More importantly, in Hollinger, the Ninth Circuit expressly addresses and resolves the issue of the relation between the good faith defense and respondeat superior. "Because the liability of persons under § 20(a) represents an extension of liability beyond that imposed by common law, such persons are afforded statutory defenses not available in the principal-agent context. Controlling persons [who are not otherwise liable under common law] may thus avoid liability . . . by demonstrating that they acted in good faith." Id. at 1578. Thus, the "good faith" defense limits the application of Section 20(a): Section 20(a) and the "good faith" defense do not limit the application of respondeat superior.
Second, defendants correctly note that respondeat superior liability "negates" the scienter requirement of Rule 10b-5. As this Court wrote in the October 19 Order, "scienter is [generally treated as] an element of both primary and secondary liability under Rule 10b-5." See Robin v. Arthur & Young & Co., 915 F.2d 1120, 1126 (7th Cir. 1990). Respondeat superior liability establishes a form of secondary liability which does not require actual knowledge or recklessness on the part of the vicariously liable principal, and, as a result, conflicts with scienter requirement of Rule 10b-5.
However, while this conflict is not insignificant, it has no relation to the question at hand, i.e. whether or not respondeat superior should apply to broker-dealers and corporations. If the conflict between respondeat superior and the scienter requirement of Rule 10b-5 were fatal to the adoption of respondeat superior, then this conflict would have barred the Ninth Circuit from adopting respondeat superior in any securities fraud case. Indeed, for this Court to narrow the scope of respondeat superior on the basis of this conflict would contradict one implied ruling of Hollinger : To wit, the scienter conflict between respondeat superior and Rule 10b-5 is not sufficient to bar the adoption of respondeat superior in the securities fraud context.
Third, defendants argue that securities broker-dealers occupy a special place in the national economy, and are regularly singled out for especially stringent regulation within the securities laws. Kersh v. General Council of Assemblies of God, 804 F.2d 546, 550 (9th Cir. 1986) (identifying broker-dealers as "a special case" meriting stricter standards for secondary liability under Section 20(a)). Hence, defendants argue, the Court should treat respondeat superior as just another of the special rules applicable only to broker-dealers.
This argument has two flaws. First, while the Ninth Circuit has closely scrutinized the activities of broker-dealers, it has never limited the application of any form of secondary liability exclusively to broker-dealers. Indeed, in Kersh v. General Council of Assemblies of God,6 which is relied on by defendants, the Ninth Circuit rejected a per se rule that would distinguish broker-dealers from non broker-dealers. Instead, the Ninth Circuit looked to the practical relationship of a superior church body to a local church to determine if the superior church body was a "control person" under Section 20(a). Kersh, 804 F.2d at 550-52. The Ninth Circuit noted that failure to supervise may establish vicarious liability for brokers and non-brokers alike where superior knew of fraud, had the power to control the inferior, and/or participated financially in the fraud.
Equally important, in adopting respondeat superior in Hollinger, the Ninth Circuit relied entirely on the statutory analysis discussed above, and never discussed the special treatment of broker-dealers as a reason for bringing respondeat superior into securities fraud suits. Defendants are not asking the Court to lay bare a limitation that is already woven into the reasoning of Hollinger. Rather defendants seek a new limitation that the Court must cut from whole cloth and attach through its own initiative. This sort of legislative adjudication is best left to the appellate courts.
Finally, defendants argue that a broad interpretation of Hollinger cannot be reconciled with the law of other circuits, at least one of which does not apply respondeat superior liability to corporations. See Sharp v. Coopers & Lybrand, 649 F.2d 175, 182-83 (3rd Cir. 1981). This insight is correct, but not because national authority is uniformly, or even predominantly, in favor of limiting respondeat superior liability to broker-dealers. A broad interpretation of Hollinger cannot be reconciled with the law of other circuits because the law of other circuits is contradictory and irreconcilable: Some circuits apply respondeat superior to corporations. See In re Atlantic Financial Management Corporation, Inc., 784 F.2d 29 (1st Cir. 1986); Kerbs v. Fall River Industries, Inc., 502 F.2d 731 (10th Cir. 1974). Others do not. Sharp, 649 F.2d at 182-83. And with regard to others it is simply impossible to tell. See Hollinger, 914 F.2d at 1576 n. 27 (discussing the law of the Fourth and Sixth Circuits). There is no basis in national legal authority for preferring a broad or narrow interpretation of Hollinger. Consequently, the broad interpretation which has been supported at length above, should prevail.
For the reasons set out above, defendants motion to dismiss plaintiffs respondeat superior allegations will be denied.
D. Plaintiffs' Conspiracy Allegations.
In the October 19 Order the Court wrote, "To adequately plead conspiracy, Plaintiffs must plead specifically with regard to each Defendant the existence of an agreement and acts in furtherance of that agreement. In re Thortec Securities Litigation, [1989 Transfer Binder] Fed. Sec. L. Rep. (CCH) para. 94,330 (N.D. Cal. 1989)." Defendants now argue that the conspiracy allegations in plaintiffs' second amended complaint should be dismissed because they fail to meet the specificity requirement enunciated in the October 19 Order. To resolve this argument the Court must explain the specificity requirement of the October 19 Order in more detail.
In their first amended complaint, which was the subject of the October 19 Order, plaintiffs did not offer even conclusory allegations that each defendant had entered into an agreement. Instead, plaintiffs asked the Court to presume an agreement based on, among other things, the nominal status of defendants as corporate officers. See Wool v. Tandem Computers, Inc., 818 F.2d 1433 (9th Cir. 1987). The Court refused to apply a status based presumption and dismissed plaintiffs' conspiracy allegations.
