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relying in part on California law
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No. 14-02-00447-CV
Opinion filed January 8, 2004.
On Appeal from the 189th District Court, Harris County, Texas, Trial Court Cause No. 00-00211.
Reversed and Remanded.
Panel consists of Justice FOWLER and Justice HUDSON. Former Chief Justice SCOTT BRISTER not participating.
OPINION
Appellants Kosti Shirvanian and various family trusts ("Shirvanians"), formerly the largest non-institutional shareholders of Waste Management, Inc., brought suit against appellees Waste Management, and former chief executives of Waste Management, Earl E.
One defendant, Gregory T. Sangalis, former general counsel of Waste Management, was nonsuited.
DeFrates and Rodney Proto ("Waste Management Group"). The Shirvanians asserted claims of fraud, intentional misrepresentation, negligent and grossly-negligent misrepresentation, and conspiracy, alleging that Proto and DeFrates induced Kosti Shirvanian and his sister, Savey Tufenkian, not to follow through with their plans to sell 3 million shares of Waste Management stock. The trial court granted appellees' motion for summary judgment and sustained appellees' special exceptions without specifying the basis for its rulings. Because the trial court erred in granting both motions, we reverse and remand this matter.
Standards of Review
After the Shirvanians sued them, appellees moved for summary judgment as an alternative to their special exceptions. The trial court entered one order in which it sustained the special exceptions and granted summary judgment and dismissed the case with prejudice, and the court later entered a final judgment. Ordinarily, we review a trial court's dismissal of a case upon special exceptions for an abuse of discretion. Melendez v. Exxon Corp., 998 S.W.2d 266, 273 (Tex. App.-Houston [14th Dist.] 1999, no pet.). However, "[w]hen a trial court dismisses a case upon special exceptions for failure to state a cause of action, we review that issue of law under a de novo standard." Boales v. Brighton Builders, Inc., 29 S.W.3d 159, 163 (Tex. App.-Houston [14th Dist.] 2000, pet. denied). We must accept as true all material factual allegations and all factual statements reasonably inferred from the allegations set forth in the appellants' pleadings. Id. (citing Sorokolit v. Rhodes, 889 S.W.2d 239, 240 (Tex. 1994)).
Appellees filed a traditional motion for summary judgment, and therefore had the burden to show that no genuine issue of material fact exists and that they are entitled to judgment as a matter of law. TEX. R. CIV. P. 166a(c); Nixon v. Mr. Prop. Mgmt. Co., 690 S.W.2d 546, 548 (Tex. 1985). As defendants, they must conclusively negate at least one essential element of each of the Shirvanians' causes of action or conclusively establish each element of an affirmative defense. Science Spectrum, Inc. v. Martinez, 941 S.W.2d 910, 911 (Tex. 1997). The appellees' summary judgment motion rested solely on their affirmative defenses. In deciding whether a disputed material fact issue exists precluding summary judgment on appellees' affirmative defenses, we resolve every reasonable inference in favor of the Shirvanians and take all evidence favorable to them as true. Id. at 911. Because the trial court's order does not specify the grounds upon which it relied in granting appellees' motion, we will uphold the judgment if it is properly supported on any ground by competent summary judgment evidence. Star-Telegram, Inc. v. Doe, 915 S.W.2d 471, 473 (Tex. 1995).
Relevant Factual Background
Waste Management's shares are publicly traded. As of January, 1999, the Shirvanians owned over 6.1 million shares of Waste Management stock, representing approximately 9.5% of all then-issued shares of Waste Management stock. They also owned options to purchase an additional 4 million shares. During the time period relevant to this lawsuit, Shirvanian and his sister, along with the family trusts named above, were the largest non-institutional investors in Waste Management. Shirvanian was Waste Management's single largest shareholder. Waste Management had acquired USA Waste Services, Inc., which had previously acquired Shirvanian's company, Western Waste, Inc. Both Shirvanian and Tufenkian had sat on the board of directors of USA Waste Services.
Shirvanian alleges that he decided, with the advice of financial advisors and other professionals, to diversify his stock holdings and sell shares of Waste Management, but he could not do so until 1999 because his shares were restricted. In the interim, he allegedly borrowed against his Waste Management shares and invested in other stocks, thereby incurring margin debt in excess of $100 million. Shirvanian further alleges that, after consulting with five accounting firms, he and his advisers planned to sell between 2.5 and 3 million shares of Waste Management at a rate of 50,000 to 100,000 shares per day between mid-April or early May and late June of 1999, after the sale restrictions were removed. The Shirvanians also allege that Tufenkian's trust planned to sell 20,000 shares per month during the same time frame. Tufenkian did not document her plan to sell Waste Management shares during this time period, and the parties dispute whether there is any writing reflecting
Shirvanian's intent to sell Waste Management shares. In any event, in January of 1999, Shirvanian sold approximately 150,000 of his shares at about $51.00 per share. He sold additional shares on four occasions in March, April, and May of 1999. Tufenkian sold 60,000 shares in increments of 20,000 before May of 1999.
The general substance of the Shirvanians' allegations is that in May, "out of a sense of `professional duty,'" Shirvanian informed Proto, then President and chief operating officer of Waste Management, and DeFrates, then chief financial officer, of the Shirvanians' intent to sell Waste Management shares. Shirvanian testified that he called Proto to get advice as to whether he should sell his shares because he "was very involved with Waste Management." As he explained, "Stocks I buy from outside area, I'm, basically, not that close to the situation." The Shirvanians allege that Proto and DeFrates made fraudulent misrepresentations to both Shirvanian and Tufenkian in an effort to induce them not to sell their shares. These misrepresentations allegedly were made during conversations between Shirvanian or Tufenkian, on the one hand, and Proto and DeFrates, on the other hand, (1) at a February 14, 1999 wedding reception, (2) during a telephone conversation between Shirvanian and Proto in May, (3) during a conversation between Shirvanian, Proto, and DeFrates at the Dallas, Texas airport, and (4) during at least two telephone conversations between Proto and Shirvanian after a drop in Waste Management's stock on July 7, 1999. Shirvanian purportedly relayed the content of his conversations with Proto and DeFrates to his sister. The specific alleged misrepresentations are as follows:
I. Shirvanian called Proto in May of 1999 to tell him about his intent to sell shares because they "were friends . . . knew each other . . . [and Shirvanian] trusted him [Proto], and . . . kindly took his advice. . . ." Proto urged Shirvanian not to sell, saying that Waste Management "is sound," "do not sell your stock," and "hold your shares." He also said Waste Management's earnings were "great" and synergies were "great"; the stock would be "going to $70 per share"; and that management was "holding some things back" that he could not divulge to Shirvanian. Proto said Waste Management would "meet its earnings projections" for 1999; he anticipated no surprises; and no unfavorable financial circumstances were known or about to be revealed. Proto said he was not going to sell his Waste Management shares.
II. In a telephone conversation with DeFrates, also in May, DeFrates told Shirvanian that Waste Management "will have a billion in cash flow next year," and Waste Management would have enough money to "choke a horse."
III. Also in May, at the airport in Dallas, Texas, during a conversation between Shirvanian, Proto, and DeFrates, Proto said Waste Management was "doing great"; [e]verything was "OK"; and "Waste Management is going to make its numbers, ($3.30) for first quarter 1999 and year end 1999."
IV. In a telephone conversation with Proto around the first week of May or May 8 or 9, 1999, Tufenkian asked Proto how Waste Management was doing and if the company was going to make enough money so that she could continue her charitable work, and he said, "Yes."
