Richard F. Thompson v. Relationserve Media, Inc. ( 2010 )

[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT FILED
________________________ U.S. COURT OF APPEALS
ELEVENTH CIRCUIT
No. 07-13225 JUNE 30, 2010
________________________ JOHN LEY
CLERK
D. C. Docket No. 06-61327-CV-PCH
RICHARD F. THOMPSON,
Plaintiff,
L. ALAN JACOBY,
Plaintiff-Appellant
Cross-Appellee,
versus
RELATIONSERVE MEDIA, INC.,
a.k.a. SendTec, Inc.,
Defendant-Appellee,
DANIELLE KARP,
Defendant-Appellee
Cross-Appellant,
MANDEE HELLER ADLER,
WARREN “PETE” MUSSER,
SCOTT YOUNG, et al.,
Defendants-Appellees.
________________________
Appeals from the United States District Court
for the Southern District of Florida
_________________________
(June 30, 2010)
Before TJOFLAT and BLACK, Circuit Judges, and EVANS,* District Judge.
BLACK, Circuit Judge:
This case comes to us as an appeal from the dismissal of appellant L. Alan
Jacoby’s putative class action lawsuit. In his Second Amended Complaint, Jacoby
alleged RelationServe Media, Inc.1 and eleven of its directors and employees2
violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by failing
*
Honorable Orinda D. Evans, United States District Judge for the Northern District of
Georgia, sitting by designation.
1
The principal defendant in this case, RelationServe Media, Inc. (RelationServe), is an
internet marketing firm that maintains its principal place of business in Fort Lauderdale, Florida.
RelationServe and Chubasco Resources Corporation merged on June 13, 2005. Following the
merger, Chubasco Resources Corporation changed its name to RelationServe. On July 26, 2006,
RelationServe changed its name to SendTec, Inc. For purposes of this opinion, we refer to
SendTec, Inc. as RelationServe.
2
These defendants, with the exception of one, are (or were) officers and/or directors of
RelationServe (Officers). Between June 2005 and February 2006, Danielle Karp served as
President, Scott Hirsch served as Chief Operating Officer, and Adam Wasserman served as
Chief Financial Officer (CFO). Eric Obeck has served as President since February 2006.
Mandee Adler served as Chief Executive Officer (CEO) between June 2005 and November
2005, followed by Shawn McNamara as interim CEO and Vice President until June 2006. In
February 2006, Paul Soltoff became CEO, and Donald Gould became CFO. Warren Musser was
appointed Chairman of the Board of Directors in June 2005 and served until October 2005, at
which point Michael Brausser became Chairman of the Board and served until September 2006.
Scott Young was the founder and president of Chubasco and served in that capacity until June
13, 2005.
2
to disclose, before the company went public, that $2,000,000 in stock had been
privately offered for sale by unregistered brokers in ten different states. In the
district court, Jacoby joined co-plaintiff Richard Thompson, who had previously
initiated this action. Thompson represented a subclass seeking recovery premised
on state law claims in the Second Amended Complaint. After twice allowing the
plaintiffs to amend their complaint, the district court dismissed with prejudice
Jacoby’s § 10(b) and § 20(a) claims pursuant to Fed. R. Civ. P. 12(b)(6). The
district court found the allegations of the Second Amended Complaint failed to
satisfy the heightened pleading requirements of the Private Securities Litigation
Reform Act (PSLRA)3 and Rule 9(b) of the Federal Rules of Civil Procedure. The
court then dismissed Thompson’s state law claims without prejudice after
concluding it no longer had supplemental jurisdiction over those claims. In
separate orders, on three different occasions, the district court denied defendant
Danielle Karp’s motions for attorneys’ fees and Rule 11 sanctions.
Jacoby appeals the dismissal of his federal securities-law putative class
action. Additionally, Karp cross-appeals the denial of her request for Rule 11
3
The PSLRA applies to private actions seeking relief on the basis of alleged violations
of the Securities Act of 1933 and the Securities Exchange Act of 1934. See 15 U.S.C. § 77z-1(c)
(1933 Act) and 15 U.S.C. § 78u-4(c) (1934 Act).
3
sanctions and attorneys’ fees.4 Because we conclude the Second Amended
Complaint fails to satisfy the standard for pleading scienter, we affirm the district
court’s dismissal of Jacoby’s § 10(b) and § 20(a) claims. With regard to sanctions,
we remand to the district court to make findings in accordance with the PSLRA.
I. FACTUAL ALLEGATIONS 5
On May 24, 2005, RelationServe entered into an Independent Consulting
Agreement with Summit Financial Partners, LLC (Summit). Under the agreement,
Summit sold shares of RelationServe through a private offering to investors in
exchange for 1,050,000 shares of stock and a 7% seller’s fee.
On June 14, 2005, RelationServe filed a Form 10-QSB quarterly statement,
its first Securities and Exchange Commission (SEC) filing, indicating Chubasco
Resources Corporation (Chubasco) had completed a reverse acquisition of
RelationServe. RelationServe Media Inc. Quarterly Report–Small Business (Form
10-QSB), at 5 (June 14, 2005).6 On June 16, 2005, RelationServe filed a Form 8-K
4
Karp also cross-appeals the dismissal of Thompson’s state law claims, contending she
is aggrieved because Thompson re-filed the claims in state court and she “is now facing the same
frivolous allegations.” Thompson’s state court action has subsequently been dismissed with
prejudice, so we decline to consider this aspect of Karp’s cross-appeal.
5
In considering a motion to dismiss, we accept all well-pleaded facts as true, and we
make all reasonable inferences in favor of the plaintiff. Bryant v. Avado Brands, Inc., 187 F.3d
1271, 1273 n.1 (11th Cir 1999)). Because the Second Amended Complaint alleges violations of
securities laws, we may also take judicial notice of relevant SEC filings. Id. at 1278.
6
RelationServe had no duty to file securities filings prior to the merger with Chubasco.
4
and disclosed, for the first time, the Independent Consulting Agreement7 with
Summit. RelationServe Media Inc., Current Report (Form 8-K), at 29 (June 16,
2005).8 On June 28, 2005, twelve days after RelationServe disclosed its
relationship with Summit, Richard F. Thompson, an Indiana resident, purchased
50,000 shares at $2.00 per share. Tony Altavilla, a Summit employee, had advised
Thompson about the private offering and helped facilitate Thompson’s purchase of
the shares. On June 30, 2005, RelationServe became a publicly-traded company
and reported to the SEC it had received $2,000,000 in subscriptions through a
private offering.9 That same day, RelationServe listed its non-restricted shares on
the Over the Counter Bulletin Board. On July 22, July 26, and August 12, 2005, L.
Alan Jacoby purchased a total of 10,000 shares of RelationServe on the open
market.
7
A full copy of the Agreement between RelationServe and Summit was attached to the
SEC filing as an exhibit; this attachment included language which explicitly noted Summit was
not acting as a broker/dealer for RelationServe, but rather serving as a promoter of the company.
8
The Second Amended Complaint omitted any reference to RelationServe’s June 16,
2005, Current Report.
9
The report filed with the SEC disclosed RelationServe “completed a private offering of
Units to ‘accredited investors,’” RelationServe “received and accepted $2,000,000 of
subscriptions in the Offering,” and “[t]he Units were issued in reliance on an exemption from
registration provided under Regulation D of the Securities Act and are restricted securities as
defined by the Securities Act.” RelationServe Media, Inc., Current Report (Form 8-K), at 2
(June 30, 2005).
5
On March 3, 2006, Thompson filed a lawsuit in Indiana state court against
RelationServe and several of the defendants named in this federal action.
Unrelated to this litigation, RelationServe filed a registration statement with the
SEC on March 20, 2006. This statement did not mention the Thompson litigation.
On May 1, 2006, RelationServe amended the registration statement to provide the
public with notice of the lawsuit, and indicated it believed the suit lacked merit. In
response to an inquiry from the SEC requesting more details about the lawsuit,
RelationServe updated its filings on May 23, 2006.10
On May 23, 2006, RelationServe stock was valued at $1.35 per share. Three
weeks later, on June 15, 2006, the stock was valued at $0.63 per share. Jacoby
attributes this decline in value to the public disclosure of Thompson’s lawsuit.
II. PROCEEDINGS IN THE DISTRICT COURT
On August 28, 2006, Thompson initiated this action by filing a class action
in the United States District Court for the Southern District of Florida.
RelationServe and the other defendants moved to dismiss the complaint; the
10
The May 23 amendment stated, in part, “[t]he Company intends to file a motion to
dismiss this action because the shares did not need to be registered under Indiana Law, as they
were exempt from registration as a ‘federal covered security.’” RelationServe Media, Inc.,
Amendment No. 2 to Form SB-2 Registration Statement (Form SB-2/A), at 64-65 (May 23,
2006). The amendment also noted “Mr. Altavilla did not sell shares on the Company’s
behalf[,]” although he “did receive, in addition to other compensation, a finder’s fee in the
amount of 7% of total gross funding provided for introductions made by him to investors not
already having a preexisting relationship with the Company.” Id.6
district court then denied these motions and ordered that Thompson file an
amended complaint. On November 13, 2006, Thompson filed the First Amended
Complaint, which added Jacoby as a co-plaintiff. The defendants again moved to
dismiss, and on March 6, 2007, the district court dismissed the amended complaint
without prejudice.
On March 19, 2007, Thompson and Jacoby filed the Second Amended
Complaint, raising claims for two putative classes: one, led by Thompson, which
included all purchasers of securities through unregistered broker/dealers of
RelationServe, and another, led by Jacoby, which included all purchasers who
bought RelationServe stock on the open market prior to May 23, 2006. Defendants
then moved to dismiss the Second Amended Complaint for failure to state a claim,
and this time the district court granted the motion with prejudice, concluding
Jacoby had failed to state a claim for a violation of either § 10(b) or § 20(a) of the
Securities Act. The district court also dismissed without prejudice Thompson’s
state law claims for lack of subject matter jurisdiction.
Once before and twice after the district court dismissed the Second
Amended Complaint, defendant Karp moved for Rule 11 sanctions and attorneys’
fees, contending the claims against her were frivolous and demonstrated an utter
7
lack of legal or factual investigation. The district court denied the motions in three
separate orders. This appeal and cross-appeal ensued.
III. DISCUSSION
Our discussion is divided into three parts. First, we address whether the
Second Amended Complaint satisfies the standard for pleading scienter. Second,
we address whether the Second Amended Complaint states a claim of secondary
liability under § 20(a). Third, we address the district court’s refusal to impose
Rule 11 sanctions and award attorneys’ fees.
A. Scienter Pleading Requirements
We review the grant of a motion to dismiss for failure to state a claim under
Fed. R. Civ. P. 12(b)(6) de novo. Fin. Sec. Assurance, Inc. v. Stephens, Inc., 500
F.3d 1276, 1282 (11th Cir. 2007).
In Count I, Jacoby asserted a violation of § 10(b) of the Securities Act and
SEC Rule 10b-5. Section 10(b) of the Securities Act makes it unlawful to “use or
employ, in connection with the . . . sale of any security . . . any manipulative or
deceptive device or contrivance.” 15 U.S.C. § 78j(b). Pursuant to § 10(b), the
SEC promulgated Rule 10b-5, which makes it unlawful, among other things, “to
make any untrue statement of a material fact or to omit to state a material fact
8
necessary in order to make the statements made, in the light of the circumstances
under which they were made, not misleading.” 17 C.F.R. § 240.10b-5(b).
To state a claim for a violation of § 10(b), a plaintiff must allege: (1) the
existence of a material misrepresentation (or omission), (2) made with scienter
(i.e., “a wrongful state of mind”), (3) in connection with the purchase or sale of any
security, (4) on which the plaintiff relied, and (5) which was causally connected to
(6) the plaintiff’s economic loss. Dura Pharm. Inc. v. Broudo, 544 U.S. 336, 341-
42, 125 S. Ct. 1627, 1631 (2005); see also Bryant v. Avado Brands, Inc., 187 F.3d
1271, 1281 (11th Cir. 1999) (elaborating on the scienter requirement).11 Because
Rule 10b-5 sounds in fraud, the plaintiff must plead the elements of its violation
with particularity. See Mizzaro v. Home Depot, Inc., 544 F.3d 1230, 1237 (11th
Cir. 2008) (stating Rule 9(b) requires securities fraud complaints “to state with
particularity the circumstances constituting fraud”).
When a § 10(b) claim is brought by a private litigant, it is subject to the
PSLRA, under which a plaintiff must “state with particularity facts giving rise to a
strong inference that the defendant acted with the required state of mind.” 15
U.S.C. § 78u-4(b)(2). In this context, a “strong inference” of scienter is one that is
11
Because we hold the Second Amended Complaint fails to satisfy the standard for
pleading scienter, we do not reach the questions of whether the Second Amended Complaint
adequately pleads the other elements of a § 10(b) claim.
9
“more than merely plausible or reasonable—it must be cogent and at least as
compelling as any opposing inference of nonfraudulent intent.” Tellabs, Inc. v.
Makor Issues & Rights, Ltd., 551 U.S. 308, 314, 127 S. Ct. 2499, 2504-05 (2007).
Three guidelines govern our review: courts must (1) “accept all factual allegations
in the complaint as true,” (2) “consider the complaint in its entirety” and determine
“whether all of the facts alleged, taken collectively, give rise to a strong inference
of scienter,” and (3) “take into account plausible opposing inferences.” Tellabs,
551 U.S. at 322-23, 127 S. Ct. at 2509; see also Rosenberg v. Gould, 554 F.3d 962,
965 (11th Cir. 2009). Moreover, “scienter must be found with respect to each
defendant and with respect to each alleged violation of the statute.” Phillips v.
Scientific-Atlanta, Inc., 374 F.3d 1015, 1017-18 (11th Cir. 2004).
Although the PSLRA imposes a heightened standard for pleading scienter, it
does not alter the substantive intent requirements necessary to establish a § 10(b)
and Rule 10b-5 violation. Mizzaro, 544 F.3d at 1238. In this Circuit, § 10(b) and
Rule 10b-5 require a showing of either an “intent to deceive, manipulate, or
defraud,” or “severe recklessness.” Id. (quoting Bryant, 187 F.3d at 1282). An
allegation of “severe recklessness” must satisfy a demanding standard:
Severe recklessness is limited to those highly unreasonable omissions
or misrepresentations that involve not merely simple or even
inexcusable negligence, but an extreme departure from the standards
of ordinary care, and that present a danger of misleading buyers or
10
sellers which is either known to the defendant or so obvious that the
defendant must have been aware of it.
Bryant, 187 F.3d at 1282 n.18. Accordingly, to survive a motion to dismiss,
Jacoby “must (in addition to pleading all of the other elements of a § 10(b) claim)
plead ‘with particularity facts giving rise to a strong inference’ that the defendants
either intended to defraud investors or were severely reckless when they made the
allegedly materially false or incomplete statements.” Mizzaro, 544 F.3d at 1238.
The Second Amended Complaint alleges RelationServe did not disclose a
broker was involved in the securities sale to hide the fact that RelationServe sold
securities through unregistered brokers. Further, the Second Amended Complaint
asserts this act of hiding RelationServe’s use of a broker “could not have been
perpetrated over a substantial period of time . . . without the knowledge and
complicity of the . . . individual Defendants.” Viewed holistically, the Second
Amended Complaint alleges the following facts as supporting a reasonable
inference of scienter: (1) ten of the individual defendants “signed [or authorized]
one or more certification[s] pursuant to the Sarbanes-Oxley Act that impermissibly
omitted material facts;” (2) each individual defendant held a management position
at RelationServe; (3) each individual defendant was “involved in the drafting,
producing, reviewing, and/or dissemination of misleading statements and [was]
aware [of]—or recklessly disregarded—the fact that misleading statements were
11
being issued and approved or ratified these statements;” (4) each individual
defendant, “by virtue of [his or her] receipt of information . . . , control over or
receipt of RelationServe[’s] materially misleading statements and/or [his or her]
associations with RelationServe . . . [was an] active and culpable participant[];” (5)
several individual defendants signed SEC forms “that failed to indicate
RelationServe had contracted with Summit;” and (6) there were “accounting
irregularities” in RelationServe’s financial statements.
These conclusory allegations are insufficient to establish a “strong inference
that the defendants acted with the required state of mind.” See Tellabs, 551 U.S.
at 314, 127 S. Ct. at 2504. The inference that the individual defendants purposely
failed to disclose the use of unregistered brokers to mislead the public regarding
the company’s worth is not as compelling as the competing inference that the
defendants did not disclose its use of unregistered brokers because the brokers
were exempt from registration. Without an allegation that any of the named
defendants knew the Summit employees (1) were not registered brokers and (2)
were required to be registered brokers, we cannot conclude the inference of
nefarious wrongdoing is “at least as compelling as any opposing inference of
nonfraudulent intent.” See id.12
Even if the Second Amended Complaint alleged the sales were not exempt
transactions, it would still not be a “cogent” possibility that the defendants failed to
disclose the use of unregistered brokers for the purpose of misleading the public.
The Second Amended Complaint does not allege facts tending to show that any of
the individual defendants were even aware of RelationServe’s relationship with
Summit. This is particularly so with respect to defendants Soltoff, Obeck, and
Gould—who, according to the Second Amended Complaint, were not employed by
RelationServe until after the events relied on by plaintiffs occurred—and with
respect to defendant Young—who, according to the Second Amended Complaint,
was not employed by RelationServe.
Simply put, the allegations in the Second Amended Complaint are
insufficient to create a “strong inference” of scienter. Accordingly, the district
court did not err by dismissing Jacoby’s § 10(b) and Rule 10b-5 claims against the
individual defendants under the heightened pleading standards imposed by the
PSLRA.
Although the Second Amended Complaint failed to adequately plead
scienter for any of the individual defendants, theoretically, the Second Amended
Complaint could create a strong inference that the corporate defendant,
RelationServe, acted with the requisite state of mind. Mizzaro, 544 F.3d at 1254.
13
Corporations have no state of mind of their own; rather, the scienter of their agents
must be imputed to them. Id. Here, the Second Amended Complaint fails to
sufficiently plead scienter as to any of the individuals who served as corporate
directors or officers of RelationServe, and there are no other allegations that give
rise to an inference of scienter. Thus, we affirm the district court’s dismissal of
Count I for failure to state a cause of action under § 10(b) and Rule 10b-5 of the
Securities Exchange Act.
B. Secondary Liability Under Section 20(a)
In Count II, Jacoby asserted a violation of § 20(a) of the Securities Exchange
Act. Section 20(a) provides:
Every person who, directly or indirectly, controls any person liable
under any provision of this chapter or of any rule or regulation
thereunder shall also be liable jointly and severally with and to the
same extent as such controlled person to any person to whom such
controlled person is liable, unless the controlling person acted in good
faith and did not directly or indirectly induce the act or acts
constituting the violation or cause of action.
15 U.S.C. § 78t(a). Section 20(a) is not a freestanding claim but rather a means of
imposing liability “not only on the person who actually commits a securities law
violation, but also on an entity or individual that controls the violator.” Laperriere
v. Vesta Ins. Group, Inc., 526 F.3d 715, 721 (11th Cir. 2008).
14
Because a primary violation of the securities law is an essential element of a
§ 20(a) derivative claim, a plaintiff who pleads a § 20(a) claim can withstand a
motion to dismiss only if the primary violation is pleaded with legal sufficiency.
Garfield v. NDC Health Corp., 466 F.3d 1255, 1261 (11th Cir. 2006). As the
Second Amended Complaint failed to allege primary liability under § 10(b), there
can be no secondary liability under § 20(a). Thus, we affirm the district court’s
dismissal of Count II for failure to state a cause of action under § 20(a) of the
Securities Exchange Act.
C. Rule 11(b) Sanctions
We review the denial of sanctions under Federal Rule of Civil Procedure 11
for abuse of discretion. BankAtlantic v. Blythe Eastman Paine Webber, Inc., 955
F.2d 1467, 1478 (11th Cir. 1992). A district court’s denial of sanctions under the
PSLRA is reviewed under the same standard. See Morris v. Wachovia Sec., Inc.,
448 F.3d 268, 277 (4th Cir. 2006) (noting review of “all aspects” of a district
court’s Rule 11 determination is for abuse of discretion, and “[n]othing in the
Reform Act’s sanctions provision changes this standard of review”); Hartmarx
Corp v. Abboud, 326 F.3d 862, 866-67 (7th Cir. 2003) (reviewing the district
court’s imposition of sanctions under the PSLRA for abuse of discretion); Gurary
v. Nu-Tech Bio-Med, Inc., 303 F.3d 212, 219 (2d Cir. 2002) (same).
15
Congress passed the PSLRA in 1995, “motivated in large part by a perceived
need to deter strike suits by opportunistic private plaintiffs that filed securities
fraud claims of dubious merit in order to exact large settlement recoveries.”
Laperriere, 526 F.3d at 719 (quoting Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir.
2000)). Through the PSLRA, Congress hoped to put an end to “the abuse of the
discovery process to impose costs so burdensome that it is often economical for the
victimized party to settle.” Id.In addition to raising the standard for pleading scienter, the PSLRA
“mandate[s] imposition of sanctions for frivolous litigation.” Merrill Lynch,
Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 81, 126 S. Ct. 1503, 1511
(2006). The PSLRA provides:
In any private action arising under this chapter, upon final
adjudication of the action, the court shall include in the record
specific findings regarding compliance by each party and each
attorney representing any party with each requirement of Rule
11(b) of the Federal Rules of Civil Procedure as to any
complaint, responsive pleading, or dispositive motion.
15 U.S.C. § 78u-4(c)(1) (emphasis added). If the court finds a party or attorney
violated any requirement of Rule 11(b), the court “shall” impose sanctions in
accordance with Rule 11. 15 U.S.C. § 78u-4(c)(3). If a complaint substantially
fails to comply with Rule 11(b), the presumptive sanction is attorneys’ fees and
expenses. 15 U.S.C. § 78u-4(c)(2). Accordingly, the PSLRA’s provisions
16
eliminate a district court’s discretion on two fronts: (1) in choosing whether to
conduct the Rule 11(b) inquiry and (2) in determining whether to impose sanctions
following a finding of a Rule 11(b) violation. See Morris, 448 F.3d at 276(“Because the sanctions instruction comes in terms of the mandatory ‘shall,’ which
normally creates an obligation impervious to judicial discretion, the district court
must impose sanctions for each violation found.” (internal citation and quotation
marks omitted)); Simon DeBartolo Group, L.P. v. The Richard E. Jacobs Group,
Inc., 186 F.3d 157, 167 (2d Cir. 1999) (noting the PSLRA circumscribes a district
court’s discretion “in choosing whether to conduct the Rule 11 inquiry at all and
whether and how to sanction a party once a violation is found”).
Although the PSLRA alters the consequences of a Rule 11(b) violation in a
private securities fraud action, the substantive analysis under Rule 11 remains the
same.12 See 15 U.S.C. § 78u-4(c); see also Citibank Global Mkts., Inc. v. Santana,
573 F.3d 17, 32 (1st Cir. 2009) (noting the PSLRA “does not alter the standards
used to judge compliance with Rule 11”); Morris, 448 F.3d at 276 (“[F]or private
securities fraud suits Congress altered the consequences of a Rule 11(b) violation
12
Under Rule 11, sanctions are properly assessed when: (1) a party files a pleading that
has no reasonable factual basis; (2) the party files a pleading based on a legal theory that has no
reasonable chance of success and cannot be advanced as a reasonable argument to change
existing law; or (3) the party files a pleading in bad faith for an improper purpose. Massengale
v. Ray, 267 F.3d 1298, 1301 (11th Cir. 2001).
17
but did not rewrite the conventional standards for evaluating Rule 11(b)
compliance.”); Simon DeBartolo Group, L.P., 186 F.3d at 167 (“The PSLRA does
not in any way purport to alter the substantive standards for finding a violation of
Rule 11 . . . .”). Moreover, nothing in the PSLRA changes our abuse of discretion
standard of review of the district court’s Rule 11(b) findings. This position is
supported by the reasoning in Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 110
S. Ct. 2447 (1990), in which the Supreme Court held an abuse-of-discretion
standard applies “in reviewing all aspects of a district court’s Rule 11
determination,” including the legal aspects. Id. at 405, 110 S. Ct. at 2461. The
Cooter & Gell Court noted “[l]egal issues are raised in considering whether a
pleading is ‘warranted by existing law or a good faith argument’ for changing the
law and whether the attorney’s conduct violated Rule 11.” Id. at 399, 110 S. Ct. at
2457. It then explained even purely legal issues in the Rule 11 context require a
district court “to consider issues rooted in factual determinations.” Id. at 401, 110
S. Ct. at 2459. In this regard, “the district court is better situated than the court of
appeals to marshal the pertinent facts and apply the fact-dependent legal standard
mandated by Rule 11.” Id. at 402, 110 S. Ct. at 2459.
In this case, however, the district court’s conclusory Rule 11 analysis is not
sufficient to permit meaningful appellate review. Although the district court
18
explicitly denied Karp’s motion for sanctions,13 its one paragraph order provides
no explanation of the basis for its ruling and does not include the specific findings
the PSLRA requires.14 Specifically, the district court’s order does not discuss
“compliance by each party and each attorney representing any party with each
requirement of Rule 11(b) of the Federal Rules of Civil Procedure as to any
complaint, responsive pleading, or dispositive motion.” 15 U.S.C. § 78u-4(c)(1).
In fact, nowhere in the June 12, 2007, order did the district court even mention the
PSLRA or any of its requirements. As a result, we remand the case to the district
court to permit it to make the PSLRA-mandated findings in the first instance.15
13
The order stated: “Plaintiffs’ claims are not frivolous, or so devoid of evidentiary
support as to warrant sanctions. Likewise, there is no evidence that Plaintiffs instituted this
action for improper purposes, such as to harass Defendants or needlessly increase the cost of
litigation.”
14
On July 16, 2007, Karp filed a second motion for attorneys’ fees and costs and moved
the court to reconsider its June 12, 2007, sanctions order, contending the PSLRA required the
court to conduct a more exacting inquiry into counsel’s compliance with Rule 11(b). The court
denied her motion without explication on July 27, 2007. On August 3, 2007, Karp moved the
court to clarify its ruling to indicate whether it had denied her motion for reconsideration on the
merits. The court, on November 20, 2007, entered an order adhering to its rulings that plaintiffs’
counsel had not violated Rule 11(b). These motions and orders are not before us because the
district court lost jurisdiction over the matter of sanctions upon the filing of the notices of
appeal. Green Leaf Nursery v. E.I. DuPont de Nemours & Co., 341 F.3d 1292, 1309 (11th Cir.
2003) (“The filing of a notice of appeal is an event of jurisdictional significance—it confers
jurisdiction on the court of appeals and divests the district court of its control over those aspects
of the case involved in the appeal.”) (quoting Griggs v. Provident Consumer Disc. Co., 459 U.S.
56, 58, 103 S. Ct. 400, 402 (1982)). Regardless, the district court’s November 20, 2007, order
added nothing of substance to the June 12, 2007, sanctions order, and is likewise inadequate to
allow meaningful appellate review.
15
Remand is consistent with the Supreme Court’s admonition in Sprint/United Mgmt.
Co. v. Mendelsohn, 552 U.S. 379, 128 S. Ct. 1140 (2008), that the circuit court should have
19
This approach is consistent with the procedure we use when a district court fails to
make the PSLRA sanctions findings altogether. See Ehlert v. Singer, 245 F.3d
1313, 1320-21 (11th Cir. 2001) (remanding for compliance with the PSLRA where
the district court made no Rule 11 findings).16
It may be tempting to engage in sanctions determinations ourselves, given
the apparent frivolity of the plaintiffs’ claims. In fact, the extensive record on
appeal may actually make such determinations possible. But, even assuming we
have the ability to conduct a thorough Rule 11 analysis, doing so in this case would
be ill-advised. Remand is the better route.
First, as is almost always the case, the district court is “better situated” than
this Court “to marshal the pertinent facts and apply the fact-dependent legal
standard mandated by Rule 11.” See Cooter & Gell, 496 U.S. at 402, 110 S. Ct. at
remanded to allow the district court to make its “determinations in the first instance, explicitly
and on the record.” Id., 128 S. Ct. at 1146. In Mendelsohn, the district court essentially
provided no explanation of the basis for its evidentiary ruling, but the circuit court presumed the
district court applied the incorrect standard and proceeded to engage in its own analysis. Id. at
1144. The Supreme Court noted the broad discretion afforded to a district court’s evidentiary
rulings and concluded the circuit court should have remanded to the district court, instead of
engaging in its own inquiry. Id. at 1144-46. Although Mendelsohn dealt with an evidentiary
ruling, the reasoning is applicable here. Both evidentiary rulings and Rule 11(b) findings are
reviewed under the deferential abuse of discretion standard. See id.; Morris, 448 F.3d at 277.
16
This approach is also consistent with the procedure followed by the Second Circuit.
See Rombach v. Chang, 355 F.3d 164, 178 (2d Cir. 2004) (remanding for compliance with the
PSLRA when the district court failed to make the required Rule 11 findings); Gurary v.
Winehouse, 190 F.3d 37, 47 (2d Cir. 1999) (remanding for findings regarding Rule 11(b)
compliance pursuant to the PSLRA after the district court implicitly denied a motion for
sanctions).
