The Ninth Circuit handed down a decision in In re: Gilead Sciences Securities Litigation, Case No. 06-16185 (9th Cir. Aug. 11, 2008) which raises significant questions about the Circuit’s application of two key Supreme Court decisions — Bell Atlantic. Corp. v. Twombly, 127 S. Ct. 1955 (2007) (complaint must be plausible) and Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005) (requiring loss causation). In Gilead Sciences, the Court reversed a district court determination which concluded that plaintiffs’ complaint failed to comply with Dura and was not plausible because of a gap of months between the time of an FDA letter disclosing defendant’s improper sales practices that fueled its revenue and a drop in the share price that followed publication of poor financials statements.

The complaint alleged a scheme which hinged on the ability of Gilead Sciences to improperly increase sales for one of its leading drugs by selling them in violation of FDA regulations regarding off-label marketing. Those regulations essentially limit marketing a drug to uses approved by the agency, not those which are not approved or off-label. Specifically, the complaint alleged that Wall Street analysts for Gilead Sciences looked to sales of its most important and promoted drug, Viread, to determine if the company was growing as expected. A failure to report good sales for this drug would result in a drop in the price of the stock.

Gilead Sciences aggressively marketed Viread sales by promoting off-label uses. As a result, in March 2002, the FDA issued a warning label to the company about these practices. Nevertheless, off-label marketing increased and the company raised the price of the drug to its wholesales.

Subsequently, in July 2003 the company issued a press release announcing that its second quarter results would exceed expectations. By the end of the month however, the FDA served a second warning letter to the company about off-label marketing for Viread. Not only did the FDA require the company to publicly correct its incorrect marketing statements about the use of the drug at a conference where those statements were made, but the agency subsequently published the letter. While the complaint claims that the public did not understand the action by the FDA, it was clear that wholesalers did. According to plaintiffs, the wholesalers drew down their excess inventory of the drug and let those levels fall below industry averages.

At the end of October, the company announced its results for the period, revealing lower Viread sales. Analysts concluded that there was lower consumer demand for the drug. Trading volume increased 1,400% the next day and the share price fell 12%.

In reversing the district court, the Ninth Circuit concluded that “the complaint sufficiently alleges a causal relationship between (1) the increase in sales resulting from the off-label marketing, (2) the Warning Letter’s effect on Viread orders, and (3) the Warning Letter’s effect on Gilead’s stock price.”

In its opinion, the Circuit Court rejected what it viewed as the district court’s skepticism about the plausibility of plaintiffs’ claims. Under Twombly, a complaint can proceed if it alleges facts to support a plausible theory. Here, despite the month’s long gap between the disclosure of the FDA warning letter and the price drop, the theory is plausible, the Court concluded.

Under Dura, the cause alleged need only be a “substantial” cause and not the only one, according to the Ninth Circuit. After emphasizing that loss causation is much more critical at trial, the opinion concludes that the link between the publication of the warning letter in July, the subsequent actions of the wholesalers and the disclosure of the poor sales in the late November is sufficient.

The Ninth Circuit’s opinion raises significant questions about its application of both Twombly and Dura. Clearly, Twombly permits a plausible, factually supported complaint to proceed despite the skepticism of the court as the opinion notes. Yet, the long delay between the disclosure of the FDA letter and the price drop presents a clear question of plausibility for which the court offers little analysis.

Similarly, the Court’s Dura analysis seems deficient. By emphasizing that loss causation is critical at trial, the Court seems to have shifted the issue from the beginning of the case to the end. This however, is at odds with the front-end loaded, gate-keeper role given to the district courts under the PSLRA and the Supreme Court’s decisions in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007) (discussed here) and Stoneridge Investment Partners, LLC v. Scientific-Atlantic, Inc., 128 S.Ct. 761 (Jan. 15, 2008) (discussed here), all of which combine to screen cases before they can reach discovery.

