Woburn Retirement System v. Salix Pharmaceuticals, Ltd. et al
OPINION & ORDER: Defendants have moved to dismiss the Consolidated Class Action Complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). For the foregoing reasons, Defendants' Motions to Dismiss are DENIED in their entirety. (As further set forth in this Opinion & Order.) (Signed by Judge Kimba M. Wood on 4/22/2016) (mro)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
In re SALIX PHARMACEUTICALS, LTD.
OPINION & ORDER
KIMBA M. WOOD, U.S. District Judge:
Lead Plaintiff Pentwater Funds and additional named Plaintiff City of Fort Lauderdale
General Employees’ Retirement System (collectively, “Plaintiffs”) bring this class action against
Salix Pharmaceuticals (“Salix”) and two of its former officers: Carolyn J. Logan, the former
Chief Executive Officer (CEO) of Salix, and Adam C. Derbyshire, the former Chief Financial
Officer (CFO) of Salix (collectively, “Defendants”). Plaintiffs allege that Defendants made false
or misleading statements regarding the financial health of Salix during the period from
November 8, 2013 to November 6, 2014 (the “Class Period”), and that these statements
artificially increased the price of Salix’s publicly-traded securities. On behalf of all parties who
purchased Salix shares during the Class Period, Plaintiffs assert that Defendants’ conduct
violates Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”).
Defendants have moved to dismiss the Consolidated Class Action Complaint pursuant to
Federal Rules of Civil Procedure 9(b) and 12(b)(6). For the reasons stated below, the Court
DENIES Defendants’ Motions to Dismiss in their entirety.
The following facts are taken from Plaintiffs’ Consolidated Class Action Complaint
(“CCAC”) and are assumed to be true for purposes of Defendants’ Motions to Dismiss. See
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007); see also Shipping Fin.
Servs. Corp. v. Drakos, 140 F.3d 129, 131 (2d Cir. 1998) (“When considering a motion to
dismiss . . . for failure to state a cause of action, a court must accept as true all material factual
allegations in the complaint.”).
A. The Parties
Lead Plaintiff Pentwater Funds consists of five related private investment funds. (CCAC
¶ 28).1 Additional named Plaintiff City of Fort Lauderdale General Employees’ Retirement
System is a pension system organized for the benefit of current and retired public employees of
the City of Fort Lauderdale, Florida. Id. ¶ 29. Plaintiffs purchased Salix common stock during
the Class Period and allege that they were damaged thereby. Id. ¶¶ 28-29.
Defendant Salix is a pharmaceutical company based in Raleigh, North Carolina, that
specializes in products for the treatment of gastrointestinal diseases. Id. ¶ 30. Defendant Carolyn
J. Logan served as a senior executive at Salix from 2000 to 2014, first as Senior Vice President
of Sales and Marketing, from 2000 to 2002, and then as President and CEO, from 2002 to 2015.
Id. ¶ 31. Defendant Adam C. Derbyshire served as CFO of Salix from 2000 to 2014. Id. ¶ 32.
During the Class Period, Defendants Logan and Derbyshire (collectively, the “Individual
Defendants”) were responsible for reviewing and signing Salix’s SEC filings and SarbanesOxley (“SOX”) certifications, and for discussing Salix’s performance on regular conference calls
held with investors and analysts. Id. ¶¶ 31-32.
The five funds are (1) PWCM Master Fund Ltd.; (2) Pentwater Equity Opportunities Master Fund Ltd.;
(3) Oceana Master Fund Ltd.; (4) Pentwater Merger Arbitrage Master Fund Ltd.; and (5) LMA SPC for and on
behalf of the MAP98 Segregated Portfolio. (CCAC ¶ 28).
B. The Alleged Scheme
1. Salix’s Sales Model
Like many pharmaceutical companies, Salix employed a wholesale model for distributing
its products: Salix sold directly to wholesale customers, who in turn sold Salix medications to
retail pharmacies to fill patient prescriptions. Id. ¶ 39. Because Salix derived its revenue from
sales to wholesalers (rather than from sales to retail pharmacies or individual customers),
wholesaler inventory levels provided a critical metric for evaluating (1) the health of the
company, and (2) continuing demand for Salix’s products. Id. ¶¶ 3, 39.
In the years prior to the Class Period, Salix regularly reported that wholesaler inventory
levels for its key drugs, Xifaxan and Apriso, were generally in the 10- to 12-week range. Id. ¶ 49.
Unlike many pharmaceutical companies, Salix did not employ Distribution Service Agreements
(“DSAs”)2 that contractually mandated these inventory levels. See id. ¶¶ 47-48. Rather, Salix
relied on internal company data to track inventory levels based on the volume of what was
shipped to wholesale customers, what was passed on to retail pharmacies, and what was
returned. Id. ¶ 48.
2. The Channel-Stuffing Scheme
Plaintiffs allege that, sometime before the start of the Class Period, Defendants initiated a
scheme to “stuff the channel” with Salix’s key products, i.e., to increase levels of wholesaler
inventory vastly beyond prescription demand, in order to make Salix’s financial performance
appear stronger than it actually was. Id. ¶ 5. Defendants allegedly did so through tactics such as:
(1) for key products, offering steep price discounts that were “two to four times greater than
industry standards”; (2) announcing future price increases in order to encourage extra purchases
DSAs are also sometimes referred to as Inventory Management Agreements (“IMAs”). (CCAC ¶ 47).
before the price increase took effect; and (3) paying wholesalers millions of dollars for
“marketing services” in exchange for quid pro quo agreements to buy even greater amounts of
Salix’s products than they otherwise would have done. Id. ¶¶ 8, 65-67. These techniques caused
wholesaler inventory levels of Salix’s key drugs, Xifaxan and Apriso, to climb significantly. By
the start of the Class Period, Salix’s wholesale customers had accumulated “at least nine months’
worth of inventory,” more than three times the amount Salix had previously reported as its
inventory level of 10 to 12 weeks. Id. ¶ 5.
On November 7, 2013, the day before the start of the Class Period, Salix announced that
it was acquiring Santarus, another pharmaceutical company that specialized in medications for
gastrointestinal conditions. Id. ¶ 58. Immediately upon completing this acquisition, the
Defendants expanded their channel stuffing scheme to include Santarus’s leading drugs,
Glumetza and Uceris. Id. ¶ 8, 59. To do this, Defendants cancelled the existing DSAs that
Santarus had in place with its wholesale customers, id. ¶ 64, and used the same techniques that
Defendants had previously employed with Salix’s own products, such as offering steep price
discounts and announcing future price increases to encourage short-term purchasing, id. ¶ 66.
According to Plaintiffs, the scheme to stuff the channel with new Santarus drugs was necessary
to offset the inevitable decline in revenues for Salix’s legacy products, Xifaxan and Apriso,
given that inventory levels for these products had reached nine months by the time Salix
announced its acquisition of Santarus. See id. ¶ 63. Although wholesaler inventory levels for
Santarus products were low at the time the company was acquired by Salix, by the end of the
Class Period they had climbed to seven months for the Santarus drug Glumetza, and five months
for the Santarus drug Uceris, all as a result of Defendants’ alleged channel-stuffing scheme. See
id. ¶¶ 8, 16, 95.
3. Potential Acquirers Discover the Channel Stuffing
Meanwhile, Salix’s strong revenue growth attracted the interest of potential acquirers. Id.
¶ 51. At the beginning of the Class Period, Defendant Logan was approached by the CEO of
another pharmaceutical company, Allergan, about the possibility of acquiring Salix. Id. ¶ 52. The
parties began negotiations, and Allergan sought to conduct a due diligence review of Salix’s
records (1) to ensure that the company’s financial statements were accurate, and (2) to make an
independent evaluation of the company’s projections for future performance. Id. ¶ 53. Salix,
however, repeatedly rejected Allergan’s requests, allegedly because Defendants knew that any
due diligence would uncover their scheme and their elevated levels of wholesaler inventory. Id. ¶
54. In July 2014, Allegan made a formal offer to buy Salix for $180 per share, and then in
August 2014, raised its offer to $205 per share, which was approximately 30% higher than
Salix’s then-share price. Id. ¶¶ 54, 90. Salix and Allergan then entered into a confidentiality
agreement, and Salix provided Allergan access to its “electronic data room.” Id. ¶ 90. Within
days of beginning its due diligence, Allergan discovered the inventory backlog. Id. ¶ 91.
