The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

The number of securities class action lawsuits filed against life sciences companies rose in both absolute and relative terms in 2012, according to a March 20, 2013 memorandum by David Kotler of theDechert law form entitled “Survey of Securities Fraud Class Actions Brought Against U.S. Life Sciences Companies.”   According to the report, a copy of which can be found here, life sciences companies “remain an increasingly popular target of securities fraud class action lawsuits.”

According to the report, 27 pharmaceutical, biotechnology and medical companies were hit with securities suits in 2012, representing about 18% of all securities suits filed during the year.  By comparison, in 2011, 17 of those companies had securities suits filed against them, representing just 9% (It should be kept in mind when comparing the two years that securities class action lawsuit filings overall declined significantly between 2011 and 2012, as discussed in greater detail here.) The 18% of all securities suits that life sciences companies’ filings represented in 2012 is “well above the percentage of securities fraud complaints filed in recent years.”

During 2012, the fillings against life sciences companies continued to be concentrated on smaller companies. During 2012, 50% of all life sciences securities suit filings involved companies with market caps of less than $250 million, as compared to 58% in 2011 and 31% in 2010.

Abut 43% of the 2012 life sciences securities complaints involved alleged misrepresentations or omissions regarding product efficacy. However, “complaints claiming financial improprieties and insider trading were still prevalent in 2012.”

Though life sciences companies continue to be the target of securities class action litigation, many of these cases are also dismissed. The report notes that “in 2012, life sciences companies continued to enjoy relative success in obtaining dismissals of the securities fraud lawsuits filed in recent years.” For example, the report shows that of the 23 securities lawsuits filed against life sciences companies in 2008, three remain pending, eleven were settled, and nine have been dismissed, or about 45% of all resolved cases.

However, as the report also notes, “it is equally worth noting that securities fraud lawsuits still carry a substantial risk of exposure, and even when settled can result in very large payments.” The report notes that the 2008 securities suit filed against Medtronic settled during 2012 for $85 million.

The report also discusses the U.S. Supreme Court’s February 2013 decision in the Amgen case (background about which can be found here). The report states that “the Supreme Court’s decision in Amgen is expected to have a profound impact on the critical class certification stage in securities fraud class action lawsuits filed against life sciences companies, especially in the Second, Fifth and First Circuits, where the previously required higher threshold for plaintiffs to overcome the class certification barrier now will be lessened.”

The report concludes with a number of practical suggestions for life sciences companies to take to minimize the risk of, and impact from, securities fraud class actions.

Very special thanks to David Kotler for providing me with a copy of the report.

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On January 10, 2013, in a detailed and interesting opinion with features that may be helpful to other life sciences securities suit defendants, Middle District of Tennessee Judge Kevin Sharp granted the motion of Biomimetic Therapeutics to dismiss the securities class action lawsuit that had been filed against the company over its disclosures concerning developments in the clinical trials of its flagship product. A copy of Judge Sharp’s opinion can be found here.

The clinical trials were conducted in support of the company’s efforts to obtain FDA approval of its bone grafting product called Augment. Biomimetic conducted the clinical trial pursuant to protocols it had proposed and that had been approved by the FDA. As later became apparent, Biomimetic based its analysis of the testing results on a different patient population than had been identified in the FDA-approved protocols. The results associated with the different population were more favorable to the company.

The FDA expressed concerns to Biomimetic about the population used and other aspects of the clinical trials in a December 3, 2012 deficiency letter. The FDA also raised a number of concerns about the trials in a May 10, 2011 briefing document released in advance of the public expert panel meeting. Following the meeting, the expert panel narrowly voted in favor of approval of the Augment’s safety and efficacy.

Biomimetic’s share price declined 35% following the FDA’s May 10, 2011 disclosure of the testing concerns. Its share price declined a further 12% following the narrow expert panel vote, out of concerns that in view of the narrowness of the expert panel vote, FDA approval without additional processes was unlikely.

Following the share price decline, shareholders filed a securities class action lawsuit in the Middle District of Tennessee against Biomimetic and certain of its directors and officers. The shareholders alleged that throughout the class period, the defendants made unjustifiably positive statements about the Augment clinical trials and omitted to disclose the specific concerns that the FDA had raised about the trials.

According to the court, the “heart” of the plaintiffs’ allegations was that the defendants had engaged in a regulatory “bait and switch” by changing the patient population used to analyze its trial results in a way that allowed the company to report more favorable results that would have been shown if the original population were used. The plaintiffs also alleged that the defendants had failed to disclose the other problems with the clinical trials, including in particular that Biomimetic had failed to include processes to capture measurements on additional items that were of particular concern to the FDA.

The defendants moved to dismiss the plaintiff’s complaint.

The January 10 Opinion

In his January 10, 2013 opinion, Judge Sharp granted the motion to dismiss without leave to amend, finding that the plaintiffs’ allegations failed to meet the pleading requirements of the PSLRA.

Judge Sharp rejected the argument that the company’s use of a modified patient population to analyze the trial results violated the FDA-approved protocol. He also found that in a press release and in an earnings call, the company had “acknowledged the confusion that had been generated between the classifications of patient populations.” In light of these disclosures, the company’s statements about the patient populations “do not suggest a knowing and deliberate intent to deceive or defraud, let alone highly unreasonable conduct.”

In reaching this conclusion, Judge Sharp put particular emphasis on the fact that the company had “never suggested approval by the FDA was assured,” adding that “quite to the contrary,” the company “repeatedly and consistently warned that there were no guarantees that Augment would be approved.”

Judge Sharp also found that plaintiffs’ allegations that the defendants had deceptively omitted to disclose other clinical trial deficiencies were also insufficient. He concluded that “the alleged deficiencies and the omission in the clinical trials do not raise a strong inference of fraudulent intent as required by the PSLRA.”

In particular, Judge Sharp rejected, as insufficient, the plaintiff’s argument that the company was “cutting corners by failing to conduct certain tests or studies.” He noted that

The notion that [Biomimetic] would recklessly forego necessary tests and studies or hide adverse events makes little sense, even disregarding Defendants’ assertion that they poured their own money into the company. Plaintiffs’ own allegation is that Augment is [Biomimetic’s] flagship product and necessary to the companies [sic] success, begging the question why it would sabotage all of the company’s efforts on the point.

Along those lines, Judge Sharp noted that neither the company nor the individual defendants had engaged in securities sales after the company received the FDA’s deficiency letter.

One particularly interesting aspect of Judge Sharp’s opinion is his consideration of the plaintiffs’ allegations that the defendants had deceptively failed to disclosed the FDA’s concerns in the deficiency letter while at the virtually the same time had made positive statements about the progress of the Augment clinical trials. Judge Sharp noted that “a deficiency letter is not a final FDA decision, but a request for more information, and in fact, very few [applications] are approved without the issuance of a deficiency letter.” Judge Sharp then cited with approval language from a prior opinion to the effect that “it simply cannot be that every critical comment by a regulatory agency has to be seen as material for securities law reporting purposes.” He concluded that based on the overall factual allegations, the company “had a reasonable basis for optimism” notwithstanding the concerns noted in the deficiency letter.

Discussion

As I noted in my recent analysis of 2012 securities class action lawsuit filings, life sciences companies continue to be a favored target for securities class action litigation. The reason the companies attract securities suits has a lot to do with the complex and unpredictable regulatory process to which the companies are subject. The regulatory process is. As this case shows, many things can happen during the course of a clinical trial, which in turn can significantly affect investors’ perceptions of the prospects for the company involved.

