Krim v. BancTexas Group, Inc.

United States Court of Appeals,
Fifth Circuit.

No. 95-11063.

Jerry KRIM, on behalf of himself and all others similarly situated, Plaintiff,

and

Harvey Greenfield, Movant-Appellant-Cross-Appellee,

v.

BANCTEXAS GROUP, INC., et al., Defendants,

and

BANCTEXAS GROUP, INC., Defendant-Appellee-Cross-Appellant.

Nov. 19, 1996.

Appeals from the United States District Court for the Northern District of Texas.

Before HIGGINBOTHAM, DUHÉ and BENAVIDES, Circuit Judges.

DUHÉ, Circuit Judge:

Attorney Harvey Greenfield appeals the district court's order levying $95,848 in sanctions

against him for violations of Fed.R.Civ.P. 11. We reverse.

BACKGROUND

Appellant Harvey Greenfield, attorney for Plaintiff Jerry Krim, filed a class action complaint

in the Southern District of Texas against BancTexas Group, Inc. and certain of its officers and

directors, alleging violations of federal securities laws arising from a prospectus containing false or

misleading statements. Greenfield later amended the class action complaint, naming an additional

defendant. Defendants moved to dismiss the amended complaint for failure to plead fraud with

particularity, as required by Fed.R.Civ.P. 9(b).

The district court never ruled on the Rule 9(b) motion, and by agreement, the case was

transferred to the Northern District of Texas. At all times relevant to this proceeding, Local Rule

10.2(c) of the Northern District of Texas allowed discovery in class actions only as to facts relevant

to class certification and prohibited discovery on the merits of the lawsuit until the district court ruled
on certification.1 On May 3, 1989, the court ordered the parties to complete discovery "as permitted

by Rule 10.2(c)."

Greenfield filed a second amended class action complaint on May 2, 1989, and a third

amended class action complaint on July 14, 1989, and on the same date moved for class certification.

Defendants moved to dismiss the third amended complaint pursuant to Fed.R.Civ.P. 9(b) and

12(b)(6), and later responded to Plaintiff's motion for class certification.

The district court found that Greenfield's conclusory allegations were insufficient to satisfy

Rule 9(b), but gave him "one final opportunity to plead his complaint in a manner that satisfies the

dictates of Rule 9(b)." Greenfield filed the fourth amended class action complaint, which was again

met with Defendants' motion to dismiss pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6). The district

court ruled o n the 9(b) motion, dismissing the complaint as against all of the defendants except

BancTexas itself. The court did not rule on the 12(b)(6) motion.

The litigation against BancTexas co ntinued, and on December 7, 1990, Greenfield served

BancTexas with a request, under Fed.R.Civ.P. 34, for production of documents. Ten days later,

BancTexas, relying on Local Rule 10.2(c)'s prohibition on discovery as to the merits of the case,

moved for protective order and to stay discovery pending the district court's ruling on the motion for

class certification. The next day, the trial court granted BancTexas's unopposed motion and held that

BancTexas need not respond to the discovery request until sixty days after a ruling on the class

certification.2

Meanwhile, on November 23, 1990, the individual defendants had moved for sanctions, and

1
Local Rule 10.2(c) was repealed after the conclusion of the underlying lawsuit. The rule
provided:

After commencement of an alleged class action, discovery shall proceed only as to
facts relevant to the certification of the alleged class. Although discovery relative
to class certification may overlap with discovery on the merits, discovery
concerning facts relevant only to the merits of the lawsuit shall not begin until the
Court has ruled on the motion for certification.

N.D.Tex.Local R. 10.2(c) (repealed 1994).
2
The court allowed discovery to proceed regarding the identities of purchasers of BancTexas's
stock.
on January 15, 1991, BancTexas filed a Rule 12(b)(6) motion to dismiss plaintiff's fourth amended

complaint. On June 28, 1991, the district court ruled on both motions. The court denied

BancTexas's motion to dismiss, but it sanctioned Greenfield, finding that the fourth amended

complaint violated Rule 11 because it "could not allege securities claims against [the individual

defendants] with the specificity required by Rule 9(b)." The court ordered Greenfield to attend ten

hours of legal education and submit letters of apology to each of the dismissed defendants.

