1 United States Court of Appeals,

Fifth Circuit.

No. 93-1550.

Adron L. MELDER, Etc., et al., Plaintiffs,

Adron L. Melder, Etc., et al., Plaintiffs-Appellants,

v.

Clifton H. MORRIS, Jr., et al., Defendants-Appellees.

Steven G. COOPERMAN, Plaintiff-Appellant,

v.

URCARCO, INC., et al., Defendants-Appellees.

Anthony HAND, et al., Plaintiffs-Appellants,

v.

URCARCO, INC., et al., Defendants-Appellees.

David J. STEINBERG, Etc., et al., Plaintiffs-Appellants,

v.

URCARCO, INC., et al., Defendants-Appellees.

Aug. 8, 1994.

Appeal from the United States District Court for the Northern

District of Texas.

Before REAVLEY, JONES and BENAVIDES, Circuit Judges.

EDITH H. JONES, Circuit Judge:

URCARCO operates a chain of "we finance" used car lots in Fort

Worth, Dall as, Houston, and Austin. The company targets market

areas with a high concentration of prospective purchasers who would

otherwise have trouble locating financing because of their income

levels, cre dit history, or inability to provide an adequate down1 The nature of URCARCO's business is prominently displayed

in the first two paragraphs of the "Prospectus Summary" in the company's November 15, 1989 IPO and May 31, 1990 SPO

prospectuses.

2 The district court took particular interest in one of the plaintiffs, Steven Cooperman, described by the court as "one of the unluckiest and most victimized investors in the history of the securities business." The court noted that Mr. Cooperman admitted in sworn interrogatories that he had been a plaintiff in 38 securities fraud cases. The plaintiffs do not challenge this finding of the district court, but they do summon the courage to allege that the court was predisposed against securities fraud actions generally. The district court's remarks in this case, however, reflect only a natural amount of skepticism in light of the suspect background of one of the "plaintiffs".

2 payment. 1 The company launched an Initial Public Offering (IPO) in

November 1989, and turned to the capital markets again in May 1990

with a Secondary Public Offering (SPO). In April 1990, URCARCO's

stock traded at a high of $255/8 per share, but in part following

some critical reports in the financial press, the company's stock

price nosedived to $107/8 per share by July 31, 1990.

This downturn precipitated the four consolidated securities

fraud suits filed against URCAR CO, its officers and directors,

Coopers & Lybrand, and three securities underwriters—Merrill Lynch,

Alex. Brown, and Cazenove. 2 The plaintiffs alleged violations of

§§ 11, 12(2), and 15 of the Securities Act of 1933, § 10(b) of the

Securities and Exchange Act of 1934 and Rule 10b-5 promulgated

thereunder, § 20(a) of the Exchan ge Act, state law

misrepresentation, Tex.Bus. & Com.Code Ann. § 27.01, and common law

fra ud. After allowing the plaintiffs to replead twice and

conducting a hearing on this matter, the district court dismissed

the federal s ecurities fraud and common law fraud claims for3 The district court declined to exercise jurisdiction over

the plaintiffs' pendent state law claims. Because the appellants do not contest this aspect of the court's dismissal, this court need not address the propriety of their dismissal. See Shushany
v. Allwaste, Inc., 992 F.2d 517, 520-21 n. 5 (5th Cir.1993).

4 The standard of review on a Rule 9(b) dismissal is the same as for a dismissal under Fed.R.Civ.P. 12(b)(6), namely de novo. See Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.1993).

3 failure to plead fraud with particularity a s required under

Fed.R.Civ.P. 9(b). 3 We have reviewed the district court's

dismissal on the pleadings de novo and AFFIRM. 4

I.

In general terms, all securities fraud claims require the

plaintiff to establish: (1) a misstatement or omission (2) of a

material fact (3) made with scienter (4) on which the plaintiff

relied (5) that proximately caused the plaintiff's injury. S ee

Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.1993). For

its part, Rule 9(b) imposes certa in pleading requirements on

securities and other fraud claims:

In all averments of fraud or mistake, the circumstances constituting fraud or mistake sha ll be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally.

Fed.R.Civ.P. 9(b). The application of the requirements of Rule

9(b) to securities fraud claims was recently addressed by this

court in Tuchman v. DSC Communications Corp., 14 F.3d 1061 (5th

Cir.1994) and Shushany, supra.

