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.
1
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
5
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-
10
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, 04/07/2003 | S091297 |
Parties
| 1 | Fritz Companies Inc. (Defendant and Respondent) Represented by William F. Alderman Orrick, Herrington & Sutcliffe 400 Sansome St. San Francisco, CA |
| 2 | Fritz, Lynn C. (Defendant and Respondent) Represented by William F. Alderman Orrick, Herrington & Sutcliffe 400 Sansome St. San Francisco, CA |
| 3 | Greenfield, Harvey (Plaintiff and Appellant) Represented by Michael David Braun Stull, Stull & Brody 10940 Wilshire Blvd. Suite 2300 Los Angeles, CA |
| 4 | Greenfield, Harvey (Plaintiff and Appellant) Represented by Marc Lawrence Godino Stull, Stull & Brody 10940 Wilshire Boulevard Suite 2300 Los Angeles, CA |
| 5 | Electronics For Imaging, Inc. (Amicus curiae) Represented by Douglas Clark WILSON SONSINI GOODRICH & ROSATI 650 Page Mill Road Palo Alto, CA |
| 6 | Electronics For Imaging, Inc. (Amicus curiae) Represented by Boris Feldman Wilson Sonsini Goodrich Rosati 650 Page Mill Road Palo Alto, CA |
| 7 | Electronics For Imaging, Inc. (Amicus curiae) Represented by Cheryl Weisbard Foung WILSON SONSINI GOODRICH & ROSATI 650 Page Mill Road Palo Alto, CA |
| 8 | Securities Industry Association (Amicus curiae) Represented by Charles D. Siegal Munger Tolles & Olson 355 So. Grand Ave., 35th Floor Los Angeles, CA |
| 9 | Securities Industry Association (Amicus curiae) Represented by George Michael Garvey Munger Tolles & Olson 355 So. Grand Ave., 35th Floor Los Angeles, CA |
| 10 | Securities Industry Association (Amicus curiae) Represented by Janice Maureen Kroll Munger Tolles & Olson LLP 355 So. Grand Ave., 35th Floor Los Angeles, CA |
| 11 | Ifilm Corporation (Amicus curiae) Represented by Raoul D. Kennedy Skadden, Arps, Slate, Meagher And Flom LLP Four Embarcadero Center San Francisco, CA |
| 12 | Ifilm Corporation (Amicus curiae) Represented by Frances Pao-Han Kao Skadden Arps et al 333 West Wacker Drive Chicago, IL |
| 13 | Ifilm Corporation (Amicus curiae) Represented by David E. Springer Skadden, Arps, Slate, Meagher & Flom 333 West Wacker Drive Chicago, IL |
| 14 | Ifilm Corporation (Amicus curiae) Represented by Garrett Jay Waltzer Skadden Arps Slate et al Four Embarcadero Center San Francisco, CA |
| 15 | Sgw Holding Inc. (Amicus curiae) Represented by Raoul D. Kennedy Skadden, Arps, Slate, Meagher And Flom Four Embarcadero Center San Francisco, CA |
| 16 | American 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 |
| 17 | American 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 |
| 18 | American 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 |
| 19 | Small, Marietta (Plaintiff and Appellant) Represented by Michael David Braun Attorney at Law 10940 Wilshire Blvd #2300 Los Angeles, CA |
| 20 | Small, Marietta (Plaintiff and Appellant) Represented by Marc Lawrence Godino Attorney at Law 10940 Wilshire Blvd #2300 Los Angeles, CA |
| Disposition | |
| Apr 7 2003 | Opinion: Reversed |
| Dockets | |
| Sep 7 2000 | Petition for review filed By counsel for Resp's. {Fritz Companies Inc.} / 40(N) |
| Sep 7 2000 | Record requested |
| Sep 25 2000 | Received Court of Appeal record 2 accordion folders. |
| Oct 27 2000 | Time Extended to grant or deny Petition for Review to Dec. 6, 2000 |
| Nov 21 2000 | Petition for review granted (civil case) Votes: George C.J., Baxter, Werdegar & Brown JJ. |
| Dec 22 2000 | Opening brief on the merits filed by respondents. ***40n*** |
| Dec 28 2000 | Application 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 2001 | Extension of Time application Granted to and including Feb. 2, 2001 to file appellant's answer brief/merits. |
| Feb 5 2001 | Answer brief on the merits filed by appellant (Greenfield). ***40n*** |
| Feb 23 2001 | Reply brief filed (case fully briefed) by respondents. |
