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United States Court of Appeals
FOR THE EIGHTH CIRCUIT
* District Court for the* Eastern District of Missouri.
Before WOLLMAN, BYE, and SHEPHERD, Circuit Judges.
Several groups of investors1 who purchased the securities of KV
Pharmaceutical Company (KV) brought this class action lawsuit alleging KV and
some of its individual officers committed securities fraud. The investors alleged KV
made false or misleading statements about its compliance with Food and Drug
Administration (FDA) regulations governing the manufacture of pharmaceutical
products, and made false or misleading statements about earnings resulting from
pharmaceutical products allegedly manufactured in violation of FDA regulations.
The district court dismissed the complaint for failure to state a claim for relief,
concluding the investors failed to allege with sufficient particularity that KV's
statements were false or misleading. The district court also dismissed the investors'
separate claims for scheme liability against individual KV officers. Finally, the
district court denied the investors' post-judgment motion to amend their complaint.
We affirm in part, reverse in part, and remand for further proceedings.2
The primary issue before us is whether the investors' complaint3 was sufficient
to withstand a motion to dismiss under Rule 12(b)(6) of the Federal Rules of Civil
Procedure. Our factual recitation therefore tracks the allegations in the complaint,
which "we are bound to accept as true for purposes of a Rule 12(b)(6) motion[.]"
1The Norfolk County Retirement System and the State-Boston Retirement
System were appointed by the court as the lead plaintiffs in this class action on behalfof all investors. Hereinafter we will refer to all the plaintiffs collectively as "theinvestors."
2We grant the motions brought by both sides to file sur-reply briefs addressing
the Supreme Court's recent decision in Matrixx Initiatives, Inc. v. Siracusano, 131S.Ct. 1309 (2011).
3Unless otherwise indicated, references to the "investors' complaint" refer to
the Consolidated Amended Complaint dated May 22, 2009.
Joyce v. Armstrong Teasdale, LLP, 635 F.3d 364, 365 (8th Cir. 2011) (internal
quotation and punctuation marks omitted).
KV is a pharmaceutical company. KV publicly traded securities between June
15, 2004, and January 23, 2009, the "Class Period" alleged in the complaint. At all
relevant times, KV had three operating segments: generic pharmaceutical products,
branded pharmaceutical products, and specialty raw materials. KV marketed each of
its segments through three subsidiary companies: ETHEX marketed the generic
products, Ther-Rx marketed the branded products, and Particle Dynamics, Inc.
marketed the specialty raw materials.
On five occasions during the Class Period (for KV's fiscal years 2004 through
2008), KV filed annual reports with the Securities and Exchange Commission (SEC)
on Form 10-K. The first of the five Form 10-Ks was filed on June 14, 2004, and the
last was filed on June 26, 2008. In the Form 10-Ks, KV explained in detail the
extensive and complex governmental regulation of the pharmaceutical industry by the
FDA. KV then made specific representations regarding its compliance with FDA
regulations. In a section entitled "Manufacturing And Facilities," KV stated in all
five of the applicable Form 10-Ks: "We believe that all of our facilities are in
material compliance with applicable regulatory requirements." In the 2004 Form
10-K, in a section entitled "Risks Related To Our Industry," KV also represented:
"We are currently in material compliance with cGMP4 and are registered with the
appropriate state and federal agencies." KV slightly modified this latter
representation in its Form 10-Ks for fiscal years 2005 through 2008 by stating: "We
believe that we are currently in material compliance with cGMP and are registered
with the appropriate state and federal agencies."
4Current Good Manufacturing Practices.
The investors' complaint alleges KV's statements regarding its material
compliance with FDA regulations were false or misleading. The investors base this
claim on KV's knowledge of the results of a series of inspections the FDA made of
KV's facilities between 2003 and 2009. The FDA reported the results of its
inspections to KV on Form 483s following inspections which concluded in April
2003, January 2004, January 2005, March 2006, April 2007, March 2008, and
February 2009. Form 483s are issued pursuant to FDA regulations to notify a
company's "top management in writing of significant objectionable conditions
relating to products and/or processes, or other violations
of the [FDA] which were
observed during the inspection" of a facility. FDA Investigations Operations Manual,
Ch. 5, § 5.2.3 (2009) (emphasis added).
On March 2, 2009, after the last inspection which concluded on February 2,
2009, the United States filed a complaint (the FDA complaint) against KV, ETHEX,
Ther-Rx, and four individual KV officers.5 The government sought a permanent
injunction to prevent KV from manufacturing and distributing pharmaceuticals due
to irregularities in its manufacturing practices. In its complaint, the FDA stated KV
had a "history of continuing . . . violations" of the FDA's current Good Manufacturing
Practices (cGMP). FDA Compl. at ¶ 23. The FDA complaint stated the "deficiencies
observed by the FDA at the most recent inspection in February 2009, are the same as,
or similar to, prior violations observed by the FDA at several other inspections during
the last eight years." Id. The government further alleged KV's "noncompliance has
5Three of the four individual KV officers sued by the United States are also
individual defendants in this case: Marc S. Hermelin, KV's Chairman and ChiefExecutive Officer (CEO) at all relevant times until his termination for cause onDecember 5, 2008; David A. Van Vliet, who served as KV's Chief AdministrationOfficer from September 2006 until September 2008, as the President and CEO ofETHEX from September 2008 until December 5, 2008, and as KV's CorporatePresident and interim CEO after Hermelin was fired for cause on December 5, 2008;and Rita E. Bleser, the President of KV's Pharmaceutical Manufacturing Divisionsince April 2007.
continued despite repeated warnings from FDA regarding its cGMP violations." Id.
at ¶ 24 (quoted in the investors' complaint at ¶ 8). The FDA complaint referred to
six FDA inspections which took place between April 2003 and February 2009, in
FDA investigators prepared and issued a detailed List of InspectionalObservations, Form FDA-483, to [KV], notifying [KV] of theinvestigator's observations. The FDA investigators discussed theviolations listed in the Form FDA-483s with [KV], who expressed adesire to correct the deficiencies. Nevertheless, FDA investigators havecontinued to observe cGMP violations at subsequent inspections.