20
2459. Given the district court’s familiarity with the case and the parties, the
district court is in a better position “to make these determinations in the first
instance, explicitly and on the record.” See Sprint/United Mgmt. Co. v.
Mendelsohn, 552 U.S. 379, 387, 128 S. Ct. 1140, 1146 (2008). Moreover, our
analysis of the sanctions issue would likely further develop the record by, for
example, expounding upon the relevant SEC filings or drawing inferences from
undisputed facts. Consequently, if we elect to make such sanctions findings at the
appellate level, the parties would necessarily be less involved in the process and
would be unable to object if and when appropriate.
Further, our decision to remand recognizes that when the district court
engaged in its sanctions analysis in 2007 our Circuit had not yet explicitly
addressed the level of specificity required by the PSLRA. To be sure, the PSLRA,
by its own terms, clearly requires findings as to each claim, each party, and each
attorney, such that the district court’s perfunctory analysis was insufficient even
without clear precedent from this Court. It is not until this case, however, that we
emphasize just how extensive the district court’s sanctions findings must be in the
PSLRA context. Thus, in light of our reiteration and accentuation of the PSLRA’s
requirements, it is appropriate to permit the district court to engage in a PSLRA-
compliant sanctions analysis prior to appellate review.
21
Additionally, we recognize the practical reality that this appeal arises from
complex factual circumstances that have not been organized in such a manner to
facilitate efficient sanctions review. As a result, prior to engaging in a Rule 11(b)
analysis, we would first have to unravel the dense record and examine it in a way
that no other issue in this case requires us to do. This task would require us to
obtain a level of familiarity with the parties and the evidence that the district court
already has; as a result, we would end up replicating much of the work that the
district court has already completed. This is not a wise use of judicial resources.
The better solution, from a practical standpoint, is for us to carefully and promptly
decide the issues on appeal, and then to remand to the district court to address any
outstanding fact-finding tasks. Expeditiousness is every bit as important to a well-
functioning judiciary as is thoroughness.
Finally, even if we were to engage in a full PSLRA sanctions analysis, it
would still be necessary to remand to the district court to determine a number of
outstanding issues. For instance, we would be unable to determine whether either
Thompson or Jacoby himself (as distinct from their lawyers) violated Rule 11 (the
record is silent on this point), whether the lawyers violated Rule 11(b)(1) by filing
the complaints for improper purposes (a subjective analysis that will likely require
testimony), or whether the plaintiffs can rebut the PSLRA’s presumptive award of
22
attorneys’ fees. These issues require the kind of record development in which
appellate courts cannot engage. As a result, even if we did expend the enormous
judicial resources necessary to parse through the record in the first instance, the
district court would still have to reexamine and further develop the record to
address these outstanding issues. Such a process would introduce even more
inevitable duplication of effort and would result in further depletion of limited
judicial resources.
Accordingly, even if we could in some cases engage in a PSLRA sanctions
analysis ourselves, we decline to do so in this case. Careful examination of the
relevant considerations counsels against such a use of judicial resources.
IV. CONCLUSION
With respect to Jacoby’s appeal, we AFFIRM the district court’s dismissal
of Counts I and II of the Second Amended Complaint pursuant to Rule 12(b)(6) of
the Federal Rules of Civil Procedure. With respect to Karp’s cross-appeal, the
district court’s order entered June 12, 2007, is VACATED and REMANDED for
further proceedings consistent with this opinion.
23
TJOFLAT, Circuit Judge, concurring in the appeal, No. 07-13225, and dissenting
in the cross-appeal, No. 07-13477:
In the appeal, I concur in the court’s judgment affirming the district court’s
dismissal of the second amended complaint. I dissent from the court’s decision in
the cross-appeal, vacating in full the district court’s decision denying Private
Securities Litigation Reform Act (“PLRSA”) sanctions, and remanding the
sanctions issues to the district court for reconsideration ab initio. I would reverse
the sanctions decision and remand the case with the instruction that the district
court sanction plaintiffs’ counsel for prosecuting the federal securities law claims
in the three complaints they presented to the district court—the initial, first, and
second amended complaints—because, in presenting those claims, counsel violated
Federal Rule of Civil Procedure 11(b)(2) as a matter of law. They also violated
Rule 11(b)(3) with respect to some of these claims because the claims lacked an
evidentiary foundation. In remanding the matter of sanctions to the district court, I
would instruct the court to hear from counsel for the parties on the questions of (1)
whether the remaining claims lacked the evidentiary support required by Rule
11(b)(3), and (2) whether plaintiffs’ counsel brought any of the claims for an
improper purpose in violation of Rule 11(b)(1).
24
The court is faced with two options in disposing of the cross-appeal. One is
to vacate the sanctions decision and remand the case for further proceedings on the
sanctions issues. The court has chosen this option. The court believes that it is
incapable of meaningfully reviewing the district court’s denial of Rule 11 sanctions
because the denial is framed in conclusory language, without findings of fact or
conclusions of law. The other option is to decide whether plaintiffs’ attorneys
failed to comply with Rule 11(b)’s requirements, and, if so, whether sanctions are
in order. I choose this option because, in the PSLRA context, Congress explicitly
requires a district court to impose sanctions whenever Rule 11 is violated. When,
as here, the record so clearly indicates a Rule 11 violation, it is both within our
capacity and in the broader interest of justice that we direct the district court to
impose sanctions that it will have to impose on remand.
An objective examination of plaintiffs’ three complaints reveals that
plaintiffs’ federal securities law claims are frivolous, and, under these facts, a
district court would necessarily abuse its discretion to conclude otherwise.
Moreover, plaintiffs sued some individual defendants who had no involvement
whatsoever in the management of Relationserve Media, Inc., or its predecessor,
Relationserve, Inc. The court’s disposition will require those uninvolved
defendants to participate in the further proceedings on remand. The disposition I
25
propose would limit their involvement to the simple task of presenting the court
with a list of their expenses, including the attorneys’ fees they incurred.
The court’s disposition is also likely to result in a second appeal, which
would put this court in the same position it now occupies. The disposition I would
reach would avoid a second appeal and thus would reduce the time, effort, and
expenses the district court, the parties, and this court will have to endure as a result
of today’s decision. To make this clear, I must take the reader through this case as
it evolved—from the filing of the initial complaint through the filing and
prosecution of the second amended complaint. I shall do so in accordance with the
following outline.
I. The Facts
A. Relationserve Media, Inc.’s and Relationserve, Inc.’s Corporate Histories
and the Alleged Fraud
B. Richard F. Thompson Sues Relationserve, Media Inc. in Indiana State
Court
II. The Federal Procedural History
A. The Initial Complaint
1. Thompson Files the Initial Complaint
2. The Defendants Warn Thompson’s Attorneys that the Suit is
Frivolous
3. The Defendants Move to Dismiss, Request the Court to Retain
Jurisdiction to Impose Sanctions
26
4. Thompson’s Attorneys Move the Court for Leave to Amend and for
Limited Discovery to Add Individual Defendants
5. The Court Grants the Attorneys Leave to Amend and Limited
Discovery and Warns the Attorneys About Rule 11
B. The First Amended Complaint
1. Thompson & Jacoby File the First Amended Complaint, Each
Purporting to Represent All Class Members on All Claims
2. The Defendants Move to Dismiss, Request the Court to Retain
Jurisdiction to Impose Sanctions
3. The Court Dismisses the First Amended Complaint
C. The Second Amended Complaint
1. Thompson & Jacoby File the Second Amended Complaint with
Jacoby Leading an Open-Market Purchaser Subclass Bringing Federal
Securities Claims and with Thompson Leading a Private Offering
Purchaser Subclass Bringing State Law Claims
2. The Defendants Move to Dismiss, and Defendant Karp Moves for
Sanctions
3. The Court Dismisses the Complaint with Prejudice but Denies
Sanctions
4. Jacoby’s Appeal, Karp’s Cross-Appeal, and this Court’s Decision
III. This Court Errs by Summarily Remanding Karp’s Cross-Appeal for Sanctions
Under the PSLRA
A. The PSLRA Rule 11 Analytical Framework & Requirements
B. A Court of Appeals Should Not Remand for Rule 11 Findings When it
Can Determine Conclusively that the District Court Abused its Discretion in
Denying Sanctions
27
IV. With Respect to Plaintiffs’ Federal Securities Law Claims, the District Court
Abused its Discretion in Denying Sanctions
A. Rule 11(b)(2) Compliance
1. The Section 11 Claims
a. The Initial Complaint’s Section 11 Claim
b. The First Amended Complaint’s Section 11 Claim
2. The Section 12 Claims
3. The Section 10(b), Rule 10b-5 Claims
a. Thompson’s Rule 10b-5 Claims
b. Jacoby’s Rule 10b-5 Claims
i. Jacoby Failed to Identify an Actionable Omission
ii. Jacoby Made Only Frivolous Scienter Allegations
iii. Jacoby Advanced a Frivolous Loss Causation
Argument
4. The Section 20(a) Claims
B. Rule 11(b)(3) Compliance
C. Rule 11(b)(1) Compliance
D. The Plaintiffs’ Attorneys’ Rule 11 Violations Trigger the PSLRA’s
Presumptive Sanction of Attorney’s Fees and Other Expenses
E. Summary
V. The Court Errs by Ignoring Karp’s Cross-Appeal for Rule 11 Sanctions on the
State Law Claims Advanced in the Second Amended Complaint
VI. Conclusion
I. The Facts
A. Relationserve Media, Inc.’s and Relationserve, Inc.’s Corporate Histories and
the Alleged Fraud
The principal defendant in this case, Relationserve Media, Inc., is an Internet
marketing firm that maintains its principal place of business in Fort Lauderdale,
28
Florida.1 The other defendants, with three exceptions, are (or were) officers and/or
directors of the company (“Officers”). Relationserve Media, Inc. was formed
when privately held Relationserve, Inc. merged with a wholly owned subsidiary of
publicly held Chubasco Resources Corp. For the sake of clarity, I refer to the
predecessor corporation as “Relationserve” and the merged entities as
“Relationserve Media” or simply “Media.”2
Relationserve was incorporated in Delaware on March 29, 2005. Shortly
thereafter, on April 20, 2005, Relationserve commenced a private offering of
common stock to “accredited investors”3 (the “April private offering”).
1
The appeal is from a district court order dismissing the federal securities law claims of
the second amended complaint for failure to comply with the heightened pleading requirements
of the PSLRA and Rule 9(b); accordingly, the complaint’s well-pleaded facts must be accepted
as true and all reasonable inferences must be drawn from those facts in favor of the plaintiff. In
the main, the facts set out in part I are taken from the three complaints filed in this case. They
were known to plaintiffs’ attorneys prior to their filing of the initial complaint. The complaints
refer to, and quote in part, filings the corporate defendant and some of the individual defendants
made with the Securities and Exchange Commission (“SEC”). Regardless of whether pled, we
“may take judicial notice . . . of relevant public documents required to be filed with the SEC, and
actually filed.” Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1278 (11th Cir. 1999). This can
be done “for the purpose of determining what statements the documents contain and not to prove
the truth of the documents’ contents.” Id. “[C]onsidering the SEC documents in this manner . . .
is permitted by Fed. R. Evid. 201, is consistent with the overall aims of the [PSLRA], and is not
inconsistent with Rule 12(b)(6), common notions of fairness, or the law of this Circuit.” Id.2
Relationserve Media, Inc. changed its name to SendTec, Inc. on July 26, 2006.
Nevertheless, I refer to the company as Relationserve Media or simply Media.
3
The term “accredited investors” is a term of art, as defined by the SEC. See 17 C.F.R.
§ 230.501(a). The term delineates those permitted to invest in certain types of high risk
investments. The term generally includes wealthy individuals and organizations, such as
corporations, endowments, or retirement plans. According to the SEC, an individual qualifies as
an “accredited investor” if his or her “individual net worth . . . at the time of . . . purchase
exceeds $1,000,000,” id. § 230.501(a)(5), or if he or she has “an individual income in excess of
29
Throughout April and May 2005, Relationserve received and accepted $1,125,000
of subscriptions in exchange for Relationserve shares. The shares were issued in
reliance on a Regulation D exemption from registration under the Securities Act of
1933 (the “1933 Act”),4 and were “restricted shares” as defined by the Act. See 17
C.F.R. §§ 230.501 et seq.5
While the April private offering was going on, on May 16, 2005,
Relationserve acquired two Internet marketing companies, Omni Point Marketing
LLC and Friendsand LLC. In exchange for the ownership interest in those
companies, Relationserve paid $500,000 cash, 8,000,000 shares of its common
stock, and a two-year promissory note for $700,000. Relationserve also issued
4,001,000 shares to its founders as compensation for bridge loan advances and
$200,000 in each of the two most recent years . . . and has a reasonable expectation of reaching
the same income level in the current year,” id. § 230.501(a)(6).
4
The 1933 Act is codified at 15 U.S.C. §§ 77a et seq.
5
Regulation D allows issuers to sell securities without registering them with the SEC if a
series of both general and specific conditions is followed. Generally, the conditions that must be
met are: (1) all sales within a certain time period must be “integrated” (that is, treated as one
offering); (2) information about the securities must be disclosed to investors; (3) there must be
no “general solicitation” of purchasers of the securities; and (4) the securities must contain
restrictions on their resale. See 17 C.F.R. § 230.502.
In this case, Relationserve sought a registration exemption on the basis of SEC-
promulgated Rule 506. Id. § 230.506. Rule 506 imposes two specific conditions that must be
met. First, “the issuer [must] reasonably believe[] that there are no more than 35 purchasers of
securities from the issuer.” Id. § 230.506(b)(2)(i). Second, the issuer must reasonably believe
that “[e]ach purchaser who is not an accredited investor either alone or with his purchaser
representative(s) has such knowledge and experience in financial and business matters that he is
capable of evaluating the merits and risks of the prospective investment.” Id. §
230.506(b)(2)(ii).
30
negotiating the acquisitions. Relationserve’s chief operating officer at the time,
Scott Hirsch, was also the indirect majority owner and president of Omni Point.
Relationserve’s then president, Danielle Karp, is Scott Hirsh’s sister.
After completing the April private offering6 and the acquisition of Omni
Point and Friendsand, on May 24, 2005, Relationserve entered an Independent
Consulting Agreement (the “consulting agreement”) with Summit Financial
Partners, LLC (“Summit”). Under the consulting agreement, Summit and its
president, Tony Altavilla, agreed to “[i]ntroduce [Relationserve] to the financial
community” and “[p]erform the functions generally assigned to stockholder
relations and public relations departments in major corporations.” Relationserve
Media Inc., Current Report (Form 8-K), Ex. 2.6, at 1–2 (June 16, 2005).7 Summit
also agreed to act as a “finder” of financing sources or acquisition candidates for
6
I infer that Relationserve completed the April private offering no later than May 19,
2005. Issuers selling securities pursuant to Regulation D must notify the SEC of the sales.
Relationserve gave the requisite notice by filing Form D on May 23, 2005. Relationserve, Inc.,
Notice of Sale of Securities Pursuant to Regulation D (Form D), at 1 (May 23, 2005).
Relationserve disclosed its receipt of $1.125 million from twenty-two accredited investors. Id. at
4. Later filings indicate that Relationserve did not receive any more subscriptions from this
offering. See Relationserve Media, Inc., Current Report (Form 8-K), at 29 (June 16, 2005) (“On
April 20, 2005 Relationserve commenced a private offering . . . . Relationserve received and
accepted $1,125,000 of subscriptions.”). The shares may not have been issued, however, until
June. See Relationserve Media, Inc., Registration Statement under the Securities Act of 1933
(Form SB-2), at 26 (Mar. 20, 2006) (“In May and June 2005, we sold 1,625,000 shares of and
granted 812,500 warrants to purchase 812,500 shares of common stock at an exercise price of
$2.00 per share for net proceeds of $1,495,026.”).
7
As indicated infra, the consulting agreement was publicly disclosed, in its entirety, in
this current report as Exhibit 2.6.
31
Relationserve. In exchange, Relationserve paid Summit 1,050,000 shares of its
common stock and promised to pay a cash finder’s fee. Id. at 3, 5. The consulting
agreement noted that “IT IS SPECIFICALLY UNDERSTOOD THAT [Summit]
IS NOT AND DOES NOT HOLD ITSELF OUT BE [sic] A BROKER/DEALER,
BUT IS MERELY A ‘FINDER’ IN REFERENCE TO [Media] PROCURING
FINANCING SOURCES AND ACQUISITION/MERGER CANDIDATES.” Id.
at 6.
From inception, Relationserve’s strategy was to become a publicly traded
company by means of a “reverse merger.” Accordingly, the April Offering’s
private placement memorandum explained the company’s intent to find
[a] publicly-traded company . . . which will acquire, by merger of
Relationserve . . . all of the issued and outstanding capital stock of
Relationserve (and any acquired businesses at the time of merger).
Thereafter, the present stockholders of Relationserve and purchasers
in the offering will, by virtue of the merger, become the controlling
stockholders of the publicly-traded company.
Relationserve, Inc., Private Purchase Offering Document, at 1 (Apr. 20, 2005).
Consistent with this representation, Relationserve explored and ultimately entered
a merger agreement with Chubasco.
Prior to the merger, Chubasco, a Nevada corporation with its principal place
of business in Canada, was an exploration-stage mining company yet to commence
operations. In total, Chubasco had 51 shareholders and about $100,000 in assets.
32
The largest shareholder, Scott Young, owned 6.8 million shares and also served as
Chubasco’s president, chief financial officer, and sole director. The remaining
fifty shareholders purchased Chubasco shares in at least one of two exempt
Regulation S offerings.8 Collectively, the fifty shareholders owned 3,216,500
shares. Chubasco became a public reporting company by filing a registration
statement for these 3,216,500 shares on October 8, 2004. Once effective, the
registration statement would allow the fifty holders to trade that stock publicly.
Chubasco Res. Corp., Registration Statement Under the Securities Act of 1933
(SB-2) (Oct. 8, 2004). After a series of amendments, the Registration Statement
became effective on February 24, 2005. Chubasco Res. Corp., Quarterly Report
(Form 10-QSB), at 10 (Mar. 17, 2005).
Sometime between March and June 2005, Relationserve’s management
approached Chubasco and suggested a reverse acquisition of Relationserve. After
determining that the reverse acquisition would be “less speculative and contain[]
greater benefits,” Chubasco terminated its mining exploration activities and
negotiated a plan of merger and reorganization with Relationserve. Chubasco Res.
Corp., Quarterly Report (Form 10-QSB), at 5 (June 14, 2005).
8
Regulation S sets out rules governing exempt sales of securities because the
transactions occur outside the United States. See 17 C.F.R. § 230.901 et seq.
33
The terms of the merger included the following. Chubasco would form a
wholly-owned subsidiary, Reland Acquisition. Reland would then merge into
Relationserve, with Relationserve surviving. Upon consummation of the merger,
each share of Reland would automatically convert into the right to receive one
share of Relationserve; thus Chubasco would own all of the issued and outstanding
shares of Relationserve. Relationserve Media Inc., Current Report (Form 8-K), Ex.
2.1 (Plan of Merger) ¶ 1.5(a) (June 16, 2005). In exchange, Relationserve’s stock
would automatically convert into the right to receive Chubasco stock on a 1:1
basis. Id. Additionally, Scott Young agreed to cancel his 6.8 million shares of
Chubasco and resign from his position as its sole director, president, and chief
financial officer. Danielle Karp, Relationserve’s president, would become the new
president and sole director of Chubasco. Finally, Chubasco would change its name
to Relationserve Media, Inc. Id. ¶ 6.4.
The merger took place on June 13, 2005. As a result of the merger,
Relationserve Media, Inc., f/k/a Chubasco Resources Corp., held Relationserve as a
wholly owned subsidiary. As planned, Scott Young resigned from all positions
with Media and Danielle Karp became its sole director and president. Media now
had two groups of shareholders. The first group consisted of the former Chubasco
shareholders who held 3,216,500 shares; these shares could be traded and
34
constituted Media’s “public float.” Id. ¶ 2.01. The second group consisted of
former Relationserve shareholders who owned 13,326,000 shares of Relationserve
stock, now convertible into Media stock. Id. Because the second group acquired
the shares in unregistered offerings and no subsequent registration statement had
been filed, the shares continued to be restricted and could not be traded. The
merger did not, of course, alter the duty of Media f/k/a Chubasco to make routine
filings with the SEC.
Accordingly, just three days after the merger, on June 16, 2005, the newly
formed Media filed an SEC current report (Form 8-K). Among other disclosures,
this report explained the merger and the resultant change in business—from mining
exploration to Internet marketing. This report also disclosed, for the first time, that
Media’s predecessor, Relationserve, had “entered into an Independent Consulting
Agreement with Summit Financial Partners, LLC.”9 Id. at 29. A full copy of the
consulting agreement was attached to the SEC filing as an exhibit; this attachment
9
There would have been no previous occasion for Relationserve to disclose the
relationship with Summit since as a private company, Relationserve had no duty to file securities
disclosures regarding its material definitive agreements. The full text of the report’s disclosure
is as follows:
On May 24, 2005, the Company entered into an Independent Consulting
Agreement with Summit Financial Partners, LLC. Under the terms of the
Agreement, Summit Financial Partners, LLC. is to provide investor relations and
similar services in exchange for issuance of 1,050,000 shares of Common Stock.
A copy of the Agreement is annexed hereto as Exhibit 2.6.
Relationserve Media Inc., Current Report (Form 8-K), at 29 (June 16, 2005).
35
included, of course, Summit’s express representation that it would not be acting as
a broker/dealer, but rather would serve merely as a finder. As a consequence of the
merger, Summit performed the same services for Media as it had for Relationserve.
Shortly after the merger, Media commenced a Regulation D, Rule 506
private offering pursuant to a private placement memorandum dated June 22, 2005
(the “June private offering”).10 It was in this offering that plaintiff Richard F.
Thompson, an Indiana resident, purchased 50,000 Media shares at two dollars per
share and three-year warrants with an exercise price of $3.50, for a total investment
of $100,000.
Thompson bought the shares on June 28, 2005, twelve days after Media had
disclosed the consulting agreement with Summit. Gary Altavilla, Summit’s
president, advised Thompson about the private offering and helped facilitate
Thompson’s purchase. At the time of his purchase, Thompson signed a
subscription agreement wherein he attested to his knowledge of the consulting
agreement and that Summit was not licensed and did not hold itself out as a
broker/dealer. Indeed, in the subscription agreement that he signed, Thompson
acknowledge[d] that . . . [he] has read and evaluated, or has employed
the services of an investment advisor, attorney or accountant to read
and evaluate, all of the documents furnished or made available by the
Company to [Thompson] . . . including . . . the Company’s Current
10
See supra note 5 for an explanation of Regulation D and Rule 506.
36
Report on Form 8-K filed with the Securities and Exchange
Commission (“SEC”) on June 16, 2005 (“Current Report”) and
subsequent SEC filings and reports . . . .
Relationserve Media, Inc., Current Report (Form 8-K), Ex. 4.1 (Subscription
Agreement), at 1–2 (June 30, 2005).11 As indicated above, this June 16, 2005
Current Report included the agreement between Media and Summit in its entirety.
On June 30, 2005, Media completed the June private offering. In a report
filed with the SEC, it disclosed:
On June 30, 2005 we completed a private offering of Units to
“accredited investors” as that term is defined in Regulation D of the
Securities Act, with each Unit consisting of 50,000 shares of our
common stock, $0.0001 par value per share (“Common Stock”), and a
three-year warrant to purchase 25,000 shares of Common Stock at
$3.50 per share (the “Offering”). We received and accepted
$2,000,000 of subscriptions in the Offering. The Units were issued in
reliance on an exemption from registration provided under Regulation
D of the Securities Act and are restricted securities as defined by the
Securities Act.
Relationserve Media, Inc., Current Report (Form 8-K), at 2 (June 30, 2005).
Attached to this filing was a copy of the “Private Offering Subscription
Agreement” the purchasers signed (the “subscription agreement”). As in
Relationserve’s April offering, all of the shares sold in Media’s June private
11
In addition to attesting that he had read Media’s SEC filings, Thompson also
“recognize[d] that Company reserves the right to pay a commission or finders fee of up to 5% of
the gross proceeds of the Offering.” Relationserve Media, Inc., Current Report (Form 8-K), Ex.
4.1 (Subscription Agreement), at 3 (June 30, 2005).
37
offering were restricted and therefore could not be resold until registered under the
1933 Act.12
In addition to this current report, on July 14, 2005, Media filed a Form D
with the SEC to give further notice of and basic details about the June private
offering. Relationserve Media, Inc., Notice of Sale of Securities Pursuant to
Regulation D (Form D), at 1 (July 14, 2005). At the time, Form D required the
issuer to disclose information about “each person who has been or will be paid or
given, directly or indirectly, any commission or similar remuneration for
solicitation of purchasers in connection with the sales of securities in the offering.”
Id. at 3. Media did not disclose Summit’s involvement in the June private offering.
Media also filed a notice of the sale of unregistered securities with the
Indiana Secretary of State in compliance with Indiana’s securities act. See Ind.
Code §§ 23-2-1-1 et seq. (2005) (repealed 2008). This notice, received and filed
by the Secretary of State’s office on July 14, 2005, disclosed that Media’s June
12
Absent an exemption, the 1933 Act generally prohibits the sale of unregistered
securities. In the subscription agreement, Media promised to register the shares within forty-five
days of the closing of the final sale in the June private offering. Relationserve Media, Inc.,
Current Report (Form 8-K), Ex. 4.1 (Subscription Agreement), at III & Ex. C. (Registration
Rights Agreement) (June 30, 2005). Media defaulted on this obligation, but in October 2005,
Media’s board “ratified waivers obtained from a majority of the purchasers in the June [] 2005
offering and entered into new Consent and Waiver Agreements containing amended registration
obligations of the Company.” Relationserve Media, Inc., Registration Statement Under the
Securities Act of 1933 (Form SB-2), at F-25 (Mar. 20, 2006). Ultimately, as discussed below,
Media did not file a registration statement for the shares until March 20, 2006, which did not
become effective until July 14, 2006.
38
private offering had attracted twenty-two accredited investors to purchase an
aggregate total of $2 million of Media’s common stock. In particular, Media
attested to its sale of $340,000 of Media shares to five accredited investors in
Indiana.13
While the June private offering was going on, Media expanded its
management team. Recall that immediately after the merger, Danielle Karp was
Media’s sole president, chief executive officer, and director; Media’s subsidiary,
Relationserve, continued to be served by Scott Hirsch as its chief operating officer.
On June 21, Media hired Mandee Heller Adler to serve as its chief executive
officer and as a director; and on June 22, Media hired Warren “Pete” Musser to
serve as a director.
As discussed above, after the merger, the 3,216,500 shares that had been
registered by Chubasco could be traded in the open market. Media’s shares began
to trade on the Over the Counter Bulletin Board (the “OTCBB”) in late June 2005.
It was from this pool of stock that plaintiff L. Alan Jacoby purchased a total of
10,000 shares of Media stock in three separate transactions. These purchases
occurred on July 22, July 26, and August 12, 2005, and Jacoby claimed to have
13
The Indiana Securities Act exempted issuers from registering with the state in certain
circumstances. See I.C. § 23-2-1-2(b)(10) (2005) (repealed 2008). As discussed in part IV,
infra, Media satisfied the requirements for an exemption.
39
paid an average of six dollars per share.14 By March 2006, almost nine months
later, Media’s shares had lost 75% of their value in the open market.
Curiously, the plaintiffs alleged that Media’s shares traded on the NASDAQ
stock exchange. There is no evidence in Media’s SEC filings, however, that
Media’s stock traded anywhere except the OTCBB. Media did apply for a
NASDAQ listing on or about July 18, 2005, but there is no evidence that the
application succeeded. To the contrary, Media’s Annual Report filed on March 20,
2006 disclosed: “Our Common Stock has been quoted on the OTC Bulletin Board
since June 30, 2005 under the symbol RSVM.OB. Prior to that date, there was no
active market for our Common Stock.” Relationserve Media, Inc., Annual Report
(Form 10-KSB), at 7 (Mar. 20, 2006).15
14
While the record does not indicate Jacoby’s purchase price, I judicially note that,
according to the OTCBB website, the closing prices of Media’s shares on those dates were as
follows: $5.50 per share on July 22; $5.13 per share on July 26; and $8.75 on August 12. Note
that this is not necessarily the price that Jacoby paid for Media’s shares, but rather is the closing
price quoted by OTCBB for the particular days.
15
The OTCBB can be accessed through a NASDAQ workstation. The OTCBB website
warns, however,
The OTCBB is a quotation medium for subscribing members, not an issuer listing
service, and should not be confused with The NASDAQ Stock Market. . . . The
OTCBB is unlike The NASDAQ Stock Market in that it: does not impose listing
standards; does not provide automated trade executions; does not maintain
relationships with quoted issuers; and does not have the same obligations for
Market Makers.
OTC Bulletin Board, Comparison of NASDAQ and OTCBB,
http://www.otcbb.com/aboutOTCBB/comparison.stm (last visited Apr. 6, 2010).
