Opinion ID: 3014742
Heading Depth: 2
Heading Rank: 2

Heading: Does Union have a valid claim under section

Text: 10(b)? Section 10(b) of the Exchange Act makes it “unlawful” 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 Commission may prescribe.” 15 U.S.C. § 78j(b). Rule 10b-5 makes it illegal, as a manipulative or deceptive device, “[t]o 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, 14 not misleading.” 17 C.F.R § 240.10b-5. To make out a securities fraud claim under section 10(b), a plaintiff must show that “(1) the defendant made a materially false or misleading statement or omitted to state a material fact necessary to make a statement not misleading; (2) the defendant acted with scienter; and (3) the plaintiff’s reliance on the defendant’s misstatement caused him or her injury.” Cal. Pub. Employees’ Ret. Sys. v. Chubb Corp., 394 F.3d 126, 143 (3d Cir. 2004) (citing In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1417 (3d Cir. 1997)). These requirements are heightened by the PSLRA, which requires that the complaint “state with particularity all facts on which [plaintiff’s] belief is formed.” 15 U.S.C. § 78u-4(b)(1). At issue in this case is whether Merck’s statements were material and whether Union properly alleged “false or misleading” statements by Merck and Medco. 1. When Merck disclosed information regarding its revenue calculations, was the disclosure material? We have said that establishing materiality is the “first step” for a plaintiff with a section 10(b) claim. In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1417 (3d Cir. 1997). The District Court discussed briefly the issue of materiality regarding Union’s § 10(b) claim, but it did not reach the issue because it ultimately found that Union had failed sufficiently to show scienter. Union argues that Merck’s statements were 15 material, citing the fact that Merck’s stock dropped significantly when The Wall Street Journal’s article detailing Medco’s accounting practices appeared. Merck claims that because its stock price rose immediately following its initial, minimal disclosure, the disclosure was immaterial as a matter of law. Our Court, as compared to the other courts of appeals, has one of the “clearest commitments” to the efficient market hypothesis.5 Nathaniel Carden, Comment, Implications of the Private Securities Litigation Reform Act of 1995 for Judicial Presumptions of Market Efficiency, 65 U. Chi. L. Rev. 879, 886 (1998). Our 1997 Burlington opinion created a standard for measuring the materiality of statements in an efficient market.6 See 114 F.3d at 1425. In 2000, we ratified the Burlington standard post-PSLRA in Oran v. Stafford. 226 F.3d 275, 282 (3d Cir. 2000) (citing Burlington). The Oran-Burlington standard holds that “the materiality of disclosed information may be measured post hoc by looking to the movement, in the period immediately following disclosure, of the price of the firm’s stock.” Id. 5 We have defined an efficient market as that in which “information important to reasonable investors (in effect, the market) is immediately incorporated into stock prices.” Burlington, 114 F.3d at 1425 (citation omitted). 6 Union has alleged that Merck’s stock traded on an efficient market. Compl. ¶ 212(c). 16 In Oran, information was disclosed on July 8, and the stock price rose for four days afterward. We held that the failure to disclose the information earlier was immaterial. Id. at 283. Similarly, in In re NAHC, Inc. Securities Litigation, we discerned “no negative effect” on a company’s stock price “immediately following” the date of disclosure. 306 F.3d 1314, 1330 (3d Cir. 2002). Again, we held the disclosed information immaterial as a matter of law. Id. In this case, the disclosure occurred on April 17, and there was no negative effect on Merck’s stock. The Wall Street Journal’s article, accompanied by a significant decline in Merck’s stock, appeared two months later. Union claims that this June stock decline demonstrates the materiality of the information Merck disclosed. But the situation we faced in NAHC was similar: the company’s stock price plunged 75% just three weeks after the disclosure was made. Id. at 1321. That disclosure was made on November 2, with no negative effect on the stock price, but the stock plummeted on November 26, after another disclosure. Id. at 1321, 1330. We held the first disclosure not material. Merck’s stock did not drop after the first disclosure, and that is generally when we measure the materiality of the disclosure, not two months later. In Basic Inc. v. Levinson, the Supreme Court declined to resolve “how quickly and completely publicly available information is reflected in market price.” 485 U.S. 224, 248 n.28 (1988). Union tells us that we cannot therefore apply the 17 Oran-Burlington standard. But it overlooks that our Court has resolved how “quickly and completely” public information is absorbed into a firm’s stock price. We have decided that this absorption occurs “in the period immediately following disclosure.” Oran, 226 F.3d at 282. This does not mean instantaneously, of course, but in this case there was no adverse effect to Merck’s stock price from the disclosure “in the period immediately following disclosure.” In fact, Merck’s stock continued to rise from its baseline of $55.02, including the April 17 S-1 filing date, for five trading days after the disclosure. The five-trading-day rise was followed by a fivetrading-day decline, which reached a low of $54.34. Then, starting on May 1, 2002, Merck’s stock remained above $55.02 until June 4. But Union expects us to ignore this one-month increase in Merck’s stock price in favor of a five-day decline of little over 1%. This we will not do. Union also argues that the April 17 disclosure was so opaque that it should not have counted as a disclosure. Although Merck disclosed that it had recognized co-payments as revenue in April, it did not disclose the sum total of those copayments until July. This is why, Union claims, the stock price did not drop until The Wall Street Journal’s reporter made public the estimated magnitude of the co-payment recognition. In effect, Union is arguing that investors and analysts stood in uncomprehending suspension for over two months until the Journal brought light to the market’s darkness. 