefore a security if the purchaser "invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party." Id. at 299, 66 S.Ct. at 1103. AA has maintained that NIDA and DOC did not "invest" with the expectation of profit, and that because NIDA participated in the management of DMCL, investment return did not depend solely on the efforts of others. 683 F.Supp. at...