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EMCORE CORP. v. PRICEWATERHOUSECOOPERS LLP
July 6, 2000
EMCORE CORPORATION, PLAINTIFF,
PRICEWATERHOUSECOOPERS LLP, NORMAN ADAMS, SHERIDAN RIGGS, JR., EDWARD CAMERON, WILLIAM DRISCOLL, JR., J. MICHAEL FARRELL, JAMES KOVACS, LENNART LINDEGREN, ROLAND MAAS, JAMES SCHIRO AND WALTER RICCIARDI, DEFENDANTS.
The opinion of the court was delivered by: Walls, District Judge.
Plaintiff Emcore Corporation, a publicly-held corporation based in
Somers, New Jersey, designs and manufactures compound semiconductor
wafers and devices used in the production of electronic goods. This
action arises, according to plaintiff, out of the concerted illegal
actions taken by defendants PricewaterhouseCoopers LLP ("PWC"), certain
PWC partners, and PWC's in-house counsel Walter Ricciardi.
The core of plaintiffs charges is that PWC performed auditing services
for Emcore while PWC partners owned Emcore stock, in violation of federal
and state regulations mandating that auditors be independent of their
clients. Emcore alleges that defendants concealed such violations and
misrepresented the nature and extent of an investigation into PWC's
business practices by the Securities Exchange Commission ("SEC").
Plaintiffs amended complaint asserts counts against all defendants under
the federal RICO statute, 18 U.S.C. § 1962(c) (Counts I and II), New
Jersey state RICO, N.J.S.A. § 2C:41-2(c) (Count IV), federal and
state RICO conspiracy (Counts III and V), as well as state law claims for
fraud, negligent misrepresentation, the New Jersey Consumer Fraud Act,
breach of fiduciary duty, malpractice, and breach of contract (Counts
Briefly, the parties' history together is as follows: In 1984, Emcore
formed as a limited partnership, and the defendant PWC partners purchased
interests in it. And in 1986, when Emcore became a corporation, the PWC
partners converted their limited partnerships into Emcore stock and
warrants. Also in that year, Emcore retained Coopers & Lybrand
("Coopers") to audit its 1986 fiscal year financial statements. Coopers
served as Emcore's auditor each fiscal year from 1986 through 1997.
Emcore asserts that it chose not to retain Price Waterhouse as its
initial auditors because Price Waterhouse, through its partners'
investments in Emcore, was, not independent.
In July 1998, Price Waterhouse and Coopers merged to form
PricewaterhouseCoopers. Soon after, PWC began its audit of Emcore's 1998
fiscal year financial statements, which plaintiff claims was crucial to
its plan to conduct a secondary public offering in early 1999. Emcore
planned to use the capital thus raised to fund a joint venture with
On January 14, 1999, unknown to Emcore, the SEC entered a Settlement
Order against PWC which recited that the firm (and its predecessor
Coopers) had repeatedly violated applicable auditor independence
regulations. What happened next is disputed.
Emcore charges that the defendants belatedly disclosed the independence
violations on January 29, 1999. PWC partner Brendan Dougher informed
Emcore's CEO Tom Werthan on February 1, 1999-the day before Emcore was to
file its Form S-3 Registration Statement with the SEC—that PWC
would not sign its consent for Emcore to incorporate past audit opinions
(the "consent") into the SEC filing until all partners had disposed of
their Emcore holdings. Am. Compl. ¶ 54. Even then, plaintiff claims,
defendants continued their pattern of concealment by misrepresenting
facts about the SEC investigation and assuring Emcore that its upcoming
public offering would not be further delayed. Id. ¶ 55. Further,
despite defendants' representations that PWC partners had fully divested
their Emcore stock by February 3 or 4, 1999, some PWC partners owned
Emcore shares as late as mid-March of that year. Id. ¶ 75. By the
time Emcore saw the full picture, the SEC announced in May that Emcore
would have to re-audit its 1998 financial statements, and Emcore retained
Deloitte & Touche LLP to do so, plaintiffs public offering had been
delayed to June 1999.