40
Around the same time that Jacoby purchased his stake in Media, Media’s
SEC filings indicate that it entered into two key transactions. First, on August 9,
2005, Media entered an asset purchase agreement to buy the business and
substantially all of the assets of theglobe.com’s wholly owned subsidiary,
SendTec, for $37.5 million. Relationserve Media, Inc., Current Report (Form 8-K)
(Aug. 12, 2005). The acquisition was subject to certain terms and conditions and
did not close until October 31, 2005. Second, on August 29, 2005, Media merged
with its wholly-owned subsidiary, Relationserve, with Media surviving.
Relationserve Media, Inc., Current Report (Form 8-K), at 2 (Sept. 2, 2005).
For the purposes of this case, two facts are crucial about the SendTec asset
acquisition. First, as part of the terms and conditions mentioned, Media agreed to
terminate its contract with Summit. Relationserve Media, Inc., Current Report
(Form 8-K), Ex. 10.1 at 10 (Nov. 4, 2005). Second, Media agreed that it would
replace certain members of its current management with SendTec-approved
managers. Relationserve Media, Inc., Current Report (Form 8-K) (Aug. 12, 2005).
Accordingly, on October 6, 2005, Media terminated its agreement with
Summit.16 The exodus of Media’s senior management team began in late October
2005: director Musser resigned on October 31; chief executive officer and director
16
Media’s SEC filings indicate this.
41
Adler resigned on November 11. With one exception, the exodus was complete by
the first week of February 2006 with the departure of president and director Karp
and chief operating officer Hirsch on February 3 and February 2, respectively. The
lone exception was chief financial officer Adam Wasserman who was hired on a
part-time basis as chief financial officer on August 9, 2005, and ultimately served
Media in some capacity until June 15, 2006.17 Media’s original management team
was replaced by Sendtek-approved replacements: Michael Brauser joined as
director and chairman of the board on October 31, 2005; Shawn McNamara joined
as interim chief executive officer, senior vice president, and assistant secretary on
November 30, 2005; and Paul Soltoff, as chief executive officer and director, Erick
Obeck, as president, and Donald Gould, as chief financial officer, all joined on
February 3, 2006. For a complete listing of the terms of Media’s officers’ service,
see the Table attached to this opinion at 142.
B. Richard F. Thompson Sues Relationserve, Media Inc. in Indiana State Court
17
The plaintiffs alleged that Wasserman ended his tenure on February 3, 2006. (Second
Am. Compl. ¶ 17.) The plaintiffs also alleged, however, that Wasserman signed a Sarbanes-
Oxley certification as the principal financial officer on March 20, 2006. (First Am. Compl. ¶
90.) The plaintiffs likely made the former allegation because Donald Gould became chief
financial officer on February 3, 2006. Nevertheless, it appears that Wasserman continued to
work for Media in some capacity until June 15, 2005. See Relationserve Media, Inc., Current
Report (Form 8-K) (June 21, 2006) (noting that Wasserman resigned from all positions on June
15).
42
On March 3, 2006, in the Circuit Court of Hamilton County Indiana,
Thompson sued Summit, Altavilla, Media, and several other entities who used
Summit’s services, seeking rescission of his shares. Thompson was represented by
Cohen & Malad, LLP, an Indiana law firm. Thompson directed three of his
fourteen counts against Media: Count 4 claimed that Media sold unregistered, non-
exempt securities in Indiana; Count 7 alleged that Media had violated the Indiana
Securities Act’s anti-fraud provisions by failing to disclose the shares’ restricted
status; and Count 13 claimed Media deceived Thompson by failing to disclose the
shares’ restricted status. The other counts of the complaint were brought against
Summit, Altavilla, and other named defendants.18
Unrelated to this litigation, on March 20, 2006, Media filed a registration
statement and its annual report. Media filed the registration statement to register
the shares it sold in its private offerings—approximately 85 million shares of
common stock—to allow the private offering stockholders to sell their shares. In
the annual report, inter alia, Media disclosed that, “[i]n August 2005, the Company
paid a $28,500 success fee to Summit for services rendered in connection with a
private placement of its common stock.” Relationserve Media, Inc., Annual Report
18
With respect to Media, Thompson claimed that Altavilla had represented that, while
Media’s shares had restrictions on resale, these restrictions would be released within 30 days of
Thompson’s purchase.
43
(Form 10-KSB), at F-26 (Mar. 20, 2006). Neither the registration statement nor
the annual report disclosed the Thompson litigation.
On May 1, 2006, Media amended this registration statement to give the
public notice of Thompson’s lawsuit. Relationserve Media, Inc., Amendment No.
1 to Form SB-2 Registration Statement (Form SB-2/A), at 53 (May 1, 2006).
Media also related that Thompson sought rescission because the shares were not
registered as required under Indiana Law and because Media failed to disclose a
commission to Altavilla. Media also asserted its belief that the suit lacked merit
but noted that it could not predict the range of any loss. This disclosure prompted
the SEC to send a letter to Media requesting more information about the Thompson
litigation.
Responding to the SEC’s letter, on May 23, 2006, Media augmented the
amendment it had made to its registration statement. Answering the SEC’s
questions, Media added that: (1) Thompson sought rescission of 50,000 shares of
stock, (2) Media did not register the shares in Indiana because they qualified for an
exemption, and (3) Altavilla did not sell shares on the company’s behalf but did
receive a seven percent finder’s fee for introducing investors to Media. Media
reiterated its belief that the action lacked merit. Relationserve Media, Inc.,
Amendment No. 2 to Form SB-2 Registration Statement (Form SB-2/A), at 64–65
44
(May 23, 2006). The last amendment to this registration statement took place on
July 13, 2006, and the SEC declared it effective on July 14, 2006.
On May 9, 2006, Relationserve Media moved the Hamilton County Circuit
Court to dismiss it from Thompson’s lawsuit. It argued that the forum selection
clause in the subscription agreement required that all litigation be conducted in
Broward County, Florida. Thompson responded to this motion by filing an
affidavit in which he averred that he had no direct communication with Media and
in fact did not read the private offering memorandum or any other materials
concerning Media; rather, his son, Greg Thompson, read the materials. The court
agreed with Media’s position and, on July 19, 2006, dismissed Media from the
case.
Just before the Indiana circuit court dismissed the case, on July 17, 2006,
Thompson sold 10,000 shares at $0.40 a share, and another 10,000 shares at $0.35
a share. These sales obviously limited his ability to seek a full rescission of his
50,000-share initial purchase. Thompson’s investment strategy took a turn later in
the day, though, as he bought another 10,000 shares of Media at $0.42 a share on
July 17, only to sell 10,000 shares the next day at $0.39 a share. One month later,
on August 16, 2006, Thompson dumped the rest of his shares in three sales at
$0.37, $0.36, and $0.35 a share.
45
II. The Federal Procedural History
A. The Initial Complaint
1. Thompson Files the Initial Complaint
On August 28, 2006, Thompson brought the present lawsuit against Media,
three of its former officers and one of its former directors in the United States
District Court for the Southern District of Florida. The former officers were
Danielle Karp, Mandee Heller Adler, and Ohad Jehassi; the former director was
Warren Musser.19 Thompson was again represented by Cohen & Malad, LLP, and
now also by a Florida law firm, Friedman, Rosenwasser & Goldbaum, P.A. Eight
days after filing the complaint, on September 5, Cohen & Malad issued a press
release publicizing the lawsuit and inviting Media shareholders to contact the
firm.20
Thompson sued on behalf of a class consisting of “[a]ll persons [including
himself] who purchased Relationserve [Media] shares during the period beginning
May 24, 2005 and ending on the date of the commencement of this litigation,” on
19
Karp served as Media’s president from June 13, 2005 to February 3, 2006. Adler was
Media’s chief executive officer from June 21, 2005 to November 11, 2005. Jehassi was the
former chief operating officer of Media, beginning his tenure in July 2005 and ending it on an
unspecified date. Musser served on Media’s board of directors from June 21, 2005 to October
31, 2005.
20
The PSLRA required this notice: “Not later than 20 days after the date on which the
complaint is filed, the plaintiff or plaintiffs shall cause to be published, in a widely circulated
national business-oriented publication or wire service, a notice advising members of the
purported plaintiff class . . . .” 15 U.S.C. § 78u-4(a)(3)(A)(i).
46
August 28, 2006.21 While not explicit, the complaint’s proposed class consisted of
two subclasses: (1) those who bought shares in the private offerings; and (2) those
who bought shares in the public market. The complaint contained nine counts.
Counts I through III alleged violations of federal securities law and, for remedies,
prayed for rescission or damages. Counts IV through IX alleged violations of
Florida and Indiana statutes.22
21
As noted above, Thompson purchased 50,000 Media shares in Media’s June private
offering. He also bought 10,000 shares on July 17, 2006, in the open market. Thompson
apparently believed that the July 17 purchase enabled him to “fairly and adequately” represent
and “protect the interests of” those of the class who purchased Media shares in the open market.
See Fed. R. Civ. P. 23(a)(4).
22
The complaint was a typical “shotgun” pleading, in that each count incorporated by
reference all preceding paragraphs and counts of the complaint notwithstanding that many of the
facts alleged were not material to the claim, or cause of action, appearing in a count’s heading.
This circuit condemns shotgun pleadings. See, e.g., Pelletier v. Zweifel, 921 F.2d 1465, 1518
(11th Cir. 1991) (“Anyone schooled in the law who read these [shotgun pleading] complaints . . .
[] would know that many of the facts alleged could not possibly be material to all of the counts.
Consequently, [the opposing party] and the district court [have] to sift through the facts
presented and decide for themselves which [are] material to the particular cause of action
asserted, a difficult and laborious task indeed.”); see also Davis v. Coca-Cola Bottling Co., 516
F.3d 955, 984 (11th Cir. 2008) (refusing to award attorneys’ fees in a Title VII case because the
use of shotgun pleadings “complicated [appellate review] to no end”); M.T.V. v. DeKalb County
Sch. Dist., 446 F.3d 1153, 1156 n.1 (11th Cir. 2006) (noting that shotgun pleadings are “frowned
upon in this circuit”); Byrne v. Nezhat, 261 F.3d 1075, 1131 (11th Cir. 2001) (“Shotgun
pleadings, if tolerated, harm the court by impeding its ability to administer justice.”); Beckwith
v. City of Daytona Beach Shores, Fla., 58 F.3d 1554, 1567 (11th Cir. 1995) (“The bar would be
better served by heeding this advice: ‘In law it is a good policy never to plead what you need not,
lest you oblige yourself to prove what you cannot.’”) (quoting Abraham Lincoln, Letter to Usher
F. Linder, Feb. 20, 1848, in The Quotable Lawyer 241 (D. Shrager & E. Frost eds., 1986)). The
first 50 paragraphs of the complaint contained allegations of fact that appeared to relate to a
particular count of the complaint but not to other counts. Utilizing this method of pleading,
Count I incorporated the first 50 paragraphs of the complaint, many of which had nothing to do
with the Count I claim(s). Counts II through IX successively incorporated the allegations of all
preceding paragraphs and counts, such that each succeeding count was loaded down with
allegations having no bearing on the claim(s) the count purported to assert.
47
Count I, “Filing of False Registration Statement,” alleged a violation of
“Section 11 of the Securities Act of 1933, 15 U.S.C. § 77l(a).” Section 11 is
actually codified at 15 U.S.C. § 77k, not § 77l(a). Section 77k provides relief for
persons who purchase securities in reliance on a false or misleading registration
statement.23 Section 77l(a), which is a codification of § 12 of the 1933 Act,
provides relief for purchasers of securities who rely on a false or misleading
23
The text of 15 U.S.C. § 77k, Civil liabilities on account of false registration statement,
states, in pertinent part:
(a) Persons possessing cause of action; persons liable
In case any part of the registration statement, when such part became effective,
contained an untrue statement of a material fact or omitted to state a material fact
required to be stated therein or necessary to make the statements therein not
misleading, any person acquiring such security (unless it is proved that at the time
of such acquisition he knew of such untruth or omission) may, either at law or in
equity . . . sue—
(1) every person who signed the registration statement;
(2) every person who was a director of (or person performing similar
functions) or partner in the issuer at the time of the filing of the part of the
registration statement with respect to which his liability is asserted;
....
(f) Joint and several liability; liability of outside director
(1) [A]ll or any one or more of the persons specified in subsection (a) shall be
jointly and severally liable, and every person who becomes liable to make any
payment under this section may recover contribution as in cases of contract from
any person who, if sued separately, would have been liable to make the same
payment, unless the person who has become liable was, and the other was not,
guilty of fraudulent misrepresentation.
(emphasis added).
48
statement in a prospectus or oral communication.24 To solve this inaccurate
citation problem, I read Count I to seek relief under both sections 11 and 12 of the
1933 Act. This squares with Count I’s allegation that
[Media’s] filings with the Securities Exchange Commission, including
the registration statements, prospectus, and amendments thereto
omitted to state material facts necessary in order to make the
statements made, in the light of the circumstances under which they
were made, not misleading in at least the following particulars:
a. RelationServe [Media] was selling its securities through
unregistered agents and broker/dealers and paying commissions to
these unregistered agents and broker/dealers;
24
The text of 15 U.S.C. § 77l, Civil liabilities arising in connection with prospectuses
and communications, states, in pertinent part:
(a) In general
Any person who
....
(2) 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, less the amount of any
income received thereon, upon the tender of such security, or for damages if he no
longer owns the security.
(emphasis added).
49
b. The sale of RelationServe [Media] stock through unregistered
agents and broker/dealers was in violation of state and federal
securities laws, which caused a substantial contingent liability for
claims of rescission by investors and exposed RelationServe to
substantial legal fees; and
c. The potential civil liability of RelationServe [Media] for selling
shares of its stock in violation of state and federal law, which would
have an adverse impact on the RelationServe [Media] financial
condition.
(Compl. ¶ 52 (emphasis added).) Count I thus alleged that Media had violated the
1933 Act by selling securities under a false or misleading registration statement(s),
prospectus, or oral communication, by failing to disclose its use of unregistered
brokers and the contingent liability arising therefrom (the “unregistered-broker
theory”).
Count II, “Violation of Securities Act of 1933,” incorporated all of the
preceding allegations of the complaint, including Count I. Count II alleged that
Media and the Officers, who were “controlling persons, offered and sold the shares
of RelationServe [Media] in violation of 15 U.S.C.A. § 77l.” (Compl. ¶ 56.)
Because I construe Count I to seek relief under § 12, codified at 15 U.S.C. § 77l,
Count II added nothing to Count I.
Count III, “Violation of Securities Exchange Act of 1934, Rule 10b-5,”
incorporated all of Counts I and II and further asserted that Media and the Officers
“offered and sold the shares of RelationServe [Media] in violation of” the
50
Securities Exchange Act of 1934 (the “1934 Act”), 15 U.S.C. § 77q, and Rule 10b-
5.25 (Compl. ¶ 60.) Section 10(b) of the 1934 Act,26 and Rule 10b-5,27 provide
25
The complaint referred to the 1934 Act, 15 U.S.C. § 77q, and Rule 10b-5. Actually,
however, § 77q codifies § 17 of the 1933 Act. Section 10 of the 1934 Act, which provides the
statutory authority for Rule 10b-5, is codified at 15 U.S.C. § 78j. The first and second amended
complaints repeated the reference to § 77q. This time, I resolve the pleading ambiguity by
assuming the citation to § 17 was an error; notwithstanding the citation to § 17, I read Count III
of the initial complaint, Count III of the first amended complaint, and Count I of the second
amended complaint to seek relief only under § 10(b) and Rule 10b-5.
This results in no prejudice to the plaintiffs or their attorneys because this circuit has
expressly refused to read a private right of action into § 17. Currie v. Cayman Res. Corp., 835
F.2d 780, 784–85 (11th Cir. 1988) (“We therefore hold that section 17(a) does not imply a
private cause of action . . . .”); see also id. at 784 n.8 (noting that the Supreme Court has not
decided the question). Therefore, reading the complaints to seek relief only under § 10(b)
removes a roadblock in the plaintiffs’ path to recovery. In any event, the plaintiffs referenced
the 1934 Act in Count III’s header and never pressed a 1933 Act § 17 claim either in the district
court or in this court. Accordingly, notwithstanding the citation error, from this point forward, I
treat the plaintiffs as bringing only a § 10(b) claim.
26
The text of § 10(b) of the 1934 Act, as codified at 15 U.S.C. § 78j, states, in pertinent
part:
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.
27
The text of Rule 10b-5, as codified at 17 C.F.R. § 240.10b-5, states that:
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,
(a) To employ any device, scheme, or artifice to defraud,
51
relief for any person who relies on a false or misleading statement in connection
with the purchase or sale of a security.
More specifically, Count III alleged that “[t]he Defendants . . . offered and
sold the shares . . . in violation of . . . Rule 10b-5.” (Compl. ¶ 60.) Because Media
and the Officers only “offered and sold” shares to the private offering purchasers,
the § 10(b), Rule 10b-5 claim was limited to the private offering subclass. The
complaint did not directly identify any false or misleading statement made by any
defendant in connection with Media’s sale of shares to Thompson or any other
private offering purchaser; nor did the complaint allege any device or scheme to
defraud. Thompson did, however, refer to the omissions in Count I’s section 11
and 12 claims. (Compl. ¶ 58 (“As stated herein, the registration statement and
prospectus contained untrue statements of material facts . . . .”).) Therefore,
Thompson claimed the private offering purchasers could recover based on Media’s
failure to disclose its use of unregistered brokers in its public offering documents.
Thompson invoked the district court’s supplemental jurisdiction for the state
law claims asserted in Counts IV though IX. See 28 U.S.C. § 1367. Count IV
(b) To make any untrue statement of a material fact or to omit 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
(c) To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
52
alleged that Media, aided and abetted by the Officers, sold Media shares through
brokers, dealers, and agents who were not registered in Florida, in violation of
Florida Statutes §§ 517.12 and 517.061. Count V alleged that sales were made in
Indiana via unregistered brokers, dealers, and agents, in violation of Indiana Code
§ 23-2-1-8. Count VI alleged that Media, aided and abetted by the Officers, sold
Media shares that were unregistered in violation of Indiana Code §§ 23-2-1-2 and
23-2-1-3. Count VII alleged that Media, aided and abetted by the Officers, sold
Media shares in violation of the anti-fraud provisions of the Indiana Securities Act,
Indiana Code § 23-2-1-12. Count VIII alleged that Media, aided and abetted by the
Officers, defrauded the purchasers of Media shares, in violation of Indiana Code §
35-43-5-3. Count IX alleged that Media and the Officers defrauded the purchasers
of Media shares, in violation of the common law.
As remedies, Thompson sought rescission or damages for the federal
securities claims brought in Counts I through III. As for the state law claims,
Thompson sought rescission for Counts IV through VII, trebled compensatory
damages for Count VIII, and compensatory and punitive damages for Count IX.
Prior to filing his complaint, Thompson disposed of all of his Media shares.
Accordingly, the remedy of rescission was not available to him in Counts I through
VII. Nor was rescission available to the members of Thompson’s open market
53
subclass because they never bought shares from Media; therefore, they could not
obtain a judgment requiring the company to return the purchase price—which they
never paid to the company—in exchange for the shares they still held.
2. The Defendants Warn Thompson’s Attorneys that the Suit is Frivolous
After Media received the initial complaint, but before filing a responsive
pleading, Thomas Fleming, one of Media’s attorneys,28 wrote to Cohen & Malad to
advise the firm that Thompson’s claims were frivolous and that the complaint had
been filed in violation of Rule 11(b). While the record does not contain Fleming’s
letter, it does contain Cohen & Malad’s reply. Richard Bell replied on behalf of
Cohen & Malad, stating:
We are in receipt of your letter of October 6, 2006. We strongly
disagree with your assessment of this securities litigation filed against
your client []. Contrary to your opinion, the lawsuit was filed in good
faith and was diligently investigated and researched before it was
filed.29
....
Lastly at some point in time both our clients will want to resolve or
settle this case. So I will commit to be respectful of your legal
positions even though I may disagree.
28
Fleming was a member of the New York firm of Olshan, Grundman, Frome,
Rosenzweig & Wolosky LLP. The firm withdrew from the case on November 17, 2006, and was
later replaced as lead counsel for Media by White & Case.
29
Rest assured that we do plan to amend the complaint and will add additional
defendants. Our investigation is ongoing.
54
(Pls.’ Mot. to Compel Disc. Ex. A (Oct. 11, 2006 Letter from Richard Bell to
Thomas Fleming, at 1, 4) (Oct. 24, 2006) (footnote in original).)
3. The Defendants Move to Dismiss, Request the Court to Retain Jurisdiction to
Impose Sanctions
Shortly thereafter, on October 20, 2006, the defendants moved to dismiss
Thompson’s complaint on a slew of grounds.30 As for the federal securities law
claims, the defendants pointed to several pleading errors. The Counts I and II
claims under § 11 and § 12 of the 1933 Act failed to identify any purchase made in
reliance on false or misleading statements in a registration statement or
prospectus.31 The Count III § 10(b), Rule 10b-5 claim failed to identify any false
or misleading statements with the particularity and specificity required by Rule
9(b) of the Federal Rules of Civil Procedure and the PSLRA.
Turning to Thompson’s state law claims, the defendants argued that those
claims were barred by the Securities Litigation Uniform Standards Act
(“SLUSA”), 15 U.S.C. § 78bb, which mandates, with limited exceptions not
30
Media filed its motion to dismiss on October 20, 2006. Karp filed her motion to
dismiss on October 31, 2006. Jehassi sought and was granted an extension to respond to the
complaint but never actually needed to respond because Thompson withdrew the complaint and
never again named him as a defendant.
31
The defendants also noted that because Thompson had purchased his shares in a
private offering in June 2005—long before Relationserve Media filed its initial registration
statement on March 20, 2006—and because it had not issued a prospectus, Thompson could not
make out a violation of §§ 11 or 12 of the 1933 Act.
55
applicable here, that class action claims involving the purchase or sale of nationally
traded securities must be asserted under federal securities law.32
In their motions to dismiss, defense counsel also notified Thompson’s
counsel that they considered the claims to be baseless and in violation of Rule 11.
Indeed, both defendants who responded to the complaint moved the court to
dismiss the case and to retain jurisdiction to impose sanctions pursuant to the
PSLRA and Rule 11.33
4. Thompson’s Attorneys Move the Court for Leave to Amend and for Limited
Discovery to Add Individual Defendants
Thompson did not respond to the defendants’ motions. Instead, on October
24, his attorneys moved the district court for leave to conduct limited discovery to
32
In relevant part, the SLUSA provides:
(f) Limitations on remedies
(1) Class action limitations
No covered class action based upon the statutory or common law
of any State or subdivision thereof may be maintained in any State
or Federal court by any private party alleging—
(A) a misrepresentation or omission of a material fact in
connection with the purchase or sale of a covered security; or
(B) that the defendant used or employed any manipulative
or deceptive device or contrivance in connection with the
purchase or sale of a covered security.
15 U.S.C. § 78bb.
33
White & Case LLP represented Media and all individual defendants except Karp, who
was represented by McClosky, D’Anna & Dieterle, LLP; Honig, who was represented by Tew
Cardenas LLP; and Hill, who was represented by Genovese Joblove & Battista, P.A.
56
obtain the last known addresses for fourteen of the company’s officers and
directors so Thompson could amend his complaint and name them as defendants.
5. The Court Grants the Attorneys Leave to Amend and Limited Discovery and
Warns the Attorneys About Rule 11
On November 3, the district court held a telephone conference to hear
argument on the pending motions. During the call, Thompson’s counsel informed
the court that they wished to file an amended complaint; the court granted them
leave to do so.34 Over Media’s strenuous objection that Thompson’s request for
limited discovery amounted to a scorched-earth litigation tactic,35 the court granted
Thompson’s motion. In granting this motion, the court, although it had not yet
read the complaint, reminded counsel,
Also, there’s Rule Eleven which provides sanctions if there is no
legitimate basis for bringing a suit or serving the various officers and
directors . . . .
....
. . . I don’t know whether these officers and directors are legitimate
targets or not. There is no way I can know. I do know you lawyers
being experienced lawyers know about Rule Eleven.
34
On November 7, 2006, the district court entered an order denying the defendants’
motions to dismiss. The order stated that the plaintiff had asked for, and had been granted, leave
to amend his complaint.
35
Media argued that plaintiff’s counsel were pursuing a scorched-earth tactic in an effort
to “coerce some money out of a business where the plaintiff lost maybe $150,000. He has
asserted class action claims. He has tried every trick in the book.” (Teleconference Tr. 5, Nov.
3, 2006.)
57
....
Mr. Goldbaum, I will tell you, you really ought to think long and hard
before you just automatically sue everyone that happens to be on the
list of officers and directors. That’s for you to decide . . . .
(Teleconference Tr. 4, 6–7, Nov. 3, 2006.) Responding to this warning,
Thompson’s counsel promised the court that they would be mindful of Rule 11 and
would name officers and directors as defendants only if they had a reasonable basis
for doing so.
B. The First Amended Complaint
1. Thompson & Jacoby File the First Amended Complaint, Each Purporting to
Represent All Class Members on All Claims
On November 13, 2006, Thompson, now joined by new co-lead plaintiff L.
Alan Jacoby,36 filed a ten-count first amended complaint against Media, eleven
Officers and two non-officers.37 Recall that Jacoby purchased Media shares in the
36
The first amended complaint never explicitly declared that Jacoby was a lead plaintiff.
In securities actions, the PSLRA requires proposed lead plaintiffs to file certifications with the
district court. See 15 U.S.C. § 78u-4(a)(2)(A) (requiring a sworn statement that, for example,
the proposed lead plaintiff has reviewed the complaint and authorized its filing). Because
plaintiffs’ counsel filed Jacoby’s certification in a separate document and incorporated it by
reference in the first amended complaint, I treat Thompson and Jacoby as co-lead plaintiffs.
(See First Am. Compl. ¶ 1.)
37
The first amended complaint dropped Ohad Jehassi as a defendant. The Officers were
Danielle Karp, Mandee Heller Adler, Warren “Pete” Musser (these three had been named as
defendants in the initial complaint), Scott Young, Scott Hirsch, Adam C. Wasserman, Michael
H. Brauser, Shawn McNamara, Paul Soltoff, Eric Obeck, and Donald Gould, Jr. The non-officer
defendants were Richard Hill and Barry Honig. Hill was a “founder of Omni Point,” the
company that Relationserve acquired on May 16, 2005. (First Am. Compl. ¶ 17.) Honig was
“not registered with the Securities Exchange Commission” and therefore violated “the securities
laws” when he “sold RelationServe securities to Investors and received remuneration.” (Id. ¶
58
open market in July 2005. Both plaintiffs purported to represent all buyers of
Media securities who bought during the class period as to all claims. (First Am.
Compl. ¶¶ 99, 102.) Like the initial complaint, however, this complaint had two
implicit subclasses: one of private offering purchasers, and one of open market
purchasers. Also like the initial complaint, this complaint was a shotgun pleading.
The new complaint differed by adding to its federal securities law claims
new theories of the defendants’ allegedly false or misleading statements. In
addition to Thompson’s unregistered-broker theory, Thompson and Jacoby also
alleged that Media failed to disclose its retention of outside counsel to investigate
accusations of employee theft and kickbacks (the “kickback theory”); that
beginning in the third quarter of 2005, its financial statements recognized income
in violation of Generally Accepted Accounting Principles (“GAAP”) and company
policy (the “overstated-income theory”); and that it did not disclose that director
Musser had been sued by stockholders of two other corporations for securities
violations (the “sued-director theory”).
18.) According to the complaint, the remainder of the defendants were Officers and/or directors
of Media: Hirsch was chief operating officer, Wasserman was chief financial officer, Brauser
was chairman of the board, McNamara was senior vice president and interim chief financial
officer, Soltoff was chief financial officer, Obeck was president, Gould was chief financial
officer, and Young founded Chubasco, Media’s predecessor. The complaint alleged that all of
these Officers signed or authorized one or more certifications with the SEC. (Id. ¶¶ 10–22.)
59
The plaintiffs also tried to strengthen Thompson’s original unregistered-
broker theory. They added an allegation that Summit and another unregistered
broker, Barry Honig, sold securities to a Florida resident, Stuart Feick. (First Am.
Compl. ¶¶ 66–67.) Additionally, the plaintiffs essentially listed all of Media’s SEC
filings to date,38 with one notable exception. The first amended complaint did not
list Media’s June 16, 2005 Form 8-K current report, which revealed the Summit
consulting agreement, and, with it, Summit’s representation that it was not licensed
and would not act as a broker/dealer for Media.39 The amended complaint alleged
that all of the listed SEC filings were false or misleading because they failed to
state the material facts recounted above, including Media’s use of an unregistered
broker—Summit—to sell its shares.
