NationsMart Corp. Securities Litigation, In re

Citation130 F.3d 309
Decision Date15 January 1998
Docket NumberNo. 96-4132,96-4132
PartiesFed. Sec. L. Rep. P 99,574, 39 Fed.R.Serv.3d 309 In re NATIONSMART CORPORATION SECURITIES LITIGATION. Jack CARLON, Helen S. Palmquist, Brian Palmquist, John D. Palmquist, Appellants, v. Michael E. THAMAN, Alice E. Brueggemann, S. Leslie Flegel, Mel A. Friedman, Alan G. Johnson, Franklin A. Jacobs, S. Lee Kling, Michael J. Dunlap, RAS Securities Corp., Pauli & Company, Inc., and NationsMart Corporation, Appellees.
CourtU.S. Court of Appeals — Eighth Circuit

Charles R. Watkins, Chicago, IL, argued (Lee Squitieri and Mark D. Mittleman, on the brief), for Appellant.

Thomas M. Newmark, St. Louis, MO, argued (David W. Harlan, Robert L. Newmark, Christine F. Miller, Alan E. Popkin, Michael H. Wetmore, Patricia A. Bronte, Kara N. Brockmeyer, Kenton E. Knickmeyer, Mark Sableman and Christopher M. Hohn, on the brief), for Appellee.

Before RICHARD S. ARNOLD, Chief Judge, FLOYD R. GIBSON and BEAM, Circuit Judges.

RICHARD S. ARNOLD, Chief Judge.

In this case, Jack Carlon, Helen S. Palmquist, Brian Palmquist, and John D. Palmquist appeal the District Court's dismissal of their class action brought under Sections 11 and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k(a) and 77o (1994); Section 12(2) of the Securities Act, 15 U.S.C. § 77l(2) (1994); and Sections 10(b) and 20 of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t (1994). This litigation involves alleged misrepresentations, misstatements, and omissions made in connection with an initial public offering on December 22, 1993, of shares in NationsMart, a Missouri corporation formed to manage laundry, dry-cleaning, and shoe-repair centers in large retail stores such as Wal-Mart and Kmart. The defendants in the action below, and the appellees before this court, include NationsMart; eight of NationsMart's officers and directors; and NationsMart's two lead underwriters, RAS Securities Corporation and Pauli & Company, Inc. 1 The District Court dismissed the plaintiffs' complaint for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6) and for failure to plead fraud with particularity under Federal Rule 9(b). We now affirm in part and reverse in part.

I.

NationsMart was formed in 1992 with the goal of applying the low-price, one-stop shopping concept, made successful by Wal-Mart and Kmart "supercenters," to the dry-cleaning, laundry, and shoe-repair markets. After filing a Registration Statement and a Prospectus with the Securities and Exchange Commission ("SEC"), NationsMart commenced an initial public offering of two million units at $7.00 per unit on December 22, 1993. 2 The Prospectus stated that NationsMart expected to raise $11.7 million in its public offering, and that it intended to use the net proceeds to fund the 51 existing NationsMart stores and to open 108 new stores by November 1994. Under the plan for growth set forth in the Prospectus, the company would open 600 new stores by 1998.

The Prospectus contained detailed financial data about NationsMart, a discussion and analysis of the company's financial situation and the results of its operation, and its strategy for future growth. It acknowledged that NationsMart had previously experienced financial losses, but stated that NationsMart's management believed that, based on a "financial model," projected income from existing stores, as well as the proceeds of the public offering, would "significantly improve the capital resources of the Company and thereby address certain of the going concern conditions." A section of the Prospectus labeled "Risk Factors" included some of the risks investors faced in buying offered units, such as NationsMart's limited operating history and the absence of a prior market for its shares; its dependence on leases from Wal-Mart, Kmart, and other "host retailers"; the competition it faced from other retailers; and its need for additional financing in the future. The Prospectus also cautioned that NationsMart's financial model reflected "only the best judgment of management" and was subject to conditions beyond the company's control.

On July 14, 1994, NationsMart announced that it was experiencing slower-than-expected growth and that it would open 35 to 45 fewer stores than anticipated in the Prospectus. NationsMart also disclosed that it had settled a "whistleblower" lawsuit with Alice Brueggemann, a former senior vice president and chief financial officer who had sued NationsMart after she was discharged in March 1994. Following these announcements, NationsMart's common stock fell to $1.875 and continued to decline until mid-1995, when the stock was delisted.

