Are You Liable? What All Clinical Stage Companies Should Understand About Risk Disclosure
A conversation between Barnes & Thornburg Partner Seth Mailhot and Clinical Leader Executive Editor Abby Proch
Whether and when to disclose something that’s happened before, during, after, or related to a clinical trial or program can trouble stakeholders up and down a company’s org chart. Typically, publicly traded pharma and biotech companies submit annual and periodic filings and other corporate disclosures (for pivotal trial readouts, FDA decisions, risk factors, etc.) with the Securities and Exchange Commission (SEC). The purpose of such public disclosures is to keep investors informed of anything of material importance, which is often debated.
Statements made publicly or in SEC filings that are false or misleading are subject to various punitive measures, including SEC orders and private litigation.
It’s paramount that sponsor companies understand as much, communicate it with their teams, and make plans for proper disclosure.
To help explain the ins and outs of clinical research disclosure liability is regulatory attorney Seth Mailhot, partner at Barnes & Thornburg.
What does the law tell us about companies’ liability in risk disclosure?
There are primarily two sets of disclosure laws that we look to. For SEC compliance, the antifraud provisions of the federal securities laws, Section 10(b) and Rule 10b-5 under the Securities Exchange Act of 1934, and Section 17(a) of the Securities Act of 1933, prohibit any manipulative or deceptive statements in press releases, reports, and other public statements. And then Section 11 of the Securities Act of 1933 covers false or misleading statements in registration statements, which are statements that are filed with the SEC and are provided to investors through the SEC system.
Generally speaking, and there are many nuances, exceptions, and side issues that must be analyzed on a fact-specific basis, the SEC disclosure laws preclude a person or company from making materially false or misleading statements, in connection with the purchase and sale of securities, with either negligent, reckless, or intentionally deceptive intent, depending on the statute. There are thus four requirements for liability for making false statements: (1) the statement must be false or misleading; (2) the misstatement must be material, meaning that a reasonable investor would find it important in making investment decisions in the total mix of information; (3) the misstatement had to have been made with the requisite intent (negligent, reckless, or intentional depending on the statute); and (4) in private actions (not SEC actions), the investor must have reasonably relied on the statement and suffered damages, thereby.
These laws potentially cover not only the C-suite individuals who are the ones making the filings with the SEC but also other employees or individuals that may be involved in drafting, revieing, editing, and publishing SEC-regulated filings and statements.
When we talk about things that could be intentionally misconstrued, what might that include?
Let's start by discussing materiality, which is the threshold of whether a statement is subject to SEC enforcement. It means that, when determining whether a material fact needs to be disclosed, there's a substantial likelihood the fact would've been viewed by a reasonable investor as having significantly altered the total mix of information made available. SEC guidance says both quantitative and qualitative factors determine whether a factor or an omission is material to investors.
A lot of clinical trials are done to bring a drug to market. Not all of those trials are material. You can have 10, 20, or more Phase 2 trials. Some are focused on particular discrete areas of safety or efficacy. Not every study is necessarily material to the end goal. Changes to a pivotal trial would be much more of a concern or much more material than a less significant Phase 2 trial.
In a lot of these filings, attorneys and the C-suite provide a laundry list of concerns that could happen — delays by the FDA or changes to reimbursement or things like that — in language used by most companies. They start by looking at risk factors listed by other companies in the same space and borrow from them. Then, they customize it to their specific needs.
Concerning the issue of quantitative versus qualitative, a delay in the clinical trial might not be quantitatively material, meaning it's only a delay of a couple of days, weeks, or even a month. But there are also qualitative concerns about materiality. Because even though it's a short delay, it could have been triggered by either a misstatement to the FDA or a misrepresentation. It could point to other causes that might require disclosure.
Say a trial has a serious adverse event or major protocol change in a pivotal study. What are some of the steps companies might take to ensure that they're disclosing it properly?
The C-suite should meet with the clinical team to address any regulatory or clinical steps that need to be taken. Then, it should assess the impact those changes will have on the deliverables of the clinical trial. Are they going to be able to reach their endpoints? Are they going to be able to do recruiting? Is there going to be a significant delay in the clinical study? Are they going to be facing a clinical hold? Do they need to suspend enrollment? Once they piece together the actual events and what those direct implications are, that's when they need to assess if this an isolated issue or more far reaching.