There are several aspects of Judge Sharp’s opinion that should be heartening to life sciences companies that find themselves targeted by securities litigation as a result of setbacks the companies experience in the clinical trial process.

First, Judge Sharp showed an uncommon willingness to immerse himself in the complexities of the regulatory process and the science involved with the Augment clinical trials. Because of his willingness to understand the complex details, he was able to understand what had happened concerning the change in patient population used for analytical purposes. He was also able to understand the company’s disclosures about the populations used. Because he had this understanding, he was not persuaded by the plaintiffs’ characterization of the change in patient populations as a “bait and switch.” Of course, other life sciences securities suit defendants may not always have a court as wiling to do the hard work to develop those kinds of detailed understandings of the process and of the science. But this case does show the possibilities arising from trying to make those kinds of arguments to the court.

A second and more interesting aspect of Judge Sharp’s opinion has to do with his analysis of the plaintiffs’ allegations concerning the defendants’ alleged failure to disclose the concerns noted in the deficiency letter. Although he does not come right out and say that life sciences companies do not have an obligation to disclose an FDA deficiency letter, Judge Sharp’s opinion certainly will provide support for other life sciences securities suit defendants who want to argue that the mere fact that the FDA has sent a deficiency letter alone is not necessarily material and that the failure to disclose concerns identified in a deficiency letter does not by itself amount to securities fraud. This aspect of Judge Sharp’s opinion could prove to be quite helpful for other life sciences securities defendants.

Another important aspect of Judge Sharp’s opinion has to do with his analysis of the company’s precautionary disclosures. He clearly considered it important that the company avoided any suggestion that approval of Augment was assured and emphasized the possibility that Augment might not be approved. The company’s precautionary disclosures, along with the absence of any insider or company stock sales at sensitive times, seems to have gone a long way toward reassuring Judge Sharp that the defendants had not set out to deceive anyone. Judge Sharp’s opinion underscores the importance for life sciences companies to avoid overly optimistic statements about future regulatory outcomes as well as for the companies to use the disclosure documents to “bespeak caution” to investors about the uncertainties of the regulatory process.

One final note about Judge Sharp’s opinion has to do with the simple fact that the dismissal was granted. Because of the unpredictability of the FDA regulatory process and because of the resulting volatility of life sciences companies’ share prices, the companies tend to attract significant levels of securities litigation. But though the companies may attract lawsuits,  that does not always mean that the suits are always great cases for the plaintiffs. As one industry observer noted (refer here), “courts continued to grant with relative frequency life sciences companies’ motions to dismiss due to plaintiffs’ inability to sufficiently plead scienter.”

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Though down from the previous year on both an absolute and a relative basis, securities class action lawsuit filings against life sciences companies remained a significant component of all securities class action lawsuit filings during 2011, according to a March 20, 2012 memorandum entitled “Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies” by David Kotler of the Dechert law firm (here).

According to the report, there were 17 securities class action lawsuits filed against life sciences companies during 2011, representing approximately 9% of all 2011 securities class action suits. The number of 2011 life sciences suits represents a decline both in absolute and relative terms from the prior year, when there were 29 securities suits involving life sciences companies, representing 16% of all securities class action lawsuits. However, the 2011 figures are consistent with albeit slightly below prior years (for example, during both 2008 and 2009, suits against life sciences companies represented 10% of all securities lawsuits).

It should be noted that these filings statistics do not reflect lawsuits filed against life sciences companies involving merger objection allegations. If the M&A suits were included, the statistics would reflect an even greater frequency of corporate and securities lawsuits involving life sciences companies.

The lawsuits filed against life science companies in 2010 had been weighted toward the larger companies. However, the lawsuits filed in 2011 were more focused on smaller companies. During 2011, 58% of all life sciences companies hit with securities suits had market capitalizations under $250 million, compared with only 31% in 2010. By contrast, during 2010, 29% of the securities lawsuits involving life sciences firm related to companies with market caps over $10 billion, whereas during 2011, there were no suits filed involving those larger life sciences companies.

Allegations relating to financial proprieties and financial misrepresentations remain an important part of suits involving life sciences companies, but to a lesser extent than in the previous year. During 2010, over half of all complaints against life sciences companies involved these financially-related allegations, but during 2011, only 35% of the suits involved these types of allegations. The report notes with respect to the 2011 suits that “half of the claims alleging financial improprieties were brought against China-based companies.”

By contrast, the report notes, “industry specific allegations were comparatively on the rise in 2011.” Eleven of the 17 lawsuits of the complaints filed against life sciences companies involved allegations of misrepresentations involving product safety or efficacy. Allegations of allegedly fraudulent life sciences product marketing were raised in seven of the suits. Allegations involving misrepresentations in connection with prospects for FDA approval were involved in four cases, and allegations relating to manufacturing were involved in three cases. (Some complaints involved more than one of these categories of allegations).

Though life sciences companies are a frequent target of securities suits, these cases are also often dismissed. During 2011, according to the report, “courts continued to gran with relative frequency life sciences companies’ motions to dismiss due to plaintiffs’ inability to sufficiently plead scienter.” On the other hand, “it is also worth noting that, even in cases that are settled, securities fraud class action lawsuits can result in very large payments.”

One development during 2011 potentially of significance with respect to securities litigation involving life sciences companies was that in March 2011, the U.S. Supreme Court issued its opinion in Matrixx Initiatives v. Siracusano (about which refer here). In its opinion, the Court rejected the argument of Matrixx Initiatives that adverse product reports must be "statistically significant" in order for a manufacturer to have an obligation to disclose the reports to investors.

As the law firm memo notes, of particular importance to life sciences companies is the question whether, as a result of the Matrixx Initiatives case, “a publicly traded life sciences company can be held liable for securities fraud for failing to disclose adverse reports” regarding its products. Life sciences companies are faced with the task of “where to draw the disclosure line in the absence of a bright line standard.”

Fortunately, the report notes, thus far, the Matrixx Initiatives decision “has not resulted in any noticeable increase in securities fraud lawsuits brought against life sciences companies,” and the case’s holding has “not yet shown any significant impact on existing case law beyond rejection of the bright line rule based on lack of statistical significance.”

The author concludes with a number of practical suggestions for life sciences companies to take to minimize the risk of, and impact from, securities fraud class actions.

Directors and Officers’ Liabilities in Failed Bank Lawsuits: In a recent post (here), I examined the February 27, 2012 decision in the FDIC lawsuit involving the failed Integrity Bank of Alpharetta, Georgia, in which Northern District of Georgia Judge Steve Jones determined that allegations of mere ordinary negligence against the bank’s former directors and officers were barred by the business judgment rule under Georgia law.

A March 2012 memorandum from the Jones Day law firm entitled “FDIC Failed Bank Director and Officer Claims – Recent Court Decisions Better Define the Landscape” (here) takes a look at the Integrity Bank decision as well as recent developments in the FDIC’s failed bank lawsuit in the Northern District of Illinois involving Heritage Community Bank (for background involving the Heritage Community Bank case, refer here).

Among other things, the memo’s authors conclude that the decision in these cases “have helped inform the strategy of former directors and officers facing potential FDIC claims or actual litigation.” Even more importantly, according to the authors, “the Integrity decision appropriately set the bar higher for FDIC claims based on ordinary negligence, at least in jurisdictions with law similar to Georgia.” Obviously the decision is particularly important in Georgia itself, which has had more bank failures than any other state during the current bank failure wave.

