United States Court of Appeals,
Fifth Circuit.
No. 93-1550.
Adron L. MELDER, Etc., et al., Plaintiffs,
Adron L. Melder, Etc., et al., Plaintiffs-Appellants,
v.
Clifton H. MORRIS, Jr., et al., Defendants-Appellees.
Steven G. COOPERMAN, Plaintiff-Appellant,
v.
URCARCO, INC., et al., Defendants-Appellees.
Anthony HAND, et al., Plaintiffs-Appellants,
v.
URCARCO, INC., et al., Defendants-Appellees.
David J. STEINBERG, Etc., et al., Plaintiffs-Appellants,
v.
URCARCO, INC., et al., Defendants-Appellees.
Aug. 8, 1994.
Appeal from the United States District Court for the Northern
District of Texas.
Before REAVLEY, JONES and BENAVIDES, Circuit Judges.
EDITH H. JONES, Circuit Judge:
URCARCO operates a chain of "we finance" used car lots in Fort
Worth, Dallas, Houston, and Austin. The company targets market
areas with a high concentration of prospective purchasers who would
otherwise have trouble locating financing because of their income
levels, credit history, or inability to provide an adequate down
1
payment.1 The company launched an Initial Public Offering (IPO) in
November 1989, and turned to the capital markets again in May 1990
with a Secondary Public Offering (SPO). In April 1990, URCARCO's
stock traded at a high of $255/8 per share, but in part following
some critical reports in the financial press, the company's stock
price nosedived to $107/8 per share by July 31, 1990.
This downturn precipitated the four consolidated securities
fraud suits filed against URCARCO, its officers and directors,
Coopers & Lybrand, and three securities underwriters—Merrill Lynch,
Alex. Brown, and Cazenove.2 The plaintiffs alleged violations of
§§ 11, 12(2), and 15 of the Securities Act of 1933, § 10(b) of the
Securities and Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder, § 20(a) of the Exchange Act, state law
misrepresentation, Tex.Bus. & Com.Code Ann. § 27.01, and common law
fraud. After allowing the plaintiffs to replead twice and
conducting a hearing on this matter, the district court dismissed
the federal securities fraud and common law fraud claims for
1
The nature of URCARCO's business is prominently displayed
in the first two paragraphs of the "Prospectus Summary" in the
company's November 15, 1989 IPO and May 31, 1990 SPO
prospectuses.
2
The district court took particular interest in one of the
plaintiffs, Steven Cooperman, described by the court as "one of
the unluckiest and most victimized investors in the history of
the securities business." The court noted that Mr. Cooperman
admitted in sworn interrogatories that he had been a plaintiff in
38 securities fraud cases. The plaintiffs do not challenge this
finding of the district court, but they do summon the courage to
allege that the court was predisposed against securities fraud
actions generally. The district court's remarks in this case,
however, reflect only a natural amount of skepticism in light of
the suspect background of one of the "plaintiffs".
2
failure to plead fraud with particularity as required under
Fed.R.Civ.P. 9(b).3 We have reviewed the district court's
dismissal on the pleadings de novo and AFFIRM.4
I.
In general terms, all securities fraud claims require the
plaintiff to establish: (1) a misstatement or omission (2) of a
material fact (3) made with scienter (4) on which the plaintiff
relied (5) that proximately caused the plaintiff's injury. See
Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.1993). For
its part, Rule 9(b) imposes certain pleading requirements on
securities and other fraud claims:
In all averments of fraud or mistake, the circumstances
constituting fraud or mistake shall be stated with
particularity. Malice, intent, knowledge, and other condition
of mind of a person may be averred generally.
Fed.R.Civ.P. 9(b). The application of the requirements of Rule
9(b) to securities fraud claims was recently addressed by this
court in Tuchman v. DSC Communications Corp., 14 F.3d 1061 (5th
Cir.1994) and Shushany, supra.
In Shushany, the court explained that Rule 9(b) requires
certain minimum allegations in a securities fraud case, namely the
specific time, place, and contents of the false representations,
3
The district court declined to exercise jurisdiction over
the plaintiffs' pendent state law claims. Because the appellants
do not contest this aspect of the court's dismissal, this court
need not address the propriety of their dismissal. See Shushany
v. Allwaste, Inc., 992 F.2d 517, 520-21 n. 5 (5th Cir.1993).
4
The standard of review on a Rule 9(b) dismissal is the same
as for a dismissal under Fed.R.Civ.P. 12(b)(6), namely de novo.
See Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.1993).
3
along with the identity of the person making the misrepresentations
and what the person obtained thereby.5 See Shushany, 992 F.2d at
521 (quoting Tel-Phonic Servs., Inc. v. TBS Int'l, Inc., 975 F.2d
1134, 1139 (5th Cir.1992)). The heightened pleading standard of
Rule 9(b) serves an important screening function in securities
fraud suits. As this court described in Tuchman,
the heightened pleading standard provides defendants with fair
notice of the plaintiffs' claims, protects defendants from
harm to their reputation and goodwill, reduces the number of
strike suits, and prevents plaintiffs from filing baseless
claims then attempting to discover unknown wrongs.
Tuchman, 14 F.3d at 1067.
Plaintiffs' complaint fails to meet the stringent pleading
requirements of Rule 9(b) as explained in Shushany. As the
district court concluded, the complaint here fails to put the
defendants on notice, places defendants' reputations at risk, and
burdens the courts with a potential strike suit. The task to which
we now turn is showing precisely how the complaint fails to meet
the requirements of Rule 9(b) on a defendant-by-defendant basis.6
5
In applying the requirement of Rule 9(b) that
"circumstances" be pleaded in detail to a securities fraud claim,
the Seventh Circuit analogized the requirement to the essentials
of the first paragraph of any newspaper story, namely the who,
what, when, where, and how. See DiLeo v. Ernst & Young, 901 F.2d
624, 627 (7th Cir.), cert. denied, 498 U.S. 941, 111 S.Ct. 347,
112 L.Ed.2d 312 (1990).
6
Appellants maintain that their 1993 Securities Act claims
were inappropriately subjected to the Rule 9(b) heightened
pleading standard. This argument is untenable in light of the
complaint's wholesale adoption of the allegations under the
securities fraud claims for purposes of the Securities Act
claims. When 1933 Securities Act claims are grounded in fraud
rather than negligence as they clearly are here, Rule 9(b)
applies. See, e.g., Shapiro v. UJB Fin. Corp., 964 F.2d 272,
287-89 (3d Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 365, 121
4
II.
In terms of its allegations against URCARCO and its officer
and directors, the complaint falls short of the heightened Rule
9(b) pleading requirements for at least two reasons. First,
plaintiffs rely heavily on alleged misstatements made in the
URCARCO prospectuses, but upon further review these alleged
misstatements amount to gross mischaracterizations of the contents
of the prospectuses. Second, the plaintiffs fail to plead scienter
adequately under Rule 9(b).
As an initial matter, the plaintiffs fail to base their
allegations on statements actually made by URCARCO, opting instead
to selectively distort the company's public statements to create an
inference of fraud. For example, the plaintiffs allege that in its
IPO and SPO Prospectuses:
the Company claimed to base its loss reserves on its own
experience with delinquencies at a time when it had been
selling cars for less than three years, so that none of its
longer-term loans had yet been paid in full, and the Company
had no reasonable basis for determining their delinquency
rate[.]
C. 51 at ¶ 89(c).7 In fact, however, this claim is belied in the
prospectuses which clearly and prominently discuss URCARCO's
limited operating history and its potential impact on the company's
loan loss provision:
The Company began operations in March 1987 and therefore has
had only a limited operating history upon which prospective
L.Ed.2d 278 (1992); Sears v. Likens, 912 F.2d 889, 892-93 (7th
Cir.1990).
7
References are to the plaintiffs' consolidated amended
class action complaint filed December 6, 1991.
5
investors may base an evaluation of its performance ...
Changes in historical experience caused by changes in economic
conditions or other factors could require a change in the
Company's periodic provision for losses.
IPO Prospectus at 5; SPO Prospectus at 5.
Similarly misconstruing the company's public statements, the
plaintiffs also allege that URCARCO in its "IPO Prospectus
minimized the risk of default by the Company's customers." C. 28
at ¶ 43. The plaintiffs read the IPO Prospectus to stress "the
Company's purported highly efficient and sophisticated collection
procedures leading investors to believe that the Company's loans
were not only safe, but constantly monitored." Id.
These serious mischaracterizations of the IPO Prospectus find
no support in the actual text of that document which clearly
explains that URCARCO makes loans to high-risk customers:
The Company finances its used car sales in a relatively
high-risk market and anticipates that a portion of its retail
sales contracts will become seriously delinquent and that in
those circumstances the Company's only practical alternative
is repossession of the cars.
