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Washtenaw County Employees' Retirement System v. Walgreen Co.

United States District Court, N.D. Illinois, Eastern Division

September 30, 2016

WASHTENAW COUNTY EMPLOYEES' RETIREMENT SYSTEM, Individually and on Behalf of All Others Similarly Situated Plaintiff,


          Sharon Johnson Coleman United States District Court Judge

         Industriens Pensionsforsikring A/S, acting as lead plaintiff on behalf of itself and all others similarly situated, brings this class action against the defendants Walgreen Co. (“Walgreens”), former Walgreens CEO Gregory D. Wasson, and former Walgreens CFO Wade Miquelon, alleging violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The defendants, in separate motions filed by Walgreens and Wasson [55] and by Miquelon [57], now move to dismiss Washtenaw's complaint for failure to state a claim. For the reasons set forth herein, those motions are granted in part and denied in part.


         The following is a general overview of the voluminous allegations contained in the amended complaint and its attachments, which are taken as true for the purposes of this motion.

         Walgreens is a retail drugstore chain that sells prescription and non-prescription drugs. Prescription drugs represent Walgreens' largest class of products and are the lead driver of its revenue and profit. At the times relevant here Gregory D. Wasson was Walgreens' CEO and a director on the company's Board of Directors and Wade Miquelon was Walgreens' CFO.

         The substantial majority of prescription drugs that Walgreens sold were generic versions of branded drugs (“generic drugs”). Because generic drugs cost less to produce than branded drugs, their sale generated a higher profit margin. That profit margin, however, was dependent on the difference between the cost to procure the generic drug and the reimbursement rate that Walgreens received for supplying a customer with the drug.

         Drug prices varied widely depending on a number of factors including (1) whether the drug was branded or generic, (2) how many companies were producing the drug (if it was a generic), (3) the relative supply and demand for the drug, (4) adverse regulatory actions impacting the drug or its manufacturing facility, or (5) consolidations of drug manufacturers and their drug portfolios. Drug manufacturers also retained significant power to set their own prices. Historically, the competitive generic drug marketplace had caused a deflationary trend in drug prices. Between 2010 and 2013 that trend began to reverse as drug manufacturers began testing price inflation strategies for mature products. By 2013 and 2014 third party metrics reflected this inflationary trend and Walgreens' primary competitors had acknowledged that generic drug costs were increasing.

         The vast majority of Walgreens' prescription drug sales were “third party sales” in which the purchaser paid a copay and a pharmacy benefit manager (PBM), private insurance company, or governmental entity reimbursed Walgreens for the remainder of the drug's cost. PBMs constituted the vast majority of the third party sales market. Walgreens' contracts with several major PBMs provided for fixed maximum rates of reimbursement for each drug over the term of the contract and contained no mechanism by which the maximum rates could be altered to respond to price variations. Thus, if generic drug prices increased Walgreens would be forced to absorb the additional costs of those drugs.

         In 2011, Walgreens, under Wasson's leadership, walked away from contract negotiations with Express Scripts, one of the largest PBMs. The decision was costly; Walgreens' inability to fill Express Scripts customer's prescriptions caused it to lose millions of customers to its rivals and caused its stock price to drop by over 25%. Although Walgreens and Express Scripts ultimately negotiated a new contract in July 2012, thereafter many investors began to question Wasson's management ability.

         In June 2012, Walgreens announced that it was entering into a strategic transaction with international “pharmacy-led health and beauty group” Alliance Boots GmbH (“Alliance”) to create the largest pharmacy company in the world. At the time, Alliance was led by CEO Stefano Pessina. During the first step of the deal, Walgreens acquired a 45% equity ownership stake in Alliance. As part of that transaction, Pessina acquired control of 8% of Walgreens common stock, making him Walgreens' largest shareholder. During the second step, which required shareholder approval, Walgreens was to acquire the remaining Alliance stock in exchange for cash and shares of Walgreens' stock. As part of this process, Walgreens announced a set of goals for FY 2016 reflecting the expected benefits of the new partnership, including generating $1 billion in combined synergies and between $9 and $9.5 billion in adjusted earnings before interest and taxes (“EBIT”). The EBIT goal was especially important to investors because it was the only metric gauging the potential profitability of the combined companies. From September 2012 through June 2013, the defendants continued to express optimism regarding the EBIT goal and to dismiss analysts' concerns regarding threats to that goal.

