anthony j. deluca, harry j. soose, francis j. harvey...
TRANSCRIPT
UNITED STATES DISTRICT COUR T
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
THOMAS L. PAYNE, SID ARCHINAL,GARY H . KARESH, JO ANN KARESH,BELCA D . SWANSON AND MERLE K.SWANSON individually and on behalf of allothers similarly situated,
Plaintiffs,V .
CIVIL ACTION NO. 02-1927
CLASS ACTION
Judge William L. Standish
ANTHONY J. DeLUCA, HARRY J .SOOSE, FRANCIS J . HARVEY, JAMES C .MCGILL, RICHARD W . POGUE, DANIELA. D'ANIELLO, PHILIP B . DOLAN, E .MARTIN GIBSON, ROBERT F .PUGLIESE, JAMES DAVID WATKINS,and THE CARLYLE GROUP,
Defendants .
PLAINTIFFS' MEMORANDUM OF LAW IN OPPOSITION TOSUPPLEMENTAL MEMORANDUM OF THE CARLYLE GROU P
AND OUTSIDE DIRECTOR DEFENDANTSREGARDING CONTROL PERSON LIABILITY
TABLE OF CONTENT S
1 . INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
11. CONTROL MAY BE ALLEGED UNDER FED.R.CIV.P . 8 NOTICE PLEADING
STANDARDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
III . CONTROL, FOR PURPOSES OF SECTION 20(a) LIABILITY, REQUIRES ONLYPOTENTIAL POWER, NOT ITS EXERCISE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
IV. CARLYLE IS ALLEGED TO HAVE POSSESSED AND EXERCISED CONTROL . . 4
A. Carlyle Possessed Control as a Shareholder Which Installed the Majority of ITGroup 's Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
B . Carlyle Not Only Possessed Control, But Also Exercised Control Through the ITGroup Directors Who Acted as Agents of Carlyle . . . . . . . . . . . . . . . . . . . . . . . . . 7
V. THE DIRECTORS ARE ALLEGED TO HAVE POSSESSED AND EXERCISED
CONTROL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
A. The Outside Directors are Control Persons As Signers of the SEC Filings WhoMisrepresented IT Group's Financial Condition . . . . . . . . . . . . . . . . . . . . . . . . . . 8
B . The Directors Are Control Persons Because They Are Members of An IdentifiableGroup, i .e ., Carlyle's Control Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1
C. Defendant Harvey Replaced DeLuca as CEO, and the Control Liability Applies toHis Period as CEO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2
VI. PLAINTIFFS DO NOT HAVE TO PLEAD CULPABLE PARTICIPATION . . . . . . . . 1 2
A. The Prevailing Case Law, Including Virtually All Cases Which Have Analyzedthe Issue, Conclude that Culpable Participation is not a Pleading Element . . . . 1 2
B. A "Culpable Participation" Pleading Requirement Would Violate Congress'sStatutory Scheme , by Making Sections 10(b) and 20(a) Redundant . . . . . . . . . . 1 4
VII. CARLYLE AND THE OUTSIDE DIRECTORS ARE ALLEGED TO HAVECULPABLY PARTICIPATED IN THE FRAUD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 5
VIII. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 6
I
TABLE OF AUTHORITIES
CASES
Aldridge v . A.T.Cross Corp . ,284 F . 3d 72 (151 Cir . 2002 ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
BDO International in Teachers ' Retirement System of LA v. A.C.L.N., Ltd . ,2003 WL 21058090Fed. Sec . L. Rep . P 92,417 (S .D.N.Y. May 12, 2003 ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Borden, Inc. v. Spoor Behrins Campbell & Young, Inc . ,735 F.Supp . 587 (S.D.N.Y.1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Cyber Media Group , Inc. v. Island Mortgage Network, Inc . ,183 F .Supp .2d 559 (E.D.N.Y . 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Dennis v . General Imaging, Inc . ,918 F.2d 496 (5' Cir . 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Derensis v . Coopers & Lybrand Chartered Accountants ,930 F. Supp. 1003 (D.N.J. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,13
Drobbin v . Nicolet Instrument Corporation ,631 F.Supp . 860 (S .D .N.Y. 1986) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Food and Allied Service Trades Dept ., AFL-CIOv. Millfeld Trading Co . ,
841 F.Supp. 1386 (S.D .N.Y. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 1 4
Hallet v . Li & Fung, Ltd .1996 WL 487952 (S .D.N.Y. Aug. 27, 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Hayley v. Parker2002 WL 925322 (C.D.Cal. March 15, 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1
IBS Financial Corp . v. Seidman & Associates ,136 F .3d 940 (3d Cir . 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5, 6, 7
In re Campbell Soup Co. Sec. Litig. ,145 F.Supp.2d 574 (D.N.J. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 1 3
In re CDNow, Inc. Sec . Litig . ,138 F.Supp.2d 624 (E .D.Pa. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 1 3
11
In re Cendant Corp . Sec. Liti g109 F.Supp.2d 225 (D.N.J. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7, 1 1
In re Digital Island See . Liti&,223 F.Supp .2d 546 (D.Del . Sept. 10, 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,8, 1 1
In re Emex Corp . Securities Litigation,2002 WL 31093612 (S .D.N.Y. Sep 18, 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
In re Health Management, Inc ., Sec. Litig. ,970 F. Supp . 192 (E.D.N.Y. 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
In re Imperial Credit Industries Inc . ,2000 WL 1049320 (C.D.Cal. February 22, 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5, 1 2
In re JWP Inc. Securities Litigation928 F.Supp. 1239 (S.D.N.Y.1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9, 1 0
In re Loewen Group Inc . ,2003 WL 22436233 (E.D.Pa . July 16 , 2003 ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
In re MicroStrategy. Inc. Sec. Litig. ,115 F.Supp.2d 620 (E.D.Va. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
In re Midlantic Corp . Shareholder Litig.,758 F.Supp . 226 (D.N.J.1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
In re MobileMedia Sec . Litig . ,28 F.Supp.2d 901 (D.N.J. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 12, 13
In re Nice Systems, Ltd. Sec . Litig . ,135 F.Supp.2d 551 (D.N.J . 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 3
In re NUI Sec. Litig . ,314 F . Supp .2d 388 (D.N.J.2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2
In re Reliance Sec . Litig . ,135 F.Supp.2d 480 (D.Del . 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4, 9
In re Rent-Way Sec. Litig. ,209 F.Supp.2d 493 (W.D.Pa. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4, 11, 1 2
In re Rockefeller Center Properties Ins . Sec. Litig . ,311 F.3d 198 (3d Cir . 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
iii
