Appendix — Sternbach v. Sirota

A-l

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

United States District Court

SOUTHERN DISTRICT OF NEW YORK

75 Civ. 1369 (CLB)

>

HOWARD SIROTA, et ai.,

Plaintiffs,

—against—

SOLITRON Devices, INC., et ai.,

Defendants.

~~

Memorandum and Order

BRIEANT, J.

This class action, brought on behalf of purchasers of shares of

Solitron Devices, Inc. against the company, Solitron Devices, Inc.

(hereinafter Solitron), its officers, Benjamin Friedman, James P.

Barry and James S. Trager, and its accountants, Louis Sternbach

& Co. (hereinafter Sternbach), was tried to a jury which

returned a general verdict for the plaintiff class, and also

answered Special Interrogatories, pursuant to Rule 49(b), Fed.

R. Civ. P. Familiarity therewith is assumed. Defendants Soli-

tron, Friedman, Barry and Trager have moved for judgment not-

withstanding the verdict, pursuant to Rule 50(b), Fed. R. Civ. P.,

or in the alternative, for a new trial, pursuant to Rule 59(a), Fed.

R. Civ. P. Defendant Sternbach has also moved for judgment

notwithstanding the verdict as well as for an order granting it

contribution-over on its cross-claims against the co-defendants.

The contribution claims were tried to the Court without a jury.

The principal allegations of the amended complaint were based

on violations of Section 10(b) of the Securities and Exchange Act

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

of 1934, 15 U.S.C. § 78j and Rule 10b-5 promulgated thereun-

der, 17 C.F.R. 240 10b-5. Specifically, the case was tried on the

theory that Solitron, the stock of which is publicly traded, and the

individual defendants violated Rule 10b-5(2) and polluted the

market, by intentionally issuing annual reports and financial

statements which contained material false representations as to

the company’s sales, income, inventory and accounts receivable,

as well as material omissions as to the true financial condition of

the company. Defendant Sternbach was alleged to be an aider

and abettor of the primary securities law violation. A pendent

state claim of common law negligence against the defendant

Sternbach was also tried to the jury.’

For convenience, we set forth the background of the litigation

and consider how it arose. Defendant Solitron, is a semi-conduc-

tor manufacturer and by virtue of its government contracts, a

small proportion of its business primarily involving its branch at

Riviera Beach, Florida, was subject to the Renegotiation Act of

1951, as amended. The Act, derived from legislation in effect

originally during World War II to prevent a repetition of claimed

“war profiteering” believed to have been committed during World

War I by so called “merchants of death,” limited the amount of

profits a contractor or subcontractor could earn on government

contracts and provided for an administrative recapture of any

excess to be determined after completion of the contracts. In

1972, the United States Renegotiation Board “determined,”

administratively, that Solitron had realized renegotiable profits,

subject to recapture, of $3,200,%w attributable to fiscal year

1967 (Pitf. Ex. 69) and renegotiate profits of $4,400,000 attrib-

utable to fiscal year 1968 (Pitf. Ex. 70).

Following the usual procedure in such matters, Solitron sought

administrative review of this assessment. It retained Mr. Alex-

ander Kirk who testified at trial. Mr. Kirk is not a lawyer; he

describes himself as a renegotiation consultant. His professional

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

work includes the representation of government contractors at the

investigatory and administrative levels, to assist them in avoiding

or minimizing recapture. Advised by Mr. Kirk, Solitron, in order

to obtain a more favorable determination of its liability, retained

Price Waterhouse & Co. to investigate, and prepare reports for

Solitron (Pitf. Ex. 9 & 9a). The reports, which are not audits,

indicated that the Board’s determination of excess profits may

have been in error, because it relied on overstated sales and

inventories in the certified financial statements of Solitron for

those years. These financials, included in Solitron’s annual report,

were prepared by Sternbach from Solitron’s books and records

and were signed by Friedman. Plaintiffs contended at trial that

the misrepresentations of fact in the corporation's certified

financials disclosed in the Price Waterhouse reports and in a letter

written by defendant Trager, acting for Solitron, to the Renegoti-

ation Board (Pitf. Ex. 115) taken together, demonstrated signifi-

cant prior violations by the defendants of the federal securities

laws.

At the time of the initial renegotiation assessment, Solitron

disclosed in its financial statements that a liability assessment had

been rendered, and was being contested but failed to disclose the

amount so assessed. The disclosure reads as follows:

“A portion of the company’s business is subject to The

Renegotiation Act of 1951, as amended. Determinations

of excessive profits in fiscal years 1967 and 1968 have been

made by The Eastern Regional Renegotiation Board but

are being contested by the Bar soe The Statutory

Board is presently reviewing The Regional Board's deter-

poe sae The fiscal years 1969 and 1970 are being

reviewed by The Regional Board but such review is not

expected to be completed until the earlier years are settled.

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

(Annual Report for fiscal year 1972, Pitf. Ex. 25.) Similar

disclosures were made in the annual reports for fiscal years ending

1973 and 1974. (Pitf. Ex. 26 and 8.)

On this basis, plaintiffs alleged that this constituted a material

omission in violation of Rule 10b-5. The latter claim was not

asserted against defendant Sternbach because it was not Soli-

tron’s accountant during this period. ’

The plaintiff class of purchasers of Solitron securities during

the 1967-1975 period was divided into two subclasses’ to corre-

spond to the time periods during which the alleged misrepresenta-

tions or omissions were made in the Solitron financial statements.

The first subclass consists of those persons who purchased Soli-

tron securities from May 5, 1967 to December 16, 1970° and who

thereafter either sold said stock at a loss or continue to hold said

stock. The claims of this class submitted to the jury concerned

misrepresentations of inventory, sales and therefore profits, con-

tained in the Solitron financial statements for the fiscal years

ending February 28, 1967, February 28, 1968 and February 28,

1970. Although plaintiffs also asserted a claim based upon mis-

representations of inventory in the financial statements for the

fiscal year ending February, 1969, that claim was dismissed by

the Court. (Tr. 1513-14).

The second subclass consists of those persons who purchased

Solitron securities from June 8, 1972 to January 27, 1975 and

who thereafter either sold that stock at a loss or still hold it. The

claim submitted to the jury on behalf of these shareholders was

based on the failure to disclose in the financial statements for the

period including fiscal year ending February 28, 1972 through

fiscal year ending February 28, 1974 the amount of contingent

liability which had been determined by the United States Rene-

gotiation Board to be owed by Solitron. Because the claims of

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

each subclass depend upon distinct misrepresentations or omis-

sions in the financial statements, the Court will consider them

separately in determining the post-trial motions

1. SuBcLass No. 1

We turn first to consider the claims of the first subclass, as to

which plaintiffs contended that the financial statements for the

fiscal years 1967, 1968 and 1970 contained misrepresentations as

to the amount of inventory, and that certain transactions between

Solitron and AEL Israel, between Solitron and Best & Raynor,

and between Solitron and JFD Electronics were characterized

improperly as sales when there were merely consignments of

unsold goods. The jury answered Speciai Interrogatories in the

affirmative as to the individual elements of this claim and also

stated the percentage by which it found the misrepresentations

had inflated the market price of Solitron securities for each of the

three years specified.

The Solitron defendants now seek to challenge the jury verdict

on various bases. They claim that:

ais te octane ee ca et eee

sustain its answers to the its

sasdiat, €2) the sation ta eanlaney Ge ecthe Oo

evidence and (3) at no time did any of the named Plain-

tiffs have a claim with respect to Solitron’s books and

records for the period ending December 16, 1970.

Defendants also move for a new trial to Rule

59(a) on the ground that it was prejudicial error for the

Court to refuse to permit the introduction of the proferred

testimony of Bernard Malina, Esq., the attorney who rep-

resented Solitron in the AEL Israel transaction, concern-

ing matters relating to Benjamin Friedman and scienter.”

(Memo of Law, filed Nov. 12, 1980, at 1-2).

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

Supplementary affidavits of various persons connected with the

AEL Israel transactions were submitted by the Solitron defend-

ants in support of the motion for a new trial, apparently on the

basis of newly discovered evidence. Defendant Sternbach has

filed an answering affidavit.

Defendant Sternbach also moves to set aside the verdict of the

jury, as it pertains to the claims of the first subclass, on the ground

that there was insufficient evidence to sustain the determination

of its liability as an aider and abettor or for common law negli-

gence under New York law.

EVIDENCE PRESENTED AT TRIAL.

The defendants’ motions must be evaluated against the appli-

cable standard. In order to enter judgment notwithstanding the

verdict, the trial court must find that “the evidence is such that,

without weighing the credibility of the witnesses or otherwise

considering the weight of the evidence, there can be but one

conclusion as to the verdict that reasonable men could have

reached.” Simblest v. Maynard, 427 F.2d 1, 4 (2d Cir. 1970)

(citations omitted). In this case, the evidence must be viewed in

light most favorable to thé plaintiffs and they must be given the

benefit of all the favorable inferences which the evidence fairly

supports. Mattivi v. South African Marine Corp., 618 F.2d 163,

167 & n.3 (2d Cir. 1980); Lebrecht v. Bethlehem Steel Corp.,

402 F.2d 585, 589 (2d Cir. 1968).

A motion for a new trial pursuant to Rule 59(a), Fed. R. Civ.

P., is addressed to the discretion of the trial judge, whose duty it is

to assure that there has been no miscarriage of justice. Beveinov.

Saydjari, 574 F.2d 676, 684 (2d Cir. 1978). Before granting a

new trial, the Court must find that the weight of the evidence is

plainly against the non-moving party. /d.

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

The jury was charged that the plaintiff was required to prove

the following five elements by a preponderance of the evidence

before it could find a primary violation of Rule 10b-5 by Solitron

or any of the individual defendants:

“The first element is that in connection with the

purchase or sale of Solitron Devices securities, namely

stock, the defendants made representations of fact. In

connection with this element you can treat the annual

reports and the press releases, which are in evidence in this

case, as representations of fact.

The second element is that these representations or any

one or more of them contained one or more untrue state-

ments of fact or omitted facts which were necessary to

make the statement not misleading in light of all the cir-

cumstances then existing.

The third element is that the misrepresentations or

omissions must have been material... .

The fourth element must be that the defendants, or the

defendant whose case you are considering, acted with

scienter. . . .

The fifth element which must be shown is that the

defendants’ conduct caused damage to the class of persons

who purchased Solitron stock during the period in which

the misrepresentations were outstanding or the omissions

were withheld from the public. That damage would be

present if it be found by you that the misrepresentations or

omissions, if there were any, caused the market price of

Solitron stock to be inflated over what it would have been

ee 10b-5 violation.” (Tr. 1583-

The Solitron defendants do not dispute that the financial state-

ments for the fiscal years ending 1967, 1968 and 1970 contain

overstatements of inventory. Nor do they contest that the con-

tract between Solitron and AEL whereby AEL agreed to dis-

tribute Solitron products in Israel was. as it most clearly states, a

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Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

consignment arrangement and that the treatment of goods con-

signed thereunder as sales included on the 1970 financials was in

error. Neither do they contest the jury finding that the misrepre-

sentations taken as a whole for these three years were material.‘

They do contend, however, that the evidence at trial was insuffi-

cient to establish that any of the individual defendant officers

sued or Solitron itself acted with the requisite scienter, and that it

did not support the jury’s determination of damages.

The Solitron defendants have failed to establish that they are

entitled to a judgment notwithstanding the verdict or a new trial

on either basis.

In order to satisfy the element of scienter, plaintiff was required

to prove that the defendant whose case is being considered partic-

ipated in the preparation or dissemination of the financial state-

ments with actual knowledge of the misrepresentations or with a

reckless disregard for their truth or falsity. See Ernst & Ernst v.

Hochfelder, 425 U.S. 185 (1976); IIT, An International Invest-

ment Trust v. Cornfeld, 619 F.2d 909, 923 (2d Cir. 1980); Lanza

v. Drexel & Co., 479 F.2d 1277, 1300-02 (2d Cir. 1973).

The misrepresentations in the financial statements for the years

ending 1967, 1968 and 1970 were based on overstatements of

inventory and improper accounting for consignments as if they

were sales. Solitron admitted these overstatements in its presen-

tation to the Renegotiation Board in 1974. The report to the

Renegotiation Board was submitted by Mr. Friedman, and con-

tained memoranda from the other officers of the company, Mr.

Trager and Mr. Barry. There is no question that as of 1974, the

three individual defendants and Solitron had actual knowledge of

the misrepresentations sufficient to satisfy the scienter require-

ment if the financial statements had been issued at that time.

The issue is whether the defendants possessed the actual knowl-

edge at the time the financial statements were issued. The

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Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

defendants argue now, as they did before the jury, that the over-

statements of inventory were not known until the late 1970's and

could not have been discovered without the time and motion

study, and its computer capability, both of which postdated the

financial statements.

They also argue that they did not learn that certain “sales”

were actually “consignments” until 1974. These arguments were

made to the jury and are merged in the jury verdict. The ques-

tion of intent is not capable of exacting proof. It is a question of

fact, peculiarly within the scope of the jury function to determine

from all the evidence presented and drawing all logical inferences.

There was sufficient evidence presented as to the intent of each

intentional effort to exaggerate or “hype” the sales and profits of

Solitron and thereby mislead prospective stock purchasers. A

reasonable jury could reject their claims at trial that they relied

inflate the company’s financials. They could also find that they

knowingly completed and gave to Sternbach false inventory cer-

tificates and Sternbach questionnaires in order to ensure that the

inflated sales and inventory figures would go undetected.

Although the goods shipped to AEL Israel were booked as

“sales,” the plain language of Solitorn's contract provided that

AEL Israe! was to be merely a distributor of Solitron semi-

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Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstcxding the Verdict

This contract, which was concealed from the auditors, also pro-

vided that each invoice pertaining to this agreement would state

on its face that the merchandise was being shipped on

consignment:

“Each shipment of merchandise under this

shall have a Consignment Number of the series 001-100

attached thereto. Solitron shall place the following

endorsement on each invoice of consigned merchandise:

‘The within merchandise bearing Consignment

Number is delivered by Solitron Devices, Inc.

to A.E.L. Israel Limited, pursuant to an Agreement

dated January 27, 1970."”

