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In re Psychemedics Corp. Securities Litigation

United States District Court, D. Massachusetts

November 7, 2017

IN RE PSYCHEMEDICS CORP. SECURITIES LITIGATION

          MEMORANDUM AND ORDER ON DEFENDANTS' MOTION TO DISMISS

          RICHARD G. STEARNS UNITED STATES DISTRICT JUDGE.

         Defendants Psychemedics Corp. and Raymond Kubacki, Psychemedics' Chief Executive Officer (CEO), move to dismiss this putative securities fraud class action brought against them by plaintiff Mary Kathleen Hermann on behalf of all other similarly situated holders of Psychemedics stock during the proposed class period for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a et seq. The Complaint alleges that Psychemedics misled investors by failing to disclose that its independent distributor in Brazil, Psychemedics Brasil, had become secretly entwined in a cartel scheme with a competitor in violation of Brazilian law, the eventual public disclosure of which precipitated a steep drop in Psychemedics' stock price. Because the Complaint fails to allege any facts that give rise to an inference that Psychemedics had any inkling of the Brazilian scheme during the time period it is accused of failing to bring its existence to light, and because plaintiff's other efforts to establish scienter are speculative and unconvincing, the court will grant the motion to dismiss.

         BACKGROUND

         Psychemedics, a Delaware corporation with its headquarters in Acton, Massachusetts, provides clinical laboratory services for the detection of illicit drugs, including hair testing. Psychemedics maintains two laboratories in Culver City, California, where hair samples are sent to be tested. The company does business in a number of countries, including Brazil, where a company named Psychemedics Brasil had the exclusive right to distribute Psychemedics' services.[1] In 2013, the Brazilian government announced its intention to require all professional motor vehicle drivers to submit to a hair drug test when applying to have their licenses renewed. This proposed new rule presented Psychemedics with a golden opportunity, leading company spokespersons to effuse over the potential for expansion of future business in Brazil. These sanguine statements to investors and shareholders form the basis of the lawsuit.

         On December 3, 2013, the day that the Brazilian government announced the anti-drug motorist initiative, [2] Psychemedics' Corporate Vice-President of Sales and Marketing, Jim Dyke, stated in a press release that Psychemedics Brasil was “a very strong partner . . . who we have worked closely with for over 15 years, ” and that both companies “look[ed] forward to continuing to work together on this new opportunity.” Compl. ¶ 6. The press release also quoted Marcello Santos Rachlyn, the President of Psychemedics Brasil, as saying, “[w]e have been extremely pleased to work closely with Psychemedics Corporation for the past 15 years.” Id. ¶ 26. A February 10, 2014 press release issued by Psychemedics quoted Kubacki as saying that Psychemedics was “very excited about competing for the hair testing business in Brazil.” Id. ¶ 42.

         Various other press releases, as well as Psychemedics' Form 10-K filings with the SEC, described Psychemedics' business in rosy terms, noting that while the company “competes with other hair testing laboratories, ” it “distinguishes itself from hair testing competitors by emphasizing the superior results the Company obtains through use of its unique patented extraction method, ” Id. ¶¶ 14, 65, 77. Subsequent press releases emphasized to investors Psychemedics intent to “compete” for a greater share of the Brazilian hair testing market if and when the testing requirement was imposed. Id. ¶¶ 53, 55, 82.

         Several of these press releases also described investments in equipment and facilities that Psychemedics had made in anticipation of the increase in orders that would (presumably) flow from the implementation of the drug testing mandate. In addition to these public statements, “confidential” witnesses cited in the Complaint noted that Kubacki traveled to Brazil on various occasions between mid-2014 and early 2015 “to assist Psychemedics Brasil develop and expand its collection network.” Id. ¶ 9. Finally, when the mandatory testing regime launched in the first quarter of 2016, Psychemedics informed investors on April 26, 2016, in a press release, that the company was “already seeing a meaningful pickup of testing volume, ” and referenced a statement by Kubacki assuring shareholders that the company was “aggressively competing” for new business in Brazil. Id. ¶ 82.