V. DeFrates and Proto said in separate conversations to Shirvanian, "I'm not selling my shares, and I don't think you should sell yours. . . . [I]f I was you, I would not sell my shares. . . . I would not get panicked. . . . If you can . . . keep your margins, I would try to do it; and I'm doing the same thing. I'm trying to save whatever I have. . . . [T]he company is going to do well. Why do you want to sell your shares?" Proto and DeFrates told Shirvanian not to sell because it would "hurt the company" and "it won't look good for the company for Kosti to sell shares."
VI. DeFrates and Proto told Shirvanian that "[e]verything we say is true facts and you can depend on it; we are going to make our earnings; and we are going to make our earnings next year; and if I was you, I would not sell my shares."
VII. At a February 14, 1999 wedding reception, in response to Shirvanian's query as to whether Waste Management would split its stock if it went up, Proto assured Shirvanian, with Tufenkian present, that "[w]hen the stock goes to $60, we will split the stock and Kosti is going to be a billionaire. He's going to make so much money, he wouldn't know what to do with it." Tufenkian's account of her conversation with Proto at the reception differs. She testified that Proto told her that Waste Management would "consider" splitting the stock if it went up.
VIII. Proto told Shirvanian the "company was doing great." Proto made a "personal commitment" to Shirvanian: "The company was doing great; they are going to make their earnings." DeFrates and Proto told Shirvanian "there was no reason to worry about anything else." They told Shirvanian "[w]e are going to make the 3.05. No problem. We're going to make a billion dollars a year positive cash flow."
The Shirvanians allege that as a result of the foregoing misrepresentations, they cancelled their plans to sell more Waste Management shares. In June of 1999, the Shirvanians possessed option rights to purchase up to 4 million additional shares of Waste Management stock. They allege that on June 30, 1999, certain of the options had to be exercised or they would expire. Shirvanian exercised his options to purchase 885,366 more shares of Waste Management stock for $6.8333 per share when their market value was $53.75 per share. The Shirvanians allege that DeFrates and Proto sold shares of Waste Management stock in May and June, while telling Shirvanian not to sell his shares.
Thereafter, Waste Management issued several press releases, including releases distributed on July 6, 1999, and July 29, 1999, in which the company announced that it would not meet its earnings projections and that previously announced earning expectations were wrong. On July 7, Waste Management's stock fell from $53.56 to below $33.94 per share, the largest one-day drop in share price in Waste Management's company history. The Shirvanians allege that during a telephone conversation on July 8, Proto told Shirvanian:" We missed our projections," and the market" over reacted"; we don't know why the market" reacted so badly"; the "market was unfair"; the market is "punishing us for bad information." Proto also allegedly made the following comments: (1) Waste Management's stock" should not have fallen below $45 per share" and that" everything is OK";" all will be OK"; and Waste Management's stock value" will come back." (2) Waste Management will "absolutely make its numbers";" we are sure." (3) There is "no more bad news"; everything is "behind us"; there will not be a "second shoe to fall." (4) Kosti should" not get panicky";" don't sell."
The Shirvanians allege that sometime between July 9 and July 13, 1999, Shirvanian had another telephone conversation with Proto in which Proto said Waste Management had "$45 value if liquidated today"; Waste Management stock "should go up to $50 per share"; things were "great"; and "I don't know of any more bad news." After the July 29 press release in which Waste Management further revised its earning projections downward, however, Waste Management's stock fell from $33 per share to $26 per share. All total, Waste Management's stock dropped from $59 per share to $24 per share during the summer of 1999.
The Shirvanians allege that in reliance on the above misrepresentations made by Proto and DeFrates, they lost the opportunity to sell their shares at a more favorable price and lost over $50 million. Shirvanian sold more than 3.5 million shares of Waste Management stock during the time frame of July 9, 1999, through August 13, 1999, at an average price of $22 per share. Furthermore, the Shirvanians allege they lost over $32 million relating to the stock options they exercised, due in part to tax liability on Shirvanian's exercise of the options.
Because of the drop in Waste Management's stock value, derivative and shareholder class action lawsuits were commenced against Waste Management and some of its former executives, including DeFrates and Proto. Two derivative lawsuits brought in Delaware state court were consolidated in the case styled In re Waste Management, Inc. Shareholders Derivative Litigation, C.A. No. 17313NC. That litigation was settled and the settlement approved by the Delaware Court of Chancery on September 30, 2001. Appellees contend that the release incorporated into the final judgment in that case bars the claims of the Shirvanians, who did not opt out of the Delaware settlement.
The Shirvanians filed this lawsuit on January 4, 2000, asserting causes of action for fraud and intentional misrepresentation, negligent and grossly-negligent misrepresentation, conspiracy, and damages. They seek to recover as damages the difference in the value of over 5 million shares of Waste Management stock before and after the July, 1999 decline in Waste Management's stock value.
There is one alleged factual basis for the conspiracy claim, according to Shirvanian's testimony. He alleges that when Proto, DeFrates, and Sangalis were at a meeting in Mexico during the operative time frame, "they were conspiring and doing things that was not the best of the corporate — or my benefit or any shareholder's benefit."
Appellees filed special exceptions and a motion for summary judgment. The basis for appellees' special exceptions is that the Shirvanians failed to state a cause of action because Texas does not recognize a common-law cause of action for fraud for a "holder claim" — a claim that Proto and DeFrates induced the Shirvanians to "hold" their stock rather than selling it — and this court should adopt federal securities law to bar such a claim. In their motion for summary judgment, appellees sought to prevail on any one of the following affirmative defenses:
This argument was the focus of appellees' combined special exceptions and motion for summary judgment. On appeal, appellees no longer make this argument their focal point, and instead argue that this court should only reach this argument if we conclude summary judgment was not proper. We make this note because appellees chastise the Shirvanians for focusing on the special exceptions argument. Such a contention is without merit when it is appellees who have shifted their argument on appeal.
(1) The Shirvanians lack capacity to sue because all of their claims can be brought only in the name of the corporation as a derivative action and none of the claims are personal to the Shirvanians.
(2) Because the Shirvanians seek to recover for an injury common to all Waste Management shareholders, the Shirvanians are improperly attempting to assert derivative claims barred under res judicata principles by the prior judgment entered by the Delaware court in the consolidated shareholder derivative lawsuit brought against Waste Management based on the decline of Waste Management's stock in July of 1999.
(3) The Shirvanians' claims are barred by the doctrines of unclean hands and unlawful acts because they (a) sought and attempted to trade on insider information from Proto and DeFrates and (b) allege they received fraudulent insider information.
(4) Even if their claims are direct claims, the Shirvanians' claims are barred under the doctrine of implied" conflict" preemption principles by federal securities laws that prohibit insider trading.
Appellees also argue on appeal that the trial court did not abuse its discretion in denying the Shirvanians' postjudgment motion for leave to amend to add a claim for overpayment of taxes predicated on Shirvanian's exercise of his options to purchase Waste Management stock at below-market prices because the Shirvanians' original complaint did not plead such a claim, and it also is a "holder" claim that fails as a matter of law.
Analysis
Though the parties cite extensive caselaw, they concede that the Texas Supreme Court has not addressed the seminal questions presented by this appeal. In this appeal, we must decide questions of first impression not only in Texas, but also in Delaware, whose law we must apply in determining whether the action is derivative or direct. This appeal also presents us with an unusual procedural framework because the trial court sustained special exceptions and at the same time granted a motion for summary judgment. We first address the propriety of summary judgment. Before doing so, we again note that appellees did not move for summary judgment on the basis that the Shirvanians cannot prove the elements of their claims for fraud, negligent misrepresentation, or conspiracy. Appellees moved for summary judgment on their defenses. We resolve every reasonable inference in favor of the Shirvanians and take all evidence favorable to them as true. See Science Spectrum, 941 S.W.2d at 911.
