Robert M. Rubin and Patricia Cohen v. Schottenstein, Zox & Dunn, Richard A. Barnhart, Danny L. Todd, and Gregory A. Todd

Citations: 110 F.3d 1247; 37 Fed. R. Serv. 3d 759; 1997 U.S. App. LEXIS 6927; 1997 WL 177178Docket: 96-3017

Court: Court of Appeals for the Sixth Circuit; April 15, 1997; Federal Appellate Court

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In the case of Rubin and Cohen v. Schottenstein, Zox & Dunn, the plaintiffs, Robert M. Rubin and Patricia Cohen, appeal a District Court decision denying their motion for final judgment and granting judgment on the pleadings in favor of defendants Schottenstein, Zox & Dunn and Richard Barnhart. The appeal arises from allegations of securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The plaintiffs claim that the defendants failed to disclose that their investment in Medical Designs, Inc. (MDI) would constitute a default under MDI's loan agreement with Star Bank, which could jeopardize their $150,000 investment. The Todds, officers of MDI, indicated the need for additional capital but did not disclose critical information regarding MDI's financial obligations and defaults. Richard A. Barnhart, legal counsel for MDI, issued an Opinion Letter validating the investment, which plaintiffs argue lacked necessary disclosures about MDI's financial state. The court confirmed its jurisdiction over the appeal and upheld the District Court's judgment, noting that the Opinion Letter did not contain any affirmative misrepresentations regarding the defaults with Star Bank.

Rubin, encouraged by the Todds, contacted Barnhart regarding a transaction involving MDI. Barnhart failed to disclose that financing and issuing additional shares would cause a default with Star Bank. After a meeting with the Todds, Rubin consulted his attorney, Stephen Weiss, who also spoke with Barnhart, yet Barnhart did not mention the impending default. On March 27, 1992, plaintiffs loaned MDI $150,000 and purchased shares, but Star Bank subsequently froze MDI’s account due to the default. 

Schottenstein, Zox & Dunn and Barnhart sought judgment on the pleadings, claiming the allegations were insufficient. In response, plaintiffs submitted affidavits from Rubin and Weiss, alleging Barnhart made four misrepresentations, including assurances about Star Bank's continued support and the need for due diligence. The District Court accepted these allegations as true but granted Barnhart's motion, ruling he did not have a fiduciary duty to disclose information due to the plaintiffs being represented by counsel.

Plaintiffs appealed on March 3, 1994, but the appeal was dismissed on March 22, 1994, as there was no final judgment due to pending claims against the Todds. After voluntarily dismissing the Todds on June 29, 1994, plaintiffs filed for final judgment on May 4, 1995, but the District Court ruled the earlier order became final upon the dismissal. The plaintiffs now appeal the denial of their motion for final judgment, though defendants argue this appeal is untimely, as it was filed after the final judgment had already been established with the dismissal of the Todds. The jurisdiction of the appeal is contingent on the timing of the notice of appeal relative to the final judgment.

Once the plaintiffs dismissed the Todds from the action, the case was deemed final for appeal purposes. Citing previous cases, notably Coffey v. Foamex L.P. and Miles v. Kohli, the court established that voluntary dismissal of remaining claims allowed for finality and appealability. The plaintiffs argued, however, that their appeal could not proceed because the District Court had not issued a judgment in a separate document, as required by Rule 58 of the Federal Rules of Civil Procedure. According to Rule 58, a judgment must be set forth in a separate document to be effective, which establishes the timeline for appeals. The separate document requirement aims to eliminate uncertainty regarding the commencement date for post-verdict motions and appeals. The court emphasized that they have consistently adhered to this requirement, referencing Supreme Court precedent and noting that failure to comply results in remanding the case to the district court for proper judgment entry, clarifying that appeals should be taken only after such entry.

The United States Supreme Court's ruling in Bankers Trust Co. v. Mallis allows for relaxation of the separate document requirement under specific conditions, notably when the district court intended its order to be final and the parties recognized this intent. If a party files a notice of appeal within thirty days of a final adjudication, and the only issue is the absence of a separate judgment, the court can still hear the appeal without the need for a separate judgment entry. 