Id. (quoted in the investors' complaint at ¶ 8).
The investors' complaint generally alleged KV's manufacturing, processing,
packing, labeling, holding and distribution of drugs were not in compliance with
cGMP, and further alleged the FDA investigators specifically documented thirty-five
Failure to follow the responsibilities and procedures applicable tothe quality control unit;
Failure to establish control procedures to validate theperformance of those manufacturing processes that may beresponsible for causing variability in the characteristics ofin-process materials and the drug product;
Failure to make written records of investigations into unexplaineddiscrepancies and the failure to make written records ofinvestigations of a batch or any of its components to meetspecifications;
Failure to review and approve drug product production andcontrol records by the quality control unit to determine
compliance with all established, approved written proceduresbefore a batch is released or distributed;
Failure to review and approve changes to written procedures bythe quality control unit;
Failure to clean, maintain, and sanitize equipment and utensils atappropriate intervals to prevent contamination that would alter thesafety, identity, strength, quality or purity of the drug product;and
Failure to follow written production and process control procedures inthe execution of production and process control functions.
The investors alleged KV's manufacturing irregularities resulted in KV selling
adulterated, unapproved, and misbranded drugs in violation of FDA regulations, and
that KV knew since early 2003 it was selling adulterated and unapproved drugs in
violation of FDA regulations. The investors alleged one of the violations "concerned
KV's most important product in 2007 and 2008, Generic Metoprolol, responsible for
the supposed explosive growth in [KV's] revenues and earnings, and sustained high
stock prices." Id. at ¶ 41. The investors alleged KV's upper management gave
instructions to violate Quality Control/Quality Assurance (QC/QA) procedures
regarding the manufacture of generic Metoprolol. Id. The investors alleged the FDA
found evidence that KV did not use the designed process for manufacturing 100mg
tablets of generic Metoprolol during the Class Period between August 5, 2007, and
October 17, 2008, by using "an active ingredient that resulted in smaller particle sizes
than approved by FDA in the validation study." Id. at ¶ 43.
The investors further alleged another "flagrant violation" of FDA regulations
involved KV's manufacture of pharmaceutical products which did not have the
correct proportion of ingredients. Instead of discarding the defective products which
were out-of-specification, KV's upper management decided to "blend" production lots
that had low assay values (which refer to the proportion of ingredients in a product)
with production lots that had high assay values. Id. at ¶ 44. In addition, the investors
alleged when KV identified the root cause of the problem during the Class Period on
August 6, 2008, it nevertheless failed to correct the problem and continued to
distribute pharmaceutical products using the faulty manufacturing process up until
the FDA's February 2009 inspection. Id. at ¶ 45.
The investors also alleged KV ignored known and required modifications in
the manufacturing process of Hydromorphone HC1 tablets. "In December 2005 and
January 2006, several validation batches 'failed to demonstrate control and
reproducibility' because 'blend uniformity and potency failures occurred.'" Id. at ¶ 51
(quoting from the 2009 Form 483). In other words, KV could not control the exact
dosage in its pharmaceutical products due to deficient manufacturing processes. KV
identified the problem during the Class Period in June 2006 and designed a new
production process. Nonetheless, KV then ignored the new production process and
reverted back to the old defective procedures that had resulted in the manufacture of
The investors further alleged KV concealed from the FDA the production of
oversized morphine sulfate tablets, which it had discovered during the Class Period
on or about May 15, 2008. KV did not file a field alert with the FDA, as required,
and did not notify the FDA until nearly five months later. At least two wrongful
death lawsuits were filed against KV relating to the ingestion of oversized morphine
sulfate tablets manufactured by KV. Id. at ¶ 54(a).
In addition to the specific violations outlined above, the investors alleged a
number of other manufacturing irregularities which were noted by the FDA in the
Form 483 from the February 2009 inspection. The investors attached a copy of the
2009 Form 483 as Exhibit 2 to their complaint. The 2009 Form 483 details a number
of manufacturing irregularities which occurred during the Class Period alleged in the
investors' complaint, including: (a) KV's failure in 2007 to implement adequate
corrective and preventative action in response to over 350 complaints of leaking
capsules of a pharmaceutical product called PrimaCare One; (b) KV's failure to
implement an adequate corrective action in response to several batches of Histinex
HC Syrup packaged with incorrect closures which the FDA identified in inspections
occurring in February 2007 and May 2007; (c) KV's failure to determine the exact
source and nature of metal found in drug products manufactured between July 22,
2008, and December 25, 2008; (d) KV's conduct in June 2008 in restocking a lot of
Metoprolol tablets initially processed in August 2007, and then returned without KV
investigating the storage conditions of the product while out of its possession, in
order to determine whether the safety, identity, strength, quality or purity of the
tablets had been destroyed; and (e) KV's conduct, between September 11, 2008, and
November 7, 2008, in using packaging components for six separate products
(including 50 mg tablets of Metoprolol) which were disqualified on May 29, 2007.