A. Summary Judgment Was Improperly Granted.
1. The Shirvanians' claims are direct, not derivative, under Delaware law.
In their second issue presented (subissues a and b), the Shirvanians assert that the trial court erred in granting summary judgment on the ground that their claims are derivative, and thus are barred by the final judgment entered in the Delaware shareholder derivative lawsuit from which the Shirvanians did not opt out. Appellees argue the Shirvanians lack capacity to sue individually because, under controlling Delaware law, the Shirvanians' claims are derivative, as they are predicated on the decline in the value of their Waste Management stock. Diminishment in share value, they claim, is an injury sustained by all Waste Management shareholders. Appellees contend that under Delaware law, the nature of the injury alleged determines whether a cause of action is derivative, not the alleged wrongful conduct. They further argue that, even if this court could consider the wrongful acts alleged by the Shirvanians, their claims would be derivative because the alleged misrepresentations made by Proto and DeFrates were statements about the financial condition of Waste Management, and therefore, the Shirvanians did not receive any information not also received by the public. They argue that misstatements to the public about a company's financial condition are actionable only in the context of derivative lawsuits and point out that the Shirvanians deny receiving "inside information" during their conversations with Waste Management executives. Appellees assert that if this court concludes the Shirvanians have direct, not derivative claims, we are creating a "fat cat" exception, allowing large shareholders with access to company executives to bring fraud claims in Texas state court when smaller shareholders likely would not have the opportunity to bring those claims. As we explain below, we disagree with appellees.
The parties agree that the law of Delaware, the place of Waste Management's incorporation, governs the issue of whether the Shirvanians' claims are direct claims against appellees or whether they are derivative from Waste Management. See TEX. BUS. CORP. ACT art. 8.02 (Vernon 2003) ("[T]he laws of the jurisdiction of incorporation . . . shall govern (i) the internal affairs of the foreign corporation . . . matters relating to its shares. . . ."). The Shirvanians contend the distinction between a direct and derivative claim under Delaware law turns on the nature of the wrong alleged and the relief sought by a plaintiff. Appellees contend the nature of the injury controls. Neither party is entirely right or wrong.
To determine whether a complaint states a derivative or an individual cause of action, courts examine the nature of the wrongs alleged in the body of the complaint, "not the plaintiff's designated or stated intention." Lipton v. News Int'l PLC, 514 A.2d 1075, 1078 (Del. 1986). The distinction between derivative and direct claims is often tenuous. Kramer v. Western Pacific Indus., Inc., 546 A.2d 348, 351-52 (Del. 1988). In Moran v. Household International, Inc., the Delaware Court of Chancery explained the distinction as follows: "To set out an individual action, the plaintiff must allege either `an injury which is separate and distinct from that suffered by other shareholders,' . . . or a wrong involving a contractual right of a shareholder, such as the right to vote, or to assert majority control, which exists independently of any right of the corporation." 490 A.2d 1059, 1070 (Del. Ch. 1985) (quoting William Meade Fletcher, 12B FLETCHER CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS § 5921 (perm.ed., rev. vol. 1984) (citation and footnote omitted)), aff'd, 500 A.2d 1346 (Del. 1985).
The Delaware Supreme Court later described the Moran formulation as a "useful guide." Lipton, 514 A.2d at 1078. The court noted, however, that Moran is not the only test for determining whether a claim is derivative or individual. "Rather, . . . we must look ultimately to whether the plaintiff has alleged `special' injury, in whatever form." Id. (emphasis added). "A special injury is established where there is a wrong suffered by [a] plaintiff that was not suffered by all stockholders generally or where the wrong involves a contractual right of the stockholders, such as the right to vote." In re Tri-Star Pictures, Inc., 634 A.2d 319, 330 (Del. 1993) (emphasis added) (citing, inter alia, Lipton, 514 A.2d at 1078); see also Grimes v. Donald, 673 A.2d 1207, 1213 (Del. 1996) ("The distinction depends upon "`the nature of the wrong alleged' and the relief, if any which could result if plaintiff were to prevail".") (quoting Kramer, 546 A.2d at 352 (quoting Elster v. American Airlines, Inc., 100 A.2d 219, 221-23 (Del. Ch. 1953)), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Furthermore, "[a] shareholder who suffers an injury peculiar to itself should be able to maintain an individual action, even though the corporation also suffers an injury from the same wrong." Lipton, 514 A.2d at 1079; see also Moran, 490 A.2d at 1070 ("Where a shareholder's complaint sets out a cause of action that is both individual and derivative, the shareholder may proceed with the individual action.") (citation omitted).
No Delaware court has resolved whether a common-law fraud claim like the one here is a direct or derivative claim, but the Delaware Supreme Court has implicitly recognized that misrepresentations may be the basis of a derivative claim or a direct action.
Delaware law also protects shareholders who receive false communications from directors even in the absence of a request for shareholder action. When the directors are not seeking shareholder action, but are deliberately misinforming shareholders about the business of the corporation, either directly or by a public statement, there is a violation of fiduciary duty. That violation may result in a derivative claim on behalf of the corporation or a cause of action for damages.
Malone v. Brincat, 722 A.2d 5, 14 (Del. 1998) (noting, without determining propriety of either characterization, that plaintiffs should be allowed to replead to assert a derivative or direct claim, on behalf of the named plaintiffs individually or on behalf of a class) (emphasis added). Other courts in Delaware also have implicitly recognized that fraud committed by an officer against a shareholder may give rise to an individual claim for damages. See Weinberger v. Lorenzo, No. 10692, 1990 WL 156529, at *3 (Del. Ch. Oct. 11, 1990) (rejecting plaintiff's direct-action theory because there were "no allegations that any class or group of . . . stockholders [were] being directly singled out and treated disparately") (cited in In re Ionosphere Clubs, Inc. v. Am. Nat'l Bank Trust Co. of Chicago, 17 F.3d 600, 605 (2d Cir. 1994) (applying Delaware law)); see also Brug v. Enstar Group, Inc., 755 F. Supp. 1247, 1257 (D. Del. 1991) (stating that plaintiffs should be allowed to amend their complaint to show that they suffered an injury distinct from that of other shareholders and that their fraudulent inducement claim could be asserted as a direct claim).
Because of the significance of Brug in the context of our discussion of Delaware law, we quote the following passages from that opinion:
Plaintiffs' Count II clearly does not assert wrongs involving their contractual rights as shareholders. Whether they have alleged an injury distinct from that suffered by other shareholders, however, is less certain. The principal harm plaintiffs have alleged is that the prices of KCI and Learning Centers stock plummeted after the revised restructuring plan was announced in September, 1989. Causes of action that allege a waste of corporate assets or a decrease in the value of stock which falls equally on all stockholders constitute claims of direct wrongs to the corporation and must be brought as derivative actions. Kramer, 546 A.2d at 353.
Apparently, plaintiffs also seek to assert that the defendants fraudulently induced them, and the members of the class they seek to represent, to purchase shares of KCI common stock. Plaintiffs allege that they and the potential class members all purchased shares between the May, 1989 announcement of the original reorganization plan and the publication of its abandonment in September, 1989. The plaintiffs' few purported allegations of fraudulent inducement, however, are vague and limited. Without more specific pleading, we cannot determine whether plaintiffs have alleged a "special injury" distinct from that suffered by other shareholders who did not purchase shares during this designated time period.
Therefore, we find that without more specific pleading demonstrating that plaintiffs have suffered a "special injury," the claim of fraud and deceit under Delaware law must be brought as a derivative action, and must therefore comply with the requirements of Delaware law for bringing such actions. We leave open the possibility, however, that plaintiffs may be able to amend their complaint to show that they have suffered an injury distinct from that of other shareholders, and that consequently this claim may be appropriately brought as a class action.
