The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

A wave of litigation followed in the wake of the April 2010 Deepwater Horizon oil spill. Among this litigation were several shareholder derivative suits filed against certain directors and officers of BP and of its U.S. subsidiary. At the time these cases first arose, I asked whether or not these suits involving (and ultimately for the benefit of) an English corporation and even asserting claims under English law would be permitted to go forward in U.S. courts.  

A September 15, 2011 ruling from Judge Keith Ellison of the Southern District of Texas determined that, notwithstanding the fact that the Deepwater Horizon disaster took place in the U.S. and caused extensive environmental damage here, “the English High Court is a far more appropriate forum for this litigation,” and accordingly he granted the defendants’ motion to dismiss the cases.  Judge Ellison’s September 15 decision can be found here.

As discussed here, plaintiffs filed the first of several derivative lawsuits in connection with the Deepwater Horizon oil spill in May 2010. Though many of the lawsuits were first filed in the Eastern District of Louisiana, the cases were ultimately consolidated through the multidistrict litigation process in the Southern District of Texas. However, while the lawsuits were filed in U.S. courts, they asserted claims under the English Companies Act of 2006 (about which refer here). The defendants moved to dismiss the consolidated derivative litigation in the grounds of forum non conveniens.

In his September 15 ruling, Judge Ellison granted the defendants’ motion to dismiss. He summarized his ruling by saying that “this case is a shareholder derivative action brought under a recently enacted U.K. statute on behalf of an English Company against numerous English defendants and other foreign nationals.” The Court, he said, is “persuaded that the Complaint should be dismissed under the doctrine of foreign non conveniens, as the English High Court is the more appropriate forum for this case.”

Judge Ellison found that considerations of public interest “most strongly favor England as the appropriate forum in which to proceed with this case.” He noted that the focus would not be the events in the Gulf that led up to the oil spill, but rather the actions of the company’s board, which took place in England. He commented that “this lawsuit is not intended to redress the devastating impact of the Deepwater Horizon disaster in the Unites States. Instead the lawsuit is intended to compensate BP for the financial and reputational harm the company suffered as a result of its high level management’s alleged disregard for the safety of its operations.”

Judge Ellison noted that “the primary concern of this derivative litigation is the internal affairs of an English corporation, and the suit seeks to recover damages for the benefit of BP only.” He concluded that England “has a far greater interest in the resolution of this dispute.”

Judge Ellison was particularly concerned that were the case to remain in a U.S. court, the court would have to interpret and apply the recently enacted Companies Act. If the case were to go forward in a U.S. court, “the Court would be faced with the formidable exercise of interpreting and applying a still nascent and evolving body of law.”

Judge Ellison did condition his dismissal on the defendants proferring adequate proof that they are amenable to service of process in England or submitting a stipulation that the will submit to the jurisdiction of the appropriate English court.

Although the claimants clearly would have preferred to pursue their mismanagement claims against the BP officials in the U.S., where the disastrous oil spill occurred, Judge Ellison found that the allegations in this case involve alleged actions or inactions that took place in England. The fact is that though the shareholders chose to file their action here in preference to England, with full awareness that English courts presented an alternative forum. The decision to file here rather than there undoubtedly had something to with a perception that a court in closer proximity to the damages cause by the spill might prove to be a more receptive forum. The selection of a U.S. court over an English one also reflects the more general advantages a plaintiff enjoys here by comparison to English courts – for example, the absence in the U.S. of a “loser pays” model, among other things.

These kinds of advantages often encourage plaintiffs with claims involving non-U.S. companies to try to pursue their claims in U.S. courts. But the outcome of the dismissal motion in the BP derivative suit represents just one more example of the many ways prospective litigants are finding it increasingly more difficult to pursue corporate and securities claims against non-U.S. companies in U.S. courts. Courts interpreting the U.S. Supreme Court’s Morrison decision have significantly narrowed the circumstances in which securities claims involving foreign companies can go forward in U.S. courts. Judge Ellison’s decision in the BP case underscores the difficulties prospective claimants may fact in pursuing derivative suits involving non-U.S. companies here as well.

