On November 22, 2020, Judge Howard C. Nielson, Jr. of the United States District Court for the District of Utah dismissed with prejudice a putative class action asserting claims under the Securities Exchange Act of 1934 against a biotechnology company and certain of its executives. In re PolarityTE, Inc. Sec. Litig., No. 2:18-cv-00510, 2020 WL 6873798 (D. Utah Nov. 22, 2020). Plaintiffs alleged that the company made material misstatements in the course of a reverse merger and in subsequent SEC filings. The Court held that plaintiffs failed to adequately allege falsity with respect to certain challenged statements and failed to establish loss causation for the remainder.
Plaintiffs alleged that the company made misstatements concerning: (1) the company's registration of a product with the FDA under a particular provision of the Public Health Service Act, which the company ultimately abandoned and refiled under a different provision after the FDA disagreed with the company's original approach, id. at *3-4; (2) the quality of the company's manufacturing facilities, in light of violations reported by the FDA, id. at *4; (3) the company's patents, including with respect to an application for which the company had received a non-final rejection a week before the merger closed and subsequently received a final rejection, id. at *2; and (4) the non-existence of any “pending or contemplated government proceedings” against the company, in light of the company having received a document request from the SEC after reporting to the SEC suspicious trading of its stock. Id. at *5.
The Court first assessed the company's statements regarding its product's registration with the FDA and concluded that plaintiffs “likely failed” to allege a material misstatement, id. at *8, because the challenged statements were either true (to the extent they preceded the company's announcement that it intended to proceed under a different regulatory scheme) or constituted statements of opinion as to whether it was appropriate to pursue registration under the framework originally chosen by the company. Id. at *8. The Court further stated that plaintiffs “likely fail[ed]” to allege that the company lacked any factual basis for its opinions, thus rendering the opinions nonactionable. Id.
The Court did not, however, definitively determine whether a material misrepresentation had been alleged with regard to the registration issues, relying instead on its conclusion that plaintiffs failed to allege loss causation because the purported corrective disclosures (articles published regarding the company) relied on information previously disclosed to the market. Id. at *9. While noting that the Tenth Circuit had not squarely addressed the issue, the Court observed that other Circuits have held that, to qualify as a corrective disclosure, the disclosure must reveal non-public information. Id. at *6. Here, however, the articles plaintiffs relied upon did not actually reveal any then-undisclosed facts; instead, all the materials the articles referenced were publicly available. Id. at *9. Furthermore, the Court explained that, although some courts have ruled that “expert analysis” of publicly available information could constitute a corrective disclosure, there was no indication that the authors of the articles relied upon by plaintiffs had any expertise beyond that of careful investors. Id.
The Court next assessed plaintiffs' allegations that the company's statements concerning the quality of its manufacturing facilities were materially misleading because the FDA had reported violations in July 2018. Id. at *10. The Court concluded that the challenged statements were either puffery or, in any event, plaintiffs failed to allege how the statements were rendered false by the FDA's findings. Id. While noting that the company had received the FDA's report before the challenged statements were made, the Court emphasized that the FDA had not made a final determination at the time, and that ultimately the FDA closed the inspection indicating that “the allegedly objectionable conditions [did] not meet the threshold of regulatory significance.” Id. Furthermore, the Court noted that two months passed between the FDA's inspection and the statements in question, during which time it “appear[ed] that [the company] had made at least some improvements to its processes” in response to the FDA's concerns. Id. at *11. In light of those circumstances, the Court concluded that the FDA's report “does not support a reasonable inference” that the individual who made the statements “did not believe the ‘puffing' statements of ‘corporate optimism.'” Id. at *11.
Turning to statements concerning the company's patents, the Court first noted that statements by the company that its products were subject to pending patent applications were true. Id. To the extent the company erroneously described certain technology as “patented,” the Court reasoned that those statements were immaterial because other company statements made clear that the technology at issue was not presently protected by existing patents but was rather the subject of pending patent applications. Id. The Court reasoned that, to the extent these statements were conflicting, that would have given “a reasonable investor sufficient pause to warrant independent verification.” Id. at *12. While the Court thus concluded that plaintiffs “likely failed” to adequately allege a material misstatement, id. at *11, it held that, regardless, plaintiffs again failed to adequately allege loss causation because the articles relied on as corrective disclosures were based on previously available information. Id. at *12.
Finally, the Court rejected plaintiffs' argument that the company's statements about not being subject to any pending or contemplated governmental proceedings were false because the company had received a document request from the SEC. Id. at *13. The Court concluded that “an isolated document request is not an investigation,” and, in context, it was not reasonable to believe the company should have expected the SEC to conduct an investigation based on the request received. Id. The Court also observed that, even if an investigation had been contemplated, the company's statement was not false because “[a]n investigation on its own is not a ‘pending legal proceeding,'” and the SEC had not informed the company that it was contemplating further action. Id.
Because plaintiffs had not filed a motion seeking leave to amend, the Court dismissed the action with prejudice. Id.
Originally Published by Shearman & Sterling, November 2020
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