Allergan then reduced its offer by $30 per share, and confidentially “advised [Salix] that it had
become concerned with the levels of wholesaler inventory of the company’s key products in the
distribution channel.” Id. Allergan allegedly told Salix that it would not move forward with the
proposed acquisition until Salix disclosed its inventory problems to investors. Id. ¶ 93.
The same day that Allergan lowered its bid, Salix began discussions with another
potential acquirer, pharmaceutical company Actavis. Id. ¶ 92. Actavis made an offer of $178 to
$180 per share, and shortly thereafter, Salix provided Actavis with access to its electronic data
room so that Actavis could conduct due diligence. Id. Actavis, like Allergan, discovered the
inventory problem almost immediately, and withdrew its offer just six days later. Id.
4. Disclosure of the Inventory Problem and Aftermath
After the close of the market on November 6, 2014, the last day of the Class Period,
Defendants issued a press release disclosing Salix’s elevated wholesaler inventory levels and
updating Salix’s revenue guidance for the remainder of 2014. Id. ¶¶ 16, 94-95. Defendants
revealed that (1) wholesaler inventory levels for Salix drugs Xifaxan and Apriso were at nine
months, and had held “largely constant” at this level throughout all of 2014, and (2) wholesaler
inventory levels for recently-acquired Santarus drugs Glumetza and Uceris were at seven months
and five months, respectively. Id. ¶ 95. The press release stated that Salix expected it would take
approximately two years to reduce inventory levels for these medications to its previouslyestablished three-month level. Id. The company also revised its full-year revenue guidance for
2014 from $1.6 billion to $1.4 billion (a reduction from $6.16 per share to $5.20 per share). Id.
Salix also announced that Defendant Derbyshire had resigned from the company, effective
immediately. Id. ¶ 97. On the same day, Salix disclosed during a conference call with investors
that the Audit Committee of Salix’s Board of Directors had retained independent counsel to
conduct a review of “the facts and circumstances raised with respect to the inventory levels of
the company’s key products.” Id. ¶¶ 93, 98.
In response to this announcement, Salix’s stock price fell sharply on the following day of
trading, dropping from $138.55 at close on November 6 to $91.47 at close on November 7, a
decline of approximately 34% in a single day. Id. ¶ 109.
Then, in January of 2015, Salix announced that its Audit Committee had determined that
Salix’s financial statements for 2013 and for the first three quarters of 2014 would need to be reissued because (1) they improperly accounted for marketing services for which Salix had paid
wholesalers; (2) they improperly recognized revenue for certain contracts upon shipment of the
drugs, rather than upon delivery; and (3) the statement for the fourth quarter of 2013 understated
the product return reserve. Id. ¶¶ 116-119. The Restatement, which was issued in March of 2015,
provided updated numbers for Salix’s net income, earnings per share, and net product revenue.
Id. ¶ 120. Salix also announced in January of 2015 that Defendant Logan was retiring and
stepping down from the Board of Directors. Id. ¶ 114.
On February 22, 2015, Salix announced that it had entered into an agreement to be
acquired by Valeant Pharmaceuticals. Id. ¶ 129. Coinciding with this announcement, Valeant’s
CEO told investors that Valeant had been given the opportunity to conduct due diligence before
proposing an offer price, and that Valeant was confident with the information that it was able to
obtain. Id. ¶¶ 128, 131-32. Valeant’s CEO stated that “[i]t was actually pretty straightforward.
We went in and we actually got our financing and we got the wholesale reports. We know
precisely how much of each product each SKU is in the channel and in detail,” and that Valeant
had “about as close to perfect information as you could have in terms of what the inventory
situation is.” Id. ¶ 132. Salix and Valeant subsequently agreed on a price of $173 per share. Id. ¶
The agreement with Valeant made the Individual Defendants eligible to receive
significant “change-in-control” payments. Id. ¶¶ 133-34. Under the terms of their employment
contracts, the Individual Defendants were entitled to receive payouts worth tens of millions of
dollars upon the acquisition of Salix, even though they were no longer working for the company.
Id. ¶¶ 38, 72. However, when they left Salix, the Individual Defendants signed agreements that
entitled the Salix Board to “claw back” these payments in a number of specified circumstances,
including if the Board determined that the departing employee had “intentionally engaged in
wrongdoing that has resulted, or would reasonably be expected to result, in material harm to
[Salix].”3 Id. ¶¶ 97, 114. On March 24, 2015, before the acquisition by Valeant was finalized, the
Salix Board exercised this power and cancelled the payments to the Individual Defendants. Id. ¶¶
134-35. However, the Board did not announce the reason(s) for its decision to exercise the
C. Allegedly False and Misleading Statements
Plaintiffs allege in the CCAC that Defendants made a number of false or misleading
statements or material omissions during the Class Period, in violation of Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder. See id. ¶¶ 151-222. In particular,
Plaintiffs allege that Defendants’ press releases, SEC filings, and statements during quarterly
conference calls with investors were false or misleading with respect to (1) the levels of
wholesaler inventory for Salix’s key products; (2) Salix’s financial results, including its net
income and net product revenue, given the company’s failure to disclose the increased inventory
levels; (3) Salix’s compliance with GAAP and SEC rules; and (4) the effectiveness of Salix’s
internal controls. Id. ¶ 151.
D. Procedural History
Plaintiffs filed their original class action complaint on November 7, 2014. (Compl. [Doc.
No. 1]). Following the appointment of Pentwater Funds as Lead Plaintiff and the consolidation of
cases, Woburn Retirement Sys. v. Salix Pharm., Ltd., Nos. 14-CV-8925, 14-CV-9226, 2015 WL
1311073 (S.D.N.Y. Mar. 23, 2015) (Wood, J.), Plaintiffs filed their Consolidated Class Action
Complaint (“CCAC”). [Doc. No. 82]. On June 12, 2015, Defendants filed the instant Motions to
The agreements also authorized the exercise of the clawback if either Logan or Derbyshire (1) breached
any obligations set forth under the agreement, including those relating to cooperation with Salix, acknowledgement
of payment, non-disclosure of confidential information, non-competition, non-solicitation, non-disparagement, and a
prohibition on making use of non-public information; (2) breached the terms of a release each was required to sign
under the agreement; or (3) was found to have committed a violation of law by the U.S. Securities and Exchange
Commission or any other regulatory or governmental agency or court of law. See (SEC Form 8-K filed Nov. 5,
2014, 3 [Doc. No. 99-7]).
Dismiss the Complaint, pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6), for
failure to state a claim. See (Mem. of Def. Salix Pharmaceuticals, Ltd., in Supp. Mot. to Dismiss
the Consolidated Class Action Compl. (“Salix Mot.”), [Doc. No. 98]); (Mem. of Def. Adam C.
Derbyshire in Supp. Mot. to Dismiss the Consolidated Class Action Compl. (“Derbyshire Mot.”),
[Doc. No. 96]); (Joinder in Mots. to Dismiss of Salix Pharmaceuticals, Ltd. and Adam C.
Derbyshire (“Logan Mot.”), [Doc. No. 101]).
In general, to survive a Rule 12(b)(6) motion to dismiss, a plaintiff must plead facts
sufficient “to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550
U.S. 544, 570 (2007). A claim is facially plausible when the supporting factual allegations
“allow the court to draw the reasonable inference that the defendant is liable for the misconduct
alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Where a plaintiff has failed to “nudge” a
claim “across the line from conceivable to plausible,” a district court must dismiss the complaint.
