Dorsey v. Portfolio Equities, Inc.

Decision Date11 August 2008
Docket NumberNo. 07-10705.,07-10705.
Citation540 F.3d 333
PartiesRobert DORSEY, On behalf of himself and others similarly situated, Plaintiff-Appellant, v. PORTFOLIO EQUITIES, INC.; Charter Home Funding, Inc.; Charter Asset Management, Inc.; Charter Equities Corp.; Harold P. Barnes, Jr.; James B. Barnes, Defendants-Appellees.
CourtU.S. Court of Appeals — Fifth Circuit

Kirk D. Fredrickson, McDonald & Fredrickson, Oklahoma City, OK, for Dorsey.

Oscar Rey Rodriguez, Stephen M. Dollar, Fulbright & Jaworski, Dallas, TX, for Defendants-Appellees.

Appeal from the United States District Court for the Northern District of Texas.

Before JONES, Chief Judge, and WIENER and CLEMENT, Circuit Judges.


Robert Dorsey ("Dorsey") challenges the district court's dismissal of his claims for fraud under federal securities law and Texas state law against Portfolio Equities, Inc. ("PEI"), Charter Home Funding, Inc. ("CHF"), Charter Asset Management, Inc. ("CAM"), Charter Equities Corp. ("CEC"), Harold Barnes ("H. Barnes"), and James Barnes ("J. Barnes") (collectively, "Defendants"). For the following reasons, we affirm in part and reverse in part the judgment of the district court.


Dorsey purchased promissory notes in February 1998 from PEI, the proceeds of which were used to fund a real estate business operated by CHF. H. Barnes was president and a director of both PEI and CHF, as well as an officer and director of CAM and CEC. According to the complaint, he "held the largest financial interest in, and day-to-day operational control of, the CHF/PEI/CAM/CEC businesses." J. Barnes was vice-president and a director of CHF.

Dorsey alleged in his complaint that the promissory notes purchased by him were scheduled to pay twelve percent interest per year on a semiannual basis and mature on December 31, 2002. He alleged that H. Barnes prepared a Private Placement Memorandum ("PPM") with assistance from J. Barnes, dated April 1, 1997, which was used to offer and sell the promissory notes. Dorsey alleged that, in 1998 and in each year thereafter, H. and J. Barnes, along with unidentified PEI officers, solicited him and other investors to reinvest their interest payments from the promissory notes in additional promissory notes that had the same terms as the first offering outlined in the PPM. Dorsey alleged that many investors purchased additional notes in response to those solicitations.

The PPM states that PEI would lend the proceeds from the sale of the promissory notes to CHF, which would "use the funds principally to acquire single-family Residences . . . which CHF becomes obligated to purchase pursuant to [its] Guaranteed Purchase Program."1 At the time that the PPM was published in April 1997, Dorsey alleged that PEI was a newly established company created for the specific purpose of financing a new business operation run by CHF, a small company with no prior business activities. The PPM stated that PEI would lend CHF up to $150,000 generated by the sale of the notes for CHF's use as general working capital. The remainder of the proceeds from the sale of the promissory notes would be used to make secured short-term acquisition loans to CHF pursuant to a loan agreement between CHF and PEI. CHF would use the borrowed money to buy residential real estate and would repay PEI when CHF sold the property. As security for the loans, CHF would either grant PEI a mortgage in the purchased property or, if CHF took title to the property in trust, assign a beneficial ownership in the trust to PEI. If CHF defaulted on its loan from PEI, PEI's security interest in CHF's properties was PEI's sole recourse against CHF.

PEI failed to repay the principal due on the promissory notes on the December 31, 2002 maturity date. Certain unidentified investors demanded payment, but PEI indicated that it had no ability to repay any principal or accrued interest due. Those investors conducted an investigation of PEI's claim, during which H. Barnes admitted that no documents exist to show that PEI received security interests in any of the properties purchased by CHF.

On March 5, 2004, Dorsey filed a putative class action against the Defendants on behalf of investors who had purchased the promissory notes issued by PEI. The complaint alleged various claims, including federal securities fraud, state common-law fraud, state statutory fraud, and state securities fraud. The Defendants moved to dismiss the complaint on several grounds, including failure to state a claim. The district court granted Dorsey permission to file an amended complaint to conform to the requirements for pleading fraud under Rule 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4(b), (d).

