Summary
rejecting "fraud on the market" presumption as a substitute for actual reliance
Summary of this case from In re Glenfed, Inc. Securities LitigationOpinion
No. B048705
2-28-1991
Previously published at 227 Cal.App.3d 1537, 234 Cal.App.3d 719, 12 Cal.App.4th 927, 6 Cal.App.4th 414 227 Cal.App.3d 1537, 234 Cal.App.3d 719, 12 Cal.App.4th 927, 6 Cal.App.4th 414, 59 USLW 2576, Fed. Sec. L. Rep. P 96,180 Gerald D. MIRKIN, et al., Plaintiffs and Appellants, v. Fred W. WASSERMAN, et al., Defendants and Respondents.
Paul, Hastings, Janofsky & Walker, William B. Campbell, Todd E. Gordinier and Elizabeth W. Sachs, Nagler & Schneider, Lawrence H. Nagler, Larry Goldberg and Harry Rebhuhn, Irell & Manella, Morgan Chu and Marjorie Nieset Neufeld, Gibson, Dunn & Crutcher, Richard P. Levy and Donald J. Schmid, Cooper & Dempsey, Michael D. Dempsey and Robert D. Donaldson, for defendants and respondents.
Gerald D. MIRKIN, et al., Plaintiffs and Appellants,
v.
Fred W. WASSERMAN, et al., Defendants and Respondents.
Feb. 28, 1991.
Review Granted June 20, 1991.
Milberg Weiss Bershad Specthrie & Lerach, William S. Lerach, Eric A. Isaacson, Blake M. Harper, Helen J. Hodges, San Diego, and Leonard B. Simon, Barrack, Rodos & Bacine, Edward M. Gergosian and Thomas M. Wilson, Barrack, Rodos & Bacine and Leonard Barrack, Wolf Haldenstein Adler Freeman & Herz, Daniel W. Krasner, Jeffrey G. Smith, and Francis M. Gregorek, Wechsler, Skirnick, Harwood, Halebian & Feffer and Stuart D. Wechsler, Kohn, Savett, Klein & Graf, Dianne Nast and Barbara Podell, and Alvin Ivers, for plaintiffs and appellants.
Paul, Hastings, Janofsky & Walker, William B. Campbell, Todd E. Gordinier and Elizabeth W. Sachs, Nagler & Schneider, Lawrence H. Nagler, Larry Goldberg and Harry Rebhuhn, Irell & Manella, Morgan Chu and Marjorie Nieset Neufeld, Gibson, Dunn & Crutcher, Richard P. Levy and Donald J. Schmid, Cooper & Dempsey, Michael D. Dempsey and Robert D. Donaldson, for defendants and respondents.
ORTEGA, Associate Justice.
We conclude the fraud-on-the-market presumption of reliance does not apply to actions under California law for fraud and deceit (Civ.Code, §§ 1572, subds. 1, 3; 1710, subds. 1, 3), negligent misrepresentation (Civ.Code, §§ 1572, subd. 2; 1710, subd. 2), or violation of Corporations Code section 1507. We affirm the judgment of dismissal following the order sustaining demurrers without leave to amend to the second amended complaint.
BACKGROUND
In reviewing a ruling on demurrer, we determine only whether the complaint states a cause of action. Accordingly, we assume the truth of the complaint's properly pleaded material allegations and reasonably interpret the complaint as a whole and read its parts in their context. (Garcia v. Superior Court (1990) 50 Cal.3d 728, 732, 268 Cal.Rptr. 779, 789 P.2d 960.) Briefly stated, the complaint alleges as follows:
Plaintiffs, who are shareholders of Maxicare Health Plans, Inc. (Maxicare), filed this consolidated class action complaint against Maxicare, 1 certain Maxicare officers and directors, 2 the accounting firm of Ernst & Whinney (succeeded by respondent Ernst & Young) and the underwriting firm of Salomon Brothers and Montgomery Securities. The complaint alleges that defendants intentionally misrepresented and deliberately concealed material information concerning Maxicare's financial condition in order to artificially inflate the price of Maxicare's publicly traded stock and to fraudulently induce public investors to purchase Maxicare securities. Moreover, while these false positive statements were disseminated between October 17, 1987, and February 29, 1988, certain of the defendants who were privy to the inside information, sold about 270,000 shares of their Maxicare common stock at artificially inflated prices. During this period, the price of Maxicare stock rose to $28.50 a share and then fell to a low of $1.50 a share prior to Maxicare's declaration of bankruptcy on March 15, 1989.
Plaintiffs bring this class action on behalf of all persons, other than defendants, who purchased Maxicare common stock or 11 3/4 percent Senior Subordinated Notes Due 1996, 3 on the "NASDAQ" national over-the counter market between October 17, 1985, and February 29, 1988. The complaint alleges liability solely under California law, listing three causes of action for fraud and deceit (Civ.Code, §§ 1572, subds. 1, 3; 1710, subds. 1, 3), 4 negligent misrepresentation (Civ.Code, §§ 1572, subd. 2; 1710, subd. 2), 5 and violation of Corporations Code section 1507 (hereinafter section 1507). 6
Defendants demurred to the complaint, contending among other things that plaintiffs had failed to allege reliance, a necessary element of each of their causes of action. Discovery has established that plaintiffs did not directly rely on defendants' alleged false representations and concealments in making their stock purchases. 7 Moreover, plaintiffs did not purchase the stock through or upon the advice of others who had received the alleged false information.
In opposition to the demurrers, plaintiffs urged the trial court to adopt the fraud-on-the-market presumption of reliance which applies in federal securities fraud actions brought under section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78a et seq.), and the Securities and Exchange Commission's Rule 10b-5 (see 17 CFR § 240.10b-5 (1990)) (hereinafter Rule 10b-5 actions). Under the fraud-on-the-market theory, plaintiffs who never heard the alleged false representations may nevertheless bring Rule 10b-5 actions if they reasonably relied on the integrity of the open and developed securities market in purchasing the securities. (See Basic Incorporated v. Levinson (1988) 485 U.S. 224, 241-242, 108 S.Ct. 978, 988-989, 99 L.Ed.2d 194.)
The trial court below refused to apply the fraud-on-the-market theory to causes of action for fraud, negligent misrepresentation and violation of section 1507, and initially sustained the demurrers with leave to amend.
Plaintiffs filed an amended complaint which was essentially unchanged. 8 At the hearing on the resultant demurrers, the trial court asked the parties to conduct a systematic survey of foreign jurisdictions with respect to the fraud-on-the-market theory. The parties submitted extensive supplemental papers, but failed to uncover a single state court decision which had applied the theory in a common law action for fraud and deceit. 9 Plaintiffs argued, however, that several federal courts have applied the theory to pendent state fraud claims in Rule 10b-5 actions. 10 Plaintiffs also contended that California courts have implicitly accepted the theory.
The trial court again sustained the demurrers, this time without leave to amend, and concluded the "fraud on the market theory which underlies plaintiff's complaint is unknown in California jurisprudence with respect to the three causes of action before the Court." The court dismissed the complaint and this appeal followed.
ISSUES
Plaintiffs contend (I) direct communication of the misrepresentation is not required to establish reliance under California law; (II) reliance is presumed under California law if the material misrepresentations were made with the purpose and effect of causing damage; (III) California law authorizes the fraud-on-the-market theory and public policy favors its application herein, and (IV) reliance is presumed when a defendant breaches its duty to disclose material information (Affiliated Ute Citizens v. United States (1972) 406 U.S. 128, 153-154, 92 S.Ct. 1456, 1472, 31 L.Ed.2d 741).
DISCUSSION
The trial court properly sustains a demurrer without leave to amend when the facts are undisputed, the nature of the claim is clear, and no liability exists under substantive law. (Wilhelm v. Pray, Price, Williams & Russell (1986) 186 Cal.App.3d 1324, 1330, 231 Cal.Rptr. 355.) On appeal, all presumptions are drawn in favor of the propriety and correctness of the trial court's determination. (Ibid.) Absent a clear showing of an abuse of discretion, the trial court's order of dismissal following the sustaining of a demurrer will be affirmed. (Ibid.)
