IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
February 17, 2009
No. 08-20059 Charles R. Fulbruge III
Clerk
ROBERT A. BRUNIG, Individual, doing business as
Brunig & Associates,
Plaintiff - Appellant
v.
JOHN S. CLARK, et al.
Defendants - Appellees
Appeal from the United States District Court
for the Southern District of Texas
Before HIGGINBOTHAM, BENAVIDES, and STEWART, Circuit Judges.
PATRICK E. HIGGINBOTHAM:
Appellant Robert Brunig, a Texas attorney, appeals the dismissal of
federal securities fraud, RICO, and state law claims brought against his former
client, Appellee John Clark, to recover legal fees Clark allegedly owed him. He
also appeals the imposition of Rule 11 sanctions requiring him to pay Clark
$33,388.77 as the cost of defending against his suit.
I
In March 2004, Clark retained Brunig’s legal services to remove liens on
and restore royalty payments from Clark’s mineral leases in Anderson County,
Texas, termed by the parties the Temple-Eastex leases. The fee arrangement
No. 08-20059
provided that Brunig was to receive on a contingent basis forty percent “of all
monies and other payment or property (including the value of all property whose
title is cleared and returned to Client) collected.”
Brunig’s efforts on behalf of Clark met with mixed success. In response
to actions brought against Clark by various parties seeking interests in Clark’s
leases, Brunig filed suit against those plaintiffs in federal court on RICO and
fraud claims. The complaint was dismissed for failure to state a claim by the
district court, and we affirmed.1 However, Brunig did successfully clear Clark’s
Temple-Eastex land, leases, and equipment from all lien claims. For this
success, Brunig sought to collect a forty percent contingency fee.
Contentious negotiations between Brunig and Clark over the fee followed.
Brunig wanted a quick sale of the Temple-Eastex leases from which he could
collect forty percent. Clark was reluctant to seek a buyer. After a significant
amount of correspondence, the parties met and agreed that Clark would
continue to hold the leases for the foreseeable future, but Brunig would receive
forty percent of lease production until its sale, at which time he would receive
forty percent of the sale price.
A few weeks after their agreement, Clark exchanged the Temple-Eastex
leases for oil and gas leases in Madisonville County, Texas. Brunig alleges that
Clark’s employee, Michael Wilson represented to him that through the exchange
Brunig would receive a forty percent interest in the Madisonville leases, that all
of the leases’ expenses would be paid out of revenues, and that he would receive
a greater return from the Madisonville leases than he would have from the
Temple-Eastex leases. On Wilson’s representations, but without seeing the
exchange agreement, the underlying leases, or the operating agreements, Brunig
consented and signed the assignment and the division order.
1
Clark v. Douglas, 2008 WL 58774, No. 06-40364 (5th Cir. 2008).
2
No. 08-20059
Then, approximately one month later, Brunig received a bill for $13,761.31
purporting to cover his portion of Madisonville’s February and March operating
expenses. Brunig was outraged; he had not expected to have to put up cash for
operating expenses. He also suspected that in exchanging the Temple-Eastex
leases for the Madisonville leases, Clark improperly pushed two months of the
Temple-Eastex expenses onto the Madisonville books. Brunig refused to pay the
invoice, and as a result, Clark sent him a notice of default.
Brunig responded by suing Clark, Clark’s trust, his company, and his
daughter alleging federal securities fraud and RICO violations, in addition to
various state law claims. The district court dismissed for failure to state a claim
and imposed sanctions on Brunig, who now appeals. We review the district
court’s grant of Appellees’ motion to dismiss for failure to state a claim de novo.2
II
Brunig first launches procedural challenges, none of which have merit.
First, Brunig contends that because Appellees filed an answer to his complaint
before the district court had ruled on their motion to dismiss, the motion was
mooted. Brunig points to F ED R. C IV. P. 12(b) which requires that motions to
dismiss be made “before pleading if a responsive pleading is allowed.” The Rule
belies Brunig’s point. In accordance with the Rule, Appellees filed their motion
to dismiss before their answer and they were not obligated to wait to answer
until the court had ruled on the motion.
Next, Brunig argues that the district court violated the non-delegation
doctrine by referring the motion to dismiss to a magistrate judge. This claim is
meritless; “a judge may designate a magistrate judge to conduct hearings,
including evidentiary hearings, and to submit to a judge of the court proposed
findings of fact and recommendations for the disposition, by a judge of the court,
2
Brown v. US, 227 F.3d 295, 297–98 (5th Cir. 2000).
