In re Storage Technology Corp. Securities Lit.

• Decision Date: 19 March 1986
• Docket Number: Civ. A. No. 84-M-1981.
• Citation: 630 F. Supp. 1072
• Parties: In re STORAGE TECHNOLOGY CORPORATION SECURITIES LITIGATION, This Document Relates to All Actions Except Civil Action No. 84-M-1995. Joseph H. LEVIT, et al., Plaintiffs, v. Jesse I. AWEIDA, et al., Defendants.
• Court: U.S. District Court — District of Colorado

630 F. Supp. 1072

In re STORAGE TECHNOLOGY CORPORATION SECURITIES LITIGATION, This Document Relates to All Actions Except Civil Action No. 84-M-1995.

Joseph H. LEVIT, et al., Plaintiffs, v. Jesse I. AWEIDA, et al., Defendants.

Civ. A. No. 84-M-1981.

United States District Court, D. Colorado.

March 19, 1986.

COPYRIGHT MATERIAL OMITTED

Nicholas E. Chimicles, Greenfield & Chimicles, Haverford, Pa., for plaintiffs.

Gerald L. Bader, Jr., Bader & Cox, Denver, Colo., for plaintiffs and for plaintiffs Scoville and Ryan.

Harry T. Daniels, Hale & Dorr, Boston, Mass., for defendants Officers/Directors.

Charles S. Battles, Jr., Gibson, Dunn & Crutcher, Denver, Colo., for defendants Outside Directors.

James E. Nesland, Ireland, Stapleton, Pryor & Pascoe, P.C., Denver, Colo., for defendant Price Waterhouse.

MEMORANDUM OPINION AND ORDER

MATSCH, District Judge.

On April 25, 1985, the Judicial Panel on Multidistrict Litigation, pursuant to 28 U.S.C. § 1407, transferred three civil actions pending before the United States District Court for the Northern District of California to this court for coordination or consolidation for pre-trial purposes with twelve civil actions pending before this court. These actions concern the conduct of Storage Technology Corporation ("STC"). One of the cases transferred from California is stayed because STC is a named defendant and it is in bankruptcy. Stipulated Pre-Trial Order No. 1, entered by Judge John P. Moore on January 24, 1985, provided for the organization of plaintiffs' counsel and for the filing of a consolidated class action complaint to supersede all existing complaints in the actions being consolidated. Stipulated Pre-Trial Order No. 2, establishing a briefing schedule, was filed in this court on February 21, 1985, following a status conference.

The consolidated amended complaint was filed on January 31, 1985, signed by Nicholas E. Chimicles as lead counsel and Gerald L. Bader, Jr. as liaison counsel. By its Order for Scheduling Conference dated July 9, 1985, this court consolidated all cases filed in California and Colorado for pre-trial purposes and ordered discovery proceedings stayed. At the scheduling conference on August 22, 1985, Irving Malchman, as counsel for the plaintiff in Civil Action No. 84-M-1995, Kamerman v. Aweida, advised the court that he objected to the consolidated amended complaint, and that his client seeks to proceed with the original Kamerman complaint, filed October 10, 1984. On August 23, 1985 the court ordered that counsel for all plaintiffs in all of the civil actions consolidated had until September 20, 1985 to disavow the inclusion of their clients' claims within the amended consolidated complaint. All plaintiffs, except Norman Kamerman, adopted the consolidated amended complaint.

The consolidated amended complaint alleges six claims for relief, designated as "counts", the first five under various sections of the Securities Act of 1933 and the Securities Exchange Act of 1934, and the sixth for negligent misrepresentation in connection with the sale of securities. The proposed classes of plaintiffs have not yet been certified.

STC manufactures, sells and services computer peripheral subsystems, particularly disk drive and tape drive systems, for use with computers manufactured by other companies. On October 31, 1984, STC filed a petition in bankruptcy under Chapter 11 of the Federal Bankruptcy Code. STC was not named as a defendant in this action.

Plaintiffs allege that STC officers and directors recklessly concealed and misrepresented STC's financial status and the development of its products through statements of unfounded optimism and failure to reveal their competitors' advantages in the market. Price Waterhouse is alleged to have knowingly or recklessly misrepresented the financial condition of STC. Each of the three groups of defendants (Officers/Directors; Outside Directors; and Price Waterhouse) moved to dismiss, strike, or for a more definite statement.

COUNT I: SECTION 10(b) OF THE SECURITIES EXCHANGE ACT OF 1934 AND RULE 10b-5

Defendants assert that this is a mismanagement case in the guise of a securities action. "Section 10(b) was not designed to regulate corporate management nor to prohibit conduct which does not involve manipulation or deception." Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 115 (2d Cir.1982). See also Santa Fe Industries, Inc. v. Greene, 430 U.S. 462, 479, 97 S.Ct. 1292, 1304, 51 L.Ed.2d 480 (1977).

