It is now a commonplace observation in the D&O arena that life sciences companies – and in particular small biopharma companies – are frequent targets of securities class action lawsuits. As a result of these observations about claims frequency, biopharma companies often pay more than other kinds of companies for their D&O insurance. But do these companies really face a heightened securities litigation exposure sufficient to warrant these higher rates? The following guest post examines this question. This post was written by Michael Klausner, Professor of Law, Stanford Law School, Jason Hegland, Executive Director, Stanford Securities Litigation Analytics, and SSLA researchers Carin LeVine, Julia Laurence and Quito Mali Tin-Hung Tsui. I would like to thank the authors for their willingness to allow me to publish their guest article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ guest post.
It is well known that biopharma companies, especially small firms reliant on one or two drugs in clinical trials, are frequent targets of securities class actions. Doug Greene, Genevieve York-Erwin and Michael Tomasulo observed in a March 14, 2017 D&O Discourse blog post titled, “Myths & Misconceptions of Biotech Securities Claims: An Analysis of Motion to Dismiss Results from 2005-2016,” that these companies have difficulty obtaining D&O insurance and when they do obtain it their premiums are high. Using data from the Stanford Securities Litigation Analytics (SSLA) database, we take a closer look at the risk facing biopharma firms with market capitalization under $1 billion, and we find that the prospects these firms face with respect to securities class actions is only slightly worse than that faced by firms of comparable size in other sectors. Small biopharma companies are targeted more frequently than are firms in most sectors, and settlements in cases against them are relatively large, but the dismissal rate for biopharma cases are much higher than dismissal rates for cases against firms in other sectors. As a result, the probability-discounted cost facing biopharma firms is not as high as apparently perceived.
We also show that the primary source of litigation against small biopharma firms is a group of plaintiffs’ law firms that we described in an earlier post as “emerging firms.” As we explained there, this is a group of firms that largely account for the steady increase in the volume of class actions over the past six years, and that tend to target smaller firms and allege smaller shareholder losses.
Figure 1 shows the distribution of securities class action filings across all sectors defined by the Global Industrial Classification System (GICS) during the period 2011 to 2017. The “health care” sector’s “biotechnology” and “pharmaceuticals” sub-industries (which we will refer to as “biopharma”) ranks high with 183 lawsuits, or roughly 17% of filings over this period.
Figure 1: Lawsuits Filed by Sector (2011 – 2017) (N =1,054)
Frequency and Content of Suits Against Small Biopharma Firms
In Figure 2 and 3, and for the remainder of this post, we focus on firms with a market cap of under $1 billion. In the biopharma sector, this limits the analysis to firms engaged in drug development that are highly dependent on the outcomes of clinical trials and FDA approval. This is the subsector of the biopharma sector that is considered particularly risky.
Figure 2 shows the number of filings against companies with market cap under $1 billion in each sector. The volume of suits against biopharma firms of this size is also relatively high—116 suits, or roughly 21% of suits against firms under $1 billion.
Figure 2: Number of Filings Within Each Sector 2011 – 2017 (Companies under $1 billion market cap, N = 546)
Figure 3 shows the percentage of publicly held companies in each sector, with market caps under $1 billion, that have been targeted in one or more securities class actions since 2011. Again, among smaller biopharma firms, a relatively high percentage are sued—100 companies out of 557 publicly held biopharma companies in this size range, which comes to 18%. In fact, the risk of a lawsuit for small biopharma firms is somewhat worse than indicated in Figure 3 because, among small biopharma firms sued, 16% have been sued two or more times between 2011 and 2017. The next highest sector in terms of multiple suits is industrials, where the comparable figure is 11%. The rate of lawsuits against biopharma companies of this size is about 21% over the seven-year period we are analyzing—that is 116 lawsuits across 557 public biopharma companies. The comparable figure for non-biopharma companies is 13%.
