Opinion
Master File Civil No. 97-2679 (JRT/RLE)
July 29, 2002
Stanley Grossman and H. Adam Prussin, Pomerantz, Haudek, Block Grossman and Gross, New York, NY, Marshall H. Tanick, Teresa J. Ayling and V. John Ella, Mansfield Tanick Cohen P.A., Minneapolis, MN, for plaintiffs.
Gregory P. Joseph, Gregory P. Joseph Law Offices LLC, New York, NY, Peter Carter, Dorsey Whitney, Minneapolis, MN, for defendants.
MEMORANDUM OPINION AND ORDER DENYING DEFENDANTS' MOTION TO DISMISS
This matter is before the Court on the motion of defendants Green Tree Financial Corporation, now known as Conseco Finance Corporation, Lawrence M. Coss, Robert D. Potts, Joel H. Gottesman, Robley D. Evans and Edward L. Finn (collectively referred to as the "defendants") to dismiss the options class action on the basis that the plaintiff option traders lack standing to sue defendants under Laventhall v. General Dynamics Corp., 704 F.2d 407 (8th Cir. 1983). For the reasons that follow, the motion is denied.
BACKGROUND
In 1997, nearly 30 putative class actions were filed against defendants for alleged violations of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b) and 78t(a), and under Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5. The cases were subsequently consolidated into two separate putative class actions, one consisting of purchasers of Green Tree stock from July 15, 1995 to January 27, 1998, File No. 97-2666 (the "stock" action) and the other consisting of traders of options on Green Tree stock during the same period, File No. 97-2679 (the "options" action). Chill v. Green Tree Fin. Corp., 181 F.R.D. 398, 407 (D.Minn. 1998).
Section 10(b) of the Securities Exchange Act of 1934 provides that:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange —
(b) To use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.15 U.S.C. § 78j(b).
Rule 10b-5 reads:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.17 C.F.R. § 240.10b-5.
A third action was also commenced by the Florida State Board of Administration, File No. 98-1162.
In this action, plaintiffs allege that they bought stock and traded options in a market in which Green Tree's stock price was artificially inflated because of the defendants' misrepresentations about its financial condition and that they suffered losses when the truth was revealed and the stock price fell. On August 24, 1999, this Court granted defendants' motion to dismiss all three complaints on the basis that the complaints failed to state fraud with sufficient particularity under the heightened pleading standards of Rule 9(b) and the Private Litigation Securities Reform Act ("PLSRA"). In re Green Tree Fin. Corp. Stock Litig., 61 F. Supp.2d 860 (D.Minn. 1999). Plaintiffs appealed the decision and on October 25, 2001, the Eighth Circuit concluded that the complaints alleged sufficient facts to state a claim under § 10(b) and Rule 10b-5 and accordingly remanded the case for further proceedings. Florida State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645 (8th Cir. 2001), reh'g en banc denied, Nov. 29, 2001. Defendants now move to dismiss the options action on the basis that plaintiff option holders lack standing to bring suit under Section 10(b) of the federal securities laws.
ANALYSIS
Defendants argue that, as a matter of law in the Eighth Circuit and this District, the option traders lack standing to pursue federal securities claims in the absence of allegations that the defendants themselves engaged in option trading. The primary authority defendants rely on for this proposition is Laventhall v. General Dynamics Corp., 704 F.2d 407, 411 (8th Cir. 1983). In Laventhall, the Eighth Circuit held that option holders lack standing to sue a corporation and corporate insiders on an insider trading claim brought pursuant to Section 10(b). In that case, the plaintiff purchased call options that gave him the right to purchase 1000 shares of common stock in General Dynamics Corporation from October 13, 1978 to February 17, 1979. Id. at 408-09. In December 1978, without disclosing a pending declaration of a cash dividend, General Dynamics purchased over 150,000 shares of its own common stock on the open market. Id. at 409. On January 4, 1979, the corporation declared a cash dividend and a stock split. Id.
