Lead Opinion
Opinion
This is а stockholder’s action charging that defendant corporation and its officers sent its stockholders a fraudulent quarterly financial report that grossly overreported earnings and profits. Plaintiff alleged that when the fraud was discovered, the price of the corporate stock dropped precipitously, causing injury to stockholders like himself.
The petition for review raised only a single issue: “Should the tort of common law fraud (including negligent misrepresentation) be expanded to permit suits by those who claim that alleged misstatements by defendants induced them not to buy and sell securities?” This overstates the matter— this case does not involve any claim by persons who do not own stock and are fraudulently induced not to buy. It does, however, present the issue whether California should recognize a cause of action by persons wrongfully induced to hold stock instead of selling it. (For convenience, we shall refer to such a lawsuit as a “holder’s action” to distinguish it from suits claiming damages from the purchase or sale of stock.)
We conclude that California law should allow a holder’s action for fraud or negligent misrepresentation. California has long acknowledged that if the effect of a misrepresentation is to induce forbearance—to induce persons not to take action—and those persons are damaged as a result, they have a cause of action for fraud or negligent misrepresentation. We are not persuaded to create an exception to this rule when the forbearance is to refrain from selling stock. This conclusion does not expand the tort of common law fraud, but simply applies long-established legal principles to the factual setting of misrepresentations that induce stockholders to hold on to their stock.
This cause of action should be limited to stockholders who can make a bona fide showing of actual reliance upon the misrepresentations. Plaintiff here has failed to plead the element of actual reliance with sufficient specificity to show that he can meet that requirement. We therefore reverse the judgment of the Court of Appeal and remand the cause to that court, with directions to have the trial court sustain defendants’ demurrer but grant plaintiff leave to amend his complaint.
I. Proceedings Below
“In reviewing a judgment of dismissal after a demurrer is sustained without leave to amend, we must assume the truth of all facts properly pleaded by the plaintiffs, as well as those that are judicially noticeable.” (Howard Jarvis Taxpayers Assn. v. City of La Habra (2001)
Stockholder Harvey Greenfield filed this action in 1996 against Fritz Companies, Inc., a corporation, and against three officers: Lynn Fritz, the company president, chairman of the board, and owner of
Before us is the validity of plaintiffs second amended complaint. It alleged that Fritz provides services for importers and exporters. Between April 1995 arid May 1996, Fritz acquired Intertrans Corporation and then numerous other companies in the import and export businesses. Fritz encountered difficulties with these acquisitions, and in particular with the Intertrans accounting system, which it adopted for much of its business. Nevertheless, on April 2, 1996, Fritz issued a press release that reported third quarter revenues of $274.3 million, net income of $10.3 million, and earnings per share of $29. The same figures appeared in its third quarter report to shareholders, issued on April 15, 1996, for the quarter ending February 29, 1996. According to plaintiff, that report was incorrect for a variety of reasons: the inadequatе integration of the Intertrans and Fritz accounting systems led to recording revenue that did not exist; Fritz failed to provide adequate reserves for uncollectible accounts receivable; and Fritz misstated the costs of its acquisitions.
The complaint alleged that on July 24, 1996, Fritz restated its previously reported revenues and earnings for the third quarter. Estimated third quarter earnings were reduced from $10.3 million to $3.1 million. Further, Fritz announced that it would incur a loss of $3.4 million in the fourth quarter.
The complaint then set forth in detail the reasons why the original third quarter report was inaccurate: improper accounting for merger and acquisition costs; improper classification of ordinary operating expenses as merger costs; improper revenue recognition; improper capitalized software development costs; and failure to allow for uncollectible accounts receivable. It alleged that the individual defendants knew or should have known that the third quarter report and press releases were false and misleading. When defendants made these statements, “defendants intended that investors, including plaintiff and the Class, would rely upon and act on the basis of those misrepresentations in deciding whether to retain the Fritz shares.”
The complaint further asserted that plaintiff and all class members received Fritz’s third quarter statement, “read this statement, including the information related to the reported revenue, net income and earnings per share, and relied on this information in deciding to hold Fritz stock through [July 24, 1996].”
With respect to damages, the complaint alleged: “In response to defendant’s disclosures on July 24, 1996, Fritz’s stock plunged more than 55% in one day, dropping $15.25 to close at $12.25 per share . . . . Had defendants disclosed correct third quarter revenue, net income and earnings per share on April 2, 1996, as
Defendants demurred to plaintiff’s second amended complaint on two grounds: (1) “California law does not recognize any [cause of action] on behalf of shareholders who neither bought nor sold shares based upon any alleged misstatement or omission”; and (2) the complaint failed to “plead with the requisite specificity the facts alleged to constitute actual reliance.” The trial court sustained the demurrer on the second ground only and entered judgment for defendants. Plaintiff appealed.
The Court of Appeal reversed. It held that the complaint stated causes of action for fraud and negligent misrepresentation and alleged actual reliance with sufficient specificity. (It did not decide whether the case should be certified as a class action.) We granted defendants’ petition for review.
II. California Recognizes a Cause of Action for Stockholders Induced by Fraud or Negligent Misrepresentation to Refrain from Selling Stock
Defendants contend that California should not recognize a cause of action for fraud or negligent misrepresentation when the plaintiff relies on the false representation by retaining stock, instead of buying or selling it. We disagree.
