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May 7, 2010

Supreme Court Clarifies When Statute of Limitations Begins To Run In Security Fraud Cases


In Merck & Co, Inc. v. Reynolds (No. 08-905), 559 U.S. _____ (2010), the Court addressed the timeliness of a complaint filed in a private securities fraud action. To be timely a complaint must be filed no more than two years after the plaintiffs “discover[ed] the facts constituting the violation.” 28 U.S.C. § 1658(b)(1). The Court held “that the cause of action accrues (1) when the plaintiff did in fact discover, or (2) when a reasonably diligent plaintiff would have discovered, ‘the facts constituting the violation’ – whichever comes first.” Critical to this case, the Court also held “that the ‘facts constituting the violation’ include the fact of scienter, ‘a mental state embracing intent to deceive, manipulate, or defraud.’”

In this case, Reynolds was the named plaintiff for group of investors claiming that Merck knowingly misrepresented the risk of heart attacks associated with the use of a pain-killing drug, Vioxx. The Reynolds plaintiffs claimed that the public’s later discovery of the risk lead to economic losses and they brought a securities fraud case under §10(b) of the Securities Exchange Act of 1934.

Reynolds’s claims had to be filed “not later than the earlier of – (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation.” 28 U.S.C. § 1658(b). The complaint was filed on November 6, 2003 and there was no dispute that this was within the five year limit contained in § 1658(b)(2). Therefore, the complaint was timely if the claim arose after November 6, 2001.

At the trial court Merck moved to dismiss the case because the plaintiffs had or should have discovered the “facts constituting the violation” prior to November 6, 2001. Merck based this argument on (1) a March 200 study comparing Vioxx with naproxen and showing adverse cardiovascular results with Vioxx; (2) an FDA warning letter dated September 21, 2001 stating Merck’s marketing regarding the cardiovascular results of Vioxx tests was “false, lacking in fair balance, or otherwise misleading, and (3) pleadings in a products-liability case from September and October 2001 alleging that Merck had intentionally concealed information about Vioxx’s risks. Reynolds argued that they did not and could not have discovered the key facts before November 6, 2001. In particular, Reynolds focused on facts relating to scienter, which they must prove as an element of their claims.

The District Court granted Merck’s motion to dismiss finding that Reynolds should have known all necessary facts prior to November 6, 2001. The Third Circuit, however, reversed holding that Reynolds did not or could not have known that Merck acted with scienter before November 6, 2001.

Initially, Merck argued that even if Reynolds did not know the facts related to scienter, those facts were not necessary to begin the running of the statute of limitations. The Court, rejected this argument. According to the Court, “Scienter is assuredly a ‘fact.’” Further, this fact “’constitute[es]’ an important and necessary element of a §10(b) ‘violation’” because “[a] plaintiff cannot recover without proving that a defendant made a material misstatement with an intent to deceive – not merely innocently or negligently.” As such, a plaintiff must have discovered or should have discovered facts demonstrating scienter before the statutes of limitations in §1658(b) begins to run.

Next the Court examined when Reynolds had or should have realized Merck acted with the requisite scienter. Merck argued that knowledge of a materially false or misleading statement or a material omission are sufficient to show scienter. The Court rejected this position. The Court found that simple incorrect statements may not have the required scienter because often the statements at issue are predictions about future earnings, which may turn out to be false without the issuer of the statement deliberately misleading investors. Therefore, a potential plaintiff must know about more than a simple false statement to be deemed to have the necessary facts supporting scienter.

Finally, Merck argued that prior to November 2001, plaintiffs had enough information that they should have made further inquiries into potential claims, so called “inquiry notice.” Merck contended that the statute of limitations should begin to run at the point plaintiffs have inquiry notice. Again the Court rejected Merck’s argument. The Court reasoned that since inquiry notice requires the plaintiff to investigate further, inquiry notice is necessarily acquired before the time at which a plaintiff would have or should have discovered all the necessary facts. The statute does not require a plaintiff to file a claim before the plaintiff has or should have knowledge of the elements of the claim, including knowledge of scienter. Thus, the point at which a plaintiff has inquiry notice cannot be the same point at which the statute of limitations begins to run.

