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IN RE PDI SECURITIES LITIGATION

August 16, 2005.

In re PDI Securities Litigation.


The opinion of the court was delivered by: JOSE LINARES, District Judge

[EDITOR'S NOTE: This case is unpublished as indicated by the issuing court.] OPINION AND ORDER

This matter comes before the Court on the motion of Defendants PDI, Inc. ("PDI") and several PDI officers (hereinafter, collectively "Defendants") to dismiss the Second Consolidated and Amended Class Action Complaint and Jury Demand (hereinafter "Second Amended Complaint") pursuant to Federal Rules of Civil Procedure 12(b)(6) and 9(b). This is a securities fraud class action suit brought by individuals who purchased the common stock of PDI between May 22, 2001 and August 12, 2002 (hereinafter, the "Class Period"). Lead Plaintiffs Gary Kessel, Rita Lesser and Lewis Lesser (collectively, "Plaintiffs") are purchasers of common stock during the Class Period. Plaintiffs aver that Defendants defrauded investors by artificially inflating that value of the common stock through accounting manipulations and false statements. The Court has jurisdiction over this action pursuant to 28 U.S.C. § 1331. Oral argument was previously heard on this matter. For the reasons discussed below, Defendants' motion to dismiss is GRANTED in part, and DENIED in part. FACTUAL AND PROCEDURAL BACKGROUND

For purposes of the instant motion, the relevant facts are as follows. PDI is a Delaware corporation, with its principal executive offices in Upper Saddle River, New Jersey. (Second Amended Complaint (hereinafter "Compl."), ¶ 7). PDI provides customized sales and marketing services to the pharmaceutical industry. (Id. ¶ 21). PDI is a publicly held corporation whose common stock is registered with the United States Securities and Exchange Commission ("SEC") and is traded on the NASDAQ National Market. (Id. ¶ 11). Defendant Charles T. Saldarini was the Chief Executive Officer and Vice Chairman of the Board of Directors of PDI during the Class Period. (Id. ¶ 8). Defendant Bernard C. Boyle was PDI's Chief Financial Officer and Executive Vice President during the Class Period (collectively Saldarini and Boyle will be referred to as "Individual Defendants" hereinafter). (Id. ¶ 9).

  Until October 2000, PDI's business historically consisted entirely of what is referred to as "contract sales" or "professional detailing," which consists of providing sales representatives to pharmaceutical manufacturers who choose to outsource selling activities for particular drugs. (Compl. ¶ 21). This business is referred to as "fee-for-service" because PDI's revenues are principally derived from the services that it provides, not the sale of the particular drug. (Id.). For several year, up to and including 2000, PDI's contract sales business enjoyed substantial growth in revenues and earnings. (Id. ¶ 22). In a November 2001 conference call, Defendant Saldarini stated that PDI knew that it was necessary to "develop additional avenues of growth . . . beyond just contract sales." (Compl. ¶ 22). Consequently, PDI sought to develop alternative types of arrangements for the sales and marketing of drugs for pharmaceutical companies. (Id.). The events that triggered the present litigation are as follows: The Ceftin Contract

  PDI negotiated its first non fee-for-service arrangement with GlaxoSmithKline ("GSK") in October 2000, which gave PDI exclusive United States marketing, sales and distribution rights for Ceftin tablets and oral suspension.*fn1 At the time PDI entered into the Ceftin contract, Ceftin had a 10.8% share of the Cephalosporin antibiotic market. (Compl. ¶ 24). This contract with GSK required PDI to make minimum quarterly Ceftin purchases and provided that the agreement could be cancelled by either party upon 120 days written notice. (Id.). Although PDI allegedly publicly stated that the Ceftin contract with GSK had a five-year term, the Ceftin patent was due to expire in 2003. (Id.).

  Plaintiffs allege that upon executing the contract, PDI promptly took steps to increase Ceftin sales and profits for the fourth quarter of 2000, by inducing drug distributors to stock up on Ceftin. (Compl. ¶ 25). As a result, that quarter, PDI reported $101 million of Ceftin revenues, representing more than half of PDI's total reported revenues for that period. (Id.). Additionally, Ceftin sales also had a dramatic effect on PDI's reported earnings for the fourth quarter of 2000, which increased to $0.77 per share, from $0.24 per share in the fourth quarter of 1999 and $0.41 per share in the third quarter of 2000. (Id.).

