Securities Act Claims and 'Inquiry Notice' in Second Circuit
The question of whether "inquiry notice" for claims under the Securities Act of 1933 survived the U.S. Supreme Court's decision in Merck & Co. v. Reynolds, which rejected inquiry notice for Section 10(b) claims under the Securities Exchange Act of 1934, was recently addressed by the U.S. Court of Appeals for the Third Circuit in Pension Trust Fund for Operating Engineers v. Mortgage Asset Securitization Transactions. Largely following the Supreme Court's analysis for Exchange Act claims in Merck, the Third Circuit rejected inquiry notice for Securities Act claims as well.1 To date, no other circuit court has considered this issue.
Not long ago, however, the issue was squarely before the U.S. Court of Appeals for the Second Circuit in Freidus v. Barclays Bank PLC. The district court in Barclays held that inquiry notice remains the appropriate standard for determining when the statute of limitations commences for Section 11 and 12 claims under the Securities Act, reasoning that Merck involved only Section 10(b) and neither the Supreme Court nor the Second Circuit have extended Merck's holding to claims under the Securities Act.
The lower court went on to conclude, however, that the plaintiffs' claims were barred under either an inquiry notice or constructive knowledge standard, opening the door for the Second Circuit to avoid the inquiry notice question altogether. And that is precisely what happened. The Second Circuit agreed with the district court that the plaintiffs' claims were time-barred under a constructive notice standard and declined to "discuss the inquiry notice issue."2
Although not resolved in Barclays, the Second Circuit will most certainly face the inquiry notice question again given the clear split within the circuit on this issue. This article will discuss the inquiry notice standard generally, the Merck decision, the ensuing disagreement among the district courts regarding Merck's impact on Securities Act claims, and the recent Third Circuit decision in Pension Trust. The article will then consider possible outcomes on the fate of inquiry notice when an appropriate case inevitably makes its way to the Second Circuit.
Inquiry Notice Generally
The federal circuit courts have all applied some form of an inquiry notice standard to determine when the statute of limitations is triggered for Section 11 and 12 claims arising under the Securities Act and Section 10(b) claims arising under the Exchange Act. While the precise standard employed by the different circuits varies, a plaintiff is generally deemed to be on inquiry notice in the Second Circuit when "circumstances would suggest to an investor of ordinary intelligence the probability that she has been defrauded."3 These circumstances, referred to as "storm warnings," may arise from "any financial, legal, or other data, including public disclosures in the media about the financial condition of the corporation and other lawsuits" alleging misconduct by the defendants.4
Once on inquiry notice, a plaintiff has a duty to investigate.5 If the plaintiff fails to do so, the Second Circuit will impute knowledge of the facts constituting the violation as of the date the duty to investigate arises, and the statute is triggered at that moment.6 If the plaintiff undertakes an investigation, the statute will not commence until a reasonably diligent plaintiff would have discovered the facts constituting the violation.7
The 'Merck' Decision
The applicability of inquiry notice to claims under Section 10(b) was put into question and ultimately rejected by the Supreme Court's Merck & Co. v. Reynolds decision in 2010.8 In Merck, a class of investors brought securities fraud claims, alleging the defendant had knowingly misrepresented the safety and commercial viability of the pain reliever Vioxx. The district court dismissed the complaint on the ground that investors were on inquiry notice more than two years before filing suit as a result of various "storm warnings," including previous lawsuits, a warning letter from the Food and Drug Administration, and numerous articles reporting on the drug's possible risks.9 The Third Circuit reversed, holding that the putative storm warnings were insufficient to trigger inquiry notice.10
The Supreme Court affirmed the Third Circuit's conclusion that the plaintiffs' claims were not time-barred but rejected application of an inquiry notice standard to Section 10(b) claims. The Merck court looked to the language of 28 U.S.C. §1658(b), which provides, in relevant part, that private causes of action for fraud under the Exchange Act must be brought within "2 years after the discovery of the facts constituting the violation…."11 The Supreme Court concluded that the concept of inquiry notice was at odds with this statutory language, which the court noted "contains no indication that the limitations period should occur at some earlier moment before 'discovery,' when a plaintiff would have begun investigating…."12
While the Merck court rejected inquiry notice based on the specific language of Section 1658, it relied on federal circuit precedent to support its holding that the word "discovery," as used in Section 1658(b), means not only "when the plaintiff did in fact discover" the facts constituting the violation (i.e., actual knowledge) but also "when a reasonably diligent plaintiff would have discovered" such facts (i.e., constructive knowledge). The court concluded that virtually all federal circuit courts had construed "discovery" to include both actual and constructive knowledge and assumed that Congress was aware of this "relevant judicial precedent" when it enacted Section 1658(b).13
The Merck court observed that the concepts of inquiry notice and storm warnings may continue to be helpful to identify when a reasonably diligent plaintiff would have ascertained the "facts constituting the violation," but the key point in time following Merck is no longer when an investor should have begun an investigation but rather, when a reasonably diligent investor would have uncovered sufficient facts of the violation.14 The Supreme Court was not called upon to decide whether some form of inquiry notice would continue to apply to other securities claims.
In a partial concurrence, Justice Antonin Scalia took issue with the majority's reading of the word "discovery" in Section 1658(b)(1) to include constructive discovery. Scalia noted that 15 U.S.C. §77m of the Securities Act, which was enacted prior to Section 1658(b)(1), "explicitly established a constructive-discovery rule for claims under §§11 and 12 of that Act," requiring that such claims 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…."15 Scalia reasoned that if "discovery" in Section 77m includes constructive discovery, as the majority held in the context of Section 1658(b)(1), the last phrase of Section 77m would be rendered superfluous.16
Split in the Courts
In the three years since Merck, district courts across the country have split on the question of whether inquiry notice is still relevant for Section 11 and 12 claims.17 District courts within the Second Circuit—where this issue has arisen more often than in all the other districts combined—are likewise divided on whether inquiry notice for Securities Act claims survived Merck.18
One line of cases has refused to apply inquiry notice to Securities Act claims post-Merck reasoning that because the Supreme Court "interpreted the Exchange Act's 'discovery' standard to imply the diligence requirement that the Securities Act makes explicit, there appears to be no principled reason to depart from the precedents of this Circuit holding that the accrual standards under the two statutes are to be treated identically."19 Another line of cases reaches the opposite conclusion, focusing on the differences in the language of Sections 1658(b) and 77m: "[Merck] held that inquiry notice does not trigger the statute of limitations in the specific context of 28 U.S.C. §1658—which is not at issue here—based on the precise language of that statute…."20