Competitive Advantage

The U.S. Court of Appeals for the Fourth Circuit has issued its first opinion applying the Tellabs decision on the pleading of scienter (i.e., fraudulent intent). Those who follow the Fourth Circuit’s jurisprudence in this area will be unsurprised to learn that the decision creates good law for defendants.

In Cozzarelli v. Inspire Pharmaceuticals, Inc., 2008 WL 5194311 (4th Cir. Dec. 12, 2008), the plaintiffs alleged that Inspire made false statements regarding a drug trial. The court found that in defining the PSLRA’s “strong inference” pleading standard for scienter, the Supreme Court “gave that standard teeth, using adjectives like ‘cogent,’ ‘compelling,’ ‘persuasive,’ ‘effective,’ and ‘powerful.'” Moreover, an inference of scienter “can only be strong – and compelling, and powerful – when it is weighed against the opposing inferences that may be drawn from the facts in their entirety.”

Based on the facts before it, the court found the inference that any allegedly omitted information about the drug trial was withheld “to protect [Inspire’s] competitive advantage” more “powerful and compelling than the inference that defendants acted with an intent to deceive.” Moreover, the plaintiffs’ motive allegations based on the company’s need to raise capital, the CEO’s performance-based compensation, and a limited amount of stock sales were “conclusory” and “lack[ed] merit.”

The court also joined a number of other circuit courts in holding (a) the signing of allegedly false SOX certifications does not contribute to an inference of scienter, and (b) Section 11 and 12(a)(2) claims that “sound in fraud” must be plead with particularity pursuant to Fed R. Civ. P. 9(b).

Holding: Dismissal affirmed.

Quote of note: “All investments carry risk, particularly in a field like biopharmaceuticals. If we inferred scienter from every bullish statement by a pharmaceutical company that was trying to raise funds, we would choke off the lifeblood of innovation in medicine by fueling frivolous litigation-exactly what Congress sought to avoid by enacting the PSLRA. Furthermore, the fact that some analysts relied on defendants’ hopeful statements to speculate-as the analysts admitted they were doing-that Study 109 would succeed adds little to an inference of scienter. Speculation by investors and subsequent buyers’ remorse cannot support an Exchange Act suit alone.”

Disclosure: The author of The 10b-5 Daily has previously represented the defendants in this case.

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