Introduction
You have asked us to research,
identify and summarize the key cases on the issue of what
might be held to constitute reasonable reliance on representations
made in a private placement memorandum offering interests
in a fund. These issues require discussion of:
Relevant Cases
NEW JERSEY
1. In re Milestone Sci. Sec.
Litig., 103 F. Supp. 2d 425 (S.D.N.J. 2000)
Defendant corporation and
officers moved to dismiss, pursuant to Fed. R. Civ. P. 9(b)
and 12(b)(6), the amended complaint of plaintiff securities
purchasers in a class action for securities fraud pursuant
to § 10(b) and § 20(a) of the Securities Exchange
Act of 1934, 15 U.S.C.S. §§ 78j(b) and 78t(a), and
Rule 10b-5, 17 C.F.R. § 240.10b-5.
Plaintiff securities purchasers
brought an securities fraud action against defendant corporation
and officers for alleged violations of § 10(b) and §
20(a) of the Securities Exchange Act of 1934, 15 U.S.C.S.
§§ 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R.
§ 240.10b-5. Plaintiffs filed an amended complaint, alleging
that defendants, in an effort to increase and maintain an
artificially high market price for securities, failed to promptly
disseminate accurate and truthful information in connection
with its operations, business, products, earnings, and present
and future business prospects. Plaintiffs argued thatThe Court
agreed with the district Court in that the plaintiff's fraud
claims were properly dismissed, because a sophisticated investor
could not have reasonably relied on the alleged fraudulent
representation of Equitable agents directly contradicted by
Equitable's documents. published reports, news articles, and
filings with the Securities and Exchange Commission were misleading.
The court noted that plaintiffs were required to satisfy the
heightened pleading requirements of Fed. R. Civ. P. 9(b) and
the Private Securities Litigation Reform Act, 15 U.S.C.S.
§ 78u-4 et seq. Motion to dismiss was granted. The Court
held that the plaintiffs failed to meet the heightened pleading
requirements for a securities fraud complaint absent credible,
particularized allegations that defendants knowingly or recklessly
provided misleading or fraudulent statements or omissions
in connection with its operations.
The Court observed that
to establish a claim under § 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C.S. § 78j(b), and Rule
10b-5, 17 C.F.R. § 240.10b-5, a plaintiff must plead
(1) a false representation, or omission, of a material fact,
(2) knowledge or reckless disregard of its falsity by a defendant
and the intention that a plaintiff rely on the falsity, (3)
reasonable reliance thereon by a plaintiff, and (4) a resultant
loss. Id at 66.
The reliance of a plaintiff
on alleged misstatements or omissions must be reasonable;
the burden of proof is upon the defendant to show reliance
was not reasonable. See Kline, 24 F.3d at 493 (citing Straub
v. Vaisman & Co., 540 F.2d 591, 598 (1976)). Where the
security involved is traded in an open and efficient market,
a plaintiff need not show individual and specific reliance
on the misrepresentation of a defendant. A plaintiff may instead
rely upon the fraud on the market theory and claim only that
he or she suffered injury in the capacity as a purchaser or
seller of a security in such a market. Id at 67.
2. Smerenko v. Cendant Corp.
223 F.3d 165 (3rd Cir. 2000)
Plaintiffs and the class
of similarly situated investors appealed from a district court
order dismissing their claims for securities fraud filed under
§ 10(b) of the Securities Exchange Act of 1934 and Rule
10b-5. The court vacated and the district court's order.
The Court of Appeals repeated
the standard that to state a valid claim under Rule 10b- 5,
a plaintiff must show that the defendant (1) made a misstatement
or an omission of a material fact (2) with scienter (3) in
connection with the purchase or the sale of a security (4)
upon which the plaintiff reasonably relied and (5) that the
plaintiff 's reliance was the proximate cause of his or her
injury. Id. at 174.
The Court of Appeals found
that plaintiffs alleged sufficient facts to establish the
elements of reliance and loss causation and that the district
court applied the incorrect analysis for determining whether
the complaint alleged that the purported misrepresentations
under § 10(b) and Rule 10b-5 were made "in connection
with" the purchase or the sale of a security. The fact
that defendants' alleged misrepresentations did not implicate
the investment value of the securities in question was insufficient
to defeat plaintiffs' claims. Accordingly, because the standard
the court articulated, applying the materiality and public
dissemination approach, was different from the one applied
by the district court, the judgment of the district court
was vacated and remanded for further proceedings.