In Shushany, the court explained that Rule 9(b) requires

certain minimum allegations in a securities fraud case, namely the

specific time, place, a nd contents of the false representations,5 In applying the requirement of Rule 9(b) that

"circumstances" be pleaded in detail to a securities fraud claim, the Seventh Circuit analogized the requirement to the essentials of the first paragraph of any newspaper story, namely the who,
what, when, where, and how. See DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir.), cert. denied, 498 U.S. 941, 111 S.Ct. 347,
112 L.Ed.2d 312 (1990).

6 Appellants maintain that their 1993 Securities Act claims were inappropriately subjected to the Rule 9(b) heightened pleading standard. This argument is untenable in light of the complaint's wholesale adoption of the allegations under the securities fraud claims for purposes of the Securities Act claims. When 1933 Securities Act claims are grounded in fraud rather than negligence as they clearly are here, Rule 9(b) applies. See, e.g., Shapiro v. UJB Fin. Corp., 964 F.2d 272, 287-89 (3d Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 365, 121

4 along with the identity of the person making the misrepresentations

and what the perso n obtained thereby. 5 S ee Shushany, 992 F.2d at

521 (quoting Tel-Phonic Servs., Inc. v. TBS Int'l, Inc., 975 F.2d

1134, 1139 (5th Cir.1992)). The heightened pleading standard of

Rule 9(b) serves an important screening f unction in securities

fraud suits. As this court described in Tuchman,

the heightened pleading standard provides defendants with fair

notice of the plaintiffs' claims, protect s defendants from harm to their reputation and goodwill, reduces the number of

strike suits, and prevent s plaintiffs from filing baseless claims then attempting to discover unknown wrongs.

Tuchman, 14 F.3d at 1067.

Plaintiffs' complaint fails to meet the stringent pleading

requirements of Rule 9(b) as explained in Shushany. As the

dis trict court concluded, the complaint here fails to put the

defendants on notice, places defendants' reputations at risk, and

burdens the courts with a potential strike suit. The task to which

we now turn is showin g precisely how the complaint fails to meet

the requirements of Rule 9(b) on a defendant-by-defendant basis. 6L.Ed.2d 278 (1992); Sears v. Likens, 912 F.2d 889, 892-93 (7th

Cir.1990).

7 References are to the plaintiffs' consolidated amended class action complaint filed December 6, 1991.

5 II.

In terms of its allegatio ns against URCARCO and its officer

and directors, the complaint falls short of the heightened Rule

9(b) pleading requirements for at least two reasons. First,

plaintiffs re ly heavily on alleged misstatements made in the

URCARCO pros pectuses, but upon further review these alleged

misstatements amount to gross mischaracterizations of the contents

of the prospectuses. Second, the plaintiffs fail to plead scienter

adequately under Rule 9(b).

As an initial matter, the plaintiffs fail to base their

allegations on statements actually made by URCARCO, opting instead

to selectively distort the company's public statements to create an

inference of fraud. For example, the plaintiffs allege that in its

IPO and SPO Prospectuses:

the Company claimed to base its loss reserves on its own experience with delinquencies at a time when it h ad been selling cars for less than three years, s o that none of its longer-term loans had yet been paid in full, and the Company

had no reasonable basis for determining their delinquency
rate[.]

C. 51 at ¶ 89(c). 7 In fact, however, this claim is belied in the

prospectuses which clearly and prominently discuss URCARCO's

limited operating history and its potential impact on the company's

loan loss provision:

The Company began operations in March 1987 and therefore has

had only a limited operating hist ory upon which prospective6

investors may base an evaluation of its performance ... Changes in historical experience caused by changes in economic

conditions or other factors could require a change in the Company's periodic provision for losses.

IPO Prospectus at 5; SPO Prospectus at 5.

Similarly misconstruing the company's public statements, the

plaintiffs also allege that URCARCO in its "IPO Prospectus

minimized the risk of default by the Company's customers." C. 28

at ¶ 43. The plaintiffs read the IPO Prospectus to stress "the

Company's purported highly efficient and sophisticated collection

procedures leading investors to believe that the Company's loans

were not only safe, but constantly monitored." Id.

These serious mischaracterizations of the IPO Prospectus find

no support in the actual text of that document which clearly

explains that URCARCO makes loans to high-risk customers:

The Company finances its used car sales in a relatively high-risk market and anticipates that a portion of its retail sales contracts will become seriously delinquent and that in those circumstances the Company's only practical alternative is repossession of the cars.

