In Re Bio-Technology General Corp. Securities Litigation

Citations: 380 F. Supp. 2d 574; 2005 U.S. Dist. LEXIS 16603; 2005 WL 1903464Docket: Civil Action 02-CV-6048(HAA)

Court: District Court, D. New Jersey; August 10, 2005; Federal District Court

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Defendants' Motion to Dismiss the Consolidated Amended Class Action Complaint in the securities litigation concerning Bio-Technology General Corporation (BTG) has been granted, resulting in the dismissal of the complaint without prejudice. The case involves investors who purchased BTG shares between April 19, 1999, and August 2, 2002. BTG, now Savient Pharmaceuticals, is a biopharmaceutical company whose stock trades on NASDAQ and is required to file reports with the SEC. Arthur Andersen served as BTG's outside auditor from 1999 to 2001, issuing unqualified opinions on BTG's financial statements. After Andersen's departure, KPMG became the auditor in May 2002. On August 2, 2002, BTG announced a forthcoming restatement of its financial results for 1999-2001, leading to a significant drop in its stock price after KPMG's resignation on October 4, 2002, citing deficient internal controls. Shareholders initiated class actions beginning December 20, 2002, culminating in the consolidation of six actions and the appointment of PKN Group as lead plaintiff. The Consolidated Amended Class Action Complaint alleges that BTG and its executives violated federal securities laws by making materially false and misleading statements about the company's financial performance, constituting a scheme to inflate stock prices through accounting fraud that breached GAAP and internal policies.

Plaintiff asserts that BTG misreported three specific items in its financial statements during the Class Period, later corrected in restatements. The Plaintiff claims BTG's management falsely attributed a significant sales increase of its drug Oxandrin to successful market penetration, when it was actually due to wholesalers preemptively stocking against a price hike. These alleged fraudulent accounting practices and misleading statements constitute violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. BTG moved to dismiss the Complaint under Rules 9(b) and 12(b)(6), arguing insufficient particularity in the allegations to meet the heightened pleading standards mandated by the PSLRA. The court must accept all well-pleaded allegations as true when considering a motion to dismiss, confining its review to the complaint while allowing consideration of referenced documents. Dismissal is warranted only if no facts could support the claim. To prevail under Section 10(b) and Rule 10b-5, a plaintiff must prove misrepresentation of material facts made with knowledge or recklessness, reasonable reliance on those misrepresentations, and resultant damages. Rule 9(b) further requires detailed pleading of fraud allegations, including specifics about the false representation, knowledge of its falsity, and the plaintiff's reliance leading to damages. The PSLRA also demands that each misleading statement and the reasons for its misleading nature be explicitly specified.

The PSLRA mandates that if allegations regarding a statement or omission are based on information and belief, the complaint must specify all underlying facts supporting that belief. It requires private securities fraud plaintiffs to detail the participants in the alleged fraud, the timing and location of events, and the misleading nature of defendants' statements. Failure to meet these heightened pleading standards results in mandatory dismissal of the complaint. Scienter, or intent to deceive, is essential for Rule 10b-5 claims, with the PSLRA imposing stricter requirements than Rule 9(b) by necessitating a "strong inference" of the defendant's state of mind. This strong inference can be established by demonstrating the defendant's motive and opportunity or presenting substantial circumstantial evidence of recklessness. The PSLRA aims to significantly raise the bar for pleading requirements in private securities fraud cases. However, courts may allow some leniency if the facts are primarily within the defendant's knowledge. 

In this context, the plaintiff claims that three items in BTG's financial statements, which were restated in September 2002, indicate a pattern of accounting fraud during Andersen's audit of BTG. Specifically, the plaintiff highlights an improper reporting of a $5 million contract fee from a June 2000 agreement with DePuy Orthopaedics, Inc. The fee was reported as income for Q2 2000, even though the agreement was finalized shortly before the quarter's end. Subsequently, following KPMG's advice, BTG restated the fee to be amortized over ten years, leading to a $4.687 million reduction in reported revenues for FY 2000.

