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Godinez v. Alere Inc.

United States District Court, D. Massachusetts

August 23, 2017

JUDITH GODINEZ, on behalf of herself and all others similarly situated, Plaintiffs,


          Patti B. Saris, Chief United States District Judge


         Plaintiffs sued Alere and three of its corporate officers alleging violations of Section 10(b) of the Exchange Act and Securities and Exchange Commission (SEC) Rule 10b-5. The suit also brings derivative claims against the officers, Chief Executive Officer Namal Nawana, Chief Financial Officer James Hinrichs, and Chief Accounting Officer Carla Flakne, under Section 20(a) of the Exchange Act. Two related cases have been consolidated with this one.

         Before the Court is Defendants' motion to dismiss Plaintiffs' supplemental and amended consolidated class action complaint for failure to state a claim under Federal Rules of Civil Procedure 9(b) and 12(b)(6) and the Private Securities Litigation Reform Act (PSLRA) (15 U.S.C. § 78u-4). Docket No. 80. At its core, resolution of the motion hinges on whether or not the complaint meets the PSLRA's heightened pleading standard for scienter. For the reasons stated below, after hearing, the motion to dismiss is ALLOWED IN PART and DENIED IN PART.


         The facts are drawn from Plaintiffs' amended complaint (Docket No. 78), documents attached to or expressly incorporated into the complaint, as well as documents the authenticity of which are not disputed by the parties, documents central to the plaintiffs' claims, and documents sufficiently referred to in the complaint. See Fire & Police Pension Ass'n of Colo. v. Abiomed, Inc., 778 F.3d 228, 232 & n.2 (1st Cir. 2015).

         I. Background

         Alere is a Delaware corporation with its principal place of business in Waltham, Massachusetts. Alere provides diagnostic testing for diseases and toxicology. It has manufacturing facilities in North America, Europe, and Asia, and its distribution network is global, with offices in thirty-two countries. One of Alere's products was INRatio, a mobile device that tested a patient's blood coagulation rate, allowing doctors to provide the correct dose of blood thinning medication to reduce the risk of stroke (too much clotting) or hemorrhage (too little clotting). Alere's other lines of business include drug testing and medical device supply.

         Plaintiffs advance four categories of conduct to support the allegation of securities fraud: 1) Alere had material weaknesses in its internal controls related to revenue recognition but only made limited disclosures of what the corporation knew; 2) Alere failed to disclose the need to recall INRatio products; 3) Alere failed to disclose billing “improprieties” in two of its divisions; and 4) Alere failed to disclose that its foreign offices regularly engaged in conduct that violated the Foreign Corrupt Practices Act (FCPA). To support the allegations of scienter, Plaintiffs highlight the decision by Alere executives to sell the company and the fact that Nawana and Hinrichs stood to receive change-of-control payments totaling $29 million if Alere was acquired. Defendants counter the inference by pointing out that Nawana and Hinrichs increased their holdings of Alere common stock during the proposed class period.

         A. Desire to Sell

         In October 2014, Nawana was promoted from Interim CEO to CEO and President. From December 2012 to July 1, 2014, Nawana had served as Alere's Chief Operating Officer. Hinrichs became Executive Vice President and CFO on April 6, 2015. Part of his compensation package entitled him to a bonus equal to the aggregate increase in the exercise price of his stock options during the first year he was CFO. Also in October 2014, Alere put in place change of control provisions which guaranteed payouts to certain corporate officers in the event of “qualifying termination.” Alere's SEC filings indicate that Nawana was entitled to a $20.5 million change-in-control payment, and Hinrichs was due $8.7 million if a qualifying termination occurred. In February 2015, Alere adopted a new compensation plan for executives, which included a short-term incentive plan based on two performance-based metrics.

         As Plaintiffs tell it, by mid-2014 Alere executives decided to sell the company and began exploring options. On August 4, 2014, Alere announced that the company intended to refocus on its core business. In September 2014, former Alere CEO Ron Zwanziger indicated that he and other former Alere executives were interested in acquiring the company for $46 per share. Alere noted this offer in a September 15, 2014 press release and Form 8-K filed with the SEC. The press release identified J.P. Morgan as financial advisor to Alere's board regarding potential corporate transactions. Although Alere rejected the Zwanziger offer, the company sold subsidiaries on October 14, 2014 and January 9, 2015 as part of its effort to refocus on its core business.

         In December 2015, an executive from Abbott Laboratories (Abbott), a large pharmaceutical corporation in the same market space as Alere, contacted Nawana to inform him that Abbott was interested in making a proposal to acquire Alere. Four days later, the Alere board authorized J.P. Morgan to contact other potential acquirers. On January 11, 2016, Alere presented at a J.P. Morgan healthcare conference at which Alere stated income for the first three quarters of 2015 that was later revised down. At the conference, Nawana also discussed Alere's INRatio2 medical device, which was later recalled. Docket No. 101, Ex. C.

