The First Circuit recently affirmed dismissal of claims under Section 10(b) and Rule 10b-5 as failing to meet the Private Securities Litigation Reform Act’s standard for pleading scienter. Corban v. Sarepta Thereapeutics, Inc., 868 F.3d 31, 42 (2017). The claims grew out of drug maker Sarepta’s description of its prospects for Food and Drug Administration (FDA) approval of a gene-therapy drug. In assessing the adequacy of the scienter allegations, the court looked primarily at the chronology of the drug maker’s statements and interactions with the FDA and whether it had a motive to lie, and it concluded that neither supported a strong inference of scienter. As Judge William Kayatta wrote for the three-judge panel that included Senior Judge Norman Stahl and retired Supreme Court Justice David Souter: “This is simply a case in which the complaint focuses too much on nuance rather than false facts or material omissions to support the necessary strong inference of scienter.” Id.

Defendant Sarepta is a biopharmaceutical company that develops gene therapies for the treatment of rare diseases. Id. at 34. The complaint—amended four times—alleged fraudulent statements about eteplirsen, a drug Sarepta sought approval for during the class period to treat a rare childhood disease in boys called Duchenne muscular dystrophy. The disease is caused by a genetic mutation that hinders the production of an essential protein for muscle function, leading to loss of muscle strength, which eventually affects the lungs and heart, causing death. The FDA ultimately approved the drug after the lawsuit was filed.

In 2013, Sarepta sought accelerated approval for eteplirsen. Id. at 35. Accelerated approval allows the FDA to approve drugs without a showing of effectiveness against the disease itself, and is available if the disease the drug treats is serious and if there is a showing that the drug affects a marker of health reasonably likely to predict an effect against the disease. Id. at 34. This marker is called a “surrogate endpoint.” Id. Sarepta had recently completed two studies showing the drug’s effect on two surrogate endpoints. The first study was a randomized double-blind trial involving twelve boys, four of whom received a placebo. The second was an unblinded study with the same boys that did not involve use of a placebo. Buoyed by the results of the studies, Sarepta told investors in March 2013 that it would file a new drug application with the FDA. Id. at 35.

The complaint against Sarepta alleged that defendants, including Chris Garabedian, the company’s then-president and CEO, made false and misleading statements about eteplirsen’s prospects for FDA accelerated approval. In a meeting with the FDA in March 2013, prior to the start of the class period, the FDA expressed serious concerns about the way Sarepta proposed to analyze the trial results that would form the basis for its application, saying that the proposed analysis “was unreasonable even for hypothesis generation.” Id. Garabedian disclosed only certain information about this meeting on a call with investors and analysts, saying that the FDA had “not made a final decision” and that it was “still too early to draw conclusions” about the FDA’s stance on Sarepta’s proposed endpoint for accelerated approval. But Garabedian struck an optimistic tone, stating that the FDA was “approaching . . . [that endpoint] as a surrogate that is reasonably likely to predict clinical benefit in the thoughtful manner we expected and is requesting more information.” Id. In July 2013, Sarepta again met with the FDA, and the FDA stated that “it was open to considering an NDA [new drug application] based on these data for filing,” so long as a number of conditions were met. Id. Sarepta publicized the FDA statement, noting that the FDA had requested additional information and predicting that the company would submit its application in the first half of 2014. Garabedian again struck an optimistic tone, saying that the company was “very encouraged by the FDA feedback.” He described the company’s choice of endpoint surrogate marker as “viable” and its analysis of that marker as “robust,” predicting that Sarepta’s data would support a new drug application filing. Id. at 35, 38. Still, the company cautioned that it did not know exactly when it would file its new drug application, that the agency had not yet accepted its surrogate endpoint, and that a filing would only indicate that the drug merited review. Id. at 36. Investors reacted more to the cautionary statements than the optimistic ones, causing a nineteen percent drop in Sarepta’s stock price on July 24, 2013, the beginning of the plaintiffs’ alleged class period. Id.

The stock would fall again—this time, sixty-four percent—at the end of the alleged class period, November 11, 2013. During the alleged class period, plaintiffs challenged several more optimistic statements. Garabedian described progress toward approval as “a tremendous achievement,” described the data from the trials as “compelling and favorable,” and characterized the FDA’s responses as “particularly encouraging because it recognizes that our Phase IIb study data set is sufficient for the FDA to consider filing.” Id. at 36. He also remarked that the company’s analysis of the study data was not “questioned or challenged [by the FDA] in terms of [Sarepta’s method for quantifying [dystrophin].” Id. The FDA had previously requested additional muscle biopsies from study participants, partly because it was concerned that a single technician had obtained and processed all muscle biopsies, id. at 40, but Garabedian characterized this request as “not an indication of the lack of strength of [Sarepta’s] current biopsy analysis and data.” Id. at 36.

September saw the failure of competitor GlaxoSmithKline’s candidate to treat Duchenne muscular dystrophy. Investors were initially optimistic that the failure would leave Sarepta with a larger market share, but on November 12, 2013, Serepta disclosed that the FDA now viewed a new drug application filing for eteplirsen as “premature.” Id. This news caused the precipitous sixty-four percent drop in Serepta’s stock. Plaintiffs filed suit, alleging that Sarepta and other defendants had overstated the significance of the trial data and exaggerated the chances that the FDA would accept a new drug application filing. Id. at 37.

Noting the Reform Act’s heightened pleading standard for scienter, id. at 37–38, the court rejected two sets of arguments as to why plaintiffs had sufficiently pleaded scienter in their fifth version of the complaint. Id. at 38–41, 41–42.

First, the court refused to draw inferences of scienter from the timeline of Sarepta’s interactions with the FDA and the challenged statements. In doing so, the court also implied that plaintiffs failed to adequately allege a false or misleading statement. The court found Garabedian’s July 2013 statements to be “poor material for building a fraud claim” because “[t]hey convey opinion more than fact. And while opinion that implies false facts may nonetheless suffice . . . these opinions came replete with caveats.” Id. at 38 (citation omitted). The court pointed to Sarepta’s disclosures that the FDA requested additional information from it and that the FDA would not commit to accepting Sarepta’s proposed surrogate endpoint—cautionary statements that caused a nineteen percent drop in Sarepta’s stock price at the beginning of the class period. Id. at 38. The caveats also “cut against the inference of scienter.” Id. “At worst,” the court wrote, “there was positive spin that put more emphasis in tone and presentation on the real signs of forward movement with the NDA than it did on causes for wondering if the journey would prove successful.” Id. Finally, with respect to the July 24 statements, the court noted that the timeline did not support an inference of fraud. Id. at 38. It was events occurring after Sarepta’s optimistic statements that presented the most important obstacles to filing a new drug application, and Sarepta could not have predicted these in July. Moreover, Sarepta ultimately proved correct in its July evaluation of the drug’s prospects for eventual approval. Id. at 39.

The court also found insufficient the allegations that Sarepta’s statements in the middle of the class period were false or misleading. The FDA’s concern about the single technician who collected all the studies’ biopsies did not render false Sarepta’s statement that the FDA had not questioned its methods. Id. at 40. “Concerns about reliability are not the same as concerns about methodology,” the court observed. Id. And even if Sarepta’s statements were misleading, plaintiffs did not sufficiently plead that they were intentionally or recklessly so. Id.

