Client Advisory - 2018 Life Sciences Securities Litigation Roundup

Companies in the life sciences industry, including biotechnology, medical devices, and pharmaceuticals, have long been favorite targets of securities class actions, and 2018 was no exception. According to a recent report by Cornerstone, approximately 16 percent of the lawsuits filed in 2018 were against companies in the broader healthcare sector—a near-record percentage and double both the number filed in 2017 and the 15-year average. Most of the cases filed against life sciences companies alleged violations of Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5 promulgated thereunder; this represents almost one-quarter of all 10b-5 cases filed in 2018. More than a dozen cases involved challenges to mergers—a reflection of both the continued consolidation in the life sciences industry and the general increase in filings in federal court after the Delaware Chancery Court’s 2016 decision in Trulia made that court a less hospitable forum for merger strike suits. Only a handful of claims were filed under Section 11 of the Securities Act, alleging violations in connection with IPOs or subsequent offerings. There is evidence, more difficult to track, that additional Section 11 cases were filed in perceived-to-be more plaintiff friendly state courts.¹

2018 also resulted in more than 40 decisions from the federal courts addressing the adequacy of claims filed against life sciences and medical device companies in prior years. Only a dozen of these cases were primarily concerned with statements regarding the results of clinical trials—a smaller percentage than in prior years. However, in almost every one of these cases², the courts³ granted defendants’ motions to dismiss. In their decisions, these courts held that adequate risk warnings (spanning as many as 40-70 pages) detailing both general and specific risks facing the company and its development efforts rendered any forward-looking statements of optimism not misleading. As long as early clinical studies demonstrated some level of safety and efficacy, courts generally accepted that opinions about a drug’s positive prospects had a reasonable basis.

Similarly, the courts that addressed the issue of adverse events during clinical trials also uniformly held that disclosure was not required unless it either rendered other prior statements materially misleading or the company was on notice that these occurrences would inevitably lead to U.S. Food and Drug Administration (FDA) intervention or non-approval. The fact that trials failed or that the FDA required additional studies or ultimately refused to approve the treatment being tested was universally rejected as fraud-by-hindsight, and not probative of defendants’ foreknowledge that their expensive and time-consuming clinical trials were doomed. In many of these instances, courts rejected the notion that scienter could be inferred from the fact that the drug or device was critical to the company’s success; that the company was small; or that hands-on management had access to information about the drug or device and interim results. Moreover, several courts held that scienter could not be inferred from the mere fact that some of these companies conducted public offerings or their executives sold stock, particularly where the trades were pursuant to Rule 10b-5-1 plans or during periods when trial results were blinded or otherwise unknown.

These decisions are encouraging and suggest that courts may be becoming increasingly skeptical of claims alleging that costly, often years-long clinical trials of new drugs or devices were instead doomed-from-the-outset mechanisms meant to enrich management at investors’ expense. The decisions also reinforce that even when a drug or device’s prospects seem rosy, worst-case scenario warnings—for example, that the drug may not work, that patients may die, that untreated patients may do better, that trials may fail, or the product may prove to have problems—will make it easier to defend the almost-inevitable post-bad-news class action.⁴ Several of the cases also underscore the dangers companies confront when they are conducting and commenting on multiple concurrent trials and/or trials with multiple endpoints and measuring dates.

Results were more mixed in cases alleging that life sciences companies mischaracterized or failed to disclose FDA interim comments about their products’ chances for approval. In Sarepta, the First Circuit Court of Appeals affirmed a dismissal applying the well-established principle that there is no duty to disclose regulatory back-and-forth with the FDA so long as the regulators’ comments fall short of mandates or final decisions. The District Court of New Jersey in a case against Insmed similarly held that that a company was under no obligation to disclose the preliminary interim comments from the European Medicines Agency (EMA), even though the concerns addressed by the EMA were the same concerns that ultimately led the EMA to require a further trial and even though the company conducted a public offering after having received these interim comments. The court’s decision focused on the fact that the EMA application was filed on the basis of Phase 2 trial data, as opposed to more robust Phase 3 trial data, and that Insmed 1) amended its application based on the EMA comments, 2) had received “breakthrough therapy” designation from the FDA, and 3) began a Phase 3 trial with the aim of obtaining ultimate FDA approval before the EMA reached its conclusion that additional study would be required. The court concluded that all of these actions indicated that the company genuinely believed that its drug would ultimately be approvable, despite the negative interim comments from the EMA.

