Gallaher v. Abbott Laboratories

• Decision Date: 17 October 2001
• Docket Number: 01-1477,Nos. 01-1473,s. 01-1473
• Citation: 269 F.3d 806
• Parties: (7th Cir. 2001) Lena Gallagher, on behalf of a class, et al., Plaintiffs-Appellants, v. Abbott Laboratories and Miles D. White, Defendants-Appellees
• Court: U.S. Court of Appeals — Seventh Circuit

Page 806

269 F.3d 806 (7th Cir. 2001)

Lena Gallagher, on behalf of a class, et al., Plaintiffs-Appellants, v. Abbott Laboratories and Miles D. White, Defendants-Appellees.

Nos. 01-1473, 01-1477

United States Court of Appeals Seventh Circuit

Argued September 28, 2001

Decided October 17, 2001

Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. Nos. 99 C 6869 and 00 C 765--James B. Moran, Judge.

Before Posner, Easterbrook, and Kanne, Circuit Judges.

Easterbrook, Circuit Judge.

Year after year the Food and Drug Administration inspected the Diagnostic Division of Abbott Laboratories, found deficiencies in manufacturing quality control, and issued warnings. The Division made efforts to do better, never to the FDA's satisfaction, but until 1999 the FDA was willing to accept Abbott's promises and remedial steps. On March 17, 1999, the FDA sent Abbott another letter demanding compliance with all regulatory requirements and threatening severe consequences. This could have been read as more saber rattling--Bloomberg News revealed the letter to the financial world in June, and Abbott's stock price did not even quiver--but later developments show that it was more ominous. By September 1999 the FDA was insisting on substantial penalties plus changes in Abbott's methods of doing business. On September 29, 1999, after the markets had closed, Abbott issued a press release describing the FDA's position, asserting that Abbott was in "substantial" compliance with federal regulations, and revealing that the parties were engaged in settlement talks. Abbott's stock fell more than 6%, from $40 to $37.50, the next business day. On November 2, 1999, Abbott and the FDA resolved their differences, and a court entered a consent decree requiring Abbott to remove 125 diagnostic products from the market until it had improved its quality control and to pay a $100 million civil fine. Abbott took an accounting charge of $168 million to cover the fine and worthless inventory. The next business day Abbott's stock slumped $3.50, which together with the earlier drop implied that shareholders saw the episode as costing Abbott (in cash plus future compliance costs and lost sales) more than $5 billion. (Neither side has used the capital asset pricing model or any other means to factor market movements out of these price changes, so we take them at face value.)

Plaintiffs in these class actions under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and the sec's Rule 10b-5, 17 C.F.R. § 240.10b-5, contend that Abbott committed fraud by deferring public revelation. The classes comprise all buyers of Abbott's securities between March 17 and November 2. (One class consists of persons who bought securities in ALZA, a firm that Abbott proposed to acquire through an exchange of securities and whose market price thus tracked Abbott's. For simplicity we treat these plaintiffs as purchasers of Abbott stock.) The district judge dismissed the complaints under Fed. R. Civ. P. 12(b)(6) for failure to state a claim on which relief may be granted. 140 F. Supp. 2d 894 (N.D. Ill. 2001). The market's non-reaction to Bloomberg's disclosure shows, the judge thought, that the FDA's letter was not by itself material or that the market price had earlier reflected the news, cf. In re Apple Computer Securities Litigation, 886 F.2d 1109 (9th Cir. 1989); Flamm v. Eberstadt, 814 F.2d 1169, 1179-80 (7th Cir. 1987); only later developments contained material information, which Abbott disclosed in September and November. Moreover, the judge concluded, plaintiffs had not identified any false or fraudulent statement by Abbott, as opposed to silence in the face of bad news. We are skeptical that these shortcomings justify dismissal for failure to state a claim on which relief may be granted; the judge's reasons seem more akin to an invocation of Fed. R. Civ. P. 9(b), which requires fraud to be pleaded with particularity, or the extra pleading requirements for securities cases created by the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b)(1). But it is not necessary to decide whether Rule 12(b)(6), Rule 12(c), Rule 9(b), or the Reform Act supplies the best basis of decision. Nor is it necessary to decide whether the news was "material" before the FDA's negotiating position stiffened, to decide whether Abbott acted with the state of mind necessary to support liability under Rule 10b-5, or to address other potential stumbling blocks. What sinks plaintiffs' position is their inability to identify any false statement--or for that matter any truthful statement made misleading by the omission of news about the FDA's demands.

Much of plaintiffs' argument reads as if firms have an absolute duty to disclose all information material to stock prices as soon as news comes into their possession. Yet that is not the way the securities laws work. We do not have a system of continuous disclosure. Instead firms are entitled to keep silent (about good news as well as bad news) unless positive law creates a duty to disclose. See, e.g., Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988); Dirks v. sec, 463 U.S. 646, 653-54 (1983); Chiarella v. United States, 445 U.S. 222, 227-35 (1980); Stransky v. Cummins Engine Co., 51 F.3d 1329, 1331 (7th Cir. 1995); Backman v. Polaroid Corp., 910 F.2d 10, 16 (1st Cir. 1990) (en banc). Until the Securities Act of 1933 there was no federal regulation of corporate disclosure. The 1933 Act requires firms to reveal information only when they issue securities, and the duty is owed only to persons who buy from the issuer or an underwriter distributing on its behalf; every other transaction is exempt under § 4, 15 U.S.C. § 77d. (No member of either class contends that he purchased securities from Abbott, or an underwriter on Abbott's behalf, between March 17 and November 2.) Section 13 of the Securities Exchange Act of 1934, 15 U.S.C. § 78m, adds that the sec may require issuers to file annual and other periodic reports--with the emphasis on periodic rather than continuous. Section 13 and the implementing regulations contemplate that these reports will be snapshots of the corporation's status on or near the filing date, with updates due not when something "material" happens, but on the next prescribed filing date.

Regulations implementing § 13 require a comprehensive annual filing, the Form 10-K report, and less extensive quarterly supplements on Form 10-Q. The supplements need not bring up to date everything contained in the annual 10-K report; counsel for the plaintiff classes conceded at oral argument that nothing in Regulation S-K (the sec's list of required disclosures) requires either an updating of Form 10-K reports more often than annually, or a disclosure in a quarterly Form 10-Q report of information about the firm's regulatory problems. The regulations that provide for disclosures on Form 10-Q tell us which items in the annual report must be updated (a subset of the full list), and how often (quarterly).

Many proposals have been made to do things differently--to junk this combination of sale-based disclosure with periodic follow-up and replace it with a system under which issuers rather than securities are registered and disclosure must be continuous. E.g., American Law Institute, Federal Securities Code xxvii- xxviii, § 602 & commentary (1978); Securities and Exchange Commission, Report of the Advisory Committee on the Capital Formation and Regulatory Process 9-14, 36-38 (1996). Regulation S-K goes some distance in this direction by defining identical items of disclosure for registration of stock and issuers' subsequent reports, and by authorizing the largest issuers to use their annual 10-K reports as the kernels of registration statements for new securities. But Regulation S-K does not replace periodic with continuous disclosure, and the...