With respect to fraud and deceit, a plaintiff must specifically plead the following elements: (1) a misrepresentation (including concealment and nondisclosure); (2) knowledge of falsity; (3) intent to induce reliance; (4) justifiable reliance; and (5) resulting damages. (Barbara A. v. John G. (1983) 145 Cal.App.3d 369, 376, 193 Cal.Rptr. 422; Okun v. Morton (1988) 203 Cal.App.3d 805, 828, 250 Cal.Rptr. 220.) The absence of any one of these elements is fatal to recovery. (Gonsalves v. Hodgson (1951) 38 Cal.2d 91, 101, 237 P.2d 656; Okun v. Morton, supra, 203 Cal.App.3d at p. 828, 250 Cal.Rptr. 220.)
Fraud actions are subject to strict pleading requirements with certain exceptions. (Committee on Children's Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 216-217, 197 Cal.Rptr. 783, 673 P.2d 660.) Generally, the pleading must state the facts constituting the fraud, and must allege each element of the cause of action. (Id. at p. 216, 197 Cal.Rptr. 783, 673 P.2d 660.) The policy of liberal construction of the pleadings will not ordinarily save a pleading that is defective in any material respect. (Ibid; Commonwealth Mortgage Assurance Co. v. Superior Court (1989) 211 Cal.App.3d 508, 518, 259 Cal.Rptr. 425; Wilhelm v. Pray, Price, Williams & Russell, supra, 186 Cal.App.3d at p. 1331, 231 Cal.Rptr. 355.)
Negligent misrepresentation, a form of deceit, consists of the following elements: (1) a misrepresentation of a past or existing material fact, (2) made without reasonable grounds for believing it to be true, (3) with intent to induce another's reliance, (4) ignorance of the truth and justifiable reliance by the party to whom the misrepresentation was directed, and (5) resulting damages. (Home Budget Loans, Inc. v. Jacoby & Meyers Law Offices (1989) 207 Cal.App.3d 1277, 1285, 255 Cal.Rptr. 483; Fox v. Pollack (1986) 181 Cal.App.3d 954, 962, 226 Cal.Rptr. 532.) 11
Similarly, recovery under section 1507 is expressly conditioned upon the injured plaintiff's reliance. The section specifically limits recovery to those persons "injured thereby who relied" on the alleged misrepresentations.
Accordingly, reliance is a common element required under each cause of action for fraud and deceit, negligent misrepresentation, or violation of section 1507. The parties do not contend, nor do we perceive, that any distinction should be drawn with respect to the reliance requirement under each cause of action based on the facts pled herein. We will thus discuss the causes of action collectively in the following sections. I
Plaintiffs contend direct communication of the misrepresentation is not required to establish reliance under California law. The general rule, however, is otherwise. It stands to reason that a "party cannot be defrauded by misrepresentations which never reached him and of which he had no knowledge at the time of his loss. [Citations.]" (Slakey Brothers Sacramento, Inc. v. Parker (1968) 265 Cal.App.2d 204, 208, 71 Cal.Rptr. 269.)
When a misrepresentation is directly communicated to a group of plaintiffs, "collective reliance by all members of a group could be proved circumstantially, through evidence that its members responded collectively to a directly communicated falsehood. [Citation.]" (Slakey Brothers Sacramento, Inc. v. Parker, supra, 265 Cal.App.2d at p. 208, 71 Cal.Rptr. 269.) Similarly, a rebuttable presumption of reliance would arise as to the entire group of plaintiffs "if the trial court finds material misrepresentations were made to the class members...." (Vasquez v. Superior Court (1971) 4 Cal.3d 800, 814, 94 Cal.Rptr. 796, 484 P.2d 964.) And an inference of justifiable reliance by each class member would arise if it could be established that a reasonable person would have relied upon the alleged misrepresentations. (Id. at p. 814, fn. 9, 94 Cal.Rptr. 796, 484 P.2d 964.)
But it would be improper to draw an inference of classwide reliance when the misrepresentations were not uniformly made to each class member. (Osborne v. Subaru of America, Inc. (1988) 198 Cal.App.3d 646, 661, 243 Cal.Rptr. 815; see Occidental Land, Inc. v. Superior Court (1976) 18 Cal.3d 355, 362, 134 Cal.Rptr. 388, 556 P.2d 750; Vasquez v. Superior Court, supra, 4 Cal.3d at p. 814, 94 Cal.Rptr. 796, 484 P.2d 964; cf. Brown v. Regents of University of California (1984) 151 Cal.App.3d 982, 990, 198 Cal.Rptr. 916.) In this case, no direct representations were made to the plaintiffs. The plaintiffs did not receive or learn of the information contained in the various prospectuses, financial statements, press releases and shareholder reports mentioned in the complaint. We conclude plaintiffs are not entitled to a presumption of classwide reliance.
We disagree with plaintiffs' assertion that Vasquez applied the fraud-on-the-market doctrine in the "parallel field of consumer law." While the Vasquez decision mentioned the inference of classwide reliance that arises in "federal class action cases in which stockholders have alleged fraud on the basis of printed misrepresentations in a corporation prospectus," Vasquez did not discuss or endorse the fraud-on-the-market doctrine. (Vasquez v. Superior Court, supra, 4 Cal.3d at p. 815, 94 Cal.Rptr. 796, 484 P.2d 964.) That case arose in a different context-- individual sales of frozen food and freezers by defendant's sales personnel who gave the same memorized sales pitch to each class member. Under those facts, the Vasquez court was not required to decide whether direct communication of the misrepresentations to each class member was a prerequisite to recovery. Here, on the other hand, the plaintiffs never read any of the materials which contained the alleged misrepresentations. Each of the plaintiffs purchased their stock over the counter, and not as a result of statements contained in a prospectus. When "an issuer or underwriter of securities offers [stock] for sale to the public, he impliedly represents that the applicable provisions of law have been complied with. The falsity of that representation may give rise to an action either for breach of warranty or for fraud depending upon the culpability of the seller in the particular transaction." (Mary Pickford Co. v. Bayly Bros., Inc. (1939) 12 Cal.2d 501, 519, 86 P.2d 102; see Universal By-Products, Inc. v. City of Modesto (1974) 43 Cal.App.3d 145, 151, 117 Cal.Rptr. 525.) But when the investors purchase stock over the counter without reading the prospectus or receiving any information concerning the company, there is no basis for drawing a classwide inference of reliance. 12
While plaintiffs have cited several cases involving indirect misrepresentations (Committee on Children's Television, Inc. v. General Foods Corp., supra, 35 Cal.3d at pp. 218-219, 197 Cal.Rptr. 783, 673 P.2d 660; Crystal Pier Amusement Co. v. Cannan (1933) 219 Cal. 184, 188, 25 P.2d 839; Hunter v. McKenzie (1925) 197 Cal. 176, 185, 239 P. 1090; Barnhouse v. City of Pinole (1982) 133 Cal.App.3d 171, 191-193, 183 Cal.Rptr. 881; Varwig v. Anderson-Behel Porsche/Audi, Inc. (1977) 74 Cal.App.3d 578, 581, 141 Cal.Rptr. 539; Massei v. Lettunich (1967) 248 Cal.App.2d 68, 73, 56 Cal.Rptr. 232), we find them to be distinguishable.
Committee on Children's Television, Inc. v. General Foods Corp., supra, 35 Cal.3d 197, 197 Cal.Rptr. 783, 673 P.2d 660 (hereinafter Children's Television ), involved a class action for fraud and deceptive advertising in the marketing of sugared breakfast cereals. The named plaintiffs (five organizations, individual adults and children) filed their complaint on behalf of all California residents who had been or were likely to be deceived or misled by the alleged deceptive advertising. The defendants included the manufacturer, advertising agencies, retailer, and individual corporate officers and employees. The complaint stated causes of action based on consumer protection statutes (Bus. & Prof.Code, §§ 17200-17208), unfair competition statutes (Bus. & Prof.Code, §§ 17500-17572), fraud (Civ.Code, § 1710), and breach of warranty. The trial court sustained the demurrers without leave to amend, concluding the complaint failed to state a sufficient factual basis for fraud. But the California Supreme Court reversed, holding that the plaintiffs should be permitted to amend their complaint to state a fraud cause of action on behalf of the individual parent and child plaintiffs.
