On January 27, 2020, Judge Richard G. Seeborg of the United States District Court for the Northern District of California granted a motion to dismiss a putative securities class action asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, against a pharmaceutical company (the “Company”) and two of its executive officers. Immanuel Lake, et al. v. Zogenix, Inc., et. al., No. 19-cv-01975-RS (N.D. Cal. Jan. 27, 2020). Plaintiffs alleged that defendants made material omissions concerning the Company’s New Drug Application (“NDA”) it was submitting to the U.S. Food and Drug Administration (“FDA”) for a medication designed to treat seizures. According to plaintiffs, the Company’s stock price fell approximately 20% when the alleged omission was revealed to the market through the FDA’s rejection of the NDA. The Court granted defendants’ motion to dismiss, finding that plaintiffs failed to sufficiently allege a misstatement or omission of a material fact and scienter, but granted leave to amend.

The Company, which specializes in developing treatments for people suffering from severe issues affecting the central nervous system, developed a drug to treat forms of childhood-onset epilepsy. The drug, which was the Company’s most promising product candidate, contains an active ingredient called fenfluramine, which was previously approved by the FDA in the 1970s at a higher dose to treat adult obesity. Based on the FDA’s prior approval of fenfluramine, the FDA permitted the Company to submit its NDA through a streamlined process pursuant to Section 505(b)(2) of the Federal Food, Drug, and Cosmetic Act, by which the Company could rely in part on prior studies or publically available literature as part of its application. The market reacted favorably to the Company’s announcement that it was permitted to use the streamlined process and in February 2019, the Company announced that it had “completed its rolling submission” of its NDA to the FDA. However, two months later the Company announced that the FDA rejected the application, because, according to the Company: “(1) ‘certain nonclinical studies were not submitted to assess toxicity’; and (2) ‘the application contained an incorrect version of a clinical study dataset.’” Following the disclosure of the FDA’s rejection, the Company’s stock fell approximately 20% and the Company experienced a one-day market capitalization loss of almost $500 million.

Plaintiffs alleged that the Company misled investors when it announced that “it had completed its NDA filing without also disclosing that it opted not to reference the[] prior toxicity studies . . . .” According to plaintiffs, this was “a material omission that concealed from the market ‘the exceedingly high risk that the FDA would refuse to file the NDA due to the absence of necessary toxicology studies.’” (emphasis in original). Specifically, plaintiffs alleged eight materially misleading omissions, falling within four categories: (1) statements concerning the Company’s completion of its rolling submission of the NDA; (2) statements that the NDA was based on data from two pivotal Phase 3 trials; (3) statements describing the Company’s potential use of the Section 505(b)(2) regulatory pathway; and (4) statements concerning the potential for the FDA to require additional studies.

With respect to the Section 10(b) claim, the Court found that plaintiffs failed to sufficiently allege falsity with the requisite particularity, because plaintiffs’ general allegations that defendants failed to inform the public that the NDA did not include two specific 6- and 9-month fenfluramine toxicity studies constituted “the very sort of fraud-by-hindsight reasoning that the PSLRA was enacted to avoid.”

The Court further stated that “[p]laintiffs appear to assume that defendants knew, at the time of filing the NDA, that the failure to reference [these two studies] made the application facially deficient and created an ‘exceedingly high risk’ of rejection, but plaintiffs pleaded no specific allegations to support this critical assumption.” The Court held that for an omission to be actionable under the securities laws, it must “affirmatively create an impression of a state of affairs that differs in a material way from the one that actually exists[,]” and found that “none of [p]laintiffs’ eight alleged misstatements meets this high bar for a materially misleading omission, primarily because none pretends to discuss what precise prior studies and research on fenfluramine would or would not be included in the NDA.” Notably, the Court indicated that its analysis might be different if plaintiffs had alleged that the Company “omitt[ed] in the NDA any reference to fenfluramine’s prior use in an FDA-approved drug while publicly touting the likely availability of the [streamlined] pathway,” but that plaintiffs’ complaint “does not appear to be making this broader allegation, given the repeated references to 6- and 9-month toxicity studies specifically.” Accordingly, the Court concluded that “a reasonable investor would not have assumed that [the Company’s] NDA would reference each and every prior study and all publicly available literature on fenfluramine,” but rather “would have assumed that [the Company] would make its best efforts to reference those prior studies and research that it thought necessary to gain approval.” As such, the Court found that plaintiffs failed to sufficiently plead that the Company’s “failure to disclose its purported decision to exclude reference to prior 6- and 9-month chronic toxicity studies in its NDA was a material omission within the meaning of the securities laws.” In so holding, the Court emphasized that “were plaintiffs’ version of falsity the law, a pharmaceutical company could be sued for securities fraud each and every time it received a NDA rejection from the FDA,” as plaintiffs could “merely parrot any deficiency identified by the FDA rejection letter and then claim the company concealed from the market that it failed to include this ‘necessary’ piece of information in its application.”

The Court next addressed plaintiffs’ attempt to plead scienter by addressing plaintiffs’ characterization of defendants’ decision to file the NDA without reference to the prior 6- and 9-month toxicity studies as a “deliberate and reckless gamble.” The Court found these allegations did not create a plausible inference of scienter, because there were “no particular allegations in the [complaint] that the FDA informed [the Company] these particular studies were required, nor [were] there specific allegations that defendants intentionally flouted any such guidance.” The Court further noted that “[w]hile ‘motive’ is not, itself, an element of securities fraud and although the absence of a motive is not dispositive, the existence of a plausible motive is directly relevant to the scienter analysis.” The Court added that it could not find a motive for the individual defendants to intentionally or recklessly exclude the studies from the NDA, because as major shareholders, they presumably sustained a meaningful portion of the $500 million loss resulting from the rejection of the application. Further, the Court found that the rationales proposed by plaintiffs for why defendants would jeopardize FDA approval by “excluding required, easily accessible information while also intentionally concealing this decision from the market simply do not hold water,” as “the financial considerations weigh strongly in favor of a[n] innocent explanation, given all defendants presumably stood to benefit financially from a successful NDA.” The Court thus held that plaintiffs did “not plead with any specificity how defendants were supposed to have known that the 6- and 9-month chronic toxicity data was the sine qua non of its NDA, the exclusion of which all but guaranteed rejection.”

Having found that plaintiffs failed to sufficiently plead a securities fraud claim under Section 10(b), the Court dismissed the Section 20(a) control person claims, but granted plaintiffs leave to amend.

Immanuel Lake, et al. v. Zogenix, Inc.