Securities Act — Limitations — Discovery, Not Inquiry Notice, Standard Applies to ’33 Act — Need Not Plead Compliance with SOL — Inquiry Notice Applies to RICO — One Panel May “Reevaluate” Another’s Decision If New Supreme Court Case
Pension Fund for Operating Eng’rs v. Mortg. Asset Securitization Transactions, Inc., 2013 U.S. App. LEXIS 19166 (3d Cir. Sept. 17, 2013):
Lead Plaintiff Pension Trust Fund for Operating Engineers (the "Operating Engineers") appeal from the District Court's initial order dismissing without prejudice their amended class action complaint (the "Amended Complaint"), which alleged violations of the Securities Act of 1933, 15 U.S.C. § 77a et seq., by subsidiaries and employees of UBS AG ("UBS"), for failure to plead compliance with the one-year statute of limitations set forth in Section 13 of the Securities Act, 15 U.S.C. § 77m. The Operating Engineers also appeal from the District Court's subsequent order dismissing with prejudice their second amended class action complaint (the "Second Amended Complaint") as untimely under an inquiry notice standard. Although we hold that a Securities Act plaintiff need not plead compliance with Section 13 and that Section 13 establishes a discovery standard for evaluating the timeliness of Securities Act claims, we nonetheless conclude that the class action claims in the original complaint (the "Original Complaint") were untimely. Therefore, we will affirm. ***
On February 22, 2010, one year after Moody's downgraded the rating of the Certificates, an investor filed the Original Complaint asserting claims under Sections 11, 12(a)(2), and 15 of the Securities Act, 15 U.S.C. §§ 77k, 77l(a)(2), and 77o, against MASTR, UBS Real Estate, UBS Securities, Martin, Dyrvik, Corcoran, Moody's, and S&P's parent company in the United States District Court for the District of New Jersey. "On March 29, 2010, in the course of the usual monitoring of its investment portfolio," the Operating Engineers "learned of significant losses to the value of the Certificates" and "the existence of potential claims." App. at 464 ¶ 193. Pursuant to the Private Securities Litigation Reform Act ("PSLRA"), Pub. L. No. 104-67, 109 Stat. 737 (1995), the Operating Engineers petitioned to be appointed as Lead Plaintiff, and the District Court granted their request on October 18, 2010.***
Both the Amended Complaint and the Second Amended Complaint asserted claims under Sections 11, 12(a)(2), and 15 of the Securities Act. Section 11 "concerns material misstatements or omissions in registration statements;" Section 12(a)(2) "concerns material misrepresentations in prospectuses and other solicitation materials;" and Section 15 "provides for joint and several liability on the part of one who controls a violator of Section 11 or Section 12." In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 269, 284 (3d Cir. 2006) (citations omitted). All three provisions are governed by the same statute of limitations, ... which is set forth in Section 13 of the Securities Act, and which requires actions to be brought "within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence," 15 U.S.C. § 77m.***
The Operating Engineers first argue that the District Court erred in requiring them to plead compliance with the statute of limitations. UBS responds that this issue is outside the scope of this appeal, and that, regardless, the Operating Engineers are incorrect on the merits. We conclude that this issue is within the scope of this appeal, and we hold that a Securities Act plaintiff is not required to plead compliance with Section 13. ***
Three courts of appeals have historically held that a Securities Act plaintiff must plead compliance with Section 13. See Davidson v. Wilson, 973 F.2d 1391 (8th Cir. 1992); Anixter v. Home-Stake Prod. Co., 939 F.2d 1420 (10th Cir. 1991), vacated on other grounds under the name Dennler v. Trippet, 503 U.S. 978, 112 S. Ct. 1658, 118 L. Ed. 2d 382 (1992); Cook v. Avien, Inc., 573 F.2d 685 (1st Cir. 1978). The Tenth Circuit provided no justification for this rule. See Anixter, 939 F.2d at 1434. The Eighth and First Circuits advanced the same rationale as the District Court. See Davidson, 973 F.2d at 1402 n.8 ("[T]he timeliness requirement is substantive."); see also Cook, 573 F.2d at 695 ("[W]hen the very statute which creates the cause of action also contains a limitation period, the statute of limitations not only bars the remedy but also destroys the liability." (quotation omitted)).