However, two life sciences companies who were less heedful of interim regulatory advice and more bullish about their prospects for approval despite it, were less fortunate, suffering a reversal of their lower court dismissals on appeals to the Sixth and Ninth Circuits, respectively. In Esperion Therapeutics, the Sixth Circuit held that dismissal was improper where the company’s characterization of an FDA meeting in a press release and analysts’ conference call was inconsistent with the later-released FDA official meeting minutes. The Sixth Circuit found that the premature and incorrect disclosure of the FDA’s comments, even if it merely reflected a misapprehension on management’s part, was reckless. The Sixth Circuit admonished that companies making definitive statements about what the FDA said before the official minutes were released acted at their peril, particularly given the “high stakes involved” concerning approval of the company’s only drug.

In Orexigen, the Ninth Circuit reversed the lower court’s dismissal of a case where the company 1) touted early positive results, flouting pointed FDA warnings that preliminary data was likely unreliable, and then 2) refused to disclose later results that showed that the early benefits were not sustained. The Ninth Circuit held that once the company decided to disclose the early favorable data, it had a duty to disclose both that 1) the FDA warned that the early results were “likely unreliable” and likely to change, and 2) the later trial results that proved the FDA’s warnings were right.

In the same vein, the District of Massachusetts held that Chiasma’s statements that it had a “clear path forward with the FDA” were misleading when, in fact, the FDA had raised significant questions about the drug’s efficacy, the durability of its effect, and the duration and robustness of the underlying clinical trials. In these circumstances, the court held that generalized risk warnings in the company’s IPO prospectus concerning the possibility of FDA non-approval were also themselves materially misleading in light of the actual negative feedback the company had already received.

In 2018 one life sciences company not only allegedly flouted the FDA’s interim advice, they flouted the FDA clinical trial process entirely. In OvaScience, a company began testing its IVF augmentation procedure without an NDA and then took its testing overseas when the FDA warned that an NDA was required. The company then allegedly misrepresented both the number and results of its procedures, excluding women who did not become pregnant from its data set and giving false excuses for why so few treatments were performed. Not surprisingly, the claims against OvaScience were sustained by the District of Massachusetts. In another case, Kitov Pharmaceuticals, plaintiffs’ claims were derived from the Israel Securities Authority’s charges against the CEO that the company’s positive Phase 3 trial results had been falsified.⁵ The Southern District of New York sustained plaintiff’s complaint against both the company and its CEO.

a. Post-Market Surveillance

Even after approval, life sciences companies faced challenges (and securities class actions) with respect to launching their products and testing them in the real-world. In ReWalk Robotics, a newly-public company repeatedly failed to timely respond to the FDA’s requirement of post-market surveillance studies to address safety concerns relating to its medical device and faced Section 10(b) and Section 11 claims. Because the plaintiff lacked standing (under Section 11) however, the decision in the case was deferred while a new plaintiff was sought.

In Aratana, a veterinary medicine company’s difficulties in securing an FDA-approved manufacturer delayed commercialization of its approved drug. However, the defendants’ actions—hiring a sales team and developing inventory—were consistent with Aratana’s expressed expectation of a near-term launch and the company timely updated the market when it encountered setbacks and was forced to change its marketing strategy. Accordingly, the Southern District of New York dismissed the case.

In 2018 there was also at least one case about significant manufacturing quality issues⁶—ZimmerBiomet, a 56-page decision from the Northern District of Indiana, about a 57-page Form 483 warning letter identifying severe deficiencies across a wide variety of compliance areas which required large-scale remediations. To make things worse (for the securities litigation), the company allegedly had a “long and troubled history of non-compliance” and responded to the FDA’s 483 by admitting that it had previously self-identified (but failed to disclose or remediate) many of the same systemic issues in its own prior internal audits. In these circumstances, the court found that the company’s risk warnings about manufacturing compliance were materially misleading and that the internal audits demonstrated scienter, i.e., that the severe problems were known and knowingly concealed. Accordingly, even in the absence of stock sales by the individual defendants,⁷ the court held that the lack of motive was not dispositive, that scienter was adequately alleged, and the defendants’ motion was denied.

In a few cases, the “issue” with a newly-approved product was not a matter of non-compliance but, rather, simply that the product was not as commercially successful as investors and the company might have hoped. In Foundation Medicine, large initial sales to major medical centers of the company’s tests for genomic mutations did not translate into broader acceptance by community health centers that largely opted for cheaper, Medicare reimbursable alternatives.⁸ Invuity’s large initial sales of its devices stalled as surgical centers waited to reorder until they exhausted initial supplies. In both cases, the District of Massachusetts and the Northern District of California, respectively, dismissed the complaints, finding that defendants had not made any material misstatements in expressing general optimism about the prospects for their products.

