|December 30, 2013|
Previously published on December 20, 2013
The Third Circuit's recently issued opinion in Pension Trust Fund for Operating Engineers v. Mortgage Asset Securitization Transactions, 2013 U.S. App. LEXIS 19166, (3rd Cir. 2013), clarified the use of the discovery rule to determine the timeliness of plaintiffs' cases alleging violations of the Securities Act of 1933. Consequently, parties now have clearer guidance as to what standard the federal courts in Pennsylvania, and elsewhere within the circuit, are to apply and what factors they are to consider when determining whether or not to dismiss an investor's claim for being stale and untimely.
Two issues were before the Third Circuit. First, were the plaintiffs required to affirmatively plead that they brought their claim within the statute's one-year statute of limitations and second, what standard was to be applied to make that determination. As to the first issue, the Court concluded that the plaintiffs did not need to affirmatively plead that they filed their claims within the one-year statute of limitations because the statute, on its face, does not require the inclusion of an explanation of compliance with the same. To the contrary, it was to be left to defendants to assert the statute as an affirmative defense.
As to the second issue, the Third Circuit determined that the discovery rule and not inquiry notice was to be applied when determining the timeliness of an investor's complaint. Under the discovery rule, the clock begins to run on a plaintiff's claim when either (a) the plaintiff did, in fact, discover the operative facts, or (b) when a reasonably diligent plaintiff would have discovered the facts constituting the violation of the securities laws which gives rise to their claim. Consequently, the discovery rule's standard is more flexible and is better situated for assessing a plaintiff's responsibility for determining if they have a case when the initial information available to them is more general in nature and thus further inquiry is necessary before a plaintiff can sufficiently determine that they have a claim and should pursue it.
By contrast, inquiry notice is less flexible because, through its focus on when the duty arose in a plaintiff to exercise reasonable diligence to uncover the basis for their claims, it starts the clock running at the earliest opportunity with less regard to the nature of the information available to the plaintiff. Under this standard, if plaintiffs cannot demonstrate the requisite notice, then they are held to have constructive notice of all facts that could have been learned. Although the two standards share some similarities, the difference is critical as inquiry notice serves to put a plaintiff on notice at the earliest opportunity possible. Thus its application often results in more claims being held to be stale and untimely. Stated differently, the discovery rule starts the clock from the point in time when the facts would lead a reasonably diligent plaintiff to investigate further, whereas inquiry notice starts the clock running when the plaintiff should have already discovered facts constituting the violation.
The Third Circuit's opinion also provides guidance as to how and when the particularity of the information about an investment in the public sphere can either begin the clock to run immediately on a plaintiff's claim, or when it merely requires plaintiffs to conduct further inquiry before the clock can begin to run out on their claims. Thus, general information about the failures of a category or class of investments may give a plaintiff an extended period of time in which to discover the facts of the misrepresentations about a specific investment. By contrast, if the investors' claims arise from a specific investment and there are news reports about that specific investment, its failures, misrepresentations, etc., then the time period between when plaintiffs ought to begin their investigation and when they ought to discover the operative facts from which their claims arise is much smaller. Keep in mind, however, that the Court also clarified that the discovery rule can be tolled by reassurances given to investors that everything is fine with their investment if an investor of ordinary intelligence would reasonably rely on such reassurances to allay their concerns.
Advisors, broker-dealers, and investment firms need not wait until they are sued to put these lessons to good use as part of any defense. The decision's clarifications can be used proactively to avoid litigation. Investors look to and rely upon their advisors to give them honest, unvarnished, and objective advice and information about their investments. Providing honest, objective information to investors puts the investors on notice earlier to investigate any claim that they might have and thus, from a risk management perspective, it is far wiser to provide investors with as specific information as possible on their investments than to provide subjective reassurances that can toll the ruling of the statute of limitations and thus expand the time investors have to file a claim.