Irwin Shapiro v. Ujb Financial Corp.Irwin Shapiro v. Ujb Financial Corp.
SCIRICA, Circuit Judge.
This case is one of a number of federal securities actions against financially troubled banking institutions. After a sharp downturn in the financial condition of defendant UJB Financial Corporation, its shareholders filed a complaint alleging violations of
The district court dismissed most of plaintiffs’ federal claims for failure to state a claim upon which relief could be granted and for failure to plead with particularity.
I. BACKGROUND
Defendant UJB Financial Corporation, a New Jersey-based bank holding company that offers a wide range of financial services, consists of 12 member banks and 11 non-bank subsidiaries.1 Its common and Series B preferred stock are traded on the New York Stock Exchange. When plaintiffs’ complaint was filed, UJB had more than $11 billion in assets, $7 billion in outstanding loans, and $8 billion in total consolidated deposits. The remaining defendants are individuals who were UJB officers2 and directors3 during the relevant time period, February 1, 1988 to July 18, 1990.
From 1987 to 1989, UJB saw substantial growth in assets, earnings, net income, and net worth. Total loans increased from $6.5 billion to $8.3 billion, total assets from $10.1 billion to $12.1 billion, and net income from $102 million to $118 million. The company‘s periodic announcements, made in quarterly and annual reports, press releases, and governmental filings, often contained more than just routine recitations of financial figures. The announcements repeatedly referred to UJB‘s “prudent,” “cautious,” and “conservative” lending policy, its “strict” credit administration practices, its “minimal” foreign loan exposure, and its “basic” approach to loan management. There were also frequent references to UJB‘s adherence to “sound” and “time-tested” banking practices, the “high” quality of its loan portfolio, and its “high safety margin.” UJB also represented that its loan loss reserves were “strong” or “very strong,” and had been and would continue to be “maintained at a level determined adequate.” The bank further attributed its overall success to its “strategy” of limiting its business dealings to the New Jersey region and avoiding concentration on a few large projects.
The first sign of a downturn appeared in March, 1990, when UJB filed a 10-K Report with the Securities and Exchange Commission. The accompanying 1989 Annual Report stated that the provision for loan losses had been increased as a “prudent” measure, and asserted that the loan loss reserves, which had recently been augmented by 13.1%, were “at a level determined adequate.” The same Annual Report contained an interview with UJB‘s President and Chief Executive Officer, Joseph Semrod, who attributed the increase in bad loans to the cyclical nature of the banking business, a slow economy, and problems in residential real estate construction and development. He noted, however, that this part of UJB‘s loan portfolio was “well secured,” and that UJB continued to have “good loan to value ratios.” He projected “continued solid growth,” but conceded that UJB was “budgeting a smaller real estate portfolio.”
UJB‘s troubles escalated in March and April of 1990 when three financial evaluation services--Moody‘s Investors Service, Fitch Investors Service, and Standard & Poors--downgraded their ratings of UJB debt, stock, and commercial paper, as well as their ratings of deposits belonging to UJB‘s principal bank subsidiary, United Jersey Bank. These analysts expected UJB‘s credit quality to deteriorate, particularly with regard to real estate, construction, and land development loans.
On April 18, 1990, UJB issued a press release announcing a dramatic decline in net income and an equally striking increase in its loan loss reserves and non-performing assets. Semrod nevertheless reassured the public that the “long term is what counts,” and that UJB was both “positioned for the ‘90s and beyond” and “focused on maximum sustainable long-range earning growth and maximum long-term return.” On July 18, 1990, UJB issued another press release announcing that the company‘s loan loss provision was four times what it had been the year before, and that earnings and income had dropped again. The price of UJB‘s common stock, which had been as high as $27 per share in the prior three years, plummeted to approximately $10 per share.
In reaction to these developments, plaintiff shareholders filed this class action. They attribute their economic losses to “a campaign [by defendants] to depict the illusion of UJB as a growing, profitable and vital lending institution with conservative lending practices, and a system of internal controls proper to ensure adequate collateralization and prompt recognition and accounting for problem loans.” According to plaintiffs, defendants’ public announcements in the years 1988-1990 portrayed UJB “in a falsely optimistic manner” by stating that the loan loss reserves were adequate, loan review procedures and policies were stringently and continuously applied, lending opportunities were balanced appropriately against risks, and financial results were positive.
The claims of the plaintiff class4 are grouped into three separate Counts. Count I alleges that defendants misrepresented and failed to disclose material information in violation of
Defendants filed a motion to dismiss, which the district court granted in part and denied in part. The district court dismissed with prejudice all claims in Counts I and II “to the extent that they rely on pp 52(a), (b), (c), (f), and (g) of the amended complaint, and to the extent that they rely upon allegations of mismanagement in pp 52(d) and (e).” It also dismissed with prejudice the § 15 claim in Count II and the negligent misrepresentation claim in Count III. The § 11 and § 12(2) claims of Count II were dismissed for failure to state a claim upon which relief could be granted, but the district court gave plaintiffs 30 days to amend their complaint to remedy defects identified in its opinion. Finally, the district court specifically upheld the § 20(a) “controlling person” claim in Count I.
