affirming Rule 11 sanctions where lawyer filed complaints lacking factual support with the improper purpose of forcing settlements
How later courts described this case
- affirming Rule 11 sanctions where lawyer filed complaints lacking factual support with the improper purpose of forcing settlements
- an error of law is an abuse of discretion
- “[C]ourts should avoid ‘the wisdom of hindsight’ when conducting Rule 11 inquiries.”
Written by the judges who cited it.
The opinion
PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
_______________________
Nos. 21-2596 and 21-2647
_______________________
TARA SCOTT; WILSON CARTER, individually and as
Trustee of the Bailey
Middleton Carter 2009 Trust, the Mary Wilson Carter 2009
Trust,
and the Wilson M. Carter 1988 Trust
Appellants in No. 21-2596
v.
VANTAGE CORPORATION; VANTAGE ADVISORY
MANAGEMENT, LLC;
VF(X), LP; TRADELOGIX, LLC; BRIAN ASKEW;
*GERALD FINEGOLD
BRIAN ASKEW,
Appellant in No. 21-2647
*(Dismissed pursuant to Court’s order dated 11/8/2021)
_______________________
On Appeal from the United States District Court
for the District of Delaware
District Court No. 1-17-cv-00448
Magistrate Judge: The Honorable Mary Pat Thynge
__________________________
Submitted Under Third Circuit L.A.R. 34.1(a)
December 15, 2022
Before: RESTREPO, McKEE, and SMITH, Circuit Judges
(Filed: April 5, 2023)
Thomas A. Uebler
McCollom D’Emilio Smith Uebler
2751 Centerville Road
Suite 401
Wilmington, DE 19808
Craig H. Kuglar
Suite A102-353
931 Monroe Drive NE
Atlanta, GA 30308
Counsel for Appellant/Cross-Appellee Brian Askew
S. Lawrence Polk
2
Eversheds Sutherland
999 Peachtree Street, N.E.
Suite 2300
Atlanta, GA 30309
Counsel for Appellees/Cross-Appellants
Tara Scott and Wilson Carter
__________________________
OPINION OF THE COURT
__________________________
SMITH, Circuit Judge.
We address here both an appeal and a cross-appeal, each
requiring us to examine the interplay between the Private
Securities Litigation Reform Act of 1995 (“PSLRA”) 1 and
Federal Rule of Civil Procedure 11 (“Rule 11”). Plaintiffs Tara
Scott and Wilson Carter (“Plaintiffs”) originally brought a
lawsuit asserting federal securities claims against Defendants
Brian Askew, Gerald Finegold, and Vantage Corporation
(“Vantage”).2 The District Court eventually granted summary
1
109 Stat. 737, codified as amended in scattered sections of
U.S.C. Title 15.
2
Plaintiffs brought federal securities claims against Askew,
Finegold, and Vantage. The District Court determined that
Plaintiffs violated Rule 11 in their claims against Finegold and
awarded attorneys’ fees, which neither Finegold nor Plaintiffs
3
judgment for Askew and this Court affirmed. After that
affirmance, the District Court performed a PSLRA-mandated
Rule 11 inquiry. The District Court determined that Plaintiffs
violated Rule 11 but chose not to award Askew attorneys’ fees
or to impose any other sanctions. In this appeal, Plaintiffs
contend that the District Court erred in concluding that they
violated Rule 11. For his part, Askew contends that the District
Court, after determining that Plaintiffs violated Rule 11, erred
in failing to impose sanctions, and that those sanctions should
have included attorneys’ fees. For the reasons stated below, we
will affirm the District Court’s order insofar as it determined:
(1) that Plaintiffs violated Rule 11 in bringing their federal
securities claims against Askew and (2) that Askew was not
entitled to attorneys’ fees. The PSLRA, however, mandates the
imposition of some form of sanctions when parties violate Rule
11 in bringing federal securities claims. And because the
District Court determined that Plaintiffs violated Rule 11 by
asserting their claims against Askew, we will vacate the
portion of the order declining to impose sanctions and will
remand this matter to the District Court with directions to issue
some form of Rule 11 sanctions against Plaintiffs.
I. BACKGROUND
We begin, as we must, with an overview of the PSLRA
and Rule 11 provisions relevant to this appeal. We will then
have contested. Vantage entered bankruptcy proceedings
before the District Court conducted its Rule 11 analysis.
Vantage and Finegold are not parties to this appeal.
4
outline the factual and procedural background of the
underlying dispute before turning to the merits.
A. Rule 11 and the PSLRA
The Supreme Court adopted the Federal Rules of Civil
Procedure, including Rule 11, in 1937. Rule 11 has been
amended at various times, but “[s]ince its original
promulgation, Rule 11 has provided for the striking of
pleadings and the imposition of disciplinary sanctions to check
abuses in the signing of pleadings.” Fed. R. Civ. P. 11, advisory
committee’s note to 1983 amendment. The 1983 Amendment
to Rule 11 attempted to address ongoing issues with litigation
“abuses” “by building upon and expanding the equitable
doctrine permitting the court to award expenses, including
attorney’s fees, to a litigant whose opponent acts in bad faith
in instituting or conducting litigation.” Id.
