Keegan Management Co., Securities Litigation, In re
| Decision Date | 14 August 1995 |
| Docket Number | 94-16135,Nos. 94-15713,s. 94-15713 |
| Citation | 78 F.3d 431 |
| Parties | Fed. Sec. L. Rep. P 99,053, 33 Fed.R.Serv.3d 1099, 96 Cal. Daily Op. Serv. 1355, 96 Daily Journal D.A.R. 2305 In re: KEEGAN MANAGEMENT CO., SECURITIES LITIGATION. Michael MOORE, et al., Plaintiffs, and Lieff, Cabraser & Heimann; Elizabeth J. Cabraser, Appellants, v. KEEGAN MANAGEMENT COMPANY, a Delaware corporation, et al., Defendants-Appellees. Michael MOORE, et al., Plaintiffs, and Richard L. Jaeger; Feldman, Waldman & Kline, Appellants, v. KEEGAN MANAGEMENT COMPANY, a Delaware corporation, et al., Defendants-Appellees. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Judith Resnik, University of Southern California Law Center, Los Angeles, California, Jerome B. Falk, Jr., Howard, Rice, Nemerovski, Canady, Robertson, Falk & Rabkin, San Francisco, California, for appellants.
No appearance for appellees.
Appeals from the United States District Court for the Northern District of California; Spencer M. Williams, District Judge, Presiding.
Before FLETCHER, POOLE, and O'SCANNLAIN, Circuit Judges.
Opinion by Judge POOLE; Partial Concurrence and Partial Dissent by Judge O'SCANNLAIN.
We consider under what circumstances and pursuant to what authority attorneys may be sanctioned for the filing of a complaint. Because we find such circumstances not present here, we reverse the district court's order imposing $100,000 in sanctions against attorneys Elizabeth Cabraser and Richard Jaeger, and their respective law firms, Lieff, Cabraser & Heimann and Feldman, Waldman & Kline.
The merits of this case, a securities class-action, are not at issue. The sole question on appeal is whether plaintiffs' counsel may be sanctioned for initiating this lawsuit.
Defendant Keegan Management was a franchisee of Nutri/System Weight Loss Centers ("Nutri/System"). It sold weight loss programs. In December 1989, Keegan made an initial public offering ("IPO") of stock at $7 per share. Stock rose to $10 per share within a few months.
In early 1990, controversy over the Nutri/System program broke out. A series of personal injury lawsuits alleging gall bladder problems resulting from weight-loss programs were filed against Nutri/System. In March, Congressional hearings on the diet industry aired testimony discussing the health risks associated with such programs, including the risk of gallstones from rapid weight loss. The Wall Street Journal published an article discussing health problems associated with the Nutri/System program. Amidst these events and other reports, Keegan's stock fell to 10% of its peak value.
Appellant law firms Lieff, Cabraser & Heimann and Feldman, Waldman & Kline were approached in late 1990 by potential clients interested in filing securities fraud suits against Keegan based on the possibility that Keegan had knowingly or recklessly failed to disclose health risks associated with its program in the 1989 IPO. Attorneys Elizabeth Cabraser of Lieff, Cabraser and Richard Jaeger of Feldman, Waldman & Kline ultimately filed separate class action suits on February 19 and March 4, 1991. The two suits, Moore v. Keegan and Crespo v. Keegan, were consolidated. These suits alleged that Keegan misrepresented the Nutri/System program as safe at a time when it knew, or was reckless in not knowing, that the program might lead to gall bladder problems.
Keegan moved for summary judgment, and the district court granted the motion in May 1992. The district court found plaintiffs' evidence of scienter, and any known link between weight loss and gall bladder problems prior to December 1989, entirely lacking. That summer, Keegan moved for Rule 11 sanctions, but withdrew its motion as part of settlement negotiations. The parties reached a settlement in November 1992. However, prior to approval of that settlement, the district court sua sponte issued an order to show cause why Rule 11 sanctions should not be entered. The court conducted a hearing on April 27, 1993. On March 31, 1994, 154 F.R.D. 237, the district court entered sanctions against Cabraser and Jaeger in the amount of $25,000 each pursuant to Rule 11 and 28 U.S.C. § 1927. It also sanctioned the attorneys' firms $25,000 each pursuant to § 1927 and its inherent power. The district court concluded that the attorneys had been reckless in filing a complaint when they could at best only guess that Keegan recklessly failed to disclose health risks when issuing the IPO. The attorneys and firms have timely appealed.