Perhaps more importantly, the Court’s opinion fails to offer any real analysis of the causation issue. The key question should be when did the facts about the fraud materialize? See, e.g., In re Initial IPO Sec. Litig., 399 F. Supp. 2d 261 (S.D.N.Y. 2006). If that occurred at the time of the FDA letter, then the district court was correct. If however, it happened at the time the financial results were released then the Ninth Circuit may be correct. Unfortunately, as with the Twombly question, the Court’s discussion of Dura fails to analyze the question or include sufficient facts to assess it.

The Fifth Amendment to the U.S. Constitution embodies fundamental rights intended by the founding fathers to protect every citizen of this country. While it is frequently referred to as the protection against self-incrimination, the text of the amendment makes no mention of “incrimination.” Rather, the text states in pertinent part that “no person shall be compelled in any criminal case to be a witness against himself …”

The SEC as a law enforcement agency is charged by Congress with enforcing the law. Enforcing the law begins with respect for it and creating an environment of compliance. In the corporate context, the SEC might call this “tone at the top,” that is, creating the kind of environment that encourages respect for, and compliance with, the law.

Why is it then that the SEC seems to be hostile to the Fifth Amendment and the basic, fundamental rights it represents and protects? When a witness declines to testify in an SEC investigation, the staff routinely insists that the witness is refusing to testify to avoid incriminating him or herself. This dialogue typically continues with the staff contending that the witness is asserting his or her “right against self-incrimination.” Producing the text of the Amendment does noting to alter the position of the staff.

At the same time, the witness is told that an “adverse inference” will be drawn from the fact that he or she has chosen to exercise a fundamental constitutional guarantee. This position is typically enunciated with a citation to Baxter v. Palmigiano, 425 U.S. 308 (1976). Even when it is pointed out that the holding of Baxter is based on the theory that the witness is appearing in an adversary proceeding where the person could be expected to respond to allegations of misconduct, which is not the case in an SEC investigation, the staff persists in this view. Their position persists, even if it is point out that the Commission contends that its investigations are not adversary proceedings, do not have targets or subjects and are only fact finding proceedings – positions argued by the SEC and accepted by the Supreme Court in SEC v. O’Brien, 467 U.S. 735 (1984).

But it gets worse. The witness is then questioned in detail, and typically the staff will reiterate over and over their “self-incrimination” theme. This procedure seems more intended to embarrass the witness than ensure that the person intends to assert the privilege to all relevant subjects. Indeed, if the only purpose for the repeated questions is to ensure that the witness will decline to testify on the same basis to all relevant subjects then an affidavit would suffice. Yet, often times the staff refuses to take an affidavit.

Later, at the Wells stage, the burdening of fundamental rights continues. At this point, the staff typically declines to give all but the most cursory information about the proposed enforcement recommendation. Not only is this contrary to the very purpose of a Wells submission, since it can deprive the Commission of important views on the proposed enforcement action, but it seems intended to penalize the witness for exercising a fundamental constitutional right.

All of this seems directly contrary to Supreme Court’s admonition that “one of the Fifth Amendment’s ‘basic functions … is to protect innocent men …’ who otherwise might be ensnared by ambiguous circumstances.'” Ohio v. Reiner, 532 U.S. 17, 21 (2001), quoting Grunewald v. United States, 353 U.S. 391 (1957), which in turn was quoting Slochower v. Board of Higher Ed. Of New York City, 350 U.S. 551, 557-558 (1956) (emphasis original).

Reiner’s point about becoming ensnared in a web of circumstances seems more than appropriate in an SEC investigation. Many times those inquiries are based on a complex web of facts that occurred years ago. Circumstances can often point in several directions and it is all too easy to become ensnared in those circumstances, particularly for a witness who may not have had access to materials to properly prepare for testimony. No doubt the staff is aware of this. Yet their position on the Fifth Amendment persists.

All of this leaves one to ask: How can the SEC enforce the law by burdening fundamental legal rights? To be sure, an assertion of the Fifth Amendment may deprive the agency of facts it wants. Whether those facts are key to the inquiry or not relevant is not the question, however. The founding fathers, mindful of this possibility, chose to embed in our law the right of a person not to testify. An agency enforcing the law should respect and honor that privilege, not burden it. If there is to be proper “tone at the top,” it should begin with the SEC. It is time for the SEC to reform its policies regarding the Fifth Amendment.