Richard F. Thompson v. Relationserve Media, Inc.

[PUBLISH]

IN THE UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT FILED

________________________ U.S. COURT OF APPEALS

ELEVENTH CIRCUIT

No. 07-13225 JUNE 30, 2010

________________________ JOHN LEY

CLERK

D. C. Docket No. 06-61327-CV-PCH

RICHARD F. THOMPSON,

Plaintiff,

L. ALAN JACOBY,

Plaintiff-Appellant

Cross-Appellee,

versus

RELATIONSERVE MEDIA, INC.,

a.k.a. SendTec, Inc.,

Defendant-Appellee,

DANIELLE KARP,

Defendant-Appellee

Cross-Appellant,

MANDEE HELLER ADLER,

WARREN “PETE” MUSSER,

SCOTT YOUNG, et al.,

Defendants-Appellees.

________________________

Appeals from the United States District Court

for the Southern District of Florida

_________________________

(June 30, 2010)

Before TJOFLAT and BLACK, Circuit Judges, and EVANS,* District Judge.

BLACK, Circuit Judge:

This case comes to us as an appeal from the dismissal of appellant L. Alan

Jacoby’s putative class action lawsuit. In his Second Amended Complaint, Jacoby

alleged RelationServe Media, Inc.1 and eleven of its directors and employees2

violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by failing

*

Honorable Orinda D. Evans, United States District Judge for the Northern District of

Georgia, sitting by designation.

1

The principal defendant in this case, RelationServe Media, Inc. (RelationServe), is an

internet marketing firm that maintains its principal place of business in Fort Lauderdale, Florida.

RelationServe and Chubasco Resources Corporation merged on June 13, 2005. Following the

merger, Chubasco Resources Corporation changed its name to RelationServe. On July 26, 2006,

RelationServe changed its name to SendTec, Inc. For purposes of this opinion, we refer to

SendTec, Inc. as RelationServe.

2

These defendants, with the exception of one, are (or were) officers and/or directors of

RelationServe (Officers). Between June 2005 and February 2006, Danielle Karp served as

President, Scott Hirsch served as Chief Operating Officer, and Adam Wasserman served as

Chief Financial Officer (CFO). Eric Obeck has served as President since February 2006.

Mandee Adler served as Chief Executive Officer (CEO) between June 2005 and November

2005, followed by Shawn McNamara as interim CEO and Vice President until June 2006. In

February 2006, Paul Soltoff became CEO, and Donald Gould became CFO. Warren Musser was

appointed Chairman of the Board of Directors in June 2005 and served until October 2005, at

which point Michael Brausser became Chairman of the Board and served until September 2006.

Scott Young was the founder and president of Chubasco and served in that capacity until June

13, 2005.

2

to disclose, before the company went public, that $2,000,000 in stock had been

privately offered for sale by unregistered brokers in ten different states. In the

district court, Jacoby joined co-plaintiff Richard Thompson, who had previously

initiated this action. Thompson represented a subclass seeking recovery premised

on state law claims in the Second Amended Complaint. After twice allowing the

plaintiffs to amend their complaint, the district court dismissed with prejudice

Jacoby’s § 10(b) and § 20(a) claims pursuant to Fed. R. Civ. P. 12(b)(6). The

district court found the allegations of the Second Amended Complaint failed to

satisfy the heightened pleading requirements of the Private Securities Litigation

Reform Act (PSLRA)3 and Rule 9(b) of the Federal Rules of Civil Procedure. The

court then dismissed Thompson’s state law claims without prejudice after

concluding it no longer had supplemental jurisdiction over those claims. In

separate orders, on three different occasions, the district court denied defendant

Danielle Karp’s motions for attorneys’ fees and Rule 11 sanctions.

Jacoby appeals the dismissal of his federal securities-law putative class

action. Additionally, Karp cross-appeals the denial of her request for Rule 11

3

The PSLRA applies to private actions seeking relief on the basis of alleged violations

of the Securities Act of 1933 and the Securities Exchange Act of 1934. See 15 U.S.C. § 77z-1(c)

(1933 Act) and 15 U.S.C. § 78u-4(c) (1934 Act).

3

sanctions and attorneys’ fees.4 Because we conclude the Second Amended

Complaint fails to satisfy the standard for pleading scienter, we affirm the district

court’s dismissal of Jacoby’s § 10(b) and § 20(a) claims. With regard to sanctions,

we remand to the district court to make findings in accordance with the PSLRA.

I. FACTUAL ALLEGATIONS 5

On May 24, 2005, RelationServe entered into an Independent Consulting

Agreement with Summit Financial Partners, LLC (Summit). Under the agreement,

Summit sold shares of RelationServe through a private offering to investors in

exchange for 1,050,000 shares of stock and a 7% seller’s fee.

On June 14, 2005, RelationServe filed a Form 10-QSB quarterly statement,

its first Securities and Exchange Commission (SEC) filing, indicating Chubasco

Resources Corporation (Chubasco) had completed a reverse acquisition of

RelationServe. RelationServe Media Inc. Quarterly Report–Small Business (Form

10-QSB), at 5 (June 14, 2005).6 On June 16, 2005, RelationServe filed a Form 8-K

4

Karp also cross-appeals the dismissal of Thompson’s state law claims, contending she

is aggrieved because Thompson re-filed the claims in state court and she “is now facing the same

frivolous allegations.” Thompson’s state court action has subsequently been dismissed with

prejudice, so we decline to consider this aspect of Karp’s cross-appeal.

5

In considering a motion to dismiss, we accept all well-pleaded facts as true, and we

make all reasonable inferences in favor of the plaintiff. Bryant v. Avado Brands, Inc., 187 F.3d

1271, 1273 n.1 (11th Cir 1999)). Because the Second Amended Complaint alleges violations of

securities laws, we may also take judicial notice of relevant SEC filings. Id. at 1278.

6

RelationServe had no duty to file securities filings prior to the merger with Chubasco.

4

and disclosed, for the first time, the Independent Consulting Agreement7 with

Summit. RelationServe Media Inc., Current Report (Form 8-K), at 29 (June 16,

2005).8 On June 28, 2005, twelve days after RelationServe disclosed its

relationship with Summit, Richard F. Thompson, an Indiana resident, purchased

50,000 shares at $2.00 per share. Tony Altavilla, a Summit employee, had advised

Thompson about the private offering and helped facilitate Thompson’s purchase of

the shares. On June 30, 2005, RelationServe became a publicly-traded company

and reported to the SEC it had received $2,000,000 in subscriptions through a

private offering.9 That same day, RelationServe listed its non-restricted shares on

the Over the Counter Bulletin Board. On July 22, July 26, and August 12, 2005, L.

Alan Jacoby purchased a total of 10,000 shares of RelationServe on the open

market.

7

A full copy of the Agreement between RelationServe and Summit was attached to the

SEC filing as an exhibit; this attachment included language which explicitly noted Summit was

not acting as a broker/dealer for RelationServe, but rather serving as a promoter of the company.

8

The Second Amended Complaint omitted any reference to RelationServe’s June 16,

2005, Current Report.

9

The report filed with the SEC disclosed RelationServe “completed a private offering of

Units to ‘accredited investors,’” RelationServe “received and accepted $2,000,000 of

subscriptions in the Offering,” and “[t]he Units were issued in reliance on an exemption from

registration provided under Regulation D of the Securities Act and are restricted securities as

defined by the Securities Act.” RelationServe Media, Inc., Current Report (Form 8-K), at 2

(June 30, 2005).

5

On March 3, 2006, Thompson filed a lawsuit in Indiana state court against

RelationServe and several of the defendants named in this federal action.

Unrelated to this litigation, RelationServe filed a registration statement with the

SEC on March 20, 2006. This statement did not mention the Thompson litigation.

On May 1, 2006, RelationServe amended the registration statement to provide the

public with notice of the lawsuit, and indicated it believed the suit lacked merit. In

response to an inquiry from the SEC requesting more details about the lawsuit,

RelationServe updated its filings on May 23, 2006.10

On May 23, 2006, RelationServe stock was valued at $1.35 per share. Three

weeks later, on June 15, 2006, the stock was valued at $0.63 per share. Jacoby

attributes this decline in value to the public disclosure of Thompson’s lawsuit.

II. PROCEEDINGS IN THE DISTRICT COURT

On August 28, 2006, Thompson initiated this action by filing a class action

in the United States District Court for the Southern District of Florida.

RelationServe and the other defendants moved to dismiss the complaint; the

10

The May 23 amendment stated, in part, “[t]he Company intends to file a motion to

dismiss this action because the shares did not need to be registered under Indiana Law, as they

were exempt from registration as a ‘federal covered security.’” RelationServe Media, Inc.,

Amendment No. 2 to Form SB-2 Registration Statement (Form SB-2/A), at 64-65 (May 23,

2006). The amendment also noted “Mr. Altavilla did not sell shares on the Company’s

behalf[,]” although he “did receive, in addition to other compensation, a finder’s fee in the

amount of 7% of total gross funding provided for introductions made by him to investors not

already having a preexisting relationship with the Company.” Id.

6

district court then denied these motions and ordered that Thompson file an

amended complaint. On November 13, 2006, Thompson filed the First Amended

Complaint, which added Jacoby as a co-plaintiff. The defendants again moved to

dismiss, and on March 6, 2007, the district court dismissed the amended complaint

without prejudice.

On March 19, 2007, Thompson and Jacoby filed the Second Amended

Complaint, raising claims for two putative classes: one, led by Thompson, which

included all purchasers of securities through unregistered broker/dealers of

RelationServe, and another, led by Jacoby, which included all purchasers who

bought RelationServe stock on the open market prior to May 23, 2006. Defendants

then moved to dismiss the Second Amended Complaint for failure to state a claim,

and this time the district court granted the motion with prejudice, concluding

Jacoby had failed to state a claim for a violation of either § 10(b) or § 20(a) of the

Securities Act. The district court also dismissed without prejudice Thompson’s

state law claims for lack of subject matter jurisdiction.

Once before and twice after the district court dismissed the Second

Amended Complaint, defendant Karp moved for Rule 11 sanctions and attorneys’

fees, contending the claims against her were frivolous and demonstrated an utter

7

lack of legal or factual investigation. The district court denied the motions in three

separate orders. This appeal and cross-appeal ensued.

III. DISCUSSION

Our discussion is divided into three parts. First, we address whether the

Second Amended Complaint satisfies the standard for pleading scienter. Second,

we address whether the Second Amended Complaint states a claim of secondary

liability under § 20(a). Third, we address the district court’s refusal to impose

Rule 11 sanctions and award attorneys’ fees.

A. Scienter Pleading Requirements

We review the grant of a motion to dismiss for failure to state a claim under

Fed. R. Civ. P. 12(b)(6) de novo. Fin. Sec. Assurance, Inc. v. Stephens, Inc., 500

F.3d 1276, 1282 (11th Cir. 2007).

In Count I, Jacoby asserted a violation of § 10(b) of the Securities Act and

SEC Rule 10b-5. Section 10(b) of the Securities Act makes it unlawful to “use or

employ, in connection with the . . . sale of any security . . . any manipulative or

deceptive device or contrivance.” 15 U.S.C. § 78j(b). Pursuant to § 10(b), the

SEC promulgated Rule 10b-5, which makes it unlawful, among other things, “to

make any untrue statement of a material fact or to omit to state a material fact

8

necessary in order to make the statements made, in the light of the circumstances

under which they were made, not misleading.” 17 C.F.R. § 240.10b-5(b).

To state a claim for a violation of § 10(b), a plaintiff must allege: (1) the

existence of a material misrepresentation (or omission), (2) made with scienter

(i.e., “a wrongful state of mind”), (3) in connection with the purchase or sale of any

security, (4) on which the plaintiff relied, and (5) which was causally connected to

(6) the plaintiff’s economic loss. Dura Pharm. Inc. v. Broudo, 544 U.S. 336, 341-

42, 125 S. Ct. 1627, 1631 (2005); see also Bryant v. Avado Brands, Inc., 187 F.3d

1271, 1281 (11th Cir. 1999) (elaborating on the scienter requirement).11 Because

Rule 10b-5 sounds in fraud, the plaintiff must plead the elements of its violation

with particularity. See Mizzaro v. Home Depot, Inc., 544 F.3d 1230, 1237 (11th

Cir. 2008) (stating Rule 9(b) requires securities fraud complaints “to state with

particularity the circumstances constituting fraud”).

When a § 10(b) claim is brought by a private litigant, it is subject to the

PSLRA, under which a plaintiff must “state with particularity facts giving rise to a

strong inference that the defendant acted with the required state of mind.” 15

U.S.C. § 78u-4(b)(2). In this context, a “strong inference” of scienter is one that is

11

Because we hold the Second Amended Complaint fails to satisfy the standard for

pleading scienter, we do not reach the questions of whether the Second Amended Complaint

adequately pleads the other elements of a § 10(b) claim.

9

“more than merely plausible or reasonable—it must be cogent and at least as

compelling as any opposing inference of nonfraudulent intent.” Tellabs, Inc. v.

Makor Issues & Rights, Ltd., 551 U.S. 308, 314, 127 S. Ct. 2499, 2504-05 (2007).

Three guidelines govern our review: courts must (1) “accept all factual allegations

in the complaint as true,” (2) “consider the complaint in its entirety” and determine

“whether all of the facts alleged, taken collectively, give rise to a strong inference

of scienter,” and (3) “take into account plausible opposing inferences.” Tellabs,

551 U.S. at 322-23, 127 S. Ct. at 2509; see also Rosenberg v. Gould, 554 F.3d 962,

965 (11th Cir. 2009). Moreover, “scienter must be found with respect to each

defendant and with respect to each alleged violation of the statute.” Phillips v.

Scientific-Atlanta, Inc., 374 F.3d 1015, 1017-18 (11th Cir. 2004).

Although the PSLRA imposes a heightened standard for pleading scienter, it

does not alter the substantive intent requirements necessary to establish a § 10(b)

and Rule 10b-5 violation. Mizzaro, 544 F.3d at 1238. In this Circuit, § 10(b) and

Rule 10b-5 require a showing of either an “intent to deceive, manipulate, or

defraud,” or “severe recklessness.” Id. (quoting Bryant, 187 F.3d at 1282). An

allegation of “severe recklessness” must satisfy a demanding standard:

Severe recklessness is limited to those highly unreasonable omissions

or misrepresentations that involve not merely simple or even

inexcusable negligence, but an extreme departure from the standards

of ordinary care, and that present a danger of misleading buyers or

10

sellers which is either known to the defendant or so obvious that the

defendant must have been aware of it.

Bryant, 187 F.3d at 1282 n.18. Accordingly, to survive a motion to dismiss,

Jacoby “must (in addition to pleading all of the other elements of a § 10(b) claim)

plead ‘with particularity facts giving rise to a strong inference’ that the defendants

either intended to defraud investors or were severely reckless when they made the

allegedly materially false or incomplete statements.” Mizzaro, 544 F.3d at 1238.

The Second Amended Complaint alleges RelationServe did not disclose a

broker was involved in the securities sale to hide the fact that RelationServe sold

securities through unregistered brokers. Further, the Second Amended Complaint

asserts this act of hiding RelationServe’s use of a broker “could not have been

perpetrated over a substantial period of time . . . without the knowledge and

complicity of the . . . individual Defendants.” Viewed holistically, the Second

Amended Complaint alleges the following facts as supporting a reasonable

inference of scienter: (1) ten of the individual defendants “signed [or authorized]

one or more certification[s] pursuant to the Sarbanes-Oxley Act that impermissibly

omitted material facts;” (2) each individual defendant held a management position

at RelationServe; (3) each individual defendant was “involved in the drafting,

producing, reviewing, and/or dissemination of misleading statements and [was]

aware [of]—or recklessly disregarded—the fact that misleading statements were

11

being issued and approved or ratified these statements;” (4) each individual

defendant, “by virtue of [his or her] receipt of information . . . , control over or

receipt of RelationServe[’s] materially misleading statements and/or [his or her]

associations with RelationServe . . . [was an] active and culpable participant[];” (5)

several individual defendants signed SEC forms “that failed to indicate

RelationServe had contracted with Summit;” and (6) there were “accounting

irregularities” in RelationServe’s financial statements.

These conclusory allegations are insufficient to establish a “strong inference

that the defendants acted with the required state of mind.” See Tellabs, 551 U.S.

at 314, 127 S. Ct. at 2504. The inference that the individual defendants purposely

failed to disclose the use of unregistered brokers to mislead the public regarding

the company’s worth is not as compelling as the competing inference that the

defendants did not disclose its use of unregistered brokers because the brokers

were exempt from registration. Without an allegation that any of the named

defendants knew the Summit employees (1) were not registered brokers and (2)

were required to be registered brokers, we cannot conclude the inference of

nefarious wrongdoing is “at least as compelling as any opposing inference of

nonfraudulent intent.” See id.

