Rehearing and Rehearing En Banc Denied July 7, 1992.
OPINION OF THE COURT
SCIRICA, Circuit Judge.
This case is one of a number of federal securities actions against financially troubled banking institutions. After a sharp downturn in the financial condition of defendant UJB Financial Corporation, its shareholders filed a complaint alleging violations of §§ 11, 12(2), and 15 of the Securities Act of 1933 and §§ 10(b), 14(a) and 20(a) of the Securities Exchange Act of 1934, and various pendant state law claims. These claims are predicated on allegedly
The district court dismissed most of plaintiffs' federal claims for failure to state a claim upon which relief could be granted and for failure to plead with particularity. Fed.R.Civ.P. 12(b)(6), 9(b). The court also found that plaintiffs failed to state a common law claim for negligent misrepresentation. We will affirm in part and reverse in part.
Defendant UJB Financial Corporation, a New Jersey-based bank holding company that offers a wide range of financial services, consists of 12 member banks and 11 non-bank subsidiaries.
From 1987 to 1989, UJB saw substantial growth in assets, earnings, net income, and net worth. Total loans increased from $6.5 billion to $8.3 billion, total assets from $10.1 billion to $12.1 billion, and net income from $102 million to $118 million. The company's periodic announcements, made in quarterly and annual reports, press releases, and governmental filings, often contained more than just routine recitations of financial figures. The announcements repeatedly referred to UJB's "prudent," "cautious," and "conservative" lending policy, its "strict" credit administration practices, its "minimal" foreign loan exposure, and its "basic" approach to loan management. There were also frequent references to UJB's adherence to "sound" and "time-tested" banking practices, the "high" quality of its loan portfolio, and its "high safety margin." UJB also represented that its loan loss reserves were "strong" or "very strong," and had been and would continue to be "maintained at a level determined adequate." The bank further attributed its overall success to its "strategy" of limiting its business dealings to the New Jersey region and avoiding concentration on a few large projects.
The first sign of a downturn appeared in March, 1990, when UJB filed a 10-K Report with the Securities and Exchange Commission. The accompanying 1989 Annual Report stated that the provision for loan losses had been increased as a "prudent" measure, and asserted that the loan loss reserves, which had recently been augmented by 13.1%, were "at a level determined adequate." The same Annual Report contained an interview with UJB's President and Chief Executive Officer, Joseph Semrod, who attributed the increase in bad loans to the cyclical nature of the banking business, a slow economy, and problems in residential real estate construction and development. He noted, however, that this part of UJB's loan portfolio was "well secured," and that UJB continued to have "good loan to value ratios." He projected "continued solid growth," but conceded that UJB was "budgeting a smaller real estate portfolio."
UJB's troubles escalated in March and April of 1990 when three financial evaluation services — Moody's Investors Service, Fitch Investors Service, and Standard & Poors — downgraded their ratings of UJB debt, stock, and commercial paper, as well
On April 18, 1990, UJB issued a press release announcing a dramatic decline in net income and an equally striking increase in its loan loss reserves and non-performing assets. Semrod nevertheless reassured the public that the "long term is what counts," and that UJB was both "positioned for the '90s and beyond" and "focused on maximum sustainable long-range earning growth and maximum long-term return." On July 18, 1990, UJB issued another press release announcing that the company's loan loss provision was four times what it had been the year before, and that earnings and income had dropped again. The price of UJB's common stock, which had been as high as $27 per share in the prior three years, plummeted to approximately $10 per share.
In reaction to these developments, plaintiff shareholders filed this class action. They attribute their economic losses to "a campaign [by defendants] to depict the illusion of UJB as a growing, profitable and vital lending institution with conservative lending practices, and a system of internal controls proper to ensure adequate collateralization and prompt recognition and accounting for problem loans." According to plaintiffs, defendants' public announcements in the years 1988-1990 portrayed UJB "in a falsely optimistic manner" by stating that the loan loss reserves were adequate, loan review procedures and policies were stringently and continuously applied, lending opportunities were balanced appropriately against risks, and financial results were positive.