The investors' complaint also alleged KV's violations of cGMP and FDA
regulations rendered certain statements KV made about its earnings false and
misleading. In November 2007, KV filed a press release with the SEC on Form 8-K
announcing its second quarter fiscal 2008 financial results. Included in the press
release was a statement attributing KV's improvements in net revenues in large part
"to the July 2007 launch of the Company's generic . . . Metoprolol." In February
2008, KV filed a press release with the SEC on Form 8-K announcing its third quarter
fiscal 2008 financial results. In the press release, KV attributed a 57.7% increase in
revenue from the prior-year quarter "primarily . . . to sales of 100mg and 200mg
strengths of metoprolol succinate extended release tablets launched in the second
quarter of fiscal 2008." In May 2008, KV filed a Form 12b-25 reporting preliminary
results for the fourth quarter fiscal 2008 financial results. KV again attributed its
increase in net revenues "primarily [to] the launch in July 2007 of the 100mg and
200mg strengths of metoprolol succinate extended-release tablets." Finally, in
August 2008, KV filed a press release with the SEC on Form 8-K reporting its first
quarter fiscal 2009 financial results. In the press release, KV stated "[r]evenue
growth during the quarter was impacted by . . . a net sales gain of 52.6% over the
prior year period at the Company's ETHEX generic/non-branded marketing
subsidiary, contributed to by sales of 25mg, 50mg, 100mg, and 200mg strengths of
The investors alleged these four statements were false and misleading because
KV knew and failed to disclose that its manufacturing process for generic Metoprolol
violated FDA regulations, including cGMP. More specifically, the investors'
complaint alleged KV's generic Metoprolol: (a) had not been developed in a
scientifically sound manner with appropriate specifications and process controls; (b)
the active pharmaceutical ingredient used in producing generic Metoprolol was
different than the one used in the design process; and (c) the particle size of post-
validation lots of generic Metoprolol was smaller than the particle sizes used in an
August 5, 2007 validation study. Investors' Compl. ¶¶ 108, 110, 113, 116. The
investors based these three allegations directly on statements the FDA made in the
The FDA's supervision of KV eventually affected its stock prices. On
December 23, 2008, KV issued a press release disclosing that, effective December 19,
it had "suspended all shipments of all FDA approved drug products in tablet form."
The price of KV's shares fell from $5.39 to $1.99. On January 23, 2009, the end of
the Class Period alleged in the investors' complaint, KV completely shut down its
manufacturing activities. Three days later, KV announced it had "suspended the
manufacturing and shipment of all of its products, other than products it distributes
but does not manufacture." KV's stock price dropped to $0.51 per share. The
investors allege they "lost approximately $1.5 billion in market capitalization" from
the collapse in KV's stock price for Class A shares "from more than $30 at the height
of the Class Period, to 51 cents at the close of trading on January 26, 2009."
After the investors filed their complaint, KV filed a motion to dismiss the
complaint for failure to state a claim for relief. The district court granted the motion
to dismiss. The district court determined the statements KV made in its Form 10-Ks
about compliance with FDA manufacturing regulations were not false or misleading
because the forms only listed "observations" rather than "violations" and were not the
FDA's final agency determination on whether KV was compliant with regulations.
The district court further determined the statements KV made attributing its financial
success to the manufacture and sale of generic Metoprolol were not false or
misleading because the statements were accurate reports of KV's financial
performance, and KV did not have a duty to disclose its manufacturing issues with
generic Metoprolol. The district court also dismissed the claims the investors brought
against the individual KV officers concluding the investors failed to establish scheme
liability. Finally, the district court denied a post-judgment motion to amend the
complaint to supplement the investors' allegations primarily with information
regarding ETHEX's guilty plea to criminal charges arising from the FDA's
investigation. The investors filed a timely appeal.
The investors' complaint alleges securities fraud claims brought under Section
10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and the SEC's Rule
10b-5, 17 C.F.R. § 240.10b-5. "Section 10(b) makes it unlawful '[t]o use or employ,
in connection with the purchase or sale of any security . . . any manipulative or
deceptive device or contrivance in contravention of such rules and regulations as the
[SEC] may prescribe as necessary or appropriate in the public interest or for the
protection of investors.'" Minneapolis Firefighters' Relief Ass'n v. MEMC Elec.
Materials, Inc., 641 F.3d 1023, 1028 (8th Cir. 2011) (quoting 15 U.S.C. § 78j(b)).
Rule 10b-5 implements the provisions of Section 10(b). Matrixx Initiatives, Inc. v.
Siracusano, 131 S.Ct. 1309, 1317 (2011). Rule 10b-5 makes it unlawful to "make any
untrue statement of a material fact or to omit to state a material fact necessary in order
to make the statements made, in the light of the circumstances under which they were
made, not misleading[.]" 17 C.F.R. § 240.10b–5(b). We employ de novo review to
determine whether the district court properly dismissed the investors' securities fraud
claims. In re NVE Corp. Sec. Litig., 527 F.3d 749, 751 (8th Cir. 2008).
The investors first argue the district erred when it determined their complaint
did not allege with sufficient particularity that KV's statements about material
compliance with FDA regulations or cGMP were false or misleading. The Private
Securities Litigation Reform Act of 1995 (PSLRA), 15 U.S.C. § 78u-4(b)(2),
"imposes a heightened pleading standard in cases alleging securities fraud."
Lustgraaf v. Behrens, 619 F.3d 867, 873 (8th Cir. 2010). The heightened standard
requires a plaintiff to "specify each statement alleged to have been misleading [and]
the reason or reasons why the statement is misleading[.]" 15 U.S.C. § 78u-4(b)(1).
The "circumstances of the fraud must be stated with particularity, including such
matters as the time, place and contents of false representations, . . . [t]his means the
who, what, when, where, and how." In re K-tel Int'l, Inc. Sec. Litig., 300 F.3d 881,
890 (8th Cir. 2002) (internal quotations and citations omitted). The PSLRA also
requires a plaintiff to plead sufficient particular facts establishing scienter. See 15
U.S.C. § 78u-4(b)(2)(A) ("[T]he complaint shall, with respect to each act or omission
alleged to violate this chapter, state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of mind.").
In their complaint, the investors alleged KV made ten specific statements about
its compliance with FDA regulations or cGMP which were false or misleading. KV
made the statements in five annual Form 10-Ks it filed with the SEC between June
14, 2004, and June 26, 2008. In each Form 10-K, KV stated "[w]e believe that all of
our facilities are in material compliance with applicable regulatory requirements."
In each Form 10-K, KV also stated "[w]e believe that we are currently in material
compliance with cGMP and are registered with the appropriate state and federal
agencies."6 Based on these specific pleadings, we have no trouble concluding the
investors satisfied the PSLRA's pleading standard with respect to the time, place, and
contents of the allegedly false or misleading representations.
