ATSI Communications, Inc. v. Shaar Fund, Ltd.

08-1815-cv
ATSI Communications v. The Shaar Fund, Ltd.

1 UNITED STATES COURT OF APPEALS
2
3 FOR THE SECOND CIRCUIT
4
5 August Term, 2008
6
7
8 (Argued: July 6, 2009 Decided: September 2, 2009)
9
10 Docket No. 08-1815-cv
11
12 - - - - - - - - - - - - - - - - - - - -x
13
14 ATSI COMMUNICATIONS, INC., a Delaware
15 Corporation,
16
17 Plaintiff,
18
19 MARYANN PERONTI, GARY M. JEWELL and JAMES
20 WES CHRISTIAN, CHRISTIAN SMITH & JEWELL,
21 LLP, and KOERNER, SILBERBERG & WEINER, LLP,
22
23 Appellants,
24
25 - v.- 08-1815-cv
26
27 THE SHAAR FUND, LTD., LEVINSON CAPITAL
28 MANAGEMENT, SHAAR ADVISORY SERVICES, N.V.,
29 MARSHALL CAPITAL SERVICES, LLC, JESUP &
30 LAMONT STRUCTURED FINANCE GROUP, RGC
31 INTERNATIONAL INVESTORS, LDC, ROSE GLEN
32 CAPITAL MANAGEMENT L.P., MG SECURITY GROUP,
33 INC., CORPORATE CAPITAL MANAGEMENT, CROWN
34 CAPITAL MANAGEMENT, INTERCARIBBEAN SERVICES,
35 LTD., JOHN DOES 1-50, KENNETH E. GARDINER,
36 CITCO FUNDS SVCS., IUC HOLLMAN, W.J.
37 LANGVELD, SAM LEVINSON, HUGO VAN NEUTEGEM,
38 DECLAN QUILLIGAN, NATHAN LIHON, WAYNE BLOCH,
39 GARY KAMINSKY, STEVE KATZNELSON and SEI
40 INVESTMENT CO.,
41
42 Defendants,
1 KNIGHT CAPITAL MARKETS, LLC,
2
3 Defendant-Appellee.
4
5 - - - - - - - - - - - - - - - - - - - -x
6

7 Before: JACOBS, Chief Judge, CALABRESI and
8 POOLER, Circuit Judges.
9
10
11 Appeal from an order entered in the United States

12 District Court for the Southern District of New York

13 (Kaplan, J.) imposing sanctions on three attorneys and their

14 law firms pursuant to Fed. R. Civ. P. 11 and the mandatory

15 sanctions provision of the Private Securities Litigation

16 Reform Act of 1995 (“PSLRA”), 15 U.S.C. § 78u-4(c). We

17 agree with the district court that the conduct here was

18 unreasonable, and we reject the argument that In re Pennie &

19 Edmonds LLP, 323 F.3d 86 (2d Cir. 2003) required the

20 district court to find subjective bad faith before imposing

21 sanctions. However, because the concerns identified in

22 Pennie remain relevant to assessing the “reasonableness” of

23 an opposing party’s fees under 15 U.S.C. § 78u-4(c)(3), we

24 vacate the amount of the award and remand for further

25 proceedings.

26
27 THOMAS I. SHERIDAN, III, Hanly
28 Conroy Bierstein Sheridan Fisher

2
1 & Hayes LLP, New York, NY, for
2 Appellants.
3
4 THORN ROSENTHAL, Cahill Gordon &
5 Reindel LLP, New York, NY, for
6 Defendant-Appellee.
7
8
9 DENNIS JACOBS, Chief Judge:

10 Three lawyers and their two firms appeal from an order

11 imposing sanctions entered in the Southern District of New

12 York (Kaplan, J.). The lawyers represented plaintiff ATSI

13 Communications, Inc. (“ATSI”) in a lawsuit alleging (inter

14 alia) that Knight Capital Markets, LLC (“Knight”), the

15 principal market-maker in ATSI stock on the American Stock

16 Exchange (“AMEX”) (along with a collection of hedge funds

17 and individual defendants) participated in market

18 manipulation in violation of federal securities laws. The

19 district court dismissed the case as against all defendants,

20 and we affirmed. 493 F.3d 87 (2d Cir. 2007). Thereafter,

21 the district court imposed sanctions on certain lawyers and

22 law firms representing ATSI (collectively the “ATSI

23 attorneys”) pursuant to the mandatory sanctions provision of

24 the Private Securities Litigation Reform Act of 1995

25 (“PSLRA”), 15 U.S.C. § 78u-4(c), on the ground that ATSI had

26 no factual basis for bringing suit against Knight.

3
1 Sanctions were the full amount of Knight’s fees and costs in

2 defending the action, $69,656.69.1

3 The chief question presented on appeal is whether the

4 rule established in In re Pennie & Edmonds LLP, 323 F.3d 86

5 (2d Cir. 2003)(“Pennie”) required the district court to make

6 a finding of subjective bad faith before imposing sanctions.

