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As the number of new securities class action lawsuits was falling last year, life science companies saw a surge in filings against them, according to a study issued by the national law firm Dechert. Life science companies are the small players in the pharmaceutical industry, counting entirely on one or two drugs under development. It is a high-risk industry rife with equally large failures and successes. When these drugs suffer setbacks, the companies’ stock tumbles precipitously. The lawsuits inevitably follow. Because of the risks associated with this industry, life science companies must carefully orchestrate their communications. Some critics argue that they are unfairly targeted by investors who blame management though they knew they were joining a risky venture. Class action lawyers disagree. Because most of these suits end in settlements, court files are largely devoid of verdicts on which to base broad conclusions, experts say. Regardless, whether it is a regulatory filing or a press release, life science companies must balance the optimism needed to attract investors with carefully crafted statements that will not inspire lawsuits should the news turn bad. CLASS ACTION TRENDS Last year saw a decline in the number of new securities class actions, from 268 to 216, but the trend was in the other direction for life sciences companies. Cases brought against them rose from 23 to 32, or 15 percent of all securities class actions, according to Dechert’s study. “The nature of the industry itself is one that’s fraught with risk,” said the co-author of the study, Michael Kichline of Dechert’s Philadelphia office. “They don’t have significant product portfolios, and their entire business is dependent on building one product.” A well-known example is ImClone Systems, the company once headed by Samuel Waksal. It opened its doors in 1984 but had only one drug of any value in the pipeline in recent years, the cancer drug Erbitux. When the Food and Drug Administration rejected the drug in December 2001, the stock plummeted, losing three-quarters of its value within weeks. Waksal received a 7-year sentence for insider trading, and magazine publisher Martha Stewart was caught for lying to federal investigators who were examining her trading activity. “When there is bad news,” said Kichline, “the market usually reacts pretty swiftly.” In 2002, a number of class actions against ImClone followed. They are pending. Large drops in a company’s stock immediately often trigger securities class actions. The reason: Damages are often measured by the amount of money lost by investors. The bigger the drop, the larger the damages. The suits accuse these companies of all sorts of wrongdoing. The majority claim that a company lied about its product’s potential success or safety at some stage of the development process, according to the Dechert study. One such case involved Regeneron Pharmaceuticals, a company developing a drug to fight obesity. After a clinical trial of its drug, Axokine, the company reported on March 31, 2003, that test patients developed antibodies that reduced its effectiveness. Within a day, the stock tumbled 56.5 percent, and eventually fell a few percentage points further. Investors lost $464 million, according to the firm that brought the case, Wolf Haldenstein Adler Freeman & Herz. Southern District Judge Robert Sweet has not ruled on the motion to dismiss said Wolf’s lawyer, Fred Isquith. Besides providing fair and accurate statements in public disclosures, said Kichline, “there needs to be an appreciation for what seem like very routine events” among life science executives. Failures to disclose manufacturing problems, termination of a contract with a supplier and other setbacks in the ordinary course of business can trigger securities class actions, he said. DISCLOSURE ISSUE In October 2003, a bevy of class action firms including Bernstein Liebhard & Lifshitz and Wolf Haldenstein Adler Freeman and Herz initiated lawsuits against Alkermes in federal court in Massachusetts. The company was accused of failing to disclose weaknesses in the manufacturing process of its schizophrenia drug, Risperdal Consta. These failures undermined the company’s ability to meet regulatory requirements and led to a 93 percent decrease in its stock price, according to plaintiffs, but had nothing to do with the efficacy of the drug. Dechert, an advisor to several life science companies, recommends that companies include more than the usual boilerplate disclaimers provided in public statements. The statements must point to specific factors that “cover the gamut of risks throughout the entire drug product life cycle,” Dechert said in its study. Dechert, which is often on the defense side in shareholder suits, also recommended that companies devise careful insider trading policies to prevent class action lawyers from using such trades to build a case. In the Regeneron complaint, for instance, plaintiffs accused executives of the company of selling shares whose price they had artificially inflated. The biggest concern for a life science company involves its handling of news related to its prominent drug. In an industry that relies on investors to fork over millions to high-risk investments, life science companies position themselves to attract investment dollars. In such an industry, companies must navigate carefully. Wolf Haldenstein’s complaint against Regeneron parses the company’s press releases and financial filings sentence by sentence, pointing to alleged omissions of negative information and overly optimistic statements of the drug’s potential success. “While soft puffery conveys a positive message and image about a company,” said Dechert’s study, “it is hard statements of fact upon which class action lawyers — with the benefit of 20/20 hindsight — will concoct a lawsuit.” UNFAIRLY TARGETED? Dechert attorneys filed an amicus brief with the Supreme Court in the Broudo v. Dura Pharmaceuticals case on behalf of the Washington Legal Foundation, arguing that the life science industry disproportionately suffers from securities class actions. But class actions attorneys say that they are not preying upon small biotechnology companies. “I would be surprised if there is empirical support” for the contention that life science companies are unfairly targeted in securities class actions, said Stanley Bernstein of Bernstein Liebhard & Lifshitz. “A lot of them do a lot of puffing in stage one,” he said, referring to the first step of a three-step drug approval process. “They string you along in stage two and stage three,” he said of many companies that drop at the first sign of bad news, “and don’t reveal the risks.” “In this environment … where you have a heightened pleading standard requiring recklessness or fraud,” said Bernstein, plaintiffs need a strong case to win a motion to dismiss. The 1995 Private Securities Litigation Reform Act made it tougher for plaintiffs to survive the early stages of a case by limiting discovery and requiring specific allegations of wrongdoing. The act, intended to curb securities class actions and their firms, has not reduced the number of actions filed despite the decrease last year. “I’m sympathetic to those who say” that people should understand the risks of this industry and not blame their losses on mismanagement, said Isquith. In these cases, he said, “I tell my client you don’t have much of a case. “But there is a small group of companies that are really quite different.” In cases where management hid significant risks to raise additional dollars from investors and paid itself millions, “it’s under these circumstances where there are substantive cases,” he said.

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