NEW ENGLAND HEALTH CARE EMPLOYEES PENSION FUND , On Behalf of Itself v. Ernst & Young , Llp

*The Honorable Gerald E. Rosen, United States District Judge for the
Eastern District of Michigan, sitting by designation.
1
RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206
ELECTRONIC CITATION: 2003 FED App. 0226P (6th Cir.)
File Name: 03a0226p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
_________________
NEW ENGLAND HEALTH CARE
EMPLOYEES PENSION FUND ,
On Behalf of Itself and All
Others Similarly Situated,
Plaintiff-Appellant,
v.
ERNST & YOUNG , LLP,
Defendant-Appellee.
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N
No. 01-6523
Appeal from the United States District Court
for the Western District of Kentucky at Bowling Green.
No. 00-00124—Joseph H. McKinley, Jr., District Judge.
Argued: May 1, 2003
Decided and Filed: July 9, 2003
Before: NELSON and COLE, Circuit Judges; ROSEN,
District Judge. *
2 New England Health
Care v. Ernst & Young
No. 01-6523
_________________
COUNSEL
ARGUED: Eric A. Isaacson, MILBERG, WEISS,
BERSHAD, HYNES & LERACH, San Diego, California, for
Appellant. Stanley J. Parzen, MAYER, BROWN, ROWE &
MAW, Chicago, Illinois, for Appellee. ON BRIEF: Eric A.
Isaacson, Joseph D. Daley, MILBERG, WEISS, BERSHAD,
HYNES & LERACH, San Diego, California, for Appellant.
Stanley J. Parzen, Jeffrey W. Sarles, MAYER, BROWN,
ROWE & MAW, Chicago, Illinois, Frank P. Doheny, Jr.,
DINSMORE & SHOHL, Louisville, Kentucky, Lora S.
Morris, MUSE & MORRIS, Louisville, Kentucky, for
Appellee.
_________________
OPINION
_________________
DAVID A. NELSON, Circuit Judge. Private lawsuits
impliedly authorized under § 10(b) of the 1934 Securities
Exchange Act, the Supreme Court held in Lampf, Pleva,
Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350
(1991), are subject to the statutory limitations provision
established in § 9(e) of the Act. Private securities fraud
actions must thus be “brought within one year after discovery
of the facts constituting the violation and within three years
after such violation.” See 15 U.S.C. § 78i(e).
The present action, a § 10(b) securities fraud case brought
by an investor against an accounting firm, is barred by the
one-year statute of limitations if the word “discovery,” as
used in the statute, extends to constructive discovery as well
as actual discovery. The plaintiff investor having been put on
“inquiry notice” of the alleged fraud more than one year

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before the filing of the complaint, in other words, the question
is whether such notice suffices to bar the action.
Like a number of our sister circuits, we believe that inquiry
notice is sufficient to trigger the running of the one-year
limitations period. The district court dismissed this case on
grounds that involved the three-year statutory period, among
other things, but we shall affirm the dismissal under the one-
year provision without reaching the grounds found persuasive
by the district court.
I
This case has its origins in financial difficulties
experienced by clothing manufacturer Fruit of the Loom, Inc.
(“Fruit”) in the 1990s. According to the plaintiff, Fruit’s
stock “collapse[d]” in November of 1995 as a result of market
changes and poor management. Fruit took steps to improve
performance in 1996, but it became clear by the fourth
quarter that Fruit would not meet its financial goals for the
year. Therefore, the plaintiff has alleged, Fruit’s management
instituted a “pull-forward” program of early shipments, which
was designed to accelerate recognition of 1997 revenues into
the fourth quarter of 1996. Fruit ended up reporting financial
results for 1996 that were much higher than expected, and
Fruit’s stock rebounded.
Fruit’s 1996 financial statements were audited by Ernst &
Young, LLP (“Ernst”), the defendant herein. According to
the plaintiff, the statements violated generally accepted
accounting principles (“GAAP”) by failing to write down
overvalued inventory and fixed assets and failing to accrue
certain liabilities, as well as by improperly recognizing 1997
revenue in 1996. In a report dated February 12, 1997,
however, Ernst certified that Fruit’s 1996 financial statements
“present fairly, in all material respects, the consolidated
financial position of [Fruit] . . . and the consolidated results
of [its] operations and [its] cash flows . . . in conformity with
4 New England Health
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No. 01-6523
generally accepted accounting principles.” The report stated
further that Ernst had conducted its audit of Fruit’s statements
“in accordance with generally accepted auditing standards”
(“GAAS”).
