Pleading Special Matters.

Pleading Special Matters: Heightened Requirements in Fraud Cases.

Although the Federal Rules of Civil Procedure typically only require that a complaint contain “a short and plain statement of the claim showing that the pleader is entitled to relief,” Fed. R. Civ. Proc. 8(a)(2), Rule 9 makes clear that claims alleging fraud are subject to a heightened pleading standard. Rule 9(b) states, “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.”

In re Rockefeller Center Properties, Inc. Securities Litigation, 311 F.3d 198 (3d Cir. 2002), offers one helpful summary of the pleading requirements under Rule 9(b). In In re Rockefeller Center, a group of investors sought to acquire Rockefeller Center Properties, Inc. (“RCPI”), the entity through which the Rockefeller family owned and controlled the landmark Rockefeller Center. During the process, RCPI management filed a proxy statement (a statement a firm must provide its shareholders when soliciting their vote) that “painted a bleak financial picture of Rockefeller Center and included management's recommendation to approve the merger.” But one month after the Shareholders voted in support of the acquisition, “the new owners of Rockefeller Center, the Investor Group, sold approximately 20% of the property to the National Broadcasting Company and its parent, the General Electric Company (‘GE/NBC’), for $440 million.”  Id. at 205-09.

The Shareholders claimed that the Investor Group had been secretly negotiating with GE/NBC, and that the Investor Group “formed an intent to sell a portion of Rockefeller Center to GE/NBC prior to the Shareholders’ vote” that it had failed to disclose. According to the Shareholders, this omission was fraudulent, and it rendered other statements in the proxy statement fraudulent too. Id. at 212. The Shareholders offered seven pieces of evidence to demonstrate these negotiations had taken place and that the Investor Group intended this sale prior to the Shareholders’ vote, including newspaper articles and employee statements. Two of them are reproduced here:

(1) Around February 1996 [before the relevant vote], the Shareholders claim that “Goldman Sachs suggested to GE/NBC that if GE/NBC was willing to pay upwards of 400 million dollars for capital lease treatment, depreciation rights and a purchase option of 93 percent of fair market value in 2022, it should simply buy the space it leased at Rockefeller Center.” . . .

(3) The Shareholders also contend that a Wall Street Journal article (the “WSJ Article”) published after the sale to GE/NBC supports their claims of fraud. The May 6, 1996 article “reported that over the past two years GE and NBC had been in discussions with every party that had had an opportunity to gain control of the Property, and that they began negotiating with defendants Rockefeller and Goldman Sachs in November 1995. The article quoted Michael Sherlock, an Executive Vice President of NBC, as stating ‘everything you can imagine was at one point, over the past year, under negotiation.’”

Id. at 212-13 (internal citations omitted). However, the district court found that these pieces of evidence were insufficient to meet the heightened requirements of Rule 9(b). Id. at 215.

The Third Circuit affirmed the district court’s dismissal of the complaint, concluding that the “Shareholders had failed to meet the heightened pleading requirements of securities fraud actions set forth in Rule 9(b) of the Federal Rules of Civil Procedure.” Id. at 205. Judge Fuentes, writing for the court, explained Rule 9(b)’s standards as follows:

Rule 9(b) imposes a heightened pleading requirement of factual particularity with respect to allegations of fraud. . . . Although Rule 9(b) falls short of requiring every material detail of the fraud such as date, location, and time, plaintiffs must use “alternative means of injecting precision and some measure of substantiation into their allegations of fraud.” The imposition of a heightened pleading requirement in fraud actions serves important objectives: “Rule 9(b)’s heightened pleading standard gives defendants notice of the claims against them, provides an increased measure of protection for their reputations, and reduces the number of frivolous suits brought solely to extract settlements.”

While we have acknowledged the stringency of Rule 9(b)’s pleading requirements, we have also stated that, in applying Rule 9(b), courts should be “sensitive” to situations in which “sophisticated defrauders” may “successfully conceal the details of their fraud.” Where it can be shown that the requisite factual information is peculiarly within the defendant's knowledge or control, the rigid requirements of Rule 9(b) may be relaxed. Nevertheless, even when the defendant retains control over the flow of information, “boilerplate and conclusory allegations will not suffice. Plaintiffs must accompany their legal theory with factual allegations that make their theoretically viable claim plausible.” . . .

Rule 9(b) requires, at a minimum, that plaintiffs support their allegations of securities fraud with all of the essential factual background that would accompany “the first paragraph of any newspaper story” - that is, the “who, what, when, where and how” of the events at issue.

Id. at 216-27 (internal citations omitted) (emphasis in original).  In addition to providing general guidelines under Rule 9(b), the Court also addressed each of the seven pieces of evidence.  The Court’s treatment of the first piece of evidence (Goldman Sachs’ suggestion that GE/NBC buy space at Rockefeller Center) and the third (the WSJ Article) are reproduced here:

1. The February 1996 Goldman Sachs Statement. . . . The fact that an employee of Goldman Sachs “suggested” this alternative does not even indicate that negotiations actually commenced. The District Court correctly noted that the allegation establishes no more than that someone at Goldman Sachs had considered a sale as an alternative. It does not establish that GE/NBC responded in any meaningful way, that Goldman Sachs advised the Investor Group to pursue a sale, or that the Investor Group formed an intent to sell a portion of the Rockefeller Center. . . .

[Furthermore,] Rule 9(b) “requires, at a minimum, that the plaintiff identify the speaker of allegedly fraudulent statements.” . . . Because the allegation fails to identify the speaker, there is no indication that the speaker had the authority to speak on behalf of Goldman Sachs or that the employee was in regular contact with the Investor Group.

3. The WSJ Article. . . . The Court agrees that the Shareholders “fail to explain how the article tends to show that the Investor Group and GE/NBC were negotiating a sale prior to the shareholder vote.” Presumably, the patently imprecise concept of “everything you can imagine” would encompass a sale, but because the negotiations “over the past year” included everything, there is no indication whatsoever when the lease negotiations morphed into negotiations for a sale. The only thing that the WSJ article establishes is that sometime before May 6, 1996, sale negotiations occurred; however, the article, even if accepted as true, does not state with the requisite specificity that sale negotiations commenced prior to the Shareholders' vote on March 25, 1996.

Id. at 218-20 (internal citations omitted).

As you read the cases in Section VI(B)(1), consider the differences between pleading under Rule 8 as interpreted by Dioguardi and Conley and Rule 9(b). Why do you think fraud was singled out in this way? Should it be? Then, as you read the cases in Section VI(B)(2), consider how those differences have narrowed in light of the Supreme Court’s decisions in Twombly and Iqbal.