Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies. August 2004

Transcription

1 d Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies August 2004

2 Life Sciences Suits on the Rise Now, more than ever, life sciences companies are in the sights of securities fraud class action lawyers. The number of life sciences companies pharmaceutical and biotechnology sued for securities fraud rose by nearly 40 percent in 2003, even as the number of securities fraud lawsuits against all companies dropped by approximately 20 percent during that time. This statistic is not an anomaly. Life sciences companies are highly susceptible to securities fraud class actions not only because their stock prices are often relatively volatile, but also because the drug product life cycle is fraught with potential for adverse events and developments. Examples of adverse events include: a new drug candidate fails in Phase III clinical trials the FDA declines to approve a new drug data emerge indicating a serious safety issue with a drug a key commercial partner withdraws from a co-promotion arrangement government regulators initiate action over quality controls at a manufacturing site a state attorney general brings an action alleging deceptive sales and marketing practices, among others Given that only a small minority of new drugs survive the FDA approval process, life sciences companies are often faced with bad news. And when the news is bad, investors react, the stock price plummets, and the company gets hit with a wave of securities fraud class actions. In this survey, we discuss the 2003 trends in terms of both the number of suits filed against life sciences companies and the types of allegations being made in those suits. We then preview issues that are on the horizon for life sciences companies and offer recommendations to minimize the risk of securities fraud suits. Dechert LLP 2

3 FINDINGS (1) The number of securities fraud suits brought against life sciences companies is on the rise In spite of an overall decline in 2003 of approximately 20 percent in securities fraud class action filings across the country, from 268 to 216, and across nearly all industries, the number of securities fraud class action cases brought against life sciences companies rose in 2003 by more than 39 percent, increasing from 23 to 32. The securities fraud class action lawsuits against life sciences companies made up 15 percent of all such lawsuits filed in 2003, up significantly from 9 percent in (2) Companies with smaller market caps are the most frequent targets As the following chart shows (Figure 1), nearly half of the life sciences companies that were sued for securities fraud in 2003 have a market capitalization of less than $500 million. The explanation for this trend is that the companies with smaller market caps tend to have fewer product candidates and, therefore, adverse events tend to have a more dramatic impact on their stock price (and therefore on the plaintiffs attorneys). (3) The substantive allegations in these lawsuits span the drug product life cycle A wide range of claims were made in the class action suits brought against life sciences companies in 2003 (see Figure 2). Often the suits contained more than one type of substantive claim. While the traditional securities fraud claim of misrepresentations/omissions regarding the financial outlook of a company remained the single most prevalent claim, the majority of the claims concerned various aspects of the drug development process. Claims that companies had deceived investors regarding product efficacy and safety topped the list Securities Fraud Class Action Lawsuits Number of Life Sciences Companies ,000 1,000-2,000 2,000-5,000 5,000-10,000 10,000+ Figure 1: Nearly half of all life sciences companies sued for securities fraud in 2003 have a market capitalization of less than $500 million. Market Capitalization (in Millions) Dechert LLP 3

4 Allegations in 2003 Lawsuits Number of Lawsuits Misrepresentations and/or non-disclosures regarding product efficacy 9 Misrepresentations and/or non-disclosures regarding product safety 8 Misrepresentations regarding the likelihood of FDA approval 5 Misrepresentations and/or non-disclosures regarding the quality of the science underlying the product candidate Misrepresentations and/or non-disclosures regarding the quality of a manufacturing process 4 1 Misrepresentations and/or non-disclosures regarding clinical trial results 1 Misrepresentations and/or non-disclosures regarding the prospect of partnering with another company to promote and commercialize the product candidate 1 Faulty accounting and/or inflating revenues 15 Figure 2: Lawsuit allegations span the drug product life cycle. THE NATURE OF THE CLAIMS regarding product efficacy The most common type of development-related securities fraud claim brought against life sciences companies in 2003 involved allegations that the company and/or its executives misled the investing public about the efficacy of a product candidate. For example, in May 2003, investors in Regeneron Pharmaceuticals sued the company and its top executives in the Southern District of New York for issuing allegedly materially false and misleading statements regarding the efficacy of its diet drug Axokine. Specifically, the plaintiffs alleged that Regeneron initiated Phase II clinical trials for Axokine for use in obese patients, and more than two-thirds of the patients on the medicine in the clinical trials developed antibodies that made the medicine less effective. According to the complaint, however, before the poor trial results were released, Regeneron and its executives allegedly had claimed that Axokine would help patients lose weight better than a placebo and led the public to believe that Axokine would have more than $500 million in annual sales. The plaintiffs further alleged that when Regeneron finally disclosed the poor results of the Phase II trials, the stock price plunged 57 percent, a market cap loss of more than $500 million. regarding product safety Another common target for the plaintiffs lawyers in 2003 was alleged misrepresentations by life sciences companies regarding the safety of a product. This claim often was linked with a claim regarding an alleged misrepresentation of the drug s efficacy. For example, in November 2003, Dechert LLP 4

