In the

United States Court of Appeals

For the Seventh Circuit

No. 11-1471

PLUMBERS AND PIPEFITTERS LOCAL UNION 719

PENSION FUND and CARPENTERS PENSION FUND

OF WEST VIRGINIA, on behalf of a class,

Plaintiffs-Appellants,

v.

ZIMMER HOLDINGS, INC.; DAVID C. DVORAK; and

JAMES T. CRINES,

Defendants-Appellees.

Appeal from the United States District Court

for the Southern District of Indiana, Indianapolis Division.

No. 1:08-cv-01041-SEB-DML—Sarah Evans Barker, Judge.

ARGUED OCTOBER 18, 2011—DECIDED MAY 21, 2012

Before EASTERBROOK, Chief Judge, and RIPPLE and

KANNE, Circuit Judges.

EASTERBROOK, Chief Judge. Two pension funds that

own shares of Zimmer Holdings, Inc., charge it with

defrauding its investors by downplaying the significance
2 No. 11-1471

of difficulties it was having manufacturing some of its

products and the high failure rate one surgeon reported

for another of its products.

Zimmer designs and makes orthopaedic reconstructive devices (and related products) that it sells throughout

the world. One of its products is the Durom Acetabular ®

Component (the Durom Cup), which is used to replace

the socket in a hip joint. One side of the Durom Cup is

a porous ceramic designed to bond with the hip bone;

the other is forged titanium designed to allow a leg bone

(or a titanium replacement for one) to move freely.

The Wikipedia article “Hip replacement” provides an

overview of the components and procedures.

One well-known surgeon, Lawrence Dorr, reported

unacceptably high failure rates after using the Durom

Cup in his patients. See William T. Long, Manish

Dastane, Michael J. Harris, Zhinian Wan & Lawrence D.

Dorr, Failure of the Durom Metasul Acetabular Component,

®

468 Clinical Orthopaedics & Related Research 400 (2010).

Zimmer announced Dr. Dorr’s preliminary findings

in 2008 and promised to investigate. Later Zimmer attributed his failure rate—which it said was substantially

higher than that experienced by other surgeons—to

improper surgical technique. It stopped selling the

Durom Cup in the United States while preparing new

instructions for implantation; Zimmer continued to sell

the Durom Cup with the original instructions in other

nations. About a month later, Zimmer returned the

Durom Cup to sale in this country; it remains available.

This suit contends that Zimmer’s statements were false:
No. 11-1471 3

that the problem stemmed from poor design or quality

control in the manufacture of its product rather than

Dr. Dorr’s technique, and that Zimmer pretended otherwise in order to avoid a decline in the price of its stock.

Plaintiffs also contend that Zimmer delayed revealing

quality-control problems at its plant in Dover, Ohio.

According to plaintiffs, Zimmer learned of problems

in late 2007 but did not reveal them in its January

2008 quarterly report and earnings call. On April 3,

2008, Zimmer announced that production of some orthopaedic products at Dover would be suspended until

improvements could be made and that a few products

would be recalled. Zimmer estimated that recalls plus

sales foregone before production resumed would cost

the company about $70 to $80 million. (Zimmer did not

close the Dover plant; the decision affected only some

of its production lines.) Plaintiffs contend that events

at Dover reveal that the quarterly reports and

earnings guidance Zimmer released in January and

April were materially false. The Dover plant returned to

full production, and plaintiffs do not contend that

the estimated cost of the suspension and recall was substantially off the mark. In January Zimmer had

projected 10% to 11% revenue growth for the year and

net earnings of $4.20 to $4.25 per share; in July it cut

this projection to 8.5% to 9% growth and net earnings of

$4.05 to $4.10 per share. Plaintiffs maintain that Zimmer

committed fraud by not using these lower estimates

in January.

The district court dismissed the complaint, finding

that it flunks the pleading standards of the Private Securi-
4 No. 11-1471

ties Litigation Reform Act of 1995 (PSLRA), 15 U.S.C. §78u4. See 673 F. Supp. 2d 718 (S.D. Ind. 2009), relying

on Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308

(2007). The judge wrote that the complaint satisfies

neither the materiality requirement nor the need to

show scienter (that is, the defendants’ knowledge that

they were lying) under the Tellabs standard: “an

inference of scienter must be more than merely

plausible or reasonable—it must be cogent and at least as

compelling as any opposing inference of nonfraudulent

intent.” 551 U.S. at 314. Plaintiffs proposed to amend

the complaint to satisfy the judge’s concerns. In a comprehensive opinion, 2011 U.S. Dist. LEXIS 9253 (S.D. Ind.

