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In re Dr. Reddy's Laboratory Limited Securities Litigation

United States District Court, D. New Jersey

March 20, 2019

In re DR. REDDY'S LABORATORY LIMITED SECURITIES LITIGATION

          MEMORANDUM AND ORDER

          PETER G. SHERIDAN, U.S.D.J.

         Defendant Dr. Reddy's Laboratories, Ltd. (Dr. Reddy's), Dr. Reddy's Laboratories Inc. (Dr. Reddy's USA), Abhijit Mukherjee, Satish Reddy, Saumen Chakraborty, and G. V. Prasad (collectively, Defendants), bring this motion to dismiss Plaintiff's Amended Consolidated Class Action Complaint (“Amended Complaint” or “AC”) in its entirety for lack of standing and failure to state a claim. (ECF No. 47).

         The allegations in this complaint arise under 15 U.S.C. § 78j(b), 78t(a), and 17 C.F.R. § 240.10b-5. Therefore, this Court has jurisdiction pursuant to 15 U.S.C. § 78aa and 28 U.S.C. § 1331. On May 9, 2018, Defendant filed this motion to dismiss the Amended Complaint. (ECF No. 47).

         Background

         The Public Employees' Retirement System of Mississippi provides retirement benefits to Mississippi public employees, and manages approximately $27.1 billion on behalf of beneficiaries. The Amended Complaint alleges Plaintiff purchased securities “at artificially inflated prices during the Class Period and was damaged upon revelation of the alleged corrective disclosures.” (AC at ¶ 53). Plaintiff purchased Dr. Reddy's securities between March 30, 2016 and April 6, 2016. (Declaration of Joel B. Strauss in Support of the Motion to Appoint Lead Plaintiff (Strauss Decl.), ECF No. 12, Ex. A, Certification of Jacqueline H. Ray, Ex. A, Mississippi PERS' Transactions in Dr. Reddy's Securities). However, the Amended Complaint defines the class period as November 27, 2014 through September 15, 2017. (AC at p. 1).

         Defendant Dr. Reddy's is an Indian pharmaceutical manufacturing company with a United States headquarters in New Jersey. (AC at ¶ 54). Dr. Reddy's securities are traded on the New York Stock Exchange. (Id.). Defendant Dr. Reddy's, USA, is a wholly owned United States subsidiary of Dr. Reddy's that “is primarily engaged in developing, manufacturing, and marketing generic pharmaceuticals and [active pharmaceutical ingredients] in the United States.” (Id. at ¶ 55). Defendant G.V. Prasad was the Chief Executive Officer and co-chairman of Dr. Reddy's during the class period. (Id. at ¶ 56). Defendant Saumen Chakraborty was the Chief Financial Officer and President of Dr. Reddy's during the class period. (Id. at ¶ 58). Defendant Abhijit Mukherjee was the Chief Operating Officer of Dr. Reddy's during the class period. (Id. at ¶ 60). Satish Reddy was co-chairman of Dr. Reddy's during the class period. (Id. at ¶ 62). All of the individual Defendants are alleged to have had “actual power and influence over Dr. Reddy's and the statements made by Dr. Reddy's.” (Id. at ¶ 53, 55, 57, 59).

         Dr. Reddy's allegedly misrepresented that it met mandatory manufacturing quality standards when it did not. This misdeed was in violation of the U.S. Federal Food, Drug and Cosmetic Act (FD&C Act) which prohibits the import of “adulterated” drugs. See 21 U.S.C. § 331(a); (AC at ¶ 1). Plaintiff asserts that Defendants are subject to current good manufacturing practices (cGMP) which sets minimum standards for safely manufacturing drugs by outlining general rules for all aspects of drug manufacture including facilities, personnel, equipment, drug components and containers, production, packaging, labeling, and record keeping. (AC at ¶ 2). Dr. Reddy's compliance with cGMP came into question after investors learned that the FDA observed nine potential violations at Dr. Reddy's manufacturing facility Unit VI, one of the largest facilities, in November 2014. (Id. ¶ 3). Dr. Reddy's and other corporate executives falsely assuaged the market's fears and downplayed the potential impact on manufacturing by stating in the June 17, 2015 annual report that “[a]ll of the [Dr. Reddy's] facilities are designed in accordance with and are compliant with current Good Manufacturing Practice requirements.” (Id.).

