(Article from Securities Law Alert, Year in Review 2020)
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First Circuit: Disclosure of FDA Concerns Undercuts Any Inference of Scienter
On April 9, 2020, the First Circuit affirmed the dismissal of a securities fraud action alleging that a biopharmaceutical company failed to disclose “material facts about [the company’s] manufacturing problems and the impact those problems were likely to have on the FDA’s approval” of the company’s ocular pain drug. Mehta v. Ocular Therapeutix, 955 F.3d 194 (1st Cir. 2020) (Stahl, J.). The First Circuit found it significant that defendants fully disclosed the FDA’s concerns regarding certain manufacturing issues. The court held that these disclosures belied any inference of scienter.
The First Circuit held that plaintiffs’ “allegations do not give rise to a strong inference of scienter.” The court noted that the company’s 2016 and 2017 Forms 10-K “disclosed receipt of the February 2016 Form 483, described its relevance to [the company’s] manufacturing capabilities, and warned of its implications.” The 2016 and 2017 Forms 10-K also specifically warned investors that resolution of the issues identified in the February 2016 Form 483 was a prerequisite for FDA approval. The First Circuit found “[t]hese informative disclosures about the nature and consequences of the February 2016 Form 483 undercut any inference that defendants intentionally or recklessly misled investors” concerning the company’s compliance with “current Good Manufacturing Practices” regulations.
Eighth Circuit: Affirms the Dismissal of a Securities Fraud Action Against a Major Retailer for Failure to Allege Scienter
On April 10, 2020, the Eighth Circuit affirmed the dismissal of a securities fraud action alleging that a major retailer and several of its executives made misstatements concerning the company’s ultimately unsuccessful foray into the Canadian market. In re Target Corp. Sec. Litig., 955 F.3d 738 (8th Cir. 2020) (Kobes, J.). The Eighth Circuit determined that “[n]othing in the complaint makes a ‘compelling’ case for fraud.” Rather, the court found “the more compelling inference” is that the company’s executives “did not understand the magnitude of the problems they faced” with the Canadian stores.
The Eighth Circuit found that “none” of plaintiffs’ allegations satisfied the scienter requirement. The Eighth Circuit found that “[t]he strongest, but still insufficient, allegation” concerned the company’s May 2014 representation that the longer the Canadian stores had been open, the better they were performing. Plaintiffs alleged that defendants must have known that this statement was false because in August 2014, the company “revealed that same-store sales had fallen more than 11% in Canada over the previous year.” The Eighth Circuit stated that “financial deterioration alone is not enough to show fraud.” The court explained that “the apparent incongruity” between the May 2014 statement and the August 2014 financial results was not sufficient to “show that the May 2014 statement was necessarily false, let alone that [company] executives knew it was false.”
Ninth Circuit: Allegations That Defendants Invested in and Touted a Product Despite Knowing the FDA Would Inevitably Deny Approval Are “Implausible”
On June 10, 2020, the Ninth Circuit affirmed the dismissal of a securities fraud action alleging that a company made misrepresentations concerning the likelihood of FDA approval for one of its products. Nguyen v. Endologix, 962 F.3d 405 (9th Cir. 2020) (Bress, J.). The court found “plaintiff’s core theory—that the company invested in a U.S. clinical trial and made promising statements about FDA approval, yet knew from its experience in Europe that the FDA would eventually reject the product—has no basis in logic or common experience.” The court determined that “the more plausible inference is that the company made optimistic statements about its prospects for FDA approval because its U.S. testing looked promising, not because the company was quixotically seeking FDA approval for a medical device application it knew was destined for defeat.”
The Ninth Circuit emphasized that “[a]llegations that are implausible do not create a strong inference of scienter.” Here, “[t]he central theory of the complaint is . . . that defendants knew the FDA would not approve [the company’s product], or at least that it would not do so on the timeline defendants were telling the market” because of an “unsolvable” problem with the product. The court found this “theory does not make a whole lot of sense” because it “depends on the supposition that defendants would rather keep the stock price high for a time and then face the inevitable fallout once [the product’s] ‘unsolvable’ . . . problem was revealed.” The court observed that “the theory might have more legs” if plaintiffs alleged that “defendants had sought to profit from this scheme in the interim, such as by selling off their stock or selling the company at a premium.” Because the complaint included no such allegations, the court found plaintiffs’ theory of scienter “does not resonate in common experience.” The court underscored that the Private Securities Litigation Reform Act “neither allows nor requires [courts] to check [their] disbelief at the door.”
