In re Baxter Int'l Inc. Sec. Litig.

IN RE BAXTER INTERNATIONAL INC. SECURITIES LITIGATION

No. 19 C 7786

UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION

January 12, 2021

Judge Sara L. Ellis

OPINION AND ORDER

An individual shareholder brought this putative securities class action lawsuit on behalf of himself and all others who purchased or acquired common stock in Baxter International Inc. ("Baxter") from February 21, 2019 through October 23, 2019 (the "Class Period"), alleging that Baxter and certain of its officers engaged in federal securities fraud. After the Court appointed putative class members Varma Mutual Pension Insurance Company ("Varma") and Louisiana Municipal Police Employees' Retirement System ("LAMPERS") as Lead Plaintiffs, they filed an amended complaint, in which they allege that Defendants Baxter, José Almeida, and James Saccaro violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"), codified at 15 U.S.C. §§ 78j(b) and 78t(a), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5.¹

Defendants move to dismiss the amended complaint [39]. They also move to have the Court consider exhibits they attach to their motion to dismiss based on the incorporation-by-reference doctrine or judicial notice [42]. Lead Plaintiffs do not oppose Defendants' request for consideration of their exhibits, and the Court may take judicial notice of or otherwise consider these exhibits in deciding Defendants' motion to dismiss, so the Court grants Defendants' motion to consider their exhibits [42]. And because Lead Plaintiffs have failed to allege facts that giverise to a strong inference of scienter on the part of any Defendant, the Court grants Defendants' motion to dismiss [39]. The Court's dismissal, however, is without prejudice.

BACKGROUND²

I. The Parties

The Court appointed Varma and LAMPERS as Lead Plaintiffs in this litigation on January 29, 2020. Varma is based in Finland and "manages the pension savings for approximately 900,000 Finns." Doc. 34 ¶ 22.³ "LAMPERS is a statewide retirement system that provides retirement, disability, and survivor benefits to full-time police officers in Louisiana and their families." Id. ¶ 21. During the Class Period, Varma and LAMPERS last purchased Baxter stock on September 17, 2019 and October 23, 2019, respectively.

Baxter is a Delaware corporation that maintains its principal executive offices in Deerfield, Illinois. It develops, manufactures, and sells a variety of renal and hospital products. Although Baxter is a U.S.-based company, it has substantial global operations and derives significant revenues from outside the United States. Baxter manufactures products in more than twenty countries and has operations in Europe, the Middle East, Africa, Asia, Latin America, and Canada. Baxter also sells its products in more than 100 countries. From 2017 through 2019, Baxter generated more than $33 billion in total sales, with just shy of $19 billion of those sales (57.5 percent) coming from outside the United States. Baxter's common stock trades on the New York Stock Exchange.

Almeida joined Baxter as an executive officer in October 2015 and has served as Baxter's Chairman, President, and Chief Executive Officer ("CEO") since January 2016. Saccaro served as Baxter's Corporate Vice President and Chief Financial Officer ("CFO") during the Class Period and as Baxter's Corporate Vice President and Treasurer from 2011 to 2013.

II. Baxter's Accounting for Foreign Transactions

Because Baxter generates most of its revenues outside the United States, a large portion of its assets and liabilities are initially denominated in foreign currencies. But Baxter reports its financial figures in U.S. dollars. Therefore, Baxter must periodically convert the value of a sale, purchase, or other financial transaction carried out using foreign currency to U.S. currency by using foreign currency exchange ("FX") rates.

Foreign currency conversion is "a critical and routine function for [Baxter], to both fund its operations and to manage currency risk." Doc. 34 ¶ 5. Baxter's central corporate management "was responsible for accounting for and reporting financial results concerning Baxter's transactions in foreign currencies." Id. ¶ 31. In particular, Baxter's senior financialexecutives, including Saccaro and Baxter's Treasurer during the Class Period, Scott Bohaboy, oversaw Baxter's various foreign currency conversion functions. Moreover, Saccaro was personally responsible for Baxter's foreign currency conversion and accounting practices when he served as Baxter's Treasurer from 2011 through 2013.

FX rates fluctuate, and the FX rate on the day a foreign transaction takes place might differ significantly from the FX rate on the day a company reports the foreign transaction. Generally Accepted Accounting Principles ("GAAP") provide a framework for addressing this issue. Under GAAP, a company should initially assess the value of the foreign transaction using the FX rate as of the date the transaction takes place and then reassess the value of the foreign transaction at the end of the reporting period (when the figures are recorded) using the FX rate at that time. Id. ¶ 43 (citing Accounting Standards Codifications ("ASC") 830-20-30, 830-20-35). The company should then report any gain or loss based on the difference between the initial value and the reassessed value as part of its net income. Id. (citing ASC 830-20-35).

