Securities Law - Illinois Securities Law

Can holders of securities seek damages based on a claim that they retained a stock in a corporation based on a fraudulent financial report?

Murphy Finance Corp. was a consumer finance company engaged in the purchasing of individual installment sales contracts from automobile dealers. KPMG was the accounting firm that audited the Mercury reports. In 1997, Mercury publicly reported that the financial reports from 1993 to 1996 had been overstated due to accounting errors. The New York Stock Exchange suspended trading and the Mercury stock dropped from $14.87 to $2.12 per share.

Plaintiffs filed a class action against Mercury’s chief executive officers and directors and KPMG alleging negligence, breach of duty and common law fraud. Mercury was later dismissed and filed for bankruptcy protection. The trial court eventually dismissed plaintiff’s fourth amended complaint on the ground that plaintiff could not allege any damage that was approximately caused by KPMG’s misrepresentations.
The Appellate Court in the case of Dloogathi and others similarly situated v. KPMG, et al., No. 1-08-0168, decided December 16, 2009, stated initially that no court in Illinois had decided whether holders of securities even have a cognizable claim based on common law fraud.

The U.S. Supreme Court considered whether a private cause of action exists for holders alleging violations of SEC Rule 10b-5, where they have neither purchased nor sold any shares. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). The Supreme Court in Blue Chip refused to recognize such a claim. The Appellate Court stated that although Blue Chip Stamps concerns the viability of a holder claim for violations of federal law and not common law fraud, the United States Supreme Court’s reasoning for prohibiting such a cause of action is relevant to the present case. In Blue Chip Stamps the Supreme Court stated in part:

“The manner in which the defendant’s violation caused the plaintiff to fail to act could be as a result of the reading of a prospectus, as respondent claims here, but it could just as easily come as a result of a claimed reading of information contained in the financial pages of a local newspaper. Plaintiff’s proof would not be that he purchased or sold stock, a fact which would be capable of documentary verification in most situations, but instead that he decided not to purchase or sell stock. Plaintiff’s entire testimony could be dependent upon uncorroborated oral evidence of many of the crucial elements of his claim, and still be sufficient to go to the jury.

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The very risk in permitting those in respondent’s position to sue under Rule 10b-5 is that the door will be open to recovery of substantial damages on the part of one who offers only his own testimony to prove that he ever consulted a prospectus of the issuer, that he paid any attention to it, or that the representations contained in it damaged him.” Blue Chip Stamps, 421 U.S. at 746 (1975)

The Appellate Court stated that they have found no case throughout the United States that directly supports a “holder” claim such as in the case of the plaintiffs, owners of Mercury Finance Stock.

The Appellate Court concluded that plaintiffs failed to adequately plead both reliance and damages and, therefore, failed to state a cause of action upon which relief could be granted. Thus, the principle decided in Blue Chips was upheld in Illinois.

One Justice concurred in part and dissented in part. Justice Murphy stated that he would hold that a “holder” cause of action exists in Illinois quoting § 525of the Restatement Of Torts that provides, “One who fraudulently makes a misrepresentation of fact, opinion, intention or law for the purpose of inducing another to act or to refrain from action in reliance upon it, is subject to liability to the other in deceit for pecuniary loss caused to him by his justifiable reliance upon the misrepresentation.” Judge Murphy did agree with the portion of the Appellate Court opinion that plaintiffs failed to plead reliance on the false statements.

The writer agrees with the majority opinion that plaintiff failed to state a claim upon which relief could be granted.

Edward X. Clinton, Sr.
Copyright 2010