Rule 11 imposes requirements on attorneys and parties
regarding pleadings and other court filings. First, a filing must
“not be[] presented for any improper purpose, such as to
harass” another party. Fed. R. Civ. P. 11(b)(1). Second, the
claims must be “warranted by existing law or by a nonfrivolous
argument for extending” or modifying existing law. Fed. R.
Civ. P. 11(b)(2). Third, “the factual contentions [must] have
evidentiary support or . . . [be] likely [to] have evidentiary
support after” discovery. Fed. R. Civ. P. 11(b)(3). Finally,
before filing, the parties and their attorneys must undertake an
“inquiry reasonable under the circumstances” to verify
compliance with Rule 11’s requirements. Fed. R. Civ. P. 11(b).
If a party violates Rule 11, a court “may impose an appropriate
sanction on any attorney, law firm, or party that violated [Rule
5
11] or is responsible for the violation.” Fed. R. Civ. P. 11(c)(1)
(emphasis added).
Congress passed the PSLRA in 1995, pursuing the
“twin goals” of “curb[ing] frivolous, lawyer-driven litigation,
while preserving [] investors’ ability to recover on meritorious
claims.’” Winer Fam. Tr. v. Queen, 503 F.3d 319, 326 (3d Cir.
2007) (quoting Tellabs, Inc. v. Makor Issues & Rts., Ltd., 551
U.S. 308, 322 (2007)). The statute was intended to accomplish
these goals, in part, by “heighten[ing] the pleading
requirements” for federal securities claims. Id. at 335.
The PSLRA also modified how courts should apply
Rule 11. First, it provides that for any private action bringing
federal securities claims, “the court shall include in the record
specific findings regarding compliance by each party and each
attorney” with Rule 11(b)’s requirements. 15 U.S.C. § 78u-
4(c)(1). The text of Rule 11 lacks such a requirement. Second,
if the court determines that any Rule 11 violations occurred in
a federal securities action, the PSLRA instructs that the “court
shall impose [Rule 11] sanctions.” Id. § 78u-4-(c)(2) (emphasis
added). By contrast, in a non-PSLRA Rule 11 inquiry, a court
“may” impose sanctions when parties violate the Rule. Finally,
if the violation constitutes a “substantial failure of a[]
complaint to comply” with Rule 11, the PSLRA creates “a
presumption that the appropriate sanction . . . is an award to the
opposing party of [] reasonable attorneys’ fees.” Id. § 78u-
4(c)(3)(A)(ii). This presumption regarding the appropriate
sanction is absent from the application of Rule 11 in other
contexts. Fed. R. Civ. P. 11(c)(4) (“A sanction imposed under
this rule must be limited to what suffices to deter repetition of
6
the conduct or comparable conduct by others similarly
situated.”).
B. Factual Background
Askew formed Vantage Corporation (“Vantage”) in
2014 to trade securities using his proprietary trading software.
He marketed Vantage stock and recruited investors, including
Plaintiffs. Gerald Finegold was Vantage’s President and
Director. Non-party Matthew Dwyer helped Askew to identify
potential investors. In April 2015, Vantage filed a Securities
and Exchange Commission (“SEC”) Form D to sell
unregistered securities in a 2016 stock offering under SEC
Rule 506(b).3 Plaintiffs purchased stock in that offering.
3
Securities offerings under SEC Rule 506(b) are exempt from
registration. But to proceed with an unregistered securities
offering, an issuer must still meet certain requirements. First,
an issuer cannot engage in general solicitation or advertising to
market the securities. Second, securities may not be sold to
more than 35 non-accredited investors. In general, SEC Rule
501 defines “accredited investor” as an individual with a high
net worth or salary, or an individual with extensive investment
experience. See 17 C.F.R. § 230.501. Third, if non-accredited
investors participate in the offering, the issuer must provide the
non-accredited investors with certain disclosure documents
about the potential investment. Finally, all non-accredited
investors must have sufficient knowledge and experience to
evaluate potential risks. See Accredited Investor, U.S. Sec. &
Exch. Comm’n (last updated Nov. 1, 2022),
7
Tara Scott, a widow, purchased $2,000,000 of Vantage
stock between January 28, 2016, and March 2, 2016. The funds
that she invested were life insurance benefits she received after
her husband died. According to Scott, she purchased the stock
based on Askew’s oral representations that the investment was
“no-risk,” that “70% of [her] investment would be placed in a
segregated account,” that she would “receive back [her] initial
investment within six months,” and that Vantage owned the
proprietary trading software that was the basis of Vantage’s
business model. JA 1431. Scott contends that none of those
representations were true. Also in 2016, Carter invested
$3,000,000 in Vantage. A portion of that investment was the
purchase of Vantage securities for Carter’s minor daughter. In
total, Vantage raised about $8 million from sixteen investors
during its 2016 stock offering.
Plaintiffs began to worry about Vantage’s financial
condition shortly after they invested their funds. Specifically,
Plaintiffs were concerned because Askew was not providing
sufficient information to them concerning the status of their
investments. They decided they would seek to recoup their
initial investments in Vantage and part ways with the company.