         In late 2013, however, Walgreens' internal long range planning process revealed that the EBIT goal was tracking at under $8.5 billion.[1] Miquelon, in a verified complaint filed in a separate action (“the Miquelon complaint”), admitted that by the end of 2013 the company had identified the sources of that deficit as (1) the unprecedented level of generic drug price inflation that the industry was experiencing and (2) reimbursement contracts that failed to provide meaningful inflationary relief. Nonetheless, Walgreens restated the EBIT goal when it reported its first quarter results for 2014. During the conference call announcing the quarterly results, Miquelon admitted that Walgreens was tracking “a bit below” the EBIT goal, but asserted that the company was prepared to mitigate the risks to achieving the goal and that it had the right tools at its disposal to meet the target. During that call, Miquelon also reassured analysts that “[q]uarter by quarter we look at [the FY2016 goals], and say are these still realistic based upon all the risk and opportunities we have internally. If we ever feel that's not the case, we'll certainly tell you.” By March 2014, the EBIT goal was tracking around $7.5 billion dollars, $2 billion less than the high end of the EBIT goal.[2]

         The class period, which runs from March to June 2014, encompasses the announcement of Walgreens second quarter results and third quarter results and public statements made in the interim. During that time, the defendants continued to issue statements that allegedly downplayed the risk to the EBIT goal. Yet Miquelon's verified complaint established that by March 2014, when Walgreens issued its second quarter results, the company was aware of the systematic inflation of generic drug prices.

         On April 9, 2014, Miquelon shared an interim long range planning update with Walgreens' Board of Directors suggesting that Walgreens would realize $7.5 billion in EBIT in 2016. Also in April, activist investors began to push aggressively for Walgreens to execute a tax inversion (by moving the company overseas) and expressed a desire that the Alliance management team take on a greater leadership role in the combined companies, sparking speculation that Wasson was losing control of Walgreens. In May, Wasson told Miquelon that if Walgreens did not proceed with the tax inversion he believed that the activist investors would force him out of his position. Around that time, Wasson also met with Miquelon to offer him a new position within the combined company. Miquelon declined the new position, and elected to leave Walgreens after Step 2 of the Alliance transaction was complete.

         By June 2014, Miquelon had finalized his estimate and conclusively determined that the EBIT goal was tracking at $7.2 to $7.5 billion. Miquelon informed Wasson of the scope of the shortfall in mid-June and advocated for publically withdrawing the EBIT goal during the next quarterly call on June 24th. Wasson argued that the scheduled earnings call should be delayed-so that the withdrawal of the EBIT goal could be bundled with favorable news-and pressured Miquelon to raise the earnings-per-share estimate well-beyond that which could be supported by the EBIT tracking numbers.

         On June 24, 2014, Walgreens issued its third quarter report and withdrew its FY 2016 earnings targets, attributing the decision to “Step 2 considerations” and “current business performance.” Walgreens, however, did not disclose the extent of the EBIT shortfall until August 6, 2014 when Walgreens confirmed that the expected 2016 EBIT was projected to be around $7.2 billion. The disclosure of this shortfall caused Walgreens stock to plummet over 14% in a single day. In subsequent appearances in support of Step 2, Wasson and Pessina attributed the “unexpected” shortfall to bad forecasting, lax controls in the financial department, and poor communication between departments. Their statements cast Miquelon as being responsible for these errors and implied that he had been pressured to leave due to the purported forecasting error. Miquelon subsequently filed the previously referenced verified complaint, suing Walgreens for breach of contract, defamation, and tortious interference with prospective economic advantage.

         On August 6, Walgreens announced that it was exercising its option to purchase the remaining 55% of Alliance Boots, thus completing Step 2 of the Walgreens-Alliance Boots transaction. Walgreens' September 2014 announcement of its fourth quarter results explicitly acknowledged, for the first time, the detrimental impact that reimbursement pressures and generic drug price inflation were having on its profit margins. Several months later Wasson resigned and Pessina replaced him as the CEO of Walgreens.

         Legal Standard

         A motion to dismiss pursuant to Rule 12(b)(6) for failure to state a claim tests the sufficiency of the complaint, not its merits. When considering dismissal of a complaint, the court accepts all well pleaded factual allegations as true and draws all reasonable inferences in favor of the plaintiff. Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). Rule 9(b), however, requires plaintiffs to plead with particularity the circumstances constituting fraud. Fed.R.Civ.P. 9(b). Particularity in pleading fraud, including securities fraud, means alleging the “who, what, when, where, and how: the first paragraph of any newspaper story.” DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990).

         Section 10(b) of the Securities Exchange Act makes it unlawful for any person to “use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” 15 U.S.C. § 78j(b). S.E.C. Rule 10b-5 implements this provision by making it illegal to make any untrue statement of a material fact or to fail to state a material fact necessary in order to prevent statements made from being misleading in light of the circumstances under which they were made. 17 C.F.R. § 240.10b-5(b). Accordingly, in order to plead that the defendants made material misrepresentations or omissions in violation of section 10(b) and rule 10b-5, the plaintiffs must allege “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 157, 128 S.Ct. 761, 169 L.Ed.2d 627 (2008). The Private Securities Litigation Reform Act (PSLRA) requires that the complaint specify each statement alleged to be misleading and the reason or reasons why that statement is misleading. 15 US.C. § 78u-4(b)(1).

