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denying summary judgment on the issue of causation when audits attached to investment materials because "audits of investment funds . . . are generally understood to be essential if a fund is to obtain any investors."
Summary of this case from In re E.S. Bankest, L.C.Opinion
00 CIV. 2284 (DLC)
June 23, 2003
Steven S. Honigman, Richard P. Swanson, Jonathan E. Polonsky, Veronica E. Rendon, Alexandra Khlyavich, Irena S. Brobston, Thelen Reid Priest LLP, New York, N.Y., Attorneys for Plaintiffs Cromer Finance, Ltd. et al.
Jeffrey H. Squire, Richard L. Stone, Mark A. Strauss, Kirby, McInerney Squire, LLP, New York, N.Y., Attorneys for Plaintiffs Cromer Finance, Ltd. et al.
Michael J. Dell, David S. Frankel, Gregory A. Horowitz, Yehudis Lewis, Kramer Levin Naftalis Frankel LLP, New York, NY., Attorneys for Defendant Deloitte Touche Bermuda.
Wesley G. Howell, Jr., John T. Behrendt, Mark B. Holton, Aric H. Wu, Denise McGinn, Gibson, Dunn Crutcher LLP, New York, N.Y., Attorneys for Defendant Deloitte Touche Tohmatsu.
OPINION AND ORDER
This litigation, which commenced on March 24, 2000, stems from the collapse of the Manhattan Investment Fund (the "Fund"), and the fraudulent acts of the Fund's manager, Michael Berger ("Berger"). Lead plaintiffs in this class action, Cromer Finance Ltd. ("Cromer") and Prival N.V. ("Prival") (collectively, "plaintiffs"), allege that the Fund lost over $400,000,000.
Plaintiffs' suit names as defendants, among others, the Bermuda-based accounting firm that audited the Fund, Deloitte Touche Bermuda ("DTB"). DTB now moves for summary judgment of the claims brought against it. Its motion is denied, with the exception of its motion to require proof of actual reliance for the common law claims. Plaintiffs have also moved to strike two affidavits of foreign law proffered by DTB; decision on that motion is reserved.
BACKGROUND
The facts of this case, as well as many of the legal issues raised in this motion, have been discussed in the many prior Opinions in this litigation. See Cromer Finance Ltd. v. Berger, 137 F. Supp.2d 452 (S.D.N.Y. 2001) (decision on first motions to dismiss); Cromer Finance Ltd. v. Berger, 2001 WL 506908 (S.D.N.Y. May 14, 2001) (motion for reconsideration); Cromer Finance Ltd. v. Berger, 158 F. Supp.2d 347 (S.D.N.Y. 2001) (forum non conveniens); Cromer Finance Ltd. v. Berger, 2001 WL 935475 (S.D.N.Y. Aug. 16, 2001) (motion to permit interlocutory appeal); Cromer Finance Ltd. v. Berger, 2001 WL 1112548 (S.D.N.Y. Sept. 19, 2001) (second motion to dismiss); Cromer Finance Ltd. v. Berger, 205 F.R.D. 113 (S.D.N.Y. 2001) (class certification); Cromer Finance Ltd. v. Berger, 2002 WL 826847 (S.D.N.Y. May 2, 2002) (motion to amend); Cromer Finance Ltd. v. Berger, 245 F. Supp.2d 552 (S.D.N.Y. 2003) (Deloitte Touche Tohmatsu's motion for summary judgment). Facts relevant to particular claims are discussed below; a brief summary follows.
The Fund, incorporated in the British Virgin Islands, began trading United States securities in 1996. The Fund was based in New York. When the Fund began losing money, Berger hid losses from investors by manufacturing false monthly account statements. DTB, which is a member of the Swiss verein Deloitte Touche Tohmatsu International ("Deloitte"), became the Fund's auditor in 1997, and issued its first audit, for the 1996 fiscal year, on May 27, 1997. The 1996 audit is addressed to "the Shareholders of Manhattan Investment Fund Ltd.," and the cover letter for the audit represents that the audit was conducted "in accordance with auditing standards generally accepted in the United States of America." Audits for the fiscal years 1997 and 1998, with similar cover letters, were issued on March 20, 1998 and March 16, 1999, respectively. All three of DTB's audits were "clean" audits.
DTB withdrew their three audits in January 2000, after the Securities and Exchange Commission ("SEC") initiated an investigation of the Fund. Plaintiffs, who generally contend that DTB ignored evidence of Berger's fraud and failed their responsibilities as auditor, have asserted seven causes of action against DTB: violation of Section 10(b) of the Securities Exchange Act ("Section 10(b)") and Rule 10b-5 promulgated thereunder, aiding and abetting common law fraud, aiding and abetting breach of fiduciary duty, common law fraud, gross negligence, negligence and professional malpractice.
DISCUSSION
Summary judgment may not be granted unless the submissions of the parties taken together "show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Rule 56(c), Fed.R.Civ.P. The moving party bears the burden of demonstrating the absence of a material factual question, and in making this determination the Court must view all facts in the light most favorable to the non-moving party. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247 (1986); Celotex Corp v. Catrett, 477 U.S. 317, 323 (1986). When the moving party has asserted facts showing that the non-movant's claims cannot be sustained, the opposing party must "set forth specific facts showing that there is a genuine issue for trial," and cannot rest on the "mere allegations or denials" of his pleadings. Rule 56(e), Fed.R.Civ.P.; accord Burt Rigid Box, Inc. v. Travelers Property Cas. Corp., 302 F.3d 83, 91 (2d Cir. 2002). Thus, in determining whether to grant summary judgment, this Court must (1) determine whether a genuine factual dispute exists based on evidence in the record; and (2) determine, based on the substantive law at issue, whether the fact in dispute is material.
