The Second Circuit And The Statute Of Limitations In Securities Fraud Actions
In Alaska Electrical Pension Fund v. Pharmacia Corporation, Case Nos. 07-4500 & 07-4564 (2nd Cir. Jan. 30, 2009), the court vacated an order from the district court granting summary judgment for defendants based the statute of limitations in a securities fraud class action. The application of the statute of limitations here was keyed to the question of “inquiry notice” or at what point plaintiffs were on reasonable notice of their claim. This question has caused a split in the circuits and which may be heard by the Supreme Court later this term. See Trainer Wortham & Co. Inc. v. Heide Betz, No. 07-1489 (S.Ct. Docketed May 29, 2008), discussed here.
The complaint is based on fraud claims keyed to the marketing of Celebrex, an anti-inflammatory prescription drug of defendants. Critical to selling this drug was the question of whether it typically caused fewer gastrointestinal side effects than many of its competitors. A long term study demonstrated that in fact the drug caused those side effects. The defendants claimed however, that the drug caused fewer side effects based on a truncated version of the study.
The truncated version of the study released by defendants became the basis for a favorable article published in September 2000 in the Journal of the American Medical Association. The article was by scientists affiliated with defendants.
In February 2001, the FDA refused to permit the removal of a warning label about the side effects based on its review of the complete study. The FDA staff did not agree with the defendants’ claims about the side effects. Subsequently, defendants issued a series of positive press releases. Financial analysts continued to rate Pharmacia’s stock positively.
On August 5, 2001, the Washington Post published a report stating that defendants had withheld the full data from JAMA. Scientists who reviewed the full study complained to JAMA after learning of the differences. A June 2002 article in the British Medical Journal called the explanations for the irregularities with the JAMA article inadequate. Following the publication of this article the share price of Pharmacia dropped 7% in three days. The first suit was filed in April 2003.
The key question as to the statute of limitations in this case is when investors were put on “inquiry notice.” This issue turned on whether plaintiffs, in the exercise of reasonable diligence, had sufficient information of possible wrong doing – that is, to “excite storm warnings of culpable activity.”
Under this objective analysis, plaintiffs are presumed to have read items such as prospectuses, quarterly reports and other similar information. Inquiry notice attempts to prevent potential plaintiffs from sitting on their hands and simply claiming a lack of knowledge. At the same time, the standard does not require a plaintiff to sort through a mound of scientific data to try and determine what happened. The question is what an investor of ordinary intelligence would know. Inquiry notice in a securities fraud case must put the investor on notice that he or she has a claim – that the defendants acted with scienter, since that is a key element of the claim.
Here, the district court thought plaintiffs were put on inquiry notice at the time of the FDA findings. The Circuit Court disagreed. The findings at the FDA were simply of a disagreement and thus were not sufficient, the court concluded. There was no indication of wrongful conduct or scienter.
While analyst reports later found that there was no justification for the use of truncated data to support the company claims, the court found that this would not put a reasonable investor on notice of “fraud, as opposed to a mere disagreement over the best method of scientific analysis … .” Indeed, the defendants’ own reassuring statements after the events at the FDA end any argument on this point. Those “reassuring statements operate as a sort of antidote to any storm warnings …,” the court held.
In fact, notice did not occur until the time of the Washington Post article, according to the Second Circuit. At that point the plaintiffs were on inquiry notice of the type of conduct necessary to bring a fraud claim.
Finally, the court rejected defendants’ claim that scienter had not been pled as required by the PSLRA. In reaching this conclusion, the court noted that “it is true that a legitimate disagreement over scientific data does not give rise to a securities fraud claim, plaintiffs alleged … bad faith misrepresentation …,” which is sufficient.