Evanston Police Pension Fund v. McKesson Corporation

Background

This putative class action arose from government investigations into alleged anticompetitive agreements in the generic-pharmaceutical industry. Evanston alleged that McKesson Corporation, a generic-drug wholesaler, and its former chief executive officer, John Hammergren, and former chief financial officer, James Beer, either participated in or knew about price-fixing and market-allocation agreements involving generic-drug manufacturers.

Evanston alleged that the defendants concealed the alleged conduct in violation of Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5. It also asserted control-person liability under Section 20(a), and alleged that Hammergren violated Section 20A by selling McKesson stock while possessing material, nonpublic information.

The challenged statements fell into six general groups: statements attributing generic-drug price increases to supply disruptions; statements describing McKesson’s value to purchasers; statements that the generic-drug market was competitive; statements describing McKesson subsidiary NorthStar Rx as a growth driver; statements about McKesson’s financial results; and statements that McKesson’s earnings had been protected from risk. Evanston alleged that McKesson’s stock price dropped after three financial announcements and two news articles concerning generic-drug pricing and government investigations.

Rule 12(b)(6) Standard and Evidence

McKesson moved to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6). The court explained that a complaint must contain enough factual allegations to make liability plausible. Securities-fraud allegations also had to satisfy the heightened requirements of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act, including particularized allegations of falsity and a strong inference of scienter—meaning an intent to deceive or deliberate recklessness.

The court held that most of the documents McKesson submitted were incorporated by reference because the complaint extensively relied on them or they formed the basis of the claims. The court also took judicial notice of two publicly filed documents that were not incorporated by reference. The court permitted Evanston to rely on allegations in the complaint filed by forty-nine state attorneys general because courts in the Ninth Circuit had relied on comparable government complaints when deciding motions to dismiss.

Section 10(b) and Rule 10b-5

To state a Section 10(b) claim, Evanston had to plead a material misrepresentation or deceptive conduct, scienter, a connection with the purchase or sale of a security, reliance, economic loss, and loss causation. McKesson challenged the complaint’s allegations of a misrepresentation, scienter, and loss causation.

Alleged participation in price fixing. The court found that Evanston did not adequately allege that McKesson or NorthStar participated in the alleged price-fixing conspiracies. Evidence of agreements among drug manufacturers did not directly show that McKesson participated. The allegations concerning Doxy DR more plausibly suggested that McKesson was a victim of the manufacturers’ agreement, and the allegations concerning Leflunomide did not connect direct evidence of one agreement to the different agreement Evanston alleged in 2015.

The court also found that parallel pricing conduct and five alleged “plus factors”—actions against self-interest, changes from earlier behavior, government investigations, market conditions favorable to collusion, and participation in trade organizations—did not plausibly show that McKesson entered an unlawful agreement. The court said that parallel conduct can result from lawful conscious parallelism, and that government investigations and trade-organization participation, without specific allegations of what McKesson agreed to, were insufficient.

Falsity and misleading statements. Although Evanston did not adequately plead McKesson’s participation in a conspiracy, the court found that it adequately pleaded that McKesson’s statements could be misleading if McKesson knew generic-drug manufacturers were fixing prices.

The court found the allegations sufficient for two categories of statements. First, statements attributing generic-drug price increases and increased profits to supply disruptions could be misleading because McKesson allegedly failed to disclose that collusive activity helped drive the increases. The court reasoned that once McKesson touted the positive effect of supply disruptions on prices and profits, it had to disclose adverse information that made those statements misleading.

Second, statements that the generic-drug market remained competitive could plausibly be understood as statements about the market as a whole and could be misleading if widespread price fixing existed. The court also found that some financial guidance was actionable to the extent it attributed revenue to generic-drug price increases, because those statements allegedly omitted the collusion that helped drive the increases.

The court found other allegations insufficient. Statements about McKesson’s value to purchasers were not necessarily guarantees that it obtained the lowest possible prices. Statements describing NorthStar as a growth vehicle were not misleading merely because other companies allegedly engaged in antitrust violations. General financial statements were not all rendered false by the alleged fraud. Finally, statements that McKesson had reduced the risk to its earnings were forward-looking, and Evanston did not plead the actual-knowledge allegations required for those statements.

Scienter. The court held that Evanston adequately pleaded scienter when the allegations were considered as a whole. The allegations included the scope and importance of the alleged price-fixing, the executives’ claimed knowledge of the generic-drug market, their positions at McKesson, and compensation arrangements tied to McKesson’s financial performance.

Under a “core operations” theory, the court found that the executives’ statements about their knowledge of generic-drug pricing, combined with the alleged importance of the pricing conduct to McKesson’s revenue, supported an inference that Hammergren and Beer acted with deliberate recklessness by attributing price increases to legitimate supply disruptions. The complaint also alleged specific compensation multipliers and amounts showing a strong correlation between McKesson’s financial performance and the executives’ stock and cash awards.

Loss causation. Loss causation means a causal connection between the alleged misstatement and the plaintiff’s economic loss. The court found the allegations sufficient at the pleading stage. Evanston alleged that McKesson’s stock price fell after disappointing financial results and after news articles reported government investigations into generic-drug price fixing. The court concluded that, taken together, the financial disclosures and investigation reports could have revealed the alleged concealed conduct to investors and could show that the misstatements proximately caused Evanston’s loss.

Section 20(a) and Section 20A

The court denied dismissal of the Section 20(a) control-person claims because Evanston adequately pleaded an underlying Section 10(b) violation.

The court also denied dismissal of the Section 20A claim against Hammergren. It held that the allegations supporting scienter also supported an inference that Hammergren possessed material, nonpublic information about collusive conduct when he sold McKesson stock. The court further held that Evanston adequately pleaded that all three challenged sales were sufficiently contemporaneous with Evanston’s trades at this stage of the litigation. McKesson’s contention that Hammergren traded under a Rule 10b5-1 plan did not require dismissal at this stage.

Disposition

The court denied McKesson’s motion to dismiss. The ruling allowed the adequately pleaded securities claims, control-person claims, and Section 20A claim to proceed, while limiting the theories and categories of statements on which Evanston could rely. This was a ruling on a motion to dismiss, not a final determination that the alleged fraud occurred.