A Question of Fraud
Below, Akin Gump’s John Wittenzellner recaps Monday’s oral argument in Merck & Co., Inc. v. Richard Reynolds (08-905). John’s earlier preview of the case is available here, and Lyle Denniston’s coverage of the cert.-stage proceedings is available here. Check the Merck v. Reynolds SCOTUSwiki page for additional updates.
Monday's oral argument in Merck v. Reynolds focused on two issues: the difference between actual and constructive knowledge in a "fraud on the market" case; and how a plaintiff should respond to receiving inquiry notice of fraud.
Kannon Shanmugam argued on behalf of petitioner Merck. He began by asserting that the discovery rule"”which provides that the statute of limitations begins to run when a plaintiff discovers the facts constituting the violation"”applies to private securities fraud claims, but he was stopped shortly thereafter by Justice Sotomayor, who asked if Congress used "unnecessary words" when differentiating between "discovery of the facts constituting a violation" and "due diligence." Justice Scalia would later return to the same point, asking if the Court was "spinning [it's] wheels" in Lampf. Mr. Shanmugam described the difference as insignificant, explaining that the default understanding is that statutes of limitations are governed by the discovery rule.
Justice Ginsburg turned the discussion back to the facts of the case by asking how the respondents should have acted in this case, according to Merck's proposed standard. The discussion revolved around the FDA Letter "“ which, Mr. Shanmugam argued, was both sufficient to put someone on inquiry notice and, more significantly, evidenced scienter, but would not have met the pleading standard. Justice Scalia was quick to point out the difference between misrepresentation and misrepresentation with scienter to defraud; in his view, the FDA Letter did not evidence scienter of fraud. Justice Ginsburg expressed similar concerns.
The next line of questioning came back to what the respondents could have done to satisfy Merck's proposed standard. Justice Breyer then presented a hypothetical that would re-surface several times during the session: when does the statute of limitations begin to run if after the plaintiff receives "storm warnings" the only evidence of scienter is in the hands of a person imprisoned in Burma who is inaccessible for six months? Mr. Shanmugam said that with diligent investigation, the statute would begin to run after six months, but without diligent investigation, it would begin to run upon receiving inquiry notice.
Arguing on behalf of respondent Reynolds, David Frederick began by explaining that in a "fraud on the market" case actual and constructive knowledge are practically the same. He then addressed Lampf, explaining that when Congress amended Section 1658(b), it incorporated the dissent in Lampf into the five-year absolute bar; thus, the two-year statute must be based on the discovery of all of the elements, including scienter.
Justice Sotomayor began the next line of questioning by asking if the initial complaint was insufficient because Mr. Frederick contends that the statute of limitations should not have run from that point. He countered by stating that the sufficiency of the first complaint was not before the court and that Merck cannot point to sufficient evidence of scienter between the publication of the FDA Letter and the filing of the first complaint. He continued on to discuss the atmosphere surrounding the amendments to Section 1658(b) to justify his contention that the statute of limitations should not begin to run until the plaintiff has enough facts to survive a motion to dismiss. He further differentiated his proposed standard from the government's, describing the government's standard as only requiring strong evidence of fraud, but not enough to survive a motion to dismiss.
Malcolm Stewart argued on behalf of the United States, as amicus curiae in support of Reynolds. His argument reinforced the need for all of the facts constituting the violation, including scienter. He also addressed Justice Scalia's initial question regarding the differences in Lampf, contending that it is natural for the statue of limitations to run from the discovery of a false or misleading statement when scienter is not one of the elements of the violation. However, as in the instant case, when scienter is one of the elements, it cannot begin to run until scienter is discovered.
Ultimately, many of the Justices appeared unconvinced that the FDA Letter was sufficient to trigger the statute of limitations. Their concerns focused on how a plaintiff should act in securities fraud cases and how to establish a workable standard for the courts.