         According to Plaintiff, the fraud began to unravel in November 2015 when the Food and Drug Administration (FDA) publicly issued a Warning Letter (the “Warning Letter”) that described three of Dr. Reddy's manufacturing facilities as suffering from “recurrent” and “long-standing failures, ” with some violations dating back to 2008. (Id. at ¶ 4). The Warning Letter questioned Dr. Reddy's ability “to achieve overall compliance with CGMP” and concluded, “It is apparent that [Defendants] have not implemented a robust quality system at [Dr. Reddy's] sites.” (Id. at Exhibit 5). The FDA “strongly recommend[ed]” that Defendants “evaluate global manufacturing operations to ensure compliance with CGMP regulations and requirements, comprehensively and immediately.” (Id. ¶ 4).

         Following the receipt of the November 2015 Warning Letter, Defendants allegedly continued to fraudulently downplay the impact of their purported compliance-related efforts on ongoing manufacturing. (Id. at ¶ 5). In February and July 2016, Defendants disclosed that production had been slowed as a result of the remediation. (Id.). In an October 25, 2016 earnings call, Defendants also touted that they had “done [their] part of it in terms of completing all the remediation activities.” (Id. at ¶ 263).

         However, between February 27 and March 8, 2017, the FDA re-inspected the three facilities under the Warning Letter and again found problems at all three facilities. (Id. at ¶ 6). One facility - Unit VII - was particularly problematic; the FDA's internal Establishment Inspection Report regarding the early 2017 inspection “found that numerous items had not been corrected” and during the inspection “repeated instances of employees providing false or misleading statements [were] discussed with firm management.” (Id. at ¶¶ 6, 321).

         During the summer of 2017, a string of disclosures revealed just how little Dr. Reddy's had accomplished in its purportedly “network wide” remediation. (Id. at ¶ 7). In August 2017, the German equivalent of the FDA rescinded Dr. Reddy's compliance certificate for a whole new facility, Unit II, which had not been implicated by the Warning Letter. (Id.). Similarly, in September 2017, the FDA found more observations of potential non-compliance at a facility based in the United Kingdom. As a result of these disclosures, the price of Defendants' U.S.-traded securities dropped over 50% from their pre-Warning Letter class period high. (Id.). Plaintiff alleges that investors were damaged by Defendants' materially false and misleading statements throughout the class period concerning: (i) Dr. Reddy's compliance with manufacturing quality regulations, including cGMP; (ii) the scope and severity of the FDA's observations of non-compliance; (iii) the company's purported progress getting back into compliance; and (iv) the extent to which getting back into compliance would impact ongoing production. (Id. at ¶ 8).

         Dr. Reddy's, like all pharmaceutical manufacturers, has a non-delegable duty to ensure that the drugs and pharmaceutical ingredients it produces are safe, effective, and in compliance with the regulations in the jurisdictions in which they are sold. (Id. at ¶ 9). For drugs sold in the United States, the regulatory regime is premised on the cGMP, which are promulgated by the FDA and codified in the Code of Federal Regulations (21 C.F.R. Parts 210 and 211). (Id. at ¶ 9). Plaintiff alleges that Dr. Reddy's routinely violated fundamental precepts of the cGMP. (Id. at ¶ 10). For example, when errors or discrepancies in the manufacture of a drug are discovered during the quality control testing phase - such as the accidental production of a batch of super- or sub-potent drugs - the manufacturer must “thoroughly” investigate and identify the cause of the error. (Id.); See 21 C.F.R. § 211.192. The FDA allegedly found numerous instances where Dr. Reddy's management knew about deviations and errors in the production of drugs at three of its largest and most important facilities yet took no action to investigate the cause of the error or to correct it. (Id.).

