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February 9, 1993

JOHN N. KAPOOR, Defendant.


The opinion of the court was delivered by: PAUL E. PLUNKETT

This matter is before us on the Motion of Defendant Kapoor to Dismiss the Complaint under Federal Rules of Civil Procedure 9(b) and 12(b)(6). For the reasons stated below, the Motion is granted in part and denied in part.


 Plaintiff Fujisawa Pharmaceutical Co., Ltd. ("Fujisawa") is a Japanese corporation in the business of manufacturing and selling pharmaceutical products in the international market. (Compl. P 4.) Plaintiff Fujisawa USA, Inc. ("FUSA") is a Delaware corporation and a wholly-owned subsidiary of Fujisawa as well as the successor by merger to Lyphomed, Inc. (Id. P 5.) Lyphomed was acquired on April 5, 1990, and merged into FUSA. Id. When FUSA acquired Lyphomed in 1990, Lyphomed was a leading producer of generic injectable drugs. Id.

 Defendant John N. Kapoor is an Illinois resident who holds a Ph.D. in Medicinal Chemistry from the State University of New York. (Id. P 13.) Between 1978 and April 1990, Kapoor served in a variety of positions with Lyphomed including sitting on the Board of Directors and serving as Vice President, General Manager, President, Chairman of the Board and CEO. (Id. P 6.) Kapoor also held more than ten percent of the outstanding stock in Lyphomed. (Id. P 6.)

 I. Lyphomed Under Kapoor

 While Kapoor was associated with Lyphomed, he controlled the affairs of the company. (Id. P 7.) In 1981, a group headed by Kapoor purchased Lyphomed in a leveraged buy out for approximately $ 2,000,000.00, and in 1983 Lyphomed was taken public. (Id. P 9.) Under Kapoor's leadership, Lyphomed manufactured both proprietary and generic *fn2" drugs. (Id. P 17.) In order to gain FDA approval to market a generic drug, the manufacturer must file a Abbreviated New Drug Application ("ANDA") with the FDA. The ANDA must contain test results that demonstrate that the proposed generic drug is the bioequivalent of the patented drug it imitates and that it has the same stability. (Id. P 18.)

 In the competitive pharmaceutical business, the ability to be the first to produce a generic equivalent of a proprietary drug 'coming off patent' is a significant advantage. Lyphomed recognized this, and in its annual report for 1984 touted its "ability to successfully complete products and bring them to the marketplace in record time." (Id. P 22.) In its Form 10-K's for 1985 and 1986, which were signed by Kapoor, Lyphomed noted that its ability to select the right products to produce generically and to "submit well prepared [sic] ANDAs in a timely manner . . . ." Id.

 Beginning in 1980 and continuing through 1986, Lyphomed and Kapoor filed false applications and information with the Food and Drug Administration ("FDA") in connection with Lyphomed applications for FDA approval of new generic drugs. (Id. P 8.) Kapoor imposed a quota system that required Lyphomed's generic research department to submit a number of ANDA's each month. (Id. P 23.) In the rush to get FDA approval for their generic products, Lyphomed and Kapoor submitted false data on certain ANDA's. Further, Kapoor ordered that normalized data *fn3" be secretly included in certain ANDA's despite the fact that the FDA required that the use of that type of data be disclosed. Finally, with Kapoor's knowledge, Lyphomed failed to disclose adverse test results and failed to record, or destroyed the results of, certain tests in violation of the FDA's ANDA regulations. (Id. P 26.)

 II. Fujisawa's Purchase of Lyphomed

 In March 1983, Lyphomed filed an initial public offering with the Securities and Exchange Commission ("SEC"). This filing contained nothing about Lyphomed's false ANDAs or the penalties that could result from those practices. (Id. P 27.) From 1984 to 1990, Kapoor courted the Plaintiffs, hoping to induce them to purchase outstanding stock in Lyphomed. (Id. P 10.) Pursuant to an agreement dated December 3, 1984, Fujisawa purchased 450,000 shares from Lyphomed and 320,000 shares from Kapoor. (Id. P 28.) In the 1984 stock purchase agreement, Kapoor individually warranted that the balance sheets of Lyphomed did not contain any misstatements of material fact and did not omit any material fact necessary to make any statements not misleading. (Id. P 29.) No information was disclosed concerning the ANDAs containing false information. Id.

 Fujisawa reviewed the 1983, 1984 and 1985 Form 10-Ks filed by Lyphomed and signed by Kapoor. None of these documents mentioned the ANDAs containing false data. However, each did state that "the Company is not aware of any current or pending proceedings before the FDA the outcome of which might materially adversely affect the Company's business or operations." (Id. P 30.)

