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In re Akorn, Inc. Securities Litigation
Citations: 240 F. Supp. 3d 802; 2017 WL 878559; 2017 U.S. Dist. LEXIS 31540Docket: 15 C 1944
Court: District Court, N.D. Illinois; March 5, 2017; Federal District Court
Five individuals have filed a lawsuit against Akorn, Inc. and its executives, Rajat Rai and Timothy A. Dick, claiming violations of the Securities Exchange Act related to their purchase of Akorn stock from May 6, 2014, to April 24, 2015. The defendants' motion to dismiss the case under Federal Rule of Civil Procedure 12(b)(6) has been denied. Akorn, a pharmaceutical company, made two major acquisitions in 2014 and faced significant internal control issues regarding financial reporting, as identified by multiple auditors, including Ernst & Young and KPMG. These auditors consistently reported that Akorn lacked effective internal controls over financial reporting from 2012 through 2014. Despite changing auditors in hopes of improvement, deficiencies remained unaddressed. BDO USA, LLP, which conducted the 2015 audit, also found significant internal control weaknesses. The allegations include failures in data validation for revenue adjustments and in preventing errors in financial statements of acquired subsidiaries. Rai and Dick publicly committed to overseeing remediation efforts for these issues. Akorn reported in its 2012 Form 10-K that it was addressing a material weakness in its internal controls by developing formal policies, improving processes, and hiring additional finance personnel. Subsequent filings in 2013 and 2014 detailed remediation plans by executives Dick and Rai, but critical material weaknesses remained unresolved through the audits of those years. Plaintiffs allege that Dick, Rai, and Akorn made false and misleading statements about the company’s financial performance during fiscal year 2014, which artificially inflated stock prices. In the first quarter of 2014, Akorn announced record revenue of $90.6 million and operating cash flow of $23.4 million, claims made during a conference call by Rai and later included in the Form 10-Q signed by both executives. However, the Form 10-Q incorrectly overstated deferred financing costs by $1.9 million, inflating net income by 3.5%, and failed to comply with GAAP standards. For the second quarter of 2014, Akorn reported record revenue of $150.7 million and a net income of $8.5 million, figures also discussed in a conference call with investors and included in the Form 10-Q signed by Dick. The Management's Discussion and Analysis section misleadingly claimed a 12.9% organic growth rate, while the actual growth was only 3.6%. The reported revenue was 12.6% higher than actual figures, and net income was reported as positive when it was negative at $1.3 million. The financial statements again did not adhere to GAAP, and efforts to rectify the internal control weaknesses were insufficient. In its November 6, 2014 press release, Akorn reported consolidated revenue for the third quarter of 2014 at $132.7 million, reflecting a 62% increase from the previous year, alongside an 11% organic growth. However, during the earnings call, it was revealed that the actual organic growth rate was only 8.3%, with actual revenue at $127.7 million and a GAAP net loss of $12.3 million, both figures worse than reported. Akorn's financial statements did not comply with GAAP, and the company failed to address material weaknesses in its internal controls. For the fourth quarter, on February 26, 2015, Akorn announced total revenue of $227.8 million, a 168% increase from the prior year, but the actual revenue was $202.9 million, resulting in a 12.3% overstatement. Net income reported was $34 million, while the actual figure was $18 million, representing a 90.4% overstatement. Akorn's acquisitions of Hi-Tech and VersaPharm occurred in 2014, with Dick and Rai discussing integration plans and cost synergies. Despite claims of successful integration, a January 12, 2015 statement indicated that residual integration work remained for Hi-Tech. Following the end of the class period, on March 2, 2015, Akorn announced a filing extension for its 2014 Form 10-K due to delays in consolidating financial data related to the newly acquired subsidiaries, which had not yet been integrated into the company's centralized accounting systems. The Company has not completed its assessment of the effectiveness of its internal financial controls as of December 31, 2014, due to existing factors. It acknowledges the presence of material weaknesses regarding the completeness and accuracy of data for significant estimates and financial reporting. Additional material weaknesses may be identified upon final assessment. The Company is working to complete its Form 10-K by the extended deadline of March 17, 2015, without expecting material changes to previously reported financial statements. Following a decline in share value, Akorn filed its Form 10-K, restating financial results for the second and third quarters of 2014 due to an error in fair value allocation from the acquisition of Hi-Tech, which led to approximately $8.9 million reductions in revenue and pre-tax income and a $5.6 million reduction in net income and retained earnings. Akorn is addressing these material weaknesses and announced additional restatements for the