United States: Federal Court Denies Motion To Dismiss Section 20A Insider Trading Claims, Finding Plaintiffs Sufficiently Pleaded Scienter Where Allegations Were "Equally Compelling" As The Opposing Inference

On July 1, 2019, Judge Michael A. Shipp of the United States District Court for the District of New Jersey denied a motion to dismiss a complaint alleging insider trading in violation of Section 20A of the Securities Exchange Act of 1934.  In re Valeant Pharma. Int’l Inc. Sec. Litig., 15-7685 (MAS) (LHG) (D.N.J. July 1, 2019).  The complaint asserts the Section 20A claims against a board member of a large pharmaceutical corporation (the “Company”) and an investment advisory firm and affiliates co-founded by that board member that traded in the Company’s stock.  The Court, which had already considered and denied a motion to dismiss the Section 10(b) and Rule 10b-5 claims in a prior ruling, concluded that the complaint adequately alleged Section 20A claims and denied the motion to dismiss.

Plaintiffs commenced the action against the Company and its officers and directors, principally alleging that the Company designed a “clandestine network” of pharmacies to block the sale of competing generic drugs and asserting Section 10(b) and Rule 10b-5 claims.  In September 2017, the Court denied defendants’ motion to dismiss those claims.  In September 2018, plaintiffs amended their complaint to add claims of insider trading against a corporate board member and an investment advisory firm (as well as its affiliates) co-founded by that board member (the “Insider Trading Defendants”).  Plaintiffs allege the Insider Trading Defendants sold 4.2 million shares of the Company’s stock for proceeds of approximately $950 million while in possession of material nonpublic information regarding the Company’s improper business and accounting practices.  Plaintiffs further allege that the Insider Trading Defendants had not sold the Company’s shares in over four years and that the sale took place only a few months before the alleged corrective disclosures.

To plead a violation of Section 20A, which is a private right of action for insider trading violations, a plaintiff must plead:  (1) a predicate violation of the Exchange Act; (2) that plaintiff traded contemporaneously with the insider; and (3) that the insider was in possession of material nonpublic information.  A plaintiff also must allege facts giving rise to a “‘strong inference’ of scienter,” which the Court noted requires an inference that is “at least as compelling as any opposing inference of nonfraudulent intent.” 

As to the first element, there is a split of authority as to whether the predicate violation of the Exchange Act is the insider trading violation itself or a separate violation.  Compare In re Able Labs Sec. Litig., No. 05-2681, 2008 WL 1967509, at *26 (D.N.J. Mar. 24, 2008) (holding sufficiently alleged Section 10(b) claim satisfied predicate violation requirement) and Hefler v. Wells Fargo & Co., No. 16-5479, 2018 WL 1070116 (N.D. Cal. Feb. 27, 2018) (same) with In re Bear Sterns, Inc., 763 F. Supp. 2d 423, 508 (S.D.N.Y. 2011) (“[A] plaintiff must ‘plead a predicate insider trading violation of the Exchange Act.’”); Thomas v. Magnachip Semiconductor Corp., 167 F. Supp. 3d 1029, 1050 (N.D. Cal. 2016) (defendant must know, at the time of trade, material nonpublic information) and In re Schering-Plough Corp./Enhance Sec. Litig., Civ. No. 08-397, 2009 WL 2855457, at *4 (D.N.J. Sept. 2, 2009) (defendants knew of advance study results when they traded).  The Court held that the Third Circuit already held that the predicate violation required to establish a Section 20A claim can be an independent violation of the Exchange Act and need not be an insider trading violation.  Because the Court already held in a previous decision that plaintiffs sufficiently alleged a violation of Section 10(b) and Rule 10b-5, the Court concluded that a predicate violation was sufficiently alleged. 

Next, the Court turned to whether plaintiffs sufficiently allege that the Insider Trading Defendants were in possession of material nonpublic information and whether they had met PSLRA’s heightened pleading standard of raising a “strong inference” of scienter for the Section 20A claims (independent of scienter alleged for the Section 10(b) claims).  First, the Court found that the complaint includes sufficiently specific allegations of material nonpublic information that Insider Trading Defendants knew, rejecting Insider Trading Defendants’ argument that the complaint at most pleads only that they had access to the information.  Second, the Court considered Insider Trading Defendants’ argument that scienter was not sufficiently pleaded because (i) the investment advisory firm had a policy limiting the amount of stock of any single company that it could hold, and (ii) Insider Trading Defendants made stock purchases during the class period at allegedly artificially inflated prices and continued to hold large amounts of stock after the alleged impropriety was disclosed.  Although the Court found these facts potentially “suggest a lack of scienter,” there were “plausible opposing inferences” because plaintiffs allege (i) Insider Trading Defendants had not previously adhered to the concentration policy, (ii) Insider Trading Defendants’ holdings were so large that they could not sell more stock without arousing suspicion, and (iii) Insider Trading Defendants’ sale was unusual because it had not sold any stock in the four years prior to the sale.  Reviewing the “opposing inferences,” the Court concluded that “the inference of scienter [was] equally compelling as the opposing inference” and held that plaintiffs sufficiently pleaded scienter for the Section 20A claims.

Finally, the Court rejected Insider Trading Defendants’ argument that the complaint insufficiently alleged that plaintiffs traded contemporaneously with the sales, because plaintiffs traded on June 11, 2015, which is not the same day of the alleged sale (June 10, 2015).  The Court held that trading on the same day is not strictly required, at least for purposes of the motion to dismiss, and that the contemporaneous requirement was satisfied in this case, because Insider Trading Defendants’ sale was so large that it was plausible to infer that it took more than one day for the sales to be completed.  Plaintiffs also pointed out that the total sales volume (4.2 million shares) on the day of Insider Trading Defendants’ sales (June 10, 2015) was equal to (or less than) the number of shares sold by Insider Trading Defendants, suggesting that additional sales must have taken place on subsequent days.  The Court declined to follow other district courts that seemingly imposed single-day requirements, observing that those previous cases did not involve sales as large as those in this case.  The Court also observed that the contemporaneous trading requirement was developed as a proxy for privity between plaintiffs and defendants and was designed to give plaintiffs a feasible way of pleading an insider trading claim given that it is virtually impossible in public market transactions to allege actual privity.  As such, the Court held that an allegation that a plaintiff “might” have traded with a defendant and been harmed is sufficient to state a claim. 

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