ATTORNEY: JUSTIN NEMATZADEH
POMERANTZ MONITOR JULY/AUGUST 2018
In Cohen v. Kitov Pharmaceuticals Holdings, Ltd., Judge Lorna Schofield of the Southern District of New York sustained, in part, the class action claims of lead plaintiffs represented by Pomerantz and the Rosen Law Firm. We brought these claims under Sections 10(b) and 20(a) of the U.S. Securities Exchange Act of 1934 and Rule 10b- 5, against defendants Kitov Pharmaceuticals Holdings, Ltd. and its CEO Isaac Israel. This was a significant victory for plaintiffs, primarily because Judge Schofield adopted an ideal blend of crediting confidential informants’ allegations about a relatively small corporation, while protecting them from retaliation. Kitov is an Israeli biopharmaceutical company. Its American depository shares trade on the NASDAQ. Kitov’s leading drug candidate is KIT-302, a fixed-dosage combination product based on two generic drugs designed to treat pain and hypertension. To commercialize the drug, it was necessary for the company to obtain FDA approval of KIT-302’s New Drug Application (“NDA”). A milestone in this process would have been reached when pivotal clinical trials were completed, the data was analyzed, and the data analyses demonstrated promising results in reducing blood pressure. To facilitate FDA approval, Kitov agreed to a procedure requiring it to conduct a detailed Phase 3 study (the “Study”). Kitov’s board of directors appointed an independent committee to evaluate whether the Study results were good enough to support the NDA. After reviewing the results, the committee determined that the Study had, indeed, demonstrated the drug’s efficacy. Plaintiffs alleged that the Study results were falsified prior to submission to the committee and that the actual, undisclosed results failed to provide statistically significant evidence of efficacy. Although the company never admitted what had happened, the truth emerged. On February 6, 2017, Mr. Israel was reportedly arrested and questioned by the Israel Securities Authority on suspicion of fraud. The next day, Kitov issued a press release announcing the launching of the formal investigation, while maintaining that it “stands fully behind the validity of all of its clinical trial results” and that it “continues to move forward toward the filing of [its] New Drug Application for KIT-302 with the FDA.” The price of Kitov’s ADS dropped precipitously after these revelations.
IDENTIFYING THE INFORMANTS. Scienter, defined as acting deliberately or recklessly in misrepresenting the facts, is an essential element of any securities-fraud claim. To state a cause of action, plaintiffs must allege facts constituting strong circumstantial evidence of conscious misbehavior or recklessness. This can be shown where a defendant engaged in deliberate illegal behavior, knew facts or had access to information contradicting its public statements, or failed to review or check information that the defendant had a duty to monitor. Judge Schofield held that, to satisfy this requirement, “[a] complaint may rely on information from confidential witnesses if they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” In support of its claim, the complaint cites information provided by several former Kitov employees and consultants. Significantly, Judge Schofield found that plaintiffs had sufficiently alleged scienter against Kitov and Mr. Israel, based, in part, on relatively general allegations from confidential informants. These allegations were relatively broad because the company, at any given time, never engaged more than ten people as employees or consultants, whose anonymity would have been jeopardized had more specific allegations been provided. Critical to this finding was plaintiffs’ reliance on several former Kitov consultants for allegations that Mr. Israel falsified the Study data: “[A]ccording to several former consultants of Kitov with knowledge of the clinical trial results, Israel was the individual who directed that the . . . data be falsified to show efficacy[.]” Judge Schofield stated that while this description may not have sufficed in an organization with hundreds of employees, any more detailed description here likely would have revealed the identity of the sources. This evidence from multiple former consultants, combined with Mr. Israel’s position as head of a small organization and news of the ISA’s investigation, gave rise to a plausible inference that Mr. Israel was responsible for the falsification of data. Judge Schofield emphasized that “[r]equiring disclosure of confidential sources could deter them from providing information ‘or invite retaliation against them.’”
DUTY TO SPEAK THE FULL TRUTH. Another major issue in the case was whether defendants had a duty to disclose that the results of the Study had been falsified. Defendants argued that they had no duty to provide any details about the Study. The court disagreed, holding that “[O]nce a company speaks on an issue or topic, there is a duty to tell the whole truth, even where there is no existing independent duty to disclose information on the issue or topic.” When defendants made statements about the Study results, including, without limitation, that they “successfully met the primary efficacy endpoint of the trial protocol[,]” they made material omissions by failing to disclose that the results had been falsified. Defendants argued that the failure to disclose falsified data was not actionable because the results were not falsified: they quoted their own SEC filings to argue that the Study was conducted by independent research organizations and that defendants had no access to the data and therefore could not have tampered with the results. But Judge Schofield, crediting plaintiffs’ allegations, found this argument unpersuasive because it was premature on a motion to dismiss.
LOSS CAUSATION. Finally, defendants argued that the complaint did not properly allege “loss causation”—that the misrepresentations concerning the Study did not “cause” the price of Kitov stock to drop. Typically, loss causation is established by showing that a curative disclosure of the true facts occurred, followed directly by a drop in the price of the company’s stock. Here, defendants argued that because they never admitted that the results of the Study were falsified, there was no curative disclosure and, therefore, no loss causation. They also argued that the results of the Israeli investigation into the company had not been disclosed when the stock price fell and therefore could not have caused the losses, asserting that plaintiffs must have shown that a “misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security.” Judge Schofield found that disclosure of the investigation and the subsequent drops in Kitov’s ADS prices sufficiently demonstrated loss causation, even though Kitov released a statement that it stood by its earlier disclosures about KIT-302 and was on track with its NDA approval.