On August 23, 2017, the United States Circuit Court of Appeals for the Third Circuit affirmed a district court decision dismissing a putative class action against Globus Medical, Inc. (“Globus” or the “Company”), a medical device company that designs, develops and sells musculoskeletal implants, and several individual officers.  Williams v. Globus Medical, Inc., No. 16-3607 (3d Cir. Aug. 23, 2017).  The lawsuit alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 based on allegations that the Company failed to disclose the termination of a distribution partnership or the impact the termination would have on its revenue projections.  The decision sheds light on how district courts in the Third Circuit should evaluate claims that are based on an alleged omission that, according to plaintiffs, rendered a prior disclosure inaccurate, incomplete or misleading, and also addresses the requirements for stating a claim based on allegedly misleading revenue projections.

The Third Circuit divided plaintiffs’ claims into two categories consisting of challenges to (i) historical statements, in particular the risk disclosures in the Company’s 2013 10-K, filed in March 2014 (“10-K”), and its 2014 1Q 10-Q, filed in late April 2014 (“10-Q”), and (ii) forward-looking statements, primarily certain sales and earnings projections made in February and April 2014 earnings conference calls.  Concerning the historical statements, plaintiffs argued that the statement in Globus’s 2013 10-K (incorporated into the 10-Q) that “[s]ome of our independent distributors account for a significant portion of our sales volume, and if any such independent distributor were to cease to distribute our products, our sales could be adversely affected” was misleading because the Company already had decided to terminate a distribution partnership at the time of the statement.  While the Court acknowledged in rejecting this argument that “courts are skeptical of companies treating as hypothetical in their disclosures risks that have already materialized,” it clarified that the materialized risk must be the disclosed risk.  In this case, “[t]he risk actually warned of [was] the risk of adverse effect on sales—not simply the loss of independent distributors generally.”  (Emphasis added).  The Court explained that the Company might have come under a duty to disclose “if the sales already were adversely affected at the time the risk disclosures were made.”  However, plaintiffs had not pleaded facts sufficient to show this was the case. 

Regarding the Company’s forward-looking statements made during the February and April 2014 earnings conference calls, the Court also rejected plaintiffs’ claim that the Company’s statements regarding its revenue projections were misleading because, at the time of the 10-K, the projections incorporated projected sales figures from the terminated distribution partnership.  The Court agreed with the district court that plaintiffs failed to plead facts sufficient to show that the revenue projections were false or misleading when made, finding that plaintiffs failed to allege any “contemporaneous sources” to show that the projections included amounts from the terminated distribution partnership or any facts quantifying such amounts or any shortfall.  Absent such allegations, plaintiffs’ claim was merely a general assertion that the revenue projections were made without a reasonable basis, which, according to the Court, could not serve as a basis for a securities fraud claim.  Separately, the Court found that the challenged revenue projections were protected under the PSLRA safe harbor because they were forward-looking and plaintiffs failed to allege facts sufficient to infer that the Company knew that ending a distribution partnership would render the Company’s overall projections misleading.  In particular, the Court agreed with the district court that while it may be plausible to “infer that the Company knew or should have known that ending its [distribution] relationship with [the distributor] could have some effect on its sales . . . actual knowledge that sales from one source might decrease is not the same as actual knowledge that the company’s overall sales projections are false.”  As support for this proposition, the Court noted the Company came within 1.17% of its original sales projections ($474.4 million actual, compared to $480 million initially projected), which further undermined plaintiffs’ claims that the sales projections could not be achieved without the distribution partnership.

The Third Circuit’s decision makes clear that courts should carefully consider the specific language of a risk disclosure when facing a claim that the disclosure said a risk “may” happen when it should have said that a risk “has” happened, and also underscores the many challenges plaintiffs face when trying to make claims based on allegedly misleading revenue projections.