As companies scale, lawsuits are par for the course. Desktop Metal (NYSE: DM) is no stranger to the legal practice, as it has already been engaged in suits with competitor Markforged. Class action suits are more likely to come up when stock prices drop, however, with angry investors compiling claims of false advertising and inflated revenue expectations. We saw it during the 3D printing bust of the last cycle and we’re seeing it again with Desktop during this slump, as a class action suit was filed against the company in December 2021.
More information about the suit was made public via a Corrected Consolidated Class Action Complaint (pdf) filed on December 20, 2022. This is the first major development in the case, as it includes testimony from seven former Desktop Metal employees (anonymously identified as FE 1 – 7 in the document). The arguments in this suit are interesting regardless of the outcome, as the employee testimony suggests that members of the company were involved in fraudulent manufacturing activity that circumvented regulations by the U.S. Food and Drug Administration (FDA).
Plaintiffs File Lawsuit Against Desktop Metal
During the class period from March 15, 2021 to November 15, 2021, lead counsel Hagens Berman argues that the defendants—made up of Desktop Metal, CEO Ric Fulop, former CFO James Haley, former CEO of EnvisionTEC Ali El-Siblani, and former Desktop Health CEO Michael Jafar— “misrepresented and concealed: (1) that there were deficiencies in EnvisionTEC’s manufacturing and product compliance practices and procedures; (2) that the foregoing deficiencies presented a material risk to the commercialization of EnvisionTEC’s products; and (3) that, as a result of the foregoing, Defendants’ positive statements about the Company’s business, operations, and prospects were materially misleading and/or lacked a reasonable basis.”
Dental Resins Manufactured Against FDA Regulations
The lawsuit claims that Desktop overinflated its revenue expectations related to the acquisition of EnvisionTEC, the inventor of digital light processing (DLP) technology. It makes a number of arguments about where Desktop executives made misleading statements. The core issue, however, relates to the FDA approval of a biocompatible resin from EnvisionTEC (later Desktop Health) used for temporary long-term use inside a patient’s mouth for dentures and crowns. Because dental 3D printing and the specific Flexcera product line were meant to drive a certain amount of revenue, the complainants take issue with this area in particular. To verify the information, the plaintiffs rely on documents, public statements, and the testimony of former employees.
“According to FE-3, after the acquisition, Defendants instituted a formal quota target at nearly five to ten times historic sales numbers—between $1 million and $1.5 million a quarter for each employee—which caused dental channel sales team members to wonder how the new sales targets were derived. ‘They were quite ridiculous honestly,’ FE-3 said of the new quotas. ‘I have no clue how they got to those numbers,’ FE-3 added, despite their years of sales experience. ‘I would love to know how they got to that”—i.e., the $1+ million targets.’”
What the plaintiffs’ counsel dug up is perhaps bigger than the issue of overinflated stock prices or anything of that nature, however. Using the testimony of former employees, the suit claims that EnvisionTEC manufactured and sold Flexcera resins and a related curing station, EnvisionTEC’s PCA 4000, counter to FDA regulations.
The FDA had approved EnvisionTEC’s site in Germany to manufacture Flexcera resin, cured with the Otoflash system made by a competitor, to make Class II medical devices, meaning that it could be used for long-term, temporary internal use in a patient. However, the lawsuit claims that EnvisionTEC, with knowledge of executives Ali El-Sibani and Michael Jafar, manufactured the material at a facility in Montreal, Canada that had not been registered with the FDA. This material was then shipped to the firm’s plant in Dearborn, Michigan in the U.S., where employees were instructed to bottle it and label it as though it came from the FDA approved facility in Germany. This occurred despite employee complaints.
The plaintiffs’ counsel claims, “In addition to increasing sales quotas, Defendants took additional steps after the launch of Desktop Health to boost EnvisionTEC’s sales and revenue numbers in contravention to FDA requirements. Specifically, Defendants directed the Company’s Montreal facility—a facility lacking required FDA registration for manufacturing Class II medical devices like Flexcera—to secretly manufacture bottles of Flexcera resin to be sold for actual patient use. This resin, in turn, was shipped to, repackaged in, and given a label indicating German origins at the Company’s Dearborn, Michigan facility—which also lacked required FDA registrations for handling the resin—before being sold to dental industry customers. Investigators’ factual findings further suggest that the Company knowingly or recklessly sold distributed bottles of Flexcera and/or E- Dent 1000 to customers using the product for permanent patient use before the Company applied for and/or obtained FDA premarket clearance.”
The suit suggests that the Montreal facility was not FDA certified, but had made small batches of Flexcera for development, testing purposes only, not for permanent patient use:
”FE-5 reported that, after receiving El-Siblani’s telephonic order, the Company’s non-FDA registered Montreal facility manufactured the requested Flexcera resin (which would later be knowingly or recklessly sold to dental channel customers for permanent patient use) and then shipped it across the U.S.-Canada border to Dearborn, MI in large drums. Employees in Dearborn then poured the batched resin into smaller, itemized bottles that could be sold to customers in the dental industry.”
