On October 1, 2019, in In re Clovis Oncology, Inc. Derivative Litigation, the Delaware Court of Chancery held that the alleged failure of a drug company’s directors to monitor management’s public statements about clinical trial results was sufficient to plead a Caremark claim. The drug company, Clovis, was conducting clinical trials of a drug for the treatment of lung cancer based on a clinical trial protocol that it had submitted to the FDA. Plaintiffs, Clovis stockholders, alleged that the company did not adhere to that protocol and misled the public about the trial’s results (by relying on skewed data about the trial’s objective response rate, or ORR, of patients who experienced meaningful tumor shrinkage when treated with the drug), resulting in an enforcement action by the SEC (with civil penalties of more than $20 million against Clovis and its officers), a federal securities class action (which Clovis settled for $142 million), and an investigation by the FDA. Plaintiffs brought a Caremark claim against Clovis’s directors for their alleged breaches of fiduciary duty for failing to monitor the company’s operations by ignoring red flags waved in front of them that the company was inflating its trial results (by including certain unconfirmed patient responses in the calculation of ORR).
Defendants moved to dismiss the Caremark claim. Although the court observed that the board had implemented a robust oversight system to bring problems to its attention (the first prong of Caremark), the plaintiffs alleged sufficient facts that the board consciously failed to monitor the results that the oversight system yielded (the second prong of Caremark). Drawing all reasonable inferences in plaintiffs’ favor, the court held that plaintiffs adequately pled that “the Board knew management was incorrectly reporting responses but did nothing to address this fundamental departure from the protocol” for the company’s “mission critical product.” In the wake of the Delaware Supreme Court’s recent decision on Caremark board oversight claims in Marchand v. Barnhill, 212 A.3d 805 (Del. 2019), this ruling provides further guidance that when “a company operates in an environment where externally imposed regulations govern its ‘mission critical’ operations,” “the board’s oversight function must be more rigorously exercised.”
DISTRICT OF MASSACHUSETTS DISMISSES CLAIM FOR FALSE AND MISLEADING STATEMENTS IN PROXY RELATING TO $1.1 BILLION SALE OF TECHNOLOGY COMPANY
On September 30, 2019, in in re Analogic Corp. Shareholder Litigation, the District of Massachusetts dismissed claims against Analogic (a medical and security technology component company) and its directors and officers arising from the sale of the company to a private equity firm. After the buyer paid $84 per share for the company while the shares traded at $96.05 just hours before the sale was announced, a purported class of the company’s former stockholders claimed that the defendants disseminated to stockholders a materially false and misleading proxy statement to secure approval of the sale in violation of Section 14(a) of the Securities Exchange Act of 1934. Plaintiff alleged that the proxy included materially false and misleading statements concerning the reasons for the company’s conservative financial projections, which allegedly “were manufactured only after it became apparent that the Board and the Committee needed to make an offer of $84.00 per share look attractive because the Board was under pressure to sell.”
The court dismissed the Section 14(a) claims for three reasons. First, the projections of the company’s future financial performance were immune from liability under the Private Securities Litigation Reform Act’s safe-harbor provision for forward-looking statements (as well as the bespeaks caution doctrine) that are accompanied by meaningful cautionary language (such as “The Company’s actual results may differ materially from such forward-looking statements as a result of numerous factors”). Second, the projections were non-actionable statements of opinion because plaintiff failed to plead that they were objectively false (i.e., facts that would demonstrate that the “projections were not actually the most reliable”) or subjectively false (i.e., that defendants “did not actually believe that the . . . projections more accurately represented Analogic’s future performance”). And third, plaintiff failed to allege that the projections were misleading where the company “provided its shareholders with every projection and financial forecast” and “[r]easonable shareholders could therefore appraise the merit of the projections on their own.” This case illustrates the pleading burden that a plaintiff faces in cases arising from allegedly false and misleading projections in proxy statements.
CHINESE EDUCATION COMPANY DEFEATS SECURITIES CLASS ACTION IN THE SOUTHERN DISTRICT OF NEW YORK
On September 25, 2019, the United States District Court for the Southern District of New York dismissed a securities class action, Lea et al. v. TAL Education Group et al., brought against TAL Education Group and its executives over two allegedly fraudulent transactions resulting in an overstatement of income. Plaintiffs had alleged that TAL overstated its income by engaging in a sham transaction whereby it sold a business, GZ 1-1, to another entity in order to realize gain from the sale, and then repurchased GZ 1-1 for the same price one year later, while allegedly maintaining control of the business throughout that period. Plaintiffs also alleged that despite records showing that TAL owned 30% of a startup, TAL actually controlled it, and therefore TAL was required to but did not consolidate that startup’s financial statements into its own.
The court found that Plaintiffs had failed to plead either a material misrepresentation or omission, or scienter. The court noted that both alleged frauds involved the issue of whether TAL controlled another entity so as to render its accounting statements false, but found that the facts alleged by Plaintiffs to show control had “alternative explanations so obvious that they render plaintiff’s [sic] inferences unreasonable.” With respect to the claims involving GZ 1-1, the Court noted that while TAL may not have transferred deferred revenue to the acquiring company, Plaintiffs did not allege that GZ 1-1’s revenues remained on TAL’s books, and “so there was no risk of double counting.” The court also noted a number of reasons why TAL would continue to pay GZ 1-1’s lease, as well as reasons why TAL would continue to be associated with GZ 1-1 (e.g., on the website), as “[c]orporate reorganizations take time and are not seamless.” The Court found that the repurchase was not sufficient to allege control, as “[t]here are a number of reasons why an entity could command the same price one year later . . . .” As to the TAL’s alleged control of the startup, the Court noted that Plaintiffs’ claims of control were based on an alleged “undisclosed related party transaction,” but the reason they claimed the parties were related was because of the alleged control—“exactly what the argument is trying to prove.” Finally, the Court held that there was no scienter because there was no material misrepresentation.