Fund v. O'Hanlon

• Decision Date: 12 August 2013
• Docket Number: Civil Action No. 04–3423.
• Citation: 964 F.Supp.2d 368
• Parties: WM HIGH YIELD FUND, et al. v. Michael A. O'HANLON, et al.
• Court: U.S. District Court — Eastern District of Pennsylvania

964 F.Supp.2d 368

WM HIGH YIELD FUND, et al.

v.Michael A. O'HANLON, et al.

Civil Action No. 04–3423.

United States District Court, E.D. Pennsylvania.

Aug. 12, 2013.

Brian M. Rostocki, David E. Sellinger, James P. McEvilly, III, John A. Curseaden, Lauren E. Wagner, Stuart M. Grant, Stephen G. Grygiel, Grant & Eisenhofer PA, Ralph N. Sianni, Stewarts Law US LLP, Wilmington, DE, for Plaintiffs.

Richard L. Scheff, Montgomery McCracken Walker & Rhoads LLP, Maura Fay McIlvain, Dilworth Paxson LLP, James J. Rohn, Patricia M. Hamill, Vincent T. Cieslik, Conrad O'Brien, William J. Taylor, Cozen O'Connor, Kelly D. Eckel, Matthew A. Taylor, Matthew Michael Ryan, Patrick J. Loftus, Duane Morris LLP, Robert E. Kelly, Kutak Rock LLP, Daniel Segal, Hangley Aronchick Segal & Pudlin, Matthew Hamermesh, Richard R. Harris, Littler Mendelson, Thomas A. Leonard, William J. Leonard, Obermayer Rebmann Maxwell & Hippel LLP, Jeffrey M. Lindy, Law Offices of Jeffrey M. Lindy, David L. Comerford, Jeffery A. Dailey, Matthew Ryan Varzally, Akin Gump Strauss Hauer & Feld LLP, Richard A. Levan, Wiggin & Dana LLP, Philadelphia, PA, Mary Margulis–Ohnuma, Carolyn Barth Renzin, Elizabeth S. Weinstein, Stillman Friedman & Shechtman PC, New York, NY, Leah J. Domitrovic, Katten, Muchin, Zavis, Rosenman, Chicago, IL, for Defendants.

MEMORANDUM

LEGROME D. DAVIS, District Judge.

Plaintiffs ¹—six institutional Funds that invested in debt securities issued by Diagnostic Ventures, Inc. (DVI, Inc.) ²—sue for violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b–5, 17 C.F.R. § 240.10b–5. They also seek imposition of liability under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a); Section 18 of the Exchange Act, 15 U.S.C. § 78r; and Pennsylvania's common law of fraud.³ Jurisdiction is the Exchange Act, 15 U.S.C. § 78aa; federal question, 28 U.S.C. § 1331; and supplemental over the state law claims, 28 U.S.C. § 1367.

Defendant Gerald L. Cohn—a former director on DVI's Board of Directors and longstanding member of the Board's credit committee—moves for summary judgment (Doc. Nos. 257, 257–1). Fed.R.Civ.P. 56. The motion asserts that the record does not establish triable disputes as to essential elements of a private securities action ⁴—a misrepresentation or omission of material fact and scienter, i.e., a wrongful state of mind. ⁵ Def. Br., Doc. No. 257–13 at 10–21. This lack of proof, it is contended, defeats the Section 10(b) and Rule 10b–5 ⁶ claims contained in Count I of the Complaint as well as the common law fraud claims contained in Count IV of the Complaint. Id. at 10, 26–27.

Defendant Cohn's motion cites Tellabs, Inc. v. Makor Issues & Rights, Ltd. for the rule that an inference of scienter “must be more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” 551 U.S. 308, 314, 324, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). It is contended that “the inference of nonfraudulent intent—that Mr. Cohn was a victim of management's fraudulent scheme—would be the more compelling one.” Def. Reply Br., Doc. No. 279 at 8; Def. Br., Doc. No. 257–13 at 11–12, 17–20. In Cohn's view, “[t]his is a case about directors who were deceived.” Id. at 14. This memorandum agrees.

The motion for summary judgment also contends that Cohn cannot be held liable under the Section 20(a) claims contained in Count II of the Complaint because the record does not establish a threshold requirement—that he actually controlled DVI, the alleged violator of the securities laws, Section 10(b). ⁷ An affirmative defense is asserted to both the Section 20(a) and Section 18 ⁸ claims contained in Count III of the Complaint—that Cohn acted in good faith and was not a culpable participant in the alleged fraud. Def. Br., Doc. No. 257–13 at 22–24. And he had no knowledge that DVI's filings with the Securities and Exchange Commission (SEC) were false or misleading. Id. at 25–26; Def. Reply Br., Doc. No. 279 at 11–13.

Plaintiffs oppose summary judgment,⁹ broadly asserting that a group of individually named Defendants—defined in the Complaint to include Cohn—signed DVI's “materially false” filings with the SEC and “otherwise were directly and personally involved in the improper and deceptive practices that artificially inflated DVI's reported financial results.” Pls. Br., Doc. No. 272 at 4. Cohn, they say, together with the other individual Defendants, “turned a blind eye to the massive fraud being perpetrated on investors.” Id.

