SUSAN KAUFMAN, ON BEHALF OF HERSELF AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFF-RESPONDENT, v. I-STAT CORPORATION; WILLIAM P. MOFFITT; LIONEL N. STERLING; IMANTS R. LAUKS AND MATTHIAS PLUM, JR., DEFENDANTS-APPELLANTS.
Supreme Court of New Jersey
Argued May 1, 2000-Decided July 27, 2000.
754 A.2d 1188
The approach we adopt for use in this context is a flexible one. Protection may be afforded to both facts and deliberative processes without strict reference to the classification of the materials. Both types of information may be entitled to protection depending on the outcome of the balancing between the need for confidentiality and the need for disclosure. That approach will allow the court to consider and accommodate the variety of opposing interests that exist when discovery of confidential materials is sought.
VIII.
We affirm the judgment of the Appellate Division ordering remand and direct that the Law Division undertake proceedings consistent with this opinion.
For affirmance in part, reversal in part-Chief Justice PORITZ, and Justices O‘HERN, STEIN, COLEMAN, LONG, VERNIERO and LaVECCHIA-6.
Opposed-None.
The opinion of the Court was delivered by
LaVECCHIA, J.
This appeal presents the question whether a class of plaintiffs in a common-law action for fraud can prove the element of reliance through the presumption of a fraud on the market. The theory of fraud on the market, as described by the United States Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988), allows plaintiffs to bring class actions under federal securities-fraud law by excusing those plaintiffs from the burden of proving individual reliance. Instead, plaintiffs may establish the reliance element of their claims by showing that they purchased securities in the secondary markets at attractive prices that had been artificially affected by an issuer‘s misrepresentations and omissions.
Plaintiff Susan Kaufman held shares of defendant i-Stat Corporation (“i-Stat“) over a period during which i-Stat allegedly misrepresented certain financial matters and the misrepresentations were discovered and publicized. The misrepresentations were never made to Kaufman by i-Stat or any intermediary. Kaufman relied on the price of the stock in her decisions, and now contends that, because i-Stat‘s misrepresentations were reflected in the share price, she can make out claims for common-law fraud and negligent misrepresentation on the basis of the share price alone.
Even though the theory of fraud on the market has a place in the securities law of this nation, it is a stranger to New Jersey‘s securities laws. It is also not consistent with the current requirements for a common-law action for fraud in New Jersey. Use of the fraud-on-the-market theory is not the equivalent of proof of indirect reliance that is required minimally in a common-law fraud action. Because we discern no compelling reason to deviate from our current standard of proof for the reliance element in a common-law fraud action, and because we, like many commenta-
I.
This matter comes before the Court as a result of the Law Division‘s grant of summary judgment for the defendants. Accordingly, we give the plaintiff the benefit of every positive inference to be drawn from the facts as she has pled them. See Brill v. Guardian Life Ins. Co. of Am., 142 N.J. 520, 523, 666 A.2d 146 (1995). In that light, we thus consider the facts.
i-Stat is a public New Jersey corporation that manufactures and markets diagnostic blood-analysis equipment designed to assist medical professionals at the point of patient care. Specifically, the company makes a hand-held blood analyzer and cartridges to test individual patients. The corporation‘s stock is traded on the NASDAQ National Market System. On October 31, 1995, during the events at issue in this action, i-Stat had 11,083,421 shares of common stock issued and outstanding.
On May 9, 1995, i-Stat announced its financial results for the first fiscal quarter of 1995, ending March 31. The company reported net sales of $3,359,000, as compared to reported net sales of $1,651,000 for the same period in the previous year. The company reported a net loss of $6,531,000 ($0.59 per share) for the first quarter as compared with a net loss of $6,056,000 ($0.55 per share) for the same period in the prior year. Kaufman alleges that, to produce the improved sales figures, i-Stat1 misrepresented acceptance of the company‘s products to the public by “re-
On May 22, 1995, Susan Kaufman purchased one hundred shares of i-Stat common stock at 21 3/4, a total investment of $2175. Meanwhile, on that date, Forbes magazine reported that a medical investment newsletter believed i-Stat was experiencing difficulties and that its products were not economical. On June 21, 1995, an article in The Financial Post, a Canadian financial publication, reported “the expected profitability and growth of the Company,” citing an interview with defendant Imants Lauks. On September 21, 1995, i-Stat reached its all-time high, trading at 43 3/4.
The bubble began to burst on January 28, 1996. On that date, The New York Times reported that Daniel R. Frank, manager of the Fidelity Advisor Strategic Opportunities Fund, whose successor is still the largest institutional holder of i-Stat, had made charitable contributions to hospitals to enable them to obtain i-Stat‘s diagnostic equipment.
Then, on March 19, 1996, The Wall Street Journal reported that the Securities and Exchange Commission (“SEC“) was investigating i-Stat‘s business. The article revealed that some of i-Stat‘s “sales” had been loans of the products to hospitals on a trial basis rather than actual sales. i-Stat responded with a press release confirming the SEC‘s investigation and inquiry into its sales procedures. On that same day, i-Stat‘s shares, which had been declining, tumbled 2 1/2 to 28 3/8. Two million shares of i-Stat, nearly one sixth of the shares outstanding on that date, traded on March 19.