The claims of the plaintiff class
The district court found that the remaining allegations in Counts I and II based on subparagraphs 52(d), (e), (h) and (i) did not satisfy Federal Rule of Civil Procedure 9(b), which requires that fraud be pleaded with particularity. However, the court did not formally dismiss these allegations. Instead, it granted plaintiffs 30 days to amend the complaint. The court also ordered class representative Jerome Katz to post $50,000 as security in connection with the § 11 and § 12(2) claims. Following this order, plaintiffs formally announced that they would neither amend their complaint nor provide security, and instead filed a timely appeal from the district court's order. Defendants moved to dismiss the appeal.
Defendants assert that there is no final appealable order because several claims were not formally dismissed by the district court.
A. § 10(b), § 11, and § 12(2) Claims
The major obstacle to appellate jurisdiction involves the allegations that did not satisfy Rule 9(b). Ordinarily, such claims are dismissed with leave to amend. Here, however, the district court did not dismiss but rather granted leave to amend, stating that "to the extent that plaintiffs do not submit these amendments within thirty days, the court will entertain a renewed motion to dismiss." No amendment was submitted, and the district court never formally dismissed the claims. Plaintiffs maintain that they cured any finality problems by announcing they would stand on their complaint and would not amend.
Guided by the Supreme Court's directive that we employ a "practical rather than a technical construction" of § 1291's finality requirement, Cohen v. Beneficial Indus. Loan Corp., 337 U.S. 541, 546, 69 S.Ct. 1221, 1226, 93 L.Ed. 1528 (1949), we have held that a plaintiff can convert a dismissal with leave to amend into a final order by electing to stand upon the original complaint. See, e.g., Borelli v. City of Reading, 532 F.2d 950, 951-52 (3d Cir.1976) ("Only if the plaintiff ... declares his intention to stand on his complaint ... the order become[s] final and appealable"). Plaintiffs here formally stood on their complaint, but defendants contend that this was not enough. They maintain that we lack jurisdiction because plaintiffs failed to obtain an explicit dismissal with prejudice. We do not agree.
The district court stated it would entertain a renewed motion to dismiss if plaintiffs did not amend, but gave no indication that it would reconsider its earlier rulings. It seems clear that the district court planned to dismiss with prejudice any claims not amended. Requiring plaintiffs to return to the district court now would be a wasteful elevation of form over substance. See Schrob v. Catterson, 948 F.2d 1402, 1407 (3d Cir.1991); but see Hatch v. Lane, 854 F.2d 981, 982 (7th Cir.1988). Thus, once the amendment period expired, the district court's order had the effect of dismissing the improperly pleaded claims with prejudice.
Our analysis is supported by Bankers Trust Co. v. Mallis, 435 U.S. 381, 98 S.Ct. 1117,
Id. at 385, 98 S.Ct. at 1120.
We believe that no practical purpose would be served if we were to dismiss this appeal. Defendants do not question the timeliness of the appeal. See Jung v. K. & D. Mining Co., 356 U.S. 335, 78 S.Ct. 764, 2 L.Ed.2d 806 (1958). Nor is there any doubt that the district court would, on remand, simply dismiss the defective claims left unamended, not revise its earlier reasoning. Id. at 337, 78 S.Ct. at 766. Therefore, we will treat the district court's order as a final dismissal.
B. § 20(a) Claim
Plaintiffs contend that § 20(a) does not create a separate cause of action, but rather depends entirely on the viability of § 10(b) claims. They maintain that "controlling person" liability can exist only if primary liability has been established as to another defendant. Therefore, once all predicate § 10(b) claims are dismissed, there are no allegations upon which § 20(a) liability can be based. We agree.
Section 20(a) imposes joint and several liability on any person who "controls a person liable under any provision of" the Securities Exchange Act of 1934.
There being no other extant claims, we are satisfied that the district court's order was final, and that we have jurisdiction over this appeal.
Plaintiffs make four principal arguments on appeal. First, they maintain that they have alleged fraud under § 10(b) with sufficient particularity, rather than mismanagement. Second, they contend that the same allegations state actionable § 11 and § 12(2) claims and are grounded in negligence rather than fraud. Third, they argue that they have properly alleged negligent misrepresentation under New Jersey law. Finally, they challenge the district court's order requiring class representative Katz to post security.
