The Ltd., Inc. v. McCrory Corp.

• Citation: 683 F. Supp. 387
• Decision Date: 07 April 1988
• Docket Number: No. 85 Civ. 7444 (RLC).,85 Civ. 7444 (RLC).
• 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

683 F. Supp. 387

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.

April 7, 1988.

COPYRIGHT MATERIAL OMITTED

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

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

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

Pollack & Kaminsky, New York City (Daniel A. Pollack Martin I. Kaminsky, of counsel), for defendants DBG Financial Co., Harold S. Divine, Arnold Broser and Steven J. Greene.

Gelberg & Abrams, New York City (Michael Luskin, of counsel), for defendant Arthur E. Strickman.

OPINION

ROBERT L. CARTER, District Judge.

BACKGROUND

In the early fall of 1984, The Limited, Inc., a corporation that operates a national chain of approximately 800 retail stores selling women's and children's apparel, entered negotiations to purchase all of the issued and outstanding stock of Lerner Stores Corporation ("Lerner"). The sellers were a collection of three corporations: McCrory Corp. ("McCrory"), which prior to April 2, 1985, owned all of the issued and outstanding stock of Lerner; Rapid-American Corp. ("Rapid-American"), of which McCrory is a wholly owned subsidiary; and Rapid-American Holding Corp. ("Holding"), of which Rapid-American is a wholly owned subsidiary. Collectively, these corporations constituted the Selling Group. Meshulam Riklis, Harold S. Divine, Bernard J. Blaney, Arnold Broser, and Stephen L. Pistner, all individual defendants, participated in the stock-sale negotiations.¹ Drexel Burnham Lambert, Inc. ("Drexel"), a non-party, acted as advisor and agent to Riklis, Riklis's staff, and the Selling Group.

In February, 1985, plaintiff and the Selling Group executed a Memorandum of Understanding. The Memorandum set forth the key provisions of the proposed stock sale and established a purchase price "equal to $160 million in excess of the audited shareholder's equity as of January 31, 1985." Amended Complaint, ¶ 22. The equity figure was to be based upon the "audited balance sheet certified by Touche Ross & Co. "Touche" in accordance with generally accepted accounting principles and on a basis consistent with the January 31, 1984 consolidated financial statements, which January 31, 1985 balance sheet shall be final and binding on all parties." Id.

Plaintiff and the Selling Group executed a stock purchase agreement on April 2, 1985. At the closing, Touche delivered a copy of Lerner's certified financial statements and the auditor's report to plaintiff, which had already been assured by Drexel and by the Selling Group's counsel that Lerner's inventory valuation would be "squeaky clean." Id., ¶ 25.

In this action, The Limited alleges that the financial statements on which it relied were materially false and misleading in at least three respects. First, the statements failed to disclose that the recorded value of Lerner's inventory was greatly inflated because of a change in its inventory markdown policies. Second, the statements did not disclose that a two-year equipment lease between Lerner's wholly owned subsidiary, Associated Lerner Shops of America ("ALSA"), and DBG Financial Company, a partnership consisting of defendants Divine, Broser, and Greene, had been extended for a period of almost twenty years at an additional rental liability of approximately $28 million. Third, the statements did not disclose Lerner's purported liability to Rapid-American for $1.3 million in insurance assessments stemming from Rapid-American's purchase of workers' compensation insurance for Lerner and other companies. As a result, plaintiff claims, it overpaid for the stock and has sustained recurring consequential losses. Plaintiff's Br. at 4-5.

THE PREVIOUS OPINION AND THE AMENDED COMPLAINT

Most of the allegations in this case have been set forth previously and need not be elaborately restated here. See The Limited, Inc. v. McCrory Corp., 645 F.Supp. 1038 (S.D.N.Y.1986) (Carter, J.), with which familiarity is assumed.

In August, 1986, the court dismissed the complaint in its entirety. Plaintiff's claims under Section 10(b) of the Securities Exchange Act of 1934 ("Section 10(b)"), 15 U.S.C. § 78j(b), Rule 10b-5 promulgated thereunder ("Rule 10b-5"), 17 C.F.R. § 240.10b-5 (1987), Section 17(a) of the Securities Act of 1933 ("Section 17(a)"), 15 U.S.C. § 77q(a), and the Racketeer Influenced and Corrupt Organizations Act of 1970 ("RICO"), 18 U.S.C. §§ 1961-1968, failed to plead fraud with the particularity required by Rule 9(b), F.R.Civ.P.²See The Limited, Inc., supra, 645 F.Supp. at 1042-47. Having failed to plead a proper Section 10(b) claim, plaintiff was not entitled to proceed with its claim under Section 20(a) of the Exchange Act ("Section 20(a)"), 15 U.S.C. § 78t(a). Its state-law claims were dismissed for lack of jurisdiction, and plaintiff was granted leave to replead.