Nor did plaintiffs sufficiently plead an intentional or reckless omission, even though Sarepta failed to disclose certain details of its communications with the FDA that might have been material to investors. “[S]imply pointing [the court] to omitted details . . . and failing to explain how the omitted details rendered the particular disclosures misleading, misses the mark,” the court wrote. Id. An allegation that Sarepta failed to report specific technical factors leading the FDA to take a position, while still reporting the FDA’s position faithfully, struck the court “as more consistent with negligence than reckless or intentional concealment.” Id.

In coming to this conclusion, the court distinguished two recent cases in other circuits: Zak v. Chelsea Therapeutics International, Ltd., 780 F.3d 597 (4th Cir. 2015), and Schueneman v. Arena Pharmaceuticals, Inc., 840 F.3d 698 (9th Cir. 2016). See id. at 40–41. The defendants in Zak were alleged to have misrepresented the FDA’s position on a drug application, saying the FDA had “agreed” that the company could submit an application, when the FDA had actually told the company that its basis for submission “typically was not sufficient to support approval.” Id. at 41 (citing Zak, 780 F.3d at 611). And the defendants in Zak allegedly misrepresented an FDA briefing document recommending against approval of their drug, describing the document as presenting only “lines of inquiry.” Id. at 41 (quoting Zak, 780 F.3d at 603). Similarly, in Schueneman, defendants were alleged to have conveyed optimism and reported “favorable results on everything” from animal studies when there was an indication that the defendants’ drug caused cancer in rats. Id. (citing Schueneman, 840 F.3d at 702, 708). The circumstance surrounding the statements and omissions at issue in Zak and Schueneman more strongly suggested scienter than did the allegations in Sarepta.

Second, the court rejected inferences of scienter based on an allegation that defendants had a motive to lie. Plaintiffs alleged two motives for misstatement: (1) to support a stock offering at the beginning of the class period, and (2) to mobilize families of boys suffering from Duchenne muscular dystrophy to pressure the FDA for accelerated approval. Id. at 41–42. The court found both of these allegations insufficient. Citing circuit precedent, the court held, “The usual concern by executives to improve financial results does not support an inference of scienter.” Id. (internal quotation marks and brackets omitted). Plaintiffs needed to allege something more, such as “that the very survival of the company was on the line.” Id. (internal quotation marks and brackets omitted.) The court found the second motive to lie implausible. See id. at 42. The complaint alleged that Sarepta sought attention for its drug and that FDA officials were made aware of this public attention. But the court doubted that Sarepta had an incentive to seek such attention. Greater public attention would lead to greater scrutiny, and the pay-off to such scrutiny was uncertain because the FDA decision-making process is not easily susceptible to outside pressure. Id.

Ultimately, the court concluded that the inferences of scienter the plaintiffs sought were not as compelling as the innocent explanation that the company had sought to navigate “the uncertain terrain of accelerated approval for a gene therapy” and “perhaps negligently, waxed too optimistically about the FDA’s expression of a willingness to consider an NDA for eteplirsen while emphasizing too little the FDA’s reservations about such an application.” Id.

A recent Third Circuit opinion demonstrates the high bar that plaintiffs face when attempting to plead the falsity of two categories of statements: (1) risk factors alleged to be misleading because the warned-of risk had already materialized, and (2) forward-looking earnings projections. In Williams v. Globus Medical, Inc., — F.3d —, 2017 WL 3611996 (3rd Cir. Aug. 23, 2017), the Third Circuit affirmed a district court ruling dismissing such claims.

Globus Medical is a medical device company that sells implants to medical professionals to be used on their patients. Globus formerly relied on both in-house sales reps and third-party distributors to sell its products. One of those distributors, Vortex Spine, LLC, was Globus’ exclusive distributor in parts of Louisiana and Mississippi. The exclusive deal between Globus and Vortex was set to expire on December 31, 2013, but the plaintiffs alleged that Globus had already decided to terminate its deal with Vortex by that date. Globus intended to take more of its sales operation in-house. Nevertheless, Globus extended the agreement with Vortex through April 2014, and it told Vortex it would use that four-month period to negotiate a new agreement. Instead, plaintiffs alleged, Globus used that time to hire an in-house salesperson to take over Vortex’s territory. Id. at *1-2

In the middle of that four-month period, during a February 26, 2014 earnings call, Globus CFO Richard Baron projected fiscal year sales of $480 million to $486 million, and earnings per share of $0.90 to $0.92. In its March 14, 2014 10-K, Globus included a risk factor cautioning:

If we are unable to maintain and expand our network of direct sales representatives and independent distributors, we may not be able to generate anticipated sales. . . . [I]f any of our independent distributors were to cease to do business with us, our sales could be adversely affected. Some of our independent distributors account for a significant portion of our sales volume, and if any such independent distributor were to cease to distribute our products, our sales could be adversely affected. In such a situation, we may need to seek alternative independent distributors or increase our reliance on our direct sales representatives, which may not prevent our sales from being adversely affected.

Id. On April 18, 2014, Globus met with Vortex and notified it that had hired an in-house sales rep for the Vortex territory. Just ten days later, on a quarterly earnings call, Baron projected the same revenue and earnings figures for the year, and on April 30, 2014, Globus filed its 10-Q that stated there had been no significant changes to its risk factors. Id. at 2.

Finally, on August 5, 2014, Globus issued a press release announcing its second quarter financial results. The press release revised its revenue guidance down by approximately $20 million for the year. In an earnings call that day, Globus COO David Demski explained the change in guidance was due to a decline in sales growth in part because, “early in the quarter we made the decision not to renew our existing contract with a significant U.S. distributor, negatively impacting our sales.” The next day Globus’ stock price dropped nearly 18 percent. When Globus announced its year-end financial results in early 2015, sales were $474.4 million — just 1 percent lower than the original guidance — and earnings per share beat the original guidance by over 5 percent. Id.

Plaintiffs filed a securities class action in the Eastern District of Pennsylvania in September 2015, alleging violations of Exchange Act Sections 10(b) and 20(a), and Rule 10b-5. The amended complaint named the company, Baron, Demski, and two others as defendants. The District Court granted the defendants’ motion to dismiss. The Third Circuit affirmed. Id. at *2-3.

The Third Circuit’s analysis began by separating the challenged statements into historical risk factor statements, and the forward-looking revenue and earnings projection statements. With respect to the historical risk factor statements, plaintiffs alleged that the Globus defendants had a duty to disclose its decision to terminate the relationship with Vortex when that decision was made around December 2013, and that they had a duty to disclose in April 2014 when Globus actually terminated the relationship. Id. at *4.

Of course, Section 10(b) and Rule 10b-5 do not require disclosure of all material information. Disclosure is required “only when necessary ‘to make . . . statements made, in light of the circumstances under which they were made, not misleading.’” Id. (quoting Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 44 (2011)). The plaintiffs in this case alleged that Globus’ failure to disclose its decision to terminate the agreement with Vortex made the existing risk disclosures inaccurate, incomplete and misleading. Globus’ risk factors warned of the potential consequences of losing a distributor when it had already decided to end its relationship with such a distributor. Typically, the Third Circuit explained, “courts are skeptical of companies treating as hypothetical in their disclosures risks that have already materialized.” Id.

“But this is not such a case.” Id. *5. The challenged risk factor was more specific — it warned of the adverse affect on sales of losing a distributor, not just the loss of the distributor. Plaintiffs did not allege that Globus’ sales were adversely affected by the decision to terminate Vortex, or the ultimate termination of Vortex, and nothing in the complaint was sufficient to infer that Globus was aware of an impact on sales prior to the disclosure in August 2014. Likewise, plaintiffs did not plead that a drop in sales was an inevitable consequence of the termination of the deal with Vortex. Indeed, sales at the end of the year were largely in line with the original forecast. Id.

