On July 13, 2020, the Second Circuit Court of Appeals vacated a decision from the Southern District of New York dismissing a securities class action complaint brought against NewLink Genetics Corporation and its officers, in Abramson v. Nguyen et al., holding that statements made in connection with NewLink’s failed Phase 3 clinical trial for a novel pancreatic cancer drug were actionable.
In their complaint, the shareholder plaintiffs claimed that NewLink made misleading statements regarding the scientific literature on pancreatic cancer survival rates and the expected survival rates in its Phase 3 clinical trial of HyperAcute Pancreas, an experimental treatment for pancreatic cancer following tumor removal. Specifically, plaintiffs alleged that NewLink’s president had misrepresented historical pancreatic cancer survival rates to make the results of NewLink’s trials more appealing, by representing that “all major studies” of pancreatic cancer showed typical survival of 15-20 months, compared to 24.1 months with NewLink’s drug, while failing to disclose that several studies reflected a longer survival period. Plaintiffs also alleged that the clinical trial had significant design flaws that NewLink failed to disclose, alleging through a confidential witness that NewLink engaged in pervasive violations of Good Clinical Practice requirements, particularly by enrolling ineligible individuals in the clinical trial. Finally, plaintiffs alleged that NewLink and its cofounders made numerous statements about the efficacy and promise of HyperAcute Pancreas following its Phase 2 trial results, which were not supported by the Phase 2 results in light of limitations in the trial’s design.
The district court granted defendants’ motion to dismiss as to all claims, holding that (1) the statements regarding the Phase 3 trial and related scientific literature were opinions, not actionable statements of fact; (2) plaintiffs had not adequately pled loss causation as to the concerns regarding clinical trial design; and (3) the statements regarding the Phase 2 trial results were nonactionable puffery. The Second Circuit reversed, concluding that, while the claims regarding HyperAcute Pancreas’s efficacy and Phase 2 trial results were properly dismissed as puffery, plaintiffs adequately pleaded that the other statements at issue were actionable.
With respect to the company’s statements about the pancreatic cancer survival rates, the Second Circuit held that even if the statements were opinion, they were still actionable under the Supreme Court’s decision in Omnicare, Inc. v. Laborers Dist. Council Const. Industry Pension Fund, because a reasonable investor could have understood them as implying untrue facts—specifically, that “no credible studies have shown … survival rates higher than 20 months.”
With respect to the claims regarding flaws in the Phase 3 clinical trial’s design, the Second Circuit held that plaintiffs had alleged sufficient facts regarding improper enrollments to raise a reasonable inference that the design flaws affected the trial outcome, and thus that plaintiffs’ losses were a “materialization of the risk” concealed, sufficient to plead loss causation.
This case is a reminder that even statements of opinion may be actionable if perceived as implying fact by a reasonable investor.
DELAWARE CHANCERY COURT REJECTS MOTION TO DISMISS COMPLAINT CHALLENGING FAIRNESS OF SQUEEZE-OUT MERGER
On July 13, 2020, the Delaware Court of Chancery allowed claims to move forward in a derivative action brought by shareholders of real estate developer HomeFed Corporation against the company’s board of directors and its primary investor, Jefferies Financial Group, in In re HomeFed Corp. Stockholder Litigation.
Plaintiffs’ claims stemmed from a 2019 squeeze-out merger through which Jefferies, HomeFed’s 70% controlling shareholder, took over the remaining shares of the company in exchange for Jefferies shares, at a ratio of two Jefferies shares per share of HomeFed. Plaintiffs alleged that Jefferies, as controlling shareholder, and HomeFed’s directors, only two of whom were not affiliated with Jefferies, breached their fiduciary duties to HomeFed’s minority shareholders by orchestrating an unfair and self-dealing transaction that provided the minority shareholders unfairly low consideration for their common stock.
Defendants moved to dismiss all claims. Their primary argument was that the claims should be dismissed because the transaction is subject to business judgment review under the Delaware Supreme Court’s framework in Kahn v. M & F Worldwide Corp (“MFW”), which grants deference to a board’s business judgment in self-dealing transactions if the board implements certain protections for minority shareholders, including requiring the approval of a fully-informed and empowered special committee of independent and disinterested directors and a majority of the minority shareholders.
The court rejected this argument, ruling that the company had failed to comply with MFW. Specifically, MFW requires these protections to be introduced, and any transaction conditioned on the protections, before the negotiation process begins. Instead, the court found, Jefferies, and certain affiliated directors, had initiated negotiations with a block of minority shareholders prior to the implementation of the necessary safeguards. The court held that an offer letter Jefferies sent to HomeFed in 2019 was a continuation of the process for purchasing the minority shares that had begun two years before, and thus that discussions with minority shareholders during the intervening time meant that MFW’s protections had not been implemented ab initio.