In contrast, three other courts of appeals have recently held that a plaintiff need not plead compliance with the statute of limitations in the Securities Exchange Act of 1934, which, as we discuss below, is similar to the statute of limitations in the Securities Act. See Johnson v. Aljian, 490 F.3d 778 (9th Cir. 2007); La Grasta v. First Union Sec., Inc., 358 F.3d 840 (11th Cir. 2004), abrogated on other grounds by Bell Atl. Corp. v. Twombly, 550 U.S. 544, 127 S. Ct. 1955, 167 L. Ed. 2d 929 (2007); Tregenza v. Great Am. Commc'ns Co., 12 F.3d 717 (7th Cir. 1993), abrogated on other grounds by Merck & Co. v. Reynolds, 559 U.S. 633, 130 S. Ct. 1784, 176 L. Ed. 2d 582 (2010).
In Tregenza, the Seventh Circuit noted that the Eighth, Tenth, and First Circuits relied on "the archaic rule that in the case of common law claims the statute of limitations merely limits the remedy, while in the case of statutory claims it limits or defines the substantive right." 12 F.3d at 719 (citation omitted). But the court rejected this theory as "a conclusion rather than an explanation," that was "especially dubious" because "the statute of limitations isn't even found in the statute that creates the substantive right." Id. The court also observed that secondary sources suggested "that statutory claims are disfavored," and "that because tolling principles do not apply to statutes of limitations governing statutory claims, it is efficient to permit judges to dispose of untimely statutory claims" at the motion to dismiss stage. Id. However, the court dismissed both of these reasons as "certainly false today." Id. Because the old rule "persisted . . . by blind inertia," and "ma[de] no sense," the court concluded, albeit in dicta, that it was "time that it was discarded." Id. at 718-19.
In La Grasta, the Eleventh Circuit followed the Seventh Circuit's recommendation in Tregenza. 358 F.3d at 845. And in Johnson, the Ninth Circuit acknowledged that it had previously adhered to the old rule for the Securities Act's statute of limitations, but the court refused to extend "such a disapproved pleading rule," which had incurred "forceful" and "justified" criticism, to the Exchange Act's statute of limitations. 490 F.3d at 781 n.13 (citations omitted). The court also recognized that the PSLRA "may require a plaintiff to plead certain facts with particularity, which may establish that the action is time-barred," but the court nonetheless rejected the possibility that the PSLRA required a different result. Id.
We agree with the Seventh Circuit's analysis in Tregenza, which is consistent with our statute of limitations precedent. ***
The Operating Engineers next argue that the District Court erred in applying an inquiry notice standard and in determining that the claims in the Original Complaint were untimely. UBS counters that the District Court correctly refused to adopt a discovery standard, and that, in any event, the claims in the Original Complaint were also untimely under that standard. Although we hold that a discovery standard governs Section 13 of the Securities Act, we conclude that the claims in the Original Complaint were untimely. ***
We first consider whether the District Court erred in applying an inquiry notice standard to determine whether the Securities Act claims in the Original Complaint were timely under Section 13 pursuant to our decision in Benak. There, we held that "to the extent a securities fraud plaintiff was on inquiry notice of the basis for claims more than one year prior to bringing the action, his or her claim is subsequently time-barred by the requisite statute of limitations." 435 F.3d at 400 (quotation omitted). We explained that under the inquiry notice standard, statutes of limitations start to run when plaintiffs "discovered or in the exercise of reasonable diligence should have discovered the basis for their claim[s] against the defendant[s]." Id. (quotation omitted). Whether reasonably diligent plaintiffs should have discovered the basis for their claims, in turn, depends on "whether they had sufficient information of possible wrongdoing to place them on 'inquiry notice' or to excite 'storm warnings' of culpable activity." Id. (quotation omitted). And whether information is sufficient to excite storm warnings depends on "whether a reasonable investor of ordinary intelligence would have discovered the information and recognized it as a storm warning." Id. (quotation omitted). Importantly, a reasonably diligent plaintiff is on inquiry notice when she would have discovered general facts about the fraudulent scheme by the defendant rather than specific facts about the fraud perpetrated on her....
If defendants carry their burden of establishing the existence of storm warnings, then "the burden shifts to the plaintiffs to show that they exercised reasonable due diligence and yet were unable to discover their injuries." Id. (quotation omitted). Plaintiffs on inquiry notice have "a duty to exercise reasonable diligence to uncover the basis for their claims." Id. at 401 (quotation omitted). If plaintiffs cannot demonstrate the requisite diligence, then they "are held to have constructive notice of all facts that could have been learned through diligent investigation during the limitations period." Id. (quotation omitted). Plaintiffs may not excuse their failure to inquire merely because "reasonable diligence would not have uncovered their injury." Id. (quotation omitted).