Plaintiff filed a putative class action claiming that he and other similarly situated option holders suffered damage because General Dynamics improperly traded stock on undisclosed material inside information. Id. Relying on the rule that "corporate insiders must either disclose material inside information known to them or refrain from trading in the shares of the corporation," plaintiff argued that "the corporation's failure to disclose its dividend plans before purchasing its common stock was a violation of this duty to abstain or disclose." Id. at 410. The Eighth Circuit disagreed. Relying heavily on Chiarella v. United States, 445 U.S. 222 (1980), the court concluded that the defendant did not owe plaintiff a duty of disclosure because "there simply existed no relationship of trust and confidence between the parties." Id. at 411-12. The court emphasized that, unlike the relationship between a corporation and its shareholders, a corporation and an options trader are not privy to any contract with each other. Id. at 411. The court described the differences as follows:
The relationship between corporate insiders and shareholders stands in stark contrast to the lack of relationship between the corporate insiders and options traders. While it is true that shareholders and options traders both rely on the fortunes of corporations, the dispositive distinction is that the options trader has no equity interest in the corporation by virtue of his selling or purchasing an option on the corporation's stock. He is owed no special duty by the officers and directors of the corporation because, quite simply, the corporation is not run for his benefit. He has contributed no equity to the corporation and, in the event of insider wrongdoing, he has no right to bring suit to make the corporation whole. Moreover, while the option writer may obligate himself in the future to purchase shares of the corporation (in the event a "naked option" is exercised), this purchase is solely for the purpose of turning the shares over to the other contractual party, not for the purpose of investing in the fortunes of the corporation. Whatever relationship this may create with the corporation, it cannot be said that it rises to the level of a relationship of trust and confidence between the options trader and the corporate insider. In short, as a shareholder one is entitled to the benefits of a trust relationship. As an options trader, one is not.
Id. (quoting O'Connor Associates v. Dean Witter Reynolds, Inc., 529 F. Supp. 1179 (S.D.N.Y. 1981). The Court also concluded that no transactional nexus exists between a corporation and option holders because they do not trade in the same market as the corporation or purchase any interest in it. In the court's view, "there must be some special relationship between plaintiff and defendant before a duty of disclosure arises." Id. at 413. Since no such relationship existed under facts of the case, the court affirmed the district court's dismissal for lack of standing.
Following Laventhall, several district courts, including one court within this District, extended Laventhall beyond the context of insider trading. In re McDonnell Douglas Corp., 567 F. Supp. 126 (E.D.Mo. 1983); Lerner v. Scimed Life Systems, Inc., No. 3-92-537, 1993 WL 374319 at *2 (D.Minn. 1994); Bianco v. Texas Instruments, 627 F. Supp. 154, 161 (N.D.Ill. 1985). In McDonnell Douglas, the option-holder plaintiff raised nondisclosure and insider trading allegations in his complaint. Plaintiff conceded that his insider trading claims were barred under Laventhall. As to the nondisclosure claims, however, he argued that Laventhall was limited to claims made in the insider trading context. The district court rejected that argument and held that the reasoning applied by the Eighth Circuit in Laventhall to preclude standing apply with equal force to the nondisclosure allegations:
In the most literal terms, the issue of options holder nondisclosure claims was not before the court in that case because the liability of a non-trading defendant was not presented by the facts. Yet, it is inescapable that the Eighth Circuit has denied the availability of such a theory to option traders. The principles relied upon in the instance of insider trading in Laventhall apply with equal force to the nondisclosure allegations of this complaint because the Epstein plaintiffs stand in the same structural relationship to the defendants under either theory.
Id. at 127. In Lerner, a court within this District adopted the reasoning applied in McDonnell Douglas to conclude that "Laventhall precludes option trader standing in non-disclosure and misrepresentation cases brought under Section 10(b) and Rule 10b-5." Id. at *2. Defendants thus argue that based on these decisions, particularly Laventhall and Lerner, plaintiff options holders lack standing to bring suit under Section 10(b). Plaintiffs argue that Laventhall does not control for a number of reasons. First, Laventhall was an insider trading case; this is an affirmative misrepresentation case.