But Plaintiffs’ investments were illiquid, and they had no right,
based on their stock agreements, to rescind those investments.
Lacking a contractual right to rescind, Plaintiffs decided
to threaten litigation and to report Vantage to the SEC as a way
of pressuring Askew and Vantage to return Plaintiffs’ initial
https://www.sec.gov/education/capitalraising/building-
blocks/accredited-investor.
8
investments. In a November 2017 email to Scott and Plaintiffs’
counsel, after suit was filed, Carter noted that Plaintiffs’
“strategy was to file [] complaints to force a settlement.” JA
147.4 Before filing suit, Plaintiffs engaged an independent
accountant who reviewed some of Vantage’s financial
documents. In a March 8, 2017 letter, the accountant concluded
that he could not say “whether anything nefarious is going []
on” with Vantage, but that the “‘smell factor’ is definitely
present.” SA 173.
C. Procedural Background
On April 20, 2017, Plaintiffs sued Vantage, Askew, and
Finegold (“Defendants”) in the U.S. District Court for the
4
This is the full text of Carter’s November 2017 email, which
he sent to Scott and their attorneys at Eversheds Sutherland:
All—I am told the SEC has completed their
investigation and notified Vantage they are
dropping their inquiries and the case.
I need some sort of signal or opinion that the
course of action has merit. I find the situation of
paying massive legal fees vs. defendants with no
assets to be untenable.
The strategy was to file these complaints to force
a settlement…I don’t foresee this outcome.
[P]lease help me understand what our current
strategy is? JA 2238.
9
District of Delaware. 5 Plaintiffs asserted ten counts in their
Complaint, including three federal securities claims.
First, under 15 U.S.C. § 771, Plaintiffs alleged a federal
securities law violation for the sale of unregistered and non-
exempt securities (the “Unregistered Securities Claim”). In this
claim, Plaintiffs alleged that Defendants did not meet
registration exemption requirements, and that Vantage’s
unregistered 2016 offering was therefore in violation of federal
securities law. The crux of this claim was that Askew sold
Vantage securities to allegedly unsophisticated and
unaccredited investors without providing sufficient
disclosures.
Second, Plaintiffs alleged that Defendants violated 15
U.S.C. § 771(a)(2) by making misrepresentations in
connection with the issuance of a security (the
“Misrepresentation Claim”). In this claim, Plaintiffs alleged
that Askew made a host of misrepresentations while selling
Vantage stock, such as misrepresenting Vantage’s resources.
Third, Plaintiffs alleged Rule 10b-5 Securities Fraud
(under 15 U.S.C. § 10b-5) (the “10b-5 Securities Fraud
Claim”). In support of this claim, Plaintiffs alleged that Askew
defrauded Plaintiffs with materially misleading statements
5
On June 22, 2017, the parties consented to full adjudication
by a magistrate judge. The case was referred to Magistrate
Judge Mary Pat Thynge that same day.
10
about Vantage and that Plaintiffs relied on Askew’s fraudulent
statements in purchasing Vantage stock. 6
1. The District Court’s adjudication of
Plaintiffs’ federal securities claims
On June 17, 2019, the District Court granted summary
judgment for Askew and Finegold on Plaintiffs’ federal
securities law claims. Before that ruling, Vantage had entered
bankruptcy proceedings in the United States Bankruptcy Court
for the Northern District of Georgia. Plaintiffs’ claims against
Vantage were therefore subject to an automatic stay.
As to the Unregistered Securities Claim, the District
Court determined that the record did not support the theory
Plaintiffs advanced. Plaintiffs had alleged that Askew and
Vantage sold securities to unaccredited investors, namely
Carter’s minor child and Dwyer (who was bankrupt at the time
of his purchase). Because minors and bankrupt individuals are
unlikely to qualify as accredited investors due to the income
and investment-experience requirements, see supra note 3,
Plaintiffs argued that Vantage was not exempt from
registration. The Court determined that Dwyer, due to his
bankruptcy, was likely unaccredited at the time of his purchase,
and that Carter’s child was indeed a minor when Carter
6
To succeed with a 10b-5 securities fraud claim, a plaintiff
must show “loss causation” in addition to reliance. To do so, a
plaintiff must demonstrate that an alleged material
misrepresentation caused the economic loss that plaintiff
suffered. McCabe v. Ernst & Young, LLP, 494 F.3d 418, 424–
26 (3d Cir. 2007).
11
purchased securities on her behalf. The Court concluded,
however, that Askew reasonably believed that both investors
were accredited at the time of their security purchases.7
Plaintiffs also alleged that Vantage engaged in a broad
solicitation campaign that was akin to a public offering. That,
they claim, would also have rendered Vantage subject to
registration. However, the Court determined that the record did
not establish that a public offering had occurred.
On Plaintiffs’ Misrepresentation Claim, the Court
concluded that such claims do not apply to the private sale of
securities. And because the Court determined that the record
contained no evidence of a public offering, the Court granted
summary judgment for Askew and Finegold.