annual and quarterly periods ending December 31, 2014, and June 30, September 30, and December 31, 2014. Errors related to sales allowances resulted in an estimated overstatement of net revenue and pretax income by $20 million to $35 million. The company projected delays in filing its Form 10-Q for the first quarter of 2015, leading to a significant drop in stock price. Following the class period, executive resignations occurred, and investigations by the Department of Justice and SEC began in November 2015. Akorn eventually filed its restated 2014 financial statements and 2015 Form 10-K on May 10, 2016, revealing a total inflation of 2014 revenue by 8.4% and net income by 194.7%. $46.9 million in revenue and $27 million in net income were lost due to inaccurate financial reporting by Akorn, enabling the company to surpass Wall Street revenue expectations for Q2 and Q4 of 2014 and to meet its annual revenue guidance issued on August 5, 2014, despite actual performance falling short. Akorn's SEC filings acknowledged internal control weaknesses that could lead to inaccurate financial reporting. The 2012 Form 10-K identified a material weakness in financial reporting controls, stating that insufficient remediation could result in material misstatements and potential restatement of financial results. Quarterly filings for the first three quarters of 2013 reiterated the material weakness and concluded that disclosure controls were ineffective, though Akorn projected remediation before the December 31, 2013 filing without guaranteeing effectiveness. On March 3, 2014, Akorn informed the SEC of its inability to timely file the 2013 Form 10-K due to ongoing material weaknesses, recognizing the risk of additional weaknesses upon assessing control effectiveness. The 2013 Form 10-K, filed on March 14, 2014, confirmed persistent material weaknesses as of December 31, 2013, along with warnings about possible misstatements. During 2014, Akorn's Form 10-Q filings for the first three quarters disclosed continued ineffectiveness of internal controls, echoing previous concerns while asserting that the financial statements reasonably represented the company's financial condition in compliance with U.S. GAAP. On March 2, 2016, Akorn announced its inability to file the 2014 Form 10-K on time, citing material weaknesses related to data completeness, accuracy, and timely financial reporting as of December 31, 2014. In the 2014 Form 10-K filed on March 17, 2015, Akorn reported material weaknesses in its internal controls related to the financial statements of acquired subsidiaries as of December 31, 2014. The filing reiterated the risk of a potential restatement if remediation efforts failed. Subsequently, on April 24, 2015, Akorn announced an estimated overstatement of $20 million to $35 million, with a warning that this estimate might change following further analysis and the discovery of additional errors. Section 10(b) of the 1934 Act prohibits manipulative or deceptive practices in the securities market, supported by SEC Rule 10b-5, which forbids fraudulent devices, misstatements, or omissions that mislead investors. A plaintiff in a 10(b) private action must prove six elements: (1) material misrepresentation or omission, (2) scienter (intent or knowledge of wrongdoing), (3) connection to the transaction, (4) reliance on the misrepresentation, (5) economic loss, and (6) loss causation. Additionally, Rule 9(b) imposes heightened pleading standards requiring specific details of the alleged fraud. The Private Securities Litigation Reform Act of 1995 mandates that plaintiffs specify misleading statements and provide a strong inference of the defendant's state of mind. Defendants challenge the plaintiffs' claims, focusing on the material misrepresentation, scienter, and loss causation elements. To establish material misrepresentation, plaintiffs must demonstrate that the defendant's misleading statements were likely to affect a reasonable investor's decision-making. The plaintiffs assert that their complaint fulfills these requirements regarding Akorn's 2014 financial performance and the integration of its subsidiaries, while defendants argue that these statements were not misleading enough to alter the information mix significantly. Not all false statements are inherently misleading; an investor aware of a known risk cannot successfully claim deception based on a false representation. An issuer must disclose the truth clearly to prevent a lie from becoming immaterial. Disclosure helps investors gauge risk magnitude, and even experienced investors may recover if a blatant lie downplays a known risk. True statements can diminish the deceptive nature of misleading statements, but this is not guaranteed. Materiality must be assessed based on how a reasonable investor would interpret withheld or misrepresented information, making it a fact-specific determination typically unsuitable for summary judgment or dismissal motions. Plaintiffs argue that Defendants' inaccurate 2014 financial results reported in SEC filings, conference calls, and press releases were materially misleading. Defendants counter that their disclosures regarding weaknesses in Akorn's internal controls sufficiently warned investors, suggesting they should have doubted the reported financial results. Akorn’s Form 10-Ks highlighted significant