Mirkin v. Wasserman

Sept. S020465. [No. 1993.] al.,

GERALD D. MIRKIN et Plaintiffs and Appellants, al., FRED W. WASSERMAN et Defendants and Respondents.

Counsel Lerach, Weiss, Bershad, Lerach, Erick A. & William S. Milberg, Specthrie Barrack, Simon, Isaacson, B. Blake M. Helen J. Leonard Harper, Hodges, Wilson, Bacine, M. Leonard Rodos & Edward M. Thomas Gergosian, Krasner, Wolf, Haldenstein, Adler, Herz, Barrack, W. Freeman & Daniel Wechsler, Skirnick, Harwood, Smith, G. Francis M. Jeffrey Gregorek, Graf, Savett, Feffer, Wechsler, Kohn, Savett, Klein & Halebian & Stuart D. Frutkin, Savett, Nast, and Alvin Podell & Stuart Diane Barbara Podell Ryan, and Ivers for Plaintiffs Appellants. General, Henrichsen, Attorney Deputy

Daniel E. Susan E. Lungren, Attorney Sidener, General, Gold, Bennett, O. Jonathan W. David B. Paul F. Steven Cuneo, M. Nelson Dan Greenfield & Chimicles and Brenda McCorquodale, Appellants. as Amici Curiae on behalf of Plaintiffs and Paul, Walker, Orrick, Sutcliffe, & & William Hastings, Janofsky Herrington Gordinier, Sachs, Bruce D. Ryan, B. Todd E. Elizabeth W. Campbell, Haller, Hobart, B. C. Dana Ernst & Carl D. Maryanne Young, Liggio, McLaren, Jr., Schneider, & Richard W. A. & Kathryn Oberly, Nagler Nagler Rebhuhn, Rebhuhn, Dennis Lawrence H. Nagler, Larry Goldberg, Harry Gibson, Manella, Chu, Neufeld, &Irell Nieset Berkbigler, Morgan Marjorie Crutcher, Schmid, Dunn & & Dempsey, Richard P. Donald J. Levy, Cooper Michael D. C. and D. Donaldson for Dempsey, Stephen Johnson Robert and Defendants Respondents. Main, Luce, Forward,

Peter D. Fred Hamilton & Zeughauser, Scripps, Boos, Bird, Danaher, Martin, Dennis Charles A. Charles A. Pettit & John L. Moses, Scott, Orrick, Sutcliffe, Bader, P. & W. Reece Barbara Herrington Fischer, Miller, Anderson, Baker, S. Kindel & Dale S. Robert Robert K. Jacobson, Karlin, Fried, Frank, Harris, Munger, Molly Shriver & Louis W. Tatum, Godward, Castro, M. Mahoney, Ray & Patrick J. Huddleson Cooley, as Amici Curiae on and A. Grundfest Joseph Gwen C. Mathewson Aragon, and Respondents. behalf of Defendants

Opinion who PANELLI, J. review determine whether granted plaintiffs, We can securities at a affected price allegedly by misrepresentations, purchased 1709 and 1710 a cause of action for deceit under Civil Code sections plead We hold relied alleging they actually misrepresentations. without not do so. Facts I. case, defend-

This after the court sustained superior comes to us demurrer, allegations ants’ law. material presents pure question of such reviewing which we assume to be true for the complaint, purpose (Garcia Superior Court rulings 50 Cal.3d 960]), 789 P.2d can briefly: be summarized Plaintiffs Gerald Mirkin and Charles Miller shares of purchased Plans, common (Maxicare) stock of Maxicare Health Inc. between October 17, 1985, 1988. Plaintiffs all February represent persons purport purchased company’s common stock or its 11.75 senior percent Maxicare, subordinated notes the same during period of time. Defendants are states, which owned and health maintenance operated organizations California; directors; including 12 Maxi Whin- care’s officers and Ernst & (succeeded ney & firm that respondent Young), accounting Ernst statements; Brothers, audited Maxicare’s financial Salomon Inc. and Securities, Inc., Montgomery of together offerings underwrote public 26, 1985, 19, Maxicare securities on November and 1986. September Maxicare, allege Plaintiffs that after substantial appearing experience 1986, growth and in 1985 and to suffer Maxicare profits began large losses. 1986, $22 $255 losses of for the reported million fourth million quarter $21.3 and year During million for first of 1988. this quarter $28.50 the value period, of Maxicare stock from a gradually high dropped $1.50 share in per 1986 to a low of share in per 1988. defendants, allege

Plaintiffs also that made numerous beginning misrepresentations about Maxicare’s and financial prospects status pro- for the and spectuses documents filed with public offerings, Commission, Exchange Securities and other communications. public According these inflated the of Maxi- plaintiffs, securities, care thus them to sell for more than their true value. allowing Plaintiffs also that several the individual sold Maxicare allege defendants during securities to same of time. public period Plaintiffs’ first consolidated amended to state causes complaint purported Code, (Civ. of action for deceit and negligent misrepresentation.1 §§ reliance, 1710.) In an element those attempting plead actual which is (Molko torts v. Holy Spirit (1988) Assn. 46 Cal.3d 1108 [252 46]; Court, 737), P.2d Garcia v. Superior supra, 50 Cal.3d at p. alleged fashion that had Maxicare conclusory they purchased “in securities reliance said Defendants demurred upon misrepresentations.” on the ground that the allegation of reliance was insufficient. When plaintiffs conceded they could not plead they had read or heard actually alleged misrepresentations, court sustained the demurrers with leave to amend.

Plaintiffs to cure the defect an amended attempted complaint by had alleging shares purchased upon integrity “[i]n the securities and market the securities and the offering process, fidelity, integrity superior knowledge finding of defendants . . . .” Once again deficient, plaintiffs’ of reliance pleading the court sustained defendants’ demurrers without leave to amend and dismissed the complaint.

On appeal, plaintiffs argued that the so-called “fraud-on-the-market” doc- trine obviates the need to reliance in plead prove actual cases where material misrepresentations alleged are to have affected the market price of (See stock. Basic Inc. v. generally Levinson 485 U.S. 241-247 194, 214-218, L.Ed.2d 108 S.Ct. Court of Appeal rejected and affirmed the argument of the judgment court. We superior granted review.

II. Discussion It is settled that a plaintiff, to state a cause of action for deceit based on a must misrepresentation, he or she relied plead actually Assn., misrepresentation. Molko (E.g., Holy Spirit 46 Cal.3d at p. 1108; 409, 977, Seeger (1941) v. Odell 414 18 Cal.2d P.2d 136 A.L.R. [115 1291]; 439, Spinks v. (1905) Clark 444 45].) 147 Cal. P. The law appears [82 1Plaintiffs also attempted to state a Corporations cause of action under Code section 1507 reports by corporations], but have challenged Appeal’s [false not the Court of decision insofar rejects as it that claim. We thus deem the claim been to have abandoned.

1089 (1890) (See, v. 82 to have been so this state. Colton always e.g., Stanford 351, 16]; (1889) Land Cal. County Cal. 383 P. Nounnan v. Sutter Co. 81 [23 536, 1, 515]; P.2d Estep Armstrong (1886) P. 69 Cal. 538 6-7 v. [11 [22 132]; 361.) (1851) Snow v. Halstead 1 Cal. is whether plaintiffs, before us question

cannot read allege they actually alleged or heard the misrepresentations, have a cause of action for deceit.2 Rather than on defendants’ pled relying securities, statements and allege about Maxicare the value of its plaintiffs on the market and the securities integrity of securities “reli[ed] offering process, and the and defend fidelity, integrity knowledge of superior ants . . . .” To their justify alleged failure to actual reliance on the plead misrepresentations, in an plaintiffs explain that the of securities traded price market, and open developed adjusts such as a national stock exchange, information, response to material whether such is true or false. information assert, In this way, plaintiffs are reflected in the market price of a security, someone indicating who relies on the market as relies, the actual value of a security indirectly, albeit on the misrepresenta tions.

Based on this reasoning, is sometimes called the fraud-on-the- doctrine, market the United States Court has held that is not Supreme “[i]t inappropriate apply a presumption of reliance” actions under brought rule of the 10b-5 (SEC). Securities and Exchange (Basic Commission Inc. v. Levinson, 241-247, 214-218, supra, 485 U.S. at pp. 250 L.Ed.2d at pp. 220; 10b-5, see SEC Rule 17 (1992) C.F.R. 240.10b-5 Rule § [hereafter 10b-5].)

The characteristics aof private action under Rule are 10b-5 from, to, derived or identical the common law of Rule deceit. 10b-5 was broad, promulgated SEC under a statutory grant authority to adopt rules to prevent use of “any manipulative or device deceptive or contriv ance” in connection with the or sale purchase (Securities of securities. Exchange Act 10(b), 78j(b).) § U.S.C. This enabling legisla § “ tion was intended by Congress to be interpreted ‘flexibly effectuate its ” remedial purposes.’ (Affiliated Ute (1972) v. United States Citizens 741, 760, U.S. 1456], L.Ed.2d 92 S.Ct. quoting Supt. of Insurance v. Bankers & Cas. Co. 404 U.S. L.Ed.2d Life charter, S.Ct. Under this broad the federal courts “have gone 2Although we do not separately plaintiffs’ discuss negligent claim for misrepresentation, our apply conclusions equally thereto. Negligent misrepresentation, which the Civil Code Code, 1709, 1710, defines (Civ. form of deceit (2)), requires subd. plead §§ prove actual reliance just as in a (Garcia claim for misrepresentation. intentional Court, Superior 50 Cal.3d at 737 & fn.

