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

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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When the United States Supreme Court issued its June 21, 2007 opinion in the Tellabs case, media commentators generally viewed it as a defense victory. My own view (expressed here), was that the decision represented more of a draw, and that the practical impact would vary from Circuit to Circuit. The suggestion that Tellabs was not a comprehensive defense victory was arguably reinforced in the ongoing Tellabs case itself, when (as discussed here) the Seventh Circuit, reconsidering the case on remand from the Supreme Court, reaffirmed its prior reversal of the district court’s dismissal of the case.

An April 16, 2008 opinion (here) from the First Circuit in the Boston Scientific securities lawsuit provides even further support for the view that Tellabs by no means put the plaintiffs’ lawyers out of business, and indeed, that in some circuits – the First Circuit, for example – Tellabs may even put the plaintiffs in a better position than the were prior to Tellabs. I discuss the First Circuit’s opinion in the Boston Scientific case in detail below, but the critical point here is that the while the district court, applying the First Circuit’s pre-Tellabs standard, had dismissed the case, the First Circuit, applying the Tellabs standard, reversed the district court and remanded the case for further proceedings.

The background regarding the Boston Scientific case can be found here. In a nutshell, the complaint alleges that in late 2003, the company became aware of serious problems in Europe with its TAXUS stent, which at the time had not been introduced in the U.S. The company allegedly experienced serious problems, allegedly of the same kind as the prior problems in Europe, after the stent was introduced in the U.S. in March 2004. The plaintiffs allege that the company sought to soft-pedal the problems by representing that they were due to physician unfamiliarity with the stent, while the company allegedly knew that the problems were actually due to manufacturing defects. The defendants allegedly withheld the true information while TAXUS sales drove up the company’s share price, allegedly in order to permit the defendants to unload their shares of the company’s stock at the inflated prices. After the company announced a series of stent recalls, its share price fell and the securities litigation ensued.

In an opinion dated June 21, 2007 (here), issued ironically the same day as the U.S. Supreme Court issued its opinion in the Tellabs case, the district court granted the defendants’ motion to dismiss. Among other things, the district court held that the plaintiff failed, as required under the PSLRA, to plead facts supporting a “strong inference” that as of the time of the stent recall and manufacturing changes, the defendants had the requisite scienter. The plaintiffs appealed.

The First Circuit, in an opinion written by Judge Sandra Lynch, noted that “the district court did not have the benefit of the Tellabs opinion, which reversed a higher standard for scienter imposed by the prior law of the circuit. We apply Tellabs and that leads us to a different result.” The court went on to note that “while there is support for the defendants’ inferences, we think, at this stage, that plaintiff’s inferences are at least equally strong.”

The First Circuit also reversed the district court’s holding as to reliant on the view that the plaintiffs’ allegations were essentially just “fraud by hindsight.” In addition, the First Circuit said that while the plaintiffs’ insider trading allegations are “on the weaker end of the spectrum…a finder of fact could reasonable ask why [the defendants] would have sold so much stock at a time when the company appeared to be soaring on the strength of TAXUS.” On these and other bases, the First Circuit concluded that “plaintiff has pled enough to give rise to inferences that are at least as strong as any competing inference regarding scienter.”

In reversing the district court, the First Circuit expressly acknowledged that Tellabs has reversed “a higher standard” that the First Circuit itself had previously “imposed” as the “law of the circuit.” This specific statement is an explicit recognition that, in the First Circuit at least, the Tellabs standard not only did not advance the defendants’ interests, but it arguably aids’ plaintiffs’ interests by imposing a lower threshold pleading requirement.

At a minimum, the First Circuit opinion in the Boston Scientific case underscores that the Tellabs opinion represents something less than that the watershed defense victory it was initially portrayed to be. The decision also highlights that even after Tellabs, in certain circumstances, plaintiffs will be able to continue to meet the PSLRA’s pleading requirements – particularly in certain circuits.

Another Options Backdating Securities Lawsuit Dismissal: In the latest dismissal motion ruling in an options backdating-related securities lawsuit, Judge Susan Illston of the United States District Court for the Northern District of California, in an April 14, 2008 opinion (here) in the UTStarcom case (about which refer here), granted the defendants’ motion to dismiss, and directing the plaintiff to file an amended complaint by May 16, 2008.

Judge Illston found that while the plaintiff had adequately pled loss causation, he had not adequately pled scienter. In rejecting the plaintiff’s scienter allegations, Judge Illitson found that “none of these factual allegations is cogent and compelling…because each could equally support the inference that the stock option had been backdated through innocent bookkeeping error.”

The UTstarcom dismissal is the latest in a series of options backdating-related securities lawsuit dismissals, as discussed in my recent post (here) commenting on other recent dismissals. I have added the UTStarcom dismissal to my running tally of the options backdating lawsuit dismissals, denials, and settlements, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for copies of the Boston Scientific and UTstarcom opinions.

A Reflective Moment: The coincidence that both of the opinions cited above were both written by women made me wonder something – how many female members of the federal judiciary are there? The answer, determined after a little bit of Internet research, is that there are a lot of female federal judges, although women clearly are still underrepresented on the U.S. Supreme Court, the First Circuit, and several other federal courts. A slightly outdated list of women in the federal judiciary can be found here.  

The list includes, among others, Leonie M. Brinkema, now a district court judge on the United States District Court for the Eastern District of Virginia. I had the privilege of seeing Judge Brinkema, while she was still known to some as “Dee Dee”, appear in court when she was an AUSA (and I was a clerk for a federal judge). She was the most skilled and effective advocate I ever saw in action.  

I learned many things from watching her, including the lesson that you did not have to be loud or obnoxious to be an effective advocate, a very important lesson for a young attorney to learn. If others of my brethren (and sistren) at the bar could also have learned the same lesson, I might still be involved in the active practice of law. Judge Brinkema is perhaps best known for presiding over the trial of 9/11 conspirator Zacharias Moussaoui, whom she told at his sentencing to life imprisonment that he would "die with a whimper."

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