Maldonado v. Dominguez

UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT

No. 97-1345

MIGUEL MALDONADO, ET AL.,
Plaintiffs - Appellants,

v.

RAMON DOMINGUEZ, ET AL.,
Defendants - Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF PUERTO RICO

[Hon. Jos Antonio Fust , U.S. District Judge]

Before

Torruella, Chief Judge,

Cyr, Senior Circuit Judge,

and DiClerico, Jr.,* District Judge.

Hilda Surillo-Pe a, with whom Jaime Sifre-Rodr guez, Luis A.

Mel ndez-Albizu and S nchez-Betances & Sifre were on brief for

appellants.
Jorge P rez-D az, with whom Pietrantoni M ndez & Alvarez was

on brief for Dean Witter Reynolds, Inc.
Amanda Acevedo-Rhodes, with whom Luz Ivette Rivera and Luz

Ivette Rivera & Asociados were on brief for appellee Ram n

Dom nguez.

February 27, 1998

* Of the District of New Hampshire, sitting by designation.

TORRUELLA, Chief Judge. Plaintiffs invested in and
TORRUELLA, Chief Judge.

became directors of a corporation called the Puerto Rico

International Bank ("PRIBANK"), which was designed to create huge

profits for its investor-directors by leveraging its collateral

with low interest loans in order to purchase higher interest

mortgage obligations. When PRIBANK failed, the plaintiffs

brought this suit, claiming that the investment bankers marketing

the PRIBANK stock defrauded them by failing to mention the

possibility that PRIBANK's securities would be "called" in the

event of an interest rate adjustment. The investors filed this

suit under sections 12(2) and 17(a) of the Securities Act of

1933, 15 U.S.C. 77l, 77q, as well as section 10(b) of the

Securities Act of 1934, 15 U.S.C. 78j, and Rule 10(b)(5) of the

Securities and Exchange Commission ("SEC") promulgated

thereunder. The district court dismissed all of these claims on

a motion to dismiss. We affirm.

BACKGROUND
BACKGROUND

In addressing a 12(b)(6) motion, we must accept all

well-pleaded facts as true and accord the plaintiff the benefit

of all reasonable inferences. See LeBlanc v. Great Am. Ins. Co.,

6 F.3d 836, 841 (1st Cir. 1993). The following recitation of

this case's background reflects this standard.

Plaintiffs Miguel Maldonado, et al. -- important

clients of Dean Witter Reynolds, Inc. of Puerto Rico ("Dean

Witter") -- received mailed invitations to a meeting at an

exclusive San Juan club where they would be presented with a

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select investment opportunity. At the August 30, 1993 meeting,

Ram n Dom nguez, Senior Vice-President and Sales Manager of Dean

Witter, made a presentation regarding the formation of PRIBANK, a

new corporation. He explained PRIBANK's investment philosophy,

and stated that individual investors' participation would be

limited to ten blocks of $350,000, with an additional $1.5

million coming from himself and Antonio Luis Rosado -- Vice

President of Santander National Bank, and president-to-be of

PRIBANK. Each investor would become a director of the

corporation. According to Dom nguez, PRIBANK was a virtually

risk-free investment which was projected to return 176% of the

investors' principal in only two years.

PRIBANK's strategy was relatively simple. PRIBANK

would use $5 million of collateral to open margin accounts of

almost $300 million with various brokerage houses. PRIBANK would

be permitted to leverage itself through these brokerage houses

for 60 times its capital because it had the credit of Dean Witter

to back it up and because funds provided to PRIBANK on its margin

accounts were not allowed to be used for the purchase of credit

risk assets. In other words, PRIBANK would be seen by the

brokerage houses as a safe entity because its investments would

be low risk and its credit with Dean Witter was trusted.

The money in PRIBANK's margin accounts would be used to

purchase Real Estate Mortgage Investment Conduits ("REMICs") and

Collateralized Mortgage Obligations ("CMOs"), effectively making

PRIBANK the lender for numerous home mortgages. These REMICs and

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CMOs would pay interest to PRIBANK at a higher rate than PRIBANK

was required to pay to the brokerage houses for the money in its

margin accounts. The difference between the low interest rate

PRIBANK would be paying and the higher interest rate PRIBANK

would be collecting -- the "spread" -- would be PRIBANK's profit.

Since PRIBANK was able to borrow approximately 60 times more than

its collateral, a spread of only 1 percent would have resulted in

huge profits for PRIBANK's investors.

