Supreme Court of California Justia
Docket No. S091297

Small v. Fritz Companies

Filed 4/7/03

IN THE SUPREME COURT OF CALIFORNIA

MARIETTA SMALL, as Public

Administrator, etc.,* )
)


S091297

Plaintiff and Appellant,

Ct.App. 1/4 A086982

v.

San Francisco County

FRITZ COMPANIES, INC., et al.,

Super. Ct. No. 981760

Defendants and Appellants.





This is a stockholder’s action charging that defendant corporation and its

officers sent its stockholders a fraudulent quarterly financial report that grossly

overreported earnings and profits. Plaintiff alleged that when the fraud was

discovered, the price of the corporate stock dropped precipitously, causing injury

to stockholders like himself.1 The trial court sustained a demurrer without leave to

amend and entered judgment for defendants; the Court of Appeal reversed. We

granted defendants’ petition for review.

The petition for review raised only a single issue: “Should the tort of

common law fraud (including negligent misrepresentation) be expanded to permit


*

Harvey Greenfield, plaintiff in the superior court, died while this case was

pending here. We granted the motion of Marietta Small, the Public Administrator
for the Estate of Harvey Greenfield, to substitute as appellant.
1

The trial court has the initial responsibility whether to certify this case as a

class action. It has not yet ruled on the matter. Consequently, we do not discuss
whether class certification is appropriate.




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suits by those who claim that alleged misstatements by defendants induced them

not to buy and sell securities?” This overstates the matter – this case does not

involve any claim by persons who do not own stock and are fraudulently induced

not to buy. It does, however, present the issue whether California should

recognize a cause of action by persons wrongfully induced to hold stock instead of

selling it. (For convenience, we shall refer to such a lawsuit as a “holder’s action”

to distinguish it from suits claiming damages from the purchase or sale of stock.)

We conclude that California law should allow a holder’s action for fraud or

negligent misrepresentation. California has long acknowledged that if the effect

of a misrepresentation is to induce forbearance – to induce persons not to take

action – and those persons are damaged as a result, they have a cause of action for

fraud or negligent misrepresentation. We are not persuaded to create an exception

to this rule when the forbearance is to refrain from selling stock. This conclusion

does not expand the tort of common law fraud, but simply applies long-established

legal principles to the factual setting of misrepresentations that induce

stockholders to hold onto their stock.

This cause of action should be limited to stockholders who can make a

bona fide showing of actual reliance upon the misrepresentations. Plaintiff here

has failed to plead the element of actual reliance with sufficient specificity to show

that he can meet that requirement. We therefore reverse the judgment of the Court

of Appeal and remand the cause to that court, with directions to have the trial

court sustain defendants’ demurrer but grant plaintiff leave to amend his

complaint.

I. PROCEEDINGS BELOW

“In reviewing a judgment of dismissal after a demurrer is sustained without

leave to amend, we must assume the truth of all facts properly pleaded by the

plaintiffs, as well as those that are judicially noticeable.” (Howard Jarvis

2

Taxpayers Assn. v. City of La Habra (2001) 25 Cal.4th 809, 814.) Our opinion in

this case should not be construed as indicating whether or not defendants actually

committed fraud or negligent misrepresentation.

Stockholder Harvey Greenfield filed this action in 1996 against Fritz

Companies, Inc., a corporation, and against three officers: Lynn Fritz, the

company president, chairman of the board, and owner of 39 percent of the

common stock; John Johung, the chief financial officer and a director; and

Stephen Mattessich, the corporate controller and a director.2 The action was filed

as a class action on behalf of all shareholders in Fritz “who owned and held Fritz

common stock as of April 2, 1996 through at least July 24, 1996, in reliance on

defendants’ material misrepresentations and omissions . . . and who were damaged

thereby.” The complaint alleged causes of action for common law fraud and

negligent misrepresentation, and for violations of Civil Code sections 1709 and

1710, which codify the common law actions for fraud and deceit.

Before us is the validity of plaintiff’s second amended complaint. It

alleged that Fritz provides services for importers and exporters. Between April

1995 and May 1996, Fritz acquired Intertrans Corporation and then numerous

other companies in the import and export businesses. Fritz encountered

difficulties with these acquisitions, and in particular with the Intertrans accounting

system, which it adopted for much of its business. Nevertheless, on April 2, 1996,

Fritz issued a press release that reported third quarter revenues of $274.3 million,

net income of $10.3 million, and earnings per share of $29. The same figures

appeared in its third quarter report to shareholders, issued on April 15, 1996, for

the quarter ending February 29, 1996. According to plaintiff, that report was

2

Unless otherwise indicated, Fritz refers to Fritz Companies, Inc., not to

Lynn Fritz, its president and chairman of the board.

3

incorrect for a variety of reasons: the inadequate integration of the Intertrans and

Fritz accounting systems led to recording revenue that did not exist; Fritz failed to

provide adequate reserves for uncollectible accounts receivable; and Fritz

misstated the costs of its acquisitions.

The complaint alleged that on July 24, 1996, Fritz restated its previously

reported revenues and earnings for the third quarter. Estimated third quarter

earnings were reduced from $10.3 million to $3.1 million. Further, Fritz

announced that it would incur a loss of $3.4 million in the fourth quarter.

The complaint then set forth in detail the reasons why the original third

quarter report was inaccurate: improper accounting for merger and acquisition

costs; improper classification of ordinary operating expenses as merger costs;

improper revenue recognition; improper capitalized software development costs;

and failure to allow for uncollectible accounts receivable. It alleged that the

individual defendants knew or should have known that the third quarter report and

press releases were false and misleading. When defendants made these

statements, “defendants intended that investors, including plaintiff and the Class,

would rely upon and act on the basis of those misrepresentations in deciding

whether to retain the Fritz shares.”

The complaint further asserted that plaintiff and all class members received

Fritz’s third quarter statement, “read this statement, including the information

related to the reported revenue, net income and earnings per share, and relied on

this information in deciding to hold Fritz stock through [July 24, 1996].”

With respect to damages, the complaint alleged: “In response to

defendant’s disclosures on July 24, 1996, Fritz’s stock plunged more than 55% in

one day, dropping $15.25 to close at $12.25 per share . . . . Had defendants

disclosed correct third quarter revenue, net income and earnings per share on April

2, 1996, as required by GAAP [generally accepted accounting practices], Fritz’s

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stock price would likely have declined on April 2, 1996, and plaintiff and the

Class would have disposed of their shares at a price above the $12.25 per share

closing price of that day.”

Defendants demurred to plaintiff’s second amended complaint on two

grounds: (1) “California law does not recognize any [cause of action] on behalf of

shareholders who neither bought nor sold shares based upon any alleged

misstatement or omission”; and (2) the complaint failed to “plead with the

requisite specificity the facts alleged to constitute actual reliance.” The trial court

sustained the demurrer on the second ground only and entered judgment for

defendants. Plaintiff appealed.

The Court of Appeal reversed. It held that the complaint stated causes of

action for fraud and negligent misrepresentation and alleged actual reliance with

sufficient specificity. (It did not decide whether the case should be certified as a

class action.) We granted defendants’ petition for review.


II. CALIFORNIA RECOGNIZES A CAUSE OF ACTION FOR STOCKHOLDERS

INDUCED BY FRAUD OR NEGLIGENT MISREPRESENTATION TO REFRAIN FROM

SELLING STOCK



Defendants contend that California should not recognize a cause of action

for fraud or negligent misrepresentation when the plaintiff relies on the false

representation by retaining stock, instead of buying or selling it. We disagree.



“ ‘The elements of fraud, which gives rise to the tort action for deceit, are

(a) misrepresentation (false representation, concealment, or nondisclosure);

(b) knowledge of falsity (or “scienter”); (c) intent to defraud, i.e., to induce

reliance; (d) justifiable reliance; and (e) resulting damage.’ ” (Lazar v. Superior

Court (1996) 12 Cal.4th 631, 638.) The tort of negligent misrepresentation does

not require scienter or intent to defraud. (Gagne v. Bertran (1954) 43 Cal.2d 481,

487-488.) It encompasses “[t]he assertion, as a fact, of that which is not true, by

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one who has no reasonable ground for believing it to be true” (Civ. Code, § 1710,

subd. (2)), and “[t]he positive assertion, in a manner not warranted by the

information of the person making it, of that which is not true, though he believes it

to be true” (Civ. Code, § 1572, subd. (2); see Fox v. Pollack (1986) 181

Cal.App.3d 954, 962 [describing elements of the tort]). When such

misrepresentations have occurred in connection with the sale of corporate stock,

the California courts have entertained common law actions for fraud or negligent

misrepresentation. (E.g., Hobart v. Hobart Estate Co. (1945) 26 Cal.2d 412;

Sewell v. Christie (1912) 163 Cal. 76.)

Forbearance – the decision not to exercise a right or power – is sufficient

consideration to support a contract and to overcome the statute of frauds. (E.g.,

Schumm v. Berg (1951) 37 Cal.2d 174, 185, 187-188; Rest.2d Contracts, §§ 90,

139; 1 Witkin, Summary of Cal. Law (9th ed. 1990) Contracts, § 214, p. 223.) It

is also sufficient to fulfill the element of reliance necessary to sustain a cause of

action for fraud or negligent misrepresentation. Section 525 of the Restatement

Second of Torts states: “One who fraudulently makes a misrepresentation of fact,

opinion, intention or law for the purpose of inducing another to act or to refrain

from action in reliance upon it, is subject to liability to the other in deceit for

pecuniary loss caused to him by his justifiable reliance upon the

misrepresentation.” (Rest.2d Torts, § 525, italics added.) Section 531 states the

“general rule” that “[o]ne who makes a fraudulent misrepresentation is subject to

liability to the persons or class of persons whom he intends or has reason to expect

to act or to refrain from action in reliance upon the misrepresentation, for

pecuniary loss suffered by them through their justifiable reliance in the type of

transaction in which he intends or has reason to expect their conduct to be

influenced.” (Rest.2d Torts, § 531, italics added.) And section 551, subdivision

(1) states: “One who fails to disclose to another a fact that he knows may

justifiably induce the other to act or refrain from acting in a business transaction is

6

subject to the same liability to the other as though he had represented the

nonexistence of the matter that he has failed to disclose . . . .” (Rest.2d Torts,

§ 551, italics added.)

California law has long recognized the principle that induced forbearance

can be the basis for tort liability. (Marshall v. Buchanan (1868) 35 Cal. 264;

Pollack v. Lytle (1981) 120 Cal.App.3d 931, 941, overruled on other grounds in

Beck v. Wecht (2002) 28 Cal.4th 289; Carlson v. Richardson (1968) 267

Cal.App.2d 204, 206-208; Halagan v. Ohanesian (1967) 257 Cal.App.2d 14, 17-

19; see Pinney & Topliff v. Chrysler Corporation (S.D.Cal. 1959) 176 F.Supp.

801.) California has not yet applied this principle to lawsuits involving

misrepresentations affecting corporate stock, but, as we shall explain, we should

not make an exception for such cases. Most other states that have confronted this

issue have concluded that forbearance from selling stock is sufficient reliance to

support a cause of action. (See David v. Belmont (1935) 291 Mass. 450 [197 N.E.

83]; Fottler v. Moseley (1901) 179 Mass. 295 [60 N.E. 788]; see Smith v. Duffy

(1895) 57 N.J.L. 679 [sub nom. Duffy v. Smith, 32 A. 371] [plaintiff fraudulently

induced to buy stock could recover damages for period of retaining stock in

reliance on same representation]; Continental Insurance Co. v. Mercadante (1927)

222 A.D. 181 [225 N.Y.S. 488]; Rothmiller v. Stein (1894) 143 N.Y. 581 [38 N.E.

718]; but see Chanoff v. U.S. Surgical Corp. (D.Conn. 1994) 857 F.Supp. 1011,

1108 [applying Connecticut law]; see generally, Ratner, Stockholders’ holding

Claims Class Actions Under State Law After the Uniform Standards Act of 1998

(2001) 68 U. Chi. L.Rev. 1035, 1039 (hereafter Ratner).) Gutman v. Howard Sav.

Bank (D.N.J. 1990) 748 F.Supp. 254, 264, upholding a holder’s action based on

forbearance under New York and New Jersey law, said: “Lies which deceive and

injure do not become innocent merely because the deceived continue to do

something rather than begin to do something else. Inducement is the substance of

7

reliance; the form of reliance--action or inaction--is not critical to the actionability

of fraud.” (Fn. omitted.)

Indeed, defendants do not dispute that forbearance is generally sufficient

reliance to permit a cause of action for fraud or negligent misrepresentation.

Neither do they dispute that forbearance would be sufficient reliance if a

stockholder were induced to refrain from selling his stock by a face-to-face

conversation with a corporate officer or director. Borrowing a phrase from the

United States Supreme Court opinion in Blue Chip Stamps v. Manor Drug Stores

(1975) 421 U.S. 723, 745 (Blue Chip Stamps), however, defendants argue that all

such cases are “light years away” from the world of stock transactions on a

national exchange.

Defendants first assert that in the context of stock sold on a national

exchange, a corporation cannot be found to have knowingly intended to defraud

“an anonymous shareholder like plaintiff Greenfield,” because no corporate

officer or director had a face-to-face or personal communication with him.

Nevertheless, although many fraud cases involve personal communications, that

has never been an element of the cause of action. (See Committee on Children’s

Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 218-219 [fraud

perpetrated by misleading advertisements on nationally broadcast television

shows].) Fraud can be perpetrated by any means of communication intended to

reach and influence the recipient.



But defendants’ principal argument is that in a case such as this involving a

widely held, nationally traded stock, there are compelling policy considerations

that argue against recognizing a holder’s cause of action. In particular, they

contend that allowing a holder’s action will permit the filing of nonmeritorious

“strike” suits designed to coerce settlements (see Blue Chip Stamps, supra, 421

U.S. at pp. 739-742; Mirkin v. Wasserman (1993) 5 Cal.4th 1082, 1107 (Mirkin);

8

Bily v. Arthur Young & Company (1992) 3 Cal.4th 370, 401, 406 (Bily)). We

recognize the importance of the policy considerations defendants advance, but

although those considerations may justify placing limitations on a holder’s cause

of action, they do not justify a categorical denial of that cause of action. In

explaining the basis for this conclusion, we first examine the federal cases and

statutes on which defendants rely, then the California cases, and finally

defendants’ specific policy concerns.

A. Federal Law

Congress enacted the first federal laws regulating securities in the early

1930’s in response to the stock market crash of 1929. (See Ratner, supra, 68 U.

Chi. L.Rev. at p. 1042.) The Securities Exchange Act of 1934 (15 U.S.C. § 78a et

seq.) “was designed to protect investors against manipulation of stock prices” and

to that end established extensive disclosure requirements. (Basic, Inc. v. Levinson

(1988) 485 U.S. 224, 230.) Under the authority granted by that act, the Securities

and Exchange Commission in 1942 promulgated a regulation making it “unlawful

for any person . . . to employ any device, scheme or artifice to defraud, [t]o make

any untrue statement of a material fact or to omit to state a material fact necessary

in order to make the statements made . . . not misleading, or [t]o engage in any act,

practice or course of business which operates or would operate as a fraud or deceit

upon any person, in connection with the purchase or sale of any security.” (17

C.F.R. § 240.10b-5 (hereafter Rule 10b-5).) Lower federal courts implied a

private right of action to enforce Rule 10b-5, and the United States Supreme Court

eventually endorsed this view in 1988. (Basic, Inc. v. Levinson, supra, 485 U.S. at

pp. 230-231.)

