The opinion of the court was delivered by: PECK
ANDREW J. PECK, United States Magistrate Judge:
To the Honorable Whitman Knapp, United States District Judge:
The motion before the Court raises a question of first impression: Can a director of a public corporation who believes that the company is engaged in ongoing securities fraud "blow the whistle" by disclosing to the SEC information protected by the company's attorney-client privilege, where the company's Board has not waived the privilege? As a matter of public policy, the Court holds that the answer is yes, although the company could sue the whistle-blowing director for breach of fiduciary duty if such disclosure were not in the company's best interest.
This action, by the Administrative Trustee of the bankrupt Towers Financial Corporation against Towers' former law firm, Squadron Ellenoff Plesent & Sheinfeld LLP, is but one of many suits arising from Towers' Ponzi scheme.
Accordingly, we agree with Judge Peck's finding that the Wagoner rule only applies where all relevant shareholders and/or decisionmakers are involved in the fraud, and therefore, adopt the Report with respect to this section. Absent such a finding, the fraud cannot be imputed to the corporation, thereby granting the trustee of that corporation standing to litigate a malpractice claim against third parties.
However, we disagree with Judge Peck's conclusion that the Complaint actually alleges the existence of an innocent member of Towers' management who would have been able to prevent the fraud had he known about it. As discussed above, absent such an allegation in the Complaint the trustee would not have standing to assert the instant claims under the Wagoner rule. Accordingly, defendant's motion to dismiss is granted.
We refer the matter back to Judge Peck to oversee any discovery he deems necessary and appropriate to determine whether plaintiff could amend the Complaint to allege the existence of some person(s) involved in Towers' management who was ignorant of the ongoing fraud and could and would if advised of facts known to defendant have taken steps to bring the fraudulent conduct to an end. To be valid a complaint would have to identify such person(s), and explain how he could and would have brought the fraud to an end. If Judge Peck concludes that plaintiff could make such allegations in light of the pleading requirements of Rule 11, plaintiff may file an amended complaint.
Wechsler v. Squadron, Ellenoff, Plesent & Sheinfeld, LLP, 212 B.R. 34, 1997 WL 525255 at *2 (S.D.N.Y. 1997) (Knapp, D.J. & Peck, M.J.) (emphasis added & fn. omitted). Familiarity with Judge Knapp's and my prior Opinions and Reports and Recommendations are assumed.
The Trustee has filed a motion for leave to amend, including a copy of the proposed Second Amended Complaint, accompanied by the affidavit of the alleged "innocent director," Thomas B. Evans, Jr. After the Court held oral argument on the motion on October 17, 1997, the Trustee filed a supplemental affidavit from Mr. Evans and an affidavit from a second alleged "innocent director," Ben F. Barnes.
The Governing Legal Standard on This Motion
The parties hotly dispute the appropriate legal standard to apply to this motion.
Judge Knapp dismissed the Trustee's complaint without prejudice to repleading if the Trustee was able. Wechsler v. Squadron, Ellenoff, 212 B.R. 34, 1997 WL 525255 at *2. The Trustee has sought leave to amend, which Squadron Ellenoff opposes on the ground that amendment would be futile. (See generally Squadron Br.) The appropriate standard, therefore, is whether the proposed Second Amended Complaint fails to state a claim, the traditional Fed. R. Civ. P. 12(b) standard. See, e.g., S.S. Silberblatt, Inc. v. East Harlem Pilot Block-Bldg. 1 Housing Dev. Fund Co., 608 F.2d 28, 42 (2d Cir. 1979) ("A trial court does not abuse its discretion in denying leave to amend a complaint which even as amended would fail to state a cause of action."); Skylon Corp. v. Guilford Mills, Inc., 1997 U.S. Dist. LEXIS 2104, 93 Civ. 5581, 1997 WL 88894 at *1 (S.D.N.Y. March 3, 1997) (motion to dismiss standard is "a standard substantially the same as the standard for futility under a motion to amend"); Barrett v. United States Banknote Corp., 806 F. Supp. 1094, 1098 (S.D.N.Y. 1992) ("Leave to amend will not be granted under Rule 15(a), however, where there are no colorable grounds for the proposed claim -- that is, where amendment would prove futile. . . . The 'colorable grounds' requirement mandates 'an inquiry -- comparable to that required by Fed. R. Civ. P. 12(b)(6) . . . -- as to whether the proposed amendments state a cognizable claim. . . .' In sum, amendment is futile if a proposed claim could not withstand a motion to dismiss made pursuant to Fed. R. Civ. P. 12(b)(6)."); Journal Publishing Co. v. American Home Assurance Co., 771 F. Supp. 632, 634 (S.D.N.Y. 1991) ("'"A district court is justified in denying an amendment if the proposed amendment could not withstand a motion to dismiss."' . . . The Proposed Amended Complaint may therefore be scrutinized as if defendants' objections to the amendments constituted a motion to dismiss under Fed. R. Civ. P. 12(b)(6)."); Hannah v. Metro-North Commuter R.R., 753 F. Supp. 1169, 1176 (S.D.N.Y. 1990) (same).
