The Third Circuit recently opined that sanctions were warranted against investors who pursued claims against an ailing company that were brought solely for the purpose of leveraging a settlement. The ruling stands as a stark warning of the potential consequences to securities lawyers and their clients if their claims are deemed frivolous.
In Scott, et al. v. Vantage Corp., et al., the plaintiff investors attempted to recover millions of dollars they invested in the company, which eventually declared bankruptcy. They claimed that the company sold securities without making required disclosures and that defendant Askew, a company officer, made misrepresentations about the company’s stock. The District of Delaware granted summary judgment in favor of the defendants in 2019, and the Third Circuit affirmed. After that affirmance, the district court performed a Private Securities Litigation Reform Act (PSLRA) mandated Rule 11 inquiry, and found that two of the plaintiffs’ three claims were asserted in violation of Rule 11, which forbids frivolous filings. However, the court did not award Askew attorneys’ fees or impose any other sanction.
The plaintiffs alleged in a 2017 complaint that Vantage sold securities to “unsophisticated and unaccredited investors” without making the proper disclosures and that Askew made misrepresentations about the company’s stock. The district court granted summary judgment in favor of the defendants in 2019, finding two of the plaintiffs’ three claims were in violation of Rule 11.
But because the third count, a securities fraud claim the district judge considered to be at the heart of the case, was not brought improperly, the lower court declined to award Askew attorney fees or any other sanction. Askew appealed the district court’s failure to impose sanctions, while the plaintiffs appealed the court’s finding that they violated Rule 11.
Congress passed the PSLRA in 1995, pursuing the “twin goals” of “curb[ing] frivolous, lawyer-driven litigation, while preserving  investors’ ability to recover on meritorious claims.’” The PSLRA provides that for any private action bringing federal securities laws claims, “the court shall include in the record specific findings regarding compliance by each party and each attorney” with Rule 11(b)’s requirements. See 15 U.S.C. § 78u-4(c)(1). In any non-PSLRA Rule 11 inquiry, a court “may” impose sanctions when parties violate Rule 11. Moreover, unlike in other Rule 11 contexts, the PSLRA creates a presumption that the appropriate sanction is an award to the opposing party of reasonable attorneys’ fees where the violation constitutes a “substantial failure” of a complaint to comply with Rule 11.
In a precedential opinion by Judge D. Brooks Smith, the panel concluded that the district court’s determination that Rule 11 was violated should be affirmed, and that the PSLRA required some sanction be imposed where a party violates Rule 11. The Third Circuit remanded the nature of the sanction to the district court.
The court noted that it is common for parties to litigate with a “hopeful eye” toward settlement. However, “plaintiffs did not simply have an eye toward settlement. They expressly stated that their ‘strategy was to file these complaints to force a settlement.’”
The Third Circuit upheld the district court’s ruling in all respects except for not awarding sanctions. “While we will affirm most of the district court’s Rule 11 order, the PSLRA’s text requires that some sanction be imposed where, as here, a party violates Rule 11,” Judge Smith explained. “Although we will not declare what is an appropriate sanction, we will vacate and remand this case to the district court to impose such Rule 11 sanctions as that court considers, in the exercise of its discretion, to be appropriate.” Judge Smith noted those sanctions could be applied in a number of ways, including the attorney fees Askew requested, or as a written order admonishing the lawyers responsible for the Rule 11 violations.
The Scott ruling is a cautionary tale for securities lawyers as it highlights a little known and inconsistently applied provision of the PSLRA mandating that courts conduct a Rule 11 inquiry at the end of the litigation, “upon final adjudication of the action.” The decision aligns with the express Congressional purpose to increase the frequency of Rule 11 sanctions in the securities context, and thus tilt the balance toward greater deterrence of frivolous securities claims. While the Third Circuit in Scott concluded that a sanction was mandated under the PSLRA and Rule 11, the panel properly reserved to the district court the discretion to determine the appropriate form of sanction suited to the circumstances.
Last modified: April 24, 2023