On 11 June 2018, a federal district court judge in New York dismissed with prejudice a putative securities fraud class action against veterinary pharmaceutical company Aratana Therapeutics Inc. (Aratana) and two of its officers. The plaintiffs had alleged that the defendants violated Sections 10(b) and 20(a) of the Exchange Act by making misstatements about the timeline for bringing Entyce, an appetite stimulant drug for dogs, to market, and thus caused the plaintiffs to suffer losses when Aratana later disclosed that it had not yet found a manufacturer approved by the Food & Drug Administration (FDA) and Aratana's stock price declined. The court disagreeing found that the plaintiffs had failed to allege that Aratana's statements about its FDA approvals or timeline were false or made with intent to mislead investors, and dismissed the plaintiffs' amended complaint with prejudice.
The court first considered the plaintiffs' allegation that Aratana repeatedly misrepresented that it was on the cusp of achieving, or had achieved, the FDA approvals necessary for commercialization of Entyce on Aratana's stated timelines. The plaintiffs had contended that the statements were misleading because Aratana had not yet secured an FDA-approved third-party manufacturer, so any approvals were "a mere placeholder that required further amendments and approvals." The court disagreed and found that most of Aratana's statements constituted mere puffery, statements of opinion or forward-looking statements that were not actionable. Similarly, the court held that Aratana's disclosures about FDA approval and the timeline for Entyce's commercial release could not be the basis of a lawsuit, either as opinions (such as "we believe") or as forward-looking statements accompanied by cautionary disclosures (such as warnings that Aratana was dependent on third-party manufacturers and the selection of such manufacturers was subject to FDA approval).
The court then considered whether the plaintiffs had adequately alleged that the defendants had made any misstatements with scienter (fraudulent intent). To do so, the plaintiffs would have to show that the defendants either had "motive and opportunity" to make false or misleading statements or engaged in "conscious misbehaviour or recklessness" when making the challenged statements. The court first addressed the plaintiffs' contention that the individual defendants enriched themselves through suspicious sales of Aratana stock. The defendants had countered that the individual defendants' acquisition of additional stock and stock options during the same period that they sold shares should be taken into account in comparing the volume of an insider's sales to his or her overall share holdings; the plaintiffs argued that stock and options acquired at no cost should be disregarded in determining whether the individual defendants' trading activity gave rise to an inference of scienter. Noting that the Second Circuit Court of Appeals (which covers Connecticut, New York and Vermont) had not yet definitively determined what types of shares should be included in such an analysis, the court found that "there is wisdom" in the approach taken in In re eSpeed, Inc. Securities Litigation, in which Judge Scheindlin adopted the Ninth Circuit's nuanced approach of distinguishing between exercisable vested stock options and unvested stock options that could not be sold immediately. Under that approach, the decisive question in assessing whether an insider's stock sales suggest scienter is how many shares the insider sold during the period compared to the total number he or she could have sold. Accordingly, the court counted both zero-cost shares of common stock and vested options, but not unvested options, in calculating the individual defendants' total share holdings. Under that methodology, one individual defendant had only a "minuscule overall reduction" in holdings during the class period, while the other had a significant increase in holdings. Emphasizing that this lack of evidence of suspicious sales by the individual defendants undermined the inference that they had sought to capitalize on any artificial inflation of Aratana's stock price, the court held that the plaintiffs' allegations of insider stock sales did not establish motive.
The court also rejected the plaintiffs' contention that the company and the other defendants had a motive to lie about Entyce's approvals to avoid early penalty payments on an outstanding loan, and pointed out that courts in the Second Circuit have consistently held that a desire to reduce a company's debt burden or keep a stock price high is insufficient to establish an inference of scienter. Finally, noting that the plaintiffs' complaint failed to identify any internal documents or confidential witness statements suggesting that the defendants knowingly deceived shareholders, the court concluded that the plaintiffs had not adequately alleged conscious misbehaviour or recklessness.
It is not uncommon for plaintiffs to point to insiders' sales of stock as evidence of their fraudulent intent. The court's holding here—that zero-cost stock and vested options should be counted in a defendant's overall shareholdings for purposes of analysing whether a complaint adequately alleges fraudulent intent—will potentially be useful to future defendants in trying to fend off such allegations.
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