Plaintiffs herein contend that direct communication of the alleged misrepresentations was not a prerequisite to recovery in Children's Television, since some of the adult plaintiffs in that case had never seen the commercials on children's television programs. (Children's Television, supra, 35 Cal.3d at p. 219, 197 Cal.Rptr. 783, 673 P.2d 660.) However, as the Supreme Court noted, the adult plaintiffs had been directly exposed to printed advertisements, including statements on the cereal boxes. (Ibid.) Accordingly, the Court concluded the partial lack of direct communication was not fatal to recovery: "Restatement Second of Torts section 533, states that '[t]he maker of a fraudulent misrepresentation is subject to liability ... 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 conduct.' This proposition was indorsed as California law in Varwig v. Anderson-Behel Porsche/Audi, Inc. (1977) 74 Cal.App.3d 578, 581, 141 Cal.Rptr. 539. We recognize that it does not quite cover the present case--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 misrepresentation to one group intending to influence the behavior of the ultimate purchaser, and that he succeeds in this plan." (Children's Television, supra, 35 Cal.3d at p. 219, 197 Cal.Rptr. 783, 673 P.2d 660.)
This statement, read in its context, is not a bald assertion that a defendant who makes a misrepresentation to one group with the intent of influencing another group and who succeeds in this plan, is liable even when no causal connection exists between the fraud and the damage alleged. It cannot be disputed that some causal connection must exist between the misrepresentation and the injured group's reliance thereon. (See Garcia v. Superior Court, supra, 50 Cal.3d at p. 737, 268 Cal.Rptr. 779, 789 P.2d 960; Lesperance v. North American Aviation, Inc. (1963) 217 Cal.App.2d 336, 345, 31 Cal.Rptr. 873.) In Children's Television, the children who observed the television commercials directly communicated their desire for the advertised products to their parents. But as we discuss in section II, infra, there is no allegation in this case of any relationship or communication between the plaintiffs and the more informed followers of the stock market who received the defendants' alleged misrepresentations. And as we discuss in section III, infra, no inference of a causal connection should be drawn in this case under the fraud-on-the-market theory.
Varwig v. Anderson-Behel Porsche/Audi, Inc., supra, 74 Cal.App.3d 578, 141 Cal.Rptr. 539, cited in Children's Television, is distinguishable. Varwig involved a face-to-face transaction where the seller (Autocar) lacked valid title to the used car which it sold to the plaintiff. After the car was repossessed, the plaintiff sued both Autocar and Autocar's predecessor in title (defendant) for misrepresentation of title. The appellate court concluded that the defendant's failure to directly communicate with the plaintiff did not immunize the defendant from liability since the defendant knew that Autocar was purchasing the car for resale. The Varwig court found that the defendant had " 'an advantage to gain ... by furnishing the misrepresentation for repetition' to the class of persons interested in purchasing a secondhand 1973 Chevrolet. Such advantage 'is of great significance in determining' whether respondent had 'reason to expect that' Autocar would repeat the misrepresentation. (Rest.2d Torts, § 533, com. e.) ... [O]n these facts, [defendant's] representation to Autocar was in law an indirect misrepresentation to plaintiff, who purchased the car in reliance upon Autocar's repetition of the representation." (Varwig v. Anderson-Behel Porsche/Audi, Inc., supra, 74 Cal.App.3d at p. 581, 141 Cal.Rptr. 539.)
Similarly, in face to face real estate transactions, the buyer directly relies on the seller's misrepresentations and nondisclosures of material fact. Accordingly, privity of title is not a prerequisite to recovery for fraud and deceit. (Barnhouse v. City of Pinole, supra, 133 Cal.App.3d at p. 191, 183 Cal.Rptr. 881; see La Jolla Village Homeowners' Assn. v. Superior Court (1989) 212 Cal.App.3d 1131, 1151, 261 Cal.Rptr. 146 ("Barnhouse's holding is limited to transactions involving real property as between sellers, buyers, developers, and real estate agents/brokers. [Citation.]".) In Barnhouse, the developer of suburban tract homes failed to disclose preexisting slides, seeps and springs to the original purchasers. These conditions could only be detected through expert advice. When one of the original purchasers later resold his home, he passed along the nondisclosure. The subsequent purchaser suffered damage as a result of the nondisclosure and was permitted to bring an action for fraudulent concealment against the developer despite the absence of any direct dealing with the developer. (Barnhouse v. City of Pinole, supra, 133 Cal.App.3d at pp. 190-192, 183 Cal.Rptr. 881.) Had the court ruled otherwise, the developer's liability would have vanished "simply because of the fortuitous event of an intervening resale." (Id. at p. 192, 183 Cal.Rptr. 881.) 13
We also distinguish plaintiffs' remaining cases which do not apply to the facts herein. (Crystal Pier Amusement Co. v. Cannan, supra, 219 Cal. at pp. 187-188, 25 P.2d 839 (a defendant may not escape liability to a defrauded corporation by claiming the misrepresentations were made to corporate officers and directors rather than to the corporation itself); and Hunter v. McKenzie, supra, 197 Cal. at p. 185, 239 P. 1090 (when a defendant makes misrepresentations to a husband in the presence of his wife, the wife's reliance upon the false representations may be inferred from the surrounding circumstances).)
In our view, the automobile purchaser's belief in the validity of the seller's title, or the home buyer's belief in the proper compaction of the soil, should not be compared with the investors' belief in the "integrity" of the market price of publicly traded stock, as we will discuss infra. While federal courts apply the fraud-on-the-market theory in rule 10b-5 actions, the considerations which apply there do not control fraud and misrepresentation causes of action based on California law.
II
Plaintiffs assert that reliance is presumed under California law if material misrepresentations were made with the purpose and effect of causing damage. While this Division recently stated that reliance may be presumed when "representations have been made in regard to a material matter and action has been taken" (Continental Airlines, Inc. v. McDonnell Douglas Corp. (1989) 216 Cal.App.3d 388, 426, 264 Cal.Rptr. 779), we did not imply that the presumption is proper in every instance. We conclude reliance may be presumed only when the misrepresentations were uniformly made to each class member.
Plaintiffs rely heavily on the statement of Chief Justice Lucas (then a United States District Court Judge) in In re Equity Funding Corp. of Amer. Sec. Litigation (C.D.Cal.1976) 416 F.Supp. 161, 183 (see also Zatkin v. Primuth (S.D.Cal.1982) 551 F.Supp. 39, 46, which cites Equity Funding ), that the "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." 14 But in our view, Vasquez v. Superior Court, supra, 4 Cal.3d at p. 814, 94 Cal.Rptr. 796, 484 P.2d 964, permits the inference of classwide reliance only when the misrepresentations were uniformly made to each class member. (Osborne v. Subaru of America, Inc., supra, 198 Cal.App.3d at p. 661, 243 Cal.Rptr. 815; see Occidental Land, Inc. v. Superior Court, supra, 18 Cal.3d at p. 362, 134 Cal.Rptr. 388, 556 P.2d 750; cf. Brown v. Regents of University of California, supra, 151 Cal.App.3d at p. 990, 198 Cal.Rptr. 916.) Moreover, it is not enough to show the misrepresentations were material and were intended to cause the damage alleged. The plaintiffs must also show a "complete causal connection" between the statements and the damage by showing they actually and reasonably relied on defendants' statements and nondisclosures. (Garcia v. Superior Court, supra, 50 Cal.3d at p. 737, 268 Cal.Rptr. 779, 789 P.2d 960; Lesperance v. North American Aviation, Inc., supra, 217 Cal.App.2d at p. 345, 31 Cal.Rptr. 873.)
Proof of reliance requires a demonstration of the plaintiffs' subjective knowledge or state of mind through either direct or circumstantial evidence. (Vasquez v. Superior Court, supra, 4 Cal.3d at p. 814, 94 Cal.Rptr. 796, 484 P.2d 964; Slakey Brothers Sacramento, Inc. v. Parker, supra, 265 Cal.App.2d at p. 208, 71 Cal.Rptr. 269.) The "[p]laintiffs must show 'actual' reliance, i.e., that the representation was an ' " 'immediate cause' " ' that altered their legal relations. (4 Witkin, Summary of Cal. Law (8th ed. 1974) Torts, § 472, p. 2732.) Besides actual reliance, plaintiffs must also show 'justifiable' reliance, i.e., circumstances were such to make it reasonable for plaintiff to accept defendant's statements without an independent inquiry or investigation. (4 Witkin, supra, § 475, p. 2734.)" (Wilhelm v. Pray, Price, Williams & Russell, supra, 186 Cal.App.3d at pp. 1331-1332, 231 Cal.Rptr. 355.) Although plaintiffs need not establish the misrepresentations were the sole inducements which led them to purchase the securities and suffer damages, (Vasquez v. Superior Court, supra, 4 Cal.3d at p. 814, fn. 9, 94 Cal.Rptr. 796, 484 P.2d 964), reliance may not be presumed absent direct communication of the misrepresentation to each class member.