In March of 1997, Fruit filed its Form 10-K – which
included the 1996 financial statements and Ernst’s
February 12 audit report – with the Securities and Exchange
Commission (“SEC”). The next month, Fruit distributed the
financial statements and Ernst’s certification to its
shareholders as part of an annual report. Also in April, Fruit
reported its results for the first quarter of 1997 – results that
were down from the first quarter of 1996 and that fueled a
decline in the value of Fruit stock. Fruit reported its second-
quarter results, which were again below 1996 levels, in July.
The plaintiff contends that Fruit’s first and second quarter
financial statements, which were reviewed by Ernst, departed
from GAAP.
On July 9, 1997, Fruit filed a registration statement with
the SEC in connection with a public offering of securities.
The registration statement included Fruit’s financial
statements for 1996 and the first two quarters of 1997,
incorporated Ernst’s February 12 audit report by reference,
and included a letter in which Ernst consented to the use of its
report. On August 6, 1997, Fruit filed an amendment to the
July 9 registration statement. The amendment, like the
original registration statement, incorporated Ernst’s audit
report and included Ernst’s consent to the use of that report.
For the third and fourth quarters of 1997, Fruit reported
large losses. In January of 1998, the value of Fruit’s stock
dropped to slightly more than half of what it had been in
March of 1997.
On July 1, 1998, New England Health Care Employees
Pension Fund (“New England”), undertaking to act on behalf
of itself and other purchasers of Fruit stock, sued Fruit and

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several of its directors and officers for securities fraud. New
England alleged that the defendants intentionally overstated
earnings on Fruit’s financial statements for 1996 and the first
two quarters of 1997, and that the defendants made additional
public statements about Fruit’s performance and prospects
that were intentionally false (including representations that
the financial statements adhered to GAAP). Ernst was not
named as a defendant.
While that case was pending, Fruit entered bankruptcy.
Then, on June 28, 2000 – nearly two years after the filing of
the suit against Fruit – New England brought the present
action against Ernst. New England’s complaint, which
substantially repeated the earlier allegations of fraud by Fruit
and its directors and officers, alleged that Ernst participated
in the fraud by certifying the 1996 financial statements as
consistent with GAAP, stating that it audited the statements
in accordance with GAAS, and consenting to the use of its
audit report in Fruit’s offering documents. According to New
England, Ernst’s statements and letters of consent were
fraudulent because Ernst was aware of evidence contradicting
Fruit’s reported results for 1996 and the first two quarters of
1997.
Ernst moved for dismissal under Rule 12(b)(6), Fed. R.
Civ. P., arguing that the action was time-barred and that New
England had failed to allege particular facts supporting an
inference of scienter, i.e., an inference that Ernst either knew
its statements to be false or was reckless in assessing their
truth. The district court granted the motion. The court noted
that Ernst’s audit report of February 12, 1997, was made
more than three years before the filing of suit, and it held that
Ernst’s consent letters of July 9 and August 6, 1997, did not
re-start the three-year repose period prescribed by 15 U.S.C.
§ 78i(e). The court further held that New England had not
pleaded “with particularity facts giving rise to a strong
inference that [Ernst] acted with the required state of mind”
in accordance with the Private Securities Litigation Reform
6 New England Health
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No. 01-6523
Act of 1995, 15 U.S.C. § 78u-4(b)(2). The district court
rejected Ernst’s argument that the action was barred by the
one-year statute of limitations, see 15 U.S.C. § 78i(e), holding
that it was not necessarily true that New England knew or
should have known of Ernst’s alleged fraud before June 28,
1999.
The dismissal being without prejudice, New England filed
an amended complaint against Ernst in March of 2001. Ernst
again moved to dismiss the complaint, and the district court
again granted the motion. The court rejected New England’s
argument that Ernst’s consent letters constituted new
misrepresentations – made within the three-year period of
repose – that were materially different from the
misrepresentations allegedly contained in the February 12
audit report. The court also held that New England still had
not pleaded sufficient facts showing scienter. The complaint
was dismissed with prejudice, and this timely appeal
followed.