         B. Alleged Weaknesses in Internal Controls

         1. Taxes

         On March 5, 2015, Alere filed its 2014 Annual Report (2014 10-K), which disclosed that it had a “material weakness related to the failure to design controls to assess the accounting for deferred tax assets which became recognizable” when it sold its health management business in January 2015. On May 28, 2015, Alere amended its 2014 10-K, notifying the market that it had made material errors in its prior disclosures by incorrectly accounting for income taxes associated with two divestitures during 2014. As a result, Alere revised some previously reported quarterly financial statements, and annual financial statements for the years ending December 31, 2012, December 31, 2013, and December 31, 2014.

         On November 9, 2015, in its 2015 third quarter SEC filing (2015 3Q 10-Q), Alere disclosed an internal control problem, stating that the company “did not maintain a sufficient complement of resources with adequate experience and expertise in accounting for income taxes.” On November 13, 2015, Alere made a third amendment to its 2014 10-K to reflect its internal control issue related to income tax accounting.

         According to a confidential witness, labeled in the complaint as a former Alere Senior Accountant in Western Europe from 2011 through 2014, there was a lack of internal controls at Alere, in part due to the vastness of the corporation, made up of approximately 200 entities operating in dozens of different countries and tax systems. As such, the confidential witness believed that Alere's financial information system could not ensure that all necessary information was compiled accurately, and accountants used basic spreadsheet software to reconcile revenue. The witness related that, in November 2013, Alere's tax auditing firm, PricewaterhouseCoopers (PwC), learned of a proposed $2.6 million adjustment related to internal transfer pricing. PwC advised Alere against the adjustment, but France-based employees contacted headquarters and took the adjustment.

         2. Revenue Recognition

         Other confidential witnesses -- a National Sales Manager in India from 2013 through early 2015 and a Global Vice President of Customer Experience from June 2012 through May 2014 -- also reported deficiencies in Alere's internal reporting systems in various countries, including improper revenue recognition -- the practice of claiming revenue for accounting purposes in one quarter even though Alere did not actually transfer risk of loss of the goods until after that quarter closed. The Global Vice President of Customer Experience said that at the end of financial quarters, Alere “stuffed” distribution channels by selling products at a steep discount in order to boost sales figures for that quarter. None of the confidential witnesses is alleged to have had contact with senior management. Some confidential witnesses left the company before Nawana and Hinrichs took executive roles.

         Throughout the relevant time period, Alere's annual (10-K) and quarterly (10-Q) SEC filings, including amended filings, contained the certifications required by the Sarbanes-Oxley Act (SOX), in which Nawana (once he became CEO) and Hinrichs (once he became CFO) attested that the Company's internal and disclosure controls were effective.

         C. INRatio Recall Forewarnings

         Plaintiffs allege that Alere was on notice for many years that its leading medical device, the INRatio blood clotting time measurement tool, had severe deficiencies that would probably result in a recall. According to the Global Vice President of Customer Experience, in 2007 then-CEO Zwanziger called the device “crude, ” and Alere's standard practice regarding consumer complaints about the device was to attribute issues to “user error, ” even when employees did not believe customers caused the issue. Another confidential witness, labeled as a former Quality Assurance Product Support Associate from March 2014 through February 2016, but who began in customer service at Alere in February 2010, said the device “didn't work, ” thus necessitating a recall. She said customers complained about “fluctuat[ions]” and that complaints about INRatio were “known” years prior to the 2016 recall and were “continuous.” The former Quality Assurance employee reported that Alere had to hire outside employees to handle the volume of complaints, and from October 2015 to February 2016, the company nearly doubled the internal quality assurance staff to field INRatio complaints.

         Plaintiffs allege that Alere was on notice of the INRatio issues beginning in May 2014, when the company issued a partial recall of the device's test strips, a fact memorialized in Alere's 2014 10-K. In that filing, Alere noted the test strip recall, but stated that its “emphasis on quality during 2014 has enabled us to respond to these developments more effectively than in the past and will help to mitigate any negative impact.” In November 2015, the institute which coordinated the study of the blood-thinning medicine Xarelto was investigating whether its use of INRatio devices had distorted results. That study resulted in the Food and Drug Administration (FDA) approving Xarelto. In late 2015, Alere submitted a proposed software enhancement to the FDA. Thereafter, although the precise date is not alleged in the complaint or revealed in Alere's SEC filings, the FDA informed Alere that the proposed INRatio software update failed to adequately demonstrate effectiveness. According to the complaint, the FDA advised Alere to submit a proposal to voluntarily remove INRatio devices from the market. This information was not disclosed to the market until Alere announced its voluntary recall of INRatio in July 2016.

