Jennifer Windom, Partner at Hogan Lovells, and Bolton Smith, associate at Hogan Lovells, present the risks and considerations pharmaceutical and life sciences companies have to take when making proactive and forward-looking disclosure statements. 

Publicly-traded pharmaceutical and life science companies often face a dilemma when addressing future prospects. On the one hand, companies successfully developing cutting-edge products want to publicly trumpet breakthroughs and potential use-cases as early as possible.  On the other hand, companies facing potential approval setbacks and regulatory risks may not wish to disclose their worst-case scenarios until they are certain the risks will come to fruition. And many issuers seek to insulate themselves from investor criticism by proactively disclosing specific regulatory risks and the steps they are taking to address them. Decisions around public disclosures of drug and product developments are ripe for scrutiny by securities regulators and the investing public alike. Pharmaceutical and life sciences companies need a keen understanding of federal securities laws to navigate these circumstances.

Securities disclosures and safe harbor protections 

Under federal securities laws, public companies are required to disclose material risks and to avoid publishing false, misleading, or materially incomplete information in their securities filings and offering documents. Complying with these obligations can become complicated when companies wish to make proactive or forward-looking disclosures. No company can know the future with certainty, and sometimes what may initially appear as an insignificant risk can derail an otherwise promising product development or launch. So, how can a company proactively address future events without exposing itself to securities fraud liability if something later goes wrong?

The Private Securities Litigation Reform Act1 (“PSLRA”) and related caselaw create a “safe harbor” for issuers who make forward-looking statements accompanied by meaningful disclaimers. Such protected statements may be either oral or written and can include projections of future economic performance, expected progress of a product’s development, or use-case plans.  Federal law recognises that certain statements about the future should be protected from liability because no reasonable investor could consider such statements materially misleading.

The safe-harbor doctrine is a powerful tool, but it has limits. A company cannot knowingly make a false forward-looking statement and then seek protection. Nor can a company invoke the doctrine to represent risks that have already transpired as merely hypothetical. Companies also cannot use vague, boilerplate cautionary language that fails to give investors a meaningful understanding of risks. Two recent court decisions illustrate the limitations for life sciences companies seeking to invoke the safe-harbor doctrine to avoid securities liability.

In re Axsome Therapeutics 

In March of last year, a federal district court in New York held that defendant Axsome Therapeutics, a publicly-traded company that develops therapies for central nervous system disorders, could not avail itself of the safe-harbor doctrine in connection with securities fraud allegations relating to disclosures around its manufacturing and development of AXS-07, a new migraine drug. In public press releases, SEC filings, and earnings calls, the company had touted its belief that there would be no significant issues obtaining FDA approval. The company also downplayed concerns about manufacturing delays—a problem that had plagued development of its earlier drug (AXS-05)—by explaining to investors that “existing suppliers of our product candidate active pharmaceutical ingredients and finished products will be capable of providing sufficient qualities of each to meet our clinical trial supply needs.” These statements culminated in public filings where Axsome disclosed that it was making “continued progress” toward the Prescription Drug User Fee Act date for its new drug application for AXS-07.

According to investors, however, Axsome failed to address several material concerns about its manufacturing supplier that allegedly had come to management’s attention. For example, at the same time Axsome was assuring investors of its supplier’s ability to provide sufficient quantities of AXS-07, the company supposedly had to delay critical drug studies due to lack of AXS-07 supply. Moreover, management allegedly had conducted a chemistry, manufacturing, and controls audit and found that its supplier had serious equipment problems. Months later, Axsome publicly revealed that it was experiencing manufacturing issues and that the FDA had requested additional data regarding its manufacturing process. Axsome’s share price plummeted, and investors sued based on the allegedly misleading statements about FDA approval and supplier reliability.

Axsome invoked the safe-harbor doctrine as a defense, which the court rejected.  The court observed that at the time Axsome publicly stated that its supplier could deliver sufficient AXS-07, Axsome was already aware of ongoing manufacturing concerns leading to clinical testing delays. Even though Axsome included a disclaimer in its discussion of FDA approval that “clinical trials are not always conclusive and the FDA may interpret data differently than an applicant interprets the same data,” the complaint alleged that the company already faced supply issues that had compromised the development and commercialisation of AXS-07. The court similarly rejected Axsome’s efforts to invoke the safe-harbor to protect statements about its NDA submission, concluding that Axsome was then aware of facts materially decreasing the likelihood of FDA approval. Axsome’s cautionary language could not insulate it from liability for failure to disclose risks that had already transpired. Finally, the court credited investors’ allegations that Axsome executives actually knew their forward-looking statements were false and misleading when they made them due to the undisclosed manufacturing problems and supply delays, which also brought their statements outside of safe-harbor protection.

Helo v. Sema4 Holdings Corporation 

Another recent life science securities decision from a federal court in Connecticut provides additional insight as to the limits of the safe-harbor doctrine. There, a health diagnostics testing business, Sema4, claimed that it could personalise medical care for patients using a health intelligence platform and database called “Centrellis.” To help build out this database, Sema4 announced plans to acquire a company that provided rare disease diagnostic and exome sequencing services. In public calls and filings, Sema4 touted that acquisition as enhancing Centrellis’s functionality by allowing the system to use state-of-the-art AI and machine learning to construct predictive models that would transform the diagnostics landscape. Sema4 forecasted that the acquisition would turn Centrellis into a market leader in the diagnostics field.  Unknown to investors, at the time of these statements, Centrellis allegedly lacked the ability to utilise data in any meaningful way and Sema4 was experiencing significant hiring difficulties and regulatory hurdles preventing Centrillis from functioning as a viable product. Sema4 denied these allegations, but nonetheless argued that its positive, forward-looking statements about Sema4’s plans for Centrellis post-acquisition were protected under the safe-harbor.

The court disagreed, for two reasons. First, the court held that Sema4’s statements had not been strictly forward-looking because, in each statement, the “speaker necessarily represents that Centrellis presently exists.” And key misrepresentations of present fact are not protected. Second, the court held that Sema4’s supposedly “cautionary” statements had not truly been so—they were “vague” and verged on being boilerplate, as well as irrelevant to the allegedly misstatements about Centrellis actually existing. The court ultimately denied Sema4’s motion to dismiss investors’ securities fraud claims.

Lessons learned

For companies focused on pharmaceutical and life science innovations, these cases provide helpful reminders as to the limits of safe-harbor protection over public statements. Companies need to consistently communicate with their researchers, regulatory teams, and vendors to detect when risks transform from hypothetical, future concerns into materialised problems. This is especially true for risks relating to issues not fully within a company’s control, such as supplier viability or regulator approval. Cutting-edge research and products also need to be fairly presented so as not to oversell current functionality or mislead investors as to how much progress has actually been made. While a company may be confident that its product will revolutionise the industry, it cannot imply that it currently has functions it does not actually possess. Finally, when crafting cautionary language for public disclosure, companies must communicate specific and meaningful disclaimers, not just generalised risks applicable to any kind of disclosure. And these warnings must actually relate to the statements they are designed to protect. If investors cannot use cautionary language to fairly temper expectations and communicate the risks of what is being disclosed, the safe harbor may not protect the disclosure.

References

1: https://www.law.cornell.edu/uscode/text/15/78u-5