On May 20, 1996, Kaufman sold 50 shares at 20 1/4. On June 19, she filed suit as putative class representative on behalf of all purchasers of i-Stat common stock between May 9, 1995, and
i-Stat filed an answer alleging various affirmative defenses. Both parties stipulated to the following: (1) Kaufman did not “actually or directly receive or rely on any communication containing any misrepresentation ... nor ... actually receive or rely on any communication which omitted material facts[;]” (2) Kaufman purchased her stock through a brokerage firm and did not directly receive or rely on any communication from the brokerage firm concerning the i-Stat purchase; and (3) Kaufman “relied exclusively on the integrity of the market price of i-Stat stock at the time of her purchase.” Therefore, Kaufman‘s satisfaction of the reliance element of the common-law fraud and negligent-misrepresentation claims depends entirely on the fraud-on-the-market theory.
i-Stat moved for summary judgment on the ground that Kaufman failed to state a cause of action in fraud or in negligent misrepresentation because she could not satisfy the actual reliance requirement in each. The trial court granted the motion, dismissing Kaufman‘s claims with prejudice. Although the court agreed with the fraud-on-the-market theory Justice Blackmun espoused in Basic, supra, it rejected the theory as a substitute for reliance, believing it would be inappropriate for a trial court to expand the common law of New Jersey. The court concluded that the issue was better addressed by an appellate court or the Legislature.
On appeal, the Appellate Division reversed the dismissal of plaintiff‘s complaint on the common-law-fraud claim but affirmed the dismissal of the negligent-misrepresentation claim. Kaufman v. i-Stat Corp., 324 N.J.Super. 344, 348, 735 A.2d 606 (App.Div. 1999). The court concluded that plaintiff‘s reliance on the integri-
The court began its analysis by noting that only the reliance element was at issue in this common-law-fraud claim and that New Jersey already allows proof of indirect reliance to satisfy this element. Id. at 349. Indirect reliance has also been adopted by the Restatement (Second) of Torts for situations involving reliance by party B on a false representation initially made to party A who the maker knew or had reason to expect would communicate the information to party B such that the information would influence party B‘s conduct in a transaction. Ibid. (citing Restatement (Second) of Torts § 533 (1977)).
Using a similar analysis, reasoned the Appellate Division, federal courts have permitted the reliance element of a securities-fraud claim under
In examining the negligent-misrepresentation claim, the Appellate Division concluded differently. The court acknowledged that the measure of liability for negligent misrepresentation “involves a weighing of the relationship of the parties, the nature of the risk, and the public interest in the proposed solution.” Ibid. (quoting Goldberg v. Housing Auth., 38 N.J. 578, 583, 186 A.2d 291 (1962)). In H. Rosenblum, Inc. v. Adler, 93 N.J. 324, 352, 461 A.2d 138 (1983), this Court imposed liability on an independent accountant who issued financial statements on which reasonably foreseeable recipients relied for business purposes. Given the facts in that matter, the Court did not reach the issue of claims by individuals who do not receive audited statements from the company, like purchasers of the corporation‘s stock. Id. at 353. Later, the Court clarified that limited liability was necessary in a negligent-misrepresentation claim to avoid “potentially unlimited liability.” Petrillo v. Bachenberg, 139 N.J. 472, 484, 655 A.2d 1354 (1995), quoted in Kaufman, supra, 324 N.J.Super. at 355. The Appellate Division therefore believed it was constrained by the precedent of Rosenblum, and declined to broaden the scope of liability for negligent misrepresentation. Ibid. The court rea-
We granted certification. 162 N.J. 489, 744 A.2d 1211 (1999).
II.
Assuming the allegations made by plaintiff Susan Kaufman on behalf of a putative class are correct, and because this is an appeal of a grant of summary judgment we give her the benefit of every inference that they are, then the misrepresentations and omissions made by the management of i-Stat corporation caused her to lose money. If she can prove that her loss resulted from an act prohibited under Section 10(b) of the Securities Exchange Act of 1934,
Rule 10b-5 makes it
unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To 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.
The misdeeds that plaintiff alleges i-Stat to have committed, if proven, clearly fall within the ambit of the Rule. Many actions
The change has come about neither because state courts have greater expertise in these matters nor because they are more convenient. The impetus for these state court filings was provided by Congress’ passage of the Private Securities Litigation Reform Act of 1995, Pub. L.No. 104-67, 109 Stat. 737 (“PSLRA“). Congress enacted the PSLRA to reduce or eliminate class-action strike suits filed by investors when the price of a stock declined. PSLRA‘s provisions have made litigating such cases much more difficult for plaintiffs.
Among the restrictions imposed was a stay of discovery during the pendency of any motion to dismiss, Congress having found that plaintiffs often used this period as a fishing expedition to discover information that would underlie the suit.
the difference between the purchase or sale price paid or received, as appropriate, by the plaintiff for the subject security and the mean trading price of that security during the 90-day period beginning on the date on which the information correcting the misstatement or omission that is the basis for the action is disseminated to the market.
