Statutes of limitations, a long-standing bulwark of civil litigation, mitigate the risk that evidence of meritorious claims will become stale and relieve defendants who might be exposed to claims from unending uncertainty about whether claims will be brought. But these twin rationales are balanced against allowing plaintiffs sufficient time to discover and file meritorious claims. This balance is manifest in the judicial and congressional effort to fashion a statute of limitations for securities fraud claims. The Supreme Court in Merck & Co. v. Reynolds recently attempted to strike that balance in its interpretation of the statute of limitations for securities fraud claims under section 10(b) and Rule 10b-5. But we show that the Court has failed. Merck presents a pleading trap for victims of securities fraud that will preclude the adjudication of meritorious claims.
Moreover, the Supreme Court's Merck decision exemplifies a much more serious problem with the entire limitations regime for securities fraud. We demonstrate that the discovery provision in that regime should be discarded for a singular statute of repose as the discovery provision unnecessarily precludes meritorious claims without providing any more support for the twin rationales beyond what is already provided by a statute of repose alone. The repose provision by itself reduces the use of stale evidence and litigation uncertainty and it does not unnecessarily preclude meritorious claims. In this sense, our proposal bucks the trend of scholarship addressing the statute of limitations that advocates eliminating limitations periods entirely. We find that insights from behavioral economics and practical realities of market activity justify some measure of repose. Thus, we advocate abolishing the discovery provision in the statute of limitations but keeping the statute of repose.
TABLE OF CONTENTS INTRODUCTION I. THE SUPREME COURT, CONGRESS, AND THE STATUTE OF LIMITATIONS FOR PRIVATE SECURITIES FRAUD A. Statutes of Limitations, Repose, and Discovery-Accrual B. The Supreme Court's Limitations Period 1. "Discovery" 2. "The Facts Constituting the Violation" C. Congress and the Sarbanes-Oxley Act II. MERCK & CO. V. REYNOLDS AND THE IMPORTANCE OF THE STATUTE OF LIMITATIONS A. Vioxx, Heart Attacks, and Stock Fraud B. The Supreme Court 1. "Discovery" 2. "'The Facts Constituting the Violation" 3. Justice Scalia's Concurrence C. The Reach of Merck and Subprime Litigation III. THE DANGERS OF MERCK AND ABOLISHING DISCOVERY-ACCRUAL A. The Problematic Incorporation of Scienter 1. Scienter on the Offensive: Collective Scienter and Core Operations 2. The Pleading Game Plaintiffs Cannot Win 3. Failing To Achieve Uniformity in the Statute of Limitations B. The Illusory Benefits to a Discovery Provision 1. The Practical Realities of Securities Litigation and Prompt Filing 2. The Discovery of Merited Section 10(b) and Rule 10b-5 Claims 3. The Discovery Provision's Increased Costs Associated with Securities Litigation IV. MARKET FUNCTIONS, BEHAVIORAL ECONOMICS, AND THE CASE FOR RETAINING REPOSE FOR SECURITIES FRAUD ACTIONS A. Loss Aversion and Nonculpable Market Participants B. Event-Accrual and the Five-Year Statute of Repose CONCLUSION INTRODUCTION
Statutes of limitations have been part of the architecture of civil litigation for centuries. (1) These limitations are designed to mitigate the risk that evidence of meritorious claims will become stale and to relieve potential defendants from unending uncertainty about whether they will be brought into court. (2) The "stale evidence" rationale is rooted in the premise that resolving claims on their merits is more likely if the evidence, including testimony based on recall, is produced closer in time to the event that gives rise to the claim. (3) The "litigation uncertainty" rationale is based on two related propositions: (1) a party who is uncertain about whether it will be sued is more likely to be distracted by the threat of litigation, and thus less likely to devote resources to productive purposes; and (2) at some point in time, it is simply unjust to subject a party to the sword of Damocles--the lingering possibility that litigation could be brought at any moment. (4) These rationales are invariably balanced against allowing potential plaintiffs sufficient time to discover and file meritorious claims.
