Reisman v. Kpmg Peat Marwick Llp

• Decision Date: 28 February 1997
• Docket Number: Civ. A. No. 96-10521-WGY.
• Citation: 965 F.Supp. 165
• Parties: Howard REISMAN, Amalia Reisman, Galite Reisman, Kenneth Reisman, Talia Reisman, and Amgata Holdings, Ltd., Plaintiffs, v. KPMG PEAT MARWICK LLP, Defendant.
• Court: U.S. District Court — District of Massachusetts

965 F.Supp. 165

Howard REISMAN, Amalia Reisman, Galite Reisman, Kenneth Reisman, Talia Reisman, and Amgata Holdings, Ltd., Plaintiffs, v. KPMG PEAT MARWICK LLP, Defendant.

Civ. A. No. 96-10521-WGY.

United States District Court, D. Massachusetts.

February 28, 1997.

COPYRIGHT MATERIAL OMITTED

Alexander T. Bok, Edward T. Dangel, III, Dangel, Donlan & Fine, Boston, MA, for Howard Reisman, Amalia Reisman, Galite Reisman, Kenneth Reisman, Talia Reisman, Amgata Holdings Ltd.

Arnold P. Messing, Joseph H. Zwicker, Andrea L. Crowley, Choate, Hall & Stewart, Boston, MA, for KPMG Peat Marwick, LLP.

MEMORANDUM AND DECISION

YOUNG, District Judge.

I. Introduction

The plaintiffs Howard, Amalia, Galite, Kenneth, and Talia Reisman (the "Reismans"), and a related company, Amgata Holdings Ltd.¹ ("Amgata," collectively "the plaintiffs") come before this Court having sued the local office of an international public accounting firm, KPMG Peat Marwick LLP ("Peat Marwick"). In their Complaint,² the plaintiffs allege that Peat Marwick violated Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 (Count I), and engaged in unfair and deceptive trade practices under Mass.Gen.L. ch. 93A (Count II) common law fraud (Count III), and negligent misrepresentation (Count IV). The plaintiffs contend that they lost $14,000,000 in the sale of their company, Varnet Software Corporation ("Varnet"), to Marcam Corporation ("Marcam"), a company whose financial records were audited by Peat Marwick. The plaintiffs claim that Peat Marwick is liable to them because, in its role as Marcam's accountant, Peat Marwick played a "central role in the issuance of fraudulent and misleading financial statements from 1991 to 1993." Complaint ("Compl.") at 1.³

Peat Marwick has moved to dismiss the complaint, asserting, inter alia, that the plaintiffs' claims are time-barred; that the plaintiffs have failed to state a claim upon which relief may be granted, and that the plaintiffs have failed to plead their allegations of fraud with particularity.

II. Statement of Facts

In ruling on a motion to dismiss, this Court must take the material facts as alleged in the Complaint as true and view them in the light most favorable to the plaintiffs. Deren v. Digital Equip. Corp., 61 F.3d 1, 1 (1st Cir. 1995). Although the Complaint is factually complex, the story can be distilled to its essence as follows:⁴ Marcam, based in Massachusetts, is a publicly traded company specializing in the supply of application software products for business planning and control. Its securities are traded on the NASDAQ Stock Exchange. At all times relevant to this lawsuit, Peat Marwick served as the accounting firm responsible for preparing Marcam's financial statements. According to financial statements produced by Peat Marwick, between 1987 and 1990 Marcam's reported revenue increased from $5,500,000 to $28,500,000. The company's net income similarly increased from a loss of $1,440,000 in 1987 to a gain of $4,230,000 in 1990. The three specific transactions which give rise to the plaintiffs' claims against Peat Marwick involve 1) accounting treatment of Marcam's acquisition of certain European distributorships, 2) accounting treatment of Marcam's purchase of MAPICS software, and 3) Marcam's purchase of Varnet, the plaintiffs' company.

A. The European Subsidiaries

In 1991, Marcam decided to expand its product line and began to acquire companies offering products which complemented Marcam's core business. That same year, in order to increase its European revenues, Marcam invested in and took control of its European distributors in Italy, Belgium, and the Netherlands. The plaintiffs allege that although "Marcam financed, controlled, and operated these European distributors as its subsidiaries,"⁵ Peat Marwick "knowingly falsely reported that these [European] distributors were not subsidiaries," Compl. ¶ 17, and failed to include the sales and net losses of the European distributors in Marcam's financial statements, as required by Accounting Principles Board Statement 4 and Rule 3A-02 of SEC Regulation S-X. Had the financial operations of the European distributors been set forth properly, the plaintiffs claim that Marcam's financial statements would have reflected a net loss instead of a profit for the fiscal years 1991 through 1993.

