By Donielle Tigay Stutland, J.D.
The Delaware Chancery Court denied a motion to dismiss a derivative lawsuit against the board of directors of Clovis Oncology, Inc., for breach of fiduciary duties regarding the failure of the cancer drug Rociletinib; however, the court did dismiss claims of insider trading.
The Delaware Chancery Court denied a motion to dismiss claims in a derivative suit of a breach of fiduciary duties of the directors of Clovis Oncology, Inc., regarding the failure of an oncology drug. The court did dismiss claims relating to insider trading of the directors. Stockholders of Clovis allege that members of the Clovis board of directors (the Board) breached their fiduciary duties by failing to oversee the Rociletinib (Roci) clinical trial and then allowing the company to mislead the market regarding the drug’s efficacy. Further, the stockholders allege that the Board ignored red flags that Clovis was not adhering to the clinical trial protocols, thereby placing FDA approval of the drug in jeopardy. Using skewed results, the Board then allowed the company to deceive regulators and the market regarding the drug’s efficacy. When the public was informed of the true results of the trials, Clovis’ stock price immediately dropped 70 percent, wiping out more than $1 billion in market capitalization. The Delaware Chancery court found that there are enough facts for the derivative suit regarding the Boards’ fiduciary duties to continue (In Re Clovis Oncology, Inc. Derivative Litigation, October 1, 2019, Slights, J.).
Background. Clovis was initially capitalized by investors, and had no sales revenue. Its prospects rested largely on one of its three developmental drugs, Roci, a cancer drug designed to treat a previously untreatable type of lung cancer. There is an estimated $3 billion annual market for drugs of this type; as such, Clovis expected Roci to generate large profits if Clovis could secure FDA approval and take the drug to market.
If clinical trial protocols are not adhered to, the FDA will not approve a new drug for market. Clovis selected the RECIST trial protocol for its clinical trial called TIGER-X. Under RECIST, the success-defining metric is called the objective response rate (ORR). ORR measures the percentage of patients who experience meaningful tumor shrinkage when treated with the drug. On June 12, 2014, the Board received reports indicating Clovis was improperly calculating Roci’s ORR. The Board then continued to use this improperly calculated number, which was based on unconfirmed responses, as well as disseminate it to the public through various means, despite the fact that it was no longer RECIST compliant in its trials. The directors signed the 2014 annual report, which reaffirmed previously inflated ORR reports.
By November 2015, the FDA indicated to Clovis that it may only report confirmed responses and that TIGER-X must conform to RECIST. The public was then informed of Roci’s true ORR by means of a press release on November 16, 2015, stating the correct confirmed ORR was as low as 28–34 percent (Clovis had previously reported it around 58-60 percent). Clovis’ stock price immediately dropped 70 percent, wiping out more than $1 billion in market capitalization.
After the stockholders requested to examine the company’s books and records, they filed their first complaint on March 23, 2017. The company filed a motion to dismiss, based on three counts. Count I, regarding the directors’ breach of their fiduciary duties by misleading stockholders regarding the TIGER-X trials, Count II for unjust enrichment related to insider stock trading of the directors, and Count III related to a derivative claim related to insider trading.
Fiduciary Duty Claim. The court found that there were enough facts pled that the Board, "ignored red flags that the Company was violating—perhaps consciously violating—the RECIST protocol and then misleading the market and regulators regarding Roci’s progress through the TIGER-X trial," and as such, denied the motion to dismiss with respect to Count I.
Under the breach of fiduciary duty claim, the stockholders alleged that the Board failed to institute an oversight system for the TIGER-X trial, and/or (ii) the Board Defendants consciously disregarded a series of red flags related to the TIGER-X trial. The court looked at the standard set forth in In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996)
Under Caremark, "[t]he legal academy has observed that Delaware courts are more inclined to find Caremark oversight liability at the board level when the company operates in the midst of obligations imposed upon it by positive law yet fails to implement compliance systems, or fails to monitor existing compliance systems, such that a violation of law, and resulting liability, occurs."
The court used a two-prong test in Caremark. Under the first prong of Caremark requires Plaintiffs to well-plead that the Board "completely fail[ed] to implement any reporting or information system or controls[.]" Caremark’s second prong is implicated when it is alleged the company implemented an oversight system but the board failed to "monitor it. In this instance, given that the Board reviewed the TIGER-X trials at each meeting, as well as the fact that management was publicly reporting incorrect information, knowing that TIGER-X was not in compliance with RECIST, the court found that the Caremark standard was met. Vice Chancellor Slights denied the motion to dismiss on Count I.
Insider Trading Claims. The court noted that for Counts II and III, under Brophy v. Cities Serv. Co., 70 A.2d 5 (Del. Ch. 1949), the stockholders must plead facts that support an inference that the directors acted with scienter. A Brophy claim usually rests on circumstantial facts and a successful claim typically includes allegations of unusually large, suspiciously timed trades that allow a reasonable inference of scienter.
The facts of this case indicate that the directors each only made one stock trade, the trade was six months prior to the revealing of results related to the lower trial results, and that the trades had a very insignificant impact and each director’s overall ownership of the company. In fact, each of the directors retained between 96% and 99.9% of their total holdings as the date of the alleged improper trades. While one director, Erle Mast, did make nine trades in this time period, he still retained over 90 percent of his ownership.
The court concluded that the directors, "rode over the falls with the rest of Clovis’ stockholders when the corporate storm hit the Company." As such, the court denied the motion to dismiss on Counts II and III.
The case is No. C.A. No. 2017-0222-JRS.
Attorneys: Seth D. Rigrodsky (Rigrodsky & Long, P.A.) for Carl McKenry. William M. Lafferty (Morris, Nichols, Arsht & Tunnell LLP) for Clovis Oncology, Inc.
Companies: Clovis Oncology, Inc.
MainStory: TopStory CaseDecisions FDCActNews ClinicalNews DrugBiologicNews DelawareNews
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