Catton v. Defense Tech. Sys. Inc., 2013 U.S. App. LEXIS 19771 (2d Cir. Sept. 27, 2013):

Todtman, Nachamie, Spizz & Johns, P.C. ("Todtman") and John Brady both appeal from the February 29, 2012, and August 2, 2012, orders issued by the United States District Court for the Southern District of New York (Zilly, J.) imposing sanctions on Todtman pursuant to Federal Rule of Civil Procedure 11(b). The district court sanctioned Todtman because its attorney, Richard Ciacci, filed a Third Amended Complaint that included the objectively unreasonable allegation that the defendants' securities fraud had caused John Scotto to lose approximately $500,000.   The district court also sanctioned Todtman for presenting frivolous arguments to the court in an attempt to defend Scotto's claim of loss at summary judgment. On appeal, Todtman contends that it should not have been sanctioned, while Brady contends that the sanction amount was insufficient. We assume the parties' familiarity with the underlying facts, procedural history, and issues on appeal.

First, Todtman contends that Ciacci did not violate Rule 11 by filing either the Third Amended Complaint or the opposition to summary judgment because it was entitled to rely primarily on Scotto's testimony, Scotto's 2004 tax returns, and the purported LH Ross account statement produced by Scotto in discovery. We hold that the district court did not abuse its discretion when it found that (1) Scotto's story was objectively unreasonable and (2) the tax returns and account statement did not even arguably render the story reasonable. We find the district court's analysis of this issue to be persuasive. Todtman contends that the evidence did not foreclose the possibility that Scotto had an account with LH Ross & Company, Inc.; however, Todtman's attorneys should have contacted SAL Financial Services,   Inc., to investigate whether it maintains the relevant records before filing either the Third Amended Complaint or the opposition to the defendants' motion for summary judgment. See Fed. R. Civ. P. 11(b) ("By presenting to the court a pleading, written motion, or other paper . . . an attorney . . . certifies that to the best of the person's knowledge, information, and belief, formed after an inquiry reasonable under the circumstances . . . (2) the claims, defenses, and other legal contentions are warranted by existing law or by a nonfrivolous argument for extending, modifying, or reversing existing law or for establishing new law; [and] (3) the factual contentions have evidentiary support." (emphasis added)).

Second, Todtman contends that this case presents "exceptional circumstances" such that "a law firm [need not] be held jointly responsible for a violation committed by its partner, associate, or employee." Fed. R. Civ. P. 11(c)(1). Todtman cites Morris v. Wachovia Securities, Inc., Civil Action No. 3:02cv797, 2007 WL 2126344 (E.D. Va. July 20, 2007), which suggests that, under the "exceptional circumstances" provision, "perhaps a firm could get off the hook by raising the defense   that a rogue lawyer altered a firm-approved pleading before submitting it or disobediently filed a pleading his superiors had rejected as frivolous." Id. at *5 (brackets omitted) (quoting Ted Schneyer, A Tale of Four Systems: Reflections on How Law Influences the "Ethical Infrastructure" of Law Firms, 39 S. Tex. L. Rev. 245, 259 (1998)). Todtman argues that its employee Richard Ciacci, who filed the offending documents here, was just such a "rogue lawyer" because Ciacci paid for the costs of Scotto's case without the firm's knowledge. We disagree. Even if we were to accept the "rogue lawyer" theory suggested by Morris, Todtman still has not shown that Ciacci was a rogue attorney with respect to the actions that warranted sanctions here. Todtman does not contend that Ciacci altered a firm-approved pleading. In fact, Todtman does not claim that it disapproved of either the Third Amended Complaint or the opposition to summary judgment--the two papers for which Ciacci and Todtman were sanctioned. Consequently, we hold that "exceptional circumstances" do not apply here and that Todtman is jointly and severally liable for the sanctions against Ciacci.

Third, Todtman contends that the district  court's decision to make Todtman's liability joint and several with Scotto's liability was based on the district court's mistaken belief that the collateral posted by John Brady had not yet been disbursed to Scotto. Todtman contends that the district court was under the false impression that the sanctions amount could be taken from that collateral before it was released by the court. We disagree. The district court clearly understood that the collateral had been disbursed to Scotto: It discussed "the $271,817.43 disbursed from collateral posted by defendant" and referred to the stipulation and order providing for the disbursement. App'x at 1486 (emphasis added). Moreover, the district court in no way indicated that the sanction--or its joint and several nature--had been imposed based on the understanding that Scotto would be paying the full amount on behalf of both Scotto and Todtman out of the collateral that had been posted by Brady. The district court did not discuss the collateral in the context of Todtman's motion for reconsideration, Todtman's ability to pay, or Todtman's liability more broadly.

We turn now to Brady's cross-appeal. Brady argues that the district court abused its discretion by excluding from the sanctions award all fees incurred prior to the filing of the Third Amended Complaint. We disagree. During the discovery period between the filing of the Second Amended Complaint and the Third Amended Complaint, it became apparent that the accuracy of Scotto's tax returns was subject to serious question. Scotto attributed the relevant losses on his 2004 Schedule D to transactions made through a brokerage firm called "First Providence." At a deposition on December 5, 2006, Scotto claimed that the correct name of the brokerage firm was actually "L.H. Ross or L.H. Roth"--after having been informed that First Providence was out of business at the time of the alleged transactions. At a hearing on June 15, 2007, Judge Scheindlin stated that the case would be referred to the United States Attorney for investigation into possible tax fraud. Then, one week prior to the filing of the Third Amended Complaint, a defense attorney stated at a hearing in Ciacci's presence that a clearing firm for L.H. Ross had no record of an account under Scotto's name. This made any reliance on Scotto's story or on the tax returns objectively unreasonable. "[T]he point at which an  argument turns from merely 'losing' to losing and sanctionable is often difficult to discern," Motown Prods., Inc. v. Cacomm, Inc., 849 F.2d 781, 785 (2d Cir. 1988) (per curiam), and we do not think that the district court abused its discretion in identifying that point as the filing of the Third Amended Complaint.