                                                         United States Court of Appeals
                                                                  Fifth Circuit

                         REVISED MAY 12, 2005
                                                               F I L E D
                                                                April 15, 2005
                 IN THE UNITED STATES COURT OF APPEALS
                                                           Charles R. Fulbruge III
                         FOR THE FIFTH CIRCUIT                     Clerk



                             No. 04-20380


ROBERT F SMITH

                            Plaintiff - Appellant

     v.

WASTE MANAGEMENT INC., a Delaware Corporation

                            Defendant - Appellee


      Appeal from the United States District Court for the
               Southern District of Texas, Houston


Before KING, Chief Judge, and JOLLY and DENNIS, Circuit Judges.

KING, Chief Judge:

     Plaintiff-Appellant Robert Smith, the former owner of

several million shares of Waste Management, Inc. stock, has sued

Defendant-Appellee Waste Management for fraud and negligent

misrepresentation in connection with losses he sustained when

Waste Management’s share price fell in late 1999.    On appeal,

Smith alleges that the district court erred when it found that

his claims were derivative and barred by res judicata.        For the

following reasons, we AFFIRM the judgment of the district court.




                                   1
                 I. FACTUAL AND PROCEDURAL BACKGROUND

     Robert Smith is a former officer and director of USA Waste

Services, Inc.    In July of 1998, USA Waste merged with Waste

Management, Inc.    At the time of the merger, Smith held a

substantial number of USA Waste shares.    As a result of the

merger, these shares were converted into Waste Management shares.

By June of 1999, Smith owned approximately 2.4 million Waste

Management shares, most of which had been committed by him as

collateral for loans used to pay for his business endeavors.      By

pledging Waste Management shares as collateral, Smith had

obtained $54 million in loans from five lenders.    He had also

pledged 1.3 million of his Waste Management shares to borrow an

additional $50 million from Merrill Lynch & Co.

     In the late spring of 1999, Ed Hayes, an accountant who

served as the chief financial officer for various companies owned

by Smith, allegedly began urging Smith to sell at least some of

his Waste Management stock to reduce his loan balances.    Chris

Pakeltis, Smith’s personal accountant, also allegedly recommended

that he sell some of his Waste Management shares during this time

period.   Smith, however, chose not to sell his shares.   According

to him, his decision to retain his Waste Management shares

resulted from public statements made by Waste Management.

Specifically, on May 6, 1999, Waste Management stated in a press

release that its first-quarter net income had increased 93% from

the previous year and that earnings per share had similarly

                                  2
increased by 79%.   Likewise, on May 6, 1999, Waste Management

conducted a conference call with investors and analysts, during

which it predicted that its earnings would climb to $3.50 per

share by the next year.   Additionally, Waste Management officers

stated at an industry convention that earnings per share would

likely be $3.60 by the next year.     According to Smith, he decided

not to sell his Waste Management shares after hearing these

positive representations about Waste Management’s future

earnings.

     On July 6, 1999, Waste Management revealed that its second-

quarter earnings would fall $250 million below the levels it had

predicted several weeks before.   As a result of this

announcement, Waste Management’s stock price dropped by more than

$20 per share.   On August 3, 1999, Waste Management made another

negative adjustment to its projected second-quarter earnings, and

its share price continued to drop.    By the end of 1999, Smith’s

Waste Management shares, as a result of the decline in the

company’s share price, had fallen to 40% of their value at the

time of the merger.   Furthermore, as a result of this drop in

value, Smith’s Waste Management shares were rendered insufficient

collateral for his various business loans, and the banks that

made the loans foreclosed upon his Waste Management stock.

According to Smith, these foreclosures had a domino effect,

causing his other business loans, which were not secured by Waste

Management shares, to be harmed, since Smith’s sudden need for

                                  3
available resources caused him to default on these loans as well.

Ultimately, Smith filed a petition for bankruptcy.

     As a result of the decline in Waste Management’s share

price, two derivative actions were brought on behalf of all Waste

Management stockholders in Delaware.   On September 20, 2001, a

settlement of the consolidated Delaware actions (the “Delaware

litigation”) was approved by the Delaware Chancery Court, and

final judgment was entered.   In re Waste Management, Inc.

Shareholder Derivative Litigation, C.A. No. 17313 NC (Del. Ch.