Plaintiff alleges that Defendants violated SEC Staff Accounting Bulletin (SAB) 101 and BTG's own accounting policies by incorrectly recognizing the entire $5 million DePuy payment as income for Q2 2000. SAB 101 outlines that revenue should be deferred unless received in exchange for completed products or services. The Plaintiff argues that no milestone was achieved within the first days of a ten-year license agreement, suggesting that the Defendants either misrepresented a milestone or fabricated one to wrongfully recognize revenue. Although SAB 101 became effective on December 3, 1999, BTG announced its adoption as of January 1, 2000, while planning to review and potentially restate previously recognized revenues. 

Defendants seek dismissal of the Complaint, asserting that the Plaintiff has not adequately pleaded scienter, pointing to the non-refundable nature of the payment, its classification as a milestone payment by BTG, a clean opinion from Andersen on BTG's reporting, and subsequent disagreement from KPMG, who recommended a restatement. The Defendants characterize the situation as a mere disagreement over the application of an accounting rule. 

The court recognizes that to establish a strong inference of scienter, a plaintiff must show either motive and opportunity or strong circumstantial evidence of misbehavior. Allegations must be specific and cannot rely on general assertions that defendants benefitted from wrongdoing. A concrete personal benefit resulting from the alleged fraud must be demonstrated to satisfy the pleading requirements for scienter.

Plaintiff presents three allegations to demonstrate Defendants' motive for misreporting the DePuy license fee as income for FY 2000. First, the Plaintiff claims that the $4.687 million misreported amount constituted 5.5% of BTG’s originally reported revenues. Second, this amount represented a significant percentage of BTG's reported net income of $7.717 million, with the actual net income later restated to only $765,000, or less than 10% of the original figure. However, these allegations alone do not establish sufficient motive for a strong inference of scienter, as supported by case law. Third, the Plaintiff points to BTG's acquisition of Myelos Corporation, alleging that Defendants aimed to inflate BTG’s share price before finalizing the acquisition agreement. The $35 million deal involved $21 million in BTG stock, with share value based on a prior 20-day trading average. Plaintiff claims that the Defendants delayed announcing BTG's Q4 and FY 2000 results until after the Myelos agreement was executed, suggesting that earlier disclosure of actual results would have jeopardized the acquisition. However, the Court finds the Plaintiff's argument regarding motive insufficient, noting the lack of evidence that the Myelos acquisition was anticipated during the reporting of the DePuy fee. The acquisition occurred over six months after the fee was recognized, undermining the inference of motive.

The Myelos acquisition cannot be used as evidence of Defendants' motive to misrepresent income for Q2 2000 since there is no indication that they anticipated such misrepresentation would benefit the acquisition. Relevant case law shows that intent to defraud requires a clear expectation of advantage from the misrepresentation, which is absent here. Even if Defendants aimed to inflate BTG's share price before the acquisition, the timing of their announcement—two days after the valuation period—undermines any inference of malicious intent. Additionally, there are no allegations that the Individual Defendants gained personal benefits from the purported fraud, which weakens claims of motive. General allegations of a desire to boost stock price do not suffice to infer motive, as they could apply to any corporate officer. 

The Court determines that without more specific allegations linking the reporting of the DePuy agreement fee to the Myelos acquisition, the claims regarding motive are insufficient. Furthermore, in order to establish a strong inference of scienter through circumstantial evidence, the plaintiff must present compelling facts. Recklessness, as defined in relevant case law, requires a significant departure from ordinary care that poses a risk of misleading investors. While the Plaintiff alleges that circumstances around BTG's recognition of the DePuy fee indicate Defendants' scienter, these claims are vague, attributing knowledge to Defendants collectively without detailing individual awareness.

The Complaint alleges that the Individual Defendants, due to their high-level positions and Board memberships within BTG, were involved in preparing the company’s financial statements or should have been aware of its true business condition. Specifically, the plaintiff claims that defendants Fass, Sternlicht, and Bond are responsible for false statements as they are considered part of "group-published" information. Group pleading, which emerged in the 1980s to aid securities fraud plaintiffs in attributing corporate statements, allows for naming corporate officers as defendants without detailing their specific involvement. However, following the enactment of the Private Securities Litigation Reform Act (PSLRA), courts have largely ruled that group pleading does not meet the PSLRA's heightened pleading standards. The Third Circuit has not definitively ruled on the survival of group pleading post-PSLRA, but prevailing authority in the district suggests it has been abolished. Courts have held that generalized claims of knowledge based solely on defendants' corporate roles are insufficient. Nonetheless, knowledge may be imputed to individual defendants regarding disclosures tied to the company's core business. The Court concludes that allegations relying solely on group pleading do not sufficiently establish a strong inference of scienter and that imputation of knowledge should be limited to cases where specific corporate responsibilities are outlined.