[
15 U.S.C.A. § 78u-4(e)(1) .]
Most of those cases newly brought in state court have been, as this one is, substitutes for Rule 10b-5 actions.2 To maintain those actions’ viability, the plaintiffs bringing them have sought to have the courts hearing them incorporate the doctrine of fraud on the market into the common law of their respective states. Plaintiff, however, has cited no case in which a state court ruling on its common law has accepted the invitation. Defendants, by contrast, have found several cases declining to allow the fraud-on-the-market theory to establish reliance at common law. See Mirkin v. Wasserman, 5 Cal.4th 1082, 23 Cal. Rptr.2d 101, 858 P.2d 568, 580 (1993) (declining to expand common-law cause of action when procedurally controlled state statutory remedy, amenable to fraud-on-the-market presumption, already available); Malone v. Brincat, 722 A.2d 5 (Del. 1998) (declining to expand common-law cause of action when federal statutory remedy available); Kahler v. E.F. Hutton Co., 558 So.2d 144 (Fla.Dist.Ct.App.1990); Constantine v. Miller Indus., No. E1999-01575-COA-R3-CV, 2000 WL 336663 (Tenn.Ct.App. March 31, 2000). See also Rosenthal v. Dean
The federal courts with jurisdiction in New Jersey have rejected the idea that fraud on the market can create a common-law action for fraud. Thus, the Third Circuit, in one of the landmark decisions on fraud on the market, Peil v. Speiser, 806 F.2d 1154 (3d Cir. 1986), on which the Supreme Court relied extensively in Basic, declined to allow a state-law claim to proceed because “no state courts have adopted the theory, and thus direct reliance remains a requirement of a common law securities fraud claim.” Id. at 1163 (adjudicating Pennsylvania-law claim). The District of New Jersey has also rejected the invitation to expand the common law of fraud. See Weikel v. Tower Semiconductor Ltd., 183 F.R.D. 377, 400 n. 12 (D.N.J.1998); Easton & Co. v. Mutual Benefit Life Ins. Co., 1993 WL 89146, at *6 (D.N.J.); Cammer v. Bloom, 711 F.Supp. 1264, 1298 (D.N.J.1989); In re ORFA Sec. Litig., 654 F.Supp. 1449, 1460 (D.N.J.1987) (“There does [sic] not appear to be any common law exceptions to the requirement of individual reliance (analogous to the judicially created Rule 10b-5 exceptions)“). But see In re Zenith Labs. Sec. Litig., 1993 WL 260683 (D.N.J.) (predicting that New Jersey Supreme Court would allow fraud-on-the-market proof of negligent misrepresentation and allowing negligent-misrepresentation claims to survive summary judgment).
The many state-law class actions for securities fraud triggered further federal reform legislation, the Securities Litigation Uniform Standards Act of 1998, Pub.L. No. 105-353, 112 Stat. 3227, (codified in scattered sections of
To some degree, SLUSA allows the Court to consider this claim free from the threat that securities-fraud plaintiffs will bring actions in New Jersey with only the most tenuous of connections here because this is the only state that allows them to do so. Nevertheless, the excepted plaintiffs remaining under SLUSA, namely state or municipal entities, state pension funds, or combinations of the same, could still bring a significant amount of litigation here. Further, SLUSA excepts classes of fewer than fifty plaintiffs.
Federalism permits the state and national governments to resolve similar matters in different ways. See State v. Preciose, 129 N.J. 451, 475, 609 A.2d 1280 (1992) (“considerations of federalism dictate that our state courts should enforce New Jersey‘s post-conviction rules without attempting to emulate the federal habeas decisions“). A court‘s decision to follow its own lead, however, ought to be firmly grounded in public policy. Cf. State v. Hempele, 120 N.J. 182, 229, 576 A.2d 793 (1990) (Garibaldi, J., dissenting) (observing that “under principles of federalism, there is no sound public policy that would justify” departure from federal approach in Fourth Amendment case). The question in this matter is whether the public interest in the development of our
III.
A.
Plaintiff characterizes the fraud-on-the-market theory as no more than a reasonable application of indirect reliance principles. Indirect reliance allows a plaintiff to prove a fraud action when he or she heard a statement not from the party that defrauded him or her but from that party‘s agent or from someone to whom the party communicated the false statement with the intention that the victim hear it, rely on it, and act to his or her detriment. See Judson v. Peoples Bank & Trust Co., 25 N.J. 17, 27, 134 A.2d 761 (1957); Metric Inv., Inc. v. Patterson, 101 N.J.Super. 301, 306-07, 244 A.2d 311 (App.Div.1968). The Appellate Division accepted plaintiff‘s argument, noting that the fraud-on-the-market theory of federal securities fraud law was “[b]ased on a similar analysis,” and holding “that indirect reliance in the form of reliance on the integrity of the market price for a corporate security which has been artificially inflated by the corporation‘s deliberate false statements concerning its financial condition may satisfy the reliance element of a common law fraud action.” Kaufman, supra, 324 N.J.Super. at 350, 354.
