MISHLER, District Judge:
This is an appeal from an order of the United States District Court for the Southern District of New York, Pierce, J., dismissing plaintiffs' proposed class action. Plaintiffs, Kalman and Anita Ross, allege that on July 23, 1973 they purchased 100 shares of common stock of the defendant company, A. H. Robins Company, Inc., ("Robins"), a manufacturer and distributor of pharmaceutical products. They instituted this action pursuant to § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, Rule 10b-5, promulgated thereunder, 17 C.F.R. § 240.10b-5 and common law principles, on behalf of all persons who purchased such stock "from April 1972 through in or about July, 1974 . . . and who still owned shares of Robins at the end of said period and who have suffered damages as a result thereof." (Complaint ¶ 2). In addition to Robins, also named as defendants are seven individuals who are identified as directors and/or officers of Robins. The gravamen of the complaint is that the defendants manipulated and artificially inflated the market price of Robins' common stock by disseminating false and misleading information about the effectiveness and safety of the Dalkon Shield, an interuterine birth control device which it manufactured, and by failing to reveal information which indicated that the shield was less effective and more dangerous than the company's earlier public statements had indicated. The district court determined that: (1) to the extent that the alleged false and misleading statements were contained in papers filed with the Securities and Exchange Commission, the plaintiffs could not maintain the action under § 10(b) and Rule 10b-5. Their exclusive remedy was under § 18 of the Exchange Act, 15 U.S.C. § 78r; and (2) the plaintiffs had failed to plead with the degree of specificity required in fraud actions by Rule 9(b) Fed.R.Civ.P. Therefore, the court dismissed the action with prejudice.
We hold that the district court erred in concluding that the action could not be maintained under § 10(b) of the Exchange Act and Rule 10b-5. On the question of the pleadings, we agree with the determination made below that the complaint fails to meet the requirements of Rule 9(b). However, because we are hesitant to preclude the prosecution of a possibly meritorious claim because of defects in the pleadings, we believe that the plaintiffs should be afforded an additional, albeit final opportunity to conform the pleadings to Rule 9(b).
The complaint which is the subject of this appeal was filed in the district court on June 1, 1978.
The gist of plaintiffs' claim is contained in paragraph 13:
According to paragraph 14:
These statements are quoted at length and identified as appearing in Robins' 1970 Annual Report, 1971 Annual Report and a prospectus issued in or about March 1972. (Complaint ¶ 15-¶ 17).
Paragraph 18 is of crucial importance.
Specifically, it alleges that "among other things" the "defendants knew or recklessly disregarded," inter alia, the "facts" that the pregnancy rate from use of the shield "was significantly higher than the low pregnancy rate Robins had indicated in [its] 1970 Annual Report . . .," and that, "the rate of medical removals of the shield required by manifestations of pain, bleeding and infection was significantly higher than . . . indicated in the 1970 Annual Report . . ." These facts were evidenced by data "found in an updated April 1972 unpublished study on the Shield by Mary Gabrielson . . . ." Paragraph 18 further states the defendants knew or recklessly disregarded the fact that: their conclusions about the shield's safety and effectiveness were based on insufficient data; that in 1972 and 1973 there was an "alarming increase" in the rate of septic abortions and deaths resulting from the shield; and that other "significant health hazards" existed.
Paragraph 20 states that the defendants "failed to make proper and timely disclosure" of these facts and the fact that "Robins was incurring substantial risks to its reputation . . . and substantial risks of substantial liability for injuries from use of the Dalkon Shield."
The complaint also charges that "during the class period" further misleading statements "were made and issued with the knowledge, approval and/or acquiescence of Robins' Board of Directors which consisted at all relevant times of the individual defendants." (Complaint ¶ 21). These statements, language of which is quoted, were allegedly contained in: Robins' 10-K forms for the fiscal years ending December 1972 and December 1973; a press release issued April 19, 1973; press releases dated July 18, 1973, January 31, 1974 and April 18, 1974; and Robins' 1973 Annual Report issued in March 1974. (Complaint ¶ 22-¶ 33). In plaintiffs' view, these statements were misleading in that they continued to speak glowingly of the company and of continued expectations of success and did not disclose the serious problems concerning Robins' continued sale and distribution of the Dalkon Shield.
The named plaintiffs and members of the putative class allegedly "made their purchases of Robins' common stock at prices that were inflated by [these] misleading public reports and press releases and the representations contained therein and by
Sometime beginning in or about the middle of May 1974, information about the serious medical problems which were resulting from use of the Dalkon Shield began to be disclosed to the public.
The defendants' conduct is alleged to have violated § 10(b) and Rule 10b-5.
