By Lisa Seachrist
WASHINGTON — In 1992, Alliance Pharmaceutical Corp., saw its stock fall from $10 to $6 per share following news it had stopped a Phase II clinical trial in light of potential safety issues seen in animal data.
As if losing 40 percent of its stock value in a single day of trading wasn't disastrous enough, the company was facing shareholder charges of fraud in federal civil court within 24 hours.
Alliance, however, took the path less traveled. When faced with what the company considered a frivolous securities lawsuit, it chose to defend itself rather than settle with the plaintiffs.
"We were unusual; we didn't settle the case," said Ted Roth, executive vice president and chief financial officer at Alliance. "The allegations were that we didn't disclose to shareholders the information we had in hand before we suspended enrollment in our clinical trial. That was interpreted to be fraud and the lawsuit was filed."
Several million dollars, several dozen depositions of company employees and outside investigators, and untold hours spent preparing for the litigation later, the company won a summary judgment dismissing the case in May 1995.
Biotechnology and other small high-tech industries, which rely on public equity markets for financing and experience huge swings in stock value, have been targets for "strike" suits alleging fraud when stock prices plummet as a result of hitting product development stumbling blocks. Typically, these cases are settled for dollar amounts that closely approximate the cost of defending against the litigation.
Cases Went From Federal To State Courts
To protect companies from this type of securities litigation, Congress in 1995 overrode a presidential veto to raise the pleading standards in such cases in federal court and create safe harbors for companies to make forward-looking statements.
Those provisions haven't been enough to end the risk of frivolous securities litigation against high-tech companies. The suits have moved from federal courts, where 85 percent of the litigation took place before 1995, to state courts, where the federal provisions do not apply.
As a result, both the House and the Senate are considering bills to move all securities litigation, which involves stocks that are traded on the national markets, to the federal courts. The move toward creating uniform standards for such litigation is supported by the Biotechnology Industry Organization (BIO) and the Uniform Standards Coalition, a consortium of high-tech industries.
"At the time we were working to have the Private Securities Reform Act passed in 1995, there had never been any pattern of state litigation," said Mark Gitenstein, partner with Mayer, Brown and Platt, in Washington, and counsel to the Uniform Standards Coalition. "We couldn't go to Congress and ask them to fix a problem that didn't exist. Now we have seen a huge increase in the state cases since the law went into effect."
Gitenstein noted the legislation, in part, was designed to encourage companies to be more open about their business plans. However the rapid increase in state lawsuits means the safe harbor provisions for forward-looking statements in effect can't be used.
"It's basically a dead letter," Gitenstein said. "It really is one of the great failures of the 1995 act that these cases can be tried in state courts."
That loophole also places companies at risk of state litigation should clinical trials be halted or fail. BIO estimates that failure of a Phase II trial results in an average 34 percent drop in share price, while failure of a pivotal Phase III trial leads to an average 44 percent drop.
For Alliance, the announcement that a Phase II trial of a blood substitute was halted took the company's stock down 40 percent. The company made the decision when preclinical studies revealed some animals experienced a decrease in platelets. Roth noted, however, further study revealed the platelet problem was species specific and did not occur in humans. The clinical trial was resumed in six to eight months.
"We had experienced an issue in our drug development that as a responsible company we had to be sure wouldn't manifest in humans," Roth said. "The plaintiffs claimed we defrauded shareholders by not informing them of the problem before we suspended the clinical trial."
Roth said the plaintiffs were five or six people who held fewer than 20,000 shares of the 20 million shares outstanding.
New Laws Would Return Federal Jurisdiction
Federal standards for filing a case require plaintiffs to have specific allegations of wrongdoing before allowing them to enter into the discovery process. In the case of Alliance, the charges allowed the plaintiffs' attorneys to begin lengthy and very expensive discovery searches, requesting statements and documents from the company and its employees.
"The plaintiffs' attorneys use the discovery process as a bludgeon to force settlement," Gitenstein said. "These cases aren't about fraud, they are about settlement."
Gitenstein said legislation to remedy this problem has garnered a broad base of bipartisan support, with 30 cosponsors for the Senate's version of the bill, S. 1260, and 187 cosponsors for the House's version, H.R. 1689.
Senate Majority Leader Trent Lott (R-Miss.) has said he wants to see the bill through markup before Congress goes on break in mid-April.
"We are aiming to have it passed into law by Memorial Day," said Gitenstein.
BIO recently brought officers from biotech companies to Congress to make sure lawmakers understand how important the legislation is to the industry.
"The entire biotech industry should have an interest in the outcome of this legislation because the natural volatility of our share prices makes us attractive targets for frivolous securities lawsuits," said Scott Melville, a spokesman from Cephalon Inc., in West Chester, Pa. *