Defendants note this shift from a chain of communicated false statements, however indirectly passed along from one to another, and argue that this Court‘s standard for reliance, even indirect reliance, requires that the plaintiff have actually relied on the misstatement, i.e., that the plaintiff actually received and considered the misstatement or omission, however indirectly uttered, before he or she completed the transaction. Defendant argues that until the decision below, “no New Jersey state court [had]
We agree with defendants. The actual receipt and consideration of any misstatement remains central to the case of any plaintiff seeking to prove that he or she was deceived by the misstatement or omission. The element of reliance is the same for fraud and negligent misrepresentation. Compare Rosenblum, supra, 93 N.J. at 334, 461 A.2d 138 (“Negligent misrepresentation is ... [a]n incorrect statement, negligently made and justifiably relied on, [and] may be the basis for recovery of damages for economic loss ... sustained as a consequence of that reliance.“) with Gennari v. Weichert Co. Realtors, 148 N.J. 582, 610, 691 A.2d 350 (1997) (“The five elements of common-law fraud are: (1) a material misrepresentation of a presently existing or past fact; (2) knowledge or belief by the defendant of its falsity; (3) an intention that the other person rely on it; (4) reasonable reliance thereon by the other person; and (5) resulting damages.“). See also Kuhnel v. CNA Ins. Cos., 322 N.J.Super. 568, 581, 731 A.2d 564 (App.Div.1999), cert. denied, 163 N.J. 12, 746 A.2d 458 (2000) (affirming trial court‘s dismissal of fraud and negligent-misrepresentation claims for plaintiffs’ failure to show detrimental reliance).
With regard to a negligent-misrepresentation claim, in Rosenblum, supra, while finding that an accounting firm could be liable to someone relying on its statements, even though that party was not its client, we nevertheless held that plaintiffs alleging deceit “would have to establish that they ... received ... the statements ... that they relied on the statements and that the misstatements therein ... were a proximate cause of the ... damage.” Id. at 350, 461 A.2d 138 (citations omitted). We laid out plaintiff‘s burden this way to retain the concept of reliance defined in Judson, Metric, and their antecedents and at the same time avoid potentially unlimited liability for the makers of the statements to parties other than those to whom the statements
Because negligent misrepresentation does not require scienter as an element, it is easier to prove than fraud. The Appellate Division correctly reasoned that, because the Rule 10b-5 action requires a plaintiff to prove scienter, expanding fraud on the market to cover a tort without scienter would be inconsistent with the theory of recovery. Kaufman, supra, 324 N.J.Super. at 355-56. Nevertheless, our law of indirect reliance, even though most recently clarified in negligent-misrepresentation cases, is the same in fraud cases, the element of reliance being the same in both.
B.
Other states similarly have held that the doctrine of indirect reliance requires that the plaintiff have relied on the substance of the allegedly fraudulent claim. The Florida District Court of Appeals, which has rejected the fraud-on-the-market theory, see Kahler, supra, distinguished its acceptance of indirect reliance because, with indirect reliance, the actual substance of the misrepresentation is communicated to the plaintiff at the end of a series of communications begun by the defendant with the intent that the plaintiff will hear the misrepresentation. See Joseph v. Norman LaPorte Realty, Inc., 508 So.2d 496 (Fla.Dist.Ct.App.1987).
Similarly, the California Court of Appeal recently held, relying on Mirkin, supra, “[i]t must be shown the defendant made misrepresentations or omissions directly to one victim who then repeated the misrepresentations or omissions to another who thus was an indirect recipient of the defendant‘s communications.” Gawara v. United States Brass Corp., 63 Cal.App.4th 1341, 74 Cal.Rptr.2d 663, 672 (1998) (reversing plaintiffs’ verdict for failing “to establish all the necessary links in the chain“).
In Mirkin, the plaintiffs, as here, invoked Section 533 of the Restatement of Torts (Second), which states that:
The maker of a fraudulent misrepresentation is subject to liability for pecuniary loss to another who acts in justifiable reliance upon it if the misrepresentation, although not made directly to the other, is made to a third person and the maker intends or has reason to expect that its terms will be repeated or its substance communicated to the other, and that it will influence his conduct in the transaction or type of transaction involved.
The court, however, rejected the plaintiffs’ proposition that a scheme allowing a person to state a claim based on secondhand misrepresentations also allowed reliance to be presumed on behalf of market investors. Mirkin, supra, 858 P.2d at 576. Instead, the court noted, “[r]eliance at common law has two components-awareness of the misrepresentation and action based thereon. The plaintiff in a fraud-on-the-market case under Rule 10b-5 is not required to prove the first component.” Id. at 579 n. 8 (emphasis added).
C.
Indirect reliance remains today what we held it to be in Judson and Rosenblum, supra. If proven, it is an element of a claim of fraud. If a party to a transaction makes a false statement to another party, intending or knowing that the other party in the transaction will hear it and rely on it, and the second party to the transaction actually hears the substance of the misrepresentation, by means however attenuated, and considers the actual content of that misrepresentation when making the decision to complete the transaction, then that person has established indirect reliance to support a fraud claim.
In this case, plaintiff has explicitly stated that she did not consider i-Stat‘s financial statements, either by herself or in consultation with an investment professional, but acted only on the market price. By that statement she denies that she ever considered i-Stat‘s sales volume in her buying decision. Thus, she has failed to establish that she relied, however indirectly, on the misstatements of i-Stat and its management. Therefore, under our traditional standard for proof of reliance, even indirect reliance, plaintiff fails to show reliance and, therefore, fails to make out a claim for fraud.
