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holding that scienter of partner of accounting firm could be imputed to the firm itself under traditional agency principles
Summary of this case from Adams v. Kinder-Morgan, Inc.Opinion
00 CIV. 2284 (DLC), 00 CIV. 2498 (DLC)
May 2, 2002
Steven S. Honigman, Richard P. Swanson, Jonathan E. Polonsky, Veronica E. Rendon, Thelen Reid Priest LLP., New York, NY, Attorneys for Plaintiffs Crorner Finance, Ltd., et al., Jeffrey H. Squire, Richard L. Stone, Mark A. Strauss, Kirby, Mclnerney Squire LLP., New York, NY., Attorneys for Plaintiffs Cromer Finance, Ltd., et al., Steven E. Greenbaum, Scott M. Berman Brown Rudnick Berlack Israels, LLP., New York, NY., Attorneys for Plaintiffs Argos, et al.
Gregg L. Weiner, Fried, Frank, Harris, Shriver Jacobson, New York, NY., Attorney for Defendants Ernst Young Bermuda, Fund Administration Services (Bermuda) Ltd., and Kempe Whittle Associates Limited. Michael J. Dell, Kramer Levin Naftalis Frankel LLP., New York, NY., Attorney for Defendant Deloitte Touche Bermuda, Mark B. Holton, Gibson, Dunn Crutcher, LLP., New York, NY., Attorney for Defendant Deloitte Touche Tohmatsu, Martin I. Kaminsky, Edward T. McDermott, Pollack Kaminsky, New York, NY., Attoreny for Defendant Financial Asset Management, Inc., Michael Berger, pro se, West Hampton Beach, NY.,
OPINION AND ORDER
The plaintiffs in these two securities fraud actions seek to amend their pleadings to reassert causes of action that were previously dismissed against Deloitte Touche Tohmatsu ("Deloitte"), a Swiss Verein headquartered in New York, and in the case of the Cromer class action, to assert additional causes of action against Deloitte and Deloitte's affiliate, Deloitte Touche (Bermuda) ("DTB"). The plaintiffs seek to hold Deloitte and DTB liable for audits they allege these firms issued for the Manhattan Investment Fund, Ltd. (the "Fund"), an offshore investment fund operated from New York by defendant Michael Berger ("Berger"). Due to Berger's fraudulent misrepresentations regarding the Fund, and the misrepresentations and omissions in the Fund's audits, the plaintiffs assert that they lost hundreds of millions of dollars they had invested in the Fund.
By Opinion and Order dated April 17, 2001 ("April 17 opinion"), Deloitte's motion to dismiss the claims against it contained in earlier pleadings was granted in its entirety. Cromer Finance Ltd. v. Bercier, 137 F. Supp.2d 452 (S.D.N Y 2001). Familiarity with the April 17 Opinion is assumed. Relying principally on the theories (1) that the DTB partner in charge of the Fund audits, William Jack ("Jack"), was Deloitte's agent, and separately (2) that Deloitte failed to disclose that only the seven-partner firm DTB stood behind the Fund audits, the plaintiffs have added allegations, and in the case of the Cromer action, have also added causes of action, which they contend require Deloitte to answer again as a defendant in these actions. Finding that plaintiffs have sufficiently alleged Deloitte's participation in the audits based on an agency theory, the motion to amend is granted in part. The motion to amend is denied with respect to those additional causes of action pleaded in the Cromer action on the theory that Deloitte failed to disclose that only DTB, and not the global Deloitte firm, stood behind and would be liable for the Fund audits.
Subsequent motions for reconsideration brought by DTB and the Fund administrators, the Ernst Young defendants, were denied. Cromer Finance Ltd. v. Berger, Nos. 00 Civ. 2284,00 Civ. 2498 (DLC), 2001 WL 506908 (S.D.N.Y. May 14, 2001). Motions by DTB and the Ernst Young defendants for an order permitting an interlocutory appeal pursuant to 28 U.S.C. § 1292 (b) of the denial of these defendants' motions to dismiss were denied. Cromer Finance Ltd. v. Berger, Nos. 00 Civ. 2284,00 Civ. 2498 (DLC), 2001 WL 935475 (S.D.N.Y. Aug. 16, 2001). Opinions have also been issued denying the motions by DTB and the Ernst Young defendants to dismiss these actions on the ground of forum non conveniens, and denying the motion to certify an interlocutory appeal from the forum non conveniens Opinion. Cromer Finance Ltd. v. Berger, 158 F. Supp.2d 347 (S.D.N.Y. 2001); Cromer Finance Ltd. v. Berger, Nos. 00 Civ. 2284,00 Civ. 2498 (DLC), 2001 WL 1135627 (S.D.N.Y. Sept. 26, 2001). A class of investors was certified in the Cromer action on December 27, 2001. Cromer Finance Ltd. v. Berger, 205 F.R.D. 113 (S.D.N.Y. 2001), petition for leave to appeal pursuant to Rule 23(f), Fed.R.Civ.P., denied (2d Cir. Feb. 6, 2002).
