Whether large or small, or based in the U.S. or abroad, life sciences companies are an increasingly attractive target for shareholder suits.
The number of securities fraud class action suits filed in the U.S. in 2019 across all industries totaled 404, just one more than the 403 cases filed in 2018 and down from the peak of 412 in 2017, according to a new Dechert LLP report. However, nearly 25% of the suits filed in 2019 involved life sciences companies, compared with about 20% in the previous two years – which set records for the number of shareholder suits filed against companies in the health care industry, including drug and device manufacturers.
2019 continued that record-setting streak with 97 suits, up nearly 149% from the 39 life sciences shareholder suits filed in 2014. Even in 2017, the peak year for shareholder suits across the board, only 88 were filed against life sciences companies.
The increasing shareholder activity in the sector “is a bit eye-opening,” David Kistenbroker, a Dechert partner and co-author of the report, told BioWorld.
Part of the reason for the growth is cannabis. While no cannabis companies have been named in shareholder suits in the past, nine suits were filed in 2019 against cannabis companies, most of which were incorporated in Canada, Kistenbroker said.
The cannabis suits also account, in part, for the growth of shareholder action against life sciences companies based in other countries. Last year, 22 shareholder suits were filed against companies based in Canada, Ireland and other countries. Although incorporated elsewhere, the companies are subject to U.S. securities regulations since they trade stock or American depository receipts on U.S. exchanges.
Increasing shareholder activity against foreign life sciences companies reflects a trend in other sectors, which also are seeing more suits against companies located elsewhere, Kistenbroker said.
The continued growth in shareholder litigation against life sciences companies is indicative of the activity in the space, Angela Liu, a Dechert partner and co-author of the report, told BioWorld. For instance, M&As are a popular target for shareholder litigation across the board. Thus, the continuing M&A activity in the life sciences is contributing to the growth of securities suits in the space.
Kistenbroker and Liu found that about 46% of the shareholder claims filed against life sciences companies in 2019 involved alleged misrepresentations of material information made in connection with proposed mergers, sales, offerings and other transactions.
Nearly 27% of the claims alleged misrepresentations regarding purported unlawful conduct in both the U.S. and abroad, including illegal kickback schemes, anticompetitive conduct, tax issues and inadequate internal controls in financial reporting.
Size doesn’t matter
Size doesn’t seem to matter when it comes to securities class action suits, as it’s not just the companies with deep pockets that shareholders are dragging into court. Of the 97 life sciences companies named in suits last year, 48, or 49%, had a market capitalization of less than $500 million – with 31 of those having a market capitalization of less than $250 million, whereas 16 had a market capitalization of $5 billion or more. (See market capitalization chart, below.)
Liu and Kistenbroker said they weren’t surprised by the number of shareholder suits against smaller companies, which generally have a minimal, or no, revenue stream and perhaps only one molecule in the pipeline. Given what may already be a low stock value, any negative FDA action involving such companies can trigger a huge percentage drop, Kistenbroker explained. The size of that drop attracts shareholder law firms looking for litigation targets.
In addition to fluctuating stock valuations, small companies that are new to both the regulatory and securities environments may be particularly vulnerable to shareholder suits, as navigating disclosure requirements can be especially challenging for newcomers. They can have quite a learning curve, Kistenbroker said of small companies struggling to get their first molecule across the finish line. “Experience is a great teacher,” he added.
Meanwhile, the life sciences sector in general may be more vulnerable to shareholder suits than other industries due to regulatory interactions with the FDA and to the clinical development process for drugs and devices – both of which can be fraught with disclosure pitfalls.
For instance, about 17.5% of shareholder claims filed against life sciences companies in 2019 involved alleged misrepresentations regarding product efficacy and safety, which could, at times, impact the likelihood of FDA approval. And about 15.5% of the claims stemmed from alleged misrepresentations regarding regulatory hurdles, the timing of FDA approval or the sufficiency of applications submitted to the FDA.
While drug and device companies can’t prevent shareholder suits, they can better defend against them by deeply reviewing and beefing up their internal processes for drafting public disclosures, Kistenbroker advised. The best defense in a shareholder suit, he said, is making all disclosures as complete and as accurate as possible.