Wage & Hour Litigation: Big and Getting Bigger: According to the title of a March 19, 2012 Corporate Counsel article, wage and hour litigation is “Big – and Getting Bigger” (here). Among other things, the article notes that “there has been more than a 325 percent increase in wage and hour lawsuits filed over the last ten years.” In the reporting year ended March 31, 2011, there were over 7,000 wage and hour claims filed in federal courts, which is “higher than the total filings of all other types of employment cases combined.”

Among other reasons cited in the article for this upsurge in wage and hour litigation is that these cases, according to one commentator quoted in the article “are very lucrative for plaintiffs lawyers,” as well as easier and less expensive for plaintiffs’ lawyers than discrimination class actions. Another reason for the increase in cases is that “employers continue to struggle with the law,” which in many ways is maladapted to today’s work place (where, for example, workers often find they must check blackberries, even outside of normal work hours). Employers struggling with how to apply the law are “confounded by the scarcity of case law” – although, as the article notes, the U.S. Supreme Court is scheduled to hear argument in a wage and hour case on April 16, 2012, in the Christopher v. SmithKline Beacham Corp. case. (Background on the Christopher case can be found here.)

A Break in the Action: Over the next several days, I will likely not be posting as frequently due to extended travel oblligations. The D&O Diary will resume its normal publication schedule in April.

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Since late last year, reports have been circulating that the U.S. government is investigating whether drug companies paid bribes overseas to increase sales and to obtain regulatory approvals. Some firms have now announced that they have reached settlements with enforcement authorities. And now the first civil lawsuit relating to these investigations has been filed, as discussed below.

According to press reports and company filings, a number of companies have disclosed last year that they were being investigated for possible FCPA investigations involving a broad range of possible violations including bribing government-employed doctors; paying sales agent commissions that are passed along to doctors, paying hospital committees to approve drug purchases and paying regulators to win drug approvals. Additional press coverage regarding the breadth of this industry probe can be found here.

The first enforcement action and  settlement related to this investigation emerged last month, when governmental regulators announced that Johnson & Johnson had agreed to pay more than $70 million dollars to settle FCPA-related allegations. The SEC’s April 8, 2011 litigation release can be found here, the U.S. Department of Justice’s April 8, 2011 press release can be found here and the U.K. Serious Fraud Office’s press release can be found here.

As reflected in the enforcement authorities’ various press releases, Johnson & Johnson’s subsidiaries, employees and agents were alleged to have paid bribes to public doctors and administrators in Greece, Poland and Romania and kickbacks to Iraq to win business there. Johnson & Johnson’s payments to settle the various probes included $48.6 million to the SEC in disgorgement and prejudgment interest, a $21.4 million criminal penalty to the Justice Department and a £4.8 million ($7.8 million) to the U.K. Serious Frauds Office. A detailed overview of the allegations and the settlements can be found on the FCPA Professor’s Blog (here). According to the FCPA Blog (here), the Johnson & Johnson settlement is the tenth largest FCPA settlement ever.

Moreover, it appears that other settlements arising out of the probe may soon follow. Last week, Eli Lilly. disclosed that it is in “advanced discussions” to settle bribery related allegations. According to news reports, the activities under investigation involve alleged improper payments in Poland and possibly include activities in other countries as well.

The ongoing investigation is affecting ordinary business operations in companies caught up in the probe. For example, SciClone Pharmaceuticals announced earlier this week that its compensation committee would defer decisions on executive compensation until its board receives a report of a foreign bribery probe. The internal investigation is said to be parallel to that of the U.S. enforcement authorities.

And now it appears that the ongoing drug company bribery probe has also produced its first civil lawsuit. On May 2, 2011 investors filed a shareholders’ derivative suit in the District of New Jersey against Johnson & Johnson, as nominal defendant, and eleven board members, relating to the company’s settlement of the bribery charges. The complaint, which can be found here, alleges that the individual defendants breached their duty of loyalty by “failing to cause J&J to implement an internal controls system for detecting and preventing bribes to public doctors and administrators in Greece, Poland, and Romania, and kickbacks to Iraq to win business there.”

The complaint asserts claims for breach of fiduciary duty, mismanagement, abuse of control, corporate waste, unjust enrichment and violations of the federal securities laws.” The complaint seeks to hold the individuals liable to the company for damages, which the complaint alleges, referring to the fines, disgorgement and interest that the company has agreed to pay, exceed $70 million.

The FCPA itself does not provide for a private right of action. But as I have observed in previous posts (refer for example here) , one of the frequent accompaniments of an FCPA enforcement action is a follow on civil action, of the type filed against the Johnson & Johnson officials. And while the fines, disgorgements and penalties paid in connection with the FCPA settlement would not typically be covered un der a D&O policy, the defense costs incurred in connection with the follow on civil action would be covered, and settlements and judgments entered in the civil action would at least potentially be covered, subject to all of the applicable policies terms and conditions.

With the signs suggesting that there may be further enforcement actions and settlements in connection with the ongoing pharmaceutical industry bribery probe, there is an accompanying concern that as the overall investigation moves forward, there may also be a parallel wave of follow on civil litigation. This possibility is not only an added concern for the affected companies themselves and their senior executives, but is also a concern for the D&O insurance carriers.

There are a number of interesting features of the Johnson & Johnson settlement that may be significant in connection with the continuing investigations against the other drug companies. The first is that in connection with the Johnson & Johnson enforcement action, the governmental authorities took the position that the FCPA was relevant with respect to payments made to doctors in the counties specified. The position of the SEC and the other enforcement authorities is that because the health system in the counties involved is a government operation, the doctors involved are “foreign officials” within the meaning o f the FCPA, which , as discussed on the FCPA Professor blog here and here, is noteworthy issue of considerable interest and concern.

The other interesting about the Johnson & Johnson settlement relates to the comments in the DoJ’s press release with respect to Johnson & Johnson’s cooperation. The DoJ noted not only the company’s “timely voluntary disclosure” but also noted the company’s “significant assistance in the industry-wide investigation.” The press release also states that the company received a reduction in its criminal fine” as a result of its cooperation in the ongoing investigation of other companies and individuals.” The clear implication is not just that the probe is ongoing but that other companies and individuals are under investigation. The upshot may well be, as suggested above, that there will be further enforcement actions and possibly further settlements ahead.

The DoJ’s press release also underscored the extent to which the investigation of corrupt activities is a global, cross-border undertaking. In its press release, the DoJ noted not only the investigative collaboration with other U.S enforcement agencies and with the U.K. serious fraud office, but also recognized the helpful assistance of investigative bodies in Greece and Poland. These circumstances highlight both the collaborative international scale of the investigations but also how seriously the matters are being taken by a wide variety of governments and governmental authorities.

Finally in light of the magnitude of the Johnson & Johnson settlement (and the fact that the settlement made the Top 10 List) it is probably worth reflecting that the company reached this settlement while, at least according to the DoJ, receiving a reduction in its penalties not only because of the cooperation noted above, but also because of the company’s “pre-existing compliance and ethics programs, extensive remediation, and improvement of its compliance systems.” That the company should still face fines and penalties of the magnitude to which it agreed notwithstanding the credits the company received for these efforts is a striking development.

