In re: Carter-Wallace, Inc. Sec. Litigation

• Decision Date: 01 August 1999
• Docket Number: Docket No. 99-9475,INC,CARTER-WALLAC
• Citation: 220 F.3d 36
• Parties: (2nd Cir. 2000) IN RE:SECURITIES LITIGATION EUGENE HONEYMAN, individually and on behalf of all others similarly situated, Consolidated-Plaintiff-Appellant, JOAN T. BRUNJES, on behalf of herself and all others similarly situated, Plaintiff-Appellant, v. HENRY H. HOYT, JR.; DANIEL J. BLACK; PAUL A. VETERI;, Defendants-Appellees, JOSEPH S. HARUN, Consolidated-Defendant-Appellee
• Court: U.S. Court of Appeals — Second Circuit

Page 36

220 F.3d 36 (2nd Cir. 2000)

IN RE: CARTER-WALLACE, INC. SECURITIES LITIGATION

EUGENE HONEYMAN, individually and on behalf of all others similarly situated, Consolidated-Plaintiff-Appellant, JOAN T. BRUNJES, on behalf of herself and all others similarly situated, Plaintiff-Appellant, v. HENRY H. HOYT, JR.; DANIEL J. BLACK; PAUL A. VETERI; CARTER-WALLACE, INC., Defendants-Appellees, JOSEPH S. HARUN, Consolidated-Defendant-Appellee.

Docket No. 99-9475

August Term, 1999

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

(Argued June 6, 2000)

(Decided: August 07, 2000)

Appeal from a dismissal by the District Court for the Southern District of New York (Richard Owen, Judge) of a complaint alleging a violation of Section 16(b) of the Securities Exchange Act. Because the complaint sufficiently alleges beneficial ownership of the stock at issue, we reverse.

Appeal from a dismissal pursuant to Fed. R. Civ. P. 12(c) of plaintiffs-appellants' securities fraud class action. The United States District Court for the Southern District of New York, Duffy, J., held that the complaint failed to allege scienter.

Affirmed.

RICHARD J. KILSHEIMER, New York City (Frederic S. Fox, Joel B. Strauss, Kaplan, Kilsheimer & Fox, New York City), David J. Bershad, William C. Fredericks, Milberg Weiss Bershad Hynes & Lerach, New York City, Co-Lead Counsel for Appellants.

Joseph H. Weiss, Weiss & Yourman, New York City,Jules Brody, Stull, Stull & Brody, New York City, for Appellants.

ERIC M. NELSON, New York City (Matthew D. Griffin, Whitman Breed Abbott & Morgan, New York City, of counsel), for Appellees.

Before: MESKILL and WALKER, Circuit Judges, and HADEN, District Judge^*.

MESKILL, Circuit Judge:

Appellants Joan T. Brunjes and Eugene Honeyman, co-lead plaintiffs in this securities fraud class action, appeal the dismissal of their claim pursuant to Fed. R. Civ. P. 12(c). See In re Carter-Wallace, Inc. Sec. Litig., No. 94 Civ. 5704, 1999 WL 1029713, at *3-6 (S.D.N.Y. Nov. 10, 1999). The appellants alleged that defendants-appellees Carter-Wallace, Inc., and members of its Board of Directors (collectively "Carter-Wallace") violated Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, by running advertisements in medical journals stating that Carter-Wallace's new epilepsy drug, Felbatol, had an "unprecedented safety profile" and that "no life-threatening liver toxicities or blood dyscrasias have been attributed to Felbatol monotherapy," even though Carter-Wallace was aware of medical reports that some patients using Felbatol had developed severe or fatal illnesses. On remand from an earlier appeal, In re Carter-Wallace, Inc. Sec. Litig., 150 F.3d 153 (2d Cir. 1998) (Carter-Wallace I), the United States District Court for the Southern District of New York, Duffy, J., granted Carter-Wallace's motion to dismiss on the ground that the appellants failed to allege scienter. We agree and affirm the decision of the district court.

BACKGROUND

On a motion to dismiss, we accept the factual allegations contained in the complaint as true. See Jaghory v. New York State Dep't of Educ., 131 F.3d 326, 329 (2d Cir. 1997). In July 1993, Carter-Wallace's new epilepsy drug, Felbatol, was approved for sale by the Food and Drug Administration (FDA). At the time, Felbatol was considered a major advance in epilepsy treatment. It was thought to be unburdened by the risk of serious side effects, which plagued other epilepsy drugs. To promote Felbatol, Carter-Wallace ran advertisements in medical journals. A sixteen page advertisement appeared in the January 1994 issues of Neurology and Archives of Neurology. The advertisement stated that Felbatol had an "unprecedented safety profile" and that "no life-threatening liver toxicities or blood dyscrasias have been attributed to Felbatol monotherapy." The same statements were made in shorter advertisements running monthly in the same journals through July 1994.

