## In the



# U n ited S ta tes Co urt o f Ap p ea ls

F o rth eS e v e n th C ir cu it

____________ N o. 07

- 1992 E DWARD T. J OY CE , etal. , P laint if fs -App el lants , v. M OR GAN S TAN LEY & C O ., I NC ., D efend a nt-A pp ellee.

____________ A pp eal from the United S t ates Di strictC our t fo r the N o rthernDi stricto f Illino is, Eas tern Div isi on. No . 06 C4754

— SamuelD er-Yegh iayan, Judg e.

____________ A RG UE D J AN UA RY 25, 2008

— D ECI DE D A UGUS T 19, 2008

____________

B efore B AUER, W OO D , an d E VANS, C ircu it Judges. W OO D , C ircu it Judge. Edw ar d T . Joyce and hi s fel l ow pla i nti ff s w er e shar ehol ders and o pti on hol ders in 21 st Century Telec om G ro up , I nc. ( “21s t Century ”)

. ( W e r efer to them her e a s the S hare hol ders. ) T h is case i s o ne o f m an y tha t arose w he n th e t elecom m un ications ind us try f el l upon hard t i m es ar ound the end ofthe 1990 s. 21 st Century and a co m pany c all ed RC N Cor pora ti on e nter ed i nto a m er gerag re em en t on D ecem ber12 , 19 99, under2 N o. 07

- 1992

w hi ch RCN was to acqui re a ll o f21 st Century’ s co m m on shar es. Def endant M or gan S tanl ey & Co. , I nc. (“M or gan S ta nl ey ”) a dvi sed 21 stCe nt ur y i n c o nne ct i o n wi ththe dea l

. To th e S ha r eh o l der s’ g r ea t di smay, be tween the dat e o fthe mer g era g r ee m en t an d the e ff ec ti ve da te o fthe m er ger, A pri l 28 , 20 00, the m ar ke t val ue o fRCN st ock plum m ete d. I n the end, the S hare hol ders’ newly acqui re d RC N st ockwas w or thl ess . The Shar ehol ders bel i eve thatM or gan S tanl ey ou ght t o com pensate them f orthei r l oss es. A l though M or gan S t a nl e y wa s a c t i ng a s the fi na nc i a l a dv i s o r t o the 21 st Century cor pora ti on, theym ai ntai n th at i t s houl d al so have gi ven a dvic e t o the S h ar eh ol ders about how to m i ni m i ze thei r exposure to a potenti al l oss i n val u e of RCN s to ck

. M o r g anS ta nl eydi d no t do s o , i n the i r o pi ni o n, because i m ple m entat i on o fthe properhedgi ng st ra teg i es pr o b a b l y wo ul d h ave de pr e s s e d the v a l ue o fR CN sto ck

— an ou tc om e M or ga n Sta n ley so u gh t t o av oid because i t was o perat i ng under a co nfl i ct o fi nter estcause d by i ts pri orbusi ness re l atio nshi p w i th RCN

. M or gan S ta nl eymove d t o di smi ss the c o m pl aintb as ed o n the Shar ehol ders’ al l ege d l ack ofst anding, thei r f ai lu re to st at e a cl ai m , a nd the i r f ai l ur e to s ue wi th i n the st atut o r y l i m i ta ti o ns pe r i o d. The di st r i ctco ur t g r an te d the m o ti o n t o di smi ss , a nd we affi r m the di smissa l o n the m er i ts.

I I n i ts m oti on t o dism i ss, M or gan S tanl ey ar gued that the S hare hol ders did nothave st anding to su e becauseN o. 07