The court next turned to the forward-looking statements at issue. Plaintiffs alleged that the Globus defendants violated Section 10(b) and Rule 10b-5 by issuing revenue projections that did not account for the company’s decision — already made at the time — to terminate the relationship with Vortex. The district court dismissed these claims on two grounds — that the plaintiffs failed to plead the projections were false when made, and that the statements were covered by the Private Securities Litigation Reform Act’s safe harbor for forward-looking statements. The Third Circuit again affirmed the district court ruling. Id. at *6.

Under Third Circuit precedent, when pleading the falsity of a forward-looking statement, plaintiffs must “plead factual allegations that show the projections were ‘made with either (1) an inadequate consideration of the available data or (2) the use of unsound forecasting methodology.’” Id. (quoting In re Burlington coat Factory Sec. Litig., 114 F.3d 1410, 1430 (3d Cir. 1997)). Here, the plaintiffs alleged that the Globus sales forecasts incorporated Vortex’s sales figures. Plaintiffs made that assertion based on “numerous inferences” including that defendant Baron said in the August 2014 earnings call that “the decision not to renew the distributor, and the impact to pricing will affect our top line expectations,” and other similar statements that could demonstrate that the loss of the Vortex sales were a driver in the change in revenue and earnings projections. Those allegations failed to plead the falsity of projections. In particular, the court was critical of the plantiffs’ use of hindsight conjecture rather than contemporaneous information to show that the Vortex sales were a component of the original projections. Id. at *6-7.

Finally, the Third Circuit addressed whether the statements were protected by the Reform Act’s safe harbor, which immunizes forward-looking statements if they are accompanied by meaningful cautionary language, are immaterial, or if the plaintiff fails to show the statement was made with actual knowledge it was false. In this case, the court determined that the plaintiffs did not meet their burden that the revenue and earnings forecasts were made with actual knowledge of their falsity. Plaintiffs could only point to three facts in support of the actual knowledge requirement:

(1) during the August 5, 2014, call explaining the revisions to the sales projections, COO Demski stated that the company “understood the risks to our short-term results” when it terminated its relationship with Vortex []; (2) during that same call, CEO Paul and CFO Baron acknowledged that they recalled Globus’s 2010 experience with “distributor turnover” and the two-year period it took to get the company “back to where [it was],”; and (3) the nature of the market for spinal implant products and the importance of goodwill between salespeople and customers.

Id. at *7. The Third Circuit agreed with the district court that these facts only made it plausible to infer that the defendants should have known that ending the Vortex relationship could have some effect on sales, but that is not the same as actual knowledge that the forecasts were false. Instead, the court found that the more plausible inference was that Globus accounted for the change from Vortex to an in-house sales rep when it made the initial projections. Id. at *7-8.

On August 18, 2017, a Ninth Circuit panel affirmed in part, reversed in part, and vacated in part the district court’s dismissal of the amended securities fraud class action complaint in In re Atossa Genetics, Inc. Securities Litigation before remanding for further proceedings. In re Atossa Genetics, Inc. Sec. Litig., 868 F.3d 784 (9th Cir. 2017). The complaint alleged that certain statements by Atossa and its CEO concerning the company’s breast cancer screening products were materially false or misleading—in particular, statements concerning U.S. Food and Drug Administration (“FDA”) clearance of one of its products. The district court found that each challenged statement either was not false or misleading or was not material; the Ninth Circuit, on the other hand, concluded that the complaint sufficiently alleged that some were materially false or misleading. There’s nothing groundbreaking about the panel’s analytical framework or approach here, which is consistent with previous case law, but the opinion is unusually clear and helpful in parsing exactly which sorts of statements in biotech cases are likely to survive motions to dismiss, and which are not.

Atossa develops and markets breast-cancer screening products. In 2009, it purchased the patent rights to the Mammary Aspirate Specimen Cytology Test System (“MASCT System”), a pump that extracts nipple aspirate fluid (“NAF”) from women’s breasts, which can then be tested for cancerous or pre-cancerous cells. Before Atossa acquired the MASCT system, the product had been cleared by the FDA through a “premarket notification/510(k) process” that allows companies to market devices that are “substantially equivalent” to devices already legally marketed in the U.S., as long as the FDA provides clearance by letter. The FDA cleared the MASCT system for use as a sample collection device, but the FDA did not clear the MASCT system for the screening or diagnosis of breast cancer.

Initially, Atossa marketed the MASCT system as a solo product, but later it started marketing it in combination with Atossa’s ForeCYTE test, a diagnostic tool that tested the NAF samples for cancer markers. Atossa never sought or obtained FDA clearance for either the ForeCYTE test or the combination of the MASCT system and the ForeCYTE test.

Following Atossa’s IPO in 2012, the company and its CEO made the following types of statements challenged in the litigation:

(1) statements describing the ForeCYTE test as FDA-cleared;

(2) statements describing the MASCT system as FDA-cleared;

(3) statements in a Form 8-K regarding a warning letter the company received from the FDA about the MASCT system and ForeCTYE test;

(4) statement in a Form 10-Q that Atossa was “reasonably confident in its responses” to the FDA’s warning letter; and

(5) a statement by the CEO that “2013 and 2014 are execution years, where FDA clearance risk has been achieved, patents have been obtained, clinical trials have been achieved, manufacturing has been achieved—so now it’s really a matter of going from less than 100 doctors doing our test to the expectation of thousands of doctors.” (emphasis added)

The panel carefully analyzed each of these categories of statements and concluded that most were in fact sufficiently alleged to be material and false or misleading. The court found this clearly to be the case with respect to the first category, since Atossa did not receive FDA clearance for either the ForeCTYE test or its combination with the MASCT system, and it would undoubtedly have been important to investors to know that one of Atossa’s main sources of revenue was not FDA-cleared. The court rejected the defendants’ argument that the market was aware at the time that the ForeCYTE test was not cleared: cautionary language in the IPO materials stating that the FDA likely would require premarket notification for certain lab tests in the future did not imply that the ForeCYTE test had not yet received clearance. And in any case, plaintiffs alleged direct reliance on these statements, in addition to “fraud on the market,” so it didn’t matter whether Atossa’s offering documents previously revealed that the ForeCYTE test was not cleared.

The panel found the second category straightforward too: unlike the ForeCYTE test, the MASCT system was cleared by the FDA, so statements to that effect were not false. Plaintiffs argued that the statements nonetheless were misleading in context, since a reasonable investor would have believed that the MASCT system was FDA-cleared not only for sample collection but also for breast cancer screening. The court disagreed, finding that Atossa marketed the MASCT system as a collection tool only, which was precisely the purpose for which it had been FDA-cleared.

The third category was more complicated as it involved allegedly misleading omissions. On February 20, 2013, Atossa received a warning letter from the FDA stating that it had discovered during a lab inspection that the MASCT system had been modified without obtaining a new 510(k) clearance. The FDA warned that this meant the MASCT system was misbranded and adulterated in violation of certain regulations. The FDA also specifically advised that the modified MASCT system required submission of a new 510(k) notification, that the ForeCTYE test required separate clearance, and that Atossa’s website and product labels were misleading because they described the MASCT system as “FDA-approved” and the ForeCYTE test as “FDA Cleared.”

