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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF DELAWARE COLLINS & AIKMAN CORPORATION, et al., Plaintiffs, v. DAVID A. STOCKMAN, et al., Defendants. ) ) ) ) ) ) ) ) )

C.A. No. 07-265-SLR-LPS

OPENING BRIEF IN SUPPORT OF DEFENDANT KPMG LLP'S MOTION TO DISMISS THE FIRST AMENDED COMPLAINT

EDWARDS ANGELL PALMER & DODGE LLP Michael J. Maimone (#3592) Paul D. Brown (#3903) Joseph B. Cicero (#4388) 919 North Market Street, 15th Floor Wilmington, DE 19801 (302) 777-7770 [email protected] OF COUNSEL: Peter W. Devereaux Christopher Harris Latham & Watkins LLP 885 Third Avenue New York, NY 10022 (212) 906-1200 April 28, 2008

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TABLE OF CONTENTS PAGE TABLE OF AUTHORITIES ..................................................................................................... iv I. II. III. IV. INTRODUCTION .......................................................................................................... 1 NATURE AND STAGE OF PROCEEDINGS................................................................ 2 SUMMARY OF ARGUMENT....................................................................................... 3 BACKGROUND ............................................................................................................ 4 A. B. Factual Allegations.............................................................................................. 4 The Roles Of Plaintiff And KPMG In Financial Reporting .................................. 6 1. 2. Management Prepares Financial Statements And Auditors Audit Them ....................................................................................................... 6 GAAS Establishes That Auditors Are Not Expected To Uncover Collusive Fraud Being Committed And Concealed By Management ............................................................................................ 7

V.

ARGUMENT.................................................................................................................. 8 A. B. C. Motion To Dismiss Standard ............................................................................... 8 Michigan Law Governs The Claims Against KPMG ........................................... 9 Michigan's Wrongful Conduct Rule Bars All Of Plaintiff's Claims ................... 10 1. 2. 3. Management's Allegedly Fraudulent Conduct Is Imputed To C&A........ 10 Plaintiff's Allegations Satisfy All Of The Elements Of Michigan's Wrongful Conduct Rule ......................................................................... 12 Recent Michigan And Other Precedent Holds That The Wrongful Conduct Rule Bars A Bankrupt Company's Claims For Alleged Negligence/Malpractice Against Its Former Auditors............................. 14 Plaintiff Does Not Allege How KPMG's Audit Or Review Of The Company's Statements Proximately Caused C&A Harm........................ 16 Plaintiff's Damages Theory Fails As A Matter Of Law .......................... 21 a. b. Plaintiff Relies On A "Deepening Insolvency" Theory Of Damages .................................................................................... 21 Michigan Has Adopted And Would Likely Reject The Theory Of Deepening Insolvency ............................................... 22

D.

Plaintiff Fails To Allege Causation Or Cognizable Damages ............................. 16 1. 2.

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c. E.

Even If Michigan Accepted The Doctrine Of Deepening Insolvency, It Would Not Apply Here ........................................ 23

Plaintiff's Negligence Claim Fails As A Matter Of Law .................................... 24 1. 2. 3. 4. 5. Alleged Failure To Consider Red Flags.................................................. 26 Alleged Failure To Examine Related Party Transactions ........................ 26 Alleged Failure To Identify Internal Control Problems........................... 27 Alleged Failure To Assess C&A's Ability To Continue As A Going Concern....................................................................................... 27 Alleged Failure To Uncover "False Side Letters"................................... 27

F.

Plaintiff's Fraud Claim Must Be Dismissed For Failure To Comply With Rule 9(b)'s Heightened Pleading Requirements ................................................. 28 1. 2. Plaintiff Has Failed To Plead That KPMG'S 2003 Audit Opinion Was A Material False Statement ............................................................ 29 The Complaint Fails To Allege With Particularity That KPMG Acted With Scienter............................................................................... 30 a. b. c. d. e. The Standard For Pleading Auditor Scienter Is Unusually Demanding................................................................................. 30 Plaintiff's Sole Motive Allegation, About Fees, Cannot Raise An Inference Of Scienter .................................................. 31 Boilerplate Allegations Of GAAS Violations Do Not Establish A Showing Of Knowledge Or Recklessnes.................. 31 Plaintiff's Generalized Allegations That KPMG Had Access To C&A Are Insufficient To Plead Scienter.................... 32 Plaintiff's Allegations Of Red Flags Are Insufficient To Raise An Inference Of Scienter .................................................. 32 (1) (2) (3) Plaintiffs' "Red Flags" Are Not Pled With Specificity, And Lack Factual Support............................ 32 KPMG Had No Actual Knowledge Of These SoCalled Red Flags............................................................. 33 Plaintiff Does Not Allege GAAS Failures, i.e., That The Red Flags Required Audit Procedures KPMG Did Not Perform ............................................................. 34

f.

Plaintiff's Allegations That KPMG Did Not Uncover Plaintiff's Fraud Does Not Mean That KPMG Acted Recklessly .................................................................................. 34 Plaintiff Cannot Establish That KPMG's Audit Amounted To "No Audit At All" Or That "No Reasonable Accountant" Would Have Reached The Same Result ................. 35 ii

g.

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3. G. H. VI.

Plaintiff Has Failed To Plead Reliance ................................................... 36

Plaintiff Has Failed Adequately To Plead An Aiding And Abetting Claim Against KPMG.................................................................................................. 37 Plaintiff Has Failed To Plead A Breach Of Contract Claim Against KPMG....... 39

CONCLUSION............................................................................................................. 40

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TABLE OF AUTHORITIES CASES PAGE(S)

AUSA Life Insurance Co. v. Ernst & Young, 119 F. Supp. 2d 394 (S.D.N.Y. 2000) ........................................................................... 20 Askanase v. Fatjo, 828 F. Supp. 465 (S.D. Tex. 1993) ................................................................................ 39 Baena v. KPMG LLP, 389 F. Supp. 2d 112 (D. Mass. 2005). ................................................................15, 16, 26 Baena v. KPMG LLP, 453 F.3d 1 (1st Cir. 2006). ........................................................................... 12, 13, 15, 16 Battenfeld of America Holding Co., Inc. v. Baird, Kurtz & Dobson, 60 F. Supp. 2d 1189 (D. Kan. 1999).............................................................................. 39 Begier v. Price Waterhouse, No. 87-6096, 1992 WL 236175 (E.D. Pa. Sept. 14, 1992) ............................................. 40 Bell Atlantic Corp. v. Twombly, 127 S. Ct. 1955 (2007) .............................................................................................. 8, 36 Broderick v. PricewaterhouseCoopers LLP, 169 Fed. Appx. 496 (9th Cir. 2004).......................................................................... 31-32 Brownell v. Garber, 503 N.W.2d 81 (Mich. Ct. App. 1993) .......................................................................... 39 Cambridge Biotech Corp. v. Deloitte & Touche, No. 96-1480-A, 1997 WL 42516 (Mass. Super Ct. Jan. 28, 1997) ............................25, 26 Cenco Inc. v. Seidman & Seidman, 686 F.2d 449 (7th Cir. 1982) ...................................................................................12, 37 Chase Bank of Texas v. Grant Thornton L.L.P., No. 236237, 2003 WL 21350362 (Mich. Ct. App. June 10, 2003) ...................... 29, 37-39 Christians v. Grant Thornton L.L.P., 733 N.W.2d 803 (Minn. Ct. App. 2007) ..............................................................16,17, 22 Churella v. Pioneer St. Mutual. Insurance Co., 671 N.W.2d 125 (Mich. Ct. App. 2003) ........................................................................ 36