I. Subject Matter Jurisdiction
As they did in three prior motions, DTB continues to challenge the existence of subject matter jurisdiction. DTB asserts that the allegations supporting the prior analysis of the "conduct" and "effects" tests have proven to be baseless. It argues that discovery has shown that none of the beneficial owners of shares in the Fund were United States residents, which it contends eliminates any possible "effects" in the United States. DTB emphasizes that neither named plaintiff resides in the United States, contending that their absence prevents the entire class from showing the existence of any effect of the fraud in the United States. It also claims that none of plaintiffs' losses were caused by DTB's conduct in the United States, and that it is inappropriate to aggregate DTB's conduct with that of other participants in the fraud. DTB requests a hearing on this issue prior to trial.
The issue of subject matter jurisdiction has already been addressed at length in this case. See Cromer, 137 F. Supp.2d 452 at 479 (motion to dismiss); Cromer, 2001 WL 506908, at *6-*7 (motion for reconsideration); Cromer, 2001 WL 935475, at *2 (motion for interlocutory appeal). The standard applied in prior Opinions has not changed. In brief,
The Second Circuit has developed two tests to determine whether the Court should entertain subject matter jurisdiction over a particular transnational securities fraud claim, the conduct test and the effects test. Itoba Ltd. v. LEP Group PLC, 54 F.3d 118, 121-22 (2d Cir. 1995). The two tests need not be applied "separately and distinctly," and "an admixture or combination of the two often gives a better picture of whether there is sufficient United States involvement to justify the exercise of jurisdiction by an American court." Id. at 122. Indeed, certain facts, such as making telephone calls or sending investment information to the United States, can be "characterized as either conduct or effects in the United States." [Europe and Overseas Commodity Traders, S.A. v. Banque Paribas London, 147 F.3d 118, 128 n. 13 (2d Cir. 1998).]
Cromer, 137 F. Supp.2d at 479.
DTB's aggregation argument has already been addressed as follows:
The [Motion to Dismiss] Opinion noted that even were the Court to accept the defendants' argument regarding aggregation, the individual actions on the part of [the Fund administrator] and DTB are sufficient for subject matter jurisdiction under undisputed law. . . . DTB argues that no evidence exists that its conduct had any "effects" in the United States and that its conduct occurred entirely outside of the United States. DTB ignores the myriad of contacts which the Court detailed in its [Motion to Dismiss] Opinion (and reiterated in its [Motion for Reconsideration] Opinion) sufficient under an "admixture" of the conduct and effect tests to find subject matter jurisdiction over DTB. For example, DTB won the right to act as auditor for the Fund by sending a "Proposal of Professional Services" to Berger in New York, and DTB's annual audit reports — allegedly containing material, false information regarding the Fund — were exported by mail from Bermuda to the United States. See Europe and Overseas Commodity Traders, S.A. v. Banque Paribas London, 147 F.3d 118, 128 (2d Cir. 1998) ("Telephone calls and facsimile transmissions conveying offers to sell securities and investment information could be characterized as either conduct or effects in the United States."). DTB does not dispute that, as it indicated in its own audit reports, the Fund was designed for both foreign investors and "tax exempt United States investors" nor that when it addressed its audit reports to "the Shareholders of the Manhattan Investment Fund Ltd.," it understood that its allegedly fraudulent audits would be mailed to the Fund's shareholders, even if [the Fund's Administrator] did the actual mailing. See Consolidated Gold Fields PLC v. Minorco, S.A., 871 F.2d 252, 262 (2d Cir. 1989) (holding the transmittal of tender offer documents to the United States was an "effect" in that it was "a direct and foreseeable result of the conduct outside the territory of the United States"). In addition, the audits themselves were created using information emanating from the United States for a Fund which DTB understood was managed entirely from New York, and DTB chose to rely at least in part on its United States-based affiliates to perform aspects of its audit work. . . . This fact intensive inquiry does not create an appropriate basis for certification.
Cromer, 2001 WL 935475, at *3.
Recently, in addressing the existence of subject matter jurisdiction in an action brought by the SEC in connection with this very fraud, the Second Circuit reaffirmed the use of the effects and conduct test and the existence of subject matter jurisdiction for "claims involving transnational securities frauds." S.E.C. v. Berger, 322 F.3d 187, 192 (2d Cir. 2003). In particular, relying on the conduct test alone, it held that there was a sufficient basis to find subject matter jurisdiction over the fraud. Id. at 195. "[W]hile operating entirely from New York, Berger executed a massive fraud upon hundreds of investors involving transaction on United States exchanges." Id. at 195. In so ruling, the Second Circuit rejected the arguments made by the defendant — Berger — that his actions in the United States were merely preparatory to the fraud, that jurisdiction did not exist because the investors were largely if not exclusively foreign, and that the false financial statements were prepared and mailed from abroad. Id. at 194-94. DTB has not shown why the reasoning in Berger should not control here.
