On October 29, 2019, Judge Charles R. Breyer of the United States District Court for the Northern District of California denied a motion to dismiss a putative securities class action brought against a pharmaceutical wholesaler and two of its former executives. Evanston Police Pension Fund v. McKesson Corp., et al., 18-cv-06525-CRB (N.D. Cal. Oct. 29, 2019). Plaintiffs asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, alleging that defendants knew about and participated in a price-fixing conspiracy that allowed the company to profit from the inflated prices of generic drugs during the alleged class period and caused the company to suffer decreased earnings once reports revealed government investigations into alleged price-fixing and prices dropped. The Court denied defendants’ motion to dismiss, holding that plaintiffs adequately alleged material misstatements, scienter, and loss causation at the pleading stage.
The Court first addressed plaintiffs’ allegations that defendants participated in or knew of a price-fixing conspiracy. The Court held that plaintiffs failed to sufficiently plead direct evidence of defendants’ participation in an unlawful price-fixing agreement, noting that rather than pleading direct evidence of participation by defendants, plaintiffs merely pled “direct evidence of unlawful agreements among generic drug manufacturers” and that “the more plausible inference from this evidence is that [the company, a wholesaler,] was a victim of, not a participant in,” the price-fixing conspiracy. Id. at *10. The Court also found plaintiffs’ circumstantial-evidence allegations of “parallel conduct[] and five plus factors”—(1) actions against self-interest, (2) deviation from pre-collusion behavior, (3) state and federal investigations, (4) a market susceptible to collusion, and (5) participation in trade organizations—to be insufficient, relying on the Ninth Circuit’s rejection of “very similar plus factors” in In re Musical Instruments and Equipment Antitrust Litigation, 798 F.3d 1186, 1189-94 (9th Cir. 2015). The Court did, however, find that plaintiffs adequately alleged that the company’s executives “were aware of price-fixing in the generic pharmaceutical industry when the challenged statements were made.” Id. at *14.
The Court next considered six categories of statements plaintiffs alleged were made false or misleading based on defendants’ awareness of price-fixing in the generic pharmaceuticals industry, and it held that three of the categories could not be found to be false or misleading.
First, regarding defendants’ statements that the company “provided value to its pharmaceutical customers by obtaining competitive prices for generic drugs,” the Court found that such statements “were not rendered false by the manufacturers’ price-fixing conspiracy” and they “simply described the value of a wholesaler to independent pharmacies.” Id. at *15. Similarly, the Court found that statements by defendants that a generic-drug manufacturing subsidiary of the company was a “growth vehicle” were not false or misleading, because plaintiffs had “not sufficiently alleged [the subsidiary’s] participation in an unlawful conspiracy” and, therefore, “a general discussion of its growth and other merits would not be rendered misleading by failing to disclose other companies’ antitrust violations.” Id. at *16. The Court also rejected plaintiffs’ argument that a third category of statements that the company had “derisked its FY17 earnings from generics inflation” were false or misleading, finding such statements to be “essentially forward-looking” and, therefore, not actionable. Id. at *17.
The Court held, however, that three other categories of statements were actionable. Statements that supply disruptions could increase prices were held to be actionable despite defendants’ arguments that, even if there were a price-fixing conspiracy, the company might still have faced a supply disruption which would increase prices and, indeed, that any illegal agreement between manufacturers limiting supply of drugs to the company would “technically be a supply disruption.” Id. at *14-15. The Court held instead that “[h]aving touted the good news that supply disruptions were leading to increased prices and thus increased profits,” defendants “had a duty to also disclose that some portion of its increased profits was actually [allegedly] due to far riskier and less sustainable unlawful agreements.” Id. at *15. The Court similarly found defendants’ statements describing the generic drug market as “competitive” were false or misleading, because “[c]laiming the generic drug market is competitive would be misleading if there was in fact widespread price fixing.” Id. at *16. Finally, the Court determined that certain statements by defendants attributing the company’s positive financial results to “legitimate market forces,” such as drug price increases, were false or misleading, because they “put generic drug price increases at issue, and therefore obligated [the company] to disclose the collusion helping to drive the inflation.” Id. at *17.
The Court next held that plaintiffs sufficiently alleged scienter under the “core operations” theory, pursuant to which the falsity of a statement may itself be “indicative of scienter where it is combined with allegations regarding a management’s role in the company that are particular and suggest that defendant had actual access to the disputed information, and where the nature of the relevant fact is of such prominence that it would be absurd to suggest that management was without knowledge of the matter.” Id. at *19. Based on the executive defendants’ “statements touting their knowledge of the generics market, combined with the magnitude of the price-fixing conspiracy, its significance to [the company’s] revenues, and the executive defendants’ roles at the company,” the Court held that the company and its top executives must have been aware that collusive behavior drove price inflation. Id. at *18. Had the company’s executives possessed the “intimate” knowledge of generic drug pricing and conditions in the market they claimed, the Court held, “it was at least deliberately reckless not to investigate the accuracy of their statements that price increases were being driven by specific, legitimate supply disruptions, rather than collusive activity.” Id. at *19. The Court also held that the “strong correlation between financial results and stock options or cash bonuses” for company executives supported an inference of scienter. Id. at *21.
Finally, the Court determined that plaintiffs sufficiently alleged loss causation based on the company’s stock price drops when the purported corrective disclosures occurred. As such, the Court thus denied the motion to dismiss.
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