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Pharmaceutical

and Medical Device

Law

Regulation of Research, Development, and Marketing

Second Edition

Chapter 12: Securities Law Issues and Disclosure Considerations

for Life Sciences CompaniesReprinted by Permission

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The American Bar AssociationHealth Law Section

Bloomberg BNa, arlington, va

Pharmaceutical

and Medical Device

Law

Regulation of Research, Development, and Marketing

Second Edition

Editor-in-Chief

Michael E. ClarkDUANE MORRIS LLPHouston, Texas

A

Copyright © 2015The American Bar Association

Library of Congress Cataloging-in-Publication DataNames: Clark, Michael E., 1956- editor. | American Bar Association. Health Law Section, sponsoring body.Title: Pharmaceutical and medical device law : regulation of research, development, and marketing / by Michael E. Clark, American Bar Association Health Law Section.Description: Second edition. | Arlington, VA : Bloomberg BNA, 2015. | Includes index.Identifiers: LCCN 2015045560Subjects: LCSH: Pharmacy--Law and legislation--United States. | Drugs--Law and legislation--United States. | Medical instruments and apparatus industry--Law and legislation--United States. | Drug development--United States.Classification: LCC KF2915.P4 P495 2015 | DDC 344.7304/16--dc23 LC record available at http://lccn.loc.gov/2015045560

The materials contained in this work represent the opinions of the individual authors and should not be construed to be those of either the American Bar Association (ABA) or the ABA Health Law Section, or any other person or entity. The authors expressly reserve the right to freely advocate other positions on behalf of clients. Nothing contained herein is to be considered the rendering of legal advice for specific cases, and readers are responsible for obtaining such advice from their own legal counsel. These materials are intended for educational and informational purposes only.

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12-1

12Securities Law Issues and Disclosure Considerations for Life Sciences CompaniesMichael E. Clark*

I. Introduction .................................................................................................... 12-1A. GeneralRule:NoAffirmativeDisclosureDuties .................................. 12-5B. Exceptions ............................................................................................... 12-7C. Common Disclosure Issues Facing Life Sciences Companies in

Dealing with the FDA ............................................................................. 12-81. PredictionsofDrugApprovals,Denials,andFinancialEstimates ...... 12-92. Disclosure of Clinical Tests and Results .......................................... 12-123. DisclosuresofInspectionandEnforcementEvents ........................ 12-15

II. OverviewoftheKeyFederalStatutes ......................................................... 12-18A. The Securities Act of 1933 .................................................................... 12-19B. The Securities Exchange Act of 1934 ................................................... 12-24

III. ReportingObligationsofPubliclyTradedCompanies ................................ 12-25A. MaterialityandtheProbability-MagnitudeTest ................................... 12-25

1. Judicial Standard .............................................................................. 12-252. QuantitativeStandards ..................................................................... 12-293. QualitativeStandards ....................................................................... 12-304. OptimisticStatementsVersusSpecificPredictions ......................... 12-30

a. SoftInformationandPuffery ...................................................... 12-31b. The “Bespeaks Caution” Doctrine .............................................. 12-33c. StatutorySafeHarbors:Forward-LookingStatements ............... 12-36

5. Third-PartyStatementsandtheEntanglementDoctrine ................. 12-42B. AgencyPronouncementsaboutMateriality .......................................... 12-45

1. SECStaffAccountingBulletinNo.99—Materiality ...................... 12-452. SEC Staff Accounting Bulletin No. 100—Restructuring

and Impairment Charges .................................................................. 12-463. SECStaffAccountingBulletinNo.101—RevenueRecognition.... 12-474. SEC Rules ........................................................................................ 12-49

*SpecialCounsel,DuaneMorris,LLP,Houston,Texas.

12-2 Pharmaceutical and Medical Device Law

a. Rule 405—Promulgated Under the Securities Act ..................... 12-49b. Rule 408—Promulgated Under the Securities Act ..................... 12-49c. Rules 12b-20 and 14a-9—Promulgated Under the

Exchange Act .............................................................................. 12-50d. Rules 175 and 3b-6—Promulgated Under the Exchange Act ..... 12-50

C. SEC-MandatedPeriodicDisclosureofSpecifiedInformation ............ 12-511. RegulationS-K ................................................................................ 12-52

a. Item 10b ...................................................................................... 12-53b. Item 103 ...................................................................................... 12-53c. Item 303 ...................................................................................... 12-54d. Item 401(f) ................................................................................. 12-56e. Item 404(a) and Self-Dealing ...................................................... 12-56f. Item 503(c) .................................................................................. 12-56

2. Regulation S-X ................................................................................ 12-58a. Article 3 ...................................................................................... 12-58b. Article 10 .................................................................................... 12-58

3. Periodic Forms ................................................................................. 12-59a. Form8-K ..................................................................................... 12-59b. Form 10-Q ................................................................................... 12-60c. Form10-K ................................................................................... 12-60

4. Regulation FD .................................................................................. 12-61D. HowtoMakeDisclosures ..................................................................... 12-62

1. DutytoUpdate ................................................................................. 12-642. DutytoCorrect ................................................................................ 12-65

IV. Securities Fraud and Anti-Manipulation Rules ............................................ 12-65A. ManipulativeConduct ........................................................................... 12-66B. KeyProvisions ...................................................................................... 12-68

1. Exchange Act Section 9 ................................................................... 12-682. Exchange Act Section 10(b) ............................................................ 12-683. Exchange Act Section 14(e) ............................................................. 12-694. Securities Act Section 11 ................................................................. 12-705. Securities Act Section 12(a)(2) ........................................................ 12-716. Securities Act Section 17(a)(2) ........................................................ 12-71

C. Scienter ................................................................................................. 12-72D. TheFraud-on-the-MarketTheoryandtheFraud-Created-the-

MarketTheory ...................................................................................... 12-77E. PrimaryandSecondaryLiabilityIssues ............................................... 12-81

1. Central Bank .................................................................................... 12-822. ControlPersonLiability .................................................................. 12-833. SEC v. ZandfordandPrimaryLiabilityUnderSections

10(a) and (c) ..................................................................................... 12-87 V. Defenses to Securities Fraud Cases.............................................................. 12-89

A. Truth on the Market .............................................................................. 12-89B. LackofMateriality ............................................................................... 12-90C. Failure to Establish Essential Elements ................................................ 12-91

VI. Insider Trading ........................................................................................... 12-100A. StatutoryInsiders:Section16andtheProhibition

Against Short Swing Trading ............................................................. 12-101B. The Disclose-or-Abstain Rule ............................................................. 12-103C. DutytoDiscloseMaterialFacts .......................................................... 12-103

1. InsiderTradingofCompanySecuritiesBasedon Material Nonpublic Information .................................................... 12-104

Ch. 12.

Securities Law Issues and Disclosure Considerations 12-3

2. When Applicable Statute or Regulation Mandates Disclosure ...... 12-1053. When Prior Statement of Material Fact Becomes False

or Misleading in Light of Undisclosed Information ...................... 12-105D. TheClassicalTheoryofInsiderTradingLiability .............................. 12-105E. TheMisappropriationTheoryofInsiderTradingLiability ................ 12-106F. Differences Between the Use and Mere Possession

of Nonpublic Information ................................................................... 12-1071. TheKnowingPossessionStandard ................................................ 12-1072. The Use Test .................................................................................. 12-108

G. SECRule10b5–1andtheAffirmativeDefensefor Written Preexisting Stock Trading Plans ............................................ 12-108

VII. PrivateSuitsandthePrivateSecuritiesLitigationReformActof1995 .... 12-109A. Class Actions ........................................................................................12-114

VIII. SEC Enforcement ....................................................................................... 12-120A. AdministrativeProceedings ................................................................ 12-123B. Three-TierMonetaryPenalties ........................................................... 12-126C. AgencyCivilRemedies ...................................................................... 12-126D. Dodd-FrankActProvisions................................................................ 12-126

1. WhistleblowerProvisions .............................................................. 12-1262. AidingandAbettingLiabilityAuthorized .................................... 12-1293. Extraterritorial Reach (Limited Repeal of Morrison) ................... 12-130

IX. Criminal Violations .................................................................................... 12-130A. Securities Fraud Based on Rule 10b-5 Violations .............................. 12-133B. Insider Trading .................................................................................... 12-133C. Foreign Corrupt Practices Act ............................................................. 12-135D. Sarbanes-OxleySecuritiesFraudStatute ............................................ 12-139

X. Conclusion.................................................................................................. 12-141

I. Introduction

Thischapterexaminessomekeyriskareasunderthefederalsecuritieslawsfacingpubliclytradedpharmaceuticalcompaniesandmedicaldevicemanufac-turers.Understandingthemiscritical,asviolatingthevariousdisclosuredutiesand other mandates imposed under the federal securities laws1 can be ruinous. Breachesofthesedutiesoftengenerateparalleladministrative,civil,andevencriminal proceedings, along with significant fines, penalties, and restitutionorders.Thelifesciencesindustryencountersheightenedsecuritiesfraudliabilityforseveralreasons—itisheavilyregulated,highlyprofitable,andoneinwhichasmallfractionofnewproductswillultimatelygetapprovedforsaleandmar-keting.2Asabackgroundperspective,“[d]uringthe...1990s,issuerswere...

1Althoughstatesecuritieslawsalsoposelitigationriskstopharmaceuticalcompanies,ananalysisoftheselawsisbeyondthescopeofthischapter.Astosomeofthecostsinvolvedwiththemandateddisclosureobligations,see,e.g.,MichaelD.Guttentag,An Argument for Imposing Disclosure Requirements on Public Companies, 32 Fla. St. U. L. Rev.123,124(2004)(“Disclo-surerequirementsaretheprimarytoolthefederalgovernmentusestoregulatepubliccompanysecurities.Tocomply...,U.S.publiccompaniesproducemorethanonemillionpagesofinfor-mationeverymonth.”)(internalnotesomitted).

2SeeWilliamO.Fischer,Key Disclosure Issues for Life Sciences Companies, FDA Product Approval, Clinical Test Results, and Government Inspections, 8 Mich. Telecomm. Tech. L. Rev.

Ch. 12.I.


suedat therateofroughlyoneevery1.7tradingdays. . . .TheaverageandmedianclassactionsettlementforJanuary1991throughJune1999...[was]reportedat$8.3millionand$4.2million,respectively.”3

Despiteaseriesofproceduralreformsenactedtominimizefrivoloussecu-ritiesfraudclassactions,4notallcourtshavebeenwillingtosummarilydismisscomplaintsagainstdrugmanufacturersandmedicaldevicemanufacturersfiledbyinvestorswhoclaimtohavesufferedharmbecausematerialinformationwasnot timely or adequately disclosed—or they were misled about theirinvestment.5

For these reasons and others, pharmaceutical companies and medicaldevicemanufacturers,alongwiththosewhoworkwiththem,mustbefamiliarwiththenumerous,expandingmandatesimposedbysecuritieslaws.Thischap-tershouldhelptocomplywiththesetasks.Thefirstpartofthechapterexamineskeyfederalstatuteswithwhichpubliclytradedorlistedcompaniesmustcomply.ThenextpartfocusesonthedisclosureobligationsimposedbytheU.S.Secu-

115,116(2002)(“FDAactionscanhaveanextraordinaryinfluenceonthefortunesofbiotech-nologycompanies.TimelyFDAapprovalofadrugormedicaldevicecanpermitacompanytoexploitaninvitingmarketwindow.FDAproductapprovalis...tiedtoclinicaltestresultswhichdemonstrate‘efficacy’andsafety.Delayedapproval,unfavorabletestresults,orthedenialofanFDAapplicationmayruinacompany....[¶]Allofthismakesregulatoryeventsandclinicaltest-ingmattersofgreatconcerntoboththemanagersoflifesciencescompaniesandinvestorsinthosecompanies.Whatbiotechnologycompaniesdisclose—anddecideagainstdisclosing—aboutsucheventscaninfluencethepriceofthosecompanies’stocks.Thesedisclosuredecisions...canhaveimportant securities law implications. Inaccurate statements—and,under somecircumstances,decisions tokeep information about regulatory and testingdevelopmentswithin the companyrather than including it in apublic statement—may lead toprivate lawsuits, . . . enforcementactions,andevencriminalprosecutions.”).

3PaulA.Griffinetal.,Stock Price Response to News of Securities Fraud Litigation: Market Efficiency and the Slow Diffusion of Costly Information1(StanfordLawSchool,JohnM.OlinPrograminLawandEconomics,WorkingPaperNo.208,2000)(pagereferencesunavailableandinternalnotesomitted),available at http://papers.ssrn.com/paper.taf?abstract_id=251766.

4SeeMichaelE.Clark,A Step Forward in Recognition of Compliance Efforts: The SEC’s January 2006 Statement Concerning Financial Penalties,9(8)Health Care Compliance Let-ter,at5(2006)(“Threereformmeasureshavebeenenactedtoaddresssuchconcerns:(1)The...[PSLRA](which...imposesheightenedpleadingstandardsonclassactionplaintiffs);(2)TheSecuritiesLitigationUniformStandardsActof1998(limitingtheavailabilityofsecuritiesfraudclassactions in statecourts andmaking removal jurisdictionmandatory to the federaldistrictcourtinwhicharelatedfederalactionispending);and(3)TheClassActionFairnessActof2005(expandingfederalcourtsubjectmatterjurisdictionoverclassactionsinwhichatleastoneclassmember is diverse in citizenship from the defendant and the amount-in-controversy exceeds$5 million).”) (internal notes omitted).

5See, e.g.,MarcJ.Sonnenfeldetal.,Disclosing Product Developments to Investors, 18(4) Insightsat22,22–23(2004)(“Inanumberofsecuritiesfraudclassactionsinvolvinglifesciencescompaniesduringthepastfewyears,courtshavedeclinedtodismisscomplaints...eventhoughtheallegedlyfraudulentstatementswereaccompaniedbycautionarylanguage.Inthesecuritiesfraudclassactionarising...[from]allegedmisrepresentations...byImCloneSystems,Inc.,thecourtfoundthatwarningsaboutrisksanduncertaintiesinobtainingmarketingapproval...werenotsufficientlyspecifictoprotectthestatements...[.][T]hecompany’sdisclosuresthatitsbusinesswas‘subjecttoregulationprimarilybytheFDA,’that‘[n]oncompliancewithapplicablerequirementscanresultinrefusaltoapproveproductlicensesorotherapplications,’thatthereare‘risksanduncertaintiesassociatedwithcompletingpre-clinicalandclinicaltrials. . .’andthat‘actualresultsmaydiffermaterially’fromthosepredicteddidnotbringthestatementswithinthesafeharborprovisionsofthePSLRA.”)(internalnotesomitted;citingIrvinev.ImCloneSystems,Inc.,Nos.02Civ.109RO,7499RO,2003WL21297285,at*1(S.D.N.Y.June4,2003)).

Ch. 12.I.


ritiesandExchangeCommission(SEC)andcourtsonreportingissuers,6 along withtheadministrative,judicial,andstatutorystandardsusedfordeterminingthe adequacy of disclosures by publicly traded companies.Attention is thengiventothesecuritiesrulesandthedifferenttheoriesofsecuritiesfraudliabilitythathavebeendevelopedincaselaw.Thisdiscussionisfollowedbyananalysisofkeydefensesthatmaybeavailabletocompaniesandindividualsinsecuritiesfraudcases,coupledwithanexaminationoftheinsidertradingtheoriesandtherulesandstandardsappliedinsuchcases.Beforeturningtoenforcementissues,attentionisgiventoprivatelitigationrisksandconsiderationsbecauseprivateactionsconstituteasignificantriskareaforpharmaceuticalcompaniesandmed-ical device manufacturers, and are often filed in tandem with governmentenforcementactions.ThechapterconcludesbyexaminingSECandcriminalenforcement issues.

TheU.S.SupremeCourthasbeenactiveinevaluatingsecuritieslawissuesinrecentterms.Privatesecuritiesfraudclassactionsandgovernmentsecuritiesenforcementproceedingsagainstpharmaceuticalcompaniesandmedicaldevicemanufacturershavecontinuedtobevigorous,whileclassactionscontinuetoplaguepharmaceuticalcompaniesandmedicaldevicemanufacturers.Togiveaperspective:

A significant proportion of large pharmaceutical companies in theS&P500 in2009—15outof22,or68percent—havefacedatleastoneclassactionbetween2002and2009,comparedwith31percentforS&P500companiesoverall.Further-more,medianlossesinshareholdervalueforclassactionsagainstpharmaceuticalcompaniesweretypicallylargerthanthemedianlossesforclassactionsagainstother companies during this period.7

A. General Rule: No Affirmative Disclosure Duties

Asexplainedelsewhere,“[o]ursecuritieslawsaredesignedtoeffectivelyregulatepubliclytradedentitiesthrougha‘cradletograve’approach...inthreebroadways:(1)bydisclosureduties,(2)byrestrictionsonfraudandmanipula-tion, and (3) by restrictions on insider trading.”8 Despite these broad rules,

6Sections 13(a) and 15(d) of the Securities Exchange Act of 1934 (Exchange Act) require thatissuersofsecuritiesregisteredunderSection12oftheActprovidespecificinformationintheformatrequiredbySECrulesorregulations,suchasannualandquarterlyreports.Section13oftheExchangeActiscodifiedat15U.S.C.§78m.UnderSection15(d)oftheExchangeAct,thedutytofileisautomaticallysuspendedforanyfiscalyear(otherthanthefirstyeartheregistrationbecameeffective)if,atthebeginningofthatyear,thesecuritiesofeachclasstowhichtheregis-trationstatementrelatesareheldbylessthan300personsofrecord.

7CornerstoneResearch,Pharmaceuticals Industry Securities Class Actions(May14,2010).See alsoGibsonDunn,2010 Year-End Securities Litigation Update(Jan.11,2011)(“[T]hepaceofsecuritiesclassactionfilings...declinedsteadilyfrom2008throughthefirsthalfofthisyear.Inthesecondhalfof2010,however,NERAEconomicConsulting...report[s]thatfilingshavepickedupsignificantlyandthatthenumberoffilingsthisyearisontracktoexceedlastyear’stotal.[¶]...[T]herehavebeen123filingsinthefivemonthsfromJuly1throughNovember30,2010,whichalreadyexceedsthe101filingsfromJanuary1throughJune30,2010.Inall,NERAprojects239filingsin2010...anincreasefromlastyear’s220filings.”),available at http://www.gibsondunn.com/publications/pages/2010Year-EndSecuritiesLitigationUpdate.aspx.

8MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.01(internalnotesomitted).

Ch. 12.I.A.


publicly traded companies generally can remain silent without violating thefederal securities laws as long astheydonotthenhaveamandatorydisclosureobligation.RespondingtotheSEC’speriodicreportinganddisclosurerequire-mentsissomewhatliketakingasnapshotofinformationataspecifictime,asopposed to taking time-lapse photographs and reporting about changes that occurredoveraperiodoftime.

Toillustratetheseprinciples,considerthecaseofGallagher v. Abbott Lab-oratories,9inwhichtheSeventhCircuitdiscussedanissuingcompany’sdisclo-sure obligation under the securities laws in rejecting the claim that apharmaceuticalmanufacturer had a duty to correct its previously filed Form10-K.Asthecourtexplained,thefederalsecuritieslawscontemplatethatissu-ers10 will make periodic (but not continuous) disclosures of information.11 See also In re Alliance Pharmaceutical Corp. Securities Litigation,12 in which a post-PrivateSecuritiesLitigationReformAct(PSLRA)13 class action securities fraudcasewasdismissedafterthejudgefoundthatthepharmaceuticalmanu-facturerwasundernodutytodisclosebadnewsaboutthetestingofatemporaryblood substitute,as of the date of a registration statement after amergerbyAlliance Pharmaceutical with another manufacturer.14

Althoughtherewasconsiderabledebateforyearsabouthowmuchinfor-mationpubliclytradedcompaniesarerequiredtodisclose(alongwithwhen and howtheirdisclosuresshouldbemade),15Sarbanes-Oxley’senactmentin2002

9269 F.3d 806 (7th Cir. 2001).10Theterm“issuer”inthischapterfollowsthemeaninggiventoitbyRegulationFD—i.e.,

anissuerisacompanythathasaclassofsecuritiesregisteredunderSection12oftheExchangeActorisrequiredtofilereportsunderSection15(d)oftheExchangeAct.See17C.F.R.§243.101.

11See Gallagher,269F.3dat809(“Section13[oftheExchangeAct]andtheimplementingregulationscontemplatethatthesereportswillbesnapshotsofthecorporation’sstatusonornearthefilingdate,with updates due not when something ‘material’ happens, but on the next prescribed filing date....Regulationsimplementing§13requireacomprehensiveannualfiling,theForm10-Kreport,andlessextensivequarterlysupplementsonForm10-Q.Thesupplementsneednotbringuptodateeverythingcontainedintheannual10-Kreport....”)(emphasisadded).

12279F.Supp.2d171(S.D.N.Y.2003).13Pub.L.No.104-67,109Stat.737(1995)(codifiedinscatteredsectionsoftitle15ofthe

U.S.Code).AlthoughthePSLRA’simportanceanditsimpactuponprivatesecuritiesfraudcasesareaddressedindetailinSectionVII., thelegislationgenerallyincreasedtheburdensonclassactionplaintiffsbyrequiringthatfraudandscienterallegationsbepleadedwithgreatparticularityandbylettingdefendantsobtainadiscoverystaypendingasummaryjudgmentdetermination.

14Alliance Pharm.,279F.Supp.2dat189 (“There isnogeneralduty toprovide ‘statusreports’regardingongoingactivities . . . . [T]heProspectuscontainednostatementsregardingthepreliminaryresultsorprogressoftheUnitedStatescardiacclinicaltrial,andnopredictionsthatthepositiveresultsoftheEuropeanclinicaltrialwouldberepeated.***[¶]AllitsaysisthatOxygentiscurrentlybeingevaluated....”).

15SeeZoharGoshen&GideonParchomovsky,The Essential Role of Securities Regulation 38–39 (Columbia Law and Economics,Working Paper No. 259, 2004) (“Probably the mostdebatedissueinsecuritiesregulationiswhetherdisclosuredutiesshouldbemandatory.Oppo-nents. . .arguethatthemarketgivescorporationssufficientincentivestodiscloseallmaterialinformation;otherwise,investorswill‘assumetheworst’anddiscountthevalueoftheirsecurities.Mandatorydisclosure,theyargue,iscostlyanduselessbecausemarketsareefficient.”)(internalnotes omitted). See alsoMichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace, 2006 Health Law&Compliance Update§5.01(“TheSEChasdevelopedex ante rulesandregulationsthatapplytocompaniesseekingtobecomepubliclytraded...[which]addressthetypeandthecontentofmaterialsthatmustbeincludedincompanies’offeringmaterials.Forcompaniesthatarealready

Ch. 12.I.A.


largelymootedthisdebatebyincreasingtheamountofinformationthatissuersmustpubliclydiscloseandrequiringthattheybemadeinagreatlycompressedtimeframe.16

B. Exceptions

Depending on the facts, various important exceptions may modify thegeneralrulethatissuersneednotmakedisclosuresunlessanduntiltheyhaveamandatory reporting obligation. Familiarity with these exceptions is criticalbecauseifoneappliesthenpharmaceuticalcompaniesandmedicaldeviceman-ufacturers may have an affirmative reporting obligation imposed on them.Arguably themost important exception to the general rule concerns insidertradingliability.Generally,inordertoavoidbeingheldliableincivilproceed-ings,insidersordinarilymustdisclose or abstain from trading in their compa-nies’securities.17Thisisbecausetheyarepresumedtohaveanunfairadvantage(theso-called“parityofinformation”concern)18overtheinvestingpublic.(Still,the disclose-or-abstain rule has been tempered somewhat by case decisionsholdingthatnotallinternalinformationwilltriggerthisduty;rather,onlymate-rial information must be disclosed before a corporate insider trades in the secu-

publiclytraded,theSEChaspromulgatedcorrespondingex postrulesandregulationsthatgovernthe contentofinformationthatmustbedisclosed,when itmustbedisclosed,andtherequired formatfordisclosure.”)(internalnotesomitted,citingDonaldC.Langevoort,Agency Law Inside the Corporation: Problems of Candor and Knowledge,71U.Cin. L. Rev.1187,1197(2003);Gos-hen&Parchomovsky,at6–7);andRobertH.Rosenblum,An Issuer’s Duty Under Rule 10b-5 to Correct and Update Materially Misleading Statements, 40 Cath. U. L. Rev.289,297–98(1991)).

16See,e.g.,MichaelE.Clark,Compliance and Governance Issues and Trends After Sar-banes-Oxley,2005Health Law&Compliance Update§1.06n.90(“Thetimeframeformak[ing]adisclosureofmaterialinformationwasgreatlyreduced...pursuanttoSarbanes-Oxleyinthenew8-Krules.See alsoDixieL.Johnson,From the Chair, 9(1) Securities Rep. (ABA Sec. of Bus.LawComm.onFed.Reg.ofSec.),Spring2004,at1)(“Withthe...newForm8-Krules,theSEChasaddressedtherequirementoftheSarbanes-OxleyAct...thatissuersdisclose,‘onarapidandcurrentbasis,’materialinformationabouttheissuer’sfinancialconditionoroperationsthattheSECdeemsnecessarytoprotectinvestorsandthepublicinterest.BeginningAugust23,2004,mostpubliccompaniesmustdisclose,within four business days,variousitemsthat‘unquestionablyorpresumptivelyhavesuchsignificancethatcurrentdisclosureshouldberequired....’”).

17SeeSECv.TexasGulfSulphurCo.,401F.2d833,848(2dCir.1968) (enbanc),cert. denied sub nom. Coatesv.SEC,394U.S.976(1969)(abrogated as stated inPfeifferv.Toll,989A.2d683,705(Del.Ch.2010))(“Theessenceof...[Rule10b-5]isthatanyonewho,tradingforhis own account in the securities of a corporation has ‘access . . . to information intended to be availableonlyforacorporatepurposeandnotforthepersonalbenefitofanyone’maynottake‘advantageofsuchinformationknowingitisunavailabletothosewithwhomheisdealing,’i.e.,theinvestingpublic.In reCady,Roberts&Co.,40SEC907,912(1961).Insiders...are...pre-cludedfromsounfairlydealing,buttheRuleisalsoapplicabletoonepossessingtheinformationwhomaynotbestrictlytermedan‘insider’withinthemeaningofSec.16(b)oftheAct.Cady, Roberts,supra.Thus,anyone in possession of material inside information must either disclose it totheinvestingpublic,or . . . abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.”) (emphasis added).

18Clark,2006Health Lawand Compliance Update§5.01(internalnotesomitted,citingTowerC.Snow,Jr.,etal.,Defending Securities Class Actions,Securities Litigation: Planningand Strategies forthe’90sand Beyond,Vol. II (ALI-ABASH083,1996),andDonaldC.Langevoort&C.MituGulati,The Muddled Duty to Disclose Under Rule 10b-5,57Vand. L. Rev. 1639,1643–44(2004)).

Ch. 12.I.B.


ritiesof thesubjectcompany.19)Moreover, thenatureof theunderlyingdutymustbecloselyconsideredwhenanalyzingdisclosuredutiesandpossiblevio-lations,becausesecuritiesfraudliabilitydoesnotresultsolelyfromabreachofduties;instead,somefraudordeceptionmustalsobeinvolved.20

C. Common Disclosure Issues Facing Life Sciences Companies in Dealing with the FDA

Corporateexecutives’reluctancetodisclosebadinformationuntilnootherchoicesremainisunderstandable;21officersandexecutivesofpharmaceuticalmanufacturersandmedicaldevicecompaniesarenodifferent.Yet,comparedtoother issuers, pharmaceutical manufacturers and medical device companiesoftenfaceincreasedsecuritiesfraudrisksfortheiractionsornonactions,basedonvariousfactors,suchas:

1. Howtheydiscloseinformationabouttheprogressofclinicaltestingandevaluation;

2. Whethertheydisclosematerialinformationtooearly22ortoolate;23

19See id. See alsoLangevoort&Gulati,at1643–44(“Twocentralandrequiredelementsinanysecuritiesfraudcasearematerialityandduty....Materiality refers to . . .whether . . . infor-mationwouldlikelybeimportanttothereasonableinvestor.Duty . . . refers to whether there is anobligationtodisclose...[.][T]heformerisusuallyafactualquestionandthelattera[legal]question[.][M]anyfacts(suchaspreliminarymergernegotiations)...canfallwithinthedefini-tionofmaterialityyetdonothavetobedisclosed.”)(emphasisaddedandinternalnotesomitted).Insider trading is explained in more detail in Section VI.

20SeeClark,2006Health Lawand Compliance Updateat§5.01(“Abreachoffiduciarydutiesaloneisinsufficienttoestablishfraudliabilityunderthefederalsecuritieslaws[.][It]mustbecoupledwithfraudordeceptiontobeactionableassecuritiesfraud.”)(internalnotesomitted,citingDonald C. Langevoort,Agency Law Inside the Corporation: Problems of Candor and Knowledge,71U.Cin. L. Rev.1187,1197(2003);Goshen&Parchomovsky,The Essential Role of Securities Regulation6–7;Rosenblum,40Cath. U. L. Rev. at 297–98.

21SeeClark,2006Health Lawand Compliance Updateat§5.04(“If...companyofficialsbelievethatabusinesssetbackisanaberrationthatwillsoonbecorrected,theymayworrythat...report[ing]thenegativenews...maybeharmfultothecompanyanditsshareholders.Ontheotherhand,becausetoooftenhopespringseternal,theSECworriesthatwithouthard-and-fastrules[whichinstruct]...whencompaniesmustreportcertainmajorevents,thereisasignificantdangerthatunrealisticbeliefsheldbycompanyofficersanddirectors...mayleadtoincreasedharmtotheinvestingpublicandshareholders.”)(internalcitationsomitted).See also Donald C. Langevoort,Organized Illusions: A Behavioral Theory of Why Corporations Mislead Stock Mar-ket Investors (and Cause Other Social Harms), 146 U. Pa. L. Rev.101,117(1997)(“Unlesstheproblemsarealreadycommonknowledgeamongemployees,therecouldbeaslippageininternalmotivationandmorale.Inotherwords, thedisclosurecouldbecomeaself-fulfillingprophecy,doomingwhateverremainingchancesofsuccesstheproject[hasofsucceeding].”).

22SeeHowardL.Dorfman&Linda PissotReig,Avoiding Legal and Ethical Pitfalls of Industry Sponsored Research: The Co-Existence of Research, Scholarship, and Marketing in the Pharmaceutical Industry,59Food&DrugL.J.595,596(2004)(“[W]hatarethelegalandethicalstandardstoapplyto...reportingtheresultsofclinicalresearch?Ifinformation...isdisseminated...tooearly...,argumentscanberaisedthatcompaniesareengaginginoff-labelpromotion....Butifpreliminaryinformationisnotmadewidelyavailable,manufacturerscanbeaccusedofselectivedissemination.”).

23See, e.g.,AlanN.Salpeter&HarleyHutchins,Recent Developments Help the Defense of Drug Companies in 10b-5 Cases, 51 Food&DrugL.J.345,345(1996)(“Drugcompanieshaveanunusualproblemwhenfacedwithasecuritiesfraudaction.Theymustexplainwhyallbad

Ch. 12.I.B.


3. Whethertheymakeinadequatedisclosures;24

4. Whethertheyprovidemisleadingdisclosures;25 or5. Whethertheymakeanydisclosuresatall.

Atbottom,thetimingandmannerbywhichlifesciencescompaniespubliclydisseminate disclosures of information to the public are critically importantconsiderations.

1. Predictions of Drug Approvals, Denials, and Financial EstimatesAsnoted,thenatureofthelifesciencesindustryoftenmeansthatdrugand

devicemanufacturersmustcarefullyweighvarious risksunder the securitieslaws—including whether and how to make predictions about their experimental newdrugsanddevices,alongwithwhetherandwhentodisclosethattheFoodandDrugAdministration(FDA)willapproveorrefusetoapprovetheirproductsforsaleandmarketing.Closelyrelatedistheissueofwhetherandwhentheymustprovidecorrective informationaboutpriordisclosuresthat,althoughaccu-ratewhentheyweremade,may,havebecomemisleadingorinaccuratebecauseofinterveningdevelopmentsnotyetknownbythepublic.

Inrecentyears,federalcourtshavetackledmanyoftheseissues.Reviewingthe facts and rationales of some reported decisions helps to better understand andpredictthelikelyconsequencesofcertainactions(orinactions)bypharma-ceuticalcompaniesandmedicaldevicemanufacturers.Keepinmindthatjustbecauseamanufacturer’spredictionaboutsecuringFDAapproval later turnsouttobeinaccuratewillnot,byitself,provideasufficientbasisforimposing

news about their products was not discloseable. . . . All drugs cause side effects. Side effects are [regularly]reportedtothecompanyand...the...FDA...beforeandafteradruggoestomarket.Anyreportofanadversereaction...,ifviewedinavacuum,couldberegardedasnegativenewsthatshouldhavebeenpubliclydisclosed.”)(internalnoteomitted).

24See,e.g.,In reGuidantCorp.SecuritiesLitig.,MasterFileNo.1:03-CV-0892-SEB-WTL,2004WL2538374at*11(S.D.Ind.Nov.8,2004)(unreported)(dismissingasecuritiesfraudclassactionfiledagainstamedicaldevicemanufacturer)(“Tosustainasecuritiesfraudaction,Plaintiffsmustallegefactsindicatingthat...DefendantswereunderadutytodisclosetheAncure-relatedFDAregulationcomplianceproblems.[A]corporationdoesnothaveanindependentdutytodis-closeall...newsthatmayinfluenceitsstockprice.Adutytodisclosureiscreatedwhenadditionalinformationisnecessarytorectify‘incompletedisclosures’or‘half-truths.’Plaintiffshavefailedto indicate the manner in which news releases about the results of clinical studies or statements ofpufferyinvokeadutytodiscloseFDAcomplianceproblems....Plaintiffs’selectionsfromthecitednewsreleasesarenot‘incompletedisclosures’or‘half-truths’ofthattypethatrequireadditionalinformationtoclarifythem.”).

25See,e.g.,Walsinghamv.BiocontrolTech.,Inc.,66F.Supp.2d669,676–77(W.D.Pa.1998)(refusingtodismissaclassactionsecuritiesfraudcomplaintagainstamedicaldevicemanu-facturerformakingfalseandmisleadingrepresentationsaboutthelikelihoodofFDAapprovalforamedicaldevicethatwasthecompany’sonlyviableproduct,andformakingomissionsaboutitstesting)(“[D]efendantstaketheapproachofdissectingseveralindividualallegedmisrepresenta-tionsinthecomplaintandarguingtheliteraltruthofeach.InthecontextofaSection10(b)action,. . . we must consider . . . the allegations . . . in the aggregate. The plaintiff alleges . . . the defendants issuedmisleadingpress releases touting theDiasensor1000’seffectivenessandreliabilityandprojectingitsimminentapprovalbytheFDAeventhoughBICO’sowntestingrevealedthattheDiasensor1000wasneither[sic]effective,reliable,normarketable....Thus,althoughseveralofthestatementsmaynothavebeenliterallyfalsewhenconsideredinavacuum,theycouldbemisleading when considered in context of the alleged omissions.”) (internal note omitted).

Ch. 12.I.C.1.


securitiesfraudliability.Instead,asecuritiesfraudplaintiffmustdemonstratethattheunderlyingstatementwasfalsewhenitwasmadeorthatnogoodfaith,objectivebasisexistedformakingthestatementatthetimeitwasmade.26

In re Medimmune, Inc. Securities Litigation27 illustrates when a pharma-ceuticalmanufacturer’spredictionsofFDAapprovalofanewdrugapplication(NDA)mayconstitutesecuritiesfraud.InMedimmune,adistrictcourtpartiallydismissedapre-PrivateSecuritiesLitigationReformActsecuritiesfraudclassactioncomplaintinsummaryjudgment.TheMedimmune plaintiffs had alleged thatthepharmaceuticalmanufacturerartificiallyinflateditsstockpricebydis-seminatingfalseandmisleadingstatementsaboutitsexperimentaldrug,Respi-vir. Specifically, they alleged that investors were misled into believing thatRespivirwassafeandeffective,andwouldsoonbeFDA-approved,whenthecompanyknewotherwise—asdemonstratedbycorrespondencewiththeFDA(whichhadexpressedconcernsaboutdatasuppliedbyMedimmune).Nonethe-less,despitethesetroublingallegations,thecourtwasnotpersuadedthatthisconduct constituted securities fraud because the manufacturer had providedadequate warnings about the inherent risks in the regulatory drug approvalprocess.28

Inanotherdecision,theplaintiffsinIn re Cryomedical Sciences, Inc. Secu-rities Litigation29pursuedadifferentapproachagainstamedicaldevicemanu-facturer.TheycontendedthatCryomedicalScienceshaddisseminatedfalseandmisleadingstatementsinpressreleasesandForm10-Ksaboutaproductdevel-oped forcryogenic surgeryofprostatecancerpatientsandhadpromoted thedeviceforanoff-label treatmentwithoutrevealingtheFDA’sconcernsaboutimpropermarketingofthedevice.Thetrialcourtwasnotconvinced,anddis-missedthecomplaintafterfindingthattheseallegationswerelittlemorethan“fraud-by-hindsight,”notingthattheimpropermarketinghadlittletodowithsecurities fraud concerns.30

26See, e.g.,WilliamO.Fischer,Key Disclosure Issues for Life Sciences Companies, FDA Product Approval, Clinical Test Results, and Government Inspections, 8 Mich. Telecomm. Tech. L. Rev.115,118(2002)(“Acompanymustmakea‘false’statement...tobeliableunderthesecuritieslaws.Themerecircumstancesthat...[it]predictstheFDAwillapproveagivenprod-uctbyastateddate,andthatdatepasseswithoutanysuchapproval,donotcombinetomakethepredictionnecessarily‘false.’Apredictionisnot‘false’underthesecuritieslawssimplybecauseitdoesnotcometrue...orbecauseinhindsightadifferentpredictionwouldhavebeenamorereasonableforecast.Courtsfindaprediction‘false’if...[when]thecompanymadethepredictiontherewasnogoodfaith,reasonable,objectivebasisforit,or(undersometests)ifthosemakingaforecastknewsomeundisclosedfactthatseriouslythreatenedthepredictedevent.”)(internalcitations omitted).

27873 F. Supp. 953 (D. Md. 1995).28Id.at964–65(Although“itistruethata‘guarantee’ofapprovalofaproductbyafederal

agencymightbeactionable... thekeywordis‘guarantee.’Mereexpressionsofhopeorexpecta-tionregardingfutureapproval...arenotactionable....[H]ere,virtuallyeveryreferencemade...toFDAapprovalwashedgedbyvariationsoftheproviso‘ifandwhenapprovedbyFDA’....SincePlaintiffshavefailedtopleadfactsthatevenremotelysuggestDefendantswereguarantee-ingapprovalofRespivirbytheFDA...theirclaimisinsufficientlypledandwillbedismissed.”).

29884 F. Supp. 1001 (D. Md. 1995).30Id.at1020–21(“Plaintiffs...contendthatCryomedicalknewin1993thatits510(k)for

theUrethralWarmerwouldnotbeapprovedand...didnotdivulgethis...until1994.Theyrelyonpressreleases...subsequentlyissued[in]...1994toimplythatDefendantsknew...

Ch. 12.I.C.1.


Defendantsinsuchsuitsarenotalwayssofortunate.Forexample,inIn re Biogen Securities Litigation,31 the court refused to dismiss a securities fraud classactionafterfindingthatmaterialfactissuesremainedaboutwhetherBio-gen had made fraudulent statements about its blood thinning drug and therefore hadadutytocorrectthem.32AvariantofthisissueisseeninPadnes v. Scios Nova, Inc.,33 an unreported decision about a securities fraud class action. The Padnesplaintiffscomplainedabouttheinadequacyofmethodsthatthepharma-ceutical company used in developing a drug for which FDA approval wassought.Specifically,theycomplainedthattheinvestigationalnewdrug’sPhase2protocolwasnotdouble-blinded.Eveniftheseallegationsweretrue,thecourtexplained,thiswouldnotprovethatfraudwascommittedbecause“[t]hesecu-rities lawsdonot . . . require[] thatcompanies reportonly informationfromoptimalstudies...[n]or...[dothey]requirethatcompanieswhoreportinfor-mation from imperfect studies include exhaustive disclosures of proceduresused,includingalternatives. . .notutilizedand. . .opinions. . .[about]theeffects of these choices on the interpretation of the outcome data.”34

Another interesting decision to note is In re PLC Systems, Inc. Securities Litigation,35whereasimilarchallengewaspartiallyrejectedinasecuritiesfraudclassactionagainstamedicaldevicemanufacturer.TheplaintiffscontendedthatPLCSystems,whichmanufacturedalasertobeusedasanalternativetoangio-plastyandcoronarybypasssurgery,36 had misrepresented the clinical and regu-latoryprogressof theheart laser inviolationofSections10(b)and20of theExchange Act and Rule 10b-5 promulgated thereunder.37 Although FDA person-nelhadinitiallyrecommendedagainstapprovingthedeviceoverconcernsaboutdatasuppliedbyPLCSystems,theysubsequentlyvotedtoapproveitformar-keting.38Inanalyzingtheclaims,thecourtwrote:

Exactlywhatisbeingallegedasfraudisdifficulttodiscern.The securities laws do not impose a duty to conduct ‘good science,’althoughhere,thereisnothinginthepleadingsotherthanplaintiffs’opiniontosuggestthatPLCshouldhavedesignedabetterclinicaltrial...orthatthedatagenerated...werefundamentallyunsoundorinaccuratelyreported.39

thattheFDAwouldnotgrantpremarketapprovalfortheAccuProbe.Thisisfraudbyhindsight...andisnotactionableunderthesecuritieslaws.[¶]...[I]n1993theFDAmerelyrequestedadditionalinformation....EvenifCryomedicalhadsuspicions,thesecuritieslawsdonotrequirethe disclosure of suspicions.”).

31179 F.R.D. 25 (D. Mass. 1997).32Id.at34(“Aspeakeralsohasa‘dutytocorrect’misinformationwhenadisclosureis...

misleadingwhenmade....TheFirstCircuitCourt...hasrejectedadutyto‘correct’anoptimis-ticreportwithnegativeinformationacquiredaftertheissuanceofthereportsolongastheinitialreportwas‘preciselycorrect’whenissuedandremainedsothereafter. . . .”)(internalcitationsomitted).

331996WL539711(N.D.Cal.Sept.18,1996).34Id. at *5 (internal citation omitted).3541 F. Supp. 2d 106 (D. Mass. 1999).36Id. at 107–08.37Id.38Id. at 114.39Id. at 121 (internal citation omitted and emphasis added).

Ch. 12.I.C.1.


2. Disclosure of Clinical Tests and ResultsAstheprecedingcasesdemonstrate,securitiesfraudcasesoftengetfiled

onceapharmaceuticalproductormedicaldevicefailstosecureitsanticipatedapproval or if the approval comes later than predicted.Under these circum-stances,courtstrytodistinguishbetweenstatementsmadebyacompanyingoodfaithandthosemadeinbadfaith(orthatwereobjectivelyunreasonablewhentheyweremade).Theoutcomeoftenhingesonthemagnitude and the materiality oftheFDA’sexpressedconcernsandwhethertheissuer’ssubsequentdisclosures(orlackofdisclosures)wereobjectivelyreasonableinlightofitsknowledge.40

AvariationonthepreviouslydescribedfactpatternswaspresentedinIn re Bayer AG Securities Litigation,41anunreporteddecisioninvolvingapartiallydismissed securities fraud class action complaint. The plaintiffs claimed that Bayermadematerialmisstatementsandomissionsaboutthesafetyandcom-mercial viability of its cholesterol-lowering drug that later was voluntarilyrecalled.42Bayer responded that it hadnoduty todisclose the adverse eventreportsaboutitsdrug,relyingoncasesholdingthatrandomadversereportsdonot constitute material information that must be disclosed.43 The court found Bayer’sargumenttobeunconvincing,explainingthatitscaseauthoritydidnotholdthat“adverseeventreportsarealways immaterial.”44Rather,suchreports

40WilliamO.Fischer,Key Disclosure Issues for Life Sciences Companies, FDA Product Approval, Clinical Test Results, and Government Inspections, 8 Mich. Telecomm. Tech. L. Rev. 115,172(2002)(“WhentheFDAprovidesaprivate,negativecommenttoacompanywhichthenmakesapositivepublicstatementaboutitsclinicaltests,thesignificanceoftheFDAcommentgoesmostlytotheprobabilitythatthetestswillleadtoFDAapprovalandthespeed...thatmighthappen.Ifthenegativeview...takestheformofaninquiry,itmaynotbematerial...evenif...[it]impliesstaffconcernaboutthetests,providedthatthecompany’sviewthatthecriticismisunwarrantedfallswithintherangeofscientificreasonableness.ThisistheMedImmunemessage,temperedbythecautionthatalifesciencescompanyshouldbecareful...aboutimplyingthattheFDAdoesormustagree.Ifthecompanyhasalreadypublishedtheharddata...andifthesecuritiesmarketislikelytoknowhowtheFDAviewssuchdata(asinBiogen),thentheFDA’scomment itselfadds little to themarket’scalculationof licenseprobabilityandtiming.In thatevent,theFDAcommunicationshouldbeimmaterial.”)(internalcitationsomitted).

41No.03Civ.1546(WHP),2004WL2190357(S.D.N.Y.Sept.30,2004).42“Plaintiffs allege that three general categories of statements . . . were misleading: state-

mentsregarding...[thedrug’s]safetyandapproval...;statements...[aboutits]commercialpotential;andannouncementsaboutBayer’soverallfinancialperformance.”Id at *8.

43See id. at *8–*10 (“Defendants contend that theywere under no duty to disclose theadverseeventreports...becausetheSecondCircuithasheldthatsuchreportsdonotprovidereliable information that a drug is unsafe. See In reCarter-Wallace,Inc.Sec.Litig.,150F.3d153(2dCir.1998)[abrogated in part as stated in In reSanofi-AventisSecs.Litig.,774F.Supp.2d549,563(S.D.N.Y.2011)];(In reCarter-WallaceSec.Litig.),220F.3d36(2dCir.2000)....[]TheCarter-Wallacecasesinvolvedsecuritiesfraudclaimsagainstadrugmanufacturerforallegedmisstatementsaboutthesafetyofitsepilepsydrug....TheSecondCircuitconcludedthatthedrugmanufacturer’sassurancesaboutsafety‘did not become materially misleading until [it] had information . . . [the drug] had caused a statistically significant number of aplastic-anemia deaths and therefore had reason to believe that the commercial viability of Felbatol was threatened.’...Asaresult,the...manufacturerhadnodutyunderSection10(b)todisclosetheFelbatol-relateddeathsbeforeitwithdrewthedrug....[¶]Similarly,theThirdCircuithasheldthatadrugman-ufacturer’sfailuretodiscloseadverseeventreportsdoesnotgiverisetoasecuritiesfraudclaim.Oranv.Stafford,226F.3d275(3dCir.2000)[criticized by Nathensonv.ZonagenInc.,267F.3d400,415(5thCir.Tex.2001)].

44Id. at *11–*12 (emphasis added).

Ch. 12.I.C.2.


mustbeevaluatedinlightofknownfactstodeterminewhethertheyarematerialandtriggeradisclosureresponsibility.45Under thefacts,Bayerhadaduty toupdate its statements about anticipating a strong potential for sustained growth from theproductbecause ithadvoluntarily recalled thecholesterol-loweringdrug.46

Pharmaceuticalcompaniesalsomayviolatethefederalsecuritieslawsbynottimelyandadequatelydisclosingrequiredpostapproval surveillance infor-mation about fast track drug products.47TheFDAcanwithdrawitsapprovalofdrugsthatobtainedfasttrackapprovalifthemanufacturerfailstoconductdili-gentlytherequiredpostapprovalstudyofthedrug.48InaJune2005report,the

45Id.46Id.47Title21U.S.C.§356(“Fasttrackproducts”)provides,inrelevantpart:

(a) Designation of drug as fast track product(1) In generalTheSecretaryshall,attherequestofthesponsorofanewdrug,facilitatethedevelop-

mentandexpeditethereviewofsuchdrugifitisintendedforthetreatmentofaseriousorlife-threatening condition and it demonstrates the potential to address unmet medical needs forsuchacondition.(Inthissection,suchadrugisreferredtoasa“fasttrackproduct”.)...(b)Approvalofapplicationforfasttrackproduct...(2) LimitationApprovalofafasttrackproductunderthissubsectionmaybesubjecttotherequirements—(A)thatthesponsorconductappropriatepost-approvalstudiestovalidatethesurrogate

endpointorotherwiseconfirmtheeffectontheclinicalendpoint;and(B) that the sponsor submit copies of all promotional materials related to the fast track

productduringthepreapprovalreviewperiodand,followingapprovalandforsuchperiodthereafterastheSecretarydeterminestobeappropriate,atleast30dayspriortodissemi-nation of the materials.(3)ExpeditedwithdrawalofapprovalTheSecretarymaywithdrawapprovalofafasttrackproductusingexpeditedproce-

dures . . . if—(A)thesponsorfailstoconductanyrequiredpost-approvalstudyofthefasttrackdrug

withduediligence;(B)apost-approvalstudyofthefasttrackproductfailstoverifyclinicalbenefitof

theproduct;(C)otherevidencedemonstratesthatthefasttrackproductisnotsafeoreffectiveunder

theconditionsofuse;or(D) the sponsor disseminates false or misleading promotional materials with respect

to the product. 48See 21 U.S.C. §356 (2004).As the FDA’s Center for Drug Evaluation and Research

(CDER)explained,“Section130(a)ofTitleIoftheFoodandDrugAdministrationModernizationActof1997...addedsection506B(ReportsofPostmarketingStudies)totheFederalFood,Drug,and CosmeticAct.” CDER, Postmarketing Study Commitments FrequentlyAsked Questions(FAQ),available at http://www.fda.gov/cder/pmc/pmcfaq.htm.This provision, codified at (21U.S.C.§356b),“requiressponsorstoreporttoFDAannuallyontheprogressofpostmarketing study commitments.” Id.Thepostmarketingstudyresultsareusedto“gatheradditionalinforma-tionaboutaproduct’ssafety,efficacy,oroptimaluse.”Id.

Title21oftheUnitedStatesCode,Section356bprovides,inrelevantpart:(a) Submission(1) In generalAsponsor...thathasenteredintoanagreement...toconductapostmarketingstudy

ofadrugshallsubmittotheSecretary,within1yearaftertheapprovalofsuchdrugandannuallythereafteruntilthestudyiscompletedorterminated,areportoftheprogressofthestudyorthereasonsfor...[not]conduct[ing]thestudy....

Ch. 12.I.C.2.


HouseEnergyandCommerceCommitteecritiquedtheFDA’sandtheSEC’sinadequateresponsestothefailuresbydrugmanufacturerstotimelyfilerequiredreportsaboutdrugsapprovedonanacceleratedbasis.49 The report noted that 25 ofthe28pharmaceuticalcompaniesthathadreceivedacceleratedapprovalfordrugproductsconditioneduponconductingpostmarketingstudieswerepubliclytradedandthereforehadtocomplywiththeSEC’sdisclosurerequirements.50 Yet,ofthe25pharmaceuticalcompanies,“68[percent]...ha[d]notdisclosedanyoftheirpost-marketingstudycommitmentstotheirshareholdersinthefil-ings with the SEC.”51Badasthatmaysound,theSECexplainedthat,forpur-posesofestablishing securities fraud liability,otherconsiderationshad tobemade before concluding that the unreported information was material and should havebeendisclosedtoinvestors.52

Thenatureoftheindustryalsoofferslimitedopportunitiesforthepublicto learnabout theprogress(orsetbacks)of investigationaldrugsanddevicesfrommanufacturersintheirperiodicSECfilings.Significantly,theFDAwillnotdiscloseinformationaboutthestatusofinvestigationalnewdrugapplications(INDs)andNDAs,orinvestigationaldeviceexemptions(IDEs)untilafter a drug ordevicehasbeenapproved:

Generally,theFDA’sapproachtodatadisclosurehasbeenthatnopublicdisclosureofinformationwilltakeplaceuntil...adrugisapproved.[21C.F.R.§314.430(b)–(d)]Indeed,theagencywillnotevenacknowledgethatanINDoranNDAhasbeenfiled,althoughcompaniesfilingwiththe[SEC]...reportsuchinformationandoftenensurethatpositivefindingsfromtheirstudiesreceivemediacoverage.ForthosedrugsthatareevaluatedbyFDAadvisorycommittees,thereisanadditional,

(d) DisclosureIfasponsorfailstocompleteanagreeduponstudy[as]required...,theSecretaryshall

publishastatement...statingthatthestudywasnotcompletedand,ifthereasonsforsuchfailure tocomplete the studywerenot satisfactory to theSecretary,a statement . . . [soindicating].(e)NotificationWithrespecttostudiesofthetyperequired...,theSecretarymayrequirethatasponsor

who...failstocompletebyitsdeadlineastudy...foradrugorbiologicalproduct...notifypractitionerswhoprescribesuchdrugorbiologicalproductofthefailuretocompletesuchstudyandthequestionsofclinicalbenefit,and,whereappropriate,questionsofsafety,thatremainunansweredasaresultofthefailuretocompletesuchstudy.49See House Energy & Commerce Comm., Conspiracy of Silence—How the FDA

AllowsDrugCompaniestoAbusetheAcceleratedApprovalProcess7(2005),available at http://www.huffingtonpost.com/theblog/archive/Markey_Report.pdf.

50See id. at 17.51Id.52As the SEC explained in response to the congressional report:a pharmaceutical or biotechnology companywould be required to disclose informationregardingthestatusofaparticularpost-marketingstudycommitmentiftheinformationismaterial,thatis,ifinvestorswouldfindthatinformationtobesignificantinassessinganinvestmentinthatcompany.Whetherinvestorsmightconsidersuchinformationtobesig-nificanttoacompanywoulddependuponthecompany’sbusinessanditscurrentorfutureresultsofoperations.Numerousevents,conditionsorfactorscomprisethetotalmixofinfor-mationavailableaboutthecompany,itsfinancialconditionanditsprospectsmayenterintothedeterminationastowhetheranyonepieceofinformationwouldbematerialtoinvestors.

Id.(referringtoAppendixI:SECResponsetoRep.MarkeyLetter,Mar.23,2005,at3).

Ch. 12.I.C.2.


briefwindowinwhichtheNDAisformallyacknowledgedandthedatasupportingthe application are disclosed.

ThetwostatutesthathaveprovidedthegreatestaccesstopharmaceuticaldataaretheFederalAdvisoryCommitteeAct(FACA)[5U.S.C.app.II§§1–15(2000)]andtheFreedomofInformationAct(FOIA)[5U.S.C.§552(2000)].FACAensuresthatadvisorycommitteesaresubjecttotransparencyrequirementssuchasadvancenoticeofupcomingmeetings,opportunitiesforpublicattendanceandinput,andthepreparationoftranscripts.FOIArequirespublicdisclosure,uponrequestbyanyindividual,ofagencydocumentsthatdonotfallintooneofninespecificexemptionsfrom disclosure.

In2004,theFDAprocessedatotalof18,540FOIArequestsatacostof$12.8million.53

3. Disclosures of Inspection and Enforcement EventsFDAinspectionandenforcementactivitiesmaytriggerdisclosureobliga-

tions.Yet,asageneralrule,“[a]companyneednotpublicizetheresultsofeveryFDA inspection . . . .”54Afact-specificanalysisshouldbeperformedtoassessiftheeventissosignificant—inlightofthehistoryofevents,themanufacturer’ssize,theprofitabilityoftheproductsatissue,andtheinformationinthepublicrealm—thatareasonableinvestorwouldwanttoknowabouttheeventindecid-ingwhethertobuyorsellthecompany’ssecurities.

TheSupremeCourt’sdecisioninOmnicare, Inc. v. Laborers District Coun-cil Construction Industry Pension Fund 55clarifiesanimportant,recurringissueforlifesciencescompanies—namelywhenisalistedcompany’spubliclyfiledstatementsaboutitscompliancewithlaws,rules,andregulationsactionableasasecuritiesfraudviolation?AtissuewasregistrationstatementthatOmnicare,thenation’s largestproviderofpharmacy services tonursinghomes,filed inconnectionwithitspublicofferingofstock.Intheregistrationstatement, thecompanyincludedthemandateditemsalongwithitsanalysisabouttheeffectsofvariousfederalandstatelawsonitsbusinessmodelandtherebatesitreceivedfrom others.56SoonafterthegovernmentsuedOmnicare,plaintiffsbroughttheirprivatelawsuit,allegingthatOmnicarehadmademateriallyfalseclaimsaboutits legal compliance, contending that the company’s receipt of rebateswereactually illegal“kickbacks.”57The trial judgedismissed theirclaims,holdingthat legal opinions about compliance constitute “soft information” not actionable assecuritiesfraudwithoutevidencetheywereknowntobefalsewhenmade.Onappeal,theSixthCircuitreversed,holdingthatplaintiffsonlyhadtoallegethestatementswerefalsewhenmade,notthatanyoneatOmnicaredisbelieved

53PeterLurie&AllisonZieve,Sometimes the Silence Can Be Like the Thunder: Access to Pharmaceutical Data at the FDA,69Law&Contemp.Probs.85,89(2006)(internalnotesomitted); see FDA,FreedomofInformationAnnualReport2004,available athttp://www.fda.gov/RegulatoryInformation/FOI/FOIAAnnualReports/ucm148104.htm.

54WilliamO.Fischer,Key Disclosure Issues for Life Sciences Companies, FDA Product Approval, Clinical Test Results, and Government Inspections, 8 Mich. Telecomm. Tech. L. Rev. 115,139–40(2002)(internalcitationsomitted).

55135S.Ct.1318,191L.Ed.2d253(2015).56Omnicare, 135S.Ct.1318,1323.57Id. at 1324.

Ch. 12.I.C.3.


them at the time.58TheSupremeCourt,inturn,rejectedtheSixthCircuit’sanal-ysis,explaining:

WhattheFundsinsteadclaimisthatOmnicare’sbeliefturnedouttobewrong—thatwhateverthecompanythought,itwasinfactviolatinganti-kickbacklaws.Butthatallegationalonewillnotgiverisetoliabilityunder§11’sfirstclausebecause,aswehaveshown,asincerestatementofpureopinionisnotan“untruestatementofmaterialfact,”regardlessofwhetheraninvestorcanultimatelyprovethebeliefwrong.Thatclause,limitedasitistofactualstatements,doesnotallowinvestorstosecond-guessinherentlysubjectiveanduncertainassessments.59

InalengthyopinionthatreferencedOmnicare,thejudgeinIn re BioScrip, Inc. Securities Litigation60partiallydeniedamotiontodismissasecuritiesfraudclass action against a pharmaceutical company. The plaintiffs alleged thecompanycommittedsecuritiesfraudbynottimelydisclosingitsreceiptofacivilinvestigativedemand(CID),whichtheycontendedwasmaterialbecauseaCIDsignalstheexistenceofaFalseClaimsAct(FCA)investigationthatmayhavesignificant, negative impact on a company.61 BioScrip was one of three pharmaceuticalcompaniesacceptedbyNovartisPharmaceuticalsCorp.tosellan iron-chelation drug.62Asealedquitamwasfiledin2011againstNovartisandBioscript claiming their arrangement violated theFCAand the federalAnti-KickbackStatute,whichledtoaninvestigationandresultedintheDepartmentof Justice’s (DOJ’s) intervening against BioScrip in January 2014.63 The plaintiffsclaimedthatBioScripwaitedalmostayeartorevealitsreceiptoftheCID,sayingthattheCIDalertedBioScripthat“thegovernment‘hasreasontobelievemaybeinpossession,custody,orcontrolofanydocumentarymaterialor information relevant to a false claims law investigation.’”64 Soon after September 2013, when BioScrip disclosed the investigation, its stock value(whichhadbegundroppinginAugust)declinedrapidly.Thedeclinecontinuedthroughearly2014,whenBioScripfurtherrevealedthatithadsettledwiththeDOJandagreedtopay$15million.65 The plaintiffs sued within a week. Their corecomplaintfocusedonallegedlyfalseandmisleadingstatementsmadeaboutBioScrip’scomplianceactivities (i.e.,BioScripstated itsbelief that itwas insubstantial compliance with all laws, rules and regulations) and the CID,contendingthestatementswereknowinglyfalsewhenmadeoromittedmaterialfacts thatareasonableinvestorshouldknow.66 Citing to Omnicare, thejudgeobserved thatonceBioScripchose tospeak itwas required to tell thewholetruth. But the court also concluded that “opinion statements are not whollyimmune from liability” and may be considered material misstatements oromissionsunderseveralcircumstances.67

58Id.59135 S. Ct. at 1327.60No.13-CV-6922(AJN),2015U.S.Dist.LEXIS46763(S.D.N.Y.Mar.31,2015).612015 U.S. Dist. LEXIS 46763 at *2–3.62Id. at *7.63Id. at *10.64Id. at *11.65Id. at *18–19.66Id. at *24–25.67Id. at *29–30.

Ch. 12.I.C.3.