In particular, it is noteworthy that the Second Circuit cited with approval two of its prior opinions in ways that have particular resonance with DTB's arguments. It quoted a prior decision's comment that there is "`jurisdiction over a predominantly foreign securities transaction under the conduct test when, in addition to communications or meetings in the United States, there has also been a transaction in a U.S. exchange, economic activity in the U.S., harm to a U.S. party, or activity by a U.S. person or entity meriting redress'". Id. at 194 (citing Banque Paribas, 147 F.3d at 130 n. 16). Drawing on a quotation from Bersch v. Drexel Firestone, Inc., 519 F.2d 974 (2d Cir. 1975), it noted that "`Congress did not mean the United States to be used as a base for fraudulent securities schemes even when the victims are foreigners, at least in the context of suits by . . . named foreign plaintiffs.'" Berger, 322 F.3d at 195 (citing Bersch, 519 F.2d at 987).
Taking a cue from the Berger decision, the conduct test so clearly presents a sufficient basis for finding subject matter jurisdiction over this action, that it is unnecessary to consider the effects test as well. Indeed, Berger himself is one of the defendants in this action, as is Financial Asset Management, Inc. ("FAM"), which Berger used as an "introducing broker", and Deloitte, the foreign auditing organization which is run from its headquarters located in New York City. There is no dispute that DTB is properly joined as a party to this action under traditional joinder principles. All of the causes of action and defendants are tied together through their connection to the single scheme which was the fraud committed by Berger in New York. It matters not, therefore, whether any beneficial owner of shares in the Fund or the two named plaintiffs are United States residents.
DTB's remaining argument is that the issue of subject matter jurisdiction is defendant specific and that its conduct cannot be aggregated with the conduct of any other defendant in assessing jurisdiction. Even if that were true, the undisputed facts described in the decision denying the motion for an interlocutory appeal and quoted above, Cromer, 2001 WL 935475, at *3, provide a more than sufficient basis for finding subject matter jurisdiction under the conduct test over an action against DTB.
DTB, however, is wrong about the standard for subject matter jurisdiction. The issue is whether the court has jurisdiction over the transaction, not whether it separately has jurisdiction over the particular acts committed by each defendant in connection with the transaction. Indeed, it is the simple fortuity of litigation that Berger himself will not be sitting as a defendant at the upcoming trial. Were he still an active participant in this litigation, the flaw in DTB's reasoning would be even more apparent.
Berger became a fugitive after entering a guilty plea to the fraud that forms the basis for this action. Berger, 322 F.3d at 191.
DTB has not cited any Second Circuit decision that leads to any other conclusion. In Itoba Ltd. v. LEP Group PLC, 54 F.3d 118, 124-35 (2d Cir. 1995), the single Second Circuit decision cited by DTB, the plaintiff, an off-shore entity, sued a foreign holding company, LEP Group PLC, and four individuals. One of the individual defendants, William Berkley, was a LEP director and a United States citizen. While the other claims were based on an alleged failure to disclose material information in SEC filings, the claim against Berkley arose from his sale of LEP shares on the same day the plaintiff purchased shares. Id. at 121. The Second Circuit reversed the dismissal of the complaint, which had been dismissed for a lack of subject matter jurisdiction. Id. The Second Circuit held that there was subject matter jurisdiction based on a combination of the conduct and effects test. Id. at 124. In doing so, it examined all of the relevant facts, but did not engage in a defendant by defendant analysis. Id. at 123-24. It then observed
For some reason that is not clear to us, the magistrate judge did not consider it necessary to address specifically Itoba's causes of action against any of the individual defendants. She simply recommended a blanket dismissal of the complaint as to all defendants, which recommendation was adopted without discussion by the district court. We find this particularly troublesome with respect to the defendant Berkley.
Id. at 124. Read in context, this passage does not dictate that the relevant facts regarding a transaction should not be considered in the aggregate to determine whether subject matter jurisdiction exists over all defendants connected to the transaction. It instead expresses surprise at the lower court's decision to "silently" dismiss without any analysis the quite separate insider trading claims against Berkley. Id. at 125.
DTB cites two other cases to support its contention that an aggregation approach is disfavored in the Second Circuit, although neither provide such support. DTB cannot rely on Department of Econ. Dev. v. Arthur Andersen Co., 683 F. Supp. 1463 (S.D.N.Y. 1988); the court there found sufficient domestic activity in the performance of the audits at issue to find subject matter jurisdiction over two foreign accounting firms in a suit brought by a foreign plaintiff. Id. at 1470-71. In Zoelsch v. Arthur Andersen Co., 824 F.2d 27 (D.C. Cir. 1987), West German plaintiffs sued one defendant, an American accounting firm. The case, therefore, did not address the aggregation of contacts with the United States for separate defendants, and its dicta regarding the aggregation of activities by non-party participants has no relevance to the issues here. See id. at 36.
In sum, DTB has not shown that there is a basis to revisit the prior determinations that there is subject matter jurisdiction. There is no need for a pre-trial hearing.