In

Birnbaum v. Newport Steel Corp. (2nd Cir. 1952) 193 F.2d 461, the

United States Court of Appeals for the Second Circuit interpreted Rule 10b-5 as

aimed only at “ ‘a fraud perpetrated upon the purchaser or seller’ of securities and

9

as having no relation to breaches of fiduciary duty by corporate insiders upon

those who were not purchasers or sellers.” (Id. at p. 463.) This interpretation of

Rule 10b-5 barred holder’s actions under that rule.

In 1975, the United States Supreme Court agreed that Rule 10b-5 did not

permit holder’s actions. (Blue Chip Stamps, supra, 421 U.S. at pp. 733, 749.) Its

decision was based largely on two policy considerations: The danger of vexatious

and meritless suits filed simply to extort a settlement (id. at pp. 739-740) and the

difficulties of proof that arise when the crucial issues may depend entirely on oral

testimony from the stockholder (id. at pp. 743-747).

But then the high court addressed the argument that complete

nonrecognition of holder’s actions would result in injustice by denying relief to

victims of fraud. That injustice would not occur, the court observed, because its

decision was limited to actions under Rule 10b-5; defrauded stockholders might

still have a remedy in state court. The high court said: “A great majority of the

many commentators on the issue before us have taken the view that the Birnbaum

limitation on the plaintiff class in a Rule 10b-5 action for damages is an arbitrary

restriction which unreasonably prevents some deserving plaintiffs from recovering

damages which have in fact been caused by violations of Rule 10b-5. . . . We

have no doubt that this is indeed a disadvantage of the Birnbaum rule, and if it had

no countervailing advantages it would be undesirable as a matter of policy . . . .”

(Blue Chip Stamps, supra, 421 U.S. at pp. 738-739, fn. omitted.) Then in a

footnote, the court observed: “Obviously this disadvantage is attenuated to the

extent that remedies are available to nonpurchasers and nonsellers under state law.

[Citations.] Thus, for example, in Birnbaum itself, while the plaintiffs found

themselves without federal remedies, the conduct alleged as the gravamen of the

federal complaint later provided the basis for recovery in a cause of action based

on state law. [Citation.] And in the immediate case, respondent has filed a state-

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court class action held in abeyance pending the outcome of this suit. [Citation.]”

(Id. at p. 739, fn. 9.) In short, the high court’s decision in Blue Chip Stamps, while

recognizing policy considerations similar to those defendants advance here, did

not view those considerations as justification for a total denial of relief to

defrauded holders; it reasoned only that the federal courts could deny a forum to

wronged stockholders who are not sellers or buyers without unjust consequences

because these stockholders retained a remedy in state courts.

Defendants here also refer to later federal legislation. In 1995, Congress,

over presidential veto, passed the Private Securities Litigation Reform Act of 1995

(hereafter sometimes referred to as PSLRA) (Pub. L. No. 104-67 (Dec. 22, 1995)

109 Stat. 737). The PSLRA arose from Congressional concern that the “current

system of private liability under the federal securities laws d[id] not adequately

distinguish between meritorious and frivolous claims.” (Sen. Com. on Banking,

Housing, and Urban Affairs, Subcom. on Securities and Investment, Staff Rep. on

Private Securities Litigation (May 17, 1994) p. 13, as cited in Perino, Fraud and

Federalism: Preempting Private State Securities Fraud Causes of Action (1998)

Stan. L.Rev. 273, 290.) “Congress enacted the PSLRA to deter opportunistic

private plaintiffs from filing abusive securities fraud claims, in part, by raising the

pleading standards for private securities fraud plaintiffs.” (In re Silicon Graphics

Inc. Securities Litigation (9th Cir. 1999) 183 F.3d 970, 973.) To this end, the

PSLRA imposed a heightened pleading requirement, requiring plaintiffs in Rule

10b-5 cases to “state with particularity facts giving rise to a strong inference that

the defendants acted with the required state of mind.” (15 U.S.C. § 78u-4(b)(2).)

Later, concerned that plaintiffs were evading the PSLRA by filing in state court,

Congress in 1998 passed the Uniform Standards Act, which preempts state court

class actions based on untrue statements or omissions in connection with the

purchase or sale of a security. (15 U.S.C. § 77p(b).) The recent Sarbanes Oxley

11

Act of 2002, which imposes numerous restrictions on corporate accounting

practices, does not restrict private causes of action, but instead extends the period

for filing suit. (15 U.S.C. § 7201 et seq.)

The two statutes on which defendants rely, the PSLRA and the Uniform

Standards Act, do not affect state court holder’s actions; the PSLRA governs only

actions in federal court, and the Uniform Standards Act by its terms applies only

to suits involving the purchase or sale of stock. As defendants note, both acts

demonstrate that Congress in 1995 and in 1998 viewed stockholder class actions

with considerable suspicion. Yet Congress did not abolish stockholder class

actions under Rule 10b-5: by requiring specific pleading, it attempted to bar

abusive suits while permitting meritorious suits. The Sarbanes Oxley Act of 2002

shows Congress’s recent concern to reduce procedural barriers to meritorious

suits.

B. California Decisions

Neither the California Legislature nor the California electorate through its

initiative power has enacted measures limiting stockholder actions. In 1996, two

competing initiatives were defeated at the polls; one would have deterred

stockholders suits, the other would have encouraged such suits. (Compare Ballot

Pamp., Prim. Elec. (Mar. 26, 1996) text of Prop. 201; with Ballot Pamp., Gen.

Elec. (Nov. 5, 1996) text of Prop. 211.)

Defendants, however, rely on two decisions of this court that have cited

policy concerns in limiting liability to stockholders: Bily, supra, 3 Cal.4th 370,

and Mirkin, supra, 5 Cal.4th 1082.

In Bily, a majority of this court held that an accounting firm was not liable

in negligence to persons who relied on its audit to purchase corporate stock. The

decision weighed the advantages and disadvantages of recognizing such a cause of

action (Bily, supra, 3 Cal.4th at pp. 396-407), and concluded that lenders and

12

investors may not recover for negligence (id. at p. 407) but may recover for fraud

(id. at p. 376) and negligent misrepresentation (id. at p. 413). The majority

explained: “By allowing recovery for negligent misrepresentation (as opposed to

mere negligence), we emphasize the indispensability of justifiable reliance on the

statements contained in the report. . . . [A] general negligence charge directs

attention to defendant’s level of care and compliance with professional standards

established by expert testimony, as opposed to plaintiff’s reliance on a materially

false statement made by defendant. . . . In contrast, an instruction based on the

elements of negligent misrepresentation necessarily and properly focuses the

jury’s attention on the truth or falsity of the audit report’s representations and

plaintiff’s actual and justifiable reliance on them. Because the audit report, not the

audit itself, is the foundation of the third person’s claim, negligent

misrepresentation more precisely captures the gravamen of the cause . . . .” (Ibid.,

fn. omitted.) Bily thus supports our conclusion here that California recognizes a

holder’s action based on fraud or negligent misrepresentation.

Bily’s holding denying a cause of action for negligence rested on the

premise that auditors, because they contract only with the corporation, owe no

duty of care to the stockholders. (Bily, supra, 3 Cal.4th at p. 376.) That reasoning

cannot be applied in this case. A corporation has a statutory duty to furnish

stockholders with an annual report (Corp. Code, § 1501(a)); furnishing a report

that is false, misleading, or improperly prepared is a breach of duty. Officers and

directors owe a fiduciary duty to stockholders. (Tenzer v. Superscope, Inc. (1985)

39 Cal.3d 18, 31; Jones v. H. F. Ahmanson & Co. (1969) 1 Cal.3d 93, 109-110;

Fisher v. Pennsylvania Life Co. (1977) 69 Cal.App.3d 506, 513.) A controlling

stockholder, such as defendant Lynn Fritz here, also owes fiduciary duties to

minority stockholders. (Jones v. H. F. Ahmanson & Co., supra, at pp. 109-110.)

13

Thus the complaint alleges breach of duties that are already well established in

California law.



In Mirkin, a majority of this court rejected the “fraud on the market”

doctrine used in federal cases under Rule 10b-5. That doctrine makes it

unnecessary for buyers or sellers of stock to prove they relied on a defendant’s

misrepresentations, on the theory that whether or not they relied the

misrepresentation influenced the market price at which they later bought or sold.

(See Basic, Inc. v. Levinson, supra, 485 U.S. 224.) By rejecting the “fraud on the

market” doctrine, Mirkin held that a plaintiff suing for fraud or negligent

misrepresentation under California law must prove actual reliance. (Mirkin,

supra, 5 Cal.4th at pp. 1090-1098.) The court carefully noted that its decision did

not deprive the plaintiffs who did not actually rely on the misrepresentation of a

remedy for fraud, for they retained remedies under both state and federal securities

laws that presumed reliance on material misrepresentations. (Id. at p. 1090, citing

federal Rule 10b-5, Corp. Code, §§ 25000, 25400, & Bowden v. Robinson (1977)

67 Cal.App.3d 705, 714.)



Mirkin involved a suit by a seller of securities. But Mirkin impliedly

recognized that holders also have a cause of action under California law when it

noted that if it had adopted the fraud on the market doctrine, persons could sue on

the ground that they missed a favorable opportunity to sell stock “because the

market was affected by negligent misrepresentations that they never heard.”

(Mirkin, supra, 5 Cal.4th at p. 1108, italics added.) The italicized language

implies that holders retain a cause of action if they can prove actual reliance on a

misrepresentation instead of fraud on the market.

In contrast to Mirkin, supra, 5 Cal.4th 1082, the complaint before us asserts

that plaintiff read the false financial statement and relied on it. And, unlike the

buyers of securities who sued in Mirkin, persons who hold stock in reliance upon

14

misrepresentations are totally dependent for redress upon state common law

causes of action. They have no remedy under either federal Rule 10b-5 or

Corporations Code sections 25000 and 25400, because all of these provisions are

limited to suits by buyers or sellers of securities.

In sum, the federal and state decisions and actions we have examined

recognize the danger that shareholders may bring abusive and nonmeritorious suits

to force a settlement from the corporation and its officers, but they do not view

that danger as justifying outright denial of all shareholders’ causes of action. To

the contrary, when courts deny relief to the plaintiff before them, they affirm that

the plaintiff could seek redress in another forum (Blue Chip Stamps, supra, 421

U.S. at p. 739, fn. 9 [plaintiff could sue in state court]; Mirkin, supra, 5 Cal.4th at

p. 1090 [plaintiff could sue in federal court]; or that the plaintiff could prevail by

bringing a cause of action for fraud or negligent misrepresentation instead of one

for ordinary negligence (Bily, supra, 3 Cal.4th at pp. 376, 407).



C. Defendants’ Policy Arguments

Our examination of the specifics of defendants’ policy contentions also

yields the conclusion that they may justify limiting a holder’s cause of action but

do not justify total denial of the cause of action. Each of defendants’ policy

contentions shares the same defect. Defendants do not argue that a holder’s suit

for fraud is intrinsically unjust; instead, they claim that some of those suits will be

nonmeritorious, or frivolous, or will be filed solely to coerce a settlement, or will

raise problems of pleading or proof. And instead of offering a proposal to separate

the wheat from the chaff, defendants contend that we should deny holders a cause

of action entirely, thus rejecting the just and the unjust alike. Yet defendants’ own

authorities confirm the validity of state court holder’s actions and suggest that any

proposal to limit them should be more discriminating than outright denial of the

cause of action.

15



With respect to defendants’ first concern, that allowing a holder’s action

will lead to the filing of nonmeritorious “strike” suits, commentators distinguish

between two opposite undesirable outcomes: (a) allowing a plaintiff to obtain a

large settlement or judgment when no fraud occurred, and (b) denying redress

when fraud actually occurred. (They refer to these outcomes as “type I error” and

“type II error,” respectively.) (See Painter, Responding to a False Alarm:

Federal Preemption of State Securities Fraud Causes of Action (1998) 84 Cornell

L.Rev. 1, 71; Stout, Type I Error, Type II Error, and the Private Securities

Litigation Reform Act (1996) 38 Ariz. L.Rev. 711 (hereafter Stout).)

When Congress enacted the Private Securities Litigation Reform Act of

1995 and the Uniform Standards Act of 1998, it was almost entirely concerned

with preventing nonmeritorious suits. (Stout, supra, 38 Ariz. L.Rev. 711.) But

events since 1998 have changed the perspective. The last few years have seen

repeated reports of false financial statements and accounting fraud, demonstrating

that many charges of corporate fraud were neither speculative nor attempts to

extort settlement money, but were based on actual misconduct. “To open the

newspaper today is to receive a daily dose of scandal, from Adelphia to Enron and

beyond. Sadly, each of us knows that these newly publicized instances of

accounting-related securities fraud are no longer out of the ordinary, save perhaps

in scale alone.” (Schulman, Ottensoser, & Morris, The Sarbanes-Oxley Act: The

Impact on Civil Litigation under the Federal Securities Laws from the Plaintiffs’

Perspective (2002 ALI-ABA Cont. Legal Ed.) p. 1.) The victims of the reported

frauds, moreover, are often persons who were induced to hold corporate stock by

rosy but false financial reports, while others who knew the true state of affairs

exercised stock options and sold at inflated prices. (See Purcell, The Enron

Bankruptcy and Employer Stock in Retirement Plans, Congressional Research

Service (Mar. 11, 2002).) Eliminating barriers that deny redress to actual victims

16

of fraud now assumes an importance equal to that of deterring nonmeritorious

suits.

Defendants argue that under plaintiff’s theory an entire universe of

potential investors could state a class action for fraud any time a stock price

fluctuated. If stock prices went up, investors could allege that they had elected not

to purchase shares based on a company’s inadequately optimistic forecasts. If

stock prices dropped, investors could allege that they decided not to sell (or not to

buy “put options”) based on unduly optimistic disclosures. This argument

overstates the case, however. We are here concerned not with the universe of

potential investors who might decide to buy Fritz’s stock, but with the more

limited group of owners of that stock who actually relied on false representations.

Although any owner can file suit when the price of a stock drops, to survive a

demurrer to the complaint the owner must allege fraud with specificity. (Lazar v.

Superior Court, supra, 12 Cal.4th at p. 635.) A pleading that merely alleges a

decline in the market price of stock obviously does not state a cause of action.



Defendants further argue that even if a plaintiff adequately pleads reliance,

proof of reliance will often depend on oral testimony: The stockholder will testify

that he read the financial statement but there may be no written record that he did

so; he will testify that he decided not to sell the stock, and perhaps that he told his

broker, or a friend, or a spouse, of his decision, but there may be no writing to

evidence this fact. Thus, defendants are concerned that they will have no way to

rebut false claims of reliance.



