Judge: Regulatory Inspection Report Can Form Basis of Class Action Lawsuit

In the long list of things that are inadvisable to regulatory professionals, making misleading statements to the authority in charge of regulating your business likely ranks near the top. Those found to have misled the US Food and Drug Administration (FDA) have in the past been publicly warned, fined, imprisoned, shut down and barred from participating in federal programs. Now KV Pharmaceuticals is facing the prospect of an additional action: a class-action shareholder lawsuit as the result of an FDA inspection report.

On Monday, 4 June a federal appeals court ruled a securities fraud class action lawsuit could proceed against pharmaceutical manufacturer KV Pharmaceuticals for purportedly causing $1.5 billion in shareholder losses after first misleading FDA about manufacturing problems at a facility and later shutting down the facility's manufacturing operations.

KV Pharmaceuticals has been beset with issues since 2008, when it fired its then-CEO, Marc Hermelin, after he was accused of violating the Federal Food, Drug and Cosmetic Act for shipping oversized tablets containing an excess of the approved active ingredient. Hermelin pleaded guilty to the accusations in 2011 and was sentenced to 30 days in prison and ordered to pay a $1,000,000 fine and forfeit $900,000.

The company's manufacturing subsidiary Ethex Corp., which was responsible for manufacturing the oversized tablets, had earlier pleaded guilty to two felonies related to failing to notify FDA about manufacturing problems at the facility in a timely manner. KV Pharmaceuticals then dissolved Ethex after the federal government threatened to exclude the entire company from participating in federal healthcare programs including Medicare and Medicaid.

Reuters explains the investors contend a Form FDA 483, the inspection report riled by FDA, "contradicted statements KV made to investors" by showing the company was not in compliance with FDA regulations.

While the case was initially dismissed because of judicial precedence saying form 483s are not final determinations made by FDA, but are instead preliminary and contestable findings, a three-judge panel reversed that decision on 4 June.

"There is a substantial likelihood the presence of these factors would be viewed by a reasonable investor as significantly altering the total mix of information made available, irrespective of whether the Form 483 represents the FDA's final say on compliance issues," Judge Kermit Bye wrote in his decision.

Reuters also notes this decision is a marked reversal from existing precedence, which has found Form 483 reports to be immaterial to federal securities law.

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