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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.

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