The opinion of the court was delivered by: JOHN LIFLAND, Senior District Judge
MEMORANDUM AND ORDER (Lernout, Hauspie, and Bastiaens)
Plaintiffs Rocker Management, LLC, Rocker Partners, LP, Rocker
Offshore Management Company, Inc., and Compass Holdings Ltd.
(collectively, "Rocker") have asserted claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 (the
"Exchange Act"), 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5,
17 C.F.R. § 240.10b-5, promulgated thereunder by the United States
Securities and Exchange Commission ("SEC"), against Defendants
Jozef Lernout, Pol Hauspie, Gaston Bastiaens, Carl Dammekens,
Allan Forsey, Ellen Spooren, Erwin Vandendriessche, Gerald
Calabrese,*fn1 Klynveld Peat Marwick Goerdeler
Bedrijfsrevisoren (a/k/a KPMG Bedrijfsrevisoren or KPMG Belgium),
KPMG International ("KPMG"), KPMG UK, KPMG LLP, Paul Behets, and
SG Cowen Securities Corporation ("Cowen") (collectively,
"Defendants").*fn2 Plaintiffs also bring state law claims
for tortious interference with prospective economic advantage,
conspiracy to tortiously interfere, and aiding and abetting
Before the Court are the Motions of individual defendants Jozef
Lernout, Pol Hauspie, and Gaston Bastiaens ("Individual
Defendants") to dismiss Counts I, II, V, VI, and VII of the First
Amended Complaint and Jury Demand for failure to state a claim
under Federal Rules of Civil Procedure 12(b)(6), 9(b), and the
Private Securities Litigation Reform Act,
15 U.S.C. § 78u-4(b)(1), (2) (the "PSLRA" or "Reform Act").*fn3 For the
reasons set forth below, these motions will be denied.
The facts are taken from Plaintiffs' 315-paragraph, 132-page
Amended Complaint. Lernout & Hauspie Speech Products N.V. ("L&H"
or "the Company"), formed in 1987 by Jozef Lernout and Pol
Hauspie, was a Belgian-American company that specialized in speech recognition, text-to-speech
conversion, and digital speech compressions. (Am. Comp. ¶¶ 1,
12). L&H's stock was traded on American and European exchanges.
Since its initial public offering in 1995, L&H reported rapid
growth in its revenues due to its domination of its software
market, its acquisition of other companies, and its development
of revolutionary and "industry first" products. (Am. Compl. ¶
32). Following public announcements in late 1999 and the first
quarter of 2000 concerning both its reported revenues and its
products, in addition to "strong buy" recommendations from L&H's
investment banker, SG Cowen Securities Corporation ("Cowen"), and
revenue compilations by its independent auditor, L&H's stock
price rose from less than $19 in late November 1999 to a high of
$72 in 2000 upwards of a 300% increase. (Id. ¶¶ 2, 63). The
increase in stock price is alleged to be the result of a scheme
of fraud and deception on the part of L&H together with its
related capital funds, officers and directors, accountants, and
investment bankers. The unveiling of that scheme in the latter
half of 2000, due to investigative reporting by the Wall Street
Journal, sent the stock price into a tailspin. The exchanges then
halted trading in the stock, and L&H sought refuge in bankruptcy
Plaintiffs are hedge funds that, while also purchasing shares
of stocks believed to be likely to appreciate, identify and sell
short*fn4 shares of stocks that they believe to be likely to
decline in price. Beginning in June 1998, Plaintiffs established
and built short positions in L&H stock for essentially three
reasons: (1) L&H's senior management had a poor track record,
having previously run another technology company, Quarterdeck,
into the ground based on an aggressive growth-by-acquisition
strategy that they appeared to be repeating at L&H (2) there
was a limited market available for L&H's products; and (3) Rocker
doubted whether L&H had sound fundamentals for its business.
(Id. ¶ 100).
Plaintiffs charge that Defendants engaged in a scheme to
squeeze*fn5 Plaintiffs out of the L&H market by releasing
fraudulent information to the market, causing the price of L&H
stock to double and triple from the prices at which Plaintiffs
had sold short. The inflation of the price of L&H stock squeezed
Plaintiffs, forcing them to reduce their net short positions
through cover purchases at artificially high prices, resulting in
substantial realized losses in the tens of millions of dollars.
(Id. ¶ 5).
A. KPMG Certification of L&H's 1998 Financials
On April 9, 1999, KPMG Belgium published its Independent
Auditor's Report on L&H's financial statements for the year
ending December 31, 1998. (Id. ¶ 51). KPMG Belgium allegedly
made several false statements in those certified financials.