7 The ATSI attorneys argue that here, as in Pennie, such a

8 finding is needed because the sanctions procedure (initiated

9 by the district court after the litigation was over)

10 afforded them no 21-day safe harbor in which to withdraw or

1
Subsequent to the filing of the instant appeal,
ATSI’s attorneys and Knight entered into a settlement
agreement, the execution of which was made contingent upon
vacatur of the district court’s judgment, and of two related
orders issued by the district court. The parties jointly
moved in this Court for an order vacating the judgment and
the orders. See ATSI Commc’ns, Inc. v. The Shaar Fund,
Ltd., 547 F.3d 109, 111 (2d Cir. 2008). We denied the
motion, explaining that “[d]enial of vacatur here, despite
the possibility that the parties’ settlement efforts may
fail as a result, nonetheless advances ‘the public interest’
in preserving judicial precedent . . . and the proper course
of appellate procedure.” Id. at 113 (quoting U.S. Bancorp
Mortgage Co. v. Bonner Mall P’Ship, 513 U.S. 18, 26–27
(1994)). We acknowledged that the decisions of a federal
district court “are not precedential in the technical
sense,” id. at 112, but added that “we would be hard pressed
to conclude that the judgment here, sanctioning lawyers
appearing before a United States District Court, is
insignificant. And it is precisely to avoid the public’s
scrutiny of the sanctions that ATSI’s counsel seeks
vacatur.” Id. at 114.
4
1 amend the challenged pleading. We conclude that Pennie’s

2 subjective bad faith requirement does not exist in the

3 context of the PSLRA because the statute itself puts

4 litigants on notice that the court must (and therefore will)

5 make Rule 11 findings at the conclusion of private

6 litigations arising under the federal securities laws. Such

7 notice alleviates the concern that animates Pennie: that

8 Rule 11 sanctions should not be sprung on lawyers when they

9 no longer have the chance to withdraw or amend a challenged

10 claim. At the same time, however, that concern should

11 inform consideration as to whether opposing attorney’s fees

12 are “reasonable” under 15 U.S.C. § 78u-4(c)(3).

13

14 BACKGROUND

15 More detailed factual background is provided in our

16 previous opinion in this case, ATSI Commc’ns, Inc. v. Shaar

17 Fund, Ltd., 493 F.3d 87 (2d Cir. 2007)(“ATSI I”).

18 ATSI describes itself as a firm which was “founded in

19 December of 1993 to capitalize on the opportunities

20 anticipated by trends towards deregulation and privatization

21 of telecommunications markets within Mexico and other Latin

5
1 American countries.” In 1999, needing capital,2 ATSI issued

2 four series of convertible preferred stock (“Preferred

3 Stock”), shares of which were convertible, with minimal

4 restrictions, to ATSI common shares in increasing amounts as

5 the price of ATSI common shares declined. Because there was

6 no limit on the number of common shares into which the

7 Preferred Stock could convert, securities such as these are

8 called “floorless” convertibles. ATSI I, 493 F.3d at 94. A

9 holder of such Preferred Stock who wanted to increase

10 ownership or acquire the company could actually benefit from

11 a decline in ATSI share price. Accordingly, ATSI elicited

12 the purchasers’ representations that they would not sell

13 shares short, or were not purchasing with an intent to

14 resell. Id. at 95–96. ATSI issued Preferred Stock at

15 various points to (among others) defendants The Shaar Fund,

16 Ltd. (“Shaar Fund”) and Rose Glen Capital Management, L.P.

17 (“Rose Glen”).

18 Between July 1999 and 2002, ATSI share prices gyrated

19 between $1 and $9 per share, but closed on August 16, 2002

2
ATSI feared that it would not be able to “raise
money on any acceptable terms.” ATSI I, 493 F.3d at 94
(quoting ATSI Annual Report (Form 10-K) at 16 (July 31,
2000)).
6
1 at $0.09. ATSI alleged that these price fluctuations were

2 the result of manipulation by some purchasers of the

3 Preferred Stock, including Shaar Fund and Rose Glen. On the

4 basis of the trading volume and price movements around the

5 time that the Shaar Fund and Rose Glen converted their

6 shares of Preferred Stock, ATSI believed that these

7 defendants and others engaged in a scheme to cause a “death

8 spiral” in ATSI’s share price. It is alleged that the

9 scheme worked as follows:

10 The [defendant] would short sell the
11 victim’s common stock to drive down its
12 price. He then converts his convertible
13 securities into common stock and uses
14 that common stock to cover his short
15 position. The convertible securities
16 allow a manipulator to increase his
17 profits by allowing him to cover with
18 discounted common shares not obtained on
19 the open market, to rely on the
20 convertible securities as a hedge against
21 the risk of loss, and to dilute existing
22 common shares, resulting in a further
23 decline in stock price.
24
25 Id. at 96 (footnote omitted).