“ ‘The elements of fraud, which gives rise to the tort action for deceit, are (a) misrepresentation (false representation, concealment, or nondisclosure); (b) knowledge of falsity (or “scienter”); (c) intent to defraud, i.e., to induce reliance; (d) justifiable reliance; and (e) resulting damage.’ ” (Lazar v. Superior Court (1996)
Forbearance—the decision not to exercise a right or power—is sufficient consideration to support a contract and to overcome the statute of frauds. (E.g., Schumm v. Berg (1951)
California law has long recognized the principle that induced forbearance can be the basis for tort liability. (Marshall v. Buchanan (1868)
Indeed, defendants do not dispute that forbearance is generally sufficient reliance to permit a cause of action for fraud or negligent misrepresentation. Neither do they dispute that forbearance would be sufficient reliance if a stockholder were induced to refrain from selling his stock by a face-to-face conversation with a corporate officer or director. Borrowing a phrase from the United States Supreme Court opinion in Blue Chip Stamps v. Manor Drug Stores (1975)
Defendants first assert that in the context of stock sold on a national exchange, a corporation cannot be found to
But defendants’ principal argument is that in a case such as this involving a widely held, nationally traded stock, there are compelling policy considerations that argue against recognizing a holder’s cause of action. In particular, they contend that allowing a holder’s action will permit the filing of non-meritorious “strike” suits designed to coerce settlements (see Blue Chip Stamps, supra, 421 U.S. at pp. 739-742 [95 S.Ct. at pp. 1927-1929]; Mirkin v. Wasserman (1993)
A. Federal Law
Congress enacted the first federal laws regulating securities in the early 1930’s in response to the stock market crash of 1929. (See Ratner, supra, 68 U. Chi. L.Rev. at p. 1042.) The Securities Exchange Act of 1934 (15 U.S.C. § 78a et seq.) “was designed to protect investors against manipulation of stock prices” and to that end established extensive disclosure requirements. (Basic Inc. v. Levinson (1988)
In Birnbaum v. Newport Steel Corp. (2d Cir. 1952)
In 1975, the United States Supreme Court agreed that Rule 10b-5 did not permit holder’s actions. (Blue Chip Stamps, supra, 421 U.S. at pp. 733, 749 [95 S.Ct. at pp. 1924, 1931-1932].) Its decision was based largely on
But then the high court addressed the argument that complete nonrecognition of holder’s actions would result in injustiсe by denying relief to victims of fraud. That injustice would not occur, the court observed, because its decision was limited to actions under Rule 10b-5; defrauded stockholders might still have a remedy in state court. The high court said: “A great majority of the many commentators on the issue before us have taken the view that the Birnbaum limitation on the plaintiff class in a Rule 10b-5 action for damages is an arbitrary restriction which unreasonably prevents some deserving plaintiffs from recovering damages which have in fact been caused by violations of Rule 10b-5. . . . We have no doubt that this is indeed a disadvantage of the Birnbaum rule, and if it had no countervailing advantages it would be undesirable as a matter of policy . . . .” (Blue Chip Stamps, supra, 421 U.S. at pp. 738-739 [95 S.Ct. at pp. 1926-1927], fn. omitted.) Then in a footnote, the court observed: “Obviously this disadvantage is attenuated to the extent that remedies are available to nonpurchasers and nonsellers under state law. [Citations.] Thus, for example, in Birnbaum itself, while the plaintiffs found themselves without federal remedies, the conduct alleged as the gravamen of the federal complaint later provided the basis for recovery in a cause of action based on state law. [Citation.] And in the immediate case, respondent has filed a state-court class action held in abeyance pending the outcome of this suit. [Citation.]” (Id. at p. 739, fn. 9 [
Defendants here also refer to later federal legislation. In 1995, Congress, over presidential veto, passed the Private Securities Litigation Reform Act of 1995 (hereafter sometimes referred to as PSLRA) (Pub.L. No. 104-67 (Dec. 22, 1995) 109 Stat. 737). The PSLRA arose from congressional concern that the “current system of private liability under the federal securities laws d[id] not adequately distinguish between meritorious and frivolous claims.” (Sen. Com. on Banking, Housing, and Urban Affairs, Subcom. on Securities and Investment, Staff Rep. on Private Securities Litigation (May 17, 1994) p. 13, as cited in Perino, Frаud and Federalism: Preempting Private State Securities Fraud Causes of Action (1998) 50 Stan. L.Rev. 273, 290.) “Congress enacted the PSLRA to deter opportunistic private plaintiffs from filing abusive securities fraud claims, in part, by raising the pleading standards for private securities fraud plaintiffs.” (In re Silicon Graphics Inc. Securities Litigation (9th Cir. 1999)
The two statutes on which defendants rely, the PSLRA and the Uniform Standards Act, do not affect state court holder’s actions; the PSLRA governs only actions in federal court, and the Uniform Standards Act by its terms applies only to suits involving the purchase or sale of stock. As defendants note, both acts demonstrate that Congress in 1995 and in 1998 viewed stockholder class actions with considerable suspicion. Yet Congress did not abolish stockholder class actions under Rule 10b-5: by requiring specific pleading, it attempted to bar abusive suits while permitting meritorious suits. The Sarbanes Oxley Act of 2002 shows Congress’s recent concern to reduce procedural barriers to meritorious suits.
B. California Decisions
Neither the California Legislature nor the California electorate through its initiative power has enacted measures limiting stockholder actions. In 1996, two competing initiatives were defeated at the polls; one would have deterred stockholder suits, the other would have encouraged such suits. (Compare Ballot Pamp., Primary Elec. (Mar. 26, 1996) text of Prop. 201, pp. 68-70; with Ballot Pamp., Gen. Elec. (Nov. 5, 1996) text of Prop. 211, pp. 95-96.)
Defendants, however, rely on two decisions of this court that have cited policy concerns in limiting liability to stockholders: Bily, supra,
In Bily, a majority of this court held that an accounting firm was not liable in negligence to рersons who relied on its audit to purchase corporate stock. The decision weighed the advantages and disadvantages of recognizing such a cause of action (Bily, supra, 3 Cal.4th at pp. 396-407), and concluded that lenders and investors may not recover for negligence (id. at p. 407) but may recover for fraud (id. at p. 376) and negligent misrepresentation (id. at p. 413). The majority explained: “By allowing recovery for negligent misrepresentation (as opposed to mere negligence), we emphasize the indispensability of justifiable reliance on the statements contained in the report. . . . [A] general negligence charge directs attention to defendant’s level of care and compliance with professional standards established by expert testimony, as opposed to plaintiffs reliance on a materially false statement made by defendant. ... In contrast, an instruction based on the elements of negligent misrepresentation necessarily and properly focuses the jury’s attention on the truth or falsity of the audit report’s representations and plaintiffs actual and justifiable reliance on them. Because the audit report, not the audit itself, is the foundation of the third person’s claim, negligent misrepresentation more precisely captures the gravamen of the cause . . . .” (Ibid., fn. omitted.) Bily thus supports our conclusion here that California recognizes a holder’s action based on fraud or negligent misrepresentation.
Bily’s holding denying a cause of action for negligence rested on the premise that auditors, because they contract only with the corporation, owe no duty of
In Mirkin, a majority of this court rejected the “fraud on the market” doctrine used in federal cases under Rule 10b-5. That doctrine makes it unnecessary for buyers or sellеrs of stock to prove they relied on a defendant’s misrepresentations, on the theory that whether or not they relied the misrepresentation influenced the market price at which they later bought or sold. (See Basic Inc. v. Levinson, supra,
Mirkin involved a suit by a seller of securities. But Mirkin impliedly recognized that holders also have a cause of action under California law when it noted that if it had adopted the fraud on the market doctrine, persons could sue on the ground that they missed a favorable opportunity to sell stock “because the market was affected by negligent misrepresentations that they never heard.” (Mirkin, supra,
In contrast to Mirkin, supra,
In sum, the federal and state decisions and actions we have examined recognize the danger that shareholders may bring abusive and nonmeritorious suits to force a settlement from the corporation and its officers, bút they do not view that danger as justifying outright denial of all shareholders’ causes of action. To the contrary, when courts deny relief to the plaintiff before them, they affirm that the plaintiff
C. Defendants ’ Policy Arguments
Our examination of the specifics of defendants’ policy contentions also yields the conclusion that they may justify limiting a holder’s cause of action but do not justify total denial of the cause of action. Each of defendants’ policy contentions shares the same defect. Defendants do not argue that a holder’s suit for fraud is intrinsically unjust; instead, they claim that some of those suits will be nonmeritorious, or frivolous, or will be filed solely to coerce a settlement, or will raise problems of pleading or proof. And instead of offering a proposal to separate the wheat from the chaff, defendants contend that we should deny holders a cause of action entirely, thus rejecting the just and the unjust alike. Yet defendants’ own authorities confirm the validity of state court holder’s actions and suggest that any proposal to limit them should be more discriminating than outright denial of the cause of action.