IPO Prospectus at 5. An interested reader need go no further than
the second page of the IPO Prospectus to find a prominently
displayed, clear explanation that the Company purposefully targets
prospective purchasers of used cars "unable to obtain traditional
car financing because of their income levels, credit history or
inability to provide a sufficient down payment." Id. at 2.
Significantly, the IPO explains the risk that URCARCO assumed
to gain a competitive advantage:
The Company believes that most used car dealers that finance
purchases for their customers require approximately a 507
downpayment by these customers, so that the downpayment covers
6
the cost of the car for the dealer. The Company believes that
its low downpayment financing for customers provides it a
competitive advantage over most "we finance" dealerships
selling used cars.
Id. at 21. No reasonable reader of the IPO Prospectus could
conclude that URCARCO was somehow attempting to lead investors to
believe its loans were "safe" when its express corporate purpose
was to the contrary.8
8
A careful review of both the IPO and SPO prospectuses
inescapably leads to the conclusion that if plaintiffs' counsel
had been bound under the same strictures concerning veracity as
were the appellees under governing securities law standards,
their complaint would have to be labeled misleading. Plaintiffs
repeatedly allege "misrepresentations" in appellees' securities
filings that mischaracterize those documents. Some examples of
this tactic are repeated in the text supra. Others are as
follows:
1. Plaintiffs allege that, contrary to representations
that Urcarco required a cash down payment of 10 to 157,
"Urcarco financed 1007 of many of its sales." C. 49 at ¶
87(a). The prospectuses state, however, that: "A
customer's down payment on a car sold by the Company
typically ranges from 57 to 207 of the sales price,
including the value of a trade-in, if any." IPO Prospectus
at 4. This statement does not preclude the possibility of
1007 financing of sales when trade-ins are included.
2. The complaint states that, contrary to its
representations, the Company used vertical integration as a
means of artificially inflating its earnings by, for
example, recording "sales" of repossessed cars from its lots
to its wrecking and salvage facilities at amounts that it
knew would never be realized. C. 49 at ¶ 87(c). One
searches the IPO and SPO in vain for an intimation of this
alleged misrepresentation. Those documents state only that
vertical integration is "a means to utilize the remaining
value of trade-ins, possessions and other cars considered by
the company to be no longer suitable for re-sale." IPO
Prospectus at 4 (emphasis added). No other statements or
financial information support plaintiffs' claim of
"artificial inflation" of such sales.
3. Plaintiffs' complaint alleges that the company
claimed to use "highly sophisticated credit evaluation
procedures" when in reality it had "no effective central
7
In addition to severely distorting the company's public
statements in their complaint, plaintiffs do not merit a third
opportunity to replead for still another reason, namely their
controls over its credit department." C. 28 at ¶ 42; C. 50
at ¶ 87(e). Again, there is no misstatement of this nature
in the IPO and SPO. For instance, the IPO states that: "A
prospective customer's credit status is carefully evaluated
by the Company by verifying job history, residency and other
pertinent information." IPO Prospectus at 4. The IPO
further states that: "Most of the sales financed by the
Company are to individuals who typically have limited access
to credit, but satisfy sufficient other criteria stipulated
by the Company, such as job and residence history, to lead
the Company to believe that such person is an acceptable
credit risk notwithstanding his inability to obtain
traditional car financing." Id. at 23.
4. No one could misread the IPO and SPO, as plaintiffs'
complaint does, to suggest that those documents misleadingly
imply that repossessed cars were being restocked for retail
resale at fair market value when in reality they were being
auctioned off to dealers. See C. 29 at ¶ 44. On the
contrary, the IPO describes that repossessed cars are
assigned a "fair value, as estimated by the company taking
into consideration its prior costs, its current wholesale
value and other factors," and it clearly indicates that in
some cases the repossessed autos may be turned over to the
salvage operations. IPO Prospectus at 23-24. None of this
is necessarily inconsistent with sending repossessed autos
to auction when circumstances so necessitate.
5. Finally, the complaint states that the Company
misrepresented its delinquency and repossession rates
because it stated that it had a strategy of extending and
working out even the most seriously delinquent loans and
thereby "falsely assured the investing public that workouts
were successful." C. 51 at ¶ 89(b). The IPO states the
company's policy on seriously delinquent customers after a
detailed description of its credit and collection
procedures. See IPO Prospectus at 22-23. One may question
the business judgment represented by the policy, but the IPO
by no means suggests that this policy assures prospective
investors that workouts are successful.
