# Small v. Fritz Companies, Inc.

> California Supreme Court · April 7, 2003 · 132 Cal. Rptr. 2d 490

URL: https://www.frixlaw.com/law-library/cases/9795895

## Case

- **Full name:** MARIETTA SMALL, as Public Administrator, Etc., Plaintiff and Appellant, v. FRITZ COMPANIES, INC., Et Al., Defendants and Respondents
- **Court:** California Supreme Court
- **Decided:** April 7, 2003
- **Citations:** 132 Cal. Rptr. 2d 490; 30 Cal. 4th 167; 65 P.3d 1255
- **Precedential status:** Published
- **Opinion:** Concurrence by Baxter
- **Judges:** Kennard, Baxter, Brown
- **Cited by:** 295 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/9795895

## How later opinions describe it (automated extraction)

- holding that California permits a shareholder, who was wrongfully induced to hold a stock rather than sell it, to sue under common law fraud or negligent misrepresentation, but requires him to allege fraud with “specificity to show a bona fide claim of actual reliance”
- stating that in California, fraud claims have five elements: “(a) misrepresentation (false representation, concealment, or nondisclosure); (b) knowledge of falsity (or ‘scienterO; (c) intent to defraud, i.e., to induce reliance; (d
- recognizing securities fraud claims by ''holders,” as distinct from purchasers and sellers, under California law

## Opinion text

BAXTER, J., Concurring.
I agree with the majority’s reasoning and result as far as they go. Thus, I accept in principle that the shareholder of a publicly traded company may have a direct common law action against the company and its officials when their intentional or negligent misrepresentations about the company’s financial condition, on which he personally relied, induced him not to sell his shares, and thus caused him damage. Despite an “efficient market” for the shares, I can conceive that delayed disclosure of bad news, under circumstances suggesting that earlier reports were dishonestly or incompetently false, might have an effect on the market price of the shares beyond the effect of the bad news itself.
I also strongly agree that in a suit of this kind—a so-called holder’s action—the complaint must plead specific facts showing actual, personal reliance on the defendants’ alleged misrepresentations. As the majority indicate, the complaint before us is not specific enough in its allegations of actual reliance, and a remand for possible amendment is appropriate. 1
But under the protracted circumstances of this case, the majority’s disposition is incomplete. Counting the original complaint, filed in October 1996, *194 there have been three attempts to state a cause of action. So far, these efforts have produced three appellate decisions, two from the Court of Appeal and one from this court. It is time to move this long-pending lawsuit beyond the pleading stage, one way or the other, by providing guidance on all the significant legal issues bearing on the sufficiency of the complaint. 2
However, the majority encourage yet another round of pleading litigation, because they omit all reference to an element even more crucial and basic than those they discuss. The majority properly demand specificity in the complaint’s allegations of reliance, but they overlook, by failing to address, the brief and conclusory way in which damage is pled. 3
On that point, the second amended complaint contains an additional fatal gap. The complaint recites that the original named plaintiff and other members of the alleged class are persons who held Fritz stock from before April 2, 1996, when Fritz first overstated its third quarter results, through July 24, 1996, when Fritz downgraded its third quarter figures and also announced disappointing fourth quarter earnings. According to the complaint, these investors suffered “detriment” when the price of Fritz shares plummeted by 55 percent, to $12.25 per share, on July 24, 1996—detriment they could have avoided if, as they would have done, they had sold their shares upon a timely disclosure of the truth.
There are many uncertainties in this vague claim of damage, as defendants and their amici curiae have stressed at length. But the most fundamental flaw is the complaint’s utter failure to state whether, or how, the described shareholders have suffered a realized loss as a result of the alleged fraud. The complaint does not allege that any such investor sold shares at a price depressed by revelation of the scandal. Nor does it articulate any other way in which this group of Fritz shareholders sustained actual out-of-pocket damage as a direct result of the July 24, 1996, disclosures. The complaint *195 simply suggests that because these persons were holding Fritz shares on July 24, they are entitled to recover any difference between the price to which the shares actually fell on that date, and the price at which the shares could have been promptly sold if the true third quarter results had been announced in timely fashion.