With respect to defendants’ first concern, that allowing a holder’s action will lead to the filing of nonmeritorious “strike” suits, commentators distinguish between two opposite undesirable outcomes: (a) allowing a plaintiff to obtain a large settlement or judgment when no fraud occurred, and (b) denying redress when fraud actually occurred. (They refer to these outcomes as “type I error” and “type II error,” respectively.) (See Painter, Responding to a False Alarm: Federal Preemption of State Securities Fraud Causes of Action (1998) 84 Cornell L.Rev. 1, 71; Stout, Type I Error, Type II Error, and the Private Securities Litigation Reform Act (1996) 38 Ariz. L.Rev. 711 (hereafter Stout).)
When Congress enacted the Private Securities Litigation Reform Act of 1995 and the Uniform Standards Act of 1998, it was almost entirely concerned with preventing nonmeritorious suits. (Stout, supra, 38 Ariz. L.Rev. 711.) But events since 1998 have changed the perspective. The last few years have seen repeated reports of false financial statements and accounting fraud, demonstrating that many charges of corporate fraud were neither speculative nor attempts to extort settlement money, but were based on actual misconduct. “To open the newspaper today is to receive a daily dose of scandal, from Adelphia to Enron and beyond. Sаdly, each of us knows that these newly publicized instances of accounting-related securities fraud are no longer out of the ordinary, save perhaps in scale alone.” (Schulman et al., The Sarbanes-Oxley Act: The Impact on Civil Litigation under the Federal Securities Laws from the Plaintiffs’ Perspective (2002 ALI-ABA Cont. Legal Ed.) p. 1.) The victims of the reported frauds, moreover, are often persons who were induced to hold corporate stock by rosy but false financial reports, while others who knew the true state of affairs exercised stock options and sold at inflated prices. (See Purcell, The Enron Bankruptcy and Employer Stock in Retirement Plans, Congressional Research Service (Mar. 11, 2002).) Eliminating barriers that deny redress to actual victims of fraud now assumes an importance equal to that of deterring nonmeritorious suits.
Defendants further argue that even if a plaintiff adequately pleads reliance, proof of reliance will often depend on oral testimony: The stockholder will testify that he read the financial statement but there may be no written record that he did so; he will testify that he decided not to sell the stock, and perhaps that he told his broker, or a friеnd, or a spouse, of his decision, but there may be no writing to evidence this fact. Thus, defendants are concerned that they will have no way to rebut false claims of reliance.
A corporation’s financial report invites shareholders to read and rely on it. Some undoubtedly will do so. The possibility that a shareholder will commit perjury and falsely claim to have read and relied on the report does not differ in kind from the many other credibility issues routinely resolved by triers of fact in civil litigation. It cannot justify a blanket rule of nonliability.
There are, moreover, strong countervailing policy arguments in favor of allowing a holder’s cause of action. “California . . . has a legitimate and compelling interest in preserving a business climate free of fraud and deceptive practices.” (Diamond Multimedia Systems, Inc. v. Superior Court (1999)
Civil Code section 3274 declares that in California money damages are not only the prescribed remedy “for the violation of private rights” but also “the means of securing their observance.” Because of the limited resources available for enforcing the Security and Exchange Commission’s mandatory disclosure system, “private litigation has been frequently recognized as performing a useful augmentative deterrent, as well as a compensatory role.”
Finally, as this court said in Emery v. Emery (1955)
III. Adequacy of Plaintiff’s Pleading of Reliance
Defendants here attack plaintiffs pleading indirectly. Instead of arguing that plaintiffs complaint does not adequately plead reliance, defendants’ brief argues that this court should reject a holder’s cause of action because it raises troublesome questions of pleading and proving reliance. For the reasons stated in part II. of this opinion, defendants’ arguments are insufficient to justify an absolute denial of a holder’s cause of action. For the guidance of the parties and future litigants, however, we will discuss the adequacy of plaintiffs complaint.
Ideally, what is needed is some device to separate meritorious and non-meritorious cases, if possible in advance of trial. California’s requirement for specific pleading in fraud cases serves that purpose (Committee on Children’s Television, Inc. v. General Foods Corp., supra, 35 Cal.3d at pp. 216-217). “In California, fraud must be pled specifically; general and conclusory allegations do not suffice. [Citations.] ‘Thus “ ‘the policy of liberal construction of the pleadings . . . will not ordinarily be invoked to sustain a pleading defective in any material respect.’ ” [Citation.] This particularity requirement necessitates pleading facts which “show how, when, where, to whom, and by what means the representations were tendered.” ’ ” (Lazar v. Superior Court, supra,
California courts have never decided whether the tort of negligent misrepresentation, alleged in the complaint here, must also be pled with specificity. But such a requirement is implied in the reasoning of two decisions (Committee on Children’s Television, Inc. v. General Foods Corp., supra,
In the trial court and the Court of Appeal, defendants claimed that plaintiffs assertion of having relied on defendants’ misrepresentations was insufficient. We agree that in view of the danger of nonmeritorious suits, such conclusory language does not satisfy the specificity requirement. In a holder’s action a plaintiff must allege specific reliance on the defendants’ representations: for example, that if the plaintiff had read a truthful account of the corporation’s financial status the plaintiff would have sold the stock, how many shares the plaintiff would have sold, and when the sale would have taken place. The plaintiff must allege actions, as distinguished from unspoken and unrecorded thoughts and decisions, that would indicate that the plaintiff actually relied on the misrepresentations.
Plaintiffs who cannot plead with sufficient specificity to show a bona fide claim of actual reliance do not stand out from the mass of stockholders who rely on the market. Under Mirkin, supra,
Plaintiff here did not attempt to bring a derivative action, however. His complaint does not allege injury to the corporation or a wrong common to the entire body of stockholders, but only to those stockholders who actually relied on defendants’ misrepresentations.
We conclude that plaintiff did not adequately plead reliance in this case. But because the requirement we set forth here has not been stated in previous cases, plaintiff should be given leave to amend his complaint to make the necessary allegations.
The judgment of the Court of Appeal is reversed, and the cause is remanded for further proceedings consistent with this opinion.
George, C. J., Werdegar, J., and Moreno, J., concurred.
Notes
The trial court has the initial responsibility whether to certify this case as a class action. It has not yet ruled on the matter. Consequently, we do not discuss whether class certification is appropriate.
Unless otherwise indicated, Fritz refers to Fritz Companies, Inc., not to Lynn Fritz, its president and chairman of the board.
We express no view on whether the facts as alleged in the complaint imply a wrong to the corporation, or whether the corporation, by perpetrating a fraud on the market, wronged the entire body of stockholders.
Concurrence Opinion
The majority opinion, which I authored, upholds the right of stockholders to sue for fraudulent or negligent misrepresentation when they reasonably rely on the misrepresentation to refrain from selling their stock. It does not discuss whether the plaintiff here has adequately pled damage, because defendants did not raise that question. I write separately to explain my disagreement with the separate opinions of Justices Baxter and Brown.
Justice Baxter’s concurrence urges this court to declare that holder plaintiffs must allege they sustained realized, permanent damage. Such a requirement, he acknowledges, would mean in many cases that plaintiffs must allege they sold the stock after learning of the fraud.
Justice Baxter begins his discussion with the correct proposition that a plaintiff must show actual damages. But he asserts two more propositions that are unsound and unsupported by any authority. First, he asserts that defrauded stockholders incur no damages unless the value of their stock was permanently diminished. Second, he maintains that if, after an initial decline when the fraud is revealed, the price of the stock at any later time rises for reasons unrelated to the fraud, this rise reduces or eliminates the plaintiff’s loss.