1090 under liability in imposing [Rule] law the limits of the common far beyond 1968) F.2d 303 (2d Cir. 406 Corporation (Green . .” v. 10b-5 . . Wolf result, Rule are distinct under 10b-5 100].) aAs “[a]ctions A.L.R.Fed. [9 [citation], and are claims deceit and misrepresentation common-law from the common by investors provided add to the designed protections to part Levinson, 22 fn. 485 U.S. at (Basic supra, [99 v. Inc. law [citation].” F.2d (9th 1975) 524 216]; Cir. Blackie v. Barrack at see also L.Ed.2d essence, amounts, to a plea this court Plaintiffs’ argument deceit. law of common into the the fraud-on-the-market doctrine incorporate so, is it Nor concede.3 done as plaintiffs court has appellate No state wrong, an unremedied remedy create a to do so order to necessary to apply. seek they of the doctrine even benefit give plaintiffs laws, and state securities under the federal have remedies already Plaintiffs material based on actions a presumption both of afford Levinson, 0b-5, v. in Basic Inc. 1 (See interpreted Rule misrepresentations. 214-218, 220]; 241-247, see L.Ed.2d pp. U.S. at pp. [99 Code, v. Robinson Bowden & as interpreted Corp. also §§ Indeed, the parties Cal.App.3d [136 applying trial court by order a Colorado single, unpublished 3Plaintiffs have identified common claims. doctrine to law fraud fraud-on-the-market doctrine, see v. declining to the fraud-on-the-market apply For state court decisions Gaffin 467, 474-475, & Co. v. E.F. Hutton (Del. 1992) and Kahler Teledyne, Inc. 611 A.2d 1986) (3d 806 F.2d Cir. 1990) Speiser See also Peil v. (Fla.Dist.Ct.App. 558 So.2d 145. 1154, 1163, (“no adopted courts have [fraud-on-the- state fn. 17 A.L.R.Fed. 419] [93 securities a common law requirement theory, and thus direct reliance remains market] claim”). fraud the Court California have followed the lower federal courts in opinions, In recent to fraud doctrine declining to the fraud-on-the-market apply in this case Appeal’s opinion (In 1992) (N.D.Cal. Technologies Sec. Lit. arising state common law. re Sunrise claims under 97,042; Microsystems Sec. Lit. (CCH) In re Sun Rep. Fed. Sec. L. Transfer ¶ [1992 Binder] 96,916; (CCH) Keegan In re 1992) Rep. (N.D.Cal. Fed. Sec. L. ¶ Transfer Binder] [1992 (CCH) Rep. L. (N.D.Cal. 1991) Fed. Sec. ¶ Co. Lit. Transfer Management Binder] Sec. [1991 96,275; Toolworks, (N.D. 1991) Fed. Binder] Cal. Transfer Inc. Sec. Lit. [1991 In re Software 96,425; 1991) (N.D.Cal. Freightways, Inc. (CCH) Church v. Consolidated Rep. Sec. L. ¶ 96,162; Thor (CCH) Antonopulos v. American Rep. Transfer Fed. Sec. L. ¶ [1991 Binder] 96,057.) (CCH) 1991) Rep. (N.D.Cal. Fed. Sec. L. ¶ Inc. Transfer oughbreds, Binder] [1991 Earlier, this court predict how attempted on the issue as split the federal courts had doctrine, v. e.g., Cytryn the fraud-on-the-market Compare rejecting would decide it. cases 95,409, Victor v. (CCH) (N.D.Cal. 1990) Rep. Fed. Sec. L. Cook Transfer Binder] ¶ 94,548, and In re (CCH) (N.D.Cal. 1989) Rep. Transfer Fed. Sec. L. White Binder] ¶ Rep. (N.D.Cal. 1988) Sec. L. Transfer Fed. Equities Litigation Technical Binder] [1988-1989 doctrine, 94,093, stage of class (CCH) provisionally, albeit at the applying with cases ¶ certification, (N.D.Cal. 1990) Litigation e.g., In re Worlds Wonder Securities [1989-1990 95,004, Litigation (CCH) In re Rep. Sec. L. ZZZZ Best Securities Transfer Fed. ¶ Binder] 94,485, (CCH) Weinberger (C.D.Cal. 1989) Rep. Fed. Sec. L. Transfer Binder] ¶ (N.D.Cal. 1984) Jackson 102 F.R.D. 839. that inform us a class action on behalf Maxicare’s under investors Rule has (Zucker, 10b-5 been filed federal et court. al. v. Maxicare Health Plans, Inc., Nevertheless, (C.D.Cal.) et al. CV-88-02499.) Dock. No. establish a of reliance under presumption state common law would offer certain plaintiffs advantages, primarily more favorable statute of limita- tions and the possibility recovering form of relief punitive damages—a that the federal and state securities laws do not authorize.

To obtain these advantages, law plaintiffs argue already California affords a presumption of reliance in actions for deceit. con- Plaintiffs also that, tend if the law does not afford such a we presumption, should one adopt at this time as a matter of We find policy. arguments both unpersuasive.

A. The Law Deceit.

1. The Requirement Actual Reliance. begin

Plaintiffs their argument by observing that the statutes pertain Code, ing to the tort (Civ. of deceit 1710) do expressly §§ require a showing of actual reliance. This leads plaintiffs to the conclusion that reliance, California, causation, which, is merely one method of proving contend, can be pled by alleging defendants’ misrepresentations had the purpose sell, effect of causing purchase or to whether or not such misrepresentations ever came to plaintiffs’ attention.

It is true that the relevant statutes do not expressly mention element of reliance. Civil Code section 1709 provides only who willfully “[o]ne deceives another with intent to him induce alter his position injury to his risk, is liable for any which damage he thereby suffers.” Nor is there any mention of reliance in Civil Code section defini- offers three tions of “deceit” that may fact, pertain to this case: “1. suggestion, as true, of that which true; is not by [jQ one who does not believe it to be 2. The assertion, fact, true, as a of that which is not by one who has no reasonable true; ground for fact, it believing to be 3. The of a suppression [and] [f] it, one who is bound to disclose or who gives information of other facts which are to mislead likely for want of communication of that fact. . . .”

However, law, like much of our the law of deceit California is not purely it statutory; is a mixture of statutory and common law. Provisions of the Civil Code that law, are substantially same as the common such as the provisions torts, that codify common law “must be construed as contin- thereof, uations Code, and not as new (Civ. enactments.” 5.) Civil Code § sections 1709 and 1710 have been recognized as continuations 1038, 1043, (Lacher (1991) Superior Cal.App.3d law. Court common Thus, statutes it is consistent with those entirely fn. in deceit to actions for always courts have required plaintiffs that California v. Molko (E.g., law element of actual reliance. and the common prove plead 1108; Odell, Assn., supra, 18 Seeger Holy Spirit supra, 46 Cal.3d at v. p. Clark, 444; 414; v. Cal. at Colton supra, at v. 147 p. Spinks p. Cal.2d Co., 383; supra, supra, County 82 v. Sutter Land Stanford, Cal. at Nounnan p. 538; 6-7; v. Cal. Snow Estep supra, v. 69 at pp. Armstrong, p. 81 Cal. assert, Halstead, true, that 361.) It supra, plaintiffs 1 Cal. at be may for in an action can be of as the mechanism of causation reliance thought Court, toBut (Cf. 50 Cal.3d at Superior deceit. Garcia v. does not from the requirement that characterization excuse accept plaintiffs reliance, is to “establish specific necessary of since pleading pleading and alleged causal between the complete relationship” (Ibid.) the harm claimed to have resulted therefrom. 1711, obviate rely,

Nor does Civil section also Code who the need to reliance. The section plead provides or prove “[o]ne a deceit or a class of with intent to defraud the practices public, particular class, in that every is deemed to have intended defraud individual persons, here, it relevant who is misled the deceit.” the extent be actually To with false the statute out that one who makes simply points representations in intent victim any particular Litigants fraudulent need not have mind. (See Slakey on section 1711 must still actual reliance. rely plead prove Sacramento, 204, (1968) Brothers Inc. v. Parker 265 207-210 Cal.App.2d insufficient]; v. of cf. Wennerholm Cal.Rptr. [pleading reliance [71 269] 713, (1942) Med. Cal.2d P.2d University Sch. 20 716-717 [128 Stanford sufficient]; 45 A.L.R. Block Tobin [pleading 1358] [same]; see v. Schmidt also Schell Cal.App.3d 288] (1954) reliance P.2d Cal.App.2d [proof 82] 287-289 insufficient]; cf. Murphy (1955) Nathanson v. 369-370 Cal.App.2d sufficient].) P.2d [proof 174] reliance Plaintiffs actual argue require proof pleading The would render meaningless. provi another the Civil Code provision in question, damages sion section the measure of for “[o]ne defines ordinary defrauded sale or . .” The purchase, exchange of . . property damages measure of cases is difference between actual value such “the of that with which the defrauded and the value of that person actual parted received, which he with from the together damage arising additional any However, Code, 3343, (Civ. (a).) lost particular transaction . . . .” subd. § relied on are also when profits reasonably available defrauded party “[t]he the fraud from entering into transaction and anticipating profits (a)(4)(ii).) use or subsequent (Id., sale of subd. property.” § additional “reliance for requirement Plaintiffs statute’s argue were would if . . . actual damages meaningless subjective if statute in all merit required might fraud cases.” have argument the fraud relied on that the defrauded have only “reasonably said must party However, statutory one of the into the transaction.” entering only full, provides the statute lost recovery of read prerequisites profits; “reasonably defrauded party that lost are available when the profits only anticipating profits entering relied on the fraud in into the transaction and in Code, 3343, (Civ. subd. subsequent property.” use or sale § from (a)(4)(ii), added.) in a fraudu- italics one can Obviously, purchase property lent transaction without the use or resale. anticipating property’s from profit Therefore, the the eliminating statute cannot be read as element of plausibly reliance from the tort of deceit. on this

Finally that actual reliance cannot point, plaintiffs argue be an element logically of a cause of action deceit for based on an omission because it is to demonstrate reliance on that one was impossible something not told. In argument, cite v. support Ute plaintiffs Citizens Affiliated States, bank, United supra, 406 (Ute), U.S. 128 which the of a officers which served as the agent transfer for a Native American corporation assets, holding tribal purchased from shares individual members tribe in face-to-face transactions without conveying cautionary information their duties required them to convey without informing sellers they, the buyers, (Id. were at profiting. 759-762].) 150-154 pp. L.Ed.2d pp. Ob-5, Interpreting Rule 1 high held court “positive proof is not a to prerequisite recovery” case a failure “involving primarily to disclose . . (406 . .” U.S. at 153 L.Ed.2d at p.

We see no reason to adopt Ute presumption California law. Con- assertion, to trary it plaintiffs’ is not logically impossible prove reliance that, an omission. One need only prove had the omitted information been disclosed, one would have been aware of it and behaved differently. More- over, below, as we shall explain the body of law that has developed under Rule 10b-5 is not sufficiently analogous to law fraud its justify importation into the latter.4 4It also deserves mention that federal have courts identified two practical problems serious First, the Ute presumption. created “through pleading, ‘every clever fraud case based on ” misrepresentation

material (Gruber facilely be turned into a material [can] omissions case.’ Cantor, Price 1044, Waterhouse (E.D.Pa. 1991) 1050, v. F.Supp. 776 Beck quoting v. Fitzgerald & Co. (N.D.Ill. 1985) F.Supp. Second, the Ute presumption it makes difficult to allocate the proof burden of in cases that reason, involve both misrepresentations and omissions. For this the federal do courts uniformly apply opinions holding the Ute presumption Compare such cases. Permitting

2. Decisions a Class-wide Reliance. Inference of In two cases consumer class actions we held that it involving would infer each member of a class had relied on appropriate actually (1971) alleged (Vasquez Superior defendant’s Court misrepresentations. Cal.3d [Vasquez]; 814-815 484 P.2d Occidental Cal.Rptr. 964] Land, Superior Inc. v. Court 18 Cal.3d 362-363 [134 Land]) P.2d The each case plaintiffs specifi 750] [Occidental that the defendants had made each cally pled identical representations class member. these decisions do an Accordingly, argument not support reliance on the presuming part of who never read or heard persons alleged such as in the misrepresentations, case before us. plaintiffs plaintiffs Vasquez, supra, Cal.3d who had frozen purchased contracts, food freezers on installment that the sellers had alleged and value misrepresented of the merchandise. We held that the had actual reliance adequately pled and that the action could be maintained as a properly class action. We reached these conclusions because had pled actual reliance on an individual and basis because reliance, case, under the the peculiar facts of was a common issue. This truly was because plaintiffs asserted that “they demonstrate [could] [that the] were in misrepresentations fact made to each class member without individ- ual testimony because the salesmen defendant employed by [the seller] memorized a standard statement (which in containing representations turn were manual) based on a narrative and printed sales and that this statement was recited rote by (Id. member every of class.” at pp. 811-812.) Land,

The facts of Occidental supra, 18 Cal.3d are similar. The had plaintiffs, who in purchased houses a subdivision and sold developed by defendant, alleged that the defendant had misrepresented future cost certain maintaining common areas. Relying Vasquez, supra, on Cal.3d 800, we held that actual reliance was a common issue and that the trial court did thus not abuse its by discretion certifying action as a class action. We because, reached this conclusion as Vasquez, that the plaintiffs alleged defendant’s had misrepresentations been made actually to each member of Indeed, the class. the misrepresentations were contained a public report, presumption inapplicable whenever the pleadings disclose misrepresentations both and omis- (Cavalier 749, 753-757, sions Carpets, Caylor (11th Inc. v. 1984) Cir. 746 F.2d v. Sheftelman (N.D.Ga. 859, 867-868, 1987) Co., Jones Cantor, 667 F.Supp. Beck v. & Fitzgerald supra, 621 F.Supp. 1556-1557), opinions holding with proof that the burden of on issue of reliance must be case-by-case determined on a Lybrand (3d (Sharp Coopers basis & Cir. 175, 186-189, 1981) F.2d Waterhouse, Gruber v. supra, F.Supp. pp. Price at 1050-1051). state obligated writing and to read and report was purchaser “[e]ach 358; Land, see id. (Occidental that he so.’’ 18 Cal.3d also supra, had done 359, 363.) at pp. Land,

Plaintiffs, Occidental Vasquez misinterpret and rely heavily that we pleading proof those decisions. Plaintiffs “held argue where direct each of a fraud material required reliance victim are reliance, that, are absence actual misrepresentations alleged” doctrine, reliance fraud-on-the-market pled equivalent be of the “by i.e., class, with material to the action consistent misrepresentations plus fact, In we held What we did hold thing. thereon.” no such that, actually was been when same material have class, as communicated to each inference reliance arises member an Land, 9; the entire (Vasquez, class. Cal.3d 814 & fn. Occidental supra, at p. 358, 359, mean that actual 18 Cal.3d While this does pp. reliance can when each member has proved on a class-wide class basis read or heard the same so much nothing either case misrepresentations, hints that a plaintiff may alleging cause of action for deceit without plead actual reliance.

