Plaintiffs' second Prospectus aiding and abetting claim also fails for lack of scienter.
b. Conspiracy Allegations
Liability for conspiring to violate the federal securities laws requires "specific facts showing 'an agreement to participate in an unlawful act.'" June 18, 1991 Order at 9 (quoting Alfus v. Pyramid Technology Corp., 745 F. Supp. 1511, 1520 (N.D. Cal. 1990)). Plaintiffs offer no evidence of an agreement by Deloitte to enter into a conspiracy with Toolworks. Plaintiffs, instead offer speculative inferences that a conspiracy existed. This will not do. See, e.g., Richards v. Neilsen Freight Lines, 810 F.2d 898, 902 (9th Cir. 1987) (speculative inferences of conspiracy will not help).
Summary judgement is therefore GRANTED in favor of Deloitte with respect to Plaintiffs' Section 10(b) claims.
B. Section 11 Claims
Section 11 limits an accountant's liability to a statement in a registration statement "which purports to have been prepared or certified by him." 15 U.S.C. § 77k(a)(4). An accountant may therefore be held liable only for those statements "expressly attributed to the accountant" on the face of the registration statement. McFarland v. Memorex Corp., 493 F. Supp. 631, 643 (N.D. Cal. 1980), modified on other grounds, 581 F. Supp. 878 (N.D. Cal. 1984).
Here, the only statement attributed to Deloitte in the Prospectus is Deloitte's audited March 31, 1990 Financial Statements. Deloitte is accordingly liable under Section 11 for any material misrepresentations or omissions in the March 31, 1990 Financial Statements, unless it establishes an affirmative due diligence defense. Herman & MacLean v. Huddleston, 459 U.S. 375, 382, 74 L. Ed. 2d 548, 103 S. Ct. 683 (1983).
Deloitte seeks summary judgment on Plaintiffs' Section 11 claims against it primarily on the issue of due diligence.
It claims that the investigation performed in connection with the March 31, 1990 Financial Statements entitles it to the "due diligence" defense. See id.; 15 U.S.C. § 77k(b)(3)(B). Plaintiffs respond that Deloitte cannot establish a due diligence defense because there is substantial evidence that Deloitte failed to perform a reasonable investigation into (1) Toolworks' Nintendo business, (2) Toolworks' Mindscape business, and (3) recognition of revenues on Toolworks' OEM software licensing business.
Section 11 requires a "reasonable" investigation by accountants. 15 U.S.C. § 77k(b)(3). This means that accountants are expected to investigate, to various degrees, facts supporting and contradicting inclusions in registration statements. They must undertake that investigation which a reasonably prudent man in that position would conduct. See Feit v. Leasco Data Processing Equipment Corp., 332 F. Supp. 544 (E.D.N.Y. 1971); see also Escott v. Barchris Construction Corp., 283 F. Supp. 643, 703 (S.D.N.Y. 1968) (accountants held to standards of their own profession, GAAS). If accountants establish a reasonable investigation under the circumstances of the case, they are entitled to the statutory due diligence defense.
1. Nintendo Business
The Court has found that Plaintiffs have failed to offer any admissible evidence of a material misrepresentation or omission in the March 31, 1990 Financial Statements with respect to Toolworks' Nintendo business.
Plaintiffs accordingly fail to establish their burden under Celotex for a Section 11 claim.
2. Mindscape Software
Plaintiffs allege two general misrepresentations in the March 31, 1990 Financial Statements with respect to Mindscape Software: (1) the improper inclusion of Mindscape royalty advances and guarantees in revenues; and (2) the improper inclusion of obsolete Mindscape computer software in inventory, resulting in an inventory reserve which should have been higher than stated. The Court has found that Plaintiffs have failed to offer any admissible evidence of a material overstatement with respect to royalty advances and guarantees,
and accordingly now finds that Plaintiffs also fail to establish their Celotex burden here.
