You might have noticed that the current Bausch & Lomb product recall is on my list of things to blog about. Let us start in on it:
As you likely know, Bausch & Lomb announced a worldwide recall yesterday of its MoistureLoc product. This recall comes about a month after B&L disclosed concerns about and discussions with the FDA regarding a rare eye infection (Fusarium keratitis) that had cropped up among some number of MoistureLoc users (and users of other products, made by other companies, it is worth noting). At that point, in April, B&L suspended sales in the US of its MoistureLoc product.
The CEO of B&L told us yesterday that investigations have shown that there had been no contamination or tampering with the MoistureLoc product, which leads B&L to deduce that â€œsome aspect of the MoistureLoc formula may be increasing the relative risk of Fusarium infection in unusual circumstances.” To be safe, B&L is recalling the product, while B&L continues to investigate the link between the infection and MoistureLoc.
Three things are interesting to me:
1. The wires tell us that the FDA just released a report chastising B&L for not reporting in a timely fashion 35 cases of eye infections reported by its MoistureLoc users in Singapore and for not notifying the FDA immediately when B&L withdrew its product from the Singapore market in February (well before B&L pulled the product in the US). (I could not get my hands on the FDA report, hence my introduction â€œthe wires tell us.â€?)
2. The MoistureLoc solution has apparently been used since late 2004. In December of 2005, a class-action suit was filed against B&L by a woman who claimed that she suffered an eye infection as a result of using B&Lâ€™s solution, and the infection ultimately required her to get a corneal transplant.
3. The RiteAid and Target directors have not yet responded to a fax (or e-mail) I sent to them last month, asking whether I should stop using their generic eye care products (in the event that their products were made by B&L and/or Alcon).
Allow me to expand on these three things: Points two and three above are interesting to me because they would make good facts for an exam question. Specifically, I view B&Lâ€™s disclosure failures and the fact that B&L was on notice of potential problems months ago as raising fun securities fraud and director liability (for good faith failures) issues.
On the issue of securities fraud, B&L appears to have been holding off on filing 10Qs and 10Ks for months. Initially, the reason given was unrelated to the MoistureLoc eye infection issues. My question is â€œat what point did B&L know enough about the eye infection potential that it became material disclosure that *had* to be made, such that the failure to make the disclosure while making *other* disclosure constituted securities fraud?â€?
Remember the balancing test from Basic v. Levinson â€“ essentially balance the contingency against the impact it would likely have if it came to pass? It seems to me that (a) getting sued by a bunch of folks who have serious eye problems (including blindness- God forbid), (b) having to pull a relatively significant product, and (c) losing consumer confidence in other unrelated products are all things that I would peg as â€œmaterial enoughâ€? (for lack of a better phrase) under Basic to merit disclosure sooner rather than later. I understand that making disclosure sooner rather than later raises the risk of alienating investors if it later turns out that the fungal infection issue is a non-starter. But we are talking about eyes here, people; not toenail fungus infections.
On the director liability front, I would love to know how much the B&L directors knew about the potential MoistureLoc concerns and when they knew it. I see this as a policy sort of exam question â€“ â€œif you are called by your friend Sue, a director for Generic Eye Care Inc., and she tells you that the COO of Generic mentioned something while on the links with her about a class action suit related to eye infections but the COO said this sort of litigation was de rigeur in the medical products world, and Sue asks you if she needs to raise a red flag with her fellow directors, what do you tell her? Remember that the modern board is a â€˜monitoring board,â€™ at best.â€?
With respect to point three above, I faxed (or e-mailed) letters to the Boards of Directors of both Target and Rite-Aid back in April when I heard about B&Lâ€™s product recall, asking whether either of their private label eye solutions (which I use) were actually B&L products about which I should be concerned. I also asked in the letter what I should do, in terms of using the products and/or getting my eyes examined.
In a *shocking* turn of events, I have not yet heard back from even a single director.
My search for a more accurate shorthand was for use in my securities regualtion class which was presumably filled with newbies. Regardless, as a former transactional attorney and contract drafting aficionado, I crave precision. I did nonetheless use the “material omission” shorthand in a recent article I wrote but dropped a footnote explaining it was not technically correct. Also, I may disagree with myself on the 10-K point, but I would need to give it more thought.
Thanks for the response.
This article fills in a little more info that probably outlines B&L’s defense:
There’s also another press release on 3-31 that outlines the background (not sure how this didn’t end up in an 8-K):
Interestingly, these two items indicate that B&L notified the FDA as early as December 2005 and the CDC at least sometime before March 31, 2006. This makes the “wires tell us” part of the facts above pretty suspect since the FDA apparently was told of the problem before the Singapore recall.
Given the background info, this is probably the hardest type of disclosure issue a company has to deal with. They appear to have had no evidence of a product defect. The problem arose in a small isolated market — if it’s a product problem and not a manufacturing problem you’d think it would show up in the US or EU, where the usage volume is much higher. Probably handled poorly, but to say it is securities FRAUD is a pretty tough call.
