Appeal from an order entered in the United States District Court for the Southern District of New York (Kaplan, J.) imposing sanctions on three attorneys and their law firms pursuant to Fed. R. Civ. P. 11 and the mandatory sanctions provision of the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(c). We agree with the district court that the conduct here was unreasonable, and we reject the argument that In re Pennie & Edmonds LLP, 323 F.3d 86 (2d Cir. 2003) required the district court to find subjective bad faith before imposing sanctions. However, because the concerns identified in Pennie remain relevant to assessing the "reasonableness" of an opposing party's fees under 15 U.S.C. § 78u-4(c)(3), we vacate the amount of the award and remand for further proceedings.
The opinion of the court was delivered by: Dennis Jacobs, Chief Judge
Before: JACOBS, Chief Judge, CALABRESI and POOLER, Circuit Judges.
Three lawyers and their two firms appeal from an order imposing sanctions entered in the Southern District of New York (Kaplan, J.). The lawyers represented plaintiff ATSI Communications, Inc. ("ATSI") in a lawsuit alleging (inter alia) that Knight Capital Markets, LLC ("Knight"), the principal market-maker in ATSI stock on the American Stock Exchange ("AMEX") (along with a collection of hedge funds and individual defendants) participated in market manipulation in violation of federal securities laws. The district court dismissed the case as against all defendants, and we affirmed. 493 F.3d 87 (2d Cir. 2007). Thereafter, the district court imposed sanctions on certain lawyers and law firms representing ATSI (collectively the "ATSI attorneys") pursuant to the mandatory sanctions provision of the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(c), on the ground that ATSI had no factual basis for bringing suit against Knight.
Sanctions were the full amount of Knight's fees and costs in defending the action, $69,656.69.*fn1
The chief question presented on appeal is whether the rule established in In re Pennie & Edmonds LLP, 323 F.3d 86 (2d Cir. 2003)("Pennie") required the district court to make a finding of subjective bad faith before imposing sanctions. The ATSI attorneys argue that here, as in Pennie, such a finding is needed because the sanctions procedure (initiated by the district court after the litigation was over) afforded them no 21-day safe harbor in which to withdraw or amend the challenged pleading. We conclude that Pennie's subjective bad faith requirement does not exist in the context of the PSLRA because the statute itself puts litigants on notice that the court must (and therefore will) make Rule 11 findings at the conclusion of private litigations arising under the federal securities laws. Such notice alleviates the concern that animates Pennie: that Rule 11 sanctions should not be sprung on lawyers when they no longer have the chance to withdraw or amend a challenged claim. At the same time, however, that concern should inform consideration as to whether opposing attorney's fees are "reasonable" under 15 U.S.C. § 78u-4(c)(3).
More detailed factual background is provided in our previous opinion in this case, ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007)("ATSI I").
ATSI describes itself as a firm which was "founded in December of 1993 to capitalize on the opportunities anticipated by trends towards deregulation and privatization of telecommunications markets within Mexico and other Latin American countries." In 1999, needing capital,*fn2 ATSI issued four series of convertible preferred stock ("Preferred Stock"), shares of which were convertible, with minimal restrictions, to ATSI common shares in increasing amounts as the price of ATSI common shares declined. Because there was no limit on the number of common shares into which the Preferred Stock could convert, securities such as these are called "floorless" convertibles. ATSI I, 493 F.3d at 94. A holder of such Preferred Stock who wanted to increase ownership or acquire the company could actually benefit from a decline in ATSI share price. Accordingly, ATSI elicited the purchasers' representations that they would not sell shares short, or were not purchasing with an intent to resell. Id. at 95--96. ATSI issued Preferred Stock at various points to (among others) defendants The Shaar Fund, Ltd. ("Shaar Fund") and Rose Glen Capital Management, L.P. ("Rose Glen").
Between July 1999 and 2002, ATSI share prices gyrated between $1 and $9 per share, but closed on August 16, 2002 at $0.09. ATSI alleged that these price fluctuations were the result of manipulation by some purchasers of the Preferred Stock, including Shaar Fund and Rose Glen. On the basis of the trading volume and price movements around the time that the Shaar Fund and Rose Glen converted their shares of Preferred Stock, ATSI believed that these defendants and others engaged in a scheme to cause a "death spiral" in ATSI's share price. It is alleged that the scheme worked as follows:
The [defendant] would short sell the victim's common stock to drive down its price. He then converts his convertible securities into common stock and uses that common stock to cover his short position. The convertible securities allow a manipulator to increase his profits by allowing him to cover with discounted common shares not obtained on the open market, to rely on the convertible securities as a hedge against the risk of loss, and to dilute existing common shares, resulting in a further decline in stock price.
Id. at 96 (footnote omitted).
ATSI sued a host of defendants in October 2002, alleging misrepresentations in connection with securities transactions, and market manipulation in violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. However, ATSI's complaint alleged no specific acts of short selling, and instead relied on circumstantial allegations: past similar practice by Shaar Fund and Rose Glen, and clearinghouse records showing that in a 10-trading-day period (December 31, 2002 to January 14, 2003), over eight million shares were traded in excess of settlement, which (ATSI claimed) could only have resulted from "sham" trading. ATSI I, 493 F.3d at 97.
In a First Amended Complaint filed in March 2003, ATSI added a claim of market manipulation against Knight Capital Markets LLC, f/k/a Trimark Securities Inc., (hereinafter "Knight"), the principal AMEX market-maker for ATSI stock.*fn3 ATSI failed to serve Knight. Judge Kaplan dismissed the complaint without prejudice as against Shaar Fund and Rose Glen on the ground that its allegations of manipulation were "conclusory," "offer[ed] no particulars," and failed to meet the requirements of Rule 9(b). ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., No. 02 Civ. 8726(LAK), 2004 WL 616123, at *3 (S.D.N.Y. Mar. 30, 2004).*fn4
ATSI then filed a Second and Third Amended Complaint. The Third Amended Complaint's sole allegations ...