None of the invoices for goods shipped to AEL Israel contained

this required endorsement, nor did they indicate, in any other

manner, the true nature of the transaction. Each on its face

appeared to record a sale. No auditor who examined any of the

invoices would be apprised that it was a consignment rather than

a sale. The jury could also find that the “sales” to AEL Israel

were booked as such at a point in time close to the end of the fiscal

year 1970, in an attempt to hype the sales, and thereby the profits

of the company. The jury could apply its logic, its common sense

and experience to find that the last sales booked in any fiscal year

are the most profitable, because the overhead and administrative

expenses of a company have already been covered. The jurors

could conclude on the totality of the evidence that the $1,053,468

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Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

recorded as sales to AEL Israel, in itself approximately 4% of the

year’s total sales of $30.9 million, was material misrepresentation

and inflation of earnings. Mr. Friedman himself was the “sales-

man” in charge of the AEL account (Tr. 420). This was not the

first time that Solitron included consignment shipments as sales

in order to hype its profits. Plaintiffs proved that in 1969 con-

signment shipments to Best & Raynor (in the United Kingdom)

amounting to $443,780 were improperly included as sales. Simi-

larly, in 1969 and 1970, shipments to JFD Electronics, a company

_ fun by Mr. Robert Dressler (with whom Mr. Friedman was

acquainted and with whom he spoke about the transaction), in

the amount of $468,634 were also booked as “sales.” The jury

could consider this evidence of prior, similar acts as well as the

paper trail left by the AEL transaction in determining the intent

of the defendants. An inference of fraud is compelling.

The jury had sufficient evidence before it to support a conclu-

sion that the Solitron defendants intentionally polluted the mar-

ket with false and fraudulent sales and profit figures, and only

disclosed the true information when it became helpful to Solitron

in its Renegotiation dealings to do so. Therefore, the Court

rejects the defendants’ contention that there was insufficient evi-

dence on this claim to support the jury verdict. Nor do I find that

the verdict is so contrary to the weight of the evidence so as to

require a new trial.

Each defendant has also argued that his individual involvement

in the preparation and dissemination of the false financial state-

ments and his individual knowledge is insufficient to sustain a

finding that he intentionally violated Rule 10b-5. This is plainly

not the case.

Mr. Trager participated in the preparation of the financial

statements as a member of the Sternbach audit team for the fiscal

years ending 1967 and 1968 and was the comptroller of the

Tappan Division of Solitron from June 1969. He currently serves

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Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment No‘withstanding the Verdict

as Treasurer of Solitron. Mr. Trager coordinated the presenta-

tion made to the Renegotiation Board seeking a reduction in the

assessment levied against Solitron. When these company offi-

loss it had incurred in 1971 could not be applied for Renegotiation

purposes to reduce the profits earned in previous years, they

attempted to show that the profits of earlier years had been

overstated when reported, and were “phony.”

It is important to note that when the time came to dispute the

amount of profit, Mr. Trager knew where to look for evidence.

Trager testified that it was he who informed the Renegotiation

Board that the inventory for the years 1967 to 1970 had been

overvalued. He admitted that the suggestion that the revaluation

of inventory would yield overpriced inventories in earlier years

was his. It was not an endeavor undertaken pursuant to a sugges-

tion of the Renegotiation Board (Tr. 245). In the presentation

to the Renegotiation Board, the build-up of inventory was cited in

support of the claim that inventory was overstated. If this be

evidence of overstatement, it was equally available when the

information to submit to the Renegotiation Board, admitting that

Best & Raynor and JFD Electronics were recorded improperly on

the books of Solitron as sales in the year’of shipment. To sub-

stantiate this argument before the Renegotiation Board, he relied

on letters he received from each of these companies indicating

that each was acting as a distributor on a consignment basis.

(Tr. 164, 165). Although he had already received the letters for

Best & Raynor and JFD Electronics, he, nevertheless, in January

1970, prepared and signed an internal control questionnaire for

Sternbach and in response to an inquiry as to whether consign-

ments were under inventory control, checked “not applicable.”

(Pitf. Ex. 32). He received a copy of the letter sent from AEL

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

Israel to Mr. Cole at Sternbach prior to the certification of the

financials and issuance of the 1971 annual report but after the

closing date of fiscal year 1971. Mr. Trager had these three

letters in 1970-71. In 1974, he contended for the first time that

Trager was the source of the information in the Price Waterhouse

Report dealing with the consignments. (Pitf. Ex.9). Although

he testified that he came to this conclusion only after obtaining a

legal opinion in 1974, the jury could infer that he already knew

these transactions were consignments and lied about the state of

his knowledge. Here again, he knew where to look.

Mr. Barry was charged as a defendant only in respect to Soli-

tron financials for the year ending February 1970, during which

he was employed as the head of its accounting department. In

preparation for the Sternbach audit, he certified that the inven-

tory for fiscal year 1970 was taken at his direction and that each

item was priced at the lower of cost or market. (Tr. 528, 529).

These figures were then provided to Sternbach, and formed the

basis for the financial statements and Sternbach’s opinion. Mr.

Barry testified that he did not spotcheck the inventory sheets for

accuracy in 1970, nor did he attempt to ascertain the method by

which the items on the sheets were “costed” (Tr. 526). He

testified further that no person to his knowledge attempted for

Solitron to verify the inventory figures for this period. In fact, in

a letter written to the Renegotiation Board he admitted the inade-

quacies of the accounting procedures employed (Pitf.101). This

was evidence from which the jury could conclude that Mr. Barry

acted with scienter when he certified the inventory to Sternbach

for fiscal year ending 1970.

The Solitron defendants contend in their Reply Brief filed on

this motion, that the amount attributable to 1970 recosting errors

was minimal and that the materiality requirement has not there-

fore been met. This argument presupposes that the jury found

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Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

that the figures contained in Solitron’s 1974 presentation to the

Renegotiation Board were unavailable in 1970. Clearly this lat-

ter contention was not accepted by the jury, and properly so.

Mr. Friedman was the president, chief executive officer and the

overall manager of Solitron. The jury could find that he partici-

pated in the preparation or dissemination of the financial state-

ments in the annual report issued over his signature and did so

with scienter. He was in constant communication with the

Riviera Beach division and was aware of its sales. He also knew

that the inventory figures were increasing, and knew the effect

this had on the profits of the company. He testified at trial that

“What's written in the [Price Waterhouse] report I agree with.”

(Tr. 491). That report on inventory overvaluation cited the

buildup on inventory as evidence of the fact.

With respect to the consignment transactions, Mr. Friedman

personally negotiated and signed the written contract with AEL

Israel, which plainly specified a consignment arrangement ( Pitf.

Ex. 9). The testimony of Dr. Reibman, the principal of AEL

Israel, showed that the written and executed agreement accorded

with his understanding of the arrangement. Mr. Friedman con-

tends, however, that the first draft of the agreement provided that

the risk of loss would be on AEL, indicating that the transaction

was a sale. He testified that he believed the final contract contin-

ued to provide for a sale. The jury could conclude from the

evidence presented that Mr. Friedman knew the difference

between a consignment and a sale, although he testified to the

contrary. And the jury could conclude that he read the AEL

contract before he signed his name to it, and thereby learned that

it provided for distribution on a consignment basis, and that risk

of loss was placed on Solitron.

Neither do I find any prejudicial error resulting from the exclu-

sion of Mr. Malina’s proffered testimony, which would warrant

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Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

the grant of a new trial. Mr. Malina was the attorney for Soli-

_ tron who participated in the drafting of the AEL Israel consign-

ment contract. His testimony was offered at trial on the issue of

whether Mr. Friedman acted with scienter. An offer of proof was

taken outside the hearing of the jury, as contemplated by Rule

103, F.R.Evid., and the proof was excluded, pursuant to Rule

403, F.R.Evid. as lacking probative value. The proffered testi-

mony of Mr. Malina failed to demonstrate, as defendant now

contends, that Mr. Friedman was unaware that the contract he

signed varied from the initial understanding that he now claims

he reached with AEL, or that he was unaware of the difference

between a consignment and a sale, or that he relied on the expert

advice of his attorney in treating this substantial transaction as a

sale.

The offer of proof demonstrated that the signed contract dif-

fered from the original or first draft of a proposed agreement

between the parties. This is not unusual. Beyond that, the most

that Mr. Malilna’s testimony showed was his inability to recall

the surrounding details. The lack of any probative value on the

question of scienter is apparent from the testimony given. With

respect to the original meeting between Mr. Friedman and AEL

representatives, Mr. Malina testified:

_Q. Was anything said with respect to the kind of rela-

if any, that was to exist between Solitron and

AEL Israel? A. None that I can recall. (Emphasis

added) (Tr. 1191).

Mr. Malina yielded no information relevant to Mr. Friedman’s

knowledge or intent at that time:

Q. Was there any discussion between you and Mr.

Friedman prior to the time you participated in drafting

relating to the subject of who would assume the risk of loss

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

es OS oe Oe ee oe SS

gen RE . I don't recall a conversation directed to

point.

~~ Are you saying that there was no uch. COnNente

tion? A. I can’t say with absolute certainty that the

conversation never took place but / don’t recall any.

Q. Do you remember what the initial drafts of the

agreement provided with respect to who would assume the

risk of loss, whether it was Solitron, AEL or some other

party? A. I believe in the initial draft it was AEL that

was to assume the risk of loss. (Tr. 1192-93) (Emphasis

Q. Did there come a time that the drafts that were

exchanged changed that provision so that the risk of loss

was to be borne by Solitron? A. Yes, I believe that is so.

Q. Did you discuss the change with Mr. Friedman? A.

ee ee ete te Mr. Friedman on

recall a specific conversation on that point.

Q. Did you ever tell Mr. Friedman that the agreement

provided that the merchandise was to be consigned to

AEL Israel? A. J don't recall the specific conversation.

I can— (Tr. 1194).

Q. Did tell me a few minutes ago [outside the

courtroom} that you never told Mr. Friedman that the

agreement that the merchandise was to be con-

signed? A. Yes. That is essentially so, yes.

|The Cour: Were you under oath when you told him

t

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

Q. Did you ever explain to Mr. Friedman what the

work ‘consignment’ means inlaw? A. / don't recall any

no.

Q. Are you saying that you didn’t tell Mr. Friedman?

The Court: He doesn’t recall any such conversation.

A. I don’t recall. (Tr. 1195-96) (Emphasis added)

i

This testimony does not demonstrate “Friedman’s contemporane-

ous state of mind.” (Def. Memo. of Law at 27). It does not

show that Mr. Friedman believed the transaction to be a sale or

even that he believed the original draft agreement terms had not

been changed when the final agreement was presented for his

signature. It does not prove any advice given to him by his

attorney upon which he could be said to have relied. It shows

nothing except that attorney Malina has a poor memory, and, like

many potential witnesses, he will tell a litigant what the litigant

wants to hear, so long as he is outside the courtroom and not

under oath. There is no substance to defendants’ claim of

prejudice from the exclusion of this basically irrelevant

testimony.

The Solitron defendants have submitted affidavits from three

individuals involved in the arrangements surrounding the AEL

contract in support of their motion for a new trial. These specifi-

cally concern a trip to Israel in April 1971 by Mr. Friedman and

Mr. Cole. The affidavits of Dr. Riebman, Mr. Dor and Mr.

Ravillan attempt to show that Mr. Cole of Sternbach was

apprised of the true nature of the relationship between Solitron

and AEL in April 1971, a date prior to the certification of the

financial statements for fiscal year ending in February 1971.

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Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

They also show that Mr. Friedman was not a party to these

discussions about the financial arrangements. This appears to be

the basis for the argument that Mr. Friedman never knew the true

nature of the transaction and instead relied on Mr. Cole, his

accountant.

Dr. Riebman, the president of AEL Israel, says only that ( Affi-

davit of Dr. Riebman, sworn to November 4, 1980):

“Mr. Cole reviewed the financial aspects of the relation-

ship between Solitron and A.E.L. Israel with Gideon Dor,

the vice president of finance for A.E.L. Israel and Rony

Ravillan, the Israeli attorney who was advising the parties.

As I recollect, Mr. Friedman did not concern himself with

the financial or legal aspects of the matter but was fully

involved in the engineering and sales discussions. To my

form of transaction with Mr. Friedman, his interest appar-

ently being in the volume of anticipated business and mar-

ket opportunities.”

This is so much doubletalk and collected buzz words. He pro-

vides no specific information about the discussions.

Gideon Dor’s affidavit, sworn to November 12, 1980, was spe-

cific. He now states that Mr. Cole was advised specifically that

this transaction was a consignment:

“Mr. Cole and I discussed the accounting transaction

upon the sale of any of the semiconductor merchandise

from the bonded warehouse. These discussions were sum-

marized in my letter to Mr. Cole dated May 7, 1970

attached hereto as Exhibit ‘A’. Mr. Cole and I discussed

that the arrangement between AEL and Solitron was that

of a consignment, and that any remittance to Solitron

would only take plave upon a sale of the consigned mer-

chandise to a third party and subsequent collection.”

A-19

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

Rony Ravillan (Affidavit sworn to November 12, 1980)

recounts the same conversation but with less specificity:

“In April 1970, several Solitron personnel visited Israel.

Among the Solitron personnel were Benjamin Friedman,

Solitron President and other people, which to the best of

my recollection included Mr. Edward Cole, the Accoun-

tant for Solitron. Among the subjects discussed with Mr.

Cole were the legal procedures involved in the handling

and accounting for money due Solitron upon the sale of

the merchandise in the bonded warehouse and the setting

up of Solidev Israel Ltd. and since the merchandise was

only be made after a sale of said merchandise from the

bonded warehouse.”

The opposing affidavit of Mr. Cole, sworn to January 12, 1981,

directly contradicts this claim:

“I did not discuss with Mr. D‘Or any of. the matters

referred to in his affidavit. Specifically, 1 deny discussing

‘the nature of the financial arrangements between A.E.L.

and Solitron’; the maintenance of the merchandise in a

bonded warehouse in Israel; visiting any bonded ware-

house in Israel; discussing ‘the accounting transaction

upon the sale of any of the semiconductor merchandise

from’ any bonded warehouse; ‘that the arrangement

between A.E.L. and Solitron was that of a i

and that any remittance to Solitron would only take place

upon a sale of the consigned merchandise to a third party

and subsequent collection.