But Justice Baxter’s premises are wrong. Temporary injury is legally compensable. Examples abound. One who sustains personal injuries may sue even if the injuries will eventually heal. A temporary taking of property is compensable, even if the property is later returned. (See, e.g., Kimball Laundry Co. v. U. S. (1949)
Justice Baxter acknowledges that in other areas of tort law a temporary loss of enjoyment or use of property is compensable. (Conc. opn., post, at p. 199.) The property owner is not required to “realize” the loss by selling the property before the damage has been cured. Underlying Justice Baxter’s proposal of a different, unique rule for securities fraud may be his sense that losses in stock value are mere “paper” losses, and somehow not real. (Conc. opn., post, at p. 196, italics omitted.)
I disagree. The economy is filled with what could derisively be termed “paper assets”—the appreciated value of real estate, the goodwill of a business, uncollected accounts receivable, the balance of a checking account, etc. Business and individual investors make decisions based on the value of such assets. A decline in the value of stock, like a decline in the balance of a bank account or in the worth of a physical asset, is a decline in the net worth of the stockholder, whether or not
I disagree also with Justice Baxter’s second premise—that the damages defrauded stockholders should receive would become unduly speculative if they continued to hold the stock because of the possibility that the price of the stock might increase later, at any time into the indefinite future, because of matters unrelated to the fraud. The accepted rule is to the contrary. In a securities fraud case, the loss is calculated by using the “market price after the fraud is discovered when the price ceases to be fictitious [i.e., based on false data] and represents the consensus of buying and selling opinion of the value of the securities.” (Rest.2d Torts, § 549, com. c, p. 110.) Later price changes, in either direction, do not affect the calculation of the loss.
This rule does not necessarily mean that damages must be computed on the basis of the market price of the stock on the day the possible fraud is revealed; the market may take longer to digest and react to the news. In 1995 Congress, in the Public Securities Litigation Reform Act of 1995 (PSLRA), addressed proof of damages in cases in which a plaintiff who was fraudulently induced to purchase securities sued the corporation and its officers after the fraud was revealed and the price fell. (15 U.S.C. § 78u-4(e).) The PSLRA calculates damages based on the mean trading price of the security within a 90-day period after the date when the misstated or omitted fact is disclosed to the market. (Kaufman, Securities Litigation: Damages (2002) § 3.13, pp. 3-95 to 3-102.) (The mean trading price is the average of the closing prices of the security throughout the 90-day period.) If, however, the plaintiffs sell the security before the expiration of the 90-day period, damages are based on the mean trading price in the postdisclosure period ending on the date of the sale.
Justice Baxter’s proposal that stockholders should not be able to sue until they “realize” their loss is a notion rarely mentioned and never endorsed in the cases and commentaries on securities regulation.
No commentators, including those critical of holder’s actions, support or even discuss the notion advanced by Justice Baxter that, except in cases of corporate bankruptcy or special damages, stockholders must sell their stock before bringing suit. This proposal was not briefed in this case; it arose only during questioning at oral argument. We should be very hesitant to adopt a rule of our own invention that has not been briefed or previously tested by judicial opinion or academic commentary.
Moreover, a “sell to sue” rule might have harmful consequences. Justice Baxter considers it unlikely that defrauded stockholders would sell to preserve their right to damages, further depressing the price of the stock, unless they planned to sell anyway. This is speculation without analysis. Mutual funds and institutional stockholders make daily decisions how to allocate their assets and might well decide that holding stock affected by fraud is less attractive than some alternative investment if, by not selling their shares, they would lose the opportunity to recover damages in a class fraud action. Individual investors who think the stock may eventually recover some of its value may still believe that possibility of recovery is worth less than their right to damages. And some investors may try to have their cake and eat it too; selling their stock to “realize” their loss, so they can join in a fraud suit, then repurchasing the stock so they can share in any fiiture appreciation. Ultimately, the question of the effect of a “sell to sue” rule is an empirical one. If this court were to adopt a “sell to sue” rule, it would launch an experiment, without any input from
II
I disagree also with Justiсe Brown’s concurring and dissenting opinion. Justice Brown notes that plaintiff pled that Fritz Companies, Inc.’s (Fritz’s) shares were traded in an “efficient market,” and she declines to accept or reject the efficient capital market hypothesis
I agree with Justice Brown that plaintiff here is not entitled to damages on the theory that he would have sold Fritz stock at artificially high prices maintained through Fritz’s concealment of adverse information. “Plaintiffs cannot claim the right to profit from what they allege was an unlawfully inflated stock value.” (Chanoff v. U. S. Surgical Corp., supra, 857 F.Supp. at p. 1018; see Arent v. Distribution Sciences, Inc. (8th Cir. 1992)
Justice Brown, however, relies on the efficient capital market hypothesis to argue that as a matter of law plaintiff sustained no damage. She asserts: “The true worth of Fritz’s stock on July 24 necessarily reflected the fact that the restated third quarter results should have been reported on April 2. Thus, the price of Fritz stock on July 24 was, by definition, the same price the stock would have had on that date if defendants had reported Fritz’s true third quarter results on April 2.” (Conc. & dis. opn., post, at p. 205.) This argument is logically unsound. Under the semistrong version of the efficient capital market hypothesis (see ante, fn. 5), the price of Fritz’s stock on July 24 necessarily reflected the fact that the third quarter results should have been reported on April 2. But that does not mean the price on July 24 was the same price the stock would have had on that date if Fritz had reported those results on April 2. Here is why: On July 24 the market had additional information—that the April 2 report was false and that the true facts had been concealed for over three and one-half months. Justice Brown asserts that in an efficient market, “the market price of a stock reflects all
Justice Brown goes on to say: “While loss of investor confidence in management may adversely affect a stock’s price, the July 24 announcement would have caused investors to lose confidence in Fritz’s managements even if it had been made on April 2.” (Conc. & dis. opn., post, at p. 205.) A company’s announcement of a quarterly loss will indeed shake investor confidence. But an announcement that its past report was false and that the loss was concealed from public view generates far greater anxiety. Investors will not only question management’s competence but also its integrity. Investors would have reason to wonder whether there were other, yet undisclosed instances of fraud, and to doubt whether management really recognized its duty to protect the interests of stockholders. Investors would be concerned, too, that lenders would doubt the integrity of the management and question their financial data, affecting the company’s credit status. They would fear that the company might incur the disruption and expense of defending numerous lawsuits, such as this one. In sum, revelations of false financial statements and management misrepresentations raise a host of concerns that may lead to a decline in stock values beyond that warranted by the financial information itself.