Sale of EnvisionTEC Curing Station Against FDA Regulations
Additionally, El-Siblani instructed employees to push its less expensive PCA 4000 curing machine over a more costly competitor’s machine, the OtoFlash. While the competitor’s unit was approved, the PCA 4000 had not been cleared with the FDA for use with 3D printed medical devices. According to the suit, EnvisionTEC employees were not comfortable with pushing the PCA over the OtoFlash, with at least one dental sales representative, Kevin Dillon, asking on a sales conference call if it was even strong enough to cure the material properly. When Dillon said he would not sell the PCA 4000, El-Siblani is reported to have said, in paraphrased terms, “This is the one I am telling you to sell, so do it.”
The documents claim, “[A]fter the call, Dillon relayed to FE-4 that he had spoken with EnvisionTEC’s German facility; and (iv) the German facility had told Dillon that it had tested the PCA 4000 on Flexcera resin and had not found it to be compatible. As FE-4 further explained, ‘not compatible’ meant that the PCA 4000’s constant-light curing method was not ‘strong enough’ to completely cure Flexcera resin.”
When customers did use the PCA 4000 to cure Flexcera based on company instructions, they complained about the part’s “gummy” quality. To compensate, EnvisionTEC doubled the suggested curing times, which still did not meet the recommendations of the German staff responsible for the FDA-certified facility. In one case, a former employee (FE-6), sent the product out to an independent lab to determine if they met the proper standards:
“FE-6 noted that, in particular, the strength of Flexcera Smile cured with the PCA 4000 was significantly less than the Company claimed in its FDA filings. For example, though the Company claimed that Flexcera-printed dentures had a flexural strength of about 90 megapascals (MPa), FE-6’s validation tests using the Company’s IFU found a strength of only 72 MPa…As a result, FE-6 concluded that the Company’s Flexcera line of medical grade dental resin could not qualify as a ‘rigid dental material’—a requirement for dentures. In their opinion, this was because the Flexcera resin did not reach a high enough temperature in the PCA 4000 curing box.”
This employee then confronted higher-ups, including Jafar, via email and was told that the data submitted to the FDA and listed in marketing materials was achieved with the Otoflash, not the PCA 4000.
Desktop Metal Addresses Issues at EnvisionTEC
Interestingly, despite all of the issues raised by the plaintiffs, Desktop Metal management seemed to respond appropriately to the malfeasance taking place in the EnvisionTEC division. In November 2021, FE-5 collated information related to the issues they’d witnessed and emailed it to “several, high-level people in different departments across Desktop Metal, including Human Resources and Operations.” Then, on November 8, 2021, Desktop Metal filed a Form 8-K with the SEC, explaining that, on November 4, 2021, the Audit Committee of the Company’s Board of Directors hired a third party to run an independent internal investigation into matters that included “manufacturing and product compliance practices and procedures with respect to a subset of its photopolymer equipment and materials at its EnvisionTEC US LLC facility.”
That same day, it filed another Form 8-K noting that, on November 5, 2021, a day after the investigation began, El-Siblani resigned as Chief Executive Officer of EnvisionTEC US LLC and as a director of Desktop Metal.
This was followed by a comment about the Flexcera and PCA 400 issues in its Quarterly Report, published on November 15, 2021. Specifically, Desktop Metal said in its Form 10-Q for the quarter:
“As of November 12, 2021, based on compliance issues with certain shipments of EnvisionTEC’s Flexcera dental resins and its PCA 4000 curing box, the Company has determined that it will notify the FDA and consult with them on the appropriate voluntary market action with respect to these products. The Company does not expect the costs of any such market action to have a material impact on its financial statements.”
In January 2022, Desktop Metal initiated a recall for its Flexcera Smile dental resin, made from April 1, 2021 to September 15, 2021 due to the fact that it was “[m]anufactured in a non-FDA registered manufacturing facility” and because the “product was mislabeled as being of German origin.” The FDA ordered customers to “stop dispensing and distributing and quarantine [the identified] lots”, which was estimated to be about “795 units.”
This was followed by a recall for all “PCA 4000 Curing Units” with “SKU number ACC-06-1000” sold to non-industrial users, as the machine “may not fully cure EnvisionTEC dental resins to desired product specifications.”
Desktop Metal declined to comment on the litigation. For the plaintiffs, the primary issue is whether or not investors were or were not misled by marketing related to Desktop’s acquisition of EnvisionTEC and future profits that were to be derived in the dental market. However, for the public at large, the concern would be the safety practices of the company.
Based on documents from the lawsuit itself, it seems as though Desktop Metal management responded to the whistleblower complaints immediately, much more quickly than one might expect from a corporation. A third-party investigator was hired, the responsible parties were made to leave Desktop Metal, the FDA was notified, and the products were recalled. While potentially dangerous, issues were addressed as quickly as possible.
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