Sept. 20, 2001).   The judgment in the Delaware litigation

disposed of all derivative claims by Waste Management

shareholders that related to, inter alia: (1) Waste Management’s

revenue shortfall for the second quarter of 1999; (2) Waste

Management’s budgeting process for 1998, 1999, and 2000; (3)

public statements by Waste Management or company officials

regarding the company’s actual or projected financial performance

or results (including, without limitation, representations made

in the third quarter of 1999); and (4) the company’s financial

reporting and accounting practices during 1998 and 1999.

     Notwithstanding the Delaware litigation, Smith sued Waste

Management in the United States District Court for the Northern

District of Illinois, alleging fraud and negligent

misrepresentation, seeking actual damages of $100 million, and

seeking punitive damages of an additional $100 million.    This

case was subsequently transferred to the United States District

                                 4
Court for the Southern District of Texas.        Waste Management moved

for dismissal under FED. R. CIV. P. 12(b)(6), claiming that

Smith’s claims were derivative in nature and barred by res

judicata because of the September 20, 2001 order and final

judgment in the Delaware litigation.         The district court agreed,

holding that Smith’s claims were derivative and barred by res

judicata.   Smith now appeals the district court’s dismissal of

his suit.

                      II.   STANDARD OF REVIEW

     This court reviews de novo the grant of a motion to dismiss

under FED. R. CIV. P. 12(b)(6).     Martin K. Eby Const. Co. v.

Dallas Area Rapid Transit, 369 F.3d 464, 472 (5th Cir. 2004).         A

complaint “should not be dismissed for failure to state a claim

unless it appears beyond doubt that the plaintiff can prove no

set of facts in support of his claim which would entitle him to

relief.”    Conley v. Gibson, 355 U.S. 41, 45-46 (1957).

                            III.   DISCUSSION

A.   Smith’s Claims Are Derivative

     The first question before this court is whether Smith’s

claims are direct or derivative.         Smith states that because Waste

Management is a Delaware corporation, Delaware law will determine

the answer to this question.       He then argues that the district

court erred when, relying on Delaware law, it found that he had

alleged derivative, not direct, claims because he did not allege


                                     5
a “special injury” distinct from that suffered by other

shareholders or a wrong involving one of his contractual rights

as a shareholder.   According to Smith, he has alleged a special

injury because while other Waste Management shareholders did not

uniformly forego the recommended sale of their shares, he did.

Specifically, Smith argues that, unlike other Waste Management

shareholders, he made a specific decision, contrary to the advice

of his accountants, to hold his Waste Management shares when he

was advised to sell them.

     Smith also claims on appeal that the Supreme Court of

Delaware has articulated recently a new standard for determining

whether a claim is derivative or direct in Tooley v. Donaldson,

Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004).   According to

Smith, Tooley states that the determination of whether a claim is

derivative or direct will turn solely on who suffered the alleged

injury and who would benefit from any recovery.   Smith then

states that his claims are direct because: (1) he relinquished

the opportunity to sell his shares in 1999 and, hence, he

suffered the alleged injury; and (2) he would receive the benefit

of any recovery from his lawsuit.

     This court looks to the Delaware law, including the Delaware

Supreme Court’s recent opinion in Tooley, to decide whether

Smith’s claims are direct or derivative.1   In Tooley, the

     1
          Smith and Waste Management agree, and the district
court correctly concluded, that Delaware law applies to whether

                                 6
Delaware Supreme Court discarded the “special injury” test urged

by Smith and in its place articulated the following test for

determining whether a claim is derivative or direct:   “The

analysis must be based solely on the following questions:     Who

suffered the alleged harm--the corporation or the suing

stockholder individually--and who would receive the benefit of

the recovery or other remedy?”   Tooley, 845 A.2d at 1035.

According to the Delaware Supreme Court, this approach is “to be

applied henceforth in determining whether a stockholder’s claim

is derivative or direct.”   Id. at 1033.   The court then clarified

this test, stating:

     The proper analysis has been and should remain that
     . . . a court should look to the nature of the wrong and to
     whom the relief should go. The stockholder’s claimed direct
     injury must be independent of any alleged injury to the
     corporation. The stockholder must demonstrate that the duty
     breached was owed to the stockholder and that he or she can
     prevail without showing an injury to the corporation.

Id. at 1039 (emphasis added).


