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.

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).

A senior officer’s violations of a corporation’s code of conduct do not give rise to a claim for violation of the federal securities laws—even where the corporation (including the officer himself) has touted the company’s high standards for compliance with its own ethical code.  That was the Ninth Circuit’s holding in a recent opinion affirming a district court’s dismissal of a putative class action filed against Hewlett-Packard and its former CEO and Chairman, Mark Hurd.  Retail Wholesale & Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co. and Mark A. Hurd, 845 F.3d 1268 (9th Cir. 2017).  The case arose out of Hurd’s departure from the company following revelations of Hurd’s relationship with an HP contractor and subsequent efforts to cover up the relationship.  Plaintiffs brought claims under Section 10 of the Securities Exchange Act of 1934 and Rule 10b-5, alleging that HP had materially misrepresented or alternatively made material omissions about its high ethical standards and compliance with its Standards of Business Conduct (“SBC”), where its Chairman and CEO was found to have violated the SBC.

HP touted its strict code of conduct prior to Hurd’s resignation for violating the code.

Several years earlier, under Hurd’s leadership, HP had revised and strengthened its SBC following a 2006 ethics scandal in which it was revealed that HP had hired detectives to spy on directors, employees and journalists.  While the then-Chairman and General Counsel faced criminal charges, Hurd (then-CEO) was found free of any wrongdoing in that scandal, and was promoted to Chairman in addition to his role as CEO.  As the Ninth Circuit noted, following the scandal “Hurd took many opportunities to proclaim HP’s integrity and its intention to enforce violations of the SBC.”

Four years later, in 2010, former HP contractor Jodie Fisher contacted HP’s Board of Directors through her attorney, alleging that Hurd had sexually harassed Fisher.  The Board launched an investigation, and Hurd initially lied to the Board about the nature of his relationship with Fisher before admitting to a “very close personal relationship” with her.  The investigation revealed that Hurd had also falsified expense reports to hide his relationship.  Hurd resigned following the investigation, and HP acknowledged in a press release that Hurd knowingly violated the SBC and acted unethically.  HP’s stock dropped immediately upon the announcement of Hurd’s resignation, resulting in a $10 billion loss in market cap.

Statements about a code of conduct must be both objectively false and material to be actionable.

Investors filed a putative class action claiming that the violations of the SBC amounted to securities fraud, either in the form of material misrepresentations because HP’s statements about its ethics were inconsistent with Hurd’s conduct, or in the form of material omissions regarding Hurd’s unethical behavior, which Plaintiffs claimed HP had a duty to disclose.  The district court rejected both theories and dismissed the complaint with prejudice.  A three-judge panel of the Ninth Circuit unanimously affirmed the dismissal.

In this issue of first impression before the Ninth Circuit, the court articulated a two-part test for determining whether a violation of a corporate code of ethics may give rise to a securities fraud claim.  First, it examined the objective falsity of the company’s statements regarding its code of ethics.  Second, it turned to the materiality of those statements.  The court found that Plaintiffs’ claims failed under both elements.

As to objective falsity, the Ninth Circuit held that HP and Hurd had made no “objectively verifiable” statements about its compliance with the SBC, and instead characterized the code of conduct and statements about it as “inherently aspirational.”  Plaintiffs pointed in particular to Hurd’s comments prefacing the SBC as revised following the 2006 scandal, in which Hurd urged employees to “commit together, as individuals and as a company, to build trust in everything we do . . .”  But the Court reasoned that such statements are not “capable of being objectively false,” and thus found no affirmative misrepresentation.

The Ninth Circuit further found that the challenged representations were not material.  It noted that companies are required by the SEC to publish their codes of conduct, and “it simply cannot be that a reasonable investor’s decision could conceivably have been affected by HP’s compliance with SEC regulations requiring publication of ethics standards.”  Moreover, while plaintiffs pointed to the stock drop as evidence of materiality, the court cited its decision in Police Ret. Syst. Of St. Louis v. Intuitive Surgical, Inc., 759 F.3d 1051, 1060 (9th Cir. 2014), for the proposition that the stock drop goes to reliance, not materiality.  Where, as here, there was no actionable misstatement, the court would not reach the reliance analysis.