Plaintiffs emphasize that every court of appeals that has addressed the issue has limited Laventhall in this manner and has concluded that options traders have standing to sue corporate defendants for affirmative misrepresentations. Deutschman v. Beneficial Corp., 841 F.2d 502 (3d Cir. 1988); Fry v. UAL Corp., 84 F.3d 936 (7th Cir. 1996); Backman v. Polaroid Corp., 893 F.2d 1405 (1st Cir. 1990), opinion withdrawn pending petition for rehearing en banc, rev'd on other grounds, Backman v. Polaroid Corp., 910 F.2d 10 (1st Cir. 1990) (en banc). See also Arakis Energy Corp. Sec. Litig., No. 95-CV-3431, 1999 WL 1021819 at *3-4 (E.D.N.Y. 1999) (unpublished opinion); Liebhard v. Square D Co., 811 F. Supp. 354 (N.D.Ill. 1992); Margolis v. Caterpillar, 815 F. Supp. 1150, 1154-56 (C.D.Ill. 1991); In re Adobe Systems, Inc. Sec. Litig., 139 F.R.D. 150, 154-55 (N.D.Cal. 1991); Tolan v. Computervision Corp., 696 F. Supp. 771 (D.Mass. 1988); In re Digital Equip. Corp. Sec. Litig., 601 F. Supp. 311 (D.Mass. 1984); Lloyd v. Industrial Bio-Test Laboratories, Inc., 454 F. Supp. 807, 811 (S.D.N.Y. 1978). The leading circuit court decision on this view is Deutschman v. Beneficial Corp., 841 F.2d 502 (3d Cir. 1988). In that case, Robert Deutschman, a purchaser of call options on stock, filed a two-count complaint alleging that the defendant corporation issued false and misleading statements in connection with the strength of its stock, misrepresentations which, upon disclosure of the actual facts, led to losses for plaintiffs. Id. at 503. The district court granted defendants' motion to dismiss on the basis that two Supreme Court decisions limit a defendant's "exposure to liability for damages under section 10(b) to persons in some special relationship of trust or confidence toward the section 10(b) plaintiff." Id. at 506. The Third Circuit disagreed, stating:
The district court's reliance on Chiarella and Dirks is entirely misplaced. Those cases dealt not with injury caused by affirmative misrepresentations which affected the market price of securities but with the analytically distinct problem of trading on undisclosed information; a theory of recovery which Deutchman does not plead. The "disclose or abstain from trading" rule laid down in insider trading cases imposes on insiders a duty to disclose information which need not otherwise be disclosed before they act on that information in any uninformed marketplace. . . . Nothing in those opinions, however, can be construed to require the existence of a fiduciary relationship between a section 10(b) defendant and the victim of that defendant's affirmative misrepresentation.
The court also rejected the district court's reliance on Laventhall, concluding that it was "quite distinguishable" from the factual allegations raised in the case at bar: In Laventhall no misstatements were made to the public. Instead, the defendant corporation, without disclosure, traded in its own securities after a decision had been made to change its dividend policy. . . . [T]he Laventhall holding, like the Chiarella and Dirks holdings, is simply not relevant to the distinct issue of affirmative misrepresentations affecting a market in securities. No Supreme Court case and no Court of Appeals case has ever imposed a transactional nexus requirement in a section 10(b) affirmative misrepresentation case.
Id. at 506-07 (emphasis added).
Eight years later, the Seventh Circuit addressed the same issue and reached the same conclusion. Fry v. UAL Corp., 84 F.3d 936 (7th Cir. 1996). The court concluded:
By holding that option traders have standing to sue under Section 10(b), the Seventh Circuit decision overruled Bianco v. Texas Instruments, 627 F. Supp. 154, 161 (N.D.Ill. 1985), a district court opinion which had held that option traders lack standing even for misrepresentation cases.