Inmostofthesecuritiesfraudcomplaintsdiscussedinthissubsection,theplaintiffsfailedtoconvincethecourtthatthepharmaceuticalmanufacturershadadutytodiscloseplantinspectionsbytheFDAafterdeficiencieswerefoundinthemanufacturingprocesses.Forinstance,inAcito v. IMCERA Group, Inc.,68 theSecondCircuitaffirmedthesummarydismissalofacomplaint,explainingthat although “the third inspection revealednumerous deficiencies, the com-plaint,atmost,allegesmismanagementoftheplant.Itiswellsettled‘thatsection10(b)wasnotdesignedtoregulatecorporatemismanagement.’”69Similarly,inAnderson v. Abbot Laboratories, Inc.,70thejudgedismissedasecuritiesfraudclass action complaint filed shortly afterAbbot Labs entered into a consentdecreewiththeFDA,paidthelargestfine(atthattime)everimposedbytheFDA($100million),andagreedtowithdraw125productsfromthemarket.TheAndersonplaintiffsallegedthatAbbottLabsmisledinvestorsbynotpromptlydisclosingproblemsrevealedbytheFDAinspections.Thejudgewasnotcon-vinced, pointing out that the problems allegedwere not somaterial to havetriggeredanimmediatedisclosureobligationinlightofthelonghistoryofsim-ilarinspections,theamountofinformationpubliclyavailableaboutpastFDAinspections and outcomes, and the lack of objective evidence to support aninferencethatAbbotLabscouldhaveexpectedtheseinspectionswouldleadtomarkedlydifferentresultsbasedonitspriordealingswiththeFDA.71

Another interesting decision worth noting is In re Par Pharmaceutical Securities Litigation,72 which addresses some recurring issues that pharmaceu-tical manufacturers and medical device companies encounter when agencyenforcement actions are threatened—i.e.,dotheyhaveadutytoreportacriminalproceeding?Andiftheyhavesuchaduty,atwhatstageoftheproceedingshouldit be reported? The In re ParplaintiffsallegedthatParhadnotpubliclydisclosedanongoingschemetobribeFDAofficialstoapproveitsnewdrugsanddelaythe approval of competitors’ drugs. They also alleged that Par had falselyclaimed that its success ingetting itsdrugsapproved faster resulted from itssuperior abilities over its competitors.73 In its defense, Par Pharmaceuticalsreliedoncasesthatholdthat“acorporationisundernodutytoannouncepub-liclythatitoritsofficersareguiltyofunchargedcriminalbehavior,ortoaccuseitself of antisocial or illegal policies.”74Butthesecaseswerenotcontrolling,thecourtfound,because“[t]heillegalityofcorporatebehaviorisnotajustification

6847 F.3d 47 (2d Cir. 1995).69Id. at 53 (internal note omitted).70140 F. Supp. 2d 894 (N.D. Ill. 2001).71Id.at902(“ThehistorybetweenAbbottandtheFDAmakesall theundisclosedinfor-

mation,viewedincontext,seemfairlyinconsequential.Aninvestorwithfullinformationwouldseeaseriesofinspections,Forms483,negotiations,re-inspections,moreForms483andmorenegotiations.Abbotthadalsobeenin,andout,ofanFDAmonitoringplan....Giventherepeat-ingcycleofinspections,findingsandnegotiations,withoutanyFDAsanctions,plaintiffsmustgiveusareasontobelievethistimewasdifferent—somethingthatshowsAbbott’sprospectshadgenuinelychangedorsomethingfromtheFDAthatsaid,‘Thistimewe’reserious.’Thisplaintiffshavefailedtodo.”)(internalnoteomitted).

72733F.Supp.668(S.D.N.Y.1990).73Id. at 672–74.74Id. at 674–75 (internal notes omitted).

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for withholding information that the corporation is otherwise obligated to disclose. . . .”75

II. Overview of the Key Federal Statutes

TheSECadministerstwomajorstatutesthatareimportanttolistedphar-maceuticalcompaniesandmedicaldevicemanufacturers:76 the Securities Act of 1933 (Securities Act)77 and the Securities Exchange Act of 1934 (Exchange Act).78Pursuanttoitsauthority,79 the Commission has promulgated numerous

75Id.76TheSECalsoadministersseveralotherimportantstatutes,including• ThePublicUtilityHoldingCompanyActof1935,Pub.L.No.333,49Stat.848(1935),

codified as amended at15U.S.C.§§79a–79z-6(whichprovidedtheCommissionwithauthorityovervariouspracticesofholdingcompanies,includingtheirissuanceofsecuritiesandabilitytoengageinaffiliatetransactions,andplacedrestrictionsonthegeographicscopeofholdingcompanysystemsandlimitedregisteredholdingcompaniestoactivitiesrelatedtotheirgasorelectricbusinesses);

• TheTrustIndentureActof1939,Pub.L.No.253,53Stat.1149(1939),codified as amended at15U.S.C.§§77aaa–77bbbb(whichprotectsholdersofdebtsecurities(suchasbonds,debentures,andnotes),byprovidingthattheymaynotbeofferedforpublicsalewithouta trust indenture (a formal agreement between the issuer of bonds and the bondholder) thatconformstotheAct’sstandards);

• TheInvestmentCompanyActof1940,Pub.L.No.76-768,54Stat.789(1940),codified as amended at15U.S.C.§§80a-1–80a-64(whichregulatesmutualfundsandotherinvestmentcompaniesthatinvestandtradeinsecuritiesissuedbyothercompanies);

• TheInvestmentAdvisersActof1940,Pub.L.No.76-768,54Stat.847(1940),codified as amended at15U.S.C.§§80b-1–80b-21(whichregulatesinvestmentadvisorsbyrequiringthattheyberegistered);

• TheSecuritiesInvestorProtectionActof1970,Pub.L.No.91-598,84Stat.1636(1970),codified as amended at15U.S.C.§§78aaa–78lll(whichcreatedtheSecuritiesInvestorProtectionCorporationandcharged itwith restoring funds to investorswith assets inthehandsofbankruptandfinanciallytroubledbrokeragefirms,andwithoversightoverliquidatingsecuritiesfirmsinfinancialtrouble);and

• The Public CompanyAccounting Reform and Corporate ResponsibilityAct of 2002(commonlyknownastheSarbanes-OxleyAct),Pub.L.No.107-204,116Stat.745(2002),codified as amended in scattered sections of 15 U.S.C. (which amended and enacted new provisionsintheExchangeAct).

77Pub.L.No.73-22,48Stat.74(1933),codified as amended at15U.S.C.§§77a–77aa.78Pub.L.No.73-291,48Stat.881(1934),codified as amended at15U.S.C.§§78a–78ll.See

MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update§5.01.

79In United States v. O’Hagan,521U.S.642,672–3(1997),theSupremeCourtaddressedhowfartheCommission’srulemakingauthorityextended.Althoughitdeclinedtodrawabrightline, theCourt observed that theCommission’s authority is substantial because itsmission isprophylacticinnature:

We need not resolve . . . whether the Commission’s authority under §14(e) [of theExchangeAct]to“define...suchactsandpracticesasarefraudulent”isbroaderthan...[its]fraud-definingauthorityunder§10(b),forweagree...thatRule14e-3(a),asappliedtocasesofthisgenre,qualifiesunder§14(e)asa“meansreasonablydesignedtoprevent”fraudulent tradingonmaterial,nonpublic informationin the tenderoffercontext.A pro-phylactic measure, because its mission is to prevent, typically encompasses more than the core activity prohibited.AswenotedinSchreiber[v.BurlingtonNorthern,Inc., 472 U.S. 1(1985)],§14(e)’srulemakingauthorizationgivestheCommission“latitude,”eveninthe

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implementingregulationstoprotecttheinvestingpublicandmakethefinancialmarkets more transparent.80

A. The Securities Act of 1933

The Securities Act was a reform measure enacted to respond to problems believedtohaveresultedinthe1929stockmarketcrash,81 and was designed to regulatetheintegrityofthedomesticsecuritiesmarketsinanex ante fashion.82 “TheSecuritiesAct,[o]ftenreferredtoasthe‘truthinsecurities’law,hastwobasicobjectives,to‘requirethatinvestorsreceivefinancialandothersignificantinformationconcerningsecuritiesbeingofferedforpublicsale’andto‘prohibitdeceit,misrepresentations,andotherfraudinthesaleofsecurities.’”83 “A pri-marymeansofaccomplishingthesegoalsisthroughthedisclosureofimportantfinancial information through the registration of securities. This information enables investors, not the government, to make informed judgments about

contextofatermofartlike“manipulative,”“toregulatenondeceptiveactivitiesasa‘rea-sonablydesigned’meansofpreventingmanipulativeacts,withoutsuggestinganychangeinthemeaningoftheterm‘manipulative’itself.”472U.S.,at11,n.11...[.](internal citations omitted and emphasis added).80See, e.g.,ThomasLeeHazen,Market Manipulation and Deceptive Practices—Sections 9,

10, 14(e), 15(c),2Lawof Securities Regulation§12.1(4thed.2002)(observing,interalia,thatSection10(b)oftheExchangeActempowerstheSECtopromulgaterulesbarringmanipulativeanddeceptiveconduct).SeeSectionsIII.B.andIII.C.foradetaileddiscussionoftheseregulations.

TheCommissiondescribesitsmissionasbeingto“protectinvestors,maintainfair,orderly,andefficientmarkets,andfacilitatecapitalformation.”SEC,TheInvestor’sAdvocate:HowtheSECProtectsInvestors,MaintainsMarketIntegrity,andFacilitatesCapitalFormation,available athttp://www.sec.gov/about/whatwedo.shtml.

81See The Regulation of Securities Offerings, Securities Act Release Nos. 33–7606A,34–40632A,IC-23519A,FileNo.S7-30-98(Nov.24,1998)(“TheSecuritiesActwasadoptedinresponsetotheactivitiesculminatinginthe1929marketcrash.PresidentFranklinD.Rooseveltarticulatedtheunderlyingphilosophyofregulatingsecuritiesofferingswhichcontinuestoday:‘[t]hereis...anobligationuponustoinsistthateveryissueofnewsecuritiestobesoldininter-statecommerceshallbeaccompaniedbyfullpublicityandinformation,andthatnoessentiallyimportantelement...shallbeconcealedfromthebuyingpublic.’H.R.Rep.No.85,73rdCong.1stSess.,at1–2(1933).”),available athttp://www.sec.gov/rules/proposed/337606a1.txt.

8215U.S.C.§77aet seq.83The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity,

and Facilitates Capital Formation,available at http://www.sec.gov/about/whatwedo.shtml. See generallyRoyceDeR.Barondes,The Bespeaks Caution Doctrine: Revisiting the Application of Federal Securities Laws to Opinions and Estimates,19J.Corp.L.243,245–46(1994)(“Undersection11oftheSecuritiesActof1933[15U.S.C.§§77a–77aa]acompanysellingsecuritiesina transaction registered with the SEC (i) pursuant to a registration statement containing an untrue statementofamaterialfactoromittingamaterialfactnecessarytomaketheregistrationstatementnotmisleadingwillbeliable,(ii)toanypersonacquiringtheregisteredsecurity,(iii)fordamagesthatexcludeanydecreaseinvaluethedefendantshowsrepresentsotherthanadecreasearisingfromtheuntruestatementoromission.Thecompany’sdirectors,otherpersonssigningtheregis-trationstatement,andtheunderwritershavea‘duediligence’defense.[15U.S.C.§77k(b)(3)(A)]However,theissuerdoesnothavethesamedefense.Section12(2)ofthe1933Actprovidesthatpersonsofferingorsellingsecurities,whetherregisteredornot,pursuanttofalseormisleadingprospectusesareliabletopurchasersfortheconsiderationpaidlessincomereceived....”)(inter-nal notes omitted).

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whether to purchase a company’s securities.”84 The Securities Act regulates initialpublicofferingsofsecuritiesbyrequiringmostpubliclytradedcompaniestofollowproscribedregistrationproceduresthat,amongotherthings,requirespecifiedinformationtobeincludedinaprospectus.TheCommissionhassum-marizedthebasicsoftheregistrationprocess,85whichgenerallyrequiresfillingout a form with the following information:

• Adescriptionofthecompany’spropertiesandbusiness;• Adescriptionofthesecuritytobeofferedforsale;• Informationaboutthemanagementofthecompany;and• Financialstatementscertifiedbyindependentaccountants.Registration statements and prospectuses86becomepublicshortlyafterthey

arefiledwiththeSEC.Registrationstatementsaresubjecttoexaminationforcompliance with disclosure requirements. But not all offerings of securities must be registered with the Commission.87Someofthekeyexemptionstoregistrationare:

84Id. (emphasis added). See also Michael H. Dessent, Joe Six-Pack, United States v. O’Hagan, and Private Securities Litigation Reform: A Line Must be Drawn, 40 Ariz. L. Rev. 1137,1145–46(1998)(“Thetheorybehindthe1933Actisthatinvestorsneedtobeadequatelyprotectedbya‘fullandfairdisclosure’ofallmaterialinformationwhichaprospectivepurchaserwould want to know before bringing a new issue.”).

85SEC,TheInvestor’sAdvocate:HowtheSECProtectsInvestors,MaintainsMarketInteg-rity,andFacilitatesCapitalFormation,available at http://www.sec.gov/about/whatwedo.shtml.

86See generallyRoyceDeR.Barondes,Adequacy of Disclosure of Restrictions on Flipping IPO Securities,74Tul. L Rev.883,888–89(2000)(“Therulesgoverningdisclosurerequiredinpublic offerings are bifurcated. There is a general obligation to disclose in the offering document ...allmaterialinformation.Thatobligationismostprominentlysetforthinsections11and12oftheSecuritiesAct.. . .Sections11and12respectivelyprovideremediesagainst(1)certainpersonsassociatedwiththesaleofsecuritiesbymeansofaregistrationstatementthat‘containedan untrue statement of a material fact or omitted to state a material fact required to be stated . . . ornecessarytomakethestatements...notmisleading,’and(2)onewhooffersorsellssecuritiesusingaprospectus,orwithanoralstatement, that ‘includesanuntruestatementofamaterialfactoromitstostateamaterialfactnecessaryinordertomakethestatements,inthelightofthecircumstancesunderwhichtheyweremade,notmisleading(thepurchasernotknowingofsuchuntruthoromission).’Inadditiontothesegeneraldutiesnottosellsecuritiesbymeansoffalseormisleadingofferingdocuments,theSEChaspromulgatedspecificrulesidentifyingitems...requiredtobeincludedinregistrationstatements.Liabilitymaybeimposediftheprospectusomitsafactnecessarytomaketheprospectusnotmisleading,eveniftheregistrationstatementandthecorrespondingprospectusincludealltheitemsspecificallycalledforbytheformonwhichtheoffering has been registered.”) (internal notes omitted).

87SeeMarkF.Donahue,Regulation D: A Primer for thePractitioner,8Del. J. Corp. L. 495,496–97(1984)(“Inthe1933ActCongressexemptedcertainclassesofsecuritiesandcertaintransactionsfromtheregistrationobligations.Specifically,section3(a)exemptscertainclassesofsecuritiesfromtheregistrationrequirements[SecuritiesAct§3(a),codifiedat15U.S.C.§77c(a)]andsection4exemptsnonpublicofferings[SecuritiesAct§4(2),codifiedat15U.S.C.§77d(2)]and certain other types of transactions, including transactions by persons not involved in thedistributionprocess.[SecuritiesAct§4(1),codifiedat(4)815U.S.C.§77d]Additionally,Con-gress empowered the SEC to adopt additional limited exemptions consistent with public interest andinvestorprotection.[SecuritiesAct§3(b),codifiedat15U.S.C.§77c(b)].”)(internalnotesomitted).

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• Privateofferingstoalimitednumberofpersonsorinstitutions;88

• Offeringsoflimitedsize;• Intrastateofferings;89 and• Securitiesofmunicipal,state,andfederalgovernments.90

ShortlyaftertheSecuritiesActtookeffect,Congressrealizedthatitsanti-fraud and antimanipulation measures were too limited in reach to protect the securitiesmarketsadequately.91TheExchangeActwaspassedinthenextyeartoprotectthelarger,secondarysecuritiesmarkets.92IntheExchangeAct,Con-gressalsocreatedtheSECandempowereditto“register,regulate,andoverseebrokeragefirms,transferagents,andclearingagenciesaswellasthenation’ssecurities self regulatory organizations (SROs),”93 such as the various stockexchanges, includingtheNewYorkStockExchangeandtheAmericanStockExchange.Althoughmostofthischapter’sremainingdiscussionwillfocuson

88RegulationD,codifiedat17C.F.R.§230.506, isarguably themost importantof theseexemptions.Itexemptsoffersandsalesofsecuritiesbyanissuerthathave“nomorethan[,]ortheissuerreasonablybelievesthattherearenomorethan[,]35purchasersofsecuritiesfromtheissuerinanyoffering,”andeachpurchaserwhoisnot“anaccreditedinvestor‘eitheraloneorwithhis...representative(s)hassuchknowledgeandexperienceinfinancialandbusinessmattersthatheiscapableofevaluatingthemeritsandrisksoftheprospectiveinvestment,ortheissuerreasonablybelievesimmediatelypriortomakinganysalethatsuchpurchasercomeswithinthisdescription.’”17C.F.R.§§230.506(b)(2)(i),(ii).

89SeeMaryE.T.Beach,Unregistered Offerings of Corporate Securities Including Regula-tion D and Regulation A,Fundamentalsof Securities Law(ALI-ABACourseNo.SL006,Jan.2006),foradescriptionoftheintrastateexemption(notingthatSecuritiesAct§3(a)(11)providesan exemption from the registration requirements for offers or sales of securities to residents of a singlestatebyanissuerwhoresidesorisincorporatedinthesamestateanddoesbusinessinthatstate).Therearethreekeypartstotheintrastateexemption:(1)theissuermustbedoingbusinesswithinthestate(whichmeanshavingsubstantialoperationalactivitiesinthestate);(2)alloffersandsalesmustbetoresidentsofthestate;and(3)thesecuritiesthataresoldmustcometorestinthehandsofinvestorswhoresideinthestate.TheSEC’simplementingregulationfortheintrastateexemptioniscodifiedat17C.F.R.§230.147.

90See generallyLeighWalton&EdwardC.Meade,Representing the Growing Business: Tax,Corporate,Securities,and Accounting Issues,Latest Developmentsin Exempt offerings (ALI-ABACourse No. Sl054, Nov. 2005) (observing, inter alia, that SecuritiesAct §3(a)(2)exemptssecuritiesissuedorguaranteedbyfederal,state,orlocalgovernments;securitiesissuedbybanksortrustfunds;industrialdevelopmentbondsecurities;andspecificinterestsinemployeebenefitplans).

91SeeDonahue,8Del. J. Corp.L.at496(“Asageneralrule,the1933ActmakesitunlawfultosellasecuritywhichhasnotbeenregisteredwiththeSEC.[SecuritiesAct§5(a)(1),codifiedat 15U.S.C. §77(e)(a)(1)]Registration involves filing a registration statement and disclosingrequiredinformationregardingtheissuer,theissuer’sbusiness,andthesecuritybeingofferedforsale.[SecuritiesAct§7,codifiedat15U.S.C.§77g]Acorollaryprovisionrequiresthatanysecuritydeliveredforsalebeaccompaniedorprecededbyaprospectus[SecuritiesAct§5(b)(2),codifiedat15U.S.C.§77e(b)(2)],whichcontainsmostof the informationdisclosed in the registrationstatement.[SecuritiesAct§10(a)(1),codifiedat15U.S.C.§77j(a)(1)]”)(internalnotesomitted).

92SeeMichaelH.Dessent,Joe Six-Pack, United States v. O’Hagan, and Private Securities Litigation Reform: A Line Must Be Drawn, 40 Ariz. L. Rev.1137,1145–46(1998)(“The1933Actnowincludesanumberofprivateremediesforinvestors.[15U.S.C.§§77a–77aa]Therearegeneralanti-fraudprovisionspreventingmaterialomissionsandmisrepresentationsinconnectionwiththesaleofsecurities;however,thescopeofthe1933Actisnarrow,dealingonlywithdistri-butionsofsecuritiesandprotectingjustpurchasers.”)(internalnoteomitted).

93SEC,TheInvestor’sAdvocate:HowtheSECProtectsInvestors,MaintainsMarketInteg-rity,andFacilitatesCapitalFormation,available at http://www.sec.gov/about/whatwedo.shtml.

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ExchangeActissues,includingRule10b-594 (promulgated in 1948 to implement Section10(b)oftheSecuritiesExchangeAct),95severalcasesareworthreview-ingbecausetheyinvolvedallegedSecuritiesActviolationsbypharmaceuticalcompanies.

For example, in In re Alliance Pharmaceutical Corp. Securities Litiga-tion,96 theclassactionplaintiffsunsuccessfullyallegedthatAlliancePharma-ceutical had a duty to disclose bad news, as of the date of the registrationstatement,aboutitstestingofatemporarybloodsubstituteafteritsmergerwithanotherpharmaceuticalcompany.Inparticular,theplaintiffsclaimedthatAlli-ancePharmaceutical’s registration statementandprospectusomittedmaterialfacts that were needed to make particular representations in the statement not misleading, thereby violating Sections 11 and 12(a)(2) of the SecuritiesAct(codified,respectively,at15U.S.C.§§77kand77l(a)(2)).97 The court was not convinced,explainingthat“[p]laintiffsprovidenoauthority...thatliabilitycanattach—under Section 11wheneventsthatoccuraftertheeffectivedateoftheregistration statement render statements therein misleading.”98 The court observedthat“plaintiffsconflatetheissuesof(1)whetherdefendantshadadutytodiscloseparticularfacts;(2)whetherdefendantshadadutytoupdateinfor-mationobtainedsubsequenttodisclosure;and(3)whichprovisionofthesecu-ritieslawsdefendantswouldbeliableunderiftheyviolatedeitherduty.”99

In Oxford Asset Management, Ltd. v. Jaharis,100theEleventhCircuitcon-frontedabroadercontentionaboutadrugcompanythatallegedlyissuedmis-leadingofferingmaterialsinviolationofSection11oftheSecuritiesAct.Theplaintiffscontendedthatthepharmaceuticalmanufacturershouldhavedisclosedthedrugsalevolumeforanextended-releaseniacinpreparationinitsprospectus.Theappellatecourt,however,rejectedtheargumentthatissuersmustdiscloseallmaterialinformationtotheoffering,explaining:

94Rule10b-5,codifiedat17C.F.R.§240.10b-5,provides:Itshallbeunlawfulforanyperson,directlyorindirectly,bytheuseofanymeansorinstru-mentalityofinterstatecommerce,orofthemailsorofanyfacilityofanynationalsecuritiesexchange,(a) Toemployanydevice,scheme,orartificetodefraud,(b) Tomakeanyuntruestatementofamaterialfactortoomittostateamaterialfactneces-

saryinordertomakethestatementsmade,inthelightofthecircumstancesunderwhichtheyweremade,notmisleading,or

(c) Toengageinanyact,practice,orcourseofbusinesswhichoperatesorwouldoperateasafraudordeceituponanyperson,inconnectionwiththepurchaseorsaleofanysecurity.

95Section10(b)oftheExchangeAct,codifiedat15U.S.C.§78j(b),providesinrelevantpart:Itshallbeunlawfulforanyperson,directlyor indirectly,bytheuseofanymeansor

instrumentalityof interstatecommerceorof themails,orofanyfacilityofanynationalsecuritiesexchange—...[t]ouseoremploy,inconnectionwiththepurchaseorsaleofanysecurityregisteredonanationalsecuritiesexchangeoranysecuritynotsoregistered,oranysecurities-basedswapagreement...anymanipulativeordeceptivedeviceorcontrivanceincontraventionofsuchrulesandregulationsastheCommissionmayprescribeasnecessaryorappropriateinthepublicinterestorfortheprotectionofinvestors.96279F.Supp.2d171(S.D.N.Y.2003).97Id. at 181.98Id. at 183 (emphasis in original).99Id.100297 F.3d 1182 (11th Cir. 2000).

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Section11(a)onlymakesactionabletheomissionofamaterialfactrequired to be stated in the prospectus or necessary to make the statements in the prospectus not misleading.Toholdthatsection11(a)imposesliabilityunlesstheprospectusincludes allmaterialfactsissimplytowhollyignoreandrendersuperfluousthatsection’squalifyinglanguage“requiredtobestatedthereinornecessarytomakethestatementsthereinnotmisleading.”Thiswemaynotdo.101

In Freedman v. Value Health, Inc.,102acourtalsorejectedallegationsthatapharmaceutical company violated the SecuritiesAct by providing materiallymisleading statements in its offering materials related to a merger. The Second Circuit explained that neither the challenged press release nor the prospectus was materiallymisleadingdespiteplaintiffs’allegationsthatthedisclosurewarning—whichindicatedthatthecompanies’contracts“couldlosemoneyinthefuture”—concealedthat theyalreadywere losingcontracts.As thecourtexplained, the“profitablecontractsmorethanoffsetthelosses,sotherewasnooverall‘materialadverseeffectontheresultsofoperationsorfinancialcondition....’”103

Bycomparison,inNeubauer v. Eva-Health USA, Inc.,104 the court upheld mostoftheallegationsofsecuritiesfraudbasedonallegedlyfraudulentstate-mentsmadebythepharmaceuticalcompanyinanofferingprospectus.Inpart,theplaintiffsclaimedthat“[t]heofferingmemorandumallegedlydescribed...Rifkin,Eva-Health’schairmanand[CEO]...andtheinventorofitsproductline,asamedicaldoctorandPh.D.andstatedthatthetechnologyforthecom-pany’sproductswasprotectedbytwopatents.Both . . .statements . . .werefalse;Rifkin...heldneitherdegree,andtherewerenopatents.”105Assuch,theplaintiffshadstatedanactionablecomplaintforwhichsummaryjudgmentwasimproper on the pleadings.

A more technical issue was presented in Kainos Laboratories, Inc. v. Bea-con Diagnostics,Inc.106Inanunreportedopinion,thedistrictcourtdismissedsecurities fraud allegations against the biotechnology company for allegeddefectsinaprivateplacementmemorandum(PPM),explainingthatthePPMwas notapublicoffering,and thatapublicoffering isa requiredelementofproofrequiredbytheSecuritiesActtostateacauseofaction.107

101Id. at 1190 (emphasis added).10234F.App’x408(2dCir.2002)(unreported).103Id. at 411 (internal citation omitted).104158F.R.D.281(S.D.N.Y.1994).105Id. at 282.106No.C-97-4618MHP,1998WL2016634(N.D.Cal.Sept.14,1998).107Id. at *4 (“In Gustafson[v. Alloyd Co.,513U.S.561(1995)], the Court considered specif-

ically...whethersection12(2)’srightofactionextendedtoa‘private,secondarytransaction.’...Ininterpretingtheterm‘prospectus’asusedinsection12,theCourtlookedtobothsection2(10)oftheSecuritiesAct,15U.S.C.§77b(10),whichdefinesa‘prospectus,’andsection10ofthe1933Act,15U.S.C.§77c,whichsetsforththeinformationwhichmustbecontainedinaprospectus.TheCourtdeterminedthata‘prospectus’musthavethesamemeaninginbothsections10and12,andfurtherinterpreted‘prospectus’torefer‘toadocumentsolicitingthepublictoacquiresecurities.’”)(internalcitationsomitted).

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B. The Securities Exchange Act of 1934

Aspreviouslyexplained,mostsecuritiesfraudactionsarebasedonallegedviolationsofSection10(b)oftheExchangeAct108anditsimplementingrule,10b-5,because theseprovisionshaveamuchbroader reach than thosemadeunder the Securities Act (which must be tied to fraudulent conduct related to a publicofferingthatresultsinharmtostockpurchasers).Asthejudgehandlingthe Enron-related litigation explained:

Securitiesfraudactionsunder§10(b)andRule10b-5arenotmerelylimitedtothe making of an untrue statement of material fact or omission to state a material fact.Section10(b)prohibits“anymanipulativeordeceptivecontrivance,”which...theSupremeCourt,relyingonWebster’sInternationalDictionary,includes“aschemetodeceive”or“scheme,planorartifice.”109

AlthoughSection10(b)’sandRule10b-5’sscopearebroad,therearelimits.Inparticular, inanalyzing the limitsof the“inconnectionwith” language,110 courthaveexpressedconcernsaboutlettingplaintiffsexpandtheseprovisionsinways that conflictwith settled principles of corporate law.The judiciallycreated insider trading liability theoryalonehasbeen thesubjectofmultipleSupreme Court decisions.111

10815U.S.C.§78aet seq.109In reEnronCorp.Sec.Deriv.&ERISALitig.,235F.Supp.2d549,577–78(S.D.Tex.

2002),citingErnst&Ernstv.Hochfelder,425U.S.185,199n.20(1976),criticized by Santa Fe Industries,Inc.v.Green,430U.S.462,480(1977).

110See, e.g., Marc L. Steinberg&Ralph C. Ferrara,1Securities Practice: Federal and State Enforcement§2:12(2ded.2002),discussingthemeaningofthisstatutorylanguageinconnectionwiththe“misappropriation”doctrine—underwhich“temporary”or“situational”insidershavebeenheldliableforinsidertradingviolations.(“Section10(b)mandatesthat‘themisappropriator’sdeceptiveuseofinformationbe‘inconnectionwiththepurchaseorsaleof[a]security.’Suchdeceptionoccurs‘inconnectionwith’thepurchaseorsaleofsecuritieswhenthefiduciary’sfraudisconsummated.AndthefraudunderSection10(b)isconsummated,notwhenthefiduciaryprocurestheconfidentialinformation,butwhenwithoutrevelationtohissource(s),heutilizestheinformationtoengageinsecuritiestrading(ortoengagein‘tipping’).Accordingly,the‘inconnectionwith’requirementlimitsliabilityunderthemisappropriationtheorytousingconfidentialinformation...tocapitalizeonsecuritiestransactions.Ontheotherhand,ifthemisap-propriatorutilizestheconfidentialinformationforanotherpurpose...,thenthemisappropriationtheoryunderSection10(b)wouldbeinapplicablebecausethedeceptivepracticewouldnotbe‘inconnectionwith’thepurchaseorsaleofasecurity.”)(pagereferencesunavailable;internalreferences omitted).

111Id.at§2:8:Since1980,theSupremeCourthashandeddownfourdecisionsaddressinginsidertrad-

ing. In Chiarella v. United States,[445U.S.222(1980)]theCourtheldthat,withoutadutytodisclose,silencewillnotgiverisetoliabilityunderSection10(b)oftheExchangeActandRule10b-5promulgatedthereunder.AsstatedbytheSupremeCourt,theimpositionofSection10(b)liabilitybasedonsilence“ispremiseduponadutytodisclosearisingfromarelationshipoftrustandconfidencebetweenpartiestoatransaction.”Id. at 230.

In Dirks v. SEC,[463U.S.646(1983)]theCourtheldthatthedutyoftippeestodiscloseor abstain from trading under Section 10(b) and Rule 10b-5 depends on “whether the insider personallywillbenefit[e.g.,byreceiptofpecuniarygainorreputationalenhancementthatwilltranslateintofutureearnings],directly,orindirectly,fromhisdisclosure.Absentsomepersonalgain,therehasbeennobreachofdutytostockholders.Andabsentabreachbythe

Ch. 12.II.B.


III. Reporting Obligations of Publicly Traded Companies

Congressdidnotdefinetheterm“materiality”ineithertheSecuritiesActor the ExchangeAct; consequently, considerable scholarly commentary andregulatory interesthasbeen focusedonwhether, fordisclosurepurposes, thematerialityofinformationshouldbeevaluatedunderaquantitativeapproach,aqualitativeone,orahybrid.Inshort,areportingcompany’sdisclosureobliga-tions are best analyzed under a hybrid approach. “As the Second Circuitexplained in United States v. Matthews,112courtshavegenerallyrejectedtheideathatmanagementmustmakeexpansivequalitativedisclosures[thatare]notatleast implicit in an SEC regulation.”113 On the other hand:

[W]henacorporationmakesadisclosureitmustensurethatthestatementscontainthecompletestoryanddonotmisleadtheinvestingpublic.Ifastatementisnotaccurateatthetimeofrelease,thecompanymustimmediatelyissueacorrectivedisclosure.Moreover,iffutureeventsrenderapriorpublicstatement“alive”inthemarketplace,materiallymisleadingorincomplete,thecorporationmustupdateitwithfresh,accurateinformation.114

City of Bristol Pension Fund v. Vertex Pharms., Inc.,115isillustrativeandunderscorestheimportanceofmakingcorrectivedisclosuresassoonaspossible.Inthatmatter,theCityofBristolPensionFundwasfoundtolackstanding—anditscomplaintwasdismissed—becauseVertexPharmaceuticals,Inc.,hadmadea correctivedisclosurebefore the pension fund bought its stock. Despite the plaintiff’sclaimsthatithadboughtVertex’scommonstockatartificiallyhighpricescausedbyVertex’sfalseandmisleadingstatementsaboutitsproducts,116 theevidencedemonstratedthatVertexhadcorrectedamisleadingstatementtheday before the plaintiff first purchased the shares, so this misrepresentationlegallyhadnotcauseditsloss.117

A. Materiality and the Probability-Magnitude Test

1. Judicial StandardThedifficultyindetermining what and when information must be disclosed

bypubliclytradedcompanieshasbeenablysummarizedasfollows:Itissomewhatdifficultforcompliancepurposestoalwaysknowwhatinformationthatpublicly-tradedcompaniesneedtodiscloseandwhenitmustbedisclosed...toavoidmaking[an]...inadvertentviolationofanSECruleorregulation.Whileitisclearthatsomequalitativeinformation—suchasmajorcorporateevents[as,

insider,thereisnoderivativebreach[bythetippee].”(Pagereferencesunavailable;internalreferences omitted.)112787 F.2d 138 (2d Cir. 1986).113J.BradleyBennett&AndrewJ.Brauer,To Tell or Not to Tell: Weighing the Benefits and

Pitfalls Self-Reporting Corporate Wrongdoing,38(13)Sec. Reg.&Law Rep.(BNA),526,526(Mar.27,2006).

114Id.115Civ.No.12-11654-FDS2014U.S.Dist.LEXIS43400(D.Mass.Mar.31,2014).116Vertex Pharms., Inc.,2014U.S.Dist.LEXIS43400at*1–2.117Id. at *2.

Ch. 12.III.A.1.


forexample,]...thefilingforbankruptcyprotectionorbeingnamedinacriminalindictment—mustbedisclosed,thereisa[considerableamount]...ofinformationforwhichdisclosurewouldnotappeartoberequired,sinceitwouldseemunlikelytohaveasubstantialimpactonacompany’sbottomlineif...consideredusingaquantitativeapproach.Unfortunately,theSEChasprovidedconflictingguidance...overtheyears....118

In1988,theSupremeCourtrevisitedthemateriality119 issue in Basic, Inc. v. Levinson.120Inthislandmarksecuritiesfraudcase,theplaintiffsfocusedonthreepublicstatementsthatBasicissuedduringatwo-yearperiodinwhichitdeniedthatmergernegotiationswereunderwayevenasitscorporaterepresen-tativeswereprivatelymeetingwithrepresentativesofanothercompanytodis-cussthepossibilityofamerger.Basicalsoclaimedtobeunawareofdevelopmentsthatwouldexplaintheheavytradingofitsstock.121FollowingBasic’sbelatedmerger announcement, Levinson and other former shareholders filed a classactionagainstBasicanditsdirectors,claimingthatthedefendantshadissuedfalseormisleadingpublicstatementsthatresultedindamagestothem,invio-lation of Section 10(b) of the Exchange Act and Rule 10b-5.122Thejudgegrantedsummaryjudgment,holdingthatBasic’smisstatementswereimmaterialbecausethemergernegotiationswerepreliminarywhenitsstatementsweremade.123 On appeal,theSixthCircuitreversed,holdingthatalthoughBasiclackedadutytodiscloseitsmergernegotiations,itwasnotfreetomakemisleadingstatementsaboutthemergerissue.Theappealscourtremarkedthatalthoughpreliminarymergerdiscussionsareimmaterialasamatteroflaw,“‘onceastatementismadedenyingtheexistenceofanydiscussions,evendiscussionsthatmightnothavebeenmaterialinabsenceofthedenialarematerialbecausetheymakethestate-mentmadeuntrue.’”124TheSupremeCourtacceptedcertioraritoresolvealower

118MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.04(internalcitationsomitted).

119See id.(“[T]heregulatorystructureimposedbythefederalsecuritieslawsdoesnotapplyifstatementsarenotmaterial.Forthatreason,courtshaveheldthatthefederalsecuritieslawsarenotdesignedtoinsureagainstlossesthatresultfrominvestors’irrationalrelianceonimmaterialinformationorwhentheyengageinsimilarlyriskyinvestmentbehavior.[¶]...[T]heprotection...providedthroughthe...PSLRAtocertainappropriatelylabeled‘forwardlooking’statementsreflectsapolicydeterminationthatthe[se]...lawsshouldnotmakeactionableflawsormistakesinall information thatpublicly tradedbusinessescommonlydisclose.This statutory (and reg-ulatory)safeharborprotectioneffectivelycodifies the judiciallydeveloped‘BespeaksCautionDoctrine’thatrecognizesthatcertainstatementsofpubliclytradedcompaniesshouldnottriggerliabilityunderthefederalsecuritieslaws...[when]noreasonablepersoncouldproperlyrelyuponthem....[¶]Inaddition,therearewholecategoriesofstatementsthatcourtshavebeenunwillingtofindactionableunderthefederalsecuritieslaws—includingopinions,estimates,commercialspeech,andother‘softinformation.’”)(internalcitationsomitted).

120485U.S.224(1988),criticized in concurring opinion by HalliburtonCo.v.EricaP.JohnFund,Inc.,134S.Ct.2398(U.S.2014).

121Id. at 227.122Id. at 228.123Id. at 229.124Id., citing Levinson v. Basic Inc., 786 F.2d 741, 749 (6th Cir. 1986) (vacated and

remanded).

Ch. 12.III.A.1.


federalappealscourtsplitregardingthefraud-on-markettheorythattheSixthCircuit had adopted in its opinion.125

TheCourtbeganbyexaminingitspriordecisionsthatinterpretedtheaffir-mativedisclosureobligationsofissuersunderthefederalsecuritieslaws,notingthatithadadoptedastandardformaterialityintheproxy-solicitationcontextinTSC Industries, Inc. v. Northway,Inc.126 The TSC Industries decision held that “‘[a]nomittedfactismaterialifthereisasubstantiallikelihoodthatareasonableshareholderwould consider it important in deciding how to vote,’”127 and it further held that “‘there must be a substantial likelihood that the disclosure of theomittedfactwouldhavebeenviewedbythereasonableinvestorashavingsignificantlyalteredthe‘totalmix’ofinformationmadeavailable.’”128 The Basic Courtadoptedthisformulationofthematerialitystandardforsecuritiesfraudcases under Section 10(b) of the Exchange Act and Rule 10b-5.129 It also adopted theSecondCircuit’sbalancingapproachfordeterminingmaterialityissuesastowhetherdisclosuresneedtobemadeaboutcontingentorspeculativeinformationor events.130 As the Second Circuit had explained in Securities & Exchange Commission v. Texas Gulf Sulphur,131materiality“‘depend[s]...uponabalanc-ing of both the indicated probabilitythattheeventwilloccurandtheanticipatedmagnitudeoftheeventinlightofthetotalityofthecompanyactivity.’”132 In tryingtoprovidemorehelpabouthowtoapplythe“probability–magnitudetest”for determining whether merger discussions should be disclosed, the Courtnoted:

Whethermergerdiscussionsinanyparticularcasearematerial...dependsonthefacts.Generally...toassesstheprobability that the event will occur,afactfinderwill need to look to indicia of interest in the transaction at the highest corporate levels. . . . [W]enotebywayofexamplethatboardresolutions, instructionstoinvestmentbankers,andactualnegotiationsbetweenprincipalsortheirintermedi-ariesmayserveasindiciaofinterest.Toassessthemagnitude of the transaction to the issuerofthesecuritiesallegedlymanipulated,afactfinderwillneedtoconsidersuchfactsasthesizeofthetwocorporateentitiesandofthepotentialpremiumsovermarketvalue.No particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material.133

Federalcourtsroutinelyapplythismaterialitystandardinsecuritiesfraudcases against life sciences companies.For example, inConnecticut v. Mylan Laboratories, Inc.,134 the Third Circuit upheld the dismissal of a securities fraud suitagainstapharmaceuticalcompanyfornottimelydisclosingtheexistenceofanticompetitivesupplycontractsforsourcematerialsusedformanufacturingtwoofitsgenericantianxietymedications.Inholdingthatthefailuretodisclose

125Id. at 230.126426 U.S. 438 (1976).127Basic,485U.S.at231,citingTSC Indus., Inc., 426 U.S. at 449.128Id.at231–32,citingTSC Indus., Inc., 426 U.S. at 449.129Id. at 232.130Id. at 238.131401F.2d833,859(2dCir.1968).132Basic,485U.S.at238,citingTexas Gulf Sulphur Co., 401 F.2d at 849 (emphasis added).133Id. at 239 (internal note omitted and emphasis added).134230 F.3d 594 (3d Cir. 2000).

Ch. 12.III.A.1.


theexistenceandsubstanceofthecontractswasimmaterial,thecourtnotedthemanufacturerhaddisclosedthattheFTCwasinvestigating“whether...[it]hadengagedinactivitiesrestrictingcompetitioninthemanufactureorsaleofphar-maceuticalingredientsorproducts”and,further,thatit“maybeunabletorealizeitsplansandobjectives...iftheFTCconcludes...thattheCompanyhasactedimproperly.”135“[T]hispublicdisclosure...putpotentialinvestors...onnoticethatMylan’sallegedanticompetitiveactivity...couldsubjectthecompanytoantitrustactionbytheFTC.”136

Another decision worth noting is Ballan v. Upjohn Co.,137 a pre-PSLRA securitiesfraudclassaction,wherethecourtlikewiseappliedBasic’smaterialitystandardindecidingnottosummarilydismissasuitfiledbyinvestorsagainstthepharmaceuticalcompany, itsofficers,anddirectors.Theplaintiffsallegedthat the defendants committed securities fraud by disseminating misleadingreportsaboutthesleepingdrugHalcionandbynotdisclosingitssideeffects.138 InrejectingUpjohn’sargumentthatthenondisclosureswereimmaterial,139 the court found that the pleadings raised a fact issue, explaining that “althoughinformationmay trickle into themarket from third-party sources, statementsfromthecompanyitself,ortheabsencethereof,maybe‘viewedbyareasonableinvestor as having significantly altered the ‘total mix’ of information madeavailable.’”140 See also In re Sofamor Danek Group, Inc.,141 where the Sixth Circuit upheld the dismissal of a securities fraud class action against a medical devicemanufacturer.ThecourtappliedBasic’smaterialitystandardinassessingwhetherthemanufacturerhadcommittedsecuritiesfraudbyviolatingadutytodisclosetheillegalpromotionofitsdevicesanditspracticeofcharginghospitalsexcessivepricesforitsproducts.Plaintiffscontendedthat:

themarketwasunawarethatthecompanywasimproperlypromotingitsproductsforpedicularuseandthatsuchpromotionwashavingamaterialimpactonthecompany’sfinancialposition[;]...thatitwasnotuncommonforthecompany’ssalesrepresentativestoassistsurgeonsduringoperationsinwhichDanekscrewswereinsertedinthepedicle;thatthecompanysurrep-titiouslysponsoredseminarsatwhichpediclefixationwaspromoted[.]...142

AfterfindingthatthecompanyhadpubliclydisclosedtheFDA’swarnings(althoughithaddownplayedtheirsignificance),andnotingthatnoregulatoryactionshadbeentakenduringtheclassperiodorlater,thecourtruledthattheplaintiffs had not met their burden of proof.143

Inlightoftheoftenconfusinganalysisseenindecisionsthataddressdis-closure obligations, it helps to note that courts have employed a bifurcated

135Id. at 599–600 (internal note omitted).136Id.137814 F. Supp. 1375 (W.D. Mich. 1992).138Id.at1378.Specifically,“[p]laintiffs . . .claimthatdefendantsconsistentlytoutedthe

safetyandeffectivenessofHalciondespitedefendants’awarenessoftheproblemsexperiencedbypersonswhoconsumedHalcion.”Id. at 1379.

139Id. at 1381.140Id.at1382,citingTSC Indus., Inc., 426 U.S. at 449.141123 F.3d 394 (6th Cir. 1997).142Id. at 399.143Id. at 401–02.

Ch. 12.III.A.1.


approach for assessing securities fraud claims—depending on whether a com-plaint alleges that there were nondisclosuresthatviolatedsomeaffirmativedutyorifthecomplaintallegesaffirmativemisrepresentations.“Inomissioncases,itiscriticaltorecognizethedifferencebetweenthemerepossessionofmaterialinformationandadutytodiscloseit.Itisnowwellestablishedthat‘[s]ilence,absentadutytodisclose,isnotmisleadingunderRule10b-5.’”144

But...onceanissuer...choosestomakevoluntarydisclosures,[it]...hasadutytospeakcompletely....Inaddition,somecourtsfindthatifasecuritiesissuerchoosestomakevoluntaryforward-lookingdisclosures,[it]...alsohasadutytoupdatethoseforward-lookingstatementstoreflectanysubsequentdevelopmentsaslongastheoriginaldisclosuresremainaliveinthesecuritiesmarketplace....145

2. Quantitative StandardsTheSEChasnotalways required issuers tousequalitativestandards to

assess their disclosure obligations under the Commission’s various periodicreportingrequirements.Notuntilthe1970swasaqualitativestandardformate-rialityintroduced,whichdevelopmenttroubledissuersandcommentators,whocomplainedthataqualitativematerialitystandarddoesnotprovideabright-lightbenchmarkandcausecompaniestoerronthesideofdisclosurebydisclosinginformationthatmaynotbenecessaryornotinthecompany’sbestintereststodisclose.146 Although the number of items and the amount of information that issuersmustperiodicallysubmittotheSEChasincreasedovertheyears,147 much oftheinformationthatmayneedtobedisclosedcanbeassessedbyusingquan-titativestandards.Asonecommentatorhasexplained:

144AlanJ.Berkeley,Materiality, Informal Disclosure, Soft Information, and Forward Look-ing Statements Under Securities Laws247,254(ALI-ABASH001,2002),citingBasicInc.v.Levinson,485U.S.224,229(1988)andChiarellav.UnitedStates,445U.S.222(1980).

145PeterH.Huang,Moody Investing and the Supreme Court: Rethinking the Materiality of Information and the Reasonableness of Investor,13Sup. Ct. Econ. Rev.99,112–13(2005)(inter-nalnotesomittedciting,interalia,FirstVa.Banksharesv.Benson,559F.2d1307,1314(5thCir.1977),cert. denied,435U.S.952(1978)),abrogated in part as stated inNewbyv.EnronCorp.(In reEnronCorp.Secs.),610F.Supp.2d600,647(S.D.Tex.2009).

146See John Fedders, Qualitative Materiality: The Birth, Struggles, and Demise of an Unworkable Standard, 48 Cath. U. L. Rev.41,41(1998)(“Aquantitative standardofmaterialitytraditionallyhasbeenemployedwhenmakingdisclosuredecisionsunderthefederalsecuritieslaws.[It]...utilizesbenchmarksofassets,earnings,andliabilities,andismeasuredbyamount,number,orpercentage.Itsapplicationproducesreportsoffinancialresultsandforeseeablemate-rial financial consequences—information that is economically significant to investors. [¶] Inthe1970s,aqualitative standardofmaterialitywasintroducedbythe...Commission....Thestandardemployednodefinablebenchmarks.Themeasurementwasbyquality,kind,andessentialcharacterorconduct.TheSECviewedunadjudicatedviolationsoflaw,orevenantisocialoruneth-icalconduct,aspossiblegroundsfordisclosureregardlessofsizeorimpactonbusinessbecausecorporateofficialswerewillingtoengageinsuchconduct.”)(emphasisadded).

147See, e.g., Herbert S.Wander, Securities Law Disclosure After Sarbanes-Oxley, Post-graduate Course in Federal Securities Law (ALI-ABACourse of StudyMaterials,Aug.2004)(“TheSEC...made...majorrevisionstothedisclosurereportingsystemasaresultof...Sarbanes-Oxley...including:[¶]Faster insider reporting under Section 16(a)...[¶]CEO and CFO Certification...[¶]Speedier filings of Forms 10-K and 10-Q...[¶]Improvements to MD&A...[¶][and]Changes to Form 8-K”)(internalnotesomitted,emphasisadded,andpagereferencesnotavailable).

Ch. 12.III.A.2.


Regulation S-K sets out five major categories of both narrative and financialinformation that corporations must disclose. These . . . include information about theissuer’sbusiness;securitiesoutstandingandtobeissued;financialresultsofoperations;directorsandexecutiveofficers,includingmanagementcompensationandsecurityownershipbymanagement;andthespecificsofthestockissuance,whereapplicable.Withineachcategory,RegulationS-Kisextremelyspecificaboutwhat needs to be disclosed.148

Moreover,asanothercommentatornoted:“[t]heSEChaspromulgatedrulesspec-ifyinginformationthatmustbereportedinvariousdisclosuredocuments[] . . .thatreflecttheSEC’sjudgmentofwhatismaterialandgermanetoanevaluationofacompany’sbusiness,earnings,andprospects.Mostofthosemandatesrelatetoquantitativeinformation.”149Infairness,theCommissionhastriedtointegratethereportingprocess tominimizethecomplianceburden,allowingpartieswhohavemadeSecuritiesActdisclosurestoincorporatethembyreferenceintoreportsrequiredbytheExchangeAct.150

3. Qualitative StandardsThe SEC emphasizes that companies should not rely exclusively on a

quantitativeapproachwhenevaluatingwhetherinformationshouldbepubliclydisclosed.Itbelievesthatsomeinformationistooimportantnottodisclose,evenif itmaynot reasonablybeexpected to immediatelyor significantlyaffect acompany’sbottomline.Inthatregard,variousSECregulationsrequirepubliclytradedcompaniestodisclosecertainqualitativecategoriesofinformation,suchascompanyfinancials.151 Other important examples of disclosure requirements involvingqualitative informationare setout in theprovisions relating to theloyaltyandhonestyofcorporateofficialstowardtheiremployerinItem401(f)ofRegulationS-K(whichmandatesthereportingofcriminalchargesandciviljudgmentsinvolvingfederalsecuritieslawviolations),andItem404ofRegula-tionS-K(whichmandatesreportingofself-dealingandconflictsofinterest).152

4. Optimistic Statements Versus Specific PredictionsFederal courts acknowledge that a substantial amount of business speech

isnotactionableunderthesecuritieslaw,particularlystatementsthatreasonableinvestorsshouldknowtheycannotrelyuponbecausethestatementsareincapa-

148CynthiaA.Williams,The Securities and Exchange Commission and Corporate Social Transparency,112Harv. L. Rev.1197,1207–08(1999)(internalnotesomittedreferring,respec-tively,toReg.S-K,Items101–3,Items201–02,Items301–04,Items401–05,andItems501–12).

149Fedders,at45(internalnotesomittedciting,asexamples,RegulationS-B,17C.F.R.pt.228(1998)(disclosureforsmallbusinessissuers);RegulationS-K,17C.F.R.pt.229(requisitecontentsofcertaindisclosureforms);andRegulationS-X,17C.F.R.pt.210(statementsregardingcompanyfinancials)).

150Id.(internalcitationsomittedreferringtotheSEC’sAdoptionofIntegratedDisclosureSystem,SecuritiesActReleaseNo.6383,ExchangeActReleaseNo.18524,24SECDocket1262,1262,1300(Mar.3,1982)(adoptingintegrateddisclosure)).Severaloftheitemsthatmustbeperi-odicallysubmittedtotheSECbyissuersareaddressedinmoredetailatSectionsIII.B.andIII.C.

151SeeMichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update§5.04(citingFedders,48Cath. U. L. Rev. at 45).

152SeeFedders,at45.

Ch. 12.III.A.2.


bleofverification.Ashasbeennoted,courtswillexaminestatementsallegedtobefraudulentormisleadingtodetermineiftheyweremadeingoodfaithorbadfaith,orlackedareasonablebasisinfactwhenmade.Thisisbecausecourtshaveheld that “disclosure of an opinion or estimate implies a representation that the opinionorestimatehasbeenformedonareasonablebasis,andthatrepresenta-tionisconsidereda‘fact’withinthecoverageofsections11and12(2)ofthe1933 Act and Rule 10b-5.”153

An example of this is found in In re Transkaryotic Therapies, Inc. Securi-ties Litigation,wherethecourtrefusedtosummarilydismissasecuritiesfraudclass action complaint alleging that a pharmaceutical manufacturer made false andmisleadinglyoptimisticstatementsabouttheefficacyofitsnewdrug(Repla-gal) for treating Fabry’s disease154 and the likelihood that the FDA would approvethedrug.Theplaintiffschargedthatthemanufacturerhadnotpubliclydisclosed the serious concerns the FDA had expressed about the product. Based onthesefacts,thecourtheldthatthemanufacturer’sexpressionsaboutobtainingFDAapprovalofitsNDAcouldnotfairlybecategorizedasnonactionableopti-mism;rather,theyweremisleading.Asthecourtexplained,“[i]na‘CompleteReviewLetter’...theFDA’sCenterforBiologicsEvaluationandResearch...deniedapprovalforReplagal.Thisnon-publicletterstatedbluntly...thatboth...[NDAs]‘failedtodemonstrateefficacy.’”155AdayafterTranskaryoticTher-apiesreceivedthecompletereviewletter,itissuedapressreleasethatonlysaidthattheFDAaskedformoreinformation;overaprotractedperiod,thecompanycontinuedtoissuesimilarstatementswhiletrumpetingtheefficacyofitsprod-ucts, leadinganalysts to report thatFDAwould soonapprove thedrug.156 In defense,Transkaryotic argued that its actionswere not actionable fraud, butmerelyanexpressionofoptimism,citingIn re Biogen Securities Litigation157 as support.158 After examining the holding in Biogen, thedistrictcourtobservedthat“[t]he‘mostrelevantanddisappointingaspect’oftheBiogenstudywasitsfailuretoshowefficacy—preciselytheinformationthat...[Transkaryotic]didnot disclose in the present case.”159

a. Soft Information and PufferySoftinformation“refer[s]generallytoinformationaboutaparticularissuer

oritssecuritiesthatinherentlyinvolvessomesubjectiveanalysisorextrapola-tion,suchasprojections,estimates,opinions,motives,orintentions.”160 In light

153319 F. Supp. 2d 152 (D. Mass. 2004).154Fabry’sdiseaseisafatstoragedisordercausedbyanenzymedeficiencythatputssufferers

atincreasedriskofstrokes,heartattacks,andkidneydamageastheygrowolder.See http://www.ninds.nih.gov/disorders/fabrys/fabrys.htm.

155Transkaryotic Therapies, Inc., 319 F. Supp. 2d at 156.156Id. at 156–57.157179F.R.D.25,39(D.Mass.1997).158Transkaryotic Therapies, Inc., 319 F. Supp. 2d at 159.159Id.160BruceA.Hiler,The SEC and the Courts’ Approach to Disclosure of Earnings Projections,

Asset Appraisals, and Other Soft Information: Old Problems, Changing Views, 46 Md. L. Rev. 114,116(1987)(internalnoteomitted,citingKohnv.AmericanMetalClimax,Inc.,458F.2d255,265(3dCir.),cert. denied,409U.S.874(1972),disapproved byErnst&Ernstv.Hochfelder,425

Ch. 12.III.A.4.a.


oftheclearlysubjectivenatureofsoftinformation,courtsordinarilywillrejectclaimsthatdependonsuchevidence,reasoningthatsoftinformationcannotbematerial.“[I]ndeterminingwhetherstatementsareimmaterialunderthefederalsecurities laws it is important to ask whether a reasonable person would be able toobjectivelyverifythestatements.If...notverifiable,theylikelycanbecat-egorizedas‘softinformation’andwillnotalonesupportanyclaimsforsecuritiesfraudliability....”161

Statementsthatcanfairlybecategorizedasadvertisingtalkor“puffery”constituteacommonlyencounteredtypeofsoftinformation.Still,inordertoreceiveprotection,evenstatementsthatqualifyaspufferymustbemadeingoodfaith. As one scholar explains:

[S]tatementsthataretoovague,promotional,orhyperbolic,constitutemerepufferyandarethereforeimmaterialasamatteroflaw....Thepufferydoctrineis...closelyrelated to so-calledpufferyclaimsarising inFederalTradeCommission (FTC)regulationofconsumerproductadvertising;casesofFTCenforcementprosecutionsagainstdeceptiveadvertising;andtheFTC’sPolicyStatementonDeception.162

TheSixthCircuitexplainedtherespectiveattributesofsoftinformationandhardinformation in In re Sofamor Danek Group, Inc.,163 as follows:

ThepropositionthatthecompanywasengaginginillegalpromotionofitsproductswhenithelpedfundtheSpinalScienceAdvancementFoundationandalloweditssalesrepresentatives...toattendoperationswheresurgeonsmadeattachmentstothepedicle[thecompany’smedicaldevice]isnotapropositionthatcanfairlybesaidtofallinthecategoryof“hard”information.Hardinformation“istypicallyhistoricalinformationorotherfactualinformationthatisobjectivelyverifiable....”Suchinformationistobecontrastedwith“soft”information,whichincludespredic-tionsandmattersofopinion....ThelegalityofSofamorDanek’ssupportforthenon-profitfoundation,forexample,wasamatterofopinion—”softinformation.”And“ourcasesfirmlyestablishtherulethatsoftinformation...mustbedisclosedonlyif...virtuallyascertainashardfacts.”164

Severalfederalcourtshavehadtodecidewhetherstatementsbypharma-ceuticalmanufacturers andmedical device companies are protected asmerepufferyorarenotprotectedbecausetheywerenotmadeingoodfaithorlackeda reasonable basis for being made. An example is seen in In re Cambrex Corp.

U.S.185,96S.Ct.1375(1976),overruled in part by Kershner v. Mazurkiewicz,670F.2d440(3dCir.1982)(softinformationincludes“futureearnings,appraisedassetvaluationsandotherhypo-thetical data”)). See alsoSusannaKimRipken,Predictions, Projections, Precautions- Conveying Cautionary Warnings in Corporate Forward-Looking Statements, 2005 U. Ill. L. Rev. 929,937–38 (2005) (“Soft information generally encompasses predictive statements or subjectiveanalyses,suchasprojections,forecasts,plans,opinions,motives,or intentions.Thesetypesofstatementsoftenrequirethepassageof timetodiscerntheir truthorfalsity,unlikeobjectivelyverifiablehistoricalfacts,or‘hardinformation.’”)(internalnotesomitted).

161MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.04.

162PeterH.Huang,Moody Investing and the Supreme Court—Rethinking the Materiality of Information and the Reasonableness of Investor, 13 Sup. Ct. Econ. Rev.99,113(2005).

163123 F.3d 394 (6th Cir. 1997).164Id. at 401–02 (internal citation omitted).

Ch. 12.III.A.4.a.


Securities Litigation,165where a district court partially dismissed a securitiesfraudclassactionagainstapharmaceuticalmanufacturer.Inrejectingtheargu-mentthat“manyoftheallegationsmadebyplaintiffsintheircomplaint...areinactionable statements of corporate optimism, or are forward-looking state-ments...protectedbythesafeharborprovisionofthePSLRAandthebespeakscautiondoctrine,”166thecourtexplainedthatevenstatementsthatwouldseemtobepufferycanbeactionableifnotgroundedingoodfaith:

[Puffing]statements,evenifarguablymisleading,donotgiverisetoafederalsecu-ritiesclaimbecausetheyarenotmaterial....However...statements of opinion by top corporate officials may be actionable if they are made without a reasonable basis. . . .Thereason. . . is thatsuchstatements“canbemateriallysignificanttoinvestorsbecauseinvestorsknowthatthesetopofficialshaveknowledgeandexpertisefarexceedingthatoftheordinaryinvestor.”167

Another district judge reached the same conclusion in In re Intermune, Inc.,168rejectingtheargumentthatthechallengedstatementsweremerepuff-ery.169Inexplainingitsdecision,thejudgecitedIn re Apple Computer Securities Litigation,whichheldthat“[a]projectionorstatementmaybequestionedifanyofthefollowingthreefactorsareaccurate:(1)thestatementisnotgenuinelybelieved;(2)therelacksareasonablefoundationforthebelief;or(3)thespeakerisawareofundisclosedfactsthattendtodiscredittheaccuracyoftheprojec-tion.”170 See also In re Viropharma, Inc. Securities Litigation,171 where a district judge partially granted amotion to dismiss the securities fraud class actioncomplaint that claimed the pharmaceutical manufacturer had issued false and misleading statements about its drug product for treating the most common causeofcolds.Asthecourtexplained,suchstatementsweremorethanmerepuffingbecause“thePlaintiffshavepleadedthatthestatementsmadebyDefen-dantswerecontrary to the thenexistingstateof facts, forexample, thatPle-conarilwaseffectiveforalladultswhenitwasnot.”172

b. The “Bespeaks Caution” DoctrineThe“bespeakscaution”doctrine,whichwascraftedbythecourts,served

asthebasisforsubsequentstatutoryandregulatorysafeharborsintroducedbyCongressandtheSECtoprotectcompanydisclosuresthatmeetcertainrequire-ments. The bespeaks caution doctrine is analogous to the concept of caveat emptor and permits defendants in securities fraud cases to call attention to prior publicwarningsthatsignaledtheinherentunreliabilityofstatementsclaimedto

165No.03-CV-4896(WJM),2005WL2840226(D.N.J.Oct.27,2005).166Id. at *4.167Id. at *6 (internal citations omitted).168No.C03-2954SI,2004WL1737264(N.D.Cal.July30,2004)(unreported).169886F.2d1109,1113(9thCir.1989).170Intermune,2004WL1737264,at*4,citingIn reAppleComputerSec.Litig.,886F.2d

at 1113.171No.02-1627,2003WL1824914(E.D.Pa.Apr.7,2003)(unreported),called into doubt

by Heywoodv.CellTherapeutics,Inc.,No.C05-0396RSM,2006WL5701625(W.D.Wash.May4,2006).

172Id. at *6.

Ch. 12.III.A.4.b.


beactionableunderthesecuritieslaws.Asablynoted,“[s]ecuritiescasescontainsuchan‘Itoldyouso’issue,formallyreferredtoas‘bespeakscaution.’Caselaw indicates that themateriality of forward-looking statements.[173] must be evaluatedinlightofwarningsorcautionarystatementsmadebythedefendantsprior to the release of the bad news. . . .”174Thedoctrinecoversthecategoriesofstatementscommonlyconsideredtobeimmaterial,suchasforecasts,projec-tions,andopinions.Importantly,evenifacompanycannotachievesafeharborstatus under the statutoryor regulatoryprovisions, this doctrinemay still beasserted by the defense.175Nevertheless, a pharmaceuticalmanufacturer or amedicaldevicecompanywillwanttotakeadvantageofthestatutorysafehar-borsbecausethereareproceduraladvantagesindoingso.176

Thebespeaks caution defense hasmetwith varying results because theissuesarefactuallybound.Afewrepresentativecasesillustratesomesuccessesandfailuresbylifesciencesentitiesthathaveraisedthisdefense.Forexample,in Warshaw v. Xoma Corp.177 the court held that a pharmaceutical manufacturer failedtoadequatelyqualifyitsstatements(aboutobtainingFDAapprovalforitsdrugproduct)asnecessaryforobtainingsafeharborprotection.Inalatercase, In re QLT Inc. Securities Litigation,178 a pharmaceutical manufacturer assertedbespeakscautionasadefense,but itdidnotqualify forprotectionbecausethecompany’spublicestimatesaboutitsproductfortreatingmaculardegenerationdiseasewerenotforward-looking,didnotmeetthestatutoryandregulatorysafeharborprotections,anddidnotqualifyforprotectionunderthebespeaks caution doctrine: “Because statements identified in the ComplaintregardingthesizeoftheexistingmarketforVisudyneandQLT’sprogressinseeking HCFA approval concern existing facts and are therefore not ‘for-ward-looking,’[they]...aresubjecttoneitherthestatutory‘safeharbor’northe‘bespeakscaution’doctrine.”179

173SeeTowerSnow,Jr.,etal., Defending Securities Class Actions,Securities Litigation: Planning and Strategiesforthe’90sand Beyond(ALI-ABASH083,1996),at205–06(“TheReformActdefinesaforward-lookingstatementasfollows:[¶]1)astatementcontainingapro-jectionofrevenues,income(includingincomeloss),earnings(includingearningsloss)pershare,capitalexpenditures,dividends,capitalstructure,orotherfinancialitems;2)astatementofplansandobjectivesofmanagementforfutureoperations,includingplansorobjectivesrelatingtotheproductsorservicesoftheissuer;3)astatementoffutureeconomicperformance,includinganysuchstatementcontainedinadiscussionandanalysisoffinancialconditionbythemanagementorintheresultsofoperationsincludedpursuanttotherulesandregulationsoftheCommission;4)anystatementoftheassumptionsunderlyingorrelatingtoanystatementdescribedaboveinsubparagraph(A),(B),or(C);5)anyreportissuedbyanoutsidereviewerretainedbyanissuer,totheextentthatthereportassessesaforward-lookingstatementmadebytheissuer;or6)astatementcontainingaprojectionorestimateofsuchotheritemsasmaybespecifiedbyruleorregulationoftheCommission.15U.S.C.§77z-2(i);15U.S.C.§78u-5(i).”).