In re Splash Tech . Holdings, Inc. Sec . Litig . ,2000 WL 1727377 (N .D .Cal . Sept . 29, 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 8, 1 1
In re Splash Tech. Holdings, Inc . ,2000 WL 1727405 (N .D . Cal . Sept. 29, 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1
In re Tel-Save Sec . Litig . ,1999 WL 999427 (E.D.Pa . Oct.19 , 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 10, 12
In re The Loewen Grou Inc . ,2004 WL 1853137 ( E .D.Pa. Aug 18, 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 3
In re Tyson Foods, Inc . ,2004 WL 1396269 (D .Del . Jun 17, 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 6
In re U.S . Interactive, Inc. Securities Litig. ,2002 WL 1971252 (E .D.Pa. Aug 23, 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 1 2
In re WorldCom Inc . Sec. Liti . ,2003 WL 21219049 (S .D.N.Y. May 19, 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 11, 1 4
Jones v . Intelli-Check, Inc . ,274 F.Supp.2d 615 (D .N.J. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 1 3
Marburg Management Inc . v. Kohn,629 F.2d 705 (2d Cir . 1980) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 4
Paraschos v. YBM Magnex Intern ., Inc . ,2000 WL 325945 (E.D.Pa.2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Rochez Bros ., Inc . v . Rhoades ,527 F .2d 880 (3d Cir . 1975) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 4, 7, 13, 1 5
Rocker Management , L.L.C . v . Lernout & Hauspie Speech Products N.V. ,2005 WL 1365465 (D .N.J. June 7, 2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
S.E.C. v. First Jersey Secs ., Inc . ,101 F.3d 1450 (2d Cir.1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 4, 5
Sanders v. Gardner ,7 F . Supp.2d 151 (E.D.N.Y.1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Shadie v. Aventis Pasteur, Inc . ,254 F.Supp.2d 509 (M.D. Pa. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 4
iv
Sheehan v. Little Switzerland, Inc . ,136 F.Supp.2d 301 (D.Del . 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,8, 10, 1 1
Sloane Overseas Fund , Ltd, v . Sapiens Intern . Corp., N.V. ,941 F.Supp. 1369 (S.D.N.Y.1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Teachers ' Retirement System of LA v . A.C .L.N., Ltd. ,2003 WL 21058090 ; Fed. Sec . L. Rep. P 92,41 7(S .D.N.Y. May 12,2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Theoharous v . Fong,256 F.3d 1219 (11 " Cir. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Tracinda Corp . v. Daimlerchrysler AG ,197 F.Supp.2d 42 (D .Del .2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 1 6
VT Investors v. R & D Funding Corp.,733 F.Supp. 823 (D .N.J. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 5
CODES
17 C .F.R. § 240.12b-2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 3-5
Federal Rules of Civil ProcedureRule8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Federal Rules of Civil ProcedureRule 9(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Securities Exchange Act of 1934Section 10(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Secu rities Exchange Act of 1934Section 20(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 -3,5-1 6
v
I. INTRODUCTION
The Second Amended Complaint ("SAC") plainly states a control person claim against the
Carlyle Group ("Carlyle") and the outside directors . The Moving Brief of Carlyle and the outside
directors in response to the SAC's allegations of control person liability is universally incorrect .
Significantly, Fed .R.Civ .P. Rule 8 pleading standards apply to a Section 20(a) claim, and
culpable participation is not a pleading element of control person liability . Moreover, "control"
requires power but not necessari ly its exercise, and stock voting power is sufficient under applicable
SEC regulations to show control . 17 C.F . R. § 240 .12b-2 . Furthermore, Carlyle exercised control by
installing a majority of the board, including director Fran Harvey, who admitted he was acting "for
Carlyle" although not formally denominated a Carlyle director . In addition, the outside directors,
acting as agents for Carlyle, exercised collective control over the Company, including controlling
the contents of its SEC filings . '
As explained in the main opposition brief , Carlyle 's participation in the scheme was perfectly
consistent with its interests, and completely plausible . The scheme did not cause Carlyle to lose
money. Rather, by concealing IT Group's true financial condition, the scheme served to prolong the
life of IT Group and maintain its stock price at inflated levels, which is what Carlyle would have
wanted as a shareholder. While IT Group may have had additional motivations by prolonging the
Company's life,' the scheme, at a minimum, allowed Carlyle to continue to collect its preferred
dividends and advisory fees . Ultimately, while Carlyle did want the Company to succeed, its actions
in concealing IT Group's problems and misrepresenting its financial condition, even in the interests
of resurrecting the Company or delaying its demise, nevertheless constitute violations of the
securities laws.
'Although culpable participation is not a required pleading element of a Section 20(a) claim,because the outside directors (and their principal Carlyle) are alleged to have signed IT Group's SECfilings while being aware of Defendants' scheme (and therefore of the misleading nature of thefilings), these defendants were culpable participants .
21t is very possible that Carlyle was hoping to conceal IT Group's problems long enough tosell off portions of the business, divest itself of the stock, or otherwise come out whole or even reapa gain .
II. CONTROL MAY BE ALLEGED UNDER FED.R.CIV.P. 8 NOTICE PLEADINGSTANDARDS
The pleading of a Section 20(a) control person claim "is governed by Rule 8, Fed .R.Civ .P."
In re WorldCom, Inc . Securities Litigation, 294 F.Supp.2d 392, 415 (S.D.N.Y .2003). "The
heightened pleading requirements of Rule 9(b) do not apply to claims under Section 20(a) .
Allegations that `support a reasonable inference that [defendants] had the potential to influence and
direct the activities of the primary violator' suffice to plead control person liability ." In re U.S .
Interactive, Inc. Sec . Litig . , 2002 WL 1971252 at * 20, (E.D.Pa. Aug 23, 2002) (citing In re Tel-Save
Sec. Litig . , 1999 WL 999427 at *6 (E.D.Pa. Oct.19, 1999) and quoting In re Health Management
Inc., Sec . Litig . , 970 F .Supp. 192, 205 (E.D .N.Y.1997)) .
