Heightened Pleading Standards Under Section 11 of the Securities Act of 1933: Rubke v. Capitol Bancorp, Ltd.

In Rubke v. Capitol Bancorp, Ltd., 551 F.3d 1156 (9th Cir. 2009), the Ninth Circuit Court of Appeals held plaintiff Rubke did not plead any claims with the level of specificity required by F.R.C.P 9(b) or the pleading standards of the Private Securities Litigation Reform Act (“PSLRA”).

Capitol Bancorp (“Capitol”), a bank holding company, solicited investors for a minority holding in Napa Community Bank (‘NCB”) and bought a 51% controlling interest through their subsidiary First California Northern (“FCN”). After buying out the minority shareholders of FCN at a 67% premium, Capitol made the offer to acquire the minority interest in NCB in early 2005 at approximately a 50% premium to book value. According to some NCB minority shareholders, Capitol persuaded members of the NCB board to call and direct NCB shareholders to tender their shares. These shareholders were told that 98% of all minority shareholders had already tendered and that non-tendered positions would become illiquid and possibly worthless.

A class of minority shareholders brought suit claiming that Capitol could not purchase their shares of NCB at a price below fair market value. On appeal, Rubke challenged the district court’s dismissal of their claims against Capitol and its CEO Joseph Reid under § 11 of the Securities Act of 1933 and § 10(b) and §14(e) of the Securities Act of 1934. A successful claim under § 11 of the Securities Act must state both that a misrepresentation or omission existed in the registration statement and that it was material in nature.

The Ninth Circuit noted that the heightened pleading standards contained in the PSLRA did not apply to claims under § 11.  Nonetheless, to the extent sounding in fraud, F.R.C.P 9(b) required that the claim be alleged with "increased particularity,"  a threshold that none of Rubke’s six § 11 claims met. 

Rubke’s § 11 claims alleged both express and implied misrepresentation in Capitol’s registration statement. The claims took issue with Capitol’s fairness opinions, its previous tender offer for FCN, NCB’s future income projections, an inferred requirement to participate in the tender offer, the premium to book value offered, and the misleading comments made in phone calls to shareholders. In every instance the plaintiff’s claims were either too broad or based on inferences regarding Capitol’s intentions without actually tying these claims back to the facts. In upholding the dismissal of these § 11 claims, the 9th Circuit held repeatedly that Rubke’s “beliefs” were not factually supported in the pleadings and no connection was made as to why Capitol’s omissions were material misrepresentations.

Rubke also challenged the district court’s ruling that their claims under § 10(b) of the Exchange Act did not satisfy the pleading standards of the PSLRA. Section 10(b) prohibits fraud or deceit in business transactions pertaining to the sale of securities. The PSLRA requires a plaintiff to plead both fraud and scienter with particularity and factual support.  Due to the similarity of pleading requirements under PSLRA and F.R.C.P § 9(b), the court used § 10(b) to analyze only the phone conversations. The court found the phone calls to shareholders of NCB by Dennis Pedisich, a NCB board member, alone were insufficient for a claim under § 10(b). Rubke did not allege Capitol or its officers made any of the calls, or encouraged Pedisich to make his calls. 

• Rubke has failed to reveal "the sources of her information" with regard to the telephone conversations, and has not otherwise described how she knows that Capitol "exhorted" Pedisich to make the calls. Thus, she has not properly alleged the falsity of these statements under the PSLRA.

Furthermore, plaintiff did not allege fact that would support a showing of intentional or reckless behavior, with the complaint containing little more than motive, something the court found inadequate. 

• The complaint alleges that Capitol "[was] motivated to [acquire shares of NCB] for financial as well as strategic reasons related to taking total control of NCB to maintain Capitol's business plan and to freeze out dissident shareholders;" that Capitol was motivated to acquire the NCB shares at a discount to fair value; that Capitol was motivated to acquire over 80% of the NCB stock for tax purposes, and over 90% in order to effect a squeeze-out of the minority shareholders; and that Capitol needed to set a precedent so that it could continue to enforce the 150% buyout in future business ventures. These allegations are hardly indicative of scienter. Instead, they merely restate the obvious: that Capitol would benefit from buying out the minority shareholders. Even considered holistically, under Tellabs, these motive allegations cannot support a strong inference of scienter.

Rubke’s final challenge was under § 14(e) of the Exchange Act, which requires an offeror to fully inform shareholders of their rights when they are faced with a tender offer. The court stated that the analysis and conclusions to this issue were exactly the same as those under § 10(b) and therefore dismissed the § 14 claims as well.

In sum, the 9th Circuit Court of Appeals upheld the district court’s decision, dismissing Rubke’s claims with prejudice.

The primary materials for this post are available on the DU Corporate Governance website.