174MituGulatietal.,Fraud by Hindsight, 98 Nw. U.L. Rev.773,793–94(2004)(internalnotes omitted).

175SeeMichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update§5.04.

176ThestatutorysafeharborsarediscussedinSectionIII.A.4.c.,below.17774 F.3d 955 (9th Cir. 1996).178312F.Supp.2d526(S.D.N.Y.2004).179Id. at 533 (emphasis added).

Ch. 12.III.A.4.b.


Ontheotherhand,thecourtinIn re Bausch & Lomb, Inc. Securities Liti-gation180heldthatthecompany’sstatementsqualifiedforprotectionandpartiallydismissedthesecuritiesfraudclassaction(whichallegedthatBausch&Lombhad filed materially misleading periodic reports with the SEC regarding itspharmaceutical, surgical segment,andvisionsegments).Thecourtexplainedthat“‘[t]hetouchstoneofthe[bespeakscaution]inquiryisnotwhetherisolatedstatementswithinadocumentweretrue,butwhetherdefendants’representationsoromissions,consideredtogetherincontext,wouldaffectthetotalmixofinfor-mationandtherebymisleadareasonableinvestorregardingthenatureof thesecuritiesoffered.’”181Bycomparison,thecourtinBarrios v. Paco Pharmaceu-tical Services, Inc.,182 found thatacompany’sprivateplacementmemosuffi-cientlydisclosed thematerial investment risks for investors. It explained thecontoursofthebespeakscautiondoctrineasfollows:“Theeconomicprojectionswerecloakedinexpresswarningsthattheywereentirelyspeculative;theyarenotactionable,becausetheybespeakcautioninpreciselanguageandspecificallydisclosethenatureandextentoftherisksinvolved.”183

A non-pharmaceutical securities fraud decision worth examining is Iowa Public Employees’ Retirement System v. MF Global, Ltd.,184 which addressed the judiciallycreatedbespeakscautiondoctrine.Inthisdecision,theSecondCircuitreinstatedasecuritiesfraudcomplaintafterfindingthatthedoctrinehadbeenapplied improperly to dismiss the complaint. The plaintiffs alleged thatMFGlobal’s2007prospectusandregistrationstatementincludedmaterialmisstate-ments and omissions that exaggerated its risk-management measures. After news brokethatanMFGlobalbrokerhadevadedthecompany’stradingrestrictionsandlost$141millionwhilespeculatinginwheat,185thecompany’sstockpricedropped28percentinaday,followedbyanother17percentthenextday—foracapitalizationlossofmorethan$1.1billionintwodays.186

Infindingthatthetrialjudgehaderredinrelyingonthebespeakscautiondoctrinetodismissthecomplaint,theSecondCircuitnotedthat“characteriza-tionsofMFGlobal’srisk-managementsystem...invitetheinferencethatthesystemwillreducethefirm’srisk.However,bespeakscautiondoesnotapplyinsofarasthosecharacterizationscommunicatepresentorhistoricalfactastothe measures taken.”187

YetanothernuanceisseenfromIowa Public Employees’ Retirement Sys-tem,which illustrates how different courts of appeal address securities fraud liabilityissueswhenstatementshaveamixedpresentandfuturecomponent,asthefollowingcommentaryexplains:

180No. 01-CV-6190 (CJS), 2003 U.S. Dist. LEXIS 24062 (W.D.N.Y. Mar. 28, 2003)(unreported).

181Id. at*8 (internal citationomitted).Thecourt alsonoted that “[t]obeeffective, suchcautionarylanguageneedsto‘identifytheallegedlyundisclosedrisk,’andmustnotbesuchthatitwouldmisleadareasonableinvestor‘intothinkingthattheriskthatmaterializedandresultedinhislossdidnotactuallyexist.’”Id.

182816F.Supp.243(S.D.N.Y.1993).183Id. at 250.184620 F.3d 137 (2d Cir. 2010).185Id. at 139.186Id.187Id. at 142 (internal citations omitted).

Ch. 12.III.A.4.b.


TheSecondCircuitsuggeststhat[the]districtcourtshouldseverforward-lookingcomponents from statements also containing present components. The Third Cir-cuit, inInreAetna, Inc.SecuritiesLitigation,No.09-2970,2010WL3156560(3dCir.Aug.11,2010)...heldthatdespitethatcertainelementsofdefendants’statementsregardingpricingpolicieswerepartlyhistorical,thoseelementscouldnotbedistinguishedfromthestatements’otherassertionsaboutthefuture.TheThirdCircuit explained that while mixed present/future statements are “not entitled to thesafeharborwithrespecttothepartofthestatementthatreferstothepresent,”when the present tense statements cannot “meaningfully be distinguished fromthefutureprojectionofwhichtheyareapart,”totheextentthatthosestatementscontainedassertionsaboutthepresent,“theassertionsofcurrentfactaretoovagueto be actionable.”188

c. Statutory Safe Harbors: Forward-Looking StatementsIn accordance with the Exchange Act189andtheSecuritiesAct,190 the SEC

haspromulgatedregulatorysafeharborrulestoprovidepubliclytradedcompa-nieswith incentives to disclose financial information.191Although theSEC’sregulatorysafeharborrulesareofsomehelptoissuerswhenmakinginforma-tional disclosures, they are not as robust as the safe harbor protections thatCongresslaterenactedinthePSLRA.“Thekeydifferencebetweentheprotec-tionsofferedbythesafeharborsintheSECrules—comparedtothestatutorysafe harbors under the PSLRA—is that the latter ‘shield certain forward-looking statementsfromprivateactionsunder theanti-fraudprovisionsof thefederalsecuritieslaws.’”192

Notably, thestatutorysafeharborsdonot require issuers to update their forward-looking statements.193But,somesignificantlimitationsexisteveninthescopeofthestatutorysafeharbors.Specifically,becauseoftheoperativelan-guage,theydonotcoverforward-lookingstatementsmadeaspartofaninitialpublic offering or a tender offer under the Securities Act or the Exchange Act.194

188JohnP. Stigi III&SarahE.Aberg,Second Circuit Rejects Application of “Bespeaks Caution” Doctrine to Statement Containing Both Historical and Forward-Looking Elements,Nat’l L. Rev. (Sept. 28, 2010), available at http://www.natlawreview.com/article/secondcircuit-rejects-application-bespeaks-caution-doctrine-to-statement-containing-both-hi.

18915U.S.C.§78u-5.19015U.S.C.§77z-2.191SeeSectionIII.B.4.d.,below,discussingRules175and3b-6(safeharborforforward-

ing-lookingstatements),whichrespectivelycoverdisclosuresofinformationundertheSecuritiesAct and the Exchange Act.

192MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.05(internalnotesomitted,citingAllanHorwich,Section 11 of the Securities Act: The Cor-nerstone Needs Some Tuckpointing,58Bus. Law.1,34(Nov.2002)andPeterH.Huang,Moody Investing and the Supreme Court: Rethinking the Materiality of Information and the Reasonable-ness of Investor, 13 Sup. Ct. Econ. Rev.99,126–27(2005)).

193TowerC.Snow,Jr.,etal.,Defending Securities Class Actions,Securities Litigation: Planning and Strategiesforthe’90sand Beyond(ALI-ABASH083,1996)(internalnoteomitted,citing15U.S.C.§§77z-2(d)and78u-5(d))(pagereferencesunavailable).

194SeeSecuritiesAct§27A(b)(2)(D)andExchangeAct§21E(b)(2)(D),codifiedat15U.S.C.§§77z-2(b)(2)(D)and78u-5(b)(2)(D),respectively.See alsoHorwich,58Bus. Law. at 34 (“In the PSLRA,Congresscreatedasafeharborfromprivatecivilliabilityforforward-lookingstatementsin certain documents under both the Securities Act and the Exchange Act . . . . The safe harbor

Ch. 12.III.A.4.b.


The statutory safeharbors for forward-looking statementsprovide threeseparatemechanisms to avoid securities law liabilitywhenmaking informa-tional disclosures:

First,theSafeHarborappliesiftheforward-lookingstatementisaccompaniedby“meaningfulcautionarystatements”identifyingimportantfactorsthatcouldcauseactualresultstodiffer....Second,[it]...protectscorporationsfromliabilityiftheforward-lookingstatementisimmaterial.Finally,thecorporationisprotectediftheplaintiffcannotprovethattheforward-lookingstatementwasmadewith‘actualknowledge’thatitwasfalseormisleading....”195

Moreover, issuersmust clearly identify all statements that are forward-lookinginordertobeeligibleforprotectionunderthestatutorysafeharborsforforward-lookingstatementsprovidedunderSection27AoftheSecuritiesAct,and Section 21E of the Exchange Act.196Inseveraldecisions,pharmaceuticalmanufacturersandmedicaldevicecompanieshavefailedtosatisfytherequire-mentsofthestatutorysafeharbortoprotecttheirpublicstatements.Observinghowthesedefendantsfellshortofthedifferentrequirementsisillustrative.

In In re Regeneron Pharmaceuticals, Inc. Securities Litigation,197 a court deniedapharmaceuticalcompany’smotiontodismissasecuritiesfraudclassaction complaint in which the plaintiffs alleged that Regeneron Pharmaceuticals includedfalseandmaterialmisstatementsinForm10-QsfiledwiththeCom-mission. The complaint focused on the purported discussion in the Form 10-Qs aboutthesafetyandefficacyresultsobtainedduringclinictrialsforthefast-trackdevelopmentofitsexperimentaldrugtocombatobesity.198 In deciding that the safeharborwasnotavailabletothedefendant,thedistrictjudgemadetwokeyobservations: First, “[s]tatements that might arguably have some forward-looking aspect are unprotected by the PSLRA safe harbor provision to the extent

isavailableonlytoanissuerthatfilesreportswiththeSECasapubliclytradedcompany.The safe harbor does not, however, apply to a statement ‘made in connection with an initial public offering.’Takentogether,theseprovisionsmeanthat,insofarasthesafeharborisavailableforaforward-lookingstatementmadeinaregistrationstatement,itisavailabletoacompanythatisalreadyfilingreportsasapubliclyheldcompanyandpreviouslymadearegisteredpublicoffer-ing.Thatis,thestatutorysafeharborisnotavailableforstatementsmadeinconnectionwithaninitialpublicofferingeveniftheissuerisalreadyreportingasapubliccompany.”)(internalnotesomitted and emphasis added).

195SusannaKimRipken,Predictions, Projections, Precautions Conveying Cautionary Warn-ings in Corporate Forward-Looking Statements, 2005 U. Ill. L. Rev.929,932–33(2005)(internalnoteomitted,citing15U.S.C.§§77z-2and78u-5).

196SeeSnow(“TheReformActaddsa‘safeharbor’forforward-lookingstatementsmadeundercertainconditions.SecuritiesAct,§27A;ExchangeAct§21E.Thesafeharborapplieswhenaforward-lookingstatementis(1)identifiedassuchandaccompaniedby‘meaningfulcautionarystatementsidentifyingimportantfactorsthatcouldcauseactualresultstodiffermateriallyfromthoseintheforward-lookingstatement,’orisnotmaterialor(2)iftheplaintifffailstoprovethatthe forward-looking statement was made with actual knowledge that it was false or misleading. If thestatementismadeonbehalfofacompany,thecompanywillnotbeliableunlessanexecutiveofficerapproved the statementand thatofficerhadknowledge that the statementwas falseormisleading.”)(pagereferencesunavailable).

197No.03Civ.3111(RWS),2005WL225288(S.D.N.Y.Feb.1,2005)(unreported),dis-agreed with by In reNYSESpecialistsSecuritiesLitigation,No.03CIV.8264(RWS),405F.Supp.2d281(S.D.N.Y.Dec.13,2005).

198Id. at *7.

Ch. 12.III.A.4.c.


that they are premised on representations of present fact.”199Second,“thesafe harbor provision does not protect a statement made with ‘actual knowledge’ that it was false and misleading[][and]PlaintiffshaveallegedthatDefendantsactedwith such knowledge.”200

SimilarlyinIn re Amylin Pharmaceuticals, Inc. Securities Litigation,201 the courtdeniedamotiontodismiss thecomplaintafterfindingthatbecausethecompany’sdisclosuresaboutitstestingandtheresultsofitsdrugtotreatmeta-bolic disorders were not forward-looking, they were not protected by thePSLRA’ssafeharbor.Asthejudgenoted,“[t]oreceivesafeharborprotection,this forward-looking statementmust have been accompanied bymeaningful languageidentifyingimportantfactorsthatcouldcauseactualresultstodiffermateriallyfromthoseintheforward-lookingstatement.”202Butthecautionarylanguage thatAmylin Pharmaceuticals included in its SECfilings, the courtexplained,was“nottailoredtoDefendants’statementregardingthesufficiencyofthetrialresultsanddidnotprovidemeaningfulinformation...regardingtheFDA’sconcernthatthetrialdesignswereinconsistentwithclinicalpracticeandthat data from such trials would not be considered pivotal data for NDAapproval.”203

In Asher v. Baxter International Inc., 204asecuritiesfraudclassaction,thecontinueduseofboilerplateriskwarningsaftervariousnegativedevelopmentspreventedthepharmaceuticalmanufacturerfromobtainingsafeharborprotec-tion.By comparison, in In re Columbia Laboratories, Inc. Securities Litiga-tion,205thecourtheldthatapharmaceuticalcompanywasentitledtosafeharbortreatmentbecauseitcompliedwiththerequirementsofthePSLRA’sstatutorysafe harbor. Columbia Laboratories had made statements about two experimen-taldrugs(Advantage-SandCrinone)beingtestedthatithopedwouldproveto

199Id. at *13 (emphasis added and internal notes omitted).200Id.,citing15U.S.C.§78u-5(c)(1)(B).201No.01-CV-1455BTM(NLS),2003WL21500525(S.D.Cal.May1,2003)(unreported).202Id. at *7.203Id. at *7–8.204377F.3d727(7thCir.2004).AstheSeventhCircuitexplained,Baxterdidnotchangeits

boilerplatecautionsevenafteritreceivedbadnews.Subsequently,itwasimpropertodismisstheplaintiffs’allegationsatthesummaryjudgmentstage.See id. at 734:

Thestatutecallsforissuerstorevealthe“importantfactors”butnottoattachprobabilitiestoeachpotentialbadoutcome,ortorevealindetailwhatcouldgowrong....YetBaxter’schosenlanguagemayfallshort.Thereisnoreasontothink...beforeplain-

tiffshaveaccesstodiscovery—thattheitemsmentionedinBaxter’scautionarylanguagewerethosethatatthetimewerethe...“important”sourcesofvariance.Theproblemisnotthatwhatactuallyhappenedwentunmentioned;issuersneednotanticipateallsourcesofdeviationsfromexpectations.Rather,theproblemisthatthereisnoreason(onthisrecord)toconcludethatBaxtermentionedthosesourcesofvariancethat(atthetimeoftheprojection)weretheprincipalorimportantrisks....Moreover,the cautionary language remained fixed even as the risks changed. . . . This raises the possibility—nogreaterconfidenceispossiblebeforediscovery—that Baxter omitted important variables from the cautionary language and so made projections more certain than its internal estimates at the time warranted. Thus thiscomplaintcouldnotbedismissedunderthesafeharbor,thoughwecannotexcludethepossibilitythatifafterdiscoveryBaxterestablishesthatthecautionsdidrevealwhatwere,ex ante,themajorrisks,thesafeharbormayyetcarrytheday.(emphasis added).205144 F. Supp. 2d 1362 (S.D. Fla. 2001).

Ch. 12.III.A.4.c.


besafeandeffectivebecauseofahugerevenuepotential.206 The court found that thechallengedstatementswereclearlyforward-lookingandhadbeenproperlyidentifiedassuch;therefore,theywereprotectedunderthesafeharbor.207

Another example about the importance of issuing proper forward-looking statementsforthestatutorysafeharborisfoundinSarafin v. BioMimetic Ther-apeutics, Inc.,208whereajudgedismissedaprivatesecuritiesfraudcomplaintbecause the company was held to have adequately warned investors aboutinvestment risks associatedwith theFDAapprovalprocess. In this case, theplaintifffiledaputativeclassactioncomplaintagainstthecompany,itsfounder/CEO,anditsCFO.Theplaintiffclaimedtheyhadknowinglyorrecklesslymademateriallyfalseandmisleadingrepresentationstoinvestorsaboutclinicaltrialsof the company’s flagship bone-grafting product and its prospects for FDAapproval.209Duringaclinicaltrial,thecompanyhadswitchedtoasubsetoftheidentifiedpatientpopulationwithwhomtheproductwasbeingtestedunderthepremarketapprovalprocess(whichexaminesmanufacturinginformation,datafrompreclinical studies,andclinical trials todeterminewhethera sponsoreddeviceissafeandeffectiveforitsintendeduse).Thischangefromtheprotocol,plaintiffclaimed,skewedthesignificanceoftheresultsandrenderedthetestinginsufficientfortheFDAtoapprovetheproduct.210Inevaluatingtheallegations,thejudgeobservedthatalthoughthecompanymaynothavehadadutytospeak,ithadtodosotruthfullyonceitchosetospeak.211Inthatregard,thecompany’sswitching of patients in the protocol was done in response to an FDA request to correctdeficienciesidentifiedinaconditionalapprovalletter.212 The FDA expert panelhadrecommendedapprovingtheproduct,whichsupportedthecompany’sexpressedoptimism,andthefactthattheofficershadpouredtheirmoneyintothecompanydidnotsupportthattheirmotivewastocommitsecuritiesfraud.213

206Id. at 1365–66.207Asthejudgeexplained,[T]hedisputedstatements...withrespecttoAdvantage-Sconstituteforward-looking

statements.AllofthedisputedstatementsreflectDefendants’optimismandexpectationsaboutafutureevent...anditsfutureplansforitsproductbasedonthatassumption.Defen-dantsstatethattheyare“optimistic”Advantage-SwouldpasstheUNAIDSstudy...,thatthey“believed”Advantage-SwouldbetheonlyproductavailabletowomentopreventthetransmissionofHIV...,andthatthey“believed”ColumbiawouldreceiveFDAapprovalwithinsixmonths....DefendantsfurtherprojectedthatsuccessfulcompletionofthestudywouldleadtoFDA“approvalinsixmonthsofsubmission”...,a“world-widemarketforsuchproductsexceeding$1billion”...,andathreeorfouryearinvestmentperiod....Thesoundnessoftheseexpectationsorthemotivationforthemisirrelevanttotheanalysis.Thesestatementsarealllinkedtothesamefutureeventandrefertoitaccordingly—thepos-siblesuccessfulcompletionoftheUNAIDSstudy.Thus,thestatementsmadebyDefendantsregardingAdvantage-Stoutingitspossibleeffectivenessandpromotingitsmarketabilityclearlyconstituteforward-lookingstatementsunderthePSLRAinthattheyare“assump-tionsunderlyingorrelatingto”the“plansandobjectivesofmanagement...relatingto”Advantage-S.15U.S.C.§78u-5(i)(1)(B),(D).

Id. at 1368 (internal citations omitted).208No.3:11-0653,2013U.S.Dist.LEXIS4909(M.D.Tenn.Jan.10,2013).209Id. at *1–2.210Id. at *6–7.211Id. at *26.212Id. at *27–28.213Id. at *46–47.

Ch. 12.III.A.4.c.


Inapairof lawreviewarticlesdiscussedbelow, theauthorsaddressedwhattheyregardedasmajormistakesmadebysomefederalcourtsinassessingtheavailabilityofthePrivateSecuritiesLitigationReformActof1995214 statu-torysafeharborprotectionforforward-lookingstatements.Althoughthestatuteprovidesalternateprongsforsatisfyingthesafeharbortest,somecourtshaveeffectivelyconflatedtheprongsintoasingletest,holdingthatnoprotectionisavailable to individuals or businesses that knowingly provide incomplete orinaccurate information in forward-looking statements. A closer look at the lan-guageofthisstatutorysafeharborhelpsilluminatetheconflictingapproaches.Note that although a knowledge element is included inProngTwo, no suchrequirementappearsinProngOne.Further,becauseCongressusedthedisjunc-tiveterm“or”toseparatetheseprongs,therulesofstatutoryconstructionsuggestthatCongresschosetomakethetestsdifferentbynotincludingaknowledgeelement in Prong One.215

Companionsafeharborprovisionsforforward-lookingstatementsappearintheSecuritiesActandintheSecuritiesExchangeAct,respectivelycodifiedat15U.S.C.§77z-2and15U.S.C.§78u-5(b)(2)(D).Belowisthepertinenttextfrom the Securities Act:

Sec. 77z-2. Application of Safe Harbor for Forward-Looking Statements(c) Safe harbor(1) In generalExceptasprovidedinsubsection(b)...,inanyprivateactionarisingunderthissubchapter that is based on an untrue statement of a material fact or omission of a materialfactnecessarytomakethestatementnotmisleading,apersonreferredtoinsubsection(a)...shallnotbeliablewithrespecttoanyforward-lookingstatement,whetherwrittenororal,ifandtotheextentthat—(A) the forward-looking statement is—

(i)identifiedasaforward-lookingstatement,andisaccompaniedbymeaningfulcautionarystatementsidentifyingimportantfactorsthatcouldcauseactualresultstodiffermateriallyfromthoseintheforward-lookingstatement;or(ii)immaterial;or

(B)theplaintifffailstoprovethattheforward-lookingstatement—(i)ifmadebyanaturalperson,wasmade with actual knowledgebythatpersonthat the statement was false or misleading;or(ii)ifmadebyabusinessentity;was—(I)madebyorwiththeapprovalofanexecutiveofficerofthatentity,and(II) made or approved by such officer with actual knowledgebythatofficerthat the statement was false or misleading.216

214Pub.L.No.104-67,109Stat.737(1995)(codifiedasamendedinscatteredsectionsof15U.S.C.).

215See, e.g.,ConnecticutNat’lBankv.Germain,503U.S.249,112S.Ct.1146,1149(1992)(“[I]ninterpretingastatuteacourtshouldalwaysturntoonecardinalcanonbeforeallothers....[C]ourtsmustpresumethatalegislaturesaysinastatutewhatitmeansandmeansinastatutewhatitsaysthere.”).TheSupremeCourthasalsostatedthat“(c)anonsofconstructionordinarilysuggest that terms connectedby a disjunctivebegiven separatemeanings, unless the contextdictatesotherwise....”Reiterv.SonotoneCorp.,442U.S.330,339(1979); see also generally U.S. GAO, Statutory Interpretation: Determining Congressional Intent, in 1 Principles ofFederalAppropriationsLaw,ch.2,pt.D (3ded.Jan.2004),available athttp://www.gao.gov/special.pubs/d04261sp.pdf.

21615U.S.C.§77z-2(emphasisadded).

Ch. 12.III.A.4.c.


Inhis article,217AllanHorwichexplains that although the statutory safeharbor protection for forward-looking statements is partly derived from thebespeaks cautiondoctrine,thePSLRA’ssafeharborisbroader:“TheConferenceReportreflectsthatbespeakscautionwasamodelfor,butdidnotnecessarilysettheouterlimitsof,thefirstprong,asitdescribedthesafeharboras‘basedonaspectsofSECRule175andthejudiciallycreated“bespeakscaution”doc-trine.’”218Heobservesthatfederalcourtshavetakenoneofthreeapproachesinanalyzing the applicability of the PSLRA’s statutory safe harbor for for-ward-looking statements:

Judicialinterpretationsofthestatutorysafeharborforforward-lookingstatementsvarywidely.Somecasestreatthesecond(actualknowledge)prongasirrelevantifthefirstprongissatisfied.Acontrarylineofcasestreatsthesecondprongaspertinentevenifthefirstpronghasbeenormaybesatisfied;thatis,anallegationofactualknowledgeprecludesdismissalevenifthereweremeaningfulcautionarystatements.Thereisyetathirdperspective:thatifactualknowledgeoffalsityisalleged,thecautionarystatementscannotbe“meaningful”sothatthefirstprongcannotbesatisfied.219

AsHorwichalsonotes,theSEChastakenthepositionthatwarningsinaforward-looking statement are not meaningfulifapartyisawareofthecurrentexistenceofaproblem,inwhichcaseitshouldnotbeallowedthebenefitofthePSLRA’s statutory safe harbor protections.220 In her article,221 Professor Ann MoralesOlazábalexplainsthat,bydefinition“anissuer’spredictionsandprojec-tions regarding future corporate conduct or performance are . . . forward look-ing.”222Thisappearstobetheprevailingviewofcourtsthathaveconsideredtheissue.223Ontheotherhand,theFifthandSeventhCircuitshaveincorporatedanintentinquiryfordeterminingthesafeharbor’savailability.224

217AllanHorwich,Cleaning the Murky Safe Harbor for Forward-Looking Statements: An Inquiry into Whether Actual Knowledge of Falsity Precludes the Meaningful Cautionary Statement Defense, 35 J. Corp. Law 519, 520 (2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1532934.

218Id. at 538 (citing H.Rep.No.104-369,at43 (1995),reprinted in 1995 U.S.C.C.A.N. 730,742).

219Id. at 539.220See id. at553–54(citingBriefforSECasAmicusCuriaeinSlaytonv.Am.ExpressCo.,

No.08-5442-cv(2dCir.Jan.21,2010),available athttp://www.sec.gov/litigation/briefs/2010/slayton0110.pdf)(“Astatementofpredictionorexpectation,likeAmex’sstatementthat‘losses...are expected tobesubstantiallylower,’containsatleastthreeimplicitfactualassertions,including(i)thatthestatementisgenuinelybelieved;(ii)thatthereisareasonablebasisforthatbelief;and(iii) that thespeaker isnotawareofanyundisclosedfacts tending toseriouslyundermine theaccuracyofthestatement.Ifthespeakeractuallyknowsthatanyoftheimplicitrepresentationsisfalse,thenthespeakerknowsthatthestatementismisleading.”).Cf. Harrisv.IVAXCorp.,182F.3d799,807(11thCir.1999)(discussingthe“meaningfulness”standardandexplainingthatthesafeharboronlyrequirescautionarylanguageintheforward-lookingstatementastoimportantfactorsthatcouldcauseactualresultstodiffermaterially).

221AnnMoralesOlazábal,False Forward-Looking Statements and the PSLRA’s Safe Harbor,86 IndianaL.J. 596(2011),available athttp://ilj.law.indiana.edu/articles/86/86_2_Olazabal.pdf.

222Id. at 596.223Id. at 609.224See Rosenzweig v.Azurix Corp., 332 F.3d 854, 870 (5th Cir. 2003) (implying that

substantialallegationsofscientermightdefeatProngOnedespitesufficientcautionarylanguage

Ch. 12.III.A.4.c.


5. Third-Party Statements and the Entanglement DoctrineCourtsrecognizethatpubliclytradedcompaniessometimesunderminethe

independenceofthirdpartiesuponwhomtheinvestingpublicmayrely,suchasbondratingagenciesandsecuritiesanalysts,bytryingtocontrolandspintheinformationprovidedtothem(orthatisnotdisclosed).Ontheotherhand,courtsalsoareawarethattheratingagenciesandanalystsoftenmakepredictions—with little or no input from the companies discussed in their reports—that can laterprovetobegrosslyerroneous.225 In determining whether or not securities fraudliabilityispropertoimposeonthesepubliclytradedcompanies,courtsfocus on evidence tending to demonstrate complicity or intent by thesecompanies:

[S]implybecausestatementsofthirdpartiesmaylaterprovetobeinaccurate...willnotbeenoughtomakepublicly-tradedentitiesliableforfraudunderthefederalsecuritieslaws.Instead,theirliabilitywillbelimitedtothosecircumstanceswhereitcanbeshownthat[they]...effectivelycausedtheunderlyingmisstatementstobemadeor...‘adopted’thestatementsas...accurateandcompletewhentheyknew otherwise. . . .226

Totheextentthatpubliclytradedcompaniesactinbadfaithandusethirdparties tospreadmisinformation, theymaybeheld liableforsecuritiesfraudundertheentanglementtheory.Nevertheless,plaintiffsinprivatesecuritiesfraudlitigationfaceadifficultburdeninestablishingentanglementliabilityinmanycasesbecauseoftheheightenedpleadingstandardsofthePSLRA,alongwiththerequirementthatfraudmustbepleadedwithspecificityunderRule9(b)oftheFederalRulesofCivilProcedure.227

For example, in In re Cardinal Health, Inc. Securities Litigation,228 the courtrefusedtoholdCardinalHealthliableforanalysts’misstatementsbecause

beingprovided)andAsherv.Baxter,377F.3d727(7thCir.2004)(makingasubjectiveanalysispart of ProngOne’s requirements in a suit against amedical devicemanufacturer). See also Olazábal, at 609–10.TheAsher court observed, inter alia, that “[a] safe harbormatters onlywhen the firm’s disclosures (including the accompanying cautionary statements) are false ormisleadingly incomplete; yet whenever that condition is satisfied, one can complain that thecautionarystatementmusthavebeeninadequate.Thesafeharborlosesitsfunction.Yetitwouldbeunsoundtoreadthestatutesothatthesafeharborneverworks;thenonemightaswelltreat§77z-2and§78u-5asdefunct.”Asher,at733.

225See, e.g., In reSyntexCorp.Sec.Litig.,95F.3d922(9thCir.1996),whichisanalyzedbelow in this Section.

226MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.04(internalcitationomitted).See, e.g.,SouthlandSec.Corp.v.InspireIns.SolutionsInc.,365F.3d353,373(5thCir.2004)(“Generally,securitiesissuersarenotliableforstatementsorfore-castsdisseminatedbysecuritiesanalystsorthirdpartiesunlesstheyhave‘sufficiently entangled [themselves]withtheanalysts’forecasts[soas]torenderthosepredictions‘attributableto[theissuers].’’...[T]oattributethird-partystatementstothedefendants,theinvestorsmustdemon-stratethatthestatementswereadoptedbythedefendantsorattributabletothedefendantsinsomeway,suchaswhenofficialsofacompany‘have,bytheiractivity,madeanimpliedrepresentationthattheinformationtheyhavereviewedistrueoratleastinaccordancewiththecompany’sviews.’. . .”) (internal notes omitted).

227FederalRuleofCivilProcedure9(b)requiresthat“[i]nallavermentsoffraudormistake,thecircumstancesconstitutingfraudormistakeshallbestatedwithparticularity.”

228426 F. Supp. 2d 688 (S.D. Ohio 2006).

Ch. 12.III.A.5.


the plaintiffs did not satisfy the heightened pleading requirements for fraudallegations imposed by the PSLRA and by Federal Rule of Civil Procedure9(b).229Also, inIn re Alkermes Securities Litigation,230entanglement liabilitywasoneoftheissuesforwhichthemagistrate-judgerecommendeddismissingthe class action securities fraud complaint. Alkermes, which specialized indevelopingcontrolled-releasedrugdeliverytechnologies,hadenteredintoanagreement in 1996 with an affiliate of Johnson & Johnson PharmaceuticalResearch&Development,L.L.C., todevelopRisperdalConsta,aninjectableformoftheschizophrenicdrugRisperdal.231Astotheentanglementliability,theplaintiffsallegedthatthedefendantstoldanalyststo“basetheirfinancialmodelsonassumptionsofa10[percent]returnoninvestment,”whichstatementwasfalseormisleading“becausethe‘defendantswouldnotreceiveanythingneara10[percent]royalty.’”232 In recommending that the entanglement allegations be dismissed, the court explained that the reasoning expressed in the followingexcerpt from In re Boston Technology, Inc. Securities Litigation233 was both applicableandpersuasive:

Tostateaclaimoffraudonthebasisofananalyststatement,acomplaintmustallege‘entanglement,’andmust,pursuanttoRule9(b),dosowithsufficientpar-ticularity....Inthiscase,theapplicationofRule9(b)totheanalyststatementsrequiresthatplaintiffsspecifythetime,place,speaker,andcontentofwhatwassaidtothefirmsbythedefendantsthatwouldhaveinducedthemtomaketheallegedlymisleading comments and forecasts.234

A class of plaintiffs also raised the entanglement issue in In re ICN/Viratek Securities Litigation,235inwhichtheyclaimedthatkeyofficialsatICN/ViratekhadreviewedandmadecorrectionstoinitialreportspreparedbyPaineWebberanalystsaboutthecompany’sdrugribavirinbeforethesereportswerepublicly released.236 Consequently, they contended, ICN/Viratek should be

229Id.at*51(“Toproveentanglementplaintiffsmustallegethatdefendantsusedtheanalystsas‘conduits,’makingfalseandmisleadingstatementstotheminhopesthattheanalystswouldtakesuchinformationbacktothemarketsandinvestorswouldrelyonit....Further,becauseentan-glementiscentraltofraudallegations,aplaintiffmustpleadsuchallegationswithparticularityandstatewhosuppliedtheinformationtotheanalyst,howtheanalystreceivedtheinformationandhowthedefendantwasentangledwithormanipulatedtheinformationandtheanalyst....Accordingly,thepleadingsshould:(1)identifythespecificforecastsandnametheinsiderwhoadoptedthem;(2)pointtospecificinteractionsbetweentheinsiderandtheanalystwhichallegedlygaverisetotheentanglement;and(3)statethedatesonwhichtheactswhichallegedlygaveriseto the entanglement occurred.”) (internal notes omitted).

230No.03-12091-RCL,2005WL2848341(D.Mass.Oct.6,2005)(unreported).231Id. at *1.232Id. at *3 (internal notes omitted).2338F.Supp.2d43,58(D.Mass.1998).234Alkermes,2005WL2848341,at*13(internalnoteomitted).235No.87Civ.4296,1996WL164732(S.D.N.Y.Apr.9,1996)(unreported),disagreed with

by Vento&Co.ofNewYorkv.MetromediaFiberNetwork,Inc.,No.97CIV.7751(JGK),1999WL147732(S.D.N.Y.Mar.18,1999).

236Accordingtotheplaintiffs,PaineWebberandtheauthorofitsinitialreport...weregivenaccesstonon-publicinfor-mationaboutthedefendantcorporations...[during]aduediligencereviewthatPaineWeb-berconductedinrelationtoitspriorunderwritingofdefendants’securitiesofferings;...corporateofficerMilanPanic...andthreeotheremployeesofthedefendantcorporations

Ch. 12.III.A.5.


held responsible for the dissemination of the misleading Paine Webber reports.237 Inanalyzingthisissue,thejudgefirstcitedkeylanguagefromElkind v. Liggett & Myers, Inc.,238 a seminal Second Circuit case that addressed entanglement liability(andwasbindingprecedentforthejudge):

[Elkind]...setsthestandardforwhenacompanymaybeheldliableasapri-marywrongdoerforstatementsmadebythirdparties...inresearchreports....

According to Elkind,acompanymaybeheldliableasaprimarywrongdoeronlyifithasso“entangleditself”withtheissuanceofananalyst’sreportthatthestatementsofthereportmay...beattributedtothecompany....InElkind, the Second Circuit stated that:

[A]companymaysoinvolveitselfinthepreparationofreportsandprojectionsbyoutsidersastoassumeadutytocorrectmaterialerrorsinthoseprojections.Thismayoccurwhenofficialsofthecompanyhave,bytheiractivity,madeanimpliedrepresentationthattheinformation...reviewedistrueoratleastinaccordancewiththecompany’sviews.

Elkindalsonotedthat“corporateprereleasereviewofthereportsofanalystsisariskyactivity,fraughtwithdanger,”inpartbecausemanagementmusttakecarenottomisleadthepublicby“impliedapprovalofreviewedanalyses.239

Because ICN/Viratek officials had been presented with the preliminaryreportfromthePaineWebberanalysts,whichreportincludedobviouserrorsthattheanalystswerenotaskedtocorrect,afactissuewaspresentedastowhetherICN/Viratek should be held liable for the acts of its agents under the entangle-menttheoryofliability,andsummaryjudgmentwasimproper.240

Inanoldersecuritiesfraudclassaction,In re Syntex Corp. Securities Liti-gation,241 the Ninth Circuit also held that a pharmaceutical manufacturer was not liableundertheentanglementtheoryofliabilityforallegedlyfalseandmislead-ing statements contained in analysts’ reports about the company. The classplaintiffsalleged that,during the timeperiodat issue,Syntexwas facing theexpirationofitspatentonNaprosyn,itsflagshipproduct,andexpectedthatitsrevenueswouldsoonsharplydecline.242Consequently,theyclaimed,Syntexhadengagedinvariousfraudulentactstostaveofftheanticipateddeclineinreve-nues,whichincludedprovidingfalselyoptimisticforecaststosecuritiesanalysts,who repeated the false representations.243Theproblemwithplaintiffs’allega-tions,astheNinthCircuitpointedout,wasthatSyntexhad“neverendorsedor

...reviewedthefulltextof[theinitialreport]...forPaineWebber;and...Panicmadeseveralchangesandadditionsto[it]...toensureitsaccuracy,thedaybeforethereportwaspubliclydisseminated.

Id. at *3.237Id. at *3.238635 F.2d 156 (2d Cir. 1980).239ICN/Viratek, 1996 WL 164732 (internal citations omitted).240Asthejudgenoted,“[h]ere,however,unlikeinElkind,theClasshassubmittedevidence

indicatingnotonlythatdefendantsreviewedthePaineWebberreport,butalsothatdefendantsdid failtocorrectfactualstatementsinthereportthattheyknewwereerroneous—whileatthesametime making other corrections and additions to the report.” Id. at *4.

24195 F.3d 922 (9th Cir. 1996).242Id. at 925.243Id.

Ch. 12.III.A.5.


adoptedthestatementsofanalysts”;instead,“thesestatementsweretheculmi-nationofaone-wayflowofinformation,fromSyntexrepresentativestoanalystsandfromtheanalyststotheircustomers.”244Asthecourtobserved,“when...Syntex’sCEOwasaskedabouttheanalysts’predictionsrelatedtofutureearn-ingspershare,[he]...stated,‘Wedon’tforecastearnings,’andemphasizedthatsuchestimatesshouldnotbeattributedtoSyntex.”245

B. Agency Pronouncements About Materiality

TheSEChasemphasizedthatissuersshouldnotexclusivelyrelyonqual-itativemeasureswhenassessingthematerialityofinformationandwhetheritshouldbedisclosedornot;instead,intheagency’sopinion,developmentsper-tainingtocertaincategoriesofinformationarebasicallypersematerial—underaqualitativeapproach—andmustbedisclosed.SeveralimportantStaffAccount-ingBulletins(SABs)arerelevanttothis:(1)SABNo.99—Materiality;(2)SABNo.100—RestructuringandImpairmentCharges;and(3)SABNo.101—Rev-enue Recognition.246

1. SEC Staff Accounting Bulletin No. 99—MaterialityInSABNo.99,247theSEC“instructedfirmsandtheirauditorsnottoexclu-

sivelyusequantitativemeasuresfordeterminingthematerialityofinformationunder their disclosure obligations. This pronouncement warns against using numericalthresholds,asmanycompaniesandtheirauditorshavedone,indeter-mining whether to disclose information.”248 The SEC also set out six categories ofinformationthatpubliclytradedcompaniesmustreport—evenifitwouldnototherwiseappear tobenecessary ifapublicly tradedcompanyevaluated theinformationforpurposesofthedisclosureobligationunderapurelyquantitativeapproach:

1. Whether the misstatement arises from an item capable of precise mea-surementor...arisesfromanestimate;

2. Whetherthemisstatementmasksachangeinearningsorothertrends;3. Whetherthemisstatementhidesafailuretomeetanalysts’consensus

expectationsfortheenterprise;

244Id. at 934.245Id.246See generallyMatthew S.Mokwa,Enron, Sarbanes-Oxley, and the End of Earnings

Management,39Tex. J. Bus.L.325,349–50(Fall2003).24764Fed.Reg.45,150(Aug.19,1999),codifiedat17C.F.R.pt.211.248MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded

Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.04(omittinginternalcitationtoColleenP.Mahoneyetal.,SEC Enforcement and Financial Reporting,Postgraduate Coursein Federal Securities Law1499,1520(SG022ALI-ABA,2001))(“[SAB99]setsforththeSECstaff’sviewthatmaterialityinthecontextoffinancialstate-mentscannotbeassessedsolelybyrelianceupon‘quantitativebenchmarks.’ThefirstpartofSAB99addressestheassessmentofmaterialitybypublicissuers.TheSABnotesthatcertainissuersandauditorshavedevelopeda‘ruleofthumb’forassessingmaterialityunderwhichitemsthatfallunderafivepercentthresholdaredeemedimmaterial,absentextraordinarycircumstances.”).

Ch. 12.III.B.1.


4. Whetherthemisstatementaffectstheregistrant’scompliancewithreg-ulatoryorcontractualrequirements;

5. Whether themisstatementhas theeffectof increasingmanagement’scompensation;and

6. Whether a knownmisstatementmay result in significant positive ornegativemarketreaction.249

DespitetheCommission’sposition,itisunrealisticfortheCommissiontohold that information falling within one of these categories will be presump-tivelyconsideredmaterial—becausesomeinformationwithinthesesixcatego-riesmaybesominororsoattenuatedthatareasonableinvestorwouldnotfinddisclosure of the information to be helpful.250

2. SEC Staff Accounting Bulletin No. 100—Restructuring and Impairment ChargesInSABNo.100, theCommissionexpressedtheviewsof itsstaffabout

howpubliclytradedcompaniesshouldaccountforanddisclosecertainexpensesthatarecommonlyreportedinconnectionwithdifferentexitactivitiesandbusi-ness combinations.251 Although this accounting bulletin is somewhat technical becauseofitsnature,theSECprovidesseveraldifferentexamplesinthebulletintohelpstresstheimportanceofdisclosingaccurateandtimelyinformationaboutthesemajoreventsinapubliclytradedcompany’sreportingperiod.Oneoftheclearest statements contained in SAB No. 100 along these lines is the following passage,whichinstructscompanieswhentheymustincludeinformationinthemanagement’sdisclosureandanalysis(MD&A)part252 of their reporting obli-gations under Item 303:

[T]heeconomicorothereventsthatcausearegistranttoconsiderand/oradoptanexitplanorthatimpairthecarryingamountofassets,generallyoccurovertime....[A]s those events and the resulting trends and uncertainties evolve, they oftenwillmeettherequirementfordisclosurepursuanttothe...MD&Arulespriortothe period in which the exit costs and liabilities are recorded pursuant to GAAP. Whetherornotcurrentlyrecognizableinthefinancialstatements,materialexitorinvoluntary termination costs that affect a known trend, demand, commitment,event,oruncertaintytomanagement,shouldbedisclosedinMD&A.253

249Id. (internal citation omitted).250SeeJoanMcLeodHemingway, Materiality Guidance in the Context of Insider Trading,

A Call for Action,52Am. U. L. Rev.1131,1150–62(2003)(“SECStaffAccountingBulletinNo.99instructsagainstexclusiverelianceuponquantitativemeasuresindeterminingmateriality;butdoesitnotseemrationalthatthereissomeleveloffinancialimpactthatissodeminimisastobeimmaterial—oratleastpresumptivelyimmaterial?...Absentdecisionallawthatisdeterminative(oratleasthighlyinstructive)astotheanswerstothesequestions,onecannotsaythatanypartic-ularthresholdhasanyparticularsignificance....”)(internalnotesomitted).

251SeeReleaseNo.SAB100(Nov.24,1999)(amendingpt.211oftit.17oftheCodeofFederalRegulationsbyaddingSABNo.100tothetablefoundinsubpt.B),available at http://www.sec.gov/interps/account/sab100.htm.

252ThisisdiscussedinfurtherdetailinSectionIII.C.1.c.,below.253See ReleaseNo.SAB100(InterpretiveResponsetoQuestion16).

Ch. 12.III.B.1.


Inrecentyears,lengthyallegationsofaccountingirregularitiesbypubliclytradedcompanieshavebecomeamajorfeatureinmanysecuritiesfraudclassactions.Nevertheless,courtshaveconsistentlyheldthatplaintiffsmustallegemore than just evidence that a publicly traded company violated generallyacceptedaccountingprinciples(GAAP)conventionsinlightoftheheightenedpleadingrequirementsimposedonprivatesecuritiesfraudplaintiffs.Toavoidsummaryjudgment,asthefollowingcasesreflect,suchplaintiffsmustproperlyassertthattheallegationsofaccountingirregularitiesprovidestrongcircumstan-tialevidenceofadefendant’sscienter.

Forexample,inIn re Cardinal Health Inc. Securities Litigation,254 the core theoryofliabilityallegedintheclassactionsecuritiesfraudcomplaintwasthat,“from 1998 through 2002, while Cardinal’s pharmaceutical distribution unitunderwentareorganization,...[thecompany]engagedinanelaborateaccount-ingscheme...toartificiallyinflateitsearningsandconcealdebt.”255InrejectingCardinalHealth’sargumentthattheallegationsinthecomplaintwereinsuffi-cienttoestablishsecuritiesfraudliabilitybasedonGAAPviolations,thecourtexplained that “CardinalDefendants emphasize that Plaintiffs have failed toallegeGAAP violations because they have not indicated any true ‘misstate-ments’or‘omissions’byCardinalDefendants....CardinalDefendants’argu-mentsfallshort,inpart,however,becausethisCourthasalreadyfoundthatthePlaintiffs adequately pled scienter as to Cardinal Defendants’ GAAPviolations.”256

In re Odyssey Healthcare, Inc. Securities Litigation257 addressed numerous pleadingdeficienciesintheplaintiffs’complaintagainsttheoperatorofMedi-care-certifiedhospices,includingthattheplaintiffshadnotsufficientlypleadedhowthedefendantactedwiththerequisitescientertoviolatethesecuritieslawsasrequiredbythePSLRA.Thecourtexplained,inrelevantpart,that:

UnderthePSLRA,acomplaintmust“statewithparticularityfactsgivingrisetoa strong inference that the defendant acted with the required state of mind.” 15 U.S.C.§78u-4(b)(2)....“[T]hemere publication of inaccurate accounting figures or failure to follow GAAP, without more, does not establish scienter. The party must know that it is publishing materially false information, or must be severely reckless in publishing such information.”258

3. SEC Staff Accounting Bulletin No. 101—Revenue RecognitionAs the Enron debacle has demonstrated, details about how a company

accountsforandrecognizesrevenuearecriticalinformationthatpubliclytradedcompaniesmustdiscloseandexplaintotheinvestingpublic.StaffAccountingBulletin No. 101259providestheSEC’sviewsabouthowcompaniesshouldapply

254426 F. Supp. 2d 688 (S.D. Ohio 2006). See also the discussion of In re Cardinal Health atSectionIII.A.5.,above.

255426 F. Supp. 2d at 697.256Id. at 745.257424 F. Supp. 2d 880 (N.D. Tex. 2005).258Id.(emphasisadded)(pagereferencesnotavailable).259SeeReleaseNo.SAB101(Dec.3,1999)(amending17C.F.R.§211byaddingSABNo.

101tothetablefoundinSubpartB),available athttp://www.sec.gov/interps/account/sab101.htm.

Ch. 12.III.B.3.


generallyacceptedaccountingprinciplestoselectedrevenuerecognitionissues,anditstatesinrelevantpart:

AregistrantshoulddiscloseitsaccountingpolicyfortherecognitionofrevenuepursuanttoAPBOpinionNo.22,DisclosureofAccountingPolicies....Because revenue recognition generally involves some level of judgment, the staff believes that a registrant should always disclose its revenue recognition policy.Ifacompanyhasdifferentpoliciesfordifferenttypesofrevenuetransactions...thepolicyforeachmaterialtypeoftransactionshouldbedisclosed.Ifsalestransactionshavemultipleelements...theaccountingpolicyshouldclearlystatetheaccountingpolicyforeachelementaswellashowmultipleelementsaredeterminedandvalued.Inaddition,thestaffbelievesthatchangesinestimatedreturnsrecognizedinaccordancewithSFASNo.48shouldbedisclosed,ifmaterial(e.g.,achangeinestimatefromtwopercent of sales to one percent of sales).260

AfederaljudgeinColoradodismissedasecuritiesfraudclassactioncom-plaintagainstamedicaldevicemanufacturerfiledafterthecompanyrestateditsearnings. In Sorkin, LLC v. Fischer Imaging Corp.,261 the court held that the plaintiffs had not adequately described the fraud and scienter elementswithsufficientparticularityasneededtomeettherequirementsunderthePSLRA.Amongtheirallegations,theplaintiffscontendedthatthemedicaldeviceman-ufacturerhadmisrepresenteditsfinancialconditioninSECfilingsandinpressreleases to inflate thevalueof itsstockartificially.262Moreover, theplaintiffsallegedthatFischerImaginghadengagedinvariousaccountingirregularities,includingtheprematureorimproperrecognitionofrevenueastodevicesthathadnotbeenshippedfromthecompany’swarehouses,inviolationofSABNo.101.263But the judgewas not convinced even by the claim that the conductviolated the SAB, finding that the plaintiffs had not demonstrated that theaccounting irregularities were performed with the requisite scienter.264

Other cases involving pharmaceutical companies have reached similardispositionsontheissueoftheadequacyoftheallegedsecuritiesfraudviola-tions arising from accounting irregularities because the class action plaintiffs failedtosufficientlypleadtherequisitescienterwiththedegreeofparticularityrequiredbythePSLRA.AninterestingcaseisIn re Alpharma, Inc. Securities Litigation,265whichinvolvedasecuritiesfraudclassactionfiledagainstaphar-maceuticalmanufacturer forallegedaccounting irregularitiesbya subsidiarythatartificiallyinflatedtheparentcompany’sstockpriceinviolationofGAAPandthecompany’srevenuerecognitionpolicy.But,asthedistrictcourtobserved,theallegationsamountedtolittlemorethanmismanagement,sotheyfailedtoadequatelystateacauseofactionforsecuritiesfraud.266

260See id.(InterpretiveResponsetoQuestion1)(emphasisadded).261No.03-CV-00631-RPM,2005WL1459735(D.Colo.June21,2005)(unreported).262Id. at *1–2.263Id. at *4.264Id. at *5–6.265372F.3d137(3dCir.2004),abrogated in part as stated in In reRadianSecs.Litig.,2010

U.S.Dist.LEXIS42849(E.D.Pa.Apr.30,2010).266Id. at 151–52.

Ch. 12.III.B.3.


4. SEC RulesOver the years, the Commission has issued a wide variety of different

materialstohelpguidetheoperationsofissuersandself-regulatoryorganiza-tions(SROs),andtoeducatetheinvestingpublic.267Havingaworkingunder-standingof thedifferent typesofmaterials, and their respective authority, isimportantforpubliclytradedcompanies,asthefollowingexplains:

TheSECrules,adoptedthroughtheformalproceduresoftheAdministrativePro-cedureAct,havetheforceoflawandare...multi-layered.Theycomeintheformof“Regulations,”whichcontainindividual“Rules,”which...referto“Forms”or “Schedules,”which contain “Items,”which . . . often cross-reference otherschedules.SECpronouncementsonhowtointerprettherulesinlightofspecificfactscomein“InterpretiveReleases,”“No-ActionLetters,”agencyenforcementproceedings, amicus briefs filed with federal courts, andmiscellaneous publiccommentsbyagencyofficials.268

a. Rule 405—Promulgated Under the Securities ActRule 405269definesthemeaningofvarioustermsthatareusedintheSecu-

ritiesAct.Oneofthemostimportantdefinitionsprovidedisfortheterm“mate-rial”:“[t]heterm‘material,’whenusedtoqualifyarequirementforthefurnishingofinformationastoanysubject,limitstheinformationrequiredtothosematterstowhichthereisasubstantiallikelihoodthatareasonableinvestorwouldattachimportanceindeterminingwhethertopurchasethesecurityregistered.”270

b. Rule 408—Promulgated Under the Securities ActRule408,promulgatedpursuanttotheSecuritiesAct271 (and a companion

provisiontoRule405),addressesthedisclosureobligationsofissuersofregis-tration statements, and requires them “[to] contain, in addition to particularspecificallyrequireddisclosures,‘suchfurthermaterialinformation...neces-sary tomake therequiredstatements, in the lightof thecircumstancesunderwhichtheyaremade,notmisleading.’”272 This language (along with the lan-guage of other rules below) arguablymandates a duty for issuers to updateperiodic disclosures for those time periods when the issuers do not otherwise haveanydisclosureduty.273

267The Commission provides a wealth of information at itsWeb page, http://www.sec.gov,includinginformationaboutregulatoryactions(suchasproposedrules,finalrules,conceptreleases,andSROrulemaking),staffinterpretations(includingstaffaccountingbulletinsandstafflegalbulletins),litigation(includinglitigationreleases,administrativeproceedings,Commissionopinions,andtradingsuspensions),andfilingsandforms(throughits“Edgar”database).

268DaleOesterle,The Inexorable March Toward a Continuous Disclosure Requirement: “Are We There Yet?,” 20 Cardozo L. Rev.135,139–40(1998)(internalnotesomitted).

26917C.F.R.§230.405.270PeterH.Huang,Moody Investing and the Supreme Court: Rethinking the Materiality

of Information and the Reasonableness of Investor,13Sup. Ct. Econ. Rev.99,109–10(2005)(internal notes omitted).

27117C.F.R.§230.408.272Huang,at109–10(internalnotesomitted).273SeeOesterle,at143(“Wheneveradutytospeakattaches...anissuermustfirstsatisfy

thesubjectmatterrequirementsofthatparticularstatute,rule,regulation,orschedule.Second,

Ch. 12.III.B.4.b.


c. Rules 12b-20 and 14a-9—Promulgated Under the Exchange ActRules12b-20and14a-9,promulgatedundertheExchangeAct,274 impose

the same requirement on issuers as does Rule 408 promulgated under the Secu-ritiesAct to disclose such supplemental information necessary to make therequired statements not misleading in light of the circumstances.

d. Rules 175 and 3b-6—Promulgated Under the Exchange ActAsdiscussedearlierinSectionII.A.,theCommissionpromulgatedregula-

torysafeharborsinthelate1970stogiveissuersincentivestodiscloseinforma-tion to the public about their businesses and operations:275 Rule 175276 and Rule 3b-6.277“Rule175,thesafeharborforincomeprojectionsundertheSecuritiesAct,generallyprotectssuch‘forward-looking’statementswhenmadeingoodfaithandwhentheyhaveareasonablebasis.Itscounterpart,Rule3b-6,offerssimilarsafeharborprotectionforpubliclytradedcompaniesundertheSecuritiesExchange Act.”278Buttheseregulatorysafeharborsdonotprovidethedegreeof protection subsequently made available for such companies by CongressunderthePSLRA.Thedifferencesbetweenthefeaturesoftheregulatorysafeharborandthestatutorysafeharborswereablyexplainedinthefollowing:

SEC Rule 175 deems certain forward-looking statements “not to be a fraudulent statement” for purposes that encompass a section 11 claim. The protection applies tostatementsmadeinaregistrationstatement,evenifthecompanyisnotalreadyfilingExchangeActreports.Theforward-lookingstatementisprotected...“unlessitisshownthatsuchstatementwasmadeorreaffirmedwithoutareasonablebasisor was disclosed other than in good faith.” The burden to show lack of reasonable basisorlackofgoodfaithisontheplaintiff....[But]...thePSLRAstatutorysafeharborisimmeasurablymorevaluable....Under the statutory safe harbor, a defendant who makes a motion for summary judgment based on the safe harbor is protected from discovery,exceptasitrelatestothenarrowissuesimplicatedbythatmotion....Bycontrast,anydetermination...oftheRule175safeharbor...involvesaninquiryintothedefendant’sgoodfaithandreasonablebasis....ThisisthekindofbroaddiscoverythatthePSLRAsoughttopreclude....Thus,Rule175affordsfarlessprotectionthanthenewstatutorysafeharbor,withtheresultthatexcludingapplicationof thestatutorysafeharbortoinitialpublicofferings

thefirmmustsatisfyageneralobligation,known...asthe‘half-truth’rule,to‘add[]suchfurthermaterialinformation...asmaybenecessarytomaketherequiredstatements,inthelightofthecircumstances...notmisleading.’”)(internalnotesomitted).

27417C.F.R.§§240.12b-20and240.14a-9.275SeeRoyceDeR.Barondes,The Bespeaks Caution Doctrine: Revisiting the Application

of Federal Securities Laws to Opinions and Estimates,19J.Corp.L.243,249(1994)(“TheSECadoptedthefinalrulescreatingthesafeharborsforprojections,Rule175underthe1933ActandRule3b-6underthe1934Act...,onJune25,1979.”)(internalnotesomitted).

27617C.F.R.§230.175.277Id.at§240.3b06.278MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded

Entities in the Post-Sarbanes-Oxley Marketplace,Health Lawand Compliance Update§5.05(internal citations omitted).

Ch. 12.III.B.4.c.


isofconsiderablesignificance to thepotentialdefendants involved inan initialpublic offering.279

C. SEC-Mandated Periodic Disclosure of Specified Information

Toavoidsecuritieslawliability,publiclytradedpharmaceuticalcompaniesmustcomplywithvariousspecificandexactingrequirements.Understandinghowthisregulatoryframeworkisdesignedtooperateisnecessarytoensuringpropercompliance.UndertheframeworkcreatedbyCongresstoregulatesecu-rities,mostpubliclytradedcompaniesmustregisterwiththeCommissionbeforetheycanlawfullyissuepublicofferingsofsecurities.Thereafter,thesecompa-nies (known as issuers)mustperiodicallyorepisodicallydisclosespecificinfor-mation.280 This basic framework of federal securities regulation has been augmentedbyjudicialopinionsaboutinsidertradingandsecuritiesfraud,whichprohibitcompaniesthatdiscloseinformationfrommakingaffirmativemisrep-resentations of material facts.

Moreover,ifacompanyhasadutytodisclose,thenitmusttimelydisclosematerialinformation.Andifanindividualisan“insider”ofacompany,heorshecannottradeinitssecuritiesunlesstheinsiderhasfirstpubliclydisclosedallinside information (or has otherwise complied with the requirements of SEC rules that offer some limited safe harbor protections for insiders). This frame-workhasbeenmodifiedbycertainSECrulesthatrequireissuerstoprovideadditional information to update their prior disclosures as needed in light of interveningdevelopments to prevent their prior disclosures frombecomingmisleading.281 In addition, through the Sarbanes-Oxley reform legislation,Congresshasmandatedthatreportingentitiesmustprovidefarmoreinforma-tiontotheSECthantheyhadinthepast,andmustdosoinacompressedtimeperiod.282

279AllanHorwich,Section 11 of the Securities Act: The Cornerstone Needs Some Tuckpoint-ing, 58 Bus. Law.1,36–37(Nov.2002)(internalnotesomittedandemphasisadded).

280See, e.g.,JamesD.Cox&RandallS.Thomas,Public and Private Enforcement of the Securities Laws: Have Things Changed Since Enron?(Vand.Law&Econ.,WorkingPaperNo.05–02,2004)(“Disclosureismandatedepisodicallyforsucheventsaspublicofferings,proxysolicitations, and tender offers.Most public companies also face periodic disclosure require-ments....Lessformalrequirementsfordisclosurearise...[from]disclosureobligationsanchoredintheantifraudprovision,suchasthedutytoupdate....Evenbroaderthanthedutytoupdateisthecaselawsurroundinghalftruthswhichimposeadutytodisclose...toavoidwhathasbeenrepresentednottobemateriallymisleadinginlightofwhathasnotbeendisclosed....”).

281SeeSectionsIII.B.4.b.andIII.B.4.d.,above(discussingSECRules408,175,and3b-6).282See generally,SethAronsonetal.,Understanding the Securities Laws 2003: Liability

for Exchange Act Violations, Understandingthe Securities Laws,1385PLI/Corp.834,836(2003) (“With theSarbanes-OxleyActof2002,companies . . . [must]makecertain real-timedisclosures....Issuers...[must]‘disclose...onarapidandcurrentbasissuchadditionalinfor-mationconcerningmaterialchangesinthefinancialconditionoroperationsoftheissuer,inplainEnglish...astheCommissiondetermines,byrule....’15U.S.C.§78m(l)....[A]failuretodosocangiverisetocivilliability....Thesedisclosuresinclude:(1)Achangeincontrol...;(2)Thecompany’sacquisitionordispositionofasignificantamountofassets;(3)Thecompany’sbankruptcyorreceivership;(4)Achangeinthecompany’scertifyingaccountant;(5)Theresig-nationofacompanydirector;and(6)Achangeinthecompany’sfiscalyear.15U.S.C.§78m(l);see alsoProposedRule:AdditionalForm8-KDisclosureRequirementsandAccelerationofFiling

Ch. 12.III.C.


ThissectionofthechapteraddressesingreaterdetailthekeyprovisionsofimportantSECregulationsthatspecifywhatinformationpubliclytradedcom-paniesmustreport,whentheinformationmustbereported,andinwhatformatitmustbereported.TheSeventhCircuit’sopinioninGallagher v. Abbott Lab-oratories283providesagoodtransitionherebecausethecourtsummarizedthemajordisclosureobligationsofissuersunderfederalsecuritieslaw:

Wedonothaveasystemofcontinuousdisclosure.Insteadfirmsareentitledtokeepsilent...unlesspositivelawcreatesadutytodisclose....The1933Actrequiresfirmstorevealinformationonlywhentheyissuesecurities,andthedutyisowedonlytopersonswhobuyfromtheissueroranunderwriterdistributingonitsbehalf;everyothertransactionisexemptunder§4,15U.S.C.§77d....Section13ofthe. . .ExchangeAct. . .addsthattheSECmayrequireissuerstofileannualandother periodic reports—with the emphasis on periodic rather than continuous. . . .284

1. Regulation S-KRegulationS-K285isverycomprehensive.Itrequiresthatcompaniesseek-

ingtoregisterwiththeCommissionmustdiscloseawidevarietyofinformationthattheSECdeemsimportantfortheinvestingpublic.Almost50specificitemsor categories of information must be addressed. Most of these requirements call forquantitativeinformationtobedisclosed.Othersaddressqualitativeinforma-tion,suchas“aregistrant’sbusinessdevelopmentandprospects,legalproceed-ings, properties, financial performance, directors and officers, litigation, andsecurities.”286TheprovisionsofRegulationS-KapplytoregistrationstatementsfiledundertheSecuritiesActand,thereafter,toepisodicreportssubmittedunderthe Exchange Act.287

Date—ReleaseNos.33-8106,34-46084;FileNo.S7-22-02,June17,2002(specifyingcurrentandproposed disclosures required).”).