The crux is whether the investors' complaint adequately sets forth the reasons
why KV's statements about its material compliance with FDA regulations or cGMP
were false or misleading. The investors rely upon KV's knowledge of the results of
the series of inspections performed by the FDA before, during, and after the Class
Period, which were reported to KV on Form 483s. The final Form 483 issued by the
FDA following its February 2009 inspection documented thirty-five separate
significant objectionable conditions or other FDA violations which were observed
during the inspection. The investors rely upon the fact that when the FDA filed its
complaint seeking to permanently enjoin KV's operations, it alleged KV had a history
of continuing cGMP violations, and the violations observed in the February 2009
inspection were "the same as, or similar to, prior violations observed by FDA at
several other inspections conducted during the last eight years." The investors note
the objectionable conditions observed by the FDA in February 2009 extended back
into the Class Period, and thus contend the February 2009 Form 483 was relevant to
the statements KV made during the Class Period. See, e.g., In re Merck & Co., Inc.
Sec. Litig., 432 F.3d 261, 272 (3d Cir. 2005) ("[B]oth post-class-period data and
pre-class data [can] be used to 'confirm what a defendant should have known during
the class period,' [since] '[a]ny information that sheds light on whether class period
6As noted above, KV not only represented its belief
that it was in material
compliance in the 2004 Form 10-K, but affirmatively stated "[w]e are currently inmaterial compliance with cGMP and are registered with the appropriate state andfederal agencies."
statements were false or materially misleading is relevant.'") (quoting In re Scholastic
Corp. Sec. Litig., 252 F.3d 63, 72 (2d Cir. 2001)).
In response, KV argues allegations of a company's mere receipt of Form 483s
can never satisfy the materiality requirements of a securities fraud claim because
Form 483s simply do not implicate a company's compliant status with FDA
regulations or cGMP, material or otherwise. KV refers to the explanatory language
included on the face of all Form 483s, which informs recipients "[t]his document lists
observations by the FDA representative(s) during the inspection of your facility.
They are inspectional observations, and do not represent final Agency determination
We reject KV's contention that the receipt of Form 483s can never render a
company's statements about compliance with FDA regulations or cGMP false or
misleading. The "fundamental purpose" of the Securities Exchange Act is to
"implement a philosophy of full disclosure" in order "to protect investors against
manipulation of stock prices." Basic Inc. v. Levinson, 485 U.S. 224, 230 (1988)
(internal quotation marks and citations omitted). To accomplish that purpose, the
Supreme Court has "explicitly . . . defined a standard of materiality" to determine
when a statement or omission would be considered false or materially misleading by
a reasonable investor. Id. at 231. "To fulfill the materiality requirement there must
be a substantial likelihood that the disclosure of the omitted fact would have been
viewed by the reasonable investor as having significantly altered the total mix of
information made available." Detroit Gen. Ret. Sys. v. Medtronic, Inc., 621 F.3d 800,
805 (8th Cir. 2010) (internal quotation marks and citation omitted). Under the
circumstances present in this case, we conclude there is a substantial likelihood KV's
disclosure of its receipt of Form 483s, during the same time period it was representing
it was in material compliance with FDA regulations and cGMP, would have been
viewed by the reasonable investor as having significantly altered the total mix of
Our rejection of KV's per se rule, holding a company's receipt of Form 483s
never renders statements about material compliance with FDA regulations or cGMP
false or misleading, is consistent with a number of district court decisions which
have recognized the materiality of a company's receipt of Form 483s. See McGuire
v. Dendreon Corp., 688 F. Supp. 2d 1239, 1241, 1244-45 (W.D. Wash. 2009)
(Dendreon II) (granting leave to amend a complaint where a defendant stated his
company had "hosted a good inspection" at a manufacturing plant without revealing
the fact that the FDA issued a Form 483 following the inspection, concluding "the
existence of the Form 483 might well have led his audience to conclude it was not
good inspection"); Yanek v. Staar Surgical Co., 388 F. Supp. 2d 1110, 1129 (C.D.
Cal. 2005) (finding the FDA's issuance of a Form 483 material to a company's
statements about the timing of FDA approval of an implantable contact lense (ICL)
because issuance of the Form 483 was a "fact bearing on possible delays in FDA
approval of the ICL"); Wilkof v. Caraco Pharm. Labs, Ltd., No. 09-12830, 2010 WL
4184465, at *6 (E.D. Mich. Oct. 21, 2010) (denying a motion to dismiss in a case
where a company represented it was "substantially cGMP compliant"
contemporaneously with receiving Form 483s noting serious manufacturing
problems, including tablet size variation, failures to thoroughly investigate, and the
company's general "inability to produce quality pills, i.e.
, drug products that have the
identity, strength, quality, and purity they purport or are represented to possess"); In
re Able Labs. Sec. Litig., No. 05-2681, 2008 WL 1967509, at *16, 30 (D.N.J. March
24, 2008) (denying a motion to dismiss in a case involving a company's receipt of an
FDA warning letter and Form 483 where the defendants represented the company was
compliant with cGMP and all applicable FDA requirements); In re Cryolife, Inc., No.
Civ.A.1:02CV1868-BBM, 2003 WL 24015055, at *8 (N.D. Ga. May 27, 2003)
(denying a motion to dismiss in a case involving a company's receipt of a Form 483
noting twelve specific observations of regulatory violations at the same time it
represented it in was "in compliance with all FDA regulations").7
7We are not persuaded by KV's reliance on Acito v. IMCERA Group, Inc., 47
F.3d 47 (2d Cir. 1995), which held a company was not obligated to disclose the
The issuance of a Form 483 represents a risk that the FDA may take corrective
action against a company, and thus a company is obligated to assess the seriousness
of the risk and disclose such information to potential investors if it also represents it
is in compliance with FDA regulations and cGMP. See Gebhardt v. ConAgra Foods,
Inc., 335 F.3d 824, 831 (8th Cir. 2003) ("We keep in the forefront of our minds [the]
fact that '[j]ust because a hidden risk does not materialize doesn't mean its
concealment cannot hurt investors.'") (quoting Rodney v. KPMG Peat Marwick, 143
F.3d 1140, 1144 (8th Cir. 1998)); see also In re SFBC Intern., Inc. Sec. & Derivative
Litig., 495 F. Supp. 2d 477, 481 n.2 (D. N.J. 2007) ("While the observations
contained in a Form 483 report do not constitute a final agency determination
regarding the facility's compliance with applicable laws and regulations, corrective
action by the inspected company is expected."); McGuire v. Dendreon Corp., No.
