Opinion ID: 75504
Heading Depth: 2
Heading Rank: 2

Heading: Allegations with respect to CL

Text: 1. C&L audited Fran’s Fashions’ consolidated balance sheet and its consolidated statement of operations for the fiscal year ended June 29, 1991. 2. C&L issued an unqualified audit opinion in which it stated that its audit of Fran’s Fashions had been conducted in accordance with 8 “generally accepted auditing standards” (“GAAS”).3 Plaintiffs allege that this statement was false and misleading because numerous auditing standards adopted by the American Institute of Certified Public Accountants (“AICPA”) were violated. For example, they allege that C&L did not maintain an independence in mental attitude when conducting the audit; did not exercise due professional care in the performance of the examination and preparation of the report; did not obtain sufficient competent evidence to afford a reasonable basis for its audit opinion; and did not make reasonably adequate informative disclosures. 3. C&L audited Conston for the fiscal year ended March 2, 1991, and the short period ended June 1, 1991. On August 1, 1991, C&L issued an unqualified audit report which was included in Conston’s Form 10- K filed with the SEC on August 30, 1991. This audit report stated that the audit had been conducted in accordance with GAAS. 4. C&L knew that Fran’s Fashions and Conston were suffering tremendous losses and would require significant and immediate funds from Cascade in order to continue operating as going concerns, yet C&L made no attempt to verify independently Cascade’s financial data, which had been prepared by Cascade’s independent auditor, Levy. Plaintiffs allege that numerous “red flags” put C&L on notice that Cascade was incapable of providing Fran’s Fashions and Conston with the required capital. 5. Plaintiffs allege that, had C&L properly conducted its audits of Fran’s Fashions and Conston, it would have issued “going concern” qualifications in connection with both subsidiaries’ financial 3 Generally accepted auditing standards (“GAAS”) are the standards prescribed by the Auditing Standards Board of the American Institute of Certified Public Accountants (“AICPA”) for the conduct of auditors in the performance of an examination. See SEC v. Price Waterhouse, 797 F. Supp. 1217, 1222-23 n.17 (S.D.N.Y. 1992). Generally accepted accounting principles (“GAAP”) comprise a set of basic accounting principles pertaining to business entities that are approved by the Financial Accounting Standards Board of the AICPA. See id. These principles establish guidelines for measuring, recording, and classifying a business entity’s transactions. See id. 9 statements. 6. In the fall of 1990, Cascade asked C&L its opinion on whether Conston’s financial statements needed to be consolidated with those of Cascade. In concluding that consolidation was not necessary, C&L purportedly relied on Financial Accounting Standard (“FAS”) No. 94. Plaintiffs allege that C&L interpreted FAS No. 94 “too narrowly.” By rendering such an opinion, Plaintiffs allege that C&L substantially furthered the Cascade fraud by allowing Cascade to omit Conston’s poor financial results from its own. 7. C&L received a copy of Cascade’s 1991 10-K shortly after it was filed with the SEC on September 27, 1991. The 10-K revealed that Conston’s financial statements still had not been consolidated with those of Cascade. The 10-K also stated that there were 126 Fran’s Fashions stores. Plaintiffs allege that C&L knew, or was reckless in not knowing, that only 70-80 such stores existed. 8. C&L did not withdraw its audit opinion on Conston’s March 2, 1991, and June 1, 1991, financial statements until November 29, 1991. C&L did not withdraw its auditor’s report for the consolidated financial statements of Fran’s Fashions for the fiscal year ended June 29, 1991, until December 3, 1991.4 V. STANDARD FOR PLEADING VIOLATIONS OF SECTION 10(b) AND RULE 10b-5 In their amended complaint, Plaintiffs allege that C&L and GY&S violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated 4 In their amended complaint, Plaintiffs also allege that, in October 1991, a British investment firm with large holdings in Cascade stock, Casenove & Co., contacted C&L in an effort to determine the truth or falsity of Cascade’s public statements. C&L allegedly helped allay Casenove’s fears and confirmed that all 126 of Fran’s Fashions stores existed. Plaintiffs fail to allege reliance on C&L’s alleged statement to Casenove in their amended complaint, and they make no reference to this allegation on appeal. Therefore, we do not consider this allegation. 10 thereunder. A. Section 10(b) and Rule 10b-5 Section 10(b) states: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange – (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors. 15 U.S.C. § 78j (1997). One of the rules adopted by the SEC, Rule 10b-5, provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5 (2000). 11 In order to state a claim under § 10(b) and Rule 10b-5, a plaintiff must show the following: (1) a misstatement or omission, (2) of a material fact, (3) made with scienter, (4) on which plaintiff relied, (5) that proximately caused his injury. Bryant, 187 F.3d at 1281. A showing of severe recklessness satisfies the scienter requirement. See McDonald v. Alan Bush Brokerage Co., 863 F.2d 809, 814 (11th Cir. 1989). 'Severe recklessness is limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it.' Id. at 814 (quoting Broad v. Rockwell Int'l Corp., 642 F.2d 929, 961-62 (5th Cir. 1981) (en banc)). B. Federal Rule of Civil Procedure 9(b) In order to survive a motion to dismiss, Plaintiffs' claims of fraud under § 10(b) and Rule 10b-5 also must satisfy the requirements of Fed. R. Civ. P. 9(b). Rule 9(b) provides: In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally. 12 Fed. R. Civ. P. 9(b).5 The particularity rule serves an important purpose in fraud actions by alerting defendants to the 'precise misconduct with which they are charged' and protecting defendants 'against spurious charges of immoral and fraudulent behavior.' Durham v. Bus. Management Assocs., 847 F.2d 1505, 1511 (11th Cir. 1988) (quoting Seville Indus. Mach. Corp. v. Southmost Mach. Corp., 742 F.2d 786, 791 (3d Cir. 1984)). The application of Rule 9(b), however, must not abrogate the concept of notice pleading. Id. Rule 9(b) is satisfied if the complaint sets forth (1) precisely what statements were made in what documents or oral representations or what omissions were made, and (2) the time and place of each such statement and the person responsible for making (or, in the case of omissions, not making) same, and (3) the content of such statements and the manner in which they misled the plaintiff, and (4) what the defendants obtained as a consequence of the fraud. Brooks v. Blue Cross and Blue Shield of Florida, Inc., 116 F.3d 1364, 1371 (11th Cir. 1997) (internal quotation omitted).