Thompson v. Paul
United States Court of Appeals for the Ninth Circuit
October 27, 2008
Cite as 06-15515

Federal Vis-à-Vis State Laws in Securities Exchange Act Violations

Pamela Thompson was a Chief Financial Officer (CFO) of YP.Net, a publicly traded company. She resigned from her work because of highly questionable accounting and auditing practices at the company. More specifically, she resigned because of the refusal of YP.Net officers and directors to make proper disclosures to the Securities and Exchange Commission. She forwarded her resignation from YP.Net to the Securities and Exchange Commission Enforcement Division because of her concerns of illegal conduct.

Thereafter, YP.Net filed a civil suit against her. The suit was allegedly filed to protect the Chief Executive Officer (CEO) of the company, Angelo Tullo, who was then subject to criminal investigation by several federal agencies. Both YP.Net and Tullo were both represented by the law firm L&R.

While representing an alter ego of YP.Net in an attempt to purchase assets of the company in bankruptcy, attorneys at L&R became aware that Tullo was a target of a criminal investigation with several federal law enforcement agencies. These criminal matters were never disclosed in any SEC filings. During the pendency of the litigation between Thompson and Y.Net, L&R attorneys vehemently denied any and all knowledge of a criminal investigation targeted at Angelo Tullo.

To resolve the suit filed by YP.Net against Thompson, the parties entered into a settlement memorandum whereby Thompson was to receive a substantial amount of common stock in YP.Net. In part, the agreement was based upon the false representation by L&R attorneys that there in fact was no criminal investigation targeted at the CEO Angelo Tullo.

Before the final settlement documents could be executed, the L&R attorneys withdrew from the YP litigation due to an undisclosed conflict that they had purportedly just discovered. The settlement was finalized with the help of a new YP.Net counsel. Days after, Tullo was indicted of fraud, conspiracy, money laundering and orchestrating a ponzi scheme. As a result, the value of the YP.Net common stock that Thompson received under the settlement plummeted in value.

Because of this, Thompson and her four children sued the law firm and three individual partners and two spouses of those partners under a federal claim, Section 10(b) and Rule 10-b and numerous claims under the state law.

The district court dismissed Thompson’s Section 10(b) claim with prejudice under Federal Rule of Civil Procedure 12(b)(6). After the district court had entered final judgment of dismissal of all of her claims, including her state-law claims, Thompson asked the district court to certify a question of state law to the Arizona Supreme Court.

The district court denied the request.

On appeal, Thompson contends that the district court erred in dismissing her claim under Section 10(b) because it incorrectly relied on state rather then federal law. She also contends that the district court erred in denying her request to certify the question of state law.

In deciding this case, the Court of Appeal ruled that “The principle is well settled that federal law, rather than state law, governs the construction of all aspects of Rule10b-5[.]” Huddleston v. Herman & MacLean, 640 F.2d 534,557 n.40 (5th Cir. 1981) (citations and internal quotations omitted), rev’d in part on other grounds, 459 U.S. 375(1983). Section 10(b) is not an exception to the general rule that “[a] claim which arises under a federal statute and implicates federal policy is appropriately decided under federal law.” In re Nucorp Energy Sec. Litig., 772 F.2d 1486, 1489(9th Cir. 1985). See also In re Columbia Gas Sys. Inc., 997F.2d 1039, 1055 (3rd Cir. 1993) (similar).

“Federal statutoryrights could be easily defeated if state law could be used to control the incidents of those rights and the defenses to them.” Petro-Ventures, Inc. v. Takessian, 967 F.2d 1337, 1340 (9thCir. 1992). See also Dura Pharms., Inc. v. Broudo, 544 U.S.336, 341 (2005) (noting that a Section 10(b) “private damages action . . . resembles, but is not identical to, common-law tort actions for deceit and misrepresentation”); Huddleston, 459U.S. at 388 (similar); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 744-45 (1975) (similar).

As to the issue of certification, the Court said that since the L&R defendants’ liability is governed by federal rather than state law, Thompson’s appeal of the district court’s refusal to certify is moot with respect to that claim. However, it is not moot with respect to her state-law misrepresentation claims.

The Court, in sum, reversed the district court’s dismissal under Rule 12(b) (6) of Thompson’s claim under Section 10(b). It held that Thompson’s complaint states a claim upon which relief can be granted under Section 10(b). However, the Court affirmed the district court’s denial of Thompson’s motion to reconsider and to certify a question of state law to the Arizona Supreme Court.