Court OKs Suits by Out-of-State Investors

Out-of-state investors may sue California companies in state court for illegal market manipulation, the California Supreme Court ruled Monday.

The decision was a setback for the state’s high-technology companies, which have been targets of many stock fraud suits, generally alleging that corporate officers inflated stock prices by making false statements about a company’s prospects.

Shareholder lawsuits have soared in California’s courts since Congress passed a law in 1995 that attempted to make it tougher to pursue securities cases in federal court. The federal change spurred disgruntled investors to file suits instead under a 1968 California securities fraud law.

A second federal law that took effect in November will prevent new shareholder class-action suits in any state court. Today’s ruling will allow existing class-action suits filed by non-Californians to go forward. Lawyers estimate that there are about 50 to 100 such suits now pending that collectively could be worth hundreds of millions of dollars in damages.

Monday’s ruling will also allow new individual complaints and those filed by groups of fewer than 50 plaintiffs.

The high-tech industry argued that only state residents should be allowed to sue under the California law. The court disagreed in a 5-2 decision, ruling that all investors may sue under the California law as long as the alleged fraud occurred in the state.

California “has a legitimate and compelling interest in preserving a business climate free of fraud and deceptive practices,” Justice Marvin R. Baxter wrote for the court. “California business depends on a national investment market to support our industry. The California remedy for market manipulation helps to ensure that the flow of out-of-state capital necessary to the growth of California business will continue.”

Baxter conceded that the ruling may increase the burden on state courts. But he said a plain reading of the state law shows it applies to all investors.

The court agreed with the defendants that the Legislature passed the Corporate Securities Law to regulate securities in the intrastate market, which were not reached by federal securities regulations.

“It does not follow, however, that the civil remedies . . . are available only to persons who bought or sold securities in California,” Baxter wrote.

The court also contended that allowing such shareholder suits under state law would not hurt business in the state.

“Quite the opposite,” Baxter wrote. “By affording a remedy to persons who are the victims of manipulative conduct, [the state law] stimulates commerce in corporate stock.”

Justices Janice Rogers Brown and Ming W. Chin dissented.

The ruling stemmed from a class-action lawsuit against Diamond Multimedia Systems Inc. by people who bought stock between Oct. 26, 1995, and June 20, 1996.

The complaint charges that corporate officers were aware of negative information and approved false statements that induced others to buy company stock, whose prices later fell. Diamond has denied the allegations.

“Obviously we are disappointed, but this may be a case where we lost this battle but we won the war,” Diamond attorney Steven M. Schatz said.

He said the Diamond case helped spur the passage of the new Securities Litigation Uniform Standards Act of 1998, which preempts all major securities class-action litigation in state courts.

Schatz said high-tech companies are often the target of shareholder suits because their stock prices are historically volatile.

“Companies frequently decide it is better to settle than bear the risk of an adverse judgment,” Schatz said.

Shares of San Jose-based Diamond rose 59 cents to close at $6.97 on Nasdaq.