## In the



# U n ited S ta tes Co urt o f Ap p ea ls

F o rth eS e v e n th C ir cu it
N o. 11

- 1471 P LU MBE R SAN D P IPEF ITTERS L OC AL U NI ON 719 P EN S I ON F UND a nd C ARP EN TERS P EN S I ON F UND OF W ES T V IRGINIA, o n behal fo fa cl ass , P laint if fs -App el lants , v.

Z IMM ER H OLDI NGS, I NC .; D AVI D C. D VORAK; a nd J AM ES T. C RI NES, D efend a nts-A pp ellees

.

A pp eal from the United S t ates Di strictC our t fo r the S outhernDi stricto f Indian a, Indian apolisDiv isi on. No . 1:08- cv-01041- S EB-DML

— Sarah E vansBarker, Ju dge
.
A RG UE D O CT OB ER 18, 2011

— D ECI DE D M AY 21, 2012

Be f o r e E A S T E RB R OO K, Chi e f Judg e, a nd R IPPLE a nd K ANN E , C ircu it Judges . E A S T E RB R OOK, Chi e

f Judg e . Tw o pensi on fund s that own shar es ofZi m m erH ol dings, I nc. , char ge i t with defr auding i ts i nvest or s b y downp l ayi ng the si gni fi cance2 N o. 11

- 1471 ofdi ffi cul ti es i t was havi ng m an u f actur i ng so m e o fi ts products a nd the hi gh f ai l ure ra te one surg eon re p or ted f orano thero fi ts products. Z i m m erdesi gns a nd m ake s o rthopaedicr eco nstr ucti ve dev i ce s ( an d r el at ed pr o duct s) th ati t se l l s th r o ug ho ut the worl d. One ofi ts products i s the Durom A cetabul ar ® Com ponent ( the Duro m Cup ) , wh i ch is u sed to r epl ace th e s oc ke t in a h ip j oin t. O n e s id e o f th e D u ro m C u p is a por ous c er am i c desi gned to bo nd with the hi p bone; th e othe r i s f o r g ed ti ta ni um de si g ne d t o a l l o w a l egb o ne ( or a ti tani um re pla cem ent f or one) to m ov e fr eel y. The W i ki pedia ar ticl e “ H i p re pla cem ent” provi des an ove rv i ew o fthe com ponents a nd pro cedures. On e we l l

- k no wn s ur g e o n, La wr e nc e Do r r, r e po rt ed unacceptabl y hi gh f ailur e ra tes afterusi ng the Durom Cu p i n hi s pati ents. S ee W i l l i am T. Long, M ani sh Da s t a ne , Mi c ha e l J
. Ha r r i s , Z hini a n W a n & La wr e nc e D. D or r, Fai l ureof

t heD urom M e t as ul Ace t ab ul arCom pone nt, ® 468 C li nical Ort hop aed ics & Related Res earch 400 (2010). Zim m er announced Dr. Dorr ’ s pre l i m i naryfi nd i ngs i n 200 8 and pr om i sed to i nvest i gat e. LaterZi m m erat tr ibuted hi s f ai l ure ra te

— w h ich it sa id w as su b st an tia lly hi g he r tha n tha t ex per i en ce d b y o ther s ur g eo ns

— to i m pr o pers ur g i ca l t ec hni que . I t st o pped se l l i ngthe Du ro m Cup i n the U ni ted S tat es w hi l e pr eparing new i n st ru c tio n s fo r im p lan ta tio n ; Zim m er co n tin u ed to se ll the Duro m Cup with the o ri gi nal i nstr ucti ons i n other na ti o ns . Abo uta month l at er, Zi m m err etur ned the Du ro m Cup to sa l e in thi s co untry; i t r em ai ns av ai l able. This sui t co ntends that Z im m er ’ s s tat em ents w er e f al se:N o. 11