Alison Frankel’s September 16, 2011 Thomson Reuters News & Insight article about Judge Ellison’s decision can be found here. Victor Li’s September 16, 2011 Am Law Litigation Article about the decision can be found here.

For Whom the Statute Tolls: Under Section 13 of the ’33 Act, liability actions alleging a violation of the statue must be brought within one year of “discovery of the untrue statute or omission.” Section 13 provides further that in no event shall the action be brought more than three years after the security was first offered to the public. The one year provision represents a statute of limitation and the three year provision represents a so-called “statute of repose.”

Questions of statutes of limitation and repose might seem obscure, but they can often be critical in determining whether or not a case will go forward. A September 15, 2011 decision by Southern District of New York Judge Laura Taylor Swain in the Morgan Stanley Mortgage Pass-Through Certificates Litigation (here) presents interesting and potentially significant rulings on both the statute of limitations and statute of repose issues.

The case involves claims asserted by investors who purchased certain mortgage-backed securities issued by various Morgan Stanley related entities. The plaintiffs allege that the offering documents related to these securities misrepresented and omitted material facts regarding the underwriting standards applied by the loan originators. As detailed in Alison Frankel’s September 16, 2011 article in Thompson Reuters News & Insight (here), this lawsuit has a convoluted procedural history, in part due to the plaintiffs’ efforts to assemble a group of prospective class representatives whose claims were not time-barred. This latest dismissal motion round involved amended allegations and additional named plaintiffs. The defendants again moved to dismiss based on the statute of limitations and the statute of repose.

Judge Swain’s 40- page opinion reflects a number of interesting rulings, particularly with respect to the timeliness questions. First, she rejected the defendants’ arguments, based on information that was publicly available more than a year before the initial complaint was filed, that the claims of the Public Employees’ Retirement System of Mississippi (MissPERS) were untimely. Judge Swain said that though there was ample publicity on issues pertaining to circumstances relevant to the securities, none of the various items of publicity “addresses, even at a speculative level, the disregard of underwriting practices, neglect of appraisal standards, or consequent LTV ration misrepresentations alleged in the [amended complaint]”

Nevertheless, though she found that the early warnings were not sufficient to trigger inquiry notice, she also found that the plaintiffs had not alleged with sufficient specificity the time and circumstances of their discovery of the conduct alleged in their claims. Accordingly she allowed the plaintiffs leave to replead to establish the circumstances of their discovery in order to establish compliance with the one year statute of limitations.

Perhaps even more interesting is Judge Swain’s ruling on the question of the three-year statute of repose, and in particular her application of what is known as the American Pipe tolling doctrine. Under this doctrine, which derives from a 1974 U.S. Supreme Court opinion, the initiation of an earlier class action suit tolls the running of the statute of limitations for other purported class members who may later seek to intervene and represent the class. The application of the American Pipe tolling doctrine to the running of the statute of limitations is well established. A long standing question has been whether American Pipe tolling also applies to the statute of repose. Judge Swain held that American Pipe tolling does apply to the statue of repose, and denied defendants’ argument that the claims of certain new plaintiffs were barred by the statue of repose in the ’33 Act.

In holding that American Pipe tolling applies even to the three-year statute of repose, Judge Swain declined to follow two recent decisions by other Southern District of New York judges. She reasoned that the tolling doctrine is equitable in nature and “permits a court – after weighing the equities in the discrete case before it – to authorize plaintiffs to bring actions outside the limitations period.”

Judge Swain’s ruling about the statute of repose represents a potentially big deal. If followed by other courts, it could potentially be very significant in cases where an initial plaintiff’s purported class action is dismissed for the plaintiff’s lack of standing. Other prospective claimants who might want to come forward at that point might find their claims blocked by the statute of repose, if the initial filing did not toll the statute’s running.

This possibility is not merely theoretical, particularly with respect to the many mortgage-backed securities class action claims that have been asserted in the wake of the financial crisis. In many of these cases, the claimants have had some of their initial claims dismissed because the named plaintiff did not actually buy securities in all of the offerings in which the securities were sold. Judge Swain’s ruling, if followed, would remove one potentially significant impediment that might other wise exist for other prospective claimants who did buy securities in the other offerings and who might want to come forward and assert class claims on behalf of other investors who bought those securities.

