Federal Appeals Court Does Not See Fraud By Hindsight

January 20, 2017

Investors sued a biotech company and its CEO amid claims that the defendants had issued press releases that fraudulently under-stated the timeframes to begin and complete FDA trials. Defendants countered that the trials progressed as would have normally been expected. In the end, it came down to a duel between what was an inference, what was an implication, and what should have reasonably been inferred and what was (or was not) implied.

Two Claims. Both Rejected.

Plaintiffs filed a lawsuit in the United States District Court for the District of Massachusetts ("DMA"), but that court granted Defendants' Motion to Dismiss. On appeal to the United States Court of Appeals for the First Circuit ("1Cir"). Edmond Ganem, Plaintff/Appellant, and Battle Construction Co., Inc, individually and on behalf of all others smiliarly situated; Steve Adams, Plaintiffs, v. Invivo Therapuetucs Holdings Corp, Frank Reynolds, Defendants (Opinion, 1Cir, No. 15-1544, January 9, 2017), we have this characterization of how the table was set on appeal:

Ganem brought this action against InVivo and its former CEO, Reynolds, on behalf of a putative class "consisting of all persons and entities who purchased the common stock of [InVivo] - 11 - from April 5, 2013, through August 26, 2013, inclusive" -- i.e., all purchasers of stock between the dates of the initial announcement of the clinical trial and the press release nearly five months later that revealed problems with the timeline for the trial. The operative amended complaint asserted two claims: first, that InVivo and Reynolds deceived investors into buying common stock at high prices, artificially boosted by the false or misleading press releases, in violation of § 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5; and, second, that Reynolds is liable as a "controlling person" under § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a).

The district court rejected both claims, concluding that Ganem had failed adequately to plead material misrepresentations or scienter supporting a claim under § 10(b) and Rule 10b-5, and that, absent a primary violation under § 10(b), Ganem's derivative control person claim against Reynolds must be dismissed. Battle Constr. Co., Inc. v. InVivo Therapeutics Holdings Corp., 101 F. Supp. 3d 135, 141-42 & n.6 (D. Mass. 2015). We focus on the claim under § 10(b) and Rule 10-b5 (the "10(b) claim"). . . .

Page 10 - 11 of the 1 Cir Opinion

Spinal Cord Injury Device

Plaintiffs' Complaint alleged that in 2013, InVivo had disclosed its need to secure an Investigational Device Exception ("IDE") in order to initiate human clinical trials for a new medical device for treating spinal cord injuries that the company was developing. Upon being granted an IDE, InVivo would then be able to obtain either a Pre-Market Approval ("PMA") or a Humanitarian Device Exemption ("HDE").

March 29, 2013 FDA Letter

On March 29, 2013, the Food and Drug Administration's ("FDA's") Office of Device Evaluation transmitted to InVivo an 11-page letter, which conditionally approved the start of the study for the device. Among the imposed FDA conditions were revised informed-consent documentation, a three-month limit on the study to three institutions and one subject; and a subsequent limit of a total of five subjects enrolled over at least a 15-month period. The March 29th FDA letter listed 13 issues requiring further information prior to the initiation of the study and proposed additional study modifications.

April 5, 2013 InVivo Press Release

On April 5, 2013, InVivo issued a three-page press release, which contained a "Safe Harbor Statement" that  characterized much of the commentary as "forward-looking statements." "InVivo Therapeutics Receives Approval from FDA for First Human Trial Using Biomaterials for Traumatic Spinal Cord Injury." (Press Release, April 5, 2013). Plaintiffs alleged that the April 5th InVivo Press Release did not disclose the conditional nature of the FDA's approval or the need to implement proposed changes to the study's protocol. Consequently, Plaintiffs argued that the press release was fraudulent because it did not disclose concerns and conditions that were ultimately raised during clinical trials by the FDA. Further, Plaintiffs argued that the alleged material omissions resulted in the April 5th Press Release being viewed as relatively good news, which supported the increase of InVivo's stock price: 

[H]istorical stock prices cited by both parties indicate that there was a relatively high volume of trading on Monday, April 8, 2013, after the press release the previous Friday. That day, the stock price rose from $2.85 per share to $3.19 per share.

