Sofamor Danek Group, Inc., In re

• Decision Date: 09 October 1997
• Docket Number: 95-6592,Nos. 95-6491,s. 95-6491
• Parties: Fed. Sec. L. Rep. P 99,510 In re SOFAMOR DANEK GROUP, INC. Bruce G. MURPHY, Randy Owen, Mary Kennedy, and Lynda Kramer, Plaintiffs-Appellants, Mike Roberts, Plaintiff, v. SOFAMOR DANEK GROUP, INC., E. Ron Pickard, Laurence Y. Fairey, Leander D. Beard, George F. Rapp, Miles D. Igo, Alan J. Olsen, Yves Paul Cotrel, and Phillipe Cotrel, Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 394

123 F.3d 394

Fed. Sec. L. Rep. P 99,510

In re SOFAMOR DANEK GROUP, INC. Bruce G. MURPHY, Randy Owen, Mary Kennedy, and Lynda Kramer Plaintiffs-Appellants Mike Roberts, Plaintiff, v. SOFAMOR DANEK GROUP, INC., E. Ron Pickard, Laurence Y Fairey, Leander D. Beard, George F. Rapp, Miles D Igo, Alan J. Olsen, Yves Paul Cotrel, and Phillipe Cotrel, Defendants-Appellees.

Nos. 95-6491, 95-6592.

United States Court of Appeals, Sixth Circuit.

Argued Oct. 22, 1996.

Decided Aug. 14, 1997.

Rehearing and Suggestion for Rehearing En Banc Denied Oct. 9, 1997.

Alexander W. Wellford, Jr. (briefed), Humphreys, Dunlap, Wellford, Acuff & Stanton, Memphis, TN, Steven J. Toll (argued and briefed), Cohen, Milstein, Hausfeld & Toll, Washington, DC, for Plaintiffs-Appellants.

Earle J. Schwarz (briefed), Saul C. Belz (briefed), Jennifer W. Sammons (briefed), Waring Cox, Memphis, TN, Kenneth M. Kramer (argued and briefed), Shearman & Sterling, New York City, for Defendants-Appellees.

Before: MERRITT, BROWN, and NELSON, Circuit Judges.

OPINION

DAVID A. NELSON, Circuit Judge.

This is an appeal from the dismissal of five consolidated securities fraud cases. The plaintiffs--each of whom in 1993 and/or 1994 made one or two purchases of between 100 and 500 shares of common stock in the defendant corporation--allege that they and members of a shareholder class they purport to represent paid inflated prices for their stock because the company and its officers and directors publicly misrepresented the company's marketing practices and failed to disclose (1) that medical devices manufactured by the company were being promoted for a use not approved by the United States Food and Drug Administration and (2) that medical devices which the company lent to hospitals without initial charge under a "loaner kit" program were ultimately being sold to the hospitals at twice the regular list price.

Granting a motion for dismissal under Rule 12(b)(6), Fed.R.Civ.P., the district court concluded that the alleged misrepresentations and failures to disclose were not actionable under the federal securities laws and that the plaintiffs had failed to state a claim for common law fraud and negligent misrepresentation. We find ourselves in substantial agreement with the district court's analysis, and we shall affirm the dismissal.

I

Defendant Sofamor Danek Group, Inc., which has its headquarters in Memphis, Tennessee, was organized in 1983 as an Indiana corporation. Originally named Biotechnology, Inc., it was renamed Danek Group, Inc., a few years later. The company received its present name in June of 1993, when it acquired all of the capital stock of Sofamor, S.A., a privately held French company, in exchange for newly issued shares of Danek common stock.

The initial public offering of Danek stock took place in 1991, at which time 1.8 million shares--approximately 22 percent of all shares outstanding after the offering--were sold at $15.00 per share. The stock (which was subsequently split two-for-one) was traded on the over-the-counter market until shortly after the Sofamor acquisition; Sofamor Danek was then listed on the New York Stock Exchange. As of December 31, 1993, the company had 24,369,838 shares of common stock outstanding. During the fourth quarter of 1993 the price per share ranged between a low of $27.25 and a high of $38.75.

Sofamor, S.A., had been controlled by Dr. Yves Paul Cotrel (one of the defendants herein) and members of his family. A proxy statement/prospectus issued in connection with Danek's proposed acquisition of Sofamor indicated that upon completion of the acquisition the current officers and directors of Danek would be left with ownership of roughly one quarter of the outstanding stock of Sofamor Danek. Dr. Cotrel and his family--who were to receive two seats on the Sofamor Danek board of directors--would own a slightly smaller percentage.

