2nd Circuit Imposes Stiff Fine in Securities Fraud Case

A small New York law firm faces nearly $200,000 in sanctions after the 2nd U.S. Circuit Court of Appeals decided it had not received a severe enough penalty for an abusive securities fraud suit. The court found Jaroslawicz & Jaros was subject to full sanctions, including appellate expenses. The ruling marks the third time the appellate court has weighed in on this case, which dates back to 1997.

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A small New York law firm faces nearly $200,000 in sanctions after a federal appeals court said it had not received a severe enough penalty for an abusive securities fraud suit. The 2nd U.S. Circuit Court of Appeals found Jaroslawicz & Jaros was subject to full sanctions under 15 U.S.C. � 78u-4(c), including appellate expenses. Martin E. Karlinsky of Rosenman & Colin, who represented NU-Tech Bio-Med, the defendant in the suit, said the final bill owed to his client and his firm would be around $190,000. Southern District Judge Louis L. Stanton had found that the Jaroslawicz firm should pay half of NU-Tech’s costs plus attorney fees, approximately $62,500. Robert J. Tolchin, an attorney at Jaroslawicz who handled the case before the 2nd Circuit, did not return a phone call seeking comment. David Jaroslawicz could not be reached for comment. A ruling by 2nd Circuit Judge Guido Calabresi, Gurary v. NU-Tech Bio-Med Inc., 01-7969(L), delved into vagaries of the Private Securities Litigation Reform Act of 1995 (PSLRA), through which Congress intended to impose hefty sanctions for frivolous securities litigation. It also marks the third time the appellate court has weighed in on this case, which dates back to 1997. Mordechai Gurary first filed suit against NU-Tech and Isaac Winehouse, a member of an equities company, alleging that Winehouse was manipulating NU-Tech’s stock price and that NU-Tech was withholding material information about Winehouse’s actions. Judge Stanton dismissed the suit, but declined to impose sanctions against Jaroslawicz & Jaros without issuing findings. The 2nd Circuit affirmed the dismissal but remanded the case, asking the judge to submit findings on the sanctions. Judge Stanton submitted findings and again denied sanctions. The 2nd Circuit later reversed Stanton again, ordering him to impose sanctions. After the judge ordered sanctions, both sides appealed: NU-Tech asked for full sanctions rather than half, and Jaroslawicz & Jaros argued that Judge Stanton had abused his discretion by ordering sanctions that went beyond the cost of the initial action. Jaroslawicz also argued that the sanctions should be reduced because he had recently contracted an unspecified disabling disease and because he operated a small law firm. The 2nd Circuit sided with NU-Tech, saying that the suit constituted a “substantial failure” to comply with requirements of Rule 11(b) of the Federal Rules of Civil Procedure. The court rejected Jaroslawicz’s health-related arguments, saying they could not be considered because Jaroslawicz refused to submit financial and medical evidence related to his condition. Further, the appeals court held that “the presence of some nonfrivolous claims in an otherwise frivolous complaint is not sufficient, standing alone, to establish that either the violation of Rule 11 was de minimis or that the sanctions would create an unreasonable burden, for purposes of overcoming the statutory presumption of the PSLRA.” In a 42-page opinion issued last Friday, the court discussed at length the meaning of “substantial failure” and “de minimis” under the PSLRA. “While the mischief that Congress was addressing is clear, the statutory language Congress employed is not,” Judge Calabresi wrote. In addition, the judge said the statute does not indicate what courts should do when both nonfrivolous and frivolous claims are present. Jaroslawicz argued that a complaint containing a nonfrivolous allegation could not constitute a substantial violation, and even if it did, the complaint would fall under de minimis and unreasonable burden defenses. But the 2nd Circuit rejected that reasoning, saying it would “permit the very mischief that Congress manifestly intended to prohibit.” After a lengthy examination of the legislative history, the court adopted NU-Tech’s interpretation of substantial failure: “a substantial violation occurs whenever the nonfrivolous claims that are joined with frivolous ones are insufficiently meritorious to save the complaint as a whole from being abusive.” TWO-STEP PROCEDURE The court then laid out a two-step procedure for district courts facing such suits: determine whether claims in violation of Rule 11 have been brought, and if so, examine whether nonfrivolous claims are sufficient to make “the suit as a whole nonabusive.” “If no such weighty nonfrivolous claims are attached, the statutory presumption applies,” Judge Calabresi wrote. The court left unanswered what “suffices to rebut the presumption under the rubric of de minimis.” It also did not say whether the presence of a nonfrivolous claim against one defendant might prevent frivolous claims against a second defendant from being viewed as a substantial violation of PSLRA. In addition, the court left undecided how strong nonfrivolous arguments must be to limit sanctions only to the frivolous complaints. In a separate 12-page concurring opinion, Chief Judge John M. Walker agreed with the majority’s outcome, but said there was no reason to consider the language of the PSLRA at such length. “The difficulty of applying the [PSLRA] provisions in some cases does not make the statute unclear,” Judge Walker wrote. “To the contrary, given the case-specific inquiry prescribed by Congress, and the wide range of scenarios likely to arise in this context, I fail to see how Congress could have spoken more clearly.” Judge Winter Ralph K. Winter joined in Judge Calabresi’s opinion.

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