The opinion of the court was delivered by: Hochberg, District Judge
This matter comes before the Court upon Defendant Schiff's motion in limine to exclude certain arguments and evidence concerning Mr. Schiff's purported "omission" liability [Dkt. 155]. Defendant Schiff has also moved to dismiss from Count Two a theory of omission liability for statements made in Bristol-Myers Squibb's ("BMS") SEC filings [Dkt. 164].*fn1 The Court has considered the briefs of the parties, and oral argument on February 26, 2008, and several earlier dates when the issue of omission liability arose.
This matter also comes before the Court upon Defendant Schiff's motion to exclude proposed Government expert testimony under Daubert [Dkt. 180, 221] and the Government's omnibus motion to exclude proposed defense expert testimony [Dkt. 190, 222].*fn2 The Court has made its determination after considering the written submissions of the parties, and after having an evidentiary Daubert hearing and oral argument on March 11, 2008.
Trial had been scheduled to begin in July 2007, which was then adjourned at the joint request of all parties until September 2007, and then adjourned again until January, 2008. On November 1, 2007, the Court granted the joint application for severance and again adjourned the trial date to permit the parties additional time to obtain expert witnesses. Trial was rescheduled to commence March 17, 2008, then adjourned to March 24, 2008. For the reasons given below, the Court issues a narrow ruling dismissing one theory of omission liability and providing Daubert rulings on proffered experts. The Court expects that trial will proceed as scheduled on all remaining theories of conspiracy, misrepresentation, omission, aiding and abetting, and "scheme" liability on both Counts of the indictment on March 24, 2008.
The original indictment in this case, filed in May 2006, included charges that Defendant Schiff had violated GAAP and had employed improper accounting procedures related to reserve accounts and revenue recognition.*fn3 In April, 2007, the Government filed a Superseding Indictment [Dkt. 49]. In the Superseding Indictment, the Government made an effort to remove the accounting issues from the case. Thus, charges related to GAAP accounting and corporate reserves were removed from the indictment. Nonetheless, the parties continued to dispute whether the accounting issues had been completely excised.
To further remove accounting issues from the trial, the Government entered into a stipulation (the "Stipulation") with Defendant Schiff and joined in the Defendants' motion to sever. The Stipulation replaced in the indictment the phrase "artificially inflated BMS's sales and earnings" with "created a false and misleading picture of Bristol's business performance." The Stipulation also mandates that the following instruction be read to the jury:
Defendant "Schiff is not charged with engaging in any improper accounting practices that violated any principle of quantitative accounting, whether expressed in GAAP or otherwise, including in connection with the recognition of revenue paid by wholesalers to BMS for the pharmaceutical sales at issue in this case."*fn4
In both the conspiracy and substantive counts, the indictment charges both express misstatements and omissions to state. The motion to dismiss omission liability relates only to specific challenged misstatements and omissions to state in the SEC filings and corollary misstatements and omissions on analyst calls, and does not affect the theory of the case based on numerous other alleged misstatements and omissions to state in analyst calls. (See Dkt. 154-20 (listing alleged misstatements not challenged by the instant motion).)*fn5
To further clarify the allegations of false or misleading statements charged against Defendant Schiff, the Court ordered the Government to list all alleged misstatements and omissions it would seek to prove. The Government provided this information on November 30, 2007 (the "Bill of Particulars"). The Government detailed over 100 statements on analyst calls (in the space of 14 single-spaced pages). It also identified omissions in SEC filings (but no express misstatements in the SEC filings).
As its theories of the case have evolved, the Government has asserted different legal theories about why Defendants had a duty to speak upon which liability for alleged omissions to state is based.*fn6 Finally, at oral argument on February 26, 2008, the Government was again pressed to state the basis of Defendant Schiff's legal duty to speak underlying his alleged omissions to speak in the SEC filings. This time, a new legal theory was stated: Defendant Schiff's liability for omissions to state in the SEC filings stemmed from prior misleading statements of both Defendant Schiff and Defendant Lane on analyst calls, linking alleged misstatements on analyst calls to alleged omissions to state in the SEC filings as "all of a piece."*fn7
(2/26/08 Tr. at 124-25.) The Government having finally settled upon its legal theory, the Court will permit no further "legal theory morphs" in this case, which has been awaiting a trial for several years.