Just a few days later, Atossa filed a Form 8-K stating that it had received a warning letter from the FDA explaining that the FDA believed that modifications to the MASCT system required new 510(k) clearance. However, the 8-K did not mention the FDA’s concerns regarding either the ForeCYTE test’s lack of FDA clearance or Atossa’s false or misleading marketing materials. In those regards, it stated only that:

“The Letter also raises certain issues with respect to the Company’s marketing of the [MASCT] System and the Company’s compliance with the FDA Good Manufacturing Practices regulations, among other things . . . Until these issues are resolved Atossa may be subject to additional regulatory action by the FDA . . . .”

The Ninth Circuit concluded that though not literally false, the complaint sufficiently alleged that these omissions were materially misleading: “In particular, the omissions gave the reasonable inference that the FDA had raised no concerns related to clearance for the ForeCYTE test, when, as alleged, the FDA had raised precisely that concern.” Nor did Atossa’s general disclaimer that it could be subject to future regulatory action from “other matters” cure the misleading nature of the filing since, as the district court had noted, the allegedly misleading part of the filing concerned only past facts, not statements about the future.

The Ninth Circuit affirmed dismissal of the claim in the fourth category, finding the statement that the company was “reasonably confident in its response” to the FDA warning letter to be “mere corporate optimism,” too unspecific and subjective to ground a claim.

Finally, the court analyzed the fifth category—the CEO’s statement that “FDA clearance risk has been achieved”—as a statement of opinion under Omnicare, and concluded that it was misleading by omission. Under Omnicare, “when a plaintiff relies on a theory of omission, the plaintiff must allege ‘facts going to the basis for the issuer’s opinion . . . whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.” (quoting City of Dearborn Heights, 856 F.3d 605, 616 (9th Cir. 2017)). The court concluded that the CEO’s statement minimizing FDA clearance risk was materially misleading:

“Here, saying that FDA clearance risk has been achieved is another way of expressing a belief that Atossa’s conduct mostly complies with FDA rules governing 510(k) clearance. And failing to disclose that the FDA gave a warning about the ForeCYTE Test not having 510(k) clearance is an omission concerning knowledge that the Federal Government has taken the opposite view concerning the lawfulness of Atossa’s alleged conduct.”

Ultimately, the Ninth Circuit’s careful analysis of each statement’s alleged falsity and materiality, or lack thereof, makes this a worthwhile read. The opinion also nicely illustrates a trend my co-authors and I identified with respect to motion to dismiss decisions in securities cases brought against young biotech companies bringing their first products to market, “Myths & Misconceptions of Biotech Securities Claims: An Analysis of Motion to Dismiss Results from 2005-2016.” As explained in that article, biotech companies are much more likely to get into trouble for statements describing or characterizing feedback from or interactions with the FDA—which concern past facts—than they are for nearly any other kind of statement, including optimistic predictions about drug trials or financial projections. In Atossa, the Ninth Circuit found a general statement of even ill-advised corporate optimism not to be actionable, but found several statements characterizing FDA feedback and the ForeCYTE test’s regulatory status to have been sufficiently alleged to be materially false and misleading. Biotech securities class actions go best when a company has tried to be as factual as possible when describing FDA feedback.

On July 28, the Ninth Circuit reversed the dismissal of a securities class action, and remanded to the Central District of California. In re Quality Sys., Inc. Sec. Litig., 865 F.3d 1130 (9th Cir. 2017). Quality Systems, which develops and markets electronic health records software, allegedly made false statements about its current and past sales “pipeline,” and used those statements to support public projections about the company’s future performance. Id. at 1135. The court addressed the application of the Private Securities Litigation Reform Act’s Safe Harbor for forward-looking statements—essentially predictions regarding future events or performance. The court announced a bright-line rule for “mixed” statements, which occur “[w]here a forward-looking statement is accompanied by a non-forward-looking factual statement that supports” it. Id. at 1146. The court held that “[i]f the non-forward-looking statement is materially false or misleading, it is likely that no cautionary language—short of an outright admission of the false or misleading nature of the non-forward-looking statement—would be ‘sufficiently meaningful’ to qualify the statement for the safe harbor.” Id. at 1146–47. The court further ruled that for “mixed” statements, whether “the non-forward-looking statements are, or may be, untrue is clearly an ‘important factor’ of which investors should be made aware.” Id. at 1148.

Doug Greene, Peter Hawkes, and I authored an amicus curiae brief on behalf of the Washington Legal Foundation, urging the Ninth Circuit to rehear the case en banc to replace the panel’s unduly constricted approach to the Safe Harbor with a context-driven standard that is consistent with Congress’s judgment in enacting the Safe Harbor. The brief first explains that the Safe Harbor was enacted to encourage companies to offer predictions about their future performance without the fear of crippling securities litigation if their predictions are not borne out by future events. To accomplish that, the Safe Harbor protects false or misleading forward-looking statements if they are identified as forward-looking and accompanied by “meaningful cautionary statements” identifying important risk factors that could affect future performance. The Safe Harbor offers an independent second prong that protects forward-looking statements if the speaker lacks actual knowledge that the statements are false. The brief shows that courts have been reluctant to apply the first prong of the Safe Harbor independently, fearing that it gives companies a “license to defraud.” By announcing an inflexible rule that, for “mixed statements,” cautionary language cannot be “meaningful” absent an admission of the falsity of any inaccurate statements of present or past fact—regardless of whether the company even knows they are false—the Ninth Circuit panel similarly nullifies the Safe Harbor’s first prong by ignoring disclosures of other “important” risk factors and holding companies strictly liable for innocent misstatements.

On July 7, the Second Circuit affirmed in part and vacated in part an order by Judge Rakoff of the S.D.N.Y. certifying two classes in the In re Petrobras Securities litigation, — F.3d –, 2017 WL 2883874 (2d Cir., July 7, 2017). In doing so, the Second Circuit joined several other circuits in declining to adopt a “heightened” version of the implied class certification requirement of ascertainability, which arose in the Third Circuit. Having rejected defendants’ arguments on this point, however, the Second Circuit applied Morrison v. National Australia Bank, 561 U.S. 247 (2010), in assessing whether the plaintiffs had met the predominance standard for class certification, and held that they had failed to do so, because individual questions of transactional domesticity—which under Morrison must often be considered when the territorial scope of the securities laws is at issueprevailed over common ones.

Petrobras is a multinational oil and gas company based in Brazil and majority-owned by the Brazilian government. Plaintiffs in Petrobras were holders of Petrobras equity and debt securities, who alleged that value of these securities fell dramatically following the revelation of a long-term money-laundering and kickback scheme at the company. Defendants included Petrobras and a number of its executives. In re Petrobras, 2017 WL 28883874 at *1.

The district court certified two classes of plaintiffs, the first asserting claims under the Exchange Act, and the second asserting claims under the Securities Act. On appeal, defendants challenged class certification on the grounds that (1) these classes were not sufficiently “ascertainable”; and (2) plaintiffs had not met the Rule 23(b)(3) requirement “that questions of law or fact common to class members predominate over any questions affecting only individual members.” In an opinion written by Judge Garaufis of the E.D.N.Y. (sitting by designation), and joined by Judges Hall and Livingston, the Second Circuit rejected defendants’ acertainability argument, but sided with them on their predominance argument. Id. Specifically, the court of appeals found that the district court had “erred in conducting its predominance analysis without considering the need for individualized Morrison inquiries.” Id. at *6.

