Form 483s Can be "Material" Under Federal Securities Law

The U.S. Court of Appeals for the Eighth Circuit in a recent ruling in Pub. Pension Fund Grp. v. KV Pharm. Co., No. 10-3402 (8th Cir. June 4, 2012) became the first federal appeals court to hold that a "Form 483" issued by the Food and Drug Administration (FDA) could satisfy the materiality requirement of a securities fraud claim.^[1] Prior to this decision, companies generally have claimed that, because it is not final agency action, receipt of a Form 483 is insufficient to meet the materiality standard.

FDA issues a Form 483 following a facility inspection to document any conditions at the facility that may constitute violations of the Federal Food Drug and Cosmetic Act. The Form 483 describes conditions or practices which, in the investigator's judgment, indicate that "any food, drug, device, or cosmetic has been adulterated or is being prepared, packed, or held under conditions whereby it may become adulterated or rendered injurious to health."^[2] The findings are discussed with the company's senior management at the conclusion of the inspection. When deciding whether additional regulatory action is needed, FDA considers the Form 483, a detailed Establishment Inspection Report prepared by the investigator, evidence collected during the inspection, and the company's response to the Form 483 observations.

In the case involving KV Pharmaceuticals (KV), from 2003 to 2009 FDA issued numerous Form 483s relating to the manufacturing, processing, packing, labeling, holding, and distribution of various drugs. In 2009, FDA filed a complaint seeking a permanent injunction to prevent KV from continuing its manufacture and distribution of pharmaceuticals, citing many of the violations documented in the Form 483s. The complaint caused a significant decrease in KV's stock price.

Soon thereafter, several groups of investors brought a class action lawsuit against KV, alleging they purchased the securities at prices that were inflated by KV's misrepresentations about being in "material compliance" with FDA's requirements. Despite the multitude of deficiencies recorded on the Form 483s spanning many years, the drug company continued to state on its Form 10-Ks filed with the Securities and Exchange Commission that "all of our facilities are in material compliance with applicable regulatory requirements."^[3] The investors asserted in the lawsuit a $1.5 billion loss in market capitalization after KV's announcements about manufacturing problems caused a collapse in stock price for Class A shares "from more than $30 at the height of the Class Period, to 51 cents."^[4]

The investors initially filed the case in the U.S. District Court for the Eastern District of Missouri. They alleged that KV made false or misleading statements about the state of its compliance with FDA's regulations governing the manufacture of pharmaceuticals. The trial court dismissed the complaint for failure to state a claim, and the investors appealed to the EighthCircuit.

To protect investors against manipulation of stock under the Securities Exchange Act, the Supreme Court has imposed a standard of materiality for statements and omissions made in public filings.^[5] The Eighth Circuit further defined this standard in a recent case involving an alleged omission, Detroit Gen. Ret. Sys. v. Medtronic, Inc., 621 F.3d 800, 805 (8th Cir. 2010), finding that "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available." The Eighth Circuit then applied this standard in KV.

After citing the litany of violations described in the Form 483s, the Court of Appeals announced the following principle regarding the significance of Form 483s in rendering its decision in KV:

[F]or purposes of pleading a securities fraud claim, the issuance of Form 483s may render a defendant's statement about its compliance with FDA regulations or cGMP false, or at least misleading, in some circumstances. The FDA's issuance of Form 483s may be material depending on a number of factors, including the number, severity, and pervasiveness of objectionable conditions noted, as well as whether a company has failed to address or correct the deficiencies noted by the FDA.^[6]

In reversing in relevant part and remanding the case to the District Court for further consideration, the Eighth Circuit ruled in this case that knowledge of KV's receipt of the Form 483s would have been viewed by the reasonable investor as having significantly altered the total mix of available information.^[7]

While the KV decision does not create a concrete rule with respect to Form 483s, it does have clear implications for publicly-traded companies that are regulated by FDA. Officials at such companies should now ensure that any Form 483s received are evaluated (like all other relevant information) to determine whether they meet the investor "materiality" threshold that triggers a disclosure requirement.

For more information about this subject, please contact Frederick A. Stearns (stearns@khlaw.com, +1 202.434.4288); Cynthia B. Lieberman (lieberman@khlaw.com, +1 202.434.4114).