The Limited, Inc. v. McCrory Corp.

• Decision Date: 01 August 1986
• Docket Number: No. 85 Civ. 7444 (RLC).,85 Civ. 7444 (RLC).
• Citation: 645 F. Supp. 1038
• Parties: THE LIMITED, INC., Plaintiff, v. McCRORY CORPORATION, Rapid-American Corporation, Rapid-American Holding Corporation, Touche Ross & Co., DBG Financial Company, Meshulam Riklis, Harold S. Divine, Bernard J. Blaney, Stephen L. Pistner, Arthur E. Strickman, Arnold Broser and Steven J. Greene, Defendants.
• Court: U.S. District Court — Southern District of New York

645 F. Supp. 1038

THE LIMITED, INC., Plaintiff, v. McCRORY CORPORATION, Rapid-American Corporation, Rapid-American Holding Corporation, Touche Ross & Co., DBG Financial Company, Meshulam Riklis, Harold S. Divine, Bernard J. Blaney, Stephen L. Pistner, Arthur E. Strickman, Arnold Broser and Steven J. Greene, Defendants.

No. 85 Civ. 7444 (RLC).

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

August 1, 1986.

Parker Chapin Flattau & Klimpl, New York City, for plaintiff; Alvin Stein, Mark Abramowitz, Stephen F. Harmon, Katherine C. Ash, of counsel.

Rubin Baum Levin Constant & Friedman, New York City, for defendants McCrory Corp., Rapid-American Corp., Rapid-American Holding Corp., Meshulam Riklis, Bernard J. Blaney and Stephen L. Pistner; Steven Marshall, of counsel.

Pollack & Kaminsky, New York City, for DBG Financial Co., Arnold Broser, Harold S. Divine, and Steven J. Greene.

Gelberg & Abrams, New York City, for defendant Arthur E. Strickman.

Gibson, Dunn & Crutcher, New York City, for defendant Touche Ross & Co.; Walter L. Stratton, John T. Behrendt, Mitchell A. Karlan, Dvora Wolff Rabino, of counsel.

ROBERT L. CARTER, District Judge.

Plaintiff The Limited, Inc. ("The Limited"), a Delaware corporation which operates a national chain of retail stores selling women's apparel, brings this fraud action against three corporate defendants, McCrory Corporation ("McCrory"), Rapid-American Holding Corporation ("Holding"), Rapid-American Corporation ("Rapid-American"), (collectively the "Selling Group"), DBG Financial Company ("DBG"),¹ Touche Ross & Co. ("Touche"),² and seven present or former directors or officers of the Selling Group corporations (the "individual defendants").³

Plaintiff who purchased from the Selling Group all of the issued and outstanding stock of Lerner Stores Corporation ("Lerner"), a business which operates a national chain of approximately 800 retail stores selling women's and children's apparel, seeks damages for alleged violations by all defendants of § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5; seeks damages from the individual defendants as controlling persons of Lerner, pursuant to § 20 of the Exchange Act, 15 U.S.C. § 78t(a); seeks damages against all defendants, except Touche, for violation of the Racketeer Influenced and Corrupt Organizations Act of 1970 ("RICO"), 18 U.S.C. §§ 1961-68; seeks damages against all defendants, except Touche, under § 17 of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a)(2); and seeks damages against all the defendants pursuant to § 352-c of the General Business Law of the State of New York.⁴

In essence, plaintiff charges that during the period that plaintiff was negotiating the purchase of Lerner stock, defendants made either misrepresentations or omissions which falsely inflated the value of Lerner's assets and net income.

Two motions are now before the court. The Selling Group and individual defendants⁵ have filed a motion to dismiss the complaint pursuant to Rule 9(b), F.R.Civ.P., for failure to plead fraud with the requisite particularity, and Rule 12(b)(6), F.R.Civ.P., for failure to state a claim upon which relief can be granted. Defendant Touche, the accounting firm that audited the financial statements of Lerner for the year ended January 31, 1985, has separately moved to dismiss the complaint, pursuant to Rule 9(b), F.R.Civ.P. and 12(b)(6), F.R.Civ.P.

FACTS

In the fall of 1984, plaintiff entered into negotiations with three inter-related corporations, the Selling Group, to purchase all issued and outstanding Lerner stock. Comprising the Selling Group were McCrory—a subsidiary of Rapid-American— which prior to April 2, 1985, owned all issued and outstanding capital stock of Lerner; Rapid-American, the principal shareholder of McCrory; and Holding, the sole stockholder of Rapid-American. (Complaint ¶ 5, ¶ 6, ¶ 7). According to plaintiff, the purchase price of Lerner stock would equal a certain sum of money in excess of the book value of the stock as determined by a certified year-end audit performed by defendant Touche, an accounting firm. On or about April 2, 1985, the Selling Group jointly sold all of the issued and outstanding stock of Lerner to plaintiff, pursuant to a memorandum of understanding and a stock purchase agreement. (Id. ¶ 19, ¶ 28).⁶

Plaintiff alleges that during the seven month negotiation period, the Selling Group corporations, acting through certain of their controlling officers and directors, entered into an agreement to defraud plaintiff. First, defendants are alleged to have caused Lerner to deviate from its usual markdown practices by limiting the amount of permanent markdowns at retail to a total of $80,000,000. Plaintiff contends that this $80,000,000 figure was "totally inadequate," (Complaint ¶ 25), as Lerner would have had to take significant additional markdowns in order to sell both its current and out of season inventory. This restriction on permanent markdowns is said to have distorted the true market value of Lerner's inventory, resulting in an inflated valuation of Lerner's assets and Lerner's net income on Lerner's financial statements for the year ended January 31, 1985. (Complaint ¶¶ 26-29).