38
The plaintiffs alleged that the following documents contained false or misleading
statements due to omissions of material fact: (a) the June 13, 2005 Form 8-K; (b) the June 14,
2005 quarterly statement Form 10-QSB filed by Chubasco; (c) the June 27, 2005 Form 8-K; (d)
the June 30, 2005 Form 8-K; (e) “several Form 8K’s [sic]” filed in July, August and September
2005; (f) the August 18, 2005 quarterly statement Form 10-QSB; (g) the November 18, 2005
quarterly statement Form 10-QSB; (h) “several Form 8K’s [sic]” filed in November 2005; (i)
“several” Form 8-Ks filed on December 5, 2005; (j) the December 30, 2005 Form 8-A
Registration Statement; (k) “several Form 8K’s [sic]” filed in February 2006; and (l) the March
20, 2006 Form SB-2 and Form 10-K. (First Am. Compl. ¶¶ 72–92.)
39
That the amended complaint contained no explicit reference to the June 16, 2005
current report is noteworthy for three reasons. First, the plaintiffs chose to list almost every
other SEC filing, made both before and after June 16, 2005. Second, Thompson had attested in
the subscription agreement he signed when he purchased his shares in the private offering that he
had read and reviewed this June 16, 2005 filing. See supra note 11 and accompanying text.
Third, the plaintiffs cited the June 16 filing in the initial complaint verbatim, and the only time
the agreement was disclosed was in the June 16, 2005 filing.
60
Counts I through III replicated nearly verbatim Counts I through III of the
initial complaint. Count I alleged that Media violated § 11 by filing a false
registration statement; Count II claimed that Media violated § 12 by issuing false
or misleading prospectuses or oral communications; Count III alleged violations of
§ 10(b) and Rule 10b-5. The plaintiffs added a new count, Count IV, “Violation
Of Section 20(a) of The Exchange Act Against the Individual Defendants.” That
count asserted that the Officers were liable for the Count III § 10(b), Rule 10b-5
violations because the Officers were controlling persons under § 20(a) of the 1934
Act, 15 U.S.C. § 78t.40 For all three federal securities claims, the plaintiffs alleged
the same misleading statements—Media’s securities filings misled because they
omitted Media’s use of an unregistered broker, its investigation of kickbacks, its
overstatement of income, and its sued director.
Similarly, with two notable exceptions, the plaintiffs re-pled their state law
claims almost verbatim. See Part II.A.1, supra. The state law claims were now
pled as Counts V through X (they were pled as counts IV through IX in the initial
40
Section 20(a) provides:
Every person who, directly or indirectly, controls any person liable under any
provision of [the 1934 Act] or of any rule or regulation thereunder shall also be
liable jointly and severally with and to the same extent as such controlled person
to any person to whom such controlled person is liable, unless the controlling
person acted in good faith and did not directly or indirectly induce the act or acts
constituting the violation or cause of action.
15 U.S.C. § 78t(a).
61
complaint). The two exceptions involved the allegations of fraud in the now Count
VIII Indiana Securities Act fraud claim and the now Count IX Indiana deception
claim. In the initial complaint’s iteration, Thompson alleged that Media
fraudulently failed to disclose: sizeable commissions and fees it paid to Altavilla,
that the stock was not registered and therefore restricted, and that Media had hired
“unregistered agents to sell there [sic] securities.” (Compl. ¶¶ 76, 78.) In the
amended complaint, Thompson eliminated any claim that Media misled him about
the unregistered status of his shares and pled the unregistered-broker, kickback,
overstated-income, and sued-director theories of misrepresentation instead. (First
Am. Compl. ¶¶ 147, 149.)
2. The Defendants Move to Dismiss, Request the Court to Retain Jurisdiction to
Impose Sanctions
The defendants responded to the first amended complaint with motions to
dismiss, which articulated virtually the same rationales as their previous motions to
dismiss. Addressing the Counts I and II claims under § 11 and § 12 of the 1933
Act, the defendants argued that the private offering subclass could not have relied
on a Media registration statement or prospectus because none had been issued for
those shares. Addressing Jacoby’s purchase of 10,000 shares in the open market in
July and August 2005, the defendants argued that these shares were purchased
under a registration statement and prospectus issued by Chubasco in February 2005
62
and thus could not form the basis for a § 11 or § 12 claim against Media. Turning
to the Count III § 10(b), Rule 10b-5 claim, the defendants argued that the plaintiffs
failed to plead the claim with the particularity and specificity demanded by Rule
9(b) and the PSLRA. As for the state law claims, the defendants again reiterated
that they were barred by the SLUSA, and, even if they were not barred by the
SLUSA, they failed to state a claim. Finally, defendants Media, Adler, Musser,
Wasserman, Brauser, McNamara, Soltoff, Obeck, Gould, and Young, and, in her
separate motion, defendant Karp, reiterated the request that the court retain
jurisdiction to impose sanctions.
In response to the defendants’ motions, plaintiffs’ counsel conceded that
their § 11 claim had no merit.41 Although the plaintiffs also conceded that their §
12 claim could not succeed on the basis of any false or misleading prospectus, they
maintained the claim had merit because Thompson relied on certain (unidentified)
“oral communication[s]” in the June private offering.42 (Pls.’ Resp. to Defs.’ Mot.
41
In their response, plaintiffs’ counsel stated: “After reviewing the Defendants’ briefs
and further investigating the claims, Plaintiffs Jacoby and Thompson have decided to abandon
their Section 11 claims.” (Pls.’ Resp. to Defs.’ Mot. to Dismiss 26, Jan. 29, 2007.)
42
The first amended complaint alleged that Thompson had relied on “oral
communications” from Altavilla. Paragraph 56 stated: “Before investing Plaintiff Richard F.
Thompson reviewed the public statements on the internet about Relationserve [Media], listened
to the sales pitch of Tony Altavilla and reviewed all document[s] presented by Tony Altavilla.”
Paragraph 58 stated: “In order to complete the purchase of Relationserve [Media] shares by the
Plaintiff Richard F. Thompson, Altavilla negotiated the final purchase price between the parties,
and facilitated wire transfers of money from the Plaintiff to Relationserve [Media].”
63
to Dismiss 25, Jan. 29, 2007.)43 As for the § 10(b), Rule 10b-5 claim, counsel
argued that they had met the strict pleading requirements of Rule 9(b) and the
PSLRA.44 (Id. at 11.)
Regarding the state law claims, the plaintiffs conceded that the SLUSA
barred them from maintaining three of the five claims as class actions: the Count
VIII Indiana securities fraud claim, the Count IX Indiana deception claim, and the
Count X common law fraud claim. They argued that Counts V, VI, and VII were
cognizable. (Id. at 23–24.) Counts V and VI alleged that Media sold securities via
unregistered brokers in violation of Florida and Indiana law, respectively; Count
VII alleged that Media sold unregistered, non-exempt securities in violation of the
Indiana Securities Act. The defendants contended that these claims were “not
within the purview of SLUSA because the claims do not allege that the Defendants
misrepresented or omitted a material fact in connection with the purchase or sale of
such security.” (Id. at 23 (quotation omitted).)
3. The Court Dismisses the First Amended Complaint
43
Plaintiffs’ counsel apparently concluded that they lacked evidentiary support, legal
support, or both, for the “oral communication[s],” because, when they filed the second amended
complaint, they did not assert a § 12 claim.
44
The plaintiffs’ allegations of fraudulent conduct on the part of the Officers were that
they “omitted to state material facts” in documents with the SEC. (See First Am. Compl. ¶¶
9–22.) For example, “Defendant Danielle Karp was the President and Secretary of
Relationserve. Danielle Karp signed one or more certifications per Sarbanes-Oxley Act filed
with the SEC which omitted to state material facts.” (Id. at ¶ 10.)
64
The district court heard the defendants’ motions to dismiss during a
conference call with counsel on March 6, 2007. Referring to the § 10(b), Rule
10b-5 claims, the court questioned whether Thompson was a suitable class
representative because of a possible conflict with the open market purchasers. The
court also indicated that it had serious concerns about the adequacy of the
plaintiffs’ pleading. At one point, the court said:
So I don’t see anything where it is alleged that [Thompson and
Jacoby] relied on anything specific. Nothing is tied together. There
are a lot of things thrown out in the first amended complaint, but I see
very little connecting of the dots.
Seems to me there are some real gaps there. Seems to me you may
have more than one lawsuit tied into one lawsuit. . . .
....
Again, it’s kind of hard to follow. It’s like so what, who relied on it,
who did what? Where is the reliance causation?
I don’t see . . . where anyone is alleged to have relied on any
particular filing whether [a Form] 10[-] K, [Form] 10-Q[SB], or
registration statement that led that person to purchase something.
(Hr’g Tr. 8, Mar. 6, 2007.) After detailing why the federal securities claims failed,
the court offered plaintiffs’ counsel “one final time to take care of” the
deficiencies. (Id. at 5.) The court therefore dismissed the first amended complaint
without prejudice, with leave to file a second amended complaint by March 19,
2007.
65
C. The Second Amended Complaint
1. Thompson & Jacoby File the Second Amended Complaint with Jacoby Leading
an Open-Market Purchaser Subclass Bringing Federal Securities Claims and with
Thompson Leading a Private Offering Purchaser Subclass Bringing State Law
Claims
The plaintiffs filed a second amended complaint on March 19, 2007. This
complaint, unlike the prior ones, pled two class actions: one under federal
securities law, with Jacoby as the class representative, and the other under state
law, with Thompson as the class representative. Both actions sought rescission or
damages for purchasers of Media stock.
As for the federal claims, Jacoby brought his class action in two counts, I
and II, “on behalf [of] himself and all others similarly situated that purchased
RelationServe Media, Inc. . . . securities on the open market prior to May 23,
2006.” (Second Am. Compl. ¶ 1.) In Count I, except for the class definition,
Jacoby replicated the claim brought by Thompson in Count III of the initial
complaint and by Thompson and Jacoby in Count III of the first amended
complaint—that Media and the Officers “offered and sold RelationServe securities
in violation of” § 10(b) of the 1934 Act and Rule 10b-5. (Second Am. Compl. ¶¶
101–03.)45 In Count II, except for the class definition, Jacoby replicated the §
45
In drafting the second amended complaint, plaintiffs’ counsel did not include the § 11
and § 12 claims asserted in Counts I and II of the initial and first amended complaints, which
were based on misrepresentations allegedly made in Media’s registration statement and
prospectus. See supra parts II.A and B. Nonetheless, in presenting Count I in the second
66
20(a) claim brought by Thompson and Jacoby in Count IV of the first amended
complaint—“[b]y virtue of their positions as controlling persons [of Media], the
individual Defendants are liable” for Media’s violation of § 10(b) and Rule 10b-5.
(Id. ¶¶ 104–11.)
The biggest difference between the federal securities claims in the first and
second amended complaints was what the second amended complaint omitted.
Gone was Thompson from any federal securities claim; gone were two of the
individual defendants;46 gone were the § 11 and § 12 claims; gone were the
kickback and the overstated-income theories of misrepresentation.47 Only Jacoby
remained, representing open market purchasers and bringing a § 10(b), Rule 10b-5
claim and a parasitic § 20(a) claim.48 Jacoby asserted only the unregistered-broker
and sued-director theories of misrepresentation.
amended complaint, counsel repeated the allegation that “RelationServe[ Media’s] registration
statement(s) and prospectus contained misleading information and omitted material facts
necessary to make the statements alleged therein not misleading.” (Second Am. Compl. ¶ 102.)
46
The plaintiffs dropped Richard Hill and Barry Honig.
47
The plaintiffs did not even plead the factual predicate for the kickback theory; the
plaintiffs did plead the factual predicate for the overstated-income theory (Second Am Compl. ¶¶
60, 61), but did not plead it as an actionable omission in the § 10(b), Rule 10b-5 claim, (id. ¶¶ 3,
80, 95). Further, in the district court and in this appeal, the plaintiffs advanced it only to
demonstrate the defendants’ venal character in support of the plaintiffs’ scienter argument.
48
A § 20(a) claim is a parasitic claim because it can only succeed if a predicate § 10(b),
Rule 10b-5 claim succeeds; thus the § 20(a) claim lives and dies by the Rule 10b-5 claim.
67
Thompson asserted his class action in Count III “on behalf of himself and all
others similarly situated that purchased RelationServe [Media] securities by way of
a private offering.” (Id. ¶ 2.) Count III alleged that the defendants
violated the securities laws of California, Connecticut, Florida,
Illinois, Indiana, Nevada, New Jersey, New York, Ohio, and
Pennsylvania by way of (1) their sale of RelationServe [Media]
securities through the use of broker/dealers and agents who were not
registered with the SEC [and those states] and (2) their payment of a
commission.49
(Id. ¶ 113.) Furthermore,
[e]ach Defendant having access to RelationServe [Media] business
prior to and during RelationServe[ Media’s] use of unregistered
broker/dealers personally participated or aided in making the sales to
Thompson and his putative class and is jointly and severally liable for
rescission if the purchaser still owns the security or for damages if the
purchaser has sold the security.
(Id. ¶ 114.) Here again, most notable was what was omitted: gone was the claim
that Media sold unregistered, non-exempt securities in violation of the Indiana
securities act, and gone were all of the state law fraud claims.
The first 100 paragraphs resembled the first 117 paragraphs of the first
amended complaint. Like that complaint, the second amended complaint omitted
any reference to Media’s June 16, 2005 current report, which indicated that
Summit was not registered and would not act as a broker/dealer, but, rather would
49
As it pertained to the securities laws of Florida and Indiana, Count III replicated the
allegations of Counts IV and V of the initial complaint and Counts V and VI of the first amended
complaint.
68
only act as a finder. Nevertheless, the second amended complaint addressed the
licensing issue by alleging that “RelationServe [Media], and its officers and
directors, knew and failed to report . . . that Summit and its agents [we]re not
registered with the SEC or the state securities divisions.” (Second Am. Compl. ¶
45.) It also alleged that the Officers acted with scienter in failing to report this: the
Officers “knew and/or recklessly disregarded the falsity and misleading nature of
the information which they caused to be disseminated to the investing public.” (Id.
¶ 80.)
2. The Defendants Move to Dismiss, and Defendant Karp Moves for Sanctions
Once again, the defendants moved to dismiss the plaintiffs’ complaint. They
did so on several grounds, among them that (1) the § 10(b), Rule 10b-5 claim’s
allegations of misrepresentation and scienter were insufficient under the
heightened pleading requirements of Rule 9(b) and the PSLRA; and (2) as a
consequence, the parasitic § 20(a) claim failed. As for Thompson’s state law class
action, the defendants pointed out that of the ten states where Media allegedly sold
shares through unregistered brokers, the plaintiffs had identified only one sale in
only one state—specifically, Media’s sale to Thompson through Summit in
Indiana. Accordingly, the state law claims in all states except Indiana failed from
69
the get-go. As for the Indiana sale to Thompson, the plaintiffs pointed out that
Summit did not need to be registered as a broker under Indiana law.
In addition to moving for the dismissal of the complaint, defendant Karp
moved for sanctions against the plaintiffs and their attorneys under Rule 11 with
respect to all counts and under the PSLRA with respect to the Count I § 10(b),
Rule 10b-5 claim and the Count II § 20(a) claim.50
3. The Court Dismisses the Complaint with Prejudice but Denies Sanctions
On June 12, 2007, the district court entered an order disposing of the
defendants’ motions. The court dismissed Count I because it failed to meet the
heightened pleading standards of Rule 9(b) and the PSLRA. In the court’s view,
the § 10(b), Rule 10b-5 elements of misrepresentation and scienter had not been
pled with the requisite specificity. Specifically, the § 10(b), Rule 10b-5 claim did
not identify one statement of significance in any SEC filing that was allegedly false
or misleading due to the omission of a material fact, and it pled scienter in a
conclusory fashion, thereby failing to create a strong inference of severe
recklessness on the part of Media or the Officers. The court dismissed Count II
50
All defendants except Jehassi sought Rule 11 sanctions when they moved the district
court to dismiss the initial complaint; eleven of thirteen defendants renewed this request in their
motions to dismiss the first amended complaint; and all defendants renewed this request in their
motions to dismiss the second amended complaint. Karp was the only defendant who sought the
imposition of sanctions in a separate motion and was the only defendant who appealed the denial
of sanctions.
70
because Count I was legally insufficient. The dismissal of Counts I and II left the
court with the state law claims of Count III. The court declined to exercise its
supplemental jurisdiction over those claims and therefore dismissed them without
prejudice.
In a separate order entered on June 12, the court denied Karp’s motion for
sanctions. The court found “that Plaintiffs’ claims are not frivolous, or so devoid
of evidentiary support as to warrant sanctions. Likewise, there is no evidence that
Plaintiffs instituted this action for improper purposes, such as to harass [Media,
Karp, or any other named defendant] or needlessly increase the cost of litigation.”
(Sanctions Order 1, June 12, 2007 (internal citations omitted).)51 Karp contended
that sanctions were warranted because, “[i]n dismissing the instant matter three
times for failing to state a cause of action, the District Court in essence ruled
Plaintiffs’ claims were frivolous.”
4. Jacoby’s Appeal, Karp’s Cross-Appeal, and this Court’s Decision
51
The two page order denying sanctions did not explicitly address Rule 11(b)
compliance under the PSLRA with respect to: (1) the § 11 claims brought as Count I in the
initial and first amended complaints; (2) the § 12 claims brought as Count II in the initial and
first amended complaints; (3) the § 10(b), Rule 10b-5 claims brought as Count III of the initial
complaint and first amended complaints and Count I of the second amended complaint; or (4)
the § 20(a) claims brought as Count IV of the first amended complaint and Count II of the
second amended complaint. After declining to exercise jurisdiction over Count III of the second
amended complaint, Thompson’s state law claims, the district court did not decide whether Rule
11 sanctions should be imposed for plaintiffs’ prosecution of those claims.
71
Subsequently, Jacoby appealed to this court and Karp cross-appealed.
Jacoby appeals the district court’s dismissal of the § 10(b), Rule 10b-5 and § 20(a)
claims of the second amended complaint. Karp cross-appeals the court’s denial of
PSLRA Rule 11 sanctions for the federal claims and ordinary Rule 11 sanctions for
the second amended complaint’s state law claims.
Today, the court correctly affirms the dismissal of Jacoby’s federal securities
law claims. The court disposes of Karp’s appeal regarding PSLRA sanctions by
vacating the district court’s sanctions order and remanding the case for further
proceedings, because the district court’s PSLRA order is too conclusory to permit
meaningful appellate review. The court’s disposition contains insufficient
instructions as to precisely what the district court must do on remand. In my view,
under the court’s disposition, the district court must carry out its PSLRA duties
from scratch with respect to all parties and their respective attorneys. Finally, the
court makes no explicit holding regarding Karp’s motion for ordinary Rule 11
sanctions on the state law claims.
III. This Court Errs by Summarily Remanding Karp’s Cross-Appeal for Sanctions
Under the PSLRA
In Karp’s cross-appeal for Rule 11 and PSLRA sanctions, the court errs for
two reasons. First, the court’s opinion fails to make perfectly clear that, on
remand, the district court must review and make “specific findings regarding”
72
plaintiffs and plaintiffs’ counsel’s compliance with each requirement of Rule 11(b)
with respect to all three complaints.52 Second, the court should not have remanded
with a blank slate; at bottom, the court should have instructed the district court to
sanction plaintiffs’ attorneys for noncompliance with Rule 11(b). This discussion
proceeds in two parts. Part A sets out the duties the PSLRA imposes on district
courts and shows that the district court must review all three complaints for Rule
11 compliance on remand. Part B explains that under the PSLRA, there is no need
for a remand when the record demonstrates conclusively that an attorney or party
violated Rule 11.
A. The PSLRA Rule 11 Analytical Framework & Requirements
The PSLRA mandates sanctions for filing and prosecuting frivolous or
abusive securities actions under the 1933 and 1934 Acts and emphasizes the need
not only to deter such filings but also to compensate the victims. See H.R. Rep.
No. 104-369, at 39–40 (1995) (Conf. Rep.), reprinted in 1995 U.S.C.C.A.N. 730,
738–39. Accordingly, the PSLRA requires both (1) mandatory findings regarding
compliance with Rule 11, and (2) mandatory sanctions whenever any portion of a
52
See 15 U.S.C. §§ 77z-1(c), 78u-4(c). Full compliance with the PSLRA requires the
district court to review the motions the defendants filed in response to the three complaints as
well, but the focus on remand will be the complaints.
73
plaintiff’s complaint fails to comply with Rule 11.53 15 U.S.C.
53
Section 78u-4(c), which is materially identical to § 77z-1(c), provides:
Sanctions for abusive litigation
(1) Mandatory review by court
In any private action arising under this chapter, upon final adjudication of
the action, the court shall include in the record specific findings regarding
compliance by each party and each attorney representing any party with
each requirement of Rule 11(b) of the Federal Rules of Civil Procedure as
to any complaint, responsive pleading, or dispositive motion.
(2) Mandatory sanctions
If the court makes a finding under paragraph (1) that a party or attorney
violated any requirement of Rule 11(b) of the Federal Rules of Civil
Procedure as to any complaint, responsive pleading, or dispositive motion,
the court shall impose sanctions on such party or attorney in accordance
with Rule 11 of the Federal Rules of Civil Procedure. Prior to making a
finding that any party or attorney has violated Rule 11 of the Federal
Rules of Civil Procedure, the court shall give such party or attorney notice
and an opportunity to respond.
(3) Presumption in favor of attorneys’ fees and costs
(A) In general
Subject to subparagraphs (B) and (C), for purposes of paragraph
(2), the court shall adopt a presumption that the appropriate
sanction—
(i) for failure of any responsive pleading or dispositive
motion to comply with any requirement of Rule 11(b) of
the Federal Rules of Civil Procedure is an award to the
opposing party of the reasonable attorneys’ fees and other
expenses incurred as a direct result of the violation; and
(ii) for substantial failure of any complaint to comply with
any requirement of Rule 11(b) of the Federal Rules of Civil
Procedure is an award to the opposing party of the
reasonable attorneys’ fees and other expenses incurred in
the action.
74
§ 77z-1(c); 15 U.S.C. § 78u-4(c).
The PSLRA-mandated Rule 11 compliance review is sweeping. In a
paragraph entitled “Mandatory review by court,” the statute provides that, in any
private securities action, “the court shall include in the record specific findings
regarding compliance by each party and each attorney . . . with each requirement of
Rule 11(b) . . . as to any complaint, responsive pleading, or dispositive motion.”
15 U.S.C. § 78u-4(c)(1) (emphasis added). Congress imposed this heavy duty on
district courts via statute; thus, whether a party moved for sanctions is irrelevant.
(B) Rebuttal evidence
The presumption described in subparagraph (A) may be rebutted only
upon proof by the party or attorney against whom sanctions are to be
imposed that—
(i) the award of attorneys’ fees and other expenses will impose an
unreasonable burden on that party or attorney and would be unjust,
and the failure to make such an award would not impose a greater
burden on the party in whose favor sanctions are to be imposed; or
(ii) the violation of Rule 11(b) of the Federal Rules of Civil
Procedure was de minimis.
(C) Sanctions
If the party or attorney against whom sanctions are to be imposed meets
its burden under subparagraph (B), the court shall award the sanctions that
the court deems appropriate pursuant to Rule 11 of the Federal Rules of
Civil Procedure.
Because the two subsections are materially identical, from this point forward, I cite only to 15
U.S.C. § 78u-4(c).
75
Moreover, because Congress extended this duty to “any” complaint, when a
plaintiff files multiple complaints, each must be scrutinized. See Reeves v. Astrue,
526 F.3d 732, 734 (11th Cir. 2008) (“Statutory interpretation begins and ends with
the text of the statute so long as the text’s meaning is clear.”). The PSLRA does
not grant a get-out-of-jail-free card—one nonfrivolous complaint does not
immunize the earlier filing of frivolous complaints. See ATSI Commc’ns, Inc. v.
Shaar Fund, Ltd., 579 F.3d 143, 152 (2d Cir. 2009) (“The PSLRA sanctions
provision forecloses the kind of safe harbor afforded in Rule 11(c)(2). The PSLRA
explicitly directs courts to make Rule 11 findings ‘upon final adjudication of the
action’ . . . and it is well-settled that no safe harbor could apply retroactively.”)
(quoting 15 U.S.C. § 78u4-(c)(1)). Even in the ordinary Rule 11 context, where a
complaint contains multiple claims, one nonfrivolous claim will not preclude
sanctions for frivolous claims. E.g., Reed v. Great Lakes Cos., 330 F.3d 931, 936
(7th Cir. 2003) (“The fact that Reed’s accommodation claim, while it has failed,
was not frivolous would be no bar to imposing sanctions for putting his opponent
to the expense of opposing a frivolous claim (or defense) just because he had a
nonfrivolous claim as well.”). Here, the district court erred when it based its
sanctions review on only the second amended complaint. The district court should
76
have reviewed all three complaints (as well as, for that matter, each party, each
attorney, and each motion to dismiss) for compliance with Rule 11.
Although the PSLRA forces a district court to conduct the Rule 11 inquiry, it
does not alter the ordinary Rule 11 analysis. Simon DeBartolo Group, L.P. v.
Richard E. Jacobs Group, Inc., 186 F.3d 157, 167 (2d Cir. 1999). Rule 11 is
violated when: (1) a paper is presented for “any improper purpose, such as to
harass or to cause unnecessary delay or needless increase in the cost of litigation;”
(2) the legal contentions are not “warranted by existing law” or by a “nonfrivolous
argument” for changing existing law; or (3) the factual contentions lack evidentiary
support. Fed. R. Civ. P. 11(b) (2006).54 A Rule 11(b)(2) or (b)(3)
violation—bringing a legally or factually frivolous claim—is often probative of a
54
When this case was litigated, Federal Rule of Civil Procedure 11(b) provided:
(b) Representations to Court. By presenting to the court (whether by signing,
filing, submitting, or later advocating) a pleading, written motion, or other paper,
an attorney . . . is certifying that to the best of the person’s knowledge,
information, and belief, formed after an inquiry reasonable under the
circumstances,—
(1) it is not being presented for any improper purpose, such as to harass or to
cause unnecessary delay or needless increase in the cost of litigation;
(2) the claims . . . and other legal contentions therein are warranted by existing
law or by a nonfrivolous argument for the extension, modification, or reversal of
existing law or the establishment of new law;
(3) the allegations and other factual contentions have evidentiary support or, if
specifically so identified, are likely to have evidentiary support after a reasonable
opportunity for further investigation or discovery . . . .
Fed. R. Civ. P. 11 (2006). Rule 11 was amended in 2007 “as part of the general restyling of the
Civil Rules,” this amendment was “intended to be stylistic only.” Fed. R. Civ. P. 11 advisory
committee’s note, 2007 amendment. Nevertheless, I refer to the 2006 version of the Rule.
77
Rule 11(b)(1) improper purpose violation. Therefore, it helps to begin the PSLRA
examination with Rule 11(b)(2) and (3).
In this circuit, there are two prongs to the Rule 11(b)(2) and (b)(3) inquiry:
whether the legal claims or factual contentions are objectively frivolous, and, if so,
whether a reasonably competent attorney should have known they were frivolous.
Worldwide Primates, Inc. v. McGreal, 87 F.3d 1252, 1254 (11th Cir. 1996). Both
inquiries measure attorney conduct under an objective reasonably competent
attorney standard. Donaldson v. Clark, 819 F.2d 1551, 1556 (11th Cir. 1987) (en
banc).
A legal claim is frivolous if no reasonably competent attorney could
conclude that it has any “reasonable chance of success” or is a reasonable argument
to change existing law. Worldwide Primates, 87 F.3d at 1254 (quoting Jones v.
Int’l Riding Helmets, Ltd., 49 F.3d 692, 694 (11th Cir. 1995)); McGregor v. Bd. of
Comm’rs of Palm Beach County, 956 F.2d 1017, 1022 (11th Cir. 1992) (“If an
allegation in a complaint contains no colorable claim for relief, then a Rule 11
sanction is proper.”). Not every Federal Rule of Civil Procedure 12(b)(6)
dismissal will warrant sanctions, but sanctions may be imposed when settled
precedent clearly bars a claim. See Davis v. Carl, 906 F.2d 533, 538 (11th Cir.
1990) (noting that legal claims are frivolous in egregious circumstances such as
78
when a party ignores the plain language of a statute of limitations or conceals
controlling authority); compare Thomas v. Early County, Ga., No. 09-12232, 2010
WL 27970, at *4 (11th Cir. Jan. 7, 2010) (unpublished) (concluding that Rule
11(b)(2) had been violated where “allegations of vicarious liability fail as a matter
of long-established law”), with Anderson v. Smithfield Foods, Inc., 353 F.3d 912,
915–16 (11th Cir. 2003) (per curiam) (affirming a district court’s dismissal of a
RICO count, but reversing the imposition of sanctions when there was “scant on-
point authority” to guide the attorney to the conclusion that the claim had no
chance of success).
A factual claim is frivolous if no reasonably competent attorney could
conclude that it has a reasonable evidentiary basis. Davis, 906 F.2d at 535–37.
Thus, where no evidence or only “patently frivolous” evidence is offered to
support factual contentions, sanctions can be imposed. Id. at 537. If, however, the
evidence supporting the claim is reasonable, but simply “weak” or “self-serving,”
sanctions cannot be imposed. Id. at 536.
Once a court concludes that either the factual or legal contentions are
frivolous, the question becomes whether the attorney should have known they were
frivolous. Worldwide Primates, 87 F.3d at 1254. We ask what was known or
reasonably knowable when the paper was “present[ed] to the court.” Fed. R. Civ.
