Ruling Gives Investors a New Weapon

Investors may sue a company in California when inaccurate corporate reporting induces them to hold on to a stock instead of unloading it, the California Supreme Court ruled Monday.

The ruling follows a wave of explosive business scandals involving companies that used deceptive accounting practices to mislead shareholders about their profitability.

“The last few years have seen repeated reports of false financial statements and accounting fraud, demonstrating that many charges of corporate fraud were ... based on actual misconduct,” Justice Joyce L. Kennard wrote in the majority opinion.

The sort of lawsuit sanctioned by Monday’s decision is barred in federal court and has generally been dismissed by California courts. To sue in federal court, an investor must have taken action and suffered -- actually selling shares and losing money -- based on a company’s misrepresentations.

The ruling Monday said that in California, suits can be brought by investors who sat tight because of a company’s erroneous claims about its financial health or other matters.

“We conclude that California law should allow a holder’s action for fraud or negligent misrepresentation,” Kennard wrote.

The widely watched case was brought in 1996 by a New York investor against Fritz Cos., a San Francisco transportation firm now owned by United Parcel Service.

The plaintiff, Harvey Greenfield, who died last year, alleged that Fritz exaggerated its profitability by misstating the cost of acquisitions and recording revenue that didn’t exist. The company denied the allegations.

Fritz stock plunged 55% after it restated its third-quarter earnings on July 24, 1996, and said it would have a loss of $3.4 million in the fourth quarter. The company’s stock never returned to its mid-1990s peak of $43.

The California Supreme Court ruling referred the case back to Superior Court for possible trial.

Although the ruling handed shareholders a weapon, the court made it difficult for plaintiffs to prevail. Stockholders must prove that they relied on a company’s misrepresentations in deciding against selling a stock, the court said.

The justices who dissented -- Janice Rogers Brown and Ming W. Chin -- said it wouldn’t be possible for plaintiffs to prove that they had suffered monetary damages due to inaccurate company reporting.

Writing for the minority, Brown said that if Fritz had reported its financial situation earlier, the stock price would have suffered then, too. “All of the alleged misrepresentations concerned public information that defendants had to disclose,” Brown wrote. “In an efficient market, the market price of stock reflects all publicly available information.”

Experts said that because specific evidence would be needed to show individuals’ reliance on company reports in deciding not to unload a stock, it may be difficult to bring class-action lawsuits on behalf of many investors.

Companies had urged the California Supreme Court to throw out the Greenfield suit, warning that a ruling in favor of the plaintiff could spark frivolous lawsuits designed to force companies to pay large settlements in lieu of costly court battles.

Previous rulings “recognize the danger that shareholders may bring abusive and nonmeritorious suits to force a settlement from the corporation and its officers,” Kennard wrote in the majority opinion. But that danger, she added, doesn’t justify the “the outright denial of all shareholders’ ” complaints.

An attorney for Fritz declined to comment. Michael D. Braun, who represented Greenfield, said he will have to assess what information he has to show that Greenfield specifically relied on the company’s alleged misrepresentations when he held on to the Fritz stock. Under the ruling, the Greenfield suit can’t go forward until it is amended with that information.

Ken Philpot, a San Francisco securities lawyer, called the ruling significant for aggrieved shareholders. But Philpot added that they face many hurdles.

“Plaintiffs will have to show they actually read the information, that they were considering selling,” he said, “and didn’t sell based on the information.”