26 ATSI sued a host of defendants in October 2002,

27 alleging misrepresentations in connection with securities

28 transactions, and market manipulation in violation of

29 § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.

30 § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. However,

7
1 ATSI’s complaint alleged no specific acts of short selling,

2 and instead relied on circumstantial allegations: past

3 similar practice by Shaar Fund and Rose Glen, and

4 clearinghouse records showing that in a 10-trading-day

5 period (December 31, 2002 to January 14, 2003), over eight

6 million shares were traded in excess of settlement, which

7 (ATSI claimed) could only have resulted from “sham” trading.

8 ATSI I, 493 F.3d at 97.

9 In a First Amended Complaint filed in March 2003, ATSI

10 added a claim of market manipulation against Knight Capital

11 Markets LLC, f/k/a Trimark Securities Inc., (hereinafter

12 “Knight”), the principal AMEX market-maker for ATSI stock.3

13 ATSI failed to serve Knight. Judge Kaplan dismissed the

14 complaint without prejudice as against Shaar Fund and Rose

15 Glen on the ground that its allegations of manipulation were

16 “conclusory,” “offer[ed] no particulars,” and failed to meet

17 the requirements of Rule 9(b). ATSI Commc’ns, Inc. v. Shaar

3
SEC regulations define a “market-maker” as “a dealer
who, with respect to a particular security, (i) regularly
publishes bona fide, competitive bid and offer quotations in
a recognized interdealer quotation system; or (ii) furnishes
bona fide competitive bid and offer quotations on request;
and, (iii) is ready, willing and able to effect transactions
in reasonable quantities at his quoted prices with other
brokers or dealers.” 17 C.F.R. § 240.15c3-1(c)(8).
8
1 Fund, Ltd., No. 02 Civ. 8726(LAK), 2004 WL 616123, at *3

2 (S.D.N.Y. Mar. 30, 2004).4

3 ATSI then filed a Second and Third Amended Complaint.

4 The Third Amended Complaint’s sole allegations concerning

5 Knight were as follows:

6 220. Trimark Securities, a/k/a Knight
7 Securities Group, Inc. (“Knight”) was the
8 principal declared market maker in ATSI
9 stock. Most ATSI trades (including, upon
10 information and belief, the 8,257,493
11 shares that [were traded in excess of
12 settlement]) were traded through Knight.
13
14 221. Any manipulation which took place
15 would have involved Knight, who knew or
16 should have known that they were
17 prohibited from engaging in the activity
18 complained of in paragraphs 184 through
19 219 [which purported to allege
20 manipulation by other defendants].
21
22 222. ATSI believes that Knight was a
23 cooperating broker-dealer with the
24 defendants listed herein engaging in
25 similar trades on behalf of the
26 defendants.
27
28 Third Amended Complaint ¶¶ 220–22.

29 All or most of the defendants, including Knight, moved

4
In addition, the district court granted motions by
various other defendants to dismiss for lack of personal
jurisdiction. ATSI Commc’ns, Inc. v. The Shaar Fund, Ltd.,
No. 02 Civ. 8726(LAK), 2004 WL 909173 (S.D.N.Y. Apr. 28,
2004).

9
1 to dismiss the Third Amended Complaint. In February 2005,

2 the district court granted the motions with prejudice on the

3 ground that the complaint failed to “allege sufficient facts

4 to link this [market] data to any of the defendants.” ATSI

5 Commc’ns, Inc. v. Shaar Fund, Ltd., 357 F.Supp.2d 712, 719

6 (S.D.N.Y. 2005). The court ruled that the allegations

7 against Knight were “even more tenuous . . . [and] far too

8 conclusory to pas[s] muster under Rule 9(b).” Id. at 719.

9 At the end, that order referenced the mandatory

10 sanctions provision of the PSLRA, and “invited” the parties

11 to make submissions as to sanctions. Id. at 721. The court

12 explained that the PSLRA requires a district court, at the

13 conclusion of private actions brought under federal

14 securities laws, to “include in the record specific findings

15 regarding compliance by each party and each attorney

16 representing any party with each requirement of Rule 11(b).”

17 15 U.S.C. § 78u-4(c)(1). If a violation is found, sanctions

18 are mandatory. Id. at § 78u-4(c)(2).

19 Multiple defendants--including Knight–-moved for Rule

20 11 sanctions. In opposition, ATSI submitted affidavits from

21 its counsel, James Wes Christian of Christian Smith &

22 Jewell, LLP (a Houston, Texas firm), and its local counsel,

10
1 Carl S. Koerner, of Koerner, Silberberg & Weiner, LLP,

2 detailing the steps they took prior to bringing suit, and

3 arguing that they had no subjective bad faith. By order

4 dated July 28, 2005, the district court denied the sanctions

5 motions without prejudice to reinstatement pending the

6 appeal of the underlying dismissal.