The district court found that the remaining allegations in Counts I and II based on subparagraphs 52(d), (e), (h) and (i) did not satisfy
II. JURISDICTION
Defendants assert that there is no final appealable order because several claims were not formally dismissed by the district court.7 According to defendants, the following two groups of claims rendered the district court‘s order non-final: (1) all claims asserted in Counts I and II, to the extent they rely upon allegations of fraud in subparagraphs 52(d), (e), (h), and (i) of the complaint, and (2) the § 20(a) claim asserted in Count I. We will address these contentions in turn.
A. § 10(b), § 11, and § 12(2) Claims
The major obstacle to appellate jurisdiction involves the allegations that did not satisfy
Guided by the Supreme Court‘s directive that we employ a “practical rather than a technical construction” of
The district court stated it would entertain a renewed motion to dismiss if plaintiffs did not amend, but gave no indication that it would reconsider its earlier rulings. It seems clear that the district court planned to dismiss with prejudice any claims not amended. Requiring plaintiffs to return to the district court now would be a wasteful elevation of form over substance. See Schrob v. Catterson, 948 F.2d 1402, 1407 (3d Cir.1991); but see Hatch v. Lane, 854 F.2d 981, 982 (7th Cir.1988). Thus, once the amendment period expired, the district court‘s order had the effect of dismissing the improperly pleaded claims with prejudice.
Our analysis is supported by Bankers Trust Co. v. Mallis, 435 U.S. 381, 98 S.Ct. 1117, 55 L.Ed.2d 357 (1978), where the United States Supreme Court addressed the effect of the parties’ failure to comply with
Certainty as to timeliness ... is not advanced by holding that appellate jurisdiction does not exist absent a separate judgment. If, by error, a separate judgment is not filed before a party appeals, nothing but delay would flow from requiring the court of appeals to dismiss the appeal. Upon dismissal, the district court would simply file and enter the separate judgment, from which a timely appeal would then be taken. Wheels would spin for no practical purpose.
We believe that no practical purpose would be served if we were to dismiss this appeal. Defendants do not question the timeliness of the appeal. See Jung v. K. & D. Mining Co., 356 U.S. 335, 78 S.Ct. 764, 2 L.Ed.2d 806 (1958). Nor is there any doubt that the district court would, on remand, simply dismiss the defective claims left unamended, not revise its earlier reasoning. Id. at 337, 78 S.Ct. at 766. Therefore, we will treat the district court‘s order as a final dismissal.
B. § 20(a) Claim
Plaintiffs contend that § 20(a) does not create a separate cause of action, but rather depends entirely on the viability of § 10(b) claims. They maintain that “controlling person” liability can exist only if primary liability has been established as to another defendant. Therefore, once all predicate § 10(b) claims are dismissed, there are no allegations upon which § 20(a) liability can be based. We agree.
Section 20(a) imposes joint and several liability on any person who “controls a person liable under any provision of” the Securities Exchange Act of 1934.8 The text of the statute plainly requires the plaintiff to prove not only that one person controlled another person, but also that the “controlled person” is liable under the Act. If no controlled person is liable, there can be no controlling person liability. Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1440-41 n. 8 (9th Cir.1987). Here the dismissal of the § 10(b) claims against UJB made it impossible to hold the individual defendants liable under § 20(a).
There being no other extant claims, we are satisfied that the district court‘s order was final, and that we have jurisdiction over this appeal.
III. DISCUSSION
Plaintiffs make four principal arguments on appeal. First, they maintain that they have alleged fraud under § 10(b) with sufficient particularity, rather than mismanagement. Second, they contend that the same allegations state actionable § 11 and § 12(2) claims and are grounded in negligence rather than fraud. Third, they argue that they have properly alleged negligent misrepresentation under New Jersey law. Finally, they challenge the district court‘s order requiring class representative Katz to post security.
Our review of the district court‘s dismissal of the complaint for failure to state a claim upon which relief can be granted is plenary. We must accept as true the factual allegations contained in the complaint, and may affirm the dismissal only if it appears certain that plaintiffs can prove no set of facts that would entitle them to relief. Ransom v. Marrazzo, 848 F.2d 398, 401 (3d Cir.1988). We also have plenary review of the district court‘s interpretation of the federal securities laws, Dent v. Cunningham, 786 F.2d 173, 174 (3d Cir.1986), and its determination of New Jersey law. Salve Regina College v. Russell, --- U.S. ----, 111 S.Ct. 1217, 113 L.Ed.2d 190 (1991). Finally, we review the district court‘s requirement of security for abuse of discretion.
A. § 10(b)
Under the authority provided by
1. Rule 12(b)(6)
As we have noted, the thrust of the complaint is that UJB and the individual defendants misrepresented the true status of the company‘s loan loss reserves, financial health, lending practices, and internal controls. The district court found that many of the alleged misrepresentations or omissions involved either failures to predict or mismanagement--not fraud--and were not actionable under the federal securities laws.
The basis for the district court‘s decision was In re Craftmatic Sec. Litig., 890 F.2d 628 (3d Cir.1990), where we held that “[w]here the incremental value of disclosure is solely to place potential investors on notice that management is culpable of a breach of faith or incompetence, the failure to disclose does not violate the securities laws.” Id. at 640. In Craftmatic we provided an extensive review of the Supreme Court‘s jurisprudence on materiality,11 noting that the courts are “reluctant to permit a federal securities claim to stand when the plaintiff has failed to allege more than nondisclosure of mismanagement.” Id. at 639.
