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

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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