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U.S. 2nd Circuit Court of Appeals
GURARY v ISSAC WINEHOUSE
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
August Term, 2000
(Argued: September 19, 2000Decided: December 19, 2000 )
Docket No. 00-7151
MORDECHAI GURARY,
Plaintiff-Appellee,
- v.-
ISAAC WINEHOUSE and ISAAC WINEHOUSE, doing business as Wall &
Broad Equities,
Defendants,
NU-TECH BIO-MED, INC.,
Defendant-Appellant.
Before: WALKER, Chief Judge, and MINER and POOLER, Circuit Judges.
Appeal from an order entered in the United States District Court for the Southern District of New York (Stanton, J.) denying the imposition of sanctions pursuant to the Private Securities Litigation Reform Act of 1995 and Federal Rule of Civil Procedure 11, the court having found that the claims made in the plaintiff's complaint were warranted by a conceivable nonfrivolous extension of existing law.
Affirmed in part, vacated and remanded in part.
MARTIN E. KARLINSKY, Camhy Karlinsky & Stein LLP, New York, NY (Douglas A. Amedeo, Camhy Karlinsky & Stein LLP, New York, NY, on the brief), for Defendant-Appellant.
DAVID JAROSLAWICZ, Jaroslawicz &
Jaros, New York, NY (Robert J.
Tolchin, Jaroslawicz & Jaros, New York,
NY, of counsel), for Plaintiff-Appellee.
MINER, Circuit Judge:
Defendant-appellant Nu-Tech Bio-Med, Inc. ("Nu-Tech") appeals from an order entered in the United States District Court for the Southern District Court of New York (Stanton, J.) denying its motion for sanctions pursuant to the Private Securities Litigation Reform Act of 1995 ("PSLRA") and Federal Rule of Civil Procedure 11 ("Rule 11") against plaintiff-appellee Mordechai Gurary ("Gurary").
Gurary brought suit against Nu-Tech and defendant Isaac Winehouse ("Winehouse") to recover damages for securities fraud pursuant to section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j, and 17 C.F.R. § 240.10b-5 ("Rule 10b-5") thereunder. The district court granted summary judgment in favor of both defendants and denied their motions for sanctions under Rule 11. We affirmed the summary judgment but remanded for further findings regarding compliance with Rule 11 as mandated by the PSLRA. See Gurary v. Winehouse, 190 F.3d 37, 47 (2d Cir. 1999). On remand, the district court concluded that sanctions were not warranted because "[a] conceivable extension of existing law might" render Gurary's claims of securities fraud properly pleaded. Gurary v. Winehouse, No. 97-3803, 2000 WL 20706, at *1 (S.D.N.Y. Jan. 12, 2000). For the reasons that follow, we affirm in part, and vacate in part the order of the district court and remand for further proceedings consistent with this opinion.
BACKGROUND
In November 1996, Nu-Tech raised nearly $14 million by issuing shares of Series A Convertible Preferred Stock (the "preferred"). That stock, while having no voting rights and paying no dividends, was convertible into common stock at the lesser of $17.50 per share or 75 percent of the average closing price of the common stock for the five trading days prior to the date of the holder's notice of conversion. Because the preferred paid no dividends, had no voting rights, and was convertible to common stock at a bargain price, it would almost always be converted. In addition, purchasers of the preferred were likely to profit from conversion no matter what happened to the price of the common stock, provided that the company survived. That is, so long as the price of the common did not fall more than 25 percent after conversion, shareholders of the preferred would profit by conversion and sale of the common into which the preferred was converted.1
This litigation arose out of an alleged scheme by defendant Winehouse in which Winehouse allegedly organized a "cartel" to purchase a percentage of Nu-Tech convertible stock in the names of nominees. He allegedly arranged for a number of securities firms to become market makers in Nu-Tech common stock, and then proceeded to sell the common stock short,2 allegedly to drive down the price of the common stock. Gurary concedes that this alleged manipulation did not begin before November 6, 1996.
On October 31, 1996, Gurary purchased 1,000 shares of Nu-Tech common stock at $14.60, and then on November 7, 1996, purchased another 5,500 shares at $15.50 per share. After becoming concerned about his investment when the stock price began to decline, Gurary spoke with J. Marvin Feigenbaum ("Feigenbaum"), chairman of Nu-Tech, sometime in December 1996. Feigenbaum assured Gurary that he had alerted Winehouse that Nu-Tech would refuse to register the common stock into which the preferred was convertible unless Winehouse and his group stopped shorting the common stock. Feigenbaum predicted that this "threat" would convince Winehouse to stop shorting the stock because a refusal to register the common issued upon conversion would force Winehouse to cover his short position by purchasing Nu-Tech common stock at a possibly higher price in the open market. Based on Feigenbaum's assurances, Gurary purchased another 1,000 shares on December 24, 1996, at a price of $11.75 per share. Gurary claims to have subsequently learned that Winehouse and his associates arranged to "borrow" an unlimited number of shares from market makers for the express purpose of continuing to short the stock using nominee names.
Gurary spoke to Feigenbaum again on February 18, 1997. Feigenbaum told Gurary that he had met that day with Winehouse and others in another attempt to stop the short selling. Feigenbaum explained to Gurary that Nu-Tech had offered to repurchase the group's preferred shares at cost plus ten percent and to allow the group to keep its existing profits from the short sales if it would cease its activities. Although Winehouse refused the offer, Feigenbaum told Gurary that Nu-Tech would not surrender to Winehouse and would refuse to register the short sellers' shares. Apparently comforted by these assurances, Gurary bought another 8,350 shares of Nu-Tech common at a price of $11.57 that same day.
On March 12, 1997, Feigenbaum and another Nu-Tech board member met with Winehouse and asked that Winehouse and his group accept registration of the common stock into which their preferred was convertible over a period of twelve months rather than insisting that it be registered immediately. Winehouse refused this offer also and said that he would continue to sell short. Nu-Tech common stock dropped approximately $6 per share over the next two days as the Winehouse group continued its short sales. Six days later, Gurary, in a conference call arranged by an intermediary, spoke directly with Winehouse, who allegedly admitted to him that he deliberately had shorted the stock to drive the price down, that he intended to continue, and advised Gurary to sell his shares because the price would drop to "a dollar."
On May 23, 1997, Gurary brought suit against Nu-Tech and Winehouse in the United States District Court for the Southern District of New York as a result of the alleged manipulation of the Nu-Tech stock. Gurary's complaint principally alleged that defendants Winehouse and Nu-Tech manipulated Nu-Tech's common stock in violation of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j, and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5, by making numerous misstatements and omissions of material fact in connection with the purchase and sale of the convertible preferred stock and the shorting of the common stock.3
Both defendants moved to dismiss the complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief may be granted. In an Affidavit In Opposition to defendants' motion, Gurary's counsel, David Jaroslawicz, requested that he be granted leave to amend the complaint if the district court discovered any pleading deficiency. The district court, observing that Gurary's claims were based on four purchases, two purchases on October 31, 1996 and November 7, 1996, and two later purchases on December 24, 1996 and February 18, 1997, granted the motion in favor of Winehouse and Nu-Tech, after converting their 12(b)(6) motion into one for summary judgment.4 However, the district court did not comment on Gurary's request for leave to amend and therefore implicitly denied it.
Gurary appealed to this Court, and defendants Nu-Tech and Winehouse cross- appealed on the grounds that the district court improperly denied their motions for sanctions made pursuant to the PSLRA. In an opinion dated August 24, 1999, we affirmed in part, and vacated and remanded in part. With respect to Gurary's first purchase on October 31, 1996, we concluded that this purchase failed to state a cognizable claim under Rule 10b-5 because Gurary failed to "allege culpable deception in connection with the purchase or sale of a security" in that the alleged manipulation did not commence until November 6, 1996, and Gurary's first purchase preceded that date. Gurary, 190 F.3d at 45 (internal quotation marks omitted). We also concluded that Gurary's second purchase failed to state a cognizable claim under Rule 10b-5 because Gurary, at the very most, paid less for the security on November 7, 1996, than he otherwise would have as a result of the defendants' alleged fraud. We noted that a defrauded buyer may only recover "the excess of what he paid over the value of what he got," not the opposite. Id. at 46 (internal quotation marks omitted). With respect to Gurary's last two purchases, we concluded that because "there [was] no suggestion in the complaint or in Gurary's affidavit that Feigenbaum did not intend to do just what he promised at the times he made the statements [to Gurary]," Gurary's claim under Rule 10b-5 was "fundamentally flawed" as it failed to allege that Feigenbaum secretly intended not to perform or knew that he could not perform. Id. at 44. We also vacated and remanded in part for the district court to make "findings regarding compliance with Rule 11(b) [as mandated by the PSLRA]." Id. at 47.
In an order dated January 12, 2000, the district court determined that sanctions were not warranted because Gurary "could colorably argue [based on a conceivable extension of the law:] (1) that he relied on the market price as indicating the fair market value of Nu-Tech common stock for his first two purchases, only to see it depressed by illegal market manipulation in violation of . . . the . . . Exchange Act . . ., and (2) that in reliance on Feigenbaum's promise to prevent further manipulation and stabilize the price, [Gurary] made two further purchases on which (the promises proving worthless) he suffered even more losses." Gurary, 2000 WL 20706, at *1. In addition, the district court noted that "[a]lthough a more scholarly and meticulous practitioner, or one more expert in federal procedure and securities law, might have foreseen that the complaint would be dismissed, it cannot be said that a competent attorney could not form the requisite responsible belief as to the validity of [Gurary's] claims." Id. (internal quotation marks omitted). Nu-Tech now appeals the district court's order.5 We affirm in part, and vacate and remand in part for further proceedings consistent with this opinion.
DISCUSSION
I. The Private Securities Litigation Reform Act of 1995 and Rule 11
In 1995, Congress passed the PSLRA to give "teeth" to Rule 11, "[r]ecognizing . . . the need to reduce significantly the filing of meritless securities lawsuits without hindering the ability of victims of fraud to pursue legitimate claims, and [because] . . . [e]xisting Rule 11 has not deterred abusive securities litigation." Simon DeBartolo Group, L.P. v. Richard E. Jacobs Group. Inc., 186 F.3d 157, 166-67 (2d Cir. 1999) (internal quotation marks omitted). The PSLRA, which added section 21D(c), codified at 15 U.S.C. § 78u-4(c)(1), to the Exchange Act, requires that a district court make specific findings as to a party's compliance with Federal Rule of Civil Procedure 11(b) at the conclusion of a case arising under the Exchange Act, see Simon DeBartolo Group, L.P., 186 F.3d at 167 (citing 15 U.S.C. § 78u-4(c)(1)), and also mandates the imposition of sanctions if the court determines that Rule 11 has been violated. See 15 U.S.C. § 78u-4(c)(2).
If a court finds a Rule 11 violation, "a rebuttable presumption [arises] that the appropriate sanction for a complaint that substantially fails to comply with Rule 11(b) `is an award to the opposing party of the reasonable attorneys' fees and other expenses incurred in the action.'" Id. (quoting 15 U.S.C. § 78u-4(c)(3)(A)(ii)). However, if a party against whom sanctions will be imposed successfully meets its burden by providing sufficient "rebuttal evidence" under 15 U.S.C. § 78u-4(c)(3)(B) that such fees and expenses are not appropriate, then courts should "award the sanctions [they] deem[] appropriate pursuant to Rule 11." 15 U.S.C. § 78u-4(c)(3)(C). The PSLRA does not alter the substantive standards for finding a Rule 11 violation but circumscribes "courts' discretion in choosing whether to conduct the Rule 11 inquiry at all and whether and how to sanction a party once a violation is found." Simon DeBartolo Group, L.P., 186 F.3d at 167.
Rule 11(b) provides in relevant part that:
By presenting to the court (whether by signing, filing, submitting, or later advocating) a pleading, written motion, or other paper, an attorney or unrepresented party is certifying that to the best of the person's knowledge, information, and belief, formed after an inquiry reasonable under the circumstances,--
. . .
(2) the claims, defenses, and other legal contentions therein are warranted by existing law or by a nonfrivolous argument for the extension, modification, or reversal of existing law or the establishment of new law;
(3) the allegations and other factual contentions have evidentiary support or, if specifically so identified, are likely to have evidentiary support after a reasonable opportunity for further investigation or discovery[.]
Fed. R. Civ. P. 11(b). The 1993 Advisory Committee Notes explain that Rule 11(b)(2) "establishes an objective standard, intended to eliminate any `empty-head pure-heart' justification for patently frivolous arguments." Also, "the extent to which a litigant has researched the issues and found some support for its theories even in minority opinions, in law review articles, or through consultation with other attorneys should certainly be taken into account in determining whether paragraph [(b)](2) has been violated. Although arguments for a change of law are not required to be specifically so identified, a contention that is so identified should be viewed with greater tolerance under the rule." Id. While monetary sanctions may be imposed in some circumstances under Rule 11, see Fed. R. Civ. P. 11(c)(2), they "may not be awarded against a represented party for a violation of subdivision (b)(2)," Fed. R. Civ. P. 11(c)(2)(A), because "responsibility for such violations is more properly placed solely on the party's attorneys." Fed. R. Civ. P. 11 (advisory committee notes to 1993 amendments); see also Simon DeBartolo Group, L.P., 186 F.3d at 166.
II. Standard of Review
We review a district court's determination with respect to sanctions under the PSLRA and Rule 11 for abuse of discretion. See Simon DeBartolo Group, L.P., 186 F.3d at 167 (citing Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405 (1990)). Rule 11 is violated when it is "clear under existing precedents that there is no chance of success and no reasonable argument to extend, modify or reverse the law as it stands." Id. (quoting Mareno v. Rowe, 910 F.2d 1043, 1047 (2d Cir. 1990)) (internal quotation marks omitted). That is, material errors of law constitute "per se abuses of discretion." Id.; see also Cooter & Gell, 496 U.S. at 405 (concluding that an erroneous view of the law would constitute abuse of a court's discretion); Sussman v. Bank of Israel, 56 F.3d 450, 456 (2d Cir. 1995) (same); see also Pierce v. F.R. Tripler & Co., 955 F.2d 820, 831 (2d Cir. 1992) (finding an abuse of discretion where the district court awarded sanctions against a party who has a good faith basis to pursue legal argument supported by one state court decision in the absence of contrary controlling authority).
III. Imposition of Sanctions
Citing Eastway Construction Corp. v. City of New York, appellant Nu-Tech asserts generally that the district court abused its discretion in denying sanctions against defendant-appellee Gurary because his claims against Nu- Tech involving all four purchases "failed to satisfy fundamental and threshold requirements for a Rule 10b-5 claim" and that Gurary has "failed . . . to suggest any reason that he could have achieved `success under existing precedents,' and . . . has failed to advance any `reasonable argument . . . to extend, modify or reverse the law as it stands.'" 762 F.2d 243, 254 (2d Cir. 1994). We agree with respect to Gurary's first two purchases, on October 31, 1996 and November 7, 1996, respectively, but disagree with respect to Gurary's December 24, 1996 and February 18, 1997 purchases.6 |