  Plaintiffs contend that PDI promoted the product for uses which had not been approved by the United States Food and Drug Administration ("FDA"), although there was no substantial evidence that the drug was effective for the unapproved uses. (Id.). Consequently, in March 2001, the FDA advised PDI that their promotional materials violated the U.S. Food, Drug and Cosmetic Act and applicable FDA regulations, and ordered PDI to "immediately cease distribution of the sales ads and other similar promotional materials for Ceftin that contain the same or similar claims or presentations." (Compl. ¶ 26). Following the FDA's actions, Ceftin's share of the Cephalosporin market declined such that by May 2001, it was 10.7%.*fn2 (Id. ¶ 27). By July 2001, Ceftin's share of prescriptions for Cephalospotin fell further to 8.7%, representing a 20% decline from the drug's market share at the commencement of the Ceftin contract, and a decline of more than 30% from the level attained when the aforementioned marketing materials were in use. (Id.). Additionally, Plaintiffs allege that when faced with this declining market share in the second quarter of 2001, PDI attempted to boost Ceftin's sales by announcing that price increases were to take effect in the beginning of July of that year, thereby inducing distributors to increase the Ceftin inventories in anticipation of the price change. (Compl. ¶ 28). As a result, PDI's reported Ceftin's sales in the second quarter of 2001 increased by an additional $10 million to $15 million and added $0.13-0.20 per share to its reported earnings. (Id.).

  Approximately one and one-half years prior to PDI entering into the Ceftin contract with GSK, another company, Ranbaxy Pharmaceuticals, Inc. ("Ranbaxy"), had applied to the FDA for marketing approval for a generic version of Ceftin. GSK initiated a patent infringement action seeking to enjoin Ranbaxy from producing the generic version of Ceftin. (Compl. ¶ 29). The district court entered an injunction against Ranbaxy, who then appealed to the United States Court of Appeals for the Federal Circuit. (Id.). In August 2001, the Federal Circuit reversed the lower court's decision on grounds that Ranbaxy's version of Ceftin did not violate the Ceftin patent. (Compl. ¶ 30). Plaintiffs contend that Defendants allegedly assured investors that reduced profits were the "worst case scenario" for the Ceftin contract because the projections were based upon the first launch of the generic form on October 1, 2001, and PDI could avoid losses by terminating the contract. (Id.). Plaintiffs allege that not only was the October 1, 2001 date exaggerated (since no generic form of Ceftin was ever introduced in 2001), the representation concerning contract termination was false given PDI's knowledge of the millions of dollars in write-offs of capitalized contract acquisition costs, the continued liability for sales returns, and the cost of administering Medicaid rebates as a result of the Ceftin contract termination. (Id.). It was not until November 13, 2001 that PDI publicly disclosed that PDI would incur these costs if the Ceftin contract was terminated. (Id.).

  The Lotensin Contract

  In 2001, Novartis Pharmaceutical Corporation ("Novartis") was selling three drugs for treating hypertension, namely, Diovan, Lotrel and Lotensin, and was expected to introduce five new drugs in 2002. (Compl. ¶¶ 33-35). Lotensin, an angiotension converting enzyme ("ACE") inhibitor had been selling in the market for many years and was nearing the end of its patent life. (Id. ¶ 35). Plaintiffs allege that in order to develop a relationship with Novartis, which PDI hoped would lead to profitable future contracts, PDI agreed to market Lotensin in the United States at its own expense. (Id. ¶ 36). PDI's sole compensation for these efforts was a split of net Lotensin sales over a baseline amount. (Id.). Plaintiffs allege that the exact amount, undisclosed at the time, would cause PDI to lose money on the contract throughout 2001. (Id.) Additionally, Plaintiffs contend that although Lotensin's market share was decreasing at this time, PDI was guaranteed to lose money on the contract even if it realized a substantial increase in market share. (Id.).