5 a putative class of shareholders sued Titan Pharmaceuticals and three of its executives for securities fraud in the Northern District of California, alleging that they issued a series of material misrepresentations to the market concerning Titan s drug, Iloperidone. Specifically, the complaint alleged that the defendants failed to disclose that Iloperidone caused negative cardiovascular, urogenital, and respiratory reactions. In addition (as is often the case), the plaintiffs alleged that Titan and the individual defendants engaged in insider trading during the time of the alleged fraud. On the announcement of the news relating to the safety of Iloperidone, Titan s stock fell 58 percent. regarding the likelihood of FDA approval A number of securities fraud claims brought against life sciences companies in 2003 were based on allegations that the company made misrepresentations regarding the likelihood of FDA approval of its product. For example, in January 2003, in a federal district court in Massachusetts, a putative class of shareholders of Transkaryotic Therapies Inc. charged the company and some of its officers with failing to disclose the true prospects of FDA approval for Transkaryotic s Replagal enzyme therapy for the treatment of Fabry disease. Specifically, the plaintiffs alleged that the company and the individual defendants knew in 2000 that the FDA considered the Phase II study to be uninterpretable and that its data did not support approval. When Transkaryotic finally disclosed these facts in 2003, its stock price fell 85 percent from its high during the alleged class period. regarding the quality of the science underlying the product candidate Securities fraud class actions brought against life sciences companies also often involve allegations that a company misled the public about the quality of the science underlying the product. In December 2003, for example, a putative class of shareholders of Cerus Corporation sued Cerus and certain of its officers and directors for securities fraud in the Northern District of California. The plaintiffs alleged that the defendants misled the public about the company s development program for the Intercept Blood System for Red Blood Cells, a system that applies Cerus Helinx technology for the treatment of red blood cell concentrates. In particular, the plaintiffs charged that the defendants knew that the red blood cells treated with a certain Helinx compound would develop antibodies rendering the Intercept Blood System ineffectual and that they misinformed the investing public when they claimed that the system would prevent the replication of undesired viruses, bacteria, and other pathogens, cutting off their capacity to cause infection. regarding the quality of the manufacturing process Life sciences companies also face the threat of securities fraud litigation arising out of alleged misrepresentations regarding the quality of the manufacturing process of a product. In October 2003, a putative class of shareholders in Alkermes Inc. sued the company and certain of its officers and directors for securities fraud in a federal district court in Massachusetts. Specifically, the plaintiff class alleged that the defendants concealed from the investing public significant quality issues with the manufacturing process of its Risperdal Consta drug that impacted the ability of the company to meet clinical development deadlines for the drug. Plaintiffs further alleged that when defendants announced the receipt of a non-approvable letter for Risperdal Consta, Alkermes stock price dropped and traded at 93 percent lower than its high during the period of the alleged fraud. regarding the cinical trial results A final type of FDA process-related allegation upon which a securities fraud lawsuit was brought against a life sciences company in 2003 concerned the alleged misrepresentation and/or nondisclosure of clinical trial results. In April 2003, a putative class of shareholders sued Pharmacia and certain of its officers and directors for securities fraud in a federal district court in New Jersey, based on the allegation that Pharmacia and the individual defendants manipulated the results of the clinical study for Celebrex. Allegedly, the company did not include the final analysis of all of the data collected through the entire Dechert LLP 5

