KEY DISCLOSURE ISSUES FOR LIFE SCIENCES COMPANIES: FDA
PRODUCT APPROVAL, CLINICAL TEST RESULTS,
AND GOVERNMENT INSPECTIONS†
William O. Fisher*
Cite as: William O. Fisher, Key Disclosure Issues
for Life Sciences
Companies: FDA Product Approval, Clinical Test Results,
and Government Inspections,
8
available at http://www.mttlr.org/voleight/Fisher.pdf
I. Predicting FDA Approval
A. When Is a Prediction
False?
B. The Private Securities Litigation Reform Act
Protections for Predictions: Cautionary Language
and Liability Only for Knowing Falsity
C. Express
Predictions of FDA Approval
D. Financial
Projections Anticipating FDA Approvals
E. Final Thoughts on
Predictions of FDA Approval
II. Disclosing
Test Results
A. The Possible
Ambiguity of Test Results
B. Disclosing
Positive Test Results
1. Disclosing
Selected Information
About Clinical Tests
2. Addressing
Internal Disagreements
Over Test Results
3. Confusion
Created by Publication of “Hard”
Information From Clinical Trials
C. Disclosing
Negative Test Results
1. When
Negative Results Become Material
2. When
a Company Must Disclose Material
Negative Results
D. Insider Trading
Based on Unpublished Test Results
and FDA Approvals
III. Disclosing FDA Actions and Disclosing
Communications with the FDA
A. FDA Questions and
Comments About Tests
B. Company
Characterization of Interim FDA Action
C. Disclosing
Application Denials
IV. Disclosing and Commenting on Government
Inspections, Investigations and Prosecutions
A. Materiality
B. Duty To Disclose
C. How To Phrase a
Disclosure
Conclusion
The government, particularly the Food and Drug Administration (“FDA”), heavily regulates the life sciences industry. FDA actions can have an extraordinary influence on the fortunes of biotechnology companies. Timely FDA approval of a drug or medical device can permit a company to exploit an inviting market window. FDA product approval is, in turn, tied to clinical test results which demonstrate “efficacy” and safety. Delayed approval, unfavorable test results, or the denial of an FDA application may ruin a company.
Beyond the FDA product approval process and related testing lie FDA inspections and the possibility that the government will investigate charges such as the submission of false data. Problems found by inspection or revealed by investigation can, in turn, influence FDA action on further product approvals.
All of this makes regulatory events and clinical testing matters of great concern to both the managers of life sciences companies and investors in those companies. What biotechnology companies disclose—and decide against disclosing—about such events can influence the price of those companies’ stocks. These disclosure decisions, therefore, can have important securities law implications. Inaccurate statements—and, under some circumstances, decisions to keep information about regulatory and testing developments within the company rather than including it in a public statement—may lead to private lawsuits, Securities and Exchange Commission (“SEC”) enforcement actions, and even criminal prosecutions.
This article addresses issues arising from disclosures about:
a) FDA product approval, particularly predictions about such approval;
b) Clinical tests;
c) Communications with the FDA before product approval; and
d) FDA inspections, government investigations, and the possible consequences of such actions.
The recent adoption of Regulation FD[1] emphasizes that life sciences companies must communicate information on these four key subjects directly, often making announcements in these critical areas to a market that has not been alerted by analysts who have anticipated the news. All of this increases the pressure on biotech executives who address the investment community.
