Corporate Governance

Trainer v. Betz: The Supreme Court, Deregulation, and Rule 10b-5 (Part 1)

By J. Robert Brown

We have posted on the overlooked role of the courts in the current turmoil.  But for the DC Circuit's decision in Goldstein, there would be far more information about hedge funds, large players in the financial markets.  Today we write about what may be a good example of the legislative role of the Supreme Court, particularly its mission to cut back on private law suits under Rule 10b-5, and what President Obama will confront. 

As the student post has described, the 9th Circuit recently held in Betz v. Trainer Wortham, 519 F.3d 863 (9th Cir. 2008) that the test for determining when the statute of limitations under Section 10(b) (two years from the date of discovery and not more than five years from the date of the fraud) would begin to run was "inquiry-plus-reasonable diligence."  In effect, plaintiff had to have some objective indication of the fraud and then was given a reasonable time to investigate before the statute would start to run.

The holding was unremarkable, adopting the test more or less used in most circuits.  What made the case a bit more unusual was the application of the facts to the test.  The plaintiff alleged that she had been promised that her principal would be sacrosanct.  Six months into the investment, she received account statements that showed a decline in principal.  Plaintiff apparently made some inquiries but it took a year or so before initiated face to face discussions to uncover what had happened.  She allegeldy received assurances that the decline was "temporary" and that defendants were "taking care of everything."   Later she was told there was a "serious problem" with the way the account had been managed and that they would "take care of the amount because it was 'the right thing to do."

The case, therefore, turned on whether she was on inquiry notice when she received the first statements showing a drop in princpal and whether the "assurances" somehow prevented her from uncovering the facts constituting the allege fraud.  In other words, the case seemed routine and, even though another panel or another circuit might have come out differently, it raised few issues of lasting significance.

Not to Chief Judge Kozinski.  He was outraged by the decision, beginning his dissent (joined by judges O'Scanlain and Bea) to the denial for rehearing en banc this way:  "Here we are, out in left field again."  He argued that the case was at odds with the other ten circuits that had ruled on the matter.  First, he asserted that the inquiry notice issue could be determined as a matter of law where there were no facts in dispute.  For Kozinski, the inquiry notice started when plaintiff received the first statement indicating that her principal had declined.  "Since Betz's theory of fraud is that she was told her money would not be put at risk, she had at least inquiry notice that someone had lied to her when she saw her principal melt away like a posicle in July." 

Even assuming adequate inquiry notice. Kozinski has no patience with the allegations that the plaintiff was "thwarted" in discovering the facts because of the assurances provided by the broker.  Kozinski was troubled by the fact that the plaintiff was led to believe that matters would improve but was not misinformed about the state of her account.

• But ours is not a case where defendant thwarted plaintiff from developing the facts.  Indeed, Betz doesn't claim that the bank misrepresented any facts.  The bank did not, for example, tell Betz that she still had 100 percent of her principal, even though the statements didn't show it. Quite the opposite:  The bank confirmed that Betz's principal was gone.  The bank did predict she would get her money back when the stock market recovered, but such a statement only confirms tha plaintiff's investment is subject to market fluctuations and is therefore not free from risk.  A defendant who conceals facts may conceivably prevent a reasonably diligent investor from discovering the truth, but a defendant who jollies a disappointed investor along with sunny forecasts of future bull markets conceals nothing and thus does not prevent the investor from gathering enough information to bring suit. 

The dissent and the cert petition attracted the attention of the Supreme Court.  The Court asked for the views of the Solicitor General on the case.  Let us discuss this a bit more in the next post. 

Full post as published by The Race to the Bottom on November 19, 2008 (boomark / email).