Institutional Investors and Class Action Tolling

Blair A. Nicholas is a senior and managing partner of Bernstein Litowitz Berger & Grossmann LLP, and David Kaplan is a senior counsel at the firm. This post is based on a Bernstein Litowitz publication by Mr. Nicholas and Mr. Kaplan.

Stock fraud, accounting scandals, and predatory behavior by investment banks have long plagued our nation’s financial markets. Fortunately, for over forty years, investors’ individual claims for recovery of damages under the U.S. securities laws have been protected and preserved by the filing of a securities class action. In 2013, however, a split emerged among the federal circuits regarding the scope of this class action “tolling” rule. That split, which recently deepened, has created great uncertainty and imposed heavy burdens on the institutional investor community.

In a pending appeal to the Third Circuit, 55 public and private pension funds with over $1.5 trillion in assets under management, together with the National Conference on Public Employee Retirement Systems (NCPERS), expressed the strong support of the institutional investor community for broad application of the class action tolling rule to both the statute of limitations and the statute of repose for federal securities law claims. See North Sound Capital LLC v. Merck & Co., Inc., Nos. 16-1364; 16-1365; 16-1366; 16-1367 (“North Sound Capital”). The institutional investor amicus brief in North Sound Capital, which our firm filed on behalf of these prominent funds, emphasizes the importance of private securities class actions to institutional investors, and the importance of the “American Pipe” tolling doctrine to the court system as a whole.

This timeliness issue—which impacts not only securities cases, but virtually all class actions involving claims governed by statutes of repose—will likely be taken up by the U.S. Supreme Court in the near future.

Background

The Supreme Court laid down the class action tolling doctrine over forty years ago in the landmark case of American Pipe & Construction Company. v. Utah, 414 U.S. 538 (1974). Under American Pipe and its progeny, an unnamed member of a prospective investor class has been able to rely on the commencement of a securities class action to protect and preserve the timeliness of its individual damages claims until the court decides whether to grant the case class action status or the investor decides to opt out and assert its claims in an individual action.

For four decades, it has been understood nationwide that the American Pipe rule applied to both the statute of limitations and the statute the repose governing claims brought under the federal securities laws. In particular, this includes the 3-year repose period applicable to strict liability claims under Sections 11 of the Securities Act of 1933 for material misrepresentations in public offerings, and the 5-year repose period applicable to claims under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 for fraud in connection with open market purchases. See, e.g., Albano v. Shea Homes Ltd. P’ship, 634 F.3d 524, 537 (9th Cir. 2011) (noting that while the Supreme Court has not specifically addressed the issue, the “majority of federal courts” nationwide hold that the American Pipe rule applies to statutes of repose or renders the statute of repose “superfluous”).

In 2013, the U.S. Court of Appeals for the Second Circuit upset this settled law by holding in Police and Fire Ret. Sys. of the City of Detroit v. IndyMac MBS, Inc., 721 F.3d 95 (2d Cir. 2013) (“IndyMac”) that the American Pipe rule does not apply to the 3-year repose period applicable to claims under Section 11 of the Securities Act. Earlier this month, the Sixth Circuit extended IndyMac in holding that American Pipe also does not apply to the 5-year repose period applicable to antifraud claims under Section 10(b) of the Exchange Act. See Stein v. Regions Morgan Keegan Select High Income Fund, Inc.,— F.3d—, 2016 WL 2909333 (6th Cir. May 19, 2016). Consequently, there is now an even 2-2 split among the federal circuits on this critical timeliness issue. The Tenth Circuit and the Federal Circuit line up on the other side and take the long-accepted view that class action tolling applies to both the statute of limitation and the statute of repose. See Joseph v. Wiles, 223 F.3d 1155 (10th Cir. 2000); Bright v. United States, 603 F.3d 1273 (Fed. Cir. 2010). The Third Circuit is set to break this 2-2 tie in the case of North Sound Capital.

What’s at Stake for Investors

As detailed in the institutional investor amicus brief, the practical effect of limiting the American Pipe rule to the statute of limitations would be to impose heavy burdens on investors. The Second Circuit’s IndyMac decision and the Sixth Circuit’s recent Stein decision have taken an exceedingly narrow and impractical view of the American Pipe rule. In these Circuits—which cover New York, Connecticut, New Hampshire, Michigan, Ohio, Kentucky, and Tennessee—institutional investors must incur the costs and burdens of extensively monitoring dozens of active securities class actions and, in any case in which the fund has a material financial interest, deciding whether to intervene or file opt-out actions to prevent their individual claims from lapsing under the statute of repose.

