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ENDO v. ALBERTINE

September 9, 1994

HENRY T. ENDO et al., Plaintiffs,
v.
JOHN M. ALBERTINE, et al., Defendants.


HOLDERMAN


The opinion of the court was delivered by: JAMES F. HOLDERMAN

JAMES F. HOLDERMAN, District Judge:

 Plaintiffs Henry T. Endo, John Lesch and Frank Tracy, on behalf of themselves and a class of similarly situated individuals, *fn1" initially filed a nine-count complaint against defendants Fruit of the Loom, Inc. ("FOL"), various directors and officers of FOL including John M. Albertine, William F. Farley, William K. Hall, Richard M. Cion, Douglas M. Kinney, and Robert J. Meier (collectively referred to as "FOL defendants") accounting firms Arthur Andersen & Co. and Ernst & Young, and investment banking firms Drexel Burnham Lambert Inc., *fn2" Merrill Lynch Capital Market, Shearson Lehman Hutton Inc., and Dean Witter Reynolds, Inc. (collectively referred to as "Underwriter defendants") *fn3" alleging violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) et seq. ("1934 Act"), and Rule 10b-5 promulgated thereunder (Count I); violations of §§ 11, 12(2) and 17(a) of the Securities Act of 1933, 15 U.S.C. § 77a et seq. ("1933 Act") (Counts II, III and VIII); common law fraud (Count IV); violations of the Illinois Consumer Fraud Act (Count V); negligence (Count VI); violations of the Illinois "Blue Sky" Act (Count VII); and breach of fiduciary duty (Count IX).

 In an order dated January 29, 1993, United States District Judge James H. Alesia found that the allegations contained in PP 34(c), (d), (e), (f), and 35(a) and (b) of plaintiffs' complaint failed to allege material misrepresentations or omissions of material facts, and dismissed all counts in the complaint to the extent the claims relied on these paragraphs. See Endo v. Albertine, 812 F. Supp. 1479, 1498 (N.D. Ill. 1992) ("Endo I"). In addition, Judge Alesia dismissed Count III as to the accounting firm defendants and the FOL defendants and Counts VI, VII, VIII and IX as to all defendants for failure to state a claim upon which relief can be granted.

 All defendants have now separately filed motions for summary judgment as to all five remaining counts of plaintiffs' complaint. Plaintiffs have also moved for partial summary judgment on Count II against defendant FOL and the Underwriter defendants. In addition, the FOL defendants have filed a motion to strike the affidavit of Paul Grier submitted by plaintiff in opposition to defendants' motions for summary judgment. For the reasons stated below, the FOL defendants' motion for summary judgment is denied, the FOL defendants' motion to strike is denied, the Underwriter defendants' motion for summary judgment is denied, defendant Arthur Andersen's motion for summary judgment is granted, defendant Ernst & Young's motion for summary judgment is denied, and plaintiffs' motion for summary judgment is denied.

 BACKGROUND

 Plaintiffs allege that, through a Registration Statement and Prospectus, the various defendants disseminated false and misleading statements and failed to disclose material facts in relation to a public offering of securities made by FOL on March 3, 1987. On March 3, 1987, FOL made a public offering consisting of 31,050,000 shares, including over-allotment options at $ 9.00 per share, of Class A Common Stock, $ 60 million principal amount of 6-3/4% convertible subordinated debentures due in the year 2002, and $ 280 million principal amount, including over-allotment options, of 10-3/4% senior subordinated notes due in 1995. Plaintiffs allege that in the Registration Statement and Prospectus, defendants made various material misrepresentations and omissions of fact which purportedly inflated the price of the securities issued. Plaintiffs claim that they were induced by the allegedly false statements contained in FOL's Registration Statement and Prospectus to purchase shares of FOL stock at inflated prices.

 More specifically, plaintiffs' claims in Counts I through V are all based on the same set of the following allegations:

 
(a) The defendants failed to disclose that the Company would be required to pay over $ 100 million to the IRS for prior years income tax deficiencies, including failing to disclose that amount of potential accumulated interest thereon and that the Company would have to borrow funds to pay the IRS;
 
(b) The defendants failed to disclose that the Company had retained substantial contingent environmental liabilities of its former subsidiaries and would be required to make substantial expenditures to fund these liabilities;
 
(c) The defendants failed to disclose that the Company was operating at or near 100% capacity and would be required to borrow substantial additional funds for capital expansion.

 While not all the elements of each of the remaining claims contained in plaintiffs' complaint are identical, each claim requires proof of a misrepresentation or omission of a material fact and proof of a loss caused by the alleged misrepresentation or omission. Therefore, if the undisputed facts establish that defendants made no material misrepresentations or omissions in the Registration Statement and Prospectus or that plaintiffs suffered no loss as a result of any misrepresentation or omission, defendants would be entitled to summary judgment on the remaining five counts of plaintiffs' complaint.

 I. Tax Obligations

 Plaintiffs allege that defendants violated § 10(b) of the 1934 Act by failing to fully disclose the future tax obligations of FOL. *fn4" More specifically, plaintiffs claim that defendants knew but failed to disclose in the Registration Statement or Prospectus that FOL would be required to pay the IRS a cash payout in excess of $ 100 million in tax deficiencies for the tax years 1970-77, and that FOL would have to borrow funds to meet these tax obligations.