Jan. 28, 2011), the district court held that the proposed

amendment would be futile. The judge did, however,

withdraw the ruling that Zimmer’s statements were

not material, anticipating that the Supreme Court’s decision in Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct.

1309 (2011), then under advisement, might undercut

this aspect of the earlier ruling. That left the scienter

holding as the basis of the district court’s judgment.

The Durom Cup was failing in the United States at

an unacceptably high rate. Plaintiffs say that this must

have been caused by design or manufacturing problems,

because Dr. Dorr believed that surgeons had used

proper methods. Zimmer announced, however, that it

thought the problem one of technique and that it was

taking the device off the market, in the United States

only, for a brief period (which turned out to be one

month) in order to revise the instructions for use and

provide additional education to surgeons. Given the
No. 11-1471 5

conflict between Dr. Dorr and Zimmer, plaintiffs

contend, a jury could infer that Zimmer was lying and

knew it. We agree with the district court that this

approach is unavailing.

Zimmer did not try to hide the failures Dr. Dorr had

encountered. Dorr made a public announcement, and

so did Zimmer, which added (what was anyway evident) that lower sales and more products-liability litigation might ensue. Three months before Dorr made his

public statement in April 2008, Zimmer had announced

that the Durom Cup was challenging to implant and

that changes in labeling or training might be required.

No one could predict how serious the problem would

turn out to be, so Zimmer’s decision not to try to

quantify the effect in January can’t be treated as a

fraud. Zimmer knew that results in Europe had been

better. While Dorr was reporting failure rates of 20% or

so, a group in Europe was reporting failure rates of less

than 1%. The Durom Cup had been used in Europe

since 2003 but had not been introduced in the United

States until mid-2006; perhaps European surgeons had

confronted and overcome challenges that colleagues in

the United States were facing. The different success rates

can’t have been caused by design or manufacture: all

Durom Cups have one design and are made in the

same plant.

Corporate executives who know that one group of

surgeons experiences success, and another group

failure, with the very same medical device could believe

that the different outcomes had been caused by dif-
6 No. 11-1471

ferences in the way the surgeons had implanted the

device. That’s what Zimmer’s executives said they had

concluded. The complaint does not establish an inference of scienter that is “at least as compelling as any

opposing inference of nonfraudulent intent.” Indeed,

even today plaintiffs have not supplied a cogent reason

to think that Zimmer’s statements were false, let alone

knowingly false. The Food and Drug Administration

has never concluded that the Durom Cup was defectively designed or made, indeed never even issued

a warning or caution concerning the Durom Cup.

As for the Dover facility and its products: plaintiffs

say that Zimmer’s management knew of the qualitycontrol problems and should have announced them

earlier. Yet quality control is an issue at all medical companies. Knowing of “problems,” which are common,

differs from knowing that a facility must be closed

and some of its products recalled. In the proposed

amended complaint, plaintiffs offered examples of events

that, in their view, show that Zimmer must have

known that the income and earnings projections made

in January 2008 were bound to be embarrassed by

looming problems at Dover:

• David C. Dvorak, Zimmer’s CEO, decided not

to invest in quality systems that might have

avoided problems at the Dover facility.

• Before the FDA inspection, Dvorak and other

executives attended meetings at which

quality issues were discussed.

• Dvorak hired a specialist to help the company avoid FDA warning letters.
No. 11-1471 7

• Zimmer coached a team of employees on what

to say to an FDA inspector.

The district judge replied: “In terms of their relevance

to scienter, these allegations miss the mark. It is irrelevant that Defendant Dvorak or anyone else at Zimmer

knew that an FDA inspection occurred, took actions to

mitigate any consequences of that inspection, or that

the company was concerned with the quality of its [orthopaedic surgical products]. These facts are not inconsistent with the statements at issue.” 2010 U.S. Dist. LEXIS

9253 at *55-56. That is to say, once again the complaint lacks cogent support for a contention that

Zimmer’s statements were false, let alone fraudulent.

We asked plaintiffs’ counsel at oral argument for the

best evidence that anything Zimmer said throughout the

first six months of 2008 was false. Counsel pointed to

this exchange during a conference call between financial

analysts and Dvorak on January 29, 2008.

