In the September 6, 2018 edition of The Legal Intelligencer, Edward Kang, Managing Member of KHF, and Tianna Kalogerakis, Associate of KHF, co-authored “Borrowing Statute: NY’s Bar to the Unsuspecting, Out-of-State Investor.”
Despite the plaintiff-friendly pleading standards for securities fraud outlined by the Supreme Court in Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010), out-of-state investors need to be particularly vigilant in pursuing fraud-related common law claims in New York, being careful not to become blocked by the borrowing statute.
New York City is home to the world’s largest stock exchange, the New York Stock Exchange, and is host to financial service providers. This concentration of wealth and financial expertise has enticed many out-of-state investors to place their money in securities with New York-based financial institutions in the prospect of riches; however, coupled with the influx of these out-of-state investments is the potential for legal action by each dissatisfied or defrauded investor. New York developed the “borrowing statute” to protect its residents and deter actions by nonresidents including out-of-state investors in securities and commodities. Despite the plaintiff-friendly pleading standards for securities fraud outlined by the Supreme Court in Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010), out-of-state investors need to be particularly vigilant in pursuing fraud-related common law claims in New York, being careful not to become blocked by the borrowing statute.
As with any pleading, the timeliness of a complaint is critical, yet the nature of fraud can make a timely filing within the applicable statute of limitations challenging. A plaintiff must consider how a court will calculate when the statute of limitations period began. In situations where the plaintiff immediately realizes that they have been injured, this process is fairly straightforward —generally, the plaintiff is barred from bringing a claim after the allotted limitations period is over. In instances where the plaintiff discovers the fraud outside of the time allotted in the statute of limitations, however, establishing the applicable time period for a timely filing becomes particularly fact-intensive, and it is a plaintiff’s responsibility to establish that their claims are timely under the applicable discovery rule.
Out-of-state investors may have the option of pursuing private actions under federal or state law, and the type of action dictates the applicable statute of limitations. For out-of-state investors who pursue securities fraud claims, the statute of limitations is either five years from the violation (statute of repose) or two years from discovery of the facts constituting the violation (statute of limitation). As these claims are governed by federal law, the statute of limitations remains the same despite the jurisdiction. But, 28 U.S.C. Section 1658(b) does not cover “fraud-related” common law claims, such as aiding and abetting securities fraud. It is in the pursuit of claims outside of securities violations established by the Securities Act of 1933 or the Securities Exchange Act of 1934 where the borrowing statute can hurt out-of-state investors.
The ‘Merck’ Standard
The Supreme Court’s decision in Merck changed the discovery rule for securities fraud claims concerning the onset of the applicable two-year statute of limitations. Before Merck, most courts (including the District Court of New Jersey in Merck) deemed that a plaintiff was on “inquiry notice” (also referred to as “storm warnings”) when public information was made available that would lead a reasonable investor to investigate the possibility of fraud. The onset of inquiry notice began the running of the statute of limitations as the plaintiff should have begun their investigation on that date. The Merck court, agreeing with the U.S. Court of Appeals for the Third Circuit, overruled this analysis, holding instead that the limitations period begins to run only after “a reasonably diligent plaintiff would have discovered the facts constituting the violation, including scienter—irrespective of whether the actual plaintiff undertook a reasonably diligent investigation.” Stated plainly, post-Merck, the limitations period begins when a reasonable investor conducting a timely investigation would have found the facts constituting a securities violation, including scienter.
The favorable impact of Merck to grant a potential plaintiff more time to bring a securities claim is intuitively recognizable. In the wake of Merck, class action securities filings have grown in frequency. Federal class action securities fraud filings hit a record pace in the first half of 2017. In the first six months of 2017, plaintiffs filed 226 new federal class action securities fraud cases. This number reflects a 135-percent increase compared to the 1997–2016 historical semiannual average of 96 filings. During the 18-month period before June 2017, more securities fraud class actions were initiated in federal court than initiated in any equivalent period since the enactment of the Private Securities Litigation Reform Act (PSLRA) of 1995.
Although the discovery rule standard articulated in Merck is plaintiff-friendly (which also conforms to the pleading standard of Twombly and Iqbal), the out-of-state investor should still exercise caution for a good reason: the Merck discovery rule standard applies to federal securities fraud claims only. In other words, the pre-Merck discovery rule standard continues to apply to nonsecurities fraud claims.