BTW, the general public has no idea how much companies struggle with these type of disclosure issues all the time.
Bill, thanks for the comment. It appears that I was replying to JLBurns as you were typing – your concern hits some of what JLBurns was likely thinking.
My above post should have hopefully clarified my view on the “obligation to speak” point. B&L most assuredly was not keeping quiet over the past several months, such that saying nothing about the potential MoistureLoc problem (once the materiality determination was made) seems from my perspective not to have been an option.
BTW, as to your linked post wherein you discuss “material omission” shorthand, I would like to hope that most of the folks having the conversation (in the world, not on this blog or on your earlier thread!) know that “material omission” really means “material omission when under the obligation to speak” such that worries about shorthand only pertain to discussion involving Section 10(b) newbies. I suppose those last six words – “when under the obligation to speak” – merit more discussion (I think I might disagree with you on the 10-K point in most (all?) cases), but it is past midnight, and I am not sure I have more blogging in me for the evening. I have to start slowly, you see – I do not yet have the stamina and fortitude of a seasoned blogger. I have to pace myself….
JLBurns, thanks for the comment. I should have spelled out more clearly for readers the dates pertaining to what B&L was saying when.
As I understand Rule 10b-5, Section 10(b), and the related jurisprudence, if an issuer is going to speak, he needs to speak FULLY about the available material information or he needs to remain silent. Speaking up and only mentioning the material good things is not an option in most instances, as I read it. Therefore, my concern is not the insider trading concern – my concern is not about what insiders were selling when. My concern is about the investors who were buying, selling, and holding B&L stock based on what might well have been half-truths in the months leading up to B&Lâ€™s disclosure in April of the potential MoistureLoc problems.
Letâ€™s look at what B&L was saying on what dates (my dates are likely off by a day or two â€“ I pulled dates from EDGAR, so I likely have the dates that B&Lâ€™s forms hit EDGAR, as opposed to when they were filed or when the press releases were issued):
7-28-2005: B&L filed their 10-Q. Nothing was said about any MoistureLoc problems or potential problems. Indeed, in the discussion of reserves for product warranties and in the discussion of litigation, not a peep was uttered about MoistureLoc. But in the MD&A, we see â€œLens care sales for the first six months in the Americas increased six percent in constant currency and reflected continued market acceptance and share gains for ReNu with MoistureLoc multi-purpose solution. For the quarter, overall lens care sales growth was led by the Company’s lines of all-in-one solutions for both soft and rigid gas permeable contact lenses. Year-to-date overall lens care gains were attributed to the Company’s lines of all-in-one solutions, which reflected share gains subsequent to the late 2004 launch of ReNu with MoistureLoc and incremental sales associated with the launch of ReNu MultiPlus in Japan.â€?
10-26-2005: B&L issues press release and files 8-K noting that the quarterly report will likely be late, in part due to accounting problems. B&L provides draft numbers, for the 9 months through Sept. 24, 2006, and notes that â€œLens care sales growth reflected the continued successful global rollout of ReNuÂ® with MoistureLocâ„¢ multi-purpose solution, the introduction of ReNu MultiPlusÂ® solution in Japan, and gains for the BostonÂ® lines of rigid gas permeable solutions.â€? No mention is made of any looming MoistureLoc problems.
11-3-2005: Notification of inability to timely file Form 10-Q is filed. No mention of the MoistureLoc issue.
11-30-2005: 8-K is filed mentioning, among other things, the 10Q delay. No mention of potential MoistureLoc problems.
12-23-2006: 8-K discussing need to restate financials is filed. New financial estimates for past several years are proffered. No mention is made of MoistureLoc, though other specific problems underpinning the restatement are discussed.
3-1-2006: 8-K is filed. No mention of looming MoistureLoc problems.
3-3-2006: Another 8-K is filed. Ditto the lack of MoistureLoc mention.
3-17-2006: Notification is filed that B&L will be filing their 10-K late. No mention of the eye fungus issue is mentioned, though *other* reasons for the delay are discussed at length.
4-12-2006: FINALLY: An 8-K announcing the initial US recall of MoistureLoc is filed. But nothing is said (that I could find) about the recall months earlier in Singapore. It seems to me that if you are talking about one recall of a product, youâ€™d better mention the earlier recall of the same product if you are not wanting to make a material omission.