On the other hand, the PWC defendants claim that as soon as they became
aware of the compliance issues, they advised Emcore of the need to
disclose the violations to the SEC and promptly disposed of their Emcore
holdings. PWC Br. at 2. On February 4, 1999, PWC signed the consent and
Emcore filed with the SEC immediately afterward. Defendants concede that
SEC clearance process was delayed, but insist that the delay was partly
because the Commission had other substantive concerns about Emcore, and
that they never predicted whether a re-audit would be required. In
short, defendants argue that they acted promptly to correct any
violations, committed no fraud, and cannot be held responsible for the
delay in Emcore's public offering.
On June 11, 1999, Emcore consummated its public offering of 3,897,441
shares of common stock at a price of $19.00 per share.
Defendants now move to dismiss the R.Civ.P. 12(b)(6) and 9(b). The
court heard oral argument on June 26, 2000.
I. Standard for Motion to Dismiss
On a motion to dismiss pursuant to Fed. R.Civ.P. 12(b)(6), the court is
required to accept as true all allegations in the complaint and all
reasonable inferences that can be drawn therefrom, and to view them in
the light most favorable to the nonmoving party. See Oshiver v. Levin,
Fishbein, Sedran & Berman, 38 F.3d 1380, 1384 (3rd Cir. 1994). The
question is whether the plaintiff can prove any set of facts consistent
with its allegations that will entitle it to relief, not whether it will
ultimately prevail. Hishon v. King & Spalding, 467 U.S. 69, 73, 104
S.Ct. 2229, 81 L.Ed.2d 59 (1984). While a court will accept well-plead
allegations as true for the purposes of the motion, it will not accept
unsupported conclusions, unwarranted inferences, or sweeping legal
conclusions cast in the form of factual allegation. See Miree v. DeKaib
County, Ga., 433 U.S. 25, 27 n. 2, 97 S.Ct. 2490, 53 L.Ed.2d 557 (1977).
Moreover, the plaintiff must set forth sufficient information to outline
the elements of its claims or to permit inferences to be drawn that these
elements exist. See Fed.R.Civ.P. 8(a)(2); Conley v. Gibson, 355 U.S. 41,
45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957).
Emcore alleges that it suffered two distinct types of injury as a
direct result of defendants' RICO violations: 1) it paid PWC for an audit
"which ultimately was worthless" and was forced to retain and pay
Deloitte & Touche to re-audit its 1998 financial statements and 2) its
public offering was delayed, which damaged its relationships with its
business venture partners, including General Electric, lenders, vendors
and underwriters. Am. Compl. ¶¶ 46, 104.*fn1
Defendants initially raise a standing argument: they argue that because
their alleged acts did not proximately cause Emcore's injuries, the
federal and state RICO claims should be dismissed.
A civil RICO plaintiff "only has standing if, and can only recover to
the extent that, [it] has been injured in [its] business or property by
the conduct constituting the violation." Sedima, S.P.R.L. v. Imrex Co.,
Inc., 473 U.S. 479, 496, 105 S.Ct. 3275, 87 L.Ed.2d 346 (1985). Under
Supreme Court precedent, simple "but
for" causation does not establish RICO standing. Holmes v. Sec. Investor
Protection Corp., 503 U.S. 258, 267, 112 S.Ct. 1311, 117 L.Ed.2d 532
(1992). Instead, a RICO plaintiff must show that defendants' acts
proximately caused its injuries. Id. The Holmes Court recognized that this
inquiry, analogous to that into antitrust standing, is a prudential one:
[W]e use "proximate cause" to label generically the
judicial tools used to limit a person's responsibility
for the consequences of that person's own acts. At
bottom, the notion of proximate cause reflects "ideas
of what justice demands, or of what is
administratively possible and convenient."