II. Securities Law Claims
DTB argues that plaintiffs cannot prove two essential elements of the federal securities fraud claim: loss causation and transaction causation. The legal framework for analyzing these two elements has been described in several prior opinions in this action, including the Opinion certifying a class:
It is well settled in the Second Circuit that:
"Causation under federal securities laws is two-pronged: a plaintiff must allege both transaction causation, i.e., that but for the fraudulent statement or omission, the plaintiff would not have entered into the transaction; and loss causation, i.e., that the subject of the fraudulent statement or omission was the cause of the actual loss suffered. . . . Transaction causation is based upon the plaintiff's reliance upon the defendant's deceptive statements or omissions; that is, but for such conduct by the defendant, the plaintiff would not have acted to his detriment. Loss causation is somewhat different. It has been likened to the tort concept of proximate cause, meaning that in order for the plaintiff to recover it must prove the damages it suffered were a foreseeable consequence of the misrepresentation."
Cromer, 205 F.R.D. at 128 (class certification) (citing Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95-96 (2d Cir. 2001) (emphasis added and in original)).
a. Transaction Causation
Plaintiffs are entitled to a rebuttable presumption of reliance.
It is difficult to imagine an investor putting money into any fund without relying on the integrity of the process for calculating the fund's NAV, as supported by auditor review. Just as the [fraud on the market theory] presumes that investors rely on the integrity of a process — namely, that the market will incorporate material information about a security into its price — the theory advanced by the plaintiffs in this case also presumes that investors rely on the integrity of a process — namely, the processes by which the NAV of a private fund is determined and then confirmed by that fund's auditor.
Cromer, 205 F.R.D. at 131.
DTB argues that the presumption of reliance is inappropriate, because its audits do not in fact confirm the process used by the Fund's administrator to calculate the NAV or net asset value. Although its year-end audit included the net asset figure, the number of shares issued and outstanding, and the year-end net asset value per share, it asserts that as the audit reports do not describe the NAV calculation process, plaintiffs could not reasonably have relied on them to confirm the accuracy of the monthly NAV contained in the Fund's monthly statements. Without proof that the audits functioned as an approval of the NAV calculation process, it contends that allowing the federal securities fraud claim to proceed would amount to reviving aiding and abetting liability. In addition, without a presumption of reliance, DTB argues that the claim must be dismissed since it can be shown as a matter of law that the named plaintiffs did not actually rely on the audits in making investment decisions. DTB next argues that it will be able to show that the plaintiffs did not exercise the minimal due diligence required to succeed before the jury since DTB will be able to establish at trial that the audits disclosed that the Fund had not abided by the Fund's own sector concentration limits, a fact that was material to the decision of both named plaintiffs to invest in the Fund. Finally, DTB argues that Cromer's federal law claim is time-barred because it was on notice as of 1998 that the sector concentration limits had been violated, and the lawsuit was filed more than one year thereafter.
Each of DTB's arguments raises inherently fact intensive questions that are inappropriate for summary judgment. Only one of these issues requires any comment in this Opinion. It is undisputed that the annual audit confirmed the reported year-end financial statements for the Fund, including the year-end NAV. That is sufficient to support the presumption of reliance.
As the Fund's Offer Memorandum explained, in what will probably be shown to be the customary definition for a NAV, the "Net Asset Value per Share is equal to the relevant Net Asset Value divide[d] by the number of Shares outstanding . . . expressed in U.S. dollars." The assets, of course, are principally the value of the securities held by the Fund. The financial statements in the audits themselves make the calculation of the NAV transparent. The assets and liabilities are itemized and the net assets calculated. Next, the shares issued and outstanding are listed. Finally, the net asset value per share is identified. One of the class representatives has further testified that he specifically relied on the fact that the NAV number was audited. The plaintiffs hotly contest the facts and inferences on which DTB relies in this motion; a jury will have to decide whether transaction causation has been established.
b. Loss Causation
The legal framework for loss causation has been previously described in this action. Cromer, 205 F.R.D. 113 at 128 (citing Suez Equity, 250 F.3d at 98-99). Loss causation, however, has not been previously disputed by DTB. See Cromer, 205 F.R.D. at 128.
Loss causation is akin to the concept of "proximate cause" in tort law, "meaning that in order for the plaintiff to recover it must prove the damages it suffered were a foreseeable consequence of the misrepresentation." Suez Equity, 250 F.3d at 96; see also Manufacturers Hanover Trust Co. v. Drysdale Sec. Corp., 801 F.2d 13, 21 (2d Cir. 1986). The Second Circuit has noted that "[a] foreseeability finding turns on fairness, policy, and . . . `a rough sense of justice.'" AUSA Life Ins. Co. v. Ernst Young, 206 F.3d 202, 217 (2d Cir. 2000) (quoting Palsgraf v. Long Island R. Co., 248 N.Y. 229, 352 (1928)). Determining whether a loss was a foreseeable consequence of a particular defendant's actions is, ultimately, a public policy question, which asks how far back along the causal chain should liability for the plaintiffs' losses extend. Suez Equity, 250 F.3d at 96; AUSA Life Ins. Co., 206 F.3d at 210. In assessing loss causation allegations, courts ask "[w]as the damage complained of a foreseeable result of the plaintiff's reliance on the fraudulent misrepresentation?" Weiss v. Wittcoff, 966 F.2d 109, 111 (2d Cir. 1992) (citation omitted).
