(The article featured
below is a selection from Federal
Securities Law Reporter, which is available to subscribers of that
publication.)
Government Lawyers Argue for Expanded Inquiry
Notice Definition
On November 30, 2009, the U.S. Supreme Court will hear oral
argument in an important securities litigation case. The court will address the
meaning of "inquiry notice" for limitations
purposes in its review of Merck & Co. v. Reynolds, a 3rd Circuit
decision arising from the Vioxx litigation. The U.S. District Court for the
District of New Jersey had previously dismissed the action on limitations
grounds, concluding that there were ample "storm
warnings" concerning the safety of Vioxx from press reports and FDA
statements. However, Judge Dolores K. Sloviter wrote that the lower court "acted
prematurely in finding as a matter of law" that the plaintiffs were
on inquiry notice resulting in the dismissal under the statute of limitations.
Initially, the appeals court reaffirmed the standard for inquiry
notice in the circuit, stating that the question is "whether
the plaintiffs, in the exercise of reasonable diligence, should have known of
the basis for their claims depends on whether they had sufficient information of
possible wrongdoing to place them on inquiry notice or to excite storm warnings
of culpable activity." Judge Sloviter then wrote that with regard to
the claimed misrepresentations concerning the safety profile for Vioxx that "the
fact that many securities analysts continued to maintain strong growth ratings
for Vioxx at the same time that its safety was being questioned is certainly
relevant to whether such questions constituted sufficient information of
possible wrongdoing to trigger storm warnings."
A significant element of the claim involved a study of Vioxx and
naproxen, a non-prescription pain reliever. The study showed a higher rate of
heart problems for Vioxx users than for naproxen patients. However, Merck
asserted that the disparity could be accounted for by the beneficial effects of
naproxen on the cardiovascular system rather than any unreasonable danger
associated with Vioxx. Judge Sloviter concluded that "there
is no reason to suspect that Merck did not believe the naproxen hypothesis"
until a Harvard study in 2003 discredited the notion. Accordingly, the panel
found that Merck did not know its public statements in 2001 were false.
The SEC and the solicitor general have filed an amicus brief with
the high court urging the justices to affirm the 3rd Circuit decision. According
to the government brief, the limitations period "does
not begin to run until the plaintiff has actually discovered, or in the exercise
of reasonable diligence ought to have discovered, facts demonstrating that all
the elements of a securities fraud violation can be established." In
particular, the government argued, because scienter is an essential element of a
Section 10(b) violation, the term "facts constituting
the violation" is best construed to include facts demonstrating that
the defendant possessed the requisite mental state. While the concept of
discovering the relevant facts encompasses constructive as well as actual
discovery, the government asserted that "constructive
discovery is properly deemed to occur at the time a reasonably diligent investor
would have unearthed the relevant facts" and not when such an
investor would begin investigating.
The government brief rejected the company's argument that the
relevant facts for inquiry notice include only those concerning the
defendant’s conduct, and not the defendant’s state of mind. Because the
potential plaintiff must be alerted to the possible existence of a violation
rather than just a misstatement, the government lawyers stated that "it
is particularly clear that the "facts constituting the violation"
include facts demonstrating the requisite scienter."
Several organizations have also filed briefs with the court,
including the Pharmaceutical and Research Manufacturers of America, the
Washington Legal Foundation, the U.S. Chamber of Commerce and the Securities
Industry and Financial Markets Association. For example, according to the SIFMA
brief, inquiry notice is triggered by awareness of an injury, regardless of
whether the plaintiff had knowledge of the defendant's culpability. SIFMA
concluded that when "a plaintiff has not conducted any
investigation...no purpose would be served by extending the time within which to
sue beyond two years from inquiry notice that there was a
misrepresentation."
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