In applying this standard, the District Court refused to extend the Supreme Court's holding in Merck that a discovery standard applies to the Exchange Act's statute of limitations. 130 S. Ct. at 1798. The court reasoned that the discovery standard "applied to a securities fraud action under [the Exchange Act], and not to . . . claims under the Securities Act," and that "while some other Circuits have adopted the Merck standard for [Securities Act] claims, the Third Circuit has yet to do so." App. at 19 n.5. Merck's impact on Benak is another issue of first impression for us.
In Merck, the Supreme Court affirmed our reversal of the district court's dismissal of securities claims as untimely, but rejected and replaced our inquiry notice standard with a discovery standard. Merck concerned the Exchange Act's statute of limitations, which provides that a claim involving "fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws . . . may be brought not later than . . . 2 years after the discovery of the facts constituting the violation," 130 S. Ct. at 1790 (quoting 28 U.S.C. § 1658(b)(1)). Because "the word 'discovery' is often used as a term of art in connection with the 'discovery rule'" in statutes of limitations, the Court first adopted a discovery standard, holding that an Exchange Act claim accrues "(1) when the plaintiff did in fact discover, or (2) when a reasonably diligent plaintiff would have discovered, 'the facts constituting the violation' -- whichever comes first." Id. at 1789-90, 1793.
The Court next rejected the inquiry notice standard, which it understood to refer "to the point where the facts would lead a reasonably diligent plaintiff to investigate further," id. at 1797, as the statute of limitations trigger, even when "the actual plaintiff fails to undertake an investigation once placed on 'inquiry notice,'" id. at 1798. The Court explained that inquiry notice "is not necessarily the point at which the plaintiff would already have discovered . . . 'facts constituting the violation.'" Id. at 1797. For this reason, the inquiry notice standard conflicts with the text of the statute, which "says that the plaintiff's claim accrues only after the 'discovery' of [the facts constituting the violation]," and "contains no indication that the limitations period should occur at some earlier moment before 'discovery,' when a plaintiff would have begun investigating." Id. Thus, the Court held that "the 'discovery' of facts that put a plaintiff on 'inquiry notice' does not automatically begin the running of the limitations period." Id. at 1798. ***
We agree with the Operating Engineers that the discovery standard announced by the Supreme Court in Merck applies not only to the Exchange Act's statute of limitations, but also to the Securities Act's statute of limitations. Importantly, both statutes incorporate the word "discovery," which the Merck Court identified as a term of art representing the discovery rule. Compare 28 U.S.C. § 1658(b)(1) ("[A] private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws . . . may be brought not later than . . . 2 years after the discovery of the facts constituting the violation." (emphasis added)), with 15 U.S.C. § 77m ("No action shall be maintained to enforce any liability created under [the Securities Act] unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of due diligence." (emphasis added)). Neither statute includes any language suggesting that the limitations period begins to run before discovery. Cf. Gabelli v. SEC, 133 S. Ct. 1216, 1220, 185 L. Ed. 2d 297 (2013) (declining to graft the discovery rule onto 28 U.S.C. § 2462 because "the most natural reading" of that statute of limitations, which expressly referenced "accrual" not "discovery," was that the "clock begins to tick  when a defendant's allegedly fraudulent conduct occurs").
Moreover, the Merck Court pointed out that the Exchange Act's statute of limitations is indirectly based on the Securities Act's statute of limitations. 130 S. Ct. at 1794-96. Indeed, the Exchange Act's statute of limitations repeats the language of the Supreme Court's decision in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364, 111 S. Ct. 2773, 115 L. Ed. 2d 321 (1991). That decision, in turn, looked to the Securities Act's statute of limitations, among others. Id. at 360 & n.7.