Smith’s claims are direct or derivative. In a diversity action,
a federal court must apply the choice of law rules of the state
in which it sits. Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S.
487, 496 (1941). “Where a transferee court presides over [a]
diversity action[] . . . under the multidistrict rules,” the
governing law comes from the “jurisdiction in which the
transferred” case originated. In re Air Disaster, 81 F.3d 570,
576 (5th Cir. 1996). Because Smith originally filed suit in
Illinois, Illinois conflict rules apply. Under Illinois law, the
determination of whether a plaintiff’s claims are direct or
derivative depends upon the law of the company’s state of
incorporation. Lipman v. Batterson, 738 N.E.2d 623, 626 (Ill.
App. Ct. 2000); Spillyards v. Abboud, 662 N.E.2d 1358, 1361 (Ill.
App. Ct. 1996). Because Waste Management is incorporated in
Delaware, Delaware law will determine whether Smith’s claims are
direct or derivative.

                                 7
     Applying the principles set forth in Tooley to the present

case, it is clear that Smith’s claims are derivative, not direct.

The misrepresentations that allegedly caused Smith’s losses

injured not just Smith but the corporation as a whole.    In Manzo

v. Rite Aid, No. Civ. A. 18451-NC, 2002 WL 31926606, at *5 (Del.

Ch. 2002) (unpublished), aff’d, 825 A.2d 239 (Del. 2003), the

Delaware Chancery Court, relying on Kramer v. Western Pacific

Industries, Inc., 546 A.2d 348 (Del. 1988), found that a

plaintiff’s claims were derivative, not direct.2   Explaining its

holding, the court stated that “[t]o the extent that plaintiff

was deprived of accurate information upon which to base

investment decisions and, as a result, received a poor rate of

return on her Rite Aid shares, she experienced an injury suffered

by all Rite Aid shareholders in proportion to their pro rata

share ownership.”   Manzo, 2002 WL 31926606, at *5.   Thus, when a

corporation, through its officers, misstates its financial

condition, thereby causing a decline in the company’s share price

when the truth is revealed, the corporation itself has been

injured.   Here, the harm that befell Smith--the drop in share

price caused by the untimely disclosure of unfavorable financial

data--was a harm that befell all of Waste Management’s

     2
          Tooley explicitly endorsed Kramer’s approach of looking
at the nature of the wrong and to whom the relief should go in
order to determine if a suit is derivative or direct. Tooley,
845 A.2d at 1038. Thus, even though Manzo was decided before
Tooley, it applied the correct test, and there is no reason to
think it is no longer good law.

                                 8
stockholders equally.    Stated differently, the misconduct alleged

by Smith did not injure Smith or any other shareholders directly,

but instead only injured them indirectly as a result of their

ownership of Waste Management shares.      As such, Smith cannot

prove his injury without also simultaneously proving an injury to

the corporation.    Accordingly, in light of Tooley, we find that

Smith’s claims are derivative under Delaware law.      See Tooley,

845 A.2d at 1033, 1035, 1039.

       Our conclusion is reinforced by the fact that if Smith’s

claims were construed as direct rather than derivative, Smith

would be allowed to benefit (by obtaining a judgment against

Waste Management) at the expense of all other shareholders who

are similarly situated.    That is, Smith would be allowed to

recover the full amount of his losses from the diminished assets

of Waste Management, while similarly situated shareholders would

not.    By finding that Smith’s claims are derivative, we ensure

that Smith will not incur a benefit at the expense of other

shareholders similarly situated.       See Cowin v. Bresler, 741 F.2d

410, 414 (D.C. Cir. 1984) (“Requiring derivative enforcement of

claims belonging in the first instance to the corporation also

prevents an individual shareholder from incurring a benefit at

the expense of other shareholders similarly situated.”).

       Our conclusion that Smith’s claims are derivative is similar

to the Texas Court of Appeal’s recent holding in Shirvanian v.

DeFrates, No. 14-02-00447-CV, 2004 WL 2610509, at *1 (Tex. App.--

                                   9
Hous. [14 Dist.] Nov. 18, 2004) (Shirvanian II).     In this case,

certain Waste Management shareholders, whose shares declined in

value as a result of the decline in Waste Management’s share

price in the summer of 1999, sued the corporation for fraud,

intentional misrepresentation, negligent and grossly negligent

misrepresentation, and conspiracy, arising from alleged oral

inducements not to sell their Waste Management shares.    On

January 8, 2004, the Texas Court of Appeals issued an opinion in

favor of the plaintiffs, holding that their lawsuit was a direct

action, not a derivative action.     Shirvanian v. DeFrates, No.