With this background in mind, the October 19 Order should be read to require sufficient specificity to move plaintiffs' conspiracy allegations beyond the level of status based pleading. Plaintiffs are not required to plead their evidence, or to plead facts which are peculiarly within the control of defendants, such as the nature and terms of the conspiratorial agreement. Deutsch v. Flannery, 823 F.2d 1361, 1366 (9th Cir. 1987). However, plaintiffs must allege facts that connect each defendant with the conspiracy by some means other than their nominal status as directors or officers of NET.
Plaintiffs' conspiracy allegations meet this standard -- more or less. With regard to the existence of an agreement, plaintiffs have alleged that each individual defendant entered into a conspiratorial agreement, the rough time the agreement was entered, and certain terms and goals of the alleged agreement. Second Amended Complaint at paras. 12, 18. These allegations are sufficient. The details of an illegal conspiracy is information peculiarly within the control of defendants. Consequently, under Rules 9 and 8 plaintiffs are not required to plead the details of a conspiracy to defraud in exact detail. Deutsch, 823 F.2d at 1366. To require otherwise would significantly hinder, if not bar, legitimate conspiracy claims. Id.
Defendants allegations of acts in furtherance of the conspiracy are also sufficient as to defendants Warmenhoven, Roach, and Smith. Plaintiffs allege that each of these defendants made particular fraudulent misrepresentations that furthered the conspiracy by further misleading investors as to success of NET as a business venture and as to the value of NET's stock. Second Amended Complaint paras. 18, 28-51. These allegations specifically allege acts in furtherance of the conspiracy.
However, plaintiffs allegations regarding defendant Schlumberger are not sufficient. Plaintiffs have alleged no overt acts in furtherance by defendant Schlumberger. Instead, in an attempt to meet the terms of the October 19 Order, plaintiffs allege that the absence of acts in furtherance -- i.e. Schlumberger's total silence and inaction -- is itself an act in furtherance because it failed to prevent or hinder the operation of the conspiracy.
Whether silence and inaction can never constitute "acts in furtherance" is not resolved by the October 19 Order. But the October 19 Order does establish that status based pleading is insufficient to state a claim for conspiracy under the circumstance of the present case. Plaintiffs allegations regarding Schlumberger amount to status based pleading in disguise. Hence, plaintiffs allegations of conspiracy regarding Schlumberger are insufficient, and plaintiffs conspiracy claim against Schlumberger should be dismissed.
For the reasons set out above, defendants Warmenhoven and Smith's motion to dismiss plaintiffs' conspiracy claims will be denied. In addition, defendant Schlumberger's similar motion will be granted.
E. Certain Allegations Against Defendant Roach Do Not Meet The Specificity Requirement of Rule 9(b).
Rule 9 provides that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Interpreting this rule, the Court held in the October 19 Order that to allege fraud plaintiffs must specifically plead " either particular misrepresentations by identified defendants, or particular misrepresentation published through identified forms of group published information" that would give rise to a presumption that the misrepresentation originated from certain directors and officers of NET. See Semegen v. Weidner, 780 F.2d 727, 731, 735 (9th Cir. 1985) (allegations stating time, place, and manner of representation meet the requirements of Rule 9). The Court went on to strike paragraphs which alleged misrepresentations by third party financial analysts -- not "identified defendants "-- published independently of NET -- not through "group published information."
Now plaintiffs have amended and restated the paragraphs previously stricken by the Court. Second Amended Complaint at paras. 34, 40-42, 46. Plaintiffs now attempt to link the misrepresentations by third party financial analysts with "identified defendants" by averring in a generic way that the representations by third parties were "based on" information originating from defendant Roach, "inasmuch as he was the person primarily responsible for communicating on behalf of NET with analysts and was the Company's principal officer over." Second Amended Complaint at para. 34; see Second Amended Complaint at 40-42, 46.
These generic representations fail to meet the terms of the October 19 Order or Rule 9. No representations of any kind by Roach are specifically alleged. Indeed, plaintiffs do not even allege that third party financial analysts repeated other unidentified statements by Roach. Plaintiffs only allegation is that, because of Roach's status at NET, the Court might presume that he passed unidentified misinformation onto third party financial analysts at an unidentified time and place and in an unidentified manner.
As the Court indicated in the October 19 Order, the Ninth Circuit only applies such a status based presumption to "group published information," and independently published statements by financial analysts are not "group published information." Consequently, plaintiffs allegations in paragraphs 34, 40-42, and 46 of the second amended complaint are insufficient and will be stricken.
For the reasons set out above, defendants NET, Warmenhoven, and Schlumberger's motion to dismiss plaintiffs' claim for violations of Rule 10b-5 is DENIED. Defendants NET, Warmenhoven, and Schlumberger's motion to dismiss plaintiffs' respondeat superior claim against NET is also DENIED.
Defendants NET, Warmenhoven and Smith's motion to dismiss plaintiffs' conspiracy claims is DENIED. However, defendant Schlumberger's motion to dismiss plaintiffs' conspiracy claim against him is GRANTED.
Defendant Roach's motion to strike paragraphs 34, 40-42, and 46 of the second amended complaint is GRANTED.
Finally, the parties shall appear before this Court for status conference on Wednesday, April 17, 1991, at 9:00 a.m. The parties shall file status conference statements before the status conference in conformity with the local rules.
IT IS SO ORDERED.