- 1471 3 that the pr obl em st em m ed fr om poordesi gn o r quali ty contr ol i n the m anufa cture of i ts product ra th er than D r. Do rr’s te c h niq ue , and that Zim m er pret en d ed otherw i se i n or der t o avo i d a decl i ne i n the pri ce o fi ts sto ck. Pl aintif f s al so c o nt en d tha t Zi m m erde l ay ed r ev ea l i ng quali ty- contr olpro bl em s a t its p lant i n Dover, Ohio

. Ac c o r d i n gt o p l a i n t i ff s , Z i mme r l e a r n e d o fp r o b l e ms in l ate 2 0 0 7 b u t d id n ot reveal them i n its Janu ary 2008 quart er ly re p ort a nd ea rni ngs c al l

. On A pri l 3, 2008 , Zi m m erann ou nced that producti on o fso m e o rthop ae d i c p ro d u c ts atD ov er w ou ld be su sp en d ed u n til i mpr o v e men t s c o ul d b e ma de a nd tha ta fe w pr o du cts woul d b e r ec al l ed. Zi m m ere st i m ated tha t r ec al l s pl us sal es f or ego ne be for e producti on r esum ed w oul d cost the c om pany abo ut $7 0 t o $80 m i l l i on. ( Zim m erdi d not c l o s e th e D o v e r pl a n t ; th e d e c i s i o n a ffe c t e d o n l y s o me ofi ts producti on l i n es .) Pl ai nti ff s co ntend that eve nts atDo ve r reve al th at th e qua r te r l y r epo r ts a nd ea r ni ng s g ui dance Z i m m err el ea se d i n J an ua r y a nd A pri l were m ate ria lly f al se. The Doverpl ant r etur ned to fullpro du cti on, and pla i nti ff s do not conte nd that the e sti m ate d costo fthe suspensi on a nd r ecal l was substa nti al ly off the m ar k. I n J anuaryZi m m erhad pr oj ec te d 1 0% to 1 1% r ev en ue g r o wth fo r the y ea r a nd ne t ea r ni ng s o f$ 4. 20 t o $ 4. 25 pe r s ha r e; i n Jul y i t cut thi s proj ecti on t o 8. 5% to 9% gr owth and net ear ni ngs o f $4. 05 to $4. 10 per shar e. P lai nti ff s m ai ntai n that Zim m er com m i tte d frau d by notusi ng the se l ower e sti m ate s i n J anuary . The di st r i ctc o ur t di smi ss ed th e co m pl aint, fi ndi ng th at it flu n ks th e p lea d in g s ta n d ar d s of th e P riv at e Se c u ri-4 N o. 11

- 1471 ti es Li ti g at i o n Re f o r m Acto f1 99 5 ( PS LRA), 15 U. S
. C. § 78 u4. S e e 6 7 3 F
. S u p p . 2 d 7 1 8 ( S
. D. I n d

. 2 0 0 9 ) , r e l y i ng o n Tel labs, Inc. v. M ako r Is sue s & Rights, Ltd

. , 55 1 U
. S. 30 8 ( 2007 )
. The j ud ge w ro te that the c om pla i nt sa ti sfi es nei therthe m ate ri al i ty re quir em en t northe need to show sci enter( that i s, t h e defe nd ants’ kno w l edge that they w er e ly i ng) under the Tel labs st andard: “a n in fer e n c e o f sc ien te r m u st be m or e t h an m er ely p lau sib le or rea so n ab le