A further property of PRIBANK's investment structure

made it unique. PRIBANK would only purchase investments called

"floaters," which would be re-priced and adjusted for prevailing

interest rates every thirty days. Every thirty days, PRIBANK

would collect interest on these investments. PRIBANK planned to

carefully structure its investments so that each month, on the

same day that interest payments were due to the brokerage houses,

PRIBANK would also collect interest on its investments.

Dom nguez labelled this as "matching."

This would give PRIBANK an advantage over normal

financial institutions which purchased floating REMICS and CMOs

without this perfect matching. Normal financial institutions

have mismatched inventories, and have to keep reserves on hand to

account for withdrawals and to pay obligations when they come

due. The higher interest rates these institutions make on their

loans barely make up for the potential interest lost on the money

sitting in their reserves at any given time. However, due to its

perfect matching, PRIBANK would not be required to keep any

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significant reserves on hand, and could invest all of its money

every month, enabling it to take full advantage of the spread in

interest rates. Therein lay the key to PRIBANK's philosophy, and

eventually to its downfall.

Dom nguez explained that PRIBANK's goal was to make

money based upon the interest rate spread, and yet insulate

itself from any changes in interest rates. Whether rates went up

or down, the spread would always remain. What Dom nguez failed

to explain to the investors was that PRIBANK was not a risk-free,

or even a low-risk investment. Instead, PRIBANK would be engaged

in highly leveraged margin trading, and, like any margin trader,

PRIBANK's investments could be subject to "margin calls." That

is, if interest rates went up, the value of REMICs and CMOs (and

other loan obligations) would go down, and brokerage houses could

require investors to put up more collateral to cover the paper

loss. Margin calls do not necessarily occur on the same day that

investments are adjusted and repriced -- at the 30-day mark in

PRIBANK's case -- but can occur at any time after the value of

the investments falls. PRIBANK, which was designed to profit by

having no reserves, would not be able to cover any margin calls.

Therefore, any significant hike in interest rates could bankrupt

PRIBANK, and its investors would lose their investments.

This significant risk was not disclosed to investors at

the August 30, 1993 meeting. Instead, investors were told that

fluctuating interest rates would pose no threat to PRIBANK's

profitability. The investors believed that Dom nguez and Rosado

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had struck upon a scheme whereby they could make huge profits for

little or no risk. They invested $350,000 each in exchange for a

5.5% share of PRIBANK and a seat on the board. Dom nguez and

Rosado made commissions on this $3.5 million of investments.

PRIBANK began operations in January 1994.

On February 4, 1994, the Federal Reserve increased

interest rates by 1/4 point. This increase was the first of

several increases which were to occur in future weeks. Brokerage

houses soon began to make margin calls. To meet the margin

calls, PRIBANK was required to sell investments before their

agreed-upon settlement dates, resulting in significant penalties.

As one margin call was being paid off, another loan would be

called, and PRIBANK would scramble to sell another investment,

incurring more penalties, and draining PRIBANK's original $5

million collateral.

In the midst of this collapse, on February 23, 1994,

PRIBANK held a meeting of the board. At the meeting, Dom nguez

presented a picture of a smoothly-running operation, pointing out

promising investments that PRIBANK was looking into and failing

to mention the fact that PRIBANK was already experiencing margin

calls and sustaining losses. Soon after this meeting, PRIBANK

lost its remaining assets and its stock became worthless.

The present suit was brought before the District Court

of Puerto Rico under the Securities Act of 1933, 15 U.S.C. 77

(the "1933 Act" or "Securities Act"), and the Securities Act of

1934, 15 U.S.C. 78 (the "1934 Act" or "Exchange Act").

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Plaintiffs allege that fraudulent statements and omissions were

made by Dom nguez and Rosado, and further allege vicarious

liability on the part of Dean Witter. The district court

dismissed all claims on Rule 12(b)(6) motions. This appeal

followed.

On appeal, plaintiffs make a number of claims. First,

they argue that, to the extent that the district court converted

any of the Rule 12(b)(6) motions into motions for summary

judgment under Rule 56(c), plaintiffs received inadequate notice

and opportunity to submit evidence. At issue is both whether

such a conversion actually occurred and whether a conversion

would have been appropriate at that stage of the case.

Plaintiffs next claim that the district court erred in

finding that there is no implied private cause of action under

section 17(a) of the 1933 Act. Plaintiffs urge this court to

recognize such a cause of action.

Plaintiffs further contend that the district court

erred in concluding that PRIBANK stock was privately offered.

The character of PRIBANK's offering became material to the case

when, shortly after this complaint was filed, the Supreme Court

decided Gustafson v. Alloyd Co., 513 U.S. 561, 577-78 (1995),

holding that section 12(2) of the 1933 Act did not apply to

private offerings.