internal control problems and warned that material misstatements could occur. Despite these warnings, Defendants asserted that the reported financial results accurately reflected Akorn's condition, claiming compliance with U.S. GAAP. Plaintiffs successfully alleged that Defendants' financial reporting was materially false or misleading, noting substantial overstatements: 8.4% in revenue and 194.7% in net income. The subsequent restatement of these results indicates materiality, as financial standards prescribe restatement only for material errors. Additionally, a 22% decline in Akorn’s stock price following the revelation of these misstatements further supports the claim of materiality, suggesting that reasonable investors found this information significant enough to impact their investment decisions. The fact that Akorn’s financial statements did not comply with GAAP enhances the assertion that they were misleading. Defendants' warnings regarding the potential for inaccuracies in financial reports did not adequately address the extent of these inaccuracies, and the true financial state of Akorn was revealed only after the class period. As such, the disclosures did not sufficiently mitigate the risk of deception, leading to the conclusion that Defendants' statements about Akorn's 2014 financial results are considered material misrepresentations at the pleading stage. Additionally, Plaintiffs contend that Defendants made materially misleading statements about Akorn's integration of Hi-Tech and VersaPharm. Specifically, during various conference calls in 2014, Defendants asserted that the integration was on track and would yield significant cost synergies, yet failed to disclose the difficulties encountered in the integration process which resulted in substantial inaccuracies in Akorn's financial performance. In defense, Defendants argue that their statements regarding the integration are forward-looking and thus protected under the Private Securities Litigation Reform Act (PSLRA), which offers a safe harbor for such statements if they include meaningful cautionary language or are deemed immaterial. However, mixed statements that refer to both present and future conditions do not qualify for this protection concerning the present aspect. The court must determine if Defendants' claims about being “on track” for integration are purely forward-looking or if they also imply a current factual state which may render them non-protected under the PSLRA. The “on track” statements are deemed nonactionable due to accompanying cautionary language, but the parts referencing current conditions are not forward-looking and thus fall outside the PSLRA safe harbor. The key issue is whether these statements, which assert that Akorn was “on track” with its integration efforts, were materially false or misleading. Plaintiffs allege that Akorn faced significant integration challenges, particularly with its accounting systems for Hi-Tech and VersaPharm, which adversely affected the accuracy of financial statements. The inability to integrate these systems timely led to inaccuracies in reserve accounts and violations in accounting practices, suggesting that investors would view the misrepresentations as significantly impacting their decisions. Moreover, a statement made by Rai on January 12, 2015, regarding integration status is also considered materially misleading as it pertains to present facts, thus not qualifying for the safe harbor. The Court finds that many alleged misstatements are based on present or historical facts and the PSLRA safe harbor does not apply, as the defendants did not challenge the relevance of Rai’s statement in their briefs. The forfeiture doctrine applies to both a litigant's failure to raise a general argument and the failure to advance specific points supporting that argument. To establish liability under Section 10(b) and Rule 10b-5, a private plaintiff must demonstrate that the defendant acted with scienter, which involves an intent to deceive, manipulate, or defraud. Scienter can be shown through knowledge of a statement's falsity or reckless disregard for a substantial risk of its inaccuracy. The Private Securities Litigation Reform Act (PSLRA) mandates that plaintiffs allege facts with particularity to establish a strong inference of the required mental state for each defendant. Corporate scienter can be inferred without identifying specific individuals responsible for fraudulent actions, but it must focus on the mental state of the officials who made or approved the statements. The Supreme Court emphasizes that the collective allegations must create a strong inference of scienter, rather than relying on isolated allegations. Courts must consider plausible nonculpable explanations alongside inferences favoring the plaintiff, requiring that the inference of scienter be at least as compelling as any opposing inferences. In this case, plaintiffs argue that the defendants acted knowingly or recklessly to conceal Akorn's financial situation and maintain inflated stock prices. The defendants counter that they made genuine efforts to inform investors about risks. The court's role is to evaluate the plausibility of these competing inferences based on the factual allegations in the complaint. Plaintiffs highlight specific allegations against Dick and Rai regarding their