The ascertainability requirement for class certification does not appear in Rule 23 itself, but is instead an “implied” mandate that a class be “sufficiently definite so that it is administratively feasible for the court to determine whether a particular individual is a member.” Id. at *5 (quoting Brecher v. Republic of Argentina, 806 F.3d 22 (2d Cir. 2015)). In several opinions, including Byrd v. Aaron’s Inc., 784 F.3d 154 (3d Cir. 2015), the Third Circuit has interpreted the ascertainability requirement as requiring a showing of administrative feasibility at the class certification stage—that is, a showing by plaintiffs that there will be an administratively feasible means of determining whether class members fall within the class definition. Petrobras, 2017 WL 2883874 at *11.

In Petrobras, the Second Circuit joined the Sixth, Seventh, Eighth and Ninth Circuits in rejecting this “heightened” ascertainability standard, and clarified its own ruling in Brecher, holding that ascertainability should not be evaluated with reference to administrative feasibility, but rather whether the proposed class is “defined by objective criteria.” Id. at *10. In Petrobras, this “modest threshold requirement” was met, because the proposed classes were concretely defined to include “persons who acquired specific securities during a specific time period, as long as those acquisitions occurred in ‘domestic transactions.’” Id. at *12.

Having rejected defendants’ arguments regarding ascertainability, however, the Second Circuit nonetheless vacated the district court’s certification order on the ground that it did not adequately consider domestic territoriality as defined by Morrison in evaluating the Rule 23 predominance requirement.

In Morrison, the Supreme Court held that the US securities laws are presumed to apply only to (1) transactions in securities listed on domestic exchanges; and (2) “domestic transactions” in other securities. In a subsequent case, Absolute Activist v. Ficeto, 677 F.3d 60 (2d Cir. 2012), the Second Circuit elaborated on the second prong of Morrison, holding that transactions in securities not listed on domestic exchanges are “domestic” if “irrevocable liability is incurred or title passes within the United States”; and also ruled that transactional domesticity is a “merits” question of the kind that can considered in a Rule 12(b)(6) motion.

In Petrobras, there was no doubt that the equity transactions at issue fell within Morrison’s first prong, given that the Petrobras equity securities were traded on the NYSE. There was also no doubt that the debt transactions did not fall within the first prong, since the debt securities did not trade on any U.S. exchange, and were instead traded on various over-the-counter markets. The hard question in Petrobras was whether the over-the-counter debt securities transactions fell into the category of “domestic transactions” notwithstanding the fact that they were not conducted on domestic exchanges—a question rendered more difficult by the fact that these transactions differed in their particulars. Id. at 3.

The district court did consider Morrison-based challenges to plaintiffs’ claims before issuing its class certification order, dismissing two named plaintiffs from the case after finding that their over-the-counter debt securities transactions did not qualify as domestic under Morrison and Absolute Activist. Id. at *7-8. But the Second Circuit nonetheless found that the district court did not adequately address Morrison in the certification context. Id. at *14-16.

Generally speaking, a plaintiffs seeking to demonstrate that a particular over-the-counter transaction was domestic may offer “evidence ‘including, but not limited to, facts concerning the formation of the contracts, the placement or purchase orders, the passing of title, or the exchange of money.’” Id. at *14 (quoting Absolute Activist, 677 F.3d at 70). As the Second Circuit observed in Petrobras, “these transaction-specific facts are not obviously ‘susceptible to [ ] class-wide proof.’” Id. (quoting Tyson Foods v. Bouaphakeo, 136 S.Ct. 1036, 1045-46 (2016)).

The district court approved two class representatives with claims based on over-the-counter transactions in debt securities. For each of these two plaintiffs, domesticity was not seriously at issue, as they placed their purchase orders in the United States and procured their securities directly from U.S. underwriters. But the Second Circuit described these two class representatives as “the easy case,” and concluded that the district court’s certification order “offers no indication that [it] considered the ways in which evidence of domesticity might vary in nature or availability across the many permutations of transactions in Petrobras Securities.” Id. at *15.

According to the Second Circuit, these likely intra-class differences give rise to a predominance problem, because “the investigation of domesticity appears to be an ‘individual question’ requiring putative class members to ‘present evidence that varies from member to member.’” Id. at *14 (quoting Tyson Foods, 136 S.Ct. at 1045). In this case, the Second Circuit concluded, “it cannot be said that the class members’ Morrison inquiries will ‘prevail or fail in unison.’” Id. at *16. On this basis, the Second Circuit vacated the district court’s certification of the two classes insofar as they included all otherwise-eligible members who acquired their Petrobras securities in “domestic transactions”—allowing, however, that the district court might, on remand, properly certify one or more classes that would capture some or all of the members of the vacated classes. Id. at *16.

Finally, the Second Circuit also addressed a ruling by the district court, with respect to the Exchange Act class, that plaintiffs were entitled to a presumption of reliance under the “fraud on the market” theory established in Basic v. Levinson, 485 U.S. 224 (1998). While the defendants pointed to the fact that plaintiffs provided no empirical data showing that the price of the relevant Petrobras securities moved up and down predictably in response to news about the company, the Second Circuit noted that such data may suffice but is not necessary to show market efficiency, and held that the district court properly considered other forms of direct and indirect evidence in ruling that the Basic presumption applied for purposes of class certification. Id. at *20.

The Second Circuit, affirming the Southern District of New York’s dismissal of a ’33 Act securities class action, reaffirmed that the Circuit’s operative test for determining the materiality of omissions is the test set forth in DeMaria v. Andersen, 318 F.3d 170 (2d Cir. 2003), and explicitly rejected the First Circuit’s test in Shaw v. Digital Equipment Corp., 82 F.3d 1194 (1st Cir. 1996).  In refusing to adopt Shaw’s standard—known as the “extreme departure” test—the court endorsed a test that it determined to be the “classic materiality standard in the omission context” and rejected the test that it found to “leave too many open questions” and to be “analytically counterproductive.”

Stadnick v. Vivint Solar, Inc. is a putative class action alleging violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 based on Vivint Solar’s alleged failure to disclose financial results for the quarter that ended the day before Vivint’s IPO, as well as Vivint’s alleged misstatements regarding the company’s expansion in Hawaii for failing to disclose the impact of the state’s evolving regulatory scheme.

The company’s unique business model and accounting methods are key to the case and the court’s analysis.  Vivint’s business model operates by leasing solar energy panels to its customers and maintaining ownership of the underlying panels.  This model allows Vivint to capitalize on the tax credits associated with solar energy.  Vivint finances its company through outside investors, who invest the capital necessary to purchase tranches of solar energy systems.  The outside investors then receive title to the system they financed and receive most of the monthly lease payments until the system is paid off.  At that time, Vivint then starts to receive most of the revenue.  Based on this set up, Vivint’s income is accordingly allocated between its public shareholders and its outside investors.  To properly calculate this income, Vivint employs an accounting method that allocates the income between the shareholders and outside investors.  Due to Vivint’s business model and this accounting method, Vivint shows significant income fluctuations from quarter to quarter.  Vivint experienced one such dramatic income swing in the quarter directly preceding its IPO.

Vivint issued its IPO on October 1, 2014.  In its registration statement, Vivint set forth the financial results from the previous quarters and warned investors that its business model and accounting practices could impact the allocation of income between shareholders and outside investors.  It also listed the “key operating metrics” for evaluating the company’s financial performance.

Vivint disclosed the financial results for the third quarter on November 10, 2014.  In that disclosure, Vivint revealed a significant decline in income to shareholders.  Specifically, the net income to shareholders was measured at negative $35.3 million, down from $5.5 million in the previous quarter.  However, the results showed that despite this loss, Vivint’s “key operating metrics,” which the company previously had set forth as its measure for evaluating the company’s financial success, were strong.  For example, the company’s installations were up 137 percent from the previous year and its market share increased from 9 percent to 16 percent in that quarter.