79
P. 11(b). Again, measured objectively, if a reasonable investigation would have
revealed the error to a reasonably competent attorney, then sanctions can be
imposed; if not, then sanctions cannot be imposed. The reasonableness of the
inquiry turns on the totality of the circumstances, including, for example, the time
available for investigation and whether the attorney had to rely on the client,
another member of the bar, or others. Worldwide Primates, 87 F.3d at 1254.
Rule 11(b)(1) sanctions are appropriate when an attorney or party presents a
paper for an improper purpose. Improper purpose is often inferred from
circumstantial evidence. For example, it can be inferred from “‘excessive
persistence in pursuing a claim or defense in the face of repeated adverse rulings.’”
Indus. Risk Insurers v. M.A.N. Gutehoffnungshütte GmbH, 141 F.3d 1434, 1448
(11th Cir. 1998) (quoting Pierce v. Commercial Warehouse, 142 F.R.D. 687,
690–91 (M.D. Fla. 1992)). A “motive to harass” can also be inferred from an
attorney’s filing of factually or legally frivolous claims. Cf. Carr v. Tillery, 591
F.3d 909, 919–20 (7th Cir. 2010).
Ordinarily, even in the face of a blatant Rule 11 violation, a district court
retains discretion to decide how to sanction the party or even not to impose
sanctions at all. This discretion derives from Rule 11’s plain text: “If, after notice
and a reasonable opportunity to respond, the court determines that Rule 11(b) has
80
been violated, the court may impose an appropriate sanction on any attorney, law
firm, or party . . . .” Fed. R. Civ. P. 11(c)(1) (emphasis added); see also Fed. R.
Civ. P. 11 advisory committee’s note, 1993 Amendment (“[W]hat sanctions, if any,
to impose for a violation are matters committed to the discretion of the trial
court.”). Thus, ordinarily, a court can excuse an attorney’s negligence, mistake, or
plain-old incompetence.
But the PSLRA strips the district court of the discretion to grant mercy—the
PSLRA forces a district court to sanction an attorney for violating any prong of
Rule 11. The statute provides, in a paragraph entitled “Mandatory sanctions,” that
“[i]f the court makes a finding . . . that a party or attorney violated any requirement
of Rule 11(b) . . . as to any complaint, responsive pleading, or dispositive motion,
the court shall impose sanctions on such party or attorney . . . .” 15 U.S.C. § 78u-
4(c)(2) (emphasis added). Likewise, the PSLRA curtails a district court’s
discretion in fashioning the sanction. It does so by erecting a rebuttable
presumption that when any complaint “substantial[ly]” fails to comply with Rule
11, the sanction is the defendant’s attorneys’ fees for the entire action. Id. § 78u-
4(c)(3)(A)(ii).55 Even when the presumption is rebutted,56 a district court still must
55
For responsive pleadings and dispositive motions, the PSLRA erects a similar
presumption but without the requirement that the violation be “substantial” and limiting the
award of fees to those caused by the violation. See 15 U.S.C. § 78u-4(c)(3)(A)(i) (stating the
penalty for “failure of any responsive pleading or dispositive motion to comply with any
requirement of Rule 11(b)” is an “award to the opposing party of the reasonable attorneys’ fees
81
sanction the party in some appropriate manner. Id. § 78u-4(c)(3)(C) (“If the party
or attorney [to be sanctioned] meets its burden under subparagraph (B), the court
shall award the sanctions that the court deems appropriate pursuant to Rule 11 . . .
.”) (emphasis added).
The PSLRA’s mandate regarding Rule 11(b) compliance resulted from
Congress’s recognition of “the need to reduce significantly the filing of meritless
securities lawsuits without hindering the ability of victims of fraud to pursue
legitimate claims.” H.R. Rep. No. 104-369, at 39 (1995) (Conf. Rep.), reprinted in
1995 U.S.C.C.A.N. 730, 738. Further, in enacting the PSLRA, Congress
commented that the “[e]xisting Rule 11 has not deterred abusive securities
litigation” and that the PSLRA’s sanctions requirement would put “teeth” into Rule
11. Id. The Senate Report accompanying the legislation further notes,
Although private securities class actions can complement SEC
enforcement actions, the evils flowing from abusive securities
litigation start with the filing of the complaint and continue through to
the final disposition of the action. A complaint alleging violations of
the Federal securities laws is easy to craft and can be filed with little
or no due diligence.
and other expenses incurred as a direct result of the violation”).
56
The presumption can be rebutted if the party or attorney is able to prove (1) that the
sanction would impose an unreasonable, unjust burden and that a failure to impose the sanction
would not impose a greater burden on the other party; or (2) that the Rule 11(b) violation was de
minimis. 15 U.S.C. § 78u-4(c)(3)(B). Although they had the opportunity to do so when
opposing Karp’s requests for sanctions, neither the plaintiffs nor their counsel have made either
argument or offered either type of proof in this case.
82
....
Most defendants in securities class action lawsuits choose to settle
rather than face the enormous expense of discovery and trial. Of the
approximately 300 securities lawsuits filed each year, almost 93%
settle at an average settlement cost of $8.6 million. These cases are
generally settled based not on the merits but on the size of the
defendant’s pocketbook.
The fact that many of these lawsuits are filed as class actions has had
an in terrorem effect on Corporate America . . . . These lawsuits have
added significantly to the cost of raising capital and represent a
“litigation tax” on business. Smaller start-up companies bear the
brunt of abusive securities fraud lawsuits. Many of these companies
are high-technology companies which, by their very nature, have
unpredictable business prospects and, consequently, volatile stock
prices.
S. Rep. No. 104-98, at 8–9 (1995), reprinted in 1995 U.S.C.C.A.N. 679, 687–88
(footnotes omitted).
Accordingly, the PSLRA’s sanctions mandate reflects Congress’s policy to
prevent the misuse of judicial resources in the securities context. To effectuate its
goals, Congress imposed a heavy burden on the district courts and removed the
courts’ discretion to grant mercy for a Rule 11(b) violation.
Significantly, our sister circuits agree with this strict, literal, and unforgiving
interpretation of the way Congress has curtailed the district courts’ Rule 11
discretion through the PSLRA; the courts of appeals that have considered the issue
have uniformly agreed—Congress meant what it said when it made Rule 11
83
sanctions mandatory whenever a violation is found. See Citibank Global Mkts.,
Inc. v. Rodriguez Santana, 573 F.3d 17, 31 (1st Cir. 2009) (“The statute requiring
such findings does not appear to brook any exceptions”); Morris v. Wachovia Sec.,
Inc., 448 F.3d 268, 276 (4th Cir. 2006) (“Because the sanctions ‘instruction comes
in terms of the mandatory “shall,” which normally creates an obligation impervious
to judicial discretion’ . . . the district court must impose sanctions for each
violation found.”) (quoting Lexecon Inc. v. Milberg Weiss Bershad Hynes &
Lerach, 523 U.S. 26, 35, 118 S.Ct. 956, 962 (1998)); Gurary v. Nu-Tech Bio-Med,
Inc., 303 F.3d 212, 215 (2d Cir. 2002) (“If the court determines that a violation has
occurred, the imposition of sanctions is mandatory.”).
In addition to mandating the Rule 11 inquiry and mandating sanctions for
any Rule 11 violation, the PSLRA imposes three procedural requirements. First,
the district court’s duty to conduct the Rule 11 compliance review is triggered only
“upon final adjudication of the action.” 15 U.S.C. § 78u-4(c)(1). Second, if, after
examining the complaints, responsive pleadings, or dispositive motions, the court
concludes that sanctions may be in order, the court “shall give [the] party or
attorney [against whom sanctions might be imposed] notice and an opportunity to
respond.” Id. § 78u-4(c)(2). Although the statute does not specify the type of
notice that should issue, an order directing the party or attorney “to show cause”
84
why sanctions should not be imposed would suffice. Cf. Fed. R. Civ. P. 11
advisory committee’s note, 1993 Amendment (“The power of the court to act on its
own initiative is retained, but with the condition that this be done through a show
cause order.”). Third, a district court must reduce its Rule 11 compliance review
to “specific findings.” These specific findings are akin to the findings of fact and
conclusions of law a district court makes pursuant to Federal Rule of Civil
Procedure 52(a) at the conclusion of a bench trial. These findings aid the court of
appeals in reviewing the district court’s sanctions decision. In this case, in addition
to erring by focusing solely on the second amended complaint, the district court
erred by entering only a conclusory order.
B. A Court of Appeals Should Not Remand for Rule 11 Findings When it Can
Determine Conclusively that the District Court Abused its Discretion in Denying
Sanctions
The PSLRA does not explain how a court of appeals should review a district
court’s failure to conduct an adequate PSLRA examination evidenced by “specific
findings” regarding the parties’ and their attorneys’ compliance with Rule 11.
Today, the court equivocates on whether it is possible for an appellate court to
determine PSLRA Rule 11 compliance when faced with conclusory findings and
declines to do so in this case. Maj. Op. at 20, 23. That conclusion, however,
ignores the precedent of this circuit, will set the stage for error on remand, will
85
generate another appeal, and will waste the time and resources of the district court,
this court, and the litigants. In my view, under the PSLRA, when it can be
determined conclusively that an attorney or party violated Rule 11, the court of
appeals should hold that sanctions must be imposed. This is so even where, as
here, the court of appeals can reach that holding only as to some of the claims or
defenses.
We review a district court’s Rule 11 determination for abuse of discretion.
Souran v. Travelers Ins. Co., 982 F.2d 1497, 1507 n.10 (11th Cir. 1993). “‘A
district court would necessarily abuse its discretion if it based its ruling on an
erroneous view of the law or on a clearly erroneous assessment of the evidence.’”
McGregor v. Bd. of Comm’rs of Palm Beach County, 956 F.2d 1017, 1022 (11th
Cir. 1992) (quoting Cooter & Gell v. Hartmax Corp., 496 U.S. 384, 405, 110 S. Ct.
2447, 2461 (1990)).
The court seems to doubt whether it can review the district court’s exercise
of discretion in this case because the record contains only a conclusory,
unreviewable order. Accordingly, the court remands the case to the district court
so that it can make findings of fact and conclusions of law regarding the parties’
and counsel’s compliance with Rule 11. There is no doubt, however, that even
without extensive findings, it is possible for this court to review PSLRA Rule 11
86
determinations under the abuse of discretion standard. Sometimes, the record on
appeal will disclose Rule 11 violations that are so egregious that any refusal by the
district court to impose sanctions would necessarily constitute an abuse of
discretion. To see why, it is necessary to unpack the abuse of discretion standard
and the elements of a Rule 11 violation.
The critical difference between abuse of discretion review and de novo
review is that abuse of discretion “recognizes [a] range of possible conclusions the
trial judge may reach.” United States v. Frazier, 387 F.3d 1244, 1259 (11th Cir.
2004) (en banc). More specifically,
[b]y definition . . . under the abuse of discretion standard of review
there will be occasions in which we affirm the district court even
though we would have gone the other way had it been our call. That
is how an abuse of discretion standard differs from a de novo standard
of review. As we have stated previously, the abuse of discretion
standard allows “a range of choice for the district court, so long as that
choice does not constitute a clear error of judgment.”
Id. (quoting Rasbury v. I.R.S., 24 F.3d 159, 168 (11th Cir. 1994)). That said,
abuse of discretion never gives the district court unfettered discretion: the court
must not base its discretionary decision on an erroneous view of the law or a
clearly erroneous assessment of the evidence. Accordingly, the “range of possible
conclusions” varies with the nature of the inquiry (legal v. factual) and the relative
merit of the parties’ competing positions (whether the question is close). In sum,
87
when reviewing the elements of a district court’s decision of whether to impose
sanctions, the relevant question is not whether we would have come to the same
decision if deciding the issue in the first instance. The relevant inquiry, rather, is
whether the district court’s decision was tenable—in the “range of possible
conclusions,” or, metaphorically, “in the ballpark.”
In the non-PSLRA context, the Rule 11 ballpark is large because, as
discussed above, a district court has discretion to grant mercy for a violation of
Rule 11. Moreover, no hard legal test governs the court’s exercise of this ability to
be merciful. Thus, in an ordinary Rule 11 case, although a district court could not
arbitrarily ignore a Rule 11 violation, it has very broad discretion, and a remand
will almost always be necessary. The PSLRA, however, eliminates this wellspring
of discretion.
It follows that the PSLRA Rule 11 ballpark is much smaller. And while it is
difficult to make generalizations about the size of its fences, because the Rule 11
inquiry is governed by an objective standard, it is clear that they will sometimes be
so small as to admit only one conclusion. As discussed in part III.A, supra, to
conclude that Rule 11 has been violated, a district court must make two
determinations. First, the court must determine that a paper was filed for an
improper purpose, or contained legally frivolous claims, or contained factually
88
frivolous claims. Fed. R. Civ. P. 11(b). Second, the court must decide that a
reasonable investigation under the circumstances would have disclosed the
frivolity. Id. Thus, if, for example, a statute of limitations clearly bars a claim,57
and the record makes clear that the attorney had ample time for pre-filing
research,58 a district court could only conclude that Rule 11 has been violated
without abusing its discretion.59 Put differently, if the district court had the correct
view of the law and facts in mind, it could only conclude that the claim is
frivolous. See McGregor, 956 F.2d at 1022 (“A district court would necessarily
abuse its discretion if it based its ruling on an erroneous view of the law or on a
57
The Rule 11(b)(2) determination is whether counsel’s view of the law supporting the
plaintiff’s claim is tenable, or in the ballpark, which is a legal rather than a factual determination.
58
Though the reasonable inquiry under the circumstances prong will sometimes
necessitate a remand for findings, most complaints are not researched and filed at the eleventh-
hour. Therefore, in most cases, a reasonably competent attorney will have had time to discover
the violation.
In this case, for example, plaintiffs’ counsel were fully informed as to the circumstances
surrounding Thompson’s and Jacoby’s purchases of Media stock, had complete access to
Media’s SEC filings, and had ample time to research and consider the validity of the claims they
asserted in the three complaints presented to the district court. This is evident because the
plaintiffs brought a claim based on substantially the same facts in Indiana circuit court five
months before filing this suit. It is obvious that under the objective standard, five months is
more than enough time to research a claim.
59
By contrast, under the PSLRA, if the Rule 11 determination focuses on whether the
paper was filed for an improper purpose, a remand will more likely be necessary because the
district court has wider discretion with respect to factual determinations. Where the ballpark
would admit more than one conclusion, a remand is necessary.
89
clearly erroneous assessment of the evidence.”) (emphasis added) (quoting Cooter,
496 U.S. at 405, 110 S. Ct. at 2461).
Encapsulating this in a standard: under the PSLRA, when the court of
appeals can determine conclusively that Rule 11 has been violated, it should hold
that sanctions must be imposed. In such a case, we would reverse the district
court’s decision with respect to the claims a reasonably competent attorney could
not have presented and remand the case for the imposition of sanctions. This
standard finds support in precedent and avoids wasting the courts’ and litigants’
time and resources.
This standard is consistent with the clear precedent of this Circuit. Pelletier
v. Zweifel, 921 F.2d 1465, 1514, n.87 (11th Cir. 1991) (concluding that a remand
is unnecessary when the record “demonstrates beyond any question that Rule 11
sanctions are in order”). It also comports with how our sister circuits dispose of
cases when a district court’s sanctions decision is unreviewable because no
explanation is given, but the outcome is clear. See, e.g., Carr v. Tillery, 591 F.3d
909, 919–20 (7th Cir. 2010) (imposing § 1927 sanctions because the suit was “so
lacking in merit” that its filing “indicates a motive to harass” made conclusive by
the tone of the complaint and the briefs on appeal, even though the district court
denied the motion “without explanation”); cf. Citibank Global Mkts., 573 F.3d at
90
32 (concluding that “no purpose would be served by remanding this case to the
district court for Rule 11 findings” pursuant to the PSLRA because, in part, the
record revealed no basis for finding a Rule 11 violation); Dellastatious v. Williams,
242 F.3d 191, 197 n.5 (4th Cir. 2001) (finding no basis for sanctions under the
PSLRA and, thus, concluding that “a remand here would be unnecessary”).60
A case the court relies upon to justify its decision to remand, Gurary v.
Winehouse, 190 F.3d 37 (2d Cir. 1999) (“Gurary I”), illustrates how an
unnecessary remand can invite error and waste resources. In Gurary I, because the
district court made conclusory PSLRA Rule 11 findings, the court of appeals
remanded the case. Id. at 47. On remand, the district court assumed the court of
appeals “regarded [its] findings as merely formalistic” and simply gave a more
detailed explanation of its original decision. Gurary v. Winehouse, No.
97CIV3803, 2000 WL 20706, at *1 (S.D.N.Y. Jan. 12, 2000). On appeal from
that order, the Second Circuit reversed because two of the plaintiff’s claims were
barred by “both the plain language of the Exchange Act and well-settled case law.”
Gurary v. Winehouse, 235 F.3d 792, 798–99 (2d Cir. 2000) (“Gurary II”).
60
Note that when Citibank and Dellastatious concluded that a remand was unnecessary
because there was no basis for sanctions under the PSLRA, they were implicitly holding that a
district court would necessarily abuse its discretion if it imposed sanctions. There is no
meaningful difference between this and the conclusion that a district court would necessarily
abuse its discretion if it refused to impose sanctions.
91
Specifically, the Guary II court held that the plain language of Rule 10b-5 would
“prohibit a court from adopting a rule that would support Gurary’s claim.” Id. at
799. Accordingly, the court remanded the case for a determination of the amount
of sanctions. Ultimately, it took a third appeal and one more remand to close the
case,61 but the parties and the court would have avoided considerable time and
expense had the Gurary I court pointed out the obvious.
To be sure, courts of appeals must exercise caution when deciding whether
to remand a case. Sometimes the Rule 11 violation will not be so clear as to admit
only one conclusion. Sometimes the party or attorney against whom sanctions
have been imposed did not have the opportunity to be heard. Sometimes the
procedural history of the case will indicate that extenuating circumstances altered
the standard of care for the prefiling inquiry. Sometimes, particularly with respect
to the fact-heavy prongs of Rule 11, the record will not allow the court of appeals
to determine conclusively whether sanctions were warranted. In those cases, a
remand would be appropriate. But not in this case.
IV. With Respect to Plaintiffs’ Federal Securities Law Claims, the District Court
Abused its Discretion in Denying Sanctions
61
Gurary v. Nu-tech Bio-Med, Inc., 303 F.3d 212 (2d Cir. 2002) (“Gurary III”).
92
After clearing the ground of any objection plaintiffs and their attorneys
might have to a conclusion that they violated Rule 11, I explain why the plaintiffs’
federal securities law claims and some of the factual allegations are so frivolous
that the district court necessarily abused its discretion when it denied sanctions.
That is, the violations are so clear that no matter what rationale the district court
might have had, it abused its discretion when it denied sanctions. Part A examines
the federal securities law claims in all three complaints for Rule 11(b)(2)
compliance; Part B examines all three complaints’ factual allegations pertaining to
the securities law claims for Rule 11(b)(3) compliance; Part C then turns to
whether the plaintiffs brought this action for an improper purpose under Rule
11(b)(1); Part D explains how the district court should proceed on remand.
First, the ground clearing. The plaintiffs’ attorneys in this case had adequate
notice of the possibility of sanctions and the possible grounds for the same.62 The
62
This is certainly so with respect to the plaintiffs’ legal contentions. As for the
evidentiary support Rule 11(b)(3) required for those claims, Karp’s separate motion for sanctions
expressly discussed factual deficiencies in the plaintiffs’ complaint. Even if this were not the
case, “Rule 11 alone should constitute sufficient notice of the attorney’s responsibilities since the
rule explicitly requires the attorney to certify that a complaint is well grounded in fact.”
Donaldson v. Clark, 819 F.2d 1551, 1560 (11th Cir. 1987) (en banc); id. at 1561 (“When an
attorney has failed to present necessary factual support for claims despite several opportunities to
do so, for example, further hearing on the sanctions issue may well be not only unnecessary but
also a waste of judicial resources.”). Notably, in their briefs to this court, plaintiffs said nothing
about the adequacy of the notice they received regarding the possibility of sanctions against
them or their attorneys.
93
PSLRA itself gave statutory notice. See ATSI Commc’ns v. Shaar Fund, Ltd., 579
F.3d 143, 152 (2d Cir. 2009) (“By virtue of this statutory notice, consideration of
sanctions in the PSLRA context can never be sua sponte and can never come as a
surprise, because Congress, not the court, has prompted and mandated a Rule 11
finding.”). Moreover, as discussed above, in their motions to dismiss the three
complaints, the defendants asked the court to retain jurisdiction to impose
sanctions. In response to the second amended complaint, Karp also sought
sanctions in a separate motion. Finally, the district court personally warned the
plaintiffs’ attorneys about the requirements of Rule 11. In response to these
motions and in their briefs to this court, the plaintiffs’ attorneys never attempted to
excuse their filing of frivolous claims because extenuating circumstances
precluded an adequate prefiling investigation. Nor could they have. The plaintiffs’
attorneys brought this case five months after filing a similar complaint against
Media in an Indiana circuit court; then, the district court gave the plaintiffs two
chances to amend their initial complaint. Because the plaintiffs’ attorneys had
adequate notice and ample time to research the claims, all that remains to be
decided is whether the complaints contained frivolous legal claims or factual
allegations, or were brought for an improper purpose.
A. Rule 11(b)(2) Compliance
94
Rule 11(b)(2) prohibits claims that are not “warranted by existing law or by
a nonfrivolous argument for [changing] existing law or the establishment of new
law.” Fed. R. Civ. P. 11(b)(2) (2006). The plaintiffs asserted claims under four
federal securities law provisions which are subject to the PSLRA’s mandatory
sanctions review: (1) the 1933 Act § 11 claims, brought by Thompson in the initial
complaint and Thompson and Jacoby in the first amended complaint; (2) the 1933
Act § 12 claims, brought by Thompson in the initial complaint and Thompson and
Jacoby in the first amended complaint; (3) the 1934 Act § 10(b), Rule 10b-5 claims
(the “Rule 10b-5 claim(s)”), brought by Thompson in the initial complaint,
Thompson and Jacoby in the first amended complaint, and Jacoby in the second
amended complaint; and (4) the 1934 Act § 20(a) claims brought by Thompson
and Jacoby in the first amended complaint and Jacoby in the second amended
complaint.
1. The Section 11 Claims
The § 11 claims advanced in both the initial and the first amended
complaints are legally frivolous. Section 11 prohibits false or misleading
statements in a registration statement. 15 U.S.C. § 77k. Section 11 provides, in
relevant part, “[i]n case any part of the registration statement, when such part
became effective, contained an untrue statement of material fact or omitted to state
95
a material fact required to be stated therein or necessary to make the statements
therein not misleading, any person acquiring such security” may sue. Id. § 77k(a).
Thus, to state a § 11 claim, a plaintiff must show (1) the purchase of a security
under a registration statement, (2) after the registration statement became effective,
and (3) that the registration statement contained a “material misstatement or
omission.” Herman & MacLean v. Huddleston, 459 U.S. 375, 381–82, 103 S.Ct.
683, 687, 74 L. Ed. 2d 548 (1983). Because the § 11 claims in the initial and first
amended complaints differed, I address each in turn.
a. The Initial Complaint’s Section 11 Claim
In the initial complaint, Thompson was the only plaintiff, and the
unregistered-broker theory was the only alleged material misstatement or omission.
Thompson purchased Media stock in two transactions: 50,000 shares in the 2005
June private offering, and 10,000 shares in the open market after his shares were
registered.
Thompson’s private offering purchase could never have formed the basis for
a § 11 claim because he did not purchase the shares under any effective registration
statement. By definition, a private offering means that the shares were issued in
reliance on an exemption from registration. It would have been impossible for
Thompson to rely on a registration statement that never existed. Accordingly, as a
96
private offering purchaser, Thompson could never have succeeded on a § 11 claim.
Because, however, Thompson claimed to represent the open market
purchasers—presumably based on his July 2006 open market
purchase—Thompson and some of his class members purchased shares that had
been registered. The class period stretched from May 24, 2005 to August 28, 2006
(Thompson first filed this suit on August 28, 2006). During that time, only two
registration statements existed: Chubasco’s February 2005 statement, in effect for
the entire class period, and Media’s July 2006 registration statement, in effect after
July 14, 2006. Therefore, with the exception of one month, the sole registration
statement in effect during the class period was Chubasco’s.
It would have been impossible, however, for Chubasco’s registration
statement to misrepresent or omit Media’s use of an unregistered broker because it
became effective in February 2005—well before any of this alleged wrongdoing
took place. Indeed, as of February 2005, Relationserve had not even been
organized. Without a crystal ball, it would have been impossible for Chubasco to
predict that Relationserve would suggest a merger, much less that it would use an
unregistered broker. Therefore, no open market purchaser who bought before July
14, 2006, could ever have succeeded on a § 11 claim.
97
Media first filed the other registration statement on March 20, 2006, to allow
its private offering purchasers to sell their shares. This registration statement was
amended three times and became effective on July 14, 2006. Thus, for purchasers
of Media stock between July 14 and August 28, 2006, Thompson could at least
identify an effective registration statement that was issued after the alleged use of
an unregistered broker.
Still, for the § 11 claim to have any chance of success, the July 14
registration statement would have had to fail to disclose Media’s use of an
unregistered broker when it became effective. Again, the unregistered-broker
theory was the only misrepresentation or omission identified in the initial
complaint. The July 14 statement, however, disclosed Thompson’s state court
action and Thompson’s allegation that Media failed to disclose a commission it
paid to Summit and Altavilla. And indeed, Thompson eventually contended that
the May 20 amendment to this registration statement corrected the alleged
omission of Media’s use of an unregistered broker. (See Second Am. Compl. ¶ 73
(“Between RelationServe’s the [sic] May 23, 2006 disclosure [in Media’s amended
registration statement] and June 15, 2006, RelationServe[ Media’s] shares fell . . . .
This drop was caused by the public’s knowledge of Thompson’s lawsuit.”).) Thus,
98
even for this class of purchasers, Thompson failed to identify any misstatement or
omission.
Even putting all of this aside, Thompson could never have recovered on a §
11 claim based on his open market purchase. Section 11 expressly prohibits
recovery by persons who “at the time of [the] acquisition [] . . . knew of such
untruth or omission.” 15 U.S.C. § 77k(a). By his own admission, Thompson knew
of Media’s alleged use of an unregistered-broker when he purchased the 10,000
shares in July 2006. Accordingly, Thompson could never have succeeded or
adequately represented the open market purchasers on a § 11 claim.
Particularly egregious was the initial complaint’s § 11 claim against the
individual Officers. For an individual to be liable under § 11, the individual must
have either (1) signed the registration statement, (2) been a director of the issuer at
the time of the filing, (3) been named as about to become a director, (4) been
named as a person having prepared or certified any report or valuation used in
connection with the registration statement, or (5) been an underwriter. Id. None of
the individual defendants were even affiliated with either Media or Chubasco when
either registration statement was first filed.63 Nor do their names appear as having
63
Thompson sued Danielle Karp, Mandee Heller Adler, Ohad Jehassi, and Warren
“Pete” Musser. Karp stopped working for Media on February 3, 2006; Adler on November 11,
2005; Musser on October 31, 2005. Although it is unclear when Jehassi ended his tenure, he was
99
certified any report or valuation used in either registration statement. Finally
there is no allegation and there is no evidence that any of these Officers sold stock
under the registration statement, thus it would have been impossible for these
individuals to act as underwriters. Nevertheless, the plaintiffs sought to hold
“[Media] and the individual Defendants” liable for violating § 11. (Compl. ¶ 54.)
Overall, Thompson’s § 11 claim in the initial complaint is frivolous beyond
doubt. None of the individual defendants had anything to do with either
registration statement. As against Media, the initial complaint attempted to state a
§ 11 claim on the basis of a registration statement that did not exist (Thompson’s
private offering purchase), or, alternatively, a registration statement that never
contained a material misstatement or omission when it became effective
(Chubasco’s registration statement became effective long before any of the alleged
misconduct took place and by the time Media’s July 14 registration statement
became effective, it, too, had been cured of all deficiencies). Finally, Thompson
admittedly knew of the alleged fraud when he purchased his shares, so the § 11
claim would fail even had the July 14 registration statement omitted the alleged
fraud. No argument for the modification of existing law could be deemed
reasonable in view of Thompson’s complete failure to satisfy the basic elements of
never a director, and never signed a registration statement in any capacity.
100
§ 11. Therefore, the district court necessarily abused its discretion by failing to
sanction Thompson’s attorneys for bringing this § 11 claim.
b. The First Amended Complaint’s Section 11 Claim
The first amended complaint’s § 11 claim differed from the initial
complaint’s iteration by adding Jacoby as a co-lead plaintiff, adding ten new
individual defendants, and adding three new theories of misrepresentation.
Nevertheless, like the initial complaint, the first amended complaint’s § 11 claim is
frivolous: Jacoby lacked standing to sue; Thompson knew of the alleged fraud.