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City of Novi v. Robert Adell Children's Funded Trust, 701 N.W.2d 144 (Mich. 2005) ...................................................................................... 29 City of Pontiac v. Pricewaterhouse Coopers, L.L.P., No. 06-076389-NM, 2008 WL 375992 (Mich Ct. App. Feb. 12, 2008).................7, 17, 23 Conley v. Gibson, 355 U.S. 41 (1957).......................................................................................................... 8 D.D. Hamilton Textiles, Inc. v. Estate of Mate, 269 A.D.2d 214 (N.Y. App. Div. 1st Dep't 2000) ......................................................... 25 D.E. & J. Ltd. Partnership v. Conaway, 284 F. Supp. 2d 719 (E.D. Mich. 2003), aff'd, 133 Fed. Appx. 994 (6th Cir. 2005).................................................................29, 32 Deephaven Private Placement Trading, Ltd. v. Grant Thornton & Co., 454 F.3d 1168 (10th Cir. 2006) ..................................................................................... 29 Dresser v. Cradle of Hope Adoption Ctr., Inc., 358 F. Supp. 2d 620 (E.D. Mich. 2005) ........................................................................ 16 Dunn v. Lederele Laboratories, 328 N.W.2d 576 (Mich. Ct. App. 1982) ........................................................................ 20 Matter of Estate of Butterfield, 341 N.W.2d 453 (Mich. 1983) ..................................................................................... 23 Estate of Goldman v. Nat'l Bank of Detroit, 601 N.W.2d 126 (Mich. Ct. App. 1999) ........................................................................ 37 Evans v. Pearson Enter., Inc., 434 F.3d 839 (6th Cir. 2006) ........................................................................................ 37 Fidel v. Farley, 392 F.3d 220 (6th Cir. 2005) .................................................................................... 33-34 Flamm v. Scherer, 198 N.W.2d 702 (Mich. Ct. App. 1972) ........................................................................ 40 Frye v. City of Detroit, 256 Mich. 466 (1932).................................................................................................... 19 Glazier v. Lee, 429 N.W.2d 857 (Mich. Ct. App. 1998) ........................................................................ 13

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Grassmueck v. American Shorthorn Ass'n, 402 F.3d 833 (8th Cir. 2005) ......................................................................................... 16 Green Tree Fin. Corp.- Ala. v. Randolph, 531 U.S. 79 (2000).......................................................................................................... 4 Haliw v. Sterling Heights, 627 N.W.2d 581 (Mich. 2001) ...................................................................................... 17 In re Amcast Industrial Corp., 365 B.R. 91 (Bankr. S.D. Ohio 2007)............................................................................ 23 In re Burlington Coat Factory Securities Litigation, 114 F.3d 1410 (3d Cir. 1997) .......................................................................................... 8 In re Cardinal Health Inc. Securities Litigation, 426 F. Supp. 2d 688 (S.D. Ohio 2006) .....................................................................30, 34 In re CitX Corp., Inc., 448 F.3d 672 (3d Cir. 2006) .....................................................................................22, 24 In re Dublin Securities, Inc., 133 F.3d 377 (6th Cir. 1997) ......................................................................................... 16 In re Hayes Lemmerz Int'l, Inc. Equity Securities Litigation, 271 F. Supp. 2d 1007, 1019 (E.D. Mich. 2003) ............................................................. 33 In re IKON Office Solutions, Inc. Securities Litigation, 277 F.3d 658 (3d Cir. 2002) .................................................................................7, 31, 36 In re Integrated Resources Real Estate Ltd. Partnerships Securities Litigation, 815 F. Supp. 620 (S.D.N.Y. 1993) ................................................................................ 27 In re Livent Securities Litigation, 78 F. Supp. 2d 194 (S.D.N.Y. 1999)......................................................................... 33-35 In Re Marsh & McLennan Cos. Inc., Securities Litigation, 501 F. Supp 2d 452 (S.D.N.Y. 2006)............................................................................. 30 In re Parmalat Securities Litigation, 501 F. Supp. 2d 560, (S.D.N.Y. 2007)................................................................20, 22, 24 In re Royal Ahold N.V. Securities & ERISA Litigation, 351 F. Supp. 2d 334 (D. Md. 2004)............................................................................... 35

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In re Spear & Jackson Securities Litigation, 399 F. Supp. 2d 1350 (S.D. Fla. 2005) .......................................................................... 32 In re Stone & Webster, Inc. Securities Litigation, 414 F.3d 187 (1st Cir. 2005).......................................................................................... 30 In re Suprema Specialties, Inc. Securities Litigation, 438 F.3d 256 (3d Cir. 2006) .......................................................................................... 31 In re Williams Securities Litigation, 496 F. Supp. 2d 1195 (N.D. Okla. 2007) ....................................................................... 27 In re WorldCom, Inc. Securities Litigation, 352 F. Supp. 2d 472 (S.D.N.Y. 2005)............................................................................ 35 In re Worlds of Wonder Securities Litigation, 35 F.3d 1407 (9th Cir. 1994) ......................................................................................... 31 Jackson Nat. Life Ins. Co. v. Kennedy, 741 A.2d 377 (Del. Ch. Ct. 1999).................................................................................. 38 Johnson v. Metabolife International, Inc., No. Civ.A.3:01-CV-2082-G, 2002 WL 32494514 (N.D. Tex. Oct. 23, 2002) ................ 28 Kalnit v. Eichler,, 264 F.3d 131 (2d Cir. 2001) .......................................................................................... 31 Kennilworth Partners L.P. v. Cendant Corp., 59 F. Supp. 2d 417 (D.N.J. 1999).................................................................................. 32 Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487 (1941)........................................................................................................ 9 Kloian v. Schwartz, 725 N.W.2d 671 (Mich. Ct. App. 2006) ........................................................................ 25 Krieger v. Gast, No. 4:99-CV-86, 2000 WL 288442 (W.D. Mich. Jan. 21, 2000).................................... 38 LaMothe v. Automobile Club Insurance Association, 543 N.W.2d 42 (Mich. Ct. App. 1995) .......................................................................... 32 Malpiede v. Townson, 780 A.2d 1075 (Del. 2001)............................................................................................ 38