The question is whether other courts will follow Judge Swain on these issues, or will follow the other two Southern District of New York decisions that recently went the other way and held that American Pipe tolling does not apply to the statute of repose.  In her September 16, 2011 Am Law Litigation Daily article about Judge Swain’s ruling in the Morgan Stanley case (here), Susan Beck identifies and links to the two other recent Southern District of New York rulings that Judge Swain declined to follow. She also speculates that the Second Circuit will likely weigh in on these issues, given that the two prior cases (which resulted in dismissals) are on appeal to the Second Circuit and have been consolidated for one hearing before that court.

Special thanks to a loyal reader for sending me a copy of Judge Swain’s decision in the Morgan Stanley case.

When Words Fail: Here in the blogosphere, the deadline is always right now. Because of the need for speed and the fact that I work alone (often late at night or very early in the morning), mistakes sometimes make their way into my blog posts. Because I don't the benefit of an editor's surveillance, I am always grateful when readers point out the errors to me, so that I at least have the opportunity to make a correction.

Massive media organizations publishing on a regular weekly basis with the benefit of a large editorial staff have fewer excuses for errors. For that reason, I am always appalled at the slips that make their way into print in some traditional print publications.

This week’s candidate for the boo-boo that someone really should have caught appears in the current issue of Time Magazine (cover date September 26, 2011). In an article entitled “After Three Years and Trillions of Dollars, Our Banks Still Don’t Work” (here, subscription required), Stephen Gandel writes, with reference to comments by analyst Meredith Whitney about the banking sector, “Eventually, Whitney says, growing litigation issues and a continued drop in housing market were bound to burst the levy.” I am pretty sure Whitney meant that eventually the “levee” was bound to burst, as a "levy" might be on a ballot or be imposed but I have never heard of one bursting. In addition, I feel pretty confident that if this were pointed out to Gandel, a “damn” would burst out as well.

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Years from now, when the history of the Roberts Court is finally written, I hope that the historians will be able to explain why during the first dozen years of the 21^st century, the U.S. Supreme Court seemed so eager to take up securities cases. But whatever the reason, on June 27, 2011, on the final day of a term in which the Court heard three different securities cases, the Supreme Court granted a petition for writ of certiorari to hear yet another securities case next term.

The case is styled as Credit Suisse Securities (USA) LLC v. Simmonds and the question that the Supreme Court will address has to do with the interpretation and application of the statute of limitations in Section 16(b) of the ’34 Act, relating to so-called “short swing profits.” Here is the Question Presented in the case:

Whether the two-year time limit for bringing an action under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), is subject to tolling, and, if so, whether tolling continues even after the receipt of actual notice of the facts giving rise to the claim.

The litigation arises out of the IPO laddering scandal from the dot com era. The plaintiff filed fifty-four related derivative complaints under Section 16(b) in connection with 54 IPOs in 1999 and 2000. The gist of the plaintiff’s allegation is that the supposed arrangement whereby the underwriters had arranged for post-IPO stock purchases of the issuers’ securities at progressively higher prices (“laddering”) constituted prohibited short-swing profits. The plaintiff seeks to compel the underwriter defendants to disgorge their profits.

The District Court granted the defendants’ motions to dismiss. As to thirty of the cases, the district court granted the dismissal motion as to thirty of the companies based upon the inadequacy of the derivative demand letters the plaintiff had sent to the issuer companies. The District Court dismissed the remaining twenty-four cases on the basis of Section 16(b)’s two year statute of limitations. The plaintiff appealed.

In a December 2, 2010 opinion (as amended on January 18, 2011) written  by Judge Milan Smith a three-judge panel the Ninth Circuit affirmed the district court’s ruling as to the demand letters, but reversed the district court as to the statute of limitations issue. The specific issue the Ninth Circuit addressed was whether the two-year statute of limitations is a strict statute of repose, or whether it is a “notice” or “discovery” statute that is tolled until the claimant has sufficient information to be put on notice.

