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On April 7, 2017, the First Circuit held that defendants’ alleged knowledge of undisclosed facts is not sufficient, standing alone, to raise an inference of scienter. Brennan v. Zafgen, 853 F.3d 606 (1st Cir. 2017) (Stahl, J.). Rather, plaintiffs must also allege that defendants “knew or should have known that their failure to disclose those facts risked misleading investors.”

The case before the First Circuit concerned allegations that a biopharmaceutical company and its CEO failed to disclose two “superficial” adverse events that occurred during clinical trials for the company’s only drug-in-development. Defendants did, however, disclose two “serious” adverse events.

The First Circuit acknowledged defendants’ alleged “awareness of some connection” between the drug and the adverse events based on news and scientific articles. However, the court found defendants’ alleged knowledge insufficient to support an inference that “defendants deliberately or recklessly risked misleading investors by not disclosing the two superficial adverse . . .  events.” The First Circuit found defendants’ “disclosures both before and during the class period weaken[ed] the complaint’s scienter showing.” The court underscored that “defendants disclosed to investors the two serious adverse [ ] events, and noted on several occasions that the company was not going to disclose all adverse events as they occurred.”

The First Circuit also found the “marginal” materiality of the adverse events in question weighed against an inference of scienter. The court emphasized that in Matrixx Initiatives v. Siracusano, 563 U.S. 27 (2011),[1] the Supreme Court held that “the mere existence of reports of adverse events—which says nothing in and of itself about whether the drug is causing the adverse events—will not satisfy” the materiality standard. Id. (quoting Matrixx, 563 U.S. 27). Here, the court found it “unlikely that a reasonable investor . . . would have viewed the two superficial adverse . . . events, at the time they occurred, as having significantly altered the information available to them.”