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Marksman Partners, L.P. v. Chantal Pharm. Corp., 46 F. Supp. 2d 1042 (C.D. Cal. 1999) ........................................................................... 36 Maxwell v. KPMG, LLP, No. 03 C 3524, 2007 WL 2091184 (N.D. Ill. July 19, 2007) ......................................... 21 Maxwell v. KPMG LLP, --- F.3d ---, 2008 WL 746849 (7th Cir. Mar. 21, 2008) ......................................18, 19, 21 MCA Financial Corp. v. Grant Thornton, L.L.P., 687 N.W.2d 850 (Mich. Ct. App. 2004) ..................................................................passim McIntyre v. Lyon, 37 N.W.2d 903 (Mich. 1949) ........................................................................................ 37 Miller v. N.Y. Produce Exch., 550 F.2d 762 (2d Cir. 1977) .......................................................................................... 16 Monroe v. Hughes, 31 F.3d 772 (9th Cir. 1994)........................................................................................... 25 Montcalm Fibre Co. v. Advanced Organics, No. 249642, 2005 WL 957425 (Mich. Ct. App. Apr. 26, 2005) aff'd, 474 Mich. 857 (2005) ..............................................................................16,18, 20 Munroe v. Harriman, 85 F.2d 493 (2d Cir. 1936) ......................................................................................11, 12 Naghiu v. Inter-Continental Hotels Group Inc., 165 F.R.D. 413 (D. Del. 1996) ..................................................................................... 10 Nat'l Turners Bldg. & Loan Ass'n v. Schreitmueller, 288 Mich. 580 (Mich. 1939) ......................................................................................... 11 Nisselson v. Lernout, 469 F.3d 143 (1st Cir. 2006) ........................................................................................ 13 Official Comm. of Unsecured Creditors of Color Tile v. Coopers & Lybrand LLP 322 F.3d 147 (2d Cir. 2003) .......................................................................................... 16 Official Comm. of Unsecured Creditors of Corell Steel v. Fishbein & Co., P.C., No. 91 Civ. 4919, 1992 WL 196768 (E.D. Pa. Aug. 10, 1992) ...................................... 39 Official Comm. of Unsecured Creditors of PSA. Inc. v. Edwards, 347 F.3d 1145 (11th Cir. 2006) ..................................................................................... 16

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Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) ...............................................................................13, 22, 24 Orzel v Scott Drug Co., 537 N.W.2d 208 (Mich. 1995) .................................................................................. 1, 12 Pension Benefit Guaranty Corp. v. White Consolidated Industries, Inc., 998 F.2d 1192 (3d Cir. 1993) .......................................................................................... 6 Pew v. Cardarelli, No. 03-742, 2005 U.S. Dist. LEXIS 40018 (N.D.N.Y. Mar. 17, 2005), aff'd, 164 Fed. Appx. 31 (2d Cir. N.Y. 2006) ................................................................ 27 Pilot Industrial, Inc. v. Grant Thornton, LLP, No. 258689, 2006 WL 2033996 (Mich. Ct. App. July 20, 2006)............................... 24-25 PR Diamonds, Inc. v. Chandler, 364 F.3d 671 (6th Cir. 2004) .................................................................................... 30-33 Prentis Family Foundation, Inc. v. Barbara Ann Karmanos Cancer Institute, 698 N.W.2d 900 (Mich. Ct. App. 2005) ........................................................................ 23 Raritan River Steel Co. v. Cherry, Bekaert & Holland, 322 N.C. 200 (1988) ....................................................................................................... 7 Rose v. National Auction Group, 646 N.W.2d 455 (Mich. 2002) ...................................................................................... 23 Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000) ............................................................................................ 30 Scalici v. Bank One, NA, No. 254632, 2005 WL 2291732 (Mich. Ct. App. Sept. 20, 2005) .................................. 13 Sender v. Buchanan (In re Hedged-Investment Associates), 84 F.3d 1281 (10th Cir. 1996) ....................................................................................... 16 Seus v. John Nuveen & Co., Inc., 146 F.3d 175 (3d Cir. 1998) ............................................................................................ 4 Shivers v. McMartin, Wasek & Assoc., Inc., No. 251569, 2005 WL 1959480 (Mich. Ct. App. Aug. 16, 2005) .................................. 36 Skinner v. Square D Co., 516 N.W.2d 475 (Mich. 1994) ...........................................................................17, 18, 20

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Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007) .............................................................................................. 6, 30 Transnation Title Ins. Co. v. Livingston, No. 243509, 2004 WL 203075 (Mich. Ct. App. Feb. 3, 2004) ...................................... 11 Travelers Indemnity Co. v. Lake, 594 A.2d 38 (Del. 1991) ................................................................................................. 9 Trenwick America Litigation Trust v. Ernst & Young, L.L.P., 906 A.2d 168 (Del. Ch. 2006), aff'd, 2007 Del. LEXIS 357 (Del. Aug. 14, 2007) ..............................................22, 23, 38 United States v. Arthur Young & Co., 465 U.S. 805 (1984)...................................................................................................... 25 Whitwell v. Archemere Acad. Inc., 463 F. Supp. 2d 482 (D. Del. 2006)............................................................................... 10 Yadlosky v. Grant Thornton L.L.P., 120 F. Supp. 2d 622 (E.D. Mich. 2000)................................................................... 29-31 Zucker v. Sasaki, 963 F. Supp. 301 (S.D.N.Y. 1997) ................................................................................ 31 STATUTES 15 U.S.C. § 78ff (2006)................................................................................................. 14 15 U.S.C. § 78j-1 .......................................................................................................... 26 RULES Fed. R. Civ. P. 8(a) ....................................................................................................... 28 Fed. R. Civ. P. 9(b) .................................................................................................passim Fed. R. Civ. P. 12(b)(6)............................................................................................. 3, 11

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MISCELLANEOUS Codification of Statements on Auditing Standards ("AU") §§ 110.01-110.03.............. 7, 8 Codification of Statements on Auditing Standards ("AU") § 230.12................................ 8 Codification of Statements on Auditing Standards ("AU") § 315 .................................. 27 Codification of Statements on Auditing Standards ("AU") § 316 .............................26, 32 Codification of Statements on Auditing Standards ("AU") §§ 316.09-316.12........7, 8, 26 Codification of Statements on Auditing Standards ("AU") §§ 316.85........................... 32 Codification of Statements on Auditing Standards ("AU") § 326 .................................. 28 Restatement of Conflicts (Second) § 11 (1971) ............................................................... 9 Restatement of Conflicts (Second) §§ 145, 148, 188 (1971) ...................................... 9, 10 OTHER MATERIALS S.E.C. v. Collins & Aikman Corp., No. 07 Civ. 2419 (March 26, 2007)................................................................ 6, 34, 35, 39 United States v. Stockman, No. 07 Civ. 0220 (March 21, 2007).......................................................... 6, 14, 34, 35, 39

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I.

