EP Medsystems Inc. v. Echocath Inc.

• Decision Date: 26 December 2000
• Citation: 235 F.3d 865
• Parties: (3rd Cir. 2000) EP MEDSYSTEMS, INC., Appellant v. ECHOCATH, INC. NO. 98-6461
• Court: U.S. Court of Appeals — Third Circuit

Page 865

235 F.3d 865 (3rd Cir. 2000)

EP MEDSYSTEMS, INC., Appellant v. ECHOCATH, INC.

NO. 98-6461

UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT

Argued December 6, 1999

Filed December 26, 2000

On Appeal from the United States District Court for the District of New Jersey (D.C. Civil No. 97-cv-04926) District Judge: Hon. Alfred J. Lechner, Jr. [Copyrighted Material Omitted]

John J. Murphy, III (Argued) Stradley, Ronon, Stevens & Young, LLP Cherry Hill, New Jersey 08002, Attorney for Appellant

Richard G. Primoff (Argued) Rubin Baum Levin Constant & Friedman New York, New York 10112, Attorney for Appellee

Before: SLOVITER, ROTH and COWEN, Circuit Judges

OPINION OF THE COURT

SLOVITER, Circuit Judge.

EP MedSystems, Inc. appeals the dismissal with prejudice of its securities action against EchoCath, Inc. According to the complaint, the Chief Executive Officer of EchoCath enticed MedSystems into investing $1.4 million in EchoCath by assuring MedSystems that lengthy negotiations had already taken place with four prominent companies to market certain new EchoCath products and that contracts with these companies were "imminent." Relying on cautionary language contained in several public documents filed by EchoCath with the Securities Exchange Commission, the District Court held that these representations, as well as other related representations, were immaterial as a matter of law under the "bespeaks caution" doctrine and the general test for materiality. It also held that MedSystems failed to adequately plead scienter, reasonable reliance, and loss causation and could not do so. It accordingly dismissed the complaint without leave to amend.

Our review of a decision granting a motion to dismiss is plenary. We must accept as true all the factual allegations in the complaint. See United States v. Gaubert, 499 U.S. 315, 327 (1991).

I. BACKGROUND

The following facts are drawn largely from the amended complaint and the documents attached to the pleadings by the parties, including several EchoCath public filings with the Securities Exchange Commission (SEC).

EchoCath is a small New Jersey research and development company engaged in developing, manufacturing, and marketing medical devices to enhance and expand the use of ultrasound technology for medical applications and procedures. Among the products that EchoCath has developed with the company's proprietary ultrasound technology are ColorMark, which highlights metallic objects such as needles and other interventional instruments in color to permit them to be seen on existing ultrasound imaging screens, and EchoMark, which electronically marks and displays the position of non-metallic objects such as catheters within the body. The parties refer to these two products as the "women's health products." EchoCath describes its women's health products as enabling physicians to perform procedures such as needle biopsies, catheterizations, and intravascular imaging more safely and efficiently.

EchoCath consummated its initial public offering on January 17, 1996 and issued a lengthy Prospectus that included details of the company's technologies, future plans, capitalization, collaborative agreements, and selected financial data. The Prospectus also included the caution that "[a]n investment in the securities offered . . . is speculative in nature and involves a high degree of risk," App. at 81, and set forth several pages of risk factors. In particular, EchoCath cautioned investors that the company "intend[ed] to pursue licensing, joint development and other collaborative arrangements with other strategic partners . . . [but] [t]here can be no assurance . . . that the Company will be able to successfully reach agreements with any strategic partners, or that other strategic partners will ever devote sufficient resources to the Company's technologies." App. at 84.

More than six months after the public offering, MedSystems began consideration of a sizable investment in EchoCath. MedSystems is itself a small company involved in the development, marketing, and sales of cardiac electrophysiology products used to diagnose and treat certain cardiac disorders. See Amended Complaint P 5. In August 1996, the chief executive officers of the two companies met at EchoCath's plant in Monmouth Junction, New Jersey, where MedSystems management toured EchoCath's facilities to evaluate the technology under development. See id. P 9.

Frank DeBernardis, the Chief Executive Officer (CEO) of EchoCath, made a lengthy presentation during the August meeting to David Jenkins, MedSystems President and CEO, James Caruso, its Chief Financial Officer (CFO), and Anthony Varrichio, a Director. See id. PP 9, 10. DeBernardis represented that EchoCath had engaged in lengthy negotiations to license its products and was on the verge of signing contracts with a number of prominent medical companies, which he identified as including UroHealth, Johnson & Johnson, Medtronic, and C.R. Bard, Inc., to develop and market EchoCath's women's health products. See id.