I did not meet with Mr. Ravillan at all and deny having

any discussions with him. Moreover, I was not a member

of any group with whom Mr. Ravillan had any discussions.

He certainly did not inform me that merchandis¢ would be

held in a bonded warehouse or that it was received on

consignment or that payment would only be made after

sale of any merchandise.”

A-20

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

Cole states that he met with Mr. Dor who showed him AEL’s

bookkeeping system. This system, he contends, was appropriate

for recording actual purchases only. He also stated that he

visited the AEL facility. Cole observed “open racks in their

salesroom containing Solitron merchandise in addition to other

electronic devices of other companies,” and concluded “[t] his

was not a bonded warehouse by any stretch of the imagination.”

These statements were consistent with his testimony at trial con-

cerning the April 1970 trip to Israel. (Tr. 775-78, 1368-69).

The disparity between these affiants cannot be resolved without

an evidentiary hearing to determine credibility. Assuming the

accuracy of the affidavits submitted on behalf of defendants,

however, I do not believe they warrant the grant of a new trial on

the issue of liability of the Solitron defendants.

No showing has been made that this evidence was not known to

defendants at the time of trial, or was not discoverable with due

diligence, thereby justifying a grant of a new trial on the ground

of newly discovered evidence. See, 6A J. Moore, Federal Prac-

tice, 1 59.08(3) (2d ed. 1979). In fact, at the hearing on this

motion, the defendants’ attorney stated that he had decided, pre-

sumably for valid tactical reasons, to forego cross-examination of

Mr. Cole on this point. Nor do I find it likely that the evidence, if

admitted, would change the verdict.

The Solitron defendants also contend that there was insuffi-

cient evidence to sustain the jury determination of damages. On

the issue of damages, plaintiffs presented the expert testimony of

two witnesses, Mr. Lieberman and Mr. Gorkiewicz. Mr. Lieber-

man computed the effect that public disclosure of correct figures,

assuming them to be such, set forth in the Price Waterhouse

Reports would have on earnings per share of Solitron stock during

each year in issue. Mr. Gorkiewicz then gave his opinion as to

what the market price of Solitron would have been if the correct

earnings per share had been disclosed. His opinion was based on

A-21

Memorandum an Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

his conclusion that proper market valuation of Solitron shares

was best obtained by utilizing the earnings approach, that is,

looking at earnings per share and the rate of growth. The verdict

returned by the jury adopted Mr. Gorkiewicz’s figures reduced by

twenty-five percent. Defendants now argue that (1) the jury

applied the expert’s estimates to the wrong years; (2) there was

no factual basis for his theoretical estimates; and (3) the jury's

verdict constitutes an impermissible compromise verdict. First,

defendants argue that Mr. Gorkiewicz’a estimates were based on

a year-long period extending from the beginning to the end of the

fiscal year which the periods set forth for the jury were deter-

mined by the dates the annual reports were issued. The year-

long periods presented to the jury in Special Interrogatory No. 6a

were stipulated to be the accurate time periods. There is no

question that the parties considered these periods to correspond to

the figures opined by Mr. Gorkiewicz. (See, Tr. 1413). A

review of the transcript reveals that Mr. Gorkiewicz’s estimates

of inflation of market price were given in response to a question

based on the same time period as appeared in the Special Inter-

rogatories. The defendants’ second point was argued to the jury

and is merged in the jury verdict. The defendants presented the

expert testimony of Mr. Rogalski to demonstrate that the earn-

ings approach utilized by Mr. Gorkiewicz to value the stock was

erroneous. They argued to the jury that investors do not

purchase stock on the basis of earnings and that, in fact, after a

brief period the price of Solitron continued to rise once the disclo-

sure took place in 1971.° This presented an issue of fact which

was resolved by the jury. The third contention in regard to the

damage determination is that the verdict must be set aside as an

Gorkiewicz’s estimate of damages by twenty-five percent across

the board. It is true that a jury may not compromise on liability.

A-22

Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

Therefore, when a cause of action is brought to recover an undis-

puted sum of liquidated damages, a partial damage award will be

set aside as a compromise verdict. See, Banco Popular de Puerto

Rico v. Deliz, 407 F.2d 1388 (ist Cir. 1969); National Fire

Insurance Co. of Hartford v. Great Lakes Warehouse Corp., 261

F.2d 35 (7th Cir. 1958). When the amount of damages is in

dispute, the jury is free to compromise on the issue of damages

and adopt the figure it perceives as fair.

“In many cased of unliquidated damages it is quite proper

for a jury to compromise the differences of the parties

where amount of the verdict is not so grossly inadequate as

to render it a farce. Commendable as such practice may

be, however, a jury cannot compromise an issue of

liability.”

National Fire Insurance Co. of Hartford, supra at 38.

In this instance, there was no sum of liquidated damages nor a

stipulated amount of damages. The jury was free to accept

plaintiff's theory but to reduce the plaintiff's figures to compen-

sate for exaggeration.

NAMED CLASS REPRESENTATIVES

The Solitron defendants also challenge the verdict by arguing

that no named plaintiff is, or ever was, a proper class representa-

tive. They therefore ask the Court to decertify the class pursuant

to Rule 23(c)(1), dismiss the individual claims of the named

representatives and enter judgment in defendants’ favor.

As originally certified, the first sub-class consisted of “those

persons who purchased Solitron stock during the period from

May 5, 1967 to [June 2, 1971] and who thereafter either sold

said »<ock at a loss or still hold said stock.” Memorandum Deci-

sion, February 14, 1979, at 3-4. The closing date of the class

A-23

Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

corresponds to a date two days after the publication of the 1970

annual report which the piaintiffs stipulated correctly represented

the fiscal 1970 sales and income.‘

The appropriated closing date of this sub-class was in dispute

throughout this litigation. The plaintiffs’ claim was that the

misrepresentations in the financial statements caused the market

price of the shares to be inflated until the date on which full

disclosure was made. They maintained that the appropriate clos-

ing date was the date when the market had assimilated the annual

report for fiscal year 1971 which disclosed an inventory write-

down of approximately Ten Million Dollars, that is, June 2, 1971.

The Solitron defendants, however, contended that no shareholder

who purchase shares after December 16, 1970 could have been

damaged by this inflation because on December 14, 1970 Solitron

issued a press release which disclosed an inventory write-down of

approximately Seven Million Dollars. Recognizing that the

Supreme Court has held in Eisen v. Carlisle & Jacquelin, 417

US. 156 (1974) that the Court on a Rule 23 motion lacks power

to “conduct a preliminary inquiry into the merits of a suit in order

to determine whether it may be maintained as a class action,” the

Court certified the first sub-class as extending until June 2, 1971.

Two of the named plaintiffs were purchasers of shares during this

period. Family Restorations, Inc. purchased 400 shares in April,

1971; Howard Sirota purchased 25 shares in June, 1971. The

plaintiffs tried ihe class claims on behalf of all purchasers within

these time periods who continued to hold their shares after June

2, 1971. Because plaintiffs conceded that at least partial disclo-

sure had occurred in December 1970, there was a question of fact

for the jury to resolve as to the effect of that disclosure on any

alleged inflation of the market price. The Court, therefore,

requested, prior to the submission of the case to the jury, that the

parties draft an appropriate interrogatory to submit to the jury on

A-24

Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

this question. In lieu of this interrogatory, the parties advised the

Court that they had stipulated that the class period would close

on December 16, 1970.

“The Court: Gentlemen, as I understand it, rather than

modifying the interrogatory to be given to the jury as I

invited you to agree upon a form of doing so, and I believe

I did indicate if you couldn’t agree I would modify it some

way myself, but I understand that rather than agreeing on

a modification or asking the Court to make one you have

agreed on some other solution of the problem which is

created by the press release of December 1970.

Would you be good enough to state your understanding

oS ated

r. Oestreich [Plaintiff's counsel]: I think the under-

sstticn bauale tachocadick end nsdn me

among the parties that the class period which begins after

the publication of the annual report of Solitron for the

year ending February 28, 1967 will end upon the publica-

tion of the December 14, 1970 third quarter shareholder

release by Solitron.

And in conformance with your Honor’s prior ruling,

giving two days for the absorption of that information in

the public marketplace, and said information having been

published in the Wall Street Journal on December 16th, it

is hereby stipulated that that class period will end on

December 16, 1970.

The Court: Is it so stipulated?

_ Mr. Morrison [Counsel for Solitron defendants]: Yes, it

is.

The Court: Do you want the interrogatories amended as

they now stand to put that as the cutoff date? Did you

expect me to deal with that press release in any way—

Mr. Rabin [Plaintiff's counsel]: No.

The Court: —on the charge?

Mr. Rabin: No, not at all. Just leave the interrogatory

the way it is.

The Court: All of you are in agreement?

Mr. Morrison: Yes.” (Tr. 1517-18).

A-25

Memorandum and Order of the

District Court Sternbach’s Motion for

Judgment Notwit the Verdict

The effect of this stipulation was to place the class representa-

of the class entitled to recover. The defendants argue that there

was no proof of any damage, that is market inflation, occurring

after December 16, 1970 and that the named plaintiffs are not,

and never were, proper class representatives. The basis of this

argument is that their claims are not typical of those of the class

as required by Rule 23(a)(3), Fed, R. Civ. P. and that the “case

or controversy” requirement of Article III of the United States

Constitution is not therefore met. No contention is made that

the class representatives, or their attorneys, failed to provide

adequate representation for the class interests.

The Court adheres to its earlier decision and finds that the class

was properly certified on February 14,1979. The analysis of that

determination will not be recounted here. The question remain-

ing is whether the class should be decertified because proof at

subsequent trial, and/or the stipulation of their own counsel,

barred the individual claims of the class representatives.

Although the individual claims were barred, a viabie controversy

defendants. When the case was submitted to the jury, there was

a sufficient adverse relationship between the members of the class

and the defendants to satisfy the case or controversy requirement

of Article III of the United States Constitution and to allow them

to succeed to the adversary position theretofore held by the class

representatives. See Franks v. Bowman Transportation Co.,

Inc., 424 U.S. 747 (1976); Sledge v. J. P. Stevens & Co., Inc.,

585 F.2d 625 (4th Cir. 1978), cert. denied, 440 U.S. 981 (1979).

The class was certified prior to trial, the class claims were tried

to the jury and the class members had an interest adverse to the

defendants. I do not conclude that any benefit would result from

A-26

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

a dismissal at the close of trial, simply because the proof at trial

demonstrated that the individual claims of the class representa-

tives were barred.

In East Texas Motor Freight System, Inc. v. Rodriguez, 431

U.S. 395 (1977), the Supreme Court vacated a judgment where

the Court of Appeals certified a class on appeal after the district

court had dismissed the individual claims of the class representa-

tives. The Court recognized that a different situation would exist

if the class had been certified properly before tria! and the class

cl-‘ms tried to the jury (431 U.S. at 406, n. 12):

“Obviously, a different case would be presented if the

District Court had certified a class and only later had it

appeared that the named plaintiffs were not class members

or were otherwise inappropriate class representatives. In

such a case, the class claims would have already been

tried, and, provided the initial Certification was proper and

decertification not appropriate, the claims of the class

members would not need to be mooted or destroyed

because subsequent events or the proof at trial had under-

mined the named plaintiffs’ individual claims. See, ¢.g.,

Franks v. Bowman Transportation Co., 424 U.S. 747,

752-57; Moss v. Lane Co., 471 F.2d 853, 855-56 (CA4).”

I find, therefore, that the class as modified may succeed to the

adversary position of the named representatives. The defen-

dant’s motion for judgment notwithstanding the verdict on the

basis is denied.

LIABILITY OF ACCOUNTANTS AS AIDERS AND ABETTORS

Louis Sternbach & Co. was found liable to the plaintiff class as

an aider and abettor of the primary security law violation. Three

essential elements must be proved to establish aiding and abetting

liability [/77, An International Investment Trust v. Cornfeld,

619 F.2d 909, 922 (2d Cir. 1980) ]}:

A-27

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

“(1) the existence of a securities law violation by the

primary (as opposed to the aiding and abetting) party;

(2) ‘knowledge’ of this violation on the part of the

aider and abettor; and

(3) ‘substantial assistance’ by the aider and abettor in

the achievement of the primary violation. [Citations

omitted ].”

With regard to the existence of the primary violation, the

defendant Sternbach contends that the original figures in the

financial statements were accurate and contests the validity of the

Price Waterhouse Reports. Although Sternbach points out that

defendants only, they did form the basis of establishing the pri-

mary violation. The jury found that the Solitron defendants had

violated Rule 10b-S . This Court has determined that there was

sufficient evidence to support their determination to withstand the

defendants’ judgment n.o.v. motions. The first element, the vio-

lation of the securities law by the primary party, has been proved.

Defendant Sternbach argues that its actions in connection with

the financial statements do not constitute substantial assistance.

Defendant contends that mere inaction or a failure to disclose

cannot be regarded as substantial assistance. Sternbach audited

the books and records of Solitron and certified the financials for

its Annual Report to shareholders. This does aot constitute mere

inaction. If this was done with actual knowledge of the primary

fraud, I think it would be sufficient to establish substantial assis-

tance. This need not be decided, however, because I find that

there was no proof at trial from which reasonable jurors acting

reasonably could conclude that Sternbach acted with scienter.

In order to prove that an aider and abettox acted with scienter,

plaintiffs were required to prove that the accountants rendered

A-28

Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

substantial assistance with actual knowledge of the primary

fraud. Edwards & Hanly v. Wells Fargo Securities Clearance

Corp., 602 F.2d 478, 484 (2d Cir. 1979), cert. denied, 444 US.

1045 (1980); accord, IIT, An International Investment Trust v.

Cornfeld, supra. Proof of negligence is insufficient. Ernst &

Ernst v. Hochfelder, 425 U.S. 185 (1978). Although this Cir-

cuit has held that proof of recklessness will suffice when the aider

and abettor owes a fiduciary duty to plaintiff, Rolf v. Blyth,

Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir. 1978), cert.

denied, 439 U.S. 1039 (1978), no argument has been made that

the accountants owed a fiduciary duty to the plaintiff investors.