3. Indirect Communication Cases. not, next argue Plaintiffs need order to state a cause of action deceit, plead were alleged misrepresentations communicated to Instead, them directly by defendants. according to indirect com- plaintiffs, valid, munication suffices. While the it does not these principle help plaintiffs, who cannot that the plead alleged ever came their attention. 533,

The Restatement Second of Torts section articulates the rele vant in this “The maker principle way: of a fraudulent misrepresentation is subject to liability for pecuniary loss to another who justifiable acts reliance it if the upon misrepresentation, although directly not made other, is made to a third and person the maker intends or has reason to expect that its other, terms will be or repeated its substance communicated to and that it will influence his conduct in the transaction type transac tions A involved.” few cases this state expressly section 533 apply Porsche/Audi, (Varwig v. 578, Anderson-Behel (1977) Inc. 74 Cal.App.3d 581 539]; Cal.Rptr. [141 Barnhouse v. City (1982) Pinole 133 Cal.App.3d 171, 191 Cal.Rptr. 881]), and [183 several cases that section 533 predate apply that the principle (American section restates T. Co. v. California 42, etc. (1940) Ins. Co. 497]; 15 Cal.2d 67 Crystal P.2d Pier [98 Amusement 184, Co. v. (1933) 839, Cannan 219 1357]; Cal. 188 P.2d A.L.R. 91 [25 1096 1090]; (1925)

Hunter v. 197 Cal. P. Massei v. 185 [239 McKenzie 232]; (1967) Pugh Lettunich 248 73 Harold v. Cal.App.2d [56 112]; (1959) 174 McKee 608-609 P.2d Simone v. Cal.App.2d [345 667]; (1956) 142 Murphy, 313-314 P.2d Nathanson v. Cal.App.2d 363, 368; (1954) 124 supra, Schilling 132 Wice v. Cal.App.2d Cal.App.2d 231]; 745 P.2d v. Williams 109 Cal.App.2d Strutzel P.2d These cases offer no assistance. As the of the Restate- language indicates, ment who hears an plaintiff alleged misrepresentation indirectly Torts, (Rest.2d 533.)5 “justifiable must still show reliance it. . . upon § The need to show reliance is confirmed this state by opinions claims for deceit based indirect addressing communications. Inc., Porsche/Audi, supra,

The plaintiff Varwig v. Anderson-Behel an used car dealer Cal.App.3d (Varwig), automobile from a purchased when a who claimed to have clear title. The claim to be erroneous proved lienholder and the seller’s car. Plaintiff sued both the seller repossessed seller, who was also an automobile dealer. The the latter’s granted trial court motion for reversed. Based on summary judgment, but Court of Appeal dealers, the circumstances of the transaction between two contem consumer, the car’s eventual resale an plated implicit, to a the court found fraudulent, representation dealer that the dealer by selling buying was a transferable title. Because it receiving was foreseeable buying dealer would repeat the court held that the false claim misrepresentation, “in of title was law an indirect misrepresentation plaintiff, purchased the car (Id. of the upon repetition representation.” [the seller’s] Pinole, The facts City of Barnhouse v. Cal.App.3d defendant, (Barnhouse), The are similar. built houses property developer, on landfill the bed of a diverted stream. The knew that the houses buyers fill stood on but were told that the had taken remedial measures developer recommended an engineer. buyers did not know that the developer had not the engineer’s followed or that there were plan other soil drainage One problems. buyer resold his house to the sued the plaintiff, who developer for deceit. The trial court granted motion for a developer’s nonsuit. The Court of Appeal Varwig, supra, reversed. 74 Following reason, comment plaintiffs 5For this derive no assistance from a in Restatement indicating person a who makes a misrepresentation agency to a credit in order to obtain Torts, rating a favorable persons rely (Rest.2d credit is liable to agency’s report. who on the 533, (f).) communicated misrepresentation com. While the § in such a case need not be verbatim, only the defendant is liable to a plaintiff justifiable upon “who acts in reliance it (Id., 533.) ....’’ §

1097 Torts, 533, the court Restatement Second of section Cal.App.3d the developer’s incomplete had relied on indirectly reasoned plaintiff had defendant original buyers. Varwig, As representations there and that subsequent reason to would be expect purchasers buyers repre would the defendant’s original repeat fraudulently incomplete (Barnhouse, at supra, sentations about the 133 property. Cal.App.3d pp. 191-193.)

These decisions do not this case. To support plaintiffs’ position that a a say plaintiff relies on secondhand can state of action deceit reliance be cause for is not say presumed, contend. finds no plaintiffs Certainly support presumption one Bamhouse, received tibe same Varwig from misleading communications that the had received original purchasers the defendants.

Nor do the decisions that of the preceded section 533 Restatement Indeed, Second Torts that reliance can suggest each decision presumed. holds that actual expressly reliance is The rule typically stated required. such ‘“A language as this: made to one with the representation person another, him, intention that it shall reach the ears of and be acted upon by him, and which does reach and is acted him upon by injury, to his gives person so it the acting same relief if upon right to or redress as it had been ” Cannan, made him directly.’ Pier (Crystal supra, Amusement Co. v. 219 p. Cal. at Henry (1901) v. 24 quoting Dennis 95 Me. A. 60] added]; Co., see also T. [italics American Co. v. Ins. 15 supra, etc. California 67; McKenzie, 185; Cal.2d at p. Hunter v. supra, 197 Cal. at v. p. Massei Lettunich, 73; supra, 248 at Cal.App.2d p. Pugh, Harold v. 174 supra, 608-609; McKee, at Cal.App.2d pp. Simone v. 142 supra, at Cal.App.2d pp. 313-314; 368; supra, Nathanson v. Murphy, 132 at v. Cal.App.2d p. Wice Schilling, 745; supra, Williams, 124 at Cal.App.2d Strutzel Cal.App.2d cases,

In fewa courts this state have found under the liability common law for misrepresentations not actually communicated the plaintiff. These however, cases do not assist these plaintiffs, because the courts that decided the cases relied on expressly agency rather than the principles concept fraud on the (Grinnell market. v. Charles (1969) & Co. Pfizer 424, 441 Cal.App.2d [Grinnell]; Cal.Rptr. Toole v. Richardson- 369] Merrell Inc. (1967) Cal.App.2d 29 A.L.R.3d [Toole]; Roberts v. 988] Salot P.2d Cal.App.2d 301 [333 [Roberts].) Grinnell and 232] Toole were man- against suits pharmaceutical ufacturers brought by plaintiffs who product-related had suffered injuries. in The court each case held that the had read heard the plaintiffs, manufacturers’ could nevertheless sue of representations, express for breach did warranty because the who administered the physicians pharmaceuticals and, so, on the in had rely representations doing acted as the plaintiffs’ 441; Toole, (Grinnell, agents. supra, supra, at Cal.App.2d p. Roberts, 707.) at Similarly, supra, the court Cal.App.2d Cal.App.2d 294, a in which lender case a made to a owner’s misrepresentations property “agent,” held that fraud simply agent] by worked upon misrepre- “[a] [the sentation or silence was worked her he right and has a upon principal (Id. 300.) action for redress.” at p.

Plaintiffs also rely on Committee on Children’s opinion Television, Corp. (1983) Inc. v. General Foods 35 Cal.3d 197 (Children’s Television). 673 P.2d The a case involved complaint 660] against entities involved and manufacturing sugared advertising breakfast cereals intended for among children. other plaintiffs alleged, that the things, defendants their fraudulently represented consumption products benefited a child’s health. The trial court sustained defendants’ demurrers to the On complaint. the defendants appeal, argued plaintiffs had not reliance on the adequately pled alleged misrepresentations children, because “one a group, [had] receive[d] different group, parents, (Id. at purchase[d] product.” [had]

The court disposed defendants’ a objection single, enigmatic sen- tence whose interpretation has considerable debate. To spawned avoid para- debate, phrasing language way might fuel the we unintentionally sentence, concludes, shall quote as well as the it in full: paragraph “Restatement Second of Torts section states that maker of a ‘[t]he fraudulent misrepresentation subject to liability ... to another who acts in justifiable reliance if it upon not made misrepresentation, although other, to the directly is made to a third and the person maker intends or has reason to that its expect terms will be or its repeated substance communi- other, cated and that it will influence his conduct.’ This proposition [ejndorsed was as California law in Varwig [supra, 74 Cal.App.3d p. 581]. We recognize that it does not cover the quite present do not case—plaintiffs allege children to their repeated representations and we parents, not, would imagine that most cases did but their simply expressed however, desire for the product. Repetition, prerequisite should not be a liability; it should be makes misrepresentation sufficient defendant group one intending to purchaser, the behavior the ultimate influence Television, that he plan." (Children’s succeeds in this Cal.3d at p. added.) italics in many not so adopting,

Plaintiffs read Children’s Television as albeit words, the Children’s According fraud-on-the-market doctrine. to plaintiffs, " the if it is sufficiently alleged Television that reliance is recognizes pled it, of segment defendant made to the a marketplace, or and he ‘intending to influence the of the ultimate purchaser, behavior ” however, believe, in Tele succeeds this We not that Children’s do plan.’ a If intended to supports actually vision such the court had proposition. the such a drastic to settled on a as change point important announce law deceit, in the nature of reliance an one expect action would to see and announcement of the new rule to be with reasons the citation supported sentence, Instead, authority. single one finds only unsupported in . . . reasoning authority language: “Repetition tentative phrased (35 219.) should not be a . . .” Cal.3d at prerequisite liability p. to . circumstances, Under these we Televi- cannot read Children’s responsibly sion the if way interpre- would have us read it there is a narrower plaintiffs Indeed, that is an tation consistent with the case. there is holding the such The court’s reference the interpretation. to section 533 of Restatement the Varwig, supra, Second Torts and even Cal.App.3d though court noted that the stated in principle quite those authorities “d[id] the (35 219), cover case” present Cal.3d at strongly indicates that holding was based on the of an idea indirect Rather than representation. speculate court intended to the fraud-on-the-market adopt doctrine silentio, sub stays one closer the actual reading to of the language opinion by it as recognizing, simply, that children cannot expected convey repre- Indeed, sentations about products precision. with says exactly opinion this explaining why did not need to set out their complaint precise language each allegedly false advertisement: “Children are particular unlikely to recall the specific advertisements led them to desire . product. (Ibid.) . .”