At oral argument, plaintiffs relied on the recent favorable decision in In re MDC Holdings Securities Litigation (S.D.Cal.1990) 754 F.Supp. 785 Plaintiffs' reliance is misplaced. In MDC Holdings, the federal district court denied a defendant's motion to strike the plaintiffs' pendent common law claims for fraud and deceit, after concluding the fraud-on-the-market theory is applicable to such claims under Vasquez v. Superior Court, supra, 4 Cal.3d at p. 814, 94 Cal.Rptr. 796, 484 P.2d 964. We hold otherwise, and respectfully disagree with the court's opinion on this point in MDC Holdings for the reasons stated above. (See In re Wyse Technology Securities Litigation (N.D.Cal.1990) [1990 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 95,509 at p. 97,686, 1990 WL 169149.)
III
Plaintiffs contend California law authorizes the fraud-on-the-market theory and public policy favors its application herein. We disagree.
As with common law fraud and negligent misrepresentation actions, reliance must also be proven in Rule 10b-5 actions. (Basic Incorporated v. Levinson, supra, 485 U.S. at p. 243, 108 S.Ct. at p. 989.) However, the Ninth Circuit has relaxed the plaintiff's burden of proof in Rule 10b-5 actions by adopting the fraud-on-the-market theory of reliance. (Blackie v. Barrack (9th Cir.1975) 524 F.2d 891, 905-908.) This theory is explained in a Third Circuit opinion as follows: "The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, 15 the price of a company's stock is determined by the available material information regarding the company and its business. [Citation.] Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.... The causal connection between the defendants' fraud and the plaintiffs' purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations." (Peil v. Speiser (3d Cir.1986) 806 F.2d 1154, 1160-1161.) The fraud-on-the-market theory has gained wide acceptance by other federal courts under Rule 10b-5 (see, e.g., Finkel v. Docutel/Olivetti Corp. (5th Cir.1987) 817 F.2d 356, 361-363 (fraud-on-the-market theory applies to omissions under Rule 10b-5(1) and (3), but not to affirmative misrepresentations under Rule 10b-5(2)); Harris v. Union Elec. Co. (8th Cir.1986) 787 F.2d 355, 367, and fn. 9; Lipton v. Documation, Inc. (11th Cir.1984) 734 F.2d 740, 747-748; T.J. Raney & Sons v. Fort Cobb, Okl. Irr. Fuel (10th Cir.1983) 717 F.2d 1330, 1332-1333; Ross v. A.H. Robbins Co. (2d Cir.1979) 607 F.2d 545, 553), and was approved by four members of the United States Supreme Court in Basic Incorporated v. Levinson, supra, 485 U.S. 224, 108 S.Ct. 978.
In Basic, Justice Blackmun, joined by Justices Brennan, Marshall, and Stevens, affirmed the lower court's application of the fraud-on-the-market theory in a Rule 10b-5 action. The plurality opinion reasoned that the high volume of exchanges conducted in modern securities markets has outstripped the "face to face transactions contemplated by early fraud cases" (id. at pp. 243-244, 108 S.Ct. at pp. 989-990; see Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 744-745, 95 S.Ct. 1917, 1929-1930, 44 L.Ed.2d 539 ("[T]he typical fact situation in which the classic tort of misrepresentation and deceit evolved was light years away from the world of commercial transactions to which Rule 10b-5 is applicable."), thus requiring a reexamination of the reliance requirement in Rule 10b-5 cases. 16 Justice Blackmun concluded that the presumption of reliance by investors upon the integrity of a stock's market price is "consistent with, and, by facilitating Rule 10b-5 litigation, supports, the congressional policy embodied in the 1934 Act." (Basic Incorporated v. Levinson, supra, 485 U.S. at p. 245, 108 S.Ct. at p. 990.) 17 In addition, he noted that 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." (Id. at p. 246, 108 S.Ct. at p. 991, fn. omitted.) Justice Blackmun also commented that the fraud-on-the-market theory has been accepted by commentators and "nearly every court that has considered the proposition...." (Id. at p. 247, 108 S.Ct. at p. 991.)
While Justice Blackmun's opinion approved of the fraud-on-the-market theory in Rule 10b-5 litigation, it distinguished causes of action based on common law fraud and misrepresentation, and noted that actions under Rule 10b-5 are "in part designed to add to the protections provided investors by the common law, [citation]." (Basic Incorporated v. Levinson, supra, 485 U.S. at p. 244, fn. 22, 108 S.Ct. at p. 990, fn. 22.) Other Supreme Court decisions have similarly stated that "an important purpose of the federal securities statutes was to rectify perceived deficiencies in the available common-law protections by establishing higher standards of conduct in the securities industry." (Herman & MacLean v. Huddleston (1983) 459 U.S. 375, 389, 103 S.Ct. 683, 691, 74 L.Ed.2d 548; see Ernst & Ernst v. Hochfelder (1976) 425 U.S. 185, 203, 96 S.Ct. 1375, 1385, 47 L.Ed.2d 668; S.E.C. v. Capital Gains Bureau (1963) 375 U.S. 180, 186, 84 S.Ct. 275, 280, 11 L.Ed.2d 237 (a fundamental purpose common to the federal securities statutes is "to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics"); McClure v. Borne Chemical Company (3d Cir.1961) 292 F.2d 824, 834.) While the passage of federal securities statutes has induced federal courts to adopt the fraud-on-the-market theory of reliance in order to correct perceived deficiencies in the protection to investors available under the common law (Herman & MacLean v. Huddleston, supra, 459 U.S. at p. 389, 103 S.Ct. at p. 691), those federal statutes do not govern our state law causes of action for fraud, negligent misrepresentation, and violation of section 1507. The federal statutory remedies for securities fraud evolved from but remain distinct from the traditional common law fraud remedies. (S.E.C. v. Capital Gains Bureau, supra, 375 U.S. at p. 194, 84 S.Ct. at p. 284 ("There has also been a growing recognition by common-law courts that the doctrines of fraud and deceit which developed around transactions involving land and other tangible items of wealth are ill-suited to the sale of such intangibles as advice and securities, and that, accordingly, the doctrines must be adapted to the merchandise in issue."); Herman & MacLean v. Huddleston, supra, 459 U.S. at pp. 388-389, 103 S.Ct. at pp. 690-691 ("Moreover, the antifraud provisions of the securities laws are not coextensive with common-law doctrines of fraud." [Fn. omitted.] ).)
Accordingly, we distinguish the federal court decisions which have applied the fraud-on-the-market theory in Rule 10b-5 litigation.
With respect to the Supreme Court's decision in Basic, we note that Justice White, joined by Justice O'Connor, wrote separately to express his disapproval of the fraud-on-the-market theory. (Basic Incorporated v. Levinson, supra, 485 U.S. at pp. 260-263, 108 S.Ct. at pp. 998-999, White, J. concurring and dissenting.) Because Justice White's concurring and dissenting opinion raises several weighty objections to the fraud-on-the market theory which we think are persuasive in arguing against its application here, we quote from his opinion at length:
"At the bottom of the Court's conclusion that the fraud-on-the-market theory sustains a presumption of reliance is the assumption that individuals rely 'on the integrity of the market price' when buying or selling stock in 'impersonal, well-developed market[s] for securities.' [Citation.] Even if I was prepared to accept (as a matter of common sense or general understanding) the assumption that most persons buying or selling stock do so in response to the market price, the fraud-on-the-market theory goes further. For in adopting a 'presumption of reliance,' the Court also assumes that buyers and sellers rely--not just on the market price--but on the 'integrity' of that price. It is this aspect of the fraud-on-the-market hypothesis which most mystifies me.