- 1992 3 thei r cl ai m i s der i vati ve ra therthan dir ect. I t co ntends that th e y a r e b r i n g i n g a s u i t th a t s h o u l d b e b r o u g ht b y t he cor pora ti on, a n d they have not gone thr ough the pro per channel s t o obt ai n author i ty to bri ng the sui t i n a der i vative capaci ty. M or gan S tanl ey com es to thi s co ncl usi on by obs er vi ng that the Shar ehol ders’ dam age s res ult ed fro m th e d ro p in s to c k p ric e, an d th at ty p e of h ar m is g en er al l y a di r ec t ha r m t o the c o r po r at i o n thr o ug h the di m i nut i o n o fi ts a ss et s an d o nl y a n i ndi r ec t ha rm t o the Shar ehol ders; i n add i ti on, the harm i s not unique t o these pla i nti ff s but ra theri s co m m on t o al l shar ehol ders. T h i s a r g u me n tmi s c o n c e i v e s th e S h a r e h o l d e r s ’ c l a i m, and to the e xtent that the d i str i ct c ourtr el i ed on “ sta nd i ng” as a gr ou nd f ordi sm i ssi ng the cas e, i t e rr ed. W hethero r not the a rgum en t is com p ell ing, th e Shareh olders are ac tu al l y as se r tingtha t th e f ai l ur e to he dge , r athe r tha n the drop i n sto ck pri ces, c au sed thei r l oss es. I n other w or ds, they thi nk tha t M or gan St anl ey preve nted them fro m ta kin g s elf-h elp m ea su re s t h at w ou ld h av e in su lat ed th eir perso nal por tf ol i os f ro m the drop i n val ue suffer ed by R C N . Th e Sh ar eh old er s m ay n ot rely on th e d ro p in sto ck val ue as the cause or m ea su re o fthei r dam age , be ca u s e ( a s th e y c o n c e d e ) Mo r g a n S t a n l e y h a d n o th i ng to do w i th thatpri ce dr op. By co ntra st, i t i s pos sible to see the f a i l ur e t o h e dg e a s a c a us e - i n- f a c to fthe S ha re h old er s’ fin an c ial los s, an d th ey h av e a lleg ed th at th is f ai l ure w as caused by a breac h o fan a l l ege d du ty that M or gan S tanl ey owed to them

. Because 21stCentury a s a c or p or ati on di d not s ufferany l oss r el ate d to a l ack of adv i ce abo uthe dgi ng ( sinc e 21 stCe nt ur y r ec ei ve d no R C N stock in the trans action ), the Sh areh olders ass ert4 N o. 07

- 1992 th at th eir claim i s d irect rather th an de rivat ive. W e are wi l l i ngt o g o thi s f ar( butlittl e f ar th er ) wi ththe i r a r g um en t. T h e rea l iss u e is w h et h er an y su c h d u ty ex ist s at a ll.

II Tur ni ngt o the mer i ts , M organ S ta nl eya r g ue s th atthe Shar eh o l de r s h a v e f a i l e d t o s t a t e a c l a i m. T he l a w r e c ogni ze s t wo ty p e s o ffr a u d , a c t u a l a n d c o n s t r u c t i v e . The Shar ehol ders concede that theyf ai l ed to al l ege actual f r a u d

. I n s t e a d , th e y s a y th a tth e y ar e pl e a d i n gs o me type ofco nstr ucti ve f ra ud , and they add th at thi s k i nd o f cl ai m s ho ul d no t be s ubj ec t to th e he i g ht en ed pl ea di ng r equi r ements ofF ED
. R. C IV
. P. 9 ( b )

. Unl i k e a c t ua l fr a ud , const ructi ve f ra ud “r equi re s nei theractual di shones ty nor in te n t t o d ec eiv e, be in g a br ea c h of leg al or eq u ita b le du ty w hi ch, i rr espec tive o fthe m or algui l t o fthe w ro ngdoer, the l aw decl ar es f ra ud ule nt b ec au se ofi ts tendency to decei ve othe rs . ” P o tt i n g e rv . P o tting er, 60 5 N

. E.2 d 1130, 11 38 ( I l l

. App. Ct

. 1 99 2)

. Co ns tr uct i ve fr au d i nc l ude s “a ny ac t, s ta te m en t o r om i ss i o n w hi cham o unt s to po si ti ve fr au d orwh i ch i s co nstr ued as a fra ud by the cour ts because o fi ts detri m entaleff ect up on p u b l i c i nter est s a nd publi c o r pri vate co nfi dence. ” Id. Thi s cl ai m r equi re s the exi ste nce of a co n fid en tia l or fid u c iar y re lat ion sh ip . In d ee d , a pla i nti ffcl ai m i ng co nstr ucti ve f ra ud “m ust s how that defe nd ant ( 1) br eached th e fi du ci ar y duty he o w ed to pl aint i ffa nd ( 2) k ne w ofthe b r each an d a cc ept ed th e f rui ts ofthe f ra ud