Brug, 755 F. Supp. at 1257-58 (emphasis added).
We disagree with appellees' assertion that the recent Delaware Court of Chancery opinion of Manzo v. Rite Aid holds to the contrary. The plaintiff in Manzo brought a putative class action on behalf of holders of Rite Aid stock, alleging fraudulent representations in communications made to the public or all shareholders. No. Civ. A. 18451-NC, 2002 WL 31926606, at *1 (Del. Ch. Dec. 19, 2002). She did not allege as part of her breach of fiduciary duty claim, as the Shirvanians do, that she received direct misrepresentations from directors or officers of Rite Aid. Moreover, the court in Manzo acknowledged that Malone "contemplates that intentional misrepresentations to `holders' of stock when . . . the board is not seeking shareholder action could give rise to either a direct or a derivative claim." Id. at *5. The same is true for Estate of Peterson v. Glenmede Corp., Cowin v. Bresler, Bokat v. Getty Oil, Leach v. FDIC, Crocker v. FDIC, Barsky v. Arthur Andersen, LLP, and Kramer — all cited by appellees as support for their contention that the Shirvanians' claims are derivative. Not one of those cases involved face-to-face or telephone conversations in which the defendants made material misrepresentations directly to plaintiffs or involved a cancellation of a plan to sell shares during a particular time frame because of those direct, personal misrepresentations. In contrast, the Shirvanians allege that they were told Waste Management's stock would not drop in price and would likely split; they were told that Proto and DeFrates were not selling their stock, and they were asked not to sell their shares for the good of the company.
See Bokat v. Getty Oil Co., 262 A.2d 246, 248 (Del. 1970) (claim of mismanagement and no allegation of fraud or misrepresentations); In re Oracle Corp. Deriv. Litig., 808 A.2d 1206, 1208 (Del. Ch. 2002) (plaintiffs bringing derivative action alleged corporate insiders sold stock at more favorable prices and did not disclose material information in breach of their fiduciary duties to company); Cowin v. Bresler, 741 F.2d 410, 416 (D.C. Cir. 1984) (applying Delaware law) (plaintiffs alleged claims of fraud (relating to "deceptive and incomplete reports"), mismanagement and self-dealing, all in violation of common-law fiduciary duty); Estate of Peterson v. Glenmede Corp., No. 05-95-00237-CV, 1996 WL 640594, at *1 (Tex. App.-Dallas Oct. 25, 1996, writ denied) (not designated for publication) (applying Delaware law) (plaintiff alleged fraud by defendants "conceal[ing] the pendency" of repurchase transaction and by making "false public statements"); see also Arent v. Distrib. Sciences, Inc., 975 F.2d 1370, 1372 (8th Cir. 1992) (applying Minnesota law) (plaintiffs' claims against third-party company regarding its nondisclosures); Leach v. FDIC, 860 F.2d 1266, 1272 (5th Cir. 1988) (RICO claim and claim under National Bank Act based on alleged mismanagement and nondisclosure regarding financial condition of bank); Crocker v. FDIC, 826 F.2d 347, 350-51 (5th Cir. 1987) (applying Mississippi law) (plaintiffs alleged defendants supplied false financial statements and reports to plaintiffs and general public); Barksy v. Arthur Andersen, LLP, No. H-02-1922, (S.D. Tex. Aug. 16, 2002) (order denying remand, consolidating and administratively closing action) (applying Oregon law) (plaintiff alleged stock price was artificially inflated because of financial improprieties; suit involved stock options that plaintiff claimed he was induced to exercise; "the gravamen of Barsky's case, and of the claims of Enron shareholders and option holders generally, is the diminished value of Enron stock").
Appellees' only real argument is that their claims must be derivative because the Shirvanians seek damages based on diminishment in the value of the shares they were going to sell — which is the same type of damages in the derivative suit against Waste Management. However, the measure of damages alone does not dictate whether a fraud claim is direct or derivative. A corporate officer's fraud has been recognized as the basis for a shareholder's direct claim for damages. For example, a leading commentator, often cited by Delaware courts when addressing whether a claim is direct or derivative, has recognized that fraud may give rise to a shareholder's individual cause of action for damages. See 12B Fletcher Cyclopedia CORP. § 5911 (perm. ed., rev. vol. 2000) ("If the injury is one to the plaintiff . . . shareholder as an individual, and not to the corporation, as where the action is based on a contract to which the shareholder is a party, or on a right belonging severally to the shareholder, or on a fraud affecting the shareholder directly . . . it is an individual action.") (emphasis added).
As noted above, the fact that other shareholders also suffered an injury during the relevant time period does not preclude the Shirvanians from having a direct claim based on a distinct injury or wrong suffered by them. See Lipton, 514 A.2d at 1079. Likewise, the fact that some of the Shirvanians' factual allegations could give rise to derivative claims, such as mismanagement or breach of fiduciary duty based on insider trading, does not dictate that their claims for fraud, misrepresentation, and conspiracy are derivative when they allege that Proto and DeFrates knowingly made specific misrepresentations. See Moran, 490 A.2d at 1070 ("Where a shareholder's complaint sets out a cause of action that is both individual and derivative, the shareholder may proceed with the individual action.") (citation omitted).
After reviewing many cases and commentaries like the one above, we conclude that the Shirvanians' claims are direct, not derivative. We do not reach this result without careful consideration. Every commentator and jurist we have read has acknowledged that the rule differentiating between direct and derivative claims is easy to state and hard to apply. We agree. And it is especially difficult to apply in this case, which involves diminishment in share value — damages shareholders typically recover in a derivative suit. That is the biggest hurdle we see with the Shirvanians' claims. But, having acknowledged that, this case also is unlike any other we have reviewed. There is no Delaware case like this one; at least we have not found and the parties have not cited one. Thus, although the Shirvanians' ultimate damages may resemble damages suffered by all shareholders, they are personal; the origin and method of infliction of the injury are very different from every other shareholder's claimed injury.
We note our agreement with appellees that the Shirvanians' petition did not sufficiently plead that they suffered injury in their capacity as buyers of Waste Management stock based on their exercise of options to purchase additional Waste Management shares. See Pls.' Orig. Pet. ¶¶ 46-47 ("Proto, DeFrates, Sangalis, and Waste Management intended to induce Kosti and the Family Trusts to rely on their statements and omissions and thus not sell their shares of Waste Management. . . . Kosti and the Family Trusts had no actual knowledge that statements made by Proto, DeFrates, Sangalis, and Waste Management were false. Had Proto, DeFrates, Sangalis, and Waste Management not made such misrepresentations, Kosti and the Family Trusts would have sold a substantial number of shares in Waste Management."). Their claims are clearly "holder" claims.
The Shirvanians got into this mess because they were very unusual shareholders; they owned a bigger piece of the pie than the other individual shareholders. And they claim that because they owned a bigger piece of the pie, and literally started part of the company, they felt they owed a duty to inform the company's officers that they would be selling large quantities of stock to diversify their stock portfolios. They allege in their pleadings that this started DeFrates's and Proto's "full-court press" to keep them from selling. No other shareholder had this direct interaction. In fact, taking the reasonable assumptions from the pleadings, the officers would not have cared if other, minor shareholders sold their shares. It was precisely because the Shirvanians were special — by owning a large piece of the business — and therefore had a special relationship with the officers, that they allege the officers wanted, and were able, to deceive them. As the Shirvanians allege in their brief on appeal, their common-law claims are personal to them. The implication from the pleadings is that if the officers had treated the Shirvanians like any other shareholder, and simply had let them rely on the public materials, the Shirvanians would have continued selling their stock, just as they were doing when they first approached the officers. In that instance, they would have been relying on general information about the company. But, because they were unlike every other shareholder, they claim the officers felt compelled to deceive them. And so, Proto and DeFrates made repeated false statements about their own intent to sell their shares and asked Shirvanian (and Tufenkian) not to sell their shares, in part for the good of the company, in part for their own financial good. This plan of action would not fall proportionately on all the shareholders; it would fall disproportionately, allegedly only on the Shirvanians and Tufenkian.
