Small v. Fritz Companies, Inc.

• Citation: 132 Cal.Rptr.2d 490,30 Cal.4th 167,65 P.3d 1255
• Decision Date: 07 April 2003
• Docket Number: No. S091297.,S091297.
• Court: United States State Supreme Court (California)
• Parties: Marietta SMALL, as Public Administrator, etc., Plaintiff and Appellant, v. FRITZ COMPANIES, INC., et al., Defendants and Respondents.

132 Cal.Rptr.2d 490

30 Cal.4th 167

65 P.3d 1255

Marietta SMALL, as Public Administrator, etc.,¹ Plaintiff and Appellant, v. FRITZ COMPANIES, INC., et al., Defendants and Respondents.

No. S091297.

Supreme Court of California.

April 7, 2003.

Stull, Stull & Brody, Michael D. Braun, Marc L. Godino, Los Angeles, Timothy J. Burke, Jules Brody and Mark Levine for Plaintiff and Appellant.

Orrick, Herrington & Sutcliffe, William F. Alderman, San Francisco, and E. Anne Hawkins for Defendants and Respondents.

Wilson Sonsini Goodrich & Rosati, Boris Feldman, Douglas J. Clark and Cheryl W. Foung, Palo Alto, for Electronics for Imaging, Inc., as Amicus Curiae on behalf of Defendants and Respondents.

Skadden, Arps, Slate, Meagher & Flom, Raoul D. Kennedy, San Francisco, Garrett J. Waltzer, Palo Alto, David E. Springer and Frances P. Kao for Ifilm Corp. and SGW Holding Inc., as Amici Curiae on behalf of Defendants and Respondents.

Munger, Tolles & Olson, Charles D. Siegal, George M. Garvey, Los Angeles, and Janice M. Kroll for Securities Industry Association as Amicus Curiae on behalf of Defendants and Respondents.

Richard I. Miller; Wilke, Fleury, Hoffelt, Gould & Birney, Matthew W. Powell, Sacramento, Paul A. Dorris, Daniel L. Baxter; Willkie Farr & Gallagher, Kelly

M. Hnatt and Daniel B. Rosenthal for American Institute of Certified Accountants as Amicus Curiae on behalf of Defendants and Respondents.

KENNARD, J.

This is a stockholder's action charging that defendant corporation and its officers sent its stockholders a fraudulent quarterly financial report that grossly overreported earnings and profits. Plaintiff alleged that when the fraud was discovered, the price of the corporate stock dropped precipitously, causing injury to stockholders like himself.² The trial court sustained a demurrer without leave to amend and entered judgment for defendants; the Court of Appeal reversed. We granted defendants' petition for review.

The petition for review raised only a single issue: "Should the tort of common law fraud (including negligent misrepresentation) be expanded to permit suits by those who claim that alleged misstatements by defendants induced them not to buy and sell securities?" This overstates the matter—this case does not involve any claim by persons who do not own stock and are fraudulently induced not to buy. It does, however, present the issue whether California should recognize a cause of action by persons wrongfully induced to hold stock instead of selling it. (For convenience, we shall refer to such a lawsuit as a "holder's action" to distinguish it from suits claiming damages from the purchase or sale of stock.)

We conclude that California law should allow a holder's action for fraud or negligent misrepresentation. California has long acknowledged that if the effect of a misrepresentation is to induce forbearance—to induce persons not to take action—and those persons are damaged as a result, they have a cause of action for fraud or negligent misrepresentation. We are not persuaded to create an exception to this rule when the forbearance is to refrain from selling stock. This conclusion does not expand the tort of common law fraud, but simply applies long-established legal principles to the factual setting of misrepresentations that induce stockholders to hold on to their stock.

This cause of action should be limited to stockholders who can make a bona fide showing of actual reliance upon the misrepresentations. Plaintiff here has failed to plead the element of actual reliance with sufficient specificity to show that he can meet that requirement. We therefore reverse the judgment of the Court of Appeal and remand the cause to that court, with directions to have the trial court sustain defendants' demurrer but grant plaintiff leave to amend his complaint.

I. PROCEEDINGS BELOW

"In reviewing a judgment of dismissal after a demurrer is sustained without leave to amend, we must assume the truth of all facts properly pleaded by the plaintiffs, as well as those that are judicially noticeable." (Howard Jarvis Taxpayers Assn. v. City of La Habra (2001) 25 Cal.4th 809, 814, 107 Cal.Rptr.2d 369, 23 P.3d 601.) Our opinion in this case should not be construed as indicating whether or not defendants actually committed fraud or negligent misrepresentation.