Id. at 268-69, 112 S.Ct. 1311 (citations omitted). Fortunately, the Court
then explained three concerns which guide the standing determination:
First, the less direct an injury is, the more
difficult it becomes to ascertain the amount of
plaintiffs damages attributable to the violation, as
distinct from other, independent, factors. Second,
quite apart from problems of proving factual
causation, recognizing claims of the indirectly
injured would force courts to adopt complicated rules
apportioning damages among plaintiffs removed at
different levels of injury from the violative acts, to
obviate the risk of multiple recoveries. And,
finally, the need to grapple with these problems is
simply unjustified by the general interest in
deterring injurious conduct, since directly injured
victims can generally be counted on to vindicate the
law as private attorneys general, without any of the
problems attendant upon suits by plaintiffs injured
Id. at 269-70, 112 S.Ct. 1311 (citing, inter alia, Assoc. Gen.
Contractors, 459 U.S. 519, 103 S.Ct. 897, 74 L.Ed.2d 723 (1983)). This
analysis applies to both federal and New Jersey RICO claims. See, e.g.,
Callahan v. A.E.V., Inc., 182 F.3d 237, 260 (3rd Cir. 1999) (federal
RICO); Interchange State Bank v. Veglia, 286 N.J. Super. 164, 668 A.2d 465,
472 (1995) (state RICO).
The Third Circuit has recently decided several illustrative cases. In
Steamfitters Local Union No. 420 Welfare Fund v. Philip Morris, Inc.,
171 F.3d 912 (3rd Cir. 1999), plaintiff union health and welfare funds
sued tobacco companies and industry organizations, alleging that the
defendants were liable for the funds' costs to treat their participants'
smoking-related illnesses. The Circuit Court rejected plaintiffs'
theory, reasoning: "[I]f the Funds are allowed to sue, the court would
need to determine the extent to which their increased costs for
smoking-related illnesses resulted from the tobacco companies' conspiracy
to suppress health and safety information, as opposed to smokers' other
health problems, smokers' independent . . . decisions to smoke, smokers'
ignoring of health and safety warnings. . . . [T]his, causation chain is
much too speculative and attenuated to support a RICO claim." Id. at
Likewise, the Third Circuit denied standing to plaintiffs in Callahan
v. A.E.V., Inc., 182 F.3d 237, 260 (3rd Cir. 1999). There plaintiff "mom
and pop" beer distributorships alleged that their supermarket-style
competitor, "Beer World," had undercut their prices and injured their
businesses by operating more than one distributorship in violation of the
Pennsylvania Liquor Code. Apparently, the owner of Beer World had
misrepresented his ownership of a chain of stores by filing false
affidavits with the Pennsylvania Liquor Control Board (LCB). See id. at
240. The Circuit Court concluded that the LCB and the Commonwealth of
Pennsylvania were the "direct victims" of the defendants' actions and
that the plaintiffs' losses were "at most derivative" of the governmental
injuries. Id. at 261.
The defendants' analysis cannot now overcome the allegations of the
amended complaint. Emcore alleges that defendants' disclosure of
independence violations, coupled with their refusal to consent to
incorporation of past audit opinions, pushed the SEC filing date from
February 2 to February 4, 1999. More significantly, the SEC determined
during its clearance process that PWC's audit was deficient because of
the independence violations, and required Emcore to obtain reaudited
financial statements for 1998, by another auditor. Id. ¶ 76. Emcore
was not able finally to amend its registration statement until June 9,
1999. Id. ¶ 78. This narrative leads to the conclusion that Emcore
has standing to bring its RICO claims.