This case reaffirms the high burden that directors, and controlling shareholders, must satisfy under MFW to prompt business judgment review of a transaction involving a controlling shareholder, and the necessity that procedural protections be implemented prior to engaging in negotiations, no matter how protracted.
APP DEVELOPER CHEETAH MOBILE PREVAILS ON MOTION TO DISMISS SECURITIES CLAIMS CONNECTED TO “CLICK INJECTION” SCHEME
On July 16, 2020, a judge in the Southern District of New York dismissed securities claims against Chinese app developer Cheetah Mobile Inc. and certain corporate officers in& Marcu v. Cheetah Mobile Inc. The plaintiffs, investors in Cheetah, brought claims under Section 10(b) and 20(a) related to an alleged “click injection” scheme in seven of Cheetah’s apps. According to plaintiffs, the scheme was premised on a feature where newly installed applications perform a “lookback” to see where the last click came from and provide a referral bonus to the developer at that click. Cheetah apps allegedly required its users to give permissions for Cheetah to see when new apps are downloaded, along with the ability to launch other apps. Cheetah’s apps used those permissions to search for “bounties” and inject fake clicks to make it appear as though the users had clicked through an ad published by Cheetah and downloaded the newly added application on Cheetah’s referral, thus prompting referral payments to Cheetah.
Plaintiffs relied principally on a November 2018 article from Buzzfeed that uncovered the scheme. In a statement responding to that article, Cheetah had stated that third party software development kits, integrated into its apps, were responsible for the click injection. Cheetah’s stock fell roughly 37% in response to the article.
Plaintiffs’ complaint alleged that Cheetah’s failure to disclose the misconduct rendered several statements by the company misleading, including (1) Cheetah’s public statements regarding the popularity and functionality of its applications generally, (2) statements regarding Cheetah’s revenue and sources and drivers of revenue, and (3) the company’s risk disclosures.
The court took issue with the fact that many of the statements alleged by plaintiffs to be misleading were about general topics concerning Cheetah’s apps that were completely unrelated to any scheme to garner referral bonuses from advertisers, such as statements about the user’s experience, an app’s popularity on Google Play, or similar topics. Such statements, the court held, were not rendered misleading by the alleged omissions. The court also rejected plaintiffs’ claims that revenue-related statements were misleading for “fail[ing] to reveal” that Cheetah had earned revenue from fraudulent techniques, noting that the revenue-related statements at issue were limited to true statistical facts. As a result, none of the statements at issue were the kind of “half-truth” necessary to state a securities law claim.
The court found plaintiffs allegation that Cheetah’s disclosures regarding revenue drivers were misleading by omission to be closer to the mark, but nonetheless ruled that because those disclosures used language that implied other sources of revenue, this allegation failed as well. Finally, the court found that plaintiffs’ allegations regarding risk disclosures were neither adequately alleged in the complaint nor were they misleading in any event.
Separately, the court held that dismissal was appropriate because plaintiffs failed to adequately plead scienter. The court held that plaintiffs’ heavy reliance on circumstantial evidence was insufficient, and that the complaint failed to plead facts giving rise to a strong inference that the company’s executives knew about the alleged click injection scheme.
CHANCERY COURT CUTS DOWN APPRAISED VALUE OF TECH COMPANY TO 23 CENTS PER SHARE
On July 14, 2020, the Delaware Chancery Court ruled in Kruse v. Synapse Wireless, Inc. that the appraised value of Synapse, a wireless technology “internet of things” company, was just $0.23 cents per share, far below the value sought by a former shareholder of the company.
McWane Inc., Synapse’s majority shareholder, completed a buyout of the shares in Synapse that it did not already own in 2016, at a price of $0.43 per share. Every Synapse shareholder except petitioner had accepted the consideration, but petitioner sought appraisal of his 582,216 shares, claiming that he was entitled to $4.14 per share, or $2.4 million. In contrast, Synapse claimed he was owed only $.06 per share.
After a trial last year in which both parties presented expert testimony regarding Synapse’s 2016 value, Vice Chancellor Slights issued a lengthy opinion valuing the shares at $0.23, in light of Synapse’s serious financial struggles from 2012 through its buyout. The vice chancellor acknowledged that valuation of Synapse was difficult, given the lack of contemporaneous market evidence and that McWane had acquired a majority of its shares at a price of $4.997 in 2012. Ultimately, the court concluded that Synapse had adequately demonstrated it performed a reliable appraisal of Synapse’s fair value as of the date of the merger. In reaching this conclusion, the vice chancellor noted that “one expert credibly made the best of less than perfect data” while the others did not. The vice chancellor made adjustments to one of the discounted cash flow analyses offered by Synapse’s experts and held that the appraised value was $0.228 per share, entitling Kruse to $133,015.