U.S. Supreme Court Allows Merck Vioxx Securities Suit to Proceed
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A unanimous U.S. Supreme Court held on April 27, 2010 that the shareholder lawsuit arising from Merck’s alleged misrepresentations regarding Vioxx is not time-barred by the applicable statute of limitations. A copy of the Court’s opinion can be found here.
Background
In an action filed in November 6, 2003, the plaintiffs had contended that the company knowingly misrepresented the risk of using Vioxx, and that when the risks were disclosed the company’s share price fell. Merck claims that more than two years prior to the filing the plaintiffs had or could have discovered the "facts constituting the violation, and therefore was barred by the applicable statute of limitations.
The District Court granted Merck’s motion to dismiss, holding that events more than two years prior to the filing should have alerted the plaintiffs to the possibility of a misrepresentation, placing the plaintiffs on "inquiry notice."
The Third Circuit reversed the district court, holding that while events more than two years prior to the filing constituted "storm warning," the events did not suggest scienter, and consequently did not put the plaintiffs on "inquiry notice."
Merck filed a petition for writ of certiorari to the U.S. Supreme Court, and the Supreme Court agreed to hear the case.
The Supreme Court’s Holdings
Justice Breyer's opinion for the Court (with separate concurring opinions by Justices Stevens and Scalia) affirmed the Third Circuit and held that the plaintiffs’ complaint was timely.The Court’s opinion reflected several specific holdings.
First, the Court held that the statute’s requirement of filing within two years of "discovery" encompasses "not only facts plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known." (This is the portion of the opinion in which the concurring Justices did not join. Justice Stevens said this finding was not necessary to the Court’s holding. Justice Scalia, joined by Justice Thomas, disagreed with this part of the opinion while joining the Court’s holding.)
Second, the court held that the "discovery" of the facts that "constitute the violation" required the discovery of scienter-related facts. The Court found that "it would frustrate the very purpose of the discovery rule … if the limitations period began to run regardless of whether a plaintiff had discovered any facts suggesting scienter," as otherwise a defendant could conceal that he made a misstatement with an intend to deceive, and the two-year limitations period would expire before the plaintiff had actually discovered the fraud.
In reaching this conclusion about what is required to trigger the running of the statute of limitations, rejected Merck’s argument that the statute of limitations could begin to run once plaintiffs were on "inquiry notice." The court observed that the "terms such as ‘inquiry notice’ and ‘storm warnings’ may be useful to the extent that they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating," but in any event the "limitations period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered the facts ‘constituting the violation,’ including scienter."
Finally, the Court rejected Merck’s argument that pre-November 2001 circumstances "reveal ‘facts’ indicating scienter," concluding that prior to November 6, 2001, "the plaintiffs did not discover, and Merck has not shown that a reasonably diligent plaintiff would have discovered, the ‘facts constituting the violation.’" Thus, the Court concluded, the "plaintiffs’ suit is timely."
Discussion
In a sense the issues addressed in the Court’s opinion are narrow and technical. In the vast scheme of things, statutes of limitations issues arguably might not affect many securities lawsuits, many of which historically have been filed shortly after the news triggering a sharp stock price drop, when, as is usually alleged, the truth was revealed to the marketplace.
However, there are at least a couple of current circumstances that may make the Supreme Court’s opinion in the Merck case particularly relevant just now.
First, since the second half of 2009, there have been an increasing number of case filings in which the filing date has come well after the proposed class period cutoff date. The later in time the filing date occurs, the likelier it is that statute of limitations issues could become relevant. Clarity around the issue of what triggers the running of the ’34 Act’s two-year statute of limitations, and particularly the clarification of the requirement for the discovery of facts constituting scienter, may help courts dealing with these belated cases to determine timeliness issues.
