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The Sarbanes-Oxley Act of 2002 contains some good news for investors. It extends the statute of limitations for securities claims to two years after the discovery of facts constituting the violation and to five years after the violation actually occurred. While time limits have been liberalized, the rules for applying these limits in individual cases remain a developing area of the law. In Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 360 (1991), the U.S. Supreme Court held that causes of action under � 10(b) and Rule 10b-5 must be brought within one year of the discovery of the facts constituting the violation and within three years of the violation actually occurring. Eleven years later, Congress modified Lampf by extending the statute of limitations for claims of securities fraud, deceit or manipulation to the earlier of two years after the discovery of the facts constituting the violation or five years after such violation. See Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745, Title VIII, � 804(a) (2002) (amending 28 U.S.C. 1658 by inserting *an exception to the general four-year statute of limitations for civil actions arising under acts of Congress). The act clearly provides that this amendment “shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002].” Left unresolved is whether the amendment salvages expired claims or extends the limitations period for pending claims. Compare Roberts v. Dean Witter Reynolds Inc., 2003 WL 1936116 (M.D. Fla. March 31, 2003) (holding that the amendment revives expired claims) with De La Fuente v. DCI Telecommunications Inc., 2003 WL 832009 (S.D.N.Y. March 4, 2003) (holding that the amendment does not apply to claims pending at time of enactment). Further litigation should be expected on this issue. PLAINTIFF’S DUTY TO INVESTIGATE A majority of the U.S. circuit courts of appeals now agree that “storm warnings” may place the plaintiff on inquiry notice of the possibility of fraud, triggering the plaintiff’s duty to investigate in a reasonably diligent manner. See Maggio v. Gerard Freezer & Ice Co., 824 F.2d 123 (1st Cir. 1987); Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000); In re Nahc Inc. Sec. Litig., 306 F.3d 1314 (3d Cir. 2002); Howard v. Haddad, 962 F.2d 328 (4th Cir. 1992); Harner v. Prudential-Bache Securities Inc., 35 F.3d 565 (Table), 1994 WL 494871 (6th Cir. 1994); Marks v. CDW Computer Ctrs. Inc., 122 F.3d 363 (7th Cir. 1997); Great Rivers Cooperative v. Farmland Indus. Inc., 120 F.3d 893 (8th Cir. 1997); Sterlin v. Biomune Sys., 154 F.3d 1191 (10th Cir. 1998); Theoharous v. Fong, 256 F.3d 1219 (11th Cir. 2001). Several circuits have more liberally held that the statute of limitations begins to run from the date the plaintiff should have discovered the alleged fraud in the exercise of reasonable diligence, not the date the storm warnings first appeared. See, e.g., Young v. Lepone, 305 F.3d 1 (1st Cir. 2002); Fuqua v. Ernst & Young LLP, 33 Fed. Appx. 569 (2d Cir. 2002); Law v. Medco Research, 113 F.3d 781 (7th Cir. 1997). However, adding to the complexity of this analysis, at least one circuit has held that “the running of the statute of limitations begins when a plaintiff is put on inquiry notice-that is, when the plaintiff has been presented with evidence suggesting the possibility of fraud.” Harner, 1994 WL 494871, at *4. The precise definition of a “storm warning” varies from circuit to circuit. The 7th Circuit has stated: “The facts constituting [inquiry] notice must be sufficiently probative of fraud-sufficiently advanced beyond the stage of a mere suspicion, sufficiently confirmed or substantiated-not only to incite the victim to investigate but also to enable him to tie up any loose ends and complete the investigation in time to file a timely suit.” Fujisawa Pharm. Co. Ltd. v. Kapoor, 115 F.3d 1332, 1335 (7th Cir. 1997). “The test for ‘storm warnings’ is an objective one, based on whether a ‘reasonable investor of ordinary intelligence would have discovered the information and recognized it as a storm warning.’” In re Nahc, 306 F.3d at 1325; see also Sterlin, 154 F.3d at 1204 n.22. Often the prospectus or offering memorandum itself contains information that triggers a storm warning. In Harner, the 6th Circuit noted that the prospectus warned investors of the risks of investing in the depressed aircraft market, conflicting with oral representations that the aircraft-leasing market outlook was good. See 1994 WL 494871, at *5-6. This discrepancy, the court concluded, was sufficient to put the investors on notice of “possible problems with the investment.” A dramatic market loss or drop in stock price also may be sufficient notice that an investor did not receive accurate information about the investment and thus trigger the investor’s duty to inquire further. See Cooperativa de Ahorro y Credito Aguada v. Kidder, Peabody & Co., 129 F.3d 222, 224 (1st Cir. 1997). However, a market drop usually has to be accompanied by some other evidence of fraud. See Law, 113 F.3d at 784. Public disclosures in the media may also put investors on inquiry notice. For instance, in In re USEC Sec. Litig., 190 F. Supp. 2d 808, 820-21 (D. Md. 2002), information that appeared in various industry publications and a newspaper were deemed to trigger the plaintiffs’ duty to investigate. In Sterlin, an article in Barron’s questioning whether the company’s purpose was to create a viable product or simply to “sell shares” also was held to be a storm warning. 