These allegations are insufficient to support monetary recovery for the alleged fraud and deceit. In California, “recovery in a tort action for fraud is limited to the actual damages suffered by the plaintiff. [Citations.]” (Ward v. Taggart (1959) 51 Cal.2d 736, 741 [ 336 P.2d 534 ], italics added.) “ ‘Actual’ is defined as ‘existing in fact or reality,’ as contrasted with ‘potential’ or ‘hypothetical,’ and as distinguished from ‘apparent’ or ‘nominal.’ (Webster’s Third New Internat. Dict. (1964) p. 22.) It follows that ‘actual damages’ are those which compensate someone for the harm from which he or she has been proven to currently suffer or from which the evidence shows he or she is certain to suffer in the future.” (Saunders v. Taylor (1996) 42 Cal.App.4th 1538, 1543 [ 50 Cal.Rptr.2d 395 ].)
Where fraud is alleged to have caused damage in connection with the purchase, sale, or exchange of property, California applies the out-of-pocket loss rule. This doctrine limits recovery to the difference between the actual values, intrinsic and economic, of that which the defrauded person gave up and that which he or she received in return, plus sums expended in reliance on the fraud, and it precludes recovery based on the “benefit of the bargain,” i.e., the plaintiffs expectancy interest created by the fraud. (Civ. Code, § 3343; see Alliance Mortgage Co. v. Rothwell (1995) 10 Cal.4th 1226, 1240 [ 44 Cal.Rptr.2d 352 , 900 P.2d 601 ].)
Similar limitations to actual out-of-pocket loss must, of course, apply where one alleges that he was induced by fraud or deceit to hold property he would otherwise have sold. At the least, the defrauded person must plead and prove that, aside from any specific reliance expenses, he ultimately gave up more value, or received less, in exchange for the property, or that its value was permanently diminished, as a result of the fraud.
All persons who bought Fritz shares at a price unfairly inflated by the false reports of April 1996, or who sold such shares at the depressed price produced by the July 24, 1996, disclosure of the misrepresentations, either gave up more, or received less, for their shares than if the alleged fraud had not occurred. This gap between what the shareholders actually paid or received, and what they fairly should have paid or received, will never diminish or disappear, no matter what happens to the price of the stock thereafter. If capable of measurement, the difference represents actual out-of-pocket damage that the law should compensate.
*196 The same premise does not necessarily apply, however, where there was neither a purchase nor a sale related to the fraud. In a holder’s action, the plaintiff presumably bought the shares at their fair prefraud value. If he did not sell them when the fraud was disclosed, at a price influenced by the disclosure, but instead retained them for a substantial period thereafter, their value, subject to the daily fluctuations of an efficient securities market, may have risen or fallen during that time for reasons, and in an amount, unrelated to the fraud.
Of course, persons who held Fritz shares on July 24 suffered at least momentary paper losses when the price of those shares dropped. These investors’ balance sheets of assets and liabilities, computed as of July 24, would show lower values for their Fritz shares than on July 23. However, such shareholders did not necessarily suffer permanent realized losses, and the law may compensate only the latter. Only those who sold the shares on the bad news, or otherwise incurred measurable, irretrievable out-of-pocket losses as a result, should be deemed to have suffered actual damage subject to recovery. Otherwise, damages are entirely speculative, and the opportunity for windfall recoveries is manifest.
If a company’s stock was held for a substantial period after the fraud and its disclosure, intervening events may have obliterated the effect of the fraud on the value of the shareholders’ investments. An efficient public securities market responds rapidly and accurately both to changing general economic conditions, and to the shifting prospects of each business whose shares are traded therein. Transitory events that affected the price of the company’s shares on certain days during a particular year may have little to do with the value of the shares months or years later. A company’s fortunes may rebound from fraud, perhaps under new and honest management, such that an investment retained for the long term may ultimately be worth more than if the fraud had never occurred. Certainly an attempt to trace the effect of a fraud that occurred in 1996 on the current value of the company’s shares is an exercise in futile speculation.
