Appeal from the United States District Court for the District of New Jersey. (D.C. Civil Action No. 02-cv-03185). District Judge: Honorable Stanley R. Chesler.
The opinion of the court was delivered by: Ambro, Circuit Judge
Argued September 29, 2005
Before: ALITO, and AMBRO, Circuit Judges RESTANI,*fn1 Chief Judge
Merck & Co., Inc. planned an initial public offering of its wholly owned subsidiary-Medco Health Solutions, Inc. Before the IPO was to occur, however, information about Medco's aggressive revenue-recognition policy came to light. Some details about the policy were disclosed in Merck's registration statements filed with the Securities and Exchange Commission, but a Wall Street Journal article reading between the lines of this disclosure precipitated a decline in Merck's stock. After further disclosures and larger declines in Merck's stock price, the Medco IPO was canceled. Union Investments Privatfonds GmbH, as lead plaintiff for a class of Merck stockholders, claims that Merck and Medco committed securities fraud under section 10(b) of the Securities Exchange Act of 1934 and that Merck's officers made material misstatements or omissions in the registration statements in violation of section 11 of the Securities Act of 1933. Union also alleges that the Merck officers and Merck, as Medco's parent company, are jointly and severally liable as controlling persons under section 20(a) of the '34 Act. The District Court dismissed all of these claims on a motion under Federal Rule of Civil Procedure 12(b)(6). We affirm.
I. Factual Background and Procedural History
Because we review this case at the Rule 12(b)(6) stage, we take as true the facts pled in the plaintiff's complaint. Union is the lead plaintiff for a class of investors owning stock in Merck, a global pharmaceutical company.*fn2 This suit stems from the actions surrounding Merck's plan to spin off Medco in a 2002 initial public offering. Union alleges that Medco engaged in improper accounting practices, which were not fully disclosed until, after several amendments, Merck filed a registration statement gaining SEC approval. Union further alleges that Merck and Medco made misleading statements about the post-IPO independence of the two entities.
Merck first announced its plans for the Medco IPO in a January 2002 press release, in which Raymond Gilmartin, Merck's Chairman and CEO, said that the two companies would pursue independent strategies for success. On April 17, 2002, Merck filed its first Form S-1 with the SEC. The SEC did not approve this S-1, and Merck kept trying, finally securing SEC approval with its fifth S-1, filed on July 9. Market reaction led Merck to drop Medco's offering price, to postpone indefinitely the IPO, and finally to drop the IPO altogether.
A. Medco's Revenue-Recognition Policy
Medco is a pharmacy benefits manager (PBM). It saves its clients (plan sponsors) money by negotiating discount rates with pharmacies and influencing doctors to prescribe cheaper, but still therapeutically appropriate, medicines. When a customer buys drugs at a local pharmacy, the pharmacist checks with Medco to ensure that the customer is an approved beneficiary. Then the customer makes a co-payment-usually between $5 and $15-which goes directly to the pharmacy, not to Medco.
Although Medco did not handle these co-payments, it interpreted the accounting standards to allow it to recognize the co-payments as revenue.*fn3 But it did not disclose this revenue-recognition policy. In fact, Merck's 1999 SEC Form 10-K stated that Medco recognized revenue "for the amount billed to the plan sponsor." After Merck changed auditors, and before it began filings for the Medco IPO, it changed this language in its 2001 Form 10-K to state that revenues were "recognized based on the prescription drug price negotiated with the plan sponsor."
Merck's April 17 Form S-1 disclosed for the first time that Medco had recognized as revenue the co-payments paid by consumers, but it did not disclose the total amount of co-payments recognized. The day this S-1 was filed, Merck's stock price went up $0.03-from $55.02 to $55.05.*fn4 Merck filed an amendment to its S-1 on May 21 and another on June 13.
On June 21, 2002, The Wall Street Journal reported that Medco had been recognizing co-payments as revenue and estimated that in 2001 $4.6 billion in co-payments had been recognized. Barbara Martinez, Merck Included Co-Payments Among Revenue, Wall St. J., June 21, 2002, at C1. Later disclosures would show the actual number to be $5.54 billion. The market's reaction was immediate; that day Merck's stock lost $2.22-dropping from $52.20 to $49.98. Six days later, Merck announced the postponement of the Medco IPO and indicated that it would drop Medco's offering price.
Merck filed its fourth S-1 on July 5, 2002, finally disclosing the full amount of co-payments it had recognized as revenue. The S-1 showed that Medco had recognized over $12.4 billion dollars in co-payments as revenue, $2.838 billion in 1999, $4.036 billion in 2000, and $5.537 billion in 2001. Four days later, Merck announced that it would postpone the Medco IPO indefinitely, even as it filed its last S-1, which was approved by the SEC.
Merck's stock continued to fall, reaching $45.75 on July 9, the end of the class period, and $43.57 on July 10.
B. Merck's and Medco's Independence
In the January 2002 press release, Gilmartin said, regarding the planned Medco IPO, "[W]e believe the best way to enhance the success of both businesses going forward is to enable each one to pursue independently its unique and focused strategy." The independence of Merck and Medco had been and was to become a subject of some debate.
The Federal Trade Commission had launched an investigation of Medco in 1996 to determine whether it was giving preferential treatment to Merck's drugs. (The FTC also investigated some of Merck's competitors for similar reasons.) Other drug manufacturers divested their PBMs, but Merck kept Medco. In 1998 Merck entered into an FTC consent decree, which suggested, inter alia, that Medco had given favorable treatment to Merck's drugs.
Merck and Medco throughout the class period asserted that the two companies stayed independent. Both companies maintained policies of independence posted on their websites.
But Union produced data suggesting that Merck's market share of drugs sold by Medco was in several instances much higher than Merck's national market share. In its April 2002 S-1, Merck disclosed that post-IPO Medco would be obligated to continue this elevated level of Merck drug sales; the two companies had signed an agreement requiring Medco to sell a higher share of Merck drugs than Merck's national third-party market share. The May and June amendments to the S-1 fleshed out the terms of this agreement, which required Medco to pay Merck 50% of its lost revenue if it failed to hit the sales targets.
C. The Class Action is Filed
The initial complaint was filed in July 2002. Union was appointed lead plaintiff in November 2002, and it filed its corrected amended complaint in March 2003. At the time, Union's lead counsel was Bernstein Litowitz Berger & Grossman LLP. Defendants filed a motion to dismiss pursuant to Rule 12(b)(6), and the District Court granted it in July 2004. Union appealed that decision in August 2004. Only then did it hire Milberg Weiss Bershad & Schulman LLP as its counsel for this appeal.
II. Jurisdiction and Standard of Review
The District Court had subject matter jurisdiction under 28 U.S.C. § 1331 and under 15 U.S.C. §§ 77v and 78aa. It granted a motion to dismiss under Rule 12(b)(6), so ...