Full opinion text
MEMORANDUM AND ORDER O’CONNOR, District Judge. TABLE OF CONTENTS I. INTRODUCTION ............................................. 658 II. THE LAW AS TO THE CLAIMS OF PLAINTIFFS AND THE CLASS .. 661 A. Jurisdiction and Venue...................................... 661 B. Touche, Ross & Co. as a Defendant...........................'. 661 C. Right of Action Under Section 10(b) of the 1934 Act, Rule 10b-5 and Section 17(a) of the 1933 Act.............................. 661 D. The Elements of Plaintiffs’ Cause of Action..................... 662 1. Materiality............................................ 663 2. The Degree of Fault Required............................ 664 3. Causation.................................'............ 665 4. Statute of Limitations................................... 666 E. Accountants’ Liability....................................... 667 III. THE CLAIMED MISCONDUCT.................................. 669 A. Background............................................... 669 B. The Purchase of SaxonS and Activities Through October 29,1968 .... 670 1. The Acquisition of SaxonS............................... 670 2. The “Audit” of SaxonS................................. 671 3. The Operation of SaxonS as a Topsy’s Subsidiary............. 672 4. Kansas City Star Article, August 23,1968 ................... 673 5. The 8-K Report, September 23,1968 ....................... 674 6. Topsy’s Letter to Shareholders, September 26,1968 ........... 674 7. The Registration Statement and Preliminary Prospectus....... 674 8. G. H. Walker Research Report, October 10,1968 ............. 676 9. Kansas City Times Article, October 11,1968 ................. 677 C. From the Filing of the Registration Statement Through the Closing of the Offering...............................................677 1. Topsy’s 1968 Annual Report..............................677 2. Kansas City Times and Star Articles......................'. 678 3. Topsy’s Letter to Shareholders, December 18,1968 ........... 678 4. Kansas City Star and Times Articles.......................678 5. The Final Prospectus....................................679 (a) The SaxonS Section of the Prospectus...................679 (b) Audited SaxonS Financials and the “Use of Proceeds” Section............................................687 (c) The “Management and Principal Stockholders” Section of the Prospectus.........................................690 (d) The “Transactions with Management” Section of the Prospectus ............................................ 691 D. From the Closing of the Offering Through August 1, 1969 ........ 691 1. Kansas City Star Article, February 23, 1969 ................ 693 2. Quarterly Report to Shareholders, March 19, 1969 ........... 693 3. Kansas City Times Article, March 20,1969 .................. 693 4. G. H. Walker Research Notes, April 11, 1969 ................ 693 5. Quarterly Report to Shareholders, June 20, 1969 ............. 694 6. The New Franchise Agreement........................... 694 7. The Poulos Transactions.................................■ 695 8. The Gottleib Transaction ................................ 695 E. After August 1, 1969 ....................................... 695 1. The Settlement with West............................... 695 2. Repurchase of the Debentures............................ 695 3. Securing Advances to SaxonS .............:.............. 696 4. The 1969 Audit and Annual Report........................ 696 5. Quarterly Report to Shareholders, November 28, 1969 ........ 698 6. Annual Meeting of Shareholders.......................... 698 7. Quarterly Report to Shareholders, March 6, 1970 ............ 699 8. The Feibleman Settlement............................... 700 9. Quarterly Report to Shareholders, June 24, 1970 ............. 701 10. Topsy’s 1970 Annual Report.............................. 702 IV. DECISION AND DISPOSITION ................................. 702 A. Statute of Limitations ...................................... 702 B. The Merits................................................ 706 C. The Cross-Claims........................................... 708 1. Topsy’s Cross-Claim for Indemnity Against Touche Ross....... 708 2. G. Kenneth Baum’s Claim Against Topsy’s..................709 V. FINALE..................................................... 709 I. INTRODUCTION. This action was brought by a number of purchasers of common stock and convertible subordinated debentures issued by Topsy’s International, Inc. Plaintiffs have alleged that defendants violated Section 17(a) of the Securities Act of 1933 [15 U.S.C. § 77q(a)], Section 10 of the Securities Exchange Act of 1934 [15 U.S.C. § 78j(b)], Rule 10b-5 promulgated thereunder [17 C.F.R. § 240.10b-5], and the Kansas Blue Sky Law [K.S.A. 17-1268] in that they participated in a scheme to create an active and rising market in Topsy’s stock up to the date of the public offering of stock and debentures, by means of statements which contained misrepresentations or were misleading because they omitted material facts. Plaintiffs have further alleged that thereafter defendants concealed the misstatements and omissions to maintain a market price for Topsy’s securities above that which would have prevailed if accurate information had been disclosed. The alleged misrepresentations and omissions center on SaxonS, an Ohio corporation in the business of franchising roast beef sandwich shops, purchased by Topsy’s in the summer of 1968. On February 4, 1969, Topsy’s made a public offering of $6,000,-000.00 5%% convertible subordinated debentures due February 1, 1984, and 104,796 shares of Class A Common Stock owned by three Topsy’s officers — Jerry D. Berger, James T. House, and Harry Nuell. The final prospectus for the offering stated that the net proceeds from the sale of debentures would be used “to finance the acquisition, construction and development of sites for SaxonS Sandwich ShoppeS.” Information disseminated to the public was generally favorable until March 6, 1970, when a letter from Topsy’s to its shareholders reported that Topsy’s had repurchased three SaxonS franchised units, which resulted in a reduction in second quarter earnings in the amount of $292,000.00. In a letter to shareholders of June 24, 1970, Topsy’s reported that it was discontinuing its SaxonS operations. The case was certified as a class action by an order of June 27, 1974. Seiffer v. Topsy’s International, Inc., 64 F.R.D. 714 (D.Kan.1974), app. dismissed 520 F.2d 795 (10th Cir. 1975), cert. denied 423 U.S. 1051, 96 S.Ct. 779, 46 L.Ed.2d 640 (1976). The class was defined as consisting of purchasers of the Common Stock of Topsy’s from September 28, 1968 to March 10, 1970, and purchasers of the debentures from February 4, 1969 to March 10, 1970. These dates coincide roughly with when shareholders would have received letters from Topsy’s management announcing the acquisition of SaxonS and reporting the losses from the repurchase of SaxonS units. On September 30, 1968, the bid prices of Topsy’s Class A Common Stock ranged between a high of 36% and a low of 35; the asked prices ranged between a high of 37% and a low of 35%. On October 18, 1968, Topsy’s declared a 100% stock dividend. The effect was to double the number of shares outstanding while cutting in half the market price of the shares. On