Private equity shops escape Zimmer Biomet class action

A federal judge in Indiana last week dismissed a clutch of private equity shops from a securities class action brought against ZBH, alleging that the company and its management concealed problems at a plant in its Warsaw, Ind., home base.

The lawsuit, filed in December 2016 in the U.S. District Court for Northern Indiana, concerns Zimmer Biomet’s revelation in the fall of that year that prompted it to take its North Campus plant in Warsaw off line and cut its full-year guidance. But the full extent of the facility’s problems were kept under wraps until an analyst’s note forced the company to come clean, the lawsuit alleged. The resulting foofaraw pared some 20% from ZBH share prices in a single week, according to court documents.

FDA inspectors documented numerous violations in a Form 483 in autumn 2016. In its reply in December of that year, Zimmer Biomet told the FDA that it cleaned house after the inspection, replacing five operations and quality executives as it sought to bring the facility back into compliance and noting that company-wide audits put in place after the $14 billion merger of Zimmer and Biomet had already turned up problems at the site. (A re-inspection last April resulted in another Form 483 warning and by August Zimmer Biomet revealed that the FDA sent a formal warning letter.)

The lawsuit’s plaintiffs, led by Rajesh Shah, alleged that the company’s management concealed the issues at the North Campus plant during a conference call discussing its third-quarter 2016 results.

“While analysts may have been shocked by this development, Shah alleges that defendants were anything but taken aback. According to Shah, the company’s challenging situation would have come as no surprise at all had ZBH not misled investors as to the cause of the issues and made materially misleading statements in the process. Shah alleges that all of the causes of the lower-than-anticipated third-quarter growth, downward projection in fourth-quarter growth and attendant supply shortages were the result of substantial issues at North Campus which ZBH and its co-defendants are alleged to have known about and appreciated for months,” according to the documents.

The lawsuit also accused the PE firms, including funds affiliated with Kohlberg Kravis Roberts, TPG Global and Goldman Sachs Capital Partners, of ditching their collective 10% stake in Zimmer Biomet in June and August 2016 based on their alleged inside knowledge of the North Campus situation. Those stock sales reaped proceeds of roughly $2.25 billion, according to the documents.

But Judge Philip Simon ruled that, although two of the PE shops (KKR and TPG) had directors on the Zimmer Biomet board, there is no evidence that they were privy to any inside information.

“[T]here is no allegation that any information relating to problems at North Campus was in fact shared with the private equity defendants, whether in this instance or any others. In essence, Shah has alleged nothing more than that the private equity defendants had potential access to insider information,” Simon wrote [emphasis his]. “Plaintiffs’ allegations as to the Goldman funds are even more deficient on this front, as there is no allegation that any of the Goldman funds were affiliated with any of ZBH’s board of directors. Nor is there any allegation that any representative of any of the Goldman funds otherwise participated in the management of ZBH or attended meetings of ZBH’s board of directors.”

Simon dismissed the two  insider trading counts without prejudice, giving Shah a chance to file an amended complaint should more evidence of prior knowledge turn up during discovery, and dismissed with prejudice another two counts alleging securities violations by the PE players on the grounds that the stock sales were made via underwriters.

The judge allowed the case to proceed against the company and its management.

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