3
No. 08-20059
of any motion [to dismiss].”3 Relatedly, Brunig contends that he did not consent
to the magistrate. But “the consent of the parties is not required” for such a
reference.4
Brunig also claims that the district court judge did not review the
magistrate’s report de novo, basing this assertion on the bare fact that the
district court’s order does not explicitly state that it conducted a de novo review.
There is no evidence that the district court did not conduct a de novo review.
Without any evidence to the contrary, and in a case where the relevant record
includes only the complaint, we will not assume that the district court did not
conduct the proper review.5
Finally, Brunig urges that the district court dismissed his case on grounds
not raised in the motion to dismiss, thus depriving him of an opportunity to
respond. This contention is not supported by the record. Appellees’ motion to
dismiss sought dismissal of the federal securities fraud and RICO claims because
the complaint failed to state a claim. The district court agreed and granted the
motion.
III
Brunig also challenges the dismissal on substantive grounds. His
complaint alleged two federal securities fraud claims, one under § 12(2) of the
Securities Act of 1933 and another under § 10(b) of the Securities Exchange Act
of 1934. The district court dismissed both claims for failure to plead fraud with
particularity.6
3
28 U.S.C. § 636(b)(1)(B).
4
Newsome v. EEOC, 301 F.3d 227, 230 (5th Cir. 2002).
5
See Kreimerman v. Casa Veerkamp, 22 F.3d 634, 646 (5th Cir. 1994).
6
The district court’s order dismissed solely based on the failure to adequately plead
securities fraud. We nevertheless note that Appellees’ motion to dismiss seriously misstated
the law in arguing that the exemption in 15 U.S.C. § 77c(a)(11) for wholly intrastate offerings
4
No. 08-20059
We address the claims separately. As to the § 12(2) claim, regardless of
whether the complaint pleads fraud with particularity, the claim fails for a more
fundamental reason—the Supreme Court in Gustafson v. Alloyd Co.7 interpreted
§ 12(2) of the Securities Act to apply only to initial public offerings or sales made
to the public through a widely-disseminated prospectus. Section 12(2) is
unavailable in a privately-negotiated assignment such as the assignment
present in this case. The dismissal of that claim is AFFIRMED.8
Section 10(b) of the Securities Exchange Act of 1934 applies more broadly,
generally dealing with post-distribution securities trades. Rule 10b-5 makes it
unlawful 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 . . . in connection
with the purchase or sale of any security.”9 Our case law has distilled the
regulation’s language into well-settled elements: to state a cause of action a
plaintiff must allege “1) a misstatement or omission 2) of material fact 3)
occurring in connection with the purchase or sale of a security, that 4) was made
with scienter and 5) upon which the plaintiff justifiably relied, 6) and that
proximately caused injury to the plaintiff.” 10 The district court dismissed on the
applied in this case. The exemption does not apply to § 12(2) because § 12(2) explicitly imposes
liability “whether or not exempted by the provisions of section 77c of this title.” 15 U.S.C.
77l(2). The exemption also does not apply to § 10(b) claims under the Exchange Act of 1934.
The exemption is found in the Securities Act of 1933.
7
513 U.S. 561 (1995).
8
“We need not accept the district court’s rationale and may affirm on any grounds
supported by the record.” Brown v. US, 227 F.3d 295, 298 (5th Cir. 2000) (quoting McGruder
v. Will, 204 F.3d 220, 222 (5th Cir. 2000)).
9
17 C.F.R. § 240.10b-5.
10
Rosenzweig v. Azurix Corp., 332 F.3d 854, 865 (5th Cir. 2003).
5
No. 08-20059
grounds that Brunig failed to plead Clark’s misstatements with particularity as
required by the Private Securities Litigation Reform Act.11
While we agree with the district court that Brunig’s complaint tends to the
unartful and prolix, it does explicitly allege misstatements and omissions
attributable to Clark. Brunig alleges that shortly after February 13, 2007,
Clark’s employee Michael Wilson informed him that as a result of the Temple-
Eastex for Madisonville lease exchange, Brunig would receive a forty percent
working interest and a twenty percent net revenues interest in the Madisonville
leases on which he “would not be required to make any payments as the owner
of a working interest, but all expenses would be paid out of revenues.” Brunig
alleges that he relied on the statement—which proved misleading as Brunig
received a substantial bill for operating expenses—agreeing to the assignment
“in good faith based on Michael Wilson’s representations.”
