Livid Holdings Ldt v. Salomon Smith Barney

Citation: Not availableDocket: 03-35374

Court: Court of Appeals for the Ninth Circuit; August 2, 2005; Federal Appellate Court

Original Court Document: View Document

SummaryOriginalCytator Case TreatmentBackward CitatorAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

Livid Holdings Ltd. appeals against several defendants including Salomon Smith Barney, Inc., and others, in a case presided over by Judge John C. Coughenour in the Western District of Washington. The appeal, argued on October 5, 2004, and filed on April 6, 2005, involves allegations regarding the purchase of PCI stock by the defendants, which Livid claims was based on contingent events and that the defendants were aware UAE was not contractually obligated to buy its share of the stock. 

The court amended its opinion to clarify that it is uncertain whether the defendants purchased preferred or common shares of PCI stock, but noted that this distinction is irrelevant to Livid's claims. It asserts that all defendants bought stock under the same conditional terms as UAE, knowing the sale was incomplete when the relevant notice was attached to the Memorandum aimed at attracting additional investors. 

Further amendments removed statements regarding the defendants’ acknowledgment of their knowledge of these conditions, as the case is at the Rule 12(b)(6) motion stage without the defendants having answered the complaint. The opinion also emphasizes that Livid claims the defendants' misrepresentation directly caused its financial losses, linking this to PCI's eventual bankruptcy, which resulted in a total loss of Livid's investment. The opinion cites relevant case law to support the assertion that the alleged misstatements or omissions contributed to the economic harm experienced by Livid.

Livid Holdings, Ltd. appeals the district court's dismissal with prejudice of its complaint against the corporate successors of Schroders, Co., Inc. The complaint alleges violations of the Securities Exchange Act of 1934, specifically Rule 10b-5, the Washington Securities Act, and Washington tort law. Livid contends that it purchased $10 million worth of shares in Purely Cotton, Inc. (PCI) based on misleading information provided in a Confidential Offering Memorandum created by Schroders, who facilitated a $25 million private placement of PCI stock in January 1999. 

Livid claims that the Defendants misrepresented the contractual obligations of a key investor, UAE, which was purportedly not bound to purchase its share of the stock. Moreover, Livid asserts that the Defendants amended the Offering Memorandum without adequately updating it to reflect significant changes in PCI's circumstances, thereby misleading potential investors. The court's decision to dismiss Livid's complaint was deemed erroneous. 

The panel voted to deny the petition for rehearing, with Judges Reinhardt and Thomas affirming this decision, and Judge D. Nelson also recommending denial. The full court was notified of the petition but no further votes were requested, leading to a final denial of both rehearing and en banc review.

Livid's claims against the Defendants stem from a notice's last sentence, which Livid argues implies that PCI received $25 million from an initial sale, despite the fact that less than $2 million had actually been paid. Livid asserts that further payments were contingent upon UAE approving a PCI business plan and appointing a new CEO, indicating that UAE was not obligated to pay for PCI stock. The pleadings do not clarify whether Defendants purchased preferred or common shares, but Livid claims both types were acquired under the same conditional terms as UAE, suggesting the Defendants were aware the sale was incomplete when the notice aimed to attract new investors. Livid also alleges a motive for the Defendants to mislead potential investors since PCI had not compensated Schroders for earlier fundraising services. The district court dismissed Livid's claims with prejudice, finding that Livid did not adequately plead a material misrepresentation or satisfy the PSLRA's heightened pleading standards for scienter. Furthermore, the court deemed the alleged misrepresentation immaterial and concluded that the Defendants were not considered sellers of securities under the WSA. The court also dismissed Livid's state tort claims due to unreasonable reliance on the notice's representations and denied the request to amend the complaint, believing further attempts would be futile. The standard of review for dismissals under Federal Rule 12(b)(6) is de novo, focusing on the complaint and viewing factual allegations favorably toward the nonmoving party. A dismissal without leave to amend is reviewed de novo, and such dismissal is improper unless it is clear that no amendment could salvage the complaint.

Section 10(b) of the 1934 Act prohibits the use of manipulative or deceptive devices in connection with security transactions, as detailed in Rule 10b-5, which specifically makes it illegal to make untrue statements of material facts or to omit necessary material facts that would render prior statements misleading. A Rule 10b-5 claim comprises five elements: (1) a misrepresentation or omission of material fact; (2) scienter; (3) causation; (4) reliance; and (5) damages. Claims must adhere to the heightened pleading standards of Federal Rule of Civil Procedure 9(b) and the PSLRA, which mandates that plaintiffs specifically plead facts that strongly infer the defendant's required state of mind.

Materiality is established if there is a substantial likelihood that a reasonable investor would have acted differently had the misrepresentation not occurred. In this case, Livid sufficiently alleged that a reasonable investor would not have invested $10 million in PCI stock if aware of the company's $25 million cash shortfall, contrasting with the misleading financial portrayal in the Memorandum.

The district court ruled that cautionary language in a notice attached to the Memorandum rendered the statements legally immaterial under the bespeaks caution doctrine, which protects defendants against securities fraud claims when forward-looking statements include adequate risk disclosures. However, such a dismissal requires a strong showing that reasonable minds could not disagree on the misleading nature of the statements. The court found that the contested sentence could be interpreted to imply that the cash had already been received but was not updated in the Memorandum, indicating potential ambiguity that undermines the district court's conclusion.