283269 F.3d 806 (7th Cir. 2001).284Id.at808–10(internalcitationsomitted).Thecourtsubsequentlyaddressedtheplaintiffs’

arguments as follows:[P]laintiffsinsistthatAbbotthada“dutytocorrect”the10-Kreport.Yetastatementmaybe“corrected”onlyifitwasincorrectwhenmade...[.]Inordertomaintainthedifferencebetweenperiodic-disclosure andcontinuous-disclosure systems, it is essential todrawasharplinebetweendutiestocorrectanddutiestoupdate....If,forexample,the10-KreporthadsaidthatAbbott’snetincomefor1998was$500million,andtheactualincomewas$400million,Abbottwouldhavehadtofixtheerror.Butifthe10-Kreporthadprojectedanetincomeof$125millionforthefirstquarterof1999,andaccountantsdeterminedinMaythattheactualprofitwasonly$100million,therewouldhavebeennothingtocorrect;aprojectionisnotrenderedfalsewhentheworldturnsoutotherwise....Amendingthe10-Kreporttoshowtheresultsfor1999astheycamein...wouldupdatethereport,notcorrect ittoshowAbbott’sactualconditionasofMarch9.

Id.28517C.F.R.§§229.10–229.702.286Troy Paredes,Blinded by the Light: Information Overload and its Consequences for

Securities Regulation(FacultyWorkingPapersSeries,No.03-02-02,June1,2003)(internalnotesomitted),available at http://www.ssrn.com/abstract=413180.

287SeeGregoryS.Porter,What Did You Know and When Did You Know It: Public Company Disclosure and the Mythical Duties to Correct and Update,68Fordham L. Rev.2199,2252–53(2000).

Ch. 12.III.C.


a. Item 10bInItem10(b)ofRegulationS-K(entitled“Standardinstructionsforfiling

formsunderSecuritiesActof1933,SecuritiesExchangeActof1934”),288 the Commission indicates that it “encourages . . . management’s projections offutureeconomicperformancethathaveareasonablebasisandarepresentedinan appropriate format.”289TheCommission,inotherwords,encouragesissuerstoprovideforward-lookingstatements290toaddressspecificissues:

1. Aprojectionofrevenues,income(loss),earnings(loss)pershare,capitalexpenditures,dividends,capitalstructure,orotherfinancialitems;

2. Management’splansandobjectivesforfutureoperations;3. Future economicperformancecontained inmanagement’sdiscussion

andanalysisoffinancialconditionandresultsofoperations includedpursuanttoItem303ofRegulationS-K...orItem9ofForm20-F;or

4. Theassumptionsunderlyingorrelatingtoanyofthestatementsdescribedinparagraphs(c)(1),(2),or(3)ofthissection[17C.F.R.§§230.175(c),240.3b-6(c)].291

Moreover,thewordingusedinItem10(b)arguablysupportstheargumentthatissuersmustupdateanypriordisclosureswheneveritbecomesnecessarytoprevent the information frombecomingmisleading in lightof interveningdevelopments.292Assuch,insomewaysItem10(b)parallelsSECRules408,175,and3b-6.

b. Item 103Item 103 of Regulation S-K293 requires the disclosure of “anymaterial

pending legal proceedings” against the corporation including “the name of the courtoragencyinwhichtheproceedingsarepending,thedateinstituted,theprincipalpartiesthereto,adescriptionofthefactualbasisallegedtounderlietheproceeding and the relief sought.” The disclosure obligation also encompasses “similarinformationastoanysuchproceedingsknowntobecontemplatedbygovernmentalauthorities.”294

28817C.F.R.§229.10(b).289JoelSeligman,The SEC’s Unfinished Soft Information Revolution,63Fordham L. Rev.

1953,1954–1955(1995)(internalcitationsomitted).290Item10(b)provides,inrelevantpart:TheCommissionencouragestheuseindocumentsspecifiedinRule175undertheSecuritiesAct...andRule3b-6undertheExchangeAct...ofmanagement’sprojectionsoffutureeconomicperformancethathaveareasonablebasisandarepresentedinanappropriatefor-mat.TheguidelinessetforthhereinrepresenttheCommission’sviewsonimportantfactorstobeconsideredinformulatinganddisclosingsuchprojections.291Seligman,at1954–55(internalcitationsomitted).292SeePorter,at2252–53,indicatingthatacontinuousreportingobligationmaybesupported

bythelanguageofItem303ofRegulationS-K,whichrequiresthedisclosureofknowntrendsthatarereasonablylikelytoleadthecompany’sliquiditytoincreaseordecreaseinamaterialway.

29317C.F.R.§229.103.294J.BradleyBennett&AndrewJ.Brauer,To Tell or Not to Tell: Weighing the Benefits and

Pitfalls Self-Reporting Corporate Wrongdoing,38(13)Sec. Reg.&Law Rep.,526,526(Mar.27,2006).

Ch. 12.III.C.1.b.


Inparagraphs1and2ofItem103,theCommissionfurtherinstructsissuersthatthedisclosureobligationthatisotherwiserequiredmaynotbenecessaryunder certain circumstances:

1. Ifthebusinessordinarilyresultsinactionsfornegligenceorotherclaims,no such action or claim need be described unless it departs from the normal kind of such actions.

2. No information need be given with respect to any proceeding thatinvolvesprimarilyaclaimfordamagesiftheamountinvolved,exclusiveofinterestandcosts,doesnotexceed10percentofthecurrentassetsofthe registrant and its subsidiaries on a consolidated basis.

Note also that these two paragraphs appear to require the use of both a qualitativeandaquantitativestandard,respectively.

c. Item 303ManyscholarsbelievethatItem303,management’sdiscussionandanaly-

sis295isthemostimportantofthemanyitemsinRegulationS-X.296 Numerous classactionsecuritiesfraudplaintiffshavetriedwithoutsuccesstohavedefen-dants held accountable for the false or misleading nature of disclosures made under theMD&Arequirements.But theproblemwith thiscontention,as theSixth Circuit explained in In re Sofamor Danek Group, Inc.,297isthataprivatecauseofactionisnotrecognizedforallegedviolationsofItem303’srequire-mentsbydisclosingcompanies:

[P]laintiffs...acknowledgethatthecourtshavebeenreluctanttorecognizeaprivaterightofactionunderItem303.Theplaintiffssuggest,however,thattheabsenceof a separate cause of action “does not preclude plaintiffs from arguing . . . that defendants’disclosuredutyundertheRule10b-5claimmaystemfromItem303.”Perhapsso—butforreasonssimilartothoseexplainedabove,wedonotfindtheargumentpersuasive.298

29517C.F.R.§229.303.296See, e.g.,Seligman,at1968–69(“Inmanyrespects,themostsignificantmandatoryfor-

ward-lookingstatementrequirementsappearinItem303ofRegulationS-K....Itisacompre-hensivedisclosureitem.Ineffect,theCommissionstaffhasemployedtheconceptsofliquidityandcapitalresourcestorequiremanagerstocommentonmaterialchangesthatmayoccurinaregistrant’sbalancesheet....[¶]Item303(a)requiresmanagementsofallregistrantstodiscussandanalyzefinancialconditionandresultsofoperationsforfullfiscalyears.Item303(b)directsregistrantsrequiredbyArticle3ofRegulationS-Xtoprovideasimilaranalysisininterimfinancialstatements.Management’sdiscussionandanalysis...mustfocusonanyfactsanduncertaintiesthatmaypreventreportedfinancialinformationfromservingasanaccuratebasisforprojectingfutureoperatingresultsorfinancialcondition.”)(internalcitationsomitted).

See also, e.g.,MarkS.Croft,MD&A: The Tightrope of Disclosure,45S.C.L.Rev.477,477–79(1994)(“The...CommissionenvisionedItem303...asameanstoelicitandtoimprovecor-poratecommunicationwiththepublicconcerningwhathasalreadyoccurredandwhatliesaheadfinanciallyforpubliccompanies(registrants)....UnderItem303anditsapplicableinterpretivereleases,theMD&Adisclosurerequirementsareopen-endedandexceedinglycomplex....”).

297123 F.3d 394 (6th Cir. 1997).298Id. at 403 (internal notes omitted).

Ch. 12.III.C.1.b.


AlthoughitisarguablethatprivateliabilitymayattachunderRule10b-5todisclosuresthatfailtoadheretoItem303’srequirements,299 the Commission canclearlybringenforcementactionsagainstcompaniesthatviolatethisreport-ingobligation.See,forexample,In re Andrx Corp.,300 in which a pharmaceutical manufacturerenteredintoaconsentdecreetosettletheCommission’sclaimsinanactionfiledpursuant toSection21Cof theExchangeAct.Includedin thefactualfindingsoftheconsentdecreewereparagraphsdiscussinghowAndrxhadviolateditsobligationsunderItem303bymeansofitsjointventureactiv-itieswitharelatedentity.301 Note that the Commission indicates that the proba-bility-magnitudetestisnottobeusedindeterminingmaterialityforpurposesof disclosures under Item 303.302

299SeeBennett&Brauer,at527(“ManagementDiscussionandAnalysis . . . inprospec-tuses,10-Ks,and10-Qsmayalsoprovidea...disclosureobligationofpotentialsecuritieslawinfractions.”).

300No.3-11107,2003SECLEXIS1082(S.E.C.May6,2003).301Id. *14–16:23.Section13(a)oftheExchangeActrequiresissuersthathavesecuritiesregistered...

tofileperiodic reports containing informationprescribedby specificCommission rules.Suchreportsmustbecompleteandaccurate....Anissuerviolatestheseprovisionsifitfilesa periodic report that contains false or misleading information. . . . No showing of scienter isrequiredtoestablishaviolationofSection13(a)oftheExchangeAct....24.Moreover,Item303ofRegulationS-KrequiresaMD&Adisclosureaspartofperi-

odicreportsfiledpursuanttoSection13(a).TheMD&Aisintendedtogivetheinvestoranopportunitytolookatthecompanythroughtheeyesofmanagementandbetterevaluatethe quality of earnings and the likelihood that past performance is indicative of futureperformance. . . .25.Duringtherelevanttimeperiod,Cybearwassubjecttothereportingrequirements

ofSection13(a)of theExchangeActand the rules thereunder.CybearviolatedSection13(a)oftheExchangeActandRules12b-20and13a-13thereunderbecausethefinancialstatementsincludedinitsquarterlyreportsfiledwiththeCommission...didnotaccuratelyreportCybear’srevenues.26.Inaddition,Cybear’sMD&AdisclosurefortheperiodendedJune30,2000,didnot

discussknownuncertaintiesrelatingtoitsfuturerevenuestreamandfinancialcondition.Specifically,theMD&AdidnotsufficientlydisclosethatamajorityofCybear’srevenuesfor thequarter ended June30,2000 includedorders entered . . . byCybearemployees.Moreover,CybeardidnotsufficientlydisclosethatseniormanagementofbothCybearandAndrxwereevaluatingwhetherCybearwouldcontinuetorecognizerevenuesfrominter-nallyplacedordersinfuturequartersandthepotentialimpactthiscouldhaveonCybear’sfinancialstatements.

(Internal citations omitted.)302SeeMarkS.Croft,MD&A: The Tightrope of Disclosure,45S.C.L.Rev.477,482–83

(1994)(“[I]nannouncingthematerialitystandardforMD&Adisclosure,theCommissiondeclaredthat‘[t]heprobability/magnitudetest formaterialityapprovedby theSupremeCourt inBasic, Inc. v. Levinson...isinappositetoItem303disclosure.’InSecuritiesActReleaseNo.6835,theCommissionsetforththerequirementthatregistrantsapplythefollowingtwo-prongmaterialitytestwhenmanagementknowsofatrend,demand,commitment,eventoruncertainty:(1)Istheknowntrend,demand,commitment,eventoruncertaintylikelytocometofruition?Ifmanagementdeterminesthatitisnotreasonablylikelytooccur,nodisclosureisrequired.(2)Ifmanagementcannotmakethatdetermination,itmustevaluateobjectivelytheconsequencesoftheknowntrend,demand,commitment,eventoruncertainty,ontheassumptionthatitwillcometofruition.Disclo-sureisthenrequiredunlessmanagementdeterminesthatamaterialeffectontheregistrant’sfinan-cialconditionorresultsofoperationsisnotreasonablylikelytooccur.”)(internalnotesomitted).

Ch. 12.III.C.1.c.


In Simon v. American Power Conversion Corp.,303adistrictjudgeheldthatthe defendant manufacturer of power supplier was required to disclose in its quarterly10-Qformthat ithaddiscoveredadefectaffectinganumberof itsproductseventhoughthedefectwouldhavenoeffectonitsrevenueorprofitsduringthequarterinquestion.Asthecourtexplained,“Item303(b)imposesthedisclosureobligationsfortheinterim10-Qreports,whileItem303(a)doesthesameforacorporation’sannual10-Kdisclosures.BecauseItem303(b)explic-itly incorporatessomeof therequirementsofItem303(a),muchof thesameinformation is required of both disclosures.”304

d. Item 401(f)Item 401(f)305ofRegulationS-K(proxystatementsindirectorelections)

“outlinesdisclosureofcertainevents—includingcriminalproceedings,bank-ruptcypetitions,andotherenforcementactions—occurringwithinthepastfiveyearsthatare‘materialtoanevaluationoftheabilityorintegrityofanydirector,person nominated to become a director[,] or executive officer of theregistrant.’”306

e. Item 404(a) and Self-DealingTo determine whether disclosures must be made under Item 404(a)307 of

RegulationS-K,theSECinstructsissuerstofocusontheconductofkeyindi-vidualsinsidetheirorganizationsaswellasothersimportanttotheirorganiza-tions during the time of the reporting period. Issuers must disclose transactions thathaveinvolvedover$60,000betweentheirmanagementanddirectorsandofficers;nomineesfordirectors;securitiesholderswhoownover5percentofanyclassofthecompany’svotingsecurities;andanyfamilymembersoftheforegoingpersons.Moreover,“[i]ftheconductatissuecouldbecharacterizedas self-dealing, [then] Item 404(a) of Regulation S-K clearly mandatesdisclosure.”308

f. Item 503(c)InItem503(c),309registrantsareinstructedtoincludespecificdisclosures

about information deemedmaterial by the agency for investors. Item503(c)providesinrelevantpart:

Whereappropriate,provideunderthecaption“RiskFactors”adiscussionofthemostsignificantfactorsthatmaketheofferingspeculativeorrisky.. . .Explainhow the risk affects the issuer or the securities being offered. Set forth each risk factorunderasubcaptionthatadequatelydescribestherisk....Theriskfactorsmayinclude,amongotherthings,thefollowing:

303945 F. Supp. 416 (D.R.I. 1996).304Id. at 431 n.19.30517C.F.R.§229.401(f).306J.BradleyBennett&AndrewJ.Brauer,To Tell or Not to Tell: Weighing the Benefits and

Pitfalls Self-Reporting Corporate Wrongdoing, 38(13) Sec. Reg.&Law Rep.526,527(Mar.27,2006).

30717C.F.R.§229.404(a).308Id.30917C.F.R.§229.503(c).

Ch. 12.III.C.1.c.


(1) Yourlackofanoperatinghistory;(2) Yourlackofprofitableoperationsinrecentperiods;(3) Yourfinancialposition;(4) Yourbusinessorproposedbusiness;or(5) Thelackofamarketforyourcommonequitysecuritiesorsecuritiesconvertible

intoorexercisableforcommonequitysecurities.310

The class plaintiffs in the WorldCom securities fraud litigation311 contended that the company failed to disclose properly its self-dealing transactions asrequiredbyItem503(c).Indiscussingtheplaintiffs’securitiesfraudtheory,thedistrictjudgeinitiallyobservedthatheknewofnocasesinwhichacourthadwrittenaboutItem503(c);then,thejudgeobservedthattheCommission’sguid-ance on Item 503(c) also has been limited.312Variouscommentators,thejudgenoted,havediscussedItem503(c),andsomehaveopinedthatcompliancewiththisitemis“purelyvoluntary”inlightoftheCommission’sconflictingstate-ments on the subject.313 Despite being aware that finding liability based onviolationsofItem503(c)couldbeproblematic,thedistrictjudgeheldthattheplaintiffshadadequatelypleadedhowWorldCom’sviolationsofitsdisclosureobligations under Item 503(c) constituted securities fraud:

LeadPlaintiffhasshownthattheissueoftheconditionofWorldCom’slong-distancebusinesswasofsufficientimportanceto[its]...overalleconomichealth...thatafact-findercoulddeterminethatitwasappropriateunderItem503,aswellasmaterialtoinvestors,tohaveamorecompletedescription...ofthestateof that business.314

Morerecently,inMilano v. Perot Systems Corp.,315asecuritiesfraudcase,acourtrejectedanattempttotiethedisclosureobligationsaddressedbyItem503(c)toallegedlymisleadingandfraudulentstatements.TheplaintiffsclaimedthatPerotSystemshelpedelectricitysupplierswithgamingCalifornia’sdereg-ulatedelectricitymarketsduring2000and2001,butthenfailedtodisclosethis“risky”lineofbusinessinitsofferingmaterialsandinitssubsequent10-Qsand10-Ks,althoughrequiredtodosounderItem503(c).316 The district court dis-agreed,observingthatPerotSystemshadnoinformationtoindicatethatitslineofbusinessinCaliforniawouldmaketheIPOriskyatthetimewhenitmadethevariousdisclosures.317

310Id.311In reWorldComSec.Litig.,346F.Supp.2d628(S.D.N.Y.2004).312Id. at 690.313See id.at691–93(“Securitieslawcommentatorshavenotedthat‘eventhoughtheinclu-

sionofariskfactorssectioninaprospectusfiledunderthe1933ActistechnicallyvoluntaryunderItem503(c)ofRegulationS-K...thisinclusionhasbecomewidelyacceptedasasoundandpru-dentdefensivemeasureinaneramarkedbyclassactionlawsuits.’2AlanR.Bromberg&LewisD.Lowenfels,Bromberg&Lowenfels on Securities Fraudand Commodities Fraud§5:280(2ded.2001).TheSECitself,however,hasissuedconflictingstatements.”)(internalnotesomitted).

314Id. (internal notes omitted).3152006WL929325(N.D.Tex.Mar.31,2006).316Id. at *1.317See id.at*19(“BythetimetheRegistrationStatementwasissuedin1999,nothinghad

comeofISO’schargesofbreachofcontractandofethicsorofcomplaintsmadebyothercus-tomerstowhomPerotproposedgamingtransactions.DuringtheintervalofmorethanoneyearbetweenISO’schargesandissuanceoftheRegistrationStatement,ISOhadneitherfiledalawsuitnorthreatenedtocancelitscontractnorfurtherpursueditsallegationsinanymeaningfulway.”).

Ch. 12.III.C.1.f.


2. Regulation S-XInArticle1ofRegulationS-X,318 the Commission explains that the regu-

lationsetsforth“theformandcontentofandrequirementsforfinancialstate-ments required tobefiledasapartof . . .Registrationstatementsunder theSecuritiesActof1933,”aswellastheformandcontentandrequirementsforfinancial statements required tobefiledasapartof“annualorother reportsundersections13and15(d),”and,asapartof“proxyandinformationstatementsunder section 14 of the Securities Exchange Act of 1934.”319

a. Article 3Article 3 of Regulation S-X sets out the accounting rules about the form

andcontentoffinancialstatementsrequiredfordisclosuredocuments,andtheregulation’sgeneral instructionsspecify thebalancesheetsandstatementsofincomeandcashflowsthatmustbeincludedinthesedisclosuredocuments.320 The instructions included among the 20 or so rules that make up Article 3 are relatively detailed. For example, Rule 3–01 (Consolidated Balance Sheets)specifies that a registrant and its subsidiariesmust file consolidated, auditedbalancesheetsasoftheendofeachofthetwomostrecentfiscalyears,oriftheregistrant has been in existence for less than one fiscal year, itmust file anauditedbalancesheetasofadatewithin135daysofthedateitfiledtheregis-tration statement.321

b. Article 10Article10ofRegulationS-Xrequiresissuerstofileinterimfinancialstate-

ments, which are designed to help the investing public obtain accurate andreasonablycurrentinformation.Article10instructsissuerstoincludesufficientinformationintheirinterimfinancialstatementstopreventtheirdisclosuresfrombeingmisleading.Thisseemstoimposeanimplicitdutytoupdateonissuersunder some circumstances.322Plaintiffs’attorneyshaveattemptedtocontendthat

31817 C.F.R. pt. 210.319Reg.S-X,Art.1(a)(1),(2).320SeeArticle3—GeneralInstructionsastoFinancialStatements,available at http://www.

law.uc.edu/CCL/regS-X/art3.html.321SeeRule3-01—ConsolidatedBalanceSheets,available at http://www.law.uc.edu/CCL/

regS-X/SX3-01.html.322Art.10,¶5provides,inrelevantpart:Theinterimfinancialinformationshallincludedisclosures...sufficient...tomaketheinterim informationpresentednotmisleading. . . . [D]isclosure shallbeprovidedwhereeventssubsequenttotheendofthemostrecentfiscalyearhaveoccurredwhichhaveamate-rialimpactontheregistrant.Disclosuresshouldencompass...significantchangessincetheendofthemostrecentlycompletedfiscalyearinsuchitemsas:accountingprinciplesandpractices;estimatesinherentinthepreparationoffinancialstatements;statusoflong-termcontracts;capitalizationincludingsignificantnewborrowingsormodificationofexistingfinancingarrangements;andthereportingentityresultingfrombusinesscombinationsordispositions. Notwithstanding the above, where material contingencies exist, disclosure of such matters shall be provided even though a significant change since year end may not have occurred.

(Emphasis added).

Ch. 12.III.C.2.


abreachofthisdutyisactionableassecuritiesfraud(asisabreachofthesamedutysetoutinotherSECrules).323

3. Periodic FormsAspartoftheirExchangeActduties,issuersprovidetwoperiodicreports:

annualreportsonForm10-KandquarterlyreportsonForm10-Q.Inaddition,theymustfilecurrentreportsasmaybenecessaryifspecifiedeventsoccur.InvariousrulestheCommissionimplicitly requires issuers to update their disclo-suresasnecessarytopreventpriorinformationfrombeingmisleading.Insixspecified instances theCommissionexplicitly requires issuers to update their disclosures:

1. Thereisachangeincontroloftheissuer;2. The issuer or its majority-owned subsidiaries acquire or dispose of

significantassets;3. Theissuerentersintobankruptcyorreceivership;4. Theissuerchangesitscertifyingaccountant;5. Anyoftheissuer’sdirectorsresign;or6. Thereisachangeintheissuer’sfiscalyear.324

a. Form 8-KForm8-K325 consists of 10 disclosure items. Public issuers must use Form

8-Ktofilecurrentreportsifanyofthesixeventsdescribedaboveoccurs.326 The filingofaForm8-KcurrentreportisrequiredbyRules13a–11orRule15d–11,andbyRegulationFDforanyreportsofnonpublic information thatmustbedisclosed.

Notably,thetimeallowedinwhichtofileaForm8-Kreporthasbeendra-maticallyreducedinrecentyears:Originally,Form8-Kreportscouldbefiled

323Therearegoodcountervailingargumentswhycourtsshouldbereluctanttoacceptsucharguments. See, e.g.,MituGulati,When Corporate Managers Fear a Good Thing Is Coming to an End: The Case of Interim Nondisclosure,46UCLAL.Rev.675,716–17(1999)(“Bothdefendants’lawyersandcourtshavecharacterizedplaintiffs’claimsforunripedataasnomorethanclaimsthat companies should disclose their internal forecasts for current quarter results. There is a grain oftruthinthedefendants’claimbutnotenoughtoforecloseanypossibleobligationtodiscloseintraquarterlydata.[¶]Harddataaboutasmallfractionofaquarterdoesnotbecomeaforecastastothefullquarter,justbecausethequarterisnotcompleteorbecausethequarterlyresultshavenotbeenfullycompiledorverified.Data(oratrend)concerningwhathappenedinthefirsthalfofaquarterisstilldataaboutthefirsthalf,andnotaforecastastothefullquarter.Dataregardingthefirsthalfcanhelpsomeoneforecastfull-quarterresults,butmakingthatforecastisuptotheinvestor.[¶]Theconfusionwithunripeharddataandforecastsoffull-quarterresultsarisesoutofwhatcompanieswilldo,inpracticalterms,iftheyareunderanobligationtodisclosematerialunripedataintheofferingcontext.Inpracticalterms,acompanywillprefertodiscloseitsinternalforecasts of the full-quarter results than to disclose the partial-quarter unripe data itself.”) (internal notesomitted).SeeSectionsIII.B.4.b.andIII.B.4.c.foradiscussionof thedutiesimposedbySecurities Act Rule 408 and Exchange Act Rules 12b-20 and 14a-9.

324SeeRobertH.Rosenblum,An Issuer’s Duty Under Rule 10b-5 to Correct and Update Materially Misleading Statements, 40 Cath. U. L. Rev.289,297–98(1991).

32517C.F.R.§249.308.326See generallyNote,WallySuphap,Getting It Right Versus Getting It Quick: The Quali-

ty-Timeliness Tradeoff in Corporate Disclosure, 2003 Colum. Bus. L. Rev.661,677–79.

Ch. 12.III.C.3.a.


aslateas10daysaftertheendofthemonthinwhichtheeventrequiringdisclo-sureoccurred,whichmeantthatacompanydidnothavetoreportaForm8-Keventoccurringonthefirstdayofamonthuntil40dayslater;327however,aspartofitsSarbanes-Oxleyreformmeasures,CongressshortenedthereportingtimetofileaForm8-Ktowithinfourbusinessdays.328

b. Form 10-QIssuers must use the Form 10-Q329tofilequarterlyreportsasrequiredby

Section 13 or 15(d) of the Exchange Act. Pursuant to Rule 13a-13 or Rule 15d-13,thisformshallbefiledwithin45daysaftertheendofeachofthefirstthreefiscalquartersofeachfiscalyear (except thatacceleratedfilershaveonly40days),butareportdoesnotneedtobefiledforthefourthquarterofanyfiscalyear.330

c. Form 10-KIssuersmustusetheForm10-K331tofiletheirannualreportspursuantto

Section 13 or 15(d) of the Exchange Act of 1934 and transition reports. The SEC requiresissuerstoincludespecificinformationintheirForm10-Ksthatiscov-eredbyvariousprovisionsofRegulationS-K,including:

• InformationaboutlegalproceedingsasrequiredbyItem103;• Informationaboutself-dealingtransactionsrequiredbyItem404;• InformationabouttheMD&ArequiredbyItem303;and• InformationaboutmarketriskrequiredbyItem305.332

327Id.at677–78(internalnotesomittedandemphasisadded;citingExchangeActReleaseNo.34,925,1936SECLEXIS391(S.E.C.Nov.11,1936)).

328InReleaseNos.33-8400;34-49424;FileNo.S7-22-02,Final Rule: Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date(Aug.23,2004),theSECexplainedinrelevantparthowandwhyithadchangedthereportingrequirementsforForm8-K:

UnderthepreviousForm8-Kregime,companieswererequiredtoreportveryfewsig-nificantcorporateevents.The limitednumberofForm8-Kdisclosure itemspermittedapubliccompanytodelaydisclosureofmanysignificanteventsuntiltheduedateforitsnextperiodicreport....Therevisionsthatweadopttodaywillbenefitmarketsbyincreasingthenumberofunquestionablyorpresumptivelymaterialeventsthatmustbedisclosedcur-rently.Theywillalsoprovideinvestorswithbetterandmoretimelydisclosureofimportantcorporateevents.OnJuly29,2002,CongressenactedtheSarbanes-OxleyActof2002.Section409ofthis

Act requires public companies to disclose “on a rapid and current basis” material informa-tionregardingchangesinacompany’sfinancialconditionoroperationsaswe,byrule,deter-minetobenecessaryorusefulfortheprotectionofinvestorsandinthepublicinterest....

Seehttp://www.sec.gov/rules/final/33-8400.htm.32917C.F.R.§249.308a.330SeeSEC,Form10-Q:GeneralInstructions,available athttp://www.sec.gov/about/forms/

form10-q.pdf.33117C.F.R.§249.310.332SeeSEC,Form10-K—AnnualReportPursuant toSection13or15(D)of theSecuri-

tiesExchangeActof1934:GeneralInstructions,available athttp://www.sec.gov/about/forms/form10-k.pdf.

Ch. 12.III.C.3.a.


Annualreportsmustbefiledwithin60daysaftertheendofthefiscalyearcoveredbythereport(and75daysforfiscalyearsendingbeforeDecember15,2006)forlargeacceleratedfilers,within75daysaftertheendofthefiscalyearcoveredbythereportforacceleratedfilers,andwithin90daysaftertheendofthefiscalyearcoveredbythereportforallotherregistrants.333

4. Regulation FDWhen an issuer or someone acting on its behalf discloses material nonpub-

lic information about that issuer or its securities to anyone, the issuermustpubliclyandsimultaneouslydisclosetheinformationifthedisclosureisinten-tional,oritmustpromptlydisclosetheinformationifthedisclosureisuninten-tional. InRegulation FD,334 theCommission defined the term “promptly” tomeannot less thanwithin 24 hours of the commencement of the next day’stradingafteraseniorofficialoftheissuerlearnsabouttheunintentionaldisclo-sure or is reckless in not knowing about it.335Inpromulgatingthisregulation,theCommissionintendedtoleveltheplayingfieldforthegeneralpublic,asablyexplainedbyasecuritieslawprofessor:

[T]heSECadoptedRegulationFD[in2000]inresponsetotheperceivedunfairnesswhen companies selectively disclose336materialnonpublicinformationtoanalysts,institutionalinvestors,andothersecuritiesmarketinsiders.TheRegulation’sbasicpremiseprovides that“whenan issuer,orpersonactingon itsbehalf,disclosesmaterialnonpublic informationto[selective]persons . . . , itmustmakepublicdisclosure of that information.” The timing of when the issuer must make such a publicdisclosuredependsonwhethertheselectivedisclosurewasintentionalornonintentional.337

TheCommission’sfirstmajorenforcementproceedingunderRegulationFDwasanactionagainsta largepharmaceuticalcompany,Schering-Plough.Thepharmaceuticalcompanyanditsthen-CEOsettledthroughaconsentdecreeunderwhichScheringwasorderedtopaya$1millionpenaltyanditsCEOtopaya$50,000penalty.338 In explaining the conduct that led to the agreed cease-and-desist order, theCommission noted that, among other things, “Schering

333Id.33417C.F.R.§243.101.335Id., available at http://a257.g.akamaitech.net/7/257/2422/01apr20051500/edocket.access.

gpo.gov/cfr_2005/aprqtr/pdf/17cfr243.100.pdf.336“Selectivedisclosuregenerallyreferstothepracticeinwhichissuersofsecurities‘selec-

tivelyprovidematerial,nonpublicinformationtocertainpersons—often,securitiesanalystsorinstitutionalinvestors—beforedisclosingthissameinformationtothepublic.’”JonJordan,Cor-porate Issuers Beware: Schering-Plough and Recent SEC Enforcement Actions Signal Vigorous Enforcement of Regulation FD,58U.Miami L. Rev.751,752–53(2004)(internalnotesomittedreferringtoRegulationFD:HearingBeforetheHouseSubcomm.onCapitalMarkets,Ins.andGov’tSponsoredEnters.,Comm.onFin.Servs.,107thCong.(2001)(writtenstatementoftheSEC)).

337Marc. I. Steinberg, Insider Trading, Selective Disclosure, and Prompt Disclosure: A Comparative Analysis,22U.Pa. J. Int’l Econ.L.635,649(2001)(internalnotesomittedcitingSelective Disclosure and Insider Trading, ExchangeAct Release No. 43,154, [2000TransferBinder]Fed.Sec.L.Rep.(CCH)¶86,319,at83,676(Aug.15,2000))(emphasisadded).

338SeeSchering-PloughCorp.,ExchangeActReleaseNo.48,461(Sept.9,2003);Jordan,58 U. Miami L. Rev. at 751–52.

Ch. 12.III.C.4.


violatedRegulationFDandExchangeActSection13(a),and[itsCEO]causedsuchviolations,byprovidingguidancethatincludedmaterial,nonpublicinfor-mationaboutSchering’searningsprospectsduringprivatemeetingswithinsti-tutionalinvestorsandanalysts,andbyfailingtomakeapublicdisclosureoftheinformationasrequiredbyRegulationFD.”339

D. How to Make Disclosures

Inlightofthevariousdangersinvolvedwithpubliclydisclosinginforma-tion, issuersmust ensure that someone experiencedwith andknowledgeableabouttherequirementsofthevariousrules,regulations,andcaselawisinvolvedin the process.340

Tocomplywiththedutytoupdateorcorrectincompleteormisleadingdisclosures,companiesandtheircounselmustanalyzethecompany’spastSECfilings,pressreleases,andpublicstatementstoensurethatnocategoricaldenialsofsecuritieslawviolationsweremadeandnoinformationwasprovidedtothemarket-placemateriallyinconsistentwiththefindingsofaninternalinvestigation.341

This subsection covers two related issues that need to be considered inanalyzingwhetherthereisadutytospeak,and,ifso,whatshouldbedissemi-nated in thedisclosureprocess: theduty toupdateand theduty tocorrect.342 Althoughplaintiffssometimestrytoconflatetheseseparateconceptsintoone,there is a coredistinctionbetween these twoconcepts, as explained in In re Alliance Pharmaceutical Corp. Securities Litigation:343Adutytocorrectisonlyanissueifanissuerhaspreviouslymadeafalseormisleadingstatement.Beforediscussingthesedutiesinmoredetail,herearesomebasicsuggestionsaboutwhatpubliclytradedpharmaceuticalmanufacturersandmedicaldevicecompa-nies should focus on in preparing and disclosing informational disclosures:

339Schering-Plough Corp., at ¶4, available at http://www.sec.gov/litigation/admin/34-48461.htm.

340See, e.g.,DaleOesterle,The Inexorable March Toward a Continuous Disclosure Require-ment: “Are We There Yet?,” 20 Cardozo L. Rev.135,224(1998)(“Thereisnodoubtthatthedisclosureofbadnewsaffectsafirm’sbusinessreputation...[.]...[T]hedraftingofanegativereleaseisnoeasytask.Excessivefranknessandzealaboutafirm’stroublescanmisleadinvestorswhoselltheirstockandlaterfindtheirwayintoplaintifflawyers’officeswhenthefirm’sfortunesrebound.On theotherhand,measured,minimal releasesofbadnewscanbackfire as startledinvestors,cravingmoredetail,assumetheworstbaseduponwithheldinformation.”).

341J.BradleyBennett&AndrewJ.Brauer,To Tell or Not to Tell: Weighing the Benefits and Pitfalls Self-Reporting Corporate Wrongdoing, 38(13) Sec. Reg.&Law Rpt.526,527(Mar.27,2006).

342SeeOesterle,at143(“Therearetwosupplementaryorderivativedoctrines,whichapplywheneverafirmhasthedutytospeak,thathavethepotentialtosignificantlywidenthedisclosureobligation.Thefirstdoctrinedealswiththeculpabilityof‘half-truths.’Theseconddoctrineisadutytoupdatedisclosuresthatwerecorrectwhenmadebuthavebeenmadeincorrectormislead-ingbysubsequentevents....”)(internalnotesomitted).

343279F. Supp. 2d 171 (S.D.N.Y. 2003) (“[P]laintiffs conflate the issues of (1)whetherdefendantshadadutytodiscloseparticularfacts;(2)whetherdefendantshadadutytoupdateinformationobtained subsequent todisclosure; and (3)whichprovisionof the securities lawsdefendantswouldbe liableunder if theyviolated eitherduty.”).SeeSection II.A., above, forfurther discussion of this case.

Ch. 12.III.C.4.


1. Identifyforward-lookingstatements,andusecautionary language specific totheissuesbeingdiscussed;

2. Identify statements involving timelines for regulatory approval (e.g.,approvalforinitiatingclinicaltrialsorforreceivingmarketingapproval) clearly as forward-looking statements with meaningful cautionary language;

3. Usemeaningfulcautionarylanguagetoindicatetheinherentrisksinvolvedin research and development, including nonclinical and clinical testresults,whichareuncertainandsubjecttodifferinginterpretation;and

4. Preparemoresubstantiveandspecificpublicdisclosurestoaddresscon-cernsidentifiedinrecentcourtdecisions,makingsureitwillbeimportanttoavoidviolationsoftheFDA’sregulationsonpreapprovalpromotion.344

Moregenerally,publiclytradedpharmaceuticalmanufacturersandmedicaldevicecompaniesshouldconsiderhowtheinformationtheyplantodisclose(ornot)wouldappearintheprismofacourtroomifarguedbycounselforclassaction plaintiffs in a securities fraud case. An issuer should expect that each disclosureforwhichsafeharbortreatmentissoughtwillbechallenged;thattheinformationnotprovidedinthedisclosurewilltakeongreatsignificance;andthatthecautionarylanguageprovidedwillbecriticizedasvague,stale,oroth-erwise inadequate.

Forexample,inIn re Cell Pathways, Inc.,345 a court refused to dismiss a securitiesfraudclassaction(allegingthecompanymadefalseandmisleadingstatementsaboutthetestingandstatusofanINDdespiteknowingaboutflawsin a Phase 3 study), reasoning that the company’s warnings about possibleadverseeffectswerenotentitledtosafeharbortreatmentbecauseithadpresentknowledgeofadverseeffects.346 Compare that holding with the one in Barrios v. Paco Pharmaceutical Services, Inc.,347 where the court held that the drug manufacturer’s private placement memo sufficiently disclosed the materialinvestmentrisksinvolved(i.e.,thatthebespeakscautiondoctrineprotectedthestatements).348 In re Pozen Securities Litigation349involvedaclassactionsecu-ritiesfraudcomplaintagainstanewdrugmanufacturerinvolvingitsproductfortreating migraine headaches, which illustrates the importance of carefully

344MarchJ.Sonnenfeldetal.,Disclosing Product Developments to Investors, 18(4) Insights 4,22,25(2004)(emphasisadded).

345MasterFile01-CV-1189,2000WL805221(E.D.Pa.June20,2000)(unreported),called into doubt by Heywoodv.CellTherapeutics,Inc.,No.C05-0396RSM,2006WL5701625(W.D.Wash.May4,2006).

346Id.at*11(“[T]otheextentthatthechallengedstatementswereaccompaniedbycaution-arylanguage,suchwarnings...wereinsufficientinlightofCPI’sknowledgeatthetime...thattheriskshadalreadymaterialized.‘Warningsofpossibleadverseeventsareinsufficienttomakeomissions of present knowledgeof certain future events legally immaterial.’”) (internal notesomitted).

347816F.Supp.243(S.D.N.Y.1993).348Id.at250(“InthefaceofthecontentofthePPM,nopotentialinvestorwasatlibertyto

...ignorethespecificsofwhatwasstated...andbelievethataninvestmentwasbeingmadeinanassuredproject...[.]Itwasexpresslystatedthattherewasnoassurancethattheinvestmentobjec-tives...wouldberealized.Theeconomicprojections...arenotactionable,becausetheybespeakcautioninpreciselanguageandspecificallydisclosethenatureandextentoftherisksinvolved.”).

349386 F. Supp. 2d 641 (M.D.N.C. 2005).

Ch. 12.III.D.


reviewingtheclarityoftermsusedandanywarningsgivenindisclosures.350 See also Asher v. Baxter International, Inc.,351 a class action securities fraud case againstamedicaldevicemanufacturer,wherethecourtexplainedthedifferencesbetween boilerplate warnings and those entitled to protection.352

1. Duty to UpdateAsonesecurities lawprofessorexplains,“[u]nder theso-called‘duty to

update’...,companieshaveaproactiveresponsibilitytoinformthemarketplacewheneventsevolve...torendermisleadingsomepriorstatementuponwhichthemarketisstillrelying.”353AgoodexampleofthisdutyisseeninIn re Time Warner, Inc. Securities Litigation,354 “where the Second Circuit found that Time WarnermighthaveviolatedRule10b-5bynotissuingapressreleaseafteritbecameclearthatitspriorstrategyofseekingfinancialpartnerswouldhavetobeabandonedinfavorofadilutivestockoffering.”355 “Section 409 of the Sar-banes-OxleyActaddedtothe...ExchangeActanewSection13(l)thatman-dates real time disclosures of ‘additional information concerning material changes in thefinancialconditionoroperationsof’securities issuers.”356 The languageusedinthisprovisionappearstoimposeonissuersadutytoupdatesimilartotheirobligationstofilecurrentreportsofmaterialdevelopmentsunderForm8-K—andmanyotherrulesandregulationsissuedbytheCommissiondothe same.357

350Id. at 645–46 (“Pozen’s drafting of the press release all but invited such a claim. In refer-encetotheprimaryendpointofreliefofmigrainepain,Pozendefinedtheterm‘sustainedrelief’as‘reliefwithin2hoursofdosing’withnorelapseoverthenext22hours.Thatis,Pozendefinedashowingof‘sustainedrelief’ofpainassatisfyingthetwo-hourprotocolusedintheclinicalstudies.Pozenthenappliedadifferentdefinitiontotheterm‘sustainedrelief’whenusedinrelationtothesecondaryendpoints.Inthatcontext,Pozenintendedthetermtomeanreliefattimesmorethantwohoursafterdosing.Althoughpoorlywritten...,amoderatelycarefulreadingofthepressreleasemakesthedifferentusageclear....[¶]Useofthesametermwithdifferentdefinitionswithinasinglepublicstatementcouldundoubtedlyconfusesomeinvestors.Thesecuritieslaws,however,whileplacingsignificantburdensonissuerstomakeaccurateandcompletepublicdisclosures,alsoplacetheminimalburdenoninvestorstoactreasonably....”)(internalnotesomitted).

351377 F.3d 727 (7th Cir. 2004).352Id.at733(“PlaintiffssaythatBaxter’scautionswereboilerplate,buttheyaren’t.State-

mentsalongthelinesof‘allbusinessesarerisky’or‘thefutureliesahead’cometonothingotherthancaveatemptor (which isn’tenough); thesestatements,bycontrast,at least includedBax-ter-specificinformationandhighlightedsomepartsofthebusinessthatmightcauseproblems....Baxtersaysthatmentioningthesebusinesssegmentsdemonstratesthatthecautionissufficient;butthisalsoiswrong,becausethenanyissuercouldlistitslinesofbusiness,say‘wecouldhaveproblemsinanyofthese,’andavoidliabilityforstatementsimplyingthatnosuchproblemswereonthehorizonevenifaprecipicewasinsight.”).

353DonaldC.Langevoort,Organized Illusions: A Behavioral Theory of Why Corporations Mislead Stock Market Investors (and Cause Other Social Harms), 146 U. Pa. L. Rev.101,163(1997) (internal notes omitted).

3549F.3d259,267–68(2dCir.1993).355Langevoort,at163(internalnotesomitted).356PeterH.Huang,Moody Investing and the Supreme Court: Rethinking the Materiality

of Information and the Reasonableness of Investor, 13 Sup. Ct. Econ. Rev.99,112–13(2005)(internalnoteomitted,citing15U.S.C.§78.13(l)).

357SeeSectionsI.C.2.,III.A.1.,III.B.4.b.,andIII.B.4.c.,above.See also In reBayerAGSec.Litig.,No.03Civ.1546(WHP),2004WL2190357(S.D.N.Y.Sept.30,2004)(holdingthatthe

Ch. 12.III.D.


2. Duty to CorrectAdutytocorrectapriordisclosurewillonlybeimposedifanissuer’sprior

disclosure was misleading or false when it was made.[D]isclosureswill be evaluatedunder theprismof truthfulness and adequacyundertheso-called“Half-TruthDoctrine”andinlightoftheirSEC-mandateddisclosureobligations.Insum,anytimewhencompanieshaveadutytospeak,orotherwisechoosetospeak,theymustspeaktruthfullyandcompletelyaboutallmaterialitems.Buteveniftheirstatementsaretruthfulandcomplete...[whenthey are]madewill not foreclose liability. Instead, liability can be created ifsubsequenteventsrenderthedisclosedinformationincompleteandtheinforma-tion“remainsalive”inthepubliceye.Underthesecircumstances,courtshavestruggledtodecidewhetherpubliclytradedentitiesmustupdateorsupplementdisclosedinformation.Ontheotherhand,courtshavenot experienced the same probleminholdingthatthatwhencompaniesdecidetospeak(whethertheyarerequiredtodosoornot),companiesmustdosocompletely—orelsetheymayliableunderthe“Half-TruthDoctrine.358

IllustrativeofthedutytoupdateisIn re Neopharm, Inc.359 In this securi-tiesfraudclassaction,thecourtrefusedtoimposeadutytoupdatebasedonthefacts.TheclassactioncomplaintfocusedonNeopharm’sreportsaboutitsexperimental drug (liposome encapsulated paclitaxel) and published clinical teststhatthedrughelpedpatientstoleratetheanticancerdrug,paclitaxel(mar-keted by BristolMyers Squibb as Taxol®).360 The court explained that the problemwith the plaintiffs’ theorywas that “NeoPharm’s pre-Class Periodstatementsfallintothedutytoupdatecategoryandarenotactionable....Noallegation is made that these subsequent events rendered these statementsuntrue when made. As such, NeoPharm had no duty to correct thesestatements.”361

IV. Securities Fraud and Anti-Manipulation Rules

Courts evaluate alleged securities fraud actions under differentapproaches, depending on whether the alleged fraud involves an omission (which requiresproof toestablish thebreachofaduty todisclosematerial

pharmaceuticalmanufacturerhadadutytoupdateitspredictionsaboutexpectedincomebasedonadrugthatthecompanyknewithadalreadyrecalled);In reAlpharmaSec.Litig.,372F.3d137(3dCir.2004)(holdingthattheplaintiffshaderroneouslyconflatedthedutytocorrectwiththedutytoupdate);Rule408oftheSecuritiesAct(indicatingthatanissuerofaregistrationstatementmustprovideanyfurtherinformationnecessarytomaketherequiredstatementsnotmisleadinginlightofinterveningdevelopmentsofwhichtheissuerisaware);Rules12b-20and14a-9oftheExchangeAct(same);andArt.10ofRegulationS-X(instructingissuerstoensurethattheirinterimfinancialstatementsincludesufficientinformationtopreventthestatementsfrombeingmisleading).

358MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.04(internalcitationomitted).

359No.02C2976,2003WL262369(N.D.Ill.Feb.7,2003)(unreported).360Id. at *3.361Id. at *10.

Ch. 12.IV.


informationandtheplaintiff’srelianceontheinformation)oranaffirmativemisrepresentation of material information (which does not depend on an underlyingduty).362Foromissioncases,theFifthCircuitdescribestheburdenas follows:

Becauserelianceissodifficulttoprovewhenadefendanthasfailedtodiscloseamaterialfactratherthanmisrepresentingit,theSupremeCourthasallowedthetrieroffacttopresumerelianceinanomissioncasewheretheplaintiffscouldjustifiablyexpect that the defendants would disclose material information.363

A. Manipulative Conduct

In addition to proscribing fraudulent or deceptive conduct, the federalsecurities laws prohibit acts constituting manipulation. Because Congress did notexplicitlydefine“manipulation”ineithertheSecuritiesActortheExchangeAct, ithasbeen left forcourtsand regulators todevelop the term’smeaningunder the securities laws.364 The text of the securities laws describes some of the conductCongressmeant to prohibit—wash sales,matched orders, and shortsales.365 As noted in Santa Fe Industries, Inc. v. Green,Congress proscribedcertaintradingpracticesthatitdeemedtobemanipulative.366 “‘Manipulation is virtuallyatermofartinsecuritieslawandreferstomatchedordersandwashsales.’”367As the Court also observed, the language in Section 10(b) of theExchange Act shows that Congress intended to limit the reach of this Act to

362See alsoGregoryS.Porter,What Did You Know and When Did You Know It: Public Company Disclosure and the Mythical Duties to Correct and Update, 68 Fordham L. Rev.2199,2199(2000)(“Allegationsofsecuritiesfraudgenerallycanbebrokendowninto twotypesofcases—thoseclaimingfraudbaseduponwhatacorporationoritsinsidershavesaid,andthoseclaimingfraudbaseduponwhattheyhavenotsaid,butshouldhave.”).

363Shoresv.Sklar,647F.2d462,468(5thCir.1981)(enbanc),overruled in part as stated inRegentsoftheUniv.ofCal.v.CreditSuisseFirstBoston,482F.3d372,392(5thCir.Tex.2007)(omittinginternalcitationtoAffiliatedUteCitizensv.UnitedStates, 406 U.S. 128 (1972)).

364See Clark, at §5.02 (“Because the federal securities laws are so broadly written andbecausemanykeytermsareundefined,ithasfallentothecourts,theSEC,andprivatelitigantstoaddressthefairmeaningofsuchtermsastheyareusedintheselaws.”).

365SeeDanielR.Fischel&DavidJ.Ross,Should the Law Prohibit Manipulation in Finan-cial Markets?,105Harv. L. Rev.503,504(1991)(“Tocurtailthepoolsandrelatedspeculativeexcesses, Congress proscribed certain trading practices deemed to be manipulative. Amongthe practices so classified were wash sales [15 U.S.C. §78i(a)(1)(A)], matched orders [id.,§§78i(a)(1)(B), (C)], short sales [id., §78j(a)], and amore amorphous practice believed to becharacteristicofthepools—tradinginasecurity‘forthepurposeofinducingthepurchaseorsaleofsuchsecuritybyothers.’ [Id.§78i(a)(2)]Thestatutoryprovisionsgoverning thesepracticesweredesigned‘topurgethesecuritiesexchangesofthosepracticeswhichhavepreventedthemfromfulfillingtheirprimaryfunctionoffurnishingopenmarketsforsecuritieswheresupplyanddemandmayfreelymeetatpricesuninfluencedbymanipulationorcontrol.’[Senate Comm.on Banking& Currency,Stock Exchange Practices,S.Rep.NO.1455,73dCong.,2dSess.30(1934)(FletcherReport),reprinted in 5 LegislativeHistoryof the Securities Actof 1933 and Securities Exchange Actof1934,atItemNo.21(J.S.Ellenberger&EllenP.Mahereds.,1973)].”)(internalnotesomitted).

366430 U.S. 462 (1977).367Id.at463(citingErnst&Ernstv.Hochfelder,425U.S.185,199(1976))(internalnote

omitted).

Ch. 12.IV.


fraudulentormanipulativeconduct.368Later,inSchreiber v. Burlington North-ern, Inc.,369 the Court held that the term manipulative has the same meaning in actions brought under Section 14(e) of the Securities Act as it does under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.370 It empha-sizedthatmisrepresentationornondisclosurewascriticaltoafindingofmanip-ulativeconductunderSection14(e):“Weholdthattheterm‘manipulative’asusedin§14(e)requiresmisrepresentationornondisclosure.Itconnotes‘conductdesignedtodeceiveordefraudinvestorsbycontrollingorartificiallyaffectingthepriceofsecurities.’”371Simplyput,withoutmisrepresentationornondisclo-sure, Section 14(e) has not been violated.As commentators have explained,othersectionsoftheExchangeActalsoprovideguidanceaboutthemeaningoftheterm“manipulative”inSection10(b)oftheExchangeAct.372

368Id. at 473–74 (“The language of §10(b) gives no indication that Congress meant toprohibitanyconductnotinvolvingmanipulationordeception....ThustheclaimoffraudandfiduciarybreachinthiscomplaintstatesacauseofactionunderanypartofRule10b-5onlyiftheconductallegedcanbefairlyviewedas‘manipulativeordeceptive’withinthemeaningofthestatute.”) (internal citations omitted).

369472 U.S. 1 (1985).370Id.at7–8(“[Petitioner]...argues...thattheterm‘manipulative’takesonameaning

in§14(e)thatisdifferentfromthemeaningithasin§10(b)....Allthreespeciesofmisconduct,i.e.,‘fraudulent,deceptive,ormanipulative,’listedbyCongressaredirectedatfailurestodisclose.Theuseoftheterm‘manipulative’providesemphasisandguidancetothosewhomustdeterminewhichtypesofactsarereachedbythestatute;itdoesnotsuggestadeviationfromthesection’sfacialandprimaryconcernwithdisclosureorcongressionalconcernwithdisclosurewhichisthecore of the Act.”) (internal citation omitted).

371Id.at12(citingErnst&Ernstv.Hochfelder,425U.S.at199).372SeeSteveThel,Regulation of Manipulation Under Section 10(B): Securities Prices and

the Text of the Securities Exchange Act of 1934, 1988 Colum. Bus. L. Rev.359,380–81(1988)(“Agoodguidetothemeaningofthewordmanipulativeinsection10(b)isavailablefromsections9and10(a)oftheAct,whichwereenactedin1934alongwithsection10(b).Sections9and10areentitled‘Prohibitionagainstmanipulationofsecurityprices’and‘Regulationof theuseofmanipulativeanddeceptivedevices,’respectively.Congresslabeledthepracticesthatitaddressedinthesesectionsasmanipulative,andtakentogetherthetwosectionsgivethewordmeaningforthepurposeofconstruingsection10(b).[¶]Sections9and10,liketherestoftheAct,contemplateextensiveregulationofthemarkettowardtheendofprotectingthepublicfromspeculativeandmanipulativeconduct.Section9startsbydeclaringavarietyoftradingpracticesandcommunica-tionsunlawfuliftheyaremotivatedbycertainpurposesorhavecertainconsequences.Therestofsections9and10makeitunlawfultodoavarietyofthingsincontraventionofSECrules....”)(internal notes omitted).

See also Thomas Lee Hazen,Market Manipulation and Deceptive Practices—Sections 9, 10, 14(e), 15(c), 2 Law Sec. Reg.§12.1(4thed.2002)(“Section9...outlawsmanipulativepracticesinconnectionwiththetradingofexchange-listedsecuritiesandalsoprovidesaprivateremedyfor[injured]investors....[¶]Section9’sprohibitionsaresupplementedbysection10(b)whichempowerstheSECtopromulgaterulesbarringmanipulativeaswellasdeceptiveconductandalsobysection15(c)whichprohibitsfraudulentandmanipulativeconductbybroker-dealers.Thelanguageofsection9limitsitsapplicationtomanipulationofsecurities...subjecttotheExchangeAct’s registrationandreportingrequirementsbyvirtueofbeing listedonanationalexchange;whereassection10(b)isnotsolimitedandappliestoallsecuritiestransactionsutilizinganinstrumentalityofinterstatecommerce.Unlikemostotherprovisionsofthe1934Act,section9islimitedtosecuritiesonanationalexchangeanddoesnotapplytothesecuritiesofthemanyregisteredissuers...tradedintheover-the-countermarkets.”)(internalcitationsomitted;pagereferencesnotavailable).

Ch. 12.IV.A.


B. Key Provisions

1. Exchange Act Section 9Section 9(a)(2) of the ExchangeAct makes it unlawful for anyone to

“directlyorindirectly,...effect...aseriesoftransactionsinanysecurityreg-istered on a national securities exchange creating actual or apparent activetradinginsuchsecurityorraisingordepressingthepriceofsuchsecurity,forthepurposeofinducingthepurchaseorsaleofsuchsecuritybyothers.”373 Sec-tion9containsother importantprovisions.Asonecourtexplained,“[Section9(a)(2)]isquiteseparatefromthesubsectionsof§9prohibitingmanipulationthroughfraudulentdevicessuchaswashsales,15U.S.C.§78i(a)(1)(A),matchedsales,id.at§78i(a)(1)(B)-(C),andfalsestatements,id.at§78i(a)(4).”374 A good discussion about manipulation under Section 9 of the Exchange Act is set out in Sullivan & Long, Inc. v. Scattered Corp.,375 which held that most forms of manip-ulationinvolvedeception.Thecaseinvolvedanappealfromthedismissalofacomplaintfiledafteranotoriousepisodeofshort-sellinginvolvingthecommonstock of LTV Corporation.376TheSeventhCircuitfoundthattheshort-sellingatissuewasneitherdeceptivenormanipulative.377

2. Exchange Act Section 10(b)Section10(b)oftheExchangeActmakesitunlawfulforanyperson“to

useoremploy,inconnectionwiththepurchaseorsaleofanysecurity...anymanipulativeordeceptivedeviceorcontrivanceincontraventionofsuchrulesandregulationsasthe[SEC]mayprescribe.”378Basically,inorder“[t]ostateaclaimforreliefunderRule10b-5,aplaintiffmustallegethat‘inconnectionwiththepurchaseorsaleofsecurities, thedefendant,actingwithscienter,madeafalse material representation or omitted to disclose material information and that plaintiff’srelianceondefendant’sactioncaused[plaintiff]injury.’”379Aprivatesecuritiesfraudplaintiffmustallegeandprovethefollowingessentialelements:(1) scienter (i.e., the defendant actedwith the intent to defraud, deceive, or

37315U.S.C.§78i(a)(2).See generallyDanielR.Fischel&DavidJ.Ross,Should the Law Prohibit Manipulation in Financial Markets?,105Harv. L. Rev.503,534–35(1991).

374Markowskiv.SEC,274F.3d525,529(D.C.Cir.2001).37547F.3d857,869(7thCir.1995).376Id. at 859.377See id.at864.(“[N]othingalleged...isthekindofconductthatthesecuritieslawsare

aimedatcombatting....[N]oneoftheplaintiffs’specificlegalcontentionshasmerit.Theycon-tend...that‘byunprecedentedmassiveshortsellingandbydisguisingthenatureoftheirtrades,thedefendantscontrolledthepriceofLTV,’inviolationofsection9(a)(2)ofthe...ExchangeAct....[T]heessenceoftheoffenseiscreating‘afalseimpressionofsupplyordemand,’forexamplethroughwashsales,wherepartiesfictitiouslytradethesamesharesbackandforthathigherandhigherpricestofoolthemarketintothinkingthatthereisalotofbuyinginterestinthestock.Therewasnothinglikethathere.OntheothersideofallofScattered’stransactionswererealbuyers,bettingagainstScattered...thatthepriceofLTVstockwouldrise.AndScatteredmadenorepresentations,trueorfalse,actualorimplicit,concerningthenumberofsharesthatitwould sell short. . . .”).

37815U.S.C.§78j(b).379ElizabethA.Nowicki,10(b) or Not 10(b): Yanking the Security Blanket for Attorneys in

Securities Litigation,2004Colum. Bus. L. Rev.637,642(2004)(internalnotesomitted).

Ch. 12.IV.B.1.


manipulate),(2)materiality,(3)losscausation,380(4)transactioncausation,and(5) that the fraud occurred “in connection with the purchase or sale of securi-ties.”381SECRule10b-5,whichwaspromulgatedbytheCommissionin1948toeffectuatethepurposesofSection10(b)oftheExchangeAct,makesitunlaw-ful to:

1. Employanydevice,scheme,orartificetodefraud;2. Makeanyuntruestatementofamaterialfactortoomittostateamaterial

factnecessaryinordertomakethestatementsmade,inthelightofthecircumstancesunderwhichtheyweremade,notmisleading;or

3. Engageinanyact,practice,orcourseofbusinessthatoperatesorwouldoperateasa fraudordeceituponanyperson, inconnectionwith thepurchaseorsaleofanysecurity.382

Becausethisrule’slanguageissosimilartothefederalmailfraud383 and wire fraud384statutes,courtshavegivenRule10-b5similarexpansivetreatment.

3. Exchange Act Section 14(e)Section14(e)oftheExchangeActprovides,inrelevantpart:Itshallbeunlawfulforanyperson...toengageinanyfraudulent,deceptive,ormanipulativeactsorpractices,in connection with any tender offer....The[SEC]shall, for the purposes of this subsection, by rules and regulations define, andprescribemeans reasonablydesigned toprevent, suchacts andpractices as arefraudulent,deceptive,ormanipulative.385

Section14(e)’s language is very similar to that inRule10b-5.Notably,however,Section14(e)isfaciallylimitedtoamuchnarrowerclassofconduct(i.e.,fraudcommittedinconnectionwithtender offers—ratherthansecondary

380See id. at 644–46 (“To establish transaction causationor‘reliance’underSection10(b),aplaintiffmust‘demonstratethatdefendants’conductcausedhimtoengageinthetransactioninquestion.’Toestablishloss causationunderSection10(b),plaintiffs‘mustallegethattheywouldnothavesufferedalossontheirinvestmentifthefactswereastheybelievedthemtobeatthetimetheypurchasedthesecurities.’‘Thedamagecomplainedof[must]beoneoftheforeseeableconsequences of themisrepresentation.’ Lastly, a plaintiffmust show that the complained ofmisstatementoromissionwasmade‘inconnectionwiththepurchaseorsaleofanysecurity.’”)(emphasis added and internal notes omitted).

381See id. See alsoRoyceDeR.Barondes,The Bespeaks Caution Doctrine: Revisiting the Application of Federal Securities Laws to Opinions and Estimates,19J.Corp.L.243,245–46(1994)(“TheelementsofaclaimforviolationofRule10b-5...underthe...ExchangeAct...inconnectionwiththepurchaseorsaleofsecuritiesare(i)amaterialmisstatementoromission,(ii)scienter,(iii)damage,and(iv)causation.AlthoughtheSupremeCourthasdeclinedtodecidewhetherrecklessnesswouldconstitutescienter,courtsofappealshavegenerallyfoundreckless-ness to be adequate.”) (internal notes omitted).

382Rule 10b-5 is codified at 17 C.F.R. §240.10b-5. See generally Stuart Sinai,Rumors, Possession v. Use, Fiduciary Duty and Other Current Insider Trading Considerations, 55 Bus. Law. 743 (Feb. 2000).

38318U.S.C.§1341.384Id.at§1343.38515U.S.C.§78n(e)(discussedinSinai,Rumors, at743(pagereferencesunavailableand

internal note omitted)).

