Lena Gallagher, on behalf of a class v. Abbott Laboratories and Miles D. White

In the
United States Court of Appeals
For the Seventh Circuit
Nos. 01-1473 & 01-1477
Lena Gallagher, on behalf of a class, et al.,
Plaintiffs-Appellants,
v.
Abbott Laboratories and Miles D. White,
Defendants-Appellees.
Appeals from the United States District Court for the
Northern District of Illinois, Eastern Division.
Nos. 99 C 6869 and 00 C 765--James B. Moran, Judge.
Argued September 28, 2001--Decided October 17, 2001
Before Posner, Easterbrook, and Kanne,
Circuit Judges.
Easterbrook, Circuit Judge. Year after
year the Food and Drug Administration
inspected the Diagnostic Division of
Abbott Laboratories, found deficiencies
in manufacturing quality control, and
issued warnings. The Division made
efforts to do better, never to the fda’s
satisfaction, but until 1999 the fda was
willing to accept Abbott’s promises and
remedial steps. On March 17, 1999, the fda
sent Abbott another letter demanding
compliance with all regulatory
requirements and threatening severe
consequences. This could have been read
as more saber rattling--Bloomberg News
revealed the letter to the financial
world in June, and Abbott’s stock price
did not even quiver--but later
developments show that it was more
ominous. By September 1999 the fda was
insisting on substantial penalties plus
changes in Abbott’s methods of doing
business. On September 29, 1999, after
the markets had closed, Abbott issued a
press release describing the fda’s
position, asserting that Abbott was in
"substantial" compliance with federal
regulations, and revealing that the
parties were engaged in settlement talks.
Abbott’s stock fell more than 6%, from
$40 to $37.50, the next business day. On
November 2, 1999, Abbott and the fda

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resolved their differences, and a court
entered a consent decree requiring Abbott
to remove 125 diagnostic products from
the market until it had improved its
quality control and to pay a $100 million
civil fine. Abbott took an accounting
charge of $168 million to cover the fine
and worthless inventory. The next
business day Abbott’s stock slumped
$3.50, which together with the earlier
drop implied that shareholders saw the
episode as costing Abbott (in cash plus
future compliance costs and lost sales)
more than $5 billion. (Neither side has
used the capital asset pricing model or
any other means to factor market
movements out of these price changes, so
we take them at face value.)
Plaintiffs in these class actions under
sec.10(b) of the Securities Exchange Act
of 1934, 15 U.S.C. sec.78j(b), and the
sec’s Rule 10b-5, 17 C.F.R. sec.240.10b-5,
contend that Abbott committed fraud by
deferring public revelation. The classes
comprise all buyers of Abbott’s
securities between March 17 and November
2. (One class consists of persons who
bought securities in alza, a firm that
Abbott proposed to acquire through an
exchange of securities and whose market
price thus tracked Abbott’s. For
simplicity we treat these plaintiffs as
purchasers of Abbott stock.) The district
judge dismissed the complaints under Fed.
R. Civ. P. 12(b)(6) for failure to state
a claim on which relief may be granted.
140 F. Supp. 2d 894 (N.D. Ill. 2001). The
market’s non-reaction to Bloomberg’s
disclosure shows, the judge thought, that
the fda’s letter was not by itself
material or that the market price had
earlier reflected the news, cf. In re
Apple Computer Securities Litigation, 886
F.2d 1109 (9th Cir. 1989); Flamm v.
Eberstadt, 814 F.2d 1169, 1179-80 (7th
Cir. 1987); only later developments
contained material information, which
Abbott disclosed in September and
November. Moreover, the judge concluded,
plaintiffs had not identified any false
or fraudulent statement by Abbott, as
opposed to silence in the face of bad
news. We are skeptical that these
shortcomings justify dismissal for
failure to state a claim on which relief
may be granted; the judge’s reasons seem
more akin to an invocation of Fed. R.
Civ. P. 9(b), which requires fraud to be
pleaded with particularity, or the extra

