Kaufman v. I-Stat Corp.

*119 STEIN, J.,

dissenting.

In this appeal, the issue before the Court is whether reliance on the integrity of the market price for a corporate security satisfies the reliance element of a cause of aetion for common law fraud. The Appellate Division held that it does. Kaufman v. i-Stat Corp., 324 N.J.Super. 344 , 735 A.2d 606 (1999). Because I believe that the Appellate Division’s thorough and well-reasoned opinion reflects the correct disposition of that issue, I dissent.

I

The narrow issue before the Court is whether the fraud-on-the-market theory of reliance, articulated and adopted by the United States Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 241-48, 108 S.Ct. 978, 989-92 , 99 L.Ed.2d 194, 214-19 (1988), adequately may satisfy the reliance element of a state law claim for common law fraud.

A

A common-law fraud action has five elements. They are “(1) a material misrepresentation of a presently existing or past fact; (2) knowledge or belief by the defendant of its falsity; (3) an intention that the other person rely on it; (4) reasonable reliance thereon by the other person; and (5) resulting damages.” Gennari v. Weichert Co. Realtors, 148 N.J. 582, 610 , 691 A.2d 350 (1997).

Since 1957 New Jersey has recognized that indirect reliance may satisfy the reliance element of a common law fraud action. See Judson v. Peoples Bank & Trust Co., 25 N.J. 17, 27 , 134 A.2d 761 (1957) (holding that misrepresentation by one family member made with intent that it be communicated to other family members sufficient to satisfy reliance element of common law fraud and observing that “reliance may be found by fair inference”); Metric Investment, Inc. v. Patterson, 101 N.J.Super. 301, 306 , 244 A.2d 311 (App.Div.1968). Likewise, the Restatement of Torts states that

*120 [t]he maker of a fraudulent misrepresentation is subject to liability for pecuniary loss 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 in the transaction or type of transaction involved.

[Restatement (Second) of Torts § 533 (1977).]

Thus, proof that a party deliberately made false representations with the intent that they be communicated to others for the purpose of inducing others to rely upon them may satisfy the reliance element of common law fraud.

In this appeal, i-Stat issued materially misleading public statements about its financial condition and prospects, subsequent to which the price of its stock rose. The stock market “act[ed] as the unpaid agent of the investor [and] inform[ed plaintiff] that given all the information available to it, the value of the stock is worth the market price.” Basic, supra, 485 U.S. at 244 , 108 S.Ct. at 990 , 99 L.Ed 2d at 216 (quoting In re LTV Securities Litigation, 88 F.R.D. 134, 143 (N.D.Tex.1980)). Under the principle of indirect reliance applied by this Court in Judson , and consistent with the Restatement (Second) of Torts ’ position, i-Stat’s intentional misrepresentation may be actionable as a common law fraud even though the authors of the false information did not communicate directly to plaintiff.

The question thus is whether the principle of indirect reliance applies in the context of purchasers of publicly traded securities where the fraud was perpetrated generally on the public with the intention that all purchasers of the securities would be defrauded. The answer to that question is found in the United States Supreme Court’s analysis of the fraud-of-the-market theory in Section 10b-5 cases. 15 U.S.C.A. § 78j(b).

B

In relevant part, the Securities and Exchange Commission’s Rule 10b-5, 17 C.F.R. § 240 .10b-5 (1987) (Rule 10b-5) provides that

*121 [i]t shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, ... [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading---in connection with the purchase or sale of any security.

A plaintiff who is injured by a violation of Rule 10b-5 may bring a claim under section 10b of the Securities Exchange Act of 1934 (the Exchange Act), 15 U.S.C.A. § 78a to 78mm. A claim brought under the Act requires that a plaintiff show the following: “(1) a false representation of (2) a material (3) fact; (4) defendant’s knowledge of its falsity and his intention that plaintiff rely on it; (5) the plaintiffs reasonable reliance thereon; and (6) his resultant loss.” Peil v. Speiser, 806 F.2d 1154, 1160 (3d Cir.1986) (citing 3 Loss, Securities Regulation 1431 (1961)). Reliance is an essential element of a cause of action under section 10b of the Act.