A corporation’s financial report invites shareholders to read and rely on it.

Some undoubtedly will do so. The possibility that a shareholder will commit

perjury and falsely claim to have read and relied on the report does not differ in

kind from the many other credibility issues routinely resolved by triers of fact in

civil litigation. It cannot justify a blanket rule of nonliability.

17



There are, moreover, strong countervailing policy arguments in favor of

allowing a holder’s cause of action. “California . . . has a legitimate and

compelling interest in preserving a business climate free of fraud and deceptive

practices.” (Diamond Multimedia Systems, Inc. v. Superior Court (1999) 19

Cal.4th 1036, 1064.) When corporate financial statements are revealed to be false

or misleading, the harm done may extend well beyond the particular investors who

receive those statements. Financial institutions will hesitate to loan money to

corporations if they cannot trust the corporate books, and the refusal of lenders to

advance funds can doom a corporation, harming its stockholders, creditors, and

employees. Potential investors, learning of one corporate fraud, will fear there

may be others yet unrevealed, and may discount the price of that corporation (and

possibly other corporations) below what the bare financial data would warrant.

The resulting losses can have economy-wide consequences in terms of loss of

employment and failure of investor confidence in the stock market. (See Stout,

supra, 38 Ariz. L.Rev. at pp. 713-714; House Com. on Fin. Services, The Enron

Collapse: Impact on Investors and Financial Markets, 107th Cong., 1st Sess.

(Dec. 12, 2001).)

Civil Code section 3274 declares that in California money damages are not

only the prescribed remedy “for the violation of private rights” but also “the

means of securing their observance.” Because of the limited resources available

for enforcing the SEC’s mandatory disclosure system, “private litigation has been

frequently recognized as performing a useful augmentative deterrent, as well as a

compensatory role.” (Seligman, The Merits Do Matter (1994) 108 Harv. L.Rev.

438, 456.) “The SEC repeatedly has noted that government regulation alone is not

sufficient to keep markets honest. It has consistently stated that the private civil

remedy is a key element in establishing a trusted market in which individuals and

pension funds could safely invest.” (Labaton, Consequences, Intended and

18

Unintended, of Securities Law Reform (1999) 29 Stetson L.Rev. 395, 401.)

Denying a cause of action to persons who hold stock in reliance upon corporate

misrepresentations reduces substantially the number of persons who can enforce

corporate honesty.

Finally, as this court said in Emery v. Emery (1955) 45 Cal.2d 421, 430,

“[e]xceptions to the general principle of liability (Civ. Code, § 3523 [‘For every

wrong there is a remedy.’]) . . . are not to be lightly created . . . .” We have

recognized some exceptions, notably in cases where it would conflict with the

need to protect the finality of adjudication (see Cedars-Sinai Medical Center v.

Superior Court (1998) 18 Cal.4th 1, 10-11), or in which the defendant owed no

duty to the person injured (e.g., Bily, supra, 3 Cal.4th 370). But the reasons for

those exceptions do not apply here. Persons claiming that, for reasons of policy,

they should be immune from liability for intentional fraud bear a very heavy

burden of persuasion, one that defendants here have not sustained. We recognize,

however, that the risk of encouraging nonmeritorious suits justifies using the

requirement for specific pleading to place limits on the cause of action. (See

Cedars-Sinai, supra, 18 Cal.4th at pp. 13-14.) We explain those limits in the next

part.

III. ADEQUACY OF PLAINTIFF’S PLEADING OF RELIANCE

Defendants here attack plaintiff’s pleading indirectly. Instead of arguing

that plaintiff’s complaint does not adequately plead reliance, defendants’ brief

argues that this court should reject a holder’s cause of action because it raises

troublesome questions of pleading and proving reliance. For the reasons stated in

part II of this opinion, defendants’ arguments are insufficient to justify an absolute

denial of a holder’s cause of action. For the guidance of the parties and future

litigants, however, we will discuss the adequacy of plaintiff’s complaint.

19



Ideally, what is needed is some device to separate meritorious and

nonmeritorious cases, if possible in advance of trial. California’s requirement for

specific pleading in fraud cases serves that purpose (Committee on Children’s

Television, Inc. v. General Foods Corp., supra, 35 Cal.3d at pp. 216-217). “In

California, fraud must be pled specifically; general and conclusory allegations do

not suffice. [Citations.] ‘Thus “ ‘the policy of liberal construction of the

pleadings . . . will not ordinarily be invoked to sustain a pleading defective in any

material respect.’ ” [Citation.] This particularity requirement requires pleading

facts which “show how, when, where, to whom, and by what means the

representations were tendered.” ’ ” (Lazar v. Superior Court, supra, 12 Cal.4th at

p. 645.)



California courts have never decided whether the tort of negligent

misrepresentation, alleged in the complaint here, must also be pled with

specificity. But such a requirement is implied in the reasoning of two decisions

(Committee on Children’s Television, Inc. v. General Foods Corp., supra, 35

Cal.3d at p. 216; B.L.M. v. Sabo & Deitsch (1997) 55 Cal.App.4th 823, 835-837)

and was asserted expressly in Justice Mosk’s dissenting opinion in Garcia v.

Superior Court (1990) 50 Cal.3d 728, 748. Because of the potential for false

claims, we hold that a complaint for negligent misrepresentation in a holder’s

action should be pled with the same specificity required in a holder’s action for

fraud. (We express no view on whether this pleading requirement would apply in

other actions for negligent misrepresentation.)

In the trial court and the Court of Appeal, defendants claimed that

plaintiff’s assertion of having relied on defendants’ misrepresentations was

insufficient. We agree that in view of the danger of nonmeritorious suits, such

conclusory language does not satisfy the specificity requirement. In a holder’s

action a plaintiff must allege specific reliance on the defendants’ representations:

for example, that if the plaintiff had read a truthful account of the corporation’s

20

financial status the plaintiff would have sold the stock, how many shares the

plaintiff would have sold, and when the sale would have taken place. The plaintiff

must allege actions, as distinguished from unspoken and unrecorded thoughts and

decisions, that would indicate that the plaintiff actually relied on the

misrepresentations.

Plaintiffs who cannot plead with sufficient specificity to show a bona fide

claim of actual reliance do not stand out from the mass of stockholders who rely

on the market. Under Mirkin, supra, 5 Cal.4th 1082, such persons cannot bring

individual or class actions for fraud or misrepresentation. They may, however, be

able to bring a corporate derivate action against the corporate officers and

directors for harm caused to the corporation. (Sutter v. General Petroleum Corp.

(1946) 28 Cal.2d 525, 530.) Because a plaintiff in a derivative action is suing on

behalf of the corporation, he or she need not show personal reliance.

Plaintiff here did not attempt to bring a derivative action, however. His

complaint does not allege injury to the corporation or a wrong common to the

entire body of stockholders, but only to those stockholders who actually relied on

defendants’ misrepresentations.3 Thus the complaint must stand or fall on the

allegations of personal reliance.

We conclude that plaintiff did not adequately plead reliance in this case.

But because the requirement we set forth here has not been stated in previous

cases, plaintiff should be given leave to amend his complaint to make the

necessary allegations.


3

We express no view on whether the facts as alleged in the complaint imply

a wrong to the corporation, or whether the corporation, by perpetrating a fraud on
the market, wronged the entire body of stockholders.

21



The judgment of the Court of Appeal is reversed, and the cause is remanded

for further proceedings consistent with this opinion.

KENNARD,

J.

WE CONCUR:

GEORGE, C. J.
WERDEGAR, J.
MORENO, J.


22










CONCURRING OPINION BY KENNARD, J.




The majority opinion, which I authored, upholds the right of stockholders

to sue for fraudulent or negligent misrepresentation when they reasonably rely on

the misrepresentation to refrain from selling their stock. It does not discuss

whether the plaintiff here has adequately pled damage, because defendants did not

raise that question. I write separately to explain my disagreement with the

separate opinions of Justices Baxter and Brown.

I

Justice Baxter’s concurrence urges this court to declare that holder

plaintiffs must allege they sustained realized, permanent damage. Such a

requirement, he acknowledges, would mean in many cases that plaintiffs must

allege they sold the stock after learning of the fraud.

Justice Baxter begins his discussion with the correct proposition that a

plaintiff must show actual damages. But he asserts two more propositions that are

unsound and unsupported by any authority. First, he asserts that defrauded

stockholders incur no damages unless the value of their stock was permanently

diminished. Second, he maintains that if, after an initial decline when the fraud is

revealed, the price of the stock at any later time rises for reasons unrelated to the

1

fraud, this rise reduces or eliminates the plaintiff’s loss.1 The possibility of such a

rise, he maintains, would make damages too speculative. These premises lead

Justice Baxter to conclude that in most instances stockholders must sell their stock

in order to sue, because there is no other way they can fix the amount of damages

suffered and prove they will not benefit from an increase in the value of the stock,

at some unknown future date, arising from unknowable future circumstances.

But Justice Baxter’s premises are wrong. Temporary injury is legally

compensable. Examples abound. One who sustains personal injuries may sue

even if the injuries will eventually heal. A temporary taking of property is

compensable, even if the property is later returned. (See, e.g., Kimball Laundry v.

United States (1949) 338 U.S. 1 [eminent domain]; Zaslow v. Kroenert (1946) 29

Cal.2d 541 [conversion].) To state a cause of action, a plaintiff whose property is

damaged need not plead that its value will be forever impaired. (See, e.g., Wolfsen

v. Hathaway (1948) 32 Cal.2d 632 [temporary damage to pasturage, which would

regenerate naturally].) In Mears v. Crocker First Nat. Bank (1948) 84 Cal.App.2d

637, the appellate court upheld a cause of action for conversion when a company

wrongfully refused for six weeks to transfer title to stock on its books.

Justice Baxter acknowledges that in other areas of tort law a temporary loss

of enjoyment or use of property is compensible. (Conc. opn., post, at p. 7.) The

property owner is not required to “realize” the loss by selling the property before

the damage has been cured. Underlying Justice Baxter’s proposal of a different,

unique rule for securities fraud may be his sense that losses in stock value are

1

He does not, however, argue that if the price of the stock falls further

because of factors unrelated to the fraud, this decline increases the plaintiff’s
damages. Justice Brown’s concurring and dissenting opinion, on the other hand,
does imply that a decline caused by intervening causes unrelated to the fraud
would increase the plaintiff’s damage. (See conc. & dis. opn., post, at p. 13.)

2

mere “paper” losses, and somehow not real. (Conc. opn., post, at p. 5, italics

omitted.)

I disagree. The economy is filled with what could derisorily be termed

“paper assets” – the appreciated value of real estate, the goodwill of a business,

uncollected accounts receivable, the balance of a checking account, etc. Business

and individual investors make decisions based on the value of such assets. A

decline in the value of stock, like a decline in the balance of a bank account or in

the worth of a physical asset, is a decline in the net worth of the stockholder,

whether or not the stock is sold. For individual stockholders, it affects such

matters as whether the stockholders will take a vacation, whether they can get a

mortgage, and what other investments they make or do not make. It can have

drastic effects on retirement plans. Businesses and institutions also hold stock. A

decline in the value of the stock it holds can lead a college to raise tuition or an

insurer to raise premiums. It affects a company’s ability to borrow money or issue

new stock. In sum, ours is a paper economy, and declines in stock prices have real

and serious effects whether or not the stockholders sell the stock.

I disagree also with Justice Baxter’s second premise -- that the damages

defrauded stockholders should receive would become unduly speculative if they

continued to hold the stock because of the possibility that the price of the stock

might increase later, at any time into the indefinite future, because of matters

unrelated to the fraud. The accepted rule is to the contrary. In a securities fraud

case, the loss is calculated by using the “market price after the fraud is discovered

when the price ceases to be fictitious [i.e., based on false data] and represents the

consensus of buying and selling opinion of the value of the securities.” (Rest.2d

Torts § 549, com. c, p. 110.) Later prices changes, in either direction, do not

affect the calculation of the loss.

3



This rule does not necessarily mean that damages must be computed on the

basis of the market price of the stock on the day the possible fraud is revealed; the

market may take longer to digest and react to the news. In 1995 Congress, in the

Public Securities Litigation Reform Act (PSLRA), addressed proof of damages in

cases in which a plaintiff who was fraudulently induced to purchase securities

sued the corporation and its officers after the fraud was revealed and the price fell.

(15 U.S.C. § 78u-4(e).) The PSLRA calculates damages based on the mean

trading price of the security within a 90-day period after the date when the

misstated or omitted fact is disclosed to the market. (Kaufman, Securities

Litigation: Damages (2002) § 3.13.) (The mean trading price is the average of the

closing prices of the security throughout the 90-day period.) If, however, the

plaintiffs sell the security before the expiration of the 90-day period, damages are

based on the mean trading price in the postdisclosure period ending on the date of

the sale.2 (Ibid.) There are differences between the buyer’s actions regulated by

the PSLRA and the holder’s actions at issue here, but they share a common need:

to fix a postdisclosure date and price to use in calculating damages. In this respect

the two actions are analogous, and the federal legislation regulating buyer’s action

suggests a workable rule for computing damages in holder’s actions: It recognizes

that the market may overreact to news of fraud, and that a later price may be a

better indicator of the true postdisclosure value of the stock, but it does not

diminish a plaintiff’s damages because of the possibility that long-term economic

factors may eventually cause the stock price to rise to its predisclosure level.

Justice Baxter’s proposal that stockholders should not be able to sue until

they “realize” their loss is a notion rarely mentioned and never endorsed in the


2

Not on the sale price alone, as Justice Baxter proposes.

4

cases and commentaries on securities regulation.3 A quarter of a century ago a

similar argument was rejected in Harris v. American Investment Company (8th

Cir. 1975) 523 F.2d 220, 227-228, which held that in a buyer’s action no sale was

required: “A defrauded buyer of securities may maintain an action for damages

under § 10(b) . . . even though he continues to hold the securities. [Citations.] At

common law, a defrauded purchaser of securities is under no duty to sell them

prior to maintaining an action for deceit but may hold them for investment

purposes if he chooses. [Citations.] Thus, Harris was under no duty to sell his . . .

stock, for mitigation of damages or any other purposes, prior to commencing this

action . . . . Harris’s damages may be measured as of the date of public discovery

of the fraud. Under those circumstances the plaintiff will not be able to avail

himself of any further decrease in the value of the stock after that date. So also the

defendant should not be able to avail itself of any increase in the value of the stock

after that date. This is the only method in which a consistent measure of damages

can be obtained.” This reasoning applies equally to a holder’s action as involved

here.

No commentators, including those critical of holder’s actions, support or

even discuss the notion advanced by Justice Baxter that, except in cases of

corporate bankruptcy or special damages, stockholders must sell their stock before

bringing suit. This proposal was not briefed in this case; it arose only during

questioning at oral argument. We should be very hesitant to adopt a rule of our


3

Justice Baxter cites Chanoff v. U.S. Surgical Corp. (D.Conn. 1994) 857

F.Supp. 1011, but that case held that courts should not entertain a holder’s action
at all – a minority view and one that Justice Baxter rejects. Chanoff did not say
that a holder’s action could be sustained if the holder sold the stock after
disclosure of the fraud.

