Appeal from an order of the District Court for the Southern District of New York, Morris E. Lasker, Judge, dismissing an amended complaint in a purported class action by a stockholder, alleging violations §§ 10b, 18 and 20 of the Securities Exchange Act and the Securities and Exchange Commission's Rule 10b-5, on the grounds that the complaint failed to meet the requirements of F.R.Civ.P. 9(b) and to state a claim on which relief could be granted under F.R.Civ.P. 12(b)(6).
Friendly, Mulligan and Meskill, Circuit Judges.
This is an appeal from an order of Judge Lasker in the District Court for the Southern District of New York dismissing an amended complaint in a stockholder's purported class action alleging violations of §§ 10(b), 18 and 20 of the Securities Exchange Act and the Securities and Exchange Commission's Rule 10b-5 for failure to allege fraud with the "particularity" required by F.R.Civ.P. 9(b) and to state a claim on which relief could be granted under F.R.Civ.P. 12(b)(6).
Plaintiff Frank Denny, who purchased 15 shares of defendant The Chase Manhattan Corporation (the Corporation) on December 12, 1974 at 27 1/4 per share, close to the low for the year, sought to represent a class of all persons who had purchased stock or other securities of the Corporation since January 1, 1973, upon the basis of false and fraudulent statements of the Corporation and either sold such securities at a loss or still retain them.*fn1 The defendants are the Corporation, its directors and principal officers, and Peat, Marwick, Mitchell & Co. (PMM), its certified public accountants. Judge Lasker dismissed the initial complaint, filed on February 3, 1976, which did not even identify the statements alleged to be false and misleading, for noncompliance with F.R.Civ.P. 9(b), but granted leave to "replead within twenty days, upon an adequate description of the facts contributing to his [Denny's] various beliefs and upon a particular statement of the alleged fraud," 73 F.R.D. 6 (S.D.N.Y. 1977). The judge recognized that F.R.Civ.P. 9(b) must be reconciled with F.R.Civ.P. 8(a)(2) which requires only "a short and plain statement of the claim showing that the pleader is entitled to relief" but insisted that plaintiff "identify the offending publications" and "disclose those facts that have led him to believe that defendants' publications are false"; also "the facts recited must be such as to permit an inference of fraud." 73 F.R.D. at 9.
The amended complaint sought to meet the identification requirement by alleging on information and belief that "commencing on or about July 1, 1973, and continuing to date," defendants engaged in a scheme to misrepresent the Corporation's financial condition, and "as part of said scheme . . . issued to the public false and fraudulent interrelated annual and interim financial statements, proxy solicitations and prospectuses ("Statements") during the period including the annual reports for 1973, 1974 and 1975." The falsity and fraud concerned loans by The Chase Manhattan Bank (the Bank), a wholly owned subsidiary of the Corporation, to Chase Manhattan Mortgage and Realty Trust (CMART), and other real estate investment trusts (REIT), private builders and developers; the Bank's extensive foreign activities and loans, including loans to governments, governmental agencies and enterprises located in the "third world countries" and behind the "iron curtain"; the amounts reserved for loan losses; alleged delays in writing off unspecified loans known to be uncollectible; investments "in the debt obligations and other securities of States and other political subdivisions of the United States, including the City and State of New York, and various subdivisions thereof" which allegedly had become "increasingly risky and speculative," without providing adequate reserves or properly disclosing the risks; possible liability to third parties for the sale of New York City securities; alleged nonpayment of advisory fees accrued from CMART; and inadequate management policies which led to the undisclosed overvaluation, in the amount of $32.8 million, of securities held by the Corporation.*fn2 The amended complaint contained general allegations of knowledge or recklessness on the part of the Corporation and the individual defendants designed to comply with Ernst & Ernst v. Hochfelder, 425 U.S. 185, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976). So far as concerned PMM, the amended complaint alleged that PMM knew or should have known that it was relying upon the judgment of management, had failed to take appropriate steps to substantiate that judgment, and "knew, was reckless in failing to know or ascertain, or should have known all of the facts set forth herein."
The Corporation and the individual defendants countered with a motion supported by an affidavit of the Corporation's Controller, Michael P. Esposito, Jr., to which were annexed its annual reports for 1971-1975 and its Form 10-K for 1973, seeking dismissal of the complaint under F.R.Civ.P. 9(b) and 12(b)(6) or, alternatively, summary judgment under F.R.Civ.P. 56(b). PMM also moved for dismissal of the entire complaint or, in the alternative, for summary judgment with respect to five claims and dismissal of the remainder. Plaintiff's counter-statement pursuant to General Rule 9(g) of the district court, in addition to mentioning a prospectus of the Corporation dated August 2, 1974 and a proxy statement of September 9, 1974, contained the following:
Plaintiff has no information respecting advances of monies, loans, renegotiations thereof, purchases of loans, property swaps and whether advisory fees were, in fact, paid. He requires discovery under Rule 56(f) since all of the information and evidence are in the exclusive possession and control of defendants.