In the October 1993 Form 10-K releasing Marcam's fiscal 1993 results, Peat Marwick for the first time consolidated the losses suffered by two of the European distributors. In 1994, when Peat Marwick issued revised financial statements for Marcam showing losses for the fiscal year 1991-1993 period, the changes to the statements were explained as restatements rather than as charges to earnings. The result of this characterization was that Marcam's reported fiscal 1993 net income of $2,550,000 was inflated by $5,600,000 due to the alleged fraudulent reporting of the European subsidiaries. Had the losses of the European subsidiaries been accurately reported, the plaintiffs allege that Marcam's stock would have traded at a lower price.

B. The MAPICS Software

In late 1992, Marcam announced that it would purchase the worldwide rights to IBM's MAPICS software for 1,600,000 shares of Marcam common stock. The plaintiffs claim that Peat Marwick acted fraudulently by reporting the MAPICS transaction so as to avoid reporting substantial losses for each quarter during 1993. Peat Marwick allegedly reported that Marcam was only acquiring "the exclusive worldwide marketing rights" to the MAPICS product line, rather than the MAPICS software itself. Based on this allegedly false characterization, Peat Marwick utilized a highly favorable accounting treatment to inflate Marcam's fiscal 1993 results, recording 100% of the $15,600,000 initial cost of the license as an asset on its balance sheet. The plaintiffs allege that, under Generally Accepted Accounting Principles, Peat Marwick should have caused Marcam's financial statements to reflect an expense of $5,500,000 for the MAPICS purchase price in the second quarter of 1993. Had the MAPICS transaction been properly recorded, the plaintiffs allege that Marcam's second quarter 1993 earnings would have been greatly reduced, with a similar negative effect upon Marcam's stock valuation. As with the European distributors, when Peat Marwick issued revised financial statements for the fiscal year 1991 through 1993 period, it explained the changes as restatements rather than as charges to earnings. The result of the mischaracterization of the MAPICS transaction, the plaintiffs aver, was that Marcam's reported fiscal 1993 net income of $2,550,000 was inflated by $9,000,000.

C. The Varnet Transaction

In early 1993, the plaintiffs entered into negotiations to sell their company, Varnet, to Marcam. Following discussions between the principals of the two companies, Marcam valued the price of all the shares of Varnet at approximately $23 million. On May 17, 1993, after reviewing and relying upon Marcam's 1991, 1992, and first quarter 1993 financial reports issued by Peat Marwick, the plaintiffs signed a letter of intent to exchange their shares in Varnet for $23 million worth of Marcam's restricted stock. One month later, after reviewing Marcam's second quarter 10-Q report, filed in May, 1993, the plaintiffs completed the stock swap transaction with Marcam, receiving 885,000 restricted shares of Marcam in consideration for the shares in Varnet and the execution of various employment and non-competition agreements. In addition to preparing and supplying Marcam's financial statements to the plaintiffs, Peat Marwick structured the MAPICS and Varnet transactions, including the issuance of an opinion letter on pooling without which, allege the plaintiffs, the Varnet transaction would not have been consummated. Finally, late in 1993, the plaintiffs sold all of their shares in Marcam and executed a general release absolving Marcam from liabilities of all sorts.⁶ Following the sale and release, the plaintiffs state that they neither received nor reviewed the subsequent SEC filings or other information relating to Marcam or to Peat Marwick. The Reismans allege that they were unaware of any wrongdoing by Peat Marwick until May, 1995.

The stock swap transaction had a four month escrow period, and the plaintiffs had to wait an additional month to obtain and register their Marcam stock. Upon finally acquiring stock in Marcam, the plaintiffs learned that between June, 1993, when they consummated the stock swap transaction with Marcam, and December, 1993, when they eventually sold their holdings in Marcam, Marcam's stock had dropped sixteen points from the price at the time of exchange to its alleged "true" value. The plaintiffs contend that they lost $14,000,000 as a direct result of Peat Marwick's false statements. Had Marcam's true financial position been accurately and honestly reported by Peat Marwick, the plaintiffs aver that the 1991, 1992, and 1993 statements would have demonstrated that Marcam was in poor financial condition, having lost money over the two and one half years prior to the stock swap transaction for Varnet. The plaintiffs state that they would never have exchanged Varnet's stock for Marcam's stock had they known of Marcam's perilous financial state.

III. Standard of Review

A motion to dismiss tests the legal sufficiency of the complaint, not the plaintiff's likelihood of ultimate success. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974). In assessing a motion to dismiss, the Court must take all allegations contained in the complaint as true and must draw all inferences in favor of the plaintiffs. Deren, 61 F.3d at 1; Watterson v. Page, 987 F.2d 1, 3 (1st Cir.1993). A complaint should not be dismissed "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78...