The Shirvanians have pleaded with particularity the deception and fraud that caused them to act differently than they would have, but for the officers' alleged misrepresentations. They are not alleging that DeFrates and Proto only told them general information about the financial condition of the company. To the contrary, they contend Proto and DeFrates made repeated false statements about their own intent to sell their shares and asked Shirvanian (and Tufenkian) not to sell their shares. Their allegations and their claims are qualitatively different than those in cases cited by appellees where the basis for the fraud claims are financial statements, annual reports, SEC filings or similar public communications. In those cases, in the absence of direct misrepresentations, plaintiffs often are not able to establish the requisite elements of their fraud claim.
We later address appellees' arguments regarding whether the doctrines of unclean hands and unclean acts or federal securities insider trading laws bar the Shirvanians' claims because of the nature of the misrepresentations alleged. See infra A.3 and A.4.
By reaching this conclusion, we do not believe that the floodgates will open or that we are making an unfair "fat cat" exception. A claim like the Shirvanians is unusual — witness our inability to locate another suit like this. In spite of the recent spate of corporate lapses, the great majority of corporate officers are acting for the good of the company and not for the bad. So, not often will a corporate officer make fraudulent statements and misrepresentations directly to a shareholder to convince him to hold his stock. And this leads us to the "fat cat" argument made by appellees throughout their briefing on appeal. Shirvanian and Tufenkian were targeted (if their allegations are true) precisely because they were "fat cats" — "it won't look good for the company if [you] sell shares," "it will hurt the company." Shirvanian and Tufenkian were singled out and treated disparately. DeFrates and Proto engaged in a concerted effort, directly aimed at Shirvanian and Tufenkian. The other shareholders were not privy to this alleged fraudulent treatment. Having been treated differently from the other shareholders, having been singled out, they incurred a special injury, and we can find no legal reason under Delaware law not to allow them to sue.
Thus, resolving every reasonable inference in favor of the Shirvanians and taking all evidence favorable to them as true, we agree that summary judgment was improper on the ground that their claims were derivative. Accordingly, we sustain the Shirvanians' issue 2(a).
2. Because the Shirvanians' claims are direct, their claims were not released in In re Waste Management, Inc. Shareholders Derivative Litigation.
In light of our conclusion that the Shirvanians' claims are direct claims, the Shirvanians are not barred from asserting those claims because of the release executed in the consolidated shareholder derivative lawsuit filed in Delaware on behalf of all Waste Management shareholders. Although the release, incorporated into the "Order and Final Judgment" of September 20, 2001, is broad, we need not decide whether the Shirvanians' claims fall within the scope of the release because it specifically carves out direct claims:
5. Nothing in this Release shall be deemed to bar any claim asserted against the Company by any present or former WMI shareholder seeking a direct recovery on his or her own behalf (or on behalf of others similarly situated), as opposed to a derivative recovery on behalf of the Company.
Resolving every reasonable inference in favor of the Shirvanians and taking all evidence favorable to them as true, summary judgment for appellees on the ground that the Shirvanians' claims were released in the Delaware derivative shareholder action was improper. Accordingly, we sustain the Shirvanians' issue 2(b).
Because of our resolution of this subissue, we need not address the Shirvanians' argument that appellees' res judicata argument lacks merit because they failed to offer pleadings from the prior derivative action as summary judgment evidence.
3. The Shirvanians' common-law fraud claims are not impliedly preempted by federal securities laws prohibiting insider trading.
The Shirvanians also argue in their second issue presented (subissue d) that summary judgment for appellees was improper on the ground that the Shirvanians' claims are impliedly preempted by federal securities laws. Appellees argue that the Shirvanians' claims are predicated on the notion that Proto and DeFrates had a duty to tell Shirvanian insider information about Waste Management. Thus, they argue that the Shirvanians' claims are impliedly preempted because any such duty to tell Shirvanian the truth would conflict with federal securities laws.
Federal preemption of state law may occur expressly or impliedly. See, e.g., La. Pub. Serv. Comm'n v. FCC, 476 U.S. 355, 368-69 (1986); Am. Cyanamid Co. v. Geye, 79 S.W.3d 21, 23-24 (Tex. 2003). Implied preemption applies where (a) "it is impossible for a private party to comply with both state and federal law," or (b) "under the circumstances of [a] particular case, [the challenged state law] stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress." Crosby v. Nat'l Foreign Trade Council, 530 U.S. 363, 372-73 (2000) (citations omitted).
The only opinion cited by appellees to support their implied preemption argument is Chanoff v. United States Surgical Corp., 857 F. Supp. 1011 (D. Conn. 1994), aff'd, 31 F.3d 66 (2d Cir. 1994), cert. denied, 513 U.S. 1058 (1994). In Chanoff, the plaintiffs asserted a holding claim and alleged that certain defendants had misled investors generally, and that one of the defendants "specifically misled" Mr. Chanoff "through false and misleading statements made to him in personal letters and telephone conversations." Id. at 1014. The plaintiffs alleged that, in reliance on the misrepresentations, they refrained from selling their stock, which subsequently lost much of its value. Id. at 1014-15. The court concluded that, to the extent the plaintiffs' claims were based on the defendants' duty to disclose information to Mr. Chanoff in personal exchanges, the claims were preempted by federal securities laws prohibiting such selective disclosures. Id. at 1016.
Chanoff appears to be alone in applying implied preemption to a holding claim based on direct misrepresentations. But see Crocker, 826 F.2d at 352 n. 6 (stating in dicta that if plaintiffs had received concealed material information and sold their stock for a profit before the public was made aware of the defendant bank's failing condition, such a profit would have resulted from insider trading in violation of the securities laws). The Shirvanians correctly note that there was no allegation in Chanoff that the plaintiffs had a plan to sell stock, that the defendants affirmatively advised the plaintiffs not to sell shares, or affirmatively misrepresented their own intent to sell. The same is true for Crocker.
We are not persuaded that we should adopt the reasoning of one federal district court and hold that the Shirvanians' claims are impliedly preempted under state law. The Supreme Court's decision in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), reflects an intent not to usurp the powers of states to hear common-law fraud claims merely because those claims are asserted in the securities context. One commentator has noted the problem with arguing that implied preemption should be applied to all holding claims:
We discuss Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), and its holding that only purchasers and sellers of securities can seek to recover for damages for fraud under federal securities laws in more detail in section B below.
If the survival of holding claims serves to undermine the Reform Act [1995 Private Securities Litigation Reform Act] in an intolerable way, Congress can respond, much as it did with the passage of the SLUSA [Securities Litigation Uniform Standards Act of 1988] itself, and correct the oversight. Some scholars have argued for precisely this; others have gone so far as to suggest that courts should fill the gap themselves by applying the judicial doctrine of `implied preemption.' Neither course is wise. The Supreme Court's decision in Blue Chips to limit the scope of federal securities fraud liability to market participants who either bought or sold securities, and so to leave to the states the task of policing misrepresentations between corporations and non-transacting shareholders, maintained the proper division of power between state and federal law in the securities field. It follows that this division should not now be upset through federal pre-emption.
. . . .
. . . Were the federal government to pre-empt such claims, it would represent a much more serious usurpation of state power over matters of corporate governance. Not only would such pre-emption do violence to the federal system by preventing opportunity for healthy interjurisdictional competition, but it would do so without significant corresponding efficiency gains.
. . . .