The court also rejected plaintiffs’ alternative theory that HP failed to disclose material facts concerning Hurd’s noncompliance with the SJC.  The court found that HP’s “transparently aspirational” statements in and about the SBC did not amount to a suggestion that nobody at HP would ever violate the SBC.  Absent statements creating the impression that everyone at HP was in full compliance with the ethical standards, there was nothing that gave rise to a duty to disclose noncompliance.

The future is dim for securities claims based on violations of a company’s ethical code—and that’s good news for companies and their directors and officers who wish to adopt and tout strong codes of conduct.

Plaintiffs may complain that the Ninth Circuit’s opinion takes away a tool for enforcing compliance with codes of conduct, as (at least in the Ninth Circuit) securities class actions based on alleged noncompliance with SEC-mandated codes of conduct are unlikely to survive a motion to dismiss.  Indeed, defense counsel are already brandishing Hewlett-Packard to support the assertion that statements about ethics-policy compliance are not actionable under the securities laws—Goldman Sachs sent a letter to the Second Circuit recently citing the HP decision in support of Goldman’s bid to decertify a class of investors suing over its Abacus CDO.

But I think the better view is that the court’s ruling finding that “aspirational” statements will generally not support a finding of falsity or materiality under the securities laws should provide a level comfort to companies seeking to adopt robust ethical codes, and to speak freely both within the company and publicly about their values and compliance goals—with a few notes of caution.

First, it probably goes without saying that, even under the Ninth Circuit’s newly-articulated standard, companies should avoid unequivocal statements in or about their codes of conduct suggesting for example that there will be no violations of the ethical code.  Such statements will likely prove false over time, and probably demonstrably so.  But apart from those types of unequivocal statements, the Ninth Circuit’s ruling should be an encouraging sign for companies who adopt and publish strong codes of conduct, and for directors and officers who make statements about their efforts to abide by such codes.  As the court made clear, these “aspirational statements” about a company’s compliance with its own code of conduct—even where strongly stated or oft-repeated—will typically be neither objectively false nor material under the securities laws.  As the court noted, “A contrary interpretation—that statements such as, for example, the SBC’s ‘we make ethical decisions,’ or Hurd’s prefatory statements, can be measured for compliance—is simply untenable, as it could turn all corporate wrongdoing into securities fraud.”

The second caution is that the Ninth Circuit’s ruling did not go so far as to say that non-compliance with a code of conduct could never be actionable under federal securities laws.  The court imagined that “the analysis would likely be different if HP had continued the conduct that gave rise to the 2006 scandal while claiming that it had learned a valuable lesson in ethics.”  Accordingly, companies should continue to be particularly vigilant to avoid repeating (or continuing) prior ethical lapses, which the Ninth Circuit suggested could give rise to causes of action, particularly where the company indicated through public statements that such conduct had ceased.

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)).

In a 91-page opinion covering several important securities-litigation issues, the Second Circuit upheld the district court’s partial judgment against Vivendi following a three-month jury trial that resulted in the jury finding Vivendi liable under Section 10(b) and Rule 10b-5.

As I was preparing to summarize the opinion for this blog, I read a summary by Wiley Rein’s David Topol and Jennifer Williams in Kevin LaCroix’s blog, The D&O Diary.  Their post is excellent and comprehensive.  So instead of publishing a separate summary, I obtained their permission to refer readers of this blog to their post:

Vivendi: A Victory for Plaintiffs on the Price Maintenance Theory and on Loss Causation .