Brunig also alleges an omission. After Brunig executed the assignment for
his interests, he requested and received from the Madison County Clerk
documentation indicating that Clark, in addition to the sixty percent working
interest and thirty percent net revenue interest that he had informed Brunig he
was taking, had also taken overriding royalty interests in the Madisonville
leases. Because overriding royalty interests reduce the amount of production
available to the working interests, that Clark was taking such an interest was
material to Brunig’s decision to invest in the lease.
In addition to pleading omissions and misstatement with particularity, a
plaintiff must also “state with particularity facts giving rise to a strong inference
11
15 U.S.C. § 78u-4(b)(1) ( . . . “the complaint shall specify each statement alleged to
have been misleading, the reason or reasons why the statement is misleading, and, if an
allegation regarding the statement or omission is made on information and belief, the
complaint shall state with particularity all facts on which that belief is formed.”).
6
No. 08-20059
that the defendant acted with the required state of mind.” 12 The requisite
scienter includes “severe recklessness,” which we find is at play here. Based on
the nature of working interests—which are by definition the lease interest that
bears the cost of operations—Appellees’ were either aware of the possibility that
Brunig would have to make cash payments or severely recklessness in not
realizing this possibility. Clark and his agent Michael Wilson were in possession
of the exchange agreements, the leases, and the leases’ operating agreements,
which despite Brunig’s requests were only belatedly provided to him, and these
documents put them in the position to know which parties would bear the costs
of developing the leases. This situation, as alleged in Brunig’s complaint,
supports an inference that Appellees’ knew, or recklessly disregarded, that there
was at least a possibility Brunig would have to make payments for operating
expenses.
That Clark was taking a secret overriding royalty interest in line for
payment above Brunig’s interest also supports a strong inference of scienter; the
inference that Clark omitted to inform Brunig of his overriding royalty to induce
Brunig to accept an interest that would have been less attractive had the
disclosure been made. Thus, we find that Brunig adequately, though unartfully,
pled a securities fraud claim under § 10(b) of the Securities Exchange Act of
1934.13
12
15 U.S.C. § 78u-4(b)(2).
13
The parties do not contest, and therefore we do not address, whether Brunig’s
interest in the Madisonville leases constitutes a “security” under the Securities Exchange Act.
See Adena Exploration, Inc. v. Sylvan, 860 F.2d 1242 (5th Cir. 1988).
7
No. 08-20059
IV
Regarding Brunig’s RICO claims, dismissal under Rule 12(b)(6) is
appropriate unless the complaint pleads “enough facts to state a claim to relief
that is plausible on its face.”14
In order to state a claim under RICO, a plaintiff must allege, among other
elements, the existence of an enterprise. Brunig’s complaint does not make
plausible that either a legal enterprise or an association-in-fact existed. His
complaint alleges that “Clark, the Trust, CPLI, Liedtke, BBC, and others, known
and unknown, associated themselves in fact.” This is a conclusory statement,
a recitation of the elements masquerading as facts. It does not make it any more
or less probable that the listed parties have an existence separate and apart
from the pattern of racketeering, are an ongoing organization, and function as
a continuing unit as shown by a hierarchical or consensual decision making
structure.15 We affirm the dismissal of Brunig’s RICO claims.
V
On the recommendation in the magistrate’s report, the district court
imposed Rule 11 sanctions on Brunig, ordering him to pay $33,388.77 to
Appellees as the reasonable attorneys’ fees incurred defending against his suit.
The parties agree that the court imposed the sanctions on its own initiative,
because even though Appellees’ filed a motion seeking sanctions, their motion
failed to follow the safe harbor procedures of Rule 11.16
14
Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007).
15
See Crowe v. Henry, 43 F.3d 198, 205 (5th Cir. 1995).
16
A party’s motion for sanctions must first be served on the opposing party and cannot
be filed with the court until twenty-one days after service, thus giving the opposing party an
opportunity to correct its actions. See FED . R. CIV . P. 11(c)(1)(A).
8
No. 08-20059
Brunig contests that the district court did not follow the required
procedure for imposing sua sponte sanctions. Rule 11, at the time sanctions
were imposed in this case, stated in relevant part:
On its own initiative, the court may enter an order
describing the specific conduct that appears to violate
subdivision (b) and directing an attorney, law firm, or party
to show cause why it has not violated subdivision (b) with
respect thereto.