The division of authority [between Laventhall on the one hand and Deutschman on the other] is illusory. Laventhall was an insider-trading case. The decision against liability turned on the fact that a corporation has no fiduciary obligation to option traders, as it does to its own shareholders. The existence of fiduciary obligation was critical because insider trading is the abuse of a fiduciary position, rather than out-and-out fraud, that is, fraud accomplished by misrepresentations (or what amounts to the same thing, misleading omissions). The duty not to make misrepresentations does not depend on the existence of a fiduciary relationship. Basic, Inc. v. Levinson, 485 U.S. 224, 240 n. 18 (1988). If it did, very little fraud would be actionable. The garden-variety fraud in which the seller of a product misrepresents its qualities to the buyer would not be, because a seller is not his buyer's fiduciary. So the case law provides no support for the defendant's position.
Id. at 938. Plaintiffs also argue that neither of the two lower court decisions defendants rely on, McDonnell Douglas and Lerner, help defendants because both of those cases involved allegations of non-disclosure, not affirmative misrepresentations.
Although of no precedential value, a panel of the First Circuit has also taken the position that option traders have standing to sue under Section 10(b) on a misrepresentation theory. Backman v. Polaroid Corp., 893 F.2d 1405 (1st Cir. 1990), opinion withdrawn pending petition for rehearing en banc, rev'd on other grounds, Backman v. Polaroid Corp., 910 F.2d 10 (1st Cir. 1990) (en banc). It is also noteworthy that Senior Judge Floyd Gibson of the Eighth Circuit, sitting by designation, joined the panel opinion distinguishing Laventhall and upholding the standing of plaintiff option holders to sue Polaroid under Section 10(b) on a misrepresentation theory.
Defendants respond that each of the cases relied on by plaintiffs have one thing in common: none of the cases were decided by the Eighth Circuit and none of them are reconcilable with the Eighth Circuit's reasoning in Laventhall. Defendants argue further that, to the extent there is a distinction that can be drawn between allegations of non-disclosure and affirmative misrepresentations, this case is essentially a non-disclosure case and thus, the decisions in Lerner and McDonnell Douglas control.
While the issue presented here is a close one, the Court concludes that the options plaintiffs do have standing to sue under Section 10(b). This conclusion is not inconsistent with Laventhall. The rule laid down by the Eighth Circuit in that case deals with the fundamentally separate and distinct issue of when corporate insiders have a duty to disclose for purposes of trading on material inside information. Tolan v. Computervision Corp., 696 F. Supp. 771, 775 (D.Mass. 1988) ("There is a fundamental distinction, however, between liability for not disclosing material information prior to trading by an insider and the broader liability for issuing false and misleading statements because the misrepresenting party can be held liable, even if he did not trade in the security"). In the context of Section 10(b) allegations premised on fraudulent misrepresentations, which are the claims at issue here, courts uniformly agree that option traders have standing. Deutschman v. Beneficial Corp., 841 F.2d 502 (3d Cir. 1988); Fry v. UAL Corp., 84 F.3d 936 (7th Cir. 1996); Backman v. Polaroid Corp., 893 F.2d 1405 (1st Cir. 1990), opinion withdrawn pending petition for rehearing en banc, rev'd on other grounds, Backman v. Polaroid Corp., 910 F.2d 10 (1st Cir. 1990) (en banc); Arakis Energy Corp. Sec. Litig., No. 95-CV-3431, 1999 WL 1021819 at *3-4 (E.D.N.Y. 1999) (unpublished opinion); Liebhard v. Square D Co., 811 F. Supp. 354 (N.D.Ill. 1992); Margolis v. Caterpillar, 815 F. Supp. 1150, 1154-56 (C.D.Ill. 1991); In re Adobe Systems, Inc. Sec. Litig., 139 F.R.D. 150, 154-55 (N.D.Cal. 1991); Tolan v. Computervision Corp., 696 F. Supp. 771 (D.Mass. 1988); In re Digital Equip. Corp. Sec. Litig., 601 F. Supp. 311 (D.Mass. 1984); Lloyd v. Industrial Bio-Test Laboratories, Inc., 454 F. Supp. 807, 811 (S.D.N.Y. 1978).