The Ninth Circuit, following its own prior precedent, held that the two-year statute operates as a “notice” statute, and the running of the statute is tolled until there has been adequate disclosure of the trade. Because the statute begins to run only when the defendant files a Section 16(a) disclosure statement, and because the defendants did not file a Section 16(a) statement, the Ninth Circuit held that the claims are not time-barred.

In an unusual twist, Judge Smith, the author of the opinion for the three judge panel, added an additional opinion “specially concurring” in the result and expressing his view that the two-year statute of limitations is a statute of repose, and that were it not for the prior Ninth Circuit precedent on which the court relied in deciding this case, he would have voted that the Section 16(b) cases could not be brought more than two years after the short-swing trades took place.

The defendants affected by the Court’s ruling on the statute of limitation filed a petition for a writ of certiorari with the United States Supreme Court and on June 27, 2011, the Court granted the petition.

Discussion

There was a time when the Supreme Court rarely took up securities cases. That time is long passed. The Court is not only routinely taking up securities cases, but it is even taking up routine matters – this is the second securities-related statute of limitations case the Court has taken up recently. Just last year the Court dealt with statute of limitations issues in the Merck case.

The Court has only just accepted this case and it has not yet been briefed, much less argued. The Supreme Court does not explain why it takes up the cases it takes up. But I have to say that it doesn’t seem very likely that the Supreme Court took up this case to affirm the Ninth Circuit’s holding. I have no idea how five or more votes on this case will line up, but if I had to predict I would guess that the Court will say that two –year statute of limitations in Section 16(b) operates as a statute of repose.

It seems that Judge Smith’s unusual appended opinion specially concurring in the holding but in effect dissenting from the Ninth Circuit’s precedent operated like an entreaty to the Supreme Court to clean up the situation.

The one wild card is that Chief Justice Roberts may not participate in this case. The Court’s June 27 order specifies that Roberts did not participate in consideration of the cert petition. He may be conflicted out, perhaps as a result of his prior activities while in private practice. If Roberts does not participate, the conservative majority that lined up together this past term on the Janus Capital (refer here) and Wal-Mart Stores case (here) may not be able to put together the five votes to control the outcome. In which case, the outcome of the Supreme Court review may be too close to call.

But in any event, next October we will enter yet another Supreme Court term with at least one securities case on the Court’s docket. I know for sure at least one blog post I will be writing somewhere between next October and next June.

Special thanks to a loyal reader for alerting me to the cert petition grant.  

A Year After Morrison: Speaking of the Supreme Court and securities cases, the first anniversary of the Morrison v. National Australia Bank case has just passed, and in recognition of the event, Luke Green had an interesting retrospective post on his ISS Securities Litigation InSights blog (here). I have long thought that the Morrison case was one of the most interesting developments in this area, and as Green’s post makes clear, the case has had a multitude of interesting implications.

Summertime: “Love to me is like a summer day/silent because there’s just too much to say./Still and warm and peaceful,/even clouds that may drift by can’t disturb our summer sky.”

Pentwater, Michigan  June 26, 2011

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When the U.S. Supreme Court issued its ruling earlier this year in the Merck case pertaining to the question of what triggers the running of the statute of limitations in securities cases, there was some speculation that the decision might encourage an influx of cases involving events from the distant past. There really have not been that many cases that seemed to have been filed in reliance on Merck -- at least not until now.

A case filed late last week, in which the class period cutoff date is over three years past, seems to represent a pretty clear example of a filing made in reliance on Merck, and may suggest both the kinds of filings that Merck may encourage and also the problems these cases may present.

Just to review, in its April 2010 decision in Merck, the U.S. Supreme Court held that the statute of limitations for cases under Section 10(b) is not triggered until the claimants have, or with reasonable diligence could have had, knowledge of the facts constituting the violation, including in particular facts constituting scienter.