October 22, 1968, prior to reflection of the dividend, the bid prices of the stock ranged between a high of 41 and a low of 39%; the asked prices ranged between a high of 42 and a low of 40%. After reflection of the dividend on that day, the bid prices ranged between a high of 20% and a low of 20 V2; the asked price was 21V2. On February 4, 1969, the bid prices ranged between 28 and 26%; the asked prices ranged between 29 and 27V2. From that date date prices moved rather steadily downward. On March 10, 1970, the bid prices ranged between a high of 5 and a low of 3%; the asked prices ranged between 5V2 and 4%. The original complaint in this action was filed November 11, 1971, by Robert Seiffer, Leah Seiffer, Marshall Gordon, Herman Horowitz, Stephen Horowitz, and Hefjos, Inc. on behalf of themselves and all other holders of stock and debentures against Topsy’s, Jerry D. Berger, James T. House, and Harry Nuell. Berger is, and was in 1968-1970, the founder of Topsy’s, its chairman of the board, chief executive officer, and chief financial officer. In the 1969 offering he sold 80,226 shares of Class A Common Stock and realized net proceeds of approximately $2,089,054.04. House was, at all relevant times, president and a director of Topsy’s. In the 1969 offering he sold 20,000 shares of Class A Common Stock realizing net proceeds of approximately $520,800.00. Nuell was secretary-treasurer and a director of Topsy’s. In the 1969 offering he sold 4,570 shares of stock (all that he owned at that date), realizing approximately $119,002.80 in net proceeds. The complaint alleged violations of Sections 5, 11, 12(2), and 17(a) of the 1933 Act, Section 10(b) of the 1934 Act, Rule 10b-5, and Kansas securities laws. The First Amended Complaint was filed January 31, 1972. Mark T. Anthony and Joseph and Rea Fried were added as named plaintiffs. All of the underwriters of the 1969 offering, except Dempsey-Tegeler & Co., Inc., were added as defendants. The Second Amended Complaint was filed on October 24,1972. While the parties remained the same, the alleged violations were narrowed somewhat to Section 17(a) of the 1933 Act, Section 10(b) of the 1934 Act, Rule 10b-5, and K.S.A. 17-1268. The underwriters then cross-claimed against Topsy’s, Berger, House, and Nuell and filed third-party complaints against Tucker, Charno, Widens, Jouras & Tucker, G. Kenneth Baum, and Touche, Ross & Co. Tucker Charno was counsel for Topsy’s, Berger, House, and Nuell in the 1969 offering. Its five attorneys worked in an office-sharing arrangement until they formed a partnership on January 1, 1969. G. Kenneth Baum was a director of Topsy’s. Touche, Ross, a partnership, had performed auditing services for Topsy’s from 1967, when it merged with the Kansas City accounting firm of Lipoff, Sharlip & Pesman, until 1973. One of the underwriters, G. H. Walker & Co., undertook a separate defense and also filed a cross-claim against Topsy’s, Berger, House, and Nuell, and third-party complaints against Tucker Charno, Baum, and Touche, Ross. G. H. Walker was subsequently acquired by White, Weld & Co., which was substituted as a party defendant. Topsy’s, Berger, House, and Nuell cross claimed against the underwriters and filed third-party complaints against Tucker Charno and Touche Ross. On October 10, 1973, plaintiffs filed a Third Amended Complaint adding Tucker Chamo and John D. Crouch, Thomas H. Devine, Jerry B. Jackson, Loren G. Hoffman, Carl Lipoff, Mary McCann, Rodney T. Minkin, Robert J. Petsche, and Ben Ruben, et aL, d/b/a Rouche Ross & Co., as defendants. The third-party complaints against these newly-added defendants were then reasserted as cross-claims. Tucker Charno and Touche Ross then filed cross-claims against the other defendants and each other. Tucker Charno also filed a third-party complaint against Baum. On July 22, 1974, the underwriters filed third-party complaints against Bryan, Cave, McPheeters & McRoberts (underwriters’ counsel in the 1969 offering) and Jerome F. Tegeler, John C. Hecht, Albert Gummersbach, and Lewis J. Whitney (alleged to be control persons of Dempsey-Tegeler & Co., Inc., the lead underwriters). Topsy’s, Berger, House, and Nuell filed third-party complaints against Bryan Cave and the above-named control persons of Dempsey-Tegeler and Dempsey-Tegeler & Co. The third-party complaint against Dempsey-Tegeler & Co. was dismissed by the court; the others were subsequently voluntarily dismissed by the underwriters, Topsy’s, Berger, House, and Nuell. Plaintiffs sought leave to file a Fourth Amended Complaint which would have added Bryan Cave and the Dempsey-Tegeler control persons. Leave, however, was denied. In March 1976, plaintiffs and the class settled with Topsy’s, Berger, House, Nuell, and most of the underwriters. Topsy’s paid $1,000,000.00; Berger, House and Nuell paid $225,000.00. The settlement with the underwriters was $194,100.00, including $16,500.00 paid by G. Kenneth Baum. Baum had not been sued by the plaintiffs but was named as a third-party defendant by the underwriters. This settlement disposed of their claims against him. In July 1977, a settlement of $8,250.00 between plaintiffs and the class and underwriter Lester, Ryons & Co. was approved by the court. In September 1978, the court approved a settlement of $1,100,000.00 and all court costs to date, between plaintiffs and the class and Tucker Charno. The cross-claims between Topsy’s, Berger, House, Nuell, the underwriters, White Weld, and Tucker Charno were dismissed on stipulation of these parties. - Thus, plaintiffs’ claims against Touche Ross and cross-claims between Touche Ross and Topsy’s, Berger, House, Nuell, the underwriters, White Weld, and Tucker Charno remain for determination. Trial to the court began January 15, 1979, and continued to April 11, 1979. On May 8, 1979, Baum filed a cross-claim for indemnity against Topsy’s. Post-trial briefs and suggested findings and conclusions were filed on August 15, 1979, and reply memoranda were filed on September 17, 1979. Since that time, the court has engaged in the painstaking process of reviewing, sifting, and analyzing the great mass of testimony, evidence, and argument submitted for its consideration in determining the difficult questions presented by this case. The court is now prepared to render its decision. Before doing so, however, the court wishes to gratefully acknowledge the diligence, industry, and cooperation of counsel for all parties. The high quality of advocacy during the trial, and especially in the post-trial briefs, has aided the court immeasurably. II. THE LAW AS TO THE CLAIMS OF PLAINTIFFS AND THE CLASS. A. Jurisdiction and Venue. Jurisdiction and venue in this action are based upon Section 22(a) of the Securities Act of 1933 [15 U.S.C. § 77v(a)] and Section 27 of the Securities Exchange Act of 1934 [15 U.S.C. § 78aa]. As the court indicated in its order of October 2, 1972, this court has subject matter jurisdiction and venue is proper in this district. B. Touche Ross & Co. as a Defendant. Touche Ross has argued that it has never been sued by the plaintiffs and is not a defendant in this action. Touche Ross is a partnership and agrees that it may be sued under its common name. Federal Rule of Civil Procedure 17(b). The Third Amended Complaint, however, named certain Touche Ross partners “d/b/a Touche, Ross & Co.” Touche Ross has long participated in this action under its common name, frequently referring to itself as “Defendant Touche Ross.” See, e. g. Document 1121. This participation leads us to assume that it had adequate notice that whatever form plaintiffs initially used, the suit was against the partnership. We have found no cases considering this question, but because we believe that Touche Ross partnership has not been prejudiced by plaintiffs’ initial disregard of the common name, we hold that Touche, Ross & Co. is properly a defendant here. C. Right of Action Under Section 10(b) of the 1934 Act, Rule 10b-5, and Section 17(a) of the 1933 Act. Touche Ross vigorously contends that plaintiffs have no private right of action under Section 10(b) and Rule 10b-5. Section 10(b) of the 1934 Act does not, of course, by its terms provide an express civil right of action and the history of the section does not show any sign that Congress considered the problem of private suits. