Appeal from the United States District Court for the District of New Jersey (D.C. Criminal Action No. 2-06-cr-00406-001) District Judge: Honorable Faith S. Hochberg.
The opinion of the court was delivered by: Ambro, Circuit Judge
Before: AMBRO, ROTH and ALARCÓN*fn1 , Circuit Judges.
Frederick Schiff and Richard Lane were high-ranking corporate executives at the pharmaceutical giant Bristol-Myers Squibb ("Bristol"). They were criminally indicted for allegedly orchestrating a massive securities fraud scheme related to Bristol's wholesale pharmaceutical distribution channels in the early 2000s, in violation of, inter alia, 15 U.S.C. § 78j(b) and Securities and Exchange Commission ("SEC") Rule 10b-5. The Government filed this interlocutory appeal in response to the District Court's March 19, 2008 opinion that addressed several contested theories of liability as well as expert witness issues under Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579 (1993).*fn2 On appeal are two issues: (1) whether the District Court properly dismissed the Government's theories of omission liability under Rule 10b-5 that attempted to hold Schiff accountable for omissions in quarterly SEC 10-Q filings based on his and Lane's alleged misstatements in Bristol's quarterly conference calls; and (2) whether the District Court abused its discretion in excluding the Government's expert, following a Daubert hearing, who would have testified to Bristol's stock price drop as evidence of Rule 10b-5's materiality element. Because we agree that the Government's omission liability theories are not viable, we affirm the District Court's dismissal of these theories. As to the expert testimony, we conclude that the District Court's ruling excluding the Government's materiality expert was not an abuse of discretion.
The criminal charges against the defendants stem from the Government's allegations that Schiff and Lane's statements to the investing public, in, among other things, public analyst conference calls and alleged omissions in SEC filings were misleading. Bristol is a public corporation and leading manufacturer of pharmaceuticals and health care products. Schiff was promoted to Bristol's Chief Financial Officer ("CFO") from Controller in April 2001. He left the company in mid-April 2002. As CFO, he had primary responsibility for Bristol's SEC filings (and signed those filings). Lane was President of Bristol's Worldwide Medicines Group, and left the company in early-April 2002. Both Schiff and Lane represented Bristol on quarterly public conference calls with Wall Street analysts.
Bristol's primary sales and distribution channel for its pharmaceutical products is through wholesalers, who, in turn, supply pharmacies, hospitals, and other health care providers. The wholesalers buy and maintain an inventory, typically based on projected "prescription demand" (i.e., customers' demand for the products). They generally try to target their purchases to this demand projection, and not in excess of it, because more inventory results in higher carrying costs. If wholesalers purchase in excess of demand, it also affects Bristol by reducing the company's later sales while its wholesalers "work down" excess inventory to normal demand levels before purchasing more product.
From 2000 through 2001, Bristol implemented a sales strategy that underlays this case. The Company gave its wholesalers financial incentives, amounting to tens of millions of dollars each quarter, purportedly to spur them to buy its products in excess of prescription demand projections. For example, in August 2001 Schiff and Lane approved $47 million in sales incentives for the third quarter, and in November 2001 Lane approved $85 million in sales incentives for the fourth quarter. These incentives allegedly covered the wholesalers' carrying costs and guaranteed return on their investment until they sold the products. The Government characterizes this as a deceptive strategy to increase sales and earnings in the short term to meet Bristol's aggressive sales and earnings targets,*fn3 and, in turn, artificially inflate the stock price.*fn4
To conceal these practices from Bristol's shareholders and potential investors, Schiff and Lane allegedly "made materially false and misleading statements and omissions of material fact in analyst conference calls, press releases, and meetings with investors."*fn5 (Gov't Br. at 6.) The analyst calls are pertinent to the Government's omission liability theories that are a part of this appeal. The first analyst call Schiff participated in was on April 25, 2001, after he was promoted to CFO (whereas Lane was involved in analyst calls dating back to 2000). A sampling of the actionable statements made by Schiff and Lane in analyst calls include:
4/25/01 Schiff -- "We look at, very closely, the wholesaler stocking inventories . . . . [T]here are no unusual items that we see in the inventory levels." (App. 73 (first quarter -- Schiff and Lane on call));
7/25/01 Schiff -- "we don't see anything unusual" in the "wholesaler inventories" (App. 73 (second quarter -- Schiff and Lane on call))
Lane -- when asked whether there were inventory issues, he responded "no" (App. 500--02);
10/23/01 Schiff -- inventory was "up a couple of weeks" and expected "to be lower in the fourth quarter" (App. 74--75 (third quarter -- Schiff and Lane on call)); and
12/13/01 Schiff -- "We don't see any significant changes" in the prior call's statements that "inventory levels are slightly higher" and "would be reduced by the end of the year" (App. 75 (outside of quarterly call cycle, Schiff and Lane on call)).