| Mar 21 2001 | Received application to file Amicus Curiae Brief from attorneys for Electronics for Imaging, Inc. in support of respondent (Fritz). |
| Mar 21 2001 | Received 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 2001 | Application 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 2001 | Received application to file Amicus Curiae Brief by Ifilm Corp and SGW Holding Inc. in support of respondent with request for judicial notice. |
| Mar 26 2001 | Received 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 2001 | Permission 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 2001 | Amicus Curiae Brief filed by: ELECTRONICS FOR IMAGING, INC. in support of respondent (Fritz Co.). Answer due in 20 days. |
| Mar 27 2001 | Exhibits 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 2001 | Received application to file Amicus Curiae Brief by Securities Industry Assoc. in support of respondents (Fritz). ***40n*** |
| Apr 2 2001 | Application 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 2001 | Amicus 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 2001 | Permission to file amicus curiae brief granted Securities Industry Assoc. |
| Apr 2 2001 | Amicus Curiae Brief filed by: SECURITIES INDUSTRY ASSOCIATION in support of respondent (Fritz). Answer due in 20 days. |
| Apr 6 2001 | Application 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 2001 | Permission to file amicus curiae brief granted American Institute of Certified Public Accountants in support of respondent. |
| Apr 6 2001 | Amicus 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 2001 | Extension of Time application Granted to and including May 18, 2001 for appellant to file a single answer to multiple AC briefs. |
| May 22 2001 | Response 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 2001 | Additional 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 2001 | Letter sent to counsel re: Conflict letter and form. Form to be returned within 15 days. |
| Dec 20 2001 | Supplemental brief filed Supplemental opening brief by counsel for appellant. **40n** |
| Dec 21 2001 | Certification of interested entities or persons filed by counsel for respondent (Fritz Companies Inc., et al). |
| Dec 21 2001 | Supplemental brief filed Supplemental opening brief by counsel for respondent ***(40n)*** |
| Jan 4 2002 | Note: |
| Jan 9 2002 | Supplemental reply brief filed (AA) Reply brief by counsel for appellant Harvey Greenfield. **40n** |
| Jan 9 2002 | Supplemental reply brief filed (AA) Reply brief by counsel for respondent Fritz Companies Inc., etc. **40** |
| Aug 16 2002 | Filed 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 2002 | Case ordered on calendar 1-7-03, 9am, S.F. |
| Jan 7 2003 | Cause argued and submitted |
| Jan 8 2003 | Received: copies of two decisions cited at oral argument by Respondent. |
| Feb 21 2003 | Filed 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 2003 | Filed document entitled: Memorandum of Points & Authorities in Support of Motion to Substitute Party - from counsel for plaintiff and appellant. |
| Apr 2 2003 | Filed 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 2003 | Order 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 2003 | Note: Case title changed to: Marietta Small, as Public Administrator, etc., Plaintiff and Appellant. |
| Apr 7 2003 | Opinion 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 2003 | Remittitur issued (civil case) CA1/4 |
| May 9 2003 | Note: record sent to CA1/4. |
| May 13 2003 | Received document entitled: Receipt for remittitur - from CA1/4. |
| Briefs | |
| Dec 22 2000 | Opening brief on the merits filed |
| Feb 5 2001 | Answer brief on the merits filed |
| Feb 23 2001 | Reply brief filed (case fully briefed) |
| Mar 27 2001 | Amicus Curiae Brief filed by: |
| Apr 2 2001 | Amicus Curiae Brief filed by: |
| Apr 2 2001 | Amicus Curiae Brief filed by: |
| Apr 6 2001 | Amicus Curiae Brief filed by: |
| May 22 2001 | Response to Amicus Curiae Brief filed by: |
