On May 19, 2022, the United States Court of Appeals for the Ninth Circuit affirmed a district court's dismissal of a putative class action against a pharmaceutical company (the "Company") asserting claims under Section 10(b) of the Securities Exchange Act of 1934. In re Nektar Therapeutics Inc. Sec. Litig., No. 21-15170 (9th Cir. May 19, 2022). Plaintiffs alleged that the Company misled investors about the results of its preliminary trial of the Company's flagship drug when it presented the information without disclosing that outlier data was included in the average. In December 2020, the Northern District of California dismissed the complaint for failure to plead falsity, scienter, or loss causation, which we covered here. The Ninth Circuit affirmed the dismissal, holding that plaintiffs failed to sufficiently explain how the inclusion of the outlier data misled investors, or how the announcement of subsequent trial results caused a loss.
The Company researches and develops new drugs for cancer, autoimmune disease, and chronic pain. Plaintiffs' claims concerned public statements and presentations the Company made about its flagship drug candidate, which stimulates the production of cells that kill infected or malignant cells. During the Phase 1 clinical trial of 28 patients for the drug, the Company reported interim results and presented a chart that showed increases in cancer-fighting cells "by an average of 30-fold" in tumors of ten patients who took the drug. After the Company completed a larger Phase 1/2 trial, it announced that the overall response rate for the drug in treating melanoma declined from the 85% in the Phase 1 trial to only 50% in the Phase 1/2 trial. On the next trading day, the Company's stock dropped 42%, from $90.35 to $52.57. Approximately four months later, an anonymous short-seller's report claimed that the Phase 1 charts showing an average 30-fold increase failed to disclose the presence of an outlier patient whose cancer-fighting cells increased 300-fold and claimed a second chart showed that other patients in the initial trial had much more modest increases in their cancer-fighting cells.
Plaintiffs claimed that the Company misled investors by displaying its 30-fold chart without disclosing the inclusion of outlier data. In addition to the anonymous short-seller's report, plaintiffs also relied on statements from a confidential witness who worked in the Company's Clinical Development Operations, that the patient who saw a 300-fold increase in cancer-fighting cells was the only outlier included in the contested chart, and that without that patient there would have been "nowhere near" the 30-fold increase the Company touted. The confidential witness also described that the Company modified reporting deadlines to include good data and exclude negative data. The district court dismissed the claims for failure to allege falsity, scienter, and loss causation.
The Ninth Circuit affirmed the dismissal for two reasons. First, plaintiffs failed to adequality allege falsity and did not explain with sufficient specificity why the Company's statements about the clinical trial would be materially misleading to investors, even if they did rely on outlier data. Specifically, plaintiffs failed to explain what the data would have been if the outlier had been excluded or even that the outliner 300-fold patient actually was included in the 10-patient average chart they contested. Instead, plaintiffs relied on "vague and hyperbolic assertions" from a confidential witness (such as that the 30-fold chart was "misleading," "deceitful," and "lacking scientific integrity") that failed to provide "some specificity to anchor [plaintiffs'] contentions that investors would find one study outcome to be meaningfully different from another." Moreover, plaintiffs' expert statistical analysis that the patients' fold change could not have been more than 5.55-fold without the outlier patient was provided without any "plausible justification for the assumptions" or reasoning. Finally, plaintiffs failed to show why data without the outlier patient would have been material to a reasonable investor and did not explain how much change in cell production a reasonable investor would have understood to be materially different from the 30-fold increase the Company advertised.
Second, plaintiffs failed to plausibly allege loss causation. The Company's disclosure of its Phase 1/2 trial results did not suggest that the Phase 1 data was improperly manipulated or that the methodology was flawed and did not correct or revise the prior data. Rather, the Phase 1/2 results were simply from "a different and more comprehensive test [that] were not as promising" as the Phase 1 data, "relatively disappointing test results," and "not any revelation of earlier falsehoods." The Court also held that the anonymous short-seller's report could not establish loss causation because short-sellers have a financial incentive to convince others to sell, and the posts contained disclaimers from the authors that they made "no representation as to the accuracy or completeness of the information," and therefore would have been taken with "healthy grain of salt" by the investors and not as revealing false statements.
In affirming the dismissal of the complaint, the Court observed that "[p]harmaceutical companies often suffer setbacks in their clinical trials after earlier testing offered highly promising results." Such disappointments are "the nature of the industry," and "it does not necessarily mean that a pharmaceutical company committed securities fraud."
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