Wright v. Ernst & Young LLP, Docket No. 97-9241

• Decision Date: 06 August 1998
• Docket Number: Docket No. 97-9241
• Citation: 152 F.3d 169,1998 WL 455600
• Parties: Fed. Sec. L. Rep. P 90,266 Irene L. WRIGHT, on behalf of herself and all others similarly situated, Plaintiff-Appellant, v. ERNST & YOUNG LLP, Defendant-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

Page 169

152 F.3d 169

Fed. Sec. L. Rep. P 90,266

Irene L. WRIGHT, on behalf of herself and all others similarly situated, Plaintiff-Appellant, v. ERNST & YOUNG LLP, Defendant-Appellee.

Docket No. 97-9241.

United States Court of Appeals Second Circuit.

Argued April 27, 1998.

Decided Aug. 6, 1998.

David A.P. Brower, Wolf Haldenstein Adler Freeman & Herz, New York City (Daniel W. Krasner, Wolf Haldenstein Adler Freeman & Herz, New York City, Charles J.

Piven, Baltimore, MD, of counsel), for Appellant

Bruce M. Cormier, Associate General Counsel, Ernst & Young LLP, Washington, DC (Michael J. Crane, Assistant General Counsel, Ernst & Young LLP, New York City, Robert J. Ward, Mayer, Brown & Platt, New York City, Michele Odorizzi, Mayer, Brown & Platt, Chicago, IL, of counsel), for Appellee.

Before: VAN GRAAFEILAND, MESKILL and CABRANES, Circuit Judges.

MESKILL, Circuit Judge:

Plaintiff-appellant Irene Wright appeals from a final judgment rendered in the United States District Court for the Southern District of New York, Scheindlin, J., dismissing her amended class action complaint charging defendant accounting firm Ernst & Young LLP with making materially false representations in connection with BT Office Products' sale of common stock, all in violation of § 10(b) of the Securities Exchange Act of 1934 (the Act), 15 U.S.C. § 78j(b), and Securities and Exchange Commission (SEC) Rule 10b-5, 17 C.F.R. § 240.10b-5. See Wright v. Ernst & Young LLP, 1997 WL 563782 (S.D.N.Y. Sept. 10, 1997). The district court dismissed the amended complaint pursuant to Fed.R.Civ.P. 12(b)(6) for failure to state a claim on which relief could be granted, but sua sponte granted leave to replead. The plaintiff-appellant declined to replead and instead filed this appeal, asserting that the amended complaint adequately stated a cause of action for violation of federal securities law. The question we must answer is whether, under the Act, persons who purchase stock in a company that issued a press release containing false and misleading financial information, with a notation that the information is unaudited and without mention of its outside auditor, can recover from the auditor for its private approval of the information contained in the press release. We conclude that under these circumstances, primary liability is foreclosed by Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), and by our recent decision in Shapiro v. Cantor, 123 F.3d 717 (2d Cir.1997). Accordingly, we affirm the judgment of the district court dismissing the amended complaint.

BACKGROUND

The appellee, Ernst & Young LLP (Ernst & Young or the firm), is a firm engaged in the business of providing various accounting services, including auditing and financial analysis. At all relevant times, Ernst & Young was the outside auditor for BT Office Products, Inc. (BT), a corporation engaged in the distribution and sale of office products. The gravamen of the amended complaint is that Ernst & Young violated the antifraud provisions of the Act by orally approving BT's materially false and misleading financial statements that BT in turn disseminated to the public in a January 30, 1996 press release. Plaintiff-appellant Irene Wright (Wright) represents a class of investors who purchased BT common stock during the period between BT's January 30, 1996 press release and BT's public statement on March 28, 1996 disavowing the financial statements contained in that release (the class period). Wright claims that because "the market knew and relied on the fact that these financial statements were approved by [Ernst & Young]," Ernst & Young is liable for losses suffered once BT's true financial picture emerged. Wright also filed a class action suit in the Southern District of New York against BT alleging securities fraud in connection with the same set of circumstances. In March 1997, the class reached a settlement with BT under which the company agreed to pay $1,480,000 to the class.