— i t m ust be co gent and at l eas t a s co m pel l i nga s an y o ppo singi nfer en ce o fno nfr au dul en t i nt en t. ” 55 1 U. S
. a t 314. P la i nt i ff s pr o po se d t o a m en d the co mpl a i n tt o s a t i s fy th e j u d g e ’ s c o n c e r n s . I n a c o mp r e h e n siv e o p in ion , 201 1 U .S. D ist . L EXIS9 2 5 3 ( S
. D
. I n d. J an. 28 , 20 11), t h e dist ri ct c ourthel d that the pro posed am en d m en t w ou ld be futile. Th e j ud ge d id , how ever, w ithd raw the r u li ng that Zim m er’s statem en ts w ere n o t m at er ial, an tic ip at in g t h at th e Su p re m e C ou rt ’s d ec isi o n i n M at r ixx Ini t i a tive s , Inc . v. Si r ac us ano , 13 1 S
. Ct. 13 09 ( 2011 ) , the n un dera dvi se m en t, mightunde r cut thi s aspect of the ear l i er rul i ng. That l eft the s ci enter hol ding as the b asi s o fthe dist ri ct c ourt ’ s j ud gm ent. The Du ro m Cup was f ai l i ng i n the U ni ted S tat es at an unacceptabl y hig h ra te. Pl ai nti ff s s ay that thi s m ust have been caused bydesi gn o r m anufa cturing pro bl em s, because Dr. Dorrbel i eve d t h at surgeo ns had used p ro p er m et h o d s . Zim m er an n ou n c ed , ho w ev er , th atit th ou gh t the pro bl em o ne o fte chnique and that i t was tak i ng the devi ce o ffthe m ar ket, i n the U ni ted S tat es o nl y, f o r a b r i efpe r i o d ( whi chtur ne d o utt o b e o ne m o nth) i n o r dert o r ev i se the i ns tr uct i o ns f o r us e an d pr o vi de addi ti o na l e duca ti o n t o s ur g eo ns . Gi ve n theN o. 11

- 1471 5

co nfl i ctb etwee n Dr
. Do r r a nd Zi m m er, pl aint if fs co nt en d, a j ur y c o ul d i nfertha t Zi m m erwas l yi nga nd kn ew it. W e a gr ee w ith th e d i s t r i c t c ou rtth at th is approach i s unavai l i ng. Zim m erdi d not t ry t o h ide the f ai l ures Dr. Dorrhad en co unt er ed. Do r r made a publ i c an no unc ement, a nd so d i d Z im m er , w h ich ad d ed (w h at w as an yw ay ev ident) that l ower s ales and m or e pr oducts- l i abi l i ty l i ti gatio n m igh t e n su e. T h re e m on th s b efo r e D or r m ad e h is pu bl i c st ate m ent in A pri l 20 08, Zi m m er h ad announced th atthe Dur o m Cup wa s ch al l en g i ngt o i m pl an t an d tha tc ha ng e s in lab e l i ngo r t r a i ningmi g htb e r e qu i r e d. N o on e c ou ld p re d ict h ow se riou s t h e p ro b lem w ou ld turn ou t t o be, so Zi m m er ’ s deci si on notto tr y t o quanti fy the effect i n J anuarycan’ t be tr eat ed as a f ra ud

. Zi m m erk n ew thatr esul ts i n Europe had bee n bett er . W hi l e Dor r w as repor ti ng f ai l ure ra tes o f20 % o r so, a gr ou p in Europe w as re port i ng f ai l ure ra tes o fl ess t ha n 1 %. T h e D u r o m C u p h a d b e e n u s e d i n E u r o pe si nce 20 03 but had not been i ntro du ced i n the U ni ted States unti l m i d-20 06; per haps European s urge ons had c on fro n te d an d ov er c om e c h alle n ge s t h at co llea gu es in the Unite d Sta tes were f aci ng. The di fferent s uccess r ate s c an ’t h av e b ee n ca u se d b y d es ign or m an u fac tu re : all Dur o m Cups ha ve o ne de si g n a nd a r e m ad e inthe sam e pl ant. Corpor ate exec uti ves w ho know t hat o ne gr oup of su r g eo ns e xpe r i ences suc ce ss , a nd a no th erg r o up f ai l ure, with the ve rysa m e m edi caldevi ce c oul d believe th at th e d ifferent ou tcom es ha d been cau s ed by d if

-6 N o. 11

- 1471 fer en ce s i n the way the s ur g eon s ha d i m pl an te d the devi ce. That’ s what Zi m m er ’ s e xecuti ves sai d they had con clud ed

