The recent First Circuit decision in Fire and Police Pension Ass’n v. Abiomed, Inc., No. 14-1502, is noteworthy for its unusual mix of scienter and materiality analysis to affirm dismissal of a section 10(b) securities class action. Ultimately, the court affirmed dismissal for the lack of sufficient scienter allegations under the heightened pleading standard of the Private Litigation Securities Reform Act (PSLRA), but it was the court’s mixing of scienter and materiality considerations that provokes interest. The court also made it clear that a securities fraud claim cannot be based on an alleged failure to disclose misconduct while the resolution of the matters at issue with regulators remain uncertain. A copy of the opinion is available here: Fire and Police Pension Ass’n v. Abiomed Inc.
The claims were founded on allegations that Abiomed, Inc., which sells medical devices, made misrepresentations about the Impella 2.5, a micro heart pump, which was Abiomed’s most important product. The alleged misrepresentations and omissions related to interactions between Abiomed and the FDA regarding marketing used to promote the Impella 2.5, and the possible promotion of off “off-label” uses of the device, that is, uses for purposes beyond those approved by the FDA.
The gist of the complaint was that Abiomed failed to disclose in its SEC filings several FDA communications warning about possible marketing and advertising improprieties, and failed to disclose that its revenues from the sales of that device were achieved in violation of FDA rules. After ongoing communications between Abiomed and the FDA in 2010-2012, two things occurred. In November 2012, Abiomed disclosed that federal prosecutors were investigating Abiomed’s promotional and marketing practices and published revised revenue projections, which was followed by a significant decline in stock price. And in February 2013, the FDA gave Abiomed a “Close-Out Letter” stating its concerns had been adequately addressed by the company, and afterward, the stock price recovered its earlier losses.
The court noted that although it was “far from clear” that “plaintiffs plausibly alleged that “defendants made false or misleading statements which had a material effect on Abiomed’s stock price,” it was affirming the district court’s ruling that the plaintiffs did not sufficiently allege that defendants made those statements with a “conscious intent to defraud or ‘a high degree of recklessness.’” Slip op. at 4 (quoting ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 58 (1st Cir. 2008)).
The court’s consideration of the materiality of the alleged misstatements played a significant role in its scienter analysis. The court wrote:
We do address the strength of the materiality of the statements because “[t]he question of whether a plaintiff has pled facts supporting a strong inference of scienter has an obvious connection to the question of the extent to which the omitted information is material.” . . . “If it is questionable whether a fact is material or its materiality is marginal, that tends to undercut the argument that defendants acted with the requisite intent or extreme recklessness in not disclosing the fact.” . . . The materiality of the impugned omission here — Abiomed’s failure to state that some of the increased revenues were due to off-label marketing — is marginal at best. Plaintiffs’ contention that the omission would have mattered to a reasonable investor depends on a long chain of inferences, most of which are not sufficiently substantiated by the allegations in the complaint.
Slip op. at 29 (citations omitted). The court also took note that Abiomed’s disclosures explicitly warned about the FDA’s marketing concerns, including disclosures that concerns raised in FDA Warning Letters could have serious consequences. Id. at 31-32.
Defense counsel should take particular note of the court’s response to the allegation that “Abiomed should have affirmatively admitted widespread wrongdoing rather than stating that the outcome of its regulatory back-and-forth with the FDA was uncertain.” Slip op. at 32. Class action complaints often allege fraud based on a failure to disclose that matters involving regulatory uncertainty (or other uncertainties) should have been disclosed as company shortcomings. But the court here correctly noted that this approach would improperly mandate potentially misleading disclosures of uncertain future events:
That would be a perverse result; such an admission would have been misleading, since the off-label marketing issues had the potential to be resolved with no adverse action from the FDA. We made a similar point in In re Boston Scientific Corp. Securities Litigation, 686 F.3d 21 (1st Cir. 2012), where we noted that “a company may behave ‘irresponsibly’ if it issues an ominous warning about an uncertain risk that ‘had not yet been adequately investigated.’” Id. at 31. … There must be some room for give and take between a regulated entity and its regulator.
Id. at 32-33.
The opinion also addresses allegations of statements by so-called “confidential witnesses,” whose statements about the company’s operations did not support scienter because the alleged roles of these persons did not put them in a position to provide information about the knowledge and intent of company management. See id. at 35-36. The court likewise found allegations of stock sales by insiders insufficient to support scienter because the facts alleged did not show unusual or suspicious trading. See id. at 36-38.
But the two key takeaways from this opinion are: (1) that even without showing alleged misrepresentations were immaterial as a matter of law – which is often tough on a motion to dismiss – defendants can use doubts about materiality to support arguments that scienter is not sufficiently supported under the PSLRA standard; and (2) that allegations of failure to disclose regulatory concerns fall short of fraud when the matters are being actively discussed with law enforcement authorities and it remains uncertain whether they can be resolved without any enforcement action.
January 12, 2005
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