In re Delcath Systems, Inc.: Court Finds Elements of Securities Fraud under §10(b) and 10b-5 Sufficiently Pled

In In re Delcath Sys., Inc. Sec. Litig., No. 13 Civ. 3116 (LGS), 2014 BL 179685 (S.D.N.Y. June 27, 2014) the plaintiff, Delcath Systems Group, brought a class action on behalf of all persons or entities that were shareholders of Delcath Systems, Inc. from April 21, 2010 to September 13, 2013 (collectively “Plaintiffs”). Plaintiffs sought remedies under the Securities Exchange Act of 1934 alleging that shareholders purchased Delcath stock in reliance on material misrepresentations and omissions made by defendants Delcath Systems, Inc. and its then CEO Earmonn Hobbs (together “Defendants”). Defendants moved to dismiss the complaint for failure to state a claim. The court denied Defendants’ motion because the complaint sufficiently stated a claim for relief under Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder. 

According to the allegations, Defendants filed a New Drug Application but were subsequently denied by the FDA. Defendants then submitted a revised application, which the FDA accepted for review on October 15, 2012. On April 30, 2013, the FDA published briefing documents, which stated that 7% of participants treated with the Melblez Kit died and 24% of the patients experienced serious side effects such as heart attack and acute kidney failure. None of the patients in the control group, however, died. Upon release of these findings, Delcath stock declined over 40%.

On May 2, 2013, the FDA met with the Oncologic Drugs Advisory Committee (ODAC) to discuss the Melblez Kit. The ODAC panel shared the same concerns as the FDA and voted against approving the Melblez Kit. As a result, Delcath stock declined another 42%. On September 13, 2013, the FDA issued a Complete Response Letter rejecting the Melblez Kit without further testing. In total, Delcath stock fell from $1.39 to $0.34 between April 30, 2013 and September 13, 2013.

Plaintiffs alleged that investors relied on Defendants’ misleading statements and omissions. First, Plaintiffs alleged the company and Mr. Hobbs made several overly optimistic statements regarding the likelihood of FDA approval. Second, Plaintiffs alleged Defendants made misleading statements about the safety of the Melblez Kit and failed to disclose the results of the control group in which no participants died.

Defendants moved to dismiss the claims pursuant to Federal Rule of Civil Procedure 12(b)(6). In order "[t]o survive a motion to dismiss, a complaint must plead enough facts to state a claim to relief that is plausible on its face." Furthermore, to allege a violation of securities fraud under Section 10(b) and Rule 10b-5, a plaintiff must plead: “(1) a material misrepresentation (or omission); (2) scienter, i.e., a wrongful state of mind; (3) a connection with the purchase or sale of a security; (4) reliance . . . ; (5) economic loss; and (6) loss causation."

In the present case, the court determined whether the complaint sufficiently pleaded three of the six elements: a material misrepresentation or omission, scienter, and loss causation. The court found the complaint sufficiently pleaded these elements with respect to Phase II Results Statements.  The court, however, found the complaint did not sufficiently plead that the statements made regarding the FDA’s approval were false and misleading.

In analyzing whether a statement or omission is materially misleading, the court must determine “whether a reasonable investor would have viewed the nondisclosed information as having significantly altered the total mix of information made available." Regarding the statements made about the FDA’s approval, the court found that Defendants did not express certainty that the Melblez Kit would receive FDA approval, and, therefore, those statements were forward-looking statements in conjunction with meaningful cautionary statements.  As a result, the statements fell within the safe harbor in the PSLRA and were therefore not actionable.   

As a result, the court denied Defendants’ motion to dismiss because the complaint sufficiently stated a claim for relief under the Section 10(b) of the Securities and Exchange Act and Rule 10b-5 promulgated thereunder.

Primary materials are available on the DU Corporate Governance website.

Andrea LaFrance