When Worlds Collide: Eighth Circuit Finds Failure to Disclose FDA 483 Observations Can Support Securities Fraud Claims

Many FDA-regulated companies are subject to securities law requirements to disclose financial and other information. In a recent decision – Public Pension Fund Group, et al. v. KV Pharmaceutical Co., No. 10-3402, 2012 WL 1970226 (8^th Cir. June 4, 2012) – the U.S. Court of Appeals for the Eighth Circuit explored the intersection between FDA enforcement communications and a company's public statements regarding compliance with FDA requirements.

The KV case is important for FDA-regulated businesses because the court found that public statements made by a company regarding its regulatory compliance could form the basis of securities law claims if the FDA had raised concerns about the company's compliance.

Background:  From 2003 to 2009, KV was inspected by the FDA seven times, and each time KV received a Form 483, setting forth failures to comply with FDA's current Good Manufacturing Practices (cGMPs) relating to its drug products. The Form 483 states that its contents are "inspectional observations" and not final agency determinations. In many cases, the issues cited in Form 483s can be resolved without additional FDA action. In other instances, the observations lead to formal enforcement actions.

In KV's case, the problems recurred and were not addressed to the agency's satisfaction. FDA eventually brought civil and criminal cases against KV and some KV officers. Eventually, a KV subsidiary and the former KV CEO pled guilty and stopped production and sales of certain products.

Throughout this period, KV was also filing quarterly and annual reports under the Securities Exchange Act of 1934 ("Exchange Act"). In its annual 10-K reports, KV disclosed the comprehensive regulation of pharmaceutical companies by the FDA and the risks of non-compliance. At various times from 2004 to 2009, KV stated in its SEC reports:

• "We believe that all of our facilities are in material compliance …"
• "We are currently in material compliance with cGMP …"
• "We believe that we are currently in material compliance with cGMP …" 

During this same period, KV stock dropped from a $30 trading price to less than $1. Shareholders filed a class action complaint for securities fraud under Section 10(b) of the Exchange Act and Rule 10b-5 asserting that that the statements in KV's SEC reports regarding FDA compliance were false or misleading.

Trial court decision:  KV moved to dismiss the securities case under the Private Securities Litigation Reform Act of 1995 (PSLRA), asserting that the shareholders failed to plead fraud with sufficient specificity. KV also asserted that, as a matter of law, its SEC reports were not false or misleading because the FDA Form 483 observations, did not need to be disclosed because the Form 483s were not final determinations by the FDA but only observations.

The trial court agreed with KV and dismissed the complaint, and this appeal followed.

Eighth Circuit decision:  The appellate court reversed the trial court and held that the shareholders had satisfied the enhanced pleading requirements of PSLRA and that their complaint was sufficient under Rule 12(b)(6) of the Federal Rules of Civil Procedure. The appellate court found that investors could have considered the Form 483s significant in view of KV's repeated assurances that it was in material compliance with FDA regulations.

The key issue before the court was whether the failure to disclose the adverse information in the Form 483s conflicted with the compliance-related disclosures in KV's SEC filings. KV argued that 483 observations are not material, are not final FDA actions and are only "observational." Essentially, KV argued that a Form 483 "can never render a company's statement about compliance with FDA regulations … false or misleading."

The appellate court rejected KV's position. The court found that the issuance of a Form 483 represents a risk that the FDA may take action against a company, and that the company must assess the seriousness of the risk and may need to disclose it to investors if it also represents that it is in material compliance with FDA regulations. The court stated, "[T]he issuance of Form 483s may render a defendant's statements about its compliance with FDA regulations … false or misleading, in some circumstances" (emphasis added). The court looked to the following factors in determining whether disclosure of Form 483 information is required:

• The number, severity and pervasiveness of the findings
• Whether the company addressed or corrected the conditions
• What statements the company has made about compliance with FDA requirements

In this case, KV continued to tell the public that it was in material compliance with cGMP despite the numerous issues raised by the FDA. "Boilerplate" SEC disclosures concerning regulatory compliance over time came into conflict with the number and severity of issues raised in the Form 483s. According to the appellate court, "[t]here is a substantial likelihood the presence of these factors would be viewed by a reasonable investor as significantly altering the total mix of information made available, regardless of whether the Form 483 represents the FDA's final say on compliance issues."

Meaning of the case:  This latest decision is consistent with Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (2011), in which the Supreme Court found that a securities fraud claim could be based on the failure of a pharmaceutical company to disclose adverse event reports associated with its product even though the data in those reports was not statistically significant (see an earlier legal update). Both cases base liability on whether the omitted fact(s) would alter the "total mix" of available information.

Note that the court did not find that KV had violated Rule 10b-5, only that the shareholders had adequately pled the basis for securities fraud claims. However, defeating a motion to dismiss is often key to forcing a company to settle a class-action securities case.

The KV decision reinforces that an FDA-regulated public company must continuously reassess its statements in SEC filings about its FDA compliance status. KV's positive statements in its SEC reports asserting compliance with FDA requirements may trigger an obligation to disclose contrary information. KV exacerbated the problems by ignoring the conflicting information over a period of years.

Conclusion:  If an SEC-reporting company receives a Form 483 (or other notice of non-compliance), the company should make a detailed, fact-sensitive determination of the information known to investors concerning its compliance status. The Eighth Circuit has now established that a Form 483 can cause conflicting public statements to be actionable under the securities laws.

Companies need to ensure that their disclosure controls and practices are effective and that FDA compliance information is evaluated by those who are responsible for SEC compliance. Companies that fail to evaluate all FDA communications can expose themselves and their executives to serious liabilities under the securities laws.