Twombly, 550 U.S. at 570. The Court must accept as true all well-pleaded factual allegations in a
complaint and “draw all inferences in the plaintiff’s favor.” Allaire Corp. v. Okumus, 433 F.3d
248, 249-50 (2d Cir. 2006). But a court is “not bound to accept as true a legal conclusion
couched as a factual allegation.” Twombly, 550 U.S. at 555.
A complaint that asserts securities fraud, however, must satisfy the heightened pleading
requirements of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation
Reform Act (PSLRA), 15 U.S.C. § 78u-4. See ECA & Local 134 IBEW Joint Pension Trust of
Chicago v. J.P. Morgan Chase Co., 553 F.3d 187, 196 (2d Cir. 2009). Rule 9(b) provides that a
party alleging fraud “must state with particularity the circumstances constituting fraud,” Fed. R.
Civ. P. 9(b), and the PSLRA provides that a party alleging fraud must “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)(A); see also ECA, 553 F.3d at 196 (quoting Teamsters Local 445
Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 194 (2d Cir. 2008)) (noting that
although a court will “normally draw reasonable inferences in the non-movant’s favor on a
motion to dismiss, the PSLRA establishes a more stringent rule for inferences involving scienter”
(internal quotation marks omitted)).
Because Plaintiffs assert claims of securities fraud under Section 10(b) of the Exchange
Act and Rule 10b-5, they are subject to these heightened pleading requirements.
“The elements of a private securities fraud claim based on violations of § 10(b) and Rule
10b-5 are: ‘(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a
connection between the misrepresentation or omission and the purchase or sale of a security; (4)
reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.’”
Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179, 2184 (2011) (quoting Matrixx
Initiatives, Inc. v. Siracusano, 563 U.S. 27, 37-38 (2011)); see also ATSI Commc’ns, Inc. v.
Shaar Fund, Ltd., 493 F.3d 87, 105 (2d Cir. 2007).
Here, Defendants allege that Plaintiffs have failed to show the first and second elements
listed above, namely (1) a material misrepresentation or omission by Defendants, and (2)
scienter.4 The Court disagrees.
The Court finds unavailing Defendants’ brief suggestion in two footnotes that Plaintiffs do not adequately
allege loss causation. See (Salix Mot., 15 n.10); (Salix Reply, 5 n.6). Plaintiffs have adequately alleged loss
causation because the alleged misstatements and omissions discussed herein were corrected by the November 6,
2014 disclosure, not when Salix issued its Restatement. See Police & Fire Ret. Sys. of City of Detroit v. SafeNet,
Inc., 645 F. Supp. 2d 210, 231 (S.D.N.Y. 2009)) (Crotty, J.).
A. Actionable Misstatements or Omissions
To succeed on their Section 10(b) claims, Plaintiffs must allege that each Defendant
made a “material misrepresentation or a material omission as to which he had a duty to speak.”
S.E.C. v. Goldman Sachs & Co., 790 F. Supp. 2d 147, 162 (S.D.N.Y. 2011) (Jones, J.). Under
Rule 9(b), Plaintiffs must “(1) specify the statements that the plaintiff contends were fraudulent,
(2) identify the speaker, (3) state where and when the statements were made, and (4) explain why
the statements were fraudulent.” Rombach v. Chang, 355 F.3d 164, 170 (2d Cir. 2004) (quoting
Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)). “At the pleading stage, a
plaintiff satisfies the materiality requirement of Rule 10b-5 by alleging a statement or omission
that a reasonable investor would have considered significant in making investment decisions.”
Caiola v. Citibank, N.A., New York, 295 F.3d 312, 329 (2d Cir. 2002) (quoting Ganino v.
Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000)).
“An omission is actionable under federal securities laws only when the defendant is
subject to a duty to disclose the omitted facts.” In re Bank of Am. AIG Disclosure Sec. Litig., 980
F. Supp. 2d 564, 575 (S.D.N.Y. 2013) (Koeltl, J.), aff’d, 566 F. App’x 93 (2d Cir. 2014) (internal
quotation marks and alterations omitted.). This duty can arise in one of two ways: either (1)
“expressly pursuant to an independent statute or regulation—i.e., an affirmative legal disclosure
obligation”; or (2) “as a result of the ongoing duty to avoid rendering existing statements
misleading by failing to disclose material facts.” In re Sanofi-Aventis Sec. Litig, 774 F. Supp. 2d
549, 561 (S.D.N.Y. 2011) (Daniels, J.) (internal citations and quotation marks omitted).
Plaintiffs properly allege that Defendants made material misstatements or omissions with
respect to the inventory levels of Salix’s drugs during conference calls with investors on
February 27, May 8, and August 7, 2014, and in their accompanying press releases and SEC
1. The Alleged Misstatements
a. The February 27 Conference Call
On February 27, 2014, during a conference call held with analysts to discuss Salix’s
fourth quarter 2013 financial results, an analyst asked, “on Xifaxan, anything going on in the
quarter inventory wise which would prevent quarter-over-quarter growth?” Defendant
Derbyshire responded, “in terms of the inventory levels on Xifaxan based on the latest run rate or
run rate data, we were right in line with demand, so no changes with Xifaxan.” (CCAC ¶ 171).
Plaintiffs allege this statement was misleading because Defendant Derbyshire said that
there were no changes to report on Xifaxan inventory levels, even though (1) inventory levels
had climbed to approximately nine months, and (2) Salix had previously reported on numerous
occasions that inventory levels for Xifaxan were in the range of 10 to 12 weeks. Id. ¶ 172.
b. The May 8 Press Release and Conference Call
On May 8, 2014, Salix issued a press release summarizing their first quarter 2014 results.
In the press release, Defendant Logan was quoted as saying that “sales of Xifaxan 550 and
Apriso were below prescription demand for the first quarter of 2014,” but that “[w]e expect
Xifaxan 550 sales to exceed prescription demand or be in line with prescription demand in the
second quarter of 2014 as wholesalers bring Xifaxan 550 inventories back to more typical
levels.” Id. ¶ 182.
Plaintiffs allege that Logan’s statement was misleading, because her comment that Salix
expects wholesalers to bring inventory “back to more typical levels” in the coming quarter(s)
implied that the then-current level of wholesaler inventory was below the typical level of 10 to
12 weeks. Id. ¶ 182. This was misleading in light of the fact that Xifaxan inventory levels
throughout the Class Period were astronomically higher than the previously reported “typical”
level. Id. ¶ 183.
On the same day, in a conference call with analysts, Derbyshire repeated these assertions
almost verbatim during his prepared remarks, again noting the expectation that wholesalers
would “bring Xifaxan 550 levels back to more typical levels.” Id. ¶ 188. Later, during the
question-and-answer portion of the call, Derbyshire responded to several questions from analysts
regarding inventory levels of Xifaxan. One such exchange:
Q (analyst): “Maybe you can clarify the comment about the inventory level . . . . [I]f you can
just clarify for each of your products and the Santarus products, where it stood at the end of
the year and where it stands now.”
A (Derbyshire): “Yes, so we would expect by the end of second quarter that, ideally, all of
our inventories for all of our products would be in that 10- to 12-week range. Clearly, we
would be in the two- to three-month range, so we would fully expect that. Keep in mind that
shipments, especially of the Santarus products, were happening very early in the quarter, in
first quarter. And so here we are in May, so inventories are again at that two- to three- month
timeframe. We would like for it to be 10 to 12 weeks and we would expect it to be there by
the end of second quarter.”
Id. ¶ 192.
Plaintiffs allege that this comment was misleading because it implied that then-current
inventory levels were such that Defendants reasonably expected them to be in the 10- to 12week range by the end of the second quarter—roughly seven weeks from the date of the phone
call—even though inventory levels for Xifaxan were, in fact, approximately nine months and, as
Salix later disclosed, would take almost two years to return to the “typical” level. Id. ¶ 193.
Q (analyst): “I was wondering if you guys could maybe quantify on a dollar basis how much
inventory contributed to maybe Uceris and how much of the draw down contributed to
A (Derbyshire): “[I]f you look at the run rate for Xifaxan and apply it to what was shipped,
so the run rate would be about $175 million and we shipped $114 million. So that would
imply that a month-and-a-half or so of inventory was – came down.”
