Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—EDMO: Public Pension Fund Group Adequately Pleaded Scienter, Loss Causation, (May 1, 2013)

By Jay Fishman, J.D.

The United States District Court for the Eastern District of Missouri granted the plaintiff Public Pension Fund Group’s (Public Pension) motion for a ruling on its class action securities fraud complaint, specifically declaring that Public Pension survived the defendant KV Pharmaceutical Company’s (KV) previous motion to dismiss the complaint by proving that KV, through its former Chief Executive Officer Marc Hermelin, acted with scienter and effected loss causation (Public Pension Fund Group v. KV Pharmaceutical Company, April 30, 2013, Jackson, C.).

The court initially dismissed Public Pension’s claim that KV and Hermelin made false and misleading statements in connection with KV’s compliance with certain United States Food and Drug Administration (FDA) regulatory requirements, in violation of Exchange Act Section 10(b) and Rule 10b-5. The United States Court of Appeals for the Eighth Circuit, however, reversed the court’s motion to dismiss, holding that Public Pension’s complaint adequately pleaded that KV’s regulatory compliance statements were false or misleading but failed to rule on the scienter and loss causation elements of the complaint.

Scienter. The court, relying on a 2007 holding in Tellabs, Inc. v. Makor Issues & Rights, Ltd. that inferences of scienter are found from scrutinizing the alleged facts collectively rather than individually, determined that the complaint’s factual allegations demonstrated a strong inference of scienter. The complaint specifically pleaded that: (1) KV and Hermelin knew of the FDA violations concerning their manufacture and distribution of publicly dangerous, defective pharmaceutical drugs because of the FDA Forms 483 provided to KV that listed the violations, and KV’s discussions with the FDA concerning the violations, as evidenced by the government’s preliminary injunction complaint against KV; (2) Hermelin’s signing a consent decree with the government reflecting he knew of the FDA violations since January 1, 2005; (3) Hermelin’s termination for cause with the full knowledge of the all pertinent facts; and (4) the ongoing nature of the fraudulent scheme over a substantial time-period because Hermelin and other officers knew of participated in the scheme at KV’s highest level.

The court agreed with Hermelin that a press release announcing his termination and the consent decree he signed were not, by themselves, enough to allege scienter. However, the court nevertheless found a strong inference for scienter on determining that the facts, when taken together, strongly suggested Hermelin knew of the violations by having access to the FDA’s Forms 483 before he signed each KV Form 10-K.

Loss causation. The court determined that Public Pension sufficiently pleaded loss causation, relying on a 2009 holding in McAdams v. McCord that a plaintiff proves this element of a fraud claim by showing a causal connection between the defendant’s misstatements and the plaintiff’s loss and that loss was foreseeable and caused by the materialization of the concealed risk. The court found that Public Pension sufficiently alleged that: (1) KV’s materially false and misleading statements and omissions about its manufacture and distribution of publicly dangerous defective pharmaceutical drugs caused an artificially inflated price for KV securities; and (2) KV’s subsequent securities price decline that led to Public Pension’s substantial monetary losses was foreseeable and caused by the materialization of the concealed risk KV took by not disclosing its continuous non-compliance with the FDA Forms 483 information.

The case is No. 4:08-CV-1859 (CEJ).

Attorneys: Jason G. Crowell (Osburn and Hine, L.L.C.) and Javier Bleichmar (Labaton Sucharow, LLP) for Public Pension Fund Group. David A. Rosenfeld (Coughlin Stoia, LLP), Don R. Lolli (Dysart and Taylor), J. Michael Ponder (Cook and Barkett), and Jonathan M. Plasse (Labaton Sucharow, LLP) for Joseph Mas, Building Trades United Pension Trust Fund and New Jersey Carpenters Pension Fund. F. Joseph Warin (Gibson and Dunn) and Robert P. Berry (Berry and Maxson, LLC) for KV Pharmaceutical Company and David A. Van Vliet. Jeffrey E. McFadden (Steptoe and Johnson, LLP) for Marc S. Hermelin. Kurtis B. Reeg (Reeg Lawyers, LLC) for Rita E. Bleser.

Companies: KV Pharmaceutical Company; Public Pension Fund Group

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