Negotiations between MedSystems and EchoCath commenced "in earnest" in November 1996. See id. P 12. Throughout the negotiations and until the closing in February 1997, EchoCath's CEO continued to represent to MedSystems officials that EchoCath was actively moving forward with the line of women's health products described in the August meeting, see id., and that the contracts with UroHealth, Johnson & Johnson, Medtronic and C.R. Bard to develop these products were "imminent," see id. P 15. The complaint points to a specific telephone conversation between December 16 and December 20, 1996 during which EchoCath's CEO DeBernardis reiterated these representations to the CFO of MedSystems. See id. P 12.

On December 20, 1996, DeBernardis delivered a group of documents to MedSystems, which included the previously issued 1996 EchoCath Prospectus and EchoCath's financial projections and marketing plan for fiscal years 1997 and 1998 entitled "EchoCath's Operating Model." See id. PP 13, 14. The Operating Model "outline[d] the sales and marketing goals for the next two years (February 1996 - January 1998)." App. at 29. It projected sales from the women's health products of $852,000 in 1997 ($736,000 for ColorMark and $116,000 for EchoMark) and $3,286,000 in 1998 ($2.5 million for ColorMark and $786,000 for EchoMark) and represented that these sales projections were "conservative" estimates. App. at 19. The Operating Model contained the statements that the Model "is intended as a beginning guide, and it is expected that it will be revised," and it is "a simplified form of accounting" but it "does reflect accurately cash and income flows." App. at 19, 29. The Operating Model included the statement that"[t]his Model is driven by a number of assumptions." App. at 19.

The Operating Model also stated that EchoCath expected other income in 1996 and 1997, including $450,000 in the form of license fees and Milestone payments from Medtronic, arising out of a licensing agreement EchoCath had with Medtronic for the use of leads with permanent pacemakers and defibrillators, a grant of $560,000 from the National Institute of Health, and $500,000 from another company interested in using the EchoMark technology. App. at 19. In the same paragraph, it noted that "[n]egotiations for these contracts are in process." App. at 19.

In an additional communication to MedSystems on December 23, 1996, this one by Daniel Mulvena, the Co-Chairman of EchoCath's Board, EchoCath stated that it anticipated that other outside investment in the company would provide sufficient operating funds to allow EchoCath to actively develop the women's health products for at least 18 to 24 months. See Amended Complaint P 26.

On February 27, 1997, MedSystems entered into a subscription agreement with EchoCath to purchase 280,000 shares of preferred EchoCath stock for $1,400,000. See id. P 8. In the agreement, MedSystems specified that it "ha[d] not relied upon any representation or other information (oral or written) other than as contained in documents or answers to questions so furnished to [MedSystems] by [EchoCath]," that it had "relied on the advice of, or has consulted with, only its own Advisors," and acknowledged that "an investment in the Shares involves a number of very significant risks and [MedSystems was] able to bear the loss of its entire investment." App. at 63. Nonetheless, MedSystems alleges in the complaint that it relied on the representations from EchoCath's CEO of imminent contracts, the forecasted sales, the expected fees and payments referred to in the Operating Model, and the assurance that EchoCath would have sufficient liquidity to continue operation for 18 to 24 months. See Amended Complaint P 32.

In the fifteen months after MedSystems made its investment, EchoCath failed to enter into a single contract or to receive any income in connection with the marketing and development of the women's health products. It also did not receive the expected payments from license fees. See id. P 25. In September 1997, EchoCath advised MedSystems that EchoCath would run out of operating funds in 90 days if new investment in the company was not forthcoming. See id. P 27.

MedSystems filed suit in the United States District Court for the District of New Jersey, alleging that EchoCath intentionally or recklessly made misrepresentations to MedSystems in connection with the sale of securities in an effort to induce MedSystems to purchase its securities, in violation of Section 10 of the Securities Exchange Act of 1934, 15 U.S.C. S 78j and Rule 10b-5. See id. PP 30, 35. MedSystems also alleged a supplemental state law fraud claim. MedSystems alleged that EchoCath was not on the verge of signing contracts with any company to develop its line of women's health products in August of 1996, or any other time up to the closing on February 27, 1997. See id. P 17. MedSystems also alleged that...