Maldonado v. Dominguez
Procedural entryThis page is a short order in Maldonado v. Dominguez. Read the opinion of the Court — 137 F.3d 1 →
Opinion
USCA1 Opinion
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
____________________
No. 97-1345
MIGUEL MALDONADO, ET AL.,
Plaintiffs - Appellants,
v.
RAMON DOMINGUEZ, ET AL.,
Defendants - Appellees.
____________________
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF PUERTO RICO
[Hon. Jos Antonio Fust , U.S. District Judge] ___________________
____________________
Before
Torruella, Chief Judge, ___________
Cyr, Senior Circuit Judge, ____________________
and DiClerico, Jr.,* District Judge. ______________
_____________________
Hilda Surillo-Pe a, with whom Jaime Sifre-Rodr guez, Luis A. __________________ _____________________ _______
Mel ndez-Albizu and S nchez-Betances & Sifre were on brief for _______________ _________________________
appellants.
Jorge P rez-D az, with whom Pietrantoni M ndez & Alvarez was ________________ ____________________________
on brief for Dean Witter Reynolds, Inc.
Amanda Acevedo-Rhodes, with whom Luz Ivette Rivera and Luz _____________________ _________________ ___
Ivette Rivera & Asociados were on brief for appellee Ram n ____________________________
Dom nguez.
____________________
February 27, 1998
____________________
____________________
* Of the District of New Hampshire, sitting by designation.
TORRUELLA, Chief Judge. Plaintiffs invested in and TORRUELLA, Chief Judge. ___________
became directors of a corporation called the Puerto Rico
International Bank ("PRIBANK"), which was designed to create huge
profits for its investor-directors by leveraging its collateral
with low interest loans in order to purchase higher interest
mortgage obligations. When PRIBANK failed, the plaintiffs
brought this suit, claiming that the investment bankers marketing
the PRIBANK stock defrauded them by failing to mention the
possibility that PRIBANK's securities would be "called" in the
event of an interest rate adjustment. The investors filed this
suit under sections 12(2) and 17(a) of the Securities Act of
1933, 15 U.S.C. 77l, 77q, as well as section 10(b) of the
Securities Act of 1934, 15 U.S.C. 78j, and Rule 10(b)(5) of the
Securities and Exchange Commission ("SEC") promulgated
thereunder. The district court dismissed all of these claims on
a motion to dismiss. We affirm.
BACKGROUND BACKGROUND __________
In addressing a 12(b)(6) motion, we must accept all
well-pleaded facts as true and accord the plaintiff the benefit
of all reasonable inferences. See LeBlanc v. Great Am. Ins. Co., ___ _______ __________________
6 F.3d 836, 841 (1st Cir. 1993). The following recitation of
this case's background reflects this standard.
Plaintiffs Miguel Maldonado, et al. -- important
clients of Dean Witter Reynolds, Inc. of Puerto Rico ("Dean
Witter") -- received mailed invitations to a meeting at an
exclusive San Juan club where they would be presented with a
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select investment opportunity. At the August 30, 1993 meeting,
Ram n Dom nguez, Senior Vice-President and Sales Manager of Dean
Witter, made a presentation regarding the formation of PRIBANK, a
new corporation. He explained PRIBANK's investment philosophy,
and stated that individual investors' participation would be
limited to ten blocks of $350,000, with an additional $1.5
million coming from himself and Antonio Luis Rosado -- Vice
President of Santander National Bank, and president-to-be of
PRIBANK. Each investor would become a director of the
corporation. According to Dom nguez, PRIBANK was a virtually
risk-free investment which was projected to return 176% of the
investors' principal in only two years.
PRIBANK's strategy was relatively simple. PRIBANK
would use $5 million of collateral to open margin accounts of
almost $300 million with various brokerage houses. PRIBANK would
be permitted to leverage itself through these brokerage houses
for 60 times its capital because it had the credit of Dean Witter
to back it up and because funds provided to PRIBANK on its margin
accounts were not allowed to be used for the purchase of credit
risk assets. In other words, PRIBANK would be seen by the
brokerage houses as a safe entity because its investments would
be low risk and its credit with Dean Witter was trusted.
The money in PRIBANK's margin accounts would be used to
purchase Real Estate Mortgage Investment Conduits ("REMICs") and
Collateralized Mortgage Obligations ("CMOs"), effectively making
PRIBANK the lender for numerous home mortgages. These REMICs and
-3-
CMOs would pay interest to PRIBANK at a higher rate than PRIBANK
was required to pay to the brokerage houses for the money in its
margin accounts. The difference between the low interest rate
PRIBANK would be paying and the higher interest rate PRIBANK
would be collecting -- the "spread" -- would be PRIBANK's profit.
