First Circuit Affirms The Dismissal Of A Putative Securities Fraud Class Action Against Medical Robotics Company In Connection With The FDA’s Issuance Of A Warning Letter
On August 25, 2020, the United States Court of Appeals for the First Circuit affirmed the dismissal of a putative securities fraud class action asserting violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the “Securities Act”) as well as Section 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 against a medical robotics company (the “Company”) as well as certain of its officers. Yan v. ReWalk Robotics Ltd., et al., No. 19-1614, 2020 WL 5014858 (1st Cir. Aug. 25, 2020). Plaintiffs alleged that the Company made false or misleading statements and omissions in its IPO registration statement (the “Registration Statement”) and subsequent quarterly and annual disclosures concerning its dealings with the Food and Drug Administration (the “FDA”) regarding one of the Company’s devices. The First Circuit affirmed the district court’s dismissal of the Securities Act claims, finding that plaintiffs failed to allege a material misstatement or omission. Although it disagreed with the district court’s reasoning in dismissing the Exchange Act claims for lack of standing, the First Circuit nevertheless found that the Exchange Act claims were properly dismissed because plaintiffs failed to sufficiently allege a material misstatement or scienter.
The Company designs and manufactures robotic exoskeletons that offer greater mobility to individuals with spinal cord injuries, including an exoskeleton that is intended for use in a home or general community setting (“the device”). The device is subject to regulation by the FDA, which approved the device so long as the Company conducted a post-market surveillance study of the safety of the device outside institutional settings. Although the safety of the device had been demonstrated in institutional settings, such as hospitals and rehabilitation centers, there was limited data on its safety in the home or community settings—the intended environment for the device. The FDA ordered the Company to submit the proposed study plan for approval and begin the study within fifteen months.
Upon submitting the proposed study plan for approval, but before receiving FDA approval of that plan, the Company issued its Registration Statement and a month later went public. The Registration Statement allegedly touted the device as, among other things, a “breakthrough product” with “compelling clinical data,” but noted that the FDA had ordered the performance of a post-market surveillance study and failure to comply may result in the device’s removal from the market.
According to plaintiffs, the Company missed certain deadlines for submitting plans for its post-market surveillance study, and, when it did submit such plans, the FDA deemed them inadequate. As a result, one year after its IPO, the FDA issued a warning letter to the Company, stating (1) that the Company had not made satisfactory progress towards commencing an approved post-market surveillance study, (2) the device was “misbranded” under the Food Drug, and Cosmetic Act, and (3) the Company would be sanctioned if it did not take corrective action. In the year between the IPO and its receipt of the warning letter, the Company allegedly did not disclose that the FDA was dissatisfied with the Company’s progress towards commencing the study. And in subsequent quarterly and annual disclosures, the Company allegedly continued to tout the device and assure investors it was making progress in commencing the post-market study. Plaintiffs alleged that the Company waited six months after receiving the warning letter to disclose it to the public, doing so just days before the FDA was scheduled to make the letter public.
In January 2017, plaintiffs filed the proposed class action complaint focusing only on alleged misrepresentations in the Registration Statement. Plaintiffs alleged that the Company failed to disclose sufficient information concerning the reasoning for the FDA’s order mandating a post-market surveillance study. In August 2017, plaintiffs amended the complaint to include claims under Section 10b and Rule 10b-5 of the Exchange Act, further alleging that the Company failed to disclose the FDA’s dissatisfaction with its progress towards commencing its study.
The district court dismissed the Securities Act claims, holding that plaintiffs failed to allege any false or misleading statements or omissions. The district court similarly dismissed the Exchange Act claims, holding that (1) lead plaintiff purchased his securities well before the Company made the alleged misstatements or omissions, and (2) lead plaintiff, after the supplemental briefing, had not plausibly alleged that a common fraudulent scheme united the alleged misrepresentations in the Registration Statement and those made in public filings and on investor calls after the Company’s IPO. The district court further held that, because lead plaintiff’s Exchange Act claims failed, he lacked standing to move to amend the complaint to add another lead plaintiff to pursue these claims.
