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KATZ v. HOUSEHOLD INTL.

August 24, 1995

MOISE KATZ, Plaintiff,
v.
HOUSEHOLD INTERNATIONAL, INC., DONALD C. CLARK, and EDWIN P. HOFFMAN, Defendants.



The opinion of the court was delivered by: BRIAN BARNETT DUFF

 This case comes before the Court on the Defendant's motion for a clarification of the Court's award of attorneys' fees in light of the instructions of the Court of Appeals on remand. The Defendant contends that the Plaintiff's complaint in its entirety was a sanctionable filing and points out that we have already taken evidence on the amount of fees it reasonably incurred in responding to it. Therefore, the Defendant argues we should award the amount we previously ascertained. We agree. For the reasons explained below, we grant the Defendant's motion.

 BACKGROUND

 At the end of October, 1991, the Defendant company ("Household") released a statement that earnings would be lower than expected. Soon after the press release, its stock price went down. The Plaintiff ("Katz") claims to have been a holder of shares of stock in the Defendant company. About two weeks after the price drop, Katz filed a complaint on November 13, 1991, alleging securities fraud under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). This Court granted Household's motion to dismiss Katz' complaint for reasons discussed in open court on December 19, 1991. We granted leave to refile. The Plaintiff then filed an amended complaint on January 2, 1992. On January 16, 1992, because Katz still failed to state a claim on which relief could be granted, we dismissed Katz' amended complaint. *fn1" Katz did not appeal either dismissal, and they became final and unappealable.

 After Katz' time for appeal had lapsed, Household filed a motion for sanctions and an award of fees under Rule 11 of the Federal Rules of Civil Procedure ("Federal Rules" or "Fed. R. Civ. P."). On March 15, 1993, in a written order ("Order"), this Court granted Household's motion for sanctions and an award of fees under Rule 11 of the Federal Rules because the Court found that Katz filed his securities fraud complaint and amended complaint without first engaging in a reasonable pre-filing inquiry to locate "facts from which a plausible inference of fraudulent intent could be drawn." (Order at 2). The Order stated, "Plaintiff's original and amended complaints were therefore not reasonably grounded in either fact or law." (Order at 3). After reviewing the affidavit of Household's counsel concerning costs and expenses incurred by them, and after considering arguments by both sides about the amounts in question, on April 26, 1993, we awarded fees and expenses in the amount of $ 54,111.99.

 On September 28, 1994, the Seventh Circuit Court of Appeals vacated and remanded this Court's award of fees. See Katz v. Household International, Inc., 36 F.3d 670 (7th Cir. 1994). The Court of Appeals drew a distinction which we overlooked within Katz' complaint between a "primary theory" concerning misrepresentations about firm performance in a recessionary economy and an "alternative theory" concerning fraudulent future projections. The Court of Appeals held that this Court abused its discretion in granting the award on the ground that we failed to take note of Katz' alternative theory of securities fraud. In consequence, they held that review of the award "has proven impossible." Id. at 675-76.

 The opinion of the Court of Appeals states, "we might be inclined to conclude that the district court did not abuse its discretion in imposing a sanction, notwithstanding the brevity and imprecision of its order," because "even the most superficial review of our case law would have made clear" that Katz' primary theory of securities fraud must fail. Katz, 36 F.3d at 674-75. A reasonable pre-filing inquiry would have prevented Katz from inadequately pleading his primary theory of Household's alleged misrepresentations about firm performance in a recessionary economy. The Court of Appeals came to the same conclusion as this Court's Order by determining that neither the complaint nor the amended complaint alleged the circumstances of any purported misrepresentation with the particularity required under Rule 9(b) of the Federal Rules. Id. at 675 (citing Graue Mill Development Corp. v. Colonial Bank & Trust Co., 927 F.2d 988, 992-93 (7th Cir. 1991); Sears v. Likens, 912 F.2d 889, 893 (7th Cir. 1990)). The Court of Appeals observed that Katz "failed to identify a single instance in which Household actually made [the statement that its financial condition would improve even if the economy did not]." Katz, 36 F.3d at 675.

 The Court of Appeals nonetheless vacated this Court's award of fees after identifying an "alternative theory" we overlooked. *fn2" Id. The alternative theory involved "statements [that] were fraudulent because they were inconsistent with financial information in the defendants' possession." Id. at 693. The Court of Appeals construed the alternative theory to contain an allegation that Household's projections of future performance at its September 4, 1991, meeting with securities analysts did not lie within the safe harbor protection afforded by Securities and Exchange Commission ("SEC") Rule 175. See 17 C.F.R. § 230.175; Arazie v. Mullane, 2 F.3d 1456, 1465-66 (7th Cir. 1993); Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 513-14 (7th Cir. 1989). "Projections may be actionable if they are made with the knowledge that they are incorrect or are otherwise without reasonable basis." Katz, 36 F.3d at 675; see generally, Thomas L. Hazen, The Law of Securities Regulation § 3.7 (2nd ed. 1990 & Supp. 19-94). The Court of Appeals indicated that the part of the complaint containing the alternative theory might not have been sanctionable under Rule 11.