. . . [P]re-emption would prohibit not only holding claims based on forward-looking statements, but also holding claims based on purely factual misrepresentations.
Amanda M. Rose, LIFE AFTER SLUSA: WHAT IS THE FATE OF HOLDING CLAIMS? The Pre-emptive Force of the 1998 Legislation should not Upset the Long-Held Balance in the U.S. Federal System by Trumping all State Actions, 69 DEF. COUNSEL J. 455, 460 (2002).
In any event, even if we were to hold that a plaintiff's conduct in seeking "inside" information could bar a fraud claim in Texas, reviewing the evidence in this case in a light most favorable to the Shirvanians, we conclude that not all of their communications with Proto and DeFrates involved material, nonpublic information, or "inside" information. Statements made by Proto and DeFrates asking Shirvanian and his sister to refrain from implementing their plans to sell shares of Waste Management stock, as well as Proto's and DeFrates's statements that they were not selling their own shares, do not reveal inside information because that information is not material, nonpublic information about Waste Management. See generally United States v. O'Hagan, 521 U.S. 642, 651-52 (1997) ("Under the `traditional' or `classical theory' of insider trading liability, § 10(b) and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information."). Thus, at a minimum, there remains a fact question for the jury to decide the nature of the representations made by Proto and DeFrates and whether those statements were relied upon by the Shirvanians. Accordingly, we sustain the Shirvanians' issue 2(d).
4. The Shirvanians' claims are not barred by the equitable doctrines of unclean hands or unlawful acts.
In subissue c of their second issue presented, the Shirvanians contend the trial court erred in granting summary judgment in favor of appellees on the ground that their claims are barred by the equitable doctrines of unclean hands or unlawful acts. Similar to appellees' implied preemption argument, appellees contend that because the Shirvanians sought and/or received inside information, they cannot recover on their common-law claims under these equitable doctrines.
Our research leads us to conclude that the separation between law and equity still stands, at least as applied to the doctrine of unclean hands. As a result, this doctrine does not apply to a damages action. "`The maxim that he who comes into equity must come with clean hands is strictly an equitable doctrine, and does not apply in a suit that is not an equitable proceeding.'" Steubner Realty 19, Ltd. v. Cravens Road 88, Ltd., 817 S.W.2d 160, 164 (Tex. App.-Houston [14th Dist.] 1991, no writ) (quoting Ligon v. E.F. Hutton Co., 428 S.W.2d 434, 437 (Tex. App.-Dallas 1968, writ ref'd n.r.e.)); see also McMahan v. Greenwood, 108 S.W.3d 467, 494 (Tex. App.-Houston [14th Dist.] 2003, pet. denied) (citing Steubner Realty 19, Ltd. for same proposition). The only exception is in a case where a party has raised the defense of estoppel. Steubner Realty 19, Ltd., 817 S.W.2d at 437. We do not agree with appellees that State Farm Fire and Casualty Co. v. Gandy, 925 S.W.2d 696, 706 (Tex. 1995), supports a contrary holding merely because of that opinion's reference to the merger of law and equity in Texas. Thus, we conclude appellees' unclean hands defense fails as a matter of law.
We also note, however, that even if appellees could rely on the doctrine of unclean hands, they still would not prevail. We have already held that many of the statements about which the Shirvanians complain do not constitute inside information; the doctrine of unclean hands simply would not apply to those statements.
We also disagree with appellees' contention that they have shown harm, a prerequisite to the application of the unclean hands doctrine. See Willis v. Donnelly, 118 S.W.3d 10, 38 (Tex. App.-Houston 2003, no pet.) ("[A] party complaining of an opponent's unclean hands must show that he himself has been injured by such conduct to justify the application of the principle to the case.") (internal quotation marks omitted). Jackson Law Office, P.C. v. Chappell, 37 S.W.3d 15 (Tex. App.-Tyler 2000, pet. denied), cited by appellees, is distinguishable because of its unusual facts. Id. at 27 (involving attorney and setting aside of fraudulent transfer). No Texas court has held that the filing of the lawsuit in which the unclean hands defense is raised is sufficient to show harm to the party asserting the defense. If we accepted that premise, every defendant would be able to show harm. Even assuming the Shirvanians sought or received inside information, appellees have not shown that they were harmed by that conduct. To the contrary, the Shirvanians allege that they were asked not to sell their shares because it would hurt the company, meaning that it presumably would hurt the company's share value if they sold such large numbers of their shares. Accepting the Shirvanians' allegations as true, it is fair to surmise that Waste Management, Proto, and DeFrates (both of whom sold shares before the July press releases issued by Waste Management) benefitted from the Shirvanians not selling their shares at the time when they planned to do so.
We also agree with the Shirvanians that the unlawful acts doctrine, first articulated in Gulf, Colorado Santa Fe Railway Co. v. Johnson, 71 Tex. 619, 9 S.W. 602, 603 (1888), does not apply to their claims. "In more recent cases, the unlawful acts doctrine and public policy of this state have been defined in such a manner that recovery is barred when the claimant has knowingly and willfully engaged in criminal acts which contributed to the injury alleged to have accrued." Gladu v. Wallace, No. 11-02-00211-CV, 2003 WL 2010946, at *2 (Tex. App.-Eastland May 01, 2003, no pet.) (not designated for publication). Our review of the cases where that doctrine has been applied indicates that they have involved knowing and willful violations of state criminal law. See, e.g., Ward v. Emmett, 37 S.W.3d 500, 503 (Tex. App.-San Antonio 2001, no pet.) (affirming summary judgment for defendants because plaintiff's claims for damages arose from murder she committed); Saks v. Sawtelle, Goode, Davidson Troilo, 880 S.W.2d 466, 470-71 (Tex. App.-San Antonio 1994, writ den'd) (affirming summary judgment in favor of law firms and attorneys who had advised plaintiffs on loan transaction because plaintiffs were convicted of scheme to defraud a federally chartered or insured financial institution); Dover v. Baker, Brown, Sharman Parker, 859 S.W.2d 441, 450 (Tex. App.-Houston [1st Dist.] 1993, no writ) (affirming summary judgment against Dover because his claims for damages resulted from illegal business transactions in which he knowingly and wilfully participated). No Texas court has held that insider trading, as defined by federal securities laws (or attempted insider trading), is an unlawful act precluding recovery on common-law fraud and misrepresentation claims against a corporation and its officers.
And again, construing the evidence in a light most favorable to the Shirvanians, some of the alleged misrepresentations do not contain inside information. A jury may determine later that the misrepresentations the Shirvanians relied on were the product of inside information, but that is a question for the jury, not for this court on summary judgment review. In short, based on our review of the pertinent Texas caselaw discussing the unlawful acts doctrine, it does not apply to the Shirvanians' claims. The trial court improperly granted summary judgment on the basis of these defenses, and thus, we sustain the Shirvanians' issue 2(c).
We do not look to federal authority discussing the in pari delicto doctrine's availability as between a tippee and tipper in a federal securities fraud case because that authority is not persuasive, as the doctrine is dissimilar to the unclean hands and unlawful acts doctrines in Texas. See Am. Nat'l Bank Trust Co. of Chicago v. Levy, 404 N.E.2d 946, 948 (Ill.App. Ct. 1980) (distinguishing Kuehnert as inapplicable to claim for breach of contract to pay brokerage commission because Kuehnert did not involve common-law action and instead involved federal securities laws and "the public policy aims of that legislation").
Because of our disposition of each of these issues — which, again, relate to the summary judgment the trial court granted against the Shirvanians and in favor of appellees' affirmative defenses — we conclude that summary judgment was improperly granted in favor of appellees. We therefore reverse that judgment. We now turn our attention to whether the trial court properly sustained appellees' special exceptions.
