Case Title: Susan Kaufman v. i-Stat Corporation, et als.

Citation: 

Docket Number: a-49-99

State: new-jersey

Court: New Jersey Supreme Court

Date: 2000-07-27T00:00:00Z

Document:
(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized). LaVECCHIA, J., writing for a majority of the Court. The issue in this appeal is whether a class of plaintiffs in a common-law action for fraud can prove the element of reliance through the presumption of fraud on the market, a theory adopted by the U.S. Supreme Court in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), which allows plaintiffs to bring class actions under federal securities fraud law by excusing them from the burden of proving individual reliance on a misrepresentation. Instead, under the fraud-on-the-market theory, plaintiffs may establish the reliance element of their claims by showing that they purchased securities in the secondary markets at attractive prices that had been artificially affected by an issuer's misrepresentations and omissions. i-Stat is a public New Jersey corporation that manufactures and markets diagnostic blood-analysis equipment designed to assist medical professionals at the point of patient care. The corporation's stock is traded on the NASDAQ National Market System. On May 9, 1995, i-Stat announced its financial results for the first fiscal quarter of 1995. The company reported net sales of $3,359,000 - about $1.7 million more than sales reported for the same period in the previous year. On May 22, 1995, Kaufman purchased one hundred shares of i-Stat common stock at 21 3/4, a total investment of $2175. The stock climbed to 43 3/4 by September of that year. However, in January 1996, The New York Times reported that the largest institutional holder of i-Stat had made charitable contributions to hospitals to enable them to obtain i-Stat's diagnostic equipment. In addition, in March 1996, The Wall Street Journal reported that the Securities and Exchange Commission ( SEC ) was investigating i-Stat's business. The article revealed that some of i-Stat's sales had been loans of the products to hospitals on a trial basis rather than actual sales. i-Stat responded with a press release that confirmed the SEC's investigation and inquiry into its sales procedures. On that same day, i-Stat's shares, which had been declining, tumbled 2 to 28 3/4. Nearly one-sixth of the outstanding i-Stat shares traded on that date. On May 20, 1996, Kaufman sold 50 shares of the i-Stat stock at 20 1/4. On June 19, 1996, she filed suit as putative class representative on behalf of all purchasers of i-Stat common stock between May 9, 1995 and March 19, 1996. She alleged common-law fraud and negligent misrepresentation, contending that i-Stat's deliberately false and misleading statement regarding its financial status and deceptive sales practices inflated the stock price during the class period. i-Stat filed an answer alleging various affirmative defenses. The parties stipulated that Kaufman did not actually or directly receive or rely on any communication containing any misrepresentation, or on any communication that omitted material facts; that she purchased her stock through a brokerage firm and did not directly receive or rely on any communication from that firm concerning the i-Stat purchase; and that she relied exclusively on the integrity of the market price of i-Stat stock at the time of the purchase. i-Stat subsequently moved for summary judgment on the ground that Kaufman failed to state a cause of action in fraud or in negligent misrepresentation because she could not satisfy the actual reliance requirement in each. The trial court granted i-Stat's motion, dismissing Kaufman's claims. The trial court rejected the fraud-on-the-market theory as a substitute for reliance. Under that theory, the market price reflects the value of the stock to the investor based on all of the information available at the time. Therefore, an investor relying on a price that is actually based on misrepresentations is entitled to recover damages when he or she trades at a loss. On appeal, the Appellate Division reversed the dismissal of Kaufman's complaint on the common-law fraud claim but affirmed the dismissal of the negligent misrepresentation claim. Noting that New Jersey already allows proof of indirect reliance to satisfy the reliance element of a common-law fraud claim, the court concluded that Kaufman's reliance on the integrity of the market price of the security was sufficient to satisfy the reliance requirement of a common-law fraud claim when the security was inflated artificially by the corporation's deliberate false statements. The court concluded that the reasoning of the federal securities law cases, which allows the reliance element of a securities fraud claim under section 10(b) of the Securities Exchange Act of 1934 to be satisfied by reliance on the market price of the security, should apply to common law fraud claims for securities fraud because the reliance element of a securities fraud claim under these regulatory provisions is substantially the same as in a common law fraud action. The Supreme Court granted Kaufman's petition for certification. HELD: In a common-law action for fraud, a plaintiff may not establish the element of reliance on a misrepresentation or omission through the presumption of fraud on the market. 