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 729, 95 S.Ct. 1917, 1922, 44 L.Ed.2d 539 (1975). Similarly Rule 10b-5 makes no expression of a private right of action. In 1946 it was held that a private right existed under the Rule, Kardon v. National Gypsum Co., 69 F.Supp. 512 (E.D.Pa.1946), and in 1971 the Supreme Court confirmed without discussion that such a cause of action existed. Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6,13 n.9, 92 S.Ct. 165, 169 n.9, 30 L.Ed.2d 128 (1971). While, in recent years there has been a trend toward limiting the scope of the private cause of action and increasing judicial concern with the vexation of litigation, the Supreme Court has continued to operate on the assumption that a private right exists. See, e. g. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); Blue Chip Stamps, supra. We hold that a private right of action under Section 10(b) and Rule 10b-5 exists in the circumstances of this case. We considered the question of whether a private right of action exists under Section 17(a) of the 1933 Act in our order of November 8, 1978. We have taken the position that because Section 17(a) is virtually identical to Rule 10b-5, there is little practical point in denying the right to maintain a private action. The conduct prohibited by Section 17(a) does not seem to vary in any significant respect from that prohibited by Rule 10b-5. R. Jennings, & H.-Marsh, Securities Regulation 864 (1977). While Rule 10b-5 relates only to sales and Section 17(a) to offers or sales, in the circumstances of this case the difference is irrelevant. Touche Ross argues further that plaintiffs have no right of action under Section 10(b), Rule 10b-5, and Section 17(a) because Section 18 of the 1934 Act provides the exclusive remedy for misleading documents filed with the SEC. In our order of November 8, 1979, we concluded that the remedies afforded by Section 10(b), as well as other sections of the 1934 Act, are cumulative and not mutually exclusive. While we did not discuss Touche, Ross & Co. v. Reddington, 442 U.S. 560, 99 S.Ct. 2479, 61 L.Ed.2d 82 (1979) in our earlier order, we do not believe it requires a different result. The Court in Reddington held that a private cause of action could not be implied from Section 17(a) of the 1934 Act [15 U.S.C. § 78q(a)], which requires broker-dealers and others to keep such records and file such reports as the Securities Exchange Commission may prescribe. Using the Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975) test, the Supreme Court concluded that there was “no basis in the language of § 17(a) for inferring that a civil cause of action for damages lay in favor of anyone.” Reddington, supra, 442 U.S. at 571, 99 S.Ct. at 2486. In what is essentially dictum, the Court went on to consider Section 18(a) of the 1934 Act, which does create a cause of action against persons who make or cause to be made materially misleading statements in reports or other documents filed with the Commission, including reports filed pursuant to Section 17(a). Section 18(a) was not available to the Reddington plaintiffs because the section grants the right of action only to purchasers or sellers who rely on such misrepresentations. Although the Court noted that “[tjhere is evidence to support the view that § 18(a) was intended to provide the exclusive remedy for misstatements contained in any reports filed with the Qommission,” Reddington, supra at 573, 99 S.Ct. at 2488, it did not consider the overlap of sections of the 1934 Act, for example Section 10(b), which have long been held to provide implied causes of action. We do not believe that the Court intended its passing observation on Section 18(a) to indicate that Section 18(a) must now preclude actions under Section 10(b) when such law suits involve allegations of misleading statements in documents filed with the Commission. D. The Elements of Plaintiffs’ Cause of Action. In order to make out a private cause of action, plaintiffs must prove • certain elements. The violations must be in connection with the purchase or sale of securities. Blue Chip Stamps, supra. The misrepresentations or omissions must be material. Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54, 92 S.Ct. 1456, 1472, 31 L.Ed.2d 741 (1972). A defendant must have acted with some form of scienter beyond mere negligence. Ernst & Ernst, supra, 425 U.S. at 193, 96 S.Ct. at 380. There must be a causal relationship between the claimed violations and the injuries suffered by plaintiffs. Affiliated Ute, supra, 406 U.S. at 154, 92 S.Ct. at 1472. The “in connection with” element has clearly been shown in this case and need not be discussed. The other elements warrant further comment. 1. Materiality. Materiality is an element of common law fraud that is required by the express language of Rule 10b-5(2) and by interpretation of subsections (1) and (3). The concept of materiality is basically an objective one. 3 A. Bromberg, Securities Law: Fraud § 8.3 at 201 (1977). The test for materiality has been articulated in a variety of phrases. In a 1970 case involving alleged violation of Section 14(a) of the 1934 Act and Rule 14a-9 thereunder (misleading statements in proxy statements), the Supreme Court held that the determination of materiality “indubitably embodies a conclusion that the defect was of such a character that it might have been considered important by a reasonable shareholder who was in the process of deciding how to vote.” Mills v. Electric Auto-Lite Co., 396 U.S. 375, 384, 90 S.Ct. 616, 621, 24 L.Ed.2d 593 (1970) (emphasis added). In Mitchell v. Texas Gulf Sulfur Co., 446 F.2d 90 (10th Cir. 1971), cert. denied 404 U.S. 1004, 92 S.Ct. 564, 30 L.Ed.2d 558 (1971), rehearing denied 405 U.S. 918, 92 S.Ct. 943, 30 L.Ed.2d 788 (1972), a 10b-5 case, the court held that “[mjisrepresented or omitted facts become material, hence actionable under 10b-5, when, considering the complaining parties as reasonable investors, the disclosure of the undisclosed facts or candid revelation of misleading facts would affect their trading judgment. . The implicit variables to be weighed in a materiality analysis are the magnitude and probability of the occurrence of the event, set against the size and total activity of the subject company.” Mitchell, supra at 97 (emphasis added). In 