WASHINGTON -- An estimated 10 percent of publicbiotechnology companies have been frivolously sued byshareholders under precedents set by a 45-year-old law, HollieBaker, a partner in the Washington, D.C., law firm Hale andDorr, told those attending the monthly meeting of theBiotechnology Industry Organization (BIO) Washington chapterthis week.
Under section 10b(5) of the Securities Act of 1934, anyshareholder who has lost money can file a class-action suitagainst a company or its officers, alleging fraud, Hale and Dorrpartner Geoffrey Stewart said. "Even if you own one share andyou lose a nickel, you can bring a lawsuit on behalf of allpeople who have lost anything," he said.
The suits are popular enough to inspire ambulance chasing. "Ifyou read in the morning business section that some companylost 30 percent of its stock value, I promise you that withinseveral days you will find they will have been sued," saidStewart.
The standard of proof is laudably high -- intent to cheat -- saidStewart, but the cost of the suits is ruinous to companies; legalfees can reach $1 million. Companies frequently have to hireeconomists, scientists and others as expert witnesses. Morethan 90 percent of companies (of all types) that are sued willsettle.
Biotechnology companies are especially vulnerable to thesesuits because their stocks are so volatile, said Stewart.
The suits are usually based on "the argument that the companymade optimistic statements about how great it was going to do,when it knew or should have known that things weren't goingto work out so well," said Stewart.
Plaintiffs tend to be individuals "who get a hot tip and buy astock," said Stewart. Even random methods of choosingsecurities, such as throwing a dart at the stock pages, do notdisqualify suits because "the law presumes the market price isalways perfect."
Stewart offered advice on how to thwart suits. "Avoid puffery.Every time I see a company say, 'We are poised to capitalize on...' I want to send them my business card. That's the kind oflanguage lawyers will stuff down your throat."
Companies should be discreet about trumpeting a drug'sprogress toward FDA approval, he said, because "the stock willgo nuts."
Also, when starting a company, choose locations such as Bostonor Chicago, which have seen few 10b(5) lawsuits. Avoid theWest Coast, where suits are epidemic.
BIO is working with a coalition of companies from the computerindustry, the venture capital industry, accounting groups andthe National Association of Manufacturers to change thestandards for bringing lawsuits, Mary Beth Bierut, BIO'sdirector of federal government affairs, told BioWorld. Thedifficulty is doing so without weakening consumer protection,she said.
Stewart also discussed a change in the interpretation of anobscure rule of accounting that has discouraged so-called cross-investment in biotechnology companies (where one companybuys stock in another). Once again, the volatility ofbiotechnology stocks intensifies the problem.
The rule, SFAS 12, requires that if one company invests inanother's stock, and that company's stock value drops, theinvesting company must report the loss as an expense againstthat quarter's income. But what goes down doesn't usuallybounce back up again, so the investing company is stuck withan apparent loss even if the stock rises again.
All this didn't matter much until recently, said Stewart,because companies believed they were not obliged to writedown temporary drops in value if they were holding securitieslong-term.
Now, a series of Securities and Exchange Commission (SEC)orders appears to be shrinking the length of time indicated bythe word "temporary" so that the regulation can catch stocks inthe cellar much more quickly than previously. And sincebiotechnology stocks can fluctuate rapidly, paper losses canmount quickly; companies with biotechnology investmentsmust re-examine their investments quarterly, Stewart toldBioWorld.
"This is a new burden that no one could have foreseen, and it'sgoing to have a profound impact on the biotechnologyindustry," he said.
But there will be a way around the problem, Chuck Ludlam,BIO's vice president for government affairs, said at themeeting: "Create joint ventures or R&D vehicles that are notpublicly traded to make it harder for third parties to determinewhat the carrying value should be."
-- David C. Holzman Washington Editor
(c) 1997 American Health Consultants. All rights reserved.