Biotech Cos. Face Pressure To Disclose
Law360, New York (May 9, 2016, 3:50 PM ET) -- When reacting to regulatory and clinical developments, management of a publicly-traded, clinical-stage biotechnology company, frequently may face a tension between a “duty to disclose” and the “pressure to disclose.” The “duty to disclose” material information is defined by legal principles. In contrast, the “pressure to disclose” is fueled by business and market realities. While every situation will be different, when deciding when and what to disclose, there are several practical steps that can be taken by management to facilitate and support that decision.
A biotechnology company with a product candidate in clinical trials faces many challenges. In addition to day-to-day operational issues and the seemingly constant need for additional capital, such a company faces the uncertainty of obtaining U.S. Food and Drug Administration marketing approvals. The approval process is expensive and, despite careful planning or promising early results, clinical trials often do not go as expected. Throughout this regulatory approval period, management likely will encounter difficult disclosure questions arising from clinical and regulatory events.
Typically, a duty to disclose arises out of one of two scenarios. In the first, there is a statute or regulation that mandates disclosure such as the line items in a current report on Form 8-K or under Regulation FD. In the second, disclosure is required to avoid rendering existing statements misleading such as in connection with an offering and sale of securities. As a general principle, absent one of these scenario or under other limited circumstances, there is no affirmative duty to disclose material information simply because it exists. As reaffirmed by the U.S. Supreme Court in 2011, “it bears emphasis that Section 10(b) and Rule 10b-5(b) do not create an affirmative duty to disclose any and all material information. Disclosure is required under these provisions only when necessary 'to make ... statements made, in light of the circumstances under which they were made, not misleading.'” Matrixx Initiatives Inc. v. Siracusano, 131 S.Ct. 1309, 1322 (2011) (citing Basic Inc. v. Levinson, 485 U.S. 224 (1988)).
While a decision to announce positive news is easy, the absence of a duty to disclose adverse regulatory or clinical events provides little solace to an early stage biotechnology company. Investors demand information about clinical trials and regulatory developments. Without FDA-approved products, the clinical stage company is valued by the market based on the perceived future potential of its product candidates. In this environment, investors do not perceive ”no news” as “good news,” and silence can be reflected in a volatile stock price. In addition, maintaining secrecy of adverse events may prevent the company from raising capital and heighten the risk of leaks and/or illegal insider trading. Thus, faced with these realities, management often will decide to disclose the negative information. Once it does so, however, the company must speak truthfully and without omitting material facts. The proper balance can be difficult to achieve.
The U.S. Securities and Exchange Commission’s recent enforcement action against Aveo Pharmaceuticals Inc. illustrates the challenges that a company might encounter in connection with its disclosure decisions. In its complaint, the SEC alleges that Aveo concealed the FDA’s level of concern about a lead drug candidate in public statements to investors by omitting the fact that FDA staff had recommended a second clinical trial to address its concerns about patient death rates during the first clinical trial. Rather than addressing the FDA’s specific statements, Aveo’s public disclosures instead concentrated on the FDA’s expressed concern about the overall survival trend and the uncertainty and expense surrounding possible additional trials that the FDA could require Aveo to conduct. Aveo agreed to pay a $4 million penalty to settle the SEC’s charges without admitting or denying the allegations in the complaint.
Without judging Aveo’s disclosure choices, identifying the material facts in particular circumstances can sometimes be difficult. In some situations, a more generalized approach to the disclosure may be appropriate, such as when there are a number of uncertainties created by the events in question. If, for example, the FDA had advised a company that it had substantial doubts about the approvability of a product candidate, but requested and said it would consider additional data before the submission of a new drug application, then the FDA’s overall doubts could be viewed as more significant than its request for additional data. In other instances, such as the FDA questioning the safety of a product candidate, a more specific disclosure could be needed.