. ” P rodrom os v. Ev eren Secs

. , Inc. , 79 3 N

. E

. 2d 151, 158 (I ll

. A p p . Ct

. 2003). The Shar ehol ders d id asser t that M or gan S tanl ey owed them a fi du ci ar y duty and that there w as a co nfi denti alN o. 07

- 1992 5

re l ati onshi p between them selv es and M or gan S tanl ey. They at tached t o t h eir se cond am ended com pla i nt a f ai rnes s o pini on i ssued by M or gan S tanl ey to the b oar d of dir ecto rs o f 21st Century. M or gan S tanl ey’ s o pini on not es that 21stCe n tu ry “ha[ s] as ked f oro ur o pini on a s to whethe r the Co ns i der ation to be r ec ei ve d b y the hol ders ofshar es . . . is f ai r f ro m a fi nanci alpoi nt o fvi ew to such [sha re]ho lders

. ” ( Em pha si s adde d)

. Th e co m pl aint alle ge s t h at “[a ]t t h e t im e M or ga n Sta n ley w as en ga ge d , i t knew .

. . thatthe perso ns to be benefitted by its serv i ces w er e the 2 1stCentury stoc kho lders

. . . . ”; i t co nti nued with the a l l ega ti on that “ M or gan S tanl ey knew it s f ai rnes s opi ni on would be r e l i e d on by RCN ’ s s hare hol ders [ si c

— ap p ar en tly it m ea n t 2 1s t C e n t u ry ’s s h ar eh old er s] in d e c i d i n gt o v o t e f o r th e me r g e r s a l e t o R C N. ” ( E mphasi s a dd ed). Fi nal l y, it a ssert ed that “[ a] s a r esul t o f i ts e ng ag ement, M o r g anS ta nl eyo wed 2 1s t Cen tu r y a nd The Shar ehol ders a du ty o f full an d fa ir disclo sure . ” ( Em phasis add ed ). The Shar ehol ders al so ple aded a co nfl ict o f i nter est re l ating to the fi du ci ar y duty that M or gan S tanl ey al l egedl y o w ed to them

. I n the engag em ent l ett er, M or gan Stan le y ex p li citly d isclosed the p oten tial con fl ict ofi nt erest : “M or gan St anl ey has been advi si ng RC N C or p or ati o n ( ’ RCN ’ ) i n co nne ct i o n w i ththe Tra ns ac ti o n. RCN and 21stCentury have r equeste d that M or gan Sta nl ey disc o nt i nu e p r o v i di ngs e r v i c e s t o R CN a nd i ns t e a d p r o v i de s e r v i c e s t o the Co mpa ny . Th e Co mpany u nd e r s t a nd s th at M organ Stanley m ay us e the s am e team m em bers for th is engagem en t.” The Sh a r e hold ers all ege th at th ere6 N o. 07

- 1992

w as a nef ar i ous purpos e b eh i nd RCN ’ s s ugges ti on that M or gan S tanl ey advi se 21stCentury : Unbe k no wnstt o 21 stCe nt ur y , the r ea l r ea so n why R C N w an ted M organ Stanley t o b e 21st C en tu ry’s advi sorwas to ensur e that RC N ’ s i nter est s would not be h arm ed by the ad vice g iv e n to 21st C en tu ry’s shar ehol ders. M or gan S tanl ey und er sto od thatthis w as RC N ’ s m oti vati on f orr ecom m ending M or gan St anl ey to 21stCentury

. I ro ni cal l y, 21 st Century w as eag erto hi re M or gan S t anl ey not despit e but b e ca us eof i t s p r i o r r e l at i o n s h i p wi th R C N. The Shar ehol ders’ co m pla i nt co m es peri l ousl y c l ose to sugge sti ng that 21st Century w as si m ply hop in g t hat the b r e a c h o ffi du c i a r y du t y wo ul d c utthe o ther w ay