Focusing on the causal link between defendants' alleged racketeering
acts and plaintiffs injuries, see Shearin v. E.F. Hutton Group, Inc.,
885 F.2d 1162 (3rd Cir. 1989), overruled on other grounds, Beck v.
Prupis, ___ U.S. ___, ___, 120 S.Ct. 1608, 1613, 146 L.Ed.2d
561 (2000), the court reads the complaint to allege that Emcore would
earlier have been able to secure a re-audit absent defendants' acts of
misrepresentation and concealment. In short, the court can, and must on a
motion to dismiss, infer that the defendants' actions postponed Emcore's
public offering. See Am. Compl. ¶ 67. (Of course, on a motion to
dismiss, the court can and does not credit the defendants' vague
assertion that the SEC had other nonaudit-related concerns about Emcore
which delayed the clearance process.) PWC Br. at 10 n. 7. Here, Emcore's
alleged injuries were not derivative, but direct. See Spitzer v.
Abdelhak, No. 98-6475, 1999 WL 1204352 (E.D.Pa. Dec.15, 1999); cf.
Callahan, 182 F.3d at 262 n. 16.
Additionally, defendants do not dispute the link between their alleged
actions, Emcore's economic injury in paying for a useless audit, and
Emcore's need to pay another accounting firm to redo PWC's work.
Plaintiffs audit expenses were an obvious direct injury and provide an
alternate basis for this holding.
The defendants' motion to dismiss Emcore's federal and state RICO
claims for lack of standing is denied.
III. Pleading Predicate Acts
To plead a violation of 18 U.S.C. § 1962(c), Emcore must allege: 1)
the conduct 2) of an enterprise 3) through a pattern 4) of racketeering
activity. Sedima, 473 U.S. at 496, 105 S.Ct. 3275 (quoted in Rehkop v.
Berwick Healthcare Corp., 95 F.3d 285, 289 (3rd Cir. 1996)). Defendants
seek to dismiss Emcore's substantive federal and state RICO claims
(Counts I, II and IV) because plaintiff failed to plead each defendant's
participation in at least two "predicate acts" of racketeering activity.
*fn2 See Banks v. Wolk, 918 F.2d 418, 421 (3rd Cir. 1990); State v.
Ball, 141 N.J. 142, 163, 661 A.2d 251 (N.J. 1995). They claim first that
Emcore has fallen short, both substantively and under Fed.R.Civ.P. 9(b),
of identifying actionable predicate offenses. Further, defendants argue
that plaintiff failed to attribute specified fraudulent acts to each
named defendant, but has instead impermissibly "lumped them
together." In response, Emcore relies on the federal doctrine of notice
pleading, see Fed.R.Civ.P. 8, and the fulsome allegations of the amended
Plaintiff grounds the challenged counts in allegations of federal mail
fraud, 18 U.S.C. § 1341, and wire fraud, 18 U.S.C. § 1343. These
violations constitute predicate offenses under federal RICO,
18 U.S.C. § 1961 (1), and the state law, N.J.S.A. 2C:41-1(2)
(incorporating by reference federal list of racketeering activities). To
allege mail or wire fraud, plaintiff must describe: 1) the existence of a
scheme to defraud, 2) the use of the mails or wires in furtherance of the
fraudulent scheme,*fn3 and 3) culpable participation by the defendants. See
U.S. v. Pearlstein, 576 F.2d 531, 534 (3rd Cir. 1978); U.S. v. Hannigan,
27 F.3d 890, 892 (3rd Cir. 1994); see also United States v. Frey,
42 F.3d 795, 797 (3rd Cir. 1994) (noting parallelism between mail and
wire fraud statutes).
