On December 7, 2021, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of a securities fraud putative class action alleging that biopharmaceutical company Alkermes PLC and certain of its executives had defrauded investors by mispresenting the U.S. Food and Drug Administration’s feedback on ALKS 5461, an opioid combination drug originally intended to treat major depressive disorder and cocaine dependence.
Plaintiff asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, alleging that defendants made misleading statements about the FDA’s approval process relating to ALKS 5461. The U.S. District Court for the Eastern District of New York dismissed plaintiff’s complaint, concluding that plaintiff had failed to plead the required strong inference of scienter.
On appeal, the Second Circuit agreed. The Second Circuit found that while plaintiff alleged that Alkermes “mischaracterized” the FDA’s response to Alkermes’ “novel approach to providing evidence of efficacy for a new drug,” the FDA had told Alkermes that the approach appeared “reasonable” and Alkermes had disclosed that there was a risk that the FDA would not accept it. The Second Circuit concluded that rather than support an inference of fraud, the circumstances, including Alkermes’s disclosures, “reflect[ed] the iterative process between a company and the FDA, particularly when the agency must evaluate a novel study methodology” and that Alkermes “viewed ALKS 5461’s chances of FDA approval with optimism, yet still made honest attempts to disclose the FDA’s feedback where relevant and to caution the market as to the risks inherent in proposing new study designs.” Having affirmed the dismissal of the primary Section 10(b) claim, the Second Circuit also affirmed the dismissal of the secondary Section 20(a) claim. Finally, the Second Circuit also affirmed the district court’s refusal to grant plaintiff leave to further amend its complaint, concluding that plaintiff had not provided an adequate explanation as to the specific changes it would make to cure the pleading deficiencies.
Goodwin represented defendants in connection with the successful motion to dismiss and the successful appeal.
Delaware Court of Chancery Allows SPAC Litigation to Proceed
On January 3, 2022, Vice Chancellor Lori W. Will of the Delaware Court of Chancery largely denied defendants’ motions to dismiss in In re MultiPlan Corp. Stockholders Litigation, a challenge to the merger between Churchill Capital Corp. III, a SPAC, or special purpose acquisition company, and MultiPlan Inc. The case reflects the novel application of traditional fiduciary duty principles in the SPAC context.
In February 2020, the SPAC went public, raising $1.1 billion from investors. In July 2020, the SPAC’s board approved a merger agreement with MultiPlan, a healthcare data analytics company, and recommended that the SPAC’s stockholders approve the merger. According to plaintiffs, the proxy statement issued in connection with the merger failed to disclose that MultiPlan’s largest customer was developing its own data analytics platform. In October 2020, the SPAC’s stockholders approved the merger. When the development of MultiPlan’s largest customer’s data analytics platform later became public, MultiPlan’s share price fell and this litigation was filed. Plaintiffs asserted breach of fiduciary duty claims against the SPAC, its founder, directors, and officers, and certain affiliated entities, alleging, among other things, that the proxy statement was materially false and misleading.
Vice Chancellor Will concluded that the entire fairness standard of review, which requires defendants to provide that both the price and the process of the challenged transaction were fair to stockholders, applied to the merger, or de-SPAC transaction, for two reasons. First, the court held that plaintiffs had adequately alleged that the merger was a conflicted controller transaction because Michael Klein, who, through the SPAC’s sponsor entity controlled the SPAC, had a “potential conflict [with] public stockholders resulting from their different incentives [with respect to] a bad deal versus no deal.” Specifically, the sponsor held warrants and founder shares that were worth about $356 million when the merger closed — “representing a 1,219,900% gain on the [s]ponsor’s $25,000 investment” — but would have been worthless had there been no deal. The SPAC’s public stockholders, on the other hand, would have received back their investments had the SPAC failed to close a deal. Second, the court held that plaintiffs had adequately alleged that the SPAC’s directors were conflicted because their economic interest in the sponsor meant that they would “benefit from virtually any merger — even one that was value diminishing for [public] stockholders” and because they were not independent of Klein, who had appointed many of them to other SPAC boards. Applying the entire fairness standard, Vice Chancellor Will refused to dismiss the claims against the SPAC’s directors.