Dorsey's amended complaint alleged that H. Barnes had falsely represented to investors that collateral security interests would be available to repay the promissory notes in the event that PEI or CHF were unable to pay on the maturity date. He alleged that the representations of H. Barnes were false at the time Dorsey purchased his promissory notes in February 1998 and thereafter because PEI had already made unsecured loans to CHF from mid-1997 to early 1998 in violation of the terms of the PPM. Dorsey pointed to H. Barnes's admission that no documents exist to show that security interests had been given in any of CHF's properties as the factual basis of his allegation.

The Defendants moved to dismiss Dorsey's amended complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The district court dismissed with prejudice all but one of Dorsey's claims for failure to state a claim, but Dorsey voluntarily dismissed that claim and his petition for class certification. The district court entered a final order disposing of all claims. Dorsey appealed, seeking relief only for himself as a single investor and challenging the dismissal of his claims for fraud under federal securities law and Texas state law.


This court reviews a district court's dismissal under Rule 12(b)(6) de novo, "accepting all well-pleaded facts as true and viewing those facts in the light most favorable to the plaintiffs." Stokes v. Gann, 498 F.3d 483, 484 (5th Cir.2007) (per curiam). This court, however, "will not strain to find inferences favorable to the plaintiff." Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353, 361 (5th Cir.2004) (internal quotations omitted). To avoid a dismissal for failure to state a claim, "a plaintiff must plead specific facts, not mere conclusory allegations." Tuchman v. DSC Commc'ns Corp., 14 F.3d 1061, 1067 (5th Cir.1994) (internal quotations and citation omitted).

Generally, a court ruling on a motion to dismiss may rely on only the complaint and its proper attachments. Fin. Acquisition Partners LP v. Blackwell, 440 F.3d 278, 286 (5th Cir.2006). A court is permitted, however, to rely on "documents incorporated into the complaint by reference, and matters of which a court may take judicial notice." Tellabs, Inc. v. Makor Issues & Rights, Ltd., ___ U.S. ___, 127 S.Ct. 2499, 2509, 168 L.Ed.2d 179 (2007). Because the court reviews only the well-pleaded facts in the complaint, it may not consider new factual allegations made outside the complaint, including those made on appeal. See Fin. Acquisition Partners LP, 440 F.3d at 289.


Both federal securities claims and state-law fraud claims are subject to the pleading requirements of Rule 9(b). See Abrams v. Baker Hughes Inc., 292 F.3d 424, 430 (5th Cir.2002); Williams v. WMX Technologies, Inc., 112 F.3d 175, 177 (5th Cir.1997) ("We see no principled reason why the state claims of fraud should escape the pleading requirements of the federal rules. . . ."). A heightened level of pleading is imposed for fraud claims: "In alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." FED.R.CIV.P. 9(b). "This Court interprets Rule 9(b) strictly, requiring a plaintiff pleading fraud to specify the statements contended to be fraudulent, identify the speaker, state when and where the statements were made, and explain why the statements were fraudulent." Herrmann Holdings Ltd. v. Lucent Techs. Inc., 302 F.3d 552, 564-65 (5th Cir.2002) (internal quotations omitted). Put simply, Rule 9(b) requires the complaint to set forth "the who, what, when, where, and how" of the events at issue. ABC Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d 336, 350 (5th Cir.2002) (internal quotations omitted).

"Importantly, though, the second sentence of Rule 9(b) relaxes the particularity requirement for conditions of the mind, such as scienter: `Malice, intent, knowledge, and other conditions of mind of a person may be averred generally.'" Tuchman, 14 F.3d at 1068 (quoting FED. R. CIV. P. 9(b)). "Although Rule 9(b) expressly allows scienter to be `averred generally', simple allegations that defendants possess fraudulent intent will not satisfy Rule 9(b)." Melder v. Morris, 27 F.3d 1097, 1102 (5th Cir.1994). "The plaintiffs must set forth specific facts supporting an inference of fraud." Id. "Alleged facts are sufficient to support such an inference if they either (1) show a defendant's motive to commit securities fraud or (2) identify circumstances that indicate conscious behavior on the part of the defendant." Herrmann Holdings Ltd., 302 F.3d at 565 (internal quotations omitted). "If the facts pleaded in a complaint are peculiarly within the opposing party's knowledge, fraud pleadings may be based on information and belief. However, this luxury must not be mistaken for license to base claims of fraud on speculation and conclusory allegations." Tuchman, 14 F.3d at 1068 (internal quotations and citation omitted).

Federal securities fraud claims are also subject to the pleading requirements of the PSLRA. See 15 U.S.C. § 78u-4(b); Abrams, 292 F.3d...

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