(Article from Securities Law Alert, June 2020)
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On June 10, 2020, the Ninth Circuit affirmed the dismissal of a securities fraud action alleging that a company made misrepresentations concerning the likelihood of FDA approval for one of its products. Nguyen v. Endologix, 2020 WL 3069776 (9th Cir. 2020) (Bress, C.J.). The court found “plaintiff’s core theory—that the company invested in a U.S. clinical trial and made promising statements about FDA approval, yet knew from its experience in Europe that the FDA would eventually reject the product—has no basis in logic or common experience.” The court determined that “the more plausible inference is that the company made optimistic statements about its prospects for FDA approval because its U.S. testing looked promising, not because the company was quixotically seeking FDA approval for a medical device application it knew was destined for defeat.”
The Ninth Circuit emphasized that “[a]llegations that are implausible do not create a strong inference of scienter.” Here, “[t]he central theory of the complaint is . . . that defendants knew the FDA would not approve [the company’s product], or at least that it would not do so on the timeline defendants were telling the market” because of an “unsolvable” problem with the product. The court found this “theory does not make a whole lot of sense” because it “depends on the supposition that defendants would rather keep the stock price high for a time and then face the inevitable fallout once [the product’s] ‘unsolvable’ . . . problem was revealed.” The court observed that “the theory might have more legs” if plaintiffs alleged that “defendants had sought to profit from this scheme in the interim, such as by selling off their stock or selling the company at a premium.” Because the complaint included no such allegations, the court found plaintiffs’ theory of scienter “does not resonate in common experience.” The court underscored that the Private Securities Litigation Reform Act “neither allows nor requires [courts] to check [their] disbelief at the door.”
The Ninth Circuit found “persuasive” the Fourth Circuit’s decision in Cozzarelli v. Inspire Pharm., 549 F.3d 618 (4th Cir. 2008). There, plaintiffs alleged that company executives made misleading statements concerning the likelihood of success of a drug study even though they knew the study would fail. The Fourth Circuit found it “improbable that [a company] would stake its existence on a drug and a clinical trial that the company thought was doomed to failure.” As in Cozzarelli, the Ninth Circuit determined that “[t]he more plausible inference to be drawn from the allegations in the complaint is that defendants made promising statements about the timing of FDA approval based on the initial results of the U.S. clinical trial, but then modulated their optimism when the results began to raise more questions.” The court concluded that the allegations did not give rise to “a strong inference of scienter.”