12

Even if the Second Amended Complaint alleged the sales were not exempt

transactions, it would still not be a “cogent” possibility that the defendants failed to

disclose the use of unregistered brokers for the purpose of misleading the public.

The Second Amended Complaint does not allege facts tending to show that any of

the individual defendants were even aware of RelationServe’s relationship with

Summit. This is particularly so with respect to defendants Soltoff, Obeck, and

Gould—who, according to the Second Amended Complaint, were not employed by

RelationServe until after the events relied on by plaintiffs occurred—and with

respect to defendant Young—who, according to the Second Amended Complaint,

was not employed by RelationServe.

Simply put, the allegations in the Second Amended Complaint are

insufficient to create a “strong inference” of scienter. Accordingly, the district

court did not err by dismissing Jacoby’s § 10(b) and Rule 10b-5 claims against the

individual defendants under the heightened pleading standards imposed by the

PSLRA.

Although the Second Amended Complaint failed to adequately plead

scienter for any of the individual defendants, theoretically, the Second Amended

Complaint could create a strong inference that the corporate defendant,

RelationServe, acted with the requisite state of mind. Mizzaro, 544 F.3d at 1254.

13

Corporations have no state of mind of their own; rather, the scienter of their agents

must be imputed to them. Id. Here, the Second Amended Complaint fails to

sufficiently plead scienter as to any of the individuals who served as corporate

directors or officers of RelationServe, and there are no other allegations that give

rise to an inference of scienter. Thus, we affirm the district court’s dismissal of

Count I for failure to state a cause of action under § 10(b) and Rule 10b-5 of the

Securities Exchange Act.

B. Secondary Liability Under Section 20(a)

In Count II, Jacoby asserted a violation of § 20(a) of the Securities Exchange

Act. Section 20(a) provides:

Every person who, directly or indirectly, controls any person liable

under any provision of this chapter or of any rule or regulation

thereunder shall also be liable jointly and severally with and to the

same extent as such controlled person to any person to whom such

controlled person is liable, unless the controlling person acted in good

faith and did not directly or indirectly induce the act or acts

constituting the violation or cause of action.

15 U.S.C. § 78t(a). Section 20(a) is not a freestanding claim but rather a means of

imposing liability “not only on the person who actually commits a securities law

violation, but also on an entity or individual that controls the violator.” Laperriere

v. Vesta Ins. Group, Inc., 526 F.3d 715, 721 (11th Cir. 2008).

14

Because a primary violation of the securities law is an essential element of a

§ 20(a) derivative claim, a plaintiff who pleads a § 20(a) claim can withstand a

motion to dismiss only if the primary violation is pleaded with legal sufficiency.

Garfield v. NDC Health Corp., 466 F.3d 1255, 1261 (11th Cir. 2006). As the

Second Amended Complaint failed to allege primary liability under § 10(b), there

can be no secondary liability under § 20(a). Thus, we affirm the district court’s

dismissal of Count II for failure to state a cause of action under § 20(a) of the

Securities Exchange Act.

C. Rule 11(b) Sanctions

We review the denial of sanctions under Federal Rule of Civil Procedure 11

for abuse of discretion. BankAtlantic v. Blythe Eastman Paine Webber, Inc., 955

F.2d 1467, 1478 (11th Cir. 1992). A district court’s denial of sanctions under the

PSLRA is reviewed under the same standard. See Morris v. Wachovia Sec., Inc.,

448 F.3d 268, 277 (4th Cir. 2006) (noting review of “all aspects” of a district

court’s Rule 11 determination is for abuse of discretion, and “[n]othing in the

Reform Act’s sanctions provision changes this standard of review”); Hartmarx

Corp v. Abboud, 326 F.3d 862, 866-67 (7th Cir. 2003) (reviewing the district

court’s imposition of sanctions under the PSLRA for abuse of discretion); Gurary

v. Nu-Tech Bio-Med, Inc., 303 F.3d 212, 219 (2d Cir. 2002) (same).

15

Congress passed the PSLRA in 1995, “motivated in large part by a perceived

need to deter strike suits by opportunistic private plaintiffs that filed securities

fraud claims of dubious merit in order to exact large settlement recoveries.”

Laperriere, 526 F.3d at 719 (quoting Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir.

2000)). Through the PSLRA, Congress hoped to put an end to “the abuse of the

discovery process to impose costs so burdensome that it is often economical for the

victimized party to settle.” Id.

In addition to raising the standard for pleading scienter, the PSLRA

“mandate[s] imposition of sanctions for frivolous litigation.” Merrill Lynch,

Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 81, 126 S. Ct. 1503, 1511

(2006). The PSLRA provides:

In any private action arising under this chapter, upon final

adjudication of the action, the court shall include in the record

specific findings regarding compliance by each party and each

attorney representing any party with each requirement of Rule

11(b) of the Federal Rules of Civil Procedure as to any

complaint, responsive pleading, or dispositive motion.

15 U.S.C. § 78u-4(c)(1) (emphasis added). If the court finds a party or attorney

violated any requirement of Rule 11(b), the court “shall” impose sanctions in

accordance with Rule 11. 15 U.S.C. § 78u-4(c)(3). If a complaint substantially

fails to comply with Rule 11(b), the presumptive sanction is attorneys’ fees and

expenses. 15 U.S.C. § 78u-4(c)(2). Accordingly, the PSLRA’s provisions

16

eliminate a district court’s discretion on two fronts: (1) in choosing whether to

conduct the Rule 11(b) inquiry and (2) in determining whether to impose sanctions

following a finding of a Rule 11(b) violation. See Morris, 448 F.3d at 276

(“Because the sanctions instruction comes in terms of the mandatory ‘shall,’ which

normally creates an obligation impervious to judicial discretion, the district court

must impose sanctions for each violation found.” (internal citation and quotation

marks omitted)); Simon DeBartolo Group, L.P. v. The Richard E. Jacobs Group,

Inc., 186 F.3d 157, 167 (2d Cir. 1999) (noting the PSLRA circumscribes a district

court’s discretion “in choosing whether to conduct the Rule 11 inquiry at all and

whether and how to sanction a party once a violation is found”).

Although the PSLRA alters the consequences of a Rule 11(b) violation in a

private securities fraud action, the substantive analysis under Rule 11 remains the

same.12 See 15 U.S.C. § 78u-4(c); see also Citibank Global Mkts., Inc. v. Santana,

573 F.3d 17, 32 (1st Cir. 2009) (noting the PSLRA “does not alter the standards

used to judge compliance with Rule 11”); Morris, 448 F.3d at 276 (“[F]or private

securities fraud suits Congress altered the consequences of a Rule 11(b) violation

12

Under Rule 11, sanctions are properly assessed when: (1) a party files a pleading that

has no reasonable factual basis; (2) the party files a pleading based on a legal theory that has no

reasonable chance of success and cannot be advanced as a reasonable argument to change

existing law; or (3) the party files a pleading in bad faith for an improper purpose. Massengale

v. Ray, 267 F.3d 1298, 1301 (11th Cir. 2001).

17

but did not rewrite the conventional standards for evaluating Rule 11(b)

compliance.”); Simon DeBartolo Group, L.P., 186 F.3d at 167 (“The PSLRA does

not in any way purport to alter the substantive standards for finding a violation of

Rule 11 . . . .”). Moreover, nothing in the PSLRA changes our abuse of discretion

standard of review of the district court’s Rule 11(b) findings. This position is

supported by the reasoning in Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 110

S. Ct. 2447 (1990), in which the Supreme Court held an abuse-of-discretion

standard applies “in reviewing all aspects of a district court’s Rule 11

determination,” including the legal aspects. Id. at 405, 110 S. Ct. at 2461. The

Cooter & Gell Court noted “[l]egal issues are raised in considering whether a

pleading is ‘warranted by existing law or a good faith argument’ for changing the

law and whether the attorney’s conduct violated Rule 11.” Id. at 399, 110 S. Ct. at

2457. It then explained even purely legal issues in the Rule 11 context require a

district court “to consider issues rooted in factual determinations.” Id. at 401, 110

S. Ct. at 2459. In this regard, “the district court is better situated than the court of

appeals to marshal the pertinent facts and apply the fact-dependent legal standard

mandated by Rule 11.” Id. at 402, 110 S. Ct. at 2459.

In this case, however, the district court’s conclusory Rule 11 analysis is not

sufficient to permit meaningful appellate review. Although the district court

18

explicitly denied Karp’s motion for sanctions,13 its one paragraph order provides

no explanation of the basis for its ruling and does not include the specific findings

the PSLRA requires.14 Specifically, the district court’s order does not discuss

“compliance by each party and each attorney representing any party with each

requirement of Rule 11(b) of the Federal Rules of Civil Procedure as to any

complaint, responsive pleading, or dispositive motion.” 15 U.S.C. § 78u-4(c)(1).

In fact, nowhere in the June 12, 2007, order did the district court even mention the

PSLRA or any of its requirements. As a result, we remand the case to the district

court to permit it to make the PSLRA-mandated findings in the first instance.15

13

The order stated: “Plaintiffs’ claims are not frivolous, or so devoid of evidentiary

support as to warrant sanctions. Likewise, there is no evidence that Plaintiffs instituted this

action for improper purposes, such as to harass Defendants or needlessly increase the cost of

litigation.”

14

On July 16, 2007, Karp filed a second motion for attorneys’ fees and costs and moved

the court to reconsider its June 12, 2007, sanctions order, contending the PSLRA required the

court to conduct a more exacting inquiry into counsel’s compliance with Rule 11(b). The court

denied her motion without explication on July 27, 2007. On August 3, 2007, Karp moved the

court to clarify its ruling to indicate whether it had denied her motion for reconsideration on the

merits. The court, on November 20, 2007, entered an order adhering to its rulings that plaintiffs’

counsel had not violated Rule 11(b). These motions and orders are not before us because the

district court lost jurisdiction over the matter of sanctions upon the filing of the notices of

appeal. Green Leaf Nursery v. E.I. DuPont de Nemours & Co., 341 F.3d 1292, 1309 (11th Cir.

2003) (“The filing of a notice of appeal is an event of jurisdictional significance—it confers

jurisdiction on the court of appeals and divests the district court of its control over those aspects

of the case involved in the appeal.”) (quoting Griggs v. Provident Consumer Disc. Co., 459 U.S.

56, 58, 103 S. Ct. 400, 402 (1982)). Regardless, the district court’s November 20, 2007, order

added nothing of substance to the June 12, 2007, sanctions order, and is likewise inadequate to

allow meaningful appellate review.

15

Remand is consistent with the Supreme Court’s admonition in Sprint/United Mgmt.

Co. v. Mendelsohn, 552 U.S. 379, 128 S. Ct. 1140 (2008), that the circuit court should have

19

This approach is consistent with the procedure we use when a district court fails to

make the PSLRA sanctions findings altogether. See Ehlert v. Singer, 245 F.3d

1313, 1320-21 (11th Cir. 2001) (remanding for compliance with the PSLRA where

the district court made no Rule 11 findings).16

It may be tempting to engage in sanctions determinations ourselves, given

the apparent frivolity of the plaintiffs’ claims. In fact, the extensive record on

appeal may actually make such determinations possible. But, even assuming we

have the ability to conduct a thorough Rule 11 analysis, doing so in this case would

be ill-advised. Remand is the better route.

First, as is almost always the case, the district court is “better situated” than

this Court “to marshal the pertinent facts and apply the fact-dependent legal

standard mandated by Rule 11.” See Cooter & Gell, 496 U.S. at 402, 110 S. Ct. at

remanded to allow the district court to make its “determinations in the first instance, explicitly

and on the record.” Id., 128 S. Ct. at 1146. In Mendelsohn, the district court essentially

provided no explanation of the basis for its evidentiary ruling, but the circuit court presumed the

district court applied the incorrect standard and proceeded to engage in its own analysis. Id. at

1144. The Supreme Court noted the broad discretion afforded to a district court’s evidentiary

rulings and concluded the circuit court should have remanded to the district court, instead of

engaging in its own inquiry. Id. at 1144-46. Although Mendelsohn dealt with an evidentiary

ruling, the reasoning is applicable here. Both evidentiary rulings and Rule 11(b) findings are

reviewed under the deferential abuse of discretion standard. See id.; Morris, 448 F.3d at 277.

16

This approach is also consistent with the procedure followed by the Second Circuit.

See Rombach v. Chang, 355 F.3d 164, 178 (2d Cir. 2004) (remanding for compliance with the

PSLRA when the district court failed to make the required Rule 11 findings); Gurary v.

Winehouse, 190 F.3d 37, 47 (2d Cir. 1999) (remanding for findings regarding Rule 11(b)

compliance pursuant to the PSLRA after the district court implicitly denied a motion for

sanctions).

20

2459. Given the district court’s familiarity with the case and the parties, the

district court is in a better position “to make these determinations in the first

instance, explicitly and on the record.” See Sprint/United Mgmt. Co. v.

Mendelsohn, 552 U.S. 379, 387, 128 S. Ct. 1140, 1146 (2008). Moreover, our

analysis of the sanctions issue would likely further develop the record by, for

example, expounding upon the relevant SEC filings or drawing inferences from

undisputed facts. Consequently, if we elect to make such sanctions findings at the

appellate level, the parties would necessarily be less involved in the process and

would be unable to object if and when appropriate.

Further, our decision to remand recognizes that when the district court

engaged in its sanctions analysis in 2007 our Circuit had not yet explicitly

addressed the level of specificity required by the PSLRA. To be sure, the PSLRA,

by its own terms, clearly requires findings as to each claim, each party, and each

attorney, such that the district court’s perfunctory analysis was insufficient even

without clear precedent from this Court. It is not until this case, however, that we

emphasize just how extensive the district court’s sanctions findings must be in the

PSLRA context. Thus, in light of our reiteration and accentuation of the PSLRA’s

requirements, it is appropriate to permit the district court to engage in a PSLRA-

compliant sanctions analysis prior to appellate review.

21

Additionally, we recognize the practical reality that this appeal arises from

complex factual circumstances that have not been organized in such a manner to

facilitate efficient sanctions review. As a result, prior to engaging in a Rule 11(b)

analysis, we would first have to unravel the dense record and examine it in a way

that no other issue in this case requires us to do. This task would require us to

obtain a level of familiarity with the parties and the evidence that the district court

already has; as a result, we would end up replicating much of the work that the

district court has already completed. This is not a wise use of judicial resources.

The better solution, from a practical standpoint, is for us to carefully and promptly

decide the issues on appeal, and then to remand to the district court to address any

outstanding fact-finding tasks. Expeditiousness is every bit as important to a well-

functioning judiciary as is thoroughness.

Finally, even if we were to engage in a full PSLRA sanctions analysis, it

would still be necessary to remand to the district court to determine a number of

outstanding issues. For instance, we would be unable to determine whether either

Thompson or Jacoby himself (as distinct from their lawyers) violated Rule 11 (the

record is silent on this point), whether the lawyers violated Rule 11(b)(1) by filing

the complaints for improper purposes (a subjective analysis that will likely require

testimony), or whether the plaintiffs can rebut the PSLRA’s presumptive award of

22

attorneys’ fees. These issues require the kind of record development in which

appellate courts cannot engage. As a result, even if we did expend the enormous

judicial resources necessary to parse through the record in the first instance, the

district court would still have to reexamine and further develop the record to

address these outstanding issues. Such a process would introduce even more

inevitable duplication of effort and would result in further depletion of limited

judicial resources.

Accordingly, even if we could in some cases engage in a PSLRA sanctions

analysis ourselves, we decline to do so in this case. Careful examination of the

relevant considerations counsels against such a use of judicial resources.

IV. CONCLUSION

With respect to Jacoby’s appeal, we AFFIRM the district court’s dismissal

of Counts I and II of the Second Amended Complaint pursuant to Rule 12(b)(6) of

the Federal Rules of Civil Procedure. With respect to Karp’s cross-appeal, the

district court’s order entered June 12, 2007, is VACATED and REMANDED for

further proceedings consistent with this opinion.

