Fischer v. Kletz, 65 Civ. 787.

• Citation: 266 F. Supp. 180
• Decision Date: 05 April 1967
• Docket Number: No. 65 Civ. 787.,65 Civ. 787.
• Parties: Stephen FISCHER et al., Plaintiffs, v. Michael KLETZ et al., Defendants (and fifteen other actions consolidated therewith).
• Court: U.S. District Court — Southern District of New York

266 F. Supp. 180

Stephen FISCHER et al., Plaintiffs, v. Michael KLETZ et al., Defendants (and fifteen other actions consolidated therewith).

No. 65 Civ. 787.

United States District Court S. D. New York.

April 5, 1967.

COPYRIGHT MATERIAL OMITTED

Pomerantz, Levy, Haudek & Block, New York City, for plaintiffs.

Kaufman, Taylor, Kimmel & Miller, New York City, for plaintiffs.

Phillips, Nizer, Benjamin, Krim & Ballon, New York City, for defendant Peat, Marwick, Mitchell & Co.

Securities and Exchange Commission, Washington, D. C., amicus curiae.

OPINION

TYLER, District Judge.

In October, 1966, plaintiffs in this class action¹ moved against defendant Peat, Marwick, Mitchell & Co. ("PMM") for further discovery under Rule 34, F.R. Civ.P., based in part upon the allegations set forth in paragraphs 25 through 25.3 of the second consolidated amended complaint (hereinafter "the complaint"). PMM opposed this motion, and, in addition, cross-moved against the plaintiffs, pursuant to Rule 12(b) (1) and/or 12(b) (6), F.R.Civ.P., for an order by this court dismissing paragraphs 25-25.3 of the complaint on the grounds that the court has no jurisdiction over the subject matter contained therein and/or that the allegations of these paragraphs fail to state a claim upon which relief can be granted. Plaintiffs and the Securities and Exchange Commission ("SEC"), which has filed an amicus curiae brief, strenuously oppose the cross-motion.

The discovery motion was disposed of by this court in a memorandum opinion, dated November 1, 1966; this opinion will deal with PMM's cross-motion to dismiss paragraphs 25-25.3 of the complaint.

For the purposes of this motion, the parties agree in principle that the facts urged upon the court by the plaintiffs must be accepted as true and that the challenged portions of the complaint must be upheld if they are supported by any viable rule of law. There follows a summarization of the facts which reasonably can be read from the formal complaint allegations, particularly those under fire in this motion.

Sometime early in 1964, PMM, acting as an independent public accountant, undertook the job of auditing the financial statements that Yale Express System, Inc. ("Yale"), a national transportation concern, intended to include in the annual report to its stockholders for the year ending December 31, 1963. On March 31, 1964, PMM certified the figures contained in these statements. On or about April 9, the annual report containing the certification was issued to the stockholders of Yale. Subsequently, on or about June 29, 1964, a Form 10-K Report, containing the same financial statements as the annual report, was filed with the SEC as required by that agency's rules and regulations.

At an unspecified date "early in 1964", probably shortly after the completion of the audit, Yale engaged PMM to conduct so-called "special studies" of Yale's past and current income and expenses. In the course of this special assignment, sometime presumably before the end of 1964,² PMM discovered that the figures in the annual report were substantially false and misleading.

Not until May 5, 1965, however, when the results of the special studies were released, did PMM disclose this finding to the exchanges on which Yale securities were traded, to the SEC or to the public at large.

Furthermore, during the course of PMM's special studies, Yale periodically announced to PMM an intention to issue several interim statements and reports to show the company's 1964 financial performance. In at least two instances, Yale was told by PMM that figures derived from the special studies could not be used as a basis for these interim statements; in addition, PMM recommended that the figures developed by Yale through its internal accounting procedures be used in the reports.

Yale thereupon issued several interim statements containing figures which were not compiled, audited or certified by PMM. As in the case of the annual and SEC reports, later developments revealed that the figures contained in these interim statements were materially false and misleading.

Plaintiffs allege that, from the compilation of figures for 1964 and its knowledge of the contents of the interim reports, PMM knew that the figures contained in those statements were grossly inaccurate. No disclosure of this finding has yet been made to the exchanges, the SEC or the public.

