Securities Snapshot September 24, 2019

Third Circuit Reverses Dismissal of Opt-out Plaintiff's State Law Fraud Claim Under the Securities Litigation Uniform Standards Act

Summary

Third Circuit Reverses Dismissal of Opt-Out Plaintiffs’ State Law Fraud Claim Under the Securities Litigation Uniform Standards Act; Marvell Technology Group Agrees to Pay $5.5 Million to Settle SEC Charges it Misled Investors; District of Nevada Dismisses Some Exchange Act Claims Against Allegiant Air and its Executives; Southern District of New York Narrows Claims Against Retina Drug Company in Case Involving Alleged Misleading Statements About Clinical Trials.

On September 12, 2019, the Third Circuit in North Sound Capital LLC v. Merck & Co., Inc. revived a fraud claim under New Jersey state law against two pharmaceutical companies, Merck and Schering-Plough (which have since merged), brought by sixteen investors who had opted out of previous class actions. The allegations in the previous class actions and the opt-out suits were substantially similar and centered around the clinical trial results—and Merck’s and Schering-Plough’s allegedly misleading statements about those results—for the anti-cholesterol drugs Vytorin and Zetia. The key difference in the opt-out suits was the addition of a fraud claim under New Jersey common law. The question in this appeal was whether the Securities Litigation Uniform Standards Act (“SLUSA”) bars investors who have opted out of a class action from bringing individual actions under state law.

The District of New Jersey had held that SLUSA precluded the opt-out suits because they were “covered class actions,” which SLUSA defines to include lawsuits that “are joined, consolidated, or otherwise proceed as a single action for any purpose.” The district court based this holding on the fact that the opt-out cases and the class actions shared similar substantive allegations. But two of the three judges on the Third Circuit panel disagreed that sharing allegations is enough to satisfy SLUSA’s definition of “covered class actions”; rather, “some actual coordination is required to constitute a single action” and “there was no such coordination between Plaintiffs’ opt-out suits and the prior class actions.” The majority emphasized that the actions did not temporally overlap and the fact that the defendants already had engaged in discovery in the class actions that would equally apply to the opt-out cases does not establish “coordination” for SLUSA purposes. While the dissenting judge observed that SLUSA’s definition of “covered class actions” is broad (e.g., “otherwise proceed”; “for any purpose”), the majority’s ruling establishes important limitations on SLUSA’s scope.

MARVELL TECHNOLOGY GROUP AGREES TO PAY $5.5 MILLION TO SETTLE SEC CHARGES IT MISLED INVESTORS

On September 16, 2019, the Securities and Exchange Commission announced that Marvell Technology Group, Ltd. had agreed to pay $5.5 million to settle charges that it misled investors when it engaged in an undisclosed revenue management scheme designed to mask declining sales and meet publicly-issued guidance. In its order, the SEC found that the company, a producer of semiconductor components, had orchestrated a plan to accelerate, or “pull-in,” sales from future quarters to the current quarter. This practice was directed by the company’s senior management, who placed significant pressure on sales employees to pull-in sales and refused to abandon the practice even after concerns were raised.

The SEC found that the undisclosed use of pull-ins misled investors in three different ways. First, investors were led to believe that the company was meeting its public guidance through normal customer demand, even though senior management knew that the company’s revenue, without the use of pull-ins, was significantly lower. Therefore, investors were deprived of the ability to evaluate the company’s financial results in the appropriate context.

Second, investors were not informed of the adverse impact of pull-ins on revenue and sales in future quarters. The SEC found that the company’s senior management had been warned of the consequences of pull-ins on future revenue, and internal analyses had noted the cumulative effects of the practice on customers, who were starting to carry excess inventory and resist additional pull-ins.

Third, investors were not aware that the practice of pull-ins masked declining sales and market share. For instance, Marvell characterized its Q4 2015 financial results as “overall on target” and touted an increase in sales and market share, even though its sales (without the benefit of pull-ins) actually decreased that quarter.

The SEC also found that the company’s internal disclosure process failed to ensure that it adequately considered its disclosure obligations. The Disclosure Committee, which was responsible for ensuring the accuracy of the company’s financial disclosures, did not consider whether the pull-in practice needed to be disclosed. Senior management also failed to consider whether the practice needed to be disclosed, even though at least one employee raised disclosure concerns. In addition, senior management failed to inform the board and the auditors about the pull-in practice.

Based on these findings, the SEC concluded that Marvell had violated the antifraud and reporting provisions of the Securities Act and Exchange Act, respectively, and ordered the company to cease and desist from any future violations and pay a $5.5 million civil penalty.