For the forgoing reasons, the Court determined that the statue of limitations under “§1658(b)(1) begins to run once plaintiff did discover or a reasonably diligent plaintiff would have ‘discover[ed] the facts constituting the violation.’ – whichever comes first.” Since none of the facts known prior to November 6, 2001 gave Reynolds knowledge about the element of scienter, the Third Circuit’s decision was affirmed.

Jason B. Desiderio, Esq.

Absent An Agreement Between The Parties To The Contrary, Imposing Class Arbitration On The Parties Is Inconsistent With The Federal Arbitration Act

In Stolt-Nielsen S.A. v. AnimalFeeds International Corp. (No. 08-1198), 559 U.S. ____ (2010), the Supreme Court refused to force class arbitration where the parties had not previously consented to it.

Stolt is a shipping company. AnimalFeeds shipped products with Stolt pursuant to a standard contract. The contract had an arbitration clause, which, the parties stipulated, did not address whether class arbitration was proper.

A criminal investigation revealed that Stolt was engaged in an illegal price fixing conspiracy. Upon learning of the conspiracy, AnimalFeeds brought class action against Stolt in the District Court for the Eastern District of Pennsylvania asserting antitrust claims. Other companies brought similar suits, including one in the District Court for the District of Connecticut. In the Connecticut case the District Court held the claims were not subject to arbitration under the contract’s arbitration clause. The Second Circuit, however, reversed.

While the Connecticut case was at the Second Circuit, the Judicial Panel on Multidistrict Litigation consolidated all of the cases, including AnimalFeeds’ case, in the District of Connecticut. As such, AnimalFeed and Stolt were required to arbitrate their dispute pursuant to the Second Circuit’s decision.

Then AnimalFeed submitted to Stolt a claim for class arbitration in New York City. The parties agreed that a panel of arbitrators would determine if class arbitration was proper under the governing arbitration clause. As part of this process the parties stipulated that the arbitration clause was silent on the issue of class arbitration.

AnimalFeeds gave three reasons for allowing class arbitration. First, since the arbitration clause was silent on the issue, class arbitration was permitted under Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003). Second, the clause should allow class arbitration as a matter of public policy. And third, the arbitration clause is unconscionable and unenforceable if it forbade class actions.

The panel of arbitrators rejected AnimalFeeds’ first argument, and the Supreme Court agreed. Also, the panel did not address AnimalFeeds’ third argument. Instead, the arbitrators determined that class arbitration was proper as a matter of public policy. Specifically, “the panel based its decision on post-Bazzle arbitral decisions that ‘construed a wide variety of clauses in a wide variety of settings as allowing for class arbitration.’” The arbitration was then stayed to allow for judicial review. The District Court for the Southern District of New York vacated the arbitrators’ decision, but again the Second Circuit reversed.

The Supreme Court explained that the job of an arbitrator is to interpret and enforce a contract. An arbitrator’s decision is unenforceable if he exceeds that mandate. By relying on post-Bazzle arbitral decisions and acting as if they had the powers of a common law court, the arbitrators exceeded their authority. Instead, the panel was required to determining what the absence of an agreement to class arbitration meant under the FAA, federal maritime law, or New York law. Since the arbitrators exceeded their authority, the Supreme Court vacated the arbitrators’ decision and decided the issue themselves under §10(b) of the FAA.

According to the Court, the Federal Arbitration Act imposes specific “rules of fundamental importance.” One of these rules is “that arbitration ‘is a matter of consent, not coercion.’” Arbitration agreements are contracts, which should be enforced according to the parties’ intentions. As such, parties can structure their agreements to arbitrate as they see fit, and can choose with whom they want to arbitrate. Thus, ‘a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.”

Because of the fundamental differences between class arbitration and bilateral arbitration, an agreement to arbitrate, alone, cannot be construed as an agreement to accept class arbitration. The Court, therefore, held that absent an agreement to accept class arbitration, imposing class arbitration on the parties is inconsistent with the FAA.

Jason B. Desiderio, Esq.

About May 2010

This page contains all entries posted to Business Torts and Employment Litigation Blog in May 2010. They are listed from oldest to newest.

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