Federal Securities Claims Without Fraud Element Must Still be Pled with Particularity if Nonfraud Securities Claim is Part of Defendant’s Alleged Fraudulent Conduct Under the Exchange Act and Rule 10(b)-5
Plaintiffs filed a putative class action under the Securities Act, 15 U.S.C. § 77a et seq., and the Exchange Act, 15 U.S.C. § 78a et seq., alleging that defendant “employed a fraudulent scheme to control the revenue growth; defense attorneys filed a motion to dismiss for failure to meet the pleading requirements of FRCP Rule 9(b) and the federal Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. § 78u-4(b). The federal court granted the motion to dismiss, and required that plaintiffs pay defense costs and fees incurred in connection with the motion to dismiss as a prerequisite to plaintiffs’ filing a motion to amend their class action complaint. Wagner v. First Horizon Pharm. Corp., 464 F.3d 1273, 1275-76 (11th Cir. 2006). Rather than pay these defense costs, plaintiffs allowed the complaint to be dismissed and then appealed. Id., at 1276.
The Eleventh Circuit first observed that Section 11 of the Securities Act creates “virtually absolute [liability], even for innocent misstatements,” as does Section 12(a)(2); thus, “neither allegations of fraud nor scienter are necessarily part of either of these claims.” Wagner, at 1277. The Circuit Court therefore characterized claims under Sections 11 and 12(a)(2) as “nonfraud” claims, and noted: “The question presented . . . [is] whether there are circumstances when [Rule 9(b)] would require nonfraud securities claims to be pled with particularity.” Id. While noting that sister circuits are split on this issue, the Eleventh Circuit adopted the conclusion of the majority of the circuits that have addressed the question and held “Rule 9(b) applies when the misrepresentation justifying relief under the Securities Act is also alleged to support a claim for Fraud under the Exchange Act and Rule 10(b)-5, id. The Circuit Court explained its holding at page 1278 as follows:
If plaintiffs bring a § 11 or § 12(a)(2) claim without alleging the misrepresentation at issue in the claim was fraudulent, they would avoid the heightened pleading requirements of Rule 9(b). On the other hand, if the would-be plaintiffs are claiming that the § 11 or § 12(a)(2) misrepresentation is part and parcel of a larger fraud, then the rule’s protective purpose attaches and the plaintiffs must plead with particularity. In a complaint subject to Rule 9(b)’s particularity requirement, plaintiffs retain the dual burden of providing sufficient particularity as to the fraud while maintaining a sense of brevity and clarity in the drafting of the claim, in accord with Rule 8. [Citation.]
The Court then turned to the motion to dismiss itself, and while it agreed that the complaint failed to provide the requisite specificity the Circuit Court nonetheless reversed and remanded with instructions to permit plaintiffs to amend their class action complaint. The lack of specificity arose from “plaintiffs’ ‘failure to link their specific allegata to the causes of action pled in their complaint.’” Wagner, at 1278. In other words, the district court did not find a lack of specificity per se, but rather that plaintiffs “did not clearly link any of [the factual allegations] to its causes of action.” Id., at 1280. The Eleventh Circuit explained the problem at page 1279 as follows:
The concern we address today is structural and does not express an opinion on the merits of the claim. The lack of connection between the substantive count and the factual predicates is the central problem with each of the enumerated counts in the complaint, because courts cannot perform their gatekeeping function with regard to the averments of fraud. It is not that we know that the plaintiffs cannot state a claim but rather that we do not know whether they have. This is because the plaintiffs have not connected their facts to their claims in a manner sufficient to satisfy Rule 9(b).
Nonetheless, on the particular facts of the case, the Circuit Court held that an order for more definite statement under Rule 12(e) was the appropriate remedy, not dismissal under Rule 12(b)(6). Wagner/i, at 1280. Indeed, the Court concluded that the district court should have ordered plaintiffs to replead the class action complaint sua sponte. Id. Accordingly, it reversed dismissal of the action and remanded the matter to the district court.
NOTE: The Circuit Court did not mince words concerning the state of the pleadings: “The complaint at issue in this case is a proverbial shotgun pleading. Shotgun pleadings are those that incorporate every antecedent allegation by reference into each subsequent claim for relief or affirmative defense. . . . “[S]hotgun pleadings wreck havoc on the judicial system.” . . . Such pleadings divert already stretched judicial resources into disputes that are not structurally prepared to efficiently use those resources.” Wagner, at 1279 (citations omitted).