— th at i s, th at M o r g an S ta nl ey woul d vi o l at e conti nuing du ti es ofl oya l ty w i th r espectto RCN ’ s co nfi denti al inform ation by u sin g th at inform ation for 21st C en tu ry’s benefi t. I t s ays , f orexam ple , “2 1stCentury knew that M or ga n Sta n ley h ad rep re se n te d R C N ’s in te re st s in ot h er sign ifica n t t ra n sa c tio n s; i.e. , thatth er e w as a techni calco n flict[, ] ” but 21stCenturynonethel ess ag re ed to engag e M or gan S tanl ey “[ i ]n the bel i efthatM or gan St anley w as intim a tely a w a reo fRCN ’ s busi ness, capi tal stru ctu re and other s igni ficanti nf

or m at i on r eg ar di ng R C N

. . . . ” (Em p ha sis add ed ). Be that as i t m ay , 2 1s t C entury ’ s m oti vati ons ar e no t r el ev an t f o r o ur pur p oses. W ha t i s i m po r ta nti s th atthe Shar ehol d er s al l ege d that M or gan S tanl ey bre ached i ts su p p osed du ty to the Sh a r e h olders. Th e Shareh olders charg ed that the “ f ai rnes s o pini on was n ot based on a nN o. 07

- 1992 7 in d ep en d en t in ve st iga tio n by M o r ga n Sta n ley an d it f ai l ed to a d dress se ri ous r i sks as soc i ate d w i th the tr ansac tio n an d w ay s t o h ed ge th os e ris ks .” Despi te the f ac t th atthe pr ec edi ngl an g ua g e o fthe com plaint expl i ci tl y l oca tes the bre ach i n an al l ege d d efi cienc y i n th e fai rnes s op inion, th e Sh a rehold ers ha ve n o w t o l d u s ( i n a n e ff o r tt o d i s t i n g u i s h v a r i o us c a s e s ci t e d b y Mo r g a n S t a n l e y ) th a tth e y “ a r e n o tc o mp lai nin g abou t M organ Stan ley’s fai rnes s op inion.” Rath er, they say, theyar e cl ai m i ng tha t M or gan Stanl ey owed th em “a n e xt r a c ont r ac t ual duty [ to a dvi se th em ab o ut hedgi ng] thataro se o ut o fthe speci alci rcum sta nces of th e re lat io n s h i p be tw ee n M or ga n Sta n ley an d p lain tiffs .” ( Em pha si s added)

. The c o m pl aint, ho wev er, make s no m enti on o fany ex tr a-c ontr actualduty. W hi l e the S hare

hol ders m ay “poin t to (orev en hypothesi ze) f acts co ns i s t e ntwi t h theexi s t i ng l angu ageo fthe com pla i nt[ , ] ” they “m ay not am end the co m pla i nt o n appeal to st ate a new cl ai m . . . . ” Am

. Int e r - Fi de l i ty E xc h. v. A m . R e - Ins uranc eCo. , 17 F.3d 10 18, 1022 (7th C ir. 1994) (em p ha sis add ed ). Even i fwe pu t a si de th is failure to put M or gan S tanl ey on not i ce o fan a l l ege d extra

- contra c tualduty, we see n o w ay thatthe Shar ehol ders can sho w thatthei r re l ati onshi p w i th M or gan S tanl ey posse sse d the “s peci al ci rcum stan c es ” nece ssa ryto gi ve ri se to an extr a- contr actu al fid u c iar y d u ty . On e s u c h n ec es sa ry “c irc u m st an c e” is tha tthe a l l e g e dl y s up e r i o r p a r t y mus th a v e a c c e pt e d a d u ty to gu ar d th e int er es ts of th e d ep en d en t p ar ty
. P o m m ier v. P eop les B a nkM a ryc rest, 967 F. 2d 1115 , 1119 ( 7th Ci r. 19 92) ( “ T h e f a c t th a t o n e p a r t y t r u s t s th e o th e r i s i n s u ffi c i e n t
. We8 N o. 07