Page 9 of the 1Cir Opinion

August 27, 2013 InVivo Press Release

Plaintiffs asserted that before the market's opening on August 27, 2013, InVivo issued "InVivo Therapeutics updates Clinical Plan" (Press Release, August 27, 2013), which targeted the the first quarter of 2014 as the expected initial enrollment of the first patient and disclosed that "it will take at least 21 months to complete enrollment." In response to that clarification: 

Ganem alleges that InVivo's stock price dropped in reaction to the revised 2014 start date and estimated 21-month time for completion of the clinical trial revealed in this press release. Historical stock prices show that an unusually high volume of trading started on Friday, August 23, 2013, and continued from Monday, August 26 through the end of the class period on August 28. The stock price fluctuated during those four trading days, ultimately dropping from $4.00 per share at the opening of trading on August 23 to $2.07 at the close of trading on August 28. 

Page 10 of the 1Cir Opinion

Penny Pinching?

An interesting aspect of this litigation is presented in Footnote 5 to the 1Cir Opinion:

InVivo also argues that its forward-looking statements are protected by the bespeaks caution doctrine, which "embodies the principle that when statements of 'soft' information such as forecasts, estimates, opinions, or projections are accompanied by cautionary disclosures that adequately warn of the possibility that actual results or events may turn out differently, the 'soft' statements may not be materially misleading under the securities laws." Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1213 (1st Cir. 1996); see also id. at 1213 n.23. InVivo does not, however, invoke the statutory safe harbor codifying the bespeaks caution doctrine, 15 U.S.C. § 78u-5(c)(1), because, it explains, "arguably, the [statutory] safe harbor does not apply to the challenged statements because, while InVivo is now listed on the NASDAQ, the Company could have been, at the time, considered an issuer of 'penny stock.'" See id. § 77z-2(b)(1)(C) (excluding issuers of "penny stock" from the statutory safe harbor). Because the absence of a material misrepresentation or omission is determinative, we need not decide the applicability of either the bespeaks caution doctrine or the statutory safe harbor to InVivo's statements.

Imminent Domain?

In parsing through Appellant Ganem's arguments, 1Cir considered his contention that InVivo misrepresented the imminence of the study's commencement as likely falling within 2013. In weighing the impact of the March 29th FDA Letter, 1Cir echoes DMA and declines to interpret the content of the FDA's letter as erecting a material barrier to immediate enrollment of the first patient. As 1Cir interprets the FDA Letter, it merely required various changes before enrolling the first human but such did not rise to the level of a material pre-condition, as supported by the acknowledgement that InVivo "may enroll one subject at this time." 1Cir viewed the contents of the FDA Letter as consistent with InVivo's published view that the study would proceed within a few months. As to Ganem's other timing-delay arguments, 1Cir dismissed them as mere speculation.

Fraud By Hindsight

In affirming DMA's dismissal, 1Cir explained that:

[G]anem is left only with the inference that because, in retrospect, the test lagged significantly behind the proposed timeline, the timeline must have always been impossible to achieve. Yet, as the district court properly recognized, "fraud by hindsight" does not satisfy the pleading requirements in a securities fraud case. See ACA Fin. Guar. Corp. 512 F.3d at 62 ("A plaintiff may not plead 'fraud by hindsight'; i.e., a complaint 'may not simply contrast a defendant's past optimism with less favorable actual results' in support of a claim of securities fraud." (quoting Shaw 82 F.3d at 1223)); Gross v. Summa Four, Inc., 93 F.3d 987, 991 (1st Cir. 1996). The securities laws do not make it unlawful for a company to publicize an aggressive timeline or estimate for a proposed action without disclosing every conceivable stumbling block to realizing those plans. Hence, while "greater clairvoyance" might have led InVivo to propose a more conservative timeline, "failure to make such perceptions does not constitute fraud." Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978) (Friendly, J.).

Pages 20 -21 of the Opinion