The Court of Appeals went
on to disagree with the defendant's argument that it is unreasonable
as a matter of law to rely on information concerning a tender
offer or a merger before the transaction is finalized, we
disagree. The Court referred to a Supreme Court case which
cautioned that "no particular event or factor short of
closing the transaction need be either necessary or sufficient
by itself to render merger discussions material." Basic,
Inc., 485 U.S. at 239. The Court of Appeals reasoned that
other courts have similarly held that information concerning
a tender offer may be material while the transaction is still
in the planning stage. The Court stated, “If it may
be reasonable for an investor to find information concerning
a tentative tender offer or a merger important when making
an investment decision, we see no reason why the conditional
nature of
those transactions should necessarily prevent the investor
from reasonably relying on that information as well.”
Id. 181.
3. Weiner v. Quaker Oats
Co., 129 F.3d 310 (3rd Cir. 1997)
Plaintiff stockholders bought
shares in defendant corporation while it was negotiating a
leveraged purchase of another company. Six weeks before the
purchase closed, defendant issued an annual report setting
forth its debt to capitalization ratio (ratio) and its projected
earnings over time. After closing, the ratio changed, which
caused plaintiffs' stock to decrease in value. Plaintiffs
sued the corporation and its chairman under §§ 10(b)
and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C.S.
§§ 78j(b) and 78t(a), and SEC rule 10b-5, 17 C.F.R.
§ 240.10b5, and the trial court granted defendants' motion
to dismiss. On appeal, the court held that the annual report,
when considered with other reports containing the same ratio,
could lead a reasonable investor to believe that the ratio
would not change. Thus, the ratio was material and plaintiffs
stated a cause of action under rule 10b-5 on that issue. However,
because the projected earnings were qualified by the phrase
"over time," they were not material. The court affirmed
the judgment on the claim based on projected earnings reversed
it on the claim based on the ratio, and remanded the case
for further proceedings.
The Court observed that
in general, Section 10(b) and Rule 10b-5 do not impose a duty
on defendants to correct prior statements -- particularly
statements of intent -- so long as those statements were true
when made. The Court referred to In re Phillips Petroleum,
881 F.2d at 1245, in this context. However, the Court also
observed that "there can be no doubt that a duty exists
to correct prior statements, if the prior statements were
true when made but misleading if left unrevised." Id.
To avoid liability in such circumstances, "notice of
a change of intent be disseminated in a timely fashion."
Id. at 1246. Whether an amendment is sufficiently prompt is
a question that "must be determined in each case based
upon the particular facts and circumstances." Id.
The Court held that, therefore,
defendants have failed to establish that plaintiffs can prove
no set of facts in support of their claim, which would entitle
them to relief. The complaint alleges facts on the basis of
which a reasonable fact finder could determine that Quaker's
statements regarding its total debt-to-total capitalization
ratio guideline would have been material to a reasonable investor,
and hence that Quaker had a duty to update such statements
when they became unreliable. Id at 318
4. EP Medsystems Inv., v.
Ecocath, Inc., 235 F.3d 865 (3rd Cir. 2000)
Plaintiff filed suit against
defendant alleging that the chief executive officer of defendant
enticed plaintiff into investing $ 1,400,000 in defendant
by assuring plaintiff that lengthy negotiations had already
taken place with four prominent companies to market certain
new defendant products, and that contracts with these companies
were "imminent." Relying on cautionary language
contained in public documents filed by defendant with the
Securities Exchange Commission, the district court held that
these representations were immaterial as a matter of law under
the "bespeaks caution" doctrine and the general
test for materiality. It also held that plaintiff failed to
adequately plead scienter, reasonable reliance, and loss causation.
The complaint was dismissed and plaintiff appealed. The court
reversed the decision of the district court, finding that
there was a statement of fact in the context presented by
plaintiff's complaint that could be found to meet the requirement
of materiality. Moreover, a trier of fact could find that
reliance was reasonable and that there was the requisite causal
connection between the assurances and plaintiff's loss, i.e.,
its investment. The court reversed the order dismissing the
complaint and remanded for further proceedings in accordance
with this opinion; there was a statement of fact in the context
presented by plaintiff's complaint that could be found to
meet the requirement of materiality.
5. William Kozin & Kurt
Kozin v. Richard J. Dunn, Kevin R. Dunn, 2005 U.S. Dist. LEXIS
18156 (D.N.J. 2005)
Plaintiffs, a father and
his son, sued defendants, a corporation, its president, and
its secretary, alleging, inter alia, common law fraud and
securities fraud under Rule 10b- 5, 17 C.F.R. § 240.10b-5,
and § 10(b) (15 U.S.C.S. § 78j(b)) of the Securities
Exchange Act of 1934, 15 U.S.C.S. § 78a et seq. Defendants
moved to dismiss the common law fraud and federal securities
fraud claims for failure to state a claim.
Plaintiffs alleged that
defendants approached them seeking investments and made various
fraudulent misrepresentations concerning the corporation's
sources of financing and specific targets for imminent acquisition.
