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MORSE v. ABBOTT LABS.

February 14, 1991

SIDNEY MORSE, Plaintiff,
v.
ABBOTT LABORATORIES, ROBERT A. SCHOELLHORN, DUANE L. BURNHAM, THOMAS R. HODGSON, THEODORE A. OLSON, JACK W. SCHULER, and CHARLES J. ASCHAUER, JR., Defendants


James F. Holderman, United States District Judge.


The opinion of the court was delivered by: HOLDERMAN

JAMES F. HOLDERMAN, UNITED STATES DISTRICT JUDGE

 Plaintiff Sidney Morse brought this class action pursuant to Section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), Rule 10b-5 promulgated thereunder, and the common law claims of fraud and negligent misrepresentation alleging that Abbott Laboratories, an Illinois corporation, and six directors and/or officers of Abbott ("defendants") failed to disclose material adverse information concerning Abbott.

 FACTS

 The facts according to the first amended class action complaint are as follows: On July 5, 1989, the Food and Drug Administration (FDA) commenced an inspection of Abbott's pharmaceutical facilities in North Chicago, Illinois. (para. 25.) The inspection, which lasted until November 3, 1989, uncovered serious unsanitary conditions which violated the health and safety rules and regulations of the FDA. (Id.) The FDA issued a report on November 3, 1989, which enumerated fifty-six citations in connection with the four month inspection. (Id.) Abbott's response to the FDA findings was deemed "insufficient" by the FDA. (para. 28.) Thereafter, the FDA imposed regulatory sanctions on Abbott. The sanctions barred Abbott from selling the affected products to any federal agency and precluded Abbott from receiving approval for any New Drug Applications or Abbreviated New Drug Applications regarding the affected products until adequate corrective action was taken. (paras. 26, 28.) None of Abbott's public statements issued during the alleged class period (February 21, 1989 through March 20, 1990) disclosed this information. (para. 29.) Two of the statements included notes acknowledging the comprehensive government regulation that Abbott operates under and the types of regulatory actions which the government has the power to impose. (paras. 30, 35.) There was no discussion, however, of the FDA inspection of the North Chicago facility. Abbott's violations were not made public until a stock analyst obtained the FDA report pursuant to a Freedom of Information Act request. (para. 38.)

 DISCUSSION

 I. COUNT I: SECTION 10(b) AND RULE 10b-5

 A. SUFFICIENCY OF FACTS ALLEGING FRAUD

 Defendants argue that Morse has failed to plead fraud with the particularity required by Fed. R. Civ. P. 9(b). (Mem. in Support, p. 4.) Defendants rely on DiLeo v. Ernst & Young, 901 F.2d 624 (7th Cir. 1990), for the proposition that a plaintiff alleging fraud cannot simply point to the difference in a firm's condition as reflected by two financial statements, but instead must point to some facts suggesting that the downturn in the firm's condition is attributable to fraud. Id. at 627. In light of DiLeo, defendants argue that Morse's allegations only point out that Abbott issued financial reports which did not disclose the alleged violations of FDA regulations, and that later the alleged violations came to light. (Mem. in Support, p. 5.) "From this plaintiff makes the inference, forbidden by DiLeo, that defendants' fraud accounts for the earlier nondisclosure." (Id.)

 In DiLeo, the plaintiff alleged that the auditors of Continental Illinois Bank did not increase the Bank's reserves for nonperforming loans fast enough when the auditors became aware that a substantial amount of the loans were uncollectible. DiLeo, 901 F.2d at 626. Judge Easterbrook found nothing in DiLeo's complaint other than the change in the condition of the firm to suggest that the auditors were even negligent. Id. at 628. "Rule 9(b) required the district court to dismiss the complaint, which discloses none of the circumstances that might separate fraud from the benefit of hindsight." Id.

 Morse's complaint goes beyond merely describing financial reports that do not disclose the FDA violations. The complaint details the inspection of Abbott facilities by the FDA from July 5, 1989 to November 3, 1989, and the fifty-six citations that resulted therefrom. (Complaint, para. 25.) The complaint describes the serious sanctions imposed by the FDA after Abbott failed to respond to the violations. (Id., P 26.) In light of these allegations, Morse's description of financial reports, issued during the relevant period and lacking disclosure of the FDA actions, can be seen as "suggesting that the [nondisclosure] is attributable to fraud."

 The court concludes that the complaint alleges facts which, if true, establish that defendants acted consciously to defraud investors. The complaint describes a situation in which a corporation and its "insiders" realized the significance of FDA sanctions, know about FDA inspections of their facilities, the violations uncovered and the sanctions imposed, and do not thereafter disclose this material information on SEC filings. To require greater detail of the alleged fraudulent scheme at this time would be tantamount to allowing only those with inside information to bring suit. This is especially true where the heart of the alleged fraud lies with material omissions, a type of fraud which is evidenced by the absence, rather than the presence, of express fraudulent conduct. Thus, the court finds that Morse's first amended complaint ...


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