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Cody v. Conformis, Inc.

United States District Court, D. Massachusetts

August 3, 2016

WILLIAM M. CODY, THOMAS S. NELSON, and JAMES SCHAEFER, individually and on behalf of all others similarly situated Plaintiffs,
v.
CONFORMIS, INC., PHILIPP LANG, and PAUL WEINER, Defendants.

          OPINION AND ORDER

          GEORGE A. O’TOOLE, JR. United States District Judge.

         The plaintiffs, William M. Cody, Thomas S. Nelson, and James Schaefer, [1] bring claims under the Securities Act of 1933 and the Securities Exchange Act of 1934 (the “Securities Act” and the “Exchange Act, ” respectively) against the defendants, ConforMIS, Inc., Philipp Lang, and Paul Weiner. ConforMIS is a medical device company headquartered in Massachusetts. Lang is the company’s President and Chief Executive Officer. Weiner is its Chief Financial Officer.

         The defendants have moved to dismiss all claims against them. The primary Securities Act claim, brought under Section 11, see 15 U.S.C. § 77k, alleges material misstatements in or omissions from ConforMIS’s prospectus, issued in connection with its initial public offering (“IPO”). The primary Exchange Act claim alleges a violation of Rule 10b-5, see 17 C.F.R. § 240.10b-5, [2] and alleges material misstatements or omissions in the company’s prospectus and in a post-IPO earnings conference call that Lang and Weiner held with analysts and investors. The plaintiffs also bring two derivative claims for officer or director liability against Lang and Weiner under Section 15 of the Securities Act and Section 20(a) of the Exchange Act. It appears undisputed that if the primary claims fail, so too do the individual liability claims.

         For the reasons explained in more detail below, the plaintiffs have not adequately pled claims under either Section 11 or Rule 10b-5. Specifically, the Amended Complaint does not allege facts that would support a plausible conclusion that any of the challenged statements were false or misleading when made. Nor, as to the Exchange Act claims, do the factual allegations of the Amended Complaint support a strong inference of scienter, an essential element of a claim under Rule 10b-5.

         I. Factual Background

         The Amended Complaint alleges the following: ConforMIS manufactures and sells custom designed joint replacement devices, particularly knee replacement devices. The fundamental proposition of the company’s business plan is that implants designed specifically for a particular patient are superior in performance to mass-produced “off-the-shelf” implants precisely because each ConforMIS device is designed to match the unique anatomical geometry of a specific person, leading to better clinical outcomes. In addition to the implant device itself, the company delivers to surgeons a set of instruments it dubs “iJigs” to be used in the implant surgery.

         In the first half of 2015, ConforMIS operated manufacturing facilities in Bedford and Burlington, Massachusetts. At the time of its IPO, July 1, 2015, the company was in the process of shutting down its Burlington facility and transferring those operations to a new facility in Wilmington, Massachusetts. Primary manufacturing operations were transferred after the IPO.

         As a medical device company, ConforMIS must comply with the Food and Drug Administration’s QSR (Quality System Regulation) protocol. See generally 21 C.F.R., Part 820. The QSR does not itself establish a specific set of quality control rules, but rather requires a manufacturer of medical devices to establish and enforce policies and procedures sufficient to achieve effective quality control. In its prospectus, the company stated that it believed its existing Burlington and Bedford facilities were in compliance with the QSR. (The Wilmington facility was still in the process of being validated.)

         An important part of ConforMIS’s manufacturing process is the cleaning and sterilization of the iJigs, the surgical instruments that accompany the knee replacement devices. According to the Amended Complaint, the iJigs were first cleaned in-house and then sent out to a vendor to be sterilized. The Amended Complaint describes the process in some detail:

32. On information and belief, iJigs were cleaned ultrasonically in ConforMIS’s facilities before being sterilized.
33. Ultrasonic cleaning usually has four steps: (1) submerging the item in cleaning solution; (2) introducing ultrasonic sound waves over a specific time period, which scrub the item clean as tiny bubbles rapidly form and then implode around the item; (3) rinsing off the solution; and (4) drying the item.
34. ConforMIS has used different sterilization methods at different times, including hydrogen-oxide sterilization and ethylene-oxide sterilization.
35. Ethylene-oxide sterilization is more efficient than hydrogen-peroxide sterilization, but ethylene-oxide sterilization has a much higher risk of leaving dangerous residues, including ethylene oxide itself, ethylene chlorohydrin, and ethylene glycol.
36. On information and belief, ConforMIS primarily used hydrogen-peroxide sterilization before its IPO.
37. At some point in 2014, ConforMIS decided to outsource its sterilization process to an outside vendor called STERIS.
38. After its IPO, ConforMIS began to rely more heavily on ethylene-oxide sterilization.

(Am. Compl. ¶¶ 32-38 (dkt. no. 23).) According to the Amended Complaint, the use of ethylene oxide in the sterilization process presents a risk that if the item is not thoroughly dried after its cleaning, the remaining moisture may lead to the formation of ethylene glycol, a moderately toxic type of antifreeze. (See id ¶¶ 45-47.)

         From the “Risk Factors” section of the prospectus, the plaintiffs cite the following statements by the company:

We may encounter problems or delays in the manufacturing of our products or fail to meet certain regulatory requirements that could result in a material adverse effect on our business and financial results.
. . .
We may encounter other difficulties in increasing and expanding our manufacturing capacity, including difficulties:
• acquiring raw materials for 3D printing;
• deploying new manufacturing processes, including DMLS 3D printing;
• acquiring 3D printers, especially DMLS 3D printers;
• managing production yields;
maintaining quality control and assurance;
• maintaining component availability;
maintaining adequate control policies and procedures;
• hiring and retaining qualified personnel; and
• complying with state, federal and foreign regulations.

(Mem. of Law in Supp. of Defs.’ Mot. to Dismiss, Ex. A, at 31-32 (dkt. no. 29-2) (bold face supplied by plaintiffs);[3] Am. Compl. ¶¶ 95-96.)

         In the “Business” section of the prospectus, under “Manufacturing, ” the plaintiffs point to the following statements:

We conduct our manufacturing activities in state-of-the-art design and manufacturing facilities in Bedford, Burlington ...

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