INTRODUCTION "When a plaintiff's action is based, in whole or in part, on his own illegal conduct, a

fundamental common-law maxim [known as the wrongful conduct rule] generally applies to bar the plaintiff's claim." MCA Fin. Corp. v. Grant Thornton, L.L.P., 687 N.W.2d 850, 853 (Mich. Ct. App. 2004) (quoting Orzel v. Scott Drug Co., 537 N.W.2d 208, 212 (Mich. 1995)). This case is simply a transparent effort by Plaintiff Collins & Aikman Litigation Trust (the "Litigation Trust"),1 successor to the debtors, Collins & Aikman Corporation and Collins & Aikman Products Company (collectively, "C&A" or the "Company"), to profit from Plaintiff's own accounting fraud ­ a fraud that was designed to deceive, among others, C&A's independent auditor, KPMG LLP ("KPMG"). In the binding case of MCA Financial Corp., the Michigan Court of Appeals held that the wrongful conduct rule of Michigan (the governing law for the claims against KPMG) bars a debtor or its trustee from bringing any claims against its auditor relating to the debtor's fraud. See 687 N.W.2d at 853. The same result is mandated here. Plaintiff's claims also fail because Plaintiff fails to plead how KPMG's supposed misconduct was the proximate cause of its alleged injury, given that Plaintiff's own actions, before and after KPMG's 2003 audit and its review of the Company's financial statements, admittedly caused the alleged injury. Moreover, Plaintiff's primary damages allegation against KPMG, the theory of "deepening insolvency," has not been adopted by Michigan courts, or by any court in these circumstances, where Plaintiff has failed to allege facts demonstrating that a

1

While the caption and preliminary paragraph of the First Amended Complaint identify C&A as plaintiff, paragraph five identifies the plaintiff as the Litigation Trust. In any event, the Litigation Trust, as successor to C&A and its subsidiaries (Compl. ¶ 5), stands in the shoes of the debtor, C&A, and is subject to all applicable defenses, including that of in pari delicto, that KPMG would have against C&A. See infra Section V.C.1. Consequently, as used hereinafter, "Plaintiff" refers to C&A and its subsidiaries, as well as the Litigation Trust.

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continued existence harmed C&A. Beyond these fatal defects which defeat all of Plaintiff's claims against KPMG, each claim suffers additional shortcomings. The negligence claim fails because Plaintiff's conclusory allegations that KPMG violated Generally Accepted Auditing Standards ("GAAS") do not allege that KPMG failed to perform some action required under GAAS, much less tie any alleged audit failures to material misstatements in the 2003 financial statements. Even more deficient is Plaintiff's attempt to twist this into a fraud claim. Plaintiff cannot establish with empty recitations of supposed GAAP and GAAS violations that KPMG's 2003 audit opinion ­ its only alleged "statement" ­ was false, much less that KPMG acted with scienter. Moreover, Plaintiff argues that KPMG defrauded C&A by recklessly not catching and informing Plaintiff of its own fraud. Plaintiff cannot establish that it reasonably relied on KPMG's audit opinion when Plaintiff knew the truth, and knew that KPMG's opinion was based on incomplete information due to Plaintiff's own active concealment. Plaintiff's theory is particularly ironic given that KPMG uncovered the accounting errors here, required management to explain and investigate, and refused to proceed with the 2004 audit. Plaintiff's claim for aiding and abetting management's breach of fiduciary duty fails because Plaintiff has not (and cannot) allege that KPMG knew of Plaintiff's fraud. Plaintiff's breach of contract claim fails because a claim against an auditor for failing to perform an audit properly sounds in negligence rather than contract, and any contract breach here was caused by Plaintiff's own breach in failing to provide accurate information to KPMG. II. NATURE AND STAGE OF PROCEEDINGS On May 17, 2007, C&A filed this action against former C&A officers, directors, Heartland Industrial Partners, L.P. and related entities, and C&A's outside auditors, PricewaterhouseCoopers ("PWC") and KPMG. Defendants filed motions to dismiss. Rather 2
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than oppose, Plaintiff filed an amended complaint. The First Amended Complaint was filed January 28, 2008. KPMG now moves to dismiss the First Amended Complaint for failure to state a claim pursuant to Fed. R. Civ. P. 12(b)(6). III. SUMMARY OF ARGUMENT 1. 2. Michigan law governs Plaintiff's claims against KPMG. The "wrongful conduct" rule, or "in pari delicto," bars all of Plaintiff's claims

against KPMG because Plaintiff stands at least in equal fault; Plaintiff's wrongful conduct proximately caused the alleged harm; and criminal statutes prohibit Plaintiff's conduct. 3. Plaintiff fails to show how any alleged error by KPMG caused Plaintiff's loss

given that Plaintiff's own management caused the various accounting errors and hid those errors from KPMG. Moreover, Plaintiff's primary damages theory of deepened insolvency has not been recognized by Michigan courts and has been rejected by most recent foreign courts. 4. 5. Plaintiff's negligence/malpractice claim fails to identify any GAAS violation. Plaintiff's fraud claim fails to allege with particularity facts showing that KPMG

made materially false statements, that it did so intentionally or recklessly, or that Plaintiff relied on those statements in any way. 6. Plaintiff's aiding and abetting claim fails to allege with particularity facts

demonstrating that KPMG had knowledge of management's breaches of fiduciary duty. 7. Plaintiff's breach of contract claim is duplicative of its negligence/malpractice

claim and fails because of Plaintiff's own breach.2

2

Further, as set out in KPMG's Motion to Stay (D.I. 56), Plaintiff's claims against KPMG should be dismissed in favor of binding arbitration as agreed to by the parties pursuant to the terms of their contract. While the Federal Arbitration Act provides solely for a stay pending arbitration, the Third Circuit has held that this Court may dismiss an action in its entirety where 3
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IV.

BACKGROUND A. Factual Allegations

Plaintiff represents the estate in bankruptcy of C&A and its subsidiary debtors, a manufacturer and supplier of automobile components. First Amended Complaint, dated January 28, 2008 ("Compl.") ¶¶ 5-6. In early 2001, C&A was acquired by Heartland, which in turn was managed by Defendant David A. Stockman. Id. ¶¶ 27-28, 36. Plaintiff alleges that C&A then went on a takeover spree, acquiring a number of companies in 2001. Id. ¶¶ 47, 51-52. Plaintiff alleges that Stockman, now in control of a highly-leveraged and much-expanded C&A, faced considerable pressure to increase revenues and income. His response was to enter into a series of fraudulent transactions to improve the appearance of C&A's financial statements. Id. ¶ 39. Beginning in 2001 (shortly after the acquisition of Joan Fabrics), Stockman, Michael Stepp (C&A's Chief Financial Officer) and Elkin McCallum (a board member of C&A and principal of Joan Fabrics) allegedly negotiated and entered into several false transactions, in which "round trip" payments were made between Joan Fabrics and C&A and recorded as rebate payments for prior purchases, thus improperly inflating C&A's quarterly income. Id. ¶¶ 54-69. During 2002, C&A purchased at inflated prices certain business lines and other assets from defendant McCallum, who then repaid the overpayments as a series of unearned "supplier rebates" to C&A. Id. ¶¶ 119-121. Plaintiff alleges that, in the second quarter of 2002, Stockman and his associates also began to recognize improperly, or "pull forward," rebates from other suppliers. Id. ¶¶ 61-65. In 2004, Plaintiff expanded its improper rebate recognition practices to certain capital expenditures as well. Id. ¶¶ 66-68. The alleged purpose of these various acts was

