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PSLRA Class Action Defense Cases–Cozzarelli v. Inspire Pharmaceuticals: Fourth Circuit Affirms Dismissal Of Securities Fraud Class Action Holding Allegations In Class Action Complaint Failed To Meet PSLRA’s Heightened Pleading Requirements

Securities Fraud Class Action Complaint Failed to Adequately Plead Strong Inference of Scienter Required by Private Securities Litigation Reform Act (PSLRA) because Defense Presented Compelling Inference that Company Refused to Disclose Details of Phase III Drug Trials for “Competitive Reasons,” thereby Supporting District Court Order Dismissing Class Action Complaint Without Leave to Amend Fourth Circuit Holds

Plaintiffs filed a class action against Inspire Pharmaceutical and three of its directors (collectively “Inspire”), as well as other defendants, alleging violations of federal securities laws; the class action complaint asserted that Inspire “overstat[ed] the prospects for an experimental drug that the company was developing to treat dry eye disease.” Cozzarelli v. Inspire Pharmaceuticals Inc., 549 F.3d 618 (4th Cir. 2008) [Slip Opn., at 2]. Specifically, the class action alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and of Rule 10b-5, as well as violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. See id., at 6. Defense attorneys moved to dismiss the class action on the ground that the allegations in the class action complaint failed to meet the heightened pleading requirements established by the Private Securities Litigation Reform Act of 1995 (PSLRA), and the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., ___ U.S. ___, 127 S.Ct. 2499 (2007). See id., at 2-3 and 6-7. Specifically, Inspire argued that plaintiff’s class action complaint failed to raise the requisite “strong inference of scienter,” id., at 6, or that defendants had made false or misleading statements, id., at 7. The magistrate recommended that the motion be granted, and the district court dismissed the class action. Id., at 6-7. The Fourth Circuit affirmed.

In brief, Inspire had reached Phase III trials of its drug diquafosol tetrasodium, but while the study showed that the drug objectively resulted in substantial improvement of dry eye disease, the company failed to achieve its second primary goal, or “endpoint,” in that patients did not report subjective feelings of improvement. See Inspire, at 3-4. The FDA gave Inspire two options: (1) “conduct two additional trials that met both an objective endpoint and a subjective endpoint,” or (2) “conduct one additional trial that replicated – this time as a primary endpoint – the corneal clearing that Inspire achieved” in its prior study. Id., at 4. Inspire chose the second option but was “tight-lipped” about details of its new study, id., at 5. Inspire made several “generic” comments about its new study, including that it was “very similar” to the prior study and that it was a “confirmatory” Phase II trial, id. Additionally, some stock analysts “speculated that the primary endpoint of [the new study] was only a relative improvement in corneal staining scores and that [the new study] was likely to meet that endpoint.” Id. In point of fact, however, the new study failed to meet its primary endpoint, and Inspire’s stock plunged 44.5% on the news. Id., at 6. Plaintiffs’ class action complaint followed, id.

As noted above, the district court dismissed the class action, agreeing with the magistrate that plaintiffs failed to allege facts sufficient to give rise to a strong inference of scienter, or that defendants had made false or misleading statements. Inspire, at 6-7. The Fourth Circuit agreed. After explaining the purpose behind the PSLRA, and summarizing the Supreme Court’s decision in Tellabs, see id., at 7-10, the Circuit Court stated that the scienter argument was dispositive and, accordingly, that it would “therefore assume for the sake of argument that defendants’ statements were misleading and turn to plaintiffs’ theory of scienter.” Id., at 10. The Fourth Circuit found that plaintiffs’ argument required that defendants’ statements be taken out of context, but that Tellabs counseled courts to “examine the facts as a whole, including facts found in ‘documents incorporated into the complaint by reference.’” Id., at 11 (citation omitted). In context, it was clear that Inspire repeatedly announced that it would not disclose details of the new study for “competitive reasons,” id., at 11-12, thus supporting the inference that Inspire withheld details of the study “with the intent to protect Inspire’s competitive interests” rather than to defraud investors, id., at 12. Because the fact support two inferences – the “nefarious intent” advocated by plaintiffs, and the “innocent one” advocated by defendants – the Circuit Court explained that it was required to “weigh those competing inferences and determine whether plaintiffs’ inference of scienter is ‘cogent and at least as compelling’ as defendants’ inference of a legitimate business judgment.” Id., at 12 (citation omitted). The Court ultimately concluded that “the inference that defendants acted with the nonfraudulent intent to protect their competitive advantage is more powerful and compelling than the inference that defendants acted with an intent to deceive.” Id., at 12-13; see also id., at 13-16. It therefore affirmed the district court order dismissing the class action complaint without leave to amend. Id., at 20.

NOTE: The Fourth Circuit also affirmed dismissal of the class action’s claims under Sections 11 and 12(a)(2) of the Securities Act of 1933. See Inspire, at 16-19.

Download PDF file of Cozzarelli v. Inspire Pharmaceuticals