Daly v. Pyschemedics Corporation et al
Judge Richard G. Stearns: ORDER entered granting 27 Motion to Dismiss. (RGS, law2)
UNITED STATES DISTRICT COURT
DISTRICT OF MASSACHUSETTS
CIVIL ACTION NO. 17-10186-RGS
IN RE PSYCHEMEDICS CORP.
MEMORANDUM AND ORDER
ON DEFENDANTS’ MOTION TO DISMISS
November 7, 2017
Psychemedics’ Chief Executive Officer (CEO), move to dismiss this putative
securities fraud class action brought against them by plaintiff Mary Kathleen
Hermann on behalf of all other similarly situated holders of Psychemedics
stock during the proposed class period for alleged violations of Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a et seq.
The Complaint alleges that Psychemedics misled investors by failing to
disclose that its independent distributor in Brazil, Psychemedics Brasil, had
become secretly entwined in a cartel scheme with a competitor in violation
of Brazilian law, the eventual public disclosure of which precipitated a steep
drop in Psychemedics’ stock price. Because the Complaint fails to allege any
facts that give rise to an inference that Psychemedics had any inkling of the
Brazilian scheme during the time period it is accused of failing to bring its
existence to light, and because plaintiff’s other efforts to establish scienter
are speculative and unconvincing, the court will grant the motion to dismiss.
Psychemedics, a Delaware corporation with its headquarters in Acton,
Massachusetts, provides clinical laboratory services for the detection of illicit
drugs, including hair testing. Psychemedics maintains two laboratories in
Culver City, California, where hair samples are sent to be tested. The
company does business in a number of countries, including Brazil, where a
company named Psychemedics Brasil had the exclusive right to distribute
Psychemedics’ services. 1 In 2013, the Brazilian government announced its
Unless otherwise noted, “Psychemedics” as used in this opinion refers
to defendant Psychemedics, a U.S. company, while “Psychemedics Brasil”
refers to the independent Brazilian distributor, which is not a party to this
case. The Complaint uses ambiguous, and at times conflicting, descriptive
language that muddies the waters as to the precise relationship between
Psychemedics and Psychemedics USA. See Compl. ¶ 2 (describing the
Brazilian company as an “affiliate” of Psychemedics); id. ¶¶ 4, 15 (alleging
that the Brazilian company was Psychemedics’ “exclusive distributor”); ¶ 24
(stating that Psychemedics Brasil describes itself on its website as
Psychemedics’ “legal representative” in the country); ¶ 44 (citing a February
10, 2014 press release from Kubacki describing Psychemedics Brasil as “a
Brazilian-owned independent distributor”). At oral argument on the motion
to dismiss, plaintiff’s counsel described the relationship as one of “agency,”
with Psychemedics Brasil operating as the American company’s “sales arm,”
and that it was “not a coincidence” that the two entities shared the same
name. Defendant’s counsel identified Pyschemedics Brasil as the American
company’s “liaison to doing business in Brazil,” while emphasizing that the
two entities are independent and that Psychemedics did not have an
ownership stake in its Brazilian namesake. Construing the facts in the light
intention to require all professional motor vehicle drivers to submit to a hair
drug test when applying to have their licenses renewed. This proposed new
rule presented Psychemedics with a golden opportunity, leading company
spokespersons to effuse over the potential for expansion of future business
in Brazil. These sanguine statements to investors and shareholders form the
basis of the lawsuit.
On December 3, 2013, the day that the Brazilian government
announced the anti-drug motorist initiative, 2 Psychemedics’ Corporate VicePresident of Sales and Marketing, Jim Dyke, stated in a press release that
Psychemedics Brasil was “a very strong partner . . . who we have worked
closely with for over 15 years,” and that both companies “look[ed] forward to
continuing to work together on this new opportunity.” Compl. ¶ 6. The press
release also quoted Marcello Santos Rachlyn, the President of Psychemedics
Brasil, as saying, “[w]e have been extremely pleased to work closely with
most favorable to the plaintiff as the non-moving party, the court assumes
that Psychemedics Brasil operated as Psychemedics’ exclusive distributor in
Brazil, with which the defendant had a longstanding and “close” working
relationship. Compl. ¶ 6. However, there are no allegations of a corporate
relationship such as parent-subsidiary, or that the two companies comingled
assets or shared their management personnel.