Furthermore, both the Supreme Court and this Court have treated as interchangeable precedent dealing with the different statutes of limitations. ***
UBS also asserts that the Second Circuit has "concluded that Merck applies only to securities fraud claims arising under the Exchange Act, and not to non-fraud Securities Act claims." Response Br. at 36 (citing Koch v. Christie's Int'l PLC, 699 F.3d 141, 149-50 (2d Cir. 2012)). But UBS overstates the Second Circuit's holding. In Koch, to distinguish the Racketeer Influenced and Corrupt Organizations Act ("RICO") statute of limitations, the court stated that "[n]othing in Merck's discussion of [28 U.S.C.] § 1658(b) purports . . . to apply [the discovery standard] outside the context of the statute at issue in that case." 669 F.3d at 149. However, the RICO statute of limitations is "silent on the issue" of accrual, and for this reason, the general discovery accrual rule applies to a RICO claim, whereby the "discovery of the injury, not discovery of the other elements of a claim, is what starts the clock." Id. (quoting Rotella v. Wood, 528 U.S. 549, 555, 120 S. Ct. 1075, 145 L. Ed. 2d 1047 (2000)). In contrast, Merck "involved a statutory exception to the common law rule" because the Exchange Act statute of limitations "was not silent, but rather stated that discovery of the facts constituting the 'violation' lead to accrual." Id. Because the Securities Act statute of limitations is also expressly contingent on the discovery of the facts constituting the violation, namely, "the discovery of the untrue statement or the omission," 15 U.S.C. § 77m, Koch is distinguishable. Therefore, pursuant to the Supreme Court's decision in Merck, we hold that the discovery standard governs whether Securities Act claims are timely under Section 13.
Footnote 5. Although this panel lacks the authority to overrule a binding precedential opinion of a prior panel, we may reevaluate our precedent in light of an intervening Supreme Court decision. Inst. Inv. Grp. v. Avaya, Inc., 564 F.3d 242, 276 n.50 (3d Cir. 2009).
Regarding the amount of information a reasonably diligent plaintiff must have about a particular fact before she is deemed to have "discovered" it under the new standard, we agree with the Second Circuit's analysis in City of Pontiac General Employees' Retirement System v. MBIA, Inc., 637 F.3d 169, 174-75 (2d Cir. 2011). As the MBIA court pointed out, the Merck Court "specifically referenced pleading requirements when discussing the limitations trigger." Id. at 175 (citing Merck, 130 S. Ct. at 1796). Also, it is logical to link the statute of limitations standard with the pleading standard; the purpose of statutes of limitations is to prevent stale claims, but claims cannot be stale until they have accrued, and claims cannot accrue until they can be adequately pled. Id. Thus, we adopt the MBIA court's holding that "a fact is not deemed 'discovered' until a reasonably diligent plaintiff would have sufficient information about that fact to adequately plead it in a complaint . . . with sufficient detail and particularity to survive a 12(b)(6) motion to dismiss." Id.
Despite our holding that the inquiry notice standard no longer governs the statute of limitations under Section 13 for Securities Act claims, we disagree with the Operating Engineers' recommendation that we discard Benak and its progeny. The Merck Court clearly preserved a limited role for the old standard, acknowledging that "terms such as 'inquiry notice' and 'storm warnings' may be useful to the extent that they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating." 130 S. Ct. at 1798. This information may be helpful because the "limitations period puts plaintiffs who fail to investigate once on 'inquiry notice' at a disadvantage because it lapses [a certain time] after a reasonably diligent plaintiff would have discovered the necessary facts," and a "plaintiff who fails entirely to investigate or delays investigating may well not have discovered those facts by that time." Id. (citation omitted). However, we caution that the inquiry notice standard can only play a supporting role because "the limitations period does not begin to run until the plaintiff . . . discovers or a reasonably diligent plaintiff would have discovered 'the facts constituting the violation,' . . . irrespective of whether the actual plaintiff undertook a reasonably diligent investigation." Id.
We also disagree with UBS's suggestion that because Section 11 and Section 12(a)(2) claims do not include a scienter element, there is no practical difference between the discovery standard and the inquiry notice standard for Securities Act claims. On the one hand, the two standards will not automatically yield the same result for Securities Act claims. See id. at 1797 ("[T]he point where the facts would lead a reasonably diligent plaintiff to investigate further . . . is not necessarily the point at which the plaintiff would already have discovered facts showing scienter or other 'facts constituting the violation.'" (emphasis added)). On the other hand, the difference between the two standards will normally fluctuate in tandem with the level of specificity of the information about a fact that is available to a reasonably diligent plaintiff. See id. at 1798 ("[A] reasonably diligent investigation . . . may consume as little as a few days or as much as a few years." (quotation omitted)); MBIA, 637 F.3d at 175 ("[T]he amount of particularity and detail a plaintiff must know before having 'discovered' the fact will depend on the nature of the fact."). Thus, if the information is generalized, -- i.e., does not refer to a specific security or defendant -- then there will typically be a larger temporal disparity between the start of the investigation and the discovery of the facts constituting the violation. But if the information is particularized, -- i.e., does refers to a specific security or defendant -- then there will usually be a smaller temporal disparity between the start of the investigation and the discovery of the facts constituting the violation.
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