Ch. 12.IV.B.3.


market fraud). Still, insider trading is easier to establish if the conduct fallswithin this narrower range.386

4. Securities Act Section 11As one court has explained, a Section 11 violation is establishedwhen

“materialfactshavebeenomittedorpresentedinsuchawayastoobscureordistorttheirsignificance.”387Moreover,“materialfactsincludenotonlyinfor-mationdisclosing theearningsanddistributionsofacompanybutalso thosefactswhichaffecttheprobablefutureofthecompanyand...mayaffectthedesire of investors to buy, sell, or hold the company’s securities.”388 Actions under Section 11 of the Securities Act do not require proof of causation or reli-ance(unlikeprivatesecuritiesfraudcasesunderSection10(b)oftheExchangeAct).

IllustrativeisHarvey M. Jasper Retirement Trust v. Ivax Corp.,389 where thecourtrefusedtodismissasecuritiesfraudcomplaintfiledafteramerger.Theclassplaintiffsallegedthatapharmaceuticalcompanydefraudedthemby“chan-nelstuffing”itsinventoryandmisleadinginvestorsaboutthesizeofthemarketforthecompany’sproducts.Asthecourtobserved:

Section11oftheSecuritiesActallowspurchasersofregisteredsecuritiestorecoverfrom the issuer if its registration statement contained an untrue material fact or omitted tostatea requiredmaterial fact. . . .Plaintiffsneednotpleadorproveprivity,reliance,causationorscienterinordertorecoverunderSections11,12(2)or 14(a) of these Acts. . . .”390

Congress shifted the burden on the scienter issue in Section 11 actions to defendantsotherthantheissuer(i.e.,company’sdirectors,otherswhosigntheissuer’sregistrationstatement,andunderwriters)whocanassert theduedili-gencedefense.Astothisdefense,15U.S.C.§77k(b)(3)(A)makesitonlyavail-abletoapartythatcandemonstratethatitmadereasonableeffortstoascertainthat the representations contained in the registration statements were true and accurate.391

386See, e.g.,MarkJ.Krudys,Insider Trading by Members of Creditors’ Committees—Action-able!,44DePaul L. Rev.99,106n.35(“In1980,theCommissionpromulgatedRule14e-3.Rule14e3(a)providesthatanypersonwhoobtainsinsideinformationregardingatenderofferfromeither the offeror or the target must either disclose the information or abstain from trading. Rule 14e-3doesnotrequiretheCommissiontoprovethatthetenderofferinformationwasobtainedpursuanttoabreachofafiduciaryduty.17C.F.R.[§]240.14e-3(1994)(pursuanttoSection14(e)ofthe1933ExchangeAct,15U.S.C.[§]78(n)(e)(1988)).”).

387In reElanCorp.,2004WL1305845,at*7–8(S.D.N.Y.May18,2004)(unreportedrec-ommendationfrommagistrate-judgeregardingasecuritiesfraudcomplaintarisingfrommergeroftwopharmaceuticalcompaniesforallegedlyimproperaccountingdevices,suchasroundtrippingandtheuseofspecialpurposeentities,toartificiallyraisestockprice;citingrespectively,I.MeyerPincus&Assocs.,P.C.v.Oppenheimer&Co.,936F.2d759,761(2dCir.1991)andSECv.TexasGulfSulphurCo.,401F.2d833,849(2dCir.1968)).

388Id.389920 F. Supp. 1260 (S.D. Fla. 1995).390Id. at 1266.391See alsoRoyceDeR.Barondes,The Bespeaks Caution Doctrine: Revisiting the Appli-

cation of Federal Securities Laws to Opinions and Estimates,19J.Corp.L.243,245–46(1994)(observingthattheissuerdoesnothavethesamedefense:“Actionsundersections11and12(2)

Ch. 12.IV.B.3.


5. Securities Act Section 12(a)(2)Asonecommentatorhasexplained, “Section12(a)(2) [of theSecurities

Act]isanexpress,negligence-likecauseofactionformisstatementsoromis-sionsina‘prospectusororalcommunication’madeinconnectionwiththesaleorofferforsaleofasecurity.”392Underthisprovision,“shareholdersmustprovetheexistenceofamaterialmisstatementoromission”and“that theydidnotknowofthemisstatementoromissionatthetimetheyboughtthesecurity.”393 Finally, “liability is limited to sellers of securities, and the buyermust havepurchasedsecuritiesfrom,orhavebeeninprivitywith,theseller.”394 In order forliabilitytoattachunderSection12(2),materialityalsomustbeestablished.395 NotethatinSection12(b)cases,Congressshiftedtheburdenofprovingalack ofscientertothedefendant.Thisrequiresadefendanttoprovethatheorshe“‘didnotknow,andintheexerciseofreasonablecarecouldnothaveknown,oftheuntruthoromission.’”396

6. Securities Act Section 17(a)(2)Section 17(a)(2)397 of the Securities Act “explicitly bars persons from

obtainingmoneyorpropertybymeansof‘anyomissiontostateamaterialfactnecessary. . . tomakethestatementsmade,inthelightofthecircumstances

ofthe1933Actprovideadefensetothosemakingareasonableinvestigation(exceptforissuersastoactionsundersection11,whodonothavethatdefense).”).

15U.S.C.§77k(b)(3)(A)providesinrelevantpart:[N]operson,otherthantheissuer,shallbeliableasprovidedthereinwhoshallsustain

the burden of proof— . . .(3)that...(A)asregardsanypartoftheregistrationstatementnotpurportingtobemade

ontheauthorityofanexpert,andnotpurportingtobeacopyoforextractfromareportorvaluationofanexpert,andnotpurportingtobemadeontheauthorityofapublicofficialdocumentorstatement,he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required tobestatedthereinornecessarytomakethestatementsthereinnotmisleading.

(Emphasis added.)392HillaryA.Sale,Disappearing Without a Trace—Sections 11 and 12(A)(2) of the 1933

Securities Act,75Wash. L. Rev.429,437–38(2000)(internalnotesomitted).See also Neubauer v.Eva-HealthUSA,Inc.,158F.R.D.281,284n.1(S.D.N.Y.1994),inwhichthecourtpartiallydismissedasecuritiesfraudcomplaintthatallegedmateriallyfalseandfraudulentstatementsweremadeinaprospectusaboutthedevicemanufacturer’schairmanandCEO,byrepresentingthathewasanM.D.andaPh.D.whohadprotectedthemedicaldeviceswithpatents—whichwasnottrue: “The elements of a claim under Section 12(2) of the Securities Act differ from those under Rule10b-5inatleastoneimportantrespect.Section12(2)imposesstrictliabilityformaterialfalsestatementsoromissions,subjecttostatutorydefenses,whereasRule10b-5requiresscienter. In consequence,aSection12(2)claimneednotcontainavermentsoffraudandmaynotbesubjectto Rule 9(b).” Id.

393Id.394Id.395Louis Loss,Assault on Securities Act Section 12(2), 105Harv. L. Rev. 908, 910–11

(1992).396Id.,citing§12(2)oftheSecuritiesActof1933,15U.S.C.§77l(2).39715U.S.C.§77q(a)(2).

Ch. 12.IV.B.6.


underwhichtheyweremade,notmisleading.’”398Inturn,“thetextfromSection17(a)wasincorporatedverbatimbythe. . . [SEC]intowhathasbecomethemostlitigatedantifraudprohibitionofthesecuritieslaws,Rule10b-5underthe. . . Exchange Act.”399

C. Scienter

Pharmaceutical companies and medical device manufacturers that arenamedinprivatesecuritiesfraudcasescanassertvariousdefenses,including:

1. Thelackofmaterialityoftheallegedlyfalseormisleadingstatementsunder one or more theories: a. Thestatementsmettheconditionsnecessaryforstatutorysafeharbor

protection;400

b. The statements met the conditions for regulatory safe harborprotection;401

c. Thestatementsfellwithinthebespeakscautiondoctrinebecausetheyareofatypethatnoreasonableinvestorwouldrelyuponinlightofthewarningsfromtheissuer;402 or

d.Thestatementswere“softinformation”andincapableofverification,constitutedcommercialspeech,orwerepuffery;403

2. Thelackofcausation(transactionalandloss);and3. Thepleadingslacktherequisitespecificityrequiredtoallegefraudor

scienterunderFederalRuleofCivilProcedure9(b)404 or the PSLRA.SecuritiesfraudormisrepresentationcasesfiledunderSection10(b)ofthe

ExchangeActandRule10b-5requirethatplaintiffsallegeandprovethatthedefendant(s)actedwiththerequisitescienter.Astoanyallegedfraudbasedonthenondisclosureofmaterialinformation,pharmaceuticalcompaniesmayarguethattheyshouldnotbeheldliablebecausetheyfollowedFDApolicythatdis-courages premature disclosure of side effects.405Illustrative isCity of Sterling

398DonaldC. Langevoort,Half-Truths, Protecting Mistaken Inferences by Investors and Others,52Stan. L. Rev.87,90–91(1999)(internalnotesomitted).

399Id.400SeeSectionIII.A.4.c.,above,discussing15U.S.C.§§77z-2and78u-5.401SeeSectionIII.B.4.d.,above,discussingRules175and3b-6.402SeeSectionIII.A.4.b.,above.403Id.404Fed.R.Civ.P.9(b)providesthat“[i]nallavermentsoffraudormistake,thecircumstances

constituting fraudormistakeshallbestatedwithparticularity.Malice, intent,knowledge,andotherconditionofmindofapersonmaybeaverredgenerally.”

405SeeTonyaSmitsRodriguez,Comment,Extending the Fraud on the Market Theory: The Second Circuit’s Connection Test for SEC Rule 10b-5,25Iowa J. Corp. L. 423 (2000) (“The scien-terelementofRule10b-5canshielddrugcompaniesfromsecuritiesliabilityinsomecases.IfthedrugmanufacturercanestablishthatitdelayeddisclosureofpotentialsideeffectsinaccordancewiththeFDA’sdiscouragementofearlydisclosureanddisclosedsideeffectsassoonasacausalrelationshipwasestablished,investorswillhaveadifficulttimeprovingthatthemanufacturerwasreckless,muchlessthatthemanufacturerintendedtodeceive.Moreover,thedrugmanufacturerwillprobablybeliableonlyifitkneworrecklesslyignoredthefactthatmisinformationwouldmisleadinvestors.Thescienterelementallowsaco-existenceofRule10b-5’sdisclosureprovi-sions and policies against premature disclosure of potential drug side effects.”).

Ch. 12.IV.B.6.


Heights General Employees’ Retirement System v. Hospira, Inc.,406 where a federalcourtdismissedasecuritiesfraudcasewithoutprejudiceagainstHospira,Inc.(amanufacturerofinjectabledrugsandinfusionpumps)andcertainexec-utives said to have engaged in a scheme to fraudulently inflate the price ofcompanystockthatcausedtheclassmemberstobuythestockatinflatedpricesand resulted in losses once the true facts became known.407 The complaint focused on FDA inspections of the company’s manufacturing facilities thatresultedinwarningletters.Theplaintiffsclaimedthatvariousfalseandmislead-ingstatements(includingomissionsofmaterialfacts)weremadeaboutHospi-ra’sfinances,qualitycontrolissues,remediationefforts,andrelationshipwiththeFDAinSECfilings,pressreleases,conferencecalls,andinvestorconfer-ences.Theyfurtherclaimedthatthisallowedcompanyexecutivesto“linetheirpockets” before the truth emerged.408Thejudgewasnotconvinced,andfoundthat the plaintiffs had not met the PSLRA’s heightened pleading standardsbecausemanyofthestatementstheyrelieduponwereambiguousorotherwiseconstitutednonactionablepuffery.409

The plaintiffs in In re Abbott Depakote Shareholder Derivative Litigation410 faredmuchbetterinasuittheyfiledafterAbbottsettledcivilandcriminalcaseswiththefederalgovernmentand49statesbypleadingtoamisdemeanor(forintroducingmisbrandedDepakoteproductsintointerstatecommerce),payinga$700millionfine,paying$800milliontoresolvestateandfederalcivilclaims,andpaying$100milliontoresolvestateconsumerprotectionclaims.Abbotthadalsoenteredintoacorporateintegrityagreement.411ThiswasnotAbbott’sfirsttime insuchasituation. InJuly2003, itwasputunderafive-yearcorporateagreementafterpaying$600milliontosettlechargesrelatedtoitsmarketingofa different product.412The plaintiffs’ second amended complaint alleged thatalthoughAbbott’sboardhadbeenpresentedwithvariousredflagstoinvestigate,itfailedtotimelyactuponthem.TheseredflagsincludedaDepartmentofJus-tice letter sent toAbbott’s law department that requiredAbbott to preservedocumentscoveredbymultiplesubpoenasconcerningDepakoteandtocollectresponsivedocumentsfromemployees,aswellasreportsfromAbbott’sPhar-maceuticalProductsDivisionaboutitsmarketingandpromotionalstrategiesforproducts likeDepakote. In addition, theFDA’sDivisionofDrugMarketing,AdvertisingandCommunicationssentaletterforAbbotttoceaseusingmislead-ingsalematerials,notingthatitssalerepresentativeshadprovidedmaterialstocustomers that omitted material information about Depakote.413Abbott’scounselarguedthatthecomplaintshouldbedismissed,astheplaintiffshadnotmadea

406No.11-C-8332,2013U.S.Dist.LEXIS19156(N.D.Ill.Feb.13,2013)(grantingmotionsto dismiss and strike).

407Id. at *3–4.408Id. at *10–11.409Id. at *69–82.410No. 11-CV-08114, 2013 U.S. Dist. LEXIS 78841 (N.D. Ill. June 5, 2013) (denying

dismissalofshareholders’derivativeactionbasedonboard’soversightfailures).411Id. at *7–8.412Id. at *9–10.413Id. at *11–13.

Ch. 12.IV.C.


demandontheboardbeforefilingsuit.414 Delaware law excuses not making such ademandonly“ifthereisasubstantiallikelihoodthatacompany’sdirectorswouldfacepersonalliabilityfortheconductcomplainedofinthedemand.”415 Thejudgefoundthatsuchademandwasnotnecessary.

Despiteaparticularlyegregioussetoffacts,In re Jiangbo Pharmaceuti-cals, Inc., Securities Litigation416illustratestheextentofthePSLRA’sheight-enedpleading standards.There, the judge dismissed a securities fraud classaction complaint after determining that it failed to meet the pleading standards. Jiangboisadomesticholdingcompanythatoperatesandownsthepharmaceu-ticalbusinessofacompanythatresearches,develops,manufactures,andsellspharmaceutical products, health supplements, and herbal-based medicinalcompounds in China.417TheplaintiffssuedJiangbo’sofficersandexternalaudi-torclaimingthattheyviolatedRule10b-5andSections10(b)and20(a)oftheSecuritiesAct,whichinturncausedtheminjuries.418TheirlawsuitwasfiledsoonaftertheSECstartedanonpublicinvestigationofJiangbo,whichwasfollowedbyoneconductedbyJiangbo’sauditcommitteeintoissuesraisedbytheSEC.419 Theyidentifiedmateriallyfalseandmisleadingstatementsoromissionsinvar-iouspressreleases,SECfilings,andfinancialstatementsthatoverstatedJiang-bo’scashbalances,didnotrevealrelated-partytransactionsandtheexistenceofSECandinternalinvestigations,anddidnotdiscloseJiangbo’snoncooperationwiththeAuditCommittee’sinternalinvestigation.TheplaintiffsclaimedthattheseactionsweredonetomaintainartificiallyhighmarketpricesforJiangbo’ssecurities.420TheyalsoclaimedthatthecleanauditreportfiledforFY2010wasfalse because it was not performed in accordance with Public CompanyAccountingOversightBoard(PCAOB)standardsandthatJiangbo’sfinancialstatementsdidnotfairlypresentitsconsolidatedfinancialposition.421

NASDAQhadhalted the trading of Jiangbo’s stock inMay2011 afterJiangbo announced that its CFO had resigned at the end of March 2011—around the time when the SEC informed Jiangbo that it had begun a nonpublic formal investigationandtheauditcommitteehiredalawfirmtoconductaninternalinvestigationandanexternalauditortoassistit.422 With the consent of the Audit Committee,thelawfirmandexternalauditorslaterwithdrewfromrepresentingit,followedbytheresignationoftwooftheBoard’sindependentdirectors.423 Againstthesedisturbingallegations,thejudgeruledthatplaintiffshadfailedtomeet the PSLRA’s heightened scienter requirements and dismissed thecomplaint.424

414Id. at *15.415Id.at*17(citingWoodv.Baum,953A.2d136,141,n.11(Del.2008)).416884 F. Supp. 2d 1243 (S.D. Fla. 2012).417Id. at 1248.418Id.419Id.420Id. at 1248–49.421Id. at 1251.422Id.423Id. at 1252.424Id. at 1263.

Ch. 12.IV.C.


The facts at issue in In re WebMD Health Corp. Securities Litigation425 exemplifyastrikesuitfiledsoonafteracompany’sprojectionsaboutitsprofit-abilityturnedouttobeinaccurate.Butmoreisrequiredtoconstituteactionablesecuritiesfraud.Theplaintiffsallegedthatduringtheperiodatissue,thedefen-dantsknewaboutadversedevelopmentsrelatingtoWebMD’sbusinessandthepharmaceutical industry, and had defrauded investors by releasing revenueforecastsknowntobeinflatedbeforetherealfactsslowlyemerged.426 The plain-tiffs claimed that the defendants’motive for concealing the true informationaboutthecompany’sfinancialoperationswastheirdesiretosellthecompanyinaprivateplacement.427Thecourtdisagreed,findingthatstatementstheplaintiffscharacterizedasevidenceofscienterinsteadwereprotectedunderthePSLRAas forward-looking statements.428

The outcome was better for the plaintiffs in Public Pension Fund Group v. KV Pharmaceutical Co.,429 where the Eighth Circuit reinstated some counts in adismissedsecuritiesfraudcomplaintafterfindingthattheirallegationsaboutthedefendant’sfailuretomeettheFDA’scurrentgoodmanufacturingpractices(cGMPs)hadsufficientlystatedtriablefacts.Initsopinion,theappealscourtexplainedwhythedistrictjudgehaderredindismissingtheclassactionfiledbyinvestorsagainstKVandsomeofficers.TheplaintiffshadallegedthatKVmadeactionablyfalseandmisleadingstatementsaboutitscompliancewithFDAreg-ulationsgoverning themanufactureofpharmaceuticalproductsandabout itsearnings.430TheyfiledsuitaftertheFDAissuedacomplaintagainstKVandfourindividualofficersseekingapermanentinjunctiontopreventKVPharmafrommanufacturing and distributing pharmaceuticals because of irregularities in its manufacturing processes and history of violating the FDA’s cGMPs.431 On appeal,theprimaryissuewaswhetherthecomplaintwassufficienttowithstanda Rule 12(b)(6) motion to dismiss.432Between2004and2008,KVfiledrequired10-Kannualreportsthatexplainedhowthepharmaceuticalindustrywasexten-sively regulatedandmadespecific representationsabout its compliancewithFDA regulations.433TheplaintiffsclaimedthatwhenKVmadestatementsaboutitscompliancewithFDAregulationstheywerefalseandmisleadingbecausetheywerebasedonitsknowledgeofinspectionsmadeofKV’sfacilitiesbetween2003 and 2009.434 The Eighth Circuit found that although no appeals court had heldthereisaperserulethatholdsacompany’sreceiptofanFDAForm483(notifyingacompany’smanagementofobjectionableconditions)will,byitself,render its statements aboutmaterial compliancewith agency regulations notfalseormisleading,severaldistrictcourtshadruledthatthereceiptofForms

425No.11Civ.5382(JFK),2013U.S.Dist.LEXIS1512(S.D.N.Y.Jan.2,2013).426Id. at *6.427Id. at *7–8.428Id. at *18.429679 F.3d 972 (8th Cir. 2012).430Id. at 975.431Id. at 976.432Id. at 975.433Id. at 975–76.434Id. at 976.

Ch. 12.IV.C.


483 can be material.435TheEighthCircuitagreed,rulingthatthereceiptofthesenoticesfromtheFDAwassufficienttoestablishthat,ataminimum,thecom-pany’srepresentationsofitscomplianceweremisleadingwhenmadeandthere-fore sufficient to support allowing some of the complaint’s allegations towithstand challenge.

Another failure-to-disclose case worth noting is In re Delcath System, Inc.,436wherethejudgeexplainedhedeniedthemotiontodismissasecuritiesfraud complaint that alleged material misstatements were made about the like-lihoodofapprovalforanewdeviceinPhase3testingknownasthe“MelblezKit,”whichwas “designed to administer high-dose chemotherapy and othertherapeutic agents to treat metastatic cancer in the liver.”437 As the opinion explained,criticaltothefunctioningoftheunapprovednewmedicaldevicewasafilterthatwouldextracthighdosesoftheparticularchemotherapyagentwhilealsoreducingthetoxicitytotheliver.438DuringthePhase3trialofthekit,thecompanyusedadifferentfilter(the“Clarkfilter”)thanhadbeenusedduringboth Phase 1 and part of the Phase 2 testing of the product.439 Delcath conducted its Phase 3 testing at medical centers throughout the United States under an FDA-approved“SpecialProtocolAssessment”inwhichpatientswererandomlyassignedtoeitherpatientswhoweretreatedusingtheMelblezKitorinacontrolgroupthatreceivedthebestalternativecare.440

WithinamonthafterDelcathfileditsNDA,itannouncedthattheFDAhadsenta“refusaltofile”letterthatrequestedmoreinformation“involvingmanu-facturing plant inspection timing, product and sterilization validations andadditionalsafetyinformation.”441Subsequently,thecompanyannouncedithadrefilleditsNDA,whichproposedusingathirdfilter(the“Generation2”or“Gen2” filter) which, the company announced, had been accepted for review.442 Withinmonths,theFDApublishedstaffbriefingdocumentsreportingthat“7%ofPhaseIIIparticipantstreatedwiththeMelblezKitdied,whilenoneofthepatientsintheControlGroupdied”and“that24%ofthepatientsintheDrugGroupexperiencedserioussideeffectssuchasheartattackandacutekidneyfailure.”443 Predictably, once the FDA’s briefing documents were released,Delcathsharesplummeted,whichwasfollowedbyaunanimousdecisionnottoapprovethedevice.444Amongthemateriallymisleadingstatementsmadebythecompany, theplaintiffsalleged ithad failed to include informationabout thetoxicityproblemsassociatedwiththeclinicalstudieswhenitreportedthePhase3 testing.445Thejudgeagreed,explainingthat:

435Id. at 981.436No.13Civ.3116(LGS),2014U.S.Dist.LEXIS88116(S.D.N.Y.June27,2014).437In re DelcathSystem,Inc.,2014U.S.Dist.LEXIS88116at*4.438Id. at *4.439Id. at *5–6.440Id. at *6.441Id. at *7.442Id.443Id. at *7–8.444Id. at *8–10.445Id. at *12.

Ch. 12.IV.C.


TheComplaintsufficientlyallegestwomaterialomissionsthatcausedatleastsomeof the Phase III Results Statements to be misleading until the FDA disclosed the missingfactsintheirbriefingdocumentsonApril30,2013.First,theCompanydiscloseddataregardingthenumberandpercentageofSAEsintheDrugGroup,but did not disclose comparable information for the Control Group.Thisomission,combinedwiththestatementthattheMelblezKitcausedsideeffects“similar”tothosecausedbytraditionaltreatmentmethods,issufficienttoallegethatinvestorsweremisledabout thesafetyof theCompany’sproduct.Second, theCompanydisclosedthe7%mortalityratefromtreatment in theDrugGroup,butnot that there were zero deaths from treatment in the Control Group.446

Assuch,thejudgenoted,“[t]heallegationsheredonotinvolvedifferinginterpretationsofdiscloseddata,butratherdatathatwasnotdisclosed.”447

D. The Fraud-on-the-Market Theory and the Fraud-Created-the-Market Theory

Classactionplaintiffsoftenrelyuponthefraud-on-the-market theory448 to establishthenecessarycausationelementinsecuritiesfraudactions.Thisdoc-trineprovidesarebuttablepresumptionthatplaintiffsreliedonanissuer’sfraudor misstatements of material facts. The use of the presumption helps plaintiffs avoid shouldering the almost impossible burden of demonstrating that eachplaintiffwasdamagedbytheallegedlywrongfulconduct.Plaintiffscanobtainthepresumptionbydemonstratingthat thesecuritiesat issueweresold inanefficientmarket.“Mostcourtsapplyapresumptionofrelianceunderthetheory

446Id. at *22–23 (emphasis supplied).447Id. at *26.448Asonecommentatorhasexplained,Thefraud-on-the-markettheoryrestsonthehypothesisthatwell-developedsecuritiesmar-ketsare“efficient.”Theefficientmarkettheory...comesinthreeforms:

Theweakform...postulatesthatastock’spriceisatleastsubstantiallyindependentofpastpriceperformance....Thesemi-strongformgoesfurther,claiming“thatcurrentpricesfullyreflectpublicknowledge....”Finally,thestrongform...assertsthatbothpublicandprivateinformationarefullyreflectedinthepriceofastock.Byexpresslyreferringtostudiesthat“tendedtoconfirm...thatthemarketpriceofsharestradedonwell-developedmarketsreflectsallpubliclyavailableinformation,”[Basic v. Levinson, 485U.S.224,246(1988)]...implicitlyendorsedthesemi-strongformoftheefficientmarkettheory.

WilliamO.Fischer,Does the Efficient Market Theory Help Us Do Justice in a Time of Madness?,54 EmoryL.J.843,850(2005)(internalcitationsomitted).See alsoLarryE.Ribstein,Fraud on a Noisy Market(IllinoisLawandEcon.,WorkingPaperNo.LE05-022,Mar.8,2006),available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=803064 and 10(1) Lewis&Clark L. Rev. 137(2006).(“Federalsecuritiesregulationassumesthatinvestorsrelyonandmarketsreflectnewinformationinpredictableways.It followsthatdisclosureregulationhasevidentbenefits.Butif,instead,marketpricesaremovedotherthanbyinformation,theregulatoryprescriptionisnolongerclear.Evenifmoreinformationmakesirrationalmarketsmoreefficient,withoutaclearviewofhowthemarketprocessesinformation,regulationandliabilitymaydomoreharmthangood.Forcingcorporationsorinsiderstopaydamageslinkedtothemarket’sirrationalresponsetodisclosuresmayhaveperverseeffects,includingdiscouragingdisclosure.[¶][T]hemarket’spotentiallyirrationalresponsetoinformationraisesdoubtsaboutthescopeofliabilityforincom-pletedisclosure,andspecificallyaboutthefraud-on-the-market...theory,especiallyinlightoftheSupremeCourt’srecentopinioninDura Pharmaceuticals,Inc. v. Broudo,”544U.S.336(2005).).

Ch. 12.IV.D.


whenplaintiffsshowthatabsentthedefendant’sfraud,thesecuritieswouldhavebeen unmarketable.”449 In Basic v. Levinson,450 the Supreme Court adopted the fraud-on-the-markettheoryandtheunderlyingefficientmarkethypothesis.Inordertoobtainthepresumptionofreliance,classactionplaintiffsmustgenerallyestablish:

1. The defendants made a public misrepresentation or failed to disclose materialinformationorboth;

2. Thefalsehoodwasmaterial;3. Thestocktradedonanefficientmarket;4. Areasonable,relyinginvestorwouldhavebeeninducedbythemisrep-

resentationornondisclosuretomisjudgethestock’svalue;and5. The plaintiff traded in the stock between the time the misrepresentation

or nondisclosure was made and when it was corrected.451

An example of how the presumption has been applied in a class action against a pharmaceutical manufacturer is seen in Asher v. Baxter International, Inc.452Thepresumptionisrebuttablebyevidencethatseversthepresumedlink-agebetweentheallegedmisconductandreliancebytheclassmembers.453Also,the widespread use of the fraud-on-the-market theory is increasingly beingcalled into question by commentators who criticize the underlying efficientmarketstheoryandwhetherthecausalpresumptionismeritedinmanycases.454

449JulieA.Herzog,Fraud Created the Market: An Unwise and Unwarranted Extension of Section 10(b) and Rule 10b-5,63Geo. Wash. L. Rev.359,360(1995).

450485U.S.224(1988).SeeSectionIII.A.1.,above,forfurtherdiscussion.451Herzog,at367–68(internalcitationsomitted).452377F.3d727,731–32(7thCir.2004)(“[T]hisisnotatraditionalsecuritiesclaim.Itisa

fraud-on-the-marketclaim.NoneoftheplaintiffsassertsthathereadanyofBaxter’spressreleasesorlistenedtoanexecutive’soralstatement.Insteadthetheoryisthatotherpeople(professionaltraders,mutualfundmanagers,securitiesanalysts)didthereading,andthattheymadetradesorrecommendationsthatinfluencedtheprice.Inanefficientcapitalmarket,allinformationknowntothepublicaffectsthepriceandthusaffectseveryinvestor.Basic Inc. v. Levinson,485U.S.224,241–47...(1988),holdsthatrelianceontheaccuracyofthepricecansubstituteforrelianceontheaccuracyofparticularwrittenororalstatements,whenthestatementsaffecttheprice-astheydoforlargeandwell-followedfirmssuchasBaxter,forwhichthereisaliquidpublicmarket.Thisworksonlytotheextentthatmarketsefficientlyreflect(andthusconveytoinvestorstheeconomicequivalentof)allpublicinformation.”).

453See, e.g.,Ribstein,at148:[InBasic v. Levinson,485U.S.224(1988)][t]heCourtapprovedthefollowingelementsoftheCourtofAppealstest,whilenotingthat‘elements(2)and(4)maycollapseintoone’:[¶](1)thatthedefendantmadepublicmisrepresentations;(2)thatthemisrepresentationswerematerial;(3)thatthesharesweretradedonanefficientmarket;(4)thatthemisrepre-sentationswouldinduceareasonable,relyinginvestortomisjudgethevalueoftheshares;and (5) that the plaintiff traded the shares between the time the misrepresentations were madeandthetimethetruthwasrevealed.[See id.at248n.27]TheCourt,however,allowed“[a]nyshowingthatseversthelinkbetweentheallegedmisrepresentationandeitherthepricereceived(orpaid)bytheplaintiff,orhisdecisiontotradeatafairmarketprice,willbesufficienttorebutthepresumptionofreliance.”[Id.at248.]

(Internal notes omitted.)454See, e.g.,AlonBrav&J.B.Heaton,Market Indeterminancy, 28 J. Corp.L.517,535–36

(2003)(“Aninteresting,buttroubling,useofefficientmarketstheoryinlaw...hasgrownoutof. . . Basic Inc. v. Levinson,wheretheCourtruledthatplaintiffscouldrelyona‘fraudonthemar-ket’theoryofpresumptiverelianceaslongasthesecurityatissuetradedinan‘efficient’market.

Ch. 12.IV.D.


TheSupremeCourt’sdecisioninDura Pharmaceuticals, Inc. v. Broudo455 (a securities fraud class action in which the Court ruled that PSLRA plaintiffs who filesecuritiesfraudcomplaintsmustbothallegeandprovelosscausation)hasfurther called into question the strength of the presumption.

In Connecticut Retirement Plans & Trust Funds v. Amgen, Inc.,456 the NinthCircuitjoinedtheThirdandSeventhCircuitsbyholdingthat,inordertoinvokethefraud-on-the-marketpresumptionattheclasscertificationstage,aplaintiff must demonstrate the security was traded in an efficient market;demonstrate that the alleged misrepresentations were public; and plausibly allege that the claimed misrepresentations were material.457 The court held that thejudgehadnotabusedhisdiscretionbycertifyingtheclass,findingthattheplaintiffhadplausiblyallegedthatseveralofthedefendants’publicstatementsaboutAmgen’spharmaceuticalproductswerefalseandmaterial.458 In particu-lar,thecomplaintsetoutfouractionablemisstatementsbyAmgen:(1)down-playingtheFDA’ssafetyconcernsaboutitsproductsbeforeanFDAmeetingwithagroupofoncologists;(2)concealingdetailsaboutaclinicaltrialcanceledoverconcernsthatAmgen’sproductexacerbatedtumorgrowthinasmallnum-ber of patients; (3) exaggerating the FDA-approved uses and safety of itsproducts; and (4) falsely claiming that it promoted its products solely forapproveduseswhenithadpromotedsignificantoff-labelusageinviolationoffederal drug branding statutes.459

The fraud-created-the-market doctrineisacorollarytothefraud-on-the-market doctrine that was first recognized by the Fifth Circuit in Shores v. Sklar.460Thisdoctrineprovidesplaintiffswithapresumptionofrelianceonthemarket’sintegrity.Butnotallappellatecourtsfollowthisdoctrine,norhastheSupremeCourtruledonit.Thedoctrineissummarizedinthefollowingexcerpt:

Underthefraudcreatedthemarkettheory,whentheallegedfraudissopervasivethatabsentthefraudthesecuritiescouldnothavebeenmarketed,arelianceelementisestablishedunderRule10b-5bythebuyer’srelianceontheintegrityofthemar-ket.Thepurchaserscancontendthattheyareentitledtoapresumptionofreliancesincethesecuritieswerebroughttothemarketfraudulently.Thepurchaserofanoriginalissuesecurityreliesindirectlyontheintegrityoftheregulatoryprocessand

Sincethen,federalcourtshavepassedjudgmentonwhethercertainsecuritiestradeinefficientorinefficientmarkets.Thesedecisionsrevealconsiderablelackofscientificsophistication,poorappreciationofmarketefficiencytheory,andarbitraryvariationfromcasetocase.Theuseofeffi-cientmarketstheoryinmanyreportedcasesisinexpertatbest,erraticatworst.Thisinconsistentnatureofefficientmarketsevidenceinreportedcasesisperhapsunsurprisingsincethe‘science’supportinganabilitytodistinguishefficientandinefficientmarketsforlitigationpurposesishighlysuspect.”) (internal notes omitted).

455544U.S.336,341–42(2005).SeeSectionVII.,below,forfurtherdiscussion.456660 F.3d 1170 (9th Cir. 2011).457Id. at 1172.458Id.459Id. at 1172–73.460647F.2d462,468–70(5thCir.1981)(enbanc)(upholdingsecuritiesfraudchargesbased

on an offering circular’s untrue statements andmisleading omissions that were disseminatedinto themarketplaceand resulted from the successfulperpetrationof fraudon the investmentcommunity).

Ch. 12.IV.D.


thetruthofanyrepresentationsmadetotheappropriateagenciesandtheinvestorsat the time of the original issue.461

Although Malack v. BDO Seidman, LLP,462didnotinvolvealifesciencescompany,itisworthnotingbecauseitsignaledtheThirdCircuit’srejectionofthefraud-created-the-market theoryofsecuritiesfraud liability,adding to thecircuitsplitaboutthisevidentiarydoctrine.InMalack,theThirdCircuitjoinedtheSeventhCircuitinrejectingthistheoryandlinedupagainsttheFifth,Tenth,andEleventhCircuits,whichhaveacceptedit.463 The fraud-created-the-market theoryalsohelpsprivatesecuritiesfraudplaintiffstomeettheirburdenofproofbyallowingthemtoassumerelianceonadefendant’sallegedmisrepresenta-tions,provided that theycandemonstrate thesecuritieswouldnothavebeenoffered without the misrepresentations:

The Supreme Court has established two rebuttable presumptions of reliance under Rule 10b-5: (1) under Affiliated-Ute Citizens of Utah v. United States[406U.S.128,153–54(1972)],ifadefendantmakesamaterialomissiontoaninvestortowhomthedefendantowesaduty;and(2)underBasic, Inc. v. Levinson[485U.S.224,245(1988)],ifthedefendantmakesamaterialmisrepresentationinawell-developedandefficientmarket.UnderthetheoryadoptedinBasic,whichisknownasthefraud-on-the-markettheory,courtspresumeinvestors’reliancewhenpursuingrecoveryforfraudonanefficientsecondarymarket.

Butinvestorsdonotenjoyapresumptionofrelianceifthefraudoccurredinanundeveloped, inefficient, or primarymarket. Thus, to obtain a presumption ofrelianceinthiscontextandtofacilitateclasswideresolution,plaintiffsdevisedthefraud-created-the-markettheory,whichassumesinvestorsrelieduponthemarketitselftopreventtheentryof“unmarketable”securities.464

At theThirdCircuit,Malack contended that thepresumption shouldbeappliedbecausethefraud-on-the-markethypothesisallowsbuyersofsecuritiestorelyonthemarket’slegitimacy.Butthecourtrejectedthisrequestbasedonpublicpolicyconsiderations,explainingthatallowingthepresumptionwouldreduce investors’ incentives to reviewofferingmaterials for investments andcouldtherebyleadtomorefrivoloussecuritiesfraudlitigation.465

461William M. Prifti,24Securities Pub.&Priv. Offerings§10:9(2005)(pagereferencesnot available).See also JulieA.Herzog,Fraud Created the Market: An Unwise and Unwar-ranted Extension of Section 10(b) and Rule 10b-5,63Geo. Wash. L. Rev.359,363(1995)(“Thefraud-created-the-markettheorystatesthatabsenttheegregiouscaseoffraud,thesecuritiescouldnothavebeenmarketed.Thecourtsadoptingthetheoryaccepttheargumentthatplaintiffsareentitledtopresumeacertaindegreeofintegrityinthemarket.Thus,theydonotrequireplaintiffswhopurchasedorsoldsecuritiesthatwerefraudulentlymarketedtoprovereliance.Rather,courtspresume reliance on the market itself as able to keep such securities off the market. The circuits aredividedastowhethertoadoptthefraud-created-the-markettheoryandtowhichcircumstanceswarrantapplicationofthetheory.”)(internalnotesomitted).

462617F.3d743,743–44(3dCir.2010).463SeeMattSilverman,Note,Fraud Created the Market: Presuming Reliance in Rule 10b-5

Primary Securities Market Fraud Litigation,79FordhamL.Rev.1787,1790–91(2011).464MichaelJ.Kaufman&JohnM.Wunderlich,Fraud Created the Market,Ala.L.Rev.

(forthcoming)at7–8(June17,2011)(internalnotesomitted),abstract available at http://ssrn.com/abstract=1866430.

465SeeChadbourne&ParkeLLP,“Fraud Created the Market” Securities Fraud Theory Rejected by the Third Circuit, Widening Circuit Split,ClientAlert(Aug.25,2010),available

Ch. 12.IV.D.


E. Primary and Secondary Liability Issues

OneofCongress’keygoals inpassingthePSLRAwastomakeitmoredifficultforprivateplaintiffstofileso-called“strikesuits,”atermthatdescribessecuritiesfraudclassactionsthat,despiteverylooseevidence,namedeep-pock-etedsecondaryactors,suchasaccountingfirmsorlawfirms,asconspiratorsorcoschemersinthehopethattheywillfindthatsettlingtheallegationsismorecosteffectivethanincurringtheenormouslitigationcostsneededtoprevail.466 ThePSLRAiscoveredingreaterdepthinSectionVII.,below.

The1995enactmentofthePSLRAachievedCongress’desiredeffect,andprivateclassactionplaintiffshavefounditdifficulttosuccessfullypursueclaimsofsecuritiesfraudviolationsagainstlawfirmsandaccountingfirmsassecond-aryactors;however,intheaftermathofEnronandotherlargecorporatescan-dals,plaintiffs’counselhavebeguntoconvincesomefederaljudgestoacceptnew theories of liability against accounting firms and law firms.467 Before

at http://www.chadbourne.com/files/Publication/656f9992-3826-4c25-ace3-33ede8de9f6e/ Presentation/PublicationAttachment/346251ae-732d-448c-83be-38c239759986/Security%20Lit- %20Fraud%20Created%20Market%20ca.pdf.

466SeeAdamC.Pritchard,Should Congress Repeal Securities Class Action Reform? 5 (John M.OlinLaw&Econ.,WorkingPaperNo.03-003;GeorgetownUniv.LawCenter,Business,Econ.,&Reg.Policy,WorkingPaperNo.389561,Mar.2003),available at http://papers.ssrn.com/abstract=389561(“Filingnumerouscasesisnotonlyreasonablebutalsoprofitableforplaintiffs’attorneysbecauseoftheincentivesthatdefendantsface.Ifplaintiffscanwithstandamotiontodismiss,defendantsgenerallywillfindsettlementcheaperthanlitigatingtoajuryverdict,evenifthedefendantsbelievethatajurywouldsharetheirviewofthefacts.Anycaseplausibleenoughtogetpastajudgemaybeworthsettlingifonlytoavoidthecostsofdiscoveryandattorneys’fees,which can be enormous in these cases. . . .”). See alsoAnnMoralesOlazábal,Safe Harbor for Forward-Looking Statements Under the Private Securities Litigation Reform Act of 1995: What’s Safe and What’s Not?,105Dick. L. Rev.1,1–3(2000)(“The[PSLRA]...hadadualobjective.First,itwaspassedinanefforttolimitso-calledsecuritiesfraud‘strikesuits.’Thesetypicallyhavetakentheformofclassactionlawsuitsfiledbyinvestorsinresponsetoadropinastock’svalue,allegingthatastatementmadebyanissuerofthesecuritywaseitherfalseormisleading.Frequentlythesesuitsgeneratesubstantialsettlementfigures,whetherornottheyhaveanymeritatall. . . . Second . . . Congress also sought . . . to encourage . . . issuers to disclose more information totheinvestingpublic.ThustheActimmunizessomeissuerstatementswitha‘safeharbor.’”).See, e.g.,JosephDeSimoneetal.,Asher to Asher and Dust to Dust—The Demise of the PSLRA Safe Harbor,1N.Y.U.J.L.&Bus.799,806(2005)(“CongressenactedthePSLRAwiththehopeofreducing‘abusive’and‘meritless’securitieslitigation.Itdesiredtodeterso-called‘strikesuits’inwhichshareholdersfiledbaselessclassactionlawsuitsunderthefederalsecuritieslawsinordertopressurecorporatedefendantsintosettlingclaimsratherthansubmittocostlyandburdensomediscovery.”)(internalnoteomitted).See also id.(citingH.R.Conf. Rep.104-369,at31–32(1995)and noting that Congress enunciated four problems that the PSLRA was intended to correct: “(1) theroutinefilingoflawsuitsagainstissuersofsecuritiesandotherswheneverthereisasignificantchangeinanissuer’sstockprice,withoutregardtoanyunderlyingculpabilityoftheissuer,andwithonlyfainthope that thediscoveryprocessmight leadeventually tosomeplausiblecauseofaction;(2)thetargetingofdeeppocketdefendants,includingaccountants,underwriters,andindividualswhomaybecoveredbyinsurance,withoutregardtotheiractualculpability;(3)theabuseofthediscoveryprocesstoimposecostssoburdensomethatitisofteneconomicalforthevictimizedpartytosettle;and(4)themanipulationbyclassactionlawyersoftheclientswhomtheypurportedlyrepresent.”).

467See, e.g., Andrew S. Gold, Reassessing the Scope of Conduct Prohibited by Section 10(B) and the Elements of Rule 10b-5: Reflections on Securities Fraud and Secondary Actors, 53 Cath. U. L. Rev.667,668–69(2004)(“Tworecentpost-Central Bankdevelopmentsmeritparticular

Ch. 12.IV.E.


discussingthesetheoriesandthecasesinwhichtheyhavebeenaccepted,ithelpsto reviewCentral Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,468 the seminal decision that eliminated aiding and abetting liability forsecondaryactors.

1. Central BankSecondary actors’ risk of facing securities fraud liability dramatically

decreased in 1994 after Central Bank, “which eliminated private aiding andabettingliabilityinsecuritiesfraudcases.”469Thecaseinvolvedasuitfiledbypurchasersofbondsthat laterdefaulted.ThesebondshadbeenissuedbytheColorado Springs–Stetson Hills Public BuildingAuthority to finance publicimprovements at a planned residential and commercial development.470 The classplaintiffsallegedthatCentralBankwassecondarilyliablebecauseithadsubstantiallyaidedandabettedviolationsofSection10(b)oftheExchangeActandRule10b-5: itknewa salewas imminent,but failed to inform thebondbuyers ormake public its knowledge that the appraisal for these bondswasinaccurate.471Afterapplyingstandardrulesofstatutoryconstruction,theCourtfoundthattheExchangeAct’slanguagecouldnotsupportaidingandabettingliabilityforsecondaryactorsaslowercourtshadaccepted,explainingthat“[i]f. . .Congress intendedto imposeaidingandabettingliability,wepresumeitwouldhaveusedthewords‘aid’and‘abet’inthestatutorytext.Butitdidnot.”472 Note,however,thatbecausetheSupremeCourtexpresslylimitedtheliabilityofaidersandabetterstoprivatesecuritiesfraudactions,thisformofsecondaryliability remains available to establish liability in enforcement proceedingsbroughtbytheCommission,orincriminalprosecutionspursuedbytheDepart-ment of Justice.

attention.TheSEC...hassupportedaformofthe‘participation’test,wherebyasecondaryactorisliableforsecuritiesfraudwhenitsparticipation...canbeconsidereda‘co-author’oftheissuer’sfraudulentstatements,evenif...notattributedtothesecondaryactor....Asaresult,courtsmayconcludethattheSEC’spositionmeritsjudicialdeferenceifthestatuteisambiguous.”).

468511 U.S. 164 (1994).469SeeJohnC.Coffee,Jr.,Gatekeeper Failure and Reform: The Challenge of Fashioning

Relevant Reforms, 84 B.U. L. Rev.301,318–20(2004).470Central Bank,511U.S.at167,superseded by statute as stated in dissenting opinion in

StoneridgeInv.Partners,LLCv.Scientific-Atlanta,Inc.,552U.S.148,128S.Ct.761,169L.Ed.2d627,640(2008).

471Id. at 168–69.472Id. at 177. See also idat177–78(“Asinearliercasesconsideringconductprohibitedby

§10(b),weagainconcludethatthestatuteprohibitsonlythemakingofamaterialmisstatement(oromission)orthecommissionofamanipulativeact.See Santa Fe Industries,430U.S.at473,97S.Ct.,at1301(‘languageof§10(b)givesnoindicationthatCongressmeanttoprohibitanyconductnotinvolvingmanipulationordeception’);Ernst & Ernst,425U.S.,at214,96S.Ct.,at1391(‘Whenastatutespeakssospecificallyintermsofmanipulationanddeception...wearequiteunwillingtoextendthescopeofthestatute’).Theproscriptiondoesnotincludegivingaidtoapersonwhocommitsamanipulativeordeceptiveact.Wecannotamendthestatutetocreateliabilityforactsthatarenotthemselvesmanipulativeordeceptivewithinthemeaningofthe statute.”).

Ch. 12.IV.E.


2. Control Person LiabilityThefederalsecuritieslawsincludeprovisionsthatprovideforsecondary

liability,themostimportantofwhichconcerntheliabilityofcontrolpersons.473 UnderSection15oftheSecuritiesAct,474 and under Section 20 of the Exchange Act,475individualswhoseimportanceandpositiontoanissuerallowsthemtodirect others can be held liable for securities fraud if their conduct meets other specifiedrequirements.476Forexample,inNeubauer v. Eva-Health USA, Inc.,477 asecuritiesfraudcomplaintwasfiledagainstthepharmaceuticalcompanyanditsofficersbasedonfraudulentstatementsincludedintheofferingprospectus.The plaintiffs alleged that the offeringmaterials falsely described that Eva-Health’sCEO(Rifkin)wasanM.D.andaPh.D.whohadpatentedthetechnol-ogyforthecompany’slineofproducts.478 The complaint sought damages for securitiesfraudunderSection20oftheExchangeActfromRifkinandhiswife,thecorporatesecretary,ascontrollingpersons.479Thejudgeanalyzedtheissuesinlightof thedefendants’motiontodismissthecomplaint.Astothecontrolpersonliabilityissue,thejudgefoundthatthestandardofreviewwasnotunderFederal Rule of Civil Procedure 9(b)’s heightened pleading requirement forfraud,but,instead“[t]heissueiswhethertheplaintiffshaveallegedfactswhich,iftrue,wouldpermitatrieroffacttoconcludethatthedefendantscontrolledEva-Health.”480Assuch,thejudgefoundthattheplaintiffhadstatedsufficientfactstoimposecontrolpersonliabilityforbothRifkins.

Another case in which plaintiffs pursued damages in part based on control personliabilityisIn re Cryomedical Sciences, Inc. Securities Litigation.481 The

473SeeLoftusC.Carson,II,Liability of Controlling Persons Under the Federal Securities Acts,72Notre Dame L. Rev.263,273–74(1997)(“Acontrollingpersonundersection20(a)isdescribedas‘everypersonwhocontrolsdirectlyorindirectly,’whileitslegislativehistorylists‘stockownership,lease,contractandagency’asexamplesofbasesuponwhichapersoncanbedeterminedtobeacontrollingperson.Thus,Congresshasidentifiedsomeofthemeansbywhichapersonmayhavecontrolwithinthepurviewofsections15and20(a).Congress has not, how-ever, offered a definitive formula for determining whether in a particular context a person is a controlling person.”) (internal citations omitted and emphasis added).

47415U.S.C.§770.475Section20(a)provides:“Everypersonwho,directlyor indirectly,controlsanyperson

liableunderanyprovisionofthisChapterorofanyruleorregulationthereundershall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable,unlessthecontrollingpersonactedingoodfaithanddidnotdirectlyorindirectlyinducetheactoractsconstitutingtheviolationorcauseofaction.”15U.S.C.§78t(a)(emphasisadded).

476SeeCarson,at265(“InthecourseofadoptingtheSecuritiesAct...andthe...ExchangeAct...Congressdeterminedthat,tobeeffective,aschemeoffederalsecuritiesregulationshouldencompass the conduct of persons with control of direct perpetrators of securities fraud. Conse-quently,CongressincludedprovisionsintheSecuritiesAct(section15)andtheExchangeAct(section20(a)thatprovideforthepotentialliabilityofpersonsbasedontheircontrolrelationshipwithprimaryviolatorsofthoseActs.Undertheseprovisions,controllingpersonsareliabletothesameextentastheircontrolledpersons,unlessthecontrollingpersonscanestablishthedefensesprovidedforunderthemeasures.”)(internalcitationsomitted).

477158F.R.D.281(S.D.N.Y.1994),discussedinSectionII.A.,above.478Id. at 282.479Id. at 282–83.480Id. at 284–85 (internal notes omitted).481884F.Supp.1001(D.Md.1995),discussedinSectionI.C.1.

Ch. 12.IV.E.2.


classactionplaintiffsallegedthatthemedicaldevicemanufacturerhadmadefalseandmisleadingstatementsinvariouspubliclyfileddocuments,includingpressreleasesandSECfilings,aboutitsproductusedforcryogenicsurgeryofprostate cancer patients.482Astothecontrolpersonliabilityissue,theplaintiffs’pleadingswereheldtobeinsufficientbecausetheydidnotprovidesufficientinformationaboutfactsotherthanonesconcerningthedefendants’statusinthecompany.483

AthirdillustrativecaseisSorkin, LLC v. Fischer Imaging Corp.484 Sorkin allegedthatFischerImaginghadmisrepresenteditsfinancialconditioninSECfilingsandinpressreleases,inordertoartificiallyinflatethevalueofitsstock.ThesecuritiesfraudcomplaintincludedclaimsbasedoncontrolpersonliabilityagainstMorganNields,amemberofthecompany’sboardofdirectors.Indis-missingthecomplaint,thejudgenotedthatNieldshadnot been a member of the board during the applicable time period in issue.485Yet,evenifhehadbeena boardmember at the time, the allegationswere likely insufficient becauseactionsunderSection20oftheExchangeActrequiremorethanmerelydemon-stratingtheindividual’spositioninacompany:“Theassertionthatapersonwasamemberofacorporation’sboardofdirectors,withoutanyallegationthatthepersonindividuallyexertedcontrolorinfluenceovertheday-to-dayoperationof thecompany,doesnotsufficetosupportanallegationthat thepersonisacontrol person within the meaning of the Exchange Act.”486 As Sorkin demon-strates,“[d]efendantsinsections15and20(a)actionsmayavoidliabilityonthegroundthattheywerenotcontrollingpersons.”487Theycanalsoavoidliabilityif they can establish that they acted in good faith and did not induce theviolation.488

FollowingtheU.S.SupremeCourt’sdecision in Central Bank of Denver v. First Interstate Bank of Denver,489whichrejectedallowingplaintiffstochargeaiding and abetting liability in private securities fraud suits, plaintiffs haveadvancedvariousargumentstotrytosupportholdingputativedefendantsliableas primaryviolators.Significantly,inJanus Capital Group, Inc. v. First Deriv-

482Id. at 1010.483Id. at1020(“First,neitherstatusnorposition, inandof themselves,aresufficient for

§20(a)liability.Second,plaintiffs’‘aggregationofdefendantswithoutspecificallyallegingwhichdefendantwasresponsibleforwhichact’isimpermissibleandtheComplaintagainsttheindividualdefendantsmustbedismissed.’”)(internalcitationomitted).

484No.03-CV-00631-RPM,2005WL1459735(D.Colo.June21,2005)(unreported),dis-cussedinSectionIII.B.2.,above.

485Id.at*12(“Tostateaprimafaciecaseofcontrolpersonliability,theplaintiffmustestab-lish(1)aprimaryviolationofsecuritieslawsand(2)‘control’overtheprimaryviolatorbytheallegedcontrollingperson....Becausetheamendedcomplaintfailstostateaclaimunder§10(b)oftheExchangeActforsecuritiesfraudagainstthedefendants,theallegationsofcontrolpersonliabilityalsofail.[¶]AstoMr.Nields,the§20claimfailsfortheadditionalreasonthathisstatusasamemberoftheboardofdirectorsduringtheClassPeriodisinsufficienttoestablishthathewas a controlling person within the meaning of the Exchange Act.”).

486Id.,citingAdamsv.Kinder-Morgan,Inc.,340F.3d1083,1108(10thCir.2003).487LoftusC.Carson,II,Liability of Controlling Persons Under the Federal Securities Acts,

72 Notre Dame L. Rev.263,273–74(1997)(internalcitationsomitted).488See15U.S.C.§78t(a).489511 U.S. 164 (1994).

Ch. 12.IV.E.2.


ative Traders,490 theCourt reaffirmeditsCentral Bankholdingbyrulingthattherewasno“controlbasis”thatallowedholdingacompanyprimarilyliableunder the federal securities laws for an affiliated, noncontrolled company’sconduct in making false statements in an offering prospectus. The decision was factually limited. As the Janus Capital Group Court’s majority explained,“[t]hiscaserequiresustodeterminewhetherJanusCapitalManagementLLC(JCM),amutualfundinvestmentadviser,canbeheldliableinaprivateactionunder...[SEC]Rule10b-5forfalsestatementsincludedinitsclientmutualfunds’prospectuses.”491Criticaltothedecision,JanusInvestmentFundwasaseparatelegalentityentirelyownedbymutualfundinvestorsandheldnoassetsotherthanthoseofitsinvestors.492AlthoughJCMhadcreatedtheJanusInvest-mentFund,itsrolewastoprovidethefundwithinvestmentadvisoryservices,includingmanagementandnecessaryadministrativeservices,anditwaslegallyindependent from the fund.493AfterNewYork’sAttorneyGeneralsuedJCMandJanus Capital Group (JCG) for entering into secret arrangements that allowed markettimingtooccurinseveralfundsrunbyJCM,investorswithdrewsignif-icant amounts ofmoney from the Janus Investment Fund’smutual funds.494 BecauseJCMwascompensatedbyJanusInvestmentFundbasedonthetotalvalueofthefunds,itsmanagementfeescomprisedasignificantpartofJCG’sincome, so the Janus Investment Fund’s loss of value significantly affectedJCG’sincome.495

Theleadplaintiff,FirstDerivativeTraders,suedJCGandJCMforviolatingRule10b-5andSection10(b)oftheSecuritiesExchangeActof1934,allegingthat the defendants “‘caused mutual fund prospectuses to be issued for Janus mutualfundsandmadethemavailabletotheinvestingpublic,whichcreatedthemisleadingimpressionthat[JCGandJCM]wouldimplementmeasurestocurbmarket timing in the Janus [mutual funds].’”496 Specifically, FirstDerivativesoughttoholdJCGprimarilyliableforJCM’sactsinmateriallymisleadingtheinvestingpublicasa“controllingperson”underthefederalsecuritieslaws.497 FocusingonRule10b-5’slanguage,theCourtmajoritynotedthatthisrulemakesitunlawfulfor“‘anyperson...[t]omakeanyuntruestatementofamaterialfact’inconnectionwiththepurchaseorsaleofsecurities.”498Then,keyinginonthe “make” language, the panelmajority found that JCM had notmade the actionablestatements,explainingthat:

ForpurposesofRule10b-5,themakerofastatementisthepersonorentitywithultimateauthorityoverthestatement,includingitscontentandwhetherandhowtocommunicateit.Withoutcontrol,apersonorentitycanmerelysuggestwhattosay,not“make”astatementinitsownright.Onewhopreparesorpublishesastatementonbehalfofanotherisnotitsmaker.Andintheordinarycase,attribution

490131 S. Ct. 2296 (2011).491Id. at 2299.492Id.493Id.494Id. at 2300.495Id.496Id.497Id. at 2301.498Id.at2302(emphasisadded,quotingC.F.R.§240.10b-5(b)).

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withinastatementorimplicitfromsurroundingcircumstancesisstrongevidencethatastatementwasmadeby—andonlyby—thepartytowhomitisattributed.499

Matrixx Initiatives, Inc. v. Siracusano500 is another of the most important decisions by the Supreme Court affecting pharmaceutical companies.Afteracceptingcertioraritoresolveacircuitsplit,theCourtreassessedtheapplicablematerialitystandardforprivatesecuritiesfraudlitigation.TheCourtreversedtheNinthCircuit’sruling,whichreliedontheSecondCircuit’sreasoninginIn re Carter-Wallace, Inc., Securities Litigation501 as support for dismissing a pri-vatesecuritiesfraudclassactioncomplaintbecauseitfoundthattheplaintiffshad not adequately pleaded amaterialmisstatement or omission.The lowercourts reasoned that the plaintiffs had failed to allege adequate facts needed to giverisetoastronginferenceofscienterwithsufficientparticularity.Inpartic-ular,thedistrictcourtruledthattherewasnotastatisticalcorrelationbetweenanyharmassociatedwiththeuseofthedrugandthemanufacturer’sfailuretodiscloseadverseeventsrelatedtotheuseofthedrug,asnecessarytomakethenondisclosureamaterialomission.TheCourtdisagreedwiththisanalysisandreaffirmedthematerialitytestsetoutinBasic Inc. v. Levinson.502 As the Court explained,incertaininstancesitisreasonableforinvestorstoactoncausationevidencethatisnotstatisticallysignificantbecausemedicalprofessionalsandregulators do so as well.503Moreover,determiningtheissueofmaterialityisafact-specificundertakingthatrequiresconsiderationofthesource,content,andcontextofsuchreportsbecauseadverseeventreportscomeinvariousforms—suchasdirectusercomplaintstomanufacturers,detailedcasereportspublishedinmedicaljournals,orlarge-scalepublishedclinicalstudies.504

The Matrixxdecisionisimportantforanumberofreasons.“[I]t...[clar-ifies]thestandardsforpleadingaviablesecuritiesclaim”505 and it “highlights thedifficultiesfacedbypharmaceuticalcompaniesindeterminingwhennega-tivereportsaboutadrugortreatmentrequiredisclosure.”506Thetaskofevalu-ating aputative life sciencesdefendant’s scienter for not disclosing a risk isdifficultbecauseitrequiresexaminingwhatadefendantknew—orshouldhaveknown—about the facts that created a risk. As “actual or imputed appreciation oftheriskitself...isonly[appropriate]wherethe‘dangerofmisleading’isknownorsufficiently‘obvious’thatthedefendantactsrecklessly[,]”theessen-tialanalysisalsorequiresfocusingon“thepotentialimpact(‘misleading’)ofthefaultydisclosureoninvestors,which...dependsonthematerialityoftheinfor-

499Id. at 175.500131 S. Ct. 1309 (2011).501220 F.3d 36 (2d Cir. 2000).502485U.S.224,108S.Ct.978(1988).503Matrixx Initiatives,131S.Ct.at1321.504Id.(citingBasicInc.v.Levinson,485U.S.at236).505Wilson Sonsini Goodrich&Rosali,WSGRAlert, Supreme Court Rejects Attempt to

Equate Statistical Significance with Materiality in Suit for Securities Fraud(Mar.2011),available at http://www.wsgr.com/publications/PDFSearch/wsgralert_statistical_significance_materiality.pdf.

506Id.


mation.”507 Before Matrixxwasannounced,lowercourtsreachedwildlydiffer-entresultsincaseswithsimilarissues,asthefollowingcasesillustrate.

3. SECv.Zandford and Primary Liability Under Sections 10(a) and (c)TheSupremeCourt’sdecisioninSEC v. Zandford 508expandedtheliability

theoriesthatcanbeassertedtochargesecondaryactors,suchasaccountingfirmsandlawfirms,asprimaryviolators.Zandford,asecuritiesbroker,hadpersuadedanelderlymantoopenajointinvestmentaccountforhimselfandhisintellec-tuallydisableddaughter, andthentogiveZandfordthediscretiontomanagetheaccount and a general power of attorney to engage in securities transactionswithouttheirpriorapproval.Whentheelderlymandiedafewyearslater,itwasdiscoveredthatthemoneyhaddisappeared.509 Zandford was indicted on federal wirefraudchargesforsellingsecuritiesintheelderlyman’saccountandmakingpersonaluseoftheproceeds.TheindictmentwasfollowedbyanSECcomplaintallegingthatZandfordhadviolatedSection10oftheExchangeActandRule10b-5byengaginginaschemetodefraudthemanandhisdaughterandmisap-propriating their securities without their knowledge or consent. After Zandford wasconvicted,thedistrictcourtgrantedsummaryjudgmentfortheSECinthecivilcase.510Onappeal,theFourthCircuitreversed,directingthatthecomplaintbedismissed.ItdidsoafterfindingthatneitherthecriminalconvictionnortheSEC’sallegationswassufficienttodemonstratethat,asstatutorilyrequired,thefraudwasperformed“inconnectionwiththepurchaseorsaleofanysecurity.”Thecourtreasonedthatschemewastostealthefamily’sassetsandnottomanip-ulateaparticular security,which lacked thenecessary relationship tomarketintegrityor investorunderstanding.511 The Supreme Court accepted certiorari and,onreview,theCourtinitiallyobservedthatithaspreviouslyheldthatCon-gress’ intent inpassing the securities lawswas that the statutesbeconstruedflexibly.Moreover,becausetheSECischargedwithadministeringtheselaws,andithastakenanexpansiveviewofthestatutorylanguage,whichisreasonableinlightofthecongressionalintent,itsviewwasentitledtodeference.512Finally,theCourtheldthatbecausetheSEC’scomplaintdescribedafraudulentschemeinwhichthesecuritiestransactionsandbreachesoffiduciarydutyhadcoincided,the breaches were “in connection with” securities sales within the meaning of Section10(b).TheSupremeCourtreversedtheFourthCircuit’sdecisionandthe complaint was reinstated.513

The class action plaintiffs in In re Enron Corp. Securities Derivative & ERISA Litigation514convincedthedistrictjudgenottosummarilydismisstheir

507AllanHorwich,An Inquiry into the Perception of Materiality as an Element of Scienter under SEC Rule 10b-5,Nw.L.&Econ.Res.PaperNo.11-11,at6(Apr.27,2011)(internalnotesomitted),available athttp://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1896490_code337501.pdf?abstractid=1824685&mirid=1.