Next, plaintiffs argue that their claim under section

10(b) of the 1934 Act -- and Rule 10b-5 of the Securities and

Exchange Commission promulgated thereunder -- was pled with

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sufficient particularity. Specifically, they contest the

district court's ruling that they had failed to plead specific

facts which create a triable question on the issue of defendants'

"scienter."

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Finally, plaintiffs claim that the district court

abused its discretion in denying their request for leave to file

an amended complaint after the district court entered judgment.

The argument stems from the district court's issuance of a margin

order which indicated that this seemingly tardy request for leave

would be granted. We address these arguments in turn.

ANALYSIS
ANALYSIS

I. Conversion of 12(b)(6) Motions
I. Conversion of 12(b)(6) Motions

Plaintiffs allege that the district court improperly

converted the series of 12(b)(6) motions at issue into motions

for summary judgment pursuant to Fed. R. Civ. P. 56(c).

Plaintiffs argue that such a conversion is necessarily improper

where defendants have offered no materials outside the pleadings

and where the court has not given express notice of its intent to

convert the motions. As a matter of law, plaintiffs are correct.

However, a close reading of the district court opinion reveals

that the court dismissed these claims based solely on the

insufficiency of the pleadings, and we affirm on those grounds.

In Moody v. Town of Weymouth, 805 F.2d 30, 31 (1st Cir.

1986), we held that when a district court fails to give express

notice to the parties of its intention to convert a 12(b)(6)

motion into a motion for summary judgment, there is no reversible

error if the party opposing the motion (1) has received materials

outside the pleadings, (2) has had an opportunity to respond to

them, and (3) has not controverted their accuracy. The Moody

"exception" to the rule that the district court must notify the

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parties of an intent to convert motions is limited, and unless

the three factors listed above are present the exception does not

apply. See Cooperativa de Ahorro y Cr dito Aguada v. Kidder,

Peabody & Co., 993 F.2d 269, 273 (1st Cir. 1993) (in deciding a

12(b)(6) motion, a district court normally must either ignore

extraneous materials or give the parties notice and an

opportunity to respond to the conversion to a summary judgment

motion). In the present case, the plaintiffs filed a detailed

pleading with several documentary exhibits. Defendants argue

that this fact alone put plaintiffs on notice that any 12(b)(6)

motion could be converted into a 56(c) motion for summary

judgment. This argument fundamentally misinterprets Moody and

therefore fails.

Plaintiffs were therefore surprised to find that the

district court had converted the motions. Throughout its

opinion, the district court used language consistent with an

award of summary judgment, ruling that "Plaintiffs have failed to

adduce sufficient evidence to create a material issue of fact."

However, an opinion's plain language does not always mirror its

plain logic, and while a quick perusal of the opinion might lead

one to believe that the district court had applied the wrong

standard of decision, looking past the terminology employed by

the court reveals an opinion illustrating the legal insufficiency

of the pleadings for each claim in this suit. See Garita Hotel

Ltd. Partnership v. Ponce Fed. Bank, F.S.B., 958 F.2d 15, 18 (1st

Cir. 1992) (the determination of whether a district court has

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converted a 12(b)(6) motion is "functional rather than

mechanical"). On that basis, we affirm the standard of decision

actually employed by the district court, and we now examine each

of the district court's rulings regarding the insufficiency of

the pleadings in this case.

II. Section 17(a) of the 1933 Act
II. Section 17(a) of the 1933 Act

The district court dismissed one of the plaintiffs'

claims after concluding that there was no implied private cause

of action under section 17(a) of the 1933 Act. We agree.

Section 17 of the 1933 Act provides that:

It shall be unlawful for any person in the
offer or sale of any securities by the use of
any means or instruments of transportation or
communication in interstate commerce or by
theuse of the mails, directly or indirectly -

(1) to employ any device, scheme, or artifice
to defraud, or
(2) to obtain money or property by means of
any untrue statement of a material fact or
any omission 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
(3) to engage in any transaction, practice or
course of business which operates or would
operate as a fraud or deceit upon the
purchaser.

