Court Opinion

ID: 4107522
Source: CourtListenerOpinion
Date Created: 2016-12-15 16:00:39.653628+00
Date Added: 2024-06-11T14:36:27.375410
License: Public Domain

16-1168
In Re: DNTW Chartered Accountant Sec. Litig.

                           UNITED STATES COURT OF APPEALS
                               FOR THE SECOND CIRCUIT

                                     SUMMARY ORDER

Rulings by summary order do not have precedential effect. Citation to a summary order
filed on or after January 1, 2007, is permitted and is governed by Federal Rule of Appellate
Procedure 32.1 and this court’s Local Rule 32.1.1. When citing a summary order in a
document filed with this court, a party must cite either the Federal Appendix or an
electronic database (with the notation “summary order”). A party citing a summary order
must serve a copy of it on any party not represented by counsel.

        At a stated Term of the United States Court of Appeals for the Second Circuit, held at the
Thurgood Marshall United States Courthouse, at 40 Foley Square, in the City of New York, on
the 15th day of December, two thousand sixteen.

Present:       ROBERT A. KATZMANN,
                    Chief Judge,
               RALPH K. WINTER,
                    Circuit Judge,
               SIDNEY H. STEIN,
                    District Judge.*

IN RE: DNTW CHARTERED ACCOUNTANT
SECURITIES LITIGATION
__________________________________________

PAUL STEMBOROWSKI, individually and on
behalf of all others similarly situated, GEORGE
PILNEY, JEFF SOMERS

       Plaintiffs-Appellants,

               -v-                                    No. 16-1168

SPENCE WALKER, BRYCE WALKER, DNTW
CHARTERED ACCOUNTANTS, LLP,

       Defendants-Appellees,

                                                       
*
   Judge Sidney H. Stein of the United States District Court for the Southern District of New
York, sitting by designation.

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JOHN AND JANE DOES, 1-5, DNTW TORONTO
LLP,

       Defendants.

For Plaintiffs-Appellants:                            PHILLIP C. KIM (Laurence M. Rosen, on the
                                                      brief), The Rosen Law Firm, New York,
                                                      NY.

For Defendants-Appellees:                             JOHN H. EICKEMEYER (Charles J. Nerko, on
                                                      the brief), Vedder Price P.C., New York,
                                                      NY.

       Appeal from the United States District Court for the Southern District of New York

(Gardephe, J.).

       ON CONSIDERATION WHEREOF, IT IS HEREBY ORDERED, ADJUDGED,

and DECREED that the judgment of the district court is AFFIRMED.

       Plaintiffs-appellants brought this putative class action against the auditors of a fake, but

publicly traded, company, Subaye, Inc. (“Subaye”). Defendants-appellees DNTW Chartered

Accountants, LLP, a Canadian accounting firm, and two of its partners, Spence and Bryce

Walker, (collectively “DNTW”) issued clean audit reports that were incorporated into Subaye’s

2009 and 2010 10-K filings. DNTW failed to detect that Subaye was a fraud with no real

business operations. Plaintiffs brought one claim for violations of § 10(b) of the Securities

Exchange Act of 1934 (the “Exchange Act”) and SEC Rule 10b-5 and another claim for

violations of § 20(a) of the Exchange Act. After granting plaintiffs leave to amend their

complaint, the district court dismissed the § 10(b) and Rule 10b-5 claim for failure to adequately

plead scienter and the § 20(a) claim for failure to plead a primary violation. We affirm. We

assume the parties’ familiarity with the underlying facts, the procedural history of the case, and

the issues on appeal.

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       We review dismissal of plaintiffs’ claims de novo, “accepting all factual allegations in

[plaintiffs’] complaint as true.” Ellul v. Congregation of Christian Bros., 774 F.3d 791, 796 (2d

Cir. 2014). “To state a claim for relief under § 10(b) and Rule 10b–5, plaintiffs must allege . . .

scienter . . . .” Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 172 (2d Cir. 2005).

       Plaintiffs argue that they adequately pleaded scienter “by alleging facts . . . constituting

strong circumstantial evidence of . . . [DNTW’s] recklessness.” ATSI Commc’ns., Inc. v. Shaar

Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007). Specifically, they argue that they adequately alleged

DNTW’s scienter under a “red flags” theory.