DISCUSSION
Under Rule 15(a), Fed.R.Civ.P., once a responsive pleading has been served, a party may amend its pleadings "only by leave of court or by written consent of the adverse party; and leave shall be freely given when justice so requires." The Supreme Court has emphasized that amendment should normally be permitted and that a refusal to grant leave must be justified by grounds such as undue delay, bad faith, or futility. Foman v. Davis, 371 U.S. 178, 182 (1962); see also Milanese v. Rust-Oleum Corp., 244 F.3d 104, 110 (2d Cir. 2001). Refusal to grant leave to amend "without justification is `inconsistent with the spirit of the Federal Rules.'" Rachman Baci Co. v. Liberty Mut. Ins. Co., 46 F.3d 230, 234 (2d Cir. 1995) (quoting Foman, 371 U.S. at 182).
Deloitte and DTB oppose the amendments principally on the ground of futility. See Nettis v. Levitt, 241 F.3d 186, 193 (2d Cir. 2001); see also Koehler v. Bank of Bermuda (New York) Ltd., 209 F.3d 130, 138 (2d Cir. 2000). A court should only deny leave to amend for failure to state a claim if the complaint as amended would be subject to dismissal under Rule 12(b)(6), Fed.R.Civ.P. Ricciuti v. N.Y.C. Transit Auth., 941 F.2d 119, 123 (2d Cir. 1991). The standard governing a Rule 12(b)(6) motion set forth in the April 17 Opinion is incorporated herein. Cromer Finance Ltd., 137 F. Supp.2d at 468.
The plaintiffs assert ten causes of action against Deloitte, including securities fraud in violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, violation of Section 20(a) of the Exchange Act, common law fraud, aiding and abetting common law fraud, aiding and abetting common law breach of fiduciary duty, gross negligence, and professional malpractice. The plaintiffs make the following allegations in their proposed amended pleading in support of reasserting against Deloitte their previously asserted causes of action.
The allegations are primarily derived from the proposed Third Amended Complaint in the Cromer action, and "plaintiffs" refers to theCromer plaintiffs. The allegations in the proposed Fourth Amended Complaint in the Argos action are substantially similar.
The plaintiffs in the Arcros action do not allege causes of action for gross negligence or professional malpractice against Deloitte.
A. Reinstatement of Previously Dismissed Claims
1. Factual Allegations Against Deloitte Deloitte's Global Marketing
Deloitte holds itself out as a leading unified international professional services firm that delivers accounting, assurance, advisory, tax, and consulting services "`seamlessly' around the globe." In marketing materials distributed to the investment fund community and the investing public, Deloitte represents itself as an auditor, stating that "Deloitte Touche Tohmatsu's audit services are at the core of the professional services" that it offers investment management companies, and that Deloitte conducts those audits through its "internationally experienced professionals" who are "deploy[ed] . . . across borders to support [its] clients' needs."
Deloitte's charter confers upon it the capacity to promulgate relevant professional standards for its member firms, and the power and authority to exercise oversight over these entities. Deloitte entities perform quality-control cross-checks of one another's work product. This oversight means that Deloitte's clients receive uniform, quality service wherever they do business, anywhere in the world." In keeping with its structure and objectives, Deloitte requires member firms to use its name and logo when pitching services to potential clients, and also to include the Deloitte name and logo when delivering the contracted-for services to clients.
Deloitte's Relationship with DTB
DTB is the Bermuda office of Deloitte. William Jack ("Jack"), the DTB partner in charge of the Fund audits, was Deloitte's contact person in Bermuda for asset management company audits, and acted in that capacity when he signed the audit opinions for the Fund. Deloitte identifies Jack as a global practice leader who is responsible for ensuring that Deloitte clients "receive uniform, quality service." Jack is Deloitte's only "Asset Management Global Contact" in Bermuda. Deloitte also represents to the investing community that Jack is a member of Deloitte's Global Financial Services Industries (GFSI) team and is part of Deloitte's global investment management and hedge fund practice. Based upon these connections, the plaintiffs allege that Jack possessed "actual authority" to act on behalf of Deloitte, that Jack acted as an agent and representative of Deloitte within the scope of his agency when he signed the Fund's audit opinions, and that "there was an understanding between [Deloitte] and Jack that [Deloitte] would control Jack's work."