We have held that a district court imposing sua sponte sanctions abuses
its discretion by disregarding Rule 11 ’s procedural requirements that it issue
a show cause order and describe the specific offensive conduct.17 Brunig’s brief
asserts that the district court never issued a show cause order. This assertion
misstates the record—the magistrate report’s final section described Brunig’s
conduct, recommended that the district court judge impose sanctions, and
directed Brunig “[i]f [he] chooses to show cause why sanctions may not be
warranted in this case.” 18 This report was filed September 24, 2007, over two
months before the district court ordered sanctions on December 7, 2007. Brunig
had ample time to show cause why sanctions should not be entered. And, in fact,
on October 10, 2007 Brunig did object to the magistrate judge’s sanctions
recommendation in a document styled “Robert A. Brunig’s Objection to Report
& Recommendation.” Brunig’s quibble that he was not given notice through a
show cause order is incorrect.19
17
See Goldin v. Bartholow, 166 F.3d 710, 722 (5th Cir. 1999).
18
We find no fault in the fact that the show cause order occurred in the magistrate
report instead of in a separate, stand-alone order. Rule 11 requires that sanctions motions by
parties “be made separately from other motions and requests.” There is no corollary
requirement for sua sponte show cause orders.
19
Brunig cites Johnson v. Waddell & Reed, Inc., 74 F.3d 147 (7th Cir. 1996), as a case
in which an appellate court reversed sua sponte sanctions because the plaintiff was not
afforded an opportunity to show cause. In that case, however, there was no show cause order
before sanctions were imposed; the district court relied on its grant of the plaintiff’s Rule 59(e)
9
No. 08-20059
Brunig also objects to the nature of the sanction; that the district court
abused its discretion by imposing a sanction of attorneys’ fees. The text of Rule
11 makes plain that a sanction order “directing payment to the movant of some
or all of the reasonable attorneys’ fees” is only available “if imposed on motion
and warranted for effective deterrence.” 20 Here, while Appellees’ filed a
sanctions motion, it did not comply with the Rule 11 safe-harbor requirements.21
Thus, as the parties concede, the sanction was on the court’s own initiative.
Attorneys’ fees paid to another party are not a valid sua sponte sanction under
the Rule.22
We REVERSE and REMAND the sanctions order for the district court’s
reconsideration in light of this opinion. We AFFIRM the dismissal of the § 12(2)
securities fraud claim, but REVERSE the dismissal of the § 10(b) securities
fraud claim and REMAND that claim, along with the supplemental state law
motion for reconsideration as a substitute procedure through which the plaintiff could object
to the sanctions. Id. at 151. The Seventh Circuit rejected this “makeshift procedure”
explaining that “although the district court provided a kind of notice and an opportunity to
respond, this occurred after sanctions had been imposed and while they remained in effect.”
Id. Here, in contrast, Brunig received notice through the magistrate’s report and had ample
opportunity to respond before the district court imposed sanctions.
20
F ED . R. CIV . P. 11(c)(2); see Thornton v. General Motors Corp., 136 F.3d 450, 455 (5th
Cir. 1998).
21
See infra note 16.
22
“This court . . . has affirmed a district court’s determination that the least severe
sanction for a lawsuit that is wholly frivolous is the imposition of reasonable attorneys’ fees
and expenses.” Mercury Air Group, Inc. v. Mansour, 237 F.3d 542, 548 (5th Cir. 2001) (citing
Granader v. McBee, 23 F.3d 120, 124 (5th Cir. 1994)). The affirmed sanction in that case,
however, was pursuant to a motion by a party, not on the court’s initiative as in this case. We
additionally note that the PSLRA provides for a presumption in favor of attorneys’ fees and
costs “for substantial failure of any complaint to comply with any requirement of Rule 11(b)"
in securities fraud cases. See 15 U.S.C. § 78u-4(c)(3). However, the statute also defers to the
procedural rule, stating that courts shall impose sanctions “in accordance with Rule 11.”
Thus, despite the PSLRA’s presumption in favor of attorneys’ fees, that form of sanction is only
available on motion.
10
No. 08-20059
claims, for further proceedings consistent with this opinion. We AFFIRM the
dismissal of the RICO claims.
11