Citations
- 378 F. Supp. 112
Full opinion text
MacMAHON, District Judge.
This action was tried to the court, without a jury, on eleven trial days, commencing October 15, 1973 and ending October 29, 1973. Plaintiffs Gerald L. Herzfeld and General Investors Co., a partnership, invoking federal question and pendent jurisdiction, sue the public accounting firm of Laventhol, Krekstein, Horwath & Horwath (“Laventhol”) under the anti-fraud provisions of § 10(b) of the Securities Exchange Act of 1934 (“the Act”), 15 U.S.C. § 78j(b); SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5; New York General Business Law § 352-c (McKinney’s Con-sol.Laws, c. 20, 1968) ; and the common law.
By leave of court, Laventhol has impleaded third-party defendants Irwin H. Kramer and Allen & Company Incorporated, claiming these defendants should indemnify it for any liability to plaintiffs. Allen & Company and Allen & Company Incorporated (collectively “Allen”) counterclaim against Laventhol seeking damages under § 10(b) of the Act, Rule 10b-5, § 352-c of the New York General Business Law, and the common law.
This action arises out of a private placement of $7.5 million of securities on December 16, 1969 by The Firestone Group, Ltd. (“FGL”), a Delaware corporation engaged in real estate syndication with its principal place of business in California. The securities in question were sold in units consisting of a $250,000 note and 5,000 shares of FGL common stock, at a price of $255,000 each. FGL hired Allen, an investment banking firm, to assist with the private placement and retained Laventhol to perform an audit of FGL’s financial statements and to prepare and issue a report and audited financial statements for the eleven-month period ending November 30, 1969. Laventhol knew that its report and audited financial statements would be relied upon by Allen and by prospective investors.
In 1971, FGL petitioned for reorganization under Chapter XI of the federal bankruptcy law. During, the bankruptcy proceedings, the $250,000 notes contained in each unit were converted into 25,000 shares of FGL preferred stock, and the 5,000 shares of common stock were reversed split 10 for 1, becoming 500 shares of new common stock. The value of the units, as of October 1, 1971, was estimated at trial to be $27,750 each.
Plaintiffs and Allen contend that the report and financial statements, prepared and issued by Laventhol on December 6, 1969, were materially misleading and that- their reliance on the report led to the damages they subsequently suffered.
Essentially, plaintiffs and Allen challenge the accounting treatment accorded by Laventhol to the purported purchase and sale by FGL of certain nursing home properties in November 1969. In the audited report, Laventhol treated these transactions as an acquisition and sale in which FGL first supposedly purchased the nursing homes from Monterey Nursing Inns, Inc. (“Monterey”) for $13,362,500 on November 22, 1969 and then, four days later, sold them to Continental Recreation Company, Ltd. (“Continental”) for $15,393,000 on November 26, 1969. Moreover, in the report’s income statement, Laventhol treated as current income $235,000 and as deferred gross profit $1,795,000 of the projected profit from the transactions.
Plaintiffs and Allen contend that the accounting treatment accorded the Monterey-Continental transactions (“Monterey transactions”) was incorrect and not, as Laventhol represented, “in conformity with generally accepted accounting principles” and that the financial statements did not “present fairly the financial position” of FGL as of November 30, 1969. Specifically, they claim that the Monterey transactions were “phony” and intended solely to give support to the private placement and that Laventhol knew or should have known they were “phony,” or that the transactions involved nothing more than an option to buy the property at the buyers’ discretion and that Laventhol knew or should have known them to be options.
The purchase and sale of the nursing homes was the largest single transaction in the history of FGL. The magnitude and importance of the Monterey transactions can be shown by a comparison of the financial condition of FGL, with and without the Monterey transactions, as in the table below:
Monterey Monterey
Included Excluded
Sales $22,132,607 $6,739,607
Total Current Assets 6,290,987 1,300,737
Net Income 66,000 -169,000 (Loss)
Deferred Profit 1,795,000 None:
Earnings/Share 10£ -25