A second and perhaps more important reason the Court’s holding in Merck could prove relevant just now has to do with the continuing litigation arising out of the subprime meltdown and the credit crisis. As we move forward in time and the crisis-related events recede further into the past, additional filings increasingly may raise questions of timeliness. Statute of limitations questions are already arising in some of these cases, as I discussed in a recent post (here), and they are increasingly likely to arise in future cases.
The Merck opinion’s clarification of what is required to trigger the running of the statutue of limitations will help sort out these issues. In particular, the Court’s clarification that facts constituting "inquiry notice" and "storm warnings" alone are not sufficient to trigger the running of the statute could be particularly significant.
One final thought about this case is that the Court’s opinion definitely is helpful to the plaintiffs. In recent years, the Court has developed a reputation as hostile to private securities lawsuits. Without a doubt, the Court has issued a series of decisions (Tellabs, Stonridge, Twombley/Iqbal, Dura, etc.) that have proved helpful to defendants. But the Court’s opinion in the Merck case is not only helpful to the plaintiffs in that case but it likely will prove useful to plaintiffs in other cases as well.
Honestly, I didn’t see this coming. I thought, given the Court’s recent track record and given what I thought was the common sense notion that the Court would not grant cert just to affirm the Third Circuit, I thought this case would likely lead to a victory for Merck in another defense friendly decision. Instead, the plaintiffs prevailed in a unanimous holding. Maybe my presumptions were completely off base, but I still find the outcome interesting and a little unexpected.
Special thanks to the several readers who sent me copies of the opinion.
This was indeed a surprising result. In addition, Scalia's concurrence argued that the correct meaning of discovery in the statute is actual discovery only, and not constructive discovery - a position even even better for plaintiffs than the majority position.
Although this is a statute of limitations opinion, it will have two important effects on the merits. First, to reach the outcome, the court had to factually determine when plaintiffs could have discovered the fraud. The court's finding that plaintiffs would not reasonably have discovered the fraud sooner than they actually did now makes it more likely that a jury will make a similar finding on that issue at trial.
Secondly, in virtually all 10b-5 cases, the SOL will not begin to run until some facts directly indicating defendants' scienter (intent to deceive or reckless disregard for the truth) become public information. It is now impossible for a 10b-5 defendant (except the extremely rare case in which an insider is a plaintiff) to argue that the plaintiffs should have discovered the fraud sooner than the damning facts' publication in the general or financial media.
This was an excellent factual case in which to argue the SOL discovery issue, particularly because the concealed information was medical rather than financial, which has two advantages: (a)“accounting standards " are not there to muck up what is otherwise a fairly clear fraud, and (b) there is a clearer moral turpitude, due to the physical harm and even deaths (allegedly) due to Merck's conduct, than in most financial cases.
Defendants are now suddenly the ones put at a disadvantage by the difficult pleading standards of the 1995 Reform Act. By making fraud so difficult to plead, the Act also makes fraud difficult to discover; indeed, discovery is nearly impossible without the unwilling disclosure of inside information by the defendants themselves, including information showing their own culpable conduct. In this case, we had the edifying spectacle of defendants arguing that publicly available facts prior to the price drop were sufficient to indicate fraudulent intent -- while, on a dispositive motion and/or at trial, they must argue that much more incriminating facts show no fraudulent intent.
The opinion's tone (to me, rather more enthusiastic than usual), and its odd decision to accept cert. merely to affirm a Third Circuit opinion, may indicate that this wildly pro-business court, in these asset-bubble-infested times, is beginning to see the benefits to the securities markets from serious enforcement and more reasonable legal barriers to recovery for fraud.
Actually, if you had read the oral argument transcript it was very easy to see this coming. The Court roughed up Merck's lawyer pretty badly. And the Court was right. A plaintiff cannot even bring one of these cases without strong evidence of scienter, and it is hard to see how the statute can start running when fraudulent states of mind are being concealed along with most of the hot documents. Scienter was not possible to even plead in Merck until the case was filed. Finally, this decision should be read carefully by those of us who handle fidelity insurance cases and claims, as the discovery test under such policies is very close to the Court's in this case.