The District Court Opinion
The defendants moved the district court for an order dismissing the complaint on the grounds that: (1) the court lacked subject matter jurisdiction over the action; (2) the action could not be maintained under § 10(b) and Rule 10b-5 because § 18 of the Exchange Act was the exclusive remedy for the acts complained of; and (3) it failed to comply with the pleading requirements of Rule 9(b) Fed.R.Civ.P.
Judge Pierce rejected the defendants' contention that the complaint essentially stated claims for corporate mismanagement and was therefore not properly brought under the federal securities laws. He concluded that plaintiffs' claim "is arguably within the purview of Section 10(b) unless Section 18 of the Securities Exchange Act of 1934 provides plaintiffs an exclusive remedy." The district court analyzed the substantial differences between sections 10 and 18 of the Exchange Act. See discussion infra. Reviewing the "legislative scheme embodied in the 1934 Act," the court concluded that "[t]he substantive and procedural requirements contained therein implicitly indicate that Congress intended [§ 18] to be the primary vehicle for remedying the unlawful acts it proscribes." It held that as to material misstatements and omissions contained in papers filed with the S.E.C., the plaintiffs could proceed only under § 18 of the Exchange Act.
The district court also determined that the complaint did not meet the pleading requirement of Rule 9(b) in that it failed to aver the alleged fraud with particularity. Two primary shortcomings in the complaint were noted. First, the complaint failed to "particularize the time when the defendants allegedly knew or recklessly disregarded the undisclosed information." This failing was found to be particularly crucial because the defendants' purported duty to disclose adverse information concerning the shield might have arisen during the class period but after the named plaintiffs' purchase. In that case, they would not be proper class representatives. Secondly, the complaint was held defective because it did not set forth "the circumstances which lead [plaintiffs] to believe that defendants knew or recklessly disregarded the information
The Securities Act of 1933, 15 U.S.C. § 77a et seq. ("1933 Act") and the 1934 Act "constitute interrelated components of the federal regulatory scheme governing transactions in securities." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 206, 96 S.Ct. 1375, 1387, 47 L.Ed. 668 (1967). While only a limited number of the Acts' provisions contain authorizations for private civil actions,
Section 18 expressly creates a private remedy for "false or misleading" statements contained in "any application, report or document" filed with the S.E.C. pursuant to the 1934 Act in favor of any person "who, in reliance upon such statement, shall have purchased or sold a security at a price which was affected by such statement."
Whether a plaintiff can rely upon an implied right of action under § 10(b) and Rule 10b-5 or must proceed according to the terms of § 18 can be an issue of controlling significance. Section 18 requires that a plaintiff establish knowledge of and reliance upon the alleged misstatements contained in any document filed with the S.E.C. Heit v. Weitzen, 402 F.2d 909, 916 (2d Cir. 1968), cert. denied, 395 U.S. 903, 89 S.Ct. 1740, 23 L.Ed.2d 217 (1969) ("Reliance on the actual [filed] report is an essential prerequisite for a Section 18 action and constructive reliance is not sufficient."); Jacobson v. Peat, Marwick, Mitchell & Co., 445 F.Supp. 518, 525 (S.D.N.Y.1977) ("Plaintiff may only recover if he is able to establish reliance on the actual 10-K form," or
We begin our analysis by noting that much of the case law relied upon by the parties is inapposite. Defendants argue that disposition of the case before us is controlled by National Railroad Passenger Corp. v. National Association of Railroad Passengers, 414 U.S. 453, 94 S.Ct. 690, 38 L.Ed.2d 646 (1974). There, the Supreme Court refused to imply a cause of action under a provision of the Rail Passenger Service Act of 1970, 45 U.S.C. § 501 et seq., because it found that the express remedies provided in the Act were "the exclusive means to enforce the duties and obligations imposed by the Act." Id. at 458, 94 S.Ct. at 693. Relying on this holding, defendants urge that since § 18 provides an express remedy for the acts complained of, we should not imply a remedy for those acts under § 10(b). Plaintiffs on the other hand contend that the factors enunciated by the Supreme Court in Cort v. Ash, 422 U.S. 66, 78, 95 S.Ct. 2080, 2088, 45 L.Ed.2d 26 (1975), relevant in determining "whether a private remedy is implicit in a statute not expressly providing one" are pertinent to our determination. In their view, application of these factors requires a finding that a remedy should be fashioned under § 10(b) for the activities alleged in the complaint.
