In this putative class action, investors alleged that Biogen executives misled the public about the impact on sales of the company’s multiple sclerosis drug Tecfidera after one patient’s death. Plaintiffs alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act by Biogen and three Biogen executives. The First Circuit affirmed the District Court’s dismissal of the investors’ amended complaint for failure to meet the heightened pleading requirements of the Private Securities Litigation Reform Act, as well as the District Court’s denial of investors’ motion to vacate the dismissal and for leave to file a second amended complaint.

Tecfidera accounted for one-third of Biogen’s revenues prior to the announcement of the patient death during an earnings call in October 2014. Following the announcement and an FDA warning to the public about the patient death, Biogen eventually revised its estimate of overall 2015 revenue growth, “based largely on revised expectations for the growth of Tecfidera.” Biogen’s stock plummeted over 20 percent in one day following the announcement of the revised revenue growth estimate.

Plaintiffs’ amended complaint set forth numerous allegedly misleading statements made by defendants regarding the material impact of the patient death on Tecfidera sales, “alleg[ing] in substance that Biogen executives made statements about future Tecfidera sales that were misleading because they were unduly optimistic.”

To support their claims that the statements were made with scienter and were misleading, plaintiffs relied on the statements of several confidential witnesses. Of the 20 misrepresentations alleged in the complaint, the District Court found that only three of defendants’ statements appeared to be “plausibly misleading” based on the complaint’s allegations. The court found that the remainder of the statements were either protected by the Reform Act’s safe harbor for forward-looking statements, or constituted immaterial expressions of corporate optimism or puffery. With respect to the three “plausibly misleading” statements, the court commented that “[e]ven assuming that defendants made a materially false or misleading statement, plaintiffs have not sufficiently alleged that defendants made those statements with ‘conscious intent to defraud or a high degree of recklessness.’” The District Court also found that the record gave rise to inferences in the defendants’ favor. In granting the motion to dismiss, the court noted that, “[b]ased on the complaint as a whole, plaintiffs’ asserted inference of scienter may be plausible, but it is not strong, cogent, or compelling” as required by the Reform Act’s heightened pleading standards.

In affirming the dismissal, the First Circuit adopted the District Court’s analysis regarding the falsity of defendants’ statements, focusing on the complaint’s allegations of scienter with respect to the three “plausibly misleading” statements. The First Circuit found that the confidential witness statements, a substantial basis for the complaint’s allegations as to scienter, “very often made about events occurring after the defendants’ statements at issue, are so lacking in connecting detail that they cannot give rise to a strong inference of scienter.”  Elaborating on this conclusion, the First Circuit found that the allegations were “insufficiently particular, do not make misleading the defendants’ public disclosures, and do not speak with specificity as to why the defendants’ alleged misstatements were untrue or misleading.” In particular, the confidential witness statements did “not even begin to quantify the magnitude” of the decline in Tecfidera sales, “explain with any precision” the specific cause of the decline, or contain contemporaneous facts that “purport to contradict” Biogen’s financial reports during the class period. The allegations suffered from “a significant timing problem” in that the majority of the confidential witness statements and other alleged “evidentiary admissions” did not address how the defendants’ statements were “knowingly or recklessly misleading at the time they were made.” Indeed, the First Circuit found that the witness statements were “consistent with the defendants’ public disclosures,” and that the defendants repeatedly warned investors about the growth risks throughout the class period.

The court also rejected plaintiffs’ scienter allegations based on the “core operations” inference of scienter and the individual defendants’ motive. First, the court rejected the “core operations” allegations as “inapt” because plaintiffs did not plead “materially” contradictory “reasonably accessible data within the company” at the time the statements were made. As for motive, the court agreed that that the “most cogent inferences from the record favor the defendants,” including the defendants’ compensation structure, which was tied in part to revenue growth, as well as the fact that the individual defendants increased their Biogen stock holdings during the class period, thereby suffering losses as a result of the decline in share price. The court underscored the importance of “evaluating the complaint as a whole, including ‘plausible opposing inferences’,” as a part of the scienter analysis.