         Starting in 2012 through the start of the class period, Dr. Reddy's management oversaw a dramatic increase in the volume of production at the company's manufacturing facilities, including those at the center of this action. (Id. ¶ 12). However, a well-placed confidential witness and former Dr. Reddy's employee, identified as “CW 1, ” who had firsthand information of Dr. Reddy's manufacturing facilities in India, stated that the ramp up in production output led to increased quality problems and delays. (Id.). As a result, significant pressure was put on the quality teams to cut corners and release batches of products from the review cycle without performing adequate quality assurance or control. (Id.).

         In November 2014, after performing an unannounced on-site inspection of Unit VI, one of Dr. Reddy's largest manufacturing facilities, the FDA caught Dr. Reddy's shirking on its responsibility to follow the cGMP and other mandatory regulations used to ensure drug safety. (Id. at ¶ 13). They communicated that they observed nine objectionable instances of potential non-compliance. (Id.). For example, Dr. Reddy's allegedly had manipulated and deleted quality control testing data using a quality control laboratory that was not disclosed to the FDA. (Id.). Dr. Reddy's had used the undisclosed lab to test and retest batches of pharmaceutical products that had failed quality control until they successfully passed muster. (Id.). The FDA privately communicated these observations to Defendants in a November 21, 2014 FDA Form 483 Notices of Inspectional Observations. (Id. at ¶¶ 13, 120).

         At the start of the class period, on November 27, 2014, investors learned of the FDA's observations of potential non-compliance at Unit VI from an online industry publication named In-Pharmatechnologist.com and an Indian publication named the Deccan Chronicle. (Id. at ¶¶ 14, 214, 224). Nevertheless, that same day, Defendants immediately issued a press release “clarification” and commented in the industry publication. (Id. at ¶¶ 14, 158, 214). They acknowledged receipt of the FDA Form 483, but then inaccurately assuaged investors' fears, claiming “there is no implication on manufacturing, ” and that they were “confident it [wouldn't] lead to any further enforcement.” (Id. at ¶¶ 14, 158, 214).

         Analysts covering Dr. Reddy's apparently did not believe the FDA Form 483 would adversely affect the company. (Id. at ¶¶ 15, 221). The next day, November 28, 2014, an analyst named IndiaNevish issued a report stating: “[Dr. Reddy's] has clarified that these observation[s] would not have any material impact on company's operation or consolidated results . . . . We find non-stoppage of production from facility under observation to be positive for [Dr. Reddy's] as it implies [Dr. Reddy's] following norms to comply with USFDA regulation.” (Id. ¶¶ 15, 221). The report was available on publications including Bloomberg INNS, Thomson First Call, Reuters, and Factiva INDIV. (Id. at ¶ 221 n.6).

         Dr. Reddy's went on to privately receive at least two more FDA Form 483s for two other manufacturing facilities in India in January and March 2015. (Id. at ¶ 16). Together, the thirty-three observations at three different facilities depicted a pervasive pattern of: (1) neither recording nor maintaining quality control testing data; (2) failing to investigate the cause of failing quality control test results; and (3) failing to mitigate the risks of microbiological contamination. (Id.).

         Despite receiving these two additional FDA Form 483s, Defendants allegedly knowingly misled investors by claiming that they were in full compliance with cGMP. (Id. at ¶ 17). For example, on June 17, 2015, Defendants claimed in their annual report for the year ended March 31, 2015, that “[a]ll of the facilities are designed in accordance with and are compliant with” the cGMP. (Id.).