Approximately one month later, BancTexas moved for summary judgment. Greenfield then

filed a brief in opposition to the motion for summary judgment, supplemented by an affidavit pursuant

to Fed.R.Civ.P. 56(f). In the affidavit, Greenfield noted that although BancTexas did produce a

limited number of documents in October of 1989 in connection with settlement discussions,

Greenfield had otherwise been unable to obtain substantive discovery due to the court's protective

order. He thus asked the court to deny the summary judgment motion, or in the alternative, postpone

consideration of the motion until discovery was complete.

On February 14, 1992, the district court granted BancTexas's motion for summary judgment,

rejecting Greenfield's Rule 56(f) affidavit on the grounds that the affidavit gave no reason why the

October 1989 discovery did not enable Greenfield to oppose the motion for summary judgment; that

there was no justification for not conducting discovery before the court issued the December 1990

protective order; and that the affidavit did "not adequately disclose the benefits of additional

discovery." Plaintiff appealed, and BancTexas moved for sanctions, seeking recovery of its fees and

expenses in defending t he lawsuit. The trial court denied the sanctions motion without prejudice

pending the conclusion of Plaintiff's appeal.

On appeal, we affirmed. Krim v. BancTexas Group, Inc., 989 F.2d 1435 (5th Cir.1993). We

held that the district court did not err in refusing to permit further discovery on the merits prior to

granting BancTexas's motion for summary judgment and that summary judgment was appropriate

based on the pleadings and evidence adduced. Id. After Plaintiff's unsuccessful appeal, BancTexas
renewed its motion for Rule 11 sanctions.3

The court concluded that BancTexas had made a prima facie showing of Rule 11 violations,

and ordered a hearing to allow Greenfield to present evidence and argument in opposition. Thereafter

the district court granted BancTexas's motion for sanctions. The court found that Greenfield had

violated Rule 11 by signing the third amended class action complaint, the fourth amended class action

complaint, and the brief in opposition to BancTexas's motion for summary judgment. Specifically,

the court found that a number of Greenfield's allegations in these three pleadings were not well

grounded in fact, and that Greenfield did not conduct a reasonable inquiry into the supporting facts

before signing the three pleadings. In addition, the district court specifically found that Greenfield

had not violated Rule 11 by signing the class action complaint and the first amended class action

complaint because at the time those pleadings were filed, Greenfield had made a reasonable factual

inquiry.4 After receiving pleadings from both parties regarding the amount of the sanctions, the court,

on October 11, 1995, ordered Greenfield to pay BancTexas the sum of $95,848 for violations of Rule

11.

On appeal, Greenfield asserts that his investigation into the factual basis for the pleadings was

3
In its amended motion for sanctions, BancTexas asserted that Greenfield violated Rule 11 in
connection with the following eight pleadings:

1. class action complaint (filed September 30, 1988);

2. amended class action complaint (filed November 16, 1988);

3. second amended class action complaint (filed May 2, 1989);

4. third amended class action complaint (filed July 14, 1989);

5. memorandum in opposition to defendants' motion to dismiss (filed December 4, 1989);

6. fourth amended class action complaint (filed May 23, 1990);

7. brief in opposition to defendant's second motion to dismiss (filed June 26, 1990); and

8. brief in opposition to defendant's motion for summary judgment (filed September 20, 1991).
4
The court also found that Greenfield did not violate Rule 11 by signing either of the two
oppositions to BancTexas's motions to dismiss because these motions addressed the adequacy of
the complaint against BancTexas, and that Greenfield did not violate Rule 11 regarding the
second amended class action complaint because he did not sign that pleading.
adequate, especially in light of Local Rule 10.2(c) and the district court's orders prohibiting discovery

on the merits. We agree, and reverse.

ANALYSIS

A. Standard of Review

We review all aspects of a district court's Rule 11 determination for abuse of discretion.

Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405, 110 S.Ct. 2447, 2460-61, 110 L.Ed.2d 359

(1990); Thomas v. Capital Sec. Servs., Inc., 836 F.2d 866, 872 (5th Cir.1988) (en banc). A district

court abuses its discretion if it imposes sanctions based upon an erroneous view of the law or a clearly

erroneous assessment of the evidence. F.D.I.C. v. Calhoun, 34 F.3d 1291, 1297 (5th Cir.1994)

(citing Cooter & Gell, 496 U.S. at 405, 110 S.Ct. at 2460-61).

B. Rule 11 Liability

Throughout this litigation, Greenfield was bound by Local Rule 10.2(c), which permitted

discovery only of facts relevant to class certification; by a court order directing the parties to

complete disco very in accordance with Rule 10.2(c); and by another court order specifically

prohibiting Greenfield from conducting discovery on the merits. We find it necessary to reverse the

order levying Rule 11 sanctions because Greenfield was prohibited from conducting further

investigation into the facts behind his allegations because of the local rule, the two court orders, and

the lack of any reasonable alternative means of investigation.

Rule 11 imposes three affirmatives duties upon an attorney who signs a pleading, motion, or

other document. Childs v. State Farm Mut. Auto. Ins. Co., 29 F.3d 1018, 1024 (5th Cir.1994);

Thomas, 836 F.2d at 873-74. In this case, the district court found that the only duty violated by

Greenfield was the duty to conduct a reasonable inquiry into the facts supporting the documents. See

Childs, 29 F.3d at 1024; Thomas, 836 F.2d at 874. Specifically, the district court found that

Greenfield had breached his Rule 11 duty by signing the third amended complaint (filed July 14,

1989), the fourth amended complaint (filed May 23, 1990), and the brief in opposition to summary

judgment (filed September 20, 1991), without conducting a reasonable inquiry into the facts

supporting these three pleadings.
 The court found, however, that Greenfield did conduct a reasonable inquiry in the facts

supporting the class action complaint and the first amended class action complaint, and thus declined

to impose Rule 11 sanctions with respect to those pleadings. The allegations of securities fraud made

by Greenfield in the third and fourth amended complaints did not differ from those made in the initial

and first amended complaints; the later two pleadings simply were more detailed. Greenfield was

not sanct ioned for anything that he added to the later two pleadings and was not sanctioned for

bringing a frivolous lawsuit at the outset; he was sanctioned because his inquiry into the facts was

insufficient by the time he filed the third and fourth amended complaints, appro ximately nine and

twenty months after the inception of the lawsuit, respectively. The district court thus believed that

Greenfield breached his duty by not conducting a reasonable inquiry into the facts between November

16, 1988 (when Greenfield filed the first amended complaint), and July 14, 1989 (when Greenfield

filed the third amended complaint). The district court held that, between these dates, Greenfield

should have done two things: commenced formal discovery and conducted his own investigation.

1. Discovery

First, Greenfield simply could not, at any time, conduct discovery on the merits of the case

because of Local Rule 10.2(c), which prohibited discovery on the merits, and the court order, dated

May 3, 1989, directing that discovery be completed in accordance with Rule 10.2(c). In addition,

when Greenfield did serve BancTexas with a discovery request on December 7, 1990, the district

court issued a protective order on December 18, 1990, reinforcing Local Rule 10.2(c)'s prohibition

on merits discovery until after class certification. It was an abuse of discretion for the district court

to sanction Greenfield for not conducting discovery, when discovery was expressly prohibited.

We reject any contention that Greenfield did not actually rely on Rule 10.2(c) or otherwise

should have sought to have t he pro hibitions of that rule lifted. First, it is irrelevant whether

Greenfield actually subjectively relied on Local Rule 10.2(c) or the initial court order as the reasons

why he did not conduct discovery. The mere fact that Greenfield was prohibited from conducting

discovery is enough at least to create the inference that Greenfield's lack of action was a result of the

local rule and order. The court's initial order was based on Local Rule 10.2(c), and when Greenfield
did attempt to conduct merits discovery, BancTexas immediately sought, and was granted, a

protective order against such discovery based on Rule 10.2(c).