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In my year-end securities litigation survey, I noted that while a number of new trends emerged during 2010, one securities lawsuit filing trend had remained constant during the year – that is, life sciences companies remained a favored securities class action lawsuit target. The heightened exposure that life sciences companies face is fully detailed in a March 2011 memo from David Kotler and Kathleen O”Connor  of the Dechert law firm entitled “Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies.” A copy of the memo can be found here.

According to the memo, 29 different life sciences companies and their directors and officers were the subject of class action securities lawsuit filings in 2010, representing about 16.5% of all2010 securities lawsuit filings. Both the absolute filing numbers and the relative percentages of all filings are up from recent years. The 29 life sciences securities suits were up substantially from the 19 filed in 2009 (representing 10% of all securities suits that year) and from the 23% filed in 2008 (representing 10% of all securities suits).

It is worth noting that the count of 29 suits involving life sciences companies  does not include lawsuits involving allegations relating to mergers and acquisitions. If the merger objections suits were included, at least seven more suits would be added to the count.

The 2010 life sciences securities suits as a group do reflect certain distinctive characteristics. First, the 2010 lawsuits were more heavily weighted towards life sciences companies with larger market capitalizations. 28% of the 2010 lawsuits were brought against life sciences companies with market capitalizations over $10 billion, by contrast to only 5% in 2009.

The 2010 life sciences securities suits  also involved a significant number of lawsuits based not on such industry specific issues as FDA approvals or safety recalls. Consistent with the patterns of securities suit filings against life sciences companies in recent years, more than half of the filings involved allegations of financial improprieties, such as misstated or misleading financial reports or accounting mistakes or mismanagement.

To be sure, many of the 2010 did involve more industry specific allegations such as prospects or timing of FDA approval (9 of the 29 2010 lawsuits); allegations involving product efficacy (8); product safety (7); marketing practices (4); and manufacturing processes (2). Another five involved insider trading allegations.

The memo’s authors have been tracking the life sciences cases since 2007, and while the filings from those earlier years have not yet fully developed, there is some growing evidence to suggest that though life sciences companies may be sued more frequently than other cases, the cases may be dismissed more frequently than are cases in the larger universe of securities class action lawsuits.

The authors note that the SEC and the DoJ have made a priority of Foreign Corrupt Practices Act (FCPA) enforcement regarding life sciences companies and in at least one case (involving SciClone Pharmaceuticals), the FCPA enforcement has resulted in a follow-on securities class action lawsuit.

The authors also include a discussion of the U.S. Supreme Court’s recent decision in the Matrixx Initiatives case (about which refer here). They note that “by rejecting statistical significance as setting a minimal threshold for disclosure, Matrixx will require life sciences companies to assess … disclosures and investor impact more holistically, and on a case by case basis.” The authors also note that “life sciences companies are now faced with heavily fact-specific questions of where to draw the disclosure line in the absence of a bright-line standard.”

The authors conclude with a number of practical suggestions for life sciences companies to take to minimize the risk of, and impact from, securities fraud class actions.

Share the Road: The April 2, 2011 Wall Street Journal carried a rant entitled “Dear Urban Cyclists: Go Play in the Traffic” (here), written by alleged humorist P.J. O’Rourke. O’Rourke apparently is incensed by what he perceives as the increasing preference of traffic planners for urban bicycle lanes. His essay contains a lot of statements like “ bike lanes violate fundamental principles of democracy.” Some might say that Mr. O’Rourke’s comments want proportionality.

My own perspective on urban cycling took a completely unexpected turn during a recent visit to London. Owing to historically unprecedented weather conditions – it was sunny and pleasant six straight days in a row while I was there – I had occasion to try out the new Barclays Bicycle Hire arrangement. The way this arrangement works is that you pay a fee for bicycle access (one pound for a single day, five pounds for a week), and then you pay a one pound an hour usage fee. (There are other arrangements for longer term users.) The best part of the arrangement is that once you have paid the access fee, you can pick up or drop off a bike at any of the numerous bike racks around the city.

What this means is that you can rent a bike and tool around the city without having to cycle all the way back to the place where you first rented it. You can also drop the bike off at a rack if you just want to stop and get a snack or go in a store. The first day I tried the system, I picked up a bike in Green Park and cycled all the way around Hyde Park; dropped the bike off and took the tube to Trafalgar Square  and then biked down Whitehall, past Parliament, across Lambeth Bridge to Lambeth Park; then I dropped the bike off in Vauxhall and took the tube to Regent’s Park, picked up another bike at the tennis courts there and cycled around the Park.

The second time I tried it, I ran a relay of bicycles all across the west end into Kensington, Notting Hill and Bayswater, stopping and starting for meals and shopping, all the while traveling through and exploring parts of the city I have never seen before.

According to Wikipedia (here) , there are over 5,000 bicycles and 317 docking stations available in central London. The docking stations were first installed in London in July 2010, but the heavy, three-speed bicycles themselves are already ubiquitous (particularly on kind of bright, sunshiny days I enjoyed there last week).

There are downsides. Among other things, the rental does not include a helmet. In addition, the left hand lane rule of the road that prevails in London led to intermittent tense moments for me, particularly with respect to other cyclists whose behavior was not always predictable. Also, it takes a certain kind of courage to try to ride a bike through, say, Piccadilly Circus.

All of those concerns notwithstanding, I have to say that I found this bicycle hire scheme absolutely marvelous. One of the docking stations is located just outside the hotel I favor when I visit London, and now that I am comfortable with the scheme, I intend to take advantage of the arrangement on future visits. It is a convenient and enjoyable way to get around the city.

As for Mr. O’Rourke and his dyspeptic vision of urban bicycling, I can only surmise that he had not given the new London bicycle hire arrangement a chance. I think a cruise around Hyde Park on a sunny afternoon would do him a world of good, and might entirely alter his views about urban bicycling and democracy.

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With four more securities suits involving Chinese or China-linked companies this past Friday, the phenomenon of securities class action lawsuits against these firms has emerged as one of the most distinct securities litigation trends so far this year. The filing trend actually first emerged in the second half of 2010, but it has continued into 2011 and appears to have gained significant momentum in recent weeks following recent revelations of accounting irregularities involving Chinese companies.

The four latest suits involving Chinese-linked companies are as follows:

1. China Electric Motor, Inc.: According to their April 1, 2011 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit in the Central District of California against China Electric Motor, a Delaware corporation with its principle place of business in China, as well as the certain of its directors and officers and the underwriters who underwrote the company’s January 29, 2010 IPO.

According to the Complaint (here), the lawsuit follows the company’s March 31, 2011 announcement that it is forming a special committee to investigate accounting discrepancies “concerning the Company’s banking statements” identified by the company’s auditors. The company has delayed release of its fourth quarter and year end financial statements and trading in the company’s securities has been halted.

2. Advanced Battery Technologies, Inc.: In their April 1, 2011 press release (here), the plaintiffs’ lawyers state that they have filed a securities class action lawsuit in the Southern District of New York against Advanced Battery and certain of its directors and officers. According to the complaint (here), the company is a Delaware corporation with offices in New York that, through subsidiaries, owns two Chinese operating companies.

The complaint alleges that the company made misleading statements about its ownership interests in certain Chinese operating companies and that it failed to disclose or fully disclose certain related party transactions involving the company’s CEO. The complaint also alleges, relying heavily on a securities analyst’s report , that the company made false statements about its supposed investment in a company that may not even exist.