Justice Brown argues alternatively that damages would be speculative because of the difficulty in separating the loss in value attributable to fraud from that attributable to the disclosure of truthful but unfavorable financial data. But “though the fact of damage must be clearly established, the amount need not be proved with the same degree of certainty but may be left to reasonable approximation or inference. Any other rule would mean that sometimes a plaintiff who had suffered substantial damage would be wholly denied recovery because the particular items could not, for some reason, be precisely determined.” (6 Witkin, Summary Cal. Law (9th ed. 1988) Torts, § 1325, p. 782.) Numerous decisions support this principle. (See Clemente v. State of California (1985)
Thus, once a plaintiff holder can show that a portion of the loss is attributable to fraud, difficulty in proving the amount of the damages will not bar a cause of action. Proof will, of course, often require expert evidence. Such evidence is commonplace in securities fraud actions. (See Sowell v. Butcher & Singer, Inc. (3d Cir. 1991)
It is unclear what limits Justice Brown would place on the class of holders who could recover damages. She distinguishes cases upholding claims by persons who rely on face-to-face misrepresentations by defendants, thus implying that in her view such persons would have a valid cause of action. But the class of persons who rely on face-to-face misrepresentations is a miniscule class and the face-to-face nature of the representations may not make damages any more or less speculative than in other cases, depending upon whether the defendants made the same representations to the stockholders generally.
She also distinguishes cases in which the investors “alleged facts indicating that they were preparing to sell or considering the sale of their stock or property and that the misrepresentations induced them not to sell.”
III
In sum, disclosures during the past three years have revealed extensive fraud involving numerous corporations, often involving false financial reports and the concealment of true financial data—fraud so massive that it contributed to an overall decline in the stock market and perhaps to a decline in the economy generally. The victims include not only those who bought or sold stock in reliance upon the false statements, but also those who held stock in reliance. The majority opinion allows such holders to sue for damages. That
He does not, however, argue that if the price of the stock falls further because of factors unrelated to the fraud, this decline increases the plaintiffs damages. Justice Brown’s concurring and dissenting opinion, on the other hand, does imply that a decline caused by intervening causes unrelated to the fraud would increase the plaintiffs damage. (See conc. & dis. opn., post, at p. 209.)
Not on the sale price alone, as Justice Baxter proposes.
Justice Baxter cites Chanoff v. U.S. Surgical Corp. (D.Conn. 1994)
Adopting a “sell to sue” rule would require a court to decide two questions: (1) How soon must the stockholder sell after the disclosure? (2) How long, if at all, must the stockholder wait before buying back for the court to recognize the sale as valid to “realize” the loss?
There are three versions of the efficient capital market hypothesis. The weak version holds that market prices eventually reflect all publicly available information. The semistrong version says that prices do so rapidly. The strong version holds that prices reflect all material information, even that not available to the public. (Saari, The Efficient Capital Market Hypothesis, Economic Theory and the Regulation of the Securities Industry (1977) 29 Stan. L.Rev. 1031, 1041.)
The weak version obviously does not aid Justice Brown’s position. For reasons stated in text (post, at p. 190), neither does the semistrong version. The strong version, which would imply that the market knew Fritz’s financial reports were false long before Fritz disclosed this fact, would assist Justice Brown, but “[n]o one these days accepts the strongest version of the efficient capital market hypothesis, under which non-public information automatically affects prices. That version is empirically false . . . .” (West v. Prudential Securities (7th Cir. 2002)
Numerous factual assertions in her opinion are not statements of proven fact, but propositions derived from the efficient capital market hypothesis. These include:
(a) “ ‘The [efficient] market not only reflects publicly available information with great rapidity; it also anticipated formal public announcements of much information.’ ” (Conc. & dis. opn., post, at p. 203.)
(b) “Because the market accurately and efficiently assimilates all public information . . . .” (Conc. & dis. opn., post, at p. 204.)
(c) “[P]laintiff forgets that stock prices in an efficient market ‘react quickly and in an unbiased fashion to publicly available information.’ ” (Conc. & dis. opn., post, at p. 205.)
Each of these statements is based on or a quotation from Saari, The Efficient Capital Market Hypothesis, Economic Theory and the Regulation of the Securities Industry, supra, 29 Stan. L.Rev. 1031, 1050.
Justice Brown’s assertion that plaintiff cannot allege a causal relationship between the misrepresentations and damages (conc. & dis. opn., post, at p. 192) assumes that plaintiff cannot allege that he was prepared to sell or considering the sale of his Fritz stock and that the misrepresentations induced him not to sell. This mаy or may not be true. Until this decision was filed, plaintiff did not know what he had to allege to state a cause of action. This is why the court gives him leave to amend.
Concurrence Opinion
I agree with the majority’s reasoning and result as far as they go. Thus, I accept in principle that the shareholder of a publicly traded company may have a direct common law action against the company and its officials when their intentional or negligent misrepresentations about the company’s financial condition, on which he personally relied, induced him not to sell his shares, and thus caused him damage. Despite an “efficient market” for the shares, I can conceive that delayed disclosure of bad news, under circumstances suggesting that earlier reports were dishonestly or incompetently false, might have an effect on the market price of the shares beyond the effect of the bad news itself.
I also strongly agree that in a suit of this kind—a so-called holder’s action—the complaint must plead specific facts showing actual, personal reliance on the defendants’ alleged misrepresentations. As the majority indicate, the complaint before us is not specific enough in its allegations of actual reliance, and a remand for possible amendment is appropriate.
But under the protracted circumstances of this case, the majority’s disposition is incomplete. Counting the original complaint, filed in October 1996, there have been three attempts to state a cause of action. So far, these efforts have produced three appellate decisions, two from the Court of Appeal and one from this court. It is time to move this long-pending lawsuit beyond the pleading stage, one way or the other, by providing guidance on all the significant legal issues bearing on the sufficiency of the complaint.
However, the majority encourage yet another round of pleading litigation, because they omit all reference to an element even more crucial and basic than those they discuss. The majority properly demand specificity in the complaint’s allegations of reliance, but they overlook, by failing to address, the brief and conclusory way in which damage is pled.
There are many uncertainties in this vague claim of damage, as defendants and their amici curiae have stressed at length. But the most fundamental flaw is the complaint’s utter failure to state whether, or how, the described shareholders have suffered a realized loss as a result of the alleged fraud. The complaint does not allege that any such investor sold shares at a price depressed by revelation of the scandal. Nor does it articulate any other way in which this group of Fritz shareholders sustained actual out-of-pocket damage as a direct result of the July 24, 1996, disclosures. The complaint simply suggests that because these persons were holding Fritz shares on July 24, they are entitled to recover any difference between the price to which the shares actually fell on that date, and the price at which the shares could have been promptly sold if the true third quarter results had been announced in timely fashion.
These allegations are insufficient to support monetary recovery for the alleged fraud and deceit. In California, “recovery in a tort action for fraud is limited to the actual damages suffered by the plaintiff. [Citations.]” (Ward v. Taggart (1959)
Where fraud is alleged to have caused damage in connection with the purchase, sale, or exchange of property, California applies the out-of-pocket loss rule. This doctrine limits recovery to the difference between thе actual values, intrinsic and economic, of that which the defrauded person gave up and that which he or she received in return, plus sums expended in reliance on the fraud, and it precludes recovery based on the “benefit of the bargain,” i.e., the plaintiffs expectancy interest created by the fraud. (Civ. Code, § 3343;
Similar limitations to actual out-of-pocket loss must, of course, apply where one alleges that he was induced by fraud or deceit to hold property he would otherwise have sold. At the least, the defrauded person must plead and prove that, aside from any specific reliance expenses, he ultimately gave up more value, or received less, in exchange for the property, or that its value was permanently diminished, as a result of the fraud.