In our view, neither of these cases is particularly instructive. Both deal primarily with the issue of under what circumstances a private civil remedy should be judicially created for the violation of a particular statutory provision. Other recent Supreme Court decisions have also addressed this issue. See, e. g., Touche Ross & Co. v. Redington, supra; Cannon v. University of Chicago, 441 U.S. 677, 99 S.Ct. 1946, 60 L.Ed.2d 560 (1979).
We, however, are not being asked to create a new judicial remedy. It is well established that a private remedy exists for actions violative of § 10(b) and Rule 10b-5. Rather than being asked to create a new remedy, we are being asked to determine whether a party should be allowed to invoke an established remedy in the face of a statute which may, in certain circumstances, provide another remedy for the same conduct. Resolution of this issue turns upon the question of whether allowing invocation of the § 10(b) remedy would impermissibly nullify the limitations and requirements inherent in § 18. We conclude that it would not.
Plaintiffs' position is that where a party can state a claim under § 10(b), it is of no
This view is supported by the language of the Court in S.E.C. v. National Securities, 393 U.S. 453, 89 S.Ct. 564, 21 L.Ed.2d 668 (1969):
Id. at 468, 89 S.Ct. at 573 (emphasis added). See also Schaefer v. First National Bank of Lincolnwood, 509 F.2d 1287, 1293 (7th Cir. 1975), cert. denied, 425 U.S. 943, 96 S.Ct. 1682, 48 L.Ed.2d 186 (1976) ("The plaintiffs may make their claim for relief under Rule 10b-5 even though the alleged market rigging scheme also falls squarely within section 9(a)(2)" of the 1934 Act.).
Notwithstanding these cited authorities, we believe that this position is overly broad in light of more recent Supreme Court decisions which have cast considerable doubt on the continuing vitality of the view that the remedies in the securities acts were meant to freely overlap.
In Ernst & Ernst v. Hochfelder, supra, the Court held that the significant procedural restrictions attendant to actions under the express remedies of the 1933 Act which allow recovery based on negligent conduct
425 U.S. at 210, 96 S.Ct. at 1389. See also Blue Chip Stamps v. Manor Drug Stores, supra, 421 U.S. at 736, 95 S.Ct. at 1925-1926 (In establishing the purchaser-seller requirement in § 10(b) actions, the Court indicated that "[i]t would indeed be anomalous to impute to Congress an intention to expand the plaintiff class for a judicially implied cause of action beyond the bounds it delineated for comparable express causes of action.").
Similarly, in Touche Ross & Co. v. Redington, supra, ___ U.S. at ___, 99 S.Ct. at 2488, the Court, in finding it improper to imply a cause of action under § 17 of the 1934 Act, stated:
These decisions lend at least some support to defendants' position that § 10(b) should be viewed as a "catch-all" provision intended to prevent the use of manipulative and deceptive devices not proscribed by other provisions of the Act and not as a "vehicle
We do not believe, however, that by permitting the plaintiffs to proceed under § 10(b) in the instant case, we would be nullifying the terms of the remedy which Congress designed in § 18. Our conclusion rests in large part upon this court's decision in Fischman v. Raytheon Manufacturing Co., 188 F.2d 783 (2d Cir. 1951). In Fischman, both preferred and common stockholders of the defendant company, alleging that the company had made material misrepresentations in a prospectus and registration statement, instituted an action pursuant to § 10(b) and Rule 10b-5 and § 11 of the 1933 Act. Section 11 creates a cause of action in favor of any person acquiring stock where the relevant registration statement contains a material factual misrepresentation.
188 F.2d at 787 (emphasis added).
Defendants here correctly point out that § 11 of the 1933 Act proscribes conduct which is different from that within the purview of § 10(b). Whereas the latter provision, as the Supreme Court's holding in Ernst & Ernst v. Hochfelder, supra, makes clear, predicates relief upon a showing of fraud or deceit, the former provision does not. It was on this basis that the Fischman court, anticipating the holding in Ernst & Ernst, sanctioned plaintiffs' action under § 10(b). See Beecher v. Able, 435 F.Supp. 397, 412 (S.D.N.Y.1977) ("Although plaintiffs need not under § 10(b) meet various stringent requirements under § 11, they must sustain a significantly greater burden of proof."). Defendants contend that in the instant case, on the other hand, no similar justification exists for bypassing the express "reliance" requirement of § 18. We disagree.
Under the rule established in Ernst & Ernst v. Hochfelder, supra, a party may not be held liable under § 10(b) unless he acted with scienter. It may well be that a similar requirement attaches to § 18 liability. See Ernst & Ernst v. Hochfelder, supra, 425 U.S. at 211 n.31, 96 S.Ct. at 1389 n.31 ("[T]he legislative history of . . . section  suggests something more than negligence on the part of the defendant is required for recovery."). But, we may leave for another day the issue whether something akin to scienter is the sine qua non of a defendant's liability under § 18. In any case, there are substantial differences in the burden facing the plaintiff under the two statutes — differences which justify application of the logic of Fischman.