154 F.3d at 1204. However, if the market fails to react to the public disclosure, a plaintiff may be able to argue that it was a premature storm warning and thus did not trigger a duty to investigate. See Law, 113 F.3d at 784. A bankruptcy filing likewise may indicate that representations about the soundness of an investment were false, and thus put investors on notice of the need to investigate further. For example, in Theoharous, 256 F.3d at 1228, the 11th Circuit held that the plaintiff’s claims were time-barred because the announcement that the company was filing for bankruptcy put investors on notice that previous reports of the company’s “solid financial health” were inaccurate. An investigation by a company audit committee or other investigating body may constitute a storm warning. However, in Young, the 1st Circuit held that a plaintiff who delayed filing a claim until an audit committee completed its investigation of the allegations “could not be faulted, as a matter of law, for awaiting the results of that investigation before jumping to the conclusion that management was cooking the books.” 305 F.3d at 12. Also, when the public is led to believe that an announced investigation is moot, the announcement may not constitute a storm warning. See Siebert v. Nives, 871 F. Supp. 110 (D. Conn. 1994). Once on inquiry notice, plaintiffs have a duty to exercise reasonable diligence to uncover the basis for their claims, and they are held to have constructive notice of all facts that could have been learned through diligent investigation during the limitations period. Maggio, 824 F.2d at 127-128. This inquiry is both subjective and objective. The plaintiffs must first show that they investigated the suspicious circumstances — a subjective standard — and then the court must determine whether their efforts were adequate — an objective standard. See Mathews v. Kidder-Peabody & Co. Inc., 260 F.3d 239, 252 (3d Cir. 2001). Diligent investigation may involve as little as reading the prospectus. See Dean Witter Reynolds v. McCoy, 853 F. Supp. 1023 (D. Tenn. 1995), aff’d, 70 F.3d 1271 (1995). When more is required, however, the totality of the circumstances determines what is sufficient. An investor who relies solely on assurances from his broker that the investor has not been misled does so at his peril. In Cooperativa, the 1st Circuit noted that “even an investor of ordinary judgment and experience can discern that there is some risk in limiting inquiry to the very broker who may have misled or even defrauded the investor.” 129 F.3d at 225. Given that the broker did not “provide … anything more than bland generalities about market fluctuations and repeated reassurances that the investment was safe,” the court held that the investor did not conduct an adequate investigation into storm warnings. Id. The court suggested that a reasonable inquiry might have involved pursuing the brokerage firm’s offer to assess the situation, seeking an expert opinion on this set of investments from a wholly independent party, or using the investor’s own resources to investigate promptly the nature of the investment. CLASS ACTIONS A statute of limitations defense raises special issues in the certification of a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure. As an affirmative defense, a statute of limitations bar applicable to all members of the class relates to the merits of the action and therefore is beyond the scope of inquiry under Rule 23. See, e.g., In re ML-Lee Acquisition Fund II L.P. Sec. Litig., 848 F. Supp. 527 (D. Del. 1994). However, in securities cases, the applicable statute of limitations often varies among individual investors, especially when the claims do not arise under a fraud-on-the-market theory. For instance, the named plaintiff may have actual knowledge of certain facts that arguably puts the party on inquiry notice of the possibility of fraud before the putative class members were put on inquiry notice. When this occurs, the defendant may be able to claim that class certification is barred because the named plaintiff is susceptible to unique defenses. See, e.g., Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner and Smith Inc., 903 F.2d 176, 180 (2d Cir. 1990) (“Regardless of whether the issue is framed in terms of the typicality of representative’s claim … or the adequacy of its representation … there is a danger that absent class members will suffer if their representation is preoccupied with defenses unique to it”). Nevertheless, “[a]s long as a sufficient constellation of common issues binds class members together, variations in the sources and application of statutes of limitations will not automatically foreclose class certification under Rule 23(b)(3).” Waste Management Holdings Inc. v. Mowbray, 208 F.3d 288, 296 (1st Cir. 2000). Courts have explained that a unique defense such as statute of limitations will bar class certification only when it threatens to “consume the merits” of the case. See, e.g., Abt v. Mazda Am. Credit, 1999 WL 350738, at *3 (N.D. Ill. May 19, 1999). In addition, a class action plaintiff can argue that, even if a unique statute of limitations defense may apply to one or more individual class members, that defense can be addressed in a separate damages hearing and should not bar class certification. See, e.g., Town of New Castle v. Yonkers Contracting Co., 131 F.R.D. 38, 43 (S.D.N.Y. 1990). The extended statute of limitations will help plaintiffs, but inaction or delay must be defended if the claim is brought after the initial two-year period but before the absolute bar of five years. Michael A. Collora is a partner, and David M. Osborne is an associate, at Boston’s Dwyer & Collora (dwyercollora.com). Their practice includes complex civil and criminal litigation, including securities cases. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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