On August 21, 2018, Judge Kevin McNulty of the United States District Court for the District of New Jersey dismissed a putative class action against Galena Biopharma Inc. and several of its officers and employees that alleged defendants failed to make appropriate disclosures about the source of revenues associated with an opioid pain medication manufactured by Galena. In re Galena Biopharma, Inc. Sec. Litig., 2018 WL 3993453 (D.N.J. Aug. 21, 2018). Plaintiffs alleged that these omissions violated Item 303 of SEC Regulation S-K or, in the alternative, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. The Court held that, although plaintiffs had “identified several troubling practices regarding Galena,” the complaint failed to state a securities fraud claim and dismissed the complaint with leave to replead.
Plaintiffs alleged that 30 percent of the revenues from the drug were driven by two doctor-shareholders who (i) owned $1.6 million worth of company stock, (ii) were prescribing the drug for off-label purposes at pain management clinics that they ran, and (iii) also received kickbacks from Galena for selling the drug at a pharmacy they owned. Plaintiffs alleged that Galena knew but failed to disclose that its reported financial results were not indicative of future performance due to the drug’s sales being overwhelmingly, and unsustainably, driven by the two doctor-shareholder’s off-label prescriptions. Plaintiffs alleged that the eventual disclosure of the doctor-shareholder’s activities caused Galena’s stock price to drop.
Item 303 requires disclosure of any known trends or uncertainties that the registrant reasonably expects will have a material impact on net sales, revenues, or income from continuing operations. Plaintiffs alleged that defendants’ omissions violated Item 303, rendering defendants liable under Item 303 or, alternatively, under Section 10(b) and Rule 10b-5. With respect to Item 303, the Court held that the Third Circuit’s decision in Oran v. Stafford, 226 F.3d 275, 285-86 (3d Cir. 2000), foreclosed a private right of action under Item 303. 2018 WL 3993453, at *10. However, the Court continued, under Oran, a violation of Item 303’s reporting requirements could form the basis of a private securities suit if a duty to disclose is separately shown. Id. As to this question, the Court considered the Ninth Circuit’s decision in In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046, 1054 (9th Cir. 2014), which held that, to be actionable, an omitted fact under Item 303 must meet the materiality requirements of Rule 10b-5; in other words, its disclosure must be necessary in order to make the company’s statements, in light of the circumstances under which they were made, not misleading. The Court also considered the Second Circuit’s decision in Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 103 (2d Cir. 2015), which the Court characterized as more “plaintiff-friendly,” because it held that Item 303 creates an enforceable duty to disclose trends and uncertainties; as a result, the omission of material information from an Item 303 form can itself be the basis of a Rule 10b-5 claim, without regard to whether the omission rendered other corporate statements misleading. The Court concluded that the Ninth Circuit’s holding was truer to Oran, and thus held that an omission in the context of Item 303 can give rise to a Rule 10b-5 claim only if the Item 303 omission renders other statements materially misleading.
The Court determined, however, that plaintiffs’ complaint did not clearly, factually allege that defendants made material omissions under Item 303 that rendered other disclosures, such as earnings and revenue statements, materially misleading. Thus, the complaint failed to state a Rule 10b-5 claim with the requisite specificity. Id. at *11. In this regard, the Court found that plaintiffs’ theory of liability “shifts and remains unclear throughout the complaint,” id. at *8, and the complaint thus failed to plead the alleged fraud on a statement-by-statement basis. Because plaintiffs “d[id] not clearly connect each allegedly false statement to each theory,” the complaint did not satisfy the particularity requirements of the PSLRA. Id. at *11. Plaintiffs were, however, granted leave to replead.