Nor do plaintiffs derive much support from another decision on which In re heavily rely, Equity Funding Corp. Amer. Sec. Litigation (C.D.Cal. Lucas, 1976) 416 F.Supp. J.) 161 (opn. by (Equity It Funding). true that the federal court in that case denied motion defendants’ to dismiss a claim for common law deceit a securities fraud action and complaint, from judging its description did not opinion, appear Instead, actual allege reliance by each plaintiff. plaintiffs alleged that defend- “ had ants disseminated false statements ‘for the purpose effect of influencing and manipulating price of securities and for Equity Funding and with the purpose effect of influencing market open purchasers of ” securities (Id. such purchase [the] securities.’ at

We do not read opinion Equity Funding as purporting adopt law, fraud-on-the-market a matter theory as of state for several reasons. First, in the the discussing adequacy claim for deceit the plaintiffs’ court did not even the mention let alone theory, suggest an intent to it. The adopt effect,’ court said only that the plaintiffs’ “allegation of ‘purpose with the clear coupled of the materiality satisfies misrepresentations alleged, the reliance and causation requirements on that imposed pleadings assert fraud in claims (Equity Funding, supra, 183.) California.” F.Supp. Second, the fraud-on-the-market doctrine was well in not established federal system at the time. The cited opinion generally as introducing doctrine, Barrack, Blackie v. supra, 524 F.2d preceded Equity Indeed, Funding decision by only four months and was not cited the latter. it has been observed that widespread acceptance of the doctrine the lower federal courts (Basic cannot be earlier placed any than 1982 or Inc. v. 1983. Levinson, 250-251, supra, 485 U.S. at (conc. fn. pp. L.Ed.2d at p. 220] White, Third, & dis. opn. J.).) and most it was not the federal importantly, court’s role to effect changes (Erie state law. Tompkins R. Co. v. is, thus, 304 U.S. 64 L.Ed. 58 S.Ct. It unrealistic to construe the court’s opinion purporting intending to do so.6

B. Should the Law Be Changed?

Having determined that California law does not to permit plaintiffs state a reliance, cause of action for deceit without actual pleading we next consider plaintiffs’ arguments for changing the law by incorporating fraud-on-the-market doctrine.

Plaintiffs argue first that the proposed change is necessary to a provide unfair, contend, for victimized remedy investors. It is to require 6The argues dissent the majority concept “restricts indirect reliance” extending it to cases in which plaintiff nothing knows about purchasing the securities he is dissent, beyond their price. market According to the courts have extended liability to “those situations intermediary which an conveyed has the misrepresentation in the form of a certification, recommendation, rating, Kennard, J., price.” (Dis. or market post, opn. of ante, As we have already explained (see 1095-1100), pp. the relevant authorities do not support the dissent’s position. Nor in Learjet Corp. Spenlinhauer opinion (1st does the Cir. 1990) (cited Kennard, J., 901 F.2d opn. in dis. post, pp. 1117-1118), a less clearly relevant case on which the dissent also relies. The Learjet, federal court applying law, Kansas held that the buyer of an airplane had stated a cause of action for fraud based on allegation that the craft’s manufacturer had made certain representations the Federal Aviation Administration in order to have it (901 200-204.) certified as airworthy. pp. F.2d at Learjet says nothing doctrine, about the fraud-on-the-market and no court has relied upon Indeed, that case to justify the adoption. doctrine’s the case In inapposite. is contrast to a certification, governmental which necessarily implies particular representations re- quired made, to obtain the certification have been price necessarily implies only market buyer some willing pay quoted price. it is that stock widely accepted of actual reliance because proof pleading information, Under whether true or false. reaction material prices adjust circumstances, actual according plaintiffs, requirement these who have relied on the penalizes innocently reliance investors merely of the but demonstrate integrity particular market cannot misrepresentation.

We not in adjust do doubt that stock to the dissemination prices response However, will of material information.7 it does not follow that investors be left without a we remedy unless fraud-on-the-market doctrine. adopt Investors, case, in have under including already this remedies plaintiffs federal and law state that do not or of actual require pleading proof 10b-5, mentioned, reliance. Rule which we already have affords both a private of action federal court a right 10b-5, (See Basic Inc. v. of reliance. Rule presumption as interpreted Levinson, supra, 485 U.S. at 214-218].)8 241-247 L.Ed.2d at pp. pp. [99 Indeed, mentioned, as we have also a class action lawsuit under Rule 10b-5 based on same events involved this case has been filed federal imply 7This statement does not acceptance rejection capital of the or so-called “efficient markets hypothesis,” which is give support sometimes invoked to theoretical to such state Levinson, (Cf. ments. Basic v. supra, Inc. U.S. at pp. pp. 246 L.Ed.2d at [99 217-218], pp. fn. 24 L.Ed.2d at [adopting a of presumption reliance under 217-218] but endorsing any Rule 10b-5 not particular theory]; p. economic id. at at p. L.Ed.2d White, (conc. economists, J.) & opn. dis. of experts 222] no staff no in the schooled [“with ‘efficient-capital-market-hypothesis,* ability no to of validity empirical test the market stud ies, we not equipped are well to embrace novel constructions of statute based on contem porary microeconomic theory”].) 8The federal may courts surprised be to employ read the dissent that “do not presumption of reliance to determine the existence of a cause of action” in fraud-on-the- Kennard, J., brought (Dis. added; market cases under rule opn. p. 10b-5. of post, italics Levinson, compare Basic v. Inc. supra, 485 U.S. at at p. L.Ed.2d 218] [“an investor’s any reliance on public material . may presumed . . purposes action”].) of a Rule 10b-5 It is hard to understand why dissent asserts the fraud-on-the-market doctrine does not involve a presumption Perhaps of reliance. attempting play dissent is to down the significance event, of proposal adopt its any wrong: doctrine. In the dissent is The federal do presume courts reliance to determine the existence of a cause of action. Reliance at common law has two components—awareness misrepresentation of the and action based thereon. plaintiff The in a fraud-on-the-market case Rule required prove under 10b-5 is not Barrack, component. (Blackie the first supra, v. pp. 905-906.) 524 F.2d at That is one sense This, course, presumed. in which reliance is exactly presumption that the dissent would adopt part of the common law of deceit. That the dissent chooses to call it a presumption is of no consequence. Federal courts in fraud-on-the-market cases presume under Rule 10b-5 reliance in another sense as well. The plaintiff in such a prove case must component the second law common that, securities, reliance: but misrepresentation’s for the effect on the of the would he not have traded them. Federal courts call this element both “reliance” and “transaction causation,” using the interchangably. (9th terms v. (McGonigle 1992) Combs Cir. F.2d al., Plans, Inc., No. supra, Dock. et (Zucker, et al. v. Maxicare Health

court. CV-88-02499.) under the antifraud provisions also sue

Defrauded investors without the market that affect law for misrepresentations state securities Code, 25500.)9 very (See reliance. Corp. actual proving §§ fraud with a of securities to “afford the victims of these statutes is purpose law fraud.” common task of proving without formidable remedy (Bowden Robinson, at 67 Cal.App.3d person “a or other

Under it is unlawful for broker-dealer section security, selling offering offering purchase [a] or for sale or or purchasing make, security by sale of such for the purpose inducing purchase others, was, the circum- light the time and any statement made, any misleading respect stances under which it with was false or fact, in order necessary material fact any material or which omitted to state made, under which in the of the circumstances light to make the statements made, he knew or had reasonable were not and which misleading, 25400, (d), italics (§ subd. misleading.” to believe was so false or ground added.) 25400 have an express, private

Investors harmed a violation of section by who “[a]ny which that provides person of action under section right 25400 violation of Section act or transaction willfully participates any at a security sells any shall be liable to other or any person purchases damages for the sus- by which was affected such act or transaction price (§ 25500.) tained the latter a result of such act or transaction.” by as written, avoid “conspicuously as one has Sections 25400 court ” Robinson, (Bowden supra, 67 ‘actual reliance.’ v. of requirement [] Olson, Securities Corporate at Cal.App.3d p. quoting California 810, 821, . . but this fn. 10 courts refer to transaction causation as ‘reliance’ . [“[s]ome semantic”].) merely distinction is That, course, also of was presumed. “Reliance” in the sense of “transaction causation” is 247; v. precisely holding (supra, of Inc. v. 485 at see Malone Basic Levinson U.S. causation, sense, [“[tjransaction (E.D.Va. 1993) Microdyne Corp. 148 158 in this F.R.D. ‘reliance,’ and, therefore, thing is same as if the precisely opinion used in the Basic theory applicable, ‘fraud on the market’ found to be transaction causation must is “reliance,” sense, presumed”]). may disprove by showing The defendant in this that plaintiff engaged despite would have in the same securities transactions the defendant’s However, mean, asserts, misrepresentation. presumption this does not as the dissent that a only a cause means that the employed reliance is not to determine the existence of of action. It 248-249, Levinson, (Basic supra, U.S. at 250 presumption pp. is “rebuttable.” Inc. 218-220].) pp. L.Ed.2d at Corporations 9All further citations to statutes are to the Code unless otherwise noted. (1968-1969) (Olson).) The princi- 9 Santa Clara L.Rev. Law 1968 way: have their effect this drafters these statutes summarized pal rely upon “There is no under these sections that requirement plaintiff acts the defendant or even that he be aware statements or defendant made them or in them. All that is that the engaged required is he establish that the which or received was affected plaintiff paid statements, the defendant’s conduct or which would of course assume that However, someone acted on the basis defendant’s conduct. wrongful it not he influenced necessary personally was plaintiff prove Volk, (1 Practice the Cal. Securities Law by such conduct.” Marsh & Under 14.05[6], 14-53, (1993) omitted.)10 fn. § remedies,

These statutory do require plead prove reliance, actual can be asserted there is little Accordingly, class action. force we law plaintiffs’ argument reshape should of deceit simply in order “to remove to the effective unnecessary pleading [an] barrier[] Television, (Cf. utilization of class action procedures.” Children’s Cal.3d at an 217-218 avoid pp. unreasonably lengthy complaint, plain- [to tiffs attach a representative selection from a of advertisements pro- longed extensive media La Sala v. American Sav. & Loan campaign]; 864, 875, Assn. Cal.3d fn. 10 489 P.2d 1113] [an inappropriately class need if alleged definition class certification prevent in certification].) case fact satisfies the prerequisites argument for in any event: misplaced Actual reliance is requirement; more than a pleading observed, it is an element of the tort of deceit. As we have previously are actions only “[c]lass as a means to enforce provided substantive law. Altering the substantive law accommodate to would to procedure confuse the means with the ends—to the goal (City sacrifice for the going.” San Superior 447, 797, Jose v. (1974) 12 Court Cal.3d 462 525 Cal.Rptr. [115 701, P.2d 1223].)11 76 A.L.R.3d Marsh, Jr., 10Professor Harold reporter was the for the committee that drafted the California 1968, Corporate Securities Law of which includes 25400 sections and 25500. Robert H. Volk was of Corporations Commissioner at that time. 11The same principle disposes argument of plaintiffs’ we expand that should the law of fraud to afford them procedural the benefit of they other state rules perceive that as more rules, favorable than the corresponding federal (a) such as: may require rule that court (Civil pay defendant to the cost of to Employees Service Ins. Co. notice the class v.