18 The Journal reporter arrived at an estimate of $4.6 billion of co-payments recognized in 2001 by using one assumption and performing one subtraction and one multiplication on the information contained in the April S-1. She determined the number of retail prescriptions filled (462 million) by subtracting home-delivery prescriptions filled (75 million) from total prescriptions filled (537 million). She then assumed an average $10 co-payment and multiplied that average co-payment by the number of retail prescriptions filled to get $4.6 billion.7 The issue is whether needing this amount of mathematical proficiency to make sense of the disclosure negates the disclosure itself. We scrutinized a disclosure requiring calculation in Ash v. LFE Corp., 525 F.2d 215 (3d Cir. 1975). A proxy statement disclosed directors’ current pension amounts and, in another section, their newly proposed pension amounts, but it did not disclose the increase. Id. at 218. We held that requiring readers to perform the subtraction themselves was immaterial because the “facts [we]re disclosed prominently and candidly.” Id. at 219 (“We decline to hold that those responsible for the preparation of proxy solicitations must 7 Union makes much of the difference between the estimated $4.6 billion and the actual $5.54 billion, but had the Journal reporter used a slightly higher average co-payment, this difference would have been smaller. She noted that “$10 to $15 is typical in the industry.” Martinez, supra. Had she used $12.50, the average of $10 and $15, she would have come up with $5.78 billion. 19 assume that stockholders cannot perform simple subtraction.”). The calculation from Merck’s S-1 was somewhat more complex—it required some close reading and an assumption as to the amount of the co-payment. But the added, albeit minimal, arithmetic complexity of the calculation hardly undermines faith in an efficient market. Union points out nonetheless that Merck was followed by many analysts, including J.P. Morgan, Morgan Stanley, and Salomon Smith Barney, who “closely examine a company’s revenue and revenue growth when valuing a company’s stock” in Merck’s industry. Compl. ¶ 9. The logical corollary of Union’s argument then is the following rhetorical question: If these analysts—all focused on revenue—were unable for two months to make a handful of calculations, how can we presume an efficient market at all? Union is trying to have it both ways: the market understood all the good things that Merck said about its revenue but was not smart enough to understand the copayment disclosure.8 An efficient market for good news is an efficient market for bad news. The Journal reporter simply did 8 Union needs the market to be efficient. With an efficient market it can use the fraud-on-the-market theory, which allows it to meet its section 10(b) reliance requirement. See Burlington, 114 F.3d at 1415 n.1, 1419 n.8. The fraud-on-themarket theory supposes that “‘the price of a company’s stock is determined by the available material information regarding the company and its business.’” Basic Inc., 485 U.S. at 241 (quoting Peil v. Speiser, 806 F.2d 1154, 1160 (3d Cir. 1986)). 20 the math on June 21; the efficient market hypothesis suggests that the market made these basic calculations months earlier. But we do not wish to reward opaqueness. We decline to decide how many mathematical calculations are too many or how strained assumptions must be, but Merck was clearly treading a fine line with this delayed, piecemeal disclosure. It should have disclosed the amount of co-payments recognized as revenue in the April S-1; it should have disclosed this revenuerecognition policy as soon as it was adopted. Sunshine is a fine disinfectant, and Merck tried for too long to stay in the shade. The facts were disclosed, though, and it is simply too much for us to say that every analyst following Merck, one of the largest companies in the world, was in the dark. 2. Did Union properly allege that “false or misleading” statements were made by Merck and Medco?9 i) Were the Merck and Medco statements regarding their independence false or misleading? 