Circuit Courts Foreclose Retroactive Application Of SOXA's New Statute Of Limitations For Federal Securities Fraud Claims

Tuesday, March 1, 2005 - 01:00
James K. Goldfarb

In a decision of first impression, the U.S. Court of Appeals for the Second Circuit recently held that the new, longer statute of limitations for federal securities fraud claims that Congress adopted as part of the Sarbanes-Oxley Act ("Sarbanes-Oxley" or the "Act") does not revive claims that already were time-barred under the former, shorter limitations period as of the Act's effective date, July 30, 2002. The decision in the case known as EMAC (short for In re Enterprise Mortgage Acceptance Co., LLC, Sec. Litig. 1) prevents a plaintiff who commenced its suit prior to the Act's effective date from taking advantage of the longer statute of limitations by commencing a new but identical or nearly identical suit after the effective date. However, courts already are applying EMAC to the more common situation in which a plaintiff claims that, notwithstanding the expiration of the old statute of limitation, the new limitations period applies because the plaintiff has, in the words of Section 804(b), commenced its suit on or after the Act's effective date.

Section 804. Before Sarbanes-Oxley, a plaintiff alleging securities fraud under Section 10(b) of the Exchange Act had to file its claim within one year of discovering the facts constituting (or giving rise to notice of) the alleged violation, or three years after the violation, whichever came first. To provide investors more time to uncover and investigate potential claims, Congress included Section 804 in the Act, which provides for a two-year and five-year statute of limitations. The longer limitations period applies "to all proceedings addressed by this section [804] that are [as discussed here] commenced on or after the date of enactment of this Act." The Act also provides that nothing in Section 804 "shall create a new, private right of action."

Cases Below. The EMAC decision involved appeals from two district court decisions. In both cases, plaintiffs filed securities fraud suits before Congress enacted Sarbanes-Oxley. After Congress passed Sarbanes-Oxley, plaintiffs in In re EMAC filed new complaints and plaintiffs in Computer Associates amended their complaint to "take advantage" of the Act's extended statute of limitations. In In re EMAC two plaintiffs filed separate securities fraud suits in June 2002. Both plaintiffs claimed that defendants fraudulently induced them to participate in private placements of interests in loans to convenience stores and gas stations. Plaintiff Aetna Life Insurance Co. asserted federal claims arising out of its 1998, 1999, and 2000 purchases. Plaintiff Great Southern Life Insurance Co. asserted state claims arising out of its 1999 purchases and federal claims arising out of its 2000 purchases. Aetna then withdrew the claims arising out of its 1998 and 1999 purchases because, it conceded, the claims were time-barred under the one-year/three-year limitations scheme. In May 2003, however, both Aetna and Great Southern filed new complaints to take advantage of the new, two-year/five-year limitations scheme. Aetna alleged federal claims arising out of its 1998 and 1999 purchases. Great Southern alleged federal claims arising out of its 1999 purchases. When defendants moved to dismiss the federal claims as timebarred, plaintiffs argued that Section 804 applied retroactively to revive the stale claims. Judge Shirley Wohl Kram rejected that argument and dismissed as time-barred the claims arising out of plaintiffs' 1998 and 1999 purchases. Aetna and Great Southern appealed.

In re Computer Associates. 2002 Class Action Sec. Litig.("Computer Associates")2 was a putative securities fraud class action first filed in February 2002. Plaintiffs filed an amended complaint in October 2002, three months after Congress enacted Sarbanes-Oxley, in which they joined Ernst & Young LLP, the issuer's independent auditors, as a defendant. Plaintiffs alleged that Ernst & Young "falsely certified the propriety of the methodology used to compile, and the accuracy of the results reported in, [the issuer's] annual securities filings for 1999 and 2000." Judge Thomas Platt held that the suit was time-barred under the pre-Sarbanes-Oxley statute of limitations. He declined to apply the new statute of limitations, explaining that the amended complaint related back to the original complaint under Rule 15(c) of the Federal Rules of Civil Procedure and, therefore, was not a new "proceeding" within the meaning of Section 804. Plaintiffs appealed.

