Rudolph v. Arthur Andersen & Co.

Decision Date29 September 1986
Docket NumberNo. 85-5722,85-5722
Citation800 F.2d 1040
Parties, Fed. Sec. L. Rep. P 92,934 Sidney J. RUDOLPH, individually and on Behalf of all other persons similarly situated, and Joseph D. Decosimo, Trustee in Liquidation of the DeLorean Research Limited Partnership, a Michigan Limited Partnership, Plaintiffs- Appellants, v. ARTHUR ANDERSEN & CO., an Illinois partnership, Defendant-Appellee.
CourtU.S. Court of Appeals — Eleventh Circuit

Murray Sams, Jr., Peter J. Yanowitch, Frank D. Newman, Sams, Ward, P.A., Miami, Fla., Sidney Davis, Davis, Markel & Edwards, New York City, for plaintiffs-appellants.

Martin B. Woods, Stearns, Weaver, Miller, Wissler, Alhadeff & Sitterson, Bruce W. Greer, Greer, Homer, Cope & Bonner, P.A., Miami, Fla., James J. Sabella, New York City, for defendant-appellee.

Appeal from the United States District Court for the Southern District of Florida.

Before VANCE and ANDERSON, Circuit Judges, and PITTMAN *, Senior District Judge.

VANCE, Circuit Judge:

The district court dismissed plaintiffs' complaint and denied leave to amend on the ground that neither the complaint before the court nor the proposed amended complaint stated a federal claim. We find the proposed complaint sufficient to state a claim and thus reverse.

I.

This case stems from the travails of auto magnate John DeLorean. When DeLorean's ill-fated sports car production venture collapsed, investors in a limited partnership DeLorean set up ("DRLP") lost their money. DRLP's liquidating trustee, along with one investor, filed suit in the Southern District of Florida against defendant Arthur Andersen & Co. ("Andersen"), claiming that DeLorean 1 had intentionally defrauded the investors and that Andersen is liable for the loss because it either knew or should have known of the fraud.

Plaintiffs have had great difficulty stating a federal cause of action. Their original complaint stated only state law claims and no sufficient basis for diversity jurisdiction. Upon threat of dismissal, plaintiffs amended the complaint to allege violation by Andersen of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b), and corresponding SEC Rule 10b-5, 17 C.F.R. Sec. 240.10b-5, as well as liability on the part of Andersen for aiding and abetting securities violations by DeLorean. After Andersen moved to dismiss for failure to state a federal securities claim, plaintiffs moved for leave to amend and submitted their proposed amended complaint. The district court, however, granted Andersen's motion for dismissal. The court also denied leave to amend, concluding that the proposed complaint also failed to state a federal claim. Plaintiffs now contend that the district court erred in determining that the proposed amended complaint was insufficient.

II.

A decision whether to grant leave to amend is within the discretion of the district court, Foman v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 230, 9 L.Ed.2d 222 (1962), but that discretion is severely circumscribed. Federal Rule of Civil Procedure 15(a) declares that leave to amend "shall be freely given when justice so requires." Because "this mandate is to be heeded," there must be a "justifying reason" for a court to deny leave. Foman, 371 U.S. at 182, 83 S.Ct. at 230; see also Halliburton & Associates v. Henderson, Few & Co., 774 F.2d 441, 443 (11th Cir.1985) ("substantial reason" needed).

The district court here gave a reason for its denial of leave to amend: it concluded that allowing the amendment would be futile because the proposed amended complaint failed to state a claim. If correct, that conclusion would be sufficient to support a denial of leave. Halliburton, 774 F.2d at 444. Our role, therefore, is limited to determining whether the proposed complaint fails to state a claim under Rule 10b-5. If the complaint does state such a claim, the court's justification for denying leave to amend fails and the denial becomes improper under Foman.

III.

Plaintiffs' proposed amended complaint can reasonably be read to allege the following:

1. On March 23, 1978, DeLorean issued a Private Placement Memorandum ("the placement memo") offering DRLP limited partnership investment units for sale. The placement memo represented that the funds raised by the partnership offering would be used for research and development related to the production of a new sports car. The research and development aspect was an important part of the offering, since the return to investors was linked in part to the success of the research, and since the offering purported to make available substantial research and development tax benefits.

