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Hayes v. Gross

argued: July 9, 1992.


On Appeal From the United States District Court For the Eastern District of Pennsylvania. (D.C. Civil Action No. 90-04671).

Before: Sloviter, Chief Judge, and Stapleton and Rosenn, Circuit Judges.

Author: Stapleton


STAPLETON, Circuit Judge:


In this appeal, we consider whether plaintiff-appellant F.W. Hayes ("plaintiff") has stated a claim under the federal securities laws against officers and directors of Bell Savings Bank ("Bell"), a state-chartered savings association in the receivership of the Resolution Trust Company ("RTC"). Plaintiff alleges in his amended complaint that defendants knowingly or recklessly misrepresented the financial and operating condition of Bell, that this resulted in the artificial inflation of the market price for Bell stock, and that plaintiff and others similarly situated were injured when they purchased Bell stock at the inflated price.

At the urging of defendants and the RTC, which filed an amicus brief, the district court dismissed the complaint under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted. Relying on our decision in In re Sunrise Securities Litigation, 916 F.2d 874 (3d Cir. 1990), the district court found that plaintiff's claim was predicated on injury to Bell caused by defendants' mismanagement and that the claim was therefore a derivative one. Since plaintiff had not pleaded all of the essential elements of a derivative claim and disclaimed any desire to amend his complaint to do so, the complaint was dismissed.

Our review of a dismissal under Rule 12(b)(6) is plenary. We accept as true all well-pleaded allegations and construe them in the light most favorable to plaintiff, and we may affirm only if the complaint alleges no set of facts which, if proved, would entitle plaintiff to relief. Marshall-Silver Const. Co., Inc. v. Mendel, 894 F.2d 593, 595 (3d Cir. 1990). Because we find that the amended complaint alleges direct injury to plaintiff and states a claim under the securities laws, we will reverse the dismissal and remand for further proceedings.


We recently reviewed the relevant securities law in Shapiro v. U.J.B. Financial Corp., 964 F.2d 272 (3d Cir.), cert. denied, 121 L. Ed. 2d 278, 113 S. Ct. 365 (1992). Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1988), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (1991), make it unlawful for anyone to make a material misrepresentation in connection with a purchase or sale of securities. To state a claim under the statute and the rule, a private plaintiff must plead a false representation of a material fact, the defendant's knowledge of its falsity and his intention that the plaintiff rely on it, the plaintiff's reasonable reliance on the representation, and the plaintiff's resulting loss. Shapiro, 964 F.2d at 280. Where the security involved is traded in an open and efficient market, the plaintiff need not show personal and specific reliance on the misrepresentation made by the defendant; he may instead rely on the "fraud-on-the-market theory" and allege only that he suffered injury in his capacity as a purchaser or seller in such a market. In Shapiro, we also noted that an allegation of mismanagement on the part of a defendant will not alone support a claim under § 10(b) or Rule 10b-5; nor will an allegation that a defendant failed to disclose the existence of mismanagement. We held, however, that a complaint does allege an actionable misrepresentation if it alleges that a defendant was aware that mismanagement had occurred and made a material public statement about the state of corporate affairs inconsistent with the existence of the mismanagement. A statement of opinion or belief, if known to be false, may be the basis of such a claim. Shapiro, 964 F.2d at 281-83.

In this case, plaintiff alleges that defendants mismanaged Bell. If this were all that plaintiff alleged, the RTC would be correct in its position that only Bell has a claim against defendants and that plaintiff may assert that claim only by satisfying the prerequisites of a derivative action. But plaintiff alleges more than mismanagement. He alleges that defendants made affirmative representations inconsistent with the state of corporate affairs they knew to exist. Plaintiff alleges, for example, that defendants, knowing that Bell's loan loss reserves were grossly inadequate, caused its 1988 annual report to state that "an allowance for loan losses is maintained at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks in the loan portfolio." Amended Complaint P 35. Plaintiff also alleges that in Bell's report to stockholders for the quarter ended December 31, 1988, defendants, knowing the claim to be false, asserted that Bell's "asset quality remained strong and [that it had] a non-performing asset to total asset ratio of .63%." P 37. As a final example, plaintiff alleges that Bell's 1989 annual report asserted that "Management believes [Bell] is comfortably within the guidelines and requirements of FIRREA and foresees no problem in complying with its future regulations," when in fact defendants "knew or recklessly disregarded the fact that Bell was hopelessly incapable of substantially complying with FIRREA because of the severe deterioration in Bell's loan portfolio." P 43.

We find these representations indistinguishable from those found actionable in Shapiro. There, plaintiffs accused defendants of knowingly or recklessly misrepresenting UJB Financial Corporation's loan loss reserves as "adequate," its loan portfolio as "well secured," and its asset quality as "high." 964 F.2d at 283. Here, as in Shapiro, if plaintiff can prove that such assertions were made, that they were false, that the defendants knew them to be false or acted with reckless indifference to their falsity, and that plaintiff thereafter suffered a loss by purchasing stock, he will have proved a paradigm case of a violation of § 10(b) and Rule 10b-5.

In reaching our Conclusion that the amended complaint states a cause of action under the securities laws, we have considered the RTC's contention that plaintiff has not alleged either direct reliance on the alleged misrepresentation or facts sufficient to support a "fraud-on-the-market" theory.

The amended complaint alleges that plaintiff relied on the integrity of the market and the price for Bell stock in making his purchase. Plaintiff thus invokes the fraud-on-the-market theory and is not required to allege or prove individual reliance on particular misrepresentations. Basic Inc. v. Levinson, 485 U.S. 224, 247, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988). The theory's presumption of reliance is only available, however, if Bell stock was traded on ...

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