First Circuit Affirms Tough Standard for Alleging Securities Fraud; Revives One Claim Against Local Drug Maker


On November 28, 2016, the First Circuit upheld the dismissal of all but one of the class action securities fraud claims against Cambridge, MA drug company, ARIAD Pharmaceuticals, Inc., reaffirming the exacting pleading standards that enable defendants to put an early end to reflexive stock-drop lawsuits.  In doing so, the First Circuit also adopted strict requirements for asserting claims that defendants misled investors in a common stock offering.

In In re ARIAD Pharmaceuticals, Inc. Securities Litigation, shareholder plaintiffs appealed the District of Massachusetts’ dismissal of the federal securities fraud claims against ARIAD based on optimistic statements the company’s executives made about the prospects of ARIAD’s experimental leukemia drug, ponatinib, which ultimately did not fare so well in FDA trials.  The First Circuit largely affirmed the district court’s dismissal, holding that the complaint failed to raise a compelling inference that the company’s executives acted with scienter—or intent to defraud.  The appellate court did, however, revive a claim related to “one particular alleged misstatement” executives made at a December 2012 breakfast meeting with investment bankers.

As a check against abusive private securities fraud litigation, the Private Securities Litigation Reform Act (PSLRA) requires plaintiffs alleging violations of Exchange Act Section 10(b) and SEC Rule 10b-5 to allege with particularity facts giving rise to a strong inference that the defendants acted with scienter.  The Supreme Court’s Tellabs decision strengthened the PSLRA’s gatekeeping function by holding that a complaint’s inference of scienter must be more than just plausible or reasonable—it must be “cogent and at least as compelling as any inference of nonfraudulent intent.”  In ARIAD, the First Circuit explained that, to meet this standard, plaintiffs must show that defendants were extremely reckless in making the alleged misstatements—that at the time company executives made the statements they were aware of contradictory information.  Alternatively, plaintiffs can show that executives were motivated to commit fraud by profits from suspiciously-timed insider stock sales.

For all but one alleged misstatement, the First Circuit held that plaintiffs impermissibly sought to establish “fraud by hindsight” by only alleging that ARIAD executives “must have known” about adverse events in ponatinib’s FDA trials when they made positive statements about the drug’s prospects.  Plaintiffs failed to specify when and how the defendants learned of adverse events that would have rendered their positive statements about ponatinib misleading.  The First Circuit also held that plaintiffs’ insider trading allegations were insufficient to show fraud because the executives’ sales of company stock were not suspicious in their timing or amount, in part because the executives traded pursuant to a 10b5-1 plan, an advance directive that limits discretion in trading company stock.

However, the court left open a small window for the plaintiffs to stay in court.  Plaintiffs alleged that, at a November 2012 meeting, FDA personnel informed ARIAD executives that the company would have to include a “black box” warning on ponatinib’s label about the risk of adverse cardiovascular events.  According to the complaint, the defendants nonetheless told investment bankers that they were optimistic about the drug’s prospects for approval—“with a favorable label”—at a December 2012 breakfast meeting.  The First Circuit explained, “[w]hile management may have held out hope of achieving this result, the expression of that hope without disclosure of recent troubling developments created an impermissible risk of misleading investors.”  Plaintiffs therefore adequately alleged scienter with respect to this one claim.

The court also made it harder for plaintiffs to allege violations of Section 11 of the Securities Act of 1933, which prohibits untrue statements in a securities offering registration statement.  The First Circuit held that plaintiffs who purchased their shares in the aftermarket following ARIAD’s January 2013 common stock offering must adequately trace their shares back to that offering.  Otherwise, plaintiffs lack standing to assert claims that the registration statement was misleading.  The court rejected the plaintiffs’ argument that general allegations of traceability, without more, suffice to survive dismissal.  Rather, the First Circuit agreed with the Fourth Circuit that plaintiffs must allege sufficient facts to plausibly suggest that the shares they purchased were issued as part of the relevant offering—a significant hurdle at the pleading stage.

ARIAD is noteworthy for its rigorous application of the heightened pleading standards for class action securities fraud claims, including the First Circuit’s adoption of stricter pleading requirements for Section 11 claims.