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Securities Law Commentary
In re Merck: Class Plaintiffs Were Not on Inquiry Notice Sufficient to Time Bar Claims
In re Merck & Co., Inc. Securities, Derivative & “ERISA” Litigation
Posted: 11/17/2008
By: Joel B. Ginsberg, Esq.
Companies Mentioned: Asset Management Holding AG, Jan Charles Finance S.A., Park East, Inc., The Public Employees’ Retirement System of Mississippi
Introduction
In In re Merck & Co., Inc. Securities, Derivative & “ERISA” Litig., ___ F.3d ___, 2008 WL 4138476 (3rd Cir. 2008), a federal circuit court revived a securities fraud class action suit against Merck that accuses the pharmaceutical company of hiding the truth about Vioxx and its link to cardiac problems. The district court had dismissed the class action as time barred, claiming that the plaintiffs were on inquiry notice more than two years before filing the suit. In a split decision on appeal, the Circuit Court disagreed, finding that reassuring messages from Merck and the market prevented plaintiffs from being on inquiry notice until much later.
Detailed Commentary
BACKGROUND
The plaintiffs in this class action were purchasers of Merck & Co. stock. This action is the consolidation of several separate class actions alleging that the company and certain of its officers and directors violated various sections of both the Securities Exchange Act of 1933 and the Securities Exchange Act of 1934 by “materially misrepresent[ing] the safety and commercial viability of VIOXX.” 2008 WL 4138476, p*7.
When Merck introduced prescription painkillerVioxx to the market in 1999, it was hailed as a potential “blockbuster” drug for the company—its “savior.” 2008 WL 4138476, p*1. In 2000, Merck released a study showing a higher incidence of cardiac events in Vioxx patients compared to those taking naproxen. Merck assured the market by offering the “naproxen hypothesis” – a claim that the difference was due to the beneficial impact of naproxen, not due to any danger of Vioxx. Id. at p*2.
On September 21, 2001, the FDA sent Merck a warning letter regarding its “marketing and promotion” of Vioxx, stating in part that it was “false, lacking in fair balance, or otherwise misleading.” Id. at p*4. The FDA letter garnered a lot of media coverage, including a New York Times article regarding the health risks of Vioxx in which a Merck representative admitted a lack of proof for the naproxen hypothesis and that Vioxx may in fact cause cardiac events. Id. at p*5. Several products liability lawsuits were filed in 2001. However, at that same time, “market analysts, scientists, the press, and even the FDA agreed that the naproxen hypothesis was plausible” and “many securities analysts continued to maintain strong growth ratings for Vioxx at the same time that its safety was being questioned.” Id. at p*12.
The hammer fell in late 2003, when the media reported declining Vioxx sales, as well as a Harvard study that revealed an increased risk of heart attacks in patients taking Vioxx compared to those taking Celebrex and a placebo – the naproxen hypothesis was dispelled. Merck withdrew Vioxx from the worldwide marketplace on September 30, 2004, and the company’s previous knowledge of the safety risk was made public. Id. at pp* 6-7. The day Merck withdrew Vioxx, stockholders lost a collective $28 billion.
The first of the securities fraud class action lawsuits was filed on November 6, 2003, following publication of the declining Vioxx sales and the Harvard study results. The plaintiffs alleged that the defendants knew about the dangers (and the diminished commercial viability) of Vioxx, but misstated and failed to disclose that information, misleading shareholders and ultimately causing their investment values to drop sharply.
The District Court said investors had “storm warnings” in 2001
The District Court for the District of New Jersey had granted Merck’s motion to dismiss the suits because they were filed after the statute of limitations had run. In re Merck & Co. Inc. Sec., Derivative & “ERISA” Litig., 483 F. Supp. 2d 407 (D.N.J. 2007). The Circuit court explained its measure of timeliness in this case: “if Appellants knew of the basis for their claims prior to November 6, 2001, two years before the first securities complaint was filed, all of their claims are barred by the statute of limitations.” 2008 WL 4138476, p*7.
Whether appellants “knew” of the basis of their claim depended on whether or not they had ‘sufficient information of possible wrongdoing to place them on ‘inquiry notice’ or to excite ‘storm warnings’ of culpable activity.’ Benak ex rel. Alliance Premier Growth Fund v. Alliance Capital Mgmt, L.P. 435 F.3d 396, 400 (3rd Cir. 2006) (citing In re NAHC Inc. Sec. Litig., 306 F.3d 1314, 1325 (3rd Cir. 2002)). An investor is on inquiry notice when a “reasonable investor of ordinary intelligence would have discovered the information and recognized it as a storm warning.” In re NAHC, 306 F.3d at 1325.
