MEMORANDUM AND ORDER
Plaintiffs have filed a consolidated complaint allegingmultiple securities law violations against Tyco InternationalLtd., three of its former officers, L. Dennis Kozlowski (formerChief Executive Officer), Mark H. Swartz (former Chief FinancialOfficer), and Mark A. Belnick (former Chief Corporate Counsel),two of its former directors (Frank E. Walsh, Jr. and Michael A.Ashcroft) (collectively the "Tyco defendants"), and itsindependent accountant and auditor (PricewaterhouseCoopers("PwC")).
Defendants have filed motions to dismiss arguing that theconsolidated complaint fails to state viable claims for relief. I. STANDARD OF REVIEW
Defendants challenge the consolidated complaint pursuant toFed.R. Civ. P. 12(b)(6). A Rule 12(b)(6) challenge argues eitherthat the complaint fails to describe the claims for relief insufficient detail or that the claims are deficient even if theyare pleaded with the requisite specificity. Defendants make botharguments.
The degree of detail that a complaint must contain to survive aRule 12(b)(6) challenge depends upon the nature of the claimsunder review. In most cases, a plaintiff is required to provideonly "a short and plain statement of the claim showing that thepleader is entitled to relief." Fed.R. Civ. P. 8(a)(2). Whilethis requirement is simply stated, it has been difficult to applyin practice. A plaintiff is not required to plead evidence when aclaim is governed by Rule 8(a)(2), but she must do more thansimply recite the elements of the claim in a conclusory fashion.See Eastern Food Servs., Inc. v. Pontifical Catholic Univ.Servs. Ass'n, 357 F.3d 1, 9 (1st Cir. 2004). For cases that fallin the middle of these two extremes, all that can be said is thatthe complaint must "set forth factual allegations, either director inferential, respecting each material element necessary to sustain recovery under someactionable legal theory." United States v. Melrose-WakefieldHosp., 360 F.3d 220, 240 (1st Cir. 2004) (quoting Gooley v.Mobil Oil Corp., 851 F.2d 513, 514 (1st Cir. 1988)). Suchfactual allegations may be based either on personal knowledge or"information and belief." See Langadinos v. American Airlines,Inc., 199 F.3d 68, 73 n. 8 (1st Cir. 2001).
Special pleading requirements apply to fraud claims.Fed.R.Civ. P. 9(b) states that "[i]n all averments of fraud or mistake,the circumstances constituting fraud or mistake shall be statedwith particularity." Rule 9(b) requires "that the plaintiff'saverments of fraud specify the time, place, and content of thealleged false or fraudulent representations." Melrose-WakefieldHosp., 360 F.3d at 226. Moreover, when a cause of actionsounding in fraud is based on "information and belief," Rule 9(b)directs the plaintiff to plead sufficient supporting facts topermit a conclusion that the alleged belief is reasonable. Seeid. In contrast, "[m]alice, intent, knowledge, and otherconditions of mind of a person may be averred generally."Fed.R.Civ. P. 9(b). The Private Securities Litigation Reform Act ("PSLRA"),15 U.S.C. § 78u-4(b), establishes specific pleading requirements forfraud claims based on the Securities Exchange Act of 1934("Exchange Act"). Complaints alleging such claims must "specifyeach statement alleged to have been misleading, the reason orreasons why the statement is misleading, and, if an allegationregarding the statement is made on information and belief, thecomplaint shall state with particularity all facts on which thebelief is formed." 15 U.S.C. § 78u-4(b)(1). In addition, thePSLRA requires that a securities fraud claim plead facts withparticularity that are sufficient to give rise to a "stronginference" of scienter. 15 U.S.C. § 78u-4(b)(2). Although thePSLRA's pleading requirements are demanding, they are notinsurmountable. The real question is whether the allegations as awhole provide enough supporting detail to warrant a conclusionthat its requirements have been satisfied. See In re CabletronSys., Inc., 311 F.3d 11, 40 (1st Cir. 2002).
The parties disagree as to whether the PSLRA can ever besatisfied through "group pleading." See id. at 40 (describinggroup pleading). Insofar as the group pleading doctrine merely permits a plaintiff to rely on a presumption that statementscontained in corporate press releases, SEC filings, and othersimilar company documents are the collective work of thecompany's executive officers, the doctrine does not appear to beinconsistent with either the PSLRA or Rule 9(b). See Serabianv. Amoskeag Bank Shares, Inc., 24 F.3d 357, 367-68 (1st Cir.1994) (applying a limited version of the group pleading doctrineto securities fraud claims under Rule 9(b)); see also In reRaytheon Sec. Litig., 157 F. Supp. 2d 131, 152-53 (D. Mass.2001) (holding that group pleading doctrine survives PSLRA).Whether a similar inference is warranted when it comes to acompany's directors, however, will depend upon the unique factsof each case. Further, the doctrine does not relieve a plaintiffof the duty to plead sufficient facts as to each defendant tosupport a strong inference that the defendant acted withscienter. Accordingly, when it comes to group pleading, theultimate question is whether the facts of the case make itreasonable to apply the doctrine in the way that plaintiffspropose. II. ANALYSIS
Plaintiffs have asserted claims based on §§ 10(b), 14(a),20(a), and 20(A) of the Exchange Act and §§ 11, 12(a)(2) and 15of the Securities Act of 1933 ("Securities Act"). I evaluate thesufficiency of each claim in turn.
A. Section 10(b)
Defendants adopt a "divide and conquer" strategy in challengingplaintiffs' § 10(b) claims. They argue that the consolidatedcomplaint alleges two distinct fraud schemes: one that involveslooting and another that involves fraudulent accountingpractices. They then attack the complaint's sufficiency bychallenging each scheme as if it were described in a separatecomplaint. While I adopt a similar organizational structure inresponding to defendants' arguments, I reject their premise thatthe two schemes are unrelated. Instead, a careful reading of theconsolidated complaint reveals that it is based on allegationsthat the accounting fraud and looting schemes are bothinterrelated and interdependent. In essence, plaintiffs chargethat Tyco's senior management operated the company as a criminalenterprise in which fraudulent accounting practices were used to generate cash to fund Tyco's acquisition strategy. Thelooting, in turn, occurred both to benefit the individualdefendants and to create incentives to continue with theaccounting fraud. As I will explain, the relationship between thetwo schemes is important to consider when analyzing several ofdefendants' arguments.
1. Looting Claims
a. Santa Fe Industries, Inc. v. Green
The Tyco defendants rely on Santa Fe Industries, Inc. v.Green, 430 U.S. 462 (1977) for the proposition that plaintiffs'looting allegations describe mere corporate mismanagement thatcannot support a claim under the securities laws. This argumentis based both on a misreading of Santa Fe Industries and on amischaracterization of plaintiffs' looting claims.
Santa Fe Industries concerned a challenge by minorityshareholders to a parent corporation's attempt to merge with itspartially owned subsidiary under Delaware's short form mergerstatute, Del. Code Ann. Tit. 8, § 253. The short form mergerstatute permits a parent corporation that owns at least 90% ofits subsidiary's stock to merge with the subsidiary by offering to acquire the minority shareholders' stock at a price specifiedby the parent. See Santa Fe Indus., 430 U.S. at 465. If theminority shareholders are dissatisfied with the proposed price,the statute permits them to file suit in state court to recoverthe difference between the proposed price and the stock's fairvalue. See id. at 465-66. The plaintiffs in Santa FeIndustries filed an action in federal court charging that theparent had violated § 10(b) by attempting to use the short formmerger statute to acquire their stock at substantially less thanits fair market value. See id. at 467. The Supreme Courtrejected the § 10(b) claim and the case has since been widelycited for the proposition that "[t]o the extent that [a] claimcomprises allegations of mismanagement, it is not cognizableunder the securities laws." Shaw v. Digital Equip. Corp.,82 F.3d 1194, 1207 (1st Cir. 1996); see also In re Advanta Corp.Sec. Litig., 180 F.3d 525, 537 (3d Cir. 1999); Decker v.Massey-Ferguson, Ltd., 681 F.2d 111, 115 (2d Cir. 1982).
