As I have noted in numerous prior posts on this site, over the course of the last two years plaintiffs’ lawyers have filed a host of COVID-19-related securities claims. With the passage of time, many of these cases have now worked their way to the motion to dismiss stage. Although the results have been mixed, the dismissal motions have been granted in several cases. In the latest example of favorable outcome for a COVID-19-related lawsuit defendant, the court in the COVID-19-related securities suit pending against Chembio Diagnostics and its executives recently granted the corporate defendants’ dismissal motion. However, in an odd twist, the court denied the dismissal motion of the company’s offering underwriters. A copy of the court’s February 23, 2022 order in the case can be found here.

Background

Chembio Diagnostics provides technology for detecting and diagnosing infectious diseases. At the onset of the coronavirus outbreak, the company focused on developing a COVID-19 antibody test. Chembio’s antibody test was one of the first antibody tests authorized by the FDA during the COVID-19 public health emergency.

According to allegations subsequently filed securities class action litigation, the company represented that its test for detecting COVID-19 antibodies aided in determining current or past exposure to the COVID-19 virus, that its test provides high sensitivity and specificity, and was 100% accurate. The complaint also alleges that the company’s share price climbed from $5.12 per share on March 31, 2020 to $15.54 on April 24, 2020.

On May 7, 2020, the company closed on a public offering of approximately 2.6 million shares of Chembio stock at $11.75 per share for gross proceeds of $30.8 million.

On June 16, 2020, after the market had closed for the day, the FDA issued a press release (here) in which the agency announced that it had “revoked” Chembio’s Emergency Use Authorization (EUA) for the company’s antibody tests. The press release stated that it had revoked the authorization “due to performance concerns with the accuracy of the test.” The press release further stated that “data submitted by Chembio as well as an independent evaluation of the Chembio test … showed that this test generates a higher than expected rate of false results and higher than that reflected in the authorized labeling for the device.” The press release also said that under the circumstances “it is not reasonable to believe that the test may be effective in detecting antibodies against SARS-CoV-2 or that the known and potential benefits of the test outweigh the known and potential risks of the test, including the high rate of false results.”

On June 17, 2020, the company filed a report with the SEC on Form 8-K in which the company disclosed that the FDA had revoked the authorization.

The Lawsuit

In the following weeks, plaintiff shareholders filed a series of lawsuits in the Eastern District of New York against Chembio. These cases were later consolidated. In a consolidated amended complaint, the lead plaintiffs named as defendant not only the company itself, but also certain directors and officers of the company, as well as the offering underwriters that conducted the company’s May 2020 offering.

The consolidated amended complaint purports to be filed on behalf of two classes of investors: (1) all investors who purchased shares in or traceable to the May 7, 2020 offering; and (2) all investors who purchased Chembio’s shares between March 12, 2020 and June 16, 2020. The complaint alleges that the defendants misrepresented and failed to disclose that the Company’s COVID-19 test “did not provide high-quality results and there were material performance concerns with the accuracy of the Company’s DPP COVID-19 test.”

The complaint alleges that on June 17, 2020, the first trading day after the FDA released its letter announcing the revocation of authorization of Chembio’s test, the company’s share price fell over 60%.

The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and that defendants violated Sections 11, 12(a)(2) and (15) of the Securities Act of 1933. The defendants filed motions to dismiss.

The February 23, 2022 Order

In her detailed February 23, 2022 Opinion and Order, Eastern District of New York Judge Allyne Ross granted the Chembio defendants motions to dismiss, both as to the plaintiffs’ ’34 Act claims and as to the plaintiffs’ ’33 Act claims. However, Judge Ross denied the offering underwriter defendants’ motion to dismiss the ’33 Act claims against them. Judge Ross also granted the plaintiffs leave to seek to amend their ’33 Act claims against the Chembio defendants but denied them leave to seek to replead their ’34 Act claims against the Chembio defendants.

In granted the Chembio defendants’ motion to dismiss the plaintiffs’ ’34 Act claims, both as to Chembio itself and as to the individual Chembio defendants, Judge Ross concluded that the plaintiffs had failed to adequately allege scienter.

With respect to the individual defendants, Judge Ross concluded that the plaintiff had failed to adequately allege either motive or conscious recklessness, as required to adequately allege scienter. With respect to the plaintiffs’ supposed motive allegations, Judge Ross said that “what is missing … is the necessary concrete, individualized benefit.” She found that the plaintiffs’ allegations that the defendants were motivated by a desire to advance the company’s financial prospects or increase its media exposure were insufficient to establish a motive, as was the plaintiffs’ “bet the company” theory that because the company’s fate depended on the success of the company’s COVID test, they were motivated to misrepresent the facts. These allegations, Judge Ross said, were “too generalized” to establish the requisite “concrete and personal benefit” required to be alleged to establish scienter.