The complaint is deficient in establishing why the Individual Defendants have a specific duty related to the DePuy contract fee or any corporate policy necessitating their involvement in SEC filings. As a result, allegations based on group-published information are inadequate to meet the requirement of pleading scienter with particularity. The Complaint's assertion that the defendants acted with scienter is conclusory and lacks detail on the involvement of Individual Defendants Fass, Sternlicht, or Bond in the recording or reporting of the DePuy fee. Citing precedent, the court emphasizes that mere positional authority does not infer knowledge of wrongdoing. Consequently, the allegations related to the misreporting of the DePuy fee do not create a strong inference of scienter, leading to the dismissal of these claims.

Regarding the $2 million Oxandrin sale in Q2 1999 and its subsequent repurchase in Q1 2001, BTG reversed both transactions in its 2002 financial restatements due to uncertainties about the sale's realization. The Complaint alleges two frauds: the first claims that BTG's 1999 sales revenue was overstated due to pre-existing uncertainties, rendering the financial statements false at the time of filing. The second fraud concerns the improper reporting of the 2001 repurchase, where BTG allegedly obscured the repurchase by incorrectly increasing the cost of goods sold instead of reducing revenues. This alleged misconduct came to light only after the 2002 restatements necessitated revisions to financial statements from both 1999 and 2001.

Defendants argue that the Complaint does not adequately plead facts to establish fraud regarding the 1999 Oxandrin sale. To establish a prima facie case of fraud under Rule 10b-5, a plaintiff must demonstrate that: (1) the defendant made a materially false or misleading statement or omitted a necessary fact; (2) the defendant acted with scienter; and (3) the plaintiff relied on the misstatement, resulting in injury. The plaintiff must also meet the heightened pleading standards of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act (PSLRA).

The plaintiff asserts that a restatement of financial results implies that the original statements were false and misleading, but a restatement alone does not constitute an admission of wrongdoing. Courts have indicated that restatements can provide evidence of falsity if accompanied by specific allegations related to transactions that violated Generally Accepted Accounting Principles (GAAP). Material misrepresentations or omissions are those that a reasonable investor would find significant when making investment decisions. The determination of materiality is complex, and courts should only rule on it as a matter of law when the misrepresentations are clearly unimportant.

Applying these principles, the Court finds that the plaintiff has sufficiently alleged materially false or misleading statements concerning the 1999 Oxandrin sale and the 2001 repurchase. The alleged restatement of these transactions supports the conclusion of falsity, particularly noting that the 1999 sale was overstated by over 12%, and the accounting method used for the 2001 repurchase led to a 5.7% overstatement of reported revenues, artificially inflating sales by 10.7%.

Regarding scienter, the plaintiff has provided allegations suggesting that the defendants had motive and opportunity to commit fraud. However, mere general claims of motive and opportunity are insufficient; they must be supported by specific allegations demonstrating a concrete personal benefit to the defendants resulting from the fraud.

A general desire to boost stock prices or eliminate competition does not alone establish a strong inference of scienter. Concrete benefits linked to false statements or nondisclosures are necessary for sufficient motive allegations. The Plaintiff failed to show that the Individual Defendants personally benefited from the alleged fraudulent reporting of the 1999 Oxandrin sale and 2001 repurchase. The Court referenced a precedent where motive could be adequately pled if corporate insiders misrepresented material facts to maintain high stock prices while profiting from share sales. The Plaintiff's allegations did not support a strong inference of scienter based on motive or opportunity and relied on group pleading, which weakened the case. The circumstantial evidence was vague, lacking specific connections between the Individual Defendants and the preparation of false statements. Consequently, the Court determined that reliance and damages need not be addressed, leading to the dismissal of the motion concerning the 1999 Oxandrin sale and 2001 repurchase.