In her brief, plaintiff correctly avers that, because she brought her claim before the enactment of SLUSA, she was “clearly entitled to seek redress under state law in state court.” New Jersey provides, as do the other states and jurisdictions, a comprehensive statutory scheme of securities regulation and investor protection, the Uniform Securities Law (1997),
Although requiring privity can seem harsh when, as here, the victim of the alleged misstatement or omission is remote from the offending party, our Legislature imposed the requirement of privity to counterbalance an advantage for plaintiffs. The USL‘s drafters rejected any “requirement that the buyer prove reliance on the untrue statement or the omission. He must show only that he did not know of it.” Louis Loss, Commentary on the Uniform Securities Act 148 (1976) (Draftsmen‘s Commentary to § 410(a)). As a result, securities-fraud plaintiffs need only prove the misrepresentations and their ignorance of them, a significantly lower burden than that imposed by a common-law fraud action. As the Supreme Court of California stated in Mirkin, supra, 23 Cal.Rptr.2d 101, 858 P.2d at 580 (construing California securities statute) “the very purpose of [a statutory securities-fraud action] is to afford the victims of securities fraud a remedy without the formidable task of proving common law fraud” (quotations omitted).
Plaintiff in this action asks to be relieved of that burden in another fashion, preferable to her, through the use of the theory of fraud on the market. The Legislature, however, has already clearly stated its choice in approaching securities-fraud complaints: it did not lessen the proof required to demonstrate reliance on a misrepresentation, but instead eliminated reliance as an element of securities fraud entirely in favor of a system in
While the USL does not control the development of the common law in this area, we are informed by the choices made by the Legislature when it enacted the state statutory scheme for securities fraud. Accordingly, plaintiff‘s arguments concerning the policy benefits of adopting fraud on the market as a method of proving reliance in common-law fraud may be evaluated from the vantage point of understanding the policy choices made by our Legislature in the USL, which are unhelpful to plaintiffs here; the deliberations of other jurisdictions that have considered the theory; and analysis of the theory by academics.
V.
Since the Supreme Court accepted fraud on the market in Basic, supra, twelve years ago, no state court with the authority to consider whether Basic is persuasive has chosen to apply it to claims arising under its own state‘s laws. In considering whether to accept the theory, then, the persuasiveness of its intellectual underpinning, the Efficient Capital Markets Hypothesis, or ECMH, requires close examination. The ECMH proposes that the price of a stock reflects information known about a corporation whose securities trade publicly. The extent to which the price reflects that information is expressed by the three different forms of market efficiency-strong, semi-strong, and weak.
In a strong-form efficient market, all information that exists about a company and would be of interest to a purchaser of the
Semi-strong efficiency, which is somewhere between the other two forms in holding that most information about a company is reflected in its price fairly quickly, appears to be the form assumed to exist by the United States Supreme Court in Basic. See Nathaniel Carden, Comment, Implications of the Private Securities Litigation Reform Act of 1995 for Judicial Presumptions of Market Efficiency, 65 U. Chi. L.Rev. 879, 883 (1998).
The ECMH, perhaps because it posits that no investor can consistently outperform the market regardless of the amount of research or work undertaken beforehand, is a favorite subject for academics but is often discounted by investment professionals. For example, Warren Buffett, the well-known, successful investor, contends that proper study of a company‘s financial condition reveals its value far better than does the market price of its shares. Roger Lowenstein, Buffett: The Making of an American Capitalist 307-22 (1995).
The ECMH has suffered at the hands of academic writers as well:
We think that the legal rush to embrace and apply the efficient market hypothesis has been overly precipitous and occasionally unwise. . . . [M]ore recent economic research and controversy about the hypothesis casts doubt on E[C]MH‘s empirical claims and theoretical underpinnings. Whether markets are efficient in the sense claimed by the initial tests is now highly suspect. . . . Virtually none of this doubt,
however, has been reflected in the debates about the implications of the efficient market hypothesis for legal decisionmaking. [Jeffrey N. Gordon & Lewis A. Kornhauser, Efficient Markets, Costly Information, and Securities Research, 60 N.Y.U. L. Rev. 761, 764 (1985).]
As more time has passed, and there has been greater opportunity to examine and test market efficiency, the hypothesis has shown greater weakness.
The debate over the ECMH is fundamental because [it] is a major premise for a substantial body of corporate and securities law and scholarship [and] the United States Supreme Court has recognized the ECMH as a basis for satisfying the reliance requirement in certain securities-fraud cases. Moreover, since the late 1970s, a great deal of corporate and securities law scholarship has extolled the virtues of the ECMH and urged it as a basis to advocate many major policy prescriptions. Indeed, before the public capital market crash of October 1987, only a few sobering pieces stood to remind the legal community that the ECMH is only a hypothesis, and a dubious one at that.
[Lawrence A. Cunningham, From Random Walks to Chaotic Crashes: The Linear Genealogy of the Efficient Capital Market Hypothesis, 62 Geo. Wash. L. Rev. 546, 548-49 (1994).]