First, financial statements falsely reported L&H's 1998 revenues.
KPMG Belgium itself withdrew its own certification in late 2000
and disclosed to the investing public that its financial
statements "should not be relied upon." (Id. ¶¶ 4, 123). L&H's
Audit Committee later acknowledged that the statements inflated
L&H's actual income by nearly $28 million (including by 24% and
23% in the last two quarters of 1998, respectively). Second, KPMG
Belgium represented that it conducted an "independent" audit,
thereby indicating that it had no financial interest or ties to
L&H management. In fact, the KPMG "global account partner" for
L&H who was responsible for overseeing the audit, Paul Behets,
took a position with an L&H-related entity shortly after
overseeing and certifying these falsified financials. (Id. ¶
267). Third, KPMG Belgium represented that it "conducted [its] audits in accordance with
generally accepted auditing standards in the United States." The
financials violated many important aspects of United States
generally accepted accounting principles ("U.S. GAAP"), involving
the backdating of contracts, contracts entered into with related
parties, and the existence of side agreements releasing customers
of their obligation to pay. (Id. ¶ 209-10). Finally, KPMG
Belgium represented that the financials were "free of material
misstatement," and that the financials "present fairly, in all
material respects, the financial position of Lernout & Hauspie
Speech Products, N.V.," when, in fact, they falsely inflated
L&H's revenue by almost $28 million. (Id. ¶ 52).
B. L&H's Press Releases and Cowen's "Strong Buy"
On December 8, 1999, L&H issued a press release claiming that
its Internet translation services were to be offered on a
Microsoft website. This press release falsely stated that this
development represented an endorsement of L&H's translation
product by Microsoft. The press release quoted L&H's Chief
Executive Officer, Gaston Bastiaens, as stating that "Microsoft's
decision to offer our translation services . . . is a powerful
statement. . . . [and] emphatic recognition of the outstanding
quality, accuracy, and breadth of L&H's translation capabilities." In fact, however, this decision was simply an
advertisement for which L&H may have paid, and did not represent
any sort of endorsement by Microsoft of L&H's product. Microsoft
was actively looking for a buyer for its 7% stake in L&H. It is
alleged that the false press release had the intended effect of
pumping up the stock price given the power of a Microsoft
imprimatur in the software industry: the stock climbed in the
20's in heavy trading following the December 8th press release.
(Id. ¶¶ 55-63).
Later that month, on December 28, 1999, L&H issued a press
release proclaiming the financial success of its Korean
operation. L&H had previously acquired a Korean company, Bumil
(an acquisition on which Cowen consulted and for which KPMG did
due diligence), which subsequently operated as L&H's Korean
subsidiary. The press release, which again quoted Bastiaens,
stated that (1) L&H-Korea had closed "several deals with
customers in the telecommunications, enterprise solutions, and
embedded technologies markets"; (2) L&H experienced "strong
demand" for its products in Asia; and (3) L&H had sold its
software products to securities firms such as Hyundai Securities,
Samsung Securities, LG Securities, Daishin Securities, Daewoo
Securities, and 10 other Asian securities firms. Later
disclosures contradicted those claims of success in Asia; many of
the companies identified in the press release denied being L&H customers, there was no "strong demand" in Asia, and officials
from both Samsung Securities and LG Securities denied ever having
made any purchases from L&H. In fact, L&H's own Audit Committee
later recommended reversing every single dollar in L&H-Korea
revenues because these "customers" and this "strong demand" did
not exist. (Id. ¶ 4a-e). L&H's stock continued to trade in the
mid-20s through late 1999 and early 2000.
On January 5, 2000, Cowen issued "strong buy" recommendations
to the investing public. (Id. ¶ 69). Among other things, the
report repeated that L&H had signed deals with Asian customers
(i.e., Hyundai Securities, Samsung Securities, LG Securities,
Daishin Securities, and Daewoo Securities). Cowen's
recommendation stated that L&H's revenue results were
"impressive," rising "from about $100MM in 1997 to our 2000
estimate of slightly over $500MM." It further states that L&H's
"impressive" revenues would stop "endless short yammering in
1999." (Id. ¶ 69). Cowen presumably had knowledge to the
contrary, given that, in September 1999, it had performed its own
independent analysis of, among other things, financial and
operating data, internal financial analyses and internal
financial forecasts and reports relating to Bumil, as well as L&H
financial and operating data provided by L&H to Cowen. (Id. ¶
Shortly thereafter, on January 7, 2000, L&H filed a Form F-3
Registration Statement with the SEC for the issuance of $150 million of common
stock. This Registration Statement incorporated by reference KPMG
Belgium's certification of L&H's 1998 financial statements.