5

own invention that has not been briefed or previously tested by judicial opinion or

academic commentary.4

Moreover, a “sell to sue” rule might have harmful consequences. Justice

Baxter considers it unlikely that defrauded stockholders would sell to preserve

their right to damages, further depressing the price of the stock, unless they

planned to sell anyway. This is speculation without analysis. Mutual funds and

institutional stockholders make daily decisions how to allocate their assets and

might well decide that holding stock is affected by fraud less attractive than some

alternative investment if, by not selling their shares, they would lose the

opportunity to recover damages in a class fraud action. Individual investors who

think the stock may eventually recover some of its value may still believe that

possibility of recovery is worth less than their right to damages. And some

investors may try to have their cake and eat it too; selling their stock to “realize”

their loss, so they can join in a fraud suit, then repurchasing the stock so they can

share in any future appreciation. Ultimately, the question of the effect of a “sell to

sue” rule is an empirical one. If this court were to adopt a “sell to sue” rule, it

would launch an experiment, without any input from economists or market

analysts, which might have severe consequences.

II

I disagree also with Justice Brown’s concurring and dissenting opinion.

Justice Brown notes that plaintiff pled that Fritz’s shares were traded in an

“efficient market,” and she declines to accept or reject the efficient capital market


4

Adopting a “sell to sue” rule would require a court to decide two questions:

(1) how soon must the stockholder sell after the disclosure? (2) How long, if at
all, must the stockholder wait before buying back for the court to recognize the
sale as valid to “realize” the loss?

6

hypothesis5 (conc. & dis. opn., post, at p. 4), but despite her disclaimer she relies

on that economic theory for her analysis.6 The efficient capital markets

hypothesis, however, does not support her analysis.

I agree with Justice Brown that plaintiff here is not entitled to damages on

the theory that he would have sold Fritz stock at artificially high prices maintained

through Fritz’s concealment of adverse information. “Plaintiffs cannot claim the

right to profit from what they allege was an unlawfully inflated stock value.”


5

There are three versions of the efficient capital market hypothesis. The

weak version holds that market prices eventually reflect all publicly available
information. The semi-strong version says that prices do so rapidly. The strong
version holds that prices reflect all material information, even that not available to
the public. (Saari, The Efficient Capital Market Hypothesis, Economic Theory and
the Regulation of the Securities Industry
(1977) 29 Stan. L.Rev. 1031, 1041.)


The weak version obviously does not aid Justice Brown’s position. For

reasons stated in text (post, p. 8), neither does the semi-strong version. The strong
version, which would imply that the market knew Fritz’s financial reports were
false long before Fritz disclosed this fact, would assist Justice Brown, but “[n]o
one these days accepts the strongest version of the efficient capital market
hypothesis, under which non-public information automatically affects prices. That
version is empirically false . . . .” (West v. Prudential Securities (7th Cir. 2002)
282 F.3d 935, 938.)
6

Numerous factual assertions in her opinion are not statements of proven

fact, but propositions derived from the efficient capital market hypothesis. These
include:


(a) “The [efficient] market not only reflects publicly available information

with great rapidity; it also anticipated formal public announcements of much
information.” (Conc. & dis. opn., post, at p. 4.)


(b) “Because the market accurately and efficiently assimilates all public

information. . . .” (Conc. & dis. opn., post, at p. 6.)


(c) “[P]laintiff forgets that stock prices in an efficient market ‘react quickly

and in an unbiased fashion to publicly available information.’ ” (Conc. & dis.
opn., post, at p. 7.)


Each of these statement is based on or a quotation from Saari, The Efficient

Capital Market Hypothesis, Economic Theory and the Regulation of the Securities
Industry
(1977) 29 Stan. L.Rev. 1031, 1050.

7

(Chanoff v. U. S. Surgical Corp., supra, 857 F.Supp. at p. 1018; see Arent v.

Distribution Sciences, Inc. (8th Cir. 1992) 975 F.2d 1370, 1374; Crocker v.

Federal Deposit Ins. Corp. (5th Cir. 1987) 826 F.2d 347, 351-352.) Plaintiff is

entitled only to damages attributable to the fraud, that is, to defendants’ false

representations in April 1996 and their concealment of the true financial condition

of Fritz until July 24, 1996.

Justice Brown, however, relies on the efficient capital market hypothesis to

argue that as a matter of law plaintiff sustained no damage. She asserts: “The true

worth of Fritz’s stock on July 24 necessarily reflected the fact that the third quarter

results should have been reported on April 2. Thus, the price of Fritz’s stock on

July 24 was, by definition, the same price the stock would have had on that date if

defendants had reported Fritz’s true third quarter results on April 2.” (Conc. &

dis. opn., post, at p. 7.) This argument is logically unsound. Under the semi-

strong version of the efficient capital market hypothesis (see ante, fn. 5), the price

of Fritz’s stock on July 24 necessarily reflected the fact that the third quarter

results should have been reported on April 2. But that does not mean the price on

July 24 was the same price the stock would have had on that date if Fritz had

reported those results on April 2. Here is why: On July 24 the market had

additional information – that the April 2 report was false and that the true facts had

been concealed for over three and one-half months. Justice Brown asserts that in

an efficient market, “the market price of a stock reflects all publicly available

information.” (Conc. & dis. opn., post, at p. 5.) The efficient capital market

hypothesis does not presume that investors consider only hard economic data and

ignore other information casting doubt on the integrity or competence of

management. There is no logical reason under the efficient capital market

hypothesis to assume that investors would disregard information showing false

8

earnings reports and concealment of true data and would value the stock as if no

such things had occurred.

Justice Brown goes on to say: “While loss of investor confidence in

management may adversely affect a stock’s price, the July 24 announcement

would have caused investors to lose confidence in Fritz’s managements even if it

had been made on April 2.” (Conc. & dis. opn., post, at pp. 7-8.) A company’s

announcement of a quarterly loss will indeed shake investor confidence. But an

announcement that its past report was false and that the loss was concealed from

public view generates far greater anxiety. Investors will not only question

management’s competence but also its integrity. Investors would have reason to

wonder whether there were other, yet undisclosed instances of fraud, and to doubt

whether management really recognized its duty to protect the interests of

stockholders. Investors would be concerned, too, that lenders would doubt the

integrity of the management and question their financial data, affecting the

company’s credit status. They would fear that the company might incur the

disruption and expense of defending numerous lawsuits, such as this one. In sum,

revelations of false financial statements and management misrepresentations raise

a host of concerns that may lead to a decline in stock values beyond that warranted

by the financial information itself.

Justice Brown argues alternatively that damages would be speculative

because of the difficulty in separating the loss in value attributable to fraud from

that attributable to the disclosure of truthful but unfavorable financial data. But

“though the fact of damage must be clearly established, the amount need not be

proved with the same degree of certainty but may be left to reasonable

approximation or inference. Any other rule would mean that sometimes a plaintiff

who had suffered substantial damage would be wholly denied recovery because

the particular items could not, for some reason, be precisely determined.” (6

9

Witkin, Summary Cal. Law (9th ed. 1988) Torts, § 1325, p. 782.) Numerous

decisions support this principle. (See Clemente v. State of California (1985) 40

Cal.3d 202, 219; 6 Witkin, Summary of Cal. Law, supra, Torts, § 1325, p. 783 and

cases there cited.) It is particularly applicable in fraud cases. “Because of the

extra measure of blameworthiness inhering in fraud” (Lazer v. Superior Court

(1996) 12 Cal.4th 631, 646), the “modern tendency is to impose broader

consequences . . . than where [the defendant’s] conduct was merely negligent.” (6

Witkin, Summary of Cal. Law, supra, Torts, § 1323, p. 781.)

Thus, once a plaintiff holder can show that a portion of the loss is

attributable to fraud, difficulty in proving the amount of the damages will not bar a

cause of action. Proof will, of course, often require expert evidence. Such

evidence is commonplace in securities fraud actions. (See Sowell v. Butcher &

Singer, Inc. (3d Cir. 1991) 926 F.2d 289, 301; Behrens v. Wometco Enterprises,

Inc. (S.D.Fla. 1988) 118 F.R.D. 534, 542.) Experts may disagree—they often

do—but that is no reason to reject a holder’s cause of action.

Justice Brown fears that under the majority opinion a company would be

subject to securities fraud claims whenever it announces bad news or a negative

correction. “[P]laintiffs,” she says, “would merely have to allege a loss of investor

confidence due to investor speculation that the bad news resulted from fraud or

incompetence.” (Conc. & dis. opn., post, at p. 9.) To the contrary, under the

principles stated in the majority opinion, plaintiffs would have to allege fraud with

specificity to state a cause of action.

It is unclear what limits Justice Brown would place on the class of holders

who could recover damages. She distinguishes cases upholding claims by persons

who rely on face-to-face misrepresentations by defendants, thus implying that in

her view such persons would have a valid cause of action. But the class of persons

who rely on face-to-face misrepresentations is a miniscule class and the face-to-

face nature of the representations may not make damages any more or less

10

speculative than in other cases, depending upon whether the defendants made the

same representations to the stockholders generally.

She also distinguishes cases in which the investors “alleged facts indicating

that they were prepared to sell or considering the sale of their stock or property

and that misrepresentations induced them not to sell.”7 (Conc. & dis. opn., post, at

p. 13.) If she maintains that such persons have a valid cause of action for fraud,

then her position differs only in nuance from the majority opinion, which states

that a holder plaintiff “must allege specific reliance on the defendant’s

representations: for example, that if the plaintiff had read a truthful account of the

corporation’s financial status plaintiff would have sold the stock, how many shares

the plaintiff would have sold, and when the sale would have taken place.” (Maj.

opn., ante, at p. 20, italics added.) The difference between the majority and

Justice Brown appears to be that the majority would allow a cause of action if the

stockholder would have sold the stock if he or she had been given truthful

information, while Justice Brown would limit the cause of action to persons who

were dissuaded from selling by false information -- which may be two ways of

saying the same thing. Moreover, Justice Brown would allow greater damages

than the majority proposes, allowing persons who actually rely on

misrepresentations to claim damages for “drops in market price due to intervening

causes unrelated to the misrepresentations.” (Conc. & dis. opn., post, at p. 13.)


7

Justice Brown’s assertion that plaintiff cannot allege a causal relationship

between the misrepresentations and damages (conc. & dis. opn., post, at p. 1)
assumes that plaintiff cannot allege that he was prepared to sell or considering the
sale of his Fritz stock and that the misrepresentations induced him not to sell. This
may or may not be true. Until this decision was filed, plaintiff did not know what
he had to allege to state a cause of action. This is why the court gives him leave to
amend.


11

III

In sum, disclosures during the past three years have revealed extensive

fraud involving numerous corporations, often involving false financial reports and

the concealment of true financial data -- fraud so massive that it contributed to an

overall decline in the stock market and perhaps to a decline in the economy

generally. The victims include not only those who bought or sold stock in reliance

upon the false statements, but also those who held stock in reliance. The majority

opinion allows such holders to sue for damages. That remedy should not be so

hedged and qualified that only a fraction of those actually injured would be able to

gain redress.

KENNARD,

J.

12










CONCURRING OPINION BY BAXTER, J.




I agree with the majority’s reasoning and result as far as they go. Thus,

I accept in principle that the shareholder of a publicly traded company may have a

direct common law action against the company and its officials when their

intentional or negligent misrepresentations about the company’s financial

condition, on which he personally relied, induced him not to sell his shares, and

thus caused him damage. Despite an “efficient market” for the shares, I can

conceive that delayed disclosure of bad news, under circumstances suggesting that

earlier reports were dishonestly or incompetently false, might have an effect on the

market price of the shares beyond the effect of the bad news itself.

I also strongly agree that in a suit of this kind—a so-called holder’s

action—the complaint must plead specific facts showing actual, personal reliance

on the defendants’ alleged misrepresentations. As the majority indicate, the

complaint before us is not specific enough in its allegations of actual reliance, and

a remand for possible amendment is appropriate.1


1

As the majority set forth, the second amended complaint does aver that the

original named plaintiff (and all other alleged class members) “ ‘read [the
allegedly inaccurate third quarter statement of defendant Fritz Companies, Inc.
(Fritz)], . . . and relied on [the inaccurate] information [contained therein] in
deciding to hold Fritz stock through [July 24, 1996].’ ” (Maj. opn., ante, at p. 4,
italics added; see also id. at p. 14.) The majority do not quite say so, but I assume

(Footnote continued on next page.)

1

But under the protracted circumstances of this case, the majority’s

disposition is incomplete. Counting the original complaint, filed in October 1996,

there have been three attempts to state a cause of action. So far, these efforts have

produced three appellate decisions, two from the Court of Appeal and one from

this court. It is time to move this long-pending lawsuit beyond the pleading stage,

one way or the other, by providing guidance on all the significant legal issues

bearing on the sufficiency of the complaint.2

However, the majority encourage yet another round of pleading litigation,

because they omit all reference to an element even more crucial and basic than

those they discuss. The majority properly demand specificity in the complaint’s



(Footnote continued from previous page.)

that, consistent with Mirkin v. Wasserman (1993) 5 Cal.4th 1082, they would
deem the pleading of some such form of direct personal reliance minimally
necessary in order to eliminate persons who merely seek to invoke the “fraud on
the market” doctrine that we rejected in Mirkin for purposes of California common
law securities litigation. In addition, as the majority assert, the plaintiff must
plead, “for example, that if the plaintiff had read a truthful account of the
corporation’s financial status the plaintiff would have sold the [corporation’s]
stock, how many shares the plaintiff would have sold, and when the sale would
have taken place” (maj. opn., ante, at p. 20), and must also “allege actions, as
distinguished from unspoken and unrecorded thoughts and decisions, that would
indicate that the plaintiff actually relied on the misrepresentations” (id. at pp. 20-
21).

2

I acknowledge we cannot resolve at this stage whether the case may

properly proceed as a class action. But we facilitate that determination by
specifying all the elements of an individual cause of action.


2

allegations of reliance, but they overlook, by failing to address, the brief and

conclusory way in which damage is pled.3

On that point, the second amended complaint contains an additional fatal

gap. The complaint recites that the original named plaintiff and other members of

the alleged class are persons who held Fritz stock from before April 2, 1996, when

Fritz first overstated its third quarter results, through July 24, 1996, when Fritz

downgraded its third quarter figures, and also announced disappointing fourth

quarter earnings. According to the complaint, these investors suffered “detriment”

when the price of Fritz shares plummeted by 55 percent, to $12.25 per share, on

July 24, 1996—detriment they could have avoided if, as they would have done,

they had sold their shares upon a timely disclosure of the truth.