Numerous legal commentators also support a rule in favor of standing. Note, Private Causes of Action for Option Investors under SEC Rule 10b-5: A Policy, Doctrinal, and Economic Analysis, 100 Harv. L. Rev. 1959 (June 1987) (arguing that the policy behind Rule 10b-5 is furthered by granting option holders standing in affirmative misrepresentation cases); Elizabeth A. Sacksteder, Note, Securities Regulation for a Changing Market: Option Trader Standing Under Rule 10b-5, 97 Yale L. J. 623 (1987). Legal commentators have also criticized the holding in Laventhall, even as it applies in the context of insider trading. Deborah I. Mitchell, Leventhall v. General Dynamics Corporation: No Recovery for the Plaintiff-Option Holder in a Case of Insider Trading under Rule 10b-5, 79 Nw. U.L. Rev. 780 (Nov. 1984) (arguing that options holders should have standing for insider trading and arguing that the causation requirement under Section 10(b), rather than standing, is the proper limitation on the plaintiff class).
Although the courts in McDonnell Douglas and Lerner held that option traders lack standing to bring their federal securities claims, neither case involved affirmative misrepresentations. In the instant case, plaintiffs have not only alleged that defendants failed to disclose material information, but also that defendants' financial statements and press releases contained materially false representations. Am. Consolidated Compl. at ¶¶ 52-53. 55-69. 71-72, and 74.
Even the magistrate judge in this case has questioned the continued vitality of Lerner in light of the circuit decisions which hold that option holders have standing under Section 10(b) for claims of affirmative misrepresentations. Chill v. Green Tree Fin. Corp., 181 F.R.D. 398, 406 (D.Minn. 1998).
The Court's conclusion is also consistent with the statutory language of Section 10(b). Arakis, 1999 WL 1021819 at *3 (holding that "an action by an option holder alleging affirmative misrepresentation falls squarely within the parameters of Section 10(b)"). Section 10(b) makes it unlawful for any person, directly or indirectly, to use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance. . . ." 15 U.S.C. § 78j (emphasis added); see also Herman MacLean v. Huddleston, 459 U.S. 375, 382 (1983) (emphasizing that "a § 10(b) action can be brought by a purchaser or seller of `any security' against `any person' who has used `any manipulative device or contrivance' in connection with the purchase or sale of security'").
In addition, the elements of a fraud claim under Section 10(b) are: 1) a misrepresentation or omission; 2) of material fact; 3) made with scienter; 4) on which the plaintiff justifiably relied; 5) that proximately causes the alleged loss. Binder v. Gillespie, 184 F.3d 1059, 1063 (9th Cir. 1999); Nationsmart Corp. Sec. Litig. v. Thaman, 130 F.3d 309, 320 (8th Cir. 1997) ("To recover in a private action brought under Rule 10b-5, a plaintiff must establish: 1) that the defendant acted in a manner prohibited by the Rule, whether it be that the defendant employed a device, scheme or artifice to defraud, made misrepresentations of material fact, or engaged in acts, practices or courses of business that operate as fraud or deceit; 2) causation, often analyzed in terms of materiality and reliance; 3) damages; and 4) that the fraudulent activity occurred in connection with the purchase and sale of a security.").
Finally, the Court does not believe that allowing option holders to pursue their Section 10(b) claims under the misrepresentation theory presented in this case will open corporations up to limitless liability. As the court in Deutschman stated in rejecting the same argument made by defendant in that case:
When in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), the Supreme Court adopted the Birnbaum rule limiting section 10(b) plaintiffs to purchasers or sellers of securities, it confined section 10(b) liability to members of the precise class for the protection of which the 1934 Act was enacted: participants in the national securities markets. Option traders are participants in those markets.841 F.2d at 507. Thus, for all the foregoing reasons, defendants' motion is denied.
At oral argument, defendants' counsel suggested that half of the options class actually made money when Green Tree's stock price declined. Even if that were true, in the Court's view, those plaintiffs' claims would fail for lack of any damages caused by defendants' action, not for lack of standing.
ORDER
Based upon the foregoing, the submissions of the parties, the arguments of counsel and the entire file and proceedings herein, IT IS HEREBY ORDERED that defendants' motion to dismiss the options litigation (File No. 97-2679) [Docket No. 46] is DENIED.