Because it plays such a prominent role in the complaint, we will briefly discuss the nature of a loan loss reserve, which is defined in the banking trade as a
statement of condition, or balance sheet, account set up by a bank based on its expectations about future loan losses. As losses occur, they are charged against this reserve. That is, the loan account is credited and the reserve account is debited. The reserve is established by a debit to an expense account called the loan loss provision, with a corresponding credit to the loan loss reserve.
American Bankers Association, Banking Terminology 215 (1989). There appears to be no single method of evaluating and setting loan loss reserves, perhaps because no method has proven foolproof. C. Edward McConnell, Loan Loss Reserve Management and Unwise Lending Practices, in Bank Credit 354 (Herbert V. Prochnow ed. 1981). Some banks set their loan loss reserves by comparing the size of the reserves to that of the loan portfolio. See Keith G. Turman, Evaluating a Bank‘s Loan Loss Reserve Adequacy, Internal Auditor, February 1991, at 5253. Others also analyze the quality of their loans in varying degrees of detail and according to a range of different criteria and classifications. See, e.g., id.; Ronald A. Stoffers, Loan Loss Reserve Analysis: Is It Moving From Art to Science?, Banking Policy Report, April 1, 1991, at 4; Francis X. Conway & William A. Siegenthaler, Loan Loss Reserves: Tax, Regulatory, and Adequacy Issues, J. of Com. Bank Lending, Sept. 1987, at 4; Victor F. Ptasznik, Another Approach to Calculating the Loan Loss Reserve, J. of Com. Bank Lending, April 1987, at 7; Jerry Abner, Calculating the Loan Loss Reserve from a Watch List, J. of Com. Bank Lending, August 1985, at 2. All techniques, however, require quantitative and qualitative analyses of the past and present status of loans. See Conway & Siegenthaler, Loan Loss Reserves, supra, at 9 (“Relying on standardized, nondiscretionary formulas to aid in the determination of loan loss reserves is oversimplifying a complex problem.“); see also Allowance for Loan and Lease Losses for Federal Branches and Agencies, Office of Comptroller of the Currency, Banking Circular 201, Fed. Banking L.Rep. (CCH) p 51,132 (May 31, 1985) (describing minimum assessment customarily undertaken by soundly managed banks). No matter what method is used, the economic judgments made in setting loan loss reserves can be validated only at some future date. McConnell, supra, at 354-55.
There is nothing unique about representations and omissions regarding loan loss reserves that removes them from the purview of the antifraud provisions of the federal securities laws. In our view a reasonable investor would be influenced significantly by knowledge that a bank has knowingly or recklessly hidden its true financial status by deliberately misstating its level of non-performing loans, failing to provide adequate reserves, and indulging its problem loan customers. See In re Midlantic Corp. Shareholder Litigation, 758 F.Supp. 226, 234 (D.N.J.1990). On the other hand, mere failure to provide adequate reserves (or to perform competently other management tasks) does not implicate the concerns of the federal securities laws and is not normally actionable. Similarly, if a defendant has not commented on the nature and quality of the management practices that it has used to reach a particular statement of loan loss reserves, earnings, assets, or net worth, it is not a violation of the securities laws to fail to characterize these practices as inadequate, meaningless, out of control, or ineffective. Craftmatic, 890 F.2d at 633 n. 5 & 640 (dismissing allegations that defendants failed to disclose general subjective assessments of controls, organization, and management information systems).
However, where a defendant affirmatively characterizes management practices as “adequate,” “conservative,” “cautious,” and the like, the subject is “in play.” For example, if a defendant represents that its lending practices are “conservative” and that its collateralization is “adequate,” the securities laws are clearly implicated if it nevertheless intentionally or recklessly omits certain facts contradicting these representations. Likewise, if a defendant characterizes loan loss reserves as “adequate” or “solid” even though it knows they are inadequate or unstable, it exposes itself to possible liability for securities fraud. By addressing the quality of a particular management practice, a defendant declares the subject of its representation to be material to the reasonable shareholder, and thus is bound to speak truthfully.
Our decision that such general labels as “conservative” and “cautious” can be the basis for liability under
The Supreme Court rejected the defendants’ argument that statements of opinion or belief were not “material.” After noting that a fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote, the Court commented that
there is no room to deny that a statement of belief by corporate directors about a recommended course of action, or an explanation of their reasons for recommending it, can take on just that importance. Shareholders know that directors usually have knowledge and expertness far exceeding the normal investor‘s resources, and the directors’ perceived superiority is magnified even further by the common knowledge that state law customarily obliges them to exercise their judgment in the shareholders’ interest.
Id. at ----, 111 S.Ct. at 2757.
If a director‘s statement of belief is material because of the speaker‘s superior knowledge, then a manager‘s statement of belief must also be material. A manager‘s knowledge and expertise regarding the day-to-day operation of his company generally exceeds that of a director, and the reasonable investor is aware of this fact. Even if management sometimes acts in its own interest, a reasonable investor need not take a manager‘s statement of belief at anything less than face value.
