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CASHMAN v. COOPERS & LYBRAND

February 16, 1995

JOHN CASHMAN, ROBERT STOTLER, as next friend of Meagan Stotler, a minor, JAMES MULKA, individually, and as next friend of James Walter Mulka, Jr. and Tina Mulka, minors, NATHAN YORKE, as trustee of the Bankruptcy Estate of Karsten "Cash" Mahlmann, ROBERT BARTOSCH AND SUSAN BARTOSCH, ANTONIO CABEZAS, AMABLE ROSARIO, JAMIE ACOSTA and JOHN HERMAN, Plaintiffs,
v.
COOPERS & LYBRAND, Defendant.



The opinion of the court was delivered by: RUBEN CASTILLO

 This case involves allegations of securities fraud brought under Section 11 of the Securities Act of 1933, 15 U.S.C. § 77(k) (Count I); Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10(b)-5 (Count II). State law claims alleging common law fraud are also pled under principles of pendant jurisdiction. Defendant, Coopers & Lybrand ("Coopers"), has filed a Motion to Dismiss the Third Amended Complaint (# 33-1) pursuant to Federal Rule of Civil Procedure 12(b)(6). In addition, Plaintiffs have filed a Motion to Strike portions of Coopers' Rule 12(b)(6) Motion (# 37-1). For the reasons given below, Coopers' Motion to Dismiss is denied in part and granted in part. Plaintiffs' Motion to Strike is moot.

 BACKGROUND

 A motion to dismiss tests the sufficiency of the complaint, not the merits of the suit. Triad Ass'n, Inc. v. Chicago Housing Auth., 892 F.2d 583, 586 (7th Cir. 1989), cert. denied, 498 U.S. 845, 112 L. Ed. 2d 97, 111 S. Ct. 129 (1990). All well-pleaded facts are taken as true, all inferences are drawn in favor of the plaintiff and all ambiguities are resolved in favor of the plaintiff. Dawson v. General Motors Corp., 977 F.2d 369, 372 (7th Cir. 1992). In this case, Rule 9 of the Federal Rules of Civil Procedure requires the underlying facts of the lawsuit to be set out with particularity. Leatherman v. Tarrant County Narcotics Intelligence & Coordination Unit, 122 L. Ed. 2d 517, 113 S. Ct. 1160 (1993). The federal system of notice pleading does not favor dismissal for failure to state a claim. Gray v. County of Dane, 854 F.2d 179, 182 (7th Cir. 1988). In short, the only question is whether relief is possible under any set of facts that could be established consistent with the allegations. Bartholet v. Reishauer A.G., 953 F.2d 1073, 1078 (7th Cir. 1992)(citing Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957)). Plaintiffs' well-pleaded allegations, which the Court takes as true for purposes of this Motion, are as follows.

 I. Introduction

 Plaintiffs are currently shareholders and debenture holders of Stotler Group, Inc. ("SGI"), an Illinois corporation. Defendant Coopers & Lybrand is an independent public accountant and auditor for SGI and SGI's subsidiaries and affiliates. Coopers also acts as an advisor to SGI (Cmplt. P 1).

 In August of 1988, Plaintiffs were partners and investors in a commodities futures business owned by the Stotler & Co. Partnership (the "Stotler Partnership"). *fn1" (Cmplt. P 2). The Stotler Partnership was founded by Kenneth Stotler and other members of the Stotler family. (Cmplt. P 18). The Stotler family was actively engaged in the grain merchandising business for over seventy years. (Id.). During the 1970s, the Stotler Partnership restructured its operations to concentrate on futures commission brokerage activities (i.e., the commodities business). (Cmplt. P 19). Coopers had been the trusted advisor, independent public accountant and auditor for the Stotler Partnership since the early 1980s. (Cmplt. P 20).

 Throughout the 1980s, the Stotler partners saw their commodities futures business grow at a substantial rate and became highly profitable. (Id.). As a result of this success, the business became more and more complex, and the partners' personal assets became tied up by the business' capital needs. (Id.). Although the partners were experts in commodities trading, they were unsophisticated in the areas of complex accounting matters, regulatory net capital calculations and the management of customer accounts. (P 33a). Consequently, the partners became more and more dependent on Coopers for advice on how to manage their business. (P 20). By 1987-88, Coopers was playing an extremely influential role in guiding the Stotler Partnerships' business affairs. (Id.).

 II. The Incorporation of SGI

 First, Coopers advised the members of the Stotler Partnership to transfer substantially all of the Partnership's commodities business assets and liabilities to a newly formed non-public corporation, Stotler & Co., Inc. ("SGI"), and to make this transfer of assets in exchange for approximately 80% of the stock of a newly formed public corporation. This transfer is known to the parties as "the exchange." *fn2" (Cmplt. P 22). Pursuant to the exchange, the Partnership was to receive SGI stock for transfer into the partners' voting trust for the benefit of the partners and, after the expiration of the voting trust (which expired by its' own terms on August 21, 1990), transfer of the stock to the individual partners. The purpose of the exchange was to convert the partners/owners of the business (with unlimited risk) into shareholders/owners of the business (with limited risk). (Cmplt. P 22).