all claims are subject to arbitration. Seus v. John Nuveen & Co., Inc., 146 F.3d 175, 179 (3d Cir. 1998), overruled on other grounds, Green Tree Fin. Corp.- Ala. v. Randolph, 531 U.S. 79 (2000). 4
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artificially to improve C&A's financial statements in order to satisfy its debt covenants, and enable it to take on additional debt. Id. ¶ 70-71. Plaintiff alleges that these fraudulent transactions were undertaken by C&A's senior management, including: (1) CEO Stockman; (2) CFO Stepp; (3) Director McCallum; (4) David R. Cosgrove, C&A's Vice President of Finance; (5) Paul C. Barnaba, Director of Financial Analysis for purchasing; (6) Robert A. Krause, Vice President and Treasurer; (7) John A. Galante, Director of Strategic Planning; and at least six other directors and officers ­ all of whom are named defendants, either for allegedly participating in the fraud or knowingly allowing it to continue. Id. ¶¶ 7-20. Plaintiff further alleges that this fraud was approved by Heartland, which allegedly controlled C&A "through its share ownership of the Company and by designating a majority of the members of the Company's Board." Id. ¶ 30. Plaintiff sued the individual defendants and Heartland for violations of federal securities laws, breaches of fiduciary duty, fraud, and unjust enrichment, and Heartland for breach of contract. Id. ¶¶ 181-208. Plaintiff alleges that management misled the auditors by creating false "side letters" with suppliers attributing the rebates to past purchases, and other false and misleading documents. Id. ¶¶ 61-63, 153-54. Management presented these false documents to the auditors "as `proof' that C&A properly recorded the rebates in their accounting record." Id. ¶ 154. PWC was C&A's auditor for fiscal years 2001 and 2002. Id. ¶ 33. KPMG was C&A's auditor for fiscal year 2003 and part of fiscal year 2004. Id. ¶ 34; Affidavit of Paul D. Brown, dated April 28, 2008 ("Brown Aff."), Exs. 1 and 2. Plaintiff's allegations against KPMG and PWC are virtually identical, as are its claims for fraud, negligence/malpractice, breach of contract, and aiding and abetting the officers' breach of their fiduciary duties. Id. ¶¶ 102-108, 209-246. KPMG's only alleged false statement is its 2003 audit opinion, which stated in

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pertinent part: "In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Collins & Aikman Corporation and subsidiaries as of December 31, 2003." Id. ¶ 112. It was KPMG who uncovered the fraud. As noted in the criminal actions against C&A management, KPMG uncovered the rebate errors and brought them to C&A's audit committee. Indictment, United States v. Stockman, No. 07 Cr. 0220, ¶ 62 (Mar. 21, 2007) (the "DOJ Indictment"), Brown Aff. Ex. 3; Complaint, S.E.C. v. Collins & Aikman Corp., No. 07 Civ. 2419, ¶ 54 (Mar. 26, 2007) (the "SEC Compl."), Brown Aff. Ex. 4.3 Soon thereafter, on March 17, 2005, C&A announced it was delaying the issuance of its fiscal 2004 financial results to review its internal rebate policies; it subsequently retained independent counsel to investigate the issue. Compl. ¶¶ 80, 86. Approximately two months later, the Board of Directors removed Stockman and on May 17, 2005, C&A filed for bankruptcy. Id. ¶¶ 90-91. B. The Roles Of Plaintiff And KPMG In Financial Reporting 1. Management Prepares Financial Statements And Auditors Audit Them

A fundamental premise of financial reporting is that the company's management ­ not the auditor ­ is responsible for the company's financial statements: The financial statements are management's responsibility. The auditor's responsibility is to express an opinion on the financial statements. Management is responsible for adopting sound

3

The Court is entitled to consider public documents incorporated into the Complaint (such as the SEC Complaint, DOJ Indictment, and the Company's SEC filings), and public documents not cited by Plaintiff but embraced by its allegations, on a motion to dismiss. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2509 (2007). Additionally, a court "may consider an undisputedly authentic document that a defendant attaches as an exhibit to a motion to dismiss if the plaintiff's claims are based on the document." Pension Benefit Guar. Corp. v. White Consol. Indus., 998 F.2d 1192, 1196 (3d Cir. 1993). If this motion is converted to one for summary judgment, then KPMG requests the right to supplement the record. 6
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accounting policies and for establishing and maintaining internal control that will, among other things, record, process, summarize, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. Codification of Statements on Auditing Standards ("AU") § 110.03, "Responsibilities and Functions of the Independent Auditor"; City of Pontiac v. Pricewaterhouse Coopers, L.L.P., No. 06-076389-NM, 2008 WL 375992, at *5 (Mich. Ct. App. Feb. 12, 2008) ("An audit report represents the auditor's opinion of the accuracy of the client's financial statements at a given period of time. The financial statements themselves are the representations of management, not the auditor.") (quoting Raritan River Steel Co. v. Cherry, Bekaert & Holland, 322 N.C. 200, 207 (1988)). The auditor only opines on whether the company's financial statements fairly present, in all material respects, the company's financial position in accordance with Generally Accepted Accounting Principles or GAAP. See AU § 110.01. The issuance of an unqualified or "clean" audit opinion by an auditor "does not guarantee that a client's accounts and financial statements are correct" but rather "certifies only that [the auditor] exercised appropriate, not flawless, levels of professional care and judgment" in conducting the audit. In re IKON Office Solutions, Inc. Sec. Litig., 277 F.3d 658, 673 (3d Cir. 2002). 2. GAAS Establishes That Auditors Are Not Expected To Uncover Collusive Fraud Being Committed And Concealed By Management

GAAS recognizes that auditors are not expected to uncover management's hidden fraud: [T]he auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by fraud or error. However, absolute assurance is not attainable and thus even a properly planned and performed audit may not detect a material misstatement resulting from fraud. AU § 316.12, "Consideration of Fraud in a Financial Statement Audit" (emphasis added). 7
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Likewise, GAAS provides that: "Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute assurance that material misstatements are detected." AU § 110.02 (emphasis added). The standards recognize that fraud is particularly hard to detect where the company and an outside third party create false documentation, or withhold documentation, such that an auditor does not know the true terms of an agreement. GAAS repeatedly recognizes that it is virtually impossible for auditors to detect such hidden terms: Because of the characteristics of fraud, a properly and planned and performed audit may not detect a material misstatement . . . For example, auditing procedures may be ineffective for detecting an intentional misstatement that is concealed through collusion among personnel within the entity and third parties or among management or employees of the entity. Collusion may cause the auditor who has properly performed the audit to conclude that evidence provided is persuasive when it is, in fact, false . . . . Furthermore, an auditor may not discover the existence of a modification of documentation through a side agreement that management or a third party has not disclosed. AU § 230.12, "Due Professional Care in the Performance of Work" (emphasis added); see also AU § 316.09 (same). V. ARGUMENT A. Motion To Dismiss Standard

To survive a motion to dismiss, a plaintiff cannot simply make "bald" assertions of the existence of each element of a claim. In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1429 (3d Cir. 1997). A complaint "requires more than labels and conclusions, and a formulaic recitation of a cause of action's elements will not do." Bell Atlantic Corp. v. Twombly, 127 S. Ct. 1955, 1965 (2007) (citing Conley v. Gibson, 355 U.S. 41, 47 (1957)). "Factual allegations must be enough to raise a right to relief above the speculative level" and must "state a claim to