According to their September 17, 2010 press release (here), plaintiffs’ lawyers’ have filed an action in the District of Idaho against PCS Eduventures!.com, its CEO and its former CFO. Though the complaint (a copy of which can be found here) was only just filed last week, the lawsuit purports to be filed on behalf of investors who purchased the companies’ shares between March 28, 2007 and August 5, 2007 – a period that ends more than three years before the complaint was filed.

The gist of the complaint is that on March 28, 2007, the company announced that it had entered a license agreement with its Mideast distributor, PCS Middle East, for a fixed license fee of $7.15 million. However, the complaint alleges that PCS Middle East did not have the ability to pay the fee without first entering a contract with the Saudi Arabian government. PCS did not have a contract with Saudi Arabia, and the complaint alleges that "PCS officers knew there was no contract."

The reason that the class period cuts off in August 2007 is that on August 15, 2007, after several months worth of disclosures about the Saudi arrangement or reflecting the revenue from the arrangement, the company issued an "update" clarifying that while the company had relied on their Mideast distributor’s assurances that a contract was "imminent," in fact, the company was "unable to confirm a timeframe or other specifics regarding any such contract" and the company’s managers "do not know when our Company will be called upon to participate in the initiative through our independent licensee."

The complaint anticipates the statute of limitations issue by alleging that "it was not until August 26, 2010, when the SEC instituted a civil action against PCS and others, did [sic] any reasonable investor could have reasonably suspected that Defendants’ misstatements about its purported $7.5 million sales contract were made with scienter."

The SEC’s August 30, 2010 press release regarding its enforcement action can be found here and the SEC’s amended enforcement complaint against PCS and its CEO and former CFO can be found here.

According to the SEC’s complaint, in March 2007, the company’s Mideast representative had been promising the Saudi contract for months, at a time when the company also faced the looming possibility of missing its EBIDTA requirements in one of its loan covenants. The SEC alleges that the company concocted the license fee arrangement with its Mideast distributor as a way to come up with revenue to satisfy the EBITDA requirement.

The company booked the fee as revenue in March 2007, even though the distributor could not pay the fee until there was a Saudi contract. The SEC alleges that the company’s officers "knew there was no contract with Saudi Arabia." The SEC also alleges that in the absence of the contract, the company lacked an appropriate basis to recognize the fee as revenue, a fact of which the SEC also alleges company management was aware.

Discussion

Because the investor complaint was filed more that three years after the August 2007 "update," the complaint would appear to be untimely, unless the plaintiffs succeed in persuading the court that the statute of limitations was not triggered until the SEC filed its complaint more than three years later, in August 2010.

The U.S. Supreme Court held in Merck that the statute of limitations is not triggered until the claimant has knowledge of the facts constituting the violation, including the facts constituting scienter. The plaintiffs expressly allege in their complaint that until the SEC initiated its enforcement action, they were unaware of the facts constituting scienter – that is, that the PCS officials knew all along there was no Saudi contract.

The defendants undoubtedly will argue that the plaintiffs could have with reasonable diligence uncovered the facts constituting the violation, and indeed the company’s mealy-mouthed August 2007 "update," which uses a lot of words to explain the simple facts that there was no Saudi contract and there never had been a Saudi contract, should have set off some alarm bells.

The defendants will argue in particular that the August 2007 update specifically noted that the company had only been told that the Saudi contract was "imminent" and had been "unable to confirm the timeframe or other specifics regarding any such contract" – meaning that even back in March, when the company booked the fee revenue, the company lacked specifics regarding the contract, which suggests that the company lacked the minimum necessary to recognize the fee as revenue, and that the company clearly was as aware in March as it was in August that it lacked sufficient specifics to support recognition of the revenue.

It will be interesting to see how this case unfolds. At a minimum, the lawsuit’s filing does demonstrate the troublesome potential of the Merck decisions to encourage the pursuit of litigation over long-distant events.

The problem is that this possibility creates significant uncertainty about when events in the past so long gone that companies can be sure that they are "out of the woods" about past problems. This is also a serious problem for D&O insurance underwriters trying to assess the risk associated with companies that have had problems in the past. If cases like this one go forward, underwriters will be compelled to extend their scrutiny of a particular company far into the past, with no sure way of knowing how far back is far enough. This uncertainty poses a challenge for companies and underwriters alike.

