Chapter 13

• Jurisdiction: United States

Chapter 13 Securities Litigation Issues, Part One

Statutes of Limitations and Repose

The Sarbanes-Oxley Act increased the statute of limitations for Section 10(b). The action must be commenced within two years after discovery of the fraud and in no event more than five years after the fraud occurred. So far, this has not been extended to cases under Sections 11 and 12 because they do not "sound in fraud." Those sections have a "one year after discovery" limitation. In no event may the claims under those sections be brought more than three years after the security is "bona fide" offered to the public. Such a statute is sometimes called a "statute of repose." Unlike traditional statutes of limitation, statutes of repose may not be equitably tolled. Claims under Sections 9 and 18 of the Exchange Act have a one-year/three-year statute of limitation and repose.

In American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), the Supreme Court held that "the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action." But Section 13 of the Securities Act says that "in no event" shall an action under Section 11 of the Securities Act "be brought . . . more than three years after the sale." In Public Employees' Retirement System of Mississippi v. IndyMac, 721 F.3d 95 (2d Cir. 2013) (cert. dismissed as improvidently granted, 2014), the Second Circuit held that American Pipe did not apply to the three-year period of Section 13 because either American Pipe is a species of equitable tolling, in which case it is inconsistent with Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991) (equitable tolling does not apply to "statutes of repose"), or it is a form of "legal" tolling, in which case it would violate the Rules Enabling Act, which prohibits the creation of rules of procedure that change "substantive" rights. But see Joseph v. Wiles, 223 F.3d 1155 (10th Cir. 2000) (American Pipe does not apply to Section 13). Is there a difference between "legal" and "equitable" tolling? Is there a difference between a "statute of repose" and a "statute of limitations"? Yes. Do "statutes of repose" create substantive rights (e.g., a right to be free from having claims made against you) unlike "statutes of limitations"? Probably. Note that in CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014), the Supreme Court discussed the differences between statutes of limitation ("a time limit for suing") and statutes of repose ("another limit on the right to bring a civil action"), noting that even Congress sometimes confuses the two, and holding, without citation, that "statutes of limitation, but not statutes of repose, are subject to equitable tolling" (emphasis added). That case concerned the effect of a limitations-extending provision in the Comprehensive Environmental Response Compensation and Liability Act (CERCLA).

However, the Second Circuit later held that CTS Corp. v. Waldburger did not alter its controlling authority that the FDIC limitations-extending statute applied to all time limitations, including statutes of repose. The appeals court reasoned that the CTS holding was rooted in the text, structural and legislative history of CERCLA and that for that reason, it is not the case that a federal statute extending statutes of limitations must always be read to leave in place existing statutes of repose. FDIC v. First Horizon Asset Securities Inc., 821 F.3d 327 (2d Cir. 2016).

The issue was finally resolved by the Supreme Court in California Public Employees' Retirement System v. ANZ Securities, 137 S. Ct. 2042 (2017), which held that Section 13's three-year time limit is a statute of repose and is not subject to equitable tolling.

When does the statute begin to run? Under Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010), a Rule 10b-5 claim begins to run when a hypothetical reasonably diligent plaintiff would have discovered facts constituting the violation. Merck rejected "inquiry notice" as a beginning of the limitations period for private Section 10(b) claims. "Inquiry notice" is merely a "useful tool" for determining when a reasonable plaintiff would have discovered the facts, the statute still requires "discovery."

There remains an issue whether "inquiry notice" remains the test for Securities Act claims as well. Pension Trust Fund for Operating Engineers v. Mortgage Asset Securitization Transactions, 2013 WL 5184064 (3d Cir. 2013), rejected "inquiry notice" for Securities Act claims. The issue was before the Second Circuit in Freidus v. Barclays Bank PLC, 2013 WL 4405291 (2d Cir. 2013), but the Second Circuit declined to deal with the "inquiry notice" issue, holding only that in that case there was "constructive notice."

But this discovery rule does not apply to the SEC as a plaintiff. See Gabelli v. SEC, 133 S. Ct. 1216 (2013). Mark Gabelli (Mario Gabelli's son) was charged with violating the Investment Advisers Act (illegal for advisers to defraud clients). He and another were charged with aiding and abetting a fraud from 1999 to 2002. Allegedly they allowed one investor in a fund to engage in market timing in exchange for its investment in a hedge fund even though they banned other investors from engaging in market timing.

The complaint by the SEC was not filed until 2008, six years after the alleged fraud occurred. It was governed by 28 U.S.C. § 2462 (the general federal five-year statute of limitations). The SEC argued for the application of the Merck discovery rule. The Supreme Court disagreed. It observed that no case has ever applied the discovery rule to the government. The Court said that most private plaintiffs do not spend their days looking for evidence of fraud. (Some lawyers often do.) By contrast, the SEC's central mission is to investigate potential violations of securities laws. Therefore, the discovery rule does not apply to SEC penalty actions.

The Complaint

Commences the Litigation. The complaint must allege a violation and a right to relief. Under Rule 8 of the Federal Rules of Civil Procedure, the complaint must contain "a short and plain statement of the claim showing the pleader is entitled to relief," but the Private Securities Litigation Reform Act (PSLRA) has added additional pleading requirements for securities cases. The adequacy of the complaint is almost always challenged in a securities case because such cases have so many special pleadings requirements. The complaint should be written in crisp, concise, and plain English. Each allegation must be "simple, concise, and direct." It can be used to establish the plaintiff's themes and theories, but that is not its principal function. The most important part of drafting a complaint is gathering of the relevant facts and meeting the relevant pleading standards.

You must draft a complaint that will survive a motion to dismiss because there will almost inevitably be one. You must plead every element of each cause of action. This requires careful review of the statutes on which the causes of action depend. You must also anticipate the defendant's arguments on a motion to dismiss.

Should "borderline" claims be included if there is a good faith basis for making the allegations? Perhaps, but there could be negative consequences by including such claims, including the loss of credibility.

Who are the potential audiences? The court, the client, defendant, insurance companies, the public, the shareholders, competitors, the jury (although in practice, most complaints do not make it into the jury room).

Often, plaintiffs will make allegations based on information supplied to them by confidential witnesses. This is done in an effort to meet their pleading burden, and it is permitted. Those confidential sources will eventually be identified through discovery, but where discovery is stayed pending a motion to dismiss, it is difficult if not impossible for courts to assess the sufficiency of allegations based on confidential sources. Aren't courts required to accept all factual allegations as true for purposes of a motion to dismiss? Yes. Is this true with respect to facts pleaded based on confidential sources? Perhaps. In any event, it has been my experience that more often than not, confidential sources are misquoted in a complaint.

It sometimes turns out that allegations based on confidential sources are not true. In In re Millennial Media, Inc. Securities Litigation, No. 14 Civ. 7923 (PAE), 2015 BL 169156 (S.D.N.Y. May 29, 2015), Judge Paul Engelmayer dealt with that issue by ordering the plaintiffs to provide affidavits from a "personally knowledgeable attorney" explaining the circumstances under which the confidential source allegation came to be included in the complaint and recounting the confidential source's version of the events. He also held that counsel's reliance on investigators created a significant potential for inaccuracy and that counsel must give the confidential source the...