See also, Competitive Associates, Inc. v. Laventhol Krekstein

Horwath & Horwath, 478 F Supp. 1328, 1342 (S.D.N.Y. 1979).

The Court finds insufficient evidence in the record to establish

that the defendant Sternbach acted with actual knowledge of the

primary security vioiations. Plaintiff argues first that Mr. Cole, a

partner of Sternbach & Co., knew that the AEL transaction was

a consignment, and yet certified the financial statements which

included it as a sale. As evidence thereof, they point to the letter

of May 7, 1970 addressed to Mr. Cole and sent by Gideon Dor of

AEL Israel setting forth his understanding of the arrangement

between the two parties. Cole testified that the letter did not

correspond to his understanding of the relationship between the

parties. There was no proof of knowledge. Each of the individ-

ual defendants denied knowledge that the transactions were con-

signments and the position of the defendant Solitron, in its own

documents and those prepared for Sternbach, indicated that Soli-

tron management characterized this transaction as a sale. Plain-

tiffs also argue that the jury could infer that Sternbach had

knowledge that the AEL Israel, Best & Raynor, and JFD Elec-

tronics transactions were consignments because no confirmations

were received by Sternbach when requested, no payments were

made, no purchase orders were produced, and shipments were

A-29

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

made close to the end of the fiscal year. Assuming the validity of

plaintiffs’ contentions and that Sternbach should have been put

on notice of the irregularity and should have obtained independ-

ent evidentiary proof rather than relying on management, all that

would be proven is that the defendant acted negligently. An

inference from these facts that the defendant Sternbach must

have been aware that the sales were actually consignments and

that the financials were therefore misleading is not permissible.

See McLean v. Alexander, 599 F.2d 1190, 1199 (3d Cir. 1979).

With respect to the valuation of inventory, plaintiffs point to

the fact that the accountants testified that standard accounting

procedures were followed but that there was no independent evi-

dence in the work papers. Their argument is that if the plaintiffs

followed the proper accounting procedures, they knew of the

fraud. Alternatively, they argue that if they did not follow the

procedures set out in their own programs, they knowingly certi-

fied documents without any knowledge of their truth or falsity.

The plaintiffs argument cannot succeed. In whatever terms it is

couched, the plaintiffs are essentially arguing that there were

mistakes in the financial statements and that if Sternbach had

performed its auditing and accounting functions properly, the

errors would have been revealed. This does not equal knowing

assistance of a fraud. It may constitute negligence and if

extreme enough, recklessness, but it does not satisfy the scienter

requirement of Rule 10b-5. The jury may not infer that the

accountants acted knowingly merely from the presence of the

incorrect figures. See Jacobson v. Peat, Marwich, Mitchell &

Co., 445 F.Supp. 518, 523 (S.D.N.Y. 1977).

There was overwhelming uncontroverted evidence in favor of

the defendant Sternbach. There was no evidence from which a

reasonable juror acting reasonably could conclude that Sternbach

A-30

Memorandum and Order of the

District Court Granting Sternbach’'s Motion for

Judgment Notwithstanding the Verdict

aided and abetted the primary securities law violation with the

requisite scienter. Judgment notwithstanding the verdict is

granted to defendant Sternbach on this claim.

NEGLIGENCE OF DEFENDANT STERNBACH.

The jury also received a pendent claim under New York law

alleging negligence by the accountants and returned a verdict on

this claim for the plaintiff class against Sternbach. Sternbach

now moves to set aside this verdict because there was insufficient

proof of negligence to sustain the verdict and because plaintiffs,

by virtue of their relationship with the negligent actor, or perhaps

more properly, their lack of relationship, are not entitled to

recover under New York law.

The jury was charged that plaintiff must prove that Sternbach

failed to exercise the degree of care which a reasonably prudent

accountant would exercise in the same circumstances, that the

negligent statements inflated the market price of Solitron and

were therefore the proximate cause of damage to the plaintiff

class (Tr. 1602-03). The jury found that the accountants had

acted negligently in certifying the financial statements of Solitron

for the years 1967, 1968 and 1970. If this Court had been acting

as trier of the facts, it would have determined the issue of negli-

gence otherwise.

The function of a certified public accountant generally is to

examine the books and records, contracts and relevant papers of

the client and express an opinion as to whether its financial state-

ments being certified fairly reflect the financial status of the

corporation and its operations as of the period certified, and also

to determine whether the accounting facts are stated accurately

and in compliance with generally accepted accounting principles

consistently applied. While it is always hoped that certified pub-

lic accountants, in connection with their audits, will detect mis-

takes, frauds, embezzlements or other forms of crookedness in the

A-31

Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

company, as this Court has previously observed “no sheriff can

prevent all felonies in his bailiwick, and the law does not so

require.” Rich v. New York Stock Exchange, 379 F. Supp. 1122

(S.D.N.Y. 1974), rev'd. other grounds, 522 F.2d 153 (2d Cir.

1975).

Some evidence of failure to follow standard auditing practices

was introduced to the jury. Whether the accountants acted neg-

ligently was a question of fact upon which reasonable persons

could differ. It was within the jury's function to determine these

facts. There was not such a failure of proof to require a judgment

notwithstanding the verdict, or a new trial on this point. I decline

to disturb the jury's findings of fact.

However, for the reasons stated below, I conclude that judg-

ment must be entered for defendant on this claim as a matter of

law.

Plaintiffs are not parties who under New York law are entitled

to recover damages from Sternbach because of its negligent rep-

resentations found in Solitron’s certified financials. A plaintiff

may never recover for negligence unless the defendant owes that

plaintiff a duty to use reasonable care. In the seminal New York

case dealing with the liability of accountants to third parties,

Ultramares Corp. v. Touche, 255 N.Y. 170, 183 (1931), the New

York Court of Appeals declined to extend the auditor’s duty owed

to its employer under its contract of employment to a plaintiff

who loaned the audited company money in reliance on the certi-

fied balance sheet, although the defendant knew the balance sheet

would be shown to prospective creditors and had, in fact, fur-

nished the company 32 certified copies to be handed out to lenders

and suppliers. The Court stressed that the accountants did not

know the plaintiff was a specific company to whom the balance

sheet would be shown. The Court held, therefore, that the

accountants owed no duty, absent fraud,’ to “the indeterminate

class of persons who, presently or in the future, might deal with

A-32

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

the [audited] company in reliance on the audit.” The rationale

was that this expansion of the concept of duty would expose the

accountants to limitless liability.

“If liability for negligence exists, a thoughtless slip or

blunder, the failure to detect a theft or forgery beneath the

cover of deceptive entries, may expose accountants to a

liability in an indeterminate amount for an indeterminate

time to an indeterminate class. The hazards of a business

conducted on these terms are so extreme as to enkindle

doubt whether a flaw may not exist in the implication of a

duty that exposes to these consequences.” 255 N.Y. at

179-80.

That decision did not preclude recovery by all third party plain-

tiffs in similar situations. The Ultramares Court distinguished

Glanzer v. Shepard, 233 N.Y. 236 (1922) which had allowed a

buyer to recover from a defendant who negligently certified the

weight of goods sold. The Court concluded that the law imposed

a duty toward the plaintiff buyer because the defendant public

weigher had been made aware that the certificate was prepared

for plaintiff's sole bensfit, and had furnished it directly to the

plaintiff. The law of New York, therefore, appeared to impose a

duty to use reasonable care only when the third party and the

certificate’s intended use were identified. Otherwise, the duty to

use care was limited to those entitled by ccntract or privity.

In White v. Guarente, 43 N.Y.2d 356, 361 (1977), the New

York Court of Appeals most recent pronouncement on account-

ants’ liability to third parties, that Court extended the account-

ants’ duty to a known and settled group whom the accountant

“must have known . . . would necessarily rely on or make use of

the audit.” The Court cited Glanzer and held that this duty was

imposed by law and not limited by contract or privity. Jd. at 362.

A-33

Memorandum and Order of the

District Court Granting Sternbach's Motion for

Judgment Notwithstanding the Verdict

While Ganzer had held that a plaintiff whose reliance was specifi-

cally foreseen could recover, White extended this concept to per-

mit recovery by members of a limited class whose reliance should

have been foreseen. Plaintiff, one of twenty limited partners was

therefore permitted to recover from the accountants who were

hired by the general partners to audit the books and prepare the

partnership tax returns, “not as a mere member of the public, but

as one of a settled and particularized class among the members of

which the report would be circulated for the specific purpose of

reg the limited partnership agreed upon arrangement.” Id.

at °

In the instant case, plaintiffs, as an amorphous group of those

who traded in the public securities market during the years at

when the financial statements were certified. Their individual

and collective identity was unknown to Sternbach. Although the

defendants knew that investors would rely on the financial state-

ments, the group of potential investors was and is almost as

widespread as the general public. Although the White Court

may have expanded the scope of accountants’ negligence liability,

it distinguished but did not overrule Ultramares. We do not

agree with plaintiffs that the rationale and policy and considera-

tions supporting Ultramares have so changed with time, that the

New York Court of Appeals would overrule that decision if pre-

sented with these facts today. But see Dworman v. Arthur

Andersen & Co., N.Y.L.J., May 1, 1980 (Sup.Ct., N.Y. Co.).

Plaintiffs are plainly within the proscriptions of the White

decision.

“Indeed, the import of Ultramares is its holding that an

accountant need not respond in negligence to those in the

extensive and indeterminable investing public-at-large.”

White v. Guarente, 43 N.Y.2d at 361.

A-34

Memorandum and Order of the

District Court Granting Sternbach’'s Motion for

Judgment Notwithstanding the Verdict

Judgment notwithstanding the verdict is entered for defendant

Sternbach on the negligence or professional malpractice claim,

solely as a matter of law.

2. Second Sub-Class.

The second sub-class consists of investors who purchased Soli-

tron stock during the period extending from June 8, 1972 to

January 27,1975. Their Rule 10b-5 claim, asserted only against

the Solitron defendants, was based on the Solitron Annual

Reports for the fiscal years ending 1972, 1973 and 1974. Pilain-

tiffs allege that the statements in these Reports were materially

false and misleading because they failed to disclose the amount of

excess profits assessed by the Renegotiation Board.

The facts on which this claim is based are undisputed. Solitron

received notification in 1972 that the Renegotiation Board had

determined that it owed $3,200,000 in excess profits for fiscal

year ending February 28, 1967 and $4,400,000 attributable to the

fiscal year ending February 28, 1968. In its Annual Reports for

fiscal years 1972, 1973 and 1974, Solitron disclosed the fact that

and informed the reader that management was contesting the

assessment, and believed no significant refund would be required

when the matter was fully adjudicated. See p. 4, supra. The

jury returned a verdict for the plaintiff class and determined that

this failure to disclose had inflated the market price of Solitron

shares by 28.2 cents per share.

The defendants now move to set aside the verdict. Defendants

argue that there was no duty to disclose the precise amount of the

claim and that no materia! fact was withheld from the investing

public.

A-35

Memorandum and Order of the

District Court Granting Sternbach's,Motion for

Judgment Notwithstanding the Verdict

The only proof offered by plaintiffs in support of this claim was

the assessments rendered by the Renegotiation Board, the receipt

of this information by Trager, and the failure to disclose the

precise amount of the assessment.

Solitron management never for one moment believed that the

Renegotiation claim asserted by the Government had any merit,

or presented any real risk of loss to the corporation. They knew

that income and profits of Solitron, together with its sales and

inventory, had been materially overstated during the years 1967

through 1970. To demonstrate this fact, they commissioned the

making of the Price Waterhouse Reports. As had been noted in

our discussion of the claim asserted by the first sub-class based on

the misrepresentations in the financial statements for those years,

defendants knew exactly where to look to find the information to

support the Price Waterhouse Reports. Price Waterhouse did not

conduct an audit of the books and records of Solitron for the prior

years. It merely compiled a report from materials furnished by

management which tended to demonstrate that there were no

excess profits.

The federal securities laws do not require management to “dis-

close” in its public reports, facts or information which are conjec-

tural, speculative, or which management itself does not

reasonably believe to be true. In the circumstances of this case,

defendants reasonably believed that the “box car numbers”

attached to the Government's tentative Renegotiation assessment

were so unfounded as to be immaterial and absurd.

Solitron management here disclosed truthfully to the public,

and to the shareholders that such claim was outstanding, that

they were resisting the claim, and that they did not regard it as

having any material effect. To handle the claim, they retained

Mr. Alexander Kirk, who had previously disposed of a similar

claim made against a Solitron subsidiary by the Renegotiation

Board in a manner satisfactory to management. Although Kirk

A-36

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

was not a lawyer, the Court concludes that he understood Rene-

gotiation claims and had been effective over many years in repre-

senting clients in resisting such claims. Mr. Kirk advised

management in writing in effect that the claims had no merit, in

his professional judgment.

Any juror acting reasonably should have concluded that Soli-

tron management reasonably believed Kirk's conclusions and

opinions on the point. Disclosure was adequate.

If more is to be said about the Renegotiation claims, we observe

that Solitron was first notified of the assessments in 1972. As of

the date of trial, and for all this Court knows at the present date,

although involving a rather substantial amount of money, the

claims have never been resolved. This gives rise to two possible

conflicting inferences. The first is that the Executive Branch of

the United States Government does not know what it’s doing, is

extremely inefficient, and cannot even collect a claim against

Solitron for sums in excess of Seven Million Dollars going back to

1967 and 1968, and pending administrative resolution since 1972.

An equally possible inference, slightly more charitable, is that the

bureaucrats who asserted this federal claim against Solitron know

perfectly well that it has no merit, and for that reason they have

not pursued it. We like to think that our Government functiona-

ries are sincerely motivated, are honest, and pursue valid claims

against citizens and taxpayers in favor of the Government, or at

least claims they consider valid. When claims in large dollar

amounts such as these are allowed to slumber for almost a decade,

that fact suggests that the Renegotiation claims have no merit,

and indeed that those charged with the duty to pursue the claims

know that they have no nierit, but are too timid to put their chop

on a paper withdrawing the claims.

For all of these reasons, this Court is convinced that no reason-

able juror, acting reasonably, could find a violation of Rule 10b-5,

A-37

Memorandum and Order of the

District Court Granting Sternbach’s’ Motion for

Judgment Notwithstanding the Verdict

or any other relevant statute or rule of law in connection with

Solitron’s reporting to its shareholders of facts concerning its

outstanding Renegotiation claims.