In Brennan v. Zafgen, Inc., — F.3d –, 2017 WL 1291194 (1st Cir., April 7, 2017), the First Circuit affirmed a District of Massachusetts decision dismissing claims against Zafgen, Inc., a biopharmaceutical developer, and its CEO, Dr. Thomas Hughes. Judge Stahl, writing for a panel that included retired Supreme Court Justice Souter (sitting by designation), concluded that plaintiffs’ complaint did not allege facts giving rise to the “cogent and compelling” inference of scienter required by the Reform Act. Id. at *1 (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 324 (2007)).

Between August 2012 and May 2013, before Zafgen went public, the company conducted a Phase II trial of an anti-obesity drug called Beloranib. As the trial progressed, four patients in the trial who were receiving the drug suffered adverse “thrombotic”—i.e., blood-clotting—events of varying severity. Third-party clinical investigators classified two of these adverse thrombotic events as “superficial,” and the other two events as “serious.” In April 2014, as Zafgen was preparing for a June 2014 IPO, it disclosed the two serious events, but not the two superficial events, in its Form S-1 Registration Statement. Id. at *1-2.

In mid-October 2015, Zafgen’s share price began to decline, falling from $34.76 on October 12 to $15.75 at close of trading the next day. On October 15, Zafgen disclosed that a patient in its ongoing Phase III trial of Beloranib had died; and on October 16, the company confirmed that this patient had been treated with the drug (rather than a placebo), and that the FDA had placed Beloranib on a partial clinical hold. Also on October 16, 2015, Zafgen’s chief medical officer, Dr. Dennis Kim, disclosed for the first time the two superficial adverse events from the Phase II trial that was conducted in 2012-2013. By the end of trading on October 16, the price of Zafgen stock had dropped to $10.36. Id. at *2.

The plaintiffs in Brennan sued Zafgen and Dr. Hughes on behalf of a putative class consisting of all persons and entities who bought Zafgen stock between its IPO on June 19, 2014 and October 16, 2015, when the company announced the FDA’s partial clinical hold. Id. at *3. They argued that the company had made misleading statements about its Beloranib trial in ten different documents that were signed by Dr. Hughes, and they asserted claims under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. Specifically, the plaintiffs claimed that the challenged statements were misleading because they failed to mention the two superficial adverse events from the Phase II trial, which were disclosed for the first time by Dr. Kim on October 16, 2015. Id. at *1-3. (Despite alleging material omissions in Zafgen’s Registration Statement, plaintiffs did not assert Securities Act claims.)

The district court dismissed plaintiffs’ complaint on the ground that it failed to adequately plead a “strong inference” of scienter, as is required by the Reform Act. In doing so, the district court placed particular emphasis on the materiality of the two superficial adverse events, which it described as “marginal,” thereby weakening any inference of scienter. Id. at *4.

On appeal, the plaintiffs argued that they had, in fact, satisfied the Reform Act’s scienter requirement, because they had pled that defendants (1) knew, or were reckless in not knowing, about news and scientific articles purportedly showing a link between Beloranib and adverse thrombotic events; and (2) had a motive to commit securities fraud, as shown by Zafgen’s compensation structure, and by “heavy” insider sales before the patient death was announced. Id. at *5.

Regarding the news and scientific articles cited by plaintiffs, the First Circuit noted that “‘[t]he key question … is not whether defendants had knowledge of certain undisclosed facts, but rather whether [they] knew or should have known that their failure to disclose those facts’ risked misleading investors.” Id. (quoting City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters Corp., 632 F.3d 751, 758 (1st Cir. 2012)). In this case, the cited articles “may [have] suggest[ed]” that the defendants were aware of a link between Beloranib and thrombotic events. But the articles did not demonstrate that the defendants “deliberately or recklessly risked misleading investors” by not disclosing the two superficial events from the Phase II trial until October 16, 2015. Id.