Virginia Bankshares also rejected the argument that statements of reasons, opinions, or beliefs are not “factual” for purposes of the securities laws. Such statements, said the Court, “are factual in two senses: as statements that the directors do act for the reasons given or hold the belief stated and as statements about the subject matter of the reason or belief expressed.” Id. at ----, 111 S.Ct. at 2758.
Reasons for directors’ recommendations or statements of belief are ... characteristically matters of corporate record subject to documentation, to be supported or attacked by evidence of historical fact outside a plaintiff‘s control....
....
It is no answer to argue, as petitioners do, that the quoted statement on which liability was predicated did not express a reason in dollars and cents, but focused instead on the ‘indefinite and unverifiable’ term, ‘high’ value, much like the similar claim that the merger‘s terms were ‘fair’ to shareholders. The objection ignores the fact that such conclusory terms in a commercial context are reasonably understood to rest on a factual basis that justifies them as accurate, the absence of which renders them misleading. Provable facts either furnish good reasons to make a conclusory commercial judgment, or they count against it, and expressions of such judgments can be uttered with knowledge of truth or falsity just like more definite statements, and defended or attacked through the orthodox evidentiary process that either substantiates their underlying justifications or tends to disprove their existence.
Id. at ----, 111 S.Ct. at 2758-59 (emphasis added). For these reasons, plaintiffs here are “permitted to prove a specific statement of reason knowingly false or misleadingly incomplete, even when stated in conclusory terms.” Id. at ----, 111 S.Ct. at 2759. We believe that the evaluations of management practices and financial well-being alleged here are as conclusory (and as provable) as those in Virginia Bankshares.
In this case, plaintiffs accuse defendants of knowingly or recklessly misrepresenting that they thought UJB‘s:
--loan loss reserves were “adequate,” “adequately maintained,” “strong,” and “solid” (p 52(a), (b), (c), (e));
--loan portfolio was “well secured,” “well collateralized,” and of a high “quality” (p 52(d));
--loan to value ratio was “good” (p 52(d));
--loan management and underwriting practices were “conservative,” “basic,” “careful,” “good,” “prudent,” and “cautious,” (p 52(e));
--asset quality was “high,” while their level of bad loans was “low” (p 52(d), (g)); and
--internal controls not only existed, but were properly centralized, supervised, and managed (p 52(f), (g), (h)). Moreover, plaintiffs allege that the published figures relating to earnings, assets, and net worth were knowingly or recklessly “overstated and inflated.” p 52(a). In light of our discussion, all of these statements, if made knowingly or recklessly, are actionable.
Nevertheless, not all the allegations made in paragraph 52 are actionable. As we have noted, it is not a violation of the securities laws to simply fail to provide adequate loan loss reserves; properly collateralize or secure a loan portfolio; or provide sufficient internal controls or loan management practices.
Moreover, as the district court recognized, some of the pivotal allegations charge defendants with essentially failing to predict the future. As we pointed out previously, “where an event is contingent or speculative in nature, it is difficult to ascertain whether the reasonable investor would have considered the omitted information significant at the time.” Craftmatic, 890 F.2d at 643 (quoting Basic, Inc. v. Levinson, 485 U.S. 224, 232, 108 S.Ct. 978, 984, 99 L.Ed.2d 194 (1988) (internal quotation marks omitted)). For example, plaintiffs allege here that UJB failed to reveal that the loan loss reserves were inadequate in light of the “high risk of non-collectibility” (p 52(c)); and that UJB “would be” required to add substantial amounts to its loan loss reserves in the future (p 52(g)). Plaintiffs do not, however, allege that defendants possessed or made affirmative forecasts regarding these possible outcomes. See Craftmatic, 890 F.2d at 644. Thus, there is no allegation that defendants omitted “soft information” that can, in some circumstances, be actionable. Flynn v. Bass Bros. Enterprises, 744 F.2d 978 (3d Cir.1984). For this reason, these particular allegations contained in subparagraphs 52(c) and (g) were properly dismissed.12
Having established the applicable principles of law, we would ordinarily leave it to the district court to evaluate the remaining paragraphs and subparagraphs of the complaint, including the balance of paragraph 52. However, plaintiffs’ style of pleading has made it difficult to parse the complaint, primarily because many of the actionable allegations are intermingled with the inactionable. Moreover, the manner of pleading obscures what plaintiffs are in fact alleging. For example, subparagraph 52(c) alleges that UJB‘s “total loan reserves, particularly reserves for construction loans, were not maintained at an adequate level.” This language, taken in isolation, is plainly an allegation of inactionable mismanagement. The preamble to paragraph 52, however, states that defendants made “untrue statements of material facts,” and then lists several allegations, including subparagraph 52(c). It is difficult to discern whether plaintiffs are alleging that defendants made material statements that the reserves were adequate when in fact they were not, or whether plaintiffs are merely alleging that the reserves were inadequate. We are also troubled by certain syntactical problems. For example, subparagraph 52(a), in conjunction with the prefatory text, states:
These included, among other things, the following: that the earnings, assets, and net worth of UJB were improperly and materially overstated and inflated throughout the Class Period due to grossly inadequate provisions for loan loss reserves.