23

TJOFLAT, Circuit Judge, concurring in the appeal, No. 07-13225, and dissenting

in the cross-appeal, No. 07-13477:

In the appeal, I concur in the court’s judgment affirming the district court’s

dismissal of the second amended complaint. I dissent from the court’s decision in

the cross-appeal, vacating in full the district court’s decision denying Private

Securities Litigation Reform Act (“PLRSA”) sanctions, and remanding the

sanctions issues to the district court for reconsideration ab initio. I would reverse

the sanctions decision and remand the case with the instruction that the district

court sanction plaintiffs’ counsel for prosecuting the federal securities law claims

in the three complaints they presented to the district court—the initial, first, and

second amended complaints—because, in presenting those claims, counsel violated

Federal Rule of Civil Procedure 11(b)(2) as a matter of law. They also violated

Rule 11(b)(3) with respect to some of these claims because the claims lacked an

evidentiary foundation. In remanding the matter of sanctions to the district court, I

would instruct the court to hear from counsel for the parties on the questions of (1)

whether the remaining claims lacked the evidentiary support required by Rule

11(b)(3), and (2) whether plaintiffs’ counsel brought any of the claims for an

improper purpose in violation of Rule 11(b)(1).

24

The court is faced with two options in disposing of the cross-appeal. One is

to vacate the sanctions decision and remand the case for further proceedings on the

sanctions issues. The court has chosen this option. The court believes that it is

incapable of meaningfully reviewing the district court’s denial of Rule 11 sanctions

because the denial is framed in conclusory language, without findings of fact or

conclusions of law. The other option is to decide whether plaintiffs’ attorneys

failed to comply with Rule 11(b)’s requirements, and, if so, whether sanctions are

in order. I choose this option because, in the PSLRA context, Congress explicitly

requires a district court to impose sanctions whenever Rule 11 is violated. When,

as here, the record so clearly indicates a Rule 11 violation, it is both within our

capacity and in the broader interest of justice that we direct the district court to

impose sanctions that it will have to impose on remand.

An objective examination of plaintiffs’ three complaints reveals that

plaintiffs’ federal securities law claims are frivolous, and, under these facts, a

district court would necessarily abuse its discretion to conclude otherwise.

Moreover, plaintiffs sued some individual defendants who had no involvement

whatsoever in the management of Relationserve Media, Inc., or its predecessor,

Relationserve, Inc. The court’s disposition will require those uninvolved

defendants to participate in the further proceedings on remand. The disposition I

25

propose would limit their involvement to the simple task of presenting the court

with a list of their expenses, including the attorneys’ fees they incurred.

The court’s disposition is also likely to result in a second appeal, which

would put this court in the same position it now occupies. The disposition I would

reach would avoid a second appeal and thus would reduce the time, effort, and

expenses the district court, the parties, and this court will have to endure as a result

of today’s decision. To make this clear, I must take the reader through this case as

it evolved—from the filing of the initial complaint through the filing and

prosecution of the second amended complaint. I shall do so in accordance with the

following outline.

I. The Facts

A. Relationserve Media, Inc.’s and Relationserve, Inc.’s Corporate Histories

and the Alleged Fraud

B. Richard F. Thompson Sues Relationserve, Media Inc. in Indiana State

Court

II. The Federal Procedural History

A. The Initial Complaint

1. Thompson Files the Initial Complaint

2. The Defendants Warn Thompson’s Attorneys that the Suit is

Frivolous

3. The Defendants Move to Dismiss, Request the Court to Retain

Jurisdiction to Impose Sanctions

26

4. Thompson’s Attorneys Move the Court for Leave to Amend and for

Limited Discovery to Add Individual Defendants

5. The Court Grants the Attorneys Leave to Amend and Limited

Discovery and Warns the Attorneys About Rule 11

B. The First Amended Complaint

1. Thompson & Jacoby File the First Amended Complaint, Each

Purporting to Represent All Class Members on All Claims

2. The Defendants Move to Dismiss, Request the Court to Retain

Jurisdiction to Impose Sanctions

3. The Court Dismisses the First Amended Complaint

C. The Second Amended Complaint

1. Thompson & Jacoby File the Second Amended Complaint with

Jacoby Leading an Open-Market Purchaser Subclass Bringing Federal

Securities Claims and with Thompson Leading a Private Offering

Purchaser Subclass Bringing State Law Claims

2. The Defendants Move to Dismiss, and Defendant Karp Moves for

Sanctions

3. The Court Dismisses the Complaint with Prejudice but Denies

Sanctions

4. Jacoby’s Appeal, Karp’s Cross-Appeal, and this Court’s Decision

III. This Court Errs by Summarily Remanding Karp’s Cross-Appeal for Sanctions

Under the PSLRA

A. The PSLRA Rule 11 Analytical Framework & Requirements

B. A Court of Appeals Should Not Remand for Rule 11 Findings When it

Can Determine Conclusively that the District Court Abused its Discretion in

Denying Sanctions

27

IV. With Respect to Plaintiffs’ Federal Securities Law Claims, the District Court

Abused its Discretion in Denying Sanctions

A. Rule 11(b)(2) Compliance

1. The Section 11 Claims

a. The Initial Complaint’s Section 11 Claim

b. The First Amended Complaint’s Section 11 Claim

2. The Section 12 Claims

3. The Section 10(b), Rule 10b-5 Claims

a. Thompson’s Rule 10b-5 Claims

b. Jacoby’s Rule 10b-5 Claims

i. Jacoby Failed to Identify an Actionable Omission

ii. Jacoby Made Only Frivolous Scienter Allegations

iii. Jacoby Advanced a Frivolous Loss Causation

Argument

4. The Section 20(a) Claims

B. Rule 11(b)(3) Compliance

C. Rule 11(b)(1) Compliance

D. The Plaintiffs’ Attorneys’ Rule 11 Violations Trigger the PSLRA’s

Presumptive Sanction of Attorney’s Fees and Other Expenses

E. Summary

V. The Court Errs by Ignoring Karp’s Cross-Appeal for Rule 11 Sanctions on the

State Law Claims Advanced in the Second Amended Complaint

VI. Conclusion

I. The Facts

A. Relationserve Media, Inc.’s and Relationserve, Inc.’s Corporate Histories and

the Alleged Fraud

The principal defendant in this case, Relationserve Media, Inc., is an Internet

marketing firm that maintains its principal place of business in Fort Lauderdale,

28

Florida.1 The other defendants, with three exceptions, are (or were) officers and/or

directors of the company (“Officers”). Relationserve Media, Inc. was formed

when privately held Relationserve, Inc. merged with a wholly owned subsidiary of

publicly held Chubasco Resources Corp. For the sake of clarity, I refer to the

predecessor corporation as “Relationserve” and the merged entities as

“Relationserve Media” or simply “Media.”2

Relationserve was incorporated in Delaware on March 29, 2005. Shortly

thereafter, on April 20, 2005, Relationserve commenced a private offering of

common stock to “accredited investors”3 (the “April private offering”).

1

The appeal is from a district court order dismissing the federal securities law claims of

the second amended complaint for failure to comply with the heightened pleading requirements

of the PSLRA and Rule 9(b); accordingly, the complaint’s well-pleaded facts must be accepted

as true and all reasonable inferences must be drawn from those facts in favor of the plaintiff. In

the main, the facts set out in part I are taken from the three complaints filed in this case. They

were known to plaintiffs’ attorneys prior to their filing of the initial complaint. The complaints

refer to, and quote in part, filings the corporate defendant and some of the individual defendants

made with the Securities and Exchange Commission (“SEC”). Regardless of whether pled, we

“may take judicial notice . . . of relevant public documents required to be filed with the SEC, and

actually filed.” Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1278 (11th Cir. 1999). This can

be done “for the purpose of determining what statements the documents contain and not to prove

the truth of the documents’ contents.” Id. “[C]onsidering the SEC documents in this manner . . .

is permitted by Fed. R. Evid. 201, is consistent with the overall aims of the [PSLRA], and is not

inconsistent with Rule 12(b)(6), common notions of fairness, or the law of this Circuit.” Id.

2

Relationserve Media, Inc. changed its name to SendTec, Inc. on July 26, 2006.

Nevertheless, I refer to the company as Relationserve Media or simply Media.

3

The term “accredited investors” is a term of art, as defined by the SEC. See 17 C.F.R.

§ 230.501(a). The term delineates those permitted to invest in certain types of high risk

investments. The term generally includes wealthy individuals and organizations, such as

corporations, endowments, or retirement plans. According to the SEC, an individual qualifies as

an “accredited investor” if his or her “individual net worth . . . at the time of . . . purchase

exceeds $1,000,000,” id. § 230.501(a)(5), or if he or she has “an individual income in excess of

29

Throughout April and May 2005, Relationserve received and accepted $1,125,000

of subscriptions in exchange for Relationserve shares. The shares were issued in

reliance on a Regulation D exemption from registration under the Securities Act of

1933 (the “1933 Act”),4 and were “restricted shares” as defined by the Act. See 17

C.F.R. §§ 230.501 et seq.5

While the April private offering was going on, on May 16, 2005,

Relationserve acquired two Internet marketing companies, Omni Point Marketing

LLC and Friendsand LLC. In exchange for the ownership interest in those

companies, Relationserve paid $500,000 cash, 8,000,000 shares of its common

stock, and a two-year promissory note for $700,000. Relationserve also issued

4,001,000 shares to its founders as compensation for bridge loan advances and

$200,000 in each of the two most recent years . . . and has a reasonable expectation of reaching

the same income level in the current year,” id. § 230.501(a)(6).

4

The 1933 Act is codified at 15 U.S.C. §§ 77a et seq.

5

Regulation D allows issuers to sell securities without registering them with the SEC if a

series of both general and specific conditions is followed. Generally, the conditions that must be

met are: (1) all sales within a certain time period must be “integrated” (that is, treated as one

offering); (2) information about the securities must be disclosed to investors; (3) there must be

no “general solicitation” of purchasers of the securities; and (4) the securities must contain

restrictions on their resale. See 17 C.F.R. § 230.502.

In this case, Relationserve sought a registration exemption on the basis of SEC-

promulgated Rule 506. Id. § 230.506. Rule 506 imposes two specific conditions that must be

met. First, “the issuer [must] reasonably believe[] that there are no more than 35 purchasers of

securities from the issuer.” Id. § 230.506(b)(2)(i). Second, the issuer must reasonably believe

that “[e]ach purchaser who is not an accredited investor either alone or with his purchaser

representative(s) has such knowledge and experience in financial and business matters that he is

capable of evaluating the merits and risks of the prospective investment.” Id. §

230.506(b)(2)(ii).

30

negotiating the acquisitions. Relationserve’s chief operating officer at the time,

Scott Hirsch, was also the indirect majority owner and president of Omni Point.

Relationserve’s then president, Danielle Karp, is Scott Hirsh’s sister.

After completing the April private offering6 and the acquisition of Omni

Point and Friendsand, on May 24, 2005, Relationserve entered an Independent

Consulting Agreement (the “consulting agreement”) with Summit Financial

Partners, LLC (“Summit”). Under the consulting agreement, Summit and its

president, Tony Altavilla, agreed to “[i]ntroduce [Relationserve] to the financial

community” and “[p]erform the functions generally assigned to stockholder

relations and public relations departments in major corporations.” Relationserve

Media Inc., Current Report (Form 8-K), Ex. 2.6, at 1–2 (June 16, 2005).7 Summit

also agreed to act as a “finder” of financing sources or acquisition candidates for

6

I infer that Relationserve completed the April private offering no later than May 19,

2005. Issuers selling securities pursuant to Regulation D must notify the SEC of the sales.

Relationserve gave the requisite notice by filing Form D on May 23, 2005. Relationserve, Inc.,

Notice of Sale of Securities Pursuant to Regulation D (Form D), at 1 (May 23, 2005).

Relationserve disclosed its receipt of $1.125 million from twenty-two accredited investors. Id. at

4. Later filings indicate that Relationserve did not receive any more subscriptions from this

offering. See Relationserve Media, Inc., Current Report (Form 8-K), at 29 (June 16, 2005) (“On

April 20, 2005 Relationserve commenced a private offering . . . . Relationserve received and

accepted $1,125,000 of subscriptions.”). The shares may not have been issued, however, until

June. See Relationserve Media, Inc., Registration Statement under the Securities Act of 1933

(Form SB-2), at 26 (Mar. 20, 2006) (“In May and June 2005, we sold 1,625,000 shares of and

granted 812,500 warrants to purchase 812,500 shares of common stock at an exercise price of

$2.00 per share for net proceeds of $1,495,026.”).

7

As indicated infra, the consulting agreement was publicly disclosed, in its entirety, in

this current report as Exhibit 2.6.

31

Relationserve. In exchange, Relationserve paid Summit 1,050,000 shares of its

common stock and promised to pay a cash finder’s fee. Id. at 3, 5. The consulting

agreement noted that “IT IS SPECIFICALLY UNDERSTOOD THAT [Summit]

IS NOT AND DOES NOT HOLD ITSELF OUT BE [sic] A BROKER/DEALER,

BUT IS MERELY A ‘FINDER’ IN REFERENCE TO [Media] PROCURING

FINANCING SOURCES AND ACQUISITION/MERGER CANDIDATES.” Id.

at 6.

From inception, Relationserve’s strategy was to become a publicly traded

company by means of a “reverse merger.” Accordingly, the April Offering’s

private placement memorandum explained the company’s intent to find

[a] publicly-traded company . . . which will acquire, by merger of

Relationserve . . . all of the issued and outstanding capital stock of

Relationserve (and any acquired businesses at the time of merger).

Thereafter, the present stockholders of Relationserve and purchasers

in the offering will, by virtue of the merger, become the controlling

stockholders of the publicly-traded company.

Relationserve, Inc., Private Purchase Offering Document, at 1 (Apr. 20, 2005).

Consistent with this representation, Relationserve explored and ultimately entered

a merger agreement with Chubasco.

Prior to the merger, Chubasco, a Nevada corporation with its principal place

of business in Canada, was an exploration-stage mining company yet to commence

operations. In total, Chubasco had 51 shareholders and about $100,000 in assets.

32

The largest shareholder, Scott Young, owned 6.8 million shares and also served as

Chubasco’s president, chief financial officer, and sole director. The remaining

fifty shareholders purchased Chubasco shares in at least one of two exempt

Regulation S offerings.8 Collectively, the fifty shareholders owned 3,216,500

shares. Chubasco became a public reporting company by filing a registration

statement for these 3,216,500 shares on October 8, 2004. Once effective, the

registration statement would allow the fifty holders to trade that stock publicly.

Chubasco Res. Corp., Registration Statement Under the Securities Act of 1933

(SB-2) (Oct. 8, 2004). After a series of amendments, the Registration Statement

became effective on February 24, 2005. Chubasco Res. Corp., Quarterly Report

(Form 10-QSB), at 10 (Mar. 17, 2005).

Sometime between March and June 2005, Relationserve’s management

approached Chubasco and suggested a reverse acquisition of Relationserve. After

determining that the reverse acquisition would be “less speculative and contain[]

greater benefits,” Chubasco terminated its mining exploration activities and

negotiated a plan of merger and reorganization with Relationserve. Chubasco Res.

Corp., Quarterly Report (Form 10-QSB), at 5 (June 14, 2005).

8

Regulation S sets out rules governing exempt sales of securities because the

transactions occur outside the United States. See 17 C.F.R. § 230.901 et seq.

33

The terms of the merger included the following. Chubasco would form a

wholly-owned subsidiary, Reland Acquisition. Reland would then merge into

Relationserve, with Relationserve surviving. Upon consummation of the merger,

each share of Reland would automatically convert into the right to receive one

share of Relationserve; thus Chubasco would own all of the issued and outstanding

shares of Relationserve. Relationserve Media Inc., Current Report (Form 8-K), Ex.

2.1 (Plan of Merger) ¶ 1.5(a) (June 16, 2005). In exchange, Relationserve’s stock

would automatically convert into the right to receive Chubasco stock on a 1:1

basis. Id. Additionally, Scott Young agreed to cancel his 6.8 million shares of

Chubasco and resign from his position as its sole director, president, and chief

financial officer. Danielle Karp, Relationserve’s president, would become the new

president and sole director of Chubasco. Finally, Chubasco would change its name

to Relationserve Media, Inc. Id. ¶ 6.4.

The merger took place on June 13, 2005. As a result of the merger,

Relationserve Media, Inc., f/k/a Chubasco Resources Corp., held Relationserve as a

wholly owned subsidiary. As planned, Scott Young resigned from all positions

with Media and Danielle Karp became its sole director and president. Media now

had two groups of shareholders. The first group consisted of the former Chubasco

shareholders who held 3,216,500 shares; these shares could be traded and

34

constituted Media’s “public float.” Id. ¶ 2.01. The second group consisted of

former Relationserve shareholders who owned 13,326,000 shares of Relationserve

stock, now convertible into Media stock. Id. Because the second group acquired

the shares in unregistered offerings and no subsequent registration statement had

been filed, the shares continued to be restricted and could not be traded. The

merger did not, of course, alter the duty of Media f/k/a Chubasco to make routine

filings with the SEC.