The motions of Solitron, Trager, Barry and Friedman for judg-

meni notwithstanding the verdict is granted, so far as it pertains

to the claims of the second sub-class. The motion of Sternbach

for judgment notwithstanding the verdict is granted on both

claims. In all other respects, the motions are denied.

Cross-CLAIMS AND DEMANDS FOR INDEMNITY AND

CONTRIBUTION.

The cross-claims of the defendants were reserved to the Court

at trial. (Tr. 1644-45). The Court has not yet received a full

submission of these claims. It would seem, however, that the

Court’s analysis of the motions for judgment n.o.v. suggests that

there is no basis for granting any contribution or indemnity to any

party seeking such relief.

Sternbach, because of its negligence as found by the jury

should not be entitled to indemnity from Solitron for the costs of

defense of this lawsuit. Solitron is not entitled to any indemnifi-

cation or contribution from Sternbach, because the fraud took

place at a high level in Solitron management, and is therefore

imputed to the corporation. Neither the corporation, nor its

officers, nor the individual defendants were relying on Sternbach

in the matter. In point of fact, Sternbach was gulled by false

representations made to it by Solitron. As between an inten-

tional wrongdoer, Solitron, on the one hand, and a negligent

wrongdoer, Sternbach, on the other, this Court perceives no hasis

for indemnity or contribution. Recognizing that counse/ has not

yet been given the opportunity to make further submissions which

were promised, unless some aspect of the issues relating to the

cross-claims has been omitted from consideration by the Covrt,

the Court is prepared to regard them as properly denied.

A-38

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

Settle an interlocutory judgment on five (5) days notice of

settlement, or preferably on waiver of notice. The judgment

shall adjudicate the rights of the named parties and shall adjudi-

cate also the rights of the absent class members, reserving juris-

diction for the purpose of processing claim forms and hearing

objections to such claims, if any, and also to fix and allow legal

fees and disbursements out of the class recovery. Upon the entry

of that judgment the Court will, if so requested, consider whether

all or part of the issues therein resolved should be certified for an

interlocutory appeal pursuant to 28 U.S.C. § 1292(b).

So Ordered.

Dated: New York, New York

March 6, 1981

CHARLES L. BRIEANT

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A-40

Memorandum and Order of the

District Court Granting Sternbach’s Motion for

Judgment Notwithstanding the Verdict

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A-41

Judgment of the United States District Court

for the Southern District of New York

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF NEw YORK

75 Civ. 1369 (CLB)

>

HOWARD SIROTA,

Plaintiff,

—against—

SOLITRON Devices, INC., et al.,

Defendants.

>

JUDGMENT

WHEREAS:

This is a consolidated class action brought on behalf of certain

purchasers of stock of Solitron Devices Inc. against Solitron

Devices Inc., Benjamin Friedman, James P. Barry and James S.

Trager and Louis Sternbach & Co.

This action was tried to a jury which returned a general verdict

for the piaintiff class, and also answered special interrogatories

with respect to liability and damages, pursuant to Rule 49(b)

Federal Rules of Civil Procedure.

Defendants Solitron, Friedman, Barry and Trager moved for a

judgment n.o.v., pursuant to Rule 50(b), Fed. Rules Civ. Proce-

dure, or in the alternative for a new trial pursuant to Rule 59(a)

Fed. Rules Civ. Procedure. Defendant Sternbach also moved for

judgment n.o.v. as well as for an Order granting it contribution

over on its cross-claims against Solitron, Friedman, Barry and

Trager. Defendants’ motions have been briefed and argued

A-42

Judgment of the “'nited States District Court

for the Southern District of New York

before this Court and the Court rendered a decision on March 6,

1981 with respect to defendants’ motions, granting them in part

and denying them in part.

It is HEREBY ORDERED AND ADJUDGED:

1. That defendants Solitron, Friedman, Trager and Barry's

motions for judgment n.o.v., or in the alternate for a new trial as

to the jury verdict of liability and damages with regard to plain-

tiffs’ claims concerning misrepresentations of inventory, sales and

profits, contained in the Solitron financial statements for the fiscal

years ending February 28, 1967, February 28, 1968 and February

28, 1970 are hereby denied, and these defendants are hereby

adjudged to be liable jointly and severally for the damages set

forth below as a percentage of inflation of the purchase price to

any purchaser of the common stock of Solitron Devices, Inc. who

purchased during the following time periods and either retained

or sold said stock after December 16, 1970, except that defendant

Barry is adjudged to be liable only with respect to the period May

27, 1970 and through December 16, 1970:

Period of Overstatement Percentage of Inflation

May 5, 1967-June 5, 1968 33%

June 6, 1968-May 27, 1969 54.2%

May 27, 1970-Dec. 16, 1970 52.2%

plus pre-judgment interest from the date of purchase at 6% per

annum and for a joint bill of costs to be taxed by plaintiffs against

the above defendants only. However, the recovery of any pur-

chaser, exclusive of interest, shall not exceed the actual loss of

that purchaser based on the market price of Solitron stock on

October 31, 1979, that being the date on which the class was

A-43

Judgment of the United States District Court

for the Southern District of New York

closed and following which no opt-out was authorized, or the

actual loss based on actual selling price of the stock if sold prior to

October 31, 1979.

2. That defendant Sternbach’s motion for judgment n.0o.v. as

to the jury verdict of liability and damages against defendant

Sternbach under Rule 10b-5 and for negligent misrepresentation

with regard to plaintiffs’ claims concerning misrepresentations of

inventory, sales and therefore profits, contained in the Solitron

financial statements for the fiscal years ending February 28,

1967, February 28, 1968 and February 28, 1970 is granted, and it

is adjudged that all relief shall be denied as against defendant

Louis Sternbach & Co., without costs to any party.

3. That the motions of defendants Solitron, Friedman, Trager

and Barry for judgment n.o.v. as to the jury’s verdict of liability

and damages with regard to plaintiffs’ claims concerning Soli-

tron’s failure to disclose in the financial statements for the fiscal

years ending February 28, 1972, February 28, 1973 and February

28, 1974, the amount of contingent liability which had been

determined by the United States Renegotiation Board to be owed

by Solitron is hereby granted without costs to any party.

4. That all cross-claims and demands for indemnity and con-

tribution among and between the defendants are hereby denied

without costs to any party...

5. The Court hereby reserves jurisdiction over all matters

relating to the administration and processing of class members’

objections to such claim forms, including without limitation, the

hearing of objections to such claims, and fixing and allowing

counsel fees and expenses out of the class recovery and the entry

of any further judgment or judgments as may be necessary to

effect and enforce the rights of the parties.

A-44

Opinion of the United States Court of Appeals

for the Second Circuit

UNITED STATES COURT OF APPEALS

FoR THE SECOND CIRCUIT

Nos. 158, 310, 476—August Term, 1981

(Argued: November 9, 1981 Decided: February 19, 1982)

Docket Nos. 81-7357, 81-7367, 81-7377

>

HOWARD SiROTA, FAMILY RESTORATIONS, A Partnership,

Rosert J. BERK and BRUCE M. UMLAS, on behalf of

themselves and all others similarly situated,

F laintiffs- Appellees-Cross-Appellants,

and

UNION CARBIDE CORPORATION,

Plaintiff-Intervenor-Appellant,

—against—

SOLITRON Devices, INC., BENJAMIN FRIEDMAN,

JAMES S. TRAGER, JAMES P. BARRY,

Defendants-Appellants-Cross-Appellees,

and

Louis STERNBACH & Co.,

Defendant-Cross- Appellee.

>

Before:

LUMBARD, OAKES and KEARSE, Circuit Judges

Appeal from that part of an order of the United States District

Court for the Southern District of New York, Charles L. Brieant,

Jr., Judge, denying judgment notwithstanding the verdict to

defendants-appellants-cross-appellees, who were found liable for

A-45

Opinion of the United States Court of Appeals

for the Second Circuit

damages for violating section 10(b) of the Securities Exchange

Act, 15 U.S.C. § 78}, and Rule 10b-5; cross-appeal from that part

of the order grenting judgment notwithstanding the verdict to

defendants-appellants-cross-appellees and to defendant-cross-

appellee for certain securities law violations. Judgment affirmed

on the appeal; reversed as to defendant-cross-appellee only on the

cross-appeal; and remanded for redetermination of damages and

contribution.

PAUL WINDELS, JR., Windels, Marx, Davies & Ives

(Andrew N. Grass, Jr. and Mitchell L. Marinello, of

counsel), New York, N.Y., for Defendants-Appel-

lants-Cross- Appellees.

I. STEPHEN RABIN, Rabin & Silverman (Benedict

Wolf, Stephen D. Oestreich, Wolf Popper Ross Wolf

& Jones, and Allan K. Peckel), New York, N.Y., for

Plaintiffs- Appellees-Cross- Appellants.

RoBertT E. MESHEL, D’Amato & Lynch (John M.

Burns, III, of counsel), New York, N.Y., for Defen-

dant-Cross- Appellee.

OAKES, Circuit Judge:

This securities class action was tried on the theory that Solitron

Devices, Inc. (Solitron), and certain of its officers, aided and

abetted by its accountants, Louis Sternbach & Co. (Sternbach),

taining materially false misrepresentations of the company’s

sales, income, and inventories. The plaintiff class, purchasers of

Solitron shares on the public market (the American Stock

Exchange), received a general verdict and favorable answers to

special interrogatories from a jury in the United States District

Court for the Southern District of New York, before Charles L.

Brieant, Jr., Judge.

A-46

Opinion of the United States Court of Appeals

for the Second Circuit

The Solitron defendants appeai from the court's denial of their

motion to decertify the class, made on the ground that the named

representatives had purchased their shares after the date stipu-

lated as theclosing date for their subclass; from the court’s deci-

sion not to set aside the verdict against them with respect to fiscal

year-end financial statements for 1967, 1968, and 1970; from the

amount of damages; and from the court’s exclusion of certain

proffered testimony. The plaintiffs cross-appeal from the court's

decision to set aside the verdict against the Solitron defendants

with respect to fiscal year-end financial statements for 1972,

1973, and 1974; and from the court’s decision to set aside the

verdict against Sternbach with respect to the 1967, 1968, and

1970 reports. We reverse the damage award and the decision to

grant judgment in Sternbach’s favor notwithstanding the ver ict,

and remand for redetermination of damages and determination of

the amount of contribution owed Sternbach by the Solitron

defendants.

I. FACTS

Solitron, a manufacturer of electronic semi-conductors, was

subject by virtue of its contracts with the United States govern-

ment to the Renegotiation Act of 1951, as amended, 50 U.S.C.

App. §§ 1211-1233. In 1972 the Eastern Regional branch of the

United States Renegotiation Board, which enforces the Act’s

limits on profits from government contracts, determined that

Solitron had realized renegotiable profits of $3.2 million in fiscal

year 1967 and $4.4 million in fiscal year 1968.

Solitron, seeking administrative review of the Board's assess-

ment, retained Price Waterhouse & Co. to reexamine its financial

statements for 1967 through 1970. Price Waterhouse concluded

that those statements, prepared and certified by Sternbach and

signed by Benjamin Friedman, Solitron’s chief executive officer

and largest shareholder, had substantially overstated inventories

A-47

Opinion of the "United States Court of Appeals

for the Second Circuit

and sales. In 1973 and 1974 Solitron, seeking to avoid liability

for excess profits, disclosed these overstatements to the Renegoti-

ation Board in letters prepared by James S. Trager, a former

Sternbach accountant who was then Solitron’s assistant trea-

surer, and James P. Barry, then Solitron’s treasurer. In January

1975 the Renegotiation Board issued a final determination that

Solitron owed $3.9 million in excess profits from 1967 to 1970,

which Solitron is contesting before the Court of Claims. In

March 1975 the Securities and Exchange Commission (SEC)

brought an action against Solitron for violations of the securities

laws, but withdrew the charges the next month pending an inves-

tigation by special SEC counsel, who concluded in June 1978 that

Solitron had overstated income, but had not done so fraudulently.

Named plaintiffs Howard Sirota (who purchasec Solitron

shares on June 1, 1971) and Family Restorations (who pur-

chased Solitron shares on April 7, 1971) filed the instant action in

March 1975. They contended that the misrepresentations of fact

in the company’s 1967-70 financial statements that were revealed

in the proceedings before the Renegotiation Board demonstrated

that defendants Solitron, Friedman, Trager, Barry, and

Sternbach had violated section 10(b) of the Securities Exchange

Act of 1934, 15 U.S.C. § 78(j), and Rule 10b-5 promulgated

thereunder, 17 C.F.R. § 240.10b-5. They complained that

inventories had been overstated while consignments had been

improperly treated as sales, and that Solitron had failed to pro-

vide any reserve for probable refunds to the government of rene-

gotiated profits. Their complaint was consolidated with others

against Solitron in February 1976.

In February 1976 the named plaintiffs sought certification as

representatives of a single class of Solitron investors who pur-

chased common stock during the period beginning February 28,

1967 and ending March 20, 1975, and who thereafter sold at a

loss. Subsequently they moved for the designation of three sub-

class periods: (1) purchased between May 5, 1967 and June 15,

A-48

Opinion of the United States Court of Appeals

for the Second Circuit

1971 (which included Howard Sirota and Family Restorations);

(2) purchasers between June 15, 1971 and June 22, 1972; (3)

purchasers between June 22, 1972 and March 20, 1975. The

second of these subclasses was dismissed at trial for want of proof

of its claims.

The first subclass was originally certified by the court to

include purchasers between May 5, 1967 and June 2, 1971, not-

withstanding Solitron’s argument that its December 14, 1970

press release announcing losses and inventory writedowns of $7

million, which plaintiffs contended was itself fraudulent, had nul-

lified ary effect of the alleged misrepresentations on post-Decem-

ber purchasers of Solitron stock. The parties stipulated at the

end of trial that the subclass closed on December 16, 1970. The

claims of this 1967-70 subclass prevailed before the jury, and the

com, refusing to decertify, granted judgment notwithstanding

the verdict to Sternbach but not to Solitron, against whom the

court upheld the jury’s damage award. The third subclass, certi-

fied by the court to include purchasers between June 8, 1972 and

January 27, 1975, claimed that Solitron’s annual reports for

1972-74, which stated that the Renegotiation Board had assessed

Solitron’s excess profits but failed to disclose the amounts, were

materially false and misleading. Although this subclass also

prevailed before the jury, the court granted judgment to the

Solitron defendants notwithstanding the verdict.