It is difficult to comprehend this allegation. We do not believe that plaintiffs are alleging that the overstatement and inflation was caused by inadequate provision of loan loss reserves, yet this is what the paragraph appears to say. Similar ambiguities occur elsewhere.
Given the procedural history of this case, we would not ordinarily be disposed to offer plaintiffs yet another opportunity to revise their complaint. However, in light of the confusion that pervades plaintiffs’ allegations, we conclude that the entire complaint must be reorganized. Therefore, on remand plaintiffs should rearrange the existing allegations into discrete units that are, standing alone, each capable of evaluation under the legal principles we have set forth. Because of the procedural history here, plaintiffs may not add to the existing factual allegations in making their revisions. We also note that plaintiffs in future cases of this kind should plead clearly and coherently from the outset.
2. Rule 9(b)
In Christidis we dismissed allegations that defendants knew or should have known that loan loss reserves were understated, were improperly used, and led to distortions of other financial data. Such allegations, we stated, could only succeed if, when the loan loss reserves were established, “the responsible parties knew or should have known that they were derived in a manner inconsistent with reasonable accounting practices.” 717 F.2d at 100. We found the allegations deficient because they had not disclosed “the manner in which, in establishing reserves for bad debts in the financial statements relied upon, defendants knowingly departed from reasonable accounting practices.” Id. Despite three amendments, plaintiffs had failed to state “[w]hat those practices are and how they were departed from.” Id.
In Craftmatic, however, we recognized that:
Particularly in cases of corporate fraud, plaintiffs cannot be expected to have personal knowledge of the details of corporate internal affairs. Thus, courts have relaxed the [particularity] rule when factual information is peculiarly within the defendant‘s knowledge or control.
890 F.2d at 645 (citations omitted). Nevertheless, we also held that at the very least plaintiffs must allege that the necessary information lies within defendants’ control. Id. Although acknowledging that plaintiffs here cannot be expected to plead with specificity the details of UJB‘s internal corporate practices, the district court dismissed the remaining allegations for failure to allege defendants’ exclusive control over this information. The complaint does not specifically allege that defendants have exclusive control of information plaintiffs require.13
Had the complaint contained a boilerplate allegation that plaintiffs believe the necessary information “lies in defendants’ exclusive control,” it still would not have satisfied
B. §§ 11 and 12(2)
Count II alleges that UJB‘s Dividend Reinvestment and Stock Purchase Plan (“the DRISP“) and the accompanying prospectus and registration statement were false and misleading, and that plaintiffs purchased UJB stock “pursuant to” all three documents.15 Under the DRISP, shareholders reinvested their dividends by purchasing additional UJB shares. See App. at 438. Some of these new shares were authorized but previously unissued treasury stock, but others were purchased by UJB in the secondary market. Id.
1. Rule 12(b)(6)
a. § 11
Under
If plaintiffs’ shares were purchased in the secondary market, they would not be linked to a registration statement filed during the class period, and the § 11 claim would fail. Before discovery takes place, however, it is impossible for plaintiffs to know whether their shares were newly issued or were purchased in the secondary market. The complaint alleges that the shares were purchased “pursuant to” the DRISP. At some point, plaintiffs may be able to prove that their DRISP shares came from treasury stock. Because we cannot say that plaintiffs can prove no set of facts that would entitle them to relief, the § 11 claim cannot be dismissed at this time.
b. § 12(2)
Section 12(2) provides that a person who “offers or sells” securities by means of a prospectus or oral communication that misrepresents or omits material facts is liable to the person “purchasing such security from him.”
In Pinter v. Dahl, 486 U.S. 622, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988), the Supreme Court held that the term “seller” under § 12(1) is not limited to the person who passes title to the security, but includes anyone “who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.” Id. at 647, 108 S.Ct. at 2078. In Craftmatic we extended Pinter to § 12(2). We interpreted Pinter as having held that
the term “solicitation” does not encompass all activities related to the purchase transaction ...
....
Thus, although an issuer is no longer immune from § 12 liability, neither is an issuer liable solely on the basis of its involvement in preparing the prospectus. The purchaser must demonstrate direct and active participation in the solicitation of the immediate sale to hold the issuer liable as a § 12(2) seller.
890 F.2d at 636. We upheld allegations that each defendant “either sold [the] securities directly to plaintiffs ... or solicited plaintiffs ... and in so acting were motivated by a desire to serve their own financial interests or the financial interests of the owner(s) of [the] securities.” Id. at 637.
Plaintiffs’ complaint briefly describes the DRISP and alleges that “[i]n connection with the sale of the Company‘s common stock pursuant to the DRISP prospectus, defendant UJB was the ‘seller’ of such stock, within the meaning of § 12(2).” The district court held that this allegation was defective because plaintiffs must demonstrate “direct and active participation in the solicitation of the immediate sale.” It found no factual allegation specifying how UJB had directly and actively participated in the immediate sale, and noted that the mere preparation of a prospectus was insufficient under Craftmatic. We disagree.