Because the ECMH fails to adjust for the noise and chaos inevitable in any system created by the acts of so many participants, one observer has gone so far as to contend that “obsolescence renders the ECMH false in all its forms.” Id. at 548. Other writers have commented on causation uncertainty in understanding market reactions, noting, among other things: how inefficiently prices reflect earnings; how other publicly available financial information is underreflected; how other information, such as historical underperformance, affects price; and how the activities of underrational “noise traders” and those otherwise affected by investor sentiment distort the picture. See Victor L. Bernard, et al., Challenges to the Efficient Market Hypothesis: Limits to the Applicability of Fraud-on-the-Market Theory, 73 Neb. L.Rev. 781, 786-92 (1994).
Plaintiff argues that the academic debate goes to whether particular securities trade in efficient markets and that academics and courts remain confident that the markets are efficient. Defendants acknowledge that uncertainty whether the markets are
Our own Chancery Division has noted the uncertainty regarding the validity of the ECMH:
Most academics in the field of finance advocate a combination of the random walk and the efficient market theories. Most Wall Street professionals, the security analysts and portfolio managers, disagree. The academics say that the stock market is self-regulating as it reacts to new information, and random selection of investments will follow the market. The most dramatic example was the Forbes index, composed of twenty stocks chosen by throwing darts at a list of securities on the stock exchange. Professor Thaler and others believe that profits can be made from cracks in the efficient market, and the relative strength theory is another gloss on the random walk-efficient market theories. It has been supported, as well as criticized, in the literature.
[Johnson v. Johnson, 212 N.J.Super. 368, 392, 515 A.2d 255 (1986).]
Other courts have also expressed misgivings about the ECMH. In Mirkin, supra, the California Supreme Court accepted that fraud on the market could underlie a statutory action, but expressly declined to accept or reject the ECMH even though that court did acknowledge that the dissemination of material information affects the prices of securities. 23 Cal.Rptr.2d 101, 858 P.2d at 579 & n. 7. Also, Chancellor Allen noted, “just as the Constitution does not enshrine Mr. Herbert Spencer‘s social statics, neither does the common law of directors’ duties elevate the theory of a single, efficient capital market to the dignity of a sacred text.” Paramount Comms. Inc. v. Time Inc. 1989 WL 79880, at *19 (Del.Ch. July 14), aff‘d, 571 A.2d 1140 (Del.1989).
Even at the time of the Basic decision, skeptical voices were heard. Dissenting from the majority opinion, Justice White wrote that “with no staff economists, no experts schooled in the ‘efficient-capital-market hypothesis,’ no ability to test the validity of empirical market studies, we are not well equipped to embrace novel constructions of a statute based on contemporary microeconomic theory.” 485 U.S. 224 at 253, 108 S.Ct. at 994-95, 99 L.Ed.2d at 222. There is no greater proof now than there was
Yet now, despite there being no basis for increased acceptance of the idea of fraud on efficient markets, plaintiff asks us to expand its use beyond the carefully balanced world of the federal securities laws to the vastly more diverse universe of common-law fraud claims. In addition to our skepticism concerning its validity when used in the context of securities markets, we note that plaintiffs in other jurisdictions have attempted to establish that markets in assets other than securities are efficient enough to allow use of the fraud-on-the-market theory. Various opinions we have examined have rejected use of the theory in those other settings. The Alabama Supreme Court has rejected the fraud-on-the-market theory numerous times in the consumer fraud context. See Ex parte Household Retail Servs., Inc., 744 So.2d 871 (1999); Ex parte Exxon Corp., 725 So.2d 930 (1998); Butler v. Audio/Video Affiliates, Inc., 611 So.2d 330 (1992). See also Sing v. John L. Scott, Inc., 134 Wash.2d 24, 948 P.2d 816, 827 (1997) (Talmadge, J., dissenting) (asserting consumer fraud on the market created by interested real estate agent insider dealing in competitive transaction between agent and principal).
The Appellate Division of the Supreme Court of New York was presented with the theory in an action for malpractice against accountants who allegedly gave improper tax advice to partners in tax shelters. Ackerman v. Price Waterhouse, 252 A.D.2d 179, 683 N.Y.S.2d 179 (1998). That court also dealt with the attempt of a season ticketholder of the then-New York Nets to rely on a fraud-on-the-market approach in certifying his fellow ticketholders as a class that had been defrauded when the team sold Julius Erving to the Philadelphia 76ers in 1976. See Strauss v. Long Island Sports, Inc., 60 A.D.2d 501, 401 N.Y.S.2d 233 (1978). The plaintiff, who brought one of seven such actions, asserted that ticketholders were the equivalent of shareholders in such an action. Id. at 237.
We express no view on those cases and leave to another day whether in a proper case we would accept use of a theory akin to
Accepting fraud on the market as proof of reliance in a New Jersey common-law fraud action would undercut the public interest in preventing forum-shopping, weaken our law of indirect reliance, and run contrary to the policy direction of the Legislature and Congress. We decline to expand our law regarding satisfaction of the reliance element of a fraud action on the basis of a complex economic theory that has not been satisfactorily proven. In so holding, we note that plaintiff had available to her an adequate federal remedy perfectly suited to her complaint. She chose not to pursue it.
VI.