  Plaintiffs maintain that the baseline above which PDI would profit from Lotensin sales was so high that PDI lost $5 million on the contract in that quarter, even though Lotensin's share of the ACE inhibitor market had increased by the fourth quarter of 2001. (Compl. ¶ 36). According to Plaintiffs, PDI would have been required to increase Lotensin sales by another $10 million in the quarter in order to offset that loss . (Id.). Further, in order to achieve a projected $0.25 earnings per share, Lotensin sales would have had to have been increased over 30%. (Id.).

  Plaintiffs further allege that Defendants concealed this impediment to profitability that was created by the baseline. (Compl. ¶ 37). In support of this assertion, Plaintiffs rely on a statement made analyst in May 23, 2001, where he stated that "PDI's main goal with Lotensin will be to try and slow-down its market share deterioration. . . ." (Id.). It is Plaintiffs' contention that this was misleading because as stated above, Defendants believed that PDI needed to do a lot more than merely "slow-down" Lotensin's market share deterioration. (Id.). Plaintiffs claim that PDI regularly forecasted the future earnings and the earnings effect of large contract gains and losses. (Compl. ¶ 38). Thus, they maintain that PDI told the public that although the contract would be unprofitable in the second and third quarters of 2001, it would produce earnings of $0.25 per share by the fourth quarter of that year, knowing that this was impossible. (Id. ¶ 38).

  When the Defendants finally disclosed that the Lotensin contract would not produce $0.25 earnings in the fourth quarter in 2001, but would produce a loss of $0.23 per share, Defendants blamed this disparity on delay in completing market research and the preparation of marketing materials. (Compl. ¶ 39). Defendants also stated, for the first time, that the Lotensin contract was a "long-term strategic opportunity," presumably aimed at obtaining future profitable business from Novartis. (Id.). At the time, Defendants announced the Lotensin contract, they refused to reveal the specific baselines that would be used to compute PDI's revenues. (Id. ¶ 40). Plaintiffs admit that Defendants revealed that the baseline amount would decline over the contract life. (Id.). Despite the decline in 2002, PDI lost additional money on the contract in the first quarter of 2002, although Lotensin's market share had increased. (Id. ¶ 40). Similarly, at this time the Defendants stated that PDI would reduce the number of representatives assigned to sell Lotensin by 75%. (Id.).

  The Evista Contract

  On October 2, 2001, PDI declared that it entered into an agreement with Eli Lilly and Company ("Eli Lilly"), to co-promote Evista, an osteoporosis drug, in the United States. (Compl. ¶ 41). Pursuant to the agreement, PDI would provide a sizeable number of sales representatives to augment the existing Eli Lilly sales force already promoting Evista. (Id.). PDI's compensation for its participation in the co-promotion of Evista was a split of net sales over the baseline amount. (Id. ¶ 43). The specifics of the Evista agreement, however, were not publicly disclosed. (Id. ¶ 44).

  At the end of the Class Period, Defendants admitted that the Evista contract was a "long-term strategic opportunity." (Compl. ¶ 46). However, according to Plaintiffs, it was not until November 2002 that Defendants admitted that PDI cancelled the Evista contract because it was expected to continue to incur tens of millions of dollars of losses. (Id.). Given that the contract committed PDI to a certain level of spending for promotional activities which would result in expenses of approximately $32-48 million per year, the Evista contract, Plaintiffs assert, needed to exceed the contractual baseline by $32-48 million in order to break even. (Id. ¶ 47). By November 2002, the Evista contract had cost PDI almost $50 million in losses as a result of prior losses on the contract in addition to a $9.1 million charge related to the contract. (Id. ¶ 48).

  Thereafter, Eli Lilly awarded a contract involving the promotion of the drug Cymbalta, a drug used to treat depression, to a competitor, Innovex. (Id. ¶ 49). The Cymbalta contract could have been very profitable for PDI as there is, as Plaintiffs explain, significant promotional potential for new prescription drugs that treat depression. (Id.).