One final question has to do with the SEC’s action. I am not sure of theory on which the SEC will show that its action was timely, a question that presents its own separate set of issues and that will have to be worked out as the enforcement action goes forward. I welcome readers thoughts on the statute of limitations issues.

More Bank Failures: In case you missed it, the past Friday evening after the close of business, the FDIC took control of six more banks, bringing the 2010 year to date total number of bank failures to 125. The 2010 pace of bank closures continues to run well ahead of the pace in 2009, when the FDIC closed 140 banks. Bank closure number 125 in 2009 did not occur until December.

Among the six banks closed this past Friday night were three more Georgia banks. Since January 1, 2008, there have been 44 bank failures in Georgia, the highest total for any state during that period. However, the 14 bank failures in Georgia so far in 2010 represent only the third highest state total this year, behind Florida (23) and Illinois (15).

The Coolest Time-Waster Website Ever: Check out the Global Genie. When you click on the "Shuffle" button, the site displays a Google Earth view of some random location somewhere on five continents (Antarctica and for some reason South America are not included). Each location is helpfully identified by an accompanying Google Map. The "Shuffle" button quickly becomes addictive.

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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.

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Relatively few securities lawsuits make it to the U.S. Supreme Court, so for that reason alone it is a noteworthy development that on May 26, 2009, the U.S. Supreme Court granted Merck’s petition for a writ of certiorari in the securities class action lawsuit relating to the company’s disclosures about Vioxx, the pain medication Merck withdrew from commercial distribution in 2004.

The Supreme Court will address the question of what is required to establish "inquiry notice" sufficient to trigger the running of the two-year statute of limitations for private securities lawsuits. As discussed below, the question before the court is likely to produce an opinion that, while likely to be narrow and technical, could nevertheless have a great deal of practical significance for many cases.

Background

The first Vioxx-related securities class action lawsuit was filed on November 6, 2003. (Refer here for a detailed background on the case.) Though Vioxx was not finally withdrawn from commercial distribution until September 2004, the district court granted Merck’s motion to dismiss the consolidated class action based on the statute of limitations, finding that there was sufficient public information available prior to November 6, 2001 to trigger the plaintiffs’ duty to investigate the alleged fraud. A copy of the district court April 12, 2007 opinion can be found here.

On September 9, 2008, the Third Circuit, in an opinion (here) written by Judge Dolores Sloviter, and accompanied by a vigorous dissent from Judge Jane Roth, reversed the district court and concluded that no "storm warnings" of the alleged fraud existed for more than two years prior to the filing of the original complaint.

In order to determine whether or not there was sufficient publicly available information to trigger the statute, the Third Circuit reviewed several categories of information that the district considered to have constituted "storm warnings," including: various studies that raised concerns about Vioxx’s side-effects; an FDA warning letter that publicly criticized Merck for its misleading marketing of Vioxx; several consumer fraud lawsuits that were filed against Merck throughout 2001; and an October 2001 New York Times article that discussed Vioxx testing results and side effects.

Based on its detailed factual review of each of these various categories of information, the Third Circuit concluded that "the District Court acted prematurely in finding that [plaintiffs] were on inquiry notice of the alleged fraud." Among other things, the Third Circuit found it relevant that throughout the period Merck continued to issue reassuring statements that minimized the various public disclosures. The Third Circuit also considered it relevant that Merck’s share price did not react to the various disclosures and that the analysts following Merck did not alter their ratings in response to these developments.

In dissent, Judge Roth stated her view that there various categories of information provided sufficient "storm warnings" to put investors on inquiry notice, regardless whether or not there was any significant change in Merck’s share price or in analysts’ ratings.

The Cert Petition

In its petition for certiorari, Merck argued that the various Circuit courts have issued conflicting opinions on what is required to put a plaintiff on "inquiry notice" sufficient to trigger the running of the statute of limitations. Merck argued that the Third Circuit, together with the Ninth Circuit but in contrast to the other Circuits, had held that "no duty to investigate arises, and the statute of limitations does not begin to run, until the plaintiff receives specific evidence of the elements of its claim without the benefit of any investigation."