Accordingly, just three days after the merger, on June 16, 2005, the newly

formed Media filed an SEC current report (Form 8-K). Among other disclosures,

this report explained the merger and the resultant change in business—from mining

exploration to Internet marketing. This report also disclosed, for the first time, that

Media’s predecessor, Relationserve, had “entered into an Independent Consulting

Agreement with Summit Financial Partners, LLC.”9 Id. at 29. A full copy of the

consulting agreement was attached to the SEC filing as an exhibit; this attachment

9

There would have been no previous occasion for Relationserve to disclose the

relationship with Summit since as a private company, Relationserve had no duty to file securities

disclosures regarding its material definitive agreements. The full text of the report’s disclosure

is as follows:

On May 24, 2005, the Company entered into an Independent Consulting

Agreement with Summit Financial Partners, LLC. Under the terms of the

Agreement, Summit Financial Partners, LLC. is to provide investor relations and

similar services in exchange for issuance of 1,050,000 shares of Common Stock.

A copy of the Agreement is annexed hereto as Exhibit 2.6.

Relationserve Media Inc., Current Report (Form 8-K), at 29 (June 16, 2005).

35

included, of course, Summit’s express representation that it would not be acting as

a broker/dealer, but rather would serve merely as a finder. As a consequence of the

merger, Summit performed the same services for Media as it had for Relationserve.

Shortly after the merger, Media commenced a Regulation D, Rule 506

private offering pursuant to a private placement memorandum dated June 22, 2005

(the “June private offering”).10 It was in this offering that plaintiff Richard F.

Thompson, an Indiana resident, purchased 50,000 Media shares at two dollars per

share and three-year warrants with an exercise price of $3.50, for a total investment

of $100,000.

Thompson bought the shares on June 28, 2005, twelve days after Media had

disclosed the consulting agreement with Summit. Gary Altavilla, Summit’s

president, advised Thompson about the private offering and helped facilitate

Thompson’s purchase. At the time of his purchase, Thompson signed a

subscription agreement wherein he attested to his knowledge of the consulting

agreement and that Summit was not licensed and did not hold itself out as a

broker/dealer. Indeed, in the subscription agreement that he signed, Thompson

acknowledge[d] that . . . [he] has read and evaluated, or has employed

the services of an investment advisor, attorney or accountant to read

and evaluate, all of the documents furnished or made available by the

Company to [Thompson] . . . including . . . the Company’s Current

10

See supra note 5 for an explanation of Regulation D and Rule 506.

36

Report on Form 8-K filed with the Securities and Exchange

Commission (“SEC”) on June 16, 2005 (“Current Report”) and

subsequent SEC filings and reports . . . .

Relationserve Media, Inc., Current Report (Form 8-K), Ex. 4.1 (Subscription

Agreement), at 1–2 (June 30, 2005).11 As indicated above, this June 16, 2005

Current Report included the agreement between Media and Summit in its entirety.

On June 30, 2005, Media completed the June private offering. In a report

filed with the SEC, it disclosed:

On June 30, 2005 we completed a private offering of Units to

“accredited investors” as that term is defined in Regulation D of the

Securities Act, with each Unit consisting of 50,000 shares of our

common stock, $0.0001 par value per share (“Common Stock”), and a

three-year warrant to purchase 25,000 shares of Common Stock at

$3.50 per share (the “Offering”). We received and accepted

$2,000,000 of subscriptions in the Offering. The Units were issued in

reliance on an exemption from registration provided under Regulation

D of the Securities Act and are restricted securities as defined by the

Securities Act.

Relationserve Media, Inc., Current Report (Form 8-K), at 2 (June 30, 2005).

Attached to this filing was a copy of the “Private Offering Subscription

Agreement” the purchasers signed (the “subscription agreement”). As in

Relationserve’s April offering, all of the shares sold in Media’s June private

11

In addition to attesting that he had read Media’s SEC filings, Thompson also

“recognize[d] that Company reserves the right to pay a commission or finders fee of up to 5% of

the gross proceeds of the Offering.” Relationserve Media, Inc., Current Report (Form 8-K), Ex.

4.1 (Subscription Agreement), at 3 (June 30, 2005).

37

offering were restricted and therefore could not be resold until registered under the

1933 Act.12

In addition to this current report, on July 14, 2005, Media filed a Form D

with the SEC to give further notice of and basic details about the June private

offering. Relationserve Media, Inc., Notice of Sale of Securities Pursuant to

Regulation D (Form D), at 1 (July 14, 2005). At the time, Form D required the

issuer to disclose information about “each person who has been or will be paid or

given, directly or indirectly, any commission or similar remuneration for

solicitation of purchasers in connection with the sales of securities in the offering.”

Id. at 3. Media did not disclose Summit’s involvement in the June private offering.

Media also filed a notice of the sale of unregistered securities with the

Indiana Secretary of State in compliance with Indiana’s securities act. See Ind.

Code §§ 23-2-1-1 et seq. (2005) (repealed 2008). This notice, received and filed

by the Secretary of State’s office on July 14, 2005, disclosed that Media’s June

12

Absent an exemption, the 1933 Act generally prohibits the sale of unregistered

securities. In the subscription agreement, Media promised to register the shares within forty-five

days of the closing of the final sale in the June private offering. Relationserve Media, Inc.,

Current Report (Form 8-K), Ex. 4.1 (Subscription Agreement), at III & Ex. C. (Registration

Rights Agreement) (June 30, 2005). Media defaulted on this obligation, but in October 2005,

Media’s board “ratified waivers obtained from a majority of the purchasers in the June [] 2005

offering and entered into new Consent and Waiver Agreements containing amended registration

obligations of the Company.” Relationserve Media, Inc., Registration Statement Under the

Securities Act of 1933 (Form SB-2), at F-25 (Mar. 20, 2006). Ultimately, as discussed below,

Media did not file a registration statement for the shares until March 20, 2006, which did not

become effective until July 14, 2006.

38

private offering had attracted twenty-two accredited investors to purchase an

aggregate total of $2 million of Media’s common stock. In particular, Media

attested to its sale of $340,000 of Media shares to five accredited investors in

Indiana.13

While the June private offering was going on, Media expanded its

management team. Recall that immediately after the merger, Danielle Karp was

Media’s sole president, chief executive officer, and director; Media’s subsidiary,

Relationserve, continued to be served by Scott Hirsch as its chief operating officer.

On June 21, Media hired Mandee Heller Adler to serve as its chief executive

officer and as a director; and on June 22, Media hired Warren “Pete” Musser to

serve as a director.

As discussed above, after the merger, the 3,216,500 shares that had been

registered by Chubasco could be traded in the open market. Media’s shares began

to trade on the Over the Counter Bulletin Board (the “OTCBB”) in late June 2005.

It was from this pool of stock that plaintiff L. Alan Jacoby purchased a total of

10,000 shares of Media stock in three separate transactions. These purchases

occurred on July 22, July 26, and August 12, 2005, and Jacoby claimed to have

13

The Indiana Securities Act exempted issuers from registering with the state in certain

circumstances. See I.C. § 23-2-1-2(b)(10) (2005) (repealed 2008). As discussed in part IV,

infra, Media satisfied the requirements for an exemption.

39

paid an average of six dollars per share.14 By March 2006, almost nine months

later, Media’s shares had lost 75% of their value in the open market.

Curiously, the plaintiffs alleged that Media’s shares traded on the NASDAQ

stock exchange. There is no evidence in Media’s SEC filings, however, that

Media’s stock traded anywhere except the OTCBB. Media did apply for a

NASDAQ listing on or about July 18, 2005, but there is no evidence that the

application succeeded. To the contrary, Media’s Annual Report filed on March 20,

2006 disclosed: “Our Common Stock has been quoted on the OTC Bulletin Board

since June 30, 2005 under the symbol RSVM.OB. Prior to that date, there was no

active market for our Common Stock.” Relationserve Media, Inc., Annual Report

(Form 10-KSB), at 7 (Mar. 20, 2006).15

14

While the record does not indicate Jacoby’s purchase price, I judicially note that,

according to the OTCBB website, the closing prices of Media’s shares on those dates were as

follows: $5.50 per share on July 22; $5.13 per share on July 26; and $8.75 on August 12. Note

that this is not necessarily the price that Jacoby paid for Media’s shares, but rather is the closing

price quoted by OTCBB for the particular days.

15

The OTCBB can be accessed through a NASDAQ workstation. The OTCBB website

warns, however,

The OTCBB is a quotation medium for subscribing members, not an issuer listing

service, and should not be confused with The NASDAQ Stock Market. . . . The

OTCBB is unlike The NASDAQ Stock Market in that it: does not impose listing

standards; does not provide automated trade executions; does not maintain

relationships with quoted issuers; and does not have the same obligations for

Market Makers.

OTC Bulletin Board, Comparison of NASDAQ and OTCBB,

http://www.otcbb.com/aboutOTCBB/comparison.stm (last visited Apr. 6, 2010).

40

Around the same time that Jacoby purchased his stake in Media, Media’s

SEC filings indicate that it entered into two key transactions. First, on August 9,

2005, Media entered an asset purchase agreement to buy the business and

substantially all of the assets of theglobe.com’s wholly owned subsidiary,

SendTec, for $37.5 million. Relationserve Media, Inc., Current Report (Form 8-K)

(Aug. 12, 2005). The acquisition was subject to certain terms and conditions and

did not close until October 31, 2005. Second, on August 29, 2005, Media merged

with its wholly-owned subsidiary, Relationserve, with Media surviving.

Relationserve Media, Inc., Current Report (Form 8-K), at 2 (Sept. 2, 2005).

For the purposes of this case, two facts are crucial about the SendTec asset

acquisition. First, as part of the terms and conditions mentioned, Media agreed to

terminate its contract with Summit. Relationserve Media, Inc., Current Report

(Form 8-K), Ex. 10.1 at 10 (Nov. 4, 2005). Second, Media agreed that it would

replace certain members of its current management with SendTec-approved

managers. Relationserve Media, Inc., Current Report (Form 8-K) (Aug. 12, 2005).

Accordingly, on October 6, 2005, Media terminated its agreement with

Summit.16 The exodus of Media’s senior management team began in late October

2005: director Musser resigned on October 31; chief executive officer and director

16

Media’s SEC filings indicate this.

41

Adler resigned on November 11. With one exception, the exodus was complete by

the first week of February 2006 with the departure of president and director Karp

and chief operating officer Hirsch on February 3 and February 2, respectively. The

lone exception was chief financial officer Adam Wasserman who was hired on a

part-time basis as chief financial officer on August 9, 2005, and ultimately served

Media in some capacity until June 15, 2006.17 Media’s original management team

was replaced by Sendtek-approved replacements: Michael Brauser joined as

director and chairman of the board on October 31, 2005; Shawn McNamara joined

as interim chief executive officer, senior vice president, and assistant secretary on

November 30, 2005; and Paul Soltoff, as chief executive officer and director, Erick

Obeck, as president, and Donald Gould, as chief financial officer, all joined on

February 3, 2006. For a complete listing of the terms of Media’s officers’ service,

see the Table attached to this opinion at 142.

B. Richard F. Thompson Sues Relationserve, Media Inc. in Indiana State Court

17

The plaintiffs alleged that Wasserman ended his tenure on February 3, 2006. (Second

Am. Compl. ¶ 17.) The plaintiffs also alleged, however, that Wasserman signed a Sarbanes-

Oxley certification as the principal financial officer on March 20, 2006. (First Am. Compl. ¶

90.) The plaintiffs likely made the former allegation because Donald Gould became chief

financial officer on February 3, 2006. Nevertheless, it appears that Wasserman continued to

work for Media in some capacity until June 15, 2005. See Relationserve Media, Inc., Current

Report (Form 8-K) (June 21, 2006) (noting that Wasserman resigned from all positions on June

15).

42

On March 3, 2006, in the Circuit Court of Hamilton County Indiana,

Thompson sued Summit, Altavilla, Media, and several other entities who used

Summit’s services, seeking rescission of his shares. Thompson was represented by

Cohen & Malad, LLP, an Indiana law firm. Thompson directed three of his

fourteen counts against Media: Count 4 claimed that Media sold unregistered, non-

exempt securities in Indiana; Count 7 alleged that Media had violated the Indiana

Securities Act’s anti-fraud provisions by failing to disclose the shares’ restricted

status; and Count 13 claimed Media deceived Thompson by failing to disclose the

shares’ restricted status. The other counts of the complaint were brought against

Summit, Altavilla, and other named defendants.18

Unrelated to this litigation, on March 20, 2006, Media filed a registration

statement and its annual report. Media filed the registration statement to register

the shares it sold in its private offerings—approximately 85 million shares of

common stock—to allow the private offering stockholders to sell their shares. In

the annual report, inter alia, Media disclosed that, “[i]n August 2005, the Company

paid a $28,500 success fee to Summit for services rendered in connection with a

private placement of its common stock.” Relationserve Media, Inc., Annual Report

18

With respect to Media, Thompson claimed that Altavilla had represented that, while

Media’s shares had restrictions on resale, these restrictions would be released within 30 days of

Thompson’s purchase.

43

(Form 10-KSB), at F-26 (Mar. 20, 2006). Neither the registration statement nor

the annual report disclosed the Thompson litigation.

On May 1, 2006, Media amended this registration statement to give the

public notice of Thompson’s lawsuit. Relationserve Media, Inc., Amendment No.

1 to Form SB-2 Registration Statement (Form SB-2/A), at 53 (May 1, 2006).

Media also related that Thompson sought rescission because the shares were not

registered as required under Indiana Law and because Media failed to disclose a

commission to Altavilla. Media also asserted its belief that the suit lacked merit

but noted that it could not predict the range of any loss. This disclosure prompted

the SEC to send a letter to Media requesting more information about the Thompson

litigation.

Responding to the SEC’s letter, on May 23, 2006, Media augmented the

amendment it had made to its registration statement. Answering the SEC’s

questions, Media added that: (1) Thompson sought rescission of 50,000 shares of

stock, (2) Media did not register the shares in Indiana because they qualified for an

exemption, and (3) Altavilla did not sell shares on the company’s behalf but did

receive a seven percent finder’s fee for introducing investors to Media. Media

reiterated its belief that the action lacked merit. Relationserve Media, Inc.,

Amendment No. 2 to Form SB-2 Registration Statement (Form SB-2/A), at 64–65

44

(May 23, 2006). The last amendment to this registration statement took place on

July 13, 2006, and the SEC declared it effective on July 14, 2006.

On May 9, 2006, Relationserve Media moved the Hamilton County Circuit

Court to dismiss it from Thompson’s lawsuit. It argued that the forum selection

clause in the subscription agreement required that all litigation be conducted in

Broward County, Florida. Thompson responded to this motion by filing an

affidavit in which he averred that he had no direct communication with Media and

in fact did not read the private offering memorandum or any other materials

concerning Media; rather, his son, Greg Thompson, read the materials. The court

agreed with Media’s position and, on July 19, 2006, dismissed Media from the

case.

Just before the Indiana circuit court dismissed the case, on July 17, 2006,

Thompson sold 10,000 shares at $0.40 a share, and another 10,000 shares at $0.35

a share. These sales obviously limited his ability to seek a full rescission of his

50,000-share initial purchase. Thompson’s investment strategy took a turn later in

the day, though, as he bought another 10,000 shares of Media at $0.42 a share on

July 17, only to sell 10,000 shares the next day at $0.39 a share. One month later,

on August 16, 2006, Thompson dumped the rest of his shares in three sales at

$0.37, $0.36, and $0.35 a share.

45

II. The Federal Procedural History

A. The Initial Complaint

1. Thompson Files the Initial Complaint

On August 28, 2006, Thompson brought the present lawsuit against Media,

three of its former officers and one of its former directors in the United States

District Court for the Southern District of Florida. The former officers were

Danielle Karp, Mandee Heller Adler, and Ohad Jehassi; the former director was

Warren Musser.19 Thompson was again represented by Cohen & Malad, LLP, and

now also by a Florida law firm, Friedman, Rosenwasser & Goldbaum, P.A. Eight

days after filing the complaint, on September 5, Cohen & Malad issued a press

release publicizing the lawsuit and inviting Media shareholders to contact the

firm.20

Thompson sued on behalf of a class consisting of “[a]ll persons [including

himself] who purchased Relationserve [Media] shares during the period beginning

May 24, 2005 and ending on the date of the commencement of this litigation,” on

19

Karp served as Media’s president from June 13, 2005 to February 3, 2006. Adler was

Media’s chief executive officer from June 21, 2005 to November 11, 2005. Jehassi was the

former chief operating officer of Media, beginning his tenure in July 2005 and ending it on an

unspecified date. Musser served on Media’s board of directors from June 21, 2005 to October

31, 2005.