7 By opinion dated July 11, 2007, we affirmed the

8 district court’s dismissal. ATSI I, 493 F.3d at 104

9 (“[B]ecause ATSI has not adequately pled that the defendants

10 engaged in any short sales or other potentially manipulative

11 activity, there is no circumstantial evidence of

12 manipulative intent.”). As to Knight, we wrote:

13 The complaint is plainly insufficient in
14 alleging that [Knight] engaged in market
15 manipulation. It only alleges that
16 [Knight] was the principal market maker
17 in ATSI’s stock, that [Knight] knew or
18 should have known of the manipulation,
19 and that ATSI “believes” that [Knight]
20 was a cooperating broker-dealer. Wholly
21 absent are particular facts giving rise
22 to a strong inference that [Knight] acted
23 with scienter in manipulating the market
24 in ATSI’s common stock and any
25 allegations of specific acts by [Knight]
26 to manipulate the market, much less how
27 those actions might have affected the
28 market.
29
30 Id. at 104-05 (footnote omitted).

31 After our mandate issued, ATSI entered into settlements

11
1 with all defendants except Knight, and Knight’s motion for

2 sanctions was reinstated. By order dated March 27, 2008,

3 the district court imposed sanctions on the ground that the

4 ATSI attorneys “lacked any reasonable factual basis” for

5 bringing suit against Knight:

6 The third amended complaint makes
7 abundantly clear that plaintiff’s counsel
8 lacked any reasonable factual basis for
9 asserting that Knight had violated the
10 federal securities laws . . . . The only
11 basis for the claim against Knight was
12 that Knight was the principal market
13 maker, that it therefore must have known
14 that the [other] defendants were engaged
15 in manipulation, and that it therefore
16 must have been complicit. But that is
17 simply ridiculous. Even assuming that
18 Knight was the principal market maker,
19 all that it “must have known” is that
20 some person or persons were engaged in
21 large sales of ATSI common [stock].
22
23 ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., No. 02 Civ. 8726

24 (LAK), 2008 WL 850473, at *3 (S.D.N.Y. Mar. 27, 2008)

25 (emphasis added). The district court went on to reject as

26 “vague” the ATSI attorneys’ arguments that they had

27 diligently researched the claims and had consulted with

28 financial experts before bringing suit. Id. Crucially, the

29 district court did not make a specific finding of bad faith.

30 Sanctions in the amount of $69,656.69, representing Knight’s

12
1 total fees and costs,5 were imposed jointly and severally

2 against each of the three lawyers whose names appeared on

3 the Third Amended Complaint, and their two law firms:

4 Maryann Peronti, Gary M. Jewell, and James Wes Christian,

5 and the firms of Christian Smith & Jewell, LLP and Koerner,

6 Silberberg & Weiner, LLP.6 The ATSI attorneys have timely

7 appealed.

8

9 DISCUSSION

10 A district court’s imposition of sanctions under the

11 PSLRA and Rule 11 is reviewed for abuse of discretion.

12 Simon DeBartolo Group, L.P. v. Richard E. Jacobs Group,

13 Inc., 186 F.3d 157, 167 (2d Cir. 1999); cf. Sims v. Blot,

5
Knight did not seek recovery of an additional
$100,000 it claimed to have incurred in connection with
ATSI’s appeal. See Appellee’s Br. at 8 n.4.
6
The day after issuing its sanctions order on March
28, 2008, the district court issued a further order
explaining why it had sanctioned James Wes Christian (of
Christian Smith & Jewell, LLP) notwithstanding that Knight
had not sought sanctions against him. The court explained
that Christian was on ample notice (in light of the other
defendants’ motions for sanctions against him); and that,
under the PSLRA’s mandatory sanction provision, the court is
not bound by the defendant’s notice of motion, but rather
must make specific findings as to “each party and each
attorney representing any party.” See 15 U.S.C. § 78u-
4(c)(1).
13
1 534 F.3d 117, 132 (2d Cir. 2008) (“A district court has

2 abused its discretion if it based its ruling on an erroneous

3 view of the law or on a clearly erroneous assessment of the

4 evidence, or rendered a decision that cannot be located

5 within the range of permissible decisions.” (internal

6 citations, alterations, and quotation marks omitted)). We

7 must bear in mind, however, that when the district court is

8 “accuser, fact finder and sentencing judge” all in one,

9 Schlaifer Nance & Co. v. Estate of Warhol, 194 F.3d 323, 334

10 (2d Cir. 1999), our review is “more exacting than under the

11 ordinary abuse-of-discretion standard,” Perez v. Danbury

12 Hosp., 347 F.3d 419, 423 (2d Cir. 2003).

13 I

14 Rule 11(b)(3) provides in pertinent part that, by

15 presenting a complaint to the court, the attorney signing or

16 filing the complaint “certifies that to the best of the

17 person’s knowledge, information, and belief, formed after an

18 inquiry reasonable under the circumstances, . . . the

19 factual contentions have evidentiary support or, if

20 specifically so identified, are likely to have evidentiary

21 support after a reasonable opportunity for further

22 investigation or discovery.” Fed. R. Civ. P. 11(b)(3).