Accordingly, the decision of the Appellate Division allowing the reliance element of a fraud claim to be proven by the fraud-on-the-market theory is reversed, and the judgment of the Superior Court, Law Division is reinstated, dismissing plaintiff‘s action.
In this appeal, the issue before the Court is whether reliance on the integrity of the market price for a corporate security satisfies the reliance element of a cause of action for common law fraud. The Appellate Division held that it does. Kaufman v. i-Stat Corp., 324 N.J.Super. 344, 735 A.2d 606 (1999). Because I believe that the Appellate Division‘s thorough and well-reasoned opinion reflects the correct disposition of that issue, I dissent.
I
The narrow issue before the Court is whether the fraud-on-the-market theory of reliance, articulated and adopted by the United States Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 241-48, 108 S.Ct. 978, 989-92, 99 L.Ed.2d 194, 214-19 (1988), adequately may satisfy the reliance element of a state law claim for common law fraud.
A
A common-law fraud action has five elements. They are “(1) a material misrepresentation of a presently existing or past fact; (2) knowledge or belief by the defendant of its falsity; (3) an intention that the other person rely on it; (4) reasonable reliance thereon by the other person; and (5) resulting damages.” Gennari v. Weichert Co. Realtors, 148 N.J. 582, 610, 691 A.2d 350 (1997).
Since 1957 New Jersey has recognized that indirect reliance may satisfy the reliance element of a common law fraud action. See Judson v. Peoples Bank & Trust Co., 25 N.J. 17, 27, 134 A.2d 761 (1957) (holding that misrepresentation by one family member made with intent that it be communicated to other family members sufficient to satisfy reliance element of common law fraud and observing that “reliance may be found by fair inference“); Metric Investment, Inc. v. Patterson, 101 N.J.Super. 301, 306, 244 A.2d 311 (App.Div.1968). Likewise, the Restatement of Torts states that
[t]he maker of a fraudulent misrepresentation is subject to liability for pecuniary loss to another who acts in justifiable reliance upon it if the misrepresentation, although not made directly to the other, is made to a third person and the maker intends or has reason to expect that its terms will be repeated or its substance communicated to the other, and that it will influence his conduct in the transaction or type of transaction involved.
[Restatement (Second) of Torts § 533 (1977).]
Thus, proof that a party deliberately made false representations with the intent that they be communicated to others for the purpose of inducing others to rely upon them may satisfy the reliance element of common law fraud.
In this appeal, i-Stat issued materially misleading public statements about its financial condition and prospects, subsequent to which the price of its stock rose. The stock market “act[ed] as the unpaid agent of the investor [and] inform[ed plaintiff] that given all the information available to it, the value of the stock is worth the market price.” Basic, supra, 485 U.S. at 244, 108 S.Ct. at 990, 99 L.Ed 2d at 216 (quoting In re LTV Securities Litigation, 88 F.R.D. 134, 143 (N.D.Tex.1980)). Under the principle of indirect reliance applied by this Court in Judson, and consistent with the Restatement (Second) of Torts’ position, i-Stat‘s intentional misrepresentation may be actionable as a common law fraud even though the authors of the false information did not communicate directly to plaintiff.
The question thus is whether the principle of indirect reliance applies in the context of purchasers of publicly traded securities where the fraud was perpetrated generally on the public with the intention that all purchasers of the securities would be defrauded. The answer to that question is found in the United States Supreme Court‘s analysis of the fraud-of-the-market theory in Section 10b-5 cases.
B
In relevant part, the Securities and Exchange Commission‘s
[i]t shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
. . . .
[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, in the light of the circumstances under which they were made, not misleading . . . in connection with the purchase or sale of any security.
A plaintiff who is injured by a violation of
Prior to the United States Supreme Court‘s 1988 Basic decision, to satisfy the reliance element of a fraud claim brought under
The fraud-on-the-market theory of reliance is but a rebuttable presumption of reliance. Id. at 245, 108 S.Ct. at 990, 99 L.Ed.2d at 217. The Supreme Court found that it was fair to allow reliance to be presumed in
Defendants may “rebut proof of the elements giving rise to the presumption, or show that the misrepresentation in fact did not lead to a distortion of price or that an individual plaintiff traded or would have traded despite his knowing the statement was false.” Id. at 248, 108 S.Ct. at 992, 99 L.Ed.2d at 219 (citation omitted). Similarly, the presumption may be rebutted by “[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price” or if credible information “entered
The rationale behind the Supreme Court‘s reasoning is that “[t]he market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price.” Id. at 244, 108 S.Ct. at 990, 99 L.Ed. 2d at 216 (quoting In re LTV, supra, 88 F.R.D. at 143). Accordingly, “[a]n investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor‘s reliance on any public material misrepresentations, therefore, may be presumed for purposes of a
The Basic Court‘s holding that the use of the fraud-on-the-market theory may satisfy the reliance element of a
For an action to be maintained as a class action, “questions of law or fact common to the members of the class [must] predominate over any questions affecting only individual members.”