20

The PSLRA required this notice: “Not later than 20 days after the date on which the

complaint is filed, the plaintiff or plaintiffs shall cause to be published, in a widely circulated

national business-oriented publication or wire service, a notice advising members of the

purported plaintiff class . . . .” 15 U.S.C. § 78u-4(a)(3)(A)(i).

46

August 28, 2006.21 While not explicit, the complaint’s proposed class consisted of

two subclasses: (1) those who bought shares in the private offerings; and (2) those

who bought shares in the public market. The complaint contained nine counts.

Counts I through III alleged violations of federal securities law and, for remedies,

prayed for rescission or damages. Counts IV through IX alleged violations of

Florida and Indiana statutes.22

21

As noted above, Thompson purchased 50,000 Media shares in Media’s June private

offering. He also bought 10,000 shares on July 17, 2006, in the open market. Thompson

apparently believed that the July 17 purchase enabled him to “fairly and adequately” represent

and “protect the interests of” those of the class who purchased Media shares in the open market.

See Fed. R. Civ. P. 23(a)(4).

22

The complaint was a typical “shotgun” pleading, in that each count incorporated by

reference all preceding paragraphs and counts of the complaint notwithstanding that many of the

facts alleged were not material to the claim, or cause of action, appearing in a count’s heading.

This circuit condemns shotgun pleadings. See, e.g., Pelletier v. Zweifel, 921 F.2d 1465, 1518

(11th Cir. 1991) (“Anyone schooled in the law who read these [shotgun pleading] complaints . . .

[] would know that many of the facts alleged could not possibly be material to all of the counts.

Consequently, [the opposing party] and the district court [have] to sift through the facts

presented and decide for themselves which [are] material to the particular cause of action

asserted, a difficult and laborious task indeed.”); see also Davis v. Coca-Cola Bottling Co., 516

F.3d 955, 984 (11th Cir. 2008) (refusing to award attorneys’ fees in a Title VII case because the

use of shotgun pleadings “complicated [appellate review] to no end”); M.T.V. v. DeKalb County

Sch. Dist., 446 F.3d 1153, 1156 n.1 (11th Cir. 2006) (noting that shotgun pleadings are “frowned

upon in this circuit”); Byrne v. Nezhat, 261 F.3d 1075, 1131 (11th Cir. 2001) (“Shotgun

pleadings, if tolerated, harm the court by impeding its ability to administer justice.”); Beckwith

v. City of Daytona Beach Shores, Fla., 58 F.3d 1554, 1567 (11th Cir. 1995) (“The bar would be

better served by heeding this advice: ‘In law it is a good policy never to plead what you need not,

lest you oblige yourself to prove what you cannot.’”) (quoting Abraham Lincoln, Letter to Usher

F. Linder, Feb. 20, 1848, in The Quotable Lawyer 241 (D. Shrager & E. Frost eds., 1986)). The

first 50 paragraphs of the complaint contained allegations of fact that appeared to relate to a

particular count of the complaint but not to other counts. Utilizing this method of pleading,

Count I incorporated the first 50 paragraphs of the complaint, many of which had nothing to do

with the Count I claim(s). Counts II through IX successively incorporated the allegations of all

preceding paragraphs and counts, such that each succeeding count was loaded down with

allegations having no bearing on the claim(s) the count purported to assert.

47

Count I, “Filing of False Registration Statement,” alleged a violation of

“Section 11 of the Securities Act of 1933, 15 U.S.C. § 77l(a).” Section 11 is

actually codified at 15 U.S.C. § 77k, not § 77l(a). Section 77k provides relief for

persons who purchase securities in reliance on a false or misleading registration

statement.23 Section 77l(a), which is a codification of § 12 of the 1933 Act,

provides relief for purchasers of securities who rely on a false or misleading

23

The text of 15 U.S.C. § 77k, Civil liabilities on account of false registration statement,

states, in pertinent part:

(a) Persons possessing cause of action; persons liable

In case any part of the registration statement, when such part became effective,

contained an untrue statement of a material fact or omitted to state a material fact

required to be stated therein or necessary to make the statements therein not

misleading, any person acquiring such security (unless it is proved that at the time

of such acquisition he knew of such untruth or omission) may, either at law or in

equity . . . sue—

(1) every person who signed the registration statement;

(2) every person who was a director of (or person performing similar

functions) or partner in the issuer at the time of the filing of the part of the

registration statement with respect to which his liability is asserted;

....

(f) Joint and several liability; liability of outside director

(1) [A]ll or any one or more of the persons specified in subsection (a) shall be

jointly and severally liable, and every person who becomes liable to make any

payment under this section may recover contribution as in cases of contract from

any person who, if sued separately, would have been liable to make the same

payment, unless the person who has become liable was, and the other was not,

guilty of fraudulent misrepresentation.

(emphasis added).

48

statement in a prospectus or oral communication.24 To solve this inaccurate

citation problem, I read Count I to seek relief under both sections 11 and 12 of the

1933 Act. This squares with Count I’s allegation that

[Media’s] filings with the Securities Exchange Commission, including

the registration statements, prospectus, and amendments thereto

omitted to state material facts necessary in order to make the

statements made, in the light of the circumstances under which they

were made, not misleading in at least the following particulars:

a. RelationServe [Media] was selling its securities through

unregistered agents and broker/dealers and paying commissions to

these unregistered agents and broker/dealers;

24

The text of 15 U.S.C. § 77l, Civil liabilities arising in connection with prospectuses

and communications, states, in pertinent part:

(a) In general

Any person who

....

(2) offers or sells a security . . . by the use of any means or instruments

of transportation or communication in interstate commerce or of the mails,

by means of a prospectus or oral communication, which includes an

untrue statement of a material fact or omits to state a material fact

necessary in order to make the statements, in the light of the

circumstances under which they were made, not misleading (the purchaser

not knowing of such untruth or omission), and who shall not sustain the

burden of proof that he did not know, and in the exercise of reasonable

care could not have known, of such untruth or omission,

shall be liable . . . to the person purchasing such security from him, who may sue

either at law or in equity in any court of competent jurisdiction, to recover the

consideration paid for such security with interest thereon, less the amount of any

income received thereon, upon the tender of such security, or for damages if he no

longer owns the security.

(emphasis added).

49

b. The sale of RelationServe [Media] stock through unregistered

agents and broker/dealers was in violation of state and federal

securities laws, which caused a substantial contingent liability for

claims of rescission by investors and exposed RelationServe to

substantial legal fees; and

c. The potential civil liability of RelationServe [Media] for selling

shares of its stock in violation of state and federal law, which would

have an adverse impact on the RelationServe [Media] financial

condition.

(Compl. ¶ 52 (emphasis added).) Count I thus alleged that Media had violated the

1933 Act by selling securities under a false or misleading registration statement(s),

prospectus, or oral communication, by failing to disclose its use of unregistered

brokers and the contingent liability arising therefrom (the “unregistered-broker

theory”).

Count II, “Violation of Securities Act of 1933,” incorporated all of the

preceding allegations of the complaint, including Count I. Count II alleged that

Media and the Officers, who were “controlling persons, offered and sold the shares

of RelationServe [Media] in violation of 15 U.S.C.A. § 77l.” (Compl. ¶ 56.)

Because I construe Count I to seek relief under § 12, codified at 15 U.S.C. § 77l,

Count II added nothing to Count I.

Count III, “Violation of Securities Exchange Act of 1934, Rule 10b-5,”

incorporated all of Counts I and II and further asserted that Media and the Officers

“offered and sold the shares of RelationServe [Media] in violation of” the

50

Securities Exchange Act of 1934 (the “1934 Act”), 15 U.S.C. § 77q, and Rule 10b-

5.25 (Compl. ¶ 60.) Section 10(b) of the 1934 Act,26 and Rule 10b-5,27 provide

25

The complaint referred to the 1934 Act, 15 U.S.C. § 77q, and Rule 10b-5. Actually,

however, § 77q codifies § 17 of the 1933 Act. Section 10 of the 1934 Act, which provides the

statutory authority for Rule 10b-5, is codified at 15 U.S.C. § 78j. The first and second amended

complaints repeated the reference to § 77q. This time, I resolve the pleading ambiguity by

assuming the citation to § 17 was an error; notwithstanding the citation to § 17, I read Count III

of the initial complaint, Count III of the first amended complaint, and Count I of the second

amended complaint to seek relief only under § 10(b) and Rule 10b-5.

This results in no prejudice to the plaintiffs or their attorneys because this circuit has

expressly refused to read a private right of action into § 17. Currie v. Cayman Res. Corp., 835

F.2d 780, 784–85 (11th Cir. 1988) (“We therefore hold that section 17(a) does not imply a

private cause of action . . . .”); see also id. at 784 n.8 (noting that the Supreme Court has not

decided the question). Therefore, reading the complaints to seek relief only under § 10(b)

removes a roadblock in the plaintiffs’ path to recovery. In any event, the plaintiffs referenced

the 1934 Act in Count III’s header and never pressed a 1933 Act § 17 claim either in the district

court or in this court. Accordingly, notwithstanding the citation error, from this point forward, I

treat the plaintiffs as bringing only a § 10(b) claim.

26

The text of § 10(b) of the 1934 Act, as codified at 15 U.S.C. § 78j, states, in pertinent

part:

It shall be unlawful for any person, directly or indirectly, by the use of any means

or instrumentality of interstate commerce or of the mails, or of any facility of any

national securities exchange

....

(b) To use or employ, in connection with the purchase or sale of any

security registered on a national securities exchange or any security not so

registered . . . any manipulative or deceptive device or contrivance in

contravention of such rules and regulations as the Commission may

prescribe as necessary or appropriate in the public interest or for the

protection of investors.

27

The text of Rule 10b-5, as codified at 17 C.F.R. § 240.10b-5, states that:

It shall be unlawful for any person, directly or indirectly, by the use of any means

or instrumentality of interstate commerce, or of the mails or of any facility of any

national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

51

relief for any person who relies on a false or misleading statement in connection

with the purchase or sale of a security.

More specifically, Count III alleged that “[t]he Defendants . . . offered and

sold the shares . . . in violation of . . . Rule 10b-5.” (Compl. ¶ 60.) Because Media

and the Officers only “offered and sold” shares to the private offering purchasers,

the § 10(b), Rule 10b-5 claim was limited to the private offering subclass. The

complaint did not directly identify any false or misleading statement made by any

defendant in connection with Media’s sale of shares to Thompson or any other

private offering purchaser; nor did the complaint allege any device or scheme to

defraud. Thompson did, however, refer to the omissions in Count I’s section 11

and 12 claims. (Compl. ¶ 58 (“As stated herein, the registration statement and

prospectus contained untrue statements of material facts . . . .”).) Therefore,

Thompson claimed the private offering purchasers could recover based on Media’s

failure to disclose its use of unregistered brokers in its public offering documents.

Thompson invoked the district court’s supplemental jurisdiction for the state

law claims asserted in Counts IV though IX. See 28 U.S.C. § 1367. Count IV

(b) To make any untrue statement of a material fact or to omit to state a material

fact necessary in order to make the statements made, in the light of the

circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would

operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

52

alleged that Media, aided and abetted by the Officers, sold Media shares through

brokers, dealers, and agents who were not registered in Florida, in violation of

Florida Statutes §§ 517.12 and 517.061. Count V alleged that sales were made in

Indiana via unregistered brokers, dealers, and agents, in violation of Indiana Code

§ 23-2-1-8. Count VI alleged that Media, aided and abetted by the Officers, sold

Media shares that were unregistered in violation of Indiana Code §§ 23-2-1-2 and

23-2-1-3. Count VII alleged that Media, aided and abetted by the Officers, sold

Media shares in violation of the anti-fraud provisions of the Indiana Securities Act,

Indiana Code § 23-2-1-12. Count VIII alleged that Media, aided and abetted by the

Officers, defrauded the purchasers of Media shares, in violation of Indiana Code §

35-43-5-3. Count IX alleged that Media and the Officers defrauded the purchasers

of Media shares, in violation of the common law.

As remedies, Thompson sought rescission or damages for the federal

securities claims brought in Counts I through III. As for the state law claims,

Thompson sought rescission for Counts IV through VII, trebled compensatory

damages for Count VIII, and compensatory and punitive damages for Count IX.

Prior to filing his complaint, Thompson disposed of all of his Media shares.

Accordingly, the remedy of rescission was not available to him in Counts I through

VII. Nor was rescission available to the members of Thompson’s open market

53

subclass because they never bought shares from Media; therefore, they could not

obtain a judgment requiring the company to return the purchase price—which they

never paid to the company—in exchange for the shares they still held.

2. The Defendants Warn Thompson’s Attorneys that the Suit is Frivolous

After Media received the initial complaint, but before filing a responsive

pleading, Thomas Fleming, one of Media’s attorneys,28 wrote to Cohen & Malad to

advise the firm that Thompson’s claims were frivolous and that the complaint had

been filed in violation of Rule 11(b). While the record does not contain Fleming’s

letter, it does contain Cohen & Malad’s reply. Richard Bell replied on behalf of

Cohen & Malad, stating:

We are in receipt of your letter of October 6, 2006. We strongly

disagree with your assessment of this securities litigation filed against

your client []. Contrary to your opinion, the lawsuit was filed in good

faith and was diligently investigated and researched before it was

filed.29

....

Lastly at some point in time both our clients will want to resolve or

settle this case. So I will commit to be respectful of your legal

positions even though I may disagree.

28

Fleming was a member of the New York firm of Olshan, Grundman, Frome,

Rosenzweig & Wolosky LLP. The firm withdrew from the case on November 17, 2006, and was

later replaced as lead counsel for Media by White & Case.

29

Rest assured that we do plan to amend the complaint and will add additional

defendants. Our investigation is ongoing.

54

(Pls.’ Mot. to Compel Disc. Ex. A (Oct. 11, 2006 Letter from Richard Bell to

Thomas Fleming, at 1, 4) (Oct. 24, 2006) (footnote in original).)

3. The Defendants Move to Dismiss, Request the Court to Retain Jurisdiction to

Impose Sanctions

Shortly thereafter, on October 20, 2006, the defendants moved to dismiss

Thompson’s complaint on a slew of grounds.30 As for the federal securities law

claims, the defendants pointed to several pleading errors. The Counts I and II

claims under § 11 and § 12 of the 1933 Act failed to identify any purchase made in

reliance on false or misleading statements in a registration statement or

prospectus.31 The Count III § 10(b), Rule 10b-5 claim failed to identify any false

or misleading statements with the particularity and specificity required by Rule

9(b) of the Federal Rules of Civil Procedure and the PSLRA.

Turning to Thompson’s state law claims, the defendants argued that those

claims were barred by the Securities Litigation Uniform Standards Act

(“SLUSA”), 15 U.S.C. § 78bb, which mandates, with limited exceptions not

30

Media filed its motion to dismiss on October 20, 2006. Karp filed her motion to

dismiss on October 31, 2006. Jehassi sought and was granted an extension to respond to the

complaint but never actually needed to respond because Thompson withdrew the complaint and

never again named him as a defendant.

31

The defendants also noted that because Thompson had purchased his shares in a

private offering in June 2005—long before Relationserve Media filed its initial registration

statement on March 20, 2006—and because it had not issued a prospectus, Thompson could not

make out a violation of §§ 11 or 12 of the 1933 Act.

55

applicable here, that class action claims involving the purchase or sale of nationally

traded securities must be asserted under federal securities law.32

In their motions to dismiss, defense counsel also notified Thompson’s

counsel that they considered the claims to be baseless and in violation of Rule 11.

Indeed, both defendants who responded to the complaint moved the court to

dismiss the case and to retain jurisdiction to impose sanctions pursuant to the

PSLRA and Rule 11.33

4. Thompson’s Attorneys Move the Court for Leave to Amend and for Limited

Discovery to Add Individual Defendants

Thompson did not respond to the defendants’ motions. Instead, on October

24, his attorneys moved the district court for leave to conduct limited discovery to

32

In relevant part, the SLUSA provides:

(f) Limitations on remedies

(1) Class action limitations

No covered class action based upon the statutory or common law

of any State or subdivision thereof may be maintained in any State

or Federal court by any private party alleging—

(A) a misrepresentation or omission of a material fact in

connection with the purchase or sale of a covered security; or

(B) that the defendant used or employed any manipulative

or deceptive device or contrivance in connection with the

purchase or sale of a covered security.

