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In contrast to firmly established federal precedent, recent state court decisions have sparked interest in securities fraud holding claims. A holding claim is one brought by a plaintiff who was already a shareholder at the time of the alleged fraud, contending that the fraud induced him or her to hold the stock, rather than purchase or sell any shares. The gist of a holding claim is that absent the fraud, the plaintiff would have sold at an earlier time and for a more favorable price. While federal law clearly limits standing in securities fraud cases to purchasers and sellers, states are not bound by this doctrine. Accordingly, plaintiffs are now attempting to bring holding claims under common law fraud theories. This is not surprising, following the corporate scandals at Enron and other companies. The Houston-based energy firm helped change the tide of opinion toward securities fraud and corporate governance litigation. Whereas the 1990s saw major legislation from Congress making it more difficult for plaintiffs to bring suit, the prevailing sentiment after Enron is that the need for greater scrutiny over corporate conduct outweighs the need to curb perceived abuses by plaintiffs’ counsel. Holding claims are benefiting from that view. This article will discuss briefly the background involving holding claims, and the recent decisions in Small v. Fritz Cos. Inc., 65 P.3d 1255 (Calif. 2003), and Shirvanian v. DeFrates, 2004 WL 35987 (Texas App.-Houston Jan. 8, 2004), endorsing holding claims under state law. Federal courts have barred holding claims for almost as long as they have permitted private suits under � 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, the principal anti-fraud provisions of the federal securities laws. In 1952, the 2d U.S. Circuit Court of Appeals decided in Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952), that Rule 10b-5 was “directed solely at [fraudulent activity] associated with the sale or purchase of securities” and thus limited standing to purchasers and sellers. In 1975, the U.S. Supreme Court adopted the Birnbaum rule in Blue Chip Stamps v. Manor Drugs, 421 U.S. 723 (1975), and the purchaser-seller doctrine is now well developed. State law, on the other hand, is remarkably underdeveloped. Birnbaum limited its application to 10b-5 claims, holding that they bore “no relation to breaches of fiduciary duty by corporate insiders upon those who were not purchasers and sellers.” The Supreme Court in Blue Chip Stamps expanded on this point, stating that any concerns about the severity of the Birnbaum rule were “attenuated to the extent that remedies are available to nonpurchasers and nonsellers under state law.” Nonetheless, it appears that holding claims simply haven’t been litigated often in state court. In fact, the most useful opinions prior to Small come from federal diversity cases interpreting state law. In Gutman v. Howard Savings Bank, 748 F. Supp. 254 (D.N.J. 1990), a New Jersey district court determined that holding claims were available under New York and New Jersey law. The court found that in fraud cases outside of the securities context, reliance could be established either by action or forbearance. The court also noted that the Restatement (Second) of Torts � 525 specifically authorizes fraud claims based on misrepresentations that are intended to and do induce inaction. In 1994, a Connecticut federal district court reached a different conclusion in Chanoff v. United States Surgical Corp., 857 F. Supp. 1011 (D. Conn. 1994). The Chanoff court held that any common law fraud claims premised on the defendants’ breach of a duty of disclosure of material, nonpublic information were pre-empted by federal insider trading laws, while any holding claims not premised on a duty of selective disclosure could not be brought because the alleged damages were “too speculative to be actionable.” ‘Small’ is significant Decided in December 2003, Small represents the most significant endorsement of holding claims to date. In most respects, it is typical of many modern-day securities fraud cases. The plaintiffs alleged that certain revenue and earnings figures contained in an April 1996 press release and subsequent report to shareholders were incorrect and misstated the costs associated with several acquisitions made by the company. The company ultimately restated its revenue and earnings figures in July 1996. This led to the filing of several federal class actions brought by shareholders who purchased shares between April and July, as well as the state court holding claim at issue in Small. The court concluded that holding claims are permitted under California law, but that such claims are limited to plaintiffs who could make a bona fide showing of actual reliance. It observed that California had long recognized common law fraud claims based on forbearance in other contexts, and declined to create an exception where the forbearance is to refrain from selling stock. The court noted that its holding was consistent with the Restatement’s position. It also reasoned that its holding would be consistent with Blue Chip Stamps because the Supreme Court based its opinion in part on the notion that state law remedies would be available. The Small court then turned to the defendants’ policy arguments that allowing holding claims would lead to a rash of meritless “strike suits” and open the door for litigation whenever a stock price fluctuated, and that proof of reliance would depend heavily on the plaintiff’s irrebuttable and unreliable oral testimony. The court felt that these concerns were not sufficient to justify a categorical denial of holding claims. However, the court did recognize the need for a mechanism to separate the wheat from the chaff. Accordingly, the court established that holding-claim