Source: https://m.openjurist.org/137/f3d/1
Timestamp: 2020-02-16 23:09:51
Document Index: 46994575

Matched Legal Cases: ['§ 77', '§ 78', '§ 240', '§ 77', '§ 78', '§ 78']

137 F. 3d 1 - Maldonado v. Dominguez
137 F3d 1 Maldonado v. Dominguez
137 F.3d 1
Miguel MALDONADO, et al., Plaintiffs--Appellants,
Ramon DOMINGUEZ, et al., Defendants--Appellees.
Heard Nov. 16, 1997.
Plaintiffs were therefore surprised to find that the district court had converted the motions. Throughout its opinion, the district court used language consistent with an award of summary judgment, ruling that "Plaintiffs have failed to adduce sufficient evidence to create a material issue of fact." However, an opinion's plain language does not always mirror its plain logic, and while a quick perusal of the opinion might lead one to believe that the district court had applied the wrong standard of decision, looking past the terminology employed by the court reveals an opinion illustrating the legal insufficiency of the pleadings for each claim in this suit. See Garita Hotel Ltd. Partnership v. Ponce Fed. Bank, F.S.B., 958 F.2d 15, 18 (1st Cir.1992) (the determination of whether a district court has converted a 12(b)(6) motion is "functional rather than mechanical"). On that basis, we affirm the standard of decision actually employed by the district court, and we now examine each of the district court's rulings regarding the insufficiency of the pleadings in this case.
II. Section 17(a) of the 1933 Act
15 U.S.C. § 77q. Courts and law enforcement agencies have the authority to enforce section 17(a) of the 1933 Act via injunction and criminal prosecution. However, for years circuit courts have struggled with the question of whether an implied private right of action to enforce section 17(a) also exists. The Supreme Court has never answered the question. See Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 304 n. 9, 105 S.Ct. 2622, 2625 n. 9, 86 L.Ed.2d 215 (1985). Until today, neither had this court. See Cleary v. Perfectune, Inc., 700 F.2d 774, 779 (1st Cir.1983)(declining to reach this question).
This issue has caused confusion because, while neither the language nor the history of section 17(a) clearly indicates a congressional intent to create a private right of action, see Newcome v. Esrey, 862 F.2d 1099, 1103-07 (4th Cir.1988), section 10(b) of the 1934 Act--with substantially similar language--has always been interpreted to provide for a private right of action. See Herman & MacLean v. Huddleston, 459 U.S. 375, 385-87, 103 S.Ct. 683, 688-90, 74 L.Ed.2d 548 (1983) (expressly interpreting section 10(b)'s private right of action as consistent with securities laws' "broad remedial purposes"). While some courts did not find the requisite congressional intent to infer a private right of action from section 17(a), see Touche Ross & Co. v. Redington, 442 U.S. 560, 574-76, 99 S.Ct. 2479, 2488-89, 61 L.Ed.2d 82 (1979) (legislative intent is the primary factor to consider when addressing whether a private right of action exists), other circuits found no meaningful distinction between section 17(a) and section 10(b). Compare Daniel v. Teamsters, 561 F.2d 1223, 1244-46 (7th Cir.1977) (holding that a private right of action exists), and SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 867 (2d Cir.1968) (Friendly, J., concurring) (same), with Landry v. All American Assur. Co., 688 F.2d 381, 384-91 (5th Cir.1982) (holding that no private right of action exists), and Stephenson v. Calpine Conifers II, Ltd., 652 F.2d 808, 815 (9th Cir.1981) (same).
III. Section 12(2) of the 1933 Act
Plaintiffs also brought suit under section 12(2) of the Securities Act. This provision establishes civil liability for any person who uses fraudulent means to sell a security.1 However, after the complaint was filed in this case, the Supreme Court conclusively decided that section 12(2) applies exclusively to "initial public offerings." See Gustafson v. Alloyd Co., 513 U.S. 561, 577-78, 115 S.Ct. 1061, 1070-71, 131 L.Ed.2d 1 (1995). The district court, ruling that the pleadings established that PRIBANK stock had been placed privately, dismissed the 12(2) claim. Plaintiffs appeal this ruling, arguing that their pleadings did not admit that PRIBANK stock was placed privately. Since Gustafson was decided after their complaint was filed, the plaintiffs argue that they should have received permission to amend their complaint, which currently fails to explicitly address whether PRIBANK's stock was placed privately or publicly. Therefore, the question for this court to decide is whether the pleadings, in their current form, establish that PRIBANK's stock was placed privately.
