The Supreme Court of the United States recently issued a decision regarding application of the statute of limitations for securities fraud actions. In Merck & Co. v. Reynolds, No. 08-905, 2010 WL 1655827 (U.S. Apr. 27, 2010), the Supreme Court held that the statute of limitations is not triggered until a plaintiff discovers, or a reasonably diligent plaintiff would have discovered, facts comprising the violation, including scienter. 2010 WL 1655827, at *15.
Merck involved an appeal to the Supreme Court from the decision of the Court of Appeals for the Third Circuit in In re Merck & Co. Inc. Securities, Derivative & “ERISA” Litigation, 543 F.3d 150, 161-71 (3d Cir. 2008). The plaintiffs had brought a Section 10(b) claim purportedly based on Merck & Co., Inc.’s (“Merck”) representations regarding its blockbuster arthritis drug, VIOXX. 543 F.3d at 160. Merck’s shareholders filed a securities fraud class action against the Company on November 6, 2003, alleging that the Company had “materially misrepresented the safety and commercial viability of VIOXX.” Id.
Prior to the filing of the lawsuit, there had been much public discussion regarding the safety of VIOXX , including Merck’s own press releases, an FDA hearing, product liability lawsuits, various articles in the mainstream and in industry media, an FDA warning letter, analyst reports, a modified labeling on the product, and various medical studies. Id. at 154-60. These public discussions related to whether VIOXX caused an increased incidence of cardiac attacks in patients, as compared to other arthritic drugs, such as naproxen. Id. In defense of its product, Merck repeatedly made public statements to the effect that, although not certain, this finding was likely a result of the beneficial impact of naproxen in blocking platelet aggregation and, hence, cardiac attacks, rather than the result of a harmful effect of VIOXX on the heart. Id. at 154-155. The evidence indicated, however, that Merck was “concerned” early on “that VIOXX could cause harmful cardiovascular . . . events” and that “there was ‘a substantial chance’ and a ‘possibility’ of [such] events that could ‘kill [the] drug.’” Id. at 154.
Before the lower court, the defendants moved to dismiss the complaint as time-barred based on these prior disclosures. Id. at 160. The district court granted the motion and held that the plaintiffs should have known of the facts underlying their claims by November 6, 2001, two years before the complaint was filed. Id. at 160-61. On appeal, the Third Circuit reversed, rejecting Merck’s argument that the public news about VIOXX should have placed the plaintiffs on notice. In particular, the Circuit Court relied on the fact that the public coverage reiterated Merck’s counter-argument regarding the cardiac events and the possibility that the actual explanation was unknown. Id. at 169. The court determined that “storm warnings” for purposes of triggering the statute of limitations are those signs that notify a plaintiff, prior to its own deeper inquiry, that it may have a securities fraud claim. The Supreme Court affirmed the Third Circuit’s decision and provided additional guidance on both the inquiry notice standard as well as the storm warnings doctrine.
First, and as a threshold matter, the Court confirmed that “discovery,” as used in the statute of limitations set forth in 28 U.S.C. § 1658(b), includes both actual discovery and constructive discovery. Accordingly, “discovery as used in this statute encompasses not only those facts the plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known.” Merck, 2010 WL 1655827, at *11.
Second, the Court concluded that, in order to trigger the statute of limitations, discovery of facts regarding scienter will be required. Id. at *12. In support, the Court turned to the express language of the applicable statutory provision, which speaks in terms of “facts constituting the violation[,]” of which scienter was one. Further, because scienter is a necessary element of a Section 10(b) cause of action, the Court concluded that there would be an inherent contradiction in allowing the limitations period to progress with no regard to whether any facts suggesting scienter had been discovered or should have been discovered. Such a reading, the Court feared, would permit a defendant to escape liability as long as the defendant concealed for two years the fact that the material misstatement was made with an intent to deceive. Id. However, mindful of the slippery slope that this argument presented, the Court was careful to note that its opinion did not necessarily extend to “other facts necessary to support a private Section 10(b) action.” Id.
Third, the Court clarified the inquiry notice standard and rejected Merck’s argument that the limitations period should run from inquiry notice for those plaintiffs who fail to investigate once they are placed on inquiry notice. Distinguishing between a reasonably diligent plaintiff and the actual plaintiff, the Supreme Court held that a court must examine when a reasonably diligent plaintiff should have discovered the facts at issue. Thus, whether an actual plaintiff is reasonably diligent in investigating once storm warnings are evident is irrelevant under the new analysis. Id. at *15.