It is important to bear in mind when considering Santa FeIndustries, however, that the complaint that was before thecourt in that case did not allege that the defendants had madeany misstatements or omissions of material fact in connection withthe purchase or sale of a security. See id. at 474(recognizing that "the finding of the District Court, undisturbedby the Court of Appeals, was that there was no `omission' ormisstatement in the information statement accompanying the noticeof merger"). Thus, the decision does not necessarily preclude aclaim such as the one at issue here, which is based on theconcealment of allegedly material information concerningcorporate misconduct rather than on the underlying misconductitself.
Defendants nevertheless argue that a plaintiff can never bepermitted to base a § 10(b) claim on a failure to disclosecorporate misconduct if the misconduct would support a breach offiduciary duty claim under state law. Otherwise, they argue,quintessentially state law claims could always be transformedinto federal securities law violations merely by alleging thatdefendants failed to disclose the misconduct. But this argumentoverstates the case. In Estate of Soler v. Rodriguez,63 F.3d 45 (1st Cir. 1995), the First Circuit flatly rejected the viewthat an otherwise actionable claim under § 10(b) is barred bySanta Fe Industries merely because it is based on a failure todisclose conduct that can be remedied through a breach of fiduciary dutyclaim under state law. See id. at 56.
Other circuits have struggled in the wake of Santa FeIndustries to articulate a more nuanced standard to distinguishcases in which the failure to disclose mismanagement will supporta § 10(b) claim from those in which it will not. Four circuitopinions illustrate these efforts. In Kas v. Financial GeneralBankshares, Inc., 796 F.2d 508 (D.C. Cir. 1986), the District ofColumbia Circuit acknowledged that a § 10(b) claim cannot bebased on a failure to disclose mismanagement where the omission'smateriality depends solely on either a legal judgment that thedefendants' conduct amounts to a breach of fiduciary duty or adetermination that the defendants' motives were improper. Id.at 513. At the same time, however, the court recognized that"Santa Fe certainly does not preclude liability under sections10(b) and 14(a) where a proxy statement fails to disclose eitherthat a member of management has a personal stake in the corporatedecision being made or that some special relationship existsbetween a member of management and some party with interestsadverse to the shareholders." Id. The Third Circuit, in In reCraftmatic Sec. Litig., 890 F.2d 628 (3d Cir. 1989) similarly suggested that Santa Fe Industries will bar an otherwiseactionable § 10(b) claim where the omitted information ismaterial only because it would "place potential investors onnotice that management is culpable of a breach of faith orincompetence. . . ." Id. at 640. In Panter v. Marshall Field &Co., 646 F.2d 271 (7th Cir. 1981), the Seventh Circuitdetermined that Santa Fe Industries will bar a § 10(b) claimthat is based on the failure to disclose mismanagement when the"central thrust" of the claim is mismanagement rather than theconcealment of material information from investors. Id. at 289.Finally, in 7547 Corp. v. Parker & Parsley Dev., 38 F.3d 211(5th Cir. 1994), the Fifth Circuit concluded that the complaintbefore it stated a viable claim under § 10(b) notwithstanding thedefendants' agreement that it was based on the failure todisclose fiduciary breaches because "the breaches of fiduciaryduty held violative of rule 10-b(5) included some element ofdeception." Id. at 231 (quoting Santa Fe Indus.,430 U.S. at 474-75).
I need not determine which circuit court's test best separatesactionable mismanagement claims from a nonactionable claimsbecause the complaint at issue here would survive dismissal underany plausible test. Unlike other cases in which § 10(b) claims have been dismissed on the basis of Santa FeIndustries, this case concerns an alleged failure to disclosematerial information about compensation and related partytransactions that must be accurately disclosed to investorspursuant to SEC regulations. See discussion infra PartII.A.1.d. Moreover, the consolidated complaint alleges that theomitted information was material, not merely because itdemonstrated an exercise of poor judgment or even a lack of goodfaith by senior management, but because it concerned the transferof hundreds of millions of dollars from Tyco to the individualdefendants in unauthorized compensation for their participationin a larger criminal scheme to inflate the price of Tyco's stockthrough fraudulent accounting practices. Such allegations plainlyamount to more than the type of mere mismanagement that cannotserve as the basis of a viable § 10(b) claim after Santa FeIndustries.
b. Fraud "in connection with" the sale or purchase of asecurity
Defendants next argue that the looting allegations will notsupport a § 10(b) claim because the looting did not occur "inconnection with" the purchase or sale of a security.15 U.S.C. § 78j(b). In essence, defendants argue that the looting claims consist of nothing more than charges of self-dealing by theindividual defendants at Tyco's expense. These charges, theyargue, have nothing to do with the purchase or sale of anysecurity. This argument mischaracterizes the plaintiffs' lootingclaims.
A fair reading of the consolidated complaint demonstrates thatplaintiffs base their looting claims not on the looting itself,but on misrepresentations and omissions that Tyco and theindividual defendants allegedly made about the looting in variousSEC filings. In a case such as this, which involves a publiclytraded security, the "in connection with" requirement issatisfied "by showing that the misrepresentations in questionwere disseminated to the public in a medium upon which areasonable investor would rely, and that they were material whendisseminated." Semerenko v. Cendant Corp., 223 F.3d 165, 176(3d Cir. 2000); see also McGann v. Ernst & Young,102 F.3d 390, 392-93 (9th Cir. 1996); In Re Ames Dep't Stores, Inc. StockLitig., 991 F.2d 953, 963 (2d Cir. 1993). As investors plainlyare entitled to assume that SEC filings are accurate andcomplete, and plaintiffs have sufficiently claimed that themisrepresentations and omissions concerning looting were material,1 plaintiffs easily satisfy the "in connectionwith" the sale or purchase of a security requirement.
c. Scienter
Tyco argues that the scienter of the individual defendantscannot be attributed to it because it was an innocent victim ofthe looting. In making this argument, Tyco invokes the "adverseinterest" exception to the general rule that "scienter allegedagainst the company's agents is enough to plead scienter for thecompany." In re Cabletron, 311 F.3d at 40. The adverse interestexception potentially applies where "an agent secretly is actingadversely to the principal and entirely for his own or another'spurposes. . . ." Restatement (Second) of Agency § 282; see alsoWight v. BankAmerica Corp., 219 F.3d 79, 87 (2d Cir. 2000)(applying New York law). Tyco's argument is unavailing for two reasons, each of which isindependently sufficient to resolve the matter. First, plaintiffscontend that the adverse interest exception is inapplicablebecause the individual defendants did not act "entirely for theirown benefit" when they engaged in the looting. Instead,plaintiffs argue that the consolidated complaint can fairly beread to charge that the looting was a part of a larger scheme toartificially inflate the price of Tyco's stock through fraudulentaccounting practices. According to plaintiffs, the accountingfraud scheme benefitted Tyco by allowing it to generate cashthrough stock sales and borrowing to fund its acquisitionstrategy, and the looting furthered the fraud scheme by givingthe individual defendants a financial incentive to implement thescheme. While plaintiffs ultimately may not be able to prove thistheory at trial, it is sufficient at this stage of theproceedings to rebut Tyco's reliance on the adverse interestexception.