The district court found that “there was an overwhelming collection of information signaling deceit by Merck with respect to the safety of Vioxx” publicly available to investors by October 9, 2001. In re Merck, 483 F. Supp. 2d at 419. Indeed, the district court referred to the FDA warning letter as a “smoking gun’ that should have put plaintiffs on notice. Id. at 422-23. The district court thus concluded that sufficient storm warnings of fraud existed more than two years before plaintiffs filed the first securities fraud action and thus dismissed the consolidated action as time-barred. Id. at 424.
Circuit Court clarifies the standard for inquiry notice
As a preliminary matter to its opinion, the Circuit Court addressed the standard for inquiry notice in order to clarify previous opinions. The plaintiffs argued that the “statute of limitations does not begin to run until there is sufficient evidence of probable, rather than possible, wrongdoing by the defendants.” 2008 WL 4138476, p*8. The court noted that there was precedent for both the “possible” and the “probable” version of the standard.
The court cleared up the inconsistency by stating that the standard is: “’whether the plaintiffs, in the exercise of reasonable diligence, should have known of the basis for their claims depends on whether they had sufficient information of possible wrongdoing to place them on inquiry notice or to excite storm warnings of culpable activity.” 2008 WL 4138476, p*8 (citing Benak, 435 F.3d at 400 (citations, alteration, and internal quotation marks omitted)). The point at which plaintiffs have “sufficient information of possible wrongdoing” is beyond the point of mere suspicion or the incitement of an investigation by the plaintiff – it is the point where the plaintiff has been able to conduct enough of an investigation to adequately plead a complaint alleging culpable activity. 2008 WL 4138476, p* 11.
The District Court mischaracterized plaintiff’s claims
The plaintiffs alleged that the District Court mischaracterized the basis of their claims and, as a result, incorrectly identified the date on which plaintiffs were on inquiry notice. Specifically, the plaintiffs alleged that Merck made false and misleading statements about Vioxx’s commercial prospects, and that Merck knew the drug was so dangerous that it lacked those prospects.
The district court, on the other hand, characterized plaintiff’s claim as relating to Merck’s misrepresentations about Vioxx’s safety profile. Though the drug’s safety profile is closely related to its commercial viability, it is not the same thing – the former is a consumer fraud issue while the latter is a securities fraud issue. 2008 WL 4138476, p* 13. “Even though there were analysts who connected Vioxx’s safety to its commercial viability, it appears that they were not so worried about Vioxx’s safety after the FDA warning letter was made public that they felt it necessary to retract their opinions about Vioxx’s future profitability or Merck’s market position.” Id., p*12.
The Circuit Court warned that the FDA letter could not independently excite a storm warning because it “was not issued in a vacuum of information.” 2008 WL 4138476, p* 14. The court acknowledged that other reports, lawsuits and documents questioning the safety of Vioxx also came out in 2001, but the court found that none of them constituted sufficient information of possible wrongdoing under securities laws to raise a storm warning of culpable activity. Id. p*16.
This was especially true because at that same time, “market analysts, scientists, the press, and even the FDA agreed that the naproxen hypothesis was plausible, at the very least. None suggested that Merck believed otherwise… Merck continued to reassure the investing public at this time…” Id., p*19. Moreover, Merck’s stock price did not react to the FDA letter and contemporaneous reports in a way that would put investors on inquiry notice. The court noted that “information that is material to reasonable investors is immediately incorporated into the stock price.” Id., p.*15. The stock analysts unwavering support of Vioxx at the time, along with Merck’s reassurances and little stock movement, combined to dissipate any storm warnings created by the FDA letter for investor purposes.
The court found that there was “no reason to suspect that Merck did not believe the naproxen hypothesis” until the 2003 Harvard study, which “for the first time belied Merck’s assurances that naproxen was responsible for the disparity in the first study.” Id., p*19. The court determined that the publication of that study put plaintiffs on inquiry notice, meaning that the complaint was timely filed. The court reversed the District Court’s dismissal by a 2-1 vote and remanded the case for further proceedings.
The single dissenting appellate judge wrote that she believed the FDA warning letter was sufficient to put plaintiffs on inquiry notice and that it provided “storm warnings to put the [investors] on notice of their claims regardless of any significant change in stock price or analysts’ stock rating or projections at that time.” Id., p* 19.
The author, Joel B. Ginsberg, Esq., is an associate in the transactional department of Zuber & Taillieu LLP, focusing on corporate law, and securities and finance law.
Securities Law Summary
Read the related Securities Law summary: Third Circuit Reinstates Vioxx Class Action Suit Against Merck
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