By David R. Woodcock, Jr., and Christina L. Stanland 

Life sciences companies are frequent targets of securities class actions. There likely are many reasons for this, including the fact that these companies are often characterized by uncertainty in terms of product development and viability, occasional volatile stock prices, a need for lengthy testing and government approval processes for their products, young management teams, and products with enormous potential for future revenue generation but serious risk of failure to come to market.

Some practical aspects of securities class actions make it unlike many other kinds of litigation faced by life sciences companies. First, securities class actions almost always involve claims that high level corporate officers and directors committed fraud and enriched themselves at the expense of shareholders. For young companies trying to build their reputations in the market, like many life sciences companies are, such allegations can impede growth because with an unproven product history, the companies often rely heavily on their managements’ reputations. Second, the types of allegations usually present in securities class actions can impact a company’s ability to borrow, engage in corporate deals, and otherwise fully access the credit and equity markets. Third, securities class actions are expensive to litigate and to settle. It can cost tens of millions of dollars to defend even meritless claims if they survive a motion to dismiss due in large part to high cost of electronic and other discovery, including depositions. Moreover, if summary judgment is denied after discovery, the cost of settlement rises even higher. And the average settlement value for securities class actions since 1996 has ranged from $8 million in 1996 to a high of $80 million in 2006. Removing some one-off smaller cases from the data, in 2009, the average settlement value was $42 million.¹ In 2009, the median settlement was $9 million, which was similar to the median settlements from 2007 and 2008.² Finally, securities class actions can take a long time to resolve and rarely go to trial. For class actions filed from 1996 - 2006 and resolved by the end of 2009, the median time to resolution was 31 months, with a median time to settlement of 36 months and a median time to dismissal of 23 months.³

This article briefly discusses securities class action claims against life sciences companies and some of the things a company can do to prepare for such litigation.

Securities Class Actions Against Life Sciences Companies 
Securities litigation against life sciences companies have remained fairly steady — around 10 - 12 percent of total securities class actions filed over the past few years. Overall in 2009, there were 17 securities class actions filed against life sciences companies, or approximately 10 percent of all securities class actions.⁴ In 2008, there were 23 new securities class actions filed against life sciences companies, or approximately 10 percent of the total 226 new lawsuits that year, compared to 21 securities class actions, or 12 percent, filed against life sciences companies in 2007.⁵ This steady supply of cases is due, in part, to a sophisticated plaintiffs’ class action bar that has become equipped to understand and track disclosure and financial issues in the life sciences industry.

In 2009, most allegations against life sciences companies fell into three categories: (1) claims related to the status of drug or device approval, trials, and FDA actions; (2) claims related to financial issues or business operations (not specifically tied to drug or device approvals); and (3) claims related to acquisitions or tender offers.⁶ At a more granular level, common allegations concern misrepresented results or progress on clinical trials, financial misstatements or improperly recognized revenue, disclosures about product commercial viability or ultimate efficacy, manufacturing deficiency or controls, merger integration issues, and issues with the company’s intellectual property.

Reviewing the allegations from complaints filed in 2009, defendants are alleged to have engaged in the following violations of the securities laws:

• Concealing serious issues at two of the company’s manufacturing facilities which caused shortages in the company’s top-selling product and delayed formulation of another product, as well as halting production of two other top-selling products because of contamination.
• Misleading investors regarding the status of a new drug application (NDA) with the FDA and failing to disclose that the FDA had requested several reports from the company before the NDA could be considered, thus delaying approval of drug.
• Failing to reveal serious customer complaints regarding its over-the-counter (OTC) product and failing to submit reports to the FDA as required.
• Failing to disclose the known possibility that the reimbursement rate for Medicare would be reduced, leading to lower revenues in the future.
• Failing to disclose an FDA-issued “approvable letter” indicating that the NDA was approvable, subject to satisfying concerns about the safety and efficacy. This was contrary to previous statements that the drug was “virtually guaranteed” to be approved.
• Issuing false and misleading statements regarding the company’s failure to meet the FDA’s current Good Manufacturing Practice, failing to take corrective actions regarding same, and failing to remedy repeat violations of FDA regulations.
• Neglecting to disclose that the company had failed to “focus enough effort on filling the pipeline for new case starts” for its product.
• Misrepresenting and omitting material information concerning quality and realistic likelihood of fulfillment contracts in “backlog” when the company knew or should have known that figures for potential sales would not be met.
• Failing to report results of safety studies and falsely represented that it had completed the first phase of trials in Europe and obtained “informed consent” waiver in the EU and “compassionate waiver” in the U.S.