15 U.S.C. 77(q). Courts and law enforcement agencies have the

authority to enforce section 17(a) of the 1933 Act via injunction

and criminal prosecution. However, for years circuit courts have

struggled with the question of whether an implied private right

of action to enforce section 17(a) also exists. The Supreme

Court has never answered the question. See Bateman Eichler, Hill

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Richards, Inc. v. Berner, 472 U.S. 299, 304 n.9 (1985). Until

today, neither had this court. See Cleary v. Perfectune, Inc.,

700 F.2d774, 779 (1stCir. 1983)(declining to reachthis question).

This issue has caused confusion because, while neither

the language nor the history of section 17(a) clearly indicates a

congressional intent to create a private right of action, see

Newcome v. Esrey, 862 F.2d 1099, 1103-07 (4th Cir. 1988), section

10(b) of the 1934 Act -- with substantially similar language --

has always been interpreted to provide for a private right of

action. See Herman & MacLean v. Huddleston, 459 U.S. 385-87

(1983) (expressly interpreting section 10(b)'s private right of

action as consistent with securities laws' "broad remedial

purposes"). While some courts did not find the requisite

congressional intent to infer a private right of action from

section 17(a), see Touche Ross & Co. v. Redington, 442 U.S. 560,

574-76 (1979) (legislative intent is the primary factor to

consider when addressing whether a private right of action

exists), other circuits found no meaningful distinction between

section 17(a) and section 10(b). Compare Daniel v. Teamsters,

561 F.2d 1223, 1244-46 (7th Cir. 1977) (holding that a private

right of action exists), and SEC v. Texas Gulf Sulphur Co., 401

F.2d 833, 867 (2d Cir. 1968) (Friendly, J., concurring) (same),

with Landry v. All Am. Assur. Co., 688 F.2d 381, 384-91 (5th Cir.

1982) (holding that no private right of action exists), and

Stephenson v. Calpine Conifers II, Ltd., 652 F.2d 808, 815 (9th

Cir. 1981) (same).

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However, in Aaron v. SEC, 446 U.S. 680, 695-97 (1980),

the Supreme Court held that, unlike section 10(b) of the Exchange

Act, section 17(a) of the Securities Act does not require proof

of scienter. Thus, while the implied cause of action under 10(b)

would expose only the deceitful to private causes of action, an

implied cause of action under 17(a) would impose such liability

on merely negligent wrongdoers. Furthermore, the Court had ruled

four years earlier that a judicially created cause of action,

such as the one implied under section 10(b), could not be

extended to actions premised on negligent wrongdoing. See Ernst

& Ernst v. Hochfelder, 425 U.S. 185, 210 (1976).

Aaron and Ernst highlighted for courts a significant

distinction between implying private causes of action under the

two sections. While the 10(b) implied cause of action has

continued to enjoy unanimous recognition and the imprimatur of a

unanimous Supreme Court in Huddleston, the 17(a) cause of action

has been held up to renewed scrutiny. In recent years, every

circuit to have addressed the issue has refused to recognize a

private right of action under section 17(a), including four

circuits which originally had held otherwise. See Finkel v.

Stratton Corp., 962 F.2d 169, 174-75 (2d Cir. 1992) (noting that

Kirshner v. United States, 603 F.2d 234 (2d Cir. 1978), had been

overruled); Newcome v. Esrey, 862 F.2d 1099, 1101-07 (4th Cir.

1988) (overruling Newman v. Prior, 518 F.2d 97 (4th Cir. 1975));

Stephenson v. Paine Webber Jackson & Curtis, Inc., 839 F.2d 1095,

1100 (5th Cir.); Schlifke v. Seafirst Corp., 866 F.2d 935, 942-43

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(7th Cir. 1989)(overruling Daniel v. Teamsters, 561 F.2d 1223

(7th Cir. 1977), rev'd on other grounds, 439 U.S. 551 (1979));

Deviries v. Prudential-Bache Sec., Inc., 805 F.2d 326, 328 (8th

Cir. 1986); Puchall v. Houghton, Cluck, Coughlin & Riley (In re

Washington Pub. Power Supply Sys. Sec. Litig.), 823 F.2d 1349,

1350 (9th Cir. 1987) (overruling Mosher v. Kane, 784 F.2d 1385

(9th Cir. 1986); Stephenson v. Calpine Conifers II, Ltd., 652

F.2d 808, 815 (9th Cir. 1981)); Zink v. Merrill Lynch Pierce

Fenner & Smith, Inc., 13 F.3d 330, 334 (10th Cir. 1993); Currie

v. Cayman Resources Corp., 835 F.2d 780, 784-85 (11th Cir. 1988).

We now come to the same conclusion.

In determining whether an implied private right of

action exists in a statute, we look to congressional intent, see

Touche Ross, 442 U.S. at 574-76, keeping in mind that there is a

strong presumption against such inferences. See Sterling Suffolk

Racecourse v. Burrellville Racing, 989 F.2d 1266, 1268 (1st Cir.

1993). In this case, we do not find sufficient evidence of

congressional intent to overcome the presumption. As the

district court observed, Congress explicitly provided for private

causes of action in sections 11 and 12 of the 1933 Act. While

the fact that other provisions of a complex statutory scheme

create express remedies does not in itself prove that Congress

did not imply a private remedy in another section, see Cannon v.