1972, the Supreme Court, in a 10b-5 case, again employed the “might” language of Mills: “Under the circumstances of this case, involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this decision.” Affiliated Ute, supra, 406 U.S. at 153-54, 92 S.Ct. at 1472 (emphasis added). What commentators have called the great “would-might” debate appears to have been resolved by the Supreme Court in TSC Industries v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976). R. Jennings & H. Marsh, supra at 931-32. The TSC case concerned alleged violations of Rule 14a-9 and the Court stated the general standard of materiality as follows: An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. This standard is fully consistent with Mills general description of materiality as a requirement that “the defect have a significant propensity to affect the voting process.” It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available. TSC, supra at 449, 96 S.Ct. at 2132. The standard of TSC may be adapted to the circumstances of this case and as such will be used as the standard of materiality here. An omitted or misstated fact is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to purchase securities — that is, it would have assumed actual significance in his deliberation, or it would have been viewed by him as having significantly altered the total mix of information made available. 2. The Degree of Fault Required. In considering this problem we have found helpful Professor Ruder’s approach, which defines conduct in descending order of degree of culpability: 1. Deliberate conduct exists when the defendant has an intent to injure others. 2. Knowing conduct exists when the defendant acts with the knowledge that his acts may injure others. Knowing conduct would include knowing misrepresentation or nondisclosure. 3. Reckless conduct exists when the defendant acts in conscious disregard of, or indifference to, the risk that others will be misled. This conduct includes what is sometimes referred to as “gross negligence.” 4. Negligent conduct exists when the defendant acts unreasonably but does not act with conscious disregard of consequences. 5. Innocent conduct exists when the defendant cannot reasonably be expected to know the true facts. Ruder & Cross, Limitations on Civil Liability Under Rule 10b-5, 1972 Duke L.J. 1125 (1972). In 1976, the Supreme Court held that a private cause of action will not “lie under § 10(b) and Rule 10b-5 in the absence of any allegation of ‘scienter’ — intent to deceive, manipulate, or defraud.” Ernst & Ernst, supra, 425 U.S. at 193, 96 S.Ct. at 1381. While the Court drew the culpability line above negligence, it did not specify precisely where it should be based. Rather, the Court stated that “[i]n this opinion the term ‘scienter’ refers to a mental state embracing intent to deceive, manipulate, or defraud. In certain areas of the law recklessness is considered to be a form of intentional conduct for purposes of imposing liability for some act. We need not address here the question whether, in some circumstances, reckless behavior is sufficient for civil liability under § 10(b) and Rüle 10b-5.” Id. at 193-94 n.12, 96 S.Ct. at 1381 n.12. The Tenth Circuit has not addressed directly the question in the context of a private suit for damages. In Edward J. Mawod & Co. v. SEC, 591 F.2d 588 (10th Cir. 1979), an appeal from a SEC enforcement action, the court held that in such cases reckless behavior satisfies the scienter requirement. In 1977, the Tenth Circuit stated that “[wjillful or intentional misconduct, or the equivalent thereof, is essential to recovery” under Section 10(b) or Rule 10b-5. Utah State University v. Bear, Stearns & Co., 549 F.2d 164, 169 (10th Cir. 1977) (emphasis added). In this District, Judge Rogers has taken the “or the equivalent thereof” language to mean that recklessness is sufficient. In re Clinton Oil Securities Litigation, [77-78 Transfer Binder] CCH Sec.L.Rptr. ¶ 96,015 (D.Kan. 3/18/77). The courts of appeal that have considered the question have agreed that recklessness is enough to satisfy the scienter requirement. Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38 (2nd Cir. 1978), cert. denied 439 U.S. 1039, 99 S.Ct. 642, 58 L.Ed.2d 698 (1978); Coleco Industries, Inc. v. Berman, 567 F.2d 569 (3rd Cir. 1977), cert. denied 439 U.S. 830, 99 S.Ct. 106, 58 L.Ed.2d 124 (1978); First Virginia Bankshares v. Benson, 559 F.2d 1307 (5th Cir. 1977), cert. denied 435 U.S. 952, 98 S.Ct. 1580, 55 L.Ed.2d 802 (1978); Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th Cir. 1977), cert. denied 434 U.S. 875, 98 S.Ct. 225, 54 L.Ed.2d 155 (1977); Nelson v. Serwold, 576 F.2d 1332 (9th Cir. 1978), cert. denied 439 U.S. 970, 99 S.Ct. 464, 58 L.Ed.2d 431 (1978). In McLean v. Alexander, 599 F.2d 1190 (3rd Cir. 1979), recklessness was considered in the context of accountants’ liability. We find the McLean court’s analysis particularly appropriate and adopt it here: In Sundstrand Corp. v. Sun Chemical Corp., supra, the Seventh Circuit stated the minimum threshold for liability under § 10(b) as follows: “[RJeckless conduct may be defined as highly unreasonable [conduct], involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.” In context, the Sundstrand formula was applied only to omissions, but the standard of liability proposed there is, we think, equally applicable to misstatements, and we approve it in both contexts. Accord, Rolf v. Blyth, Eastman Dillon & Co., supra, 570 F.2d at 47. The Sundstrand formulation of recklessness makes it clear, as did Hochfelder, that negligence — whether gross, grave or inexcusable — cannot serve as substitute for scienter. At the same time, as applied to the somewhat specialized area of accountants’ liability, that standard preserves a federal right of action for the kind of accountants’ fraud that has been generally recognized as actionable at common law since the leading case of Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931). Judge Cardozo’s opinion in Ultramares would have permitted recovery for fraud upon a showing that a misrepresentation was made knowingly or wilfully, or with reckless disregard for its truth or falsity, or without a “genuine belief” in its truth. Further, fraud “includes the pretense of knowledge when knowledge there is none.” As Judge Swan made clear in O’Connor v. Ludlam, 92 F.2d 50, 54 (2d Cir. 1937), also an accountants’ liability case, in an action for fraud under the Ultramares standard: the issue [is] whether the defendants had an honest belief that the statements made by them were true. “If they did have that honest belief, whether reasonably or unreasonably, they are not liable. If they did not have an honest belief in the truth of their statements, then they are liable, so far as [scienter] is concerned.” It seems to us that the purpose of footnote 12 of the Hochfelder opinion was to preserve, at least in the context of accountants’ liability, the standards of scienter developed in Ultramares and O’Connor v. Ludlam. And the core requirement of those cases is that the plaintiff establish that the defendant lacked a genuine belief that the information disclosed was accurate and complete in all material respects. Accord, Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d at 1045 n.20. We stress that to prove scienter the plaintiff need not produce direct evidence of the defendant’s state of mind. Circumstantial evidence may often be the principal, if not the only, means of proving bad faith. A showing of shoddy accounting practices amounting at best to a “pretended audit,” or of grounds supporting a representation “so flimsy as to lead to the conclusion that there was no genuine belief back of it” have traditionally supported a finding of liability in the face of repeated assertions of good faith, and continue to do so. In such cases, the factfinder may justifiably conclude that despite those assertions the “danger of misleading . . . [was] so obvious that the actor must have been aware of it.” Sundstrand Corp. v. Sun Chemical Corp., supra, 553 F.2d at 1045. McLean, supra at 1197-98. We hold that recklessness as explained by the McLean court will satisfy the scienter requirement of Ernst & Ernst. 