There are many uncertainties in this vague claim of damage, as defendants

and their amici curiae have stressed at length. But the most fundamental flaw is

the complaint’s utter failure to state whether, or how, the described shareholders

have suffered a realized loss as a result of the alleged fraud. The complaint does

not allege that any such investor sold shares at a price depressed by revelation of

the scandal. Nor does it articulate any other way in which this group of Fritz

3

Throughout this litigation, defendants and their amici curiae have

volunteered only two attacks on the various complaints filed herein: first, that
there is no California common law holder’s action, and second, that the allegations
of reliance are insufficient. Perhaps, therefore, the majority are within their
technical rights to avoid other issues. However, this court did solicit and receive
supplemental briefs on the issue “whether, in light of the so-called ‘efficient
capital markets hypothesis’ or otherwise, the complaint sufficiently alleges a
causal relationship between the alleged misrepresentations and any alleged,
nonspeculative damages.” (Italics added.) At oral argument, I questioned counsel
specifically about the problem of realized loss. Hence, the parties have had
reasonable notice and opportunity to brief and argue the issue, and we may resolve
it in the interest of judicial efficiency. (Cal. Rules of Court, rule 29(b)(2).)


3

shareholders sustained actual out-of-pocket damage as a direct result of the July

24, 1996, disclosures. The complaint simply suggests that because these persons

were holding Fritz shares on July 24, they are entitled to recover any difference

between the price to which the shares actually fell on that date, and the price at

which the shares could have been promptly sold if the true third quarter results had

been announced in timely fashion.

These allegations are insufficient to support monetary recovery for the

alleged fraud and deceit. In California, “recovery in a tort action for fraud is

limited to the actual damages suffered by the plaintiff. [Citations.]” (Ward v.

Taggart (1959) 51 Cal.2d 736, 741, italics added.) “ ‘Actual’ is defined as

‘existing in fact or reality,’ as contrasted with ‘potential’ or ‘hypothetical,’ and as

distinguished from ‘apparent’ or ‘nominal.’ (Webster’s Third New Internat. Dict.

(1964) p. 22.) It follows that ‘actual damages’ are those which compensate

someone for the harm from which he or she has been proven to currently suffer or

from which the evidence shows he or she is certain to suffer in the future.”

(Saunders v. Taylor (1996) 42 Cal.App.4th 1538, 1543.)

Where fraud is alleged to have caused damage in connection with the

purchase, sale, or exchange of property, California applies the out-of-pocket loss

rule. This doctrine limits recovery to the difference between the actual values,

intrinsic and economic, of that which the defrauded person gave up and that which

he or she received in return, plus sums expended in reliance on the fraud, and it

precludes recovery based on the “benefit of the bargain,” i.e., the plaintiff’s

expectancy interest created by the fraud. (Civ. Code, § 3343; see Alliance

Mortgage Co. v. Rothwell (1995) 10 Cal.4th 1226, 1240.)

Similar limitations to actual out-of-pocket loss must, of course, apply where

one alleges that he was induced by fraud or deceit to hold property he would

otherwise have sold. At the least, the defrauded person must plead and prove that,

4

aside from any specific reliance expenses, he ultimately gave up more value, or

received less, in exchange for the property, or that its value was permanently

diminished, as a result of the fraud.

All persons who bought Fritz shares at a price unfairly inflated by the false

reports of April 1996, or who sold such shares at the depressed price produced by

the July 24, 1996, disclosure of the misrepresentations, either gave up more, or

received less, for their shares than if the alleged fraud had not occurred. This gap

between what the shareholders actually paid or received, and what they fairly

should have paid or received, will never diminish or disappear, no matter what

happens to the price of the stock thereafter. If capable of measurement, the

difference represents actual out-of-pocket damage that the law should compensate.

The same premise does not necessarily apply, however, where there was

neither a purchase nor a sale related to the fraud. In a holder’s action, the plaintiff

presumably bought the shares at their fair prefraud value. If he did not sell them

when the fraud was disclosed, at a price influenced by the disclosure, but instead

retained them for a substantial period thereafter, their value, subject to the daily

fluctuations of an efficient securities market, may have risen or fallen during that

time for reasons, and in an amount, unrelated to the fraud.

Of course, persons who held Fritz shares on July 24 suffered at least

momentary paper losses when the price of those shares dropped. These investors’

balance sheets of assets and liabilities, computed as of July 24, would show lower

values for their Fritz shares than on July 23. However, such shareholders did not

necessarily suffer permanent realized losses, and the law may compensate only the

latter. Only those who sold the shares on the bad news, or otherwise incurred

measurable, irretrievable out-of-pocket losses as a result, should be deemed to

have suffered actual damage subject to recovery. Otherwise, damages are entirely

speculative, and the opportunity for windfall recoveries is manifest.

5

If a company’s stock was held for a substantial period after the fraud and its

disclosure, intervening events may have obliterated the effect of the fraud on the

value of the shareholders’ investments. An efficient public securities market

responds rapidly and accurately both to changing general economic conditions,

and to the shifting prospects of each business whose shares are traded therein.

Transitory events that affected the price of the company’s shares on certain days

during a particular year may have little to do with the value of the shares months

or years later. A company’s fortunes may rebound from fraud, perhaps under new

and honest management, such that an investment retained for the long term may

ultimately be worth more than if the fraud had never occurred. Certainly an

attempt to trace the effect of a fraud that occurred in 1996 on the current value of

the company’s shares is an exercise in futile speculation.

Thus, I cannot accept the narrow “snapshot” theory of damage on which the

current complaint asks us to focus. Any instantaneous paper loss incurred by

longtime Fritz shareholders who saw their share values drop on July 24, 1996, but

did nothing in response, is not necessarily an accurate measure of the actual

damage, if any, they ultimately did or will suffer because of the company’s

misrepresentations.4

No case I have found squarely embraces or rejects the notion that one who

alleges he was induced by fraud to retain securities can recover damages simply

by pleading and proving that he continued to hold the shares after disclosure of the

truth caused their value to drop. Of course, there are no prior California decisions

recognizing a cause of action for fraudulent inducement to hold publicly traded


4

When questioned about these difficulties at oral argument, plaintiff’s

counsel responded gamely but offered little to refute my concerns.


6

securities. Most of the authorities the majority cite from other jurisdictions are of

ancient vintage and do not focus on measurement of damages for marketplace

fraud in a modern efficient securities market.

In the most recent “proholder” case cited by the majority (Gutman v.

Howard Sav. Bank (D.N.J. 1990) 748 F.Supp. 254), the complaint expressly

alleged that when the fraud was disclosed, the plaintiffs did sell their stock “at

great loss.” (Id. at p. 257.) On the other hand, the one recent “antiholder”

decision acknowledged by the majority (Chanoff v. U.S. Surgical Corp.

(D.Conn. 1994) 857 F.Supp. 1011 (Chanoff)) , affd. (2d Cir. 1994) 31 F.3d 66,

cert. den. (1994) 513 U.S. 1058 reasoned at length that damages for securities

fraud, where there has been neither a purchase nor a sale in reliance on the fraud,

were too speculative to be actionable. (857 F. Supp. at p. 1018.)

Even if my reasoning means that, in some cases, investors would have to

sell their shares in order to recover, I foresee no dire market consequences. In the

first place, the class of shareholders to whom such a requirement would apply is

relatively small. For reasons indicated above, those who bought shares in reliance

on the company’s misrepresentations would never have to sell to sue. Among

those who bought before the fraud occurred, the only ones who could sue in any

event would be those with evidence, other than their own uncorroborated claims,

that they had intended to sell but were induced not to do so by their personal

reliance on the misrepresentations. It thus seems likely that the general loss of

confidence in company management by investors, particularly institutional

investors, would far overshadow any market effect of shareholders induced to sell

only to preserve their rights to bring holder’s actions.

In any event, it seems unlikely that defrauded holders will sell simply to

preserve their right to sue and recover damages, when they otherwise would have

been inclined to retain their shares despite the disclosure of the fraud. Those who

7

sell on the disclosure presumably do so because they make a rational decision to

cut their losses. Those who decide not to sell may be acting on an equally rational

belief that the company and its shares will recover and prosper. This latter group

may believe they will profit less by selling and suing than by waiting for the

recovery. Whichever choice an investor makes, he should not have his cake and

eat it too. Both economics and law are replete with elections of this kind. I see no

fundamental problem with imposing one here.

Indeed, by allowing holders to sue and recover even when they realized no

loss, we do more harm to the company’s prospects, and to the value of its shares,

than by withholding such eligibility. Investors are likely to display little interest in

the stock of a corporation saddled with such unjustified liabilities.

I do not suggest that an open-market sale of the company’s shares is the

only possible way a shareholder can incur a realized loss. If fraud caused a

company to fail, such that its shares became permanently worthless, or led to a

merger or acquisition in which remaining shareholders received a low value

traceable to the effect of the fraud, that might suffice.5 So might any showing that


5

Injuries of this kind, I realize, might be considered “ ‘injury to the

corporation, or to the whole body of its stock or property without any severance or
distribution among individual shareholders’ ” (Sutter v. General Petroleum Corp.
(1946) 28 Cal.2d 525, 530), such that only a derivative action would be available.




Though neither the record nor the parties have so informed us, it appears

that in May 2001, nearly five years after the alleged 1996 fraud and its disclosure,
Fritz was acquired for substantial value by United Parcel Service, Inc. (Yahoo!
Finance, EDGAR Online, SEC Filings, Fritz Companies Inc. (FRTZ), form 8-k
(May 24, 2001) <http://biz.yahoo.com/e/010524/frtz.html> [as of April 7, 2003];
UPS Pressroom, 2001 Press Releases, UPS to Acquire Fritz Companies, Inc. for
$450 Million in Class B Common Stock
(Jan. 10, 2001)
<http://pressroom.ups.com/pressreleases/archives/archive/0,1363,3844,00.html>
[as of April 7, 2003].) This intervening development only underscores the

(Footnote continued on next page.)

8

a fraud-related collapse of the company’s share prices led to a margin call against

a suing shareholder, at least where pledged collateral was sold at an unfavorable

price to cover the margin loan. (But see Chanoff, supra, 857 F.Supp. 1011, 1018.)

I am not concerned that the limitations I propose would allow Fritz and its

dishonest officials to escape liability for their fraud. Anybody who bought shares

at an artificially high price in reliance on the falsely optimistic report of April 2,

1996, or sold them at a depressed price when the dishonesty was disclosed on July

24, 1996, or could otherwise demonstrate an actually realized loss from the

misrepresentation, would have a remedy. To exclude persons who cannot

demonstrate actual loss of this kind is simply to recognize one element of a

common law action for fraud, i.e., damage caused by the fraud.

In her separate concurring opinion, Justice Kennard insists my conclusions

flow from two false premises—that temporary loss is not compensable (conc. opn.

of Kennard, J., ante, at pp. 1-2), and that damages would be too speculative if the

shares continued to be held until after intervening market forces, unrelated to the

fraud, had determined their value (id. at pp. 2-3). Her contentions are not

persuasive.

At the outset, her examples of compensable “temporary” losses are inapt.

I agree that any demonstrable loss or damage arising from temporary deprivation

of the full possession, enjoyment, and use of one’s property is compensable where

caused by such acts as conversion, trespass, or eminent domain. (See, e.g.,

Kimball Laundry Co. v. U. S. (1949) 338 U.S. 1 [condemnation of laundry plant


(Footnote continued from previous page.)

difficulty of tracing the effect of long-past events on the current value of
investments retained for substantial periods after those events occurred.


9

for duration of war]; Wolfsen v. Hathaway (1948) 32 Cal.2d 632 [wrongful

temporary damage to pasturage]; Zaslow v. Kroenert (1946) 29 Cal.2d 541

[conversion of real property]; Mears v. Crocker First Nat. Bank (1948)

84 Cal.App.2d 637 [conversion by failure to transfer ownership of stock on

company books; measure of damages not discussed].)

No such issue arises in this case. There is no claim of deprivation of the

possession, enjoyment, or use of the shares at issue here. All the rights, privileges,

and powers of ownership were retained, including the right to sell the shares, or

not to do so, when the alleged fraud was disclosed. Plaintiff simply seeks

compensation for a drop in their trading value on a particular day, claiming it

resulted from the fraud. But the complaint pleads no facts indicating that this

downward turn on the price chart for the shares, however temporary, caused an

actual, realized loss.

Justice Kennard’s argument that “paper” losses are real because they

influence the actual conduct of economic affairs is also beside the point. The fact

remains that in California, one does not suffer legally cognizable damage merely

because disclosure of a fraud caused a transitory “blip” in the value of one’s stock

portfolio. On the contrary, damages for fraud or deceit in connection with the

purchase, sale, or exchange of property are limited to out-of-pocket loss—i.e., the

difference between the actual value of that with which the defrauded person

parted, and that which the defrauded person received, as a result of the fraud. In

other words, the person must actually give more, or receive less, for property than

if the fraud had not occurred. (Civ. Code, § 3343.)

As a consequence, one who did not purchase, but merely held, shares in

reliance on fraud cannot establish an out-of-pocket loss simply on the theory that a

10

later disclosure of the fraud caused the daily trading value of the shares to fall on a

particular day. Yet this is the sum and substance of the damage allegations here.6

Though the plaintiff in this case seeks damages measured by the price to

which Fritz shares fell on the very day the alleged fraud was disclosed, I do not

contend that one must sell on that very day in order to show compensable damage.

I have no quarrel with Justice Kennard’s observation that the market may take

some time to digest the bad news, that a somewhat later date may provide a better

measure of how the market reacted to the fraud and its disclosure. All I propose is

that the plaintiff in a holder’s action must plead and prove an actual, realized loss

which can be directly attributed, in a specified amount, to the fraud and its

disclosure. It simply stands to reason that the longer the interval between


6

I agree that where one was induced by marketplace fraud to buy publicly

traded shares at an inflated price, and did not sell them before the fraud was
disclosed, the amount of any compensable loss must be measured by the accurate
value the market places on the shares when the truth becomes known (see Rest.2d
Torts, § 549, com. c, p. 110, cited in conc. opn. of Kennard, J., ante, at p. 3)—at
least after discounting factors unrelated to the fraud that may also have affected
the intervening change in price. This only restates the fundamental truth that one
who paid too much as a result of fraud is entitled to recover the excess over what
he should have paid, no more or less. It does not mean that compensable damage
is necessarily suffered by one who merely held shares in reliance on fraud, then
did nothing when disclosure of the fraud caused the market price of the shares to
fall. Harris v. American Investment Company (8th Cir. 1975) 523 F.2d 220,
which Justice Kennard cites for the proposition that a defrauded shareholder need
not “realize” his loss in order to recover, is unavailing for similar reasons. That
case involved a defrauded purchaser. As I have explained at length (see ante,
p. 5), defrauded buyers are always damaged, and permanently so, by the
difference between the fraud-inflated price they paid and the true value of the
shares at that time. Persons who merely held shares through both the fraud and its
disclosure are not similarly situated.


11

disclosure on the one hand, and the moment a loss was allegedly realized on the

other, the less likely it may become that this link can be established.

Nor do I suggest that such a claim is obviated by the passage of time simply

because the value ultimately received for the stock was influenced in part by

intervening market forces unrelated to the fraud. But in an efficient public

securities market, which responds rapidly to changing conditions, events

subsequent to the fraud may so intervene that, as a logical matter, the value the

plaintiff ultimately obtained bears no relationship whatever to the fraud. In such a

case, I continue to believe, fraud-related damages should not be recoverable.