Id. ¶ 194.
Later in the call Derbyshire made a similar statement regarding the impact of inventory
changes on revenue: “[O]n your question regarding the revenue . . . And then for Xifaxan, it
represented a decrease in inventory of a little over a month.” Id. ¶ 196.
Plaintiffs allege that Derbyshire’s comments were misleading because, like Logan’s and
Derbyshire’s earlier statements, they implied that inventory levels for Xifaxan were below the
typical level of 10 to 12 weeks, rather than significantly above that level. Id. ¶¶ 195, 197.
c. The August 7 Conference Call
On August 7, 2014, Salix held a conference call with analysts to discuss their second
quarter 2014 results. See id. ¶¶ 204-21. During the call, Derbyshire again made statements and
answered questions regarding the inventory levels of Salix’s key products, including Xifaxan. In
his opening remarks, he stated that “product revenue for Xifaxan and Apriso was impacted by
some inventory destocking in the wholesale channel during the second quarter of 2014, although
less than the first quarter of 2014. Currently we expect destocking may continue to a lesser
degree in the third quarter and normalize in the fourth quarter.” Id. ¶ 204.
Later in the call, Derbyshire responded to a number of questions regarding current
wholesaler inventory levels for Xifaxan:
Q (analyst): “If I could follow up on the inventory a little bit more, I know some of these
things are difficult to predict, but maybe you could share a little bit more perspective on what
investigation you’ve done with your customers and where things stand relative to IMA
levels? I think we discussed last quarter, you try to keep these products in a pretty tight range
of 10 weeks to 12 weeks and looking over last quarter and this quarter, it seems that some of
these products have come down relative to the run rate . . . . So I was hoping you could share
a little bit more color on what on a product-by-product basis, some of them seem to be at
very high inventory levels and some quite low, where they individually stand.”
A (Derbyshire): “Yeah, sure I would expect that Glumetza and Uceris will come down in
third quarter and then as you can see both with Apriso and Xifaxan they did come more in
line with demand. They didn’t quite get there, but we would expect that to continue to
become more in line with demand in third quarter and then to normalize in fourth quarter.”
Q (analyst): “[W]hat’s your sense of how much inventory is in the channel at this point? . . .
It is within your contractual ranges or not?”
A (Derbyshire): “Well, we don’t have IMAs, we don’t have any contracts.”
Q (analyst): “Okay, So you have nothing . . . “
A (Derbyshire): “Right.”
Q (analyst): “. . . so your 10 weeks . . . “
A (Derbyshire): “Right.”
Q (analyst): “. . . to 12 weeks is not contractual it’s just your goal.”
A (Derbyshire): “Right. Correct.”
Id. ¶ 210. Derbyshire later reiterated his comments that he expected wholesale inventory levels to
return to normal levels during the third and fourth quarters, but stated that the “normal” level in
the future would be lower than 10 to 12 weeks:
Q (analyst): “What are your plans to get better clarity going forward so we have more of a –
is there anything you can do in terms of reaching out to customers, is the former target of say
12 weeks, 13 weeks just too high for the wholesalers without some type of contractual
A (Derbyshire): “So your first question, yes, I mean obviously we have – we’re in touch with
our trade partners. But you’re right, I mean I think the reality of keeping that three months of
inventory is no longer going to be the case. So they again they’re softening and we can
expect them to continue to soften some in the third quarter and more so normalize in fourth
Id. ¶ 216. Derbyshire later repeated his statement that the new “normal” level of inventory for
wholesalers was eight to ten weeks, rather than the prior level of 10 to 12 weeks, and suggested
that this shift was the cause of the inventory destocking. See id. ¶ 212.
Throughout the call Derbyshire consistently avoided providing direct answers about
current inventory levels for Salix’s products, but reassured investors that his predictions were
based on accurate information about those inventory levels:
Q (analyst): “I’m sorry if I missed this. I don’t think I heard your estimate for where you
think inventory levels actually are at the end of the second quarter for Xifaxan and Apriso?
And perhaps a naïve question, but how do you actually know with specificity without
A (Derbyshire): “[W]e have visibility in the inventories because we know what we ship, we
know what pulls through, we know what returns are. So, we have a visibility into inventory
level. Again we would be hopeful because we are not under IMAs that when things do
normalize that we can normalize around that eight week or a little less level and that would
be true for both Xifaxan and for Apriso.”
Id. ¶ 218.
Plaintiffs allege that these statements were misleading because they implied that the
reduction in revenue for Xifaxan was attributable to a reduction of wholesaler inventory below
the prior stated target of 10 to 12 weeks, even though inventory levels were, in fact, at or around
nine months. Id. ¶¶ 217, 219, 221. The statements were also misleading because they implied
that the destocking was likely to conclude within a few months, even though Defendants later
announced that it would take approximately two years to return inventory to the previous levels.
Id. ¶¶ 205, 209, 213, 221. And Derbyshire’s final quoted statement was misleading because it
asserted that Defendants had knowledge of the inventory levels and implied that his other
statements with respect to inventory levels were based on that knowledge. See id. ¶ 219. If
Defendants did not, as they claim, have actual knowledge of the elevated inventory levels, this
statement was false and misleading.
2. Defendant’s Statements Are Not Protected by the PSLRA Safe Harbor
Defendants argue that the above statements regarding inventory levels are not actionable
because they are forward-looking statements entitled to protection under the PSLRA safe harbor
and the bespeaks caution doctrine.5 The PSLRA provides that a defendant “shall not be liable
with respect to any forward-looking statement” if (1) the statement is “identified as a forwardlooking statement, and is accompanied by meaningful cautionary statements identifying
important factors that could cause actual results to differ materially from those in the forwardlooking statement,” 15 U.S.C. § 78u-5(c)(1)(A)(i), or (2) the plaintiff fails to show that the
statement was “made with actual knowledge” that the statement was false or misleading, id. §
78u-5(c)(1)(B)(i)-(ii).6 However, neither of these provisions applies to the above statements.
The PSLRA defines “forward-looking statements” as:
(A) a statement containing a projection of revenues, income (including income loss), earnings (including
earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items;
(B) a statement of the plans and objectives of management for future operations, including plans or
objectives relating to the products or services of the issuer;
(C) a statement of future economic performance, including any such statement contained in a discussion
and analysis of financial condition by the management or in the results of operations included pursuant
to the rules and regulations of the Commission;
(D) any statement of the assumptions underlying or relating to any statement described in subparagraph
(A), (B), or (C);
(E) any report issued by an outside reviewer retained by an issuer, to the extent that the report assesses a
forward-looking statement made by the issuer; or
(F) a statement containing a projection or estimate of such other items as may be specified by rule or
regulation of the Commission.
15 U.S.C. § 78u-5(i)(1).
For a defendant who is a natural person, the plaintiff must show that the statement was made “with actual
knowledge by that person that the statement was false or misleading.” 15 U.S.C. § 78u-5(c)(1)(B)(i). For a
defendant who is a business entity, the plaintiff must show that the statement was (1) “made by or with the approval
of an executive officer of that entity” and (2) “made or approved by such officer with actual knowledge by that
officer that the statement was false or misleading.”
a. Defendants’ Statements Are Not Protected under the Actual Knowledge
The PSLRA safe harbor requires plaintiffs to show that forward-looking statements were
made with actual knowledge of their falsity by the speaker. 15 U.S.C. § 78u-5(c)(1)(B)(i)-(ii).
“[B]ecause the safe harbor specifies an ‘actual knowledge’ standard for forward-looking
statements, ‘the scienter requirement for forward-looking statements is stricter than for
statements of current fact. Whereas liability for the latter requires a showing of either knowing
falsity or recklessness, liability for the former attaches only upon proof of knowing falsity.’”
Slayton v. Am. Express Co., 604 F.3d 758, 773 (2d Cir. 2010) (quoting Institutional Investors
Group v. Avaya, Inc., 564 F.3d 242, 274 (3d Cir. 2009)); see also In re ITT Educ. Servs., Sec.
