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In re Akorn, Inc. Securities Litigation

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

March 6, 2017

In re AKORN, INC. SECURITIES LITIGATION

          MEMORANDUM OPINION AND ORDER

          Gary Feinerman Judge.

         Five individuals bring this suit against Akorn, Inc. and two of its officers, Rajat Rai and Timothy A. Dick, on behalf of themselves and a putative class of others who purchased Akorn stock between May 6, 2014 and April 24, 2015, alleging violations of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5. Doc. 82. Defendants move to dismiss the operative complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). Doc. 86. The motion is denied.

         Background

         Akorn is a pharmaceutical company. Doc. 82 at ¶ 3. It made two substantial corporate acquisitions in 2014: Hi-Tech Pharmacal Co., Inc. on April 17, 2014, and VPI Holdings Corp., the parent company of VersaPharm Inc., on August 12, 2014. Ibid. At all relevant times, Rai was Akorn's CEO and a director, and Dick was its CFO, Principal Financial Officer, and Principal Accounting Officer. Id. at ¶¶ 23-24. Plaintiffs are individuals who purchased Akorn common stock during the class period, which runs from May 6, 2014 through April 24, 2015. Id. at ¶¶ 1, 17-21.

         In resolving Defendants' Rule 12(b)(6) motion, the court assumes the truth of the operative complaint's well-pleaded factual allegations, though not its legal conclusions. See Zahn v. N. Am. Power & Gas, LLC, 815 F.3d 1082, 1087 (7th Cir. 2016). The court must also consider “documents attached to the complaint, documents that are critical to the complaint and referred to in it, and information that is subject to proper judicial notice, ” along with additional facts set forth in Plaintiffs' brief opposing dismissal, so long as those additional facts “are consistent with the pleadings.” Phillips v. Prudential Ins. Co. of Am., 714 F.3d 1017, 1020 (7th Cir. 2013). The facts are set forth as favorably to Plaintiffs as those materials allow. See Pierce v. Zoetis, Inc., 818 F.3d 274, 277 (7th Cir. 2016). In setting forth those facts at the pleading stage, the court does not vouch for their accuracy. See Jay E. Hayden Found. v. First Neighbor Bank, N.A., 610 F.3d 382, 384 (7th Cir. 2010).

         A. Akorn's Internal Controls

         “Internal control over financial reporting” refers to policies and procedures that “provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. GAAP.” Doc. 82 at ¶ 47. A corporation's CEO and CFO are responsible for designing or supervising those procedures. Ibid.

         Akorn suffered from serious internal control problems for many years, beginning in 2012. Id. at ¶ 64. Akorn hired independent auditor Ernst & Young to conduct its 2012 year-end audit, which concluded that Akorn “has not maintained effective internal control over financial reporting as of December 31, 2012.” Id. at ¶ 66. Akorn decided to switch audit firms due to Ernst & Young's “adverse internal controls report, ” id. at ¶ 104, and hired KPMG to conduct its 2013 year-end audit, id. at ¶ 69, with the hope that KPMG's report would be “more favorable, ” id. at ¶ 104. That hope was dashed when KPMG concluded that Akorn “has not maintained effective internal control over financial reporting as of December 31, 2013.” Id. at ¶ 69. KPMG conducted a mid-year audit in 2014 and again identified internal control deficiencies. Id. at ¶ 107. Later that year, KPMG conducted a “roll-forward audit” and determined that Akorn had not remedied the deficiencies it had previously identified. Ibid. KPMG conducted Akorn's 2014 year-end audit and concluded, once again, that Akorn “has not maintained effective internal control over financial reporting as of December 31, 2014.” Id. at ¶ 75. Akorn then dismissed KPMG and hired a different firm, BDO USA, LLP, to conduct its 2015 year-end audit. Id. at ¶ 123. BDO concluded that Akorn “did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2015.” Id. at ¶ 80.

         The auditors' conclusions were based on several deficiencies in Akorn's internal controls. For example, the 2013 year-end audit identified the absence of controls designed to validate the data used to calculate gross to net revenue adjustments. Id. at ¶ 193. The 2014 year-end audit identified the absence of accurate controls to prevent or detect material errors in the financial statements of acquired subsidiaries. Ibid.

         Dick and Rai committed in public filings to participate in and closely monitor remediation efforts. Akorn's Form 10-K for the 2012 fiscal year stated:

We are working to remediate the material weakness. We have begun taking steps and plan to take additional measures to remediate the underlying causes of the material weakness, primarily through the continued development and implementation of formal policies, improved processes and documented procedures, as well as the hiring of additional finance personnel.