Q: All right, and you mentioned you talked about

investing in compliance and systems. Do you

currently have any issues with the FDA, any

warning letters, that usually takes a few months

for those to be posted, that they may have been

issued or 483’ed?

A: We don’t have any warning letters at this point.

This statement is true. FDA inspectors had not issued a

warning letter at any of Zimmer’s plants. Plaintiffs call

the answer fraudulent because of what they describe as

a materially misleading omission: the question asked
8 No. 11-1471

about warning letters or “483”s, and the answer concerned only warning letters.

In industry jargon, a “483” is an observation by an

inspector, providing information about “significant

objectionable conditions” (not serious enough to merit a

warning or any formal action by the agency) that the

inspector believes will be useful to the company.

The shorthand “483” derives from the fact that these

observations are recorded on the FDA’s Form 483. As

the questioner remarked, it might take time for any

warning or Form 483 to be prepared and transmitted

after an inspection. But inspectors often make observations verbally with written follow-up, and the questioner

was interested in this possibility. The complaint alleges

that an inspector at Dover made eight verbal 483 observations to the plant’s managers during a nine-day visit

that ended on January 29, 2008, the day of the conference

call (which began at 8 A.M.). It is not clear how quickly

these 483 observations reached Zimmer’s CEO. Only one

of the eight concerned quality control; others dealt with

recordkeeping and a recall that occurred in 2006. At all

events, it is hard to call a truthful answer to a compound question “fraud.”

Oral exchanges are less precise than written ones.

Dvorak did not know what question was coming, had to

answer off the cuff, and did not have an opportunity

to review the question and edit his answer before

the next question was posed. This question mentioned

warnings first, and Dvorak said that Zimmer had not

received any. The questioner could have followed up
No. 11-1471 9

about 483 observations, but didn’t. In the language of

Tellabs, nothing here supports an inference of scienter

that is “cogent and at least as compelling as any

opposing inference of nonfraudulent intent.” The worst

one could say about Zimmer’s answer is that it was

evasive, which is short of fraudulent. Cf. Bronston v.

United States, 409 U.S. 352 (1972) (evasive answer cannot

be basis of a perjury conviction).

Plaintiffs contend that we should infer scienter

because Dvorak and other top managers had an incentive to make Zimmer look good in order to keep their

jobs, improve their bonuses, and increase the value of

their stock options. This is too generic to satisfy Tellabs.

A similar assertion could be made about every firm in

the world, but the fact that managers benefit from

higher stock prices does not imply that any particular

manager committed fraud. Quite the contrary. Managers

usually do best when a firm has long-term success. Those

who boost prices fraudulently for six months or so—as

plaintiffs say Dvorak and Zimmer’s other top managers

did—and then see market capitalization decline, may

find themselves on the street, and their stock options

won’t vest. If, as plaintiffs maintain, Dvorak and other

managers told a series of lies during the first half of

2008 about one plant and one product that together

produced less than 10% of the firm’s income (Zimmer

says that it was only 2% of global revenue and 3.6% of

the year’s profit), and affected earnings by only 15¢ a

share, they were putting their fortunes and careers at

stake in exchange for very little return. This aspect of
10 No. 11-1471

plaintiffs’ arguments thus undermines, rather than

strengthens, the inference of scienter.

At any given time, one or another product of a drug

or medical-device producer with a portfolio of thousands

(Zimmer has more than 130,000 unique product codes)

is harder to make or less successful than hoped. Qualitycontrol issues at pharmaceutical and medical-device

producers are endemic, as customers and regulators

always want higher quality even though investors want

only “enough” quality. Investing beyond the point of

diminishing returns injures rather than helps investors;

competent managers will do just what Zimmer’s were

alleged to have done and take a beady-eyed view of

proposals to invest tens of millions in new capital equipment at every plant encountering problems that might

be solved more cheaply. The allegations of this complaint concern the problems Zimmer faced in 2008; in

a different year the headaches would have come from

a different plant or a different product, but the fact

that these particular problems occurred—and that information came out over time, as more news accumulated—does not imply that any manager was lying to

investors.

Plaintiffs point to many other supposedly false statements and a host of detail that supposedly shows that

one or another statement was knowingly false. The

district court’s two lengthy opinions address all of these

other statements. We have covered only the highlights—but, because these highlights are plaintiffs’ strongest arguments, there is no need to fill the Federal
No. 11-1471 11

Reporter with the rest. We agree with the way the district court addressed them, and its judgment is

AFFIRMED.

5-21-12