S.E.C. v. Rauscher Pierce Refsnes, Inc.

• Citation: 17 F.Supp.2d 985
• Decision Date: 24 August 1998
• Docket Number: No. CIV-98-0027-PHX-ROS.,CIV-98-0027-PHX-ROS.
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. RAUSCHER PIERCE REFSNES, INC., James R. Feltham and Dain Rauscher Inc., Defendants.
• Court: U.S. District Court — District of Arizona

17 F.Supp.2d 985

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. RAUSCHER PIERCE REFSNES, INC., James R. Feltham and Dain Rauscher Inc., Defendants.

No. CIV-98-0027-PHX-ROS.

United States District Court, D. Arizona.

August 24, 1998.

COPYRIGHT MATERIAL OMITTED

Peter H. Bresnan, Securities & Exchange Commission, Washington, DC, for Securities and Exchange Commission.

Joel Philip Hoxie, David Eric Rauch, Snell & Wilmer LLP, Phoenix, AZ, for Rauscher Pierce Refsnes, Inc., James R. Feltham and Dain Rauscher Inc.

AMENDED ORDER

SILVER, District Judge.

BACKGROUND

In 1988, the Department of Administration of the State of Arizona (the "DOA") issued $121,830,000 of tax-exempt certificates of participation (the "1988 COPs") to finance the construction of six state buildings. The 1988 COPs could not be redeemed until July of 1998, and bore an average interest rate of 7.55%. In 1990, Defendant Rauscher Pierce Refsnes, Inc.¹ ("Rauscher") became the financial adviser to the DOA for lease purchases and bond transactions. Rauscher's contract was renewed by the DOA in 1991 and 1992. By 1992, interest rates had fallen well below the 7.55% the state was paying on its 1988 COPs, and Defendants recommended that the DOA take advantage of this situation by advance refunding the 1988 COPs. (Compl. ¶ 14.) Defendants advised the DOA to issue new tax-exempt municipal securities (the "1992B COPs") bearing a lower interest rate than that of the 1988 COPs, and invest the proceeds into United States Treasury securities, to be held in an escrow account and used to make debt service payments on the 1988 COPs until they were redeemed in 1998. Id. In addition to providing the DOA with advice on the 1992B COPs offering, Defendants assigned themselves the responsibility of selling the DOA the United States Treasury securities it would buy with the proceeds from the 1992B COPs bond offering. Id. ¶ 18.

On June 10, 1992, the underwriters of the 1992 offering priced the 1992B COPs. On that same day, Defendants purchased a portfolio of Treasury securities and priced them for delivery on June 16, 1992. Id. ¶ 19. On June 16, 1992, the bond offering closed with the DOA issuing $129,640,000 of the 1992B COPs. The proceeds from the sale were turned over to an escrow trustee who then bought the Defendants' portfolio of United States Treasury securities. Id. Plaintiff, the Securities Exchange Commission (the "SEC"), filed a lawsuit against Defendants on January 8, 1998, alleging that during their participation in the 1992B COPs offering, Defendants violated federal securities laws by making materially false and misleading statements in connection with the sale of securities, by omitting to disclose material information that they were under a duty to disclose, and by charging their client excessive markups. Plaintiff requests that this Court order Defendants to return the profits from their allegedly illegal conduct, impose civil penalties upon Defendants, and enjoin Defendants from violating the securities laws in the future. On March 31, 1998, Defendants James Feltham and Dain Rauscher filed motions to dismiss the Amended Complaint (hereinafter "Complaint") in its entirety, pursuant to Rule 12(b)(6) for failure to state a claim upon which relief can be granted.

On August 7, 1998, the Court conducted oral argument and took the matter under advisement. The Court has resolved to deny Defendants' motions to dismiss, but also to allow Plaintiff to allege with particularity the market standard.

LEGAL STANDARD

The Ninth Circuit Court of Appeals has held that "the conditions that must be met before a motion may be granted under Fed.R.Civ.P. 12(b)(6) are quite strict." Church of Scientology of California v. Flynn, 744 F.2d 694, 695-96 (9th Cir.1984). This Court may only dismiss the Complaint 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. 744 F.2d at 696 (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)). In considering a motion to dismiss, this Court must take "as true the facts alleged in the complaint ... drawing all reasonable inferences in the plaintiff's favor." Jackson Nat'l Life Ins. Co. v. Merrill Lynch & Co., 32 F.3d 697, 699-700 (2d Cir.1994).