Il. DISCUSSION

A. Certification of the Class

The Solitron defendants appeal first from the court’s decisions

to certify and not to decertify the class represented by plaintiffs

Sirota and Family Restorations. The court certified this subclass

on February 13, 1979 to include purchasers of Solitron stock

between May 5, 1967 and June 2, 1971 (two days after release of

the 1970 annual report). The parties stipulated at the close of

A-49

Opinion of the United States Court of Appeals

jor the Second Circuit

trial, however, that December 16, 1970 (two days after the press

release reflecting $7 million dollar inventory write-downs) was

the closing date for the class. Family Restorations bought its

shares on April 7, 1971; Sirota on June 1, 1971. Thus the named

plaintiffs were in the subclass as originally certified but out of it as

stipulated. The Solitron defendants argue on appeal that the

named plaintiffs were not qualified to represent the class. They

argue that the court erred, first by not ruling before certification

that the December 1970 press release had cut off any injury to the

market or to the named plaintiffs from the 1967, 1968, and 1970

financial reports, and second by not decertifying the class when

the plaintiffs rested their case without having shown that the

December 1970 press release was fraudulent.

1. Certification

Judge Brieant certified the subclass as extending until June 2,

1971 on the ground that precertification “inquiry into the merits

of a suit” was barred by Eisen v. Carlisle & Jacquelin, 417 US.

156, 177 (1974). Eisen held that Fed. R. Civ. P. 23 gave a

district court no authority to hold a precertification hearing on the

merits in order to determine whether a suit may be maintained as

a class action, and therefore that the lower court’s allocation of

the costs of class notice to defendants upon a preliminary deter-

mination that plaintiffs were “more than likely” to prevail was

improper. Class certification motions are not subject to the same

standards as motions for dismissal for failure to state a claim or

for summary judgment. See Miller v. Mackey International,

Inc., 452 F.2d 424, 428 (Sth Cir. 1971), cited with approval in

Eisen, 417 US. at 178.

On the other hand, there can be no doubt that it is proper for a

district court, prior to certification of a class, to allow discovery

and to conduct hearings to determine whether the prerequisites of

Rule 23 are satisfied. “[A] preliminary hearing, addressed not to

A-50

Opinion of the United States Court of Appeals

for the Second Circuit

the merits of plaintiffs individual claim, but to whether he is

asserting a claim, which, assuming its merits, will satisfy the

requirements of Rule 23, has never been regarded as violative of

the rule stated in Eisen ....” Doctor v. Seaboard Coast Line

Railroad Co., 540 F.2d 699, 707 (4th Cir. 1976) (emphasis in

original) (footnote omitted). Indeed a district court may be

reversed for premature certification if it has failed to develop a

sufficient evidentiary record from which to conclude that the

requirements of numerosity, typicality, commonality of question,

and adequacy of representation have been met. See, e.g., Cha-

teau de Ville Productions, Inc. v. Tams-Witmark Music Library,

Inc., 586 F.2d 962, 966 (2d Cir. 1978).

The issue here falls between the prohibition in Eisen and the

obligation to rest certification under Rule 23 on something more

than the pleadings, see, e.g., Professional Adjusting Systems of

America, Inc. v. General Adjustment Bureau, Inc., 64 F.R.D. 35,

38 (S.D.N.Y. 1974) (Gurfein, J.) If the Solitron defendants

were arguing that a district court must determine whether the

named plaintiffs have a meritorious claim before they can be

certified as class representatives, they would plainly be wrong.

See, e.g., Huff v. N.D. Cass Co., 485 F.2d 710, 714 (Sth Cir.

1973) (en banc) (vacating dismissal of class action on ground

that “a class plaintiff who otherwise meets the demands of 23(a)

and (b) should not += found to be disqualified solely by an

advance determination that his claim is predictably not a winning

claim and that, therefore, he cannot adequately represent the

class as mandated by 23(a)(4)”). Solitron’s argument may be,

rather, that some kinds of merits determinations are crucial to

determining whether a class action is proper and that in such

circumstances Eisen poses no bar.

The dictum in Huff did suggest that some very basic merits

determinations—e.g., whether a named piaintiff suing his

employer was ever employed by the defendant, 485 F.2d at

714—may be made prior to certification because they affect

A-51

Opinion of the United States Court of Appeals

for the Second Circuit

whether the named representative has the nexus with the class

required by Rule 23. But the determination involved here is not

so basic. No case cited by Solitron supports the proposition that

a district court abuses its discretion by certifying when it later

appears that plaintiffs lacked a meritorious cause of action. Doc-

tor v. Seaboard Coast Line Railroad Co. cites the Huff dictum,

but only to support the more obvious proposition that the court

may properly “identify the character or type (but not the merits)

of each plaintiff's claim and then . . . determine whether there was

a class to which such claim . . . was common and of which it was

typical. . . .” 540 F.2d at 708-09 (emphasis in original). In

Doctor the district court denied class representative status to

plaintiffs whose claims were plainly unfit for a class action

because they were not shared by any other employees; the court

never reached nor thought it proper to reach the merits of the

As Judge Gurfein wrote, in making a certification decision, a

of discovery . . . . [E]nough must be laid bare to let the judge

survey the factual scene on a kind of sketchy relief map, leaving

for later view the myriad of details that cover the terrain.” Pro-

fessional Adjusting Systems of America, Inc. v. General Adjust-

ment Bureau, Inc., 64 F.R.D. at 38. On this view, it would be

improper for a district court to resolve substantial questions of

fact going to the merits when deciding the scope or time limits of

the class. Even a case on which the Solitron defendants rely

heavily, In re LTV Securities Litigation, 88 F.R.D. 134, 147-48

(N.D. Tex. 1980), supports this view. In that case, Judge Hig-

ginbotham decided to close the class period on the date of a press

release he regarded as cutting off further claims. He also chose

the earlier of two suggested dates for opening the class period,

however, thus including in the class those who purchased before

the first announcement of restated earnings, stating that while

“the court has reservations as to whether plaintiff can make out a

A-52

Opinion of the United States Court of Appeals

for the Second Circuit

claim with regard to the 1975 period, [it] believes that a suffi-

ciently substantial question has been presented such that the class

period must commence at the earlier time period proffered.” /d.

at 147. Thus where it was disputed whether part of a proposed

class had a cause of action, Judge Higginbotham certified the

Here too, the district court may properly have believed at the

time of the decision to certify that there was a substantial ques-

tion of fact for the jury whether the December 1970 press release

had cured the market, barring post-December claims, or was

itself fraudulent. Solitron’s arguments about that release would

then have appeared to be defenses on the merits. The parties’

post-trial stipulation to a December 16, 1970 closing date for the

therefore find that it was proper for Judge Brieant to certify the

class as he did, including post-December claimants within the

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A-53

Opinion of the United States Court of Appeals

for the Second Circuit

would not need to be mooted or destroyed because subsequent

even‘s or the proof at trial had undermined the named plaintiffs’

individual claims.” East Texas Motor Freight System, Inc. v.

Rodriguez, 431 U.S. 395, 406 n.12 (1977) (citing Franks v.

Bowman Transportation Co., 424 U.S. 747, 752-57 (1976).

Here certification was proper, and there was no need for decertifi-

cation. But for the parties’ stipulati wm to December 16, 1970 as

the closing date, the question of the effect of the press release

(and thus the question of the merit of the named plaintiffs’

claims) would have been resolved by the jury verdict. The

defendants have not shown that the named plaintiffs failed to

represent the class adequately, and the class’s victory before the

jury might be thought to rebut such an argument in any case.

Thus the subsequent definition of the class to exclude the individ-

ual named plaintiffs did not require decertification of the class.

B. Sufficiency of the Evidence

1. Fraud by the Solitron Defendants, 1967-70

The Solitron defendants also appeal from the district court’s

decision not to set aside the jury’s verdict that in the company’s

financial statements for 1967, 1968, and i970 they knowingly and

materially misrepresented inventories and characterized certain

consignments as sales. As the court properly noted, judgment

notwithstanding the verdict may be entered only if the evidence,

viewed in the light most favorable to the non-movants without

considering credibility or weight, reasonably permits only a con-

clusion in the movants’ favor. Mattivi v. South American

Marine Corp., “Huguenot”, 618 F.2d 163, 167 (2d Cir. 1980);

Simblest v. Maynard, 427 F.2d 1, 4 (2d Cir. 1970).

"A-54

Opinion of the United States Court of Appeals

for the Second Circuit

a. Inventory Overstatements

It is undisputed that the financial statements for the fiscal years

ending 1967, 1968, and 1970 materially overstated inventory.

The Solitron defendants argue collectively, however, as they did

below to the jury and the court, that the inventory recosting that

demonstrated the substantial over-statements was not even possi-

ble until Solitron had acquired for the first time a computer

capability and a sophisticated inventory costing system based

upon newly developed time-and-motion studies recommended by

Price Waterhouse in 1972, some two years after the misstate-

ments. They therefore argue that the evidence was insufficient to

show scienter, i.e., that there was either actual knowledge of the

misrepresentations or a reckless disregard for the representations’

truth or falsity. See Ernst & Ernst v. Hochfelder, 425 U.S. 185

(1976); IIT, an International Investment Trust v. Cornfeld, 619

F.2d 909, $23 (2d Cir. 1980), See also Polf v. Blyth, Eastman

Dillon & Co., 570 F.2d 38, 47-48 (2d Cir.), cert. denied, 439

U.S. 1039 (1978), on appeal from remand, 637 F.2d 77 (2d Cir.

1980).

We agree with Judge Brieant’s post-verdict assessment that

there was sufficient evidence of scienter on the part of the com-

pany as! the individual defendants to sustain the jury verdict

against the Solitron defendants for 1967, 1968, and 1970. The

jury could properly infer intent from subsequent admissions of

misrepresentations, coupled with the defendants’ continuous inti-

mate knowledge of company affairs. Solitron benefited from

overstating its inventory. From 1966 through 1970 its reported

earnings per share surged upward 100%, 50%, 33%%, and 20%

respectively. The price of the stock followed the reported earn-

ings, enabling Solitron to make numerous acquisitions’ after a

five-for-one split in April 1968. There was direct evidence that

A-55

Opinion of the United States Court of Appeals

for the Second Circuit

Friedman as well as Trager knew that inventory had increased

from $1.5 million in 1966 to $2.94 million in 1967, while the

inventory-turnover rate declined from 6 times a year to 4.5 times

a year; that inventory had increased nearly $5 million in 1968,

reducing inventory turnover to less than 2.5 times per year; and

that in 1970 inventory had increased by nearly $4 million to $12.5

million, with a turnover rate of only 1.9. The Solitron defendants

admitted such overstatements of inventory to the Renegotiation

Board in 1974.

There was also direct evidence that accounting procedures at

the Riviera Beach, Florida plant, where Solitron carried on its

government business, were inadequate to cost inventory accu-

rately. As Barry stated in a letter to renegotiation counsel, the

accounting department was “understaffed” and “poorly man-

aged,” in keeping with the company’s policy at that time: “get the

shipment out the back door, get the invoice in the mail to the

customer, operate with a minimum overhead, and profits will be

generated.” Inability to cost certain “highly reliable” and com-

mercial inventory resulted in overstatements in 1967 of $556,000,

in 1968 of $1.35 million, and in 1969 of $904,000; there were also

raw-material and piece-part costing and other errors of lesser

year 1968 amounted to $1.05 million.

The evidence of each individual! defendant's knowledge of and

lated Rule 10b-5. Friedman, the head of the company, was in

touch with the Florida plani by telephone each day, received

regular summaries and reports from the plant, and frequently

visited it. He testified at trial that he knew the effect of inventory

A-56

Opinion of the United States Court of Appeals

for the Second Circuit

valuation on profits. There was thus evidence from which the

jury could have concluded that he was aware of the company’s

failure to cost its inventory properly.

Trager, who had been employed by Sternbach until 1971 and

who had worked on Solitron audits every year from 1964 to 1969,

became comptroller of Solitron in the spring of 1969, assistant

treasurer in 1970, and treasurer in 1974. He prepared the

reports to the Renegotiation Board showing that profits had been

inflated because of overvaluation of inventory, and testified that

he knew where to look for the evidence of this overvaluation.

Barry, who was liable for 1970 only, spent fifteen years as an

accountant in the Intelligence Division of the Internal Revenue

Service before joining the Solitron accounting department at

Riviera Beach in July 1968. He became head of that accounting

department in 1969 and treasurer of Solitron in 1970. He went

back to the 1967-70 inventory figures for Riviera Beach and

showed the inventory overstatements. His documentation helped

Price Waterhouse reach its conclusions about inventory overstate-

ments and helped Trager prepare his reports to the Renegotiation

Board. Barry admitted to the Renegotiation Board the inade-

quacies of the Riviera Beach accounting procedures. His testi-

mony at trial showed that he had not verified the 1970 inventory

sheets that he certified as properly costed.

Without the overstatements, not only would the earnings per

share have been less during the years 1966 through 1970, but the

gradient of earnings growth would have been flatter. Indeed in

1970 there would have been a decline in earnings. There was

expert testimony before the jury about the effect that the over-

statement of earnings and the gradient of earnings growth have

on stock prices generally. Overall, we believe there was substan-

tial evidence to support the jury’s verdict that the Solitron defend-

ants all had the necessary scienter; the court’s refusal to set aside

the verdict was proper.

A-57

Opinion of the United States Court of Appeals

for the Second Circuit

b. Consignments Reported as Sales

The Solitron defendants claim further that there was no evi-

dence they committed fraud in reporting three consignment

transactions—with Best & Raynor, JFD Electronics Co., and

AEL Israel, Ltd.—as sales. We find Judge Brieant’s conclusion

to the contrary correct. Trager, in preparation for the Renegoti-

ation Board proceedings, went back to documents that had been

in his possession in 1969 and 1970, and showed that the transac-

tions classified as sales had in fact been consignments. Friedman

negotiated and signed the written contract with AEL Israel,

which was specified as a consignment arrangement in accord with

the understanding of the principal officers of AEL. Yet over

$700,000 of consignments were carried on the books as sales.

