Stark Trading v. Falconbridge Limited ( 2009 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 08-1327
S TARK T RADING and S HEPHERD
INVESTMENTS INTERNATIONAL L TD.,
Plaintiffs-Appellants,
v.
F ALCONBRIDGE L IMITED and
B RASCAN C ORPORATION,
Defendants-Appellees.
A ppeal from the U nited States District Court
for the Eastern District of W isconsin.
N o. 05-C-1167— A aron E. Goodstein, M agistrate Judge .
A RGUED S EPTEMBER 8, 2008—D ECIDED JANUARY 5, 2009
Before P OSNER, K ANNE, and T INDER, Circuit Judges.
P OSNER, Circuit Judge. The plaintiffs have appealed
from the dismissal, for failure to state a claim, of their
securities fraud suit. The suit is based primarily on the
Securities and Exchange Commission’s Rule 10b-5. The
2 No. 08-1327
claims they make under other provisions of federal securi-
ties law—all but section 11 of the Securities Exchange Act,
15 U.S.C. § 77k, which we discuss at the end of this
opinion—fall with the 10b-5 claim.
The parties have spent too much time in this court, as
they did in the district court, arguing over whether the
typically Brobdingnagian complaint (289 paragraphs
sprawling over 85 pages) adequately alleges scienter, as
required by 15 U.S.C. § 78u-4(b)(2). (The suit is more
than three years old, yet it has not progressed beyond the
motion to dismiss stage.) A claim of fraud fails if there
is no proof that the plaintiff relied to his detriment on the
defendant’s misrepresentations or misleading omissions.
Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 341-42
(2005); Central Bank of Denver, N.A. v. First Interstate Bank
of Denver, N.A., 511 U.S. 164, 180 (1994); Isquith v.
Caremark Int’l, Inc., 136 F.3d 531, 534, 536 (7th Cir. 1998).
“[W]ithout reliance, fraud is harmless.” Dexter Corp. v.
Whittaker Corp., 926 F.2d 617, 619 (7th Cir. 1991). So implau-
sible is an inference of reliance from the complaint in
this case when read in conjunction with documents of
which the court can take judicial notice, Deicher v. City of
Evansville, 545 F.3d 537, 541-42 (7th Cir. 2008); Bryant v.
Avado Brands, Inc., 187 F.3d 1271, 1278 (11th Cir. 1999), that
the dismissal of the 10b-5 claim must be affirmed without
regard to scienter or the other issues that the parties
have spent years jousting over.
The complaint tells the following story. Brascan Asset
Management, Inc. (now called Brascan Corporation) owned
41 percent of the common stock of Noranda, Inc., which
No. 08-1327 3
in turn owned 59 percent of Falconbridge, Inc., both being
large Canadian mining companies. Brascan wanted to get
out of Noranda. It was able to cause Noranda to offer
Noranda’s common stockholders, who of course in-
cluded Brascan, preferred stock in exchange for their
common stock. (That is called an issuer bid.) Noranda
agreed to redeem the preferred stock for cash, at a price
of $25 a share, which exceeded the current market value
of the common stock. By redeeming, Brascan would be
able to exchange its shares for cash and thus achieve its
objective of getting out of Noranda. Why it didn’t cause
Noranda simply to offer $25 per share to all the common
stockholders, thus cutting out the intermediate swap of
common for preferred, is not explained, but probably
was connected with the next and critical transaction, for
which Noranda needed a lot of its common stock.
For on the same day that it announced the issuer bid
(March 9, 2005), Noranda also announced that it would
offer every minority shareholder in Falconbridge 1.77
shares of Noranda common stock for each share of
Falconbridge common stock that the shareholder ten-
dered. The offer was conditioned on being accepted
by more than half the minority shareholders (the half
being weighted of course by number of shares).
The offer succeeded, and the two hedge funds that are
the plaintiffs in this case were among the minority share-
holders who tendered their stock by the expiration date,
May 5. Three months later, Noranda and Falconbridge
merged. The resulting firm was named Falconbridge
Limited, and was eventually acquired by a Swiss mining
4 No. 08-1327
company named Xstrata. But in October 2005, before that
acquisition, another mining company, Inco, offered to buy
Falconbridge Limited at a price substantially above the
tender-offer price (1.77 shares of Noranda common stock
for every share of Falconbridge common stock) that the
plaintiffs had received for their Falconbridge stock.