         Further, on July 30, 2015, Defendants falsely claimed that their compliance issues were “pretty much a one site specific issue” and that they had “comprehensively addressed almost all the observations raised” despite having received two additional FDA Form 483s for two separate facilities and, according to the FDA, having proposed woefully inadequate corrective actions. (Id. at ¶ 18 (emphasis omitted)). Plaintiff contends that Defendants failed to fix the problems at their manufacturing facilities - despite claiming they had - and the FDA escalated its enforcement by issuing the November 2015 Warning Letter to Defendant Reddy. (Id. at ¶ 19). The Warning Letter had revealed that Dr. Reddy's manufacturing quality problems were not an isolated “one site specific issue, ” but rather, a pattern of cross-facility, persistent violations. Multiple violations dating back to 2008 and multiple observations from the FDA Form 483s remained uncorrected. (Id.; see AC at Exhibits 2 (March 6, 2015 Form 283), 3 (January 31, 2015 Form 283), 4 (November 21, 2014 Form 483), 5 (November 2015 Warning Letter)).

         Furthermore, the Warning Letter memorialized portions of Defendants' responses to the FDA following their receipt of the three FDA Form 483s. (AC at ¶ 20). The FDA's descriptions of these responses show that Defendants knew about the specific non-compliant conditions at the same time they claimed that all manufacturing facilities were “compliant” with the cGMP. (Id.).

         For instance, in a December 15, 2014 letter responding to the FDA Form 483 issued to Unit VI in November 2014, Defendants attempted to justify their use of an undisclosed quality control lab to test and retest products until they passed, while only recording passing results. (Id. at ¶ 21). According to the FDA, Defendants' response “acknowledged that [their] analysts failed to document and start investigating [out-of-specification] results” in the undisclosed quality control lab. (Id.). However, the November 2015 Warning Letter concluded that eleven months after the December 2014 letter, Defendants still had “not assessed how [their] reliance on the incomplete and inaccurate data generated by the [custom quality control] laboratory” affected the quality of the facility's products. (Id.) Defendants' late 2014 and early 2015 acknowledgments in their responses to the FDA establish their knowledge that the statements were false and misleading. (Id.).

         Based on these observations and others, the Warning Letter concluded: “Several violations are recurrent or represent long-standing failures to adequately resolve significant manufacturing quality problems. It is apparent that you have not implemented a robust quality system at your sites.” (Id. at ¶ 22, Ex. 5, Warning Letter at 9).

         Wall Street analysts covering Dr. Reddy's were surprised by the Warning Letter. A Morgan Stanley analyst stated, “Hitherto, only one site, which is located at Srikakulam [(Unit VI)] was perceived to be under FDA risk; warning letters to two additional sites is disappointing.” (Id. at ¶ 21). Equirus echoed the surprise: “While we knew about the Srikakulam facility issues, we never knew about the seriousness of observations at the other plants - mainly as management commentary was very optimistic in the quarterly calls. This clearly is significantly against our expectations . . . .” (Id. at ¶ 23).

         On November 6, 2015, Dr. Reddy's issued a press release publicly acknowledging that it had received the Warning Letter, marking the first time the market learned of same. (Id. at ¶¶ 198, 248, 291). Dr. Reddy's American Depositary Shares (“ADSs”) dropped 18%. (Id. at ¶ 24). When reports in the media first circulated on November 27, 2015, Dr. Reddy's ADSs dropped an additional 5.6%. (Id. at ¶ 24).

         Nevertheless, instead of acknowledging the significant impact that an “organization-wide” “revamp [of their] quality systems and processes” to “fully comply with the cGMP quality standards across all of [their] facilities” would have on production, Defendants claimed on November 9, 2015 that they had “de-risked” the three facilities subject to the Warning Letter and there would be minimal impact on manufacturing. (Id. at ¶ 25). As part of the remediation, Defendants promised to engage an outside consultant to perform a “third party assessment of [their] quality systems and evaluate [their] global manufacturing operations to ensure compliance with CGMP regulations” as required by the FDA. (Id. at ¶ 26).

         On November 5, 2015, Defendants hired Lachman Consultants Services, Inc. (“Lachman”), a consulting firm that specializes in responding to FDA warning letters. (Id. at ¶¶ 26, 61). According to CW 1, Lachman came in after Dr. Reddy's received the Warning Letter; due to Dr. Reddy's extended review process and Lachman's subsequent review, Dr. Reddy's batch releases slowed down by as much as 66%, and management was fully aware of this slow down. (Id. ¶ 27).