Our review of the district court's dismissal of the complaint for failure to state a claim upon which relief can be granted is plenary. We must accept as true the factual allegations contained in the
A. § 10(b)
Under the authority provided by § 10(b) of the Exchange Act of 1934,
1. Rule 12(b)(6)
As we have noted, the thrust of the complaint is that UJB and the individual defendants misrepresented the true status of the company's loan loss reserves, financial health, lending practices, and internal controls. The district court found that many of the alleged misrepresentations or omissions involved either failures to predict or mismanagement — not fraud — and were not actionable under the federal securities laws.
The basis for the district court's decision was In re Craftmatic Sec. Litig., 890 F.2d 628 (3d Cir.1990), where we held that "[w]here the incremental value of disclosure is solely to place potential investors on notice that management is culpable of a breach of faith or incompetence, the failure to disclose does not violate the securities laws." Id. at 640. In Craftmatic we provided an extensive review of the Supreme Court's jurisprudence on materiality,
Because it plays such a prominent role in the complaint, we will briefly discuss the nature of a loan loss reserve, which is defined in the banking trade as a
American Bankers Association, Banking Terminology 215 (1989). There appears to be no single method of evaluating and setting loan loss reserves, perhaps because no method has proven foolproof. C. Edward McConnell, Loan Loss Reserve Management and Unwise Lending Practices, in Bank Credit 354 (Herbert V. Prochnow ed. 1981). Some banks set their loan loss reserves by comparing the size of the reserves to that of the loan portfolio. See Keith G. Turman, Evaluating a Bank's Loan Loss Reserve Adequacy, Internal Auditor, February 1991, at 5253. Others also analyze the quality of their loans in varying degrees of detail and according to a range of different criteria and classifications. See, e.g., id.; Ronald A. Stoffers, Loan Loss Reserve Analysis: Is It Moving From Art to Science?, Banking Policy Report, April 1, 1991, at 4; Francis X. Conway & William A. Siegenthaler, Loan Loss Reserves: Tax, Regulatory, and Adequacy Issues, J. of Com. Bank Lending, Sept. 1987, at 4; Victor F. Ptasznik, Another Approach to Calculating the Loan Loss Reserve, J. of Com. Bank Lending, April 1987, at 7; Jerry Abner, Calculating the Loan Loss Reserve from a Watch List, J. of Com. Bank Lending, August 1985, at 2. All techniques, however, require quantitative and qualitative analyses of the past and present status of loans. See Conway & Siegenthaler, Loan Loss Reserves, supra, at 9 ("Relying on standardized, nondiscretionary formulas to aid in the determination of loan loss reserves is oversimplifying a complex problem."); see also Allowance for Loan and Lease Losses for Federal Branches and Agencies, Office of Comptroller of the Currency, Banking Circular 201, Fed. Banking L.Rep. (CCH) ¶ 51,132 (May 31, 1985) (describing minimum assessment customarily undertaken by soundly managed banks). No matter what method is used, the economic judgments made in setting loan loss reserves can be validated only at some future date. McConnell, supra, at 354-55.
There is nothing unique about representations and omissions regarding loan loss reserves that removes them from the purview of the antifraud provisions of the federal securities laws. In our view a reasonable investor would be influenced significantly by knowledge that a bank has knowingly or recklessly hidden its true financial status by deliberately misstating its level of non-performing loans, failing to provide adequate reserves, and indulging its problem loan customers. See In re Midlantic Corp. Shareholder Litigation, 758 F.Supp. 226, 234 (D.N.J.1990). On the other hand, mere failure to provide adequate reserves (or to perform competently other management tasks) does not implicate the concerns of the federal securities laws and is not normally actionable. Similarly, if a defendant has not commented on the nature and quality of the management practices that it has used to reach a particular statement of loan loss reserves, earnings, assets, or net worth, it is not a violation of the securities laws to fail to characterize these practices as inadequate, meaningless, out of control, or ineffective. Craftmatic, 890 F.2d at 633 n. 5 & 640 (dismissing allegations that defendants failed to disclose general subjective assessments of controls, organization, and management information systems).