Superior Court (1978) 362, 360, 497]; 22 Cal.3d cf. Eisen 374-381 P.2d v. Cal.Rptr. 584 [149 Carlisle & Jacquelin 156, (1974) 732, 748-749, 417 U.S. 177-179 L.Ed.2d S.Ct. 2140] 94 [plaintiffs notice]); (b) must bear the cost of denying the rule that orders class certification are Industries, appealable (Richmond immediately 462, v. Dart (1981) Inc. Cal.3d 23]; cf. Coopers Lybrand & P.2d Livesay 437 U.S. 468-477 351, 357-363, L.Ed.2d 98 S.Ct. denying subject class to 2454] [orders certification not interlocutory (c) appeal]); and plaintiffs rule that a can on recover less-than-unanimous and 25500 is that their under sections 25400 remedy Plaintiffs assert coex- under the sections is not liability precisely It is true that inadequate. However, the statutory under Rule 10b-5.12 state liability tensive with sugges- as limited as to suggest. Contrary plaintiffs’ is not remedy plaintiffs for remedy sections 25400 and 25500 do argument, provide tion oral transactions, i.e., in with aftermarket resales of securities fraud connection in a after have from the purchased issuing corporation public been with connection liability only To read the sections as offering. imposing broadly with the which statutory language, issuer transactions is inconsistent or person offering “a or other or for sale selling refers to broker-dealer (§ italics . . . .” purchasing offering security to purchase added.) that addressed knew how to write a statute Clearly Legislature (See intended do. only issuer transactions when that was what it § in an security is unlawful offer this state any person any or sell [“It .”], added.) issuer transaction . . . italics correct, it under sections liability

Nor is also suggest, and the 25400 and 25500 of contract between the requires privity plaintiff defendant. The also knew how to write a statute that conditioned Legislature In did these liability Legislature just section 25501 privity. person words: who violates Section 25401 shall be liable to the “Any person (§ him . . . .” purchases security security who him or sells a from limitation; contrast, added.) italics such it Section contains no more provides broadly “[a]ny willfully any who person participates any act other or transaction violation of Section 25400 shall be liable to person purchases any security or sells at a was affected words, (§ added.) In such act or transaction . . . .” italics other “[ujnder Section 25501 the defendant is liable with whom only person deals; whereas, he under Section 25500 the defendant be liable to any Volk, 14.05[2][e], (1 in the & person trading market. . . .” Marsh § 14-50; Olson, 98.) at see supra, also 9 Santa Clara L.Rev. at p. p. Plaintiffs that out to the fraud-on-the-market doctrine point incorporate into the common law of deceit would those that advantages beyond afford the relevant statutes such as a and the provide, longer period right limitations However, to recover we have in recent punitive damages. emphasized decisions that courts “should hesitant when tort to ‘impose [new duties] Proc., 618; Proc., (Code jury verdict [requiring Civ. cf. Fed. Rules Civ. rule 48 a unanimous § parties stipulate’’]). verdict otherwise “[u]nless 12Contrary suggestion, imply the dissent’s we do not hold or that sections 25400 and Kennard, J., “give plaintiffs equivalent (Dis. opn. 25500 the state of of a rule 10b-5 action." post, p. 1122.) respects The state and federal and different remedies are alike some necessarily others. Nor do we about how the state suggestions endorse the dissent’s other interpreted. statutes should be

1105 [citation], when do involve complex policy especially so would decisions’ subject such decisions are more deliberation legislative appropriately (1990) 51 (Moore University and resolution.” v. Regents California 120, 146, 479, 3659], Cal.3d 136 P.2d A.L.R.4th quoting 793 Cal.Rptr. [271 278, Community (1988) Nolly Cal.Rptr. v. Grace Church 47 Cal.3d 299 [253 97, Droeger 763 P.2d set of brackets in see also v. original]; 948] [first Friedman, Sloan & Ross 54 41 812 Cal.3d Cal.Rptr. 931]; P.2d & Foley Corp. (1988) v. Interactive Data 47 Cal.3d fn. has force 765 P.2d This admonition particular fraud, area, when the plea to concerns an such securities expand liability tiie Legislature already has acted. Indeed, ex through that advantages plaintiffs would obtain panded under the with several liability common law to conflict appear specific legislative choices. policy

Plaintiffs, for sue the law deceit example, prefer would under because the statute of that favor- limitations such claims is more applies able to than the limitation claims under state periods applicable to Proc., and federal law. (Compare securities Code Civ. years § [three after fraud], Code, discovery of the facts with constituting Corp. § after year discovery [one or years four after act the viola- constituting tion]; Pleva, Lampf, cf. Lipkind, Prupis Petigrow (1991)_ & v. Gilbertson U.S._ [115 L.Ed.2d 111 S.Ct. [adopting a limitations one-year 2773] However, period without equitable tolling 10b-5].) actions under Rule the shorter limitations in the period Corporations Code was specifically intended to counterbalance the tremendous that a advantage presumption Robinson, reliance affords (Bowden to plaintiffs. v. supra, Cl at Cal.App.3d p. Because the “statutory liabilities some instances be based on fraud, lesser degree of fault than common law it is also important businesses be freed from potential liabilities of in order indefinite duration with corporations may determine some reasonable what their certainty financial situation is as of any given of time. point only This is important to the corporation and its officers and directors but also to all of its shareholders and to persons generally interested in buying selling its Volk, (1 14-66; shares 14.08[l][a], market.” Marsh & cf. p. § Pleva, Lampf, Lipkind, Gilbertson, Prupis & Petigrow supra,_U.S. at p. — L.Ed.2d at S.Ct. at [observing “policy 2780] considerations implicit any provision”].) [are] limitations

Plaintiffs would also sue prefer to under the law of deceit because that law, in laws, contrast to the applicable securities an award of permits However, punitive damages. the failure of the laws securities to authorize punitive damages appears to reflect another deliberate policy choice.

While the courts of this state have not had occasion to comment on available, reasons did not make there why Legislature punitive damages is extensive on the reasons the federal has not commentary why judiciary made damages available under Rule 10b-5. The state punitive provisions (1 were drafted and “in the light should be considered of this experience.” Volk, [3], 14-15.) Marsh & 14.01 In federal supra, at summary, § decisions reflect a longstanding consensus “the burden on the securities business from . . . their to en punitive damages outweigh[s] contribution (Carras 1975) (4th forcement of securities laws.” v. Burns Cir. 516 F.2d 260; 18; Corporation, supra, see also Green v. 406 F.2d 303 & fn. Wolf 679, 695; (E.D.Va. 1990) Vicente v. v. Obenauer Baumel F.Supp. Diaz (4th 1969) 576.) Rosen Cir. F.2d

Punitive can or as damages justified be as a deterrent measure only However, retribution. the additional federal decisions explain, deterrent value of needed in this area punitive damages does to be appear alone, for several The first reasons. reason is that actual damages, represent (See securities fraud Green v. potentially crushing liability cases. Wolf Corporation, supra, 18.) 406 F.2d at & fn. Under the p. 303 fraud-on-the- doctrine, market which can Rule and state invoke both under 10b-5 (§§ 25500), securities law “the any defendant be liable to may person in the trading market for time that the market have any length may Volk, 14.05[2][e], been affected his (1 misstatement.” Marsh & § mechanism, 14-50.) second reason is that the class action individuals, litigation makes affordable for tends to ensure that the securities laws will be enforced. Because device this small procedural many “allow[s] action, claims to the same litigated overall size of compensatory alone damages (deHaas constitute a deterrent.” significant Empire 1223, 1231; Company (10th Petroleum 1970) Cir. 435 F.2d Green v. Wolf Corporation, supra, 303.) 406 F.2d at p.

Nor is it clear that are punitive damages needed as a retributive measure. Both federal and state laws strongly society’s express disapprobation securities fraud through (15 78ff(a) criminal sanctions. U.S.C. [providing § for million]; for imprisonment $2.5 to 10 up years fines of up 25540, 25541 for [providing §§ to 5 imprisonment up years fines of $250,000].) toup (15 Federal and state laws also for civil provide penalties. 78ff(c); U.S.C. § § are, moreover,

There good reasons not to combine a cause of action that deceit, an permits award of such as common law with the punitive damages, An fraud-on-the-market doctrine. assessment of the defendant’s culpability, for the purpose setting damages, would take punitive presumably into

1107 on the market. account the total effect of the defendant’s However, and “if may juries sue several lawsuits are separately, the same defendant for the same damages against able assess punitive transaction, (deHass Empire there is a of Petroleum danger overkill.” Company, F.2d at supra, 435

Also worth the considering punitive damages is effect of prospect might have on the settlement value As the marginal high of claims. court noted a to sue under limiting decision class investors permitted Ob-5, “[tjhere 1 Rule under recognition litigation has been widespread Rule 10b-5 and presents danger degree of vexatiousness different Chip Stamps kind from that which in general.” (Blue accompanies litigation 539, 551, Drug (1975) v. Manor 95 Stores U.S. L.Ed.2d [44 S.Ct. difference Chip Stamps].) The main is reason for the 1917] [Blue doctrine, reliance, which, ffaud-on-the-market by creating presumption both encourages aggregation plaintiff’s of claims and diminishes addition, burden of In the lawsuit proof. may very pendency “[t]he frustrate or which normal business of the delay activity totally defendant result, (Id. unrelated to the lawsuit.” L.Ed.2d at As a p. 740 “even a little complaint by objective very standards have chance may of success at trial ahas settlement value to the of any out plaintiff proportion to its prospect for success at trial as he long so suit from prevent being (Ibid/ resolved him against by dismissal or summary judgment.” cf. Alexander, Do the Merits Study Matter? A Settlements in Securities Class (1991) Actions [arguing, Stan.L.Rev. 497 based an empirical study, that for practical the settlement value purposes of a securities fraud class action is merit].) not a function of To create a cause of action that would offer prospective plaintiffs both the of a advantage of reliance presumption and the prospect recovering punitive damages only could exacerbate the problem.

Finally, to incorporate fraud-on-the-market doctrine into law of deceit would permit avoid plaintiffs to two limitations that important the federal courts have imposed on market-reliance under brought cases Rule actions, first, In 10b-5. such a plaintiff must he plead prove, or she actually purchased sold (Blue Chip securities Stamps, U.S. at and, second, 730-755 pp. 546-560]) L.Ed.2d at pp. defendant had scienter—a of fault than degree greater (Ernst & negligence Ernst v. 677-789, 425 U.S. 194-215 L.Ed.2d Hochfelder S.Ct. & Ernst]). These requirements 1375] [Ernst of actions under Rule 10b-5, like the relatively short limitations ban period on punitive effort, damages, reflect a deliberate guided by judicial with experience cases, securities fraud to balance the advantages associated with a presump tion of reliance against danger of and harassing (See claims. speculative Chip Stamps, supra,

Blue 421 U.S. at pp. 738-749 L.Ed.2d pp. [44 Ernst, 550-557]; supra, Ernst & 425 U.S. at fn. 33 L.Ed.2d at however, 689].) The same requirements, are not necessarily of part Thus, common law of deceit. common law claims based on the permit fraud-on-the-market doctrine would the door to class action lawsuits open based on exceedingly speculative theories. For unhindered example, rules, Chip Blue and Stamps Ernst & Ernst might ground investors sue on the they missed favorable or to sell securities opportunities buy because the market affected was by negligent never heard. such Considering we are reminded prospects, admonition that “ ‘the inexorable broadening of the class of plaintiff sue this area ” Ernst, of the law will result in ultimately (Ernst more harm than & good.’ 214-215, supra, 425 689], U.S. at . fn. 33 pp L.Ed.2d at p. Blue quoting Chip Stamps, U.S. at pp. 555-556].) 747-748 L.Ed.2d at pp.

In summary, to incorporate fraud-on-the-market doctrine into common law of deceit only would about bring difficulties that the state Legislature and the federal courts have apparently attempted to avoid. Nor would the proposed expansion of the common law deceit offer benefits difficulties, sufficient to offset the since the state and federal securities laws offer already remedies that give plaintiffs the benefit of a presumption circumstances, reliance.13 Under these there is insufficient justification for upsetting policy choices existing laws reflect. we Accordingly, decline to do so.

Disposition judgment of Court of is affirmed. Appeal * Arabian, J., Baxter, J., J., Turner, J., and George, concurred. KENNARD, J., Concurring Dissenting. I concur the judgment only to the extent it declines to apply fraud-on-the-market principle claims for negligent In misrepresentation. all other I dissent. respects,

The ffaud-on-the market principle embodies this 1. In an logic: open market, developed securities the price of each security adjusts to rapidly reflect all public information that is material to the value. 2. When security’s false information material to a value security’s is made public, security’s 13Contrary Kennard, (dis. J., to the suggestion dissent’s opn. post, 1121-1123), pp. our analysis any is not based in way on the concept preemption. *Presiding District, Five, Justice of the Appeal, Court of Appellate Second Division assigned by the Chairperson of the Judicial Council. artificially One who 3. inflated or artificially depressed. thereby material false infor- disseminating intentionally a security’s price by inflates who, the market’s integrity on relying defrauds every person mation mechanism, inflated artificially at the security purchases price-setting price. the fraud-on-the-market has endorsed

The United States Court Supreme victims of federal it to routinely apply compensate and courts principle, Because federal securities laws. fraud in actions under brought securities although actual establishing is a means of fraud-on-the-market principle reliance, needed with investing it public indirect and because provides this court prices, fraudulent of securities’ against manipulation protection an and proving it as a valid method of recognize pleading should action for fraud.