In reliance on these statements, the father lent the corporation
$ 150,000, and the son entered into an employment agreement
with the corporation. The corporation defaulted under the
terms of the promissory note and never paid the son under
the employment agreement. The court determined that plaintiffs
adequately alleged common law fraud under Fed. R. Civ. P.
9(b) based upon, inter alia, defendants' fraudulent misrepresentations
that were supported by certain documents and their detrimental
reliance. However, the federal securities fraud claims were
dismissed under the Private Securities Litigation Reform Act
because (1) plaintiffs failed to show scienter based upon
motive and opportunity due to the individual defendants' shareholder
status and based upon recklessness and (2) the complaint did
not plead falsity adequately since plaintiffs did not show
why the statements were misrepresentations.
The court granted defendants'
motion to dismiss with respect to the federal securities fraud
claims and dismissed those claims without prejudice. The court
denied the motion to dismiss with respect to the common law
fraud claims.
6. Grace Cowit, v. Roberts
Pharmaceutical Corp., 1996 U.S. Dist. LEXIS 22506 (D.N.J.
1996)
Plaintiff stock purchaser,
on behalf of herself and all others similarly situated, filed
a claim alleging misrepresentation and fraud in connection
with the purchase of stock in the defendant corporation. Defendants,
three principal financial offers, were also named as parties.
Defendants filed a motion for dismissal of the purchaser's
amended complaint under Fed. R. Civ. P. 12(b)(6) and for partial
dismissal under Fed. R. Civ. P. 9(b).
Defendants sought dismissal
of the purchaser's claims on the basis that: (1) the
complaint failed to allege an actionable misrepresentation
or omission; (2) the purchaser failed to set forth any ground
for alleging scienter for the alleged fraud; (3) the purchaser's
claims lacked the specificity required under Fed. R. Civ.
P. 9(b). The court was reluctant to characterize many of the
statements and omissions as misleading at this stage of the
case. Many of the statements, required additional facts and
a wider context to determine whether they were actionable
as a matter of law. The court could not find that defendants'
alleged statements and/or omissions were not actionable as
a matter of law. Although several of the statements could
constitute mere "puffing," others were not "so
obviously unimportant" to a reasonable investor that
they could not violate the securities laws. The court was
not persuaded that the complaint suffered from a lack of particularity
under Fed. R. Civ. P. 9(b). As to whether statements by Wall
Street analysts were actionable under Rule 9(b), the court
found in favor of defendants and should grant the motion to
dismiss based on these allegations.
The court ordered that the
motion of defendants for dismissal under Fed. R. Civ.
P. 9(b) of that portion of the complaint based upon statements
allegedly made to a Wall Street analysts be granted. The court
further ordered that the motion of defendants for dismissal
under Fed. R. Civ. P. 12(b)(6) be denied.
7. Morton I. Thomas Edco Surgical Supply
Co., Inc. V. Duralite Company, Inc., 524 F.2d 577 (3rd Cir.
1975)
Defendants, former business
partners of plaintiff, appealed an order of the United States
District Court for the District of New Jersey, assessing damages
against defendants, a corporation and individuals, under §
§ 10(b), 20 and 29(b) of the Securities Exchange Act
of 1934, 15 U.S.C.S.§ § 78j, 78t, and 78cc(b), and
S.E.C. Rule 10b-5.
Plaintiff and individual
defendants were partners in Defendant Corporation. After some
time, plaintiff withdrew. To discuss the sale of plaintiff's
stock, plaintiff met a defendant partner, who indicated to
plaintiff that the stock was valueless and that defendant
corporation had little chance of continuing. Defendants were
meanwhile discussing a merger with another company. Plaintiff
agreed to transfer the stock in exchange for cancellation
of indebtedness. When plaintiff discovered that the corporation
had become a subsidiary of another, he sued for damages based
on misrepresentation under § § 10(b), 20 and 29(b)
of the Securities Exchange Act of 1934, 15 U.S.C.S.§
§ 78j, 78t, and 78cc(b), and S.E.C. Rule 10b-5. The lower
court awarded damages to plaintiff. On appeal, the court affirmed.
The court held that the lower court did not err in finding
that defendants were culpable because they knew that the corporation's
prospects were improving, the knowledge was material, and
that defendants misrepresented plaintiff, and plaintiff relied
on the misrepresentation.
The court affirmed the order
except as to defendant corporation. That portion of
the order was reversed and remanded for further consideration
of damages. The Court held that the elements of a plaintiff's
case on liability for securities fraud include knowledge by
the defendants, intent to defraud, or scienter, failure to
disclose to the plaintiff, materiality of the facts, and,
in some instances, reliance by the plaintiff. |