Our decision that such general labels as "conservative" and "cautious" can be the basis for liability under Rule 10b-5 is supported by the Supreme Court's recent decision in Virginia Bankshares, Inc. v. Sandberg, ___ U.S. ___, 111 S.Ct. 2749, 115 L.Ed.2d 929 (1991). In that case, the executive committee and board of directors of a bank approved a merger proposal that would pay its minority shareholders $42 per share. The directors solicited proxies for voting on the proposal at the company's annual meeting. In the solicitation sent to minority shareholders, the directors stated that the merger was an opportunity to achieve a "high" value at a "fair" price. Id. at ___, 111 S.Ct. at 2756. After the merger was approved, the plaintiff filed a complaint alleging violations of SEC Rule 14a-9, which prohibits the making of false or misleading statements of material fact in — and the omission of material facts necessary to make existing statements not false or misleading from — a proxy statement. 17 C.F.R. § 240.14a-9 (1991). Specifically, the plaintiff alleged that the directors had not in fact believed that the price offered was "high" or that the terms of the merger were "fair."
The Supreme Court rejected the defendants' argument that statements of opinion or belief were not "material." After noting that a fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote, the Court commented that
Id. at ___, 111 S.Ct. at 2757.
If a director's statement of belief is material because of the speaker's superior knowledge, then a manager's statement of belief must also be material. A manager's knowledge and expertise regarding the day-to-day operation of his company generally exceeds that of a director, and the reasonable investor is aware of this fact. Even if management sometimes acts in its own interest, a reasonable investor need not take a manager's statement of belief at anything less than face value.
Virginia Bankshares also rejected the argument that statements of reasons, opinions, or beliefs are not "factual" for purposes of the securities laws. Such statements, said the Court, "are factual in two senses: as statements that the directors do act for the reasons given or hold the belief stated and as statements about the subject matter of the reason or belief expressed." Id. at ___, 111 S.Ct. at 2758.
Id. at ___, 111 S.Ct. at 2758-59 (emphasis added). For these reasons, plaintiffs here are "permitted to prove a specific statement of reason knowingly false or misleadingly incomplete, even when stated in conclusory terms." Id. at ___, 111 S.Ct. at 2759. We believe that the evaluations of management practices and financial well-being alleged here are as conclusory (and as provable) as those in Virginia Bankshares.
In this case, plaintiffs accuse defendants of knowingly or recklessly misrepresenting that they thought UJB's:
— loan loss reserves were "adequate," "adequately maintained," "strong," and "solid" (¶ 52(a), (b), (c), (e));
— loan portfolio was "well secured," "well collateralized," and of a high "quality" (¶ 52(d));
— loan to value ratio was "good" (¶ 52(d));
— loan management and underwriting practices were "conservative," "basic," "careful," "good," "prudent," and "cautious," (¶ 52(e));
— asset quality was "high," while their level of bad loans was "low" (¶ 52(d), (g)); and
— internal controls not only existed, but were properly centralized, supervised, and managed (¶ 52(f), (g), (h)). Moreover, plaintiffs allege that the published figures relating to earnings, assets, and net worth were knowingly or recklessly "overstated and inflated." ¶ 52(a). In light of our discussion, all of these statements, if made knowingly or recklessly, are actionable.
Nevertheless, not all the allegations made in paragraph 52 are actionable. As we have noted, it is not a violation of the securities laws to simply fail to provide adequate loan loss reserves; properly collateralize or secure a loan portfolio; or provide sufficient internal controls or loan management practices.
Moreover, as the district court recognized, some of the pivotal allegations charge defendants with essentially failing to predict the future. As we pointed out previously, "where an event is contingent or speculative in nature, it is difficult to ascertain whether the reasonable investor would have considered the omitted information significant at the time." Craftmatic, 890 F.2d at 643 (quoting Basic, Inc. v. Levinson, 485 U.S. 224, 232, 108 S.Ct. 978, 984, 99 L.Ed.2d 194 (1988) (internal quotation marks omitted)). For example, plaintiffs allege here that UJB failed to reveal that the loan loss reserves were inadequate in light of the "high risk of non-collectibility" (¶ 52(c)); and that UJB "would be" required to add substantial amounts to its loan loss reserves in the future (¶ 52(g)). Plaintiffs do not, however, allege that defendants possessed or made affirmative forecasts regarding these possible outcomes. See Craftmatic, 890 F.2d at 644. Thus, there is no allegation that defendants omitted "soft information" that can, in some circumstances, be actionable. Flynn v. Bass Bros. Enterprises, 744 F.2d 978 (3d Cir.1984). For this reason, these particular allegations contained in subparagraphs 52(c) and (g) were properly dismissed.
