Greenstone v. Cambex Corp.

• Decision Date: 03 June 1992
• Docket Number: Nos. 91-2241,92-1026,s. 91-2241
• Parties: , Fed. Sec. L. Rep. P 97,003 Amy GREENSTONE, and all Others Similarly Situated, Plaintiffs, Appellants, v. CAMBEX CORPORATION, et al., Defendants, Appellees. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 22

975 F.2d 22

61 USLW 2236, Fed. Sec. L. Rep. P 97,003

Amy GREENSTONE, and all Others Similarly Situated Plaintiffs, Appellants, v. CAMBEX CORPORATION, et al., Defendants, Appellees.

Nos. 91-2241, 92-1026.

United States Court of Appeals First Circuit.

Heard June 3, 1992.

Decided Sept. 18, 1992.

Roger W. Kirby with whom Jeffrey H. Squire, Kaufman, Malchman, Kaufmann &amp Kirby, New York City, Thomas G. Shapiro, Gretchen Van Ness, and Shapiro Grace & Haber, Boston, Mass., were on brief, for plaintiffs, appellants.

John D. Donovan, Jr. with whom Andrew C. Pickett and Ropes & Gray, Boston, Mass., were on brief, for defendants, appellees.

Before BREYER, Chief Judge, O'SCANNLAIN, ^* and CYR, Circuit Judges.

BREYER, Chief Judge.

The question on this appeal is whether the appellant's complaint states a claim for fraud under the federal securities laws, 15 U.S.C. § 78j(b), a claim that she must plead "with particularity." Fed.R.Civ.P. 9(b). The district court held that it did not, and it dismissed the complaint. 777 F.Supp. 88. We affirm that decision.

I The Allegations

The plaintiff (and appellant), Amy Greenstone, filed a securities fraud claim against Cambex Corporation and several of its officers. Her complaint, in essence, says (1) that Cambex would sell its Cambex memory boards for use in IBM computers; (2) that it would accept IBM memory boards as "trade-ins;" (3) that a lessor of IBM computers claimed that Cambex's business was unlawful, sued Cambex and won; and (4) that Cambex should have disclosed the threat of such a lawsuit in advance. Her complaint more specifically alleged:

1. Cambex Corporation makes various computer products, including memory boards.

2. In 1989 and 1990 Cambex sold memory boards for use in IBM computers. The Cambex customer would replace the IBM memory board in his IBM computer with a Cambex memory board. Cambex would accept, as a trade-in in part payment for its memory board, the IBM memory board that the Cambex board had replaced. Cambex then would either resell the IBM memory board or lease the IBM memory board to others, thereby obtaining additional revenue.

3. If the Cambex customer had an IBM computer that he had leased, rather than bought, Cambex would sometimes return the IBM board to the IBM computer before the customer returned the IBM computer to the IBM computer lessor.

4. In 1989 and 1990 Cambex's financial statements showed significant revenues from this "IBM memory board replacement" activity. During this time Cambex issued other public statements, which said, for example, that its sale of Cambex's "substantially better" memory boards, and resale, or lease, of less desirable IBM memory boards taken as trade-ins, made a "steady contribution to revenues and profits," helped bring about "steadily improving results," helped account for Cambex's "sound performance," and, in general, helped Cambex maintain profits.

5. On Friday, February 1, 1991, IBM Credit (a subsidiary of IBM and a lessor of IBM computers) filed a lawsuit against Cambex. IBM Credit claimed in essence that the terms of its leases prohibited its lessees (and Cambex) from removing IBM's memory boards and selling, or leasing, them to others without IBM Credit's approval.

6. About one month later, Cambex and IBM Credit settled the lawsuit. Cambex agreed to pay IBM about $6 million and "to comply with IBM Credit's terms and conditions of its subleases."

7. Throughout 1989 and 1990 Cambex executives knew that Cambex did not have the legal right to take, and to resell or lease, the IBM memory boards.

8. On January 22, 1991, just before IBM's lawsuit, she bought 500 shares of Cambex stock at a price of $14 5/8 per share. About two weeks later, just after the IBM lawsuit became public, she sold the shares at $12 7/8 per share, a loss of $1.75 per share, or 12% of the purchase price. During those two weeks, Cambex stock had suddenly climbed to $18 per share, from which height it fell, on the day the lawsuit was announced, to $11 3/4, closing the day at $13 1/4 per share.

The complaint goes on to claim, in general terms, that the facts set forth show that Cambex and its officers violated the securities law--law that forbids any person "in connection with the purchase or sale" of securities, to make an

untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading....