Accordingly, I would require that those who assert they were induced by

fraud to hold company shares must plead and prove specific facts showing that

they actually realized out-of-pocket losses as a result of the fraud and its

disclosure. Pleading and proof that the price of the shares fell on a particular day

as a result of disclosure of the fraud would not suffice. Because that is all the

current complaint claims, I find its damage allegations inadequate to state a cause

of action. I would allow an opportunity to amend the complaint in accordance

with the views expressed in this opinion.

BAXTER, J.

12










CONCURRING AND DISSENTING OPINION BY BROWN, J.

Like the majority, I agree that California law does not categorically

preclude a cause of action for fraud or negligent misrepresentation alleging that

the plaintiff refrained from selling stock due to the defendant’s misrepresentations.

(See maj. opn., ante, at pp. 5-19.) I also agree that plaintiff did not state such a

cause of action because he failed to plead actual reliance with adequate specificity.

(See id. at pp. 19-21.) In particular, plaintiff failed to “allege actions, as

distinguished from unspoken and unrecorded thoughts and decisions, that would

indicate that [he] actually relied on the misrepresentations.” (Id. at pp. 20-21.) I

also agree with Justice Baxter that plaintiff, in order to allege damages with

sufficient particularity, “must plead and prove an actual, realized loss which can

be directly attributed, in a specified amount, to the fraud and its disclosure.”

(Conc. opn. of Baxter, J., ante, at p. 11.) Nonetheless, I write separately because I

believe plaintiff does not and cannot allege a causal relationship between the

alleged misrepresentations and damages. Accordingly, I would affirm the trial

court’s decision to sustain defendants’ demurrer without leave to amend.

I

As a threshold matter, this court may address the issue of whether plaintiff

adequately pled damage causation even though neither the trial court nor the Court

of Appeal considered it. First, the parties had ample opportunity to address the

issue. Various amici curiae raised the issue of damage causation, and plaintiff had

1

an opportunity to respond. Moreover, the parties specifically briefed the court on

the issue of “whether, in light of the so-called efficient capital markets hypothesis,

the complaint sufficiently alleges a causal relationship between the alleged

misrepresentations and any alleged nonspeculative damages.” Thus, our

resolution of the issue of damage causation should come as no surprise.

Second, upon reviewing a judgment of dismissal following the sustenance

of a demurrer, the reviewing court may affirm “on any grounds stated in the

demurrer, whether or not the [lower] court acted on that ground.” (Carman v.

Alvord (1982) 31 Cal.3d 318, 324.) “ ‘[I]t is the validity of the court’s action, and

not of the reason for its action, which is reviewable.’ ” (E.L. White, Inc. v. City of

Huntington Beach (1978) 21 Cal.3d 497, 504, fn. 2, quoting Weinstock v. Eissler

(1964) 224 Cal.App.2d 212, 225.) The trial court in this case sustained

defendants’ general demurrer, which alleged, among other things, that plaintiff

failed to “state facts sufficient to constitute a cause of action.” (Code Civ. Proc., §

430.10, subd. (e).) Thus, we must affirm the judgment of dismissal if the

complaint, for any reason, fails to state a cause of action. (See Aubry v. Tri-City

Hospital Dist. (1992) 2 Cal.4th 962, 967 [“The judgment must be affirmed ‘if any

one of the several grounds of demurrer is well taken’ ”].) Because damage

causation is an essential element of any cause of action for fraud or negligent

misrepresentation, I see no reason to remand for further proceedings if plaintiff

cannot sufficiently plead this element. And I do not believe he can.

II

“In an action for [common law] fraud, damage is an essential element of the

cause of action.” (Committee on Children’s Television, Inc. v. General Foods

Corp. (1983) 35 Cal.3d 197, 219 (Committee on Children’s Television).)

“Misrepresentation, even maliciously committed, does not support a cause of

2

action unless the plaintiff suffered consequential damages.” (Conrad v. Bank of

America (1996) 45 Cal.App.4th 133, 159.) “A ‘complete causal relationship’

between the fraud or deceit and the plaintiff’s damages is required.” (Williams v.

Wraxall (1995) 33 Cal.App.4th 120, 132, quoting Garcia v. Superior Court (1990)

50 Cal.3d 728, 737.) At the pleading stage, the complaint “must show a cause and

effect relationship between the fraud and damages sought; otherwise no cause of

action is stated.” (Zumbrun v. University of Southern California (1972) 25

Cal.App.3d 1, 12 (Zumbrun).)

Like any other element of fraud or negligent misrepresentation, damage

causation “must be pled specifically; general and conclusory allegations do not

suffice.” (Lazar v. Superior Court (1996) 12 Cal.4th 631, 645.) “Allegations of

damages without allegations of fact to support them are but conclusions of law,

which are not admitted by demurrer.” (Zumbrun, supra, 25 Cal.App.3d at p. 12.)

If the existence—and not the amount—of damages alleged in a fraud pleading is

“too remote, speculative or uncertain,” then the pleading cannot state a claim for

relief. (Block v. Tobin (1975) 45 Cal.App.3d 214, 219; see also Agnew v. Parks

(1959) 172 Cal.App.2d 756, 768.) And “ ‘the policy of liberal construction of the

pleadings . . . will not ordinarily be invoked to sustain a pleading defective’ ” in

alleging damages caused by the alleged misrepresentations. (Committee on

Children’s Television, supra, 35 Cal.3d at p. 216, quoting 3 Witkin, Cal.

Procedure (2d ed. 1971) Pleadings, § 574.)

In this case, plaintiff alleges that defendants’ misrepresentations induced

him to forbear from selling his stock in Fritz Companies, Inc. (Fritz). Plaintiff

claims he suffered damages from this induced forbearance because, absent the

misrepresentations, he would have sold his stock at a price higher than the price of

the stock on the day defendants revealed their misrepresentations. As explained

3

below, plaintiff cannot sufficiently allege a causal relationship between the alleged

damages and the alleged misrepresentations.

Because we must “ ‘accept as true all the material allegations of the

complaint’ ” (Charles J. Vacanti, M.D., Inc. v. State Comp. Ins. Fund (2001) 24

Cal.4th 800, 807, quoting Shoemaker v. Myers (1990) 52 Cal.3d 1, 7), I assume,

for purposes of this appeal, that Fritz stock traded in an efficient market.1 In an

efficient market, “the market price of shares . . . reflects all publicly available

information, and, hence, any material misrepresentations.” (Basic, Inc. v.

Levinson (1988) 485 U.S. 224, 246, fn. omitted.) “[P]ublicly available

information relevant to stock values is so quickly reflected in market prices that, as

a general matter, investors cannot expect to profit from trading on such

information.” (Stout, Are Takeover Premiums Really Premiums? Market Price,

Fair Value, and Corporate Law (1990) 99 Yale L.J. 1235, 1240, fn. omitted.)

“The [efficient] market not only reflects publicly available information with great

rapidity, it also anticipates formal public announcements of much information.”

(Saari, The Efficient Capital Market Hypothesis, Economic Theory and the

Regulation of the Securities Industry (1977) 29 Stan. L.Rev. 1031, 1050 (The

Efficient Capital Market Hypothesis).) Therefore, such a market, by definition, is

“efficient in assimilating the information available to it.” (Id. at p. 1056.)

With this in mind, I now turn to plaintiff’s damage allegations. Plaintiff

claims as damages the difference between the price of Fritz stock on the date he

would have sold the stock if defendants had timely reported Fritz’s true third

quarter results on April 2, 1996 and the price of Fritz stock on July 24, 1996—the

date defendants actually announced Fritz’s true third quarter results. In other

1

In doing so, I neither accept nor reject the so-called efficient capital markets

hypothesis. (See Mirkin v. Wasserman (1993) 5 Cal.4th 1082, 1101, fn. 7.)

4

words, plaintiff seeks to recover some portion of the $15.25 drop in Fritz stock

price that occurred on July 24—the day defendants publicly corrected the alleged

misrepresentations they made in April. Although the complaint is less than clear,

plaintiff appears to claim that this drop in stock price is recoverable as damages

because it was caused by: (1) the content of defendants’ misrepresentations; (2)

the timing of the announcement of Fritz’s true third quarter results, which

coincided with the announcement of Fritz’s disappointing fourth quarter results;

(3) the loss of investor confidence in Fritz’s management resulting from the

delayed disclosure of the bad news; and (4) intervening causes with no connection

to the misrepresentations, i.e., portions of the fourth quarter results. Plaintiff’s

theories of damage causation, however, cannot support a claim for fraud or

negligent misrepresentation.

First, plaintiff suffered no injury due to the content of the alleged

misrepresentations.2 All of the alleged misrepresentations concerned public

information that defendants had to disclose. In an efficient market, the market

price of a stock reflects all publicly available information. (Basic, Inc. v.

Levinson, supra, 485 U.S. at p. 246.) Therefore, the price of Fritz stock after the

April 2 misrepresentations was unlawfully inflated. If Fritz had timely reported its

true third quarter results on April 2, then the market price of Fritz stock would

have reflected this information and would have dropped accordingly. (See Arent

v. Distribution Sciences, Inc. (8th Cir. 1992) 975 F.2d 1370, 1374 (Arent) [“But if

everyone had known this adverse fact, then the stock’s value would have reflected

the adversity”].) Even assuming plaintiff would have sold his stock immediately


2

Although plaintiff acknowledged that he may not recover all of the drop in

stock price that occurred on July 24, he did not eschew recovery of some of the
declines in stock price allegedly caused by the misrepresentations.

5

after a timely announcement of Fritz’s true third quarter results, he would have

suffered a drop in share price commensurate to the inflation in share price caused

by the content of the misrepresentations. Because the market accurately and

efficiently assimilates all public information (see The Efficient Capital Market

Hypothesis, supra, 29 Stan. L.Rev. at p. 1044), this drop in share price would have

been equal to any drop in share price attributable to the representations made on

July 24 (see Chanoff v. United States Surgical Corp. (D.Conn. 1994) 857 F.Supp.

1011, 1018, affd. by (2d Cir. 1994) 31 F.3d 66 (Chanoff) [“plaintiffs cannot claim

the right to profit from what they allege was an unlawfully inflated stock value”]).

As such, plaintiff could not have profited from a timely announcement of Fritz’s

third quarter results absent “insider trading in violation of the securities laws.”

(Crocker v. FDIC (5th Cir. 1987) 826 F.2d 347, 351, fn. 6 (Crocker); see also

Levine v. Seilon, Inc. (1971) 439 F.2d 328, 333, fn. omitted [plaintiff “could

hardly be heard to claim compensation . . . from some innocent victim if he had

known of the fraud and the buyer did not”].) Thus, as a matter of law, plaintiff

suffered no damages due to the misrepresentations themselves. (See Arnlund v.

Deloitte & Touche LLP (E.D.Va. 2002) 199 F.Supp.2d 461, 489 (Arnlund)

[finding that stockholders who allegedly held their stock in reliance on the

defendant’s public misrepresentations cannot, as a matter of law, state a common

law fraud claim, because they failed “adequately to plead causation between the

misrepresentation and the harm”].)

Second, plaintiff suffered no cognizable injury from the timing of the

announcement of Fritz’s true third quarter results. (See Chanoff, supra, 857

F.Supp. at p. 1018 [rejecting claim that the timing of the disclosure caused

damage].) Plaintiff contends the drop in Fritz’s stock price was more dramatic on

July 24 because Fritz simultaneously announced its restated third quarter and

disappointing fourth quarter results. Plaintiff, however, ignores his own

6

allegations. According to plaintiff, defendants concealed the costs of Fritz’s

acquisitions on April 2 and did not reveal these costs until July 24. Specifically,

plaintiff alleged that defendants deliberately concealed that Fritz would have to

take an $11 million charge in the third quarter and an additional $11.5 million

charge in the fourth quarter. Thus, even if Fritz had timely announced these

charges on April 2, the announcement would have not only resulted in lower

reported third quarter earnings, but also presaged Fritz’s fourth quarter loss.

Indeed, when Fritz announced these charges on July 24, it expressly

acknowledged that these charges reduced its previously reported third quarter

earnings and caused the reported fourth quarter loss. As such, any psychological

effect allegedly caused by the timing of the announcement would have occurred

even if defendants had timely reported the information allegedly concealed by

Fritz’s management for three months. Any damages attributable to the combined

effect of the negative third and fourth quarter earnings announcement on July 24

are therefore illusory.

In any event, plaintiff forgets that stock prices in an efficient market “react

quickly and in an unbiased fashion to publicly available information.” (The

Efficient Capital Market Hypothesis, supra, 29 Stan. L.Rev. at p. 1044, italics

added.) Stock prices in an efficient market “are by definition ‘fair’ . . . [and] it is

impossible for investors to be cheated by paying more for securities than their true

worth.” (Id. at p. 1069, fn. omitted.) The true worth of Fritz’s stock on July 24

necessarily reflected the fact that the restated third quarter results should have

been reported on April 2. Thus, the price of Fritz stock on July 24 was, by

definition, the same price the stock would have had on that date if defendants had

reported Fritz’s true third quarter results on April 2. (See ibid.)

7

Third, any drop in stock price due to an alleged loss in investor confidence

in Fritz management caused by the delayed announcement is either illusory or too

speculative to constitute cognizable damages.3 While loss of investor confidence

in management may adversely affect a stock’s price, the July 24 announcement

would have caused investors to lose confidence in Fritz’s management even if it

had been made on April 2. As alleged in the complaint, Fritz’s management made

a series of acquisitions. During these acquisitions, Fritz touted its ability to

seamlessly integrate these acquisitions into its existing infrastructure and claimed

that these acquisitions would improve Fritz’s financial performance. However, the

July 24 announcement—which stated that previously unreported acquisition costs

had lowered Fritz’s third and fourth quarter earnings—refuted these claims. As

such, the July 24 announcement established that Fritz’s management had

miscalculated its strategy, mismanaged the acquisitions and failed to achieve its

corporate objectives regardless of its timing. Thus, the contents of the July 24

announcement had, by itself and irrespective of any fraudulent delay in reporting

these contents, already destroyed investor confidence in Fritz’s management.

Indeed, the analyst reports cited in plaintiff’s supplemental brief verify this.

Moreover, any drop in stock price attributable to the additional loss of

investor confidence resulting from investor suspicion of fraud induced by the

delay in the announcement is too remote and speculative to support cognizable

damages. As an initial matter, the allegedly fraudulent nature of the delay could


3

In reaching this conclusion, I do not, as Justice Kennard suggests, rely on

the efficient capital market hypothesis. (See conc. opn. of Kennard, J., ante, at p.
8.)

8

not have affected Fritz’s stock price. When Fritz made the July 24 announcement,

Fritz did not announce that it had intentionally or negligently concealed the

acquisition costs or misrepresented its third quarter earnings on April 2. Rather,

Fritz announced that it had failed to account for certain acquisition costs, which

lowered its previously reported third quarter earnings and caused a fourth quarter

loss. Unlike recent cases of corporate fraud, nothing in this record even suggests

that the public attributed the three-month delay in announcing these acquisition

costs to fraud or negligence at the time of the announcement or that public

suspicion of fraud somehow resulted in a greater drop in stock price than would

have otherwise occurred. Thus, any deliberate or negligent concealment of these

costs by defendants could not have influenced Fritz’s stock price on July 24.