508535 U.S. 813 (2002).509Id. at 815–16.510Id. at 816.511Id. at 816–18.512Id. at 819–20.513Id. at 825.514235 F. Supp. 2d 549 (S.D. Tex. 2002).

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allegationsbasedontheexpansiveinterpretationoftheschemelanguagepro-videdinZandford,alongwiththestatutorylanguageusedbyCongressinSec-tions 10(a) and (c) of the ExchangeAct.As the district court explained, inrelevantpart:

Securities fraud actions under §10(b) and Rule 10b-5 are not merely limited to the making of an untrue statement of material fact or omission to state a material fact. Section10(b)prohibits“anymanipulativeordeceptivecontrivance,”which...includes“aschemetodeceive”or“scheme,planorartifice.”...Whilesubsection(b)ofRule10b-5providesacauseofactionbasedonthe“makingofanuntruestatementofamaterialfactandtheomissiontostateamaterialfact,”subsections (a) and (c) “are not so restricted”andallowsuitagainstdefendantswho,withscienter,participatedin“a‘courseofbusiness’ora‘device,schemeorartifice’that‘operatedasafraud’onsellersorpurchasersofstockevenifthesedefendantsdidnotmakeamateriallyfalseormisleadingstatementoromission....Inthiscase,plaintiffsallegebothfraudulentstatementsandactsastheirrequisitemanipulativeordeceptivepractices.”515

Thisdecisioneffectivelyblursthe“substantialparticipation”distinctionmadein Central Bankinfavoroftheexpansiveconceptof“schemeliability.”516

Asimilarargumentwasmadebysecuritiesfraudplaintiffswiththesameresults in In re Global Crossing, Ltd. Securities Litigation.517 As the Global Crossingcourtexplained,inrelevantpart:

It isapparentfromRule10b-5’s languageandthecaselawinterpretingit thatacauseofactionexistsundersubsections(a)and(c)forbehaviorthatconstitutesparticipation ina fraudulent scheme,evenabsenta fraudulent statementby thedefendant. . . . In the wake of Central Bank,courtshavenotbeenreluctanttofindfraudallegationssufficientunderthesesubsections,providedthattheotherrequire-mentsforestablishingaprimaryviolationhavebeenmet....Claimsforengaging

515Id. at 577–78 (emphasis added and internal citations omitted).516See,e.g.,JohnJ.Clarke,Jr.,etal.,Potential Liabilities in Initial Public Offerings,1518

PLI/Corp.319,352–53(2005)(“TheSouthernDistrictofTexasdecisioninEnronfurthererodestheSupremeCourt’sstalwartpositioninCentral Bankbyrejectingboththe‘bright-line’andthe‘substantialparticipation’testsandinsteadrelyingon‘schemeliability.’”).See also Andrew S. Gold,Reassessing the Scope of Conduct Prohibited by Section 10(B) and the Elements of Rule 10b-5: Reflections on Securities Fraud and Secondary Actors, 53 Cath. U. L. Rev.667,668–69(2004) (“Two recent post-Central Bankdevelopmentsmeritparticularattention.TheSEC. . .hassupportedaformofthe‘participation’test,wherebyasecondaryactorisliableforsecuritiesfraudwhenitsparticipation...canbeconsidereda‘co-author’oftheissuer’sfraudulentstate-ments,evenif...notattributedtothesecondaryactor....Asaresult,courtsmayconcludethattheSEC’spositionmeritsjudicialdeferenceifthestatuteisambiguous.Forexample,theEnron courtapparentlydeferredtotheSEC’sinterpretation.Inaddition,inSecurities Exchange Comm’n v. Zandford, theSupremeCourt embraced the entirety ofRule 10b-5, including parts (a) and(c),whichpermit‘scheme’and‘courseofbusiness’liability.[¶]ArecentproposalsuggeststhatZandfordpermitsabroadreadingofprimaryliabilityforsecondaryactorswhenevertheycanbesaidtoparticipateina‘fraudulentscheme,’[see, e.g., Amicus Curiae Memorandum of the State AttorneysGeneralRelatingtoDefendant’sMotiontoDismissat10,In reEnronCorp.Sec.Litig.,235F.Supp.2d549(2002)(No.H-01–3624)]thusrecastingissuesofsecondaryparticipationintermsofanoverarchingprimaryliability.‘Scheme’liabilitywouldnotrequireamisstatementbyasecondaryactortotriggerliability.”)(internalcitationsomitted).

517322F.Supp.2d319(S.D.N.Y.2004).


in a fraudulent scheme and for making a fraudulent statement or omission are thus distinctclaims,withdistinctelements.518

V. Defenses to Securities Fraud Cases

Pharmaceutical companies may have the best opportunities to defendagainstsecuritiesfraudactionsfiledagainstthembyfocusingtheirdefenseinthefollowingthreeareas:(1)thelackofmateriality,(2)thelackofadutytodisclose,and(3)thelackofscienter.519 The following discussion includes cases inwhichpharmaceuticalcompanieshaveassertedoneormoreofthesedefenses.

A. Truth on the Market

As the court in In re Andrx Corp.520 explained in dismissing a securities fraudclassactioncomplaintagainstagenericdrugmanufacturer,thetruth-on-the-marketdoctrineisacorollarytothefraud-on-the-marketdoctrine.Itpro-videsthedefensewithanopportunitytoshowthattheallegedlyfalsestatementswere immaterial.521Underthetruth-on-the-marketdoctrine,defendantscanusetheefficientmarkethypothesis(uponwhichthefraud-on-the-marketdoctrineisbased) againstsecuritiesfraudplaintiffsbydemonstratingthatthemarkethadalreadyassimilatedenoughnegativeinformationbeforetheallegedlyfraudulentstatementsweremadeand, therefore, thestatementswere immaterial.“[T]hetruth-on-the-market defense argues that an issuer’s statements or omissionscannot bemisleading if there already is countervailing information, such asanalysts’reports,inthepublicdomainthatisthereforepartofthe‘totalmix’ofinformationthatisavailable.”522 The leading case about the truth-on-the-market doctrineistheNinthCircuit’sopinioninIn re Apple Computer Securities Liti-gation,523whichconcernedaclassactionsecuritiesfraudcomplaintfiledafter

518Id. at 335–36 (internal citations omitted).519SeeAlanN.Salpeter&HarleyHutchins,Recent Developments Help the Defense of Drug

Companies in 10b-5 Cases, 51 Food&DrugL.J.345,345(1996)(“Fortunatelyfordrugcom-panydefendants,...recentcasesprovideinsightonhowtosuccessfullydefendagainstsucha10b-5claim.[Thereare]...threepossibleareasofdefense:lackofmateriality,no‘dutytospeak,’and lack of scienter. The latter two arguments are the most fertile.”) (internal note omitted).

520296 F. Supp. 2d 1356 (S.D. Fla. 2003).521Id.at1368(“Thetruthonthemarketdoctrineisacorollarytothefraudonthemarket

doctrine,pursuanttowhich‘amisrepresentationisimmaterialiftheinformationisalreadyknowntothemarketbecausethemisrepresentationcannotthendefraudthemarket.’...‘Adefendantmayrebutthepresumption...byshowingthatthetruthofthematterwasalreadyknown.’...However,beforethetruthonthemarketdoctrinecanbeapplied,theDefendantsmustshowthat‘the information that was withheld or misrepresented was transmitted to the public with a degree of intensityandcredibilitysufficienttoeffectivelycounterbalanceanymisleadingimpressioncreatedbyinsider’sone-sidedrepresentations.’”)(internalcitationsomitted).

522PeterH.Huang,Moody Investing and the Supreme Court: Rethinking the Materiality of Information and the Reasonableness of Investor, 13 Sup. Ct. Econ. Rev.99,118(2005)(internalnoteomittedcitingWieglosv.CommonwealthEdisonCo.,892F.2d509,516(7thCir1989)).

523886 F.2d 1109 (9th Cir. 1989).

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an innovative new product called “Lisa” did not successfully launch.524 The Ninth Circuit explained:

[I]nafraudonthemarketcase,thedefendant’sfailuretodisclosematerialinfor-mationmaybeexcusedwherethatinformationhasbeenmadecrediblyavailabletothemarketbyothersources.Theissue...[regarding]Apple’smisstatementsiswhether,inlightofthepress’documentationofLisa’srisks,[525]arationaljurycouldnonethelessfinda‘substantiallikelihood’thatfulldisclosuresbyApplewouldhave‘significantlyalteredthe‘totalmix’ofinformationmadeavailable.’”526

B. Lack of Materiality

Thedistinctionbetweenhowcourtsanalyzecasesinvolvingthenondisclo-sureofmaterialfactsandcasesinvolvingmaterialmisstatements is often used indeterminingwhethertheallegedlywrongfulconductismaterial.527 In In re Apple Computer Securities Litigation, theNinthCircuit explained that “[i]nordertoavoidRule10b-5liability,anymaterialinformationwhichinsidersfailtodisclosemustbetransmittedtothepublicwithadegreeofintensityandcred-ibilitysufficienttoeffectivelycounter-balanceanymisleadingimpressioncre-atedbytheinsiders’one-sidedrepresentations.”528 Because the securities laws arenotdesignedtooperateasinsuranceforfoolishdecisions,courtsalsoexam-ine themixof information thatwas already in themarketplace todeterminewhether a defendant’s failure to provide the informationwas actionable. “InanalyzingRule10b-5causationissues,courtsoftenstatethatinvestorsmaynotsimplyclosetheireyestoobviousrisks,butmustexerciseduediligenceinpro-tectingthemselves.”529Ontheissueofduediligenceinnondisclosurecases,as“thefactsshownothingonwhichtheplaintiffcouldhaverelied,courtsshiftthe

524Thenumberofproductfailuresinthecomputerindustryhasledtotheterm“vaporware”beingusedtodescribehypedproductsthatfailtomeetexpectations;similarproblemsareseeninthepharmaceuticalindustry,whereinvestorsanticipatenewproductsthatfailtosuccessfullylaunch. See generallyThereseH.Maynard,Spinning in a Hot IPO: Breach of Fiduciary Duty or Business as Usual, 43 Wm.&Mary L. Rev. 2023 (2002). See alsoRobertA.Prentice,Beware of Vaporware: Product Hype and the Securities Fraud Liability of High-Tech Companies,8Harv. J. Law&Tech.1,15(1994)(extensivelyanalyzingtheIn re Apple Computerscaseandobserving,interalia,that“[c]ompaniesmustrealizethatwhentheyoverpromise,theyrisknotonlyalienat-ingcustomersanddealersbutalsoinvestors[]...[andalso]shareholders’multi-milliondollarsecuritiesfraudclaimsbecauseproductpreannouncementsandotherpromotionalactivityaffectthecompany’sstockprice.”).

525TheNinthCircuitpointedoutthatthepresshadextensivelycoveredtheissuesinvolvingLisa,makingitclearthatthemarketwasawarethedevelopmenthadsubstantialrisks:“ThepressportrayedLisaasagamble,withthepotentialforeitherenormoussuccessorenormousfailure.Atleasttwentyarticlesstressedtherisks...anddetailedtheunderlyingproblemsproducingthoserisks.Manyoftheoptimisticstatementschallengedbyplaintiffsappearedinthosesamearticles,essentiallybracketedbythefactswhichplaintiffsclaimApplewrongfullyfailedtodisclose.ThemarketcouldnothavebeenmademoreawareofLisa’srisks.”In re Apple Sec. Litig., 886 F.2d at 1116.

526886F.2dat1115(referringtotheSupremeCourt’smaterialitystandardsetoutbyTSCIndustries,Inc.v.Northway,Inc.,426U.S.438,449(1976)).

527See Section III.A.2.528886 F.2d at 1116.529C.EdwardFletcher,Sophisticated Investors Under the Federal Securities Laws, 1988

DukeL.J.1081,1090(1988)(internalnotesomitted).


burdenofprooftothedefendant:theplaintiff’sshowingofmaterialnondisclo-sureestablishescausationandthedefendantcanprevailonlybyshowingthatthe plaintiff would have made the same investment if full disclosure hadoccurred.”530

Inanalyzingallegedmisrepresentationstodeterminewhethertheyconsti-tuteactionablesecuritiesfraud,courtswilllikewiseevaluatethefactstodecidewhetherthereappearstobeacausallinkorjustahindsight-drivencriticism.Forexample,inDemarco v. Depotech Corp.,531 the court dismissed a class action securitiesfraudcomplaint thatclaimedthatDepotech’sstockwasinflatedbymisrepresentationsaboutitsproduct.Inexplainingthisdecision,thecourtwrotethat“[t]he...ComplaintblendshindsightwithspeculationanddistortsDefen-dants’publicstatements....Intheend,plaintiffs’theoryoffraudrestsonhind-sight-driven criticism prompted by [FDA’s] ultimate refusal to recommendapprovalofDepoCyt.”532

Singh v. Schikan,533asecuritiesfraudclassaction,arosefromaregistrationstatementfiledinconnectionwithaninitialpublicoffering(IPO)foranewdrugbeingtestedforaformofmusculardystrophyforwhichnotreatmentwasavail-able.ThecontroversyinvolvedstatementsmadeaboutverbalFDAapprovalofthe product that coincided with the IPO but did not hold up when the Phase 3 testsfailedtoachievetheirendpoints,whichresultedinadropinthevalueofthe shares.534Intheplaintiffs’amendedsecuritiesfraudclassactioncomplaint,theyallegedthattheregistrationstatementhadmateriallyfalseormisleadinginformationaboutthedevelopmentofthedrug,itsprospectsforapproval,anditsfuturecommercialprospectsinthatitfailedtodisclose,amongotherthings,thattheenrollmentforthePhase3trialwassubstantiallyrelaxedanddefendantslackedagoodfaithbasisformakingthepositivestatementsabouttheproduct.535 Asthecourtexplained,theplaintiffsadmittedtheregistrationstatementmadenoaffirmativemisstatements;“[r]ather,whatplaintiffsallegeislackingintheRegistrationStatement is essentiallyanextra levelofdisclosure spellingoutinferences and drawing conclusions for investors.”536 At bottom, the judgerejected the theory, explaining that “[u]ltimately, plaintiffs’ complaint morecloselyresemblesacriticismofthe...studies’designthanaclaimfornondis-closure,aformofhindsightpleadingnotcognizableunderSection11.”537

C. Failure to Establish Essential Elements

Severallifesciencescompaniesandotherissuershaveprevailedinsecuri-ties fraud cases because the plaintiffs committed one or more fundamental and irreparable mistakes, such as not complying with the PSLRA’s heightenedpleadingrequirements,ornotshowingthatthecomplaintwasactionableunder

530Id. at 1087–88 (internal notes omitted).531149 F. Supp. 2d 1212 (S.D. Cal. 2001).532Id. at 1232.533No.14Civ.5450(NRB),2015U.S.Dist.LEXIS58801(S.D.N.Y.May4,2015).5342015 U.S. Dist. LEXIS 58801 at *11–14.535Id. at *14–15.536Id. at *15.537Id. at *26.

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thesecuritiesfraudlaws.Forexample,inIsquith ex rel. Isquith v. Caremark Inter-national, Inc.,538theSeventhCircuitaffirmedthedismissalofasecuritiesfraudcomplaint(whichallegedthatBaxterInternational,Inc.,.hadsubmittedafraudu-lent statement to theSECinconnectionwithaspin-off),afterfinding that thespin-offofthecompany’swhollyownedsubsidiarywasnotastocksale,whichisanessentialelementofasecuritiesfraudcomplaint.Asthecourtexplained,“[t]hebiggestproblemwiththesuitisnotthedifficultywe’rehavingfiguringouthowthemembersoftheclasscouldhavebeenhurtbytheallegedfraudinconcealingthetruepurposeofthespinoff....Rather,itistheabsenceofotherelementsoffederalsecuritiesfraud,suchasthattherehave[sic]beenasale.”539SimilarlyinKainos Laboratories,Inc. v. Beacon Diagnostics, Inc.,540 a district court dismissed asecuritiesfraudsuitafterfindingthataprivateplacementmemorandumforabiotechnologycompanydidnotconstituteapublicoffering.541

A technical pleading issue involving the “group pleading doctrine”wasaddressedbytheFifthCircuitinNathenson v. Zonagen, Inc.542 The group plead-ingdoctrinehasbeenrecognizedbysomecourtsasanexceptiontoFederalRuleof Civil Procedure 9(b)’s heightened pleading requirement for fraud, whichallowssecuritiesfraudplaintiffstoobtainapresumptionthatacompany’sseniorofficers should be held collectively responsible for fraudulent statements ormisrepresentationscontained incertain“groupprepared”documents,suchasprospectusesandSECfilings.InNathenson,theFifthCircuitheldthatthisdoc-trinedidnotsurvivethePSLRA’senactmentbecauseCongressclearlyintendedforclassactionplaintiffsinsecuritiesfraudcomplaintstoadheretothePSLRA’sheightened pleading requirements.543

OneofthemostsignificantsecuritieslawdecisionsinyearswasannouncedbytheSupremeCourtinDura Pharmaceuticals,Inc. v. Broudo.544 In Dura,theCourtreversedtheNinthCircuitanddismissedaclassactionclaimingthatapharmaceuticaldevicemanufacturerhadmademisrepresentationsaboutfutureFDAapprovalofanewasthmaticspraydevice.TheCourtfoundthattheNinthCircuit’sformulationofthelosscausationstandard545 was inappropriate because thePSLRAexplicitlyrequires546 that securities fraud class action plaintiffs plead

538136 F.3d 531 (7th Cir. 1997).539Id. at 354.540No.C-97-4618MHP,1998WL2016634(N.D.Cal.Sept.14,1998)(unreported),dis-

cussedinSectionII.A.,above.541Id. at *4.542267 F.3d 400 (5th Cir. 2001).543Id. at 410–11.544544 U.S. 336 (2005).545LarryE.Ribstein,Fraud on a Noisy Market153(IllinoisLaw&Econ.,WorkingPaper

No.LE05-022,Mar.8,2006)(publishedat10(1)Lewis&Clark L. Rev. 108) (“The complaint allegedthatplaintiffssuffereddamageswhenthey‘paidartificiallyinflatedpricesforDurasecu-rities.’[SecondConsol.AmendedComplaintforViolationoftheSec.Exch.Actof1934at85,In reDuraPharm.,Inc.Sec.Litig.,No.99-CV-0151-L(NLS),2000WL33176043(S.D.Cal.2000)]TheNinthCircuitheldthatthisallegationofpriceinflationatthetimeofpurchasewassufficient.[Broudo v. Dura Pharm., Inc.,339F.3d933,938(9thCir.2003),”rev’d by DuraPharms.,Inc.v.Broudo,544U.S.336,125S.Ct.1627(2005))(internalnotesomitted).

546Title15oftheU.S.C.78u-4(b)(4)providesthat“[i]anyprivateactionarisingunderthischapter,theplaintiffshallhavetheburdenofprovingthattheactoromission...causedthelossforwhichtheplaintiffseekstorecoverdamages.”

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and prove loss causation.547As one scholar has explained, “[l]oss causationfunctionsasakindofproximatecauserequirement,toprotectdefendantfromopen-endeddamagesformarketfluctuations thatdonot relate todefendant’swrong.”548Assuch,itrequiresmorethanjustshowingthattheplaintiffboughtstockataninflatedprice.549

In In re Dura Pharmaceuticals, Inc. Securities Litigation,550 on remand fromtheCourt’sdecisioninDura Pharmaceuticals, Inc.,thedistrictjudgepartlygrantedthedefendant’smotiontodismisstheamendedcomplaint.ThejudgeobservedthattheCourt’sinterveningopinioninTellabs, Inc. v. Makor Issues & Rights, Ltd.,551instructsthatallegedfactsshouldbeadjudgedsufficienttogiverise to a strong inference of scienter. Tellabsalsorequirestrialjudgestoconsiderplausible opposing inferences.552Thisprocessnecessarilyinvolvesassessingthereasonablenessinvolvedwithdrawingsuchaninference:“AcomplaintsurvivesamotiontodismissunderthePSLRA‘onlyifareasonablepersonwoulddeemthe inference of scienter cogent and at least as compelling as any opposinginference one could draw from the facts alleged.’”553Moreover, the analysisshouldbeperformedbylookingattheallegationsas a whole,notinisolation.554 Asthejudgeexplained,severaloftheallegationsatissuefocusedonthedefen-dant’s purportedly materially false statements, but they failed to meet thePSLRA’sheightenedpleading standardsbecause thealleged statementswerefactuallytrueorsimplypredictive.555Ontheotherhand,certainstatementsaboutthemarketingoftheinhalerproductweremateriallyfalsebecausethecompanyhadtoldanalysts itwasclosetobringingtheproduct tomarketwithinafewmonthswhen, in fact, ithadnotyetfiled foranNDAandclinical trialshad“progressedinawaythatdoomedtheinhaler’sprospectsofFDAapproval.”556

547Dura Pharm., Inc., 544 U.S. at 341–42.548Ribstein,at150(internalnotesomitted).549SeeWilliamO.Fischer,Does the Efficient Market Theory Help Us Do Justice in a Time

of Madness?,54EmoryL.J.843,874–75(2005).See alsoStephenM.Sinaiko&BrendanM.Schulman,The Impact of Dura Pharmaceuticals on Private Securities Fraud Actions,The Met-ropolitan Corporate Counsel(June2005)(“[T]heSupremeCourtunanimously...rejectedthenotionthataninvestorsufferscompensableinjurysimplyby...havingpurchasedasecurityatapriceinflatedbyamisstatementoromission.TheCourtreasonedthatinmanyinstances—suchaswhereaninvestorpurchasessecuritiesatanartificiallyinflatedpricebutsellsbeforeanycorrectivedisclosure—amisstatementoromissionmayinflatethepriceofasecuritybutcausenolossatall.Thus,theCourtheldthat,in‘fraudonthemarket’cases,‘aninflatedpurchasepricewillnotitselfconstituteorproximatelycausetherelevanteconomicloss.’Rather,theCourtruledthat,undersection10(b)andRule10b-5,plaintiffsmustpleadandproveapecuniarylosscausedbytheallegedmisstatementoromission.”)(pagereferencesunavailable).

550No.99CV0151JLS(WMC),548F.Supp.2d1126(S.D.Cal.Feb.20,2008),on remand from DuraPharms.,Inc.v.Broudo,544U.S.336(2005),called into doubt by In re Cutera Sec. Litig.,610F.3d1103(9thCir.2010).

551551U.S.308,322(2007).552In reDuraPharms.,2008WL483613,at*2(citingTellabs, 551 U.S. 308).553Id.554Id.at*9(“[T]heproperinquiry‘iswhetherallofthefactsalleged,takencollectively,give

risetoastronginferenceofscienter,notwhetheranyindividualallegation,scrutinizedinisolation,meetsthatstandard.’”MiddlesexRet.Sys.v.QuestSoftware,Inc.,2007WL3296784,at*12(C.D.Cal.Oct.22,2007)(quotingTellabs,551U.S.at322)(emphasissupplied)).

555Id. at *7.556Id.

12-94 Pharmaceutical and Medical Device Law Ch. 12.V.C.

In applying the Tellabs test, the judge found that plaintiffs were entitled toreceiveastronginferenceofscienterfromtheallegedfacts,explaining:

Thisinferenceissupportedbythelengthoftimethatdefendantsknewabouttheproblemsin the inhaler’sdevelopment, theapparent inabilityofDura’sproductdevelopmentteamtoobtainanymeaningfulimprovementintheinhalerperformance,thegravityoftheproblemswiththeinhaler(includinganearlyreturnratemorethanthirtytimestheindustrystandard),thefrequencyoftheproductdevelopmentmeetings,Garner’sspecificinquiryabouttheinhaler’sreliabilityduringonesuchmeeting,andtheNDA’sfailurefortheveryreasonsidentifiedintheEiseleListanddiscussedduringtheproductdevelopmentmeetings.557

At issue in Plumbers & Pipefitters Local Union 719 Pension Fund v. Zim-mer Holdings, Inc.,558asecuritiesfraudclassaction,wereallegationsthatZim-merhaddefraudedinvestorsbydownplayingthesignificanceofdifficultiesinmanufacturingsomeproductsandthehighfailureratereportedbyasurgeon(Lawrence Dorr) after using the Durom Cup, an orthopedic reconstructivedevicethatZimmermanufactured.AfterZimmerannouncedDr.Dorr’sprelim-inaryfindings,itpromisedtoinvestigate.Upondoingso,itattributedhisreportsabout the product’s high failure rate (substantiallymore than other surgeonsexperienced) to improper surgical technique.559 Zimmer temporarily stoppedselling the product in the United States while it prepared new instructions for implantationand,thecourtobserved,theproductremainsavailabletoday.560 The plaintiffscontendedthatZimmer’sstatementswerefalsebecausetheproblemswiththeproductsstemmedfrompoordesignorqualitycontrolinmanufacturing,andZimmerpretendedotherwise toavoidadecline in its stockprice.561 The judgefound,however,thatZimmerhadnottriedtohidetheproblems.Rather,ithadpubliclyannouncedtheissueafterDr.Dorr’sstatement.562 The plaintiffs claimedthatajurycouldinferZimmerwaslying,butthecourtofappealsdis-agreed,563remarkingthat“[n]oonecouldpredicthowserioustheproblemwouldturnouttobe,soZimmer’sdecisionnottotrytoquantifytheeffectinJanuarycan’tbetreatedasafraud.”564 The appeals court explained that the complaint didnotestablishtherequiredinferenceofscienter,whichwasatleastascom-pellingasanopposinginferenceofnonfraudulentintent,565 noting further that theFDAhadnotconcludedtheproductwasdefectivelydesignedormadeandhad not issued a warning or caution about the product.566

A similar issue was presented in Anderson v. Peregrine Pharms., Inc.,567 whichconcernedallegedlyfalseandmisleadingstatementsabouttheeffective-

557Id. at *11.5582012U.S.App.LEXIS10136(7thCir.May21,2012).559Id. at *2.560Id. at *2–3.561Id. at *3.562Id. at *6.563Id. at *5–6.564Id. at *6.565Id. at *7.566Id.567SACV12-1647PSG(FMOx),2013U.S.Dist.LEXIS120419(C.D.Cal.,Aug.23,2013)

(dismissedbyAndersonv.PeregrinePharms., Inc.,2014U.S.Dist.LEXIS77721 (C.D.Cal.,May1,2014)).


nessofanexperimentaldrugdevelopedbyabiopharmaceuticalcompanythatdevelops and manufactures monoclonal antibodies to treat cancer and viralinfections.Inthiscase,agroupofbuyersofstocksuedthecompanyandcertainkeyofficersanddirectors,claiming that theyhadmade falseandmisleadingstatementsabouttheeffectivenessofanexperimentaldrugintendedfortreatingnon-small cell lung and other cancers.568 The securities fraud claims focused on pressreleasesandstatementsabouttheeffectivenessofbavituximab,theexper-imentaldrug,whichwasPeregrine’skeyproductatthetime.569 The statements and releases discussed results of double-blinded Phase 2 clinical trials of the drugbyindependentinvestigators.570Afterthetrialwasunblended,“Peregrinebeganmaking public statements about bavituximab’s efficacy” including “apressreleaseinwhichitannounced‘positivetop-lineresults’fromthetrial.”571 PreliminaryresultsfromthePhase2trialwereincludedinthecompany’s2012Form10-K.572Afewmonthslater,Peregrineissuedacorrectivereleasedisclos-ing errors in the study that called the announced results into question. ItexplainedthattheerrorwasdiscoveredwhilepreparingtomeetwiththeFDAtodiscussthePhaseIIresultsanddevelopaplanforPhase3testing.573Allegedly,an independentcontractorhadmislabeledsomepatientvials forplaceboandlow-dose patients.574

Againstthesefacts,thejudgedismissedtheclaims,findingthatthe§10(b)claimsfailedtoadequatelyallegetherequiredscienter.575Inrejectingtheplain-tiffs’claimsthatthedefendantsactedwithdeliberaterecklessnessbynotveri-fyingtheaccuracyofthestudy’sresultsbeforepublishingthem,thejudgenotedthat“[t]oestablishthatDefendantsactedwithdeliberaterecklessnessinordertosupportaninferenceofscienterinthiscontext,Plaintiffmustpleadmorethansimple,oreveninexcusable,negligence.”576

More commonly, federal courts dismiss private securities fraud classactions when the plaintiffs cannot establish the heightened pleading standards forintent.Forexample,inIn re AstraZeneca Securities Litigation,577 the court dismissed the plaintiffs’ amended securities fraud class action complaintbecause it did notmeet thePSLRA’s heightened pleading requirements forintent.578As the court explained, the plaintiffs were foreign nationals whopurchased their stock on foreign exchanges.579Thejudgeruledthatthefederalsecurities laws do not provide subject matter jurisdiction to consider suchclaims.Under applicable precedent, a plaintiff can establish subjectmatterjurisdictionfortransnationalsecuritiesfraudthroughtwoalternatetests:the

568Anderson,2013U.S.Dist.LEXIS120419,at*2.569Id. at *3.570Id. at *6.571Id. at *6–7.572Id. at *8.573Id. at *9.574Id. at *10.575Id. at *17.576Id.at*21(citingZuccoPartners,LLCv.DigimarcCorp.,552F.3d981,991(9thCir.

2009)).577No.05Civ.2688(TPG),2008WL2332325(S.D.N.Y.June3,2008).578Id. at *1.579Asthejudgenoted,morethan90%ofthepurportedvictimsoftheallegedfraudwere

foreignbuyers.Id. at *11.

Ch. 12.V.C.


conduct test and the effects test.580 Both parties contended that the conduct test applied.Under this test, a court can obtain subjectmatter jurisdiction overforeignersbuyingstockonforeignexchangesifthe“defendants’conductintheUnitedStateswas‘morethanmerelypreparatorytothefraud’”and“‘par-ticularactsorculpablefailurestoactwithintheUnitedStatesdirectlycausedlosses to foreign investorsabroad.’”581Theplaintiffsclaimed theyreliedonvariousmisleadingpressreleasesdisseminatedfromAstraZeneca’sDelawareheadquarters.582 But the plaintiffs’ securities fraud theory required them todemonstrate that AstraZeneca had directlycausedtheirlossesbyrelyingonthefraud-on-the-markettheory—whichhasnotbeenacceptedwhentheunderly-ing purchases are made on foreign exchanges “because of a concern that allowing foreign purchasers on foreign exchanges to plead reliance in this mannerwouldextendthejurisdictionalreachoftheUnitedStatessecuritieslaws too far.”583

In addition to having to surmount the PSLRA’s heightened pleadingrequirements for intent and fraud, plaintiffs also must meet the applicablestatutesoflimitations,asexplainedinIn re Zyprexa Products Liability Litiga-tion.584 Inthisopinion,thejudgegrantedasummaryjudgmentorderforEliLillyandCompany,thedefendantinthissecuritiesfraudclassaction,whichwasfiledaftersafetyconcernswereprintedintheNew York Times about the company’sprescriptiondrugusedtotreatschizophrenia(claimingthatLillymadefraudulentmaterialmisrepresentationsaboutZyprexaintryingtomarketit for off-label uses while suppressing negative information).As the judgeexplained, substantial litigation has been filed against Lilly throughout theUnitedStatesonvarioustheories.585Inthecasebeforethecourt,theplaintiffsallegedthatLillyanditsemployeeshadfailedtodiscloseorhadmisrepresentedthelinkbetweenZyprexaandelevatedlevelsofbloodglucosecomparedtootherantipsychoticdrugsandfailedtodiscloseormisrepresentedtheunlawful,off-la-belmarketingoftheproductfornon-FDA-approveduses.586 The court explained that plaintiffs failed to meet the applicable two-year statute of limitationsbecausesufficientinformationalreadywaspubliclyavailabletoinvestorsbeforethe New York Times article was published:

Underrulinglaw. . .“stormwarnings”frominformationavailabletothestockmarket,placeeveryhypothesizedreasonablyastuteandwellinformedinvestoronnoticeoftheneedforfurtherinquiry,beginningtherunningoftheapplicabletwo-yearstatuteoflimitations....Theindividualunsophisticatedinvestor’slackofawarenessisignored;thelawtiltsthesubstantive-proceduralbalanceagainstsuch

580Id.(citingItobaLtd.v.LEPGrp.PLC,54F.3d118,122(2dCir.1995),abrogated in part byMorrisonv.Nat’lAustl.BankLtd.,561U.S.247,130S.Ct.2869,177L.Ed.2d535,549(2010)).

581Id. (quoting In reVivendiUniversal,SASec.Litig.,381F.Supp.2d158,169(S.D.N.Y.2003)).

582Id.583Id. at *12 (citations omitted).584Nos.04-MDL-1596,07-CV-1310,2008WL1923126(E.D.N.Y.May5,2008).585Id. at *1.586Id. at *2.


a consumer. It applies the much-debated caveat emptorprinciplefavoringgreaterandfreercommercebylimitinglitigation,andrequiringdismissalofthiscase.587

Several subsequent securities fraud complaints against pharmaceuticalcompaniesandmedicaldevicemanufacturershavebeendismissedfornotmeet-ingtheheightenedpleadingrequirementsimposedbythePSLRA588 and Federal RuleofEvidence9(b),589aswellasguidanceprovidedbytheSupremeCourtforjudgestolookbeyondconclusoryallegationsindeterminingtheadequacyof such pleadings.590For example, inCaplin v. Trans 1, Inc.,591 the plaintiffs allegedthatthespinaldevicemanufacturerhadcoachedphysiciansonhowtomisleadinsurerssotheywouldpayforservicesassociatedwithusingthedevice.Astheopinionexplains,“TranS1...designs,markets,andsellsmedicaldevicesusedinspinalprocedures”andthe“AxiaLIFlineofproductsisthecompany’sprimarysourceofrevenue.”592TheAxiaLIF’stypeofspinalsurgeryallowsasurgeontoperformspinalfusionutilizinga“pre-sacralapproach,”meaningthatapatientliesonhisorherstomachwhilethesurgeonworksupthetailbone;inmostspinalsurgeries,thepatientliesonhisorherbackandthesurgeryisper-formed through the front of the spine.593 TranS1 obtained FDA approval tomanufacture and sell the AxiaLIF products through the less rigorous 510(k) approvalprocessformedicaldevices,thensoughttoensurethatsurgeonswouldbepaidforperformingtheAxiaLIFprocedureandusingrelatedmedicaldevic-es.594In2008,asignificantproblemdevelopedaftertheAMAchangedtheCPTcodeforAxiaLIFtodescribeaCategoryIIIdevice(whichismoretightlyreg-ulated) following the recommendation from the National Association of Spine SurgeonsReimbursementCodingCommittee.TheCategoryIIIclassification“istypically reserved for newer or experimental procedures in which a limitedamountofresearchdataisavailableregardingsafetyandeffectiveness.”595 After thenewCPTcodetookeffectinJanuary2009,mostinsurerschosenottoreim-bursesurgeonswhoperformedtheAxiaLIFprocedure,whichallegedlyimper-iled thedevice’s future.596Theplaintiffs claimed this caused thecompany tounlawfullycoachphysiciansonhowtoavoidtheCategoryIIICPTcodesotheywould get paid for the procedure.597Thisbehaviorviolatedvariousfederallaws,

587Id. In addition, similar information was publicly available about the off-labelingmarketing of the drug before the limitations period expired. Id. at *23.

588Thecomplaintmust“statewithparticularityfactsgivingrisetoastronginferencethatthedefendantactedwiththerequiredstateofmind.”15U.S.C.§78u-4(b)(2).

589Theruleprovides,inrelevantpart,thatinfraudactions,“[i]nallegingfraudormistake,apartymuststatewithparticularitythecircumstancesconstitutingfraudormistake.”

590SeeBellAtl.Corp.v.Twombly,550U.S.544,555,570(2007)(acomplaintfailingtoallegesufficientfactstostateaclaimforreliefplausibleonitsface,meaningmorethanjustlabelsandconclusionsoraformulaicrecitationoftheelements,maybedismissedpursuanttoFed.R.Civ.P.12(b)(6));DuraPharms.v.Broudo,544U.S.336(2005)(plaintiffsinprivatesecuritiesfraudlitigationmustpleadandprovelosscausation).

591No.7:12-CV-23-F,973F.Supp.2d596(E.D.N.C.2013).592Caplinv.Trans1,Inc.,973F.Supp.2dat599.593Id. at 599–600.594Id. at 600.595Id.596Id.597Id.

Ch. 12.V.C.


includingthefederalFalseClaimsAct,andposedasubstantialriskofcivilandcriminalpenalties,butbecauseTranS1’sinvestorswerenottoldaboutsuchrisks,theyboughtthecompany’sstockatanartificiallyinflatedprice.Theplaintiffsalso claimed that the companymademisleading public statements as to theCategoryIIIdesignationinviolationofthesecuritieslaws,andthat itsstate-mentsaboutcomplyingwithapplicableregulationsandrulesweremateriallymisleadingbecausetheydidnotrevealitsfraudulentreimbursementschemes.598 Later,inaForm8-Kfiling,thecompanydisclosedthattheOfficeoftheInspec-tor General for the U.S. Department of Health and Human Services hadrequested documents for the period in question.599 The defendant moved todismissthecomplaint,arguingthattheplaintiffshadfailedtoadequatelyallegelosscausation.Thejudgegrantedthemotion,explainingthat“allowingeverysecurities fraud plaintiff to successfully plead loss causation based on theannouncementofagovernmentinvestigationraisescountervailingpublicpolicyconcerns.”600

In Erica P. John Fund, Inc. v. Halliburton Co.,601akeydecisionaffectingsecurities fraudclass actions, theU.S.SupremeCourt unanimously ruled thatcourts cannot require plaintiffs to establish loss causation as an element of a secu-ritiesfraudcaseduringtheclasscertificationstage,rejectingtheapproachadvo-cated by the FifthCircuit.602The complaint at issue alleged that “Halliburtondeliberatelymadefalsestatementsabout(1)thescopeofitspotentialliabilityinasbestoslitigation,(2)itsexpectedrevenuefromcertainconstructioncontracts,and(3)thebenefitsofitsmergerwithanothercompany.”603 These false statements later resulted in losses to investors following Halliburton’s corrective disclo-sures.604Aftertheplaintiffssurvivedadismissalmotion,theysoughtcertificationoftheirproposedclass,andthedistrictjudgefoundthatalthoughtheymetthegeneralrequirementsforclassactionssetoutinFederalRuleofCivilProcedure23(a),theFifthCircuit’sdecisioninOscar Private Equity Investments v. Alle-giance Telecom, Inc.,605 required them to establish loss causation for class certi-fication,606whichtheywereunabletodo.Theplaintiffsappealed,andtheFifthCircuitaffirmed,holdingthat,“[i]nordertoobtainclasscertificationonitsclaims,[theEricaP.JohnFund]wasrequiredtoprovelosscausation,i.e.,thatthecor-rectedtruthoftheformerfalsehoodsactuallycausedthestockpricetofalland

598Id. at 602.599Id. at 603.600Id. at 610.601131S.Ct.2179(2011),available athttp://www.supremecourt.gov/opinions/10pdf/09-1403.

pdf.602See generallyWilsonSonsiniGoodrich&Rosati,FirmAlert,U.S. Supreme Court Finds

That Plaintiffs Need Not Prove Loss Causation at Outset of Securities Fraud Class Actions (June 6, 2011), available at http://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/pdfsearch/wsgralert_loss_causation.htm(noting,interalia,that“[t]heCourt’sdecision...takesawayaninterestingbutcontroversialgambitonthepartofclassactiondefendantstoterminateasecuritiesclassactioninitsearlystages”).

603Erica P. John Fund, Inc.,131S.Ct.at2183.604Id.605487F.3d261,269(5thCir.2007).606Erica P. John Fund, Inc., 131 S. Ct. at 2183–84.


resulted in the losses.”607TheSupremeCourtgrantedcertiorari to“resolveaconflictamongtheCircuitsastowhethersecuritiesfraudplaintiffsmustprovelosscausationinordertoobtainclasscertification.”608ItemphaticallyrejectedtheFifthCircuit’s impositionof thisadditionalburden forclasscertification,explaining that

[t]heCourtofAppeals’requirementisnotjustifiedbyBasic [v. Levinson,485U.S.224(1988)]oritslogic....[W]ehaveneverbeforementionedlosscausationasapreconditionforinvokingBasic’srebuttablepresumptionofreliance.Theterm“losscausation”doesnotevenappearinourBasic opinion. And for good reason: Losscausationaddressesamatterdifferentfromwhetheraninvestorreliedonamisrepresentation,presumptivelyorotherwise,whenbuyingorsellingastock.609

Whenfacedwithvariousclaimedpleadingdeficiencies,otherfederalcourtsgrantedandrejectedmotionstodismissanumberofsecuritiesfraudclassactioncomplaints against life sciences entities. Although their expressed reasoning is oftenfactuallybound,sometimestheapparentlydisparatedecisionscanbehardto reconcile.For example, inHill v. Gozani,610 theFirstCircuit affirmed thedismissalofasecuritiesfraudclassactioncomplaintagainstamedicaldevicemanufacturerforfailingtopleadactionablemisconduct.Inthatproceeding,thecomplaintallegedaschemebyNeuroMetrix,Inc.,andthreeofitsofficers(col-lectivelythedefendants)regardingamedicaldevicethecompanymanufacturedthatvastly simplifiedamedicalprocedure (i.e., the“NC-Stat,”whichpermitsnoninvasivenerveconductionstudiestodetect,diagnose,andmonitorneurolog-ical conditions affecting the peripheral nerves).611 In marketing the NC-Stat,NeuroMetrixinformedphysicianstheycouldbillinsurersfortheprocedureusingstandardizedbillingcodes for specializedprocedures.612 The plaintiffs alleged thatthedefendantsknewthecodeshadartificiallyhighratesandthattheirschemewouldsoonbediscovered,whichwouldcausethecompany’sprofitmarginstodropquicklyandleadtothecollapseofitsstockvalue.613Theplaintiffssimilarlyclaimed that the company’s individual officers knew the risk and thereforedivestedsignificantamountsofstockatgreatprofitbeforethenewsbroke,alongwiththecivilandcriminalinvestigationsthatfollowed.614Thedefendantsmovedto dismiss, claiming that the plaintiffs had not adequately alleged actionablemisstatements,scienter,losscausation,orindividualliability.615Thejudgeagreedafter struggling to parse through the complaint’s large block quotes of text

607Id.at2184(quotingArchdioceseofMilwaukeeSupportingFund,Inc.v.HalliburtonCo., 597F.3d330,334(5thCir.2010),vacated byEricaP.JohnFund,Inc.v.HalliburtonCo.,131S.Ct.2179,180L.Ed.2d24(2011)(“EPJFundmust‘establishacausallinkbetweentheallegedfalsehoodsanditslossesinordertoinvokethefraud-on-the-marketpresumption.’”)).

608Id.609Id.at2185–86(internalcitationsomitted,citingDuraPharms.,Inc.v.Broudo,544U.S.

336,341–42(2005)).610638 F.3d 40 (1st Cir. 2011).611Id. at 46–50.612Id.613Id.614Id.615Id. at 50–52.

Ch. 12.V.C.


claimed to be misleading.616InsteadoffindingthatNeuroMetrixhadprovidedactivelymisleadingwarningstotheinvestingpublic,thejudgenoted(andtheappeals court agreed) that the disclosures contained express warnings that increasedasthereimbursementissuesbecamemoresevere.Consequently,theinvestorshadbeenadequatelyapprisedofthedefendants’reimbursementstrat-egyandthesubstanceofdisputeswithinsurers.617

Another interesting caseworthmentioning involved a Sarbanes-OxleywhistlebloweractionbyaformerpharmaceuticalcompanyCFOwhoclaimedthathesufferedretaliationafterquestioningmanagement’sunlawfulactivities.The whistleblower in McManus v. McManus Financial Consultants, Inc.,618 allegedthathewasterminatedforinformingmanagementtheywouldbecom-mittingsecuritiesfraudiftheyissuednewsharesandresetthepriceofcurrentshares without obtaining new consideration and a new agreement.619 But the boarddidsoanyway,andthecompanyallegedlyfiledaForm8-Kthatfalselystatedthetransactionwastocorrectanerrorintheoriginalconversionprice.620 In turn, the plaintiff filed anOccupationalHealth andSafetyAdministration(OSHA) complaint alleging Sarbanes-Oxley Act violations. After OSHAdeclinedtopursuethematter,theplaintiffreceivedarighttosueletter,621 and suedfortortiousdischargeunderNevadalaw.Thesuitwasdismissedforlackofsubjectmatterjurisdictionbecauseofalackofcompletediversityoverthedefendants.622Theplaintiffrefiled,allegingthathehadsufferedretaliationandwasprotectedasawhistleblowerbytheSarbanes-OxleyAct.623 The defendants claimed that the amended complaint did not state a claim upon which relief could begranted, and the judge agreed.Although theplaintiff claimed thathehadexposedthedefendants’plantocommitsecuritiesfraud,thejudgefoundthattheForm8-K’sdisclosuredidnotsupporthistheory.Rather,asthejudgepointedout,theForm8-Kdirectlycontradictedtheclaimsofmaterialomission.624

VI. Insider Trading

Wheneverexecutives,scientists,andotheremployeesoragentswhoworkforpubliclytradedpharmaceuticalmanufacturersormedicaldevicecompaniesareprivytoinformationthatisnotavailabletothegeneralpublic,theymustbecarefulnot to takeadvantageof the information.Generally, toavoidcivilorcriminalinsidertradingliability,suchpersonscannotbuyorselltheircompany’sstockduringthetimeswhentheyhavesuchinformationunlesstheyfirstpubliclydisclosetheinformation.ThesedangersareillustratedbytheimprisonmentofDr.SamuelWaksal,animmunologistwhofoundedImCloneSystemsInc.,and

616Id.617Id.618No.3:11-CV-00134-LRH-VPC,2012U.S.Dist.LEXIS37289(D.Nev.Mar.19,2012).619Id. at *2.620Id. at *3.621Id.622Id.623Id.at*4.TheSarbanes-Oxleywhistleblowerprotectionsarecodifiedat18U.S.C.§1514A.624No.3:11-CV-00134-LRH-VPC,2012U.S.Dist.LEXIS37289,at*10(D.Nev.Mar.19,

2012).


whowasseekingNDAapprovalforthedrugErbituxasacancertreatment.625 AsWaksal’s case demonstrates, courts have embraced the SEC’s expansivereadingofthefederalsecuritieslawstocoverconductbycompanyinsiderswhoprofitattheexpenseofthegeneralpublicbytradingthesecuritiesoftheircom-paniesbasedonmaterialinformationnotavailabletothepublic.626

Theinsidertradingliabilitytheoriesaregenerallybasedona“parityofinformation”concern.Thisbasicfairnessconcern...ledtotheSEC’sgeneralrulethatinsidersmustdisclose-or-abstainfromtradingonsuchinformationtoavoidinsidertradingliability.Noticethat,inadditiontoSection10(b)andthecompanionSECregulationRule10b-5, thereareotherfederalsecurities lawsthathavebeeninterpretedtoforbidinsidertradingliability—includingSection14(e)oftheSecuritiesExchangeAct,andthecompanionSECregulationRule14(e).627

A. Statutory Insiders: Section 16 and the Prohibitions Against Short-Swing Trading

ItisclearthatunderSection16ofthe...ExchangeActcertainindividualsarecorporate insiders—includinghigh-rankingcorporateofficersandholdersof10percentofthevotingclassofstock.Such‘Section16insiders’cannottradeinacompany’sequitieswithoutfirsthavingmaderequiredpublicly-fileddisclosuresortheywillbeheldstrictly liableandforcedtodisgorgeany‘short-swing’profits(obtainedfromtradingtheircompany’sequitiesduringasix-monthperiod).628

Aspreviously explained, the term “insider” covers not onlySection 16insiders,butalsoextendstocover“situationalinsiders”whoobtainaccesstomaterialconfidential informationunder theexpressor impliedunderstanding

625SeeSectionI.,above.Also seeKennethN.Gilpin,ImClone Founder Pleads Guilty to Avoid-ing Sales Tax on Art,N.Y.Times,Mar.3,2003,available athttp://www.nytimes.com/2003/03/03/business/03CND-MARTHA.html?ex=1148616000&en=eab192ebac8097e9&ei=5070; http://www.sec.gov/litigation/complaints/comp18026.htm(insidertradingcomplaint);http://news.find-law.com/cnn/docs/imclone/usvwaksal080702ind.pdf (indictment against Waksal); http://www.sec.gov/litigation/complaints/comp18169.htm(insidertradingcomplaint)andhttp://news.findlaw.com/cnn/docs/mstewart/usmspb10504sind.pdf (indictment against Stewart); PressReleaseNo.2004-13,SEC, SEC and FDA Take Steps to Enhance Inter-Agency Cooperation(Feb.5,2004)(indicating that FDA has adopted a procedure to refer to SEC staff possible instances of securities lawsviolationsbypubliccompanies),available athttp://www.sec.gov/news/press/2004-13.htm;Sonnenfeldetal.,Disclosing Product Developments to Investors, 18(4) Insights at 24 (2004).

626SeeSectionI.C.,above.627MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded

Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.03(internalcitationsomittedciting,interalia,RobertS.Karmel,Insider Trading: Law, Policy, and Theory AfterO’Hagan,20Cardozo L. Rev.83,85–86(1998)(“Therearefoursourcesfortheprohibitionsagainsttradingoninsideinformationunderthe...securitieslaws[:][S]ection10(b)oftheSecuritiesExchangeActof1934...andSECRule10b-5...thereunder;section16oftheExchangeAct;section14(e)oftheExchangeActandSECRule14e-3...thereunder;andthestatutoryamendmentstotheExchangeActpassedinthe1980sthatincreasedthesanctionsforinsidertradingviolations.[TheInsiderTradingSanctionsActof1984,Pub.L.No.98-376,98Stat.1264(codifiedasamendedinscatteredsubdivisionsof15U.S.C.§78)andtheInsiderTradingandSecuritiesFraudEnforcementActof1988,Pub.L.No.100-704,102Stat.4677(codifiedasamendedinscatteredsubdivisionsof15U.S.C.§§78,80b-4a)]”)).

6282006Health Lawand Compliance Update§5.03(internalcitationsomitted).

Ch. 12.VI.A.

12-102 Pharmaceutical and Medical Device Law Ch. 12.VI.A.

thattheywillnotexploittheiraccesstothatinformationtothedetrimentofthecompany.629

Aninsiderisdefinedbythestatuteasabeneficialownerofmorethan10percentofanyclassofthecorporation’snonexempt,registeredequitysecurities,oradirectororofficerofthecompanyissuingthestock.630ByreferencetoSECRule16a-1(f),whichdefinestheterm“officer,”631 an insider also includes “all companydirectors,officers(includingpresidents,vice-presidentsinchargeofaprincipalbusinessunit,andotherofficerswhoperformimportantpolicy-makingfunctions)and...[10percentequityholdersofpublicly-heldentities].”632

Ingeneral,underSection16(b)oftheExchangeAct,633statutoryinsidersareheldstrictlyliableforanyshort-swingprofitsthattheyrealizebytradinginthe securities of their companieswithin a six-month time period.Moreover,underSection16(a)oftheExchangeAct“insiders[must]...filereportswiththe...[SEC]regardingtheirownershipof,andtransactionsin,employersecu-rities.”634 “The elements of a claim under Section 16(b) are that ‘there was (1) a purchaseand(2)asaleofsecurities(3)byanofficerordirectoroftheissueror

629See id.,notingthat,inUnited States v. O’Hagan,521U.S.642(1997),theCourtapprovedtheuseofthe“misappropriationdoctrine”thattheSEChadsuccessfullyurgedinsomeofthefederalcourtsofappealtofillthelogicalgapsleftopenbytheclassicaltheoryofinsidertradingliabilitybecausetemporaryinsidersshouldnotbeallowedtoexploitaninformationaladvantageagainsttheinvestingpublic.

63015U.S.C.§78p(a-b).631Rule16a-1(f)provides:The term“officer” shallmeanan issuer’spresident,principalfinancialofficer,principalaccountingofficer(or,ifthereisnosuchaccountingofficer,thecontroller),anyvice-presi-dentoftheissuerinchargeofaprincipalbusinessunit,divisionorfunction(suchassales,administrationorfinance),anyotherofficerwhoperformsapolicy-makingfunction,oranyotherpersonwhoperformssimilarpolicy-makingfunctionsfortheissuer.Officersoftheissuer’sparent(s)orsubsidiariesshallbedeemedofficersoftheissueriftheyperformsuchpolicy-makingfunctionsfortheissuer.Inaddition,whentheissuerisalimitedpartnership,officersoremployeesofthegeneralpartner(s)whoperformpolicy-makingfunctionsforthelimitedpartnershiparedeemedofficersofthelimitedpartnership.Whentheissuerisatrust,officersoremployeesofthetrustee(s)whoperformpolicy-makingfunctionsforthetrustaredeemedofficersofthetrust.632Id. See alsoMarcI.Steinberg,Insider Trading, Selective Disclosure, and Prompt Disclo-

sure: A Comparative Analysis,22U.Pa. J. Int’l Econ.L.635,637(2001).633Section16(b)oftheExchangeAct,codifiedasamendedat15U.S.C.§78p(b),provides,

inrelevantpart:Forthepurposeofpreventingtheunfairuseofinformationwhichmayhavebeenobtainedbysuchbeneficialowner,director,orofficerbyreasonofhisrelationshiptotheissuer,any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer . . . involving any such equity security within any period of less than six months,unlesssuchsecurityorsecurity-basedswapagreementwasacquiredingoodfaith inconnectionwithadebtpreviouslycontracted,shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transactionofholdingthesecurityorsecurity-basedswapagreementpurchasedorofnotrepurchasingthesecurityorsecurity-basedswapagreementsold for a period exceeding six months. . . .(Emphasis added.)634MaxJ.Schwartz,A Primer on Stock-Based Compensation and Selected Recent Develop-

ments: Hot Issues in Executive Compensation 2002,537PLI/Tax9,30–32(2002).


byashareholderwhoownsmorethantenpercentofanyoneclassoftheissuer’ssecurities(4)withinasix-monthperiod.’”635

For example, in Securities & Exchange Commission v. Patel,636 which involvedanenforcementproceedingagainst the founderofapharmaceuticalcompany,theSecondCircuitheldthatPatelviolatedtheinsidertradinglawsbysellingthecompany’sstockbasedonundisclosednegativeinformationtoavoidlossesthatheotherwisewouldhaveincurred.

B. The Disclose-or-Abstain Rule

Theseminalinsidertradingdecisioninvolvingthedisclose-or-abstainruleis In re Cady, Roberts & Co.,637 which arose from an enforcement proceeding conductedby theCommission.TheCady, Roberts & Co. court held that the disclose-or-abstainruleisbasedontwoconsiderations:“Thefirstisarelation-shipwhichgivesaccesstoinsideinformation‘intendedtobeavailableonlyforacorporatepurposeandnotforthepersonalbenefitofanyone.’”638 The second considerationisthe“‘inherentunfairnessinvolvedwhereapartytakesadvan-tageofsuchinformationknowingit isunavailable to thosewithwhomheisdealing.’”639Becauseinsidersarepresumedtohaveaninformationadvantageovertheinvestingpublic,theycannottradeinthesecuritiesoftheircompanywithoutfirstdisclosinganymaterialinsideinformationevenifthecompanyhasno current disclosure obligations.640

C. Duty to Disclose Material Facts

Pharmaceuticalmanufacturers andmedical device companies that haveregisteredwiththeSECasissuershaveperiodicandepisodicdisclosureobliga-tionsimposedbyvariousrulesandregulationspromulgatedbytheCommissionpursuant to its authority to administer the federal securities laws, aswell asdisclosureobligationsimposedbycaselaw.641Moreover,thejudicialstandardformaterialityprovidesthat“[w]hetherafactismaterial‘dependsonthesig-nificancethereasonableinvestorwouldplaceonthewithheldormisrepresented

635Pfeiffer v.Price,No. 04-296-SLR,2004WL3119780, at *5 (D.Del.Dec. 27, 2004)(unreported),citingGwozdzinskyv.Zell/ChilmarkFund,L.P.,156F.3d305,308(2dCir.1998).

63661F.3d137(2dCir.1995).Thecontoursofthedisclose-or-abstainrulearecoveredatSectionsI.B.,above,andVII.,below.

63740S.E.C.907(Nov.8,1961).638AllanHorwich,Possession Versus Use: Is There a Causation Element in the Prohibition

on Insider Trading, 52 Bus. Law.1235,1239(1997),citingCady,Roberts&Co.,40S.E.C.at911.639Id.640See generally,BruceA.Hiler,The SEC and the Courts’ Approach to Disclosure of Earn-

ings Projections, Asset Appraisals, and Other Soft Information: Old Problems, Changing Views, 46 Md. L. Rev.114,118–69 (1987).SeeSection I.B., above, forexceptions to thedisclosureobligations.

641SeeSectionI.A.,above,foradiscussionofthedisclosureobligations.TheepisodicandperiodicdisclosureobligationshavebeencoveredindetailinSectionIII.,above.

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information.’”642 Under the related TSC Industriestest,643“[a]misrepresentationoromissionismaterialiftheinformation‘wouldhavebeenviewedbytherea-sonable investorashavingsignificantlyalteredthe‘totalmix’of informationmadeavailable.’”644

1. Insider Trading of Company Securities Based on Material Nonpublic InformationInadditiontothewell-publicizedinsidertradingproceedings(andrelated

criminalactions)institutedbytheCommission(andtheDOJ)againstSamuelWaksalandMarthaStewart,645severalotherinsidertradingproceedingshavebeenagainstindividualsfortradinginthesecuritiesofhealthcareandlifesci-encescompanies.Forexample,Securities & Exchange Commission v. Terner646 involvedanenforcementactionforinsidertradingviolationsfiledbytheCom-mission againstDr. JacobY.Terner, theCEO and chairman of the board ofdirectors forMediCorp, Inc. (an operator ofHMOs acquired by FoundationHealthCorporationthroughamergerinJuly1992).647 The Commission alleged thatDr.Ternerandanotherboardmemberconveyedmaterialnonpublicinfor-mation about the merger negotiations to third parties who tipped friends and colleagues,who in turn profited by almost $370,000 collectively by tradingCenturystockwhilepossessingmaterial,nonpublicinformation.648 Dr. Terner subsequentlyagreedtopayacivilfineof$225,750—theamountthatoneofhiscolleagueshadillegallyreapedinprofits.649

Inanotherinsidertradingenforcementproceeding,Securities & Exchange Comm’n v. Mutchnick,650 theCommissionallegedthatDr.MiltonMutchnick,“theleadphysicianinaclinicaltrialofanantihepatitisdrug,uponlearningofdisappointingresults,tippedfriendsandfamily...who...[sold]theirsharesin[Alpha1Biomedicals,Inc.andSciClonePharmaceuticals,Inc.]thecompa-niesdevelopingthedrugsbeforethepublicannouncement....”651 Although Dr. Mutchnickdidnotpersonallytrade,hesettledtheactionbypaying$163,000.652 In a related proceeding, the Commission filed a complaint charging insider

642AlanJ.Berkeley,Materiality, Informal Disclosure, Soft Information, and Forward Look-ing Statements Under Securities Laws247,249(ALI-ABASH001,2002),citingBasicInc.v.Levinson,485U.S.224,240(1988).SeealsoSectionIII.A.1.,above,foradditionaldiscussionofBasic,Inc.

643TSCIndus.,Inc.v.Northway,Inc.,426U.S.438,449(1976).644Berkeley,at249,citingTSCIndustries,Inc.,426U.S.at449.645SeeSectionVI.,above,foradiscussionofWaksal.646SECLitig.Rel.No.15401,1997SECLEXIS1398(C.D.Cal.July2,1997),available at

http://www.sec.gov/litigation/litreleases/lr15401.txt.647RobertA.Prentice,Clinical Trial Results, Physicians, and Insider Trading,20J.Legal

Med.195,204(1999).648SeeSECLitig.Rel.No.15401(July2,1997).649SeePrentice,at204.650SECLitig.Rel.No.15322,1997SECLEXIS773(E.D.Mich.Apr.10,1997),available

athttp://www.sec.gov/litigation/litreleases/lr15322.txt.651RobertA.Prentice,Clinical Trial Results, Physicians, and Insider Trading,20J.Legal

Med. 209–10 (1999) (internal note omitted).652Id.


trading against Dr. Rangarao Panguluri, Dr. Mutchnick’s assistant.653 “Ulti-mately,ajudgeorderedDr.Panguluritopayafineof$75,000andhistippeestopayaround$350,000,roughlytwicetheamountoftheirprofitsgainedandlossesavoided.”654

2. When Applicable Statute or Regulation Mandates DisclosureAmong themany SEC regulations and rules thatmandate periodic and

episodicdisclosuresarethefollowingimportantprovisions:1. RegulationS-K655 (pertaining to registration statements)—including Item

10b(policyonprojections),Item103(pertainingtolegalproceedings),Item303(MD&A),Item401(f)(concerningdirectors,executiveofficers,promoters,andcontrolpersons),Item404(a)(concerningself-dealingandrelatedtransactions),andItem503(c)(involvingriskfactors);

2. Regulation S-X656(proscribingtheform,content,andrequirementsforfinancialstatementsmandatedtobefiledasapartofregistrationstate-mentsundertheSecuritiesAct,andtheform,content,andrequirementsforfinancialstatementstobefiledasapartofannualorotherreportsunder the Exchange Act)—including Articles 3 (general instructions for financialstatements)and10(interimfinancialstatements)andvariousperiodic forms657(8-K,10-Q,10-K);and

3. Regulation FD658 (requiring simultaneous public disclosure of material informationwhentheinformationhasbeenprovidedtoaspecifiedlistof recipients).

3. When Prior Statement of Material Fact Becomes False or Misleading in Light of Undisclosed InformationThe judicially imposedduty toupdatedoctrine is explained indetail in

SectionIII.D.1.,above.TherelateddutytocorrectdoctrineisexplainedindetailinSectionIII.D.2.,above.

D. The Classical Theory of Insider Trading Liability

Theso-calledclassicaltheoryofinsidertradingliabilitygenerallyreferstothebodyofcasesthatprecededthemisappropriationtheoryofinsidertradingliability.Asnoted,theclassicaltheoryofliabilitywasenunciatedintheseminalCady, Roberts decision659andlaterexplainedbytheSupremeCourtinUnited States v. O’Hagan:660

653SECv.Panguluri,SECLitig.Rel.No.15905,1998SECLEXIS2038(C.D.Cal.Sept.24,1998).

