Plaintiffs in Securities Fraud Class were on Inquiry Notice of Claims Against Company thus Rendering Class Action Complaint Barred by Statute of Limitations New York Court Holds
Several securities fraud class action lawsuits were filed in federal courts against MBIA and various individual defendants alleging that certain financial statements contained materially misleading statements in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. The actions were consolidated in the Southern District of New York, and defense attorneys moved to dismiss on the grounds that claims were time barred and that the allegations in the class action complaints failed to satisfy the heightened pleading requirements for securities fraud cases. In re MBIA Inc. Securities Litig., ___ F.Supp.2d ___, 2007 WL 473708 (S.D.N.Y. February 13, 2007) [Slip Opn., at 1-2]. The district court concluded that the class action claims were barred by the applicable statute of limitations and dismissed the complaint.
The class action complaint alleges that in 1998 MBIA – which is in the “primary business [of] selling financial guarantee insurance to public finance and structured finance clients” – entered into retroactive reinsurance agreements to protect itself against an anticipated $170 million loss in order to avoid a downgrade of its AAA rating. MBIA, at 3-4. According to the complaint, MBIA entered into a series of side agreements with the reinsurance companies that were not publicly disclosed for the purpose of inducing the reinsurers to cover the $170 million loss; under these side agreements, “MBIA promised to transfer insurance policies on the highest rated bonds in its portfolio, along with the associated premiums, to the Reinsurers over a period of six years.” Id., at 4-5. The complaint also alleged that MBIA improperly booked these premiums as income rather than as loans. MBIA’s disclosures of these transactions painted a positive picture for the company, see id., at 5-6; however, in the months following MBIA’s disclosures, several published reports explained the trade-offs realized through the deals, some viewing the strategy as “the bond insurance equivalent to Houdini” and others viewing it as “innovative,” id., at 6-7. And in 2002, a 66-page research report by Gotham Partners on MBIA detailed credit concerns involving the company’s guarantee portfolio, which MBIA immediately criticized in a press release that “contained no factual discussion of the transactions related by the [research] report.” Id., at 8-10.
The statute of limitations previously applicable in Section 10(b) and Rule 10b-5 cases is “‘one year after the discovery of the facts constituting the violation and within three years after such violation.'” MBIA, at 11-12 (quoting Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364 (1991)). Sarbanes-Oxley extended these deadlines to two years and five years, respectively, for those securities fraud cases that were not already time-barred prior to the Act’s enactment in June 2002, but did not affect Second Circuit authority defining “what constitutes ‘discovery of facts’ sufficient to trigger the statute of limitations,” id., at 12 (citation omitted). Because the district court’s summary of the applicable law is thorough and concise, we quote at length from pages 13 to 15:
“Discovery takes place when the plaintiff obtains actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge.” . . . Thus, “‘discovery’ under the 1934 Act limitation provisions includes constructive or inquiry notice, as well as actual notice.” . . . “The test as to when fraud should with reasonable diligence have been discovered is an objective one.” . . . Therefore, “when the circumstances would suggest to an investor of ordinary intelligence the probability that she has been defrauded, a duty of inquiry arises, and knowledge will be imputed to the investor who does not make such an inquiry.” . . . [¶] The circumstances that give rise to a duty of inquiry are often referred to as “storm warnings”. . . . To constitute storm warnings, the information “‘must be such that it relates directly to the misrepresentations and omissions the Plaintiffs later allege in their action against the defendants.’” . . . Although the fraud must be probable, not merely possible . . ., an investor “does not have to have notice of the entire fraud being perpetrated to be on inquiry notice.” . . . [¶] Inquiry notice can arise based on facts disclosed in “any financial, legal or other data available to the plaintiffs[.]” . . . Articles in the financial press may of course give inquiry notice. . . . Indeed, a single published article may be sufficient to impose the duty to inquire. . . . (Citations omitted.)
Defense attorneys argued that the statute of limitations began to run in 1998 when the company itself described the arrangements as “‘borrowing’ money from reinsurers and ‘paying it back’ through a commitment to cede future businesses.” MBIA, at 17. The defense also pointed to the Gotham report, which expressly concluded that the transactions were “not in fact reinsurance, but rather a loss-deferral, earnings-smoothing device.” Id. The district court agreed that the Gotham report placed the public on notice of the probability of fraud, id., at 17-18. In response to plaintiffs’ argument that MBIA’s “vehement denial” of the Gotham report undermined the notice imputed by that report, id., at 18-19,the district court held that MBIA’s press release did nothing to address the specifics raised in the report and represented “no more than the ‘mere expressions of hope, devoid of any specific steps taken to avoid under-reserving in the future’ that led the Court of Appeals to reject the claimed reassurances” in a separate case. Id., at 19 (citations omitted). Because plaintiffs were on inquiry notice no later than 2002, the class action claims were time-barred. Id., at 21-22.