As discussed above, any viable § 11 claim could only have been based on
Media’s July 14, 2006, registration statement. To have standing to sue under § 11,
a plaintiff must have bought the shares “pursuant to” an effective registration
statement. Huddleston, 459 U.S. at 382, 103 S. Ct. at 687. That is, a plaintiff must
be able to “‘trace the purchase of his securities to the registration statement that
allegedly violated section 11.’” In re Hamilton Bankcorp., Inc. Sec. Litig., 194 F.
Supp. 2d 1353, 1356–57 (S.D. Fla. 2002) (quoting In re Unicapital Corp. Sec.
Litig., 149 F. Supp. 2d 1353. 1369 (S.D. Fla. 2001)). Here, Jacoby swore that his
only purchases of Media stock occurred in July and August of 2005. It therefore
would have been impossible for Jacoby to trace his stock to the July 14, 2006,
registration statement and his § 11 claim is clearly frivolous.
101
Turning to Thompson’s two purchases, his attorneys’ new theories of
alleged fraud did not render Thompson’s § 11 claim non-frivolous. The July 14
registration statement did not disclose the facts underlying the kickback, overstated
income, and sued-director theories, but, even so, Thompson could never have
prevailed. For one, the sued-director theory is simply frivolous on the merits:
Media had no duty to disclose the fact that a former director had been sued—but
not necessarily found liable—for securities violations.64 Assuming that Media had
a duty to disclose the overstated income and kickbacks, Thompson’s claim is still
frivolous because, as discussed above, Thompson admitted that he knew of the
facts underlying the alleged fraud when he completed his July 2006 open market
purchase.65 (See First Am. Compl. ¶¶ 97, 80, 71, 81, 62, 3.)
64
The sued director, director Musser, served on the board from June 2005 to October
2005. No registration statement was issued during that period and there is no duty to disclose
information about the lawsuits of past directors. See 17 C.F.R. § 228.401(d) (2005) (“Describe
any of the following events . . . that are material to an evaluation of the ability or integrity of any
director, person nominated to become a director, executive officer, . . . of the small business
issuer.”). What is more, the plaintiffs alleged only that director Musser had been sued for
securities law violations, not that he had actually been found liable, which is a prerequisite for
reporting. 17 C.F.R. § 228.401(d)(4) (2005) (“Being found by a court of competent jurisdiction
(in a civil action) [or by] the Commission . . . to have violated a federal or state securities . . .
law . . . .”).
65
Thompson’s claim may well be frivolous for another reason: he suffered no damages
that could be traced to the disclosure of any of the alleged misrepresentations. Under § 11, a
plaintiff need not plead damages or loss causation as a part of a prima facie case, Huddleston,
459 U.S. at 382, 103 S. Ct. at 687. Moreover, the damages are presumed to be the difference
between the higher of the price paid or the offering price and the “value” of the security at the
time of the suit. 15 U.S.C. § 77k (emphasis added). Accordingly, even where, as here, the
lawsuit at issue is the first disclosure of the alleged misrepresentation, a plaintiff can argue that
102
Most troubling, in both plaintiffs’ § 11 claims, the plaintiffs’ attorneys
repeated their egregious claims against three of the initial complaint’s individual
defendants who could never have been held liable for any § 11 violation based on
the July 14 registration statement. Worse, in the face of the district court’s Rule 11
warning not to sue officers just because they were officers, the plaintiffs’ attorneys
added ten new defendants, four of whom had nothing to do with the July 14, 2006,
registration statement. This brought the total of individuals who were allegedly
liable for the § 11 violation to thirteen, seven of whom could never have been
liable under the plain language of § 11. Specifically, as to defendants Karp, Adler,
Musser, Young, Hill, Honig, and Hirsch, the plaintiffs’ § 11 claim is frivolous
beyond any doubt.66 Young, Hill, and Honig never worked for Media; Karp,
the damages are the difference between the market price on the day the suit was filed and the
actual value of the stock on that day. See Grossman v. Waste Mgmt. Sys., Inc., 589 F. Supp.
395, 415–16 (N.D. Ill. 1984). Thompson, however, could never succeed on such a theory
because he bought Media stock in the open market and sold it one day later; accordingly, he both
purchased and sold over-valued stock and suffered no loss. See In re Initial Pub. Offering Sec.
Litig., 241 F. Supp. 2d 281, 347 (S.D.N.Y. 2003).
66
Defendants Soltoff, Wasserman, McNamara, and Brauser signed the initial March 20
iteration of the July 14, 2006, registration statement; Gould signed the third amendment to this
registration statement. Obeck was not a director and did not sign or certify the registration
statement, but sold stock under the July 14, 2006, registration statement and may have been a
control person underwriter. See 15 U.S.C. § 77b(11) (“The term ‘underwriter’ means any person
who . . . offers or sells for an issuer in connection with[] the distribution of any security . . . .
[T]he term ‘issuer’ shall include . . . any person directly or indirectly controlling or controlled by
the issuer . . . .”).
103
Adler, Musser, and Hirsch all ended their tenure with Media well before the
registration statement was first filed on March 20, 2006.67
2. The Section 12 Claims
The § 12 claims—brought as Count II in both the initial and first amended
complaints—are legally frivolous beyond doubt. Section 12 prohibits any person
from offering or selling securities by means of a false or misleading statement in a
prospectus or oral communication. 15 U.S.C. §77l. Because the 1933 Act
requires, in relevant part, that a prospectus include the “information contained in
the registration statement,” 15 U.S.C. § 77j(a)(1), there is substantial overlap
between § 11 and § 12. The major difference between the two statutes is that § 12
imposes a privity requirement not found in § 11 and § 12 allows liability for “oral
communications.” See In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347,
358 (2d Cir. 2010). Thus, even assuming that § 12’s privity requirement is
satisfied here, Thompson’s and Jacoby’s § 12 claims are frivolous for the same
reasons as their § 11 claims.68
67
Adler stopped working at Media on November 11, 2005; Karp on February 3, 2006;
Musser on October 31, 2005; Hirsch on February 2, 2006.
68
It is very unlikely that the privity requirement could be satisfied here because Media
did not sell the stock, its private offering purchasers did. See Ehlert v. Singer, 245 F.3d 1313,
1316 (11th Cir. 2001) (“Section 12 liability extends to those who transfer title to the security and
to those who successfully solicit the purchase.”); Thomas Lee Hazen, Treatise on the Law of
Securities Regulation § 7(7) (6th ed.) (“The issuer will not ordinarily be a section 12 seller since
104
Nevertheless, in responding to the defendant’s motion to dismiss the first
amended complaint, the plaintiffs’ attorneys defended Thompson’s § 12 claims on
the basis of certain oral communications by Altavilla. (See Pls.’ Resp. to Defs.’
Mot. to Dismiss First Am. Compl., Jan. 29, 2007.) This argument is frivolous
because the plaintiffs never identified these oral communications in any
complaint.69 (See, e.g., Compl. ¶¶ 55–56; First Am. Compl. ¶¶ 122–23.)
the presence of an underwriter as an intermediary means that the issuer is not in privity with the
purchaser of the security.”); id (“[O]rdinarily an issuer’s officers and directors will not have a
sufficiently substantial connection to qualify as sellers . . . .”).
69
Even had Thompson pled the alleged “oral communications,” his claim would still
border on frivolous because the oral communications were made in connection with his June
private offering purchase. The Supreme Court has made clear that the only oral communications
that count are those that “relate to a prospectus.” Gustafson v. Alloyd Co., 513 U.S. 561,
567–68, 115 S. Ct. 1061, 1065–66, 131 L. Ed. 2d. 1 (1995). And, by defining “prospectus” as a
“term of art referring to a document that describes a public offering of securities by an issuer or
controlling shareholder,” the Supreme Court has limited § 12 claims to public offerings. See id.
at 584, 115 S. Ct. at 1073–74.
Thompson’s claim would “border” on frivolous because it is not on all fours with
Gustafson. Gustafson involved a private secondary sale of securities from one equity holder to
another, id. at 564–65, 115 S. Ct. 1064–65; Thompson purchased Media shares in a private
primary sale from an issuer. See, e.g., Yung v. Lee, 432 F.3d 142, 148 (2d Cir. 2005) (noting
that the Second Circuit had yet to “reach the issue of whether the rationale for . . . Gustafson . . .
necessarily precludes a Section 12(a)(2) claim with respect to any private securities transaction).
But when the plaintiffs’ attorneys filed the initial and first amended complaints, at least three
circuits had already held that no § 12 claim could lie in any private offering. See id. (citing
Lewis v. Fresne, 252 F.3d 352, 357 (5th Cir. 2001); Maldonado v. Dominguez, 137 F.3d 1, 8 (1st
Cir. 1998); Joseph v. Wiles, 223 F.3d 1155, 1161 (10th Cir. 2000)). Nevertheless, this circuit
had not ruled on the question prior to Thompson’s suit. Therefore, had Thompson alleged the
oral communications, I would remand so that the district court could make the Rule 11
determination in the first instance. In any event, I note my deep concern that Thompson’s
attorneys never mentioned Gustafson and simply justified the § 12 claims because “an oral
communication is sufficient so long as an instrument of interstate commerce is involved.” (Pls.’
Resp. to Defs.’ Mot. to Dismiss First Am. Compl. 25, Jan. 29, 2007.)
105
3. The Section 10(b), Rule 10b-5 Claims
To evaluate the legal sufficiency of the Rule 10b-5 claims in all three
complaints, it is first necessary to clarify who brought the claim. In the initial
complaint, Thompson alone brought the claim; in the first amended complaint,
Thompson and Jacoby brought the claim together; in the second amended
complaint, Jacoby alone brought the claim. I first discuss Thompson’s Rule 10b-5
claims in the initial and first amended complaints, and then turn to Jacoby’s in the
first and second amended complaints.
Implementing § 10(b), Rule 10b-5 forbids, in relevant part, “any person,
directly or indirectly . . . (b) To make any untrue statement of a material fact or to
omit 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 . . . .” 17
C.F.R. § 240.10b-5 (2005). To state a claim for an omission, a plaintiff must plead
six elements with particularity: (1) an omission of material fact, (2) made with
scienter, (3) in connection with the purchase or sale of a security, (4) reliance on
the omission, (5) economic loss, and (6) loss causation (a causal relationship
between the omission and the economic loss). See Dura Pharms., Inc. v. Broudo,
544 U.S. 336, 341–42, 125 S. Ct. 1627, 1630–31, 161 L. Ed. 2d. 577 (2005).
106
Ultimately, I conclude that all of the Rule 10b-5 claims are so frivolous that
the district court necessarily abused its discretion when it denied sanctions.
Thompson’s claims are frivolous because he never identified a false or misleading
statement and because he knew of the alleged fraud when he purchased his shares.
Jacoby’s claims are frivolous because he too failed to allege any actionable
omission, he egregiously failed to allege scienter with the specificity required by
the PSLRA and Rule 9(b), and because he advanced a frivolous argument so as to
cherry-pick the starting point for measuring loss causation.
a. Thompson’s Rule 10b-5 Claims
Neither of Thompson’s purchases form the basis for a nonfrivolous Rule
10b-5 claim. As for the purchase in the 2005 June private offering, Thompson
never identified any false or misleading statement. As for the July 2006 open
market purchase, Thompson admittedly knew about the alleged fraud when he
bought the stock and suffered no loss that could have been traced to any fraud on
the part of the defendants.
Thompson identified no actionable false or misleading statement in
connection with his 2005 June private offering purchase. The PSLRA requires
plaintiffs to “specify each statement alleged to have been misleading [and] the
reason or reasons why the statement is misleading” 15 U.SC. § 78u-4(b(1). In the
107
initial complaint’s Rule 10b-5 claim, Thompson alleged only the unregistered-
broker theory of misrepresentation. E.g. Compl. ¶ 37.70 The trouble is that the
2005 June private offering formed the basis for this alleged omission, thus no SEC
filing prior to Thompson’s purchase could have disclosed the alleged contingent
liability—the contingency had not happened yet.71 Moreover, Media did disclose
Summit’s unregistered status in the June 16 current report, which Thompson
certified that he had read. Thompson thus did not—and could not—point to any
specific statement that was misleading because of Media’s use of an unregistered
broker prior to Thompson’s June 2005 purchase.
In his Indiana state securities law fraud claim (brought in Count VII of the
initial complaint), Thompson did allege other specific omissions. Giving
Thompson’s attorneys the benefit of the doubt, I will assume that Thompson meant
to plead these same omissions in his Rule 10b-5 claim. On this assumption,
Thompson alleged that Media: (1) failed to disclose “sizeable commissions and
fees to Altavilla” and (2) failed to explain that the shares in the private offering
70
In the first amended complaint, Thompson added the kickback theory, the overstated-
income theory, and the sued-director theory. Any Rule 10b-5 claim based on these theories is
frivolous because Thompson completely failed to plead loss causation. See page 95–96, infra.
71
This fact is especially significant because throughout this litigation, Thompson’s
purchase was the only purchase specifically identified as having been illegally brokered by
Summit.
108
were restricted securities and were not registered. (Compl. ¶ 78.) But Media
disclosed all of this in the subscription agreement Thompson signed. Thompson
“acknowledge[d] that . . . [he] has read and evaluated . . . the Company’s Current
Report on Form 8-K . . . on June 16, 2005.” Relationserve Media Inc., Current
Report (Form 8-K), Ex. 4.1 (Subscription Agreement), ¶ 1.4 (June 30, 2005). The
June 16, 2005 Form 8-K attached Media’s agreement with Summit, including the
provision that Summit would be paid a seven percent finder’s fee. Thompson also
recognize[d] that the purchase of Units involves a high degree of risk
in that . . . (ii) the Units are not registered under the Securities Act of
1933 . . . or any state securities law; (iii) there is no trading market for
the Units, none is ever likely to develop, and the Subscriber may not
be able to liquidate his investment.
Id. ¶ 1.2.
Even further assuming Thompson had alleged—as he did in Indiana circuit
court—that Altavilla never provided him with the full subscription agreement and
told him the shares would be registered and could be quickly sold for a profit, it
would not save his Rule 10b-5 claim. The subscription agreement expressly
required Thompson to
represent[] that, except as expressly set forth in the Offering
Documents, no representations or warranties have been made to the
Subscriber by the Company or any agent, employee or affiliate of the
Company and in entering into this transaction, the Subscriber is not
relying on any information, other than that contained in the Offering
109
documents and the results of independent investigation by the
Subscriber.
Id. at ¶ 1.14. In view of this representation, any argument that Thompson
justifiably relied on Altavilla’s misrepresentation is frivolous. See Rissman v.
Rissman, 213 F.3d 381, 383–84 (7th Cir. 2000) (joining two courts of appeals in
holding “that non-reliance clauses in written stock-purchase agreements preclude
any possibility of damages under the federal securities laws for prior oral
statements”). And because justifiable reliance on a misrepresentation is a
prerequisite to a Rule 10b-5 recovery, even this hypothetical Rule 10b-5 claim
utterly fails.
Any Rule 10b-5 claim based on Thompson’s July 2006 open market
purchase is preposterous. It is hornbook law that an investor who is aware of the
fraudulent conduct cannot recover in a Rule 10b-5 action predicated on that same
fraudulent conduct because it is impossible to prove reliance or transaction
causation. See Thomas Lee Hazen, Treatise on the Law of Securities Regulation §
12(10) (6th ed.); see, e.g., Gurary v. Winehouse, 190 F.3d 37, 44–45 (2d Cir.
1999). And indeed, by Thompson’s own admission, he became aware of the
alleged fraud on May 1, 2006, fully two months before his open market purchase.
(First Am. Compl. ¶ 97 (“Thompson did not discover the omissions set forth above
110
until May 01, 2006.”).) Worse than simply knowing of the alleged fraud, when
wearing the open market purchaser hat, Thompson caused his own harm.
Specifically, he brought suit in an Indiana circuit court, then, five months later,
sued in federal court purporting to represent a class of shareholders injured by
Media’s failure to disclose the factual basis of his Indiana lawsuit. Thus, there can
be no doubt that Thompson purchased Media stock in the open market with full
awareness of the alleged fraud, if fraud there was, and could not, under any
circumstances, have succeeded in a Rule 10b-5 claim based on that purchase.
Even assuming Thompson did not have knowledge, he could never have
proved loss causation. Thompson purchased 10,000 shares on July 17, 2006, at .42
cents a share, only to sell them the very next day at .39 cents per share. To prove
loss causation, Thompson would have needed to show that the market became
aware of the alleged fraud in the twenty-four hours between his purchase and sale.
Thompson alleged no such disclosure, nor could I find one. In fact, Media did not
file any SEC documents on July 17th or July 18th, or any day thereafter until
August 14, 2006.
For many of the same reasons, Thompson could never have “fairly and
adequately” represented the subclass of purchasers who bought Media’s shares in
the open market as required by Federal Rule of Civil Procedure Rule 23(a)(4).
111
Unlike Thompson, most open market purchasers who purchased before the
disclosure of Thompson’s Indiana lawsuit, would not have had actual knowledge
of Media’s use of an unregistered broker. See, e.g., Gary Plastic Packaging Corp.
v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 903 F.2d 176, 180 (2d Cir. 1990)
(“[C]lass certification is inappropriate where a putative class representative is
subject to unique defenses which threaten to become the focus of the litigation. . . .
there is a danger that the absent class members will suffer if their representative is
preoccupied with defenses unique to it.”) (internal citations omitted).72
Worse, Thompson had a fundamental conflict of interest with the open
market purchasers. Assuming, for the sake of argument, that Thompson could
have rescinded his private offering purchase, Media’s illegal sale of securities gave
him a de facto “put option” at two dollars per-share. A put option grants the holder
the right to sell the securities at a given price (the seller promises to buy the
72
In addition to Thompson’s inability to satisfy the Rule 23(a)(4) requirement of “fairly
and adequately” representing the class, Thompson’s class would likely fail for want of typicality
and commonality. Fed. R. Civ. P. 23(a)(2)–(3); see Cooper v. Southern Co., 390 F.3d 695, 713
(11th Cir. 2004) (“A class representative must possess the same interest and suffer the same
injury as the class members in order to be typical under Rule 23(a)(3). Typicality measures
whether a sufficient nexus exists between the claims of the named representatives and those of
the class at large.”) (internal citations and quotations omitted) (overruled on other grounds by,
Ash v. Tyson Foods, Inc., 546 U.S. 454, 457, 126 S.Ct. 1195, 1197, 163 L. Ed. 2d 1053 (2006)).
Because Thompson’s initial purchase was in a private offering, Thompson had received and
relied on information (the offering documents and subscription agreement) not available to those
who bought shares in the open market. Accordingly, it is highly doubtful that he could have
fulfilled the typicality and commonality requirements of Rule 23(a)(2) and (3).
112
securities at that price). Thus if Thompson could have rescinded his purchase,
Media would have had to return his full purchase price (two dollars per share) in
exchange for the securities (50,000 shares plus warrants). Of course, Thompson
would never have exercised this right if the value of his shares grew beyond two
dollars per share; but if they fell, he could have recouped his entire investment less
the cost of enforcement. Thompson essentially had a risk-free investment that
harmed the open market purchasers. Accordingly, Thompson “derive[d] a net
economic benefit from the very same conduct alleged to be wrongful” to the open
market purchasers. Valley Drug Co. v. Geneva Pharm., Inc., 350 F.3d 1181, 1190
(11th Cir. 2003). When a named plaintiff has such a conflict with the proposed
class, the named plaintiff can never adequately represent the class. See id. at 1189(“A fundamental conflict exists where some party members claim to have been
harmed by the same conduct that benefitted other members of the class. In such a
situation, the named representatives cannot ‘vigorously prosecute the interests of
the class through qualified counsel.’”) (quoting In re HealthSouth, 213 F.R.D. 447,
461–62 (N.D. Ala. 2003)). No reasonably competent attorney could have
contended otherwise.73
73
Here, of course, the plaintiffs’ attorneys did so contend by arguing to the district court
that “there is no conflict between Plaintiffs and other class members—all investors are aligned in
the common interest of recovering the maximum possible damages from defendants.” (Mem. of
113
b. Jacoby’s Rule 10b-5 Claims
I now turn to Jacoby’s Rule 10b-5 claims in the first and second amended
complaints. Under a literal reading, Jacoby’s claim is simply laughable. Jacoby
alleged that Media and its officers “offered and sold Relationserve [Media]
securities in violation of 15 U.S.C.A. § 17q and Rule 10b-5.” (Second Am. Compl.
¶ 103 (emphasis added); see also First Am. Compl. ¶ 127 (“The Defendants,
including the Individual Defendants . . . offered and sold the shares of
Relationserve [Media] . . . .”) (emphasis added).) Jacoby purported to bring this
claim on behalf of the open market purchasers, but Media never “offered and sold”
securities in any public offering. Rather, Media only sold securities in exempt
private offerings. No Rule 10b-5 claim can survive on the basis of an offer and
sale of securities that never existed.
In an abundance of caution, however, I will read Jacoby’s Rule 10b-5 claim
broadly to invoke the fraud-on-the-market doctrine. Under the fraud-on-the-
market doctrine, a plaintiff must still plead all the elements of a Rule 10b-5 claim,
but benefits from a presumption that the plaintiff indirectly relied on the alleged
misrepresentation by relying on the integrity of the stock price established by the
Law in Supp. of Pls.’ Mot. for Appointment as Co-Lead Pls. 12, Nov. 3, 2006.)
114
market. See Basic, 485 U.S. at 242, 108 S. Ct. at 989 (citing Peil v. Speiser, 806
F.2d 1154, 1160–61 (3d Cir. 1986)).
Read broadly, Jacoby claimed that Media misstated its financial health in
sundry SEC filings by failing to report “$2,000,000 in contingent civil and criminal
liabilities and other material information to the investing public.” (E.g. Second
Am. Compl. ¶ 11.) In the first amended complaint, Jacoby asserted four theories of
fraudulent omissions, which formed the basis of this liability: the unregistered-
broker theory, the kickback theory, the overstated-income theory and the sued-
director theory. In the second amended complaint, Jacoby only replicated the
unregistered-broker theory.74 Whether based on any of these theories, Jacoby’s
Rule 10b-5 claim is legally frivolous.
The three abandoned theories are the easiest to conclude are frivolous.
Assuming Media had a duty to disclose the kickbacks, overstated income, and sued
director, Jacoby never alleged that the truth became known to the market and that
this failure caused any economic loss to him. No Rule 10b-5 claim can survive
74
Actually, Jacoby also pled the sued-director theory of liability. (Second Am. Compl. ¶
95(b).) In Jacoby’s response to the defendants’ motion to dismiss, however, Jacoby abandoned
it and did not press it here. (See, e.g., Pls.’ Mem. in Resp. to Defs.’ Mot. to Dismiss 7, n.3, April
30, 2007 (“Jacoby withdraws this allegation as [Media] is correct in its . . . assertion that there is
no nexus between this specific failure and Jacoby’s damages.”).) Similarly, Jacoby did plead the
facts underlying the overstated-income theory, but did not assert it as an actionable Rule 10b-5
omission. (See Second Am. Compl. ¶¶ 60, 3, 86, 95.) Jacoby did not press any claim based on
overstated income here.
115
without these elements; Jacoby completely failed to plead them—despite three
chances to do so—rendering any claim based on the theories frivolous.75
Only the unregistered-broker theory remains. On this theory, Jacoby’s
fraud-on-the-market, Rule 10b-5 claim fails because Jacoby never identified an
actionable omission, utterly failed to plead scienter, and advanced an untenable
theory of loss causation.
i. Jacoby Failed to Identify an Actionable Omission
Most importantly, Jacoby never identified any actionable omission. Under
the plain language of Rule 10b-5, for the omission of a material fact to be
actionable, there must have been a duty to disclose the fact. 17 C.F.R. § 240.10b-5
(2005) (prohibiting the omission of a material fact “necessary to make the
statements made . . . not misleading.”); Basic, 485 U.S. at 239, n.17, 108 S. Ct. at
987, n.17 (“Silence, absent a duty to disclose, is not misleading under Rule
10b-5.”). Most commonly, a duty to disclose is triggered either because the
omitted fact was necessary to render a preexisting statement not misleading, or
because the securities law otherwise required its disclosure. Thomas Lee Hazen,
supra, § 12.19(1).
75
This reasoning also applies to any claim based on these alleged omissions by
Thompson in the first amended complaint.
116
Here, Jacoby identified no specific statements made by the defendants
rendered actually misleading by the alleged omission, or any other duty to speak.
The closest Jacoby came was quoting the Sarbanes-Oxley Act certifications signed
by Officers Adler and Wasserman on Media’s August 2005 Form 10-QSB.
(Second Am. Compl. ¶ 58.)76 Jacoby alleged that Adler and Wasserman certified
that the Quarterly Report “complie[d] with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934 [and that] the information contained
in the Report fairly present[ed], in all material respects, the financial condition and
results of the operations of the Company.” (Id.) Jacoby further alleged that the
“statements” Adler and Wasserman made in their certifications “were false and
76
Jacoby also pointed to other Sarbanes-Oxley certifications. I say this was the closest
Jacoby came because the August 2005 certifications were closest in time to Summit’s alleged
illegal conduct.
Jacoby also pointed to Media’s failure to disclose Summit’s involvement in the June
private offering on SEC Form D filed on July 16, 2005. The 2005 Form D required disclosure of
certain background information with respect to “each person who has been or will be paid or
given, directly or indirectly, any commission or similar remuneration for solicitation of
purchasers in connection with sales of securities in the offering.” Assuming, for the sake of
argument, that Media knew that Summit “solicited” purchasers—which would go beyond merely
acting as a finder—this amounted to an omission. The trouble for Jacoby is that he did not base
his claim on this omission. Rather, he alleged that Media failed to disclose and account for the
$2 million contingent liability flowing from the use of an unregistered broker. Indeed, if the
Form D omission had formed the basis for his claim, this alleged omission was corrected on
March 20, 2006, when Media disclosed its August 2005 payment to Summit of a total “success
fee” of $28,500 “in connection with a private placement of its common stock.” Relationserve
Media, Inc., Registration Statement under the Securities Act of 1933 (Form SB-2), at F-22
(March 20, 2005). Jacoby, however, alleged that the omission was not corrected until the May
23, 2006 disclosure of Thompson’s Indiana lawsuit.
117
misleading because they failed to indicate that Relationserve [Media] and its
officers and directors had violated state and federal securities law, presenting a
$2,000,000.00 contingent civil and criminal liability.” (Id. ¶ 59.) As the district
court aptly noted, however, “Jacoby’s argument is circular because it contends that
the filing was misleading precisely because the filing promised not to be
misleading.” (Dismissal Order 7, June 12, 2007.)
Again endeavoring to give the plaintiffs’ lawyers the benefit of the doubt, I
will not stop here. I will assume that Jacoby meant to say that, after the June 2005
private offering, Media had a duty to report the contingent liability on its financial
statements or SEC reports either because of specific SEC disclosure requirements
or a GAAP violation (because Media promised to comply with GAAP).77 Even
so, Jacoby did not point to an actionable omission.
As relevant here, two line-items on the 2005 Form 10-QSB required
management to disclose certain contingent liabilities. See 17 C.F.R. § 228.10 et
seq. (2005) (repealed 2008). First, Item 103 of Regulation S-B required disclosure
of “any pending legal proceeding” or of “any proceeding that a governmental
authority is contemplating (if the small business issuer is aware of the
77
Relationserve Media Inc., Quarterly Report (Form 10-QSB), at 6 (Aug. 18, 2005)
(“The consolidated financial statements are prepared in accordance with generally accepted
accounting principles in the United States of America (‘US GAAP’).”).
118
proceeding).” id. § 228.103. Second, Item 303 of Regulation S-B required
disclosure of “[a]ny known . . . uncertainties that have or are reasonably likely to
have a material impact on the small business issuer’s short-term or long-term
liquidity.” Id. § 228.303(b)(1)(i) (emphasis added).78
For its part, at the time, GAAP, via Financial Standards Accounting Board
(“FASB”), Financial Accounting Standards 5 (“FAS 5”),79 required the reporting of
a “loss contingency”80 when “there [wa]s at least a reasonable possibility that a loss
or an additional loss may have been incurred.” FAS 5, ¶ 10; see also id. ¶ 3
(distinguishing loss contingencies that are “probable,” that is, “the future event or
events are likely to occur;” from those that are “reasonably possible,” that is, “the
chance of the future event or events occurring is more than remote but less than
likely;” from those that are “remote,” that is, “the chance of the future event or
78
The assumption that Item 303 of Regulation S-B would impose an actionable duty to
speak under Rule 10b-5 is generous. At least the Third Circuit has expressly held that “a
violation of SK-303’s reporting requirements does not automatically give rise to a material
omission under Rule 10b-5” and that where plaintiffs fail to plead “any actionable
misrepresentation or omission” under Rule 10b-5, Item 303 cannot provide a basis for liability.
Oran v. Stafford, 226 F.3d 275, 288 (3d Cir. 2000). Item 303 of the 2005 iteration of Regulation
S-B and Item 303 of Regulation S-K are materially identical.
79
See City of Monroe Employees Ret. Sys. v. Bridgestone Corp., 399 F.3d 651, 677–78
(6th Cir. 2005) (identifying FAS 5 as GAAP); Ganino v. Citizens Utils. Co., 228 F.3d 154, 160
n.4 (2d Cir. 2000) (“The SEC treats the FASB’s standards as authoritative.”). FAS 5 has since
been superseded by FASB’s codification of GAAP, which became effective in 2009.