Litig., 34 F. Supp. 3d 298, 306 (S.D.N.Y. 2014) (Oetken, J.).
However, this safe harbor provision does not apply to any “allegedly false statement
[that] has both a forward-looking aspect and an aspect that encompasses a representation of
present fact.” In re Nortel Networks Corp. Sec. Litig., 238 F. Supp. 2d 613, 629 (S.D.N.Y. 2003)
(Berman, J.); see also In re Regeneron Pharm., Inc. Sec. Litig., No. 03-CV-3111, 2005 WL
225288, at *13 (S.D.N.Y. Feb. 1, 2005) (Sweet, J.) (“Statements that might arguably have some
forward-looking aspect are unprotected by the PSLRA safe harbor provision to the extent that
they are premised on representations of present fact.”). The safe harbor also does not protect
material omissions. In re Complete Mgmt. Inc. Sec. Litig., 153 F. Supp. 2d 314, 340 (S.D.N.Y.
2001) (Buchwald, J.); City of Providence v. Aeropostale, Inc., No. 11-CV-7132, 2013 WL
1197755, at *12 (S.D.N.Y. Mar. 25, 2013) (McMahon, J.).
Defendants are correct that many of the above-identified statements are forward-looking,
because they predict future inventory levels. But a number of these statements also encompass
representations of present fact, and those representations are not subject to the PSLRA safe
harbor. For instance, statements by the Individual Defendants in the first quarter 2014 press
release and conference call describe their expectation that wholesaler inventory of Xifaxan
would return to “typical” levels by the end of the following quarter. Those statements, in turn,
are predicated upon representations that current inventory levels lie below the previously-stated
target level of 10 to 12 weeks, because Salix Executives expected revenue to rise in the
following quarter as wholesalers “bring Xifaxan 550 inventories back to more typical levels.”
Those representations concerning current inventory levels constitute actionable misstatements,
and, because they pertain to present facts rather than future projections, are not subject to the
heightened scienter requirement of the PSLRA safe harbor.7
Similarly, many of Defendants’ statements are made misleading because of material
omissions, particularly in light of historical facts regarding inventory.8 For instance, during the
second quarter 2014 conference call, analysts repeatedly questioned Derbyshire about the current
wholesaler inventory levels for each of Salix’s products, asking: “I was hoping you could share a
bit more color on what on a product-by-product basis, some of them seem to be at very high
inventory levels and some quite low, where they individually stand”; “[W]hat’s your sense of
The Aeropostale decision provides a helpful analogy. There, the court held that certain earnings
projections were not protected under the PSLRA safe harbor:
Viewed in isolation, Aeropostale’s earnings projections fall within the definition of a forward-looking
statement under the PSLRA . . . . But these statements are accompanied by statements that the projections
and outlook incorporate the effect of clearing through the inventory, sometimes even within the same
sentence. Such statements imply that the earnings projections accurately reflect the sales and inventory
problems that Defendants were aware of at the time the statements were made, demonstrating that the
statements are not solely forward-looking, but instead incorporate a present fact whose accuracy could be
determined at the time the statements were made.
See Aeropostale, 2013 WL 1197755, at *13 (internal quotations omitted).
Prior to the start of the Class Period, the Individual Defendants had “repeatedly addressed analyst and
investor questions concerning the company’s inventory levels for its key products.” (CCAC ¶ 147). These
statements established an expectation among investors and analysts that inventory for Xifaxan and other Salix
products was generally in the 10- to 12-week range. Id. (alleging statements dating back to 2005 that “trade
inventory is three months”; “inventory levels will flatten out at roughly the 10- to 12-week level that we like to keep
in the channel”; and that Salix would maintain 10 to 12 week inventory levels for Xifaxan, which is “where the
majority of [Salix’s] products are”).
how much inventory is in the channel at this point?”; and “I’m sorry if I missed this. I don’t think
I heard your estimate for where you think inventory levels actually are at the end of the second
quarter for Xifaxan and Apriso.” (CCAC ¶¶ 210, 218). In response to these questions,
Derbyshire never mentioned Salix’s current inventory levels of Xifaxan or Apriso, or even rough
estimates of those levels, but offered repeated assurances that he expected the inventory levels to
“normalize” in the following quarter to the “new normal” level of approximately eight weeks.
The omission of any information with respect to current inventory levels is material and
misleading, because that omission led analysts to believe that inventory levels were merely
slightly outside of the range that Defendants described as “normal” and could be returned to that
level within about three months. In fact, as Defendants later revealed, it would take several years
to return wholesaler inventory of Xifaxan to the prior level of 10 to 12 weeks, and presumably
even longer to reduce it to the “new normal” level of eight weeks. The statements are also
misleading in light of Derbyshire’s assurance that “we have visibility in the inventories,” because
it led investors to believe that Defendants’ future projections were based on accurate knowledge
of current inventory levels. If Derbyshire did not have such knowledge, as Defendants contend,
then his statement that he did was materially misleading.
The Court’s reading of these statements is bolstered by Plaintiffs’ allegations regarding
public comments made by analysts after the conference calls. See (CCAC ¶¶ 79, 82-84). These
comments reveal that analysts understood the Defendants’ statements as representations of the
current levels of wholesaler inventory, not just future projections. Id. Although a listener’s
misunderstanding of what was said does not, on its own, make a statement misleading, the
allegation that several different analysts understood Defendants as describing current inventory
levels provides support for the Court’s conclusion that Defendants’ statements are reasonably
interpreted as such.
In sum, Defendants’ statements in the May 8 press release and conference call and the
August 7 conference call, taken in light of the overall context in which they were made, are not
subject to the PSLRA safe harbor for forward-looking statements because they (1) incorporated
misleading representations of present fact, and/or (2) were made misleading by material
b. Defendants’ Cautionary Language Was Inadequate
Defendants’ statements are also not entitled to protection under the meaningful
cautionary language prong of the PSLRA safe harbor or the similar judicially-created bespeaks
caution doctrine. See Slayton, 604 F.3d at 770 n.5 (2d Cir. 2010).
“To avail themselves of the safe harbor protection under the meaningful cautionary
language prong, defendants must demonstrate that their cautionary language was not boilerplate
and conveyed substantive information.” Slayton, 604 F.3d at 772.9 To be eligible for the safe
harbor, “the relevant cautionary language must be prominent and specific, and must directly
address exactly the risk that plaintiffs claim was not disclosed.” In re MF Global Holdings Ltd.
Sec. Litig., 982 F. Supp. 2d 277, 304 (S.D.N.Y. 2013) (Marrero, J.) (internal quotation marks
omitted); In re Barrick Gold Sec. Litig., No. 13-CV-3851, 2015 WL 1514597, at *8 (S.D.N.Y.
Apr. 1, 2015) (Scheindlin, J.) (“[T]he cautionary language must be . . . tailored to the specific
Other Circuits have held similarly. See Institutional Investors Group v. Avaya, Inc., 564 F.3d 242, 256 (3d
Cir. 2009) (“Cautionary language must be extensive and specific. A vague or blanket (boilerplate) disclaimer which
merely warns the reader that the investment has risks will ordinarily be inadequate to prevent misinformation. To
suffice, the cautionary statements must be substantive and tailored to the specific future projections, estimates or
opinions . . . which the plaintiffs challenge.”); Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353,
372 (5th Cir. 2004) (“The requirement for meaningful cautions calls for substantive company-specific warnings
based on a realistic description of the risks applicable to the particular circumstances, not merely a boilerplate litany
of generally applicable risk factors.”)
future projections, estimates, or opinions that the plaintiffs challenge.” (internal quotation marks
omitted)). “Vague disclosures of general risks will not protect defendants from liability.” In re
MF Glob. Holdings, 982 F. Supp. 2d at 304.
