12-3576, 12-3612
Jay Dees Inc. v. Defense Technology Systems Inc.


                                  UNITED STATES COURT OF APPEALS
                                      FOR THE SECOND CIRCUIT

                                              SUMMARY ORDER

Rulings by summary order do not have precedential effect. Citation to a summary order filed on or
after January 1, 2007, is permitted and is governed by Federal Rule of Appellate Procedure 32.1 and
this court’s Local Rule 32.1.1. When citing a summary order in a document filed with this court, a
party must cite either the Federal Appendix or an electronic database (with the notation “summary
order”). A party citing a summary order must serve a copy of it on any party not represented by
counsel.

    At a stated Term of the United States Court of Appeals for the Second Circuit, held at the
Thurgood Marshall United States Courthouse, at 40 Foley Square, in the City of New York, on
the 27th day of September, two thousand thirteen.

Present: ROBERT A. KATZMANN,
                     Chief Judge,
         DENNIS JACOBS,
         SUSAN L. CARNEY,
                     Circuit Judges.
____________________________________________________________

HARRY CATTON, PHILLIP MARKS, STEPHEN KEVELSON, ERIK
KAHN, ROBERT WISSENBACH, JOHN DOES 1-10, JAY DEES INC.,

                                Plaintiffs,

JOHN SCOTTO,

                                Plaintiff-Counter Defendant,

TODTMAN NACHAMIE, SPIZZ & JOHNS, P.C.,

                                Appellant-Cross Appellee,

                                -v-                            Nos. 12-3576,
                                                                    12-3612

DEFENSE TECHNOLOGY SYSTEMS INC., DANIEL McPHEE,
PHILLIP RAUSCH,

                                          Defendants-Counter Claimants-Cross
                                          Defendants,
EDWARD McPHEE,
                                Defendant-Counter Claimant,
DAVID HISCHBERG, ESQ.,

                          Defendant,

JOHN BRADY,

                           Defendant-Cross Defendant-Counter
                           Claimant-Appellee-Cross Appellant.
____________________________________________________________

For Appellant-Cross Appellee:                   ALEX SPIZZ (Stephen D. Oestreich and Rebecca
                                                Hollis, on the brief), Todtman Nachamie Spizz
                                                & Johns, P.C., New York, NY

For Defendant-Cross Defendant-
                                       RALPH P. FERRARA (Morgan J. Zucker, on the
Counter Claimant-Appellee-Cross Appellant:
                                       brief), Richardson & Patel LLP, Princeton, NJ
________________________________________________

        Appeal from the United States District Court for the Southern District of New York
(Zilly, J.).


       ON CONSIDERATION WHEREOF, IT IS HEREBY ORDERED, ADJUDGED,

AND DECREED that the judgment of the district court be and hereby is AFFIRMED.

       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




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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



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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

                                                  4
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.

       Brady also argues that the district court abused its discretion when it failed to find “a

substantial failure of any complaint to comply with any requirement of Rule 11(b)” pursuant to

15 U.S.C. § 78u-4(c)(3)(A). Brady contends that “[t]he misconduct here thoroughly infected the

entire set of plaintiffs’ pleadings” because (1) “Scotto claimed to have laid out nearly half of the

                                                 5
aggregate funds for the four remaining plaintiffs,” (2) “[Scotto’s] alleged loss constituted nearly

40% of the aggregate alleged loss,” (3) “Scotto was the one who procured the investments from

the other plaintiffs,” and (4) “[Scotto’s] testimony and evidence were the lynchpin [sic] to the

other plaintiffs’ success.” Brief for Brady at 53. But Brady fails to acknowledge that it was only

Scotto’s claim of loss, and not his testimony regarding the fraud more generally, that was the

basis for the sanctions here. And this Court has already rejected the argument that Scotto’s

claim of loss “infected” the entire case. See Scotto v. Brady, 410 F. App’x 355, 361 (2d Cir.

2010) (summary order) (“[E]vidence relating to [Scotto’s] losses was of extremely limited

relevance to the remaining claims and defenses.”). “[A] substantial violation occurs whenever

the nonfrivolous claims that are joined with frivolous ones are insufficiently meritorious to save

the complaint as a whole from being abusive,” Gurary v. Nu-Tech Bio-Med, Inc., 303 F.3d 212,

222 (2d Cir. 2002), and here the district court did not abuse its discretion in finding that the

Third Amended Complaint as a whole was not abusive and did not substantially fail to comply

with Rule 11.

       In addition, Brady contends that the district court abused its discretion by discounting by

35% the attorneys’ fees incurred in moving for Rule 11 sanctions. But, in the circumstances

presented here, the Private Securities Litigation Reform Act provides only for “an award to the

opposing party of the reasonable attorneys’ fees and other expenses incurred as a direct result of

[a] violation.” 15 U.S.C. § 78u-4(c)(3)(A)(i). It was not an abuse of discretion for the district

court to conclude that the portion of Brady’s sanctions motion requesting that Todtman be

required to pay all of Brady’s attorneys’ fees for the entire action—despite the fact that Brady

lost at jury trial—was not a “direct result” of the Rule 11 violation but instead was the result of

Brady’s own misunderstanding of the law.




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       Finally, Brady contends that the district court abused its discretion by excluding from the

sanction amount Brady’s attorneys’ fees incurred during Scotto’s prior appeal from the grant of

summary judgment on his claim. We disagree. Scotto’s appeal was not the “direct result” of

Ciacci’s allegations at issue in the Third Amended Complaint and the opposition to summary

judgment; instead, it was the “direct result” of Scotto’s decision to appeal, which was made long

after Todtman had withdrawn from the case and ceased to represent Scotto. The district court

did not abuse its discretion by concluding that “because Mr. Ciacci had relocated to [another

firm] by the time Mr. Scotto was perfecting his appeal, the Todtman firm no longer had control

over or responsibility for Mr. Ciacci’s actions, and the Court will not hold the Todtman firm

liable for such conduct.” App’x at 1485 (citation omitted).

       We have considered the parties’ remaining arguments and find them to be without merit.

For the reasons stated herein, the judgment of the district court is AFFIRMED.

                                                 FOR THE COURT:
                                                 CATHERINE O’HAGAN WOLFE, CLERK




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