"To define the term 'integrity of the market price,' the majority quotes approvingly from cases which suggest that investors are entitled to ' "rely on the price of a stock as a reflection of its value." ' [Citations.] But the meaning of this phrase eludes me, for it implicitly suggests that stocks have some 'true value' that is measurable by a standard other than their market price. While the Scholastics of Medieval times professed a means to make such a valuation of a commodity's 'worth,' I doubt that the federal courts of our day are similarly equipped.
"Even if securities had some 'value'--knowable and distinct from the market price of a stock--investors do not always share the Court'spresumption that a stock's price is a 'reflection of [this] value.' Indeed, 'many investors purchase or sell stock because they believe the price inaccurately reflects the corporation's worth.' See Black, Fraud on the Market: A Criticism of Dispensing with Reliance Requirements in Certain Open Market Transactions, 62 N.C.L.Rev. 435, 455 (1984) (emphasis added). If investors really believed that stock prices reflected a stock's 'value,' many sellers would never sell, and many buyers never buy (given the time and cost associated with executing a stock transaction). As we recognized just a few years ago: '[I]nvestors act on inevitably incomplete or inaccurate information, [consequently] there are always winners and losers; but those who have "lost" have not necessarily been defrauded.' Dirks v. SEC, 463 U.S. 646, 667, n. 27, 103 S.Ct. 3255, 3268, n. 27, 77 L.Ed.2d 911 (1983). Yet today, the Court allows investors to recover who can show little more than that they sold stock at a lower price than what might have been.
"I do not propose that the law retreat from the many protections that § 10(b) and Rule 10b-5, as interpreted in our prior cases, provide to investors. But any extension of these laws, to approach something closer to an investor insurance scheme, should come from Congress, and not from the courts." (Basic Incorporated v. Levinson, supra, 485 U.S. at pp. 255-257, 108 S.Ct. pp. 995-996, White, J., concurring and dissenting, fns. omitted.)
As indicated by Justice White in Basic, commentators have not unanimously embraced the proposition that the market price of a stock accurately reflects its value. While the proposition has been accepted by many (see authorities cited in Finkel v. Docutel/Olivetti Corp., supra, 817 F.2d at p. 361, fns. 12, 13), we share Justice White's uncertainty over the validity of the efficient market thesis which underlies the fraud-on-the-market theory. (See In re LTV Securities Litigation (N.D.Tex.1980) 88 F.R.D. 134, 144.)
To the best of our knowledge, no state court has applied the fraud-on-the-market theory to common law fraud actions. (Peil v. Speiser, supra, 806 F.2d at p. 1163, fn. 17 ("While the fraud on the market theory is good law with respect to the Securities Acts, no state courts have adopted the theory, and thus direct reliance remains a requirement of a common law securities fraud claim. [Citation.]"; Cammer v. Bloom (D.N.J.1989) 711 F.Supp. 1264, 1298; In re ORFA Securities Litigation (D.N.J.1987) 654 F.Supp. 1449, 1460 ("There does not appear to be any common law exceptions [sic] to the requirement of individual reliance (analogous to the judicially created Rule 10b-5 exceptions)."); Rosenberg v. Digilog Inc. (E.D.Pa.1985) 648 F.Supp. 40, 43-44; McFarland v. Memorex Corporation (N.D.Cal.1982) 96 F.R.D. 357, 364 ("[I]ndividual reliance on the fraud and the misrepresentation must be proven by plaintiffs. This may not be an essential element of a class action brought under Section 10, but it is still a required element of common law fraud and deceit.").)
Plaintiffs contend the cases mentioned above misconstrue the fraud-on-the-market theory by assuming it provides a substitute for reliance rather than a method of proving reliance. (See, e.g., Rosenberg v. Digilog Inc., supra, 648 F.Supp. at p. 43 ("I am not convinced, however, that plaintiff may offer any substitute for actual reliance with regard to his pendent state law claims for fraud and common law misrepresentation."); In re ORFA Securities Litigation, supra, 654 F.Supp. at p. 1460; Cammer v. Bloom, supra, 711 F.Supp. at p. 1298.) We find this supposed distinction to be irrelevant. And in any event, we also believe the fraud-on-the-market theory eviscerates the reliance requirement.
If the theory merely provided a presumption of reliance, a defendant should be able to rebut that presumption by showing the plaintiff's lack of reliance. However, the plaintiff's actual reliance or lack of reliance is irrelevant under the fraud-on-the-market theory, since the theory assumes the market price of a stock accurately reflects its value, and that the investor relied on the market price in purchasing the stock. Thus in order to rebut the presumption, the defendant would have to show the market price did not reflect the misrepresentations or omissions, which would require a judicial reexamination of the underlying premise of the fraud-on-the market theory. Since most if not all federal courts have accepted the premise for policy reasons under Rule 10b-5, a defendant's likelihood of success is slim, thus making the presumption virtually impossible to rebut. We believe the presumption effectively eliminates the reliance requirement. (But see contra, Lipton v. Documation, Inc., supra, 734 F.2d at pp. 747-748 ; In re LTV Securities Litigation, supra, 88 F.R.D. at p. 144.)
Most of the federal courts which have considered the theory's applicability to pendent state law claims have done so in the distinguishable context of deciding class certification issues. It appears that many federal courts in California will provisionally certify a class with respect to such state claims when a class is certified for the litigation of federal security law claims. While some federal courts "have found that the fact that reliance varies with the knowledge and circumstances of the individual investor makes class certification inappropriate for common law fraud claims" (In re ORFA Securities Litigation, supra, 654 F.Supp. at p. 1460), other courts have granted certification with the knowledge that separate hearings, questionnaires, and special masters are available if necessary "to effectively litigate the reliance issues." (Id. at p. 1462; see, e.g., Cameron v. E.M. Adams & Co. (9th Cir.1976) 547 F.2d 473, 477; Weinberger v. Thornton (S.D.Cal.1986) 114 F.R.D. 599, 606; In re Pizza Time Theatre Securities Litigation (N.D. Cal.1986) 112 F.R.D. 15, 19; In re Victor Tech. Securities Litigation (N.D.Cal.1984) 102 F.R.D. 53, 59 (also citing Dekro v. Stern Bros. & Co. (W.D.Mo.1982) 540 F.Supp. 406, 418-19; Koenig v. Smith (E.D.N.Y.1980) 88 F.R.D. 604, 607).)
While it thus appears pendent state fraud claims are often certifiable as class actions in federal courts, we are not thereby required to apply the fraud-on-the-market theory in state court class actions. Deference to federal class certification decisions concerning state law issues is especially unwarranted because the federal courts, in deciding such certification questions, do not decide the merits of the cause of action. (In re ORFA Securities Litigation, supra, 654 F.Supp. at p. 1459; McFarland v. Memorex Corp., supra, 96 F.R.D. at p. 360; cf. Ramtek Securities Litigation (N.D.Cal.1990) [1990 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 95,483 at p. 97,520, 1990 WL 157391.)
Plaintiffs claim a California appellate court properly deferred to the federal class certification cases in Schneider v. Vennard (1986) 183 Cal.App.3d 1340, 228 Cal.Rptr. 800. In Schneider, the court denied class certification because a federal securities fraud action was already pending between the parties. Although the plaintiffs in Schneider argued that it was uncertain whether the federal court would exercise pendent jurisdiction over their state law causes of action, the Court of Appeal stated that "in the Northern District of California securities actions are routinely filed with pendent state claims which are then certified as class actions," and cited In re Activision Securities Litigation (N.D.Cal.1985) 621 F.Supp. 415, 431. (Schneider v. Vennard, supra, 183 Cal.App.3d at pp. 1347-1349, 228 Cal.Rptr. 800.) Plaintiffs claim that by its citation to In re Activision, the Schneider court implicitly adopted In re Activision's favorable interpretation of Vasquez v. Superior Court, supra, 4 Cal.3d 800, 94 Cal.Rptr. 796, 484 P.2d 964. According to In re Activision's interpretation of Vasquez, a classwide inference of reliance may arise even without actual communication of the misrepresentations to each class member. ( In re Activision Securities Litigation, supra, 621 F.Supp. at p. 431.) But as we previously discussed, we read Vasquez more narrowly and conclude a classwide inference may only arise if the misrepresentations were communicated to each class member. Moreover, since the Schneider opinion never discussed whether classwide inferences may be drawn in the absence of direct communication of the misrepresentations to each class member, it would be improper to read such a holding into the opinion.