CO7-800MJP, 2008 WL 5130042, at *6 (W.D. Wash. Dec. 5, 2008) (Dendreon I)
("One need not know the contents of an unfavorable report (a fair characterization of
the Form 483 under the best of circumstances) to state with a high degree of certainty
that the mere fact of its existence would have a negative impact on the hopes and
expectations of investors, and thus upon the value of the stock.").
From our review of the caselaw we glean the following principle: for purposes
of pleading a securities fraud claim, the issuance of Form 483s may render a
defendant's statement about its compliance with FDA regulations or cGMP false, or
at least misleading, in some circumstances. The FDA's issuance of Form 483s may
be material depending on a number of factors, including the number, severity, and
pervasiveness of objectionable conditions noted, as well as whether a company has
failed to address or correct the deficiencies noted by the FDA. There is a substantial
likelihood the presence of these factors would be viewed by a reasonable investor as
results of unfavorable FDA inspections to the investing public. Id. at 52. Acito didnot involve allegations by investors that a company made false or misleadingstatements about its compliance with FDA regulations or cGMP, and thus the SecondCircuit did not address the issue we face here.
significantly altering the total mix of information made available, irrespective of
whether the Form 483 represents the FDA's final say on compliance issues.8
In this case, the investors' complaint pleads numerous, severe, and pervasive
objectionable conditions which were outlined in the Form 483s. The investors
alleged there was a lengthy history of KV manufacturing adulterated, unapproved,
and misbranded drugs in violation of FDA regulations due to manufacturing
irregularities. The manufacturing irregularities included KV's failure to manufacture
pharmaceutical products with the correct proportion of ingredients, and the correct
tablet sizes, during the Class Period. The investors also alleged KV failed to address
or correct serious manufacturing problems during the Class Period (including the
failure to investigate metal particles found in four different products, and the
development of new design processes to correct problems but then a failure to
implement them), incorporating the allegations in the FDA's March 2009 complaint
which indicated KV's "noncompliance has continued despite repeated warnings from
FDA regarding its cGMP violations." Finally, the investors' complaint indicates KV's
operations were ultimately shut down as a result of its failure to comply with the
FDA's requirements, and the stock market reacted to news of the shutdown with a
8We reject KV's contention that its statements about material compliance with
FDA regulations and cGMP were not false or misleading because the Form 483s werepublicly available through a Freedom of Information Act (FOIA) request. Havingchosen to represent it was in material compliance with FDA regulations and cGMP,KV was obligated to make a full disclosure of any material facts. See K-tel, 300 F.3dat 898 (explaining that a party with no duty to speak on a particular topic mustnevertheless make a full disclosure when it chooses to speak); see also Sailors v. N.
States Power Co., 4 F.3d 610, 612 (8th Cir. 1993) ("A duty [to disclose] arises . . . ifthere have been inaccurate, incomplete or misleading disclosures."). If KV hadchosen only to indicate that it was regulated by the FDA, the public availability of theForm 483s may have insulated it from a claim for securities fraud. See Sailors, 4 F.3dat 612-13. KV went a step farther, however, and affirmatively represented it wascompliant with FDA regulations, giving rise to a duty to disclose materialinformation.
significant drop in the price of KV's stock. See Medtronic, 621 F.3d at 807 ("A
significant change in stock price upon disclosure of withheld information is strong
evidence that the information was material.").
Under this set of facts,9 we conclude the investors' complaint adequately set
forth the reasons why KV's statements about its compliance with FDA regulations
and cGMP were false, or at least misleading, at the time they were made.
The investors next argue the district court erred when it determined they did
not sufficiently plead that KV made false or misleading statements about earnings
tied to the manufacture of generic Metoprolol. The investors contend KV had a duty
to disclose the manufacturing problems associated with generic Metoprolol because
KV chose to publicly highlight the product's financial success. Although KV
accurately reported its past financial figures, the investors claim the statements were
nevertheless misleading because KV omitted the material fact that it could not
9The pleaded facts in this case are significantly different from those involved
in Acito, where the results of unfavorable FDA inspections were found not to bematerial. Acito involved three FDA inspections which took place at just one plantamong thirty of the company's business locations, a plant which produced just ten ofone thousand products manufactured by the company in over thirty countries, 47 F.3dat 52, whereas here the investors allege the FDA violations covered the entire rangeof KV's operations and products, including generic Metoprolol, which the investorsalleged was responsible for an explosive growth in KV's earnings and sustained highstock prices. In addition, the conditions in the plant at issue in Acito improvedbetween the first and second inspections, id., whereas here the investors alleged therewas an eight-year history of continuing cGMP violations which eventually led theFDA to completely shut down KV's operations. Moreover, as we stated above, Acitodid not involve allegations that the company made false or misleading statementsabout its compliance with FDA regulations or cGMP. See ante at n.6.
manufacture generic Metoprolol within approved FDA guidelines and was violating
cGMP in its production of generic Metoprolol.
The district court held KV did not have a duty to disclose its manufacturing
KV did not attribute its financial success to its outstandingmanufacturing processes or quality control measures associated with theproduction of the generic metoprolol. Moreover, the financialstatements did not discuss KV compliance with the FDA regulations.
Because KV chose only to speak about the financial status of thecompany, KV was not required to dump all known information about itsmanufacturing and regulatory issues.
Pub. Pension Fund Grp. v. KV Pharm. Co., 705 F. Supp. 2d 1088, 1102 (E.D. Mo.