Second, all defendants, except Touche, allegedly saddled Lerner with a multi-million twenty-year equipment lease. During negotiations for the sale of Lerner stock, these defendants failed to disclose to plaintiff that a two-year operating lease dated June 1, 1983 between DBG⁷ and Lerner, for equipment which cost approximately $3,800,000 at a total rental of $2,880,000, was extended for an additional period of almost twenty years at a total additional rental of approximately $28,000,000. (Complaint ¶ 29). The financial statement of Lerner failed to reflect Lerner's liability for the purported lease extension, resulting in a materially false and overstated picture of Lerner's book value. (Complaint ¶ 30).

DISCUSSION

On a motion to dismiss, the court must accept as true the factual allegations of the complaint. See Cruz v. Beto, 405 U.S. 319, 322, 92 S.Ct. 1079, 1081, 31 L.Ed.2d 263 (1972) (per curiam); Joyce v. Joyce Beverages, Inc., 571 F.2d 703, 706 (2d Cir.), cert. denied, 437 U.S. 905, 98 S.Ct. 3092, 57 L.Ed.2d 1135 (1978). Accordingly, for the purpose of examining the instant motions to dismiss, the relevant facts outlined above are accepted as true.

Rule 9(b) requires that when a complaint alleges fraud, "the circumstances constituting fraud ... shall be stated with particularity." It is well settled that allegations of fraud under the federal securities laws and RICO are subject to this requirement. Moss v. Morgan Stanley Inc., 719 F.2d 5, 19 (2d Cir.1983), cert. denied, 465 U.S. 1025, 104 S.Ct. 1280, 79 L.Ed.2d 684 (1984); Ross v. A.H. Robins Co., 607 F.2d 545, 557 (2d Cir.1979); Denny v. Barber, 576 F.2d 465, 470 & n. 4 (2d Cir.1978); Segal v. Gordon, 467 F.2d 602, 606-08 (2d Cir.1972). The "circumstances" constituting fraud means "matters such as time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation." Robertson v. National Basketball Ass'n, 67 F.R.D. 691, 697 (S.D.N.Y.1975) (Carter, J.); see also Jacobson v. Peat, Marwick, Mitchell & Co., 445 F.Supp. 518, 522 (S.D.N.Y.1977) (Werker, J.).

A. The Section 10(b) and Rule 10b-5 Claims

Successful § 10(b)⁸ and Rule 10b-5⁹ actions require, inter alia, a showing that defendants had intended to deceive, manipulate or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). Defendants in the Selling Group and the individual defendants contend that the § 10(b) and Rule 10b-5 allegations in the complaint are based on information and belief insufficiently supported by particular facts. Rule 9(b) pleadings normally cannot be based solely upon "information and belief." Segal v. Gordon, supra, 467 F.2d at 608. Even when matters are peculiarly within the adverse parties' knowledge, a complaint based solely upon information and belief will survive a motion to dismiss under Rule 9(b) only if the pleading includes a statement of facts upon which the belief is founded. Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 379 (2d Cir.1974), cert. denied, 421 U.S. 976, 95 S.Ct. 1976, 44 L.Ed.2d 467 (1975); Somerville v. Major Exploration, Inc., 576 F.Supp. 902 (S.D.N.Y.1983) (Carter, J.).

Contrary to defendants' suggestion, plaintiff's contention that the Selling Group "knew or should have known" the misleading nature of certain omitted facts does not, itself, violate the specificity requirements of Rule 9(b), see Fox v. Prudent Resources Trust, 382 F.Supp. 81, 95 (E.D. Pa.1974), citing Dudley v. Southeastern Factor & Finance Corp., 446 F.2d 303, 308 n. 6 (5th Cir.1971), as the factual support for plaintiff's allegations is clear. Plaintiff maintains that during the seven month negotiation period when the Selling Group was actively negotiating plaintiff's purchase of all issued and outstanding Lerner stock, Lerner's equipment lease obligation was extended by approximately $28 million, and Lerner's permanent markdown was limited to $80 million. (Complaint ¶¶ 22, 24). Neither of these two facts was included in Lerner's financial statement for the year ended January 31, 1985. The complaint thus identifies both the document alleged to contain the securities fraud violations and the specific omissions that make such document false and misleading. Gilman Bros., Inc. v. Peat, Marwick, Mitchell & Co., 1978 CCH Fed. Sec. L.Rep. ¶ 96,512 at 93,994 (S.D.N.Y.1978) (Weinfeld, J.); Denny v. Barber, 73 F.R.D. 6, 9 (S.D.N.Y.1977).

To the extent that defendants assert they have insufficient notice of the alleged wrongs, their motion to dismiss is rejected. The complaint adequately details the nature and essential factual elements of the alleged fraud so that it is...