Deloitte's Connections to the Fund Audits
Deloitte was also directly identified as responsible for the Fund audits. The plaintiffs allege that DTB and Deloitte "joined in preparing and issuing the financial statements at issue in this case as a unified, multi-national accounting firm." In its audit proposal addressed to Berger, DTB stated that it is "part of Deloitte Touche Tohmatsu International." The Offering Memorandum which was sent to all Fund investors stated that the Fund had retained "Deloitte Touche," with a Bermuda address, as independent auditors. The audit reports bear the name and logo of Deloitte as well as "Deloitte Touche" with an accompanying Bermuda address, and Deloitte required that its name and logo be affixed to the Fund audit reports. The audits are addressed to "the Shareholders" of the Fund and signed "Deloitte Touche," in a cursive signature. Each audited financial statement represented that "we have audited the accompanying statements" and that "in our opinion," such financial statements present fairly the financial condition of the Fund. The Fund audit reports were provided to each investor by the Fund administrator.
Based on the foregoing allegations, the plaintiffs allege that the knowledge about the misrepresentations in the Fund audits issued for the years 1996, 1997, and 1998 can be attributed not only to DTB but also to Deloitte. Accordingly, the allegations in the complaint regarding scienter are directed not only to DTB, but also to Deloitte.
2. Securities Fraud Claims
a. Application of Agency Law Principles to Federal Securities Fraud Claims
The April 17 Opinion granted Deloitte's motion to dismiss the securities fraud claims against it on the ground that scienter had not been adequately pleaded. Specifically, the April 17 Opinion stated:
The plaintiffs have not alleged that [Deloitte] knew that the audit reports contained false information, and their allegations are insufficient to infer that [Deloitte] was reckless. The Complaint does not allege that [Deloitte] was even aware of the reports, much less aware that its name and logo were included on the audit reports. There are no allegations that it failed to review or check information that it had a duty to monitor, that it was aware of any danger that the audit reports included misleading information, or that it was on notice of such a danger.Cromer Finance Ltd., 137 F. Supp.2d at 493. The April 17 Opinion further stated that, although the use of Deloitte's name on the audit reports "was undoubtedly of great importance to investors, . . . . the use of a defendant's name on a document containing misleading information is, by itself, insufficient to constitute scienter." Id. at 494. The plaintiffs contend that the scienter of Jack, the DTB partner in charge of the Fund audits, may be imputed to Deloitte because he signed off on the Fund audits not only in his capacity as a DTB partner but also in his capacity as an agent exercising actual authority to act on behalf of Deloitte.
The April 17 Opinion referred to Deloitte Touche Tohmatsu as "DTT," rather than as "Deloitte."
Under New York law, an agency relationship results from a manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and the consent by the other to act." N.Y. Marine Gen. Ins. Co. v. Tradeline, L.L.C., 266 F.3d 112, 122 (2d Cir. 2001) (citation omitted); see also Restatement (Second) of Agency § 1 (1958). To bind a principal, "an agent must have authority, whether apparent, actual or implied." Merrill Lynch Interfunding. Inc. v. Argenti, 155 F.3d 113, 122 (2d Cir. 1998). Actual authority "is created by direct manifestations from the principal to the agent." Reiss v. Societe Centrale du Groupe des Assurances Nationales, 235 F.3d 738, 748 (2d Cir. 2000) (citation omitted); see also Peltz v. SHB Commodities, Inc., 115 F.3d 1082, 1088 (2d Cir. 1997); Minskoff v. Am. Express Travel Related Serv. Co., 98 F.3d 703, 708 (2d Cir. 1996). The consent for actual authority may be either express or implied from "the parties' words and conduct as construed in light of the surrounding circumstances." Riverside Research Inst. v. KMGA, Inc., 489 N.Y.S.2d 220, 223 (1st Dep't 1985), aff'd, 68 N.Y.2d 689 (1986); see also Minskoff, 98 F.3d at 708. "[I]mplied actual authority . . . is dependent on verbal or other acts by a principal which reasonably give an appearance of authority" in a manner that is "brought home to the agent." Greene v. Hellman, 51 N.Y.2d 197, 204 (1980); see also Fed. Ins. Co. v. Diamond Kamvakis Co., 536 N.Y.S.2d 760, 762 (1st Dep't 1989). Whether actual authority exists "depends on the actual interaction between the putative principal and agent, not on any perception a third party may have of the relationship." Itel Containers Int'l Corp. v. Atlantrafik Express Serv. Ltd., 909 F.2d 698, 702 (2d Cir. 1990). Where an agency relationship exists, "knowledge acquired by an agent acting within the scope of its agency is imputed to the principal." N.Y. Marine, 266 F.3d at 122.