IPO Prospectus at 5. An interested reader need go no further than

the second page of the IPO Prospectus to find a prominently

displayed, clear explanation that the Company purposefully targets

prospective purchasers of used cars "unable to obtain traditional

car financing because of their income levels, credit history or

inability to provide a sufficient down payment." Id. at 2.

Significantly, the IPO explains the risk that URCARCO assumed

to gain a competitive advantage:

The Company believes that most used car dealers that finance purchases for their customers requ ire approximately a 507 downpayment by these customers, so that the downpayment covers8 A careful review of both the IPO and SPO prospectuses

inescapably leads to the conclusion that if plaintiffs' counsel had been bound under the same strictures concerning veracity as were the appellees under governing securities law standards, their complaint would have to be labeled misleading. Plaintiffs repeatedly allege "misrepresentations" in appellees' securities filings that mischaracterize those documents. Some examples of this tactic are repeated in the text supra. Others are as

follows:

1. Plaintiffs allege that, contrary to representations that Urcarco required a cash down payment of 10 to 157, "Urcarco financed 1007 of many of its sales." C. 49 at ¶ 87(a). The prospectuses state, however, that: "A customer's down payment on a car sold by the Company typically ranges from 57 to 207 of the sales price, including the value of a trade-in, if any." IPO Prospectus at 4. This statement does not preclude the possibility of 1007 financing of sales when trade-ins are included.

2. The complaint states that, contrary to its representations, the Company used vertical integration as a means of artificially inflating its earnings by, for example, recording "sales" of repossessed cars from its lots to its wrecking and salvage facilities at amounts that it knew would never be realized. C. 49 at ¶ 87(c). One

searches the IPO and SPO in vain for an intimation of this alleged misrepresentation. Those documents state only that vertical integration is " a means to utilize the remaining value of trade-ins, possessions and other cars considered by the company to be no longer suitable for re-sale." IPO Prospectus at 4 (emphasis added). No other statements or financial information support plaintiffs' claim of

"artificial inflation" of such sales.

3. Plaintiffs' complaint alleges that the company claimed to use "highly sophisticated credit evaluation procedures" when in reality it had "no effective central

7 the cost of the car for the dealer. The Company believes that

its low downpayment financing for c ustomers provides it a competitive advantage over most "we finance" dealerships selling used cars.

Id. at 21. No reasonable reader of the IPO Prospectus could

conclude that URCARCO was somehow attempting to lead investors to

believe its loans were "safe" when its express corporate pu rpose

was to the contrary. 8controls over its credit department." C. 28 at ¶ 42; C. 50

at ¶ 87(e). Again, there is no misstatement of this nature in the IPO and SPO. For instance, the IPO states that: "A prospective customer's credit status is carefully evaluated by the Company by verifying job history, residency and other pertinent information." IPO Prospectus at 4. The IPO further states that: "Most of the sales financed by the Company are to individuals who typically have limited access to credit, but satisfy sufficient other criteria stipulated by the Company, such as job and residence history, to lead the Company to believe that such person is an acceptable credit risk notwithstanding his inability to obtain traditional car financing." Id. at 23.

4. No one could misread the IPO and SPO, as plaintiffs' complaint does, to suggest that those documents misleadingly imply that repossessed cars were being restocked for retail resale at fair market value when in reality they were being

auctioned off to dealers. See C. 29 at ¶ 44. On the contrary, the IPO describes that repossessed cars are assigned a "fair value, as estimated by the company taking into consideration its prior costs, its current wholesale value and other factors," and it clearly indicates that in some cases the repossessed autos may be turned over to the salvage operations. IPO Prospectus at 23-24. None of this is necessarily inconsistent with sending repossessed autos

to auction when circumstances so necessitate.

5. Finally, the complaint states that the Company misrepresented its delinquency and repossession rates because it stated that it had a strategy of extending and working out even the most seriously delinquent loans and thereby "falsely assured the investing public that workouts
were successful." C. 51 at ¶ 89(b). The IPO states the company's policy on seriously delinquent customers after a detailed description of its credit and collection procedures. See IPO Prospectus at 22-23. One may question the business judgment represented by the policy, but the IPO by no means suggests that this policy assures prospective

investors that workouts are successful.

These allegations boil down to plaintiffs' attempt to chastise as fraud business practices that, in hindsight, might have been more cautious. Misjudgments are not,
however, fraud.