In the current case, it must be determined if a separate judgment is necessary after a notice of dismissal is filed to establish jurisdiction. The Ninth Circuit's decision in McCalden v. California Library Ass'n illustrates that a series of district court orders did not suffice as an entry of judgment due to the lack of a separate judgment document. Consequently, the appellate time frame did not commence, rendering the appeal timely. The Ninth Circuit holds that a stipulated dismissal does not trigger the appeal period without a formal judgment entry.

Conversely, the Eleventh Circuit maintains that a voluntary dismissal order serves as a final judgment for appeal purposes, as demonstrated in McGregor v. Board of Comm'rs of Palm Beach County. In McGregor, the plaintiff's appeal was deemed untimely because it was filed more than thirty days after the dismissal order. Unlike McGregor, the current case involved only a notice of dismissal without a formal motion or order to conclude the case.

The Supreme Court's guidance in Bankers Trust emphasizes the importance of the technical application of the separate-judgment requirement to ensure clarity on the time frame for appeals. While parties may waive this requirement if it was inadvertently overlooked, the intent is to prevent the loss of appeal rights rather than to impose unnecessary barriers. The court underscores that compliance with Rule 58 is crucial to avoid confusion regarding the finality of judgments. In this case, the parties did not waive the requirement; thus, failing to meet it could lead to the loss of an appeal, contrary to Bankers Trust's principles. The appellate court opts to apply Rule 58 mechanically to maintain the right to appeal and decides to address the merits of the case without requiring a remand for formal judgment entry.

Regarding the standard of review, the District Court's dismissal of the plaintiffs' claims is treated as a summary judgment due to the consideration of evidence beyond the pleadings. The appellate court conducts a de novo review, assessing whether genuine issues of material fact exist by viewing the evidence favorably for the nonmoving party. Summary judgment is deemed appropriate if there are no genuine disputes of material fact, and the moving party is legally entitled to judgment.

Section 10(b) of the Securities Exchange Act of 1934 prohibits the use of manipulative or deceptive practices in securities transactions, as enforced by Rule 10b-5 established by the Securities and Exchange Commission. Rule 10b-5 makes it unlawful to: (a) employ devices or schemes to defraud; (b) make untrue statements or omit material facts that render existing statements misleading; or (c) engage in practices that defraud in connection with securities transactions. To establish a claim for securities fraud under Section 10(b), a plaintiff must prove four elements: (1) misrepresentation or omission of a material fact; (2) scienter (intent to deceive); (3) justifiable reliance on the misrepresentation; and (4) proximate cause of the damages. In determining justifiable reliance, a recklessness standard is applied, considering factors such as the plaintiff's sophistication in securities matters, relationships with the defendant, access to information, existence of fiduciary duty, concealment of fraud, and opportunity to detect fraud. If a plaintiff claims securities fraud based on omissions, reliance may be presumed, but this presumption can be rebutted by the defendant. The plaintiffs allege that the defendants committed securities fraud by failing to disclose material facts and by making false statements. Additionally, case law indicates that attorneys can be held liable for securities fraud if they fail to disclose significant information in offering materials, as demonstrated in a prior case where an attorney did not reveal critical details about shares in escrow and the financial status of a company involved in a merger.

A reasonable jury could determine that Snyder was aware of misleading information in the amended offering circular and had a duty to inform investors under Section 10(b)/Rule 10b-5. Snyder's involvement in editing the marketing materials and drafting an opinion letter for SDE's board suggests his participation in the alleged fraudulent scheme. In contrast, Barnhart and his law firm are not liable under Section 10(b) for failing to disclose defaults with Star Bank, as Barnhart was not tasked with preparing an offering circular, and his opinion did not concern the loan terms. The Fourth Circuit's case, Schatz v. Rosenberg, illustrates that an attorney's silence does not violate securities laws without a duty to disclose, which arises only from a fiduciary relationship. Since no such relationship existed between the law firm and the plaintiffs in Schatz, the court ruled against liability. Similarly, in Roberts v. Peat, Marwick, Mitchell & Co., the Ninth Circuit found no duty to disclose omitted information about property interests because the law firm was only responsible for assessing marketability, the plaintiffs had equal access to relevant records, and the firm was not involved in initiating the transaction.