For various reasons not directly pertinent to this case,
implementation of the hair-testing requirement was delayed several times.
The mandate did not ultimately go into effect until the beginning of 2016.
Compl. ¶ 37.
Psychemedics Corporation for the past 15 years.” Id. ¶ 26. A February 10,
2014 press release issued by Psychemedics quoted Kubacki as saying that
Psychemedics was “very excited about competing for the hair testing
business in Brazil.” Id. ¶ 42.
Various other press releases, as well as Psychemedics’ Form 10-K
filings with the SEC, described Psychemedics’ business in rosy terms, noting
that while the company “competes with other hair testing laboratories,” it
“distinguishes itself from hair testing competitors by emphasizing the
superior results the Company obtains through use of its unique patented
extraction method,” Id. ¶¶ 14, 65, 77. Subsequent press releases emphasized
to investors Psychemedics intent to “compete” for a greater share of the
Brazilian hair testing market if and when the testing requirement was
imposed. Id. ¶¶ 53, 55, 82.
Several of these press releases also described investments in
equipment and facilities that Psychemedics had made in anticipation of the
increase in orders that would (presumably) flow from the implementation of
the drug testing mandate.
In addition to these public statements,
“confidential” witnesses cited in the Complaint noted that Kubacki traveled
to Brazil on various occasions between mid-2014 and early 2015 “to assist
Psychemedics Brasil develop and expand its collection network.”
¶ 9. Finally, when the mandatory testing regime launched in the first quarter
of 2016, Psychemedics informed investors on April 26, 2016, in a press
release, that the company was “already seeing a meaningful pickup of testing
volume,” and referenced a statement by Kubacki assuring shareholders that
the company was “aggressively competing” for new business in Brazil. Id. ¶
The difficulty with all these statements, according to the plaintiff, is
that they failed to disclose that Psychemedics was reaping the benefits of an
illicit arrangement between Psychemedics Brasil and its ostensible rival,
Omega Brasil. In essence, Omega Brasil had been bribed to steer exclusive
contracts for drug collection points to Psychemedics at the expense of Omega
USA, for whom Omega Brasil served as an in-country distributor. This
corrupt arrangement had been facilitated by family relationships among
employees of the two Brazilian companies, and had virtually eliminated
market competition for the supply of hair testing products and services. In
other words, plaintiffs argue that the ebullient statements touting
Psychemedics’ prospects for capturing a substantial share of the expected
expansion of the Brazilian market for hair testing services were misleading
because the Brazilian distributor was “cheating – not competing – in order
to expand Psychemedics’ collection network and win new business in Brazil.”
Pl.’s Opp’n at 6.
Omega USA, disgruntled by the rumors that it had been betrayed by its
Brazilian distributor, undertook a confirmatory investigation and pursued
remedies in the Brazilian courts against both Omega Brasil and
Psychemedics Brasil, alleging violations of Brazil’s anti-competition laws. 3
Compl. ¶¶ 36-40. While the court pleadings were publicly available in
Portuguese, the Complaint alleges that the legal proceedings in Brazil were a
camera obscura to investors in the United States because of the language
barrier and the lack of English-language media coverage. Id. ¶¶ 38-39.
On January 20, 2017, a Brazilian judge ruled in favor of Omega USA,
finding that Psychemedics Brasil and Omega Brasil had conspired against
Omega USA, effectively shutting it out of the Brazilian hair-testing market.
Id. ¶ 11. The judge ordered Psychemedics Brasil and Omega Brasil to
indemnify Omega USA for a then-undetermined amount of lost profits. On
January 31, 2017, a Brazilian law firm representing Omega USA issued a
press release celebrating the judgment that the firm had won. Id. ¶ 12. The
The Brazilian lawsuit was initially filed by Omega Brasil, which
alleged that Omega USA had unlawfully terminated their distribution
agreement. Compl. ¶ 38. Omega USA then filed a counterclaim that accused
Omega Brasil and Psychemedics Brasil of anticompetitive practices. Id. ¶ 39.
firm’s announcement was picked up and published by Bloomberg, which
added that Psychemedics Brasil was facing further investigation by Brazil’s
Administrative Council for Economic Defense for engaging in “cartel
practices.” Id. ¶ 98.
