In Public Pension Fund Group, et al. v. KV Pharmaceutical Company, et al. (No. 10-3402, June 4, 2012), the United States Court of Appeals for the Eighth Circuit reversed a lower court’s dismissal of a securities fraud class action brought under the Private Securities Litigation Reform Act (the “PSLRA”). The Eighth Circuit elucidated its view on the duty to update and, for the first time, addressed the rules regarding scheme liability that were implemented under the Securities Exchange Act. The case involved a publicly-traded pharmaceutical company, KV Pharmaceutical (the “Company”), whose stock price fell from $5.39 to $1.99 after it announced that it had “suspended all shipments of all FDA approved drug products in tablet form.” The plaintiffs had argued that the Company’s statement in several Form 10-Ks that it was “in material compliance with applicable regulatory requirements” was false and misleading because the Company had received a number of Form 483s from the FDA during the class period. The Court described Form 483s as notice by the FDA to Company management of “significant objectional conditions, relating to products and/or processes, or other violations of the [FDA] which were observed during the inspection of a facility.” The Company argued that its receipt of Form 483s could not be material as a matter of law because on their face they are described as “observations and do not represent final Agency determinations regarding . . . compliance.”

The Eighth Circuit disagreed with the Company and the lower court. The Eighth Circuit concluded that there was a substantial likelihood that KV’s receipt of the Form 483s during the same time it was representing it was in material compliance with FDA regulations would have been viewed by the reasonable investor as having significantly altered the total mix of information available. The Court further noted that the issuance of a Form 483 represents a risk that the FDA may take corrective action against a Company and thus a Company is obligated to assess the seriousness of the risk and disclose the information to potential inventors if it also represents it is in compliance with FDA regulations. In a footnote the Court further noted that, having chosen to tell investors it was in material compliance with FDA regulations, “KV was obligated to make a full disclosure of any material facts.”

While the Eighth Circuit’s analysis suggests its decision is limited to the facts and circumstances before it, the Court’s discussion of the duty to update requires public companies that disclose to investors that they comply with regulations to carefully consider whether any regulatory determinations (or in the case of FDA Form 483s – regulatory observations) require the tempering of any unconditional statements of compliance. The Court’s conclusion in this case was certainly impacted by what were described as “pervasive objectionable conditions” that ultimately led to the shutdown of KV’s operations.

Interestingly, the Court held there was NO duty to disclose manufacturing problems with respect to a particular drug because the Company had only disclosed financial results with respect to the drug and had not said anything about manufacturing processes or how manufacturing impacted revenues.

Finally, for the first time, the Eighth Circuit also addressed the requirements for pleading scheme liability. The plaintiff had sued two individual officers under Rule 10b-5(a) and (c). Rule 10b-5(a) prohibits “any device, scheme or artifice to defraud.” 17 C.F.R. §240.10b-5(a). Rule 10b-5(c) prohibits “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.” 17 C.F.R. §240.10b-5(c). The plaintiff argued the officers had carried out a scheme that caused investors to purchase KV securities at an inflated price. The Court affirmed the district court’s dismissal of the claim holding: “We join the Second and Ninth Circuits in recognizing a scheme liability claim must be based on conduct beyond misrepresentations or omissions actionable under Rule 10b-5(b).” Because the plaintiffs had not alleged with specificity actions the officers engaged in other than those that were actionable under Rule 10b-5(b), the Court affirmed the lowers court’s dismissal of scheme liability claims against the officers. Other courts have taken a more permissive view of pleading scheme liability so the Court’s decision will make it more difficult for plaintiffs to pursue scheme liability claims in the Eighth Circuit.