Haft v. Eastland Financial Corp.

• Decision Date: 18 January 1991
• Docket Number: Civ. A. No. 90-0302P.
• Citation: 755 F. Supp. 1123
• Parties: Marshall HAFT, Plaintiff, v. EASTLAND FINANCIAL CORP., Herbert L. Miller and Nicolas F. Vrabel, Defendants.
• Court: U.S. District Court — District of Rhode Island

755 F. Supp. 1123

Marshall HAFT, Plaintiff, v. EASTLAND FINANCIAL CORP., Herbert L. Miller and Nicolas F. Vrabel, Defendants.

Civ. A. No. 90-0302P.

United States District Court, D. Rhode Island.

January 18, 1991.

COPYRIGHT MATERIAL OMITTED

Amedeo C. Merolla, Providence, R.I., Jules Brody, Melissa R. Emert and Mark Levine of Stull, Stull & Brody, New York City, for plaintiff.

William R. Grimm, Providence, R.I., Douglas M. Kraus, Marco E. Schnabl and Derek J.T. Adler of Skadden, Arps, Slate, Meagher & Flom, New York City, for defendants.

MEMORANDUM AND ORDER

PETTINE, Senior District Judge.

This case is representative of a number of cases that have recently been brought against financial institutions in the wake of the downturn in this region's economy. The story is a familiar one in securities litigation. DiLeo v. Ernst & Young, 901 F.2d 624, 617 (7th Cir.), cert. denied, ___ U.S. ___, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990). "At one time the firm bathes itself in a favorable light. Later the firm discloses that things are less rosy. The plaintiff contends that the difference must be attributable to fraud." Id. In the instant case, the named plaintiff, Marshall Haft, bought stock in the defendant corporation on the open market. He alleges that his recent losses on that stock resulted from the defendants' violations of several federal security laws and common law.

The defendant, Eastland Financial Corporation, is a publicly-owned holding company for Eastland Savings Bank, a Rhode Island chartered, FDIC insured stock savings bank headquartered in Woonsocket, Rhode Island. The individual defendants are Herbert L. Miller and Nicolas F. Vrabel. Mr. Miller, at all relevant times, has been Chairman and Chief Executive Officer of the corporation and the bank; Mr. Vrabel has been Treasurer of the corporation, Executive Vice President and Chief Financial Officer of the bank.

Mr. Haft brought this suit as a class action¹ after Eastland announced, on September 15, 1989, that its non-performing loans had increased dramatically due to the "deterioration in the collateral underlying certain loans." As a result, loan loss reserves were greatly increased and a related charge against earnings for $27 million was taken.²

Plaintiff alleges that during the class period, from July 1988 to September 1989, the defendants misrepresented the financial condition of their institution, "in a scheme and continuous course of conduct to inflate the market price of the Corporation's securities." The plaintiff further contends that the defendants accomplished this "through a series of materially misleading representations and omissions contained in the Prospectus, annual and quarterly reports issued by Eastland between July 12, 1988 and September 16, 1989." The essence of plaintiff's argument is that the defendant corporation "represented itself to the investing public as a highly successful bank which was well managed" and that it had "issued highly favorable results and portrayed its loan portfolio as being of high quality and sound." When the less than rosy announcement came on September 15, the plaintiff was, allegedly, taken by surprise.

Plaintiff claims jurisdiction in this Court pursuant to Section 22 of the Securities Act of 1933, 15 U.S.C. § 77v, Section 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa, 28 U.S.C. § 1331, and the principles of pendent jurisdiction. The complaint consists of four counts: Count I is against all defendants for the violation of Sections 11 and 15 of the Securities Act of 1933 ("1933 Act"), 15 U.S.C. §§ 77k and 77o, Count II is against all defendants for the violation of Section 10(b) and Rule 10b-5, 15 U.S.C. § 78j(b), 17 C.F.R. § 240.10b-5 and Section 20, 15 U.S.C. § 78t of the Securities Exchange Act of 1934 ("1934 Act"), Counts III and IV are against all defendants for state law violations sounding, respectively, in common law fraud and negligent misrepresentation. Defendants have moved to dismiss pursuant to Fed.R.Civ.P. 9(b) and Fed.R.Civ.P. 12(b)(6).