2010) (internal quotation marks omitted). We agree with the district court. KV did
not undertake a duty to speak about its manufacturing problems with generic
Metoprolol solely by reporting historical financial results.
"Silence, absent a duty to disclose, is not misleading under Rule 10b-5." Basic
Inc., 485 U.S. at 239 n.17. Even assuming KV's manufacturing problems with
generic Metoprolol were material, "[m]ateriality alone is not sufficient to place a
company under a duty of disclosure." K-tel, 300 F.3d at 898 (citation omitted). In the
statements at issue, KV only reported past financial performance. The financial
statements did not discuss compliance with FDA regulations, or tie KV's financial
performance directly to manufacturing processes. As a result, KV's statements did
not trigger a duty to disclose its compliance with FDA regulations, or to discuss its
manufacturing problems with generic Metoprolol. While Rule 10b-5 requires "an
actor to provide complete and non-misleading information with respect to the subjects
on which he undertakes to speak
. . . the requirement is not to dump all known
information with every public announcement[.]" Id. (internal quotations and citation
The primary case cited by the investors, In re Gilead Sciences Securities
Litigation, 536 F.3d 1049 (9th Cir. 2008), does not support their argument that KV
had a duty to disclose the manufacturing problems associated with generic
Metoprolol. The investors contend Gilead held a company's failure to disclose its off-
label sale of a pharmaceutical product, contrary to FDA regulations, "was actionable
because Gilead chose to tout the drug as a primary driver of its earnings." Appellants'
Br. at 49. The investors rely upon the following quote from Gilead:
Gilead issued a press release announcing that it anticipated its secondquarter financial results would exceed analysts' expectations, andexplaining that the company's success "was driven primarily by strongsales growth of Viread. . . . Increasing Viread sales reflect broaderprescribing patterns in all commercial markets, as well as increases inU.S. wholesaler inventory levels in the second quarter in anticipation ofa Viread price increase."
These statements were materially false and misleading because Gileadand its Officers' "marketing and promotional activities for Viread werenot in compliance with FDA approved guidelines, violated federal laws,and created serious public health and safety implications for Vireadusers."
Gilead, 536 F.3d at 1052. The above quote appears in the portion of the opinion
where the Ninth Circuit merely summarized the allegations in the plaintiffs'
complaint, however, and does not represent the court's holding. Indeed, Gilead did
not even address whether a statement was misleading due to a duty to disclose, but
rather dealt with the issue of loss causation. See id. at 1056-58.
The investors also rely upon the Supreme Court's recent decision in Matrixx,
contending it stands for the broad proposition that a statement ascribing past financial
success to a particular product is misleading unless the problems associated with the
product are also disclosed. We disagree. Matrixx involved the cold remedy, Zicam,
which allegedly accounted for 70% of Matrixx's sales. 131 S.Ct. at 1323. Matrixx
made public statements attributing a sizeable net sales increase to Zicam, and
projecting future growth of the company due to the sale of Zicam. See Siracusano v.
Matrixx Initiatives, Inc., 585 F.3d 1167, 1181 (9th Cir. 2009). The Supreme Court
held the plaintiffs stated an actionable claim by pleading that Matrixx failed to
disclose reports of a possible link between Zicam and loss of the sense of smell
(anosmia). Matrixx, 131 S.Ct. at 1323. Significantly, however, the misleading
statements upon which the Supreme Court focused were not the reports of past
financial success attributing earnings to the sale of Zicam. Rather, the statements the
Supreme Court held actionable were those in which Matrixx "stated that reports
indicating that Zicam caused anosmia were 'completely unfounded and misleading'
and that 'the safety and efficacy of zinc gluconate for the treatment of symptoms
related to the common cold have been well established.'" Id. Matrixx made these
statements while at the same time projecting future growth in the sale of Zicam. See
id. ("Matrixx told the market that revenues were going to rise 50 and then 80
Thus, in Matrixx there was a direct connection between the information the
company failed to disclose – the adverse reports of a link between the use of Zicam
and anosmia – and the public statements the company made indicating the reports that
Zicam causes anosmia were completely unfounded and misleading. In addition, the
company made statements projecting future growth attributable to the product in
issue. This case is distinguishable. KV's statements were accurate reports of its past
financial success, and there was no direct connection between those statements and
the alleged manufacturing problems associated with generic Metoprolol. In addition,
the investors do not allege KV misled investors with projections regarding future
performance, as KV only undertook to speak about its past financial success. We
therefore conclude the district court did not err when it determined the investors'
complaint did not sufficiently plead that KV made false or misleading statements
about earnings tied to the manufacture of generic Metoprolol.
The investors next contend the district court improperly dismissed their claims
brought pursuant to Rules 10b-5(a) and (c) against two individual KV officers: David
A. Van Vliet, KV's Chief Administrative Officer from September 2006 until
September 2008, the President and CEO of ETHEX from September 2008 until
December 5, 2008, and KV's Corporate President and interim CEO after December
5, 2008; and Rita E. Bleser, the President of KV's Pharmaceutical Manufacturing
Division since April 2007. Rule 10b-5(a) prohibits "any device, scheme or artifice
to defraud." 17 C.F.R. § 240.10b-5(a). Rule 10b-5(c) prohibits "any act, practice, or
course of business which operates or would operate as a fraud or deceit upon any
person[.]" 17 C.F.R. § 240.10b-5(c). Claims brought under Rules 10b-5(a) and (c)
are generally referred to as "scheme liability" claims. See, e.g., In re DVI, Inc. Sec.
Litig., 639 F.3d 623, 643 n.29 (3d Cir. 2011) ("We refer to claims under Rule
10b-5(a) and (c) as 'scheme liability claims' because they make deceptive conduct
actionable, as opposed to Rule 10b-5(b), which relates to deceptive statements.").
The investors generally alleged Van Vliet and Bleser "carried out a plan,
scheme, and course of conduct which was intended to and, throughout the Class
Period, did . . . deceive the investing public . . . and . . . caused . . . members of the
Class to purchase KV securities at artificially inflated prices." Investors' Compl.