         Plaintiffs allege that Alere became aware of additional adverse information concerning INRatio in late January 2016, based on a private complaint filed in Delaware Chancery Court to which Plaintiffs lacked access. In February and March 2016, the New York Times published articles about INRatio, including information that the FDA was investigating whether use of INRatio compromised results in clinical trials, and more generally led doctors to give patients the wrong dose of warfarin. One article reported that the FDA had received more than 9, 000 reports of INRatio product malfunctions, and more than 1, 400 reports of INRatio causing injuries -- far more than market leader Roche's similar product, which had just ninety-five injury reports over the same period.

         D. Billing Issues at Alere Subsidiaries

         Alere's Toxicology Division provides drug testing for employers and government bodies. Plaintiffs allege that Alere knew of problems with billing practices in its Toxicology Division, since August 2013, when Horizon Blue Cross and Blue Shield filed a complaint in New Jersey Superior Court. The New Jersey complaint alleged that Alere and a company it acquired defrauded Horizon of at least $36 million by making false and fraudulent insurance claims for unnecessary tests. A confidential witness, labeled as a former Medicaid Accounts Resolutions Specialist, who worked for Alere in Florida from 2010 through October 2012, stated that Alere would conduct and bill for unnecessary toxicology screenings. Another confidential witness, the former Alere Toxicology Billing and Pricing Supervisor from March 2014 through August 2014 stated that, during those five months, there were two Medicare audits and one internal audit. The confidential witness stated that, based upon these audits, Alere learned of problems with its billing practices.

         Alere's Arriva subsidiary, which sells diabetes testing supplies and other durable medical equipment, also allegedly had a history of violating Medicare billing requirements, and was subject to multiple government investigations. In particular, Plaintiffs allege Alere, via Arriva, was on notice of billing issues in that subsidiary because Arriva previously acquired AmMed Direct, LLC (AmMed), which was the subject of a Federal False Claims Act suit in Tennessee. According to the complaint, the suit subsequently settled. Furthermore, in March 2015, Alere disclosed that Arriva was responding to a Civil Investigative Demand (CID) from the U.S. Attorney for the Middle District of Tennessee in connection with an investigation into possible improper claims submitted to government healthcare programs.

         E. FCPA Improprieties

         Plaintiffs allege that Alere was on notice of FCPA improprieties no later than fall 2013. The complaint recites statements from a confidential witness, the National Sales Manager in India from 2013 through early 2015. The National Sales Manager stated that, in late summer or early fall 2013, Deloitte conducted an internal investigation into Alere's government bidding practices in India. The confidential witness stated that the government bidding process was “highly corrupted, ” with state contracts facilitated by “under the table” dealings between Alere distributors and government officials. The complaint does not allege that the confidential witness's determination that the government bidding process was “highly corrupted” was a conclusion reached in the alleged Deloitte audit.

         II. The Alleged Fraud is Revealed

         On February 1, 2016, Abbott announced its intention to purchase Alere for $56 per share, a premium of $18.80 per share. If the deal closed, Nawana and Hinrichs stood to collect approximately $29 million in change-of-control payments. Alere filed a Form 8-K with the SEC on the date the merger was announced, which attached the merger agreement as an exhibit. Within the merger agreement Alere warranted that it had complied with securities laws and SEC regulations since January 1, 2014, and that none of the “Company SEC documents” since that date “contained any untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements therein, in light of the circumstances in which they were made, not misleading.” The merger agreement also warranted that Alere had disclosed all liabilities, “whether accrued, absolute, contingent or otherwise, ” that would “individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.” Finally, the merger agreement warranted that Alere was not aware of pending or threatened legal or administrative proceeding, suit, claim, investigation, arbitration or action against the company or its subsidiaries that would be expected to have a material adverse effect.

         Soon after the merger was announced, however, and throughout the remainder of 2016, Plaintiffs recite a series of events and disclosures that illuminate the scope of the fraud alleged in this lawsuit.

         A. February 26, 2016 and March 15, 2016 - Alere's Delayed 2015 10-K amid Accounting Woes and Potential FCPA Violations

         On February 26, 2016, Alere first disclosed that its 2015 Annual Report (2015 10-K) would be delayed, because it was “conducting an analysis of certain aspects of revenue recognition in Africa and China and any potential implications on . . . internal controls over financial reporting for the year ended December 31, 2015.” At the same time, Alere disclosed that it received a SEC subpoena on January 14, 2016 in connection with a previously-disclosed formal SEC investigation into sales practices in Africa. On March 15, 2016, Alere filed a Form 8-K disclosing that the company would need a further extension of the time to file its 2015 10-K, because its analysis of revenue recognition accounting practices in Africa and China was continuing. That Form 8-K also disclosed that on March 11, 2016, Alere received a grand jury subpoena from the ...

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