Once that information is gathered, they need to deliver that to the makers of the statement for evaluation, that is, the persons or groups in charge of drafting and publishing public statements on behalf of the company. At that point, the makers and the clinical team must engage in a dialogue. Sometimes, there's tension around assessing whether a particular concern is material because the disclosure laws could pose problems with encouraging investment. Sometimes, the different groups don’t agree on whether it’s material. Therefore, it's generally recommended that outside counsel with experience in securities law help assess materiality of these particular incidents and whether disclosure is warranted. Having knowledgeable counsel weigh in on disclosure issues not only makes it more likely that disclosures are properly made but also provides some defense to claims that the company acted deceptively or in bad faith. To be sure, reasonable reliance on the advice of counsel can be a powerful defense to liability. Once an assessment has been made, the makers carry out any necessary disclosures and make sure that investors are informed on a timely basis. If the company determines that a disclosure is not proper or timely, the decision should be carefully documented in the company’s files, spelling out the appropriate reasoning for the decision. Again, if a company is exercising reasonable business judgment decisions, this also provides a defense to claims that the company and its representatives were acting with the intent to deceive or defraud investors.
Where do you see the breakdowns occurring between clinical teams and those statement makers?
In the best-run companies, there's harmony in the decision-making. Occasionally you will see a breakdown where either there's an interest in underplaying a risk or a concern with investors or an overestimation of the materiality of a particular situation. I've seen it where the C-suite will be much more focused on encouraging investment and wants to downplay concerns. And I've seen the inverse where you have clinical teams overestimate the materiality of a concern. Ideally, you compromise on a disclosure or address the concern so that everyone feels like they've been heard and the consensus decision was reasonable.
What are some common disclosure missteps?
A lot of companies miss the fact that the SEC does not make decisions on materiality in isolation. We have seen numerous times where the SEC communicates directly with the FDA and other regulators on particular issues. With certain disclosure statements that are SEC-reviewed prior to publishing, we've seen responses that could only have come from within the FDA — for example, where there was a level of sophistication and knowledge about the clinical trial or the drug’s intended use. I usually start by telling companies whatever we write will be reviewed by the FDA, not just the SEC. The SEC does not work in a silo. They are directly communicating with the FDA.
When trouble with risk disclosure arises, who first spots it? And how is it bubbled up to the surface?
If it's a draft statement submitted to the SEC that is reviewed by the SEC Department of Corporate Finance prior to publication, critiques and comments will come directly from the SEC. With postmortem issues, where a company has already published a public statement and investors or regulators claim that it contains an omission or was otherwise misleading or false, the SEC Enforcement Division, private litigants, or even media outlets can raise this matter.
Typically, there'll be a trigger event that will cause a disclosure to come under the microscope, whether it's a filing that the FDA has refused or disappointing results from a clinical trial. Those events will then trigger a retroactive review of SEC statements to see whether this risk was adequately disclosed. If not, that gives either private litigants an opportunity to litigate or the SEC an opportunity to reevaluate statements or press releases and consider whether enforcement action is needed.
When a triggering event occurs, given the cottage industry among private plaintiffs in the business of trolling negative FDA rulings and pouncing on company’s prior disclosures deemed to be inadequate, an often advisable rule-of-thumb (but again, subject to case-specific analysis) is: When in doubt, disclose the event. As with the case of other civil and criminal liability, the cover-up is often worse than the crime (or the negative event).
What can C-suite folks do to be on top of their risk disclosure?
It really helps to have quality counsel helping you through the process from the beginning and being open to reviewing how risks are disclosed by other companies in your space. Taking a look at how enforcement actions have occurred or if plaintiff litigation exists in that area can help inform what decision-making needs to be done. And then to some extent, they should inform staff about these realities, in addition to their regulatory responsibilities. Their clinical teams, or whoever's fully invested in the company, need to understand materiality, responsibilities, and qualitative and quantitative issues within SEC reporting.
About The Expert:
Seth Mailhot is a partner at Barnes & Thornburg who works with clients to implement premarket strategies and product approvals, as well as handle post-market compliance and enforcement defense. His work covers FDA-regulated industries including pharmaceuticals, medical devices, biotechnology, food, dietary supplements, cosmetics, tobacco, and emerging areas, such as digital health, cannabidiol, psychedelics, artificial intelligence, and cybersecurity. Seth’s background as a chemical engineer and more than a decade of service at the FDA — as an investigator, compliance officer, and regulatory researcher — gives him uncommon insight into how the agency operates and what regulators expect.