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The federal judge overseeing the litigation caused by Cendant Corp.’s 1998 stock plunge says the company can pursue its suit to recoup any losses caused by Ernst & Young. The accounting firm sought dismissal on grounds that the litigation was barred by securities law, arguing in particular that its $355 million settlement with Cendant’s shareholders in 1999 obviated an additional payment to the company itself. But in his April 12 opinion, U.S. District Judge William Walls ruled that all but one of Cendant’s claims for negligence, fraud and breach of contract were legally sustainable. The decision clears the way for Cendant to continue the case and try to prove liability and win damages at trial or seek a settlement with Ernst & Young to recover some of the $3 billion the company paid shareholders to settle a class action fraud case. “This is now the springboard to allow Cendant’s claims to go forward,” says Cendant’s counsel, Michael Rosenbaum of Short Hills, N.J.’s Budd Larner Gross Rosenbaum Greenberg & Sade. Shares of Cendant, which was created in 1997 by the merger of CUC International Inc. of Stamford, Conn., and HFS Inc. of Parsippany, N.J., lost billions of dollars in value in April 1998 after the company announced it had discovered irregularities in CUC’s premerger accounts. Cendant, now in New York, has alleged that CUC executives created $500 million in fake revenue to make the company an attractive merger partner and that as CUC’s outside accounting firm, Ernst & Young failed to report the wrongdoing or knowingly and recklessly facilitated it. Ernst & Young denied the charges and sought dismissal on several grounds. It argued that the Private Securities Litigation Reform Act, designed to foster settlements and curb the excesses of class action plaintiffs, does not allow contribution claims by settled defendants or allow indemnification claims. The accounting company also argued that it had no fiduciary duty to the company, that the breach of contract claim was defectively drawn and that the negligence and malpractice claims didn’t comply with New Jersey’s Affidavit of Merit statute. Walls did dismiss one count of the complaint, agreeing with Ernst & Young that the PSLRA barred Cendant, as a settling defendant, from seeking a contribution under Section 11 of the Securities Act of 1933. Eleven other counts survived. Ernst & Young argued that Cendant’s state law claims alleging breach of contract, negligence, fraud and breach of fiduciary duty were really claims for indemnification, which also are barred by the PSLRA. Walls ruled, however, that the claims were independent allegations that are not pre-empted by federal securities law. He found that Cendant had standing to assert breach of contract claims even though the shareholders of the company that hired Ernst & Young, Cendant predecessor HFS, have benefited from the class action settlements. “That the shareholders may have already been compensated by the company and by E&Y does not lessen the harm to the corporation,” he wrote. “Similarly, even if the shareholders receive a ‘duplicative and indirect’ benefit, that does not eliminate the corporation’s right to recovery.” On the professional negligence counts, he said the law of HFS’s home base, Connecticut, applies and that state has no affidavit-of-merit requirement. He also rejected Ernst & Young’s argument that it was relieved of its contract responsibilities by CUC’s failure to provide correct information for the audit. “The very duty it undertook was to exercise due care and disclose any acts of fraud it uncovered,” Walls said. Ernst & Young attorneys at Roseland, N.J.’s Lowenstein Sandler referred calls to corporate headquarters in New York. Spokesman Les Zukie says, “We are pleased that the judge dismissed the Section 11 claim against Ernst & Young but disagree with his decision not to dismiss the remaining claims. We continue to believe those claims have no merit and intend to seek review of the judge’s decision by the appellate court.”

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