Securities Suits Prompted by Probes Pose Challenges for Pharma

When life sciences companies face securities lawsuits, they tend to have a common pattern: A company suffers a setback, ensuing publicity triggers a stock price decline, then shareholder claims seek to recover investment losses.

For life sciences companies with products on the market, announcements of regulatory scrutiny of alleged practices related to sales, marketing, or billing are often followed by securities litigation from private plaintiffs based on the same alleged underlying activity.

After the government announces an investigation or lawsuit, plaintiffs’ counsel may seek to capitalize on this by filing securities litigation. In some instances, the latter lawsuit will move more quickly than the underlying antitrust or kickback claims, posing the risk that these claims would be presented first in the context of a Section 10(b) case.

Some courts have rebuffed efforts to make securities litigation the vehicle to adjudicate unresolved regulatory matters. In Kessman v. Myriad Genetics, securities litigation was filed after the company disclosed a subpoena from the Department of Health and Human Services related to its alleged billing practices.

The court observed that the underlying premise of plaintiffs’ claims was that Myriad’s billing practices were illegal. The court declined to wade into the issue, noting that without any agency action establishing that billing practices were improper, the lawsuit was premature, and that the regulator “is far better situated to evaluate Myriad’s billing practices than is the court.”

Other courts have taken a markedly different path. Multiple generic drug manufacturers have faced regulatory scrutiny for alleged price-fixing. Courts have allowed plaintiffs to proceed with securities claims premised on alleged antitrust violations, despite the underlying conduct still being adjudicated.

One recent case illustrates the complexities of having securities litigation run ahead of regulatory action. Plaintiffs in In re Acadia Pharmaceuticals alleged that undisclosed kickbacks rendered statements about commercialization of the company’s product misleading. Although the court granted two successive motions to dismiss, it resolved a materiality issue against the company based on an ongoing Justice Department investigation.

By the time a third motion to dismiss was filed, the government had concluded its investigation without further action or prosecution. The court held this “significantly undermine[d]” the plaintiff’s kickback allegations and altered the materiality calculus in the company’s favor.

Alleged Wrongdoing ‘At Issue’

Apart from timing problems, the interplay between securities litigation and unresolved underlying proceedings can pose disclosure issues.

Courts have agreed that companies have no obligation to accuse themselves of uncharged or unadjudicated wrongdoing, or to characterize their actions in pejorative terms. But courts have qualified this by stating that once a company puts its sources of financial success “in play” or “at issue,” it may assume a duty to disclose that its financial performance depends on improper conduct.

In isolation, a source-at-issue rule seems problematically open ended—a company can’t avoid putting the source of its revenue at issue. At a minimum, a company must do so quarterly in the management’s discussion and analysis section of its forms 10-K and 10-Q. In practice, courts have attempted to apply this concept with nuance.

In City of Sterling Heights Police & Fire Retirement System v. Reckitt Benckiser, plaintiffs alleged that company statements were misleading in light of undisclosed alleged anticompetitive conduct. The court held that statements about patient and physician preference for the company’s drug put the source of revenue at issue—and were therefore alleged to be misleading without discussion of the anticompetitive conduct—but that purely quantitative financial statements didn’t.

Similarly, in Halman Aldubi Provident & Pension Funds v. Teva Pharmaceuticals, a securities case piggy-backing on allegations of illegal kickbacks, the court held that statements attributing success to brand loyalty and patient and physician choice put sources of revenue in play, but that statements about compliance with applicable laws and regulations didn’t.

By contrast, in Derr v. Ra Medical Systems, the court dismissed plaintiffs’ attack on the company’s marketing related statements in light of the company’s risk disclosures. While the company in Ra didn’t accuse itself of off-label marketing, it disclosed that a competitor had done so.

The company stated in its risk disclosures that while it didn’t believe its marketing activity was improper, the Food and Drug Administration, Health and Human Services, the Justice Department, or other regulators could view matters differently. The court concluded that, by means of those statements, the company had informed investors adequately that it was risking regulatory scrutiny.

Takeaways

Robust cautionary statements may help alleviate risk in this area. Companies have seen success defeating securities litigation (even in instances where regulators concluded that sales, marketing, or billing practices were improper) when they provided enough information about alleged misconduct that investors could make their own risk assessments.

Particularly in areas where the regulatory landscape is unclear, companies may do well to include such information in a carefully crafted risk disclosure.

When facing piggy-back securities litigation, companies should consider whether a stay would be advantageous. While courts have considerable discretion in how they manage their dockets, the defendants in Teva successfully sought a stay of the securities proceeding pending resolution of the underlying government action.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Sara B. Brody is partner at Sidley Austin, co-leader of the securities and shareholder litigation practice group, and heads the Northern California litigation practice.

Sarah Hemmendinger is partner at Sidley Austin.

Robin E. Wechkin is counsel at Sidley Austin.

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