Supreme Court and Limitations Period for Securities Fraud

In a victory for the plaintiff shareholders, the US Supreme Court unanimously ruled in Merck & Co., Inc. v. Reynolds that the statute of limitations actions brought under §10(b) of the Securities Exchange Act of 1934 begins to run upon “discovery of the facts constituting the violation.” The Court held “facts showing scienter are among those that ‘constitut[e] the violation.’” Justice Breyer, writing for the Court ruled that, due to delayed discovery of the claim, the two-year statute of limitations did not bar the investors from bringing a securities fraud action. The decision stated:

We conclude that the limitations period in §1658(b)(1) begins to run once the plaintiff did discover or a reasonably diligent plaintiff would have “discover[ed] the facts constituting the violation”—whichever comes first. In determining the time at which “discovery” of those “facts” occurred, terms such as “inquiry notice” and “storm warnings” may be useful to the extent that they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating. But the limitations period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered “the facts constituting the violation,” including scienter—irrespective of whether the actual plaintiff undertook a reasonably diligent investigation.

Now the shareholders may pursue their claims that Merck & Co. Inc. violated federal securities law by misrepresenting the safety and commercial viability of Vioxx, a pain reliever ultimately withdrawn from the market. The Court affirmed the Third Circuit Court of Appeal’s decision In re Merck & Co. Securities, Derivative & ERISA Litigation, 543 F.3d 150 (3d Cir. 2008), which held that the statute of limitations does not begin to run until the plaintiff has information suggesting defendant’s scienter. The Third Circuit decision reversed the judgment of dismissal entered by the US District Court for the District of New Jersey, which ruled that the claims were barred by the statute of limitations because the plaintiffs “were put on inquiry notice of the alleged fraud more than two years before they filed suit.” See In re Merck & Co., Inc. Securities, Derivative & “”Erisa” Litigation, 483 F.Supp.2d 407 (D.N.J. 2007).

Justice Scalia, joined by Justice Thomas, concurred in part and concurred in the judgment. Justice Scalia argued for an even more plaintiff-friendly result, stating that the statute of limitations should begin to run when a plaintiff actually discovers facts constituting the violation, rather than when a reasonably diligent plaintiff should have known such facts.

In its decision the Court rejected Merck’s proposed “inquiry notice” standard as inconsistent with the statute, which provides that “discovery” is the event that triggers the 2-year limitations period—for all plaintiffs. It noted that courts applying the traditional discovery rule have long had to ask what a reasonably diligent plaintiff would have known and that courts in at least five Circuits already ask this kind of question in securities fraud cases. Whether the interpretation of “knowledge” to include constructive knowledge will make a meaningful difference in a significant number of cases is unclear. District courts may yet find complaints untimely based on what a “reasonably diligent” investor would do.