Since PRIBANK was able to borrow approximately 60 times more than
its collateral, a spread of only 1 percent would have resulted in
huge profits for PRIBANK's investors.
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USCA1 Opinion
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
____________________
No. 97-1345
MIGUEL MALDONADO, ET AL.,
Plaintiffs - Appellants,
v.
RAMON DOMINGUEZ, ET AL.,
Defendants - Appellees.
____________________
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF PUERTO RICO
[Hon. Jos Antonio Fust , U.S. District Judge] ___________________
____________________
Before
Torruella, Chief Judge, ___________
Cyr, Senior Circuit Judge, ____________________
and DiClerico, Jr.,* District Judge. ______________
_____________________
Hilda Surillo-Pe a, with whom Jaime Sifre-Rodr guez, Luis A. __________________ _____________________ _______
Mel ndez-Albizu and S nchez-Betances & Sifre were on brief for _______________ _________________________
appellants.
Jorge P rez-D az, with whom Pietrantoni M ndez & Alvarez was ________________ ____________________________
on brief for Dean Witter Reynolds, Inc.
Amanda Acevedo-Rhodes, with whom Luz Ivette Rivera and Luz _____________________ _________________ ___
Ivette Rivera & Asociados were on brief for appellee Ram n ____________________________
Dom nguez.
____________________
February 27, 1998
____________________
____________________
* Of the District of New Hampshire, sitting by designation.
TORRUELLA, Chief Judge. Plaintiffs invested in and TORRUELLA, Chief Judge. ___________
became directors of a corporation called the Puerto Rico
International Bank ("PRIBANK"), which was designed to create huge
profits for its investor-directors by leveraging its collateral
with low interest loans in order to purchase higher interest
mortgage obligations. When PRIBANK failed, the plaintiffs
brought this suit, claiming that the investment bankers marketing
the PRIBANK stock defrauded them by failing to mention the
possibility that PRIBANK's securities would be "called" in the
event of an interest rate adjustment. The investors filed this
suit under sections 12(2) and 17(a) of the Securities Act of
1933, 15 U.S.C. 77l, 77q, as well as section 10(b) of the
Securities Act of 1934, 15 U.S.C. 78j, and Rule 10(b)(5) of the
Securities and Exchange Commission ("SEC") promulgated
thereunder. The district court dismissed all of these claims on
a motion to dismiss. We affirm.
BACKGROUND BACKGROUND __________
In addressing a 12(b)(6) motion, we must accept all
well-pleaded facts as true and accord the plaintiff the benefit
of all reasonable inferences. See LeBlanc v. Great Am. Ins. Co., ___ _______ __________________
6 F.3d 836, 841 (1st Cir. 1993). The following recitation of
this case's background reflects this standard.
Plaintiffs Miguel Maldonado, et al. -- important
clients of Dean Witter Reynolds, Inc. of Puerto Rico ("Dean
Witter") -- received mailed invitations to a meeting at an
exclusive San Juan club where they would be presented with a
-2-
select investment opportunity. At the August 30, 1993 meeting,
Ram n Dom nguez, Senior Vice-President and Sales Manager of Dean
Witter, made a presentation regarding the formation of PRIBANK, a
new corporation. He explained PRIBANK's investment philosophy,
and stated that individual investors' participation would be
limited to ten blocks of $350,000, with an additional $1.5
million coming from himself and Antonio Luis Rosado -- Vice
President of Santander National Bank, and president-to-be of
PRIBANK. Each investor would become a director of the
corporation. According to Dom nguez, PRIBANK was a virtually
risk-free investment which was projected to return 176% of the
investors' principal in only two years.
PRIBANK's strategy was relatively simple. PRIBANK
would use $5 million of collateral to open margin accounts of
almost $300 million with various brokerage houses. PRIBANK would
be permitted to leverage itself through these brokerage houses
for 60 times its capital because it had the credit of Dean Witter
to back it up and because funds provided to PRIBANK on its margin
accounts were not allowed to be used for the purchase of credit
risk assets. In other words, PRIBANK would be seen by the
brokerage houses as a safe entity because its investments would
be low risk and its credit with Dean Witter was trusted.