Plaintiffs alternatively argue that the adverse interestexception is itself subject to an exception "when an innocentthird-party relies on representations made with apparentauthority." Donald C. Langevourt, Agency Law Inside the Corporation: Problems of Candor and Knowledge, 71 U. Cin. L.Rev. 1187, 1214 (2003); see also Restatement (Third) of Agency,§ 5.04 (Tentative Draft No. 4, 2003). The exception potentiallyapplies here to the extent that plaintiffs qualify as innocentthird parties who were justified in believing that the individualdefendants were acting with Tyco's authority when they made themisstatements and omissions on which the looting claims arebased.
I agree with plaintiffs that the adverse interest exception isinapplicable when a corporate officer or director makes amaterial misstatement or omission to an innocent third-partywhile acting with the apparent authority of the corporation forwhom he works. The First Circuit, in In re Atlantic FinancialManagement, 784 F.2d 29 (1st Cir. 1986), recognized as much whenit held that "a corporation's liability for an agent'smisrepresentations may rest upon a theory of `apparentauthority.'" Id. at 31-32 (quoting Restatement (Second) ofAgency, § 8). Although the misrepresentations that were at issuein that case were not adverse to the corporate defendants'interests, the risk allocation policies that led the court toapply the apparent authority doctrine to misstatements generallyapply with equal force when the misstatements are adverse to the corporation'sinterests. Compare In re Atlantic, 784 F.2d at 32 (fair andefficient allocation of risk favors application of apparentauthority doctrine to § 10(b) claim) with Restatement (Third)of Agency § 5.04 cmt. C (Tentative Draft No. 4, 2003) (fair andefficient allocation of risk justifies innocent party exceptionto adverse interest rule). Accordingly, because the consolidatedcomplaint properly pleads both that the plaintiffs are innocentparties and that the individual defendants acted with apparentauthority when they allegedly made the misstatements andomissions on which the looting claims are based, the complaintsufficiently alleges that the scienter of the individualdefendants is attributable to Tyco.
d. Duty to disclose
Tyco next argues that the looting claims are not actionablebecause it was not required to disclose the looting.
A § 10(b) claim cannot be based on a failure to discloseinformation unless the omitted information was material and thedefendant was under a duty to disclose it. See Gross v. SummaFour, Inc., 93 F.3d 987, 992 (1st Cir. 1996). The First Circuithas recognized three circumstances in which a corporation may be required to disclose material, nonpublic information. The firstis when the corporation has made a statement of material factthat becomes false or misleading if the undisclosed informationis omitted. See Gross, 93 F.3d at 992. The second is wheninsiders trade stock or a corporation issues stock on the basisof the undisclosed information. See Shaw, 82 F.3d at 1204.The third is when a statute or regulation requires theinformation to be disclosed. See Gross, 93 F.3d at 992 n. 4;Shaw, 82 F.3d at 1202 n. 3. Plaintiffs rely on the thirdcircumstance, claiming that Tyco was required to disclose thelooting under items 402 and 404 of SEC Regulation S-K.
Item 402 requires "the disclosure of all plan and non-plancompensation awarded to, earned by, or paid to" the corporation'sdirectors, its CEO, its four most highly compensated executiveofficers, and up to two additional individuals who would havebeen among the most highly paid if they had been executiveofficers. 17 C.F.R. § 229.402. Item 404 requires the disclosureof "transactions" involving more than $60,000 between thecorporation and its directors, executive officers, nominees fordirector positions, individuals who own more than 5% of acorporation's stock, and immediate family members of any person subject to the disclosure requirement. 17 C.F.R. § 229.404.Plaintiffs argue that Tyco was required to disclose the lootingeither as compensation or as related party transactions.
Tyco offers three arguments in opposition. First, it assertsthat it was not required to disclose the looting because lootinginvolves the taking of property without authorization. Items 402and 404, by contrast, apply only if a corporation is a willingparticipant in a financial transaction. I disagree. This is not acase of routine theft by a low-ranking employee, which obviouslywould not be covered by Items 402 and 404. Instead, plaintiffscharge that Kozlowski, Swartz, and other senior executives ranTyco as a criminal enterprise and that Kozlowski authorized thelooting as compensation for participation in a larger scheme toartificially inflate the price of Tyco's stock. Defendants havefailed to present a persuasive case that the benefits authorizedby a corporation's CEO are exempt from disclosure under Items 402and 404 merely because the benefits were concealed from thecorporation's directors.
Tyco's second argument is that it was not required to reportthe looting because its board of directors did not learn of it until long after it occurred. As I have explained in discussingTyco's scienter argument, because Kozlowski's knowledge of thelooting is attributable to Tyco, this contention does not relieveTyco of liability.
Finally, Tyco argues that plaintiffs cannot base their claimson Items 402 and 404 because these regulations do not give riseto a private right of action for damages. This argument failsbecause although plaintiffs rely on Items 402 and 404 toestablish that Tyco had a duty to disclose the looting, they basetheir cause of action on § 10(b), rather than on the disclosureregulations themselves. It is no longer open to dispute that aprivate right of action exists to enforce § 10(b) when theelements of a § 10(b) violation are present. See Herman &MacLean v. Huddleston, 459 U.S. 375, 385-87 (1983). I find nosupport in the language, structure, or purpose of Items 402 and404 to support defendants' argument that a person who fails todisclose material information that is required by items 402 and404 cannot be sued for damages pursuant to § 10(b) when the otherelements of a § 10(b) claim have been satisfied. 2. Accounting Fraud Claims
Plaintiffs dedicate more than 220 paragraphs of theconsolidated complaint to a recitation of allegedly false andmisleading statements and omissions by the defendants concerningTyco's financial condition. In a separate section, they describeseveral accounting schemes that defendants allegedly used tomislead investors. Then, they attempt to support their statedbelief that the specified statements were misleading by citing tofindings in the Boies reports2 that Tyco engaged in"aggressive accounting" of the types described in theconsolidated complaint and by pointing to billions of dollars inrestatements and corrections that Tyco was required to make toaddress past accounting errors. They seek to support their claimthat defendants acted with scienter by charging that: (1) thetargeted accounting practices plainly violated Generally AcceptedAccounting Principles ("GAAP") and thus were unlikely to have been innocently adopted; (2) the identified restatements are solarge that they are indicative of fraud; and (3) the allegationsof massive looting and hundreds of millions of dollars in stocksales by insiders at inflated prices give rise to a stronginference that the defendants acted with scienter. Finally, theplaintiffs assert that they suffered compensable injuries thatwere caused, at least in part, by the alleged accounting fraud.Not surprisingly, defendants argue that these allegations are notdescribed in sufficient detail to survive a motion to dismiss. Iexamine defendants' most significant arguments in turn.
a. Identification of misleading statements and omissions
The PSLRA requires a plaintiff pleading securities fraud to"specify each statement alleged to have been misleading."15 U.S.C. § 78U-4(b)(1). Plaintiffs satisfy this requirement byidentifying hundreds of specific statements in press releases,quarterly (Form 10-Q) and annual (Form 10-K) reports, other SECforms including 8-K's, S-8's and S-4's, proxy statements,statements made by several of the individual defendants duringconference calls with the media, and statements from thirdparties that identify individual defendants as the source of their information. The sheer quantity of these statementsprevents me from describing all of them and, in any event, such arecitation is not required. See In re Cabletron,311 F.3d at 28-33. Nevertheless, I list a few to illustrate the general toneof the consolidated complaint: • 2000 10-K incorrectly listed net income as $4,519.9 million (Compl. ¶ 462); • 2000 Proxy Statement falsely listed Kozlowski and Swartz as having no outstanding loans from Tyco (Compl. ¶ 317); • 2000 Annual Report to Shareholders falsely stated that Tyco's "exceptional financial results" were the product of its "growth-on-growth" strategy (Compl. ¶ 467); • January 17, 2001 Conference Call where CEO Kozlowski misleadingly reported that revenue was up 21% for the quarter as a result of organic growth (Compl. ¶ 477); • March 16, 2001 Form S-3 and related Prospectus incorporated the same materially false and misleading statements set forth in Tyco's Annual Report on Form 10-K for fiscal year ended September 30, 2000, Tyco's 10-Q's and Form 8-K's, and the Consent of PwC, dated March 14, 2001, permitting the incorporation by reference of PwC's materially false and misleading report, dated October 24, 2000 (Compl. ¶ 500-03); • 2001 10-K incorrectly listed net income for fiscal 2001 as $3,970.6 million (Compl. ¶ 571).These statements and others of similar ilk adequately specify the"time, place, and content" of each allegedly misleading statement. Aldridge v. A.T. Cross Corp., 284 F.3d 72, 78 (1stCir. 2002).
