By Mark S. Nelson, J.D.
The Delaware Chancery Court added to Delaware’s string of recent cases finding that shareholder derivative complaints successfully pleaded Caremark claims, which rank among the most difficult claims to plead. In the latest example, the court held that, for purposes of a motion to dismiss, a shareholder derivative complaint sufficiently pleaded that Clovis Oncology, Inc.’s board consciously disregarded red flags about the conduct of a drug trial while also acquiescing in the company’s public reporting of the inflated results of the drug trial. However, the court dismissed counts for unjust enrichment and for breach of fiduciary duty, the latter count being predicated on the “Brophy” theory of improper insider stock sales (In re Clovis Oncology, Inc. Derivative Litigation, October 1, 2019, Slights, J.).
Lung cancer drug trial. The heart of the case appeared to be that Clovis was in close competition with AstraZeneca PLC to develop rival drugs to treat otherwise untreatable forms of lung cancer. AstraZeneca’s drug candidate hit required milestones using “confirmed” results. By contrast, Clovis’s drug candidate routinely missed required milestones as the company attempted to sugar coat trial results for shareholders and the public by reporting a mix of “confirmed” and “unconfirmed” results.
Clovis’s board allegedly disregarded numerous red flags about the drug trial despite having members who possessed experience and expertise in clinical drug trials. During the time frame cited by the complaint, board members signed Clovis’s annual report, which contained inflated drug trial results, and they signed a prospectus for a secondary offering that also contained similarly inflated drug trial results. At one point, Clovis’s chief medical officer abruptly resigned. The company would eventually become the target of private securities class action litigation, an SEC enforcement action, and an FDA investigation.
The complaint further alleged that three of Clovis’s directors and one of its co-founders made suspicious stock sales during the several months leading up to public revelation of the true (dismal) drug trial results and the revelation that the FDA likely would not approve the drug. Clovis’s stock fell precipitously after these revelations were made, wiping out $1 billion in Clovis’s market capitalization. Clovis eventually withdrew its drug application.
Caremark claim pleaded. The gist of a Caremark claim is that a company’s board either did not have oversight systems in place or that it consciously disregarded those systems. The court noted that the language used by Delaware courts to describe the Caremark claim implies the need for a plaintiff to show scienter.
With respect to the first Caremark prong, the court concluded that an allegation that Clovis lacked any oversight systems could not succeed. The court explained that Clovis did have relevant board committees that engaged in general oversight of the company.
But the court’s analysis of the second Caremark prong yielded a different result. Here, the court said the complaint painted a picture of a board that consciously disregarded red flags about Clovis’s conduct of the drug trial. Specifically, the court noted efforts by the company to repeatedly deviate from well-established drug trial procedures common in the industry as well as to flaunt FDA regulations. According to the court, the plaintiffs pleaded “serial non-compliance” with drug trial standards by Clovis that would result in the company’s failure to obtain FDA approval of its drug and spark a stock sell-off that would harm its shareholders.
No Brophy claim. Delaware’s Brophy decision sets the standard for claims that a director breached the duty of loyalty by trading company stock on the basis of material, non-public information. The size and temporal proximity of trades generally will not be enough on their own to plead a Brophy claim, so a complaint must allege scienter. The complaint against Clovis alleged that one of the company’s co-founders (who also is a former Clovis CEO), along with two other directors, engaged in insider trading of Clovis stock in anticipation of the revelation that its drug trial was flawed.
With respect to the former CEO, the court noted that he traded 3,000 shares of Clovis stock multiples times, each time at the start of the month, before the public revelations about the drug trial. The former CEO also retained 90 percent of his Clovis holdings. The court further explained that the two directors cited by the complaint likewise retained 96 percent or more of their Clovis holdings. Moreover, the court noted the lack of any allegations that the insiders’ trading patterns had changed over time.
“In other words, in large measure, notwithstanding their alleged knowledge of the corporate trauma soon to come, each of these Defendants rode over the falls with the rest of Clovis’ stockholders when the corporate storm hit the Company,” said the court. The Brophy claim was, thus, dismissed.
Lastly, the court concluded that the plaintiffs’ allegation of unjust enrichment must be dismissed. That claim, the court noted, lacked any strong ties to the Brophy or Caremark claims. The court also noted that allegations about the Clovis directors’ regular compensation or their profits from Clovis stock sales were equally unavailing.
The case is No. 2017-0222-JRS.