Turning to plaintiffs’ motive allegations relating to insider trading and Zafgen’s compensation structure, the First Circuit agreed with the district court that “the strength of the insider trading allegations drifts towards the marginal end of that spectrum because [CEO] Hughes and all other Zafgen insiders kept the vast majority of their Zafgen holdings.” Id. at *6 (observing that after accounting for vested options, Dr. Hughes retained at least 93 percent of his Zafgen stock, and every other insider identified in the complaint retained at least 85 percent). In light of this fact, the district court was correct in determining that the plaintiffs’ insider trading allegations “d[id] not alter the conclusion that the complaint as a whole fails to raise a strong inference of scienter.” Id.

As for the plaintiffs’ arguments regarding Zafgen’s compensation structure, the First Circuit found that the complaint’s allegations offered no basis for inferring fraudulent intent, but showed only “the usual concern by executives to improve financial results.” Id. (quoting In re Cabletron Sys., Inc., 311 F.3d 11, 39 (1st Cir. 2002)). An allegation that a defendant had motive and opportunity to commit fraud, or that a corporation “rewards [its executives for] the achievement of corporate goals,” does not satisfy the Reform Act “without something more.” Id.

The First Circuit also discussed several other considerations that “bolster[ed]” its conclusion that the complaint’s allegations did not give rise to a sufficiently strong inference of scienter. These included the fact that (1) the materiality of the two undisclosed superficial adverse events was “marginal,” which “tends to undercut the argument that the defendants acted with the requisite intent … in not disclosing [them],” id. at *7 (quoting In re Ariad Pharm. Sec. Litig., 842 F.3d 744, 751 (1st Cir. 2016)); and (2) Zafgen’s disclosures before and during the class period mentioned the two serious thrombotic events from the Phase II study, and also stated that the company would not disclose all adverse events as they occurred, which “weaken[ed] the complaint’s scienter showing,” id. at *8.

Having thus concluded that the plaintiffs’ allegations, considered as a whole, did not give rise to a “cogent and compelling” inference of scienter, the First Circuit affirmed the dismissal of plaintiffs’ Section 10(b) claim as well as their Section 20(a) claim against Dr. Hughes, which was derivative of the former. Id.

In Ganem v. InVivo Therapeutics Holdings Corp., 845 F.3d 447 (1st Cir. Jan. 9, 2017), the First Circuit affirmed a District of Massachusetts decision dismissing claims against InVivo Therapeutics Holdings Corp., a biotechnology company, and its former CEO, Frank Reynolds. The First Circuit held that InVivo could not be liable for its projections about the start and end dates of a clinical study, because the plaintiff failed to adequately allege that these statements were rendered materially misleading by the nondisclosure of conditions imposed on the study by the FDA. Having found that the complaint did not support a Section 10(b) or Rule 10b-5 claim against InVivo, the First Circuit held that the plaintiff could not pursue a control person claim against Reynolds.

In early March 2013, InVivo issued its Form 10-K for 2012, in which it stated that its “Lead Product Under Development” was a device called “biopolymer scaffolding,” which was designed to prevent further harm to patients who had already suffered a spinal injury. The annual report indicated that before InVivo could market the device in the U.S., it would have to obtain an Investigational Device Exception (IDE) from the FDA, which would allow it to conduct necessary human clinical trials. Id. at 450.

On March 29, 2013, the FDA sent InVivo a letter indicating that its application for an IDE had been “approved with conditions.” The letter said that InVivo could begin the study immediately with a single human subject, but that that InVivo would need to meet a set of 11 conditions in 45 days and any additional subjects could only be enrolled in the study in five stages over a minimum period of 15 months. The FDA letter also included eight recommended modifications to the study’s design. Id. at *451.

On April 5, the week after receiving the FDA letter, InVivo issued a press release stating that the FDA had approved its IDE application, and indicating that the company “intends to commence a … clinical study in the next few months.” The April 5 release also quoted Reynolds as saying, “we expect to have all data [from the completed study] to the FDA by the end of 2014.” On April 8, the first trading day after InVivo issued this release, its stock price rose from $2.85 to $3.19 on “relatively high” trading volume. Id. at *451-52.

On May 9, InVivo issued another press release, indicating that the company “expects to commence the [study] in mid-2013 and submit data to the FDA by the end of 2014.” There was no allegation that the May 9 release led to an increase in InVivo’s stock price. Id. at 452-53.