As set forth in the amended complaint against Ernst & Young, BT embarked on a series of acquisitions in 1987, including the purchase of a stationer known as Summit Office Supply (BT-Summit). As BT expanded, its management decided to engage Ernst & Young to audit its year-end financial statements. Ernst & Young issued audit opinions certifying the accuracy of BT's financial statements for the years ending December 31, 1993 and December 31, 1994. Later, in July 1995, the firm updated and re-released In the fall of 1995, the firm began a new "full-scope" audit of BT-Summit. Pursuant to this effort, it discovered an under-accrual of BT-Summit's accounts payable and alerted BT management. Upon consideration, however, Ernst & Young concluded that the under-accrual was not material and advised BT that it was probably a carryover of a similar under-accrual from the year before. Accordingly, the amended complaint avers that "on January 22, 1996 [Ernst & Young] signed off on BT Office Products' 1995 financial statements ... and authorized [BT] to release its 1995 year end results with full knowledge of the fact that the market would and did interpret the release of these figures as having been approved by [Ernst & Young]." The amended complaint further states that based on Ernst & Young's oral assurances, BT issued a press release on January 30, 1996 that set forth BT's 1995 financial results and indicated strong growth during 1995. The press release also stated, however, that the figures were "unaudited" and it made no mention of Ernst & Young.

the December 31, 1994 audit opinion as a "Report of Independent Auditors" for use in BT's initial public offering prospectus, which included a statement of BT's first quarter earnings for 1995. The audit upon which that report was based included a "full-scope" audit of several BT subsidiaries, but only a "limited review" of BT-Summit's accounts.

In late February and March of 1996, it became apparent to both BT and Ernst & Young that the under-accrual problem at BT-Summit was more serious than previously believed. A further investigation revealed not only that BT-Summit employees used improper accounting techniques, but substantial company funds had been embezzled. In light of these discoveries, BT announced on March 28, 1996 that it was restating its 1995 financial results from a previously announced profit of $1.5 million to a loss of $200,000. With that announcement, BT's stock lost more than 25% of its value, injuring Wright and the other class members.

The amended complaint alleges that "due to [the firm's] recklessness and failure to follow Generally Accepted Auditing Standards ('GAAS') [Ernst & Young, by electing to perform only a limited review of BT-Summit,] did not uncover the massive 'accounting and financial reporting irregularities' at BT-Summit." Allegedly because of this recklessness, Wright and other class members purchased stock at an artificially inflated price and later suffered injury once BT's true financial picture emerged.

In the proceedings before Judge Scheindlin, Ernst & Young filed a motion to dismiss, arguing, inter alia, that because it did not itself make any false statement to the public, the amended complaint alleged nothing more than "aiding and abetting" liability, a form of Rule 10b-5 liability that the Supreme Court abolished in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994). In opposing that motion, Wright argued that the amended complaint properly alleged a 10b-5 violation because it alleged that Ernst & Young provided false and misleading advice to BT, knowing that the advice would be passed on to investors. Moreover, because Ernst & Young allegedly "signed-off" or approved the financial information within that press release, Wright averred that the market understood the press release as an implied statement by Ernst & Young that the financial information contained therein was accurate. In reply, Ernst & Young pointed out that BT's January 30, 1996 press release did not purport to repeat any statement made by Ernst & Young and that the press release expressly stated that the 1995 financial results were "unaudited."

On September 9, 1997 Judge Scheindlin granted the motion to dismiss. In doing so, she rejected Wright's argument that BT's press release constituted an implied statement to the public that Ernst & Young had approved BT's financial statements, noting that such a claim was refuted by BT's statement in the press release that the 1995 financial results were "unaudited." See Wright, 1997 WL 563782, at * 2. Further, the court observed that transforming that disclaimer into a guarantee of the statement's accuracy would "seriously deter disclosure of unaudited financial information." Id. The court also observed that sustaining the amended complaint in light of Ernst & Young's "clearly

tangential role in the alleged fraud would effectively revive aiding and abetting liability under a different name, and would therefore run afoul of the Supreme Court's holding in Central Bank." Id., 1997 WL 563782 at * 3. Finally, Judge Scheindlin concluded that although the amended complaint also alleged misstatements by Ernst & Young in connection with BT's 1995 initial public offering prospectus, the amended complaint failed to allege fully a § 10(b) cause of action on that ground. Id., 1997 WL 563782 at * 4. Accordingly, the court sua sponte granted Wright leave to cure the defects by filing a second amended complaint by September 29, 1997. Wright did not file a second amended complaint and accordingly, the district court entered judgment on September 30, 1997. Wright filed a notice of appeal on October 1, 1997.

DISCUSSION

On appeal, Wright argues that the district court (1) erred in holding that the amended complaint failed to allege that Ernst & Young made an actionable misstatement within the meaning of the...