In re Cell Therapeutics, Inc.: Examining the Pleading Requirements of Securities Fraud

In In re Cell Therapeutics, Inc. Class Action Litig., 2011 U.S. Dist. LEXIS 11157 (W.D. Wash. Feb. 4, 2011), the district court declined to dismiss plaintiff's claim despite arguments that plaintiffs had inadequately alleged scienter, loss causation, and the inapplicability of the safe harbor for projections.  

Cell Therapeutics, Inc. (“CTI”) was developing a cancer-fighting drug called Pixantrone.  In order to fast-track the drug’s development, CTI and the FDA entered into a Special Protocol Assessment (“SPA”) in 2004.  SPAs bypass lengthy and costly procedures for new drug applications and are invalidated by modifications to the testing procedure not agreed to by the FDA.

On March 25, 2008, CTI announced it was closing the drug study.  Plaintiffs alleged that the announcement failed to reveal that (1) the study was closing with 140 enrollees rather than the intended 320, and (2) the FDA did not agree to the drug study’s modification. The defendants issued various press releases characterizing the SPA as still viable, not revealing that the testing procedure had been modified without FDA approval.  

The class action complaint alleges violations of securities fraud under § 10(b) of the Exchange Act and SEC Rule 10b-5.  Plaintiffs were required to plead (1) a material misrepresentation or omission; (2) scienter; (3) a connection between the misrepresentation or omission and purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation. 

With respect to allegations of scienter, the court rejected the defendants’ contention that plaintiffs needed to produce a “smoking gun.”  Nonetheless, plaintiffs produced allegations of "particularly strong evidence of scienter."  One confidential witness, according to the complaint: 

• told two of the individual Defendants . . .  that the SPA had been invalidated by their unilateral actions (¶ 43) – is probably sufficient by itself to support a strong inference of scienter (at least for those two individual Defendants and the company). 

With respect to loss causation, plaintiffs cited two separate corrective disclosures and the impact on share prices.  The first occurred on February 8, 2010, when a 39% drop in CTI’s stock followed disclosure that the SPA was invalid.  The other occurred when, on March 22, 2010, share prices fell 48% in a single day upon news that CTI had unilaterally altered the clinical testing protocol.

The court premised the analysis by noting that loss causation was not "subject to a heightened pleading requirement under either the PSLRA or the FRCP".  In addition, the element was "a highly fact-specific issue" and that "determination of loss causation [was] 'generally inappropriate on a motion to dismiss.'”  With respect to the two allegedly corrective disclosures, the court acknowledged that the drop in share prices may have had multiple causes, including causes unrelated to the fraud.  Nonetheless, plaintiffs only needed to show that the alleged misrepresentations were a "contributing" factor.  In both cases, the court concluded that the plaintiffs met this requirement.   

Finally, the court also dismissed claims that the disclosure was protected by the safe harbor for forward looking statements.  Although the various disclosure documents contained cautionary language, the cout noted that some of the allegations involved not forward information but present facts.  The safe harbor did not apply to those types of allegations. 

The opinion can be found at the DU Corporate Governance website.