Plaintiffs further contend that the fraud-on-the-market theory is a federal class action procedural device, and as such, should be adopted herein under our state Supreme Court's mandate in Jolly v. Eli Lilly & Co. (1988) 44 Cal.3d 1103, 1118, 245 Cal.Rptr. 658, 751 P.2d 923 ("We have repeatedly directed that in the absence of controlling state authority, California courts should utilize the procedures of rule 23 of the Federal Rules of Civil Procedure (28 U.S.C.) to ensure fairness in the resolution of class action suits."); Green v. Obledo (1981) 29 Cal.3d 126, 145-146, 172 Cal.Rptr. 206, 624 P.2d 256 ("It is well established that in the absence of relevant state precedents our trial courts are urged to follow the procedures prescribed in rule 23 of the Federal Rules of Civil Procedure for conducting class actions."); and Vasquez v. Superior Court, supra, 4 Cal.3d at pp. 820-821, 94 Cal.Rptr. 796, 484 P.2d 964.
We disagree with plaintiffs' assertion that the fraud-on-the-market theory is a procedural device which is prescribed in rule 23 of the Federal Rules of Civil Procedure. The theory, if applied, would eliminate California's reliance requirement and thus work a change in our substantive law. Application of the theory under Rule 23 would be contrary to the purpose of the rule, which "was not intended to make a change in the substantive law." (City of San Jose v. Superior Court (1974) 12 Cal.3d 447, 462, fn. 9, 115 Cal.Rptr. 797, 525 P.2d 701.) We follow our Supreme Court's statement in City of San Jose: "We decline to alter this rule of substantive law to make class actions more available. Class 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--to sacrifice the goal for the going." (Id. at p. 462, 115 Cal.Rptr. 797, 525 P.2d 701, fn. omitted.)
We are not persuaded by plaintiffs' policy argument that if we refuse to apply the fraud-on-the-market theory, defendants will escape liability for fraud, leaving the average investor without a remedy. As plaintiffs acknowledged below, they could have brought a Rule 10b-5 action in federal court and obtained the benefit of the fraud-on-the-market theory. It appears that plaintiffs may have forsaken their Rule 10b-5 remedy because they perceived "certain advantages to pursuing their class action in state court. 18 The substantive requirements of some of their state law causes of action are less burdensome than those for a 10(b)-5 claim. For example, plaintiffs must establish 'scienter' under a 10(b)-5 claim [citation], while a cause of action for negligent misrepresentation requires only a showing of negligence. [Citation.] Punitive damages are available on some of their state law claims, while such damages are not recoverable under a 10(b)-5 claim. [Citations.]" (Schneider v. Vennard, supra, 183 Cal.App.3d at p. 1348, 228 Cal.Rptr. 800.) However, these state and federal causes of action are not interchangeable. The mere availability of the fraud-on-the-market theory in Rule 10b-5 actions does not make the theory applicable to the state law causes of action alleged in the complaint.
We have no quarrel with plaintiffs' contentions that "California's policy is to protect the public from fraud and deception in securities transactions" (Hall v. Superior Court (1983) 150 Cal.App.3d 411, 417, 197 Cal.Rptr. 757), and that a corporate misrepresentation which artificially inflates the market price of a stock to the injury of innocent investors is an actionable wrong (H.W. Smith, Inc. v. Swenson (1930) 105 Cal.App. 60, 63-64, 286 P. 1050). While we abhor the type of misconduct alleged in the complaint, we do not think that is justification for obliterating the reliance requirement from California law.
A recent federal court decision that directly considered whether the fraud-on-the-market theory applies to fraud and deceit causes of action under California law has ruled against its application. (Cytryn v. Cook (N.D.Cal.1990) [1990 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 95,409, 1990 WL 128233.) As do the plaintiffs in this case, the plaintiffs in Cytryn relied on a contrary finding in In re ZZZZ Best Sec. Litig. (C.D.Cal.1989) [1989 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 94,485 at pp. 93,087-93,088, 1989 WL 90284. (See also In re Atlantic Financial Federal Securities Litigation (E.D.Pa.1990) [1990 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 95,644 at p. 97,991, 1990 WL 171191.) But as the Cytryn court pointed out, "[t]hat position has been uniformly rejected in [the Northern District of California]. [Citations.]" (Cytryn v. Cook, supra, [1990 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 95,409 at p. 97,018; see, e.g., Victor v. White (N.D.Cal.1989) [1989 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 94,548, at p. 93,510, 1989 WL 108276 ("In addition, plaintiffs' reliance on the fraud on the market theory, under which reliance is presumed, also does not apply to their common law fraud claims where facts constituting reliance must be specifically pled.").)
Similarly, other federal courts have also concluded the fraud-on-the-market theory is inapplicable to common law causes of action in the absence of state court precedent extending the theory. (In re Bexar Cty. Health Fac. Dev. Corp. Sec. Lit. (E.D.Pa.1989) 125 F.R.D. 625, 636; Snider v. Upjohn Co. (E.D.Pa.1987) 115 F.R.D. 536, 542; Rosenberg v. Digilog Inc., supra, 648 F.Supp. at pp. 43-44; Steiner v. Southmark Corp. (N.D.Tex.1990) 734 F.Supp. 269; Nave v. Boyd (W.D.Wash.1986) [1986 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 72,393 at p. 71,783 ("The court does not believe that 'market reliance' is sufficient for purposes of common law fraud. The concept of reliance under Washington common law clearly presupposes communication of a representation to the party who claims to have relied on it.... The communication may be indirect, through third parties, as long as the communication is such as the maker of the representation intends or has reason to expect. [Citations.] Nevertheless the communication must occur.").)
We conclude that California law does not permit the application of the fraud-on-the-market theory of reliance to causes of action based on fraud and deceit, negligent misrepresentation, or violation of section 1507. 19
IV
Relying on Affiliated Ute Citizens v. United States, supra, 406 U.S. 128, 92 S.Ct. 1456, 31 L.Ed.2d 741, plaintiffs claim that when a defendant breaches a duty to disclose material facts, the injured party's reliance upon the omissions may be presumed. In Affiliated Ute Citizens, which involved a Rule 10b-5 cause of action, the defendant bank and its employees had purchased securities from a group of unsophisticated plaintiffs. The fraud allegation was based primarily on the defendants' concealment of the higher price which the securities would bring in a secondary market fostered by the bank. The Tenth Circuit Court of Appeals concluded that positive proof of the plaintiffs' reliance upon the defendants' fraudulent conduct was a prerequisite to recovery. The Supreme Court reversed, stating: "Under the circumstances of this case, involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this decision. [Citations.] This obligation to disclose and this withholding of a material fact establish the requisite element of causation in fact. [Citation.]" (Id. at pp. 153-154, 92 S.Ct. at p. 1472.)
The Affiliated Ute Citizens opinion does not elaborate on the reasons for this rule, and we have found no published opinion by a California court which discusses that case. The Washington Supreme Court explained the Affiliated Ute Citizens rule as follows: "[I]t is generally said that the rationale is that it is virtually impossible to prove reliance in cases alleging nondisclosure of material facts. The inquiry that would normally be made in a case of affirmative misrepresentation--did the plaintiff believe the defendant's representation, and did that belief cause the plaintiff to act--does not apply in a case of nondisclosure. [Citation.] Since there is no affirmative representation in a nondisclosure case, a plaintiff who was required to prove reliance would have to show that he believed the opposite of the omitted fact, and this would be practically impossible to prove. [Citations.] [p] ... According to many federal courts, the rule [enunciated in Affiliated Ute Citizens ] does not mean that proof of omission of a material fact conclusively resolves the causation question, but rather that it establishes a rebuttable presumption of reliance." (Morris v. International Yogurt Co. (1986) 107 Wash.2d 314, 328, 729 P.2d 33, 40-41.)
In our view, the California Supreme Court established a similar presumption of reliance (as opposed to eliminating the need for reliance) in Vasquez v. Superior Court, supra, 4 Cal.3d at p. 814, fn. 9, 94 Cal.Rptr. 796, 484 P.2d 964. In both Vasquez and Affiliated Ute Citizens, the plaintiffs were defrauded in direct individual transactions with representatives of the defendant. Accordingly, neither opinion discussed whether direct communication of the misrepresentations to each member of the class was a prerequisite to recovery.