Finally, on August 27, InVivo issued another press release entitled, “InVivo Therapeutics Updates Clinical Plan.” This release stated that the company “now expects that, based on the judgment of new management, it will enroll the first patient in [the study] during the first quarter of 2014,” and that additional patients would be enrolled over a period of 21 months after the enrollment of the first. Between August 23, when InVivo’s stock had begun to trade at an unusually high volume, and August 28, the day after the issuance of the “update” release, InVivo’s stock price fell from $4.00 to $2.07. Id. at *453.

The plaintiff in the Ganem litigation sued InVivo and Reynolds on behalf of a putative class consisting of all persons and entities who bought InVivo stock between April 5 and August 26, 2013—that is, all purchasers between the date when InVivo announced it had obtained approval to conduct the study, and the date when it revised the study timeline. The complaint asserted that InVivo and Reynolds had violated Section 10(b) and Rule 10b-5 by making misleading statements about the timing of the study in the April 5 and May 9 press releases. The plaintiff’s basic theory was that the projections in these releases were materially misleading because InVivo had failed to reveal that the FDA’s approval was conditional; that InVivo would need to conduct the study in five stages; and that the FDA had recommended modifications to the study design. Id. at *453-55.

The district court dismissed the complaint, finding that the plaintiff had failed to allege material misrepresentations or scienter to support the first claim. On appeal, the First Circuit considered only whether the plaintiff had pled an actionable misrepresentation—a question that disposed of the entire complaint when answered in the negative. Id. at *454. Notably, although the challenged statements were forward-looking, the First Circuit did not apply the Reform Act’s safe harbor for forward-looking statements, finding that “the absence of a material misrepresentation or omission is determinative.” Id. at 454 n. 5.

Regarding InVivo’s statements in the challenged releases that it expected to begin the study “in the next few months” and in “mid-2013,” the First Circuit held that these projections were not materially misleading because there was nothing in the FDA approval letter that would have prevented InVivo from initiating the study on this schedule. Although the FDA had required, for example, that InVivo meet a set of conditions within 45 days, the plaintiff had alleged “no facts suggesting that InVivo would fail to meet that deadline.” Id. at 456.  Likewise, the First Circuit found that InVivo could conceivably have completed the study and submitted data to the FDA within the timeline it offered in these releases (i.e., “by the end of 2014”) while complying with all of the requirements in the FDA letter, including the stipulation that the study must have five stages to be completed over a minimum of 15 months. Id. at *456-57.

Given that the FDA’s approval letter was not inconsistent with InVivo’s projections, the First Circuit concluded that the plaintiff was left “only with the inference that because, in retrospect, the [study] lagged significantly behind the proposed timeline, the timeline must always have been impossible to achieve.” Id. at *457. The court noted, however, that “fraud in the hindsight does not satisfy the pleading requirements in a securities fraud case,” and although “’greater clairvoyance’ might have led InVivo to propose a more conservative timeline [for its study], ‘failure to make such perceptions does not constitute fraud.’” Id. (quoting Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978)).

The First Circuit affirmed the dismissal of nearly all securities class action claims against Ariad Pharmaceuticals, Inc. (Ariad) and four corporate officers, in In re Ariad Pharmaceuticals, Inc., Securities Litig., 842 F.3d 744 (1st Cir. 2016). The litigation focused on Ariad’s public statements about the potential for FDA approval of an experimental drug designed to treat a particular type of leukemia.  Ariad made robust public statements about the efficacy of the drug, until the FDA pulled the drug from clinical trials amid negative side effects. The First Circuit found that other than one statement, the allegations of misrepresentations were insufficient to support a strong inference of scienter. The court also held that the allegations of insider trading were not actionable.

Ariad is a pharmaceutical company employing R&D to develop new products. One such product showed promise in treating a chronic form of leukemia. After a series of clinical trials, Ariad sought FDA approval. The FDA initially rejected Ariad’s application, but eventually approved limited use, with the caveat that the packaging must indicate a significant risk of adverse cardiovascular events (a so-called “black-box” label). Black-box labels are the strictest warnings issued by the FDA and indicate that evidence of a serious hazard exists with the drug. Despite the concerns and the required label, Ariad projected public confidence about the drug’s effectiveness, which included a statement that management believed the drug would be approved “with a favorable label.” Within a year, however, clinical studies showed increased medical complications, ultimately resulting in the decision to suspend commercial distribution of the drug.  Ariad’s stock price went from $23/share to $2.20/share.