¶ 163. To support this general allegation, the investors incorporated their allegations
regarding the false and misleading statements about KV's compliance with FDA
regulations and cGMP, and the allegations regarding the false and misleading
statements about earnings tied to the production of generic Metoprolol, and then
alleged Van Vliet and Bleser "had actual knowledge of the misrepresentations and
omissions of material fact as set forth herein." Id. at ¶ 167. Other than incorporating
the allegations regarding the misrepresentations and omissions, the investors only
generally alleged Van Vliet and Bleser "employed devices, schemes, and artifices to
defraud[,] . . . engaged and participated in a continuous course of conduct to conceal
adverse material information about the business [and] engaged in transactions,
practices and a course of conduct that operated as a fraud and deceit upon the
purchasers of KV securities." Id. at ¶¶ 164-66.
Based upon these allegations, the district court dismissed the scheme liability
claims against Van Vliet and Bleser because the "plaintiffs fail to allege with
sufficient particularity how the scheme operated and how Van Vliet and Bleser were
actually involved. As such, the Court finds that lead plaintiffs' conclusory allegations
fail to state claims under Rule 10b-5(a) and (c) against Van Vliet and Bleser." KV
Pharm., 705 F. Supp. 2d at 1106. We agree with the district court.
The investors' conclusory allegations regarding Van Vliet and Bleser
employing devices, schemes, and artifices to defraud do not satisfy the requirements
of pleading fraud under Rule 9(b) of the Federal Rules of Civil Procedure. See, e.g.,
In re Parmalat Sec. Litig., 414 F. Supp. 2d 428, 432 (S.D.N.Y. 2006) ("Although the
heightened pleading requirements of the PSLRA do not apply to claims under Rule
10b-5(a) and (c), such claims must be pleaded with specificity under Rule 9(b).
Accordingly, a plaintiff . . . must specify, with particularity, what manipulative acts
were performed, which defendants performed them, when the manipulative acts were
performed and what effect the scheme had on the securities at issue.") (internal
quotation marks and citations omitted). The investors do not allege what specific
manipulative acts either Van Vliet or Bleser performed, or when the manipulative acts
The only scheme liability allegations in the investors' complaint which
arguably are not
merely conclusory are those which incorporate the allegations
regarding the misrepresentations or omissions about FDA/cGMP compliance, and
earnings tied to generic Metoprolol. The investors allege Van Vliet and Bleser had
knowledge of those misrepresentations or omissions. The district court held,
however, that misrepresentation claims under Rule 10b-5(b) cannot simply be recast
as scheme liability claims under Rules 10b-5(a) and (c) unless a plaintiff alleges a
defendant "participated in a scheme that encompassed conduct beyond
misrepresentation." KV Pharm., 705 F. Supp. 2d at 1104 (quoting In re Alstom SA
Sec. Litig., 406 F. Supp. 2d 433, 475 (S.D.N.Y. 2005)).
We have not directly addressed this issue in our circuit, but "the two circuit
courts that traditionally see the most securities cases [are] the Second and Ninth
Circuits." Nicholas Fortune Schanbaum, Scheme Liability: Rule 10b-5(a) and
Secondary Actor Liability after Central Bank, 26 Rev. Litig. 183, 197 (Winter 2007).
Both the Second and the Ninth Circuits have held "[a] defendant may only be liable
as part of a fraudulent scheme based upon misrepresentations and omissions under
Rules 10b-5(a) or (c) when the scheme also encompasses conduct beyond those
misrepresentations or omissions." WPP Luxembourg Gamma Three Sarl v. Spot
Runner, Inc., 655 F.3d 1039, 1057 (9th Cir. 2011); Lentell v. Merrill Lynch & Co.,
396 F.3d 161, 177 (2d Cir. 2005) ("[W]here the sole basis for such claims is alleged
misrepresentations or omissions, plaintiffs have not made out a market manipulation
claim under Rule 10b-5(a) and (c)[.]"). We join the Second and Ninth Circuits in
recognizing a scheme liability claim must be based on conduct beyond
misrepresentations or omissions actionable under Rule 10b-5(b). Because the
investors do not allege with specificity (or otherwise) what conduct Van Vliet and
Bleser engaged in beyond having knowledge of the misrepresentations and omissions
regarding FDA/cGMP compliance and earnings tied to generic Metoprolol, the
district court correctly dismissed the scheme liability claims against the two
Finally, the investors contend the district court erred when it denied their post-
judgment motion to amend the complaint. Because the motion to amend was filed
post-judgment, we review the district court's decision for an abuse of discretion,
keeping in mind the district court was not at liberty to "ignore the Rule 15(a)(2)
considerations that favor affording parties an opportunity to test their claim on the
merits[.]" United States ex rel
. Roop v. Hypoguard USA, Inc., 559 F.3d 818, 824 (8th
On appeal, the investors focus on two aspects of their proposed amended
complaint. First, the proposed amended complaint alleged KV engaged in a criminal
cover-up of its manufacturing problems starting in May 2008. The cover-up
ultimately resulted in ETHEX pleading guilty in February 2010 to two felony counts
of fraud "as a result of failing to report [to the FDA] the discovery of tablets that did
not meet product specifications." Investors' Second Amended Compl. (SAC) ¶ 104.
As part of the guilty plea, ETHEX agreed to pay $27 million in fines, restitution, and
administrative forfeitures. Referring to the criminal information filed by the United
States against ETHEX, the investors alleged the guilty plea resulted from two specific
instances in May 2008 in which KV received reports of oversized morphine tablets
from pharmacies. KV investigated the problem in May and June 2008 and discovered
the problem was not limited to morphine tablets, but extended to additional products
including Propanefone (an anti-arrhythmic drug used to treat heart disease) and
dextroamphetamine sulfate (a drug marketed for use primarily by children to treat
attention deficit hyperactive disorder). KV reported the discovery of the oversized
morphine tablets to the FDA "more than a month late," which itself "violated FDA
regulations," but more "[c]ritically, KV did not reference the discovery of other
oversized tablets." Id. at ¶ 112.