The parties have relied on cases applying both New York agency law and federal common law agency principles, but have not addressed the choice of law issue. Federal choice of law rules are a "species of federal common law." Bianco v. Erkins (In re Gaston Snow), 243 F.3d 599, 605 (2d Cir. 2001), cert. denied, 122 S.Ct. 618 (2001). Before a court can use federal choice of law principles, it must identify "`a significant conflict between some federal policy or interest and the use of state law.'" Id. at 606 (quoting Atherton v. FDIC, 519 U.S. 213, 218 (1997)). No such conflict is readily apparent here. Applying the choice of law principles of the forum state, New York, "the law of the jurisdiction having the greatest interest in the litigation" will supply the applicable law. Id. at 607-08. It is likely that a New York court would apply federal common law principles of agency in the context of a federal securities law violation. The plaintiffs, however, have also alleged common law fraud causes of action. It should be noted, in any event, that there does not appear to be any substantive difference between federal common law principles of agency and New York agency law, and the parties have not identified one. Both bodies of law draw on the Restatement (Second) of Agency. As a consequence, this Opinion will rely on both sources of agency law.
The plaintiffs have adequately alleged that Jack had actual authority to act as Deloitte's agent when performing audit work. The allegations in the complaint, and the inferences that can be fairly drawn from them, support the assertion of the agency status.
In opposing this motion, Deloitte admits that it represents itself to the world as an auditor, and that its goal is to achieve the quality and uniformity of service that a single international accounting firm would provide. Nonetheless, since the laws of many nations in which its member firms operate prohibit the operation of foreign accounting firms, Deloitte contends that it is actually not a single international accounting firm and that it and its member firms "promote" the "concept" of uniformity of service, without "conveying that a single international accounting firm actually exists." This distinction, even if valid and effectively conveyed, does not exclude the creation of an agency relationship or address the sufficiency of the complaint's allegations of agency.
While national laws enacted to effect the regulation of accounting practices may create a barrier to the formation of an international accounting firm, those laws could not excuse any entity's misrepresentation of its structure or work and Deloitte does not suggest that they do.
Deloitte emphasizes that in alleging actual authority, the plaintiffs cannot rely on any representations in Deloitte's marketing materials because they were statements made not to Jack directly, but to third parties. See Itel Containers, 909 F.2d at
702. The plaintiffs, however, do not allege that an agency relationship existed between Jack and Deloitte because that was the way third parties perceived the relationship. Although the conduct of Deloitte or Jack alleged in the pleadings may well have led others to understand that an agency relationship existed, the plaintiffs' allegations of agency rest sufficiently on Deloitte's organization of its own business operations and the way it chose to use its member firms generally, and DTB and Jack specifically, to perform the audit work that Deloitte advertised that it was equipped to do around the world. It is fair to infer, in the context of pleading standards, that the representations made to third parties bore a relationship to the way Deloitte actually conducted its business. The allegations in the amended pleading, which rely on a variety of sources of information and not just marketing materials, are sufficient to infer that the words of and conduct by Deloitte vis-a-vis Jack were effective in conveying to Jack his actual authority to act as Deloitte's agent.
In arguing that the complaint may not base its allegations of agency on statements in marketing materials, Deloitte relies on three cases that stand principally for the proposition that references made in marketing materials to "global" or "worldwide" firms are not alone sufficient to establish Personal jurisdiction over a foreign defendant. In Reingold v. Deloitte Haskins Sells, 599 F. Supp. 1241 (S.D.N.Y. 1984), the court refused to find personal jurisdiction over an Australian accounting firm because it shared referral fees with its United States-based affihate, and concluded that their joint membership in what was described as a "single cohesive worldwide organization" was insufficient to make the American entity the alter ego of the Australian entity for jurisdictional purposes. Id. at 1253-54 n. 10. In Aerotel, Ltd. v. Sprint Corporation, 100 F. Supp.2d 189 (S.D.N.Y. 2000), the court addressed the sufficiency of the pleadings to establish jurisdiction on an alter ego theory, and concluded that statements to the public intended to create the impression that a global communications company existed would not be sufficient to in fact "create" a single entity structure, although the allegations that the entities were "mere departments" of a parent were sufficient to defeat the motion to dismiss for lack of jurisdiction. Id. at 193-94. Finally, in Howard v. Klynveld Peat Marwick Goerdeler, 977 F. Supp. 654 (S.D.N.Y. 1997), aff'd, 173 F.3d 844 (2d Cir. 1999), the court dismissed for lack of personal jurisdiction, an employment discrimination complaint filed against a Netherlands-based association with no office or employees in the United States, observing that the complaint was devoid of any factual allegations that a United States-based entity was an agent of the defendant, and that marketing statements to the effect that the defendant was an international network of member firms was insufficient to create personal jurisdiction over the foreign defendant. Id. at 661-62. These cases, taken singly or together, do not indicate that statements made by a principal in marketing materials, and the inferences that can be drawn from them, particularly when combined with allegations based on other sources of evidence, may not be used to plead a conveyance of actual authority by the principal to an agent.