Baxter's process for converting the value of foreign transactions into their reporting currencies (the "FX Convention") did not adhere to this framework. For its initial assessment, Baxter did not use the FX rate on the date a foreign transaction took place; it initially assessed the value of all foreign transactions in a particular month using an FX rate from a specified date near the middle of the previous month. Then, instead of reassessing the value of a foreign transaction at the end of the reporting period based on the FX rate at that time, Baxter reassessed the value of foreign transactions at the end of each month using FX rates from a specified date near the middle of the current month. In short, the FX Convention used non-current foreign exchange rates for both the initial assessment and the subsequent reassessment. The upshot was that individuals were able to undertake foreign transactions after the related exchange rates werealready known, and, as Baxter would discover and disclose, individuals used this ability to undertake transactions to improperly generate non-operating FX gains or avoid FX losses.⁴

Baxter reported any gains or losses based on the fluctuation in FX rates as non-operating income or expenses that comprised one component of the "Other (Income) Expense, net" line item of its financial statements. Id. ¶ 83; Doc. 41-3 at 62.⁵ The "Other (Income) Expense, net" line item, in turn, was one component that Baxter subtracted from its operating income to arrive at net income. See, e.g., Doc. 41-3 at 48. Thus, gains based on the change in FX rates for foreign transactions increased Baxter's net income, and losses decreased Baxter's net income. From 2014 through the first half of 2019, Baxter consistently reported net foreign exchange gains based on FX rate fluctuations: $8 million in 2014, $113 million in 2015, $28 million in 2016, $50 million in 2017, $73 million in 2018, and $22 million for the first half of 2019.

Leading up to the Class Period, Defendants touted Baxter's "foreign exchange gains as a driver of Baxter's future performance." Doc. 34 ¶ 57. For example, during an April 2016 earnings call with analysts, Saccaro represented that Baxter's first-quarter results for 2016, which compared favorably to its expectations, were driven by "a lower negative impact from foreign exchange," and on the same call, Almeida "specifically tied favorability from foreign exchange versus previous guidance to reported quarterly adjusted earnings of $0.36 per diluted share, exceeding [Baxter's] guidance range by between 20% and 32%." Id. ¶¶ 58-59. During an October 2017 earnings call with investors, Saccaro "stressed that [Baxter's] top line growthexceeded our expectations, driven in substantial part by a favorable foreign exchange benefit." Id. ¶ 62. And during an earnings call to discuss Baxter's fourth-quarter 2017 results, "Saccaro highlighted that adjusted earnings increased 12% to $0.64 per diluted share, which exceeded [Baxter's] previous guidance of $0.56 to $0.59 per share driven by . . . a modest benefit from foreign exchange gains on balance sheet positions." Id.

III. Defendants' Allegedly False and Misleading Statements

Lead Plaintiffs allege that from January 2019 through July 2019, Defendants made a series of false and misleading statements or omissions regarding Baxter's income and other key financial metrics related to FX rate fluctuations, its compliance with GAAP, and the adequacy and effectiveness of its internal controls over financial reporting.

A. Baxter's 2018 10-K and Related Statements

On January 31, 2019, Baxter issued an earnings press release in which it reported adjusted earnings-per-share ("EPS") of $3.05 for 2018.⁶ After the stock market closed on the first day of the Class Period, February 21, 2019, Baxter filed its 10-K annual report for 2018 (the "2018 10-K"), which Almeida and Saccaro signed. Baxter's 2018 10-K reported the following financial figures:

• For 2018, "$73 million of income related to foreign currency fluctuations"; for 2017, $50 million of income from foreign currency fluctuations; and for 2016, $28 million of income from foreign currency fluctuations;

• "Other (income) expense, net" was $139 million of income in 2018, $19 million of expense in 2017, and $4.275 billion of income in 2016;• "$14.2 billion and $14.483 billion retained earnings to begin the fiscal years of 2017 and 2018, respectively"; and

• GAAP EPS of $2.99 for 2018, $1.30 for 2017, and $9.01 for 2016.

Doc. 34 ¶¶ 132-34. Lead Plaintiffs further allege that Defe...