On December 10, 2019, Judge Jennifer A. Dorsey of the United States District Court for the District of Nevada denied a motion to dismiss a putative securities class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 against a life science company specializing in cannabidiols (“CBD”) and certain of the company’s executives. In re CV Sciences, Inc. Sec. Litig., 2019 WL 6718086 (D. Nev. Dec. 10, 2019). Plaintiffs alleged that the company made misleading statements that a CBD product was proprietary and had a patent application pending by failing to disclose that the U.S. Patent and Trademark Office (“USPTO”) had rejected its patent application twice, including a “final rejection” on the ground that the proposed invention was obvious. Id. at *1. The Court held that plaintiffs had sufficiently alleged the falsity of the alleged misrepresentations at the motion-to-dismiss stage, and therefore declined to dismiss the complaint.
Defendants argued that statements that its product was “patent-pending,” “patent-protectable,” and “proprietary” were not material misrepresentations because the patent application process often extends beyond a “final rejection” by the USPTO to include appeals, and because the word “proprietary” was non-actionable puffery. Id. at *4. Plaintiffs countered that in the context of the USPTO rejections such statements were misleading, and both sides submitted statistics regarding the percentage of patent applications that are ultimately approved after receiving a “final” rejection. Id. In light of these “dueling statistics,” the Court determined that whether a reasonable investor would believe that a patent remains pending after a final rejection but before potential appeals have been exhausted would require discovery and expert testimony and, therefore, could not be resolved on the pleadings. Id.
The Court also rejected defendants’ argument that the alleged misrepresentations were protected under the PSLRA “safe harbor” provision as forward-looking statements accompanied by meaningful cautionary language.Id. at *6.Although, the Court noted, statements that a product is “patent-protectable” and “proprietary” may appear to be forward-looking, plaintiffs had alleged that the “contingency those statements refer to was already resolved” by the patent rejections, and the statements were therefore not protected under the PSLRA safe harbor.Id. at *7.
In addition, the Court rejected defendants’ theory that the “truth-on-the-market defense” would bar plaintiffs’ claims because the patent rejections were publicly posted on the USPTO’s website.Id. at *5.The Court emphasized that, under Ninth Circuit precedent, the “truth-on-the-market” defense would only excuse insiders’ failure to disclose material information if that information was separately conveyed to the public “with a degree of intensity and credibility sufficient to effectively counter-balance any misleading impression created by the insiders’ one-sided representations.”Id. (citing In re Apple Computer Sec. Lit., 886 F.2d 1109, 1115 (9th Cir. 1989)).In light of plaintiffs’ allegations that defendants “repeatedly reassured investors over an extended period of time,” the Court concluded that it was unable to resolve at this stage whether publication of patent rejections on the USPTO website was sufficient to counter-balance any false impression created by defendants’ statements.Id.
The Court also held that plaintiffs had adequately alleged scienter.The Court noted that defendants conceded that they had knowledge of the patent rejections.Id.As such, applying the core operations theory—under which courts can infer that facts critical to a business’s core operations are known to key officers—the Court determined that defendants’ knowledge of the rejections “raises a strong inference of scienter on its own, and it is at least as strong as any opposing inference that the defendants lacked the requisite state of mind.”Id. Turning to the issue of loss causation, the Court concluded that plaintiffs adequately pleaded loss causation because they alleged the company’s stock price fell by more than half once it was reported that the company’s patent applications had been twice rejected.Id. at *6.While defendants argued that the company’s stock price recovered after the fall, the Court emphasized that the stock could have recovered for other reasons and therefore dismissal on that basis was not appropriate.Id. at *5.The Court also rejected defendants’ attempt to apply a provision of the PSLRA limiting damages depending on the trading price during a 90-day period following a corrective disclosure.Id. at *5.The Court noted that consideration of the applicability of this provision was more appropriate on a class certification or summary judgment motion, supported by expert testimony, and therefore denied this aspect of the motion to dismiss without prejudice.Id