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California Recognizes Holder's Actions

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  • Baker, John
    The California Supreme Court has recognized a cause of action, referred to as a holder s action, for fraud or negligent misrepresentation by persons
    Message 1 of 3 , Apr 7, 2003
      The California Supreme Court has recognized a cause of action, referred to as a "holder's action," for fraud or negligent misrepresentation by persons wrongfully induced to hold stock instead of selling it. Small v. Fritz Companies, No. S091297 (Calif. Apr. 7, 2003). The plaintiff alleged that the defendant corporation and its officers sent its stockholders a fraudulent quarterly financial report that grossly overreported earnings and profits and that the plaintiff relied on this information in deciding not to sell his shares. The California court, in a 4-3 decision, ruled that California law does allow holder's actions, although it did not go so far as to recognize claims by persons who do not own stock and are fraudulently induced not to buy. The U.S. Supreme Court ruled in 1975 that Rule 10b-5 does not permit holder's actions.

      If the California Supreme Court's analysis is correct, the Securities Litigation Uniform Standards Act of 1998 will not affect holder's actions under state law. The Uniform Standards Act, or SLUSA, provides that covered class actions based upon state law may not be maintained by any private party alleging untrue statements or omissions in connection with the purchase or sale of a covered security. The California court said that the Uniform Standards Act will not affect state court holder's actions, because the Act by its terms applies only to suits involving the purchase or sale of stock.

      Although the California Supreme Court allowed the cause of action, it also ruled that the plaintiff had not adequately pled reliance. The court ruled that in a holder's action, a plaintiff must allege specific reliance on the defendants' representations and must allege actions, as distinguished from unspoken and unrecorded thoughts and decisions, that would indicate that the plaintiff actually relied on the misrepresentations. The plaintiff was given leave to amend his complaint to make the necessary allegations.

      The court's opinion is available online at

      http://www.courtinfo.ca.gov/opinions/documents/S091297.PDF


      John M. Baker <JMB@...>
      Stradley, Ronon, Stevens & Young, LLP Http://www.stradley.com
      1220 19th Street, N.W., Suite 600, Washington, DC 20036
      (202) 419-8413 Fax (202) 822-0140
      FundLaw Listowner Http://groups.yahoo.com/group/fundlaw
    • Christopher
      I d simply like to add that both Baxter and Brown wrote very intriguing decisions -- Baxter in partial concurrence with the majority, Brown in dissent. The
      Message 2 of 3 , Apr 8, 2003
        I'd simply like to add that both Baxter and Brown wrote very
        intriguing decisions -- Baxter in partial concurrence with the
        majority, Brown in dissent. The California court has staked out
        three distinct positions on the debate over the difficult policy
        isues involved in holders rights, and I would expect that that
        scholarly commentary in the months to come will break down largely
        along the same lines.

        Justice Marvin R. Baxter agreed that there should be a holders' right
        of action, but he differed from the majority in that he would have
        required realized damages. In effect, this would require potential
        plaintiffs to sell after taking a loss in the market value of their
        stock, and then to sue on the damages so calculated. This is in many
        respects an appealing rule, since docket space is too precious a
        resource to employ much of it on lawsuits for merely nominal damages,
        the dips that will be plentiful within the career of the buy-and-hold
        portion of one's portfolio.

        Justice Janice R. Brown was more thorough in her disagreement with
        the majoruty. She believed that the plaintiff had as a matter of law
        sustained no damages. The price of Fritz stock between the time of
        the misrepresentations and the time of their disclosure
        was "unlawfully inflated," and the disclosure simply brought the
        stock back to where its price would have been had the accounting been
        honest throughout (on the assumption that capital markets are
        efficient). No harm, no foul, for anyone who bought before the
        misstatements and sold after the truth came out.

        Justice Joyce L. Kennard, who not only wrote for the court but he
        wrote a concurrence with herself, in order to make a more
        idiosyncratic response to Baxter and Brown, pointed out that
        reduction in the value of a home, or a plot of land, is legally
        cognizable as an injury. There is no "sell to sue" rule in such
        cases nor should there by, she believes, for stock portfolios. She
        also expressed doubts that markets are as rational as Justice Brown's
        argument requires that they be. The psychological consequences of
        the revelation of a fraud can, she maintained, drive the price of a
        stock well below what it would have been had there been no fraud.
      • Gene Hanson
        ... But the damages are not merely nominal. The stock was reduced in value because of the fraud. Why should the stockholder not be able to recover damages
        Message 3 of 3 , Apr 9, 2003
          Christopher wrote:

          >I'd simply like to add that both Baxter and Brown wrote very
          >intriguing decisions -- Baxter in partial concurrence with the
          >majority, Brown in dissent. The California court has staked out
          >three distinct positions on the debate over the difficult policy
          >isues involved in holders rights, and I would expect that that
          >scholarly commentary in the months to come will break down largely
          >along the same lines.
          >
          >Justice Marvin R. Baxter agreed that there should be a holders' right
          >of action, but he differed from the majority in that he would have
          >required realized damages. In effect, this would require potential
          >plaintiffs to sell after taking a loss in the market value of their
          >stock, and then to sue on the damages so calculated. This is in many
          >respects an appealing rule, since docket space is too precious a
          >resource to employ much of it on lawsuits for merely nominal damages,
          >the dips that will be plentiful within the career of the buy-and-hold
          >portion of one's portfolio.
          >
          But the damages are not merely nominal. The stock was reduced in value
          because of the fraud. Why should the stockholder not be able to recover
          damages for the reduction in value? Under Justice Baxter's view, a
          stockholder who sold would be able to reover, while a stockholder who
          did not would not be able to recover, even though both suffered exactly
          the same injury. Dips in the value of stock may be plentiful, but dips
          due to fraud presumably are not, and even if they were (indeed,
          particularly if they were), a stockholder should not be precluded from
          suing.

          >Justice Janice R. Brown was more thorough in her disagreement with
          >the majoruty. She believed that the plaintiff had as a matter of law
          >sustained no damages. The price of Fritz stock between the time of
          >the misrepresentations and the time of their disclosure
          >was "unlawfully inflated," and the disclosure simply brought the
          >stock back to where its price would have been had the accounting been
          >honest throughout (on the assumption that capital markets are
          >efficient). No harm, no foul, for anyone who bought before the
          >misstatements and sold after the truth came out.
          >
          A dubious assumption. As Justice Kennard pointed out in her separate
          concurring opinion, the value of the stock undoubtedly declined more
          because of the fraud than it would have had the correct figures been
          timely reported. On Justice Brown's reasoning, even a selling
          stockholder whould not be able to recover. Only those who bought in
          reliance on the fraudulent income reports would be entitled to recover.

          >Justice Joyce L. Kennard, who not only wrote for the court but he
          >wrote a concurrence with herself, in order to make a more
          >idiosyncratic response to Baxter and Brown,
          >
          Idiosyncratic?

          > pointed out that
          >reduction in the value of a home, or a plot of land, is legally
          >cognizable as an injury. There is no "sell to sue" rule in such
          >cases nor should there by, she believes, for stock portfolios. She
          >also expressed doubts that markets are as rational as Justice Brown's
          >argument requires that they be. The psychological consequences of
          >the revelation of a fraud can, she maintained, drive the price of a
          >stock well below what it would have been had there been no fraud.
          >
          Clearly the better view, in my opinion.

          Gene Hanson
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