Similarly, Deloitte's reliance on two cases for the proposition that statements by the agent, including the agent's use of the principal's name and logo, cannot be used as the basis for claiming the existence of an actual agency relationship, is misplaced. For example, in Fletcher v. Atex, Inc., 68 F.3d 1451 (2d Cir. 1995), the Second Circuit undertook a "close reading" of the record created on summary judgment and found "no evidence" that the principal had conferred actual authority on the agent "to act on its behalf." Id. at 1461. It held that the "presence of a parent's logo on documents created and distributed by a subsidiary,standing alone, does not confer authority upon the subsidiary to act as an agent." Id. at 1461-62 (emphasis supplied). Similarly, in Carte Blanche (Singapore) PTE., Ltd. v. Diners Club Int'l, Inc., 758 F. Supp. 908 (S.D.N.Y. 1991), the statements by the principal acknowledging the putative agent's right to use its trademark were insufficient evidence, in the context of a summary judgment motion, of a conveyance of actual authority to bind the principal to a contract. Id. at 920. Deloitte also contends that it may only be held liable for Jack's knowledge and conduct under an agency theory if Jack was a senior or superior officer" of Deloitte. In support of this novel contention, Deloitte relies solely onLoucrhry v. Lincoln First Bank, N.A., 67 N.Y.2d 369 (1986). Adopting the position of the Restatement (Second) of Agency, the New York Court of Appeals held in Loucihry that in order to impose punitive as opposed to compensatory damages on an employer for the intentional wrongdoing of its employees, a "superior officer in the course of employment" must order, participate in, or ratify "outrageous conduct." Id. at 378. There is no authority for extending this principle to the compensatory damages claims at issue here.
Relying on Jack's affidavit and evidentiary materials extrinsic to the pleadings, Deloitte further contends that the plaintiffs are unable to show that Jack accepted the agency relationship, believed that he was acting on behalf of Deloitte in conducting the Fund audits, or that his actions were taken on behalf of and for the benefit of Deloitte as opposed to DTB or himself. The plaintiffs' burden on this motion is simply to allege facts sufficient to permit them to survive a motion to dismiss. As discussed above, the allegations in the amended pleading satisfy this burden.
Deloitte argues that allegations of statements made by Deloitte in 2001 cannot establish an agency relationship between Jack and Deloitte during 1997-1999, when the Fund audits were issued. A determination of whether the plaintiffs are able to show Deloitte's conveyance of actual authority to Jack at the time the audits were issued will have to await the litigation of the merits of the claims. Plaintiffs have alleged sufficient facts to withstand a motion to dismiss and thus may amend the complaint.
b. Impact of Central Bank on the Application of Agency Principles
Deloitte argues that it is inappropriate, after the decision in Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994), to utilize common-law principles of agency to establish its scienter under the federal securities laws. In Central Bank, the Supreme Court construed Section 10(b) as prohibiting "only the making of a material misstatement (or omission) or the commission of a manipulative act." Id. at 177. It observed that aiding and abetting liability would extend beyond that statutory prohibition and would reach "persons who do not engage in the proscribed activities at all." Id. at 176. Consequently, "[b]ecause the text of § 10(b) does not prohibit aiding and abetting, . . . a private plaintiff may not maintain an aiding and abetting suit under § 10(b)." Id. at 191. The Court went on to note, however, that
[t]he absence of § 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met.Id. (emphasis in original).
Central Bank does not undermine the application of the hoary principles of agency law to hold principals responsible for the misstatements and omissions of their agents. "Central Bank did not eliminate Primary liability for business entities." Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 101 (2d Cir. 2001) (emphasis in original). The decision in Central Bank is simply "inapposite" since there was "no allegation" there "that the defendants were agents of the alleged defrauder, acting for the defrauder." Id. at 100-01.
In Suez, the Second Circuit applied agency principles to reverse a dismissal of Section 10(b) claims brought against corporate defendants. The Second Circuit noted that "[a] corporation can only act through its employees and agents." Id. at 101. The Second Circuit is not alone in taking this approach. The Third Circuit has also concluded that Central Bank's discussion of aiding and abetting liability "should not be transplanted into the more settled realm of agency law." Am. Tel. Tel. Co. v. Winback Conserve Program, Inc., 42 F.3d 1421, 1432 (3d Cir. 1994). Under agency law, "[t]he principal is held liable not because it committed some wrongdoing outside the purview of the statute which assisted the wrongdoing prohibited by the statute, but because itsstatus merits responsibility for the tortious actions of its agent." Id. at 1431 (emphasis in original); see also Vento Co., LLC v. Metromedia Fiber Network, Inc., No. 97 Civ. 7751 (JGK), 1999 WL 147732, at *12 (S.D.N Y Mar. 18, 1999); Pollack v. Laidlaw Holdings, Inc., No. 90 Civ. 5788 (DLC), 1995 WL 261518, at *17 (S.D.N.Y. May 3, 1995); In re Rickel Assoc., Inc., 272 B.R. 74, 94 n. 13 (S.D.N.Y. 2002).
