Recent Third Circuit Opinion in Inquiry Notice

A recent Third Circuit decision provides another illustration of the obstacles federal courts impose on investors who allege securities fraud.  In DeBenedictis v. Merrill Lynch & Co., 2007 WL 1732254 (3d Cir. June 18, 2007), the court held that the lead plaintiff's class action against his brokerage firm for recommending the purchase of Class B mutual fund shares was time-barred because he was on "inquiry notice" of his claims more than two years before.  A significant portion of the opinion is a verbatim recital, from both the mutual fund prospectus and the SAI, of the descriptions of the different classes of mutual fund shares and the compensation structure for sales personnel.  (The court does not acknowledge, if indeed it is aware, that most mutual fund investors do not receive the SAI.)  In addition, the court took judicial notice of two articles (one from USA Today, one from Time magazine) and a Wall St. Journal article that warned investors about the high costs of Class B shares, as well as several NASD press releases disciplining other brokerage firms for unsuitable recommendations of Class B shares.  According to the Third Circuit, these communcations put the plaintiff on inquiry notice because a "reasonable investor of ordinary intelligence would have discovered the information and recognized it as a storm warning."  It did not matter, as the plaintiff argued, that the media coverage and the NASD actions did not specifically identify Merrill Lynch as an offender; in fact, the Wall St. Journal referred approvingly to Merrill Lynch's efforts to train its brokers on the different classes of mutual funds.  Instead, the court concludes: "even if a mutual fund investor failed to read the Registration Statements when they were initially received and failed to run any independent calculations of the fees that would be incurred on Class B shares [!], the news articles questioning the profitability of such shares and highlighting the possible conflict of interest would urge the reasonable investor to return to the profitability of his or her own investments and investigate their broker's conflict of interest."   Thus, apparently, a reasonable investor is expected to follow media coverage of his investments in order to second-guess the recommendation of his trusted "financial consultant."