(Article from Securities Law Alert, November 2016)
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On October 26, 2016, the Ninth Circuit revived a securities fraud action alleging that Arena Pharmaceuticals had made material misrepresentations concerning the safety profile of and likelihood of FDA approval for lorcaserin, a weight-loss drug. Schueneman v. Arena Pharmaceuticals, 2016 WL 6246875 (9th Cir. 2016) (Bybee, J.) (Arena II). The Ninth Circuit determined that once the company chose to represent that animal studies supported the drug’s safety, the company was then required to disclose the existence of a rat study linking the drug to cancer.
Background
In March 2009, Arena’s CEO reported to investors that he was “confident” about the likelihood of FDA approval for lorcaserin based, among other things, on “all the animal studies that ha[d] been completed.” In May 2009, Arena submitted an SEC filing representing that “the long-term safety and efficacy of lorcaserin had been demonstrated, in part, through . . . preclinical, animal studies.” Neither disclosure mentioned a nonclinical study suggesting that lorcaserin caused cancer in rats (the “Rat Study”).
On September 14, 2010, “the FDA disclosed the existence of the Rat Study and concerns about lorcaserin’s possible carcinogenicity for the first time.” Arena’s stock price fell in value by 40% on the day of the FDA’s announcement.
Plaintiffs subsequently brought the instant securities fraud action in the Southern District of California. The district court dismissed the complaint for failure to raise a strong inference of scienter. The court found the “more plausible inference” from plaintiffs’ allegations was that “[d]efendants had a legitimate scientific opinion” that the Rat Study did not indicate that lorcaserin would cause cancer in humans. Shueneman v. Arena Pharmaceuticals, 2014 WL 12515272 (S.D. Cal. 2014). The court held defendants’ “legitimate and unanticipated scientific disagreement with the FDA” regarding the implications of the Rat Study did not “give rise to a strong inference of scienter.” Plaintiffs appealed.
Arena Had a Duty to Disclose the Rat Study Because It Chose to Discuss Other Animal Studies
The Ninth Circuit found the question of Arena’s obligation to disclose the Rat Study presented a “close case” under the federal securities laws. Arena II, 2016 WL 6246875. The court stated that “[d]efendants may not have had a duty to disclose the Rat Study had they not been representing that animal studies supported lorcaserin’s safety and therefore its likelihood of being approved” by the FDA. However, the Ninth Circuit determined that “once they raised the animal studies, [d]efendants were obligated to disclose the Rat Study’s existence to the market.”
The court explained that under the Supreme Court’s decision in Matrixx Initiatives v. Siracusano, 563 U.S. 27 (2011), “companies can control what they have to disclose under [the securities laws] by controlling what they say to the market” (quoting Matrixx, 563 U.S. 27). Once a company opts to “tout” positive information to the market, the company is then “bound to do so in a manner that wouldn’t mislead investors” (quoting Berson v. Applied Signal Tech., 527 F.3d 982 (9th Cir. 2008)). Specifically, the company must “disclos[e] adverse information that cuts against the positive information.”
Here, the Ninth Circuit found that “once defendants chose to tout lorcaserin’s likely approval by referencing allegedly positive animal and preclinical studies, they were bound to do so in a manner that wouldn’t mislead investors as to potentially negative information within their possession.” The court observed that “Arena was free to express confidence in FDA approval” and even “might have represented that [it] was working through some requests from the FDA and was confident the data would vindicate lorcaserin.” What the company “could not do was express confidence by claiming that all of the data was running in lorcaserin’s favor,” because “[i]t was not.”
The Ninth Circuit rejected defendants’ claim that the allegations reflected merely “a good-faith scientific disagreement between the FDA and Arena about the meaning of the Rat Study.” The court explained that “the simple fact that Arena had an explanation for its view of the data d[id] not mean investors would not want to know that Arena and the FDA were at odds” concerning the implications of the Rat Study. The court reasoned that “Arena could have remained silent about the dispute or it could have addressed its discussions with the FDA head-on[,] [b]ut it could not represent that there was no controversy here because all the data was favorable.”
Plaintiffs Sufficiently Alleged Scienter
The Ninth Circuit found plaintiffs had “alleged scienter with sufficient particularity to survive a motion to dismiss.” The court explained that plaintiffs’ “theory of fraud [was] not that [d]efendants intentionally misled the market about the objective safety of lorcaserin” but rather, that “[d]efendants intentionally withheld information material to the market’s assessment of whether and when the FDA would likely approve lorcaserin.” Here, the court found “no question” that defendants allegedly “knew that the Rat Study existed” but made no mention of the study when representing that animal studies supported lorcaserin’s safety.