Imagine two investors in Houston invest separately in a publicly traded art gallery in New York City. Each reaches an agreement to buy preferred stock and the gallery offers each a painting to sweeten the deal. Shortly after both deals close, a prominent art critic discovers that approximately 50 percent of the gallery’s art collection is inauthentic. This includes the paintings that the company gave to the investors. When the gallery acquired the art it had negligently assumed that the pieces were genuine. As a result, the value of the preferred stock tumbles and the paintings become worthless.
In order to recoup their money, the investors sue the gallery for negligent misrepresentation. Both investors file their claims in federal court—the first in the Southern District of New York and the second in the Southern District of Texas. For the paintings, both investors plead under state law. For the preferred stock, each uses state law and the Securities Act of 1933 (“Securities Act”), the latter of which creates a cause of action if a person provides false information in a securities transaction. For each claim the investors provide the minimal amount of specificity required under the federal pleading standard—Federal Rule of Civil Procedure (FRCP) 8(a)—which requires “a short and plain statement . . . showing that the pleader is entitled to relief.” The gallery moves to dismiss all claims.
Although the complaints contain the same allegations, the district courts reach different results. The Southern District of New York throws out the state-law claims regarding the painting and the stock, but allows the Securities Act claim to proceed. While this may seem like an absurd result, the court is following Second Circuit precedent. The Second Circuit classifies state-law negligent misrepresentation as a type of fraud claim.4 As such, the two state-law claims fall under a heightened pleading standard—FRCP 9(b)—which requires that parties plead “fraud or mistake” with particularity. The pleadings contain enough detail to satisfy the minimal requirements of Rule 8(a), but not enough detail to satisfy the more stringent Rule 9(b) requirements applicable to state-law claims. Meanwhile, the Securities Act claim, which contains the same elements as state-law negligent misrepresentation, is not considered fraud under Second Circuit precedent. Consequently, Rule 9(b) does not apply, and the claim survives under the more lenient Rule 8(a).
By contrast, the Southern District of Texas allows all three claims to proceed. Under Fifth Circuit precedent, negligent misrepresentation claims are not fraud, whether pleaded under state law or the Securities Act. Therefore, Rule 8(a)—not Rule 9(b)—applies.
Same claims. Same facts. Different results.
The law surrounding Federal Rule of Civil Procedure 9(b) and negligent misrepresentation is convoluted. Under Rule 9(b), a party who sues for fraud or mistake—or who uses fraud or mistake as a defense—must give a detailed account of the claim. Currently, courts disagree about whether Rule 9(b) applies when a party sues for negligent misrepresentation—a fraud-like tort that holds parties liable for careless misstatements. Some federal circuit courts hold that negligent misrepresentation constitutes fraud for the purposes of the Rule. Other circuits determine that Rule 9(b) does not apply. A third group of circuits looks to state law to determine whether negligent misrepresentation is fraud. Compounding the confusion, some courts find that negligent misrepresentation is fraud if the party uses state law to file the claim, but not fraud if the party uses the Securities Act of 1933—a federal statute concerning the registration and sale of securities. This inconsistency can lead to absurd results.
The inconsistent approaches described above create two principal issues. First, the circuit split creates incentives for forum shopping. Plaintiffs will file negligent misrepresentation claims in federal courts with the most lenient pleading standards. Forum shopping between federal courts to gain better treatment under the Federal Rules undermines “the goal of uniformity of federal procedure.” If a favorable federal court is not available, a plaintiff will file in a lenient state court. The Supreme Court has discouraged state-federal forum shopping because of concerns of equal treatment and legal reciprocity. Defendants will also forum shop by attempting to remove the claim to a court in which the standard may be higher, which raises the same concerns.
Second, the difference between how courts treat state-law and Securities Act claims creates an unnecessary trap for plaintiffs. Parties who understand the issue will simply file under both state law and the Securities Act. It is unclear, however, who is aware of the discrepancy. No court or law review article has addressed the differential treatment.
Despite the different approaches adopted by the circuits and the potential for inconsistent and absurd results, the Supreme Court has not resolved the issue. This Comment examines the circuit split and the tension between state-law negligent misrepresentation and the Securities Act in order to demonstrate that Rule 9(b) should not apply to negligent misrepresentation.