  Allegedly False and Misleading Statements

  On May 22, 2001, the first day of the Class Period, PDI held a conference call with securities analysts to discuss the contract with Novartis for the distribution of Lotensin. (Compl. ¶ 51). During the conference call, Saldarini represented that the Lotensin agreement was expected to add $0.25 earnings per share to the company's fourth quarter 2001 earnings, although startup costs, such as training and promotional costs, would likely depress earnings for the second and third quarters. (Id.). Plaintiffs claim that these statements were intended to increase the price of PDI common stock. (Id. ¶ 52). Plaintiffs further claim that the price did increase by $5.10 following the May 22 conference from $86.08 per share on May 22, 2001 to close at $91.18 on May 23, 2001. (Id.). Plaintiffs further allege that these statements were intended to convey the false and misleading impression that the terms of the Lotensin contract were advantageous to PDI, and that PDI would earn significant profits after the initial investment of start-up costs. (Id. ¶ 53). Plaintiffs further charge that Defendants knowing or recklessly failed to disclose that PDI had purposefully entered into an unprofitable contract with Novartis in order to: (1) retain the services of marketing representatives who would otherwise have left PDI; and (2) to obtain future profitable business from Novartis. (Id.). PDI subsequently issued a press release on July 20, 2001 announcing that Pfizer, Inc. ("Pfizer") had elected not to renew a product detailing agreement that was due to expire on October 31, 2001. (Compl. ¶ 54). The press release assured investors that the termination would not adversely affect its earnings for 2001 or 2002. (Id.; Declaration of Israel David ("David Decl."), Ex.3).

  Thereafter, a conference call was held on August 14, 2001, involving Saldrini and Boyle. (Compl. ¶ 55; David Decl. Ex.4). They discussed PDI's results for the second quarter of 2001 and its expected results for the remainder of 2001. (Id.). Defendants further noted that PDI would likely earn $0.20 per share less than previously forecasted for the third quarter due to a Ceftin inventory glut at distributors. (Compl. ¶ 55; David Decl. Ex.4 at 8). However, both Defendants advised that despite the expected weakness in the third quarter, PDI would meet previously announced expected earnings for the year 2001 of $2.30 per share based on expected strength in the fourth quarter. (Compl. ¶ 55). Plaintiffs allege that the aforementioned statements were materially false and misleading because Defendants failed to divulge that PDI had never increased Ceftin's market share, except for the periods where it was allegedly employing unlawful marketing materials or artificially increasing market share by "incentivizing" distributors to stock up on Ceftin. (Id. ¶ 56).

  Subsequently, PDI issued a press release on August 21, 2001, announcing the Federal Circuit's decision holding that Ranbaxy's generic Ceftin did not infringe GSK's patent. (Compl. ¶ 57; David Decl. Ex.5). Defendants advised that Ranbaxy could begin selling generic Ceftin upon obtaining FDA approval. (Id.). Further, the press release advised that PDI was evaluating its options and additional announcements would be forthcoming. (Compl. ¶ 57). PDI subsequently issued a press release on August 23, 2001, discussing its options in light of the Federal Circuit's decision. (Id. ¶ 58). PDI also discussed the financial implications on PDI's business for the remainder of 2001 and 2002 resulting from the immediate introduction of generic Ceftin, noting that in the third and fourth quarters of 2001, PDI "expects a severe impact on net revenue and profitability," and that "[s]uch impact will result partly from wholesalers and other trade customers reducing projected purchases from PDI in anticipation of building generic cefuroxime axetil tablet inventories from other suppliers, and partly because sales and marketing costs cannot be significantly reduced over the short-term." (Compl. ¶ 59).

  On August 24, 2001, Saldarini held a conference call to address concerns prompted by the aforementioned developments concerning Ceftin. (Compl. ¶ 60; David Decl. Ex.7). Saldarini explained that even if introduced in October of that year, the generic Ceftin could not satisfy the entire fourth quarter demand for Ceftin, and he expected that 80% of the fourth quarter demand would be satisfied by Ceftin and not the generic competition. (Compl. ¶ 61). He further claimed that the company was expecting Ceftin to contribute $0.30-0.40 earnings per share by 2002. (Id.; David Decl. Ex.7 at 6). Plaintiffs contend Saldarini's statements regarding the impact of generic competition for Ceftin were false and misleading because the Defendants failed to disclose that the termination of the Ceftin contract would cause PDI to incur "massive expenses," and further, PDI never increased Ceftin's market share, except when it "had unlawfully promoted the drug or artificially inflated reserve by shifting sales into an earlier quarter at the expense of a later quarter." (Compl. ¶ 62).