The majority refers to limitations on the fraud-on-the-market theory of reliance and notes that commentators and investors may disagree about whether the market price of a security fully reflects the present value of a company. Ante at 113-17, 754 A.2d at 1198-1200. However, adoption of the fraud-on-the-market principle does not require us to “adopt any particular theory of how quickly and completely publicly available information is reflected in market price.” Basic, supra, 485 U.S. at 248, n. 28, 108 S.Ct. at 992, n. 28, 99 L.Ed.2d at 219, n. 28. It requires merely that we accept that “[t]he idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers as to the fair price of a security brings [sic] about a situation where the market price reflects as nearly as possible a just price.” Id. at 246, 108 S.Ct. at 991, 99 L.Ed. 2d at 217 (quoting H.R.Rep. No. 73-1383, at 11 (1934)). The significance of the fraud-on-the-market principle derives not from the infallibility of the market price of securities but rather from the theory‘s implicit acknowledgment that the investing public is entitled to assume that SEC-mandated disclosures have been made and that fraudulent misrepresentations have not unlawfully affected the market price.
II
The majority asserts that to accept the fraud-on-the-market theory of reliance as proof of reliance in a common law fraud suit would “undercut the public interest in preventing forum-shopping, weaken our law of indirect reliance, and run contrary to the policy
A
The Appellate Division cogently reasoned that “a defendant‘s misrepresentation may be an immediate cause of a plaintiff‘s injury-producing conduct even though the defendant did not make the misrepresentation directly to the plaintiff, and even though the plaintiff never heard or read the precise words of the misrepresentation.” Kaufman, supra, 324 N.J.Super. at 352, 735 A.2d 606 (citation and quotation omitted). The Appellate Division also rejected the claim that the fraud-on-the-market theory of reliance should not be adopted merely because plaintiffs have an adequate remedy available under federal law. Id. at 353, 735 A.2d 606. As Judge Skillman observed: “The Securities Exchange Act of 1934 states that ‘the rights and remedies provided by this chapter shall be in addition to any and all remedies that may exist at law or in equity.’
Moreover, class action lawsuits for securities fraud are so few in number that the adoption of the fraud-on-the-market theory as a rebuttable presumption of reliance will have little or no impact on the operation of state courts. For example, in 1999, 216 securities class action suits were filed in federal courts. Stanford Securities Class Action Clearinghouse, (visited Jul. 6, (2000) <http://securi-
Moreover, the enactment by Congress of legislation restricting the fora in which victims of securities fraud may sue limits further those plaintiffs who are permitted to maintain a securities fraud cause of action in state courts. Initially, in 1995 Congress passed the Private Securities Litigation Reform Act (PSLRA). PSLRA imposed many procedural restrictions on federal class-action plaintiffs. In 1998 Congress enacted the Securities Litigation Uniform Standards Act (SLUSA), which sharply limits the number of securities fraud class action suits that may be brought in state courts. SLUSA, by its terms, preempts all but a limited group of future class action common law fraud claims that would otherwise be filed in state court and requires that they be filed in federal court. SLUSA provides that the vast majority of class actions, including suits such as the one at bar, that are based on a state‘s statutory or common law alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security” or “any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security” may not be brought in a state court.
Nevertheless, the PSLRA and SLUSA permit specific but restricted classes of plaintiffs to maintain their causes of action in
B
The statute of limitations for a lawsuit for securities fraud brought in federal court under
III
Recognizing fraud on the market as a means of proving reliance in common law fraud actions requires “merely an application of existing common law principles expressed in the indirect reliance cases from . . . other jurisdictions, and in the Restatement Second of Torts.” Mirkin v. Wasserman, 5 Cal.4th 1082, 23 Cal.Rptr.2d 101, 858 P.2d 568, 593 (1993) (Kennard, J., concurring in part and dissenting in part). It requires only that we recognize that “[t]he genius of the common law is its flexibility and capacity for growth and adaptation.” Russick v. Hicks, 85 F.Supp. 281, 285 (D.Mich. 1949) (citing Funk v. United States, 290 U.S. 371, 54 S.Ct. 212, 78 L.Ed. 369 (1933)). “It has always been recognized that the common law is not a rigid, inflexible, static thing, but is a living organism, ever growing and expanding to meet the problems and needs of changing social and economic conditions.” Ibid. Merely because an asserted right is somewhat novel is “not [a] valid reason[] for denying its existence. . . . The common law is not a primer of rigid and absolute rules, but rather a body of broad and comprehensive principles created by judicial decisions and based on justice, reason, and common sense.” Id. at 285-86.
I would affirm the judgment of the Appellate Division. Justice O‘HERN and Justice LONG join in the opinion.
For affirmance in part, reversal and reinstatement in part—Chief Justice PORITZ and Justices COLEMAN, VERNIERO, and LaVECCHIA—4.
For affirmance—Justices O‘HERN, STEIN, and LONG—3.
754 A.2d 1206
IN THE MATTER OF ARTHUR L. CHIANESE, AN ATTORNEY AT LAW.
July 27, 2000.
ORDER
This matter having been duly presented to the Court, it is ORDERED that ARTHUR L. CHIANESE formerly of RED BANK, who was admitted to the bar of this State in 1987, and who was suspended from the practice of law for a period of three years effective April 4, 1997, by Order of this Court dated March 11, 1999, be restored to the practice of law, effective immediately.