Prior to the United States Supreme Court’s 1988 Basic decision, to satisfy the reliance element of a fraud claim brought under Rule 10b-5 victims of fraudulent misrepresentations were required to show that they actually relied on the misrepresentations made by defendants. For example, in Vervaecke v. Chiles, Heider & Co., 578 F.2d 713, 719 (8th Cir.1978), the court of appeals found that the plaintiff, who did not receive or read the company’s offering statements until after the commitment to purchase the defendant company’s securities was made, was not permitted to proceed with his claim that the company’s misleading offering statements caused his loss. Because the plaintiff could not in his own right make a claim, he was not permitted to represent a class of plaintiffs. Ibid. Likewise, in Cavalier Carpets, Inc. v. Caylor, 746 F.2d 749, 754-55 (11th Cir.1984), the Court of Appeals affirmed the District Court’s determination that the plaintiffs in a Rule 10b-5 securities fraud suit were required to show “that they reasonably relied upon the [misrepresentations or omissions] or on the notion that [they] had received all the information from the [defendants that would be material and exercised due diligence in examining the information otherwise available to [them] which relates to the alleged misrepresentation or omission.”

*122 In Basic, supra, the Supreme Court first concluded that the reliance element in a claim based on fraudulent misrepresentations under Rule 10b-5 may be satisfied by proof that the plaintiff relied on the integrity of the market price. 485 U.S. at 247 , 108 S.Ct. at 992 , 99 L.Ed.2d at 218 . The Supreme Court stated that the fraud-on-the-market theory of reliance is “based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business____ Mislead-

ing statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.” Id. at 241-42 , 108 S.Ct. at 989 , 99 L.Ed.2d at 215 (quoting Peil, supra, 806 F.2d at 1160-61 ). As such, “[t]he 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.” Ibid.

The fraud-on-the-market theory of reliance is but a rebuttable presumption of reliance. Id. at 245, 108 S.Ct. at 990 , 99 L.Ed.2d at 217 . The Supreme Court found that it was fair to allow reliance to be presumed in Rule 10b-5 cases because requiring “a plaintiff to show a speculative state of facts, ie., how he would have acted if omitted material information had been disclosed or if the misrepresentation had not been made would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market.” Ibid, (citations omitted).

Defendants may “rebut proof of the elements giving rise to the presumption, or show that the misrepresentation in fact did not lead to a distortion of price or that an individual plaintiff traded or would have traded despite his knowing the statement was false.” Id. at 248 , 108 S.Ct. at 992 , 99 L.Ed.2d at 219 (citation omitted). Similarly, the presumption may be rebutted by “[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price” or if credible information “entered *123 the market and dissipated the effects of the misstatements.” Id. at 249 , 108 S.Ct. at 992 , 99 L.Ed.2d at 219 .

The rationale behind the Supreme Court’s reasoning is that “[t]he 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.” Id. at 244 , 108 S.Ct. at 990 , 99 L.Ed.2d at 216 (quoting In re LTV, supra, 88 F.R.D. at 143 ). Accordingly, “[a]n investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.” Id. at 247 , 108 S.Ct. at 992 , 99 L.Ed 2d at 218. Thus, the fraud-on-the-market theory of reliance is sufficient to satisfy the reliance element of a Rule 10b-5 claim.

The Basic Court’s holding that the use of the fraud-on-the-market theory may satisfy the reliance element of a Rule 10b-5 claim is not based on the specific language of the Act. Kaufman, supra, 324 N.J.Super. at 351 , 735 A.2d 606 . Instead, the holding relies on the fact that the reliance elements of securities law claims and common law fraud actions are virtually identical. Basic, supra, 485 U.S. at 243 , 108 S.Ct. at 989 , 99 L.Ed.2d at 215 . Accordingly, “the reasoning of Basic and other eases brought under federal securities law is equally applicable to a common law action for securities fraud.” Kaufman, supra, 324 N.J.Super. at 352 , 735 A.2d 606 .