An attorney may be liable for securities fraud due to failure to disclose material information when a confidential or fiduciary relationship exists. In this case, no such relationship was found between the plaintiffs and attorney Barnhart. Thus, the claim of an attorney-client relationship is rejected. Barnhart's role was limited to drafting an opinion letter regarding MDI's corporate powers and the validity of a note, without any obligation to inform investors about the borrower's financial stability. The status of loans from Star Bank to MDI was irrelevant to Barnhart's duties, and plaintiffs had access to the information themselves, negating liability for Barnhart's inaction.

The District Court considered statements made by Barnhart, such as claims about Star Bank's funding intentions, but these were viewed as opinions rather than factual misrepresentations. However, under Section 10(b) of the Securities Exchange Act, opinions can be actionable if the speaker does not genuinely believe them or if they lack factual basis. If Barnhart was aware of contrary information, his statements could constitute misrepresentations regarding MDI's financial relationship with Star Bank.

Misrepresentations by Barnhart regarding MDI's financial status do not establish liability under Section 10(b) because the plaintiffs failed to show justifiable reliance on those misrepresentations. The Second Circuit case Royal American Managers, Inc. v. IRC Holding Corp. illustrates that reliance is unjustifiable when a party has its own legal representation and access to relevant information. In that case, RAM was informed by IRC's attorney that a 49% stock sale would not require prior approval from the New York State Insurance Department (NYSID), but the court found RAM's reliance on this statement unjustifiable due to RAM's business acumen, its own counsel's involvement, and access to necessary information.

Similarly, in the current case, Barnhart's vague statements, including his assertion that contacting Star Bank was unnecessary, do not amount to material misrepresentations, and the plaintiffs should have relied on their own counsel's advice regarding due diligence. Consequently, no genuine issue of material fact exists concerning the possibility of securities fraud under Section 10(b).

Furthermore, the plaintiffs' claim that the defendants were aiders and abettors of securities fraud is no longer valid following the Supreme Court's ruling in Central Bank v. First Interstate Bank, which clarified that aiding and abetting is not actionable under Section 10(b).

To establish a claim for actual fraud under Ohio law, five elements must be proven: (1) a material misrepresentation or concealment of fact, (2) knowledge of the falsity or recklessness regarding the truth, (3) intent to mislead, (4) reasonable reliance by the victim, and (5) resulting injury. In contrast, constructive fraud does not require proof of intent. The claims against Barnhart and his law firm for fraud fail due to the same issues present in the plaintiffs' Section 10(b) claims, specifically the lack of reasonable reliance on Barnhart's representations. As a result, the District Court appropriately dismissed these state law claims. A dissenting opinion argues that the court misjudged Barnhart's role and imposed an unreasonable standard on the plaintiffs while allowing issuers' lawyers a lower level of responsibility. The dissent emphasizes that Barnhart, as the attorney for the securities issuer, should be analyzed like any other participant in the securities transaction, asserting that he had a duty to disclose material omissions during direct communications with the plaintiffs, which could expose him to liability under securities law.

A law firm was found not liable for securities fraud due to a lack of duty to disclose specific information, determined by examining five factors: the relationship between the defendant and plaintiff, the comparative access to information, the benefits derived from the relationship, the defendant's awareness of the plaintiff's reliance, and the defendant's involvement in initiating the securities transaction. In this case, factors two, three, and four indicated a duty to disclose. Barnhart, the defendant, had a vested interest in ensuring his long-time client received financing, and it should have been clear to him that the plaintiffs relied on this information.

The court accepted the defendants' claim that the plaintiffs could have discovered the true status of a relationship with Star Bank with minimal effort; however, the evidence did not support this assertion. It was noted that relevant information about the loans was held by Star Bank, which typically would not disclose such details without customer consent. The analysis suggested that had Star Bank been authorized to share information, it could have prevented the litigation.