80
FAS 5 defined a “contingency” as “an existing condition, situation, or set of
circumstances involving uncertainty as to possible gain . . . or loss.” FAS 5, ¶ 1.
119
events occurring is slight”). GAAP did not require disclosure of loss contingencies
arising out of “unasserted claims” when there was no indication that the potential
claimant was aware of the claim, unless it was both “probable that a claim w[ould]
be asserted” and there was a “reasonable possibility that the outcome w[ould] be
unfavorable.” FAS 5, ¶ 10.81
Despite Jacoby’s shotgun pleadings, his allegations do not even remotely
suggest that Media or any of its officers knew enough about Thompson’s possible
claim to trigger a reporting obligation under Regulation S-B or GAAP. For one, as
of August 2005, Media had no duty to report the claim as a pending legal
proceeding. Other than Thompson’s March 3, 2006, Indiana lawsuit, Jacoby did
not allege that any private placement purchaser sued Media. Nor did Jacoby allege
any government investigation into Media’s contract with Summit (despite Media’s
81
Appendix A of FAS 5 gave this example:
[A]n enterprise may believe there is a possibility that it has infringed on another
enterprise’s patent rights, but the enterprise owning the patent rights has not
indicated an intention to take any action and has not even indicated an awareness
of the possible infringement. In that case, a judgment must first be made as to
whether the assertion of a claim is probable. If the judgment is that assertion is
not probable, no accrual or disclosure would be required. On the other hand, if
the judgment is that assertion is probable, then a second judgment must be made
as to the degree of probability of an unfavorable outcome. . . . If an unfavorable
outcome is probable but the amount of loss cannot be reasonably estimated,
accrual would not be appropriate, but disclosure would be required . . . .
FAS 5 at ¶ 35.
120
full disclosure of that agreement in the June 2005 Form 8-K). As a result, Media
had absolutely no duty to report the so-called contingent liability as a pending legal
proceeding.
Nor did Jacoby allege facts that would have required disclosure under Item
303 of Regulation S-B, “Management’s Discussion and Analysis.” Jacoby claimed
that Media should have disclosed a contingent liability arising out of the conduct of
another entity, Summit. In the consulting agreement, Summit represented that it
was not a registered broker and that it did not need to be a registered broker,
because it would only act as a finder. Under federal law, this contract was not per
se illegal. See Paul Anka, SEC No-Action Letter, Fed. Sec. L. Rep. ¶ 79,797 (July
24, 1991) (granting no action relief to a finder who would merely refer accredited
investors to the issuer). State regulation of broker/dealers and finders varies.
Thus, to show a “known” “uncertainty” “reasonably likely to have a material
impact” on Media’s liquidity, Jacoby would have had to plead some facts
indicating that Media knew that Summit had breached its agreement and violated
federal or state law.82 Jacoby failed to do so.
82
In fact, at the time, Media would have had no reason to believe Summit would breach
the consulting agreement and broker a private offering purchase in violation of state law. This is
because the cost to Summit would have likely been prohibitive. Breaching the consulting
agreement in this manner would, in addition to rendering Summit liable to the purchaser for
rescission or damages, have exposed Media to potential civil and criminal liability. If Media
were sued by a purchaser, the company would have demanded that Summit hold it harmless.
121
Jacoby identified only one private offering transaction allegedly brokered by
Summit: Thompson’s.83 The factual allegations concerning Thompson’s purchase
focused almost entirely on Summit’s interaction with Thompson rather than
Summit’s interaction with Media. (See, e.g., Second Am. Compl. ¶ 40 (“In June
2005, Altavilla began soliciting Thompson and other class members and
encouraged them to purchase RelationServe [Media] securities by way of a private
offering.”); id. at ¶ 41 (“Thompson . . . . reviewed all documents presented by
Altavilla, and listened to the sales pitch of Altavilla.”).) It simply does not follow
that because Summit gave Thompson a sales pitch that Media knew about the sales
pitch, much less that it would subject Media to legal liability.
The closest Jacoby came to alleging Media’s awareness of Summit’s breach
was, “Altavilla negotiated the purchase price of [Thompson’s] shares, facilitated
the wire transfer, and oversaw the delivery of certificates.” (Id. at ¶ 42.) Viewed
in the light most favorable to Jacoby, it could be inferred that Altavilla had some
contact with someone at Media. It cannot be inferred that whoever acted for Media
Depending on the outcome of the litigation, Summit might have had to return to Media the
1,050,000 shares it received pursuant to the consulting agreement, as well as any finder’s fees it
may have earned.
83
In the first amended complaint, Jacoby did allege one other sale through an
unregistered broker to a Stuart Feick. I do not include Feick in this discussion because the
allegation was abandoned and not pled in the second amended complaint. See Part IV.B, infra.
122
gleaned that the exchange gave Thompson the ability to rescind his purchase, let
alone that it was “reasonably likely” that Thompson would seek rescission.
This is especially so in light of Indiana law. Thompson’s theory of liability
relied on Indiana Securities Law § 8(b). Section 8(b) provided, in relevant part,
“[i]t is unlawful for a[n] . . . issuer to employ an agent unless the agent is
registered.” I.C. § 23-2-1-8(b) (2005) (repealed 2008). An “agent” was defined as
an “individual, other than a broker-dealer, who represents a[n] . . . issuer in
effecting or attempting to effect purchases or sales of securities.” I.C. § 23-2-1-
1(b) (2005) (repealed 2008). However, an agent did not include “an individual
who represents an issuer in: . . . (2) effecting transactions exempted by section 2(b)
of this chapter.” Id. Section 2(b)(10), in turn, exempted transactions where: (A)
the issuer reasonably believed there were no more than 20 purchasers in Indiana;
(B) the issuer did not “offer or sell . . . securities by means of a form of general
advertisement or general solicitation;” (C) the issuer reasonably believed that each
purchaser was buying for the purchaser’s own investment and was aware of the
restrictions imposed on the transferability of the securities; (D) . . . (E) . . . (F) . . . ;
(G) “[t]he issuer need not [have] compl[ied] with clause (D), (E), or (F) if: . . .
there [were] not more than fifteen (15) purchasers in Indiana and each Indiana
purchaser [wa]s an accredited investor . . . .” Id.
123
Media had every reason to believe that it complied with this exception.
Media’s Form D disclosed that there were only five (5) Indiana investors total. To
qualify for the Rule 506 Regulation D exemption under federal law, Media could
not have offered or sold securities by means of a general advertisement or
solicitation. In signing the subscription agreement, Thompson certified that he
purchased the units “for his . . . own account, for investment only.” Relationserve
Media Inc., Current Report (Form 8-K), Ex. 4.1 (Subscription Agreement), ¶ 1.7
(June 30, 2005). Additionally, Thompson certified that he knew the shares were
not registered under the 1933 Act and that the shares could not be traded under
federal law “for at least one (1) year . . . and there can be no assurance that the
conditions necessary to permit such sales . . . will ever be satisfied.” Id. at ¶1.8;
see also id. at 1.2. Finally, Thompson certified that he was an accredited investor
under Indiana law.84 Consequently, even assuming that Media knew of Summit’s
84
Compare I.C. § 23-2-1-1(r) (2005) (repealed 2008) (equating the definition of
“accredited investor” with the definition in the federal Securities Act), and 17 C.F.R. 230.215(f)
(2005) (“accredited investor” includes a “natural person who had an individual income in excess
of $200,000 in each of the two most recent years or joint income with that person’s spouse in
excess of $300,000 in each of those years and has a reasonable expectation of reaching the same
income level in the current year.”), with (Defs.’ Mot. to Dismiss, at 58, ex. F (Oct. 20, 2006)
(certifying that Thompson satisfied the requirements of 17 C.F.R. 230.215(f)).).
124
breach, Media would have had little reason to suspect that Thompson would have
sued because he could not recover under state law.85
Even putting the exemption aside, this would still be correct. Indiana law
prevented plaintiffs who knowingly participated in a violation of the securities law
from prevailing. See I.C. § 23-2-1-19(a) (2005) (repealed 2008) (“A person who
offers or sells a security in violation of this chapter . . . is liable to any other party
to the transaction who did not knowingly participate in the violation or who did not
have, at the time of the transaction, knowledge of the violation . . . .”) (emphasis
added). Again, in the subscription agreement, Thompson certified his knowledge
of Summit’s unregistered status and that he relied only on the offering documents.
By now, it should be apparent that Jacoby did not plead sufficient facts to
show that the alleged contingent liability was “known,” much less “reasonably
likely” to materially impact Media’s liquidity. Therefore, Regulation S-B imposed
no duty to report the so-called contingent liability on Media’s Forms 10-QSB or
10-K. A fortiori, then, Jacoby failed to allege sufficient facts to trigger a reporting
85
Indeed, after the district court dismissed this case, the plaintiffs pressed Thompson’s
state court claims in a Florida circuit court. That court granted the defendant’s motion to dismiss
in part because Media complied with Indiana’s limited offering exemption, Indiana Code § 23-2-
1-2(1). Thompson v. Sendtec, Inc., No. 07-17797(09), slip op. at 4–5 (Fla. Cir. Ct. Aug. 6,
2007).
125
obligation under GAAP. Under GAAP, because Jacoby did not allege that any
lawsuit had even been threatened, Media had a duty to report the purported liability
only if it was both probable that a suit would be filed and reasonably possible that
Media would lose. I have already explained at length why Media would have had
no reason to believe either that Thompson would have filed suit or that he could
have succeed.
All in all, even giving Jacoby the benefit of the doubt by assuming that he
invoked the fraud-on-the-market theory, Jacoby completely failed to point out any
actual statement that was misleading on account of the alleged omission or any
other duty to speak. Even further assuming that Jacoby had pled a duty to report
the liability under Regulation S-B or GAAP, his claim is still frivolous because he
alleged no facts that would have triggered any reporting requirement. An
actionable misrepresentation or omission is step one in any Rule 10b-5 claim;
Jacoby failed to take this first step, and his claim is therefore frivolous under any
reasonable view of the law.
ii. Jacoby Made Only Frivolous Scienter Allegations
Jacoby’s Rule 10b-5 claim is also legally frivolous because he completely
failed to plead scienter with the specificity required by established law. This is
especially inexcusable with respect to the Officers because the district court
126
cautioned against “just automatically su[ing] everyone that happens to be on the
list of officers and directors.” (Teleconference Tr. 4, 6–7 (Nov. 3, 2006).)
Negligence has long been insufficient to trigger civil liability under Rule
10b-5. In Ernst & Ernst v. Hochfelder, the Supreme Court held that a defendant
must act with scienter, defined as a “mental state embracing intent to deceive,
manipulate, or defraud.” 425 U.S. 185, 193 n.12, 96 S. Ct. 1375, 1381 n.12, 47 L.
Ed. 2d 668 (1976). In this circuit, “severe recklessness” can amount to scienter,
but it is the bare minimum. Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1282–83
(11th Cir. 1999) (“We quantify scienter as encompassing at least a showing of
severe recklessness . . . .”). “‘Severe recklessness is limited to those ‘highly
unreasonable omissions or misrepresentations that involve . . . an extreme
departure from the standards of ordinary care.’” Id. at 1282 n.18 (quoting
McDonald v. Alan Bush Brokerage Co., 863 F.2d 809, 814 (11th Cir. 1989)).
Since 1996, the PSLRA has required plaintiffs to “state with particularity
facts giving rise to a strong inference that the defendant acted with the required
state of mind.” 15 U.S.C. 78u-4(b)(2) (emphasis added). Thus, in a securities
fraud class action, a plaintiff may no longer plead the scienter element generally, as
was previously possible under Rule 9(b). Rather, the complaint must allege facts
supporting a strong inference of scienter “for each defendant and with respect to
127
each violation.” Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015, 1016 (11th Cir.
2004). Jacoby’s attorneys do not come close to meeting this standard because they
alleged only conclusory statements, not facts giving rise to an inference of scienter.
Jacoby’s best argument is that Karp intentionally hid Summit’s involvement
in the 2005 June private offering on the Form D she signed and filed with the SEC.
Karp did not list Summit in response to a question that asked for basic information
about “each person who has been or will be paid or given, directly or indirectly,
any commission or similar remuneration for solicitation of purchasers in
connection with sales of securities in the offering.” Relationserve Media, Inc.,
Notice of Sale of Securities Pursuant to Regulation D (Form D), at 3 (July 16,
2005). At the time, however, it was unclear that a finder constituted a person
compensated for “solicitation” of purchasers. A new version of Form D, adopted
by the SEC in 2009, requires information about any person paid transaction-based
compensation “in connection with” the offering, “including finders.” Thus, it is
unclear that Karp even knew that she needed to disclose Summit on the Form D,
particularly so because Media had already publicly disclosed that Summit could act
as a finder on the June 16, 2005, current report.
128
Jacoby’s remaining scienter allegations can loosely be grouped into three
categories: (1) the officers must have known, (2) the “venal” character of the
corporation, and (3) motive and opportunity.
Typical of Jacoby’s “they must have known” allegation is the following:
“The ongoing fraudulent scheme and violation of securities laws described in this
Complaint could not have been perpetrated over a substantial period of time . . .
without the knowledge and complicity of the personnel at RelationServe[ Media’s]
highest level, including the individual Defendants.” (Second Am. Compl. ¶ 81.) 86
When Jacoby filed the first and second amended complaints, it was absolutely
clear that this sort of conclusory allegation could not satisfy the requirement that
the complaint state “facts” “with particularity.” See, e.g., In re Recoton Corp. Sec.
86
(See also Second Am. Compl. ¶ 76 (“Defendants acted with scienter, in that
Defendants knew RelationServe[ Media’s] public documents and statements issued and/or
disseminated by or in the name of RelationServe [Media] were materially false and
misleading.”); id. ¶ 78 (“Defendants knowingly and substantially participated or acquiesced in
the issuance or dissemination of such statements or documents.”); id. ¶ 79 (“Defendants, by
virtue of their receipt of information reflecting RelationServe [Media] and its business practices,
control over or receipt of RelationServe [Media] materially misleading statements and/or their
associations with RelationServe [Media] were active and culpable participants in the fraudulent
scheme alleged herein.”); id. ¶ 24 (“The above-listed Defendants, by virtue of their high-level
positions with RelationServe [Media], directly participated in the management of RelationServe
[Media], were directly involved in RelationServe[ Media’s] day-to-day operations at the highest
levels, and were privy to proprietary information concerning RelationServe [Media] and its
business operations and financial condition as alleged herein.”); id. ¶ 25 (“The above-listed
Defendants were involved in the drafting, producing, reviewing, and/or dissemination of
misleading statements and were aware—or recklessly disregarded—of the fact that misleading
statements were being issued and approved or ratified these statements in violation of federal
securities law.”).)
129
Litig., 358 F. Supp. 2d 1130, 1147 (M.D. Fla. 2005) (“Conclusory allegations that
do no more than state that [the defendant] ‘would have known,’ ‘knew and
ignored,’ or ‘recklessly failed to know’ are insufficient to state a claim under
PSLRA and 9(b).”) (footnotes omitted). Rather, this kind of allegation is a mere
conclusion. And particularly because of the theory of liability asserted here—
Media’s failure to disclose a contingent liability arising from Summit’s breach of
its contract with Media—it is a dubious conclusion at that.
This conclusory allegation that “they must have known” is particularly
dubious when applied to certain Officers. Recall that the alleged fraud involved
Summit’s breach of the consulting agreement during the June private offering.
Media’s SEC filings indicate that the offering ended on June 30, 2005. Of all the
individual defendants named in the complaints, only Karp, Hirsch, Adler, and
Musser worked for Media when Summit allegedly breached the agreement.
Moreover, Adler and Musser did not commence their employment with Media
until June 21, 2006, only nine days prior to the end of the June private offering.
All of the other individual defendants either never worked for Media (Young,
Honig, and Hill), or began their tenure after Summit’s alleged breach concluded
(Jehassi, Wasserman, Brauser, McNamara, Soltoff, Obeck, and Gould). See Table
at 142, infra. As applied to the latter group of defendants, the “they must have
130
known” allegation is absurd. Without more, especially after a personal warning
from a district court not to sue officers just because they were officers, no
reasonably competent attorney could have sued these officers.87
Perhaps recognizing the insufficiency of the “they must have known”
allegations, Jacoby’s counsel also alleged that accounting irregularities show that
Media had a venal corporate character. According to Jacoby, an officer of Media
discovered a memorandum from “Richard Hill . . . a founder of Relationserve to
[an employee] in RelationServe’s finance department . . . instruct[ing the
employee] to recognize specific revenue in violation of company operating
procedures, applicable law, and generally-accepted accounting principles.”
(Second Am. Compl. ¶ 60.) This entire argument is frivolous because the alleged
accounting irregularities were ordered by Richard Hill, who was never a Media
Employee or even a defendant in the second amended complaint.88 Especially
87
Even worse, the plaintiffs repled the same “they must have known” allegations in the
second amended complaint after the district court had warned them against such reasoning in the
teleconference when the court dismissed the first amended complaint. The court explained to the
plaintiffs that “[i]t’s not fair to throw every defendant in there when we know from the facts we
have alleged in the first amended complaint that some of these defendants could not be held
responsible for some preexisting public statements.” (Hr’g Tr. at 10, Mar. 6, 2007.)
88
Plaintiffs sued Hill in the first amended complaint. Hill moved to dismiss in part
because he was “never an officer or director of Relationserve [Media] . . . and Plaintiffs plead no
other facts to establish that Hill controlled corporate affairs or policies.” (Def. Hill’s Mot. to
Dismiss First Am. Compl. 5.) The plaintiffs did not rename Hill as a defendant in the second
amended complaint.
131
because the alleged misconduct violated “company operating procedures,” it
cannot be inferred that Media had a venal corporate culture based on the misdeeds
of a non-employee.
Moreover, the Media employee who allegedly followed Hill’s instruction
was not a corporate officer or defendant in the suit and never signed an SEC filing.
In any event, five months before Jacoby filed his second amended complaint, this
court squarely held that accounting irregularities, even violations of GAAP in
Sarbanes-Oxley certified accounting statements, cannot support an inference of
scienter unless the officer certifying the statements was “severely reckless.”
Garfield v. NDC Health Corp., 466 F.3d 1255, 1266 (11th Cir. 2006). This
standard is satisfied if “the person signing the certification had reason to know, or
should have suspected, due to the presence of glaring accounting irregularities or
other ‘red flags,’ that the financial statements contained material misstatements or
omissions.” Id.89 Here, Jacoby pointed to no glaring violations in Media’s
certified accounting statements. Thus, he based his venal corporate culture
89
Garfield v. NDC Health Corp., 466 F.3d 1255 (11th Cir. 2006) was decided on
October 12, 2006; Jacoby filed his second amended complaint on March, 19, 2007. Even prior
to Garfield, we had made clear that “allegations of violations of GAAS or GAAP, standing
alone, do not satisfy the particularity requirement of Rule 9(b).” Ziemba v. Cascade Intern., Inc.,
256 F.3d 1194, 1208–09 (11th Cir. 2001); see also id. at 1209 (“[P]laintiffs must therefore allege
more than mere violations of auditing standards.”).
132
allegation on the misdeeds of two individuals when neither individual was a
defendant in the second amended complaint and both acted in violation of
company policy. Without more, alleging that the defendant Officers or Media had
a “venal character” is unfounded and irresponsible.
Finally, Jacoby claimed that scienter could be inferred because “[t]he
individual Defendants engaged in the above-alleged activities to inflate the price of
RelationServe [Media] securities, to protect and enhance their respective positions,
and to enhance the substantial compensation they obtained thereby.” (Second Am.
Compl. ¶ 82.) It is immediately apparent that, like the other scienter allegations,
this one is conclusory. Notably, Jacoby never alleged that any officer or director
defendant sold Media stock during the class period, or did anything else that would
support the motive and opportunity theory. It stands to reason, of course, that a
company’s officers and directors have a motive to commit securities fraud. But
that could be said of any public company’s officers and directors, which is why the
precedent of this circuit squarely forecloses any argument that stand-alone
allegations of “motive and opportunity” will satisfy the PSLRA’s standard.
Bryant, 187 F.3d at 1285–86 (“While allegations of motive and opportunity may
be relevant to a showing of severe recklessness, we hold that such allegations,
133
without more, are not sufficient to demonstrate the requisite scienter in our
Circuit.”).
Jacoby’s scienter allegations boil down to three empty conclusions born of
no facts: because the defendants were officers or directors of Media, (1) they must
have known about Summit’s breach, (2) they were immoral, and (3) they had a
motive to lie. These allegations probably fail under ordinary notice pleading
standards;90 they certainly fail under any reasonable view of the PSLRA’s
heightened pleading requirements. Without more, no reasonably competent
attorney could have brought Jacoby’s claim.
iii. Jacoby Advanced a Frivolous Loss Causation Argument
Finally, Jacoby’s Rule 10b-5 claim is legally frivolous because he advanced
an untenable theory of loss causation. Loss causation is an essential element of a
Rule 10b-5 claim and requires a plaintiff to prove that the defendant’s fraud
proximately caused the plaintiff’s loss. Dura, 544 U.S. at 346, 125 S. Ct. at 1633.
As explained above, Jacoby’s Rule 10b-5 claim alleged that Media fraudulently hid
a $2 million contingent liability arising out of Summit’s work in the 2005 June
90
For the purposes of this sanctions discussion, the law is frozen as it existed in
2006—as such, Ashcroft v. Iqbal, ___ U.S. ___, 129 S. Ct. 1937, 173 L. Ed. 2d 868 (2009) does
not apply. Nevertheless, our cases made clear that although we accept a plaintiff’s allegations as
true, “conclusory allegations, unwarranted deductions of facts or legal conclusions masquerading
as facts” are insufficient to avoid dismissal. See Oxford Asset Mgmt., Ltd. v. Jaharis, 297 F.3d
1182, 1188 (11th Cir. 2002).
134
private offering. Jacoby’s theory fails because he began to measure loss causation
over twenty days after the market had learned of the alleged fraud.
Even before Dura, our cases “explicitly require[d] proof of a causal
connection between the misrepresentation and the investment’s subsequent decline
in value.” Robbins v. Koger Props., Inc., 116 F.3d 1441, 1448 (11th Cir. 1997)
(citing cases). To prove loss causation, a plaintiff must allege that the fraud-
induced price inflation was removed from the stock price and caused the plaintiff’s
losses. Id. (granting judgment as a matter of law for defendant company because
there was “no evidence that this price inflation [caused by defendant’s fraud] was
removed from the market price of [the] stock.”).
Jacoby’s loss causation theory boils down to this: Media’s May 23, 2006,
disclosure of Thompson’s Indiana lawsuit corrected Media’s failure to disclose its
use of an unregistered broker-dealer; on May 23, Media’s shares traded at $1.35
and eventually fell to $.63 per share on June 13, 2006; the May 23 disclosure
caused this stock price drop. Media, however, initially disclosed Thompson’s
Indiana suit on May 1, 2006. Jacoby’s loss causation argument is frivolous
because the market had already known and digested all the information supposedly
added by the May 23 disclosure.
135
On March 3, 2006, Thompson filed his Indiana lawsuit against Media.
Media’s first disclosure of this lawsuit came in the May 1, 2006 amendment to the
registration statement that was filed on March 20. That amendment disclosed, in
pertinent part, that
On March 3, 2006, Richard F. Thompson, Thompson Family Wealth
Management, Dwight Thompson, Greg Thompson and Parabolic
Investment Fund, L.P. commenced an action in the State Court of
Indiana, County of Hamilton, against Anthony D. Altavilla, Summit
Financial Partners, LLC, Barron Partners, LP, US MedSys Corp. and
RelationServe Media, Inc. The plaintiffs in this action assert a variety
of claims against non-related defendants. As against the Company,
plaintiffs seek rescission of the RSMI common stock they purchased
in July 2005, alleging that the shares they received were not registered
as required under Indiana Law, and that the Company failed to
disclose a commission to Mr. Anthony Altavilla. The Company
believes this action is without merit, and intends to vigorously defend
itself with respect to this matter, however; its outcome or range of
possible loss, if any, cannot be predicted at this time. The Company
cannot provide any assurance that the outcome of this matter will not
have a material adverse effect on its financial position or results of
operations.
Relationserve Media, Inc., Amend. No. 1 to Form SB-2 Registration Statement
(Form SB-2/A), at 53 (May 1, 2006). Jacoby seems to have alleged that this
disclosure was insufficient because it was incomplete. (See Second Am. Compl. ¶
72 (“On May 23, 2006, RelationServe [Media] updated its disclosure concerning
Thompson’s lawsuit . . . .”).)
136
Media filed a second amendment to the registration statement on May 23,
2006, which amplified the May 1 amendment.91 This amendment stated:
On March 3, 2006, Richard F. Thompson, Thompson Family Wealth
Management, Dwight Thompson, Greg Thompson and Parabolic
Investment Fund, L.P. commenced an action in the State Court of
Indiana, County of Hamilton, against Anthony D. Altavilla, Summit
Financial Partners, LLC, Barron Partners, LP, US MedSys Corp. and
RelationServe Media, Inc. The plaintiffs in this action assert a variety
of claims against non-related defendants. As against the Company,
plaintiffs seek rescission of the 110,000 shares of Company[] common
stock they purchased in July 2005 (plaintiffs also received warrants
for 55,000 shares of RSMI common stock), alleging that the shares
they received were not registered as required under Indiana Law, and
that the Company failed to disclose a commission. The Company
intends to file a motion to dismiss this action because the shares did
not need to be registered under Indiana Law, as they were exempt
from registration as a “federal covered security.” Mr. Altavilla did not
sell shares on the Company’s behalf. Mr. Altavilla did receive, in
addition to other compensation, a finder’s fee in the amount of 7% of
total gross funding provided for introductions made by him to
investors not already having a preexisting relationship with the
Company.
91
Recall that Media filed this amendment after receiving an inquiry from the SEC on
May 11, which asked (1) whether the shares sold to Thompson were registered under Indiana
law; (2) whether Altavilla sold shares for Media and received compensation for each sale; and
(3) because Thompson was seeking rescission, the number of shares he purchased and the price
he paid.
Media did allege that even the May 23 amendment failed to disclose Altavilla’s sales in
other states and the amount of Summit’s commissions. I assume that Jacoby still deemed the
May 23 amendment sufficient to give the market notice of the fraud and simply included these
observations for some other purpose. I say this for two reasons: (1) if the May 23 amendment
did not give the market notice of the fraud, then Jacoby would have no loss causation argument
at all, and (2) as a matter of fact, Media had already disclosed the full amount of the finder’s fees
it paid to Summit.
137
Relationserve Media, Inc., Amend. No. 2 to Form SB-2 Registration Statement
(Form SB-2/A), at 64–65 (May 23, 2006).
Jacoby’s argument that the May 1 amendment was incomplete and that the
public did not know about the compensation package Summit and Altavilla
received is frivolous. As relevant to the unregistered-broker theory, the May 23
amendment added the number of shares purchased by the plaintiffs, and that
Summit did not sell shares on Media’s behalf but did receive a finder’s fee. The
material aspects of both of these amplifications had already been disclosed to and
digested by the market. The efficient market theory—on which Jacoby
relies—posits that all publicly available information about a security is reflected in
the market price of the security. As of July 14, 2005, the market knew that Media
sold $340,000 worth of stock to five Indiana investors. Relationserve Media, Inc.,
Notice of Sale of Securities Pursuant to Regulation D (Form D), at 7 (July 14,
2005). As of June 16, 2005, the market knew that Summit could act as a finder and
would be paid a seven percent finder’s fee. Relationserve Media, Inc., Current
Report (Form 8-K), Ex. 2.6 (June 16, 2005). And as of March 20, 2006, the
market knew that Media paid Summit a total “success fee” of $28,500 in
connection with its private placement of common stock. Relationserve Media,
Inc., Registration Statement under the Securities Act of 1933 (Form SB-2), at F-22
138
(March 20, 2005). Accordingly, the market had absorbed this information well
before the May 23 amendment. If not, those shares were not being traded in an
“impersonal, well-developed” and efficient market, as required for the application
of the fraud-on-the-market doctrine. Basic, 485 U.S. at 247, 108 S. Ct. at 991. It
follows that the proper starting place for measuring loss causation should have
been no later than May 1.
4. The Section 20(a) Claims
The § 20(a) control-person claims are frivolous beyond doubt. As discussed
in Part II.B & C, supra, § 20(a) is a parasitic federal securities claim that imposes
joint and several liability against individuals “who, directly or indirectly, control[]
any person liable under any provision of [the 1934 Act] or of any rule and
regulation thereunder.” 15 U.S.C. § 78t(a). In this circuit
[A] defendant is liable as a controlling person under section 20(a) if
he or she “had the power to control the general affairs of the entity
primarily liable at the time the entity violated the securities laws . . .
[and] had the requisite power to directly or indirectly control or
influence the specific corporate policy which resulted in the primary
liability.”
Brown v. Enstar Group, 84 F.3d 393, 396 (11th Cir. 1996) (quoting Brown v.