With respect to the plaintiffs’ recklessness allegations, Judge Ross noted that while communications during the class period “may have increased defendants’ concerns” that the FDA’s emergency use authorization for the company’s COVID test might be revoked, it “would be unreasonable to infer that the date necessarily notified defendants that revocation was inevitable,” given that the defendants continued to send more data to the FDA to address the regulator’s concerns. Judge Ross also noted the competing inference that, at the outset of the pandemic and when there were few testing options available, “the FDA would maintain the EUA” is “more compelling given the facts pleaded. Accordingly, Judge Ross said, “plaintiffs have not adequately pleaded that officer and director defendants were reckless in failing to warn that the EUA would be revoked” Judge Ross also concluded that the plaintiffs had not sufficiently alleged scienter as to Chembio itself, as well.

Judge Ross then turned to the plaintiffs’ ’33 Act allegations. She noted at the outset that the parties disputed the pleading standard applicable to the ’33 Act claims. The plaintiffs argued that the strict liability standard under the ’33 Act applied. The defendants argued that because the plaintiffs’ allegations “sounded in fraud,” a more rigorous pleading standard applied. Judge Ross concluded that the more rigorous standard applied noting that, even though the plaintiffs’ disclaimed any intent to allege fraud in connection with the ’33 Act claims; “the gravamen of plaintiffs’ factual claims is fraud.” She noted that both the plaintiffs’ ’34 Act claims and the plaintiffs’ 33 Act claims “share a nucleus of operative facts” and are therefore “substantially intertwined.” Therefore, the plaintiffs’ ’33 Act claims against the Chembio defendants must be evaluated under the more rigorous pleading standard. However, the plaintiffs’ ’33 Act claims against the underwriter defendants “sound in negligence” and are therefore evaluated under the more relaxed pleading standard.

Given that she had already found in connection with the plaintiffs’ ’34 Act claims that the plaintiffs had insufficiently alleged scienter and therefore do not “support a compelling inference of fraud,” Judge Ross granted the motion to dismiss the ’33 Act claims as to the Chembio defendants. However, because the ’33 Act claims against the underwriter defendants sounded in negligence and not in fraud, she evaluated those claims under the more relaxed pleading standard. After specifically finding that the company’s offering documents in connection with the May 22 contained a material omission with respect to the disclosures concerning the company’s test’s accuracy (“one of the most significant risks to Chembio’s business”), she concluded that the plaintiffs’ had adequately alleged a ’33 Act claim against the underwriter defendants.

Finally, while denying plaintiffs leave to seek to replead their ’34 Act claims, she granted the plaintiffs leave to seek to replead their ’33 Act claims against the Chembio defendants.

Discussion

Judge Ross’s ruling is obviously a big win for the Chembio defendants, as she granted the dismissal motion as to all of the plaintiffs’ claims against them. To be sure, she did grant plaintiffs leave to seek to replead the ’33 Act claims against the Chembio defendants, but given Judge Ross’s analysis, the plaintiffs will face a significant hurdle in trying to re-wire their ’33 Act allegations so that they do not sound in fraud and therefore are not subject to the more rigorous pleading standard.

However, it is worth noting that, given that she granted the dismissal motion as to the plaintiffs’ ’34 Act claims without leave to replead, the plaintiffs could submit a proposed amended complaint that entirely omits the ’34 Act claims, and therefore omits all of the fraud allegations associated with those claims. That could give the plaintiffs the opportunity to try to argue that, in connection with renewed dismissal motions relating to the forthcoming amended pleading, that their ’33 Act claims do not “sound in fraud” and therefore that the less demanding pleading standard applies.

There is an ironic twist in the outcome here, in that Judge Ross granted the Chembio defendants’ dismissal motion but denied the underwriter defendants’ dismissal motion. The ironic effect is enhanced by the fact that, in denying the dismissal motion as to the underwriter defendants, she specifically found that the plaintiffs had adequately alleged that the offering documents contained a material omission. And not just a material omission, but one that related to “one of the most significant risks to Chembio’s business” (that is, the effective rate of the company’s tests). There could be further to go in this case, but the way things currently stand seems a little odd, with the claims against the corporate defendants knocked down, but the claims against the offering underwriters sustained.

In any event, at least as things currently stand, the outcome of the dismissal motion ruling in this case is one more data point suggesting that the plaintiffs’ in these coronavirus-related securities lawsuits are not faring particularly well. Of the coronavirus-related cases that have reached the dismissal motion stage, the motions have largely been granted – though the dismissal motions have been denied at least in part in coronavirus-related securities  suitsfiled against vaccine manufacturers Inovio and Vaxart (as discussed here and here, respectively), as well as, more recently, in the pandemic-related lawsuit filed against online video platform Zoom (as discussed here). A guest post I published last week (here) provided a detailed overview of the current state of the coronavirus-related securities litigation prepared by ISS Securities Class Action Services.