       Plaintiffs face a high bar. For them to prevail, their complaint must have “state[d] with

particularity facts giving rise to a strong inference” of scienter, 15 U.S.C. § 78u-4(b)(2)(A), such

that “a reasonable person would deem the inference of scienter cogent and at least as compelling

as any opposing inference one could draw from the facts alleged,” Tellabs, Inc. v. Makor Issues

& Rights, Ltd., 551 U.S. 308, 324 (2007). To properly plead recklessness, plaintiffs must allege

       conduct that is highly unreasonable, representing an extreme departure from the
       standards of ordinary care, not merely a heightened form of negligence. And for
       an independent auditor, the conduct must, in fact, approximate an actual intent to
       aid in the fraud being perpetrated by the audited company, as, for example, when
       a defendant . . . disregards signs of fraud so obvious that the defendant must have
       been aware of them. Mere allegations of GAAP violations or accounting
       irregularities, or even a lack of due diligence, will not state a securities fraud
       claim absent evidence of corresponding fraudulent intent.

In re Advanced Battery Techs., Inc., 781 F.3d 638, 644 (2d Cir. 2015) (internal citations and

quotation marks omitted).

       Plaintiffs do not clear this high bar for pleading an auditor defendant’s scienter. Among

plaintiffs’ primary allegations is that defendants were aware of Subaye’s deficient internal

controls over financial reporting. However, DNTW expressly disclaimed providing any opinion

concerning Subaye’s internal controls and sometimes sought confirmation of Subaye’s finances

                                                  3
from outside sources. The more compelling inference to be drawn from these allegations is that

DNTW tried, albeit inadequately, to compensate for Subaye’s deficient internal controls and did

not intend to aid in Subaye’s fraud.

       Another of plaintiffs’ key allegations supports the conclusion that defendants behaved, at

worst, negligently. During the fourth quarter of 2010, Subaye recorded an $18.8 million asset

labeled “Cash Held in Trust” on its balance sheet. Plaintiffs’ App. 23, ¶ 49. After Subaye failed

to provide adequate documentation of this asset to DNTW, DNTW insisted that the $18.8 million

be booked as a marketing expense rather than as an asset. These allegations undermine any

inference of scienter by demonstrating that DNTW, through its audit, actively opposed Subaye’s

efforts to misrepresent its financial position.

       Plaintiffs’ remaining allegations do not establish a “strong inference” of scienter. 15

U.S.C. § 78u-4(b)(2)(A). Plaintiffs alleged, inter alia, that Subaye grew rapidly while

simultaneously restructuring its businesses; DNTW failed to obtain competent evidence to

support the existence of $8.1 million in purportedly refundable deposits for inventoriable assets;

DNTW relied on documents provided by Subaye to confirm Subaye’s cash balances; DNTW

received accounts receivable confirmations within eleven days after they were mailed out, which

Bryce Walker recognized was an unusually quick turnaround; DNTW received certain accounts

receivable confirmations from Subaye’s bookkeepers instead of from Subaye’s customers; and

Subaye’s bank statements contained a one-time infusion of $6.7 million cash at the end of a

reporting period. Even when considered in the aggregate, these allegations, do not “approximate

an actual intent to aid [Subaye’s] fraud.” In re Advanced Battery Techs., 781 F.3d at 644.

Instead, plaintiffs’ allegations “lead[] to an inference of, at worst, laziness.” In re Longtop Fin.

Techs. Ltd Secs. Litig., 939 F. Supp. 2d 360, 382 (S.D.N.Y. 2013). Accordingly, the district court

                                                  4
properly dismissed plaintiffs’ claim for violations of § 10(b) of the Exchange Act and SEC Rule

10b-5.

         The district court also properly dismissed plaintiffs’ claim for violations of § 20(a) of the

Exchange Act. A control person claim under § 20(a) requires “a primary violation by the

controlled person.” ATSI Commc’ns., 493 F.3d at 108. As explained above, plaintiffs failed to

adequately allege a primary violation of § 10(b) of the Exchange Act or SEC Rule 10b-5. As

such, plaintiffs’ § 20(a) claim fails.

         We have considered all of plaintiffs-appellants’ contentions on appeal and have found in

them no basis for reversal. For the foregoing reasons, the judgment of the district court is

AFFIRMED.

                                                FOR THE COURT:
                                                CATHERINE O’HAGAN WOLFE, CLERK

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