Ninth Circuit Reverses Dismissal Of Shareholder Action Where Company Failed To Disclose Negative Information That Cut Against Positive Information It Disclosed
10/31/2016On October 26, 2016, the United States Court of Appeals for the Ninth Circuit reversed a district court’s dismissal of a putative securities class action against Arena Pharmaceuticals (“Arena” or the “Company”) where the district court ruled that plaintiffs failed to adequately plead scienter. Schueneman v. Arena Pharmaceuticals, Inc., No. 14-55633, -- F.3d ---- (9th Cir. Oct. 26, 2016). This reversal sheds light on how courts sometimes evaluate scienter when an issuer comes under “an affirmative duty to disclose” adverse information because it has disclosed positive information, and the disclosure of the adverse information is found to be necessary to make the disclosures that have been made not misleading.
This suit relates to Arena’s statements that it was confident that lorcaserin, a weight loss drug, would be approved by the Food and Drug Administration (“FDA”) and that “all the animal studies that [had] been completed” to assess carcinogenic risks in humans “supported Arena’s case for approval.” At the time of those statements, Arena did not also disclose follow-up testing and then-ongoing discussions with the FDA regarding whether or not the animal studies had shown lorcaserin was causing cancer in rats. On September 14, 2010, the FDA disclosed the FDA’s concerns about possible carcinogenicity on its website. Arena’s stock price dropped nearly 40%, and this action alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ensued. Ultimately, the FDA accepted the Company’s interpretation of the studies and approved lorcaserin.
The U.S. District Court for the Southern District of California dismissed the complaint twice, concluding that the Company’s back-and-forth with the FDA constituted a scientific dispute between the Company and the FDA about the import of the animal studies. Because the Company believed its interpretation of the animal studies results was correct, the complaint’s allegations were insufficient to raise an inference of an intent to defraud. The Ninth Circuit disagreed, holding that the complaint sufficiently alleged scienter because the Company allegedly knew the FDA’s requests for follow-up studies and bi-monthly reports were “highly unusual” and “out-of-process.” The Company nevertheless expressed confidence in FDA approval and attributed that confidence to the animal studies that were the subject of the follow-up studies and reports. The Court acknowledged that “companies can control what they have to disclose . . . by controlling what they say to the market.” Once Arena chose to make positive statements to the market, however, it was bound to make those statements not misleading by also disclosing “adverse information that cuts against the positive information.” To avoid this result, the Court explained that Arena could have expressed confidence in lorcaserin’s future without attributing this confidence to the results of the studies. Arena could not, however, represent that all of the results were favorable without also disclosing its discussions with the FDA.
This ruling underscores that, in cases where a court concludes a duty to disclose adverse information has arisen based on the disclosure of positive information, the issue of the knowledge component of scienter may come down to the simple question of whether or not the defendant knew of the adverse information at the time of the challenged disclosures. Here, Arena allegedly knew the follow-up was unusual, and that was enough to allege scienter.