  On November 12, 2001, PDI issued another press release announcing a loss of $17.3 million for the third quarter of 2001. (Compl. ¶ 63). Saldarini stated that PDI would terminate the Ceftin agreement with GSK, but that PDI had "positive developments in the pipeline. . . ." (Id.). Plaintiffs maintain that the revelations in the November press release were much worse than PDI had previously led investors to believe. (Id. ¶ 65). The price of PDI common stock declined from a $29 per share close on November 12, 2001, to close at $18.35 per share on November 13, 2001. (Id.).

  On November 13, 2001, PDI held a conference call with investors and analysts. (Compl. ¶ 66; David Decl. Ex.8). During the call, Saldarini revealed that PDI would not profit from the Ceftin contract in the fourth quarter. (Compl. ¶ 66). He further advised that the Lotensin contract would not contribute to fourth quarter earnings as expected because PDI "did not have the marketing materials, the positioning and support programs in place." (Id.).

  Procedural History

  Plaintiffs initiated the instant action on January 16, 2002. On May 23, 2002, the Honorable Magistrate Judge Ronald J. Hedges, U.S.M.J. granted Plaintiff Gary Kessel's motion to consolidate civil case 02-cv-211, with 02-cv-367 and 02-cv-699. Thereafter, a Consolidated and Amended Class Action Complaint was filed on July 30, 2002. On November 19, 2002, Plaintiffs' motion to file an Amended Complaint was granted, and the Second Amended Complaint was subsequently filed on December 13, 2002. Count I of Plaintiffs' Second Amended Complaint is premised on violations of Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, against all the Defendants. Count II alleges a violation of Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against Defendants Saldarini and Boyle as the controlling persons of PDI. Defendants presently move to dismiss the Second Amended Complaint under Fed.R.Civ.P. 9(b), 12(b)(6), and the Private Securities Litigation Reform Act of 1995 (hereinafter the "Reform Act" or "PSLRA"), 15 U.S.C. §§ 78u-4, et seq.

  LEGAL STANDARDS

  A. Rule 12(b)(6), Rule 9(b), and the Reform Act

  1. Fed.R.Civ.P. 12(b)(6)

  The applicable inquiry under Federal Rule 12(b)(6) is well-settled. Courts must accept all well-pleaded allegations in the complaint as true and to draw all reasonable inferences in favor of the non-moving party. Scheuer v. Rhodes, 416 U.S. 232, 236 (1974), overruled on other grounds, Harlow v. Fitzgerald, 457 U.S. 800 (1982); Allegheny Gen. Hosp. v. Philip Morris, Inc., 228 F.3d 429, 434-35 (3d Cir. 2000). The question is not whether plaintiffs will ultimately prevail in a trial on the merits, but whether they should be given an opportunity to offer evidence in support of their claims. Scheuer, 416 U.S. at 236. Dismissal under Rule 12(b)(6) is not appropriate unless it appears beyond doubt that plaintiff can prove no set of facts in support of his claim which would entitle him to relief. Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 346 (citing Conley v. Gibson, 355 U.S. 41, 45-46 (1957)).

  The Third Circuit has further noted that courts are not required to credit bald assertions or legal conclusions improperly alleged in the complaint. In re Burlington Coat Fact. Sec. Litig., 114 F.3d 1410, 1429 (3d Cir. 1997). Similarly, legal conclusions draped in the guise of factual allegations may not benefit from the presumption of truthfulness. In re Nice Sys., Ltd. Sec. Litig., 135 F. Supp. 2d 551, 565 (D.N.J. 2001). 2. Heightened pleading requirement

  Fed.R.Civ.P. 9(b) imposes a heightened pleading requirement of factual particularity with respect to allegations of fraud, independent of the standard applicable to a Rule 12(b)(6) motion. Rule 9(b) states: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). "This particularity requirement has been rigorously applied in securities fraud cases." In re Burlington, 114 F.3d at 1417 (citations omitted). As such, plaintiffs averring securities fraud claims must specify "`the who, what, when, where, and how: the first paragraph of any newspaper story.'" In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999) (quoting DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990)). The Third Circuit has further noted that "[a]lthough Rule 9(b) falls short of requiring every material detail of the fraud such as date, location, and time, plaintiffs must use ...


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