Additionally, the Plaintiff raised concerns regarding BTG's improper capitalization of research and development expenses for Oxandrin, totaling $3,118,000 from 1999 to 2001. BTG's policy was to expense these costs, but KPMG asserted they should have been expensed during the incurred periods. The Plaintiff argued that BTG's restatement of financial statements confirmed the improper capitalization. The Defendants moved to dismiss these allegations, asserting a failure to plead scienter adequately. The Complaint did not establish motive or opportunity but suggested circumstantial evidence, including a statement from BTG's 1999 Form 10-K about increased research and development expenses related to product development.

Plaintiff asserts that an unnamed product is Oxandrin and claims that Defendants exhibited scienter by failing to expense similar costs for a new Oxandrin formulation. The Complaint notes that after acquiring Myelos, BTG expensed $45,600,000 for in-process research and development, suggesting that their willingness to expense these costs implies fraudulent intent regarding the Oxandrin expenses. However, the mere restatement of financial results does not suffice to establish a strong inference of scienter; additional evidence of fraudulent intent is required. Allegations of GAAP violations alone cannot substantiate a securities fraud claim unless linked with evidence of intent. 

Plaintiff primarily relies on the restatement of Oxandrin R&D costs and presents two circumstantial pieces of evidence interpreted as indicative of fraudulent intent, though these interpretations are not compelling. The assertion that Defendants improperly capitalized Oxandrin costs does not inherently imply scienter, especially given the lack of allegations that Defendants knew these costs should have been expensed. Furthermore, Plaintiff fails to provide specific facts demonstrating why the capitalized costs should have been recognized as R&D expenses or why Defendants were reckless in their classification. The reference in BTG's 1999 Form 10-K to increased R&D expenses alongside capitalized costs does not establish a direct link to fraudulent intent without demonstrating that the two cost sets were similarly categorized. Overall, Plaintiff's allegations lack particularized facts necessary to support a plausible claim of securities fraud, failing to detail the specifics of the capitalized costs and the reasoning behind Defendants' accounting decisions.

Plaintiff's allegations of recklessness against Defendants hinge on the assertion that the guidelines for classifying research and development costs were straightforward, undermining Defendants' claims of acting reasonably and in good faith. Without specific factual pleading, the Court finds only a weak inference of scienter regarding Defendants' treatment of Oxandrin-related costs, further diminished by reliance on impermissible group pleading. The Complaint fails to detail the Individual Defendants' involvement in preparing or disseminating false statements, leading to the dismissal of claims related to Oxandrin research and development costs.

Additionally, the Complaint claims that Defendants made false or misleading statements in press releases and SEC filings about Oxandrin sales, particularly attributing a significant sales increase to successful market penetration through a partnership with Abbott Laboratories' Ross division. In reality, Plaintiff argues that the sales surge resulted from wholesalers overstocking in anticipation of a price increase, which BTG had communicated. Reports from Gentiva, BTG's distributor, indicated that sales from the Ross market contributed minimally to the increase. After BTG disclosed the true nature of the sales increase on October 8, 2001, the stock price dropped by 19%. Plaintiff asserts that Defendants failed to disclose material information regarding the sales increases and prescription rates.

Plaintiff alleges that Defendants failed to inform investors that the average dosages of Oxandrin prescribed in the long-term care market were significantly lower than those in the AIDS market, leading to a misinterpretation of prescription increases as reflective of actual sales growth. Additionally, the Plaintiff claims that a price increase expectation led to overstocking by wholesalers only in Q1 2001, with Q2 sales driven by a contractual arrangement between BTG and Gentiva, which inflated Gentiva’s purchases based on prior sales rather than indicating a sustained demand. Furthermore, Plaintiff asserts that a substantial portion of the sales increase in Q1 2001 was due to a single bulk purchase by distributor Bindley, not general wholesaler stocking. These omissions are alleged to have caused investor harm and violated securities laws.

Defendants seek dismissal of the Complaint, arguing it does not adequately plead false statements or scienter, and that any forward-looking statements are protected by the PSLRA's "safe harbor" provision. They also contend that the Complaint fails to meet the PSLRA's "information and belief" pleading standard, which requires particularity in alleging facts supporting such belief. While some courts previously required naming confidential sources, recent Third Circuit rulings clarify that such a requirement does not exist, although sufficient details must be provided to indicate that the sources would have relevant information, and additional facts must be presented to substantiate claims of false statements.

