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From Securities Regulation Daily, September 2, 2014

Turnabout lets Botox plaintiffs take on Allergan board anew

By Mark S. Nelson, J.D.

Investors seeking to hold Allergan, Inc.’s (Allergan’s) board responsible for the company’s civil and criminal woes will get another chance to make their case now that the Ninth Circuit has upended a district court ruling that tossed the suit because the derivative plaintiffs failed to allege particularized facts showing why demand on the board should be excused. The Ninth Circuit said the district court fumbled its application of Delaware law and should have drawn inferences for, not against, the plaintiffs. Circuit Judge Stephen Reinhardt, who wrote for the panel, specially concurred to voice worries about the court’s standard of review in future demand futility cases (Rosenbloom, et al v, Pyott, et al, September 2, 2014, Reinhardt, S.).

Rocky road. According to the derivative plaintiffs’ first amended complaint, Allergan’s board was aware the company had aggressively marketed its Botox product for unapproved (i.e., “off-label”) uses, possibly running afoul of federal and state laws. Botox is a purified toxin approved by the FDA during 1989 to 2010 to treat four ailments. Doctors can prescribe the drug for other uses, but the drug’s makers are limited in how they advertise off-label uses.

The derivative case arose from a series of civil and criminal claims made against Allergan in the mid- to late 2000s. Allergan settled three qui tam actions filed in a three-year span beginning in 2007 for $225 million. In 2010, Allergan pleaded guilty to a federal criminal charge of distributing a misbranded drug/biologic and was to pay $375 million in fines. All told, Allergan ended these cases for $600 million, but allegedly kept violating federal drug laws by marketing Botox for off-label uses.

By September of 2010, two sets of plaintiffs sued Allergan’s board in federal court in California and in Delaware’s Chancery Court. The district court in California acted first to dismiss the case because the plaintiffs there failed to make a demand on Allergan’s board. By contrast, the Delaware court found demand to be excused, but was reversed by the state’s high court because collateral estoppel barred that case once the district court in California issued its ruling (Pyott, et al v. Louisiana Municipal Police Employees’ Retirement System, et al, April 4, 2013, Berger, C.; Louisiana Municipal Police Employees’ Retirement System, et al v. Pyott, et al, June 11, 2012, Laster, J.).

Pleading and reviewing futility. The plaintiffs here said demand was excused because Allergan’s board decided to let the company follow a business plan built on a strategy of law breaking. The plaintiffs also said that Allergan’s directors remained willfully mute while knowing (or having constructive knowledge) of the company’s unlawful acts.

In reviewing the district court’s ruling, the Ninth Circuit relied on its own cases telling appeals courts to use the abuse of discretion standard. As a result, the court refused to apply the de novo standard urged by the plaintiffs. The Ninth Circuit also reiterated that while FRCP 23.1 sets the pleading standard for demand futility, the court must apply the substantive law of a company’s state of incorporation in judging if demand is futile (Delaware law here).

The Ninth Circuit said it need not choose between Delaware’s Aronson and Rales/Caremark rubrics based on whether a board did or did not make a decision because both approaches will excuse demand when a majority of a board faces a substantial likelihood of personal liability on a theory of breach of the duty of loyalty. But the court did acknowledge in a footnote that courts have gone both ways in cases, like this one, where directors allegedly were consciously inactive.

Moreover, Circuit Judge Reinhardt wrote for the panel and specially concurred to say he would use the de novo standard to review the district court’s ruling. According to the judge, federal courts routinely use the de novo standard to review the sufficiency of a complaint, so why not use this standard in cases that raise issues under FRCP 23.1 too. He implied that judicial efficiency may favor de novo review despite FRCP 23.1’s “preference” for district court rulings, because district courts are not always better at judging the sufficiency of pleadings than are circuit courts, derivative suits are costly, and dismissal under FRCP 23.1 typically ends a suit.

Judge Reinhardt also noted that the Supreme Court agreed to hear a similar case raising the de novo-versus-abuse-of-discretion issue last year, until that case settled, depriving the court of a chance to issue an opinion. He said the First, Sixth, Seventh, and Eighth circuits use the de novo standard and that the D.C. and Second circuits are worried about the continued use of the abuse of discretion standard. He said some state courts have begun to use de novo review in similar cases, including in Delaware.

Conscious inaction. The circuit court found that demand on Allergan’s board can be excused due to the board’s conscious inaction in dealing with an allegedly unlawful marketing plan. The district court had abused its discretion in reaching the opposite conclusion. In its review, the circuit court ditched a director-by-director analysis of the plaintiffs’ futility arguments because the plaintiffs claimed that a majority of Allergan’s board was involved in most, if not all, of the company’s disputed marketing plans. As a result, the court put the question this way: did the plaintiffs allege a reasonable inference of conscious inaction not unlike scienter?

