The opinion of the court was delivered by: Katz, Senior District Judge.
This securities fraud action was originally brought against defendants
Ikon Office Solutions, Inc., and several of its officers and directors by
plaintiffs who had purchased Ikon stock. Several months after the original
complaint was filed, the plaintiffs were granted leave to file an amended
complaint that added Ernst & Young, Ikon's accounting firm, as a
defendant. Ernst & Young now moves for dismissal of the two counts in
which it is named.*fn1
Ikon supplies copiers, printing systems, and related services
throughout the United States, Canada, and Europe. Its shares are actively
traded on the New York Stock Exchange. Beginning in 1995 and continuing
into 1998, Ikon purchased close to 200 independent companies, which Ikon
then attempted to integrate into its own network. Ikon experienced a
variety of problems associated with this "transformation program,"
particularly with respect to its internal auditing procedures. After a
special review procedure" in the summer of 1998, on August 14, 1998, Ikon
announced a $110 million charge to earnings-$94 million in the third
fiscal quarter and $16 million against previously reported second fiscal
quarter earnings. See Compl. ¶ 97.*fn2 Following this charge, Ikon's
stock dropped sharply.
The present motion centers on the role Ernst & Young (E & Y) may have
in these problems. Plaintiffs' claims against E & Y are made under
Section 11 and Section 10(b) of the Securities Act of 1933 and the
Securities Exchange Act of 1934, 15 U.S.C. § 77k, 78j(b). Plaintiffs
allege that E & Y violated these statutes by (1) issuing an unqualified
audit report dated October 15 and 27 of 1997 for the fiscal year ending
September 30, 1997, stating that financial statements issued by Ikon
conformed with Generally Accepted Accounting Principles (GAAP) and that E
& Y's audit itself complied with Generally Accepted Accounting Standards
(GAAS),*fn3 see Compl. ¶ 109*fn4; and (2) permitting the
incorporation by reference into a May 1997 securities registration
statement of a false or misleading audit opinion on Ikon's fiscal 1996
financial statements. See id. ¶ 182. Although the court will
subsequently discuss the particular allegations in more detail,
plaintiffs focus on several specific problems: internal controls, doubtful
accounts, lease default reserves, overstatement of subsidiary income, and
allegations that one of Ikon's officers was "cooking" the books.
Plaintiffs allege that E & Y was aware of these problems from a very
early date but nonetheless continued to issue unqualified statements
regarding Ikon's finances.
A motion to dismiss should be granted only if, accepting all facts
pleaded as true and viewing them in the light most favorable to
plaintiffs, plaintiffs are still not entitled to relief. In making this
assessment, the court should not look to whether plaintiffs will
"ultimately prevail"; it should only consider whether they are allowed to
offer evidence in support of their claims. In re Burlington Coat Factory
Sec. Litig., 114 F.3d 1410, 1420 (3d Cir. 1997) (citations omitted).
Complaints alleging securities fraud must also comply with Federal Rule
of Civil Procedure 9(b), which requires that fraud be averred with
particularity. See Fed.R.Civ.P. 9(b).
III. Section 10(b) Claims
Section 10(b) of the Securities Exchange Act makes it unlawful for any
person to "use or employ, in connection with the purchase or sale of any
security, . . . any manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the Commission may
prescribe[.]" 15 U.S.C. § 78j(b). Rule 10b-5, in turn, states in
relevant part that it is unlawful 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 light of the circumstances under which they
were made, not misleading[.]" 17 C.F.R. § 240.10b-5 (b).
The Third Circuit explained the obligations of a plaintiff alleging
violations of these requirements:
The first step for a Rule 10b-5 plaintiff is to
establish that defendant made a materially false or
misleading statement or omitted to state a material
fact necessary to make a statement not misleading.
Next, plaintiff must establish that defendant acted
with scienter and that plaintiffs reliance on
defendant's misstatement caused him or her injury.
Finally, since the claim being asserted is a "fraud"
claim, plaintiff must satisfy the heightened pleading
requirements of Federal Rule of Civil Procedure 9
In re Burlington Coat Factory, 114 F.3d at 1417 (citations omitted); see
also 15 U.S.C. § 78u-4 (b)(1) (plaintiffs alleging Rule 10b-5
violations must "specify each statement alleged to have been misleading,
[and] the reason or reasons why the statement is misleading").
As plaintiffs have identified the statements in question and defendant
has not challenged materiality, the court must look to the scienter and
fraud pleadings. A plaintiff must plead facts giving rise to a "strong
inference" that the defendant possessed the requisite scienter, that is,
the intent to commit fraud. That strong inference of fraud may be
established either "(a) by alleging facts to show that defendants had
both motive and opportunity to commit fraud, or (b) by alleging facts
that constitute strong circumstantial evidence of conscious misbehavior
or recklessness." In re Burlington Coat Factory, 114 F.3d at 1418.
The court also acknowledges the requirements of the Private Securities
Litigation Reform Act, 15 U.S.C. § 78u-4 (b)(1), which state:
In any private action arising under this chapter in
which the plaintiff may recover money damages only on
proof that the defendant acted with a particular state
of mind, the complaint shall, with respect to each act
or omission alleged to violate this chapter, state
with particularity facts giving rise to a strong
inference that the defendant acted with the required
state of mind.
The third step is meeting the requirements of Rule 9(b). To do so,
plaintiffs must plead "(1) a specific false representation of material
fact, (2) knowledge of its falsity by the person who made it, (3)
ignorance of its falsity by the person to whom it was made, (4) the
maker's intention that it should be acted upon, and (5) detrimental
reliance by the plaintiff." In re Burlington Coat Factory, 114 F.3d at
1421, citing In re Westinghouse Sec. Litig., 90 F.3d 696, 710 (3d Cir.
B. Pleadings in this Case
1. Failure to Plead Identity
E & Y first argues that the complaint must be dismissed because
plaintiffs have alleged wrongdoing by E & Y collectively rather than by
naming particular individuals. The court agrees with plaintiffs that they
have pleaded identity sufficiently, especially since no individual
defendants are named. The statements in question were issued as
representations of the corporation Ernst & Young, and it is untenable to
suggest that a plaintiff must, at the pleading stage, be, able to
identify each Individual accountant or researcher who may have worked on
a particular project. To do so would make the pleading standard virtually
impossible to meet. In many places, the plaintiffs have referred to
particular memoranda, speakers, or workpapers when there is need for a
more particularized allegation, and E & Y cannot ...