Rule 10b-5 and the Statute of Limitations: Actual Knowledge Not Inquiry Notice. An Amicus Brief Filed at the US Supreme Court in Merck v. Reynolds

51 Pages Posted: 3 Nov 2009

See all articles by J. Robert Brown

J. Robert Brown

University of Denver Sturm College of Law

Date Written: November 2, 2009

Abstract

After more than a half century of judicial monopoly, Congress in 2002 adopted Section 1658(b), thereby creating a statute of limitations and repose for fraud actions brought under Section 10(b) and Rule 10b-5. The five year period of repose represents an outside cut-off that commences at the time of the violation. The two year limitations period begins upon “discovery of the facts constituting” the fraud. See 28 U.S.C. § 1658(b). Under the self-evident meaning of this language, the limitations period begins only when plaintiffs discover - that is, actually know - that they have been defrauded. The legislative history confirms this actual-knowledge standard. The limitations period was not meant to be used to investigate whether a fraud occurred, but to address the “obstacles” that exist “after the fraud is discovered,” including the need to unravel the complexities of the violation and address the logistical concerns in bringing a claim, particularly the need to marshal the facts sufficient to meet the heightened pleading standards set out in the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (PSLRA). See S. Rep. No. 146, 107th Cong., 2d Sess. 9 (May 6, 2002).

This Court in Lampf adopted an actual-knowledge, not an inquiry-notice, standard for determining the accrual date of the one year limitations period. This was apparent from this Court’s express reliance on Section 9(e) of the Exchange Act, 15 U.S.C. § 78i(e), with its actual knowledge standard, as the appropriate model, and the explicit rejection of Section 13 of the 1933 Act, with its inquiry notice standard. Lampf’s reliance on an actual knowledge standard was also apparent in this Court’s treatment of equitable tolling. Tolling had allowed courts to ensure fairness by using equity to delay the accrual date where plaintiffs were unaware of the fraud through no fault of their own. Lampf concluded, however, that equitable tolling would henceforth be “unnecessary,” an approach that could only be understood as a direct consequence of an accrual standard that depended upon plaintiffs’ actual knowledge of the fraud. With plaintiffs aware of having been defrauded, a tolling doctrine designed to provide additional time to uncover the violation had become superfluous or “unnecessary.”

The actual-knowledge standard does not interfere with the goals of finality and the elimination of stale claims. Those concerns are addressed through the adoption of a five year statute of repose. As for the assertion that the actual knowledge standard somehow allows plaintiffs to delay the onset of the limitations period through inactivity, this concern is misplaced. First, the modern realities of class action securities fraud suits against public companies provide considerable practical incentive to investigate the mere suspicion of a violation. Any delay in investigation could result in the expiration of the period of repose or the failure to meet the heightened pleading standards contained in the PSLRA.

The possibility of deliberate inactivity is also belied by the competitive reality of class action securities litigation. SOX sought to increase the role of institutional investors, those plaintiffs with the resources available to conduct investigations. In addition, law firms that delay investigating the possibility of fraud could find themselves at a competitive disadvantage. The first firm to become aware of the fraud and discern the applicable class will be in a position to identify possible lead plaintiffs, the investors with the largest financial interest in the relief sought, increasing the potential likelihood that it will be designated lead counsel. See 15 U.S.C. § 78u-4. Second, a legal standard that determines actual knowledge through reference to the entire class will essentially eliminate even the possibility of the strategic use of inactivity. In the context of class actions against public companies for securities fraud, actual knowledge is most appropriately considered through resort to the information known to the class as a whole. To the extent known to the class, plaintiffs will be unable to rely on their own unawareness to delay the onset of the limitations period. This also provides plaintiffs with an additional incentive to investigate even the possibility of fraud in order discover facts known to the market.

This use of the inquiry notice standard on the one hand permits the elimination of potentially meritorious claims and on the other hand encourages the filing of meritless claims. Meritless claims do more than waste resources. They open plaintiffs and their counsel to the possibility of sanctions under Rule 11. See 15 U.S.C. § 78u-4(c)(making mandatory consideration of sanctions under Rule 11 upon final adjudication of a securities fraud action).

Suggested Citation

Brown, J. Robert, Rule 10b-5 and the Statute of Limitations: Actual Knowledge Not Inquiry Notice. An Amicus Brief Filed at the US Supreme Court in Merck v. Reynolds (November 2, 2009). U Denver Legal Studies Research Paper No. 09-27, Available at SSRN: https://ssrn.com/abstract=1498672 or http://dx.doi.org/10.2139/ssrn.1498672

J. Robert Brown (Contact Author)

University of Denver Sturm College of Law ( email )

2255 E. Evans Avenue
Denver, CO 80208
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
157
Abstract Views
2,730
Rank
339,922
PlumX Metrics