Mirkin v. Wasserman

• Decision Date: 28 February 1991
• Docket Number: No. B048705,B048705
• Parties: 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.
• Court: California Court of Appeals Court of Appeals

Page 729

278 Cal.Rptr. 729

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.

No. B048705.

Court of Appeal, Second District, Division 1, California.

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 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.

& 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.

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 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.

(Civ.Code, §§ 1572, subd. 2; 1710, subd. 2), ⁵ and violation of Corporations Code section 1507 (hereinafter section 1507). ⁶

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 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.

                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 [12 Cal.App.4th 936] fraud claims in Rule 10b-5 actions. 10  Plaintiffs also contended that California courts have implicitly accepted the theory
                

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...