The plaintiffs had begun buying that stock on March 17;
they do not say when they stopped, except that it had to be
before the May 5 deadline for tendering. They had bought
into Falconbridge because they thought the company
was worth more than its current capitalization by the
stock market. At the same time that they had bought
Falconbridge shares they had sold some Noranda stock
short, apparently as a hedge. According to the complaint,
Falconbridge was Noranda’s major asset (how major, no
one has bothered to tell us), so if its shares fell in value or
even just failed to rise Noranda’s share price would
probably fall and the plaintiffs would obtain some
profits from their short sales to offset the lack of profit
from being long in Falconbridge. By the same token, if
Falconbridge’s stock rose in price Noranda’s stock price
probably would rise too and if it did the plaintiffs would
lose money from their short sale. But they thought
Falconbridge stock more likely to rise, and so invested
much less in selling stock in Noranda short than in
buying stock in Falconbridge.
Brascan states in its brief that the plaintiffs hoped to
make money both from Falconbridge’s stock price rising
and Noranda’s falling. That’s a misunderstanding of
hedging. The prices of the two companies were going to
move in the same direction, but by going long in one
No. 08-1327 5
and short in the other the plaintiffs were reducing the
variance in the expected return on their investments.
That is what hedging means. But this is an aside.
In a typical Rule 10b-5 case, the plaintiff buys stock at a
price that he claims was inflated by misrepresentations
by the corporation’s management and sells his stock at a
loss when the truth comes out and the price plummets.
Our plaintiffs believed they were buying an undervalued
stock, and events after their purchase, culminating in
Xstrata’s purchase of Falconbridge Limited (Falconbridge’s
successor) at a high price, proved them correct. They do
argue that the issuer bid (the offer to swap preferred
stock in Noranda for common stock) inflated the ap-
parent value of Noranda stock, and therefore made the
offer of Noranda stock for Falconbridge stock look gener-
ous. But they were not fooled. They knew that the
tender offer undervalued Falconbridge—that Noranda
was trying to buy out the minority shareholders (thus
including the plaintiffs) cheap.
They admit that before the period for tendering their
Falconbridge shares to Noranda expired, they “became
aware of some of the inaccuracies in the offering docu-
ments”—and that is an understatement. On April 29, a
week before the deadline in the tender offer, they wrote
a letter to the Ontario Securities Commission that
alleges, and in considerable detail (the letter, including
enclosures, runs to 21 pages, much of it in fine print), most
of the facts that their complaint charges as fraud, such as:
(1) concealing a conflict of interest of the investment
bank that had provided a valuation of Falconbridge for
the tender offer, and of the special committee of Falcon-
6 No. 08-1327
bridge that had advised Falconbridge’s minority share-
holders to accept the offer on the basis of the investment
bank’s valuation, and (2) overstating Noranda’s value, thus
enabling Noranda to pay for Falconbridge in a thoroughly
debased currency (Noranda’s overvalued stock), which
further reduced the real price at which Noranda was
able to buy out Falconbridge’s minority shareholders.
The plaintiffs must have been gratified to learn, from
their perceiving the “inaccuracies” in the tender-offer
registration statement, that they had been right that
Falconbridge was undervalued; their letter to the
securities commission was calculated to force Noranda
to sweeten its offer (though that never happened). But
they say in paragraph 205 of the complaint, which is the
heart of their case, that they were afraid that the tender
offer would succeed and that unless they tendered their
shares they would be squeezed out and Canadian law,
which governs the squeezing out of minority shareholders
in a Canadian corporation, would not protect them, as
U.S. law does, from a predatory majority shareholder.
