The High Court Giveth—and the High Court Taketh Away?

Investors celebrated the recent unanimous Merck decision on inquiry notice that allowed the Vioxx fraud litigation to proceed. In that case, the court held that the limitations period for securities fraud cases begins to run on the earlier of 1) the date on which the plaintiff actually discovered the facts constituting the violation or 2) the date on which a reasonably diligent plaintiff would have made that discovery. In securities fraud cases, held the Court, facts showing scienter are among those that constitute the violation (Merck & Co., Inc. v. Reynolds).

This week, however, the Supreme Court vacated a 9th Circuit ruling in favor of an investor, and directed the appeals court to reconsider its ruling in light of Merck. The case, Betz v. Trainer Wortham & Co., Inc., included a dissent from the en banc reconsideration denial and language in the defendants' certiorari petition that can at least be described as "colorful."

The 9th Circuit allowed a suit filed by Heide Betz, a retired art dealer, against Trainer Wortham, an investment firm, to go forward. Betz told the Trainer Wortham employees that she knew "nothing" about stocks and bonds. She invested $2.2 million with Trainer Wortham, and claimed that the firm agreed to invest the money in a way that would allow her to withdraw $15,000 monthly while maintaining the principal. Betz received account statements at least monthly. In February 2000, she received a statement reflecting an account value below her initial investment of $2.2 million. By July 2001, she had received 29 account statements, each reflecting an account balance of less than $2.2 million. In March 2001, Betz's account balance dropped to $848,000.

Betz spoke with a Trainer Wortham employee about the declining value of her account. The employee told her the market would rebound and her account balance would be back to $2.2 million. When subsequent account statements showed the balance of Betz's account continuing to fall, she met with the original representative who allegedly told her that there was a “serious problem” with the way the portfolio had been managed and that the president of Trainer Wortham would “take care of the account." In May 2002, after Betz had met with the firm's president in person, employees told her to be patient with them and not take any legal action. However, in June 2002, the firm advised Betz that Trainer Wortham was “not going to do anything at all” to remedy the declining value of her account. Betz filed her complaint in this case on July 11, 2003. The district court held that because Betz had inquiry notice of the defendants' violations before July 11, 2001, her claims were time-barred.

On appeal, the 9th Circuit concluded that the suit could not be deemed untimely as a matter of law. The panel rejected the defendants' contention that the account statements would have spurred a reasonable investor to inquire further whether Trainer Wortham had defrauded her. According to the appeals court, the "express assurances" that the firm would remedy the problems with the account "may have lulled a reasonable investor into inaction."

A divided court denied en banc review. Chief Judge Alex Kozinski, dissenting from the en banc rehearing denial, wrote that Betz at least had "inquiry notice that someone had lied to her when she saw her principal melt away like a popsicle in July." He stated that the majority adopted a "bizarre" definition of inquiry notice, in which "notice that actually causes the investor to make inquiries is nevertheless insufficient to put a reasonable investor on notice to make inquiries." The chief judge concluded that "no other court in the known universe has adopted such an oxymoronic rule," and observed that "here we are, out in left field again."

In the petition for certiorari, the firm scoffed at the court's holding concerning the impact of the assurances made to Betz. According to the petition, "it would be unreasonable for a victim who is on inquiry notice to suspend the inquiry just because an Artful Dodger chirps reassuring platitudes," as "any swindler unscrupulous enough to pull off a fraud in the first place would have no qualms about trying to allay suspicions or defer confrontation." The firm wrote that "the Ninth Circuit has declared itself a haven for hucksters and procrastinators, and has all but converted brokers and investment advisors into unwilling guarantors of market performance."

The Supreme Court vacated the 9th Circuit decision and remanded without further comment. It certainly appears, however, that the high court was not satisfied with the latitude given to Betz on the timing of her complaint. Merck gave investors a greater opportunity to discover and sue for fraud, but the Betz case indicates that this opportunity has its limits. The court may well have put some teeth into the "reasonably" component of the "reasonably diligent plaintiff" standard.

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