Securities Enforcement and Litigation Trends Affecting Life Sciences Companies in 2020
As 2020 draws to a close, companies in the life sciences industry are reflecting on a year that has presented both opportunities and challenges. From the securities enforcement and litigation perspective, life sciences companies continue to face increased scrutiny arising out of disclosure and event-driven trading issues relating to worldwide business disruptions and developments of COVID-19 diagnostics, therapeutics and vaccines. While life sciences companies are accustomed to stringent regulatory oversight, extra vigilance this year and beyond can help to ensure that they do not find themselves on the receiving end of enforcement actions or securities lawsuits.
SEC Enforcement Actions
At the outset of the pandemic in March, the SEC's Co-Directors of Enforcement issued a rare public statement emphasizing "the importance of maintaining market integrity and following corporate controls and procedures" during COVID-19 and reminding public companies "to be mindful of their established disclosure controls and procedures, insider trading prohibitions, codes of ethics, and Regulation FD and selective disclosure prohibitions to ensure to the greatest extent possible that they protect against the improper dissemination and use of material nonpublic information."1
In addition, in light of heightened regulatory and enforcement concerns relating to COVID-19 business activity, the SEC formed a special Coronavirus Steering Committee in 2020. Among other actions, the Committee worked to suspend trading in the securities of two dozen issuers where questions arose regarding their disclosures about potential COVID-19 treatments, the manufacture and sale of personal protection equipment, or disaster-response capabilities.2 For example, the SEC issued a trading suspension against Blackhawk Growth Corporation in connection with statements regarding the company's purported agreement to distribute COVID-19 antibody tests and its sales and delivery of such tests. Under federal securities laws, the SEC may suspend trading in any stock for up to 10 business days for the public interest and in order to protect shareholders. While trading suspensions are not enforcement actions and do not constitute a finding of wrongdoing, they often reflect the extent to which the SEC staff believes there may be inaccurate or incomplete information in the marketplace for a particular issuer's securities—and in some cases, they may lead to an enforcement action where there is evidence of fraud or financial reporting and other disclosure violations. Indeed, the SEC's Division of Enforcement has been quite active, both in cases originating from trading suspensions and otherwise. For example, the SEC suspended trading against Praxsyn Corporation in March 2020 and followed up by filing fraud charges one month later.
Overall, the SEC has opened more than 150 COVID-related inquiries, many of which have involved life sciences companies, and a number of enforcement actions already have commenced, albeit against smaller companies.3 Illustrative examples include:
- SEC v. Praxsyn Corporation, No. 9:20-cv-80706 (S.D. Fla. April 28, 2020), where the SEC charged microcap company Praxsyn Corporation and its CEO for issuing allegedly false and misleading press releases claiming the company was able to acquire and supply large quantities of N95 or similar masks to protect wearers from COVID-19.
- SEC v. Turbo Global Partners, Inc., No. 8:20-cv-01120 (M.D. Fla. May 14, 2020), where the SEC charged microcap company Turbo Global Partners, Inc. and its CEO for issuing allegedly false and misleading press releases claiming that the company had the ability to sell products that could assist in detecting individuals infected with COVID-19.
- SEC v. Applied BioSciences Corp., No. 1:20-cv-03729 (S.D.N.Y. May 14, 2020), where the SEC charged microcap company Applied Biosciences Corp. for issuing an allegedly false and misleading press release claiming that it was offering and shipping a COVID-19 fingerprick test to the general public for private use.
- SEC v. Nielsen, No. 5:20-cv-03788 (N.D. Cal. June 9, 2020) and SEC v. Schena, No. 5:20-cv-06717 (N.D. Cal. Sept. 25, 2020), where the SEC charged (i) an investor in microcap company Arrayit Corporation for allegedly false and misleading statements made on an online investment forum about the approval status of a COVID-19 blood test, and (ii) the president of Arrayit for allegedly false and misleading statements concerning the development of the blood test as well as the company's intention to resolve a delinquency in filing required periodic reports with the SEC. These cases followed an action brought by the U.S. Department of Justice against the president of Arrayit charging him with one count of securities fraud and one count of conspiracy to commit health care fraud. U.S. v. Schena, No. 5:20-mj-70721 (N.D. Cal. June 8, 2020).
- SEC v. Gomes, No. 1:20-cv-11092 (D. Mass. June 9, 2020), where the SEC charged five individuals and six offshore entities for a scheme involving promotional campaigns that, in some instances, included allegedly false and misleading information designed to capitalize on COVID-19, such as claims that certain companies could produce medical quality facemasks or possessed automated kiosks for retailers to use in response to COVID-19.
Securities Class Actions
Over the past few years, securities class actions against life sciences companies have comprised 20-25% of all shareholder actions, and there is no expectation that this year will be any different. The heightened scrutiny on disclosures relating to COVID-19 matters has also resulted in a greater risk of shareholder actions, including potentially a higher likelihood of courts finding materiality and loss causation. Plaintiffs' firms are aggressively looking for actions to bring and already have started filing lawsuits based on alleged misstatements involving testing, therapies, and vaccines. For example:
- Gelt Trading v. Co-Diagnostics, Inc. No. 2:20-cv-00368 (D. Utah June 15, 2020); Chernysh v. Chembio Diagnostics, Inc., No. 2:20-cv-02706 (E.D.N.Y. June 18, 2020), which are securities class actions alleging misrepresentations by two companies that COVID-19 tests were 100 percent accurate, when the FDA has since given guidance that no such tests are 100 percent accurate, or in the case of Chembio Diagnostics, Inc., the FDA found that the test was not effective.