Thus, I cannot accept the narrow “snapshot” theory of damage on which the current complaint asks us to focus. Any instantaneous paper loss incurred by longtime Fritz shareholders who saw their share values drop on July 24, 1996, but did nothing in response, is not necessarily an accurate measure of the actual damage, if any, they ultimately did or will suffer because of the company’s misrepresentations. 4
No case I have found squarely embraces or rejects the notion that one who alleges he was induced by fraud to retain securities can recover damages *197 simply by pleading and proving that he continued to hold the shares after disclosure of the truth caused their value to drop. Of course, there are no prior California decisions recognizing a cause of action for fraudulent inducement to hold publicly traded securities. Most of the authorities the majority cite from other jurisdictions are of ancient vintage and do not focus on measurement of damages for marketplace fraud in a modem efficient securities market.
In the most recent “proholder” case cited by the majority (Gutman v. Howard Sav. Bank (D.N.J. 1990) 748 F.Supp. 254 ), the complaint expressly alleged that when the fraud was disclosed, the plaintiffs did sell their stock “at great loss.” (Id. at p. 257.) On the other hand, the one recent “antiholder” decision acknowledged by the majority (Chanoff v. U.S. Surgical Corp. (D.Conn. 1994) 857 F.Supp. 1011 (Chanoff), affd. (2d Cir. 1994) 31 F.3d 66 , cert. den. (1994) 513 U.S. 1058 [ 115 S.Ct. 667 , 130 L.Ed.2d 601 ] reasoned at length that damages for securities fraud, where there has been neither a purchase nor a sale in reliance on the fraud, were too speculative to be actionable. (Chanoff, supra, 857 F. Supp. at p. 1018 .)
Even if my reasoning means that, in some cases, investors would have to sell their shares in order to recover, I foresee no dire market consequences. In the first place, the class of shareholders to whom such a requirement would apply is relatively small. For reasons indicated above, those who bought shares in reliance on the company’s misrepresentations would never have to sell to sue. Among those who bought before the fraud occurred, the only ones who could sue in any event would be those with evidence, other than their own uncorroborated claims, that they had intended to sell but were induced not to do so by their personal reliance on the misrepresentations. It thus seems likely that the general loss of confidence in company management by investors, particularly institutional investors, would far overshadow any market effect of shareholders induced to sell only to preserve their rights to bring holder’s actions.
In any event, it seems unlikely that defrauded holders will sell simply to preserve their right to sue and recover damages, when they otherwise would have been inclined to retain their shares despite the disclosure of the fraud. Those who sell on the disclosure presumably do so because they make a rational decision to cut their losses. Those who decide not to sell may be acting on an equally rational belief that the company and its shares will recover and prosper. This latter group may believe they will profit less by selling and suing than by waiting for the recovery. Whichever choice an investor makes, he should not have his cake and eat it too. Both economics and law are replete with elections of this kind. I see no fundamental problem with imposing one here.
*198 Indeed, by allowing holders to sue and recover even when they realized no loss, we do more harm to the company’s prospects, and to the value of its shares, than by withholding such eligibility. Investors are likely to display little interest in the stock of a corporation saddled with such unjustified liabilities.
I do not suggest that an open-market sale of the company’s shares is the only possible way a shareholder can incur a realized loss. If fraud caused a company to fail, such that its shares became permanently worthless, or led to a merger or acquisition in which remaining shareholders received a low value traceable to the effect of the fraud, that might suffice. 5 So might any showing that a fraud-related collapse of the company’s share prices led to a margin call against a suing shareholder, at least where pledged collateral was sold at an unfavorable price to cover the margin loan. (But see Chanoff, supra, 857 F.Supp. 1011, 1018 .)
I am not concerned that the limitations I propose would allow Fritz and its dishonest officials to escape liability for their fraud. Anybody who bought shares at an artificially high price in reliance on the falsely optimistic report of April 2, 1996, or sold them at a depressed price when the dishonesty was disclosed on July 24, 1996, or could otherwise demonstrate an actually realized loss from the misrepresentation, would have a remedy. To exclude persons who cannot demonstrate actual loss of this kind is simply to recognize one element of a common law action for fraud, i.e., damage caused by the fraud.
In her separate concurring opinion, Justice Kennard insists my conclusions flow from two false premises—that temporary loss is not compensable (conc. opn. of Kennard, J., ante, at p. 186), and that damages would be too speculative if the shares continued to be held until after intervening market forces, unrelated to the fraud, had determined their value (id. at pp. 186-187). Her contentions are not persuasive.
