On February 5, 2020, Judge Matthew F. Kennelly of the United States District Court for the Northern District of Illinois sustained some but not all claims in a putative class action asserting violations of Sections 10(b) and 18 of the Securities Exchange Act of 1934 against a pharmaceutical company and certain of its executives. Twin Master Fund, Ltd. v. Akorn, Inc., No. 19-CV-3648 (N.D. Ill. Feb. 05, 2020). Plaintiffs alleged that the company knowingly made false statements and omissions regarding the company’s compliance with FDA regulations governing data integrity and manufacturing in public statements and filings and in a publicly filed merger agreement. The Court held that plaintiffs had adequately alleged misrepresentations as to a number of statements, but dismissed plaintiffs’ claims with respect to certain others.
As background, the defendant pharmaceutical company had announced it would be acquired by another company and had executed and filed a merger agreement appended to a Form 8-K. Before the merger closed, a whistleblower alerted the acquiring company as to possible regulatory compliance issues at the defendant, which ultimately led the acquiring company to terminate the merger. Slip op. at 4-5. The defendant pharmaceutical company then brought suit in Delaware chancery court, seeking an order requiring consummation of the merger. The Delaware court, after a trial, concluded that the termination was valid based on the inaccuracy of the pharmaceutical company’s representations in the merger agreement that it was in compliance with all applicable regulations and would act in “the ordinary course of business.” Id. at 5-6. The same conduct and facts that the chancery court held rendered the representations inaccurate were at issue in the securities litigation, but the District Court held that the chancery court’s findings of falsity were not determinative as to whether there had been actionable misrepresentations because the chancery court’s findings on that issue were not essential to its judgment and because of differences in the applicable standards. Id. at 17.
As a threshold matter, the Court held that plaintiffs’ claims under Section 18 of the Exchange Act, which establishes civil liability for knowingly making false statements in any SEC filing, were timely. Although Section 18 was originally subject to a one-year limitations period from the time a reasonably diligent plaintiff would have discovered, or did discover, the alleged wrongful conduct, the Court held that the Sarbanes-Oxley Act had extended that period to two years because Section 18 concerns “claim[s] of fraud, deceit, manipulation, or contrivance.” Id. at 7.
The Court then addressed the allegations that the company had a duty to disclose its alleged issues regarding compliance with data integrity regulations under Item 303 of Regulation S-K, which requires the disclosure of “any known trends or uncertainties” which have had or may have a material impact on sales or revenues. Noting that the Seventh Circuit had not yet addressed whether Item 303 can give rise to liability under the Exchange Act, and that the Ninth and Second Circuits were split on the issue, the Court adopted the Second Circuit’s conclusion that Item 303 imposes a duty to disclose for purposes of the Exchange Act—which, subject to a materiality analysis under Basic Inc. v. Levinson, 485 U.S. 224, 238 (1988), can give rise to liability under Section 10(b)—because a reasonable investor “would understand a company’s nondisclosure of Item 303 conditions as a representation that no such condition exists.” Id. at 14 (citing Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 102 (2d Cir. 2015)).
Applying that analysis, the Court concluded that plaintiffs had sufficiently alleged: (a) a violation of Item 303, because the company’s noncompliance with FDA data integrity standards was a known trend that could reasonably be expected to cause a material impact on revenues by affecting the approval of FDA applications and potentially leading to sanctions; and (b) that the alleged 303 violation was material under Basic because the noncompliance could lead to serious consequences such as an FDA enforcement action or failure of the merger, even if the risk of such outcomes might be low. Id. at 15-16.
The Court also held that plaintiffs had sufficiently alleged that the company made an actionable misrepresentation when it represented in the publicly filed merger agreement that it was in compliance with “all applicable Laws (including all rules, regulations, guidance and policies) relating to or promulgated by the [FDA]” even though the company’s global compliance team had identified “severe noncompliance” at several sites. Id. at 17-19 (citing Glazer Capital Management, LP v. Magistri, 549 F.3d 736 (9th Cir. 2008)). The Court held, however, that statements on the company’s website asserting that it had internal policies to ensure regulatory compliance were insufficient to support a claim for fraud, because plaintiffs had not alleged with particularity the “who, what, when, where, and how” of the alleged fraud regarding these statements, or that the company, in fact, lacked such policies. Id. at 20.
The Court also rejected claims based on three alleged misstatements relating to the company’s manufacturing facilities because plaintiffs had not sufficiently alleged the claims were materially misleading. More specifically, the Court held that (1) statements that the company’s facilities were approved by the FDA could not be materially misleading absent further allegations as to what it meant to be FDA approved and how the statements were false, (2) statements that the company had expertise in research and development and manufacturing were non-actionable puffery, and (3) statements that the FDA had determined, after an inspection at one facility, that the company did not have to take any further action were not materially false (despite the fact that known issues still allegedly existed) because the FDA had in fact so determined. Id. at 20-22.
The Court then addressed allegations that the company had misrepresented the volume of its pending applications to the FDA. The Court held that the company’s statement that it had a “large pipeline” of pending applications amounted to mere puffery. Id. at 22-23. But the Court held that an executive’s statement on an earnings call that “we should now expect to receive approvals for other [applications]” was actionable, despite being forward looking, because it was not accompanied by cautionary language referring to the allegedly known data integrity issues that could undermine such approvals. Id. at 24.
The Court rejected claims based on statements that the company would operate “in the ordinary course of business” during the pendency of the merger, that the company had “effective” controls and procedures governing its disclosures, and on statements made in a press release denying data integrity problems, because plaintiffs had failed to establish that a reasonable investor would have been misled based on the statements made and/or in light of conflicting public information. Id. at 24-26.
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