United States: Eastern District Of New York Dismisses Putative Class Action Against Pharmaceutical Company For Failure To Adequately Allege Misstatements And Scienter

On August 6, 2019, Judge Edward R. Korman of the United States District Court for the Eastern District of New York dismissed a putative securities class action asserting claims against a pharmaceutical company and certain of its officers under Section 10(b) of the Securities Exchange Act of 1934.  In re Aceto Corp. Sec. Litig., No. 18-CV-2425 (ERK-AYS) (E.D.N.Y. Aug. 6, 2019).  Plaintiff alleged that defendants made misrepresentations in connection with disclosures concerning the company's compliance with internal controls, earnings forecasts, and regarding the valuation of goodwill and intangible assets.  The Court held that the complaint failed to plead an actionable misstatement or scienter, but granted leave to replead.

Plaintiff's claims relating to internal controls stemmed from the company's November 2017 disclosure that it had misapplied cash in 2015 due to "a material weakness in the design and effectiveness of [the company's] internal control over financial reporting."  Slip op. at 2.  Based on this disclosure, plaintiff argued that the company's August 2017 SOX certification was necessarily false.  The Court disagreed, however, because the complaint contained no non-conclusory allegations that the August 2017 statements were false when made.  Id. at 7.  The Court noted that plaintiff's complaint assumed that because a problem was disclosed in November 2017, defendants must have known of the problem sooner; but this was impermissible "fraud by hindsight."  Id.

Next, plaintiff alleged that the company's February 1, 2018 earnings guidance was false, based on the company's April 18, 2018 press release cautioning that the February 1 guidance should no longer be relied upon.  The Court determined that the February 1 projections were non-actionable under the PSLRA's "safe harbor" provision, as they were forward-looking statements accompanied by meaningful cautionary language that went beyond "mere boilerplate."  Id. at 8-10.  Specifically, the Court noted that the challenged press release incorporated by reference meaningful cautionary language pertaining to specific risks identified in the company's SEC filings.  Id. at 9-10.  The Court rejected plaintiff's attempt to avoid the PSLRA safe harbor by characterizing the financial projections as mixed statements also containing present and historical fact.  The Court emphasized that plaintiff failed to identify what present fact was false, and was thus essentially arguing that the projections were false because the forecast did not materialize, which was once again impermissible "fraud-by-hindsight."  Id. at 11-12.  And the Court also rejected plaintiff's argument that, standing alone, the "temporal proximity" between the February 1 forecast and the April 18 press release suggested that the earlier statement was false when made.  Id. at 12.

Plaintiff further alleged that the company's impairment of its goodwill and intangible assets in the third quarter of 2018 due to the loss of government contracts should have been assessed by the time of its February 1, 2018 press release, rendering that press release false and misleading.  The Court held that plaintiff failed to allege any facts to suggest that information was omitted or that defendants had a duty to disclose information sooner than they did.  The Court emphasized that the calculation of goodwill is a statement of opinion, not fact, and to be liable for making a false statement of opinion, the plaintiff must show the speaker did not hold the belief she professed or that the supporting fact she supplied was untrue.  Id. at 13.  The Court also noted that, while an opinion may also be actionable if the speaker omits material information, here the company did disclose that it risked losing government contracts, but it was not required to "assume the worst" and take impairments sooner.  Id. at 13-14.

The Court held that plaintiff also failed to adequately allege scienter.  The Court rejected plaintiff's argument that scienter could be inferred by individual defendants' signing certain filings, as there were no "factual allegations to show they were aware of or reckless to any alleged misstatements."  Id. at 16.  The Court also rejected plaintiff's attempts to establish scienter based on "circumstantial evidence of recklessness," noting that this requires "highly unreasonable" conduct and a danger that was either known to the defendant or "so obvious that the defendant must have been aware of it."  Id. at 17.  Plaintiff pointed to the "temporal proximity" of the alleged misrepresentation to the disclosure of its falsity and to the size of the impairment, but the Court determined that, without more, such allegations could not support an inference of recklessness.  Id. at 17-19.  While plaintiff argued that the resignation of the company's CFO supported an inference of scienter for executives that remained, the Court noted that there may be any number of reasons that an executive might resign which are not related to fraud.  Id. at 18.  Finally, the Court rejected plaintiff's argument based on a "core operations" theory, which allows courts to draw an inference of scienter where the alleged misrepresentation was of critical importance to the company such that high-level officers or directors should have had knowledge by virtue of their positions.  Id. at 19.  The Court noted that it was not clear within the Second Circuit whether this theory was permissible to establish scienter, but in any event, plaintiff failed to identify specific facts of "critical importance" that the individual defendants should have known.  Id. at 19-20.  Thus, taken collectively, plaintiff's allegations did not give rise to a strong inference of scienter.

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