Figure 3: Companies Sued as a Percent of Public Companies by Sector 2011 – 2017 (Companies under $1 billion market cap)
Note: 546 companies were sued among the 3,917 publicly held companies in the CRSP database during this period with market valuations under $1 billion.
Class actions against small biopharma firms rarely involve allegations of accounting-related misstatements. Of the 116 suits filed against small biopharmas from 2011 to 2017, only seven (6%) allege accounting misstatements. Figure 4 describes the content of the 109 non-accounting cases. Seventy-five percent of those cases involve misstatements regarding clinical trials and the new drug application process. Among that subset of cases, 70% involve misstatements regarding Phase 3 clinical trials, and 33% involve misstatements regarding Phase 2 clinical trials. (Some cases involve misstatements regarding multiple phases of the development trial process, so the percentages in right-hand chart of Figure 4 do not add to 100%.) Cases among the 109 non-accounting cases that do not involve alleged misstatements about clinical trials and approval involve alleged misstatements related to a firm’s operations, the safety and efficacy of its drugs on the market, and compliance with regulatory guidelines in its facilities.
Figure 4: Non-Accounting Cases Filed Against Biopharma Firms 2011 – 2017 (Companies under $1 billion market cap, N = 109) (Types of alleged misstatements are not mutually exclusive.)
On average, these lawsuits involve substantial stock drops—stock drops that are greater than those associated with alleged misstatements in suits against firms of similar size in other sectors. Figure 5 shows stock drops associated with alleged corrective disclosures. Mean and median drops in biopharma cases are substantially larger than those in other cases.
Figure 5: Aggregate Disclosure Loss as Percent of Max Market Cap for Cases Filed 2011 – 2017 (Companies under $1 billion market cap, N = 546*)
* Calculating shareholder losses in relation to alleged misstatements and corrective disclosures is an ongoing project at SSLA, with a priority placed on settled cases. These figures are based on 54% of the 546 cases covered.
Dismissal and Settlement
While the frequency of lawsuits against small biopharma firms is relatively high, the dismissal rate is also high. Between 2011 and 2017, a total of 511 cases were resolved—100 against biopharma companies and 411 against others. As shown in Figure 6, the rate of dismissal was far higher in cases against biopharma firms than in cases against non-biopharma firms—62% compared to 46%, respectively. This differential in dismissal rates counterbalances the relatively high rate at which biopharma firms were sued during this period—21% vs. 13%, respectively, over seven years as explained above. If we combine the figures for the percentage of firms sued during the 2011 to 2017 period with the percentage of resolved cases that were settled—which as we have said come from two overlapping but different sets of cases—we find that the implied rate at which biopharma and non-biopharma firms face settlements are 8% and 7% respectively over a seven-year period. For biopharma firms, that comes to 1.15% per year and for non-biopharma firms, it means 1% per year.
Figure 6: Dismissal Rate for Cases Resolved 2011 – 2017 (Companies under $1 billion market cap, N = 519)
Figure 7 shows settlement size both in raw dollar figures and as a percentage of stock drop associated with alleged corrective disclosures. The dollar figures for mean settlements are essentially the same for biopharma cases as for other cases, but the medians are substantially different. Median settlements with small biopharma firms are $5.9 million compared to $3.8 million for cases against firms of similar size in other sectors. The difference between means and medians indicates that settlements for both sets of firms are highly skewed toward higher settlements, with non-biopharma skewed more. The lower variance of biotech settlements suggests that insurers may be able to predict the cost of biotech insurance policies more accurately than they can predict others. When measured as a percentage of the stock drop associated with corrective disclosures, the means and medians are roughly similar. In fact, biotech settlements are slightly smaller.
Figure 7: Settlement Sizes in Raw Dollar and as a Percentage of Stock Drop for Cases Resolved 2011-17 (Companies under $1 billion market cap, N = 258*)
* There were 264 settlements during this period. In 258 of those cases, the court has approved the settlement amount. Calculating shareholder losses in relation to alleged misstatements and corrective disclosures is an ongoing project at SSLA, with a priority placed on settled cases. These figures are based on 54% of the 546 cases covered.