All persons who bought Fritz shares at a price unfairly inflated by the false reports of April 1996, or who sold such shares at the depressed price produced by the July 24, 1996, disclosure of the misrepresentations, either gave up more, or received less, for their shares than if the alleged fraud had not occurred. This gap between what the shareholders actually paid or received, and what they fairly should have paid or received, will never diminish or disappear, no matter what happens to the price of the stock thereafter. If capable of measurement, the difference represents actual out-of-pocket damage that the law should compensate.
The same premise does not necessarily apply, however, where there was neither a purchase nor a sale related to the fraud. In a holder’s action, the plaintiff presumably bought the shares at their fair prefraud value. If he did not sell them when the fraud was disclosed, at a price influenced by the disclosure, but instead retained them for a substantial period thereafter, their value, subject to the daily fluctuations of an efficient securities market, may have risen or fallen during that time for reasons, and in an amount, unrelated to the fraud.
Of course, persons who held Fritz shares on July 24 suffered at least momentary paper losses when the price of those shares dropped. These investors’ balance sheets of assets and liabilities, computed as of July 24, would show lower values for their Fritz shares than on July 23. However, such shareholdеrs did not necessarily suffer permanent realized losses, and the law may compensate only the latter. Only those who sold the shares on the bad news, or otherwise incurred measurable, irretrievable out-of-pocket losses as a result, should be deemed to have suffered actual damage subject to recovery. Otherwise, damages are entirely speculative, and the opportunity for windfall recoveries is manifest.
If a company’s stock was held for a substantial period after the fraud and its disclosure, intervening events may have obliterated the effect of the fraud on the value of the shareholders’ investments. An efficient public securities market responds rapidly and accurately both to changing general economic conditions, and to the shifting prospects of each business whose shares are traded therein. Transitory events that affected the price of the company’s shares on certain days during a particular year may have little to do with the value of the shares months or years later. A company’s fortunes may rebound from fraud, perhaps under new and honest management, such that an investment retained for the long term may ultimately be worth more than if the fraud had never occurred. Certainly an attempt to trace the effect of a fraud that occurred in 1996 on the current value of the company’s shares is an exercise in futile speculation.
Thus, I cannot accept the narrow “snapshot” theory of damage on which the current complaint asks us to focus. Any instantaneous paper loss incurred by longtime Fritz shareholders who saw their share values drop on July 24, 1996, but did nothing in response, is not necessarily an accurate measure of the actual damage,
No case I have found squarely embraces or rejects the notion that one who alleges he was induced by fraud to retain securities can recover damages simply by pleading and proving that he continued to hold the shares after disclosure of the truth caused their value to drop. Of course, there are no prior California decisions recognizing a cause of action for fraudulent inducement to hold publicly traded securities. Most of the authorities the majоrity cite from other jurisdictions are of ancient vintage and do not focus on measurement of damages for marketplace fraud in a modem efficient securities market.
In the most recent “proholder” case cited by the majority (Gutman v. Howard Sav. Bank (D.N.J. 1990)
Even if my reasoning means that, in some cases, investors would have to sell their shares in order to recover, I foresee no dire market consequences. In the first place, the class of shareholders to whom such a requirement would apply is relatively small. For reasons indicated above, those who bought shares in reliance on the company’s misrepresentations would never have to sell to sue. Among those who bought before the fraud occurred, the only ones who could sue in any event would be those with evidence, other than their own uncorroborated claims, that they had intended to sell but were induced not to do so by their personal reliance on the misrepresentations. It thus seems likely that the general loss of confidence in company management by investors, particularly institutional investors, would far overshadow any market effect of shareholders induced to sell only to preserve their rights to bring holder’s actions.
In any event, it seems unlikely that defrauded holders will sell simply to preserve their right to sue and recover damages, when they otherwise would have been inclined to retain their shares despite the disclosure of the fraud. Those who sell on the disclosure presumably do so because they make a rational decision to cut their losses. Those who decide not to sell may be acting on an equally rational belief that the company and its shares will recover and prosper. This latter group may believe they will profit less by selling and suing than by waiting for the recovery. Whichever choice an investor makes, he should not have his cake and eat it too. Both economics and law are replete with elections of this kind. I see no fundamental problem with imposing one here.
Indeed, by allowing holders to sue and recover even when they realized no loss, we do more harm to the company’s prospects, and to the value of its shares, than by withholding such eligibility. Investors are likely to display little interest in the stock of a corporation saddled with such unjustified liabilities.
I do not suggest that an open-market sale of the company’s shares is the only
I am not concerned that the limitations I propose would allow Fritz and its dishonest officials to escape liability for their fraud. Anybody who bought shares at an artificially high price in reliance on the falsely optimistic report of April 2, 1996, or sold them at a depressed price when the dishonesty was disclosed on July 24, 1996, or could otherwise demonstrate an actually realized loss from the misrepresentation, would have a remedy. To exclude persons who cannot demonstrate actual loss of this kind is simply to recognize one element of a common law action for fraud, i.e., damage caused by the fraud.
In her separate concurring opinion, Justice Kennard insists my conclusions flow from two false premises—that temporary loss is not compensable (conc. opn. of Kennard, J., ante, at p. 186), and that damages would be too speculative if the shares continued to be held until after intervening market forces, unrelated to the fraud, had determined their value (id. at pp. 186-187). Her contentions are not persuasive.
At the outset, her examples of compensable “temporary” losses are inapt. I agree that any demonstrable loss or damage arising from temporary deprivation of the full possession, enjoyment, and use of one’s property is compensable where caused by such acts as conversion, trespass, or eminent domain. (See, e.g., Kimball Laundry Co. v. U. S. (1949)
No such issue arises in this case. There is no claim of deprivation of the possession, enjoyment, or use of the shares at issue here. All the rights, privileges, and powers of ownership were retained, including the right to sell the shares, or not to do so,
Justice Kennard’s argument that “paper” losses are real because they influence the actual conduct of economic affairs is also beside the point. The fact remains that in California, one does not suffer legally cognizable damage merely because disclosure of a fraud caused a transitory “blip” in the value of one’s stock portfolio. On the contrary, damages for fraud or deceit in connection with the purchase, sale, or exchange of property are limited to out-of-pocket loss—i.e., the difference between the actual value of that with which the defrauded person parted, and that which the defrauded person received, as a result of the fraud. In other words, the person must actually give more, or receive less, for property than if the fraud had not occurred. (Civ. Code, § 3343.)
As a consequence, one who did not purchase, but merely held, shares in reliance on fraud cannot establish an out-of-pocket loss simply on the theory that a later disclosure of the fraud caused the daily trading value of the shares to fall on a particular day. Yet this is the sum and substance of the damage allegations here.
Though the plaintiff in this case seeks damages measured by the price to which Fritz shares fell on the very day the alleged fraud was disclosed, I do not contend that one must sell on that very day in order to show compensable damage. I have no quarrel with Justice Kennard’s observation that the market may take some time to digest the bad news, that a somewhat later date may provide a better measure of how the market reacted to the fraud and its disclosure. All I propose is that the plaintiff in a holder’s action must plead and prove an actual, realized loss which can be directly attributed, in a specified amount, to the fraud and its disclosure. It simply stands to reason that the longer the interval between disclosure on the one hand, and the moment a loss was allegedly realized on the other, the less likely it may become that this link can be established.