I Health of Maxicare This is a consolidated class action shareholders directors, Plans, (Maxicare) Maxicare certain of its senior against Inc. and officers, underwriters, The purchased and accountants. named plaintiffs 1,400 October shares of Maxicare common stock at various times between 17, 1985, all (the and sue on behalf of February They class period). defendants, certain other than common stock or persons, purchased dam- notes of Maxicare the class Plaintiffs seek to recover during period. securities, theories ages, consisting of the loss of value of Maxicare fraud and Because the case comes to including negligent misrepresentation. demurrer, this court after the of the sustaining allegations complaint, below, (Livitsanos Superior summarized are deemed true. Court Cal.4th P.2d Cal.Rptr.2d Maxicare in the engaged is a owned California publicly corporation (HMO’s). During nationwide of health maintenance operation organizations the class it made and common stock. Also period, offerings of notes public the class made during defendants various statements period, public reports shareholders, statements, federal securities financial audit filings, reports, releases, communications, in press and other Maxicare’s they reported assets; net earnings and forecast terms its future business glowing pros- financial, and extolled the and pects; accounting, virtues of its computerized management system. control

These statements were and Maxicare’s public materially misleading. false net and were end earnings assets less than and toward the represented; million, $450 period, class after two acquiring large HMO’s for some Maxicare incurred heavy losses that defendants materially underreported. between the and true discrepancies reported earnings resulted from costs, failure to establish medical adequate reserves for failure to promptly incurred, medical write- report pay costs and failure to make timely downs of will obtained HMO good Contrary acquisitions. public statements, financial, Maxicare’s system accounting, computerized management controls was defective and seriously effectively unable for, or contain the of medical anticipate, provide rapidly increasing costs care, or to Each either knew integrate newly HMO’s. defendant acquired false, were public disregarded statements information recklessly the indicating statements’ or made the statements and falsity, negligently carelessly, without reasonable them true. grounds believing to be

Knowing that their public offering statements would affect the directly securities, and aftermarket of prices Maxicare’s traded defendants publicly omissions, made these “false and positive” statements or assisted or permit- them, ted other defendants to make the effect of for the and with purpose and the and manipulating inflating of the Maxicare notes common prices stock and inducing investors to these Maxicare securities. public purchase statements, As a result of the false positive Maxicare notes common and (NASDAQ) stock traded on the national the during over-the-counter market $1,000 $28 class period prices note and Vi share. When the up per per known, true state of affairs became the Maxicare notes publicly of interim, $lVi and its fell In plunged common stock share. while per Maxicare’s internal were known problems to defendants but not publicly disclosed, certain defendants their liquidated holdings own of over 273,000 stock, shares of Maxicare common from the receiving proceeds $4.6 sales excess of million. were

Plaintiffs of the ignorant adverse facts Maxicare’s busi- concerning ness and financial “In condition. of the securities upon integrity market and the securities and offering and and process, fidelity integrity defendants, facts, superior knowledge of the true ignorance plain- tiffs and other members of Plaintiff class were induced to and did Maxicare purchase securities.” Had that defendants had plaintiffs known information, publicly misstated and failed to disclose material would not have purchased Maxicare securities at the inflated As artificially prices. conduct, a result of defendants’ plaintiffs suffered the loss of value injury by their investments Maxicare securities.

II Reliance is an (Molko Holy essential element of a fraud cause action. v. 1092, Spirit (1988) 46]; Assn. 46 Cal.3d 762 P.2d Cal.Rptr. (1988) Cal.Rptr. 44 Cal.3d 1070-1071 Court Superior Brown v. 470]; America 56 Cal.2d Vai v. Bank 751 P.2d Thus, whether is not presented the issue 364 P.2d fraud, allege prove what a must plaintiff reliance is an element of but establish that element. fraud, that the defendant’s

In reliance is by showing an action for proved the plain- was “an immediate cause” of or nondisclosure misrepresentation Assn., supra, 46 Cal.3d (Molko Holy Spirit tiffs conduct. injury-producing A defendant’s misrepresentation establish that the plaintiff may that in its showing is an “immediate cause” of conduct plaintiff’s have engaged “in all would not probability” absence the reasonable plaintiff (Ibid.) authorities estab- following in the conduct. As injury-producing lish, aof an “immediate cause” a defendant’s misrepresentation did make even the defendant though conduct plaintiff’s injury-producing and even directly though plaintiff misrepresentation plaintiff, never heard or read the words of the precise misrepresentation.

The reliance Restatement Second of Torts the of indirect principle states “The maker way: subject liability this of a fraudulent is to misrepresentation it if the for loss to another who acts reliance pecuniary justifiable upon other, made a third not made to the is to misrepresentation, although directly the will be maker intends or has reason to that its terms person expect other, influ- or its substance the and that it will repeated communicated to ence his conduct the of transaction involved.” transaction or type [or her] Torts, (Rest.2d §

Consistent with the long recognized Restatement this court has position, that a representation directly be actionable even it was not made may though the (American party seeking recovery. T. Co. v. etc. Ins. Co. California 42, (1940) 497]; 15 Cal.2d 67 P.2d Pier Co. v. Crystal Amusement [98 184, 839, (1933) 1357]; Cannan v. 219 Cal. 188 P.2d A.L.R. Hunter 91 [25 176, (1925) 1090].) 197 Cal. A 185 P. is misrepresentation [239 McKenzie actionable, held, no less our have an courts because it was made to originally intermediary conveyed (Varwig who it to the v. party ultimately injured. Porsche/Audi, 578, (1977) Anderson-Behel Inc. 74 580 Cal.App.3d [141 539]; 68, (1967) Massei v. Lettunich Cal.Rptr. 248 73 Cal.App.2d [56 232]; (1959) Harold v. P.2d Pugh 174 608 Cal.App.2d [345 112]; 232]; (1958) Roberts v. Salot P.2d 166 300 Cal.App.2d [333 667]; (1956) Simone v. McKee 142 313-314 P.2d Wice Cal.App.2d [298 Thus, Schilling (1954) 231].) 124 P.2d for Cal.App.2d example, one who an investment to one misrepresents soundness of investor, potential knowing that this is the remarks to person likely repeat investors, other potential is liable to one who receives the misinformation fashion, it, (Strutzel this acts (1952) and suffers loss. v. Williams upon 988]; Cal.App.2d Murphy P.2d see also Nathanson v. 368-369 P.2d Cal.App.2d Nor is it necessary intermediary transmit misrepresentation Rather, verbatim. even misrepresentation though remains actionable it, intermediary has or summarized even it paraphrased or transformed from certification, an fact assertion of into a A rating, recommendation. com- ment to section 533 Restatement Second of Torts illustrates this point: “One of the situations to which the rule stated this Section is frequently is where are applied misrepresentations made to a credit-rating company the purpose obtaining a credit based on them. In rating this case the maker subject to liability any person who to and does extend expected credit him in upon rating erroneous so procured. fact rating company figures does not communicate the misstated the maker is immaterial. It is that their substance is enough with reasonable accuracy rating given expresses or that the summarized Torts, 533, f, 74-75, (Rest.2d the misstatements made." com. pp. § effect of Thus, added.) italics the Restatement that when recognizes a fraudulent statement has been transformed into and become embedded a credit rating, maker of the misrepresentation is liable for fraud to persons on the rely rating extending credit.

Courts have applied this of indirect reliance in a concept variety case, situations. In one an manufacturer airplane was to have made alleged misrepresentations (FAA) to the Federal Aviation Administration to obtain certification of a A particular aircraft. the aircraft held purchaser of was have stated a valid claim against the manufacturer for fraudulent misrepre- sentation reliance FAA in by alleging on the certification deci- making the (Learjet sion purchase. Corp. Spenlinhauer (1st 1990) Cir. 901 F.2d 198, 200-202.) effect, In so holding, the federal court in that recognized, FAA on the certification was reliance on the manufacturer’s mis- because the representations, had become embedded in the misrepresentations Or, comment, certification. the language of the Restatement the certifica- tion expressed the effect of the manufacturer’s misrepresentations.

Courts in California and other states have the indirect applied of principle reliance to the situation which a manufacturer of a or prescription drug medical device has misrepresented its and effectiveness to product’s safety the A medical profession. injured the device patient by drug or is permitted to sue the manufacturer for fraud without doctor who proof pre- scribed the drug or recommended the device repeated misrepresentations

1113 1989) (D.Or. 708 (Allen F.Supp. v. G.D. Searle & Co. the patient. 1160-1161; 241 441 P.2d (1987) Kan. Tetuan v. A.H. Robins Co. 1227-1228]; (1969) 274 Cal.App.2d Charles & Co. Grinnell v. Pfizer (1967) 369]; Inc. Toole v. Richardson-Merrell Cal.Rptr. 988].) These courts A.L.R.3d Cal.App.2d effect, concluded, and learning reliance on the that a patient’s have misrep the manufacturer’s of the constitutes reliance on integrity physician resentations, in the have become embedded because recommendation to patient. physician’s prescription the party injured conveys misrepresentation The intermediary It can be the entity. it need an individual or a governmental not be market, In re Equity as shown by mechanism of a price-setting developed 1976) an (C.D.Cal. Funding Corp. Litigation F.Supp. Amer. Sec. claims under both alleged action filed federal court which the plaintiffs claims, In federal and California law. California discussing pendent court, federal reasoned as judge, district court now Chief Justice of this fraud, law, “Under for must follows: California order to recover plaintiffs show that relied to their detriment on the material misrepresentation(s) of the the reliance ele- alleged defendants. have plaintiffs [Citations.] ment to sustain a fraud claim under California law these necessary against In it 22(d)(1) defendants. of the for is Paragraph Complaint, example, alleged Funding these defendants and others disseminated EFCA [Equity Life Corporation Funding and EFLIC Insurance Com- [Equity America] financial pany] influencing statements ‘for the and with the effect of purpose and and manipulating securities Equity Funding purpose and with the effect of market of EFCA securi- influencing open purchasers ties to In purchase 22(d)(2) such securities.’ Paragraphs ‘purpose and effect’ allegation as it to the debenture repeated pertains purchasing ’ .... This allegation ‘purpose effect, coupled with the clear materiality the misrepresentations alleged, the reliance and cau- satisfies requirements sation imposed pleadings claims in assert fraud Califor- (Id. 182-183, added.) nia.” at pp. italics

One final In “intermediary” case deserves mention. Committee on Child- Television, ren’s Inc. Corp. v. General Foods 35 Cal.3d 197 [197 660], P.2d the asserted a claim for fraud against manufacturer, a cereal a retailer and advertising agencies, alleging two (Id. 204-205.) The deceptive advertising for breakfast cereals. sugared pp. demurred, defendants that the was deficient because it contending complaint alleged children were the and that exposed advertising to parents the purchased cereals. The defendants that the could not have argued parents 219.) relied on (Id. that had made them. misrepresentations not been at p. This court the that it either that rejected position allege was essential to the had been made to the or that the misrepresentations directly parents children had the to their This court repeated misrepresentations parents. stated that repetition such “should not be a it should prerequisite liability; be sufficient that defendant makes a to one intend- misrepresentation group ing to influence the the behavior of ultimate and that he succeeds purchaser, Television, (Committee in this on plan.” Children’s Inc. v. General Foods Corp., supra, 35 Cal.3d 219.) sufficient, that the

By holding of reliance was we plaintiffs’ pleading in recognized alleged had become embedded the children’s cereal which the preferences, children then communicated to the were, in parents, and that these the children expressing the preferences, comment, the language of Restatement the effect expressing misrep- of Television, (Committee resentations. on Children’s Inc. v. General Foods Corp., supra, 35 Cal.3d demonstrates,

As review this law indirect pertinent case principle reliance makes an intentional actionable even misrepresentation though originator falsehood’s did not it to the speak directly injured party. Liability for fraud when attaches originator’s conveyed falsehood has been injured an party by a form that intermediary substantially expresses falsehood, effect of the and the injured has relied the falsehood as party upon market, so In the conveyed. context of a securities developed impersonal mechanism, price-setting constantly adjusts trading prices information, securities response public disclosures of material is such an intermediary. information,

Because it adjusts rapidly to reflect material public information, same that a credit way rating adjusted is to reflect material of an price traded openly security the effect of a fraudulent may express reason, statement. For this a fraudulently market manipulated like reliance on a price, inflated credit fraudulently rating, equivalent This, law to direct reliance on the fraudulent original summary, statement. is what federal mean courts fraud on the market.