Investors could certainly speculate that Fritz’s management engaged in

wrongdoing or acted incompetently in delaying the announcement. But such

investor speculation could occur in every case in which a company announces bad

news or issues a negative correction. Thus, any drop in stock price allegedly

caused by investor speculation that earlier company statements were dishonestly

or incompetently false will occur regardless of whether the defendants acted

fraudulently. As such, defendants’ alleged misrepresentations could not have

caused the drop in stock price resulting from such investor speculation. In any

event, any claim that the mere possibility of fraudulent conduct by defendants may

have caused a greater drop in investor confidence and a correspondingly greater

drop in stock price than would have otherwise occurred is highly speculative and

should not be cognizable as a matter of law. (See Marino v. Coburn Corp. of

America (E.D.N.Y., Feb. 19, 1971) 1971 WL 247, p. *4 [in determining damages,

courts should ignore “fanciful speculation about the psychology of investors”].)

9

Indeed, recognizing such a theory of damages would subject a company to

securities fraud claims, including buyer or seller claims, whenever that company

announces bad news or issues a negative correction. In order to escape dismissal,

the securities plaintiffs would merely have to allege a loss of investor confidence

due to investor speculation that the bad news resulted from fraud or incompetence.

As such, companies would be forced to expend considerable resources defending

against claims of fraud or negligent misrepresentation regardless of their merits.

Rather than make California the locale of choice for securities class actions, I

would refuse to recognize such speculative damages.

Finally, to the extent plaintiff claims injury due to drops in the stock price

unrelated to the misrepresentations, i.e., the announcement of fourth quarter

losses, he does not allege the requisite causal relationship. “Remote results,

produced by intermediate sequences of causes, are beyond the reach of any just

and practicable rule of damages.” (Martin v. Deetz (1894) 102 Cal. 55, 68; see

also Hotaling v. A. B. Leach & Co., Inc. (1928) 247 N.Y. 84, 87 [159 N.E. 870]

(Hotaling) [“defendants [guilty of securities fraud] should not be held liable for

any part of plaintiff’s loss caused by subsequent events not connected with such

fraud”].) Plaintiff, as a matter of law, cannot establish that any portion of the drop

in Fritz’s stock price on July 24 was caused by defendants’ alleged

misrepresentations. (See ante, at pp. 5-10.) Consequently, plaintiff cannot claim

any drop in Fritz’s stock price attributable to other causes as damages in his fraud

and negligent misrepresentation claims. (See Martin, at p. 68; Service by

Medallion, Inc. v. Clorox Co. (1996) 44 Cal.App.4th 1807, 1818-1819 [no causal

connection between damages caused by termination of contract and fraud which

induced plaintiff to enter into contract]; cf. Carlson v. Richardson (1968) 267

Cal.App.2d 204, 208 [no unjust enrichment where the increase in property value

10

“resulted from market conditions rather than from any act or forbearance to act”

on the part of plaintiff].)

Plaintiff’s inability to allege this requisite causal connection simply reflects

the speculative nature of these damages. Plaintiff alleges that he would have

avoided drops in Fritz’s stock price unrelated to the misrepresentations because he

would have sold his stock at some indefinite date after April 2—the date

defendants should have reported Fritz’s true third quarter results. Plaintiff,

however, alleges no facts indicating when he would have sold his stock. He does

not allege any facts suggesting that he was planning or considering such a sale

before the misrepresentations. He does not even allege that he sold his Fritz stock

after defendants revealed the fraud on July 24. (See Blake v. Miller (Wis. 1922)

189 N.W. 472, 476 [absent allegation that plaintiff was considering some sort of

action, allegation of forbearance is wholly speculative].) Because the date on

which plaintiff would have sold his shares is, at best, conjectural, it is impossible

to ascertain which drops in stock price he would have avoided. Thus, the

existence of any damages due to intervening causes unrelated to the

misrepresentations is too remote, speculative and uncertain to support a fraud

claim. (See Crocker, supra, 826 F.2d at p. 351 [claim that plaintiff would have

sold his stock at some indefinite date is too speculative to state an injury]; Seibu

Corp. v. KPMG LLP (N.D.Tex. Oct. 2, 2001, No. 3-00-CV-1639-X) 2001 WL

1167317, p. *7 [rejecting claim that fraud negatively affected the timing and

quantity of plaintiff’s stock sales in some indefinite manner as too speculative to

state a claim for damages]; Himes v. Brown & Co. Securities Corp.

(Fla.Dist.Ct.App. 1988) 518 So.2d 937, 938-939 [holding that lack of evidence

indicating when plaintiff would have sold the stock renders his claim of damages

too speculative to recover]; see also Calistoga Civic Club v. City of Calistoga

11

(1983) 143 Cal.App.3d 111, 119 [finding fraud claim too speculative and

uncertain because there was no determinable basis for ascertaining damages].)

In concluding that plaintiff failed to adequately plead damage causation, I

would not preclude all fraud or deceit claims premised on induced forbearance.

As the majority notes, California courts have long recognized that plaintiffs may

suffer cognizable damages from forbearance induced by fraud or deceit. (See,

e.g., Marshall v. Buchanan (1868) 35 Cal. 264, 268 [allegations that defendant’s

face-to-face misrepresentations induced plaintiff not to enforce a judgment stated a

claim for fraud].) Holding that plaintiff failed to allege damage causation would

not diminish the vitality of those cases. Rather, I merely apply timeworn

principles governing fraud claims to the unique context of securities allegedly

trading in an efficient market.

Indeed, my conclusion would not preclude stockholders who allegedly held

stock in reliance on another’s misrepresentations from stating a cause of action for

fraud or deceit. Under a different set of facts, these stockholders may be able to

allege cognizable damages. Indeed, the out-of-state cases cited by plaintiff—

which are distinguishable from the facts of this case—offer examples of such

facts. For example, many of these cases involved individual or face-to-face

misrepresentations made directly to the investor.4 Unlike the public


4

(See, e.g., Marbury Management, Inc. v. Kohn (2d. Cir. 1980) 629 F.2d

705, 707 (Marbury) [defendant made individual misrepresentations directly to
plaintiffs which induced them to buy and hold securities]; Gutman v. Howard
Savings Bank
(D.N.J. 1990) 748 F.Supp. 254, 260, 266 [defendants made
individual misrepresentations directly to plaintiffs which allayed their concerns
about defendants’ misleading public statements]; Fottler v. Moseley (Mass. 1901)
60 N.E. 788, 788 [defendant made face-to-face misrepresentations which induced
plaintiff to hold his stock]; Duffy v. Smith (N.J.Ct.App. 1895) 32 A. 371, 372
(Duffy) [same]; Rothmiller v. Stein (1894) 143 N.Y. 581, 586-587 [38 N.E. 718,

(Footnote continued on next page.)

12

misrepresentations alleged in this case, these private misrepresentations would not

be immediately reflected in the market price of the stock. Thus, the investors in

these out-of-state cases could have profited from accurate information and

therefore suffered cognizable damages.5 (See The Efficient Capital Market

Hypothesis, supra, 29 Stan. L.Rev. at p. 1053 [investors with access to nonpublic

information may generate superior returns].)

Likewise, the investors in many of these out-of-state cases alleged facts

indicating that they were preparing to sell or considering the sale of their stock or

property and that the misrepresentations induced them not to sell prior to the

revelation of the truth.6 Unlike plaintiff, these investors did not simply allege that

they would have sold their stock or property at some indefinite date after the

revelation of the truth absent the misrepresentations; they alleged facts indicating a

specific date on which they would have sold prior to the revelation of the truth.

Thus, the claim of these investors that they would have avoided certain drops in



(Footnote continued from previous page.)

719] [same]; Seideman v. Sheboygan Loan & Trust Co. (Wis. 1929) 223 N.W.
430, 432 (Seideman) [same].)
5

Many of these cases predate federal securities laws which defined required

disclosures to the public and prohibited insider trading.
6

(See, e.g., David v. Belmont (Mass. 1935) 197 N.E. 83, 85 [evidence

established that plaintiff intended to sell his stock until he saw the
misrepresentations]; Fottler v. Moseley, supra, 60 N.E. at p. 788 [defendant broker
knew that plaintiff had given him a sell order]; Continental Ins. Co. v. Mercadente
(1927) 225 N.Y.S. 488, 489 [222 A.D. 181, 182] [defendants knew plaintiffs were
planning to sell the bonds if the obligor’s financial condition deteriorated];
Rothmiller v. Stein, supra, 38 N.E. at p. 719 [defendants knew plaintiff had
received two offers for his stock and was considering a sale]; Seideman, supra,
223 N.W. at p. 432 [plaintiff informed defendants that she wanted a refund of her
investment].)

13

market price due to intervening causes unrelated to the misrepresentations was

neither speculative nor uncertain.7

Finally, the investors in most of the out-of-state cases cited by plaintiff

alleged that the misrepresentations induced them to purchase and retain their

stock or property.8 These investors not only paid more than they should have for

the stock or property but also would have avoided subsequent drops in market

price because they would not have otherwise purchased the stock or property. In


7

Because these cases predate federal securities law, their specific facts are

unlikely to arise in today’s highly regulated world of securities trading. Perhaps
the only modern analogy is the situation where an investor tells his or her broker
to sell a company’s stock if it drops below a specific price. Due to the company’s
misrepresentations, however, the stock price never falls below that price and the
investor either cancels the sell order or allows it to lapse. Following the revelation
of the truth, the company’s stock price falls below the price at which the investor
had previously intended to sell. Like the investors in the cited cases, this investor
can identify a specific drop in stock price that he or she would have avoided
absent the misrepresentations and can therefore allege damage causation.
8

(See, e.g., Marbury, supra, 629 F.2d at p. 710 [emphasizing that plaintiffs

did not merely allege an inducement to hold, but to both purchase and retain,
stock]; Primavera Familienstifung v. Askin (S.D.N.Y. 2001) 130 F.Supp.2d 450,
504-507, amended on reconsideration on other grounds by 137 F.Supp.2d 438
[complaint alleging induced purchase and retention of stock stated cognizable
damages]; Zivitz v. Greenburg (N.D.Ill. Dec. 3, 1999, No. 98-C-5350) 1999 WL
1129605, p. *1 [fraud induced plaintiffs to “buy and hold stock”]; Kaufman v.
Chase Manhattan Bank, N.A.
(S.D.N.Y. 1984) 581 F.Supp. 350, 354 [finding
damage causation where the fraud induced plaintiff to purchase and retain the
investment]; Freschi v. Grand Coal Venture (S.D.N.Y. 1982) 551 F.Supp. 1220,
1230 [claim that fraud induced purchase and retention of investment alleged
ongoing fraud]; Duffy, supra, 32 A. at p. 372 [fraud induced plaintiff to both
purchase and retain stock]; Hotaling, supra, 247 N.Y. at pp. 86, 91-92 [159 N.E.
at pp. 871, 872-873] [fraud induced plaintiff to purchase and retain bonds];
Singleton v. Harriman (1933) 272 N.Y.S. 905, 906 [152 Misc. 323, 324]
(Singleton) [fraud induced plaintiff to purchase and retain stock for investment];
Kaufmann v. Delafield (1928) 229 N.Y.S. 545, 546-547 [224 A.D. 29, 30-31]
(Kaufmann) [fraud induced plaintiff to purchase and retain investment].)

14

other words, the date of purchase established a clear and definite point at which

the defendants’ fraud subjected these investors to risks—i.e., drops in market price

due to intervening causes—that they would not have otherwise faced. The proper

measure of damages was therefore the difference between the amount of the

fraudulently induced investment and the value of the stock or property “after the

fraud ceased to be operative.” (Duffy, supra, 32 A. at p. 372; see also Marbury,

supra, 629 F.2d at p. 708; Hotaling, supra, 247 N.Y. at pp. 87-88 [159 N.E. at p.

873]; Singleton, supra, 272 N.Y.S. at p. 906 [152 Misc. at p. 324]; Kaufmann,

supra, 229 N.Y.S. at p. 547 [224 A.D. at p. 30].)

In contrast, plaintiff, as a matter of law, cannot recover any losses from a

drop in market price caused by the misrepresentations. (See ante, at pp. 5-12.)

Moreover, the misrepresentations did not induce plaintiff to subject himself to the

risk of drops in market price due to intervening causes unrelated to the

misrepresentations. Plaintiff agreed to take this risk before the misrepresentations.

Under these circumstances, he can hardly claim damages based on the fruition of

these risks, especially where, as here, the date on which he would have sold the

stock is wholly speculative. Any contrary conclusion would make defendants the

unpaid insurers of plaintiff’s risk. Accordingly, I would follow those courts that

have dismissed fraud and negligent misrepresentation claims virtually identical to

plaintiff’s and affirm the dismissal of plaintiff’s complaint. (See, e.g., Arent,

supra, 975 F.2d at p. 1374; Arnlund, supra, 199 F.Supp.2d at p. 489; Chanoff,

supra, 857 F.Supp. at p. 1019.)

I also see no reason to remand in order to give plaintiff an opportunity to

amend the complaint to allege damage causation. Although the sustaining of a

demurrer without leave to amend is generally an abuse of discretion “ ‘if there is

any reasonable possibility that the defect can be cured by amendment,’ ” “the

burden is on the plaintiff to demonstrate that the trial court abused its discretion.”

15

(Goodman v. Kennedy (1976) 18 Cal.3d 335, 349, quoting Cooper v. Leslie Salt

Co. (1969) 70 Cal.2d 627, 636.) “ ‘Plaintiff must show in what manner he can

amend his complaint and how that amendment will change the legal effect of his

pleading.’ ” (Ibid.) Although defendants raised the damage causation issue in

their first demurrer, and plaintiff had two opportunities to amend, nothing in the

record suggests plaintiff can amend his complaint to allege damage causation.

Plaintiff’s supplemental briefs—which specifically addressed the issue of damage

causation—confirm this. In his briefs, plaintiff claims that his complaint

adequately pleads damage causation premised on the loss of investor confidence in

Fritz’s management. In espousing this theory of damage causation, however, he

offered no alternative if the court rejected his theory and never asked for an

opportunity to amend the complaint to allege damage causation. Because

“[n]either the record nor the tenor of [plaintiff’s] briefs or oral argument indicates

any ability upon [his] part to plead and prove facts which would establish” the

element of damage causation, the trial court did not abuse its discretion by

refusing leave to amend. (Id. at pp. 349-350.)