Prior to and during the publication of the advertisements, Carter-Wallace learned that some patients taking Felbatol were developing illnesses. Pursuant to FDA regulation, drug manufacturers must relay to the FDA reports from doctors describing illnesses developed by patients using the manufacturer's product, regardless of whether there is a known or perceived causal connection between the drug and the illness. See 21 C.F.R. § 314.80 (1999). Among the most serious illnesses reported to Carter-Wallace was aplastic anemia, a frequently fatal form of acquired bone marrow failure. According to the complaint, from October 1993 until July 1994, Carter-Wallace received and was aware of at least fifty-seven adverse medical reports relating to Felbatol, including at least six deaths and six cases of aplastic anemia. In July 1994, Carter-Wallace received four additional reports of aplastic anemia, along with reports of other illnesses and deaths. On August 1, 1994, Carter-Wallace, in association with the FDA, sent a letter to doctors warning of an association between Felbatol and aplastic anemia. The letter recommended the immediate withdrawal of patients from treatment with Felbatol. That day, following disclosure of the letter, Carter-Wallace's common stock fell $4.875 per share, almost 33 percent, from $15.625 to $10.75 on heavy trading.

Shortly after the plunge in Carter-Wallace's stock price, two class actions were filed with Joan T. Brunjes and Eugene Honeyman serving as lead plaintiffs of classes of investors who bought stock during a period beginning January 20, 1994 and ending July 31, 1994. The class actions were consolidated into the present suit. The second amended class action complaint alleged three claims: (1) that the advertisements in the medical journals were materially false and misleading, (2) that Carter-Wallace failed to disclose information (the adverse medical reports) that made representations in its financial statements misleading, and (3) that Carter-Wallace violated Generally Accepted Accounting Principles (GAAP) by overvaluing its inventory of Felbatol when it allegedly knew that Felbatol would not be commercially viable. Carter-Wallace moved for dismissal pursuant to Fed. R. Civ. P. 12(b)(6). The district court found that the advertisements in the medical journals were not made "in connection with" the purchase or sale of securities. The district court dismissed the other claims as well, reasoning that Carter-Wallace was under no duty to disclose the adverse reports or re-value its inventory because prior to August 1, 1994 there was no statistically significant link between Felbatol and any side effect. On appeal, we affirmed the district court's dismissal of the financial statements claim and the GAAP claim. With respect to the medical advertisement claim, however, we disagreed with the district court's determination that advertisements in medical journals could not, as a matter of law, be made "in connection with" a securities transaction. We remanded to the district court to determine, in the first instance, "whether the appellants' complaint with respect to the advertisements sufficiently alleges the other elements of a Section 10(b) claim." Carter-Wallace I, 150 F.3d at 157.

On remand, Carter-Wallace moved for judgment on the pleadings on the ground that the complaint had failed to allege scienter. The district court agreed and dismissed the claim.

DISCUSSION

A district court's grant of judgment on the pleadings is reviewed de novo. See Williams v. Apfel, 204 F.3d 48, 49 (2d Cir. 2000). The standards governing this case are not disputed by the parties.¹ "[A] plaintiff must plead that `in connection with the purchase or sale of securities, the defendant, acting with scienter, made a false material representation or omitted to disclose material information and that plaintiff's reliance on defendant's action caused [plaintiff] injury.'" In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 264 (2d Cir. 1993) (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 61 (2d Cir. 1985)) (second alteration in original). "The scienter needed in connection with securities fraud is intent `to deceive, manipulate, or defraud,' or knowing misconduct." Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 538 (2d Cir. 1999) (quoting SEC v. First Jersey Sec., 101 F.3d 1450, 1467 (2d Cir. 1996)). For purposes of its motion, Carter-Wallace has conceded all of the elements of the appellants' claim except scienter. Thus, the sole issue on appeal is whether the complaint sufficiently alleges scienter. For the reasons that follow, we conclude that it does not.

Fed. R. Civ. P. 9(b) requires that allegations of fraud be pled with specificity. Although Rule 9(b) raises the pleading standard in fraud cases, it provides that "[m]alice, intent, knowledge, and other condition of mind of a person may be averred generally." However, "the relaxation of Rule 9(b)'s specificity requirement for scienter must not be mistaken for license to base claims of fraud on speculation and conclusory allegations." Shields v. Citytrust Bancorp, 25 F.3d 1124, 1128 (2d Cir. 1994) (internal quotation marks omitted). In order to plead scienter, we require the complaint "to allege facts that give rise to a strong inference of fraudulent intent." Id.; see also Mills v. Polar Molecular Corp., 12 F.3d 1170, 1176 (2d Cir. 1993). A "strong inference of fraudulent intent" may be established either "(a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Shields, 25 F.3d at 1128 (citing In re Time Warner, 9 F.3d at 268-69).

The appellants argued both the "conscious misbehavior" and "motive and opportunity" theories before the district court. On appeal, they have abandoned the "motive and opportunity" theory. To survive dismissal under the "conscious...