Having established the applicable principles of law, we would ordinarily leave it to the district court to evaluate the remaining paragraphs and subparagraphs of the complaint,
It is difficult to comprehend this allegation. We do not believe that plaintiffs are alleging that the overstatement and inflation was caused by inadequate provision of loan loss reserves, yet this is what the paragraph appears to say. Similar ambiguities occur elsewhere.
Given the procedural history of this case, we would not ordinarily be disposed to offer plaintiffs yet another opportunity to revise their complaint. However, in light of the confusion that pervades plaintiffs' allegations, we conclude that the entire complaint must be reorganized. Therefore, on remand plaintiffs should rearrange the existing allegations into discrete units that are, standing alone, each capable of evaluation under the legal principles we have set forth. Because of the procedural history here, plaintiffs may not add to the existing factual allegations in making their revisions. We also note that plaintiffs in future cases of this kind should plead clearly and coherently from the outset.
2. Rule 9(b)
Rule 9(b) requires a plaintiff to plead (1) a specific false representation of material fact; (2) knowledge by the person who made it of its falsity; (3) ignorance of its falsity by the person to whom it was made; (4) the intention that it should be acted upon; and (5) that the plaintiff acted upon it to his damage. Christidis v. First Pennsylvania Mortgage Trust, 717 F.2d 96, 99 (3d Cir.1983). Despite these stringent requirements, the courts should be "sensitive" to the fact that application of the Rule prior to discovery "may permit sophisticated defrauders to successfully conceal the details of their fraud." Id. at 99-100. They should also respect the "general simplicity and flexibility" of the Federal Rules of Civil Procedure. Id. at 100.
In Christidis we dismissed allegations that defendants knew or should have known that loan loss reserves were understated, were improperly used, and led to distortions of other financial data. Such allegations, we stated, could only succeed if, when the loan loss reserves were established, "the responsible parties knew or should have known that they were derived in a manner inconsistent with reasonable accounting practices." 717 F.2d at 100. We found the allegations deficient because they had not disclosed "the manner in which, in establishing reserves for bad debts in the financial statements relied upon, defendants knowingly departed from reasonable accounting practices." Id. Despite three amendments, plaintiffs had
In Craftmatic, however, we recognized that:
890 F.2d at 645 (citations omitted). Nevertheless, we also held that at the very least plaintiffs must allege that the necessary information lies within defendants' control. Id. Although acknowledging that plaintiffs here cannot be expected to plead with specificity the details of UJB's internal corporate practices, the district court dismissed the remaining allegations for failure to allege defendants' exclusive control over this information. The complaint does not specifically allege that defendants have exclusive control of information plaintiffs require.
Had the complaint contained a boilerplate allegation that plaintiffs believe the necessary information "lies in defendants' exclusive control," it still would not have satisfied Rule 9(b). As we have noted, even under a more relaxed application of the rule, plaintiffs must accompany such an allegation with a statement of facts upon which their allegation is based. Craftmatic, 890 F.2d at 645; Moore v. Kayport Package Express, Inc., 885 F.2d 531, 540 (9th Cir.1989); 2A James W. Moore & Jo D. Lucas, Moore's Federal Practice ¶ 9.03 at 9-29 to 9-29 (1991) ("where the facts are in the exclusive possession of the adversary, courts should permit the pleader to allege the facts on information and belief, provided a statement of the facts upon which the belief is founded is proffered"). To avoid dismissal in these circumstances, a complaint must delineate at least the nature and scope of plaintiffs' effort to obtain, before filing the complaint, the information needed to plead with particularity. This requirement is intended to ensure that plaintiffs thoroughly investigate all possible sources of information, including but not limited to all publicly available relevant information, before filing a complaint. We will allow plaintiffs another opportunity to meet this standard.
B. §§ 11 and 12(2)
Count II alleges that UJB's Dividend Reinvestment and Stock Purchase Plan ("the DRISP") and the accompanying prospectus and registration statement were false and misleading, and that plaintiffs purchased UJB stock "pursuant to" all three documents.
1. Rule 12(b)(6)
a. § 11
Under § 11 of the Securities Act, any person acquiring a security issued pursuant to a false or misleading registration statement may recover damages. See 15 U.S.C. § 77k. Plaintiffs allege that they purchased UJB stock "pursuant to" a DRISP registration statement. The district court dismissed this claim, holding that although plaintiffs need not prove their shares are traceable to a false or misleading registration statement at this early stage of the litigation, they must allege it. We agree that traceability must be alleged, but our review of plaintiffs' complaint leads us to conclude that this has been done.