B. Special Exceptions Were Improperly Sustained.
The basis for appellees' special exceptions was that the Shirvanians failed to state a cause of action because the Texas Supreme Court has not recognized a common-law fraud cause of action predicated on holding stock. Appellees largely rely on Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), for its holding that only purchasers and sellers of securities can seek to recover for damages for fraud under federal securities laws. Before discussing Blue Chip Stamps, we first lay down the framework for common-law fraud claims in Texas.
Neither party argues for the application of another state's law to the question of whether the Shirvanians' claims — holding claims — are cognizable in Texas. Except for the application of Delaware law to resolve whether the Shirvanians' claims are direct or derivative, we apply Texas law to the other issues raised in this appeal.
To prevail on a fraud claim in Texas, a plaintiff must prove (1) the defendant made a material misrepresentation that was false, (2) knew the representation was false or made it recklessly as a positive assertion without any knowledge of its truth, (3) intended to induce the plaintiff to act upon the representation, and (4) the plaintiff actually and justifiably relied upon the representation and thereby suffered injury. Ernst Young v. Pacific Mut. Life Ins. Co., 51 S.W.3d 573, 577 (Tex. 2001). It is generally recognized that a claim of fraud is cognizable in Texas if the misrepresentation induces inaction — refraining from taking some planned action — on the plaintiff's part. See, e.g., TCA Bldg. Co. v. Entech, Inc., 86 S.W.3d 667, 674 (Tex. App.-Austin 2002, no pet.) ("An essential element of a common-law fraud action is a plaintiff's reasonable or justifiable reliance upon the defendant's alleged misrepresentation, which reliance induced action or inaction on the plaintiff's part and caused him pecuniary loss."). See generally Burroughs v. APS Int'l, Ltd., 93 S.W.3d 155, 162 (Tex. App.-Houston [14th Dist.] 2002, pet. denied) ("One who makes a fraudulent misrepresentation may be liable to a third person, to whom the misrepresentation was not directly made, if the person making the misrepresentation had intent or knowledge that it should be exhibited or repeated to a third person and intended or had reason to expect the third person would act or refrain from acting in reliance upon the misrepresentation.") (citing, inter alia, Texas Capital Sec., Inc. v. J.D. Sandefer, III, 58 S.W.3d 760, 772 (Tex. App.-Houston [1st Dist.] 2001, pet. denied) (quoting RESTATEMENT (SECOND) OF TORTS § 531 (1976))).
Because of our disposition of the trial court's grant of summary judgment in favor of appellees on the Shirvanians' fraud claim, we need not discuss the elements of claims of intentional and negligent misrepresentation in Texas.
The parties have each cited us to Texas cases they argue control our decision. See Haase v. Glazner, 62 S.W.3d 795 (Tex. 2001); Texas Capital, 58 S.W.3d at 760. However, neither case is on point. One of the cases does not involve a holding claim; instead, it involves alleged fraud and fraudulent inducement arising out of a contract. See Haase, 62 S.W.3d at 796-98 (considering whether a party could maintain a claim for fraud or fraudulent inducement when the basis of the claim was a contract unenforceable under the Statute of Frauds; holding plaintiff cannot assert a fraudulent inducement claim in the absence of a contract). The second case involved statements made to shareholders, and contained postpurchase evidence similar to what we have here, but neither the parties nor the court treated it as a holding claim. See Texas Capital, 58 S.W.2d at 772-73 (deciding whether sufficient evidence of pre- and post-purchase reliance existed concerning stock broker's statements made to shareholders about the health of the company).
Because no Texas court has addressed this question, we have looked to authority from other jurisdictions. This authority has endeavored to determine whether holder claims can be asserted as common-law fraud claims in state court. A federal district court sitting in Texas has implicitly recognized that holding claims may be cognizable under Texas law. In Gutierrez v. Deloitte Touche, L.L.P., 147 F. Supp.2d 584 (W.D. Tex. 2001), the court held that the plaintiffs' Texas common-law claim that they were fraudulently induced to hold stock did not state a cause of action for misrepresentations made "in connection with the sale or purchase" of a security, and thus, the plaintiffs' lawsuit was not properly removed to federal court under the SLUSA. Id. at 594. The court addressed the defendants' argument that the court should disagree with other court decisions dismissing or remanding cases to state court where plaintiffs' claims related to holding securities, not the purchase or sale of covered securities as required by the SLUSA. Id. In declining to disagree with those decisions, the court noted that Blue Chip Stamps expressly stated that holding claims could be asserted under state law. Id.
The Court in Blue Chip Stamps held that claims brought on behalf of persons who claimed they were defrauded into not purchasing a stock were not covered under section 10b of the Securities Exchange Act of 1934. In so holding, the Court noted "[o]bviously this disadvantage is attenuated to the extent that remedies are available to nonpurchasers and nonsellers under state law." As with section 78bb(f) of the SLUSA, the 1934 Act made it unlawful to use deceptive devices or make misleading statements "in connection with the purchase or sale of any [covered] security." Blue Chip Stamps does seem to support plaintiffs' position that persons who were allegedly defrauded into continuing to hold a stock (nonsellers or holders) may state valid claims under state theories of recovery without running afoul of federal securities law.
Id. (quoting Blue Chip Stamps, 421 U.S. at 725, 728, 738 n. 9, 738-39).
In an opinion issued earlier this year, the California Supreme Court is the most recent court to address this issue; it responded to many of the same arguments raised by appellees in this case. In Small v. Fritz Companies, Inc., 65 P.3d 1255 (Cal. 2003), shareholders sued a corporation and its officers, alleging that they disseminated a fraudulent quarterly financial report that overreported earnings and profits. Id. at 1256. The only question for the court to decide was whether the "tort of common law fraud (including negligent misrepresentation) [should] be expanded to permit suits by those who claim that alleged misstatements by defendants induced them not to buy and sell securities." Id. The court concluded that California should allow a holder's action for fraud or negligent misrepresentation. Id. at 1257. The court reasoned that such a holding was consistent with California law allowing a cause of action for fraud if the effect of the misrepresentation is to induce forbearance. Id.
We are not persuaded to create an exception to this rule when the forbearance is to refrain from selling stock. This conclusion does not expand the tort of common law fraud, but simply applies long-established legal principles to the factual setting of misrepresentations that induce stockholders to hold onto their stock.
Id. In reaching this conclusion, the court relied on sections 525, 531, and 551 of the Restatement (Second) of Torts, as well as authority from other states. Id. at 1259. "Most other states that have confronted this issue have concluded that forbearance from selling stock is sufficient reliance to support a cause of action." Id. (citing, inter alia, Gutman v. Howard Sav. Bank, 748 F. Supp. 254 (D.N.J. 1990); David v. Belmont, 197 N.E. 93 (Mass. 1935); Fottler v. Moseley, 60 N.E. 788 (Mass. 1901); Smith v. Duffy, 32 A. 371 (N.J. 1895); Continental Ins. Co. v. Mercadante, 225 N.Y.S. 488 (1927)). One fact distinguishing Fritz from the case at hand, and making this case even stronger for the proposition that a holder's action should be recognized in Texas, is that the misrepresentations at issue in Fritz were public statements, not misrepresentations made directly to a specific shareholder. The significance of this fact was not lost on the California Supreme Court: "Neither do they [defendants] dispute that forbearance would be sufficient reliance if a stockholder were induced to refrain from selling his stock by a face-to-face conversation with a corporate officer or director." Id.
