Rule 10b-5 and the Statute of Limitations: The Supreme Court Shows Interest

A decision from the Ninth Circuit has attracted the attention of the U.S. Supreme Court after the court adopted an “inquiry plus reasonable diligence” standard to trigger the running of the limitations period for securities fraud claims under Section 10 (b). The Court then found that the time period stopped following assurances from the putative defendants.  The U.S. Supreme Court has issued an invitation to the Acting Solicitor General to provide the  government’s views on the issue.

The Ninth Circuit ruling arose in Betz v. Trainer, 519 F. 3d 863, (9th Cir. 2008).  The case involved a retired art dealer who invested $2.2 million with the investor advisory group Trainer Wortham & CO.  Betz, the plaintiff, alleged that the firm fraudulently promised that the funds would yield a healthy monthly return without risk to the principal.  The district court found Betz’s securities fraud claim barred by the statute of limitations, holding that the period began to run when she received statements from the firm that showed a decline in her principal.  

On appeal, the Ninth Circuit first had to address whether actual or inquiry notice can start the running of the statute of limitations on a federal securities claim. Citing “uniformity amongst sister circuits,” the Ninth Circuit found that either would start the statute to run.  Since Betz did not to have actual notice, the court went on to define inquiry notice.  It required application of a two prong test, “inquiry plus reasonable diligence.” Under this standard, a plaintiff satisfies inquiry notice when there exists sufficient suspicion of fraud to cause a reasonable investor to investigate the matter further. Once a plaintiff has inquiry notice, the court asks, “when the investor, in the exercise of reasonable diligence, should have discovered the facts constituting the alleged fraud.” The answer to that second prong determines when the statute of limitations began to run.

Turning to the facts of the case, the Ninth Circuit first addressed when Betz received inquiry notice. The court held that declining account balances, in and of itself, did not necessarily suffice as inquiry notice of fraud.  As the court reasoned: 

• "poor market performance, standing alone, does not necessarily suggest securities fraud ..., but could also be explained by poor management, general market conditions, or other events unrelated to fraud, creating a jury question on inquiry notice.” See Gray, 82 F. 3d at 881).

Likewise, a statement from a Trainer & Wortham employee that there was a “serious problem” with Betz's portfolio did nothing more than indicate that the defendants had not been able to make good on their promise, providing no evidence that the defendants had intentionally or deliberately and recklessly misled Betz.

Continuing with the inquiry plus reasonable diligence analysis, the Court further held that even if Betz was on inquiry notice of fraud, under the second prong of our inquiry notice standard, Betz, in the exercise of reasonable diligence, would not necessarily have discovered the facts constituting the alleged fraud since the defendants assured her that her account problems would be amended and therefore lulled Betz into delaying the onset of legal action. Viewing these findings in a light most favorable to Betz, the Court ruled "a rational jury could conclude that a reasonable investor in Betz’s shoes would not have initiated further inquiry at a time beyond the statute of limitations."

The primary materials for this issue are available on the DU Corporate Governance Website.