 Second, Coopers advised the members of the Partnership to sell additional shares of SGI stock and debentures to the public in an initial public offering ("IPO"), simultaneously with the exchange. (Cmplt. P 23). One purpose of the IPO was to secure a new source of regulatory capital so that SGI and its subsidiaries would have sufficient regulatory capital for the foreseeable future. (Cmplt. P 23). The combination of the exchange and the IPO is known to the Plaintiffs as the "Transaction."

 Coopers represented to the Partnership that this proposed Transaction would achieve the following results: (1) the transfer of the business assets and liabilities to SGI would result in SGI having a net book value of $ 6 million ("6M") on a pooling of interest basis before the IPO; and (2) the net proceeds from the IPO and SGI's internally generated funds would be sufficient to meet SGI's regulatory capital needs for the foreseeable future. (Cmplt. P 24). Because the Transaction involved complex and sophisticated issues, the Stotler Partnership relied on Coopers' expertise and authorized Coopers to go forward with structuring the Transaction. (Cmplt P 24).

 Based on Coopers' advice, SGI was incorporated on September 9, 1987. (Cmplt. P 26). As a result of this Transaction, the Stotler Partnership received an 80% majority interest in SGI and the remaining interest was sold in an IPO on August 2, 1988. (Cmplt. P 2). At the time the business went public, it was worth approximately $ 25,000,000 ("$ 25M"). (Cmplt. P 2). Within two years of the Transaction, the business was bankrupt. (Cmplt. P 2).

 III. Coopers' Role In The Transaction

 Coopers structured and played a central role in each aspect of the Transaction to ensure that SGI was formed to acquire the stock of Stotler & Company, an Illinois Corporation (the "Corporation"). (Cmplt. P 27). Coopers was also retained for the purpose of ensuring that the Partnership transferred to SGI assets and liabilities with a net book value of $ 6M. (Cmplt. P 28).

 Part of Coopers' role was to assist in the preparation of an agreement (the "Exchange Agreement") between the Partnership and SGI regarding the transfer of assets. The Exchange Agreement structured by Coopers contained the conditions Coopers recommended, including the requirement that the assets and liabilities transferred to SGI would have a net book value of $ 6M. (Cmplt. P 28). Coopers also structured the Transaction in such a way that the shareholders of Stotler Management Corporation ("SMC") *fn3" and Stotler Funds Inc. ("SFI") *fn4" (which consisted largely of the partners of the Partnership) would exchange all of their outstanding shares in SMC and SFI for shares of SGI common stock. (Cmplt. P 22). As a result of these transfers, the Corporation, SMC and SFI were to become wholly-owned subsidiaries of SGI. (Cmplt. P 27).

 Coopers also structured the Initial Public Offering ("IPO") by advising the drafters of the SGI Prospectus (the "Prospectus") *fn5" . (Cmplt. P 30). During preparation of the Prospectus, Coopers again represented to the Stotler Partnership that: (1) the transfer of the business assets and liabilities to SGI would result in a net book value of $ 6M on a pooling of interest basis; and (2) the net proceeds from the IPO and SGI's internally generated funds would be sufficient to meet SGI's net capital needs for the foreseeable future. (Cmplt. P 32).

 Relying on these statements, the Partnership incorporated this information into three areas of the Prospectus: (1) at page F-20, the "Notes and Statement of Financial Condition," the Partnership stated that, "the Partnership will transfer net assets with a value equal to $ 6M . . . to SGI . . . "; (2) at page 4, the Prospectus provided summary financial data regarding pro forma net income "adjusted to reflect, as of January 1, 1987, the transfer from the Partnership of net assets . . . equal to $ 6M and net assets per share based on unaudited pro forma balances as of March 31, 1988; and (3) at page 8, under the heading "DILUTION," the Prospectus listed a number of net tangible asset values per share which could only be correct if the $ 6M transfer was effective. (Cmplt. P 35).

 These statements, which ultimately proved to be misstatements, were made by the Partnership in reliance upon Coopers & Lybrand's expertise, as indicated in the "expertising" section of the Prospectus. (Cmplt. P 35). At pages 41 and 42 of the Prospectus, under the heading "Experts," the Partnership stated:

 
The statement of financial condition of Stotler Group, Inc. as of March 31, 1988, the statements of financial condition of Stotler & Co. (a Partnership) as of December 31, 1986 and 1987, and the statement of income, changes in the Partnership capital and changes in the financial position for each of the five years in the period ending December 31, 1987, and financial statement schedules, included in the Prospectus and in the Registration Statement, have been included therein in reliance on the reports of ...

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