If plaintiffs' shares were purchased in the secondary market, they would not be linked to a registration statement filed during the class period, and the § 11 claim would fail. Before discovery takes place, however, it is impossible for plaintiffs to know whether their shares were newly issued or were purchased in the secondary market. The complaint alleges that the shares were purchased "pursuant to" the DRISP. At some point, plaintiffs may be able to prove that their DRISP shares came from treasury stock. Because we cannot say that plaintiffs can prove no set of facts that would entitle them to relief, the § 11 claim cannot be dismissed at this time.
b. § 12(2)
Section 12(2) provides that a person who "offers or sells" securities by means of a prospectus or oral communication that misrepresents or omits material facts is liable to the person "purchasing such security from him." 15 U.S.C. § 77l (1988). The district court dismissed the § 12(2) claim, finding insufficient plaintiffs' allegation that defendants were "sellers" within the meaning of the statute.
In Pinter v. Dahl, 486 U.S. 622, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988), the Supreme Court held that the term "seller" under § 12(1) is not limited to the person who passes title to the security, but includes anyone "who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner." Id. at 647, 108 S.Ct. at 2078. In Craftmatic we extended Pinter to § 12(2). We interpreted Pinter as having held that
890 F.2d at 636. We upheld allegations that each defendant "either sold [the] securities directly to plaintiffs ... or solicited plaintiffs ... and in so acting were motivated by a desire to serve their own financial interests or the financial interests of the owner(s) of [the] securities." Id. at 637.
These plaintiffs were not required to allege that UJB directly "solicited" the sales. The Pinter/Craftmatic solicitation rule applies only when the defendant issuer is not in direct privity with the purchaser. Pinter adopted solicitation liability as an expansion of the restrictive view that § 12 extended only to sellers in direct privity. 486 U.S. at 644, 108 S.Ct. at 2077. In Craftmatic, because the securities were purchased from an underwriter acting as a middleman, the defendant was not in privity with plaintiffs. Here, however, the newly offered shares purchased through the DRISP were sold directly to plaintiffs by UJB. See App. at 438 ("Purchases of UJB Common Stock may be made directly from UJB or on the open market, at the discretion of senior management of UJB.").
2. Rule 9(b)
The district court held that the § 11 and § 12(2) allegations in Count II "sounded in fraud" and that Rule 9(b) applies. We agree.
Count II incorporates by reference all preceding factual allegations, including those delineating defendants' "intent." It also states that the DRISP prospectus was false and misleading "in the particulars previously described," and mentions the false and misleading nature "of the representations described above." Complaint ¶¶ 62-63. Although Count II does not allege fraudulent intent or recklessness (a prerequisite to a successful fraud claim), neither does it allege negligence. The specific factual allegations upon which Count II is based do, however, repeatedly aver that defendants "intentionally," "knowingly," or "recklessly" misrepresented and omitted to represent certain material information. For example, paragraph 53, which expressly purports to characterize all of the complaint's factual allegations, asserts that:
Complaint ¶ 53. The only reasonable conclusion that can be drawn is that plaintiffs charge defendants with fraud. There is not a hint in the allegations that defendants
Plaintiffs contend that because Count II does not mention the intent required for fraud, we must necessarily infer that the claims are grounded in negligence. As defendants point out, however, Rule 9(b) refers to "averments" of fraud, and thus requires us to examine the factual allegations that support a particular legal claim. Plaintiffs also maintain that their incorporation by reference of earlier factual allegations should not "contaminate" Count II. We agree that a pleader should not be penalized for economizing. Here, however, only one paragraph preceding Count II refers to the DRISP. Quite simply, plaintiffs did not allege ordinary negligence there or anywhere else.
Moreover, we are not presented with a "mixture of allegations of negligence, fraud, and the misleading nature of" certain communications. In re Consumers Power Co. Sec. Litig., 105 F.R.D. 583, 594 (E.D.Mich.1985). As we have noted, the complaint is devoid of allegations that defendants acted negligently in violating §§ 11 and 12(2). Instead, it brims with references to defendants' intentional and reckless misrepresentation of material facts. We see no way to construct a negligence cause of action here.