At the time the complaint in this case was filed, Rule 11 provided in relevant part that by signing a filing, an attorney certified
that to the best of the signer's knowledge, information, and belief formed after reasonable inquiry it is well grounded in fact and is warranted by existing law or a good faith argument for the extension, modification, or reversal of existing law, and that it is not interposed for any improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of litigation.
Fed.R.Civ.P. 11. The district court sanctioned Cabraser and Jaeger pursuant to the first prong, the "frivolousness prong." We review the district court's entry of Rule 11 sanctions for an abuse of discretion. Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405, 110 S.Ct. 2447, 2460-61, 110 L.Ed.2d 359 (1990); Newton v. Thomason, 22 F.3d 1455, 1463 (9th Cir.1994).
Cabraser and Jaeger raise several challenges to these sanctions. We need address only one. Cabraser and Jaeger argue that the district court erred by failing to consider after-acquired factual evidence that would have adequately supported the complaint. We agree.
Under the district court's understanding of the law, the key question was, "What did plaintiffs know when they filed their lawsuit?" District Court 3/31/94 Order at 241. Applying this understanding, the district court excluded from consideration any evidence supporting the suit which was unknown to counsel at the time of filing. This included a scientific study published in August 1989--several months before the IPO--suggesting a weight loss/gallstone link, as well as a declaration from plaintiffs' expert Dr. J.W. Marks reviewing the scientific literature and asserting that such a link was well-established prior to the IPO. These exclusions were dispositive; the district court acknowledged that "if, prior to filing the complaint, Plaintiffs had in their possession the same information that they offered in opposition to summary judgment, it would have been sufficient to justify filing this lawsuit." District Court 3/31/94 Order at 241.
In effect, the district court applied a subjective-objective test. Objectively, would a reasonable attorney have believed plaintiffs' complaint to be well-founded in fact based on what plaintiffs' attorneys subjectively knew at the time? Appellants argue that an objective-objective test should apply: would a reasonable attorney have believed plaintiffs' complaint to be well-founded in fact based on what a reasonable attorney would have known at the time? Alternatively, the issue may be framed as whether the "reasonable inquiry" and "well-founded" requirements are conjunctive or disjunctive. An attorney may not be sanctioned for a complaint that is not well-founded, so long as she conducted a reasonable inquiry. May she be sanctioned for a complaint which is well-founded, solely because she failed to conduct a reasonable inquiry?
We conclude that the answer is no. In Townsend v. Holman Consulting Corp., 929 F.2d 1358 (9th Cir.1990) (en banc), an en banc panel of this court canvassed the circuit's Rule 11 law. It explained the requirements for sanctioning an attorney under the frivolousness prong:
Our cases have established that sanctions must be imposed on the signer of a paper if ... the paper is 'frivolous.' The word 'frivolous' does not appear anywhere in the text of the Rule; rather, it is a shorthand that this court has used to denote a filing that is both baseless and made without a reasonable and competent inquiry.
Id. at 1362 (citation omitted) (emphasis added). Townsend thus approves of the conjunctive requirement and the objective-objective rule. Townsend goes on to expressly embrace an objective-objective analysis in dismissing an attorney's lack of awareness of favorable precedent: "The fact that [counsel] did not cite that case ... does not render his argument sanctionable, since, objectively, his request was warranted by existing law." Id. at 1367.
We have subsequently reconfirmed Townsend 's objective-objective approach. "Because the frivolousness prong of Rule 11 is measured by objective reasonableness, see Zaldivar v. Los Angeles, 780 F.2d 823, 829 (9th Cir.1986), whether [a party] actually relied on" the cases which show its claims aren't frivolous is irrelevant. Unigard Sec. Ins. Co. v. Lakewood Eng'g & Mfg. Corp., 982 F.2d 363, 370 (9th Cir.1992). The same rule must apply to the factual basis for a claim.
Some language in our prior cases suggests the opposite result. We have held that "an attorney violates [R]ule 11 whenever he signs a pleading, motion, or other paper without having conducted a reasonable inquiry into whether his paper is frivolous, legally unreasonable, or without factual foundation." Unioil, Inc. v. E.F. Hutton & Co., 809 F.2d 548, 557 (9th Cir.1986) (), cert. denied, 484 U.S. 822, 108 S.Ct. 83, 98 L.Ed.2d 45 (1987). Under Unioil, it appears not to matter whether a filing is frivolous, so long as the signing attorney has failed to conduct a reasonable inquiry. This language accords with the district court's subjective-objective approach, but is inconsistent with Townsend. To the extent Unioil endorses a subjective-objective test and authorizes sanctions solely for an unreasonable inquiry, we believe it has been implicitly overruled by the en banc decision in Townsend. 1
Townsend compels our...
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