Corporate Governance

Merck v. Reynolds: The Supreme Court, Rule 10b-5, and the Statute of Limitations (Faculty Amici and the Meaning of Lampf)

By J. Robert Brown

One of the most puzzling things about this area of law has been the judicial interpretation of the Supreme Court's analysis in Lampf.  Lampf held that under Rule 10b-5, the courts should look to the one year, three year limitations period in Section 9(e) of the Exchange Act.  Congress superseded Lampf in 2002 (in SOX) by adopting Section 1658(b) and a two year, five year period.  Congress, however, made clear that it was only extending the time period but otherwise leaving the analysis in Lampf untouched.  Thus, in construing Section 1658, it was important to understand the meaning of Lampf. 

In determining the limitations period, Lampf looked to Section 9(e) and explicitly rejected the limitations period in Section 13 of the Securities Act of 1933.  Section 13 contained an inquiry notice standard (the limitations period began upon discovery or when, upon reasonable diligence, discovery would have occurred).  Section 9(e) was triggered only by discovery.  It was clear, therefore, that in using Section 9(e) as a model, the Court in Lampf had rejected an inquiry notice standard and had intended to adopt an actual discovery standard for commencing the period of limitations.  This point was made at length in the brief submitted by law faculty.

It was this very point that Justice Scalia brought home during the oral argument.

• JUSTICE SCALIA: Mr. Shanmugam, in Lampf we -- we had to choose between what statute of limitations provision, Federal one, we thought applied. And we had two choices. One was section 77m, which reads after such discovery -- "after the discovery of the untrue statement or the omission or after such discovery should have been made by the exercise of reasonable diligence." That was one choice.  The other choice was 78i(e), which simply said: "unless brought with one year after the discovery of the facts constituting the violation. No statement of "or after it should have been made by the exercise," okay? We chose the latter in Lampf.  Now, you are telling me that there was no choice between the two, that -- that "after discovery" always means after discovery was made or after it should have been made? What were we doing in Lampf, spinning our wheels?

• MR. SHANMUGAM: No --

• JUSTICE SCALIA: I mean, I read this statute -- and 1658 tracks, not 77m, which says "after discovery should have been made"; it tracks 78i(e), which says "after discovery." Now, to me that means after discovery, period.

• MR. SHANMUGAM: Well, Justice Scalia, the Court did choose to essentially incorporate the language from -- section 9e of the 1934 Act. There were various provisions in the '33 Act and the '34 Act that incorporated discovery rules.

• JUSTICE SCALIA: Just tell me what the difference was between 77m and 77i(e)?

• MR. SHANMUGAM: Well --

• JUSTICE SCALIA: What was the difference, unless it was that 77m -- I'm sorry, 78i(e) --absolutely required knowledge?

• MR. SHANMUGAM: Well, I think one potential difference is that section 13, section 77m, refers to discovery of the untrue statement or the omission. But I think more broadly with regard to both section 9e and the other provisions of the 1934 Act to which the Court looked, courts had actually construed those provisions as reaching both actual and constructive discovery at the time the Court decided Lampf. So I --

• JUSTICE SCALIA: So there was no difference between the two and we were just wasting our time?

• MR. SHANMUGAM: No, there was really --there was no difference between the two, and I think really for the reasons that the government states in its brief as well as the reasons that we state in our opening brief, the default understanding has always been that a reference to discovery includes at least constructive discovery. And a rule that triggers the limitations period from actual discovery would have significant vices because it would give plaintiffs --

Since Justice Scalia is unlikely to concede that the Court in Lampf was just "wasting our time," he is likely to agree that the Court selected Section 9(e) for a reason and the only meaningful reason is that the Section relied upon an actual knowledge rather than inquiry notice standard. 

The transcript of the oral argument is here. The primary materials in the case can be found at the DU Corporate Governance web site.  The Faculty amicus brief is posted on SSRN.

Full post as published by The Race to the Bottom on December 01, 2009 (boomark / email).