Stockholder Harvey Greenfield filed this action in 1996 against Fritz Companies, Inc., a corporation, and against three officers: Lynn Fritz, the company president, chairman of the board, and owner of 39 percent of the common stock; John Johung, the chief financial officer and a director; and Stephen Mattessich, the corporate controller and a director.³ The action was filed as a class action on behalf of all shareholders in Fritz "who owned and held Fritz common stock as of April 2, 1996 through at least July 24, 1996, in reliance on defendants' material misrepresentations and omissions ... and who were damaged thereby." The complaint alleged causes of action for common law fraud and negligent misrepresentation, and for violations of Civil Code sections 1709 and 1710, which codify the common law actions for fraud and deceit.

Before us is the validity of plaintiffs second amended complaint. It alleged that Fritz provides services for importers and exporters. Between April 1995 and May 1996, Fritz acquired Intertrans Corporation and then numerous other companies in the import and export businesses. Fritz encountered difficulties with these acquisitions, and in particular with the Intertrans accounting system, which it adopted for much of its business. Nevertheless, on April 2, 1996, Fritz issued a press release that reported third quarter revenues of $274.3 million, net income of $10.3 million, and earnings per share of $29. The same figures appeared in its third quarter report to shareholders, issued on April 15, 1996, for the quarter ending February 29, 1996. According to plaintiff, that report was incorrect for a variety of reasons: the inadequate integration of the Intertrans and Fritz accounting systems led to recording revenue that did not exist; Fritz failed to provide adequate reserves for uncollectible accounts receivable; and Fritz misstated the costs of its acquisitions.

The complaint alleged that on July 24, 1996, Fritz restated its previously reported revenues and earnings for the third quarter. Estimated third quarter earnings were reduced from $10.3 million to $3.1 million. Further, Fritz announced that it would incur a loss of $3.4 million in the fourth quarter.

The complaint then set forth in detail the reasons why the original third quarter report was inaccurate: improper accounting for merger and acquisition costs; improper classification of ordinary operating expenses as merger costs; improper revenue recognition; improper capitalized software development costs; and failure to allow for uncollectible accounts receivable. It alleged that the individual defendants knew or should have known that the third quarter report and press releases were false and misleading. When defendants made these statements, "defendants intended that investors, including plaintiff and the Class, would rely upon and act on the basis of those misrepresentations in deciding whether to retain the Fritz shares."

The complaint further asserted that plaintiff and all class members received Fritz's third quarter statement, "read this statement, including the information related to the reported revenue, net income and earnings per share, and relied on this information in deciding to hold Fritz stock through [July 24, 1996]."

With respect to damages, the complaint alleged: "In response to defendant's disclosures on July 24, 1996, Fritz's stock plunged more than 55% in one day, dropping $15.25 to close at $12.25 per share.... Had defendants disclosed correct third quarter revenue, net income and earnings per share on April 2, 1996, as required by GAAP [generally accepted accounting practices], Fritz's stock price would likely have declined on April 2, 1996, and plaintiff and the Class would have disposed of their shares at a price above the $12.25 per share closing price of that day."

Defendants demurred to plaintiffs second amended complaint on two grounds: (1) "California law does not recognize any [cause of action] on behalf of shareholders who neither bought nor sold shares based upon any alleged misstatement or omission"; and (2) the complaint failed to "plead with the requisite specificity the facts alleged to constitute actual reliance." The trial court sustained the demurrer on the second ground only and entered judgment for defendants. Plaintiff appealed.

The Court of Appeal reversed. It held that the complaint stated causes of action for fraud and negligent misrepresentation and alleged actual reliance with sufficient specificity. (It did not decide whether the case should be certified as a class action.) We granted defendants' petition for review.

II. California Recognizes a Cause of Action for Stockholders Induced by Fraud or Negligent Misrepresentation to Refrain from Selling Stock

Defendants contend that California should not recognize a cause of action for fraud or negligent misrepresentation when the plaintiff relies on the false representation by retaining stock, instead of buying or selling it. We disagree.

"`The elements of fraud, which gives rise to the tort action for deceit, are (a) misrepresentation (false representation, concealment, or nondisclosure); (b) knowledge of falsity (or "scienter"); (c) intent to defraud, i.e., to induce reliance; (d) justifiable reliance; and (e) resulting damage.'" (Lazar v. Superior Court (1996) 12 Cal.4th 631, 638, 49 Cal.Rptr.2d 377, 909 P.2d 981

.) The tort of negligent misrepresentation does not require scienter or intent to defraud. (Gagne v. Bertran (1954) 43 Cal.2d 481, 487-488, 275 P.2d 15.) It encompasses "[t]he assertion, as a fact, of that which is not true, by one who has no reasonable ground for...