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July 28, 2012
Eyeball Reliance?: Second Circuit Finds That Rule 406 Applied In Misleading Statements Appeal
Federal Rule of Evidence 406 provides that
Evidence of a person’s habit or an organization’s routine practice may be admitted to prove that on a particular occasion the person or organization acted in accordance with the habit or routine practice. The court may admit this evidence regardless of whether it is corroborated or whether there was an eyewitness.
This "habit" rule is often used to prove a "matter of practice," as was the case with the recent opinion of the Second Circuit in Gould v. Winstar Communications, Inc., 2012 WL 2924254 (2nd Cir. 2012).In Gould,
Winstar was a broadband communications company whose core business was to provide wireless Internet connectivity to various businesses. GT served as Winstar's independent auditor from 1994 until Winstar filed for bankruptcy in April 2001, and GT regarded Winstar as "one of [its] largest and most important clients."
In 1999, however, the relationship deteriorated. Winstar warned GT that it would likely terminate the relationship if GT's performance on unrelated international tax planning and other accounting matters proved unsatisfactory. In March 1999 at least one member of Winstar's board of directors openly urged during a board meeting that the GT partner overseeing the audit of Winstar be removed from the Winstar account. GT eventually re-staffed the Winstar account so that the 1999 audit was managed by a partner, Gary Goldman, and a senior manager, Patricia Cummings, neither of whom had previously reviewed or audited the financial records of a telecommunications company....
GT's audit for 1999 included several "large account" transactions that Winstar consummated in an attempt to conceal a decrease in revenue associated with Winstar's core business. Most of the large account transactions involved Lucent Technologies, Inc. ("Lucent"), Winstar's strategic partner, and all of them were consummated at the end of Winstar's fiscal quarters in 1999. Together, the transactions accounted for $114.5 million in revenue, or approximately 26 percent of Winstar's reported 1999 operating revenues and 32 percent of its "core" revenues that year. At the time, GT considered these transactions to be "red flags," warranting the accounting firm's "heightened scrutiny." However, GT ultimately approved Winstar's recognition of revenue in connection with each of these transactions.
Among those subsequently bringing an action against GT were the Jefferson plaintiffs.
From December 1998 to February 2001, the Jefferson Plaintiffs purchased over $200 million worth of Winstar stock. The investment portfolios of most of the Jefferson Plaintiffs were managed by Ronald Clark, the Chief Investment Officer for Allianz of America ("Allianz"). The remaining entities deferred to Clark to select their investments in United States securities. Although Clark enjoyed ultimate authority for these investment decisions, he relied on recommendations from a team of analysts, including Livia Asher, who recommended that Allianz purchase Winstar stock. Based on Asher's recommendation, Clark caused Allianz and the other Jefferson Plaintiffs to invest in Winstar.
Clark, it appears, did not personally review Winstar's financial statements prior to making the decision to invest in Winstar. Instead, he relied on Asher to review the statements as part of her job. During discovery, however, Asher acknowledged that she was uncertain of the date of, or reason for, her recommendation that Allianz purchase Winstar stock. Nor could she specifically recall reading Winstar's 1999 Form 10–K report. However, Asher testified that she "probably flipped through every single page" of the report, based on her practice. She explained, "I can't imagine any reason why I would not have looked at this,...given our position in the stock and given what I would normally do." Asher added that she habitually read auditors' opinion letters included in Forms 10–K to make sure that auditors believed that an issuer's reports were "kosher," but she did not specifically recall reviewing GT's audit report.
The Jefferson Plaintiffs' action against GT included a claim for misleading statements pursuant to 15 U.S.C. § 78r(a), which requires, inter alia, actual, rather than constructive reliance. Based upon Asher's aforementioned testimony, the district court granted GT's motion for summary judgment dismissing this claim, finding that the Jefferson Plaintiffs failed to prove actual reliance.
The Second Circuit, however, reversed, finding that
Even assuming that such "eyeball" reliance is the sort of actual reliance required by our precedents, the District Court's conclusion somewhat understates the record evidence on this score. Ronald Clark and Livia Asher worked on behalf of the Jefferson Plaintiffs. Although Asher was unable to recall specifically that she reviewed GT's audit opinion letter, there was evidence that she actively reviewed such letters as a matter of practice in deciding whether to recommend certain stocks. At this stage of the proceedings, Asher's testimony is enough; from that evidence, a jury reasonably could infer that she actually reviewed the relevant documents. See, e.g., Fed.R.Evid. 406.
July 28, 2012 | Permalink
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