Nor do I suggest that such a claim is obviated by the passage of time simply because the value ultimately received for
Accordingly, I would require that those who assert they were induced by fraud to hold company shares must plead and prove specific facts showing that they actually realized out-of-pocket losses as a result of the fraud and its disclosure. Pleading and proof that the price of the shares fell on a particular day as a result of disclosure of the fraud would not suffice. Because that is all the current complaint claims, I find its damage allegations inadequate to state a cause of action. I would allow an opportunity to amend the complaint in accordance with the views expressed in this opinion.
As the majority set forth, the second amended complaint does aver that the original named plaintiff (and all other alleged class members) “ ‘read [the allegedly inaccurate third quarter statement of defendant Fritz Companies, Inc. (Fritz)], . . . and relied on [the inaccurate] information [contained therein] in deciding to hold Fritz stock through [July 24, 1996].’ ” (Maj. opn., ante, at p. 173, italics added; see also id. at p. 180.) The majority do not quite say so, but I assume that, consistent with Mirkin v. Wasserman (1993)
I acknowledge we cannot resolve at this stage whether the case may properly proceed as a class action. But we facilitate that determination by specifying all the elements of an individual cause of action.
Throughout this litigation, defendants and their amici curiae have volunteered only two attacks on the various complaints filed herein: first, that there is no California common law holder’s action, and second, that the allegations of reliance are insufficient. Perhaps, therefore, the majority are within their technical rights to avoid other issues. However, this court did solicit and receive supplemental briefs on the issue “whether, in light of the so-called ‘efficient capital markets hypothesis’ or otherwise, the complaint sufficiently alleges a causal relationship between the alleged misrepresentations and any alleged, nonspeculative damages.” (Italics added.) At oral argument, I questioned counsel specifically about the problem of realized loss. Hence, the parties have had reasonable notice and opportunity to brief and argue the issue, and we may resolve it in the interest of judicial efficiency. (Cal. Rules of Court, rule 29(b)(2).)
When questioned about these difficulties at oral argument, plaintiff’s counsel responded gamely but offered little to refute my concerns.
Injuries of this kind, I realize, might be considered “ ‘injury to the corporation, or to the whole body of its stock or property without any severance or distribution among individual shareholders’ ” (Sutter v. General Petroleum Corp. (1946)
Though neither the record nor the parties have so informed us, it appears that in May 2001, nearly five years after the alleged 1996 fraud and its disclosure, Fritz was acquired for substantial value by United Parcel Service, Inc. (Yahoo! Finance, EDGAR Online, SEC Filings, Fritz Companies Inc. (FRTZ), form 8-k (May 24, 2001) <http://biz.yahoo.eom/e/ 010524/fftz.html> [as of April 7, 2003]; UPS Pressroom, 2001 Press Releases, UPS to Acquire Fritz Companies, Inc. for $450 Million in Class B Common Stock (Jan. 10, 2001) <http://pressroom.ups.eom/pressreleases/archives/archive/0,1363,3844,00.html> [as of April 7, 2003].) This intervening development only underscores the difficulty of tracing the effect of long-past events on the current value of investments retained for substantial periods after those events occurred.
I agree that where one was induced by marketplace fraud to buy publicly traded shares at an inflated price, and did not sell them before the fraud was disclosed, the amount of any compensable loss must be measured by the accurate value the market places on the shares when the truth becomes known (see Rest.2d Torts, § 549, com. c, p. 110, cited in cone. opn. of Kennard, J., ante, at p. 187)—at least after discounting factors unrelated to the fraud that may also have affected the intervening change in price. This only restates the fundamental truth that one who paid too much as a result of fraud is entitled to recover the excess over what he should have paid, no more or less. It does not mean that compensable damage is necessarily suffered by one who merely held shares in reliance on fraud, then did nothing when disclosure of the fraud caused the market price of the shares to fall.
Harris v. American Investment Company (8th Cir. 1975)
Concurrence Opinion
Like the majority, I agree that California law does not categorically preclude a cause of action for fraud or negligent misrepresentation alleging that the plaintiff refrained from selling stock due to the defendant’s misrepresentations. (See maj. opn., ante, at pp. 173-183.) I also agree that plaintiff did not state such a cause of action because he failed to plead actual reliance with adequate specificity. (See id. at pp. 184-185.) In particular, plaintiff failed to “allege actions, as distinguished from unspoken and unrecorded thoughts and decisions, that would indicate that [he] actually relied on the misrepresentations.” (Id. at p. 184.) I also agree with Justice Baxter that plaintiff, in order to allege damages with sufficient particularity, “must plead and prove an actual, realized loss which can be directly attributed, in a specified amount, to the fraud and its disclosure.” (Conc. opn. of Baxter, J., ante, at p. 200.) Nonetheless, I write separately because I believe plaintiff does not and cannot allege a causal relationship between the alleged misrepresentations and damages. Accordingly, I would affirm the trial court’s decision to sustain defendants’ demurrer without leave to amend.
I
As a threshold matter, this court may address the issue of whether plaintiff adequately pled damage causation even though neither the trial court nor the Court of Appeal considered it. First, the parties had ample opportunity to address the issue. Various amici curiae raised the issue of damage causation, and plaintiff had an opportunity to respond. Moreover, the parties specifically briefed the court on the issue of “whether, in light of the so-called efficient capital markets hypothesis, the complaint sufficiently alleges a causal relationship between the alleged misrepresentations and any alleged nonspeculative damages.” Thus, our resolution of the issue of damage causation should come as no surprise.
Second, upon reviewing a judgment of dismissal following the sustenance of a demurrer, the reviewing court may affirm “on any grounds stated in the demurrer, whether or not the [lower] court acted on that ground.” (Carman v. Alvord (1982)
II
“In an action for [common law] fraud, damage is an essential element of the cause of action.” (Committee on Children’s Television, Inc. v. General Foods Corp. (1983)
Like any other element of fraud or negligent misrepresentation, damage causation “must be pled specifically; general and conclusory allegations do not suffice.” (Lazar v. Superior Court (1996)
In this case, plaintiff alleges that defendants’ misrepresentations induced him to forbear from selling his stock in Fritz Companies, Inc. (Fritz). Plaintiff claims he suffered damages from this induced forbearance because, absent the misrepresentations, he would have sold his stock at a price higher than the price of the stock on the day defendants revealed their misrepresentations. As explained below, plaintiff cannot sufficiently allege a causal relationship between the alleged damages and the alleged
Because we must “ ‘accept as true all the material allegations of the complaint’ ” (Charles J. Vacanti, M.D., Inc. v. State Comp. Ins. Fund (2001)
With this in mind, I now turn to plaintiffs damage allegations. Plaintiff claims as damages the difference between the price of Fritz stock on the date he would have sold the stock if defendants had timely reported Fritz’s true third quarter results on April 2, 1996, and the price of Fritz stock on July 24, 1996—the date defendants actually announced Fritz’s true third quarter results. In other words, plaintiff seeks to recover some portion of the $15.25 drop in Fritz stock price that occurred on July 24—the day defendants publicly corrected the alleged misrepresentations they made in April. Although the complaint is less than clear, plaintiff appears to claim that this drop in stock price is recoverable as damages because it was caused by: (1) the content of defendants’ misrepresentations; (2) the timing of the announcement of Fritz’s true third quarter results, which coincided with the announcement of Fritz’s disappointing fourth quarter results; (3) the loss of investor confidence in Fritz’s management resulting from the delayed disclosure of the bad news; and (4) intervening causes with no connection to the misrepresentations, i.e., portions of the fourth quarter results. Plaintiffs theories of damage causation, however, cannot support a claim for fraud or negligent misrepresentation.
