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Plumbers and Pipefitters Local Union 719 Pension Fund and Carpenters Pension Fund of West Virginia, On Behalf of A Class v. Zimmer Holdings

May 21, 2012

PLUMBERS AND PIPEFITTERS LOCAL UNION 719 PENSION FUND AND CARPENTERS PENSION FUND OF WEST VIRGINIA, ON BEHALF OF A CLASS, PLAINTIFFS-APPELLANTS,
v.
ZIMMER HOLDINGS, INC.; DAVID C. DVORAK; AND JAMES T. CRINES, DEFENDANTS-APPELLEES.



Appeal from the United States District Court for the Southern District of Indiana, Indianapolis Division. No. 1:08-cv-01041-SEB-DML--Sarah Evans Barker, Judge.

The opinion of the court was delivered by: Easterbrook, Chief Judge.

ARGUED OCTOBER 18, 2011

Before EASTERBROOK, Chief Judge, and RIPPLE and KANNE, Circuit Judges.

Two pension funds that own shares of Zimmer Holdings, Inc., charge it with defrauding its investors by downplaying the significance of difficulties it was having manufacturing some of its products and the high failure rate one surgeon reported for another of its products.

Zimmer designs and makes orthopaedic reconstruc- tive devices (and related products) that it sells throughout the world. One of its products is the Durom ®Acetabular Component (the Durom Cup), which is used to replace the socket in a hip joint. One side of the Durom Cup is a porous ceramic designed to bond with the hip bone; the other is forged titanium designed to allow a leg bone (or a titanium replacement for one) to move freely. The Wikipedia article "Hip replacement" provides an overview of the components and procedures.

One well-known surgeon, Lawrence Dorr, reported unacceptably high failure rates after using the Durom Cup in his patients. See William T. Long, Manish Dastane, Michael J. Harris, Zhinian Wan & Lawrence D. Dorr, Failure of the Durom Metasul ®Acetabular Component, 468 Clinical Orthopaedics & Related Research 400 (2010). Zimmer announced Dr. Dorr's preliminary findings in 2008 and promised to investigate. Later Zimmer attrib- uted his failure rate--which it said was substantially higher than that experienced by other surgeons--to improper surgical technique. It stopped selling the Durom Cup in the United States while preparing new instructions for implantation; Zimmer continued to sell the Durom Cup with the original instructions in other nations. About a month later, Zimmer returned the Durom Cup to sale in this country; it remains available. This suit contends that Zimmer's statements were false: that the problem stemmed from poor design or quality control in the manufacture of its product rather than Dr. Dorr's technique, and that Zimmer pretended other- wise in order to avoid a decline in the price of its stock.

Plaintiffs also contend that Zimmer delayed revealing quality-control problems at its plant in Dover, Ohio. According to plaintiffs, Zimmer learned of problems in late 2007 but did not reveal them in its January 2008 quarterly report and earnings call. On April 3, 2008, Zimmer announced that production of some ortho- paedic products at Dover would be suspended until improvements could be made and that a few products would be recalled. Zimmer estimated that recalls plus sales foregone before production resumed would cost the company about $70 to $80 million. (Zimmer did not close the Dover plant; the decision affected only some of its production lines.) Plaintiffs contend that events at Dover reveal that the quarterly reports and earnings guidance Zimmer released in January and April were materially false. The Dover plant returned to full production, and plaintiffs do not contend that the estimated cost of the suspension and recall was sub- stantially off the mark. In January Zimmer had projected 10% to 11% revenue growth for the year and net earnings of $4.20 to $4.25 per share; in July it cut this projection to 8.5% to 9% growth and net earnings of $4.05 to $4.10 per share. Plaintiffs maintain that Zimmer committed fraud by not using these lower estimates in January.

The district court dismissed the complaint, finding that it flunks the pleading standards of the Private Securi-ties Litigation Reform Act of 1995 (PSLRA), 15 U.S.C. §78u-4. See 673 F. Supp. 2d 718 (S.D. Ind. 2009), relying on Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007). The judge wrote that the complaint satisfies neither the materiality requirement nor the need to show scienter (that is, the defendants' knowledge that they were lying) under the Tellabs standard: "an inference of scienter must be more than merely plausible or reasonable--it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." 551 U.S. at 314. Plaintiffs proposed to amend the complaint to satisfy the judge's concerns. In a com-prehensive opinion, 2011 U.S. Dist. LEXIS 9253 (S.D. Ind. Jan. 28, 2011), the district court held that the proposed amendment would be futile. The judge did, however, withdraw the ruling that Zimmer's statements were not material, anticipating that the Supreme Court's deci-sion in Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (2011), then under advisement, might undercut this aspect of the earlier ruling. That left the scienter holding as the basis of the district court's judgment.

The Durom Cup was failing in the United States at an unacceptably high rate. Plaintiffs say that this must have been caused by design or manufacturing problems, because Dr. Dorr believed that surgeons had used proper methods. Zimmer announced, however, that it thought the problem one of technique and that it was taking the device off the market, in the United States only, for a brief period (which turned out to be one month) in order to revise the instructions for use and provide additional education to surgeons. Given the conflict between Dr. Dorr and Zimmer, plaintiffs contend, a jury could infer that Zimmer was lying and knew it. We agree with the district court that this approach is unavailing.

Zimmer did not try to hide the failures Dr. Dorr had encountered. Dorr made a public announcement, and so did Zimmer, which added (what was anyway evi- dent) that lower sales and more products-liability litiga- tion might ensue. Three months before Dorr made his public statement in April 2008, Zimmer had announced that the Durom Cup was challenging to implant and that changes in labeling or training might be required. No one could predict how serious the problem would turn out to be, so Zimmer's decision not to try to quantify the effect in January can't be treated as a fraud. Zimmer knew that results in Europe had been better. While Dorr was reporting failure rates of 20% or so, a group in Europe was reporting failure rates of less than 1%. The Durom Cup had been used in Europe since 2003 but had not been introduced in the United States until mid-2006; perhaps European surgeons had confronted and overcome challenges that colleagues in the United States were facing. The different success rates can't have been caused by design or manufacture: all Durom Cups have one design and are made in the same plant.

Corporate executives who know that one group of surgeons experiences success, and another group failure, with the very same medical device could believe that the different outcomes had been caused by dif-ferences in the way the surgeons had implanted the device. That's what Zimmer's executives said they had concluded. The complaint does not establish an infer- ence of scienter that is "at least as compelling as any opposing inference of nonfraudulent intent." Indeed, even today plaintiffs have not supplied a cogent reason to think that Zimmer's statements were false, let alone knowingly false. The Food and Drug Administration has never concluded that the Durom Cup was defec- tively designed or made, indeed never even issued a warning or caution concerning the Durom Cup.

As for the Dover facility and its products: plaintiffs say that Zimmer's management knew of the quality-control problems and should have announced them earlier. Yet quality control is an issue at all medical com-panies. Knowing of "problems," which are common, differs from knowing that a facility must be closed and some of its products recalled. In the proposed amended complaint, plaintiffs offered examples of events that, in their view, show that Zimmer must have known that the income and earnings projections made in January 2008 were bound to be embarrassed by looming problems at Dover:

* David C. Dvorak, Zimmer's CEO, decided not to invest in quality systems that might have avoided problems at the Dover facility.
* Before the FDA inspection, Dvorak and other executives attended meetings at which ...

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