Steptoe Obtains Federal Securities Fraud Class Action Dismissal

On February 22, Steptoe scored a major victory in obtaining the dismissal of a federal securities fraud class action filed against client Mark Hermelin, former Chief Executive Officer of KV Pharmaceuticals, Inc. The class plaintiffs alleged that KV, Mr. Hermelin, and other defendants failed to disclose in Securities and Exchange Commission filings KV's alleged material non–compliance with practices established by the Food and Drug Administration (FDA), failed to predict the shutdown of its pharmaceutical manufacturing operations in 2009, and published financial results that failed to reflect the regulatory violations in question.

Key to the plaintiffs' allegations were a number of post–inspection reports KV had received from the FDA during the class period that contained "observations" of the company's manufacturing processes and operations; an injunctive suit filed by the FDA in early 2009 citing the company for alleged repeated violations of FDA regulations; and a consent decree into which the company, Mr. Hermelin, and other defendants had entered around that same time. According to plaintiffs, the FDA observation reports, combined with the injunctive suit and the consent decree, evidenced the defendants' contemporaneous knowledge of material non–compliance with FDA practices.

In a motion to dismiss fully briefed on September 3, 2009, Steptoe argued that the "observations" contained in the FDA reports were precisely that—observations—not violations, as the plaintiff repeatedly tried to characterize them in their papers. Steptoe also argued that attributing the alleged violations referenced in the injunctive suit and consent decree to the state of mind of the defendants during an earlier time period was classic "fraud by hindsight," and that the defendants had no duty to disclose the existence of the FDA reports because those reports were publicly available through the Freedom of Information Act process. 

In the February 22 decision, Judge Carol Jackson of the US District Court for the Eastern District of Missouri dismissed the consolidated amended complaint in its entirety as to Mr. Hermelin and the other defendants, largely adopting the arguments raised in our papers. The decision marked a significant victory in an emerging trend in federal securities litigation: allegations of securities fraud based on the failure to disclose regulatory, rather than accounting or finance, irregularities. Steptoe's team was led by Jeff McFadden and consisted of Pat Linehan, Shawn Davisson, and Rob Moore.

To learn more about the case, please click here for the Law 360 article titled “KV Pharma Shareholder Suit Over Recalls Nixed” (subscription required).