We are also not persuaded by BancTexas's argument that Greenfield should have sought relief

from the discovery prohibitions. It is disingenuous for BancTexas to argue that Greenfield should

have sought relief from Local Rule 10.2(c), when BancTexas specifically opposed Greenfield's merits

discovery request based on that very rule. While it may not have been a good idea for Greenfield to

have acquiesced in the order prohibiting merits discovery, BancTexas simply cannot use the local rule

and the court orders as both a sword and a shield.

We take note that our earlier panel opinion affirming the dismissal of the case against

BancTexas stated that there was "no evidence whatsoever to suggest that [Greenfield] did rely on

Local Rule 10.2(c) in delaying to make his first request for discovery on the merits until more than

two years from the date of filing of his initial complaint." Krim, 989 F.2d at 1441 n. 3. We are not

bound by this statement because it is dicta, and self-described as such. Id. (stating that "consideration

of whether plaintiff did rely on the local rule is not essential to our decision in this case"). Further,

our statement was made in the context of a motion for summary judgment, not one for Rule 11

sanctions.

Finally, we are not convinced by the argument that because Local Rule 10.2(c) permitted class

discovery that overlaps with discovery on the merits, Greenfield should have served a discovery

request pertaining to class certification that would somehow have provided him with enough facts

sufficient to know whether his allegations had sufficient basis in fact. The factors that a district court

must consider in determining whether to certify a class include: numerosity, commonality, typicality,

and adequacy of representation. Fed.R.Civ.P. 23(a). Any discovery as to these factors would have

been unlikely to have disclosed facts regarding the merits of the fraud claim. This is especially true

regarding the facts at issue in this part icular case. In our earlier opinion affirming the grant of

summary judgment, we held that Greenfield did not create a genuine issue of material fact regarding

whether BancTexas had knowledge of the information allegedly omitted from its prospectus and

whether the information allegedly omitted was material, two essential elements of the securities fraud
claims. Krim, 989 F.2d at 1445. We fail to see how conducting discovery relative to class

certification would have incidentally provided Greenfield with information suggesting that he would

have been unable to prove knowledge or materiality. While we do not condone the fact that

Greenfield waited until two years after the filing of his complaint to seek discovery regarding class

certification, this cannot be a basis for the Rule 11 sanctions.

2. Outside Investigation

As a practical matter, any investigation that Greenfield might have attempted short of

discovery could not have produced facts regarding the merits of his allegations. First, BancTexas

counsel admitted during oral argument that between the filing of the first and third complaints,

Greenfield's only realistic course of action was to conduct discovery. Second, the nature of a

securities fraud action is such that the information necessary to support the allegations of fraud must

come primarily, if not exclusively, from discovery. See Thomas, 836 F.2d at 875 (stating that one

factor a court may consider in determining whether an attorney has made a reasonable inquiry into

the facts supporting the allegations is the extent to which development of the facts requires

discovery). We earlier affirmed the district court's dismissal of Greenfield's case in part because he

had failed to produce any genuine issue of fact pertaining to scienter, an essential element of a claim

brought under §§ 10(b) and 20(a) of the Securities Exchange Act of 1934. In order to prove

knowledge on the part of BancTexas, it probably would have been necessary for Greenfield to have

procured internal corporate documents belonging to BancTexas, documents available only through

discovery. See Smith v. Our Lady of the Lake Hosp., Inc., 960 F.2d 439, 446 (5th Cir.1992) (noting

that "virtually all of the factual materials relevant to proving the RICO [fraud] case were beyond

[Plaintiff's] reach, in the hands of the defendants"). As the Smith Court noted, "The essence of the

alleged offense was the defendants' agreement and intent to defraud, which cannot be ascertained

easily from extrinsic evidence; a party should be given some leeway in making allegations about such

matters, as long as the lawyer's investigation is otherwise reasonable." Id. In this case, extrinsic

investigation was, practically speaking, not an option, and discovery on the merits, Greenfield's

remaining source of information, was prohibited by a local court rule and the district court's orders.
 We need not reach the other issues raised by Greenfield or the issues raised by BancTexas in

its cross-appeal.

REVERSED and RENDERED.