Delaware Chancery Court Grants Software Company’s Motion to Dismiss Stockholder Class Action Lawsuit After Stockholder Vote Cleansed Alleged Improprieties in Connection with Merger

In this Issue

• Delaware Chancery Court Grants Software Company’s Motion to Dismiss Stockholder Class Action Lawsuit After Stockholder Vote Cleansed Alleged Improprieties in Connection with Merger
• First Circuit Affirms Dismissal of Shareholder Class Action Complaint, Finding Investors Failed to Paint Compelling Picture of Scienter
• SEC Announces Settled Charges Against Public Companies for Violations of Whistleblower Protection Rule
• District of Massachusetts Dismisses Purported Class Action Lawsuit, Finding No Duty to Conduct “Good Science”

Delaware Chancery Court Grants Software Company’s Motion to Dismiss Stockholder Class Action Lawsuit After Stockholder Vote Cleansed Alleged Improprieties in Connection with Merger

On June 21, 2024, the Delaware Chancery Court dismissed a putative class action lawsuit brought by a former stockholder of Anaplan Inc. — a manufacturer of software that tracks corporate performance — against certain former Anaplan officers and directors for breach of fiduciary duty and waste.

The case involved a merger agreement through which Thoma Bravo, a private equity firm, acquired Anaplan for approximately $10.3 billion. After the agreement was finalized but before the deal closed, certain of Anaplan’s officers and directors caused Anaplan to breach the merger agreement by issuing more than $157 million in equity grants to new and existing employees, far outstripping the $105 million cap set by the merger agreement. When Thoma Bravo expressed disapproval for such equity grants made in excess of the cap, the parties agreed to amend the merger agreement by (1) lowering the acquisition price from $66.00 per share to $63.75 per share, which, in turn, trimmed approximately $400 million off the original purchase price; (2) waiving and limiting certain of Thoma Bravo’s closing conditions; and (3) increasing the termination fee from $586 million to $1 billion. Anaplan then submitted the revised merger agreement to its stockholders, who approved the transaction.

The plaintiff alleged that the defendants breached their fiduciary duties by causing Anaplan to breach the original merger agreement and violate its Revlon duties to “obtain and to maintain the highest price reasonably available” and committed waste by then giving up $400 million of value to remedy their breach. Ultimately, the court did not have to reach these issues. Instead, applying Delaware precedent under Corwin v. KKR Fin. Hldgs. LLC, the court dismissed the complaint in its entirety, holding that any wrongdoing was cleansed by a fully informed vote of stockholders approving the amended merger agreement. The court reasoned that, based on fulsome disclosures in a supplemental proxy statement, “[s]tockholders would . . . understand that, rather than continue to dispute the issue and risk losing the deal, the Board made the business judgment that it was in the best interests of Anaplan and its stockholders to agree to a price reduction in return for securing the still premium transaction and enhanced closing certainty.” The court pointed out that Anaplan stockholders had all “the material information they needed — including, most importantly, about the price — to make an informed decision.” The court rejected the plaintiff’s argument that the transaction was situationally or structurally coercive because Anaplan stockholders had two good options to choose from when casting their vote — retain interest in a multibillion-dollar company with significant revenue or sell their shares at a 41% premium — and the plaintiff did not allege self-dealing or other “extraneous factors.”

Finally, the court rejected the plaintiff’s waste claim because stockholders did not “give up value in exchange for nothing” but received a premium in the form of $10.4 billion in cash and a number of concessions from Thoma Bravo, including waiving certain conditions and nearly doubling Thoma Bravo’s reverse termination fee.

The decision reemphasizes the importance of providing full and unequivocal disclosures of all relevant information, good and bad, in soliciting shareholder approval of board decisions. Companies should not underestimate the potentially curative nature of shareholder approval.

First Circuit Affirms Dismissal of Shareholder Class Action Complaint, Finding Investors Failed to Paint Compelling Picture of Scienter

On July 2, 2024, the First Circuit affirmed dismissal by the US District Court for the District of Massachusetts of a putative class action complaint brought by stockholders of Frequency Therapeutics, Inc., a biotechnology start-up, against the company and certain of its officers for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (Exchange Act), as well as Securities and Exchange Commission (SEC) Rule 10b-5.

Frequency Therapeutics was developing a treatment called FX-322 for individuals suffering from severe hearing loss. While initial FX-322 clinical trials were promising, subsequent testing during the Phase 2a trial did not produce statistically significant results, which Frequency Therapeutics explained in a press release “potentially suggest[ed] bias due to trial design.” In the wake of this press release, Frequency Therapeutics stock plummeted.

The plaintiffs alleged that the company and its officers knowingly misrepresented the experimental validity of the Phase 2a trial by touting the study design as encompassing individuals who “have meaningful word recognition deficits,” despite allegedly knowing that tinnitus patients (who do not suffer from this impairment) gained access to the confidential Phase 2a participation criteria and used that information to “fake their way into the study” under the belief that FX-322 could help alleviate their symptoms. The defendants moved to dismiss, and the district court granted the motion, holding that the plaintiffs failed to allege sufficient facts to support a finding of scienter.