PwC charges that plaintiffs have failed to identify anymisstatements that it made on Tyco's behalf, but a careful reviewof the consolidated complaint reveals that plaintiffs base theirclaims against PwC on its allegedly false statements in auditletters, dated October 21, 1999, October 24, 2000, and October18, 2001, that Tyco's financial statements had been prepared inaccordance with GAAP and that PwC's audits of Tyco had beenconducted in accordance with Generally Accepted AccountingStandards ("GAAS"). Compl. ¶¶ 169-72. These allegations identifythe misstatements on which plaintiffs' claims are based with thepartiality required by the PSLRA.
b. Reasons why statements are misleading
The PSLRA also requires a plaintiff to explain why eachspecifically identified statement is misleading. See15 U.S.C. § 78U-4(b)(1). Plaintiffs seek to satisfy this requirement bydescribing several different accounting schemes that defendantsallegedly used to artificially inflate the price of Tyco's stock.First, they claim that Tyco caused several specified acquisitiontargets to overstate reserves, pre-pay expenses, and engage in other similar actions prior to the acquisition to make it appearthat the target company was growing more rapidly after theacquisition than in fact was the case. Second, they charge thatTyco failed to properly disclose a $4.5 billion impairment to thegoodwill of one of its subsidiaries. Third, they claim that Tycoimproperly recognized as earnings hundreds of millions of dollarsin excess reimbursements from independent dealers at another ofits subsidiaries, rather than spreading the reimbursements overthe life of the dealer contracts as GAAP requires. Finally, theycharge that Tyco failed to disclose certain specified practicesthat violated federal income tax laws.3
Defendants counter that these allegations are insufficientbecause plaintiffs have not properly linked their theories ofaccounting fraud to the specific statements that they claim aremisleading. Condemning plaintiffs' organizational approach asimpermissible "puzzle pleading," they argue that the PSLRArequires a plaintiff to separately identify each allegedly misleading statement and immediately thereafter list the reasonswhy the statement is misleading. The consolidated complaint failsto meet this requirement, defendants claim, because it lists allof the misleading statements in one section but describes theaccounting schemes that make the statements misleading indifferent sections. Although I am sympathetic to defendants'contention that the consolidated complaint is difficult todecipher, I do not agree that it is so poorly drafted that itviolates the PSLRA. After identifying each specific misleadingstatement, the complaint refers readers to other sections thatlist multiple reasons why the statement is misleading. This is areasonable way to address a complicated securities fraud case. Itdoes not violate the PSLRA merely because it makes the complaintdifficult to understand
Defendants next argue that the consolidated complaint isdeficient because it fails to identify specific amounts by whichvarious accounts were misstated. The PSLRA, however, does notrequire such specificity if the complaint otherwise provides adetailed description of the fraud schemes. See Aldridge,284 F.3d at 81. Plaintiffs support their claim that Tyco engaged inacquisition accounting fraud by identifying several acquisition targets and describing the types of charges and other financialmachinations that occurred at the target companies before theacquisitions were completed. When describing their allegationthat Tyco failed to properly record impairments to goodwill,plaintiffs identify the affected subsidiaries and the amount bywhich the goodwill was overstated. In describing Tyco's allegedfailure to properly account for dealer reimbursements, plaintiffsagain identify the affected subsidiary, describe the fraud schemein detail and explain how the improper accounting affected theaccuracy of Tyco's financial statements. Finally, plaintiffsexplain that Tyco allegedly committed undisclosed tax fraud byinstructing companies with which it was doing business to directrebate checks to offshore subsidiaries of Tyco where they wouldnot be subject to United States income taxes. No more is requiredto satisfy this aspect of the PSLRA.
PwC argues that the consolidated complaint fails tosufficiently explain why the statements on which plaintiffs'claims against it are based were misleading. Again, I disagree.Much like the complaint in Kinney v. Metro Global Media, Inc.,170 F. Supp. 2d 173 (D.R.I. 2001), plaintiffs charge thecompany's independent accountant with issuing unqualified audit reports certifying the company's financial statements forspecific years and claiming that the audits were performed inconformity with GAAS. Also, as in Kinney, the complaint lists anumber of auditing standards and principles allegedly violated byPwC which, taken as a whole, render the certified financialstatements materially misleading.4 Here, as in Kinney,the "[p]laintiffs specified each statement they alleged to bemisleading [(the audit statements of financial statements, datedOctober 21, 1999, October 24, 2000, and October 18, 2001 (Compl.¶¶ 24, 170-72), and registration statements and prospectusesfiled during the class period that incorporated PwC's auditreports with PwC's consent (E.g., Compl. ¶¶ 24, 173, 286))]and specified the reasons why the statements were allegedly misleading [(violations of GAAP, violations of GAAS, failure toreport inadequate internal controls at Tyco, failure to reportlooting behavior, etc.)]. . . ." Id. at 179. And like the courtin Kinney, these detailed allegations are sufficient to survivea motion to dismiss even under the heightened pleading standardsof the PSLRA. Id.
c. Facts supporting belief that statements are misleading
The PSLRA requires a plaintiff to explain with particularitywhy allegations made on information or belief are reasonable.15 U.S.C. 78U-4(a)(1). Defendants argue that plaintiffs have failedto satisfy this requirement with respect to their acquisitionaccounting fraud claims.
A careful review of the consolidated complaint reveals thatplaintiffs have pleaded sufficient facts to support theirasserted belief that defendants engaged in acquisition accountingfraud. Plaintiffs devote more than 20 paragraphs to aspecification of facts that they claim support their belief onthis point. Although several of their assertions are based onnewspaper accounts and reports from independent analysts,plaintiffs also cite to admissions by Tyco such as its statement that "there were instances where prior management appeared toinfluence the management of an acquisition target into adoptingaccounting treatments that `over-accrued' expenses prior to anacquisition's consummation or otherwise exceed what was permittedby GAAP." Compl. ¶ 106. When these allegations are viewed in thecontext of the complaint as a whole, they are sufficient tosatisfy this aspect of the PSLRA.
d. Scienter
Defendants next argue that the consolidated complaint does notsupport a strong inference that they acted with scienter."Liability under section 10(b) and Rule 10b-5 . . . requiresscienter, `a mental state embracing intent to deceive,manipulate, or defraud.'" In re Cabletron, 311 F.3d at 38(quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12(1976)). Scienter also "may extend to a form of extremerecklessness that `is closer to a lesser form of intent.'" In reCabletron, 311 F.3d at 38 (quoting Greebel v. FTP Software,Inc., 194 F.3d 185, 198-99 (1st Cir. 1999); see alsoAldridge, 284 F.3d at 82. Under the PSLRA, "the plaintiff must. . . show that the inferences of scienter are both reasonableand strong." Aldridge, 284 F.3d at 78 (quotations omitted). The FirstCircuit, however, has "rejected any rigid formula for pleadingscienter, preferring to rely on a `fact-specific approach' thatproceeds case by case." In re Cabletron, 311 F.3d at 38(quoting Aldridge, 284 F.3d at 82); see also Greebel,194 F.3d at 196. While scienter can be established through directevidence of "conscious wrongdoing," other types of evidence alsomay be considered. "[T]he plaintiff may combine various facts andcircumstances indicating fraudulent intent — including thosedemonstrating motive and opportunity — to satisfy the scienterrequirement." Aldridge, 284 F.3d at 82.