The Private Securities Litigation Reform Act (the “Reform Act”)[2] does not remove the possibility that shareholders will sue on allegations of inaccurate or incomplete disclosures. Some Reform Act protections require disclosing companies to take affirmative steps. Life sciences executives can find it difficult, in the particular circumstances they face, to take full advantage of the Reform Act’s necessarily general provisions. Moreover, the Reform Act applies only to private suits by shareholders, not to enforcement actions by the SEC, which has been active in the biotech arena.[3]
FDA approval is critical to a biotechnology product. Investors want to know when such approval is likely. While there is no requirement that life sciences companies forecast when the FDA will approve a product or even the timing of intermediate events in the FDA application process,[4] companies may nevertheless make predictions about approval to keep shareholders informed. Even putting aside express predictions of FDA action, biotech companies releasing financial forecasts frequently base those predictions on assumptions about FDA approval.[5]
A company must make a “false” statement in order to be
liable under the securities laws. The mere circumstances that a company
predicts the FDA will approve a given product by a stated date, and that date
passes without any such approval, do not combine to make the prediction necessarily
“false.” A prediction is not “false” under the securities laws simply because
it does not come true[6] or because in hindsight a different
prediction would have been a more reasonable forecast.[7] Courts find a prediction “false” if at
the time the company made the prediction there was no good faith, reasonable,
objective basis for it, or (under some tests) if those making a forecast knew
some undisclosed fact that seriously threatened the predicted event.[8]
The Reform Act added sections to both the Securities Act of 1933 and the Securities Exchange Act of 1934 to provide a “safe harbor” for “forward-looking statements” that SEC-filing companies make.[9] Predictions of FDA approval should fall within the statute’s definition of “forward-looking statements.”[10]
The safe harbor provides two principal protections. First, a company is not liable for a forward-looking statement that is identified as such “and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially” from those predicted.[11] Second, the Reform Act restricts the companies and executives liable for predictions to those who meet a high and strict standard of culpability. Where a life sciences company makes a prediction outside offering documents, shareholders are most likely to challenge the prediction in a private securities lawsuit under section 10(b) of the Securities Exchange Act and SEC Rule 10b-5.[12] In addition to falsity, plaintiffs in such lawsuits must plead and prove that the defendants had “scienter,” which the Supreme Court has defined to mean “a mental state embracing intent to deceive, manipulate, or defraud.”[13] A majority of circuit courts have held that scienter encompasses some form of extreme recklessness.[14] Under the Reform Act, however, a company and its executives are not liable for a “forward-looking statement” in a private shareholder lawsuit unless the plaintiff pleads and proves that the defendants made the statement “with actual knowledge . . . that [it] was false or misleading.”[15]
Turning to the first protection, if a life sciences enterprise accompanies a forward-looking statement predicting FDA approval with “meaningful cautionary” language, the company should be able to dismiss a lawsuit based on the circumstance that FDA approval did not materialize at the predicted time. This should be true regardless of plaintiffs’ allegations about the defendants’ mental state when they made the prediction, and regardless of whether the factors expressly identified by the company’s cautionary language were the ones that eventually caused the FDA to delay or deny approval. Congress expected
that the cautionary statements [will] identify important factors that could cause results to differ materially—but not all factors. Failure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor. The Conference Committee specifies that the cautionary statements identify “important” factors to provide guidance to issuers and [this is] not to provide an opportunity for plaintiff counsel to conduct discovery on what factors were known to the issuer at the time the forward-looking statement was made.
The use of the words “meaningful” and “important factors” are intended to provide a standard for the types of cautionary statements upon which a court may, where appropriate, decide a motion to dismiss, without examining the state of mind of the defendant. The first prong of the safe harbor requires courts to examine only the cautionary statement accompanying the forward-looking statement. Courts should not examine the state of mind of the person making the statement.[16]
As significant as this first protection is, it is uncertain how effective it will be in stopping lawsuits based upon inaccurate forecasts of FDA approval. The Conference Report made this comment on the cautionary language needed to bring the first protection into play:
[B]oiler plate warnings will not suffice . . . . The cautionary statements must convey substantive information about factors that realistically could cause results to differ materially from those projected in the forward-looking statement, such as, for example, information about the issuer’s business.[17]
The central question is what cautionary language courts will find “meaningful” and what they will consider “boilerplate.” As this article sets out below, some pre-Reform Act decisions considering the “bespeaks caution” defense gave short shrift to express warnings that the company was not making bankable predictions about FDA actions.[18] While the Reform Act’s first protection for forward-looking statements is stronger than the “bespeaks caution” doctrine,[19] it remains unclear what language will suffice to shield forecasts from future lawsuits.
