"U.S. Supreme Court Addresses Statute of Limitations for Securities Fraud Actions"
Merck & Co., Inc. v. Reynolds presented the first opportunity for the Supreme Court of the United States to construe the statute of limitations and repose governing private rights of action under Section 10(b) of the Securities Exchange Act of 1934.1 Section 1658(b) mandates that claims must be brought not later than the earlier of “2 years after the discovery of the facts constituting a violation” or “5 years after such violation.” In an opinion authored by Justice Stephen Breyer, the Court rejected what was commonly known as the “inquiry notice” standard and held that Section 1658(b)’s two-year limitations period begins to run when a plaintiff discovers, or a reasonably diligent hypothetical plaintiff would have discovered, facts constituting the underlying violation — including scienter — whichever occurs earlier.2
While in some circumstances this decision may make it more difficult for defendants to prevail on a statute of limitations defense at the motion to dismiss phase, the Court did definitively hold that the applicable two-year statute of limitations begins to accrue not just upon actual discovery but also upon when a reasonably diligent plaintiff would have discovered facts constituting the underlying alleged violations, regardless of whether any investigation was actually conducted:
- Actual or Constructive Discovery Is the Trigger: The Court held that, for purposes of the statute of limitations analysis, the use of the word “discovery” in Section 1658(b) by Congress means that the limitations period begins upon the earlier discovery of “not only of those facts the plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known.”
- “Facts Showing Scienter” Are Necessary: In light of the heightened pleading requirements for scienter in Section 10(b) claims, the Court explained that “facts showing scienter” are among those that must be discovered before the limitations period begins to run. The Court further noted that if the rule were otherwise, plaintiffs would be required to sue before they had facts necessary to plead scienter with specificity to avoid a limitations-period bar. Referring to the Court’s prior holding in Tellabs, Inc. v. Makor Issues & Rights, Ltd., Justice Breyer stated that “unless a [Section] 10(b) plaintiff can set forth facts in the complaint showing that it is more likely than not that the defendant acted with the relevant knowledge or intent, the claim will fail.” This interpretation of Tellabs may be significant, as some courts have read Tellabs to require plaintiffs to only plead facts showing an inference of scienter that is at least as likely as a nonculpable one.
- Effect on Other Elements Was Not Addressed: The Court did not address whether a plaintiff must also have discovered facts relating to other elements of a private right of action such as reliance, losses and loss causation, leaving these issues for further percolation through the courts.
- “Inquiry Notice” Discarded: The Court made clear that “inquiry notice” — i.e., the point “where the facts would lead a reasonably diligent plaintiff to investigate further” — may occur before discovery of the facts constituting the Section 10(b) claim, and accordingly is no longer determinative of when a claim accrues and the limitations period commences. However, “inquiry notice” does bear upon the question of whether a reasonably diligent plaintiff would have been prompted to being investigating a potential violation.
Another noteworthy aspect of the Merck decision is found in Justice Antonin Scalia’s concurrence, wherein he argues as a matter of statutory interpretation against implying a constructive-discovery rule for Section 10(b) claims and instead reasons that “discovery” as used in that section must mean “actual discovery.” Justice Scalia points to the explicit language of Section 13 of the Securities Act of 1933, applicable to claims alleging violations of Sections 11 and 12 of that Act, which requires that actions must be brought within one year “after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence.” In language that may become more significant as the lower courts begin to consider how Merck may differentially impact statute of limitations determinations in Section 10(b) and Section 11 and 12 claims, Justice Scalia recognizes that a constructive-discovery standard may be easier to apply to Section 11 and 12 claims because “determining when the plaintiff should have uncovered an untrue assertion in a registration statement or prospectus is much simpler than assessing when a plaintiff should have learned that the defendant deliberately misled him using a deceptive device covered by [Section] 10(b).”
Relatedly, the Court’s decision to apply both an actual notice and a constructive-notice standard will likely require increased scrutiny at the motion to dismiss stage of what information is known or with reasonable diligence could be known upon investigation in the two years prior to filing of a complaint. Depending on the context-specific record in any particular case, and where unlike in Merck where the allegations concerning scienter were alleged to be discovered after the two-year period, there may be instances where a statute of limitations defense remains viable even for Section 10(b) claims notwithstanding the Court’s specific holding as applied to the unique facts in Merck.
1 28 U.S.C. § 1658(b) applies to claims of “fraud, deceit, manipulation or contrivance in contravention of a regulatory requirement concerning the securities laws.”
2 The Court expressly noted that the five-year statute of repose in Section 1658(b) is “an unqualified bar” which is not subject to tolling and provides “defendants total repose after five years.”
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