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From Securities Regulation Daily, March 17, 2015

Split appellate panel revives fraud claims against drug company

By Amanda Maine, J.D.

A divided federal appellate panel remanded a securities class action against a pharmaceutical company to the district court, finding that the court had erred in dismissing the complaint due to lack of scienter. It was not appropriate for the lower court to take judicial notice of SEC filings not mentioned in the complaint, according to the panel. The panel also disagreed with the lower court’s conclusion that the defendants’ statements about the likelihood of FDA approval did not give rise to a strong inference of scienter (Zak v. Chelsea Therapeutics International, Ltd., March 16, 2015, Keenan, B.).

Background. In 2008, pharmaceutical company Chelsea Therapeutics International began trials for its drug Northera, which would be used to treat symptoms of symptomatic neurogenic orthostatic hypotension. One study, named Study 301, showed statistically significant improvement in participants symptoms’, although it only employed a treatment period of one week. Three other studies, Study 302, Study 303, and Study 306, were not successful.  In December 2010, FDA officials warned Chelsea that one study was typically not sufficient to support approval of a new drug. Despite this, Chelsea announced that the FDA agreed that the company’s Northera application could be submitted based on data from Study 301, and in September 2011, Chelsea submitted its application based on the data from Studies 301 and 302.

An FDA staff member prepared a briefing document recommending against the approval of Northera. On February 13, 2012, Chelsea issued a press release stating that the briefing document indicated that there were issues with Northera’s development program. Absent from the press release was the recommendation that Northera not be approved.  Chelsea’s stock price fell 37 percent after the press release was issued, and fell a further 21 percent eight days later when the briefing document became public.

An FDA advisory committee gave its non-binding recommendation in favor of approving Northera on February 23, 2012. However, the FDA denied Chelsea’s application on March 28, 2012, stating that it required an additional successful study.

Lower court dismissal. Chelsea investors sued the company and several corporate officers for securities fraud, claiming that they misled investors to believe that the FDA would approve Northera based on the results of only one successful study. The district court found that the complaint did not adequately plead scienter, stating that because none of the officers sold their shares of Chelsea stock during the class period, any inference of scienter was undermined. Their statements may have been “overly optimistic” about the likelihood of FDA approval for Northera, but this was not enough to establish a strong inference of scienter. The plaintiffs appealed.

Judicial notice. A split Fourth Circuit panel first objected to the lower court’s taking judicial notice of Chelsea’s SEC filings that, according to the defendants, showed that certain officers had not sold their stock during the class period. The panel acknowledged that securities fraud claims are frequently bolstered by demonstrating that defendants made unusual stock sales, but the Chelsea investors made no such allegation.  The SEC filings were not explicitly referenced in the plaintiffs’ complaint, the panel observed, and as such, the district court should not have considered the filings when weighing the sufficiency of the allegations.

Scienter. The panel also disagreed with the lower court’s conclusion that the plaintiffs’ allegations claiming that the defendants intentionally or recklessly failed to disclose that the FDA expected Chelsea to produce two successful studies demonstrating durability of effect did not raise a strong inference of scienter.  None of the defendants’ statements to investors addressed the FDA’s “critical expectation” of two successful studies, even though they were aware of this expectation, the panel held. Also damning to the defendants’ arguments was their failure to disclose in the February 13 press release that the FDA briefing document had recommended against Northera’s approval. The inference of scienter was at least as compelling as the opposing inference that Chelsea had signaled to investors Northera’s weakness and simply failed to provide further details, the panel concluded, and remanded the case to the district court.

Dissent. Judge Thacker disagreed with her colleagues, writing that the allegations suggested that Chelsea submitted its Northera application with justifiable confidence in its chances for success. In her dissent, Judge Thacker emphasized that the PSLRA requires a showing of wrongful intent, which the plaintiffs here failed to do. She noted that, contrary to the plaintiffs’ and the majority’s declaration, the FDA does not require data from two successful studies to gain approval for a new drug. She also observed that the FDA’s advisory committee voted seven-to-four to recommend approval of Northera.  With this in mind, the most compelling inference is not that the Chelsea defendants acted with wrongful intent, but rather, that they believed that the prospects of Northera’s approval were good, according to Judge Thacker.

The case is No. 13-2370.

Attorneys: Richard William Gonnello (Faruqi & Faruqi, LLP) for Roman Zak. Barry M. Kaplan (Wilson Sonsini Goodrich & Rosati) for Chelsea Therapeutics International, Ltd.

Companies: Chelsea Therapeutics International, Ltd.

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