Mendel, 864 F. Supp. 1138, 1145 (M.D. Ala. 1994) (alteration in original); see also
Theoharous v. Fong, 256 F.3d 1219, 1227 (11th Cir. 2001).
139
Here, the plaintiffs’ attorneys alleged that each of the fourteen individual
defendants in the first amended complaint and the eleven individual defendants in
the second amended complaint were liable as “control persons” under § 20(a). All
of the § 20(a) claims are frivolous because the plaintiffs never pled a nonfrivolous
primary Rule 10b-5 claim. Moreover, some of the defendants never even worked
for Media; therefore, absent extraordinary facts not alleged here,92 they could not
conceivably have had the power to control either Media’s “general affairs” or to
directly or indirectly control or influence the specific “corporate policy” resulting
in the primary liability. Thus, even had the plaintiffs pled a valid Rule 10b-5
claim, as against defendants Young, Hill, and Honig—who never worked for
Media—plaintiffs’ § 20(a) claim would still be clearly frivolous. Either way, the §
20(a) claims were so frivolous that the district court necessarily abused its
discretion when it denied sanctions.
B. Rule 11(b)(3) Compliance
I now review all three complaints for Rule 11(b)(3) compliance. Rule
11(b)(3) requires that the factual contentions “have evidentiary support or, if
92
For example, the plaintiffs might have an argument if the non-employees had the
power to control the corporate policy of Media by contract, majority shareholder status, or
otherwise. Cf. Theoharous v. Fong, 256 F.3d 1219, 1228 (11th Cir. 2001) (rejecting the
argument that a minority stake gave the § 20(a) defendants the power to control the general
busines affairs of the company).
140
specifically so identified, are likely to have evidentiary support after a reasonable
opportunity for further investigation or discovery.” Fed. R. Civ. P. 11(b)(3)
(2006). Ordinarily, it is difficult for a court of appeals to conclude that a
complaint’s factual contentions lack all non-frivolous evidentiary support because
there is no requirement that all evidence be attached to the complaint. Here,
however, it is possible to conclude this with respect to some of the factual
contentions because the plaintiffs’ attorneys misrepresented easily verifiable SEC
filings. After setting out these violations, I also point out suspicious factual
contentions to facilitate the district court’s review on remand.
First, the blatant violations. As discussed above, in their § 11 claims, the
plaintiffs’ attorneys alleged that each of the individual defendants met at least one
of the statutory conditions necessary to their liability as individuals. Paraphrasing,
to be liable, an individual must have either, (1) signed the registration statement in
some capacity, (2) been a director or named as about to become a director, or (3)
been an underwriter. See 15 U.S.C. § 77k. When the plaintiffs filed suit, the two
registration statements and the SEC filings clearly indicated that eight of the named
individual defendants could not possibly have fit into either of the first two
categories. With respect to the underwriter category, with one exception, none of
these eight individual defendants even sold shares under either registration
141
statement. Moreover, there is no allegation that any of the individual defendants
had been underwriters. Accordingly, the plaintiffs’ factual contention that these
individual defendants fit into § 11’s categories of those who could be held liable is
frivolous beyond doubt. See also supra part IV.A.1.
Moving on, in all three complaints, the plaintiffs’ attorneys alleged that
Media and its Officers knew and failed to report in SEC filings that Summit and its
agents were not registered with the SEC. (Compl. ¶ 33; First Am. Compl. ¶ 68;
Second Am. Compl. ¶ 45.) But as explained above, Media repeatedly disclosed
Summit’s unregistered status. On June 16, 2005, Media made its entire agreement
with Summit public by filing it with the SEC. The agreement declared: “IT IS
SPECIFICALLY UNDERSTOOD THAT [Summit] IS NOT AND DOES NOT
HOLD ITSELF OUT BE [sic] A BROKER/DEALER, BUT IS MERELY A
‘FINDER’ IN REFERENCE TO THE COMPANY PROCURING FINANCING
SOURCES AND ACQUISITION/MERGER CANDIDATES.” Relationserve
Media, Inc., Current Report (Form 8-K), Ex. 2.6 (Consulting Agreement), at 6
(June 16, 2005). Media attached the same agreement to its August 2005 quarterly
report. See Relationserve Media, Inc., Quarterly Report (Form 10-QSB), at 26
(Aug. 15, 2005) (incorporating the agreement by reference). In light of these
142
disclosures, no reasonably competent attorney could have alleged that Media failed
to disclose Summit’s unregistered status in its SEC filings.
Nor could a reasonably competent attorney have alleged, as plaintiffs’
attorneys did, that Karp signed a Form 10-QSB on June 14, 2005, which “failed to
indicate that RelationServe [Media] had contracted with Summit to sell
RelationServe [Media] securities or alert the investing public to the contingent civil
and criminal liabilities that derive from this agreement.” (Second Am. Compl. ¶
37.) This is because Karp never signed this Form 10-QSB; Scott Young did on
behalf of the predecessor public corporation, Chubasco. See Chubasco Resources
Corp., Quarterly Report (Form 10-QSB), at 8 (June 14, 2005) (signed by Scott
Young, dated June 13, 2005). Plaintiffs’ counsel also alleged that Karp signed a
“Form 10SB” “[o]n June 30, 2005” (Second Am. Compl. ¶ 43) but no such filing
exists (only a Form 8-K was signed or filed on that date). No reasonably
competent attorney could have contended that Karp signed forms that were never
filed or forms that were filed but without her signature.
I now turn to some of the questionable factual assertions that the district
court should examine on remand. To begin, the first amended complaint contained
allegations and defendants not realleged and renamed in the second amended
complaint. The first amended complaint alleged: (1) Altavilla sold Media
143
securities to Florida resident Stuart Feick, and (2) Media received information
about employee thefts and kickbacks in July 2005. (First Am. Compl. ¶¶ 62, 92.)
Neither allegation appears in the second amended complaint. In the first amended
complaint, the plaintiffs named Barry Honig and Richard Hill as defendants, but
not in the second. To be sure, there may be a completely innocent explanation for
not realleging these facts and renaming these defendants, but the district court must
determine what evidentiary basis the plaintiffs had in the first place.
Appearing in both the first and second amended complaints, another
questionable factual contention is that Media traded on the NASDAQ stock
exchange. (See First Am. Compl. ¶ 24; Second Am. Compl. ¶ 26.) Media’s SEC
filings indicate that it traded only on the National Association of Securities
Dealers’ Over-the-Counter Bulletin Board. This seems to be confirmed by the
OTCBB website, which has stock prices for Media beginning in July 2005 through
the filing of the second amended complaint. If Media traded on NASDAQ, Jacoby
would have had an easier time proving his Rule 10b-5 claims. This is because
Jacoby seemed to invoke the fraud-on-the-market doctrine, which requires a
plaintiff to prove that the security traded on an efficient market. Securities traded
on NASDAQ are often presumed to be traded on an efficient market. E.g., Burke
v. China Aviation Oil (Singapore) Corp., 421 F. Supp. 2d 649, 653 (S.D.N.Y.
144
2005) (“The NASDAQ is recognized as maintaining an efficient market, but the
Court is unaware of any court holding that the OTCBB or Pink Sheets meet this
same standard.”). If an efficient market cannot be presumed, a plaintiff must plead
and prove its existence. E.g., id. Although I cannot take judicial notice that Media
never traded on NASDAQ, the district court should explore the basis for the
plaintiffs’ contention.
Finally, in the initial and second amended complaints, Jacoby in effect
alleged that Summit sold all of the securities in the June private offering where
Media grossed $2 million dollars from buyers in California, Connecticut, Florida,
Illinois, Indiana, Nevada, New Jersey, New York, Ohio, and Pennsylvania.
Relationserve Media, Inc., Notice of Sales of Unregistered Securities (Form D), at
4, 7–8 (July 14, 2006). This allegation is implicit because the plaintiffs repeatedly
claimed that Media failed to report a $2 million dollar contingent liability arising
out of Media’s sales of securities through Summit. (See, e.g., Second Am. Compl.
¶¶ 44, 46; see also Compl. ¶ 24 (“In order to complete the purchase of
RelationServe [Media] shares by the Plaintiff and Class members . . . .”).) This
allegation is suspicious for two reasons.
First, other than Thompson, in the initial and second amended complaints
plaintiffs never provided specific facts about private offering purchasers in the
145
other states. Second, in the initial and second amended complaints, the plaintiffs
never alleged that any unregistered broker participated in the sales except for
Summit. This latter point is significant because Summit was entitled to a 7%
finder’s fee of the “total gross funding provided” by investors Summit introduced
to the company. Relationserve Media, Inc., Current Report (Form 8-K), Ex. 2.6
(Consulting Agreement), at 6 (June 16, 2005). Therefore, if Summit had been
responsible for all $2 million raised in the June private offering, it would have
earned a $140,000 finder’s fee. Media’s SEC filings, however, indicate that
Summit received only $28,500. Relationserve Media, Inc., Registration Statement
under the Securities Act of 1933 (Form SB-2), at F-22 (March 20, 2005). Thus,
the district court should find out what evidence the plaintiffs had to support their
claim that Summit’s activity subjected Media to a $2 million liability.
I could go on, but will stop here. The plaintiffs’ attorneys must be
sanctioned for their clear violations of Rule 11(b)(3) and the district court should
explore their questionable factual contentions—both those I identified and any
others—on remand.
C. Rule 11(b)(1) Compliance
Rule 11(b)(1) prohibits filing papers for an improper purpose. On this
record, while there are indications that the plaintiffs’ attorneys brought this action
146
for an improper purpose, it is not so clear that the district court necessarily abused
its discretion in denying sanctions under Rule 11(b)(1).
Most troubling is that, in the face of a warning by the district court, the
plaintiffs’ attorneys sued multiple officers with only the barest allegation that they
had any part in—or even knowledge of—the alleged wrongdoing. This is
especially so in light of the particular Officers the plaintiffs added in the first
amended complaint: nine out of ten of the new defendants either never worked for
Media or began working there after (and in most cases long after) Summit
allegedly breached the consulting agreement. See Table at 142, infra. And,
particularly with respect to the § 11 claims, the defendants added four new
plaintiffs who could not possibly be held liable under the statute bringing the total
number of such defendants to seven (eight if Jehassi is included from the initial
complaint). Suing individual defendants without any legal or evidentiary basis is
strong evidence that, as the defense counsel argued, plaintiffs were conducting
scorched earth litigation. (Hr’g Trans. 4, Nov. 3, 2006.)
And indeed, it could be inferred that the plaintiffs’ attorneys attempted to
extort a settlement by strategically bringing frivolous claims, adding numerous
defendants, overstating the scope of the plaintiffs’ injury, and filing difficult to
decipher shotgun pleadings, all while counting on the district court not to clear the
147
smoke. If plaintiffs’ counsel pursue this strategy long enough, defendants will
settle. Further evidence of this comes from plaintiffs’ attorney Richard Bell’s
letter, replying to defense counsel’s warning that the suit was frivolous, that “at
some point in time both our clients will want to resolve or settle this case.”
On the other hand, the plaintiffs’ attorneys did voluntarily drop some of the
Officer defendants and some of their frivolous claims. And as for Bell’s letter,
most civil cases settle. Accordingly, it is unclear whether the plaintiffs’ attorneys
were employing a calculated strategy or were just incompetent.93 After considering
any new Rule 11(b)(2) and (3) violations, the district court should evaluate the
evidence and determine whether the attorneys brought this case in bad faith or for
an improper purpose.
Finally, I note that the district court must determine whether Jacoby or
Thompson violated Rule 11.94 The current record is much less developed in this
regard, but there is still one fact that raises an eyebrow: Thompson’s purchase on
93
The plaintiffs’ attorneys expressly disavowed any incompetence in their argument to
the district court that they should be appointed class counsel: “The attorneys at Cohen & Malad
are highly skilled and experienced practitioners with extensive experience in federal securities
class action litigation and are throughly committed to the vigorous prosecution of this action.”
(Mem. of Law in Supp. of Pls.’ Mot. for Appointment as Co-Lead Pls. 13, Nov. 3, 2006.)
94
“A represented party who is responsible for a violation of Rule 11 may be sanctioned.
Responsibility for a violation will depend on the extent of the client’s involvement in the
management of litigation and the decisions that resulted in a violation of the Rule.” James Wm.
Moore et. al., Moore’s Federal Practice § 11.23[6][c][i] (3d Ed. 2009).
148
July 17, 2006, of 10,000 Media shares, only to sell them the next day for a small
loss. This could indicate that Thompson purchased the shares to enable himself to
act as lead plaintiff for the open market purchasers. The district court should
consider this on remand.
D. The Plaintiffs’ Attorneys’ Rule 11 Violations Trigger the PSLRA’s Presumptive
Sanction of Attorney’s Fees and Other Expenses
Having identified the violations of Rule 11(b) that can be conclusively
determined from the record, all that remains is to determine whether the violations
are “substantial.” The PSLRA creates a presumptive sanction of a defendant’s
attorneys’ fees incurred in the action for “any complaint” that “substantially” fails
to comply with Rule 11.
Here, I would hold that the plaintiffs’ attorneys triggered this presumption
three separate times. In the initial complaint, all of the federal securities claims
violated Rule 11(b)(2)—the § 11 claim, the § 12 claim, and the Rule 10b-5 claim.
In the first amended complaint, all of the federal securities claims violated Rule
11(b)(2)—Thompson and Jacoby’s § 11 claims, § 12 claims, Rule 10b-5 claims,
and § 20(a) claims. In the second amended complaint, Jacoby realleged his
frivolous Rule 10b-5 and § 20(a) claims. Even setting aside the Rule 11(b)(3)
violations and the possibility of 11(b)(1) improper purpose violations, it is clear
149
that each of the three complaints “substantial[ly] fail[ed]” to comply with Rule 11.
15 U.S.C. § 78u-4(c)(3)(A)(ii).95 On remand, the plaintiffs will have the
opportunity to rebut the presumption by demonstrating that the award of attorneys’
fees would impose an unreasonable, unjust burden on them and that the failure to
award fees would not impose a greater burden on the defendants. See 15 U.S.C. §
78u-4(c)(3)(B)(i).
E. Summary
In sum, with respect to Karp’s motion for Rule 11 sanctions under the
PSLRA, I would hold as follows. I would hold that the plaintiffs’ attorneys
violated Rule 11(b)(2) with respect to every federal securities claim brought in this
case. I would hold that the plaintiffs’ attorneys violated Rule 11(b)(3) by alleging
that some of the individual defendants’ met § 11’s statutory requirements, Karp
signed and filed SEC filings that she never signed or filed, and Media never
disclosed Summit’s unregistered status. Finally, I would hold that the Rule 11(b)
violations triggered the PSLRA’s presumptive sanction of the defendant’s
attorneys’ fees incurred in the entire action. A remand would still be necessary for
95
Although the Rule 11(b)(2) violations alone trigger the PSLRA’s presumption, a
remand is still necessary for further findings regarding (b)(1) and (3) because further violations
will have a bearing on the scope of the harm caused to the defendants and the plaintiffs’ ability
to rebut the presumption.
150
four determinations: (1) whether Thompson and Jacoby violated Rule 11, (2)
whether the plaintiffs’ attorneys violated Rule 11(b)(1) by filing any or all of the
complaints for an improper purpose, (3) whether other Rule 11(b)(3) violations
exist, and (4), in any event, whether the plaintiffs can rebut the PSLRA’s
presumptive award of attorneys’ fees. I would also instruct the district court to
consider whether the plaintiffs should be sanctioned under 28 U.S.C. § 1927 for
“unreasonably and vexatiously” multiplying these proceedings.
V. The Court Errs by Ignoring Karp’s Cross-Appeal for Rule 11 Sanctions on the
State Law Claims Advanced in the Second Amended Complaint
The court does not address Karp’s cross-appeal seeking non-PSLRA Rule 11
sanctions against the plaintiffs’ attorneys for filing the state law claims. Karp
properly moved for Rule 11 sanctions only with respect to the second amended
complaint. See Fed. R. Civ. P. 11(c)(2) (requiring that a motion for sanctions be
made separately from any other motion and be served but not filed for twenty-one
days). The district court did not consider Karp’s motions for sanctions because it
refused to exercise its supplemental jurisdiction over the claims and dismissed
them without prejudice. Such a dismissal does not and should not insulate
frivolous claims from Rule 11 scrutiny. Accordingly, I would vacate the district
court’s refusal to consider Rule 11 sanctions on the state law claims brought in the
151
second amended complaint and order the district court to decide whether to impose
sanctions for those claims.
VI. Conclusion
Congress enacted the PSLRA to address the “evils flowing from abusive
securities litigation,” especially in the class action format.96 As the Senate
Judiciary Committee observed, these evils generally have their onset with “the
filing of the complaint and continue through to the final disposition of the
action.”97 Among other evils, these actions generate “an in terrorem effect on
Corporate America[,] . . . add[ing] significantly to the cost of raising capital and
represent[ing] a ‘litigation tax’ on business.”98 This is precisely what has occurred
in this case. In addition to imposing a litigation tax on Media, this action has
wreaked havoc on individuals who had absolutely nothing to do with the injuries
purportedly suffered by Jacoby and Thompson and the members of the classes they
attempted to represent.
A careful reader of the orders and opinions in this case—the district court’s
perfunctory order refusing to sanction plaintiffs’ counsel because, although
96
S. Rep. No. 104-98, at 8 (1995), reprinted in 1995 U.S.C.C.A.N. 679, 687.
97
Id. As the Committee saw it, “[a] complaint alleging violations of the Federal
securities laws is easy to craft and can be filed with little or no due diligence.” Id.98
Id. at 9, 1995 U.S.C.A.N. 688.
152
plaintiffs were unable to state a claim sufficient to withstand a Rule 12(b)(6)
motion to dismiss, their claims were not frivolous, and this court’s opinion—may
conclude that Congress was out to lunch when it enacted the PSLRA. For, if this
case is typical, the federal courts cannot, as a practical matter, enforce the PSLRA.
That is, if a case is pled as this case was, handled in the district court as this case
was, and disposed of on appeal as this case is, I doubt that the time, expense, and
burden on judicial resources incurred in PSLRA enforcement is worth the candle.
The point is not to pick fault with Congress for passing the PSLRA; the point is
that the courts must carry out the PSLRA mandate by enforcing it in a manner
consistent with congressional intent.
This case was litigated under the Rule 12(b)(6) umbrella. The initial and
two succeeding complaints were typical shotgun pleadings99 and thus were
practically incapable of precise comprehension by the district judge and opposing
counsel. After reading the first amended complaint, the district judge indicated as
much in a telephone conversation he conducted with counsel. Referring to the
complaint’s allegations, he made these observations: “Nothing is tied together;” “I
see very little connecting the dots;” “Seems to me there are some real gaps there;”
99
See, e.g., supra note 22.
153
“Again, it’s kind of hard to follow. It’s like . . . who did what?”100 The court
therefore gave plaintiffs’ counsel one more chance to file a comprehensible
pleading that would connect the dots, close the gaps, and explain who did what.
They responded with the second amended complaint. It did not clear the air, so the
court dismissed it under Rule 12(b)(6) for failure to satisfy the heightened pleading
standards of Rule 9(b) and the PSLRA.
When the court subsequently turned to the question of whether the plaintiffs
and/or their attorneys should be sanctioned under the PSLRA for noncompliance
with the requirements of Rule 11(b), it did not parse the allegations of the
complaints that had been filed, as I have done here. Rather, it perfunctorily
concluded—without reference to any of the complaints’ allegations—that
plaintiffs’ had complied with Rule 11. The court stated, “Plaintiffs’ claims are not
frivolous, or so devoid of evidentiary support as to warrant sanctions. Likewise,
there is no evidence that Plaintiffs instituted this action for improper purposes,
such as to harass Defendants or needlessly increase the cost of litigation.” (Order
on Mot. For Attys.’ Fees and Rule 11 Sanctions, 1, June 12, 2007 (internal
citations omitted).). I am convinced that the court ruled in this way because it did
not realize just how insufficient the pleadings were; the court was too busy to plow
100
(Hr’g Tr. at 8, Mar. 6, 2007.)
154
through the pleadings and see them for what they were—simply smoke and
mirrors.
This case demonstrates that it is easy for a district court to dismiss a federal
securities law complaint under Rule 12(b)(6) and Rule 9(b) without carefully
parsing it, identifying which allegations pertain to which claims, and squeezing the
controversy down to its core. That approach, however, is not consistent with the
PSLRA’s requirements. The PSLRA forces a district court to determine whether
the complaint—three complaints in this case—satisfied “each requirement of Rule
11(b),” and, having done that, to enter “in the record specific findings regarding
compliance” with those requirements.101 The approach the court must take is the
one I have taken here: parse the complaint’s allegations, determine which
allegations pertain to which claims, and examine the claims under the PSLRA’s
lens.
The PSLRA and the broader interests of justice would best be served by a
district court laying the foundation for this task early on. Here, for example, the
district court could have done so after it examined plaintiffs’ first amended
complaint.102 It could have parsed the complaint, detailed the problems, and,
101
See 15 U.S.C. 78u-4(c)(1).
102
The court did not read the initial complaint due to plaintiffs’ request for leave to file
an amended complaint. The court’s first encounter with plaintiffs’ allegations came when it read
155
pursuant to its inherent power, ordered a repleader. Such an order would be akin to
a Federal Rule of Civil Procedure 12(e) motion for a more definite statement in
that it would “point out the defects” of the complaint and explain what would be
necessary to cure them.103 We have stated on several occasions that
The importance of using the Rules to uncover bogus claims and
defenses, thereby reducing the parties’ dispute to its bare essentials,
cannot be overemphasized. As we have stated on several occasions . .
. if, in the face of a shotgun complaint, the defendant does not move
the district court to require a more definite statement, the court, in the
exercise of its inherent power, must intervene sua sponte and order a
repleader.104 Implicit in such instruction is the notion that if the
plaintiff fails to comply with the court’s order—by filing a repleader
the first amended complaint prior to its telephone conference with the parties’ attorneys.
103
Federal Rule of Civil Procedure 12(e) provides:
A [defendant] may move for a more definite statement of a [claim] . . . which is
so vague or ambiguous that the party cannot reasonably prepare a response. The
motion must be made before filing a responsive pleading and must point out the
defects complained of and the details desired. If the court orders a more definite
statement and the order is not obeyed within 14 days after notice of the order or
within the time the court sets, the court may strike the [claim] or issue any other
appropriate order.
104
Discharging this duty ensures that the issues get defined at the
earliest stages of litigation. The district court “should [strike] the
complaint[ ] and instruct[ ] counsel to replead the[ ] case[ ]-if
counsel could in good faith make the representations required by
Fed. R. Civ. P. 11(b).” Cramer v. Florida, 117 F.3d 1258, 1263
(11th Cir. 1997) citing Ebrahimi v. City of Huntsville Bd. of
Educ., 114 F.3d 162 (11th Cir. 1997) (per curiam); Cesnik v.
Edgewood Baptist Church, 88 F.3d 902, 905 (11th Cir. 1996);
Anderson v. Dist. Bd. of Trustees of Cent. Fla. Community
College, 77 F.3d 364, 366–67 (11th Cir. 1996); Pelletier v.
Zweifel, 921 F.2d 1465, 1517–18 (11th Cir. 1991); Fullman v.
Graddick, 739 F.2d 553, 557 (11th Cir. 1984).
156
with the same deficiency—the court should strike his pleading or,
depending on the circumstances, dismiss his case and consider the
imposition of monetary sanctions.
Byrne v. Nezhat, 261 F.3d 1075, 1132–33 (11th Cir. 2001) (footnote in original).105
The attorneys representing the plaintiffs in this case purport to be
sophisticated class action lawyers who specialize in federal securities law cases. I
have no doubt that faced with a detailed order requiring a more definite statement
“connecting the dots,” filling in the “gaps,” and indicating “who did what,” so that
the allegations would not be “hard to follow,” sophisticated securities lawyers
would have done a better job of drafting the second amended complaint. Better
yet, had the court engaged counsel face-to-face in chambers, explained what the
PSLRA and Rule 11(b) demanded, and told them what they would have to allege
to stay in court, we probably would not be here. Counsel would have dismissed
the case voluntarily under Federal Rule of Civil Procedure 41(a)(1)(A), or, if they
produced an amended complaint that simply mimicked their earlier complaint (as
the second amended complaint did), the court, in the exercise of its discretion,
would have dismissed the complaint under Rule 41(b) and its inherent power for
105
Fed. R. Civ. P. 16 provides further authority for a district court to squeeze down the
case sua sponte. “At any pretrial conference, the court may consider and take appropriate action
on the following matters: (A) formulating and simplifying the issues, and eliminating frivolous
claims or defenses; (B) amending the pleadings if necessary or desireable . . . .” Fed. R. Civ. P.
16(c)(2)(A)–(B).
157
failure to comply with a court order.106 Had the court dealt with plaintiffs’ counsel
in this way, it would have been easier for the court—regardless of the tact
plaintiffs’ counsel may have taken in responding to the court’s demand for a more
definite statement—to carry out its PSLRA duties at the end of the day.
Of course, that is not how the district court handled this case. And that
would have been satisfactory had the district court taken up the task of parsing the
complaints at the end of the action. Instead, the district court kicked the task down
the road. Today, this court unfortunately follows the same approach. This judicial
approach takes the teeth out of the PSLRA and delays the day when the parties will
have repose. Meanwhile, litigants in the court’s queue waiting to have their cases
heard will have to wait even longer. Worst of all, handling PSLRA cases in this
106
As we stated in State Exch. Bank v. Hartline,
The Federal Rules expressly authorize a district court to dismiss a claim,
including a counterclaim, or entire action for failure to prosecute or obey a court
order or federal rule. Fed. R. Civ. P. 41(b)-(c). See, e.g., Veazey v. Young’s
Yacht Sale & Service, Inc., 644 F.2d 475 (5th Cir. 1981). In addition to the
federal rule, this power, as well as the power to strike a pleading, is inherent in a
trial court’s authority to enforce its orders and ensure prompt disposition of legal
actions. Link v. Wabash Railroad Co., 370 U.S. 626, 630–31, 82 S. Ct. 1386,
1388–89, 8 L. Ed. 2d 734 (1962); Marshall v. Southern Farm Bureau Casualty
Co., 353 F.2d 737, 737 (5th Cir.), cert. denied, 384 U.S. 910, 86 S. Ct. 1352, 16
L. Ed. 2d 363 (1966). Cf. 6 C. Wright & A. Miller, Federal Practice and
Procedure § 1526 at 597 (1971) (defense may be stricken for failure to provide
information required in pretrial order). An appellate court reviewing the exercise
of this power is constrained by the abuse of discretion standard. Link, 370 U.S. at
633, 82 S. Ct. at 1390.
693 F.2d 1350, 1352 (11th Cir. 1982).
158
manner destroys confidence in the ability of the courts to resolve disputes and
administer civil justice. Congress, the courts, the litigants, and the public deserve
better.
I respectfully dissent.
159
Table107
Defendant Complaint(s) Named as Relationserve Media, Inc. Term
Defendant of Service
Danielle Karp Initial, First Amended, CEO (6/13/2005–6/21/2005)
Second Amended President (6/13/2005–2/3/2006)
Dir. (6/13/2005–2/3/2006)
Scott Hirsch First Amended, Second COO (6/13/2005–2/2/2006)
Amended
Mandee Adler Initial, First Amended, CEO (6/21/2005–11/11/2005)
Second Amended Dir. (6/30/2005–11/11/2005)
Warren Musser Initial, First Amended, Dir. (6/21/2005–10/31/2005)
Second Amended
Ohad Jehassi Initial COO (7/2005– )
Adam First Amended, Second CFO (8/9/2005–2/3/2006)
Wasserman Amended Employee (2/3/2006–6/15/2006)
First Amended, Second Chairman (10/31/2005–9/7/2006)
Michael Amended
Brauser
Shawn First Amended, Second Interim CEO
McNamara Amended (11/30/2005–2/3/2006)
SVP (11/30/2005–6/15/2006)
107
This table is based on the allegations plaintiffs made in the second amended
complaint, supplemented by SEC filings where noted below. The abbreviations are: chief
executive officer (“CEO”), director (“Dir.”), chief operating officer (“COO”), chief financial
officer (“CFO”), assistant secretary (“Assistant Sec’y”); senior vice president (“SVP”).
The difference between the dates listed and what was pled are as follows: Danielle Karp
(the second amended complaint alleged only that she was president from June 13, 2005 to
February 3, 2006); Mandee Heller Adler (the CEO dates are the same but the second amended
complaint alleged only that she served as a director); Adam C. Wasserman (the second amended
complaint alleged only that he served as CFO from August 9, 2005 until February 3, 2006);
Shawn McNamara (the start dates are the same but the second amended complaint lumped
together the interim president and SVP positions by alleging that McNamara served in both roles
for his entire time at Media).
160
Assistant Sec’y
(11/30/2005–6/15/2006)
Paul Soltoff First Amended, Second CEO (2/3/2006– )
Amended Dir. (2/3/2006– )
Eric Obeck First Amended, Second President (2/3/2006– )
Amended
Donald Gould, First Amended, Second CFO (2/3/2006– )
Jr. Amended
Scott Young First Amended, Second None (resigned on consummation
amended of merger)
Richard Hill First Amended None
Barry Honig First Amended None
161