3. China Intelligent Lighting and Electronics, Inc.: According to the their April 1, 2011 press release (here), plaintiffs’ attorneys have filed a complaint in the Central District of California against the company, certain of its directors and officer and the investment banks that underwrote the company’s June 18, 2010. (One of the investment banks, Westpark Capital, was also involved in the China Electric IPO described above.) The company is a Delaware Corporation with its principle place of business in China. A copy of the complaint can be found here.

The lawsuit follows the company’s March 29, 2011 press release in which it announced the termination of its auditor, MaloneBailey LLP; its auditor’s resignation and withdrawal of the audit opinion it issued in connection with the prior year end financial statement; and the formation of a special investigation committee. The press release also discloses that the SEC has launched a formal investigation of t he company.

In the press release, the company also discloses that MaloneBailey resigned “due to accounting fraud involving forging of the Company’s accounting records and forging bank records.” The auditors also allegedly stated that the “accounting records at the company have been falsified.” 

4. China Century Dragon Media: According to their April 1, 2011 press release (here), plaintiffs lawyers have filed a securities class action lawsuit against the company, certain of its directors and officers and against its offering underwriters. Among the offering underwriters named as defendant in the case is the Wespark Capital firm, which was involved in the China Electric Motor and China Advanced Lighting offerings described above. A copy of the complaint, which was filed in the Central District of California, can be found here.

The China Century Dragon Media lawsuit follows the company’s March 28, 2011 announcement of the resignation of its auditor, MaloneBailey LLP (the same firm as withdrew from auditing China Intelligent Lighting, as noted above), and the firm’s withdrawal of its prior audit opinions. The press release discloses that the auditor has resigned as a result of “irregularities” that may indicate that the company’s “accounting records have been falsified.” The discrepancies could also indicate material errors in the company’s prior financial statements. The company also disclosed that its shares have been delisted and the SEC has commenced a formal investigation.

These four new lawsuits join the seven suits that had previously been filed so far in 2011 against Chinese and China-linked companies. Of these eleven total lawsuits, six have been filed just since March 18, 2011. The eleven suits against Chinese-related firms already exceed the ten lawsuits that were filed against Chinese companies in 2010. Signs are that there may be further suits to follow shortly, as the law firm that filed all four of the above described lawsuits issued an April 1, 2011 press release (here) that it is investigating possible securities law violations involving Keyuan Petrochemicals (a Nevada corporation with its principal place of business in China), following the company’s April 1, 2011 announcement that it was delaying filing its year end financial statements and initiating an audit committee investigation of certain “concerns.” 

The rash of lawsuits has arisen at the same time that the Public Company Accounting Oversight Board raised concerns in a March 14, 2011 report (here) about accounting and auditing standards at Chinese companies that have conducted IPOs in the U.S. or that have become U.S. publicly traded companies through reverse mergers. The report identifies a number of factors that may undermine the ability of audit firms to complete their audit functions completely or effectively. In light of the concerns in the PCAOB report, it hardly comes as a surprise that accounting concerns are coming to light in connection with some of these Chinese firms.

The allegations raised in these cases, like the allegations in the four cases described in detail above, fall into two basic categories: Inadequate disclosures involved related-party transactions (see especially Tongxin [here], China Valves Technology [here], and China Integrated Energy [here]), and accounting irregularities or accounting improprieties (see especially China Media Express [here], China AgriTech [here], ShegndaTech [here] and NIVS Intellimedia Technology Group [here].

Another familiar theme running through at least a few of these cases is that the lawsuits followed the resignation of the MaloneBailey firm as the defendant company’s auditors. The audit firm’s resignation preceded the lawsuits filed against NVIS Intellimedia Technology Group, China Intelligent Lighting and Electronics, and China Century Dragon Media.  MaloneBailey is identified in Table 8 of the PCAOB report as the U.S.-based firm with the most Chinese reverse merger company clients. In addition, a number of the companies named as defendants in these suits conducted offerings with the investment bank Westpark Capital, Inc as one of their offering underwriters.

These firms’ involvement may well be purely coincidental. The larger pattern is that there seems to be a growing number of Chinese and China-linked companies that are announcing concerns related to the accounting and reported financial statements. Whether these issues will continue to emerge will remain to be seen. But for now, a securities litigation filing trend that first developed in the second half of 2008 seems to be going strong as we head into the second quarter of 2011. 

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As the various year-end securities litigation studies have all shown, cases against financial services companies have dominated securities lawsuit filings for the last several years. But throughout that period, the plaintiffs’ attorneys have also continued to pursue claims against companies in other industries, particularly companies in the life sciences sector. A recent memorandum from David Kotler of the Dechert law firm entitled "Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies" (here) takes a closer look at the securities lawsuits that were filed against life sciences companies in 2009.

According to the memo, there were 19 life sciences companies sued in securities class action lawsuits in 2009, representing roughly 10% of all 2009 securities suits. The 2009 filings against life sciences companies represents a slight decline from the 23 that were filed in 2008, but the proportion of all filings as the same, as the 23 filing in 2008 also represented about 10% of all filing. These proportions are slightly down from but roughly equal with the immediately preceding years – 14% in 2007, 13% in 2006 and 16% in 2005.

Consistent with prior years, the majority of 2009 life sciences company filings (12 out of 19) were brought against companies with market capitalizations under $250 million. This is roughly proportionate to the representation of companies of that size among all life sciences companies, as companies with market capitalizations under $250 million represent about 65% of all life sciences companies.

By contrast to prior years, but perhaps consistent with the overall economic environment, the 2009 life sciences lawsuits were more focused on allegations of financial improprieties rather than claims of misrepresentations involving industry-specific issues such as product safety or efficacy. Nine of the nineteen cases involved allegations of accounting improprieties, compared to six alleging misrepresentations involving product safety and six involving the prospects for or timing of FDA approval.

One particularly interesting section of the memorandum is its analysis of the current status of the securities lawsuits that were filed against life sciences companies in 2007. The memo reports that of the 25 life sciences lawsuits filed that year, 13 (or more than half) have either been dismissed or had summary judgment entered for the defense. As the memo notes this is "an exceptionally high rate of dismissals" (compared, for example, to the historical norms of securities lawsuit dismissals in the 33-40% range).

According to the memo, this dismissal rate suggests that "the securities fraud complaints brought against life sciences companies (at least in 2007) were not particularly well founded." The basis for dismissal of a majority of the dismissed cases was the plaintiffs’ failure to adequately plead scienter.

The memo includes a reference to the possibility, based on statements of DoJ officials, of life sciences companies’ increased exposure to FCPA enforcement proceedings, which also includes the possibility of civil litigation following on in the wake of disclosures of FCPA actions.

The memo’s analysis of the outcomes of the 2007 cases squares with my own perception that life sciences companies are frequently sued, perhaps more frequently than other companies, but that plaintiffs’ lawyers often have a hard time making the allegations stick. The memos analysis suggests that even if life sciences companies are sued more frequently than companies in other industries, the claims against life science companies may be dismissed more frequently as well.

Special thanks to David Kotler, the author of the Dechert memo, for sending me a copy of the memo.

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In prior posts (most recently here), I discussed the fact that while litigation against the financial sector has predominated recent securities lawsuit filings, plaintiffs’ attorneys also have targeted other sectors, including in particularly the life sciences sector. An April 2009 memorandum by David Kotler of the Dechert law firm entitled "Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies" (here) takes a closer look at the 2008 life sciences securities lawsuits and analyzes the allegations on which the claims are based.