The First Circuit affirmed the dismissal, rejecting the plaintiffs’ argument that the defendants were reckless in ignoring signs, or that they knew, that the Phase 2a trial might be infected with bias when the challenged statements were made. First, the court held that a confidential witness’s statements — which alleged, among other things, that the chief development officer knew about a “discrepancy between certain patients’ responses during the screening process for admission into Phase 2a and subsequent examinations by the investigators” — failed to indicate when the officer learned of this discrepancy or explain why initial reports of improved hearing would raise concerns in a double-blind trial if clinicians would not have known whether participants were in the treatment group or placebo group. The court also rejected the plaintiffs’ theory that suspicious stock sales supported scienter, holding that the CEO’s sale of 15% of his shares “did not reduce his investment in the company by enough to allow for the strong inference of scienter,” and the plaintiffs did not allege that he knew of the study’s flaws. Finally, the court rejected the plaintiffs’ “core-operations” argument that the defendants must have known about the Phase 2a study concerns because FX-322 was so important to the company, reasoning that the importance of a product “provides no sufficient basis for determining when and what senior management were told” about such concerns.

The court held that viewed in its totality, the amended complaint failed to paint a compelling picture of scienter, concluding that “while each individual fact about scienter may provide only a brushstroke, our obligation is to consider the resulting portrait. At the same time plaintiffs cannot amalgamate a series of sketchy brushstrokes and call it a [V]an Gogh.” This decision demonstrates that a confidential witness’s statements regarding an allegedly known discrepancy in a double-blind clinical trial on their own may not be sufficient for courts to determine whether scienter has been adequately pled, because allegations of fraudulent intent must be considered holistically. Nevertheless, life science companies should be careful if they discover an issue while conducting a clinical trial because the timing of such discovery may make all the difference in a court finding fraudulent intent.

SEC Announces Settled Charges Against Public Companies for Violations of Whistleblower Protection Rule

On September 9, 2024, the SEC announced settled charges against seven public companies for violations of Exchange Act Rule 21F-17, which prohibits any person (including entities) from taking any action to impede an individual from communicating directly with the SEC about a possible securities law violation. In the settlements, the SEC found that the language set forth in employment and other agreements limiting employees’ right to file a complaint with any federal government agency or recover a monetary reward for their participation in an investigation by a government agency “created impediments to participation in the Commission’s whistleblower program by requiring employees to forgo either their right to file a complaint with the Commission staff or the financial award they might receive for doing so.” In each of the orders, the SEC indicated that it was unaware of any instances in which the companies took action to enforce these provisions or in which these provisions had an actual chilling effect on affected employees, demonstrating its view that it does not need to establish that any individual was actually impeded to establish that there was a violation.

Notably, the SEC also found that consulting services agreements in two of the settled actions, which contained language prohibiting contractors from voluntarily providing information about certain business-related operations to government agencies without first disclosing to the company, also violated the rule.

The companies, without admitting or denying the SEC’s findings, agreed to pay more than $3 million in combined civil penalties. In determining whether to accept the settlement offers, the SEC took into consideration remedial steps undertaken by the companies, including revising the relevant agreements and notifying affected employees or contractors that their agreements do not limit their ability to contact SEC staff or to obtain an award in connection with information they provide.

The SEC continues to pursue whistleblower protection investigations and actions. Public and private companies should consider examining their agreements, including with third parties, as well as their policies, procedures, and processes to ensure the language contained therein is compliant with the rule.

District of Massachusetts Dismisses Purported Class Action Lawsuit, Finding No Duty to Conduct “Good Science”

On September 18, 2024, the US District Court for the District of Massachusetts dismissed, with prejudice, a putative class action lawsuit filed by stockholders of Invivyd, Inc. (known during the relevant time period as Adagio Therapeutics, Inc.) against the company and two of its officers alleging claims under Exchange Act Sections 10(b) and 20(a) and Rule 10b-5.

Adagio, a biopharmaceutical company, developed a monoclonal antibody therapy known as ADG20, which showed promise against initial strains of COVID-19. In November 2021, when Omicron emerged as a new variant of the virus, Adagio and its officers made various statements indicating they expected that ADG20 would similarly protect and fight against Omicron. Adagio’s stock price reacted favorably to this news, with shares trading as high as $78.82 per share on November 30, 2021. However, subsequent testing found a 300-fold reduction in the efficacy of ADG20 against the Omicron variant. Adagio’s share price plummeted to $5.57 per share after it disclosed this. The plaintiffs alleged that, in light of these results, the defendants’ earlier statements regarding the projected efficacy of ADG20 were false and misleading.

The court dismissed the plaintiffs’ claims in their entirety, concluding that the statements in question were all indications of the defendants’ subjective beliefs regarding ADG20 based on the information available to them at the time and that a reasonable investor “would not expect the defendants to have conducted all possible analyses before offering their predictions.” That the statements omitted warnings from public health officials that Omicron may be resistant to monoclonal antibodies such as the defendants’ product also did not render the statements materially misleading because “it is not a material omission to fail to point out information of which the market is already aware.” While the court noted that the defendants’ scientific opinions ultimately turned out to be false, the court nevertheless held that there was no evidence that the facts underlying their expressed beliefs were untrue or that they knew the statements were false when made.

The court also held that the plaintiffs had not provided either direct or indirect evidence of scienter to support their allegations. The court found that the defendants had no conclusive evidence that ADG20 was ineffective against the Omicron variant when they made their statements, meaning their hedging, forward-looking statements regarding what they “expecte[d]” or “anticipate[d]” the study results to show while noting the supporting data was “yet to come” could not be considered highly reckless. The court also noted that the defendants were transparent when discussing the basis for their predictions, which undercut any allegations of recklessness. Finally, the court rejected the plaintiffs’ “fraud by hindsight” theory, finding that intent to defraud could not be inferred just from the fact that the in vitro results ultimately demonstrated that ADG20 was markedly less effective against Omicron.

This decision reinforces that “the securities laws do not impose a duty to conduct ‘good science.’” While most life sciences companies are bullish going into clinical studies and may offer their scientific opinions of optimism about those trials, their opinions must be truly held and supported by facts to avoid potential liability under the securities laws.

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.