         The PSLRA, moreover, contains a safe harbor provision that heightens the pleading requirements for forward looking statements. 15 U.S.C. § 78u-5(c). A plaintiff alleging that a forward-looking statement contains a misrepresentation or omission must establish a strong inference that the forward-looking statement was made with actual knowledge by the speaker that the statement was false or misleading. 15 U.S.C. § 78u-5(c)(1)(B). In order to establish a “strong inference, ” the pleadings must demonstrate that a reasonable person would deem the inference of scienter to be at least as compelling as any opposing inference that one could draw from the facts alleged. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 324, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). Additionally, a defendant cannot be liable for any forward-looking statement that is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially. 15 U.S.C. § 78u-5(c)(1)(A)(i).

         The plaintiff also alleges that the defendants violated Section 20(a) of the Securities Exchange Act. Section 20(a) provides:

Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable (including to the Commission in any action brought under paragraph (1) or (3) of section 78u(d) of this title), unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constitution the violation or cause of action.

15 U.S.C. § 78t(a). In order to allege a section 20(a) claim, the plaintiff must therefore allege (1) a primary securities violation; (2) that the individual defendant exercised general control over the individual or organization that committed the violation; and (3) that the individual defendant “possessed the power or ability to control the specific transaction or activity upon which the primary violation was predicated, whether or not that power was exercised.” Harrison v. Dean Witter Reynolds, Inc., 974 F.2d 873, 881 (7th Cir. 1992); Zurich Capital Markets, Inc. v. Coglianese, 388 F.Supp.2d 847, 866 (N.D.Ill. 2004) (St. Eve, J.).


         March 2014 Statements On March 25, 2014 Walgreens issued its second quarter report and Wasson and Miquelon held a conference call with investors to present the report and to answer questions about it. During that call, Miquelon stated:

[We] reviewed [the] fiscal-year 2016 goals internally and performance to date with respect to four of our five goals remains on track with or slightly ahead of our expectations.
As stated on our last call our adjusted operating income goal of $9 billion to $9.5 billion is currently tracking below the CAGR required to meet this goal and below our initial expectations. We continue to recognize that there are risks to achieving this goal; however, we remain focused on delivering it.
And as I also stated we have identified a range of further opportunities including benefits from our AmerisourceBergen relationship, incremental Alliance Boots synergies, business expansion and new initiatives and cost savings which can all help mitigate these risks. The asset optimization program that Greg described highlights our focus on efficiencies while the increase in our fiscal-year 2014 synergy estimate demonstrates that we are driving additional synergies with Alliance Boots and AmerisourceBergen.

(Dkt. 47 ¶ 158). Additionally, a slide accompanying the defendants' presentation listed the five previously announced FY2016 goals, including the EBIT goal of $9 to $9.5 billion. The plaintiff contends that these statements are false and misleading because they reaffirm the 2016 EBIT goal, despite the defendants' knowledge that that goal was tracking at least $1.5 billion below target. The plaintiff alleges that by late 2013 Walgreens had identified a shortfall of $500-$600 million with respect to the EBIT target and that, by April 2014, the company had accumulated an additional $1 billion in risk to the EBIT target. The plaintiff further alleges that the defendants knew that the largest source of the EBIT shortfall was the systematic reversion to an inflationary generic drug price trend.

         As an initial matter, this Court rejects the characterization of these statements as a reaffirmation of the goal. Although the defendants did state what the EBIT goal was and renew their commitment to attempt to attain that goal, they also expressly acknowledged that they were not currently on track to attain it. Thus, their statements were not misleading about the current status of the goal. Moreover, the defendants' statements were not actionable based on the theory that the EBIT goal might be unobtainable because the plaintiff has not plausibly alleged that the goal was in fact unobtainable. Cf. Lindelow v. Hill, No. 00 C 3727, 2001 WL 830956, at *4 (N.D.Ill. July 20, 2001) (Holderman, J.) (recognizing statements of “strategy” and “goals” to be actionable where the defendants knew or recklessly ignored the fact that the stated goals were unobtainable). And the plaintiff has not alleged facts establishing that the defendant's future looking statement that they “remained committed” to achieving the EBIT goal was false or misleading. The defendants also were not obligated to provide additional information or internal forecasts about the extent of the shortfall once it was disclosed. See Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 516 (7th Cir 1989) (recognizing that firms have no obligation to reveal in-house estimates that are in the process of consideration and revision); see also City of Livonia Emps.' Ret. Sys. and Local 295/Local 851 v. Boeing Co., 711 F.3d 754, 759 (7th Cir. 2013) (“There is no duty of total corporate transparency-no rule that every hitch or glitch, every pratfall, in a company's operations must be disclosed in ‘real time, ' forming a running commentary, a baring of the corporate innards, day and night.”).