The amended complaint exceeds 70 pages and contains nine claims: The Selling Group, Riklis, and Touche are charged with primary violations of Section 10(b) and Rule 10b-5. The seven individual defendants, along with DBG and Touche, are charged with aiding and abetting those alleged violations. Each defendant is charged with violating Section 17(a). Each individual defendant is charged with liability as a controlling person under Section 20(a). Riklis and Divine are charged with violating Section 1962(c) of RICO. Finally, in a series of state-law claims, the complaint charges Touche with common-law negligence; each defendant with common-law fraud; and each defendant with liability under Section 352-c of New York's General Business Law ("the Martin Act"). N.Y.Gen.Bus.L. § 352-c (McKinney 1984). Plaintiff seeks compensatory damages, punitive damages, treble damages under its RICO claim, and costs.

The amended complaint differs in several respects from the original: (1) It charges only defendants Riklis, the Selling Group, and Touche with primary violations of Section 10(b) and Rule 10b-5, and alleges that all individual defendants, along with DBG and Touche, were aiders and abettors; (2) it includes Touche among those defendants charged with violating Section 17(a); (3) it interposes a RICO charge against only Riklis and Divine, not, as previously, against all defendants except Touche; (4) it asserts a common-law fraud claim against all defendants and, on the basis of this new claim, seeks $25 million in punitive damages; and (5) it invokes a new theory of misrepresentation — the nondisclosure of the insurance assessments liability. More generally, the amended complaint no longer charges defendants with the same acts of wrongdoing. It attempts to remedy its previous deficiencies by distinguishing among defendants and specifying those aspects of the alleged fraud in which each participated.

As before, Touche moves for dismissal under Rules 9(b) and 12(b), F.R.Civ.P. The remaining defendants jointly move for dismissal on the same grounds and for partial summary judgment pursuant to Rule 56, F.R.Civ.P. Defendants DBG and Greene join in the foregoing motion but state additional grounds for dismissal as to them.

MOTIONS TO DISMISS THE AMENDED COMPLAINT

It is "the accepted rule that a complaint should not be dismissed for failure to state a claim 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 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957); see Cruz v. Beto, 405 U.S. 319, 322, 92 S.Ct. 1079, 1081-82, 31 L.Ed.2d 263 (1972) (per curiam). Thus, the court must construe the allegations of the complaint favorably to the pleader. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974); cf. Joyce v. Joyce Beverages, Inc., 571 F.2d 703, 706 (2d Cir.) (plaintiff's allegations must be accepted as true), cert. denied, 437 U.S. 905, 98 S.Ct. 3092, 57 L.Ed.2d 1135 (1978). Even if it appears "on the face of the pleadings that a recovery is very remote and unlikely, ... that is not the test." Scheuer, supra, 416 U.S. at 236, 94 S.Ct. at 1686; see First Fed. Sav. & Loan Ass'n v. Oppenheim, Appel, Dixon & Co., 634 F.Supp. 1341, 1353 (S.D.N.Y.1986) (Lasker, J.) "The issue is ... whether the claimant is entitled to offer evidence to support the claims." Scheuer, supra, 416 U.S. at 236, 94 S.Ct. at 1686.

I. Touche's Motion

Plaintiff alleges that Touche, as Lerner's auditor, knew that Lerner's inventory was overvalued and deliberately or recklessly failed to correct the overstatement, see Amended Complaint, ¶¶ 96-100; knew of the purported lease extension but failed to disclose its existence, see id., ¶¶ 101-104; and was negligent in failing to discover Lerner's purported liability for the insurance assessments. See Plaintiff's Br. at 17 n. 7. Touche argues that plaintiff is not entitled to offer proof of these assertions because there has been no allegation of actual damages.

A. Damages

Proof of actual damages is essential to each of the claims asserted against Touche. E.g., 15 U.S.C. § 78bb(a) (limiting recovery under the Exchange Act to "actual damages"); Ostano Commerzanstalt v. Telewide Systems, Inc., 794 F.2d 763, 766 (2d Cir.1986) (under New York law, plaintiff in fraud may recover only out-of-pocket damages); Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 61 (2d...