Livid Holdings Ltd. v. Salomon Smith Barney, Inc.

Citations: 416 F.3d 940; 2005 WL 1803885Docket: No. 03-35374

Court: Court of Appeals for the Ninth Circuit; April 6, 2005; Federal Appellate Court

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The opinion from April 6, 2005, has been amended to clarify specific allegations made by Livid Holdings, Ltd. regarding the purchase of PCI stock by the Defendants. Key changes include an assertion that Defendants knew UAE was not contractually bound to purchase its share of the stock and a distinction on whether Defendants bought preferred or common shares. It is noted that even if Defendants purchased common shares, the terms were conditional, similar to UAE's, indicating knowledge of an incomplete sale. The amendments also include a modification of language regarding misrepresentation by the Defendants, emphasizing that such misrepresentation directly related to Livid's economic loss, particularly due to PCI's eventual bankruptcy. The panel has voted to deny the petitions for rehearing and rehearing en banc, with no further petitions allowed. The opinion concludes that the district court erred in dismissing Livid's complaint against the corporate successors of Schroders, who are accused of violations under federal and state securities laws.

Livid's claims originate from its December 1999 acquisition of $10 million in Purely Cotton, Inc. (PCI) shares. In January 1999, Schroders facilitated a $25 million private stock placement for PCI and created a Confidential Offering Memorandum detailing PCI's operations and financial status. After the Memorandum was distributed, Livid asserts that UAE, a Gibraltar-based company, intended to buy over 98% of the offering, while individual Defendants, directors and/or officers of Schroders, agreed to purchase the remaining shares. Livid contends there was no binding contract requiring UAE to pay more than $2 million of the total purchase price and that Defendants knew UAE's purchase was contingent on future events.

In September 1999, PCI requested additional copies of the Memorandum, which prompted Defendant Van der Vord and his team to attach a notice indicating the Memorandum had not been updated since January 1999 and that the initial $25 million raise had been completed. Livid argues this statement misleadingly implied that PCI had received the proceeds of the initial sale, despite UAE and the Defendants having paid less than $2 million. Livid claims that further payments from UAE were contingent on approval of PCI's business plan and a new CEO, indicating UAE was not obligated to pay for the shares. 

The pleadings do not clarify whether the Defendants acquired preferred or common shares, but Livid maintains that the Defendants purchased under the same conditional terms as UAE and were aware of the incomplete sale when the notice was added to attract more investors. Livid alleges the Defendants had an incentive to mislead potential investors due to PCI's outstanding payments owed to Schroders for prior services. 

The district court dismissed Livid's claims with prejudice, concluding that Livid failed to adequately plead material misrepresentation and did not meet the heightened scienter pleading standards under the PSLRA. The court also dismissed the state securities claim, finding the alleged misrepresentation immaterial and ruling that the Defendants were not considered sellers of securities under the WSA.

The district court dismissed Livid’s state tort claims, finding its reliance on the notice's representations unreasonable, and denied Livid leave to amend its complaint, citing futility. The review of dismissals under Federal Rule 12(b)(6) is conducted de novo, focusing on the complaint and construing facts in favor of the nonmoving party. A dismissal is inappropriate unless it is evident that no facts could support the claim. Furthermore, a dismissal without leave to amend is also reviewed de novo and is improper unless the complaint is irreparable. 

Under federal securities law, specifically Section 10(b) of the 1934 Act and Rule 10b-5, it is unlawful to use deceptive devices in connection with securities transactions. A Rule 10b-5 claim requires proof of a misrepresentation or omission of a material fact, scienter, causation, reliance, and damages. The PSLRA mandates heightened pleading standards, requiring plaintiffs to allege facts that strongly infer the defendant's state of mind. A misrepresentation is deemed material if there is a substantial likelihood that a reasonable investor would have acted differently had the truth been disclosed. 

Livid sufficiently pled materiality by demonstrating that a reasonable investor would not have purchased $10 million of PCI stock if aware that the company had $25 million less in cash than represented. This misrepresentation significantly altered Livid’s perception of PCI’s financial health, as the true negative net worth would have influenced investment decisions.

The district court determined that the cautionary language in the notice attached to the Defendants' Memorandum rendered the statements therein legally immaterial, invoking the bespeaks caution doctrine. This doctrine allows courts to rule that forward-looking statements with sufficient cautionary language can protect defendants from securities fraud claims. While the doctrine has been applied to optimistic projections, the court emphasized that dismissal based on this doctrine requires a clear showing that reasonable minds could not disagree about the misleading nature of the statements. 

The court disagreed with the district court's interpretation of a specific statement regarding PCI's capital from a stock sale, suggesting that it implied the cash had already been received rather than warning that it might not have been. Furthermore, the district court erroneously extended the doctrine to statements of fact, a position not supported by this circuit and rejected by others. The circuit has only applied the doctrine to forward-looking statements, and the court now explicitly adopts the rationale of other circuits that limit the doctrine's application to avoid allowing management to disguise misrepresentations under general cautionary language. Consequently, the court found that the district court erred in deeming the contested statement immaterial.

Regarding scienter, the court highlighted the Private Securities Litigation Reform Act (PSLRA) requires plaintiffs to plead detailed facts indicating strong circumstantial evidence of deliberate recklessness. To establish this strong inference, the totality of the allegations must suggest that the defendants acted with conscious recklessness, rather than merely indicating opportunity or motive to commit fraud.

