“When a company's stock declines, a shareholder lawsuit often follows. This case is no exception.”
Chief Judge Jeffrey R. Howard of the First U.S. Circuit Court of Appeals wrote those words to open his opinion in In re ARIAD Pharmaceuticals, Inc. Securities Litigation. A unanimous three-judge panel that included former Associate Justice David H. Souter affirmed the dismissal of most of the securities fraud claims against a biopharmaceutical company and other defendants on scienter grounds.
The case arose from alleged misstatements and omissions by ARIAD officers concerning the approval process for ponatinib, a leukemia drug. In October 2012, the Food and Drug Administration rejected ARIAD’s proposed labeling, citing concerns about adverse cardiovascular events and dosage reductions. The FDA approved the marketing of ponatinib on a limited basis in December 2012, but the agency required ARIAD to include a "black box" warning on ponatinib's label about the risk of adverse cardiovascular events.
Despite the black box warning requirement, ARIAD continued to publicly project confidence in ponatinib. In October 2013, though, ARIAD informed investors that it was stopping enrollment in all clinical studies of ponatinib due to increased instances of medical complications in the drug trials. ARIAD issued a Form 8-K and a press release indicating that it had agreed to halt the trial, and on Oct. 31, 2013, the company announced that it was "temporarily suspending the marketing and commercial distribution" of ponatinib at the direction of the FDA. The price of ARIAD stock tumbled to $2.20 per share. Prior to the black box warning disclosure the year before, ARIAD shares were trading at more than $23 a share.
Investors filed suit in the U.S. District Court for the District of Massachusetts, alleging violations of Exchange Act §10(b) and Rule 10b-5, as well as Securities Act violations in connection with a January 2013 common stock offering. The district court dismissed all Exchange Act claims, finding that while the complaint sufficiently alleged material misrepresentations or omissions about ponatinib, the pleadings failed to give rise to a "strong inference" of scienter as required by the Private Securities Litigation Reform Act of 1995 (PSLRA). On the Securities Act claims, the district court held that the complaint did not plausibly allege any material misrepresentations or omissions in relation to the January 2013 offering.
On appeal, the First Circuit panel affirmed the dismissal of most of the Exchange Act claims, as well as the Securities Act counts. According to the panel, most of the allegations represented an impermissible attempt to establish “fraud by hindsight.” The complaint failed to allege any specific facts about when the defendants learned of the adverse events, and allegations that senior management “must have known” failed to meet the PSLRA pleading requirements.
The appellate panel reversed the dismissal of one Exchange Act claim, however. On Dec. 11, 2012, an investment bank published a report on ARIAD following a meeting with ARIAD's senior management. The officers indicated that they were optimistic about ponatinib's prospects for approval "with a favorable label." The report also stated that the drug's "profile continues to look very benign, with few worrisome signals." The report cited pancreatitis as "the most prevalent" serious adverse event and noted "low rates of cardiovascular issues." According to the court, it was knowingly or recklessly misleading for the corporate officers to express optimism about ponatinib's chances for approval with a "favorable label" after learning that the FDA had rejected ARIAD's proposed label. The court recognized that management may have held out hope of achieving this result, but the optimistic expressions without disclosure of recent troubling developments created “an impermissible risk of misleading investors.”
The case reflects a long-term trend in securities litigation, where much of the development and presentation of the plaintiffs’ case is frontloaded into the dismissal motion stage. Given the PSLRA’s discovery stay, class action plaintiffs must, without the benefit of discovery, develop their cases through the use of investigators, experts and forensic accountants to a level of completeness comparable to what plaintiffs in other areas of federal litigation would present at the summary judgment stage.
These cases also often involve the district judge playing the role of fact-finder in the early stages of the litigation. The PSLRA requires plaintiffs to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” According to the U.S. Supreme Court in Tellabs Inc. v. Makor Issues & Rights Ltd., “an inference of scienter must be more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Due to the PSLRA scienter pleading requirement, judges are making factual rulings on elements of the prima facie case in deciding motions to dismiss that are left to juries in most other areas of federal litigation.
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