Squadron Ellenoff, however, contends that because the issue here is the Trustee's standing, the standard is different:
MR. KAUFMANN [Squadron Ellenoff's counsel]: This is a standing motion to dismiss. The standard there is not like a motion to dismiss for failure to state a claim where the burden is on the defendant and all allegations are deemed to be true. Here, the Second Circuit says and the Supreme Court says, the burden is on the party seeking to establish standing, and in this instance doubts are resolved in favor of us, not the trustee. So the standard to which the court referred is not the usual motion to dismiss for failure to state a claim, it's a very different standard.
(10/17/97 Oral Arg. Tr. at 21.) Squadron Ellenoff further contends that the "Trustee now bears the 'burden of persuasion' to establish the facts necessary to obtain standing." (Squadron Br. at 4.)
Squadron Ellenoff is correct that the burden of proof of standing is on the Trustee, but incorrect in claiming that the Trustee has not adequately satisfied its burden at the pleading stage.
The Supreme Court summarized the burden on the plaintiff of establishing standing at the various stages of a case:
The party invoking federal jurisdiction bears the burden of establishing these elements. Since they are not mere pleading requirements but rather an indispensable part of the plaintiff's case, each element must be supported in the same way as any other matter on which the plaintiff bears the burden of proof, i.e., with the manner and degree of evidence required at the successive stages of the litigation. At the pleading stage, general factual allegations of injury resulting from the defendant's conduct may suffice, for on a motion to dismiss we "presume that general allegations embrace those specific facts that are necessary to support the claim." In response to a summary judgment motion, however, the plaintiff can no longer rest on such "mere allegations," but must "set forth" by affidavit or other evidence "specific facts," which for purposes of the summary judgment motion will be taken to be true. And at the final stage, those facts (if controverted) must be "supported adequately by the evidence adduced at trial."
Lujan v. Defenders of Wildlife, 504 U.S. 555, 561, 112 S. Ct. 2130, 2136-37, 119 L. Ed. 2d 351 (1992) (citations omitted); see also, e.g., National Org. for Women, Inc. v. Scheidler, 510 U.S. 249, 256, 114 S. Ct. 798, 803, 127 L. Ed. 2d 99 (1994) (applying Lujan principle and holding that "nothing more [than plaintiff's allegations in complaint] is needed to confer standing . . . at the pleading stage"); FW/PBS, Inc. v. City of Dallas, 493 U.S. 215, 231, 110 S. Ct. 596, 608, 107 L. Ed. 2d 603 (1990) ("it is the burden of the 'party who seeks the exercise of jurisdiction in his favor,' . . . 'clearly to allege facts demonstrating that he is a proper party to invoke judicial resolution of the dispute.'" Plaintiffs' affidavits were not sufficient to show standing to challenge certain aspects of statute); Gladstone Realtors v. Village of Bellwood, 441 U.S. 91, 109, 115, 99 S. Ct. 1601, 1613, 1615-16, 60 L. Ed. 2d 66 (1979) (as to standing, Court will "'accept as true all material allegations of the complaint, and . . . construe the complaint in favor of the complaining party,' . . . as standing was challenged largely on the basis of the pleadings." Court "conclude[s] that the facts alleged in the complaints and revealed by initial discovery are sufficient to provide standing under Art. III. It remains open to petitioners, of course, to contest these facts at trial."); McNutt v. General Motors Acceptance Corp. of Indiana, Inc., 298 U.S. 178, 189, 56 S. Ct. 780, 785, 80 L. Ed. 1135 (1936) (party asserting federal court