What about the timing of settlements in the litigation process? This can affect defense costs and create distraction for management of a company trying to defend a lawsuit. As we have in past reports from our database, we divide the litigation process into three stages: early pleading, late pleading, and discovery. Early pleading settlements are those that settle prior to a ruling on a first motion to dismiss. Late pleading settlements are those that settle after an initial motion to dismiss is granted without prejudice, and before a subsequent motion to dismiss is either granted with prejudice or denied. Discovery stage settlements are those that settle after some or all of plaintiffs’ claims survive a motion to dismiss. Figure 8 shows the timing of settlements among biopharma firms and firms of similar size in other sectors.
Figure 8: Settlement Timing for Cases Resolved 2011-17 (Companies under $1 billion market cap, N = 264)
There is some bad news here regarding cases against small biopharma firms. Among the cases that are not dismissed, settlements tend to occur somewhat later in cases against small biopharma firms than among others. Twenty-four percent settle prior to the first ruling on a motion to dismiss—the early pleading stage—compared to 30% for cases in other sectors. That difference is essentially mirrored in the percentage of cases that settle during discovery—65% of biopharma cases settle at that stage compared to 59% of other cases. The higher rate of biopharma settlements occurring in discovery may be related to the high rate of dismissal for these suits. Defendants may tend to resist early settlements in biopharma cases in the hope of dismissal.
Emerging Firms vs. Established Firms
Readers may recall from our June 2016 guest post on the D&O Diary and a subsequent article in the Wall Street Journal in August 2018 with updated numbers, that we have attributed much of the increase in securities class actions over recent years to a group of three plaintiffs’ firms that we called “emerging” firms. Those firms have actually been around for quite some time, but the volume of their cases, as well as their overall share of the securities class action market, has increased dramatically in recent years. On the other hand, a group of firms that we called the “established” firms—the 10 firms that served as lead counsel more than any others since 2000 and that are credited with at least five of the largest 100 securities class action settlements during that period—accounted for none of the growth in securities class action.
As shown in Figure 9, the emerging firms cohort, to which we added an additional firm in 2017, is responsible for a disproportionately high number of shareholder class actions against small biopharma firms, and the established firms are responsible for a disproportionately small number of suits. Whereas among all securities class actions filed from 2011 to 2017, emerging and established firms have served as lead counsel 38% and 41%, respectively, they have served as lead counsel in, respectively, 54% and 13% of cases against small biopharma firms. The difference is even more stark when comparing on a per firm basis. Among all securities class actions filed from 2011 to 2017, emerging firms outpace established firms by more than two to one in lead counsel appointments among all securities class actions, and by more than ten to one among cases against small biopharma firms.
Figure 9: Plaintiffs’ Firms Targeting Biopharma Firms in Cases Filed 2011– 2017 (Companies under $1 billion market cap, N = 546)
The Bottom Line
The data described above show that securities class actions pose only a slightly greater danger for small biopharma firms than they do for firms of similar size in other sectors. The likelihood of a lawsuit is greater and, on average, settlements are larger for biopharma firms. On the other hand, the likelihood of dismissal is substantially larger for biopharma firms. How do the numbers net out? Based on data from 2011 to 2017, the probability of being a defendant in a case that settles—that is, a case that is not dismissed—is approximately 1.15% and 1% per year for biopharma and non-biopharma firms, respectively. The mean settlements in biopharma and non-biopharma cases are $9 million and $8.9 million, respectively. So, the probability-discounted cost facing biopharma firms is $103,500, compared to $89,000 for non-biopharma firms. As we explain above, those figures would be closer if we were to base them solely on the number of settled suits over the 2011 to 2017 period, as opposed to the number of suits filed and the percentage of resolved suits that have settled.