The Third Circuit engaged in a searching analysis of plaintiffs’ falsity and scienter allegations and found them insufficient under the exacting standards of the Reform Act, upholding the district court’s dismissal of the complaint in OFI Asset Management v. Cooper Tire & Rubber, — F.3d —, 2016 WL 4434404 (3d Cir. 2016).

In its ruling, the Third Circuit also had some harsh words for plaintiffs’ “kitchen sink” pleading style, finding that it “has been a hindrance at every stage of these proceedings.”  Id. at *7.

The case is tied to Cooper’s failed merger with Apollo Tyres.  Cooper was valuable to Apollo largely due of its manufacturing facility in China (“CCT’), of which it owned 65%, with the remaining 35% owned by a Chinese company.  The merger fell through after workers at CCT went on strike, denied Cooper officials access to the facility, refused to provide Cooper with financial information, and stopped producing Cooper-branded tires.  At the same time, the merger announcement led to a labor dispute in Cooper’s U.S. manufacturing facilities, with a labor arbitrator eventually finding in favor of the union and barring Cooper from selling two of its U.S. plants to Apollo.

Plaintiffs alleged that Cooper made a number of false or misleading statements under Section 10(b) and 14(a) in connection with the failed merger, including in the merger agreement, the proxy statement, its financial statements, and two 8-Ks containing news about the merger.  The claim was dismissed by the district court in Delaware for failure to adequately allege falsity and scienter.

Prior to oral argument, the district court had ordered plaintiffs to submit a letter identifying the five most compelling examples of allegedly false statements, with three factual allegations demonstrating the falsity of each statement and three allegations supporting scienter as to each of the statements.  Upon appeal, plaintiffs’ first objection was as to the court’s process, arguing that the court abused its discretion by considering only five “artificially selected” allegedly false statements, and failing to rule on the whole of plaintiffs’ complaint.

The Third Circuit considered plaintiffs’ “umbrage. . . unfounded.” Far from harming OFI’s case, the court found that the district judge had tried to “give OFI an assist,” by offering it a chance to frame the issues in its complaint more clearly.  Asking OFI to bring some order and clarity to its 100-page, 245-paragraph complaint was well within the district judge’s discretion to manage complex disputes, and does not show that the judge failed to consider the allegations as a whole.  Id. at *6.

Held the Third Circuit: “As pled, the Complaint presents an extraordinary challenge for application of the highly particularized pleading standard demanded by the PSLRA. This is true not only due to the length of the Complaint, but also its lack of clarity. . . . Now that OFI has come to us with the same kind of broad averments that drove the District Court to demand specificity, we find ourselves more than sympathetic to the Court’s position.”  Id. at *6.

After holding that the district court had not abused its discretion in managing the case, the Third Circuit went on to explore in detail each of the allegedly false statements, finding that none of them were sufficient to maintain a claim.  In doing so, the court considered the context of each allegedly false or misleading statement, and examined whether the allegations of falsity as to each were sufficiently specific, rejecting those allegations that lacked the particularity required of the Reform Act or which failed to show how a statement was misleading rather than simply incomplete.

As to a number of forward-looking statements, the Third Circuit held that its allegations of falsity failed to account for the Reform Act’s Safe Harbor.  Because the statements had been accompanied by meaningful cautionary statements, the court held that the Safe Harbor immunized them from liability—and thus they were not actionable even if plaintiffs could show that they were false and made with scienter.  Id. at *15.

In regard to one isolated statement, the court also found that even if OFI had sufficiently pleaded technical falsity, it nevertheless failed to raise a strong inference of scienter, because the “plausible opposing inferences” were more likely, “including that the statement was simply imprecise or received little attention due to the context in which it was made[.]”  Id. at 12.

Wrote the court: “OFI’s post hoc scouring of countless pages of documents for a stray and inartfully phrased comment that can be argued to be technically false seems like just the sort of litigation maneuver the PSLRA was meant to eliminate. One purpose of the statute was to prevent disappointed investors from treating every imprecise statement during a transaction as an invitation to file a lawsuit.”  Id. at *13.