Judge Lasker handled the matter - most usefully in our view - by conducting a hearing in which, after announcing his tentative view that the amended complaint was still deficient, he afforded plaintiff's counsel an opportunity to take up the amended complaint in detail and convince him otherwise. He concluded, in a memorandum, that many allegations remained "vague and conclusory"; that where specificity had been provided, the complaint "merely recited neutral facts which are irrelevant to the claims that they embellish, and which do not permit an inference of wrong-doing"; and that the events upon which Denny based his claim of fraud occurred after his purchase whereas the pre-purchase events constituted merely claims of mismanagement. Accordingly he dismissed the complaint as failing to meet the requirements of F.R.Civ.P. 9(b) and to state a claim under F.R.Civ.P. 12(b)(6).
Plaintiff took a timely appeal to this court. Thereafter he moved for leave to file a second amended complaint. Judge Lasker correctly denied this on the ground that, in view of the filing of the appeal, he was without jurisdiction to allow the amendment. See Segal v. Gordon, 467 F.2d 602, 608 n.12 (2 Cir. 1972); Grand Opera Co. v. Twentieth Century-Fox Film Co., 235 F.2d 303 (7 Cir. 1956); Droppleman v. Horsley, 372 F.2d 249 (10 Cir. 1967); Thompson v. Harry C. Erb, Inc., 240 F.2d 452, 454 (3 Cir. 1957); Merritt-Chapman & Scott Corp. v. City of Seattle, 281 F.2d 896 (9 Cir. 1960); 3 Moore, Federal Practice para. 15.07, at 856-57; 6 Wright & Miller, Federal Practice and Procedure § 1489, at 445.
Although Denny brought this suit as a class action on behalf of all persons who had purchased securities of the Corporation since January 1, 1973, and had sold such securities at a loss or still retained them, the district court held and Denny does not seriously dispute that the complaint must be dismissed if it did not adequately allege the issuance of fraudulent misleading statements prior to his purchase on December 12, 1974. Apart from the fact that the action was never certified as a class action under F.R.Civ.P. 23(c)(1), if Denny himself cannot share in any recovery because no fraudulent statements were issued before his purchase,*fn3 see Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737-38, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975); Greenstein v. Paul, 275 F. Supp. 604 (S.D.N.Y. 1967), aff'd, 400 F.2d 580, 581 (2 Cir. 1968); Halperin v. Edwards, 430 F. Supp. 121, 124-25 (E.D.N.Y. 1977), he would not be a proper representative of persons who bought securities after fraudulent statements were issued - if indeed this occurred. Greenstein v. Paul, supra; Basch v. Talley Industries, Inc., 53 F.R.D. 14, 19 (S.D.N.Y. 1971) (Gurfein, J.). See generally Dolgow v. Anderson, 43 F.R.D. 472, 492 (E.D.N.Y. 1968), rev'd on other grounds, 438 F.2d 825 (2 Cir. 1971); 3B Moore, Federal Practice para. 23.04, at 23-254. As Judge Hufstedler said in a slightly different context, 492 F.2d 136, 147 (9 Cir. 1973) (dissenting opinion) a statement which the Supreme Court approved in Blue Chip Stamps v. Manor Drug Stores, supra, 421 U.S. at 739 (1975), damage actions under Rule 10b-5 can be "brought only by those persons whose active participation in the marketing transaction promises enforcement of the statute without undue risk of abuse of the litigation process and without distorting the securities market."
With the inquiry thus limited we think the amended complaint was properly dismissed. Of the reports mentioned so generally by plaintiff, the only ones that antedated his purchase were the Corporation's Annual Report for 1973, the contents of which we have been able to examine because it is an exhibit to the affidavit in support of defendants' motions to dismiss and/or for summary judgment, see F.R.App.P. 10; 9 Moore, Federal Practice para. 210.04, and "interim financial statements, proxy solicitations and prospectuses" for 1973 and the first three quarters of 1974, the misstatements in which are nowhere described.
The amended complaint does not state what items in the 1973 Annual Report were knowingly false. The brief for the Corporation and the individual defendants lists 16 instances in which the complaint refers to events occurring in whole or in part after December, 1974, the date of plaintiff's purchase, almost all of which were revealed in the Corporation's annual reports for later years. Such allegations as arguably relate at least in part to events prior to December, 1974 do not allege fraud with sufficient particularity. Thus it is said that the Bank's foreign operations and loans, which are indeed depicted with enthusiasm in the 1973 Report, were "speculative and risky." Yet there is no specification of what loans, at what times, and in what amounts were "risky." In the absence of such particulars, and given the myriad of foreign loans made by the Bank during the early 1970's, the simple use of the epithet "risky" is no better than a "mere conclusory allegation to the effect that defendant's conduct was fraudulent," which we have held to be insufficient. Segal v. Gordon, 467 F.2d 602, 607 (2 Cir. 1972), quoting Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 444 (2 Cir. 1971). Under the circumstances, such a pleading does not "give the defendant fair notice of what the plaintiff's claim is and the grounds upon which it rests," Shemtob, supra, 448 F.2d at 444. Moreover, even if we were to find this allegation sufficiently particular, there is considerable doubt whether it alleges a violation of 10b-5. Not every "risky" investment rises to the level of fraud because the risk is insufficiently disclosed.
The amended complaint is replete with other allegations suffering the same deficiencies. For example, plaintiff alleges that of the loans made to REITs other than CMART, more than half were "speculative and risky" construction and development loans. Plaintiff also alleges that the Bank invested in securities of states and cities, and that the continuation of such investments had become "risky and speculative." Again, no specification of transactions is provided, and there is not even an indication of the date at which defendants knew the investments had become so ...