Court Opinion

ID: 9539141
Source: CourtListenerOpinion
Date Created: 2023-08-07 07:47:27.419602+00
Date Added: 2024-06-11T14:58:28.225281
License: Public Domain

KENNARD, J., Concurring and Dissenting.
I concur in the judgment only to the extent it declines to apply the fraud-on-the-market principle to claims for negligent misrepresentation. In all other respects, I dissent.
The ffaud-on-the market principle embodies this logic: 1. In an open and developed securities market, the price of each security rapidly adjusts to reflect all public information that is material to the security’s value. 2. When false information material to a security’s value is made public, the security’s *1109price is thereby artificially inflated or depressed. 3. One who artificially inflates a security’s price by intentionally disseminating material false information defrauds every person who, relying on the integrity of the market’s price-setting mechanism, purchases the security at the artificially inflated price.
The United States Supreme Court has endorsed the fraud-on-the-market principle, and federal courts routinely apply it to compensate the victims of securities fraud in actions brought under federal securities laws. Because the fraud-on-the-market principle is a means of establishing actual although indirect reliance, and because it provides the investing public with needed protection against fraudulent manipulation of securities’ prices, this court should recognize it as a valid method of pleading and proving reliance in an action for fraud.
I
This is a consolidated class action by shareholders of Maxicare Health Plans, Inc. (Maxicare) against Maxicare and certain of its directors, senior officers, underwriters, and accountants. The named plaintiffs purchased 1,400 shares of Maxicare common stock at various times between October 17, 1985, and February 29, 1988 (the class period). They sue on behalf of all persons, other than defendants, who purchased common stock or certain notes of Maxicare during the class period. Plaintiffs seek to recover damages, consisting of the loss of value of Maxicare securities, on theories including fraud and negligent misrepresentation. Because the case comes to this court after the sustaining of a demurrer, the allegations of the complaint, summarized below, are deemed true. (Livitsanos v. Superior Court (1992) 2 Cal.4th 744, 747 [7 Cal.Rptr.2d 808, 828 P.2d 1195].)
Maxicare is a publicly owned California corporation engaged in the nationwide operation of health maintenance organizations (HMO’s). During the class period, it made public offerings of notes and common stock. Also during the class period, defendants made various public statements in reports to shareholders, federal securities filings, financial statements, audit reports, press releases, and other communications, in which they reported Maxi care’s net earnings and assets; forecast in glowing terms its future business prospects; and extolled the virtues of its computerized financial, accounting, and management control system.
These public statements were materially false and misleading. Maxicare’s net earnings and assets were less than represented; and toward the end of the class period, after acquiring two large HMO’s for some $450 million, *1110Maxicare incurred heavy losses that defendants materially underreported. The discrepancies between the reported and true earnings resulted from failure to establish adequate reserves for medical costs, failure to promptly report and pay medical costs incurred, and failure to make timely write-downs of good will obtained in HMO acquisitions. Contrary to the public statements, Maxicare’s computerized system of financial, accounting, and management controls was seriously defective and unable to effectively anticipate, provide for, or contain the rapidly increasing costs of medical care, or to integrate the newly acquired HMO’s. Each defendant either knew that the public statements were false, recklessly disregarded information indicating the statements’ falsity, or made the statements negligently and carelessly, without reasonable grounds for believing them to be true.
Knowing that their public statements would directly affect the offering and aftermarket prices of Maxicare’s publicly traded securities, defendants made these “false positive” statements and omissions, or assisted or permitted other defendants to make them, for the purpose and with the effect of manipulating and inflating the prices of the Maxicare notes and common stock and inducing public investors to purchase these Maxicare securities. As a result of the false positive statements, Maxicare notes and common stock traded on the national over-the-counter market (NASDAQ) during the class period at prices up to $1,000 per note and $28 Vi per share. When the true state of affairs became publicly known, the price of Maxicare notes plunged and its common stock fell to $lVi per share. In the interim, while Maxicare’s internal problems were known to defendants but not publicly disclosed, certain of the defendants liquidated their own holdings of over 273,000 shares of Maxicare common stock, receiving proceeds from the sales in excess of $4.6 million.
Plaintiffs were ignorant of the adverse facts concerning Maxicare’s business and financial condition. “In reliance upon the integrity of the securities market and the securities offering process, and the fidelity and integrity and superior knowledge of defendants, and in ignorance of the true facts, plaintiffs and other members of the Plaintiff class were induced to and did purchase Maxicare securities.” Had plaintiffs known that defendants had publicly misstated and failed to disclose material information, they would not have purchased Maxicare securities at the artificially inflated prices. As a result of defendants’ conduct, plaintiffs suffered injury by the loss of value of their investments in Maxicare securities.