The memo notes that the 23 securities lawsuits filed against life sciences companies in 2008 is about the same number as the 25 life sciences securities lawsuits filed in 2007. However, the report also notes that the 2008 life sciences securities lawsuit filings represented only 10% of all securities lawsuit filings during the year, compared to 14% in 2007. The report attributes this slight drop to the fact that securities lawsuits in the financial sector "skyrocketed" in 2008.

The memo reports that, similarly to prior years, half of the life sciences companies sued in 2008 were very small, with market capitalizations below $250 million. However, by contrast to 2007, when nearly half of the life sciences companies sued had market capitalizations greater than $10 billion, on 2008 "only 13% of total actions were brought against the largest companies."

With respect to the allegations raised in the new lawsuits, the memo notes that in 2008, the majority of claims "pertained to accounting improprieties and/or misstated or misleading financial results and forecasts, by comparison to the 2007 filings, where industry-specific issues such as product safety, efficacy or marketing predominated.

The memo does note that about 25% of the 2008 filings contained allegations of alleged misrepresentations or nondisclosure regarding the commercialization or marketing of the product, and about 25% alleged that the defendants had made false and misleading statements about the safety of their product.

The memo also notes that one trend observed in 2007 had continued in 2008; that is, the plaintiffs’ lawyers are continuing to include key research personnel as defendants, on the apparent theory that these individuals "had a high level position within the company and access to internal information," and therefore "they knew and failed to disclose the allged adverse non-public information." The memo reports that key research personnel were named as defendants in five of the 23 life sciences securities lawsuits filed in 2008.

With respect to the likelihood of future litigation in the sector, the memo notes that life sciences companies "are particularly vulnerable to securities lawsuits because of their inherently volatile stock prices, often driven by a drug or device product life cycle that is fraught with potential for adverse and unpredictable events." That vulnerability "may increase in coming months and years when the boom of securities class actions in the financial sector busts." The memo speculates that "once plaintiffs’ targets in the financial sector dry up, other sectors, including life sciences, may see an increase in lawsuits aimed their way."

In discussing the 2007 version of Dechert’s life sciences securities litigation report, I had raised (here) the question whether or not the numerous lawsuits against life sciences companies actually were successful, and in particular, I asked whether or not the cases were dismissed more frequently than other securities lawsuits. The 2008 Dechert memo addresses these questions by taking a look at how the 2007 life sciences securities lawsuits have fared so far.

The 2008 memo reports that of the 25 life sciences securities lawsuits filed in 2007, eleven have been dismissed and two have settled. The memo states that the two settlements are "within the standard range" for securities lawsuit settlements generally, and that the dismissal rate "mirrors that of securities class actions in general."

The dismissals largely have been based on the plaintiffs’ failure to fulfill the requirements for pleading scienter. The memo comments that "though plaintiffs may be given multiple opportunities to amend their complaints, they will not be able to survive a motion to dismiss with general, conclusory or generic allegations of knowing misconduct."

The Dechert memo’s tally of 23 life sciences securities lawsuits in 2008 squares with my own count. I note that in preparing my count of the life sciences lawsuits, I had used a rather narrow definition of the category, limiting the "life sciences" companies to those either in SIC Code series 283 (Drugs) or SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies).

The memo, which concludes with practical risk minimization suggestions, is quite good and merits reading at length and in full.

Special thanks to the author of the Dechert memo, David Kotler, for providing me with a copy of the memo.

The Rise and Fall of Bill Lerach: The Professional Liability Underwriting Society (PLUS) has posted its acclaimed video, "The Rise and Fall of Bill Lerach," on the members’ section of its website. PLUS members can access the video here. The video alone might justify cost of membership. A trailer of the video can be found on the Securities Docket site, here.

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The 2008 securities lawsuit filings were dominated by new lawsuits filed against companies in the financial sector, as has been well-documented elsewhere (refer here). But while lawsuits against financial companies were the most prominent feature of the 2008 securities filings, there were also a significant number of lawsuits filed against companies outside the financial sector. In particular, life sciences companies, which historically have experienced a heightened level of securities litigation exposure, suffered a significant level of litigation activity once again in 2008.

For purposes of this post, I am including under the heading "life sciences" companies any company either in SIC Code series 283 (Drugs) or in SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies). Reasonable minds could differ about whether additional categories should also be included within life sciences companies, but the interests of simplicity and consistency with my own prior analyses support this categorical definition.

A review of the 2008 securities lawsuit filings shows that, notwithstanding the primacy of litigation involving financial companies during the year, heightened securities litigation activity involving life sciences companies continued in 2008.

According to my analyses, during 2008, there were 15 new securities lawsuits filed against companies in the 283 SIC Code series, including nine in the 2834 SIC Code category (Pharmaceutical Preparations). There were also eight securities lawsuits filed against companies in the 384 SIC Code category, including five in the 3845 SIC Code category (Electromedical Apparatus).

The fact that there were 23 new securities lawsuits filed against life sciences companies in 2008 is quite remarkable given the predominance of the credit crisis litigation wave.

The total number of life sciences lawsuits is significant in relative terms as well. By way of comparison to the 23 new securities lawsuits filed against life sciences companies in 2008, there were 21 securities lawsuits filed against life sciences companies in 2007. (My detailed analysis of the 2007 life sciences securities lawsuits can be found here.)

The fact that the number of lawsuits filed against life sciences companies actually increased in 2008 is extraordinary in light of the extent of the surging credit crisis litigation wave.

The 23 securities lawsuits filed against life sciences companies in 2008 represents approximately 10% of the total of 226 new securities lawsuits overall that were filed in 2008, which is comparable to the 12% that life sciences lawsuits represented of 2007 securities lawsuit filings.

That this significant of a percentage of securities litigation activity is unrelated to the credit crisis litigation wave underscores a point I have previously emphasized (for example, here), that while the subprime and credit crisis-related litigation wave is a significant factor driving securities lawsuits filing activity, it is by no means the sole factor.

The lawsuits filed against life sciences companies in 2008 involved a wide variety of allegations. The most common allegation, asserted in five of the lawsuits, is that the defendant company misrepresented the results or progress of one or more of its clinical trials. Lawsuits filed against four companies alleged financial misstatements or improper revenue recognition.

Other lawsuits involved allegations relating to disclosures about product efficacy; manufacturing deficiencies or controls; merger integration issues; misrepresentations about an officer’s credentials; intellectual property concerns; and product commercial viability.

The attributes of these companies that most frequently attract litigation is the combination of their susceptibility to disruptive events and the vulnerability of their share prices. These kinds of setbacks are an almost inevitable attribute of the regulatory and scientific environment in which these companies operate. However, these kinds of risks are also often comprehensively disclosed.

As a result, though life sciences companies are frequently sued, they have not proven to be easy targets. As I noted here and here, lawsuits filed against life sciences companies are frequently dismissed. Nevertheless, life sciences companies continue to attract the unwanted attention of the plaintiffs’ lawyers.

Securities Litigation Survey: Readers interested in securities litigation topics under the year-in- review heading will want to take a look at  the January 2009 memorandum by the Skadden law firm entitled "Securities Litigation 2008 – Noteworthy Decisions" (here). The memorandum does a particularly good job briefly summarizing the eleven decisions discussed as well as identifying the significance of the decisions.

Early Registration Deadline Approaching: The early registration deadline for the C5 D&O Liability Insurance Conference is approaching. The Conference is scheduled to take place March 24 and 25, 2009 in London. As reflected in the program brochure, which can be accessed here, the program has a number of interesting speakers and will be addressing many of the current hot topics in D&O insurance. I will be participating in a panel entitled "Current Litigation Trends in Europe and the US: Are Class Actions on the Horizon?"