Affiliated Ute Citizens is also distinguishable because it involved a Rule 10b-5 cause of action. Plaintiffs contend its application should not be restricted to such actions, however, and contend its holding is applicable to state law actions for fraud and deceit under Edens v. Goodyear Tire & Rubber Co. (4th Cir.1988) 858 F.2d 198, 207; Brandon v. Chefetz (1985) 106 A.D.2d 162, 485 N.Y.S.2d 55, 59; Weinberg v. Hertz Corp. (1986) 116 A.D.2d 1, 499 N.Y.S.2d 693, 696; and Morris v. International Yogurt Co., supra, 107 Wash.2d 314, 729 P.2d 33. None of these cases involved California law, however, and we are not bound by them. In addition, the cases are factually distinguishable.
Edens v. Goodyear Tire & Rubber Co., supra, 858 F.2d 198, involved a cause of action under South Carolina law for fraudulent breach of contract, which requires proof of: (1) a breach, (2) fraudulent intent, and (3) a fraudulent act accompanying the breach. (Id. at p. 202.) The fraudulent act in Edens consisted of the defendant's nondisclosure of the extension of a completion date. Applying Affiliated Ute, the Edens court concluded the plaintiff "was excused from directly proving reliance, since the unfair or dishonest act accompanying the breach of contract was Goodyear's intentional concealment of the extension." (Id. at p. 207, fn. omitted.) Edens is obviously distinguishable because the parties had directly communicated with each other in negotiating their contract. Moreover, the defendant in Edens conceded the reliance issue at trial by failing to request any jury instruction on reliance and by failing to object to the trial court's decision not to instruct the jury on reliance. (Id. at p. 207.) The defendant also failed to challenge the reliance finding on appeal.
The two cases decided by the New York Appellate Division, Brandon v. Chefetz, supra, 485 N.Y.S.2d 55, 59, and Weinberg v. Hertz Corp., supra, 499 N.Y.S.2d 693, 696, are also distinguishable. Brandon involved a class certification issue in a state court action brought by shareholders as a result of fraudulent nondisclosures in the corporation's written tender offer to its shareholders. Accordingly, the court made only a limited determination "as to whether on the surface there appears to be a cause of action which is not a sham [citation]." (Brandon v. Chefetz, supra, 485 N.Y.S.2d at p. 59.) Similarly, Weinberg also dealt with class certification issues. The Weinberg court permitted the class action to proceed, commenting that reliance would be presumed, "subject to such proof as is required on the trial." (Weinberg v. Hertz Corp., supra, 499 N.Y.S.2d at p. 696.)
Significantly, in another opinion by the New York Appellate Division, the court refused to extend the Affiliated Ute Citizens presumption and the fraud-on-the-market doctrine to a common law fraud action. (Strauss v. Long Island Sports, Inc. (1978) 60 A.D.2d 501, 401 N.Y.S.2d 233, 237.) In Strauss, a disgruntled season ticket holder sued the New York Nets for false advertising after the team traded a star player, Julius Erving. The court refused to certify the plaintiff class, finding that individual questions of fact concerning reliance predominated. The Strauss court concluded the fraud-on-the-market theory applies only to Rule 10b-5 actions, citing the Ninth Circuit's decision in Blackie v. Barrack, supra, 524 F.2d at p. 907. The Strauss court also stated: "In the securities cases, reliance by some stock purchasers on the defendant's misrepresentations may have affected the price of the stock traded on the open market, thereby causally affecting a purchaser (or seller) not privy to those misrepresentations. In the ticket purchaser case, on the other hand, whether one purchaser relied in purchasing his ticket on management's misrepresentation of fact has no causal relation to the purchase of a ticket by another person not privy to those misrepresentations." (Strauss v. Long Island Sports, Inc., supra, 401 N.Y.S.2d at p. 237.) While plaintiffs herein contend this quoted passage recognizes the validity of the fraud-on-the-market theory under appropriate circumstances, that is not the holding of the case.
The Washington decision cited by plaintiffs, Morris v. International Yogurt Co., supra, 107 Wash.2d 314, 729 P.2d 33, addressed a franchisor's failure to disclose a material fact in violation of a statute. No issue of common law fraud was raised. Because the applicable statute's language concerning the omission of a material fact was virtually identical to the corresponding language in Rule 10b-5, the Morris court found it appropriate to look to the federal courts' construction of that rule for guidance. Moreover, the Washington Supreme Court found the reasons for adopting the Affiliated Ute Citizens presumption of reliance in the context of the statute at issue in Morris were as strong as under Rule 10b-5. This case, however, involves causes of action which do not mirror Rule 10b-5. Accordingly, we distinguish the Morris decision.
DISPOSITION
We affirm the judgment (order of dismissal).
SPENCER, P.J., and DEVICH, J., concur. --------------- 1 Maxicare filed for bankruptcy under Chapter 11 on March 15, 1989, and this action was stayed with respect to Maxicare (11 U.S.C. § 362(a)). Accordingly, Maxicare is not a party to this appeal. 2 The individual defendants are Fred W. Wasserman, Pamela K. Anderson, David M. Hallis, Samuel L. Westover, Gerald Zaid, Charles W. Smith, III, Randall Anderson, Alan Bloom, Howard Freedland, Charles E. Lewis, James A. McIntyre, and Peter J. Ratican. 3 Although none of the lead plaintiffs purchased the notes, the class certification issue is not before us. We do not decide whether plaintiffs are proper class representatives. 4 The fraud allegations emcompass affirmative misrepresentations as well as nondisclosure of material information. Civil Code section 1572 states in relevant part: "Actual fraud, within the meaning of this Chapter, consists in any of the following acts, committed by a party to the contract, or with his connivance, with intent to deceive another party thereto, or to induce him to enter into the contract: [p] 1. The suggestion, as a fact, of that which is not true, by the one who does not believe it to be true; [p].... [p] 3. The suppression of that which is true, by one having knowledge or belief of the fact...." Similarly, Civil Code section 1710 states in relevant part: "A deceit ... is either: [p] 1. The suggestion, as a fact, of that which is not true, by one who does not believe it to be true; [p].... [p] 3. The suppression of a fact, by one who is bound to disclose it, or who gives information of other facts which are likely to mislead for want of communication of that fact...." 5 Negligent misrepresentation is defined in Civil Code section 1572, subdivision 2, as: "The positive assertion, in a manner not warranted by the information of the person making it, of that which is not true, though he believes it to be true." And Civil Code section 1710, subdivision 2 defines negligent misrepresentation as: "The assertion, as a fact, of that which is not true, by one who has no reasonable ground for believing it to be true." 6 "Any officers, directors, employees or agents of a corporation who do any of the following are liable jointly and severally for all the damages resulting therefrom to the corporation or any person injured thereby who relied thereon or to both: [p] (a) Make, issue, deliver or publish any prospectus, report, circular, certificate, financial statement, balance sheet, public notice or document respecting the corporation or its shares, assets, liabilities, capital, dividends, business, earnings or accounts which is false in any material respect, knowing it to be false, or participate in the making, issuance, delivery or publication thereof with knowledge that the same is false in a material respect. [p] (b) Make or cause to be made in the books, minutes, records or accounts of a corporation any entry which is false in any material particular knowing such entry is false. [p] (c) Remove, erase, alter or cancel any entry in any books or records of the corporation, with intent to deceive." (§ 1507.) 7 Plaintiffs concede they "cannot plead direct reliance on behalf of themselves or the class and their action is at an end in the Superior Court." 8 Paragraph 55 of the amended complaint states: "As a result of the dissemination of the aforementioned false and misleading Registration Statements, Prospectuses, and other communications, the market price of Maxicare common stock and 11 3/4% Notes were artificially inflated throughout the Class Period. Each of the alleged false statements was disseminated by the defendants for the purpose and with the effect of influencing both the purchase of the 11 3/4% Notes and Maxicare's common stock in the offering and open market trading thereof. In ignorance of the adverse facts concerning Maxicare's business and financial condition which were concealed by defendants, the members of the class purchased Maxicare securities at artificially high prices, relying upon the integrity of the market, and were damaged thereby. Had plaintiffs and the members of the Plaintiff class known of the materially adverse information not disclosed by the defendants, they would not have purchased Maxicare securities at the artificially inflated prices they did." (Emphasis added.) 