As this case represents the novel application of traditional fiduciary duty principles in the SPAC context, it remains to be seen how the court’s view of the economic interests of SPAC participants will impact future litigation. Vice Chancellor Will noted that while the breach of fiduciary duty claims against the SPAC’s directors were not dismissed, “[that] conclusion does not address the validity of a hypothetical claim where the disclosure is adequate and the allegations rest solely on the premise that fiduciaries were necessarily interested given the SPAC’s structure” and that “[i]f public stockholders, in possession of all material information about the target, had chosen to invest rather than redeem, one can imagine a different outcome.”
Ex-Theranos CEO Elizabeth Holmes Convicted on Four Counts of Fraud
On January 3, 2022, after a four month trial and seven days of deliberation, a jury convicted former Theranos CEO Elizabeth Holmes of four of the 11 counts with which she was charged: one count of conspiracy to defraud investors and three counts of wire fraud. The jury concluded that Holmes and former business partner Sunny Balwani had intentionally solicited payments from investors with false statements about the blood testing devices developed by Theranos, its business partnerships, and its financial model. The jury also concluded that Holmes had committed wire fraud in connection with investments Theranos obtained from (1) PFM Sciences, (2) a firm associated with the family of former Education Secretary Betsy DeVos, and (3) Daniel Mosely, formerly an advisor to Henry Kissinger. Evidence introduced at trial in connection with those counts indicated that Holmes had misrepresented, among other things, Theranos’ revenue from the U.S. Department of Defense, the use of Theranos’ technology by the military, and the endorsement of Theranos’ technology by pharmaceutical companies. The jury did not reach a verdict with respect to three additional counts of wire fraud. The jury cleared Holmes of charges that she had defrauded medical patients who used Theranos’ blood testing devices.
Holmes faces up to 20 years in prison for each count on which she was convicted, as well as potential fines and restitution. Her sentencing has not yet been scheduled.
Second Circuit Vacates Dismissal of Securities Fraud Class Action Against Hain
On December 17, 2021, the U.S. Court of Appeals for the Second Circuit vacated the dismissal of a securities fraud putative class action against The Hain Celestial Group, Inc. and certain of its current and former officers, remanding the suit to the U.S. District Court for the Eastern District of New York for further consideration.
Plaintiffs asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, alleging that defendants made misleading statements attributing Hain’s growing sales levels to strong consumer demand when in fact they were allegedly due to “channel stuffing,” in which customers were incentivized to purchase more product than needed prior to the end of each quarter, and also that defendants’ channel stuffing constituted an unlawful scheme to defraud investors. The U.S. District Court for the Eastern District of New York dismissed the complaint, concluding that plaintiffs had failed to allege a violation of Rule 10b-5 and had also failed to allege scienter.
On appeal, the Second Circuit vacated the dismissal. The Second Circuit noted that as opposed to a violation of Rule 10b-5(a) or 10b-5(c), a violation of Rule 10b-5(b) does not require the defendant to have used a fraudulent scheme or practice, but instead “focus[es] . . . on whether something said was materially misleading.” The Second Circuit found that “[t]he district court mistakenly imported the requirement of clauses (a) and (c) of a fraudulent scheme or practice into clause (b), which includes no such requirement” and that “[t]he success of . . . a complaint in alleging a violation of clause (b) does not depend on whether the alleged channel stuffing practices were fraudulent or otherwise illegal.” The Second Circuit also concluded that “[t]he district court’s mistaken understanding of the substance of the alleged offense inevitably affected the district court’s view of whether it was done with scienter” and that the district court had also failed to weigh plaintiffs’ scienter allegations as a whole.
The Second Circuit’s decision reaffirms that a defendant may be held liable for securities fraud for a misleading statement even where the statement does not implicate illegal or otherwise fraudulent activity.
Kate E. MacLeman