17 C.F.R. § 240.10b-5(b) (emphasis added). The complaint argues that Cambex's financial statements, though literally true, were "misleading" in "light of the circumstances under which they were made," for they failed to disclose Cambex's potential legal liability to IBM lessors.

The district court concluded that the complaint did not state an actionable claim because it failed to meet the requirement of Fed.R.Civ.P. 9(b), which says:

In all averments of fraud ... the circumstances constituting fraud ... shall be stated with particularity.

The complaint did not set forth "the circumstances constituting fraud ... with particularity." (Emphasis added). For this reason, it dismissed the complaint. The court also refused to permit the plaintiff to file an amended complaint. She now appeals.

After examining both the complaint and the proposed amended complaint, we conclude that neither sets forth a claim of securities fraud with sufficient particularity. In explaining our conclusion, we shall focus on the proposed amended complaint, which, essentially, reiterates the initial complaint with additional detail. (Our conclusions apply to the initial complaint a fortiori ).

II The Financial Statements

The complaint lists specific statements that it says mislead by omission. Many of these statements consist of figures, e.g. revenue, income and profit figures, on Cambex's 1989 and 1990 income statements and balance sheets, filed with the SEC in those years. The statements are accurate and could not mislead unless, given the circumstances, an investor would normally have expected to find some kind of qualification of the figures, disclosing a significant potential liability. Generally Accepted Accounting Principles, with which the SEC ordinarily requires compliance, set forth rules that govern such disclosures. The kind of potential liability at issue here is

a loss contingency involving an unasserted claim or assessment when there has been no manifestation by a potential claimant of an awareness of a possible claim or assessment....

Financial Accounting Standards Board Statement No. 5, § 10. The rules say that financial statements need not disclose this kind of potential liability unless:

it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable.

Id.; see Loss & Seligman, Securities Regulation 652-57 (1989) (discussing application of FASB Statement No. 5 to the disclosure of unasserted legal claims); S.E.C. Accounting Release (Dec. 20, 1973) ("[P]rinciples, standards, and practices promulgated by the FASB in its Statements and Interpretations will be considered by the Commission as having substantial authoritative support, and those contrary to such FASB promulgations will be considered to have no such support." (footnotes omitted)); S.E.C. v. Steadman, 967 F.2d 636, 645 (D.C.Cir.1992) (considering FASB No. 5 in SEC suit alleging that company failed to disclose contingent liability). Given the kinds of qualifications that investors would necessarily expect financial statements to disclose, we do not see how these financial statements could have materially misled unless, at the time Cambex filed its financial statements, Cambex (and its officers) knew that the future IBM Credit suit was "probable." The question is whether the complaint alleges specific facts sufficient to support that claim.

Conclusory Allegations. The complaint says, in conclusory fashion, (1) that Cambex "knew" that IBM Credit's leases forbade Cambex's memory trade-ins and (2) that the defendants "knowingly or recklessly" published misleading financial statements. Appellant argues that at least the first of these assertions satisfies Rule 9(b), for that rule permits averments of "knowledge" in "general[ ]" terms. Rule 9(b), however, also requires the plaintiff to plead "the circumstances constituting fraud ... with particularity." Fed.R.Civ.P. 9(b). And, one cannot avoid the latter requirement simply through a general averment that defendants "knew" earlier what later turned out badly.

Case law requires a plaintiff to do more. The courts have uniformly held inadequate a complaint's general averment of the defendant's "knowledge" of material falsity, unless the complaint also sets forth specific facts that make it reasonable to believe that defendant knew that a statement was materially false or misleading. See, e.g., Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir.1990) ("Although scienter need not be alleged with great specificity, plaintiffs are still required to plead the factual basis which gives rise to a 'strong inference' of fraudulent intent." (citation omitted)); DiLeo v. Ernst & Young, 901 F.2d 624, 629 (7th Cir.) ("Although Rule 9(b) does not require 'particularity' with respect to the defendants' mental state, the complaint still must afford a basis for believing that plaintiffs could prove scienter."), cert. denied, --- U.S. ----, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990); Romani v. Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir.1991) ("Although a plaintiff need not specify the circumstances or evidence from which fraudulent intent could be inferred, the complaint must provide some factual support for the allegations of fraud. The requirement that supporting facts be pleaded applies even when the fraud relates to matters peculiarly within the knowledge of the opposing party." (citations omitted)); Wayne Inv., Inc. v. Gulf Oil Corp., 739 F.2d 11, 14...