The Securities Exchange Act of 1934 provides that private actions alleging securities fraud are timely if they are filed within “2 years after the discovery of the facts constituting the violation” and within “5 years after such violation.” 28 U.S.C. § 1658(b). On April 27, 2010, in a decision likely to have significant ramifications, the Supreme Court addressed the first of these limitations, holding in Merck & Co. v. Reynolds, No. 08-905, that the two-year limitation period does not begin to run until a reasonably diligent plaintiff would have uncovered evidence of scienter—that is, evidence that the defendant not only made a false or misleading statement, but did so knowingly or deliberately.
In an opinion by Justice Breyer, the Court held that § 1658(b)(1), which imposes the two-year limitation, instructs courts to apply the so-called “discovery rule,” according to which a claim accrues when the plaintiff knows, or with the exercise of reasonable diligence should have known, the facts that give rise to the cause of action. The Court also held that one of the facts necessary to trigger the two-year limitations period for securities fraud claims is evidence of scienter, since the heightened pleading requirements in fraud cases require the plaintiff to set forth facts suggesting scienter in the complaint. Further, the Court explained that for the plaintiff to have notice of scienter, there must be evidence not just that the defendant made a false or misleading statement, but that the defendant was aware that the statement was false and deliberately lied. Finally, the Court clarified that it is not sufficient for the plaintiff to have mere “inquiry notice” that would lead a reasonably diligent plaintiff to begin investigating; rather, the two-year statute of limitations does not begin to run until the time that a reasonably diligent investigation would have actually uncovered the evidence of scienter.
Justice Scalia wrote a brief concurrence, joined by Justice Thomas, explaining that as he reads the statute, the two-year limitations period should begin to run only once the plaintiff has actual knowledge of scienter, rather than mere constructive knowledge based on what a reasonably diligent plaintiff should have discovered. Justice Stevens also authored a short concurrence stating that he would reserve decision on whether the statute requires actual or constructive knowledge because the answer to that question would not affect the outcome in this case.
The Court’s decision will be of great significance to any business facing potential securities fraud claims, since today’s decision makes it substantially more difficult for defendants accused of fraud to prevail on a statute of limitations defense. The Court acknowledged concerns that its decision “will give life to stale claims or subject defendants to liability for acts taken long ago” (slip op. 14), but stated that these concerns are adequately addressed by the statutory bar on any private securities action brought more than five years after the alleged violation. There is also a significant likelihood that the decision will be applied to a variety of fraud claims arising outside of the securities context, which would potentially allow plaintiffs to bring claims based on long-ago conduct where businesses do not have the benefit of the securities statute’s five-year repose period.