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Refusing to close courthouse doors that are already shut in the federal courts, the California Supreme Court on Monday allowed investors who hold stock that declines in value to sue for fraud. The unanimous decision clearing the way for so-called holder’s actions should please the plaintiffs bar. But it was not a total victory. The court also erected high hurdles that corporate lawyers hope will restrict the number of such suits — and may make them impossible to bring as class actions. “Persons claiming that, for reasons of policy, they should be immune from liability for intentional fraud bear a heavy burden of persuasion, one that defendants here have not sustained,” Justice Joyce Kennard wrote. “We recognize, however, that the risk of encouraging nonmeritorious suits justifies using the requirement for specific pleading to place limits on the cause of action.” The U.S. Supreme Court eliminated holder’s actions — lawsuits by those who neither buy nor sell stock based on false or misleading information, but nevertheless lose money — in 1975. But federal courts have long noted that state law remedies are available. Stockholder Harvey Greenfield filed a class action against Fritz Companies Inc. in 1996, alleging that the company inflated its earnings through improper accounting. When the company announced that it would restate its earnings, its market value dropped 55 percent. (Greenfield died while the case was pending at the Supreme Court and was replaced by the administrator of his estate.) Though it posthumously upheld Greenfield’s right to sue, the court may also have made it impossible to pursue the case further. One significant hurdle the court erected is that investors must plead with specificity their reliance on public statements made by company executives. What that means — be it notes, testimony from a broker or other means beside the word of the plaintiff — will have to be decided by the courts. But it may be too late for Greenfield’s estate. As estate lawyer Michael Braun, a partner at Stull Stull & Brody put it: “That situation is exacerbated by the fact that Mr. Greenfield is deceased.” Since the onus is on the individual shareholder to demonstrate reliance on company statements, the Supreme Court may have also made class actions an impossibility. Depending on how future courts rule, groups of investors with different showings of reliance may not be suitable for class certification. “That will certainly be the next big question — whether these matters can be sustained as a class action,” Braun said. Orrick, Herrington & Sutcliffe partner William Alderman, who represents Fritz Companies, said his client had asked him not to comment to the media. He had argued that the court should make a policy decision to bar such suits as a way of limiting nonmeritorious claims. But after the recent financial scandals, Monday’s majority was clearly in no mood to do so, and instead endorsed the view that the plaintiffs bar isn’t the pack of shady lawyers some make it out to be, but a force for integrity in the nation’s markets. “The last few years have seen repeated reports of false financial statements and accounting fraud, demonstrating that many charges of corporate fraud were neither speculative nor attempts to extort settlement money, but were based on actual misconduct,” Kennard wrote. “Denying a cause of action to persons who hold stock in reliance upon corporate misrepresentations reduces substantially the number of persons who can enforce corporate honesty.” Reed Smith Crosby Heafey securities partner Kenneth Philpot said the case is not an opening of the floodgates — at least not in the long term. There will be much litigation early on about Small v. Fritz Companies Inc., 03 C.D.O.S. 2983, he said, but at the end of the day the decision doesn’t give the plaintiffs bar much to stand on. Another hurdle Philpot sees is one addressed in a concurrence by Justice Marvin Baxter: damages. Baxter wrote about the difficulty in divining loss when the company’s value eventually recovers. Another question would be how to separate losses attributable to fraud versus losses attributable to other reasons, such as bad business decisions. Braun said the Supreme Court ordered another round of briefing on whether the plaintiffs could state a cognizable theory of damages. Apparently, the court was satisfied, but Justice Janice Rogers Brown and Ming Chin dissented in part to say that Greenfield could not prove actual damages. Philpot said it will be an ongoing problem. “The difficulty in proving actual damages and actual reliance are two huge hurdles” to bringing holder’s actions, Philpot said. Braun was emphasizing the positive. “I guess one can always say it could be better, but I certainly think the court took a step in the right direction, and it was an important decision for shareholders. It recognized a very basic right,” he said. In another decision released Monday, the court upheld 5-2 a jury finding that Contra Costa County could be liable for maintaining a dangerous condition at a bus stop. Though majority author Kathryn Mickle Werdegar wrote that the court was not ensnaring counties in a wide net of liability, Brown dissented. She wrote that the holding could bankrupt public services such as the bus transportation system at issue in Bonanno v. Central Contra Costa Transit Authority, 03 C.D.O.S. 2976. “Where you stand can depend on where you sit, and, let us be frank, Supreme Court justices don’t sit on buses very often,” Brown wrote. “Therefore, the majority would do well to consider the plight of those dependent on WestCAT, the transit agency serving northwestern Contra Costa County.”

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