Because I find, for the foregoing reasons, that the plaintiff has failed to state a claim upon which relief can be granted and that, more specifically, plaintiff has failed to plead with the requisite particularity, defendants motion is granted and plaintiff's case is dismissed without prejudice.³

Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), Rule 10b-5, 17 C.F.R. § 240.10b-5⁴

Although it is not strictly "chronological," I will begin my analysis with Count II of plaintiff's complaint — the alleged violations of Section 10 of the 1934 Act. To state a claim under Section 10(b) and Rule 10b-5, the factual allegations in the complaint must indicate that 1) the defendants misrepresented or omitted material facts in connection with the purchase or sale of securities; 2) that the plaintiffs relied on such misrepresentations or omissions to their detriment, and 3) that the misrepresentations or omissions were made with scienter. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 205-06, 96 S.Ct. 1375, 1386-87, 47 L.Ed.2d 668 (1976). Pursuant to Fed.R.Civ.P. 12(b)(6), such a complaint generally should not be dismissed if it satisfies Rule 8(a)(2) which requires "a short and plain statement of the claim showing that the pleader is entitled to relief." The complaint need only "give the defendant fair notice of what the plaintiff's claim is and the grounds upon which it rests." Conley v. Gibson, 355 U.S. 41, 47, 78 S.Ct. 99, 103, 2 L.Ed.2d 80 (1957). A claim should be dismissed only if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Id. at 45-46, 78 S.Ct. at 102.

When the complaint sounds in fraud, however, Fed.R.Civ.P. 9(b) applies. Rule 9(b) states that "in averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge and other condition of mind of a person may be averred generally." This rule, known as the "particularity requirement", applies to Section 10(b) and Rule 10b-5 claims because "fraud lies at the core of the action." Hayduk v. Lanna, 775 F.2d 441, 443 (1st Cir.1985) (emphasis in original). The heightened pleading standard must, therefore, be applied to plaintiff's Section 10 claims. See New England Data Services, Inc. v. Becher, 829 F.2d 286, 288-89 (1st Cir.1987); Hayduk, 775 F.2d at 442; Wayne Investment, Inc. v. Gulf Oil Corp., 739 F.2d 11, 13 (1st Cir.1984). Plaintiff's Section 10 claims will not survive dismissal unless each element of the claim is pled with "particularity." Whether a complaint is "particular" enough to avoid dismissal is, necessarily, a fact oriented determination. The First Circuit precedent, therefore, although quite clear in concept, is difficult to apply without first exploring the basic purposes of the particularity requirement as they have been outlined by our Court of Appeals.⁵

To begin, the First Circuit has stated that:

generally, there are three purposes behind Rule 9(b)'s particularity requirement: (1) to place the defendants on notice and enable them to prepare meaningful responses; (2) to preclude the use of a groundless fraud claim as a pretext to discovering a wrong or as a `strike suit';⁶ and (3) to safeguard defendants from frivolous charges which might damage their reputations. Becher, 829 F.2d at 289 (citations omitted).

The plaintiff has argued that in the First Circuit, notice is the main purpose of the rule. Hayduk, 775 F.2d at 444. In Hayduk, however, the Court of Appeals stated that notice is "a main purpose of the rule." Id. (emphasis added). The statement in Hayduk does no more than state one of the main purposes; it does not denigrate the others. Moreover, in Hayduk itself, the court also states that a purpose of the rule is to appraise and prevent strike suits. Id. at 443.

To avoid the evils caused by mere conclusory allegations of fraud, the First Circuit has stated that "rule 9(b) requires `specification of the time, place and content of an alleged false representation, but not the circumstances or evidence from which fraudulent intent could be inferred.'" Id. at 444 (citing McGinty v. Beranger, 633 F.2d 226, 228 (1st Cir.1980); Wayne, 739 F.2d at 13-14). From this quote, the plaintiff contends that once the complained of statements have been set forth verbatim in the complaint with specifics as to time and place, the particularity requirement has been met. The inquiry, however, does not end with this technical compliance. The circumstances of the misrepresentation must be specified; the specific basis for the claim must be alleged. See Hayduk, 775 F.2d at 444. Although the "circumstances or evidence from which fraudulent intent could be inferred," Hayduk, 775 F.2d at 444, need not be alleged with particularity;⁷ this does not mean that a complaint need not give any indication of the basis upon which it alleges fraud. The fact that a plaintiff, to avoid dismissal, can generally allege scienter (the third element in a Section 10 claim), does not mean that the plaintiff has no obligation to indicate some basis for suspecting that there has been a misrepresentation or omission of a material fact (the first element in a Section 10 claim).⁸ Defendants must be apprised of what they did wrong. See id. at 445. A complaint must do more than offer speculation, it must make some step toward showing that "fraud was actually committed." Wayne, 739 F.2d at 14.

What allegations are, therefore, necessary to meet the first element of a Section 10 claim? It has been suggested that a "complainant's failure to describe how the challenged statements are misleading cause it to run afoul of Rule 9(b)...." Konstantinakos v. F.D.I.C., 719 F.Supp. 35, 39 n. 7 (D.Mass.1989) (emphasis added). A plaintiff must plead "the who, what, when, where, and how: the first paragraph of any newspaper story." DiLeo, 901 F.2d at...