DISCUSSION

Plaintiff argues that it has adequately stated three claims in its Complaint. First, Plaintiff asserts that Defendants violated Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a)²; Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5³; and Sections 206(1) (2), and (3) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6⁴; by making false and misleading statements in the tax compliance certificate they issued to the DOA's bond counsel. Second, Plaintiff asserts that Defendants violated the aforementioned statutes by failing to disclose material information concerning their sale of Treasury securities to their client the DOA. Third, Plaintiff contends that Defendants violated the aforementioned statutes by failing to disclose that they were charging the DOA excessive markups on the Treasury securities they sold them. Defendants contend that Plaintiff has pled no facts in support of its allegations, and therefore, this Court must dismiss each claim pursuant to Rule 12(b)(6) for failure to state a claim. Each of Plaintiff's claims will be examined in turn.

A. Plaintiff's Claim of False and Misleading Statements

In order for Plaintiff to succeed in proving a claim of securities fraud, Plaintiff must prove that "(1) in connection with the purchase or sale of a security; (2) the defendant acting with scienter⁵; (3) made a material misrepresentation ...." Grandon v. Merrill Lynch & Co., Inc., 147 F.3d 184, 188 (2d Cir.1998). Because Plaintiff's claim involves fraud, Rule 9(b) requires that "the circumstances constituting fraud or mistake, shall be stated with particularity." Fed. R.Civ.P. 9(b). This requirement of particularity "usually requires the claimant to allege at a minimum the identity of the person who made the fraudulent statement, the time, place, and content of the misrepresentation, the resulting injury, and the method by which the misrepresentation was communicated." 2 James Wm. Moore, Moore's Federal Practice § 9.03[1][b] (3d ed.1998). In addition to these minimum requirements, the Ninth Circuit has held that in order to satisfy Rule 9(b) in a securities fraud case:

a plaintiff must set forth more than the neutral facts necessary to identify the transaction. The plaintiff must set forth what is false or misleading about a statement, and why it is false. In other words, the plaintiff must set forth an explanation as to why the statement or omission complained of was false or misleading.

In re GlenFed, Inc., Securities Litig., 42 F.3d 1541, 1548 (9th Cir.1994) (en banc). The Ninth Circuit has explained that "a pleading is sufficient under Rule 9(b) if it identifies the circumstances of the alleged fraud so that the defendant can prepare an adequate answer." Kaplan v. Rose, 49 F.3d 1363, 1370 (9th Cir.1994); see also Warshaw v. Xoma Corp., 74 F.3d 955, 960 (9th Cir. 1996).

There can be no question that Plaintiff has met the minimum requirements for pleading fraud.⁶ The only remaining question is whether Plaintiff has adequately explained what is false about each of Defendants' statements. Plaintiff argues that its complaint adequately explains which statements were false and the reasons why each was false or misleading. Defendants argue that Plaintiff's complaint is insufficient because Plaintiff cites no facts and relies entirely on conclusory allegations of fraud to explain why Defendants' statements are false.⁷ Plaintiff is only required to identify which of Defendants' statements are false or misleading, and explain why those statements were false or misleading when they were made. Plaintiff has met the burden.

Plaintiff contends that Defendants' statement that the sale of the escrow securities "was an arm's length transaction" is false and misleading because Defendants were involved on both sides of the transaction. (Compl. ¶ 33.) Plaintiff alleges that Defendants recommended to the DOA that they buy securities, and then sold the DOA the securities they recommended it buy. Id. ¶ 18. Plaintiff alleges that it was impossible for Defendants to truthfully state in the Certificate that the transaction was made at arm's length in light of Defendants' fiduciary relationship with the DOA and their undisclosed material financial interest in the sale of the securities. Id. ¶ 33. Defendants argue that the statement was not false because the sale was conducted at arm's length, meaning the sale was between a willing buyer and a willing seller. (Rauscher Reply at 22.) Defendants further contend that Plaintiff's allegation that a financial adviser cannot enter into an "arm's length" transaction with an issuer client for tax purposes is contrary to the SEC and IRS regulations that existed in 1992, which allowed interested sellers to state that they sold securities in an arm's length transaction. (Rauscher Reply at 16-17.) These arguments go to Plaintiffs ultimate ability to prove this allegation, they do not establish that Plaintiff cannot, as a matter of law, prove that the statement was misleading or false.

Plaintiff's second allegation is that Defendants' statement that the escrow securities were priced "without regard to any amount paid to reduce the yield" and that "the price was no higher than the price Rauscher would have charged any other customer ... in a transaction in which the yield on the [escrow securities] was not subject to any limitation" is false. (Compl. ¶ 34.) Plaintiff contends that this statement is false because at the time Rauscher priced the escrow securities it knew or should have known that a positive arbitrage situation existed and priced the securities in...