9 Scienter and reliance typically would come next in our analysis after materiality. See Burlington, 114 F.3d at 1417. But because we have decided that the initial S-1 disclosure was not materially false or misleading and did not omit sufficient facts, we do not discuss scienter here. 21 Union’s complaint alleges that Medco made false statements about Merck’s and Medco’s independence. The District Court held that these statements were not actionable because Union’s supporting evidence came mostly from dates outside the class period. Medco’s website contained statements about Medco’s independence policy. The website stated, among other things, that Medco would “make decisions on the therapeutic aspects of its programs without substantive influence from Merck” and would “treat Merck products no differently from those of any other manufacturer, observing the same procedures for independent clinical review as it does for drugs of any other manufacturer.” Compl. ¶ 126. Union produced data showing the extent to which Merck’s market share among Medco beneficiaries was significantly higher than its nationwide market share. The District Court discarded this market-share evidence, holding it unusable because most of it arose from outside the class period. To support its holding, the Court cited only a case from the Northern District of California, Clearly Canadian, which held “statements made or insider trading” done outside the class period “irrelevant to [the] plaintiffs’ fraud claims.” In re Clearly Canadian Sec. Litig., 875 F. Supp. 1410, 1420 (N.D. Cal. 1995). The Clearly Canadian Court, though, had just denied the defendants’ motion to dismiss and was striking from the plaintiffs’ complaint nearly 20 pages of allegations of statements and insider trading from outside the class period. Id. The Court was removing out-of-period claims because the 22 defendants were not liable for them; it was not addressing their relevance as evidence. Two Second Circuit cases have, however, addressed outof-period information for the purposes of allowing inferences to be drawn. In Novak v. Kasaks the plaintiffs’ complaint provided facts about inventory write-offs from after the expiration of the class period, and the Court held that those facts supported the plaintiffs’ allegations that inventory issues existed during the class period. 216 F.3d 300, 312–13 (2d Cir. 2000). It further held that a report showing inventory information “six months after the Class Period . . . supports the inference that inventory during the Class Period was similar[].” Id. at 213. In a 2001 case the Second Circuit reversed the District Court, holding that pre-class data was relevant to show defendants’ knowledge at the start of the class period. In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 72 (2d Cir. 2001). The Court made clear that both post-class-period data and pre-class data could be used to “confirm what a defendant should have known during the class period,” noting that “[a]ny information that sheds light on whether class period statements were false or materially misleading is relevant.” Id. The District Court in our case found that Union could not “rely on statistical data collected prior to the commencement of the class period . . . to buttress [its] contention that the statements on Medco’s website were misleading.” In re Merck & Co., Inc. Sec. Litig., No. 02-CV-3185 (SRC), slip op. at 34 23 (D.N.J. July 6, 2004). This finding directly conflicts with the Second Circuit’s holding in Scholastic, and the Clearly Canadian case is meager support. We shall follow the Second Circuit here and hold the pre-class data regarding Merck’s market share relevant to showing Medco’s statements to be misleading. The District Court therefore incorrectly disregarded the evidence of Medco’s favoritism toward Merck products.10 ii) Did Gilmartin’s January 2002 statement fall within the “forward-looking statement” safe harbor? Union alleged that Gilmartin’s statement in a January 2002 press release was false and misleading. As we noted, Gilmartin, discussing the planned Medco IPO, said, “[W]e believe the best way to enhance the success of both businesses going forward is to enable each one to pursue independently its unique and focused strategy.” The District Court held that this statement fell within the “forward-looking statement” safe harbor, thereby foreclosing liability for the statement. Union argues that this statement cannot meet the safe harbor’s requirements because it was about a planned initial public offering. Concerned about the effect of litigation’s specter on 10 We of course do not remand this case, because we held against Union on materiality. 24 corporate disclosure, Congress created in the PSLRA a safe harbor for forward-looking statements. S. Rep. No. 104-98, at 16, reprinted in 1995 U.S.C.C.A.N. 679, 695. This safe harbor is designed to shield statements like those regarding revenue projections and future business plans from leading to liability. Id. at 17, reprinted in 1995 U.S.C.C.A.N. 679, 696. But the safe harbor does not apply to statements “made in connection with an initial public offering.” 15 U.S.C. § 78u- 5(b)(2)(D). It can be assumed that statements made in a registration statement and prospectus filed for an IPO are made “in connection with” that IPO. See, e.g., In re Ravisent Techs., Inc. Sec. Litig., No. Civ.A. 00-CV-1014, 2004 WL 1563024, at  n.27 (E.D. Pa. July 13, 2004) (registration statement); In re Musicmaker.com Sec. Litig., No. CV00-2018 CAS(MANX), 2001 WL 34062431, at  n.7 (C.D. Cal. June 4, 2001) (registration statement and prospectus). One case has suggested that statements made at pre-IPO presentations are “in connection with” an IPO. See In re Ins. Mgmt. Solutions Group, Inc. Sec. Litig., No. 8:00CV2013T26MAP, 2001 WL 34106903, at ,  (M.D. Fla. July 11, 2001). We hold today only that a statement made in a press release several months before a planned IPO that never subsequently happened is not “in connection with” an IPO. We do not address, however, whether statements made in registration statements and prospectuses may lead to liability if 25 an IPO does not occur.11