14
1 Since the inquiry must be “reasonable under the

2 circumstances,” liability for Rule 11 violations “requires

3 only a showing of objective unreasonableness on the part of

4 the attorney or client signing the papers.” Ted Lapidus,

5 S.A. v. Vann, 112 F.3d 91, 96 (2d Cir. 1997)(emphasis

6 omitted).

7 In In re Pennie & Edmonds LLP, 323 F.3d 86, 91 (2d Cir.

8 2003), we recognized an exception to the standard of

9 objective unreasonableness applicable when a district court

10 initiates Rule 11 sanctions sua sponte “long after” the

11 sanctioned lawyer had an opportunity to correct or withdraw

12 the challenged submission. In such cases, a lawyer may be

13 sanctioned only upon a finding of subjective bad faith. Id.

14 The exception is justified in order to strike a proper

15 “balance,” and prevent over-deterrence. Id. at 91. We

16 focused on the procedural differences in how sanctions are

17 imposed under Rule 11(c)(2) and (c)(3). When the sanctions

18 process is initiated by a motion from an opposing party

19 (under Rule 11(c)(2)), the challenged lawyer has a 21-day

20 “safe harbor” to withdraw or amend. When sanctions are

21 initiated by a court sua sponte (under Rule 11(c)(3)), no

22 such safe harbor is afforded. The Advisory Committee’s note

15
1 to the 1993 amendments to Rule 11 explained: “Since show

2 cause orders will ordinarily be issued only in situations

3 that are akin to a contempt of court, the rule does not

4 provide a ‘safe harbor’ to a litigant for withdrawing a

5 claim, defense, etc., after a show cause order has been

6 issued on the court’s own initiative.” Fed. R. Civ. P. 11

7 advisory committee’s note to 1993 Amendments. Pennie

8 reasoned that since show cause orders should only issue in

9 situations “akin to” contempt, and contempt sanctions

10 require a finding of bad faith, Schlaifer Nance, 194 F.3d at

11 338, then court-initiated Rule 11 sanctions should also

12 require a finding of subjective bad faith, at least when

13 sanctions are imposed at the end of a litigation and the

14 sanctioned lawyer has had no opportunity to withdraw or

15 amend. Pennie, 323 F.3d at 90. We perceived a risk that,

16 otherwise, lawyers would be inhibited from filing

17 submissions that they honestly believe
18 have plausible evidentiary support for
19 fear that a trial judge, perhaps at the
20 conclusion of a contentious trial, will
21 erroneously consider their claimed belief
22 to be objectively unreasonable. This
23 risk is appropriately minimized, as the
24 Advisory Committee contemplated, by
25 applying a “bad faith” standard to
26 submissions sanctioned without a “safe
27 harbor” opportunity to reconsider.

16
1 Id. at 91. Pennie stopped short, however, of a blanket rule

2 that the subjective bad faith standard applied whenever

3 there was no longer a safe harbor, finding it sufficient in

4 that case that the court sua sponte initiated sanctions

5 proceedings “long after” the lawyer had an opportunity to

6 amend or withdraw. 323 F.3d at 91.7

7 Pennie drew a sharp dissent, which argued that all Rule

8 11 violations should be assessed under the standard of

9 objective reasonableness, and that the majority over-read

10 the intent of the Advisory Committee.8 And some circuits

11 have declined to follow Pennie. See Young v. City of

7
We wrote: “It is arguable, as [appellant] contends,
that a ‘bad faith’ standard should apply to all
court-initiated Rule 11 sanctions because no ‘safe harbor’
protection is available and because the Advisory Committee
contemplated such sanctions for conduct akin to contempt.
However, we need not make so broad a ruling in the pending
case.” 323 F.3d at 91.
8
Judge Underhill, sitting by designation, argued that
Rule 11 liability should be consistently assessed under the
objective reasonableness standard because that standard is
set forth in Rule 11(b): “The fundamental flaw in the
majority’s interpretation of Rule 11 is that it seeks to use
procedural distinctions drawn in section (c), regarding how
sanctions can be imposed with and without a motion, to
modify the substantive requirements of section (b), which
controls whether a violation of Rule 11 has occurred. Under
a plain reading of Rule 11, the procedural distinctions set
forth in section (c) have no bearing whatsoever on the
state-of-mind requirement of section (b).” 323 F.3d at 94
(Underhill, J., dissenting).
17
1 Providence ex rel. Napolitano, 404 F.3d 33, 40 (1st Cir.

2 2005) (declining to follow Pennie and noting that “only [the

3 Second Circuit] has read the present rule to require bad

4 faith”); Kaplan v. DaimlerChrysler, A.G., 331 F.3d 1251,

5 1256 (11th Cir. 2003) (declining to “resolv[e] the . . .