3. Causation. As we indicated above, there must be a causal connection between the claimed violations of Section 10(b) and Rule 10b-5 and the injuries suffered by plaintiffs. Affiliated Ute, supra, 406 U.S. at 154, 92 S.Ct. at 1472. We believe the problem of causation in the circumstances of this case can best be understood in terms of two components: transaction causation and loss causation. With respect to the first, our concern is that there was a causal relationship between the alleged misrepresentations and omissions and the purchases by plaintiffs and the class of Topsy’s securities and debentures. In common law fraud cases this relationship is insured by the requirement that a plaintiff prove that he justifiably relied on a defendant’s misrepresentations. See, e. g. Restatement (Second) of Torts § 525 (1977). In the context of private actions under the federal securities laws, there has been a steady trend away from requiring proof of reliance to establish transaction causation. In Mills v. Electric Auto-Lite, a proxy case, the Supreme Court stated “[w]here the misstatement or omission in a proxy statement has been shown to be ‘material,’ . that determination itself indubitably embodies a conclusion that the defect was of such a character that it might have been considered important by a reasonable shareholder who was in the process of deciding how to vote. This requirement that the defect have a significant propensity to affect the voting process is found in the express terms of Rule 14a-9, and it adequately serves the purpose of ensuring that a cause of action cannot be established by proof of a defect so trivial, or so unrelated to the transaction for which approval is sought, that correction of the defect or imposition of liability would not further the interests protected by Section 14(a).” Mills, supra, 396 U.S. at 384, 90 S.Ct. at 621. The Supreme Court used this approach in Affiliated Ute, supra, 406 U.S. at 153-54, 92 S.Ct. at 1472, a 10b-5 case. As we indicated in Seiffer, 63 F.R.D. at 718, and our order of November 8, 1978, we regard Affiliated Ute as controlling. As the Second Circuit noted in Titan Group, Inc. v. Faggen, 513 F.2d 234, 238 (2nd Cir. 1975), “[t]he parallel elements of materiality and reliance both serve to restrict the potentially limitless thrust of Rule 10b-5 to those situations in which there exists a causation in fact between the act and the injury.” When it is, as a practical matter, impossible to demonstrate reliance, resort must be had to materiality. It seems particularly appropriate to focus on materiality in a case such as the one before us, which involves communications which allegedly contained misrepresentations and failed to disclose material facts, and which were disseminated to thousands of investors. See Mills, supra, 396 U.S. at 380, 90 S.Ct. at 619, citing with approval the Seventh Circuit’s conclusion that “[rjeliance by thousands of individuals, as here, can scarcely be inquired into.” We do not believe, however, that these cases mean that reliance is absolutely irrelevant in this case. Rather, we are in accord with Professor Ruder’s conclusion that a finding of materiality gives rise to a presumption of reliance which may be rebutted. Ruder & Cross, supra at 1137-38. See also Rifkin v. Crow, 574 F.2d 256 (5th Cir. 1978). Thus, defendant Touche Ross was afforded the opportunity to present proof that the presumption of reliance was incorrect. With respect to loss causation, the securities transactions, assuming that they were caused by material misstatements and omissions, must be shown to have resulted in the injury for which plaintiffs wish to be compensated. In our order of January 4, 1979, we held that there is a presumption in plaintiffs’ favor that a loss shown by a decline in market price between the time of purchase and the time of discovery is attributable to the alleged fraud. The presumption is rebuttable and defendants were given the opportunity to prove that the decline was attributable to factors apart from the misrepresentations and omissions. 4. Statute of Limitations. As we have held in earlier orders, the Kansas statute of limitations for fraud [K.S.A. 60-513(a)(3)] and the federal tolling doctrines are applicable in this case. Seiffer, 63 F.R.D. at 716; Memorandum and Order, November 8, 1978. We relied on Esplin v. Hirschi, 402 F.2d 94 (10th Cir. 1968), which in turn relied on Holmberg v. Armbrecht, 327 U.S. 392, 66 S.Ct. 582, 90 L.Ed. 743 (1946). The Holmberg court expressed the doctrine as follows: If want of due diligence by the plaintiff may make it unfair to pursue the defendant, fraudulent conduct on the part of the defendant may have prevented the plaintiff from being diligent and may make it unfair to bar appeal to equity because of mere lapse of time. Equity will not lend itself to such fraud and historically has relieved from it. It bars a defendant from setting up such a' fraudulent defense, as it interposes against other forms of fraud. And so this Court long ago adopted as its own the old chancery rule that where a plaintiff has been injured by fraud and “remains in ignorance of it without any fault or want of diligence or care on his part, the bar of the statute does not begin to run until the fraud is discovered, though there be no special circumstances or efforts on the part of the party committing the fraud to conceal it from the knowledge of the other party.” Id. at 396-97, 66 S.Ct. at 584-585 (citations omitted). We are in accord with Professor Ruder’s interpretation of the doctrine “that where a person has been injured by fraud, his lack of diligence in pursuing his rights, which normally would bar his claim, will be excused by a defendant’s fraudulent concealment. This standard implies further that a plaintiff can assert the tolling doctrine even in the absence of defendant’s concealment if the plaintiff is diligent in his efforts to discover the fraud.” Ruder & Cross, supra at 1143. We understand that to mean that our concern must be with when, in light of the allegations of a defendant’s fraudulent concealment, a plaintiff should have discovered the fraud. The statute of limitations begins to run at that point. In our earlier order we indicated that in this case an objective standard of due diligence should be applied. Seiffer, 63 F.R.D. at 719. Thus, we must determine when, in light of the allegations of fraudulent concealment, a