The district court incorrectly applied the bespeaks caution doctrine to factual statements, despite its limited acceptance in this circuit and outright rejection by the First and Seventh Circuits. These circuits maintain that the doctrine does not apply to false representations of present or historical facts but only to forward-looking statements. The Ninth Circuit has previously recognized that the bespeaks caution rule is inapplicable to historical misrepresentations. The court emphasizes that extending this doctrine to historical facts could allow management to obscure intentional misrepresentations under vague cautionary language. Consequently, it holds that the district court erred in deeming the contested statement immaterial.

Regarding scienter under the PSLRA’s heightened pleading standard, plaintiffs must provide strong circumstantial evidence of deliberate recklessness. The Ninth Circuit requires that the totality of allegations must suggest a strong inference of intentional misconduct. In this case, Livid claims that Defendants, aware of the incomplete stock sale, misled investors by issuing a notice that omitted critical information about the sale's status. The district court concluded that the Defendants lacked the intent to mislead, positing that a more explicit misrepresentation would have been made if that were the case. The Ninth Circuit disagrees, asserting that the statement, which falsely claimed the stock offering was completed, was already sufficiently explicit.

Livid has established a strong inference of scienter, indicating that Defendants acted with deliberate recklessness by allegedly knowing the false nature of a contested statement at the time it was made, thus meeting the heightened pleading standard. This inference is bolstered by Livid's claim of Defendants’ motive to misrepresent the stock sale status. While motive alone does not satisfy the scienter standard, it can be considered alongside other allegations of intent to mislead. Consequently, the court reverses the district court's finding that Livid failed to demonstrate the requisite scienter.

Regarding causation under Rule 10b-5, Livid sufficiently pled both transaction causation and loss causation. Livid contends that it would not have purchased PCI stock but for Defendants' misrepresentation, which concealed PCI's financial troubles leading to its bankruptcy and Livid's total investment loss. The court finds this sufficient to survive a motion to dismiss.

On the issue of reliance, the district court ruled that Livid could not establish reliance due to cautionary language in the notice. However, the court declines to apply the bespeaks caution doctrine to historical facts, reversing the district court's conclusion on reliance. It further criticizes the district court's suggestion that Livid failed to conduct due diligence, emphasizing that Livid's reliance on Defendants' misrepresentations resulted in damages, which are adequate for surviving the motion to dismiss under Rule 12(b)(6).

Defendants contend that Livid’s federal securities claim is time-barred, providing an alternative basis for affirming the district court's dismissal. The court can affirm based on any supported ground, regardless of whether the district court relied on it. However, the current record does not show that the statute of limitations has expired. Rule 10b-5 lacks its own statute of limitations, but the Supreme Court has determined that the limitations period in § 9(e) of the 1934 Act applies to these actions, necessitating that claims be filed within one year after discovering the violation or within three years of the violation itself. The Sarbanes-Oxley Act (SOA) amended this, establishing a new limits framework: claims must be filed within two years of discovery or five years after the violation, applicable to actions commenced after its enactment on July 30, 2002. Livid filed its complaint on August 1, 2002, but this does not automatically qualify it under the SOA's extended period, as the SOA clarifies it does not create new private rights of action. Defendants argue that the pre-SOA limitations had lapsed prior to Livid’s filing, implying a need to discern if the SOA revives expired claims. The court cannot conclude that the pre-SOA limitations had run at the time of filing. According to pre-SOA rules, Livid's claim would be barred if it discovered the relevant facts over a year before filing. Defendants assert that Livid was put on inquiry notice of the alleged fraud on March 19, 2000, when three PCI employees filed an involuntary bankruptcy petition against PCI. The court has yet to definitively establish whether actual or inquiry notice triggers the statute of limitations for Rule 10b-5, having previously noted a preference for an inquiry notice standard coupled with a reasonable diligence requirement, though it has not formally adopted this standard.

Livid alleges it did not gain actual notice of the alleged fraud until late September 2001, upon receiving a report from the independent auditor related to bankruptcy proceedings. If actual notice is necessary to initiate the statute of limitations, it cannot be determined that Livid filed its complaint more than one year after discovering the fraud. The allegations do not clarify whether Livid's filing was timely if inquiry notice is applicable. Under the circuit’s modified inquiry notice standard, it remains uncertain whether Livid should have been aware of the fraud prior to filing. The court cites a precedent indicating that financial difficulties alone do not typically indicate fraud, and the bankruptcy petition alone may not meet the inquiry-plus-due diligence standard. Livid learned about PCI's bankruptcy on May 25, 2001, prompting it to investigate, which revealed representations about a $25 million stock sale. Therefore, it cannot be concluded, as a matter of law, that Livid was on notice of the alleged fraud a year before filing.

Regarding Livid’s state securities claim, the district court dismissed it based on a finding of immateriality related to the federal securities claim. Since this finding is reversed, the dismissal of the state claim is also reversed. Additionally, contrary to the district court's ruling, Washington law allows for claims against defendants who were substantial contributive factors in a sales transaction, regardless of whether they directly sold the securities. Livid's allegations indicate that the defendants inserted misleading statements that induced its stock purchase, creating a factual issue about their role as sellers under the Washington Securities Act.

The district court also dismissed Livid’s state tort claims for fraudulent and negligent misrepresentation, asserting unreasonable reliance on the notice's statements. However, since the court erred in determining Livid's reliance was unreasonable concerning the federal securities claim, this decision is similarly reversed for the state tort claims.

In conclusion, Livid’s complaint sufficiently states claims for federal and state securities fraud, as well as state tort violations, even under heightened pleading standards. The case is remanded for further proceedings consistent with this opinion.