6 ‘mens rea’ issue that split the Pennie panel”).9

7 In this case, the ATSI attorneys’ principal argument is

8 that, because the sanctions against them were initiated by

9 the court at a time when the ATSI attorneys no longer had an

10 opportunity to amend or withdraw the pleading, Pennie barred

11 imposition of sanctions without a finding of subjective bad

12 faith.

13 This case is distinguishable from Pennie because the

14 statutory wording of the PSLRA puts private securities

15 litigants on sufficient notice that their actions will be

9
Instead of requiring subjective bad faith, other
circuits have urged district courts to use extra care in
imposing sanctions after a lawyer has lost the opportunity
to amend or withdraw the challenged claim. See, e.g.,
Hunter v. Earthgrains Co. Bakery, 281 F.3d 144, 151 (4th
Cir. 2002) (In the absence of the safe harbor, “a court is
obliged to use extra care in imposing sanctions.”); United
Nat’l Ins. Co. v. R & D Latex Corp., 242 F.3d 1102, 1115
(9th Cir. 2001) (Rule 11(b)(2) standard “is applied with
particular stringency where, as here, the sanctions are
imposed on the court’s own motion.”); Barber v. Miller, 146
F.3d 707, 711 (9th Cir. 1998). None of the other circuits
has required a heightened mens rea.
18
1 the subject of Rule 11 findings. The statute

2 requires district courts, at the conclusion of private

3 actions arising under federal securities laws, to make Rule

4 11 findings as to each party and each attorney, 15 U.S.C.

5 § 78u-4(c)(1); and if a Rule 11 violation is found, the

6 statute requires courts to impose sanctions, 15 U.S.C.

7 § 78u-4(c)(2). Such statutory notice is the functional

8 equivalent of the forewarning given litigants by the

9 pendency of a Rule 11 finding. The express congressional

10 purpose of the PSLRA provision was to increase the frequency

11 of Rule 11 sanctions in the securities context, and thus

12 tilt the “balance” toward greater deterrence of frivolous

13 securities claims. “Recognizing what it termed ‘the need to

14 reduce significantly the filing of meritless securities

15 lawsuits without hindering the ability of victims of fraud

16 to pursue legitimate claims,’ and commenting that the

17 ‘[e]xisting Rule 11 has not deterred abusive securities

18 litigation,’ the 104th Congress included in the [PSLRA] a

19 measure intended to put ‘teeth’ in Rule 11.” Simon

20 DeBartolo, 186 F.3d at 166–67 (quoting H.R. Conf. Rep. No.

21 104-369 (1995), reprinted in 1995 U.S.C.C.A.N. 730). By

22 virtue of this statutory notice, consideration of sanctions

19
1 in the PSLRA context can never be sua sponte and can never

2 come as a surprise, because Congress, not the court, has

3 prompted and mandated a Rule 11 finding.

4 The PSLRA sanctions provision forecloses the kind of

5 safe harbor afforded in Rule 11(c)(2). The PSLRA explicitly

6 directs courts to make Rule 11 findings “upon final

7 adjudication of the action,” 15 U.S.C. § 78u-4(c)(1), and it

8 is well-settled that no safe harbor could apply

9 retroactively. See Pennie, 323 F.3d at 89. “The PSLRA

10 . . . does not in any way purport to alter the substantive

11 standards for finding a violation of Rule 11, but functions

12 merely to reduce courts’ discretion in choosing whether to

13 conduct the Rule 11 inquiry at all and whether and how to

14 sanction a party once a violation is found.” Simon

15 DeBartolo, 186 F.3d at 167 (emphasis added). It is

16 therefore significant that, when the PSLRA was enacted in

17 1995, Pennie had not yet been decided, and all Rule 11

18 violations at the time were assessed under the objective

19 reasonableness standard. See, e.g., Ted Lapidus, 112 F.3d

20 at 96.

21 In sum, the mandate of the PSLRA obviates the need to

22 find bad faith prior to the imposition of sanctions. At the

20
1 same time, the concerns identified in Pennie have some

2 bearing in the PSLRA context. As will be discussed in Part

3 III, the ex post nature of PSLRA sanctions may influence

4 whether an opposing party’s fees are reasonable under the

5 circumstances; it could not have been Congress’s intent to

6 incentivize undue delay, or discourage lawyers from promptly

7 filing their own Rule 11 motions simply because the court

8 will automatically make Rule 11 findings at the end of a

9 litigation.

10 II

11 In the alternative, the ATSI attorneys argue that

12 their actions were reasonable even under an objective

13 standard: “if there was [market] manipulation, it was not

14 unreasonable to impute knowledge of it to Knight.”

15 Appellants’ Br. at 26. They rely on the role of a market-

16 maker in the securities industry, and argue that market-

17 makers should have “special knowledge” of irregular trading

18 in their assigned securities, especially in thinly traded

19 securities such as ATSI. They also point out that there

20 have been viable claims against market-makers for engaging

21 in manipulation. See In re Blech Sec. Litig., No. 94 Civ.

22 7696, 2002 WL 31356498 (S.D.N.Y. Oct. 17, 2002)).