The fraud-on-the-market was in the context of federal principle developed law, securities which provides variety remedies to private preserve enhance the securities integrity public markets. Of interest to particular case, the issue in this federal law fraudulent permits person injured by manipulation of the of a publicly damages traded to recover security under 10(b) (15 section of the Securities U.S.C. Exchange Act of 1934 Exchange rule the Securities 10b-5 of and administrative 78j(b)1) § (hereafter rule In (1992)2). such actions (17 240.10b-5 Commission C.F.R. § prin- actions), the ffaud-on-the-market routinely apply federal courts 10b-5 inflated artificially a at security who have purchased those ciple permit the were aware of they proving without damages recover prices was security’s manipulated. which the price false information specific principle the ffaud-on-the-market The decision to articulate first appellate held 1975) in which the court (9th 524 F.2d was Blackie v. Barrack Cir. unnec- is subjective particular misrepresentations reliance on “proof the of stock inflating price a claim a deception to establish 10b-5 essary (Id. holding explained in the market.” at court traded open unaware of a “A be either exchanges may this on the stock way: purchaser it; he may on directly rely purchase false or not representation, may specific ratio, trend, other factor. earnings a or some price price because of Nevertheless, favorable market price he relies generally supposition inflated the artificially and that has validly manipulation set no unsuspected underlying indirectly representations and thus on the truth price, not, pays he price—whether stock he is aware it or reflects direct from each misrepresentations. purchaser material Requiring proof defeat he would relied on a when particular representation purchasing indirect, the fact that those whose reliance was recovery by despite if have only purchased causational chain is broken would purchaser leave even had he We decline to such stock known of misrepresentation. (Id. added.) market italics open purchasers unprotected.” The United prin- States Court the ffaud-on-the-market Supreme approved L.Ed.2d Basic Inc. v. Levinson 485 U.S. ciple any directly indirectly, by any 1“It shall be unlawful for the use of means or person, or mails, instrumentality facility any national any of interstate commerce or of the or of exchange— securities “(b) any security registered on employ, purchase To use or in connection with the or sale of deceptive exchange any security registered, any manipulative a national securities or not or so as the regulations device or contrivance in contravention of such rules and [Securities Commission Exchange] public as in the interest or for prescribe necessary appropriate or (15 protection 78j.) of investors.” U.S.C. § any or any person, directly indirectly, by 2“It shall be unlawful for or the use of means commerce, instrumentality facility any any of interstate or of the mails or of national exchange, securities device, scheme, defraud, “(a) employ any To or artifice to “(b) any fact To make untrue statement of a material fact or to omit state material made, necessary light in order to under which make the statements in the of the circumstances made, misleading, were or act, “(c) engage any practice, operate To or would operates course of business which upon any person, fraud or deceit (17 240.10b-5.) purchase any security.” “in connection with the C.F.R. or sale of § action, element a rule S.Ct. After that reliance was an 10b-5 noting 978]. in “Recent the court its of the these words: explained approval principle tended that the market Congress’ studies have to confirm empirical premise reflects all avail- of shares traded on markets price well-developed publicly information, and, hence, It has able material been any misrepresentations. who imagine buyer noted that ‘it is hard to that there ever is a or seller does in the dice a integrity. knowingly on market Who would roll rely Indeed, crooked court that has consid- crap game?’ nearly every [Citation.] ered the that where state- materially misleading has concluded proposition market ments have been disseminated into an impersonal, well-developed securities, integrity for the reliance of individual on the market have may generally be Commentators price presumed. applauded An theory. of one variation or another of the fraud-on-the-market adoption at market in investor who or sells stock set does so buys price by reliance on the available integrity publicly Because most price. any public information is reflected market an investor’s reliance on price, therefore, material of a misrepresentations, purposes presumed (Id. 218], omitted.) Rule 10b-5 action.” 246-247 L.Ed.2d at fns. pp. The fraud-on-the-market not been limited to rule 10b-5 has principle true, out, actions. it is no state Although majority points yet as court has an action for appellate applied logic fraud-on-the-market fraud, federal courts have reasoning fraud-on-the-market applied pendent (In fraud Group, claims under the laws of other states. re Healthcare Services 97,374, Litigation (E.D.Pa. 1993) (CCH) Inc. Securities Fed. Sec. L. Rep. ¶ 95,978-95,979 law]; Hurley (D.Mass. v. Federal Ins. pp. Deposit Corp. [Pa. 27, 34, [Mass, law]; 1989) 719 Minpeco, fn. S.A. v. Hunt F.Supp. (S.D.N.Y. 1989) law].) When federal 175-177 these F.Supp. [N.Y. applying decisions state law are with the two state compared appellate cited decisions that decline to fraud-on-the-market majority apply fraud, logic to actions for the count of decisions under the laws of other states this still relatively roughly area of the law reveals a undeveloped even split. demonstrates,

As this review of the relevant the fraud-on-the- authorities market federal courts rule 10b-5 cases is principle developed fully consistent with the Restatement law. In Second of Torts and with California actions for intentional our law has never direct misrepresentation, required claim, reliance “eyeball” recognized to sustain a but has principle reliance, indirect under which a fraudulent statement is no less actionable because it has in the has through intermediary an passed process form before a undergone change inducing by party thereby suffers injury. developed traded an security open a surely as as just the effect of a fraudulent statement market may express Torts, certification f), (Rest.2d governmental com. credit rating § 198), prescription 901 F.2d doctor’s Spenlinhauer, supra, (Learjet Corp. Co., 1142), even a child’s or & (Allen F.Supp. v. G.D. Searle (Committee cereal a breakfast of a parent purchase particular importuning 197). Television, supra, 35 Cal.3d Corp., General Foods Inc. v. on Children’s unbroken, of cases, and the element In the chain of causation all such reliance is established.

Ill as a means logic the fraud-on-the-market accept To its refusal to explain fraud, dis- majority in the reliance traditional tort actions for of proving reliance” rather than establishing “presumed misses this method of proof ante, 1097.) errors underlie this Two (Maj. “actual reliance.” opn., reliance, First, indirect the of concept the restricts explanation. majority in with the case law which it in a manner at odds approves principle, Second, the misunderstands majority with the Restatement Second of Torts. in in reliance rule 10b-5 the which federal courts have presumed context actions. reliance as

The the of indirect majority professes approval principle in in of Torts and as applied stated section 533 of Restatement Second But the its own novel and restric- majority some California cases. imposes by conferring tive on this The does this interpretation principle. majority indirect reliance situations mantle of “actual reliance” those only upon by which an intermediary conveyed original misrepresentation para- has exclude summary, repetition. majority appears verbatim phrase, “actual reliance” which an interme- category from the those situations a certifica- conveyed rating, has the form of diary misrepresentation tion, recommendation, or market price. flatly indirect reliance in this manner is

Restricting principle inconsistent with comment f the Restatement Second of of section Torts and with I Rather than this acknowledging cases have cited. previously conflict, however, in way discusses the relevant authorities majority their significance. conceals f

For comment states that one whose have example, incurred artificially rating damages inflated credit is liable fraud for reliance even through rating rating on the “the does though company communicate the figures recognizing misstated maker.” Instead that this comment on the rejects very majority imposes limitation that reliance, of indirect principle majority dismisses the Restatement com- ment with this remark: “While the such a impenetrable misrepresentation verbatim, need case not be communicated the defendant is liable to a only ” ante, plaintiff justifiable ‘who acts it. . . upon (Maj. opn., fn. No less is the opaque majority’s treatment of the federal court opinion Learjet Corp. Spenlinhauer, supra, 901 F.2d held that an had airplane purchaser satisfied the reliance element fraud by pleading of a federal upon certification an agency’s expression as of misrepre- sentations that the manufacturer airplane’s had made to the certifying agency. The majority distinguish Learjet would on the that a govern- basis ment certification that the “necessarily implies particular representations made,” to obtain the required certification have been whereas the market of a traded security on an and market open developed “necessarily that some implies only buyer is to willing pay (Maj. quoted price.” opn., ante, 6.) fn. Yet p. elsewhere the majority trading concedes of prices adjust securities response to dissemination of material Thus, (Id. 1101.) information. price of securities corporation’s material expresses about the representations financial health corporation’s and in the prospects same that a way government certification of an aircraft material expresses representations about the and physical integrity soundness of aircraft.

The is its majority abrupt dismissal of cases that one who holding has been injured aby prescription drug or similar product may sue manufac- made, turer for fraud even though the fraudulent were statements not to the injured person, but to the doctor who or administered the prescribed product. asserts that majority these cases “do not assist” “because the courts that decided the cases relied expressly on rather agency principles ante, True, than the of a fraud on the concept market.” (Maj. opn., California decisions addressing this situation have alluded to but agency, this context agency is but an awkward nothing legal fiction. Most patients would no doubt be surprised learn that have their appointed doctors as agents for with dealings manufacturers of If the pharmaceutical products. conclude, concept agency is this really one could also expansive, just easily, those who use the services of credit have rating companies appointed the companies as their for the agents gathering and purpose processing information material to the credit that aircraft rating, purchasers have appointed federal government agent as their for the purpose and gathering processing information material to the soundness of airplanes, or that an open developed securities market acts as the agent of investors for the purpose gathering information material the value processing jurisdictions courts other Not surprisingly, traded securities. of openly liability fraud to justify imposing concept agency have resorted to the not their products misrepresented manufacturers who have pharmaceutical on Co., supra, F.Supp. & (See v. G.D. Searle Allen the medical profession. Co., P.2d 1142, 1160-1161; 241 Kan. Tetuan v. A.H. Robins view, pharma- 1227-1228].) explains In that best principle my reliance, agency. fraud is indirect liability company’s ceutical revealed most treatment of precedent The majority’s imperceptive Television, Inc. v. Committee on Children’s its discussion of clearly by the fraud action based 35 Cal.3d Corp., supra, General Foods There, Ias cereals. sugared breakfast allegedly advertising deceptive had purchased this court already explained, permitted parents have even the com- though children maintain the fraud suit cereals for their As the advertising. did of the any not that the had heard plaint allege parents in these here its conclusion majority this court acknowledges, expressed the terms: the children allege repeated representations do not “[Plaintiffs not, did their in cases but imagine and we would that most parents, however, should their for the simply expressed product. Repetition, desire that defendant makes a it should be sufficient liability; not be prerequisite the influence the behavior of intending a to one representation group (Id. 219.) ultimate he in this plan.” p. succeeds purchaser, “that meaning only the this Incredibly, majority interprets statement with children cannot be about expected convey representations products ante, will language simply The precision.” (Maj. opn., opinion’s this The or meaning. dispute imprecision not bear was not about precision the as- children’s of the This court repetition alleged misrepresentations. sumed for that the children did not the argument misrep- purposes repeat form, an resentations at all their but the form of original only expressed the court majority desire for made this a of this product. Having assumption, concluded that the their fraud the against could maintain action for parents makers the recon- alleged This conclusion cannot be misrepresentations. Rather, ciled with the indirect reliance. it majority’s restrictive notion of in this supports plaintiffs’ rating, case reliance on position preference, certification, recommendation, prescription, any embodiment comparable of a satisfies the reliance an action for misrepresentation requirement fraud. Barrack,