"[C]ourts in this circuit have acknowledged that control person claims need not be pleaded
with particularity so long as the underlying Section 10(b) violation is properly pled . See Derensis
v . Coopers & Lybrand Chartered Accountants , 930 F.Supp. 1003 , 1013 (D.N.J. 1996) (noting the
"`overwhelming trend in this circuit to allow section 20(a) actions to withstand Rule 9 (b) motions
based on a simple pleading of control "') (citation omitted) ; Rocker Management , L .L.C. v . Lernout
& Haus ie Speech Products N .V., 2005 WL 1365465 at *14 (D.N.J. June 7 , 2005) .
Defendants misinterpret the Third Circuit decision in In re Rockefeller Center Properties Ins .
Sec. Litig . , 311 F.3d 198 (3d Cir . 2002)(Moving Brief at 2). The decision does not hold that Section
20(a) claims "sound in fraud ." Instead, Defendants take a quotation applying to Section 10(b)
claims, and misapply the quote to Section 20(a) . In re Loewen Group Inc., 2003 WL 22436233 at
*7 (E.D.Pa. July 16, 2003), also cited at Moving Brief at . 2, never actually applies Rule 9(b) to the
Section 20(a) claims .' Indeed, the judge in that case - Judge O'Neill - ruled shortly thereafter that
"[c]laims under Section 20(a) are not subject to the heightened pleading requirements of Federal
Rule of Civil Procedure 9(b) or the Reform Act ." In re The Loewen Group Inc . , 2004 WL 1853137
at *26 (E.D.Pa. Aug 18, 2004) .
3 In re Loewen Group Inc . lumps together Section 10(b) and Section 20(a) claims as soundingin fraud, but does not specify that Rule 9(b) applies to the pleading of control and never actuallyapplies Rule 9(b) to the Section 20(a) claims, which were dismissed because the underlying Section10(b) violation was not sufficiently alleged.
2
The remainder of cases Defendants cite to are similarly ineffective . In re Digital Island Sec .
Litig. , 223 F .Supp . 2d 546 , 561 (D . Del. Sept . 10, 2002) reaches for out-of-circuit precedent to apply
particularity to the pleading of control . Id. (citing In re Splash Tech . Holdings, Inc. Sec. ~, 2000
WL 1727377, at *25 (N.D .Cal . Sept.29 , 2000 )) . In re CDNow, Inc . Sec . Litig . , 138 F .Supp .2d 624,
644 (E . D.Pa. 2001) carefully states that part icularity standards apply under Section 20 (a) only to
culpable participation , but does not apply any standard to the Section 20(a) claim because the
underlying Section 10 (b) claim was dismissed .
III. CONTROL, FOR PURPOSES OF SECTION 20(a) LIABILITY, REQUIRES ONLYPOTENTIAL POWER , NOT ITS EXERCIS E
"Control" for purposes of Section 20(a) liability requires only the abili to exercise control ,
i .e. potential control, not necessarily the actual exercise of control . The Second and Third Circuits
clearly concur on this point . The leading case in this Circuit explicitly holds that "many factors are
involved in determining if one is a `controlling person .' In making this determination, the courts
have given heavy consideration to the power or potential power to influence and control the activities
of a person, as opposed to the actual exercise thereof." Rochez Bros., Inc . v. Rhoades, 527 F .2d
880, 890 (3d Cir . 1975)(emphasis added) .
"Actual control means the practical ability to direct the actions of the controlled person . "
Sheehan v. Little Switzerland , Inc . , 136 F.Supp .2d 301 , 315 (D . Del. 2001 ) . Thus, "the pleading of
facts that `support a reasonable inference that [defendants] had the potential to influence and direct
the activities of the primary violator ' will survive a motion to dismiss ." In re Loewen Group Inc .,
2004 WL 1853137 at *26 (E.D.Pa . Aug 18 , 2004) (quoting In re MobileMedia Sec . Litig . , 28
F.Supp .2d 901 , 940 (D .N.J. 1998) (emphasis added)) . So what is relevant is the "ability," not the
actual exercise of control . 4
4Similarly, the leading case in the Second Circuit emphasizes the possession of control ratherthan its exercise, in holding that "control over a primary violator maybe established by showing thatthe defendant possessed `the power to direct or cause the direction of the management and policiesof a person, whether through the ownership of voting securities, by contract, or otherwise . "' S .E.C.v. First Jersey Secs ., Inc . , 101 F .3d 1450, 1472-73 (2d Cir . 1996) (quoting 17 C.F.R. § 240.12b-2) .In other words, "control" is the "possession" of power, not necessarily its exercise . "Actual controlrequires only the ability to direct the actions of the controlled person, and not the active exercisethereof." Sanders v. Gardner, 7 F. Supp. 2d 151, 163 (E.D.N.Y. 1998) (citations omitted), quoted
Control means either control of the "accused operations" (i .e . the issuer's activity pertaining
to the underlying facts of the fraud)' or to the content of SEC filings or public announcements
alleged to be false and misleading. In re Rent-Way Sec . Litig., 209 F.Supp.2d 493, 524 (W.D.Pa .
2002) (control liability alleged, among other reasons, because defendants had the ability to control
the content of SEC filing) .
IV. CARLYLE IS ALLEGED TO HAVE POSSESSED AND EXERCISED CONTROL
A. Carlyle Possessed Control as a Shareholder Which Installed the Majority of ITGroup's Board
The Carlyle Group is a control person as a result of its stock ownership, its installation of th e
majority of IT Group's directors, and its contractual right to appoint a majority of directors . SEC
regulations provide that control consists of the power to direct management "through the ownership
of voting securities . . . ." 17 C .F.R. § 240.12b-2, quote d in S.E.C. v. First Jersey Secs ., Inc . , 101 F .3d
1450, 1472-73 (2d Cir.1996) and Rochez Bros., Inc . v. Rhoades, 527 F.2d 880, 890-91 (3d Cir.
1975) . This control entails a showing of only "substantial stock ownership ." Sloane Overseas Fund,
Ltd. v. Sapiens Intern. Corp ., N.V., 941 F .Supp. 1369, 1378 (S .D.N.Y.1996). In fact, "substantial
stock ownership" is a factor from which "control can be directly inferred without more ." Id. Such
"substantial stock ownership" does not require majority ownership . For example, In re Emex Corp .
