First Circuit Sides with Pharmaceutical Manufacturer in Dismissing Shareholder Class Action
In a huge victory for Massachusetts-based biologics manufacturer Genzyme Corporation, the First Circuit Court of Appeals on June 5, 2014 affirmed the District Court’s dismissal of a multi-million dollar shareholder class action stemming from allegedly misleading statements regarding the approval prospects for one of its best-selling drugs. Deka Int’l S.A. Luxembourg v. Genzyme Corp. (In re Genzyme Corp. Secs. Lit.), — F.3d —, 2014 WL 2535076 (1st Cir. June 5, 2014).
The Court found that the allegations in the complaint failed to satisfy the “exacting standards” of the Private Securities Litigation Reform Act (“PSLRA”), which requires securities fraud complaints to contain allegations sufficient to create a “strong inference” of fraudulent intent. The Court held that the plaintiffs’ allegations lent themselves to a number of equally—if not more—compelling inferences that Genzyme executives acted innocently.
“Ill Organized and Convoluted” Complaint
The lawsuit stemmed from a plunge in Genzyme stock, which followed various disclosures throughout 2008 and 2009 regarding the fate of one of Genzyme’s FDA approval applications. Genzyme manufactures and markets drugs known as “biologics,” or drugs derived from biological sources rather than through chemical processes. In April 2006, the FDA granted Genzyme’s “biologics license application” (“BLA”), and approved the manufacture of “Myozene,” a biologic used in the treatment of a rare metabolic disorder called Pompe disease. The approval permitted Genzyme to manufacture Myozene only on a small scale—using 160-liter “bioreactors.” However, after realizing Genzyme needed to ramp up output to meet rising demand, the company in 2007 filed a “supplemental” BLA seeking FDA approval to manufacture “Lumizyme,” or Myozene created in larger, 2,000-liter bioreactors.
According to the plaintiffs, Genzyme executives repeatedly misled investors about the fate of the Lumizyme supplemental BLA, concealing key red flags about the drug’s approval prospects and in the process artificially inflating Genzyme stock. They charged the defendants with violations of Sections 10(b) and 20(a) of the Securities Exchange Act.
The Court, however, said the complaint was an “ill organized and convoluted collection of 364 paragraphs” that failed to “muster sufficient strength to meet the formidable pleading standard set by Congress for securities fraud claims under Section 10(b).”
“Forward-Looking Projections” Not Actionable Under Section 10(b)
First, plaintiffs alleged the defendants failed to disclose a report from an October 2008 FDA inspection for its Allston, Massachusetts facility that “observed” several potential deviations from biologics manufacturing standards. According to the plaintiffs, Genyzme intentionally failed to mention the FDA’s report during an October 22, 2008 conference call, despite being aware of its importance to investors. In fact, Genzyme failed to disclose the FDA’s report until March 2, 2009, after it received a “Formal Warning Letter” from the FDA reiterating a number of issues from its October 2008 report, along with a “Complete Response Letter” stating Lumizyme approval was being withheld pending those issues’ resolution.
The Court held that the allegations—rather than supporting an inference of fraudulent intent—supported an alternative, equally plausible theory: that the defendants ultimately disclosed the FDA’s inspection report once its relevance “became apparent” to Genzyme. The Court noted that Section 10(b) only imposes an affirmative duty to disclose information that is necessary to render earlier-disclosed information not misleading. Here, Genzyme had no reason to suspect it had previously misled investors about Lumizyme’s approval prospects until it received the February Warning Letter and the first Complete Response Letter, which “crystalized the relevance” of the FDA’s October 2008 report. This, along with the merely “observational” nature of the FDA’s October 2008 report, meant that Genzyme had no cause to believe that Lumizyme’s approval prospects were anything but solid.
Second, the plaintiffs alleged that the defendants fraudulently failed to disclose “bioreactor failure events” at two of its facilities, which purportedly jeopardized Lumizyme’s approval prospects. But the Court said the failures “bore no relation” to Lumizyme’s approval. Further, Genzyme launched an internal investigation into the failures and disclosed its findings as soon as it ascertained the failures’ cause. The Court, admonishing that “a corporation cannot be expected to inform the market of any and all developments that might possibly affect stock value,” held that it was proper for Genzyme to open an inquiry and “wait for a complete picture to become apparent” before making any formal announcements.
Third, the plaintiffs asserted generally that the defendants deceived the market by falsely assuring investors that Lumizyme’s BLA would be approved. For example, a Genzyme Vice President had told investors the likelihood of approval “seemed” to be “taking a more solid shape,” and Genzyme’s CEO stated Genzyme was “working very hard with the FDA to get everything done.” But the Court held that although the defendants used “rather rosy language to express optimism,” this language was “far from categorical” and made clear that approval “would be months away.” Genzyme’s communications “were accompanied, and supplemented, by full and prompt disclosure of all relevant communications from the FDA, . . . as well as revised earnings projections.” Accordingly, these were “mere forward-looking projections that [were] not actionable Section 10(b) transgressions.”
The Final Blow
The Court delivered the final blow to plaintiffs in denying their motion for leave to amend the complaint. Plaintiffs wanted to add new facts that allegedly strengthened their case as to the defendants’ fraudulent intent. Most of this information, however, was concededly available before the District Court’s decision—which occurred two years after the complaint was filed. In other words, the plaintiffs had two years to present their new facts but failed to seize on that opportunity.
The Court did express “discomfort” with the District Court’s decision to dismiss the complaint without prejudice. It cautioned that the PSRLA did not alter the “liberal amendment policy” of the Federal Rules of Civil Procedure. Nevertheless, it was “within the bounds of the district court’s discretion” to do so, and the Court was not at liberty to alter that decision. This, of course, being no consolation for the plaintiffs, whose chances for recovery have been snuffed out completely.