Judge Tosses Fraud Suit Against Seattle Genetics for Lack of Scienter

In Patel v. Seattle Genetics, Inc., No. C17-41RSM, 2017 BL 373924 (W.D. Wash. Oct. 18, 2017), the court granted biopharma company Seattle Genetics’ and three of its executives’ (collectively “Defendants”) motion to dismiss Carl Johnson’s, the lead plaintiff of an investor group (collectively “Plaintiffs”), Consolidated Amended Complaint (“CAC”) for failure to state a claim. Although Plaintiffs satisfied the misrepresentation element of the 10b claim in their complaint, the court held they failed to demonstrate scienter or underlying securities fraud by Defendants, and therefore dismissed Plaintiffs’ claims under SEC Rule 10b-5 and Section 20(a) of the Securities Exchange Act.

Plaintiffs alleged in their complaint that Defendants’ outward expressions about the potential of its cancer drug, referred to as 33A, to avoid liver toxicity were inconsistent with its alleged knowledge of the drug’s safety risks. Plaintiffs also alleged Seattle Genetics knowingly omitted information about liver toxicity while simultaneously touting the drug’s benefits over a predecessor drug made by Pfizer, Inc., which was pulled from the market due to patient fatalities caused by toxicity. Plaintiffs asserted that a former Seattle Genetics safety engineer shared data about the drug’s level of toxicity on each organ in the body with his superiors, though not with the named Defendants directly. In relying on this confidential witness, Plaintiffs attributed knowledge of the drug’s toxicity on Defendants through the core operations doctrine, the theory that imputes specific knowledge on senior executives based only on their general awareness of company business.

Central to Plaintiffs’ CAC is the FDA’s decision to halt trials of the drug in certain sub-groups, including patients with stem cell transplants and those undergoing chemotherapy in combination with 33A, because of toxicity concerns and patient deaths. On the same day as the FDA’s announcement, Defendants issued a press release alerting investors to the FDA’s action, which prompted Seattle Genetics’ stock to decline by over 15% and a lowering of its price target by a Credit Suisse analyst. The company also instituted “risk mitigation measures” to address the liver toxicity issues in two of its trials, while halting the others altogether. Plaintiffs filed suit two weeks later.

To adequately state a claim under Section 10(b) of the Exchange Act and Rule 10b-5, a plaintiff must allege facts sufficient to show: (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.

To meet the first element above, a complaint must "specify each statement alleged to have been misleading, [and] the reason or reasons why the statement is misleading." The plaintiff must further show defendants made misleading statements as to a material fact. A statement is material when there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." 

To properly allege scienter, the second element of a claim under 10(b) and Rule 10b-5, a complaint must allege the defendant made false or misleading statements either intentionally or with deliberate recklessness. Mere opportunity and motive to commit fraud are not sufficient.

Additionally, according to Rule 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act (“PSLRA”), fraud assertions must meet a heightened pleading standard stating the “who, what, when, where, and how” the fraud occurred.

The court found Plaintiffs adequately pled misrepresentation in its complaint. The press release issued by Defendants on the day of the FDA’s halting of its trials critically omitted data about patients who had already experienced hepatotoxic events, while simultaneously touting 33A’s lack of hepatotoxicity in comparison to Pfizer’s previous drug pulled from the market. The court held Defendants had a duty to disclose these results given the company’s positive publicity about 33A.

As for scienter, the court held the link between knowledge of 33A’s hepatotoxicity and the individual Defendants was too tenuous. The confidential witness’ communication with others in the company, rather than the individually named Defendants, was insufficiently particular, according to the court. While the executives had access to the drug’s safety data sheets about environmental toxicity (as opposed to clinical studies), abandoned a portion of a clinical trial, and had knowledge of the drug’s toxicity from a third-party risk assessment, the court held these factors did not adequately show intent or deliberate recklessness. Additionally, Plaintiffs’ allegations did not assert “cogent possible motivations” for the alleged misrepresentations.

The court held Plaintiffs’ reliance on the core operations doctrine was misplaced because the CAC contained no facts regarding when and how Defendants became aware of the toxicity information. Without those facts, the inference that Defendants were unaware of the information was equally plausible.

For the above reasons, the court granted Defendant’s 12(b)6 motion to dismiss for failure to state a claim. The court allowed Plaintiffs a 30-day leave to amend their previously amended complaint to cure its deficient claim of scienter.

The primary materials for this case may be found on the DU Corporate Governance website. The full docket is available here.