21
1 That some market-makers have engaged in manipulation

2 proves nothing. The cases relied upon by the ATSI attorneys

3 are distinguishable in critical respects. In In re Blech,

4 claims against a market maker survived summary judgment

5 because plaintiffs marshaled specific evidence that a

6 market-maker participated in an underwriter’s scheme to

7 artificially inflate certain stock prices. 2002 WL

8 31356498, at *12 (“The Plaintiffs have adduced evidence that

9 whenever [the underwriter] needed to move some stock, [the

10 market-maker] would buy it, hold the stock briefly, and when

11 [the underwriter] found a customer account into which he

12 could place the securities, [the market-maker] would sell

13 the stock back.”). Similarly, in Sedona Corp. v. Ladenburg

14 Thalmann & Co., No. 03 Civ. 3120, 2005 WL 1902780, at *12

15 (S.D.N.Y. Aug. 9, 2005), a complaint was upheld against

16 several defendants, including market-makers, on the basis of

17 “a great deal of detail regarding the nature of the conduct

18 and techniques allegedly employed in the market manipulation

19 scheme, and numerous details regarding transactions and/or

20 the participation of specific defendants in transactions.”

21 Id.

22 The ATSI attorneys’ reliance on the opportunity of a

22
1 market-maker to manipulate the market reinforces the

2 conclusion that ATSI’s complaint against Knight relied on

3 speculation. ATSI has made no sufficient, specific

4 allegation as to why Knight would have been aware of

5 manipulation based on the declines in ATSI share price and

6 assorted other irregularities, let alone who was creating

7 these anomalies, or why. As the District Court explained:

8 There would have been no reason [for
9 Knight, as market-maker,] to suppose that
10 the seller or sellers were holders of the
11 convertible preferred, let alone that the
12 object of the sales was to depress the
13 price of the common in order to improve
14 the conversion ratio. And even if that
15 could have been supposed, it is hard to
16 see how a market maker, by executing the
17 transactions, thereby would have become a
18 culpable participant in that scheme.
19
20 2008 WL 850473, at *3.

21 The ATSI attorneys also offer a textual argument-- that

22 all of their specific factual allegations (such as that

23 Knight was the principal ATSI market-maker) were true, and

24 their legal claim was phrased conditionally: “Any

25 manipulation which took place would have involved Knight,

26 who knew or should have known that they were prohibited from

27 engaging in the activity complained of in paragraphs 184

28 through 219.” Complaint ¶ 221. According to the ATSI

23
1 attorneys, the district court imposed sanctions for the

2 inference--drawn by the district court but never alleged in

3 so many words--that Knight knew or should have known of the

4 other defendants’ manipulation. 2008 WL 850473, at *3.

5 We disagree. The “inference” that Knight knew or

6 should have known of any manipulation is sufficiently drawn

7 from the fact that ATSI sued Knight for manipulation. ATSI

8 could not have sued Knight without alleging overtly or by

9 implication that Knight knew of the manipulation by other

10 defendants, because a claim of market manipulation requires

11 scienter. ATSI I, 493 F.3d at 101-02.10 The ATSI

12 attorneys’ argument proves too much: if they had not

13 intended to allege that Knight “knew or should have known”

14 of any market manipulation, they would have been vulnerable

15 to Rule 11 sanctions for bringing suit without a sufficient

10
The PSLRA heightened the pleading requirements for
scienter. See 15 U.S.C. § 78u-4(b)(2) (“In any private
action arising under this chapter . . . the complaint shall,
with respect to each act or omission alleged to violate this
chapter, state with particularity facts giving rise to a
strong inference that the defendant acted with the required
state of mind.”) (emphasis added); Tellabs, Inc. v. Makor
Issues & Rights, Ltd., 551 U.S. 308, 314 (2007) (“To qualify
as ‘strong’[,] . . . an inference of scienter must be more
than merely plausible or reasonable--it must be cogent and
at least as compelling as any opposing inference of
nonfraudulent intent.”).
24
1 legal basis.

2 Even assuming it was objectively reasonable for ATSI’s

3 attorneys to think that ATSI was the victim of a “death

4 spiral” scheme that violated the federal securities laws, it

5 was not objectively reasonable to sue Knight on no basis

6 other than that Knight had the opportunity to participate in

7 such a scheme.11

8 III

9 The district court imposed monetary sanctions in the

10 amount of $64,656.69, explaining that “[i]t is undisputed

11 that Knight spent $64,656.69 in defending this case, all of

12 it occasioned by plaintiff’s frivolous allegations.” 2008

13 WL 850473, at *4. In imposing the full amount of Knight’s

14 fees, the district court was following the rebuttable

15 presumption established by the PSLRA that an appropriate

16 sanction for the failure of a complaint to comply with Rule

17 11 “is an award to the opposing party of the reasonable

11
One possibility, not discussed below, is that ATSI
sued Knight in order to obtain access to discovery that
would have been more difficult to obtain from a third-party.
But such a tactic would expose ATSI to Rule 11 liability for
presenting a complaint for an improper purpose under Rule
11(b)(1). See, e.g., In re Kunstler, 914 F.2d 505, 518 (4th
Cir. 1990) (“If a complaint is not filed to vindicate rights
in court, its purpose must be improper.”).
25
1 attorneys’ fees and other expenses incurred in the action.”