2. At the time the memo was issued DeLorean actually intended to use the funds raised through the offering for research and development. The assumption at that point was that the manufacturing operation would be located in Puerto Rico.

3. Audit reports and other financial statements concerning DeLorean were included in the memo. These reports and statements were prepared by Andersen and were included in the memo with Andersen's permission. They related to the past financial condition of the DeLorean entities, specifically the years 1976 and 1977.

4. In late June or July 2 DeLorean found that he could gain substantial financial benefits by locating the manufacturing facility in Northern Ireland instead of Puerto Rico. The better terms offered by Northern Ireland made the research and development funds being raised through the DRLP unnecessary. Consequently, at some point prior to July 28, 1978, DeLorean devised a scheme of fraud under which he would drop the original purpose of the DRLP and instead divert the funds being raised to other uses. The DRLP investors were not told of this change in plans.

5. On or about September 22, 1978, the sale of DRLP investment units was completed and the funds raised were withdrawn or "taken down" by DeLorean, as was the original plan as set forth in the placement memo. However, DeLorean did not use these funds for research and development.

6. During the entire period from the issuance of the placement memo to the takedown of the DRLP funds by DeLorean, Andersen was performing substantial non-auditing services for the DeLorean entities.

7. Because of its business relationship with DeLorean, Andersen knew or recklessly failed to learn of DeLorean's intention to divert the partnership funds. However, since DeLorean's intent to divert was not formulated until sometime after the issuance of the placement memo, Andersen obviously did not know of the scheme until after its reports and statements were in the memo.

8. Andersen willfully or recklessly failed to disclose the alleged fraud.

IV.
A.

SEC Rule 10b-5 provides that [i]t shall be unlawful for any person, directly or indirectly ...

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any 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, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

There can be no doubt that plaintiffs' complaint contains sufficient allegations to support a Rule 10b-5 claim against DeLorean. Plaintiffs allege that in the course of selling securities--the partnership investment units 3--DeLorean continuously represented that the partnership funds would be used for research and development, while actually deciding at some point during the sale to use the funds for some other purpose. This is surely the type of "untrue statement of a material fact ... in connection with" the sale of securities that Rule 10b-5 was intended to prohibit.

It is also clear that if read literally, Rule 10b-5 would reach the alleged conduct of Andersen. The rule prohibits "omit[ting] to state a material fact" necessary to make the statements made not misleading. Plaintiffs' complaint accuses Andersen of doing just that, and of thereby leading to plaintiffs' injury.

Rule 10b-5, however, is not read literally. Instead, a defendant's omission to state a material fact is proscribed only when the defendant has a duty to disclose. Such a duty may exist "where the law imposes special obligations, as for accountants, brokers, or other experts, depending on the circumstances of the case." Woodward v. Metro Bank, 522 F.2d 84, 97 n. 28 (5th Cir.1975). In evaluating the circumstances

we consider the relationship between the plaintiff and defendant, the parties' relative access to the information to be disclosed, the benefit derived by the defendant from the purchase or sale, defendant's awareness of plaintiff's reliance on defendant in making its investment decision, and defendant's role in initiating the purchase or sale.

First Virginia Bankshares v. Benson, 559 F.2d 1307, 1314 (5th Cir.1977), cert. denied, 435 U.S. 952, 98 S.Ct. 1580, 55 L.Ed.2d 802 (1978). A duty to disclose may also be created by a defendant's previous decision to speak voluntarily. Where a defendant's failure to speak would render the defendant's own prior speech misleading or deceptive, a duty to disclose arises. See id.

We have not held these factors to be exclusive; there may be others which may properly be taken into account in a particular situation. For instance, the extent of the defendant's knowledge and the significance of the misstatement, fraud or omission might be relevant. A defendant who intentionally did not reveal what he knew to be fraud might more reasonably be expected to speak out than a defendant who merely failed to learn of a material but ambiguous omission. The extent of the defendant's participation in the fraud might also be important. See, e.g., Strong v. France, 474 F.2d 747, 752 (9th Cir.1973).

B.

Although this court has not considered the issue, but see Woodward, 522...

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