. Th e c om p lai nt doe s not est ablish an i nferen ce o fs ci en te r tha t i s “a t l east as c o m pel l i nga s an y o pp o s i ngi nfe r e nc e of no nfr a ud ul e nti nt e nt
. ” I nd e e d, eve n to day pl ainti ff s hav e no t s up pli ed a c oge nt r eas on to thi nktha t Zi m m er ’ s st at ement s w ere f al se , l eta l o ne kno w inglyf al se. The Fo od and Drug A dm i ni str ati on has never concl ud ed that the Du ro m Cu p w as d efecti vel y desi gned orm ad e, i nd eed neve r eve n i ssued a wa r ningo r c a ut i o n c o nc e r ningthe Du r o m Cup
. A s for th e D over facil ity and i ts p rod u cts: plaintiff s saythatZi m m er ’ s m an age m ent knew o fthe quali tycontr ol probl em s and s houl d hav e announced th em e a r l i e r . Y e tqu a l i t y co n t r o l i s a n i s s u e a ta l l me d i c a l c o mpan i es . Kno wi ng o f“ pr o bl ems, ” whi cha r e co m m o n, dif fe r s fr o m k no wi ngtha ta f a c i l i t y mus tb e c l o s ed and som e o fi ts products recal l ed. I n the propos ed am ended com pla i nt, pl ai nti ff s o ffer ed exam ple s o fev ents that, i n thei r vi ew , sho w thatZi m m erm ust hav e k no wn tha tthe i nc o me a nd e a r ning s p r oj e c t i o ns ma de i n J anuary20 08 w er e bo und to be em bar ra sse d by loom ing p roblem s at D over:

• Davi d C

. Dvor ak, Zi m m er ’ s CEO , deci ded not to i nvesti n qual i ty sy st em s that m i ght ha ve avo i ded pro bl em s a t the Doverf aci l i ty.

• Befo re t he FDA i nspecti on, Dvor ak and other exe c ut i v e s a t t e nd ed m eet i ngs a t which qu a l i t y i s s ue s we r e di s c us s e d.

• D v o r a kh i r e d a s p e c i a l i s tt o h e l p th e c o mpany avo i d FDA warni ng l ett er s.N o. 11

- 1471 7

• Zim m erco ached a tea m o fem plo yee s on w hat to say to an FD A i ns p ector. The distri ct j ud ge re pli ed: “In ter m s o fthei r re l evance to sci enter, thes e a l l ega ti ons m i ss the m ar k. I t i s i rr el evant that Defe nd ant Dvor ak ora n yone el se at Zim m er knew that a n FDA i nspecti on o ccurr ed, to ok acti ons to m i ti gat e a ny co nsequences ofthati nspecti on, o r that the c om pany w as concerned w i th the qual i ty ofi ts [ or thopae di c su r g i ca l pr o duct s]
. The se f ac ts ar e not i nco nsis te n t w ith th e s ta te m en ts at is su e.” 20 10 U .S. D ist . L EXIS 9 2 5 3 a t* 5 5

- 5 6
. T h a ti s t o s a y, o n c e a g a i n t he c o mpla i nt l acks co gent supp or t f ora conte nti on that Zim m er ’ s s tat em ents w er e f al se, l et al one f ra ud ule nt. W e a s k e d p l a i n t i ff s ’ c o u n s e l a to r a l a r g u me n tf o r t he bestev i dence thatan yt hi ngZi m m ers ai d through o utthe fi rs t s i x m on th s o f20 08 w as f al se. Counselpoi nted to thi s e xchange durin g a co nfe re nce ca l l betw een fi nanci al anal yst s a nd Dvor ak on J anuary29 , 20 08. Q: Allr i g ht, a nd y o u ment i o ne d y o u ta l k ed ab o ut i nv e s t i ngi n c o mpl i a nc e a nd s y s t e ms. Do y ou cur r e n t l y h a v e a n y i s s u e s wi th th e F DA , a ny war ni ngl et te r s, tha t us ua l l y t ak es a few months f o r tho s e t o b e po s t e d, tha t the y may ha v e be en i s s ue d o r 4 8 3 ’ e d? A : W e don’ t hav e a ny warni ng l ett er s a t thi s poi nt. Th i s s t a t e men ti s t r ue . F DA i ns pe c t o r s h ad noti s s ue d a w a rn in g let te r at an y of Z im m er ’s p lan ts . Pla in tiffs ca ll the a nsw erfra ud ule nt be cause ofw h at t h ey describe a s a m ate ri al l y m i sl eadi ng o m i ssi on: the q u es tio n ask ed8 N o. 11

