Securities Law | Expert Legal Commentary
June 30, 2010
Merck & Co. v. Reynolds: Statute of Limitations for Securities Fraud Begins to Run When Plaintiff Receives Evidence of Scienter
Merck & Co. v. Reynolds
Yuri Mikulka of Stradling Yocca Carlson & Rauth and Joel Ginsberg
The U.S. Supreme Court has held that the statute of limitations set forth in 28 U.S.C. section 1658(b)(1) begins to run once the reasonable investor/plaintiff discovers the facts constituting the elements of the violation, including scienter. In Merck & Co. v. Reynolds, ___ U.S. ____, 130 S.Ct. 1784 (2010), the U.S. Supreme Court affirmed the Third Circuit Court of Appeals’ finding that the investor class timely filed its action. The case has potentially far-reaching effects, in that it may enable plaintiffs to delay the filing of litigation in order to increase settlement value. Similarly, it introduces a level of uncertainty for potential defendants, who can no longer rely on a strict two-year limitations period.
On May 9, 1999, the Food & Drug Administration approved Vioxx, a painkiller developed by Merck that worked a lot like ibuprofen and naproxen, but without the gastrointestinal damage. That same year, Merck initiated research comparing Vioxx to naproxen. The results showed that people taking Vioxx had a higher incidence of heart attacks than users of naproxen, which Merck claimed was the result of naproxen’s (unproven) ability to reduce heart attacks rather than anything wrong with Vioxx.
In early 2001, the FDA and the Journal of the American Medical Association began expressing some concerns about the research results and Vioxx’s potential link to heart attacks. Most securities analysts characterized these concerns as little more than reiteration of what was already known about Vioxx.
On September 21, 2001, the FDA issued a warning letter, accusing Merck of downplaying the potential risks of Vioxx and holding out its naproxen theory as something more than an unproven theory (the “FDA warning letter”). Merck’s stock price fell briefly, but quickly recovered as analysts remained enthusiastic about Vioxx. On October 9, 2001, the New York Times published an article about the potential increased risk of heart attacks with Vioxx, but it still was primarily a reiteration of previously known information.
In October 2003, the Wall Street Journal published an article describing the results of a Harvard study that directly linked Vioxx to an increased risk of heart attacks (the “ Harvard study”). Merck’s stock plummeted and it voluntarily pulled Vioxx off the market in September 2004.
On November 3, 2003, the plaintiff class of Merck investors filed suit in federal district court in New Jersey, alleging that Merck had violated securities laws by misrepresenting the safety risks and commercial viability of Vioxx. Merck moved to dismiss, claiming that the two-year statute of limitations set forth in 28 U.S.C. section 1658(b) had already run. The district court agreed with Merck and dismissed the case.
The plaintiffs appealed to the Third Circuit Court of Appeals, which reversed the district court, holding that the plaintiffs did not have sufficient knowledge of the facts constituting their claim on or before November 3, 2001, two years before they filed the action, and therefore their claim could proceed. Merck appealed.
The Statute Does Not Run Until Plaintiffs Discover the Fact of Scienter
The statute of limitations for federal securities fraud claims is the shorter of: (1) “[two] years after the discovery of the facts constituting the violation;” or (2) “[five] years after such violation.” 28 U.S.C. section 1658(b). Both Merck and the class agreed that the two-year period does not necessarily begin when the plaintiffs have actual knowledge of the relevant facts; constructive knowledge (when the plaintiff should reasonably know the facts) would suffice. The trigger is commonly called “inquiry notice,” referencing that once plaintiffs are constructively or actually aware of the facts suggesting a violation, they are then under a duty to inquire or investigate further to determine whether a claim exists.
Merck argued that the FDA Warning Letter, which came out in September 2001, provided the kind of “storm warnings” that would give a Merck investor cause for concern and charge him or her with the responsibility of conducting a diligent investigation, i.e., put the plaintiff on inquiry notice. Merck & Co. v. Reynolds, ___ U.S. ____, 130 S.Ct. 1784, 1798 (2010). Merck argued that because the FDA Warning Letter, published more than two years before the class action was filed, should have put the investors on inquiry notice, the action should be dismissed.
But the Third Circuit disagreed, discounting the FDA Warning Letter’s effect because it did not accuse Merck of not believing its naproxen theory – it just directed Merck to clearly inform health practitioners that the theory was unproven. In re Merck & Co., Inc. Securities, Derivative & “ERISA,”543 F.3d 150, 170 – 171 (3rd Cir. 2008). Moreover, the Third Circuit pointed out that because the FDA is not charged with securities regulation, its Warning Letter could not trigger a “storm warning” in securities markets. Id. at 171. Instead, the first “storm warning,” found the Third Circuit, was upon publication of the Harvard study results in the Wall Street Journal, which was well within the limitations period. Id. at 172.
The Supreme Court agreed with the Third Circuit, framing the issue as a case concerning “the timeliness of a complaint filed in a private securities fraud action. The complaint was timely if filed no more than two years after the plaintiffs ‘discover[ed] the facts constituting the violation.’ 28 U.S.C. section 1658(b)(1). Construing this limitations statute for the first time, we hold that a 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. We also hold that the ‘facts constituting the violation’ include the fact of scienter, ‘a mental state embracing intent to deceive, manipulate, or defraud.’ Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194, n. 12 (1976). Applying this standard, we affirm the Court of Appeals’ determination that the complaint filed here was timely.” 130. S.Ct. at 1789-1790.
In amicus briefs to the Supreme Court in favor of Merck’s position, entities like the Chamber of Commerce for the United States of America argued that the Third Circuit’s ruling would allow plaintiffs to unjustly boost the value of their claims for settlement purposes by deliberately waiting until company stocked dropped significantly, thereby increasing their losses, before filing a complaint. Merck and its supporters argued that beginning the limitations period when the plaintiffs have only a general knowledge of potential fraud would encourage prompt investigation of claims and discourage potential plaintiffs from taking this “wait and see” approach. Only time will tell if this is indeed the impact of the Court’s ruling.
However, the Supreme Court’s opinion does maximize a plaintiff’s opportunity to gather the facts necessary to bring meritorious claims to court and obtain redress for their damages. The Court has frequently shown a desire to open access to courts to ensure their availability to meritorious plaintiffs, even if at the cost of allowing a few potentially meritless claims to sneak through. The Merck decision is consistent with that approach.
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