jurisdiction "must allege in his pleading the facts essential to show jurisdiction. If he fails to make the necessary allegations he has no standing." Plaintiff "must carry throughout the litigation the burden of showing that he is properly in court," and if the opposing party or the Court challenges plaintiff's standing, plaintiff must support his allegations "by competent proof."); Fund for Animals v. Babbitt, 89 F.3d 128, 134 (2d Cir. 1996) (2d Cir. 1996) (applying Lujan principle at summary judgment stage); Schulz v. Williams, 44 F.3d 48, 52 n.4 (2d Cir. 1994) (applying Lujan principle after trial); Golden Hill Paugussett Tribe of Indians v. Weicker, 39 F.3d 51, 58 (2d Cir. 1994) (applying Lujan at pleading stage and finding allegations in complaint sufficient to satisfy standing requirement); Long Island Soundkeeper Fund, Inc. v. New York Athletic Club, 1996 U.S. Dist. LEXIS 3383, 94 Civ. 0436, 1996 WL 131863 at *4 (S.D.N.Y. March 22, 1996) ("The Supreme Court has pointed out that 'each element must be supported in the same way as any other matter on which the plaintiff bears the burden of proof, i.e. with the manner and degree of evidence required at the successive stages of the litigation.' Lujan, 112 S. Ct. at 2136. Defendant has made a motion for summary judgment on the issue of Plaintiffs' standing to sue. Accordingly, it is necessary to determine whether Plaintiffs have provided facts sufficient to carry their burden of proof of standing at this point in the litigation."); New Alliance Party v. FBI, 858 F. Supp. 425, 429-30 (S.D.N.Y. 1994) ("Moreover, at the pleading stage, it is presumed that any general allegations raised in the complaint will 'embrace those specific facts that are necessary to support the claim.' . . . While plaintiffs admit that standing analysis is based upon the allegations in a complaint, they have failed to raise the factual allegations necessary to find a justiciable controversy in this case."); Ortho Pharmaceutical Corp. v. Cosprophar, Inc., 828 F. Supp. 1114, 1124 (S.D.N.Y. 1993) ("the burden of establishing the elements of standing falls upon the plaintiff, and . . . the burden of proof increases 'with the manner and degree of evidence required at the successive stages of the litigation'"), aff'd, 32 F.3d 690 (2d Cir. 1994);> State of New York v. Reilly, 143 F.R.D. 487, 491 (N.D.N.Y. 1992) ("The plaintiff bears the burden of establishing these [standing] elements. . . . Furthermore, because all of these elements are an indispensable part of the plaintiff's case, they must be supported with the manner and degree of evidence required at each successive stage of the litigation.... At the pleading stage, general factual allegations of [standing] may suffice. . . . This is so because on a motion to dismiss, the court 'presumes that general allegations embrace those specific facts that are necessary to support the claim.'"); Media Ranch, Inc. v. Manhattan Cable Television, Inc., 757 F. Supp. 310, 317 (S.D.N.Y. 1991) ("In deciding questions of standing, courts are required to accept a plaintiff's allegations as true and to construe those allegations in a manner favorable to the plaintiff. . . . It must be borne in mind that no discovery has yet occurred in this case. Consequently, at this stage of the proceedings, this Court accepts [plaintiff's] contention" as to standing).
Here, the Trustee not only has appropriately alleged in the proposed Second Amended Complaint the specific facts required by Judge Knapp's prior opinion as to standing -- that is, that Evans and Barnes were "innocent" directors who could and would have stopped the Towers' fraud by, inter alia, going to the SEC -- but also has supported these allegations with affidavits from Evans and Barnes. That ...