U.S. District Court makes summary judgment ruling.

The U.S. District Court, Central District of California, granted Ernst & Young's summary judgment motion based on aider and abettor liability but the court denied the firm's summary judgment motion as a primary violator under section 10b of the Securities Exchange Act of 1934.

This much-publicized case began when ZZZZ Best Co., Inc., at one time thought to be the nation's largest carpet cleaning company, collapsed into bankruptcy in 1987. The plaintiffs, investors in ZZZZ Best, alleged the company was a sham and that ZZZZ Best engaged in a massive securities fraud by the sale and trading of shares in a public stock offering commencing on December 9, 1986. After the company failed, the plaintiffs pursued this class action, which alleged numerous securities law violations against various defendants, including Ernst.

Ernst's role in this matter stems from its release of a review report on ZZZZ Best's first-quarter financial statements for the period ending July 31, 1986. The report, which was included in the December 1986 public offering prospectus, indicated the accounting firm was not aware of any material modifications that should be made to the consolidated interim financial statements.

The plaintiffs alleged that Ernst knew of major discrepancies in ZZZZ Best's internal accounting and that the figures released by the company were inaccurate. Consequently, they argued that Ernst knowingly engaged in a fraudulent scheme resulting in the issuance of the review report, which contained misrepresentations and/or omissions that directly affected the purchase or sale of securities. Additionally, the plaintiffs argued that Ernst was liable because it created, reviewed or issued approximately 13 other publicly-released statements related to the ZZZZ Best scheme.

In ruling on Ernst's motion, the court noted that pursuant to the U.S. Supreme Court's ruling in Central Bank of Denver v. First Interstate Bank of Denver, Ernst cannot be held liable under section 10b for simply aiding and abetting the alleged scheme. The court, however, was less benevolent to Ernst regarding its primary duties to investors. The court ruled the plaintiff could proceed with its action against Ernst for a primary violation of section 10b, despite the fact that public statements to investors were not attributed to Ernst. The court went on to recognize Ernst's "whistle-blower obligations," stating:

"If Ernst is found in trial to have sufficiently participated in the preparation of the additional misstatements or omissions such that they are attributed to Ernst, then Ernst will likewise be found to have a duty to disclose or correct these previously released misrepresentations. Moreover, if any of the additional statements incorporated data prepared by Ernst in its review report, and the review report is found to have violated rule 10b-5 [under section 10b], then Ernst will also be found to have a duty to correct any subsequent use of that information or inform parties that might potentially rely on it." (ZZZZ Best Securities Litigation, Federal Securities Law Reporter, 98,394)