On March 30, 2018, the United States District Court for the Southern District of New York dismissed a class action against Halyard Health, Inc. (“Halyard”) and its executives, along with Kimberly-Clark Corporation (“Kimberly-Clark”) and its executives, that alleged securities fraud under Sections 10(b) and 20(a) of Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5. Jackson v. Halyard Health Inc., et al., 1:16-cv-05093 (S.D.N.Y. Mar. 30, 2018). Halyard sells health and healthcare supplies and solutions. Plaintiff alleged that he acquired Halyard securities at inflated prices and suffered losses when Halyard disclosed that one of its products, the MicroCool Breathable High Performance Surgical Gown (“MicroCool”), intended to protect healthcare providers from contact with highly infectious diseases, was ineffective during the 2014 Ebola virus outbreak. The Court dismissed the action on the ground that the plaintiff failed to adequately plead facts sufficient to give rise to a strong inference of scienter as required by the Private Securities Litigation Reform Act of 1995.
Halyard was spun off from Kimberly-Clark in October 2014. MicroCool was manufactured, marketed, and sold by Kimberly-Clark from mid-2011 through the spin-off. Kimberly-Clark received approval to sell MicroCool from the Food and Drug Administration (“FDA”) through a 510(k) approval process. The MicroCool 510(k) summary stated that MicroCool met the Level 4 requirements of the Association for the Advancement of Medical Instrumentation (“AAMI”) Liquid Barrier classification, a medical safety standard that measures the resistance of materials used in protective clothing to penetration by pathogens. Plaintiff alleged that defendants were aware that MicroCool did not consistently meet minimum standards required for AAMI Level 4 protection but nevertheless continued to market MicroCool as protecting against the transmission of infectious diseases. As an example, plaintiff proffered a test report by Intertek Laboratory, dated December 27, 2012 (the “Intertek Report”), showing that over 48 of approximately 96 gowns failed the test. Plaintiff also cited two confidential witnesses who confirmed the gowns failed to demonstrate the claimed protection during independent testing. In May 2016, the news program 60 Minutes featured a segment reporting that Halyard and Kimberly-Clark “knowingly provided defective [MicroCool] surgical gowns to U.S. workers at the height of the Ebola crisis.” Halyard’s stock fell 14.4 percent following the broadcast.
The Court held that the complaint did not adequately allege facts giving rise to a strong inference of scienter. The Court first held that the complaint failed to allege that defendants had a motive to commit fraud because the stock sales plaintiff pointed to as irregular were not unusual. The Court then held that plaintiff did not specifically identify any defendant who received the 2012 report from Intertek Laboratory (or any other substantiated report of issues with MicroCool), or identify anyone whose scienter could be imputed to the company who did receive the report. The Court further held that plaintiff failed to point to anything that would suggest any defendant acted with an “extreme departure from the standards of ordinary care” by not knowing about problems with MicroCool. The Court also rejected confidential witnesses allegations as insufficient because they referred only to what “senior management” or “senior executives” knew or learned and did not add detail to the conclusory allegations of scienter otherwise included in the complaint.
The Court’s decision stands as a reminder that arguments regarding failures to plead scienter sufficiently often prove powerful at the motion to dismiss stage.