On this issue as well, DTB has not raised any arguments that are appropriate for summary judgment. DTB argues that the true causes of plaintiffs' losses were the fraudulent monthly NAVs that the Fund administrator calculated and the Fund's investment strategy of short-selling technology securities before the market moved against that sector. The plaintiffs intend to introduce evidence at trial which, if accepted by the jury, would establish that the DTB audits contained material misstatements of fact regarding the Fund, and that the losses suffered by the plaintiffs were a foreseeable consequence of the inaccuracies in the audits.
DTB's related argument, that it did not "intend or reasonably expect" investors to rely on the audits, is not a complete defense to a claim of loss causation since the issue of loss causation is an objective one: a reasonable foreseeability. In any event, to the extent that it is relevant for a jury to consider the defendant's subjective intent on this issue, the jury would be entitled to consider whether the testimony of DTB's witnesses in this regard is credible. After all, independent audits of investment funds, conducted in compliance with recognized international standards, are generally understood to be essential if a fund is to obtain any investors. Consequently, it would be quite surprising if a fund's auditors didn't understand that potential investors in a fund would require a fund to have an independent and reputable auditor before choosing to invest, and that they would rely on the annual audit to present an accurate description of the fund's financial condition. In this case, the Fund's Offer Memo explained that "Deloitte Touche", at a Bermuda address, would be the Fund's independent auditor. It does not require a long step from there to find that an investor's losses are a reasonably foreseeable consequence of misstatements in the audit that go directly to the investment quality of a fund.
This contention is based on DTB's argument that under British law, negligently performed audits may not generally be used by shareholders as a basis for a lawsuit against a corporation's auditors. Whether DTB had a reasonable and good faith belief that it could not be sued under British law for the misstatements in its audits is a separate question from whether the plaintiffs can show the existence of loss causation. This issue is discussed in more detail in connection with th negligence claim, infra.
Finally, DTB contends that the loss was suffered by the Fund and that the plaintiff-investors cannot recover for that loss. This argument is quickly rejected. While the Fund suffered a loss through Berger's fraud, the investors did so too.
III. Aiding and Abetting Claims
DTB argues that the claims that it aided and abetted a fraud and that it aided and abetted a breach of fiduciary duty are governed by Bermuda law. This Court has already held that one of those claims — the claim of aiding and abetting a fraud — would not survive when measured against the Bermuda law of aiding and abetting. The Court also found, however, that New York law applied to the claim and that it survived the motion to dismiss. Cromer, 137 F. Supp.2d at 492-93. DTB reargues that choice of law decision, and argues that summary judgment is appropriate even if New York law applies.
Choice of Law
There is no "significant federal policy, calling for the imposition of a federal conflicts rule" in this case that would require the application of federal choice of law principles. Cromer, 137 F. Supp.2d at 492 (quoting In re Gaston Snow, 243 F.3d 599, 607 (2d Cir. 2001)). The forum state's choice of law rules will, therefore, apply. Under New York law, the first question is whether there is a conflict between the laws of the relevant fora. As previously found, the elements of the aiding and abetting fraud claim under New York and Bermuda law are in conflict. "A claim for aiding and abetting fraud would only survive in Bermuda if the pleading alleged that DTB had conspired with Berger or procured or induced his fraud or that DTB joined in the common design of the fraud, none of which is alleged here." Id. The same conflict exists with respect to the claim of aiding and abetting a breach of fiduciary duty.
This Court has held that, as the forum in which the primary tort occurred, New York has the greatest interest in applying its law to the claim of aiding and abetting fraud. Id. at 492-93. DTB urges the Court to follow the reasoning of Solow v. Stone, 994 F. Supp. 173, 177-78 (S.D.N.Y. 1998), aff'd, 163 F.3d 151 (2d Cir. 1998), which it contends suggests application of the law of Bermuda to both of the aiding and abetting claims.
In Solow, the district court was confronted with claims arising from the breach of a lease agreement for commercial office space in Manhattan. The plaintiff was the lessee. The parties agreed that the court should apply the law of the place of incorporation — Delaware — to the claim that the directors of the lessor corporation breached their fiduciary duties to the plaintiff, a creditor of the insolvent corporation. The court applied a different analysis to the secondary tort claims brought against British "administrators" (a position equivalent to a trustee in bankruptcy) for aiding and abetting the directors' breach of fiduciary duty by causing the corporation to squander its assets, and for tortious interference with plaintiff's rights under the lease, as these were "not directed against the administrators in their capacity as officers or directors [of the Delaware corporation], but rather as independent actors." Id. at 177. Because the "acts giving rise" to the secondary claims occurred "in significant part" in New York, the court found that New York had the greatest interest in having its law applied, or at least that there was "no jurisdiction with an interest greater than New York's with respect to these tort claims." Id. There is no indication in the opinion whether the issue of choice of law with respect to these two claims was disputed or even addressed by the parties.
DTB argues that a similar bifurcation is appropriate and that, following Solow, this Court should apply different law to the secondary tort claims than to the torts DTB is accused of aiding and abetting. Solow, however, provides little comfort to DTB.