- 1471 ab o utwar ni ngl et te r s or “4 83 ”s , a nd the a ns wer c o ncer ned onl y warni ng l ett er s. I n i nd ustr y j ar gon, a “483 ” is a n obs er vati on byan i nsp ec to r, pr o vi di ngi nf o r m at i o n abo ut“ si g ni fi ca nt obj ecti onabl e co nd i ti ons” ( not ser i ous e n ou gh to m er i t a war ni ngo r a ny f o r m ala ct i o n b y the a g en cy ) tha t th e i nspectorbel i eve s wil l be u seful to the c om pany. The shor thand “483 ” der i ves f ro m the f act that these o b s e r v a t i o n s a r e r e c o r d e d o n th e F DA’ s F o r m 4 8 3
. As th e que st i o ne r re m ar k ed, i t m i g htt ak e ti m e f o r a ny w ar ni ng o r For m 48 3 to b e prepare d and trans m i tte d afteran insp ec tio n. But i nspector s o ften m ake o bser vati ons verbal l y with w ri tte n f ol l ow-up, and the quest i oner w as in te re ste d i n thi s pos sibi l i ty. The co m pla i nt al l ege s that an i nspectoratDoverm ade eight verba l 483 o bser vatio n s to th e pla n t’s m an ag er s d u rin g a n in e-d ay vis it that ended on J anuary29 , 20 08, the day o fthe c on fer en ce cal l (w h ich b eg an at8 A . M .). It is n otcle ar h ow qu ick ly th es e 48 3 observa ti o ns r ea ch ed Zi m m er ’ s CEO. Onl y o ne ofthe ei ght c oncer ned quali ty control; o ther s deal t with re c or d ke ep in g a n d a re c all th at o c c u rre d in 2 00 6. A t a ll e v e n t s , i ti s h a r d t o c a l l a t r ut hful a n s we r t o a c o mp ou n d qu es tio n “fra u d .” Oralexchange s a re l ess pre ci se than wri tte n on es. Dvo r a k di d no t k no w wha t qu e s t i o n wa s c o mi ng, had to answ ero ffthe cuff, a n d d id not hav e a n opportunity to review t h e q ue stion an d ed it his an sw er before the ne xt questi on w as p ose d. This questi on m enti oned w ar ni ngs fi rs t, an d D vor ak sai d that Zi m m erhad not r ec ei ve d a ny . The que st i o ne r c o ul d ha ve f oll owed upN o. 11

- 1471 9 about 483 obs er vati ons, bu t d idn’t. I n the l anguage o f Tel labs , nothi ng her e s upp or ts an i nfe re nce o fsci enter th ati s “c o g en t an d a t l ea sta s co m pel l i nga s an y opposi ng i nfe re nce o fnonfra ud ule nt intent. ” The wors t one coul d s ay about Zim m er ’ s answ er i s that i t was ev as ive , w h ich is sh or t o ffr au d u len t. C f. Bron s t on v. U nited Sta tes , 40 9 U.S
. 35 2 (19 72) ( evas i ve answ ercannot be ba sis ofa perj ury co nv iction). Pl ai nti ff s co ntend that w e s h oul d i nfe r sci enter be ca us e Dvo r aka nd ot he r t o p m an ag er s ha d a n i nc en tiv e t o m ak e Z im m e r l o o k g oo d in o rd er to ke ep th eir j obs , i m prove thei r bonuses , and i ncre ase t h e val ue o f th eir stock opt ions. T his is too gen eric to satisfy Tellabs