Here, the cautionary language provided by Defendants was inadequate to warn of the
specific risk that Plaintiffs have alleged. The cautionary statements included at the beginning of
each conference call were brief and generic, stating only that “[a]ctual results might differ
materially from those indicated by these forward-looking statements as a result of various
important factors, including those discussed in our press releases and SEC filings, including our
Form 10-K for 2013.” See, e.g. (Q2 2014 Earnings Call, 1 [Doc. No. 99-2]). This boilerplate
disclaimer fails to identify even a single “important factor” that could lead to different results.
And the general reference to factors “discussed in our press releases and SEC filings” fails to
supply the necessary specificity. Defendants cannot escape liability by referring generally to
every factor that has ever been mentioned in any one of their public statements or SEC filings,
because such a broad disclaimer fails to alert investors to the specific risks they are facing. Even
the language in the Form 10-K for 2013 fails to address the specific risk that is at issue here. In
more than twelve pages of cautionary statements, “inventory” is mentioned only once as a
possible factor that could impact future revenue predictions: “potential increased purchases of
inventory by wholesalers in anticipation of potential price increases or introductions of new
dosages or bottle sizes, and subsequent lower than expected revenue as the inventory is used.”
(2013 Form 10-K, 49 [Doc. No. 99-1]). This limited reference fails to alert the reasonable
investor either to (1) the much broader risk of inventory build-up at issue here, or (2) the lack of
management review of inventory levels to monitor the risk.
Courts have also noted that a defendant’s failure to update cautionary language over time
to reflect new information and new risks supports the conclusion that such statements are merely
boilerplate. See Slayton, 604 F.3d at 772-73 (“Our conclusion is bolstered by the fact that the
defendants’ cautionary language remained the same even while the problem changed.”). Here,
Defendants’ cautionary statements are word-for-word the same in each of the four calls that took
place during the Class Period, except for the reference to the 10-K being updated from 2012 to
2013 halfway through the Class Period. See (Q3 2013 Earnings Call, 2, [Doc. No. 99-11]); (Q4
2013 Earnings Call, 2 [Doc. No. 99-12]); (Q1 2014 Earnings Call, 2 [Doc. No. 99-4]); (Q2 2014
Earnings Call, 2-3 [Doc. No. 99-2]). And the cautions with respect to inventory in Salix’s 2012
and 2013 forms 10-K are, likewise, word-for-word the same. Defendants’ failure to update these
statements from quarter to quarter and from year to year renders them meaningless in light of the
changing circumstances and risks.
In sum, Plaintiffs have sufficiently alleged actionable misstatements and material
omissions by each Defendant necessary to support their claims under Section 10(b) of the
Defendants also argue that some of their statements are non-actionable because (1) they are statements of
opinion, see (Salix Mot. 29-30), or (2) they are mere puffery, id. at 25.
Defendants’ argument about opinion appears to pertain only to their statements about the reasons for
changes in wholesaler buying patterns. See id. at 29-30. However, to the extent that Defendants intend to argue that
the statements described above are non-actionable statements of opinion, the Court disagrees. A statement of
opinion may be actionable if it is predicated upon an untrue supporting statement of fact or if the statement omits
material facts about the speaker’s “inquiry into or knowledge concerning a statement of opinion.” Omnicare v.
Laborers Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318, 1327, 1329 (2015). Even if the projections
regarding future inventory levels are statements of opinion, those opinions either (1) are predicated upon untrue
supporting statements of fact regarding current inventory levels, or (2) omit material facts about the speaker’s
inquiry into or knowledge of facts that would support the stated opinion. Therefore, the statements are actionable.
Defendants also argue that their statements are non-actionable because they are merely “vague expressions
of puffery and corporate optimism.” (Salix Mot., 25). This argument is unavailing. Although “expressions of puffery
and corporate optimism do not give rise to securities violations” even if it later turns out the optimism was
unwarranted, City of Roseville Employees’ Ret. Sys. v. Nokia Corp., No. 10-CV-0967, 2011 WL 71588548, at *6
(S.D.N.Y. Sept. 6, 2011) (Daniels, J.) (quoting Rombach, 355 F.3d at 164), Defendants’ statements here go far
beyond the sorts of puffery that courts have previously found protected. Compare San Leandro Emergency Med.
The PSLRA requires plaintiffs to “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). A
court must decide “whether all of the facts alleged, taken collectively, give rise to a strong
inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that
standard.” Tellabs Inc., 551 U.S. at 322-23 (emphasis in original). To qualify as “strong,” the
inference of scienter “must be cogent and at least as compelling as any opposing inference of
nonfraudulent intent.” Tellabs Inc., 551 U.S. at 314; Akerman v. Arotech Corp., 608 F. Supp. 2d
372, 382 (E.D.N.Y. 2009) (citing City of Brockton Ret. Sys. v. Shaw Group Inc., 540 F. Supp. 2d
464, 472 (S.D.N.Y. 2008) (McMahon, J.)) (“When the competing inferences rest in equipoise,
the tie . . . goes to the plaintiff.”) (internal citation and quotation marks omitted). But an adequate
inference of scienter “need not be irrefutable, i.e., of the ‘smoking-gun’ genre, or even the ‘most
plausible of competing inferences.’” Tellabs Inc., 551 U.S. at 324 (quoting Fidel v. Farley, 392
F.3d 220, 227 (6th Cir. 2004)); In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 72 (2d Cir. 2001)
(“[W]e do not require the pleading of detailed evidentiary matter in securities litigation.”).
In the Second Circuit, “[t]he requisite scienter can be established by alleging facts to
show either (1) that defendants had the motive and opportunity to commit fraud, or (2) strong
Grp. Profit Sharing Plan v. Philip Morris Companies, Inc., 75 F.3d 801, 811 (2d Cir. 1996) (statements that
defendant was “optimistic about its earnings” and “expected [its products] to perform well” were non-actionable
puffery) with Novak v. Kasaks, 216 F.3d 300, 315 (2d Cir. 2000) (defendants’ statements about inventory were more
than just “rosy predictions” and therefore were actionable).
Courts have also found that statements constitute puffery when they are so generic that they “cannot have
misled a reasonable investor,” San Leandro, 75 F.3d at 811, and when they “lack the sort of definite positive
projections that might require later correction,” In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993).
Neither of those conditions is met here. Defendants’ statements could and did mislead a number of reasonable
investors, as evidenced by the comments of analysts following the quarterly conference calls. See (CCAC ¶¶ 79, 8284). And the statements provided exactly the sort of definite projections that did require later correction in the press
release and conference call on November 6, 2014, where Salix disclosed its inventory backlog. See id. ¶ 95.
Therefore Defendants’ statements cannot be characterized as vague statements of corporate optimism.
circumstantial evidence of conscious misbehavior or recklessness.” ECA, 553 F.3d at 198.
Motives common to corporate officers, like “the desire for the corporation to appear profitable
and the desire to keep stock prices high to increase officer compensation,” do not suffice to plead
scienter. Id.; Novak v. Kasaks, 216 F.3d 300, 307-08 (2d Cir. 2000) (plaintiffs must “allege that
defendants benefitted in some concrete and personal way from the purported fraud.”). A plaintiff
who cannot show scienter by alleging motive and opportunity can still “raise a strong inference
of scienter under the ‘strong circumstantial evidence’ prong, ‘though the strength of the
circumstantial allegations must be correspondingly greater’ if there is no motive.”11 ECA, 553
F.3d at 198-99 (quoting Kalnit v. Eichler, 264 F.3d 131, 142 (2d Cir. 2001)); cf. Ganino, 228
F.3d at 169 (a plaintiff is not required to plead scienter with “great specificity”).
Recklessness is defined as “conduct which is highly unreasonable and which represents
an extreme departure from the standards of ordinary care to the extent that the danger was either
known to the defendant or so obvious that the defendant must have been aware of it.” In Re
Carter–Wallace, Inc. Sec. Litig., 220 F.3d 36, 39 (2d Cir. 2000) (citation omitted); see also
Novak, 216 F.3d at 308 (“It is the actual facts of our securities fraud cases that provide the most
concrete guidance as to the types of allegations required” to meet the pleading standard for
recklessness.). “[S]ecurities fraud claims typically have sufficed to state a claim based on
recklessness when they have specifically alleged defendants’ knowledge of facts or access to
information contradicting their public statements.” Novak, 216 F.3d at 308. “Where plaintiffs
contend defendants had access to contrary facts, they must specifically identify the reports or
statements containing this information.” Id. at 309.
