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16 December 2004

Ernst & Young Prevails in Fruit of the Loom Litigation
Mayer, Brown, Rowe & Maw LLP

16 December 2004 - Mayer, Brown, Rowe & Maw LLP partners Stanley Parzen and Bradley Andreozzi won an important victory for Ernst & Young LLP ("E&Y") when the United States Court of Appeals for the Sixth Circuit affirmed the dismissal of all securities fraud claims against E&Y related to its 1998 audit of apparel manufacturer Fruit of the Loom. Fidel v. Farley, No. 02-6143 (6th Cir. Dec. 16, 2004). In the year after E&Y issued its unqualified 1998 audit opinion, Fruit of the Loom took some $220 million in inventory writeoffs and then filed for bankruptcy, but did not restate the 1998 financial statements. The same Mayer, Brown, Rowe & Maw team had represented E&Y before the U.S. District Court for the Western District of Kentucky in winning dismissals of the complaint and amended complaint.

In a unanimous opinion, the Sixth Circuit agreed that plaintiffs had failed to allege facts raising an inference that E&Y acted with scienter when issuing its 1998 audit opinion. The court rejected plaintiffs' contention that numerous "red flags" should have put E&Y on notice of alleged problems, finding that the complaint was bereft of facts showing that E&Y had failed to take those matters into account when planning its audit. The court also rejected plaintiffs' argument that scienter could be inferred from the magnitude of Fruit of the Loom's 1999 writeoffs and their closeness in time to the 1998 audit. The court held that Fruit of the Loom's 1999 reversals did not show that E&Y acted with scienter in issuing its 1998 audit opinion, rejecting plaintiffs' arguments to the contrary as "nothing more than hindsight" and "speculation." The court rejected as well plaintiffs' argument that E&Y's alleged consulting work for Fruit of the Loom raised an inference of scienter, noting that the complaint failed to allege particular facts showing what the consultants supposedly had learned that had a bearing on the 1998 audit. The court dismissed as well plaintiffs' attempt to infer scienter from the size of E&Y's auditing and consulting fees, noting that the argument was "mere speculation" in the absence of allegations showing that the relationship was unusually profitable and generated a significant portion of E&Y's revenue. Equally unavailing was plaintiffs' attempt to raise an inference of scienter from the fact that E&Y (like other auditing firms) has been sued in other cases; the court held that lawsuits regarding audits of other companies were not probative of whether E&Y acted knowingly or recklessly in preparing its audit report concerning Fruit of the Loom.

Finally, the Sixth Circuit rejected plaintiffs' attempt to hold E&Y liable for unaudited financial statements included in Fruit of the Loom's 1999 registration statement. Plaintiffs had argued that E&Y's consent to reprint its 1998 audit opinion in the 1999 registration statement "effectively represented" that E&Y approved of the unaudited statements that were separately listed in the registration statement. The Sixth Circuit agreed that because E&Y had issued no opinion on the unaudited materials, it could not be held liable for them, and that any other result would effectively revive "aiding and abetting" liability in contravention of the Supreme Court's Central Bank decision.

In separate litigation, Mayer, Brown, Rowe & Maw successfully represented E&Y before the U.S. District Court for the Western District of Kentucky and the Sixth Circuit in obtaining dismissal of all claims arising from E&Y's audit of Fruit of the Loom's 1996 financial statements. See New England Health Care Employees Pension Fund v. Ernst & Young LLP, 336 F.3d 495 (6th Cir. 2003).

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