The Bloomberg report, disclosing the existence of the scheme and the
Brazilian court ruling – had an insalubrious effect on Psychemedics’ stock
price, which dropped from an intraday high of $25.87 per share on January
31, 2017, to a low of $13.83 against a 5,000% increase in trading volume from
the previous day. Id. ¶ 101. The stock closed out the day at $18.87 per share,
representing a loss of more than 25% of its opening price. Id. The plaintiff
pounced two days later, filing the original Complaint in this court (the
amended version of the Complaint was filed on June 2, 2017).
prospective class consists of all purchasers of Psychemedics common stock
between February 10, 2014, and January 31, 2017. Psychemedics now moves
to dismiss. The court heard oral argument on October 19, 2017.
To state a claim under section 10(b) and its corresponding rule, a
plaintiff must allege: “(1) a material misrepresentation or omission; (2)
scienter; (3) a connection with the purchase or sale of a security; (4) reliance;
(5) economic loss; and (6) loss causation.” Miss. Pub. Employees Retirement
Sys. v. Boston Scientific Corp., 523 F.3d 75, 85 (1st Cir. 2008). The Private
Securities Litigation Reform Act of 1995 (PSLRA) supplies the pleading
standards a court is to apply in securities fraud cases. Under these standards,
a plaintiff must specify each statement or omission that is allegedly
misleading, explain why each statement or omission is deceitful or
disingenuous, and provide factual support for the allegations of fraud.
Greebel v. FTP Software, Inc., 194 F.3d 185, 193-194 (1st Cir. 1999).
Scienter is a “mental state embracing intent to deceive, manipulate, or
defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). A
defendant may also have the requisite mental state if it “acted with a high
degree of recklessness.” Aldridge v. A.T. Cross Corp., 284 F.3d 72, 82 (1st
Cir. 2002). “Recklessness, as used in this context, ‘does not include ordinary
negligence, but is closer to being a lesser form of intent.’” Fire & Police Ass’n
of Colo. v. Abiomed, Inc., 778 F.3d 228, 240 (1st Cir. 2015) (quoting Greebel,
194 F.3d at 188).
Thus, “a defendant can be held liable for ‘a highly
unreasonable omission, involving not merely simple, or even inexcusable,
negligence, but an extreme departure from the standards of ordinary care,
and which presents a danger of misleading buyers or sellers that is either
known to the defendant or is so obvious the actor must have been aware of
it.’” City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters
Corp., 632 F.3d 751, 757 (1st Cir. 2011) (quoting Greebel, 194 F.3d at 198).
Allegations of scienter are subject to a heightened pleading standard
under the PSLRA. See Greebel, 194 F.3d at 195. Consequently, plaintiff
must, “with respect to each act or omission . . . state with particularity facts
giving rise to a strong inference that the defendant acted with the required
state of mind.” 15 U.S.C. § 78u-4(b)(2). The requisite “strong inference”
exists where that inference is “cogent and at least as compelling as any
opposing inference of nonfraudulent intent.” Tellabs, Inc. v. Makor Issues
& Rights, Ltd., 551 U.S. 308, 324 (2007). As this formulation implies, courts
must evaluate “not only inferences urged by the plaintiff . . . but also
competing inferences rationally drawn from the facts alleged.” Id. at 314.
The critical defect here is that the Complaint is devoid of any factual
allegations that would tend to support an inference (much less direct
evidence) that Psychemedics knew of the anti-competitive cabal between
Psychemedics Brasil and Omega Brasil prior to it coming to light in the
Brazilian lawsuit. Instead, the Complaint simply asks the court to assume
knowledge on the part of Psychemedics and to impute a concomitant duty of
disclosure to investors. A few examples from the Complaint give a flavor of
plaintiff’s inverse logic:4
2. Specifically, Defendants misled investors by concealing from
them the fact that, through its affiliate Psychemedics Brasil
Exames Toxicologicos Ltda. (“Psychemedics Brasil”), the
Company participated in and benefitted from an unlawful
scheme to monopolize the Brazilian hair drug test market in
violation of Brazilian law.