Second Circuit: Reverses the Dismissal of a Securities Fraud Action Where the Allegations of a Material Omission Raised a Strong Inference of Recklessness
On August 3, 2020, the Second Circuit revived a putative securities fraud class action alleging that a real estate investment trust (“REIT”) “misled investors by failing to disclose a $15 million working capital loan it made to one of its major tenants” in May 2017, which the tenant then used to make partial rent payments to the REIT. Setzer v. Omega Healthcare Invs., 968 F.3d 204 (2d Cir. 2020) (Wesley, J.). The Second Circuit found plaintiffs adequately alleged that the REIT’s “decision not to disclose the [l]oan . . . in the context of its disclosures regarding [the tenant’s] financial health” was “a sufficiently extreme departure from the standards of ordinary care to satisfy the [Private Securities Litigation Reform Act’s] requirement for showing recklessness.”
The Second Circuit held that the REIT “was duty-bound to disclose that its loan was the source of [the tenant’s] rent payments.” The court found that “by putting [the tenant’s] rental payments in play, [d]efendants were required to speak accurately and completely.” The court determined that “[t]he omission concealed the extent of [the tenant’s] solvency problems: [the tenant] could not pay rent without borrowing from its landlord.” The court concluded that “[t]he facts as alleged create a compelling inference that [d]efendants made a conscious decision to not disclose the [l]oan in order to understate the extent of [the tenant’s] financial difficulties,” particularly because “multiple analysts ho[n]ed in on [the tenant’s] rental payments being key to [the REIT’s] prospects.”
Second Circuit: Revives a Securities Fraud Action Where Plaintiffs Adequately Pled Falsity and Loss Causation
On July 13, 2020, the Second Circuit reversed the dismissal of putative securities fraud class action claims based on its determination that plaintiffs adequately alleged falsity and loss causation as to certain challenged statements. Abramson v. NewLink Genetics Corp., 965 F.3d 165 (2d Cir. 2020) (Walker, J.). However, the Second Circuit affirmed the dismissal of claims challenging defendants’ optimistic statements regarding the results of a clinical trial because the court found those statements were “unactionable puffery.”
In September 2013, during a presentation for investors at a biotech conference, the company’s President & Chief Medical Officer (“CMO”) described the 24.1 month survival rate for participants in the company’s Phase 2 trial as “remarkable.” He stated that “all the major studies” show that “survival rates come between 15 to 19, 20 months. That’s it.” Then in March 2014, an analyst asked how the company’s statistical assumptions would be impacted if it assumed that the control group lived for 24 or 25 months. The President & CMO responded that the company did not have “any reason to believe that median survival [rate] for these patients will be more than [the] low 20s.” Plaintiffs alleged that the September 2013 and March 2014 statements were misleading because numerous significant studies “showed survival rates ranging from 25 months to 43 months.”
With respect to the September 2013 statement, the court noted that the President & CMO did not “couch his representation of survival rates with prefatory language like ‘I believe’ or ‘In my estimation.’” He instead presented a “categorical proposition,” and “cited the results of all the major American studies” in support of his statement. The court found it significant that the statement was made “at an important conference for biotech investors.” Given the context, the court determined that “[i]nvestors in attendance reasonably would not have interpreted his statement as a baseless, off-the-cuff judgment; instead, they would have credited his statement as researched and intentional, part of a well-prepared professional presentation.” The Second Circuit held that the statement could lead “a reasonable investor” to believe that “no credible studies have shown resected pancreatic cancer patients to have survival rates higher than 20 months.” The court found the March 2014 statement to be similarly misleading, “[b]oth because of its posture as a response to a specific question and its categorical nature.”
Ninth Circuit: Whistleblower Complaint Filed by a Company Insider May Constitute a Corrective Disclosure
On October 8, 2020, the Ninth Circuit revived a securities fraud action that the district court had dismissed on loss causation grounds. In re BofI Holding Sec. Litig., 977 F.3d 781 (9th Cir. 2020) (Watford, J.). The Ninth Circuit held plaintiffs adequately alleged that a whistleblower complaint filed by a former employee constituted a corrective disclosure for loss causation purposes.
The Ninth Circuit held that “the relevant question for loss causation purposes is whether the market reasonably perceived [the whistleblower’s] allegations as true and acted upon them accordingly.” In the case before it, the court noted that the whistleblower’s “descriptions of wrongdoing [were] highly detailed and specific, and they [were] based on firsthand knowledge that he could reasonably be expected to possess by virtue of his [former] position as a midlevel auditor” at the company. The court also found it significant that the stock price dropped more than 30% following the filing of the complaint. The court reasoned that “[a] price drop of that magnitude would not be expected in response to whistleblower allegations perceived as unworthy of belief.” The court concluded that plaintiffs adequately alleged that the whistleblower complaint was a corrective disclosure.