As has been documented on this blog and elsewhere, life sciences companies in general, and developmental stage biotechnology companies in particular, are frequent securities class action litigation targets. But does that really justify the perception of early stage biotech companies as representing a heightened securities litigation risk class for D&O insurers? A recent law firm paper contends that “contrary to popular belief, development stage biotech companies actually have less to fear from federal securities cases that do many other types of corporate defendants that have a far easier time securing insurance coverage.”
This helpful paper, written by Doug Greene and Genevieve York-Erwin of the Lane Powell law firm and Michael Tomasulo of AH&T, entitled “Myths & Misconceptions of Biotech Securities Claims: An Analysis of Motion to Dismiss Results from 2005-2016” appears as a March 15, 2017 post on The D&O Discourse blog (here), raises some very interesting points about the securities class action litigation risk exposures of biotech companies.
Early Stage Biotech Company Securities Suit Dismissal Rate Analysis
The authors examined the 61 final district court decisions during the period 2005 to 2016 on motions to dismiss in securities suits involving biotech companies, in which the company did not already have a drug or device on the market and its alleged false or misleading statements concerned clinical trials or the FDA approval process for its primary drug or device candidate.
Based on this review, the authors conclude that the developmental stage biotech company defendants are more likely to have their cases dismissed early in the litigation than other securities lawsuit defendants. “Contrary to conventional wisdom,” the authors state, their analysis “indicates that federal securities claims brought against biotech companies regarding the regulatory approval process actually are dismissed more frequently than average at an early stage in the litigation.”
The authors found that for the dismissal motion rulings that met their criteria, 69% resulted in complete dismissals (compared to a dismissal rate for cases in general between 33% to 40%). Moreover, the authors concluded that the dismissal rate appears to have increased in recent years. 78% of the decisions in the data set between 2012-2016 resulted in complete dismissals, compared to only 56% between 2005-2011.
The authors further note that this apparent dismissal rate increase occurred even as more securities suits are being filed against smaller biotech companies; 36 decisions in the study came from the most recent five year period, compare to only 25 in the previous seven year period.
Exploding the Other “Myths” About Biotech Company Securities Suits
Based on their analysis, the authors also concluded that a number of other frequent securities litigation assumptions about developmental stage biotech companies are merely “myths.”
First, they concluded, contrary to the myth that lawsuits against biotech companies involving the FDA approval process are “risky and expensive,” in fact “about two thirds of these cases are dismissed in full,” adding the observation that “with self-insured retentions that average a million dollars or more most such cases will not even exhaust the company’s retention.”
Second, contrary to the myth that biotech companies are at risk if they speak too positively regarding their clinical trial expectations, the authors conclude that courts recognize the inherent uncertainty in the FDA approval process and understand that predictions sometimes will prove wrong. From a legal standpoint, the biotech companies are able to rely upon the U.S. Supreme Court’s Omnicare decision (about which here), which protects statements of opinion as long as they are genuinely held and not misleading when considered in the full context. The company’s optimistic forward-looking statements may also be protected by the PSLRA’s safe harbor provisions.
Third, despite the myth that companies’ positive spin on negative results may be viewed as misleading, the authors found that even in the face of bad news, positive statements of opinion will not be viewed as false or misleading if they are honestly held and made within the proper context, especially where the company accurately discloses the underlying facts.
Finally, the authors conclude that, contrary to the common myth, biotech companies may even be able to get cases dismissed where there was capital raising or insider selling during the class period. While these facts may contribute to a finding of scienter, what may be more important is the “overall story” – that is whether the alleged motivation to commit fraud makes sense in light of the larger narrative of the company’s circumstances.
The Lessons for Defending Biotech Company Securities Suits
In addition to these overall conclusions about biotech companies and the outcomes of their motions to dismiss, the authors also reached a number of conclusions about how biotech companies many best defense themselves when they are hit with securities suits, as well as a number of steps biotech companies can take to try to position themselves better in case they are targeted with securities suits.
As far as ways to defend themselves, the authors note, first, that courts seem to be “influenced by their overall impressions,” and in particular seem to be “swayed by their overall sense of whether or not company management has honestly been doing its best to bring a product to market and inform investors of significant developments in a timely manner.” The authors note in that regard that two underlying beliefs reflected in courts’ opinions may contribute to the high dismissal rates for biotech companies: (1) that the development of new drugs and medical devices constitutes an important public good; and (2) that investment in development stage companies is inherently and particularly risky.
Second, as far as defending themselves, biotech companies are not likely to get in trouble about statements concerning their flagship products, as long as the statements are “honestly believed and are accompanies by disclosures acknowledging specific, relevant uncertainties.” Under Omnicare, a statement of opinion is only actionable if the speaker does not believe the statement or omits facts that make it misleading when viewed in its full context. This standard provides defendants to emphasize the larger context within which the statement was made. This required contextual analysis “favors defendants” and makes it even more likely that defendants’ statements of opinion — such as optimistic predictions about FDA approval or clinical results – will be dismissed, provided the defendants genuinely held those opinions.
Third, and in addition to the point about Omnicare and the law of opinion, predictions of clinical trial success or FDA approval may also be protected as forward-looking statements under the PSLRA safe harbor, as long as they are accompanies by specific and meaningful cautionary language.