A more refined analysis might differentiate litigation risk among biopharma firms. As shown above, the likelihood of a lawsuit differs across phases of clinical trial. Perhaps stock drops and settlement sizes differ as well. The increased market share of the emerging firms raises additional question regarding the future of biopharma cases. Perhaps the result will be earlier settlements, which would be consistent with these firms’ practice generally, which may mean smaller settlements than what we have seen over the past seven years. Additional digging into the data may well be warranted.
 GICS is a proprietary industry classification system jointly developed by MCSI and S&P CapitalIQ.
 Biotechnology (GICS code 35201010) is defined as “companies primarily engaged in the research, development, manufacturing and/or marketing of products based on genetic analysis and genetic engineering. Includes companies specializing in protein-based therapeutics to treat human diseases. Excludes companies manufacturing products using biotechnology but without a health care application.”
 Pharmaceuticals (GICS code 35202010) is defined as “companies engaged in the research, development or production of pharmaceuticals. Includes veterinary drugs.” While the GICS definition does not specifically say so, drugs produced by pharmaceutical firms have a chemical basis. Conversely, drugs produced by biotechnology firms have a biological basis relying on organic material.
 This excludes GICS sub-industry Life Sciences Tools & Services (GICS code 35203010), which is defined as “companies enabling the drug discovery, development and production continuum by providing analytical tools, instruments, consumables & supplies, clinical trial services and contract research services. This includes firms primarily servicing the pharmaceutical and biotechnology industries.”
 Data in Figure 1 and throughout this post are for securities class actions brought under Section 10(b) of the Securities Exchange Act, Section 11 of the Securities Act and related provisions of those laws, and exclude merger objection suits under Section 14 of the Securities Exchange Act.
 We use the CRSP database to identify all publicly-held firms with stock or ADR / ADS that traded on the AMEX, NASDAQ or NYSE exchanges for any period between 2011 and 2017.
 SSLA’s Aggregated Disclosure Loss variable aggregates the change in a firm’s market cap from one day before to one day after each corrective disclosure alleged in the plaintiffs’ last filed complaint. We collect these data for settled and dismissed cases. SSLA also computes Aggregated Disclosure Loss based upon the Plan of Allocation for settled cases.
 Whereas the prior data are based on cases filed between 2011 and 2017, these figures are for cases resolved during that period. These two sets of cases are overlapping but not identical. There is no basis in the data, however, to expect that as the filed cases are resolved, dismissal rates for them will differ from dismissal rates for cases resolved during this period.
 Our calculations are as follows. Among 557 publicly held biopharma firms, there were 116 lawsuits filed. Applying a dismissal rate of 62%, this implies that 44 cases will settle. Leaving aside the fact that some of these cases were filed against the same companies, that comes to 8% of biopharma firms over the 2011 to 2017 period. Among 3,360 publicly held non-biopharma cases, 430 cases were filed. Applying a dismissal rate of 46%, this implies that 234 will settle. That comes to 7% of non-biopharma firms. Alternatively, one could simply look at the number of settled cases during the 2011 to 2017 period. This approach yields a figure of approximately 6.6% for both biopharma and non-biopharma firms.
 Those three firms are Rosen Law Firm, Glancy Prongay LLP and Pomerantz LLP.
 Levi & Korsinsky LLP is added to that cohort here and will be added in a forthcoming report updating our 2016 report. The number of cases in which that firm served as lead counsel increased in 2015 (15 total cases), 2016 (17 cases) and 2017 (26 cases) compared to an average of 5.5 cases per year during the previous three-year period.
 These numbers exclude cases where lead counsel has not yet been appointed, except when the case is filed and subsequently dropped by a firm and no other related actions are filed, in which case we treat the single firm that filed the case as the lead counsel.
 For biopharma firms under $1 billion in market cap, there were 37 settled cases among 557 publicly traded companies. For non-biopharma firms there were 227 settled cases among 3,360 publicly traded companies. For simplicity, we do not factor into the possibility that a single firm will be sued more than once.