         Just three months after receiving the Warning Letter, on February 9, 2016, Defendants had to admit, contrary to their earlier public statements, that Dr. Reddy's was indeed experiencing manufacturing delays due to the remediation, causing the price of Dr. Reddy's ADSs to drop almost 6%. (Id. at ¶ 28).

         Defendants then falsely claimed these delays were essentially a one-time occurrence and manufacturing was “back on track.” (Id. at ¶ 29). However, on July 26, 2016, Dr. Reddy's revealed that the company's remediation efforts had once again substantially delayed production at the impacted facilities. (Id.). As a result of this news on July 26, 2016, the price of Dr. Reddy's ADSs dropped an additional 15%. (Id.).

         Plaintiff alleges that in addition to misleading the market about production delays caused by the remediation, Defendants misled the market about their progress in remediating the company's non-compliance. (Id. at ¶ 30). On May 12, 2016, Defendants claimed that they believed that “most of [their] commitments to the [FDA] will be over by the end of [May 2016].” (Id.). Similarly, Defendants claimed on July 26, 2016, that they had completed up to 98% of their commitments to the FDA. (Id.). However, at the time of these statements, Defendants knew they had not corrected the problems at the three facilities under the Warning Letter, nor had they completed a network wide revamp of the company's compliance processes. (Id.).

         On March 8, 2017, the market further learned the true state of Dr. Reddy's purported “system wide” remediation efforts when news broke that Dr. Reddy's had failed the FDA's re-inspection of Unit VII, receiving thirteen FDA observations in a March 8, 2017 Form 483. (Id. at ¶ 31; Exhibit 7). This news revealed the falsity of Defendants' claims that, since July 2016, they had basically addressed all of the FDA concerns and were merely awaiting re-inspection. (Id. at ¶ 31). Based on the news, the price of Dr. Reddy's ADSs fell once again, this time by more than 5% over two days. (Id.).

         Thirteen days later, on March 21, 2017, additional information about the failed re-inspection came to light following an economic news channel's report that “US FDA finds repeat observations from 2015 warning letter. Failed to maintain complete data to ensure compliance.” (Id. at ¶ 35). The news of five repeat observations from the Warning Letter continued to reveal the falsity of Defendants' claims that they had fully addressed the FDA's concerns. (Id. at ¶ 32).

         Additionally, the subsequently-released Unit VII establishment inspection report, dated April 4, 2017, which accompanied the Form 483, made clear that management knowingly took no action concerning, among other things, more than 1, 200 documentation errors from May 2016 to October 2016 in violation of cGMP. (Id. at ¶ 32; Exhibit 9). Consequently, the price of Dr. Reddy's ADSs took another hit, falling more than 6%. (Id. at ¶ 32).

         Finally, a string of disclosures during the summer of 2017 fully revealed just how little Dr. Reddy's had accomplished in its purportedly “network wide” remediation. (Id. at ¶ 33). On August 10, 2017, the company revealed that a German regulator would not renew a cGMP compliance certificate for a manufacturing facility that was entirely separate from the facilities under the Warning Letter. (Id.). After investors learned about the revocation of a compliance certificate at the new facility, the price of Dr. Reddy's ADSs fell almost 6% from its previous close. (Id.). Similarly, on September 15, 2017, Dr. Reddy's disclosed that the company had been advised of new FDA observations of potential non-compliance at a United Kingdom manufacturing facility. (Id.).

         When the truth was fully and finally revealed on September 15, 2017, the value of Dr. Reddy's ADSs had dropped to $33.78 from its class period high of $65.25 just before the issuance of the November 2015 Warning Letter. (Id. at ¶¶ 34, 297). From its class period high just before the issuance of the Warning Letter, Dr. Reddy's ADSs had fallen a staggering 50.17% in value. (Id.).