These plaintiffs were not required to allege that UJB directly “solicited” the sales. The Pinter/Craftmatic solicitation rule applies only when the defendant issuer is not in direct privity with the purchaser. Pinter adopted solicitation liability as an expansion of the restrictive view that § 12 extended only to sellers in direct privity. 486 U.S. at 644, 108 S.Ct. at 2077. In Craftmatic, because the securities were purchased from an underwriter acting as a middleman, the defendant was not in privity with plaintiffs. Here, however, the newly offered shares purchased through the DRISP were sold directly to plaintiffs by UJB. See App. at 438 (“Purchases of UJB Common Stock may be made directly from UJB or on the open market, at the discretion of senior management of UJB.“).16 Because plaintiffs need not allege that UJB directly and actively participated in solicitation of the purchase,17 they have adequately alleged that UJB was a “seller” within the meaning of § 12.
2. Rule 9(b)
The district court held that the § 11 and § 12(2) allegations in Count II “sounded in fraud” and that
Count II incorporates by reference all preceding factual allegations, including those delineating defendants’ “intent.” It also states that the DRISP prospectus was false and misleading “in the particulars previously described,” and mentions the false and misleading nature “of the representations described above.” Complaint pp 62-63. Although Count II does not allege fraudulent intent or recklessness (a prerequisite to a successful fraud claim), neither does it allege negligence. The specific factual allegations upon which Count II is based do, however, repeatedly aver that defendants “intentionally,” “knowingly,” or “recklessly” misrepresented and omitted to represent certain material information. For example, paragraph 53, which expressly purports to characterize all of the complaint‘s factual allegations, asserts that:
Each of the defendants, by action as hereinabove described, did so knowingly or in such a reckless manner as to constitute a willful deceit and fraud upon plaintiffs and the members of the Class. With knowledge or reckless disregard of the true financial and operating condition of UJB, the Individual Defendants caused the reports, statements and releases, to contain misstatements and omissions of material fact as alleged herein ...
Complaint p 53. The only reasonable conclusion that can be drawn is that plaintiffs charge defendants with fraud. There is not a hint in the allegations that defendants were negligent in violating §§ 11 and 12(2).18
Plaintiffs contend that because Count II does not mention the intent required for fraud, we must necessarily infer that the claims are grounded in negligence. As defendants point out, however,
Moreover, we are not presented with a “mixture of allegations of negligence, fraud, and the misleading nature of” certain communications. In re Consumers Power Co. Sec. Litig., 105 F.R.D. 583, 594 (E.D.Mich.1985). As we have noted, the complaint is devoid of allegations that defendants acted negligently in violating §§ 11 and 12(2). Instead, it brims with references to defendants’ intentional and reckless misrepresentation of material facts. We see no way to construct a negligence cause of action here.
Next we determine whether
The district court did not address whether plaintiffs’ § 11 and § 12(2) allegations were pleaded with sufficient particularity. Although we will remand for full consideration of this issue, we offer the following guidance. The most serious flaw in the § 11 claim went unnoticed by the parties. Section 11 imposes liability for false or misleading statements made in “registration statements.”
The § 12(2) claim does identify the offending prospectus, but is only slightly more informative than the § 11 allegations. The complaint neither identifies which allegedly false statements violated § 12(2) nor explains how they were false. Under
C. Negligent Misrepresentation
The district court dismissed plaintiffs’ supplementary state law claim for negligent misrepresentation, holding that New Jersey law does not extend this cause of action to the general investing public. We disagree.
Under New Jersey common law, persons who negligently misrepresent material facts may be held liable to those who, as a result of their justifiable reliance on such misrepresentation, suffer economic harm. H. Rosenblum, Inc. v. Adler, 93 N.J. 324, 461 A.2d 138, 142-43 (1983). In Rosenblum the New Jersey Supreme Court held that a buyer of stock may sue a corporation‘s outside auditor for negligent misrepresentations regarding the corporation‘s financial statements. In an exhaustive discussion, the court rejected the view that the plaintiff must be in privity with the auditor. Instead, “the independent auditor ... has a duty to all those whom that auditor should reasonably foresee as recipients from the company of the statements for its proper business purposes.” Id. at 142; see also id. at 146.
Rosenblum takes an expansive view of the range of permissible plaintiffs in a negligent misrepresentation action. It explicitly rejects the majority view that the plaintiff must be in privity, and adopts the more inclusive “reasonably foreseeable plaintiff” rule. There is no dispute here that the average investor was a reasonably foreseeable recipient of defendants’ statements about UJB. Defendants argue instead that investment by the general public is not a “proper business purpose.” To state the argument is to note its defects. As one court has explained,
Defendants ... seek to parse out a subtle distinction between a “business decision” and an “investment decision.” These terms ... distinguish between an audit statement sent directly to an institutional investor to induce an investment and audit reports released to the general public for the same purpose. The contention is that the former investors are covered under the negligent misrepresentation doctrine while the ordinary public investor remains unprotected. Rosenblum makes no such distinction between these classes of reasonably foreseeable plaintiffs.
In re Midlantic Shareholders Litig., 758 F.Supp. 226, 237 n. 9 (D.N.J.1990).19 Indeed, the Rosenblum court expressly stated that information sent to stockholders could be the basis of liability:
When the defendants prepared the Giant audit, they knew ... that it was to be incorporated in Giant‘s annual report, a report that would be transmitted to each Giant stockholder.... The defendants also knew or should have known that the audited financial statements would be available and useful for other proper business purposes, such as public offerings of securities ...