II
We review the dismissal of New England’s complaint de
novo. See, e.g., In re Comshare, Inc. Securities Litigation,
183 F.3d 542, 547 (6th Cir. 1999). In doing so, we may
affirm the judgment of the district court on any ground
supported by the record. See id. at 547-48.
A
Securities fraud litigation under § 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities and
Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5,
must be commenced, as we have seen, “within one year after
the discovery of the facts constituting the violation . . . .” 15
U.S.C. § 78i(e); see Lampf, 501 U.S. at 364, where the
Supreme Court borrowed the limitations provisions of § 9(e)

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of the 1934 Act, 15 U.S.C. § 78i(e), for actions brought under
§ 10(b) and Rule 10b-5.
Reading the language of § 9(e), narrowly, New England
argues that only actual discovery of fraud can start the one-
year limitations period. Ernst counters that the period begins
to run upon “inquiry notice” of fraud – meaning, under one
interpretation, the point at which the plaintiff should have
discovered the fraud through reasonably diligent inquiry.
New England is correct, of course, that § 9(e) refers only to
“discovery” as the trigger of the limitations period. Unlike
some other federal statutes of limitations – notably, § 13 of
the Securities Act of 1933, which allows actions based on
false offering documents to be brought “within one year after
the discovery” of the false statement “or after such discovery
should have been made by the exercise of reasonable
diligence,” 15 U.S.C. § 77m (emphasis added) – § 9(e) does
not expressly provide for inquiry notice.
That does not necessarily mean, however, that § 9(e)
requires actual discovery of fraud before the limitations
period will begin to run. The term “discovery,” when used in
a statute of limitations, can be broader than “actual
discovery.” See, e.g., J. Geils Band Employee Benefit Plan
v. Smith Barney Shearson, Inc., 76 F.3d 1245, 1254 (1st Cir.)
(holding that “discovery,” as used in a statute of limitations
within the Employee Retirement Income Security Act,
“encompasses both actual and constructive discovery”), cert.
denied, 519 U.S. 823 (1996). And there is good reason to
interpret § 9(e)’s “discovery” as “includ[ing] constructive or
inquiry notice, as well as actual notice.” Menowitz v. Brown,
991 F.2d 36, 41 (2d Cir. 1993). If actual discovery were
required, investors could extend the time for filing suit simply
by refusing to investigate possible fraud. Thus, an actual
discovery standard would encourage “the opportunistic use of
federal securities laws to protect investors against market
risk;” investors could wait to see whether a poorly performing
8 New England Health
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No. 01-6523
1Investors’ ability to hedge against risk in this manner would be
circumscribed by the three-year period of repose contained in § 9(e), see
15 U.S.C. § 78i(e), but, in the words of the Seventh Circuit, “[t]hree years
is an age in the stock market.” Tregenza, 12 F.3d at 722.
stock recovered, reap investment profits if it did, and sue for
damages if it did not. Tregenza v. Great American
Communications Co., 12 F.3d 717, 722 (7th Cir. 1993), cert.
denied, 511 U.S. 1085 (1994). 1 “This tactic is discouraged by
the doctrine of inquiry notice . . . .” Id.
The fact that Congress expressly provided for inquiry
notice in § 13 of the 1933 Act, without doing so in § 9(e),
does not persuade us that “discovery” must be read as “actual
discovery.” As the Seventh Circuit has pointed out, Congress
could not have guessed in 1934 that § 9(e) would be applied
to claims of fraud brought under § 10(b) – claims more
closely resembling “false statement” claims under §§ 11 and
12 of the 1933 Act, 15 U.S.C. §§ 77k and 77l, than “market
manipulation” claims under § 9 of the 1934 Act, id. § 78i.
See Tregenza, 12 F.3d at 721-22. Section 9(e)’s failure to use
“inquiry notice” language, therefore, cannot support an
inference that Congress intended the narrowest possible
discovery standard to apply in actions arising under § 10(b).
See id. Congress never focused on the question, because
Congress never chose any statute of limitations for § 10(b)
actions – actions that are, after all, creatures of the courts and
not of the legislature. See Lampf, 501 U.S. at 358-59.
The Supreme Court, on the other hand, did choose a statute
of limitations for § 10(b) actions, and it explicitly chose §
9(e) over § 13 and other one-year/three-year limitations
periods set out in the 1933 and 1934 Acts. See id. at 364 n.9.