A placement of stock is private if it is offered only to a few sophisticated purchasers who each have a relationship with the issuer, enabling them to command access to information that would otherwise be contained in a registration statement. See Cook v. Avien, Inc., 573 F.2d 685, 691 (1st Cir.1978). "The determination of whether an offer is not public has not been relegated to a simple numerical test." See Van Dyke v. Coburn Enters., Inc., 873 F.2d 1094 (8th Cir.1989) (citing SEC v. Ralston Purina Co., 346 U.S. 119, 125, 73 S.Ct. 981, 984-85, 97 L.Ed. 1494 (1953)). Instead, courts are required to weigh the facts of each case carefully to assess whether the offerees need to be protected under the 1933 Act. See Ralston Purina, 346 U.S. at 127, 73 S.Ct. at 985.
In this case, twelve invitations were sent to Dean Witter clients. Domnguez had personally managed accounts in the past for each of them. The plaintiffs were not merely asked passively to invest in an existing entity, but to partner in starting a new corporation. Each shareholder of PRIBANK bought a 5.5% interest in the corporation and a seat on the board of directors. The board was to meet each month, and according to PRIBANK's by-laws the board of directors had full control and direction of the corporation's affairs and business.
IV. Section 10(b) of the 1934 Act (SEC Rule 10b-5)
Plaintiffs also seek relief under section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, which prohibit any person, directly or indirectly, from committing fraud in connection with the purchase or sale of securities. See id.; Gross v. Summa Four, Inc., 93 F.3d 987, 992 (1st Cir.1996).3 Unlike section 17(a), section 10(b) requires that plaintiffs plead--with sufficient particularity to withstand Fed.R.Civ.P. 9(b)--that defendants acted with "scienter." Scienter has been defined as "a mental state embracing intent to deceive, manipulate, or defraud." See Ernst, 425 U.S. at 193 n. 12, 96 S.Ct. at 1381 n. 12. Plaintiffs allege that Domnguez and Rosado understood and concealed the risks of margin calls on the PRIBANK investments.
This circuit has been clear and consistent in holding that, under section 10(b), plaintiffs must plead specific facts giving rise to a "strong inference" of fraudulent intent. See Greenstone v. Cambex Corp., 975 F.2d 22, 25 (1st Cir.1992).4 "Courts have uniformly held inadequate a complaint's general averment of the defendant's 'knowledge' of material falsity unless the complaint also sets forth specific facts that make it reasonable to believe that defendant knew that a statement was false or misleading." Id. Applying this standard to plaintiffs' complaint, the district court dismissed the claim for failure to plead scienter with sufficient particularity.5
"This court has been 'especially rigorous' in applying Rule 9(b) in securities fraud actions 'to minimize the chance that a plaintiff with a largely groundless claim will bring a suit and conduct extensive discovery in the hopes of obtaining an increased settlement, rather than in the hopes that the process will reveal relevant evidence.' " Shaw v. Digital Equipment Corp., 82 F.3d 1194, 1223 (1st Cir.1996) (quoting Romani v. Shearson, Lehman, Hutton, 929 F.2d 875, 878 (1st Cir.1991)). However, in examining a complaint for the requisite particularity in allegations of fraud, we are required to apply a delicate standard. While Fed.R.Civ.P. 9(b) proscribes the pleading of "fraud by hindsight," we also cannot expect plaintiffs to plead "fraud with complete insight" before discovery is complete. Id. at 1225. We therefore look carefully for specific allegations of fact giving rise to a "strong inference" of fraudulent intent, see Greenstone, 975 F.2d at 25, keeping in mind that the pleading of scienter "may not rest on a bare inference that a defendant 'must have had' knowledge of the facts." Id. at 26 (quoting Barker v. Henderson, Franklin, Starnes & Holt, 797 F.2d 490, 497 (7th Cir.1986)).6
The plaintiffs' brief argues that Domnguez and Rosado were "persons highly knowledgeable and with much expertise in the field of securities and investments of the type purchased by PRIBANK." However, the complaint dismissed by the district court paints a somewhat different picture. According to the complaint, although both Domnguez and Rosado were vice-presidents of large financial institutions, "neither one of them had engaged in a REPO transaction on behalf of any bank with assets similar to those of PRIBANK, and had no manner to assure that what they represented to plaintiffs and the other investors was true." Given 10(b)'s requirement of a pleading of scienter, characterizing the defendants as irresponsible or "in over their heads" does not further the plaintiffs' cause.