461 A.2d at 154 (emphasis added). Moreover, the court looked to the expansive liability under the federal securities laws as a model for New Jersey law. Id. at 151. Therefore, it is not accurate to say that Rosenblum ‘s “business purpose” requirement limits the cause of action to those who make “significant” investments.
In sum, we find that the New Jersey Supreme Court intended to part company with the majority of states that allow only plaintiffs who are in direct privity to sue for negligent misrepresentation. Therefore, we hold that this cause of action extends to foreseeable individual investors who, as a result of their reliance on negligently made misrepresentations, suffer economic loss.20
D. Security
Under § 11(e) of the Securities Act, a district court “may, in its discretion, require an undertaking for the payment of the costs of [a Securities Act] suit, including reasonable attorney‘s fees.”21 The district court ordered plaintiff Katz to post a $50,000 bond in connection with the § 11 and § 12(2) claims. We review this aspect of the district court‘s order for abuse of discretion.
The principal purpose of § 11(e) is to deter plaintiffs from bringing meritless actions solely to procure a favorable settlement. Phillips v. Kidder, Peabody & Co., 686 F.Supp. 413, 416 (S.D.N.Y.1988); see also Hochfelder, 425 U.S. at 211 n. 30, 96 S.Ct. at 1389. Defendants concede that § 11(e) security is typically required “when the plaintiffs’ action ‘borders on the frivolous’ or ‘is brought in bad faith.’ ” Brief of Appellees at 55. The district court made no finding that Katz’ claims met either of these standards. As we have seen, many of these claims are sufficient to withstand a motion to dismiss. Therefore, we will vacate the district court‘s security requirement.
IV. CONCLUSION
For the reasons stated, we will affirm in part and reverse in part the district court‘s dismissal of Counts I and II and remand for proceedings consistent with this opinion. Moreover, we will affirm the district court‘s decision that
Each side shall bear its own costs.
SUR PETITION FOR REHEARING
Present: SLOVITER, Chief Judge, BECKER, STAPLETON, MANSMANN, HUTCHINSON, SCIRICA, COWEN, NYGAARD, ALITO and ROTH, Circuit Judges, and VanARTSDALEN*-1, District Judge.
The petition for rehearing filed by appellees in the above-entitled case having been submitted to the judges who participated in the decision of this Court and to all the other available circuit judges of the circuit in regular active service, and no judge who concurred in the decision having asked for rehearing, and a majority of the circuit judges of the circuit in regular service not having voted for rehearing, the petition for rehearing by the panel and the Court in banc, is denied.
BY THE COURT,
/s/ Anthony J. Scirica
Circuit Judge
Dated: July 7, 1992.
Notes
The district court dismissed Count V, which alleged a breach of fiduciary duties under New Jersey corporate law. This dismissal has not been appealed.
“During the Class Period, the defendants, individually and in concert, directly and indirectly, engaged and participated in or aided and abetted a continuous course of conduct and conspiracy to conceal adverse material information regarding the finances, financial condition and future prospects of UJB as specified herein. Defendants employed devices, schemes, and artifices to defraud and engaged in acts, practices, and a course of conduct as hereinafter alleged in an effort to maintain artificially high market prices for the securities of UJB. This included the formulation, making of and/or participation in the making of untrue statements of material facts and omitting to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, and engaging in acts, practices, and courses of business which operated as a fraud and deceit upon plaintiffs, and the Class. These included, among other things, the following:
(a) that the earnings, assets, and net worth of UJB were improperly and materially overstated and inflated throughout the Class Period due to grossly inadequate provisions for loan loss reserves;
(b) that the defendants caused UJB to continually understate its non-performing loans and failed to provide adequate loan loss reserves for problem loans promptly and properly, and instead granted extensions, further credits, and other beneficial terms to its problem loan customers, in order to postpone improperly the recognition of said problems in the publicly disseminated financial statements of UJB;
(c) that UJB‘s total loan loss reserves, particularly reserves for construction loans, were not maintained at an adequate level in light of the economic conditions prevailing in certain areas of loan concentration and the concomitant high risk of non-collectibility of a large portion of UJB‘s commercial real estate and other loans;
(d) that, many of UJB‘s larger problem loans, including but not limited to construction loans, and other loans in the Company‘s commercial loan portfolios, were not adequately collateralized or secure, contrary to defendants [sic] representations that:
--‘our portfolio is well secured’ and ‘we continue to have good loan to value ratio’ ...;
--the Company‘s ‘construction and real estate related loans ... are ... well collateralized ...;’
--that UJB had ‘high asset quality‘....
