Maldonado v. Dominguez ( 1998 )


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    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


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    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


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    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


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    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").


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    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


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    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."














































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    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


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    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


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    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 ___ _____________________


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    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).


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    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 ________ ______________


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    (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


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    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.




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    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. ___ ______________


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    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

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    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.

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    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-






Document Info

Docket Number: 97-1345

Filed Date: 3/2/1998

Precedential Status: Precedential

Modified Date: 3/3/2016

Authorities (35)

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Shaw v. Digital Equipment Corp. , 82 F.3d 1194 ( 1996 )

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Richard M. Moody v. Town of Weymouth , 805 F.2d 30 ( 1986 )

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Berkovitz v. Home Box Office, Inc. , 89 F.3d 24 ( 1996 )

Acevedo Villalobos v. Hon. Hernandez , 22 F.3d 384 ( 1994 )

Serabian v. Amoskeag Bank Shares, Inc. , 24 F.3d 357 ( 1994 )

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