II
Reliance is an essential element of a fraud cause of action. (Molko v. Holy Spirit Assn. (1988) 46 Cal.3d 1092, 1108 [252 Cal.Rptr. 122, 762 P.2d 46]; *1111Brown v. Superior Court (1988) 44 Cal.3d 1049, 1070-1071 [245 Cal.Rptr. 412, 751 P.2d 470]; Vai v. Bank of America (1961) 56 Cal.2d 329, 352 [15 Cal.Rptr. 71, 364 P.2d 247].) Thus, the issue presented is not whether reliance is an element of fraud, but what a plaintiff must allege and prove to establish that element.
In an action for fraud, reliance is proved by showing that the defendant’s misrepresentation or nondisclosure was “an immediate cause” of the plaintiffs injury-producing conduct. (Molko v. Holy Spirit Assn., supra, 46 Cal.3d 1092, 1108.) A plaintiff may establish that the defendant’s misrepresentation is an “immediate cause” of the plaintiff’s conduct by showing that in its absence the plaintiff “in all reasonable probability” would not have engaged in the injury-producing conduct. (Ibid.) As the following authorities establish, a defendant’s misrepresentation may be an “immediate cause” of a plaintiff’s injury-producing conduct even though the defendant did not make the misrepresentation directly to the plaintiff, and even though the plaintiff never heard or read the precise words of the misrepresentation.
The Restatement Second of Torts states the principle of indirect reliance this way: “The maker of a fraudulent misrepresentation is subject to liability for pecuniary loss to another who acts in justifiable reliance upon it if the misrepresentation, although not made directly to the other, is made to a third person and the maker intends or has reason to expect that its terms will be repeated or its substance communicated to the other, and that it will influence his [or her] conduct in the transaction or type of transaction involved.” (Rest.2d Torts, § 533.)
Consistent with the Restatement position, this court has long recognized that a representation may be actionable even though it was not made directly to the party seeking recovery. (American T. Co. v. California etc. Ins. Co. (1940) 15 Cal.2d 42, 67 [98 P.2d 497]; Crystal Pier Amusement Co. v. Cannan (1933) 219 Cal. 184, 188 [25 P.2d 839, 91 A.L.R. 1357]; Hunter v. McKenzie (1925) 197 Cal. 176, 185 [239 P. 1090].) A misrepresentation is no less actionable, our courts have held, because it was originally made to an intermediary who conveyed it to the party ultimately injured. (Varwig v. Anderson-Behel Porsche/Audi, Inc. (1977) 74 Cal.App.3d 578, 580 [141 Cal.Rptr. 539]; Massei v. Lettunich (1967) 248 Cal.App.2d 68, 73 [56 Cal.Rptr. 232]; Harold v. Pugh (1959) 174 Cal.App.2d 603, 608 [345 P.2d 112]; Roberts v. Salot (1958) 166 Cal.App.2d 294, 300 [333 P.2d 232]; Simone v. McKee (1956) 142 Cal.App.2d 307, 313-314 [298 P.2d 667]; Wice v. Schilling (1954) 124 Cal.App.2d 735, 745 [269 P.2d 231].) Thus, for example, one who misrepresents the soundness of an investment to one potential investor, knowing that this person is likely to repeat the remarks to *1112other potential investors, is liable to one who receives the misinformation in this fashion, acts upon it, and suffers loss. (Strutzel v. Williams (1952) 109 Cal.App.2d 512, 515 [240 P.2d 988]; see also Nathanson v. Murphy (1955) 132 Cal.App.2d 363, 368-369 [282 P.2d 174].)
Nor is it necessary that the intermediary transmit the misrepresentation verbatim. Rather, the misrepresentation remains actionable even though the intermediary has paraphrased or summarized it, or even transformed it from an assertion of fact into a rating, certification, or recommendation. A comment to section 533 of the Restatement Second of Torts illustrates this point: “One of the situations to which the rule stated in this Section is frequently applied is where misrepresentations are made to a credit-rating company for the purpose of obtaining a credit rating based on them. In this case the maker is subject to liability to any person who may be expected to and does extend credit to him in reliance upon the erroneous rating so procured. The fact that the rating company does not communicate the figures misstated by the maker of the misrepresentations is immaterial. It is enough that their substance is summarized with reasonable accuracy or that the rating given expresses the effect of the misstatements made." (Rest.2d Torts, § 533, com. f, pp. 74-75, italics added.) Thus, the Restatement recognizes that when a fraudulent statement has been transformed into and become embedded in a credit rating, the maker of the misrepresentation is liable for fraud to persons who rely on the rating in extending credit.