These allegations boil down to plaintiffs' attempt to
chastise as fraud business practices that, in hindsight,
might have been more cautious. Misjudgments are not,
however, fraud.
8
failure to plead scienter adequately under Rule 9(b). The scienter
element is satisfied by proof that the defendants acted with severe
recklessness. See Shushany, 992 F.2d at 521. Although Rule 9(b)
expressly allows scienter to be "averred generally", simple
allegations that defendants possess fraudulent intent will not
satisfy Rule 9(b). See Tuchman, 14 F.3d at 1068. The plaintiffs
must set forth specific facts supporting an inference of fraud.
See id. Because the complaint does not set forth specific facts to
support an inference of fraudulent intent, dismissal under Rule
9(b) is appropriate as to the corporation and its officers and
directors.
The plaintiffs attempt to meet their Rule 9(b) scienter
burden by alleging that the defendants engaged in a conspiracy to
commit securities fraud
so that they could inflate the price of the Company's common
stock in order to: (i) successfully bring to fruition the
offerings; (ii) protect and enhance their executive positions
and the substantial compensation and prestige they obtained
thereby; and/or (iii) enhance the value of their personal
URCARCO's securities holdings and options.
C. 14-15 at ¶ 19. This lone allegation of motive is materially
indistinguishable from the allegation made in Tuchman where we
concluded that such an allegation did not set out facts sufficient
to allow for a proper inference of scienter. See Tuchman, 14 F.3d
at 1068-69. Accepting the plaintiffs' allegation of
motive—basically that the defendant officers and directors were
motivated by incentive compensation—would effectively eliminate the
state of mind requirement as to all corporate officers and
defendants. See id. The district court aptly dubbed this
9
allegation "a nihilistic approach to Rule 9(b) jurisprudence".
Simply put, the lone allegation of motive is insufficient.
The defendants' motive to commit securities fraud is not
readily apparent, as there is no allegation that any of the
corporate defendants actually personally profited from the
allegedly inflated stock values or the money raised from the two
offerings. The plaintiffs therefore face a tougher standard for
establishing fraudulent intent. See id. at 1068. Again, however,
under this more stringent standard, plaintiffs' complaint fails to
provide the specific facts upon which an inference of conscious
behavior may be based. As the district court put it, "[t]he
complaint's usual practice is simply to state that the defendants
knowingly did this or recklessly did that." See, e.g., C. 23 at ¶
31 ("[T]he true adverse facts about URCARCO's financial condition
... were known to or recklessly disregarded by defendants."); C.
66 at ¶ 119 ("Because of their board membership and/or their
executive and managerial positions with URCARCO, defendants ...
knew or had access to information concerning the adverse non-public
information about URCARCO's adverse financial outlook."). In
short, because of the plaintiffs' failure to plead scienter
adequately and their serious mischaracterization of the company's
public statements, the complaint was properly dismissed as to
URCARCO and its officers and directors.
III.
As to defendant Coopers & Lybrand, the complaint fails to
plead specific facts upon which inferences of fraudulent auditing
10
or fraudulent intent may be based and was therefore properly
dismissed under Rule 9(b). The plaintiffs' boilerplate averments
that the accountants violated particular accounting standards are
not, without more, sufficient to support inferences of fraud.
Further, the plaintiffs' only allegations of the accounting firm's
intent in participating in the securities fraud are that the firm
sought to
(i) protect and enhance the substantial auditing and other
fees received from URCARCO; (ii) maintain and increase its
market share for auditing and accounting services to be
performed and thereby increase the prestige and compensation
of the Coopers and Lybrand partners responsible for the
URCARCO engagement; (iii) increase the income received by the
Coopers and Lybrand partners responsible for the URCARCO
engagement since their income was directly tied to retaining
engagements such as URCARCO; and (iv) maintain its
competitive position as to other large accounting firms by
retaining URCARCO as a client.
C. 16 at ¶ 21. As characterized by the district court, this is the
familiar " "They did it for the Money' " chorus sung by the
plaintiffs as to URCARCO and the individual defendants in part II
supra. We are not moved by this music, and, on the same reasoning
as in part II, must reject the plaintiffs' allegations of scienter
as insufficient.
A contrary conclusion would universally eliminate the state of
mind requirement in securities fraud actions against accounting
firms. This follows from the indisputable proposition that
accounting firms—as with all rational economic actors—seek to
maximize their profits; that Coopers & Lybrand attempted to
maximize profits is the essence of the plaintiffs' motive
allegations.
11
Furthermore, while the plaintiffs' motive allegations merely
describe behavior which could be alleged against auditors
generally, in this case, it seems extremely unlikely that Coopers
& Lybrand was willing to put its professional reputation on the
line by conducting fraudulent auditing work for URCARCO. In an
analogous examination of an accounting firm's motive to participate
in securities fraud, the Seventh Circuit observed that
[a]n accountant's greatest asset is its reputation for
honesty, followed closely by its reputation for careful work.
Fees for two years' audits could not approach the losses E &
W would suffer from a perception that it would muffle a
client's fraud.... E & W's partners shared none of the gain
from any fraud and were exposed to a large fraction of the
loss. It would have been irrational for any of them to have
joined cause with Continental.
DiLeo v. Ernst & Young, 901 F.2d 624, 629 (7th Cir.), cert. denied,
498 U.S. 941, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990). Likewise, we
will not indulge irrational inferences of the firm's fraudulent
intent based on these generic allegations.
Since Coopers & Lybrand's motive is not apparent, the
plaintiffs can allege scienter only under a more stringent standard
under which they must plead particular circumstances indicating the
firm's conscious behavior. See Tuchman, 14 F.3d at 1068. Our
review of the complaint and the appellant's brief reveals no such
particularized pleading. Instead of pleading with particularity,
the plaintiffs offer only rote conclusions, such as: "In the
course of rendering services to URCARCO, Coopers and Lybrand either
obtained knowledge of, or recklessly disregarded, the facts alleged
herein." C. 10 at ¶ 12. This type of pleading fails to meet the
requirements of Rule 9(b), and clearly implicates the kinds of
12
policy concerns motivating the heightened standards in Rule 9(b)
noted in part I supra. In short, the court correctly dismissed the
complaint as to Coopers & Lybrand.9
IV.
The district court also properly dismissed the complaint on
Rule 9(b) grounds as to the final defendants, the securities
underwriters, for failure to adequately plead scienter. First, the
plaintiffs' allegation as to the underwriters' motive for
committing securities fraud does not set out facts sufficient to
lead to a proper inference of scienter. The plaintiffs merely
allege that the underwriters "agreed to participate in the
wrongdoing alleged herein in order to obtain substantial fees,
expenses and discounts in connection with the Offerings." C. 15 at
¶ 20. This lone allegation of motive fails on precisely the same
rationale discussed supra in parts II and III in relation to the
other defendants. Simply put, accepting the plaintiffs' allegation
of motive as sufficient would make a mockery of Rule 9(b) by
effectively eliminating the scienter requirement as to securities
underwriters since all underwriters are, of course, fee seekers.10
9
To the extent the complaint alleges aiding and abetting
liability under § 10(b) of the Exchange Act against the
underwriters and accountants, this form of liability has been
foreclosed to private plaintiffs under the Supreme Court's recent
decision in Central Bank of Denver, N.A. v. First Interstate Bank
of Denver, N.A., --- U.S. ----, 114 S.Ct. 1439, 128 L.Ed.2d 119
(1994).
10
Furthermore, to think that the underwriters would put
their valuable professional reputation at risk to ostensibly
"profit" from two relatively minor securities offerings presents
an inference of irrationality we refuse to indulge. Cf. DiLeo v.
Ernst & Young, 901 F.2d 624, 629 (7th Cir.), cert. denied, 498
13
Second, absent pleading an apparent motive that withstands
scrutiny, plaintiffs face the tougher burden of pleading scienter
by "identifying circumstances that indicate conscious behavior on
the part of the defendant[s]." Tuchman, 14 F.3d at 1068. We have
searched the plaintiffs' complaint for allegations of specific
facts to support an inference of fraudulent intent, but have turned
up nothing. Not surprisingly, appellants' brief is not helpful,
citing only the portion of the complaint in which plaintiffs allege
that each of the underwriters "either obtained knowledge or
recklessly disregarded the facts regarding URCARCO's actual
business prospects." C. 8-10 at ¶ 11(a)-(c). In short, after
allowing the plaintiffs two opportunities to replead and a hearing
on the motion to dismiss, the district court was absolutely correct
in dismissing the complaint as to the securities underwriters and
all other defendants.
V.
For the foregoing reasons, the judgment of the district court
is AFFIRMED.
U.S. 941, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990) ("Fees for two
years' audits could not approach the losses E & W would suffer
from a perception that it would muffle a client's fraud.").
14