1. Because Congress' passage of the Private Securities Litigation Reform Act of 1995 (and other subsequent federal legislation) has made litigating class-action strike suits by investors when the price of a stock has declined much more difficult, many plaintiffs have increasingly turned to state courts. (pp. 11-16) 2. The federal courts with jurisdiction in New Jersey have rejected the idea that fraud on the market can create a common-law action for fraud. (pp. 16-17) 3. Although federalism permits the state and national governments to resolve similar matters in different ways, a court's decision to follow its own lead ought to be firmly grounded in public policy. Thus, the question in this matter is whether the public interest in the development of the common law of fraud is served by Kaufman's contention that the fraud-on-the-market theory should be permitted to be used in New Jersey, despite a contrary conclusion in the many other jurisdictions that have considered the same question. (pp. 17-19) 4. The element of reliance is the same for fraud and negligent misrepresentation. The actual receipt and consideration of any misstatement remains central to the case of any plaintiff seeking to prove that he or she was deceived by the misstatement or omission. (pp. 19-22) 5. The doctrine of indirect reliance requires a plaintiff to have relied on the substance of the allegedly fraudulent claim, regardless of whether the claim was received directly from the issuer or some third party. If proven, indirect reliance is an element of a claim of fraud. (pp. 22-24) 6. Kaufman, by her admissions, has failed to establish that she relied, however indirectly, on the misstatements of i-Stat and its management, and thus, under the traditional standard for proof of reliance, has failed to make out a claim for fraud. (p. 24) 7. Since the U.S. Supreme Court's acceptance of fraud on the market twelve years ago in Basic, no state court with the authority to consider whether Basic is persuasive has chosen to apply it to claims arising under its own state's law, and an examination of its intellectual underpinning does not support an expansion of the common law. (pp. 27-34) 8. Accepting fraud on the market as proof of reliance in a New Jersey common law fraud action would undercut the public interest in preventing forum shopping, weaken New Jersey's law of indirect reliance, and run contrary to the policy direction of the Legislature and Congress. (pp. 34-35) JUSTICE STEIN has filed a separate dissenting opinion in which JUSTICES O'HERN and LONG join. Justice Stein believes that the Appellate Division's thorough and well-reasoned opinion reflects the correct disposition of the issue. He notes that under the indirect reliance principle accepted by New Jersey courts to establish reliance in a common-law fraud action, i-Stat's intentional fraud may be actionable as a common law fraud even though the authors of the false information did not communicate it directly to the plaintiff. Justice Stein views the question as one of whether the principle of indirect reliance applies in the context of purchasers of publicly traded securities where the fraud was perpetrated generally on the public with the intention that all purchasers of the securities would be defrauded. Finally, Justice Stein notes that the fraud-on-the-market theory is merely a rebuttable presumption of reliance and that, as such, defendants may rebut proof of the elements giving rise to the presumption, or show that the misrepresentation in fact did not lead to a distortion of price, or that an individual plaintiff traded or would have traded despite his or her knowing the statement was false. Judgment of the Appellate Division allowing the reliance element of a fraud claim to be proven by the fraud-on-the market theory is REVERSED, and the judgment of the Superior Court, Law Division, is REINSTATED, dismissing plaintiff's action. CHIEF JUSTICE PORITZ and JUSTICES COLEMAN and VERNIERO join in JUSTICE LaVECCHIA's opinion. JUSTICE STEIN filed a separate dissenting opinion in which JUSTICES O'HERN and LONG join. SUSAN KAUFMAN, on behalf of herself and all others similarly situated, Plaintiff-Respondent, v. i-STAT CORPORATION; WILLIAM P. MOFFITT; LIONEL N. STERLING; IMANTS R. LAUKS and MATTHIAS PLUM, JR., Defendants-Appellants. ______________________________ Argued May 1, 2000 -- Decided July 27, 2000 On certification to the Superior Court, Appellate Division, whose opinion is reported at 324 N.J. Super. 344 (1999). Lawrence M. Rolnick argued the cause for appellants (Lowenstein Sandler, attorneys; Mr. Rolnick and Edward T. Dartley, on the brief). William C. Fredericks, a member of the New York Bar, argued the cause for respondent (Miles M. Tepper, attorney). The opinion of the Court was delivered by LaVECCHIA, J. This appeal presents the question whether a class of plaintiffs in a common-law action for fraud can prove the element of reliance through the presumption of a fraud on the market. The theory of fraud on the market, as described by the United States Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988), allows plaintiffs to bring class actions under federal securities-fraud law by excusing those plaintiffs from the burden of proving individual reliance. Instead, plaintiffs may establish the reliance element of their claims by showing that they purchased securities in the secondary markets at attractive prices that had been artificially affected by an issuer's misrepresentations and omissions. Plaintiff Susan Kaufman held shares of defendant i-Stat Corporation ( i-Stat ) over a period during which i-Stat allegedly misrepresented certain financial matters and the misrepresentations were discovered and publicized. The misrepresentations were never made to Kaufman by i-Stat or any intermediary. Kaufman relied on the price of the stock in her decisions, and now contends that, because i-Stat's misrepresentations were reflected