University of Chicago, 441 U.S. 677, 690 n.13 (1979), where the

explicit remedies in the same statute address much of the same

conduct and benefit the same parties as a potential implied

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private cause of action, the circumstances militate against that

inference. Furthermore, the legislative history of section 17(a)

does not, on the whole, favor an implied private right of action.

See Newcome, 862 F.2d at 1103-07 (conducting an in-depth

examination of the legislative history of this provision).

Therefore, the district court did not err in dismissing the

plaintiffs' claim under section 17(a) of the 1933 Act.

III. Section 12(2) of the 1933 Act
III. Section 12(2) of the 1933 Act

Plaintiffs also brought suit under section 12(2) of the

Securities Act. This provision establishes civil liability for

any person who uses fraudulent means to sell a security.1

1 According to 15 U.S.C. 77l(a)(2):

Any person who . . . offers or sells a
security . . . by the use of any means or
instruments of transportation or
communication in interstate commerce or of
the mails, by means of a prospectus or oral
communication, which includes an untrue
statement of a material fact or omits to
state a material fact necessary in order to
make the statements, in the light of the
circumstances under which they were made, not
misleading (the purchaser not knowing of such
untruth or omission), and who shall not
sustain the burden of proof that he did not
know, and in the exercise of reasonable care
could not have known, of such untruth or
omission, shall be liable . . . to the person
purchasing such security from him, who may
sue either at law or in equity in any court
of competent jurisdiction, to recover the
consideration paid for such security with
interest thereon, upon the tender of such
security, or for damages if he no longer owns
the security.

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However, after the complaint was filed in this case, the Supreme

Court conclusively decided that section 12(2) applies exclusively

to "initial public offerings." See Gustafson v. Alloyd Co., 513

U.S. 561, 577-78 (1995). The district court, ruling that the

pleadings established that PRIBANK stock had been placed

privately, dismissed the 12(2) claim. Plaintiffs appeal this

ruling, arguing that their pleadings did not admit that PRIBANK

stock was placed privately. Since Gustafson was decided after

their complaint was filed, the plaintiffs argue that they should

have received permission to amend their complaint, which

currently fails to explicitly address whether PRIBANK's stock was

placed privately or publicly. Therefore, the question for this

court to decide is whether the pleadings, in their current form,

establish that PRIBANK's stock was placed privately.

A placement of stock is private if it is offered only

to a few sophisticated purchasers who each have a relationship

with the issuer, enabling them to command access to information

that would otherwise be contained in a registration statement.

See Cook v. Avien, Inc., 573 F.2d 685, 691 (1st Cir. 1978). "The

determination of whether an offer is not public has not been

relegated to a simple numerical test." See Van Dyke v. Coburn

Enters, Inc., 873 F.2d 1094 (8th Cir. 1989) (citing SEC v.

Ralston Purina Co., 346 U.S. 119, 125 (1953)). Instead, courts

are required to weigh the facts of each case carefully to assess

whether the offerees need to be protected under the 1933 Act.

See Ralston Purina, 346 U.S. at 127.

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In this case, twelve invitations were sent to Dean

Witter clients. Dom nguez had personally managed accounts in the

past for each of them. The plaintiffs were not merely asked

passively to invest in an existing entity, but to partner in

starting a new corporation. Each shareholder of PRIBANK bought a

5.5% interest in the corporation and a seat on the board of

directors. The board was to meet each month, and according to

PRIBANK's by-laws the board of directors had full control and

direction of the corporation's affairs and business.

Section 12(2) of the 1933 Act protects those investors

who would otherwise be powerless against fraudulent offers of

securities. When a select group of investors are asked to become

directors of a new corporation, and have access to all documents

relevant to the corporation's formation and investments, they

cannot bring suit under section 12(2) when the corporation fails

for the reasons claimed in this suit. Let us be clear. We do

not mean to suggest that a director has no remedy when defrauded

by others within a new corporation, but only that, under

Gustafson, section 12(2) of the 1933 Act is not available to this

class of claimants. Under these circumstances, there was no need

to allow leave to amend the pleadings on this issue. We

therefore affirm the district court's dismissal of this claim

under Rule 12(b)(6).2

2 Plaintiffs maintain that Dom nguez' statements could form the
basis of section 12(2) claims in spite of the fact that they did
not appear in the prospectus, because section 12(2) applies more
broadly to initial public offerings which are exempted from SEC
registration -- in this case due to the "intrastate" character of