Courts have applied this concept of indirect reliance in a variety of situations. In one case, an airplane manufacturer was alleged to have made misrepresentations to the Federal Aviation Administration (FAA) to obtain certification of a particular aircraft. A purchaser of the aircraft was held to have stated a valid claim against the manufacturer for fraudulent misrepresentation by alleging reliance on the FAA certification in making the decision to purchase. (Learjet Corp. v. Spenlinhauer (1st Cir. 1990) 901 F.2d 198, 200-202.) In so holding, the federal court recognized, in effect, that reliance on the FAA certification was reliance on the manufacturer’s misrepresentations, because the misrepresentations had become embedded in the certification. Or, in the language of the Restatement comment, the certification expressed the effect of the manufacturer’s misrepresentations.
Courts in California and other states have applied the principle of indirect reliance to the situation in which a manufacturer of a prescription drug or medical device has misrepresented its product’s safety and effectiveness to the medical profession. A patient injured by the drug or device is permitted to sue the manufacturer for fraud without proof that the doctor who prescribed the drug or recommended the device repeated the misrepresentations *1113to the patient. (Allen v. G.D. Searle & Co. (D.Or. 1989) 708 F.Supp. 1142, 1160-1161; Tetuan v. A.H. Robins Co. (1987) 241 Kan. 441 [738 P.2d 1210, 1227-1228]; Grinnell v. Charles Pfizer & Co. (1969) 274 Cal.App.2d 424, 441 [79 Cal.Rptr. 369]; Toole v. Richardson-Merrell Inc. (1967) 251 Cal.App.2d 689, 707 [60 Cal.Rptr. 398, 29 A.L.R.3d 988].) These courts have concluded, in effect, that a patient’s reliance on the learning and integrity of the physician constitutes reliance on the manufacturer’s misrepresentations, because the misrepresentations have become embedded in the physician’s prescription or recommendation to the patient.
The intermediary that conveys the misrepresentation to the party injured by it need not be an individual or a governmental entity. It can be the price-setting mechanism of a developed market, as shown by In re Equity Funding Corp. of Amer. Sec. Litigation (C.D.Cal. 1976) 416 F.Supp. 161, an action filed in federal court in which the plaintiffs alleged claims under both federal and California law. In discussing the pendent California claims, the federal district court judge, now Chief Justice of this court, reasoned as follows: “Under California law, in order to recover for fraud, plaintiffs must show that they relied to their detriment on the material misrepresentation(s) of the defendants. [Citations.] The plaintiffs have alleged the reliance element necessary to sustain a fraud claim under California law against these defendants. In Paragraph 22(d)(1) of the Complaint, for example, it is alleged these defendants and others disseminated EFCA [Equity Funding Corporation of America] and EFLIC [Equity Funding Life Insurance Company] financial statements ‘for the purpose and with the effect of influencing and manipulating the price of Equity Funding securities and for the purpose and with the effect of influencing open market purchasers of EFCA securities to purchase such securities.’ In Paragraphs 22(d)(2) and (3) the ‘purpose and effect’ allegation is repeated as it pertains to the debenture purchasing plaintiffs .... This allegation of ‘purpose and effect, ’ coupled with the clear materiality of the misrepresentations alleged, satisfies the reliance and causation requirements imposed on pleadings that assert fraud claims in California.” (Id. at pp. 182-183, italics added.)
One final “intermediary” case deserves mention. In Committee on Children’s Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197 [197 Cal.Rptr. 783, 673 P.2d 660], the plaintiffs asserted a claim for fraud against a cereal manufacturer, a retailer and two advertising agencies, alleging deceptive advertising for sugared breakfast cereals. (Id. at pp. 204-205.) The defendants demurred, contending that the complaint was deficient because it alleged that children were exposed to the advertising and that parents purchased the cereals. The defendants argued that the parents could not have relied on misrepresentations that had not been made to them. (Id. at p. 219.)
*1114This court rejected the position that it was essential to allege either that the misrepresentations had been made directly to the parents or that the children had repeated the misrepresentations to their parents. This court stated that such repetition “should not be a prerequisite to liability; it should be sufficient that defendant makes a misrepresentation to one group intending to influence the behavior of the ultimate purchaser, and that he succeeds in this plan.” (Committee on Children’s Television, Inc. v. General Foods Corp., supra, 35 Cal.3d 197, 219.)
By holding that the plaintiffs’ pleading of reliance was sufficient, we recognized that the alleged misrepresentations had become embedded in the children’s cereal preferences, which the children then communicated to the parents, and that in expressing these preferences, the children were, in the language of the Restatement comment, expressing the effect of the misrepresentations. (Committee on Children’s Television, Inc. v. General Foods Corp., supra, 35 Cal.3d 197, 219.)
