Know Your Limits: Government Lawyers Weigh In on Inquiry Notice Case

In late November 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. She 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."

Oral argument is set for November 30, 2009.

.