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relief that is plausible on its face." Id. at 1965, 1974 (emphasis added). Fraud-based claims are subject to a further heightened pleading standard. (See infra Section V.F.) B. Michigan Law Governs The Claims Against KPMG

As Plaintiff's claims against KPMG arise under state law, Delaware's choice-of-law rules apply. See Klaxon Co. v. Stentor Elec. Co., 313 U.S. 487, 496 (1941). Delaware follows the Second Restatement of Conflicts, which uses different choice-of-law tests based on the underlying claim. See Travelers Indem. Co. v. Lake, 594 A.2d 38, 47 (Del. 1991). The choice of law for negligence/professional malpractice claims depends on: (1) the location where Plaintiff's injury occurred, (2) the state where the conduct giving rise to the injury occurred, (3) the domiciles and residence of the parties, and (4) the place where the relationship between the parties is centered. Restatement of Conflicts (Second) § 145 (1971). Similarly, for fraud claims, "[w]hen the plaintiff has suffered pecuniary harm on account of his reliance on the defendant's false representations and when the plaintiff's action in reliance took place in the state where the false representations were made and received, the local law of this state determines the rights and liabilities of the parties." Id. § 148. For a breach of contract claim, the court looks to the law of the state with the greatest connection to the contract; "if the place of negotiating the contract and the place of performance are in the same state, the local law of this state will usually be applied." Id. § 188. Here, all factors point to the application of Michigan law. On the tort claims, the location of the alleged injury to C&A is Michigan, the principal place of business of C&A. 2003 C&A Annual Report, Brown Aff. Ex. 5 (A complete copy of this public document is available at www.sec.gov). The allegedly injurious conduct ­ KPMG's audit work ­ took place in Michigan: the KPMG audit team was located in Michigan, was "frequently present" at C&A's headquarters and financial offices in Michigan, conducted its reviews and performed its audit in Michigan, 9
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and issued the audit opinion letter there. Compl. ¶ 34; Independent Auditor's Report, included in 2003 C&A Annual Report, Brown Aff. Ex. 5. The alleged false representation ­ KPMG's audit opinion ­ was made in Michigan, where the opinion was issued, and received in Michigan, where C&A (to whom the opinion was addressed) is based. Any action in reliance on the opinion took place in Michigan, where C&A is based. Finally, the relationship between the parties is centered in Michigan. As to the contract claims, the engagement contracts were negotiated and executed in Michigan, and sent from KPMG's office in Detroit, Michigan to C&A's headquarters in Troy, Michigan (2003 Agreement, Brown Aff. Ex. 1, at 1; 2004 Agreement, Brown Aff. Ex. 2, at 1); the audit (the subject matter of the contract) was performed in Michigan; the interactions between the parties (and their representatives) occurred in Michigan; and the ostensible injury occurred in Michigan. Therefore, Michigan law governs all of Plaintiff's claims against KPMG.4 C. Michigan's Wrongful Conduct Rule Bars All Of Plaintiff's Claims

Plaintiff alleges that KPMG is liable to Plaintiff for failing to detect various frauds that C&A's management perpetrated, which benefited C&A and were structured to avoid KPMG's detection. Because the fraudulent conduct of C&A's management is imputed to C&A, and to Plaintiff as C&A's successor, these claims are barred by the wrongful conduct rule (known in other jurisdictions as the doctrine of in pari delicto). See MCA Fin. Corp., 687 N.W.2d at 858. 1. Management's Allegedly Fraudulent Conduct Is Imputed To C&A

"[T]he fraudulent acts of a corporate officer may be imputed to a corporation where those
4

KPMG speaks only as to the law applicable to the claims against it, not against other defendants. Under the doctrine of depecage, a choice-of-law determination should be made as to each claim in a case ­ not to the case as a whole. See Restatement of Conflicts (Second) §§ 145,188 (1971); Whitwell v. Archemere Acad. Inc., 463 F. Supp. 2d 482, 485 (D. Del. 2006); Naghiu v. Inter-Continental Hotels Group Inc., 165 F.R.D. 413, 419-22 & n.4 (D. Del. 1996). 10
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acts (1) are in the course of employment and (2) are for the benefit of the corporation." MCA Fin. Corp., 687 N.W.2d at 857. While the so-called "adverse interest" exception may lie if the corporate officer's actions are done solely for his benefit, so long as the agent's actions either benefit in part, or are motivated in part to benefit, the corporation, his actions are imputed to the corporation. Id. at 858 (finding that the adverse interest exception does not apply where the corporate officers' actions were motivated "even in part, [by] a misguided belief that their wrongdoing would benefit the corporation[]"); Transnation Title Ins. Co. v. Livingston, No. 243509, 2004 WL 203075, at *4 (Mich. Ct. App. Feb. 3, 2004) (where agent is acting "at least in part on behalf of the principal's interest," his actions are imputed to the principal). Here, Plaintiff's Complaint alleges that management's fraudulent conduct was performed in the course of their employment and benefited C&A, and supports the imputation of management's actions to Plaintiff.5 For example, from 2002 to 2004, management, in the course of negotiating contracts with C&A's partners and suppliers, allegedly participated in a "rebate scheme" that served to increase C&A's reported earnings. Compl. ¶¶ 63-69. Later, in early 2005, members of management, while performing their duties in acquiring financing for C&A, allegedly included additional receivables in its "borrowing base" to reduce the amount of money owed to G.E. Capital, (id. ¶ 75), and made false statements to Credit Suisse to obtain $75 million
5

Even where an agent acts solely in his own interest, adversely to his principal, and does not in fact benefit the principal in any way, his conduct will still be imputed to principal where the agent is the "sole actor" for the principal. Nat'l Turners Bldg. & Loan Ass'n v. Schreitmueller, 288 Mich. 580, 586-87 (Mich. 1939) (citing Munroe v. Harriman, 85 F.2d 493, 496 (2d Cir. 1936)). Plaintiff alleges that Defendant Stockman was the mastermind of the alleged fraud (see, e.g., Compl. ¶ 26), and thus his actions are imputed to Plaintiff. For purposes of imputation, Stockman was the "sole actor" for C&A, as he controlled Heartland, (see id. ¶¶ 7, 28, 45), which in turn controlled C&A's operations. See, e.g., id. ¶¶ 28, 30, 45-46 (alleging Heartland's control over C&A through its share ownership and designated representatives on the C&A board); id. ¶¶ 53 et seq. (describing Stockman as causing the company to inflate its earnings by engaging in false transactions). 11
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in financing. Id. ¶ 87. These actions were in the course of their employment and directly benefited C&A ­ increasing its stock price and available capital and reducing its expenditures. See MCA Fin. Corp., 687 N.W.2d at 858 (wrongful conduct of management imputed to the company where management acted "at least in part, out of a motivation of keeping the corporations afloat, and thus provide a benefit to the corporations"); Baena v. KPMG LLP, 453 F.3d 1, 7 (1st Cir. 2006) ("A fraud by top management to overstate earnings, and so facilitate stock sales or acquisitions, is not in the long-term interest of the company; but, like price-fixing, it profits the company in the first instance and the company is still civilly and criminally liable"); Cenco, Inc. v. Seidman & Seidman, 686 F.2d 449, 451 (7th Cir. 1982) (management's "inflating of inventories" ­ permitting corporation "to borrow money at lower rates" and "greatly increas[ing] the market price of its stock" ­ benefited the corporation).6 Therefore, C&A management's actions are imputed to C&A, and, in turn, to Plaintiff. 2. Plaintiff's Allegations Satisfy All Of The Elements Of Michigan's Wrongful Conduct Rule