Plaintiffs' inventory claim also suffers from the same infirmity. Plaintiffs contend that Deloitte's decision to report a 44% reserve was improper, without putting forth any evidence that a 44% reserve resulted in a material overstatement of Mindscape inventory. Plaintiffs cannot defeat summary judgment without producing "specific facts" to establish an essential element of their claim. Celotex, 477 U.S. at 322.
3. OEM Revenue Recognition
The Court has found that Deloitte performed a scienter-free audit with regards to Toolworks' OEM revenue recognition.
This alone does not, however, establish a Section 11 due diligence defense. Whether an auditor performed a reasonable investigation is inextricably tied to compliance with its professional standards, including GAAS and generally accepted accounting principles ("GAAP"). See Escott v. Barchris Construction Corp., 283 F. Supp. at 703. Failure to comply with GAAS, GAAP and ordinary care, even where an otherwise scienter-free audit was performed, may result in Section 11 liability. See Straus v. Holiday Inns, Inc., 460 F. Supp. 729, 732 (S.D.N.Y. 1978) (Section 11 liability "may lie for wholly negligent conduct."). Deloitte must establish that it performed a reasonable investigation under the circumstances in order to receive summary judgment on the Section 11 OEM revenue recognition claim.
In order for the Court to find due diligence as a matter of law, there must be no genuine issues of material historical fact in dispute. After a careful review of the record, the Court finds that there are genuine issues of material historical fact with regards to Deloitte's OEM revenue recognition due diligence. The record, for example, is replete with disputed facts regarding whether GAAS and GAAP procedures were followed by Deloitte in its OEM revenue recognition audit. Such genuine issues of material historical fact preclude summary judgment.
Summary judgment is therefore GRANTED in favor of Deloitte as to Plaintiffs' Section 11 claims regarding Toolworks' Nintendo business and Mindscape Software, and DENIED as to Plaintiffs' Section 11 claims regarding Toolworks' OEM revenue recognition.
II. Plaintiffs' Motion for Partial Summary Judgment
Plaintiffs move for summary judgment as to Section 11 and 10(b) liability on three issues: (1) the alleged misrepresentations concerning OEM revenue in the March 31, 1990 Financial Statements, (2) Deloitte's alleged failure to perform standard audit procedures with respect to the OEM and Nintendo businesses, and (3) Deloitte's alleged active participation in making fraudulent misrepresentations to the SEC concerning OEM licensing recognition revenue.
After this Court's rulings on Deloitte's motion for summary judgment, the only undecided claims in Plaintiffs' motion are Plaintiffs' Section 11 claims with respect to Toolworks' OEM revenue recognition. As set above, however, these claims are unsuited for summary judgment since they contain genuine issues of material fact.
Plaintiffs' motion for partial summary judgment is therefore DENIED.
For the foregoing reasons, the Court hereby rules as follows:
1. Underwriters' motion for summary judgment on all claims against them is hereby GRANTED;
2. Plaintiffs' motion for partial summary judgment against the Underwriters as to liability on Plaintiffs' Section 11 and 12(2) claims is hereby DENIED;
3. Deloitte's motion for summary judgment on all claims against them is hereby DENIED. Deloitte's motion for partial summary judgment as to Section 11 and 10(b) claims against it is hereby GRANTED IN PART AND DENIED IN PART as follows:
a. Deloitte's motion for partial summary judgment on Plaintiffs' Section 10(b) primary liability claims is hereby GRANTED;
b. Deloitte's motion for partial summary judgment on Plaintiffs' Section 10(b) aiding and abetting claim is hereby GRANTED;
c. Deloitte's motion for partial summary judgment on Plaintiffs' Section 10(b) conspiracy claim is hereby GRANTED;
d. Deloitte's motion for partial summary judgment on Plaintiffs' Section 11 claims is hereby GRANTED as to Toolworks' Nintendo business and Mindscape Software claims and DENIED as to Toolworks' OEM revenue recognition claim;
4. Plaintiffs' motion for partial summary judgment against Deloitte as to liability on Plaintiff's Section 11 and 10(b) claims is hereby DENIED.
DATED: March 30, 1992
FERN M. SMITH
United States District Judge