For an action to be maintained as a class action, “questions of law or fact common to the members of the class [must] predominate over any questions affecting only individual members.” Rule 4:32-l(b)(3). Without the fraud-on-the-market theory of reliance in securities fraud cases, each individual plaintiff would be required to prove his or her own actual reliance on the fraudulent misrepresentation or omission of the defendant. In that context, individual issues of reliance would predominate over common issues and class action certification generally would be denied. *124 See, e.g., Gross v. Johnson & Johnson-Merck Consumer Pharms. Co., 303 N.J.Super. 336, 350 , 696 A.2d 793 (Law Div.1997)(denying class certification because question of each plaintiffs reliance proved to be highly individualized and complex); In re Hotel Telephone Charges, 500 F.2d 86, 89 (9th Cir.1974) (noting that class action treatment may be unsuitable in fraud case if there are material variations in representations made or in kinds or degrees of reliance by plaintiffs).

The majority refers to limitations on the fraud-on-the-market theory of reliance and notes that commentators and investors may disagree about whether the market price of a security fully reflects the present value of a company. Ante at 113-17, 754 A.2d at 1198-1200. However, adoption of the fraud-on-the-market principle does not require us to “adopt any particular theory of how quickly and completely publicly available information is reflected in market price.” Basic, supra, 485 U.S. at 248, n. 28 , 108 S.Ct. at 992, n. 28 , 99 L.Ed.2d at 219, n. 28 . It requires merely that we accept that “[t]he 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.” Id. at 246 , 108 S.Ct. at 991 , 99 L.Ed.2d at 217 (quoting H.R.Rep. No. 73-1383, at 11 (1934)). The significance of the fraud-on-the-market principle derives not from the infallibility of the market price of securities but rather from the theory’s implicit acknowledgment that the investing public is entitled to assume that SEC-mandated disclosures have been made and that fraudulent misrepresentations have not unlawfully affected the market price.

II

The majority asserts that to accept the fraud-on-the-market theory of reliance as proof of reliance in a common law fraud suit would “undercut the public interest in preventing forum-shopping, weaken our law of indirect reliance, and run contrary to the policy *125 direction of the Legislature and Congress.” Ante at 118, 754 A.2d at 1200-01. Those arguments are unpersuasive.

A

The Appellate Division cogently reasoned that “a defendant’s misrepresentation may be an immediate cause of a plaintiffs injury-producing conduct even though the defendant did not make the misrepresentation directly to the plaintiff, and even though the plaintiff never heard or read the precise words of the misrepresentation.” Kaufman, supra, 324 N.J.Super. at 352 , 735 A.2d 606 (citation and quotation omitted). The Appellate Division also rejected the claim that the fraud-on-the-market theory of reliance should not be adopted merely because plaintiffs have an adequate remedy available under federal law. Id. at 353 , 735 A.2d 606 . As Judge Skillman observed: “The Securities Exchange Act of 1934 states that ‘the rights'and remedies provided by this chapter shall be in addition to any and all remedies that may exist at law or in equity.’ 15 U.S.C.A. § 78bb(a).” Ibid. Thus, “Congress contemplated that federal remedies for securities fraud would supplement rather than preempt whatever remedies a state may elect to afford.” Ibid. “[I]n the absence of any expression of congressional intent to preempt state law or limit state remedies, [the Appellate Division could] perceive no reason why, as a matter of state policy, [it] should deny an effective state remedy to a defrauded investor simply because she also has a remedy under federal law.” Ibid. See also Herman & MacLean v. Huddleston, 459 U.S. 375, 388-389 , 103 S.Ct. 683, 691 , 74 L.Ed.2d 548, 560 (1983) (observing that securities laws were in part designed to add to protections provided investors by common law).

Moreover, class action lawsuits for securities fraud are so few in number that the adoption of the fraud-on-the-market theory as a rebuttable presumption of reliance will have little or no impact on the operation of state courts. For example, in 1999, 216 securities class action suits were filed in federal courts. Stanford Securities Class Action Clearinghouse, (visited Jul. 6, (2000) <http://securi *126 ties.stanford.edu>). Approximately forty-five securities class action suits were filed in state courts in 1999 and over half of those lawsuits were filed in California. Ibid. In contrast, in 1998 (the most recent year for which information is available), over fifteen million civil cases were filed in state courts nationwide. National Ctr. for State Courts et. at., Examining the Work of State Courts, (1998) (2000). The fact is that securities fraud cases represent only an infinitesimally small percentage of civil cases.

