Court Opinion

ID: 9795894
Source: CourtListenerOpinion
Date Created: 2023-08-31 03:41:39.659314+00
Date Added: 2024-06-11T08:40:32.931800
License: Public Domain

KENNARD, J., Concurring.
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.
I
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 *186that 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.1 The possibility of such a rise, he maintains, would make damages too speculative. These premises lead Justice Baxter to conclude that in most instances stockholders must sell their stock in order to sue, because there is no other way they can fix the amount of damages suffered and prove they will not benefit from an increase in the value of the stock, at some unknown future date, arising from unknowable future circumstances.
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) 338 U.S. 1 [69 S.Ct. 1434, 93 L.Ed. 1765, 7 A.L.R.2d 1280] [eminent domain]; Zaslow v. Kroenert (1946) 29 Cal.2d 541 [176 P.2d 1] [conversion].) To state a cause of action, a plaintiff whose property is damaged need not plead that its value will be forever impaired. (See, e.g., Wolfsen v. Hathaway (1948) 32 Cal.2d 632 [198 P.2d 1] [temporary damage to pasturage, which would regenerate naturally].) In Mears v. Crocker First Nat. Bank (1948) 84 Cal.App.2d 637 [191 P.2d 501], the appellate court upheld a cause of action for conversion when a company wrongfully refused for six weeks to transfer title to stock on its books.
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 *187such 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 the stock is sold. For individual stockholders, it affects such matters as whether the stockholders will take a vacation, whether they can get a mortgage, and what other investments they make or do not make. It can have drastic effects on retirement plans. Businesses and institutions also hold stock. A decline in the value of the stock it holds can lead a college to raise tuition or an insurer to raise premiums. It affects a company’s ability to borrow money or issue new stock. In sum, ours is a paper economy, and declines in stock prices have real and serious effects whether or not the stockholders sell the stock.
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.2 (Ibid.) There are differences between the buyer’s actions regulated by the PSLRA and the holder’s actions at issue here, but they share a common need: to fix a postdisclosure date and price to use in calculating damages. In this respect the two actions are analogous, and the federal legislation regulating buyer’s action suggests a workable rule for *188computing damages in holder’s actions: It recognizes that the market may overreact to news of fraud, and that a later price may be a better indicator of the true postdisclosure value of the stock, but it does not diminish a plaintiff’s damages because of the possibility that long-term economic factors may eventually cause the stock price to rise to its predisclosure level.
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.3 A quarter of a century ago a similar argument was rejected in Harris v. American Investment Company (8th Cir. 1975) 523 F.2d 220, 227-228, which held that in a buyer’s action no sale was required: “A defrauded buyer of securities may maintain an action for damages under § 10(b). . . even though he continues to hold the securities. [Citations.] At common law, a defrauded purchaser of securities is under no duty to sell them prior to maintaining an action for deceit but may hold them for investment purposes if he chooses. [Citations.] Thus, Harris was under no duty to sell his . . . stock, for mitigation of damages or any other purposes, prior to commencing this action. [|] . . . Harris’s damages may be measured as of the date of public discovery of the fraud. Under those circumstances, ‘[t]he plaintiff will not be able to avail himself of any further decrease in the value of the security after that date. So also the defendant should not be able to avail itself of any increase in the value of the stock after that date. This is the only method in which a consistent measure of damages can be obtained.’” This reasoning applies equally to a holder’s action as involved here.
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.4
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 *189they 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 economists or market analysts, which might have severe consequences.
II
I disagree also with Justice 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 hypothesis5 (cone. & dis. opn., post, at p. 203), but despite her disclaimer she relies on that economic theory for her analysis.6 The efficient capital markets hypothesis, however, does not support her analysis.
*190I 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) 975 F.2d 1370, 1374; Crocker v. Federal Deposit Ins. Corp. (5th Cir. 1987) 826 F.2d 347, 351-352.) Plaintiff is entitled only to damages attributable to the fraud, that is, to defendants’ false representations in April 1996 and their concealment of the true financial condition of Fritz until July 24, 1996.
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 publicly available information.” (Conc. & dis. opn., post, at p. 204.) The efficient capital market hypothesis does not presume that investors consider only hard economic data and ignore other information casting doubt on the integrity or competence of management. There is no logical reason under the efficient capital market hypothesis to assume that investors would disregard information showing false earnings reports and concealment of true data and would value the stock as if no such things had occurred.
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. *191Investors 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) 40 Cal.3d 202, 219 [219 Cal.Rptr. 445, 707 P.2d 818]; 6 Witkin, Summary of Cal. Law, supra, Torts, § 1325, p. 783 and cases there cited.) It is particularly applicable in fraud cases. “Because of the extra measure of blameworthiness inhering in fraud” (Lazar v. Superior Court (1996) 12 Cal.4th 631, 646 [49 Cal.Rptr.2d 377, 909 P.2d 981]), the “modem tendency is to impose broader consequences . . . than where [the defendant’s] conduct was merely negligent.” (6 Witkin, Summary of Cal. Law, supra, Torts, § 1323, p. 781.)
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) 926 F.2d 289, 301; Behrens v. Wometco Enterprises, Inc. (S.D.Fla. 1988) 118 F.R.D. 534, 542.) Experts may disagree—they often do—but that is no reason to reject a holder’s cause of action.
Justice Brown fears that under the majority opinion a company would be subject to securities fraud claims whenever it announces bad news or a negative correction. “[P]laintiffs,” she says, “would merely have to allege a loss of investor confidence due to investor speculation that the bad news *192resulted from fraud or incompetence.” (Conc. & dis. opn., post, at p. 207.) To the contrary, under the principles stated in the majority opinion, plaintiffs would have to allege fraud with specificity to state a cause of action.
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.”7 (Conc. & dis. opn., post, at p. 209.) If she maintains that such persons have a valid cause of action for fraud, then her position differs only in nuance from the majority opinion, which states that a holder plaintiff “must allege specific reliance on the defendant’s 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” (Maj. opn., ante, at p. 184, italics added.) The difference between the majority and Justice Brown appears to be that the majority would allow a cause of action if the stockholder would have sold the stock if he or she had been given truthful information, while Justice Brown would limit the cause of action to persons who were dissuaded from selling by false information—which may be two ways of saying the same thing. Moreover, Justice Brown would allow greater damages than the majority proposes, allowing persons who actually rely on misrepresentations to claim damages for “drops in market price due to intervening causes unrelated to the misrepresentations.” (Conc. & dis. opn., post, at p. 210.)
*193III
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 remedy should not be so hedged and qualified that only a fraction of those actually injured would be able to gain redress.

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) 857 F.Supp. 1011, but that case held that courts should not entertain a holder’s action at all—a minority view and one that Justice Baxter rejects. Chanoff did not say that a holder’s action could be sustained if the holder sold the stock after disclosure of the fraud.

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) 282 F.3d 935, 938.)

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 may 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.