"To be part of the execution of [mail] fraud . . . the use of the mails
need not be an essential element of the scheme. It is sufficient for the
mailing to be `incident to an essential part of the scheme,' or `a step
in [the] plot.'" Schmuck v. United States, 489 U.S. 705, 710-11, 109
S.Ct. 1443, 103 L.Ed.2d 734 (1989) (citations omitted). Further, the
Third Circuit notes that even "completely `innocent' mailings" (those
that contain no false information) can satisfy the mailing element. Kehr
Packages, Inc. v. Fidelcor, Inc., 926 F.2d 1406, 1415 (3rd Cir. 1991)
(quoting Schmuck v. United States, 489 U.S. 705, 715, 109 S.Ct. 1443, 103
L.Ed.2d 734 (1989)); see also Tabas v. Tabas, 47 F.3d 1280, 1295 n. 18
(3rd Cir. 1995). Thus, "[a] scheme or artifice to defraud `need not be
fraudulent on its face, but must involve some sort of fraudulent
misrepresentations or omissions reasonably calculated to deceive persons
of ordinary prudence and comprehension.'" Kehr Packages, 926 F.2d at 1415
(quoting Pearistein, 576 F.2d at 535).
The amended complaint contains, inter alia, the following allegations:
A. Defendant PWC Partners*fn4
• Professional accounting standards as expressed by SEC
regulations, the New Jersey Administrative Code, the American Institute
of Certified Public Accountants ("AICPA") and Generally Accepted
Accounting Standards ("GAAS") mandate that accountants be "independent
in the performance of professional services." "According to the AICPA,
an accounting firm is not independent if, during the period of a
professional engagement or at the time of expressing an opinion, a
member of the accounting firm has any direct or material indirect
financial indirect interest in the client." ¶¶ 23, 25-27.
• In early December 1997 after the Price Waterhouse/Coopers &
Lybrand merger was announced, Emcore's Chief Financial Officer Tom
Werthan telephoned Coopers audit partner Brendan Dougher to verify that
PWC could continue to act as Emcore's independent auditors after the
merger. Dougher claimed that all Price Waterhouse partners owning
Emcore stock would divest their Emcore holdings before the merger, that
both Coopers and Price Waterhouse were "taking all steps necessary to
ensure PWC's independence," and that PWC would in fact be independent
with respect to Emcore. ¶ 30.
• Defendant PWC partners including Cameron, Driscoll, Farrell and
Lindegren exercised warrants to purchase additional Emeore stock at
approximately $4 per share (significantly below market prices) both
before and after announcement
of the merger, and as late as January 1998. ¶¶ 28-33, 45. In January
1998, PWC partner Farrell telephoned Werthan to discuss his ownership
of Emcore stock. He suggested that Emcore should "do something" to
"make whole" the Price Waterhouse partners who were required to dispose
of their holdings in Emcore, and would thus recognize taxable gains.
¶ 33. Farrell did not dispose of his shares after that
conversation, but instead exercised 8,000 warrants to, purchase more
Emcore stock on January 30, 1998. Id. Werthan received "similar phone
calls" from other, unspecified PWC partners until he informed Dougher
that such calls were not appropriate. ¶ 34.
• On July 1, 1998, the day the merger was consummated, "some or all
of the PWC Partners" owned an aggregate 140,000 shares of Emcore common
stock. ¶¶ 36-37.
• In September 1998, soon after PWC began its audit of Emcore's
1998 financial statements, Dougher responded to another phone call from
Werthan by repeating his representation that PWC was in compliance with
applicable independence regulations. ¶¶ 38, 40, 44. However,
plaintiff alleges, defendant PWC partners including Schiro, Adams,
Biggs, Cameron, Driscoll, Farrell, Kovacs, Lindegren and Maas still
held Emcore stock during this period. ¶ 41.
• And on January 8, 1999, Dougher attended an "all hands"
organizational meeting of Emcore to prepare for the planned February 2
SEC filing. He did not then disclose that PWC's 1998 audit had violated
independence rules. ¶ 47.
• On January 29, 1999, Dougher informed Werthan by phone that PWC
had not been independent during its 1998 audit of Emcore, and that
certain PWC partners continued to hold Emeore stock to the present
date. ¶ 53.