plaintiffs must make a bona fide showing of actual reliance in the complaint. At a minimum, the complaint must show how many shares the plaintiff would have sold and when the sale would have occurred, as well as actions indicating actual reliance on the alleged misrepresentations. While this heightened pleading standard limits its impact, Small leaves several questions unresolved. One is whether a holding claim can be brought as a class action. It would appear that by requiring proof of actual reliance by each plaintiff, the court has made it very difficult for holding-claim class actions to be maintained. Federal law and other issues Another question is whether the existing federal laws designed to regulate securities class actions have any bearing on holding claims. In particular, the Securities Litigation Uniform Standards Act (SLUSA) enables defendants to remove to federal court certain state court securities class actions founded on state law, where they are subject to federal rules including heightened pleading standards. So far, most courts considering the issue have determined that holding claims are not subject to the SLUSA. This is because the SLUSA’s terms limit its scope to class actions maintainable in federal court, which excludes holding claims. Yet another question is whether a holding claim can ever sufficiently plead causation and damages. It is unclear how one should calculate damages when there is neither a purchase nor a sale of the security in question. The Small court suggests that the issue could be resolved through expert testimony, aided by specificity in the pleadings as to the planned date of sale and number of shares to be sold. The Small plaintiffs argued that they would have sold at an earlier time had the truth about the company been known then. However, one could argue that the bad financial news would have driven down the stock price in April, had it been announced then. The Small court suggested that perhaps a loss of confidence in management, and not the bad news, caused the loss. A case from Texas Shirvanian v. DeFrates presents novel questions of its own, arising out of a scandal involving Waste Management Inc. The complaint alleged that the lead plaintiff, the company’s largest shareholder, devised a detailed plan to sell off gradually a portion of his stock over a period of months, and began selling the stock according to the plan. When the plaintiff informed the defendants of this plan, they allegedly responded with a “full court press” of misrepresentations designed to prevent the plaintiff from selling. The court observed that the facts alleged presented a stronger case for a holding claim than those in Small. It agreed with Small‘s reasoning in concluding that holding claims should be recognized under Texas common law, looking at fraud cases outside of the securities context, the Restatement and Blue Chip Stamps. The court did not impose a heightened pleading standard as in Small, but expressed concerns about its holding being interpreted too broadly, stating that the facts presented were “unique” and the potential pool of plaintiffs in holding-claim cases “very narrow.” Among the questions raised by Shirvanian are whether the claims asserted were derivative and should have been brought on behalf of the company, given that the sole injury alleged was diminution in stock value. The defendants argued that this created a “fat cat” exception-allowing large shareholders to bring their own fraud suits whereas smaller shareholders could only do so through a derivative suit. The court concluded that because the plaintiffs were the sole target of the fraud, they suffered a harm not suffered by the shareholders at large, and thus were entitled to bring direct claims. Another question is whether federal insider trading laws should pre-empt holding claims. As in Chanoff, the plaintiffs’ claims were arguably based on the theory that the defendants possessed material, nonpublic information that should have been disclosed to them before it was publicly disclosed. The Shirvanian court disagreed with the argument and found Chanoff inapplicable. It noted that in this case, a pre-existing plan to sell had been alleged, and the plaintiffs would have sold without receiving inside information had the defendants not engaged in the alleged fraud. The ‘WorldCom’ opinion Recently, the Southern District of New York dismissed a holding claim in In re WorldCom, 2004 WL 2075173 (S.D.N.Y. Sept. 17, 2004), on the ground that holding claims are not recognized in Georgia, where the suit was originally brought. WorldCom is noteworthy because of its high profile, and because it agreed with the general policy reasons for barring holding claims. The court stated that the only cases recognizing holding claims either required heightened pleading, citing Small, or expressed concerns that it be construed narrowly, as in Shirvanian. WorldCom suggests that any great concern about a rush of meritless “strike suits” at this point may be unfounded. The existing cases suggest that holding claims may be flexible enough to apply to both public disclosures and face-to-face communications; holding-claim class actions are not subject to removal under the SLUSA, but will be difficult to maintain where actual reliance of each class member must be proven; and most holding claims will be subject to dismissal in the absence of specific allegations of a pre-existing plan to sell shares. Still, as Small and Shirvanian demonstrate, holding claims are probably here to stay in the abstract, and one can expect more plaintiffs to attempt to bring them. John R. Bielema Jr. is a partner, and Michael P. Carey is an associate, in the litigation department of Atlanta’s Powell Goldstein, where they concentrate on securities, corporate and commercial litigation.

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