As this review of pertinent case law demonstrates, the principle of indirect reliance makes an intentional misrepresentation actionable even though the falsehood’s originator did not speak it directly to the injured party. Liability for fraud attaches when the originator’s falsehood has been conveyed to the injured party by an intermediary in a form that substantially expresses the effect of the falsehood, and the injured party has relied upon the falsehood as so conveyed. In the context of a developed securities market, the impersonal price-setting mechanism, which constantly adjusts the trading prices of securities in response to public disclosures of material information, is such an intermediary.
Because it adjusts rapidly to reflect material public information, in the same way that a credit rating is adjusted to reflect material information, the price of an openly traded security may express the effect of a fraudulent statement. For this reason, reliance on a fraudulently manipulated market price, like reliance on a fraudulently inflated credit rating, is equivalent in law to direct reliance on the original fraudulent statement. This, in summary, is what federal courts mean by fraud on the market.
The fraud-on-the-market principle was developed in the context of federal securities law, which provides a variety of private remedies to preserve and enhance the integrity of public securities markets. Of particular interest to the issue in this case, federal law permits a person injured by fraudulent manipulation of the price of a publicly traded security to recover damages under section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. *1115§ 78j(b)1) and administrative rule 10b-5 of the Securities and Exchange Commission (17 C.F.R. § 240.10b-5 (1992)2). In such actions (hereafter rule 10b-5 actions), federal courts routinely apply the ffaud-on-the-market principle to permit those who have purchased a security at artificially inflated prices to recover damages without proving that they were aware of the specific false information by which the security’s price was manipulated.
The first appellate decision to articulate the ffaud-on-the-market principle was Blackie v. Barrack (9th Cir. 1975) 524 F.2d 891, in which the court held that “proof of subjective reliance on particular misrepresentations is unnecessary to establish a 10b-5 claim for a deception inflating the price of stock traded in the open market.” (Id. at p. 906.) The court explained the holding this way: “A purchaser on the stock exchanges may be either unaware of a specific false representation, or may not directly rely on it; he may purchase because of a favorable price trend, price earnings ratio, or some other factor. Nevertheless, he relies generally on the supposition that the market price is validly set and that no unsuspected manipulation has artificially inflated the price, and thus indirectly on the truth of the representations underlying the stock price—whether he is aware of it or not, the price he pays reflects material misrepresentations. Requiring direct proof from each purchaser that he relied on a particular representation when purchasing would defeat recovery by those whose reliance was indirect, despite the fact that the causational chain is broken only if the purchaser would have purchased the stock even had he known of the misrepresentation. We decline to leave such open market purchasers unprotected.” (Id. at p. 907, italics added.)
The United States Supreme Court approved the ffaud-on-the-market principle in Basic Inc. v. Levinson (1988) 485 U.S. 224 [99 L.Ed.2d 194, 108 *1116S.Ct. 978]. After noting that reliance was an element of a rule 10b-5 action, the court explained its approval of the principle in these words: “Recent empirical studies have tended to confirm Congress’ premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations. It has been noted that ‘it is hard to imagine that there ever is a buyer or seller who does not rely on market integrity. Who would knowingly roll the dice in a crooked crap game?’ [Citation.] Indeed, nearly every court that has considered the proposition has concluded that where materially misleading statements have been disseminated into an impersonal, well-developed market for securities, the reliance of individual plaintiffs on the integrity of the market price may be presumed. Commentators generally have applauded the adoption of one variation or another of the fraud-on-the-market theory. An investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.” (Id. at pp. 246-247 [99 L.Ed.2d at p. 218], fns. omitted.)
The fraud-on-the-market principle has not been limited to rule 10b-5 actions. Although it is true, as the majority points out, that as yet no state appellate court has applied the fraud-on-the-market logic in an action for fraud, federal courts have applied fraud-on-the-market reasoning to pendent fraud claims under the laws of other states. (In re Healthcare Services Group, Inc. Securities Litigation (E.D.Pa. 1993) Fed. Sec. L. Rep. (CCH) ¶ 97,374, pp. 95,978-95,979 [Pa. law]; Hurley v. Federal Deposit Ins. Corp. (D.Mass. 1989) 719 F.Supp. 27, 34, fn. 4 [Mass, law]; Minpeco, S.A. v. Hunt (S.D.N.Y. 1989) 718 F.Supp. 168, 175-177 [N.Y. law].) When these federal decisions applying state law are compared with the two state appellate decisions cited by the majority that decline to apply fraud-on-the-market logic to actions for fraud, the count of decisions under the laws of other states in this still relatively undeveloped area of the law reveals a roughly even split.