Although Friedman said he thought the first draft of the agree-

ment provided that the risk would be on AEL, the jury did not

have to credit his testinnony that he believed the contract—which

he signed and which placed the risk of loss on Solitron—provided

for a sale.’

2. Fraud by Sternbach

On the cross-appeal, the plaintiffs object both to the district

same “recklessness” charge with respect to Sternbach that it gave

3.

admit testimony by Solitron’s counsel in the AEL negotiations, which it

A-58

Opinion of the United States Court of Appeals

for the Second Circuit

respect to a pendent state law count, that Sternbach had been

negligent, a finding which Judge Brieant set aside and which is

not on appeal.

This court has held that proof of reckless conduct meets the

requirement of scienter in a section 10(b) claim, //T v. Cornfeld,

619 F.2d at 923. For the imposition of aider and abettor liability

under section 10(b), however, we have held that recklessness

satisfies the scienter requirement where “the alleged aider and

abettor owes a fiduciary duty to the defrauded party,” Rolf v.

Blyth, Eastman Dillon & Co., 570 F.2d at 44. We have not

decided whether recklessness is sufficient in the absence of such a

relationship. Jd. at 44 n.9. At least two district court judges

have concluded that recklessness may be sufficient, at least in the

case of accountants who know or can reasonably foresee that

third parties will rely on their audit or opinion letter. See Oleck

v. Fischer, [1979 Transfer Binder] Fed. Sec. L. Rep. (CCH) 1

96,898 (S.D.N.Y. 1979), aff'd. 623 F.2d 791 (2d Cir. 1980); In

re Investors Funding Securities Litigation, 1980 Fed. Sec. L.

Rep. (CCH) 1 97,763 (S.D.N.Y. 1980).

We have said in dicta in connection with accountants’ liability

that it is helpful to refer to ludge Goldberg's statement in Wood-

ward v. Metro Bank of Dallas, 522 F.2d 84, 97 (Sth Cir. 1975):

When it is impossible to find any duty of disclosure, an

alleged aider-abettor should be found liable only if scien-

ter of the high “corscious intent” variety can be proved.

Where some special duty of disclosure exists, then liability

should be possible with a lesser degree of scienter.

See Edwards & Haaly v. Wells Fargo Securities Clearance

Corp., 602 F.2d 478, 484-85 (2d Cir. 1979). See also IIT v.

Cornfeld, 619 F.2d at 924-25. The dicta also seem ‘9 refer to a

sliding scale of intent; Judge Gurfein wrote that “something

closer to an actual intent to aid in a fraud” is necessary to find a

A-59

Opinion of the United States Court of Appeals

for the Second Circuit

person liable for aiding and abetting, absent a fiduciary relation-

ship, than is necessary to find the principal liable. Edwards &

Hanly, 602 F.2d at 485. See also IIT v. Cornfeld, 619 F.2d at

925. The evidence here at the least would support a finding that

Sternbach’s conduct—with respect to mathematical errors, con-

signments recorded as sales, and inventory overvaluation—was

highly reckless. In light of our holding below, however, we need

not reach the question whether Sternbach, in view of whatever

duty it had to disclose, should have been judged under a reckless-

ness standard.

The court granted judgment to Sternbach notwithstanding the

verdict on the count of aiding and abetting Solitron’s 10b-5 viola-

tion, finding “no evidence from which a reasonable juror acting

reasonably could conclude that Sternbach aided and abetted the

primary securities law violation with the requisite scienter.” The

court, interpreting the requisite scienter to be actual knowledge of

the fraud since Sternbach did not owe a fiduciary duty to the

plaintiff investors, found that the evidence at most showed that

Sternbach was negligent. The proof did not show, the court

wrote, that Sternbach’s partner Edward Cole knew that the Best

& Raynor, JFD Electronics, and AEL Israel transactions were

consignments, even though “no confirmations were received by

Sternbach when requested, no payments were made, no purchase

orders were produced and shipments were made close to the end

of the fiscal year,” and even though a letter from AEL Israel to

Cole said the transaction was a consignment. The court found

also that even if, as plaintiffs sought to prove, Sternbach per-

formed inadequate and erroneous audits, this did not constitute

knowing assistance in the fraudulent overstatement of inventory.

Recalling the stringent standard for granting judgment not-

withstanding the verdict, we disagree with the court’s conclusion

that no reasonable juror could have reached a verdict against

Sternbach. First, the court’s conclusion that Sternbach lacked

actual knowledge is inconsistent with the jury’s finding, upheld by

A-60

Opinion of the United States Court of Appeals

for the Second Circuit

the court on defendants’ post-trial motion, that Trager—who was

employed by Sternbach in 1967, 1968, and early 1969—had

actual knowledge of the fraud. Second, evaluation 0: Cole’s

credibility, in the face of evidence suggesting he was on notice

that the transactions he certified as sales were consignm~nts, was

for the jury, not the court. And in light of Sternbach’s claims to

have performed various costing procedures and tests on Solitron’s

1967-70 inventory, the jury might well have concluded that

Sternbach knew that its certification of reports overstating inven-

tory was fraudulent. The combination of these facts leads us to

the conclusion that there was sufficient evidence for the jury to

infer that Sternbach had actual knowledge of fraud in violation of

Rule 10b-5.

3. Fraud by the Solitron Defendants, 1972-74

On the cross-appeal, plaintiffs also argued that the district

court erred in finding that there was no evidence to support the

verdict against the Solitron defendants with respect to the

financial statements for 1972-74. While these financial state-

ments stated that the Renegotiation Board had determined that

Solitron had made excess profits, they did not state that the

amounts involved were $3.2 million for the fiscal year ending

February 28, 1967 ard $4.4 million for the fiscal year ending

February 28, 1968. They stated only that the company was

contesting the determinations znd that management believed that

no significant refunds would be required after renegotiation.

Plaintiffs argued below that these statements were materially

misleading to investors because they suggested that the renegoti-

ation proceedings had minimal significance.

The judge overturned the jury verdict in plaintiffs’ favor

because he found that the evidence did not support any conclusion

other than that Solitron management, which never believed that

A-61

Opinion of the United States Court of Appeals

for the Second Circuit

the renegotiation assessment was meritorious, had truthfully dis-

closed to the public. The defendants knew from the Price

Waterhouse reports, which they themselves commissioned, that

Solitron inventory and income had been materially overstated;

they therefore believed that there were no excess profits. Their

renegotiation representative, Alexander Kirk, had advised them

that the renegotiation assessment had no merit.

While we find in reviewing the record that the question is a

close one, we do not think the court erred in setting aside the

verdict on this count. There was considerable evidence support-

ing the view that the defendants reasonably believed that the “box

car” numbers used in the government’s tentative renegotiation

assessment were truly unfounded. The court also noted that to

this date the renegotiation claims have never been resolved, sug-

gesting that the government either is extremely inefficient or

agrees that the renegotiation claims have no merit. Plaintiffs

presented no particular evidence to rebut the defendants’ view,

but merely argued that the Solitron defendants would not have

made the reports they did to the Renegotiation Board unless they

expected to be held liable. It is more plausible, however, to infer

that they made the reports in the expectation of avoiding liability,

in which case their statements to the public were not misleading.

C. Damages

Expert witness Gorkiewicz testified for the plaintiffs that when

earnings per share were corrected for overvaluation of inventory

and sales, Solitron shares were overpriced by 44% in 1967, 72.1%

in 1968, not at all in 1969, and 69.6% in 1970. The court sub-

mitted to the jury special interrogatory 6a as follows:

A-62

Opinion of the United States Court of Appeals

for the Second Circuit

State the percentage, if any, by which you find false or

misleading financial statements inflated the market price

of Solitron stock.

Oneretetement, Statements Fer Percentage of

oxy Year Ending Inftation, If Any

5/ 5/67 - 6/ 5/68 2/27/67

6/ 6/68 - 5/22/69 2/27/68

5/27/70 - 6/ 2/71 2/28/70

The jury responded by filling in for each of the above three

periods, respectively, 33%, 54.2% and 52.2%. The judgment

entered on April 9, 1981 limited recovery by the members of the

class by stating:

However, the recovery of any purchaser, exclusive of

interest, shall not exceed the actual loss of that purchaser

based on the market price of Solitron stock on October 31,

1979, that being the date on which the class was closed

and following which no opt-out was authorized, or the

actual loss based on actual selling price of the stock if sold

prior to October 31, 1979.

All parties are agreed that the cut-off date of October 31, 1979

is wrong and that the cut-off date for opting out is irrelevant.

The date should be December 16, 1970, when the defendants

ceased the “pollution” of the market place. Harris v. American

Investment Co., 523 F.2d 220 (8th Cir. 1975), cert. denied, 423

U.S. 1054 (1976). Thus the plaintiffs are precluded from claim-

ing a larger award based on declines in price after that date and

the defendants from awarding a smaller amount based on

increases in price thereafter. See Voege v. Ackerman, 364 F.

Supp. 72 (S.D.N.Y. 1973).

The Solitron defendants argue that plaintiffs’ damage theory is

illogical and has no support in this circuit because it does not

relate the alleged overpricing either to actual market behavior or

A-63

Opinion of the United States Court of Appeals

for the Second Circuit

to disclosure events, and because it treats the stock as overvalued

by a constant percentage for each year. But as the district court

pointed out, the year-long periods presented to the jury in Special

Interrogatory 6a were stipulated to be accurate time periods,

corresponding to the figures outlined by Gorkiewicz. And while

it seems odd that the calculations are for full years and vary

sharply from the last day of one to the first day of the next, these

are only hypothetical constructs which had to be made rather

arbitrarily since there were no disclosures until December 1970.

Each year was an era and the point in time between years an

epoch.

We agree with the court below that with respect to 1967 and

1968, the damage question was one of fact, resolved satisfactorily

by the jury through 25% reductions in Gorkiewicz’s estimates.

But we think that the Solitron defendants are correct that the

jury’s finding that the stock was overvalued by 52.2% in 1970

cannot stand. After the December 1970 disclosure of the inven-

tory write-downs, the market in the stock declined immediately

only 11% and then rose. This actual response of the market must

be taken into account in determining the damages for all or part

of the year 1970. See Shapiro v. Merrill Lynch, Pierce, Fenner

& Smith, Inc., 495 F.2d 228 (2d Cir. 1974); SEC v. Texas Gulf

Sulphur Co. 401 F.2d 833 (2d Cir. 1968) (en banc), cert.

denied, 394 U.S. 976 (1969). This is a matter we leave to the

sound discretion of the trial judge, because there might have been

other favorable developments in the company or in the market

place offsetting the harmful effects of the disclosure.

Solitron also argues that the district court erred because it

failed to consider the drastic market decline of 1970, citing Rolf

v. Blyth, Eastman Dillon & Co. and Feit v. Leasco Data Process-

ing Equipment Corp., 332 F. supp. 544, 586 (E.D.N.Y. 1971).

But these cases and the rule they announced have no bearing in a

case like this in which a stock purchaser has purchased his stock

at a price higher than he would have paid had true financial

A-64

Opinion of the United States Court of Appeals —

for the Second Circuit

statements been made. Rolf involved the decline in value of a

portfolio of one investor improperly advised by an investment

adviser who was recklessly aided and abetted by the investor’s

broker. Feit involved a fraudulent registration statement suit

under section 11, with statutorily determined damages expressly

excluding damages caused by “independent forces,” 332 F. Supp.

at 586. Here the issue is the amount by which each class member

was defrauded on the date of his purchase. Any subsequent

decline in the market had no effect on the fraudulent sale.

D. Contribution

Sternbach argues that if liable, it is entitled to contribution

from the Solitron defendants. We agree. Courts in this circuit

have permitted contribution in section 10(b) cases even though

section 10 of the Securities Exchange Act, unlike sections 9 and

18, does not expressly provide therefor. See Tucker v. Arthur

Anderson & Co., 646 F.2d 721, 727 n.7 (2d Cir. 1981); Seymour

v. Bache & Co., 502 F. Supp. 115, 119 (S.D.N.Y. 1980); Alexan-

der & Baldwin, Inc. v. Peat, Marwick, Mitchell & Co., 385 F.

Supp. 230 (S.D.N.Y. 1974); Globus, Inc. v. Law Research Ser-

vice, Inc., 318 F. Supp. 955, 958 (S.D.N.Y. 1970), aff'd, 442

F.2d 1346 (2d Cir.), cert. denied, 404 U.S. 941 (1971). In

Tucker, a section 10(b) case, this court noted that “under the

securities laws, a person who has defrauded the plaintiff in viola-

tion of those laws may be liable for contribution to another person

who has similarly defrauded the plaintiff.” 646 F.2d at 727 n.7.

The amount of contribution we leave to the sound discretion of

Judgment affirmed in part, reversed in part, and remanded.

A-65

Judgment of the Second Circuit

UNITED STATES COURT OF APPEALS

For THE SECOND CIRCUIT

#81-7357, 7367, 7377

>

Ata stated Term of the United States Court of Appeals for the

Second Circuit, held at the United States Courthouse in the City

of New York, on the nineteenth day of February one thousand

nine hundred and eighty-two.

Present:

Hon. J. E>DwARD LUMBARD,

Hon. JAMES L. OAKEs,

HON AMALYA L. KEARSE,

Circuit Judges.

>

HOWARD Sirota, FAMILY RESTORATIONS, A Partnership,

Rosert J. BERK and Bruce M. UMLAS, on behalf of

themselves and all others similarly situated,

Plaintiffs- Appellees-Cross- Appellants,

and

UNION CARBIDE CORPORATION,

Plaintiff-Intervenor-Appellant,

Vv.

SOLITRON Devices, INC., BENJAMIN FRIEDMAN,

JAMES S. TRAGER, JAMES P. BARRY,

Defendants- Appellants-Cross- Appellees,

Louts STERNBACH & Co.,

Defendant-Cross-Appellee,

>

A-66

Judgment of the Second Circuit

Appeal from the United States District Court

for the Southern District of New York

This cause came on to be heard on the transcript of record from

the United States District Court for the Southern District of New

York, and was argued by counsel.

