Opinion ID: 1154737
Heading Depth: 3
Heading Rank: 2

Heading: Should the Law Be Changed?

Text: (7a) Having determined that California law does not permit plaintiffs to state a cause of action for deceit without pleading actual reliance, we next consider plaintiffs' arguments for changing the law by incorporating the fraud-on-the-market doctrine. Plaintiffs first argue that the proposed change is necessary to provide a remedy for victimized investors. It is unfair, plaintiffs contend, to require pleading and proof of actual reliance because it is widely accepted that stock prices adjust in reaction to material information, whether true or false. Under these circumstances, according to plaintiffs, the requirement of actual reliance merely penalizes investors who have innocently relied on the integrity of the market but cannot demonstrate reliance on a particular misrepresentation. We do not doubt that stock prices adjust in response to the dissemination of material information. [7] However, it does not follow that investors will be left without a remedy unless we adopt the fraud-on-the-market doctrine. Investors, including plaintiffs in this case, already have remedies under federal and state law that do not require the pleading or proof of actual reliance. (8)(See fn. 8.) Rule 10b-5, which we have already mentioned, affords plaintiffs both a private right of action in federal court and a presumption of reliance. (See Rule 10b-5, as interpreted in Basic Inc. v. Levinson, supra, 485 U.S. at pp. 241-247 [99 L.Ed.2d at pp. 214-218].) [8] Indeed, as we have also mentioned, a class action lawsuit under Rule 10b-5 based on the same events involved in this case has been filed in federal court. (Zucker, et al. v. Maxicare Health Plans, Inc., et al., supra, Dock. No. CV-88-02499.) (7b) Defrauded investors may also sue under the antifraud provisions of state securities law for misrepresentations that affect the market without proving actual reliance. (See Corp. Code, งง 25400, 25500.) [9] The very purpose of these statutes is to afford the victims of securities fraud with a remedy without the formidable task of proving common law fraud. ( Bowden v. Robinson, supra, 67 Cal. App.3d at p. 714.) Under section 25400, it is unlawful for a broker-dealer or other person selling or offering for sale or purchasing or offering to purchase [a] security, to make, for the purpose of inducing the purchase or sale of such security by others, any statement which was, at the time and in the light of the circumstances under which it was made, false or misleading with respect to any material fact, or which omitted to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and which he knew or had reasonable ground to believe was so false or misleading. (ง 25400, subd. (d), italics added.) Investors harmed by a violation of section 25400 have an express, private right of action under section 25500, which provides that [a]ny person who willfully participates in any act or transaction in violation of Section 25400 shall be liable to any other person who purchases or sells any security at a price which was affected by such act or transaction for the damages sustained by the latter as a result of such act or transaction. (ง 25500.) Sections 25400 and 25500, as one court has written, conspicuously avoid [] the requirement of `actual reliance.' ( Bowden v. Robinson, supra, 67 Cal. App.3d at p. 714, quoting Olson, The California Corporate Securities Law of 1968 (1968-1969) 9 Santa Clara L.Rev. 75, 98 (Olson).) The principal drafters of these statutes have summarized their effect in this way: There is no requirement under these sections that the plaintiff rely upon the statements or acts of the defendant or even that he be aware that the defendant made them or engaged in them. All that is required is that the plaintiff establish that the price which he paid or received was affected by the defendant's conduct or statements, which would of course assume that someone acted on the basis of the defendant's wrongful conduct. However, it is not necessary that the plaintiff prove that he personally was influenced by such conduct. (1 Marsh & Volk, Practice Under the Cal. Securities Law (1993) ง 14.05[6], at p. 14-53, fn. omitted.) [10] These statutory remedies, which do not require plaintiffs to plead or prove actual reliance, can be asserted in a class action. Accordingly, there is little force in plaintiffs' argument that we should reshape the law of deceit simply in order to remove [an] unnecessary pleading barrier[] to the effective utilization of class action procedures. (Cf. Children's Television, supra, 35 Cal.3d at pp. 217-218 [to avoid