Sixth Circuit Court Of Appeals Rejects Claims For Securities Fraud

In a recent decision, the Sixth Circuit Court of Appeals rejected assertions that the certain shareholders in a closely held corporation were defrauded as contemplated by the Securities Exchange Act of 1934, finding that the required element of "justifiable reliance" was absent. Bender v. Logan No. 14-3647 (6th Cir. April 28, 2015).

Trina Bender, a cosmetologist, partnered with her client, Julie Logan, to open a cosmetology school, Elite Institute. Each of Trina and Julie, were to be equal 50/50 shareholders in the company. Julie Logan and her husband,Scottundertook the financial management of the entity and arranged for the preparation of the incorporation and related documents. What Bender did not realize, notwithstanding the fact that it was set forth in the documents, was that the corporation had been organized with two classes of stock, Class A (voting) and Class B (nonvoting); the Class A shares were issued to Logan while the Class B shares were issued to Bender. After the school is up and running, at the request of Scott Logan that she sign "some minor paperwork needed for their lawyer,", Bender signed over, for consideration totaling one dollar, her entire stock ownership in the company and as well resigned as an officer and director of Elite. After some further exchanges and coming to the realization of what had been accomplished, Trina and Mark Bender filed suit alleging violations of Section 10b of the Securities Exchange Act of 1934 and Rule 10b-5.

Responding to the Logan's Motion for Summary Judgment, the claims for securities fraud were dismissed based upon the Bender's inability to prove two elements of securities fraud, namely loss causation and justifiable reliance. That determination would be affirmed by the Court of Appeals, but its decision is restricted to justifiable reliance.

In order to make out a claim for fraud in a securities transaction, it was recited, based upon In re. Comshare Inc. Securities Litigation, 183 F.3d 542, 548 (6th Cir.1999), that there must be "[1] the misstatement or omission of a material fact, [2] made with scienter, [3] upon which the plaintiff justifiably relied; and [4] which proximately caused the plaintiff's injury [loss causation]." The court found there were potentially two transactions against which the securities fraud claim could be assessed, namely Bender's initial acquisition of the stock in the Elite and her subsequent sale of her stock interest in Elite. Cutting to the chase, the...