First, the aiders and abettors were British, and yet the Solow court applied New York law to their conduct. Second, although the fiduciary duty was owed to a corporation whose affairs were governed by Delaware law, the Solow court did not apply Delaware law to the claims against those who aided and abetted the breach of fiduciary duty. This suggests that there is no barrier to applying New York law to the aiding and abetting claims even though the Fund was incorporated in the British Virgins Islands. Third, Solow made its decision by conducting an interest analysis, as has already been done here. Accordingly, for the reasons already explained, Cromer, 137 F. Supp.2d at 492-93, New York law will apply to both aiding and abetting claims.
Knowledge
DTB contends that it is entitled to summary judgment on the aiding and abetting claims even under New York law for two reasons. The first is that New York law requires that a defendant have "knowledge" of the underlying fraud, see Cromer, 137 F. Supp.2d at 470, 494, and DTB argues that there is no evidence that it had knowledge of the underlying fraud or breach of fiduciary duty.
In criminal law, proof of willful blindness, or conscious avoidance, is a well-established substitute for proof of knowledge when knowledge is the required culpable state of mind. See, e.g., United States v. Reyes, 302 F.3d 48, 54-55 (2d Cir. 2002). While constructive knowledge, that is knowledge that would have been acquired from a reasonably diligent investigation, is insufficient, Kolbeck v. LIT America, Inc., 939 F. Supp. 240, 245-46 (S.D.N.Y. 1996), there is no reason to believe that New York law would not accept willful blindness as a substitute for actual knowledge in connection with aiding and abetting claims. DTB has not directly confronted the plaintiffs' argument that willful blindness is an alternative means of proving actual knowledge. Instead, it has addressed whether a showing of recklessness will suffice. As this Court has already held, a showing of recklessness will not suffice. Cromer, 137 F. Supp.2d at 495 n. 28.
The plaintiffs rely principally on In re JWP Inc. Securities Litigation, 928 F. Supp. 1239 (S.D.N.Y. 1996), to support their theory that proof of willful blindness is sufficient evidence of scienter. That case does not support their point. The court described the willful blindness standard as sufficient to satisfy the scienter requirement of a Section 10(b) claim, id. at 1256, but in fact relied on a showing of recklessness to deny summary judgment. Id. at 1256. When it applied its scienter finding under Section 10(b) to the aiding and abetting claim, id. at 1258, its discussion necessarily incorporated the recklessness standard, which is not sufficient to establish scienter for an aiding and abetting claim.
The plaintiffs have presented evidence raising questions of fact as to whether DTB consciously avoided confirming the existence of the fraud and the breach of fiduciary duty by Berger. While it may very well be that their evidence, even if believed, will only be sufficient to support a finding of recklessness, that is not a determination that can be made on summary judgment.
Proximate Cause
Finally, DTB argues that the plaintiffs have failed to present evidence that their actions proximately caused the plaintiffs' losses. Both aiding and abetting claims require proof that the aider/abettor "proximately caused the harm on which the primary liability is predicated." Cromer, 137 F. Supp.2d at 470. This argument, which is similar to DTB's attack on the loss causation element of plaintiffs' federal securities law claims, is dealt with and rejected above.
IV. Negligence
DTB moves to dismiss the negligence claim, arguing that Bermuda law applies to the claim and that the claim does not survive under Bermuda law. This is the first time DTB has raised this issue specifically in the context of the negligence claim.
In its first motion to dismiss, filed in October 2000, DTB argued that the gross negligence claim was governed by Bermuda law and that Bermuda did not recognize the tort of gross negligence. Based on the evidence submitted by the parties on that motion, evidence that concerned the law of negligence under Bermuda law, the Opinion on that motion found that
Bermuda, a common law jurisdiction, apparently has no authority directly addressed to the common law negligence and fraud claims asserted here, but would follow British law and to a lesser extent United States law. Based primarily on an analysis of British precedent, and the degree to which Bermuda courts adhere to it, it appears that there would be liability under Bermuda law for a claim of negligence against DTB for their audits of the Fund if the plaintiff alleged that DTB knew that its audits would be communicated to the plaintiffs individually or as an identifiable class in connection with a specific transaction, such as, an investment in the Fund, and also knew that those audits would very likely be relied upon by those persons in deciding whether to engage in the transaction.
Cromer, 137 F. Supp.2d at 492. Because there did not appear to be a difference between New York and Bermuda law, the Opinion did not conduct a choice of law analysis, but applied New York law to the gross negligence claim. See Fieger v. Pitney Bowes Credit Corp., 251 F.3d 386, 393 (2d Cir. 2001) (choice of law analysis only necessary when there is a difference in the law of the jurisdictions). In its motion for reconsideration, DTB reargued the holding that New York law applied to the aiding and abetting claim, but did not reargue the finding regarding gross negligence (or negligence).
In the extensive motion practice that followed in the succeeding months, DTB did not again argue that Bermuda law should govern the gross negligence or negligence claim. For example, in a motion to certify an interlocutory appeal from the denial of its motion to dismiss based on forum non conveniens, DTB argued that the domestic law of each plaintiff's country of residence would govern two of the state law claims pleaded against DTB if the Court followed the choice of law analysis it applied when it concluded that New York law would govern the aiding and abetting fraud claim. Cromer, 2001 WL 1135627, at *3.
