Tuesday, April 27, 2010
Merck Majority Says Actual or Constructive Knowledge Required to Start Limitations Period for Securities Fraud
Today, in Merck & Co., Inc. v. Reynolds(Download Merckopinion), a majority of the Justices held that the statute of limitations for securities fraud begins to run once the plaintiff actually discovered, or a reasonably diligent plaintiff would have discovered, the "facts constituting the violation" -- whichever comes first. This is contrary to the language of the statute, which states that the two-year period begins "after discovery of the facts constituting the violation" (with an outside limit of five years after the violation), as Justices Scalia and Thomas note in a concurrence. (Justice Stevens also concurred because he saw no need, in the facts of this case, to focus on the difference between actual and constructive knowledge.) While I can't explain why the majority felt the need, through some rather convoluted analysis, to include a constructive knowledge alternative to cut off a plaintiff's time for filing a complaint, at least I take comfort that the court did not adopt the anti-plaintiff "inquiry notice" standard argued by Merck. As the majority notes, the statute's knowledge standard cannot be stretched to include inquiry notice.
The majority does strongly refute two of Merck's arguments: first, that the statute does not require "discovery" of scienter-related facts, and, second, that even if "discovery" requires scienter-related facts, facts that tend to show a materially false or misleading statement (or material omission) are sufficient to show scienter as well. Both these arguments are counter to the scienter requirement of Rule 10b-5, not only the necessity of plaintiff's proving a wrongful intent but also meeting the hightened pleading requirement of PSLRA. How could plaintiff's statute of limitations begin to run when it had insufficient knowledge to file a complaint that would withstand a motion to dismiss? Only the most plaintiff-unfriendly court could so hold (as some did). But the majority reminds the defendant (just as courts frequently remind plaintiffs in granting defendants motions to dismiss) that the fact that an earnings statement is false does not neccessary mean that the defendants have lied; the misstatement may be the product of negligence.
Will the interpretation of "knowledge" to include constructive knowledge -- i.e., when a reasonably diligent plaintiff plaintiff would have discovered the facts constituting the violation -- make a meaningful difference in any significant number of cases? I don't know, but it is unfortunate that defendants are given a greater opportunity to argue that the complaint is timely, given the statute's plain meaning and the many advantages defendants currently have to get a complaint dismissed for failure to plead fraud with the requisite specificity. I fear this will give district courts freedom to find complaints untimely based on some Platonic notion of what an idealized "reasonably diligent" investor would do.