654Prentice,at209–10.655RegulationS-KisdiscussedaboveinSectionIII.C.1.656SeeSectionIII.C.2.,above.657SeeSectionIII.C.3.,above.658SeeSectionIII.C.4.,above.659SeeSectionVI.B.,above.660521 U.S. 642 (1997).

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Under the “traditional” or “classical theory” of insider trading liability, §10(b)andRule10b-5areviolatedwhenacorporateinsidertradesinthesecuritiesofhiscorporationonthebasisofmaterial,nonpublicinformation.Tradingonsuchinfor-mationqualifiesasa“deceptivedevice”under§10(b)...because“arelationshipoftrustandconfidence[exists]betweentheshareholdersofacorporationandthoseinsiderswhohaveobtainedconfidentialinformationbyreasonoftheirpositionwiththatcorporation.”...Thatrelationship...“givesrisetoadutytodisclose[ortoabstainfromtrading]becauseofthe‘necessityofpreventingacorporateinsiderfrom...tak[ing]unfairadvantageof...uninformed...stockholders.’”...Theclassicaltheoryappliesnotonlytoofficers,directors,andotherpermanentinsidersofacorporation,butalsotoattorneys,accountants,consultants,andotherswhotemporarilybecomefiduciariesofacorporation....661

E. The Misappropriation Theory of Insider Trading Liability

Because the classical theory of insider trading liability could not reachcertainindividualswhogainedaccesstoconfidentialmaterialinformationunderanexpressorimplieddutynottotakeactionadversetothecompany,includingtradinginitssecuritiesfortheindividual’sadvantage,theCommissionchampi-oned the theoryof situationalor temporary insider liability,which theCourtapprovedinUnited States v. O’Hagan.662Asonecommentatorhasnoted,“inUnited States v. O’Hagan [,theCourt]statedthat[a]...fiduciarydutycanrefertotherelationship...betweencorporate‘outsiders’andthesourceofthemate-rial,non-publicinformation(themisappropriationtheory).”663Moredirectly,themisappropriationtheoryextendsafiduciary-likedutybeyondtheinsiderwhoprovidesatiptoanypersonwhoobtainsconfidentialinformation(thetippee)and,knowingthattheinformationwasconfidential,tradesinthesecuritiesofthecompany.

A leading commentator on securities law issues, ProfessorThomasLeeHazen,664wroteaninterestinglawreviewarticleaboutwhatheterms“outsidertrading” issues under the federal securities law.665Amongotherthings,ProfessorHazenaddressestheeventsthatledtotheadoptionofRule10b5-2666—ostensi-bly toprovidemorecertaintyabout thoseactsbynontraditional insiders thatconstitutefederalsecuritieslawviolationsinlightoftheCourt’srulinginChi-arella v. United States667(thatSecuritiesExchangeActSection10(b)liabilitymustbepremisedonfraud,deception,breachofduty,orpossiblyotherwrongfulconduct,notjustpossessingmaterialnonpublicinformation).668ProfessorHazencontendsthat,inpromulgatingRule10b5-2,theCommissiontookabroad—and

661Id. at 651–52 (internal notes omitted).662521 U.S. 642 (1997).663JuliaK.Croninet al.,Securities Fraud, 38Am. Crim. L. Rev.1277,1292–93 (2001)

(internal notes omitted).664Professor Hazen has authored, among things, a seven-volume treatise on the law of

securities regulation.665SeeThomasLeeHazen,Identifying the Duty Prohibiting Outsider Trading on Material

Non-Public Information,61HastingsL.J.881(2010)[hereinafterProhibiting Outsider Trading],available at http://ssrn.com/abstract=1472090.

666Rule10b5-2iscodifiedat17C.F.R.§240.10b5-2.667445 U.S. 222 (1980).668Prohibiting Outsider Trading at 886.


justifiable—viewofSection10b’sreachastocorporateoutsidersdespitevariouscourtdecisionsquestioningitsview.669Significantly,heopinesthatalthough:

[m]anyofthecasesinvolvingthemisappropriationtheoryarebasedonafiduciaryorfiduciary-likerelationship[,]...the...theorycanalsobeapplied[without]...afiduciaryrelationshipwhentheinformationhasbeensuppliedunderacon-fidentialityagreement,atleastwhere[it]...prohibitsbothdisclosureanduseofthe information.670

ProfessorHazenexplainsthatabreachofcontractualobligationcanbesufficienttogroundasection10(b)violation.Theapplicablestatutorylanguageofsection10(b)plainlycreatesbroadliabilityfor“deceptive”conduct—nowheredoesitlimittheSEC’srulemakingauthoritytoprohibitionsontradingconductinvolvingbreachesoffiduciaryduty.Promisingtoupholdaconfidenceandthenbreachingthedutysocreatedcanproperlybecharacter-izedas“deceptive.”ItfollowsthatRule10b5-2isnotbeyondtheSEC’srulemakingauthorityand,accordingly,breachofacontractualconfidentialityagreementshouldbeabletoformthebasisofaRule10b-5outsidertradingviolation....671

F. Differences Between the Use and Mere Possession of Nonpublic Information

Becauseinsidertradingliabilitymayresultinonerouscivilenforcementsanctions and be pursued criminally by the DOJ, the courts had to decidewhetherinsidertradingliabilityisbasicallyastrictliabilityviolationorwhetheritrequiresthatanindividualactwithscienter.Inaseriesofcases,thefederalcourts of appeal had disagreed about whether the mere possession of inside information coupled with evidence of trading was sufficient or whether thegovernmentalsohadtoprovethatthetradingwasconductedwithknowledge.Thesecasesareanalyzedbelow,alongwiththeSEC’srulesubsequentlypro-mulgated to address this issue and that provided limited safe harbors underwhichinsidersmayachievesomerelieffrominsidertradingliability.

1. The Knowing Possession StandardIn United States v. Teicher,672 an appeal of a criminal case in which arbitra-

geurswereconvictedofsecuritiesfraudandrelatedoffenses,theSecondCircuitadoptedthe“knowingpossession”standard,albeitinapassagethatisarguablydictum.673Ascommentatorshaveobserved,“[t]hepossessionstandardisbased

669Id. at 886–87.670Id. at903(internalnotesomitted;citing,inter alia,SECv.Cuban,634F.Supp.2d713

(N.D.Tex.2009),vacated by SEC v. Cuban,620F.3d551(5thCir.2010)).671Id. at 907 (internal notes omitted).672987 F.2d 112 (2d Cir. 1993).673Overobjectionthatitwasoverbroad,thefollowingjuryinstructionaboutinsidertrading

liabilitywas submitted based on the SecondCircuit’s precedent concerningmisappropriationliability(becausethecaseprecededtheSupremeCourt’ssubsequentacceptanceofthisdoctrinein O’Hagan):“Thegovernmentneednotproveacausalrelationshipbetweenthemisappropriatedmaterial nonpublic informationand thedefendants’ trading.That is, thegovernmentneednotprovethatthedefendantspurchasedorsoldsecuritiesbecauseofthematerialnonpublicinforma-tionthattheyknowinglypossessed.Itissufficientifthegovernmentprovesthatthedefendants

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ontheideathatitisdifficultforapersontopossessmaterialnon-publicinfor-mationandpurchaseorsellasecuritywithoutusingthatinformation.”674

2. The Use TestSubsequently,asplitamongthecircuitsdevelopedwhenboth theNinth

Circuit675andtheEleventhCircuitruled676 against the knowing possession stan-dardinfavorofaknowingusestandardofinsidertradingliability.

Underthe“usetest,”theSECmustprovethattheinsiderusedtheinsideinformation...andnotmerelythattheinsidertradedwhile...possess[ing]...[it]....Theinsideinformationneednotbethesolecauseofthetrade,butonlya“significantfactor”intheinsider’sdecisiontobuyorsell.677

G. SEC Rule 10b5-1 and the Affirmative Defense for Written Preexisting Stock Trading Plans

In2000,theSECrespondedtoSmith and AdlerbyadoptingRule10b5-1,678 whichstatesthatapurchaseorsaleofasecurityis“onthebasisof”materialnonpublic information when the person making the purchase or sale is aware of the material nonpublic information.679 Inaddition to theawareness test,Rule10b5-1providesvariouslimitedsafeharborsforinsiderstoavoidliability:

purchasedorsoldsecuritieswhileknowinglyinpossessionofthematerialnonpublicinforma-tion.” Teicher,987F.2dat119.Thedefensehadprofferedthefollowingalternativeinstruction:Adefendantonly“usesmaterialnonpublicinformationwhereitcanbeproventhatthetradingwascausally connectedtothemisappropriatedinformationandhence,wasprovennottohavebeenconducted on an independent and proper basis.” Id.Afterdiscussingthevarioussalutaryfeaturesoftheknowingpossessionstandardoverothers,however,theSecondCircuitdecidedtoaffirmtheconvictions,findingthatthechallengederrorwasharmlessbeyondareasonabledoubt.See id. at 121.(“Inanyevent,weneedonlyrulewithrespecttothecasebeforeus.Viewingthejurychargeinitsentiretyandbasedupontherecord,wefindthatitisunnecessarytodeterminewhetherproofofsecuritiesfraudrequiresacausalconnection,becauseanyallegeddefectintheinstructionwasharmlessbeyonddoubt.”).

674StevenAmchenetal.,Securities Fraud,39Am. Crim. L. Rev.1037,1056–57(2002).675SeeUnitedStatesv.Smith,155F.3d1051(9thCir.1998),superseded by statute as stated

in Konopv.HawaiianAirlines,Inc.,236F.3d1035,1044(9thCir.2001).Thetrialcourtprovidedthefollowing jury instruction,which illustrates themajordifferencesbetween theuseand theknowing possession standards:

Inorderforyoutofindthedefendantguiltyon[theinsidertradingcounts]oftheindict-ment, the governmentmust prove a causal relationship between thematerial nonpublicinformationinthedefendant’spossessionandthedefendant’strading.That is, the governmentmust prove that thedefendant soldor sold shortPDAstock

becauseofmaterialnonpublicinformationthatheknowinglypossessed.It is not sufficient that the government proves that the defendant sold or sold short PDA stock while knowingly in possession of the material nonpublic information.However, thegovernmentneednotprovethatthedefendantsoldorsoldshortPDAstocksolelybecauseofthematerialnon-public information. It is enough if the government proves that such inside information was a significant factor in defendant’s decision to sell or sell short PDA stock.

Id. at 1066 (emphasis added).676SeeSECv.Adler,137F.3d1325(11thCir.1998).677Amchen,at1056–57(internalnotesomitted).67817C.F.R.§240.10b5-1.679Amchen,at1056–57.


1. Beforebecomingawareofthematerialnonpublicinformation,thepersonhad,ingoodfaith,(a)enteredintoabindingcontacttotrade,(b)instructedanotherpersontotrade,or(c)adoptedawrittenplan;and

2. Thecontract, instruction,orplaneither: (a) specifiesorprovides thewrittenformulaormechanismfordeterminingtheamount,price,anddate of the transactions or (b) does not permit the insider to exercise anysubsequentinfluenceoverhow,when,orwhethertoeffectsalesorpurchases,andanypersonwhodoesexercisesuchinfluenceisnotawareofmaterial,nonpublicinformationwhendoingso.680

Finally, it is important to observe that insider trading liability can alsoattachunderSECRule14e-3,681althoughonlyinthetenderoffersetting.But,asonecommentatorhaspointedout,theliabilityinthiscontextissignificantlybroader.682

VII. Private Suits and the Private Securities Litigation Reform Act of 1995

Asindicatedintheintroductiontothischapter,publiclytradedpharmaceu-ticalcompanieshavebecomeoneofthefavoritetargetsofclassactioncounsel,who have asserted different securities fraud theories in dozens of cases. The developmentofclassactionshasbeentracedtoa1963securitiesfraudclassaction,Cherner v. Transitron Electrical Corp.,683 which sought relief for false statements contained in prospectuses under Sections 11 and 12(2) of the Secu-rities Act.684 The district court in Chernerapprovedacompromisesettlementfor$5.3 million.685 By 1995, Congress had grown so concerned about abusivesecurities fraud strike suits that it enacted the Private Securities Litigation

680AlanJ.Berkeley,Materiality, Informal Disclosure, Soft Information, and Forward Look-ing Statements Under Securities Laws247,258–59(ALI-ABASH001,2002).See also Mark J. Loewenstein&WilliamK.S.Wang,The Corporation as Insider Trader,30Del. J. Corp.L.45,70–71 (2005).

681Rule14-eiscodifiedat17C.F.R.§240.14e.682SeeMarc.I.Steinberg,Insider Trading, Selective Disclosure, and Prompt Disclosure: A

Comparative Analysis,22U.Pa. J. Int’l Econ.L.635,642(2001)(“Inthislimitedcontext,theproscriptionsagainst tradingand tippingonmaterial confidential informationare significantlybroader.UnderRule14e-3,apersonwhoobtainsmaterialconfidentialinformationregardingatenderofferdirectlyorindirectlyfromtheofferor(bidder),targetcorporation,oranintermediaryneither can trade nor tip prior to adequate public disclosure (and absorption) of such information.”) (internal notes omitted).

683221 F. Supp. 48 (D. Mass. 1963).684SeeJoelSeligman,Rethinking Private Securities Litigation,73U.Cin. L. Rev.95,98

(2004)(“Theclassactionisthekeytoprivatesecuritieslitigation.Beginningwitha$5.3millionsettlementina1963SecuritiesActcase,thedevicegrewdramaticallyinfrequencyofuseandsignaled significant increases in the size of settlements or awards. Indeed, per an iron lawofunintendedconsequences,thesingledecisionthatinspiredthemostsignificantreactiontoprivateenforcementofthefederalsecuritieslawswasal988decisionwonbyaprivateplaintiff.InBasic,Inc.v.Levinson,adivided...SupremeCourtheldthatplaintiffsinaclassactionarenotrequiredtoproveindividuallythattheyreliedonafalsestatement.Instead,reliancewouldnormallybepresumedbydintofthefraud-on-the-markettheory.”).

685See Cherner, 221 F. Supp. at 53.

Ch. 12.VII.


ReformAct of 1995,which includedvarious provisions to preventmarginalclassactionsuitsfromcontinuingtobeusedasasettlementvehiclebycontin-gencyfeecounsel.686Obviouslynoteveryclassactionsecuritiesfraudproceed-ingisfrivolous,andclassactioncounselplayanimportantrolebyensuringthatindividuals who could not otherwise afford to litigate can obtain a remedy.Moreover,classactionattorneyshaveanadmittedlydifficulttaskinevaluatingthe merits of these cases.687 Congress included two heightened pleading stan-dards in the PSLRA:

First,thecomplaintmustsetforth“eachstatementallegedtohavebeenmisleading,the...reasonswhythestatementismisleading,and,ifanallegationregardingthestatementoromissionismadeoninformationandbelief,thecomplaintshallstatewithparticularityallfactsonwhichthatbeliefisformed.”15U.S.C.§78u-4(b)(1).Second,plaintiffsmuststatewithparticularityfactsgivingrisetoastronginferencethat the defendant acted with the required state of mind . . . with respect to each act oromissionallegedtobeaviolationofthesecuritieslaws.15U.S.C.§78u-4(b)(2).TheReformActmandatesdismissal,uponmotionofthedefendant,ifthecomplaintfailstomeettheserequirements.15U.S.C.§78u-4(b)(3)(A).688

Another important feature of the PSLRA is the automatic discovery stay pending the determination of a motion to dismiss.689Asonecourtexplained,“[t]hisstatutoryprohibitionismeant,inpart,topreventasituationinwhichaplaintiffsueswithoutpossessing therequisite information tosatisfy theReformAct’sheightenedpleadingrequirementsandthenusesdiscoverytoacquirethatinfor-mationto‘resuscitateanotherwisedismissiblecomplaint.’”690Otherkeyfea-turesofthePSLRAareitssafeharborprovisions,whichcanreduce“defendants’

686See, e.g.,AdamC.Pritchard,Should Congress Repeal Securities Class Action Reform?,at2(GeorgetownUniv.LawCenter,Business,Econ.,&Reg.Policy,WorkingPaperNo.389561,Mar.2003),available athttp://papers.ssrn.com/abstract=389561(“TheenactmentofthePrivateSecuritiesLitigationReformActof1995wasavictoryforaccountants,securitiesfirms,andthehigh-technologyindustry,allofwhichsoughttocurtailwhattheyperceivedasatorrentofsecuri-tiesfraudclassactions.Thosegroupsbelievedthattheyhadbeenunjustlyvictimizedbylawsuitsalleging‘fraudbyhindsight,’basedonlittlemorethanasuddendropinacompany’sstockprice.”).

687See, e.g.,PaulA.Griffinetal.,Stock Price Response to News of Securities Fraud Liti-gation: Market Efficiency and the Slow Diffusion of Costly Information2(StanfordLawSchool,JohnM.OlinPrograminLawandEcon.,WorkingPaperNo.208Nov.2000)(“Fromafinanceperspective, thecomplexityofclassactionsecuritiesfraudlitigationcentersonthefact that itisacompoundphenomenon that involves twoanalyticallydistinctevents.First, themarket isinformedofaneventthatcausesastatisticallyandfinanciallysignificantstockpricemovement,typicallyadecline....[C]ounselthenanalyzethesedeclinesforfactorsthatcouldsupport...acomplaint.Iftheybelievethattheyhaveadequatelyidentifiedsuchfactors,mostcommonlytheannouncementofasignificantaccountadjustment,earningsshortfall,orrestatement,orapatternof allegedly significant insider selling prior to the price decline, then they file the lawsuit.”),available at http://papers.ssrn.com/paper.taf?abstract_id=251766 (page references unavailableand internal notes omitted).

688TowerC.Snow,Jr.,etal.,Defending Securities Class Actions,Securities Litigation: Planningand Strategiesforthe’90sand Beyond(ALI-ABASH083,1996),at197–98.

689See15U.S.C.§78u-4(b)(3)(B),whichprovides:“Inanyprivateactionarisingunderthischapter,alldiscoveryandotherproceedingsshallbestayedduringthependencyofanymotiontodismiss,unlessthecourtfindsuponthemotionofanypartythatparticularizeddiscoveryisnecessarytopreserveevidenceortopreventundueprejudicetothatparty.”

690Snow,Jr.,etal.,at197–198(citingIn reComdiscoSec.Litig.,166F.Supp.2d1260,1263 (N.D. Ill. 2001)).

Ch. 12.VII.


exposuretoliabilityrelatedtoforward-lookingstatements.”691 PrivatesecuritiesfraudclassactionsfiledpursuanttothePSLRAareoftenwonorlostattheclasscertificationandsummaryjudgmentphases.

AmajordecisionofnoteisTellabs, Inc. v. Makor Issues & Rights, Ltd.,692 whichrequiresplaintiffstohaveconvincingevidenceoffraudinorderforaclassactioncomplainttosurvive.TheTellabsCourtheldthat,beforepleadedfactsinprivatesecuritiesfraudactionscangiverisetoastronginferenceofscienter,courtsmustconsideranyplausibleopposinginferences.InaddressingwhytheCourtdecidedtovacatetheintermediateappellatecourt’scontrarydetermina-tion, JusticeGinsburg,writing for themajority, explained thatwhile privatesecurities enforcementhas a legitimate role in augmenting thegovernment’senforcementactivitiesrelatedtoviolationsofthesecuritieslaws,suchactionsalsocanbeabusiveandimposecostsoncompanieswhoseconductconformswiththelaw—whichiswhyCongressimposedtheheightenedpleadingrequire-ments on plaintiffs who bring such allegations under the PSLRA.693 As the Court explained,Congressimposedaheightenedpleadingrequirementconcerningthefactsthatallegedlyevidencesuchaviolationandthescienterinvolved:

Exacting pleading requirements are among the control measures Congress included inthePSLRA.TheActrequiresplaintiffstostatewithparticularityboththefactsconstitutingtheallegedviolation,andthefactsevidencingscienter,i.e.,thedefen-dant’sintention“todeceive,manipulate,ordefraud.”Ernst & Ernst v. Hochfelder,425U.S.185,194, andn.12,96S.Ct.1375,47L.Ed.2d668 (1976); see15U.S.C.§78u-4(b)(1),(2).Thiscaseconcernsthelatterrequirement.Assetoutin§21D(b)(2)ofthePSLRA,plaintiffsmust“statewithparticularityfactsgivingriseto a strong inference that the defendant acted with the required state of mind.” 15 U.S.C.§78u-4(b)(2).694

Moreover, because Congress did not define what constituted a “stronginference”forscienter,federalcourtshavehadtofillinthegaps.695 In announc-ingthestandardtobeused, theCourtexplainedthat theSeventhCircuithaderredinitsformulationbynotrequiringcourtstoconsiderplausibleopposinginferences,butinsteadmechanicallyfocusingontheallegations:

[T]heCourtofAppealsfor theSeventhCircuitheldthat the“stronginference”standardwouldbemetifthecomplaint“allege[d]factsfromwhich,iftrue,area-sonable person could infer that the defendant acted with the required intent.” 437 F.3d588,602(2006).Thatformulation...doesnotcapturethestricterdemandCongress sought toconvey in§21D(b)(2). Itdoesnot suffice that a reasonablefactfinder plausibly could infer from the complaint’s allegations the requisitestateofmind.Rather,todeterminewhetheracomplaint’sscienterallegationscansurvivethresholdinspectionforsufficiency,acourtgovernedby§21D(b)(2)mustengageinacomparativeevaluation;itmustconsider,notonlyinferencesurgedbytheplaintiff,astheSeventhCircuitdid,butalsocompetinginferencesrationallydrawnfromthefactsalleged.Aninferenceoffraudulentintentmaybeplausible,

691StephenJ.Choi,The Evidence on Securities Fraud Class Actions,57Vand. L. Rev.1465,1470(2004).SeeSectionIII.A.4.c.,above,formoreonthestatutorysafeharbors.

692551 U.S. 308 (2007).693Tellabs,551U.S.at313.694Id.695Id.

Ch. 12.VII.


yetlesscogentthanother,nonculpableexplanationsforthedefendant’sconduct.Toqualifyas“strong”withintheintendmentof§21D(b)(2),wehold,aninferenceofscientermustbemorethanmerelyplausibleorreasonable—itmustbecogentandatleastascompellingasanyopposinginferenceofnonfraudulentintent.696

An example of a plaintiff’s securities fraud class action filed against ahealthcareproviderspecializinginlong-termhospitalcarefacilitiesillustratesthetypeofconductthatwillordinarilypassmuster.InMarsden v. Select Medical Corp.,697thejudgeexplainedwhyhewascertifyingaclassactionagainsttheproviderbasedonallegationsthatthecompanymadematerialmisrepresenta-tions andsuppressedmaterialinformationrelatedtotheimpactthatregulatorychangeswouldhaveonitsbusiness.Anothersecuritiesfraudclassactioncaseof interest is In re Connetics Corp. Securities Litigation.698Inthismatter,thedistrictjudgegrantedsummaryjudgmentforthedefendants,dismissingaclassactionbybuyersofapharmaceuticalmanufacturer’sstockwhosuedthecom-panyandcertainofficersfortheirconductinpublicizingthedevelopmentofanewacnemedication.Asthejudgenoted,theplaintiffsallegedthatfalseandmisleadingmaterialstatementshadbeenpubliclydisseminatedabouttheprod-uct’sprogress,itslikelihoodofFDAapproval,andprojectedrevenuesfromtheproductafterapproval.699Inparticular,theplaintiffsclaimedthatthedefendantshadsuppressednegativeinformationaboutapreclinicaltestperformedonmice,whiletoutingthedrug’sbenefits.700 The plaintiffs also alleged that defendants hadengagedinchannelstuffingtoincreasetheapparentdemandforthecom-pany’sotherproducts.701Subsequently,whenthecompanywasforcedtorestateits earnings, its stockvaluedropped, therebyharming investors.702 The court agreed with the defendants that the lead class plaintiff lacked standing for one oftheallegeddatesinthecomplaintbecausetheleadplaintiffcouldnothavesuffereddamagestraceabletothecompany’sdisclosuresbecauseithadsolditsstockinthecompanybeforethecompanymadethedisclosureandthemarketreacted to it.703Ontheotherhand,theleadplaintiffhadboughtstockondatesbefore other disclosures and drops in the stock prices and had suffered traceable damages.704Becausetheleadplaintiffsufferedinjuriesonsomeofthedatesinquestion,ithadstandingtoproceed.705Turning,however,totheadequacyofthepleadingandtheevidenceforprovingthenecessaryintenttoestablishsecuritiesfraud under the PSLRA’s heightened standards, the judge explained that theevidencewasinsufficienttoshowthatdefendantshadactualknowledgeastothefalsityoftheclaimedmisleadingstatementswhentheyweremade:

696Id. at 314.697246 F.R.D. 480 (E.D. Pa. 2007).698542 F. Supp. 2d 996 (N.D. Cal. 2008).699Id. at 999.700Id. at 1000.701Id.702Id.703Id. at 1003 (citing Dura Pharms., Inc.,544U.S.336,342(2005)(“Ashareholderwho

sellsstocksbeforeadisclosureoftruthfulinformationwillnothavesufferedanylossbasedonamisrepresentation related to that information.”)).

704Id. at 1004.705Id.

Ch. 12.VII.


PlaintiffshavenotcreatedastronginferencethatdefendantshadactualknowledgeoffalsityatthetimetheirpredictionsaboutVelacweremadebecauseduringthisperioddefendantshadnotheardanythingfromtheFDAindicatingthattheFDAhad concerns about the results of the transgenic mouse test. Although defendants mayhaveheard theconcernsexpressedbytheirpanelofexperts inJune2004,defendantswereawareofanotherdrugthathadbeenapprovedbytheFDAdespiteapositivetransgenictest.Thus,statementspredictingthattheFDAwouldapproveVelac,see, e.g.,Complaintat¶¶60,242–45,werenotmadeinthefaceofactualknowledgethatVelaccouldneverbeapproved;rather,theymayhavebeenmadeinthe optimistic belief that the transgenic testing problem was a surmountable barrier toFDAapproval....706

Similarly,inDavison v. Ventrus Biosciences, Inc.,707thecompanyreleasedpromising information about its clinical drug studies, later followedupwithinformationaboutsetbacks.Theplaintiffssuedfordamagescausedbypayinginflated stock prices because of misstatements about the experimental drugproduct.Thecomplaintallegedthat“Defendants,aspartoftheireffortstoraisecapital forVentrus, ‘touted’pre-2008Phase II test results forVEN309con-ductedbythedrug’spatentholder...‘[d]espitethefactthatthesmalltestinggroupsand subjectiveendpointsused inAmer’s studies couldnotproduceareliablegaugeoftheefficacyofVEN309.’”708 The plaintiffs alleged the mis-representationofthePhase2resultsmisledinvestorsandcausedthemeconomiclosseswhenthecompanylaterdisclosedduringPhase3testingthatitsendpointswerenotmetandabandonedthedrug’sdevelopment(causingthestockpricetodrop).709Astheopinionexplains,“[a]tthetimeVentrusacquiredthelicensetoVEN309inMarch2008,thedrughadundergone[350]...PhaseIandseven...PhaseIIstudies”andtheplaintiffs’claimsfocusedononeofthesevenPhase2 studies.710Thedefendants haddiscussionswith theFDAover a three-yearperiodaboutthemethodologyandprocedureforaPhase3trial,includingusinga “special protocol assessment” to obtain advance approval from the FDA.Althoughthecompanylaterdecidedagainstthisprocess,itimplementedsomesuggested changes to the Phase 3 protocol.711 Ventrus made three public offerings ofitsstockduringthisperiod,inwhichitraisedmorethan$70million.712 As to themeritsoftheplaintiffs’claimsabouttheallegedwrongdoingconcerningthePhase2trials,thecourtnotedthelackofsupportgiventootherplaintiffswhohaveofferedsubjectiveopinionsaboutsuchscientificmatters:

TheSecondCircuithasemphasizedthatinscrutinizingaSection10(b)claim,acourtdoesnotjudgethemethodologyofadrugtrial,butwhetheradefendant’sstatementsaboutthatstudywerefalseandmisleading.Abely v. Aeterna Zentaris Inc.,12-cv-4711,2013U.S.Dist.LEXIS78388,2013WL2399869,at*7(S.D.N.Y.May29,2013)(citingKleinman,706F.3dat154-55).InKleinman v. Elan Corp., plc, a case verymuch on point, theCourt held that plaintiffs’ criticism of the

706Id.at1008(internalnoteandcitationstoauthorityomitted).70713Civ.3119(RMB),2014U.S.Dist.LEXIS63038(S.D.N.Y.May5,2014).708Davisonv.VentrusBiosciences,Inc.,2014U.S.Dist.LEXIS63038at*3–4.709Id. at *4.710Id. at *9.711Id. at *10.712Id. at *12.

Ch. 12.VII.


methodologyusedindefendants’“post-hocanalysis”ofaPhaseIIdrugtrialdidnot support a securities fraud claim because defendants had not made misleading statementsregardingthatmethodology.

* * *

Here,asinKleinman,PlaintiffsdonotallegethatDefendants’ClassPeriodstate-mentsmisrepresentedanyfactsregardingtheGermanStudy,includingitssizeoranyotherfactsaboutitsmethodology,but,instead,criticizethestudy’smethodol-ogyasunreliable.UnderKleinman,thisisplainlyinsufficienttopleadfalsityinasecurities fraud case. . . .713

Accountingfraudallegations,whichnotlongagoweremorepopularwithclassactionsecuritiesfraudplaintiffs,havebecomelessfrequentbecausethecourtshavelookedskepticallyatallegationsthattrytoestablishfraudliabilityforacompany’suseofnon-GAAPaccountingmethods.IllustrativeisIn re Par Pharmaceutical Securities Litigation.714Thefederaljudgeinthatcasedismissedthe class action complaint (which alleged that defendants engaged in accounting fraudbyissuingfalseandmisleadingstatementsaboutthemanufacturer’sfinan-cialperformanceandprospects,whichsubsequentlycausedthevalueofPar’sstock to drop and financially harmed investors). Observing that the “grouppleading”doctrinehasbeenrejectedbythe“prevailingauthority”asameansbywhichprivatesecuritiesfraudplaintiffscanestablishadefendant’sscienterunderthePSLRA,thejudgenotedthatalthoughtheplaintiffssaidtheydidnotrelyuponthisdoctrine,theirpleadingsindicatedotherwise.715

A. Class Actions

Class action suits are popular against pharmaceutical manufacturers and medicaldevicecompanies.716Amongotherthings,thisproceduraldevicepro-

713Id. at *21–22.714No.06-CV-3226(PGS),2008WL2559362(D.N.J.June24,2008).715Id. at *9–10 (citing In reBio-TechnologyGen.Corp.Sec.Litig.,380F.Supp.2d574,

583–84(D.N.J.2005),andPaynev.DeLuca,433F.Supp.2d547,569–70(W.D.Pa.2006)).716See, e.g., DavidKotler et al., Survey of Securities Fraud Class Actions Against Life

Sciences Companies (Apr.2009)(“In2008,23differentpharmaceuticalandbiotechcompanies,alongwithnumerous...directors,officers,andkeymedicalandresearchpersonnel,weresuedfor alleged securities fraud. While the number of securities fraud lawsuits against life sciences companiesin2008remainedfairlyconstant...comparedto2007,thenatureoftheclaimsdiffereddramatically.In2008,themajorityofthe...lawsuitsfocusednotonpublicstatementsregardingtheprospectsforFDAapproval,productefficacy,orproductsafetyastheydidin2007...,butratheronthecompany’sfinancialinformation—particularlyallegationsofaccountingmistakes,improperly prepared financial statements, andmisleading information regarding a company’sfinancial health.”), available at http://www.dechert.com/library/Survey_of_Securities_Fraud_CA_4-09.pdf. See also, e.g.,Sidley&Austin,LLP,Products Liability Update: Emerging Trend in Pharmaceutical Litigation: Putative Class Actions Brought Under the Racketeer Influenced and Corrupt Organizations Act (Jan. 27, 2009),available at http://www.sidley.com/products_liability_update012709/ (“The plaintiffs’ bar is increasingly bringing putative class actionsagainstpharmaceuticalcompaniesundertheRacketeerInfluencedandCorruptOrganizationsAct(‘RICO’),whichprovidesfortrebledamages....[A]numberofelements[are]requiredtostateaviableclaimunderthecivilRICOstatutethatarenotapparentfromthestatutorylanguage...but...[from]yearsofcaselawdevelopmentinmultiplejurisdictionsandwhichareoftencomplexinnature.Asaresult,theseclaimspresentuniquechallengesforplaintiffsattemptingtostatea

Ch. 12.VII.


videsplaintiffswithgreatleverageoverdefendantstosettleonfavorableterms.Courtsandlitigantsdevoteconsiderableattentiontotheclasscertificationissuebecauseofitsimportanceinthesecases.Surprisinglystrongreasonsexistwhynamed defendants likely will settle if class certification is granted.As ablyexplainedinadraftpaper,theexistenceofinsurancecoverageprovidesstrongincentivesfornamedindividualand corporate defendants to settle.717

[O]fficersanddirectorsfacefinancialruinifthejudgeorjuryrulesagainstthemattrial.Potentialdamages...aregenerallygreaterthanthepersonalwealthofeventherichestCEOs.Thecompanycanalsofaceadevastatingblow...[if]itpaysthedamageawardaftertrial.Moreover,litigationexpensesinsecuritiesclassactionsare high. A case that goes to trial can cost between $10 and $20 million . . . .

[Other]...factorsuniquetosecuritiesclassactions...createpressuretosettle....[A]companyisgenerallyobligatedtoindemnifyitsofficersanddirectorsforcoststheyincurinconnectionwiththesesuits,includinglitigationexpensesandamountspaidinsettlement,so long as an officer has acted in “good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation.”Fromanofficer’sordirector’spointofview,settlementisessential.Ifacasegoestotrialandtheofficersordirectorslose,thereisarealdangerthatevidencewillhaveemergedsuggestingthattheytheirconductdidnotmeetthe“goodfaith”requirementforindemnification.[But]...ifthecasesettles,the[y]...willbeindemnified.Thus,fromtheofficers’anddirectors’perspectivethereisnocostentailedinasettlement,andapotentiallydevastatingcostentailedingoingtotrial.

Fromthecompany’sperspective,theD&Oinsurancepolicycreatessimilar. . .incentives.Theinsurer[must]...reimbursethecompanyforamountsitpaystoindemnifyitsofficersanddirectors, for thecompany’sownlitigationexpenses,and for amounts paid to settle a case. The policy excludes . . . losses arising out of “deliberately fraudulent” conduct . . . only if there has been a “final adjudication” of the underlying lawsuit that supports a finding that such conduct occurred. At least inaSection10(b)suit,wheretheplaintiffmustprovethatadefendantcommittedthemisstatementintentionallyorwithahighdegreeofrecklessness,alossattrialislikelytoprovidegroundsfortheinsurertodenycoverageunderthepolicy.Thus,ifacasegoestotrial,thecompanyriskslosingitsD&Ocoverage.Ontheotherhand,ifthecompanysettles,ithasastrongerbasisforkeepingitsinsuranceprotection.718

In re Schering-Plough Corp. Intron Tedomar Consumer Class Action719 focusedonaputativeclassactioncomplaintthatalleged,amongothertheories,RICOviolations.TheplaintiffsclaimedthatSchering-Ploughhadengagedinan

claimandsignificantopportunitiesforpharmaceuticalcompaniestosuccessfullydefendagainstthese claims at the critical pleading stage. The RICO cases . . . against . . . the pharmaceutical industrygenerallyfallintothreebroadcategories:(1)casesonbehalfofthirdpartypayorsandconsumer-purchaserswhopaidforadrugormedicaldeviceprescribedforanoff-labeluse;(2)product liability cases on behalf of consumerswho purchased an allegedly defective drug ormedicaldevice;and(3)casesonbehalfofthirdpartypayorsandconsumer-purchasersallegingthatmisrepresentations by the defendant caused the price for a drug ormedical device to beartificiallyinflated.”).

717See Michael D. Klausner, Are Securities Class Actions “Supplemental” to SEC Enforcement: An Empirical Analysis, CELS 2009 4thAnnual Conf. on Empirical LegalStudies Paper(preliminarydraft)(July13,2009),available at http://ssrn.com/abstract=1433577.

718Id. at 12–13 (internal notes omitted) (emphasis supplied).719No.206-CV-5774(SRC),2009WL2043604(D.N.J.July10,2009)(unpublished).

Ch. 12.VII.A.


illegal, off-label, marketing scheme involving its patented drugs Intron-A,PEG-Intron,Rebetol, andTemodar,whichharmed themandothers similarlysituated.Rather thanclaiming they sufferedharmas investors, as is farmorecommoninsuchcases,theplaintiffsallegedtheyhadtopayaninflatedpricefordrugstheywouldnothavepurchasedbutforthescheme.720 Their suit followed anadministrativeandcriminalprosecutionagainstthecompanyinwhichapartofthecompany(ScheringSales)pledguiltytocriminalconspiracyformakingfalsestatementstothegovernmentinrelationtotheFDA’sinvestigationofthealleged off-label marketing of Intron A and Temodar.721 The plaintiffs alleged that notonlyhadthedefendantssoughttomarketthesedrugsillegallyforunapproveduses(therebydrivingupthedrugs’prices),buttheyalsoomittedormisrepresentedinformationaboutthedrugs’useandefficacy.722

The results were a bit of a mixed bag for the plaintiffs in In re Pfizer, Inc., Securities Litigation,723 which resulted in a court order that granted and denied inpartthedismissaloftheirsuitfiledagainstthepharmaceuticalmanufacturerand certain executives for allegedlymakingmaterially false andmisleadingstatementsandconcealingbadresultsfromcertaindrugstudiesinordertoprofitpersonally.Theindividualdefendantswereformerhigh-rankingexecutivesofPfizerwho,theplaintiffsclaimed,wereprivytoconfidentialcompanyinforma-tion and took part in reviewing, approving, and disclosing Pfizer’s financialstatements to the public.724Inparticular, theyclaimedthedefendants“violatedfederalandstatelawsbyconcealingtheresultsofthreemedicalstudiesconcern-ing twoPfizerdrugs,CelebrexandBextra, andbymakingmisstatementsandomissionsintheirpublicfilingsandstatements.”725AndtheydidsobecausemanyofPfizer’sbestsellingdrugswerecomingoffpatentanditssuccessdependedonCelebrexandBextra’sbecomingblockbusterdrugs.726 As to some of the com-plaint’s allegations of securities fraud, the court found the allegations weresufficienttosurvivethemotiontodismissandthestrictpleadingrequirementsfor fraud under Rule 9(b) of the Federal Rules of Civil Procedure and thePSLRA,explaining:

[Thecomplaint]allegessufficientlythatthethreestudiesrevealedthatCelebrexandBextrawerelinkedtoadversecardiovasculareventstoastatisticallysignifi-cantdegree,andthattheseresultswereknowntoDefendants.[It]...alsoallegessufficientlythatDefendantskneworhadaccesstoinformationshowingthattheirpublicstatementswereinaccurate.GiventheallegedimportanceofCelebrexandBextratoPfizer’soveralleconomichealth,aswellasthefallinPfizer’sstockper-formance,theCCAC’sallegationsaresufficienttoplausiblystateaclaimunderSection 10(b) and Rule 10b-5.727

720Id. at *1.721See id.at*2(citingAmendedJudgment,UnitedStatesv.ScheringSalesCorp.,06-CR-

10250(D.Mass.Feb.7,2007)).722Id. at *3.723584F.Supp.2d621(S.D.N.Y.2008).724Id. at 628.725Id. at 627.726Id. at 628.727Id. at 632.

Ch. 12.VII.A.


Theplaintiffsinasecuritiesfraudclassactionfiledagainstamedicaldevicemanufacturer fared better. As reported in In re Boston Scientific Corp. Securities Litigation,728classactioncertificationwasgrantedagainstBostonScientific,themanufacturerofadrug-coatedcoronarystent,andcertainofitsexecutivesforallegedlymakingfalsestatementstoartificiallyinflatethecompany’sstock.729 Thisclassaction,consolidatedfromseveralseparatelyfiledcasesintoonecom-plaint, was remanded to a new federal district judge after the First Circuitreversedthedismissalofallegationsandreassignedthematter.730 The amended complaintallegedthatBostonScientificCorporationandtheexecutivesknow-inglywithheldmaterialinformationfromthepublicandmademisleadingstate-mentsaboutamedicalproduct(stents)thatwasrecalled,whichhadartificiallyinflated thepriceof the company’s securities to thebenefitof the individualdefendantsatthedetrimentofinvestors.731

Similarly,theplaintiffsinIn re Bristol-Myers Squibb Co. Securities Liti-gation732 avoided dismissal of their suit that challenged the adequacy of thecompany’sdisclosuresabout its settlementofpatent litigationwithagenericcompany which, they alleged, caused its stock to decline. This class actiondevelopedasaresultofapatentinfringementsettlementbetweenBristol-MyersSquibb(BMS)andApotex,Inc.,agenericmanufacturer,overBMS’sprofitableblood-thinning medication, Plavix. The plaintiffs claimed that the materialdetailsofthatsettlementwerenotproperlyoradequatelydisclosed.733 In partic-ular, they alleged thatBMSdidnot disclose in settling that it had agreed torelinquish certain material legal rights and had entered into oral side agreements withApotex—whichnotonlymadeBMS’spublicstatementsthatitwouldvig-orouslypursuethemattermateriallyfalse,incomplete,andmisleading,butalsoincreasedtheriskofregulatoryrejectionofthesettlementagreement(whichalsowasnottimelyreported).734Thecourt’sopinionsetoutthechronologyofBMS’sannouncementsaboutitssettlementwiththevariousnecessaryregulators,thesubsequent searchwarrant thatwas executed at its offices, the opening of acriminalprobe,andtheterminationofitsCEO—whopleadedguiltytomakingfalsestatementstothegovernmentconcerningtheamendedsettlementagree-ment.735Thejudgefoundthatomittingthesefactsfromthecompany’spublicannouncementswasmaterial,notwithstandingthecompany’scautionsthatthesettlementagreementhadtobeapprovedbyvariousregulators,explaining:

Bristol-Myersdidnotdisclose...thetermsoftheinitialandrevisedsettlementagreements,andtheinitialregulatorydisapprovalbythestateattorneysgeneral....

728604 F. Supp. 2d 275 (D. Mass. 2009).729Thejudgefoundthattheplaintiffswereentitledtocertificationbecausetheyhadraised

colorableargumentsabouttheleadplaintiff’sabilitytorelyuponthefraud-on-the-markettheoryand establish loss causation. Id. at 287.

730Id.at279(citingMississippiPub.Employees’Ret.Sys.v.BostonScientificCorp.,523F.3d75(1stCir.2008),andIn re BostonScientificCorp.Sec.Litig.,490F.Supp.2d142(D.Mass.2007),rev’d byMississippiPub.Emps.Ret.Sys.v.BostonSci.Corp.,523F.3d75(1stCir.2008)).

731Id. at 276.732586F.Supp.2d148(S.D.N.Y.2008).733Id. at 151.734Id.735Id. at 153–57.

Ch. 12.VII.A.


Plaintiffshaveplausiblypleaded thatBristol-Myers’s statementswere renderedmisleadingbythefailuretoincluderelevantinformationaboutthenatureofthesettlementnegotiationsandthetermsofthesettlementagreement....[A]reasonableinvestorwouldhaveconsideredtheundisclosedinformationmaterialinmakinginvestmentdecisions.736

InadditiontothePSLRA’sheightenedpleadingstandardsthatprivateliti-gants must overcome to recover in securities fraud actions, Supreme Courtdecisions addressing such issues737appeartohavecontributedtothedeclineinthenumberofthesecasesbeingfiled,asdifferentstudiesreveal.738 A notable exceptionistheCourt’sdecisioninMerck & Co., Inc. v. Reynolds,739 which held that the applicable statute of limitations for these suits necessarily requiresdeterminingwhena reasonablydiligentplaintiffwouldhavediscovered evi-dence of scienter because it is an essential element for the cause of action. At issueonappealwasthetimelinessofthecomplaintfiledinthisprivatesecuritiesfraudactionundertheapplicablestatuteoflimitationswhich,inrelevantpart,providesthatacomplaint is timely“iffilednomorethantwoyearsafter theplaintiffs‘discover[ed]thefactsconstitutingtheviolation.’”740 Merck had been

736Id. at 161.737See, e.g., Daniel M. Perry, A New Battleground: Class Certification Trends in

Securities Class Actions, in Recent Developments in Securities Law: Leading LawyersonUnderstandingRecentDecisions,NavigatingNewSECInitiatives,andEstablishingCompliance Policies (Aspatore 2010), available at http://www.milbank.com/images/content/1/0/1041/Aspatore-Inside-the-Minds-DPerry-chapter-reprint-0610.pdf (“Because of theheightenedpleading standards imposedby the . . . [PSLRA] and theSupremeCourt’s recentfocus on pleading standards in Bell Atl. Corp. v. Twombly,550U.S.544(2007),Tellabs Inc. v. Makor Issues & Rights,551U.S.308(2007),andAshcroft v. Iqbal,[556U.S.662](2009),manydefendantsviewthemotiontodismissasthecriticalstageinasecuritiesclassaction.Butwiththenewtrendinmeritsinquiriesattheclasscertificationstage,includingawillingnessonthepartofmanycourtstobifurcateclassandmeritsdiscovery,defendantsareincreasinglyabletoexertsubstantialleverageevenfollowingalossonamotiontodismiss.Asaresult,theclasscertificationinquiryisnowbecomingarigorousandincreasinglychallengingburdenforplaintiffs....”)(pagereferencesnotavailable).

738See, e.g., JordanMiley et al., Trends 2010 Mid-Year Study: Filings Decline as the Wave of Credit Crisis Cases Subsides, Median Settlement at Record High, NERA (July 27,2010)(observing,interalia,that“[t]hepaceoffederalsecuritiesclassactionfilingswasslowerin thefirsthalfof2010 than in2009,withfilingson track todecline fora secondsuccessiveyear from their 2008 peak. The pace of credit crisis-related filings from January to June ofthisyearslowedtoaboutthreepermonthonaverage,lessthanhalftherateobservedin2008and the first half of 2009.”);Advisen, Securities Litigation review Q2 2010: SecuritiesLitigation Surges Following a Quiet First Quarter (July 2010), available at http:// corner.advisen.com/reports_topical_sec_lit_q12010.html(observing,interalia,that“[s]ecuritiesclass action suits comprised almost half of all securities lawsuits before 2006, but have beensteadilytrendingdownwardsasapercentageofsecuritiessuitsfiled,fallingto23percentofallsecuritiessuitsin2009and19percentofthetotalthroughthefirsthalfof2010”);CornerstoneResearch, Securities ClassAction Filings: 2010Mid-YearAssessment (July 2010), available at http://securities.stanford.edu/clearinghouse_research/2010_YIR/Cornerstone_Research_Filings_2010_Mid_Year_Assessment.pdf(noting,interalia,that“[f]ederalsecuritiesfraudclassactionfilingactivitydecreasedinthefirstsixmonthsof2010,confirmingatrendthatstartedinearly2000.Inthefirsthalfof2010,thenumberoffederalsecuritiesclassactionfilings...felltothelowestsemiannuallevelsincethefirsthalfof2007.”).

739130 S. Ct. 1784 (2010).740Id. at1789–90(quoting28U.S.C.§1658(b)(1)).

Ch. 12.VII.A.


suedbyaninvestors’groupthatallegedthatthecompanyhadknowinglymis-representedtherisksassociatedwithVioxx,whichledtosubstantialeconomiclosses when such risks became known.741AstheCourt’sopinionexplains:

Thecomplaint . . .wasfiledonNovember6,2003. . .withinfiveyearsoftheallegedviolation.Therefore,thecriticaldatefortimelinesspurposesisNovember6,2001—twoyearsbeforethiscomplaintwasfiled.Merckclaimsthatbeforethisdatetheplaintiffshad(orshouldhave)discoveredthe“factsconstitutingthevio-lation.”Ifso,bythetimetheplaintiffsfiledtheircomplaint,the2-yearstatutoryperiodin§1658(b)(1)hadrun.Theplaintiffsreplythattheyhadnot,andcouldnothave,discoveredbythecriticaldatethose“facts,”particularlynotthefactsrelatedtoscienter,andthattheircomplaintwasthereforetimely.742

Inreachingitsholding,theCourtexplainedthatscienterinaSection10(b)actionreferstoamentalstateembracingtheintenttodeceive,manipulate,ordefraud(citing Ernst & Ernst v. Hochfelder743), which is a fact that a plaintiffmustestablishtoprovethatadefendantmadeamaterialmisstatementwithanintenttodeceive(citingTellabs, Inc. v. Makor Issues & Rights, Ltd.744),and,further,thatthePSLRArequiresplaintiffsto“statewithparticularityfactsgivingrisetoa strong inference that the defendant acted with the required state of mind.”745

In2010,theCourtlimitedtheavailabilityofsecuritiesactionsfortransac-tionsbroughtbyforeignerswhopurchasedsecuritiesonnondomesticexchanges.Althoughthatdecision,Morrison v. National Australia Bank,746didnotinvolvea life sciences company, it made clear that “Section 10(b) of the SecuritiesExchangeAct...doesnotprovideacauseofactiontoforeignerswhosuefor-eign and American defendants for fraud relating to securities trading on a foreign exchange.” Henceforth, a Section 10(b) claimmay only be asserted if “thepurchaseorsaleismadeintheUnitedStates,orinvolvesasecuritylistedonadomestic exchange.”747

Foravarietyofreasons,inseveralcasesinvolvingthelifesciencesindus-try,courtshavedismissedsecuritiesfraudclassactioncomplaintsseekingtoholddefendantsaccountablefornottimelyorproperlydisclosingadverseinformationtotheinvestingpublic.Forinstance,inFanon v. Guidant Corp.,748theSeventhCircuitaffirmedthedismissalofaclassactioncomplaintthatallegedthateventhoughthemedicaldevicemanufacturerknewithaddefectiveproducts,itchosetomakefalseormisleadingstatementsabouttheproducts(andthecompany’spending merger), and the individual defendants sold almost $114 million inGuidant’s stock during the alleged time period.749 In particular, the plaintiffsclaimedthatGuidantandtheindividualdefendantsmadefalseandmisleadingstatementsandomittedmaterialinformationaboutthesafetyofitsdefibrillatorsand a proposed merger with Johnson & Johnson—which information, when

741Id. at 1790.742Id.743425U.S.185,194,n.12(1976).744551U.S.308,319(2007).745Merck & Co., Inc.,130S.Ct.at1796(citing15U.S.C.§78u-4(b)(2)).746130 S. Ct. 2869 (2010).747Id. at 2888.748583 F.3d 995 (7th Cir. 2009).749Id. at 997–98.

Ch. 12.VII.A.


discoveredby thepublic,caused thecompany’sstockprice toplummetabout$3billioninvalue(whereastheapprovaloftheJ&Jmergercausedtheindividuals’stockoptionstovest).750But,astheappealscourtnoted,theplaintiffs’casesuf-feredfromtwoobstacles:TheyfailedtomeettheheightenedpleadingstandardsrequiredbythePSLRAforcomplaintsraisingclaimsunderSections10(b)and20(a)oftheSecuritiesExchangeAct;andtheyhadmadeastrategicchoicenot to introducenewevidencebeforethejudgeruledonGuidant’smotiontodismiss,whichtacticaldecisionforeclosedhavingtheissueconsideredonappeal.751

VIII. SEC Enforcement

Asthispartofthechapterillustrates,civillawsuitsarenottheonlydanger(andnotnecessarily themajordanger) facedbypublicly traded life sciencesentities.ThesecompaniessometimesmustdealwithadministrativeactionsforallegedsecuritieslawviolationsfiledbytheCommission.Notably,inthesecasesthegovernmentisnotsubjecttotheheightenedpleadingstandardsimposedbythePLSRA.TheSECbasicallyaddressessecuritiesviolationsinseveralways,including“‘administrativehearings,civilactions,[and,throughreferralstotheU.S.DepartmentofJustice,]broadcriminalprosecutions.’”752 In Section 21(a) oftheExchangeAct,CongressprovidedconsiderablediscretiontotheCommis-siontoinvestigatepossibleviolationsofthefederalsecuritieslawsandtherulesand regulations adopted to effectuate these laws:

Section21(a)furtherauthorizestheCommissiontoinvestigateanyfacts,conditions,practices,ormatterswhichitmaydeemnecessaryorpropertoaid in the enforce-ment of such provisions,intheprescribingofrulesandregulationsunderthe...ExchangeAct,orinsecuringinformationtoserveasabasisforrecommendingfurther legislation.753

“Usually,theSECstaff...conductsapreliminaryinquiry...[beforeissuing]aformalorderofinvestigationbytheCommission.Thisinformalinquirycanincludeinterviewingofwitnesses,examinationofbrokeragerecordsandotherdocuments,andreviewingtradingdata.”754

750Id. at 1000.751Id. at 1003.752MichaelE.Clark,The Growing Importance of Securities Regulation for Publicly Traded

Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update §5.01(internalnoteomittedcitingPaulMarkus,The Use of Criminal Statutes to Regulate Finan-cial Markets in the United States, 46 Am. J. Comp.L.589,598(1998Supp.)).

753RalphC.Ferrara&PhilipS.Khinda,Overview of an SEC Proceeding, 30th Annual Institute on Securities Regulation, 1085 PLI/Corp. 597, 610 (1998) (emphasis added).Sections8(e)and20(a)oftheSecuritiesActarecompanionprovisionstoSection21(a)oftheExchange Act. Id.

754J. WilliamHicks,7BExempted Transactions Underthe Securities Act of 1933 §16:7(Investigations—Procedures)(looseleaf).See also17C.F.R.§202.5(Enforcementactivi-ties),whichprovides,inrelevantpart:

(a)Where . . . it appears that theremaybeviolationof the acts administeredby theCommissionortherulesorregulationsthereunder,apreliminaryinvestigationisgenerallymade.Insuchpreliminaryinvestigationnoprocessisissuedortestimonycompelled.TheCommissionmay...makesuchformalinvestigationsandauthorizetheuseofprocessas

Ch. 12.VII.A.


Sections 21C(a) of the Exchange Act755 and 8A of the Securities Act756 set outtheCommission’sauthoritytoinvestigateviolations,pursueinjunctionpro-

itdeemsnecessarytodeterminewhetheranypersonhasviolated,isviolating,orisabouttoviolate...thefederalsecuritieslawsortherulesofaself-regulatoryorganizationofwhichthepersonisamemberorparticipant.UnlessotherwiseorderedbytheCommission,theinvestigationorexaminationisnonpublicandthereportsthereonareforstaffandCom-missionuseonly.(b)AfterinvestigationorotherwisetheCommissionmay...takeoneormoreofthe

followingactions: Institutionofadministrativeproceedings looking to the impositionofremedialsanctions, initiationof injunctiveproceedings in thecourts,and, in thecaseofawillfulviolation,referenceofthemattertothe...[DOJ]forcriminalprosecution.TheCommissionmayalso,onsomeoccasions,referthematterto,orgrantrequestsforaccesstoitsfilesmadeby...self-regulatoryorganizations...andotherpersonsorentities.755Section21C(a)oftheExchangeAct,codifiedat15U.S.C.§78u(a)(1)(Investigationsand

Actions),provides,inrelevantpart:TheCommissionmay...makesuchinvestigationsas...necessarytodeterminewhether

anypersonhasviolated,isviolating,orisabouttoviolateanyprovisionofthischapter,therulesorregulationsthereunder,therulesofanationalsecuritiesexchangeorregisteredsecu-ritiesassociationofwhichsuchpersonisamemberorapersonassociatedwithamember,therulesofaregisteredclearingagencyinwhichsuchpersonisaparticipant,therulesofthePublicCompanyAccountingOversightBoard,ofwhichsuchpersonisaregisteredpublicaccountingfirmorapersonassociatedwithsuchafirm...andmayrequireorpermitanypersontofilewithitastatementinwriting,underoathorotherwiseastheCommissionshalldetermine,astoallthefactsandcircumstancesconcerningthemattertobeinvestigated.TheCommissionisauthorized...topublishinformationconcerninganysuchviolations,andtoinvestigateanyfacts,conditions,practices,ormatters...necessaryorpropertoaidintheenforcementofsuchprovisions,intheprescribingofrulesandregulationsunderthischapter,orinsecuringinformationtoserveasabasisforrecommendingfurtherlegislationconcerning the matters to which this chapter relates.756Section8AoftheSecuritiesAct,codifiedat15U.S.C.§77h–1,provides,inrelevantpart:(a)AuthorityofCommissionIf theCommissionfinds, after notice andopportunity for hearing, that anyperson is

violating,hasviolated,orisabouttoviolateanyprovisionofthissubchapter,oranyruleorregulationthereunder,theCommissionmaypublishitsfindingsandenteranorderrequiringsuchperson,andanyotherpersonthatis,was,orwouldbeacauseoftheviolation,duetoanactoromissionthepersonkneworshouldhaveknownwouldcontributetosuchviolation,toceaseanddesistfromcommittingorcausingsuchviolationandanyfutureviolationofthesameprovision,rule,orregulation.Suchordermay,inadditiontorequiringapersontoceaseanddesistfromcommittingorcausingaviolation,requiresuchpersontocomply,ortotakestepstoeffectcompliance,withsuchprovision,rule,orregulation,uponsuchtermsandconditionsandwithinsuchtimeastheCommissionmayspecifyinsuchorder.Anysuchordermay,astheCommissiondeemsappropriate,requirefuturecomplianceorstepstoeffectfuturecompliance,eitherpermanentlyorforsuchperiodoftimeastheCommissionmayspecify,withsuchprovision,rule,orregulationwithrespecttoanysecurity,anyissuer,oranyotherperson.

* * *(f)(Cease-and-desistproceedings)provides,inrelevantpart,that:Inanycease-and-desistproceedingundersubsection(a)ofthissection,theCommission

may issueanorder toprohibit,conditionallyorunconditionally,andpermanentlyor forsuchperiodoftimeasitshalldetermine,anypersonwhohasviolatedsection77q(a)(1)ofthistitleortherulesorregulationsthereunder,fromactingasanofficerordirectorofanyissuerthathasaclassofsecuritiesregistered...orthatisrequiredtofilereportspursuanttosection78o(d)ofthistitle,if the conduct of that person demonstrates unfitness to serve as an officer or director of any such issuer.

(Emphasis added).

Ch. 12.VIII.


ceedingstoprohibitpersonsfromservingasofficersanddirectors,initiatecease-and-desistproceedings,andimposemoneypenaltiesincivilactions.Oneofthecritical events that may develop during an SEC investigation is commonlyknownasa“Wellsnotice,”aninformalCommissionpracticeofprovidingnoticetoanissuerorindividualsandofferingthemanopportunitytopersuadetheSECstaffwhytheactionshouldnotbepursued.757

Ingeneral,becausegovernmentalagencieshavegreattacticaladvantagesinenforcementactionsovercompaniesor individualschargedasdefendants,caseswherecourtsruleagainstthegovernmentareworthreviewing.Adecisioninvolving an executive of a pharmaceuticalmanufacturer inwhich the courtgranted some relief is Securities & Exchange Commission v. Reys.758There,thejudge dismissed part of a securities fraud complaint for not being specificenough.TheCommission’scomplaintagainstReys,thechairmanandCEOofCellCyteGeneticsCorporation,allegedviolationsofSection10(b)oftheSecu-ritiesExchangeActandRule10b-5,amongotherprovisions.759Inparticular,theCommissionclaimed thatReyshad repeatedlymisled thepublic aboutCell-Cyte’skeyproduct,astemcelltherapytotreatandrepairdamagedorgans,bymaking a series of misstatements and omissions.760 Reys, in turn,moved todismissthecomplaintunderFederalRulesofCivilProcedure8,9(b),and12(b)(6)for lackingspecificityandnotstatingaclaimuponwhichreliefcouldbegrantedbecausetheallegedstatementsareimmaterialornotactionable,andthescienter assertions are not plausible.761

Notably,thejudgeobservedthatalthoughReysclaimedthatthetruth-on-the-marketcorollarytothefraud-on-the-markettheoryappliedtotheallega-tions faulting him for making misleading public statements regarding the productandINDapplications(whennonehadbeenfiled),thejudgefoundthatthedoctrineisnotavailableinenforcementproceedingsbytheCommission.762 Moreover,thejudgefoundthattherewasadisputeaboutwhetherthe“bespeakscaution” doctrine applies to Commission actions—but the issue did not need tobereachedbecausethecautionarystatementsgivenappearedtobeboiler-plate,andnottailoredtothespecificfutureprojectioninquestion.763

757SeeFerrara&Khinda,at632–35.See also17C.F.R.§202.5(c);ProceduresRelatingtotheCommencementofEnforcementProceedingsandTerminationofStaffInvestigations,SecuritiesActReleaseNo.5310(Sept.27,1972).

758No.C09-1262RSM,2010U.S.Dist.LEXIS41836(W.D.Wash.Apr.28,2010).759Id. at *1–2.760Id. at *5.761Id. at *1–2.762See id. at *11–12. (“It is probably correct that a truth-on-the-market defense is not

availableatthepleadingsstage,seeAsher v. Baxter Intern. Inc.,377F.3d727,735(7thCir.2004),andinanycaseReyshascitednopublishedin-circuitcase...thatthe...doctrineappliestoanSECenforcementactionasopposedtoaprivatesecuritiesactionbasedatheoryof‘fraudonthemarket.’See In reConvergentTechs.Sec.Litig.,948F.2d507,513(9thCir.1991)[superseded by statute as stated in In reHarmonicInc.Secs.Litig.,163F.Supp.2d1079,1093(N.D.Cal.2001)].”).

763Id.

Ch. 12.VIII.


A. Administrative Proceedings

“The SEC’s primary enforcement actions include injunctive actions,actions for civil penalties, cease-and-desist orders, stop order proceedings,administrativeproceedingsagainstsecuritiesprofessionals,administrativepro-ceedingspursuanttoSection15(c)(4)ofthe...ExchangeAct,andadministra-tive proceedings against professionals pursuant toRule 102(e) of the SEC’sRules of Practice.”764TheCommissionhaspursuedseveralenforcementactionsinrecentyearsagainstpharmaceuticalmanufacturersandmedicaldevicecom-paniesandindividualsworkingwiththem.Afewofthesecasesaredescribedbelow.