DISTRICT OF NEVADA DISMISSES SOME EXCHANGE ACT CLAIMS AGAINST ALLEGIANT AIR AND ITS EXECUTIVES

On September 9, 2019, the United States District Court for the District of Nevada dismissed some of the claims in a putative securities class action brought against Allegiant Air and certain current and former executives. Brendon et al. v. Allegiant Travel Co. Plaintiffs alleged that the low-cost airline hid its poor safety record and lied to investors about safety and maintenance issues, which were revealed in a CBS News 60 Minutes report that resulted in a drop in Allegiant’s stock price. According to Plaintiffs, Defendants made materially misleading statements and omissions concerning the safety and mechanical reliability of its aircraft and the competency of its maintenance staff, in violation of Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5 promulgated thereunder, and Section 20(a).

First, the Court found that not all of the challenged statements were adequately alleged to be a material misrepresentation. The Court granted the motion to dismiss with respect to Allegiant’s Code of Ethics, which stated, among other things, that the company was required to remain “honest, fair and accountable in all business dealings” and “provide safe working conditions,” as those statements were inherently aspirational and therefore not capable of being objectively false. The Court also granted the motion to dismiss with respect to assurances that Allegiant placed its “focus on safety and reliability” and that safety was a “core fundamental” and a “number one priority,” as those statements were not capable of objective verification and thus could not be material misrepresentations. However, the Court rejected defendants’ truth-on-the-market defense based on prior local news reports regarding issues with Allegiant’s aircraft, because the 60 Minutes report relied on undisclosed maintenance information that CBS had obtained from the FAA through a FOIA request.

With respect to scienter, the Court found that stock sales by the Allegiant CEO and the company’s bonus structure did not support a strong inference of scienter. However, the Court found that Plaintiffs sufficiently pled information from former employees to raise a strong inference of scienter. Plaintiffs also sufficiently pled facts to show that management was aware of the pervasive maintenance issues, either through particularized allegations or through the “core operations doctrine” (under which the Court could infer that facts critical to a business’s core operations are known to a company’s key officers), as it was “absurd” to suggest that management would not be aware of such pervasive maintenance issues. The court found that the former employee accounts, core operations doctrine, and resignation of the COO supported a strong inference of scienter, but the Court found a stronger inference that the individual defendants believed Allegiant to be safe, and therefore granted the motion to dismiss with respect to certain statements regarding safety. The Court denied the motion with respect to other statements regarding maintenance staffing and training.

SOUTHERN DISTRICT OF NEW YORK NARROWS CLAIMS AGAINST RETINA DRUG COMPANY IN CASE INVOLVING ALLEGED MISLEADING STATEMENTS ABOUT CLINICAL TRIALS

On September 17, 2019, the United States District Court for the Southern District of New York granted in part and denied in part a motion to dismiss in Micholle v. Ophthotech Corporation, a securities class action against Opthotech, a clinical-stage biopharmaceutical company that was developing the drug Fovista for the treatment of wet age-related macular degeneration. Plaintiff alleged two categories of misrepresentations and omissions arising from Opthotech’s clinical trials of Fovista: (i) statements regarding a Phase 2 trial’s success allegedly were misleading because defendants failed to disclose that patients in the control group had a worse preexisting eye condition than those in the Fovista therapy group; and (ii) defendants allegedly failed to disclose a material change in patient enrollment criteria for a Phase 3 trial.

The court dismissed the claims as to the first category but allowed the second category to proceed. With respect to the first category, the court credited defendants’ disclosures in SEC filings that patients in the control group, on average, had larger lesions than patients in the therapy group. And plaintiff’s allegation that Opthotech did not specifically disclose the precise legion size “might have provided useful context for investors [but] does not rise to the level of an actionable omission.” With respect to the second category, the court found that the allegedly undisclosed change to patient enrollment criteria was materially misleading. Unlike the disclosures surrounding patients in the Phase 2 trial, Opthotech’s disclosure about modifying the methodology for patient eligibility was insufficient because it included the allegedly misleading language that “we have made no meaningful changes to the inclusion and exclusion criteria in these Phase 3 clinical trials from those we used in our Phase 2b clinical trial.” The court found that this language was inconsistent with data that the defendants allegedly knew, as supported by documents incorporated into the complaint, and therefore enough to plead an actionable misrepresentation as well as fraudulent intent, because defendants should have known that their statements could mislead investors. This ruling underscores the importance of specific, robust disclosures supported by facts to combat allegations of securities fraud, particularly for clinical-stage drug companies navigating the uncertainty of the clinical development process.