8 In addition to severely distorting the company's public

statements in their complaint, plaintiffs do not merit a third

opportunity to replead for still another reason, namely their9

failure to plead scienter adequately under Rule 9(b). The scienter

element is satisfied by proof that the defendants acted with severe

recklessness. See Shushany, 992 F.2d at 521. Although Rule 9(b)

expressly allows scienter to be "averred general ly", simple

allegations that defendants possess fraud ulent intent will not

satisfy Rule 9(b). See Tuchman, 14 F.3d at 1068. The plaintiffs

must set forth specific facts suppor ting an inference of fraud.

See id. Because the complaint does not set forth specific facts to

support an inference of fraudulent intent, dism issal under Rule

9(b) is appropriate as to the corporation and its officers and

directors.

The plaintiffs attempt to meet their Rule 9(b) scien ter

burden by alleging that the defendants engaged in a conspiracy to

commit securities fraud

so that they could inflate the price of the Company's common

stock in order to: (i) successfully bring to fruition the offerings; (ii) protect and enhance their executive positions

and the substantial compensation and prestige they obtained

there by; and/or (iii) enhance the value of their personal URCARCO's securities holdings and options.

C. 14-15 at ¶ 19. This lone allegation of motive is materially

ind istinguishable from the allegation made in T uchman where we

concluded that such an allegation did not set out facts sufficient

to allow for a proper inference of scienter. S ee Tuchman, 14 F.3d

at 1068-69. Accepting the plaintiffs' allegation of

motive—basically that the defendant officers and directors were

motivated by incentive compensation—would effectively eliminate the

state of mind requirement as to all corporate officers and

defendants. S ee id. The district court aptly dubbed this10

allegation "a nihilistic approach to Rule 9(b) jurisprudence".

Simply put, the lone allegation of motive is insufficient.

The defendants' motive to commit securities fraud is not

readily apparent, as there is no allegation that any of the

corporate defendants actually personally profited from the

allegedly inflated stock values or the money raised from the two

offerings. The plaintiffs therefore face a tougher standard for

establishing fraudulent intent. S ee id. at 1068. Again, however,

under this more stringent standard, plaintiffs' complaint fails to

provide the specific facts upon which an inference of conscious

behavior may be based. As the district court put it, "[t]he

complaint's usual practice is simply to state that the defendants

knowingly did this or recklessly did that." S ee, e.g., C. 23 at ¶

31 ("[T]he true adverse facts about URCARCO's financial condition

... were known to or recklessly disregarded by defendants."); C.

66 at ¶ 119 ("Because of their board membership and/or their

executive and managerial pos itions with URCARCO, defendants ...

knew or had access to information concerning the adverse non-public

information about URCARCO's adverse financial outlook. " ). In

s hort, because of the plaintiffs' failure to plead scie nter

adequately and their serious mischaracterization of the company's

public statements, the complaint was properly dismissed as to

URCARCO and its officers and directors.

III.

As to defendant Coopers & Lybrand, the complaint fails to

plead specific facts upon which inferences of fraudulent auditing11

or fraudulent intent may be based and was therefore properly

dismissed under Rule 9(b). The plaintiffs' boilerplate averments

that the accountants violated particular accounting standards are

not, without more, sufficient to support inferences of fraud.

Further, the plaintiffs' only allegations of the accounting firm's

intent in participating in the securities fraud are that the firm

sought to

(i) protect and enhance the substantial auditing and other fees received from URCARCO; (ii) maintain and increase its

market share for auditing and accounting se rvices to be performed and thereby increase the prestige and compensation

of the Coopers and Lybrand partne rs responsible for the

URCARCO engagement; (iii) increase the income received by the

Coopers and Lybrand partners responsible for th e URCARCO engagement since their income was directly tied to retaining engagements such as URCARCO; and (iv) maintain its competitive positio n as to other large accounting firms by retaining URCARCO as a client.

C. 16 at ¶ 21. As characterized by the district court, this is the

familiar " "They did it for the Money' " chorus sung by the

plaintiffs as to URCARCO and the individual defendants in part II

supra. We are not moved by this music, and, on the same reasoning

as in part II, must reject the plaintiffs' allegations of scienter

as insufficient.