But while acknowledging that “slight[]” differences in
terminology could someday “prove significant,” id., the Court
characterized the various limitations provisions as essentially
the same: “Although not identical in language, all these

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2In reaching this conclusion, we considered the SEC’s brief as amicus
curiae in Lampf, as well as the other materials that New England
submitted for judicial notice. Ernst’s motion to strike the request for
judicial notice is denied.
3Ernst suggests that this circuit endorsed the inquiry notice standard
for § 10(b) actions in Ockerman v. May Zima & Co., 27 F.3d 1151, 1155
(6th Cir. 1994). The passage that Ernst quotes, however, merely
characterizes the holding of Lampf:
“In Lampf, the Supreme Court held that all actions under section
10(b) and Rule 10b-5 must be brought within one year from the
time the fraud was discovered or should have been discovered,
but no more than three years from the transaction giving rise to
the claim.” 27 F.3d at 1155.
This gloss on Lampf – i.e., the insertion of the phrase “or should have been
relate to one year after discovery and to three years after
violation.” Id. at 355 n.2. Finding no indication that the
Court believed § 9(e) to be meaningfully different from § 13
– or, more to the point, that the Court considered the absence
of an express reference to inquiry notice in § 9(e) to be
significant – we do not think the Court’s choice of § 9(e)
forecloses an interpretation of “discovery” that includes
inquiry notice.2
We therefore join the courts of appeals of at least seven
other circuits in holding that inquiry notice is sufficient to
trigger the one-year limitations period for actions brought
under § 10(b). See LC Capital Partners v. Frontier
Insurance Group, 318 F.3d 148, 154 (2d Cir. 2003); In re
NAHC, Inc. Securities Litigation, 306 F.3d 1314, 1324-25 (3d
Cir. 2002); Young v. Lepone, 305 F.3d 1, 8 (1st Cir. 2002);
Theoharous v. Fong, 256 F.3d 1219, 1228 (11th Cir. 2001);
Sterlin v. Biomune Systems, 154 F.3d 1191, 1196 (10th Cir.
1998); Kauthar SDN BHD v. Sternberg, 149 F.3d 659, 670
(7th Cir. 1998), cert. denied, 525 U.S. 1114 (1999); Howard
v. Haddad, 962 F.2d 328, 330 (4th Cir. 1992). 3 None of our
10 New England Health
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No. 01-6523
discovered” into Lampf’s literal holding – was not essential to our decision
in Ockerman, as the sufficiency of inquiry notice was not at issue in that
case. We thus agree with New England that Ockerman does not control
the case at bar.
4The Ninth Circuit has indicated – in dictum – an inclination toward
the actual discovery standard. See Berry v. Valence Technology, Inc., 175
F.3d 699, 703-04 & n.6 (9th Cir.), cert. denied, 528 U.S. 1019 (1999). For
the reasons given above, we are not persuaded by the Ninth Circuit’s
analysis.
The Third Circuit’s position on this issue has not always been clear,
but in 2002, answering what it termed “an open question in this court,”
that circuit applied the inquiry notice standard under § 9(e). See NAHC,
306 F.3d at 1325.
sister circuits, so far as we know, has held that constructive
discovery cannot suffice to start the one-year clock running.4
Before we turn to the application of § 9(e) to the facts of
this case, we need to consider when the limitations period
begins to run under an “inquiry notice” standard. Ernst
suggests that the limitations period is triggered when the
plaintiff learns facts that would cause a reasonable investor to
investigate the possibility of fraud. Some cases support that
suggestion. See, e.g., Theoharous, 256 F.3d at 1228. The
majority view, however, is that knowledge of suspicious facts
– “storm warnings,” they are frequently called – merely
triggers a duty to investigate, and that the limitation period
begins to run only when a reasonably diligent investigation
would have discovered the fraud. See, e.g., Young, 305 F.3d
at 9-10; Rothman v. Gregor, 220 F.3d 81, 97 (2d Cir. 2000);
Sterlin, 154 F.3d at 1201-02 ; Marks v. CDW Computer
Centers, Inc., 122 F.3d 363, 367-68 (7th Cir. 1997). This
view, we believe, reflects an appropriate balance between
“the staunch federal interest in requiring plaintiffs to bring
suit promptly . . . and the equally strong interest in not driving
plaintiffs to bring suit . . . before they are able, in the exercise
of reasonable diligence, to discover the facts necessary to

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support their claims.” Young, 305 F.3d at 9 (citing Sterlin,
154 F.3d at 1202). We conclude, in accordance with the
majority view, that the § 9(e) limitations period begins to run
when a plaintiff should have discovered, by exercising
reasonable diligence, the facts underlying the alleged fraud.