The court concluded that a non-attorney in Barnhart's position would have a duty to disclose. His omissions regarding the material aspects of the Star Bank relationship were deemed misleading. Under securities law, a plaintiff does not need to prove reliance on the undisclosed facts, as long as those facts are material to a reasonable investor's decision-making. The failure to disclose such material facts, if misleading, constitutes fraud, which could apply to Barnhart as well. The situation was further complicated by the plaintiffs’ encouragement from the Todds to contact Star Bank.

D is tasked with verifying the financial representations made by the Todds regarding MDI's financial condition and its capital needs. During discussions, Barnhart, MDI's counsel, provided information about the Star Bank relationship, which the court found irrelevant to his advisory role. The court acknowledges that attorneys can be liable for omitting material information pertinent to their engagement, yet it absolves Barnhart, despite claims that he acted as a promoter for MDI. The court's reasoning is criticized for allowing attorneys to evade liability for fraudulent omissions simply because they were not explicitly hired for those interactions. This creates a potential loophole for lawyers to enhance client transactions without fear of repercussions, undermining the integrity of their role. Barnhart allegedly misled investors by claiming no issues existed with Star Bank, despite MDI being in default and the proposed investment exacerbating that situation. While the court noted that his statements could constitute material misrepresentations, it dismissed Barnhart's liability by arguing that the plaintiffs lacked justification for relying on his claims. The court questions whether investors should have directly contacted Star Bank when assured by Barnhart of the bank's favorable disposition. Although the investors failed to conduct thorough due diligence, their reliance on Barnhart’s statements was not entirely unreasonable, given the investment amount was relatively modest.

The cost of comprehensive due diligence is often excessive relative to the financing size, necessitating some level of trust. If every small investor were required to verify all information behind representations, transaction costs would rise significantly, impacting the capital market. The court's ruling that Rubin could not justifiably rely on Barnhart's misrepresentations is contested. While the court identified eight factors to assess recklessness in reliance on misrepresentations, it ultimately misapplied the principle that a represented party cannot rely on the opposing party's attorney. This principle is limited to legal opinions, not factual representations. The dissent argues that extending this principle to factual misrepresentations could allow attorneys to mislead investors without consequence, which is not a privilege that should come with a law degree. The dissenting judge notes that the case was treated as a summary judgment despite being initially considered under a different procedural rule. Plaintiffs claim that MDI was in default on its credit agreement, but this assertion is only supported by their complaint.

A letter from Danny Todd to Rubin and Cohen, dated March 30, 1992, indicates that MDI's debt incurrence and stock sale to the recipients constitute a default under certain Loan Documents with the Bank. It also states that MDI is in default of additional provisions in these documents. The district court treated a motion as one for summary judgment based on affidavits submitted. The court declined to follow the First Circuit's approach in Fiore v. Washington County Community Mental Health Center regarding the waiver of the separate document requirement after three months from the last trial order, finding it unsupported by rules or Supreme Court statements. The court ultimately reversed the jury verdict and remanded for a new trial due to inconsistent jury findings, misapplication of jury instructions, and excessive damages.

Star Bank's default provisions were based on loan agreements with MDI, which the plaintiffs had not received despite requesting them. The plaintiffs relied on Barnhart for interpreting these provisions. The absence of material misrepresentation claims against Barnhart in the amended complaint, along with submitted affidavits acknowledging weaknesses in their reliance on omissions for liability under Section 10(b), suggests recognition of a legal vulnerability. 

No clear Ohio authority exists regarding a bank's duty to maintain confidentiality about loan customers to unauthorized third parties. The debtor-creditor relationship alone does not establish a fiduciary duty. Unauthorized disclosures could potentially lead to defamation claims against a bank. The court noted that it should not assume Star Bank would disclose customer defaults without permission, as banking confidentiality is generally expected by customers. 

In a 10b-5 action, if an issuer or its executives claimed an attorney acted beyond their authority, that defense might hold some merit; however, allegations in this case are directed at Barnhart and his firm, not the Todds or MDI. The Model Rules of Professional Conduct do not require an attorney to disclose material facts to prevent aiding a fraudulent act by a client if the attorney acts independently.