The Bulls-Eye Remains on Life Sciences Sector for Securities Class Actions

Author: Susan Friedman, Esq.

Although the focus of the life sciences sector is to create products and services to improve our lives, this industry must continuously adjust to a constantly evolving landscape of legal, regulatory and compliance rules. Whether it be drug development, biomedical technologies, pharmaceuticals, biotechnology, medical devices or biologics, the heightened scrutiny of life science companies keeps them on every regulator's radar.

The life sciences sector must also contend with the plaintiffs' bar, who keep a vigilant eye on the often-volatile stock prices and disclosures made in response to events impacting the sector. These disclosures may occur in the pre-development phase, clinical testing/trial phase (also known as the pre-approval phase), or during post-approval from the US Food and Drug Administration (FDA) when a product is manufactured, launched and marketed.

Life science companies are often compelled to disclose impediments to their progress, including formal and informal communications with the FDA in the pre-development phase; negative action, feedback or determinations by the FDA; delays in clinical trials; terminations or suspensions; adverse effects patients experience; negative results from clinical data; delays in FDA submissions; manufacturing or supply chain issues; hindrances to growth in sales post-approval; and others. Most setbacks to progress for life sciences companies occur in the pre-and post-approval phases.

Each public disclosure of a setback brings the risk of a decline in stock price. Should the price of stock drop, plaintiffs' class action attorneys examine previous public statements the life sciences company made, in an effort to pinpoint inconsistencies between past positive public comments and the current negative statement to the public. In the majority of cases, plaintiffs' attorneys strive to demonstrate that any inconsistency between past and present public statements is tantamount to fraud and as such, earlier statements made were knowingly or recklessly false or misleading.¹ Thereafter, shareholders commence litigation to recoup the losses to their investments.

Typically, plaintiffs assert claims pursuant to Section 10(b) and Rule 10(b)(5) (the anti-fraud provisions) of the Securities Exchange Act of 1934, as well as Section 20(a) (controlling persons — imposing vicarious liability for fraud) based upon allegedly false and misleading statements or omissions made by the board directors, C-suite officers and the company.² Plaintiffs' law firms also pursue derivative litigation brought against directors and officers by shareholders on behalf of the company by monitoring public disclosures, decline in stock price and securities class action filings.

Further, plaintiffs' attorneys appear to have a renewed interest in making "220 demands" before filing derivative lawsuits, to obtain the books and records of life sciences companies in an effort to strengthen allegations in the derivative action.³ Delaware courts have been extremely plaintiff-friendly in this regard. The industry of plaintiffs' lawyers watching all movements of life sciences companies is flourishing in what they perceive to be a "volume business."

The numbers are in for 2022

According to Cornerstone Research, plaintiffs filed 208 securities class actions in federal and state courts in 2022, a 5% reduction in filings from 2021 (218 filings) and below the 1997-2021 average of 228.⁴ As anticipated, however, there were a substantial number of COVID-19 related securities class action filings: 20 in 2022, 60% of which were against companies in healthcare products/services and biotechnology that were specifically affected by the pandemic or involved in the development of therapeutics, vaccines and testing products, among others, to respond to the Coronavirus.⁴

In addition to COVID-19 concerns, the consumer non-cyclical sector (which primarily includes life sciences companies) was a popular target with respect to filings related to the special purpose acquisition company (SPAC) transactions; six out of the 17 SPAC related securities class actions were filed against life sciences companies.⁵

Although the total number of securities class actions filed across all industry sectors decreased in 2022, Cornerstone Research reported that the consumer non-cyclical sector (including life sciences companies) eclipsed all other industry sectors with a record number of 65 filings, 37 of which were new securities class action lawsuits against publicly traded life sciences companies.^{4, 5} Notwithstanding life sciences companies' first place position in 2022, overall securities class actions spiraled downward for these companies from 2021 with 49 filings and 2020 with 45 filings.^{1, 4, 5}

An estimated 60% of the new cases filed in 2022 pertained to the pre-approval (developmental) stage of drugs or devices.¹ Approximately 40% of those legal actions were filed as a result of publicly disclosed setbacks at the final stage of the approval process following a life sciences company's submission to the FDA of a New Drug Application (NDA), Biologics License Application (BLA), Supplemental New Drug Application (sNDA) or a pre-market submission to demonstrate that the device to be marketed was as safe and effective as a legally marketed device (510(k) application).¹ Allegations arising out of this pre-approval phase included misrepresentations regarding product efficacy and safety (including failed clinical trials); and misrepresentations pertaining to the adequacy of applications submitted to the FDA.⁶

Trending allegations in the post-approval phase following product launch included misrepresentations involving purported unlawful conduct such as illegal kickback schemes, criminal investigations and inadequate internal controls in financial reporting.⁶ Claims involving alleged misrepresentations of material information made in connection with proposed mergers, sales, initial public offerings and other transactions represented about 25% of the securities class actions against life sciences companies in 2022.⁶

Back at the courthouse

Comparable to 2020 and 2021, in 2022 securities class actions against life sciences companies were concentrated in the United States Court of Appeals for the First Circuit (includes Massachusetts), Second Circuit (includes New York), Third Circuit (includes New Jersey and Delaware) and the Ninth Circuit (includes California).⁷ The legal activity for life sciences companies in these jurisdictions combined far surpasses the rest of the nation.