Sec. Litig . , 2002 WL 31093612, at * 10 (S .D.N .Y. Sept. 18, 2002) held that two 45% owners were
each controlling persons .
In addition to its substantial stock ownership (with guaranteed dividends as a preferred
shareholder), Carlyle had majority control of IT Group's board of directors . This was a contractual
right from the provisions of Carlyle's exclusive class of preferred stock . SAC 179. Such control
meets the criteria of the SEC's regulation because Carlyle had control "through the ownership o f
in Cyber Media Group, Inc . v. Island Mortgage Network, Inc . ,183 F .Supp.2d 559, 576 (E .D.N.Y.2002). See Borden, Inc . v . Spoor BehrinsCampbell & Young, Inc . , 735 F.Supp . 587,591 (S .D.N.Y.1990) (holding that control person liability was adequately alleged because as the sole shareholderof the subsidiary, the parent corporation "had the potential power to influence and direct theactivities of" its subsidiary) .
'In re Reliance Sec. Litig . , 135 F .Supp.2d 480, 518 (D .Del . 2001) (control person claim canbe asserted through a showing that defendants exercised control over accused operations) .
4
voting securities, by contract, or otherwise." S .E.C. v. First Jersey Sees., Inc . , 101 F .3d 1450,
1472-73 (2d Cir .1996) (quoting 17 C.F.R. § 240.12b-2) .
Carlyle also exercised its control by installing a majority of IT Group's directors . Formally,
there were five Carlyle directors . SAC ¶ 80. But, in fact, there was a sixth -- defendant Fran Harvey,
who testified that he was a Carlyle board representative . SAC IT 42, 85 .6 In addition, Carlyle
reserved the right to substitute anyone it preferred for Harvey "at any time for any reason ." See
5/20/1999 Proxy Statement, Becker Decl . Exh. 12 at 3 . Consequently, Harvey was unambiguously
on the board at Carlyle's pleasure . This overt control strongly supports the inference that Carlyle
used its majority control to influence IT Group's management . See In re imperial Credit Industries
Inc ., 2000 WL 1049320, at *6 (C .D.Cal. February 22, 2000) .' See also Haslet v. Li & Fun Ltd .
1996 WL 487952, at *4 (S .D.N.Y . Aug. 27, 1996)(holding that a controlling shareholder's
representative o n the b oard o f directors " is in ore a kin t o a corporate insider" than an o utside
director) . With a majority of the board working at its command, Carlyle undeniably possessed "the
power to direct or cause the direction of the management and policies" of IT Group, as required for
control person status under 17 C.F.R. § 240.12b-2, the pertinent SEC regulation .
Carlyle's power to install a majority of directors, which Defendants do not deny and which
is admitted in IT Group's 2000 10-K (Becker Decl . Exhibit F3 at 9), is itself dispositive of Carlyle's
control over IT Group, even if that control were not exercised .' The Third Circuit in IBS Financial
'Defendants overlook that Mr. Harvey was a Carlyle director . However, the SAC pleads hisaffiliation with Carlyle very specifically. See SAC ¶78 (alleging that Dr . Harvey said "I am on twoother boards for Carlyle") and SAC ¶77 ("Carlyle had . . .installed Dr. Harvey. . .six months before itwas publicly announced .") .
7"Presumably, [controlling shareholder] ICI intended that [its director appointees] Snavelyand Shugerman would give it a means for exercising control over SPF ." In re Imperial CreditIndustries Inc ., 2000 WL 1049320 at *6 (C .D.Cal. February 22, 2000) .
g See Drobbin v . Nicolet Instrument Corporation , 631 F.Supp. 860, 885 (S .D.N.Y .1986)(ruling that a company holding "exclusive right to designate the majority of [the issuer's]directors" could be held liable under Section 20(a)) .
5
Corp . v . Seidman & Associates , 136 F.3d 940, 947 (3d Cir . 1998) rejected the argument that actual
exercise of control is needed for control person liability . The district court in IBS Financial
concluded that only the manager of the companies was a control person because "in practice, only
he has exercised actual control over these companies ." Id. at 946 . The Third Circuit, however,
rejected that analysis, holding that because the majority owner had the power to remove the manager,
that majority owner was also a control person, "notwithstanding that [the majority owner] has
refrained from, and may continue to refrain from, exercising that power ." Id . at 947 . 9
In any event, Carlyle admitted it had control of IT Group. Carlyle's own web site
characte rized IT Group as one of its "portfolio companies ," described IT Group 's CEO as part of
the "Carlyle network," and even bragged that Carlyle provides "an uncommon level of management
support, insight and expertise to suppo rt our portfolio companies . . . ." SAC ¶ 85 . Comparable
statements on BDO 's website resulted in Section 20(a) control person status for BDO Inte rnational
in Teachers ' Retirement System of LA v.A.C.L.N., Ltd . , 2003 WL 21058090, Fed. Sec . L. Rep. P
92,417 (S .D.N.Y . May 12 , 2003) .10 Moreover, Fran Harvey testified that Carlyle controlled the
Board through November 2001, a fact that c an be added by amendment . See Zabb Decl . Exh. "P" .
The cases cited at Moving B rief at 8 are not on point. The minority shareholder in
Theoharous v . Fong , 256 F.3d 1219,1227-280 (11 `h Cir . 2001 ) did not have the special control rights
9IBS Financial 's holding concerned control person status for purposes of includinginformation in a Schedule I3D . But the Third Circuit held that the requirements for Section 20(a)control person status were the same as for Schedule 13D . The court in lBS Financial, 136 F .3d, at947 n.3, concluded that "there is no apparent reason for the term `controlling person' as it is usedin section 20(a), to be more broadly construed than the term `person controlling,' as it is used inInstruction C to Schedule 13D . "
'The Court found control person liability where "[s]pecific references are made toInternational's statements [on its website] that the member firms are its `representative practice[s],'that the organization's structure `ensures strict quality control and encourages the sharing of skillsand ideas,' and that the `stringent conditions which each member firm has to comply to be part ofthe BDO network are paramount ."' Teachers' , 2003 WL 21058090, at *12 .