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IV. Section 10(b) of the 1934 Act (SEC Rule 10b-5)
IV. Section 10(b) of the 1934 Act (SEC Rule 10b-5)

Plaintiffs also seek relief under section 10(b) of the

Exchange Act, 15 U.S.C. 78j(b), and SEC Rule 10b-5 promulgated

thereunder, 17 C.F.R. 240.10b-5, which prohibit any person,

directly or indirectly, from committing fraud in connection with

the purchase or sale of securities. See id.; Gross v. Summa

Four, Inc., 93 F.3d 987, 992 (1st Cir. 1996).3 Unlike section

17(a), section 10(b) requires that plaintiffs plead -- with

sufficient particularity to withstand Fed. R. Civ. P. 9(b) --

that defendants acted with "scienter." Scienter has been defined

as "a mental state embracing intent to deceive, manipulate, or

defraud." See Ernst, 425 U.S. at 193 n.12. Plaintiffs allege

that Dom nguez and Rosado understood and concealed the risks of

margin calls on the PRIBANK investments.

This circuit has been clear and consistent in holding

PRIBANK's offering. By concluding that PRIBANK's stock was
placed privately, we need not reach this issue.

3 Under section 10(b) of the 1934 Act:

It shall be unlawful for any person, directly
or indirectly, by the use of any means or
instrumentality of interstate commerce or of
the mails, or of any facility of any national
securities exchange--
(b) To use or employ, in connection with the
purchase or sale of any security registered
on a national securities exchange or any
security not so registered, any manipulative
or deceptive device or contrivance in
contravention of such rules and regulations
as the Commission may prescribe as necessary
or appropriate in the public interest or for
the protection of investors.

15 U.S.C. 78j.

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that, under section 10(b), plaintiffs must plead specific facts

giving rise to a "strong inference" of fraudulent intent. See

Greenstone v. Cambex Corp., 975 F.2d 22, 25 (1st Cir. 1992).4

"Courts have uniformly held inadequate a complaint's general

averment of the defendant's 'knowledge' of material falsity

unless the complaint also sets forth specific facts that make it

reasonable to believe that defendant knew that a statement was

false or misleading." Id. Applying this standard to plaintiffs'

complaint, the district court dismissed the claim for failure to

plead scienter with sufficient particularity.5

"This court has been 'especially rigorous' in applying

Rule 9(b) in securities fraud actions 'to minimize the chance

that a plaintiff with a largely groundless claim will bring a

suit and conduct extensive discovery in the hopes of obtaining an

increased settlement, rather than in the hopes that the process

will reveal relevant evidence.'" Shaw v. Digital Equip. Corp.,

82 F.3d 1194, 1223 (1st Cir. 1996) (quoting Romani v. Shearson,

4 Even if plaintiffs wish to prove scienter by "recklessness,"
they still must allege, with sufficient particularity, that
defendants had full knowledge of the dangers of their course of
action and chose not to disclose those dangers to investors. See

Cook, 573 F.2d at 692.

5 In December 1995, citing "abuse in private securities
lawsuits," Congress enacted the Private Securities Litigation
Reform Act of 1995 (the "Reform Act"). 15 U.S.C. 78u-4 (1988 &
Supp. 1995). This Act implemented a "heightened" pleading
standard under federal securities law which requires that factual
allegations be of sufficient particularity to give rise to a
strong inference that the defendant acted with the requisite
state of mind. 15 U.S.C. 78u-4(b)(1). Although the Reform Act
does not retroactively apply to this case, we do not interpret
the new standard to differ from that which this court has
historically applied. See Greenstone, 975 F.2d at 22.

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Lehman, Hutton, 929 F.2d 875, 878 (1st Cir. 1991)). However, in

examining a complaint for the requisite particularity in

allegations of fraud, we are required to apply a delicate

standard. While Fed. R. Civ. P. 9(b) proscribes the pleading of

"fraud by hindsight," we also cannot expect plaintiffs to plead

"fraud with complete insight" before discovery is complete. Id.

at 1225. We therefore look carefully for specific allegations

of fact giving rise to a "strong inference" of fraudulent intent,

see Greenstone, 975 F.2d at 25, keeping in mind that the pleading

of scienter "may not rest on a bare inference that a defendant

'must have had' knowledge of the facts." Id. at 26 (quoting

Barker v. Henderson, Franklin, Starnes & Holt, 797 F.2d 490, 497

(7th Cir. 1986)).6

The plaintiffs' brief argues that Dom nguez and Rosado

6 Plaintiffs urge this court to adopt a new means for testing
whether scienter has been properly pled in 10(b) claims.
According to plaintiffs, the Second Circuit's "motive and
opportunity" test properly screens out those claims which lack
the requisite specificity to proceed with discovery. See, e.g.,

Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir. 1996)

(determining whether defendants had the motive and opportunity to
commit fraud); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124,

1128 (2d. Cir. 1994) (same). It is unclear whether this test is
compatible with this circuit's "especially rigorous" application
of Rule 9(b) in the securities fraud context. In any case, this
court has had the opportunity to develop a framework for
analyzing the sufficiency of pleadings in cases similar to the
present one, and we respectfully decline the invitation to review
or adopt Second Circuit case law on this issue. Cf. Bruce G.