In this regard, with respect to motions to dismiss securities class actions against life sciences companies (and their board directors and officers), the federal district courts granted dismissal in 15 of the 29 decisions issued which represents 52% of the judicial rulings.^{1, 5} Although the majority of rulings on motions to dismiss were in favor of defendants, approximately 25% provided plaintiffs with the ability to re-plead their dismissed claims.¹ Most of the dismissals were based on the failure of the plaintiffs to allege scienter (the intent to deceive) with particularity. An estimated one-third of the motions to dismiss were denied in whole or in part which meant that the cases could proceed to discovery.¹

In 2020, 20 out of 35 decisions were dismissed; in 2021, 19 out of 33 decisions were dismissed. Similar to years past (except for 2021), in 2022 the dismissal success rates with respect to pre-approval (by the FDA) cases showed life sciences companies to prevail in about 60% of cases and 40% post-approval cases.^{1, 4}

Finally, at the appeals level, appellate courts affirmed all six dismissals in 2022.^{1, 4} Success at the appeals level is attributable to many factors including the ability of those judges to comprehend the complexities of conducting clinical trials and the overall environment in which life sciences companies operate.

Taking aim in 2023

At the close of first quarter 2023, 57 securities class actions were filed, eight of which were against life sciences companies.⁵ The race to the courthouse continued during the second quarter of 2023 as the number of securities class actions filed total 107 as of late June 2023, 16 of which are against life sciences companies.^{8, 9} Cornerstone Research forecasts that 2023 is shaping up to be on par with 2022 for securities class action activity against life sciences companies.

Certainly, the unceasing compliance, regulatory and legal activity is a constant challenge for life sciences companies, which continues to make them attractive targets for securities class actions. Not only are companies confronted with extremely aggressive enforcement activity by the US Securities and Exchange Commission (SEC), but they must also contend with plaintiffs' attorneys who are currently laser focused on insider trading and locating former executives to bolster their cases for fraud. In this same regard, the Department of Justice's (DOJ's) new initiative of self-reporting (and remedying) corporate misconduct, plus the DOJ's new guidance on executive compensation, take aim at publicly traded companies.^{10, 11}

Further, life sciences companies have an additional layer of regulatory and compliance scrutiny provided by the FDA. Despite the declared end to the COVID 19 public health epidemic, the FDA continues to issue guidance relative to the aftermath of the pandemic.¹² In addition, whether it be the FDA's diversity action plan for clinical trials, guidance on non-human primate studies or parameters for the use of artificial intelligence, the FDA is a formidable force in the compliance and disclosure arena for life sciences companies.¹²

Hitting the Target to Mitigate Risk

The overwhelming consensus is that the combination of volatile stock prices, unpredictable nature of events plus regulatory activity places life sciences companies in a particularly precarious position. Perhaps the largest critical component of risk in the life sciences space is the public disclosure of events during the lifecycle of a product or service.

The risks related to disclosure emanate from both expected and unexpected events, SEC scrutiny (i.e., 8K filings announcing major events that must be made known to shareholders within four days of their occurrence), demands to inspect books and records in derivative litigation, fair disclosure requirements in accordance with Regulation FD (promulgated by the SEC and prohibiting selective disclosure of material non-public information)¹³ communications with the FDA, threatened litigation and many others.

The decision to disclose information rests with the company's board of directors and senior level officers, and is a vital part of directors and officers (D&O) risk management. As a threshold matter, the life sciences companies must consider the materiality of the information to be disclosed. Typically, all research and clinical trial data is deemed material and, as a general rule, if information is material for disclosure purposes, it's also material for purposes of trading.

Given the volume of cases pertaining to public disclosures, it's imperative that life sciences companies establish and implement robust controls to mitigate the risks, which may include:

• Determining materiality
• Examining prior disclosures made on the same topic
• Considering if the event triggers an 8K filing requirement
• Preparing the public announcement
• Determining timing of the disclosure
• Establishing guidelines and maintaining a checklist for internal and external communications, including all aspects of social media, computer and cellphone usage.

Board directors and officers must also contemplate whether notification of a public disclosure should be made to their D&O Liability insurers who favor full disclosure and transparency. Employing D&O specialists to determine whether it's time to engage insurers, as well as being able to provide assistance in addressing other exposure issues, can be an indispensable part of a powerful risk management program.

As always, Gallagher's Management Liability Practice stands ready to assist.