Reprinted with permission from the March 2, 2017 issue of The Legal Intelligencer. © 2017 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
As Cornerstone Research reported earlier this year in "Securities Class Action Filings: 2016 Year in Review," attorneys representing shareholder plaintiffs filed 270 securities class actions in 2016, which is a 44 percent increase from both the 188 actions filed in 2015 and the historical yearly average of 188 filings during the 1997 to 2015 time period. Although shareholder objections to merger and acquisition transactions account for most of this surge, traditional securities class action filings alone rose 11 percent from 2015 to 2016.
Consistent with this trend, the number of new filings against biotechnology (biopharmaceutical) and pharmaceutical companies increased 74 percent — from 31 actions in 2015 to 54 cases in 2016. According to our review of federal court dockets, 20 of the lawsuits filed against biotech and pharma companies in 2016 involve claims that the defendants failed to disclose negative information about their lead drug product's prospects for approval by the U.S. Food and Drug Administration (FDA) and the European Medicines Agency (EMA). As is typical in such actions, these complaints allege that the defendants failed to timely disclose disappointing clinical trial data and communications from the FDA/EMA.
Most notably, by the end of February 2017, plaintiffs attorneys already had asserted similar claims against 11 biotech/pharma companies — more than half the number of actions filed during the entire year of 2016. This sharp uptick serves as a reminder to development-stage biotech and pharma companies that they are particularly vulnerable to this type of litigation. Regardless of whether they, in fact, intentionally mislead investors, such companies — and their senior officers who speak on their behalf — should expect to face a securities class action if and when they experience a disappointing clinical or regulatory event in the development of their flagship drug, and their stock price drops after the announcement (or other revelation) of the event. As explained below, if the company has accurately described the status of its drug development in its communications with investors and provided extensive and detailed risk factors in its SEC filings, then it will have a better chance of disposing of the complaint at the motion to dismiss stage of the litigation.
Fortunately for development-stage companies, in 1995, Congress enacted the Private Securities Litigation Reform Act (PSLRA), 15 U.S. C. Sections 78u-4, 78u-5, which empowers courts to dismiss frivolous "stock drop" securities fraud complaints. Two of the statute's most potent dismissal tools are its heightened pleading requirements for plaintiffs who file suit under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 (Rule 10b-5 action), 15 U.S. C. Section 78u-4(b); and its "safe harbor" for forward-looking statements accompanied by meaningful cautionary language, 15 U.S.C. Section 78u-5(c).
The PSLRA's rigorous pleading standards require, inter alia, that the plaintiff allege "with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." For Rule 10b-5 actions, the required state of mind is scienter, which the U.S. Court of Appeals for the Third Circuit has defined as "a knowing or reckless mental state embracing intent to deceive, manipulate or defraud," as in OFI Asset Management v. Cooper Tire & Rubber , 834 F.3d 481, 490 (3d Cir. 2016) (internal quotation marks and citation omitted). "In determining whether the pleaded facts give rise to a strong inference of scienter, the court must take into account plausible opposing inferences."
The PSLRA's "safe harbor" immunizes a defendant's forward-looking statements from Rule 10b-5 liability so long as the company's communications identify the statements as forward-looking and accompany the statements with "meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement'" (quoting 15 U.S.C. Section 78u-5(c)(1)(A) (i)), or the plaintiff fails to prove that the forward-looking statement "'was made with actual knowledge by [the speaker] that the statement was false or misleading,'" (quoting 15 U.S.C. Section 78u-5(c)(1)(B)(i); alteration in original). A boilerplate disclaimer "which merely warns the reader that the investment has risks" will not satisfy the safe harbor. Rather, to be "meaningful," the company's cautionary statements "must be substantive and tailored to the specific future projections, estimates or opinions in the [documents] which the plaintiffs challenge."
When deciding a defendant's motion to dismiss a Rule 10b-5 complaint, the court should consider not only the complaint's allegations but also all documents incorporated by reference and matters of which a court may take judicial notice, see Tellabs v. Makor Issues & Rights, 551 U.S. 308, 322 (2007). Accordingly, courts often will examine the full context of the defendants' alleged misrepresentations and omissions, including the company's SEC filings, press releases, investor conference call transcripts and other matters of public record, such as FDA industry guidance and other materials posted on the agency's website.
Over the 21 years since the PSLRA was enacted, more and more federal district courts have come to appreciate the significance of their gatekeeper role when deciding motions to dismiss complaints alleging securities fraud in connection with drug development setbacks. Indeed, in 2016, courts granted such motions in 15 of 19 cases. In the Third Circuit, the U.S. District Court for the District of New Jersey issued three of the 15 dismissal decisions: Kelley v. Aerie Pharmaceuticals, No. 15-3007, 2016 U.S. Dist. LEXIS 79595 (D.N.J. June 20, 2016); In re Amarin PLC Securities Litigation, No. 13-6663, 2016 U.S. Dist. LEXIS 55568 (D.N.J. April 26, 2016); and Sapir v. Averback, No. 14-7331, 2016 U.S. Dist. LEXIS 15956 (D.N.J. Feb. 10, 2016).
In two of these cases, Sapir and Kelley, the court relied heavily on documents outside of the complaint when deciding that the plaintiffs' scienter allegations failed to plead a strong inference of scienter. In Sapir, the court determined, inter alia, that certain of the company's SEC filings and the transcript of an investor conference call "contradicted" and "undermined" the complaint's scienter allegations and, therefore, "the inference of scienter [was] far less compelling than the opposing, nonfraudulent inference." Similarly, in Kelley, the court reviewed the portions of the defendants' alleged misstatements that the plaintiffs had omitted from the complaint and held that, when "placed in context," the defendants' alleged misrepresentations did not suggest any "deceptive intent or recklessness." In the one case where the District of New Jersey refused to dismiss the complaint on failure to plead scienter grounds, Li v. Aeterna Zentaris, No. 14-7081, 2016 U.S. Dist. LEXIS 26772 (D.N.J. March 2, 2016), the court apparently did not consider documents outside of the complaint when reaching its decision.
As for the PSLRA's safe harbor, the court in Kelley found that the defendants' alleged statements that Aerie Pharmaceuticals Inc.'s drug candidate Rhopressa was a "blockbuster" or "potential blockbuster" were "inherently forward-looking" since the drug was not yet on the market. The court further determined that Aerie's written and oral cautionary statements were not "mere boilerplate," but were "extensive and detailed" and, therefore, sufficiently "meaningful" under the PSLRA. As the court explained: "Defendants did more than just warn about a competitor's success being able to harm their bottom line: they described what trials Rhopressa needed to succeed in, what would happen if Rhopressa underperformed, and stated that Rhopressa could fail to perform for a number of reasons, including Aerie's own lack of experience in designing trials."
As the decisions in Sapir and Kelley illustrate, biotech and pharma companies sued for alleged securities fraud have a better chance of defeating the action at the motion to dismiss stage if their SEC filings and other communications with investors accurately describe the status of their drug product development and provide extensive and detailed warnings regarding the risks of clinical and regulatory setbacks.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.