Lucia v. Prospect Street High Income Portfolio, Inc., s. 93-2055

• Decision Date: 10 February 1994
• Docket Number: Nos. 93-2055,93-2056,s. 93-2055
• Citation: 36 F.3d 170
• Parties: Fed. Sec. L. Rep. P 98,412, 30 Fed.R.Serv.3d 768 Robert LUCIA, et al., Plaintiffs, Appellants, v. PROSPECT STREET HIGH INCOME PORTFOLIO, INC., et al., Defendants, Appellees. Eric MILLER, et al., Plaintiffs, Appellants, v. The NEW AMERICAN HIGH INCOME FUND, et al., Defendants, Appellees. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 170

36 F.3d 170

Fed. Sec. L. Rep. P 98,412, 30 Fed.R.Serv.3d 768

Robert LUCIA, et al., Plaintiffs, Appellants, v. PROSPECT STREET HIGH INCOME PORTFOLIO, INC., et al.,

Defendants, Appellees.

Eric MILLER, et al., Plaintiffs, Appellants, v. The NEW AMERICAN HIGH INCOME FUND, et al., Defendants, Appellees.

Nos. 93-2055, 93-2056.

United States Court of Appeals First Circuit.

Heard Feb. 10, 1994.

Decided Sept. 28, 1994.

Eugene A. Spector, with whom Robert M. Roseman, Mark S. Goldman, Robert G. Eisler, Spector & Roseman, Philadelphia, PA, Nancy Gertner, Jody L. Newman, Dwyer, Collora & Gertner, Boston, MA, Garwin, Bronzaft, Gerstein & Fisher, New York City, Elwood S. Simon & Associates, Elwood S. Simon, Bloomfield Hills, MI, Wechsler, Skirnick Harwood, Halebian & Feffer, Robert I. Harwood, New York City, Levin, Fishbein, Sedran & Berman, Arnold Levin, Esq., Kohn, Nast & Graf, P.C., Robert S. Kitchenoff, Philadelphia, PA, Chertow & Miller, Marvin Miller, Chicago, IL, Shapiro Grace & Haber, and Edward Haber, Boston, MA, were on brief, for appellants.

Thomas J. Dougherty, with whom Skadden, Arps, Slate, Meagher & Flom, Boston, MA, was on brief, for appellees Messrs. Omohundro, Frabotta, Carey, Cote, Meyohas and Platt.

John D. Donovan, Jr., with whom Ivan B. Knauer, Timothy J. Hinkle, Kurt S. Kusiak, and Ropes & Gray, Boston, MA, were on brief, for appellees The New High Income Fund, Inc., Patricia Ostrander, Ellen Terry, and Richard E. Floor.

Robert A. Buhlman, with whom Gerald F. Rath and Bingham, Dana & Gould, Boston, MA, were on brief, for Prudential Securities Inc.

Peter M. Saparoff and Palmer & Dodge, Boston, MA, were on brief, for appellees Ernest E. Monrad, Joseph L. Bower, Bernard J. Korman, and Franco Modigliani.

Paul C. Madden, Paul D. Shaffner, David Moffitt, and Saul, Ewing, Remick & Saul, Philadelphia, PA, were on brief, for appellees Butcher Corp. and Bateman Eichler, Hill Richards, Inc.

Harry L. Manion, III, Thomas G. Guiney, and Cooley, Manion, Moore & Jones, P.C., Boston, MA, were on brief, for appellee Ostrander Capital Management Corp.

Eric A. Deutsch, Margaret A. Flanagan, and Testa, Hurwitz & Thibeault, Boston, MA, were on brief, for Prospect Street High Income Portfolio, Inc. and Prospect Street Inv. Management Co., Inc.

Before CYR, Circuit Judge, ALDRICH, Senior Circuit Judge, and STAHL, Circuit Judge.

STAHL, Circuit Judge.

In the late 1980's, plaintiffs-appellants purchased shares of two separate "junk bond" funds. After the value of the purchased shares plummeted, plaintiffs alleged various federal securities law violations. In a series of related rulings, the district court dismissed some of plaintiffs' allegations for failure to state a claim, and granted summary judgment in favor of defendants on all remaining claims. We affirm in part and reverse in part.

I. FACTUAL BACKGROUND AND PRIOR PROCEEDINGS

Prior to this appeal, the proceedings in these two cases were not formally consolidated. As the district court noted, the two cases raise many identical issues. Thus, our discussion, unless we specifically state otherwise, applies equally to both cases.

In 1988, both New America High Income Fund, Inc. and Prospect Street High Income Portfolio, Inc. ("the New America Fund," and "the Prospect Street Fund," or collectively "the funds") were first publicly offered on the New York Stock Exchange. Each fund's purpose, as stated in their nearly identical prospectuses, was to invest in a diversified portfolio of high yield fixed-income securities, commonly known as "junk bonds."

In April 1989, well after the initial public offerings, a study headed by Professor Paul Asquith ("the Asquith study") disclosed that the default rate of junk bonds was much higher than had been previously believed. ¹ This conclusion was reached by calculating the adverse effects of "aging" on junk bonds. ²

Within months of the study, though not necessarily as a direct result of the study, the market for junk bonds began to collapse. By November 1989, both funds had reduced their dividends, and the share value of each fund had declined considerably.

