A Move to Stop Frivolous Securities Fraud Suits
Note: This article has been updated with quotes from Richard Samp.
The Washington Legal Foundation wants courts to stop frivolous securities fraud lawsuits by prohibiting plaintiffs from pleading an intent to defraud by claiming “fraud by hindsight.”
WLF chief counsel Richard Samp filed an amicus brief [PDF] last week arguing that courts shouldn’t infer that a company acted with intent to defraud because the company “must have known” that ensuing adverse events would occur. WLF is a nonprofit, pro-business law firm in Washington, D.C.
“This litigation involves . . . abusive, lawyer-driven securities fraud claims,” the brief states. The case was brought by institutional and individual investors against Genzyme Corporation in the U.S. Court of Appeals for the First Circuit in Boston. They sued after the drug company’s stock prices dropped due to serious problems at one plant, which later became the target of Food and Drug Administration enforcement actions.
The FDA actions included informing doctors that certain medicines contained shards of metal and rubber; charging Genzyme with violations of the Federal Food, Drug and Cosmetic Act; and requiring Genzyme to pay a $175 million fine and to undertake a comprehensive remediation plan under the FDA’s oversight. The plant was temporarily closed.
Genzyme promptly disclosed the federal actions—but it hadn’t previously disclosed that the FDA had cited 16 manufacturing deficiencies in an earlier inspection and some hadn’t been remedied, the investors allege. The investors argue they had a right to know about those problems before they bought stock.
But WLF’s brief states, “They [senior officers] did not expect that the setbacks the company experienced in various ways would have a significant impact.”
At the 2012 trial, the U. S. District Court in Boston dismissed the complaint, saying the initial omission of the problems was of “doubtful” and “questionable” materiality. The trial court found that the investors inadequately pleaded scienter—the knowing intent to deceive investors—and dismissed the case before extensive discovery.
The investors appealed, saying the dismissal was improper until they have a chance to engage in discovery and look for evidence of scienter. They also sought to amend their pleadings.
The WLF brief focuses on the scienter issue, contending that investors first need some showing that the company had a sinister motive in withholding the information.
“Frivolous securities fraud litigation will continue to be a plague on the business community unless the courts are willing to weed out such lawsuits before defendants are required to respond to expensive and time-consuming discovery requests,” WLF argues.
The case is important, the WLF brief says, because overly broad definitions of materiality could “prove extremely burdensome for publicly traded corporations and would, in the end, make it more difficult for investors to discern which information released by a corporation is highly relevant to its future financial well-being.”
Samp said the U.S. Supreme Court in a 2011 decision, Matrixx v. Siracusano, made life particularly difficult for drug companies by ruling that they can be sued for failing to disclose so-called adverse event reports about their products, even if the reports are not statistically significant.”The Genzyme case is an important test of whether the damage created by the Matrixx decision can be contained,” he added.
“If courts are unwilling to dismiss cases of this sort,” Samp added, “then corporate defendants are essentially forced to pay extortionate settlements to the plaintiffs' lawyers, because the cost and disruption that the pre-trial discovery process imposes on corporations is intolerable.”