Most of these allegations will not withstand testing by a motion to dismiss because the plaintiffs will be unable to overcome the rigorous pleading standards set by the Private Securities Litigation Reform Act of 1995 or cases interpreting that statute. But, as discussed above, even meritless securities class actions can be disruptive and expensive.

Being Prepared for Securities Class Actions 
There are things a life sciences company can do to minimize potential damage and disruption if and when it is named as a defendant in a securities class action.

Implement Disclosure Policies and Follow Them
Disclosure issues are a frequent subject of securities class actions. As demonstrated by the allegations in the 2009 cases described above, life sciences companies face a number of disclosure issues particular to their industry: progress in clinical trials; clinical trial design; the inherent benefits and limitations of patents; freedom to operate issues; variability and expert opinions; warning and regulatory actions by the FDA; scientific literature produced by third parties; prospects for FDA approval; and serious adverse effects. A company can minimize the risk of making disclosure errors by having a good system and good internal procedures surrounding the process for making public disclosures – not just in public filings, but in press releases, analyst calls, and conference materials. If your company is going to make more disclosures than are required by the SEC, as many life sciences companies do on issues like the drug development process or the preliminary results of drug trials, it needs to understand that it will expose itself to heightened SEC, FDA, and private litigant scrutiny.

Implement Insider Trading Policies and Monitor Them
Insider trading has been a hot topic recently. Illegal insider trading generally involves buying or selling a security in a breach of relationship of trust and confidence, while in possession of material, nonpublic information about the security. Companies themselves may face liability if their employees engage in insider trading and the company’s insider trading policies and procedures are found to be inadequate. Thus, every company should have insider trading policies and procedures approved by counsel. But while having a policy in place is a good start, companies also need to ensure a rigorous implementation of their insider trading programs. This can be especially important for life sciences companies with historically volatile stock prices.

Check Your Indemnification Provisions and Directors and Officers Policies
Securities class actions pose a serious potential danger of monetary liability to directors and officers. Virtually all major public companies have directors and officers (D&O) liability insurance, and these policies can provide coverage for securities class actions. D&O insurance can also protect against derivative actions (which are brought by shareholders in the name of the corporation), SEC and other government investigations, and other claims that might arise from the directors’ and officers’ management of the company. The same is true of corporate indemnification provisions, under which a corporation can agree to indemnify its directors and officers against most liability, with some exceptions, such as (1) illegal acts, (2) actions undertaken in “bad faith,” and (3) self-dealing. Together, D&O insurance and corporate indemnification protect corporate management’s personal assets and contribute to good corporate governance by ensuring that management is free to manage the corporation with a minimized risk of personal liability. Corporate officers and directors need to ensure their D&O policies are robust and the company’s indemnification provisions are up to date.

Maintain the Right Tone at the Top
A company will benefit by being able to demonstrate in cases brought both by private litigants as well as by the SEC or other regulators, that its directors, officers, and other high-level employees believe in and promote the company’s policies. This is known as maintaining the right “tone at the top” and is often a key issue in securities class actions. The company should be sure that its top executives (1) have read the company’s policies and follow them, (2) are familiar with the company’s controls and promote them, (3) investigate (independently where necessary) allegations of wrongdoing received from credible sources, and, if necessary, (4) take action if a violation of policies or controls is found to have occurred. A company should consider creating a hotline for employees to report suspected wrongdoing. It is equally important for the company to promote a long term view of revenue and growth, even when such view might be difficult. Maintaining the right tone at the top makes it more difficult for plaintiffs or the government to demonstrate a culture of fraud and a willingness to mislead investors for the sake of increased profits, factors often needed to prove scienter — or an intent to mislead investors by the company — and makes it more likely that any representation that was later discovered to be false was merely a mistake.

No amount of planning can provide certainty that a public company will avoid becoming a defendant in a securities class action. This is inherent in the uncertain nature of securities fraud — distinguishing fraud from innocent business reversals or setbacks is often very difficult from the outside. But life sciences companies, like all companies, should take certain steps — especially maintaining the right tone at the top — that can minimize their risk of exposure to this expensive and disruptive type of litigation.

For more information, please contact Vinson & Elkins lawyers David Woodcock or Christina Stanland. Visit our website to learn more about V&E's Securities Litigation practice. Get a .pdf of this issue of Securities Litigation Insights e-newsletter here.