Shushany v. Allwaste, Inc.

• Decision Date: 21 May 1993
• Docket Number: No. 92-2519,92-2519
• Citation: 992 F.2d 517
• Parties: Fed. Sec. L. Rep. P 97,710, 25 Fed.R.Serv.3d 1547 Felix SHUSHANY, and Shepard Bartnoff, Plaintiffs-Appellants, v. ALLWASTE, INC., and Raymond L. Nelson, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 517

992 F.2d 517

Fed. Sec. L. Rep. P 97,710, 25 Fed.R.Serv.3d 1547

Felix SHUSHANY, and Shepard Bartnoff, Plaintiffs-Appellants, v. ALLWASTE, INC., and Raymond L. Nelson, Defendants-Appellees.

No. 92-2519.

United States Court of Appeals Fifth Circuit.

May 21, 1993.

Rehearing Denied June 22, 1993.

Thomas E. Bilek, Jacalyn D. Scott, Wilshire, Scott & Dyer, Houston, TX, Theodore C. Anderson, W.D. Masterson, Kilgore & Kilgore, Dallas, TX, Menachem E. Lifshitz, New York City, for plaintiffs-appellants.

Philip J. John, William Karl M. Kroger, Baker & Botts, Houston, TX, for Allwaste, Inc.

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

Before WIENER, BARKSDALE, and DeMOSS, Circuit Judges.

BARKSDALE, Circuit Judge:

In issue is the degree of particularity required by Fed.R.Civ.P. 9(b) to plead fraud, especially securities fraud. Felix Shushany and Shepard Bartnoff appeal the dismissal with prejudice, for failure to comply with the rule, of their consolidated action against Allwaste, Inc., and Raymond L. Nelson. We AFFIRM.

I.

Allwaste is a diversified environmental services company. One of its subsidiaries, Allwaste Asbestos Abatement, Inc. (AAA), provides asbestos abatement services. Nelson was chairman of Allwaste's board. (Allwaste and Nelson are referred to collectively as "Allwaste".) The complaint alleges that from its incorporation in 1986 through 1990, Allwaste engaged in an ambitious acquisition program, almost totally through stock for stock transactions, and reported phenomenal growth and success, including in its asbestos abatement division; that in December 1990, however, an Allwaste press release announced its decision "to restructure its Asbestos Abatement Division to reduce costs and return the division to profitability pending its ultimate disposition"; and that, following this adverse disclosure, Allwaste common stock lost approximately 70 percent of its value.

In May 1991, seeking to represent a class of Allwaste shareholders, Shushany sued Allwaste under, inter alia, federal securities laws. He basically alleged that Allwaste had fraudulently maintained in its public financial reports and releases the appearance of continued financial growth, when in fact, its asbestos abatement division had been suffering since early 1989. In its answer, Allwaste asserted, inter alia, that the complaint failed to state fraud with particularity as required by Rule 9(b).

Additionally, Allwaste propounded contention interrogatories, seeking the factual bases of Shushany's claims. In response, Shushany essentially referred Allwaste to the complaint, without providing any further detail. Allwaste then moved to compel more complete answers, again asserting that the complaint did not satisfy Rule 9(b). After two extensions of time to respond to the motion, Shushany submitted amended responses to the interrogatories, which still lacked the specificity sought by Allwaste.

Because Shushany had not purchased Allwaste stock during the purported class period, he moved to amend the complaint to extend the period. Prior to a ruling on that motion, however, Shushany's counsel filed another action for a different plaintiff, Bartnoff, stating the desired class period, and moved to consolidate the two cases. (The plaintiffs are referred to collectively as "Shushany".) Allwaste opposed both motions.

At a hearing on the motions in December 1991, the asserted Rule 9(b) deficiencies were discussed; and the court informed Shushany's counsel: "in a case like this the defendant company is entitled to know which of their documents you feel give you a claim and what you feel are wrong with them, right up front". Shushany's counsel responded: "we believe that we can do that, we believe that we can get out the specific documents that we think misrepresentations were made, [sic] and we think from those documents we can set out our complaint within the requisites of 9(b)". With Allwaste's agreement, the court granted the motion to consolidate, ordering the plaintiffs to "file their Consolidated Amended Complaint in accordance with Federal Rule 9(b)".