reasonable investor should have discovered the fraud. At issue is whether plaintiffs’ claim against Touche Ross, which was filed on October 10,1973, is time barred. Our inquiry must therefore be whether a reasonable investor should have discovered the alleged fraud of Touche Ross before October 10, 1971. E. Accountants’ Liability. Commonly, in securities fraud actions, a distinction has been drawn between primary and secondary defendants. Those persons or entities owing direct duties to the public are classified as primary wrongdoers and those whose liabilities arise because another has violated the law are classified as secondary wrongdoers. Ruder, Multiple Defendants In Securities Law Fraud Cases: Aiding and Abetting, Conspiracy, In Pari Delicto, Indemnification, and Contribution, 120 U.Pa. L.Rev. 597, 600 (1972). Accountants may be primary wrongdoers when they themselves make statements to investors which contain misrepresentations or omit to state facts necessary to make what is said not misleading. Financial statements certified by an accountant for presentation to investors give rise to a direct duty to the public. The accountant was in the position of a primary violator in McLean v. Alexander, 599 F.2d 1190 (3rd Cir. 1979), where a Certified Report of Examination, containing an audited balance sheet, was alleged to include a false statement. The scienter standard we discussed above was applied arid the Third Circuit stated that because the opinion was based upon generally accepted auditing standards, the accountant “could be held to have the necessary scienter only if the evidence supports an inference that when it expressed the opinion it had no genuine belief that it had the information on which it could predicate that opinion.” Id. at 1198. The court, in reversing the trial court, held that the investigation the accountant made and the knowledge it had could not give rise to an inference that it must have been aware of the risk that the item at issue was misleading. Id. at 1199. Accountants may also be charged as aiders and abettors. The leading case dealing with aiding and abetting is Brennan v. Midwestern United Life Insurance Co., 259 F.Supp. 673 (N.D.Ind.1966) (motion to dismiss denied), 286 F.Supp. 702 (N.D.Ind. 1968) (on merits), aff’d 417 F.2d 147 (7th Cir. 1969), cert denied, 397 U.S. 989, 90 S.Ct. 1122, 25 L.Ed.2d 397 (1970). Primary defendants were found to have violated the securities laws by fraudulently accepting orders for stock of Midwestern Life and using the payments to speculate in the commodities market. Liability was imposed on Midwestern on the ground that it knew the primary defendants were violating the securities laws and had actively aided and abetted them. While the elements of an aiding and abetting claim have not yet completely crystalized, we believe that the analysis in Woodward v. Metro Bank of Dallas, 522 F.2d 84 (5th Cir. 1975) is particularly enlightening. The Woodward court relied on the definition in SEC v. Coffey, 493 F.2d 1304 (6th Cir. 1974), cert. denied 420 U.S. 908, 95 S.Ct. 826, 42 L.Ed.2d 837 (1975): “[A] person may be held as an aider and abettor only if some other party has committed a securities law violation, if the accused party had a general awareness that his role was part of an overall activity that is improper, and if the accused aider-abettor knowingly and substantially assisted the violation.” 493 F.2d at 1316. The Woodward court rejected the definition in Landy v. Federal Deposit Insurance Corp., 486 F.2d 139 (3rd Cir. 1973), cert. denied 416 U.S. 960, 94 S.Ct. 1979, 40 L.Ed.2d 312 (1974), which referred to an “independent wrong” instead of securities law violation and to “knowledge of the wrong’s existence” instead of the aider-abettor’s awareness of his role in the improper activity. Landy omitted the “knowing” requirement of the substantial assistance element. The court in Woodward reasoned as follows: The first two Landy elements pose a danger of over-inclusiveness and seem to lose sight of the necessary connection to the securities laws. One could know of the existence of a “wrong” without being aware of his role in the scheme, and it is the participation that is at issue. The scienter requirement scales upward when activity is more remote; therefore, the assistance rendered should be both substantial and knowing. A remote party must not only be aware of his role, but he should also know when and to what [extent] he is furthering the fraud. Woodward, supra at 95. We believe that the knowledge requirements of this definition — knowledge of securities law violation, knowledge of one’s role in the fraud, and knowing assistance— as opposed to a recklessness or “should have known” standard are crucial for the reasons well-stated by Professor Ruder: In most cases, the alleged aider and abettor (or conspirator) will merely be engaging in customary business activities, such as loaning money, managing a corporation, preparing financial statements, distributing press releases, completing broker’s transactions, or giving legal advice. If each of these parties will be required to investigate the ultimate activities of the party whom he is assisting, a burden may be imposed upon business activities that is too great. Although such a duty might contribute to the protection of investors by creating another level of private investigators, creation of such a duty through the use of aiding and abetting or conspiracy concepts should take place only through the sound foundation of judicial precedent in analogous fields or express statutory language. Ruder, supra at 632-33. A “remote” party is further protected somewhat by the requirement that an aider-abettor’s assistance be “substantial,” which reflects the concern of courts with causation. In considering this, the district court in Brennan, supra, 286 F.Supp. at 725, turned to the common law roots of liability under the securities laws and noted that an “[asserted] part of the common law of torts has always been the limitation that a tortfeasor is not liable for a loss unless his tortious conduct was a substantial factor in bringing the loss about.” The problem is determining what losses, if any, the aider-abettor “conduct was in fact a substantial factor in bringing about.” Id. We believe that in order to establish aiding and abetting liability, plaintiff must prove that there were securities laws violations, that Touche Ross knew of the violations and of its role in the scheme, and, with this knowledge, substantially assisted in the violation. In light of this standard the question of an accountant’s adherence to generally accepted auditing standards and generally accepted accounting principles is of limited importance. An accountant, who knows that by complying with these standards and principles he is substantially assisting in a fraud, is not protected. On the other hand, an accountant, who relies on the profession’s standards and principles without knowledge that by doing so he is playing a role in furthering a fraud, will not be held liable. III. THE CLAIMED MISCONDUCT. A. Background. Topsy’s International, Inc. was the outgrowth of a popcorn shop located in the Country Club Plaza, Kansas City, Missouri, which was established by Jerry Berger in 1949. Prior to the summer of 1968, Topsy’s operated snack