Finally, on Plaintiffs’ 10b-5 Securities Fraud Claim, the
Court concluded that Plaintiffs failed to establish loss
causation. In particular, the Court declared that “there was no
support in the record for [P]laintiffs’ contention that
defendants made ‘serial misrepresentations’ that caused them
to purchase Vantage Corporation stock and [that caused] the
value of the stock to plummet.” JA 14–15 (emphasis added).
Plaintiffs appealed the District Court’s summary
judgment order. On February 5, 2021, this Court affirmed the
District Court’s grant of summary judgment. See Scott v.
Vantage Corp., 845 F. App’x 170 (3d Cir. 2021).
7
See 17 C.F.R. § 230.501(a) (defining “accredited investor” to
include persons “who the issuer reasonably believes” are
accredited).
12
2. The District Court’s Rule 11 analysis
Askew had filed a Rule 11 Motion on December 6,
2019, but the District Court held it in abeyance until this
Court’s February 5, 2021 ruling affirming summary judgment. 8
After our Court affirmed, the District Court performed the Rule
11 inquiry that the PSLRA mandates.
As to Finegold, the District Court concluded that
Plaintiffs violated Rule 11 and awarded Finegold his attorneys’
fees.9 As we’ve noted in the margin, neither Plaintiffs nor
Finegold appealed that aspect of the Court’s Rule 11 decision.
As to Askew, and central to our inquiry here, the District
Court concluded that Plaintiffs violated Rule 11 but declined
to impose sanctions. That Court first determined that Plaintiffs
performed a reasonable inquiry before filing their Complaint,
in part because Plaintiffs engaged an accountant who
8
In our opinion affirming summary judgment, we noted that
Askew “also appealed the District Court’s failure to decide”
Askew’s Rule 11 motion. Scott, 845 F. App’x at 181 n.10.
However, because “the District Court notified the parties it
[would] rule on that motion,” we determined that portion of
Askew’s appeal to be moot. Id.
9
The District Court concluded that Plaintiffs’ claims against
Finegold were tenuous, and that his only connection to
Plaintiffs’ claims was his “mere status” as a control person.
Moreover, Plaintiffs’ Complaint “failed to include any
allegations of [Finegold’s] action or inaction,” and Plaintiffs
“admitted they never spoke with Finegold before investing in
Vantage.” JA 33–34.
13
concluded that the “smell factor” was present. JA 19–23; SA
173. However, the Court held that Plaintiffs violated Rule
11(b)(1) by filing for an improper purpose—forcing a
settlement. In making that finding, the District Court relied
heavily on the email in which Carter articulates a “strategy”
designed “to force a settlement.” JA 23–24; see supra note 4.
The District Court also held that Plaintiffs violated Rule
11 by bringing their Unregistered Securities and
Misrepresentation Claims. For these claims, the Court
concluded that Plaintiffs violated Rule 11’s requirement that
factual contentions have, or likely will have, evidentiary
support. Fed. R. Civ. P. 11(b)(3). The Court reasoned that
Plaintiffs’ pre-filing investigation “should have revealed the
lack of factual support for the allegation that the relevant
Vantage Corporation offering was public.” JA 27. And on the
allegation of sales to unaccredited investors, the Court noted
that the Complaint failed to “identify[] any specific
individuals,” and that “[o]nly with the benefit of hindsight and
discovery did plaintiffs identify Dwyer and Carter’s minor
daughter as potentially unaccredited investors.” JA 27.
The District Court did not, however, find a violation of
Rule 11 in Plaintiffs having brought the 10b-5 Securities Fraud
Claim. In support of that claim, Plaintiffs alleged that Askew
made a host of misrepresentations in connection with the sale
of Vantage securities. Askew’s motion for summary judgment
did not rebut these misrepresentations—he only argued that
Plaintiffs failed to establish reliance and loss causation.
Plaintiffs therefore asserted that Askew “concede[d] . . .
Plaintiffs had a reasonable basis to allege” that he made
14
representations to them that “were false.” JA 28. The District
Court agreed. It determined that Plaintiffs’ “communications
with an accountant,” as well as Plaintiffs’ review of “financial
documents showing [Vantage’s] ominous financial position,”
“produced a reasonable basis to believe they had factual
support for the securities fraud claims.” JA 29.
And because the District Court considered the 10b-5
Securities Fraud Claim to be the “heart of the complaint,” it
concluded that Plaintiffs’ Rule 11 violations against Askew
were not “a substantial violation under the PSLRA.” JA 31.
Accordingly, that Court declined to award Askew attorneys’
fees or to impose any other sanctions on Plaintiffs.
Both parties appealed. Askew appealed the District
Court’s failure to impose sanctions, including attorneys’ fees.
Plaintiffs appealed the Court’s determinations that Plaintiffs
violated Rule 11.
II. JURISDICTION AND STANDARD OF REVIEW
The District Court had subject matter jurisdiction
pursuant to 28 U.S.C. § 1331. We have appellate jurisdiction
pursuant to 28 U.S.C. § 1291.
