In re St. Jude Med., Inc. Sec. Litig.

• Citation: 836 F.Supp.2d 878
• Decision Date: 23 December 2011
• Docket Number: Civil No. 10–0851 (SRN/TNL).
• Parties: In re ST. JUDE MEDICAL, INC. SECURITIES LITIGATION.
• Court: U.S. District Court — District of Minnesota

836 F.Supp.2d 878

In re ST. JUDE MEDICAL, INC. SECURITIES LITIGATION.

Civil No. 10–0851 (SRN/TNL).

United States District Court, D. Minnesota.

Dec. 23, 2011.

Dennis J. Herman, and Matthew S. Melamed, Robbins Geller Rudman & Dowd LLP, San Francisco, CA, Carolyn G. Anderson, and Brian C. Gudmundson, Zimmerman Reed, P.L.L.P., Minneapolis, MN, for Plaintiffs.

James K. Langdon, Michelle S. Grant, and Eric R. Sherman, Dorsey & Whitney LLP, Minneapolis, MN, for Defendants.

MEMORANDUM OPINION AND ORDER

SUSAN RICHARD NELSON, District Judge.

This matter is before the court on Defendants' motion to dismiss (Doc. No. 36). For the reasons stated below, this Court grants the motion in part and denies it in part.

I. FACTUAL AND PROCEDURAL BACKGROUND

In this securities fraud action, Lead Plaintiff Building Trades Pension Trust Fund and Plaintiff City of Taylor Police and Fire Retirement System claim that Defendant St. Jude Medical, Inc. (“STJ”), and four of its officers—(1) Defendant Daniel J. Starks, STJ's Chairman, President and Chief Executive Officer, (2) Defendant John C. Heinmiller, STJ's Chief Financial Officer and Executive Vice President, (3) Defendant Eric S. Fain, President of STJ's Cardiac Rhythm Management Division, and (4) Defendant Michael T. Rousseau, STJ's Group President (collectively, the “Individual Defendants”)—violated the Securities Exchange Act of 1934 and the implementing regulations issued by the Securities Exchange Commission (“SEC”). Seeking class certification on behalf of all persons similarly injured by acquiring STJ securities, Plaintiffs allege a Class Period from April 22, 2009 to October 6, 2009, when STJ announced that revenues and earnings for the third quarter of 2009 (“3Q09”) were expected to be substantially lower than what Defendants had forecast. That day, shares of STJ's common stock declined by $4.84, or 12.7%, on high trading volume (Doc. No. 23, ¶ 10), while the Dow Jones U.S. Medical Devices Index Fund, which includes not only STJ, but also its two main competitors, Medtronic Inc. and Boston Scientific Corporation, “fell by just 0.6% the same day” ( Id. ¶ 110).

On March 18, 2010, Plaintiffs filed their original Complaint (Doc. No. 1), and on August 16, 2010, they filed their Consolidated and Amended Class Action Complaint (“Complaint”), asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(b), and the SEC's Rule 10b–5, 17 C.F.R. § 240.10b–5.

Defendants now move to dismiss, claiming that the allegations of the Complaint fail to satisfy the heightened pleading requirements of the Private Securities Litigation Reform Act of 1985 (“PSLRA”), Pub.L. 104–67, 109 Stat. 743, 758 (codified at 15 U.S.C. § 78u–4), with respect to the identification of false or misleading statements and the requisite state of mind, as well as other legal requirements for pleading securities fraud claims, particularly with respect to loss causation.

II. DISCUSSION

Plaintiffs' Complaint asserts two claims: (1) a claim under Section 10(b) and Rule 10b–5 against all of the Defendants, alleging that Defendants made false statements of material fact that deceived Plaintiffs (Count I); and (2) a derivative claim under Section 20(a) against all Defendants, alleging that they were liable as “control persons” under the Exchange Act (Count II). (Doc. No. 23, ¶¶ 189–95.)

With respect to the primary claim of liability under Count I, Section 10(b)

makes it unlawful for any person to “use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”

Matrixx Initiatives, Inc. v. Siracusano, ––– U.S. ––––, 131 S.Ct. 1309, 1317, 179 L.Ed.2d 398 (2011) (quoting 15 U.S.C. § 78j(b)).

SEC Rule 10b–5 implements this provision by making it unlawful to, among other things, “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”

Id. (quoting 17 C.F.R. § 240.10b–5(b)).

At its core, the Complaint is premised largely on STJ's alleged practice of “channel stuffing,” that is, seeking or pressuring its customers to acquire large quantities of STJ's products at the end of a financial quarter so as to artificially inflate STJ's revenues and earnings for a particular quarter, and STJ's accounting for such sales.¹ Plaintiffs contend that STJ's practice of channel stuffing in 2009, while the U.S. economy further descended into recession, eventually collapsed when its customers could not continue to absorb the excess inventory. The Complaint alleges that Defendants—while recognizing internally that sales were slowing—repeatedly misrepresented to the public that STJ's growth and revenues remained strong until they were forced to disclose, on October 6, 2009, an earnings miss.