Although by no means exhaustive, some of the types ofcircumstantial evidence that have been found to be relevant inpleading scienter are: (1) GAAP violations, see In reCabletron, 311 F.3d at 39; (2) accounting shenanigans, seeid.; Geffon v. Micrion Corp., 249 F.3d 29, 36 (1st Cir.2001); (3) large-scale fraudulent practices over time, see Inre Cabletron, 311 F.3d at 39; (4) stock sales by insiders, see,e.g., In re Cabletron, 311 F.3d at 39-40; (5) the quicksettlement of an ancillary fraud suit, see Greenstone v.Cambex Corp., 975 F.2d 22, 26-27 (1st Cir. 1992); (6) disregard for the most current financialinformation when making statements, see Glassman v.Computervision Corp., 90 F.3d 617, 627 (1st Cir. 1996); (7) theself-interest of defendants in saving their own salaries or jobs,see Serabian, 24 F.3d at 368; and (8) financial restatements,see Aldridge, 284 F.3d at 83. While no single factor willgenerally be sufficient to support a strong inference ofscienter, a combination of several factors may satisfy therequirement. See In re Cabletron, 311 F.3d at 40.
Plaintiffs have identified several different factors in thiscase that are collectively sufficient to support a stronginference that Kozlowski, Swartz, and Belnick acted withscienter. First, plaintiffs describe a massive fraud schemeperpetrated by the company's senior management over an extendedperiod of time. Second, they claim that the various accountingschemes employed by the defendants violated well-establishedaccounting practices and, in some cases, were adopted indisregard of advice provided by the company's outside auditors.Third, they claim that Kozlowski, Swartz, and Belnick reapedhundreds of millions of dollars in benefits during the course of the fraud scheme in undisclosed compensation, related partytransactions, and stock sales at inflated prices. While no one ofthese factors standing alone would be sufficient, theconsolidated complaint as a whole pleads enough culpable facts togive rise to a strong inference that these defendants acted withscienter. Further, as I have explained previously when discussingplaintiffs' looting claims (see discussion supra PartII.A.1.c.), these allegations also satisfy the PSLRA's pleadingrequirements with respect to Tyco because the scienter of itssenior executives can be attributed to the company for whom theyworked.
Walsh and Ashcroft arguably are in a different position fromthe other individual defendants because they served as outsidedirectors. Plaintiffs charge that Walsh served as Tyco's leaddirector and claim that he was actively involved in negotiationssurrounding the CIT acquisition, one of the major transactions onwhich the consolidated complaint is based. They also allege thatKozlowski caused Tyco to pay Walsh a $20 million fee for his workin connection with the CIT acquisition and that Walsh laterpleaded guilty to a criminal charge in which he admitted that he knowingly concealed the $20 million payment. These allegationsare sufficient to support a strong inference that Walsh actedwith scienter with respect to his alleged failure to disclose the$20 million fee. Whether they are also sufficient to support aninference that he was a culpable participant in the allegedaccounting fraud schemes, however, is a more difficult questionthat the parties have not adequately briefed. Because I am notconfident that I can reliably resolve the issue without theirhelp, I leave its resolution for a later date.
The allegations against Ashcroft, in contrast, do not reach thenecessary threshold to make out a valid claim that he acted withscienter. The consolidated complaint's sole claim that hereceived undisclosed benefits involved the sale of his Floridahome. The complaint charges that Ashcroft sold the home to hiswife for $100 and that she immediately resold it to a Tycoemployee for $2.5 million. The complaint further charges thatTyco funds were used to cover the purchase price and that thehome thereafter was used by Kozlowski rather than its nominalowner. Plaintiffs, however, do not allege that Ashcroft was awarethat the home had been purchased with Tyco funds. This is in sharp contrast to the allegations against Walsh, because thecomplaint asserts that Walsh agreed with Kozlowski to conceal the$20 million "finders fee." While the complaint also charges thatAshcroft signed various SEC filings in his capacity as adirector, and sold in excess of $100 million in Tyco stock duringthe class period, it does not allege that he was involved in theday-to-day management of the company or that he was otherwiseprivy to management decisionmaking concerning the allegedlyfraudulent accounting practices. Under these circumstances,allegations that he signed corporate filings and sold largeamounts of stock are not sufficient, by themselves, to establishscienter. For this reason, the consolidated complaint does notstate a viable § 10(b) claim against Ashcroft.
Plaintiffs cite several facts to support their contention thatPwC acted with the degree of recklessness that is required tosupport a § 10(b) claim against a company's outside accountant.First, they allege that PwC had a motive to acquiesce in theaccounting fraud scheme because Tyco was a long-standing PwCclient and had paid PwC more than $51 million in fees duringfiscal year 2001 alone. Second, plaintiffs charge that PwC had ample opportunity to detect the accounting fraud andensure that its statements about Tyco's financial condition werecorrect because PwC personnel were regularly present at Tyco'scorporate headquarters during the class period and had fullaccess to the company's accounting records. Plaintiffs furthercharge that the accounting problems at Tyco should have beenreadily detectable by PwC during the audit process because Tycohas since admitted that: its internal accounting controls wereinadequate; it engaged in "aggressive accounting" during theperiod covered by PwC's audit letters; its earnings during theclass period were overstated by $5.6 billion; and its seniorexecutives looted hundreds of millions of dollars from thecompany during the class period. Plaintiffs also cite evidencethat they claim demonstrates that even though PwC was placed onnotice of the existence of loans from Tyco, these loansnevertheless were not disclosed in the manner required by GAAP.While no one of these factors alone would be sufficient tosupport a strong inference that PwC acted with scienter,collectively they are sufficient to give rise to a stronginference that PwC acted with the degree of recklessness required to support a finding of scienter.5
e. Loss Causation
Defendants next argue that plaintiffs have failed to adequatelyplead that the accounting fraud claims caused the losses forwhich they are seeking compensation. To survive a Rule 12(b)(6)challenge to a § 10(b) claim, a plaintiff must allege that "theact or omission of the defendant alleged to violate [§ 10(b)]caused the loss for which the plaintiff seeks to recoverdamages." 15 U.S.C. § 78u-4(b)(4). Two types of causation must bealleged: "loss causation," which addresses the relationshipbetween a misleading act or omission and stock price, and"transaction causation," which addresses the relationship betweena misleading act or omission and the plaintiff's decision to buy or sell stock. See CitiBank, N.A.v. K-H Corp., 968 F.2d 1489, 1494 (2d Cir. 1992). Defendantsargue that plaintiffs have failed to properly plead losscausation.
Most courts that have addressed the issue of loss causationhave held that a plaintiff ultimately must prove that a change instock price is causally linked to a corrective disclosure ofmisleading information. See, e.g., Emergent Capital Inv.Mgmt., LLC v. Stonepath Group, Inc., 343 F.3d 189, 197 (2d Cir.2003); Semerenko, 223 F.3d at 184-185; Robbins v. Koger Prop.Inc., 116 F.3d 1441, 1447 (11th Cir. 1997); Bastian v. PetrenRes. Corp., 892 F.2d 680, 685-86 (7th Cir. 1990); but seeBroudo v. Dura Pharm., Inc., 339 F.3d 933, 938 (9th Cir. 2003);cert. granted (change in stock price not required); In reControl Data Corp. Sec. Litig., 933 F.2d 616, 619-20 (8th Cir.1991) (same). Defendants adopt this view in arguing thatplaintiffs have failed to sufficiently plead loss causation withrespect to their accounting fraud claims. Their argument is thatbecause the consolidated complaint explicitly links decreases inTyco's stock price only to disclosures of looting by seniormanagement, the complaint does not properly plead loss causationwith respect to the accounting fraud claims.
