The opinion of the court was delivered by: Walls, United States District Judge
Plaintiff Emcore Corporation, a publicly-held corporation based in Somerset, 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 plaintiff's 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"). Plaintiff's 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 VI - XI).
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 General Electric.
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, plaintiff's 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 regulatory 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 amended complaint pursuant to Fed. 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 non-moving 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 (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. DeKalb County, Ga., 433 U.S. 25, 27 n.2 (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 (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 (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 (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 (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 plaintiff's 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 more remotely. Id. at 269-70 (citing, inter alia, Assoc. Gen. Contractors, 459 U.S. 519 (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, 668 A.2d 465, 472 (N.J. Super. Ct. App. Div. 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 933.
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.
Defendants analogize the present case to those precedents, arguing that the SEC's intervening actions and plaintiff's own shortcomings preclude liability. They first submit that Emcore's public offering was contingent on the SEC's clearance of its registration statement and that the SEC's independent decision to strictly enforce its rules and require a re-audit broke the chain of causation. Next, the defendants claim that the re-audit did not cause the postponement, "because the clearance was delayed in any event by the SEC's review of other issues relating to Emcore." PWC Br. at 10 n.7. And finally, they allege that, though the SEC finally approved Emcore's application in May 1999, Emcore did not proceed with its public offering until the following month. Id.
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 re-audited 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 plaintiff's injuries, see Shearin v. E.F. Hutton Group, Inc., 885 F.2d 1162 (3rd Cir. 1989), overruled on other grounds, Beck v. Prupis, 120 S. Ct. 1608, 1613 (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 non-audit-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. Plaintiff's 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 (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 (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 complaint.
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 (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 (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 Pearlstein, 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 Emcore 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 Emcore 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. ¶ 80.
§ 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. at 12-13.
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 plaintiff's 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. 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 ...