an unreasonably lengthy complaint, plaintiffs may attach a representative selection of advertisements from a prolonged and extensive media campaign]; La Sala v. American Sav. & Loan Assn. (1971) 5 Cal.3d 864, 875, fn. 10 [97 Cal. Rptr. 849, 489 P.2d 1113] [an inappropriately alleged class definition need not prevent class certification if the case in fact satisfies the prerequisites for certification].) The argument is misplaced in any event: Actual reliance is more than a pleading requirement; it is an element of the tort of deceit. As we have previously observed, [c]lass actions are provided only as a means to enforce substantive law. Altering the substantive law to accommodate procedure would be to confuse the means with the ends โ to sacrifice the goal for the going. ( City of San Jose v. Superior Court (1974) 12 Cal.3d 447, 462 [115 Cal. Rptr. 797, 525 P.2d 701, 76 A.L.R.3d 1223].) [11] Plaintiffs assert that their remedy under sections 25400 and 25500 is inadequate. It is true that liability under the sections is not precisely coextensive with liability under Rule 10b-5. [12] However, the state statutory remedy is not as limited as plaintiffs suggest. Contrary to plaintiffs' suggestion at oral argument, sections 25400 and 25500 do provide a remedy for fraud in connection with aftermarket transactions, i.e., resales of securities after they have been purchased from the issuing corporation in a public offering. To read the sections as imposing liability only in connection with issuer transactions is inconsistent with the statutory language, which broadly refers to a broker-dealer or other person selling or offering for sale or purchasing or offering to purchase the security.... (ง 25400, italics added.) Clearly the Legislature knew how to write a statute that addressed only issuer transactions when that was what it intended to do. (See ง 25110 [It is unlawful for any person to offer or sell in this state any security in an issuer transaction ....], italics added.) Nor is it correct, as plaintiffs also suggest, that liability under sections 25400 and 25500 requires privity of contract between the plaintiff and the defendant. The Legislature also knew how to write a statute that conditioned liability on privity. In section 25501 the Legislature did just that in these words: Any person who violates Section 25401 shall be liable to the person who purchases a security from him or sells a security to him. ... (ง 25501, italics added.) Section 25500, in contrast, contains no such limitation; it provides more broadly that [a]ny person who willfully participates in any act or transaction in violation of Section 25400 shall be liable to any other person who purchases or sells any security at a price which was affected by such act or transaction.... (ง 25500, italics added.) In other words, [u]nder Section 25501 the defendant is only liable to the person with whom he deals; whereas, under Section 25500 the defendant may be liable to any person trading in the market.... (1 Marsh & Volk, supra, ง 14.05[2][e], at p. 14-50; see also Olson, supra, 9 Santa Clara L.Rev. at p. 98.) Plaintiffs point out that to incorporate the fraud-on-the-market doctrine into the common law of deceit would afford advantages beyond those that the relevant statutes provide, such as a longer limitations period and the right to recover punitive damages. (9) However, we have emphasized in recent decisions that courts should be hesitant to `impose [new tort duties] when to do so would involve complex policy decisions' [citation], especially when such decisions are more appropriately the subject of legislative deliberation and resolution. ( Moore v. Regents of University of California (1990) 51 Cal.3d 120, 136 [271 Cal. Rptr. 146, 793 P.2d 479, A.L.R.4th 3659], quoting Nally v. Grace Community Church (1988) 47 Cal.3d 278, 299 [253 Cal. Rptr. 97, 763 P.2d 948] [first set of brackets in original]; see also Droeger v. Friedman, Sloan & Ross (1991) 54 Cal.3d 26, 41 [283 Cal. Rptr. 584, 812 P.2d 931]; Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 694 & fn. 31 [254 Cal. Rptr. 211, 765 P.2d 373].) This admonition has particular force when the plea to expand liability concerns an area, such as securities fraud, in which the Legislature has already acted. (7c) Indeed, the advantages that plaintiffs would obtain through expanded liability under the common law appear to conflict with several specific legislative policy choices. Plaintiffs, for example, would prefer to sue under the law of deceit because the statute of limitations that applies to such claims is more favorable to plaintiffs than the limitation periods applicable to claims under state and federal securities law. (Compare Code Civ. Proc., ง 338 [three years after discovery of the facts constituting a fraud], with Corp. Code, ง 25506 [one year after discovery or four years after the act constituting the violation]; cf. Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson (1991) ___ U.S. ___ [115 L.Ed.2d 321, 111 S.Ct. 2773] [adopting a one-year limitations period without equitable tolling for actions under Rule 10b-5].) However, the shorter limitations period in the Corporations Code was specifically intended to counterbalance the tremendous advantage that a presumption of reliance affords to plaintiffs. ( Bowden v. Robinson, supra, 67 Cal. App.3d at p. 714.) Because the statutory liabilities may in some instances be based on a lesser degree of fault than common law fraud, it is also important that businesses be freed from potential liabilities of indefinite duration in order that corporations may determine with some reasonable certainty what their financial situation is as of any given point of time. This is important not only to the corporation and its officers and directors but also to all of its shareholders and to persons generally interested in buying or selling its shares in the market. (1 Marsh & Volk, supra, ง 14.08[1][a], at p. 14-66; cf. Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, supra, ___ U.S. at p. ___ [115 L.Ed.2d at p. 333, 111 S.Ct. at p. 2780] [observing that policy considerations [are] implicit in any limitations provision].) Plaintiffs would also prefer to sue under the law of deceit because that law, in contrast to the applicable securities laws, permits an award of punitive damages. However, the failure of the securities laws to authorize punitive damages appears to reflect another deliberate policy choice. While the courts of this state have not had occasion to comment on the reasons why the Legislature did not make punitive damages available, there is extensive commentary on the reasons why the federal judiciary has not made punitive damages available under Rule 10b-5. The state provisions were drafted and should be considered in the light of this experience. (1 Marsh & Volk, supra, ง 14.01[3], at p. 14-15.) In summary, the federal decisions reflect a longstanding consensus that the burden on the securities business from punitive damages ... outweigh[s] their contribution to enforcement of securities laws. ( Carras v. Burns (4th Cir.1975) 516 F.2d 251, 260; see also Green v. Wolf Corporation, supra, 406 F.2d 291, 303 & fn. 18; Diaz Vicente v. Obenauer (E.D. Va. 1990) 736 F. Supp. 679, 695; Baumel v. Rosen (4th Cir.1969) 412 F.2d 571, 576.) (10) Punitive damages can be justified only as a deterrent measure or as retribution. (11) However, as the federal decisions explain, the additional deterrent value of punitive damages does not appear to be needed in this area for several reasons. The first reason is that actual damages, alone, represent a potentially crushing liability in securities fraud cases. (See Green v. Wolf Corporation, supra, 406 F.2d at p. 303 & fn. 18.) Under the fraud-on-the-market doctrine, which plaintiffs can invoke both under Rule 10b-5 and state securities law (งง 25400, 25500), the defendant may be liable to any person trading in the market for any length of time that the market price may have been affected by his misstatement. (1 Marsh & Volk, supra, ง 14.05[2][e], at p. 14-50.) The second reason is that the class action mechanism, which makes litigation affordable for individuals, tends to ensure that the securities laws will be enforced. Because this procedural device allow[s] many small claims to be litigated in the same action, the overall size of compensatory damages alone may constitute a significant deterrent. ( deHaas v. Empire Petroleum Company (10th Cir.1970) 435 F.2d 1223, 1231; Green v. Wolf Corporation, supra, 406 F.2d at p. 303.) Nor is it clear that punitive damages are needed as a retributive measure. Both federal and state laws strongly express society's disapprobation of securities fraud through criminal sanctions. (15 U.S.C. ง 78ff(a) [providing for imprisonment for up to 10 years and fines of up to $2.5 million]; งง 25540, 25541 [providing for imprisonment for up to 5 years and fines of up to $250,000].) Federal and state laws also provide for civil penalties. (15 U.S.C. ง 78ff(c); ง 25535.) There are, moreover, good reasons not to combine a cause of action that permits an award of punitive damages, such as common law deceit, with the fraud-on-the-market doctrine. An assessment of the defendant's culpability, for the purpose of setting punitive damages, would presumably take into