         The plaintiff also contends that the above statement was misleading because it acknowledged efforts to mitigate the risk to the 2016 EBIT goal but failed to recognize that those efforts would be insufficient to counteract the severe scope of the EBIT shortfall. Here, however, the defendants' statement was that there were measures to “mitigate” the risk, not to “eliminate” it. See Black's Law Dictionary 1154 (10th ed. 2014) (defining “mitigate” as “[t]o make less severe or intense; to make less harmful, unpleasant, or seriously bad.”). Thus, in order for their statement to be false or misleading the plaintiff must allege facts demonstrating that the defendants' measures were unable to in any way reduce the EBIT shortfall. The plaintiff has alleged no facts suggesting this to be the case. Additionally, because this is a forward-looking statement, the plaintiff must also allege facts creating a strong inference that the defendants had actual knowledge of the falsity of their statements. Here, the plaintiff has made no such allegation, and therefore fails to state a claim.

         During the conference call, Miquelon addressed Walgreens' softening profit margins, stating “[w]hile we always experience some level of reimbursement pressure the most significant factor affecting the pharmacy margin was dramatically slower rate [sic.] of new generic introductions year over year.” (Dkt. 47 ¶ 157). Walgreens second quarter form 10-Q similarly stated that “[r]etail pharmacy margins were negatively impacted by a significant reduction in the number of brand to generic drug conversions and lower market driven reimbursements.” (Dkt. 47 ¶ 163). The plaintiff contends that these statements were misleading because they misattributed the EBIT shortfall to the lack of new generic drug conversions instead of generic drug price inflation and unfavorable contract terms.

         These statements are adequately alleged to be false or misleading. Miquelon's statement that “we always experience some level of reimbursement pressure” portrayed the reimbursement pressures that Walgreens felt as routine. But the plaintiff has plausibly alleged that those reimbursement pressures, caused by unprecedented, systematic generic drug price inflation and detrimentally structured contracts, were anything but routine and were already recognized to be the primary cause behind the EBIT shortfall. Thus, the representation that reimbursement pressures were routine and that the primary factor impacting pharmacy margins was the reduction in brand-to-generic drug conversions is sufficiently alleged to be false or misleading. In re Gen. Elec. Co. Sec. Litig., 857 F.Supp.2d 367, 386 (S.D.N.Y. 2012) (recognizing that although there is no “duty to disclose any and all related material whenever a company speaks on a given topic”, a duty to disclose arises “when silence would make other statements misleading or false”) (internal quotations omitted); see City of Sterling Heights Gen. Emps.' Ret. Sys. v. Hospira, Inc., No. 11 C 8332, 2013 WL 566805, at *20 (N.D.Ill. Feb. 13, 2013) (St. Eve, J.) (recognizing that statements denying systematic regulatory compliance issues were actionable where the compliance problems that the defendant had experienced were plausibly alleged to be systematic in nature); see also Sapssov v. Health Mgmt. Assocs., Inc., 22 F.Supp.3d 1210, 1227 (M.D. Fla. 2014) (recognizing that, because an executive put the source of a company's success at issue, the failure to disclose the true source of the revenue could give rise to liability under section 10(b)).

         This Court is not persuaded otherwise by the defendants' assertion that generic drug price inflation was a well-known and universally recognized market trend that they therefore had no obligation to disclose. See Higginbotham v. Baxter Int'l, Inc., 495 F.3d 753, 759 (7th Cir. 2007) (“The securities laws do not require firms to ‘disclose' information that is already in the public domain.”); Garden City Empls.' Ret. Sys. v. Anixter Int'l, Inc., No. 09-CV-5641, 2012 WL 1068761, at *5 (N.D.Ill. Mar. 29, 2012) (Dow, J.) (“Defendants do not commit securities fraud by failing to specifically alert investors to the general conditions of certain segments of the market.”). Ordinarily, the defendants' are correct that they would not be required to alert investors to the existence of price inflation in particular sectors of the marketplace. Here, however, the defendants are not alleged to have failed to disclose relevant market information. Rather, they are alleged to have misrepresented that they were only experiencing routine reimbursement pressures and that the primary factor impacting pharmacy margins was the reduction in brand-to-generic conversions. These misrepresentations created a duty to disclose the existence of generic drug price inflation ...

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