bars in discount department stores or enclosed mall shopping centers, popcorn concessions in variety and discount department stores, in-plant feeding, franchised Topsy’s Popcorn & Ice Cream Shops subleased to others, and mobile units selling popcorn, soft drinks, and other items in discount department stores. The franchising operation of popcorn and ice cream shops began in 1967. In December 1967, Topsy’s made a public offering of 210,000 shares of Class A Common Stock at $19.00 per share. Topsy’s stock was (and continues to be) sold in the over-the-counter market. Topsy’s itself sold 48,343 shares; Berger sold 115,000 shares; House sold 24,000 shares; and Nuell sold 10,500 shares. Counsel for the offering was Tucker Chamo, and Ralph Tucker sold 10,500 shares of his own. The accounting firm for the offering was Touche, Ross, Bailey & Smart. DempseyTegeler & Co. acted as the lead underwriter. Prior to 1966, Topsy’s had been audited by a small local accounting firm. In 1966, the accounting firm of Lipoff, Sharlip and Pesman audited the consolidated financial statements of Topsy’s. Berger had met Nat Sharlip in 1960 through Ralph Tucker. They had a social as well as a business relationship. House had met Sharlip sometime between 1946 and 1950, and also had a social relationship with him. In 1967, the Lipoff, Sharlip and Pesman firm merged with Touche Ross. Sharlip became a Touche Ross partner as a result of the merger and was partner in charge of Topsy’s 1967 audit engagement. Touche Ross, through Sharlip, performed additional business advisory services for Topsy’s, and Sharlip frequently attended board meetings through 1970. Topsy’s, of course, reported to its shareholders on a quarterly and annual basis. Touche Ross audited the consolidated financial statements that were included in the 1968, 1969, and 1970 annual reports. The other parts of the annual reports were prepared by Topsy’s management with the assistance of Ralph Tucker, and were not reviewed by Touche Ross prior to distribution. Similarly, the quarterly reports, which did not contain audited financials, were prepared by management and not reviewed by Touche Ross before release. Jack Halper, an employee of DempseyTegeler, became a member of Topsy’s board of directors after the 1967 public offering. When Dempsey-Tegeler did an underwriting, it normally requested that one of its employees become a board member in order to keep apprised of operations and be afforded the opportunity to act as lead underwriter if a company should seek additional public financing. Dempsey-Tegeler served as Topsy’s investment banker and was consulted on major business decisions and methods of financing through Halper and another Dempsey-Tegeler employee, Wells McTaggart. The 1967 public offering followed close on the heels of Topsy’s entering the franchising field. At the time of the offering, Topsy’s had franchised six popcorn and ice cream shops in Missouri and Kansas, had executed leases for three additional locations, and was working to secure other suitable locations for franchise stores. Berger was aware that the price of Topsy’s stock began to climb with the company’s announcement that it was going into franchising, and there was a causal relationship between the announcement and the improved performance of the stock. In the first quarter of 1967, the stock was selling between l16/i6 and 2®/i6 per share. After the company’s entry into the franchising of popcorn and ice cream shops, the stock was selling in the range of 7V2 to 113A per share. In late 1967, Berger discussed with Wells McTaggart Topsy’s desire to get into some type of fast-food franchising. Topsy’s became interested in franchising roast beef restaurants about the time of the 1967 public offering. Topsy’s discussed a merger with Arby’s, which was already in the roast beef franchising business, but no merger took place. Topsy’s employed a consultant to advise it regarding the establishment of such a franchising business and, at its April 1968 board meeting, approved continued investigation of roast beef franchising. Topsy’s first became aware of SaxonS in January or February 1968, when House visited a SaxonS restaurant in Columbus, Ohio. He was very impressed with the operation. SaxonS had been incorporated since January 1967. The principal shareholders were William West, Leland Henry, and William Sapp. West acted as chief executive officer. Sometime after House’s visit to Columbus, Berger and House spoke with a Mr. Nelson who had just purchased a SaxonS franchise and signed a franchise agreement for a Topsy’s popcorn shop in Arizona. Nelson furnished them with some financial information, including projections about SaxonS units, and suggested that Topsy’s contact West. , West was invited to Kansas City in the late spring or early summer of 1968. West discussed the operation of SaxonS, how it differed from other roast beef franchise businesses, sales, profitability, and locations of units. He indicated that he was interested in expanding SaxonS, but had insufficient capital, and that' Sapp and Henry were interested in selling. Berger and House were aware that although West had originated the SaxonS concept, his restaurant experience dated only back to 1964. Prior to that time he had been in business manufacturing and selling aquariums. Sapp and Henry had considerably more restaurant experience. Ralph Tucker was present at this meeting with West. Berger and House made a trip to Columbus after West’s visit to Kansas City. They looked at sales records of the various franchise units and records of the company unit. Using data which included wage costs, food costs, rent, and other expenses, Berger analyzed the financial information they had obtained from SaxonS and made projections relating to the operation of sandwich shops and profits that could be realized from the sale of franchises. There is no indication that anyone from Touche Ross participated in these meetings with West, or assisted Berger in analyzing the financial and operating information Topsy’s had obtained about SaxonS. Upon returning from Columbus, Berger decided that he wanted to purchase SaxonS for a price as high as $500,000.00. B. The Purchase of SaxonS and Activities Through October 29, 1968. 