Livid alleges that the Defendants, who purchased PCI stock, were aware that the initial stock sale was incomplete but provided misleading information that implied the sale had been finalized. The notice statement they attached either omitted key details or intentionally misled potential investors regarding the status of the sale. The district court found that the Defendants did not demonstrate the necessary intent to mislead, reasoning they would have been more explicit if they had intended to deceive. However, the statement’s assertion that the initial stock offering "has been completed" contradicts any claim of a warning about the Memorandum's outdated status. Livid argues that the Defendants knew their statement was misleading, satisfying the heightened pleading standard for scienter due to a strong inference of deliberate recklessness. While motive alone does not meet the scienter standard, it can be considered alongside other allegations. The court concludes that the totality of the allegations supports a strong inference of the Defendants' scienter, reversing the district court's finding.

Regarding causation, the requirements under Rule 10b-5 necessitate both transaction causation (the violations led to the plaintiff's transaction) and loss causation (the misrepresentation or omission caused harm). Livid adequately pled that it would not have purchased the stock without the misleading statement and that this misrepresentation directly resulted in its financial loss, as PCI's concealed dire financial condition led to its bankruptcy and Livid's total investment loss. Thus, Livid's allegations are sufficient to withstand a motion to dismiss under Rule 12(b)(6).

The district court determined that Livid could not demonstrate reliance on Defendants' statements due to sufficient cautionary language in the notice, rendering any reliance unreasonable. However, the court's application of the bespeaks caution doctrine was rejected for historical misrepresentations, leading to a reversal of the district court's finding on reliance. The court criticized the district's factual assessment regarding investors' due diligence as inappropriate for a Rule 12(b)(6) dismissal, noting that Livid appeared to have conducted adequate due diligence, which uncovered false claims about the completion of a stock sale. If Livid justifiably relied on Defendants’ misrepresentation, resulting in damages from purchasing PCI stock, this suffices to withstand the motion to dismiss.

On the statute of limitations, Defendants contended that Livid’s federal securities claim was time-barred. The court emphasized it can affirm a dismissal on any supported ground, regardless of whether the district court utilized that ground. However, since the record did not confirm that the statute had run, the court declined to affirm on this basis. It explained that Rule 10b-5 does not have its own statute of limitations; instead, it follows the limitations outlined in the 1934 Act, which requires actions to be filed within one year after discovering the violation or three years after the violation. The Sarbanes-Oxley Act of 2002 extended this to two years after discovery or five years after the violation. Livid filed its complaint shortly after the SOA's effective date but did not automatically qualify for the longer statute. The Defendants argued that the pre-SOA limitations period had expired by the time Livid filed its complaint, and if true, it would require a finding that the SOA revived expired claims. The court refrained from deciding this matter, indicating that it could not conclude the pre-SOA statute had run when Livid filed.

Livid's claim is time-barred under the pre-SOA standard if it discovered the facts constituting the alleged violation one year prior to filing its complaint. The Defendants assert that the statute of limitations began over two years before the complaint was filed, citing a bankruptcy petition filed against PCI on March 19, 2000, which they argue put Livid on inquiry notice of potential fraud. The court has not definitively ruled on whether actual or inquiry notice triggers the statute of limitations under Rule 10b-5 but has indicated an inclination towards an inquiry notice standard with a reasonable diligence requirement. Livid contends it did not have actual notice until late September 2001, when it received an auditor's report. If actual notice is necessary, Livid's complaint may not be time-barred. However, it is unclear if Livid filed timely if inquiry notice applies, as the court maintains that mere financial difficulties do not inherently indicate fraud, suggesting the bankruptcy filing alone likely does not meet the inquiry-plus-due diligence standard. The determination of what a reasonable investor should have known is typically a jury question. Livid claims to have learned of the bankruptcy on May 25, 2001, prompting further investigation that allegedly confirmed a stock sale to PCI. The court concludes it cannot decide as a matter of law if Livid should have been aware of the fraud one year before filing.

Regarding the state securities law claim, the district court dismissed it on the grounds that the alleged misrepresentation was deemed immaterial, a finding now reversed due to the reversal of the similar finding on the federal claim. Additionally, the court found Livid's state securities claim should be dismissed because the Defendants were not direct sellers of securities. However, Washington law allows claims if Defendants were a substantial contributive factor in the sales transaction, contrary to the district court's interpretation. The court referenced precedent indicating that mere involvement in preparation or lack of personal contact with investors does not exempt parties from liability under the Washington Securities Act.

The Washington Supreme Court determined that the law firm only provided standard professional advice regarding the materiality of facts related to a sale, leading to the conclusion that other parties were primarily responsible for facilitating the sale. In contrast, Livid's allegations indicate that the Defendants included a misleading statement in the investment Memorandum that influenced its decision to purchase PCI stock. Consequently, a factual issue exists as to whether Defendants played a significant role in the sale, potentially qualifying them as sellers under the Washington Securities Act (WSA). The district court's ruling that Defendants were not a substantial factor in the transaction was deemed erroneous.

Regarding state tort claims for fraudulent and negligent misrepresentation, the district court dismissed Livid's claims on the basis of unreasonable reliance on the notice's statements. However, since the court's previous error regarding Livid's reasonable reliance on statements for its federal securities claim also applies to the state tort claims, the dismissal was reversed.

Livid's complaint successfully states claims for federal securities fraud, state securities fraud, and state tort violations, even under the heightened pleading standards of the Private Securities Litigation Reform Act (PSLRA). The case is remanded for further proceedings. The Supreme Court's ruling in Dura Pharmaceuticals, which restricts loss causation claims in fraud-on-the-market scenarios involving publicly traded stocks, does not apply here because Livid's claims pertain to a private stock sale and assert a direct causal link between the Defendants' misrepresentation and its financial loss. The district court's refusal to allow Livid to amend its complaint to include WSA violations was based on a finding of futility, although the proposed amendments were considered in the dismissal order.