The court discussed Blue Chip Stamps and that decision's recognition that the policy considerations favoring the prohibition of a holder's action under the 1934 Act do not preclude state-law remedies: "In short, the high court's decision in Blue Chip Stamps, while recognizing policy considerations similar to those defendants advance here, did not view those considerations as justification for a total denial of relief to defrauded holders; it reasoned only that the federal courts could deny a forum to wronged stockholders who are not sellers or buyers without unjust consequences because these stockholders retained a remedy in state courts." Id. at 1261. In response to the defendants' argument that a decision allowing holder's actions to be asserted under state law would open the door to frivolous litigation, the court noted (1) that it was confronted with a more limited group of owners of stock who relied on false representations in not selling their stock (as opposed to persons alleging they did not buy stock based on some misrepresentation), and (2) that a general demurrer assures a plaintiff pleads fraud with specificity, mitigating against meritless lawsuits. Id. at 1264. "Plaintiffs who cannot plead with sufficient specificity to show a bona fide claim of actual reliance do not stand out from the mass of stockholders who rely on the market." Id. at 1266.
The California Supreme Court is not alone in deciding that a holder's action should be recognized under state law, as evidenced by its recitation of cases from other states recognizing holding claims. See Gutman, 748 F. Supp. at 263 (applying New York and New Jersey law) ("The Court concludes that, under New York law, a plaintiff may state a common law fraud claim against a defendant whose misrepresentations caused plaintiff to hold securities which plaintiff otherwise would have sold."). In addition to Gutierrez, other federal district courts dealing with holding claims removed from state court under the SLUSA have held that such actions must be remanded to state court because holding claims do not come within the literal wording of the SLUSA, as they do not allege fraud in connection with the "purchase or sale of a covered security." See Gordon v. Buntrock, No. 00-CV-303, 2000 WL 556763, at *4 (N.D. Ill. 2000) ("In enacting the [SLUSA], Congress was aware of the interpretation of § 10b of the 1934 Act, which acknowledged that causes of actions for the `nonpurchase' or `nonsale' of securities were not covered by the 1934 Act, and that state law would fill those gaps. Congress could have expanded the scope of actions covered by the [SLUSA] by providing that actions alleging misrepresentations in connection with the failure to purchase or sell a covered security also shall be removable to federal court."); Lalondriz v. USA Networks, Inc., 54 F. Supp.2d 352 (S.D.N.Y. 1999) (applying Delaware law) (stating that holding claim class action based on breach of fiduciary duty of disclosure was not removable under SLUSA), aff'd on reconsid., 68 F. Supp.2d 285 (S.D.N.Y. 1999). These cases, like Blue Chip Stamps, recognize that state courts are the proper forum for the assertion of certain securities fraud claims, including holding claims.
The Gutman court's discussion of Blue Chip Stamps is particularly instructive.
The Supreme Court considered the typical fraud context to be [one] in which the parties knew each other and the alleged misrepresentations occurred through direct communications. In contrast, privity or even personal contact between the parties is rare in the securities market, and generally corporate representations reach "the readership of the daily newspapers. . . ."
One critical feature of the present case is generally absent from the securities market as described in Blue Chip Stamps. Plaintiffs had direct dealings with defendants in which the latter made certain of the representations complained of. . . . This case is, therefore, an "ordinary case of deceit" as characterized by the Supreme Court in that defendants made representations directly to plaintiffs. Such a case could not be brought by anyone who happened to own Howard stock at any time from April to December of 1989.
Gutman, 748 F. Supp. at 265-66 (citations omitted).
That same distinction applies in this case. This is an "ordinary case of deceit" based on direct misrepresentations, and our holding is limited to this narrow setting. In addition, we agree that Blue Chip Stamps does not preclude state law relief for holder's actions. And, we agree that the policy considerations raised in Blue Chip Stamps, and advanced by appellees, are not sufficient to shut the door to the Texas courts for plaintiffs with valid fraud claims. As stated by the California Supreme Court in Fritz: "We recognize the importance of the policy considerations defendants advance, but although those considerations may justify placing limitations on a holder's cause of action, they do not justify a categorical denial of that cause of action." Fritz, 65 P.3d at 1260. Our civil procedure rules in Texas and procedural vehicles, such as special exceptions and summary judgment motions, will allow defendants to challenge plaintiffs who do not properly plead or prove the requisite elements of a fraud claim predicated on holding stock.
As the Shirvanians note, the relevant federal (Securities and Exchange Act of 1934) and Texas securities fraud (The Securities Act) statutory schemes state that they are not the only remedies available to shareholders. See 15 U.S.C. § 78bb(a) ("The rights and remedies provided by this [Act of 1934] shall be in addition to any and all other rights and remedies that may exist at law or in equity."); TEX. REV. CIV. STAT. art. 581-33(M) ("The rights and remedies provided by this Act are in addition to any other rights . . . or remedies that may exist at law or in equity"); see also Marine Bank v. Weaver, 455 U.S. 551, 556 (1982) ("We are satisfied that Congress, in enacting the securities laws, did not intend to provide a broad federal remedy for all fraud.").
To the extent that many of appellees' arguments concern the proper measure of damages, an issue discussed in several concurring opinions to the Fritz opinion, see 65 P.3d at 1266, 1271, as in Fritz, that issue is not before us, and we thus will not opine as to the proper measure of damages in this case.
Crocker, cited by appellees in support of their argument that Texas courts should not recognize a holder's claim of fraud, is not persuasive. The plaintiffs in Crocker did not contend that any member of the putative class "desired specifically to sell their stock at a given point, but were deterred from effectuating a sale because of the misrepresentations." Crocker, 826 F.2d at 351 ("The claim is only that if they had known that the Bank was failing, they would have made every effort to rid themselves of the stock. We find this claim too speculative to state any injury to the shareholders, apart from a diminution in the value of their stock."). In contrast, the Shirvanians allege they had a specific plan to sell their shares at a date certain, an allegation we must accept as true for purposes of our review of the trial court's grant of summary judgment. Crocker appears to represent the minority view with respect to holding claims.
Although we are sensitive to the notion that Texas should not be a forum for "strike suits" brought by any person who claims he would have bought or sold shares based on information withheld by corporate officers, that is not the case here, and we decide, under the facts of this case, only whether a holding claim is cognizable in Texas. We disagree with appellees, however, that allowing plaintiffs to assert holding claims in Texas state court will make Texas an "attractive haven for complete bystanders who, given the flaws in their claims, have long been denied relief in federal courts." This type of holding claim will always have a very narrow pool of plaintiffs. We are not dealing with "complete bystanders." The Shirvanians were the largest individual shareholders of Waste Management. Our holding is simply that special exceptions should not have been sustained because the Shirvanians sufficiently pleaded the elements of their fraud claim under well-established Texas jurisprudence. They alleged direct, face-to-face or telephone misrepresentations made for the purpose of inducing them not to implement their plans to sell some of their Waste Management shares. A jury may very well decide there was no plan to sell shares or that the fraudulent misrepresentations were not made, but, again, those are questions for the fact finder to answer. In conducting our review, we must accept as true all material factual allegations and all factual statements reasonably inferred from the allegations set forth in appellants' pleadings. See Boales, 29 S.W.3d at 163. Accordingly, we sustain the Shirvanians' first issue.
Conclusion
Because we conclude that the Shirvanians' claims are direct, not derivative, claims under Delaware law, are not barred by a release executed in the derivative lawsuit brought in Delaware state court by Waste Management shareholders, are not impliedly preempted, and are not barred by the doctrines of unclean hands or unclean acts, and that holding claims such as the Shirvanians' are cognizable under Texas law, we reverse the trial court's order sustaining appellees' special exceptions and granting summary judgment in their favor. Because of our reversal of both of those rulings, we need not address the Shirvanians' third and fourth issues regarding the scope of the trial court's judgment and denial of their postjudgment motion to amend their pleadings.
We reverse and remand this matter to the trial court for further proceedings consistent with this opinion.