The money in PRIBANK's margin accounts would be used to
purchase Real Estate Mortgage Investment Conduits ("REMICs") and
Collateralized Mortgage Obligations ("CMOs"), effectively making
PRIBANK the lender for numerous home mortgages. These REMICs and
-3-
CMOs would pay interest to PRIBANK at a higher rate than PRIBANK
was required to pay to the brokerage houses for the money in its
margin accounts. The difference between the low interest rate
PRIBANK would be paying and the higher interest rate PRIBANK
would be collecting -- the "spread" -- would be PRIBANK's profit.
Since PRIBANK was able to borrow approximately 60 times more than
its collateral, a spread of only 1 percent would have resulted in
huge profits for PRIBANK's investors.
A further property of PRIBANK's investment structure
made it unique. PRIBANK would only purchase investments called
"floaters," which would be re-priced and adjusted for prevailing
interest rates every thirty days. Every thirty days, PRIBANK
would collect interest on these investments. PRIBANK planned to
carefully structure its investments so that each month, on the
same day that interest payments were due to the brokerage houses,
PRIBANK would also collect interest on its investments.
Dom nguez labelled this as "matching."
This would give PRIBANK an advantage over normal
financial institutions which purchased floating REMICS and CMOs
without this perfect matching. Normal financial institutions _______
have mismatched inventories, and have to keep reserves on hand to
account for withdrawals and to pay obligations when they come
due. The higher interest rates these institutions make on their
loans barely make up for the potential interest lost on the money
sitting in their reserves at any given time. However, due to its
perfect matching, PRIBANK would not be required to keep any
-4-
significant reserves on hand, and could invest all of its money
every month, enabling it to take full advantage of the spread in
interest rates. Therein lay the key to PRIBANK's philosophy, and
eventually to its downfall.
Dom nguez explained that PRIBANK's goal was to make
money based upon the interest rate spread, and yet insulate
itself from any changes in interest rates. Whether rates went up
or down, the spread would always remain. What Dom nguez failed
to explain to the investors was that PRIBANK was not a risk-free,
or even a low-risk investment. Instead, PRIBANK would be engaged
in highly leveraged margin trading, and, like any margin trader,
PRIBANK's investments could be subject to "margin calls." That
is, if interest rates went up, the value of REMICs and CMOs (and
other loan obligations) would go down, and brokerage houses could
require investors to put up more collateral to cover the paper
loss. Margin calls do not necessarily occur on the same day that
investments are adjusted and repriced -- at the 30-day mark in
PRIBANK's case -- but can occur at any time after the value of
the investments falls. PRIBANK, which was designed to profit by
having no reserves, would not be able to cover any margin calls.
Therefore, any significant hike in interest rates could bankrupt
PRIBANK, and its investors would lose their investments.
This significant risk was not disclosed to investors at
the August 30, 1993 meeting. Instead, investors were told that
fluctuating interest rates would pose no threat to PRIBANK's
profitability. The investors believed that Dom nguez and Rosado
-5-
had struck upon a scheme whereby they could make huge profits for
little or no risk. They invested $350,000 each in exchange for a
5.5% share of PRIBANK and a seat on the board. Dom nguez and
Rosado made commissions on this $3.5 million of investments.
PRIBANK began operations in January 1994.
On February 4, 1994, the Federal Reserve increased
interest rates by 1/4 point. This increase was the first of
several increases which were to occur in future weeks. Brokerage
houses soon began to make margin calls. To meet the margin
calls, PRIBANK was required to sell investments before their
agreed-upon settlement dates, resulting in significant penalties.
As one margin call was being paid off, another loan would be
called, and PRIBANK would scramble to sell another investment,
incurring more penalties, and draining PRIBANK's original $5
million collateral.
In the midst of this collapse, on February 23, 1994,
PRIBANK held a meeting of the board. At the meeting, Dom nguez
presented a picture of a smoothly-running operation, pointing out
promising investments that PRIBANK was looking into and failing
to mention the fact that PRIBANK was already experiencing margin
calls and sustaining losses. Soon after this meeting, PRIBANK
lost its remaining assets and its stock became worthless.
The present suit was brought before the District Court
of Puerto Rico under the Securities Act of 1933, 15 U.S.C. 77
(the "1933 Act" or "Securities Act"), and the Securities Act of
1934, 15 U.S.C. 78 (the "1934 Act" or "Exchange Act").