The mystery deepens. Since the tender offer would
have failed by its own terms had not a majority of the
minority shareholders tendered, why didn’t the plain-
tiffs try to dissuade the other minority shareholders
from tendering? Why didn’t they mail them copies of
the letter to the securities commission or publicize the
letter in the financial press? The minority shareholders
owned in the aggregate some 78 million shares, 5.5 million
of which were owned by the plaintiffs. Noranda needed to
obtain at least 39 million shares for the tender offer to
succeed. If the plaintiffs refused to tender, Noranda
No. 08-1327 7
would have to obtain 54 percent of the shares held by the
remaining minority shareholders, and it might fail to do
so in the face of a vigorous campaign of public opposition
to the offer, mounted by the plaintiffs.
Whatever the plaintiffs were thinking—the complaint
says virtually nothing about their strategy—we cannot
find any basis for inferring that they relied on the defen-
dants’ bad mouthing of Falconbridge. They knew better.
They knew Falconbridge was worth a lot—that’s why
they invested. They thought the tender offer price was
too low and that Noranda had resorted to fraud to make
it succeed. They had known they were buying into a
company that had a majority shareholder, that it was a
Canadian company, and therefore that a minority share-
holder would not have the same legal protections (such as
appraisal rights) that minority shareholders in U.S. corpo-
rations have. They also had to know that since they
thought Falconbridge undervalued, so would Noranda,
which would therefore try to buy out the minority share-
holders before the market revalued Falconbridge up-
ward. That would not be a nice way to treat minority
shareholders but “securities fraud does not include the
oppression of minority shareholders . . . . No more does
securities fraud include unsound or oppressive
corporate reorganizations.” Isquith v. Caremark Int’l, Inc.,
supra, 136 F.3d at 535; see Sante Fe Industries, Inc. v. Green,
430 U.S. 462, 473-77 (1977). And a week before the
deadline for tendering their shares, the plaintiffs
revealed in their letter to the securities commission the
evidence that Brascan and Noranda were trying to pull
a fast one on the minority shareholders.
8 No. 08-1327
But though the plaintiffs didn’t rely on Noranda’s
undervaluation of Falconbridge, maybe other minority
shareholders did and foolishly tendered, as a result of
which the tender offer succeeded and the plaintiffs
were left in the vulnerable position of minority share-
holders (where of course they had been from the start).
But believing that Falconbridge was undervalued and
that the value estimates publicly disseminated by
Noranda were inaccurate, why, to repeat, didn’t the
plaintiffs communicate their belief directly or indirectly
to the Wall Street analysts? Such information spreads
fast and would have given the other minority share-
holders pause.
This assumes that the plaintiffs knew something about
the tender offer that other investors did not know. That
is unlikely, since the plaintiffs were not insiders. Almost
certainly there was no deception but just a difference
of opinion in the investor community about the signifi-
cance of the widely known circumstances of the tender
offer. And if there was deception and the other minority
shareholders were too dumb to perceive it even after
being warned, why didn’t the plaintiffs sue to enjoin
the tender offer?
If contrary to the common sense of the situation other
minority shareholders were fooled even though the
plaintiffs were not, this might seem to allow the plaintiffs
recourse to the doctrine of fraud on the market. Basic Inc.
v. Levinson, 485 U.S. 224, 243-47 (1988). If a fraud affects
the price of a publicly traded security, investors will be
affected even if they trade without knowledge of the
No. 08-1327 9
misrepresentations that influenced the price at which
they traded. They are “relying,” albeit indirectly, on the
misrepresentations. “ ‘[R]eliance’ is a synthetic term. It
refers not to the investor’s state of mind but to the
effect produced by a material misstatement or omission.
Reliance is the confluence of materiality and causation.
The fraud on the market doctrine is the best example; a
material misstatement affects the security’s price, which
injures investors who did not know of the misstatement.”
Eckstein v. Balcor Film Investors, 58 F.3d 1162, 1170 (7th Cir.
1995); see Isquith v. Caremark Int’l, Inc., supra, 136 F.3d
at 536; cf. Plaine v. McCabe, 797 F.2d 713, 717 (9th Cir. 1986).