ON CONSIDERATION WHEREOF, it is now hereby ordered,

adjudged, and decreed that the judgment of said District Court be

and it hereby is affirmed in part, reversed in part and the action be

and it hereby is remanded to said district court for further pro-

ceedings in accordance with the opinion of this court.

A. Daniel Fusaro, Clerk

by S/ ARTHUR HELLER

Arthur Heller,

Deputy Clerk

A-67

Orders of the United States Court of Appeals

for the Second Circuit on Petitions for Rehearing

UNITED STATES COURT OF APPEALS

For THE SECOND CIRCUIT

Nos. 81-7357

81-7367

81-7377

At a stated term of the United States Court of Appeals, in and

for the Second Circuit, held at the United States Courthouse, in

the City of New York, on the thirteenth day of May, one thousand

nine hundred and eighty-two.

HOWARD SirROTA, FAMILY RESTORATIONS, A Partnership,

Rosert J. Berk and Bruce M. UMLAS, on behalf of

themselves and all others similarly situated,

Plaintiffs- Appellees-Cross- Appellants,

and

UNION CARBIDE CORPORATION,

Plaintiff-Intervenor-Appellant,

—against—

SOLITRON Devices, INC., BENJAMIN FRIEDMAN,

JAMES S. TRAGER, JAMES P. BARRY,

Defendants- Appellants-Cross- Appellees,

and

Louts STERNBACH & Co.,

Defendant-Cross- Appellee.

Petition for Rehearing

Petitions for rehearing containing suggestions that the action

be reheard in banc having been filed herein by counsel for the

defendant-cross-appellee, Louis Sternbach & Co., and by counsel

A-68

Orders of the United States Court of Appeals

for the Second Circuit on Petitions for Rehearing

for the defendants-appellants-cross-appellees, Solitron Devices,

Inc., Benjamin Friedman, James S. Trager and James P. Barry,

and the panel that heard the appeal having ordered that the

opinion filed February 19, 1982, be amended,

Upon consideration by the panel that heard the appeal, it is

ORDERED that the said petitions for rehearing are DENIED.

It is further noted that the suggestions for rehearing in banc

have been transmitted to the judges of the court in regular active

service and to any other judge on the panel that heard the appeal

and that no such judge has requested that a vote be taken thereon.

Filed May 13, 1982.

A. DANIEL FUSARO

by FRANCIS X. GINDHART

Chief Deputy Clerk

A-69

Orders of the United States Court of

for the Second Circuit on Petitions for

UNITED STATES COURT OF APPEALS

FoR THE SECOND CIRCUIT

Nos. 81-7357

81-7367

81-7377

At a stated term of the United States Court of Appeals, in and

for the Second Circuit, held at the United States Courthouse, in

the City of New York, on the thirteenth day of May, one thousand

nine hundred and eighty-two.

HOWARD SIROTA, FAMILY RESTORATIONS, A Partnership,

Rosert J. Berk and Bruce M. UMLAS, on behalf of

themselves and all others similarly situated,

Plaintiffs- Appellees- Appellants,

and

UNION CARBIDE CORPORATION,

Plaintiff-Intervenor-Appellee- Appellant,

Vv.

SOLITRON Devices, INC., BENJAMIN FRIEDMAN,

JAMES S. TRAGER, JAMES P. BARRY, and Louis

STERNBACK & Co.,

Defendants- Appellants-Appellees,

Order on Petition for Rebearing

On petition for rehearing it is hereby ordered that the opinion

be amended as follows:

1. Slip op. at 1369, line 24-25, should read: “make several

acquisitions.’ There was direct evidence... .”

A-70

Orders of the United States Court of

for the Second Circuit on Petitions for Re

2. Slip op. at 1369 n.2 should read: “* For example, Solitron

exchanged approximately 160,000 shares for approximately

800,000 shares of Amphenol Corporation between January and

March 1968; acquired Filmohm Corporation in April 1968 for

$3.24 million in cash plus 63,100 shares of treasury stock; and

acquired Microwave Chemicals Laboratory, Inc., in January

1969 for $91,000 in cash plus 500 shares of treasury stock.”

J. EDWARD LUMBARD

J. Edward Lumbard

JAMES L. OAKES

James L. Oakes

AMALYA A. KEARSE

Amalya A. Kearse

Circuit Judges.

A-71

Special Interrogatories Submitted to The

Jury in the District Court

UNITED STATES DISTRICT COURT

SOUTHERN District oF New YORK

75 Civ. 1369 (CLB)

>

HOWARD SIROTA, et. ai.,

Plaintiffs,

against

SOLITRON Devices, INC., et. ai.,

Defendants.

=

Special Interrogatories

(THE JURY WILL CONSIDER AND ANSWER THE FOLLOWING

QUESTIONS IN THE ORDER IN WHICH THEY APPEAR.)

1. Do you find a preponderance of the credible evidence that one

Or more misrepresentations or omissions were made in con-

nection with the financial statements of Solitron Devices, Inc.

for the following years?

Yes No

(a) Fiscal year ending February 28, 1967 v

(b) Fiscal year ending February 28, 1968 v

(c) Fiscal year ending February 28, 1970 v

(d) Period including fiscal year ending Feb-

ruary 28, 1972 through fiscal year end-

ing February 28, 1974 v

(If the answer is YES with regard to the financia! statements

for any of these years, go on and answer Interrogatory No. 2.

A-72

Special Interrogatories Submitted to [he

Jury in the District Court

Do not answer any further interrogatories with respect to the

financial statements if you have answered NO. If you

answer NO as to all years, you must enter a general verdict

in favor of all defendants on the Rule 10b-5 claim.)

2. As to any year you answered YES in Interrogatory No. |, was

that misrepresentation or omission material, as the Court

previously defined that term for you?

Yes No

(a) Fiscal year ending February 28, 1967 v

(b) Fiscal year ending February 28, 1968 v

(c) Fiscal year ending February 28, 1970 v

(If you answered YES to Interrogatories No. | and 2 for any

year, go on and answer Interrogatory No. 3 as to any year to

which you answered YES. If you answered NO as to all

years, skip to Interrogatory No. 5.)

3. If your answer to Interrogatories | and 2 is YES with regard

to any of the following financial statements, do you find by a

preponderance of the evidence that any of the following

defendants participated in the preparation and dissemination

of them to the public with actual knowledge of their falsity or

misleading nature or with a reckless disregard of their truth or

falsity?

A-73

Special Interrogatories Submitted to The

Jury in the District Court

(Answer “Yes” or “No” on each line below.)

Solitroa Me Mr. Mr

AA __| Sa ES SS TE

(i)

_ Yi Yi Yi

2/28/6 es es - es

2/28/68 ....cccesserees Yes Yes act cone Yes

2/28/70 ..cccvserereees Yes Yes Yes Yes

2/28/72 through

38/4 unsesscanseces Yes Yes Yes Yes

If the answer to Interrogatory No. 3 is NO as to all defend-

ants, you will return a verdict in favor of the defendants on

this claim and skip to Interrogatory No. 5. If your answer to

No. 3 is YES as to any defendants, proceed to Question 4.

4. Do you find from a preponderance of the evidence that the

material misstatements or omissions in the financial state-

ments of defendant Solitron Devices, Inc. were the cause of

any damages suffered by the plaintiff class?

Answer “YES” or “NO.”

Answer: YES

Answer Interrogatory 5 only if you have answered YES to

Interrogatories 1, 2, 3 and 4.

5. Do you find by a preponderance of the evidence that Louis

Sternbach & Co. knowingly rendered substantial assistance

to Solitron Devices, Inc. in violating Rule 10b-5 during the

following yzars?

A-74

Special Interrogatories Submitted to The

Jury in the District Court

(Answer “YES” or “NO” on each line below.)

Weer Ending

2/28/67 YES

2/28/68 YES

2/28/70 YES

6. Do you find by « preponderance of the evidence that Louis

Sternbach & Co. negligently made false representations to

market purchasers of Solitron stock, whom they expected to

rely upon those representations and who did in fact rely upon

them, and that such purchasers were injured as a

consequence?

Answer “YES” or “NO”,

Answer: YES

Answer 6a if you answered “YES” to Interrogatories | and 2

regarding financial statements for the fiscal years ending

1967, 1968 and 1970, and YES to Interrogatory No. 3 or if

you answered “YES” to Interrogatory No. 4.

6a. State the percentage, if any, by which you find false or

misleading financial statements inflated the market price of

Solitron stock.

Period of ‘| ees —- en | of Inflation,

5/ 5/67-6/ 5/68 2/27/67 33%

6/ 6/68-5/22/69 2/27/68 54.2%

$/27/70-6/2/7) 2/28/70 52.2%

Answer 6b if you answered “YES” to Interrogatories | and 2

regarding financial statements for the fiscal years 1972

through 1974 and “YES” to Interrogatory No. 3.

A-75

Special Interrogatories Submitted to The

Jury in the District Court

6b. State the amount, if any, by which each share of Solitron

stock was inflated by reason of the financial statements for

the fiscal years 1972 through 1974.

28.26.

THE FOREGOING ANSWERS TO INTERROGATORIES CON-

STITUTE THE UNANIMOUS VERDICT OF ALL OF THE

JURORS.

Ms. MARIAN BINIMOW

Foreman

Dated: New York, N. Y..,

October 8, 1980.

[58] Direct EXAMINATION By Mr. Rabin:

Q. Mr. Trager, you are a defendant in this action, is that

correct? A. Yes.

Q. And subsequent to June of 1962 you were employed by

Sternbach & Company as a part-time junior accountant, is that

correct? A. Yes.

Q. Sternbach & Company is an accounting firm which is also

a defendant in this action; that is correct, isn't it? A. Yes.

Q. And from 1962 to 1964 you worked for Sternbach on part-

time basis? A. Yes.

Q. From 1964 to 1966 you worked for them on a full-time

basis? A. Yes.

Q. And from 1966 to 1969 you worked for them on a part-

time basis again? A. Yes.

Q. You are an accountant, are you not, sir? A. Yes.

[128] The Court: Overruled on the theory he is a CPA.

Mr. Morrison: I object to the word “claim” and he is not a

CPA.

The Court: Objection sustained.

Mr. Rabin: He is an accountant.

The Court: That is not enough. He is a bookkeeper.

Q. Mr. Trager, did you agree with the statement of the

Court?

The Court: I understood him to say he was a CPA.

The Witness: N..

The Court: You're not?

The Witness: No, | am not. I do not have a degree in

accounting.

The Court: What education do you have professionally?

A-77

Excerpts of James Trager's Testimony

in the District Court

Trager-direct

The Witness: Two years at Columbia.

The Court: Studying what?

The Witness: Accounting.

The Court: Did you get a degree of any kind from Columbia?

The Witness: No.

[319] Q. Do you know that the company is pursuing those

to this day? A. Yes, I do.

Mr. Morrison: Thank you.

The Court: Mr. Meshel, you may examine the witness.

Mr. Meshel: Thank you.

Trager-cross

Cross EXAMINATION BY MR. MBSHEL:

Q. Mr. Trager, I believe you indicated on your direct exami-

nation by plaintiffs’ counsel that you were a member of the

Sternbach staff from 1964 to 1969; is that correct? A. Yes.

The Court: It won't be necessary to repeat his direct

testimony.

Mr. Meshel: I don’t intend to, your Honor. I just wanted to

give a frame of reference.

Q. Do you recall during the times that you were associated

with the Sternbach firm the approximate number of people that

were involved from the Sternbach firm with the audit in any

particular year of Solitron Devices? A. About a half dozen

people, maybe more.

A-78

Excerpts of James Trager's Testimony

in the District Court

Trager-cross

Q. In your testimony at examination before trial, [320] |

submit you said it was as much as twenty people at times. Do you

recall that? A. Toward the end, including observation of inven-

tories, yes, it could have been that.

Q. Soit was not just you and Mr. Cole but many people in the

Sternbach firmed who were involved in the audits of Solitron

during the various years you were involved; is that a correct

answer? A. Yes.

Q. Do I understand that the times that you were with the

Sternbach firm your work was as a staff accountant and you did

things like bank reconciliations and procedures such as that?

A. Yes.

Q. You were not involved, were you, in any year that you were

with Sternbach, in the actural costing of inventory involving the

Florida division of Solitron, the actual costing of it? A. That's

correct.

Q. You were not? A. I was not involved.

Q. Would you give us an example of the types of things you

did do as a staff accountant in addition to bank reconciliations?

[321] A. I handled the confirming of accounts receivable,

mailing out the confirmations on receivables, payables, insurance

schedules, fixed asset additions, vouchering bills to such

schedules.

Q. Without trying to minimize what you did, sir, would it be

fair to characterize those procedures as the lowest fellow on the

rung does that sort of stuff as opposed to the higher echelon

supervisory work? A. Yes.

Q. Were there other staff accountants that worked with you?

A. Yes.

A-79

Excerpts of James Trager's Testimony

in the District Court

Trager-cross

Q. Dol understand in an accounting firm there are levels of

people, starting at the staff accountant level and working

upward? A. Yes, although informal levels in a firm the size of

Sternbach.

Q. You start out as a staff accountant and then go to a senior

or something equivalent to that? A. Right.

Q. You could be as high as an audit manager—we will

explain what that is a little later—is that correct? A. Right

[322] Q. The highest fellow, the fellow responsible, is

called the partner in charge; is that correct? A. Yes.

Q. Was Mr. Cole, as far as you know while you were with

Sternbach, the partner in charge in each of the fiscal years that

you were at Sternbach and were involved in an audit of Solitron

Devices? A. Yes.

Q. Was Mr. Cole available during the years you were with

Sternbach firm—was he there for consultation and supervision, as

far as you knew? A. Yes.

Q. Did he take an active part as far as you know in the audits

of Solitron in each of the fiscal years that you were with

Sternbach and worked on audits for Solitron? A. Yes, he did.

Q. There has been testimony—

The Court: Whatever there has been, he heard I don’t want

any introductory comments to questions. Just frame the ques-

tion. If he does not understand what you are talking about, he

will tell you fast enough.

Q. There has been an item marked Plaintiffs’ Exhibit 35 in

evidence. I hand it to you, Mr. Trager.