To establish a § 10(b) violation, the plaintiff must plead and prove that the defendant acted with scienter in making a
To now hold, at this late date, that conduct is not proscribed by § 10(b) merely because it is also subject to § 18 would effectively deprive open market investors who relied on misleading market information of any remedy simply because the misinformation happened to be lodged in a form filed with the S.E.C. Such a result would be remarkably incongruous in view of the fact that it is the open market investor who over the years has become one of the prime beneficiaries of the protections afforded by § 10(b) and Rule 10b-5. As we have already indicated, we are not being asked to liberalize even further the recognized implied right of action under § 10(b) or judicially to create a new right in place of that provided by § 18. Cf. Touche Ross & Co. v. Redington, supra. Rather, plaintiffs only ask that we permit § 10(b) to be used, as it has in the past, to state a claim that is beyond the scope of § 18 — the latter section furthering the narrow and particularized objective of encouraging use of and reliance upon records filed with the S.E.C., by expressly authorizing damage suits against those who make them depositaries of materially false or misleading statements. Furthermore, we can conceive of no rational purpose which would be furthered by creating a structure where liability for material misrepresentations adversely affecting investors would vary tremendously depending upon whether the statement happened to be filed with the S.E.C. Accepting the existence of a private action under § 10(b) and its well established contours, see Cannon v. University of Chicago, supra, 441 U.S. at 691 n.13, 99 S.Ct. at 1955 n.13 (recognizing that the very existence of the implied right of action under § 10(b) can be explained historically), we believe that we can fairly say that Congress would not approve of such a disparity. We also believe that holding that plaintiffs must proceed under the terms of § 18 because the statements were filed with the S.E.C. would encourage corporate managers to include their misrepresentations in material filed with the S.E.C., for the sole purpose of insulating themselves from liability under § 10(b) and restricting the class of potential plaintiffs to the unlikely few who actually viewed and relied on the misleading information.
In view of the alternatives that face us, we choose the one which we believe gives controlling weight to the fundamental policies underlying the securities acts and which recognizes that § 10(b) and Rule 10b-5 have become, by careful judicial construction, the primary mechanisms by which open market investors can seek redress against those who manipulate the market by fraudulent activity.
We conclude that even as to those documents filed with the S.E.C., plaintiffs may seek to prosecute their claim under § 10(b) and Rule 10b-5.
Rule 9(b) Fed.R.Civ.P. provides:
This rule, which "is a special pleading requirement and contrary to the general approach of simplified pleading adopted by the federal rules," 5 Wright & Miller, Federal Practice and Procedure: Civil § 1297 at 405, generally serves two important purposes. First, it assures the defendant of "`fair notice of what the plaintiff's claim is and the grounds upon which it rests.'" Denny v. Barber, 576 F.2d 465, 469 (2d Cir. 1978) (quoting Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 444 (2d Cir. 1971)). See 5 Wright & Miller, supra, at 403-404 ("It is the pleading of these matters with precision that serves the rule's purpose by apprising the defendant of the claim against him and of the acts relied upon as constituting the fraud charged.") Secondly, the specificity requirement grows out of "the desire to protect defendants from the harm that comes to their reputations or to their goodwill when they are charged with serious wrongdoing . . . ." Segal v. Gordon, 467 F.2d 602, 607 (2d Cir. 1972). In the context of securities litigation Rule 9(b) serves an additional important purpose. It operates to diminish the possibility that "`a plaintiff with a largely groundless claim [will be able] to simply take up the time of a number of other people [by extensive discovery], with the right to do so representing an in terrorem increment of the settlement value, rather than a reasonably founded hope that the process will reveal relevant evidence . . . .'" Denny v. Barber, supra, 576 F.2d at 470, (quoting Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 741, 95 S.Ct. 1917, 1928, 44 L.Ed.2d 539 (1975)).
In Segal v. Gordon, supra, the court held:
467 F.2d at 607. Similarly, in Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 378 (2d Cir. 1974), cert. denied, 421 U.S. 976, 95 S.Ct. 1976, 44 L.Ed.2d 467 (1975), the court indicated that a complaint which merely alleged that the defendants engaged "in a course of business which operated as a fraud and deceit on the purchasers and holders of . . . stock" would be insufficient under Rule 9(b). Accord, Denny v. Barber, supra, 576 F.2d at 470.
