Schueneman v. Arena Pharmaceuticals: Sufficient Pleading of Scienter

In Schueneman v. Arena Pharmaceuticals, Inc., 840 F.3d 698 (9th Cir. 2016), the United States Court of Appeals for the Ninth Circuit reversed the District Court’s ruling of summary judgment for Arena Pharmaceuticals, Inc. (“Defendant”) based on an inadequate pleading of scienter. The Ninth Circuit held that a strong inference of scienter was properly pleaded by Schwartz (“Plaintiff”) under Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act (“PSLRA”).

Per Plaintiff’s allegations, Defendants disclosed that lorcaserin, a drug under development (the “Drug”), was not carcinogenic and supported the claim with references to animal studies.  Between September 2006 and July 2009, Defendant was in the midst of conducting clinical studies (testing on humans) and nonclinical studies (testing on animals). When Defendant filed its application for approval of the Drug with the FDA, an advisory panel published a briefing document that disclosed, for the first time, that rats used in the animal study were “getting cancer.”  The market was “surprised” by this information and stock prices “dropped significantly.”

Plaintiff’s complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”) and rule 10b-5 promulgated thereunder. Plaintiff claimed that Defendants, having raised the animal studies to support the FDA application, were obligated to reveal the rat study.   Failure to do so demonstrated scienter.

Under Fed. R. Civ. P. 9(b) a plaintiff must allege: 1) a material misrepresentation or omission by the defendant; 2) scienter; 3) a connection between the misrepresentation or omission and the purchase or sale of a security; 4) reliance upon the misrepresentation or omission; 5) economic loss; and 6) loss causation. The PSLRA requires that the complaint specify each statement alleged to have been misleading and the reason or reasons why the statement is misleading. In addition, the complaint must include allegations that give rise to a “strong inference” of scienter. A complaint will survive only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.

The court held Plaintiff had alleged scienter with sufficient particularity to survive a motion to dismiss. Specifically, the court stated that Defendants had a duty to disclose the animal studies because they had represented that the animal studies supported the Drug’s safety and therefore its likelihood of approval. Furthermore, Defendants’ failure to inform the market about the risk of non-approval or delay based on the FDA’s concerns about the rat study was “an extreme departure from the standards of ordinary care . . . .” Defendants did more than just express confidence in the Drug’s future, according to the court, they affirmatively represented that “all the animal studies” that had been completed “supported” the case for approval of the drug. According to the court, these statements could not be supported at the time and Defendants’ statement that all of the data was favorable to approval was inappropriate.

Accordingly, the Ninth Circuit reversed and remanded the case ruling that Plaintiff satisfied the scienter requirement under Fed. R. Civ. P. 9(b) and the PSLRA.

The primary materials for this case may be found on the DU Corporate Governance Website.

Ryan Cordsen