Because Plaintiffs have failed to plead scienter based on motive and opportunity, the Court proceeds to
evaluate Plaintiffs’ allegations of scienter under the strong circumstantial evidence of recklessness prong.
1. Plaintiffs’ Allegations Raise a Strong Inference of Scienter
Plaintiffs properly allege scienter based on circumstantial evidence of recklessness
because: (1) Defendants were reckless in failing to learn Salix’s true wholesale inventory levels;
(2) Salix’s Board clawed back millions of dollars’ worth of compensation from the Individual
Defendants; (3) the Individual Defendants resigned after the alleged fraud was revealed; and (4)
the magnitude of the alleged fraud, in conjunction with the fact that the fraud involved Salix’s
core operations, provides supplemental support for a strong inference of scienter.12
a. Defendants Were Reckless in Failing to Learn Salix’s True Inventory
Plaintiffs allege sufficient facts to show that Defendants knew or were reckless in failing
to learn Salix’s true inventory levels. Two sets of alleged facts support Plaintiffs’ position: (1)
the ease with which potential acquirers discovered Salix’s true inventory levels; and (2)
Plaintiffs’ identification of specific reports and statements showing that Defendants were aware
of or could access Salix’s true wholesale inventory levels.
First, potential acquirers Allergan, Actavis, and Valeant discovered Salix’s high
inventory levels within days of performing their due diligence. In re Bear Stearns Cos., Inc. Sec.,
Derivative & ERISA Litig., 763 F. Supp. 2d 423, 517 (S.D.N.Y. 2011) (Sweet, J.) (finding
scienter where “JPMorgan discovered in the course of one weekend the overvaluation of assets
and underestimation of risk exposure”). Allergan, initially denied access to Salix’s internal
information on three separate occasions, discovered Salix’s wholesale inventory levels less than
a week after accessing the company’s electronic data room. (CCAC ¶¶ 54, 91-93, 140). After
conducting its due diligence, Allergan dramatically reduced and eventually dropped its offer to
The Individual Defendants’ scienter is imputed to Salix. In re Hi-Crush Partners L.P. Sec. Litig., No. 12CV-8557, 2013 WL 6233561, at *26 (S.D.N.Y. Dec. 2, 2013) (McMahon, J.).
acquire Salix. Id. Similarly, six days after Actavis was given access to Salix’s data to conduct its
due diligence, it too withdrew its acquisition offer because of Salix’s wholesale inventory levels.
Id. ¶¶ 92, 140.
The company that ultimately acquired Salix, Valeant Pharmaceuticals, said the process of
discerning Salix’s inventory levels was “pretty straightforward.” Id. ¶¶ 132, 142. Valeant’s CEO
stated that Valeant knew “precisely how much of each product, each SKU [stock keeping unit] is
in the channel and in detail,” and that Valeant had “about as close to perfect information as you
could have in terms of what the inventory situation is.” Id. Although Valeant’s due diligence was
conducted after Salix disclosed its true wholesale inventory numbers, Valeant drew the same
conclusions from information found in Salix’s electronic data room as Allergan and Actavis. The
allegations that three different companies were able to quickly discern Salix’s true wholesale
inventory levels weigh in favor of scienter based on recklessness.
Second, Plaintiffs have identified specific reports and statements containing information
about Salix’s true wholesale inventory level. See Novak, 216 F.3d at 308; see also Sgalambo v.
McKenzie, 739 F. Supp. 2d 453, 481-82 (S.D.N.Y. 2010) (Scheindlin, J.). Plaintiffs allege that
Salix received reliable non-public reports detailing inventory levels from its wholesalers on at
least a quarterly basis. (CCAC ¶ 142). Valeant’s CEO confirmed the existence of these
“wholesale reports” when describing how Valeant was able to confidently determine Salix’s true
inventory numbers. Id. ¶ 45. Salix also maintained internal reports that were compiled “by
adding estimated inventory in the channel at the beginning of the period, plus net product
shipments for the period, less estimated prescriptions written for the period.” Id. ¶ 43. Defendant
Derbyshire oversaw this analysis, id., and acting CFO Tim Creech told investors on a conference
call that these internal reports were “consistent” with the reports provided by wholesalers, id. ¶
In addition to these reports, Plaintiffs allege that Defendants claimed they had accurate
knowledge of Salix’s wholesale inventory levels. When asked by an analyst how he knew
inventory levels with specificity, Defendant Derbyshire, CFO of Salix during the Class Period,
responded by saying, “we have visibility in the inventories because we know what we ship, we
know what pulls through, we know what returns are.” (CCAC ¶¶ 4, 48). Defendant Derbyshire’s
statement concerning Salix’s knowledge of precise inventory levels weighs in favor of scienter in
this case. See Citiline Holdings, Inc. v. iStar Fin. Inc., 701 F. Supp. 2d 506, 516 (S.D.N.Y. 2010)
(Sullivan, J.) (plaintiffs adequately pleaded scienter where they alleged defendants “told the
investing public that they monitored the value of their portfolio”); In re BP p.l.c. Sec. Litig., 843
F. Supp. 2d 712, 782-83 (S.D. Tex. 2012) (defendants repeated statements about safety weighed
“strongly in favor of the inference that [the CEO] paid special attention to . . . safety efforts or, at
the least, was reckless in not doing so while continuing to publicly tout improvements”).
The ease with which potential acquirers were able to determine Salix’s true wholesale
inventory levels, taken together with the specific reports and statements that Plaintiffs identify,
suffice to raise a strong inference of scienter.13
An additional fact supporting scienter is Defendants’ decision to cancel the DSAs for Salix’s newly
acquired company, Santarus. DSAs—which are common in the industry—are a way to reduce the risks related to
channel stuffing and better control and manage inventories. (CCAC ¶ 47). In 2008 Salix’s auditor, Ernst & Young
LLP, recommended that Salix enter into DSAs as a way to “reduce the risk of accounting issues related to ‘channel
stuffing,’” as doing so helps companies to “maintain inventory levels that are consistent with the underlying
demand.” Id. Salix not only failed to implement DSAs itself, but Salix also cancelled the DSAs between Santarus
and its wholesalers upon acquiring Santarus. Id. ¶ 48.
b. Salix’s Board Exercises the Clawback Provisions in the Individual
Defendants’ Resignation Agreements
In further support of an inference of scienter, Plaintiffs allege that Salix clawed back
millions of dollars’ worth of compensation from the Individual Defendants. (CCAC ¶¶ 23, 136,
138). Although Defendants have never explicitly admitted to engaging in wrongdoing,
Defendants do not dispute that one of provisions of the resignation agreements allows for a
clawback based on a Board determination that the Individual Defendants “intentionally engaged
in wrongdoing.”14 (Salix Reply, 6-7 [Doc. No. 112]); (Decl. of Jared J. Stanisci, Exs. G-I, [Doc.
Nos. 99-7, 99-8, 99-9]). The Board’s decision to exercise the clawback against the Individual
Defendants, regardless of the provision of the resignation agreements under which it was
exercised, weighs in favor of a strong inference of scienter.
c. The Individual Defendants’ Resignations
The Individual Defendants’ resignations provide additional evidence of scienter. See
Glaser v. The9, Ltd., 772 F. Supp. 2d 573, 598 (S.D.N.Y. 2011) (Holwell, J.) (noting that “highly
unusual or suspicious” resignations add to the overall pleading of circumstantial evidence of
fraud, including “when independent facts indicate that the resignation was somehow tied to the
fraud alleged”); Hall v. The Children's Place Retail Stores, Inc., 580 F. Supp. 2d 212, 233
(S.D.N.Y. 2008) (Scheindlin, J.) (finding that resignations of company’s CEO and auditor
supported inference of scienter); In re Scottish Re Grp. Sec. Litig., 524 F. Supp. 2d 370, 394 n.