10. Defendant Kubacki claimed Psychemedics was “aggressively
competing” for business in Brazil, but failed to disclose that
Psychemedics Brasil’s success was driven by unlawful,
15. As alleged herein, Psychemedics and Defendant Kubacki
knowingly concealed from investors that the Company’s
exclusive distributor in Brazil was conspiring with a competitor
to limit market participation in Brazil.
42. Psychemedics concealed from investors the fact that its
Brazilian expansion would benefit from its exclusive distributor’s
anticompetitive practices, which violated Brazilian law.
The common skein running through all these allegations is that
Psychemedics knew, or must have known, of its distributor’s wrongdoing, yet
In the classic example of a categorical syllogism (if A is part of C then
B is part of C), we begin with the major premise that all men are mortal,
followed by the minor premise that Socrates is a man, and the logical
conclusion that Socrates therefore is mortal. In plaintiff’s syllogistic fallacy
(drawing an affirmative conclusion from a negative premise) we start with
the negative premise that Psychemedics failed in its duty to disclose, then
proceed to the affirmative proposition that a party can violate the duty to
disclose only if it possesses fraudulent intent, and draw from this the
conclusion that Psychemedics therefore possessed scienter.
there are no factual allegations even suggesting that that was the case. The
Complaint instead iterates, in conclusory fashion, that Psychemedics must
have known of the illegal arrangement between two independent Brazilian
companies (neither of whom is a party to the case), despite the absence of
evidence that Psychemedics had any inkling of the scheme prior to
publication of the Bloomberg report.
It is axiomatic that “defendants cannot have committed fraud if they
did not know at the time that the failure to provide additional information
was misleading.” New Jersey Carpenters Pension & Annuity Funds v.
Biogen IDEC Inc., 537 F.3d 35, 48 (1st Cir. 2008); see also Miss. Pub.
Employees’ Retirement Sys., 523 F.3d at 86 (“Securities actions raise
questions of what corporate managers knew and when they knew it.”). As
Judge Saylor observed in a recent case, “a complaint is insufficient under the
PSLRA if it does not contain particularized factual allegations raising a
strong inference that at the time of disclosure defendants knew (or were
reckless by not knowing) that their failure to provide additional information
was misleading.” Brennan v. Zafgen, Inc., 199 F. Supp. 3d 444, 451 (D. Mass.
2016), aff’d, 853 F.3d 606 (1st Cir. 2017).
Apparently recognizing the thin soup of the Complaint, plaintiff
invokes a number of alternative legal theories and bits of evidence that she
says support an inference of scienter. Ensemble, she argues, these shards
are sufficient to put her beyond the pleading stage. As a general matter, a
plaintiff is perfectly entitled to point to an accumulation of pieces of indirect
evidence for purposes of establishing scienter. See, e.g., Aldridge v. A.T.
Cross Corp., 284 F.3d 72, 82 (1st Cir. 2002) (noting that a “plaintiff may
combine various facts and circumstances indicating fraudulent intent to
show a strong inference of scienter.”). However, “where a complaint is
devoid of any direct-evidence allegations, the indirect-evidence allegations
in the complaint will need to do more work to carry the burden of raising a
‘strong inference of scienter’ on their own.” Brennan, 853 F.3d at 615 n. 8.
Plaintiff’s first alternative argument is that principles of agency are
sufficient to find scienter because Psychemedics Brasil’s wrongful acts are
“imput[able] to” Psychemedics. Pl.’s Opp’n at 8. In support of this theory,
she cites In re Cabletron Sys., Inc., 311 F.3d 11, 40 (1st Cir. 2002), where the
First Circuit found that “[t]he scienter allegations against the company’s
agents is enough to plead scienter for the company.” Id. at 40. However, in
Cabletron, the First Circuit was addressing statements made by the
defendant company’s corporate officers and executives. The district court
cases cited by the plaintiff are of the same ilk. See, e.g., In Re Brooks
Automation, Inc. Sec. Litig., 2007 WL 4754051, at *12 (D. Mass. Nov. 6,
2007) (scienter allegations against the former CEO and two members of the
compensation committee of a publicly-traded semiconductor company “may
be imputed to [the company] for the purpose of establishing [the company’s]
Applying this accepted legal principle to the facts of the instant case,
had the plaintiff alleged, for example, that Kubacki’s statements were made
with the requisite level of scienter – and had the facts as alleged shown that
he knew about the corrupt arrangement between Psychemedics Brasil and
Omega Brasil – then as the company CEO, his scienter could be imputed to
Psychemedics. It is an altogether different proposition to say that the
fraudulent actions or statements undertaken by corporate officers in
Company A can support not only a claim of scienter against Company A, but
also against Company B, absent an alter-ego relationship. Allowing this type
of layering would be even more questionable in a case like this one where the
companies are separate entities that do not operate in a parent-subsidiary
context no matter how “close” their working relationship. 5
The court is not convinced by the plaintiff’s suggestion that “[t]he
Complaint is replete with allegations demonstrating Psychemedics’ control
over its extremely close corporate relationship with Psychemedics Brasil,
which establishes the existence of an agency relationship.” Pl.s’ Opp’n at 9.
