9th Circuit to corporations: Once you open your mouth, you can’t lie

October 27, 2016

For plaintiffs, one of the hardest parts of winning a securities class action is showing the defendant intended to deceive investors. As the 9th U.S. Circuit Court of Appeals put the matter in an opinion Wednesday, the Federal Rules of Civil Procedure, in combination with the 1995 law toughening the standard for shareholder class actions, “create a significant barrier for private securities plaintiffs.”

But corporate defendants, according to the 9th Circuit, give shareholders a big boost when they use a piece of information to reassure shareholders – and neglect to tell investors the whole story behind the reassurance. The appellate court, in an opinion by Judge Jay Bybee for a unanimous panel that also included Judges Harry Pregerson and Randy Smith, revived a securities class action against the biomedical company Arena Pharmaceuticals, holding that once Arena mentioned good results in animal studies on its weight loss drug lorcaserin, it was obligated to reveal a dispute with the Food and Drug Administration over the results.

The dispute involved cancer testing on rats before the FDA voted on whether to approve lorcaserin. The rats exposed to the weight loss drug developed all sorts of tumors. Arena attributed the tumors to a hormone linked to cancer in rats, minimizing the impact of the rat test results on humans. The FDA did not halt simultaneous clinical testing of lorcaserin on people, but did request more rat tests and monthly updates on the results.

While the tests were under way, Arena officials told investors in various public statements that lorcaserin was safe and likely to be approved by the FDA. Some of the statements specifically referred to animal testing that showed the product was not carcinogenic.

I bet you can guess what happens next in this tale. In 2010, the FDA published on its website briefing documents by Arena and the government on lorcaserin’s approval. The documents disclosed for the first time the rat study and the FDA’s concerns about its results. Aghast investors sold Arena shares so fast that the stock price dropped 40 percent in a single day, allegedly costing shareholders more than $100 million.

Ultimately, in 2012, the FDA approved the drug. But by then, of course, investors who’d lost money in the 2010 stock plunge had sued in federal district court in San Diego. Represented by lead counsel from Kaplan Fox & Kilsheimer, investors claimed they were duped by the company’s assurances that animal tests indicated lorcaserin was safe and would be approved.

Arena’s lawyers at Cooley argued there was nothing deceptive about the company’s statements since Arena officials believed the FDA would eventually agree with its interpretation of the rat cancer results. U.S. District Judge Cathy Bencivengo sided with Arena and dismissed the shareholder class action. She concluded that the company did not intend to deceive shareholders when it did not disclose the rat study or the FDA’s concern about its results.

The 9th Circuit disagreed, though it said this was “a close case.” The problem for Arena, the appeals court said, was that it raised the subject of animal testing. Citing the U.S. Supreme Court’s 2011 ruling in Matrixx v. Siracusano, the panel said corporations do not have an affirmative duty to reveal every piece of information to shareholders. But once they choose to tout good news, the 9th Circuit said, they are bound to disclose any bad news that undercuts it.

“Arena could have remained silent about the dispute or it could have addressed its discussions with the FDA head-on. But it could not represent that there was no controversy here because all the data was favorable,” the 9th Circuit said. “It is the failure to disclose ‘issues’ and ‘concerns’ with the rat study and the FDA’s interest in the outcome of those studies-not who was ultimately right about the underlying science-that matters. And it sure mattered to investors, who were understandably concerned by the information revealed in the FDA’s 2010 briefing documents.”

Stris & Maher, which represented Arena investors at the 9th Circuit, said the panel opinion will apply beyond the narrow category of shareholder class actions against pharma companies. “People had started to believe you couldn’t win cases without a smoking gun” proving fraudulent intent, said Dana Berkowitz of Stris & Maher. “This case shows the bar is high but not insurmountable. Once you speak, you can’t mislead.”

I emailed Arena counsel John Dwyer of Cooley but didn’t hear back.

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