         The difficulty with all these statements, according to the plaintiff, is that they failed to disclose that Psychemedics was reaping the benefits of an illicit arrangement between Psychemedics Brasil and its ostensible rival, Omega Brasil. In essence, Omega Brasil had been bribed to steer exclusive contracts for drug collection points to Psychemedics at the expense of Omega USA, for whom Omega Brasil served as an in-country distributor. This corrupt arrangement had been facilitated by family relationships among employees of the two Brazilian companies, and had virtually eliminated market competition for the supply of hair testing products and services. In other words, plaintiffs argue that the ebullient statements touting Psychemedics' prospects for capturing a substantial share of the expected expansion of the Brazilian market for hair testing services were misleading because the Brazilian distributor was “cheating - not competing - in order to expand Psychemedics' collection network and win new business in Brazil.” Pl.'s Opp'n at 6.

         Omega USA, disgruntled by the rumors that it had been betrayed by its Brazilian distributor, undertook a confirmatory investigation and pursued remedies in the Brazilian courts against both Omega Brasil and Psychemedics Brasil, alleging violations of Brazil's anti-competition laws.[3]Compl. ¶¶ 36-40. While the court pleadings were publicly available in Portuguese, the Complaint alleges that the legal proceedings in Brazil were a camera obscura to investors in the United States because of the language barrier and the lack of English-language media coverage. Id. ¶¶ 38-39.

         On January 20, 2017, a Brazilian judge ruled in favor of Omega USA, finding that Psychemedics Brasil and Omega Brasil had conspired against Omega USA, effectively shutting it out of the Brazilian hair-testing market. Id. ¶ 11. The judge ordered Psychemedics Brasil and Omega Brasil to indemnify Omega USA for a then-undetermined amount of lost profits. On January 31, 2017, a Brazilian law firm representing Omega USA issued a press release celebrating the judgment that the firm had won. Id. ¶ 12. The firm's announcement was picked up and published by Bloomberg, which added that Psychemedics Brasil was facing further investigation by Brazil's Administrative Council for Economic Defense for engaging in “cartel practices.” Id. ¶ 98.

         The Bloomberg report, disclosing the existence of the scheme and the Brazilian court ruling - had an insalubrious effect on Psychemedics' stock price, which dropped from an intraday high of $25.87 per share on January 31, 2017, to a low of $13.83 against a 5, 000% increase in trading volume from the previous day. Id. ¶ 101. The stock closed out the day at $18.87 per share, representing a loss of more than 25% of its opening price. Id. The plaintiff pounced two days later, filing the original Complaint in this court (the amended version of the Complaint was filed on June 2, 2017). The prospective class consists of all purchasers of Psychemedics common stock between February 10, 2014, and January 31, 2017. Psychemedics now moves to dismiss. The court heard oral argument on October 19, 2017.

         DISCUSSION

         To state a claim under section 10(b) and its corresponding rule, a plaintiff must allege: “(1) a material misrepresentation or omission; (2) scienter; (3) a connection with the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation.” Miss. Pub. Employees Retirement Sys. v. Boston Scientific Corp., 523 F.3d 75, 85 (1st Cir. 2008). The Private Securities Litigation Reform Act of 1995 (PSLRA) supplies the pleading standards a court is to apply in securities fraud cases. Under these standards, a plaintiff must specify each statement or omission that is allegedly misleading, explain why each statement or omission is deceitful or disingenuous, and provide factual support for the allegations of fraud. Greebel v. FTP Software, Inc., 194 F.3d 185, 193-194 (1st Cir. 1999).

         Scienter is a “mental state embracing intent to deceive, manipulate, or defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). A defendant may also have the requisite mental state if it “acted with a high degree of recklessness.” Aldridge v. A.T. Cross Corp., 284 F.3d 72, 82 (1st Cir. 2002). “Recklessness, as used in this context, ‘does not include ordinary negligence, but is closer to being a lesser form of intent.'” Fire & Police Ass'n of Colo. v. Abiomed, Inc., 778 F.3d 228, 240 (1st Cir. 2015) (quoting Greebel, 194 F.3d at 188). Thus, “a defendant can be held liable for ‘a highly unreasonable omission, involving not merely simple, or even inexcusable, negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to ...


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