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Southern District Of New York Court Finds Forward-Looking Statements Are Actionable If “Predicated Upon” Current Facts; Also Finds Clawbacks Can Support Allegations Of Scienter At The Motion To Dismiss Stage
05/02/2016On April 22, 2016, Judge Kimba Wood of the United States District Court for the Southern District of New York denied defendants’ motion to dismiss plaintiffs’ claim brought under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), holding that the Private Securities Litigation Reform Act (“PSLRA”) safe-harbor for forward-looking statements does not apply to statements that incorporate misleading representations of present fact. In re Salix Pharmaceuticals, Ltd., No. 14 Civ. 8925, 2016 WL 1629341 (S.D.N.Y. Apr. 22, 2016). Plaintiffs had alleged misrepresentations regarding the inventory levels of defendant’s primary products, intentionally increasing levels beyond customer demand, in order to make the company appear more financially robust than it was.
In Salix, plaintiffs sued the company and its former CEO and CFO for alleged misrepresentations concerning wholesale inventory levels of Salix’s main pharmaceutical products. Plaintiffs alleged that defendants had engaged in a “channel stuffing” scheme, in which they intentionally increased wholesale customers’ inventory levels “vastly beyond prescription demand” so as to make Salix appear financially stronger than it actually was. The result was that wholesalers’ inventory levels allegedly rose from normal levels of 10 to 12 weeks of supply to more than 9 months of supply. Plaintiffs alleged that the defendants made material misleading statements and omissions in violation of Section 10(b).
In denying their motion to dismiss, Judge Wood acknowledged that many of the defendants’ statements were forward-looking because they offered predictions of future inventory levels. At the same time, Judge Wood found that many of these same statements fell outside of the PSLRA’s safe harbor because they were “predicated upon” representations concerning present wholesale inventory levels. For instance, Judge Wood noted that the defendants’ statements that levels were expected to return to normal within a few months led analysts to reasonably believe that current levels were only slightly outside the normal range. However, actual levels had grown to such an extent that it would likely take Salix several years to return “normal” levels of wholesaler inventory. Judge Wood’s decision in Salix thus clarifies the limits of the PSLRA’s safe harbor and suggests that a party cannot avoid liability by couching statements in future projections if those statements can reasonably be understood as being predicated upon representations of present facts.
Judge Wood also concluded that plaintiffs had adequately alleged scienter, in part, due to the decision by Salix’s board of directors to claw back millions of dollars’ worth of compensation from the two individual defendants. Judge Wood found that this decision “weigh[ed] in favor of a strong inference of scienter” because one of the possible bases for the clawback was a determination by Salix’s board that the individual defendants had “intentionally engaged in wrongdoing.” This, however, was not the only possible basis for clawback, and the Salix board did not disclose its rationale. Judge Wood’s decision thus demonstrates that clawbacks or other post hoc adverse employment actions may be used to support scienter at the motion to dismiss stage, even if the reason for the clawback is kept confidential.
