Asecurities fraud suit might be able to go forward under Sarbanes-Oxley even though it clearly would have been barred under the pre-SOX law, a federal appellate court has ruled. The decision could potentially open the courthouse doors to many securities lawsuits presumed dead.
Several appellate courts have held in recent months that SOX—which expanded the statute of limitations for filing securities claims—does not revive suits that were barred before the statute was enacted. The St. Louis-based 8th Circuit became the latest court to adopt that view on June 6 (see related coverage at right).
But the Miami-based 11th Circuit—ruling in a case that was filed a few months after The Sarbanes-Oxley Act of 2002 took effect—said the more generous filing period in SOX might be available to the plaintiffs despite the fact that their suit clearly would have been prohibited under the old law. The court said the suit could go forward if the plaintiffs were not on notice of the alleged fraud before Sarbanes-Oxley became law on July 30, 2002.
Redburn
Thomas Redburn Jr., a partner with the law firm of Lowenstein Sandler in Roseland, N.J., calls the 11th Circuit’s ruling a “really strange opinion.”
Redburn notes that the plaintiffs were complaining about conduct that took place in 1998—which meant the three-year statute of repose for filing suit under the pre-SOX law expired in 2001. The court “must be saying that the statute of repose doesn’t matter,” says Redburn.
Although the appellate court sent the case back to trial judge to determine whether the plaintiffs had sufficient notice of wrongdoing before Sarbanes-Oxley took effect, Redburn said the 11th Circuit “pretty much telegraphed what they think about that issue—they don’t leave [the trial judge] a lot of room to conclude that the plaintiffs were on [notice] before the effective date of [SOX].”
The Short Squeeze
The 11th Circuit decision centered on a class-action suit—filed on Nov. 15, 2002 under sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5—alleging that a former broker for Dean Witter Reynolds (now Morgan Stanley) manipulated the price of e-Net stock by engaging in a “short squeeze.” Between Jan. 1, 1998, and Aug. 19, 1998, the broker allegedly manipulated stock by deceptively contriving the market prices of e-Net stock for the purpose of creating and maintaining artificially high market prices.
The suit was filed six weeks after the Securities and Exchange Commission, on Oct. 1, 2002, issued an order censuring and fining Dean Witter, and fining and barring the broker from association with any broker or dealer.
Dean Witter moved to dismiss the suit, arguing that the statute of limitations that governed was the pre-SOX period. Under the old law, complaints had to be filed within one year of the facts that caused the securities violation and within three years of that violation. Because the suit was not filed within three years of Aug. 19, 1998 (when the alleged misconduct ended), the suit was too late, Dean Witter argued.
But a federal judge in Florida ruled that Sarbanes-Oxley revived the suit. Under SOX, a securities fraud suit is timely if it was filed two years after discovery of the facts evidencing the securities fraud or five years after the fraudulent conduct. The judge allowed Dean Witter to appeal his order before the case was actually tried.
Inquiry Notice
On appeal, the 11th Circuit cited legislative history suggesting that the limitations period contained in Section 804(a) of Sarbanes-Oxley “shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act.” [Section 804(a) of SOX is codified in section 1658(a) of Title 28 of the U.S. Code.]
The key issue, the court said, was when the plaintiffs had “inquiry notice,” which refers to knowledge of facts that would lead a reasonable person to begin investigating the possibility that his legal rights had been violated. In this case, the extended statute of limitations in SOX, “is applicable to the alleged fraudulent securities conduct … provided inquiry notice was not sufficiently established to enable the plaintiff class to file this class action prior to issuance of the SEC Order,” the court wrote.
Although other circuits have ruled that SOX does not “revive” previously barred claims, the 11th Circuit said it was unnecessary to address that question in this case. “Rather than ‘reviving’ their cause of action, about which they purportedly were unknowing until the SEC Order issued, the plaintiffs’ class action was filed or commenced after the knowledge of Dean Witter’s fraudulent conduct through the SEC Order, which was after the new statute of limitations under the SOA had become effective on July 30, 2002,” the court said.
Dean Witter argued that, even under this reasoning, the suit was barred because the plaintiffs had notice of what was going long before the SEC’s order. Dean Witter cited two newspaper articles dating back to 1998, as well as relevant comments that were made that same year in an Internet chat room by an investor.
But the court said these reports might not have been enough to put investors on notice of wrongdoing before the SEC’s order. “[G]eneral skepticism expressed in a press article about corporate conduct is insufficient ‘to excite inquiry into the specific possibility of fraud.’ … Instead, ‘for a press article to put shareholders on inquiry notice, there must be some reasonable nexus between the allegations made in the article and the nature of the action subsequently brought.’”
In this case, the 11th Circuit said that the trial judge must determine “the point in time that [the representative of the plaintiff class] had sufficient specific factual information of Dean Witter’s violation of the securities laws to file the class-action complaint. If that did not occur until the Oct. 1, 2002, SEC Order, then this securities-fraud class action was timely filed on Nov. 15, 2002.”
Related coverage, documents and cases are available in the boxes above, right, and Compliance Week will continue to track this issue for subscribers in the coming weeks.
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