(Id. ¶ 4). As indicated by KPMG Belgium's later withdrawal and
the Audit Committee restatement, the 1998 revenues were falsely
inflated by almost $28 million in improperly-recorded revenue.
(Id. ¶ 81).
On February 7, 2000, L&H issued a press release about a new
"industry first" technology demonstrated at a trade conference,
i.e., a hand-held dictation device that would allow the "user
to `listen' to e-mail summaries as well as fulltext email," and
also issue computer commands by voice. In fact, the device was
secretly hardwired to a personal computer for the demonstration.
(Id. ¶¶ 76-82).
In early 2000, more press releases issued boasting of L&H's
massive increases in revenue. On February 9, 2000, the Company
announced a stock split following the reporting of "record"
revenues. That release indicated that L&H had revenues of $110
million for the fourth quarter of 1999, a 43.5% increase over
fourth quarter 1998 revenue, and revenue of $344 million for the
entire year of 1999, an increase of 62.7% over 1998 revenue.
(Id. ¶ 91). The following day, another "strong buy"
recommendation issued from Cowen stating that L&H realized $110
million in fourth quarter 1999 reported revenue, L&H booked "a
record 80 contracts for the quarter," and had a "surge in Asia
business." (Id. ¶ 95). The record revenues for 1999 and the supposed surge in Asian
business were fabricated. L&H's Audit Committee later recommended
the reversal of $182 million in L&H-Korea revenues. (Id. ¶¶ 3,
94d, 125). More than half of the revenue reported by L&H for 1999
was later reversed. (Id. ¶ 94d).
From December 1999 through March 2000, the price of L&H stock
rose to over $70 (split adjusted) an increase of more than 300%
from its early December 1999 trading price. (Id. ¶ 102).
C. L&H's Falsification of Revenues
According to L&H's restated results for 1999, L&H earned $169.5
million that year a decline of 20% from reported revenues of
$211.6 million for 1998 and less than half of the $344.2 million
L&H originally reported as 1999 revenue. (Id. ¶ 259).
Plaintiffs allege that, despite its declining revenues, L&H
created the false appearance of "record" revenues in a variety of
ways. First, L&H executed a "start-up" customer scam whereby,
among other things, investment funds affiliated with L&H would
create a "start-up" shell corporation, also often referred to as
a "Language Development Company" or "LDC" that would receive an
infusion of cash from the investment fund. The start-up would
sign a contract to pay L&H a so-called license fee that would
then be reported on L&H's books as revenue. To the extent that
any money actually changed hands on these start-up deals, the start-up paid L&H cash that originated with the
L&H-related investment fund and, thus, the revenue was
self-funded. (Id. ¶¶ 85-88). Second, L&H concealed the fact
that its 1999 revenue in its traditional markets in Europe and
the United States had declined by 20%, while the reported revenue
in Asia rose by 1900%. (Id. ¶ 94a). Third, revenues attributed
to Koscom ($5-10 million), Hung Chang ($5 million), Hyundai
Securities ($5-10 million) and LG Securities were grossly
overstated. Other Asian customers were, in reality, L&H-related
start-ups providing self-funded revenue, or, like Samsung
Securities, were never L&H customers at all. (Id. ¶ 94b-e).
The massive revenues supposedly realized in Asia were the
result of socalled "factoring agreements" with Korean banks. In a
typical factoring agreement, a company assigns an account
receivable on a customer contract to a bank, and the bank then
provides the company with cash equivalent to the amount of the
receivable. If the factoring is with recourse, however, the
company must repay the cash to the bank if the customer fails to
pay the account receivable, and in this situation the factoring
agreement is little different from a loan. L&H's factoring
agreements were, in fact, with recourse, and L&H would leave the
money on deposit with the bank as security. Nevertheless, L&H
would recognize these de facto loans on its books as revenue. In
this manner, L&H was able to create the illusion of revenue from its contracts with the shell,
"start up" customers who were never going to pay L&H. However,
when the bank did not receive payment on the account receivable,
the bank seized the cash deposit to make itself whole. In this
fashion, over $100 million in supposed L&H Korean "revenue"
disappeared from the company's bank accounts. (Id. ¶¶ 150-53).
As revealed by a report commissioned by L&H's own Audit
Committee, L&H used the following accounting tricks to improperly
record revenue: (1) booking revenue absent a contract; (2)
booking revenue when collectibility was in doubt; (3) booking
revenue on contingent contracts and/or prior to delivery; and (4)
entering into side agreements with ...