Moreover, even though the “bare fact[]” that Allergan’s board saw off-label Botox usage as a “top corporate priority” and foresaw a potential marketing goldmine for the company which they hoped might nearly double the drug’s sales, the court briefly acknowledged (and rejected) Allergan’s claim that off-label Botox usage rose unaided by the company’s marketing prowess.

According to the court, the plaintiffs alleged particularized facts showing the Allergan board’s inaction. The plaintiffs said that the board routinely eyed off-label Botox sales and even identified new uses, acquired a company to help sales, knew FDA approval for many uses was unlikely, and engaged in co-promotion/acquisition deals with specialists in fields that promote off-label drugs.

The plaintiffs also alleged that Allergan’s board got data that linked more aggressive marketing efforts with higher off-label sales. Likewise, the FDA had warned Allergan about possibly illegal sales programs that involved misbranding (but not Botox) and an employee quit supposedly due to worries about the company’s marketing plans; the court said these facts could show the board’s inaction. The court also noted allegations that Allergan’s board focused on key products like Botox, and that the company’s sizeable marketing activities continued over many years.

As for the district court’s errors, the Ninth Circuit said that court inaptly viewed the plaintiffs’ allegations apart from each other instead of together and in context. The district court also inappropriately drew inferences for Allergan’s board rather than for the plaintiffs, and the court overstepped by asking the plaintiffs to offer a proverbial “smoking gun” showing the board’s inaction.

By contrast, the Ninth Circuit found Delaware Vice Chancellor J. Travis Laster’s opinion based on nearly identical allegations to be persuasive, even though that opinion was later reversed by the Delaware Supreme Court for reasons unrelated to the merits of the case.

Unlawful B-plan. The Ninth Circuit said it also must reverse the district court’s ruling on the plaintiffs’ related allegation that Allergan’s board sought to carry-out an unlawful business plan. The panel chided the district court’s one-page analysis of this issue in finding the district court abused its discretion.

The plaintiffs here claimed that Allergan’s board saw “red flags” not as a sign the company’s marketing efforts had gone awry, but as showing the company’s efforts in line with its goals. Allergan’s board pointed to the plaintiffs’ inability to cite any formal records showing a desire to break laws and noted the company had policies that barred some off-label marketing practices. The Ninth Circuit said the district court and Allergan both went too far in demanding that the plaintiffs offer even more details at this stage of the case.

Moreover, the Ninth Circuit once again found Vice Chancellor Laster’s now reversed opinion in the Delaware case persuasive. There, the vice chancellor had referred to Allergan’s CEO/chairman as a “hard-charging CEO” who many thought of as “Mr. Botox.” The vice chancellor also found it reasonable to infer that Allergan’s board could have viewed off-label sales as a manageable risk instead of a potential legal liability.

Echoing a passage from Vice Chancellor Laster’s opinion, cited by the panel in footnote 15, the Ninth Circuit said that at the pleading stage one cannot yet tell exactly what transpired in the Allergan case. The most the panel could say is that its holding is limited to finding that the plaintiffs in the California federal case alleged particularized facts showing that demand on Allergan’s board should be excused.

The Ninth Circuit also said the plaintiffs’ appeal from the district court’s refusal to reconsider its earlier ruling is moot. Likewise, the court declined to rule on the Allergan directors’ motion to dismiss because any related (and un-waived) issues can be heard first in the district court on remand

The case is No. 12-55516.

Attorneys: Joseph D. Daley (Robbins Geller Rudman & Dowd LLP), Brian J. Robbins (Robbins Arroyo LLP), Kathleen A. Herkenhoff (The Weiser Law Firm PC) for Willa Rosenbloom, Daniel Himmel, Pompano Beach Police & Firefighters’ Retirement System, and Washington Laborers-Employers Pension Trust a/k/a Western Washington Laborers-Employers Pension Trust. Mark A. Perry (Gibson Dunn & Crutcher) for David E. Pyott, Herbert W. Boyer a/k/a Herbert W. Boyer, M.D., Louis J. Lavigne, Jr., Gavin S. Herbert, Stephen J. Ryan a/k/a Stephen J. Ryan, M.D., Leonard D. Schaeffer, Michael R. Gallagher, Robert A. Ingram, Trevor M. Jones, Ph.D., Dawn E. Hudson, Russell T. Ray, Deborah Dunsire a/k/a Deborah Dunsire, M.D., Handel E. Evans, Ronald M. Cresswell, Louis T. Rosso, Karen R. Osar, and Anthony H. Wild. John C. Hueston (Irell & Manella LLP) for Allergan, Inc.

Companies: Allergan, Inc.; Pompano Beach Police & Firefighters’ Retirement System; Washington Laborers-Employers Pension Trust a/k/a Western Washington Laborers-Employers Pension Trust

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