responsibilities for Akorn's internal controls, noting significant deficiencies under their leadership. Three independent auditing firms found Akorn’s internal controls ineffective, yet Defendants dismissed the first two firms rather than addressing identified weaknesses. Deficiencies were recognized by employees and personally known to key executives Dick and Rai, who were aware these issues could lead to inaccuracies in financial reporting. Despite acknowledging the control deficiencies, Dick and Rai falsely asserted that Akorn's 2014 financial results were accurate and compliant with GAAP. Their public filings suggested remedial measures that were straightforward but were not implemented. Instead, they worsened existing issues by acquiring subsidiaries without proper accounting support. The misrepresentation of financial results included an 8.4% inflation in revenue and a 194.7% inflation in net income, raising the inference of recklessness or knowledge of significant accounting problems that were concealed from stakeholders. The magnitude of these reporting errors contributes to the strong inference of scienter, suggesting that Dick and Rai were either aware of the inaccuracies or recklessly disregarded them, as indicated by their failure to rectify known internal control deficiencies. Akorn's accounting violations consistently resulted in inflated reported revenue and net income, impacting its ability to meet annual revenue guidance and Wall Street estimates for 2014. These violations suggest a lack of innocent error, supporting allegations of scienter. The resignation of CFO Dick following the financial restatement, along with government investigations by the SEC and DOJ, further reinforces the inference of scienter. Although defendants argue that Dick and Rai acted in good faith to balance transparency and company performance, they did acknowledge internal control weaknesses and attempted remediation, which ultimately proved insufficient. The court emphasized that the timing of Dick’s resignation and the initiation of investigations cast doubt on their motives, suggesting they did not benefit from misleading investors. While carelessness could be a plausible inference, the court found the evidence more compelling for recklessness or intentional misconduct, thus supporting the claim that Akorn’s executives acted with scienter. Additionally, under the PSLRA, plaintiffs must demonstrate that their losses were caused by the defendants' actions, specifically that the securities were inflated and dropped in value upon the revelation of the truth. Loss causation does not need to be proven until later stages of litigation, as established in Lentell v. Merrill Lynch and reinforced by Erica P. John Fund, Inc. v. Halliburton Co. and Dura Pharms. Inc. v. Broudo. Allegations of loss causation must provide some indication of the loss and the causal connection but do not impose a heavy burden on the plaintiff. In private securities actions, the complaint must simply allege facts supporting an inference that the defendants’ misstatements concealed circumstances contributing to the loss. Defendants claim plaintiffs failed to allege loss causation regarding errors in Akorn’s first quarter 2014 financial statements, but the complaint includes allegations of losses following two significant corrective disclosures: a March 2, 2015 press release about a filing extension that caused an 8% stock price drop, and an April 24, 2015 press release disclosing additional restatements that led to a 22% drop. These disclosures indicate that Akorn's financial statements were flawed, linking the first quarter results to the alleged losses. The connection's ultimate evaluation is a fact-intensive inquiry that need not be addressed at this stage. The complaint details a series of corrective disclosures followed by stock price declines, satisfying Dura’s loss causation standard. Furthermore, defendants incorrectly argue that loss causation was not alleged regarding Hi-Tech’s opening balance sheet error. The initial restatement on March 17, 2015, and the subsequent announcement on April 24, 2015, indicated that material errors necessitated restatements of Akorn’s financial results. It is not necessary for plaintiffs to link each accounting error to an immediate stock price drop at such a detailed level, as per Dura’s guidance. A plaintiff claiming economic loss must provide the defendant with an indication of the loss and a causal connection, which is not overly burdensome. Loss causation can be established through a series of partial disclosures leading to stock price deflation. It is sufficient for plaintiffs to allege a stock price drop following a specific disclosure that revealed errors in previously restated financial statements. The plaintiffs have met the necessary threshold by indicating the loss and its causal connection. Section 20(a) extends liability to individuals who control those liable under Section 10(b). The defendants argue for dismissal of the Section 20(a) claims based on inadequately pleaded Section 10(b) claims; however, since the Section 10(b) claims are adequately pleaded, the Section 20(a) claims can proceed. Consequently, the defendants' motion to dismiss is denied, and they are required to respond to the complaint by March 27, 2017. The discovery stay is lifted as per relevant statute.