I reject defendants' argument because it is based on anunfairly narrow reading of the consolidated complaint. While Iagree that the sole paragraph in the complaint that is expresslydevoted to the subject of loss causation charges that decreasesin Tyco's stock price were causally linked to disclosures thatsenior management allegedly had engaged in looting and othercriminal conduct, the same paragraph also alleges that the pricedecreases occurred "as the Tyco defendants fought off attacks onthe credibility of the company's financial statements and theintegrity of its management." Compl. ¶ 716. As other paragraphsmake clear, the attacks that defendants were resisting weredirected at many of the accounting machinations on which thepresent claims are based. Reading the complaint as a whole, itthus fairly charges that Tyco's stock price declined in partbecause investors concluded that they could no longer credit thecompany's denials of accounting misconduct. These allegations aresufficiently particular to survive a Rule 12(b)(6) challenge.
f. Other arguments
Defendants also charge that many of the consolidated complaint's allegedly misleading statements are not actionablebecause: (1) they qualify as mere puffery; (2) they areforward-looking statements protected by the PSLRA's safe harborprovision, 15 U.S.C. § 780-5(a)(1); or (3) they were made bythird parties and cannot be attributed to the defendants. Idecline to consider the merits of these arguments because theywould not produce a complete dismissal of any of the charges evenif they prove to be valid. Defendants may raise these argumentsagain later if they can demonstrate that a ruling from the courtwould significantly affect the scope of discovery, thepossibility of settlement, or the nature of the trial.
B. Section 14(a)
Section 14(a) of the Exchange Act punishes misleadingstatements or omissions of material fact that are made inconnection with the solicitation of proxies. "To prevail on aSection 14(a) claim, a plaintiff must show that (1) a proxystatement contained a material misrepresentation or omissionwhich (2) caused the plaintiff injury and (3) that the proxysolicitation itself, rather than the particular defect in thesolicitation materials, was `an essential link in the accomplishment of the transaction.'" Gen. Elec. Co. v.Cathcart, 980 F.2d 927, 932 (3d Cir. 1992) (quoting Mills v.Elec. Auto-Lite Co., 396 U.S. 375, 385 (1970)). This third steprequires a plaintiff to "establish a causal nexus between the[]alleged injury and some corporate transaction authorized (ordefeated) as a result of the allegedly false and misleading proxystatements." Royal Bus Group, Inc. v. Realist, Inc.,933 F.2d 1056, 1063 (1st Cir. 1991).
Plaintiffs base their § 14(a) claims on proxy statements issuedby Tyco on March 1, 2000, January 29, 2001, and January 28, 2002.Compl. ¶ 731. The consolidated complaint asserts that thesestatements sought proxies in order to reelect directors, allowdirector remuneration to be set by the board, and reappoint PwCas Tyco's auditor. Although the complaint is not clear on thispoint, plaintiffs apparently contend that misleading statementsand omissions in the proxy statements led to the adoption of thespecified measures and that these measures, in turn, injuredplaintiffs in their capacities as shareholders.
Defendants argue, among other things, that plaintiffs havefailed to properly plead causation. In making this argument, they rely primarily on the Third Circuit's decision in GeneralElectric Co. v. Cathcart, 980 F.2d 927 (3d Cir. 1992), in whichthe court rejected a § 14(a) claim for damages resulting fromalleged mismanagement by directors who were reelected on thebasis of allegedly misleading proxy statements. Id. at 933.There, the court reasoned that damages that are subsequentlycaused by directors who are elected on the basis of misleadingproxy statements are simply too remote from the misleadingstatements themselves to support a claim under § 14(a). Seeid. Plaintiffs have not attempted to respond to defendants'plausible causation argument, and thus they have waived theirright to object to the dismissal of the § 14(a) claims on thisbasis. See, e.g., Michelson v. Digital Fin. Servs.,167 F.3d 715, 720 (1st Cir. 1999) (failure to respond to properlypresented argument constitutes waiver of right to object).
C. Sections 11 & 12(a)(2)
Defendants challege plaintiffs' claims under §§ 11 and 12(a)(2)of the Securities Act by claiming that plaintiffs have failed toplead their claims with the particularity required by Rule 9(b). Section 11 creates a right of action for damages by securitiespurchasers when registration statements contain untrue statementsof material fact or material omissions, and plaintiffs can tracetheir shares to those registration statements.15 U.S.C. § 77k(a). Under § 11, the company, any signer of the misleadingregistration statement, the directors of the company, and anyaccountant that certified or prepared any report or valuationused in connection with the registration statement, may be heldliable. See Versyss Inc. v. Coopers & Lybrand, Etc.,982 F.2d 653, 657 (1st Cir. 1992) ("Section 11 . . . is remarkablystringent where it applies, readily imposing liability onancillary parties to the registration statement (likeaccountants) for the benefit even of purchasers after theoriginal offering."). Under § 12(a)(2), all a plaintiff need showis that he purchased a security pursuant to a prospectus or oralcommunication that contained an untrue statement of material factor a material omission. 15 U.S.C. § 77l(a)(2). The only relevantdifference between a § 11 and a § 12(a)(2) claim is that thelatter includes oral statements and plaintiffs must demonstratethat the named defendants were sellers or offerors of Tyco stock. Compare 15 U.S.C. § 77k(a) with15 U.S.C. § 77l(a)(2).
Neither § 11 nor § 12(a)(2) requires an allegation of scienter.See Shaw, 82 F.3d at 1223. Nevertheless, the First Circuithas recognized that "a complaint asserting violations of [§§ 11and 12(a)(2)] may yet sound[] in fraud" and thus may be subjectto the rigorous pleading requirements established by Rule 9(b).Id. Defendants argue that plaintiffs' claim under § 11 and §12(a)(2) are so steeped in fraud that they are required to pleadtheir claims with particularity. I disagree.
Even if I assume, as defendants insist, that fraud lies at thecore of plaintiffs' claims, I would not dismiss otherwisesufficient claims under §§ 11 and 12(a)(2) merely because theyfail to plead fraud with particularity. Instead, the properremedy for a failure to comply with Rule 9(b) would be to strikeany deficient allegations and then assess the sufficiency of theremaining allegations. See Vess v. CIBA-Geigy Corp., USA,317 F.3d 1097, 1104-05 (9th Cir. 2003); Lone Star Ladies Inv. Clubv. Schlotzsky's, Inc., 238 F.3d 363, 368 (5th Cir. 2001);Carlon v. Thaman (In re Nationsmart Corp. Sec. Litig.),130 F.3d 309, 315 (8th Cir. 1997). In the present case, because plaintiffs do notbase their §§ 11 and 12(a)(2) claims on fraud, there are noallegations of fraud to strike. Further, because the claimseasily satisfy the much less demanding requirements of Rule 8(a),they are not subject to dismissal pursuant to Rule 12(b)(6).
