X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
An attempt by disappointed investors in the bankrupt company The Warnaco Group to hold Deloitte & Touche responsible for losses from the company’s meltdown has been rejected by a federal judge. Southern District of New York Judge Miriam Goldman Cedarbaum found that the plaintiffs failed to adequately plead loss causation on the auditor’s alleged failure to disclose troubles with a Warnaco subsidiary and misstatements in its financial statements. The plaintiffs’ claims failed, she said, because they argued that Deloitte’s actions led to an artificial inflation of the company’s stock price and the Supreme Court has only recently held that artificial inflation of a stock price, without more, is insufficient to show loss causation. Warnaco collapsed in 2001 after disclosing that, for several years, it made massive misstatements of its financial condition. In addition to suing Warnaco and several officers and directors, investors in In Re The Warnaco Group, Inc. Securities Litigation (II), 01 Civ. 3346, who bought stock in the company between Aug. 15, 2000, and June 8, 2001, sought to pin some of the blame on Deloitte. The claims were dismissed in 2003, but in January 2005, Judge Cedarbaum accepted an amended complaint that focused on Warnaco’s annual audited financial statement for Fiscal Year 1999. Released in May 2000, the statement overstated Warnaco’s total stockholder equity by $30,131,000 — $26 million of which was due to the false valuation of reserves for returned unsold merchandise and the remainder due the misreporting of account balances between the company and its subsidiary, Designer Holdings Ltd. The financial statement also understated accounts payable by $18,424,000 due to errors relating to Designer Holdings, overstated accounts receivable by $64,100,000, and overstated inventory and other assets by $18,400,000. The complaint alleged that in November 2000, Deloitte personnel were present when accounting errors were disclosed at a third-quarter audit review meeting — and therefore knew about the Designer Holdings errors in the audited Fiscal Year 1999 statement. Deloitte was also accused of failing to inform the public that Warnaco was no longer in compliance with debt covenants it made under its credit agreements and that unaudited quarterly statements that contained several misstatements were “examined and reviewed” by Deloitte and the statements referred investors “for further information” to annual financial statements that Deloitte had audited. In March 2001, it was publicly disclosed that Warnaco was not in compliance with its credit agreements and the company acknowledged that it had understated its reserves for returned unsold merchandise. Deloitte, it was alleged, became aware of the understatement in mid-February 2000 but advised the company not to disclose it until early 2001. In April 2001, Warnaco’s annual audited financial statement filed with Form 10-K allegedly contained a number of falsehoods, overstating stockholder equity and inventory by almost $100 million and understated liabilities and accounts payable by roughly the same amount. By June 2001, Warnaco had filed for bankruptcy and begun issuing financial restatements. Those restatements allegedly disclosed that Deloitte had committed several violations of Generally Accepted Accounting Standards in the audit of the Fiscal Year 1999 and 2000 financial statements. But Cedarbaum said the Supreme Court made it clear in Central Bank v. First Interstate Bank, 511 U.S. 164 (1994) that a plaintiff cannot bring a claim under �10(b) of the Securities Exchange Act for aiding and abetting securities fraud. And the 2nd Circuit has observed in Shapiro v. Cantor, 123 F.3d 717 (1997) that if Central Bank “is to have any real meaning, a defendant must actually make a false or misleading statement in order to be held liable under Section 10(b).” The plaintiffs relied on In re Global Crossing, Ltd. Securities Litigation, 322 F.Supp.2d 319 (S.D.N.Y. 2004), where the court held that allegations Arthur Andersen “prepared, directed or controlled” or “helped create” or “materially assisted” in preparing false statements went well beyond the aiding and abetting liability that the Supreme Court had forbidden in Central Bank. But Cedarbaum found the cite to In re Global Crossing “unavailing,” because “Even if substantial participation in preparation of an unaudited statement is sufficient for primary liability under Section 10(b), plaintiffs do not allege such participation by Deloitte in this case. “All the plaintiffs allege is that Deloitte ‘examined and reviewed’ the quarterly statements, and that is attended quarterly review meetings,” she said. “These allegations do not rise to the level of involvement deemed sufficient in Global Crossing.” INFLATED PURCHASE PRICE And while the judge found other claims made by the plaintiffs not actionable, she said the main reason the complaint must be dismissed was its failure to show loss causation. The Supreme Court in Dura Pharm., Inc. v. Broudo, 125 S.Ct. 1627 (2005) rejected the artificial inflation theory, saying such a theory “would allow recovery where a misrepresentation leads to an inflated purchase price but nonetheless does not proximately cause any economic loss.” While it was clear that claims of artificial stock inflation must fail here, the complaint also alleged that, because of Deloitte’s conduct “Warnaco was not shut down in early October 2000 when, in reality, it was clearly in default on its credit agreements.” Moreover, the plaintiffs also charged that Deloitte failed to publicly disclose “the financial chaos within Warnaco” and that the company’s “true financial condition and internal chaos,” which prevented it from obtaining waivers on its credit agreement in March through June 2001 — and in turn caused the collapse of its stock price and forced it into bankruptcy. But the complaint, Cedarbaum said, “contains no allegations that these errors, which Deloitte discovered in the fall of 2000 and which were publicly corrected after Warnaco’s bankruptcy, played any part in the fall of Warnaco’s stock price or the company’s ultimate demise.” Christopher Lovell, Frederick W. Gerkens, III and Robert W. Rodriguez of Lovell Stewart Halebian represented the plaintiffs. Daniel F. Kolb, Amelia T.R. Starr and Gina Caruso of Davis Polk & Wardwell represented Deloitte & Touche.

This content has been archived. It is available through our partners, LexisNexis® and Bloomberg Law.

To view this content, please continue to their sites.

Not a Lexis Advance® Subscriber?
Subscribe Now

Not a Bloomberg Law Subscriber?
Subscribe Now

Why am I seeing this?

LexisNexis® and Bloomberg Law are third party online distributors of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® and Bloomberg Law customers are able to access and use ALM's content, including content from the National Law Journal, The American Lawyer, Legaltech News, The New York Law Journal, and Corporate Counsel, as well as other sources of legal information.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2021 ALM Media Properties, LLC. All Rights Reserved.