This delicate balance is manifest in the judicial and congressional effort to fashion a statute of limitations for securities fraud claims. The Supreme Court in Merck & Co. v. Reynolds recently attempted to strike that balance in its interpretation of the statute of limitations for securities fraud claims under section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. (5) The Court held in Merck that the two-year statute of limitations for plaintiff-investors begins, not when they actually discovered the fraud, but when they discovered or should have discovered the facts constituting securities fraud, which includes scienter--the "mental state embracing [an] intent to deceive, manipulate, or defraud." (6) Merck is the latest effort by the Court to fashion a limitations regime that serves both rationales. In this Article, we show that the Court has failed. Rather, Merck presents a trap for victims of securities fraud that will preclude the adjudication of meritorious claims. Moreover, Merck exemplifies a much more serious problem with the entire limitations regime for securities fraud.
Next, we argue that the discovery provision in the limitations regime should be discarded in favor of a singular statute of repose. The discovery provision unnecessarily precludes meritorious claims without providing any support for the twin rationales beyond what is already provided by the statute of repose alone. The repose provision by itself reduces both the use of stale evidence and litigation uncertainty, and it does not unnecessarily preclude meritorious claims. Our proposal bucks the trend of scholarship addressing the statute of limitations, which advocates eliminating limitations periods entirely. We find that insights from behavioral economics and practical realities of market activity justify some measure of repose. Thus, we advocate abolishing the discovery provision in the statute of limitations entirely but keeping the statute of repose.
Part I.A of this Article provides a brief overview of statutes of limitations and repose, as well as their purposes. Part I.B next provides the necessary background to understand the Supreme Court's Merck decision by discussing the initial statute of limitations for Rule 10b-5 actions that the Supreme Court adopted in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson and its common law evolution, including the federal appellate courts' interpretations of what constitutes "discovery" and "facts constituting the violation." (7) Part I.C then discusses Congress's statute of limitations in the Sarbanes-Oxley Act of 2002 (SOX) and how the federal appellate courts have interpreted it. (8)
Part II examines Merck, including its factual and procedural background, its two rulings of note, and Justice Scalia's concurrence advocating for an "actual discovery" standard, a seemingly pro-plaintiff posture. (9) Part II.C also observes that Merck will likely play an increasingly important role in securities fraud litigation.
But, as Part III then argues, Merck's discovery rule does more harm than good. First, Merck's incorporation of scienter allows defendants to trigger discovery by invoking methods of imputing knowledge. (10) Second, the discovery standard may force plaintiffs to concede that essential facts are not evidence of scienter or to allege fraud by hindsight--setting plaintiffs up for ready dismissal. (11) And third, by incorporating scienter into the discovery inquiry, Merck has failed to achieve uniformity in the statute of limitations because the courts of appeals have different interpretations of what constitutes an adequate allegation of scienter. (12)
Recognizing that Merck is marred with pitfalls and pleading traps, Part III next questions the usefulness of the discovery provision for the statute of limitations for section 10(b) and Rule 10b-5 actions and concludes it is unnecessary. The practical realities of securities fraud claims already encourage diligence and prompt filing. (13) Moreover, discovery of meritorious securities fraud claims is difficult and time-consuming. (14) By abolishing the discovery provision, meritorious claims proceed and the costs associated with litigating these colossal suits should also decrease. (15)
Yet Part IV argues that, contrary to the scholastic trend toward eschewing limitations periods entirely, some repose is still necessary. (16) Insights from behavioral economics, such as loss aversion, justify a statute of repose for section 10(b) and Rule 10b-5. Also, without repose, securities fraud would affect settled economic expectations of nonculpable market participants. Part IV then proposes a statute of repose for securities fraud. This limitation period must be a bright-line rule simple in application. And it must be long enough to promote merits resolution and to prevent an end run around the private right of action. Thus, Part IV concludes that Congress should retain only its five-year statute of repose that is triggered upon the happening of the fraud.
THE SUPREME COURT, CONGRESS, AND THE STATUTE OF LIMITATIONS FOR PRIVATE SECURITIES FRAUD
In the United States, companies are traditionally characterized by dispersed ownership, that is, "no single shareholder [or group] owns sufficient shares to ensure its ability to elect directors," and, as a result, ownership is separated from control. (17) Thus, shareholders in a dispersed ownership system depend on a company's public disclosures for information because these shareholders have little, if any, direct access to management and cannot easily monitor...