The plaintiff brought suit following the decline in stock as a result of the third-quarter earnings announcement.  The plaintiff raised two omissions as the basis for his suit: (1) Vivint’s failure to disclose the third-quarter financial information and (2) Vivint’s failure to disclose the adverse impact of the regulatory oversight in Hawaii.

The Second Circuit focused primarily on this first argument, and used this case as an opportunity to clarify the Second Circuit’s operative test for material omissions.  The plaintiff urged the court to adopt the First Circuit’s “extreme departure” test in Shaw v. Digital Equipment Corp.  In Shaw, the First Circuit held that an omission was actionable under Section 11 if there was “substantial likelihood” that the withheld information would represent an “extreme departure” from the previous financial performance.  Adopting this test would be its own extreme departure—pun intended—from the Second Circuit’s test in DeMaria v. Andersen, which looked instead to whether the information would “significantly alter[] the ‘total mix’ of information available.”  Vivint proved to be an ideal opportunity for the Second Circuit to re-exam its standards as it provides a situation in which the income swings were great enough to be reasonably seen as an “extreme departure,” but the company’s clear formula for evaluating its own performance makes clear that other factors more accurately reflect the company’s true financial health.

The court undertook an analysis of the “extreme departure” test, and affirmatively rejected that test.  The court noted that the DeMaria test used the “classic materiality standard in the omission context.”  Focusing on how the First Circuit test would allow a plaintiff to meet their burden based on two narrow metrics—which would not properly give the entire picture—the court had harsh words for the First Circuit’s test, calling it “analytically counterproductive” and “unsound[],” and noting that it “confuses the analysis.”  Once reaffirming that the Second Circuit would continue to rely on the DeMaria test, the court concluded that Vivint’s omission was not material because shareholder income and earnings-per-share are not the best indicators of Vivint’s financial performance.  The court also noted that the registration statement clearly set forth that Vivint’s unique business model meant that shareholder revenue and earnings would fluctuate.

Plaintiff’s second argument was rejected without much analysis—the court even noted this argument was “tack[ed] onto his complaint”—as the court concluded that the plaintiff failed to show that the regulatory changes adversely affected Vivint’s Hawaiian operations and that Vivint had sufficiently warned investors that such changes could impact their Hawaiian presence.

In a 5-4 decision split along traditional ideological lines, the U.S. Supreme Court held in CalPERS v. ANZ Securities, Inc., 582 U.S. ___ (2017), that the statute of repose in Section 13 of the Securities Act cannot be tolled under any circumstances. In particular, the Court held that the 3-year repose period—unlike the 2-year limitations period set forth in the same section of the Securities Act—is not tolled by the filing of a securities class action under the principles of American Pipe & Constr. Co. v. Utah, 414 U.S. 538 (1974).

Under American Pipe, the statute of limitations for a claim timely asserted in a putative class action is tolled for the period that the putative class claim is pending. Thus, if class certification is denied (or if a class member later decides to opt out of the class), individual putative class members can still pursue their separate claims, even if those claims would otherwise be untimely at the time they are filed. The question presented in CalPERS was whether that tolling principle likewise applied to Section 13’s 3-year statute of repose.

The CalPERS case arose out of the collapse of Lehman Brothers in 2008. Shortly after Lehman declared bankruptcy, a plaintiff filed a putative class action complaint alleging claims under Section 11 of the Securities Act against the underwriters of several of Lehman’s securities offerings from 2007 and early 2008. The complaint alleged that Lehman’s securities offered included material misstatements or omissions. CalPERS was not one of the named plaintiffs in that suit.

In 2011—more than three years after the last of those securities was first offered—CalPERS filed a separate complaint on its own behalf, alleging identical claims to those asserted in the putative class action. Shortly thereafter, the putative class action settled, and CalPERS opted out so it could continue to pursue its claims separately. However, the defendants then successfully moved to dismiss CalPERS’ separate lawsuit as untimely under Section 13, which provides, “In no event shall any [Section 11] action be brought…more than three years after the security was bona fide offered to the public….” The Second Circuit affirmed, and the Supreme Court granted certiorari.

Justice Kennedy delivered the opinion of the Court, joined by Chief Justice Roberts and Justices Thomas, Alito, and Gorsuch. The Court began by re-emphasizing the distinction between statutes of limitations and statutes of repose that the Court had described in CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014). Statutes of limitations are intended to encourage diligence on the part of plaintiffs, and are therefore typically triggered by the accrual of a cause of action. (Slip op. at 4-5.) Statutes of repose, by contrast, reflect “a legislative judgment that a defendant should be free from liability after the legislatively determined period of time[,]” and usually begin to run from the date of the defendant’s last culpable act. (Id. at 5 (quoting CTS Corp.).) The Court observed that Section 13 of the Securities Act has both types of time limits: a 2-year limitations period that runs from when the actionable untrue statement or omission was or should have been discovered, and a 3-year repose period that runs from the date the security was first offered. (Id. at 5-7.)

The Court explained that the distinction between the purposes of a statute of repose and a statute of limitations was decisive in the CalPERS case. Because the purpose of a statute of repose is to create an “absolute bar” to the defendant’s liability after a period of time, such statutes are generally not subject to tolling in the absence of some legislatively-enacted exception. (Slip op. at 7-8.) In particular, unlike statutes of limitations, statutes of repose are not subject to tolling based on equitable principles. (Id. at 8.) American Pipe tolling is based on just such equitable considerations: it was intended to serve judicial economy by obviating the need for protective motions to intervene by individual putative class members, while still serving the purpose of the statute of limitations by ensuring that the defendants were on notice of the substantive claims against them and the “generic identities” of the claimants. (Id. at 8-11 (quoting American Pipe).) Those considerations could not serve to toll a statute of repose, whose purpose “to grant complete peace to defendants….” (Id. at 11.) The Court found that “the text, purpose, structure, and history of the [Section 13] statute [of repose] all disclose the congressional purpose to offer defendants full and final security after three years.” (Id.)

The Court then quickly dispensed with the four counterarguments CalPERS had raised. First, the Court found that American Pipe was readily distinguishable based on the distinction between statutes of limitation and statutes of repose: while the first may be tolled based on equitable considerations, the second may not. (Slip op. at 11-12.) Second, the Court found that the fact that the class action put the defendant on notice of the putative class members’ claims missed the point—“the purpose of a statute of repose is to give the defendant full protection after a certain time.” (Id. at 12.) Moreover, while the defendant might be on notice of the claims generally, it would not be on notice of the “number and identity of individual suits, where they may be filed, and the litigation strategies they will use[,]” which could significantly affect a defendant’s “practical burdens” and “financial liability[.]” (Id. at 12-13.) Third, the Court found that a putative class member’s right to opt out, while important, could not override the “mandatory time limits set by statute.” (Id. at 13.) Fourth, the Court rejected the argument that its ruling would “create inefficiencies,” noting that the Court was not free to ignore the plain terms of the statute, and observing that, in any event, the Second Circuit had not seen any “recent influx of protective filings” since its rule was announced in 2013. (Id. at 13-14.)

Finally, the Court rejected CalPERS’ alternative argument that it had timely “brought” its “action” within the meaning of Section 13 because it was a member of the putative class on whose behalf the original lawsuit was brought, and that its separate action was merely part of that same “action.” The Court found that argument did violence to the term “action,” which generally refers to a particular “proceeding” or “suit.” (Id. at 14-15.) Moreover, the Court observed that the argument proved too much: if it were correct, there would be no need for American Pipe tolling at all, and even an action commenced “decades after the original securities offering” would be timely as long as a class action had been commenced within the applicable limitations and repose periods. (Id. at 15.)