As Shushany concedes, the consolidated complaint, however, was virtually identical to the prior complaints. Consequently, Allwaste moved to dismiss for failure to comply with Rule 9(b). At the hearing in May 1992, Shushany referred to additional information regarding the fraud, which he had supposedly provided in a second set of amended responses to interrogatories. ¹ Shushany did not, however, request leave to amend the complaint to include those details. After extensive argument, the district court stated: "I do not believe that the Plaintiffs have cured the problem from their original complaint...." And in its written opinion, it stated that the consolidated complaint was "virtually the same" as the prior complaint which "[the court] had previously found to be insufficient". ² Accordingly, it dismissed the action with prejudice. ³

II.

Shushany contends that the consolidated complaint complied with the rule. ⁴ A dismissal for failure to state fraud with particularity as required by Rule 9(b) is a dismissal on the pleadings for failure to state a claim. See Guidry v. Bank of LaPlace ("Guidry II "), 954 F.2d 278, 281 (5th Cir.1992); Fed.R.Civ.P. 12(b)(6). Accordingly, we review the dismissal de novo, and in so doing, "accept the complaint's well-pleaded factual allegations as true." Id.

The consolidated complaint had four claims: (1) against both defendants for violations of § 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.10b-5; (2) against Nelson, as a "controlling person" of Allwaste, for violations of § 20(a) of the Act, 15 U.S.C. § 78t(a); and against both defendants for (3) fraud and deceit and (4) negligent misrepresentation. ⁵

The elements of a securities fraud claim are "(1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which the plaintiff relied (5) that proximately caused his injury". Cyrak v. Lemon, 919 F.2d 320, 325 (5th Cir.1990). A fact is considered material if "there is a substantial likelihood that a reasonable shareholder would consider it important ...". TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 2132, 48 L.Ed.2d 757 (1976); see also Krim v. BancTexas Group, Inc., 989 F.2d 1435, 1445 (5th Cir.1993). Scienter is the intent to deceive, manipulate, or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193-94, 96 S.Ct. 1375, 1380-81, 47 L.Ed.2d 668 (1976). The scienter element is satisfied by proof that the defendant acted with severe recklessness, which is "limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it". Broad v. Rockwell Int'l Corp., 642 F.2d 929, 961-62 (5th Cir.) (en banc ), cert. denied, 454 U.S. 965, 102 S.Ct. 506, 70 L.Ed.2d 380 (1981).

Rule 9(b) provides: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity". Thus, allegations of fraud must meet a higher, or more strict, standard than the basic notice pleading required by Rule 8. This standard "stems from the obvious concerns that general, unsubstantiated charges of fraud can do damage to a defendant's reputation". Guidry II, 954 F.2d at 288. Additionally, Rule 9(b) is designed "to preclude litigants from filing baseless complaints and then attempting to discover unknown wrongs". Guidry v. Bank of LaPlace ("Guidry I "), 740 F.Supp. 1208, 1216 (E.D.La.1990), aff'd as modified, 954 F.2d 278 (5th Cir.1992); see also O'Brien v. National Property Analysts Partners, 936 F.2d 674, 676 (2d Cir.1991) (recognizing threefold purpose of Rule 9(b) for securities fraud claims--to provide defendant with fair notice of claim, to safeguard defendant's reputation, and to protect defendant against the institution of strike suits).

"At a minimum, Rule 9(b) requires allegations of the particulars of time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what he obtained thereby". Tel-Phonic Services, Inc. v. TBS Int'l, Inc., 975 F.2d 1134, 1139 (5th Cir.1992). "What constitutes 'particularity' will necessarily differ with the facts of each case and hence the Fifth Circuit has never articulated the requirements of Rule 9(b) in great detail". Guidry II, 954 F.2d at 288.

Shushany alleged three types of fraudulent statements contained in various Allwaste public documents and reports: ⁶ (1) that employees of various AAA divisions were instructed to engage in improper accounting practices, which resulted in an overstatement of earnings and income in Allwaste's financial reports; (2) that statements about increasing demand and opportunities for growth in the asbestos abatement industry were false; and (3) that a statement regarding the integrity and business ethics of Allwaste employees was false. We address each category separately.

A.

For the period November 22, 1989, through December 21, 1990, Shushany alleged that "[i]n the face of the worsening business environment for the asbestos abatement market", Allwaste "embarked on a plan and scheme to have Allwaste report inflated revenues and earnings". As examples, Shushany alleged the following:

(a) By no later than the Winter of 1989, the Defendants or Defendants' agents began a course and scheme designed to defraud investors by instructing employees to make arbitrary adjustments for the accounting of inventory of the asbestos operations in Houston, Texas (b) In January of 1990, the Defendants, or Defendants' agents, instructed employees, including Don...