6
that Carlyle possessed, and, unlike Carlyle, the corporate defendant could elect only a minority of
directors . Dennis v . General Imaging, Inc . , 918 F .2d 496, 509 (5 " Cir. 1990), involved a minority
shareholder who, also unlike Carlyle, was inactive, causing the court to conclude that "there is no
proof to support a contention, that Thomas had any influence at all over the corporate policies
pursued by these firms or that he knew about any of the acts alleged to give rise to Section 12 or
10(b) violations ." Id . The holding in Aldridge v . A.T.Cross Corp., 284 F .3d 72, 85 (1$t Cir . 2002)
(cited in Moving Brief at 9) reflects only that the First Circuit reading of Section 20(a) is inconsistent
with the Third C ircuit's, i n t hat the F irst C ircuit requires exercise o f control . H owever, IBS
Financial is the controlling law in this case - not Aldridge .
B. Carlyle Not Only Possessed Control, But Also Exercised Control Through theIT Group Directors Who Acted as Agents of Carlyl e
The Third Circuit has long recognized that general agency principles apply to corporate
actions in the context of the federal securities laws . As the court in In re Cendant Corp . Sec. Litig .
109 F.Supp.2d 225, 233 (D .N.J. 2000)(citing Rochez Bros ., Inc . v . Rhoades , 527 F .2d 880, 884 (3rd
Cir.1975)) stated :
"Under general agency principles, the fraud of an officer of a corporation isimputed to the corporation when the officer's fraudulent conduct was (1) inthe course of his employment, and (2) for the benefit of the corporation. . . .The underlying reason is that a corporation can speak and act only through itsagents and so must be accountable for any acts committed by one of its agentswithin his actual or apparent scope of authority and while transactingcorporate business . "
The majority of IT Group's board of directors were authorized agents of Carlyle and acte d
within the scope of their authority by approving and signing IT Group's SEC filings containing false
and misleading statements. By signing these filings, the directors possessed and exercised control
forpurposes of Section 20(a) liability, and because the directors were acting as Carlyle's agents, their
acts constitute the acts of Carlyle . Thus Carlyle both possessed and exercised sufficient control to
attach Section 20(a) control person liability .
7
V. THE DIRECTORS ARE ALLEGED TO HAVE POSSESSED AND EXERCISEDCONTROL
A. The Outside Directors are Control Persons As Signers of the SEC Filings WhoMisrepresented IT Group's Financial Condition
The Outside Directors are liable under Section 20(a), as a result of three factors : (1) their
positions as directors, (2) their duties as members of board committees, and (3) their signing of I T
Group's false and misleading Form 10-Ks . Because Plaintiffs allege that all three factors were
present , the SAC sufficiently alleges control person liability.
First, the fact that Carlyle's agents were IT Group' s directors is an important factor in
determining their status as control persons . Even if not dispositive, their positions as directors carry
considerable weight in this Circuit . "In assessing a plaintiff's pleadings for § 20(a), Third Circuit
precedent requires the court to give consideration to the powers inherent in the defendants' positions :
`Substantial weight must be given to the authority, or rather the potential authority, inherent in such
corporate positions, considered separately or in concert . Furthermore, prior to discovery, plaintiff
can hardly be able to plead the precise culpable conduct of each individual defendant ."' Paraschos
v. YBM Magnex Intern ., Inc . , 2000 WL 325945, at *9 (E .D.Pa. 2000) (quoting In re Midlantic Corp .
Shareholder Liti& . , 758 F.Supp. 226, 232 (D.N.J. 1990)) . Defendants cite cases which merely hold
that such status is not dispositive, not that it is irrelevant." Also, the underlying case law cited in
In re Digital Island is misapprehended .' 2
"See Moving Brief at 8-9, citing In re Digital Island Sec. Litig . , 223 F .Supp.2d 546, 561(status is not by itself "sufficient"), Sheehan v. Little Switzerland , 136 F .Supp.2d 301, 315 (D.Del .2001) status is "by itself. .insufficient ."
12In re Digital Island (though erroneously citing to 2000 WL 1727377, at * 16) quotes In re
Splash Technology Holdings, Inc. Sec . Litig., 2000 WL 1727405, at * 16 (N .D. Cal . 2000), for theproposition that status is not enough to show control (see 223 F .Supp .2d 546, 561) . Splash, in turn,cites Food and Allied Service Trades Dept ., AFL-CIO v. Millfeld Trading Co., 841 F.Supp. 1386,
1391 (S .D.N.Y. 1994) ("Food and Allied Service Trades"). But Food and Allied Service Tradesactually supports Plaintiffs, holding that "a requirement that plaintiffs allege more than control statusconfuses what is required to establish control liability at trial or summary judgment and what isrequired to make out a prima facie case of control liability at the pleading stage . Requiring plaintiffs
8
The SAC, at ¶142-49, alleges the Outside Directors' membership on board of director
committees : Defendants Harvey and D'Aniello were members of both the executive and
compensation committees ; McGill, Pogue , Gibson, Pugliese were members of the audit committee ;
Dolan and Watson both were members of the compensation committee . The audit committee relates
directly to the alleged wrongdoing, because the IT Group misstated its receivables . The executive
committee , which presumably is empowered to act for the full board between meetings, is likewise
implicated in the Company 's management decisions .
The second factor ---- the outside directors' duties as committee members - is suppo rted by In
re Reliance Sec. Liti .,135 F.Supp.2d 480, 518 (D .Del. 2001) which held that outside directors who
were members of the audit committee were potentially liable under Section 20(a) because "the
outside directors . . .served on subcommittees related to the oversight of CTFG's accounting and
reporting practices . These duties are sufficient to raise genuine issues of material fact regarding the
control status of these defendants ." Id. The case also upheld claims against two directors who were
members of the executive committee. In re Reliance Sec . Litig . , 91 F .Supp. 2d 706,720-721 (D.Del .
2000) . The Reliance holdings squarely support the conclusion that IT Group's audit committee
members Pogue, Gibson and Pugliese, as well as Harvey and D'Aniello, are liable under section
20(a). See also In re JWP Inc. Sec. Liti ., 928 F.Supp . 1239, 1260 (S .D.N.Y. 1996)(denying
defendants' motion for summary judgment on the Section 20(a) claim against audit committee
members) . "
to allege more than control status in their complaint would erroneously import into the pleading stagethe Second Circuit's standard of proof at trial ." 841 F .Supp.1386 at 1390. The case held thatdefendants were control persons because of their status as directors and vice presidents of sales,operations and finance .
