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From Securities Regulation Daily, February 5, 2019

High Court asked to resolve circuit split on duty to update

By Rodney F. Tonkovic, J.D.

Must an issuer update an accurate statement that is made false when circumstances change? A new petition for certiorari argues that the Ninth Circuit got it wrong.

A petition for certiorari seeks to resolve a circuit split on the duty of issuers to update historical statements made misleading by subsequent events. Five circuits recognize a duty to update that may exist under narrow circumstances. The petition maintains that the Ninth Circuit has become a clear outlier in creating a duty to update a statement of historical fact that was accurate when made if subsequent events diminish the "value" or "weight" of that statement (Hagan v. Khoja, February 4, 2019).

District court dismisses. The case was brought by shareholders in Orexigen Therapeutics, which had developed a drug to treat obesity. Acting against FDA guidelines, Orexigen leaked positive initial trial results on several occasions, including in a patent application and in SEC filings. The company continued to tout the positive results in its filings even after further testing (the "50 percent interim results") indicated that those results were no longer valid. Orexigen only commented on the interim results after a third party issued a statement revealing that the results did not show a benefit from the drug.

The district court dismissed most of the claims with prejudice after finding that Orexigen issued sufficient warnings that the initial leaked trial results might not hold up. After oral argument at the Ninth Circuit, Orexigen filed for bankruptcy, so appellate proceedings were stayed for the company itself.

Duty to disclose. The Ninth Circuit reversed, finding that the shareholders sufficiently pleaded that Orexigen executives made misleading statements regarding the initial drug trial results. The court acknowledged that Orexigen's SEC filings did not mention the 50 percent interim results and thus could not have made a misstatement about them. The court then concluded that, while the reported initial results were still accurate, Orexigen was obligated to share new information that "diminished the weight" of those results. The court explained that the initial results suggested great promise and led to higher prices for the company's stocks, and Orexigen had a duty to disclose data showing that the earlier results were not so promising after all.

Circuit split. The petition argues that certiorari is needed to resolve a circuit court split on the duty to update historical statements. The Ninth Circuit has now, in the words of the petition, imposed a duty to update a statement of historical fact that was accurate when made where the "value" or "weight" of that prior statement was later "diminished" by subsequent events. According to the petitioners, the Seventh Circuit rejects any duty to update. The First, Second, Third, Fifth and Eleventh Circuits recognize a limited duty to update, but do not require an issuer to update a statement of historical fact that was accurate when made. The Fourth, Sixth, and Tenth Circuits have not directly addressed the issue. The petition notes that legal scholars have described the case law on this the duty to update "bewildering" and in need of resolution via legislative action or a Supreme Court decision.

The petition also argues that imposing a duty to update an accurate statement of historical fact is illogical. The language of the antifraud provisions, the petition says, only imposes liability on a statement that is false when made; any other conclusion would impose a continuous obligation to disclose, a construct which the Court has rejected at least three times. The securities laws at their core have an ex ante approach, the petition says: a true statement does not become fraudulent when things unexpectedly go wrong.

Finally, the petition observes that the circuit split makes whether an issuer is subject to a duty to update a matter of the plaintiff's chosen forum. The Ninth Circuit, the petition posits, will become "the home province" for duty to update claims and will produce results that are inconsistent with what should be uniform federal securities laws. Moreover, the Ninth Circuit gave no guidance as to what it means for a prior statement to be "diminished" by subsequent events or what should be disclosed and when. Corporate issuers will then be faced with the choice of making continuous disclosures or, more likely, simply making fewer disclosures regarding historical events.

The petition is No. 18-1010.

Attorneys: John Charles Dwyer (Cooley LLP) for Joseph P. Hagan.

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