As this review of the relevant authorities demonstrates, the fraud-on-the-market principle that the federal courts developed in rule 10b-5 cases is fully consistent with the Restatement Second of Torts and with California law. In actions for intentional misrepresentation, our law has never required direct or “eyeball” reliance to sustain a claim, but has recognized the principle of indirect reliance, under which a fraudulent statement is no less actionable because it has passed through an intermediary and in the process has undergone a change in form before inducing reliance by a party who thereby suffers injury. The price of a security traded in an open and developed *1117market may express the effect of a fraudulent statement just as surely as a credit rating (Rest.2d Torts, § 533, com. f), governmental certification (Learjet Corp. v. Spenlinhauer, supra, 901 F.2d 198), doctor’s prescription (Allen v. G.D. Searle & Co., supra, 708 F.Supp. 1142), or even a child’s importuning of a parent to purchase a particular breakfast cereal (Committee on Children’s Television, Inc. v. General Foods Corp., supra, 35 Cal.3d 197). In all such cases, the chain of causation is unbroken, and the element of reliance is established.
Ill
To explain its refusal to accept the fraud-on-the-market logic as a means of proving reliance in traditional tort actions for fraud, the majority dismisses this method of proof as establishing “presumed reliance” rather than “actual reliance.” (Maj. opn., ante, p. 1097.) Two errors underlie this explanation. First, the majority restricts the concept of indirect reliance, which it approves in principle, in a manner at odds with the case law and with the Restatement Second of Torts. Second, the majority misunderstands the context in which federal courts have presumed reliance in rule 10b-5 actions.
The majority professes approval of the principle of indirect reliance as stated in section 533 of the Restatement Second of Torts and as applied in some California cases. But the majority imposes its own novel and restrictive interpretation on this principle. The majority does this by conferring the mantle of “actual reliance” only upon those indirect reliance situations in which an intermediary has conveyed the original misrepresentation by paraphrase, summary, or verbatim repetition. The majority appears to exclude from the category of “actual reliance” those situations in which an intermediary has conveyed the misrepresentation in the form of a rating, certification, recommendation, or market price.
Restricting the principle of indirect reliance in this manner is flatly inconsistent with comment f of section 533 of the Restatement Second of Torts and with cases I have previously cited. Rather than acknowledging this conflict, however, the majority discusses the relevant authorities in a way that conceals their significance.
For example, comment f states that one whose misrepresentations have artificially inflated a credit rating is liable in fraud for damages incurred through reliance on the rating even though “the rating company does not communicate the figures misstated by the maker.” Instead of recognizing that this comment rejects the very limitation that the majority imposes on the *1118principle of indirect reliance, the majority dismisses the Restatement comment with this impenetrable remark: “While the misrepresentation in such a case need not be communicated verbatim, the defendant is liable only to a plaintiff ‘who acts in justifiable reliance upon it. . . ” (Maj. opn., ante, p. 1096, fn. 5.)
No less opaque is the majority’s treatment of the federal court opinion in Learjet Corp. v. Spenlinhauer, supra, 901 F.2d 198, which held that an airplane purchaser had satisfied the reliance element of fraud by pleading reliance upon a federal agency’s certification as an expression of misrepresentations that the airplane’s manufacturer had made to the certifying agency. The majority would distinguish Learjet on the basis that a government certification “necessarily implies that the particular representations required to obtain the certification have been made,” whereas the market price of a security traded on an open and developed market “necessarily implies only that some buyer is willing to pay the quoted price.” (Maj. opn., ante, p. 1100, fn. 6.) Yet elsewhere the majority concedes that the trading prices of securities adjust in response to the dissemination of material information. (Id. at p. 1101.) Thus, the price of a corporation’s securities expresses material representations about the corporation’s financial health and prospects in the same way that a government certification of an aircraft expresses material representations about the physical integrity and soundness of that aircraft.
The majority is abrupt in its dismissal of cases holding that one who has been injured by a prescription drug or similar product may sue the manufacturer for fraud even though the fraudulent statements were made, not to the injured person, but to the doctor who prescribed or administered the product. The majority asserts that these cases “do not assist” plaintiffs “because the courts that decided the cases expressly relied on agency principles rather than the concept of a fraud on the market.” (Maj. opn., ante, p. 1097.) True, California decisions addressing this situation have alluded to agency, but in this context agency is nothing but an awkward legal fiction. Most patients would no doubt be surprised to learn that they have appointed their doctors as agents for dealings with manufacturers of pharmaceutical products. If the concept of agency is really this expansive, one could also conclude, just as easily, that those who use the services of credit rating companies have appointed the companies as their agents for the purpose of gathering and processing information material to the credit rating, that aircraft purchasers have appointed the federal government as their agent for the purpose of gathering and processing information material to the soundness of airplanes, or that an open and developed securities market acts as the agent of investors for the purpose of gathering and processing information material to the value *1119of openly traded securities. Not surprisingly, courts in other jurisdictions have not resorted to the concept of agency to justify imposing fraud liability on pharmaceutical manufacturers who have misrepresented their products to the medical profession. (See Allen v. G.D. Searle & Co., supra, 708 F.Supp. 1142, 1160-1161; Tetuan v. A.H. Robins Co., supra, 241 Kan. 441 [738 P.2d 1210, 1227-1228].) In my view, the principle that best explains the pharmaceutical company’s fraud liability is indirect reliance, not agency.