 We now understand that we gave inadequate attention to the collection of words in the complaint which established an alternative theory of securities fraud liability. We note that our expressed concern was to be faithful to the teachings of the Seventh Circuit that we should not tolerate the filing of frivolous complaints under Section 10(b) and Rule 10b-5. We presumed the Court of Appeals would recognize that we were giving effect to the policies behind those precedents summarized so admirably by Judge Easterbrook in DiLeo v. Ernst & Young, 901 F.2d 624, 626-28 (7th Cir.), cert. denied, 498 U.S. 941, 111 S. Ct. 347, 112 L. Ed. 2d 312 (1990). DiLeo urged us to be watchful about complaints that are filed with "no information other than the differences between [] two statements of [a] firm's condition," and reminded us that "Rule 9(b) require[s] the district court to dismiss [a] complaint[] which discloses none of the circumstances that might separate fraud from the benefit of hindsight." Id. at 627-28. We were also mindful of then Justice Rehnquist's lengthy and cogent admonitions about Rule 10b-5 "strike suits" in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 739-48, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975). Writing for the Court, Justice Rehnquist observed, "There has been widespread recognition that litigation under Rule 10b-5 presents a danger of vexatiousness different in degree and in kind from that which accompanies litigation in general." Id. at 739. Without animus, we assessed sanctions in part as compensation to the vexed defendant, and in part as deterrence to fulfill the goal of the reduction in the number of frivolous and merit less lawsuits which are filed without proper investigation, in tremendous haste, and on the barest whiff of a securities fraud claim.

 We note, as the discussion below will illustrate, the Court of Appeals might have decided the merits of the alternative theory in this case without remanding that part of the case back to this Court. The DiLeo court, after reviewing the merits, affirmed the dismissal of a securities complaint extraordinarily similar to this one, stating, "A remand would prolong the case without contributing to accurate resolution. . . . We affirm the judgment in order to spare both the parties and the court gratuitous travail." DiLeo, 901 F.2d at 626. Understandably, in the case at bar, the Court of Appeals chose to remand the issue of sanctions so that we, as the court in closer proximity to the issues and parties involved, may ascertain whether the alternative theory as pled was sanctionable. They know that ten years on the federal bench has given this Court ample experience in securities law and that we always welcome the challenge and the inquiry that such cases bring. *fn3" Regrettably, we proceed in the absence of their input on the merits of the underlying securities theory which we overlooked.

 We pause to wonder if the Seventh Circuit in remanding this case has repudiated Pritchard v. Rainfair, Inc., 945 F.2d 185, 192 (7th Cir. 1991). There, another panel of the Court of Appeals wrote, "the focus of a Rule 11 inquiry is generally 'on the motion or pleading as a whole, rather than on its parts,' and while we will not prohibit a district court from undertaking a point-by-point Rule 11 analysis, neither will we require it to do so." Id. (quoting Melrose v. Shearson/American Express, Inc., 898 F.2d 1209, 1217 (7th Cir. 1990)). We shall proceed with the claim-by-claim Rule 11 analysis required on remand by the Court of Appeals.

 DISCUSSION

 The Court of Appeals has provided us the opportunity to revisit our earlier ruling awarding fees in light of Katz' alternative theory of liability. They do not require this Court to revisit the award of fees in toto. They reached the same conclusion we did when they observed that Katz' primary theory was without reasonable basis. Katz, 36 F.3d at 675. They vacated the Order because they found that it "failed even to note Katz's alternative theory," Id. at 675. The Court of Appeals instructed us to decide what "portions of Katz' complaint [are] obviously without basis," id. at 676, and to set the award accordingly. We must "assess a sanction only in the amount of those fees reasonably incurred in responding to sanctionable filings." Id. (emphasis in original).

 The issue before the Court is whether the alternative theory as contained in both the original and the amended complaint constituted a sanctionable filing when Katz filed its amended complaint in January, 1992. We note that the same defect which foretold the demise of the primary theory of active misrepresentation in Katz' complaint pertains to his alternative theory of fraudulent future projections. Accordingly, we find that the complaint and the amended complaint in their entirety are not reasonably grounded in fact or law.

 I. The Merits of the Alternative Theory

 To state a claim under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, a plaintiff must allege that "while buying or selling securities the defendant, acting with scienter, made a false material representation or omitted to disclose material information and that the plaintiff's reliance on the defendant's actions caused plaintiff's injury." Ziemack v. Centel Corp., 856 F. Supp. 430, 433 (N.D. Ill. 1994) (Duff, J.) (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976)). As to scienter, the plaintiff must allege that "the defendant acted with the intent to deceive, manipulate or defraud." 856 F. Supp. at 436 (citing Ernst & Ernst, 425 U.S. at 196; 96 S. Ct. at 1380-81). A plaintiff must plead scienter if the allegation of securities fraud concerns either a misrepresentation or an omission. See Ernst & Ernst, 425 U.S. at 212, 96 S. Ct. at 1390; Thomas L. Hazen, The Law of Securities Regulation § 13.4 (2nd ed. 1990 & Supp. 1994).

 In the Seventh Circuit, scienter includes not only an intentional or knowing state of culpability, but also a reckless state of culpability. Rowe v. Maremont Corp., 850 F.2d 1226, 1238 (7th Cir. 1988); Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1044 (7th Cir.), cert. denied sub nom Meers v. Sundstrand Corp., 434 U.S. 875, 98 S. Ct. 224, 54 L. Ed. 2d 155, 98 S. Ct. 225 (1977). Reckless conduct is defined as "a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Id. at 1044-45.

 Rule 9(b) of the Federal Rules requires that any allegation of fraudulent conduct be pled with particularity. See Jepson v. Makita Corporation, 34 F.3d 1321, 1327-28 (7th Cir. 1993) (Rovner, J.). A plaintiff alleging either intentional, knowing, or reckless conduct under Section 10(b) and Rule 10b-5 must plead in detail the circumstances surrounding the alleged scienter. See Fed. R. Civ. P. 9(b); DiLeo, 901 F.2d at 627; Hazen, § 13.2.1. "This ...


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