Another Alarm Blasts as The Second Circuit Rejects Class Action Tolling of the Statutes of Repose

by Barbara J. Hart and David C. Harrison (Shareholders at Lowey Dannenberg Cohen & Hart, P.C.) (this article also appears in the third quarter 2013 edition of The NAPPA Report, the journal of the National Association of Public Pension Attorneys. )

In our prior discussion of the issue of “class standing” under the Second Circuit’s decision in NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145 (2d Cir. 2012) (“Goldman Sachs”),[1] we noted a trend eroding the tolling principles articulated in American Pipe which jeopardizes the efficiencies of the class action procedure.  These cases undercut a pension fund fiduciary’s ability to rely on the pendency of class action litigation to represent their interests.  Especially in the context of claims involving mortgage-backed securities (“MBS”), fiduciaries can no longer assume that the inclusion of their securities in the putative class definition is sufficient to protect their interests.  Rather, they must vigilantly monitor any challenges to a lead plaintiff’s standing as it relates to the fiduciary’s holdings.  Even where a lead plaintiff has vigorously defended its standing to represent a broadly defined class of investors who are similarly situated, pension plans nonetheless may be required to intervene or file protective actions - either individually or as a class representative to cure any alleged defects in standing - before the applicable limitations period expires.  Otherwise, they run the risk of being time-barred in the event the court finds that the lead plaintiff lacks standing to pursue these claims.  In this context, a fiduciary’s reliance on a pending class action, no matter how reasonable, may fall on deaf ears when it argues that American Pipe preserved its right to assert claims after the applicable limitations period has run.[2]

In Police and Fire Retirement System of the City of Detroit v. IndyMac MBS, Inc.,[3] the Second Circuit recently rejected American Pipe tolling as applied to the three-year statute of repose in Section 13 of the Securities Act of 1933.[4] The Court held that the pension funds that intervened to cure the standing defects of the named plaintiff were not entitled to rely on the inclusion of their MBS claims in the class definition, and refused to treat the pension funds as parties to the class action during the time that such claims were asserted on their behalf.  Instead, the Court held that class members should have intervened or filed new actions to preserve the claims before the three-year period of repose expired, notwithstanding that the lead plaintiff had defended its standing (albeit unsuccessfully) to assert claims on behalf of all IndyMac MBS purchasers that were commonly-situated.

The Court explained that because the lower court never had jurisdiction over these claims, applying tolling principles based upon Rule 23 would violate the Rules Enabling Act by reviving claims after the statute of repose under Section 13 had expired.[5] In so ruling, the Second Circuit underscored the often-overlooked distinctions between a statute of limitations and a statute of repose, which can result in draconian consequences for investors who are not vigilant in monitoring class litigation.  Harsher to plaintiffs than statutes of limitations, a statute of repose is triggered by defendants’ actions (e.g., the date a public offering became effective or the date defendants made the alleged misstatements); it runs for a fixed period without interruption.  Upon expiration, plaintiffs’ right to recovery is extinguished regardless of whether or not a cognizable injury has yet to materialize, or whether or not plaintiffs could have discovered the facts underlying defendants’ violation.[6] Rewarding the most cunning of defendants, “a repose period can run to completion even before injury has occurred to a potential plaintiff, extinguishing a cause of action before it even accrues.”[7] The Second Circuit acknowledges that in this age of sophisticated, well-concealed frauds, there is a problem where statutes of repose raise the distinct possibility that a potential plaintiff “might, through no lack of due diligence on [its] part, find [itself] without any recourse for an injury that, if it had occurred earlier would have been remediable.” [8] In short, the better concealed the fraud the more likely the claim will be extinguished, and the wrong will go unpunished.  The Court of Appeals has long maintained, however, that this fundamental problem is one “only Congress can address; judges may not deploy equity to avert the negative effects of statutes of repose.”[9] The fix is legislative; not pleading for alternate rulings from judges who may view their hands as tied.

The IndyMac Decision

IndyMac involved a class action on behalf of purchasers of 106 MBS offerings issued pursuant to three registration statements and related prospectuses and prospectus supplements.[10] The district court found that the complaint adequately alleged Securities Act violations based on the issuer’s widespread abandonment of underwriting guidelines.  However, the court joined several other courts in holding that the lead plaintiff lacked standing under Article III to represent purchasers of MBS offerings not purchased by the lead plaintiff.[11] The court therefore dismissed claims as to 81 of the 106 offerings the named plaintiff had not purchased.  Six public pension funds then moved to intervene as class representatives to cure the standing defects as to at least a dozen other offerings.  The proposed intervenors were aware that (i) the lead plaintiffs did not purchase most of the IndyMac offerings included in the class, and (ii) the lead plaintiffs’ standing to pursue these claims had been challenged.[12] Nonetheless, the funds took comfort in the fact that their offerings were included as part of the class definition and that the operative complaint was timely filed within Section 13’s one-year from discovery and three-years from the public offering limitations periods.  The intervenors argued that their claims were tolled by American Pipe until dismissed from the class action, at which time they moved to intervene to cure the standing defects.