Judgments regarding what information to disclose or not to disclose are inherently complicated and require careful consideration of the specific facts and circumstances. Moreover, the real time decisions that are made often will be judged with the benefit of hindsight. Prior to Matrixx, for example, drug development companies sometimes sought to rely on the statistical significance of an event in evaluating disclosure obligations. If the data were not statistically significant, then, management reasoned, the information could not be material. The U.S. Supreme Court granted certiorari in Matrixx to resolve a split among the circuit courts using this standard. Rejecting a bright line test such and statistical significance and instead applying the test articulated in Basic v. Levinson, the court held “§ 10(b)'s materiality requirement is satisfied when there is “‘a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.’” (citing Basic v. Levinson, 485 U.S. 224, at 231-232). 131 S.Ct. at 1312.
There are several practical steps that can be taken to facilitate disclosure decisions. Ideally, the company should have a standing disclosure committee or comparable group of decision-makers to discuss and review the possible disclosures. Although not mandated, in connection with the rule making relating to the CEO/CFO certifications, the SEC recommended the use of such a committee when making decisions about public disclosures. For a biotechnology company, this committee could consist of senior officers, including the chief medical or regulatory affairs officer. A disclosure committee can form an important part of the company’s disclosure controls and procedures. Using such a committee demonstrates a consistent, reasoned approach and pattern to public disclosures.
Filtering information through a disclosure committee might help to show that management did not act with the requisite degree of scienter if the company’s disclosures are later challenged. In class action lawsuit arising from the same facts involved in the SEC’s Aveo enforcement action, a U.S. District Court concluded that, despite potentially actionable statements and omissions, the plaintiffs failed to allege facts giving rise to a strong inference of scienter. Sanders v. Aveo Pharmaceutical Inc., (D. Mass. 2015). Scienter, “‘embracing intent to deceive, manipulate or defraud,’ may be shown where the defendants consciously intended to defraud, or that they acted with a high degree of recklessness.” Aldridge v. A.T. Cross Corp., 284 F.3d 72, 82 (1st Cir.2002) (internal citations omitted). A disclosure committee should help to demonstrate that management did not act recklessly in reaching its decision — the “process” contributes to the result.
With respect to the timing of the disclosure, decision-makers should not rush to make public statements until all of the facts are known. Releasing information without a complete understanding of the facts can lead to corrective or supplemental disclosures. At the same time, the decision-makers must be mindful of trends in the stock price. A significant market decline before the announcement may suggest a leak and invite inquiries from the stock exchange. Tactically, it usually is better to be out in front of the news rather than behind it.
When weighing how best to disclose the regulatory or clinical events, the decision-makers should ask questions about the circumstances surrounding the news. For example, did the speaker or party delivering the message have the authority to do so? Similarly, how formal was the communication? Another factor to consider is the tentativeness of the position or conclusion and the likelihood of changing it. As discussed above, while it is not appropriate to rely solely on empirical data when assessing disclosure obligations, such data still can be an important part of the total mix of information. Finally, the decision-makers should evaluate the potential consequences arising from the event. Typically, this involves balancing the probability of those consequences occurring against the magnitude of them to the company should they occur.
In addition to evaluating the current information and the appropriate level of disclosure, the decision-makers should take into account the company’s prior statements. Such statements could appear in SEC filings, press releases, investor presentations, and other publications. If the new information contradicts earlier statements, a company should consider whether investors are still relying on those prior statements and evaluate the need for corrective disclosure.
While there are no easy answers to disclosure questions, and each situation is unique, management needs to be ready to face the challenges. It can do so by understanding the legal framework for disclosures and having a process in place to facilitate decision-making. Only then can management ask itself “does this alter the “total mix” of information available and how will such information be perceived?”
—By Richard E. Baltz, Arnold & Porter LLP
Rick Baltz is a partner in Arnold & Porter's Washington, D.C., office and is former deputy chief of the Office of Tender Offers, Division of Corporation Finance.
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