Merck argued that as a result of its "more lenient" standard, "the Third Circuit has excused an investor from asking a single question until it has evidence not just of scienter, but of materiality and loss causation as well." Merck contended that the Third Circuit’s standard "runs contrary to the fundamental purpose of inquiry notice – to encourage the timely filing of fraud claims by placing an affirmative burden on plaintiffs to investigate potential claims."

Merck argued that the existence of a split in the circuits on this question not only undermines the goal of the uniform application of the statute of limitations, but it encourages plaintiffs to forum shop, burdens the parties with uncertainty and leaves investors unsure of their obligations.

In their brief in opposition to the writ, the plaintiffs had argued that the Third Circuit had made a very fact intensive determination, and had simply held that on the record there were not sufficient facts to trigger the obligation to investigate potential claims. The plaintiffs argued that the purported split in the circuits pertained only to what a plaintiff must do once the duty to investigate has been triggered, which, plaintiffs contend and the Third Circuit found, had not happened in this case.

On May 26, the U.S. Supreme Court granted the writ, and the case will be argued in the court term that begins in October, possibly with a new Justice on the bench.

Analysis

The possible significance of this case will be even more apparent after the case has been fully briefed and argued, but based on the record so far, I note the following:

First, the court seems to have taken this case based on Merck’s argument that there is a split of authority among the Circuit courts on what it is that puts a securities plaintiff on inquiry notice. Under these circumstances, the likeliest outcome at the Supreme Court level is that the Court will articulate the standard to be applied and then remand the case back to the lower courts for further proceedings. (I am assuming here that it is unlikely that the Third Circuit will not simply be affirmed, because the Supreme Court didn’t have to grant cert in order for the Third Circuit’s ruling to stand.)

This prospect in turn suggests a couple of things to me. The first is that the statute of limitations question in this case likely will be, as it has been up to this point, ultimately be decided on a very fact intensive basis. In addition, it also seems likeliest that the Court will simply choose among one of the existing standards for what triggers inquiry notice, which in turn suggests that it is unlikely that the Supreme Court’s decision in this case will plow any new ground.

Both of these factors suggest strongly that the Supreme Court’s decision will be narrow, precise and technical – as might be expected in a dispute over standards for triggering the statute of limitations.

That said, even if the Supreme Court’s opinion plows no new ground, it could nevertheless have enormous practical significance in at least some individual cases. Depending on how the Court’s decision unfolds, it could answer a number of critical issues that could be outcome determinative in some cases, including the following:

1. In order for plaintiff to be put on "inquiry notice," must the plaintiff be aware of the probability that fraud may have occurred, or merely the possibility that fraud may have occurred?

2. Is the awareness of the probability or possibility alone enough to trigger the statute, or must it also be shown that plaintiffs would have discovered facts sufficient to actually bring suit?

3. What is the relevance to the analysis, if any, of the presence or absence of movement in a company’s stock price or in analysts’ opinions?

4. What is the relevance to the analysis, if any, of reassurances from the Company, and how does that affect the triggering of inquiry notice?

All of that said, though the outcome of this case is likely to be narrow and technical and will likely produce a narrow definition of a technical standard, the decision potentially could have practical significance on questions of the timeliness of many securities lawsuits.

The Gibson Dunn law firm has an interesting May 27, 2009 memo here explaining in detail the contours of the split in authority among the various Circuit courts on the question of what triggers the running of the statute of limitations.

Special thanks to the several readers who send me links to briefs and articles relating to the Supreme Court’s cert grant in this case.

About the Nominee: Speaking of the recent nominee to the U.S. Supreme Court, a May 27, 2009 memo from the While & Williams firm (here) suggests that in insurance coverage cases, Second Circuit Judge Sonia Sotomayor has a track record of ruling in favor of insurers. On the other hand, as the memo also notes, not that many insurance cases actually make it all the way to the Supreme Court. Hat tip to the Point of Law blog (here) for the link to the memo.

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