in the share price, she can make out claims for common-law fraud and negligent misrepresentation on the basis of the share price alone. Even though the theory of fraud on the market has a place in the securities law of this nation, it is a stranger to New Jersey's securities laws. It is also not consistent with the current requirements for a common-law action for fraud in New Jersey. Use of the fraud-on-the-market theory is not the equivalent of proof of indirect reliance that is required minimally in a common-law fraud action. Because we discern no compelling reason to deviate from our current standard of proof for the reliance element in a common-law fraud action, and because we, like many commentators, cast a jaundiced eye on the worth of the fraud-on-the-market theory, we decline to expand our common law to permit its use. Accordingly, we reverse the judgment of the Appellate Division and reinstate the trial court's dismissal of plaintiff's fraud claim. These changes have led plaintiffs to attempt to avoid some of the new provisions of the [PSLRA] by seeking procedural advantages available in state courts. Sara Beth Brody & Ted F. Angus, Securities Litigation in State Court, 1070 WESTLAW PLI/Corp 413 (1998). The result has been a significant forum shift in class action securities fraud litigation, from federal to state court. Michael A. Perino, Fraud and Federalism: Preempting Private State Securities Fraud Causes of Action 50 Stan. L. Rev. 273, 273 (1998). Plaintiffs are filing 'weaker' cases in state court, i.e., cases in which the plaintiffs' attorney has a lower expectation that the complaint will survive a motion to dismiss under the act's 'strong inference of fraud' pleading standard [because] in state court proceedings . . . the 'strong inference of fraud' standard does not apply. Id. at 278, 315. Most of those cases newly brought in state court have been, as this one is, substitutes for Rule 10b-5 actions.See footnote 22 To maintain those actions' viability, the plaintiffs bringing them have sought to have the courts hearing them incorporate the doctrine of fraud on the market into the common law of their respective states. Plaintiff, however, has cited no case in which a state court ruling on its common law has accepted the invitation. Defendants, by contrast, have found several cases declining to allow the fraud-on-the-market theory to establish reliance at common law. See Mirkin v. Wasserman, 858 P.2d 568, 580 (Cal. 1993) (declining to expand common-law cause of action when procedurally controlled state statutory remedy, amenable to fraud-on-the-market presumption, already available); Malone v. Brincat, 722 A.2d 5 (Del. 1998) (declining to expand common-law cause of action when federal statutory remedy available); Kahler v. E.F. Hutton Co., 558 So. 2d 144 (Fla. Dist. Ct. App. 1990); Constantine v. Miller Indus., No. E1999-01575-COA-R3-CV, 2 000 WL 336663 (Tenn. Ct. App. March 31, 2000). See also Rosenthal v. Dean Witter Reynolds, Inc., 908 P.2d 1095, 1104 (Colo. 1995) (rejecting related doctrine of fraud created the market and requiring actual reliance on substance of misrepresentation). Our research reveals that one court has accepted the theory in dictum, but no claim based directly on the theory appears to have been adjudicated in the jurisdiction. Allyn v. Wortman, 725 So. 2d 94 (Miss. 1998). The federal courts with jurisdiction in New Jersey have rejected the idea that fraud on the market can create a common-law action for fraud. Thus, the Third Circuit, in one of the landmark decisions on fraud on the market, Peil v. Speiser, 806 F.2d 1154 (3d Cir. 1986), on which the Supreme Court relied extensively in Basic, declined to allow a state-law claim to proceed because no state courts have adopted the theory, and thus direct reliance remains a requirement of a common law securities fraud claim. Id. at 1163 (adjudicating Pennsylvania-law claim). The District of New Jersey has also rejected the invitation to expand the common law of fraud. See Weikel v. Tower Semiconductor Ltd., 183 F.R.D. 377, 400 n.12 (D.N.J. 1998); Easton & Co. v. Mutual Benefit Life Ins. Co., 1 993 WL 89146, at *6 (D.N.J.); Cammer v. Bloom, 711 F. Supp. 1264, 1298 (D.N.J. 1989); In re ORFA Sec. Litig., 654 F. Supp. 1449, 1460 (D.N.J. 1987) ("There does [sic] not appear to be any common law exceptions to the requirement of individual reliance (analogous to the judicially created Rule 10b-5 exceptions)"). But see In re Zenith Labs. Sec. Litig., 1 993 WL 260683 (D.N.J.) (predicting that New Jersey Supreme Court would allow fraud-on-the-market proof of negligent misrepresentation and allowing negligent-misrepresentation claims to survive summary judgment). SUSAN KAUFMAN, on behalf of herself and all others similarly situated, Plaintiff-Respondent, v. i-STAT CORPORATION; WILLIAM P. MOFFITT; LIONEL N. STERLING; IMANTS R. LAUKS and MATTHIAS PLUM, JR., Defendants-Appellants. STEIN, J., dissenting. In this appeal, the issue before the Court is whether reliance on the integrity of the market price for a corporate security satisfies the reliance element of a cause of action for common law fraud. The Appellate Division held that it does. Kaufman v. i-Stat Corp., 324 N.J. Super. 344 (1999). Because I believe that the Appellate Division's thorough and well-reasoned opinion reflects the correct disposition of that issue, I dissent. NO. A-49 SUSAN KAUFMAN, on behalf of herself and all others similarly situated, Plaintiff-Respondent, v. i-STAT CORPORATION; WILLIAM P. MOFFITT; LIONEL N. STERLING; IMANTS R. LAUKS and MATTHIAS PLUM, JR., Defendants-Appellants. DECIDED July 27, 2000 Chief Justice Poritz