Securities Litigation Alert: Ninth Circuit Clarifies Standards Governing The Statute Of Limitations For Private Claims Under Section 10(b) Of The Securities Exchange Act Of 1934

• Published date: 02 June 2023
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Criminal Law, Corporate and Company Law, Trials & Appeals & Compensation, Securities, White Collar Crime, Anti-Corruption & Fraud
• Law Firm: Cadwalader, Wickersham & Taft LLP
• Author: Mr Jason Halper, Ellen V. Holloman, Adam Magid, Jonathan Watkins and Diane Lee

In York County v. HP, Inc.,¹ the U.S. Court of Appeals for the Ninth Circuit further clarified national standards governing the two-year statute of limitations applicable to private claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Joining the Second Circuit (and others), the Court held that the statute of limitations begins to run when a "reasonably diligent plaintiff" would have discovered the "facts constituting the violation" (including scienter), and that occurs when such a plaintiff can plead those facts "with sufficient detail and particularity to survive a 12(b)(6) motion to dismiss." York contributes to a growing consensus among the circuits on the standards applicable to the two-year Section 10(b) statute of limitations. It also advances the law by articulating a framework for courts to assess when, on the pleadings alone, a Section 10(b) claim may be dismissed as untimely (i.e., when the complaint fails to plead that a "necessary" Section 10(b) "fact" became discoverable within two years of the complaint's filing). While York is an important addition to jurisprudence on Section 10(b) limitations periods, questions remain, including the full gamut of "facts constituting the violation" that a reasonably diligent plaintiff must discover for the clock to start ticking.

Background

As a judicially-crafted cause of action, a private claim for securities fraud under Section 10(b) did not come pre-packaged with an applicable limitations period. That was remedied in the Sarbanes-Oxley Act of 2002, which enacted a statutory limitations period for any "private of right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws." Under Title 28, Section 1658(b) of the U.S. Code, a plaintiff must bring such a claim "not later than the earlier of-(1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation."² But what does "discovery" mean? Does it mean actual discovery, such that a plaintiff who is not paying attention and becomes aware of a fraud four years after the fact can bring suit with impunity? And what, for that matter, are the "facts constituting the violation" that have to be "discovered"?

The Supreme Court answered these questions, in part, with its 2010 decision in Merck & Co. v. Reynolds.³ There, the Court held that "discovery" refers not only to a plaintiff's "actual discovery of certain facts" but also to "the facts that a reasonably diligent plaintiff would have discovered."⁴ The Court explained that Congress used "discovery" in Section 1658(b) as a term of art to import the long-recognized "discovery rule" by which a fraud is not deemed "discovered" until "in the exercise of reasonable diligence, it could have been discovered."⁵ The Court also clarified that scienter-"a mental state embracing intent to deceive, manipulate, or defraud"-is among the "facts constituting the violation" that a reasonably diligent plaintiff must be able to discover to start the running of the two-year limitations period.⁶ The Supreme Court left open, however, exactly how lower courts are to assess and adjudicate when a "reasonably diligent plaintiff" would have discovered those facts.

That was the question in York. The case arose from information technology company HP Inc.'s conduct in measuring and disclosing its "channel" inventory-that is, the total inventory that HP and its distributors had in stock. HP created a metric called "Weeks of Supply" (WOS) that purportedly reflected how many weeks it could supply its products if sales continued at the same pace as in prior weeks. HP calculated WOS by dividing "Tier 1" inventory-inventory held by "Tier 1" distributors that purchased supplies directly from HP-by the average number of units sold in previous weeks. Importantly, HP did not include in its calculation inventory held by "Tier 2" distributors (which purchased supplies not from HP but from "Tier 1" distributors), nor did HP disclose the omission of "Tier 2" data to investors.

As alleged, at the time of HP's allegedly incomplete disclosures, it was secretly implementing practices to offload "Tier 1" inventory onto "Tier 2" distributors, so as to depress its stated WOS metrics. For example, HP allegedly engaged in so-called "gray marketing," by which it would sell to "Tier 1" distributors that, in turn, would sell supplies at a discount outside their assigned territory, forcing local distributors to lower prices to compete. HP also offered alleged "pull-ins," i.e., steep discounts to encourage "Tier 2" distributors to take on more inventory in a given quarter than economic circumstances otherwise would dictate. Unknown to investors, according to the complaint, these practices allegedly created a misleading public picture of HP's channel health. Following an investigation, in late September 2020, the...