Federal judge dismisses investors’ complaint against Elanco alleging ‘channel stuffing’

A federal judge has dismissed, for now, an investors’ securities suit against Elanco Animal Health that claimed the Greenfield-based company defrauded shareholders by “stuffing” product distribution channels far in excess of customers’ demands.

U.S. District Court Judge Sarah Evans Barker ruled the plaintiffs failed to clearly show that public statements made by Elanco’s top officials were false and misleading during a two-year period in question.

The plaintiffs had submitted a 114-page amended complaint, filled with lengthy public statements from Elanco officials, but left the “onerous task” of trying to figure out exactly what the “misstatements” were, as well as of matching them up with reasons they were false or misleading, Barker wrote.

“Judges are not like pigs, hunting for truffles buried in briefs,” Barker wrote in her 58-page ruling on Aug. 17. She gave the plaintiffs 45 days to amend their complaint to conform with the ruling or she would dismiss the complaint with prejudice, meaning the plaintiffs could not refile the claim.

The plaintiffs alleged Elanco engaged in a scheme to deceive and defraud investors of the true value of its common stock in violation of federal securities law. They claimed company officials artificially boosted Elanco’s earnings and growth by stuffing product distribution channels, which led to the artificial inflation of the company’s stock price.

To bolster their claim, the plaintiffs submitted testimony from four confidential witnesses who worked at Elanco. The witnesses were identified as corporate accounts managers or company executives who said Elanco’s top officials pushed them to push millions of dollars’ worth of products to distributors repeatedly in the months leading up to and after Elanco’s spinoff from Eli Lilly and Co. and its initial public offering in September 2018.

During the fourth quarter of 2018, for example, “Confidential Witness 1” testified he was directed to pushed $10 million to $12 million worth of excess feed additive and vaccine inventory onto a distributor, over and above the distributor’s typical monthly purchase of $12 million in feed additive.

Another company official “Confidential Witness 3,” testified he was ordered to sell an additional $5 million among three distributors, even though each customer was already “bursting” with inventory.

Elanco had asked the judge to dismiss the claim, saying the plaintiffs had not identified with sufficient particularity any misleading affirmative statements made by company officials.

The judge agreed but said the plaintiffs will have a chance to “amend the pleading deficiencies” in an amended complaint.

Barker also wrote that channel stuffing is “not inherently fraudulent,” as a certain amount of stuffing could be innocent and might not even mislead if the seller had a realistic hope that the distributors would make vigorous efforts to sell the products.

“Channel stuffing becomes a form of fraud only when it is used … to book revenues on the basis of goods shipped but not really sold because the buyer can return them,” she wrote.

She also pointed out that the complaint did not allege Elanco was shipping unordered products to distributors.

“Instead, plaintiffs simply and repeatedly allege that Elanco’s sales practices induced distributors to purchase ‘far in excess of demand’ and in excess of the ‘needed inventory,’” Barker wrote.