Fourth, courts routinely dismiss challenges to a company’s clinical methodology or analysis. Statements interpreting clinical trial results often are found to be non-actionable expressions of opinion, although where the plaintiffs present specific allegations that the defendants were intentionally misrepresenting or manipulating data, the courts often allow those cases to go forward.
Finally, the riskiest areas for companies concern disclosures relative to FDA feedback. These claims survive motions to dismiss more often than other types of statements in biotech cases, perhaps because companies “too often cherry-pick the FDA they choose to disclose.”
The Lessons for Biotech Companies’ Disclosure Practices
Given these conclusions about how biotech companies can best defend themselves when they are hit with securities suits, there are implications for biotech companies’ disclosure practices and the ways that they can be better positioned to defend themselves when claims do arise.
First, if a company wants to express an opinion about its interactions with the FDA, it can protect itself by accurately and clearly disclosing the important positive and negative underlying facts regarding the FDA interactions.
Second, selective disclosure of some facts but not others can create difficulties and must be done with care and transparency. If a company chooses to disclose interim FDA feedback, it should do so fairly, reporting both positive and significant negative components of that feedback at the same time.
Third, companies should not overstate or misconstrue FDA opinions. Biotech firms will be best served by couching any optimism is wants to express in terms of the company’s own feelings and expectations, rather than positively characterizing the FDA’s feelings and intentions and sticking to accurate, factual accounts of FDA feedback.
The authors close their paper with the conclusion biotech companies may have less to fear from securities litigation than other kinds of companies because courts are sympathetic to the inherent risks of the industry and seem primed to dismiss these kinds of suits when the defendants can present a “credible narrative of good faith conduct.” Moreover there are steps that companies can take to better position themselves for defense in case they are sued.
The authors’ analysis is helpful and important. There is no doubt that because of the perception of heightened litigation frequency among developmental stage biotech companies, D&O insurance underwriters treat the industry as a disfavored risk class, meaning that the companies often pay higher premiums on less favorable terms compared to the premiums and terms available for smaller companies in general. The authors’ analysis about the dismissal rates for suits against these kinds of companies underscores the report’s conclusion that these kinds of companies may actually have less to fear from securities litigation than do other kinds of companies.
I also note that the authors’ dismissal rate analysis is consistent with the analysis of Michael Klausner and Jason Hegland of Stanford Law School, that owing to changes in the plaintiffs’ bar (including in particular the rise of “emerging” law firms) more lawsuits are being filed against smaller companies, but that these kinds of cases have higher dismissal rates than do cases filed by more traditional firms against a wider range of companies. Klausner and Hegland’s analysis can be found in a prior guest post on this site, here.
One thing that I think would be helpful to even further make the case to D&O insurers about the relative riskiness of developmental stage biotech companies would be if the authors were to complete the picture with a severity analysis. D&O insurers may still hang back from this class despite the dismissal rates depending on severity levels shown by the settlements of the cases that are not dismissed. I suspect that the severity analysis will show that in general the average and median settlements are lower for these kinds of cases than for the larger run of securities lawsuits. This severity information, along with the news about the higher dismissal rates, might convince insurers to compete for excess level placements for these kinds of companies, which in turn could lower their overall costs of insurance.
I am a little wary of the implications of some of the authors’ statements. The authors suggest that many of these cases are or can be defended and dismissed with defense expenditures within or below the amount of their D&O insurance policy’s self-insured retention. My concern here is that in general the D&O insurance industry lacks sufficient defense cost information to make the calculations about the appropriate retention levels, such that the primary D&O insurers might overshoot the mark in setting the retention amount – this line of analysis could end up with these kinds of companies facing retention levels that are inappropriately high.
This line of analysis also leads to the possibility that for biotech companies hit with these kinds of lawsuits, the cost of getting through the motion to dismiss could wind up being essentially a self-insured exposure, meaning that these kinds of companies wind up paying exorbitant rates for insurance that provides no little or no actual protection for the majority of claims.
All of that said, there are some important lessons here not just for the biotech companies themselves (in terms of how to conduct their public disclosures), but also for the D&O insurance community.
The most obvious lesson –which is the basic point the authors make in their paper – is that because of the heightened dismissal rate, developmental stage biotech companies arguably do not represent the level of securities litigation risk exposure that the D&O insurance industry may be assuming.
There is another important lesson here for the D&O insurance underwriters, and that is that the way that companies communicate makes big difference in whether or not they will be able to successfully defend themselves. I would go further and argue that the way that companies communicate will in the end play a big role in whether or not they even get sued in the first place.
That means that D&O insurance underwriters that want to play in this space (and there are those that do want to play in this space notwithstanding the risks, because of the elevated premiums that are available), there are big incentives to differentiate between companies based on their communications practices. The authors’ analysis and conclusions can be gleaned in order to establish a set of criteria to be used in underwriting companies within this risk class, in order to identify the ones that present a lower risk profile despite their presence in a higher frequency risk class.
My thanks to the authors for their work and analysis. I am always grateful when anyone undertaking a research project like this is willing to share their results publicly. It helps everyone. Tip of the hat to Doug Greene and his colleagues for this interesting and helpful paper.