- Yannes v. SCWorx Corp., No. 1:20-cv-03349 (S.D.N.Y. Apr. 29, 2020), which is a securities class action alleging misrepresentations by SCWorx Corp. regarding a deal to acquire two million test kits each week, when a later research report called the deal "completely bogus" and reported that suppliers would be unable to deliver.
- Wasa Medical Holdings v. Sorrento Therapeutics, Inc., No. 3:20-cv-00966 (S.D. Cal. May 26, 2020), which is a securities class action alleging misrepresentations made by Sorrento Therapeutics, Inc.'s chief executive officer to Fox News referring to a recent breakthrough in the company's COVID-19 therapy research as a "cure," when a subsequent research report described the company's claims as "very hyped."
- McDermid v. Inovio Pharmaceuticals, Inc., No. 2:20-cv-01402 (E.D. Pa. March 12, 2020); Beheshti v. Kim, No. 2:20-cv-01962 (E.D. Pa. Apr. 20, 2020); Devarakonda v. Kim, No. 2:20-cv-02829 (E.D. Pa. June 15, 2020), which are securities class and a shareholder derivative action alleging that Inovio Pharmaceuticals' executives claimed that the company had developed a vaccine for COVID-19 in a matter of hours, with plans to quickly start human testing, when plaintiffs claim that no working vaccine had in fact been developed.
- Himmelberg v. Vaxart, Inc., No. 3:20-cv-05949 (N.D. Cal. Aug. 24, 2020), which is a class action alleging that Vaxart Inc. exaggerated the prospects about its COVID-19 vaccine candidate, including by claiming participation in a federal funding initiative (which plaintiffs allege was false).
These lawsuits add to the volume of additional securities actions that are unrelated to COVID-19, which continue to be filed by plaintiffs' firms against life sciences companies. In September and October 2020 alone, almost 30 such actions were filed against life science companies in federal court.4
Given the increased scrutiny by the SEC and plaintiffs' firms, life sciences companies should take action to protect themselves and decrease risk, including:
- Companies in all industries must pay close attention to their disclosures regarding the operational and financial impacts caused by COVID-19. For companies in the life sciences industry, this may include supply chain disruptions, fewer elective surgeries, reduced demand for certain medical devices, fewer doctor visits, reduced demand for certain drugs, and disruptions in sales processes. These setbacks could have material negative effects on revenue, earnings, cash flows, and liquidity, among other financial metrics. Companies should take this into account when deciding whether and how to discuss expected future results—for example, certain life sciences and other companies have either downwardly revised their forward-looking estimates due to the impact of COVID-19 or withdrawn guidance indefinitely. Companies also should include tailored risk disclosures in their public announcements and SEC filings.
- Companies that are active in COVID-19 research should carefully consider their disclosures regarding COVID-19 testing, therapies, vaccines, and other products, including disclosures relating to clinical trials and regulatory approvals. In order to avoid any missteps, companies active in this space must be careful not to rush to make public statements or to over-promise about potential results. Similarly, companies should take into account all applicable risks, including the possibility of delays and adverse events that could negatively affect approvals. Companies also should clearly identify statements of opinions as opinions, including adding disclaimers as appropriate.
- When life sciences companies engage with the federal government, they should consider appropriate disclosures concerning their operational and financial arrangements with the government relating to the development and distribution of testing, therapies, vaccines, and other products. This is particularly true when the government makes disclosures about proprietary drugs and processes that the company itself has not publicly disclosed, which can result in heightened compliance risk in crafting disclosures as well as attract SEC attention.
- Regardless of the type of disclosure, life sciences companies should ensure that they have adequate disclosure controls in place and that these controls are being followed, including having disclosures and other public statements (for example, congressional testimony, traditional media, and social media) reviewed through the companies' disclosure counsel and, where applicable, disclosure committees. In addition, when companies do business as a co-venturer with the federal government under exigent circumstances, such as those involving COVID-19, they should consider whether changes to disclosure controls are necessary.
- When considering the possibility of a new disclosure, life sciences companies should take into account prior statements made in SEC filings, press releases, investor presentations, and other publications. If new information contradicts earlier statements, companies should consider whether investors are still relying on those prior statements and evaluate the need for corrective disclosure. The SEC's Division of Corporation Finance, Office of the Chief Accountant, and Division of Enforcement have provided guidance touching on disclosures, financial reporting, and internal controls in light of COVID-19, and life sciences companies should familiarize themselves with this guidance.5
- Finally, companies should exercise vigilance in connection with potential insider trading that may appear to be related to COVID-19 testing, therapies, and vaccines. Companies should be aware of potential risks caused by insiders who trade when positive or negative developments have not yet been publicly disclosed. Even if trading is unrelated to the specific COVID-19 disclosures, or was executed pursuant to Rule 10b5-1 plans, it may invite unwanted scrutiny if timed propitiously.
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Life sciences companies have rightly been lauded for their accomplishments in a year filled with a multitude of wide-ranging challenges. At the same time, the first wave of COVID-19-related litigation and enforcement is an indication of the increased legal risks faced by life sciences companies in the months to come. By anticipating such risks, life sciences companies can help avoid securities enforcement and litigation issues from arising.
© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
SEC, Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC's Division of Enforcement, Regarding Market Integrity (Mar. 23, 2020).
SEC Division of Enforcement, 2020 Annual Report (Nov. 2, 2020).
Stanford Law School, Securities Class Action Clearinghouse.
See, e.g., SEC, Div. of Corp. Fin., Coronavirus (COVID-19)—Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (June 23, 2020); SEC, Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19 (June 23, 2020); SEC, Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC's Division of Enforcement, Regarding Market Integrity (Mar. 23, 2020).