         Overall, Plaintiff has set forth twenty-two individual misstatements upon which the complaint is based:

• Misstatement 1: In an online publication named In-Pharmatechnologist.com dated November 27, 2014, a Dr. Reddy's spokesperson commented that the Form 483 observations by the FDA “were largely related to procedural and other compliances of the plant system”; “there is no implication on manufacturing and at this stage production continues as normal.” The spokesperson also stated she was “confident that it [wouldn't] lead to any further enforcement.” (AC at ¶ 214-15 (emphasis omitted)).
• Misstatement 2: Dr. Reddy's posted a clarification on November 27, 2014, on the Bombay Stock Exchange website clarifying a news article, which stated:
The Company clarified stating that the company had received some inspectional observations from the U.S. FDA after their visit to their API manufacturing facility in Srikakulam district of Andhra Pradesh. The company is committed to respond to the agency within stipulated timelines with their remedial plans and start implementing the necessary measures immediately. At this stage, it has no implication on any activity at the plant. Hence, these are not expected to be material to the Company[']s operations or consolidated results.
(AC at ¶ 216 (emphasis omitted)).
• Misstatement 3: During a January 29, 2015 earnings call to address “Q3 FY 2015, ” Defendant Mukherjee engaged in the following conversation:
Analyst: A quick question on Srikakulam [(Unit VI)]. My understanding has been that over the last few years, FDA generally does not stop product approvals with the 483s. It requires a warning letter, so why is that for you FDA has taken that stance?
Abhijit Mukherjee: . . . [I]f your question is a direct question that whether we will be [getting a] warning letter, I do not know. That is not our expectation. We have responded comprehensively to the nine observations [regarding Srikakulum]. We are sending an update as we speak and let us see how that pans out.
. . . .
Analyst: So just a personal thought and since it is very important for everyone, so therefore I am just pressing on that. Sir observations such as readings falling out of specifications being recorded as falling within the specifications, does it not really border on the lines of data integrated issues, what is really our internal assessment on observations such as these?
Abhijit Mukherjee: So what is available and you read are the observation by FDA. What you do not have access to are the rationale and the reasoning and the answers on this. So what I am telling you is that we have answered fairly comprehensively on most of these. Are not there insights and learning? - Yes there are insights and learning but we have answered fairly comprehensively to more of the observations. Per se if you read the observations it does not give you the full story.
(AC at ¶ 225 (emphases omitted)).
• Misstatement 4: During a July 30, 2015 earnings call to address “Q1 FY 2016, ” Defendant Mukherjee engaged in this exchange:
Analyst: So per se, the 483 issue does not like really stop you from getting on the other ANDAs, right?
Mukherjee: By no means. This is pretty must one site specific issue. A huge amount of organizational effort is standing for us everywhere where we are. Taking this is a drive to see how else we could more train, more do IT backup.
(AC at ¶ 228 (emphasis omitted)).
• Misstatement 5: On December 26, 2014, Defendants posted a clarification on the Bombay Stock Exchange in response to a report that Canada had placed an import restriction on the Unit VI facility. It stated:
The Exchange had sought clarification from Dr. Reddy's Laboratories Ltd. with respect to news article appearing in Asian Age on December 26, 2014, titled “DRL under health Canada Scanner.”
. . . Our products continue to meet intended quality standards, and we believe that, our APIs and Finished drug products manufactured using these APIs pose no risk to the health and safety of the Canadian people. The Company is working with the agency for a satisfactory resolution of the matter. At this stage, it has no implication on any activity at the plant and hence, these are not expected to be material to the Company's operation or consolidated results.
(AC at ¶ 230 (emphases omitted)).
• Misstatement 6: In Dr. Reddy's May 12, 2015 Annual Report for 2014-2015, Defendants stated that their “focus on innovation-led affordability gives our customers access to the most complex active ingredients, while maintaining a consistent global quality standard.”
(AC at ¶ 231 (emphasis omitted)).
• Misstatement 7: On June 17, 2015, Defendants filed their Form 20-F for the year ending March 31, 2015; it stated:
Quality. We are fully dedicated to quality and have robust quality processes and systems in place at our developmental and manufacturing facilities to ensure that every product is safe and of high quality. In addition, we have integrated “Quality by Design” to build ...

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