- 1992
tr ust m ostpeopl e with w h om w e cho ose to do busi ness. Th e do mi na ntp a r t y mus t a c c e pt the r e s po ns ib i l i t y , a c c e pt the t r us to fthe o the r p a r t y b e f o r e a c o ur tc a n fi nd a fi d uc iary r elationsh ip.”) (i nt erna l citations om itted ). The exhibi ts l eave no doubt that M or gan S tanl ey did not acc ep t any su ch resp ons ibi li ty, an d so no fi d uc iary dut y to war d the Sha r eh o l der s e ve r a r o se . The e ng ag ement let te r, w h ich d e f i n es th e a d vis in g re lat ion sh ip , ex p licit ly no te d tha t M o r g anS ta nl eywas wor k i ngo nl y f o r the cor pora ti on: “M or gan S tanl ey w ill a ct under thi s l ett er agreem en t as an in d ep en d en t con tracto r w it h dutie s sole ly to 21 st C ent ury . ” ( Em phasi s a dd ed). “W e hav e a cted as fi na nc ialad visor t o t heCom panyi n connect i on with thi s t ra nsacti on . . . . ” ( Em pha sis add ed). The f ai rnes s opi ni on a l so disc l ai m ed a duty to the S hare hol ders: I t i s underst oo d that t hi s l e t t e ri s f ort hei nf or m at i on of

t he B o a rd o f D irecto rs oft h e C om p an y, ex c ep t t h at th is o pinion m ayb e i nc l ude d i n i ts e nt i r ety i n a ny fi l i ng r equi r ed to b e m ade b y the Co m pan y i n re spe cto fthe M er ge r. M o rg a n S t a n l eyex p r e s s e s n o o p i n i o n a s t o t he r e l at i ve val uat i ons of e ac h of t he vot i ng a nd non- vot i ng 21 st C entu ry C o m m o n Sto ckan d th e 21 st C entu ry P referred Stock

. I n additi on, t h i s op inio n d o es no t in a ny m a nn er add re ss t he pr ice s at which theRC NCo m m on Sto ck will t r adef oll owing announcem ent o r consum m ati on o f the p ro po s e d Me r g e r, a nd M organ St anl ey expre s s e s no o pin io n o r recom m end a tio n a s to ho w th e ho lders o f the 21 st C entu ry C o m m o n S to cksho uld vo te at th e sha reho lders’ m e e t i ngs held i n con ne ction w ith th e M erger. ( Em pha si s adde d)

. Thus , M o r g anS ta nl eyne ve r o wed a ny contr actual nor extr a- contr actual du ty to the S hare hol ders.N o. 07

- 1992 9 W e rej ec te d a s i m i l arc l ai m i n HA2 0 0 3 L i q u i d a t i n g Tr u s t v. Cr e di tS u i s se S e c u r i t i e s ( USA) L L C, 517 F.3d 454 ( 7th Cir. 20 08 ), w h er e w e obs er ve d th at inv es tm en t b an ks ’ res p on sibi l i ti es ar e s et by contr act; the f act th at som eone wishes that a d i ff er ent contr act had been w ri tte n i s not a bas i s f or liab ility

. Id. at45 8- 59. I n a d d i ti o n t o the e xpl i ci t di sc l ai m er s we ha ve hi g hl i ghted, the conflict w ai vercl auses r ei nfo rce the f act that M or gan S tanl ey did notacc ept a d u ty toward the Shar eh o l d e r s . I tr e q u i r e d 21 s t Ce n t u r y t o w a i v e a l l c l a i ms ba se d o n c o nfl i cto fi nt er es t butmad e n o m en ti o n o fthe Sha rehold ers: “21s t C e n t u ry agrees th at it w il l not assert any dam age , co n flict of i nter est, o r othe r cl ai m ag ai nst us , o ur aff il iate s o r s ucho th erpa r tya r i singo uto fo ur r e la tionsh ip w ith RC N on th e basis of a con fl ict ofi nt eresto r othe rwis e. ” “ [ B]o th RCN and 21st C en turyhave w aiv ed an y p ot en tia l co n flict of in te re st .” Des pi te a l l th es e ex pl i ci t di sc l ai m er s o fa duty t o a ny o ne but 21 st Century, the Shar ehol ders ar gue that M or gan St anl ey’ s unsucce ss ful att em pt to nego ti ate a pri ce pr otect ion featu re into th e stock-for-stock sale of21st C en tu ry t o R CN de mon s t r a t e s tha ti th a d v o l un t a r i l y a c c e pt e d a fid u ci ar y duty to l oo k o ut f orthe sto ckhol ders’ i nter est s. This i s no t e nough; we are n ot aware ofany author i ty to supp or t the pro posi ti on that a n att em pt to f ac ili tat e a n ou tc om e t h at w o u ld be n efit a p ar ty au to m at ica lly m ake s the at tem pter a fi du ci ar y o fthatparty.10 N o. 07