A contrary conclusion would universally eliminate the state of

mind requirement in securities fraud actions again st accounting

firms. This follows from the indisputable proposition that

accounting firms—as with al l rational economic actors—seek to

maximize their profits; that Coopers & Lybrand attempted to

maximize profits is the essence of the plaintiffs' motive

allegations.12

Furthermore, while the plaintiffs' motive allegations merely

describe behavior which could be alleged against auditors

generally, in this case, it seems extremely unlikely that Coopers

& Lybrand was willing to put its professional reputation on the

line by conducting fraudulent auditing work for URCARCO. In an

analogous examination of an accounting firm's motive to participate

in securities fraud, the Seventh Circuit observed that

[a]n accountant's greatest asset is i ts reputation for honesty, followed closely by its reputation for careful work. Fees for two years' audits could not approach the losses E &

W would suffer from a perception that it would muffle a client's fraud.... E & W's partners shared none of the gain

from any fraud and were exposed to a large fraction of the loss. It would have been irrational for any of them to have joined cause with Continental.

DiLeo v. Ernst & Young, 901 F.2d 624, 629 (7th Cir.), cert. denied,

498 U.S. 941, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990). Likewise, we

will not indulge irrational in ferences of the firm's fraudulent

intent based on these generic allegations.

Since Coop ers & Lybrand's motive is not apparent, the

plaintiffs can allege scienter only under a more stringent standard

under which they must plead particular circumstances indicating the

fir m's conscious behavior. S ee Tuchman, 14 F.3d at 1068. Our

review of the complaint and the appellant's brief reveals no such

particularized pleading. Instead of pleading with particularity,

the plaintiffs offer only rote conclusions, such as: "In the

course of rendering services to URCARCO, Coopers and Lybrand either

obtained knowledge of, or recklessly disregarded, the facts alleged

herein." C. 10 at ¶ 12. This type of pleading fails to meet the

requirements of Rule 9(b), and clearly implicates the kinds of9 To the extent the complaint alleges aiding and abetting

liability under § 10(b) of the Exchange Act against the underwriters and accountants, this form of liability has been foreclosed to private plaintiffs under the Supreme Court's recent

decision in Central Bank of Denver, N.A. v. First Interstate Bank
of Denver, N.A., --- U.S. ----, 114 S.Ct. 1439, 128 L.Ed.2d 119
(1994).

10 Furthermore, to think that the underwriters would put their valuable professional reputation at risk to ostensibly "profit" from two relatively minor securities offerings presents an inference of irrationality we refuse to indulge. Cf. DiLeo v.

Ernst & Young, 901 F.2d 624, 629 (7th Cir.), cert. denied, 498

13 policy concerns motivating the heightened standards in Ru le 9(b)

noted in part I supra. In short, the court correctly dismissed the

complaint as to Coopers & Lybrand. 9

IV.

The district court also properly dismissed the complaint on

Rule 9(b) grounds as to the final defendants, the sec urities

underwriters, for failure to adequately plead scienter. First, the

plaintiffs' allegation as to the underwriters' motive for

committing securities fra ud does not set out facts sufficient to

lead to a proper inference of scienter. The plaintiffs merely

allege th at the underwriters "agreed to participate in the

wrongdoing alleged herein in order to obtain substantial fe es,

expenses and discounts in connection with the Offerings." C. 15 at

¶ 20. This lone allegation of motive fails on precisely the same

rationale discussed supra in parts II and III in relation to the

other defendants. Simply put, accepting the plaintiffs' allegation

of motive as sufficient would make a mockery of Rule 9(b) by

effectively eliminating the scienter requirement as to securities

underwriters since all underwriters are, of course, fee seekers. 10U.S. 941, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990) ("Fees for two

years' audits could not approach the losses E & W would suffer from a perception that it would muffle a client's fraud.").

14 Second, absent pleading an apparent motive that withs tands

scrutiny, plaintiffs face the tougher burden of pleading scienter

by "identifying circumstances that indicate conscious behavior on

the part of the defendant[s]." T uchman, 14 F.3d at 1068. We have

searched the plaintiffs' complaint for al legations of specific

facts to support an inference of fraudulent intent, but have turned

up nothing. Not surprisingly, appellants' brief is not helpful,

citing only the portion of the complaint in which plaintiffs allege

that each of the underwriters "either obtained knowledge or

recklessly disregarded the facts regarding URCARCO's actual

business prospects." C. 8-10 at ¶ 11(a)-(c). In short, after

allowing the plaintiffs two opportunities to replead and a hearing

on the motion to dismiss, the district court was absolutely correct

in dismissing the complaint as to the securities underwriters and

all other defendants.

V.

For the foregoing reasons, the judgment of the district court

is AFFIRMED.