We review a district court’s Rule 11 determinations for
abuse of discretion. Doering v. Union Cnty. Bd. of Chosen
Freeholders, 857 F.2d 191, 195 (3d Cir. 1988). Deference to a
district court can be especially important in the Rule 11 context
because the district court is “[f]amiliar with the issues and
litigants” and “is better situated than the court of appeals to
marshal the pertinent facts and apply the fact-dependent legal
15
standard mandated by Rule 11.” Cooter & Gell v. Hartmarx
Corp., 496 U.S. 384, 402 (1990). An open question for this
Court, however, is whether the interplay between the PSLRA
and Rule 11 affects in any way our abuse of discretion review.
While the PSLRA mandates and modifies the Rule 11 inquiry,
the considerations supporting abuse of discretion review
remain unchanged—the inquiry is still heavily fact-dependent
and requires familiarity with the issues and litigants. Thus, a
district court will always be “better situated than the court of
appeals” to apply the rule. Id. We therefore join the Fourth
Circuit in holding that review of a district court’s PSLRA-
mandated Rule 11 inquiry is, as with other Rule 11
determinations, subject to the deferential abuse of discretion
standard. Morris v. Wachovia Sec., Inc., 448 F.3d 268, 277 (4th
Cir. 2006) (“Nothing in the [PSLRA’s] sanctions provision
changes [abuse of discretion] review.”). Of course, “this
standard [does] not preclude [an] appellate court’s correction
of a district court’s legal errors,” Cooter & Gell, 496 U.S. at
402, including a failure to adhere to any of the PSLRA’s Rule
11 requirements.
III. DISCUSSION
We proceed now in multiple steps. First, we will affirm
the District Court’s order insofar as it finds Rule 11 violations,
including its determination that Plaintiffs’ Unregistered
Securities and Misrepresentation Claims violated Rule 11
while their 10b-5 Securities Fraud Claim did not. Second, we
will affirm the District Court’s order insofar as it determined
that Plaintiffs’ Complaint did not constitute a “substantial
failure” to comply with Rule 11. Finally, because the PSLRA
16
requires that some form of sanctions be imposed when a party
violates Rule 11, we will vacate the portion of the District
Court’s order that declined to impose sanctions.
A. The District Court Did Not Abuse Its Discretion
in Finding that Plaintiffs Violated Rule 11
A district court abuses its discretion when it renders a
decision that is “contrary to reason or without a reasonable
basis in law and fact.” Simmerman v. Corino, 27 F.3d 58, 62
(3d Cir. 1994). In applying the abuse of discretion standard, we
do not ask whether “we would make the same precise
determinations” that we are reviewing. Id. Instead, our inquiry
is whether the district court “based its ruling on an erroneous
view of the law or on a clearly erroneous assessment of the
evidence.” Cooter & Gell, 496 U.S. at 405. Applying that
deferential standard, we hold that the District Court did not
abuse its discretion in finding a Rule 11 violation.
1. Filing for an improper purpose—Rule 11(b)(1)
First, the District Court did not abuse its discretion in
finding that Plaintiffs filed for an improper purpose. Plaintiffs
are correct that settlements pervade civil litigation and that
filing a complaint with a hopeful eye towards eventual
settlement is not, by itself, a Rule 11 violation. Indeed, we have
recognized a “strong presumption in favor of voluntary
settlement[s]” because they “promote the amicable resolution
of disputes,” further “the conservation of judicial resources,”
and help parties “avoid[] the costs and risks of a lengthy and
complex trial.” Ehrheart v. Verizon Wireless, 609 F.3d 590,
594–95 (3d Cir. 2010). Considering the strong policy favoring
17
settlements, and given that “Rule 11 targets abuse,” Mary Ann
Pensiero, Inc. v. Lingle, 847 F.2d 90, 94 (3d Cir. 1988)
(internal quotation marks omitted), we caution district courts
to be wary of finding a Rule 11 violation when a plaintiff files
a lawsuit alleging colorable claims yet has the ultimate goal of
settling those claims.
Here, however, Plaintiffs did not simply have an eye
toward settlement. They expressly stated that their “strategy
was to file these complaints to force a settlement.” JA 15. The
District Court also noted (1) “Carter’s testimony admitting he
sought the return of [his Vantage investment] to make a
separate real estate transaction,” and (2) testimony from Scott
“indicating she did not even know whether her [Vantage]
investment had declined in value at the time she filed suit.” JA
23 n.108. Finally, in evaluating Plaintiffs’ federal securities
claims, the District Court determined that two out of the three
claims lacked factual support in violation of Rule 11(b)(3).
In light of the intent expressed in Carter’s email and the
other record evidence the District Court considered, and
especially considering the District Court’s findings on the
factual deficiency of Plaintiffs’ federal securities claims, we
cannot conclude that the District Court applied a “clearly
erroneous assessment of the evidence” in determining that
Plaintiffs filed for an improper purpose. Cooter & Gell, 496
U.S. at 405. While it is a close call, we are ultimately mindful
that ascertaining a party’s purpose goes to the heart of a district
court’s superior position to “marshal the pertinent facts and
apply the fact-dependent legal standard mandated by Rule 11.”
