Smith v. Ayres
| Decision Date | 03 June 1988 |
| Docket Number | No. 87-1388,87-1388 |
| Citation | 845 F.2d 1360 |
| Parties | Fed. Sec. L. Rep. P 93,784, 11 Fed.R.Serv.3d 580, RICO Bus.Disp.Guide 6956 Andrew L. SMITH, Plaintiff-Appellant, v. Jack R. AYRES, et al., Defendants-Appellees. |
| Court | U.S. Court of Appeals — Fifth Circuit |
F. Dean Armstrong, Flossmoor, Ill., for plaintiff-appellant.
Carl David Adams, Adams & Francis, Dallas, Tex., for Clayton Smith.
Edwin E. Wright, III, Ronald D. Wren, Stradley, Schmidt, Stephens & Wright, Dallas, Tex., for defendants-appellees.
Appeal from the United States District Court for the Northern District of Texas.
Before GARZA, HIGGINBOTHAM, and SMITH, Circuit Judges.
Andrew Smith sued his brother Clayton and others alleging securities fraud and RICO violations arising out of a fight for control of a family business. The district court dismissed the securities-fraud claims, both those brought individually and those brought on behalf of the corporation. The court also dismissed the RICO claim for inadequate pleading and declined to grant leave to amend. We affirm the judgment on the individual securities claim, but reverse the dismissal of the derivative claim. We affirm the district court's ruling on the RICO claim.
Smith Protective Services is a family-owned corporation in Dallas, Texas. In 1977, Andrew Smith was the President and Chairman of the Board and owned approximately 26 percent of the corporation's stock. The other owners were his mother, Coralie, 22 percent, and his brothers, Clayton and Mark, with 26 percent each.
In June, 1977, Andrew accused Clayton of embezzling money from the business and the corporation filed suit. SPS' general counsel and director, Dallas attorney Jack Ayres, represented the corporation. In the settlement of the suit, the corporation released any claim it had against Clayton in exchange for Clayton's agreement to sell his stock back to SPS. After completing the stock redemption, Andrew and Mark each held 35 percent of the outstanding shares, while Coralie held 30 percent. With their combined majority stake, Andrew and his mother had effective control.
Andrew alleges (in conclusory terms) that in 1983 Clayton set about to recover his interest in the company, and enlisted the support of Mark and Ayres. The plan was said to be to force the board to reissue Clayton's shares in the company under the theory that the prior settlement agreement had been obtained by fraud. For this purpose, Clayton retained Gerry Wren, a Dallas lawyer. Clayton intended to have Wren send a letter demanding return of his shares.
On July 20, Clayton related his plan to Ira Tobolowsky, another Dallas attorney who was also an SPS director. The next day, July 21, Tobolowsky telephoned Jack Ayres twice to discuss Clayton's demand letter. Tobolowsky later called Wren's office and learned that Wren left town without sending the letter. In a conference call that included Tobolowsky, Wren's secretary, and Ayres, Tobolowsky told Ayres that Wren had not sent the letter. Ayres then dictated a letter to Wren's secretary. When Wren's secretary learned that the recorder had failed to record, she called Tobolowsky. Tobolowsky initiated another conference call, and Ayres successfully dictated the letter to another secretary.
Later the same day Ayres received the demand letter which bore Wren's signature and which was typed on his firm's stationery. Ayres presented the letter to the Board of Directors and recommended that the Board accede to Clayton's demands. Ayres did not, however, disclose that he was the author of the letter. The Board followed his recommendation by a vote of 7-2, with only Andrew and Coralie opposed. The decision gave Clayton and Mark a 52 percent interest in the corporation. According to Andrew, they have used this control to mismanage the corporation and divert corporate assets for personal gain.
When in February, 1986, Andrew entered a plea of "no contest" to an indictment alleging cocaine possession, SPS filed suit in state court to divest Andrew of his shares in the corporation under a Texas law that assertedly prohibits felons from owning an interest in a licensed security agency. A Texas district court granted SPS an injunction requiring Andrew to sell his shares back to the corporation. 1 However, this decision was reversed on October 21, 1987, by the Texas Court of Appeals. The appellate court found that SPS had no standing to seek the injunction because SPS was seeking enforcement of a state-agency rule that the agency had not threatened to enforce. 2
Andrew filed this federal suit alleging that Clayton, Mark and Ayres violated the antifraud provision of Rule 10b-5 of the securities laws 3 as well as the Racketeer Influenced and Corrupt Organizations Act. 4 The district court dismissed Andrew's individual 10b-5 claim because Andrew did not allege the element of reliance. The court reasoned that because Andrew voted against rescission, he did nothing differently because of the letter. The district court also held that Andrew had no standing to bring a derivative securities claim on behalf of the corporation because of the state court decision divesting Andrew of his shares in SPS; at that time the decision still was pending before the state court of appeals. The district court dismissed Andrew's RICO claim for failure to plead two or more predicate acts of racketeering as required by the statute. The court also refused to grant Andrew leave to amend his complaint, finding that it would waste the resources of the court and the parties.