176 (S.D.N.Y. 2007) (Scheindlin, J.) (noting that “the resignations of [the defendants], although
Plaintiffs note that the clawback provision may be exercised if: “the Board of Directors of Parent, acting
in good faith, determines that, at any time during the period in which you were employed by Salix or served as a
director, officer or employee of the Company, including, without limitation, Parent, you intentionally engaged in
wrongdoing that has resulted, or would reasonably be expected to result, in material harm to Parent or any of its
subsidiaries or affiliates, or to the business or reputation of Parent or any of its subsidiaries or affiliates.” (Decl. of
Jared J. Stanisci, Exs. G-H, [Doc. No. 99-7, 99-8]).
not sufficient in and of themselves, add to the overall pleading of circumstantial evidence of
fraud”). Defendant Derbyshire resigned the day Salix announced its true wholesale inventory
numbers. (CCAC ¶¶ 32, 138). Defendant Logan, who was “manning the wheel” at Salix when it
was engaging in allegedly fraudulent conduct, retired two months later, during investigations by
Salix’s Audit Committee and the SEC. Id. ¶¶ 20, 115, 138. The resignations of the Individual
Defendants were “highly unusual or suspicious” because the Board exercised the clawback
provisions in their resignation agreements, and Salix later issued restatements of its financial
statements for the full year 2013 and for the first three quarters of 2014. Id. ¶¶ 116-27; see, e.g.,
In re Adaptive Broadband Sec. Litig., No. 01-CV-1092, 2002 WL 989478, at *14 (N.D. Cal.
Apr. 2, 2002) (finding support for scienter where corporate officers’ resignations “occurred as
[the company]’s financials were being restated and as [the company] was conducting its own
internal investigation.”). Thus, the circumstances of Defendants’ resignations support a strong
inference of scienter.
d. The Magnitude of the Alleged Fraud and the Core Operations Rationale
The magnitude of Defendants’ alleged fraud and the fact that it involved the core
operations of Salix’s business also support a strong inference of scienter. Although Defendants
are correct that Plaintiffs cannot plead scienter based solely on the magnitude of the fraud or on
the fact that the alleged fraud concerned Salix’s core operations, these additional allegations
buttress the allegations of scienter discussed above. See, e.g. Katz v. Image Innovations
Holdings, Inc., 542 F. Supp. 2d 269, 273 (S.D.N.Y. 2008) (Koeltl, J.) (“[T]he magnitude of the
alleged fraud provides some additional circumstantial evidence of scienter.”); In re Complete
Mgmt. Inc. Sec. Litig., 153 F. Supp. 2d at 327 (citing Rothman v. Gregor, 220 F.3d 81, 92 (2d
Cir. 2000)) (“[T]he magnitude of the write-off rendered ‘less credible’ the proposition that
defendants there were somehow surprised by their sudden reversal of fortune.”);15 In re
Wachovia Equity Sec. Litig., 753 F. Supp. 2d 326, 353 (S.D.N.Y. 2011) (Sullivan, J.) (“[T]he
Court considers ‘core operations’ allegations to constitute supplementary but not independently
sufficient means to plead scienter.”).
The magnitude of the alleged fraud is startling by any measure; inventory levels were
three times what Defendants had previously stated, and the backlog resulted in a $500 million
diminution in revenue compared to previous projections. (CCAC ¶ 5). And the alleged fraud
concerned Salix’s core drugs: Xifaxan, Apriso, Glumetza, and Uceris. Id. ¶¶ 63-68. Further,
wholesale inventory levels were crucial metrics for tracking sales of these drugs, and in turn
provided one of the “most critical accounting policies and estimates upon which [the
Company’s] financial status depends.” (CCAC ¶¶ 3, 8, 40, 146, 165). See New Orleans
Employees Ret. Sys. v. Celestica, Inc., 455 F. App’x 10, 14 & n.3 (2d Cir. 2011) (plaintiffs
properly pleaded scienter where “inventory levels” were “key to measuring Celestica’s financial
performance and [were] a subject about which investors and analysts often inquired”). The
magnitude of the alleged fraud, and the fact that it involved Salix’s key drugs and “critical”
wholesale inventory metric, all provide additional support for finding that Defendants acted with
scienter. See, e.g., In re Dynex Capital, Inc. Sec. Litig., No. 05-CV-1897, 2009 WL 3380621, at
*15 (S.D.N.Y. Oct. 19, 2009) (Baer, J.) (citing cases) (“[W]hen paired with allegations of
knowledge or recklessness the fact of the restatement, as well as its size and relation to a
defendant’s ‘core operations’ are all some evidence of scienter.”).
See also In re Bear Stearns Cos., Inc. Sec., Derivative & ERISA Litig., 763 F. Supp. 2d at 517
(“Although the size of the fraud alone does not create an inference of scienter, ‘the enormous amounts at stake
coupled with the detailed allegations regarding the nature and extent of [the client’s] fraudulent accounting and [the
accountant’s] failure to conduct a thorough and objective audit create a strong inference that [the auditor] was
reckless in not knowing that its audit opinions materially misrepresented [the company’s] financial state.’) (quoting
In re Global Crossing, 322 F. Supp. 2d 319, 347 (S.D.N.Y. 2004) (Lynch, J.)).
2. Defendant’s Arguments Are Unavailing
Defendants’ arguments against there being a strong inference that Defendants acted with
scienter fail because: (1) Defendants do not present a cogent non-fraudulent inference; and (2)
Defendants are wrong that this is a fraud-by-hindsight case.
First, Defendants fail to provide the Court with any cogent non-fraudulent inference that
is more compelling than the inferences of fraud alleged by Plaintiffs. See, e.g., Sloman v.
Presstek, Inc., No. 06-CV-377, 2007 WL 2740047, *7-8, (D.N.H. Sept. 18, 2007). Defendants
state only that there is a “plausible inference of non-culpability.” (Salix Reply, 4). To the extent
that Defendants expand on what that plausible inference may be, they do so by stating merely
that the alleged fraud was a “mistake.” (Salix Mot., 14). Defendants fail to posit any rational
inferences of benign intent.
Second, Defendants are incorrect that this is a fraud-by-hindsight case. Courts often reject
an incantation of fraud-by-hindsight when plaintiffs allege that “the company failed to take into
account information that was available to it” at the time that the company issued the incorrect
statements or omissions. In re Atlas Air Worldwide Holdings, Inc. Sec. Litig., 324 F. Supp. 2d
474, 494-95 (S.D.N.Y. 2004) (Conner, J.); see also In re Vivendi Universal, S.A., No. 02-CV5571, 2004 WL 876050, at *6 (S.D.N.Y. Apr. 22, 2004) (Holwell, J.) (collecting cases)
(rejecting defendant’s contention that “plaintiffs’ allegations of a ‘liquidity crisis’ constitute
pleading fraud by hindsight” because “the Second Circuit has explicitly recognized that plaintiffs
may rely on post-class period data to confirm what a defendant should have known during the
class period”). Here, Plaintiffs have identified wholesale reports, internal reports, and statements
by Defendants indicating their contemporaneous knowledge of wholesale inventory levels.
Although some of Plaintiffs’ allegations are based on events that occurred after the Class Period,
Plaintiffs have met their burden of pleading scienter under the PSLRA, given the events alleged
to have that occurred during the Class Period.
Accordingly, Plaintiffs’ allegations are sufficient to state a claim under Section 10(b) and
For the foregoing reasons, Defendants’ Motions to Dismiss are DENIED in their entirety.
Dated: New York, New York
April 22, 2016
KIMBA M. WOOD
United States District Judge
Because the Court finds that Plaintiffs have sufficiently alleged direct liability for each Defendant under
Section 10 of the Exchange Act, it does not reach the issue of secondary liability for the Individual Defendants
under Section 20(a).
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