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Seventh Circuit Affirms Dismissal Of Putative Class Action Against Animal Health Products Company For Failure To Adequately Allege Scienter
09/01/2026On August 14, 2026, the United States Court of Appeals for the Seventh Circuit affirmed the dismissal of a putative class action against an animal health products company and several of its officers and directors that alleged violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. Hunter v. Elanco Animal Health Inc., —F.4th—, 2026 WL 2357739 (7th Cir. Aug. 2026). Plaintiffs alleged that the company made misrepresentations by attributing revenue growth to strong end-user demand while concealing so-called “channel stuffing”—the practice of incentivizing distributors to purchase excess inventory. After the district court dismissed for failure to adequately allege false or misleading statements, the Seventh Circuit affirmed the dismissal on a different basis, holding that plaintiffs failed to adequately allege scienter.
The allegations concerned the company’s sales of products to wholesale distributors, who in turn sold them to end users such as veterinary clinics. Id. at *1. Toward the end of 2017, the company shifted from a “move out” sales model—which prioritized balancing sales to distributors with actual end-user demand—to a “move in” model that incentivized distributors to purchase as much product as possible through discounts, rebates, and extended payment terms, with less regard for the amount of products that end-users actually demanded. Id. Plaintiffs, relying in part on accounts from five confidential witnesses that were former employees of the company, alleged that the company’s CEO and CFO made false statements by attributing revenue growth to strong “underlying demand” for the company’s products during the proposed class period of May 9, 2019 through May 6, 2020. Id. at *2–3. The company’s channel stuffing allegedly peaked in the fourth quarter of 2019, at which point the company reverted to a “move out” sales model. On May 7, 2020, the company announced a $60 million reduction in channel inventory, attributing it to the COVID-19 pandemic, and the company’s stock price immediately fell approximately 13%. Id. at *4.
The Seventh Circuit first addressed the district court’s assessment of whether plaintiffs had adequately alleged false statements. The Seventh Circuit disagreed with the district court’s conclusion that, because the underlying channel stuffing was not itself fraudulent, plaintiffs could not state a claim for securities fraud. Id. at *6. The Seventh Circuit instead held that liability under Rule 10b–5(b) (in contrast to 5(a) or (c)) turns on whether the challenged statements were materially misleading, not on whether the underlying business practice was fraudulent. Id. In so holding, the Seventh Circuit endorsed the reasoning expressed in the Second Circuit’s decision in In re Hain Celestial Group, Inc. Securities Litigation, 20 F.4th 131 (2d Cir. 2021), which was the subject of our prior post, emphasizing that Rule10b–5(b) focuses “not on schemes, devices, or practices, but on statements made.” Id. at *7 (quoting Hain, 20 F.4th at 136). Ultimately, however, the Court said it did not need to resolve whether the challenged statements were misleading, because it held that plaintiffs had in any event failed to adequately allege a strong inference of scienter.
On the issue of scienter, the Seventh Circuit first noted that allegations based on four of the five confidential witnesses should be discounted steeply because they lacked personal access to information about the individual defendants’ mental state, but did not steeply discount the account of the fifth witness—a former Vice President who purportedly had direct access to the individual defendants and whose alleged version of events was also partially corroborated by other allegations. Id. at *8. Applying the Private Securities Litigation Reform Act’s requirement that plaintiffs plead a “strong inference” of scienter that is cogent and at least as compelling as any opposing inference of nonfraudulent intent, the Seventh Circuit evaluated three possible inferences that could be drawn from the allegations in plaintiffs’ complaint: (i) that the COVID-19 pandemic caused the announced inventory reduction, (ii) that the CEO and CFO intended to deceive the market, and (iii) that the CEO and CFO pursued what they believed was a legitimate sales program and did not deceive anyone about it. Id.
First, the Seventh Circuit rejected the district court’s conclusion that the strongest inference that could be drawn from plaintiffs’ allegations was that the COVID-19 pandemic caused the channel inventory reduction. Id. at *8. The Court noted that the company began reducing distributor inventory levels before the pandemic and had also reverted to its “move out” model before the pandemic too. Id.
While the Seventh Circuit determined that plaintiffs raised a “plausible” inference that the CEO and CFO knew distributor inventory levels did not match end-user demand and intended to deceive the market, the Court held this inference was not strong enough to outweigh a competing non-fraudulent inference. Id. at *9. Instead, the Court found it was more plausible that the individual defendants had “a realistic hope that their efforts to incentivize their distributors were working.” Id. The Court highlighted that the company’s sales were real, not illusory; distributors were not returning the company’s products at elevated rates; plaintiffs did not allege the CEO and CFO knew that demand was actually not strong or that the strategy was unsustainable; there were no allegations that the company’s financials had to be restated; and the strategy had worked for nearly two years. Id. The Court also rejected plaintiffs’ motive arguments, which were premised on a desire to keep the company’s stock prices high to facilitate acquisitions the company made of other businesses. The Court emphasized that every company executive is motivated to keep stock prices high and that there was a timing mismatch between the company’s adoption of the “move in” model and the acquisitions plaintiffs identified as motivating factors. Id.
Plaintiffs also asserted claims under the Securities Act based on alleged misrepresentations in the company’s merger registration statement and prospectus. Id. at *10. While Securities Act claims on their own are not subject to the heightened pleading standard for fraud, the Seventh Circuit agreed with the position of the Second, Third, Fourth, and Ninth Circuits that when the same course of conduct underlies both Exchange Act fraud claims and Securities Act claims, the Securities Act claims “sound in fraud” and must satisfy heightened pleading standards. Id. at *11. The Court rejected plaintiffs’ argument that the complaint had expressly disavowed that their Securities Act claims sounded in fraud. The Court characterized this technique as a “conclusory disclaimer” that could not override the substance of plaintiffs’ allegations, which were “classically associated with fraud.” Id. at *12. Because plaintiffs did not argue on appeal that their Securities Act claims could satisfy the heightened pleading standard imposed on traditional fraud claims, the Court affirmed that these claims were properly dismissed. Id. at *13.
The Seventh Circuit also addressed plaintiffs’ claim that the company violated Item 303 of SEC Regulation S-K by failing to disclose its channel stuffing practices as a “known trend.” The Court held that Item 303 addresses external market trends that might affect a company’s exposure, not internal business strategies, which the company did not have an affirmative obligation to disclose.
Securities Litigation