The complaint is also replete with allegations based on "information and belief" that Domnguez and Rosado were aware of the risk of margin calls. However, "information and belief" alone is insufficient to meet 9(b)'s particularity requirement in this context. See Romani v. Shearson, Lehman, Hutton, 929 F.2d 875, 878 (1st Cir.1991).
When we examine these pleadings carefully, we find that there are no specific allegations of fact which strongly imply a fraudulent intent. At most, the complaint contains general inferences that Domnguez and Rosado "must have known" about the risks of margin calls and the devastating effect they could have on PRIBANK. Unfortunately for the plaintiffs, these are precisely the types of inferences which this court, on numerous occasions, has determined to be inadequate to withstand Rule 9(b) scrutiny. See Shaw, 82 F.3d at 1223; Serabian v. Amoskeag Bank Shares, 24 F.3d 357, 367 (1st Cir.1994); Greenstone, 975 F.2d at 26; Romani, 929 F.2d at 878.7
After the district court's opinion issued in this case, the plaintiffs filed a motion for leave to amend the pleadings. The court denied this motion. However, before ruling on defendants' motions to dismiss, the district court had issued a perplexing margin order amending this case's briefing schedule. According to the margin order, any motion requesting leave to amend pleadings and amended pleadings could be filed ten days after the court resolved all "pending pleadings." While the meaning of the phrase "pending pleadings" is unclear, plaintiffs argue that the phrase referred to the pending motions to dismiss, and that the denial of their subsequent request for leave to amend was therefore an abuse of discretion.8
Looking at the order itself does not resolve our uncertainty about its interpretation. The motion that was granted via margin order was five pages long. It was entitled "Plaintiffs' Objections and Proposed Changes to Scheduling Order" and generally consisted of very ordinary requests for extensions of time. Buried on the third page, however, was a short paragraph containing the vague and confusing language sampled above, which could be interpreted as a request for a highly unconventional scheduling change. When the district court judge granted the motion, he did so by writing "granted" in the left margin of the first page, as is customary in district courts. It is entirely possible that the judge was unaware of the unusual and arguably improper request that he was supposedly granting along with the standard extensions contained in the motion. However, while the motion filed by the plaintiffs was unclear, it could not be fairly characterized as deceptive. Since no motion to reconsider this margin order was filed, and no clarification or amendment to the order issued from the court, we must give the order its reasonable construction.
This court is asked to determine the meaning, propriety, and effect of the margin order. Depending upon the interpretation of the motion, two bedrock principles of civil procedure may conflict in this case. On the one hand, a district court cannot allow an amended pleading where a final judgment has been rendered unless that judgment is first set aside or vacated pursuant to Fed.R.Civ.P. 59 or 60. See Acevedo-Villalobos v. Hernandez, 22 F.3d 384, 389 (1st Cir.1994). On the other hand, the district court's scheduling order purportedly allowed plaintiffs just such a luxury, and, if it did, they were entitled to rely on that order. See Berkovitz v. Home Box Office, Inc., 89 F.3d 24, 29-30 (1st Cir.1996) ("[W]hen a court charts a procedural route, lawyers and litigants are entitled to rely on it.").
Under these circumstances, we are keenly interested in the district court's interpretation of its own order. On review, we cannot hope to understand the nuances of a district court's briefing schedule as completely as the judge who managed the case. There may well have been comments made in scheduling conferences which clarified the order. Unfortunately, the plaintiffs never raised this issue below. Plaintiffs' request for leave to amend was part of its motion to reconsider the dismissal of its claims, and it contained no mention of the margin order or plaintiffs' understanding that they had been promised a leave to amend. This failure to raise the issue before the district court is fatal to the claim on appeal. See Villafane-Neriz v. F.D.I.C., 75 F.3d 727, 734 (1st Cir.1996). We must be especially vigilant in applying this rule where the dispute involves an understanding reached by the parties and the district court during the pre-trial stages of a case.
