On April 27, 2010, the United States Supreme Court ("Supreme Court") held in Merck & Co. v. Reynolds that the limitations period in private securities fraud actions accrues when the plaintiff discovers, or a reasonably diligent plaintiff would have discovered, "the facts constituting the violation," which include facts concerning a defendant's fraudulent intent, or scienter. In holding so, the Supreme Court acknowledged that "storm warnings" and "inquiry notice" can be helpful in determining when a reasonably diligent plaintiff should begin investigating, however, only discovery of "facts constituting the violation" triggers the limitations period.
BACKGROUND
This cause of action was brought by a group of investors alleging that Merck & Co. ("Merck") knowingly misrepresented the risks of heart attacks accompanying the use of Merck's pain killing drug, Vioxx. On November 6, 2003, plaintiffs filed an action for securities fraud pursuant to § 10(b) of the Securities Act of 1934, 15 U.S.C. § 78j(6) and Rule 10b-5 promulgated thereunder.
In 1999, Vioxx was approved by the Food and Drug Administration ("FDA") for prescription use. In March 2000, Merck announced the results of a study that found patients taking Vioxx suffered fewer gastrointestinal side effects than those prescribed a different painkiller. However, the study also revealed that patients taking Vioxx suffered heart attacks at a higher rate than those prescribed a different painkiller. Merck suggested that the adverse cardiovascular results could be explained by a benefit conferred by the other drug, rather than the harm caused by Vioxx.
Numerous press releases throughout 2000 and 2001 raised concerns over the cardiovascular risks associated with Vioxx. On September 21, 2001, the FDA issued a warning letter to Merck ("September 2001 FDA Warning Letter") stating, in part, that Merck's marketing of Vioxx was "false, lacking in fair balance, or otherwise misleading." On October 9, 2001, Merck responded to the September 2001 FDA Warning Letter by stating that it had reexamined its data and "found no evidence that Vioxx increased the rate of heart attacks."
In October 2003, the Wall Street Journal published the results of a Merck-funded study that concluded that those patients given Vioxx were more likely to have a heart attack than those who took another painkiller, or no painkiller at all. By September 30, 2004, Merck had withdrawn Vioxx from the market.
The issue before the Supreme Court was whether the lawsuit was untimely pursuant to the two-year discovery limitations since significant information regarding the possible adverse cardiovascular effects of Vioxx was made public prior to November 6, 2001 (the "critical date" for timeliness pursuant to the statute of limitations).
PROCEDURAL HISTORY
The District Court for the District of New Jersey granted Merck's motion to dismiss the complaint on statute of limitations grounds, ruling that the September 2001 FDA Warning Letter and Merck's subsequent response thereto on October 9, 2001, should have alerted the plaintiffs to a "possibility that Merck had knowingly misrepresented material facts," thus placing the plaintiff on "inquiry notice" no later than October 9, 2001.
On appeal, the Court of Appeals for the Third Circuit (the "Third Circuit") reversed the dismissal. A majority held that the events occurring before November 6, 2001, while constituting "storm warnings," did not indicate scienter and, therefore, did not place the plaintiffs on "inquiry notice" requiring them to investigate further.
Merck sought certiorari to resolve disagreements among courts of appeal over what triggers the statute of limitations period for securities fraud cases. The Supreme Court granted Merck's petition to resolve these conflicts.
LEGAL ANALYSIS
The applicable statue of limitations provides that actions involving "a claim of fraud, deceit, manipulation, or contrivance of a regulatory requirement concerning the securities laws...may be brought not later than the earlier of (i) two-years after the discovery of the facts constituting the violation; or (ii) five-years after such violation.1 Merck claimed that before the critical date plaintiffs had or should have discovered the "facts constituting the violation" and, therefore, the plaintiffs failed to file their complaint within the statute of limitations. In turn, the plaintiffs argued that they had not, and could not have, discovered by the critical date those facts related to scienter and, for that reason, their complaint was timely filed.
In a unanimous decision, the Supreme Court affirmed the Third Circuit's reinstatement of the plaintiffs' lawsuit holding that the "storm warnings" did not indicate scienter and, while they may warrant inquiry, such "inquiry notice" is insufficient to trigger the two-year statue of limitations.
Scienter
The Supreme Court held that, in the context of a § 10(b) violation, facts relating to a defendant's scienter are "facts constituting the violation" and the statute of limitations period does not begin to run until the plaintiff discovers (or a reasonably diligent plaintiff would have discovered) such facts. The Supreme Court explained that scienter, "a mental state embracing intent to deceive, manipulate, or defraud," is a critical element of a § 10(b) claim and assuredly a "fact." The Supreme Court concluded that it would frustrate the purpose of the "discovery rule" if the limitations period began to run regardless of whether a plaintiff had discovered any facts suggesting scienter.
In addition, the Supreme Court rejected Merck's argument that "facts that tend to show a materially false or misleading statement (or material omission) are ordinarily sufficient to show scienter as well." The Supreme Court reasoned that where § 10(b) is at issue, the relationship between a statement's falsity and the speaker's state of mind is context specific, "'discovery' of scienter-related facts beyond the facts that show a statement (or omission) to be materially false or misleading" may be required.
Inquiry Notice
The Supreme Court rejected the "inquiry notice" argument put forth by Merck and adopted by many courts of appeals. "Inquiry notice" is defined as the time "at which a plaintiff possesses a quantum of information sufficiently suggestive of wrongdoing that he should conduct a further inquiry." The point at which a plaintiff is put on "inquiry notice" does not necessarily correspond to the point at which a plaintiff discovers or should have discovered "the facts constituting the violation."
In addition, the Supreme Court rejected Merck's argument that the limitations period should run from "inquiry notice" when the plaintiff fails to undertake an investigation. The Supreme Court acknowledged that "storm warnings" and "inquiry notice" can be helpful in determining when a reasonably diligent plaintiff should begin investigating, however, only "discovery" of "facts constituting the violation" triggers the two-year limitations period regardless of whether or not a diligent plaintiff undertook or should have undertaken an investigation after being put on "inquiry notice."
Finally, the Supreme Court rejected Merck's argument that the plaintiffs' claim was untimely because they had or should have discovered "the facts constituting the violation" based on the various reports, articles, letters and studies concerning the safety of Vioxx, which were made public prior to November 6, 2001. The Supreme Court determined that none of the events prior to November 6, 2001 revealed facts indicative of scienter.
IMPLICATIONS
The Merck decision is likely to result in a reduction of the number of private securities fraud cases dismissed on statute of limitations grounds, and plaintiff lawyers will arguably have more time to commence securities fraud actions. Some commentators have expressed a concern that this ruling will encourage plaintiffs to "sit on their rights" in order to increase the settlement value of their claims. Those commentators have asserted that plaintiffs may intentionally delay filing complaints if they believe the company's stock prices will decline, in an effort to claim larger losses and, therefore, receive increased settlements or damage awards. The authors are of the contrary view. Most jurisdictions recognize the "first to file" rule when granting class certifications. Plaintiffs' counsel who are the first to file class action complaints tend to be granted the position of lead counsel which allows them to manage the litigation and, therefore, garner the lion's share of any attorneys fees awarded in connection with a judgment or settlement. The authors believe that the incentive to be the "first to file" will mitigate any concerns regarding plaintiffs unduly delaying commencement of a class action lawsuit.
Footnote
1. 28 U.S.C. § 1658(b).
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