13"A reasonable jury could find that the audit committee's recommendations would carrysufficient weight with the full Board, JWP's officers and E & Y that the audit committee had thepractical ability to direct JWP's accounting policies . The audit committee defendants need not, ofcourse, have actually exercised that authority to be held liable as control persons . Given thecompeting inferences that could be drawn from the evidence on this issue, we find that a questio n
9
The third and indisputably decisive factor establishing the Directors' status as control persons
is that they signed IT Group's Form 10-Ks for 1998, 1999 and 2000, all of which contained false and
misleading statements . SAC ¶58. Thus, the SAC sufficiently alleges control person liability because
"[w]here it is alleged that a defendant signed an SEC filing that contained the misrepresentations that
are the subject of the Section 10(b) claim, this is sufficient to allege control of the authors of the
filing, and the management and policies of the corporation behind the misrepresentations ." In re
WorldCom, Inc . Sec. Liter, 2003 WL 21219049, at *24 (S.D.N.Y. May 19, 2003). Similarly,
Sheehan v . Little Switzerland, Inc., 136 F.Supp .2d 301, 315 (D.Del. 2001), although cited by
Defendants at Moving Brief at 8, actually supports Plaintiffs by holding that former officers and
directors of the issuer, who would not otherwise be liable, could be held accountable under Section
20(a) because they signed the misleading SEC filings .1 4
There is substantial additional authority that signing a false and misleading SEC filing is
sufficient for Section 20(a) control person liability . See Tracinda Co . v. Daimlerc sler AG, 197
F.Supp.2d 42, 71(D .Del . 2002) ;' 5 In re Tel -Save Sec . Lid .,1999 WL 999427 at *6 (E.D.Pa. Oct.19 ,
of fact exists concerning whether the audit committee defendants possessed the actual authority tocontrol the actions ofJWP and those persons involved in its financial reporting ." In re JWP Inc. Sec .
Litig . , 928 F .Supp . 1239, 1260 (S .D.N.Y. 1996) .
""Toler, Liston, and Carey, as former officers and directors of LSI, had the power and controlto influence the publicity surrounding the merger . Although the court is mindful that the status orposition of an alleged controlling person, by itself, is insufficient to presume or warrant a finding ofpower to control or influence, the other allegations are sufficient for such a finding . The plaintiffsallege that Toler, Liston, and Carey each signed an SEC filing knowing that the filing contained anomission that would likely mislead the market . Such an allegation demonstrates culpable conduct
on the part of each of the defendants ." Sheehan v. Litt le Switzerland, Inc., 136 F.Supp.2d 301, 315
(D.Del . 2001) .
""Defendant Gentz was culpably involved in the alleged fraud by participating in thepreparation and dissemination ofthe Proxy/Prospectus and by signing the registration statement filedin connection with the Proxy/Prospectus . Accordingly, the Court concludes that Plaintiffs' havesufficiently pled the elements of their controlling persons claims to withstand dismissal . . . ." Tracinda
Co 1p . v. Daimlerch slerAG,197 F.Supp.2d 42,71 (D .Del . 2002) [references to complaint omitted] .
10
1999) ( "Allegations that a director signed a fraudulent SEC filing and was in a position to exercise
control over the primary violator are sufficient to withstand a motion to dismiss" a Section 20(a)
claim); In re Rent-Way Sec. Litig., 209 F.Supp.2d 493, 524 (W .D.Pa. 2002) ("Each of these
defendants is also alleged to have signed one or more statements filed with the SEC that were
eventually restated , and to have had the ability to control the contents of these va rious statements .") ;
Sheehan v. Little Switzerland, Inc. , 136 F . Supp .2d 301, 315 (D.Del .2001) ("The plaintiffs allege that
[defendants] each signed an SEC fling . . . .") .
The WorldCom court explained the logic of holding signers liable as control persons :
"[A]s a practical matter, just what is a signature on an SEC filed document meant torepresent if it does not represent a degree of responsibility for the material containedin that document? The ve fact that a director is required to sign these cri ticaldocuments char es the director with power over the documents and represents to thecorporation, its shareholders, and the public that the corporation's director hasperformed her role with sufficient diligence that she is willing and able to standbehind the information contained in those documents . "
WorldCom, 2003 WL 21219049, at *24 (emphasis added) .
Defendants' reliance on In re Digital Island (see Moving Brief at 5) is unavailing because
Digital Island does not refute the Sheehan holding that signing shows control . Instead, Digital Island
carefully distinguished Sheehan on its facts, noting that "the plaintiffs here do not allege facts even
arguably similar to those in Sheehan." Id. at 562 . Significantly, the Digital Island defendants,
unlike the Sheehan defendants, were not alleged to be signers .1 6
B. The Directors Are Control Persons Because They Are Members of AnIdentifiable Group, i .e., Carlyle's Control Group
To determine a defendants' control, "the question is `whether the defendant, acting alone or
as a member of an identifiable group, had the power or influence to direct significant aspects of th e
management of the corporation ."' Hayley v. Parker 2002 WL 925322, at *8 (C .D.Cal . March 15,
2002)(quoting Splash Tech. Holdings, Inc . , 2000 WL 1727405, at * 16 (N .D. Cal . Sept. 29, 2000)) .
16Defendants' Moving Brief at 6, also cites the principle in In re Cendant Sec . Litig . that
signing a document does not give rise to scienter under Section 10(b), a principle which isinapplicable to the existence of control under Section 20(a) .
11
Here, the Directors are members of an identifiable group - the Carlyle appointees to the
board. SAC ¶¶36, 39-43, 78 . "Through its control of [IT Group], [Carlyle] was able to elect . . .its
directors . . .to [IT Group]'s board. Presumably, [Carlyle] intended that [the Outside Directors] would
give it a means for exercising control over [IT Group] ." In re Imperial Credit Industries, Inc . , 2000
WL 1049320, at *6 (C .D.Cal. Feb. 22, 2000) . Since Carlyle had control, and exercised its control
through the Carlyle Directors (as discussed at Section IV .B), the Carlyle Directors, like Carlyle, are
control persons liable under Section 20(a) .