In Rockwell, clinicians from the outset viewed the company’s new product as “not better” and “not cheaper” and thus sales were less than robust. Plaintiffs complained that Rockwell had failed to disclose both the lukewarm reception and the fact that it had already begun to test a different formulation intended to address the “not cheaper” concern. Nonetheless, the Southern District of New York held that there was no duty to disclose that a replacement product was already in the offing, noting that “[v]igorously promoting a current product is not at all inconsistent with simultaneously innovating and developing new products.

b. Safety Issues

Sometimes, though, it may turn out that a new product is not just “not better,” it is decidedly worse. And rather than “vigorously promoting the current product,” the company actually strives to undermine it to prevent competition from biosimilars that might interfere with the acceptance of its new formulation.⁹ Such was the case with Endo, which hoped to introduce a new abuse-resistant harder-to-crush opioid while simultaneously attempting to crush Impax’s new generic of Endo’s existing drug. The machinations involved in these efforts are detailed and complex but, in the end, disastrous. While Endo’s new opioid was harder to crush and abuse intranasally, it turned out to be easier to inject and abuse rates increased—according to the CDC’s and Endo’s own internal research. The FDA rejected Endo’s efforts to force Impax to stop marketing the older now-generic formulation as “unsafe” and instead forced Endo to withdraw its new drug due to more significant safety concerns. Following withdrawal of its newly-formulated opioid, Endo’s stock dropped to $11.49 from its previous high of $83.25. The Eastern District of Pennsylvania denied the motion to dismiss both the 10b-5 and Section 11 claims.

However, another case involving safety-related product defects, Halyard Health, was dismissed with prejudice. The Southern District of New York held that even though a “60 Minutes” report revealed that the company’s surgical gowns, approved for infectious diseases such as Ebola, failed 77 percent of the time, the plaintiffs failed to allege with the requisite particularity that the defendants were aware of the products’ defects.

c. Marketing Issues

Two cases decided in 2018 involved off-label marketing. Both cases related to the powerful synthetic opioid fentanyl, and both involved alleged kickback schemes. However, the similar fact patterns resulted in different decisions: The Southern District of New York denied the motion to dismiss in Insys, while next door in New Jersey the federal district court granted the motion to dismiss in Galena Biopharma.

d. Insurance Reimbursement/Rebate Cases

Several cases considered in 2018 involved allegedly fraudulent reimbursement, rebate or referral practices—with mixed results. In Singer v. Reali, the Fourth Circuit Court of Appeals reversed an order granting a motion to dismiss where it was alleged that the company instructed doctors how to (mis)-code procedures utilizing its device so as to maximize insurance reimbursement. One of the several securities cases against Endo resulted in a dismissal of claims by the Southern District of New York alleging the company pre-filled reimbursement forms and offered rebates to healthcare and benefit providers. In Cardiovascular Systems and Horizon Pharma, allegations of improper kickbacks and referrals were dismissed by the District of Minnesota and the Southern District of New York, respectively. In Mylan, however, the Southern District of New York sustained claims alleging the company had misclassified its EpiPen as a generic in order to minimize rebates it was required to pay to Medicare and Medicaid where plaintiffs alleged that the Company continued this practice after being specifically advised by regulators that its classification was incorrect.

e. Anticompetitive Conduct

Mylan was also one of several cases in 2018 involving securities fraud claims based on alleged anticompetitive conduct by generic drug manufacturers. Drawing inferences on the basis of parallel pricing, the Southern District of New York held that plaintiffs adequately alleged illegal price-fixing at odds with the company’s statements about competition and compliance with laws. Mylan was followed in Taro, which asserted similar charges against another of the alleged co-conspirators. The cases against two other alleged participants, Impax¹⁰ and Teva, were dismissed without prejudice (and in Teva, without an opinion) by the Northern District of California and the District of Connecticut, respectively..

f. Cases Predicated on Government Investigations

The anticompetition-based securities claims in Mylan, Taro, and Impax were each predicated on ongoing investigations by the antitrust division of the Department of Justice (DOJ). A case against the Chinese company USANA was also based on investigations by government authorities—in this case by China for alleged violations of that country’s direct marketing laws. The District of Utah dismissed the USANA case with prejudice, however, finding that the mere fact of an investigation and subsequent warnings from the Chinese government were insufficient to demonstrate wrongdoing much less securities fraud.