1. The Acquisition of SaxonS. Having determined that Topsy’s should purchase SaxonS, Berger sent House, Tucker, and Sharlip to Columbus on the last Saturday in July 1968. They returned to Kansas City the following evening. While in Columbus, Tucker reviewed the SaxonS franchise agreement and leases. He negotiated the price and terms of the sale which were to be laid out in the final document. House inspected the three Columbus units, evaluated menus and other aspects of operations, and worked out costs of goods and estimated labor costs to project profitability. Sharlip looked at financial records and spoke with George Noxon, SaxonS’ controller. In a letter dated August 6, 1968, Sharlip reported to Berger on his trip to Columbus. He included financial statements (unaudited) as of June 30, 1968, which had been prepared by Noxon. Sharlip presented alternative ways of recognizing income from franchise fees, all of which would be in accordance with sound accounting principies. The letter included a projection of royalties of $100,000.00, based on $225,-000.00 volume, from franchises sold to date. Sharlip also stated that “[pjrofit on equipment sales to franchisees, now on hand, is projected at approximately $200,000.00 during the next twelve-month period.” The letter made no recommendation as to whether, in view of the records and statements, Topsy’s should or should not purchase SaxonS. Sharlip’s letter had no appreciable impact on Topsy’s decision to purchase SaxonS, a decision which was actually made by Berger before the trip. Had Sharlip found that the records he examined revealed serious financial problems and communicated that information to Topsy’s, the decision to purchase may well have been reversed. There is, however, nothing to indicate that he should have made such a discovery. The assumptions upon which the “projections” in the letter were based were regarded by Berger as conservative. It was recognized that Sharlip could not have acquired more in-depth information in the time allotted for the Columbus trip. None of the alternatives for recognition of income from franchise fees, which Sharlip had listed in his letter, were ultimately used. Rather, it was determined that only $2,500.00 of the $10,000.00 fee would be recognized when a franchise was sold and the rest would be deferred. The result was that, in the final prospectus, SaxonS’ net income was shown as $35,572.00 for the year ended July 31, 1968, whereas Noxon’s financial statement showed net income of $82,300.00 for the year ended June 30, 1968. The amounts deferred would increase potential income after August 1, 1968, which would be included in Topsy’s consolidated income. We find nothing suspect in this procedure. An acquisition agreement was prepared and is dated August 1, 1968. Topsy’s board of directors considered the acquisition at a special meeting on August 22, 1968. The directors present were Berger, Nuell, Sam Schultz, G. Kenneth Baum, and Jack Hal-per. Sharlip was not present. Berger told the meeting that SaxonS was well-managed by West, had great potential but insufficient capital, would accelerate Topsy’s entry into the roast beef franchising field by several years, and probably create incalculable benefits for Topsy’s. The acquisition agreement was distributed and a discussion, with many questions and answers, ensued. Berger told of a trip House and Tucker had taken to Columbus to negotiate and consummate the purchase after the preliminary dealing between himself and West. The purchase was unanimously approved. The agreement called for Topsy’s to purchase all of the outstanding stock of SaxonS in exchange for $300,000.00. West was given the option of taking his share in stock of Topsy’s, if he continued as an employee of SaxonS. He stayed on as president and hence received restricted stock of Topsy’s in lieu of cash. The purchase price was thus $203,915.00 in cash and 3,342 shares of Topsy’s Class A Common Stock. Unaudited financial statements as of June 30, 1968, a SaxonS sales brochure, a schedule of SaxonS leases, a schedule of buildings under construction, and a schedule of franchise agreements were attached to the acquisition agreement. The .selling shareholders of SaxonS warranted that the financial statements had been prepared in accordance with generally accepted accounting principles, were correct and complete, and fairly presented SaxonS’ financial position; that there had been no material adverse change in financial conditions since the date of the statements; that SaxonS had no direct or contingent liabilities not shown in the statements; and that SaxonS had paid all taxes due as of the date of the statements. The SaxonS shareholders agreed to indemnify Topsy’s and SaxonS for any loss or expense that might result from a breach of any representation or warranty made by the sellers in the agreement. 2. The “Audit” of SaxonS. In September 1968, Sharlip told Paul Eppenaur, then a senior on the audit staff of Touche Ross, to go to SaxonS’ home office to perform certain audit procedures on SaxonS’ balance sheet as of July 31, 1968, so that a Touche Ross opinion could be issued on Topsy’s consolidated (including SaxonS) financial statements for the 1969 fiscal year. Berger testified that he had told Sharlip that he wanted a full audit and presumably an opinion. For reasons which will be discussed later and because, in light of the warranty in the purchase agreement, the need for a full audit at that time was not apparent, we find Eppenaur’s understanding of what was to be done by Touche Ross to be credible and reasonable. Eppenaur spent three days in Columbus, reviewed copies of unaudited financial statements, and became familiar with SaxonS’ general ledger, other accounting records, and reports. He sent out confirmations of accounts receivable, accounts payable, and lease deposits. His field work was basically concerned only with the balance sheet of SaxonS as of July 31, 1968. His investigation of subsequent events was only related to the determination of how to account for franchise fees, with an IRS review of SaxonS’ 1967 tax return, and with making routine inquiries of SaxonS’ management as to whether there had been any material adverse changes between July 31, 1968 and the time he left Columbus. Herbert Martin, Topsy’s controller, understood that these procedures did not involve an audit of SaxonS’ statements of earnings for any period and that such an audit would have required more extensive procedures. Upon his return to Kansas City, Eppenaur examined the SaxonS franchise agreements, leases, and corporate minutes that .existed as of July 31, 1968. This review of franchise files took place in the office of John Jouras, a member of the Tucker Char-no firm; its purpose was to obtain information to assist Touche Ross in advising Topsy’s regarding the way SaxonS was to account for franchise fee income as of July 31, 1968. Until March 1969, Eppenaur did not expect to issue an audit opinion as a result of the procedures he undertook other than Touche Ross’ opinion on the Topsy’s consolidated financial statements for fiscal year 1969. We are not persuaded that any other Touche Ross personnel had such an expectation. When Eppenaur learned in March that an opinion was expected, he finished the audit schedules he had begun, prepared a trial balance, drafted a balance sheet, and wrote an audit memorandum. The opinion was issued on May 7,1969. The report was dated September 11, 1968 — the date on which Eppenaur had completed his field work in Columbus. The balance sheet contained a footnote, dated February 13, 1969, regarding SaxonS’ federal income tax liability as of July 31,1968. Touche Ross had received an IRS report on February 13, 1969, pertaining to SaxonS’ tax liability. 3. The Operation of SaxonS as a Topsy’s Subsidiary. The acquisition agreement contained specific provisions relating to leases of units in Ft. Lauderdale, Florida, and Columbus, and the home office building also in Columbus all of which were guaranteed by the selling shareholders. The agreement provided: Buyer agrees to execute a document substituting Buyer for Sellers as guarantors on said leases to the same extent that Sellers have guaranteed same, provided that the Landlord in each such lease consents to the substitution. In the event the Landlord does not consent to the substitution above provided, Buyer agrees