Id. at 402. Accordingly, because the District Court did not base
18
its finding solely on Plaintiffs’ express desire to settle the case,
we conclude that the District Court did not abuse its discretion
in finding that Plaintiffs violated Rule 11(b)(1).
2. Alleging claims without factual support—Rule
11(b)(3)
a. The Unregistered Securities and
Misrepresentation Claims
Second, the District Court did not abuse its discretion in
determining that Plaintiffs’ Unregistered Securities and
Misrepresentation Claims lacked factual support in violation of
Rule 11(b)(3). In assessing compliance with Rule 11, courts
“must apply an objective standard of reasonableness,”
assessing a party’s or attorneys’ conduct based on “what was
reasonable to believe at the time [the complaint] was
submitted.” Lingle, 847 F.2d at 94. In other words, courts
should avoid “the wisdom of hindsight” when conducting Rule
11 inquiries. Id. Here, the District Court did not abuse its
discretion in either stating the law or weighing the relevant
facts.
In setting forth the Unregistered Securities Claim,
Plaintiffs alleged that Askew “made general solicitations to
obtain investor funding, including, upon information and
belief, soliciting and/or selling to unaccredited investors.” JA
215. But as the District Court observed, Plaintiffs made general
allegations about unaccredited investors “without identifying
any specific individuals.” JA 27. Plaintiffs now identify Dwyer
and Carter’s minor daughter as potentially unaccredited
investors, but “Dwyer’s name is completely absent” from the
19
Complaint, and Carter had his minor daughter “sign a
document indicating she was accredited.” JA 27. Accordingly,
the District Court found that it was “[o]nly with the benefit of
hindsight” that Plaintiffs identified Dwyer and Carter’s minor
daughter as potentially unaccredited investors. JA 27.
In performing its Rule 11 inquiry, the District Court
applied the proper, forward-looking legal framework. And we
see no basis to conclude that its assessment of the relevant facts
was clearly erroneous. We therefore conclude that the District
Court did not abuse its discretion in finding that Plaintiffs
violated Rule 11(b)(3) in bringing the Unregistered Securities
Claim.
We reach the same conclusion as to Plaintiffs’
Misrepresentation Claim. First, the District Court correctly
concluded that such claims do not apply to the private sale of
securities. Gustafson v. Alloyd Co., 513 U.S. 561, 578 (1995)
(“The intent of Congress and the design of the statute require
that § 12(2) [15 U.S.C. § 771(a)(2)] liability be limited to
public offerings.”). The Court then marshalled the relevant
facts, finding that “the documentation [Askew provided]
[P]laintiffs as prospective investors clearly identified the
offering was private and for accredited investors only.” JA 27.
The Court also determined that Plaintiffs’ pre-filing
investigation “should have revealed the lack of factual support
for the allegation that the relevant Vantage [] offering was
public.” JA 27. Thus, similar to the Unregistered Securities
Claim, the District Court’s discussion of both the legal
framework and relevant facts indicates neither an “erroneous
view of the law,” nor a “clearly erroneous assessment of the”
20
facts. Cooter & Gell, 496 U.S. at 405. We will, therefore,
affirm the District Court’s conclusion that Plaintiffs’
Misrepresentation Claim violated Rule 11(b)(3).
We are mindful of Plaintiffs’ reference in their appellate
briefing to “observed conduct of” Askew that supported a
“reasonable basis to believe” that he engaged in a public
offering. Appellee’s Br. 25. Plaintiffs point to Scott’s March
12, 2019 declaration, stating that in July 2016 while in Aspen,
Colorado, Scott observed “Mr. Askew approach two strangers
in a bar and solicit them to invest in Vantage Corporation.” JA
1435. But the term “public offering” does not have a formulaic
definition. Instead, the existence of a public offering turns on
whether a “security holder can demonstrate that the sales were
made to individuals or entities that did not require the
registration protections of the Securities Act.” Berckeley Inv.
Grp., Ltd. v. Colkitt, 455 F.3d 195, 215 (3d Cir. 2006); Sec. &
Exch. Comm’n v. Ralston Purina Co., 346 U.S. 119, 125
(1953) (“An offering to those who are shown to be able to fend
for themselves is a transaction ‘not involving any public
offering.’” (quoting 15 U.S.C. § 77d)). Considering the lack of
precision in the definition of “public offering,” it is debatable
whether Scott’s one-off observation can support a reasonable
basis to believe that Askew publicly offered Vantage
securities. We cannot, therefore, conclude that the District
Court based its Rule 11 decision on a clearly erroneous
assessment of the facts in concluding that Plaintiffs’
Misrepresentation Claim violated Rule 11(b)(3).
