AmLawDaily catches Merck passing the reins from Cravath, Swaine & Moore to Williams & Connolly for its petition to the Supreme Court regarding the consolidated Vioxx securities litigation. In a moment, we’ll look at Merck’s (likely very, very expensive) brief, and marvel at the Catch-22 it proposes.
But first, some background, courtesy of the Third Circuit’s opinion:
Appellants, purchasers of Merck & Co., Inc. stock, filed the first of several class action securities fraud complaints on November 6, 2003, alleging that the company and certain of its officers and directors (collectively, “Merck”) misrepresented the safety profile and commercial viability of Vioxx, a pain reliever that was withdrawn from the market in September 2004 due to safety concerns. The District Court granted Merck’s motion to dismiss the complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure, holding that Appellants were put on inquiry notice of the alleged fraud more than two years before they filed suit, and thus their claims were barred by the statute of limitations. Appellants argue that the District Court erred in finding as a matter of law that there was sufficient public information prior to November 6, 2001 to trigger Appellants’ duty to investigate the alleged fraud.
The Third Circuit agreed with Appellants and reversed the dismissal. That’s what Merck has appealed to the Supreme Court.
Although Merck had internal doubts over Vioxx’s safety long before it was even approved by the FDA, it never made those doubts public (they were only discovered through litigation). After the "VIGOR" study released in 2000 suggested Vioxx had an increased risk of cardiovascular incidents over another pain reliever, naproxen, Merck argued the difference was due to a protective effect of naproxen, rather than any danger due to Vioxx. In September 2001, the FDA sent Merck a warning letter, which noted:
Although the exact reason for the increased rate of [myocardial infarctions] observed in the Vioxx treatment group is unknown, your promotional campaign selectively presents the following hypothetical explanation for the observed increase in MIs. You assert that Vioxx does not increase the risk of MIs and that the VIGOR finding is consistent with naproxen’s ability to block platelet aggregation like aspirin. That is a possible explanation, but you fail to disclose that your explanation is hypothetical, has not been demonstrated by substantial evidence, and that there is another reasonable explanation, that Vioxx may have pro-thrombotic properties.
The issue remained controversial and disputed until October 2003, when a "study by the Harvard-affiliated Brigham and Women’s Hospital in Boston that found an increased risk of heart attack in patients taking Vioxx compared with patients taking Celebrex and placebo." A week after that study was made public, the investors sued Merck.
Merck’s argument is that the FDA warning letter alone — which it vigorously disputed in public, while concealing its own internal doubts — was evidence enough that they committed securities fraud, thereby putting investors on "inquiry notice" and beginning the statute of limitations.
Thanks to the Private Securities Litigation Reform Act of 1995, and the Supreme Court’s 2007 decision in Tellabs Inc. v. Makor Issues & Rights, Ltd., investors alleging fraud need to show facts, in their initial complaint, which create an "inference of scienter" (i.e., the defendant’s intention “to deceive, manipulate, or defraud) that is
more than merely “reasonable” or “permissible”—it must be cogent and compelling, thus strong in light of other explanations. A complaint will survive, we hold, only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.
It’s a high bar to meet, a "heightened pleading requirement" to be sure. In essence, investors filing a shareholder fraud suit have to prove, when they file suit, that they’ll likely win.
Keep that in mind while reading Merck’s brief to the Supreme Court:
With regard to those elements that are required for a violation of Section 10(b), moreover, it is not necessary that the plaintiff possess sufficient information to satisfy any heightened pleading requirements applicable to those elements before the limitations period begins running. In the Private Securities Litigation Reform Act of 1995 (PSLRA)—enacted after this Court first set out the limitations period for Section 10(b) actions in Lampf—Congress adopted heightened pleading requirements for private securities-fraud actions, including the requirement that the complaint “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 1934 Act § 21D(b)(2), 15 U.S.C. 78u-4(b)(2).
In Rotella, this Court considered and rejected the argument that the existence of heightened pleading requirements should drive application of the discovery
rule. Specifically, the Court rejected the plaintiff’s contention that it should adopt a broader version of the discovery rule for civil RICO claims on the ground that, in
many cases, those claims were subject to the heightened pleading requirement for fraud claims in Federal Rule of Civil Procedure 9(b). 528 U.S. at 560-561. While acknowledging the plaintiff’s concern that a narrower rule could “allow blameless ignorance to defeat a claim,” the Court concluded that “we simply do not think such a concern should control the decision about the basic limitations rule.” Id. at 560 (internal quotation marks and citation omitted). Although the PSLRA operates differently in some respects from Rule 9(b), the basic point remains the same: under the discovery rule, the limitations period may be triggered even when a plaintiff will not possess sufficient information to satisfy any applicable heightened pleading requirements.
