Claims Sounding in Fraud

Claims Sounding in Fraud

Rule 9(b) turns on what the pleader alleges, not on what the count is called. By its terms the rule governs a party “[i]n alleging fraud or mistake” and then demands particularity about the circumstances constituting the fraud.¹ A count under a statute that never mentions fraud therefore falls within the rule when it rests on a misstatement the complaint calls part of a fraud, while a clearly negligence-based Securities Act claim has been held to stand outside it. The reason lies in what the requirement protects. The court in Wagner v. First Horizon Pharmaceutical Corp. took the twin purposes of providing notice and protecting reputation as its guide to the rule’s reach.² Both interests attach to the accusation of fraud wherever it appears in the complaint, so the name of the count cannot settle the question.

Fraud Alleged Elsewhere in the Complaint

Wagner arose from a complaint that combined a fraud claim with claims under sections 11 and 12(a)(2) of the Securities Act. The Securities Act claims did not depend on fraud, since a plaintiff can recover on the simple untruth of the statement. The complaint nonetheless alleged, elsewhere, that the facts underlying the misrepresentation were part of a fraud claim. The court held that a section 11 or section 12(a)(2) claim must be pleaded with particularity when the facts underlying the misrepresentation at stake are said to be part of a fraud claim alleged elsewhere in the complaint.³

Pleading in the alternative did not help the plaintiffs. The court rejected the argument that alternative pleading saves the nonfraud claims from making an allegation of fraud, because the risk to the defendant’s reputation remains unprotected. It found it would strain credulity to say that Rule 9(b) does not apply to an allegation that amounts to this: the defendant is a defrauder, but if he is not, the plaintiff still recovers on the untruth of the otherwise fraudulent statement.⁴

The holding has limits, and they follow from the same purposes. It adds no new elements to the nonfraud claims, and it does not raise the pleading standard for a claim that is not alleged to be part of another fraud-based claim. Plaintiffs who bring a section 11 or 12(a)(2) claim without alleging that the misrepresentation was fraudulent avoid the heightened requirements of Rule 9(b). The rule’s protective purpose attaches only when the plaintiffs claim that the misrepresentation is part and parcel of a larger fraud.⁵

A Claim That Necessarily Alleges a Scheme

A claim can sound in fraud even when no other count says so. In In re Digital Island Securities Litigation, the plaintiffs argued that a tender offeror had violated the Best Price Rule through a transaction executed before the tender offer. The court reasoned that a plaintiff who makes that argument necessarily alleges that the offeror fraudulently devised a scheme to circumvent the rule.⁶ The pre-offer agreement proves little by itself, because an offeror can and will enter into a wide variety of agreements, including agreements with shareholders, that are conditioned on the success of the tender offer.⁷ What turns such an agreement into a violation is the offeror’s purpose, so the plaintiffs’ theory had to be that the offeror intended to give the directors a premium for their shares through the merger agreement and an employment agreement. That theory is a charge of fraud, and the court required, in addition, facts giving rise to a strong inference of fraudulent intent under the PSLRA.⁸

The two cases differ in where the fraud charge comes from. In Wagner it sat in the complaint beside the nonfraud count, and in Digital Island it was built into the theory of the claim itself.

What Follows Once the Rule Applies

Once a claim sounds in fraud, the full standard for pleading fraud attaches. That standard appears in re Toyota Motor Corp. Unintended Acceleration Marketing, Sales Practices, and Products Liability Litigation: a plaintiff must plead each element of a fraud claim with particularity, setting forth more than the neutral facts necessary to identify the transaction, and must supply the who, what, when, where, and how of the fraudulent conduct charged.⁹

The permission to allege conditions of mind generally gives no relief from that burden. Rule 9(b) lets a party allege malice, intent, knowledge, and other conditions of mind generally.¹⁰ Yet when a complaint said, in conclusory fashion, that Cambex “knew” that IBM Credit’s leases forbade Cambex’s memory trade-ins and that the defendants “knowingly or recklessly” published misleading financial statements, the court held that this sentence did not rescue the pleading. The same rule also requires the circumstances constituting the fraud to be pleaded with particularity, and a plaintiff cannot avoid that requirement by averring generally that defendants “knew” earlier what later turned out badly. The court drew on an earlier decision that found allegations insufficient where they showed knowledge of falsity only through the company’s later poor financial performance and a document noting cash-flow problems that surfaced months after its bright prediction.¹¹

Where the Rule Stops

Authority on the rule’s outer edge is not uniform. The few decisions addressing Securities Act claims that are clearly negligence-based have held that Rule 9(b) does not apply to them.¹² That result fits the rule’s purposes, since a complaint charging only carelessness puts no accusation of dishonesty on the defendant’s reputation. Commentary adds that the heightened pleading requirement reaches tortious misrepresentation cases generally, not only cases for fraud, and cites a Kansas federal decision dismissing a conclusory claim of strict liability for misrepresentation under Restatement (Second) of Torts § 402B.¹³ The Eighth Circuit has adopted the opposite position from Wagner, holding Rule 9(b) irrelevant to sections 11 and 12(a)(2) in all circumstances, although it has recently implied that it may not adhere to that position forever.¹⁴

A complete answer therefore does three things: it states Wagner’s approach, it notes the Eighth Circuit’s contrary rule, and it identifies the facts that put the claim on one side or the other. The usual error is to decide the question from the heading of the count. A securities count with no fraud label may need Rule 9(b), and a negligence-based count may need only the ordinary pleading standard.