. A sim ilar a s s e rt ion co u ld be m ad e a b ou t e ve ry firm in the w or l d, but the f act that m anage rs benefit fro m hi gherst ockpri ces d oe s no t i m plythatany parti cul ar m an ager com m itted frau d

. Q uite th e con trary. M an agers usual l y do bestwh en a fi rm has l ong- ter m succe ss. Those w ho bo ostpri ces f ra ud ule ntl y forsi x m onths orso

— as p lai nt iffs say Dv orak an d Zim m er’s other t o p m an agers d id

— and then s ee m ar ketcapi tal i zati on decl i ne, m ay fi nd the m se l ve s o n the s tr ee t, a nd their st o cko pti o ns w on’ t v est
. I f, as p laintiff s m ai ntain, Dvor ak and other m anage rs to l d a se ri es ofl i es d u ri ng the fi rs t hal fo f 2008 abo ut o ne pl ant a nd o ne pro d u c t th at tog ether produced l ess than 10% of the fi rm ’ s i ncom e (Zim m er say s that i t was o nl y 2 % o fgl obalr ev en u e an d 3. 6% o f the y e a r ’ s pr o fi t ) , a nd a ffe c t e d e a r ning s b y o nl y 15 ¢ a shar e, theywere pu tti n g thei r f or tunes a nd car eer s a t sta ke i n exchange f orve ry lit tle re turn. Thi s a spect of10 N o. 11

- 1471 pla i nti ff s’ ar gum ents thus underm i nes, r atherthan stren gth en s, th e inference of scien ter. At a ny g i ve n t i m e, o ne o r anothe r pr o ducto fa dr ug o r me di c a l

- de v i c e p r o du cerwi th a p o r t f o l i o o ftho us a nd s ( Zim m erhas m or e than 130 , 000 u n ique pro du ct c odes) i s har de r t o ma k e o r l e s s s uc c e s s fultha n ho pe d. Qu a l i tycontr oli ssues atpharm aceuti cala nd m edi cal

- devi ce p rod uc ers are end em ic, as cu stom ers an d regulators al way s wanthi g he r qua l i tye ve n tho ug h i nv es to r s want onl y “ enough” quali ty. I nvest i ng be yond the poi nt o f dim i ni shi ng r etur ns i nj ures r ath er than hel ps i nvest or s; com pet en t m an ag er s wi l l do j us t whatZi m m er ’ s we re al l ege d to have done and take a bea dy-e yed vi ew o f pr o po s a l s t o i nv e s tt e ns o fmi l l i o ns i n new cap i t a l e qu i pm en t at every pl an t en co unt er i ngpr o bl ems tha t m i g ht b e s o l v e d mo r e c h e a p l y . T h e a l l e g a t i o n s o fth i s c o mp lain t c o n c er n th e p ro b lem s Z im m er fac ed in 2 00 8; in a di ffer ent y earthe headaches w oul d have co m e fro m a di ffer ent pl ant o r a d iffer ent pr oduct, but the f act th at these part i cul arpro bl em s o ccurr ed

— an d that i nform at ion c am e o uto ve r t i m e, a s m o r e ne ws a cc um ul ate d

— does not i m plythatany m anage r w as l yi ng to i nvest or s. Pl ai nti ff s point t o m any o thersupposedl y f al se sta tem ents and a hos t o fdetai l thatsupposed ly sh ows that o ne o r a no th ers ta te m en t was k no wi ng l y f al se . The dist ri ct c ourt ’ s t w o l engthy o p ini ons add re ss al l o fthes e o th ers ta te m en ts
. W e ha ve c overe d o nl y the hi g hl i ghts

—but, b ec au se the se hi g hl i g ht s ar e pl aint i ff s’ s tr o nges t a rgum ents, t h er e is no need to fi l l the Feder alN o. 11

- 1471 11 Report erwith the r est
. W e ag re e w i th the way the distr ict co u rtad d re ss ed th em , an d its j u d gm en t is AFFI RMED .

5- 21- 12