In re Psychemedics Corp. Securities Litigation: Plaintiffs Failed to Sufficiently Allege Claims Based on Violations of the FCPA

In In re Psychemedics Corp. Securities Litigation, No. 17-cv-10186-RGS, 2017 BL 399136 (D. Mass. Nov. 07, 2017), the United States District Court for the District of Massachusetts granted Psychemedics Corp. (“Psychemedics”) and Raymond Kubacki’s (“Kubacki”), Psychemedics’ Chief Executive Officer, (collectively, “Defendants”) motion to dismiss for failure to state a claim in a putative class action brought by Mary Kathleen Hermann on behalf of all of those who purchased Psychemedics common stock between February 10, 2014 and January 31, 2017 (collectively, “Plaintiffs”). Based on Plaintiffs’ failure to allege facts sufficient to support an inference of scienter, the court granted dismissal of the claims alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.

According to the allegations, the Brazilian government announced professional drivers were required to submit to a hair drug test when applying to renew licenses. On February 10, 2014, a press release issued by Kubacki stated Psychemedics was “very excited about competing for the hair testing business in Brazil.” Further, Kubacki allegedly oversaw the expansion in Brazil and Psychometrics’ SEC filings emphasized how the company differentiated itself from its competitors due to its unique patented drug extraction method. On January 31, 2017, a Psychometrics’ competitor issued a press release after winning a judgment against Psychemedics’ exclusive Brazilian distributor. In the judgment, a Brazilian judge held that Psychemedics Brasil had conspired with the competitor’s subsidiary for the hair-test market. Based on a PR Newswire press release, Bloomberg reported the distributor was also under investigation for “cartel practices.” On the day of these announcements, Psychemedics’ stock fell 25%. Plaintiffs alleged Defendants knew, or must have known, its Brazilian distributor was “cheating—not competing—in order to expand Psychemedics’ collection network and win new business in Brazil.” Plaintiffs alleged Defendants’ conduct resulting in Foreign Corrupt Practices Act (“FCPA”) violations led to material misstatements in its SEC filings in violation of Sections 10(b) and 20(a).

Under Section 10(b) and Rule 10b-5, a court may find a material misrepresentation or omission actionable in a financial statement when a company has failed to disclose an uncharged, unadjudicated wrongdoing where the failure would make other disclosures materially misleading. A court may find scienter when a plaintiff alleges facts sufficient to create a strong inference the statements would have been approved by corporate officials sufficiently knowledgeable about the company to know the statements were misleading. Further, in the First Circuit, scienter may be found when a defendant “acted with a high degree of recklessness.” Finally, under Section 20(a) control persons can be found liable for the fraud of the entities they control.

The court found Plaintiffs’ allegations would not support the inference Defendants knew of its distributor’s anti-competitive scheme or acted recklessly. Further, the court found that, absent an alter-ego relationship, actions of the distributor and its corporate officers do not support an inference of scienter to the Defendants. Finally, the court held the mere fact Defendants gained some compensation from the success of the expansion into Brazil did not support an inference of scienter.

Accordingly, the court granted Defendants’ motion to dismiss.

The primary materials for this case may be found on DU Corporate Governance website.