15 U.S.C. § 78bb.

33

White & Case LLP represented Media and all individual defendants except Karp, who

was represented by McClosky, D’Anna & Dieterle, LLP; Honig, who was represented by Tew

Cardenas LLP; and Hill, who was represented by Genovese Joblove & Battista, P.A.

56

obtain the last known addresses for fourteen of the company’s officers and

directors so Thompson could amend his complaint and name them as defendants.

5. The Court Grants the Attorneys Leave to Amend and Limited Discovery and

Warns the Attorneys About Rule 11

On November 3, the district court held a telephone conference to hear

argument on the pending motions. During the call, Thompson’s counsel informed

the court that they wished to file an amended complaint; the court granted them

leave to do so.34 Over Media’s strenuous objection that Thompson’s request for

limited discovery amounted to a scorched-earth litigation tactic,35 the court granted

Thompson’s motion. In granting this motion, the court, although it had not yet

read the complaint, reminded counsel,

Also, there’s Rule Eleven which provides sanctions if there is no

legitimate basis for bringing a suit or serving the various officers and

directors . . . .

....

. . . I don’t know whether these officers and directors are legitimate

targets or not. There is no way I can know. I do know you lawyers

being experienced lawyers know about Rule Eleven.

34

On November 7, 2006, the district court entered an order denying the defendants’

motions to dismiss. The order stated that the plaintiff had asked for, and had been granted, leave

to amend his complaint.

35

Media argued that plaintiff’s counsel were pursuing a scorched-earth tactic in an effort

to “coerce some money out of a business where the plaintiff lost maybe $150,000. He has

asserted class action claims. He has tried every trick in the book.” (Teleconference Tr. 5, Nov.

3, 2006.)

57

....

Mr. Goldbaum, I will tell you, you really ought to think long and hard

before you just automatically sue everyone that happens to be on the

list of officers and directors. That’s for you to decide . . . .

(Teleconference Tr. 4, 6–7, Nov. 3, 2006.) Responding to this warning,

Thompson’s counsel promised the court that they would be mindful of Rule 11 and

would name officers and directors as defendants only if they had a reasonable basis

for doing so.

B. The First Amended Complaint

1. Thompson & Jacoby File the First Amended Complaint, Each Purporting to

Represent All Class Members on All Claims

On November 13, 2006, Thompson, now joined by new co-lead plaintiff L.

Alan Jacoby,36 filed a ten-count first amended complaint against Media, eleven

Officers and two non-officers.37 Recall that Jacoby purchased Media shares in the

36

The first amended complaint never explicitly declared that Jacoby was a lead plaintiff.

In securities actions, the PSLRA requires proposed lead plaintiffs to file certifications with the

district court. See 15 U.S.C. § 78u-4(a)(2)(A) (requiring a sworn statement that, for example,

the proposed lead plaintiff has reviewed the complaint and authorized its filing). Because

plaintiffs’ counsel filed Jacoby’s certification in a separate document and incorporated it by

reference in the first amended complaint, I treat Thompson and Jacoby as co-lead plaintiffs.

(See First Am. Compl. ¶ 1.)

37

The first amended complaint dropped Ohad Jehassi as a defendant. The Officers were

Danielle Karp, Mandee Heller Adler, Warren “Pete” Musser (these three had been named as

defendants in the initial complaint), Scott Young, Scott Hirsch, Adam C. Wasserman, Michael

H. Brauser, Shawn McNamara, Paul Soltoff, Eric Obeck, and Donald Gould, Jr. The non-officer

defendants were Richard Hill and Barry Honig. Hill was a “founder of Omni Point,” the

company that Relationserve acquired on May 16, 2005. (First Am. Compl. ¶ 17.) Honig was

“not registered with the Securities Exchange Commission” and therefore violated “the securities

laws” when he “sold RelationServe securities to Investors and received remuneration.” (Id. ¶

58

open market in July 2005. Both plaintiffs purported to represent all buyers of

Media securities who bought during the class period as to all claims. (First Am.

Compl. ¶¶ 99, 102.) Like the initial complaint, however, this complaint had two

implicit subclasses: one of private offering purchasers, and one of open market

purchasers. Also like the initial complaint, this complaint was a shotgun pleading.

The new complaint differed by adding to its federal securities law claims

new theories of the defendants’ allegedly false or misleading statements. In

addition to Thompson’s unregistered-broker theory, Thompson and Jacoby also

alleged that Media failed to disclose its retention of outside counsel to investigate

accusations of employee theft and kickbacks (the “kickback theory”); that

beginning in the third quarter of 2005, its financial statements recognized income

in violation of Generally Accepted Accounting Principles (“GAAP”) and company

policy (the “overstated-income theory”); and that it did not disclose that director

Musser had been sued by stockholders of two other corporations for securities

violations (the “sued-director theory”).

18.) According to the complaint, the remainder of the defendants were Officers and/or directors

of Media: Hirsch was chief operating officer, Wasserman was chief financial officer, Brauser

was chairman of the board, McNamara was senior vice president and interim chief financial

officer, Soltoff was chief financial officer, Obeck was president, Gould was chief financial

officer, and Young founded Chubasco, Media’s predecessor. The complaint alleged that all of

these Officers signed or authorized one or more certifications with the SEC. (Id. ¶¶ 10–22.)

59

The plaintiffs also tried to strengthen Thompson’s original unregistered-

broker theory. They added an allegation that Summit and another unregistered

broker, Barry Honig, sold securities to a Florida resident, Stuart Feick. (First Am.

Compl. ¶¶ 66–67.) Additionally, the plaintiffs essentially listed all of Media’s SEC

filings to date,38 with one notable exception. The first amended complaint did not

list Media’s June 16, 2005 Form 8-K current report, which revealed the Summit

consulting agreement, and, with it, Summit’s representation that it was not licensed

and would not act as a broker/dealer for Media.39 The amended complaint alleged

that all of the listed SEC filings were false or misleading because they failed to

state the material facts recounted above, including Media’s use of an unregistered

broker—Summit—to sell its shares.

38

The plaintiffs alleged that the following documents contained false or misleading

statements due to omissions of material fact: (a) the June 13, 2005 Form 8-K; (b) the June 14,

2005 quarterly statement Form 10-QSB filed by Chubasco; (c) the June 27, 2005 Form 8-K; (d)

the June 30, 2005 Form 8-K; (e) “several Form 8K’s [sic]” filed in July, August and September

2005; (f) the August 18, 2005 quarterly statement Form 10-QSB; (g) the November 18, 2005

quarterly statement Form 10-QSB; (h) “several Form 8K’s [sic]” filed in November 2005; (i)

“several” Form 8-Ks filed on December 5, 2005; (j) the December 30, 2005 Form 8-A

Registration Statement; (k) “several Form 8K’s [sic]” filed in February 2006; and (l) the March

20, 2006 Form SB-2 and Form 10-K. (First Am. Compl. ¶¶ 72–92.)

39

That the amended complaint contained no explicit reference to the June 16, 2005

current report is noteworthy for three reasons. First, the plaintiffs chose to list almost every

other SEC filing, made both before and after June 16, 2005. Second, Thompson had attested in

the subscription agreement he signed when he purchased his shares in the private offering that he

had read and reviewed this June 16, 2005 filing. See supra note 11 and accompanying text.

Third, the plaintiffs cited the June 16 filing in the initial complaint verbatim, and the only time

the agreement was disclosed was in the June 16, 2005 filing.

60

Counts I through III replicated nearly verbatim Counts I through III of the

initial complaint. Count I alleged that Media violated § 11 by filing a false

registration statement; Count II claimed that Media violated § 12 by issuing false

or misleading prospectuses or oral communications; Count III alleged violations of

§ 10(b) and Rule 10b-5. The plaintiffs added a new count, Count IV, “Violation

Of Section 20(a) of The Exchange Act Against the Individual Defendants.” That

count asserted that the Officers were liable for the Count III § 10(b), Rule 10b-5

violations because the Officers were controlling persons under § 20(a) of the 1934

Act, 15 U.S.C. § 78t.40 For all three federal securities claims, the plaintiffs alleged

the same misleading statements—Media’s securities filings misled because they

omitted Media’s use of an unregistered broker, its investigation of kickbacks, its

overstatement of income, and its sued director.

Similarly, with two notable exceptions, the plaintiffs re-pled their state law

claims almost verbatim. See Part II.A.1, supra. The state law claims were now

pled as Counts V through X (they were pled as counts IV through IX in the initial

40

Section 20(a) provides:

Every person who, directly or indirectly, controls any person liable under any

provision of [the 1934 Act] or of any rule or regulation thereunder shall also be

liable jointly and severally with and to the same extent as such controlled person

to any person to whom such controlled person is liable, unless the controlling

person acted in good faith and did not directly or indirectly induce the act or acts

constituting the violation or cause of action.

15 U.S.C. § 78t(a).

61

complaint). The two exceptions involved the allegations of fraud in the now Count

VIII Indiana Securities Act fraud claim and the now Count IX Indiana deception

claim. In the initial complaint’s iteration, Thompson alleged that Media

fraudulently failed to disclose: sizeable commissions and fees it paid to Altavilla,

that the stock was not registered and therefore restricted, and that Media had hired

“unregistered agents to sell there [sic] securities.” (Compl. ¶¶ 76, 78.) In the

amended complaint, Thompson eliminated any claim that Media misled him about

the unregistered status of his shares and pled the unregistered-broker, kickback,

overstated-income, and sued-director theories of misrepresentation instead. (First

Am. Compl. ¶¶ 147, 149.)

2. The Defendants Move to Dismiss, Request the Court to Retain Jurisdiction to

Impose Sanctions

The defendants responded to the first amended complaint with motions to

dismiss, which articulated virtually the same rationales as their previous motions to

dismiss. Addressing the Counts I and II claims under § 11 and § 12 of the 1933

Act, the defendants argued that the private offering subclass could not have relied

on a Media registration statement or prospectus because none had been issued for

those shares. Addressing Jacoby’s purchase of 10,000 shares in the open market in

July and August 2005, the defendants argued that these shares were purchased

under a registration statement and prospectus issued by Chubasco in February 2005

62

and thus could not form the basis for a § 11 or § 12 claim against Media. Turning

to the Count III § 10(b), Rule 10b-5 claim, the defendants argued that the plaintiffs

failed to plead the claim with the particularity and specificity demanded by Rule

9(b) and the PSLRA. As for the state law claims, the defendants again reiterated

that they were barred by the SLUSA, and, even if they were not barred by the

SLUSA, they failed to state a claim. Finally, defendants Media, Adler, Musser,

Wasserman, Brauser, McNamara, Soltoff, Obeck, Gould, and Young, and, in her

separate motion, defendant Karp, reiterated the request that the court retain

jurisdiction to impose sanctions.

In response to the defendants’ motions, plaintiffs’ counsel conceded that

their § 11 claim had no merit.41 Although the plaintiffs also conceded that their §

12 claim could not succeed on the basis of any false or misleading prospectus, they

maintained the claim had merit because Thompson relied on certain (unidentified)

“oral communication[s]” in the June private offering.42 (Pls.’ Resp. to Defs.’ Mot.

41

In their response, plaintiffs’ counsel stated: “After reviewing the Defendants’ briefs

and further investigating the claims, Plaintiffs Jacoby and Thompson have decided to abandon

their Section 11 claims.” (Pls.’ Resp. to Defs.’ Mot. to Dismiss 26, Jan. 29, 2007.)

42

The first amended complaint alleged that Thompson had relied on “oral

communications” from Altavilla. Paragraph 56 stated: “Before investing Plaintiff Richard F.

Thompson reviewed the public statements on the internet about Relationserve [Media], listened

to the sales pitch of Tony Altavilla and reviewed all document[s] presented by Tony Altavilla.”

Paragraph 58 stated: “In order to complete the purchase of Relationserve [Media] shares by the

Plaintiff Richard F. Thompson, Altavilla negotiated the final purchase price between the parties,

and facilitated wire transfers of money from the Plaintiff to Relationserve [Media].”

63

to Dismiss 25, Jan. 29, 2007.)43 As for the § 10(b), Rule 10b-5 claim, counsel

argued that they had met the strict pleading requirements of Rule 9(b) and the

PSLRA.44 (Id. at 11.)

Regarding the state law claims, the plaintiffs conceded that the SLUSA

barred them from maintaining three of the five claims as class actions: the Count

VIII Indiana securities fraud claim, the Count IX Indiana deception claim, and the

Count X common law fraud claim. They argued that Counts V, VI, and VII were

cognizable. (Id. at 23–24.) Counts V and VI alleged that Media sold securities via

unregistered brokers in violation of Florida and Indiana law, respectively; Count

VII alleged that Media sold unregistered, non-exempt securities in violation of the

Indiana Securities Act. The defendants contended that these claims were “not

within the purview of SLUSA because the claims do not allege that the Defendants

misrepresented or omitted a material fact in connection with the purchase or sale of

such security.” (Id. at 23 (quotation omitted).)

3. The Court Dismisses the First Amended Complaint

43

Plaintiffs’ counsel apparently concluded that they lacked evidentiary support, legal

support, or both, for the “oral communication[s],” because, when they filed the second amended

complaint, they did not assert a § 12 claim.

44

The plaintiffs’ allegations of fraudulent conduct on the part of the Officers were that

they “omitted to state material facts” in documents with the SEC. (See First Am. Compl. ¶¶

9–22.) For example, “Defendant Danielle Karp was the President and Secretary of

Relationserve. Danielle Karp signed one or more certifications per Sarbanes-Oxley Act filed

with the SEC which omitted to state material facts.” (Id. at ¶ 10.)

64

The district court heard the defendants’ motions to dismiss during a

conference call with counsel on March 6, 2007. Referring to the § 10(b), Rule

10b-5 claims, the court questioned whether Thompson was a suitable class

representative because of a possible conflict with the open market purchasers. The

court also indicated that it had serious concerns about the adequacy of the

plaintiffs’ pleading. At one point, the court said:

So I don’t see anything where it is alleged that [Thompson and

Jacoby] relied on anything specific. Nothing is tied together. There

are a lot of things thrown out in the first amended complaint, but I see

very little connecting of the dots.

Seems to me there are some real gaps there. Seems to me you may

have more than one lawsuit tied into one lawsuit. . . .

....

Again, it’s kind of hard to follow. It’s like so what, who relied on it,

who did what? Where is the reliance causation?

I don’t see . . . where anyone is alleged to have relied on any

particular filing whether [a Form] 10[-] K, [Form] 10-Q[SB], or

registration statement that led that person to purchase something.

(Hr’g Tr. 8, Mar. 6, 2007.) After detailing why the federal securities claims failed,

the court offered plaintiffs’ counsel “one final time to take care of” the

deficiencies. (Id. at 5.) The court therefore dismissed the first amended complaint

without prejudice, with leave to file a second amended complaint by March 19,

2007.

65

C. The Second Amended Complaint

1. Thompson & Jacoby File the Second Amended Complaint with Jacoby Leading

an Open-Market Purchaser Subclass Bringing Federal Securities Claims and with

Thompson Leading a Private Offering Purchaser Subclass Bringing State Law

Claims

The plaintiffs filed a second amended complaint on March 19, 2007. This

complaint, unlike the prior ones, pled two class actions: one under federal

securities law, with Jacoby as the class representative, and the other under state

law, with Thompson as the class representative. Both actions sought rescission or

damages for purchasers of Media stock.

As for the federal claims, Jacoby brought his class action in two counts, I

and II, “on behalf [of] himself and all others similarly situated that purchased

RelationServe Media, Inc. . . . securities on the open market prior to May 23,

2006.” (Second Am. Compl. ¶ 1.) In Count I, except for the class definition,

Jacoby replicated the claim brought by Thompson in Count III of the initial

complaint and by Thompson and Jacoby in Count III of the first amended

complaint—that Media and the Officers “offered and sold RelationServe securities

in violation of” § 10(b) of the 1934 Act and Rule 10b-5. (Second Am. Compl. ¶¶

101–03.)45 In Count II, except for the class definition, Jacoby replicated the §

45

In drafting the second amended complaint, plaintiffs’ counsel did not include the § 11

and § 12 claims asserted in Counts I and II of the initial and first amended complaints, which

were based on misrepresentations allegedly made in Media’s registration statement and

prospectus. See supra parts II.A and B. Nonetheless, in presenting Count I in the second

66

20(a) claim brought by Thompson and Jacoby in Count IV of the first amended

complaint—“[b]y virtue of their positions as controlling persons [of Media], the

individual Defendants are liable” for Media’s violation of § 10(b) and Rule 10b-5.

(Id. ¶¶ 104–11.)

The biggest difference between the federal securities claims in the first and

second amended complaints was what the second amended complaint omitted.