In SEC v. Elan Corp., plc,765asettlementwasreachedwithElanCorp.,aforeignpharmaceuticalmanufacturerheadquarteredinIreland,toresolvealle-gationsthatitviolatedtheantifraudlawsbynotdisclosingmaterialinformationinperiodicreportsandquarterlypressreleasesdisseminatedtoinvestorsinthiscountry.766AlthoughElanCorporationdidnotadmitordenytheallegationsinthecomplaint,itconsentedtoafinaljudgmentthatpermanentlyenjoineditfromviolatingtheantifraudprovisionsofthefederalsecuritieslaws,aswellasthereporting and internal controls provisions of the ExchangeAct, and to pay$1millionindisgorgementanda$15millioncivilpenaltytobedistributedtoinvestorsharmedbytheallegedviolations.767

Similarly, in SEC v. Bristol-Myers Squibb Co.,768 the Commission announcedthesettlementofanenforcementactionfiledagainstBristol-MyersSquibb for having engaged in a fraudulent scheme to overstate its sales andearnings to create the false appearance that it hadmetor exceededfinancialprojectionssetbycompanyofficersandearningsestimatesestablishedbysecu-ritiesanalysts.BristolMyerSquibb’sschemeinvolvedchannelstuffingitsdis-tributionchannelswithexcessinventoryneartheendofeveryquartertomeetsales and earnings targets and improperly recognizing about $1.5 billion inrevenue from consignment-like sales associatedwith the channel stuffing inviolationofGAAP.769

In SEC v. Derrick S. McKinley,770theCommissionsummarizedtheinsidertradingallegationsofthecomplaintagainstaformervicepresidentandmedicaldirectorofGliatech,adomesticpharmaceuticalmanufacturer:

McKinleysoldGliatechstockwhile...possessing...material,non-publicinfor-mationconcerningproblemswithGliatech’sprimaryproduct . . .agelused to

764RalphC.Ferrara&PhilipS.Khinda,Overview of an SEC Proceeding, 30th Annual Instituteon Securities Regulation,1085PLI/Corp. 636 (1998).

765Litig. Rel. No. 19066 (Feb. 8, 2005), available at http://www.sec.gov/litigation/litre-leases/lr19066.htm.

766See LindaC.Thomsen,DeputyDirector, SECDivision ofEnforcement,Recent SEC Enforcement Cases 2–3(Feb.16,2005)MaterialsforPLIConference(Aug.28,2005).

767See Litig. Rel. No. 19066.768Litig.Rel.No.18820(D.N.J.Aug.4,2004),available athttp://www.sec.gov/litigation/

litreleases/lr18820.htm.769See id.770Litig.Rel.No.18832(N.D.OhiofiledAug.12,2004),available athttp://www.sec.gov/

litigation/litreleases/lr18832.htm.

Ch. 12.VIII.A.


reducescarringinpatientsfollowingbacksurgery.Duringatwelve-monthperiod...[he]soldshort221,000sharesofGliatechstock...reaping...approximately$1.6 million.771

An enforcement action was brought against a husband and wife in David Blech and Margaret Chassman for manipulating the stock of different biophar-maceutical companies.772AccordingtotheSEC,afterBlechwasexpelledfromthebrokerageindustryforbeingconvictedofsecuritiesfraud,hesetupover50brokerageaccountsinthenamesoffamilymembers,friends,andaprivatereli-giousinstitution.Hethenusedtheaccountstotradesignificantamountsofstockintwobiopharmaceuticalcompanies(PluristemTherapeutics,Inc.,andIntellectNeurosciences, Inc.) tocreate theappearanceofactivity in theirsecurities inordertomaintaintheirmarketpriceanduseittohisownfinancialadvantage.Blechalsoallegedlysolicitedinvestmentsforbiopharmaceuticalcompanies—including the two companies whose stock he manipulated—despite being barred bytheSECfromactingasabroker-dealer.TheCommissionalsochargedhiswife,MargaretChassman.Inaparallelaction,theU.S.Attorney’sOfficefortheSouthern District of NewYork announced criminal charges had been filedagainst Blech for engaging in deceptive activities and carrying outmatchedtradesinPluristem’sandIntellect’sstocks,sellingoffhisholdingsofPluristemandIntellectthroughnomineeaccounts,andusingthemascollateralforalineofcreditestablishedinhiswife’sname.

TheSECsufferedanotabledefeatinacaseworthmentioning,althoughnotinvolvingactionsofapharmaceuticalcompanyoritsemployees.Asoutlinedbythedistrictjudge’sopinioninSecurities & Exchange Commission v. Paster-nak,773 the decision followed a bench trial in which the SEC sought to establish civilsecuritiesfraudliabilityagainstKennethD.PasternakandJohnP.Leighton,who had been supervisors and senior executives ofKnight Securities, LP, aregisteredbroker-dealerfirm.PasternakwasKnight’sCEOandchairpersonoftheboardofdirectors;JohnLeightonheadedupitsinstitutionalsalesdesk.774 To explainwhythegovernmentfailedinitsattempttoestablishcivilfraud,thedistrictjudgeenteredlengthyfindingsoffactandconclusionsoflawfollowinga 15-day bench trial.The agency’s complaint focused onKnight’smarket-makingactivitiesandactionsbyJosephLeighton,aninstitutionalsalestraderwho is the brother of John Leighton. The judge explained that “the SECfocuseditsclaimsonforty-twotradesexecutedbyJosephin1999and2000onbehalfof‘buy-side’institutionalfirms,suchasmutualfundsandinvestmentadvisors”intheNASDAQstockmarket.775TheSECallegedviolationsofitsantifraud provisions under Section 10(b) of the ExchangeAct776 and Rule

771See id.772SeeSECLitig.Rel.No.22363(May10,2012).7732008WL2501355(D.N.J.June24,2008).774Id. at *1.775Id.77615U.S.C.§78j(b).

Ch. 12.VIII.A.


10b-5777 andunderSection17(a)of theSecuritiesAct,778 as well as control personliabilityagainstPasternakunderSection20(a)oftheExchangeAct.779

The SEC’s theory during trial had been fluid, but its core theoriesinvolved: (1) alleged “front-running” by Joseph Leighton (who, the SECalleged,wouldtakeapositioninanorderedinstitutionalsecuritybutthendelayitsexecution to takeadvantageoffluctuatingmarketconditions togenerateimproperprofits),(2)allegationsthatthedefendantsknewabouttheseactivi-ties or were reckless in not discovering them, and (3) allegations that thedefendantshadperpetuatedthisfraudbymisstatingtocustomersandthepublic“thatKnightprovided‘bestexecution’andfailingtodisclose‘themannerinwhich[Joseph]pricedexecutionstocustomers.’”780Atbottom,thejudgefoundthattheSEC’sproofandtheoriesfailed,explaining:

[T]heSECfailed toprovebyapreponderanceof theevidence thatDefendantsviolatedanyprovisionoftheSecuritiesActortheExchangeAct.Rather,theover-whelmingevidence indicates thatDefendants,JosephLeighton,andKnightdidnothingimproperinexecutingtheforty-twotradessingledoutbytheSEC.Byallaccounts,theproprietyofthemethodologyemployedtoearnprofitsonnot-heldinstitutionalordersisgaugedbyafactsandcircumstancesanalysis,requiringatrade-by-tradereview.Inthisinstance,theSECfailedtoprofferascintillaofevidenceastothefactsandcircumstancessurroundingatleastthirty-nineofthecomplained-oftrades.Furthermore,theCourtrejectstheSEC’sattempttomakeanunregulatedactofearningprofitsasecuritiesfraud.781

Thecourt’sopinioninSecurities & Exchange Commission v. Bear, Stearns & Co.,782althoughalsonotamatterinvolvingalifesciencescompany,isquiteunusual.Init,thejudgedescribedvariouslongstandingproblemsthat,forsev-eralyears,delayedthetransferof$79millioninfundsearmarkedforaggrievedinvestorsoffraudactiontotheU.S.Treasury.Tenseparateinvestmentbanks,includingBearStearns, hadagreed todisgorge substantialmonies andmakestructural reforms to compensate investors who were harmed by the undueinfluencethattheentitiesexertedovercaptiveresearchanalysts—whichcausedconflicts of interest and compromised the analysts’ objectivity about variousstockstheyreportedabout to theinvestmentcommunity.783 In noting that the difficultiesdevelopedbecausetheconsentordersweretoovagueabouthowtocompensateinvestorsfortheirlosses,thejudgeblamedtheSEC’slackofatten-tion to these details:

ThisCourtbelievedtheSEChadbroughtitsexpertisetobearontheissueatthetimethesettlementsweresubmittedforapprovalinOctober2003.ButthreeyearselapsedbeforetheSECacknowledgedthattheamountstheDefendantspaid,rep-resentingbothdisgorgementandpenalties,werenotnecessarilyconnectedtoanymeasureofinvestorlosses.(TranscriptdatedJuly17,2006at55–56.)HadtheSECrealizedthatearlier,severalexercisesinfutilitycouldhavebeenobviatedandthe

77717C.F.R.§240.10b-5.77815U.S.C.§77q(a).779Id.§§78o(c)(1),78q(a),78t(a);17C.F.R.§240.17a-3.780Pasternak,2008WL2501355,at*2.781Id. at *5.7822009WL1615831(S.D.N.Y.June10,2009).783Id. at *1.

Ch. 12.VIII.A.


currentpredicament—$75millionaccumulating interest at theFederalReserveBankofNewYorkwithnopayees—avoided.784

B. Three-Tier Monetary Penalties

Pursuant to 15 U.S.C. Section 78u(d)(3)(b)(i)–(iii), the Commission isauthorizedtoimposecivilmonetarypenaltiesunderoneofthreeprogressivelymoreonerouspenaltytiers.Underthisstatute,penaltiesaretobedeterminedbythe court based on the facts and circumstances. The three tiers are as follows:

1. First-tier penalties are not to exceed the greater of$5,000foranaturalperson,$50,000foranyotherperson,orthegrossamountofpecuniarygaintosuchdefendantasaresultoftheviolation.

2. Second-tierpenaltiesforeachviolationarenottoexceedthegreaterof$50,000foranaturalperson,$250,000foranyotherperson,orthegrossamountofpecuniarygaintosuchdefendantasaresultoftheviolationifitinvolvedfraud,deceit,manipulation,ordeliberateorrecklessdisregardofaregulatoryrequirement.

3. Third-tierpenaltiesarenottoexceedthegreaterof$100,000foranaturalperson,$500,000foranyotherperson,orthegrossamountofpecuniarygaintosuchdefendantasaresultoftheviolation,ifitinvolvedfraud,deceit,manipulation,ordeliberateorrecklessdisregardofaregulatoryrequirement;andifitdirectlyorindirectlyresultedinsubstantiallossesorcreatedasignificantriskofsubstantiallossestootherpersons.

C. Agency Civil Remedies

Anotable change in theCommission’s authorityprovidedbySarbanes-OxleyinvolvesitsnewandlowerstandardforobtaininglifetimebarordersondefendantsfoundtohaveviolatedtheantifraudprovisionsofeithertheSecuri-tiesAct or the ExchangeAct. Under the new standard, the SECmust onlydemonstratethattheperson’sconductdemonstratesunfitnesstoserveinordertoinstitutelifetimebarordersprohibitingthemfromservingasofficersordirec-tors of listed companies.785

D. Dodd-Frank Act Provisions

1. Whistleblower ProvisionsOnJuly21,2010,thefar-sweepingreformlegislationknownastheDodd-

Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)wassignedintolawbyPresidentObama.786Amongmanyotherthings,thisnewreformlegislationisdesignedtoincreasethevoluntaryreportingofsecu-rities and commodities violations by significantly enhancing whistleblower

784Id. at *9.785SeeJayneW.Barnard,Rule 10b-5 and the “Unfitness Question, 47 Ariz. L. Rev.9,10

(2005),discussingSecuritiesAct§20(e),codifiedat15U.S.C.§77t(e),andExchangeAct§21(d)(2),codifiedat15U.S.C.§78u(d)(2).

786Pub.L.No.111-203,124Stat.119(signedJuly21,2010).

Ch. 12.VIII.A.


rewards and protections. The whistleblower provisions are discussed nextbecausetheymayhaveasubstantialeffectonlarge,publiclytradedpharmaceu-ticalcompaniesandmedicaldevicemanufacturers.

TheAct’swhistleblowerprovisionsposenewdangerstopubliclytradedcompanies—including heightened Foreign Corrupt Practices Act risks and costly complianceburdens.Life sciences companies should carefully reviewtheirexistingcomplianceandgovernanceprogramsandimplementmorerobustcompliancemeasures.TheDodd-FrankAct’snew(andexpanded)whistleblowerprovisionsappearintwomainparts—Section922(relatedtotheU.S.Securitiesand Exchange Commission)787andSection748(relatedtotheU.S.CommodityFuturesTradingCommission(CFTC)).Bothprovisionsofferabountyofupto

787Section922oftheDodd-FrankActprovides,inrelevantpart:(a) In General—The Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) is amended

byinsertingaftersection21Ethefollowing:SEC.21F.SECURITIESWHISTLEBLOWERINCENTIVESANDPROTECTION.(a)Definitions—Inthissectionthefollowingdefinitionsshallapply:

(1)COVEREDJUDICIALORADMINISTRATIVEACTION—Theterm“coveredjudicialoradministrativeaction”meansanyjudicialoradministrativeactionbroughtbytheCommissionunderthesecuritieslawsthatresultsinmonetarysanctionsexceeding$1,000,000.(2)FUND—Theterm“Fund”meanstheSecuritiesandExchangeCommissionInves-

tor Protection Fund.(3) ORIGINAL INFORMATION—The term “original information” means informa-

tion that—(A)isderivedfromtheindependentknowledgeoranalysisofawhistleblower;(B) is not known to theCommission from any other source, unless thewhis-

tlebloweristheoriginalsourceoftheinformation;and(C)isnotexclusivelyderivedfromanallegationmadeinajudicialoradministra-

tivehearing,inagovernmentalreport,hearing,audit,orinvestigation,orfromthenewsmedia,unlessthewhistleblowerisasourceoftheinformation.(4)MONETARYSANCTIONS—Theterm“monetarysanctions,”whenusedwith

respecttoanyjudicialoradministrativeaction,means—(A) anymonies, including penalties, disgorgement, and interest, ordered to be

paid;and(B) anymonies deposited into a disgorgement fund or other fund pursuant to

section308(b)oftheSarbanes-OxleyActof2002(15U.S.C.7246(b)),asaresultofsuchactionoranysettlementofsuchaction.(5)RELATEDACTION—Theterm“relatedaction,”whenusedwithrespecttoany

judicialoradministrativeactionbroughtbytheCommissionunderthesecuritieslaws,meansanyjudicialoradministrativeactionbroughtbyanentitydescribedinsubclauses(I) through (IV) of subsection (h)(2)(D)(i) that is based upon the original information providedbyawhistleblowerpursuanttosubsection(a)thatledtothesuccessfulenforce-ment of the Commission action.(6) WHISTLEBLOWER—The term “whistleblower” means any individual who

provides,or2ormoreindividualsactingjointlywhoprovide,informationrelatingtoaviolationofthesecuritieslawstotheCommission,inamannerestablished,byruleorregulation,bytheCommission.(b) Awards—

(1)INGENERAL—Inanycoveredjudicialoradministrativeaction,orrelatedaction,theCommission,underregulationsprescribedbytheCommissionandsubjecttosub-section(c),shallpayanawardorawardsto1ormorewhistleblowerswhovoluntarilyprovidedoriginalinformationtotheCommissionthatledtothesuccessfulenforcementofthecoveredjudicialoradministrativeaction,orrelatedaction,inanaggregateamountequal to—

Ch. 12.VIII.D.1.


30percentofcollectedmonetarysanctionsover$1million recoveredby theSEC,theCFTC,theU.S.DepartmentofJustice,Self-RegulatoryOrganizations,and other regulators.788Congressrequiredthatthenecessaryrulestoimplementthesemeasuresbepromulgatedwithin270daysofenactment.789

UndertheDodd-FrankAct,awhistleblowerwhoprovidesoriginal infor-mation to the SEC or CFTC resulting in a successful enforcement action in whichmonetarysanctionsofmorethan$1millionareobtainedcanreceiveareward of 10 percent to 30 percent of funds collected as sanctions.790 The Dodd-FrankAct’s provisions are somewhat similar to the hugely successful FalseClaimsActwhistleblowerprovisions,whichtheDOJreportsledto$2.4billionbeingrecoveredin2009,andmorethan$24billionsince1986.791

Theplaintiffs’barthatnowhandlesquitamworkundertheFCAhasbegunusingthesewhistleblowerprovisions.Itshouldbeeasierforwhistleblowerstoseekbountiesunderthenewprovisions(ratherthanundertheFCA)because,unlikeunder thequi tamprovisions,Dodd-FrankActwhistleblowersarenotrequiredtofollowthesamecostlyandexactingstandards,includingfilinglaw-suitsinfederalcourtunderseal.Whistleblowersunderthesenewprovisionswillneitherhavetoincurthesubstantialfinancialburdensthatquitamrelatorsandtheir counsel do under the FCA, norwill they have tomeet the heightenedpleadingstandardsimposedbyFederalRuleofCivilProcedure9(b)(andappli-cable court opinions) for suits pleading fraud claims.792

TheAct’swhistleblowerprovisionsalsotakeeffectatatimewhentheDOJandSEChavealreadyincreasedresourcesdevotedtoForeignCorruptPracticesAct (FCPA)matters.TheSEChas added new, dedicatedFCPAenforcementunits,andtheDOJhasaddedprosecutorsandFBIagentsdevotedtothesemat-ters,whilefillingmorepositions.Inaddition,theSECisseekingasubstantialincrease for its budget and operations.

A related reason for the likely increase in FCPAmatters is that federalagencieshavebegunemployingextensiveundercovertechniquestoferretoutFCPAviolations.Inarecentlypublicizedmatter,undercoverlawenforcementtechniqueswereusedtouncoverallegedlywidespreadfraudandcorruptionthat

(A)notlessthan10percent,intotal,ofwhathasbeencollectedofthemonetarysanctionsimposedintheactionorrelatedactions;and(B)notmorethan30percent,intotal,ofwhathasbeencollectedofthemonetary

sanctions imposed in the action or related actions.Id.§922,124Stat.at1841.

788Id.§922,124Stat.at1842,and§748,124Stat.at1740–41.789Id.§924,124Stat.at1850,and§748,124Stat.at1746.790Afewcategoriesof individuals are excludedby theDodd-FrankAct fromqualifying

forthenewbountyhunterprovisions:individualswhoworkfortheSECorCFTC,auditorswhoconductarequiredauditofthepubliclytradedcompany,andindividualswhoareconvictedinaproceedingrelatedtothejudicialoradministrativeactionforwhichthewhistleblowerotherwisecouldreceiveanaward.SeeMichaelE.Clark,The Dodd-Frank Act’s Bounty Hunter Provisions,44(3) Rev.Sec.&Comm.Reg.31(Feb.9,2011).

791SeePressRelease,DOJ, Justice Department Recovers $2.4 Billion in False Claims Cases in Fiscal Year 2009; More Than $24 Billion Since 1986(Nov.19,2009),available at http://www.justice.gov/opa/pr/2009/November/09-civ-1253.html.

792AGooglesearchconductedwithintwoweeksoftheDodd-FrankAct’spassageusingthesearchexpressions“SECbountyhunter”and“SECwhistleblower”returnedbanneradvertisementsfromseveralplaintiffs’firms,includingawell-knownquitamlitigationfirm.

Ch. 12.VIII.D.1.


resultedinchargesbeingfiledagainst22executivesandemployeesofcompa-niesinthemilitaryandlawenforcementproductsindustryfortheirinvolvementin schemes to bribe foreign government officials. In 2010, theDOJ’s FraudSectionhad,bythattime,charged46individualswithFCPAorbribery-relatedoffenses,potentiallysurpassing,byyear’send,therecordsetin2009,whenmoreindividualswerechargedwithFCPAviolationsthaninanyprioryear(orduringthe past several years combined)—includingCEOs, CFOs, and other seniorcorporate,sales,marketing,andfinanceexecutives.FormerAssistantU.S.Attor-neyGeneral Lanny Breuer, who oversaw theDOJ’s Criminal Division, hadwarnedthat“theprospectofsignificantprisonsentencesforindividualsshouldmakecleartoeverycorporateexecutive,everyboardmember,andeverysalesagent thatwewill seek to hold you personally accountable for FCPAviola-tions.”793Predictably,thenewwhistleblowerprovisionswillincreasethenumberofFCPAmattersandlikelywillincreaseothertypesofsecuritiesandcommod-itiesfraudinvestigationsandprosecutions.

Althoughitisoftendifficulttoknowhowtobesthandleadverseemploy-ees,theActhasmadeitevenharderbyaddingenhancedwhistleblowerprotec-tions.UndertheAct,awhistleblowernowcansuearetaliatingemployerdirectlyin federal court without first having to exhaust administrative remedies. Inaddition,existingwhistleblowerprotectionsundertheSarbanes-OxleyActhavebeenclarifiedtoapplytobothparentcompaniesandaffiliateswhosefinancialinformationisincludedinconsolidatedfinancialstatements.794

2. Aiding and Abetting Liability Authorized TheDodd-FrankActalsoincludesprovisionsdesignedtomakeiteasier

for the SEC to bring and maintain enforcement actions based on expanded sec-ondary liability. The following new provisions set out the newly expandedauthority:

1. Section929M.AidingandabettingauthorityundertheSecuritiesActandtheInvestmentCompanyAct;

2. Section 929N.Authority to impose penalties for aiding and abettingviolationsoftheInvestmentAdvisersAct);

3. Section929O.Aidingandabettingstandardofknowledgesatisfiedbyrecklessness).795

AlthoughthePSLRAauthorizedtheCommissiontochargeaiderandabet-torviolationsoftheSecuritiesExchangeAct,Congressrequiredittodemonstratethatdefendant(s)knewaboutthemisconduct,whichcourtsinterpretedasrequir-ing proof of actual knowledge (and not just recklessness).796A few senators

793LannyA.Breuer,Asst.Att’yGen.,DOJCriminalDiv.,PreparedAddress to the22nd NationalForumontheForeignCorruptPracticesAct(Nov.17,2009).

794See generallyClark,at31.795Pub.L.No.111-203,124Stat.119,1861–62(2010).796See generally Morrison Overturned? What Dodd Act Means for Securities Class Actions,

RiskMetricsBlog(July26,2010)[hereinafterMorrison Overturned?];RichardGallagher&KennethHerzinger,Securities Litigation Risks for Public Companies Arising from the Dodd-Frank Wall Street Reform and Consumer Protection Act(July29,2010),available at http://www.orrick.com/publications/item.asp?action=article&articleID=2863;Investor Protection Provisions of the

Ch. 12.VIII.D.2.


pushedtoextendtoprivatelitigantstheauthoritytochargeandprovesecondaryaidingandabettingliabilityinfederalsecuritiesfraudcases,797 but Congress did notdosointheDodd-FrankAct.Thisdoesnotnecessarilymean,however,thatit will not do so in the future. Section 929Z of the Act instructs the U.S. Comp-trollerGeneralto“conductastudyontheimpactofauthorizingaprivaterightofactionagainstanypersonwhoaidsorabetsanotherpersoninviolationofthesecuritieslaws”andthentoreporttoCongressonitsfindingswithinayear.798

Similarly,althoughCongressdidnotprovideprivatelitigantswiththesameauthorityastheCommissionobtainedintheDodd-FrankAct(seebelow)regard-ing the extraterritorial reach of the federal securities laws in securities fraud actions(i.e.,legislativelyrepealingMorrison v. National Australia Bank799),italsoinstructedthatastudyonthisissuebeconducted:Section929YoftheActinstructstheSECtosolicitpubliccomments,conductthestudy,andthenprovideittoCongress,alongwithrecommendations,within18months.800

3. Extraterritorial Reach (Limited Repeal of Morrison) Section 929P(b) of theDodd-FrankAct effectively repealsMorrison v.

National Australia Bank801 for certain Commission enforcement actions. This provisionauthorizesextraterritorialjurisdictioniftheCommissionchargesvio-lations of the antifraud provisions of the federal securities laws that involve“conductwithintheUnitedStatesthatconstitutessignificantstepsinfurtheranceoftheviolation,evenifthesecuritiestransactionoccursoutsidetheUnitedStatesandinvolvesonlyforeigninvestors”or“conductoccurringoutsidetheUnitedStates that has a foreseeable substantial effect within the United States.”802

IX. Criminal Violations

ItisnotalwayseasytoknowwhatislikelytoconstituteanadministrativeenforcementproceedingbytheCommission—asopposedtoacriminalprose-cution by the DOJ, or both. Basically the decision rests on various factors,including the background of the violator (including whether the conductinvolvesafirst-timeoffenseorarepeatedoffense),theamountoftheloss(withsmallerlossestendingtobehandledadministratively),andthedegreeofprov-ableculpablescienterinvolved(withcaseshavinglessevidenceofculpabilitybeingmoreoftenroutedforadministrativeproceedings);however,otherfactorscan also play a role, aswitnessed by the doggedparallel administrative andcriminal proceedings instituted against Martha Stewart based on her trades of ImClone stock and her interaction with the Commission and the DOJ. As a senior

Dodd-Frank Act,HarvardLawSchoolForumonCorporateGovernanceandFinancialRegulation (July 11, 2010), available at http://blogs.law.harvard.edu/corpgov/2010/07/11/investor-protection-provisions-of-the-dodd-frank-act/.

797See Morrison Overturned?798Pub.L.No.111-203,§929Z,124Stat.at1871.799130 S. Ct. 2869 (2010).800Pub.L.No.111-203,§929Y,124Stat.at1871.801130 S. Ct. 2869.802Pub.L.No.111-203,§929P(b),124Stat.at1864–65.

Ch. 12.VIII.D.2.


SECofficial remarkedafewyearsback, theCommission tries todrawthesedistinctionsinhowitpursuesdifferenttypesofviolations:

Whenitcomestoasubjectarealikeprotectingtheinvestor,forexample,some laws and rules—particularly those that are compliance oriented, likereporting requirements for issuers of securities and registration of broker-deal-ers—seem more naturally to fall into the civil category. Others—like lawsagainstfraudandmarketmanipulation,or,totakeapositiononamorecontro-versialtopic,insidertrading—dealwithbehaviorthatseemsmorecriminal.Still,thereisnocrispdistinction.Includingablatantfalsehoodinaroutinefilingcanrise to the criminal, and taking advantage of inside information certainlyincludesaharmwewouldconsidercivil.803

Paralleladministrativeandcriminalenforcementactionsarealwayspossi-blewhen the federal securities lawshavebeenviolated.804Moreover,privatecivilclassactionsecuritiesfraudcomplaintsorshareholders’derivativeactionsarecommonlyfiledsoonafterenforcementactionsbecomepublic.Themajordifferenceintheelementsofproofforprivatesecuritiescasesversusgovernmentproceedingsisthatprivateplaintiffsmustestablishtheyhavebeenharmedasaresultoftheconduct;i.e.,losscausationandtransactionalcausationareessentialelements.Also, theprovisionsof thePSLRAareexpressly limited toprivatelitigationofsecuritiesfraudmatters.IntheaftermathofSarbanes-Oxley,par-allel government investigations of securities fraud violations are becomingincreasingly commonplace, as are parallel administrative and criminalenforcement actions.805 Before Sarbanes-Oxley enacted the new securitiesfraudstatute,806criminalprosecutionsofsecuritiesfraudusuallyallegedvio-lationsofSection10(b)oftheExchangeAct,alongwithitsimplementingrule,10b-5,andalsoSection32(a)oftheExchangeAct,whichsetsouttheappli-cable punishment range for criminal securities law violations.807 Criminal prosecutionsoflifesciencescompaniesandindividualswhoworkwiththemarenotlimitedtofraudulentordeceptiveconductthatharmsinvestorsorto

803ThomasC.Newkirk,Assoc.Dir.,Div.ofEnforcement,SEC,&IraL.Brandriss,StaffAttorney,Div.ofEnforcement,SEC,The Advantages of a Dual System: Parallel Streams of Civil and Criminal Enforcement of the U.S. Securities Laws,atthe16thInternationalSymposiumonEconomicCrime(Sept.19,1998)(pagereferencesnotavailable),available at http://www.sec.gov/news/speech/speecharchive/1998/spch222.htm.

804See generallyJuliaK.Croninetal.,Securities Fraud,38Am. Crim. L. Rev.1277,1280–81(2001).

805See generally, Paul Markus, The Use of Criminal Statutes to Regulate Financial Markets in the United States, 46 Am. J. Comp.L.589,598(1998Supp.)(“Inthepasttwodecades...SECenforcementlawyersand...[DOJ]prosecutorshavebeguntobringmorecriminalprosecutionsagainstsecuritiesviolators....”)(internalnotesomitted).

806SeeSectionIX.D.,below,foradiscussionoftheSarbanes-OxleySecurityFraudStatute.807SeeCroninetal.,at1287–88(“WhereastheSECuses§10(b)andRule10b-5incivil

andadministrativecases,DOJutilizes§32(a)ofthe1934Actinitscriminalproceedings.Section32(a)providescriminalpenaltiesforwillfulviolationsoftheAct,rules,orregulationsthereunder.Therefore,awillfulviolationof‘section10(b)oftheActandtheCommission’sRule10b-5there-under...admittedlyqualify’under§32(a)....[¶]Section32(a)alsostatesthatanindividualwholacksawarenessoftheexistenceofanapplicablesectionorrulemaystillbeconvictedofwillfullyviolatingthe1934Act.Penaltiesforsuchaconviction,however,donotnecessarilyentailimprisonment.”) (internal notes omitted).

Ch. 12.IX.


insidertradingviolations.Thegovernmenthasbeguntomoveintomoreesoterictheories,asthefollowingdiscusses:

Communicationofclinicaltrialresultshasbeenasubjectofothergovernmentpros-ecutionsaswell.Forexample,ForestLaboratorieswasinvestigatedforallegedlynotpublishingdatafromclinicaltrialsofitsantidepressantdrug,Celexa™(citalo-pram).Similarly,inarecent$430millionsettlement,thegovernmentallegedthatWarner-Lambert...engagedina“publicationstrategy”foritsdrugNeurontin®thatsubsidizedtheproductionanddisseminationofanecdotalreports...favorabletooff-labeluseofthedrug,butwere“ofnoscientificvalue.”808

An interesting 2010 criminal opinion that relates to the pharmaceutical industryisUnited States v. Schiff,809wheretheThirdCircuitrejectedthegov-ernment’sappealofthetrialjudge’sorderexcludingthegovernment’stheoryofomissionliabilityanditsexpertinasecuritiesfraudprosecution.Astheopinionreflects,FrederickSchiff andRichardLanehadbeenhigh-ranking corporateexecutivesatBristol-MyersSquibbwhowereindictedforallegedlyorchestrat-ingamassivesecuritiesfraudschemeintheearly2000srelatedtothecompany’swholesale pharmaceutical distribution channels.810 The government took aninterlocutoryappealafterthejudgedismissedtheprosecution’stheoryofomis-sion liabilityunderRule10b-5,which sought toholdSchiff accountable foromissionsinForm10-Qfilingsformisstatementsinquarterlyconferencecalls,and (after a Dauberthearing),811excludingtheopinionsofagovernmentexpertwhoproposedtestifyingthatthecompany’sstockpricedropwasevidenceofmaterialityunderRule10b-5.812

Bristol-MyersSquibbhadimplementedasalesstrategyduring2000–2001thatprovidedseveralmilliondollarsquarterlytoitswholesalersasincentivestobuymoreofthecompany’sproductsbeyondtheirprescriptiondemandpro-jections.813 Schiff andhis codefendantLanehad approved (individually andcollectively)morethan$100millioninsuchincentivesforthelasttwoquartersof2001which,thegovernmentcontended,coveredthewholesalers’carryingcostsandguaranteedreturnontheproductsuntiltheyweresold.814Thegov-ernmentchargedthattheyconcealedthesepracticesbymakingfalsestatementsandmaterialomissionsinvariousanalystconferencecalls,pressreleases,andmeetingswithinvestors.815Astheopinionnotes,thegovernment’stheorywasdilatoryandalsoviolatedastipulationithadpreviouslymadeaboutitstheoryofliability:

808HowardL.Dorfman&LindaPissotReig,Avoiding Legal and Ethical Pitfalls of Industry Sponsored Research: The Co-Existence of Research, Scholarship, and Marketing in the Pharma-ceutical Industry,59Food&DrugL.J.595,596(2004)(internalnotesomitted).

809602 F.3d 152 (3d Cir. 2010).810Id. at 155–56.811Daubertv.MerrellDowPharms.,Inc.,509U.S.579,113S.Ct.2786(1993).812Schiff,602F.3dat155–56.813Id. at 156–57.814Id.815Id.

Ch. 12.IX.


TheGovernment’slasttheoryofomissionliability...wasraisedforthefirsttime.. .approximatelyonemonthbeforeSchiff’strialwastobegin.. . .Underthisnewtheory,“Schiff’sliabilityforomissionstostateintheSECfilingsstemmedfrompriormisleadingstatementsofboth[SchiffandLane]onanalystcalls,link-ingallegedmisstatementsonanalystcallstoallegedomissionstostateintheSECfilingsas‘allofapiece.’”...TheCourtreiteratedthat“theGovernmentcannotpremise [omissions in] SEC filing[s] upon [any]misstatement[s] in [the] SECfiling[s]becauseithasnotallegedanymisstatement[s]”inthosefilings....Thus,omissionliabilitymustbepredicatedonotherpriorstatements....Inthiscontext,theCourtalsoremarkedthattheGovernmentwasnotallegingatheorybasedona“dutytocorrect....”816

* * *

Earlyon,theGovernmentamendedtheindictmentandenteredintoaStipulation,eliminatingallallegationsrelatedtomisstatementsinBristol’sSECfilings.Sincethen,itsintroductionofnewlegaltheoriesappearsdesignedtofindcreativewaystoholdSchiffandLaneliableforthoseSECfilings.BecausetheGovernmenthasstipulatedthattherearenoaffirmativemisstatementsinthefourcornersoftheSEC10-Qdocuments,ithasattemptedtobringthesefilingsbackintothecaseagainstthedefendantsthroughtheoriesofomissionliability....[W]econcludethattheomissionliabilitytheoriesbeingappealedareeitherwaivedornotlegallyviableas federal crimes.817

A. Securities Fraud Based on Rule 10b-5 Violations

TomaintainasecuritiesfraudcauseofactionunderRule10b-5,thegov-ernmentmustprove(1)theexistenceofasubstantivefraud,whichmayincludematerialmisrepresentations or omissions, schemes or artifices to defraud, orfraudulentacts,practices,orcoursesofbusiness;(2)thedefendantperpetratedthefraudinconnectionwiththepurchaseorsaleofasecurityorintheofferorsaleofasecurity;(3)theuseofinterstatecommerceorthemails;(4)reliancebytheinvestor,orothereffectoftheschemeoninvestors;and(5)willfulnessto commit the prohibited act.818

B. Insider Trading

InsidertradingliabilityhasbeenextensivelydiscussedinSectionsI.C.andVI.,above.

Insidertradingenforcementhasremainedactive,andenforcementactionscontinuetoimpactthepharmaceuticalindustry.Forinstance,inUnited States v. Johnson,819 a former managing director of the NASDAQ stock market pleaded guilty for buying and selling stock in NASDAQ-listed companiesbasedonmaterial,nonpublicinformationthatheobtainedwhileaNASDAQexecutive.Amongthecompanieswhosestockwasboughtandsoldbasedon

816Id. at 160 (internal notes omitted).817Id. at 161.818Croninetal.,Securities Fraud,38Am. Crim. L. Rev.at1280–81(internalnotesomitted,

citingRule10b-5andUnitedStatesv.Dixon,536F.2d1388,1396(2dCir.1976)).819No.1:11-CR-00254-AJT(E.D.Va.pleaagreementMay26,2011).

Ch. 12.IX.B.


insiderinformationwereabiotechnologycompany(UnitedTherapeuticsCor-poration) and a pharmaceutical manufacturer (Idexx Laboratories. Inc.).820 As theSECexplained,Johnson’sconductwasunjustifiable:

Johnsonobtained illicitprofitsofapproximately$175,000by insider trading inthestockofUnitedTherapeuticsCorp. (UTHR).JohnsonspokebyphonewithexecutivesatUTHRincludingtheCFOandgeneralcounselonOct.30,2007,andhebecameawareofthesuccessfulcompletionofatrialforitsdrugViveta(laterrenamedTyvaso).DespitethenonpublicandhighlyconfidentialnatureoftheVivetatrialresultsdiscussedwithhim,Johnsonpurchased10,000sharesofUTHRstockinhiswife’sbrokerageaccountonOctober31.AfterUTHRissuedapressreleaseonNovember1announcingthesuccessfultrialresults,Johnsonbegansellingallofthestockthathehadpurchasedthedaybefore,placingsellordersonlinefromhisofficecomputeratNASDAQ.821

Anotherinsidertradingactionshowsthatbadactorsarenotonlyfoundintheprivatesector.AnFDAchemistwaschargedwithinsidertradingfortradingin advanceonnonpublic information concerning the agency’s drug approvaldecisionsfor19publiclytradedcompanies.822AccordingtotheSEC,ineachinstancethechemist,ChengYiLiang,tradedinthesamedirectionastheforth-coming announcement,823 and “went to great lengths to conceal his insider trading[,]...trad[ing]insevenbrokerageaccounts,noneofwhichwereinhisname.”824TheCommissionfiledanamendedcomplaintagainstLiangonJune2, 2011, seeking a permanent injunction, disgorgement of unlawful tradingprofitsandlossesavoided,plusprejudgmentinterestandafinancialpenalty.825 Inaparallelaction,theDOJunsealedacriminalcomplaintagainstLiangandhisson,chargingthemwithconspiracytocommitsecuritiesandwirefraudfortradinginthesecuritiesoffivecompanies(ClinicalData,Inc.,VandaPharma-ceuticals,Inc.,ProgenicsPharmaceuticals,Inc.,MiddlebrookPharmaceuticals,Inc.,andMomentaPharmaceuticals, Inc.).826 Both men were arrested at their residence,andlawenforcementagentsexecutedfoursearchwarrantsinconnec-tionwiththeinvestigation.827

Demonstratingthatthegovernmentdoesnotalwaysgetitright,inSEC v. Zachariah,828adistrictjudgefoundthattheCommissionfailedtoproveitsalle-

820SeePressRelease,DOJ,FormerNASDAQExecutivePleadsGuiltytoInsiderTrading(May26,2011),available athttp://www.justice.gov/usao/vae/news/2011/05/20110526johnsonnr.html; Press Release, SEC, SEC Charges Former NASDAQManaging DirectorWith InsiderTrading (May26,2011),available athttp://www.sec.gov/news/press/2011/2011-117.htm.

821PressRelease,SECChargesFormerNASDAQManagingDirectorWithInsiderTrading.822SeePressRelease,SEC,SECChargesFDAChemistWithInsiderTradingAheadofDrug

Approval(Mar.29,2011), available at http://www.sec.gov/news/press/2011/2011-76.htm.823Id.824Id.825See SECLitig. Rel.No. 21987, SECCharges FDAChemistWithAdditional Insider

Trading(June2,2011)(describingSECv.ChengYiLiang,No.8:11-CV-00819-RWT(D.Md.)).826PressRelease,DOJ,FDAChemistandSonChargedWithTradingonInsideInformation

(Mar.29,2011),available athttp://www.justice.gov/opa/pr/2011/March/11-crm-393.html.827Id.828SECLitig.Rel.No.20564,Civ.No.09-60698(S.D.Fla.May12,2008).See also SEC

Litig.Rel.No.20564(describingallegationsinSecurities&Exch.Comm’nv.Zachariah).

Ch. 12.IX.B.


gationsthatthedefendantpossessedandimproperlyusedinsideinformation.829 TheSEC’sclaimsinvolvedthemisuseofallegedtipsinvolvingtwodeals.TheCommissionhadallegedthatZachariahP.Zachariah,Dr.MammenP.Zachariah,and Dr. Sheldon Nassberg “had engaged in illegal insider trading from which theyreapedatotalofmorethanahalf-milliondollarsinprofitsfromtheirillicitscheme.” 830 The “SEC claimed that Dr. Zachariah and his brother traded on inside informationobtainedbythedoctorinacallfromIVAX’schairman(whichwasbeingacquiredbyTevaPharmaceuticals,Ltd.).”831 Although the SEC alleged that thiscallwasmadefromtheIVAXchairman’sprivateplaneandrelayedthroughhisofficeinMiamitoDr.Zachariah,832 it did not establish who was on the phone atDr.Zachariah’soffice.833Furthermore,“thetelephonerecordscontradictedtheCommission’sclaim”byprovingthat“thechairmanplacedanothercallfromtheplanewhilethecallwasinprogressattheDoctor’sofficethusmakingitimpos-siblefortheChairmantohavebeenspeakingwiththeDoctor.”834

C. Foreign Corrupt Practices Act

Becauseitisincreasinglycommonforlargelifesciencescompaniestobemultinational companies or to conduct some of their testing and marketing activitiesoutsidetheUnitedStates,theForeignCorruptPracticesActprovisionsincorporated into the ExchangeAct may pose significant liability concerns.ViolationsoftheFCPA’saccountingandfinancialcontrolprovisionsoritsanti-briberyprovisionscanleadtocivilandcriminalliability.835

OnecommentatorhasadeptlysummarizedtheFCPAinthefollowingway:“TheFCPAaddressestheproblemoftransnationalbriberyintwo...ways.First...[it]prohibitscorruptpaymentsmadetoforeignofficials...toobtainorretain

829SeeThomasGorman,SEC Enforcement Trends 2011: The SEC in Court,SECActionsBlog(Feb.10,2011)[hereinafterSEC Enforcement Trends 2011],available at http://www.sec actions.com/?p=3058.

830Civ.No.09-60698-CIV(S.D.Fla.May12,2008).831SEC Enforcement Trends 2011.832Id.833Id.834Id.835See, e.g.,H.LowellBrown,Avoiding Bribery When Doing Business Overseas: A Primer

on the Foreign Corrupt Practices Act, 20 Me.B.J.78,83–84(2005)(“Violationof theFCPAcanresultinbothcriminalandcivilsanctions.IndividualsconvictedofviolatingtheantibriberyprovisionsoftheActaresubjecttoimprisonmentforaslongasfiveyearsandfinesofasmuchas $100,000.TheAct prohibits indemnification, either directly or indirectly, of afineor civilpenaltyimposedonanindividual.”)(internalnotesomitted,citing15U.S.C.§§78dd-2(g)(2)(B),78dd-3(e)(2), 78ff-(c)(2)(A), 78dd-2(d), 78dd-2(g)(3), 78dd-3(e)(3), and 78ff-(c)(3)).See also ArthurF.Mathews,Defending SEC and DOJ FCPA Investigations and Conducting Related Cor-porate Internal Investigations—The Triton Energy Indonesia SEC Consent Decree Settlements, 18 Nw. J. Int’lL.&Bus.303,312(1998)(“TheDOJcanprosecutecriminallyanypersonorcompany forviolationsof either thebriberyprovisionsor thebooks and records and internalaccountingcontrolsprovisions.Sincethe1988amendmentstotheFCPA,theDOJcanalsopursuecivilinjunctiveand/orpenaltyactionsagainst‘domesticconcerns’forFCPAbriberyviolations.TheSECcanpursuecivilandadministrativeenforcementactionsforviolationsofboththebrib-eryandcorruptforeignpaymentsprovisionsandthebooksandrecordsandinternalaccountingcontrolsprovisionsagainstissuers,buthasnojurisdiction...overcriminalprosecutions,oroverdomestic concerns. . . .”) (internal notes omitted).

Ch. 12.IX.C.


business. Second, theAct . . . require[s] . . . publicly traded companies [to]implementaccountingandfinancialcontrols.”836

The FCPA’s antibribery provisions are set out in Section 30A of theExchangeAct,837and,inpertinentpart,they“prohibitpubliclyheldcompaniesfrommakingpaymentstoforeignofficials‘forpurposesof’inducingthemtomisusetheiroffice‘inordertoassistsuch[company]inobtainingorretainingbusinessfororwith,ordirectingbusinessto,anyperson....’”838TheFCPA’santibriberyprovision,however,doesnotincludeso-calledgreasepayments,and“doesnotapply‘toanyfacilitatingorexpeditingpaymenttoaforeignofficial,politicalpartyorpartyofficial...toexpediteortosecuretheperformanceofroutine government action by a foreign official, political party, or partyofficial.’”839

TheFCPA’saccountingandrecordkeepingprovisionsaresetoutinSection13(b)(2)840oftheExchangeAct,and,inpertinentpart,theyrequireissuersto“‘make and keep books, records, and accounts, which, in reasonable detail,

836Brown,at78–79.837Section30AoftheExchangeActiscodified,asamended,at15U.S.C.§§78dd-1,78kk-

2.Title15,U.S.C.§78dd–1(Prohibitedforeigntradepracticesbyissuers),provides,inrelevantpart:

(a)...Itshallbeunlawfulforanyissuerwhichhasaclassofsecuritiesregisteredpursu-anttosection78lofthistitleorwhichisrequiredtofilereportsundersection78o(d)ofthistitle,orforanyofficer,director,employee,oragentofsuchissueroranystockholderthereofactingonbehalfofsuchissuer,tomakeuseofthemailsoranymeansorinstrumentalityof interstatecommercecorruptly infurtheranceofanoffer,payment,promise topay,orauthorizationofthepaymentofanymoney,oroffer,gift,promisetogive,orauthorizationofthegivingofanythingofvalueto—

(1)anyforeignofficialforpurposesof—(A)(i)influencinganyactordecisionofsuchforeignofficialinhisofficialcapac-

ity,(ii)inducingsuchforeignofficialtodooromittodoanyactinviolationofthelawfuldutyofsuchofficial,or(iii)securinganyimproperadvantage;or(B)inducingsuchforeignofficialtousehisinfluencewithaforeigngovernmentor

instrumentalitythereoftoaffectorinfluenceanyactordecisionofsuchgovernmentorinstrumentality,inordertoassistsuchissuerinobtainingorretainingbusinessfororwith,ordirectingbusinessto,anyperson[.]

838SEC,AnnualReportforFiscalYear2002,at107,available athttp://sec.gov/pdf/annrep02/ar02full.pdf.

839Arthur F. Mathews, Defending SEC and DOJ FCPA Investigations and Conducting Related Corporate Internal Investigations—The Triton Energy Indonesia SEC Consent Decree Settlements, 18 Nw. J. Int’lL.&Bus.303,313(1998)(internalnoteomitted,citing15U.S.C.§§78dd-1(b)and78dd-2(b)).

840Section13(b)(2)oftheExchangeActiscodified,asamended,at15U.S.C.§78m(b)(2).Title15,U.S.C.§78dd–1(Prohibitedforeigntradepracticesbyissuers)provides,inrelevantpart:

(b)[¶](2)Everyissuerwhichhasaclassofsecuritiesregisteredpursuanttosection78lofthistitleandeveryissuer...requiredtofilereportspursuanttosection78o(d)...shall—

(A)makeandkeepbooks,records,andaccounts,which,inreasonabledetail,accu-ratelyandfairlyreflectthetransactionsanddispositionsoftheassetsoftheissuer;(B)deviseandmaintainasystemofinternalaccountingcontrolssufficienttoprovide

reasonable assurances that—(i)transactionsareexecutedinaccordancewithmanagement’sgeneralorspecific

authorization;(ii)transactionsarerecordedasnecessary[¶]...topermitpreparationoffinancial

statementsinconformitywithgenerallyacceptedaccountingprinciplesoranyothercriteriaapplicabletosuchstatements,and[¶]...tomaintainaccountabilityforassets;

Ch. 12.IX.C.


accuratelyandfairlyreflectthetransactionsanddispositionsoftheassetsoftheissuer.’”841

The FCPA’s recordkeeping and accounting provisions are significantlybroader than the ant-bribery provisions.As one commentator has observed:“[t]heyextendtoallofacompany’sbusiness,domesticaswellasforeign,legit-imateaswellascorrupt;theyarenotlimitedtoaccountingforcorruptforeignpayments.”842Althoughtheseprovisionsare“notlimitedtomaterialtransactionsortothoseaboveaspecificdollaramount,”843anddonotrequirescienter,the“‘inreasonabledetail’phrasesubstitutesformateriality,andhasasitspurpose‘to effectively prevent off-the-books slush funds and payments of bribes’throughtherequirementoftheestablishmentandmaintenanceofasystemofrecording financial transactions in accordancewith accepted accounting andauditing methods.”844

SomenotableFCPAenforcementproceedingshaveaddressedtheconductofpharmaceuticalandmedicaldevicemanufacturers.Forexample,becauseoftheactionfiledinIn re Schering-Plough Corp.,845 thecompanyagreedtotheentryofconsentdecreethatitviolatedtheFCPA’sbooksandrecordsandinternalcontrolsprovisionswhenaPolishsubsidiary(S-PPoland)paid$76,000inbribestoinfluencedecisionsbyaPolishgovernmentofficialthatwouldhelptoobtainhospital and pharmaceutical business for the company—and these paymentswerenotaccuratelyrecordedinthebooksandrecordsofSchering-PloughCen-tral East AG.846Also, inIn re Diagnostic Products Corp.,847 a consent decree (whichincludedacriminalpenaltyof$2millionrelatedtoaDOJprosecutionfor the same conduct) was entered into with a multinational pharmaceutical companyforFCPAviolationsconcerning$1.6millioninillegalpaymentsmadebyasubsidiarytoahospitalandphysiciansinChinawhocontrolledpurchasingdecisions at the state-owned facilities; subsequently, these payments wereimproperlyrecordedinthebooksandrecordsas legitimatesalesexpenses.848 And,inIn re Syncor International Corp.,849 a consent decree was entered into withamultinationalproviderofradiopharmaceuticalproductsandservicesforFCPAviolations,includingviolationscommittedbySyncorTaiwan,itslargestforeignsubsidiary,andbySyncordeMexico,whichcollectivelypaid$6000,000

(iii)accesstoassetsispermittedonlyinaccordancewithmanagement’sgeneralorspecificauthorization;and(iv)therecordedaccountabilityforassetsiscomparedwiththeexistingassetsat

reasonableintervalsandappropriateactionistakenwithrespecttoanydifferences[.]841Donald R. Cruver,ComplyingWiththe Foreign Corrupt PracticesAct: A Guide

for U.S. FirmsDoing Businessinthe International Marketplace 14 (2d ed. 1999).842Mathews,at312.843Cruver,at17–18.844Mathews,18Nw. J. Int’lL.&Bus.at349–50(internalnotesomitted,citingH.R.Conf.

Rep.No.95–831,at10,reprintedin1977U.S.C.C.A.N.4121,4122).845Sec.ActRel.No.49,838,Admin.Proc.FileNo.3–11517,2004SECLEXIS1185(June

9,2004),available athttp://www.sec.gov/litigation/admin/34-49838.htm.846Id. at *3.847Sec.ActRel.No.51724,Admin.Proc.FileNo.3-11933,2005SECLEXIS1185(May

20,2005),available athttp://www.sec.gov/litigation/admin/34–51724.pdf.848Id. at *3–*5.849Sec.ActRel.No.46,979,Admin.Proc.FileNo.3-10969,2002SECLEXIS3151(Dec.

10,2002),available athttp://www.sec.gov/litigation/admin/34–46979.htm.

Ch. 12.IX.C.


inbribestohospitalandphysiciansinTaiwanandMexicotoretainbusinessforthecompany’sproducts,whichweresubsequentlyimproperlyrecordedinthecompany’sbooksandrecords.850Inasimultaneouslyfiledcivilcomplaint,Syn-cor agreed to pay a $500,000 civil penalty to resolve its violations of theFCPA.851

Asmentioned,asthenumberofForeignCorruptPracticesActviolationsbeinginvestigatedbytheDOJandSECcontinuestoincrease,manyofthesemattersinvolvemultinationalpharmaceuticalcompanies.Asnotedinalawfirmarticle,“anincreasingnumberofinternationalhealthcarecompanieshavefaced[FCPA]litigation....SiemensAG,Europe’slargestengineeringconglomer-ate[]withsignificanthealthcareoperations[]...agreedtopayarecord$800[million]infinesanddisgorge[]profitsafteraninvestigationintoallegationsofseriousbriberyundertheFCPA.”852DOJandSECofficialshavesaidthatthepharmaceuticalindustrywouldbeaparticularfocus,arguingthatcorruptionrisktendstobehigherinthesectorthaninmanyothers.“Thisseems...duetoacombinationof factors, including the[DOJ’sandSEC’s]objectives . . ., theongoingeffectsofthefinancialcrisis,andthegeneralnatureofthehealthcaresector,whichhasclosetiestogovernment.”853

FCPAchargesweresettledbytheSECandDOJagainstanIndiana-basedmedicaldevicecompany,asexplainedbytheCommissioninSEC v. Biomet, Inc.854 Biomet’s subsidiaries and agents bribed public doctors inArgentina,Brazil,andChinaforalmostadecade(2000through2008)towinbusiness.Tosettle the allegations, Biomet paid over $22million.According to the SEC,employeesofBiometArgentinaSApaidkickbacksashighas15to20percentofeachsaletopubliclyemployeddoctorsinArgentina;usedphonyinvoicestojustify the payments; and falsely recorded the bribes as “consulting fees” or“commissions”inthecompany’sbooksandrecords.Althoughexecutivesandauditorsknewofthepaymentsin2000,theyfailedtostopthem.

FCPA enforcement also remains spirited under the Obama administration. In thepastfewyears,“FCPAenforcement...wasnotlimitedtotheusualsuspectsasfederalauthoritiessettheirsightsonpursuingcorruptioninawidervarietyofindustries”because“[r]ecentenforcementactionsandannouncements...indicatethatthepharmaceuticalandprivateequitycompaniesareamongthosenowsub-

850Id. at *3–*4.851SECv.SyncorInt’lCorp.,No.1:02CV02421(D.D.C.2002),Lit.Rel.No.17887(Dec.

10,2002),available athttp://www.sec.gov/litigation/litreleases/lr17887.htm.852DLAPiper,Mitigating Corporate Corruption in the Healthcare Industry(July27,2009),

reprinted from FinancierWorldwide1–2(July2009).853Id. See also generallyMichaelE.Clark,Complying With the FCPA in Emerging Markets

After SOX,15(2)Bus.CrimesBull. at8(Oct.2007)(“Someof themajorfactors thatmakeFCPA compliance increasingly difficult in today’s environment include the globalization ofbusinessactivities,thegrowingopportunitiesfortransnationalcompaniestomakelargeprofitsindevelopingmarkets,andtheenactmentofanti-corruptionlawsbymostdevelopedcountries.WhenU.S. companies begin conducting business in emerging economies, theymust be particularlywaryofactionsthatcouldinvolveaforeignofficialandviolatetheFCPA.”);MichaelE.Clark,Evaluating and Minimizing the FCPA Risks When Conducting Business in Emerging Markets,54(2) Prac.Law.59(Apr.2008)(analyzingFCPAcasesagainstpharmaceuticalandhealthcarecompanies).

854SECLitig.Rel.No.22306(Mar.26,2012).

Ch. 12.IX.C.


ject to increased scrutiny.”855 To provide some context, in 2010, “[t]he DOJbrought63cases,andtheSECbrought38,ascomparedwith26DOJcasesand14 SEC cases in 2009.”856

OnesignificantFCPAenforcementcasethatinvolvedJohnson&JohnsonculminatedwithhugesettlementspaidtoresolveFCPAissuesrelatedtounlaw-fulpaymentsfromasubsidiarytogovernmentphysiciansinGreece,Poland,andRomania, as well as kickbacks paid to Iraq’s former government under theUnitedNations’OilforFoodProgram.857Notably,J&Jself-disclosedin2007thatitwasconductinganinternalinvestigationafterlearningthatsomeforeignsubsidiaries had engaged in misconduct. Despite self-disclosing and cooperat-ing,J&JhadtoagreetoaconsentorderwiththeSECandpaymorethan$48mil-lionindisgorgedprofitsandinterest.858J&Jalsohadtopaya$21.4millionfineto settle criminal charges with the DOJ.859

AnotherFCPAenforcementactioninvolvedfoodgiantTysonFoods.InFebruary2011,TysonsettledcivilandcriminalFCPAchargeswiththeSECandDOJstemmingfrompaymentsmadetotwoMexicangovernmentveteri-narianswhowereresponsibleforcertifyingforexportsalechickenproductsmanufacturedbyaTysonsubsidiary,andtheconcealmentoftheseimproperpayments,inviolationoftheFCPA’sbooksandrecordsprovisions.860

D. Sarbanes-Oxley Securities Fraud Statute

ThesecuritiesfraudstatuteenactedinSarbanes-Oxleyismodeledafterthefederalwirefraudandmailfraudstatutes,whichshouldmakeiteasierforthegovernment toallegeandprove securities fraudviolations thanviolationsofSection10(b)oftheExchangeActandRule10b-5violations.861 The statute has beenablysummarizedbyalawprofessor:

[Section807ofSarbanes-Oxleycreatedanewsecuritiesfraudstatute,codifiedat18U.S.C.Section1348]whichcarriesa...25yearmaximumtermofimprison-ment,[and]makesitacrimeto:(1)knowingly,(2)executeorattempttoexecuteaschemeorartificetodefraudanypersonin connection with any security of any

855Amy L. Riella et al., The War on Bribery Goes Global: Recent Developments and Enforcement Trends in the International Anti-Corruption Arena,BloombergL.Rep.(May2011),available athttp://www.velaw.com/uploadedFiles/VEsite/Resources/WaronBriberyGoesGloball.pdf.

856Jenner&Block, FCPA Business Guide 2011,at1(Feb.2011),available at http://www.jenner.com/files/tbl_s20Publications/RelatedDocumentsPDFs1252/3502/Jenner%20&%20Block %20FCPA%20Business%20Guide_2011.pdf.

857See $70 Million Bribery Settlement for Johnson & Johnson,TheBlogofLegalTimes(Apr.8,2011),available athttp://bit.ly/h2A1mB.

858See PressRelease,SEC, SECChargesJohnson&JohnsonWithForeignBribery(Apr.7,2011),available athttp://www.sec.gov/news/press/2011/2011-87.htm.

859Id.860See PressRelease, SEC, SECChargesTyson FoodsWith FCPAViolations (Feb. 10,

2011),available athttp://www.sec.gov/news/press/2011/2011-42.htm.86118U.S.C.§1348.SeeMichaelE.Clark,The Growing Importance of Securities Regulation

for Publicly Traded Entities in the Post-Sarbanes-Oxley Marketplace,2006Health Lawand Compliance Update§5.03.

Ch. 12.IX.D.


issuer,ortoobtainmoneyorpropertyinconnectionwiththepurchaseorsaleofsecuritiesbymeansoffalseorfraudulentpretenses,representations,orpromises.

This“mailfraudhybrid”offenseisextremelybroadinthreerespects.First,...§1348appliestoanyefforttodefraudthoseotherswhodealwithpubliclytradedcompanies[][and,therefore,]willapplytooralconversations,informalreports,presentationsandthelike,notjustofficialreportsfiledwiththeSEC.

Second,likethemail,wire,andbankfraud“schemetodefraud”statutes,§1348includesunsuccessfulandnascentefforts todefraudsincea“schemeorartificetodefraud”encompassesearly,preliminaryplanstodefraud.Third,themensreaelementin§1348isfairlyminimal,foracriminaloffense.UnliketheothernewcrimescreatedbySarbanes-Oxleywhichcontainaspecificintentelement,§1348requiresonlyproofthatadefendantacted“knowingly.”Givencaselawthatinterprets“knowingly”toincluderecklessdisregardforthetruth,§1348exposescorporateexecutivestoexpansivecriminalliability....862

IntheaftermathofEnronandthevariouslargecorporatescandalsoftheearly2000s,governmentregulatorspaidsubstantialattentiontoprotectingtheinvestingpublicbycarefullymonitoring theactionsof large,publicly tradedentities (suchaspharmaceutical companies).Congressmade it progressivelyeasierforprosecutorstoassertcriminalsecuritieslawviolationsagainstentitiesandindividuals.Whenevercriminalchargesarethreatened,lawyerswhoadvisepharmaceuticalentitiesmustpayparticularattentiontothegravepotentialharminvolvedand,ifnecessary,seekoutadvicefromexperiencedwhitecollarcrimecounsel familiar with these issues.

Inanopinioninvolvingahealthcarefinancingcompany,afederaldistrictjudgeexplainedwhyhedeniedamotionforacquittalfiledbyaformerexecutiveofNationalCenturyforconvictionsrelatedtosecuritiesfraudandotherstatutoryviolations.863NationalCenturyboughtmedicalaccountsreceivableatadiscountfrom providers. In return, the providers received fundsmuch sooner on themonies owed to them.864Tomakeitsbusinessmodelwork,NationalCenturyneededinvestors,soitsoldbondsthroughprivateplacementmemorandaandinvestor presentations. Investorswere told that these bondswere securedbymedicalaccountsreceivableandthattheirmoneywouldonlybeusedtobuy“eligible” accounts receivables—namely, receivables for medical servicesalready provided and billed to an insurer.865 But, as the court explained, theevidenceestablishedthattheserepresentationswerefraudulentbecausecertainproviderswerefinancedbyNationalCenturyinwhateveramountsneededtosatisfytheirbudgetaryneeds—apracticeknownas“advancing,”whichwaskepthiddenfrominvestors,basicallyconvertingwhatweresupposedtobesecure

862PamelaH.Bucy,Carrots and Sticks: Post-Enron Regulatory Initiatives,8Buff. Crim. L. Rev.277,288–89(2002)(internalnotesomittedandemphasisadded).

863UnitedStatesv.Poulsen,No.Cr2-06-129(1),2009WL1604975(S.D.OhioJune8,2009).864AsthejudgeexplainedindenyingthemotionforacquittalafterthejuryfoundNational

Century’s owner andCEO guilty on the various charges presented, “NationalCenturywas ahealthcare-financingcompanybased inDublin,Ohio,”which,before collapsing inNovember2002,“hadbeenthelargestprivately-heldhealthcare-financingcompanyintheUnitedStates.”Id. at *3.

865Id. at *4.

Ch. 12.IX.D.


loans to risky unsecured ones.866As such, the conduct constituted securitiesfraud.

X. Conclusion

Asthischapterillustrates,counselwhoadvisepubliclytradedlifesciencescompaniesaboutcomplianceissuesmustensurethattheirclientscomplywiththemanyexactingrequirements imposedonentities thatseek tobe listedonnationalexchanges.asthesecuritieslawsaresohighlyregulated.BecausetheserequirementscontinuetochangebyvirtueofnewSECrulesandregulations,aswellasbecauseofevolvinginterpretationsofsecuritieslawliabilityfromthecourts,stayingabreastofthesecuritieslawsisnoteasy.Thischaptershould,however,beofassistance.

866Id. at *6.

Ch. 12.X.

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