Securities Law Blog

The U.S. Supreme Court, in a unanimous decision, recently issued a ruling that will have a profound effect on shareholder fraud lawsuits. Justice Stephen Breyer wrote the opinion of the Court for Merck & Co., Inc. v. Richard Reynolds et al. that has relaxed the deadlines for the filing of cases alleging violations of the federal securities laws.

The disputed issue was the timeliness of a complaint filed in a private securities fraud action against Merck. Merck alleged that the plaintiffs should have discovered the “facts constituting the violation” before November 6, 2001, and therefore their complaint filed November 6, 2003 is beyond the statute of limitations.

According to the Court’s opinion, the November 2003 complaint alleged that Merck had defrauded investors by promoting the drug Vioxx despite its knowledge of its serious safety issues. The plaintiffs alleged their claim to be timely because they had not, and could not have, discovered by the critical date those “facts,” particularly facts related to scienter.

The applicable statute passed by Congress in 2002 provides that an action that “involved a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning securities laws…may be brought not later than the earlier of 1) two years after the discovery of the facts constituting the violation; or 2) five years after such violation.”

The Court found scienter to be a necessary fact to be discovered in order for the limitations period to begin to run. In a claim alleging fraud, a plaintiff must allege that a defendant made a “material misstatement with an intent to deceive” and not merely acted negligently. If the limitations period began to run regardless of evidence of scienter, the two year period could expire without anyone ever discovering the fraud.

The Court rejected Merck’s argument that pre-November 2001 events showed intent to defraud/deceive. (These warnings included concerns related to the health complications of Vioxx.) Merck allegedly continued to stand behind their product after a study was conducted and showed the cardiovascular risks associated with the drug.

Merck further argued that by November 1, 2001, plaintiffs possessed enough information “sufficiently suggestive of wrongdoing that they should conduct a further inquiry.” The Court found that although the plaintiff class may have been prompted to investigate further, they would not have had the facts needed to prove a fraud violation had occurred. None of the pre-November 2001 circumstances were found to provide the plaintiffs with information about Merck’s state of mind.

Justice Breyer referenced three important events that occurred after the November 1, 2001 date. These events include a Vioxx study showing increased risk of heart attacks for users, published by The Wall Street Journal (WSJ); Merck’s withdrawal of Vioxx from the market; and a WSJ article that published internal Merck emails and marketing materials that show the company “fought forcefully for years to keep safety concerns from destroying the drug’s commercial prospects.”

The Court held that the limitations period does not begin until the “plaintiff discovers or a reasonably diligent plaintiff would have discovered the facts constituting the violation,” including scienter-regardless of whether the actual plaintiff undertook a reasonably diligent investigation.