Moore v. Keegan Mgmt. Co. (In re Keegan Mgmt. Co., Sec. Litig.) - 78 F.3d 431 (9th Cir. 1996)

Rule:

Because the frivolousness prong of Fed. R. Civ. P. 11 is measured by objective reasonableness, whether a party actually relied on the cases which show its claims aren't frivolous is irrelevant. The same rule must apply to the factual basis for a claim.

Facts:

Defendant Keegan Management was a franchisee of Nutri/System Weight Loss Centers ("Nutri/System"). It sold weight loss programs. In December 1989, Keegan made an initial public offering ("IPO") of stock at $ 7 per share. Stock rose to $ 10 per share within a few months. In early 1990, controversy over the Nutri/System program broke out. A series of personal injury lawsuits alleging gall bladder problems resulting from weight-loss programs were filed against Nutri/System. In March, Congressional hearings on the diet industry aired testimony discussing the health risks associated with such programs, including the risk of gallstones from rapid weight loss. The Wall Street Journal published an article discussing health problems associated with the Nutri/System program. Amidst these events and other reports, Keegan's stock fell to 10% of its peak value.

Appellant law firms Lieff, Cabraser & Heimann and Feldman, Waldman & Kline were approached in late 1990 by potential clients interested in filing securities fraud suits against Keegan based on the possibility that Keegan had knowingly or recklessly failed to disclose health risks associatedwith its program in the 1989 IPO. Attorneys Elizabeth Cabraser of Lieff, Cabraser and Richard Jaeger of Feldman, Waldman & Kline ultimately filed separate class action suits on February 19 and March 4, 1991. The two suits, Moore v. Keegan and Crespo v. Keegan, were consolidated. These suits alleged that Keegan misrepresented the Nutri/System program as safe at a time when it knew, or was reckless in not knowing, that the program might lead to gall bladder problems. Keegan moved for summary judgment, and the district court granted the motion in May 1992. The district court found plaintiffs' evidence of scienter, and any known link between weight loss and gall bladder problems prior to December 1989, entirely lacking. That summer, Keegan moved for Rule 11 sanctions, but withdrew its motion as part of settlement negotiations. The parties reached a settlement in November 1992. However, prior to approval of that settlement, the district court sua sponte issued an order to show cause why Rule 11 sanctions should not be entered. The court conducted a hearing on April 27, 1993. On March 31, 1994, the district court entered sanctions against Cabraser and Jaeger in the amount of $ 25,000 each pursuant to Rule 11 and 28 U.S.C. § 1927. It also sanctioned the attorneys' firms $ 25,000 each pursuant to § 1927 and its inherent power. The district court concluded that the attorneys had been reckless in filing a complaint when they could at best only guess that Keegan recklessly failed to disclose health risks when issuing the IPO.

Issue:

Did the district court erred in imposing Rule 11 sanctions by failing to consider after-acquired factual evidence that would have adequately supported the complaint?

Answer:

Yes.

Conclusion:

Under the district court's understanding of the law, the key question was, "What did plaintiffs know when they filed their lawsuit?" Applying this understanding, the district court excluded from consideration any evidence supporting the suit which was unknown to counsel at the time of filing. This included a scientific study published in August 1989 - several months before the IPO - suggesting a weight loss/gallstone link, as well as a declaration from plaintiffs' expert Dr. J.W. Marks reviewing the scientific literature and asserting that such a link was well-established prior to the IPO. These exclusions were dispositive; the district court acknowledged that "if, prior to filing the complaint, Plaintiffs had in their possession the same information that they offered in opposition to summary judgment, it would have been sufficient to justify filing this lawsuit." In effect, the district court applied a subjective-objective test. Objectively, would a reasonable attorney have believed plaintiffs' complaint to be well-founded in fact based on what plaintiffs' attorneys subjectively knew at the time? Appellants argue that an objective-objective test should apply: would a reasonable attorney have believed plaintiffs' complaint to be well-founded in fact based on what a reasonable attorney would have known at the time? Alternatively, the issue may be framed as whether the "reasonable inquiry" and "well-founded" requirements are conjunctive or disjunctive. An attorney may not be sanctioned for a complaint that is not well-founded, so long as she conducted a reasonable inquiry. May she be sanctioned for a complaint which is well-founded, solely because she failed to conduct a reasonable inquiry? The answer is no.

Some language in prior cases suggests the opposite result. The appellate court has previously held that "an attorney violates Rule 11 whenever he signs a pleading, motion, or other paper without having conducted a reasonable inquiry into whether his paper is frivolous, legally unreasonable, or without factual foundation." Under Unioil, it appears not to matter whether a filing is frivolous, so long as the signing attorney has failed to conduct a reasonable inquiry. This language accords with the district court's subjective-objective approach, but is inconsistent with Townsend. To the extent Unioil endorses a subjective-objective test and authorizes sanctions solely for an unreasonable inquiry, it has been implicitly overruled by the en banc decision in Townsend. Townsend compels the current result. Its conclusion is firmly rooted in the text and policies underlying Rule 11. Rule 11 must be read not only to give effect to the Rule's central deterrent goals, but also "in light of concerns that it will spawn satellite litigation and chill vigorous advocacy[.]" The appellate court do little to undermine the deterrent goals of the Rule by not sanctioning complaints which have merit on their face. The potential for such sanctions, however, may do much to increase the frequency of the collateral litigation that is Rule 11's unfortunate side effect.

Thus, the district court based its decision on an erroneous view of the law when it focused on the plaintiffs' attorneys' subjective knowledge at the time they filed the complaint. It therefore abused its discretion. The district court itself conceded that plaintiffs' pretrial evidence was enough to render their complaint nonfrivolous. Under these circumstances, Rule 11 sanctions could not properly be imposed.