14-02-00447-CV, 2004 WL 35987 (Tex.App.--Hous. [14 Dist.] Jan.

08, 2004) (Shirvanian I).   In his briefs to this court, Smith

cites this decision in support of his claims.    After the briefs

had been filed in the present case, however, the Texas Court of

Appeals withdrew its opinion in Shirvanian I and granted

rehearing in light of Tooley.   On November 8, 2004, the Court of

Appeals, on rehearing, held that under Tooley, the plaintiffs’

claims were derivative and barred by res judicata.     Shirvanian

II, 2004 WL 2610509, at *6-7.   In the words of the Court of

Appeals:

     To decide if the harm was to the corporation or to the
     stockholder individually, the [Delaware Supreme Court
     in Tooley] suggested the most relevant question is
     whether the stockholder can prevail without showing an
     injury to the corporation. . . . The stockholder must
     demonstrate that the duty breached was owed to the
     stockholder and that he or she can prevail without
     showing a corresponding injury to the corporation.
     Applying those principles here leads to the conclusion

                                10
     that the Shirvanians’ complaints are derivative, not
     direct, and could be asserted only on behalf of the
     corporation. The misrepresentations the Shirvanians
     allege caused their injury were based on mismanagement
     of the corporation’s assets. The Shirvanians cannot
     prove their injury without proving an injury to the
     corporation. We hold, therefore, that the Shirvanians’
     suit is derivative under Delaware law.

Id. at *6.     Accordingly, Shirvanian II supports this court’s

determination that Smith’s claims are derivative, not direct.3

B.   Res Judicata Bars Smith’s Claims

         Because Smith’s claims are derivative, they are barred by

res judicata.     Res judicata prevents the relitigation of claims

that have already been finally adjudicated or that should have

been litigated in the prior lawsuit.     United States ex rel. Laird

v. Lockheed Martin Eng’g and Sci. Servs., 336 F.3d 346, 357 (5th

Cir. 2003).     Res judicata applies when: (1) there was a previous

final judgment on the merits; (2) the prior judgment was between

identical parties or those in privity with them; and (3) there is

a second action based on the same claims as were raised or could

     3
          While no court in this circuit has yet addressed
Tooley, the Delaware Chancery Court has relied on Tooley in
several cases to hold, as the Texas Court of Appeals held in
Shirvanian, that a claim is derivative, not direct. See, e.g.,
In re Syncor Int’l Corp. S’holders Litig., 857 A.2d 994, 995-98
(Del. Ch. 2004); Dieterich v. Harrer, 857 A.2d 1017, 1025-28
(Del. Ch. 2004); FS Parallel Fund L.P. v. Ergen, No. Civ. A
19853, 2004 WL 3048751, at *3 (Del. Ch. Nov. 03, 2004)
(unpublished); see also Gaia Offshore Master Fund, Ltd. v.
Hawkins, No. C03-3657, 2004 WL 2496142, at *3-4 (N.D. Cal. Nov.
5, 2004); Schuster v. Gardner, 25 Cal. Rptr. 3d 468, 476-78
(2005).




                                  11
have been raised in the first action.     See id.   Smith himself

admits that if his claims are derivative, they are barred by res

judicata.   This follows from the fact that the September 20, 2001

final judgment in the Delaware litigation against Waste

Management is a final judgment that: (1) disposes of all

derivative claims by Waste Management shareholders against the

company pertaining to misrepresentations about Waste Management’s

projected earnings and the sudden fall in its share price in

1999; and (2) is between parties identical to, or in privity

with, those now before this court.   Accordingly, because Smith’s

claims are derivative, they are barred by res judicata and the

dismissal of his complaint was proper.4

                           IV. CONCLUSION

     For the foregoing reasons, we AFFIRM the judgment of the

district court.




     4
          Because Smith’s claims are barred by res judicata, the
court need not address Waste Management’s further argument that
holder claims are not cognizable under this court’s decision in
Crocker v. FDIC, 826 F.2d 347 (5th Cir. 1987), or under the
Supreme Court’s decision in Blue Chip Stamps v. Manor Drug
Stores, 421 U.S. 723 (1975).

                                12