- 1992 III A l though we coul d affi rm the dist ri ct c ourt sol el y o n the b asi s o fi ts dism i ssa l f orf ai l ure to sta te a cl ai m , we note f orco m ple tenes s that the st atute o fl i m i tat i ons i s a n a l t e r na t i v e g r o un d o n whi c h i t s j ud g men tc a n be up he l d. The pa r ti es a g r ee tha t unde r I l l i no i s l aw the l i m i ta ti ons pe r i o d f o r thi s ty pe o fc l a i m i s fi v e y e a r s . S e e 7 3 5 I LCS 5/ 13- 205. This case w as fi l ed on A ugust 2, 2006. M or gan S ta nl ey ar g ue s th at th e S ha r eh o l der s ex per i enced ( an d wer e awar e o f ) th ei r i nj ur y o n the e ff ec ti ve da te o fthe m er ger, A pri l 28 , 20 00, by wh i c h date the st ockpri ce o f RC N ha d fa l l en subst anti al l y b el ow the pri ce that pr evai l ed at the ti m e the m er ger w as approve d o n Dec em b er 12, 19 99

. The S ha r eh o l der s co nc ede the dr o p i n pr i ce b uta r g ue that i n A pri l 20 00 they w er e ( sti l l ) notf am iliar w i th hedgi ng str ate gi es and c onse quentl y w er e unaw are that thei r l oss co uld have b ee n ave rt ed. They thus cl ai m that th eydi d no t k no w tha t th eyha d b ee n w rongfully inj ure d un tilthey l ear n e d , in D ecem ber 2002 or later, tha th e dg i ngs t r a t e g i e s wo ul d h a v e h e l pe d. The stan d ar d f orkno w l edge i s a n obj ecti ve ra therthan a su bj ective one. “P erson s ha ve kn ow ledge th at a n inj ury i s wrongfull y caused w hen they posse ss enough i nfo rm ati on about the inj ury to ale rta re aso nabl e perso n to the need for fur therinq uir ie s to det erm ine if t he c ause of t he i njury is ac t i onab l e atl aw . ” La S a lle Na t’l B a nkv. Sk idm o re, O w ing s & M er ri ll, 63 5 N .E .2d 56 4, 56 7 (I ll. A p p . C t. 19 94 ) (e m p h as is ad d ed ). M organ Stanley argu es, an d the d istri ct cou rt ag re e d , th at u p on ex p er ien c in g t h e fin an c ial los s in A p ril 2000 , the Shar ehol ders w er e put o n noti ce o fthe need toN o. 07

- 1992 11 invest igate w he th er they w e r e w rongfu ll y d ep rived of a m ea ns t o pr ev en t th i s l o ss . Thi s m ak es s en se . Itmight tak e thi rty y ears fora sto ckhol der who has no part i cul ar i n t e r e s ti n l e a r n i n gab o u th e d g i n gs t r a t e g i e s t o c o me a c r o ss th is inform ation by h ap p en stan ce. Th e statu tory p eriod can not de p en d on each i nd ivi d ua l p lai nt iff’ s d il igence

. I n th is case, it w ou ld h ave tak en l ittl e eff ort f orthe Shar ehol ders to disc ove r these hedgi ng st ra teg i es ( not onl y a ftert h e l oss but i nd eed be f or ehand) by, f or exam ple , co ntacting the Chica go Board ofTra de ( “CB OT ”) p u b lica tio n s d e p a rt m en t a n d as kin g for an y a va ilab le CB OT l i ter atur e o n w ays to m i ni m ize e xposure to a potenti aldecl i ne i n the pri ce o fa sto ck. * * * To the extent that the j ud gm ent o fthe dist ri ct c ourtwas base d on “s tandi ng” o r, m or e a ccurat el y, i nd i re ct inj ury, w e V ACATE the j ud g ment and R EMA ND f ori t t o be changed to a dism i ssa l o n the m er its . To the extent that the j ud g men tr e fl e c t s a di s mi s s a l f o r f a i l ur e t o state a cl ai m and unti m el i ness, i t i s A FFI RMED
.

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