Landgraf Analysis. To determine whether to apply Section 804 retroactively to revive time-barred claims, the Second Circuit relied on a two-prong test articulated by the Supreme Court in Landgraf v. USI Film Products.3 Under Landgraf 's first prong, a court must "determine whether Congress has expressly prescribed the statute's proper reach. If Congress has done so, the inquiry ends and the court enforces the statute as it is written." If Congress has not done so, the court proceeds to Landgraf 's second prong and must "determine whether the new statute would have retroactive effect, i.e. , whether it would impair rights a party possessed when he acted, increase a party's liability for past conduct, or impose new duties with respect to transactions already completed." If the statute would have a retroactive effect, it cannot be applied retroactively "absent clear Congressional intent to the contrary." Applying the Landgraf test, the Second Circuit held that Section 804 did not "unambiguously revive previously stale securities fraud claims," and would have an impermissible retroactive effect if it were applied in that manner. Accordingly, the Court deferred "to the longstanding presumption against retroactiv[ity]," rejected appellants' argument, and affirmed the decisions below.

No Clear Intent. Addressing the first prong of the Landgraf test, the Court rejected appellants' argument that Congress clearly intended to apply Section 804 retroactively. The Court held that the application provision of Section 804, Section 804(b), which states that the extended limitations "shall apply to all proceedings . . . that are commenced on or after the date of enactment of this Act," does not contain the "unambiguous language that the Supreme Court has asserted would amount to an express retroactivity command" or words that "Congress has used in previous statutes to indicate its intent to revive time-barred claims." The Court also observed that Section 804(c) tended to undermine appellants' position that Congress clearly intended the new statute of limitations to apply retroactively. Section 804(c), entitled "No Creation of Actions," provides that "[n]othing in this Section [804] shall create a new, private right of action." Appellees argued that applying Section 804 to revive stale claims effectively would create a new, private right of action, in clear contravention of Section 804(c).

Appellants responded that the language of Section 804(c) merely meant that Congress did not intend to create a new type of securities fraud claim. The Court acknowledged that appellants' view was "plausible," but also observed that the issue was not free from doubt because, "[w]here a plaintiff is empowered by a new statute to bring a cause of action that previously had no basis in law, a new cause of action has, in some sense of the word, been created." Thus, the Court suggested how retroactive application of the new statute of limitations (Section 804(b)) would contravene Section 804(c). The Court concluded that "the lack of clarity that results from the tension that may be implied between 804(b) and 804(c) undermines [appellants'] contention that, in enacting Section 804, Congress made its intentions for retroactivity unmistakably clear." The lack of clarity was dispositive of the first-prong analysis. The Court explained that the statute must be clear "to overcome the presumption against retroactive application and to obviate the need for proceeding to the second stage of the Landgraf test." Quoting the Supreme Court, the Second Circuit further explained that "[r]equiring clear intent assures that Congress itself has affirmatively considered the potential unfairness of retroactive application and determined that it is an acceptable price to pay for the countervailing benefits."

Retroactive Effect. In the absence of "clear evidence that Congress intended for Section 804 to apply retroactively," the Court turned to Landgraf' s second prong and analyzed whether Section 804, as applied, would have a retroactive effect. The Court began by rejecting the argument, advanced by appellants, that statutes of limitations are always procedural and, therefore, affect no substantive rights. Although acknowledging its previous ruling that the retroactive application of revised statutes of limitations "generally does not have an impermissible retroactive effect," the Court clarified that there is no "categorical exception" from Landgraf 's presumption against retroactivity: Statutes of limitations protect interests in reliance and repose, guard against demands, and limit the circumstances in which a reviewing court can grant relief. Because in different contexts a statute of limitations may fairly be described as either procedural or substantive, [appellants'] self-serving and overly broad designation of all statutes of limitations as "procedural" will not lead us to conclude that retroactive application of a revised statutes of limitations [sic] never has an impermissible retroactive effect.