In reaching this conclusion, I remain true to the purpose behind the

heightened pleading standard for fraud claims. “The pleading of fraud . . . is . . .

the last remaining habitat of the common law notion that a complaint should be

sufficiently specific that the court can weed out nonmeritorious actions on the

basis of the pleadings.” (Committee on Children’s Television, supra, 35 Cal.3d at

pp. 216-217.) This weeding out process is especially important in the securities

context. As the United States Supreme Court recognized over 25 years ago,

securities fraud litigation “presents a danger of vexatiousness different in degree

and in kind from that which accompanies litigation in general.” (Blue Chip

Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 739 (Blue Chip).) Because “a

16

complaint which by objective standards may have very little chance of success at

trial has a settlement value to the plaintiff out of any proportion to its prospect of

success at trial so long as he may prevent the suit from being resolved against him

by dismissal or summary judgment,” the danger of nuisance or strike suits is

significant. (Id. at p. 740.) The potential disruption of a defendant’s normal

business activities (ibid.), the disproportionate discovery burden on the defendant

(id. at p. 741), and the fact that these claims often turn on the oral testimony of the

plaintiff (id. at p. 742), render these lawsuits ripe for abuse. Accordingly, I

believe we must vigorously enforce our well-established standards for pleading

damage causation in fraud cases and would therefore affirm the judgment of

dismissal.

BROWN, J.

I CONCUR:

CHIN,

J.

17

See next page for addresses and telephone numbers for counsel who argued in Supreme Court.

Name of Opinion Small v. Fritz Companies, Inc.
__________________________________________________________________________________

Unpublished Opinion
Original Appeal
Original Proceeding
Review Granted
XXX 82 Cal.App.4th 741
Rehearing Granted

__________________________________________________________________________________

Opinion No.
S091297
Date Filed: April 7, 2003
__________________________________________________________________________________

Court:
Superior
County: San Francisco
Judge: Ronald Evans Quidachay

__________________________________________________________________________________

Attorneys for Appellant:

Stull, Stull & Brody, Michael D. Braun, Marc L. Godino, Timothy J. Burke, Jules Brody and Mark Levine
for Plaintiff and Appellant.


__________________________________________________________________________________

Attorneys for Respondent:

Orrick, Herrington & Sutcliffe, William F. Alderman and E. Anne Hawkins for Defendants and
Respondents.

Wilson Sonsini Goodrich & Rosati, Boris Feldman, Douglas J. Clark and Cheryl W. Foung for Electronics
for Imaging, Inc., as Amicus Curiae on behalf of Defendants and Respondents.

Skadden, Arps, Slate, Meagher & Flom, Raoul D. Kennedy, Garrett J. Waltzer, David E. Springer and
Frances P. Kao for Ifilm Corp. and SGW Holding Inc., as Amici Curiae on behalf of Defendants and
Respondents.

Munger, Tolles & Olson, Charles D. Siegal, George M. Garvey and Janice M. Kroll for Securities Industry
Association as Amicus Curiae on behalf of Defendants and Respondents.

Richard I. Miller; Wilke, Fleury, Hoffelt, Gould & Birney, Matthew W. Powell, Paul A. Dorris, Daniel L.
Baxter; Willkie Farr & Gallagher, Kelly M. Hnatt and Daniel B. Rosenthal for American Institute of
Certified Accountants as Amicus Curiae on behalf of Defendants and Respondents.


1





Counsel who argued in Supreme Court (not intended for publication with opinion):

Michael D. Braun
Stull, Stull & Brody
10940 Wilshire Boulevard, Suite 2300
Los Angeles, CA 90024
(4310) 209-2468

William F. Alderman
Orrick, Herrington & Sutcliffe
400 Sansome Street
San Francisco, CA 94111-3143
(415) 392-1122


2

Opinion Information
Date:Docket Number:
Mon, 04/07/2003S091297

Parties
1Fritz Companies Inc. (Defendant and Respondent)
Represented by William F. Alderman
Orrick, Herrington & Sutcliffe
400 Sansome St.
San Francisco, CA

2Fritz, Lynn C. (Defendant and Respondent)
Represented by William F. Alderman
Orrick, Herrington & Sutcliffe
400 Sansome St.
San Francisco, CA

3Greenfield, Harvey (Plaintiff and Appellant)
Represented by Michael David Braun
Stull, Stull & Brody
10940 Wilshire Blvd.
Suite 2300
Los Angeles, CA

4Greenfield, Harvey (Plaintiff and Appellant)
Represented by Marc Lawrence Godino
Stull, Stull & Brody
10940 Wilshire Boulevard
Suite 2300
Los Angeles, CA

5Electronics For Imaging, Inc. (Amicus curiae)
Represented by Douglas Clark
WILSON SONSINI GOODRICH & ROSATI
650 Page Mill Road
Palo Alto, CA

6Electronics For Imaging, Inc. (Amicus curiae)
Represented by Boris Feldman
Wilson Sonsini Goodrich Rosati
650 Page Mill Road
Palo Alto, CA

7Electronics For Imaging, Inc. (Amicus curiae)
Represented by Cheryl Weisbard Foung
WILSON SONSINI GOODRICH & ROSATI
650 Page Mill Road
Palo Alto, CA

8Securities Industry Association (Amicus curiae)
Represented by Charles D. Siegal
Munger Tolles & Olson
355 So. Grand Ave., 35th Floor
Los Angeles, CA

9Securities Industry Association (Amicus curiae)
Represented by George Michael Garvey
Munger Tolles & Olson
355 So. Grand Ave., 35th Floor
Los Angeles, CA

10Securities Industry Association (Amicus curiae)
Represented by Janice Maureen Kroll
Munger Tolles & Olson LLP
355 So. Grand Ave., 35th Floor
Los Angeles, CA

11Ifilm Corporation (Amicus curiae)
Represented by Raoul D. Kennedy
Skadden, Arps, Slate, Meagher And Flom LLP
Four Embarcadero Center
San Francisco, CA

12Ifilm Corporation (Amicus curiae)
Represented by Frances Pao-Han Kao
Skadden Arps et al
333 West Wacker Drive
Chicago, IL

13Ifilm Corporation (Amicus curiae)
Represented by David E. Springer
Skadden, Arps, Slate, Meagher & Flom
333 West Wacker Drive
Chicago, IL

14Ifilm Corporation (Amicus curiae)
Represented by Garrett Jay Waltzer
Skadden Arps Slate et al
Four Embarcadero Center
San Francisco, CA

15Sgw Holding Inc. (Amicus curiae)
Represented by Raoul D. Kennedy
Skadden, Arps, Slate, Meagher And Flom
Four Embarcadero Center
San Francisco, CA

16American Institute Of Certified Public Accountants (Amicus curiae)
attn: Richard I. Miller
1211 Avenue of the Americas
New York, NY 10036

Represented by Daniel Lawrence Baxter
Wilke Fleury et al LLP
400 Capitol Mall, 22nd Floor
Sacramento, CA

17American Institute Of Certified Public Accountants (Amicus curiae)
attn: Richard I. Miller
1211 Avenue of the Americas
New York, NY 10036

Represented by Paul Alan Dorris
Wilke Fleury Hoffelt et al
400 Capitol Mall, 22nd Floor
Sacramento, CA

18American Institute Of Certified Public Accountants (Amicus curiae)
attn: Richard I. Miller
1211 Avenue of the Americas
New York, NY 10036

Represented by Matthew W. Powell
Wilkey Fleury Hoffelt Et Al
400 Capitol Mall, 22nd Floor
Sacramento, CA

19Small, Marietta (Plaintiff and Appellant)
Represented by Michael David Braun
Attorney at Law
10940 Wilshire Blvd #2300
Los Angeles, CA

20Small, Marietta (Plaintiff and Appellant)
Represented by Marc Lawrence Godino
Attorney at Law
10940 Wilshire Blvd #2300
Los Angeles, CA


Disposition
Apr 7 2003Opinion: Reversed

Dockets
Sep 7 2000Petition for review filed
  By counsel for Resp's. {Fritz Companies Inc.} / 40(N)
Sep 7 2000Record requested
 
Sep 25 2000Received Court of Appeal record
  2 accordion folders.
Oct 27 2000Time Extended to grant or deny Petition for Review
  to Dec. 6, 2000
Nov 21 2000Petition for review granted (civil case)
  Votes: George C.J., Baxter, Werdegar & Brown JJ.
Dec 22 2000Opening brief on the merits filed
  by respondents. ***40n***
Dec 28 2000Application for Extension of Time filed
  by appellant to and including 2/2/01 to file opposition brief. ***OK to grant. Order being prepared.
Jan 4 2001Extension of Time application Granted
  to and including Feb. 2, 2001 to file appellant's answer brief/merits.
Feb 5 2001Answer brief on the merits filed
  by appellant (Greenfield). ***40n***
Feb 23 2001Reply brief filed (case fully briefed)
  by respondents.
Mar 21 2001Received application to file Amicus Curiae Brief
  from attorneys for Electronics for Imaging, Inc. in support of respondent (Fritz).
Mar 21 2001Received application to file:
  compendium of non-Calif. authorities in support of amicus brief from attorneys for Electronics for Imaging, Inc. in support of respondent (Fritz).
Mar 23 2001Application to appear as counsel pro hac vice (granted case)
  Application of David E. Springer to appear pro hac vice on behalf of amici curiae Ifilm Corporation and SGW Holding, Inc.
Mar 23 2001Received application to file Amicus Curiae Brief
  by Ifilm Corp and SGW Holding Inc. in support of respondent with request for judicial notice.
Mar 26 2001Received application to file Amicus Curiae Brief
  in Sacramento by American Institute of Certified Public Accountants in support of respondent (Fritz). (appli & brief under same cover)
Mar 27 2001Permission to file amicus curiae brief granted
  and to lodge the compenduim with the amicus brief granted from Electronics for Imaging, Inc. in support of respondent.
Mar 27 2001Amicus Curiae Brief filed by:
  ELECTRONICS FOR IMAGING, INC. in support of respondent (Fritz Co.). Answer due in 20 days.
Mar 27 2001Exhibits Lodged:
  Compendium of non-California authorities in support of Amicus Curiae Brief filed by ELECTRONICS FOR IMAGING, INC. in support of respondent (Fritz Co.).
Mar 27 2001Received application to file Amicus Curiae Brief
  by Securities Industry Assoc. in support of respondents (Fritz). ***40n***
Apr 2 2001Application to appear as counsel pro hac vice granted
  David E. Springer of the State of Illinois for admission Pro Hac Vice to appear on brief, and participate as non-resident counsel on behalf of Ifilm Corp. and SGW Holding Inc.
Apr 2 2001Amicus Curiae Brief filed by:
  by IFILM CORP. and SGW HOLDING INC. and judicial notice of out of state authorities cited in their brief in support of respondent (Fritz). (AC brief and judicial notice under seperate covers.) Answer due in 20 days.
Apr 2 2001Permission to file amicus curiae brief granted
  Securities Industry Assoc.
Apr 2 2001Amicus Curiae Brief filed by:
  SECURITIES INDUSTRY ASSOCIATION in support of respondent (Fritz). Answer due in 20 days.
Apr 6 2001Application for Extension of Time filed
  Appellant Greenfield asking to May 18, 2001 to file a single answer brief in response to all amicus briefs filed.
Apr 6 2001Permission to file amicus curiae brief granted
  American Institute of Certified Public Accountants in support of respondent.
Apr 6 2001Amicus Curiae Brief filed by:
  AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS in support of respondent (Fritz). (application & brief under same cover) Answer due in 20 days.
Apr 11 2001Extension of Time application Granted
  to and including May 18, 2001 for appellant to file a single answer to multiple AC briefs.
May 22 2001Response to Amicus Curiae Brief filed by:
  appellant Greenfield to AC briefs filed by: Electonics For Imaging, Inc.; Ifilm Corp. and SGW Holding Inc.; Securities Industry Assoc.; and American Institute of Certified Public Accountants. **40N**
Nov 20 2001Additional issues ordered
  To assist in the resolution of this case, the court hereby orders the parties to simultaneously brief the following issue: whether, in light of the so-called "efficient capital markets hypothesis" or the complaint sufficiently alleges a casual relationship between the alleged misrepresentations and any alleged, nonspeculative damages. **Supplemental opening briefs shall be served and filed by both parties on or before Dec. 19, 2001, and supplemental reply briefs shall be served and filed on or before Jan. 8, 2002.**
Dec 6 2001Letter sent to counsel re:
  Conflict letter and form. Form to be returned within 15 days.
Dec 20 2001Supplemental brief filed
  Supplemental opening brief by counsel for appellant. **40n**
Dec 21 2001Certification of interested entities or persons filed
  by counsel for respondent (Fritz Companies Inc., et al).
Dec 21 2001Supplemental brief filed
  Supplemental opening brief by counsel for respondent ***(40n)***
Jan 4 2002Note:
 
Jan 9 2002Supplemental reply brief filed (AA)
  Reply brief by counsel for appellant Harvey Greenfield. **40n**
Jan 9 2002Supplemental reply brief filed (AA)
  Reply brief by counsel for respondent Fritz Companies Inc., etc. **40**
Aug 16 2002Filed letter from:
  counsel for appellant dated 8/15/02. Counsel notifing the court that Mr. Greenfield passed away on July 5, 2002. Copy of death notice provided. Mr. Greenfield's estate will continue prosecuting this case.
Nov 27 2002Case ordered on calendar
  1-7-03, 9am, S.F.
Jan 7 2003Cause argued and submitted
 
Jan 8 2003Received:
  copies of two decisions cited at oral argument by Respondent.
Feb 21 2003Filed document entitled:
  Plaintiff's Notice of Motion and Motion to Substitute Party. Substitution of plaintiff Harvey Greenfield with Marietta Small, the Public Administratrix for the Estate of Harvey Greenfield.
Feb 21 2003Filed document entitled:
  Memorandum of Points & Authorities in Support of Motion to Substitute Party - from counsel for plaintiff and appellant.
Apr 2 2003Filed document entitled:
  Declaration of Marietta Small in support of motion to substitute party - from counsel for plaintiff and appellant (Greenfield). (fax filing) (hard copies recv'd 4/4/03)
Apr 3 2003Order filed
  On application of the appellant's estate and good cause appearing, the motion to substitute Marietta Small, the Public Administrator for the Estate of Harvey Greenfield, for Harvey Greenfield is hereby granted.
Apr 3 2003Note:
  Case title changed to: Marietta Small, as Public Administrator, etc., Plaintiff and Appellant.
Apr 7 2003Opinion filed: Judgment reversed
  and remanded. Majority Opinion by Kennard, J. joined by George CJ., Werdegar & Moreno, JJ. Concurring Opinion by Kennard, J. Concurring Opinion by Baxter, J. C&D Opinion by Brown, J. joined by Chin, J.
May 9 2003Remittitur issued (civil case)
  CA1/4
May 9 2003Note:
  record sent to CA1/4.
May 13 2003Received document entitled:
  Receipt for remittitur - from CA1/4.

Briefs
Dec 22 2000Opening brief on the merits filed
 
Feb 5 2001Answer brief on the merits filed
 
Feb 23 2001Reply brief filed (case fully briefed)
 
Mar 27 2001Amicus Curiae Brief filed by:
 
Apr 2 2001Amicus Curiae Brief filed by:
 
Apr 2 2001Amicus Curiae Brief filed by:
 
Apr 6 2001Amicus Curiae Brief filed by:
 
May 22 2001Response to Amicus Curiae Brief filed by:
 
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