 Fujisawa continued to purchase additional shares from Lyphomed and Kapoor in several transactions. By March 1988, Fujisawa owned twenty-eight percent of Lyphomed, but had no knowledge of the potential repercussions of the false data submitted in the ANDAs. (Id. P 33.) In 1987 and 1988, the FDA raised concerns about Lyphomed's manufacturing procedures, but Fujisawa and other stockholders were reassured in a letter from Kapoor attached to the 1987 Form 10-K. The letter said that "our quality record and relationship with the FDA has been virtually unblemished in my 10-year history, and resolution of these quality issues will be a top management priority in 1988." (Id. P 34.) No mention of the ANDAs containing false data was made.

 In a letter attached to the 1988 annual report with the Form 10-K for that year, Kapoor and another Lyphomed officer indicated that Lyphomed has reacted to the FDA's concerns in a responsible manner:

 Procedures have been examined thoroughly to reverify that each product's documentation is a complete and accurate record of the manufacturing process. An independent audit team with outstanding credentials was commissioned to ensure consistency of these procedures.

 (Id. P 35.) No mention of the ANDAs containing false information was made.

 Beginning in 1988, Kapoor attempted to convince Fujisawa to acquire Lyphomed, asserting that he was intimately familiar with every aspect of the business. Though Fujisawa initially declined, Kapoor was persistent. (Id. P 37.) In August of 1989, based on its discussions with Kapoor and Lyphomed's SEC filings, Annual Reports and other documents, FUSA made a tender offer for Lyphomed and finally merged Lyphomed into FUSA on April 6, 1990. In the process, Fujisawa paid approximately $ 800,000,000.00 for Lyphomed, (Id. P 11), $ 150,000,000.00 of which was to Kapoor for his shares.

 III. Trouble with the FDA

 The FDA promulgates strict rules concerning tests taken for ANDA purposes, and is empowered to penalize non-complying manufacturers in a variety of ways, including required recalls. (Compl. P 19.) Lyphomed documents demonstrate that Kapoor was aware of these requirements and the penalties for non-compliance. (Id. P 20.)

 In November 1991, the FDA informed FUSA that it had found "false or misleading information," including normalized data, incomplete or incorrect data, and unreported adverse test results as well as indications of destroyed or unrecorded results, in 12 ANDA filings submitted by Lyphomed between 1980 and 1986. (Id. P 45.) In response, FUSA commenced an internal audit which confirmed the FDA's allegations, id., and as a result has withdrawn or will withdraw several specified products from the market. (Id. P 46.) Further, and perhaps even more serious, FUSA has been placed on the FDA Alert List. Being on the List has rather unpleasant consequences, including: (1) the FDA will not process or approve any New Drug Applications; (2) the FDA will not process or approve any ANDAs; (3) FUSA is disqualified from doing business with the federal government; (4) the FDA will not inspect or approve FUSA's new manufacturing facilities; and (5) FUSA may not sell its products in certain foreign countries. (Id. P 48.)

 Fujisawa and FUSA have filed a ten-count Complaint seeking nearly $ 1,000,000,000.00 in damages. Counts I-III allege violation of the following securities laws and regulations: (1) 15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5; (2) Section 18 of the Exchange Act, 15 U.S.C. § 78r; and (3) Section 12(2) of the Securities Act, 15 U.S.C. § 7712. Counts IV-VI allege the following RICO violations: (1) 18 U.S.C. § 1962(c); 2) 1962(a); and 3) 1962(b). Counts VII-X are based on the following state common law theories: (1) Constructive trust; (2) Fraud; (3) Breach of fiduciary duties; and (4) Breach of Warranty.


 On a motion to dismiss, the court views the allegations of the complaint as true, along with reasonable inferences therefrom, and views these in the light most favorable to the plaintiff. Powe v. City of Chicago, 664 F.2d 639, 642 (7th Cir. 1981). The plaintiffs' complaint should not be dismissed unless it appears beyond doubt that the plaintiffs are unable to prove any set of facts which would entitle them to relief. Nevertheless, the plaintiffs must allege sufficient facts to outline the cause of action, proof of which is essential to recovery. Ellsworth v. City of Racine, 774 F.2d 182, 184 (7th Cir. 1985), cert. denied, 475 U.S. 1047, 89 L. Ed. 2d 574, 106 S. Ct. 1265 (1986) (citations omitted).

 Kapoor attacks the securities fraud counts of Fujisawa's Complaint on several grounds. We address each of them separately.

 A. Rule 9(b)

 A major underpinning of Fujisawa's *fn4" motion is that the Complaint fails to meet the requirements of Rule 9(b). *fn5" Rule 9(b) requires that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b). This means that the Complaint must state "the identity of the person making the misrepresentation, the time, place, and content of the misrepresentation, and the method by which the misrepresentation was communicated . . . ." Schiffels v. Kemper Fin. Serv., Inc., 978 F.2d 344, 352 (7th Cir 1992) (quoting Bankers 's Trust Co. v. Old Republic Ins. Co., 959 F.2d 677, 683 (7th Cir. 1992)). Rule 9(b), however, must be read in conjunction with Rule 8, which requires a short and ...

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