9 Plaintiffs stated in their supplemental papers: "Plaintiffs have conducted a search of reported state court cases on the Lexis Data Base Service. That search has revealed no state court case which expressly adopts the fraud-on-the-market theory in a common law fraud action." 10 In response to the trial court's remark that plaintiffs were asking the court to make a change in California law, plaintiffs counsel stated: "Well, to the extent that no California appellate court has developed fraud on the market, yes, but fraud claims and other state common law claims have been asserted numerous times in federal court actions in conjunction with federal securities claims, and in those actions the same types of proof have been followed." 11 Although plaintiffs' negligent misrepresentation claim is stated in terms of both positive assertions of fact and omissions, only the former will apparently support a claim for negligent misrepresentation under Civil Code section 1710, subdivision 2. (Huber, Hunt & Nichols, Inc. v. Moore (1977) 67 Cal.App.3d 278, 304, 136 Cal.Rptr. 603.) Plaintiffs contend otherwise and cite to Foster v. Xerox Corp. (1985) 40 Cal.3d 306, 219 Cal.Rptr. 485, 707 P.2d 858, which discussed a statutory exception to the exclusive remedy provided by the Workers' Compensation law when an employer's fraudulent concealment of the existence of the injury and its connection with employment causes aggravated injuries (Lab.Code, § 3602, subd. (b)(2)), and Sanfran Co. v. Rees Blow Pipe Mfg. Co. (1959) 168 Cal.App.2d 191, 335 P.2d 995, which involved causes of action for misrepresentation (Civ.Code, § 1710, subd. 1) and concealment (Civ.Code, § 1710, subd. 3). However, neither Foster nor Sanfran discussed whether omissions will support a claim for negligent misrepresentation (Civ.Code, § 1710, subd. 2), and are thus distinguishable. Moreover, we regard the issue as academic in this case since we conclude there was a lack of reliance. 12 Several federal courts have concluded that under the California Supreme Court's decision in Goodman v. Kennedy (1976) 18 Cal.3d 335, 342-343, 134 Cal.Rptr. 375, 556 P.2d 737, liability for negligent representation can only be based on statements made in the offering prospectus rather than in subsequent financial statements, SEC filings, press releases and shareholder reports. (Moskowitz v. Vitalink Communications Corp. (N.D.Cal.1990) 751 F.Supp. 155, 160-161; Levy v. Eletr (N.D.Cal.1989) 724 F.Supp. 1269, 1273; In re Worlds of Wonder Securities Litigation (N.D.Cal.1988) 694 F.Supp. 1427, 1436.) Insofar as plaintiffs' negligent misrepresentation claim is based on aftermarket statements made in financial statements, press releases and shareholder reports, these decisions indicate the cause of action should be dismissed. (But see International Mortgage Co. v. John P. Butler Accountancy Corp. (1986) 177 Cal.App.3d 806, 820, 223 Cal.Rptr. 218 ("An innocent plaintiff who foreseeably relies on an independent auditor's unqualified financial statement should not be made to bear the burden of the professional's malpractice. The risk of such loss is more appropriately placed on the accounting profession which is better able to pass such risk to customers and the ultimate consuming public.").) We need not decide this issue in this decision, which is based on plaintiffs' lack of reliance on the misrepresentations. 13 Massei v. Lettunich, supra, 248 Cal.App.2d 68, 56 Cal.Rptr. 232, is similar. In Massei, the developer of a residential subdivision neglected to properly compact the fill on which the homes were to be built. The developer also failed to inform the contracter that the lots had been filled and that an engineering report had recommended the foundations be dug four inches deeper. The contractor agreed to purchase the lots from the developer, and gave notes secured by deeds of trust on the lots. The notes would not become due until the homes had been constructed and sold. The appellate court concluded that the developer could not escape liability to the purchasers despite the fact that he had had no contact with them. The court stated: "The jury could easily have found that [the developer], in failing to disclose to the [contractors] that the lots had been filled, did so because he was fearful that the prospective purchasers would in turn learn that fact and be dissuaded. [The developer], of course, had a pecuniary interest at stake because it was agreed that the [contractors'] notes as payment for the lots would not be due and he would not be paid until the residences were sold." (Id. at p. 73, 56 Cal.Rptr. 232.) 14 The full statement reads: "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. Vasquez v. Superior Court of San Joaquin County, 4 Cal.3d 800, 94 Cal.Rptr. 796, 484 P.2d 964 (1971); Ach v. Finklestein, 264 Cal.App.2d 667, 70 Cal.Rptr. 472 (1968). 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 and EFLIC 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 and the Ankony, Liberty, and BNL exchange of stock purchasers. 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." (In re Equity Funding Corp. of Amer. Sec. Litigation, supra, 416 F.Supp. at pp. 182-183.) 15 The fraud-on-the-market theory has been applied in Rule 10b-5 actions concerning stock traded in the over the counter market as well as a stock exchange. (See Hurley v. Federal Deposit Ins. Corp. (D.Mass.1989) 719 F.Supp. 27, 33-34; Harman v. Lymphomed, Inc. (N.D.Ill.1988) 122 F.R.D. 522, 525-526.) 16 Justice Blackmun stated: " 'In face-to-face transactions, the inquiry into an investor's reliance upon information is into the subjective pricing of that information by that investor. With the presence of a market, the market is interposed between seller and buyer and, ideally, transmits information to the investor in the processed form of a market price. Thus the market is performing a substantial part of the valuation process performed by the investor in a face-to-face transaction. The market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price.' In re LTV Securities Litigation, 88 F.R.D. 134, 143 (ND Tex.1980). Accord, e.g., Peil v. Speiser, 806 F.2d, at 1161 ('In an open and developed market, the dissemination of material misrepresentations or withholding of material information typically affects the price of the stock, and purchasers generally rely on the price of the stock as a reflection of its value'); Blackie v. Barrack, 524 F.2d 891, 908 ( [9th Cir.] 1975) ('[T]he same causal nexus can be adequately established indirectly, by proof of materiality coupled with the common sense that a stock purchaser does not ordinarily seek to purchase a loss in the form of artificially inflated stock'), cert. denied, 429 U.S. 816, 97 S.Ct. 57, 50 L.Ed.2d 75 (1976)." (Basic Incorporated v. Levinson, supra, 485 U.S. at pp. 244-245, 108 S.Ct. at pp. 990.) 17 Justice Blackmun stated: "In drafting that Act, Congress expressly relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an investor's reliance on the integrity of those markets: [p] 'No investor, no speculator, can safely buy and sell securities upon the exchanges without having an intelligent basis for forming his judgment as to the value of the securities he buys or sells. The idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers as to the fair price of a security brings [sic] about a situation where the market price reflects as nearly as possible a just price. Just as artificial manipulation tends to upset the true function of an open market, so the hiding and secreting of important information obstructs the operation of the markets as indices of real value.' H.R.Rep. No. 1383, at 11." (Basic Incorporated v. Levinson, supra, 485 U.S. at pp. 245-246, 108 S.Ct. at pp. 990-991.) 18 According to defendants, a Rule 10b-5 class action involving allegations similar to those raised by plaintiffs herein is currently pending in the United States District Court, Central District, California, entitled Zucker v. Maxicare Health Plans, Inc., et al. (No. CV-88-02499 LEW). 19 We are mindful that the federal courts have been and will continue to be the most likely arena in which this issue will be revisited until our state Supreme Court resolves the matter. In ZZZZ Best Securities Litigation (C.D.Cal.1990) [1990 Transfer Binder] Fed.Sec.L.Rep. (CCH) para. 94,881 at p. 94,822, the defendants informed the trial court of this litigation and of the trial court's ruling below which rejected the fraud-on-the-market theory under California law. The federal district court was not persuaded by the California trial court's ruling however, and stated: "With all due respect to Judge Cooperman, however, this Court is not bound by his authority. '[W]hile the decrees of "lower state courts" should be "attributed some weight ... the decision [is] not controlling ..." where the highest court of the state has not spoken on the point.' [Citations.] Furthermore, with respect to California law, these unpublished orders should not even be cited. [Citation.]" (Ibid; Ramtek Securities Litigation, supra, Fed.Sec.L.Rep. (CCH) para. 95,483 at p. 97,520.)