21
b. The 10b-5 Securities Fraud Claim
Finally, the District Court did not err in determining that
Plaintiffs’ 10b-5 Securities Fraud Claim did not violate Rule
11. First, the District Court properly articulated the elements of
a 10b-5 claim.10 Second, the District Court reasonably applied
the relevant facts, emphasizing Plaintiffs’ pre-filing discussion
with an accountant and Plaintiffs’ review of documents
showing Vantage’s “ominous financial position.” JA 29. The
District Court also noted Plaintiffs’ observation that Askew
failed to rebut Plaintiffs’ contention that he made false
representations—instead, Askew focused on Plaintiffs’ failure
to establish reliance and loss causation. While it is true that the
District Court summarily dismissed the 10b-5 Securities Fraud
Claim, courts must ensure that Rule 11 “not be used as an
automatic penalty against an attorney or a party advocating the
losing side of a dispute.” Gaiardo v. Ethyl Corp., 835 F.2d 479,
482 (3d Cir. 1987). Because the District Court did not clearly
err in its assessment of the facts, we conclude that there was no
abuse of discretion in that Court’s determination that Plaintiffs
had a reasonable basis to allege securities fraud.
10
The elements are: “(1) a material misrepresentation (or
omission); (2) scienter . . . ; (3) a connection with the purchase
or sale of a security; (4) reliance . . . ; (5) economic loss; and
(6) ‘loss causation.’” McCabe v. Ernst & Young, LLP, 494 F.3d
418, 424 (3d Cir. 2007) (quoting Dura Pharms., Inc. v. Broudo,
544 U.S. 336, 341–42 (2005) (emphasis omitted)).
22
B. Rule 11 Sanctions
1. The District Court did not abuse its
discretion in declining to award Askew
attorneys’ fees.
As discussed above, the PSLRA creates a presumption
in favor of awarding attorneys’ fees when a complaint
constitutes a “substantial failure” to comply with Rule 11. 15
U.S.C. § 78u-4(c)(3)(A)(ii). The PSLRA does not, however,
define “substantial failure,” nor has this Court yet expounded
on the meaning or reach of the term. Given the lack of statutory
or Third Circuit guidance, the District Court adopted the
Second Circuit’s approach in Gurary v. Nu-Tech Bio-Med,
Inc., 303 F.3d 212 (2d Cir. 2002). There, the Second Circuit
articulated a two-step test for assessing whether a complaint
containing multiple counts constituted a substantial failure.
First, a court must determine whether the pleading of one or
more causes of action violated Rule 11. Id. at 223. Assuming,
as the District Court determined here, that some of the claims
violated Rule 11 while others did not, a court should proceed
to step two.11 In step two, a court analyzes all the claims
collectively and assesses whether the claims that do not violate
Rule 11 “are of a quality sufficient to make the suit as a whole
nonabusive.” Id. If so, the complaint is not a substantial failure,
and the presumption in favor of attorneys’ fees does not arise.
11
While it is likely that a complaint lacking even a single claim
for which there was a reasonable basis would constitute a
“substantial failure,” that issue is not before us.
23
The Fourth Circuit reasoned similarly in Morris v.
Wachovia Securities, Inc., adopting a somewhat modified
version of Gurary’s two-part test. 448 F.3d at 278–79.
Specifically, the Fourth Circuit altered the language of step two
and held that it “requires an inquiry into whether the
complaint’s Rule 11(b) violations make the complaint as a
whole ‘essentially,’ ‘without material qualification,’ ‘in the
main,’ or ‘materially’ frivolous.” Wachovia, 448 F.3d at 278–
79 (quoting Gurary, 303 F.3d at 228 (Walker, C.J.,
concurring)).
While we have doubts that any difference in the
language used by the Second and Fourth Circuits meaningfully
alters the inquiry required of a court, the Fourth Circuit’s
approach is more closely tied to the definition of “substantial.”
See Black’s Law Dictionary 1428–29 (6th ed. 1990) (defining
“[s]ubstantially” as “[e]ssentially,” “without material
qualification,” “in the main,” “in substance,” or “materially”);
Pierce v. Underwood, 487 U.S. 552, 565 (1988) (defining
“substantially justified” as “justified in substance or in the
main”). And in general, the two-step framework strikes us as a
sensible balance of the PSLRA’s “twin goals” of “curb[ing]
frivolous, lawyer-driven litigation” while also “preserving []
investors’ ability to recover on meritorious claims.” Queen,
503 F.3d at 326 (quoting Tellabs, 551 U.S. at 322)). We
therefore adopt a streamlined version of the Fourth Circuit’s
approach to assessing whether a complaint substantially
violates Rule 11. If a court determines that some claims violate
Rule 11 and others do not, the court should examine the claims
collectively to assess whether the Rule 11 violations render the
complaint, as a whole, frivolous.
24
Applying this framework, we conclude that the District
Court did not abuse its discretion in determining that Plaintiffs’
Complaint was not a substantial Rule 11 violation. First, the
District Court applied a proper legal framework. In assessing
whether there was a “substantial failure,” the District Court
asserted that it must determine whether the Rule 11 violations
it found “were sufficiently substantial to make the complaint
as a whole frivolous.” JA 30 (emphasis omitted). This closely
tracks the legal framework we articulated above. So the
District Court did not abuse its discretion in describing the
legal standard because it did not articulate an erroneous view
of the law.