 The relevant provision of the Prospectus regarding tax obligations of FOL state as follows:

 
The Company has filed two petitions with the United States Tax Court contesting statutory notices of deficiencies. The first involves approximately $ 60,000,000 of alleged deficiencies covering the years 1970 through 1975, and the second approximately $ 45,000,000 for the years 1976 and 1977. In addition, the IRS has recently assessed the Company approximately $ 93,000,000 for alleged deficiencies covering the years 1978 through 1980. The IRS is currently examining the Company's tax returns for the years 1981 through 1983. The Company believes that its ultimate deficiency, before interest, will be substantially less than the amounts asserted and that it has adequately provided for any additional taxes and interest.

 Income Taxes, Notes To Consolidated Financial Statements (Prospectus), at F-17, Exhibits to Plaintiff Henry T. Endo's Local Rule 12(m) Statement ("Endo Exhibits"), Volume I, Ex. 1.

 Plaintiffs argue that the evidence clearly establishes that defendants were aware of FOL's tax obligations at the time the 1987 Registration Statement and Prospectus were issued. More specifically, plaintiffs claim that defendants' statement in the Prospectus that FOL's ultimate tax deficiency would be substantially less than the amounts asserted by the IRS was fraudulent because defendants knew in 1986 that within a year of the offering payment of approximately $ 120 million to the IRS for tax deficiencies was likely. In addition, plaintiffs claim that defendants' failure to list the tax deficiency on FOL's balance sheet as a current liability rather than under the heading "Noncurrent and deferred income taxes" was a material misrepresentation.

 II. Environmental Liabilities

 Plaintiffs claim that defendants failed to adequately disclose FOL's contingent liabilities arising from the business and operations of its former subsidiary, Velsicol Chemical. *fn5" More specifically, plaintiffs allege that the Prospectus failed to disclose environmental liabilities FOL retained from Velsicol. The relevant provisions of the Prospectus regarding the contingent environmental liabilities of FOL state as follows:

 Contingent Liabilities, Notes To Consolidated Financial Statements (Prospectus), at F-12 and F-13, Endo Exhibits, Volume I, Ex. 1.

 
The Company and its subsidiaries are involved in certain legal actions and claims on a variety of matters, including environmental matters relating to discontinued operations. The Company also remains contingently liable for $ 118,200,000 of certain obligations of former subsidiaries of the Company. The obligations of the former subsidiaries relate primarily to future minimum lease payments under operating leases and do not consider the value of the underlying leased property. It is the opinion of management that such actions and claims will not have a material effect on the business or financial conditions of the Company.

 Prospectus, Miscellaneous, Id. at 19.

 III. Operating Capacity

 Plaintiffs allege in P 34(g) of their complaint that defendants violated § 10(b) of the 1934 Act by failing to disclose that FOL was currently operating at or near 100% capacity and would be required to borrow substantial additional funds for future capital expansion. Defendants claim that FOL fully and truthfully disclosed the details of its intended capital expansion in the Prospectus and that it was obvious that the company would need to borrow substantial funds to finance the capital expansion. In addition, defendants argue that a reasonable investor would have realized that FOL was operating at or near 100% capacity because the Prospectus stated that FOL was undergoing capacity expansion.

 ANALYSIS

 I. Count I -- Central Bank

 Included in Count I is an allegation that certain defendants are secondarily liable under § 10(b) of the 1934 Act for their conduct in aiding and abetting the other defendants' fraudulent activity. In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 128 L. Ed. 2d 119, 114 S. Ct. 1439 (1994), however, the Supreme Court held that a private plaintiff may not maintain an aiding and abetting claim under § 10(b) of the 1934 Act. Id. at 1455. The Court found that the statutory text of § 10(b) which makes it "unlawful for any person, directly or indirectly, . . . to use or employ, in connection with the purchase or sale of any security . . ., any manipulative or deceptive device or contrivance," does not reach those who aid and abet a § 10(b) violation. Id. at 1448. The Court concluded that "it is inconsistent with settled methodology in § 10(b) cases to extend liability beyond the scope of conduct prohibited by the statutory text." Id.

 Following the Supreme Court's decision in Central Bank, the parties in this case agreed that plaintiffs' claims of aiding and abetting primary violations of § 10(b) contained in Count I of the complaint should dismissed. *fn6" The only remaining issue this court must resolve regarding Count I is whether the aiding and abetting claims should be dismissed with or without prejudice.

 Plaintiffs argue that because Congress is currently considering legislation which would effectively overrule the Central Bank decision retroactively, the court should dismiss the aiding and abetting claims without prejudice to allow plaintiffs to reassert these claims if Congress enacted this legislation. Defendants argue that dismissal with prejudice is appropriate in light of the fact that they have already filed a summary judgment motion as to Count I.

