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On April 22, 2016, the Southern District of New York denied defendants’ motion to dismiss a securities fraud action brought against Salix Pharmaceuticals and two of its former officers alleging that defendants had made false or misleading statements concerning the inventory levels for certain drugs. In re Salix Pharmaceuticals, 2016 WL 1629341 (S.D.N.Y. 2016) (Wood, J.). The court held that the “actual knowledge” requirement for forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act (“PSLRA”) does not apply to any statement that “encompasses a representation of present fact.” The court further held that the PSLRA’s safe harbor “does not protect material omissions.”

PSLRA’s “Actual Knowledge” Requirement for Forward-Looking Statements Does Not Apply to Statements That Discuss Present Facts

The court explained that under the PSLRA’s safe harbor provisions, plaintiffs asserting securities fraud claims based on forward-looking statements must show that the “statements were made with actual knowledge of their falsity by the speaker.” The court noted that “the scienter requirement for forward-looking statements is stricter than for statements of current fact.” A plaintiff may establish scienter with respect to an alleged misstatement of present facts with “a showing of either knowing falsity or recklessness[.]” As to forward-looking statements, however, a plaintiff must provide “proof of knowing falsity.”

In the case before the court, defendants contended that many of the statements at issue were forward-looking because the statements “predict[ed] future inventory levels.” However, the court found that these “statements also encompass[ed] representations of present fact” and were therefore “not subject to the PSLRA safe harbor.” For example, the court pointed to statements expressing defendants’ expectation that inventory levels of certain pharmaceuticals “would return to ‘typical’ levels by the end of the following quarter.” The court determined that these statements were “predicated upon representations that current inventory levels” were not “typical.” The court held that “representations concerning current inventory levels constitute[d] actionable misstatements, and, because they pertain[ed] to present facts rather than future projections, [were] not subject to the heightened scienter requirement of the PSLRA safe harbor.”

PSLRA’s Safe Harbor Provision for Forward-Looking Statements Does Not Apply to Material Omissions

The court further explained that the PSLRA’s safe harbor provision “does not protect material omissions.”

Here, the court held that defendants’ statements concerning future inventory levels were “misleading because of material omissions” regarding the inventory levels at the time. The court found that these “omission[s] led analysts to believe that inventory levels were merely slightly outside of the range that [d]efendants described as ‘normal’ and could be returned to that level within about three months” when “[i]n fact, as [d]efendants later revealed, it would take several years to return wholesaler inventory” to a “normal” level. The court noted that while “a listener’s misunderstanding of what was said does not, on its own, make a statement misleading, the allegation that several different analysts understood [d]efendants as describing current inventory levels provide[d] support for the [c]ourt’s conclusion that [d]efendants’ statements [were] reasonably interpreted as such.”

Because defendants’ statements concerning future inventory levels included material omissions, the court held that these statements were “not subject to the PSLRA safe harbor for forward-looking statements.”

Cautionary Language Must Specifically Address the Allegedly Undisclosed Risk 

Finally, the court determined that defendants’ cautionary language “was inadequate to warn of the specific risk” of inventory build-up at issue here.

The court explained that in order “[t]o avail themselves of the safe harbor protection under the meaningful cautionary language prong, defendants must demonstrate that their cautionary language was not boilerplate and conveyed substantive information.” The court underscored that “the relevant cautionary language must be prominent and specific, and must directly address exactly the risk that plaintiffs claim was not disclosed.”

Here, the court found that defendants’ “brief and generic” disclaimers were insufficient to satisfy the PSLRA’s cautionary language requirement. The court noted that “[i]n more than twelve pages of cautionary statements, ‘inventory’ [was] mentioned only once as a possible factor that could impact future revenue predictions[.]” The court held that this “limited reference fail[ed] to alert the reasonable investor either to (1) the much broader risk of inventory build-up at issue here, or (2) the lack of management review of inventory levels to monitor the risk.” The court further found defendants’ “failure to update [the] cautionary language over time to reflect new information and new risks support[ed] the conclusion” that defendants’ warnings were “merely boilerplate.”

Court Holds Plaintiffs Adequately Alleged Scienter Under the Actual Knowledge or Recklessness Standard Applicable to Statements of Present Fact 

Because the court found that the statements at issue were not forward-looking, the court held that plaintiffs could establish scienter by showing that defendants either “knew or were reckless in failing to learn Salix’s true inventory levels.” The court found that plaintiffs had “raise[d] a strong inference of scienter” by alleging that “potential acquirers were able to determine Salix’s true whole inventory levels” with ease and also by pointing to “specific reports and statements showing that [d]efendants were aware of or could access Salix’s true wholesale inventory levels.” The court further determined that “[t]he magnitude of [d]efendants’ alleged fraud and the fact that it involved the core operations of Salix’s business also support[ed] a strong inference of scienter.”

The court therefore denied defendants' motion to dismiss in its entirety.