Justice Ginsburg dissented, joined by Justice Breyer, Sotomayor, and Kagan. Justice Ginsburg accepted CalPERS’ alternative argument that its filing date should relate back to the filing of the original class action complaint, and that by filings its separate action, CalPERS “simply took control of the piece of the action that had always belonged to it.” (Slip op. at 2-3.) She asserted that the majority’s rule would render the right to opt out “illusory[,]” because most securities class actions reach their “critical stages” years after the initial complaint is filed. (Slip op. at 1-2, 4.) Moreover, Justice Ginsburg contended, the “harshest consequences” were likely to fall on the “least sophisticated” class members, who would be unaware of their need to file a protective claim within the repose period. (Id. at 4.) Finally, she stated that the majority’s ruling was likely to “gum up the works of class litigation” by encouraging defendants to engage in dilatory tactics and encouraging the filing of protective claims. (Id. at 4-5.)

The CalPERS decision is likely to have repercussions far beyond Section 11 securities cases. The Court’s logic would also apply to the 5-year statute of repose governing class action claims under Section 10 of the Exchange Act, which are much more common. Indeed, any federal statute of repose without an express legislative tolling provision will now be fully applicable in any class action asserting a claim governed by that statute. It will be interesting to see whether the inefficiencies predicted by Justice Ginsberg come to fruition.

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.

Overruling (or, at least, creatively re-characterizing) its own precedent, the Ninth Circuit held in Resh v. China Agritech, Inc., — F.3d —, 2017 WL 2261024 (9th Cir. May 24, 2017), that the pendency of an earlier uncertified class action tolls the statute of limitations not only for later-filed individual claims, but for subsequent class actions as well. The Ninth Circuit’s decision opens the door to the possibility of serial, successive attempts to certify a class in securities (and other) cases, potentially exposing defendants to an almost never-ending series of class action lawsuits.

Under American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), and Crown, Cork & Seal Co. v. Parker, 462 U.S. 345 (1983), the pendency of a putative class action tolls the statute of limitations applicable to the individual claims of the putative class members. Thus, if the putative class action is timely brought, but class certification is later denied after the statute of limitations would have otherwise expired, putative class members would still be able to bring individual claims on their own behalf. The question in Resh was whether American Pipe tolling should apply to subsequent class actions as well.

The facts of Resh are relatively straightforward. In February 2011, a market research company raised questions about the accuracy of China Agritech’s financial reporting. Its stock price fell substantially. A few days later, a China Agritech shareholder filed a putative securities fraud class action complaint against the company and several of its managers and directors in the Central District of California. The court denied class certification, finding that, because plaintiffs had failed to establish the fraud-on-the-market presumption of reliance, issues common to the proposed class did not predominate over individual issues. Five months after that denial, and one year and eight months after the initial adverse press report, another shareholder filed a second putative securities class action in the District of Delaware. The case was transferred to the same judge in the Central District of California, who again denied class certification, this time on grounds of typicality and adequacy of the named plaintiffs.

Nine months later — and more than three years after the initial adverse press report — plaintiff Michael Resh filed yet another putative class action complaint alleging securities fraud against China Agritech and several individual defendants. A claim for securities fraud under the Exchange Act is subject to a two-year statute of limitations. Thus, if American Pipe tolling applied, the putative class action would be timely — only about 14 months had passed since the initial press report during which a putative class action was not pending. But if American Pipe tolling did not apply, the class action complaint was plainly time-barred.

The Ninth Circuit began its analysis by discarding one of its prior precedents. In Robbin v. Fluor Corp., 835 F.2d 213 (9th Cir. 1987), the Ninth Circuit had held that American Pipe tolling did not apply to a subsequent class action following a definitive determination of the inappropriateness of class certification. The Ninth Circuit dismissed Robbin as “a short opinion published 30 years ago” that had been “modified” in Catholic Social Services, Inc. v. INS, 232 F.3d 1139 (9th Cir. 2000) (en banc). 2017 WL 2261024, at *6.

In Catholic Social Services, the district court had certified a class, but had lost subject matter jurisdiction due to an intervening change in the law. See id. The Ninth Circuit held that American Pipe tolling applied to a subsequent class action in those circumstances. See id. But it also stated, “If class action certification had been denied in [an earlier case], and if plaintiffs in this action were seeking to relitigate the correctness of that denial, we would not permit plaintiffs to bring a class action.” Id. (quoting Catholic Social Services, 232 F.3d at 1147).

The Resh court found that interpreting that statement as forbidding the application of American Pipe tolling to subsequent class actions when class certification had previously been denied would be a “misreading” of Catholic Social Services. Id. at *6-*7. The court explained that it was not talking about American Pipe tolling at all. What it was actually talking about was issue preclusion — all it meant was that, if the same plaintiffs sought to bring a subsequent class action after certification had previously been denied, issue preclusion would bar them from doing so. Id. at *7.

That is, to say the least, an odd reading of Catholic Social Services. Other than the reference to “relitigat[ion],” nothing in Catholic Social Services’ analysis suggests that the court was thinking of issue preclusion. In particular, nothing in the quoted sentence indicates that, to be barred from “relitigat[ing]” class certification, the plaintiffs in the subsequent class action had to be the same plaintiffs who unsuccessfully litigated the first class action — a critical requirement for issue preclusion. In fact, the court actually cited Robbin in support of its statement, which was plainly made in the context of a discussion of the applicability of American Pipe tolling to subsequent class actions. See Catholic Social Services, 232 F.3d at 1145-49. Indeed, the Ninth Circuit expressly dealt with issue preclusion on a different issue in a separate portion of its opinion. Id. at 1151-53.

In any event, having reinterpreted Catholic Social Services as applying American Pipe tolling to subsequent class actions — regardless of the reason for the dismissal of the earlier class action — the Ninth Circuit went on to find support for its position in three recent Supreme Court precedents:

  • In Shady Grove Orthopedic Associates, P.A. v. Allstate Insurance Co., 559 U.S. 393 (2010), the Supreme Court held that Rule 23 empowers a federal court to certify a class in any type of case, not only those “made eligible for class treatment by some otherId. at 399 (emphasis in original). The Ninth Circuit concluded that to deny American Pipe tolling to subsequent class actions would essentially import “certification criteria” into Rule 23 from “some other law,” which Shady Grove forbids. 2017 WL 2261024, at *7.
  • In Smith v. Beyer Corp., 564 U.S. 299 (2011), the Supreme Court held that, after denying class certification, a federal court could not enjoin a state court from certifying a class under the “relitigation exception” to the Anti-Injunction Act because the state court action had different named plaintiffs who were not subject to claim or issue preclusion. The Court acknowledged the risk of “serial relitigation of class certification,” but found that risk was mitigated by principles of stare decisis and comity, as well as the possibility of removal under the Class Action Fairness Act (for state court actions) or MDL consolidation (for other federal actions). Id. at 316-18. The Ninth Circuit found that those considerations similarly ameliorated the unfairness of serial class certification litigation due to American Pipe 2017 WL 2261024, at *9.
  • Finally, in Tyson Foods, Inc. v. Bouaphakeo, 126 S.Ct. 1036 (2016), the Supreme Court noted that “use of the class device cannot ‘abridge…any substantive right.’” Id. at 1046 (quoting 28 U.S.C. 2072(b)). While acknowledging that Tyson Foods did not directly control, given that “statutes of limitation occupy a no-man’s land between substance and procedure,” the Ninth Circuit found that it “nonetheless reinforces our conclusion that the statute of limitations does not bar a class action brought by plaintiffs whose individual actions are not barred.” 2017 WL 2261024, at *8.