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pleading requirements for securities
cases created by the Private Securities
Litigation Reform Act of 1995, 15 U.S.C.
sec.78u-4(b)(1). But it is not necessary
to decide whether Rule 12(b)(6), Rule
12(c), Rule 9(b), or the Reform Act
supplies the best basis of decision. Nor
is it necessary to decide whether the
news was "material" before the fda’s
negotiating position stiffened, to decide
whether Abbott acted with the state of
mind necessary to support liability under
Rule 10b-5, or to address other potential
stumbling blocks. What sinks plaintiffs’
position is their inability to identify
any false statement--or for that matter
any truthful statement made misleading by
the omission of news about the fda’s
demands.
Much of plaintiffs’ argument reads as if
firms have an absolute duty to disclose
all information material to stock prices
as soon as news comes into their
possession. Yet that is not the way the
securities laws work. We do not have a
system of continuous disclosure. Instead
firms are entitled to keep silent (about
good news as well as bad news) unless
positive law creates a duty to disclose.
See, e.g., Basic, Inc. v. Levinson, 485
U.S. 224, 239 n.17 (1988); Dirks v. sec,
463 U.S. 646, 653-54 (1983); Chiarella v.
United States, 445 U.S. 222, 227-35
(1980); Stransky v. Cummins Engine Co.,
51 F.3d 1329, 1331 (7th Cir. 1995);
Backman v. Polaroid Corp., 910 F.2d 10,
16 (1st Cir. 1990) (en banc). Until the
Securities Act of 1933 there was no
federal regulation of corporate
disclosure. The 1933 Act requires firms
to reveal information only when they
issue securities, and the duty is owed
only to persons who buy from the issuer
or an underwriter distributing on its
behalf; every other transaction is exempt
under sec.4, 15 U.S.C. sec.77d. (No
member of either class contends that he
purchased securities from Abbott, or an
underwriter on Abbott’s behalf, between
March 17 and November 2.) Section 13 of
the Securities Exchange Act of 1934, 15
U.S.C. sec.78m, adds that the sec may
require issuers to file annual and other
periodic reports--with the emphasis on
periodic rather than continuous. Section
13 and the implementing regulations
contemplate that these reports will be
snapshots of the corporation’s status on
or near the filing date, with updates due

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not when something "material" happens,
but on the next prescribed filing date.
Regulations implementing sec.13 require
a comprehensive annual filing, the Form
10-K report, and less extensive quarterly
supplements on Form 10-Q. The supplements
need not bring up to date everything
contained in the annual 10-K report;
counsel for the plaintiff classes
conceded at oral argument that nothing in
Regulation S-K (the sec’s list of required
disclosures) requires either an updating
of Form 10-K reports more often than
annually, or a disclosure in a quarterly
Form 10-Q report of information about the
firm’s regulatory problems. The
regulations that provide for disclosures
on Form 10-Q tell us which items in the
annual report must be updated (a subset
of the full list), and how often
(quarterly).
Many proposals have been made to do
things differently--to junk this
combination of sale-based disclosure with
periodic follow-up and replace it with a
system under which issuers rather than
securities are registered and disclosure
must be continuous. E.g., American Law
Institute, Federal Securities Code xxvii-
xxviii, sec.602 & commentary (1978);
Securities and Exchange Commission,
Report of the Advisory Committee on the
Capital Formation and Regulatory Process
9-14, 36-38 (1996). Regulation S-K goes
some distance in this direction by
defining identical items of disclosure
for registration of stock and issuers’
subsequent reports, and by authorizing
the largest issuers to use their annual
10-K reports as the kernels of
registration statements for new
securities. But Regulation S-K does not
replace periodic with continuous
disclosure, and the more ambitious
proposals to do this have not been
adopted.
The ali’s proposal, for example, was
embraced by the sec, see 1933 Act Release
No. 6242 (Sept. 18, 1980); 1933 Act
Release No. 6242 (Jan. 31, 1982), but
never seriously pursued, and revisions of
Regulation S-K satisfied many of the
original supporters of the ali’s proposal.
The advisory committee report, prepared
by a distinguished group of scholars and
practitioners under the leadership of
Commissioner Steven M.H. Wallman, did not