2 15 U.S.C. § 78u-4(c)(3)(A)(ii) (emphasis added).12

3 Although the concerns identified in Pennie do not

4 require a finding of bad faith, they may bear on the

5 question of the reasonableness of Knight’s fees. As we

6 noted in Pennie, one purpose of the 21-day safe harbor is to

7 provide an incentive to opposing attorneys to file Rule 11

8 motions promptly: delay past the point at which a pleading

9 or motion may be amended or withdrawn may work a forfeiture

10 of Rule 11 remedies. See Pennie, 323 F.3d at 89 (“Although

11 Rule 11 contains no explicit time limit for serving the

12 motion, the ‘safe harbor’ provision functions as a practical

13 time limit, and motions have been disallowed as untimely

12
If a Rule 11 violation is contained in a responsive
pleading or dispositive motion, instead of a complaint, the
rebuttable presumption is that an appropriate sanction is
“an award to the opposing party of the reasonable attorneys’
fees and other expenses incurred as a direct result of the
violation.” 15 U.S.C. § 78u-4(c)(3)(A)(i).
Under the statute, these presumptions “may be rebutted
only upon proof by the party or attorney against whom
sanctions are to be imposed that--(i) the award of
attorneys’ fees and other expenses will impose an
unreasonable burden on that party or attorney and would be
unjust, and the failure to make such an award would not
impose a greater burden on the party in whose favor
sanctions are to be imposed; or (ii) the violation of Rule
11(b) of the Federal Rules of Civil Procedure was de
minimis.” 15 U.S.C. § 78u-4(c)(3)(B).
26
1 when filed after a point in the litigation when the lawyer

2 sought to be sanctioned lacked an opportunity to correct or

3 withdraw the challenged submission.”).

4 The PSLRA’s mandatory sanctions provision can operate

5 to reverse this incentive. By directing a district court to

6 make findings “upon final adjudication of the action,” 15

7 U.S.C. § 78u-4(c)(1), the statute might discourage the

8 filing of prompt Rule 11 motions, allowing lawyers to

9 dither, or even wait on purpose in order to increase costs

10 that can be shifted onto sanctioned counsel. Such a delay

11 would waste judicial resources, and impose unfair burdens.

12 Nothing in the PSLRA prevents an adversary from filing a

13 Rule 11 motion at an earlier point in the litigation, before

14 heavy costs have accrued. Even in the context of the PSLRA,

15 a Rule 11 letter from an opposing counsel may bring new

16 facts to light, or prompt a challenged attorney to

17 reconsider.13 Thus, in determining whether a party’s fees

18 are “reasonable” under 15 U.S.C. § 78u-4(c)(3), a district

19 court should consider whether the opposing party’s failure

20 to move for Rule 11 sanctions more promptly may have

13
The statutory notice in the PSLRA is an all-purpose
reminder, whereas an opposing party may point to a specific
aspect of a claim that it believes violates Rule 11.
27
1 unnecessarily increased the costs, and thereby unnecessarily

2 increased the sanctions. If so, a “reasonable” award might

3 be only the amount of fees that would likely have been

4 incurred if a Rule 11 motion had been promptly made.

5 In this case, Knight did not move for Rule 11 sanctions

6 until it was invited to do so by the district court, after

7 the Third Amended Complaint had been dismissed. We have no

8 reason, on this record, to think that Knight’s failure to

9 move for Rule 11 sanctions at an earlier stage was the

10 product of undue delay, or a bad faith tactic to shift

11 additional fees and costs onto ATSI.14 Nevertheless, the

12 district court should have the opportunity to consider in

13 the first instance whether Knight’s failure to move for Rule

14 11 sanctions at an earlier stage had any bearing on whether

15 its fees were “reasonable.”15

14
Indeed, Knight did not waste much time in filing a
motion to dismiss. Knight was served with the Third Amended
Complaint on September 29, 2004, and filed its motion to
dismiss on November 5, 2004.
15
The PSLRA’s rebuttable presumption that an
appropriate sanction is an award of the opposing party’s
fees (under § 78u-4(c)(3)(A)(i) or (ii)) does not appear to
preclude a court from imposing a greater sanction, with the
remainder going to the court. This way, a district court
may impose as great a monetary sanction as it deems
necessary (in light of the seriousness of the Rule 11
violation), without impairing the defendant’s incentive to
28
1 CONCLUSION

2 For the foregoing reasons, we affirm that part of the

3 district court’s order imposing sanctions, but we vacate the

4 amount of the award and remand for further consideration in

5 light of this opinion.

act promptly to reduce overall litigation costs.
29