Plaintiffs, who consist of putative classes of purchasers of each fund, commenced parallel actions against the two funds. The First Amended Complaints (hereinafter "the original complaints") were lengthy, alleging violations of a variety of federal securities laws, including section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b), and sections 11 and 12(2) of the Securities Act of 1933, 15 U.S.C. Secs. 77k, 77l(2). ³ The gist of the original complaints was that the funds' directors, advisors and underwriters ("defendants") knew of, but failed to disclose, adverse information about the junk bond market. In particular, the complaints alleged that defendants had agreed to act, and had in fact acted, as purchasers of last resort for undesirable junk bonds; that they knew of infirmities in the junk bond market at the time they publicly offered shares of the funds and thereafter; and that misleading statistics were used in the prospectuses to portray the historical performance of junk bonds. ⁴

The district court dismissed many of plaintiffs' claims on the pleadings, see Miller v. New Am. High Income Fund, 755 F.Supp. 1099 (D.Mass.1991) ("Miller I "); Lucia v Plaintiffs' Second Amended Complaints (hereinafter "the revised complaints") alleged causes of action only under sections 11 and 12(2). All section 10(b) claims presented in the original complaints were dropped. Among other things, the revised complaints focused on a ten-year comparison between junk bonds and United States Treasury securities ("Treasury securities") that was included in the prospectuses. ⁵ Though the ten-year figure showed that junk bonds had outperformed Treasury securities, the revised complaints alleged that during the six years leading up to each fund's public offering, Treasury securities had actually outperformed junk bonds. ⁶

Prospect St. High Income Portfolio, Inc., 769 F.Supp. 410 (D.Mass.1991) ("Lucia I "), but nonetheless allowed both sets of plaintiffs to replead.

Shortly after the revised complaints were filed, defendants moved for summary judgment. The district court began by ruling as a matter of law that the comparison to Treasury securities in the prospectuses was not misleading. See In re New Am. High Income Fund Sec. Litig., 834 F.Supp. 501, 506-07 (D.Mass.1993) ("Miller II "). It went on to grant summary judgment in favor of defendants on all other claims. Id.; Lucia v. Prospect St. High Income Portfolio, Inc., No. 90-10781-MA (D.Mass. Aug. 26 1993) ("Lucia II "). Plaintiffs appeal these various rulings. We address plaintiffs' claims in the order in which they were decided by the district court.

II. DISCUSSION

A. Section 10(b) Claims

The district court dismissed plaintiffs' section 10(b) claims at the first of these cases'

two pleading stages. We affirm that dismissal, though on somewhat narrower grounds than those relied upon by the district court.

1. Standard of Review

Rule 12(b)(6) dismissals are subject to de novo review. Northeast Doran, Inc. v. Key Bank of Maine, 15 F.3d 1, 2 (1st Cir.1994). While we generally credit all allegations in the complaint and draw all reasonable inferences favorable to the plaintiff, id., Rule 9(b) imposes heightened pleading requirements for allegations of fraud. "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b).

As we have stated in a recent discussion of Rule 9(b) in the securities context:

[G]eneral averments of the defendants' knowledge of material falsity will not suffice. Consistent with Fed.R.Civ.P. 9(b), the complaint must set forth specific facts that make it reasonable to believe that defendant[s] knew that a statement was materially false or misleading. The rule requires that the particular times, dates, places or other details of the alleged fraudulent involvement of the actors be alleged.

Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 361 (1st Cir.1994) (citations and internal quotation marks omitted). "We have been especially rigorous in demanding such factual support in the securities context." Romani v. Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir.1991). Moreover, this heightened pleading is required "even when the fraud relates to matters peculiarly within the knowledge of the opposing party." Id.

2. The Original Complaints

Plaintiffs' original complaints alleged various wrongdoing by defendants. The common thread running throughout the original complaints, however, was that defendants knew of infirmities in the junk bond market, and that they nonetheless entered a vast web of illicit agreements with Drexel Burnham Lambert, and with former junk bond dealer Michael Milken, in order to become purchasers of last resort for undesirable junk bonds.

The district court properly concluded that these general allegations in the original complaints were wholly conclusory. No factual basis is put forward to support plaintiffs' theory that defendants consorted with Drexel, that they dealt with Michael Milken, that they agreed to act as purchasers of last resort for undesirable bonds, or that they knew enough to anticipate the impending fall-out of the junk bond market. Because all of plaintiffs' 10(b) claims rely fundamentally on such unsupported allegations, the district court properly dismissed these claims for failure to meet Rule 9(b). ⁷ Cf. Romani, 929 F.2d at 878 (finding that complaint failed to satisfy Rule 9(b) where it contained "no factual allegations that would support a reasonable inference that adverse circumstances existed at the time of the offering, and were known and deliberately or recklessly disregarded by defendants").

B. Section 11 and 12(2) Claims

As noted above, plaintiffs were allowed to replead. Defendants' motions for summary judgment soon followed, and summary judgment...