*199 At the outset, her examples of compensable “temporary” losses are inapt. I agree that any demonstrable loss or damage arising from temporary deprivation of the full possession, enjoyment, and use of one’s property is compensable where caused by such acts as conversion, trespass, or eminent domain. (See, e.g., Kimball Laundry Co. v. U. S. (1949) 338 U.S. 1 [ 69 S.Ct. 1434 , 93 L.Ed. 1765 , 7 A.L.R.2d 1280 ] [condemnation of laundry plant for duration of war]; Wolfsen v. Hathaway (1948) 32 Cal.2d 632 [ 198 P.2d 1 ] [wrongful temporary damage to pasturage]; Zaslow v. Kroenert (1946) 29 Cal.2d 541 [ 176 P.2d 1 ] [conversion of real property]; Mears v. Crocker First Nat. Bank (1948) 84 Cal.App.2d 637 [ 191 P.2d 501 ] [conversion by failure to transfer ownership of stock on company books; measure of damages not discussed].)
No such issue arises in this case. There is no claim of deprivation of the possession, enjoyment, or use of the shares at issue here. All the rights, privileges, and powers of ownership were retained, including the right to sell the shares, or not to do so, when the alleged fraud was disclosed. Plaintiff simply seeks compensation for a drop in their trading value on a particular day, claiming it resulted from the fraud. But the complaint pleads no facts indicating that this downward turn on the price chart for the shares, however temporary, caused an actual, realized loss.
Justice Kennard’s argument that “paper” losses are real because they influence the actual conduct of economic affairs is also beside the point. The fact remains that in California, one does not suffer legally cognizable damage merely because disclosure of a fraud caused a transitory “blip” in the value of one’s stock portfolio. On the contrary, damages for fraud or deceit in connection with the purchase, sale, or exchange of property are limited to out-of-pocket loss—i.e., the difference between the actual value of that with which the defrauded person parted, and that which the defrauded person received, as a result of the fraud. In other words, the person must actually give more, or receive less, for property than if the fraud had not occurred. (Civ. Code, § 3343.)
As a consequence, one who did not purchase, but merely held, shares in reliance on fraud cannot establish an out-of-pocket loss simply on the theory that a later disclosure of the fraud caused the daily trading value of the shares to fall on a particular day. Yet this is the sum and substance of the damage allegations here. 6
Though the plaintiff in this case seeks damages measured by the price to which Fritz shares fell on the very day the alleged fraud was disclosed, I do *200 not contend that one must sell on that very day in order to show compensable damage. I have no quarrel with Justice Kennard’s observation that the market may take some time to digest the bad news, that a somewhat later date may provide a better measure of how the market reacted to the fraud and its disclosure. All I propose is that the plaintiff in a holder’s action must plead and prove an actual, realized loss which can be directly attributed, in a specified amount, to the fraud and its disclosure. It simply stands to reason that the longer the interval between disclosure on the one hand, and the moment a loss was allegedly realized on the other, the less likely it may become that this link can be established.
Nor do I suggest that such a claim is obviated by the passage of time simply because the value ultimately received for the stock was influenced in part by intervening market forces unrelated to the fraud. But in an efficient public securities market, which responds rapidly to changing conditions, events subsequent to the fraud may so intervene that, as a logical matter, the value the plaintiff ultimately obtained bears no relationship whatever to the fraud. In such a case, I continue to believe, fraud-related damages should not be recoverable.
Accordingly, I would require that those who assert they were induced by fraud to hold company shares must plead and prove specific facts showing that they actually realized out-of-pocket losses as a result of the fraud and its disclosure. Pleading and proof that the price of the shares fell on a particular day as a result of disclosure of the fraud would not suffice. Because that is all the current complaint claims, I find its damage allegations inadequate to state a cause of action. I would allow an opportunity to amend the complaint in accordance with the views expressed in this opinion.
