April.27.2010
On April 27, 2010, the Supreme Court issued an opinion in Merck & Co., Inc. v. Reynolds that clarifies the limitations period applicable to claims under Section 10(b) of the Securities Exchange Act in a way that increases the time for plaintiffs to file securities class action complaints. The Merck Court construed the meaning of the term "discovery of the facts constituting the violation" to refer to the time at which the plaintiff did in fact discover or would have discovered through the exercise of reasonable diligence facts constituting a violation of Section 10(b). It rejected Merck's argument that "inquiry notice"—that is, the point where the facts would lead a reasonably diligent plaintiff to investigate further—would be sufficient, holding that the point at which a reasonable investigation would begin is not the same as the point at which the necessary facts would be discovered. It also rejected Merck's request that an inquiry notice standard at least apply when a plaintiff fails to conduct a reasonably diligent investigation. Again, the Court found inquiry notice incompatible with the terms of the statute, regardless of the diligence of the plaintiff in investigating its potential claim.
The Court also ruled that the "facts constituting the violation" included the fact of scienter; that is, the defendant's mental state. It observed that scienter was a necessary element of any Section 10(b) claim and that Congress passed heightened pleading standards requiring that scienter be pled with specific facts showing that the defendant more likely than not acted with the relevant knowledge or intent. Given the requirement to plead facts showing scienter, the Court held it would "frustrate the very purpose of the discovery rule" if the limitations period began to run regardless of whether the plaintiff had discovered facts suggesting scienter. The Court rejected Merck's argument that knowledge of material false statements equated to knowledge of scienter, observing that in the context of Section 10(b) claims, the relation of factual falsity and state of mind is not always obvious and that more facts beyond the mere falsity of a statement may be necessary to show that it was made with the requisite scienter. The opinion does not expressly address the question of whether recklessness is sufficient to satisfy the scienter element, though the Court reiterated that plaintiffs must prove that the "defendant made a material misstatement with an intent to deceive—not merely innocently or negligently."
The Court's ruling resolved a split among the Circuits, some of which had applied an "inquiry notice" standard, either to all plaintiffs or only to those who failed to conduct reasonably diligent investigations. The ruling likely makes it more difficult for a Section 10(b) claim to be dismissed on statute of limitations grounds, as defendants will be required to show not just that plaintiffs should have investigated sooner, but that they actually knew or reasonably should have known of facts constituting the actual violation. Moreover, it likely provides plaintiffs with more time after an alleged violation occurs in which to file their complaint. In response to Merck's contention that the ruling could expose defendants to stale claims based on acts taken long ago, the Court stated that the five-year statute of repose should alleviate that fear. There is little doubt, however, that this ruling will significantly affect defendants' potential exposure under Section 10(b).