It is therefore true, at least as a theoretical matter, that, under Section 1658(b), a plaintiff may not be in a position to file a securities-fraud complaint that would survive a motion to dismiss before the limitations period runs. Even when the discovery rule is applicable, however, the purpose of the limitations period itself is to give the plaintiff a specified period of time in which to “prepare a case against [the] perpetrators”—not to sit on his complaint once it is ready. Lampf, 501 U.S. at 378 (Kennedy, J., dissenting); see, e.g., Fujisawa Pharm. Co. v. Kapoor, 115 F.3d 1332, 1334 (7th Cir. 1997). As the government has previously explained in another case involving the discovery rule, “statutes of limitations are designed to induce prospective plaintiffs to investigate and act; they are not designed to offer a period of leisure between the completion of an investigation and the filing of suit.” U.S. Br. at 13, Kubrick, supra (No. 78-1014). The possibility that a heightened pleading requirement “will exact some cost,” insofar as some plaintiffs may be unable to prepare valid complaints within the limitations period, is thus an insufficient basis for adopting a broader interpretation of the discovery rule. Rotella, 528 U.S. at 560.
Like I said: Catch-22. According to Merck, you can’t sue until you have enough evidence to show a "strong inference" of scienter, but you have to sue within two years of the first sign — determined in hindsight — of when you should have been "induce[d] … to investigate and act," even if there was no evidence of scienter.
It’s odd that Cravath and Williams & Connolly didn’t put more effort into this argument. Rotella reached its conclusion by analogizing the racketeering claims at issue there — brought by a psychiatric patient eleven years after discharge against a facility which, he alleged, fraudulently kept him there to boost profits — to medical malpractice, where the patient is typically put on "notice" of their claims at the time of their injury.
Such bears little resemblance to the Merck case, in which the investors were arguably vaguely "injured" by the 2001 FDA letter regarding Merck’s marketing, but had nothing even suggesting deliberate concealment of Vioxx’s risks until 2003.
Moving on to the next two paragraphs in Merck’s brief:
Significantly, in extending the limitations period for Section 10(b) claims from one year to two years in the Sarbanes-Oxley Act, Congress acted out of concern that the preexisting one-year period would foreclose plaintiffs who were unable to prepare complaints sufficient to satisfy the PSLRA’s heightened pleading requirements in time. In its report, the Senate Judiciary Committee observed that “[t]he one year statute of limitations from the date the fraud is discovered is * * * particularly harsh on innocent defrauded investors,” because “the complexities of how the fraud was executed often take well over a year to unravel, even after the fraud is discovered.” S. Rep. No. 146, supra, at 9. Specifically, the committee noted that, “[w]ith the higher pleading standards that * * * govern securities fraud victims, it is unfair to expect victims to be able to negotiate such obstacles in the span of 12 months.” Ibid. That concern would have been wholly misplaced if the one-year period did not begin to run until the plaintiff possessed enough information to satisfy the PSLRA’s heightened pleading requirements in the first place.
Conversely, if the limitations period were triggered only once a plaintiff was able to bring suit, the practical effect of Congress’s adoption of heightened pleading requirements in the PSLRA would have been to postpone the start of the limitations period, sometimes significantly, in many cases. Given that the PSLRA’s primary purpose was to “check * * * abusive litigation by private parties,” Tellabs Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007), it is implausible that, in enacting the PSLRA, Congress would have wanted effectively to extend the time for filing private securities fraud actions—and thus to enable more plaintiffs to use securities-fraud actions as a hedge against downside risk. See pp. 48-49, infra. In sum, the limitations period in Section 1658(b) is triggered by something short of the ability to file a viable complaint, and there is therefore no valid statutory basis for the court of appeals’ rule that a plaintiff must possess information specifically relating to scienter in order to be on inquiry notice.
That misses the point entirely. If Congress wanted to "check abusive litigation," then it is similarly "implausible" that Congress wants to force investors to file suit before they "possess sufficient information to satisfy any heightened pleading requirements."
Which is what Merck suggests.
The investors’ brief is due in October. The Supreme Court has not yet scheduled oral argument.
But it will raise an interesting question: should investors be required to sue companies at the first hint of trouble, or can they wait until they have facts suggesting wrongdoing? Do we really want to encourage suits which even the plaintiffs don’t know are meritorious?