Because of the Stipulation, the Bill of Particulars, and abandoned theories of omission liability, the analysis starts with what the Government concedes that Defendant Schiff is not charged with:
1. Inaccurate quantitative revenue figures in SEC filings and elsewhere;
2. Concepts of revenue recognition and such words as would have been required by quantitative accounting principles;
3. Omissions to state in the SEC filings based on insider trading;
4. Omissions to state in the SEC filings based on a statutory duty of disclosure;
5. Misstatements in the SEC filings;
6. Substantive liability for acts of alleged co-conspirators under Pinkerton;
7. Any misstatements or omissions other than those listed in the Bill of Particulars. Given these negotiated constraints and waived theories of liability, the Government cannot premise an omission to state in an SEC filing upon a misstatement in that SEC filing, because it has not alleged any misstatement in the SEC filing. This situation was created by the Stipulation and Bill of Particulars, which left any omission to state in the SEC filing dangling and detached from its corollary misleading statement. Thus, the Government is left arguing that Defendant Schiff had a duty to speak in BMS's SEC filings about alleged sales acceleration leading to excess inventory build-up because he made alleged oral misstatements in prior analyst conference calls. This theory attempts to fit omission liability into Oran's third prong. (See supra n.6.)
II. Defendant Schiff's Duty to Speak in BMS's SEC filings
Rule 10b-5 states, in pertinent part, that "It shall be unlawful for any person, directly or indirectly ... To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading." 17 C.F.R. 240.10b-5(b) (emphasis added). Thus, Rule 10b-5(b) examines an alleged omission together with "the statements made, in the light of the circumstances under which they were made," to see if the omitted words were "necessary" to make "the statement...not misleading."
In the Bill of Particulars, which is "a list of Defendants' statements [the Government] intends to identify as false," the Government states:
The forms 10-Q filed for the first quarter, second quarter, and third quarter of 2000, the Form 10-K for 2000, and the Forms 10-Q for the first quarter and second quarter of 2001, all signed by defendant Schiff, contain omissions regarding BMS's business performance, in that they omit any reference to the effect of sales acceleration on reported sales and earnings. (Dkt. 149-2 at 16) (emphasis added; citations omitted.)
No statements were identified as affirmative false or misleading statements in the SEC filings. The Government now wishes to argue that the Management Discussion and Analysis ("MD&A") section of the SEC filings contain omissions to state, but the Government does not connect the MD&A alleged omissions in the SEC filing to any "statements made." Undoubtably, the Government's original theory was that the sales and earnings figures in the SEC filings were "misleading statements" by Schiff, and that the MD&A omitted to state the manner in which such sales figures were obtained, which was "necessary" to make the sales and earnings figures not misleading "in light of the circumstances under which [both] were made" in the SEC filings. The Government abandoned the first part of that theory when it negotiated the Stipulation and filed the Bill of Particulars, which constrained by the Stipulation, identifies no misleading statements in the SEC filings.
It is well-settled that the non-disclosure of material information will not give rise to liability under Rule 10b-5 unless the defendant had an affirmative duty to disclose that information and "possession of material nonpublic information alone does not create a duty to disclose it." In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1432 (3d Cir. 1997); see Basic Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988) ("Silence, absent a duty to disclose, is not misleading under Rule 10b-5."); see also Oran v. Stafford, 226 F.3d 275, 285 (3d Cir. 2000). In Oran, the Third Circuit identified three ways that such a duty to disclose may arise: (1) when there is "insider trading"; (2) when there is "a statute requiring disclosure;"*fn8 or (3) where there is "an inaccurate, incomplete or misleading prior disclosure." 226 F.3d at 285-86. In this case, the prosecution has stated that the only basis for a duty to disclose that they are pursuing against Defendant Schiff is the third prong of Oran.
