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.