Tuesday, April 11, 2017

Company disclosed serious adverse events, not required to disclose superficial ones

By Rodney F. Tonkovic, J.D.

A First Circuit panel has affirmed a district court's dismissal of a fraud action against a biopharmaceutical company for failure to plead scienter. The panel held that the complaint's allegations that the company knew about scientific articles linking the company's drug to adverse events showed recklessness and that its officers' insider sales showed a motive to commit fraud did not support a strong inference of scienter. The panel concluded that the district court properly dismissed the claims (Brennan v. Zafgen, Inc., April 7, 2017, Stahl, N.).

Zafgen is a small biopharmaceutical company and the maker of a drug called Beloranib, which was designed to treat severe obesity. In 2013, Zafgen conducted a Phase II trial of Beloranib. In the prospectus for its 2014 IPO, it disclosed that two serious thrombotic (blood-clotting) events occurred during the trial. According to the complaint, however, the company did not disclose two superficial adverse events that also occurred.

In October 2015, Zafgen announced that a patient participating in the Phase III trial of Beloranib had died. During a subsequent conference call with analysts, the company disclosed for the first time that two superficial adverse thrombotic had occurred during the trial, in addition to the previously disclosed serious adverse events. By the close of trading on the day of the announcement, Zafgen's share price had dropped by nearly 51 percent.

In the district court. Investors brought a securities fraud action against Zafgen, Inc. and its CEO in the District of Massachusetts in August 2016. The complaint alleged that Zafgen's disclosures between the IPO and the 2015 announcement contained materially false misrepresentations and omissions because they failed to disclose that four, not two, adverse events occurred during the trial. The court concluded that the allegations were only marginally material, which weakened any inference of scienter.

Affirmed. On appeal, the investors asserted that the district court had improperly applied heightened PSLRA pleading requirements to their complaint. The panel agreed with the lower court that the facts alleged did not give rise to a sufficiently strong inference of scienter.

News articles. The investors first argued that Zafgen knew, or was reckless in not knowing, about news and scientific articles linking Beloranib and adverse thrombotic events. The panel said that the investors' reliance on these articles was misplaced —while the articles could suggest that the company was aware of potential problems with Beloranib, they did not show that it deliberately or recklessly risked misleading investors by not initially disclosing the two superficial events from the Phase II study. The articles, to illustrate, looked at Beloranib's general class of drugs, higher doses, or other uses. Taken together, the articles did not support the contention that Zafgen had information sufficient to form an evaluation about the need to disclose.

Motive. Continuing, the panel found that the complaint's motive allegations were similarly deficient. The investors claimed that Zafgen insiders, armed with the Phase II results, sold substantial amounts of shares in September 2015. The panel agreed with the district court that these allegations were marginal because the Zafgen insiders retained the vast majority of their holdings. Moreover, all of the inside sales occurred before the patient death during the Phase III testing.

Materiality. Finally, the panel said that the marginal materiality of the superficial adverse events bolstered its conclusions about the lack of scienter. According to the panel, it was unlikely that a reasonable investor would have viewed the superficial events as material because even the serious adverse events were not conclusively linked to the Beloranib treatment and only became significant after the later patient death. The panel noted further that Zafgen disclosed the two serious events and said all along that it would not disclose all adverse events as they occurred. The competing inference, then, was that Zafgen disclosed what it considered at the time to be the most relevant information.

The case is No. 16-2057.

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