William Beaumont Hospital Sys. v. Morgan Stanley: Hospital Fails to Satisfy Heightened Pleading Standard

In William Beaumont Hospital Sys. v. Morgan Stanley, No. 16-1135 (6th Cir. Jan. 26, 2017), the United States Court of Appeals for the Sixth Circuit affirmed the district court’s dismissal of William Beaumont Hospital System’s (“Plaintiff’) state law fraud claim against Morgan Stanley and Goldman Sachs (collectively “Defendants”) for failing to satisfy the heightened pleading standard of Fed. R. Civ. P. 9(b).

According to the allegations, Plaintiff and Defendants in 2006 entered into a structured debt-issuance agreement for auction-rate securities (“ARS”) to finance renovations of one of its hospitals and for construction of a new facility. Defendants, as underwriters for the debt, agreed to purchase and to make a public offering of the ARS. Pursuant to the agreement and related disclosures, Defendants would submit cover bids in the ARS market to prevent auction failure and reduce costs to Plaintiff. As the “economy slowly deteriorated leading up to the 2008 financial crisis,” a number of different ARS auctions failed.  Banks “began to limit inventory exposure to ARS and discuss ‘exit strategies’ regarding the ARS market.” By early 2008, Defendants stopped submitting cover bids, and while Plaintiff’s auctions never failed, demand decreased, and Plaintiff was “left paying investors a higher-fixed interest rate.”

Plaintiff filed suit against Defendants and subsequently filed arbitration proceedings before FINRA alleging fraudulent misrepresentation. In particular, Plaintiff claimed Defendants: (1) withheld information about the structure of the ARS market and their cover bid practice; (2) misrepresented the availability of rate structures in order to achieve a higher broker-dealer fee; and (3) failed to warn Plaintiff about the failing ARS market. 

In order to successfully plead fraud or misrepresentation in Michigan, a plaintiff must allege:

(1) that the defendant made a material misrepresentation, (2) that was false, (3) that the defendant knew it was false, or was made recklessly without any knowledge of its truth, (4) that the defendant made it with the intention that the plaintiff would act upon it, (5) the plaintiff acted in reliance upon it, and (6) suffered damages. 

Moreover, a plaintiff must satisfy rule 9(b)’s heightened pleading standard, which requires the complaint to contain specific facts of misrepresentation.

First, Plaintiff alleged that if it knew of the structure of the ARS market and Defendants’ cover bid practice, then it would not have signed the agreement. The court was not swayed by this argument because Plaintiff “acknowledged” in its Official Statement that broker-dealers routinely cover auctions to prevent failure, but they are not obligated to do so. The acknowledged statement also noted that “there is no assurance that any one or more Auctions will not fail.”  In light of the specific disclosures made, there was no actionable claim regarding these allegations. 

Next, the court held the allegations pertaining to the rate structure failed to meet the heightened pleading standard. Specifically, the court found the claims involved vague accusations of fraud and misrepresentation rather than the specific, identifiable statements. The court held the complaint completely void of “specific misstatements made at a certain time and place.” 

Finally, although relying on common law theories of fraud and misrepresentation, the court believed plaintiff was attempting “to impose the duties of a financial advisor on [D]efendants.” The court viewed this approach as “misguided.” Moreover, the claims could not withstand the heightened pleading standard because they failed to provide the names of representatives who participated in the conversations and ran the presentations from which Plaintiff’s allegations arose.

For the above reasons, the Sixth Circuit affirmed the district court’s dismissal of Plaintiff’s fraud claim for failure to plead with specific particularity under Rules 12(b)(6) and 9(b). 

The primary materials for this case may be found on the DU Corporate Governance Website.