Next we determine whether Rule 9(b) applies to § 11 and § 12(2) claims grounded in fraud, a question not yet decided in this court. See Craftmatic, 890 F.2d at 645 n. 28 (leaving question open with regard to § 12(2)). It is clear that neither fraud nor mistake is a necessary element of either statutory cause of action. Under § 12(2) defendants may be held liable for negligent misrepresentation or omission. Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 687-88 (3d Cir.1991); Craftmatic, 890 F.2d at 645 n. 28 (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 208-09, 96 S.Ct. 1375, 1388, 47 L.Ed.2d 668 (1976)). The same is true of § 11. Herman & MacLean v. Huddleston, 459 U.S. 375, 382, 103 S.Ct. 683, 687, 74 L.Ed.2d 548 (1983). By its plain wording, Rule 9(b) would not appear to apply to claims that a defendant negligently violated §§ 11 and 12(2); we need not and do not decide this issue. On the other hand, the plain language of the rule clearly encompasses § 11 and § 12(2) claims based on fraud like those before us. See, e.g., Sears v. Likens, 912 F.2d 889, 892-93 (7th Cir.1990) (applying Rule 9(b) to § 12(2) claim). We see no valid reason to create a special exception to Rule 9(b) for such claims. Accordingly, we hold that when § 11 and § 12(2) claims are grounded in fraud rather than negligence, Rule 9(b) applies.
The district court did not address whether plaintiffs' § 11 and § 12(2) allegations were pleaded with sufficient particularity. Although we will remand for full consideration of this issue, we offer the following guidance. The most serious flaw in the § 11 claim went unnoticed by the parties. Section 11 imposes liability for false or misleading statements made in "registration statements." 15 U.S.C. § 77k (1988). Paragraph 61 of the complaint alleges that Katz and those he represents purchased UJB stock pursuant to a DRISP "prospectus," not a registration statement. A prospectus generally makes up the bulk of the registration statement, contains nearly identical information, and serves many of the same disclosure purposes. However, it is a distinctly separate document under the federal securities laws. Paragraph 64 alleges that members of the class purchased UJB stock "pursuant to the foregoing registration statements," but no reference to a registration statement precedes paragraph 64. Indeed, paragraph 33 of the complaint describes the issuance of only a "prospectus"
The § 12(2) claim does identify the offending prospectus, but is only slightly more informative than the § 11 allegations. The complaint neither identifies which allegedly false statements violated § 12(2) nor explains how they were false. Under Rule 9(b), a plaintiff must allege the manner in which a defendant knowingly departed from the truth. Christidis, 717 F.2d at 100. As already noted, we are sensitive to the fact that premature application of Rule 9(b) can permit sophisticated defrauders to conceal fraud. Id. at 99-100. We are also aware that in cases of corporate fraud, plaintiffs cannot be expected to have personal knowledge of the details of corporate internal affairs. Craftmatic, 890 F.2d at 645. Nevertheless, "even under a non-restrictive application of the rule, pleaders must alleged that the necessary information lies within the defendants' control, and their allegations must be accompanied by a statement of the facts upon which the allegations are based." Id. The district court should, on remand, evaluate the particularity of the § 11 and § 12(2) claims in light of these comments.
C. Negligent Misrepresentation
The district court dismissed plaintiffs' supplementary state law claim for negligent misrepresentation, holding that New Jersey law does not extend this cause of action to the general investing public. We disagree.
Under New Jersey common law, persons who negligently misrepresent material facts may be held liable to those who, as a result of their justifiable reliance on such misrepresentation, suffer economic harm. H. Rosenblum, Inc. v. Adler, 93 N.J. 324, 461 A.2d 138, 142-43 (1983). In Rosenblum the New Jersey Supreme Court held that a buyer of stock may sue a corporation's outside auditor for negligent misrepresentations regarding the corporation's financial statements. In an exhaustive discussion, the court rejected the view that the plaintiff must be in privity with the auditor. Instead, "the independent auditor ... has a duty to all those whom that auditor should reasonably foresee as recipients from the company of the statements for its proper business purposes." Id. at 142; see also id. at 146.