Certainly the Complaint alleges that Psychemedics was thrilled over the
Brazilian government’s proposed hair-testing rule and frequently praised the
efforts of its Brazilian distributor to expand Psychemedics’ Brazilian market;
Next, the plaintiff argues that the “core operations doctrine” supports
a finding of scienter. See Crowell v. Ionics, Inc., 343 F. Supp. 2d 1, 19 (D.
Mass. 2004) (“[I]t can be inferred that top executives at [the company] were
aware of a scheme involving systemically fraudulent sales practices given the
importance” of the sale at issue to the company’s bottom line). The First
Circuit has to this point declined to enumerate the ways in which “core
operations” might give rise to a strong inference of scienter, see In Re Biogen
Inc. Sec. Litig., 857 F. 3d 34, 44 (1st Cir. 2017) (declining to reach the
question “because the allegations” of core operations clearly fall short).
However, even in Crowell, the court did not find that a particular sale
or investment, however much a “core” concern of the company was, standing
it might even be fair to say that in its eagerness to preserve its Brazilian
foothold, it went to great lengths to “control . . . its extremely close corporate
relationship with Psychemedics Brasil.” But control and management of a
relationship is distinct from control and management of another party to the
extent that the other party “acts as a representative of or otherwise acts on
behalf of another person with power to affect the legal rights and duties of
the other person.” See Restatement (Third) of Agency § 1.01 cmt. c (2006).
The plaintiff’s effort to tie two distinct corporate entities together through
some vague allegations of “closeness” also runs headlong into the established
principle that “the ‘presumption of corporate separateness’ is difficult to
overcome . . . [and] conclusory allegations do not suffice.” Cambridge
Literary Props., Ltd. v. W. Goebel Porzellanfabrik G.m.b.H. & Co. Kg., 295
F.3d 59, 66 (1st Cir. 2002) (quoting United Elec., Radio & Mach. Workers of
Am. v. 163 Pleasant St. Corp., 960 F.2d 1080, 1091 (1st Cir. 1992)).
alone, sufficient to establish scienter. As this court noted in a subsequent
case, the “core operations” theory in Crowell was “buttressed by a ‘plus
factor’ — an email pointing to the company’s vice president as the author of
the scheme.” In re A123 Sys., Inc. Sec. Litig., 930 F. Supp. 2d 278, 285 (D.
Mass. 2013) (citing Crowell, 348 F. Supp. 2d at 19). In the present case,
plaintiff’s “core operations” theory stands naked, unadorned by any other
piece of evidence purporting to establish the essential “plus” factor – guilty
knowledge on the part of Kubacki or Psychemedics.
Drawing the next arrow from her quiver, plaintiff trots out
“confidential” (i.e., anonymous) witness statements emphasizing the
importance of the Brazilian expansion to Psychemedics’ business and
characterizing Kubacki as a “micromanager” whose hands-on style make it
improbable that he was not complicit to the illicit arrangement in Brazil. 6
See Compl. ¶ 111 (“Confidential witnesses described the importance of the
Brazilian opportunity to Psychemedics, and explained that Defendant
Kubacki was personally involved in overseeing the expansion in Brazil,
including the development of Psychemedics Brasil’s collection network.”).
Tellingly, there are no allegations in the Complaint that the two
confidential witnesses themselves knew of the anti-competitive scheme, or
even knew of the litigation in the Brazilian courts.