The early registration deadline for this conference is February 9, 2009, after which the registration fee becomes considerably more expense.

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The heightened susceptibility of life sciences companies to securities class action lawsuits is a phenomenon that I and others have previously noted (refer here). But while life sciences companies may experience greater securities class action claim frequency, many of these lawsuits against life sciences companies are dismissed (as discussed here).

In a case the First Circuit itself called “paradigmatic” of securities cases involving life sciences companies, the appeals court recently affirmed the lower court’s dismissal of the securities lawsuit pending against Biogen Idec and certain of its directors and officers. The court’s analysis is noteworthy because of its emphasis of the issues that contribute to the vulnerability of these kinds of companies to securities lawsuits. But by way of contrast I also discuss below a recent Ninth Circuit opinion reversing the district court’s dismissal of a securities lawsuit involving Gilead Sciences.

The First Circuit’s Opinion in the Biogen Idec Case: On August 7, 2008, in an opinion written by Chief Judge Sandra L. Lynch, the First Circuit issued its opinion in New Jersey Carpenters Pension & Annuity Fund v. Biogen Idec (here). The case involves Biogen’s alleged misrepresentations and omissions pertaining to Tysabri, a new drug for multiple sclerosis and other autoimmune disorders.

In November 2004, the FDA granted accelerated approval of Tysabri. Less than three months later, on February 18, 2005, continuing clinical trials “revealed that two patients had contracted a type of infection perhaps associated with the drug.” One of the two patients died. On February 25, 2005, the company voluntarily withdrew the drug from the market. Its stock price dropped and several lawsuits were filed.

In their amended complaint, the plaintiffs alleged that, in order to facilitate their sale of shares of company stock at inflated prices, the defendants misrepresented the safety and efficacy of the drug. As the First Circuit summarized the case, the “key theme” of the lawsuit is that the defendants were “aware or at least recklessly unaware of greater safety risks with TYSABRI for opportunistic infections, particularly in combination with other MS therapies, than had been announced to the public,” and that defendants “intentionally failed to disclose this information in order to keep the share price high.”

The district court dismissed the complaint, finding that while the plaintiffs had alleged material misrepresentations and omissions with appropriate specificity, they had not alleged scienter with appropriate specificity. The plaintiffs appealed.

In evaluating the plaintiffs’ allegations, the allegations relating to the timing of defendants’ receipt of information were critical, because, as the First Circuit noted, “defendants cannot have committed fraud if they did not know at the time that the failure to provide additional information was misleading.” In that regard, the First Circuit found that “plaintiffs’ amended complaint fails to allege facts both (1) as to when defendant had information about non-PML opportunistic infection and (2) that the information available sufficiently suggested a causal connection between TYSABRI and non-PML opportunistic infections.”

The First Circuit expressed its willingness to consider factual allegations supported only by confidential sources, but the confidential sources’ allegations did not create a strong inference of scienter, because the allegations do not indicate when during the clinical trials information about infections became known.

The court also found plaintiffs’ allegations that defendants had fraudulently failed to disclose dangers of use of Tysabri in combination with other drug therapies were insufficient. Plaintiffs’ allegations that defendants had no reasonable basis to say that Tysabri was safe in combination with other drug therapies, the First Circuit found, were “not nearly so compelling as opposing inferences from the undisputed facts in the record.”

Because the First Circuit concluded that the plaintiffs had not “sufficiently alleged … that defendants had any reason to know their statements were misleading before February 18, 2005,” the Court disregarded all insider trading prior to that date. Only one insider sale was alleged on or after that date, a February 18 sale by the company’s General Counsel. But the General Counsel was not a defendant to the Section 10(b) claim, and the First Circuit held that based solely on the General Counsel’s trading “a strong inference of scienter on the part of Biogen and other individual defendants cannot be drawn.”

The First Circuit found that the plaintiffs’ allegations of scienter were not sufficient to support an alleged violation of Section 10(b), and affirmed the district court.

The court’s opinion was informed by its observations of the peculiar characteristics of securities lawsuits filed against companies involved in the drug and device development business:

The situation here is paradigmatic of securities fraud cases against drug companies where a promising drug or medical device is approved by the FDA and then later proves to have health risks which affect the market for the drug.

The court also noted that disclosures about regulatory developments provide an important context within which sudden stock price changes can occur:

The investing public is well aware drug trials are exactly that: trials to determine the safety and efficacy of experimental drugs. And so trading in the shares of companies whose financial fortunes may turn on the outcome of such experimental drug trials inherently carry more risk than some other investments.

With these comments, the First Circuit recognized the circumstances that make life sciences companies susceptible to securities lawsuits. These companies have volatile share prices that are vulnerable to sudden shocks due to the uncertainty of the regulatory process or to unexpected safety concerns. All too often these reverses result in securities lawsuits, supported only by allegations that the reverses occurred and therefore company management must have known about the problems from which the reverses arose.

The First Circuit’s opinion also evinced an appreciation of the fact that merely because a company has encountered these types of setbacks does not mean that the company has committed securities fraud. The First Circuit’s analysis helps explain why both life sciences may find themselves accused of securities fraud more frequently than other kinds of companies, and also why these cases are frequently dismissed.

Ninth Circuit Reverses Dismissal of Gilead Science Case: But while a number of the securities lawsuits filed against life sciences companies may be dismissed, that certainly does not mean that life sciences companies inevitably prevail. Indeed, there have been a number of significant settlements in securities cases involving life sciences companies (particularly large pharmaceutical companies).

Life sciences companies also face the same challenges involved in securities claims against any corporate defendant, including the possibility that a victory at the trial court level can be reversed at the appellate level. That is exactly what happened in the securities litigation involved Gilead Sciences. In an opinion dated August 11, 2008 (here), the Ninth Circuit reversed the lower court’s ruling dismissing the case for failure to adequately plead loss causation.

Gilead’s flagship produce, Viread, is an agent used with other drugs to treat HIV. The complaint alleges that the company actively marketed the drug for off-label uses, in violation of FDA rules. The company received a Warning Letter from the FDA on this topic, which the company disclosed on August 8, 2003. The company’s share price did not decline in response to this news; in fact, the share price was higher on the following trading days.

In order to address the absence of any share price decline, the plaintiffs alleged that it was not until October 28, 2003 that the public “finally realized the impact of the off-label marketing and the Warning Letter.” After market close that day, the company disclosed that Viread sales had fallen below expectations due to wholesaler overstocking during the quarter. Market analysts attributed the sales decline to “lower end-user demand.” The plaintiffs alleged that the reduced demand was “a direct result” of the Warning Letter, which exposed Gilead’s off-label marketing.

The district court found that the complaint failed to “connect the chain of events” between the failure to disclose the off-label marketing; that the decline in demand for Viread was due to the Warning Letter; and that the reduced sales caused a decrease in Gilead’s share price. The district court said there were “too many logical and factual gaps.” The district court said it could not make “the unreasonable inference that a public revelation caused a price drop three months later.” The district court dismissed the complaint for failure to adequately plead loss causation.

The Ninth Circuit, by contrast, found “the complaint sufficiently alleges a causal relationship between (1) the increase in sales resulting from the off-label marketing, (2) the Warning Letter’s effects on Viread orders, and (3) the Warning Letter’s effect on Gilead’s share price.”