The district court agreed that American Pipe tolling applied to Section 13’s statute of limitations but not to its statute of repose.  While acknowledging that some cases had reached a different result, the court considered American Pipe tolling to be an equitable, judicially created doctrine that is inapplicable to statutes of repose.[13] The court further held that the relation back doctrine under Rule 15, Fed. R. Civ. P., cannot save claims that otherwise were barred by the three-year statute of repose.[14] The court held that such a construction would conflict with the Rules Enabling Act, which provides in relevant part that the rules prescribed by the Supreme Court (including Rule 15) “shall not abridge, enlarge or modify any substantive right.”[15]

In affirming, the Second Circuit emphasized the sharp distinctions between a statute of limitations and a statute of repose.  The Court explained that statutes of limitations limit the availability of remedies and, accordingly, may be subject to equitable considerations such as tolling or a discovery rule.  In contrast, statutes of repose affect the underlying right of the defendant to be free from suit, not just the remedy, and thus run without interruption once the necessary triggering event has occurred, even if equitable considerations would warrant tolling or even if the plaintiff has not yet, or could not yet have, discovered that it has a cause of action.[16] However, as with all statutes of repose, the Court recognized that Section 13 could be subject to legislatively created exceptions, which is known as “legal” or “statutory” tolling.[17] Numerous courts had already weighed in on the issue.[18] In Joseph v. Wiles, the first Court of Appeals to address tolling the statute of repose under Section 13, the Tenth Circuit concluded that American Pipe constituted legal tolling “that occurs any time an action is commenced and class certification is pending.”  The Court explained that “Rule 23 encourages judicial economy by eliminating the need for potential class members to file individual claims.  If all class members were required to file claims in order to insure the limitations period would be tolled, the point of Rule 23 would be defeated.”[19]

More pointedly, the Tenth Circuit explained that because Joseph’s claim had always been validly asserted through the class action complaint until it was dismissed erroneously by the lower court, the claim was timely within the period demarcated by the statute of repose.  In this sense, “application of the American Pipe tolling doctrine … [did] not involve ‘tolling’ at all.  Rather, Mr. Joseph has effectively been a party to an action against these defendants since a class action covering him was requested but never denied.”[20] The Court concluded that Defendants’ potential liability should not be extinguished simply because the district court had yet to resolve class certification.[21] This view that the claim is not tolled but rather is timely filed under the umbrella of the class is arguably harmonious with IndyMac which remanded so that timely claims under the Second Circuit’s earlier Goldman Sachs decision could be reinstituted.[22]

The Second Circuit ultimately declined to take a position on American Pipe tolling.  It explained that even if “the American Pipe tolling is ‘legal’ - based upon Rule 23, which governs class actions - we nonetheless hold that its extension to the stature of repose in Section 13 would be barred by the Rules Enabling Act,” because permitting investors to intervene after the three-year repose period has run would necessarily enlarge or modify a substantive right.[23] The Court further rejected the intervenors’ policy arguments that failure to toll the statute of repose could burden the courts and disrupt the function of class actions.  The Court found that such adverse consequences were not the inevitable result of its decision “[g]iven the sophisticated, well-counseled litigants involved in securities fraud class actions,” and noted that, in any event, the problem is for Congress not the courts to address.[24] Clearly, the monitoring functions just got vastly more complex and risky and no fund should be opted out without a complaint first on file.

The Potential Adverse Consequences to Ponzi Scheme Victims

At a minimum, IndyMac rejects the theoretical underpinning of American Pipe where claims are dismissed for lack of standing.  While not the case in IndyMac, this rule likely applies even when the standing issue is not resolved until after the statute of repose expires, such that class members whose claims are dismissed from the class action will be foreclosed by the statute of repose.  As a result, fiduciaries will need to monitor class proceedings and consider filing protective actions in order to preserve their claims under the statute of repose in the event that the lead plaintiff is found not to have standing to pursue these claims.  More fundamentally, the application of statutes of repose serve to diminish or eliminate the ability of victims of long-term fraudulent schemes to seek redress under the federal securities laws.  Case in point is the application of the five-year statute of repose [a]pplicable to fraud claims under the Securities Exchange Act of 1934.[25] Although an unsettled area of the law, several courts in the First[26] and Second Circuit[27] has declined to dismiss securities claims related to misrepresentations outside of the repose period where the same defendant made at least one similar fraudulent statement within the repose period as the last act in a continuing fraudulent scheme.  In Dynex I, Judge Baer held that in cases in which a series of repeated fraudulent misrepresentations is alleged, the five-year period of repose “begins when the last alleged misrepresentation was made.”[28] The “continuing fraud theory” also has been applied to Ponzi schemes involving long periods of fraudulent conduct, such as the funneling of investor money by “feeder funds” to Bernard Madoff.  For example, in Goldenson, defendants made misrepresentations about the feeder funds investment practices and performance from 2002 through the discovery of Madoff’s scheme in December 2008.  “Because the alleged misrepresentations … came from a common group of defendants in pursuit of a common scheme,” the court concluded that “none of the misrepresentation[s] is time- barred if any of them occurred within the period of repose.”[29] Similarly, in Beacon Associates, Judge Sand found that evidence that the ‘feeder fund’ defendants had violated a continuing duty to disclose their concerns about Madoff, which rendered their prior statements about the funds’ management and performance materially misleading.  The Court found that “[t]hese continuing misrepresentations mean that Plaintiffs’ claims are not untimely, given the rule, adopted by the majority of courts in this Circuit, that the statute of repose ‘first runs from the date of the last alleged misrepresentation regarding related subject matter.’”[30]