On November 4, 1994, Helen, Brian, and John Palmquist filed a class action against the defendants in the Northern District of Illinois; and on November 7, 1994, Jack Carlon filed a class action against the defendants in the Eastern District of Missouri. 3 The Palmquists' case was transferred to the Eastern District of Missouri in February 1995, and the four plaintiffs were permitted to file a consolidated class-action complaint on May 1, 1995. 4 It is this complaint that is the subject of this appeal.

In the consolidated complaint, the plaintiffs asserted three bases for relief. Count I alleged violations of Sections 11 and 15 of the Securities Act of 1933 by all of the defendants. Count II alleged violations of Section 12(2) of the Securities Act of 1933 by NationsMart and the two lead underwriters. And Count III alleged violations of Section 10(b) and 20 of the Securities Exchange Act of 1934 and SEC Rule 10b-5 by all defendants. Factually, the complaint alleged that the defendants made false statements in and omitted material information from the Prospectus. It alleged that, given the projections of NationsMart's underwriters, the defendants knew that the company would not be able to implement the business plan outlined in the Prospectus with the proceeds of the offering. Complaint pp 22-25, 30. The plaintiffs also claimed that the defendants failed to disclose certain facts learned by NationsMart's management in the months before the effective date of the public offering, including the fact that favorable trends described in the Prospectus were not materializing and were not likely to materialize; that the costs to operate existing NationsMart stores and the cost to open new stores had been increasing; and that corporate overhead was increasing. Complaint pp 40-43. The complaint went on to allege that after the public offering the defendants continued to make statements touting NationsMart's plans to open new stores which they knew had no reasonable basis in fact, including allegedly misleading statements made to investors and statements made in annual and quarterly reports filed with the SEC. Complaint pp 45-51.

In a memorandum opinion and order on April 11, 1996, the District Court dismissed all claims against NationsMart and its directors and officers, and it dismissed most of the claims against RAS and Pauli & Company, the two lead underwriters. The Court allowed part of the § 12(2) claim in Count II of the complaint to survive with respect to the two lead underwriters. In a second opinion on November 6, 1996, the District Court dismissed the remainder of the § 12(2) claim against RAS and Pauli & Company. In these opinions, the District Court held that the plaintiffs had failed to state a claim under Federal Rule of Civil Procedure 12(b)(6) and had failed to allege fraud with particularity under Federal Rule of Civil Procedure 9(b). In the April 11 opinion and order, the District Court dismissed the case with prejudice and without leave to amend. Nevertheless, the plaintiffs later sought leave to amend the complaint and vacate the April 11 order. The District Court denied this motion in its November 6 order, stating that the plaintiffs' failure to amend the complaint before the Court entered its April 11 order constituted undue delay.

This case is now before us on appeal of Jack Carlon and Helen, Brian, and John Palmquist.

II.

For the reasons given below, we hold that the District Court erred when it dismissed the plaintiffs' claim against all defendants under § 11 of the Securities Act of 1933.

A.

The District Court based its dismissal of the complaint in part on the plaintiffs' failure to plead specific facts pursuant to Federal Rule of Civil Procedure 9(b) to support the allegations of liability under § 11 of the Securities Act. Under Federal Rule 9(b), in a complaint averring fraud, "the circumstances constituting fraud or mistake shall be stated with particularity." We hold that the particularity requirement of Rule 9(b) does not apply to claims under § 11 of the Securities Act, because proof of fraud or mistake is not a prerequisite to establishing liability under § 11.

Section 11 imposes civil liability on persons preparing and signing materially misleading registration statements. 15 U.S.C. § 77k(a) (1994). A registration statement is materially misleading if it contains an untrue statement of material fact or if it omits a material fact necessary to prevent the statement from being misleading. Id. Any person who purchases a registered security is entitled to sue under this section. Id. Section 11 imposes "a stringent standard of liability on the parties who play a direct role in a registered offering." Herman & MacLean v. Huddleston, 459 U.S. 375, 381-82, 103 S.Ct. 683, 687, 74 L.Ed.2d 548 (1983) (footnotes omitted). To establish a prima facie § 11 claim, a plaintiff need show only that he bought the security and that there was a material misstatement or omission. Scienter is not required for establishing liability under this section. Id. at 382, 103 S.Ct. at 687; In re Stac Electronics Securities Litigation, 89 F.3d 1399 (9th Cir.1996), cert. denied, --- U.S. ----, 117 S.Ct. 1105, 137 L.Ed.2d...

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