Second Circuit Clarifies Standard Regarding Knowledge Of Facts That Constitute A Securities Fraud Violation For Purposes Of Triggering The Two-Year Statute Of Limitations For Rule 10b-5 Claims

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In City of Pontiac General Employees’ Retirement System v. MBIA, Inc., 2011 U.S. App. LEXIS 3813 (2d Cir. Feb. 28, 2011), the United States Court of Appeals for the Second Circuit delineated the standard needed to asses how much information a reasonably diligent investor must have about the facts constituting a securities fraud violation before those facts are deemed “discovered” for purposes of triggering the statute of limitations for a claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission (“SEC”) Rule 10b-5, 17 C.F.R. § 240.10b-5.In doing so, the Second Circuit addressed the gap left by the United States Supreme Court in Merck & Co. v. Reynolds, 130 S. Ct. 1784, 1796 (2010), where the Supreme Court expressly declined to prescribe a list of the facts needed to constitute a securities law violation for purposes of triggering the statute of limitations.

MBIA, Inc. (“MBIA”) sells insurance policies guaranteeing the principal and interest on bonds, thereby allowing its bond issuing clients to pay lower interest rates. According to the operative complaint, in 1998, one of MBIA's major policyholders defaulted on a bond issue insured by MBIA, leaving MBIA with a $170 million debt that threatened its liquidity and credit rating. To avoid this impairment of its credit rating, MBIA made a deal with three European reinsurance companies whereby they reinsured MBIA on the defaulted bonds nunc pro tunc, which resulted in their paying the $170 million loss incurred by the bond default. In exchange, MBIA paid $3.85 million “upfront” as a premium and committed to purchasing additional reinsurance from the European companies over a six-year period at a premium of $297 million. The bonds that would be reinsured over the following six years were among MBIA's highest rated bonds. MBIA initially booked this odd transaction (“1998 transaction”) as income, and it continued to do so in its SEC Form 10-Ks from 1998 through 2003.

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