Thus, in order to proceed with the "omission to state" theory involving the SEC filings, the Government must identify the prior statement that forms the basis of Defendant Schiff's duty to disclose information in the MD&A section of the SEC filings necessary to make the "statement made not misleading" in the "light of circumstances under which they were made."
A. Government's theory of duty based on "falsity of reported sales and earnings" in the SEC filings
The Government argues that "the basis for the falsity of reported sales and earnings figures is that they omit any reference to the effect of sales acceleration and wholesaler excess inventory build up." (Dkt. 150 at 1.) Thus, the Government argues that even if, per the Stipulation, Defendant Schiff is not charged with violations of quantitative accounting or revenue recognition, he can be held liable for omissions in SEC filings that he knows make the revenue figures provided therein misleading. The Government thus simultaneously stipulates that the reported sales and earnings figures are not charged as a false statement by Defendant Schiff, and yet attempts to argue that the numbers are misleading by omission while removing GAAP principles from consideration.
The flaw in this argument is that, in this unusual case, the Government has stipulated that Defendant Schiff is not charged with knowledge of a revenue recognition falsity. And, false sales and earnings figures are not identified in the Bill of Particulars. Moreover, the meaning of the revenue numbers and whether or not they fairly represent sales and earnings is fundamentally an issue of accounting and revenue recognition, regardless of whether the accounting concepts are expressed numerically or in the profit and loss portion of the SEC filings or descriptively in words relating to those numbers in the MD&A section of those filings. GAAP accounting consists of both numbers and descriptive words relating to such numbers. But, in the Stipulation, the Government concedes that neither the quantitative numbers in the financial statements nor the accounting principles of revenue recognition are misstatements that could form the basis of liability for securities fraud under Section 10(b) and Rule 10b-5(b). Because the Government signed the Stipulation, the sales and revenue figures in the SEC filings cannot constitute a "misleading statement" upon which to base omission liability. The Bill of Particulars sets forth no other misleading statements in the SEC filings.*fn9
The "omission to state" the excess inventory build-up is thus not connected to any misleading statement made in the SEC filings. There is no "omission to state a material fact necessary to make the statement made not misleading." By implication, "the statement made" is the sales and earnings figures, but the Stipulation negotiated that away, leaving an omission unattached to a "statement made." Moreover, because in the Stipulation the Government concedes that Defendant Schiff is not charged with improper accounting practices, including those associated with revenue recognition, the Government cannot argue that the sales figures are misleading by omission of words necessary to reflect the true nature of the sales, because those are accounting concepts. In this way, the Stipulation seriously constrained the theories available upon which to premise omission liability in the SEC filings. There are many other theories upon which this trial can, and will, proceed, at long last.
Furthermore, disclosures in the MD&A section are also governed by complicated statutes and regulations, and the Government did not oppose the defense motion in limine to bar such evidence from this criminal trial. (See Dkt. 170; Dkt. 208.) As stated above, the Government might well have argued that Defendant Schiff had "a duty to speak" about the inventory build-up based on these statutory requirements, but the Government specifically eschewed this theory under prong (2) of Oran. Thus, again, through their own strategy, the Government further limited the theories on which to premise omission liability for the SEC filings (as contrasted with straightforward misstatements and/or omissions liability within the analyst calls).
In sum, omission liability cannot be premised on "falsity of reported sales and earnings" without violating the Stipulation, nor can it rest on the mere recitation of the SEC filings' numbers on the analyst calls, because that is essentially the same as the SEC figures themselves.
B. The Government's revised theory: duty based on prior statements on analyst calls
Because it is barred by the Stipulation from claiming a "misleading statement" in the SEC filings' sales figures, the Government's current theory, expressed at oral argument on February 26, 2008, is that misstatements on analyst conference calls created a duty of disclosure in the SEC filings. Specifically, the Government stated at oral argument that:
We're planning to argue that it is misleading to present the information in the Q's and K's without the further explanation of the trend, the business practice that the company was using to make its numbers, to hit its targets. But by the time we make that argument, Your Honor, the issue of Bristol's business performance is already going to be in play in public. Mr. Schiff will have -- we will have put in evidence of Mr. Schiff having made ...