Tellabs: Leaving A Trail Of Dismissed Cases

In recent weeks, the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007), construing the PSLRA requirement of a “strong inference” of scienter, has resulted in the dismissal of what seems to be an ever-increasing list of securities complaints. Since September, the Second (here), Sixth (here), Eighth (here and here) and Eleventh (here) Circuits have affirmed the dismissal of securities complaints for failing to meet the Tellabs equipoise test (here). Now, the Fourth Circuit has joined the group. Cozzarelli v. Inspire Pharmaceuticals, Inc., Case No. 07-1851 (4th Cir. Dec. 12, 2008).

Cozzarelli is a securities fraud action which alleged that Inspire Pharmaceuticals and certain of its officers, made false and misleading statements regarding a new product and its FDA trial. Specifically, the complaint alleged that before a new drug could come to market, the company had to conduct a clinical trial with a predetermined goal or endpoint that had to be satisfied. The company conducted the test. During the trial, company officials noted that it was underway and that an earlier test was similar. When the trial was completed, the company disclosed that it failed to meet its primary endpoint. The share price fell 44.5% on the day of the announcement. Suit was filed.

The Circuit Court affirmed the dismissal of the complaint for failing to plead scienter under the Tellabs standard. The Court set the tone for its opinion at the outset noting that “securities fraud actions serve an important purpose – but only when those actions are meritorious.”

Plaintiffs’ theory was that defendants misled the public to believe that the test was likely to succeed, thereby artificially inflating the stock price. This claim was based on the argument that defendant’s knew the end point of the study and made misleading statements about it. The Court concluded however, that plaintiffs’ complaint is in fact little more than “a series of isolated allegations without considering the necessary context.”

To place the allegations in context, the Court read the complete reports from which the passages in the complaint had been taken, rejecting plaintiffs’ claims that only the complaint could be reviewed. Once the complaint, and the reports on which it is based, are read in their entirety, under Tellabs the question is whether the inference of scienter raised by plaintiffs’ allegations is more cogent and at least equals the opposite inference. Here, it does not.

From a review of all of the analysts’ reports it is clear that the company refused to disclose the end point of the study for competitive reasons. The defendants withheld information, according to the reports, to protect the competitive interests of the company and not for an improper purpose, as suggested by plaintiffs.

Equally apparent is the fact that the statements made about the study by defendants were not misleading, according to the Court. Here, plaintiffs claim that CEO Shaffer lied about the end point of the study in a statement which described the study as similar to an earlier test which had a different end point. When the statements are read in context, however, it is clear that the CEO in fact had a legitimate interest in referring to the study in a general manner and not disclosing the end point. That generalization may “at most [support] an inference of imprecise or even negligent use of language, not an inference of scienter.”

Finally, the sales of stock by the individual defendants is no a motive for falsification. The sales by each defendant were relatively small and, overall, the holdings of company stock by each defendant increased during the course of the drug test. In addition, the sales by two of the defendants coincided with their departure from the company. Overall, after balancing all of the inferences, the Fourth Circuit became the fifth circuit court in recent weeks to conclude that plaintiffs failed to plead facts sufficient to meet the Tellabs test.