Deloitte argues that recent cases in this district, including this Court's opinion in In re Sotheby's Holdings, Inc. Sec. Litig., No. 00 Civ. 1041 (DLC), 2000 WL 1234601 (S.D.N Y Aug. 31, 2000), stand for the proposition that not every agency relationship will be sufficient to satisfy the scienter requirement for Section 10(b) liability, and that a principal must be the "original and knowing source" of any misrepresentation or omission to be liable based on acts of its agent. The cases on which Deloitte relies are readily distinguishable. Their discussions were addressed to the question of whether a party who was not identified as the source of the misrepresentation could be held liable.See, e.g., Sotheby's, 2000 WL 1234601, at *5; Gabriel Capital, L.P. v. Natwest Fin., Inc., 94 F. Supp.2d 491, 509-10 (S.D.N.Y. 2000). In this case, the Fund audits were directly attributed to Deloitte, whose name and logo appeared on each audit.
In sum, because the additional allegations in the proposed amended pleading are sufficient to permit the plaintiffs to proceed on the theory that Jack was Deloitte's agent, thus imputing Jack's scienter to Deloitte, the plaintiffs have cured the defect in the pleadings described in the April 17 Opinion. The plaintiffs may therefore proceed with their securities fraud claims against Deloitte for the alleged misrepresentations contained in the Fund audit reports.
3. Common Law Claims
Plaintiffs also seek, by their new allegations of an agency relationship, to reinstate against Deloitte the common law fraud, aiding and abetting common law fraud, aiding and abetting breach of fiduciary duty, gross negligence, negligence and professional malpractice claims previously dismissed. This prong of plaintiffs' motion is unopposed.
It is worth noting that in the April 17 Opinion, the plaintiffs' negligence-based claims were dismissed because the plaintiffs had not alleged "that [Deloitte] even knew that its name and logo were used on the specific audit reports at issue, and consequently, "there was no substantive communication between [Deloitte] and the investors to constitute conduct linking [Deloitte] to an identifiable class of persons." Cromer Finance Ltd., 137 F. Supp.2d at 496. In their proposed amended pleading, the plaintiffs have alleged that Deloitte required the use of its name and logo on Deloitte audits and that Deloitte knew that its logo and name were being used on the Fund audits. Accordingly, the plaintiffs' amended pleading sufficiently alleges conduct linking Deloitte to the Fund investors.
B. New Causes of Action in the Cromer Action Asserted Against Deloitte and DTB
The Argos plaintiffs do not seek to assert additional causes of action against either Deloitte or DTB.
In addition to pleading securities and common law violations based upon Deloitte's issuance of materially misleading audit reports, the plaintiffs also plead securities and common law causes of action against Deloitte and DTB based upon what they describe as material omissions in Deloitte's marketing materials, the Fund Offering Memorandum and the Fund audits. Specifically, the plaintiffs allege that Deloitte, through its global marketing campaign and the use of the name Deloitte Touche, portrays itself to financial services professionals and the investing public as a global "Big Five" accounting firm, and attracts business because of that global name and image, yet omits to explain that it is not accountable for and does not stand behind the professional services provided by its national practices.
With respect to the Fund audits, the plaintiffs allege that they were signed by "Deloitte Touche" and contained the Deloitte logo, yet omitted the fact that Deloitte would not be liable for any errors or omissions in the event of an audit failure. The plaintiffs allege that nothing on the face of the audit reports limited responsibility for the reports to DTB, and that nowhere on the Deloitte website or in any of Deloitte's advertising and marketing communications is there any indication that DTB is a separate and independent firm, unsupported by the resources of Deloitte.
Plaintiffs allege that these omissions were made "knowingly and deliberately" by both Deloitte and DTB, with the specific intent to mislead investors, and that the omissions were material to the decisions of Fund investors because they related to the "investment quality" of the Fund's shares, "affected the desirability of buying, selling or holding the Fund's securities," and related to the level of risk involved in investing in the Fund. In particular, the plaintiffs allege that an investment in a fund audited by a global accounting firm, with the resources of that firm available to compensate investors in case of an audit failure, is a substantially less risky investment than an investment in a fund whose audits are backed only by the resources of a small accounting partnership.
Plaintiffs allege that investor reliance on these omissions may be presumed, and also that investors would not have invested in the Fund had they known that Deloitte did not stand behind the Fund audits, and that the only assets available to compensate for any wrongdoing in the course of the Fund audits would be those of DTB. The plaintiffs contend that the omissions hid a risk of investing in the Fund, to wit, the risk of an uncompensated audit failure.
Deloitte and DTB oppose the amendment of the complaint to add causes of action for securities and common law fraud based upon the plaintiffs' omission theory on the ground of futility, asserting that these new allegations fail to state a claim. The elements necessary to state a claim under Section 10(b), Rule 10b-5, and for common law fraud are set forth in the April 17 Opinion. Cromer Finance Ltd., 137 F. Supp.2d at 481, 494.