(e) that UJB‘s credit review and authorization standards and policies and system of internal controls to assure adequate collateralization and prompt recognition and accounting for problem loans were not conservative, were not functioning adequately or were being disregarded, not followed or circumvented by senior officers of the Company in order to maintain artificially high reported loan and earnings growth, contrary to defendants’ representations that:
--that UJB adheres to ‘conservative policies ... in quickly recognizing non-performing assets’ ...;
--that UJB had, ‘[i]n our effort to minimize our risk ... followed conservative underwriting standards’ with respect to construction and development loans ...;
--that UJB‘s ‘corporate policy toward residential, industrial and commercial construction loans’ were ‘conservative, cautious and therefore, profitable’ ...;
--that UJB‘s loan quality was strong because the Company was ‘paying attention to the basics of loan administration’ ...;
--that ‘quality’ was a ‘guiding principle in [UJB‘s] loan portfolio’ ...;
--that UJB had a ‘lending philosophy which emphasizes the prompt identification and follow-up of problem loans’ and a ‘conservative approach to problem loan recognition’ ...;
--that UJB ‘emphasize[d] the basics of proper loan origination procedures and good credit administration’ and ‘carefully monitor[s] our portfolio and ... maintain[s] a strong allowance for loan losses ...’ ...;
--that UJB had been ‘prudent’ in construction lending ...; and
--that UJB had a ‘prudent lending philosophy‘....
(f) that, UJB‘s lending practices and controls were not sufficiently centralized, were unmanageable, and UJB‘s commercial lending officers had engaged in high risk and speculative loan transactions, which were not being adequately supervised, controlled, or directed by higher management, contrary to defendants’ representations as set forth herein;
(g) that UJB would be required to add substantial additional amounts to its loan loss reserves as a result of its lending practices, contrary to defendants representations that:
--that UJB had a ‘low level of non-performing loans,’ a ‘very strong allowance’ for loan losses and ‘solid loan loss reserve’ ...;
--that UJB‘s loan loss reserves were ‘maintained at a level determined adequate to provide for potential losses on loans‘....
(h) that by announcing increases in non-performance loans or increases in reserves at various times during the Class Period (including but not limited to announcements or statements dated October 18, 1989, January 16, 1990, March 15, and April 15, 1990), defendants failed to disclose the full truth regarding UJB‘s problem loans and lack of controls and, indeed, gave the materially false and misleading impression that UJB had taken all steps that were necessary or appropriate in connection with UJB‘s problem loans; and
(i) that given the existence of these undisclosed facts concerning UJB, its business, financial condition and performance, finances and future prospects, any investment in UJB involved an extraordinarily high degree of risk.”
Complaint p 52.
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 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) (1988).
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 device or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C. § 78j(b) (1988).
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,
(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.
The district court also dismissed Count II, which alleges that defendants violated §§ 11, 12(2), and 15, “to the extent that it relies on the points raised in” paragraph 52. Slip op. at 7. Our analysis with respect to Count I of the materiality and particularity of the fact allegations made in that paragraph also applies to Count II.
61 Class Plaintiff Jerome Katz, who purchased UJB‘s common stock during the Class period pursuant to the Company‘s Dividend Reinvestment Plan, bring [sic] this Count against defendant UJB on behalf of those members of the Class who purchased during the Class Period the Company‘s common stock pursuant to the DRISP prospectus
62 In connection with the sale of the Company‘s common stock pursuant to the DRISP prospectus, defendant UJB was the ‘seller’ of such stock, within the meaning of Section 12(2) of the Securities Act of 1933
63 The DRISP prospectus offering and describing the securities of UJB was false and misleading, inter alia, in the particulars previously described
64 In ignorance of the false and misleading nature of the representations described above, members of the Class purchased UJB securities issued pursuant to the foregoing registration statements and prospectuses
The remaining paragraphs of Count II allege damage and petition for relief.
applies by its terms only to those foreseeable users who receive the audited statements from the business entity for a proper business purpose to influence a business decision of the user, the audit having been made for that business entity. Thus, for example, an institutional investor or portfolio manager who does not obtain audited statements from the company would not come within the stated principle. Nor would stockholders who purchased the stock after a negligent audit be covered in the absence of demonstrating the necessary conditions precedent.
Id. at 153 (emphasis added). It is not clear what the court meant by “the necessary conditions precedent.” Perhaps it refers to reliance and the other elements of the cause of action. In any event, it is plain that Rosenblum does not foreclose liability to everyday investors.
Defendants also rely on Karu v. Feldman, 574 A.2d 420 (N.J.1990), a post-Rosenblum case. This reliance is misplaced. Although Karu found that the plaintiff did not state a claim for negligent misrepresentation, the decision did not turn on privity or the “business purpose” requirement. Rather, the court held that the defendant bank had not acted negligently because it had not provided certain false information to a depositor and had no duty to disclose other information. Id. at 427-28. Karu may support a finding that UJB had no duty to disclose certain information under New Jersey law, but it in no way supports the contention that a member of the investing public has no cause of action.
... In any suit under this or any other section of this title the court may, in its discretion, require an undertaking for the payment of the costs of such suit, including reasonable attorneys’ fees, and if judgment shall be rendered against a party litigant, upon the motion of the other party litigant, such costs may be assessed in favor of such party litigant (whether or not such undertaking has been required) if the court believes the suit ... to have been without merit, in an amount sufficient to reimburse him for the reasonable expenses incurred by him, in connection with such suit, such costs to be taxed in the manner usually provided for taxing of costs in the court in which the suit was heard.
15 U.S.C. § 77k(e) (1988) (emphasis added).