In a securities fraud action, plaintiff must allege acts indicating an intent to deceive, manipulate, or defraud, and F.R. Civ.P. 9(b) requires that the circumstances constituting such fraud be stated with particularity. Decker, 681 F.2d at 115 (citation omitted). See also Trussell v. United Underwriters, Ltd., 228 F.Supp. 757, 774 (D.Colo.1964). In Decker, some of defendant's reports presented a false and misleading picture of the company's assets, but its capitalization and debt structure were fully disclosed in its consolidated financial reports. This case differs from Decker in that, if plaintiffs' allegations are taken as true, STC misrepresented and failed to disclose adequately its capitalization and debt structure in all of its reports, thereby preventing shareholders from obtaining accurate information concerning the company's financial status.

Defendants further submit that the complaint should be characterized as alleging what some courts have called "fraud by hindsight."

In the typical "fraud-by-hindsight" case, the defendant company has experienced some business misfortune which is ultimately reported in its own periodic reports to stockholders and in the financial press. The publication of this information produces a drop in the market price of the company's stock and many unhappy stockholders. The suit which follows normally alleges that information concerning the impending misfortune or its root causes was omitted from earlier management publications despite the fact that management then knew the information. The omitted material is frequently contrasted with optimistic rhetoric from the pre-misfortune period in connection with an assertion that the earlier publications were false and misleading.

In re Ramada Inns Securities Litigation, 550 F.Supp. 1127, 1132 (D.Del.1982); see also Denny v. Barber, 576 F.2d 465, 470 (2d Cir.1978).

If such situations develop as a result of negligence on the part of management or as a result of unforeseeable events beyond management's control, they are not the result of securities law violations. However, such situations may occur after a deliberate decision of management to cover up facts likely to depress the market in the company's stock. In that case, there may be violations of the federal securities acts. "If there is any reasonable basis for believing a case may fall into the latter category, discovery should be permitted and the case should go forward; otherwise it should not." Ramada Inns, 550 F.Supp. at 1132.

The allegations in this complaint are sufficient to state a claim for relief under section 10(b) and Rule 10b-5. This court will exercise management and control of discovery in this action.

A. Aider and Abettor Liability

Both Price Waterhouse and the outside director defendants claim that they cannot be held secondarily liable. Liability as an aider or abettor is established by showing 1) the existence of a securities law violation by the primary party; 2) knowledge of this violation on the part of the aider and abettor; and 3) substantial assistance by the aider and abettor in the achievement of the primary violation. IIT, International Investment Trust v. Cornfeld, 619 F.2d 909, 922 (2d Cir.1980).

This circuit has expressly held that recklessness satisfies the scienter requirement for primary violations of Rule 10b-5. Hackbart v. Holmes, 675 F.2d 1114, 1117 (10th Cir.1982). Where an alleged aider and abettor owes a fiduciary duty to the defrauded party, recklessness also satisfies the scienter requirement for secondary liability. Cornfeld, 619 F.2d at 923 (quoting Rolf v. Blyth, Eastman Dillon & Co., Inc., 570 F.2d 38, 47-48 (2d Cir.), cert. denied, 439 U.S. 1039, 99 S.Ct. 642, 58 L.Ed.2d 698 (1978)). See also Woodward v. Metro Bank of Dallas, 522 F.2d 84, 97 (5th Cir. 1975); Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1044-45 (7th Cir.), cert. denied, 434 U.S. 875, 98 S.Ct. 225, 54 L.Ed.2d 155 (1977). "Moreover, one who aids and abets a fraudulent scheme may be held accountable even though his assistance consists of mere silence or inaction." Kerbs v. Fall River Industries, Inc., 502 F.2d 731, 740 (10th Cir.1974).

Plaintiffs have pleaded the existence of wrongful acts and since the defendant directors are fiduciaries, a claim of recklessness is sufficient to state a claim against them.

Plaintiffs also allege that Price Waterhouse certified STC's financial statements which were materially false and misleading and did not present STC's true financial position. It is further alleged that Price Waterhouse certified such financial statements with knowledge of or reckless disregard for the insufficiency of its auditing procedures.

Although the accountant-client relationship is not generally regarded as a fiduciary one, even in the absence of a fiduciary duty, recklessness will satisfy the scienter requirement where there was foreseeable reliance upon the defendant's actions. Fund of Funds, Ltd. v. Arthur Andersen & Co., 545 F.Supp. 1314, 1356 (S.D. N.Y.1982). "An accountant may be liable as an aider and abettor if it knows, or is reckless in not knowing, that its client has committed a primary violation, and it substantially aids the client in the overall enterprise." SEC v. Seaboard Corp., 677 F.2d 1301, 1312 (9th Cir.1982). The allegations are sufficient to state a claim against Price Waterhouse for violations of section 10(b) and Rule 10b-5.

Defendant Price Waterhouse asks that if this court finds one or more of plaint...