United States Court of Appeals
For the First Circuit
No. 03-2429
IN RE STONE & WEBSTER, INC., SECURITIES LITIGATION
ADELE BRODY, on behalf of herself and all others similarly
situated; FRED DUBOIS, JR., individually and on behalf of all
others similarly situated; ALBERT A. BLANK, on behalf of himself
and all others similarly situated; DAVID B. EVERSON, on behalf of
himself and all others similarly situated; FANNY MANDELBAUM, on
behalf of herself and all others similarly situated; MARK HANSON,
on behalf of himself and all others similarly situated,
Plaintiffs,
RAM TRUST SERVICES, INC., LENS INVESTMENT MANAGEMENT LLC,
Plaintiffs, Appellants,
v.
STONE & WEBSTER, INC., H. KERNER SMITH, THOMAS LANGFORD,
PRICEWATERHOUSECOOPERS, LLP,
Defendants, Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Reginald C. Lindsay, U.S. District Judge]
Before
Boudin, Chief Judge,
Leval, Senior Circuit Judge,*
and Harrington, Senior District Judge.**
September 13, 2005
*
Of the Second Circuit, sitting by designation.
**
Of the District of Massachusetts, sitting by designation.
LEVAL, Senior Circuit Judge. Defendant-appellees H. Kerner
Smith and Thomas L. Langford (“defendants”) petition for rehearing,
contending that the panel decision erred in vacating the district
court’s dismissal of certain “controlling person” claims under §
20(a) of the Securities Exchange Act of 1934 (“Act”), 15 U.S.C. §
78t(a), while simultaneously affirming the district court’s
dismissal of claims under § 10(b) of the Act, 15 U.S.C. § 78j(b),
and Rule 10b-5, promulgated thereunder, 17 C.F.R. § 240.10b-5
(“Rule 10b-5”), relating to the same allegedly false or misleading
statements. See In re Stone & Webster, Inc., Sec. Litig., 414 F.3d
187 (1st Cir. 2005). Defendants’ petition is denied.
Smith and Langford argue that because a controlling person
claim under § 20(a) presupposes an underlying predicate violation
by the controlled person, our affirmance of the district court’s
dismissal of the Rule 10b-5 claims necessitated affirmance also of
the dismissal of the controlling person claims arising from the
same alleged acts of fraud. According to their argument, we
“misapprehended the requirement in the 1934 Act that any claim for
violation of Section 20(a) must be based on an underlying violation
of the securities laws.” They argue that in failing to dismiss the
controlling person claims, we have rejected authoritative precedent
in this circuit. Their argument is based on a fallacious premise.
We found as to certain Rule 10b-5 claims against Smith and
Langford, that while these claims met the requirement of the
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Private Securities Litigation Reform Act (“PSLRA”) and Federal Rule
of Civil Procedure 9(b) that a complaint alleging securities fraud
set forth the basis of the claim with clarity and particularity
(what we called the “clarity-and-basis requirement”), see 15 U.S.C.
§ 78u-4(b)(1), they failed to meet another heightened pleading
requirement of the PSLRA—that the complaint allege facts supporting
a strong inference of the required state of mind (referred to in
the opinion as the “strong-inference” requirement), see 15 U.S.C.
§ 78u-4(b)(2). Because a claim under Rule 10b-5 requires proof of
scienter, and because the complaint failed to allege facts
supporting a strong inference that Smith and Langford acted with
scienter, we affirmed the dismissal of those Rule 10b-5 claims.
We then turned to the parallel claims brought under § 20(a),
arising from the same allegedly false or misleading statements.
These claims asserted controlling person liability against Smith
and Langford, predicated on violations of Rule 10b-5 by the
corporation Stone & Webster.
We considered whether the PSLRA requirement to plead facts
supporting a strong inference of scienter applies to such § 20(a)
claims, and observed that the strong-inference requirement of the
PSLRA applies only in circumstances where the plaintiff’s recovery
depends on proof that the defendant acted with a particular state
of mind. See 15 U.S.C. § 78u-4(b)(2). Based on the language of §
20(a), which treats the defendant’s good faith as a part of the
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defendant’s affirmative defense, and makes no other reference to
the defendant’s state of mind,1 see 15 U.S.C. § 78t(a), we noted
that § 20(a) does not on its face require the plaintiff to prove
any state of mind of the defendant.2 We thus concluded that the
strong-inference requirement of the PSLRA has no application to a
claim under § 20(a).3
We explained:
We recognize that a plaintiff must show under §
1
Section 20(a) provides:
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 to any person to whom 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).