In addition, a KV officer identified as "Corporate Executive A" in the criminal
information directed the cover-up by choosing to "do nothing" in response to the
problem and instructing "multiple KV employees to minimize written
communications about KV's oversized tablet manufacturing problems, and limit
distribution and discussion of any documents discussing these problems given the
'business risk' created by written materials." Id. at ¶ 115. The investors alleged Marc
Hermelin, one of the individual defendants in this case, was "Corporate Executive A"
because Hermelin was subsequently "dismissed for cause," and "Hermelin's dismissal
was a result of the Audit Committee's investigation into FDA regulatory compliance
and management misconduct." Id. at ¶¶ 113, 149.10
In addition to alleging that this conduct violated FDA regulations (which
would support the original complaint's allegation that the Form 10-K which KV filed
on June 26, 2008, was false and misleading because it represented KV was FDA
compliant), the proposed amended complaint alleged KV made an additional false
statement. The investors alleged on August 11, 2008 (during the Class Period), KV
filed a Form 10-Q with the SEC which stated: "Management is not aware of and does
not believe that there has been any misconduct that would have a material impact on
the Company's financial results." Id. at ¶ 147. The investors alleged this statement
was false and misleading since KV (and Hermelin) knew the cover-up could have a
material impact on KV's financial results because "the misconduct concerned
overdosed tablets of multiple drugs, additional recalls, and 'business risk.'" Id. at
Second, the proposed amended complaint included an expert report from a
former FDA inspector who opined that the issuance of the Form 483s meant KV was
not in compliance with cGMP. In their memorandum of law in support of the motoin
to amend, the investors argued the expert report "cure[d] the deficiencies set forth"
in the district court's order dismissing the original complaint, referring to the fact that
the order "was largely based on the Court's finding that 'the Form 483s issued to KV
10On March 10, 2011, subsequent to the district court's denial of the motion to
amend the complaint, Hermelin pleaded guilty to a criminal information charging himwith misbranding drugs. The charges against Hermelin repeat the allegations against"Corporate Executive A" from ETHEX's criminal charges. Thus, by pleading guilty,Hermelin confirmed the investors' allegations that he was the "Corporate ExecutiveA" referred to in the SAC. See Appellants' Supplemental App. at 6.
only contained observations – not a list of cGMP violations as alleged by lead
plaintiffs.'" App. at 839 (quoting the district court's order). The investors argued the
former FDA inspector's report established that the use of the term "observation" was
interchangeable with the use of the term "violation." Id. at 839-40.
The district court denied the motion to amend for several reasons. First, it
stated ETHEX's guilty plea merely added evidentiary support to the original
allegations which the district court had determined were insufficient to state a cause
of action. Second, the district court noted the cover-up conduct took place after May
2008, and therefore covered only a small portion of the relevant class period. Finally,
the district court said there was nothing about the guilty plea that mentioned
individual defendants to this action. The district court did not specifically address the
expert report from a former FDA inspector in denying the motion to dismiss.
On appeal, the investors argue the district court erred in denying the motion to
amend the complaint because ETHEX's guilty plea established felony violations of
FDA regulations beginning in May 2008. The investors argue the new allegations
regarding the guilty plea would have compelled the district court to view the criminal
behavior as an undeniable violation of FDA regulations, not merely an observation.
The investors contend their new allegations established a viable class period of at
least May 2008 through January 2009, and that KV's August 2008 statement
declaring its ignorance of material misconduct was false when made.11
Next, the investors argue the district court erred when it said the SAC did not
mention individual defendants to this action, because the SAC specifically mentioned
Hermelin and alleged he was the "Corporate Executive A" referred to in the criminal
11As we noted, the criminal conduct establishing FDA violations as early as
May 2008 would also bear on whether KV's representation of FDA compliance onJune 26, 2008, was false and misleading.
charges against ETHEX. On appeal, the investors note Hermelin's subsequent guilty
plea to misbranding drugs confirms he was "Corporate Executive A."
Finally, the investors argue the district court erred when it denied the motion
to amend the complaint on the grounds that the SAC merely added evidentiary
support to the original allegations, pointing out the district court dismissed the
original allegations precisely for lack of sufficient evidentiary support.
We conclude the district court abused its discretion in denying the motion to
amend the complaint. The new allegations supported the investors' contention that
KV made false and misleading statements during the Class Period, and we are
unaware of any legal basis for discounting this relevant information simply because
it covers only a portion of the relevant Class Period. See In re Scholastic Corp., 252
F.3d at 72 ("Any information that sheds light on whether class period statements were
false or materially misleading is relevant.").
In addition, the SAC added allegations regarding a new statement KV made on
August 11, 2008. The criminal behavior alleged in the SAC was relevant to
determining whether this new statement was actionable in its own right, irrespective
of whether the original allegations were insufficient. Yet, the district court never
addressed this issue before denying the motion to amend.
The district court also relied upon an improper factor when it stated the guilty
plea did not involve any individual defendants to this action. See Dunn v. Nexgrill
Indus., Inc. 636 F.3d 1049, 1055 (8th Cir. 2011) (indicating a "district court abuses
its discretion when it . . . considers and gives significant weight to an irrelevant or
improper factor"). The SAC specifically mentioned Hermelin and specifically alleged
he was the "Corporate Executive A" referred to in ETHEX's criminal charges. The
allegations in the SAC were already sufficient to create the inference that Hermelin
was "Corporate Executive A," but even if they were not, Hermelin's subsequent guilty
plea confirmed the SAC's allegations.
Given our preference for "affording parties an opportunity to test their claim
on the merits," Roop, 559 F.3d at 824 , as well as our determination that some of the
allegations in the original complaint already sufficiently pleaded the false or
misleading nature of statements KV made during the Class Period, we direct the
district court on remand to grant the investors' motion to amend their complaint.
For the reasons stated, we affirm in part, reverse in part, and remand to the
district court for further proceedings consistent with this opinion.
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