The Court affirms that the use of confidential witnesses by the Plaintiff meets the heightened pleading standards of the PSLRA, emphasizing that the sufficiency of allegations is assessed qualitatively based on additional supporting facts. In addressing the Defendants' claims of insufficient pleading regarding false statements about Oxandrin, the Court examines a series of public statements made by Defendants over time. These include predictions about sales growth linked to a co-marketing agreement with Ross, reported increases in Oxandrin prescriptions, and statements in BTG's financial filings indicating rapid sales growth attributed partially to this agreement. However, Defendants later clarified that increased sales were only "in part" due to Ross's efforts, revealing that average prescriptions in the long-term care market involved lower dosages and indicating expectations of a sales decline due to wholesaler stocking practices. Notably, BTG's disclosures evolved to acknowledge the impact of wholesaler stocking on sales figures, particularly in the context of pricing and market launch strategies.

BTG and its distributor Gentiva initially underestimated wholesaler purchases of Oxandrin in Q1 2001, which were higher than necessary to meet end-user demand. This overstocking was partially based on the expectation of a price increase for Oxandrin, which did occur in April 2001 at a rate of 4.2%. Yehuda Sternlicht of BTG later attributed a significant drop in sales in the second half of 2001 to this inventory accumulation, suggesting that wholesalers had anticipated the price hike. The plaintiff argues that Sternlicht’s comments imply the price increase was the sole reason for the earlier sales surge, contradicting BTG’s prior statements acknowledging the price increase. Additionally, a confidential witness from BTG indicated that sales from the Ross market were negligible, further supporting the plaintiff's claims. The court found that BTG's representations regarding the growth of Oxandrin sales were misleading, particularly in failing to disclose that a substantial portion of the Q1 2001 sales increase stemmed from a single $5.8 million purchase by wholesaler Bindley, rather than from the Ross market as claimed. The court concluded that these misrepresentations could constitute material false statements regarding Oxandrin sales.

The Court concludes that the Complaint adequately alleges material omissions and misrepresentations regarding BTG's sales of Oxandrin. Specifically, it finds that BTG failed to disclose the true reason for the elevated Q2 2001 Oxandrin sales until October 2001, which was due to Gentiva overstocking triggered by its purchasing formula, contradicting earlier claims suggesting alternative reasons for the sales growth. Additionally, the Complaint highlights a delay in disclosing an April 2001 price increase until February 2002, while BTG’s prior communications only mentioned wholesalers' expectations of a price increase, misleading investors. Furthermore, a statement by Sternlicht on February 25, 2002, implied that the price increase did not occur when expected, contradicting BTG's prior acknowledgment of the April increase. The Complaint also points out that BTG did not reveal until August 2001 that the growth in Oxandrin prescriptions due to the Ross market involved smaller dosages, which would have impacted investor perception of sales growth. Lastly, the Complaint asserts that BTG had access to industry data indicating the true nature of Oxandrin sales during Q1 and Q2 2001, as collected by BTG sales personnel, including a confidential witness. The Court finds that these allegations sufficiently demonstrate the materiality of the omissions and misrepresentations made by BTG.

BTG is accused of paying sales commissions for Oxandrin based on Gentiva's wholesaler sales, as indicated by monthly reports from Gentiva and Prometrics Consulting. An investigation by a confidential witness (CW1) revealed that while Oxandrin sales from wholesalers to pharmacies remained stable, Gentiva's sales to the wholesaler McKesson declined, leading to reduced commissions for BTG’s sales force. CW1 discovered that McKesson's sales during this period were sourced from inventory rather than new purchases from Gentiva, specifically $5.8 million of Oxandrin purchased by Bindley in Q1 2001 and resold to McKesson.

Plaintiff's evidence supporting this claim consists primarily of an email from CW1 to her attorney and a letter from the attorney to BTG’s HR Director, with no additional documentary proof of the sale. However, the Complaint suggests circumstantial evidence, indicating that BTG allocated the Bindley sale across its sales force despite its non-territorial nature, which was documented. Additionally, after salespeople complained about their commission reductions due to Gentiva's lower sales to McKesson, BTG allegedly adjusted its figures in November 2001 to credit the sales force with portions of the Bindley sale corresponding to their territories, supported by further documentation.