Cohn's alleged signature on DVI's annual Form 10–K filings with the SEC is the primary basis for the case against him. See Compl. ¶¶ 35, 106, 123, 164, 310. However, Plaintiffs more broadly assert that Cohn also signed DVI's quarterly Form 10–Q filings with the SEC for the fiscal years ended June 30, 1999 through June 30, 2002, and signed DVI's first three Form–Q filings for the fiscal year ended June 30, 2003. Pls. Br., Doc. No. 272 at 5–6. The record does not contain the cited documents that are said to exhibit Cohn's signature.

Both sides acknowledge that DVI's independent auditor, Deloitte & Touche LLP, issued and signed unqualified audit opinions ¹⁰ for DVI's annual Form 10–K filings with the SEC, certifying the soundness of DVI's financial statements for the fiscal years ended June 30, 1999 through June 30, 2002. Plaintiffs say that Deloitte's audit opinions “falsely represented to investors as fact that its audits of DVI's financial statements were performed in accordance with Generally Accepted Auditing Standards (GAAS) and that DVI's financial statements were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), which falsely reassured investors as to their accuracy.” Pls. Br., Doc. No. 272 at 4. Also, it is averred, they “read and relied on the financial information” contained in DVI's Form 10–K filings, including Deloitte's unqualified audit opinions, which were “false and misleading.” Compl. ¶¶ 305–308. In Plaintiffs' view, Cohn—by signing DVI's filings with the SEC—made the same alleged misstatements or omissions of material fact as those assertedly made by DVI and Deloitte.

As to scienter, Plaintiffs' argument is based primarily on Cohn's “role” or “function and involvement” at DVI. Pls. Br., Doc. No. 272 at 6, 8. It is asserted that “he and his family had a significant personal investment in DVI” and he “was personally involved in using his contacts to facilitate DVI accessing the capital markets for financing.” Id. That Cohn was a director and member of the Board's credit committee is cited as proof that he “was heavily involved in DVI's daily operations.” Id. at 6, 8, 9.

In addition, Plaintiffs say that Cohn either “knew or was reckless in not knowing” that DVI “was processing credit applications in disregard of its own published policies” by making loans without the credit committee's approval. Pls. Br., Doc. No. 272 at 9. Also, they say, Cohn knew that Lisa Cruikshank—Vice President, Treasury of DVI FS—resigned “due to her refusal to continue falsifying [loan covenant] compliance reports.” Id. at 6, 10. They further say that “by no later than April of 2001,” Cohn “was fully aware” that DVI was out of compliance with some covenants to its lender, Fleet Bank.¹¹Id. at 6, 9–10. In Plaintiffs' view, this reveals that Cohn was not an “outside director,” but rather “was the ultimate insider ... involved with DVI's daily operations since its inception” as well as DVI's alleged fraud. Id. at 8.

The motion for summary judgment will be granted. The record does not show that under Section 10(b), Cohn made any actionable misstatements or omissions with the requisite scienter. The common law fraud claims fail for similar reasons. The record also establishes that under Section 20(a), he did not exercise actual power or influence over the allegedly controlled violator of the securities laws, DVI. The Sections 18 claims fail as well for several reasons—including Cohn's good faith and lack of knowledge that DVI's public filings were false or misleading.

I. PROCEDURAL AND FACTUAL BACKGROUND

The Complaint, as filed on July 19, 2004, avers that during August 10, 1999 through August 13, 2003, the Plaintiff Funds invested in DVI's bonds that traded on the New York Stock Exchange (NYSE)—9 7/8 percent “Senior Notes,” which had been issued in 1997 and 1998.¹² Compl. ¶¶ 1, 12, 285. During that four-year period, it is averred that Cohn, individually and together with other DVI officers, directors, and business entities, “engaged in a scheme to falsify DVI's financial results and overstate its earnings by at least $120 million.” Id. ¶ 1. This was done to “deceive ... the investing public as to the true financial condition of DVI,” and “artificially inflate and maintain the market price of DVI's securities”—all in violation of Section 10(b) and Rule 10b–5. Id. ¶¶ 6, 35, 40, 44, 238–239, 242, 291–299 (Count I).

On August 13, 2003, DVI disclosed its intention to file for bankruptcy protection. Compl. ¶¶ 8, 197. On August 25, 2003, DVI, DVI FS, and DVI BC filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the District of Delaware,¹³ and the liquidation of assets began. Id. ¶¶ 10, 45, 200. On April 7, 2004, the Chapter 11 Examiner, R. Todd Neilson, CPA, issued an investigative report on the Debtors' financial transactions, accounting practices, and potential wrongdoing, among other topics. Id. ¶ 11; Ex'r Rep., dated Apr. 7, 2004, Decl. of James P. McEvilly, III, Ex. 2, Doc. Nos. 274–1 at 6 through 274–3 at 81.

Cohn—one of the original investors in DVI—became a director on DVI's Board of Directors from about 1986 until DVI's eventual dissolution sometime after August 25, 2003. Compl. ¶ 35; Feb. 12, 2008 Cohn Dep., 96:1–98:8, 103:5–104:12, 136:2–5, Affidavit of Julian W. Friedman, Ex. A, Doc. No. 257–4 at 5–7, 11. See also Ex'r Rep. at 18, Doc. No. 274–1 at 28; Pls. Omnibus Br. in Opposition...