As the majority set forth, the second amended complaint does aver that the original named plaintiff (and all other alleged class members) “ ‘read [the allegedly inaccurate third quarter statement of defendant Fritz Companies, Inc. (Fritz)], . . . and relied on [the inaccurate] information [contained therein] in deciding to hold Fritz stock through [July 24, 1996].’ ” (Maj. opn., ante, at p. 173, italics added; see also id. at p. 180.) The majority do not quite say so, but I assume that, consistent with Mirkin v. Wasserman (1993) 5 Cal.4th 1082 [ 23 Cal.Rptr.2d 101 , 858 P.2d 568 ], they would deem the pleading of some such form of direct personal reliance minimally necessary in order to eliminate persons who merely seek to invoke the “fraud on the market” doctrine that we rejected in Mirkin for purposes of California common law securities litigation. In addition, as the majority assert, the plaintiff must plead, “for example, that if the plaintiff had read a truthful account of the corporation’s financial status the plaintiff would have sold the [corporation’s] stock, how many shares the plaintiff would have sold, and when the sale would have taken place” (maj. opn., ante, at p. 184), and must also “allege actions, as distinguished from unspoken and unrecorded thoughts and decisions, that would indicate that the plaintiff actually relied on the misrepresentations” {ibid).
I acknowledge we cannot resolve at this stage whether the case may properly proceed as a class action. But we facilitate that determination by specifying all the elements of an individual cause of action.
Throughout this litigation, defendants and their amici curiae have volunteered only two attacks on the various complaints filed herein: first, that there is no California common law holder’s action, and second, that the allegations of reliance are insufficient. Perhaps, therefore, the majority are within their technical rights to avoid other issues. However, this court did solicit and receive supplemental briefs on the issue “whether, in light of the so-called ‘efficient capital markets hypothesis’ or otherwise, the complaint sufficiently alleges a causal relationship between the alleged misrepresentations and any alleged, nonspeculative damages.” (Italics added.) At oral argument, I questioned counsel specifically about the problem of realized loss. Hence, the parties have had reasonable notice and opportunity to brief and argue the issue, and we may resolve it in the interest of judicial efficiency. (Cal. Rules of Court, rule 29(b)(2).)
When questioned about these difficulties at oral argument, plaintiff’s counsel responded gamely but offered little to refute my concerns.
Injuries of this kind, I realize, might be considered “ ‘injury to the corporation, or to the whole body of its stock or property without any severance or distribution among individual shareholders’ ” (Sutter v. General Petroleum Corp. (1946) 28 Cal.2d 525, 530 [ 170 P.2d 898 , 167 A.L.R. 271 ]), such that only a derivative action would be available.
Though neither the record nor the parties have so informed us, it appears that in May 2001, nearly five years after the alleged 1996 fraud and its disclosure, Fritz was acquired for substantial value by United Parcel Service, Inc. (Yahoo! Finance, EDGAR Online, SEC Filings, Fritz Companies Inc. (FRTZ), form 8-k (May 24, 2001) [as of April 7, 2003]; UPS Pressroom, 2001 Press Releases, UPS to Acquire Fritz Companies, Inc. for $450 Million in Class B Common Stock (Jan. 10, 2001) [as of April 7, 2003].) This intervening development only underscores the difficulty of tracing the effect of long-past events on the current value of investments retained for substantial periods after those events occurred.
I agree that where one was induced by marketplace fraud to buy publicly traded shares at an inflated price, and did not sell them before the fraud was disclosed, the amount of any compensable loss must be measured by the accurate value the market places on the shares *200 when the truth becomes known (see Rest.2d Torts, § 549, com. c, p. 110, cited in cone. opn. of Kennard, J., ante, at p. 187)—at least after discounting factors unrelated to the fraud that may also have affected the intervening change in price. This only restates the fundamental truth that one who paid too much as a result of fraud is entitled to recover the excess over what he should have paid, no more or less. It does not mean that compensable damage is necessarily suffered by one who merely held shares in reliance on fraud, then did nothing when disclosure of the fraud caused the market price of the shares to fall.
Harris v. American Investment Company (8th Cir. 1975) 523 F.2d 220 , which Justice Kennard cites for the proposition that a defrauded shareholder need not “realize” his loss in order to recover, is unavailing for similar reasons. That case involved a defrauded purchaser. As I have explained at length (see ante, at p. 196), defrauded buyers are always damaged, and permanently so, by the difference between the fraud-inflated price they paid and the true value of the shares at that time. Persons who merely held shares through both the fraud and its disclosure are not similarly situated.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/9795895. Public record. Not legal advice.