In re Crazy Eddie Securities Litigation

• Decision Date: 19 June 1990
• Docket Number: No. 87 C 33.,87 C 33.
• Citation: 740 F. Supp. 149
• Parties: In re CRAZY EDDIE SECURITIES LITIGATION.
• Court: U.S. District Court — Eastern District of New York

740 F. Supp. 149

In re CRAZY EDDIE SECURITIES LITIGATION.

No. 87 C 33.

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

June 19, 1990.

Sirota & Sirota (Howard B. Sirota, of counsel), Milberg, Weiss, Bershad, Specthrie & Lerach (David J. Bershad, Michael C. Spencer, of counsel), New York City, for plaintiffs.

Milbank, Tweed, Hadley & McCloy (C. Stephen Howard, Kathleen C. Kauffman, David A. Jones, Susanne M. Toes, of counsel), Los Angeles, Cal., for third party defendants Oppenheimer-Palmieri Fund, L.P., Victor Palmieri and The Palmieri Co.

Tuttle & Taylor Inc., Los Angeles, Cal., Folkenflik & Associates (Max Folkenflik, of counsel), New York City, for third party defendants Entertainment Marketing, Inc., and Elias Zinn.

Shearman & Sterling (Kenneth M. Kramer, of counsel), New York City for third party plaintiff Peat Marwick Main & Co. and KMG Main Hurdman.

KPMG Peat Marwick (Joseph I. Loonan, of counsel), New York City, for third party plaintiff.

Davis, Markel & Edwards (Thomas J. Sweeney, III, of counsel), New York City, for third party plaintiff Peat Marwick Main & Co.

MEMORANDUM AND ORDER

NICKERSON, District Judge.

This consolidated action was the subject of a Memorandum and Order, dated December 30, 1988, published Bernstein v. Crazy Eddie, Inc., 702 F.Supp. 962 (E.D.N. Y.1988), vacated in part on other grounds, 714 F.Supp. 1285 (E.D.N.Y.1989), familiarity with which is assumed.

The present matter concerns the claims of the shareholder plaintiffs (plaintiffs) against Peat Marwick Main & Co. (Peat Marwick), and its third party claims against others.

Plaintiffs' claims against Peat Marwick allege violations of Section 11 of the Securities Act of 1933, 15 U.S.C. § 77a et seq. (1982 & Supp. IV 1986) (the Securities Act), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (1982 & Supp. IV 1986) (the Exchange Act), and common law fraud and negligent misrepresentation. The claims assert deficiencies in Peat Marwick's audits of Crazy Eddie's audited financial statements in 1984, 1985 and 1986 and Peat Marwick's participation in the preparation of allegedly misleading securities offering registration statements in 1985 and 1986.

Peat Marwick thereafter served and filed a third party complaint against Oppenheimer-Palmieri Fund, L.P., (the Fund), the Palmieri Company, Victor Palmieri, Entertainment Marketing, Inc., and Elias Zinn for indemnification, contribution under federal and state law. The Fund, Victor Palmieri and the Palmieri Company (third party defendants) move to dismiss the Complaint for failure to state a claim.

The first count of the third party complaint alleges, in substance, the following. Upon taking control of Crazy Eddie, Inc. (Crazy Eddie), on November 6, 1987, third party defendants failed to amend, correct or modify the misrepresentations contained in Crazy Eddie's documents serving as a predicate for the plaintiffs' claims. Those claims allege that plaintiffs continued to be misled by false and misleading information relating to the financial statements of Crazy Eddie through January 18, 1988, after third party defendants took control. As a result of the third party defendants' conduct, Peat Marwick has been named as defendant in this and other actions, incurring expenses in defending against suits, and possibly requiring the payment of damages to the plaintiffs. It is therefore entitled to indemnification or contribution.

The first count thus suggests by implication that third party defendants intentionally or negligently overstated the value of Crazy Eddie to the detriment of the plaintiffs who relied on the representations.

The second count of the third party complaint asserts, in substance, the following. Peat Marwick observed a physical inventory conducted by Crazy Eddie employees in November 1987. Following the inventory, but before Peat Marwick completed the engagement, the third party defendants announced on November 19, 1987 a $45 million shortfall and shortly thereafter fired Peat Marwick. The announcement was negligently, recklessly, or fraudulently made and caused a decline in the price of Crazy Eddie securities.

Apparently by these allegations Peat Marwick seeks to suggest that the third party defendants by the announcement intentionally or negligently understated the value of Crazy Eddie so that shareholders relying on the announcement sold their stock at less than true value. Peat Marwick seeks contribution or indemnification for any liability and expenses attributable to this conduct of third party defendants.