 The dismissal of a plaintiff's claim without prejudice under Federal Rule of Civil Procedure 41(a)(2) "is always within the discretion of the trial court." *fn7" Ratkovich v. Smith Kline, 951 F.2d 155, 157 (7th Cir. 1991) (citations omitted). "[A] district court may impose such terms and conditions [on the dismissal] as it believes necessary to protect the other parties from prejudice." Id. at 158. These terms and conditions are the "'quid pro quo of allowing the plaintiff to dismiss his suit . . . .'" Brandt v. Schal Associates, Inc., 854 F.2d 948, 955 (7th Cir. 1988) (quoting McCall-Bey v. Franzen, 777 F.2d 1178, 1184 (7th Cir. 1985)). The Seventh Circuit has listed several factors for a district court to consider in making a determination as to whether the defendant has suffered sufficient legal prejudice to justify a dismissal with prejudice. These factors include "'the defendant's effort and expense of preparation for trial, excessive delay and lack of diligence on the part of the plaintiff in prosecuting the action, insufficient explanation for the need to take a dismissal and the fact that a motion for summary judgment has been filed by the defendant." Ratkovich, 951 F.2d at 158 (quoting Pace v. Southern Express Co., 409 F.2d 331, 334 (7th Cir. 1969)).

 After careful consideration of the relevant factors, the court finds that plaintiffs' aiding and abetting claims should be dismissed without prejudice. It is clear that the plaintiffs have not shown a lack of diligence in prosecuting this action. In addition, the Supreme Court's recent decision In Central Bank provides a more than sufficient explanation for the need to voluntarily dismiss Count I. Although the defendants triggered one of the factors listed in Pace when they filed their motions for summary judgment, "'the enumeration of the factors to be considered in Pace is not equivalent to a mandate that each and every factor be resolved in favor of the moving party before dismissal is appropriate. It is rather simply a guide for the trial judge, in whom the discretion ultimately rests.'" Kovalic v. DEC Int'l, Inc., 855 F.2d 471, 474 (7th Cir. 1988) (quoting Tyco Laboratories, Inc. v. Koppers Co., Inc., 627 F.2d 54, 56 (7th Cir. 1980)).

 The court finds that because the aiding and abetting claims contained in Count I are being dismissed through no fault of the plaintiffs, plaintiffs have not caused defendants to suffer sufficient legal prejudice to justify a dismissal with prejudice. Therefore, the court dismisses the aiding and abetting claims contained in Count I as to defendant Ernst & Young without prejudice. *fn8"

 II. Defendants' Joint Motion For Summary Judgment

 A. Standard of Review

 Under Rule 56(c), summary judgment is proper "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. Pro. 56(c). In ruling on a motion for summary judgment, the evidence of the non-movant must be believed and all justifiable inferences must be drawn in the non-movant's favor. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S. Ct. 2505, 2513, 91 L. Ed. 2d 202 (1986). This court's function is not to weigh the evidence and determine the truth of the matter, but to determine whether there is a genuine issue for trial.

 A party who bears the burden of proof on a particular issue may not rest on its pleadings, but must affirmatively demonstrate, by specific factual allegations, that there is a genuine issue of material fact which requires a trial. Celotex Corp. v. Catrett, 477 U.S. 317, 324, 106 S. Ct. 2548, 2553, 91 L. Ed. 2d 265 (1986). There is no issue for trial "unless there is sufficient evidence favoring the non-moving party for a jury to return a verdict for that party." Anderson, 477 U.S. at 249, 106 S. Ct. at 2511.

 B. Standard of Materiality

 Under each of the five remaining counts, plaintiffs must establish that the Registration Statement and Prospectus used by FOL for the 1987 public offering of securities contained material misrepresentations or omissions. See 1933 Act, § 11(a), 15 U.S.C. § 77k; 1934 Act, § 10(b), 15 U.S.C. § 78j. "The Issue of materiality may be characterized as a mixed question of law and fact, involving as it does the application of a legal standard to a particular set of facts." TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 450, 96 S. Ct. 2126, 2132-33, 48 L. Ed. 2d 757 (1976). In considering whether summary judgment on the issue of materiality is appropriate, the court must consider "that the underlying objective facts, which will often be free from dispute, are merely the starting point for the ultimate determination of materiality." Id. "The determination requires delicate assessments of the inferences a 'reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact." Id. Only if the established misrepresentations or omissions are so obviously important or so obviously unimportant to an investor, that reasonable minds cannot differ on the question of materiality, can the ultimate issue of materiality be appropriately resolved as a matter of law at the summary judgment stage. Id. (citations omitted).

 The United States Supreme Court has explicitly defined the standard of materiality under securities statutes:

 
To fulfill the materiality requirement "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available."

 Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S. Ct. 978, 983, 99 L. Ed. 2d 194 (1988) (quoting TSC Industries, 426 U.S. at 448-49, 96 S. Ct. at 2132). "Materiality is a relative concept, so that a court must appraise a misrepresentation or omission in the complete context in which the author conveys it." In re Donald J. Trump Casino Securities Litigation, 7 F.3d 357, 369 (3rd Cir. 1993), cert. denied, 114 S. Ct. 1219 (1994). "In other words, a particular misrepresentation or omission ...


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