The majority’s imperceptive treatment of precedent is revealed most clearly by its discussion of Committee on Children’s Television, Inc. v. General Foods Corp., supra, 35 Cal.3d 197, the fraud action based on allegedly deceptive advertising for sugared breakfast cereals. There, as I have already explained, this court permitted parents who had purchased the cereals for their children to maintain the fraud suit even though the complaint did not allege that the parents had heard any of the advertising. As the majority here acknowledges, this court expressed its conclusion in these terms: “[Plaintiffs do not allege the children repeated the representations to their parents, and we would imagine that in most cases they did not, but simply expressed their desire for the product. Repetition, however, should not be a prerequisite to liability; it should be sufficient that defendant makes a representation to one group intending to influence the behavior of the ultimate purchaser, and that he succeeds in this plan.” (Id. at p. 219.)
Incredibly, the majority interprets this statement as meaning only “that children cannot be expected to convey representations about products with precision.” (Maj. opn., ante, p. 1099.) The opinion’s language simply will not bear this meaning. The dispute was not about precision or imprecision in the children’s repetition of the alleged misrepresentations. This court assumed for purposes of argument that the children did not repeat the misrepresentations at all in their original form, but only in the form of an expressed desire for the product. Having made this assumption, a majority of this court concluded that the parents could maintain their action for fraud against the makers of the alleged misrepresentations. This conclusion cannot be reconciled with the majority’s restrictive notion of indirect reliance. Rather, it supports plaintiffs’ position in this case that reliance on a preference, rating, prescription, certification, recommendation, or any comparable embodiment of a misrepresentation satisfies the reliance requirement in an action for fraud.
The majority also fails to acknowledge that Blackie v. Barrack, supra, 524 F.2d 891, the pioneering federal decision applying the fraud-on-the market logic to rule 10b-5 actions, places fraud on the market squarely within the framework of the indirect reliance principle. To demonstrate the point, I *1120once again quote the relevant language, this time more tightly edited to focus on the relevant issue: “A purchaser on the stock exchanges may be either unaware of a specific false representation, or may not directly rely on it .... Nevertheless, he relies generally on the supposition that the market price is validly set. . . and thus indirectly on the truth of the representations underlying the stock price—whether he is aware of it or not, the price he pays reflects material misrepresentations. Requiring direct proof from each purchaser that he relied on a particular representation when purchasing would defeat recovery by those whose reliance was indirect. . . .” (Id. at p. 907, italics added.)
This quotation, which shows that fraud on the market belongs squarely within the framework of indirect reliance, leads to consideration of the second error underlying the majority’s reasoning: the majority’s reliance on federal authority for the proposition that the reliance established by means of the fraud-on-the-market logic is presumed reliance rather than actual reliance.
To be sure, federal courts speak of a “presumption of reliance” in fraud-on-the-market cases, and it is this language that the majority has taken out of context and seized upon. The context in which federal courts presume reliance in fraud-on-the-market cases is class certification, a stage of the proceedings that this case has never reached. Federal courts do not employ a presumption of reliance to determine the existence of a cause of action.
In Basic Inc. v. Levinson, supra, 485 U.S. 224, for example, the United States Supreme Court’s references to a presumption of reliance under the fraud-on-the-market doctrine all occurred in the context of class certification. The court framed the issue as “whether the courts below properly applied a presumption of reliance in certifying the class . . . .” (Id. at p. 230 [99 L.Ed.2d at p. 207].) The court observed that “[Requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action . . . .” (Id. at p. 242 [99 L.Ed.2d at p. 215].) Holding that the presumption of reliance had been properly applied, the court mentioned that “nearly every court that has considered the proposition has concluded that where materially misleading statements have been disseminated into an impersonal, well-developed market for securities, the reliance of individual plaintiffs on the integrity of the market price may be presumed.” (Id. at p. 247 [99 L.Ed.2d at p. 218].)
