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Two Chicago attorneys and their clients, who brought a securities lawsuit against a Miami-based pharmaceutical company, have lost their fight to fend off what may be the largest sanction ever for filing a frivolous securities lawsuit. A panel of the 11th U.S. Circuit Court of Appeals affirmed U.S. District Judge Donald M. Middlebrooks’ dismissal of the Miami lawsuit against Kos Pharmaceuticals and the Rule 11 sanctions order that hits the two plaintiffs and their attorneys with a $520,000 fine. The appellate court asked Middlebrooks, who presides in Miami, to reconsider one portion of the award, which may result in a reduction of the fine. Nevertheless, according to Tracy Nichols, the Miami-based national chair of Holland & Knight’s securities litigation practice who represented Kos, there are no Rule 11 securities sanctions that even approach the half-million dollar penalty affirmed by the appellate court. When he issued the fine in January 2000, Middlebrooks criticized the plaintiffs’ attorneys for filing the lawsuit. He summed up his order in one sentence: “In short, based on the evidence uncovered by their investigation, plaintiffs should not have commenced this action.” In 1998, Chicago-based Oxford Asset Management and the profit-sharing plan of the White Plains, N.Y., law firm Lowey Dannenberg Bemporad & Selinger, sued Kos under the Securities Act of 1933 and the Exchange Act of 1934 for alleged material misrepresentations and omissions in a prospectus regarding the company’s cholesterol-reduction drug Niaspan. In addition, it alleged misrepresentations in the prospectus regarding Niaspan’s effectiveness, safety, dosage tolerability, and sales claims. The plaintiffs were represented by Arthur T. Susman and Charles R. Watkins, partners at Susman & Watkins in Chicago. The lawsuit claimed that Kos withheld from its prospectus important prescription volume data that it had compiled. The suit was originally filed in U.S. District Court in Chicago, but it later was later transferred to federal court in Miami. The plaintiffs based their suit on the fact that the prescription volume data was obtained in 1997 by a Salomon Brothers analyst. Salomon Brothers included the data in a report that projected that Kos’ revenue for 1998 would be half of what the drugmaker was touting to investors. The report caused Kos’ stock to plummet in one day from about $30 a share to $16. The plaintiffs contended in their lawsuit that Kos should have provided that information to investors. The 11th Circuit ruled, however, that plaintiffs in such lawsuits must not only show that a company omitted material facts in financial disclosures but that the company also had a duty to disclose those facts. The court said that while the Niaspan information may have been material, Kos was under no duty to disclose the volume information because withholding it did not make the results Kos reported in the prospectus less accurate. “The market’s disappointment in the changed revenue projection did not render Kos’ previously reported result unreliable,” the court wrote. “We conclude that the prospectus thoroughly explained the risks involved in marketing Nisapan, and specifically warned that Niaspan might have a slow start. “To require all material information to appear in the prospectus would,” the court went on, “result in registrants burying the shareholders in an avalanche of trivial information — a result that is hardly conducive to informed decision-making.” TOUGHER TO SUE Nichols, who represented Kos, predicts the July ruling will make it tougher for investors to sue companies on allegations of failing to disclose key financial information. Some attorneys previously have argued that plaintiffs only have to show that a material fact was omitted in financial disclosures to make a valid claim. “This decision should give companies some comfort,” says Nichols, who worked on the case with Holland & Knight partners Louise Brais in Miami and Laurie Daniel in Atlanta. “I think it will make plaintiff attorneys stop and take notice before filing bad cases.” Nichols added that meritorious cases will still be able to go forward. Susman, who represented the plaintiffs, declined to comment on the 11th Circuit ruling or the sanctions order. The plaintiffs have filed a motion, which is pending, asking the court to reconsider its decision and for an en banc hearing before the entire 11th Circuit. Richard Dannenberg, a partner with Lowey Dannenberg, whose profit-sharing plan sued Kos, said he was very surprised by the court’s decision to affirm Middlebrooks’ sanctions order. He speculated that the ruling may limit the number of plaintiffs’ securities lawsuits. “I think it will have a chilling effect on bringing plaintiffs’ securities lawsuits,” said Dannenberg. “The judge went a little haywire on this one.” Dannenberg said the firm’s profit-sharing plan lost about $15,000 from the decline of the Kos stock price. The ruling bucks the current trend of holding companies to higher disclosure standards and Congress’ efforts to hold companies and their executives more accountable for deceptive financial reporting. Among other provisions, the Sarbanes-Oxley Act, signed into law July 30 by President Bush, gives a boost to securities plaintiffs by extending the statute of limitations for class action lawsuits. The political climate was quite different in 1995, when Congress passed the Private Securities Litigation Reform Act, which mandated a Rule 11 review in every securities class action lawsuit. The Sarbanes-Oxley legislation does not change that Rule 11 provision, Nichols says. Daniel M. Bell, chairman of Kos, expressed satisfaction with the 11th Circuit ruling, which ends four years of litigation. The lawsuit was filed one year after company went public. “The dismissal of this lawsuit, and the recovery of nearly all of our expenses in defending our position, represents a total vindication of the company,” he said in a prepared statement. Kos, which aims to develop and market specialty pharmaceutical products within the cardiovascular and respiratory disease markets, recently reported revenues of $72.1 million for the six months ending June 30. For the second quarter of 2002, it reported a loss of $10.3 million, compared with a second-quarter loss of $9.6 million last year. The company’s shares, which have traded as high as $40 in the past year, were trading at about $13 Monday.

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