Michigan's wrongful conduct rule holds that "[a]s between parties in pari delicto, that is equally in the wrong, the law will not lend itself to afford relief to one as against the other, but will leave them as it finds them." Orzel, 537 N.W.2d at 212-13 (dismissing claim by a drug user who fabricated prescriptions in order to acquire narcotics against a pharmacist on the basis of the wrongful conduct rule). The Orzel court set out the three factors that trigger the wrongful conduct rule: (1) the plaintiff and defendant stand at least in equal fault, (2) the plaintiff's illegal

6

While Plaintiff claims that management was motivated to protect their reputations and income, this interest could only be served by the survival and profit of C&A. Further, where a principal accepts the benefits of a fraudulent bargain arranged by an agent, the agent's conduct is imputed to the principal and the principal is bound by the agent's knowledge of that fraud. See Munroe, 85 F.2d at 495-96. 12
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conduct is a proximate cause of the injury, and (3) the nature of plaintiff's wrongful conduct is prohibited under a criminal or penal statute. Id. at 214-17. If these factors are present, Michigan courts will grant the equivalent of a motion to dismiss. Glazier v. Lee, 429 N.W.2d 857, 860 (Mich. Ct. App. 1988); Scalici v. Bank One, NA, No. 254632, 2005 WL 2291732, at *2, 7 (Mich. Ct. App. Sept. 20, 2005); MCA Fin. Corp., 687 N.W.2d at 852-53.7 Plaintiff's allegations satisfy each of these elements. First, Plaintiff's fault for its bad conduct far exceeds any alleged fault of KPMG. The Complaint alleges that Plaintiff, through Stockman and the other officers, intentionally perpetrated the fraud that is the center of the Complaint. Even taking the allegations of the Complaint as true, KPMG merely failed to detect Plaintiff's fraud ­ a fraud Plaintiff intentionally concealed from KPMG. Compl. ¶ 154. Plaintiff stands at least in equal fault. Second, Plaintiff's fraud was a proximate cause (indeed, the direct cause) of the alleged injury. The damages theory Plaintiff has articulated against KPMG is "deepening insolvency." But it was Plaintiff who engaged in the allegedly fraudulent rebate transactions, (Compl. ¶¶ 6369), Plaintiff who prepared its allegedly fraudulent financial statements, (id. ¶¶ 80-84), and Plaintiff who decided not to file for bankruptcy earlier. Thus, Plaintiff's own wrongful conduct was at least a proximate cause of any deepened insolvency. Finally, Plaintiff's allegedly wrongful acts violated numerous criminal laws. Plaintiff's allegations against the individual defendants contain clear-cut assertions of criminal liability. Compl. ¶ 44. Moreover, the United States Attorney's Office recently unsealed an eight-count

7

Federal courts will similarly grant a motion to dismiss pursuant to Rule 12(b)(6) on the ground of in pari delicto. See Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 360 (3d Cir. 2001); Nisselson v. Lernout, 469 F.3d 143, 158 (1st Cir. 2006); cert. denied, 127 S. Ct. 2131 (U.S. 2007), Baena, 453 F.3d at 6. 13
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indictment against Defendants Stockman, Stepp, Cosgrove and Barnaba, alleging securities fraud, wire fraud, bank fraud, obstruction of agency proceedings, and criminal conspiracy. See DOJ Indictment, Brown Aff. Ex. 3. The penalties for willful securities fraud alone could result in sentences for each of up to 20 years and fines up to $5 million. See 15 U.S.C. § 78ff (2006). Because this element is also met, Plaintiff's claims against KPMG are barred by the wrongful conduct rule. 3. Recent Michigan And Other Precedent Holds That The Wrongful Conduct Rule Bars A Bankrupt Company's Claims For Alleged Negligence/Malpractice Against Its Former Auditors

The Michigan Court of Appeals recently applied the "wrongful conduct" rule to bar claims against an auditor in MCA Financial Corp., a case closely analogous to the present one. In MCA, a mortgage bank had sold and marketed fraudulent investment products to customers in violation of state and federal law. See 687 N.W.2d at 852. Management attempted to conceal the fraud but eventually failed; the company entered bankruptcy soon after the fraud came to light; and securities fraud enforcement actions were brought against management. Id. While in bankruptcy, the debtor, through its liquidating agent, sued its auditors for failing to detect fraudulent transactions and accounting irregularities. Id. The court held that management's conduct was imputed properly to the company under Michigan law, noting that actions of management to inflate the company's financial statements in order to keep it solvent are not adverse to the company's interest and thus do not trigger the "adverse interest" exception to common-law principles of agency. Id. at 858. The court further held that the wrongful conduct rule barred plaintiffs' claims against its auditor ­ both those alleging an omission (failing to detect management's fraud) and those alleging an affirmative act (certifying the company's financial statements as proper). Id. at 854-55 ("Because plaintiffs cannot show that the wrongdoing occurred at defendants' urging or affirmative advice, plaintiffs stand in pari delicto 14
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with defendants. In short, to prevail, plaintiffs would have to show more than that defendants turned a blind eye to plaintiffs' wrongdoing, but that . . . the scheme originated with defendants rather than with plaintiffs.") Finally, the court held that the debtor was not entitled even to commence an action to benefit its allegedly defrauded investors ­ if such an action existed at all, then it could only be raised by the defrauded investors directly. Id. at 856. MCA Financial Corp. is controlling precedent, on point, and requires dismissal of all claims against KPMG. Management here ­ including the dominating majority shareholder and nearly all of the officers and directors ­ conducted the alleged fraud. Compl. ¶¶ 22-25. The alleged fraud was undertaken to prop up C&A's financial statements and enable it to borrow additional funds ­ therefore, management's conduct is properly imputed to C&A. Id. ¶¶ 70-74. Under the principles of Michigan's wrongful conduct rule, C&A stands in at least equal fault to its auditors. The wrongful conduct rule thus bars all of Plaintiff's claims against KPMG. Courts in other jurisdictions similarly have applied the doctrine of in pari delicto to bar claims brought by a bankrupt debtor, or a trustee in bankruptcy, against its former auditors. For instance, in Baena v. KPMG LLP, 389 F. Supp. 2d 112, 114 (D. Mass. 2005), aff'd, 453 F.3d 1 (1st Cir. 2006), the trustee of a post-confirmation litigation trust asserted claims against the debtor's former auditor, KPMG, including claims for professional malpractice, aiding and abetting management's breach of fiduciary duty, and state unfair trade practices laws. Plaintiff alleged that KPMG's audit opinions allowed the company to take on additional debt that the company was unable to repay. Id. The trial court dismissed the claims under in pari delicto, holding that "the Breaching Managers controlled the corporation, perpetrated the fraud, and, in the words of the Complaint, `caused' the $340 million of additional debt to be incurred. As such, the corporation cannot sustain a claim against Defendants arising out of its own misdeeds." Id.

