Avoiding and Defeating Securities Fraud Actions Against Clinical-Stage Biopharmaceutical Companies

In March 2014, a clinical-stage biopharmaceutical company announced that the FDA had ordered it to suspend ongoing clinical trials for the company’s sole product as a result of concerns about possible liver toxicity. The next day, the company’s stock price dropped significantly. Two days later, plaintiffs’ lawyers filed a securities fraud class action alleging that the company and its executives failed to disclose possible liver damage issues identified during the clinical trials, resulting in an artificially inflated stock price.¹Kishtagari v. Geron Corp, 3:14-cv-01224 (N.D. Cal. 2014). The lawsuit is not unusual. Rather, it reflects a growing trend in which plaintiffs’ lawyers are bringing securities class actions against companies that experience failed or delayed clinical trials or drug approvals.

Since 2011, more than 50 securities fraud class actions have been filed in United States federal courts against biopharmaceutical companies, bringing allegations that the company made misstatements about a clinical trial or drug approval – including 18 lawsuits in 2014 alone. Although securities litigation has decreased overall in recent years, lawsuits against biotechnology firms increased by 111 percent in 2014, and such suits against pharmaceutical companies increased for the second year in a row.²“Securities Class Action Filings, 2014 Year In Review, Cornerstone Research, available at
https://www.cornerstone.com/GetAttachment/52bfaa16-ff84-43b9-b7e7-8b2c7ab6df43/Securities-Class-Action-Filings-2014-Year-in-Review.pdf. In recent years, the pharmaceutical, biotechnology and healthcare industries collectively have been among the most frequent targets of investor class actions.

Against this onslaught of litigation, biopharmaceutical companies and their counsel have employed nuanced, multidisciplinary defense strategies to defeat claims at the pleadings stage – avoiding costly litigation and settlements. In addition, there are certain steps that prudent biopharmaceutical companies can and should take, long before a suit is filed, to insulate themselves against liability or, better yet, to avoid such suits in the first place.

Many investor actions target small or medium-sized clinical stage biopharmaceutical companies that are developing a promising drug that is the subject of an Investigational New Drug Application (“INDA”). Because the share prices of such companies are highly correlated to the perceived prospects for the commercial success of a single drug, any negative news about that drug is almost certain to significantly impact the price of the company’s stock. Even though it is common knowledge that the price of such stocks can be highly volatile, large drops in share prices triggered by negative news often result in plaintiffs’ attorneys filing shareholder actions. The overwhelming majority of these actions are brought by a small handful of law firms that essentially repeat the same allegations: the company intentionally or recklessly misled investors about a commercially promising drug’s prospects for FDA approval, causing investors to suffer losses when the stock price faltered following disclosure of problems with the clinical approval process, such as a lack of efficacy or serious adverse events that made it unlikely the drug would be approved. Plaintiffs’ counsel are fully aware that if their allegations are sufficient to survive a motion to dismiss, the ultimate result is likely to be a substantial settlement – with counsel receiving a portion of the proceeds.

A number of biopharmaceutical companies have defeated such lawsuits at the motion to dismiss stage by attacking the securities fraud and scientific claims simultaneously. For example, in 2012, Aeterna Zentaris (“Aeterna”) announced that its prospective cancer drug, Perifosine, failed to meet the primary endpoints in Phase III clinical trials, driving down the company’s stock by approximately 67%. Plaintiffs filed a class action lawsuit alleging that Aeterna defrauded the market by misrepresenting the potential efficacy of Perifisone, thus artificially inflating the company’s share price. The plaintiff claimed that the defendant had falsely told investors that a drug trial was “double blind,” when it was not, and that the defendant misled shareholders into overestimating the efficacy of the drug by using a flawed trial methodology that allowed the defendant to manipulate the data. A district court in the Southern District of New York, relying on precedent from the Second and Ninth Circuit Courts of Appeals,³See Kleinman v. Elan Corp., PLC, 706 F.3d 145 (2d Cir 2013); In re Rigel Pharms., Sec. Litig., 697 F.3d 869 (9th Cir. 2012). dismissed the claim. The district court held that “a court does not judge the methodology of a drug trial, but whether a defendant’s statements about that study were false and misleading,” and also noted that “[p]ublic statements about clinical studies need not incorporate all potentially relevant information or findings, or even adhere to the highest research standards.” As the complaint raised only non-actionable critiques of trial methodology, it failed to plead fraud with particularity as required by law.⁴See Abely v. Aeterna Zentaris, Inc., No. 12 Civ. 4711, 2013 U.S. Dist. LEXIS 78388 (S.D.N.Y. May 29, 2013).