The motion to dismiss discussed above addressed the first amended complaint, which included, inter alia, common law claims of aiding and abetting both common law fraud and breach of fiduciary duty, fraud, gross negligence, negligence and professional malpractice. As noted, DTB's choice of law motion was addressed solely to two of these six common law claims: the claim for aiding and abetting fraud and gross negligence. When the plaintiffs filed a second amended complaint, DTB brought another motion to dismiss even though the pleading added no new claims against it. Cromer, 2001 WL 111254, at *1. This time, DTB argued with respect to the claims of negligence and gross negligence, that they were barred by the Martin Act, and that New York law does not recognize a separate cause of action for gross negligence by an accountant. Id. at *3. After a detailed discussion of the Martin Act and precedent applying that statute, the Opinion concluded that the Martin Act did not bar the negligence claim against DTB. Id. at *4. The Opinion briefly addressed DTB's remaining arguments that the complaint failed to state a claim under New York's law of negligence. Id. at *5. With respect to the gross negligence claim, the Opinion agreed that New York law does not recognize a cause of action for gross negligence against accountants that is independent from a fraud claim. Id. DTB's additional arguments concerning the other common law claims, all based on the application of New York law to the complaint's allegations, were denied. Id. at *2-*5. DTB did not move to apply Bermuda law to any of the claims.
In the context of opposing certification of a class, DTB argued that New York law would not accept a presumption that the plaintiffs had relied on its audits. Cromer, 205 F.R.D. at 132 n. 25. DTB did not argue that Bermuda law would or should apply to the common law claims.
Then, in a letter of October 25, 2002, DTB disclosed to plaintiffs the identity of two foreign law experts. On November 27, 2002, plaintiffs filed a motion to strike the affidavits on the law of the case doctrine and because of the "unreasonable" amount of expense and resources that it would take at this stage of the litigation to address the issue.
As the recitation above makes clear, DTB has repeatedly litigated the plaintiffs' pleadings without challenging the application of New York law to most of the common law claims. Only in the context of the gross negligence and the aiding and abetting of common law fraud claims has DTB ever directly litigated the application of New York law to the common law claims. Therefore, to this point, the Court and the parties have expended significant resources based on the assumption that New York law would govern here. To give but one example, the analysis of DTB's Martin Act argument may have been unnecessary if DTB had tried to and succeeded in convincing the Court at that time that there was a difference between New York and Bermuda negligence law and that Bermuda law applies. It is simply too late in this litigation to raise the choice of law issues again based on new affidavits of foreign law.
This is not a case where DTB can point to any change in British or Bermuda law since 2001 which could excuse its delay. Nor can DTB excuse its delay by pointing to the need to conduct discovery. The existence of any difference in the New York and Bermuda law of negligence is a question of law, not fact.
It is not, in any event, clear even now (and even without the benefit of any foreign law affidavits that the plaintiffs wish to present if their motion to strike is not granted) that there is any difference between New York and Bermuda negligence law. DTB admits that English cases since the seminal House of Lords decision on which it relies, Caparo Industries PLC v. Dickman, [1990] 2 A.C. 605, have held that "an auditor may be liable to an investor under circumstances evidencing an `assumption of responsibility' which is similar to the New York law requirement that an accountant must intend plaintiff's reliance for a particular purpose as `a primary, if not the end and aim of auditing' its client." (Emphasis supplied.)
Caparo, itself, as described by DTB, only supplies a "general" rule and explains that audit reports are generally addressed to shareholders so that they can exercise their corporate governance rights, such as the election of directors. Caparo recognized that "special factors" may create a duty from the auditors to individual shareholders as investors. DTB describes exceptions as circumstances where the audit was prepared for a corporation in the context of a "special purpose" to attract investors, or where the auditors knew that it would be relied upon by a lender for its decision about the level of lending it should make to the company. Furthermore, it is unclear to what extent the "general" rule in Caparo has applicability to the "shareholders" of an investment fund like that at issue here. It does not appear that the Fund's shareholders were participating in corporate governance other than through maintaining their investment position, buying additional shares or liquidating their shares, that is, removing their investment from the Fund.
DTB argues that even if New York law applies, the extraordinarily restrictive standard that governs negligence claims against accountants under New York law entitles them to summary judgment. The parties agree that Credit Alliance Corp. v. Arthur Andersen Co., 65 N.Y.2d 536 (1985), sets forth the standard that governs here. In Credit Alliance, the New York Court of Appeals reaffirmed the tests first articulated in opinions of the court written by Chief Judge Cardozo. Credit Alliance summarizes the requirements for accountant liability as the following:
(1) the accountants must have been aware that the financial reports were to be used for a particular purposes or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants' understanding of that party or parties' reliance.
Id. at 551 (emphasis supplied). Drawing from the articulation in earlier precedent, the use of the audit by the plaintiff cannot have been "an indirect or collateral consequence". Id. at 549 (citing Glanzer v. Shepard, 233 N.Y. 236, 238-39 (1922) (emphasis added by Credit Alliance)). Based on the accountant's knowledge, the consequence must have been "the end and aim of the transaction." Id. (same). The bond between the accountant and plaintiff must be "so close as to approach that of privity." Id. at 550 (citing Ultramares Corp. v. Touche, 255 N.Y. 170, 182-83 (1931) (emphasis added by Credit Alliance)).