-6-
Plaintiffs allege that fraudulent statements and omissions were
made by Dom nguez and Rosado, and further allege vicarious
liability on the part of Dean Witter. The district court
dismissed all claims on Rule 12(b)(6) motions. This appeal
followed.
On appeal, plaintiffs make a number of claims. First,
they argue that, to the extent that the district court converted
any of the Rule 12(b)(6) motions into motions for summary
judgment under Rule 56(c), plaintiffs received inadequate notice
and opportunity to submit evidence. At issue is both whether
such a conversion actually occurred and whether a conversion
would have been appropriate at that stage of the case.
Plaintiffs next claim that the district court erred in
finding that there is no implied private cause of action under
section 17(a) of the 1933 Act. Plaintiffs urge this court to
recognize such a cause of action.
Plaintiffs further contend that the district court
erred in concluding that PRIBANK stock was privately offered.
The character of PRIBANK's offering became material to the case
when, shortly after this complaint was filed, the Supreme Court
decided Gustafson v. Alloyd Co., 513 U.S. 561, 577-78 (1995), _________ ___________
holding that section 12(2) of the 1933 Act did not apply to
private offerings.
Next, plaintiffs argue that their claim under section
10(b) of the 1934 Act -- and Rule 10b-5 of the Securities and
Exchange Commission promulgated thereunder -- was pled with
-7-
sufficient particularity. Specifically, they contest the
district court's ruling that they had failed to plead specific
facts which create a triable question on the issue of defendants'
"scienter."
-8-
Finally, plaintiffs claim that the district court
abused its discretion in denying their request for leave to file
an amended complaint after the district court entered judgment.
The argument stems from the district court's issuance of a margin
order which indicated that this seemingly tardy request for leave
would be granted. We address these arguments in turn.
ANALYSIS ANALYSIS ________
I. Conversion of 12(b)(6) Motions I. Conversion of 12(b)(6) Motions
Plaintiffs allege that the district court improperly
converted the series of 12(b)(6) motions at issue into motions
for summary judgment pursuant to Fed. R. Civ. P. 56(c).
Plaintiffs argue that such a conversion is necessarily improper
where defendants have offered no materials outside the pleadings
and where the court has not given express notice of its intent to
convert the motions. As a matter of law, plaintiffs are correct.
However, a close reading of the district court opinion reveals
that the court dismissed these claims based solely on the
insufficiency of the pleadings, and we affirm on those grounds.
In Moody v. Town of Weymouth, 805 F.2d 30, 31 (1st Cir. _____ ________________
1986), we held that when a district court fails to give express
notice to the parties of its intention to convert a 12(b)(6)
motion into a motion for summary judgment, there is no reversible
error if the party opposing the motion (1) has received materials
outside the pleadings, (2) has had an opportunity to respond to
them, and (3) has not controverted their accuracy. The Moody _____
"exception" to the rule that the district court must notify the
-9-
parties of an intent to convert motions is limited, and unless
the three factors listed above are present the exception does not
apply. See Cooperativa de Ahorro y Cr dito Aguada v. Kidder, ___ ________________________________________ _______
Peabody & Co., 993 F.2d 269, 273 (1st Cir. 1993) (in deciding a ______________
12(b)(6) motion, a district court normally must either ignore
extraneous materials or give the parties notice and an
opportunity to respond to the conversion to a summary judgment
motion). In the present case, the plaintiffs filed a detailed
pleading with several documentary exhibits. Defendants argue
that this fact alone put plaintiffs on notice that any 12(b)(6)
motion could be converted into a 56(c) motion for summary
judgment. This argument fundamentally misinterprets Moody and _____
therefore fails.
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
-10-
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 II. Section 17(a) of the 1933 Act
The district court dismissed one of the plaintiffs'
claims after concluding that there was no implied private cause
of action under section 17(a) of the 1933 Act. We agree.
Section 17 of the 1933 Act provides that:
It shall be unlawful for any person in the
offer or sale of any securities by the use of
any means or instruments of transportation or
communication in interstate commerce or by
theuse of the mails, directly or indirectly -
(1) to employ any device, scheme, or artifice
to defraud, or
(2) to obtain money or property by means of
any untrue statement of a material fact or
any omission to state a material fact
necessary in order to make the statements
made, in the light of the circumstances under
which they were made, not misleading, or
(3) to engage in any transaction, practice or
course of business which operates or would
operate as a fraud or deceit upon the
purchaser.