Vanyo, Lloyd Winawer & David Priebe, The Pleading Standard of the

Private Securities Litigation Reform Act of 1995, PLI Corp. Law &

Practice Course Handbook Series, Sept. 1997, 71-81, available in
Westlaw at 1015 PLI/Corp. 71 (chronicling how Congress expressly
rejected the Second Circuit's "motive and opportunity" test for
pleading scienter in the Reform Act because it was incompatible
with the Act's heightened pleading requirements).

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were "persons highly knowledgeable and with much expertise in the

field of securities and investments of the type purchased by

PRIBANK." However, the complaint dismissed by the district court

paints a somewhat different picture. According to the complaint,

although both Dom nguez and Rosado were vice-presidents of large

financial institutions, "neither one of them had engaged in a

REPO transaction on behalf of any bank with assets similar to

those of PRIBANK, and had no manner to assure that what they

represented to plaintiffs and the other investors was true."

Given 10(b)'s requirement of a pleading of scienter,

characterizing the defendants as irresponsible or "in over their

heads" does not further the plaintiffs' cause.

The complaint is also replete with allegations based on

"information and belief" that Dom nguez and Rosado were aware of

the risk of margin calls. However, "information and belief"

alone is insufficient to meet 9(b)'s particularity requirement in

this context. See Romani v. Shearson, Lehman, Hutton, 929 F.2d

875, 878 (1st Cir. 1991).

When we examine these pleadings carefully, we find that

there are no specific allegations of fact which strongly imply a

fraudulent intent. At most, the complaint contains general

inferences that Dom nguez and Rosado "must have known" about the

risks of margin calls and the devastating effect they could have

on PRIBANK. Unfortunately for the plaintiffs, these are

precisely the types of inferences which this court, on numerous

occasions, has determined to be inadequate to withstand Rule 9(b)

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scrutiny. See Shaw, 82 F.3d at 1123; Serabian v. Amoskeag Bank

Shares, 24 F.3d 357, 367 (1st Cir. 1994); Greenstone, 975 F.2d at

26; Romani, 929 F.2d at 878.7

V. Leave to Amend the Complaint
V. Leave to Amend the Complaint

After the district court's opinion issued in this case,

the plaintiffs filed a motion for leave to amend the pleadings.

The court denied this motion. However, before ruling on

defendants' motions to dismiss, the district court had issued a

perplexing margin order amending this case's briefing schedule.

According to the margin order, any motion requesting leave to

amend pleadings and amended pleadings could be filed ten days

after the court resolved all "pending pleadings." While the

meaning of the phrase "pending pleadings" is unclear, plaintiffs

argue that the phrase referred to the pending motions to dismiss,

and that the denial of their subsequent request for leave to

amend was therefore an abuse of discretion.8

7 The complaint contains additional allegations that Dom nguez
and Rosado knew that PRIBANK was disintegrating at the same time
that they presented a rosy picture to investors at the February
board meeting. However, these allegations involve activity
occurring well after the original sale of PRIBANK stock, and are
therefore immaterial for the purposes of this 10(b) cause of
action. See Gross, 93 F.3d at 993 (citing Shaw, 82 F.3d at 1222,

for the proposition that allegations of conduct occurring after
sale or exchange at issue in 10(b) claim are irrelevant). Even
if the allegations are true, the fact that Dom nguez and Rosado
had discovered PRIBANK's fatal flaw before the February board
meeting is not probative of any attempt to defraud the plaintiffs
months earlier.

8 We note that a motion to dismiss is not a "pleading" as the
term is defined in Fed. R. Civ. P. 7. Furthermore, the order
does not promise to grant any motions filed after the resolution

of "pending pleadings," but instead states that such requests and
pleadings may be filed. Nonetheless, we believe that plaintiffs'

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Looking at the order itself does not resolve our

uncertainty about its interpretation. The motion that was

granted via margin order was five pages long. It was entitled

"Plaintiffs' Objections and Proposed Changes to Scheduling Order"

and generally consisted of very ordinary requests for extensions

of time. Buried on the third page, however, was a short

paragraph containing the vague and confusing language sampled

above, which could be interpreted as a request for a highly

unconventional scheduling change. When the district court judge

granted the motion, he did so by writing "granted" in the left

margin of the first page, as is customary in district courts. It

is entirely possible that the judge was unaware of the unusual

and arguably improper request that he was supposedly granting

along with the standard extensions contained in the motion.