Plaintiffs brought claims under both the Exchange Act and the Securities Act. Plaintiffs identified two categories of alleged misstatements: (1) those statements made before the FDA approved the drug for limited use; and (2) those statements made post-approval. On either side of the FDA approval timeline, the crux of the alleged misstatements related to what Ariad knew and said (or failed to say) about the rate of cardiovascular events attributed to the drug’s use. To bolster their scienter allegations, plaintiffs alleged that certain executives sold shares during the class period.

On appeal, the First Circuit affirmed, in part, the district court’s dismissal. The court overwhelmingly rejected plaintiffs’ theory because, while the complaint was replete with conclusory allegations that the Ariad defendants knew about the rate of cardiovascular events, “plaintiffs’ theory of fraud suffer[ed] from a glaring omission”—plaintiffs failed to make concrete allegations of contemporaneous knowledge. The allegations, taken as a whole, did not establish when the adverse events occurred or, more importantly, when the defendants knew about those adverse events.  Instead, the complaint sought to impermissibly establish fraud by hindsight. As such, plaintiffs failed to create the required strong inference of scienter.

The court did find, however, that one statement did support a strong inference of scienter. After the FDA had informed Ariad that its limited approval would include a black-box label requirement, Ariad published a report indicating the drug would likely receive a favorable label. The court found this allegation sufficient.

The First Circuit also dispensed with the stock-sale allegations. Relying on its decision in Greebel v. FTP Software, Inc., 194 F.3d 185 (1st Cir. 1999), the court analyzed the insider trading allegations under its holding that insider trades may be probative of scienter, but do not, on their own, establish scienter. The court found that the bulk of insider trades occurred well before the high point of Ariad’s stock price, an indication that the trades did not appear to be suspicious. Ariad’s CFO made trades closest to the stock’s high point, but, significantly, the court concluded a pharmaceutical company’s CFO is not likely to have access to nonpublic information obtained through clinical trials. As such, it was unlikely, in the court’s estimation, that the CFO’s trades indicated knowledge of negative information not yet available to the public. The upshot: none of the insider trading allegations bolstered the plaintiffs’ scienter allegations.

Finally, the First Circuit held that plaintiffs did not adequately plead that the purchase of their shares was traceable to the relevant offering. Based on the plaintiffs’ allegations, the court found it more plausible than not that they purchased shares that were issued prior to the date(s) of the alleged misstatements.

Analogizing a plaintiff’s allegations to “brushstrokes” intended to paint a “portrait” of scienter, the First Circuit found those allegations “cover[ed] too little canvas” to give rise to the strong inference of scienter required under the Private Securities Litigation Reform Act.  See Local No. 8 IBEW Ret. Plan & Trust v. Vertex Pharmaceuticals, — F.3d —-, 2016 WL 5682548 (1st Cir. 2016).  In doing so, the First Circuit reaffirmed the very high bar that a plaintiff must clear to allege scienter on the basis of recklessness.

The case arose from Vertex’s correction of previously-reported preliminary results from clinical trials for an experimental drug combination treatment for cystic fibrosis.  Initially, Vertex reported an “absolute improvement” in lung function of 5 percent or more for 46 percent of patients receiving the combination therapy, and an “absolute improvement” of 10 percent or more for 30 percent of patients receiving the treatment.  Vertex was effusive in describing the preliminary results, stating that they “exceeded expectations” and were driving Vertex to accelerate its plans to bring the treatment to market.  Immediately thereafter, Vertex’s stock price shot up by more than 55 percent, and by a few weeks later had risen more 73 percent.  During that period, several of Vertex’s officers and directors sold over half a million shares of their Vertex stock for a total of almost $32 million.

