Corporate Governance

The Supreme Court and the Mission to Restrict Investor Protection: Merck v. Reynolds (Part 1)

By J. Robert Brown

Vioxx has been in the news recently but not because of the alleged adverse health effects of their pain medication drug.  The Supreme Court granted cert in Merck v. Reynolds to address the statute of limitations under Rule 10b-5.

The plaintiff class filed suit in November 2003.  The district court dismissed the case, concluding that the statute had begun to run sometime before November 2001.  The Third Circuit reversed over the vociferous dissent of Judge Roth. 

At first blush, the case appears to be a dull one.  It turns on the type of information that will qualify as "storm warnings," thereby triggering an obligation on the part of plaintiffs to investigate the possibility of misbehavior further.  The Third Circuit, according to defendants, essentially required evidence of scienter before the facts would give rise to the requisite storm warnings.  The Third Circuit doesn't use the word scienter but does conclude that storm warnings required some evidence that Merck actually "believed otherwise" with respect to its claims on the safety of Vioxx.

The generally fact intensive nature of the case suggests that some on the Supreme Court had other reasons for taking certiorari, with the answer found in Stoneridge.  In that case, a majority of the Court more or less announced its opposition to the private right of action under Rule 10b-5 and articulated an interpretive position that sought to limit any broadening of the reach of the provision.  The approach, therefore, eschewed reliance on the language of the statute or common law fraud principles. 

To the extent Merck v. Reynolds is treated in the same fashion, shareholders and investors will lose.  The Court will not give much weight to traditional interpretive principles (including the language of the statute) and instead opt for a test that forces on plaintiffs an obligation to file fraud actions quickly.  Such an approach will effectively narrow Rule 10b-5 by depriving plaintiffs of the time they need to uncover the evidence necessary to meet the stringent pleading requirements for scienter (see Tellabs). 

Of course, the Supreme Court has also issued relatively recent opinions in the securities area that do not turn on the principles articulated in Stoneridge.  Tellabs is an example of a securities case that entailed traditional legal analysis and did not turn on the need to prevent the broadening of the reach of Rule 10b-5.  Thus, the issue is whether the approach in Tellabs or the approach in Stoneridge will carry the day.  The choice of approach will dictate the outcome.

The cert petition and other primary materials can be found on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on June 15, 2009 (boomark / email).