Gone was Thompson from any federal securities claim; gone were two of the

individual defendants;46 gone were the § 11 and § 12 claims; gone were the

kickback and the overstated-income theories of misrepresentation.47 Only Jacoby

remained, representing open market purchasers and bringing a § 10(b), Rule 10b-5

claim and a parasitic § 20(a) claim.48 Jacoby asserted only the unregistered-broker

and sued-director theories of misrepresentation.

amended complaint, counsel repeated the allegation that “RelationServe[ Media’s] registration

statement(s) and prospectus contained misleading information and omitted material facts

necessary to make the statements alleged therein not misleading.” (Second Am. Compl. ¶ 102.)

46

The plaintiffs dropped Richard Hill and Barry Honig.

47

The plaintiffs did not even plead the factual predicate for the kickback theory; the

plaintiffs did plead the factual predicate for the overstated-income theory (Second Am Compl. ¶¶

60, 61), but did not plead it as an actionable omission in the § 10(b), Rule 10b-5 claim, (id. ¶¶ 3,

80, 95). Further, in the district court and in this appeal, the plaintiffs advanced it only to

demonstrate the defendants’ venal character in support of the plaintiffs’ scienter argument.

48

A § 20(a) claim is a parasitic claim because it can only succeed if a predicate § 10(b),

Rule 10b-5 claim succeeds; thus the § 20(a) claim lives and dies by the Rule 10b-5 claim.

67

Thompson asserted his class action in Count III “on behalf of himself and all

others similarly situated that purchased RelationServe [Media] securities by way of

a private offering.” (Id. ¶ 2.) Count III alleged that the defendants

violated the securities laws of California, Connecticut, Florida,

Illinois, Indiana, Nevada, New Jersey, New York, Ohio, and

Pennsylvania by way of (1) their sale of RelationServe [Media]

securities through the use of broker/dealers and agents who were not

registered with the SEC [and those states] and (2) their payment of a

commission.49

(Id. ¶ 113.) Furthermore,

[e]ach Defendant having access to RelationServe [Media] business

prior to and during RelationServe[ Media’s] use of unregistered

broker/dealers personally participated or aided in making the sales to

Thompson and his putative class and is jointly and severally liable for

rescission if the purchaser still owns the security or for damages if the

purchaser has sold the security.

(Id. ¶ 114.) Here again, most notable was what was omitted: gone was the claim

that Media sold unregistered, non-exempt securities in violation of the Indiana

securities act, and gone were all of the state law fraud claims.

The first 100 paragraphs resembled the first 117 paragraphs of the first

amended complaint. Like that complaint, the second amended complaint omitted

any reference to Media’s June 16, 2005 current report, which indicated that

Summit was not registered and would not act as a broker/dealer, but, rather would

49

As it pertained to the securities laws of Florida and Indiana, Count III replicated the

allegations of Counts IV and V of the initial complaint and Counts V and VI of the first amended

complaint.

68

only act as a finder. Nevertheless, the second amended complaint addressed the

licensing issue by alleging that “RelationServe [Media], and its officers and

directors, knew and failed to report . . . that Summit and its agents [we]re not

registered with the SEC or the state securities divisions.” (Second Am. Compl. ¶

45.) It also alleged that the Officers acted with scienter in failing to report this: the

Officers “knew and/or recklessly disregarded the falsity and misleading nature of

the information which they caused to be disseminated to the investing public.” (Id.

¶ 80.)

2. The Defendants Move to Dismiss, and Defendant Karp Moves for Sanctions

Once again, the defendants moved to dismiss the plaintiffs’ complaint. They

did so on several grounds, among them that (1) the § 10(b), Rule 10b-5 claim’s

allegations of misrepresentation and scienter were insufficient under the

heightened pleading requirements of Rule 9(b) and the PSLRA; and (2) as a

consequence, the parasitic § 20(a) claim failed. As for Thompson’s state law class

action, the defendants pointed out that of the ten states where Media allegedly sold

shares through unregistered brokers, the plaintiffs had identified only one sale in

only one state—specifically, Media’s sale to Thompson through Summit in

Indiana. Accordingly, the state law claims in all states except Indiana failed from

69

the get-go. As for the Indiana sale to Thompson, the plaintiffs pointed out that

Summit did not need to be registered as a broker under Indiana law.

In addition to moving for the dismissal of the complaint, defendant Karp

moved for sanctions against the plaintiffs and their attorneys under Rule 11 with

respect to all counts and under the PSLRA with respect to the Count I § 10(b),

Rule 10b-5 claim and the Count II § 20(a) claim.50

3. The Court Dismisses the Complaint with Prejudice but Denies Sanctions

On June 12, 2007, the district court entered an order disposing of the

defendants’ motions. The court dismissed Count I because it failed to meet the

heightened pleading standards of Rule 9(b) and the PSLRA. In the court’s view,

the § 10(b), Rule 10b-5 elements of misrepresentation and scienter had not been

pled with the requisite specificity. Specifically, the § 10(b), Rule 10b-5 claim did

not identify one statement of significance in any SEC filing that was allegedly false

or misleading due to the omission of a material fact, and it pled scienter in a

conclusory fashion, thereby failing to create a strong inference of severe

recklessness on the part of Media or the Officers. The court dismissed Count II

50

All defendants except Jehassi sought Rule 11 sanctions when they moved the district

court to dismiss the initial complaint; eleven of thirteen defendants renewed this request in their

motions to dismiss the first amended complaint; and all defendants renewed this request in their

motions to dismiss the second amended complaint. Karp was the only defendant who sought the

imposition of sanctions in a separate motion and was the only defendant who appealed the denial

of sanctions.

70

because Count I was legally insufficient. The dismissal of Counts I and II left the

court with the state law claims of Count III. The court declined to exercise its

supplemental jurisdiction over those claims and therefore dismissed them without

prejudice.

In a separate order entered on June 12, the court denied Karp’s motion for

sanctions. The court found “that Plaintiffs’ claims are not frivolous, or so devoid

of evidentiary support as to warrant sanctions. Likewise, there is no evidence that

Plaintiffs instituted this action for improper purposes, such as to harass [Media,

Karp, or any other named defendant] or needlessly increase the cost of litigation.”

(Sanctions Order 1, June 12, 2007 (internal citations omitted).)51 Karp contended

that sanctions were warranted because, “[i]n dismissing the instant matter three

times for failing to state a cause of action, the District Court in essence ruled

Plaintiffs’ claims were frivolous.”

4. Jacoby’s Appeal, Karp’s Cross-Appeal, and this Court’s Decision

51

The two page order denying sanctions did not explicitly address Rule 11(b)

compliance under the PSLRA with respect to: (1) the § 11 claims brought as Count I in the

initial and first amended complaints; (2) the § 12 claims brought as Count II in the initial and

first amended complaints; (3) the § 10(b), Rule 10b-5 claims brought as Count III of the initial

complaint and first amended complaints and Count I of the second amended complaint; or (4)

the § 20(a) claims brought as Count IV of the first amended complaint and Count II of the

second amended complaint. After declining to exercise jurisdiction over Count III of the second

amended complaint, Thompson’s state law claims, the district court did not decide whether Rule

11 sanctions should be imposed for plaintiffs’ prosecution of those claims.

71

Subsequently, Jacoby appealed to this court and Karp cross-appealed.

Jacoby appeals the district court’s dismissal of the § 10(b), Rule 10b-5 and § 20(a)

claims of the second amended complaint. Karp cross-appeals the court’s denial of

PSLRA Rule 11 sanctions for the federal claims and ordinary Rule 11 sanctions for

the second amended complaint’s state law claims.

Today, the court correctly affirms the dismissal of Jacoby’s federal securities

law claims. The court disposes of Karp’s appeal regarding PSLRA sanctions by

vacating the district court’s sanctions order and remanding the case for further

proceedings, because the district court’s PSLRA order is too conclusory to permit

meaningful appellate review. The court’s disposition contains insufficient

instructions as to precisely what the district court must do on remand. In my view,

under the court’s disposition, the district court must carry out its PSLRA duties

from scratch with respect to all parties and their respective attorneys. Finally, the

court makes no explicit holding regarding Karp’s motion for ordinary Rule 11

sanctions on the state law claims.

III. This Court Errs by Summarily Remanding Karp’s Cross-Appeal for Sanctions

Under the PSLRA

In Karp’s cross-appeal for Rule 11 and PSLRA sanctions, the court errs for

two reasons. First, the court’s opinion fails to make perfectly clear that, on

remand, the district court must review and make “specific findings regarding”

72

plaintiffs and plaintiffs’ counsel’s compliance with each requirement of Rule 11(b)

with respect to all three complaints.52 Second, the court should not have remanded

with a blank slate; at bottom, the court should have instructed the district court to

sanction plaintiffs’ attorneys for noncompliance with Rule 11(b). This discussion

proceeds in two parts. Part A sets out the duties the PSLRA imposes on district

courts and shows that the district court must review all three complaints for Rule

11 compliance on remand. Part B explains that under the PSLRA, there is no need

for a remand when the record demonstrates conclusively that an attorney or party

violated Rule 11.

A. The PSLRA Rule 11 Analytical Framework & Requirements

The PSLRA mandates sanctions for filing and prosecuting frivolous or

abusive securities actions under the 1933 and 1934 Acts and emphasizes the need

not only to deter such filings but also to compensate the victims. See H.R. Rep.

No. 104-369, at 39–40 (1995) (Conf. Rep.), reprinted in 1995 U.S.C.C.A.N. 730,

738–39. Accordingly, the PSLRA requires both (1) mandatory findings regarding

compliance with Rule 11, and (2) mandatory sanctions whenever any portion of a

52

See 15 U.S.C. §§ 77z-1(c), 78u-4(c). Full compliance with the PSLRA requires the

district court to review the motions the defendants filed in response to the three complaints as

well, but the focus on remand will be the complaints.

73

plaintiff’s complaint fails to comply with Rule 11.53 15 U.S.C.

53

Section 78u-4(c), which is materially identical to § 77z-1(c), provides:

Sanctions for abusive litigation

(1) Mandatory review by court

In any private action arising under this chapter, upon final adjudication of

the action, the court shall include in the record specific findings regarding

compliance by each party and each attorney representing any party with

each requirement of Rule 11(b) of the Federal Rules of Civil Procedure as

to any complaint, responsive pleading, or dispositive motion.

(2) Mandatory sanctions

If the court makes a finding under paragraph (1) that a party or attorney

violated any requirement of Rule 11(b) of the Federal Rules of Civil

Procedure as to any complaint, responsive pleading, or dispositive motion,

the court shall impose sanctions on such party or attorney in accordance

with Rule 11 of the Federal Rules of Civil Procedure. Prior to making a

finding that any party or attorney has violated Rule 11 of the Federal

Rules of Civil Procedure, the court shall give such party or attorney notice

and an opportunity to respond.

(3) Presumption in favor of attorneys’ fees and costs

(A) In general

Subject to subparagraphs (B) and (C), for purposes of paragraph

(2), the court shall adopt a presumption that the appropriate

sanction—

(i) for failure of any responsive pleading or dispositive

motion to comply with any requirement of Rule 11(b) of

the Federal Rules of Civil Procedure is an award to the

opposing party of the reasonable attorneys’ fees and other

expenses incurred as a direct result of the violation; and

(ii) for substantial failure of any complaint to comply with

any requirement of Rule 11(b) of the Federal Rules of Civil

Procedure is an award to the opposing party of the

reasonable attorneys’ fees and other expenses incurred in

the action.

74

§ 77z-1(c); 15 U.S.C. § 78u-4(c).

The PSLRA-mandated Rule 11 compliance review is sweeping. In a

paragraph entitled “Mandatory review by court,” the statute provides that, in any

private securities action, “the court shall include in the record specific findings

regarding compliance by each party and each attorney . . . with each requirement of

Rule 11(b) . . . as to any complaint, responsive pleading, or dispositive motion.”

15 U.S.C. § 78u-4(c)(1) (emphasis added). Congress imposed this heavy duty on

district courts via statute; thus, whether a party moved for sanctions is irrelevant.

(B) Rebuttal evidence

The presumption described in subparagraph (A) may be rebutted only

upon proof by the party or attorney against whom sanctions are to be

imposed that—

(i) the award of attorneys’ fees and other expenses will impose an

unreasonable burden on that party or attorney and would be unjust,

and the failure to make such an award would not impose a greater

burden on the party in whose favor sanctions are to be imposed; or

(ii) the violation of Rule 11(b) of the Federal Rules of Civil

Procedure was de minimis.

(C) Sanctions

If the party or attorney against whom sanctions are to be imposed meets

its burden under subparagraph (B), the court shall award the sanctions that

the court deems appropriate pursuant to Rule 11 of the Federal Rules of

Civil Procedure.

Because the two subsections are materially identical, from this point forward, I cite only to 15

U.S.C. § 78u-4(c).

75

Moreover, because Congress extended this duty to “any” complaint, when a

plaintiff files multiple complaints, each must be scrutinized. See Reeves v. Astrue,

526 F.3d 732, 734 (11th Cir. 2008) (“Statutory interpretation begins and ends with

the text of the statute so long as the text’s meaning is clear.”). The PSLRA does

not grant a get-out-of-jail-free card—one nonfrivolous complaint does not

immunize the earlier filing of frivolous complaints. See ATSI Commc’ns, Inc. v.

Shaar Fund, Ltd., 579 F.3d 143, 152 (2d Cir. 2009) (“The PSLRA sanctions

provision forecloses the kind of safe harbor afforded in Rule 11(c)(2). The PSLRA

explicitly directs courts to make Rule 11 findings ‘upon final adjudication of the

action’ . . . and it is well-settled that no safe harbor could apply retroactively.”)

(quoting 15 U.S.C. § 78u4-(c)(1)). Even in the ordinary Rule 11 context, where a

complaint contains multiple claims, one nonfrivolous claim will not preclude

sanctions for frivolous claims. E.g., Reed v. Great Lakes Cos., 330 F.3d 931, 936

(7th Cir. 2003) (“The fact that Reed’s accommodation claim, while it has failed,

was not frivolous would be no bar to imposing sanctions for putting his opponent

to the expense of opposing a frivolous claim (or defense) just because he had a

nonfrivolous claim as well.”). Here, the district court erred when it based its

sanctions review on only the second amended complaint. The district court should

76

have reviewed all three complaints (as well as, for that matter, each party, each

attorney, and each motion to dismiss) for compliance with Rule 11.

Although the PSLRA forces a district court to conduct the Rule 11 inquiry, it

does not alter the ordinary Rule 11 analysis. Simon DeBartolo Group, L.P. v.

Richard E. Jacobs Group, Inc., 186 F.3d 157, 167 (2d Cir. 1999). Rule 11 is

violated when: (1) a paper is presented for “any improper purpose, such as to

harass or to cause unnecessary delay or needless increase in the cost of litigation;”

(2) the legal contentions are not “warranted by existing law” or by a “nonfrivolous

argument” for changing existing law; or (3) the factual contentions lack evidentiary

support. Fed. R. Civ. P. 11(b) (2006).54 A Rule 11(b)(2) or (b)(3)

violation—bringing a legally or factually frivolous claim—is often probative of a

54

When this case was litigated, Federal Rule of Civil Procedure 11(b) provided:

(b) Representations to Court. By presenting to the court (whether by signing,

filing, submitting, or later advocating) a pleading, written motion, or other paper,

an attorney . . . is certifying that to the best of the person’s knowledge,

information, and belief, formed after an inquiry reasonable under the

circumstances,—

(1) it is not being presented for any improper purpose, such as to harass or to

cause unnecessary delay or needless increase in the cost of litigation;

(2) the claims . . . and other legal contentions therein are warranted by existing

law or by a nonfrivolous argument for the extension, modification, or reversal of

existing law or the establishment of new law;

(3) the allegations and other factual contentions have evidentiary support or, if

specifically so identified, are likely to have evidentiary support after a reasonable

opportunity for further investigation or discovery . . . .

Fed. R. Civ. P. 11 (2006). Rule 11 was amended in 2007 “as part of the general restyling of the

Civil Rules,” this amendment was “intended to be stylistic only.” Fed. R. Civ. P. 11 advisory

committee’s note, 2007 amendment. Nevertheless, I refer to the 2006 version of the Rule.

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Rule 11(b)(1) improper purpose violation. Therefore, it helps to begin the PSLRA

examination with Rule 11(b)(2) and (3).

In this circuit, there are two prongs to the Rule 11(b)(2) and (b)(3) inquiry:

whether the legal claims or factual contentions are objectively frivolous, and, if so,

whether a reasonably competent attorney should have known they were frivolous.