Just keeping track of the applicable repose periods can be highly burdensome, as the periods are generally measured from the date of each alleged misrepresentation or material omission, and a single case may involve dozens of them. Those misstatement and omission dates must then be cross-referenced against the investor’s individual trading history to determine whether the expiration of each repose period is financially important, and thus whether litigation is warranted, and at what point in time.

Highlighting how extensively such monitoring procedures must be applied, a study by nine leading civil procedure and securities law professors shows that certification decisions are often not issued until well after repose periods have expired. According to the professors’ study:

  • The Securities Act’s 3-year repose period for Section 11 and 12 claims would have expired prior to an order on certification in roughly 50% of all filed cases, and in over 80% of cases that actually reached a certification order; and
  • The Exchange Act’s 5-year repose period for Section 10(b) claims would have required investors to take protective action in 25% of all filed cases, and in 75% of cases that reached a class certification order.

As a practical matter, these figures likely understate the number of cases requiring proactive monitoring. First, certification battles have grown increasingly complex in light of recent federal jurisprudence, including the Supreme Court’s decisions in Dukes, Comcast, and Halliburton II. Moreover, even if certification is granted within all applicable repose periods, courts can revisit certification at any time, which requires investors to consider taking proactive measures to protect against potential decertification of a class after repose periods have lapsed. Furthermore, under a narrow reading of American Pipe, investors must protect against any defect potentially fatal to the class action, including (i) dismissal based on technical grounds such as standing, (ii) curable defects in the class pleadings such as failure to adequately allege the defendants’ state of mind, and (iii) failure of the class plaintiffs to proffer adequate expert testimony, such as accurately apportioning price movements among fraud and non-fraud related factors.

In cases where institutional investors deem it wise to take affirmative action to protect potentially valuable securities claims, they must incur the time and cost of retaining outside counsel to prepare and actively litigate protective intervention motions and new individual actions. Investors must often make this decision on an incomplete discovery record and long before it is clear whether the class action will be successful—or even be certified. Investors’ protective suits may involve an array of subsequent procedural motions and other court-clogging motions—all of which are unnecessary, wasteful, and discouraged under the traditional American Pipe rule that protected plaintiffs and the court system as a whole from such litigious activity.

This “parade of horribles” is no scare tactic or exaggeration. We have seen this trend play out in practice in many recent cases, where institutional investors have filed opt out actions at or very near the commencement of a securities class action to ensure their individual claims for recovery were protected. A prime example is the Petrobras securities litigation pending in the Southern District of New York, which arises out of the largest corruption scandal in Brazil’s history. In Petrobras, nearly 500 individual plaintiffs have opted out early in the litigation (and continue to opt out), with their individual damages claims pending alongside the class action case, and a joint trial scheduled for this September.

Finally, it bears emphasis that because of the present national uncertainty regarding the scope of the class action tolling rule, institutional investors cannot limit these extensive monitoring procedures and proactive litigation measures to cases filed in the Second and Sixth Circuits. Instead, because the majority of federal Circuits have not weighed in on the issue, fiduciaries should be careful to ensure that best practices are in place to safeguard claims for recovery of damages in all securities class actions nationwide that are identified as meritorious and in which the investor (or its clients) has significant losses.

In sum, the constant monitoring, protective filings, and litigation activity that would be required if investors lost the full benefit of American Pipe would place a substantial burden on the court system, taxpayers, and investors, and adversely affect the retirement benefits of millions of state and local employees. A narrow application of the American Pipe doctrine would also undermine the purpose of the class action device by eviscerating class members’ ability to rely on a class action to protect their interests, and encourage the filing of individual actions to guard against the loss claims to the statute of repose. The end result would be “[a] needless multiplicity of actions—precisely the situation that Federal Rule of Civil Procedure 23 … [was] designed to avoid.” Crown, Cork & Seal Co., Inc., v. Parker, 462 U.S. 345, 351 (1983).

Supreme Court Resolution?

The Supreme Court was set to resolve the critical statute of repose issue less than two years ago in an appeal from the Second Circuit’s decision in Indymac. However, just days before oral argument, the Court dismissed certiorari as “improvidently granted” after a substantial settlement of the underlying case. Now that the Circuit split has widened, the High Court should have an even greater interest in resolving the issue. The institutional investor community would greatly benefit from such clarity.

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