## Facts

- Software Toolworks, Inc. produced software for personal computers and Nintendo game systems.
- In July 1990, Toolworks completed a secondary public offering at $18.50 per share, raising over $71 million using a registration statement and prospectus that incorporated audited fiscal 1990 financial statements certified by Deloitte & Touche.
- PaineWebber Inc. and Montgomery Securities served as underwriters and conducted diligence that included reliance on Deloitte’s audit work and management representations.
- After the offering, Toolworks’ share price fell sharply; after an October 1990 press release announcing substantial losses, the price dropped further.
- Investors filed a putative class action alleging that offering materials were materially false or misleading, including allegations that:
  - revenue was improperly recognized from OEM transactions lacking binding agreements,
  - large consignment “sales” inflated unaudited first-quarter (June quarter) results, and
  - responses to pre-effectiveness SEC inquiries about sales practices were misleading.
- Toolworks and its officers settled; claims continued against the underwriters and Deloitte.
- The district court granted summary judgment for the underwriters on all claims and for Deloitte on all but one claim; plaintiffs dismissed the remaining Deloitte claim, resulting in judgment for Deloitte as well.

## Issues

1. Whether the underwriters established the Securities Act due-diligence defense as a matter of law for alleged misstatements involving audited historical financials, SEC correspondence, and unaudited interim (June quarter) results.
2. Whether summary judgment was proper on Exchange Act § 10(b) and Rule 10b-5 claims against the underwriters based on lack of scienter, particularly as to SEC inquiries and interim results.
3. Whether summary judgment was proper for Deloitte on § 10(b)/Rule 10b-5 (and related) theories concerning (a) audited fiscal 1990 statements versus (b) alleged involvement with SEC responses and June quarter results.

## Decision

- The Ninth Circuit affirmed in part, reversed in part, and remanded.
- As to the underwriters:
  - Affirmed summary judgment regarding investigation of Nintendo-related matters and OEM revenue recognition reflected in audited financial statements.
  - Reversed summary judgment regarding diligence and knowledge tied to SEC correspondence and the June quarter (unaudited) results.
- As to Deloitte:
  - Affirmed summary judgment concerning alleged fraud tied to the audited fiscal 1990 financial statements.
  - Reversed summary judgment concerning Deloitte’s alleged role in misleading SEC responses and the June quarter results, because a factfinder could infer at least recklessness.

## Legal Principles

- Under Securities Act §§ 11 and 12(a)(2), underwriters may avoid liability by showing a reasonable investigation and reasonable grounds to believe the offering materials were not materially misleading; the assessment turns on the specific disclosure area and what warnings were apparent.
- Reliance on reputable auditors and management may support a due-diligence defense for audited historical financials when independent checks reveal no warning signs.
- Awareness of SEC inquiries or similar warning signals can require additional investigation; mere acceptance of explanations may be insufficient, creating triable issues on diligence and liability.
- Under Exchange Act § 10(b) and Rule 10b-5, liability requires scienter (at least recklessness); disputed facts about awareness of warning signs can preclude summary judgment.
- For auditors, alleged errors in audited statements, without evidence of ignored warning signs, may be insufficient to infer scienter; involvement in potentially misleading regulator-facing communications or interim-results presentations can support an inference of recklessness.

## Conclusion

The Ninth Circuit upheld summary judgment where the record showed reasonable investigation and no triable scienter regarding audited historical financials, but reinstated claims tied to SEC inquiries and unaudited interim results because factual disputes remained about the adequacy of investigation and whether the underwriters and Deloitte acted with reckless disregard.


In re Software Toolworks, Inc. Sec. Litig., 38 F.3d 1078 (9th Cir. 1994)