Rosenblum takes an expansive view of the range of permissible plaintiffs in a negligent misrepresentation action. It explicitly rejects the majority view that the plaintiff must be in privity, and adopts the more inclusive "reasonably foreseeable plaintiff" rule. There is no dispute here that the average investor was a reasonably foreseeable recipient of defendants' statements about UJB. Defendants argue instead that investment by the general public is not a "proper business purpose." To state the argument is to note its defects. As one court has explained,
In re Midlantic Shareholders Litig., 758 F.Supp. 226, 237 n. 9 (D.N.J.1990).
461 A.2d at 154 (emphasis added). Moreover, the court looked to the expansive liability under the federal securities laws as a model for New Jersey law. Id. at 151. Therefore, it is not accurate to say that Rosenblum's "business purpose" requirement limits the cause of action to those who make "significant" investments.
In sum, we find that the New Jersey Supreme Court intended to part company with the majority of states that allow only plaintiffs who are in direct privity to sue for negligent misrepresentation. Therefore, we hold that this cause of action extends to foreseeable individual investors who, as a result of their reliance on negligently made misrepresentations, suffer economic loss.
Under § 11(e) of the Securities Act, a district court "may, in its discretion, require an undertaking for the payment of the costs of [a Securities Act] suit, including reasonable attorney's fees."
The principal purpose of § 11(e) is to deter plaintiffs from bringing meritless actions solely to procure a favorable settlement. Phillips v. Kidder, Peabody & Co., 686 F.Supp. 413, 416 (S.D.N.Y.1988); see also Hochfelder, 425 U.S. at 211 n. 30, 96 S.Ct. at 1389. Defendants concede that § 11(e) security is typically required "when the plaintiffs' action `borders on the frivolous' or `is brought in bad faith.'" Brief of Appellees at 55. The district court made no finding that Katz' claims met either of these standards. As we have seen, many of these claims are sufficient to withstand a motion to dismiss. Therefore, we will vacate the district court's security requirement.
For the reasons stated, we will affirm in part and reverse in part the district court's dismissal of Counts I and II and remand for proceedings consistent with this opinion. Moreover, we will affirm the district court's decision that Rule 9(b) applies to the § 11 and § 12(2) claims,
Each side shall bear its own costs.
SUR PETITION FOR REHEARING
Present: SLOVITER, Chief Judge, BECKER, STAPLETON, MANSMANN, HUTCHINSON, SCIRICA, COWEN, NYGAARD, ALITO and ROTH, Circuit Judges, and VanARTSDALEN
The petition for rehearing filed by appellees in the above-entitled case having been submitted to the judges who participated in the decision of this Court and to all the other available circuit judges of the circuit in regular active service, and no judge who concurred in the decision having asked for rehearing, and a majority of the circuit judges of the circuit in regular service not having voted for rehearing, the petition for rehearing by the panel and the Court in banc, is denied.
Dated: July 7, 1992.
The district court dismissed Count V, which alleged a breach of fiduciary duties under New Jersey corporate law. This dismissal has not been appealed.
Complaint ¶ 52.
15 U.S.C. § 78t(a) (1988).
15 U.S.C. § 78j(b) (1988).
17 C.F.R. § 240.10b-5 (1991).
The district court also dismissed Count II, which alleges that defendants violated §§ 11, 12(2), and 15, "to the extent that it relies on the points raised in" paragraph 52. Slip op. at 7. Our analysis with respect to Count I of the materiality and particularity of the fact allegations made in that paragraph also applies to Count II.
The remaining paragraphs of Count II allege damage and petition for relief.
Id. at 153 (emphasis added). It is not clear what the court meant by "the necessary conditions precedent." Perhaps it refers to reliance and the other elements of the cause of action. In any event, it is plain that Rosenblum does not foreclose liability to everyday investors.
Defendants also rely on Karu v. Feldman, 574 A.2d 420 (N.J.1990), a post-Rosenblum case. This reliance is misplaced. Although Karu found that the plaintiff did not state a claim for negligent misrepresentation, the decision did not turn on privity or the "business purpose" requirement. Rather, the court held that the defendant bank had not acted negligently because it had not provided certain false information to a depositor and had no duty to disclose other information. Id. at 427-28. Karu may support a finding that UJB had no duty to disclose certain information under New Jersey law, but it in no way supports the contention that a member of the investing public has no cause of action.
15 U.S.C. § 77k(e) (1988) (emphasis added).