In addition, the second count claims that after the November 19, 1987 announcement third party defendants recklessly or fraudulently destroyed all documentation supporting their calculation of the purported $45 million shortfall, and refused to assist and interfered with Peat Marwick's attempts to determine the reason for it. Third party defendants thus are said to have deliberately deprived Peat Marwick of evidence crucial to its defense against plaintiffs' claims.

I. Impleader

Rule 14(a), Fed.R.Civ.P., provides that "at any time after commencement of the action a defending party, as a third-party plaintiff, may cause a summons and complaint to be served upon a person not a party to the action who is or may be liable to the third-party plaintiff for all or part of the plaintiff's claim against the third party plaintiff." A third party claim is permissible only if the "third party's liability is" "dependent upon the out come of the main claim" or the third party is "potentially secondarily liable as a contributor to the defendant." See Kenneth Leventhal & Co. v. Joyner Wholesale Co., 736 F.2d 29, 31 (2d Cir.1984).

In form the claims for indemnification and contribution purport to be dependent on the outcome of the plaintiffs' claims against Peat Marwick. Whether the second count to the extent it seeks "compensatory damages" for destruction of evidence states a permissible third party claim is a more difficult question. The court assumes for purposes of the motion that Peat Marwick may make the claims under Rule 14(a).

II. Indemnification

Indemnification "is not available as a matter of policy to parties who have `knowingly and willfully violated the federal securities laws.'" Bernstein, supra, 702 F.Supp. at 984. Because scienter is required to be held liable for violations of 10(b) under the Exchange Act, Peat Marwick may not be indemnified for these claims. See In Re Citisource, Inc. Securities Litigation, 694 F.Supp. 1069, 1079 n. 15 (S.D.N.Y.1988).

Peat Marwick argues that indemnification is available for merely negligent violations of the Securities Act. A number of courts have rejected this argument as inconsistent with the purpose of the Act. See Odette v. Shearson, Hammill & Co., 394 F.Supp. 946, 957 (S.D.N.Y.1975); Laventhol, Krekstein, et al. v. Horwitch, 637 F.2d 672, 676 (9th Cir.1980). Those courts that have permitted indemnification have done so only if the party to which the loss is shifted is one "significantly more liable" for the injury to the plaintiff. Adalman v. Baker, Watts, & Co., 599 F.Supp. 752, 755 (D.Md.1984), on other grounds affirmed in part and rev'd in part, 807 F.2d 359 (4th Cir.1986); cf. Nelson v. Quimby Island Reclamation District, 491 F.Supp. 1364, 1381 (N.D.Cal.1980). Under the pleadings Peat Marwick is significantly more responsible than third party defendants for the injury, if any, to the plaintiffs caused by Section 11 violations.

Indeed, the third party defendants are not potentially liable for a Section 11 violation. No party alleges they signed the misleading registration statements, were directors at the time of the registration filing, or had any involvement as professionals otherwise involved in the preparation of the registration statements at issue. Nor is there an allegation of any contractual obligation by the third party defendants to indemnify Peat Marwick.

The claims for indemnification under federal law are dismissed with prejudice. The court need not decide whether a party may ever be indemnified when negligently violating Section 11.

III. Contribution

To the extent that the third party complaint is read to assert that Peat Marwick may get contribution because the third party defendants, by overstating the inventory shortfall, understated the value of the Crazy Eddie stock, the third party complaint is plainly insufficient. Plaintiffs do not allege a claim based on such an understatement. Peat Marwick may not seek contribution for harm the plaintiffs do not allege to have suffered.

As Judge Haight said in Greene v. Emersons, Ltd., 102 F.R.D. 33, 35 (S.D.N.Y. 1983), "a Rule 14(a) branch cannot grow without the root of a claim asserted by plaintiff." The plaintiffs may only recover the "difference between the higher price paid and the true value of the stock when bought." Bernstein, 702 F.Supp. at 980. Peat Marwick will not be liable for any losses incurred by plaintiffs below the "true value" of the stock that may have been caused by misrepresentations, if any, undervaluing the stock.

Even as an independent claim this assertion of understatement would be insufficient. Peat Marwick argues that, by allegedly understating the value of Crazy Eddie in the November 19, 1987 announcement, the third party defendants caused an undue drop in the stock price, and that this drop induced some securities holders not to sell their stock above their purchase price, with consequent damages to those plaintiffs and alleged aggravation of Peat Marwick's damages. Cf. James v. Nico Energy Co., 838 F.2d 1365, 1371 (5th Cir.1988) (if stock sold above price of purchase, no injury suffered).

This argument ignores the fact that each member of the class who sells stock must do so to a new buyer who is entitled to damages up to the difference of his higher purchase price and the lower "true value" of the stock. An individual plaintiff's damages for claims for fraudulent overstatement...