Sec. Investor Protection Corp. v. BDO Seidman

Decision Date01 August 1999
Docket NumberDocket Nos. 99-7719
Citation222 F.3d 63
Parties(2nd Cir. 2000) SECURITIES INVESTOR PROTECTION CORPORATION, and JAMES W. GIDDENS, as Trustee for the liquidation of the business of A.R. Baron & Co., Inc., Plaintiffs-Appellants, v. BDO SEIDMAN, LLP, Defendant-Appellee. (L); 99-7720 (C)
CourtU.S. Court of Appeals — Second Circuit

Appeal from an order of the United States District Court for the Southern District of New York (Loretta A. Preska, Judge), granting defendant's motion to dismiss plaintiffs' claims for fraudulent misrepresentation, negligent misrepresentation, and breach of contract. The Second Circuit affirms the district court's dismissal of the plaintiffs' claims on behalf of broker-dealer customers. With respect to plaintiff SIPC's claims on its own behalf, this Court certifies to the New York Court of Appeals the questions of whether, under New York law, a plaintiff may state a claim for fraudulent or negligent misrepresentation against an accountant with whom the plaintiff had minimal direct contact, but whose reports were prepared for the client with the knowledge that the plaintiff would receive any negative information contained therein.

Affirmed in part; questions certified.

[Copyrighted Material Omitted] KENNETH J. CAPUTO, ESQ. (Stephen P. Harbeck, Esq., on the brief), Washington, D.C., for plaintiff-appellant Securities Investor Protection Corporation.

JAMES B. KOBAK, JR., Hughes Hubbard & Reed LLP (Daniel H. Weiner, on the brief), New York, NY, for plaintiff-appellant James W. Giddens, as Trustee for the liquidation of the business of A.R. Baron & Co., Inc.

MICHAEL R. YOUNG, Willkie Farr & Gallagher (Jeffrey O. Grossman, Willkie Farr & Gallagher; Scott M. Univer & Barbara A Taylor, BDO Seidman, LLP, on the brief), New York, NY, for defendant-appellee BDO Seidman, LLP.

Before: MESKILL and SOTOMAYOR, Circuit Judges, and KEENAN,* District Judge.


Certificate to the New York Court of Appeals pursuant to Local Rule § 0.27 and New York Compilation of Codes, Rules & Regulations, title 22, § 500.17(b).


SOTOMAYOR, Circuit Judge:

Plaintiff-appellants Securities Investor Protection Corporation ("the SIPC") and James W. Giddens ("the Trustee"), as trustee for the liquidation of the business of A.R. Baron & Co., Inc. ("Baron") (collectively, "the plaintiffs"), brought this action against the accounting firm BDO Seidman, LLP ("Seidman"), claiming that Seidman engaged in fraud, negligent misrepresentation, and breach of contract by filing false audit reports on Baron's behalf with the Securities and Exchange Commission ("SEC"). The plaintiffs allege that Seidman's conduct caused financial damage both to Baron's customers, whom the Trustee represents in liquidation and to whose claims the SIPC is subrogated, and to the SIPC in its own right insofar as it has advanced funds to cover the costs of Baron's liquidation. The district court dismissed the plaintiffs' claims, finding that the SIPC lacked standing to sue on its own behalf and that neither the SIPC nor the Trustee could state a claim upon which relief could be granted on behalf of Baron's customers because the customers did not themselves directly rely on Seidman's audit reports. For the reasons that follow, we find that the court erred in concluding the SIPC lacked standing to sue on its own behalf, but we affirm the district court's dismissal of both the SIPC's and the Trustee's claims on behalf of Baron's customers. With respect to the claims the SIPC brings on its own behalf, we certify to the New York Court of Appeals the question of whether the SIPC may recover damages where Seidman was aware that the SIPC would receive from the SEC any negative information about Baron's financial condition contained in the audit reports, but never provided those reports directly to the SIPC or engaged in more than minimal direct contact with it.

I. The Securities Investor Protection Act

The SIPC is a private, nonprofit membership corporation formed pursuant to the Securities Investor Protection Act of 1970 ("SIPA"), 84 Stat. 1636, as amended, 15 U.S.C. §§ 78aaa-78lll. Congress passed the SIPA in response to a rash of failures among securities broker-dealers in the late 1960s, resulting in significant losses to customers whose assets either were unrecoverable or became tied up in the broker-dealers' bankruptcy proceedings. See Securities Investor Protection Corp. v. Barbour, 421 U.S. 412, 413 (1975). To prevent further losses, restore confidence in the securities industry, and provide protection for future customers, Congress created the SIPC, which monitors the activities of broker-dealers and insures customers in the case of a broker-dealer's liquidation. See15 U.S.C. § 78ccc. To cover these costs, the SIPC maintains a fund ("the SIPC Fund"), which is supported by assessments on members' revenues. Seeid. § 78ddd(c). Virtually all registered broker-dealers doing business in the United States must belong to the SIPC. Seeid. § 78ccc(a)(2).