PwC also challenges plaintiffs' § 11 claim by arguing thatplaintiffs have not sufficiently alleged that their stockpurchases can be traced to a misleading registration statement.In making this argument, PwC rightly contends that in order tohave standing to bring a § 11 claim, a plaintiff must aver thatthe shares he purchased are traceable to the offering covered bythe allegedly misleading registration statement. See, e.g.,Krim v. PcOrder.com, Inc., No. A-00-CA-776-§, 2003 WL 21076787(W.D. Tex. May 5, 2003) (plaintiffs who could not tracesecurities to the registration statement lacked standing under §11). Contrary to PwC's position, however, plaintiffs have pledtraceability by asserting that they "acquired Tyco shares issuedpursuant to, or traceable to, and in reliance on, theRegistration Statements/Prospectuses." Compl. ¶ 757. Since amotion to dismiss is not the appropriate forum to test theveracity of such assertions, they are sufficient to plead traceability and therefore toestablish plaintiffs' standing to sue. See In re Ultrafem Inc.Sec. Litig., 91 F. Supp. 2d 678, 694 (S.D.N.Y. 2000)(plaintiffs' allegation in complaint "that they made theirpurchases `pursuant to and/or traceable to the RegistrationStatement'" sufficient to plead traceability and establishstanding for § 11 claims).
D. Sections 20(a) and 15
Plaintiffs also assert claims under § 20(a) of the Exchange Actand § 15 of the Securities Act against Kozlowski, Swartz,Belnick, Walsh, and Ashcroft. Both sections impose derivativeliability on defendants who "control" primary violators of thesecurities laws. See 14 U.S.C. § 78t(a); 15 U.S.C. § 77o.Because I have already determined that the consolidated complaintstates primary violations under § 10(b) of the Exchange Act and§§ 11 and 12(a)(2) of the Securities Act, the only remainingquestion is whether the complaint sufficiently alleges that theindividual defendants controlled the primary violators. On thisissue, the First Circuit has stated that "the alleged controllingperson must not only have the general power to control thecompany, but must also actually exercise control over the company." Aldridge, 284 F.3d at 85. It also has acknowledged,however, that "[c]ontrol is a question of fact that `will notordinarily be resolved summarily at the pleading stage.'" In reCabletron, 311 F.3d at 41 (quoting 2 T.L. Hazen, Treatise onthe Law of Securities Regulation, § 12.24(1) (4th ed. 2002)).
Only Walsh and Ashcroft present serious arguments for dismissalof plaintiffs' "control person" claims. Plaintiffs respond bynoting that both defendants served as directors and signedallegedly false SEC filings on Tyco's behalf. However, "[t]heassertion that a person was a member of a corporation's board ofdirectors, without any allegation that the person individuallyexerted control or influence over the day-to-day operations ofthe company, does not suffice to support an allegation that theperson is a control person. . . ." See Adams v. Kinder-Morgan,Inc., 340 F.3d 1083, 1108 (10th Cir. 2003). The only additionalallegations that plaintiffs make with respect to Ashcroft arethat he was a major shareholder and once served as the CEO of acorporation that Tyco later acquired. These facts do not addenough evidence of control to salvage plaintiffs' control personclaims against Ashcroft. Plaintiffs' claims against Walsh are marginally stronger because thecomplaint alleges that Walsh was the company's lead outsidedirector, was actively involved in at least one of the majortransactions on which the claims are based, and succeeded innegotiating a $20 million "finders fee" for himself in connectionwith that transaction. This evidence is sufficient, althoughbarely so, to survive a motion to dismiss. Accordingly, I grantAshcroft's motion to dismiss the control personal claims againsthim, but deny Walsh's corresponding motion.
E. Section 20A
Plaintiffs next assert claims under § 20A of the Exchange Actagainst Kozlowski, Swartz, Belnick, Walsh, and Ashcroft. Section20A creates a private right of action for insider trading. Itpotentially covers "[a]ny person who violates any provision of[the Exchange Act] or the rules or regulations thereunder bypurchasing or selling a security while in possession of material,nonpublic information. . . ." 15 U.S.C. § 78t-1. Plaintiffscharge that the individual defendants violated this provision byselling hundreds of millions of dollars in Tyco stock withoutdisclosing the looting and accounting fraud described in the consolidated complaint.
All five individual defendants argue that the § 20A claims aredefective because plaintiffs have failed to sufficiently allegethat they committed underlying violations of the Exchange Act. AsI have explained, this argument is valid only with respect toAshcroft.
Walsh also argues that the § 20A claim against him is invalidbecause the stock sales on which the claim is based were made tofund additional purchases of Tyco stock through the exercise ofstock options. Walsh fails to cite any case law to support thisargument. Nor does he explain why such transactions may nevercount as stock sales under § 20A. I decline to speculate aboutthe merits of an argument that has not been properly developed.Accordingly, I reject his motion to dismiss on this basis.
F. Statutes of Limitation
Plaintiffs' claims under § 10(b) and § 20(a) of the ExchangeAct and § 11, § 12(a)(2), and § 15 of the Securities Act aresubject to one-year statutes of limitation that begin to run fromthe date that the plaintiffs knew or reasonably should have known of the facts on which the claims are based.6 SeeLampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson,501 U.S. 350, 364 n. 9 (1991) (§ 10(b) claims); Westinghouse Elec.Corp. v. Franklin, 993 F.2d 349, 353 (2d Cir. 1993) (§ 14(a)claims); Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 n. 2 (2dCir. 1993) (§ 20(a) claims); Short v. Belleville Shoe Mfg. Co.,908 F.2d 1385, 1390 (7th Cir. 1990) (§ 11 and 12(a)(2) claims);Tracinda Corp. v. DaimlerChrysler AG, 197 F. Supp. 2d 42, 55 n.5 (D. Del. 2002) (§ 15 claims). Defendants argue that plaintiffs'acquisition accounting fraud claims are barred by these statutesof limitation to the extent that they are based on conduct thatoccurred more than one year before the complaints asserting theclaims were filed. Plaintiffs respond by contending that their claims are not time-barred because they acted promptly afterlearning of their potential claims.
A two-part test is used in this circuit to determine whether aplaintiff has sufficient notice of a securities claim to triggerthe one-year limitations period. First, the party invoking thestatute must demonstrate that sufficient "stormwarnings"7 of fraud were on the horizon to trigger a dutyto inquire further. See Young v. Lepone, 305 F.3d 1, 9 (1stCir. 2002). If the defendant satisfies this requirement, theplaintiff must respond with evidence establishing that even areasonably diligent investigation would not earlier have producedsufficient evidence to permit the filing of a viable complaint.See id.; see also Marks v. CDW Computer Ctrs.,122 F.3d 363, 367 (7th Cir. 1997) ("not only must the investor be onnotice of the need to conduct further inquiry, but the investoralso must be able to learn the facts underlying the claim withthe exercise of reasonable diligence"). It is only when a reasonably diligentinvestigation would have identified sufficient evidence to permitthe filing of a legally sufficient complaint that the statute oflimitation begins to run. See Young, 305 F.3d at 9. Bothparts of this test present issues of fact. See id. Thus, adispute about whether sufficient storm warnings were present todeny the plaintiff the benefit of the discovery rule generallywill not be resolvable on a motion to dismiss, unless it is plainfrom the complaint itself that the plaintiffs' claims aretime-barred. See id. at 9; see also LC Capital Partners,L.P. v. Frontier Ins. Group, Inc., 318 F.3d 148, 155 (2d Cir.2003).
Defendants attempt to satisfy the first part of this test bypointing to what they argue are multiple storm warnings thatacquisition accounting fraud was occurring well more than a yearprior to the filing of a complaint. In particular, they point to:(1) the publication of analysts' reports and newspaper articlesin October 1999 accusing Tyco of acquisition accounting fraud;(2) the announcement by Tyco in December 1999 that the SEC hadcommenced an investigation into Tyco's acquisition accounting;(3) the significant drop in Tyco's stock price that followed the announcement of the SEC investigation; and (4) thecommencement of litigation against Tyco based on acquisitionaccounting fraud in December 1999.