There exists no private right of action under section 17(a) of the 1933 Act, and section 12(2) of the Act does not apply to the issuance of securities under the circumstances presented by this case. See supra Sections II & III. No further factual allegations can save these claims. Furthermore, while the 10(b) action could survive dismissal if plaintiffs could provide more specific allegations of fact which strongly imply a fraudulent intent on the part of Domnguez and Rosado, the proposed amendments to the complaint would not do so. Plaintiffs provide an expert's affidavit concluding that defendants would have known of the likelihood that their securities would be subject to margin calls, and the devastating effect that this would have on PRIBANK. Yet, as we have stated, the pleading of scienter "may not rest on a bare inference that a defendant 'must have had' knowledge of the facts." Greenstone, 975 F.2d at 26 (quoting Barker, 797 F.2d at 497).9 We conclude that the amended 10(b) claim would not have passed 9(b) scrutiny.10
According to 15 U.S.C. § 77l(a)(2):
Any person who ... offers or sells a security ... by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable ... to the person purchasing such security from him, who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, upon the tender of such security, or for damages if he no longer owns the security.
Plaintiffs maintain that Domnguez' statements could form the basis of section 12(2) claims in spite of the fact that they did not appear in the prospectus, because section 12(2) applies more broadly to initial public offerings which are exempted from SEC registration--in this case due to the "intrastate" character of PRIBANK's offering. By concluding that PRIBANK's stock was placed privately, we need not reach this issue
Under section 10(b) of the 1934 Act:
Even if plaintiffs wish to prove scienter by "recklessness," they still must allege, with sufficient particularity, that defendants had full knowledge of the dangers of their course of action and chose not to disclose those dangers to investors. See Cook, 573 F.2d at 692
In December 1995, citing "abuse in private securities lawsuits," Congress enacted the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). 15 U.S.C. § 78u-4 (1988 & Supp.1995). This Act implemented a "heightened" pleading standard under federal securities law which requires that factual allegations be of sufficient particularity to give rise to a strong inference that the defendant acted with the requisite state of mind. 15 U.S.C. § 78u-4(b)(1). Although the Reform Act does not retroactively apply to this case, we do not interpret the new standard to differ from that which this court has historically applied. See Greenstone, 975 F.2d at 22
Plaintiffs urge this court to adopt a new means for testing whether scienter has been properly pled in 10(b) claims. According to plaintiffs, the Second Circuit's "motive and opportunity" test properly screens out those claims which lack the requisite specificity to proceed with discovery. See, e.g., Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir.1996) (determining whether defendants had the motive and opportunity to commit fraud); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d. Cir.1994) (same). It is unclear whether this test is compatible with this circuit's "especially rigorous" application of Rule 9(b) in the securities fraud context. In any case, this court has had the opportunity to develop a framework for analyzing the sufficiency of pleadings in cases similar to the present one, and we respectfully decline the invitation to review or adopt Second Circuit case law on this issue. Cf. Bruce G. Vanyo, Lloyd Winawer & David Priebe, The Pleading Standard of the Private Securities Litigation Reform Act of 1995, PLI Corp. Law & Practice Course Handbook Series, Sept. 1997, 71-81, available in Westlaw at 1015 PLI/Corp. 71 (chronicling how Congress expressly rejected the Second Circuit's "motive and opportunity" test for pleading scienter in the Reform Act because it was incompatible with the Act's heightened pleading requirements)
The complaint contains additional allegations that Domnguez and Rosado knew that PRIBANK was disintegrating at the same time that they presented a rosy picture to investors at the February board meeting. However, these allegations involve activity occurring well after the original sale of PRIBANK stock, and are therefore immaterial for the purposes of this 10(b) cause of action. See Gross, 93 F.3d at 993 (citing Shaw, 82 F.3d at 1222, for the proposition that allegations of conduct occurring after sale or exchange at issue in 10(b) claim are irrelevant). Even if the allegations are true, the fact that Domnguez and Rosado had discovered PRIBANK's fatal flaw before the February board meeting is not probative of any attempt to defraud the plaintiffs months earlier
We note that a motion to dismiss is not a "pleading" as the term is defined in Fed.R.Civ.P. 7. Furthermore, the order does not promise to grant any motions filed after the resolution of "pending pleadings," but instead states that such requests and pleadings may be filed. Nonetheless, we believe that plaintiffs' interpretation of the order as a blank check to rewrite the complaint after the case has been dismissed is not entirely implausible
Furthermore, this affidavit, along with plaintiffs' other documentary evidence in support of their request for leave to amend, indicates that Domnguez and Rosado invested and lost one and a half million dollars of their own money in PRIBANK, which undermines any inference of scienter
Plaintiffs also argue that they filed requests for leave to amend their complaint prior to the resolution of the motions to dismiss. We find that these "motions" were never actually filed. Instead, the plaintiffs, in other filings, merely mentioned that, at some point, they would seek leave to amend. That leave was not sought until after the case was dismissed. In any case, the issue is mooted by our finding that amending the complaint would be futile