The SIPA regulatory scheme imposes two primary duties on the SIPC: monitoring active broker-dealers and overseeing the liquidation of failed firms. In order to monitor broker-dealers and ensure their continuing financial viability, the SIPC relies primarily on the SIPA reporting system, which requires broker-dealers to file annual audit reports with the SEC and with one of several self-regulating bodies within the broker-dealer industry. See 17 C.F.R. § 240.17a ("Rule 17a"). These reports must include, inter alia, an analysis of the broker-dealer's compliance with the "net capital rule," which prohibits a broker-dealer from maintaining an aggregate debt greater than 1500% of its net capital, seeid. § 240.15c3-1, and other information regarding the broker-dealer's financial condition. Rule 17a requires broker-dealers to employ an independent public accountant to file these reports. Seeid. § 240.17a-5. If the information provided to the SEC and the industry self-regulating body indicates that a broker-dealer is approaching financial difficulty, those entities must notify the SIPC, which, if it deems the broker-dealer to be in danger of failure, may choose to commence liquidation proceedings. See Barbour, 421 U.S. at 416-17. This elaborate reporting scheme is designed to serve as an "early warning" system that will "enable [regulatory authorities] to take appropriate action to protect investors" before a broker-dealer collapses. Touche Ross & Co. v. Redington, 442 U.S. 560, 570 (1979).

To initiate liquidation, the SIPC may apply for a "protective decree" in federal district court invoking the protections of the SIPA. See 15 U.S.C. § 78eee(a)(3). If the court finds grounds for granting the application, it must appoint a trustee, chosen by the SIPC, to oversee the liquidation of the business. Seeid.§ 78eee(b)(3). The trustee exercises the same powers that a bankruptcy trustee exercises with respect to a debtor, including the power to distribute customer property, satisfy customer claims, and liquidate the broker-dealer's business. Seeid. §§ 78fff(a), 78fff-1(a). To ensure prompt settlement of customer claims during liquidation, the SIPC may advance funds to the trustee from the SIPC Fund for use in satisfying claims up to $500,000 per customer 1 and for administrative costs of the liquidation. See id.§ 78fff-3(a)(1). Under the terms of the SIPA, the SIPC becomes subrogated to customer claims to the extent it has advanced funds to cover those claims. Seeid.§§ 78fff-3(a), 78fff-4(c).

II. The events in this case

Pursuant to the SIPA, Seidman served as the independent certified public accountant and auditor for Baron, a registered securities broker-dealer, from 1992 through 1995. During that time, several members of Baron's management - known as the "Bressman Team," after Baron's Chief Executive Officer Andrew Bressman - engaged in several illegal activities, including, according to the plaintiffs' complaint, fraud in the sale of securities, manipulation of initial public offerings and after-market trading, and personal use of corporate credit. Ultimately, thirteen Baron employees pleaded guilty to or were convicted of criminal wrongdoing and Baron itself pleaded guilty to one count of enterprise corruption.

Baron filed for bankruptcy in 1996. On July 11, 1996, the United States District Court for the Southern District of New York (Preska, J.) entered an order finding, inter alia, that Baron's customers were in need of the protections of the SIPA and directing the appointment of the Trustee to oversee Baron's liquidation. See Securities Investor Protection Corp. v. Baron & Co., No. 99 Civ. 5171 (S.D.N.Y. July 11, 1996). Since that time, the Trustee has disbursed over $2.5 million to customers and creditors, and the SIPC has advanced over $5.5 million to cover customer claims and administrative costs of the liquidation.

The Trustee and the SIPC brought this action against Seidman in 1998, alleging that Seidman's deficient performance as Baron's certified public accountant permitted the Bressman Team's misconduct to continue undetected and that, as a result, neither the customers nor the SIPC were aware of Baron's precarious financial condition until shortly before the firm's collapse. Specifically, the plaintiffs claim, inter alia, that Seidman failed to follow proper audit procedures, failed to comply with SEC rules and regulations, and neglected to disclose Baron's inadequate internal fraud controls. They also allege that Seidman misrepresented Baron's financial condition in its audit reports to the SEC and to the National Association of Securities Dealers ("NASD"), the relevant industry self-regulating body for Baron. The Trustee sues on behalf of Baron's customers, both as bailee of the fund of customer property held by Baron prior to liquidation and as subrogee of the customers whose net equity claims it has paid....

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