Deloitte and DTB argue that the plaintiffs' omission claims must fail because (1) the alleged omissions were not material to Fund investors at the time of investment; (2) neither Deloitte nor DTB had a duty to disclose DTB's insurance coverage and other resources to Fund investors; (3) the plaintiffs have not adequately alleged scienter; (4) the alleged omissions were not "in connection with" the plaintiffs' investments in the Fund; (5) plaintiffs cannot demonstrate loss causation; and (6) the plaintiffs fail to allege actual reliance and are not entitled to a presumption of reliance based on Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972).
The plaintiffs' securities fraud claims, to the extent they are based on the alleged omissions, fail to state a claim upon which relief may be granted for at least their failure to allege "loss causation." Among other elements, in order to state a claim for securities fraud, 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 damacies it suffered were a foreseeable consequence of the misrepresentation.Suez, 250 F.3d at 95-96 (citation omitted) (second emphasis supplied);see also Castellano v. Young Rubicam, Inc., 257 F.3d 171, 186 (2d Cir. 2001). The loss causation inquiry "typically examines how directly the subject of the fraudulent statement caused the loss, and whether the resulting loss was a foreseeable outcome of the fraudulent statement."Suez, 250 F.3d at 96. Whether loss causation has been demonstrated essentially presents a question of public policy, "the resolution of which is predicated upon notions of equity because it establishes who, if anyone, along the causal chain should be liable for the plaintiffs' losses. A finding of foreseeability must satisfy the judicial mind that such result conforms to a `rough sense of justice.'" Id. (citations omitted); see also AUSA Life Ins. Co. v. Ernst Young, 206 F.3d 202, 210 (2d Cir. 2000)
Plaintiffs assert that the alleged omissions go directly to the investment quality of the Fund and the level of risk associated with investing in the Fund. In addition to relying on cases finding loss causation where alleged misrepresentations or omissions went to the investment quality of the securities involved, they place particular emphasis on the following language in Castellano:
If the significance of the truth is such as to cause a reasonable investor to consider seriously a zone of risk that would be perceived as remote or highly unlikely by one believing the fraud, and the loss ultimately suffered is within that zone, then a misrepresentation or omission as to that information may be deemed a foreseeable or proximate cause of the loss.Castellano, 257 F.3d at 188; see also AUSA Life, 206 F.3d at 235 (Winter, J., dissenting).
The plaintiffs have alleged that the failure of Deloitte to reveal that it did not stand behind the audits that bore its name caused Fund investors to underestimate the risk of an uncompensated audit failure. They argue that investors estimated the risk that the Fund assets would be misrepresented, and the value of their investment undermined, by including in their calculus their understanding that the globally recognized "Big Five" accounting firm Deloitte Touche would be responsible for the Fund's annual reports. The failure to disclose that Deloitte Touche did not stand behind the audits "induced a disparity between the transaction price and the true "investment quality' of the securities at the time of transaction." Suez, 250 F.3d at 98-99. The risk at issue in a securities fraud case, however, is the risk associated with not receiving the expected return on an investment, not the risk of being unable to collect on a judgment awarded through litigation brought by a disappointed or even defrauded investor.
The connection between Deloitte's alleged omissions and the losses incurred by Fund investors as a result of Berger's fraudulent scheme is at least one step removed from the circumstances of the cases cited by the plaintiffs. In most instances, the misrepresentations or omissions that were found to affect the quality of the investment touched on the qualifications of the person or company making the investment decisions.See, e.ci., id. at 98 (concealed lack of managerial ability of principal of a health-care financing venture where skill to manage complex debt loads was essential); AUSA Life, 206 F.3d at 230 (misrepresentations in the audits prepared by the defendant accountants, in the view of at least one member of the circuit panel, reflected on the integrity of the company management and the degree to which the company was risk averse) (Winter, J., dissenting); Marbur v. Mcrmt., Inc. v. Kohn, 629 F.2d 705, 707 — 08 (2d Cir. 1980) (individual responsible for recommending stocks was a trainee who claimed to be a licensed stock broker).
The loss causation theory articulated by the plaintiffs requires a determination of whether the financial resources of the auditor, specifically its ability to satisfy a judgment, is part of the investment quality of the Fund. This goes further than the holdings of any case upon which the plaintiffs rely since it requires consideration of an investor's ability to recover investment losses from a fund's auditor through litigation. To be clear, the plaintiffs' theory is not about the risks associated with knowledge of the identity of the auditor and its competency to perform the audit. According to the allegations in the complaint, it was disclosed that the audit work was actually being performed by Deloitte's Bermuda affihate: DTB, albeit as an agent of Deloitte. While the plaintiffs correctly note that an audit failure is one of the "risks" associated with an investment in a private fund, omissions about the financial resources of the auditor are not sufficiently connected to the value of the Fund to reflect on the investment quality of the Fund. See, e.g., Suez, 250 F.3d at 97 (distinguishing between intrinsic and extrinsic investment characteristics); Bennett v. United States Trust Co., 770 F.2d 308, 314 (2d Cir. 1985) (to go to investment quality, a misrepresentation must either relate to the "intrinsic investment characteristics of the stock involved" or bear some direct relationship to the stock's value).
