On April 5, 2023, the United States Court of Appeals for the Third Circuit affirmed a determination of the United States District Court for the District of Delaware that plaintiffs violated Rule 11 of the Federal Rules of Civil Procedure but vacated the portion of the lower court's order that declined to impose sanctions. Scott v. Vantage Corp., —F.4th—, 2023 WL 2780350 (3d Cir. 2023). The Third Circuit held that, for a claim governed by the Private Securities Litigation Reform Act ("PSLRA"), some form of sanctions must be imposed for a Rule 11 violation.
Under Rule 11(b), a filing must "not be[ ] presented for any improper purpose, such as to harass," the claims must be "warranted by existing law or by a nonfrivolous argument for extending" or modifying existing law, "the factual contentions [must] have evidentiary support or ... [be] likely [to] have evidentiary support after" discovery, and the parties and their attorneys must undertake an "inquiry reasonable under the circumstances" to verify compliance with Rule 11 prior to filing. Id. at *2. While Rule 11 states that a court "may impose an appropriate sanction," the PSLRA imposes additional requirements for private actions under federal securities laws. Id. The PSLRA requires that the court must make findings as to compliance with Rule 11(b) and that if a Rule 11 violation took place, the "court shall impose [Rule 11] sanctions." Id. Further, if the Rule 11 violation is "substantial," the PSLRA establishes a "presumption that the appropriate sanction ... is an award to the opposing party of  reasonable attorneys' fees." Id.
The Rule 11 determination at issue arose after the lower court granted summary judgment in favor of a particular defendant regarding claims under Sections 12(a)(1) and 12(a)(2) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. Id. at *4. After the Third Circuit affirmed the summary judgment order, the district court conducted a Rule 11 analysis, concluding that plaintiffs had filed the Securities Act claims without proper evidentiary support for an improper purpose, i.e., to "force a settlement." Id. at *5. However, the lower court did not find a Rule 11 violation for plaintiffs' Exchange Act claim, determining that because defendant moved for summary judgment only with respect to the reliance and loss causation elements of those claims, there was sufficient evidence supporting a misrepresentation and, thus, no Rule 11 violation. Id. Further, because the lower court considered the Exchange Act claim to be "at the heart of the complaint," it found plaintiffs' Rule 11 violations not to be "substantial" under the PSLRA and declined to award attorneys' fees or any other sanction. Id. at *6.
The Third Circuit affirmed the district court's finding that the Securities Act claims had been filed for an improper purpose and lacked proper evidentiary support. Id. at *7-8. While the Court "caution[ed] district courts to be wary of finding a Rule 11 violation when a plaintiff files a lawsuit alleging colorable claims yet has the ultimate goal of settling those claims," the Court held that the lower court here did not abuse its discretion in light of one plaintiff's email indicating that their express "strategy was to file these complaints to force a settlement" combined with the fact that two of plaintiffs' three federal securities claims lacked evidentiary support. Id. at *7. The Court further held that the lower court did not abuse its discretion in determining that the Securities Act claims lacked proper evidentiary support, noting that, for the Section 12(a)(1) claim, the complaint made only general allegations about unaccredited investors, without identifying any specific individuals, and that Section 12(a)(2) claims are inapplicable to private stock offerings like the one at issue. Id. at *8. The Court also found no abuse of discretion with respect to the district court's consideration of the Exchange Act claim. Id.
The Third Circuit similarly found no abuse of discretion in the district court's decision not to award attorneys' fees based on its determination that the Rule 11 violation was not "substantial" under the PSLRA. Id. at *9. In doing so, the Court adopted what it termed a "streamlined version" of the Fourth Circuit's approach to assessing whether a complaint substantially violates Rule 11. Thus, if a court determines that some claims violate Rule 11 and others do not, the court should examine the claims collectively to assess whether the Rule 11 violations render the complaint, as a whole, frivolous. Id.
The Third Circuit held that the lower court erred, however, in failing to impose any sanction whatsoever for the Rule 11 violation, ruling that the PSLRA mandates sanctions by using the word "shall" instead of the "may" found in Rule 11. Id. at *10. The Court accordingly vacated the district court's order and instructed the district court to use its discretion to impose some form of sanctions, which could "run the gamut" from awarding attorneys' fees to a written order admonishing plaintiffs' counsel. Id.
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