So suppose some of the minority shareholders were
induced by Noranda’s misrepresentations to tender their
shares, and others, though unaware of any representa-
tions, tendered their shares as well. They too would be
victims of deception, because had the market known the
truth the tender offer would have failed. Cf. Mills v. Electric
Auto-Lite Co., 396 U.S. 375 (1970). But no one who saw
through the fraud would be able to sue for fraud, for he
could not have relied directly or indirectly. And that was
the plaintiffs’ position. Sophisticated investors, they
must have considered the combination of the tender-
offer price and a later suit (this suit) against the de-
fendants a better deal than holding on to their shares and
by doing so, and disseminating their doubts, trying to
defeat the tender offer. That is not a strategy that the
courts should reward in the name of rectifying securities
fraud.
So even if the other minority shareholders were blind
sheep and the law impotent to prevent a dishonest
10 No. 08-1327
tender offer, the plaintiffs would not have a claim under
Rule 10b-5, or any other securities law requiring proof of
reliance, because they were never deceived. At worst
they were minority shareholders victimized by a heart-
less majority shareholder (remember that Noranda owned
59 percent of the common stock of Falconbridge), and
as we noted earlier the federal law of securities fraud does
not provide a remedy for oppression of minority share-
holders. The lack of merit of the 10b-5 claim would
be obvious had the plaintiffs refused the tender offer
and later been squeezed out, as in the Santa Fe Industries
case; but there is no pertinent difference between the
two types of case.
This leaves for consideration the plaintiffs’ claim
under section 11 of the Securities Exchange Act, which
does not require proof of reliance. Section 11 provides
that “in case any part of the registration statement, when
such part became effective, contained an untrue state-
ment 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 [with
an immaterial exception] acquiring such security” may
sue. 15 U.S.C. § 77k(a). But the plaintiff in such a suit may
recover (so far as pertains to this case) only “such
damages as shall represent the difference between the
amount paid for the security . . . and (1) the value thereof
as of the time such suit was brought, or (2) the price at
which such security shall have been disposed of in the
market before suit.” § 77k(e).
The plaintiffs gave up each of their Falconbridge shares
for 1.77 Noranda shares. On May 5, 2005, the date the
No. 08-1327 11
tender offer expired, Falconbridge stock was trading at
$39.59 (Canadian), so that was the price that the plaintiffs
paid for the Noranda shares that they received in ex-
change. On November 7, 2005, the date on which they filed
their lawsuit, a share in Falconbridge Limited (the new
Falconbridge, after its merger with Noranda) was trading
at C$34.43, so that the 1.77 Noranda shares that the plain-
tiffs had received in exchange for each share of
Falconbridge were now worth C$60.94, which exceeded
by C$21.35 what they had paid for the shares when they
accepted the tender offer. The plaintiffs coyly suggest
that maybe they sold their shares, or some of them,
before they sued, and sustained a loss. But this is nowhere
suggested in the complaint, or in the brief that the plain-
tiffs filed in the district court after the defendants
pointed out that the plaintiffs had failed to allege that they
had sold any of their shares at a loss. It would not make
sense for them to have sold their shares at a loss, since
they were convinced that Falconbridge was undervalued.
The complaint’s silence is deafening. Even notice plead-
ing requires pleading the elements of a tort, and one
element of the section 11 tort is sale at a loss. Moreover, the
complaint in a complex case must, to avert dismissal for
failure to state a claim, include sufficient allegations to
enable a judgment that the claim has enough possible
merit to warrant the protracted litigation likely to ensue
from denying a motion to dismiss. Bell Atlantic Corp. v.
Twombly, 550 U.S. 544 (2007); Limestone Development Corp.
v. Village of Lemont, 520 F.3d 797, 802-03 (7th Cir. 2008). This
suit was dismissed by the district court in January 2008,
12 No. 08-1327
more than two years after it had been filed. Just imagine
how long it would have taken to dispose of the case by
summary judgment after the usual pretrial discovery in
a big commercial case. Defendants are not to be sub-
jected to the costs of pretrial discovery in a case in
which those costs, and the costs of the other pretrial
maneuvering common in a big case, are likely to be great,
unless the complaint makes some sense. If after 85 pages
of huffing and puffing in the complaint, and another
83 pages of appellate briefs, sophisticated investors
cannot make their case seem plausible, the litigation
must end then and there.
A FFIRMED.
1-5-09