2
Because the parties had not raised the question on appeal,
we left open whether a plaintiff must prove “culpable
participation” on the part of a § 20(a) defendant, and whether the
strong-inference requirement of the PSLRA would need to be met for
this reason. See In re Stone & Webster, Inc., Sec. Litig., 414
F.3d at 194 n.4, 196 n.6.
3
This ruling also was provisional. We recognized possible
policy arguments which, notwithstanding the words of the statute,
might counsel against allowing prosecution of a secondary claim in
circumstances where the predicate claim, standing alone, would be
dismissed for failure to meet the PSLRA’s strong-inference
requirement. In view of the fact that defendants had not advanced
such an argument, we left its final resolution for another day.
See In re Stone & Webster, Inc., Sec. Litig., 414 F.3d at 201 n.11.
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20(a) that the controlled entity committed a violation of
the securities laws. If that violation was, for example,
a violation of Rule 10b-5, which requires a proof of
scienter, then the plaintiff under § 20(a) must prove
that the controlled entity acted with “a particular state
of mind.” Nonetheless, if the statute is read literally,
the strong-inference requirement of the PSLRA does not
apply. The statute states that the strong-inference
requirement applies only where the plaintiff’s recovery
depends on proof that “the defendant acted with a
particular state of mind” (emphasis added). See 15
U.S.C. § 78u-4(b)(2). The obligation to prove that the
controlled corporation acted with scienter does not
involve an obligation to prove “that the defendant acted
with a particular state of mind.”
In re Stone & Webster, Inc., Sec. Litig., 414 F.3d at 201.
The fundamental premise of defendants’ argument on this motion
is mistaken. They maintain that the Rule 10b-5 claims against
Smith and Langford, which were dismissed, allege claims which are
necessary predicates to the claims of controlling person liability
under § 20(a). They seem to argue that without establishing the
primary Rule 10b-5 liability of Smith and Langford, as alleged in
the claims that were dismissed, plaintiffs cannot establish the
secondary liability of Smith and Langford as controlling persons of
Stone & Webster under § 20(a). This is a nonsequitur. The
controlling person claims asserted under § 20(a) are predicated on
Rule 10b-5 violations by the Stone & Webster corporation, not on
Rule 10b-5 violations by Smith and Langford.
The predicate Rule 10b-5 violations could be satisfied by
frauds of Stone & Webster attributable to the actions of numerous
persons. While frauds of Stone & Webster attributable to the acts
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of Smith and Langford might serve as predicates for the controlling
person liability of Smith and Langford under § 20(a), frauds of
Stone & Webster attributable to the acts of other agents might also
serve as predicates for the § 20(a) liability. Thus, the Rule 10b-
5 claims against Smith and Langford that were dismissed were not
necessary predicates to their liability under § 20(a).
The complaint did include claims against Stone & Webster.
Those claims, however, were not dismissed. Prior to the district
court’s dismissal of the claims against Smith and Langford, the
litigation of all claims against Stone & Webster was stayed when
the corporation filed for bankruptcy protection.
Nor was the dismissal of the Rule 10b-5 claims against Smith
and Langford for reasons suggesting that there was no Rule 10b-5
violation by Stone & Webster. For example, the claims were not
dismissed on the basis of a finding that the allegedly fraudulent
statements were not false. Cf. Suna v. Bailey Corp., 107 F.3d 64,
70 (1st Cir. 1997). The dismissal also was not in circumstances
where the liability of Stone & Webster, if it existed at all,
necessarily depended on acts of Smith and Langford and no one else,
so that if Smith and Langford were not liable, Stone & Webster
could not be found liable. To the contrary, the dismissal of the
Rule 10b-5 claims against Smith and Langford was based on our
conclusion that the facts alleged failed to support a strong
inference, as required by the PSLRA, of scienter on the part of
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Smith and Langford.
In short, it is an essential element of the § 20(a)
controlling person claims in question that plaintiffs show a Rule
10b-5 violation by the controlled entity. The controlled entity
is Stone & Webster, not Smith and Langford. The dismissal of Rule
10b-5 claims against Smith and Langford is in no way incompatible
with the establishment of their secondary liability under § 20(a)
as controlling persons of Stone & Webster, predicated on Stone &
Webster having violated Rule 10b-5.
Defendants argue that our decision is inconsistent with our
prior rulings, principally in Greebel v. FTP Software, Inc., 194
F.3d 185, 207 (1st Cir. 1999). Their contention is mistaken. In
Greebel, we affirmed the dismissal of Rule 10b-5 claims against the
controlled corporation, and on that basis affirmed the dismissal of
the corresponding § 20(a) claims against the controlling persons.
See also Suna, 107 F.3d at 69-72. As explained above, that is not
what happened in the present litigation. There is no
inconsistency.
The petition for rehearing is denied.
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