Despite the court’s insistence to the contrary, Resh represents a sharp break from prior law in the Ninth Circuit. Given that the court radically reinterpreted the en banc decision in Catholic Social Services, it will be interesting to see whether the Ninth Circuit elects to reconsider the Resh decision en banc.

In the meantime, Resh increases the pressure on defendants in putative class actions pending in the Ninth Circuit to settle, lest they be saddled with the costs of serially re-litigating class certification even after prevailing. The Resh court’s suggestion that plaintiffs’ counsel, whose fees are usually contingent on the outcome of the case, “at some point will be unwilling to assume the financial risk in bringing successive suits,” id. at *9, is sure to be cold comfort to class action defendants, for whom the cost of litigation is frequently the driving factor in deciding to settle a case.

Some relief may be forthcoming soon from the Supreme Court, however. The Court is currently considering whether American Pipe tolling applies to statutes of repose, in addition to statutes of limitations. See California Pub. Employees’ Retirement Sys. v. ANZ Securities, Inc., 137 S.Ct. 811 (2017) (granting writ of certiorari). If the Supreme Court affirms that American Pipe tolling does not apply to statutes of repose, that would at least put a hard backstop on serial re-litigation of class certification. And given that there is a clear circuit split on whether American Pipe tolling applies to subsequent class actions, see, e.g., Korwek v. Hunt, 827 F.2d 874, 879 (1987), the Supreme Court may eventually take up that issue as well.

In a matter of first impression in the Ninth Circuit, the court applied the Supreme Court’s Omnicare standard for pleading the falsity of a statement of opinion to a Section 10(b) claim in City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc., — F.3d —, 2017 WL 1753276 (9th Cir. May 5, 2017).

The litigation arose from Align’s $187.6 million acquisition of Cadent Holdings, Inc. in April 2011, and Align’s alleged failures to properly assess and write off the goodwill associated with the acquisition. Align’s statements regarding the fair value of goodwill, of course, were quintessential statements of opinion, because they were inherently subjective. In Omincare, the Supreme Court set the standard for pleading the falsity of an opinion claim under Section 11. Many practitioners, including Lane Powell’s securities litigation team, had opined—and the Second Circuit and other courts had held—that the rationale of Omnicare should equally apply to Section 10(b) claims, since the falsity element is the same. In Align, the Ninth Circuit agreed, and partially overturned a previous Ninth Circuit case that permitted plaintiffs to plead falsity by alleging that “there is no reasonable basis” for the defendant’s opinion.

Align’s accounting for the acquisition resulted in $135.5 million of goodwill, $76.9 million of which was attributable to one of Cadent’s business units (the “SCCS unit”). The plaintiffs alleged that the purchase price, and thus the goodwill, was inflated due to Cadent’s channel stuffing practices prior to the acquisition, and that the defendants must have known as much after performing their due diligence. Following the acquisition, the SCCS unit’s financial results suffered due to numerous factors. Nevertheless, at the end of 2011, Align found no impairment of its recorded goodwill. Align did not perform any interim goodwill testing in the first or second quarters of 2012. Id. at *2-3.

On October 17, 2012, Align finally announced it would be conducting an interim goodwill impairment test for the SCCS unit, which it said was triggered by the unit’s poor financial performance in the third quarter of 2012 and the termination of a distribution deal in Europe. That announcement led to a 20% hit to Align’s stock price. On November 9, 2012, Align announced a goodwill impairment charge of $24.7 million, and it announced subsequent goodwill charges in the following two quarters. Id. at *3. The plaintiffs alleged that the defendants made seven false and misleading statements concerning the goodwill valuation between January 30, 2012 and August 2, 2012. The plaintiffs’ allegation was that defendants deliberately overvalued the SCCS goodwill, thereby injecting falsity into statements concerning the goodwill estimates and the related financial statements. The district court dismissed the complaint with prejudice for failing to adequately plead falsity and scienter. Id. at *4.

At issue in the Ninth Circuit was whether the plaintiffs had adequately pled that Align’s statements were false. The first question was what analytic framework applied. The plaintiffs did not dispute that five of the seven statements at issue were pure statements of opinion. However, with respect to two statements, the plaintiffs alleged the opinions contained “embedded statements of fact.” Those statements were that “there were no facts and circumstances that indicated that the fair value of the reporting units may be less than their current carrying amount,” and that “no impairment needed to be recorded as the fair value of our reporting units were significantly in excess of the carrying value.” The Court held that the former statement was an opinion with an embedded statement of fact, but that the latter was an opinion. Id. at *5.

The Court also addressed the proper pleading standard for falsity of opinion statements. The panel concluded that Omnicare established three different standards depending on a plaintiff’s theory:

  1. Material misrepresentation. Plaintiffs must allege both subjective and objective falsity, i.e., that the speaker both did not hold the belief she professed, and that the belief was objectively untrue.
  2. Materially misleading statement of fact embedded in an opinion statement. Plaintiffs must allege that the embedded fact is untrue.
  3. Misleading opinion due to an omission of fact. Plaintiffs must allege that facts forming the basis for the issuer’s opinion, the omission of which makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.

Importantly, the Ninth Circuit extended this Omnicare holding from the Section 11 context to the Section 10(b) and Rule 10b-5 claims at issue in Align. Id. at *7. In doing so, the Ninth Circuit joined the Second Circuit in extending Omnicare in this regard. See Tongue v. Sanofi, 816 F.3d 199, 209-10 (2d Cir. 2016). Finally, the court overruled part of its previous holding in Miller v. Gammie, 335 F.3d 889, 900 (9th Cir. 2003) (en banc), which allowed for pleading falsity by alleging that there was “no reasonable basis for the belief” under a material misrepresentation theory. City of Dearborn Heights, 2017 WL 1753276, at *7.

Applying this pleading standard to the Align facts, the Ninth Circuit concluded that the plaintiffs had not met their pleading burden. Because the plaintiffs did not allege the actual assumptions the defendants relied upon in conducting their goodwill analysis, the court could not infer that the defendants intentionally disregarded the relevant events and circumstances. Accordingly, six of the seven statements that relied on the material misrepresentation theory failed to allege subjective falsity and were properly dismissed. Likewise, the failure to allege the actual assumptions used by the defendants prevented plaintiffs from pleading objective falsity as to the one statement of fact embedded in an opinion statement. Id. at *8-10.

After concluding that the plaintiffs failed to allege falsity, the Ninth Circuit went on to hold that plaintiffs had not alleged scienter against the defendants, providing a second ground for dismissing the complaint. At most, the plaintiffs alleged that the defendants violated generally accepted accounting principles, but such a failure does not establish scienter. Likewise, the stock sale allegations, core operations inference, the temporal proximity between the challenged statements and the goodwill write-downs, the CFO’s resignation, and the magnitude of the goodwill write-downs did not create an inference of scienter. Id. at *10-13.

Judge Kleinfeld concurred in the judgment. He would have upheld the district court’s dismissal based on scienter alone, leaving the weightier issue of falsity described above to a future case where such a decision was necessary. Id. at *13-14 (Kleinfeld, J., concurring in the judgment).