Plaintiffs challenge the sufficiency of these storm warnings,but even more persuasively argue that a reasonably diligentinvestigation would not have produced enough information topermit them to earlier file legally sufficient securities fraudcomplaints. This is so, plaintiffs claim, because defendantsdenied that they were engaging in acquisition accounting fraudand took steps to conceal their misconduct. These steps wouldhave prevented even a diligent investor from earlier developingthe information needed to sue. The most compelling evidence thatplaintiffs cite in support of this point is the fact that the SECclosed its investigation of Tyco in July 2000 without uncoveringthe acquisition accounting fraud scheme. Plaintiffs thus sensiblyclaim that a reasonable investor could not have uncoveredsufficient evidence to support an acquisition accounting fraudclaim if the SEC, with far greater resources, was unable to do soitself. I need not resolve this dispute to dispose of defendants'argument. It is enough at this stage of the proceedings to saythat this is not a case in which I can determine when thestatutes of limitation began to run based solely on the factspleaded in the consolidated complaint.8
III. CONCLUSION
For the reasons set forth in this Memorandum and Order, I grantdefendants' motions to dismiss to the extent that they seekdismissal of plaintiffs' claims under § 14(a) of the ExchangeAct. I also grant Ashcroft's motion to dismiss plaintiffs' claims against him under § 10(b), § 20(a) and § 20A of theExchange Act and § 15 of the Securities Act. In all otherrespects, defendants' motions to dismiss (Doc. Nos. 43, 46, 47,49, 50, and 51) are denied.
SO ORDERED.
1. Although defendants argue otherwise, their position on thispoint is so insubstantial that it does not require extensiveanalysis. An omitted fact is material if its disclosure "wouldhave been viewed by a reasonable investor as having significantlyaltered the `total mix' of information made available." Basic,Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). Moreover,materiality generally presents a question of fact for the jury.See Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824, 829 (8thCir. 2003). Specific allegations that senior management looted acompany of hundreds of millions of dollars in previouslyundisclosed benefits clearly presents a triable argument that theundisclosed information was material.
2. The Boies reports were the result of a limitedinvestigation of Tyco, conducted in 2002 by the law firm Boies,Schiller & Flexner, LLP at Tyco's direction. The investigationwas principally restricted to "the integrity of the company'sfinancials and the possible existence of systemic or significantfraud, or other improper accounting that would materiallyadversely affect the Company's reported earnings or cashflow fromoperations in 2003 or thereafter." Compl. ¶¶ 28, 665.
3. The consolidated complaint also charges that Tycomisleadingly failed to disclose hundreds of acquisitions andfailed to employ sufficient internal accounting controls. It isunclear whether these allegations are intended to stand asindependent accounting fraud claims or whether they merelysupport the complaint's central allegations.
4. The consolidated complaint lists the numerous GAAPviolations that are alleged to have occurred during the classperiod. These include: (1) the improper accounting foracquisitions; (2) manipulation of accounting reserves for thepurpose of inflating Tyco's reported operating result; (3)failure to timely recognize expenses, including impairment ofcorporate assets; (4) failure to disclose material related partytransactions (the corporate looting explained in Part II.A.1.supra); (5) engaging in "aggressive" accounting for the purposeof inflating Tyco's reported results; (6) failure toappropriately restate previously issued and materially misleadingfinancial statements; (7) improper recognition of"reimbursements" from independent dealers; (8) failure todisclose accounting policies in accordance with GAAP; and (9) thefailure to disclose material contingent liabilities andsignificant risks and uncertainties. The consolidated complaint additionally lists audit violationsof GAAS by PwC. These include: (1) violation of GAAS Standard ofReporting No. 1 that requires the audit report to state whetherthe financial statements are presented in accordance with GAAP;(2) violation of GAAS Standard of Reporting No. 4 because PwCshould have stated that no opinion on Tyco's financial statementscould be reported; (3) violation of GAAS General Standard No. 2that requires independence in mental attitude be maintained bythe auditor; (4) violation of SAS No. 54 in that PwC failed toperform the audit procedures required in response to possibleimproper acts by Tyco; (5) violations of SAS No. 1 and No. 53 byfailing to adequately plan its audit and properly supervise thework and carry out procedures reasonably designed to search forand detect the existence of errors and irregularities that wouldhave a material effect upon the financial statements; (6)violation of GAAS General Standard No. 3 which requires that dueprofessional care must be exercised by the auditor; (7) violationof GAAS Standard of Field Work No. 2, which requires the auditorto make a proper study of existing internal controls, includingaccounting, financial, and managerial controls, to determinewhether reliance thereon is justified; and (8) violation of SASNo. 82 in that it failed to adequately consider the risk that theaudited financial statements were free from materialmisstatements, whether caused by errors or fraud, and that PwCignored several risk factors, including: (a) an excessiveinterest by management in maintaining or increasing the entity'sstock price through the use of aggressive accounting; (b) afailure by management to display and communicate an appropriateattitude regarding internal controls and the financial reportingprocess; (c) management displaying a particular disregard forregulatory authority; (d) management continuing to employ anineffective accounting or internal auditing staff; (e)significant party-related transactions not in the ordinary courseof business or with related entities not audited or audited byanother firm; and (f) significant bank accounts or subsidiary orbranch operations in tax-haven jurisdictions for which thereappears to be no clear business justification.
5. PwC argues that the amounts of allegedly unauthorized loansto the individual defendants were in fact disclosed in theaggregate. As plaintiffs note, however, it was not the existenceof employee loan programs that were omitted, but the impropertransactions between Tyco and the related parties that abusedthese programs. Plaintiffs claim that PwC's alleged failure toidentify the specific material related party transactions, thenature of the transactions, and the dollar amount for eachtransaction constituted a breach of GAAP. Disclosing aggregatedollar amounts of outstanding loans in general categories whileconcealing the details thus does not avoid the misconduct onwhich plaintiffs' claim is based.
6. The Sarbanes-Oxly Act, Pub.L. 107-204, created a two-yearstatute of limitation that potentially applies in proceedingsthat are commenced after the Act's June 30, 2002 effective date.See 28 U.S.C. § 1658. The new limitation period covers privaterights of action that involve "a claim of fraud, deceit,manipulation, or contrivance in contradiction of a regulatoryrequirement concerning the securities laws as defined in Section3(a)(47) of the Securities Exchange Act of 1934."28 U.S.C. § 1658. The parties disagree as to whether the two-year limitationperiod applies to plaintiffs' Securities Act claims. I decline toresolve this issue because I determine that the claims should notbe dismissed even if they are subject to only a one-yearlimitation period.
7. The First Circuit has explained that "storm warnings" exist"[w]hen telltale warning signs augur that fraud is afoot," suchthat if the warning signs are "sufficiently portentous," theymay, "as a matter of law be deemed to alert a reasonable investorto the possibility of fraudulent conduct." Young v. Lepone,305 F.3d 1, 8 (1st Cir. 2002).
8. Plaintiffs' claims are also subject to statutes of repose.The Sarbanes-Oxly Act extended the repose period from three yearsto five years for private rights of action that are asserted inproceedings that are commenced after July 30, 2002 and thatinvolve "a claim of fraud, deceit, manipulation, or contrivanceof a regulatory requirement concerning the securities laws asdefined in Section 3(a)(47) of the Securities Exchange Act of1934." 28 U.S.C. § 1658. The parties disagree as to whether theSarbanes-Oxly Act applies to plaintiffs' Securities Act claims. Idecline to resolve this dispute now because it appears that few,if any, of plaintiffs' claims would be substantially affected bythe resolution of this dispute. Defendants may raise thisargument later if they can demonstrate that a ruling from thecourt would significantly affect the scope of discovery, thepossibility of settlement, or the nature of the trial.