• On February 4, 1999, Dougher phoned Emcore's outside counsel to
inform her that all of the PWC partners had finally disposed of their
Emcore stock. ¶ 59. On February 8, Dougher mailed a letter to
Emcore's Audit Committee which represented that the PWC partners had
disposed, of their Emcore holdings "on or before February 3, 1999."
¶ 61. Plaintiff alleges that, though many PWC partners sold their
Emcore holdings between February 2-4, 1999, see ¶¶ 56-58, defendants
Lindegren and Maas did not divest their Emcore stock until mid-March
1999. ¶ 75.
• The SEC's Settlement Order of January 14, 1999 reported the
Commission's findings that PWC had repeatedly violated the independence
rules of SEC regulations and GAAS. Am. Compl. Exh. A. The SEC required
PWC to perform an internal investigation of all independence
violations, supervised by an independent firm, and to report any
additional violations to the Commission and the audit client involved.
• In response, PWC partners self-reported over 8,000 independence
violations, involving approximately 600 clients. Almost half of PWC's
partners reported at least one such violation. ¶ 85. However,
despite a warning from the SEC that criminal penalties might result
from false reporting, the SEC found that 77.5% of PWC partners selected
during a random sample failed to report at least one independence
violation. ¶¶ 81, 87.
• In September 1998, when PWC began the Emcore audit, Emcore common
stock was priced at $7.00 per share. ¶ 42. By early February 1999,
when most partners divested their holdings, Emcore was trading at a
high of $24.25 per share. ¶¶ 56-58.*fn5
The PWC partners characterize these allegations as insufficient under
Fed. R.Civ.P. 12(b)(6): "Purchasing, owning or selling Emcore stock . .
. does not constitute mail or wire fraud." PWC Br. at 12. Further, they
contend that the telephone calls to Werthan by Farrell and other unnamed
partners allegedly suggesting that Emcore "make them whole" did not
involve misrepresentations, and thus are not legally cognizable. PWC Br.
The court disagrees. Though the plaintiff has not alleged that the PWC
partners personally and affirmatively misrepresented their ownership of
Emcore stock, Emcore's allegations about the extent, timing and
profitability of these defendants' holdings, and Dougher's repeated
inaccurate assurances to the contrary, raise the inference that either
the defendant partners or PWC itself chose to actively conceal material
facts. This inference is strengthened by plaintiffs allegations that,
according to the SEC, many PWC partners failed to report accurately their
holdings despite the threat of criminal sanctions. The court finds it
appropriate to allow plaintiff discovery on the issue of the partners'
knowledge of and involvement in these nondisclosures. Concerning the
phone conversations between the partners and Werthan, the court repeats
that even "innocent" use of the wires can base an actionable fraud
claim; plaintiff need allege only that the interstate phone calls were "a
step in [the] plot." Kehr Packages, 926 F.2d at 1415; Schmuck, 489 U.S.
at 710-11, 109 S.Ct. 1443. Here Emcore persuasively argues that the
partners could not have continued to misrepresent their independence, and
buy and sell shares of Emcore, without use of the interstate wires and
mails. Emcore Br. at 37.
The PWC partners' motion to dismiss for failure to allege predicate
acts is denied.
Emcore makes the following charges against PWC, most of which concern
PWC partner Dougher and outside counsel Robert McCaw of Wilmer Cutler &
Pickering in Washington, D.C.:
• In October 1998, Dougher mailed or caused to be mailed to Emcore
an engagement letter relating to the 1998 audit, by which PWC agreed to
perform its audit "in accordance with generally accepted auditing
standards." ¶ 43. In December 1998, after the audit had been
completed, PWC signed and mailed to Emcore its audit letter, which
purportedly enclosed a "report of independent accountants" for an audit
conducted "in accordance with generally accepted accounting stardards."
• In response to direct inquiries by Werthan, Dougher repeatedly
represented that PWC would serve, and had served, as an independent
auditor, and that the partnership would take all steps necessary to
ensure independence. ¶¶ 30, 34, 40. Yet, "Dougher was well aware of