2018 was a near-record year for securities class action filings in general and against life sciences companies in particular. Robust risk disclosures often proved to be an effective inoculation against such claims, so long as companies did not make statements inconsistent with FDA comments or determinations by the agency or other regulators. Manufacturing, marketing, and market acceptance issues can also be overcome so long as the company is scrupulous about disclosing the risks of those potentialities as well as when those “risks” become realities. Not surprisingly, allegations of reimbursement and kickback schemes, improper price inflation or anticompetitive behavior may result not only in government investigations but parallel securities class actions where results may vary even on similar facts among the various federal courts. Finally, whenever often-cash-strapped life sciences companies conduct an offering, they bear the additional risk of strict liability and/or negligence-based claims under Sections 11 and 12—claims which are increasingly being brought in less-expert state courts. Careful attention to the timing of and disclosure provided in connection with a public offering is therefore particularly important to minimize exposure. The same applies with respect to individual trading; a plaintiff’s best or worst evidence of a motive to defraud. The amount, timing, and circumstances of trading by insiders is often the key to success in dismissing securities fraud class actions, making 10b-5 trading plans a very worthwhile preventative.

¹ For example, one of the federal securities cases dismissed in 2018 involved ProNai Therapeutics, which was sued under Section 10(b) in federal court in New York. The dismissal was affirmed by the Second Circuit, yet the parallel claims under Sections 11 and 12 of the Securities Act, filed in San Mateo, California, are being settled. Endo and Xbiotech are among other companies which obtained dismissal of Section 10(b) claims but faced parallel claims in state court, as well. Cornerstone has noted the increase in stand-alone Section 11 claim filings in state courts in 2018 but does not break out those filings by industry sector.

²One exception is Heartware International, a case involving both FDA 483 warning letters and significant adverse events that resulted in the company clinical trials being halted. The Southern District of New York denied the motion to dismiss without opinion and the case settled later in 2018 for $54.4 million.

³ The Southern District of New York (New Link Genetics; Stemline; ProNai Therapeutics; and Neurotrope), the District of Massachusetts (Genocea Biosciences; Inotek), and district courts in New Jersey (Roche), North Carolina (Cempra, Novan), Washington (Seattle Genetics), and California (Dynavax).

⁴ The robust risk disclosures that “saved” life sciences companies whose trials had failed or NDAs were not approved included specific warnings about:

Known toxicity risks of similar products;
Adverse events experienced in prior clinical trials;
The risk that multiple ongoing trials may yield different results;
The risk of multiple endpoints or measuring dates confounding results;
The risk of using “surrogate” measures for potential complications;
The possibility that control groups might skew blinded interim results;
The fact that the FDA may require additional studies;
The possibility that earlier trial results may not be repeated;
The risk that interim positive results may reverse;
The fact that adverse events or safety issues may make an efficacious drug not approvable or marketable;
The fact that only certain subgroups may benefit and that this may not be sufficient to support approval or marketability of the drug;
The fact that “positive” or even statistically significant results do not assure approval or market acceptance;
The fact that future funding for required trials or studies may not be forthcoming.

⁵ Although the SEC opened a formal inquiry and assisted the ISA with its investigation, the securities class action ultimately settled for $2 million after the FDA approved Kitov’s drug.

⁶ As noted, Heartware International, which was settled after its motion to dismiss was denied without opinion, supra n.2, involved both FDA 483 warning letters and significant adverse events that halted its clinical trials.

⁷ The secondary offering appears not to have been considered with respect to the company.

⁸ NantHealth involved the alleged failure to disclose certain facts relating to the product’s acceptance, i.e., that nonprofits controlled by the CEO and Chairman had allegedly funded and provided specifications for the university research which utilized the company’s tests. The Central District of California largely denied the motion to dismiss plaintiffs’ Section 10(b) and Section 11 and 12 claims.

⁹ Roche, see n.3, supra, also involved clinical trials of a new variation of an existing chemotherapy drug (Herceptin) which was meant to limit any loss of market share to biosimilar competition once Roche’s patent expired. Roche’s trials of a combination of Herceptin with another of its newer drugs were at least modestly successful (meaningfully so for some subgroups) but did indicate a greater risk profile. Unlike in Endo, however, there were no concerns about abuse of the drug nor was any anticompetitive conduct alleged.

¹⁰ Impax was also the manufacturer of the generic version of Endo’s opiate, supra. Endo was also named in the DOJ’s price-fixing suit as a result of the activities of Par Pharmaceuticals—which it had acquired—and was subsequently sued in a securities class action related to the alleged price-fixing but there has been no decision in that shareholder class action case to date. Separately, in 2018 the Southern District of New York dismissed a case challenging Endo’s optimistic statements related to its acquisition of Par as well as alleged price inflation for certain of its drugs. Another suit against Endo relating to the Par acquisition was filed in state court, alleging violations of Section 11 and 12 of the Securities Act. See n. 1, supra.