C. Defendant Harvey Replaced DeLuca as CEO, and the Control Liability Appliesto His Period as CEO
Defendant Harvey replaced defendant DeLuca as CEO on November 13, 2001 . SAC 1466 .
Therefore, the standards for allegation of control by the CEO (as explained in the main opposition
brief) apply to Mr. Harvey. Mr. Harvey admits to controlling the subject matter of the case when
he testified that he put a stop to the pay-when-paid violations . SAC 1227. Unfortunately, he at the
same time admitted scienter for a Section 10(b) violation, since neither he nor any of the other
Defendants advised the public at any time of the pay-when-paid issues - either that the regulation
had been violated, or that the regulation, if not violated, substantially impaired IT Group's ability
to collect receivables from its biggest customer, the U .S. Government .
VI. PLAINTIFFS DO NOT HAVE TO PLEAD CULPABLE PARTICIPATIO N
A. The Prevailing Case Law, Including Virtually All Cases Which Have Analyzedthe Issue , Conclude that Culpable Participation is not a Pleading Element
Numerous cases hold that the defendants' culpable participation need not be pleaded in orde r
to state a Section 20(a) claim in this Circuit . In re NUI Sec . Litia . , 314 F.Supp .2d 388, 400 n. 3
(D.N.J.2004) ." Even before the more recent, virtually unanimous precedent on this issue as cite d
"See also Jones v. Intelli-Check, Inc . , 274 F.Supp.2d 615, 645 (D .N.J. 2003), In re Rent-WaySec. Litig., 209 F.Supp.2d 493, 524 (W .D .Pa. 2002), In re U.S . Interactive, Inc . , 2002 WL 1971252at *20 (E .D .Pa. Aug.23, 2002), In re Mobilemedia Sec. Litig . , 28 F .Supp .2d 901, 941 (D .N.J. 1998),In re Tel-Save Sec . Liti ., 1999 WL 999427 at *6 (E .D.Pa. October 19, 1999) . and In re CampbellSoup Co . Sec. Litig . , 145 F.Supp.2d 574, 600 (D .N.J. 2001) .
12
herein, there was "an overwhelming trend in this circuit" not to require culpable participation .
Derensis v . Coopers & Lybrand Chartered Accountants, 930 F .Supp. 1003, 1013 (D.N.J. 1996) .
In contrast, Defendants' brief can cite only two cases referencing "culpable participation" a s
an element of pleading a Section 20(a) claim . Both cases merely offered a rote recital regarding
Section 20(a), and neither applied the culpable participation concept .' 8
The cases rejecting "culpable participation" as a Section 20(a) pleading element specificall y
held that Rochez Bros., Inc . v. Rhoades , 527 F . 2d 880 (3d Cir. 1975), the main case Defendants rely
upon , does not require "culpable pa rticipation" as a Section 20(a) pleading element . Rochez is not
a pleading case but a post-trial appeal . Thus Rochez is read to hold that "[w]hile plaintiffs will have
to prove culpable participation at trial , Rochez Brothers , Inc . v . Rhoades, 527 F .2d 880, 889 -90, the
`overwhelming trend in this circuit ' is that culpable participation does not have to be plead in order
to survive a motion to dismiss ." Jones v . Intelli-Check, Inc . , 274 F.Supp .2d 615, 645 (D .N.J.2003),
In re Campbell Soup Co . Sec. Litig . , 145 F .Supp .2d 574, 600 (D .N.J.,2001) .
Culpable participation is not an explicit element of Section 20(a), but merely related to th e
statute's affirmative good faith defense, i .e ., once "culpable participation" is shown in the plaintiff's
prima facie case, the good faith defense consists of the defendant demonstrating the absence of
culpable participation . In re Campbell Soup Company Sec. Liti&,145 F.Supp.2d 574, 600 (D.N.J .
2001).19 Thus, the rule that the plaintiff need not plead culpable participation is merely an
application of the general rule that "[i]t is the defendants' burden to plead and prove an affirmativ e
"In re Nice Systems, Ltd . Sec. Litig. , 135 F .Supp.2d 551, 588 (D .N.J. 2001) and In re CDNow Inc. Sec . Litig., 138 F.Supp .2d 624, 644, cited at Moving Brief at 3, both mentioned "culpableparticipation" in a rote recital of Section 20(a) elements . Neither of these rulings analyzed or appliedthe "culpable participation" concept, since failure to establish a Section 10(b) claim disposed of theSection 20(a) claims in both cases .
""In MobileMedia, Judge Lechner recognized that "culpable participation must be provedbefore control person liability. . . attaches . . .but held that once a plaintiff establishes a prima facie case,it is the defendants' burden to prove the absence of culpable participation ." In re Campbell SoupCompany Sec . Litig . , 145 F .Supp .2d 574, 600 (D .N.J. 2001), citing In re Mobilemedia Sec. Litig . ,28 F.Supp .2d 901, 940 (D .N.J. 1998) .
13
defense." Shadie v. Aventis Pasteur, Inc .. , 254 F .Supp.2d 509, 518 n. 6 (M.D . Pa. 2003) . See also
Fed.R.Civ. P. 8(c) .2 °
B. A "Culpable Participation" Pleading Requirement Would Violate Congress'sStatutory Scheme, by Making Sections 10(b) and 20(a) Redundant
Having absence of culpable participation as an affirmative defense at trial is quite differen t
from requiring aplaintiff to affirmatively plead culpable participation. Casting a burden on a control
person to prove innocence would give control persons an additional incentive to behave responsibly,
i .e . to actively ensure that those under control are not securities law violators . If a Section 20(a)
control person only had to avoid Section 10(b) liability to likewise avoid Section 20(a) liability, the
latter provision would be surplusage . "[I]f Section 20(a) contained the requirement that scienter be
pleaded and proved, there would be little purpose served by Section 20(a) since a defendant who acts
with scienter is liable under Section 10(b) ." WorldCom, 2003 WL 21219049, at *24 n .18 .