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at 120. The First Circuit affirmed because, "assuming fraudulent financial statements [existed], senior L&H management were, on the trustee's own version of events, the primary wrongdoers." Baena, 453 F.3d at 7. The allegations here are fundamentally the same. Several other courts have also applied in pari delicto to bar claims by a bankrupt entity against its former auditors, counsel or business partners for failing to detect management's own fraud.8 D. Plaintiff Fails To Allege Causation Or Cognizable Damages

In addition, Plaintiff's claims all fail for lack of causation or damages. 1. Plaintiff Does Not Allege How KPMG's Audit Or Review Of The Company's Statements Proximately Caused C&A Harm

For each claim, Plaintiff must allege with sufficient specificity how KPMG's actions proximately caused its injury. See Dresser v. Cradle of Hope Adoption Ctr., Inc., 358 F. Supp. 2d 620, 633 (E.D. Mich. 2005) (for fraud the "false representation relied on by plaintiff actually must be the proximate cause for the alleged injury"); Montcalm Fibre Co. v. Advanced Organics, No. 249642, 2005 WL 957425, at *4 (Mich. Ct. App. Apr. 26, 2005) (negligence and breach of contract claims require showing of proximate cause), aff'd, 474 Mich. 857 (2005). Under Michigan law, "proximate cause" requires a showing of both "cause in fact" and "legal cause."
8

See, e.g., Christians v. Grant Thornton, LLP, 733 N.W.2d 803, 814-15 (Minn. Ct. App. 2007) (in pari delicto bars trustee's negligence claim against former auditor because "when `a defendant's only sin is its failure to prevent transgressions by the plaintiff, no benefit flows to the public from rewarding the transgressor'") (quoting Miller v. N.Y. Produce Exch., 550 F.2d 762, 768 (2d Cir. 1977)); Official Comm. of Unsecured Creditors of Color Tile v. Coopers & Lybrand, LLP, 322 F.3d 147, 163-66 (2d Cir. 2003) (same for breach of fiduciary duty claim against former auditors); Official Comm. of Unsecured Creditors of PSA, Inc. v. Edwards, 437 F.3d 1145, 1152-56 (11th Cir. 2006), cert. denied, 127 S. Ct. 45 (2006) (same for trustee's RICO claims against former partners); Grassmueck v. Am. Shorthorn Ass'n, 402 F.3d 833, 837 (8th Cir. 2005) (same for trustee's negligence claims against industry organization); Terlecky v. Hurd (In re Dublin Sec., Inc.), 133 F.3d 377, 381 (6th Cir. 1997) (same for claims of negligence, breach of fiduciary duty, negligent misrepresentation, recklessness, and common law fraud against former lawyers); Sender v. Buchanan (In re Hedged-Inv. Assoc's), 84 F.3d 1281, 1285 (10th Cir. 1996) (same for trustee's claims against former partner under state partnership act). 16
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Skinner v. Square D Co., 516 N.W.2d 475, 479 (Mich. 1994); City of Pontiac, 2008 WL 375992, at *6 ("cause in fact" and "legal or proximate cause" are elements of auditing negligence claim in Michigan). "Cause in fact" requires that the injury "would not have come about but for" the defendant's conduct." Haliw v. Sterling Heights, 627 N.W.2d 581, 588 (Mich. 2001). "Legal cause" further requires that such injury was foreseeable. Skinner, 516 N.W.2d at 479. Plaintiff's allegations demonstrate that C&A's own business actions ­ fraudulent or otherwise ­ caused the Company's alleged damages. While Plaintiff claims that KPMG's failure to detect Plaintiff's own fraud was the "but for" cause of the Company's downfall (Compl. ¶ 107), even if that were true,9 "but for" causation alone is insufficient; Plaintiff fails to plead facts establishing legal causation. Plaintiff's allegations show that the C&A executives' poor, and allegedly fraudulent, business decisions were responsible for the Company's insolvency: "By the end of 2001, Collins & Aikman had announced and/or completed three major acquisitions which dramatically increased the size of the Company. This acquisition spree positioned the Company for disaster." Compl. ¶ 36. "[D]uring the time that Defendant Stockman and his confederates ran the Company, Collins & Aikman's debt load had dramatically increased from approximately $884 million as of December 30, 2000 to approximately $1.6 billion as of December 31, 2004." Id. ¶ 72. "By January 2005, just a few months after raising the $415 million in the August Senior Note Offering, the liquidity crisis at Collins & Aikman worsened. During this time, Stockman caused Collins & Aikman to delay paying its debts and bills for as long as possible because Collins & Aikman was beginning to, if it had not already, run out of credit." Id. ¶ 73. "In short, Defendant Stockman and others acting at his direction engaged in a pattern of fraudulent conduct with respect to GECC that, when discovered, caused great harm







9

Moreover, Plaintiff's but for allegations fail because it cannot show what it would have done but for KPMG's alleged negligence and that the outcome would have been any better. See Christians, 733 N.W.2d at 813 ("Certainly many positive things could have occurred but for [the auditor's] alleged negligence, but these speculative potential outcomes are the problem with the causation element rather than the answer to it."); see infra Section V.D.2.c. 17
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to the Company, its relations with GECC ­ a major lender to the Company, and its reputations in the business community." Id. ¶ 76. "Based, in material part, on these misrepresentations [by Defendant Stockman and others acting at his direction] Credit Suisse First Boston Corporation agreed to lend Collins & Aikman an additional $75 million in financing. . . [and] this particular $75 million caused Collins & Aikman to take on debt that prevented the Company from being repaired and resulted in massive losses in the value and worth of the Company." Id. ¶¶ 87, 89.

Plaintiff cannot allege that KPMG caused Plaintiff to increase its debt load, run out of credit, and have its reputation in the business community damaged, when Stockman and other C&A executives were directly responsible for those actions. In other words, Plaintiff fails to allege that KPMG proximately caused its injuries. See Skinner, 516 N.W.2d at 479; Montcalm Fibre Co., 2005 WL 957425, at *5 (holding that while a fire may have contributed to plaintiff's financial problems it could not be the proximate cause of its bankruptcy because that resulted from plaintiff's own business failings). The Seventh Circuit recently affirmed this principle, holding that an auditor cannot be liable for a company's bankruptcy caused by management's own actions because an auditor is not "an insurer against conditions outside his control." Maxwell v. KPMG LLP, --- F.3d ---, 2008 WL 746849, at *2-3 (7th Cir. Mar. 21, 2008) (Posner, J.). In Maxwell, KPMG audited the financial statements of a predecessor company, which acquired and merged an internet company into a single new company. Thirteen months later, after the dot.com bubble burst, the newlyformed company declared bankruptcy. The bankruptcy trustee for the company sued KPMG for malpractice alleging that the acquisition never would have gone through if KPMG had not approved the predecessor company's fourth-quarter earnings statement which was allegedly overstated. Id. at *1. Assuming (without deciding) that KPMG was negligent, Judge Posner held that KPMG was not the proximate cause of the company's