Defendants argue that “missing guidance does not constitute securities fraud,” and that Plaintiffs may not pursue their securities fraud claims based on hindsight. (Doc. No. 38, at 8.) But Plaintiffs' claim does not rest simply on the fact that STJ missed its guidance:

The extent to which [STJ relied on heavily discounted, end-of-quarter bulk sales to meet its sales and earnings estimates] was concealed from investors during and prior to the Class Period, as were the risks to its business arising from those sales. In particular, a deepening recession affecting the health care industry in 2009 coupled with numerous hospitals having bloated inventories of STJ CRM products at the outset of the year due to previously completed bulk sales, made STJ particularly vulnerable to missing its earnings forecasts during the Class Period. Despite this, defendants raised STJ's guidance and told investors that, due to the nature of the products it sold, the Company was well insulated from the negative effects of the economic downturn that existed during the Class Period.

(Doc. No. 23, ¶ 45.)

Plaintiffs generally allege that Defendants used various “improper artifices and devices to inflate revenues and conceal declining demand” for STJ's products. ( Id. ¶ 2.) In particular, they allege that Defendants “(i) failed to disclose” STJ's reliance on “heavily discounted, end-of-quarter bulk sales” to meet its sales forecasts; “(ii) issued materially false and misleading financial statements that failed to account for revenues from bulk sales” and other tactics; “(iii) issued financial guidance to investors that was contradicted by STJ's internal forecasts; and (iv) concealed the extent to which an ongoing economic recession was affecting or could potentially affect sales of and demand for” STJ's products. ( Id.);see also id. ¶¶ 3–5 (elaborating on basic allegations of paragraph 2.) Plaintiffs contend that “[h]eading into the Class Period, prior sales of STJ's products had resulted in a large buildup of excess and unnecessary inventory on its customers shelves,” which, “together with recessionary economic pressures, had caused many hospitals to scale back on their ... end-of-quarter bulk purchases of STJ's products.” ( Id. ¶ 6.) They further allege that although STJ officers and employees “recognized that 2009 was going to be an extraordinarily difficult year,” “STJ—alone among its competitors—raised its financial guidance and told investors its business was well insulated from the [negative] economic conditions.” ( Id.) Although STJ's practice of “channel stuffing” created, Plaintiffs allege, a “great risk of declining [business] during an extended recession, STJ reaffirmed its earnings per share (“EPS”) guidance in the first and second quarters of 2009.” ( Id. ¶¶ 6, 7.)

Plaintiffs further allege that despite their public statements, Defendants knew that their sales practices were “ultimately unsustainable”: “[r]ecognizing internally that sales would be insufficient to meet their misleading guidance, [D]efendants caused STJ to issue and sell $1.2 billion in debt securities at the end of 2Q09, [but] then used most of the proceeds to buy back Company stock in a desperate attempt to make STJ's EPS guidance easier to meet by expediently reducing the number of shares outstanding in the market.” ( Id. ¶ 8.) Moreover, Plaintiffs allege, despite Defendants' statements to the public that STJ's business was not only insulated from deteriorating economic conditions, but likely to grow, “[b]efore the end of the third quarter, STJ had laid off more than 10% of its domestic sales force due to the impact of negative economic conditions on its business.” ( Id.)

Then “[o]n October 6, 2009, just weeks after [D]efendants had reaffirmed that STJ was purportedly on track to meet its forecast guidance, the Company shocked investors by revealing a stunning miss in its 3Q09 forecast results,” that overall revenues “would be 20% below the forecast [D]efendants had just reaffirmed.” ( Id. ¶ 9.) Upon the announcement, the price of STJ's common stock dropped 12.7%. ( Id. ¶ 10.)

In the interim, however, the Individual Defendants, Plaintiffs allege, knew from internal forecasts that sales were declining and thus “made STJ stock sales that were suspicious in both timing and amount.” ( Id. ¶ 166.) For example, Starks sold a total of 300,000 shares during the Class Period–100,000 shares in each of three sales in early June 2009, late July 2009, and mid September 2009.( Id.)

Defendants now seek dismissal on several grounds, contending that the Complaint fails to plead (1) false statements with the requisite particularity, (2) facts giving rise to a strong inference of scienter, and (3) loss causation. (Doc. No. 38.) Defendants further argue that the Section 20(a) claim must also be dismissed because it is derivative of the Section 10(b) claim. ( Id. at 33.) Fi...