6 duration of the study. Once it was reported that a group of researchers reviewed the results of the clinical trials and concluded that Celebrex might carry an increased risk of cardiovascular events, Pharmacia s stock price dropped to below $40, from a high of $45. regarding the prospect of partnering with another company to promote and commercialize a product Transkaryotic s Replagal enzyme also spawned another securities fraud class action lawsuit against another life sciences company based upon a different theory. In October 2003, a putative class of shareholders of Cambrex Corporation sued Cambrex and certain of its officers and directors in a federal district court in New Jersey for securities fraud arising out of Cambrex s business relationship with Transkaryotic and the marketing of the Replagal enzyme. The Cambrex plaintiffs alleged that the defendants misled Cambrex s investors to believe it had a lucrative contract with Transkaryotic that would create double-digit growth in Cambrex s biosciences segment. However, according to the plaintiffs, the Cambrex defendants were aware that Transkaryotic likely would not get FDA approval. On the day that the defendants announced facts about Transkaryotic, the price of Cambrex s common stock dropped 20 percent from its previous day s close. ON THE HORIZON Filings against life sciences companies will continue As of the date of this publication, 14 life sciences companies have been sued for securities fraud already in Plaintiffs lawyers target marketing campaigns In 1998, the Second Circuit Court of Appeals opened a new door for plaintiffs lawyers. In re Carter-Wallace Inc. Sec. Litig., 150 F.3d 153 (2d Cir. 1998), the Second Circuit held that detailed advertisements in sophisticated medical journals could constitute statements made in connection with a securities transaction. Alleged misrepresentations or non-disclosures made in connection with a marketing campaign, therefore, are potentially a basis for a securities fraud claim. This poses certain risks and dangers to life sciences companies that frequently engage in large-scale marketing campaigns for blockbuster drugs. A Carter-Wallace type claim was filed in January 2004 in federal court in the Eastern District of Louisiana. Merck and certain of its officers were sued for securities fraud based on the allegation that they had engaged in a fraudulent marketing campaign for Merck s painkilling drug Vioxx. The plaintiffs alleged that the FDA repeatedly warned Merck that its promotional materials for Vioxx were false and misleading and lacked fair balance because they minimized the potentially serious risk of increased heart problems associated with Vioxx. Despite the warnings, the defendants allegedly continued to tout the efficacy of the drug and its superiority to its rival drug, Celebrex. Plaintiffs further alleged that when an article was published in 2003 disclosing that clinical trial data suggest that Vioxx might slightly raise the risk of heart attacks and with the growing perception that Vioxx is no better than other painkillers, Merck s stock price dropped more than 4 percent the following day. Collaboration between the SEC and the FDA In February 2004, the Securities and Exchange Commission ( SEC ) and the FDA agreed to an enhancement of their cooperative efforts to, among other things, refer to the SEC staff possible instances of securities laws violations by public companies regulated by the FDA. Thus, the SEC has publicly indicated that it intends to step up its enforcement efforts against companies, including life sciences companies, that are regulated by the FDA. This alone could ratchet up the number of enforcement actions initiated by the SEC against life sciences companies and, along with it, increase the number of private securities lawsuits. MINIMIZING THE RISK OF SECURITIES FRAUD CLASS ACTIONS There are several steps that could reduce the risk of securities fraud class actions. Aside from the obvious strategy of ensuring that the companies Dechert LLP 6

7 statements and public filings are truthful and accurate, counsel should do the following: 1. Be alert to events that may negatively impact the drug product life cycle. Some potentially troubling issues are obvious, e.g., clinical trial failures and FDA rejection. Others, however, are not so obvious, such as manufacturing problems or the loss of a key commercial partner. As described above, these events can trigger class actions. 2. Explain to managers how issues in their specific areas of responsibility could become the basis of a securities fraud class action. For example, R&D managers need to understand that how they conduct clinical trials and tests can not only affect the drug development process but also expose the company to the risk of a securities fraud class action. 3. Ensure that public statements and filings contain appropriate cautionary language or risk factors that are specific and meaningful, and cover the gamut of risks throughout the entire drug product life cycle from development to production to commercialization. DECHERT S LIFE SCIENCES PRACTICE Dechert LLP, with more than 700 lawyers firmwide, represents life sciences companies around the globe on a wide range of transactional and litigation matters. In litigation, Chambers USA 2004 described Dechert as the litigation firm par excellence. Dechert s trial team has played a major role in landmark class actions in the United States, and our lawyers have earned a reputation for aggressively, creatively, and effectively representing clients in high-risk litigation. In addition to publishing the Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies, our group regularly publishes other materials of interest to life sciences practitioners. If you would like to receive these materials, please contact: Michael L. Kichline michael.kichline@dechert.com David A. Kotler david.kotler@dechert.com 4. Ensure that the sometimes fine line between puffery and statements of fact is not crossed in public statements or filings, or even in extemporaneous statements during analyst calls and media commentary. While soft puffery conveys a positive message and image about a company that is not misleading under the securities laws, it is the hard statements of fact upon which class action lawyers with the benefit of 20/20 hindsight will concoct a lawsuit. 5. Develop and publish an insider trading policy to minimize the risk of inside trades during periods that might help class action lawyers later develop a theory. Class action lawyers aggressively monitor trades by insiders to develop allegations that a company s executives knew the truth and unloaded their shares before the truth was disclosed to the public and the stock plummeted. Dechert LLP 7

8 About Dechert LLP With more than 700 lawyers in 17 cities in the United States and Europe, Dechert LLP provides a full range of legal services to corporations and financial institutions in transactional, regulatory, and litigation matters. d 2004 Dechert LLP