account the total effect of the defendant's misrepresentations on the market. However, plaintiffs may sue separately, and if juries in several lawsuits are able to assess punitive damages against the same defendant for the same transaction, there is a danger of overkill. ( deHass v. Empire Petroleum Company, supra, 435 F.2d at p. 1231.) Also worth considering is the effect that the prospect of punitive damages might have on the settlement value of marginal claims. As the high court noted in a decision limiting the class of investors permitted to sue under Rule 10b-5, [t]here has been widespread recognition that litigation under Rule 10b-5 presents a danger of vexatiousness different in degree and in kind from that which accompanies litigation in general. ( Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 739 [44 L.Ed.2d 539, 551, 95 S.Ct. 1917] [ Blue Chip Stamps ].) The main reason for the difference is the fraud-on-the-market doctrine, which, by creating a presumption of reliance, both encourages the aggregation of claims and diminishes the plaintiff's burden of proof. In addition, [t]he very pendency of the lawsuit may frustrate or delay normal business activity of the defendant which is totally unrelated to the lawsuit. ( Id. at p. 740 [44 L.Ed.2d at p. 552].) As a result, even a complaint which by objective standards may have very little chance of success at trial has a settlement value to the plaintiff out of any proportion to its prospect for success at trial so long as he may prevent the suit from being resolved against him by dismissal or summary judgment. ( Ibid. ; cf. Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions (1991) 43 Stan.L.Rev. 497 [arguing, based on an empirical study, that for practical purposes the settlement value of a securities fraud class action is not a function of merit].) To create a cause of action that would offer prospective plaintiffs both the advantage of a presumption of reliance and the prospect of recovering punitive damages could only exacerbate the problem. (7d) Finally, to incorporate the fraud-on-the-market doctrine into the law of deceit would permit plaintiffs to avoid two important limitations that the federal courts have imposed on market-reliance cases brought under Rule 10b-5. In such actions, a plaintiff must plead and prove, first, that he or she actually purchased or sold securities ( Blue Chip Stamps, supra, 421 U.S. at pp. 730-755 [44 L.Ed.2d at pp. 546-560]) and, second, that the defendant had scienter โ a degree of fault greater than negligence ( Ernst & Ernst v. Hochfelder (1976) 425 U.S. 185, 194-215 [47 L.Ed.2d 668, 677-789, 96 S.Ct. 1375] [ Ernst & Ernst ]). These requirements of actions under Rule 10b-5, like the relatively short limitations period and the ban on punitive damages, reflect a deliberate effort, guided by judicial experience with securities fraud cases, to balance the advantages associated with a presumption of reliance against the danger of speculative and harassing claims. (See Blue Chip Stamps, supra, 421 U.S. at pp. 738-749 [44 L.Ed.2d at pp. 550-557]; Ernst & Ernst, supra, 425 U.S. at p. 214, fn. 33 [47 L.Ed.2d at p. 689].) The same requirements, however, are not necessarily part of the common law of deceit. Thus, to permit common law claims based on the fraud-on-the-market doctrine would open the door to class action lawsuits based on exceedingly speculative theories. For example, unhindered by the Blue Chip Stamps and Ernst & Ernst rules, investors might sue on the ground that they missed favorable opportunities to buy or to sell securities because the market was affected by negligent misrepresentations that they never heard. Considering such prospects, we are reminded of the admonition that `the inexorable broadening of the class of plaintiff who may sue in this area of the law will ultimately result in more harm than good.' ( Ernst & Ernst, supra, 425 U.S. at pp. 214-215, fn. 33 [47 L.Ed.2d at p. 689], quoting Blue Chip Stamps, supra, 421 U.S. at pp. 747-748 [44 L.Ed.2d at pp. 555-556].) In summary, to incorporate the fraud-on-the-market doctrine into the common law of deceit would only bring about difficulties that the state Legislature and the federal courts have apparently attempted to avoid. Nor would the proposed expansion of the common law of deceit offer benefits sufficient to offset the difficulties, since the state and federal securities laws already offer remedies that give plaintiffs the benefit of a presumption of reliance. [13] Under these circumstances, there is insufficient justification for upsetting the policy choices that the existing laws reflect. Accordingly, we decline to do so.