The principal flaw in the plaintiffs' articulation of a theory of loss causation based on the identified omissions is the failure to identify any causal connection between the investment loss suffered by the plaintiffs and the adequacy of the financial resources backing the auditor. The extent of DTB's insurance coverage, or the extent of its ability generally to satisfy a judgment, did not cause Berger to fabricate critical information about the Fund, cause DTB to perform a flawed audit, or cause the Fund to lose the hundreds of millions of dollars that the plaintiffs had invested in the Fund. Similarly, the fact that Deloitte is refusing to offer its own separate financial resources in this litigation to answer for any audit failures had no effect on those past events. While the unavailability of Deloitte's insurance coverage and its other resources to satisfy a judgment stemming from a flawed audit issued over its name and logo may create a significant loss for the plaintiffs, that loss is not proximately caused by the events that produced the investment losses on which the plaintiffs are suing. While the plaintiffs have already suffered the loss of their investments, whether they suffer the separate and independent loss of being unable to collect any judgment they should win has yet to be determined.
In arguing that loss causation exists, the plaintiffa have relied largely on analyses more appropriate to establish transaction causation or reliance. See, e.g., AUSA Life, 206 F.3d at 226 (Jacobs, J., concurring) (warning against collapsing "but-for" analysis into loss causation analysis). While some of the language used by courts to describe the application of notoriously elusive loss causation principles to the facts presented in their particular circumstances may seem to support the plaintiffs' theory, fundamentally, the element of loss causation requires an evaluation of proximate cause in the context of securities fraud. Without adequate allegations of causation, the various standards articulated to assist in applying the concept of loss causation, particularly the foreseeability of any loss, are of little help.
Not surprisingly, the plaintiffs point to the admonition that courts consider, in assessing whether loss causation exists, whether the fraud accomplished its objective. See, e.g., Castellano, 257 F.3d at 188; AUSA Life, 206 F.3d at 212-13. If Deloitte's arguments are accepted, it has surely achieved its alleged objective of winning business based on the pretense that it stood behind the audits issued in its name while avoiding liability for those audits. The issue presented by this motion is not, however, whether a wrong has been perpetrated, but whether the complaint's allegations meet the pleading requirements for the causes of action stated.
In sum, the plaintiffs have not alleged loss causation in connection with their causes of action based on the alleged omissions. For this reason, amending the complaint to add the proposed additional claims under Section 10(b) and Rule 10b-5 would be futile and is denied. For the same reason, the proposed additional claims asserted against Deloitte for control person liability, and against Deloitte and DTB for common law fraud, must also fail.
C. Delay and Prejudice
In addition to opposing the plaintiffs' motion to amend on the ground of futility, Deloitte also opposes it on the grounds of delay and undue prejudice. Deloitte claims that the plaintiffs' decision to wait until now to raise their new factual allegations was a tactical decision that should not be countenanced. Deloitte asserts that the amended pleading is motivated principally by the desire to locate a deeper pocket. Deloitte also argues that it has been prejudiced by the inability to participate in certain discovery litigation and in the briefing on class certification.
The plaintiffs discovered the new facts upon which the agency allegations are based in October 2001, two days before the Cromer plaintiffs' class certification motion was fully submitted to this Court. There is, therefore, no basis to find that the plaintiffs made a tactical decision to hold onto this new information until after a class had been certified. In any event, Deloitte has not identified any argument not already considered and rejected that it would have made in opposition to class certification. Since depositions on the merits of this litigation have not yet begun, there is no significant prejudice to Deloitte from granting the plaintiffs' motion to amend at this time. The plaintiffs discovered only recently that DTB's insurance coverage would provide a small fraction of the money necessary to make the plaintiffs whole. The discovery that DTB is "under-insured" when compared to the damages at stake here clearly caused the plaintiffs to renew their efforts to bring Deloitte into this litigation; that is not a disqualifying motive.
The original class certification motion was fully submitted on July 20, 2001, months before the plaintiffs discovered these additional facts. After oral argument was held in September, the Court requested additional briefing from the parties. A second round of briefing was fully submitted on October 25, 2001.
CONCLUSION
For the reasons stated above, the plaintiffs' motion to amend the complaint to add additional factual allegations against Deloitte and to reassert certain causes of action against Deloitte is granted. The plaintiffs' motion to amend their complaint to assert additional causes of action against Deloitte and DTB based on an omission theory is denied. The parties shall have ten days from the date of this Opinion and Order to inform the Court why this Opinion and Order does not also resolve the motion to amend filed by the plaintiffs in the Argos action.