While district courts in the Fourth,[31] Fifth[32] and Ninth[33] Circuits have reached contrary results, the IndyMac decision could very well tip the balance in favor of treating the continuing fraud doctrine as akin to fraudulent concealment a form of equitable tolling, and be deemed to have no application under a statute of repose.  The result would be devastating to victims of long-term Ponzi schemes seeking protection after discovery of the fraud and no shelter would be found from the pendency of a class action.

Conclusion

IndyMac represents a continuing retreat from the broad protections under Rule 23 previously embraced by the Second Circuit.  Unless addressed by Congress, pension funds may have no alternative but to flood the dockets with protective actions to preserve their claims and the already overtasked court system will suffer.  The doctrine of repose is a safe-haven paradise for cunning fraudsters running actively-concealed schemes.  Pension funds and other investors have their rights extinguished before discovery and even before injury or loss.  This unjust doctrine cries out for legislative action.

 


[1]NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co.: The Implications on Class Standing and Why We Should Think About Amici Support Now,” The NAPPA Report, Nov. 2012.

[2] American Pipe’s tolling doctrine was created to protect class members from being forced to file individual suits in order to preserve their claims.  In In re WorldCom Securities Litigation, 496 F.3d 245 (2d Cir. 2007), the Second Circuit explained that “the theoretical basis on which American Pipe rests is the notion that “class members are treated as parties to the class action’ until and unless they received notice thereof and chose not to continue.”  Id. at 255 (quoting American Pipe Const. Co. v. Utah, 414 U.S. 538, 551 (1974)).  Thus, the commencement of the action satisfied the purposes of the limitations provision as to all putative class members as well as for the named plaintiffs.  To hold otherwise would frustrate the principle function of the class suit because then the sole means by which members of the class could pursue their claims would be to file protective actions or motions to intervene as parties—“precisely the multiplicity of activity which Rule 23 was designed to avoid.”  American Pipe, 414 U.S. at 551.

[3] 721 F.3d 95 (2d Cir. 2013) (“IndyMac”).

[4] Section 13 of the Securities Act contains both a statute of limitations as well as statute of repose.  It provides that claims to enforce liability under sections 11 and 12(a)(2) must be brought within “one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence.”  In no event however, shall such action be brought “more than three years after the security was bona fide offered to the public, or… more than three years after the sale.”

[5] 28 U.S.C. § 2072(b).

[6] IndyMac, 721 F.3d at 106.

[7] P. Stolz Family Partnership, L.P. v. Daum, 355 F.3d 92, 103 (2d Cir. 2004) (citing Stuart v. Am. Cyanmid Co., 158 F.3d 622, 627 (2d Cir. 1998)).

[8] Stolz, 355 F.3d at 103.

[9] IndyMac, 721 F.3d at 110.

[10] Id. at *9.

[11] In re IndyMac Mortgage-Backed Sec. Litig., 718 F. Supp. 2d 495, 501 (S.D.N.Y. 2010) (IndyMac I).  This narrow view of standing was subsequently broadened by the Second Circuit’s decision in Goldman SachsGoldman Sachs held that a purchaser of a particular MBS offering may have “class standing” to represent purchasers in other offerings that are backed by loans from common originators.  693 F.3d at 164.  As we previously noted, to the extent that American Pipe tolling is dependent on establishing the standing of the named plaintiff to assert similar but not identical claims of absent class members, Goldman Sachs’ broader originator-based standing serves Rule 23’s policies of avoiding the unnecessary filing of repetitive lawsuits far better than the narrower standing analysis applied in IndyMac. On remand, the District Court in IndyMac reinstated claims for 42 MBS which it had dismissed under the narrow tranche-based theory of standing.