         Doc. 93-2 at 5. Akorn's Form 10-K for the 2013 fiscal year gave a detailed description of Dick and Rai's remediation plans, Doc. 93-8 at 15, as did Akorn's Form 10-K for the 2014 fiscal year, Doc. 93-21 at 10. Dick and Rai signed both filings, Doc. 93-8 at 16; Doc. 93-21 at 12, but they failed to remediate the key material weaknesses that were identified during the 2013 and 2014 audits. Doc. 82 at ¶¶ 7, 193.

         B. Defendants' Allegedly False and Misleading Statements

         Plaintiffs allege that Dick, Rai, and Akorn made a series of false and misleading statements and omissions regarding Akorn's financial results for each quarter in fiscal year 2014 and its acquisitions, and that those statements and omissions resulted in the artificial inflation of Akorn's stock price.

         1. 2014 First Quarter Financial Results

         On May 6, 2014, the day the class period began, Akorn issued a press release titled, “Akorn Reports 2014 First Quarter Results.” Id. at ¶ 126. The press release asserted that the company's “Key Highlights and Accomplishments” included the following: Akorn “[a]chieved record first quarter consolidated revenue of $90.6 million, an increase of 23% over last year's first quarter”; “[g]enerated record operating cash flow of $23.4 million”; and “[c]ompleted the acquisition of Hi-Tech Pharmacal Co., Inc.” Ibid. Dick and Rai participated in a conference call that day, during which Rai stated, “We are off to a good start for the year, with nearly $91 million in sales in the first quarter, up 23% from the same quarter last year.” Id. at ¶ 127. Those figures were included in Akorn's first quarter Form 10-Q, which Dick Dated: May 12, 2014. Id. at ¶ 128; Doc. 93-12 at 7. In filing the Form 10-Q, both Dick and Rai certified, in accord with Sarbanes-Oxley (“SOX”) requirements:

1. I have reviewed this Quarterly Report on Form 10-Q of Akorn, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of [Akorn] as of, and for, the periods presented in this report;
4. … [I] have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to [Akorn], including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of [Akorn's] disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in [Akorn's] internal control over financial reporting that occurred during [Akorn's] most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, [Akorn's] internal control over financial reporting; and
5. … I have disclosed, based on our most recent evaluation of internal control over financial reporting, to [Akorn's] auditors and the audit committee of [Akorn's] board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect [Akorn's] ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in [Akorn's] internal control over financial reporting.

         Doc. 82 at ¶ 128; Doc. 93-12 at 8-9.

         Despite Dick and Rai's certifications, the Form 10-Q overstated the amortization of deferred financing costs by $1.9 million, which inflated net income by 3.5%. Doc. 82 at ¶¶ 49, 129. In addition, Akorn's financial statements were not prepared in accordance with GAAP, and Akorn was not taking adequate steps to remediate the material weaknesses in its internal controls. Id. at ¶ 129.

         2. 2014 Second Quarter Financial Results

         On August 5, 2014, Akorn issued a press release titled, “Akorn Reports Preliminary 2014 Second Quarter Results.” Id. at ¶ 132. The press release stated that Akorn “[a]chieved record second quarter consolidated revenue of $150.7 million, an increase of 96% over last year's second quarter and record adjusted net income per diluted share of $0.25, an increase of 79% over last year's second quarter, ” resulting in $8.5 million of net income. Ibid. Dick and Rai participated in a conference call with investors that day, during which they both described Akorn's second quarter financial results. Id. at ¶¶ 133-135. Those financial results were included in Akorn's second quarter Form 10-Q, which Dick signed on August 11, 2014. Id. at ¶ 136; Doc. 93-15 at 8. The “Management's Discussion and Analysis” section of the Form 10-Q reported organic growth of $9.9 million, representing a growth rate of $12.9% compared to the prior year's second quarter. Doc. 82 at ¶ 136. Dick and Rai also made SOX certifications substantially similar to those reproduced above. Ibid.

         In reality, Akorn's organic growth rate was 3.6% during this period, not 12.9%. Id. at ¶ 137. Akorn's revenue was $133.9 million, 12.6% less than the $150.7 million reported, and its net income was negative $1.3 million, not the positive $8.5 million reported. Id. at ΒΆ 49. Akorn's financial statements were not prepared in accordance with GAAP, and it was ...


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