Defense counsel with a sophisticated understanding of clinical trial processes can use such precedents to seek dismissal on the pleadings where plaintiffs have failed to identify statements that are false or misleading, but rather – with the benefit of hindsight – attempt to base claims on supposed flaws in the clinical trial process.

Although biopharmaceutical companies can take comfort in the fact that at least some courts have been receptive to arguments at the motion to dismiss stage on the basis that plaintiffs were doing nothing more than critiquing the methodology of a clinical study, companies can proactively reduce their potential exposure to claims alleging that they misled investors about the likelihood of a prospective drug’s success. In addition to carefully vetting public statements to ensure their accuracy, companies should also make sure that their compliance practices relating to financial disclosures, clinical trial methodology and oversight, adverse event reporting, and pre- and post-NDA marketing are up to date. Proper compliance policies not only make a company less attractive to a plaintiff firm looking for an easy target, but they have the added benefit of lowering the risk of investigations by the FDA and securities regulators. Specifically, companies should consider taking the following steps:

• Maintain independence between the principal researcher and the company, while ensuring visibility into the clinical study methodology and data. To avoid the appearance of a conflict, clinical trials generally ought to be conducted by independent researchers who are not financially invested in the success of the product. Nevertheless, as the sponsor of the study, biopharmaceutical companies are ultimately responsible for all aspects of the study, including the quality and integrity of the study data and timely reporting of adverse events. Therefore, companies should set up mechanisms such as review committees, regular audits, and/or independent reviews to maintain consistent oversight of clinical studies.

• Establish a clinical trial review committee to oversee clinical trials, review study methodology, study data, submissions to regulators, and publications. Companies should take appropriate steps to ensure data integrity and to protect against inadvertent data errors and intentional researcher misconduct. Establishing a review committee comprised of subject matter experts from different disciplines, including legal, regulatory, and medical science, to review study data, adverse event reports, publications and regulatory submissions helps to identify inadvertent errors and to deter and detect intentional misconduct. Likewise, members of the review committee who are familiar with clinical trials should review any public statements or financial disclosures concerning the trials prior to release to ensure accuracy.

• Review adverse event logs and compare with the adverse event reports to ensure completeness and accuracy of reported events. From time to time, companies should conduct audits of adverse event logs and the files of patients enrolled in clinical studies to ensure that safety data is being appropriately identified and disclosed.

• Review company-sponsored websites and other online platforms for patient feedback. Once a drug has been released to market, patients may communicate adverse events through product websites or in another online forum. Companies that maintain online websites that allow for patient comments or feedback are required to monitor those sites and to identify and disclose any adverse events. A company that permits any type of feedback on its website should have appropriately trained personnel monitoring the site to identify and disclose to the FDA any adverse events.

The trend of plaintiffs’ counsel filing lawsuits whenever negative news about the drug approval process causes a large drop in share price is likely to continue, as evidenced by five more suits this year alone. When such suits arise, it is imperative for a company and its counsel to develop a strategy to prevail on a motion to dismiss that integrates knowledge of both securities law and the drug approval process – thereby avoiding costly and burdensome discovery and a potentially pricey settlement.