We affirm the district court's dismissal of the securities fraud claims brought by Andrew in his individual capacity. Andrew plead no facts that would support a finding that he relied on the statements he alleges to be fraudulent. As the Supreme Court recently reminded, proof of reliance is essential to a claim under Rule 10b-5 because it "provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury." 5 Here the district court correctly concluded that Andrew did not adequately plead reliance because even with true disclosure, he still would have voted against the issuance of shares to Clayton.
We are not persuaded by Andrew's arguments for a contrary result. We agree with the district court that Andrew is not entitled to a presumption of reliance. Following Affiliated Ute Citizens v. United States, 6 this Circuit has recognized that where the gravamen of the fraud is a failure to disclose, as opposed to a fraudulent misrepresentation, a plaintiff is entitled to a rebuttable presumption of reliance. 7 The presumption is a judicial creature. It responds to the reality that a person cannot rely upon what he is not told.
It follows that the first step in determining whether the Affiliated Ute presumption applies is to identify whether the plaintiff's claim is founded on a fraudulent omission. This in turn depends upon which of the three subsections in Rule 10b-5 forms the basis for the plaintiff's complaint. The Rule makes it illegal to do three things:
(1) to employ any device, scheme, or artifice to defraud,
(2) 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 light of the circumstances under which they were made, not misleading, or
(3) 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.
By the terms of the Rule, a presumption of reliance would not arise where the plaintiff's case is grounded in the second subsection. Subsection two requires disclosure only when necessary to make a statement made not misleading. For this reason, a subsection two claim always rests upon an affirmative statement of some sort, reliance on which is an essential element plaintiff must prove. Non-disclosure is relevant only as it makes the statements either false or misleading. By contrast, under the first and third subsections the duty not to engage in a fraudulent "scheme" or "course of conduct" could be based primarily on an omission. Hence, the presumption could be warranted only under subsections one and three, but not under subsection two. 8
Andrew's claim is not footed upon a specific subsection. However, even assuming that he has stated his claim under the first or third subsections and assuming that the fraudulent scheme or course of conduct primarily involved omissions, the district court was correct in its conclusion because the presumption was rebutted on the face of Andrew's complaint. As we explained in Shores v. Sklar, 9 the presumption of reliance is rebutted when the complaint admits that the plaintiff did not actually rely on defendant's alleged omission. 10 This principle applies here because the complaint admits that Andrew voted against issuing shares to Clayton.
We also reject the argument that even though Andrew's vote may have been unaffected by the Wren letter, he relied on the letter because had the fraud been disclosed, he would have sought an injunction against the Board's action. The theory is internally inconsistent: had the Wren letter not been presented or had it been presented with disclosure of its true author, there would have been no fraud on which to base injunctive relief. The only authority offered to support the theory is a line of cases in which fraudulent actions by controlling shareholders in merger transactions were held to be material because true disclosure would have led minority shareholders to seek their state-law appraisal remedies. 11 In those cases, however, the shareholders' remedy would not have been eliminated by the sought-for disclosure. In short, nothing in Andrew's complaint indicates that his individual actions were affected in any way by the alleged fraud.
Although the district court never reached...
To continue reading
Request your trial
-
United States v. Kieffer
...communications actually cross state lines to support a conviction.” Schaefer, 501 F.3d at 1202;see, e.g., Smith v. Ayres, 845 F.2d 1360, 1366 (5th Cir.1988) (Higginbotham, J.) (“As several courts have recognized, [§ 1343] requires that the wire communication cross state lines.”). In his ope......
-
Dennis v. General Imaging, Inc.
... ... SMITH, Circuit Judges ... JERRE S. WILLIAMS, Circuit Judge: ... Dr. Windsor Dennis sued Sherman Copelin, Lloyd ... 1343, 19 to require that the transmission alleged to perpetuate the fraudulent scheme be accomplished between different states. Smith v. Ayres, 845 F.2d 1360, 1366 (5th Cir.1988) ... In this case, plaintiff does not allege that any of the thirty one telephone calls he ... ...
-
Laird v. Integrated Resources, Inc.
...fraudulent intent is necessary to establish mail or wire fraud not proof of the success of a fraudulent scheme.).50 Smith v. Ayres, 845 F.2d 1360, 1366 n. 19 (5th Cir.1988); ("A Rule 10b-5 violation can constitute a predicate act under RICO...."); Corwin v. Marney Orton Investments, 788 F.2......
-
Meier v. Musburger
...and given the Illinois residence of all the parties it would not be reasonable to infer that any such use occurred."); Smith v. Ayres, 845 F.2d 1360, 1366 (5th Cir.1988)("As several courts have recognized, the statute requires that the wire communication cross state lines."); Hernandez v. B......