Within this alleged factual context, the plaintiffs assert that PMM is liable in damages for its failure to disclose not only that the certified financial statements in the 1963 annual report contained false and misleading figures but also that the interim statements issued by Yale were inaccurate. Because the bases for such claimed liability are grounded on distinctly different legal theories, the issues unique to each area will be discussed and analyzed separately.

I. ANNUAL REPORT LIABILITY

Plaintiffs attack PMM for its silence and inaction after its employees discovered, during the special studies, that the audited and certified figures in the financial statements reflecting Yale's 1963 performance were grossly inaccurate. They contend that inasmuch as PMM knew that its audit and certificate would be relied upon by the investing public,³ the accounting firm had a duty to alert the public in some way that the audited and certified statements were materially false and inaccurate. PMM counters that there is no common law or statutory basis for imposing such a duty on it as a public accounting firm retained by the officers and directors of Yale.

Strict analysis leads to the conclusion that PMM is attacked in the complaint because it wore two hats in conducting its business relations with Yale during the period in question. PMM audited and certified the financial statements in the 1963 annual report and Form 10-K as a statutory "independent public accountant"⁴ whose responsibility

"is not only to the client who pays his fee, but also to investors, creditors and others who may rely on the financial statements which he certifies. * * * The public accountant must report fairly on the facts as he finds them whether favorable or unfavorable to his client. His duty is to safeguard the public interest, not that of his client. (In the Matter of Touche, Niven, Bailey & Smart, 37 S.E.C. 629, 670-671 (1957)) (footnotes omitted)

Following the certification, PMM switched its role to that of an accountant employed by Yale to undertake special studies which were necessitated by business demands rather than by statutory or regulatory requirements. In this sense, it can be seen that during the special studies PMM was a "dependent public accountant" whose primary obligations, under normal circumstances, were to its client and not the public.

It was, of course, during the conduct of the special studies that the inaccuracies in the audited and certified statements were discovered. The time of this discovery makes the questions here involved difficult and unique. On the basis of the Commission's Touche, Niven opinion, an accountant has a duty to the investing public to certify only those statements which he deems accurate. This duty is not directly involved here, however, for the inaccuracies were discovered after the certification had been made and the 1963 annual report had been released. PMM maintains, therefore, that any duty to the investing public terminated once it certified the relevant financial statements. Plaintiffs, of course, contend to the contrary. Thus, the serious question arises as to whether or not an obligation correlative to but conceptually different from the duty to audit and to certify with reasonable care and professional competence⁵ arose as a result of the circumstance that PMM knew that investors were relying upon its certification of the financial statements in Yale's annual report.

A. COMMON LAW LIABILITY

Plaintiffs' claim is grounded in the common law action of deceit, albeit an unusual type in that most cases of deceit involve an affirmative misrepresentation by the defendant.⁶ Here, however, plaintiffs attack PMM's nondisclosure or silence.

It is Dean Prosser's view that, in contrast with the issues raised when an affirmative misrepresentation is involved, "a much more difficult problem arises as to whether mere silence, or a passive failure to disclose facts of which the defendant has knowledge, can serve as the foundation of a deceit action." Prosser, Torts 533 (2d ed. 1955). The law in this area is in a state of flux due to the inroads being made into the old doctrine of caveat emptor. Although the prevailing rule still seems to be that there is no liability for tacit nondisclosure, Dean Prosser adds the following important qualification: "to this general rule, if such it be, the courts have developed a number of exceptions, some of which are as yet very ill-defined, and have no very definite boundaries." Id. at 534. One of these exceptions is that

"one who has made a statement and subsequently acquires new information which makes it untrue or misleading, must disclose such information to any one whom he knows to be still acting on the basis of the original statement * * *." (Ibid.)

Section 551 of the First Restatement of Torts, which is couched in the specific terms of "a business transaction", is in substantial agreement with Dean Prosser. The Restatement position in Section 551(1) is that

"one who fails to disclose to another a thing which he knows may justifiably induce the other to act or refrain from acting in a business transaction is subject to the same liability to the other as though he had represented the nonexistence of the matter which he has failed to disclose, if, but only if, he is under a duty to the other to exercise reasonable care to disclose the matter in question."

Section 551(2) lists the instances when the requisite duty to disclose arises. For present purposes, the following portion from that subsection is important:

"One party to a

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