As to what B&L did know on what dates, I am highly skeptical that B&L did not have any material information about a MoistureLoc potential problem to put out sooner. Actually, given the Singapore situation, I do not think that my skepticism is unwarranted. While I cannot find any information on the FDAâ€™s website, the wires reported earlier today (and businessweek has a link: http://www.businessweek.com/ap/financialnews/D8HL5NEG1.htm?campaign_id=apn_home_up&chan=db ) that the FDA chastised B&L for (1) not telling the FDA about the fungal infection outbreak in Singapore which seems to have dated back to LAST June and (2) not reporting to the FDA sooner the withdraw of MoistureLoc products from the market in Singapore. So, as I read it, given how rare the infection is and the fact that the FDA is up in arms about B&L failing to go to the FDA sooner, it seems that B&L knew (or clearly should have known) that they potentially could have a big, big problem much sooner than April 2006. If I were an investor who bought B&L stock in December, I would be miffed. I have to believe that by December (likely/maybe/probably earlier), B&L (who reportedly pulled MoistureLoc in Singapore in February) knew they had a potentially huge problem on their hands, such that they needed to disclose this material information.
Just thinking aloud, I suppose B&L might try to argue that, even if they knew there might be a MoistureLoc problem, MoistureLocâ€™s impact on the balance sheet was small enough (in terms of revenue/profit) that the potential problem was not material. My response to that, however, would be that B&Lâ€™s materiality assessment is too narrow in scope. Going back to the Basic v. Levinson balancing test, look at the likelihood of the contingency coming to pass and balance it against the impact the contingency coming to pass would have. If the â€œcontingencyâ€? is the likelihood that MoistureLoc has some liability-creating linkage to this potentially blinding fungus (again, we are dealing with EYE fungus, not toe fungus), and if the contingency is that the linkage will lead to lawsuits of maybe even the Vioxx magnitude, and if the contingency is that the linkage will destroy some consumersâ€™ faith in B&L products such that the whole raft of B&L products will be impacted (from a sales standpoint), then the likelihood of the contingency coming to pass needs to really only be minimal in my mind to be far outweighed by the devastating impact the contingency coming to pass would have on B&L as a corporate entity.
Here ends my very informal Basic v. Levinson analysis.
Basic v. Levinson provides the rule for determining when contingent information is material but does not address in much depth when material information needs to be disclosed. As discussed in this post, just because information is material does not mean it has to be disclosed. Basic was viewed to have a duty to disclose the merger negotiations, if material, because its statements to the market that no merger negotiations were taking place created the duty. As indicated in a footnote in the opinion, presumably had Basic said nothing to the market regarding the negotiations, the issue of materiality would never have been reached because there would have been no duty to disclose the negotiations even if material. So I think Benzi is correct that there needs to be an analysis separate from the materiality issue of whether B&L had a duty to disclose earlier than it did.
Benzi, thanks for the comment.
With respect to your confusion about why I pulled in Basic, “the balancing test” when dealing with a contingency/uncertainty comes from Basic not TSC (or Mills, if we are being sticky). No? So when you say in your comment “when it had to be disclosed requires a distinct analysis, one not addressed in Basic,” do you really mean that? Basic is, to me, *the* timing case that is most helpful in a situation like the one B&L is in, where they *knew* about some eye infection cases well before they made disclosure, but likely B&L is going to argue that they did not make disclosure sooner b/c the eye infection link was initially . . . tenuous. . . a contingency. . . uncertain. . . . It was decidedly unclear when the first few cases of eye infections were reported whether the problem was really a MoistureLoc problem.
I’m thinking of pages 232-241-ish of the Basic opinion, where the Court refers to the Texas Gulf case, and the Court discusses the difficulty in determining when, exactly, a contingency becomes material such that the issuer needs to speak fully or be silent.
The point I was trying to make regarding B&L is not whether the information (that the MoistureLoc product appears to have some direct tie to a serious fungus infection such that the product needs to be recalled) ultimately *was* material. Rather, my point was that I am not convinced that B&L made disclosure in a timely fashion, WHEN the information first became material. Phrased differently, it seems to me that B&L likely knew they had a “material” problem that became material a lot sooner than April 2006 under Basic v. Levinson.
Just to beat the dead horse to be sure I am making my point clear: I do not think B&L needed to make disclosure and pull its MoistureLoc product the instant one of its lab folks (or PR folks or whoever) received a phone call saying a MoistureLoc user (or maybe even two users) in Singapore had this rare, odd fungal infection. That could have just been a fluke – even though the fungus is *rare,* I have to imagine that sometimes a person just gets the fungus for reasons unrelated to a product failure or defect. So if B&L did *not* (in my opinion) have to make disclosure and pull their product the moment they learned that the fungus infection appeared in one person who used MoistureLoc, when DID B&L have to make disclosure? That, to me, is the Basic v. Levinson question.
Perhaps we agree now?
Maybe I’m missing something, but the limited facts presented don’t create any securities fraud issue. Isn’t the rule for materiality “disclose or abstain.” Unless you are asserting B&L directors were dumping stock, they had no duty to disclose anything independent of their period reports. The fact that they delayed filing their periodic reports actually helps their case since it eliminates the material omission issue.
Not sure I follow your application of the Basic materiality test (which is the TSC v. Northway test anyway) to the issue of duty to disclose. There does not seem to be much doubt that the evolving issue with this product line became material. Whether and when it had to be disclosed requires a distinct analysis, one not addressed in Basic.