The Ninth Circuit went on to observe that “perhaps what truly motivated the dismissal was the district court’s incredulity.” The Ninth Circuit said that a district court ruling on a motion to dismiss “is not sitting as a trier of fact,” and as long as plaintiffs allege a theory that “is not facially implausible, the court’s skepticism is best reserved for later stages … when the plaintiffs’ case can be rejected on evidentiary grounds.” The Ninth Circuit concluded that “a limited temporal gap between the time of the misrepresentation is publicly revealed and the subsequent decline…does not render a plaintiffs’ theory of loss causation per se implausible.”

The Ninth Circuit said the market “did react immediately to the corrective disclosure” which the plaintiffs claims to be the October 28 press release, the date on which it is alleged the market had complete information to process the revelations about off-label marketing.

It is hardly my place to comment on the merits of a judicial opinion. Suffice it to say that reasonable minds may differ whether the district court was guilty of “incredulity” or the Ninth Circuit of “credulity.” Reasonable minds may also differ whether the three months’ lapse between the disclosure of the Warning Letter and the stock price drop is a “limited temporal gap.” Reasonable minds may also differ whether plaintiffs’ Rube Goldberg explanation for the delayed market reaction “is not facially implausible.”

On the other hand, it seems apparent that the allegation of off-label marketing troubled the Ninth Circuit and it is certainly true that a company whose alleged reverses are not due to unexpected regulatory developments or unanticipated clinical outcomes but rather to marketing activities is in a less sympathetic postion. That is obviously why the plaintiffs strained so hard to try to make the stock price drop relate back to the off-label marketing Warning Letter, because that supposed connection put the defendants in a less favorable light. Regardless, I suppose, of whether or not the stock price drop was due to the wholesaler overstocking.

The one thing that is clear is that all litigants are susceptible to the vicissitudes of the litigation process, life sciences companies as well as any other kind of company. The plaintiffs in Gilead certainly established the value of continuing to fight, as you never know when an initially disfavored hand might still be just enough to take a trick. Of course, the plaintiffs must now go back to the district court and face a court whose skepticism even the Ninth Circuit acknowledged could justify rejecting plaintiffs’ case later.

The SEC Actions Blog has an excellent lawyerly analysis critical of the Ninth Circuit's opinion in Gilead, here.

More Drug News: Biogen Idec’s drug, Tysabri, which the FDA permitted the company to reintroduce to the market in July 2006, was back in the news recently. According to an August 1, 2008 Wall Street Journal article (here), two MS patients treated with the drug have recently contracted a potentially deadly brain infection. The article stated that the company “had no plans to recall the drug or restrict its use.”

The WSJ.com Health Blog also has a post (here) discussing this development. The comments following the post make for interesting reading. It is all too easy to consider these legal issues in a vacuum, but there are real patients whose only hope is the use of these kinds of drug therapies. The eloquent pleas of these patients for the drugs to remain available are moving and impressive.

But the adverse developments cannot be minimized, and in that regard it should also be noted that Biogen Idec also faces a lawsuit from the estate of one of the deceased patients. Recent procedural developments in the case were also discussed recently on the WSJ.com Health Blog (here).

All of that said,  this about business too, and it may come as no surprise that Carl Ichan viewed the stock price drop following Biogen’s recent advserse news as an opportunity to increase his holdings in the company’s shares, perhaps to advance his agenda of getting the company to sell itself, as discussed here.

There is a Balm in Gilead: Perhaps I am presuming too much, but for me the name Gilead Sciences evokes Jeremiah, Chapter 8, Verse 22: “Is there no balm in Gilead? Is there no physician there? Why then has the health of my poor people not been restored?” (New Revised Standard Version).

This line is memorably recalled in the African-American spiritual, There is a Balm in Gilead, whose refrain captures the soothing power of the song:

There is a balm in Gilead

To make the wounded whole;

There is a balm in Gilead

To heal the sin-sick soul.

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In prior posts (most recently here), I have discussed the fact that life sciences companies remain a favored target of the plaintiffs’ securities bar. A June 2008 memorandum by Michael Kichline and David Kotler of the Dechert law firm entitled “Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies”  (here) takes a closer look at the 2007 life sciences securities lawsuits and concludes that “life sciences companies remain firmly in the crosshairs of the plaintiffs’ securities bar.”

The authors note that the 25 securities class action lawsuits filed in 2007 against life sciences companies represents a 64% increase over the 16 filed the preceding year, and also represents 14% of the 175 total securities lawsuits filed in 2007. (My own numerical analysis of the 2007 life sciences lawsuits, which can be found here, differs slightly, but only in the details, not the direction, and the difference undoubtedly is due to the narrow definition of “life sciences” I used in my analysis.)

The authors also have a number of interesting observations about the 2007 life sciences lawsuits, including the fact that “life sciences companies with the greatest market capital -- more than $10 billion – were sued at the same rate as companies with less than $250 million.”

The authors also note that the securities lawsuit allegations against life sciences companies “continue to span the product life cycle” and that many of the companies sued 2007 were sued “based on information they communicated, or failed to communicate, to the public about a drug’s efficacy, safety, and/or the results of the FDA approval process.”

One particularly interesting observation in the study is that “research personnel were frequently named as defendants,” and specifically that in five cases, the plaintiffs alleged that because “key research personnel had a high level position with the company and access to internal information, they both knew and failed to disclose the alleged adverse non-public information.”

The authors predict that life sciences companies will continue to be the targets of securities fraud lawsuits, noting that “the structural factors that lead plaintiffs’ lawyers to target life sciences companies – volatile stock prices and a drug or device product life cycle fraught with potential for adverse and unpredictable events, such as a negative clinical trial result of FDA decisions – remain challenging, especially in the current stock market and regulatory environment.” The authors predict that plaintiffs’ counsel will continue to strive to find new theories. The authors cite as an example the likelihood that “more securities lawsuits will be premised on off-label communication or sales.”

The survey, which concludes with practical risk minimization suggestions, is quite good and merits reading at length and in full.

While I concur in all of the authors’ views, I think that in order to fully appreciate life sciences companies’ securities litigation exposure, it is important to consider not only the lawsuit filings, but also the case dispositions. Life sciences companies may be frequent lawsuit targets, but that does not mean that all or even most of the lawsuits are meritorious.

As I have noted in prior posts (most recently here), many of the securities lawsuits filed against life sciences companies are dismissed. Indeed, many of the large life sciences companies that have been targeted in securities suits in recent months – including, for example, Guidant, Pfizer and Astra Zeneca – have successfully managed to get the cases dismissed. And it is not just the larger companies that have prevailed; smaller companies, such as, for example, Micrus Endovascular (which recently prevailed on its motion to dismiss, about which refer here), have also prevailed on their dismissal motions.

To be sure, there have also been many settlements of life sciences securities lawsuits, some of which have been quite significant. But overall life sciences securities lawsuits have not always been as productive for the plaintiffs’ lawyers as might be suggested by the sheer numbers of filings.

I do agree that the volatility of life sciences companies’ share price and the companies’ susceptibility to product-driven dislocations will continue to attract the unwanted attention of the plaintiffs’ lawyers. The good news for these companies is that they have potentially effective defenses available and they may be able to use these defenses to stave off the litigation assault. The risk protection steps suggested in the authors’ memorandum are particularly good starting points for preparing these defenses.

Special thanks to David Kotler of the Dechert firm for providing me with a copy of the life sciences securities litigation survey.

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