However, while the motion filed by the plaintiffs was unclear, it

could not be fairly characterized as deceptive. Since no motion

to reconsider this margin order was filed, and no clarification

or amendment to the order issued from the court, we must give the

order its reasonable construction.

This court is asked to determine the meaning,

propriety, and effect of the margin order. Depending upon the

interpretation of the motion, two bedrock principles of civil

procedure may conflict in this case. On the one hand, a district

court cannot allow an amended pleading where a final judgment has

interpretation of the order as a blank check to rewrite the
complaint after the case has been dismissed is not entirely
implausible.

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been rendered unless that judgment is first set aside or vacated

pursuant to Fed. R. Civ. P. 59 or 60. See Acevedo-Villalobos v.

Hern ndez, 22 F.3d 384, 389 (1st Cir. 1994). On the other hand,

the district court's scheduling order purportedly allowed

plaintiffs just such a luxury, and, if it did, they were entitled

to rely on that order. See Berkovitz v. Home Box Office, Inc.,

89 F.3d 24, 29-30 (1st Cir. 1996) ("[W]hen a court charts a

procedural route, lawyers and litigants are entitled to rely on

it.").

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Under these circumstances, we are keenly interested in

the district court's interpretation of its own order. On review,

we cannot hope to understand the nuances of a district court's

briefing schedule as completely as the judge who managed the

case. There may well have been comments made in scheduling

conferences which clarified the order. Unfortunately, the

plaintiffs never raised this issue below. Plaintiffs' request

for leave to amend was part of its motion to reconsider the

dismissal of its claims, and it contained no mention of the

margin order or plaintiffs' understanding that they had been

promised a leave to amend. This failure to raise the issue

before the district court is fatal to the claim on appeal. See

Villafa e-Neriz v. F.D.I.C., 75 F.3d 727, 734 (1st Cir. 1996).

We must be especially vigilant in applying this rule where the

dispute involves an understanding reached by the parties and the

district court during the pre-trial stages of a case.

In any case, we need not remand this case to allow for

a revision of the complaint because the amendments proposed by

the plaintiffs would be futile. See Foman v. Davis, 371 U.S. 178

(1962) (leave to amend shall not be granted where amendments

would be futile); Resolution Trust Corp. v. Gold, 30 F.3d 251,

253 (1st Cir. 1994) (same). In their request for leave to amend,

and again before this court, plaintiffs allude to the factual

allegations which they would incorporate into an amended

complaint, producing detailed documentary evidence for support.

Nonetheless, a careful review of this material reveals that these

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amended claims would be destined for dismissal.

There exists no private right of action under section

17(a) of the 1933 Act, and section 12(2) of the Act does not

apply to the issuance of securities under the circumstances

presented by this case. See supra Sections II & III. No further

factual allegations can save these claims. Furthermore, while

the 10(b) action could survive dismissal if plaintiffs could

provide more specific allegations of fact which strongly imply a

fraudulent intent on the part of Dom nguez and Rosado, the

proposed amendments to the complaint would not do so. Plaintiffs

provide an expert's affidavit concluding that defendants would

have known of the likelihood that their securities would be

subject to margin calls, and the devastating effect that this

would have on PRIBANK. Yet, as we have stated, the pleading of

scienter "may not rest on a bare inference that a defendant 'must

have had' knowledge of the facts." Greenstone, 975 F.2d at 26

(quoting Barker, 797 F.2d at 497).9 We conclude that the amended

10(b) claim would not have passed 9(b) scrutiny.10

9 Furthermore, this affidavit, along with plaintiffs' other
documentary evidence in support of their request for leave to
amend, indicates that Dom nguez and Rosado invested and lost one
and a half million dollars of their own money in PRIBANK, which

undermines any inference of scienter.

10 Plaintiffs also argue that they filed requests for leave to
amend their complaint prior to the resolution of the motions to

dismiss. We find that these "motions" were never actually filed.
Instead, the plaintiffs, in other filings, merely mentioned that,
at some point, they would seek leave to amend. That leave was
not sought until after the case was dismissed. In any case, the
issue is mooted by our finding that amending the complaint would
be futile.

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CONCLUSION
CONCLUSION

For the reasons stated in this opinion, we affirm the
affirm

judgment of the district court.

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