Southern District Of New York Dismisses Putative Securities Class Action Against Pharmaceutical Company For Failure To Adequately Allege Scienter
On September 30, 2019, Judge J. Paul Oetken of the United States District Court for the Southern District of New York dismissed a putative securities class action brought against a pharmaceutical company and certain of its current and former executives. Tung v. Bristol-Myers Squibb Co., et al., 18-cv-1611 (S.D.N.Y. Sept. 30, 2019). Plaintiffs allege that the pharmaceutical company (the “Company”) and defendant executives made materially misleading statements and omissions concerning the design of the Company’s clinical trial that tested the efficacy of a newly-developed anticancer drug in violation of Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5 promulgated thereunder. The Court dismissed the claims finding that plaintiffs failed to sufficiently plead scienter, but granted plaintiffs leave to amend to address the pleading deficiencies.
In early 2014, the Company announced a clinical trial that sought to determine whether its new drug, Opdivo, a checkpoint inhibitor, would outperform chemotherapy as a treatment for non-small cell lung carcinoma. Plaintiffs brought suit after the Company’s stock dropped in 2016 following the Company’s announcement that the trial “failed to demonstrate” the drug was more effective than traditional chemotherapy. Plaintiffs alleged that defendants mischaracterized the parameters of its trial by representing that the purpose of the study is to show that the drug would improve outcomes in subjects “with strongly Stage IV or Recurrent PD-L1+ non-small cell lung cancer.” PD-L1 is a protein that “when present on healthy cells, prevents the immune system from attacking them,” which is a mechanism cancer cells replicate to prevent an immune response against it. According to plaintiffs, defendants failed to clarify how much PD-L1 expression was required for a patient to “strongly” express PD-L1. After the trial failed, the Company disclosed that “strongly” meant any patient with at least 5% of cancer cells expressing PD-L1, and that the study’s design “precluded the researchers from reaching any conclusions about the efficacy of [the drug] for patients whose expression of PD-L1 were higher than 5%.” According to plaintiffs, this meant that the Company “had no means under accepted statistical methodologies of finding a significant difference between the performance of [the drug] and chemotherapy.”
The Court first considered plaintiffs’ scienter allegations and found that plaintiffs failed to plead facts raising the requisite “strong inference” that defendants had the motive and opportunity to commit fraud or that they acted recklessly in “an extreme departure from the standards of ordinary care.” The Court initially rejected plaintiffs’ contention that defendants had a fraudulent motive “to protect competitively sensitive information,” noting that guarding competitively sensitive information is merely a “generalized business motive.” The Court further found that plaintiffs failed to allege that defendants would receive any “concrete benefits” from withholding information concerning the parameters of the clinical trial, other than the general benefit of “maintaining the appearance of corporate profitability.” Accordingly, the Court noted that “[i]f scienter could be pleaded on this basis alone, ‘virtually every company in the United States that experiences a downturn in stock price could be forced to defend securities fraud actions’” (citing Acito v. IMCERA Grp, Inc., 47 F.3d 47, 54 (2d Cir. 1995)). The Court also rejected plaintiffs’ contention that defendants had a fraudulent motive to artificially inflate the stock price to sell their personal stock holdings—finding that two of the six individual defendants did not sell any stock during the putative class period, and the other four individual defendants who did sell stock during the putative class period either increased their overall holdings or maintained their holdings during the period as a result of stock purchases. According to the Court, plaintiffs failed to demonstrate that that the stock sales were “unusual” or “suspicious,” which undermines plaintiffs’ motive and opportunity allegations.
The Court similarly held that plaintiffs failed to plead facts alleging that defendants acted in a “highly unreasonable [manner] which represents an extreme departure from the standards of ordinary care.” The Court held that plaintiffs’ allegations—(i) that defendants knew the industry standards with respect to how “strong” PD-L1 expression is defined given their leading role in the market, (ii) that defendants had in prior trials “employed a 5% cut-off to define mere ‘positive’ expression” of PD-L1 which contradict their “current position. . . [that it can now] be used to define ‘strong’ PD-L1 expression,” and (iii) defendants’ own post-clinical trial statements that a 5% cut-off was not high—“fall far short of [the] demanding standard” of pleading scienter by recklessness, which requires plaintiffs to plead facts that “indicate a state of mind approximating actual intent.” In so holding, the Court noted that “conclusory allegations of [defendants’] knowledge” do not sufficiently allege their knowledge of and departure from industry standards. The Court further noted that plaintiffs did not allege the Company took the categorical position in its earlier studies that “strong” compelled a cut-off of more than 5%, and defendants’ post-clinical trial statements occurred “long after” the alleged misrepresentations were made. Additionally, the Court found that although a competing pharmaceutical company defined “strong” PD-L1 expression as 50% or greater in a similar study conducted shortly after the Company’s study, plaintiffs failed to allege that the competitor’s study “indicated that ‘strong’ must mean, as a matter of industry practice, a cut-off greater than 5%.” According to the Court, “[a]t best, the [competitor’s] study could have informed” the Company how the competitor was defining “strong” in their own study, which is insufficient to meet the heightened pleading standards under the PSLRA. Lastly, the Court rejected plaintiffs’ argument that the alleged “unexpected” departure from the Company by one of the individual defendants less than six months following the end of the putative class period provided support for scienter, finding that such departure did not rise to the level of being “highly unusual and suspicious.” For these reasons, the Court found that plaintiffs failed to sufficiently plead scienter and dismissed the Section 10(b) claims.
Based on the dismissal of the Section 10(b) claims against the Company and the individual defendants, the Court dismissed the Section 20(a) and 20A claims as there were no predicate violations of the Exchange Act under which control-person violations could be established. Noting that district courts “typically” grant plaintiffs at least one opportunity to plead fraud with greater specificity when claims are dismissed under FRCP 9(b), the Court granted plaintiffs leave to amend.