On April 1, 2002, Bristol issued its 10-K for the 2001 fiscal year. The report discussed, among other things, excess inventory levels held by wholesalers:
[T]he Company believes average wholesaler inventories of products in the U.S. increased during 2001 by approximately four weeks of additional sales. The Company believes current inventories of its products held by wholesalers in the U.S. significantly exceed levels the Company considers desirable on a going-forward basis. The Company is in the process of developing a plan to reduce these wholesaler inventory levels. The Company expects this reduction in wholesaler inventories to lower levels will negatively impact its financial results in future periods. The Company will make further disclosure later in April 2002 about the plans it is developing to reduce wholesaler inventory levels and the Company's expectations with respect to the likely impact on its financial results.
(App. 200--01.) On the next trading day, the stock price dropped 5.3%, from $40.40 to $38.24.
On April 3, 2002, at the close of the trading day, Bristol made an additional announcement in an analyst call*fn6 (outside of the quarterly cycle) and a press release. Bristol's CEO Peter Dolan announced:
Rick Lane will be leaving the Company.*fn7 . . .
We've estimated that current wholesaler inventory levels significantly exceed the level that we consider desirable. As a result of my review, we're moving as aggressively as possible to reduce shipments to wholesalers, so that wholesaler inventory levels will be more consistent with demand. We estimate that this action will reduce earnings per share by approximately 35 to 40 cents over the full time period of the reduction process.
Now, let me move to the full year 2002. Before the impact of reductions in wholesaler inventories and any non-recurring items, we estimate the full year 2002 earnings per share to be down between 25 and 30%. We expect sales to decline in the low single-digit range. That's a primary driver, as our previous guidance expected sales to increase in the mid to upper single-digit range.
. . . [W]e've identified several products in U.S. primary care that will not meet our sales estimates. Our original guidance to you for the Glucophage franchise, for example, was 1.2 to 1.4 billion for the year. Our analysis post-generic launch shows the franchise will not meet those estimates. And in particular, sales for Glucophage IR will decline more than 90% of 2001 sales.
Additionally, based on our demand-based modeling, sales for Avandia, Serzone, and Tequin will not meet our original estimates and likely decline in 2002 as compared to sales in 2001.
. . . [O]n timing of inventory, our intention is to work it down as aggressively as we possibly can over as rapid a timetable as feasible. As you know, we don't own that wholesaler inventory.
[Schiff (on excess inventory numbers):]
[T]hat's around 800 million to $1 billion. . . . We will work, as we say, as aggressively as possible to reduce the inventory. And in order to do that, we have to slow down our shipments to the wholesalers.
[Schiff:] Glucophage[,] . . . Avandia, Serzone, Tequin -- are the key products that are lower that really make up that revenue reduction. That revenue that we're seeing is causing the result to get to [ ] 25 to 30% lower.
(App. 202--07.) Dolan also indicated that the "prior sales estimates" were "dramatically off track." (App. 203--06.) On the next trading day, April 4, Bristol's stock price dropped 14.7%, from $37.70 to $32.15.
On April 25, 2002 Bristol had its first quarter analyst call. It discussed, among other things, the inventory issue and loss of exclusivity on certain products from generic competition. On April 26, ...