Moreover, the enactment by Congress of legislation restricting the fora in which victims of securities fraud may sue limits further those plaintiffs who are permitted to maintain a securities fraud cause of action in state courts. Initially, in 1995 Congress passed the Private Securities Litigation Reform Act (PSLRA). PSLRA imposed many procedural restrictions on federal class-action plaintiffs. In 1998 Congress enacted the Securities Litigation Uniform Standards Act (SLUSA), which sharply limits the number of securities fraud class action suits that may be brought in state courts. SLUSA, by its terms, preempts all but a limited group of future class action common law fraud claims that would otherwise be filed in state court and requires that they be filed in federal court. SLUSA provides that the vast majority of class actions, including suits such as the one at bar, that are based on a state’s statutory or common law alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security” or “any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security” may not be brought in a state court. 15 U.S.C.A. § 78bb(f)(1)(A) and (B). SLUSA prevents all but state or municipal entities, state pension funds, or classes comprised of less than fifty plaintiffs from filing suit in a state court. The majority’s conclusion, ante at 107, 754 A.2d at 1194, that “the excepted plaintiffs remaining under SLUSA, ... could still bring a significant amount of litigation” is overstated.

Nevertheless, the PSLRA and SLUSA permit specific but restricted classes of plaintiffs to maintain their causes of action in *127 state court. In the absence of congressional intent to the contrary, those plaintiffs should be permitted to have the benefit of the fraud-on-the-market theory of reliance under our common law fraud doctrine.

B

The statute of limitations for a lawsuit for securities fraud brought in federal court under Rule 10b-5 is shorter than a suit for common law fraud brought in state court. Compare 15 U.S.C.A. § 78i(e) (claims under section 10(b) of 1934 Act must be brought within one year of discovery of violation) with N.J.S.A. 2A:14-1 (statute of limitations governing common law fraud is six years). Federal suits brought under Rule 10b-5 also differ from common law fraud claims in that they do not permit punitive damages to be awarded. Compare 15 U.S.C.A. § 78bb(a) with Gennari, supra, 148 N.J. at 610 , 691 A.2d 350 (finding that “[b]ecause [the defendants] are liable for common-law fraud, they are subject to punitive damages”). Those differing treatments of the two types of lawsuits should not induce this Court artificially to restrict the parameters of a cause of action sounding in common law fraud. If those disparities disturb the legislature, it can readily adopt a statute of limitations provision and limits on punitive damages analogous to those eongressionally-imposed limitations in Rule 10b-5 cases.

Ill

Recognizing fraud on the market as a means of proving reliance in common law fraud actions requires “merely an application of existing common law principles expressed in the indirect reliance cases from ... other jurisdictions, and in the Restatement Second of Torts.” Mirkin v. Wasserman, 5 Cal.4th 1082 , 23 Cal.Rptr.2d 101 , 858 P.2d 568, 593 (1993) (Kennard, J., concurring in part and dissenting in part). It requires only that we recognize that “[t]he genius of the common law is its flexibility and capacity for growth and adaptation.” Russick v. Hicks, 85 F.Supp. 281, 285 (D.Mich. *128 1949) (citing Funk v. United States, 290 U.S. 371 , 54 S.Ct. 212 , 78 L.Ed. 369 (1933)). “It has always been recognized that the common law is not a rigid, inflexible, static thing, but is a living organism, ever growing and expanding to meet the problems and needs of changing social and economic conditions.” Ibid. Merely because an asserted right is somewhat novel is “not [a] valid reason[ ] for denying its existence.... The common law is not a primer of rigid and absolute rules, but rather a body of broad and comprehensive principles created by judicial decisions and based on justice, reason, and common sense.” Id. at 285-86.

I would affirm the judgment of the Appellate Division. Justice O’HERN and Justice LONG join in the opinion.

For affirmance in part, reversal and reinstatement in part— Chief Justice PORITZ and Justices COLEMAN, VERNIERO, and LaVECCHIA — 4.

For affirmance — Justices O’HERN, STEIN, and LONG — 3. ■