Taken together, these statements, according to the plaintiff, “place Kubacki
on the ground in Brazil helping to set up the vast collection network that was
the lynchpin to Psychemedics Brasil’s anticompetitive conduct at the same
time of the alleged wrongdoing.” Pl.’s Opp’n at 15.
Even crediting these confidential witness statements as accurate, they
fail to tie Kubacki himself to the anti-competitive scheme, instead asking the
court to make the leap that, as an obsessive micromanager, he had to have
known what the third-party distributor was up to. 7 This same argument has
failed to impress other courts to which it has been made. See, e.g., Lirette v.
Shiva Corp., 27 F. Supp.2d 268, 283 (D. Mass. 1998) (“[G]eneral inferences
that the defendants, by virtue of their position within the company, ‘must
have known’ about the company’s problems when they undertook allegedly
At oral argument, plaintiff’s counsel argued that discovery would
remedy the deficiencies of the Complaint by ferreting out facts showing that
Kubacki was aware of the plotting in Brazil. However, the heightened
pleading standards that apply under the PSLRA reflect a deliberate choice
made by Congress to bar even some possibly meritorious claims from
proceeding past the pleading stage. See Local No. 8 IBEW Ret. Plan &
Trust v. Vertex Pharm., Inc., 838 F.3d 76, 83 n.9 (1st Cir. 2016)
(acknowledging that “prior to discovery, few plaintiffs will be in a position to
make specific allegations about the form of internal documents” or
discussions, but also noting that Congress has nonetheless “deliberately
raised the entry bar to discovery . . . through the PSLRA’s heightened
pleading standards” (alteration in original) (quoting Auto. Indus. Pension
Trust Fund v. Textron, Inc. 682 F.3d 34, 40 (1st Cir. 2012)).
fraudulent actions . . . [are] inadequate to withstand the special pleading
requirements in securities fraud cases.”) (citing Maldonado v. Dominguez,
137 F.3d 1, 9 (1st Cir. 1998)). This argument becomes even less persuasive
where the misconduct in question results from actions taken by employees
of a third party who are not under the micromanaging boss’s direct
Finally, plaintiff argues that scienter can be inferred from the fact that
defendants had a financial motive to hide the alleged fraud because their
compensation was dependent on the successful outcome of the Brazilian
expansion. See Compl. ¶ 126 (“Defendant Kubacki’s compensation – and
particularly the form of his compensation – tracked closely with the
Company’s expansion in the Brazilian market.”); Compl. ¶ 122 (“Throughout
the Class Period, Psychemedics’ executives’ annual compensation was tied
closely to the Company’s success in Brasil. . . . This compensation structure
created an incentive for Defendant Kubacki to cause and allow Psychemedics
to profit from the unlawful, anticompetitive conduct of Psychemedics
Brasil.”). This argument, too, fails, because “‘the usual concern by executives
to improve financial results’ does not support an inference of scienter”
without “something more.” Corban v. Sarepta Therapeutics, Inc., 868 F.3d
31, 41-42 (1st Cir. 2017) (quoting In Re Cabletron, 311 F.3d at 39)). It is not
enough for a plaintiff to point to “the ever present desire to improve results,”
id., as supporting a motive to commit fraud, particularly when it is a common
practice for executive compensation to be linked to performance. See In re
Smith & Wesson Holding Corp. Sec. Litig, 604 F. Supp. 2d 332, 344 (D.
Mass. 2009) (“That the executives may have gained some compensation is
not enough [under the PSLRA], since stock-based compensation is a
common feature of pay packages and executives already have an incentive to
provide value to their shareholders.”). In sum, the mere fact that defendants
stood to gain from the success of the company’s planned expansion into
Brazil, and that they therefore may have had an incentive to hide fraud
(which they may or may not have known about), does not support an
inference of scienter that is “as compelling as any opposing inference one
could draw from the facts alleged.” Tellabs, 551 U.S. at 324.
For the foregoing reasons, defendants’ motion to dismiss is
ALLOWED. The Clerk will enter judgment accordingly and close the case.
/s/ Richard G. Stearns
UNITED STATES DISTRICT JUDGE
Disclaimer: Justia Dockets & Filings provides public litigation records from the federal appellate and district courts. These filings and docket sheets should not be considered findings of fact or liability, nor do they necessarily reflect the view of Justia.
Why Is My Information Online?