The financial crisis of 2007 and 2008 led to catastrophic losses for investors in residential mortgage-backed securities (“RMBS”). In the wake of the crisis, numerous suits were filed by investors and insurers against Wall Street banks. Plaintiffs allege that the banks issued loans to homeowners, packaged loans into securities, and sold them to investors—or induced plaintiffs to insure the securities—pursuant to offering materials that misrepresented the loans’ characteristics. The volume of these cases, all filed over the past few years, involving a similar set of background facts and a relatively new and complex type of security, created a series of decisions that have moved and clarified the law of statute of limitations. The holdings are not just relevant to the flood of RMBS cases currently facing the courts, but for all parties interested in bringing, or defending, securities and fraud-related claims.
Is “Inquiry Notice” Even the Standard Anymore?
A recent line of cases has suggested that the traditional “inquiry notice” standard for claims brought under the Securities Act of 1933 no longer applies. Rather, courts have adopted the more plaintiff-friendly standard of whether an investor could have actually amassed sufficient facts to survive a motion to dismiss.
The shift began with the Supreme Court’s decision in Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010). In Merck, the Supreme Court established a new test for measuring the statute of limitations for claims under the Securities Exchange Act of 1934. The 1934 Act’s two-year limitations period was traditionally measured by the “inquiry notice” standard, but Merck rejected it, holding that the limitations period does not begin to run until “a reasonably diligent plaintiff would have discovered ‘the facts constituting the violation,’ including scienter—irrespective of whether the actual plaintiff undertook a reasonably diligent investigation.” Id. at 1798. “Inquiry notice” does not trigger the statute of limitations, the Court held, because even a diligent investigation may not feasibly lead to “facts constituting the violation.” Id. at 1788. The Supreme Court thus confirmed that the proper focus is not on when the investigation should have begun, but rather must be on when a reasonable investigation would have borne sufficient fruit.
In City of Pontiac General Employees’ Retirement System v. MBIA Inc., 637 F.3d 169, 175 (2d Cir. 2011), the Second Circuit addressed the question of what is ‘sufficient’ fruit. The Second Circuit concluded that, under Merck, the 1934 Act’s statute of limitations does not begin to run until a plaintiff could plead sufficient facts to survive a motion to dismiss: 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.” As the Second Circuit explained: “Since the purpose is to prevent stale claims, it would make no sense for a statute of limitations to begin to run before the plaintiff even has a claim…. [I]n the limitations context, it makes sense to link the standard for ‘discovering’ the facts of a violation to the plaintiff’s ability to make out or plead that violation.” Lower courts have since applied the Merck and City of Pontiac standard to 1934 Act cases. See, e.g., S.E.C. v. Wyly, 788 F. Supp. 2d 92 (S.D.N.Y. 2011); Space Coast Credit Union v. Barclays Capital, Inc., No. 11-cv-2802 (S.D.N.Y. Mar. 20, 2012).
The question nonetheless remained: Was the abrogation of the “inquiry notice” standard driven by some peculiarity of the 1934 Act’s text? The numerous RMBS cases that were brought in the wake of the financial crisis provided the opportunity for many courts to address that question. RMBS defendants have argued that investors were on “inquiry notice” of their claims in 2007 and 2008, due to general news reporting about a shifting economy, loosened underwriting guidelines in the industry, and similar materials. One way plaintiffs have pushed back is to argue that defendants’ motions are focused on the entirely wrong standard—and many courts have agreed. For instance, the court in In re Bear Stearns Mortgage Pass-Through Certificates Litigation sided with “the majority of judges in this district” in holding that there was “no principled basis for cabining Merck’s holding” to 1934 Act’s claims. No. 08-cv-8093, 2012 WL 1076216, at *12 (S.D.N.Y. Mar. 30, 2012). As such, “Defendants’ focus on inquiry notice is misplaced. The operative question is no longer when a reasonable plaintiff would have known that she had a likely cause of action and inquired further. Rather, the question is whether a plaintiff could have pled ’33 Act claims with sufficient particularity to survive a 12(b)(6) motion . . . .” Id. at 13. Most recently, the Southern District sided with the Federal Housing Finance Agency in applying Merck to FHFA’s 1933 Act claims. Federal Housing Fin. Agency v. UBS Am., Inc., 11-cv-5201 (S.D.N.Y. May 4, 2012), Order at 22-24. See also In re Wachovia Equity Sec. Litig., 753 F. Supp. 2d 326, 371 n. 39 (S.D.N.Y. 2011) (applying Merck to 1933 Act claims); In re Direxion Shares ETF Trust, No. 09-cv-8011, 2012 WL 717967, at *2 fn. 3 (S.D.N.Y. Mar. 6, 2012) (same); Plumbers’ & Pipefitters’ Local No. 562 Supp’l Plan & Trust v. J.P. Morgan Acceptance Corp. I, No. 08-cv-1713, 2012 WL 601448, at *10 (E.D.N.Y. Feb. 23, 2012) (same).
While the concept of “inquiry notice” now appears all but dead in federal securities claims, courts have reached mixed results in extending Merck to state law claims. A federal court in Ohio recently applied Merck to Ohio’s blue sky law, drawing a comparison between the statutory language of the 1934 Act and the Ohio law, which requires knowledge of “facts” related to defendants’ wrongdoing. In re Nat’l Century Fin. Enter., Inc., 755 F.Supp.2d 857, 869-72 (S.D. Ohio 2010). But a Texas appellate court declined to apply Merck to the Texas Securities Act, “[i]n light of the differences in the language of the statutes’ limitations provisions,” particularly because intent is not at issue in the Texas statute. Allen v. Devon Energy Holdings, L.L.C. No. 01–09–00643–CV, 2012 WL 880623, *26 fn. 62 (Tex. App. Mar. 9, 2012). An Indiana appellate court likewise declined to apply Merck to the Indiana Uniform Securities Act, finding that Merck is not controlling and distinguishable on its facts, because plaintiffs were on notice of defendant’s wrongdoing “all along.” Paddock v. Maikranz, No. 82A05–1010–CT–6362011 WL 3849439, *4 fn. 6 (Ind. App. Aug. 31, 2011).
How Specific Must Information Be to Start the Clock?
Other courts dealing with RMBS cases have not felt the need to reach the Merck question. In so doing, they have established another clear statute-of-limitations trend: that, at the pleading stage at least, general information about the industry in question is insufficient to show the statute of limitations began with respect to the plaintiff’s particular securities.
Defendants in RMBS cases typically cite newspaper articles, filed complaints, and other public sources in arguing that plaintiffs were on notice of their claims outside of the limitations period. Plaintiffs...