Worldwide Primates, Inc. v. McGreal, 87 F.3d 1252, 1254 (11th Cir. 1996). Both

inquiries measure attorney conduct under an objective reasonably competent

attorney standard. Donaldson v. Clark, 819 F.2d 1551, 1556 (11th Cir. 1987) (en

banc).

A legal claim is frivolous if no reasonably competent attorney could

conclude that it has any “reasonable chance of success” or is a reasonable argument

to change existing law. Worldwide Primates, 87 F.3d at 1254 (quoting Jones v.

Int’l Riding Helmets, Ltd., 49 F.3d 692, 694 (11th Cir. 1995)); McGregor v. Bd. of

Comm’rs of Palm Beach County, 956 F.2d 1017, 1022 (11th Cir. 1992) (“If an

allegation in a complaint contains no colorable claim for relief, then a Rule 11

sanction is proper.”). Not every Federal Rule of Civil Procedure 12(b)(6)

dismissal will warrant sanctions, but sanctions may be imposed when settled

precedent clearly bars a claim. See Davis v. Carl, 906 F.2d 533, 538 (11th Cir.

1990) (noting that legal claims are frivolous in egregious circumstances such as

78

when a party ignores the plain language of a statute of limitations or conceals

controlling authority); compare Thomas v. Early County, Ga., No. 09-12232, 2010

WL 27970, at *4 (11th Cir. Jan. 7, 2010) (unpublished) (concluding that Rule

11(b)(2) had been violated where “allegations of vicarious liability fail as a matter

of long-established law”), with Anderson v. Smithfield Foods, Inc., 353 F.3d 912,

915–16 (11th Cir. 2003) (per curiam) (affirming a district court’s dismissal of a

RICO count, but reversing the imposition of sanctions when there was “scant on-

point authority” to guide the attorney to the conclusion that the claim had no

chance of success).

A factual claim is frivolous if no reasonably competent attorney could

conclude that it has a reasonable evidentiary basis. Davis, 906 F.2d at 535–37.

Thus, where no evidence or only “patently frivolous” evidence is offered to

support factual contentions, sanctions can be imposed. Id. at 537. If, however, the

evidence supporting the claim is reasonable, but simply “weak” or “self-serving,”

sanctions cannot be imposed. Id. at 536.

Once a court concludes that either the factual or legal contentions are

frivolous, the question becomes whether the attorney should have known they were

frivolous. Worldwide Primates, 87 F.3d at 1254. We ask what was known or

reasonably knowable when the paper was “present[ed] to the court.” Fed. R. Civ.

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P. 11(b). Again, measured objectively, if a reasonable investigation would have

revealed the error to a reasonably competent attorney, then sanctions can be

imposed; if not, then sanctions cannot be imposed. The reasonableness of the

inquiry turns on the totality of the circumstances, including, for example, the time

available for investigation and whether the attorney had to rely on the client,

another member of the bar, or others. Worldwide Primates, 87 F.3d at 1254.

Rule 11(b)(1) sanctions are appropriate when an attorney or party presents a

paper for an improper purpose. Improper purpose is often inferred from

circumstantial evidence. For example, it can be inferred from “‘excessive

persistence in pursuing a claim or defense in the face of repeated adverse rulings.’”

Indus. Risk Insurers v. M.A.N. Gutehoffnungshütte GmbH, 141 F.3d 1434, 1448

(11th Cir. 1998) (quoting Pierce v. Commercial Warehouse, 142 F.R.D. 687,

690–91 (M.D. Fla. 1992)). A “motive to harass” can also be inferred from an

attorney’s filing of factually or legally frivolous claims. Cf. Carr v. Tillery, 591

F.3d 909, 919–20 (7th Cir. 2010).

Ordinarily, even in the face of a blatant Rule 11 violation, a district court

retains discretion to decide how to sanction the party or even not to impose

sanctions at all. This discretion derives from Rule 11’s plain text: “If, after notice

and a reasonable opportunity to respond, the court determines that Rule 11(b) has

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been violated, the court may impose an appropriate sanction on any attorney, law

firm, or party . . . .” Fed. R. Civ. P. 11(c)(1) (emphasis added); see also Fed. R.

Civ. P. 11 advisory committee’s note, 1993 Amendment (“[W]hat sanctions, if any,

to impose for a violation are matters committed to the discretion of the trial

court.”). Thus, ordinarily, a court can excuse an attorney’s negligence, mistake, or

plain-old incompetence.

But the PSLRA strips the district court of the discretion to grant mercy—the

PSLRA forces a district court to sanction an attorney for violating any prong of

Rule 11. The statute provides, in a paragraph entitled “Mandatory sanctions,” that

“[i]f the court makes a finding . . . that a party or attorney violated any requirement

of Rule 11(b) . . . as to any complaint, responsive pleading, or dispositive motion,

the court shall impose sanctions on such party or attorney . . . .” 15 U.S.C. § 78u-

4(c)(2) (emphasis added). Likewise, the PSLRA curtails a district court’s

discretion in fashioning the sanction. It does so by erecting a rebuttable

presumption that when any complaint “substantial[ly]” fails to comply with Rule

11, the sanction is the defendant’s attorneys’ fees for the entire action. Id. § 78u-

4(c)(3)(A)(ii).55 Even when the presumption is rebutted,56 a district court still must

55

For responsive pleadings and dispositive motions, the PSLRA erects a similar

presumption but without the requirement that the violation be “substantial” and limiting the

award of fees to those caused by the violation. See 15 U.S.C. § 78u-4(c)(3)(A)(i) (stating the

penalty for “failure of any responsive pleading or dispositive motion to comply with any

requirement of Rule 11(b)” is an “award to the opposing party of the reasonable attorneys’ fees

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sanction the party in some appropriate manner. Id. § 78u-4(c)(3)(C) (“If the party

or attorney [to be sanctioned] meets its burden under subparagraph (B), the court

shall award the sanctions that the court deems appropriate pursuant to Rule 11 . . .

.”) (emphasis added).

The PSLRA’s mandate regarding Rule 11(b) compliance resulted from

Congress’s recognition of “the need to reduce significantly the filing of meritless

securities lawsuits without hindering the ability of victims of fraud to pursue

legitimate claims.” H.R. Rep. No. 104-369, at 39 (1995) (Conf. Rep.), reprinted in

1995 U.S.C.C.A.N. 730, 738. Further, in enacting the PSLRA, Congress

commented that the “[e]xisting Rule 11 has not deterred abusive securities

litigation” and that the PSLRA’s sanctions requirement would put “teeth” into Rule

11. Id. The Senate Report accompanying the legislation further notes,

Although private securities class actions can complement SEC

enforcement actions, the evils flowing from abusive securities

litigation start with the filing of the complaint and continue through to

the final disposition of the action. A complaint alleging violations of

the Federal securities laws is easy to craft and can be filed with little

or no due diligence.

and other expenses incurred as a direct result of the violation”).

56

The presumption can be rebutted if the party or attorney is able to prove (1) that the

sanction would impose an unreasonable, unjust burden and that a failure to impose the sanction

would not impose a greater burden on the other party; or (2) that the Rule 11(b) violation was de

minimis. 15 U.S.C. § 78u-4(c)(3)(B). Although they had the opportunity to do so when

opposing Karp’s requests for sanctions, neither the plaintiffs nor their counsel have made either

argument or offered either type of proof in this case.

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....

Most defendants in securities class action lawsuits choose to settle

rather than face the enormous expense of discovery and trial. Of the

approximately 300 securities lawsuits filed each year, almost 93%

settle at an average settlement cost of $8.6 million. These cases are

generally settled based not on the merits but on the size of the

defendant’s pocketbook.

The fact that many of these lawsuits are filed as class actions has had

an in terrorem effect on Corporate America . . . . These lawsuits have

added significantly to the cost of raising capital and represent a

“litigation tax” on business. Smaller start-up companies bear the

brunt of abusive securities fraud lawsuits. Many of these companies

are high-technology companies which, by their very nature, have

unpredictable business prospects and, consequently, volatile stock

prices.

S. Rep. No. 104-98, at 8–9 (1995), reprinted in 1995 U.S.C.C.A.N. 679, 687–88

(footnotes omitted).

Accordingly, the PSLRA’s sanctions mandate reflects Congress’s policy to

prevent the misuse of judicial resources in the securities context. To effectuate its

goals, Congress imposed a heavy burden on the district courts and removed the

courts’ discretion to grant mercy for a Rule 11(b) violation.

Significantly, our sister circuits agree with this strict, literal, and unforgiving

interpretation of the way Congress has curtailed the district courts’ Rule 11

discretion through the PSLRA; the courts of appeals that have considered the issue

have uniformly agreed—Congress meant what it said when it made Rule 11

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sanctions mandatory whenever a violation is found. See Citibank Global Mkts.,

Inc. v. Rodriguez Santana, 573 F.3d 17, 31 (1st Cir. 2009) (“The statute requiring

such findings does not appear to brook any exceptions”); Morris v. Wachovia Sec.,

Inc., 448 F.3d 268, 276 (4th Cir. 2006) (“Because the sanctions ‘instruction comes

in terms of the mandatory “shall,” which normally creates an obligation impervious

to judicial discretion’ . . . the district court must impose sanctions for each

violation found.”) (quoting Lexecon Inc. v. Milberg Weiss Bershad Hynes &

Lerach, 523 U.S. 26, 35, 118 S.Ct. 956, 962 (1998)); Gurary v. Nu-Tech Bio-Med,

Inc., 303 F.3d 212, 215 (2d Cir. 2002) (“If the court determines that a violation has

occurred, the imposition of sanctions is mandatory.”).

In addition to mandating the Rule 11 inquiry and mandating sanctions for

any Rule 11 violation, the PSLRA imposes three procedural requirements. First,

the district court’s duty to conduct the Rule 11 compliance review is triggered only

“upon final adjudication of the action.” 15 U.S.C. § 78u-4(c)(1). Second, if, after

examining the complaints, responsive pleadings, or dispositive motions, the court

concludes that sanctions may be in order, the court “shall give [the] party or

attorney [against whom sanctions might be imposed] notice and an opportunity to

respond.” Id. § 78u-4(c)(2). Although the statute does not specify the type of

notice that should issue, an order directing the party or attorney “to show cause”

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why sanctions should not be imposed would suffice. Cf. Fed. R. Civ. P. 11

advisory committee’s note, 1993 Amendment (“The power of the court to act on its

own initiative is retained, but with the condition that this be done through a show

cause order.”). Third, a district court must reduce its Rule 11 compliance review

to “specific findings.” These specific findings are akin to the findings of fact and

conclusions of law a district court makes pursuant to Federal Rule of Civil

Procedure 52(a) at the conclusion of a bench trial. These findings aid the court of

appeals in reviewing the district court’s sanctions decision. In this case, in addition

to erring by focusing solely on the second amended complaint, the district court

erred by entering only a conclusory order.

B. A Court of Appeals Should Not Remand for Rule 11 Findings When it Can

Determine Conclusively that the District Court Abused its Discretion in Denying

Sanctions

The PSLRA does not explain how a court of appeals should review a district

court’s failure to conduct an adequate PSLRA examination evidenced by “specific

findings” regarding the parties’ and their attorneys’ compliance with Rule 11.

Today, the court equivocates on whether it is possible for an appellate court to

determine PSLRA Rule 11 compliance when faced with conclusory findings and

declines to do so in this case. Maj. Op. at 20, 23. That conclusion, however,

ignores the precedent of this circuit, will set the stage for error on remand, will

85

generate another appeal, and will waste the time and resources of the district court,

this court, and the litigants. In my view, under the PSLRA, when it can be

determined conclusively that an attorney or party violated Rule 11, the court of

appeals should hold that sanctions must be imposed. This is so even where, as

here, the court of appeals can reach that holding only as to some of the claims or

defenses.

We review a district court’s Rule 11 determination for abuse of discretion.

Souran v. Travelers Ins. Co., 982 F.2d 1497, 1507 n.10 (11th Cir. 1993). “‘A

district court would necessarily abuse its discretion if it based its ruling on an

erroneous view of the law or on a clearly erroneous assessment of the evidence.’”

McGregor v. Bd. of Comm’rs of Palm Beach County, 956 F.2d 1017, 1022 (11th

Cir. 1992) (quoting Cooter & Gell v. Hartmax Corp., 496 U.S. 384, 405, 110 S. Ct.

2447, 2461 (1990)).

The court seems to doubt whether it can review the district court’s exercise

of discretion in this case because the record contains only a conclusory,

unreviewable order. Accordingly, the court remands the case to the district court

so that it can make findings of fact and conclusions of law regarding the parties’

and counsel’s compliance with Rule 11. There is no doubt, however, that even

without extensive findings, it is possible for this court to review PSLRA Rule 11

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determinations under the abuse of discretion standard. Sometimes, the record on

appeal will disclose Rule 11 violations that are so egregious that any refusal by the

district court to impose sanctions would necessarily constitute an abuse of

discretion. To see why, it is necessary to unpack the abuse of discretion standard

and the elements of a Rule 11 violation.

The critical difference between abuse of discretion review and de novo

review is that abuse of discretion “recognizes [a] range of possible conclusions the

trial judge may reach.” United States v. Frazier, 387 F.3d 1244, 1259 (11th Cir.

2004) (en banc). More specifically,

[b]y definition . . . under the abuse of discretion standard of review

there will be occasions in which we affirm the district court even

though we would have gone the other way had it been our call. That

is how an abuse of discretion standard differs from a de novo standard

of review. As we have stated previously, the abuse of discretion

standard allows “a range of choice for the district court, so long as that

choice does not constitute a clear error of judgment.”

Id. (quoting Rasbury v. I.R.S., 24 F.3d 159, 168 (11th Cir. 1994)). That said,

abuse of discretion never gives the district court unfettered discretion: the court

must not base its discretionary decision on an erroneous view of the law or a

clearly erroneous assessment of the evidence. Accordingly, the “range of possible

conclusions” varies with the nature of the inquiry (legal v. factual) and the relative

merit of the parties’ competing positions (whether the question is close). In sum,

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when reviewing the elements of a district court’s decision of whether to impose

sanctions, the relevant question is not whether we would have come to the same

decision if deciding the issue in the first instance. The relevant inquiry, rather, is

whether the district court’s decision was tenable—in the “range of possible

conclusions,” or, metaphorically, “in the ballpark.”

In the non-PSLRA context, the Rule 11 ballpark is large because, as

discussed above, a district court has discretion to grant mercy for a violation of

Rule 11. Moreover, no hard legal test governs the court’s exercise of this ability to

be merciful. Thus, in an ordinary Rule 11 case, although a district court could not

arbitrarily ignore a Rule 11 violation, it has very broad discretion, and a remand

will almost always be necessary. The PSLRA, however, eliminates this wellspring

of discretion.

It follows that the PSLRA Rule 11 ballpark is much smaller. And while it is

difficult to make generalizations about the size of its fences, because the Rule 11

inquiry is governed by an objective standard, it is clear that they will sometimes be

so small as to admit only one conclusion. As discussed in part III.A, supra, to

conclude that Rule 11 has been violated, a district court must make two

determinations. First, the court must determine that a paper was filed for an

improper purpose, or contained legally frivolous claims, or contained factually

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frivolous claims. Fed. R. Civ. P. 11(b). Second, the court must decide that a

reasonable investigation under the circumstances would have disclosed the

frivolity. Id. Thus, if, for example, a statute of limitations clearly bars a claim,57

and the record makes clear that the attorney had ample time for pre-filing

research,58 a district court could only conclude that Rule 11 has been violated

without abusing its discretion.59 Put differently, if the district court had the correct

view of the law and facts in mind, it could only conclude that the claim is

frivolous. See McGregor, 956 F.2d at 1022 (“A district court would necessarily

abuse its discretion if it based its ruling on an erroneous view of the law or on a

57

The Rule 11(b)(2) determination is whether counsel’s view of the law supporting the

plaintiff’s claim is tenable, or in the ballpark, which is a legal rather than a factual determination.

58

Though the reasonable inquiry under the circumstances prong will sometimes

necessitate a remand for findings, most complaints are not researched and filed at the eleventh-

hour. Therefore, in most cases, a reasonably competent attorney will have had time to discover

the violation.

In this case, for example, plaintiffs’ counsel were fully informed as to the circumstances

surrounding Thompson’s and Jacoby’s purchases of Media stock, had complete access to

Media’s SEC filings, and had ample time to research and consider the validity of the claims they

asserted in the three complaints presented to the district court. This is evident because the

plaintiffs brought a claim based on substantially the same facts in Indiana circuit court five

months before filing this suit. It is obvious that under the objective standard, five months is

more than enough time to research a claim.

59

By contrast, under the PSLRA, if the Rule 11 determination focuses on whether the

paper was filed for an improper purpose, a remand

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