The Court found that the Plaintiff's allegations met the PSLRA's requirements for pleading based on information and belief, as the Complaint provided a general description of the confidential witnesses’ knowledge and their access to relevant sales data. The allegations were determined to be sufficiently detailed to suggest that the sources would have the information claimed. The remaining issue is whether these claims provide a strong inference of scienter regarding the Defendants, necessitating proof of recklessness constituting a significant deviation from ordinary care for a viable Rule 10b-5 claim.

The plaintiff is required to specifically allege that the individual defendants had the necessary scienter, meaning they knew or should have known their statements were false. General claims that defendants "knew" or "must have known" do not suffice to establish a strong inference of scienter. The plaintiff's assertion that the Myelos acquisition provided motivation for defendants to misrepresent Oxandrin sales is deemed insufficient, as it lacks a clear connection between the acquisition and the misrepresentation allegations. The plaintiff's circumstantial evidence, which includes claims that defendants had access to sales reports from Gentiva and Prometrics, fails to establish a direct link to the named defendants—Sim Fass, Yehuda Sternlicht, and John Bond. The court emphasizes that merely alleging knowledge by subordinates does not equate to knowledge by executives, and a defendant's supervisory position does not lessen the requirement for detailed allegations in securities fraud cases. Generalized claims of knowledge are inadequate to meet the legal standards required for such allegations.

A company's executives' positions do not inherently imply knowledge or recklessness regarding corporate statements. The Plaintiff did not allege that Defendants Fass, Sternlicht, or Bond reviewed the Gentiva and Prometrics sales reports during the time they made misleading statements about Oxandrin sales. Merely having access to Oxandrin sales data does not create a strong inference of scienter (knowledge of wrongdoing). The Court emphasizes that recklessness involves a level of misrepresentation akin to conscious deception, and plaintiffs must demonstrate more than allegations of corporate mismanagement. The Defendants argue that claims suggesting the executives should have reviewed reports amount to mere errors in judgment rather than intentional fraud. The Court finds that circumstantial evidence presented by the Plaintiff is insufficient to establish a strong inference of scienter, particularly since no specific corporate policy mandating the executives' involvement in reviewing sales data was identified. Additionally, many sales reports were described as "barely comprehensible," which obscures when senior management might have understood their contents. The mere prominence of Oxandrin does not justify imputation of detailed knowledge to the Individual Defendants. The Plaintiff could strengthen their case by showing a direct corporate policy requiring the executives to review sales reports or receive summarized data from the sales staff.

In Nursing Home Pension Fund, Local 144 v. Oracle Corp., the court found that the plaintiff failed to establish a strong inference of scienter regarding misstatements about Oxandrin, relying instead on the legal notion of imputing knowledge to the Individual Defendants. Consequently, the court did not need to consider the PSLRA's safe harbor for forward-looking statements. The complaint's Count II sought to impose control-person liability on the defendants under Section 20(a) of the Exchange Act, which requires a primary violation of the Act for such liability to exist. Since the plaintiff did not adequately plead a violation of Section 10(b) or Rule 10b-5, the court granted the defendants' motion to dismiss the Section 20(a) claim. As a result, the court dismissed the plaintiff's Consolidated Amended Class Action Complaint without prejudice, allowing thirty days for the plaintiff to file a second amended complaint. The document notes that BTG, the defendant, changed its name to Savient Pharmaceuticals, Inc. in June 2003 and provides details on the executive officers named as defendants. Additionally, it mentions that discrepancies in financial reporting stemmed from research and development costs initially capitalized but later expensed.

The document outlines a financial adjustment involving a $2 million repurchase, with a deduction of $385,000 for goods in Q2 1999. It explains the Internal Revenue Code's provisions allowing taxpayers to either expense or capitalize research and development (R&D) expenditures. Expensing allows for immediate tax deductions, while capitalization requires amortization over several years. As a result, capitalizing R&D expenditures can lead to a higher reported net income in the initial year. The Complaint alleges that the Defendants' choice to capitalize certain R&D costs resulted in the improper inflation of BTG's reported net income for 1999, 2000, and 2001. Additionally, it claims that BTG wrote off $1,894,000 in manufacturing development costs from a terminated product, originally capitalized, and restated its financial statements to account for this expense, eliminating its impact on 1999 results. The Plaintiff does not provide additional details regarding these costs.