These decisions taken together establish that a plaintiff alleging fraud in connection with a securities transaction must specifically allege the acts or omissions upon which his claim rests. It will not do merely to track the language of Rule 10b-5 and rely on such meaningless phrases as "scheme and conspiracy" or "plan and scheme and course of conduct to deceive." A defendant is entitled to a reasonable opportunity to answer the complaint and must
There is no question that the plaintiffs in this instance adequately identified the alleged "misrepresentations." They point to the following specific documents: 1970 Annual Report (Complaint ¶ 15); 1971 Annual Report (Id. ¶ 16); prospectus issued in or about March 1972 (Id. ¶ 17); 1972 form 10-K (Id. ¶ 22); 1973 form 10-K (Id. ¶ 23); press release issued on or about April 19, 1973 (Id. ¶ 25); press release issued July 18, 1973 (Id. ¶ 27); press release dated January 31, 1974 (Id. ¶ 28); 1973 Annual Report (Id. ¶ 30); and finally a press release dated April 18, 1974 (Id. ¶ 32). However, we believe that the pleading is deficient in other important respects.
The complaint alleges only in a most sketchy fashion circumstances which would give rise to an inference of fraud. The complaint sets forth numerous facts which, it is alleged, indicate that "there were serious questions as to the safety and efficiency of the Dalkon Shield . . ." (Complaint ¶ 18). Some, but not all, of these facts are alleged to have been contained in a 1972 unpublished report on the Dalkon Shield prepared by a Mary Gabrielson. It is not indicated what relationship, if any, exists between Mary Gabrielson and Robins, or whether plaintiffs have any reason to believe that the defendants were even aware of the report's existence. Plaintiffs also indicate that the defendants' knowledge of the facts contained in paragraph 18 is evidenced by "among other things" the 1972 unpublished report. Plaintiffs should indicate whether they are relying solely on the study or have other reasons to believe that the defendants had knowledge of facts raising serious questions about the efficiency of the Dalkon Shield. Additionally, knowledge of many of the facts alleged in paragraph 18, e. g., the number of deaths, septic abortions and other complications resulting from the Dalkon Shield in 1972-1973, is in no way attributed to the defendants.
Plaintiffs have also failed to indicate when the defendants allegedly came into possession of this crucial information. No one disputes that the defendants eventually became aware of major safety problems involving their product. The facts alleged in paragraph 34 — that by letter dated May 8, 1974 Robins informed approximately 120,000 physicians nationwide that severe complications including death had resulted in instances where the Dalkon Shield remained in place during pregnancy — do give rise to the inference that by 1974 officials at Robins were aware that major medical problems existed. However, it is only if the defendants' knowledge of various problems with the Dalkon Shield coalesced into a duty to disclose prior to July 1973 (the time when the named plaintiffs bought stock in Robins) that the action can be prosecuted as a class action by these named plaintiffs. We believe that it is proper to require the plaintiffs, even at the pleading stage, to fix more definitively the time at which these crucial events in the complaint occurred.
As indicated above, although Rule 9(b) requires that "circumstances constituting fraud . . . shall be stated with particularity" it provides that "[m]alice, intent, knowledge, and other condition of mind of a person may be averred generally." (emphasis added). Of course, defendants' awareness of the facts alleged by the plaintiffs in paragraph 18 indicating that there were serious questions about the safety and efficacy of the Dalkon Shield is central to plaintiffs' Rule 10b-5 claim. However, at this stage of the litigation, we cannot realistically expect plaintiffs to be able to plead defendants' actual knowledge. On the other hand, plaintiffs can be required to supply a factual basis for their conclusory allegations regarding that knowledge. It is reasonable to require that the plaintiffs specifically plead those events which they assert give rise to a strong inference that the defendants had knowledge of the facts contained in paragraph 18 of the complaint or recklessly disregarded their existence. And, of course, plaintiffs must fix the time when these particular events occurred.
However, notwithstanding the deficiencies which exist in the pleading, we believe, as we indicated at the outset, that plaintiffs should be given a final chance to replead.
For the reasons set forth above, the decision of the district court is reversed. The cause is remanded.
2A Moore's Federal Practice, ¶ 9.03 at 1929-30. See 5 Wright & Miller, Federal Practice and Procedure: Civil § 1298 at 406. (Rule 9(b) does not render general principles of Rule 8 inapplicable to pleadings alleging fraud). The Second Circuit has very recently expressed this same view that "F.R.Civ.P. 9(b) must be reconciled with F.R.Civ.P. 8(a)(2) ...." Denny v. Barber, supra, 576 F.2d at 467.