[12] The Second Circuit observed that “[t]he proposed intervenors, through minimal diligence, could have avoided the operation of the Section 13 statute of repose simply by making timely motions to intervene in the action as named plaintiffs, or by filing their own timely actions.”  IndyMac, 2013 WL 3214588, at *9.

[13] In re IndyMac Mortgage-Backed Sec. Litig., 793 F. Supp. 2d 637, 642-43 (S.D.N.Y. 2011) (IndyMac II).

[14] Id. at 643.

[15] 28 U.S.C. § 2072(b).

[16] Compare Merck & Co., Inc. v. Reynolds, 559 U.S. 633 (2010) (two year limitations period for securities fraud claims does not accrue until plaintiff discovers or reasonably should have discovered facts supporting scienter), with Lampf, Pleva, Lipkind, Prupis & Petigrow, 501 U.S. 350, 360, 362 (1991) (Section 13’s three-year statute of repose serves as a “cutoff” to which principles of equitable tolling do not apply).

[17] IndyMac, 721 F.3d at 106 (citing P. Stolz Family P’ship L.P. v. Daum, 355 F.3d at 102-03).

[18] The Court observed that “the American Pipe decision contains conflicting indications of the source of authority for its tolling rule,” and the dicta in later Supreme Court decisions “provide little clarity.”  Id. at 108.

[19] 223 F.3d 1155, 1166-67 (10th Cir. 2000) (citations omitted). The Federal Circuit has tolled other statutes of repose, finding that Rule 23, upon which American Pipe was grounded, has “the force [and effect] of a federal statute”, and that “American Pipe and “Crown Cork & Seal were not based on judge-made equitable tolling, but rather on the Court’s interpretation of Rule 23.” See Bright v. United States, 603 F.3d 1273, 1279 (Fed. Cir. 2010) (legal tolling) (quoting Sibbach v. Wilson & Co., 312 U.S. 1, 13 (1941)); and Stone Container Corp. v. United States, 229 F. 3d 1345, 1354 (Fed. Cir. 2000) (legal tolling).  Contra Bridges v. Dep’t of Md. State Police, 441 F.3d 197, 211 (4th Cir. 2006).

[20] 223 F.3d at 1168.

[21] Id.

[22] 721 F.3d at 110 n.19.

[23] Id. at 109.

[24] Id.

[25] 28 U.S.C., § 1658(b) requires suit be filed the earlier of two years from discovery of the facts constituting the violation or five years from defendants misstatements or omissions.

[26] E.g., Goldenson v. Steffens, 802 F. Supp. 2d 240, 259 (D. Me. 2011); In re iBasis, Inc. Deriv. Litig., 532 F. Supp. 2d 214, 221(D. Mass. 2007); Quaak v. Dexia, S.A., 357 F. Supp. 2d 330, 337 (D. Mass. 2005).

[27] See Plymouth Cnty. Ret. Ass’n v. Schroeder, 576 F. Supp. 2d 360, 378 (E.D.N.Y. 2008); Take-Two Interactive Software, Inc. v. Brant, No. 06 Civ. 05279 (LTS), 2010 WL 1257351, at *5 (S.D.N.Y. Mar. 31, 2010); In re Dynex Capital, Inc., Sec. Litig., 05 Civ. 1879 (HB), 2006 WL 314524, at *5 (S.D.N.Y. Feb. 10, 2006) (“Dynex I), reaffirmed, 2009 WL 3380621, at *18 (S.D.N.Y. Oct. 19, 2009); In re Beacon Associates Litig., 282 F.R.D. 315, 324-25 (S.D.N.Y. 2012).

[28] 2006 WL 314524, at *5 (emphasis added).

[29] 802 F. Supp. 2d at 259.

[30] 282 F.R.D. at 324 (quoting Plymouth County Ret. Assn., 576 F. Supp. 2d at 378) (“As those statements made within the repose period likely bear a factual nexus to statements made outside of the repose period, the plaintiffs’ claims grounded on false and misleading financial statements and disclosure are timely.”).

[31] Carlucci III v. Han, 886 F. Supp. 2d 497, 514-15 (E.D. Va. 2012).

[32] Wolfe v. Bellos, No. 3:11-cv-2015-L, 2012 WL 652090, at *6 (N.D. Tex. Feb. 28, 2012); In re Affiliated Computer Servs. Derivative Litig., 540 F. Supp. 2d 695, 701 (N.D. Tex. 2007); Engel v. Sexton, Nos. 06-10447, 06-10547, 07-116, 2009 WL 361108, at *15 (E.D. La.  Feb. 11, 2009).

[33] Betz v. Trainer Wortham & Co., Inc., 829 F. Supp. 2d 860, 864 (N.D. Cal. 2011); In re Brocade Communications Sys. Derivative Litig., 615 F. Supp. 2d 1018, 1035 (N.D. Cal. 2009).

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