It was further disclosed that the disposition of Sofamor stock would be a taxable transaction; that the Sofamor shareholders intended to sell a significant portion of the newly issued shares, amounting to roughly 10 percent of Sofamor Danek's total outstanding stock; that the Sofamor shareholders had entered into an agreement designed to provide for an orderly resale; and that prevailing market prices for Sofamor Danek stock could nonetheless be adversely affected by substantial sales. The proxy statement/prospectus also noted that there had been significant volatility in the market for Danek stock since the initial public offering, which volatility might continue or increase from time to time in the future.

Both Danek and Sofamor, as the proxy statement explained, were primarily engaged in the business of developing, manufacturing and marketing spinal implant devices for surgical use. Danek entered this business segment in the mid-1980s, producing spinal implant devices at an Indiana manufacturing facility and distributing them through a subsidiary located in Memphis. By 1991, according to a prospectus issued when the company went public, Danek had two main product lines; one consisted of specialized systems of support rods and eyebolt locking mechanisms, and the other--the Danek Bone Plate and Screw Product Line--consisted of devices attached to bones in the spine to achieve fixation during healing. Other fixation and implant systems had been added by 1993.

The principal products of Sofamor, S.A., included the Cotrel-Dubousset spinal instrumentation system, which was manufactured and sold in France beginning in 1983, and a newer line designed for the treatment of degenerative diseases of the lumbo-sacral spine. By 1993 Sofamor products were marketed in over 45 countries, including the United States.

Danek's 1991 prospectus contained a "Government Regulations" section noting that within the United States the Food and Drug Administration had authority over the company's medical devices by reason of the Safe Medical Devices Act of 1990 and the 1976 Medical Devices Amendment to the Food, Drug and Cosmetic Act, 21 U.S.C. §§ 301 et seq. The prospectus went on to say that all products currently marketed by Danek had gone through a regulatory procedure known as "Section 510(k) notification," a relatively simple method of obtaining FDA clearance for devices "substantially equivalent" to products legally marketed in the past. (The 1976 Act established grandfather rights for products that had been on the market before May 28, 1976.) Section 510(k) notification, according to the prospectus, is far less complicated than the "premarket approval" required for devices that are not eligible for 510(k) treatment. A premarket approval application was said to be "a much more complex submission that typically includes a long follow-up of both animal and human studies."

In 1990, as the prospectus disclosed, the FDA advised Danek and a number of other manufacturers that they were not to promote bone plates, sacral screws, etc. for "pedicular attachment," which was said to be a "new use" for these devices. This meant that Danek could not label or promote its products as suitable for attachment to the pedicle--a boney support structure on the posterior aspect of the vertebral bodies that make up the human spine. Danek revised its promotional literature, the prospectus stated, to remove any reference to pedicular attachment. The prospectus noted that the company could not rule out the possibility of regulatory action, however, and said that such action might include an injunction against any distribution of the Danek Bone Plate and Screw Product Line. The possibility of such regulatory action was also disclosed in the annual Form 10-K filings made with the Securities and Exchange Commission for 1991 and each subsequent year through 1993.

In Europe and Asia, as the 1993 proxy statement explained, Sofamor was able to sell devices with screws intended to be inserted in the pedicle. Because use of a pedicle screw was not exempt from premarket approval by the FDA under § 510(k), however, Sofamor was said to have applied for permits to conduct clinical trials of pedicle screws preparatory to filing a premarket approval application for this use in the United States.

In connection with a discussion of "Possible Regulatory Action Involving the Danek Bone Plate and Screw Product Line," the proxy statement also explained that as part of the practice of medicine--which is not itself regulated by the FDA--American physicians were free to use Danek screws (or any other products) in the pedicle portion of the vertebra if, in the exercise of their medical judgment, the physicians deemed such use to be in their patients' best interest. "Although this practice [also referred to as "interpediculiar segmental fixation"] probably will continue in the future," the proxy statement said, "Danek cannot predict nor does it encourage the use of products for unapproved applications." Similar statements appeared in the company's 10-K forms for fiscal years 1992 and 1993.

The FDA might have disagreed with the proposition that Danek did not "encourage" use of the company's products for interpediculiar segmental fixation. In August of 1993, as the company disclosed in its Form 10-K for that year, "Danek and six other companies received warning letters from the FDA, primarily regarding the issue of supporting medical education programs that actually 'demonstrate' the use of screws in the pedicle of the spine."

The other marketing practice relevant in this litigation involves Danek's so called "loaner set" program. The 1991 prospectus said this on the subject:

"In meeting the needs of hospitals, the Company offers various instrument and implant purchase alternatives, as well as overnight shipment of implant systems for next day surgery. One of the Company's purchase alternatives consists of the Company furnishing a full set of products to a hospital without initial charge. After components are used during surgery,...