New York’s Borrowing Statute
Commonly called the “borrowing statute,” CPLR Section 202 is a reenactment of legislation with origins in past legislation dating back to 1902. The statute remains substantially the same today. The primary purpose of the borrowing statute is to prevent forum shopping by a nonresident seeking to take advantage of a more favorable statute of limitations in New York. See Antone v. General Motors, Buick Motor Division, 473 N.E.2d 742, 745 (1984). For instance, the statute of limitations in New York for an action based on fraud is the greater of six years from the date the action accrued or two years from when the plaintiff discovered the fraud or could have discovered it with reasonable diligence. By comparison, Pennsylvania provides for a two-year statute of limitation for fraud claims. The borrowing statute bars a nonresident litigant from bringing a cause of action that arose outside of New York in New York courts unless the action is timely under both the law of New York and the state where the action arose.
Under New York’s borrowing statute, when the alleged injury is purely economic, the place of injury, for statute of limitations purposes, is where the plaintiff sustains the economic impact of the loss; generally, this is where the plaintiff resides. To determine where the cause of action accrued for a business organization, one looks to its state of incorporation or its principal place of business. The borrowing statute requires that where a cause of action is brought by a nonresident, the court will apply the shorter of the two statute of limitations periods to determine whether the action is timely filed. If the statute of limitations for the nonresident’s state of residence includes a discovery rule, the court applying the borrowing statute will also determine the timeliness of the action under the foreign state’s discovery rule.
New Jersey’s statute of limitation is comparable to that of New York. But Pennsylvania and Delaware have shorter statute of limitations periods than those in New York, and each has its own discovery rules. Pennsylvania has a two-year statute of limitations for fraud-based claims, and a cause of action accrues when the plaintiff could have first maintained the action to a successful conclusion. In Delaware, a plaintiff with a fraud-based claim has a three-year statute of limitations, and a cause of action accrues at the time of the wrongful act, even if the plaintiff is ignorant of the cause of action. The statute will begin to run only upon the discovery of facts constituting the basis of the cause of action or the existence of facts sufficient to put a person of ordinary intelligence and prudence on inquiry which, if pursued, would lead to the discovery of the injury. Accordingly, a plaintiff residing in either Pennsylvania or Delaware whose claims accrued four years before they filed suit but presumed to be bound by the six-year statute of limitations of New York would be time-barred from bringing claims.
Thus, where the statute of limitations is shorter in the home state of an out-of-state investor who brings an action for securities fraud related claims (but not securities fraud claims) in New York against a party with whom they had dealings, New York’s borrowing statute will operate to bar their claims as untimely. Nonresidents pursuing nonsecurities fraud claims are particularly at risk of having their claims dismissed as they do not have the benefit of the Merck standard to enlarge the time in which they may bring viable claims. Thus, where a nonresident wishes to pursue a fraud-related claim based on securities fraud of another (e.g., aiding and abetting fraud claim against a clearing bank that participated in the primary actor’s Ponzi claim), these causes of action may accrue at different times.
Further, a general choice of law clause in an agreement will not prevent the application of the borrowing statute as New York views statutes of limitations as laws of procedure, and not substance. See 2138747 Ontario v. Samsung C & T, 144 A.D.3d 122, 126, (N.Y. App. Div. 2016), leave to appeal granted, 85 N.E.3d 98 (2017), and aff’d, 103 N.E.3d 774 (2018).
An out-of-state investor placing funds in securities or commodities in New York ought to be vigilant about pursuing fraud-related common law claims in courts of New York and begin actions within the time allowed in their home state, or risk being time-barred from raising their claims at all by New York’s borrowing statute. The Merck standard, which articulated a favorable pleading standard for litigants pursuing securities fraud claims, applies only to federal securities fraud actions, and will not defeat the New York’s borrowing statute in the context of state law claims for fraud-related activity.
Edward T. Kang is the managing member of Kang Haggerty & Fetbroyt. He devotes the majority of his practice to business litigation and other litigation involving business entities.
Tianna K. Kalogerakis, an associate at the firm, concentrates her practice on commercial litigation and business disputes such as breach of contract, breach of fiduciary duty, and business torts.
Reprinted with permission from the September 6 edition of “The Legal Intelligencer” © 2018 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or firstname.lastname@example.org.