Second, the District Court correctly applied the facts to
the legal framework. It was reasonable for the District Court to
conclude that the “gravamen” of Plaintiffs’ Complaint against
Askew was that he made misrepresentations about Vantage
that tricked Plaintiffs into making an investment that was much
riskier than Askew represented. See JA 31; JA 127, Compl.
¶ 29 (“Plaintiffs made these investments and purchased
Vantage Corporation stock as a result of direct
misrepresentations and omissions made to them by Askew.”).
Therefore, it was also reasonable to conclude that the 10b-5
Securities Fraud Claim was the “heart” of the Complaint. Id.
And finally, where, as here, a district court reasonably
determines that the “heart” of a complaint did not violate Rule
11, it is a proper exercise of discretion to conclude that the
complaint did not substantially violate Rule 11. Accordingly,
we agree with the District Court that Plaintiffs’ Rule 11
violations did not constitute a substantial failure. The PSLRA’s
attorney fee presumption is thus inapplicable here.
25
2. The District Court abused its discretion in
declining to impose any sanctions.
Finally, we address whether the District Court abused
its discretion in declining to impose sanctions after finding
Rule 11 violations. Because the text of the PSLRA makes the
imposition of sanctions mandatory after a court determines that
a party violated Rule 11, we conclude that the District Court
abused its discretion in declining to impose any form of
sanctions.
In interpreting a statute, “[w]e begin, as always, with the
text of the law.” United States v. Ashurov, 726 F.3d 395, 398
(3d Cir. 2013). When a “statute’s language is plain, the sole
function of the courts is to enforce it according to its terms.”
Doe I v. Scalia, 58 F.4th 708, 715 (3d Cir. 2023) (internal
quotation marks omitted). Here, because the text of the PSLRA
is plain, 15 U.S.C. § 78u-4-(c)(2), our inquiry begins and ends
with that plain meaning.
The PSLRA provides that a court “shall” impose
sanctions when it finds that a party has violated Rule 11. Id.
The word “shall” is “mandatory” and “normally creates an
obligation impervious to judicial discretion.” Lexecon Inc. v.
Milberg Weiss Bershad Hynes & Lerach, 523 U.S. 26, 35
(1998). For example, before Rule 11 was amended in 1993, it
dictated that a court “shall impose” an “appropriate sanction”
against a party who violated the rule. Langer v. Monarch Life
Ins. Co., 966 F.2d 786, 810 (3d Cir. 1992) (quoting Rule 11
before its 1993 amendment). We construed that language to
26
mean that “[s]anctions for violating Rule 11 [were]
mandatory,” and further held that a district court “abuse[s] its
discretion by failing to award sanctions.” Id. at 810–11.
Further, our sister circuits that have construed the PSLRA’s
use of “shall” have all concluded that it mandates sanctions
when a court determines that Rule 11 has been violated. See
Morris v. Wachovia Sec., Inc., 448 F.3d 268, 276 (4th Cir.
2006) (“Because the [PSLRA’s] sanctions ‘instruction comes
in terms of the mandatory “shall,”’ . . . the district court must
impose sanctions for each violation found.” (quoting Lexecon,
523 U.S. at 35)); Thompson v. RelationServe Media, Inc., 610
F.3d 628, 636 (11th Cir. 2010) (“[T]he PSLRA’s provisions
eliminate a district court’s discretion . . . in determining
whether to impose sanctions following a finding of a Rule
11(b) violation.”); Citibank Glob. Markets, Inc. v. Rodriguez
Santana, 573 F.3d 17, 32 (1st Cir. 2009) (same); Simon
DeBartolo Grp., L.P. v. Richard E. Jacobs Grp., Inc., 186 F.3d
157, 178 (2d Cir. 1999) (“Under the PSLRA [] the district court
was required to impose sanctions.”). Accordingly, pursuant to
the plain meaning of “shall,” a district court must impose Rule
11 sanctions when it finds Rule 11 violations in proceedings
governed by the PSLRA. The District Court’s decision to forgo
sanctions was an abuse of discretion, so we will vacate the
District Court’s order insofar as it determined that sanctions
against Plaintiffs were not required.
On remand, the District Court is instructed to impose,
in its discretion, some form of sanction against Plaintiffs in
accordance with Rule 11. We take no position on what a proper
sanction would be here, acknowledging as we must that the
District Court is better situated to make that determination. We
27
do note that the available options run the gamut from an award
of attorneys’ fees—as Askew initially requested—to “a written
order admonishing by name the individual lawyers responsible
for the Rule 11(b) violations that the district court identified in
[Plaintiffs’] complaint[].” Wachovia, 448 F.3d at 285 (where
plaintiffs had engaged in insubstantial violation of Rule 11,
vacating denial of sanctions and remanding with instructions
to name and admonish the lawyers responsible for the
violation).
IV. CONCLUSION
While we will affirm most of the District Court’s Rule
11 order, the PSLRA’s text requires that some sanction be
imposed where, as here, a party violates Rule 11. Although we
will not declare what is an appropriate sanction, we will vacate
and remand this case to the District Court to impose such Rule
11 sanctions as that Court considers, in the exercise of its
discretion, to be appropriate.
28