At that point, however, Vertex reported that the preliminary results had been overstated.  Vertex explained that it had “misinterpreted” the results received from a third-party vendor, which reflected a “relative improvement” from the patients’ baseline lung function, rather than an “absolute improvement.”  Vertex reported that, once the results were recalculated to put them in terms of “absolute improvement,” only 35 percent of patients showed an improvement in lung function of 5 percent or more, and only 19 percent showed an improvement of 10 percent or more.  Following that disclosure, Vertex’s stock price declined significantly, although it remained over 54 percent higher than it had been before the initial announcement.

Plaintiffs filed a securities class action.  The lead plaintiff, Local No. 8 IBEW Ret. Plan & Trust (“Local No. 8”), alleged that, “[w]hen faced with … study results that seemed too good to be true, Defendants, rather than checking the results, turned a blind eye, accepting and promoting unlikely data that offered them a windfall on the sale of their stock.”  Id. at *3 (quoting complaint).  Defendants moved to dismiss, arguing that the facts alleged did not give rise to a “strong inference” of scienter, as required by the Reform Act.  The district court granted the motion, and Local No. 8 appealed.

On appeal, the First Circuit explained that, to show scienter through “recklessness” rather than actual intent for purposes of a securities fraud claim, a defendant’s conduct must go beyond “merely simple, or even inexcusable negligence, but [must involve] an extreme departure from the standards of ordinary care.”  Id. (citation omitted).  The court explained that this form of recklessness is “closer to a lesser form of intent” than to ordinary negligence. Id. (citation omitted).

With that background, the First Circuit turned to the facts alleged in the complaint that Local No. 8 argued cumulatively supported an inference of scienter.  The court indicated it was “mindful that ‘[e]ach individual fact about scienter may provide only a brushstroke,’ but it is our obligation to consider ‘the resulting portrait.’”  Id. at *4 (citation omitted).  Thus, the court would evaluate each fact individually, and then assess their cumulative effect.  Id.

The First Circuit did not find that any of the facts alleged, considered individually, were particularly indicative of scienter:

  • Local No. 8 alleged that the implausibility of the initial results should have been obvious for a number of reasons, and that some individuals within the company were highly skeptical of them.  The court found that, while Defendants admitted the initial results were surprising, Local No. 8 did not allege facts indicating that they were “so obviously suspect” that Defendants should have inquired further.  Id. at *4-*6.  Nor did Local No. 8 allege that any of the individuals within the company who were “skeptical” of the results reported that skepticism to any of the Defendants.  Id. at *5.
  •  Local No. 8 argued on appeal that it was “rare” for a company to publish interim results.  The First Circuit declined to consider that contention, as it was not made in the complaint and, in any event, there was no legal requirement that Vertex double-check interim results before reporting them.  Id. at *6.
  •  The First Circuit found that Local No. 8’s allegations of insider trading also did not strongly suggest scienter.  The court observed that one of the individual defendants—Vertex’s CEO—did not sell any stock, and one of the others sold only small amounts that were consistent with his trading pattern both before the initial announcement and after the correction.  While the other individual defendants had more substantial stock sales, the court found them “perfectly understandable” in light of Vertex’s previously languishing stock price.
  • Finally, Local No. 8 alleged that the sudden retirement of Vertex’s Chief Commercial Officer, Nancy Wysenski, shortly after a U.S. Senator asked the SEC to investigate potential insider trading by Vertex executives suggested consciousness of guilt, at least with respect to her.  Id. at *7.  The court noted that the allegations “point[ing] the finger” at Wysenski “tend to exculpate the others who did not retire or leave the company.”  Id. at *8.  Moreover, “[a]lternative explanations abound[ed]” for Wysenski’s retirement—her large insider sales could have been embarrassing to the company even in the absence of fraud, or she might have been negligent in preparing the press release announcing the initial results.  Id.

The First Circuit concluded that, “[c]umulatively, the brushstrokes here do not paint the required strong inference of scienter.”  Considered in the context of the allegations as a whole, “the stock sales by some of the individual defendants and the timing of Wysenski’s retirement (which might otherwise look very different) cover too little canvas to evoke inferences of scienter strong enough to equal the alternative inference that Vertex was negligent in viewing very good results as being even better than they in fact were.”  Id.