15 U.S.C. 77(q). 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 ___ _____________________
-11-
Richards, Inc. v. Berner, 472 U.S. 299, 304 n.9 (1985). Until ______________ ______
today, neither had this court. See Cleary v. Perfectune, Inc., ___ ______ ________________
700 F.2d774, 779 (1stCir. 1983)(declining to reachthis 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. 385-87 ___ __________________ __________
(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 (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 Am. 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).
-12-
However, in Aaron v. SEC, 446 U.S. 680, 695-97 (1980), _____ ___
the Supreme Court held that, unlike section 10(b) of the Exchange
Act, section 17(a) of the Securities Act does not require proof
of scienter. Thus, while the implied cause of action under 10(b)
would expose only the deceitful to private causes of action, an
implied cause of action under 17(a) would impose such liability
on merely negligent wrongdoers. Furthermore, the Court had ruled
four years earlier that a judicially created cause of action,
such as the one implied under section 10(b), could not be
extended to actions premised on negligent wrongdoing. See Ernst ___ _____
& Ernst v. Hochfelder, 425 U.S. 185, 210 (1976). _______ __________
Aaron and Ernst highlighted for courts a significant _____ _____
distinction between implying private causes of action under the
two sections. While the 10(b) implied cause of action has
continued to enjoy unanimous recognition and the imprimatur of a
unanimous Supreme Court in Huddleston, the 17(a) cause of action __________
has been held up to renewed scrutiny. In recent years, every
circuit to have addressed the issue has refused to recognize a
private right of action under section 17(a), including four
circuits which originally had held otherwise. See Finkel v. ___ ______
Stratton Corp., 962 F.2d 169, 174-75 (2d Cir. 1992) (noting that ______________
Kirshner v. United States, 603 F.2d 234 (2d Cir. 1978), had been ________ _____________
overruled); Newcome v. Esrey, 862 F.2d 1099, 1101-07 (4th Cir. _______ _____
1988) (overruling Newman v. Prior, 518 F.2d 97 (4th Cir. 1975)); ______ _____
Stephenson v. Paine Webber Jackson & Curtis, Inc., 839 F.2d 1095, __________ ___________________________________
1100 (5th Cir.); Schlifke v. Seafirst Corp., 866 F.2d 935, 942-43 ________ ______________
-13-
(7th Cir. 1989)(overruling Daniel v. Teamsters, 561 F.2d 1223 ______ _________
(7th Cir. 1977), rev'd on other grounds, 439 U.S. 551 (1979)); _______________________
Deviries v. Prudential-Bache Sec., Inc., 805 F.2d 326, 328 (8th ________ ___________________________
Cir. 1986); Puchall v. Houghton, Cluck, Coughlin & Riley (In re _______ __________________________________ _____
Washington Pub. Power Supply Sys. Sec. Litig.), 823 F.2d 1349, _______________________________________________
1350 (9th Cir. 1987) (overruling Mosher v. Kane, 784 F.2d 1385 ______ ____
(9th Cir. 1986); Stephenson v. Calpine Conifers II, Ltd., 652 __________ __________________________
F.2d 808, 815 (9th Cir. 1981)); Zink v. Merrill Lynch Pierce ____ _____________________
Fenner & Smith, Inc., 13 F.3d 330, 334 (10th Cir. 1993); Currie ____________________ ______
v. Cayman Resources Corp., 835 F.2d 780, 784-85 (11th Cir. 1988). ______________________
We now come to the same conclusion.
In determining whether an implied private right of
action exists in a statute, we look to congressional intent, see ___
Touche Ross, 442 U.S. at 574-76, keeping in mind that there is a ___________
strong presumption against such inferences. See Sterling Suffolk ___ ________________
Racecourse v. Burrellville Racing, 989 F.2d 1266, 1268 (1st Cir. __________ ___________________
1993). In this case, we do not find sufficient evidence of
congressional intent to overcome the presumption. As the
district court observed, Congress explicitly provided for private __________
causes of action in sections 11 and 12 of the 1933 Act. While
the fact that other provisions of a complex statutory scheme
create express remedies does not in itself prove that Congress
did not imply a private remedy in another section, see Cannon v. ___ ______
University of Chicago, 441 U.S. 677, 690 n.13 (1979), where the _____________________
explicit remedies in the same statute address much of the same
conduct and benefit the same parties as a potential implied
-14-
private cause of action, the circumstances militate against that
inference. Furthermore, the legislative history of section 17(a)
does not, on the whole, favor an implied private right of action.