The First Circuit initially considered the alleged misrepresentations in the Registration Statement and affirmed the district court’s decision that lead plaintiff failed to allege any actionable misstatement or omission. According to lead plaintiff’s principal theory of liability, the Company’s description of the FDA’s evaluation of the device’s safety was misleading because “the FDA specifically determined . . . that the device’s failure to prevent a fall would be reasonably likely to cause serious injury or death” and, thus, any “boilerplate recitation of the potential adverse regulatory consequences was rendered meaningless.” The First Circuit disagreed, finding the cautionary language sufficient, noting that no reasonable investor would conclude that the FDA was concerned with “mere bumps and bruises” when the Registration Statement disclosed that a “user could experience death or serious injury” if the device were to malfunction and that, as a result, the Company needed to “demonstrate reasonable assurance of safety” to the FDA in the device’s post-market study. The Court similarly held that other alleged misstatements, such as the Company touting its “compelling clinical data” or “breakthrough device,” were inactionable statements of mere puffery. Further, the Court affirmed the district court’s dismissal of any potential claims under Regulation S-K, holding that regardless of whether these claims were adequately pleaded, they failed for the same reason plaintiffs’ Section 11 claims failed—the Registration Statement’s risk disclosures were adequate. Finally, the Court rejected plaintiff’s procedural objection that the district court had improperly dismissed some of the alleged misstatements “sua sponte” relying on the statutory safe harbor for forward-looking statements. The Court held that while “it is sometimes inappropriate for a district court to advance on its own a reason to dismiss a claim,” the issue the district court addressed posed a “pure issue of law,” plaintiff “lost no chance to marshal any supporting arguments” on appeal, and plaintiff failed to point to anything that he would have added to the appellate record had the Company raised the argument itself.
Turning to the Exchange Act claims and the alleged misrepresentations on investor calls after the IPO, the Court held that lead plaintiff lacked standing to challenge the alleged misstatements that occurred months after his purchases of the Company’s stock. Agreeing with the district court, the Court held that lead plaintiff had not sufficiently alleged that the Company had “engaged in a ‘common scheme’ that tied together claimants who purchased in the IPO with claimants who purchased after the IPO.” According to the Court, lead plaintiff failed to adequately allege any misstatement or omission in the Registration Statement and, therefore, the Company’s repetition of the same alleged misstatements on investor calls after the Company’s IPO cannot establish a “common scheme.” Accordingly, “even if fraud occurred after the IPO, there is no basis for claiming that it commenced before the IPO.” As such, the Court found that the Exchange Act claims “rise or fall . . . on consideration of [the Company’s] decision not to disclose the difficulties it was having after the IPO in seeking approval by the FDA for it study plan”—which occurred after lead plaintiff purchased the Company’s stock. The Court, therefore, concluded that “it would hardly serve the interests of class members who may have valid claims based on their facts to be represented by a person whose facts dictate he or she will lose the case even if the class members might have won.”
The Court did, however, disagree with the district court’s reasoning in dismissing the Exchange Act claims, which the district court dismissed because lead plaintiff “had no standing to ask the court to do anything at all, including adding a party.” While the First Circuit acknowledged that certain cases support this “formalistic approach,” it noted that the First Circuit “matter-of-factly” follows the Supreme Court’s approach in Sierra Club v. Morton, where the Supreme Court held that although Sierra Club lacked standing, it could amend its complaint to plead new facts that would support standing. 405 U.S. 727, 735, 741 (1972). Citing to cases in the First Circuit “reversing the denial of a motion to amend where the amended pleading established Article III standing by adding facts not contained in prior complaints” and Congress’ endorsement of this approach, the First Circuit determined that it “[saw] no reason why this permissiveness does not extend to motions seeking to add a named party asserting the exact same claims that is already pleaded in the complaint.”
Although the Court disagreed with the district court’s standing analysis as it pertained to the Exchange Act claims, the First Circuit nevertheless held that such claims were properly dismissed. In so holding, the Court noted that it has the discretion to affirm a district court’s decision on alternative grounds and that the parties had anticipated such a possibility in their briefing. In particular, the Court held that the amended complaint had not adequately pled scienter because (1) the majority of the alleged misstatements or omissions concern “run-of-the-mill regulatory back and forths”; (2) the Company has no affirmative obligation to disclose “each detail of every communication with the FDA” (quoting In re Bos. Sci. Corp. Sec. Litig., 686 F.3d 21, 31 (1st Cir. 2012)); and (3) as the Court had previously made clear, the Company’s risk disclosures were adequate. The Court noted that while the Company’s receipt of the FDA warning letter might be the exception to the Company’s “run-of-the-mill” exchanges with the FDA, the FDA took no action against the Company at the time it issued the warning letter and merely stated that the failure to take corrective action “may” result in sanctions. The Court further held that even if the Company failed to demonstrate a “sense of urgency” after receiving the FDA warning letter, such “lack of urgency might amount to poor management, [but] such a failing does not amount to securities fraud.”
Having found that plaintiffs failed to sufficiently plead a material misstatement or scienter, the First Circuit affirmed the district court’s dismissal of the amended complaint.