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persuade the sec’s other members and was
not taken up by the agency as a
legislative plan or even as the basis of
a demonstration project. Whatever may be
said for and against these proposals,
they must be understood as projects for
legislation (and to a limited extent for
the use of the sec’s rulemaking powers);
judges have no authority to scoop the
political branches and adopt continuous
disclosure under the banner of Rule 10b-
5. Especially not under that banner, for
Rule 10b-5 condemns only fraud, and a
corporation does not commit fraud by
standing on its rights under a periodic-
disclosure system. The Supreme Court has
insisted that this judicially created
right of action be used only to
implement, and not to alter, the rules
found in the text of the 1933 and 1934
Acts. See Central Bank of Denver, N.A. v.
First Interstate Bank of Denver, N.A.,
511 U.S. 164, 173 (1994) ("We have
refused to allow [private] 10b-5
challenges to conduct not prohibited by
the text of the statute."); United States
v. O’Hagan, 521 U.S. 642, 651 (1997).
Trying to locate some statement that was
either false or materially misleading
because it did not mention the fda’s
position, plaintiffs pointed in the
district court to several reports filed
or statements made by Abbott before
November 2, 1999. All but two of these
have fallen by the wayside on appeal.
What remain are Abbott’s Form 10-K annual
report for 1998 filed in March 1999 and
an oral statement that Miles White,
Abbott’s ceo, made at the annual
shareholders’ meeting the next month.
Plaintiffs rely principally on Item
303(a)(3)(ii) of Regulation S-K, which
provides that registration statements and
annual 10-K reports must reveal
any known trends or uncertainties that
have had or that the registrant
reasonably expects will have a material
favorable or unfavorable impact on net
sales or revenues or income from
continuing operations.
The fda’s letter, and its negotiating
demands, are within this description,
according to the plaintiff classes. We
shall assume that this is so. The 10-K
report did state that Abbott is "subject
to comprehensive government regulation"

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and that "[g]overnment regulatory actions
can result in . . . sanctions."
Plaintiffs say that this is too general
in light of the fda’s letter and Abbott’s
continuing inability to satisfy the fda’s
demands. Again we shall assume that
plaintiffs are right. But there is a
fundamental problem: The 10-K report was
filed on March 9, 1999, and the fda’s
letter is dated March 17, eight days
later. Unless Abbott had a time machine,
it could not have described on March 9 a
letter that had yet to be written.
Attempting to surmount this temporal
problem, plaintiffs insist that Abbott
had a "duty to correct" the 10-K report.
Yet a statement may be "corrected" only
if it was incorrect when made, and
nothing said as of March 9 was incorrect.
In order to maintain the difference
between periodic-disclosure and
continuous-disclosure systems, it is
essential to draw a sharp line between
duties to correct and duties to update.
We drew just this line in Stransky and
adhere to it now. If, for example, the
10-K report had said that Abbott’s net
income for 1998 was $500 million, and the
actual income was $400 million, Abbott
would have had to fix the error. But if
the 10-K report had projected a net
income of $125 million for the first
quarter of 1999, and accountants
determined in May that the actual profit
was only $100 million, there would have
been nothing to correct; a projection is
not rendered false when the world turns
out otherwise. See Wielgos v.
Commonwealth Edison Co., 892 F.2d 509
(7th Cir. 1989). Amending the 10-K report
to show the results for 1999 as they came
in--or to supply a running narrative of
the dispute between Abbott and the fda--
would update the report, not correct it
to show Abbott’s actual condition as of
March 9.
Updating documents has its place in
securities law. A registration statement
and prospectus for a new issue of
securities must be accurate when it is
used to sell stock, and not just when it
is filed. Section 12(a)(2) of the ’33
Act, 15 U.S.C. sec.77l(a)(2); Regulation
S-K, Item 512(a). Material changes in a
company’s position thus must be reflected
in a registration statement promptly. But
this does not imply changes in a 10-K
annual report, even when that report is

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used (as it can be with securities
registered on Form S-3, or for a shelf
offering under Rule 415) as the principal
disclosure document. Instead of changing
the 10-K report weekly or monthly, the
issuer must file and distribute an
addendum to that document bringing
matters up to date. See Form S-3, Item
11. Anyway, as we’ve already mentioned,
Abbott did not sell any stock to the
class members during the period from
March 17 to November 2, 1999.
As for White’s statements at the annual
meeting: he said very little that was
concrete (as opposed to puffery), and
everything concrete was true. White said,
for example:
The outcome [of our efforts] has been
growth more than five times faster than
the diagnostics market. We expect this
trend to continue for the foreseeable
future, due to the unprecedented state of
our new product cycle. By supplementing
our internal investment with
opportunistic technology acquisitions,
Abbott’s diagnostics pipeline is fuller
than ever before.
The statement about past performance was
accurate, and the plaintiffs have not
given us any reason to doubt that White
honestly believed that similar growth
would continue, or that White honestly
believed "Abbott’s diagnostics pipeline
[to be] fuller than ever before." Even
with the benefit of hindsight these
statements cannot be gainsaid. Here is
where Rule 9(b) pinches: Plaintiffs have
done nothing to meet the requirements for
pleading fraud with respect to the annual
meeting, even if it were possible (which
we doubt) to treat as "fraud" the
predictive components in White’s
boosterism. See DiLeo v. Ernst & Young,
901 F.2d 624 (7th Cir. 1990).
Affirmed

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