B
Like other Rule 12(b)(6) motions to dismiss, a motion to
dismiss on statute of limitations grounds should be granted
“when the statement of the claim affirmatively shows that the
plaintiff can prove no set of facts that would entitle him to
relief.” Ott v. Midland-Ross Corp., 523 F.2d 1367, 1369 (6th
Cir. 1975), quoted in Duncan v. Leeds, 742 F.2d 989, 991
(6th Cir. 1984). A court that is ruling on a Rule 12(b)(6)
motion may consider materials in addition to the complaint if
such materials are public records or are otherwise appropriate
for the taking of judicial notice. See, e.g., Jackson v. City of
Columbus, 194 F.3d 737, 745 (6th Cir. 1999), abrogated on
other grounds, Swierkiewicz v. Sorema N.A., 534 U.S. 506
(2002). New England’s complaint against Fruit, therefore, is
properly a part of the record before us.
Reading New England’s amended complaint against Ernst
in conjunction with New England’s earlier complaint against
Ernst’s client, Fruit of the Loom, we believe that New
England can prove no set of facts showing that it failed to
discover Ernst’s alleged fraud, either actually or
constructively, before June 28, 1999. No later than July 1,
1998, when it filed the complaint against Fruit, New England
was aware that Fruit’s financial statements for 1996 (and the
first two quarters of 1997) did not adhere to GAAP. New
England also knew, or could have learned through minimal
investigation of public records, that Ernst had audited Fruit’s
1996 statements and declared them to be in conformity with
GAAP. New England obviously knew enough by
July 1,1998, to conclude that Ernst’s certification was false.
12 New England Health
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No. 01-6523
New England argues that it could not have known whether
Ernst’s certification was knowingly or recklessly false until it
obtained Ernst’s workpapers through discovery in the Fruit
litigation. We agree that scienter on the part of corporate
insiders – which New England plainly alleged in the Fruit
complaint – does not necessarily imply scienter on the part of
outside auditors. At the same time, however, direct evidence
of scienter is not necessary to a determination of fraud. See,
e.g., Herman & MacLean v. Huddleston, 459 U.S. 375, 390
n.30 (1983) (noting that scienter may be proved with
circumstantial evidence). In this case, we believe, the facts
alleged in the Fruit complaint strongly suggest that Fruit’s
auditors were at least reckless.
For one thing, the alleged fraud relates primarily to
departures from GAAP contained in audited financial
statements – the “same issues,” New England has said, that
are addressed in the Ernst complaint – and not to
representations that were neither scrutinized nor approved by
the auditors. Moreover, the scope of the alleged fraud –
involving overvaluation of fixed assets and inventory by more
than $400 million, premature recognition of more than $50
million in sales, and failure to accrue liabilities and charges
totaling $89 million – is such that any reasonable investor
would question the auditors’ oversight. As New England
says in its brief, the fraud “does not involve little mistakes
that the auditors might have easily overlooked.” In the light
of the particular allegations against Fruit, we are at a loss to
understand why New England should not have determined, by
July 1, 1998, that Ernst knowingly or recklessly participated
in the alleged fraud.
At the very least, New England should have made that
determination during the 12 months that elapsed between
July 1, 1998, and June 28, 1999 – ample time, it seems to us,
for a diligent investigation to establish Ernst’s close
involvement with Fruit’s business. In sum, we are satisfied

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that New England can prove no set of facts showing that it
lacked inquiry notice before June 28, 1999.
III
Having concluded that New England’s complaint is
untimely under the statute of limitations, we need not address
the complaint’s timeliness under the three-year statute of
repose or the sufficiency of the allegations of scienter. Our
conclusion also compels a determination that the district court
did not err in dismissing the amended complaint with
prejudice. Because of the time bar, further amendment of the
complaint would be futile. See, e.g., Deutsch v. Turner
Corp., 317 F.3d 1005, 1029 n.20 (9th Cir. 2003).
AFFIRMED.

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