In re PLC Systems, Inc. Securities Litigation[20] applies this first protection. The opinion found a number of statements, including that the company believed its FDA application was “on track for approval this year,” to be within the Reform Act’s safe harbor.[21] The court quoted the following words as an example of the cautionary language PLC had included in a 10-Q filing:
Although The Heart Laser has been granted “expedited review” by the [FDA], given the current uncertainties of the time required by the FDA to approve a Pre-market Approval (“PMA”) application, the Company cannot project when, if at all, such approval would be granted. Until PMA approval, continued profitability will likely be determined by the number of international shipments and the related mix of sales and placements.[22]
Whether another court would find such language adequate to invoke Reform Act protection might well depend on the court’s view of whether such phrases provide, under the circumstances, a fair warning. Life sciences companies may wish to include additional details, cautioning investors that FDA approval is contingent on many factors—including clinical test results and the evaluation of those results[23]—that make it impossible to accurately predict when or whether the FDA will approve the drugs or devices that the companies are developing. Companies may wish to add further details, including that tests are based upon certain protocols and are subject to human errors; that there may be several ways in which to evaluate test results; and that even if the companies conclude that tests provide evidence of a drug’s or device’s effectiveness and safety, the agency may not agree because it may conclude that the protocols were not sufficiently enforced, may evaluate the significance of the test results differently, or may take a different view concerning the effect of any human errors on those results during the trials.
While the first Reform Act protection for forward-looking
statements is straightforward and objective, the second protection—no liability
absent “actual knowledge” that the prediction is false and misleading—implicates
the defendant’s mental state. The Reform Act requires that 10b-5 plaintiffs
plead “with particularity facts giving rise to a strong inference that the
defendant acted with the required state of mind.”[24]
Defendants may test such pleading with a motion to dismiss before any discovery
occurs because the Act imposes a discovery stay during the pendency of such
motions.[25]
Many decisions interpret the “particularity” requirement strictly so that, without any discovery, plaintiffs relying on “internal” documents or discussions to show that defendants knew damning facts need to identify and describe those documents or discussions in significant detail.[26] Even pre-Reform Act cases evinced concern that plaintiffs should plead the details of internal documents instead of referring to them generally.[27] Moreover, to the extent that plaintiffs rely on oral information, under the Reform Act they must plead some facts about their sources,[28] although the required particularity of identification is still in dispute.[29]
Putting all of this together, the Reform Act requires plaintiffs attacking predictions of FDA approval to, at the outset of the case and without any discovery, plead factual details giving rise to a strong inference that defendants had “actual knowledge” that the prediction was false or misleading.[30] Plaintiffs will find this a substantial hurdle to clear.[31]
It bears emphasis, however, that the Reform Act protections for “forward-looking statements” do not apply at all to some statements, such as those made in documents for an initial public offering.[32] The protections are similarly inapplicable to financial statements prepared in accordance with generally accepted accounting principles (“GAAP”).[33] If a faulty prediction of FDA approval leaves a company with unsalable inventory[34] for which it has not reserved in GAAP-prepared financials, defendants cannot rely upon the forward-looking statement protections to defend against a lawsuit charging that the failure to reserve was fraudulent. In addition, the protections apply only in private actions,[35] not in SEC enforcement proceedings.
Finally, some decisions permit plaintiffs to avoid the Reform Act protections by crafting their complaints to allege omission of the facts causing predictions to fail rather than attacking the predictions as affirmative misstatements. In In re Cell Pathways, Inc. Securities Litigation, the court denied a motion to dismiss in a case based, among other things, on statements that a Phase III trial was on schedule and that the company expected to file an application with the FDA in the first half of 1999. Plaintiffs claimed the company failed to reveal that the trial included many patients who did not meet the criteria for inclusion in the study. When defendants argued that “statements regarding . . . plans and expectations for the NDA filing . . . [were] forward-looking,” the court responded that “ ‘allegations based upon omissions of existing facts or circumstances do not constitute forward looking statements protected by the safe harbor of th