Because this action has never reached the class certification stage, this court is not called upon to decide whether each plaintiff should be required *1121to testify individually to reliance on the integrity of the market price, or whether reliance by all plaintiffs in the class might be presumed or inferred. (See Occidental Land, Inc. v. Superior Court (1976) 18 Cal.3d 355, 363 [134 Cal.Rptr. 388, 556 P.2d 750] [where same representation is made to each class member, who thereafter takes action consistent with reliance, reliance may be inferred]; Vasquez v. Superior Court (1971) 4 Cal.3d 800, 814 [94 Cal.Rptr. 796, 484 P.2d 964, 53 A.L.R.3d 513] [same].) The only issue is the existence of a cause of action for fraud. For this purpose, as previously explained, the fraud-on-the-market logic developed by the federal courts does not require the use of any presumption.
Thus, the majority is wrong when it insists that the reliance proved by the method known as fraud on the market is something other than actual reliance. No presumption is needed to prove through this method that one who has purchased a security at an artificially inflated price, believing that the price-setting mechanism is untainted, has indirectly relied on the public misrepresentations that caused the price distortion. As one federal court remarked, “reliance on the market price is conceptually indistinguishable from reliance upon representations made in face-to-face transactions.” (In re LTV Securities Litigation (N.D.Tex. 1980) 88 F.R.D. 134, 142.) The majority insists that fraud on the market is analytically distinct from other forms of indirect reliance, but it is just not so.
IV
In part II.B. of its opinion, the majority decides against “changing the law by incorporating the fraud-on-the-market doctrine.” (Maj. opn., ante, p. 1100.) llie majority does so largely on the grounds that the victims of fraudulent stock market practices have adequate remedies under federal and state securities laws, and that recognizing an additional remedy under the traditional tort cause of action for fraud would somehow interfere or conflict with those securities laws.
As I have shown, this part of the majority opinion proceeds from a mistaken premise. Recognizing fraud on the market as a method of pleading and proving reliance in actions for fraud does not require a change in California law, but merely an application of existing common law principles expressed in the indirect reliance cases from California and other jurisdictions, and in the Restatement Second of Torts. But this mistaken premise— that recognizing fraud on the market requires a change in the law—is not the only defect in this part of the majority opinion. In purporting to find a conflict between the traditional tort action for fraud and the more specific *1122remedies provided under federal and state securities laws, the majority is questioning the wisdom of Congress and our state Legislature.
Federal law at present affords victims of securities fraud a remedy through a rule 10b-5 action. But this federal cause of action was never intended to exclude any state remedies: “Congress expressly provided against any implication that it intended to pre-empt the field by declaring, in section 28(a) of the Securities Exchange Act of 1934 (48 U.S. Stat. 903), that ‘[t]he rights and remedies provided by this title shall be in addition to any and all other rights and remedies that may exist at law or in equity.’ ” (Diamond v. Oreamuno (1969) 24 N.Y.2d 494, 504 [301 N.Y.S.2d 78, 85, 248 N.E.2d 910, 915].) Because federal securities laws are cumulative to, and not exclusive of, state remedies, federal law is not offended or frustrated when, for example, federal courts in rule 10b-5 actions award punitive damages on pendent state fraud claims. (See, e.g., Halling v. Hobert & Svoboda, Inc. (E.D.Wis. 1989) 720 F.Supp. 743, 746.) Congress understood and respected the substantial interests of the states in maintaining effective state remedies to deter intentional wrongdoing within their borders, and in assuring full and effective compensation to state residents who have been the victims of such intentional wrongdoing.
Is there an adequate state remedy under California securities law? The majority confidently assures plaintiffs that they have a remedy under the Corporate Securities Act of 1968 (Corp. Code, § 25000 et seq.). Specifically, the majority locates this remedy in section 25400, subdivision (d)3 (hereafter section 25400(d)), and section 255004 of the Corporations Code.
As the majority points out, liability under these state securities law provisions encompasses both issuer and aftermarket transactions, without *1123proof of either privity of contract or direct reliance by the plaintiff. This would suggest that these provisions give plaintiffs the state equivalent of a rule 10b-5 action. At least, this is what the majority implies.
The principal limitation of section 25400(d) as a general remedy for securities fraud appears to be the requirement that the party making the misrepresentation be a “broker-dealer or other person selling or offering for sale or purchasing or offering to purchase the security.” To satisfy this requirement, the plaintiff must prove that the defendant was engaged in market activity at the time of the misrepresentations. (1 Marsh & Volk, Practice Under the Cal. Securities Laws (1993) § 14.05[4], p. 14-52.) Giving this limitation a strict construction, at least one federal court has held that when a corporation sells its stock through underwriters (as the complaint alleges in this case), the corporation and its officers are not sellers and therefore are not bound by section 25400(d). (In re Activision Securities Litigation (N.D.Cal. 1985) 621 F.Supp. 415, 422.) But the majority’s assurance that plaintiffs have a remedy under 25400(d) must mean that it disagrees with this restrictive construction.
