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Ninth Circuit Affirms Dismissal Of Putative Class Action Against Medical Device Company For Failure To Adequately Allege Scienter
06/16/2020On June 10, 2020, the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a putative securities class action against a medical device company and certain of its executives under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Nguyen v. Endologix, Inc., ––F.3d––, 2020 WL 3069776 (9th Cir. 2020). Plaintiff alleged that the company’s statements regarding the likelihood of Food and Drug Administration (“FDA”) approval of a new product were misleading because the device had allegedly experienced problems following its earlier introduction in the European market. Explaining that implausible allegations cannot create a strong inference of scienter, the Ninth Circuit held that plaintiff’s allegations failed to satisfy the Private Securities Litigation Reform Act (“PSLRA”) because plaintiff’s core theory of the case had no basis in logic or common experience. Because plaintiff had already had an opportunity to replead, the Court affirmed the dismissal with prejudice.
Plaintiff alleged that, while the FDA approval process was ongoing, the company and its CEO and CFO became aware that the product was “migrating” in European patients—that is, moving from the initial location in the body in which it had been placed. Id. at *3. Relying on statements from a confidential witness, plaintiff alleged that this complication was a serious problem that was investigated by the company, that the two individual defendants were involved in those efforts, and that the issue was discussed during a series of high-level meetings and at the company’s annual symposium. Id. Plaintiff also pointed to two studies published in Europe that found risks of migration. Id. at *4. Plaintiff alleged that in spite of these issues, the executives misleadingly stated in an investor call and press release that the product “continues to do a fantastic performance outside of the U.S.,” that it was “doing as expected” with “[n]o surprises,” and that the product “remain[ed] on track with our timeline for potential FDA approval.” Id. Ultimately, after data showed an increase in the migration rate after the product had been implanted for more than a year, the company announced that the product would not be approved by the FDA under the original timeline. Id. at *5. As a result, the company abandoned its efforts to seek approval of the product and announced that it would focus on a second-generation device. Id. at *6.
The Court explained that plaintiff’s “core theory” was that defendants’ statements about FDA approval were false “because defendants knew, based on their experience in Europe, that [the product] would encounter migration issues.” Id. at *8. The Court observed, however, that this theory “does not make a whole lot of sense” and “depends on the supposition that defendants would rather keep the stock price high for a time and then face the inevitable fallout once [the product’s] ‘unsolvable’ migration problem was revealed.” Id. The Court further noted that the complaint lacked any allegations that the executives sought to profit from the alleged scheme, such as by selling stock at an inflated price. Id. The Court concluded that “the notion that a company would promise FDA approval that it knew would not materialize does not, without more, create a strong inference of intent to deceive or deliberate recklessness.” Id.
Moreover, with respect to the allegations attributed to a confidential witness, the Ninth Circuit explained that the witness left the company before many of the alleged misstatements occurred and before the company reported less favorable second-year data, and thus there was “ample basis to question aspects of [the witness’s] claimed knowledge.” Id. at *9. The Ninth Circuit further determined that the statements attributed to the confidential witness were “high on alarming adjectives” but “short on the facts” and failed to provide sufficient detail regarding issues discovered with European patients and the specific relationship between those issues and the FDA process. Id.
The Court also noted that the allegations themselves “confirmed the absence of a strong inference of scienter.” Id. at *10. In particular, the complaint focused primarily on a European study that the company actually disclosed and discussed on an investor call, and explained at the time that the study used a different definition of migration that did not meet the benchmark used by the FDA. Id. And while plaintiff had pointed to a case study regarding a severe adverse outcome in a single patient, the Court emphasized that the complaint provided “no details on the circumstances of this patient or why this case report should have alerted [the company] to a broader problem.” Id. Ultimately, the Court concluded that “[t]he more plausible inference to be drawn from the allegations in the complaint is that defendants made promising statements about the timing of FDA approval based on the initial results of the U.S. clinical trial, but then modulated their optimism when the results began to raise more questions.” Id. at *11.
