Sixth Circuit Court of Appeals Rejects Claims for Securities Fraud

 

Sixth Circuit Court of Appeals Rejects Claims for Securities Fraud

       In a recent decision, the Sixth Circuit Court of Appeals rejected assertions that the certain shareholders in a closely held corporation were defrauded as contemplated by the Securities Exchange Act of 1934, finding that the required element of “justifiable reliance” was absent.  Bender v. Logan No. 14-3647 (6^th Cir. April 28, 2015).

       Trina Bender, a cosmetologist, partnered with her client, Julie Logan, to open a cosmetology school, Elite Institute.  Each of Trina and Julie, were to be equal 50/50 shareholders in the company.  Julie Logan and her husband, Scott undertook the financial management of the entity and arranged for the preparation of the incorporation and related documents. What Bender did not realize, notwithstanding the fact that it was set forth in the documents, was that the corporation had been organized with two classes of stock, Class A (voting) and Class B (nonvoting); the Class A shares were issued to Logan while the Class B shares were issued to Bender.  After the school is up and running, at the request of Scott Logan that she sign “some minor paperwork needed for their lawyer,”, Bender signed over, for consideration totaling one dollar, her entire stock ownership in the company and as well resigned as an officer and director of Elite. After some further exchanges and coming to the realization of what had been accomplished, Trina and Mark Bender filed suit alleging violations of Section 10b of the Securities Exchange Act of 1934 and Rule 10b-5.

      Responding to the Logan's Motion for Summary Judgment, the claims for securities fraud were dismissed based upon the Bender's inability to prove two elements of securities fraud, namely loss causation and justifiable reliance.  That determination would be affirmed by the Court of Appeals, but its decision is restricted to justifiable reliance.

      In order to make out a claim for fraud in a securities transaction, it was recited, based upon In re. Comshare Inc. Securities Litigation, 183 F.3d 542, 548 (6^th Cir. 1999), that there must be “[1] the misstatement or omission of a material fact, [2] made with scienter, [3] upon which the plaintiff justifiably relied; and [4] which proximately caused the plaintiff's injury [loss causation].” The court found there were potentially two transactions against which the securities fraud claim could be assessed, namely Bender's initial acquisition of the stock in the Elite and her subsequent sale of her stock interest in Elite.  Cutting to the chase, the Sixth Circuit found:

The Benders cannot assert a securities fraud claim based on Bender's acquisition of stock in Elite because Trina Bender was not justified in relying on the Logans’ misrepresentations. The Benders also cannot assert a securities fraud claim based on Bender's sale of stock in Elite for similar reasons.  In both transactions, the documents Trina signed would have informed her, had she read them, of the relevant facts that the Logan's allegedly obfuscated.  In neither case do her background, the nature of her relationship with the Logan's, and the attending circumstances excuse her failure to read the documents she signed.

      With respect to Bender's initial acquisition of Elite stock, which was nonvoting rather than voting:

The most salient point is that, because Bender had the documents in front of her when she signed them and the Logan's never prevented her from attempting to read them, she had perfect access to the relevant information and a perfect opportunity to detect the fraud. This is particularly true in the case of the stock certificate, which clearly stated that she was receiving “nonvoting stock.”  Bender admitted that had she read the certificate, which was not a long or complex document, she would have noticed the nonvoting “red flag.”    

      In response to the suggestion that the reliance upon the Logan's was justified absent scrutiny of the documents, it was observed that:

At the time she acquired the stock, Scot and Julie Logan were somewhere on the spectrum between social acquaintances and friends, but they were not yet Bender’s business partners, and certainly they owed her no fiduciary duty.

      Turning to Bender's sale of her interest in Elite, the Court likewise found that her lack of diligence in reading the documents presented to her, even though presented under the heading of “minor paperwork,” did not excuse her from reading the documents and coming to an appreciation of exactly what they provided for.

      In that the Sixth Circuit Court of Appeals was able to affirm the trial court's grant of summary judgment on the basis of the lack of justifiable reliance, it did not reach the question of loss causation.

      In that the trial court refused to take jurisdiction over the state law claims asserted in the complaint, presumably they will be refiled in state court.

      My only quibble with this opinion is the reference to “partners.”  The participants in the venture were shareholders/directors/officers of a corporation; there was no partnership and their inter-se relationship was not that of partners.  Clearly the Court used the term colloquially and not technically, but it would be better were it not employed.