First, plaintiff suffered no injury due to the content of the alleged misrepresentations.
Second, plaintiff suffered no cognizable injury from the timing of the announcement of Fritz’s true third quarter results. (See Chanoff, supra,
In any event, plaintiff forgets that stock prices in an efficient market “react quickly and in an unbiased fashion to publicly available information.” (The Efficient Capital Market Hypothesis, supra, 29
Third, any drop in stock price due to an alleged loss in investor confidence in Fritz management caused by the delayed announcement is either illusory or too speculative to constitute cognizable damages.
Moreover, any drop in stock price attributable to the additional loss of investor confidence resulting from investor suspicion of fraud induced by the delay in the announcement is too remote and speculative to support cognizable damages. As an initial matter, the allegedly fraudulent nature of the delay could not have affected Fritz’s stock price. When Fritz made the July 24 announcement, Fritz did not announce that it had intentionally or negligently concealed the acquisition costs or misrepresented its third quarter earnings on April 2. Rather, Fritz announced that it had failed to account for certain acquisition costs, which lowered its previously reported third quarter earnings and caused a fourth quarter loss. Unlike recent cases of corporate fraud, nothing in this record even suggests that the public attributed the three-month delay in announcing these acquisition costs to fraud or negligence at the time of the announcement or that public suspicion of fraud somehow resulted in a greater drop in stock price than would have otherwise occurred. Thus, any deliberate or negligent concealment of these costs by defendants could not have influenced Fritz’s stock price on July 24.
Investors could certainly speculate that Fritz’s management engaged in wrongdoing or acted incompetently in delaying the announcement. But such investor speculation could occur in every case in which a company announces bad news or issues a negative correction. Thus, any drop in stock price allegedly caused by investor
Indeed, recognizing such a theory of damages would subject a company to securities fraud claims, including buyer or seller claims, whenever that company announces bad news or issues a negative correction. In order to escaрe dismissal, the securities plaintiffs would merely have to allege a loss of investor confidence due to investor speculation that the bad news resulted from fraud or incompetence. As such, companies would be forced to expend considerable resources defending against claims of fraud or negligent misrepresentation regardless of their merits. Rather than make California the locale of choice for securities class actions, I would refuse to recognize such speculative damages.
Finally, to the extent plaintiff claims injury due to drops in the stock price unrelated to the misrepresentations, i.e., the announcement of fourth quarter losses, he does not allege the requisite causal relationship. “Remote results, produced by intermediate sequences of causes, are beyond the reach of any just and practicable rule of damages.” (Martin v. Deetz (1894)
Plaintiffs inability to allege this requisite causal connection simply reflects the speculative nature of these damages. Plaintiff alleges that he would have avoided drops in Fritz’s stock price unrelated to the misrepresentations because he would have sold his stock at some indefinite date after April 2—the date defendants should have reported Fritz’s true third quarter results. Plaintiff, however, alleges no facts indicating when he would have sold his stock. He does not allege any facts suggesting thаt he was planning or considering such a sale before the misrepresentations. He does not even allege that he sold his Fritz stock after defendants revealed the fraud on July 24. (See
In concluding that plaintiff failed to adequately plead damage causation, I would not preclude all fraud or deceit claims premised on induced forbearance. As the majority notes, California courts have long recognized that plaintiffs may suffer cognizable damages from forbearance induced by fraud or deceit. (See, e.g., Marshall v. Buchanan (1868)
Indeed, my conclusion would not preclude stockholders who allegedly held stock in reliance on another’s misrepresentations from stating a cause of action for fraud or deceit. Under a different set of facts, these stockholders may be able to allege cognizable damages. Indeed, the out-of-state cases cited by plaintiff—which are distinguishable from the facts of this case— offer examples of such facts. For example, many of these cases involved individual or face-to-face misrepresentations made directly to the investor.
Likewise, the investors in many of these out-of-state cases alleged facts indicating that they were preparing to sell or considering the sale of their stock or property and that the misrepresentations induced them not to sell prior to the revelation of the truth.
Finally, the investors in most of the out-of-state cases cited by plaintiff alleged that the misrepresentations induced them to purchase and retain their stock or property.
In contrast, plaintiff, as a matter of law, cannot recover any losses from a drop in market price caused by the misrepresentations. (See ante, at pp. 204-207.) Moreover, the misrepresentations did not induce plaintiff to subject himself to the risk of drops in market price due to intervening causes unrelated to the misrepresentations. Plaintiff agreed to take this risk before the misrepresentations. Under these circumstances, he can hardly claim damages based on the fruition of these risks, especially where, as here, the date on which he would have sold the stock is wholly speculative. Any contrary conclusion would make defendants the unpaid insurers of plaintiffs risk. Accordingly, I would follow those courts that have dismissed fraud and negligent misrepresentation claims virtually identical to plaintiffs and affirm the dismissal of plaintiffs complaint. (See, e.g., Arent, supra, 975 F.2d at p. 1374; Arnlund, supra,
I also see no reason to remand in order to give plaintiff an opportunity to amend the complaint to allege damage causation. Although the sustaining of a demurrer without leave to amend is generally an abuse of discretion “ ‘if there is any reasonable possibility that the defect can be cured by amendment,’ ” “ ‘the burden is on the plaintiff to demonstrate that the trial court abused its discretion.’ ” (Goodman v. Kennedy (1976)
In reaching this conclusion, I remain true to the purpose behind the heightened pleading standard for fraud claims. “The pleading of fraud . . . is . . . the last remaining habitat of the common law notion that a complaint should be sufficiently specific that the court can weed out nonmeritorious actions on the basis of the pleadings.”
Chin, J., concurred.
In doing so, I neither accept nor reject the so-called efficient capital markets hypothesis. (See Mirkin v. Wasserman (1993)
Although plaintiff acknowledged that he may not recover all of the drop in stock price that occurred on July 24, he did not eschew recovery of some of the declines in stock price allegedly caused by the misrepresentations.
In reaching this conclusion, I do not, as Justice Kennard suggests, rely on the efficient capital market hypothesis. (See conc. opn. of Kennard, J., ante, at p. 190.)
(See, e.g., Marbury Management, Inc. v. Kohn (2d Cir. 1980)
Many of these cases predate federal securities laws which defined required disclosures to the public and prohibited insider trading.
(See, e.g., David v. Belmont (1935)
Because these cases predate federal securities law, their specific facts are unlikely to arise in today’s highly regulated world of securities trading. Perhaps the only modem analogy is the situation where an investor tells his or her broker to sell a company’s stock if it drops below a specific price. Due to the company’s misrepresentations, however, the stock price never falls below that price and the investor either cancels the sell order or allows it to lapse. Following the revelation of the truth, the company’s stock price falls below the price at which the investor had previously intended to sell. Like the investors in the cited cases, this investor can identify a specific drop in stock price that he or she would have avoided absent the misrepresentations and can therefore allege damage causation.
(See, e.g., Marbury, supra,