In any event, the availability of a state securities law remedy is no more persuasive than the availability of a federal remedy as a justification for shutting the door to the traditional action for fraud. The primary purpose of our state’s corporate securities law is to protect the innocent investing public from fraudulent and manipulative practices. (Southern Cal. First Nat. Bank v. Quincy Cass Associates (1970) 3 Cal.3d 667, 675 [91 Cal.Rptr. 605 [478 P.2d 37]; People v. Baumgart (1990) 218 Cal.App.3d 1207, 1220 [267 Cal.Rptr. 534].) To provide the fullest measure of protection, the Corporate Securities Act of 1968 declares that none of its provisions “shall limit any liability which may exist by virtue of any other statute or under common law if this law were not in effect.” (Corp. Code, § 25510.) In other words, our state’s securities laws, like the federal securities laws, were intended to supplement, not replace, other statutory and common law remedies. (Bowden v. Robinson (1977) 67 Cal.App.3d 705, 716 [136 Cal.Rptr. 871].) To speak, as the majority does, of a “conflict” between securities law remedies and the traditional action for fraud is to ignore the decisions of our state Legislature and Congress to make securities laws nonexclusive and cumulative to traditional tort remedies (see Corp. Code, § 25510; 15 U.S.C. § 78bb(a)).
V
I agree with the majority that liability under the fraud-on-the-market principle should not extend to negligent misrepresentation. This court has *1124recognized that liability should be broader for actual fraud than for negligent misrepresentation. (See, e.g., Bily v. Arthur Young & Co. (1992) 3 Cal.4th 370, 415 [11 Cal.Rptr.2d 51, 834 P.2d 745].) We have emphasized that when a defendant’s misconduct is not intentional, but merely negligent, foreseeability of harm may not provide a sufficient limit on the scope of liability {id. at p. 399), and that the liability imposed should not be grossly disproportionate to the moral fault of the negligent party (id. at pp. 399-402).
As set forth earlier, the fraud-on-the-market principle has been articulated and developed in the context of rule 10b-5 actions. To recover in an action under rule 1 Ob-5, a party who has purchased a security at an artificially inflated price must prove scienter. For purposes of a rule 10b-5 claim, scienter means an “intent to deceive, manipulate, or defraud,” and does not include mere negligence. (Ernst & Ernst v. Hochfelder (1976) 425 U.S. 185, 193, 214 [47 L.Ed.2d 668, 688-689, 96 S.Ct. 1375].) Thus, the principle of fraud on the market, as its name implies, was developed for use in actions involving intentional wrongdoing, not mere negligence.
In actions involving negligence or negligent misrepresentation, courts must balance competing concerns. Liability should be sufficient to provide an incentive for due care and to compensate those most directly injured by an absence of care, but should not be so great that it is grossly disproportionate to fault or discourages participation in socially valuable endeavors. In the context of securities transactions, liability should be sufficient to promote care in the release of information material to the value of publicly traded securities, and to provide compensation to at least the most immediate victims of inaccurate information. But the liability should not be so broad as to discourage businesses from using public markets to accumulate capital.
Here, the balance would be most appropriately struck by limiting recovery for negligent misstatements to those who have received and relied upon the misstatements directly, and excluding those who have relied indirectly through the market-set price.
VI
To drive up the value of a security by means of knowingly false public statements is actual fraud. Innocent investors who purchase the security at the inflated price in ignorance of the falsehood suffer actual loss when the falsehood is revealed and the value of the security declines. When these actual victims of actual fraud seek compensation for actual losses, it requires *1125no revolution in judicial thinking to hold that the traditional tort action for fraud provides a remedy. In rejecting the fraud-on-the-market method of proving reliance in actions for fraud, the majority repudiates existing law as expressed in the indirect reliance cases. I dissent from the majority’s decision to withhold the traditional fraud remedy from those wronged by intentional manipulation of securities prices.
Mosk, Acting C. J., concurred.

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange—
“(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” (15 U.S.C. § 78j.)

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
“(a) To employ any device, scheme, or artifice to defraud,
“(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
“(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
“in connection with the purchase or sale of any security.” (17 C.F.R. § 240.10b-5.)

“It is unlawful for any person, directly or indirectly, in this state:
“(d) If such person is a broker-dealer or other person selling or offering for sale or purchasing or offering to purchase the 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 [or she] knew or had reasonable ground to believe was so false or misleading.” (Corp. Code, § 25400.)

“Any 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. Such damages shall be the difference between the price at which such other person purchased or sold securities and the market value which such securities would have had at the time of his [or her] purchase or sale in the absence of such act or transaction, plus interest at the legal rate.” (Corp. Code, § 25500.)