In a little noticed-development last week, the U.S. Supreme Court denied the petition for a writ of certiorari in Hagan v. Khoja, in which former officials of a bankrupt pharmaceutical company sought to have the Court review a decision by the Ninth Circuit to revive a securities class action lawsuit against them. Had the petition been granted, the Court would have been called upon to consider the controversial question of whether public companies have a duty to update prior disclosures that were accurate when made. The Court’s cert denial leaves the Ninth Circuit’s ruling standing and the questions surrounding the existence and requirements of a duty to update remain unsettled. The Court’s May 20, 2019 order can be found here.
This case arises out of a securities class action lawsuit filed against developmental stage pharmaceutical company Orexigen Therapeutics, Inc. and certain of its directors and officers. The plaintiffs allege that the defendants made material misrepresentations and omissions with regard to the company’s clinical trials involving its developmental stage obesity drug candidate, Contrave. The trials, known as the Light Study, were designed to measure the risk of cardiovascular events using the drug.
The study’s initial results (the “25 percent interim results”) were unexpectedly positive. The plaintiff alleges that there were a series of leaks of the interim results that affected the company’s share price. The FDA imposed a number of requirements on the company as a result of the leaks. The FDA also emphasized to the company that the interim results have a “high degree of uncertainty.”
However, the company filed a patent application in reliance on the interim results, and the company requested that the patent office publish the patent application, rescinding the company’s own earlier request to keep the application confidential. The company then attached the patent application – including the interim results – to an SEC filing on Form 8-K. Securities analysis reviewed the filing, and the company’s stock surged.
In March 2015, a senior FDA official advised the company that the agency was “very disappointed” by the company’s actions, warning that the 25 percent interim results should not be misinterpreted. An article in Forbes quoted an FDA official as saying the company’s SEC filing was “unreliable,” “misleading,” and likely false.
Two days later, the Light Study reached the 50 percent completion stage; the results no longer indicated a heart benefit from Contrave. The independent physician heading the study committee drafted a press release disclosing the updated results and the termination of the study. In subsequent SEC filings and in an investor call, the company’s executives did not refer to the 50 percent interim results or the termination of the study, referring rather to what the company might do if the study were to be terminated. Four days after the conference call, the independent physician heading the study issued a statement disclosing the 50 percent interim results and the termination of the study.
The plaintiffs allege that the company and its executives misrepresented or omitted material information about the Light Study and the interim results. The defendants filed a motion to dismiss. The court granted the defendants’ motion to dismiss and the plaintiff appealed. While the appeal was pending, Orexigen filed for Chapter 11 bankruptcy, and so the company itself is no longer a party to this case.
In an August 13, 2018 opinion (here), the Ninth Circuit largely reversed the district court’s dismissal, saying, among other things, that a corporate issuer has a duty to update a prior statement of fact when the “value” or “weight” of the statement has been “diminished” by subsequent events.
The Cert Petition
In a petition to the United States Supreme Court for a writ of certiorari, the individual defendants sought to have the Court review the Ninth Circuit’s decision and to address the question of when if ever an issuer has an affirmative duty to update a statement that was accurate when made.
The petitioners argued that the court should take up the case to address a circuit split on the question of whether or not there is a duty to update. The petitioners noted that Seventh Circuit rejects that there is any duty to update, which the First, Second, Third, Fifth, and Eleventh have held that a duty may exist in certain narrow circumstances. The Ninth Circuit, the petitioners argued, recognized an affirmative duty to update beyond anything recognized by any other circuit.
The petitioner also urged the court to take up the case in order to confirm, as the petitioners argued, that no duty to update an accurate statement of historical fact can logically exist, as the recognition of any such duty would transform the periodic disclosure regime into a continuous disclosure regime. If left standing, the petitioners argued, the Ninth Circuit’s standard would encourage disclosure shopping and leave corporate issuers with little guidance on what disclosures must be made and when.
In their opposition to the petition, the plaintiff respondents argues that the Ninth Circuit did not create a new duty but instead simply applied a previously existing “duty to correct” standard that has been recognized throughout the country, and, therefore, that there is no circuit split. The respondents also argue that because the various circuits have generally recognized that there is a duty to update in at least some circumstances.
On May 20, 2019, the Supreme Court entered an order denying the petition.
The practical effect of the Supreme Court’s order denying the writ is that the Ninth Circuit’s decision will stand. While the respondents argued that the various circuits have recognized that there may be a duty to update in certain circumstances, and therefore there is not a circuit split sufficient to justify the Court’s taking up the case, the fact is that the standards between the circuits do indeed vary.
The Ninth Circuit’s statement that an issuer must update a prior accurate statement of fact when the “value” or “weight” of the statement has been “diminished” by subsequent events is a different standard than applicable in other circuits, and it arguably could (as the petitioners contended in their petition) create a situation where a case that might be dismissed outright in another circuit could survive dismissal in the Ninth Circuit. The potential for inconsistent outcomes may in turn encourage forum shopping. The possibilities for inconsistent outcomes and forum shopping are the very sorts of considerations why the Supreme Court typically will take up cases involving circuit splits.
Beyond the consistency issue, there is the problem that the Ninth Circuit’s standard is unworkably vague. The appellate court’s statement that further disclosure is required when the “value” or “weight” of a prior statement has been “diminished” by subsequent events offers company officials precious little guidance about when and how they must make additional disclosures. What is the standard the officials are to use in deciding whether the value or weight of a prior statement has been sufficiently diminished? What disclosures are they required to make in those circumstances? The standard’s nebulousness affords far too little guidance and leaves far too much room for hindsight second-guessing.
The ultimate problem with the Ninth Circuit’s standard is that it arguably flies in the face of the basic requirements of the periodic disclosure regime applicable to U.S. reporting companies. The periodic disclosure regime in this country contrasts with the continuous disclosure regime that is in place in certain other countries – for example, Australia and Canada. Under these regimes companies must apprise investors on an ongoing basis of information that could affect the share price. By contrast, in this country, companies are only required to make disclosures according the period reporting schedule applicable under the SEC’s rules. In the intervals between the periodic reports, the issuer companies have no affirmative duty to speak.
The Ninth Circuit’s statement that further disclosure is required when the “value” or “weight” of prior accurate disclosures have been “diminished” arguably creates a regime of continuous disclosure, where companies must continuously monitor to assess whether their value has been diminished by subsequent events, a state of affairs that comes remarkably close to the requirements of a continuous disclosure regime.
In any event, now that the Supreme Court will not be taking up the question of whether or under what circumstances there is a duty to update, it will be interesting to see how the district courts in the Ninth Circuit apply the appellate courts holding in this case, and whether it results in the district courts in the Ninth Circuit in the survival of cases that would be dismissed in the other judicial circuits.
One Final Note: As I noted at the time, there was another very interesting aspect of the Ninth Circuit’s ruling in this case, and that was the appellate court’s rejection of the district court’s consideration of extraneous matter in connection with the motion to dismiss. The appellate court said that the “overuse” of the doctrines of judicial notice and of incorporation by reference could result in the improper dismissal of securities cases at the pleading stage based on extraneous matter. As I noted in discussion of these issues, the appellate court’s discussion of these issues is interesting, and its broadside against wholesale consideration of extraneous matter could have as much of an impact on future dismissal motions as any of the substantive legal issues raised in the case.