In re MicroStrateay, Inc . Sec. Litig . , 115 F.Supp.2d 620, 659 (E.D .Va. 2000) similarly
reasons that superimposing a "culpable participation" pleading requirement on a Section 20(a) claim
"would effectively conflate the requirements for secondary liability under Section 20(a) and those
for primary liability under Section 10(b) and Rule 10b-5, thereby reducing Section 20(a) to
surplusage . . . . Yet, courts should be loathe to interpret Congress's pronouncements to be
redundant . . . therefore, Section 20(a) must be read not to require Plaintiffs to show the culpable
participation of the controlling person." Id .
20The same reasoning is applied in Second Circuit case law which does not require a plaintiffto plead culpable participation . As stated in Food and Allied Service Trades Dept ., AFL-CIO v .Millfeld Trading Co ., Inc . , 841 F.Supp. 1386, 1390 (S .D.N.Y. 1994), "While Lanza [v . Drexel &Co., 479 F .2d 1277, 1299 (2d Cir.1973)] requires proof of culpable participation at the trial andsummary judgment stage, Marbur_y Management Inc . v. Kohn, 629 F.2d 705, 716 (2d Cir . 1980)establishes that once plaintiffs have pleaded control status, the burden shifts to defendants to provethat they acted in good faith . Thus, knowledge and culpability are not elements of a prima facie case ;instead, their absence constitutes an affirmative defense. (internal citations omitted) . This being thecase, it would seem imprudent to construct a pleading requirement that demands that plaintiffsanticipate and negate an alleged controlling person's good faith defense by pleading detailed factsto show the controller's culpability ." (citation omitted.)
14
This reasoning is sound. Defendants' reading of the Exchange Act fails to make any
distinction between the requirements for pleading the Section 20(a) claim and the requirements for
pleading the Section 10(b) claim. In fact, under Defendants' reading, the Section 20(a) claim is even
more onerous by including all the Section 10(b) requirements, plus the additional element of control .
The Defendants' argument would render Section 20(a) as mere surplusage, which is an
impermissible result under elementary principles of statutory interpretation .
VII. CARLYLE AND THE OUTSIDE DIRECTORS ARE ALLEGED TO HAVECULPABLY PARTICIPATED IN THE FRAUD
Culpable participation is a less stringent standard than required for a Section 10(b )
wrongdoer , as it must logically be or Section 20(a) would be extraneous . "Liability may be
established whether the secondary defendant was directly or indirectly involved in the fraud . . ."
Rochez Bros ., Inc . v. Rhoades, 527 F.2d 880, 890 (3d Cir . 1975). Also, culpable part icipation "may
be premised on inaction , but only if it is apparent that the inaction intentionally furthered the fraud
or prevented its discovery ." Id. Defendants take the second part of the definition , which applies only
to "deliberate inaction," and incorrectly expand it to apply to all culpable pa rt icipation . While
inaction must deliberately further the fraud because otherwise it would not be culpable , indirect
participation constitutes culpable participation without showing intent , because the participation
itself is culpable. VT Investors v . R & D Funding Corp. , 733 F .Supp . 823, 841 (D.N.J. 1990 ), cited
at Moving Brief at 4, is an example where the plaintiffs did not allege any pa rticipation whatsoever
by the control person and also failed to allege "deliberate inaction ." The two are distinct , alternative
ways of establishing culpable participation ."
In this case, the Board was clearly informed of va rious aspects of the scheme . See, , SAC
¶ 148 (Board informed of payables manipulation); SAC ¶ 259 (CW 3 informs board of the bad
receivables ) ; SAC ¶ 265 (CW 3 advises board of need for substantial write-offs ) ; SAC ¶ 264 (CW
2'Note that this case dates from 1990, much before the recent slew of cases holding thatculpable participation need not be alleged .
15
3 informs board of liquidity issues, including vendors walking off job due to non-payment) ; SAC
¶ 266 (CW 3, in private 2 .5 hour meeting with defendant D'Aniello, informs him of the need for
write-offs and liquidity and other company problems) ; and SAC ¶ 267 (CW 3 tours project sites with
Fran Harvey to show him the devastating effect of non-payment of vendors) .
Nevertheless, the Board, including Carlyle's representatives thereon, participated in issuance
of the misleading SEC filings and press releases . This constitutes culpable participation. See
Tracinda Corp . v. DaimlerChrysler AG, 197 F . Supp . 2d 42, 72 (D.Del . 2002), holding that "Plaintiffs
have also alleged that Defendant Gentz was culpably involved in the alleged fraud by part icipating
in the preparation and dissemination of the Proxy/Prospectus and by signing the registration
statement filed in connection with the Proxy/Prospectus ." See also In re Tyson Foods, Inc . , 2004
WL 1396269 at *13 (D.Del. Jun 17 , 2004) holding that there was no culpable pa rticipation where
the "undisputed facts" were that the defendants "did not participate in the drafting and release of the
issued statements . "
VIII. CONCLUSION
For the foregoing reasons, the motion by the Carlyle Group and the outside directors of I T
Group to dismiss the Section 20(a) claims should be denied in full .
Dated : July 27, 2005 Respectfully submitted ,
GLANCY BINKOW & GOLDBERG LLP
S/Robert M. Zabb
Lionel Z. GlancyRobert M. ZabbDale MacDiarmidDaniel Hargis
1801 Avenue of the Stars, Suite 311Los Angeles, California 90067Telephone : (310) 201-9150Facsimile: (310) 201-916 0
Lead Counsel For Class Plaintiffs
16
CHIMICLES & TIKELLIS LLPBrian LongPa. I .D. No. 82370One Haverford Centre361 West Lancaster AvenueHaverford, PA 19041Telephone: (610) 642-8500Facsimile : (610) 649-3633
CHIMICLES & TIKELLIS LLPNicholas E. ChimiclesPa. I .D. No. 17928Steven A. SchwartzPa. I .D. No. 50579One Rodney SquareP.O. Box 1035Wilmington, DE 19899Telephone : (302) 656-2500Facsimile: (302) 656-9053
MILLER SHEA PCE. Powell Miller1301 West Long Lake Road Suite 135Troy, Michigan 4809 8Telephone: (248) 267-8200Facsimile : (248) 267-821 1
LAW OFFICES OF KWASI ASIEDUKwasi Asiedu3858 Carson Street #204Torrance, CA 90503Telephone: (310) 792-3948
Counsel for Plaintiffs
17