The Court also rejected appellants' contention that appellees did not have a reliance interest in the shorter statute of limitations that was in force when appellees allegedly committed the underlying fraud. In that regard, appellants argued that appellees had no reliance interest because appellees' conduct was, at the time, unlawful.

But the Court held that the concept of an "impermissible retroactive effect" is not limited to whether the underlying conduct was lawful at the time. Applying a new statute of limitations to revive previously stale claims also has an impermissible retroactive effect: Extending the statute of limitations retroactively "increase[s] [a defendant's] liability for past conduct," Landgraf, 511 U.S. at 280, by increasing the period of time during which a defendant can be sued. This is particularly true in the context of claims that have already expired. Resurrection of such claims puts defendants back at risk at a point when defendants reasonably believe they are immune from litigation, stripping them of a complete affirmative defense they previously possessed and may have reasonably relied upon. The Court underscored that stripping appellees of an affirmative defense would "fall within the class of 'retroactive effects' against which the Landgraf Court cautioned."

Effect of the Decision. The EMAC decision is significant yet, if tethered to its facts, narrow. It squarely addresses the rare situation in which a plaintiff, like Aetna Life Insurance Co. or the Computer Associates plaintiffs, filed suit before Sarbanes-Oxley's effective date, and then attempts to avail itself of the Act's more generous statute of limitations by filing a new but identical or nearly identical suit after the effective date. However, defendants are unlikely to read the decision so narrowly. The Second Circuit's reasoning clearly applies to the more common situation in which a plaintiff files suit on or after the effective date and alleges claims that are time-barred under the former, shorter statute of limitations.

Indeed, the Seventh Circuit recently relied on EMAC in affirming a lower court's dismissal of a federal securities fraud suit. The plaintiff in Foss v. Bear Stearns & Co., Inc. ("Foss"),4 an executor, alleged that his predecessor enlisted the help of his predecessor's son-in-law and his son-in-law's employer, Bear Stearns, to secret securities from the deceased's safe-deposit box, transferred the securities to a corporation, and then withdrew the funds for personal use. These actions allegedly occurred between November 1998 and June 2000. But the executor did not file a securities fraud claim until November 2003, well after Sarbanes-Oxley's effective date and the expiration of the three-year statute of limitations. The lower court dismissed the suit on the merits and plaintiff appealed.

On appeal, defendants pressed the statute of limitations defense that they had raised below but which the lower court did not address. Specifically, defendants argued that plaintiff's claims were time-barred under the former three-year limitations period, notwithstanding that plaintiff had filed suit after the Act's effective date. The Seventh Circuit agreed, observing that the complaint "is doomed unless the new statute is retroactive." Then, without even mentioning the procedural differences underlying the filing of the complaint in the EMAC suits and the complaint in Foss, the Court held that the Second Circuit had persuasively decided the retroactivity question in EMAC. Thus, the Court highlighted that, even though by its terms Section 804 applies to "all proceedings . . . commenced on or after" July 30, 2002, Section 804 does not resuscitate claims that are dead on arrival.

1 391 F.3d 401 (2d Cir.2004).
2 No.02-CR-1266, Mem. & Order.
3 511 U.S. 244 (1994).
4 Foss v. Bear Stearns & Co., ("Foss II), __F.3d__, 2005 WL 4333724 (7th Cir. Jan11, 2005). The lower court's decision , "Foss I," is reported at WL 43724, at *1.

Jeffrey Q. Smith is a Member of King & Spalding LLP and a Senior Partner in its Business Litigation group. James K. Goldfarb is an Associate at King & Spalding. Before joining King & Spalding, he was one of the attorneys representing defendant-appellee Enterprise Mortgage Acceptance Co., LLC ("EMAC") in the case. Republished with permission from Securities Regulation & Law Report, Vol. 37, No. 6, 2/07/05, pp.236-239. Copyright 2005 by The Bureau of National Affairs, Inc. (800-372-1033)

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