DTB has offered affidavit and deposition evidence that those at DTB who were principally responsible for the audits did not intend the Fund's shareholders to rely on its audit reports even though they were addressed to the Fund's shareholders. They point out that plaintiffs have not offered any contrary testimony or evidence.
The plaintiffs have raised issues of fact regarding whether DTB was aware that the Fund's shareholders would rely on the audits in making their investment decisions, whether it intended that the audits be used for that purpose, and whether DTB took steps that link them to the shareholders, steps which evidence DTB's understanding that the Fund's shareholders would and could rely on the audits. Among other things, the audits were prepared for an investment fund and DTB made copies of the audits so that they could be distributed to each of the shareholders or their investment advisors. The fact that DTB's witnesses, including a former employee, deny any intention that shareholders rely on the audits for investment purposes can be tested by the circumstantial evidence that the plaintiffs may offer to refute the denial.
Finally, in this connection, DTB argues that it should be permitted at trial to present evidence of foreign law, specifically, evidence about the Caparo decision, to corroborate the testimony of its witnesses that they had no intention or expectation that the Fund's shareholders would rely on the audits in making investment decision. In particular, they wish to use evidence regarding Caparo to undercut any inference that may be drawn from the fact that the audits were addressed to the Fund's shareholders. The DTB partner in charge of the Fund's audit has testified the he was familiar with the Caparo decision, and because of that decision, did not intend or foresee that investors would rely on the audit in making investment decision.
Because knowledge and intent are at issue on the negligence claim, the participants in the audit will have an opportunity to describe their knowledge and intent to the jury. That testimony may even include their understanding of the Caparo decision. To the extent that the actual meaning of the Caparo decision is a collateral issue, however, extrinsic evidence should not be admitted to either bolster or attack their credibility on this issue. See, e.g., United States v. Purdy, 144 F.3d 241, 245-46 (2d Cir. 1998). The issue here is not what Caparo actually held, or even whether an accounting firm believed that it had immunity under British law from a lawsuit by a shareholder, but what it is that DTB employees knew and intended about shareholder reliance. Because the parties have not briefed this precise issue in the context of its admissibility at trial, however, it is premature to rule on the point. Decision on plaintiffs' motion to strike is therefore reserved.
V. Elements Common to Common Law Claims
DTB contends that the plaintiffs will not be able to rely on a presumption of reliance in connection with the negligence claim, or indeed any of their common law claims. DTB is correct. To the extent a common law claim requires proof of reliance, "actual" reliance must be shown. Securities Investor Protection v. BDO Seidman, LLP, 222 F.3d 63, 73 (2d Cir. 2000).
The principal New York authority on this issue is Ackerman v. Price Waterhouse, 683 N.Y.S.2d 179 (1st Dep't 1998). In Ackerman, the First Department endorsed a presumption of reliance for a claim of negligence brought against an accounting firm that had been retained by a company to provide tax schedule K-1s to limited partners who had invested in real estate limited partnerships. The court approved the certification of a class composed of the New York limited partners, and distinguished those New York cases that had found that a presumption of reliance could not be used in common law fraud or misrepresentation cases.
The common thread running through most of these cases is the issue of whether a purchaser relied on the misrepresentations of the sellers in making the decision to purchase or retain shares. In contrast, no purchasing decision was involved here; this was an express contract to perform specific services.
Id. at 193. Here, of course, the activity is precisely that distinguished by Ackerman, the purchase and retention of shares. There is no principled basis on which to distinguish Ackerman. Where the New York Court of Appeals has not yet addressed the issue, see Sumitomo Copper Litigation v. Credit Lyonnais Rouse, Ltd., 262 F.3d 134, 142 (2d Cir. 2001), it is the responsibility of a court to predict how it would rule. See Gibbs-Alfano v. Burton, 281 F.3d 12, 18-19 (2d Cir. 2002). Ackerman's recent, extensive and careful discussion of the issue is a strong basis to predict that the New York Court of Appeals would not accept a presumption of reliance in the circumstances presented here.
On the record presented with this motion, however, the Court cannot say, as a matter of law, that plaintiffs did not actually rely on the audits in making their investment decisions. Lead plaintiffs, in their deposition testimony, have stated that they did so actually rely, and their testimony creates a question of fact for trial on this issue. Even as framed by DTB, the issue of plaintiffs' actual reliance will come down to a question of credibility that is ill-suited for summary judgment.
Finally, DTB urges dismissal of plaintiffs' causes of action for fraud, gross negligence and negligence because the plaintiffs cannot demonstrate the proximate causation that is required for these claims under New York law. For the reasons discussed above, there are sufficient questions of material fact on the issue of proximate cause to merit a trial, and this part of DTB's motion is therefore denied.
For the fraud and gross negligence claims, DTB states in its brief that Bermuda law is "controlling," but does not provide a choice of law argument. With regard to the fraud claim, DTB states that the crucial elements are the same in both jurisdictions, vitiating the need for any conflict analysis. The gross negligence claim is an alternative statement of the fraud claim. See Cromer, 2001 WL 1112548, at *5.
The Court has considered DTB's remaining arguments and finds them without merit.
CONCLUSION
Deloitte Touche Bermuda's motion for summary judgment is denied with the exception of its motion to bar any presumption of reliance for the common law claims. Decision is reserved on plaintiffs' motion to strike the affidavits of foreign law.
SO ORDERED: