Summary
denying defendant's request for Rule 11 sanctions in PSLRA non-class action
Summary of this case from CMG Worldwide, Inc. v. GlaserOpinion
03 Civ. 1514 (LAK)
October 15, 2003
ORDER
The complaint alleges that plaintiff, an attorney, was persuaded to given defendant discretionary trading authority over certain of his securities accounts and that defendant then proceeded to lose a great deal of plaintiff s money by trading inherently speculative option contracts. It asserts claims under the Commodities Exchange Act, the Investment Advisers Act, and the Securities Exchange Act of 1934 ("Exchange Act") as well as a number of state law claims. Defendant moved to dismiss the entire complaint pursuant to Rule 12(b)(6) and for partial summary judgment dismissing the first and second counts of the complaint whereupon plaintiff cross-moved for leave to amend the complaint, an application which plaintiff resists on the ground that amendment would be futile. Defendant has moved also for sanctions. These motions are disposed of as follows:
Plaintiff has withdrawn the claims under the Commodities Exchange Act and the Investment Advisers Act.
1. Defendant's motion to dismiss or for partial summary judgment is granted to the extent that the Commodities Exchange Act and Investment Advisers Act (Counts 1 and 2) are dismissed. In view of the cross-motion for leave to amend, it is denied in all other respects.
2. The proposed amended complaint asserts a Rule 10b-5 claim under the Exchange Act and is the sole remaining basis for federal jurisdiction. The claim rests principally on the theory that put and call options on the SP 500 Index purchased by defendant in plaintiffs taxable account were unsuitable investments. Prop. Am. Cpt ¶ 79. It alleges also that defendant made material misrepresentations and failed to make necessary disclosures relating to the suitability of those investments. Id. ¶¶ 84-86. Defendant resists the amendment, arguing that the proposed Rule 10b-5 claim is insufficient because plaintiff "cannot demonstrate justifiable reliance . . . or scienter, "Def. Mem. in Opposition 14, and on the theory that the proposed pleading does not sufficiently allege that any misrepresentations were "in connection with" the purchase or sale of securities or loss causation.
2.1 Defendant acknowledges that unsuitability claims lie under Section 10(b) of the Exchange Act where (i) the securities were unsuitable, (ii) the defendant knew or reasonably believed they were unsuitable, (iii) the defendant recommended them anyway, (iv) the defendant knowingly or recklessly made material misrepresentations (or, owing a duty to the buyer, failed to disclose material information) to the buyer relating to the suitability of the securities, and (v) the buyer justifiably relied to its detriment on the misrepresentations or omissions. See id. at 13-14.
2.2 The essence of defendant's position with respect to justifiable reliance is that plaintiff must have received brochures regarding options risks when he opening the relevant accounts, that these made the risks clear, and that any reliance by him on the defendant with respect to the suitability of the investments therefore would have been unjustified as a matter of law. The short answer to this contention is that the fact-bound questions of what plaintiff received and whether his reliance, if any, was justified cannot be decided on a motion for leave to amend. As there is no suggestion that the proposed amended complaint fails adequately to allege justifiable reliance, defendant's argument cannot prevail, at least at this stage.
2.3 The proposed amended complaint's alleges that defendant acted with scienter in that he knew of plaintiff s conservative investment goals and was aware of the inherently speculative nature of the options he caused plaintiff to purchase. Defendant argues that this is insufficient because plaintiff made allegedly informed decisions to trade options himself despite knowledge of the risks of options trading. It is not self evident that what plaintiff allegedly knew about the risks of options trading has much bearing on whether the defendant acted with intent to defraud or its substantial equivalent. But that is neither here nor there. The fact is that the defendant resists amendment not on the ground that the scienter allegations of the complaint are insufficient, but on the ground that they are incredible in light of facts he claims were known to the plaintiff. Just as the Court will not decide the justifiable reliance issue on a motion for leave to amend, it will not decide the defendant's state of mind in that posture.
2.4 "Loss causation . . . is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff, [citation omitted] We have often compared loss causation to the tort law concept of proximate cause, `meaning that the damages suffered by plaintiff must be a foreseeable consequence of any misrepresentation or material omission.'" Emergent Capital Investment Management LLCv. Stonepath Group, Inc., 343 F.3d 189, 196(2d Cir. 2003).
The proposed amended complaint alleges that defendant knew that plaintiff was a very conservative investor, knew that the options in question were inherently speculative and involved "potential for unlimited losses," told plaintiff that he used a "very conservative" investment strategy and that plaintiffs principal would be "fully protected," and reassured plaintiff by telling him that he used offsetting put and call options to hedge, thus protecting plaintiffs principal, despite the fact that he in fact had no call options and previously had stopped buying calls. It further alleges that plaintiff relied to his detriment on these and other statements in consequence of which he lost a great deal of money.
It very well may be that plaintiff will have difficulty establishing loss causation linking particular statements with particular securities transactions. For present purposes, however, it is sufficient to conclude that it cannot be said with certainty that plaintiff has failed adequately to allege loss causation and to satisfy the "in connection with" requirement with respect to any of the alleged misstatements or omissions. The Court has considered defendants other arguments and concluded that they are without merit, at least at this stage. Accordingly, the cross-motion for leave to amend will be granted.
Inasmuch as the Exchange Act claim is sufficient to confer subject matter jurisdiction on this Court, it is unnecessary to decide the sufficiency of the pleading of the state law claims in determining whether to grant leave to amend. The Court therefore does not do so.
3. The motion for sanctions is made solely under Fed.R.Civ.P. 11 although defendant's memorandum invokes also the Private Securities Litigation Reform Act ("PSLRA"). As plaintiff withdrew the Commodities Exchange Act and Investment Advisers Act claims within the "safe harbor" period provided for by Rule 11, sanctions with respect to those claims would be inappropriate. There is no basis for sanctions under the PSLRA because there has been no final determination of the merits of the Exchange Act claim. Nor, in most circumstances, is there much to be gained by deciding sanctions motions based upon the alleged insufficiency or baselessness of claims during the continuation of litigation. See Fed.R.Civ.P. 11, 1983 Advisory Committee Note ("in the case of pleadings the sanctions issue . . . normally will be determined at the end of the litigation"). * * *
For the foregoing reasons, (1) defendant's motion to dismiss the complaint or for partial summary judgment dismissing the first two counts (docket item 6) is granted to the extent that Counts 1 and 2 are dismissed on the merits and otherwise denied on the ground of mootness, (2) plaintiffs cross-motion for leave to amend (docket item 15) is granted, provided however, that this does not imply any ruling as to the legal sufficiency of the state law claims for relief, and (3) defendant's motion for sanctions (docket item 10) is denied without prejudice to renewal at the end of the litigation.
SO ORDERED.