See Newcome, 862 F.2d at 1103-07 (conducting an in-depth ___ _______
examination of the legislative history of this provision).
Therefore, the district court did not err in dismissing the
plaintiffs' claim under section 17(a) of the 1933 Act.
III. Section 12(2) of the 1933 Act 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
____________________
1 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.
-15-
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 (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 (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. ___ ______________
-16-
In this case, twelve invitations were sent to Dean
Witter clients. Dom nguez 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.
Section 12(2) of the 1933 Act protects those investors
who would otherwise be powerless against fraudulent offers of
securities. When a select group of investors are asked to become
directors of a new corporation, and have access to all documents
relevant to the corporation's formation and investments, they
cannot bring suit under section 12(2) when the corporation fails
for the reasons claimed in this suit. Let us be clear. We do
not mean to suggest that a director has no remedy when defrauded
by others within a new corporation, but only that, under
Gustafson, section 12(2) of the 1933 Act is not available to this _________
class of claimants. Under these circumstances, there was no need
to allow leave to amend the pleadings on this issue. We
therefore affirm the district court's dismissal of this claim
under Rule 12(b)(6).2
____________________
2 Plaintiffs maintain that Dom nguez' 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
-17-
IV. Section 10(b) of the 1934 Act (SEC Rule 10b-5) 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. Plaintiffs allege ___ _____
that Dom nguez and Rosado understood and concealed the risks of
margin calls on the PRIBANK investments.
This circuit has been clear and consistent in holding
____________________
PRIBANK's offering. By concluding that PRIBANK's stock was
placed privately, we need not reach this issue.
3 Under section 10(b) of the 1934 Act:
It shall be unlawful for any person, directly
or indirectly, by the use of any means or
instrumentality of interstate commerce or of
the mails, or of any facility of any national
securities exchange--
(b) To use or employ, in connection with the
purchase or sale of any security registered
on a national securities exchange or any
security not so registered, any manipulative
or deceptive device or contrivance in
contravention of such rules and regulations
as the Commission may prescribe as necessary
or appropriate in the public interest or for
the protection of investors.
15 U.S.C. 78j.
-18-
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 Equip. Corp., ____ _____________________
82 F.3d 1194, 1223 (1st Cir. 1996) (quoting Romani v. Shearson, ______ _________
____________________
4 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. ____
5 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. ___ __________
-19-
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 Dom nguez and Rosado
____________________
6 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).
-20-
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 Dom nguez 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 Dom nguez 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 Dom nguez 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)
-21-
scrutiny. See Shaw, 82 F.3d at 1123; 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 ______
V. Leave to Amend the Complaint V. Leave to Amend the Complaint
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
____________________
7 The complaint contains additional allegations that Dom nguez
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 Dom nguez 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.
8 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' _____
-22-
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
____________________
interpretation of the order as a blank check to rewrite the
complaint after the case has been dismissed is not entirely
implausible.
-23-
been rendered unless that judgment is first set aside or vacated
pursuant to Fed. R. Civ. P. 59 or 60. See Acevedo-Villalobos v. ___ __________________
Hern ndez, 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.").
-24-
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 ___
Villafa e-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.
In any case, we need not remand this case to allow for
a revision of the complaint because the amendments proposed by
the plaintiffs would be futile. See Foman v. Davis, 371 U.S. 178 ___ _____ _____
(1962) (leave to amend shall not be granted where amendments
would be futile); Resolution Trust Corp. v. Gold, 30 F.3d 251, _______________________ ____
253 (1st Cir. 1994) (same). In their request for leave to amend,
and again before this court, plaintiffs allude to the factual
allegations which they would incorporate into an amended
complaint, producing detailed documentary evidence for support.
Nonetheless, a careful review of this material reveals that these
-25-
amended claims would be destined for dismissal.
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 Dom nguez 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
____________________
9 Furthermore, this affidavit, along with plaintiffs' other
documentary evidence in support of their request for leave to
amend, indicates that Dom nguez and Rosado invested and lost one
and a half million dollars of their own money in PRIBANK, which __________________
undermines any inference of scienter.
10 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.
-26-
CONCLUSION CONCLUSION __________
For the reasons stated in this opinion, we affirm the affirm ______
judgment of the district court.
-27-
Maldonado v. Dominguez, (1st Cir. 1998).
Maldonado v. Dominguez (Maldonado v. Dominguez) — published by Counsel Stack Legal Research, free access to 12M+ legal documents.
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