The majority acknowledge also fails to that Blackie v. F.2d the federal pioneering decision the fraud-on-the market applying actions, the logic to rule 10b-5 fraud on the market within places squarely I reliance framework of indirect To demonstrate principle. point, again once the relevant time quote language, tightly this more edited to focus on the “A relevant issue: the stock either purchaser exchanges may on unaware of a false specific representation, or on it directly rely Nevertheless, .... he generally relies on the that the market supposition set. . . and thus price validly indirectly representations on the truth not, underlying price—whether the stock he is aware of it or he pays reflects material misrepresentations. direct each Requiring proof pur- from chaser that he relied aon when particular representation purchasing would (Id. defeat by those whose recovery reliance was indirect. . . .” at added.) italics

This quotation, shows that fraud market belongs squarely reliance, within the framework of indirect leads to consideration of second error underlying majority’s reliance on reasoning: majority’s federal authority for the proposition reliance established means fraud-on-the-market logic is reliance rather than actual presumed reliance. sure,

To be federal courts of a of reliance” in fraud- speak “presumption cases, on-the-market and it is this language that the has taken out of majority context and seized upon. context which federal courts presume certification, fraud-on-the-market cases is class stage that this case has never proceedings reached. Federal courts do a not employ of reliance to determine the presumption existence of a cause of action. Levinson, 224, In Basic Inc. v. 485 U.S. for the United example, States Supreme Court’s references to a of reliance under the presumption fraud-on-the-market doctrine all occurred the context of class certifica tion. The court framed the issue as “whether the courts below properly applied reliance in presumption (Id. the . .” certifying class . . at 230 p. 207].) L.Ed.2d at The p. court [99 observed that “[Requiring proof individualized reliance from each member of the class proposed plaintiff would have effectively prevented respondents from with a class proceeding (Id. action . . . .” 242 at p. 215].) L.Ed.2d at p. Holding [99 presumption of reliance had been the court properly applied, mentioned “nearly court every that has considered the has concluded that proposition where materially misleading statements have been disseminated an into securities, impersonal, market for well-developed the reliance of individual plaintiffs on the integrity (Id. market price may be presumed.” L.Ed.2d at p.

Because this action has never reached the class certification this stage, court is not called decide whether each upon should be plaintiff required the market integrity price, to reliance on the testify individually or inferred. whether reliance all the class be by might presumed Land, (See (1976) Cal.3d Superior Occidental Inc. v. Court made to each 556 P.2d same is Cal.Rptr. representation 750] [where reliance, member, consistent with class who thereafter takes action inferred]; (1971) 4 Cal.3d Vasquez Superior Court [same].) issue is only 484 P.2d 53 A.L.R.3d 513] existence of a cause of action fraud. For this as purpose, previously federal by the fraud-on-the-market courts explained, logic developed does not the use of require any presumption.

Thus, is when it that the reliance majority wrong proved by insists method known fraud than actual on the market is other something reliance. No needed that one is this method presumption prove through who has purchased believing at an inflated security artificially price, untainted, mechanism is has relied on the price-setting indirectly public federal court caused distortion. As one remarked, “reliance on the market price conceptually indistinguishable is (In from reliance re upon representations made face-to-face transactions.” (N.D.Tex. Litigation 1980) LTVSecurities The majority 88 F.R.D. insists that fraud market is distinct from other forms of analytically reliance, indirect it just but not so.

IV In part II.B. of its opinion, majority against decides the law “changing ante, incorporating fraud-on-the-market doctrine.” (Maj. opn., 1100.) llie does majority largely grounds so on the that the victims of fraudulent stock market practices have remedies under federal and adequate laws, state securities and that an additional under the recognizing remedy traditional tort cause of action for fraud would interfere somehow or conflict with those securities laws. shown,

As I have this of the part majority from a opinion proceeds mistaken premise. Recognizing fraud on the market aas method of pleading and proving reliance in actions for fraud does not in change require law, California but an merely common law application existing principles in the expressed indirect reliance cases from California and jurisdic- other tions, and in the Restatement Second of Torts. But this mistaken premise— that recognizing fraud on the market in the requires change law—is not in only defect this of the part majority In find a opinion. purporting conflict between the traditional tort action for fraud and the specific more laws, majority remedies under federal and state securities provided Congress Legislature. the wisdom of and our state questioning a remedy through law at victims of securities fraud Federal affords present never intended to a rule 10b-5 action. But this federal cause of action was im any any “Congress against exclude state remedies: expressly provided 28(a) in it the field section by declaring, intended to plication pre-empt (48 903), that rights of the Securities Act U.S. Stat. Exchange of 1934 ‘[t]he and all other any and remedies this title shall be addition to provided by ” (Diamond at law rights equity.’ and remedies that exist or N.E.2d Oreamuno N.Y.2d N.Y.S.2d to, and not federal are cumulative Because securities laws when, of, remedies, federal law offended or frustrated exclusive state is not damages federal courts rule 10b-5 actions award example, punitive Svoboda, Inc. (See, fraud v. Hobert & e.g., Halling state claims. pendent (E.D.Wis. 1989) 746.) understood and Congress respected F.Supp. remedies effective state maintaining substantial interests of states borders, and in full assuring to deter intentional within their wrongdoing such effective to state residents who have been victims of compensation intentional wrongdoing. there an state under California securities law? adequate remedy

Is have a under the majority they remedy assures confidently Code, Securities Act of 1968 25000 et Corporate (Corp. seq.). Specifically, § (hereafter (d)3 majority remedy locates this section subdivision 25400(d)), section 255004 of the Code. Corporations section out, law As the under these state securities majority points liability transactions, without both issuer and aftermarket provisions encompasses any directly indirectly, person, 3“It is unlawful for or in this state: “(d) offering or person person selling If such is a broker-dealer or other or for sale make, inducing the purchasing offering purchase security, purpose or for the others, was, purchase security by any at the and in the or sale of such statement which time made, any light misleading respect of the circumstances under which it was false or with fact, any necessary material or which omitted to state material fact in order to make made, made, light statements in the of the circumstances under which were misleading, ground and which he knew or had reasonable to believe was so false [or she] Code, misleading.” (Corp. § 4“Any person willfully any act violation of Section participates or transaction in any any security price at a which person purchases 25400 shall be liable to other or sells by damages by was affected such act the the latter as a result of or transaction for sustained such damages such act or transaction. Such shall be the difference between the which would person purchased other or sold securities and the market value which such securities transaction, have had at the time of or sale act or purchase his in the absence of such [or her] Code, plus legal (Corp. interest at the rate.” §

1123 of either the proof privity of contract or direct reliance This plaintiff. suggest would that these the a provisions give plaintiffs equivalent state least, rule 10b-5 action. At is what the majority this implies. 25400(d) limitation of a for principal general remedy section

securities fraud to be the the appears requirement party making misrepresentation be a “broker-dealer or other or selling offering person sale or purchasing offering purchase security.” satisfy To this requirement, the must plaintiff defendant was prove engaged Volk, market activity (1 at the time Marsh & misrepresentations. (1993) 14.05[4], Practice Under the 14-52.) Cal. Securities Laws Giving § construction, this limitation strict at least one federal court has held that when a corporation (as sells its stock through underwriters the complaint alleges case), this corporation its officers are not sellers and therefore are 25400(d). (In not bound by section re Activision Securities (N.D.Cal. Litigation 1985) 621 422.) But the F.Supp. majority’s assur- ance that plaintiffs have 25400(d) under remedy must mean that it dis- agrees with this restrictive construction. event,

In any availability a state securities law remedy is no more than persuasive of a federal availability remedy as a justification for shutting door to the traditional action for fraud. The primary purpose our state’s corporate securities law is to the innocent protect investing public from fraudulent and manipulative (Southern practices. Cal. First Nat. Bank v. Quincy (1970) Cass Associates 3 Cal.3d Cal.Rptr. [91 37]; P.2d People v. Baumgart (1990) 218 Cal.App.3d 534].) Cal.Rptr. To provide fullest measure of protection, Corporate Securities Act of 1968 declares that none of its provisions “shall limit any liability exist by virtue of any other statute or under common law if this law Code, were words, effect.” 25510.) In (Corp. other our § laws, state’s laws, securities like the federal securities were intended to supplement, not replace, other statutory (Bowden common law remedies. Robinson Cal.App.3d To speak, does, as the majority of a “conflict” between securities law remedies and the traditional action for fraud is to ignore decisions of our state Legislature and Congress to make securities laws nonexclusive and cumulative to tradi- Code, tional (see 25510; tort remedies Corp. 78bb(a)). 15 U.S.C. § §

V I agree with the majority that under liability the fraud-on-the-market should principle not extend to negligent This misrepresentation. court has negligent fraud than for be broader for actual liability should recognized (1992) 3 Cal.4th (See, & Co. Bily Young v. Arthur e.g., misrepresentation. when 745].) We have emphasized 834 P.2d Cal.Rptr.2d intentional, foresee merely negligent, a misconduct is not but defendant’s liability scope a sufficient limit on ability of harm not provide 399), grossly dispro at and that the should not liability imposed {id. (id. 399-402). at pp. the moral fault of portionate negligent party to earlier, articulated set has been principle As forth fraud-on-the-market in an action and in the rule 10b-5 actions. To recover developed context of Ob-5, artificially under rule 1 at an security who has party purchased claim, inflated of a rule 10b-5 price must scienter. For prove purposes defraud,” deceive, scienter and does not means an “intent to or manipulate, (Ernst include mere 425 U.S. & Ernst v. negligence. Hochfelder Thus, 668, 688-689, L.Ed.2d principle 96 S.Ct. market, in actions fraud on the as its name was for use implies, developed mere involving wrongdoing, negligence. intentional In courts actions involving negligence negligent misrepresentation, must balance concerns. should be sufficient to Liability provide competing injured by an incentive for due care and to those most compensate directly care, an absence of so that it is great grossly dispropor- but should not be In endeavors. tionate to fault or valuable discourages participation socially transactions, liability pro- the context of securities should be sufficient care in material to the value of publicly mote the release of information securities, traded at least the most immediate provide compensation victims of inaccurate information. But the should not be so broad as liability accumulate capital. businesses from markets to discourage using public

Here, the balance would struck by limiting recovery be most appropriately relied misstatements to those who have received and negligent upon have relied directly, excluding indirectly misstatements those who through market-set price.

VI drive false knowingly public To value of a means of up security by security statements is actual fraud. Innocent investors who purchase the inflated of the falsehood suffer actual loss when the ignorance falsehood is revealed and the value of the declines. When these security losses, actual victims of actual fraud seek for actual it compensation requires no revolution hold that the tort judicial thinking traditional action for fraud In provides remedy. rejecting fraud-on-the-market method of fraud, proving reliance actions for law as majority repudiates existing in the indirect I expressed reliance cases. dissent deci- majority’s from sion to withhold traditional fraud from inten- remedy wronged by those tional manipulation securities prices.

Mosk, J., C. Acting concurred.

Case Details

Case Name: Mirkin v. Wasserman

Court Name: California Supreme Court

Date Published: Sep 9, 1993

Citation: 858 P.2d 568

Docket Number: S020465

Court Abbreviation: Cal.