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A heightened pleading standard applies for securities fraud claims brought because of false information or omissions in registration statements or prospectuses, the 2nd U.S. Circuit Court of Appeals has ruled. Deciding a case of first impression in the circuit, the appeals court has extended the requirement of pleading fraud with particularity to sections of the Securities Act of 1933 that do not require the plaintiff to show the defendant had fraudulent intent. This means that claims under securities laws for false filing statements or prospectuses must now show what statements were made, when, by whom, and why they were fraudulent. The 2nd Circuit affirmed a decision by Eastern District Judge Sterling Johnson, who dismissed a stock fraud case — brought under �� 11 and 12(a)(2) of Securities Act of 1933 — that involved a bankrupt company in the business of buying and operating golf courses. The issue in Rombach v. Chang, 02-7907, centered on a requirement of Federal Rule of Civil Procedure 9(b) that a plaintiff plead with sufficient “particularity.” Sections 11 and 12(a)(2) were cited in complaints filed by investors in Family Golf Centers Inc., which at one time operated 119 golf facilities throughout the United States. The complaints charged that executives with the company and underwriters who handled its securities made a number of misleading statements about financial problems leading up to its bankruptcy in May 2000. Section 11 of the Securities Act of 1933 imposes liability on those who sign registration statements that “contained an untrue statement of a material fact … necessary to make the statements therein not misleading.” Section 12(a)(2) imposes liability on a person who sells securities using a prospectus that contains similar omissions or misstatements. The offending statements were made in press releases, analyst reports and a slide used in a presentation for a secondary stock offering made by the company. It was also alleged that a registration statement and a prospectus issued by the company contained false and misleading information. Eastern District Judge Johnson granted the defendants’ motion to dismiss, finding that the plaintiffs “fail to plead fraud with particularity on their � 10(b) and Section 11 claims” because the allegations “do not sufficiently explain how any of the statements attributed to Defendants are false or misleading.” Johnson also dismissed claims against the underwriters, saying their “optimistic remarks” about the company’s acquisition of new courses included “substantial cautionary language and specific risk factors.” He also said their statements were “protected by traditional ‘bespeaks caution’ doctrine and the safe harbor provision” of the Private Securities Litigation Reform Act. ON APPEAL Writing on the appeal, Judge Dennis Jacobs said that “[i]n deciding this issue, several circuits have distinguished between allegations of fraud and allegations of negligence, applying Rule 9(b) only to claims pleaded under Section 11 and Section 12(a)(2) that sound in fraud.” By contrast, he said, the 8th Circuit has ruled that the particularity requirement does not apply to � 11 of the Securities Act because a plaintiff does not have to prove fraud or a mistake to establish liability. Jacobs said, “Fraud is not an element or a requisite to a claim” under �� 11 or 12(a)(2), but that “claims under those sections may — and often are — predicated on fraud. “The same course of conduct that would support a Rule 10b-5 claim may as well support a Section 11 claim or a claim under Section 12(a)(2),” he said. “So while a plaintiff need allege no more than negligence to proceed” under those sections, “claims that do rely upon averments of fraud are subject to the test of Rule 9(b).” The 2nd Circuit, he said, agreed with Johnson that the claims against the individual defendants “sound in fraud and the claims against the underwriters sound in negligence.” And the court also agreed with Johnson, he said, that the complaint lacked the particulars necessary to meet the standard set forth in Rule 9(b) and the 2nd Circuit’s interpretation Jacobs said the press releases issued by the company over time “grew hedged and guarded,” and, agreeing with Johnson, he added that “expressions of puffery and corporate optimism do not give rise to securities violations.” “To succeed on this claim, plaintiffs must do more than say that the statements in the press releases were false and misleading;” he said, “they must demonstrate with specificity why and how that is so.” Similar problems existed with the slide used in presentations, he said, and the plaintiffs failed to show specifically why the information in analyst reports was “in fact, fraudulent.” Finally, he said, the registration statement for the company’s secondary offering provided, as a whole, “a sobering picture of Family Golf’s financial condition and future plans.” Judges Guido Calabresi and Sonia Sotomayor joined in the opinion. Ralph M. Stone and John F. Carroll Jr. of Shalov Stone & Bonner represented the plaintiffs. Clifford Thau of Vinson & Elkins represented the individual defendants. Lisa Klein Wager and Adrienne M. Ward of Morgan, Lewis & Bockius represented Jeffries & Co.

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