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Brennan v. Zafgen, Inc.

United States District Court, D. Massachusetts

August 9, 2016

TERRY M. BRENNAN; RON KENNER; KEVIN KOZIATEK; VINCENT RAMPE; and DRAGON GATE MANAGEMENT LTD., individually and on behalf of all others similarly situated, Plaintiffs,
v.
ZAFGEN, INC. and THOMAS E. HUGHES, Defendants.

          MEMORANDUM AND ORDER ON DEFENDANTS' MOTION TO DISMISS

          F. Dennis Saylor IV United States District Judge

         This is a putative class action involving alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and SEC Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. The lead plaintiffs have brought suit, on behalf of a class of similarly situated persons, against biopharmaceutical company Zafgen, Inc. and its CEO Thomas E. Hughes.[1] Plaintiffs contend that class members were harmed when they purchased Zafgen's common stock at prices that were artificially inflated by the company's materially misleading statements and omissions concerning its anti-obesity drug, Beloranib.

         Before Zafgen became a public company in June 2014, it conducted a Phase II trial of Beloranib from August 2012 to May 2013 (the "ZAF-201 trial"). In the prospectus for its 2014 initial public offering, Zafgen disclosed that two “serious thrombotic events” occurred during that trial.[2] Zafgen repeated that disclosure multiple times throughout the class period (that is, from June 19, 2014, through October 16, 2015). Zafgen also stated in its disclosures that “[serious AEs] that are not characterized by clinical investigators as possibly related to Beloranib or [serious AEs] that occur in small numbers may not be disclosed to the public” until the FDA-approval process.

         In October 2015, Zafgen announced that a patient participating in the Phase III trial of Beloranib had died. After unblinding the trial two days later at the request of the FDA, the company disclosed that the patient had been receiving Beloranib, and that the drug had been placed on a clinical hold. During a conference call with analysts later that day, Zafgen disclosed, for the first time, that two “superficial” thrombotic AEs had occurred during the ZAF-201 trial, in addition to the two previously disclosed “serious” AEs. Zafgen’s stock price fell 50 percent the next day, and this lawsuit followed five days later.

         The complaint alleges that Zafgen’s disclosures during the class period contained materially false misrepresentations and omissions because they failed to disclose that four, not two, AEs occurred during the ZAF-201 trial. It also alleges that defendants made those false disclosures with scienter, that is, with an intent to defraud or a high degree of recklessness. The complaint alleges that when defendants made the disclosures, they knew or recklessly disregarded “that there was a significant risk of thrombotic adverse events in future clinical trials of Beloranib.” (Compl. ¶ 36). As evidence of defendants’ knowledge of that risk, the complaint cites scientific literature and news articles that explored “a potential connection between antiangiogenics, such as Beloranib, and thrombotic adverse events.” (Pl. Mem. 13-14). The complaint also alleges that Hughes and other Zafgen insiders had a motive to inflate the company’s stock price, as demonstrated by insider stock sales in September 2015.

         Defendants have moved to dismiss the complaint pursuant to Fed.R.Civ.P. 12(b)(6) and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4, for two principal reasons.[3] First, they contend that the complaint fails to set forth plausible allegations that Zafgen’s disclosures contain actionable misrepresentations or omissions. Second, they contend that it fails to allege specific facts that give rise to a strong inference of scienter.[4]

         As the First Circuit has stated, “[a] statement cannot be intentionally [or recklessly] misleading [under the securities laws] if the defendant did not have sufficient information at the relevant time to form an evaluation that there was a need to disclose certain information and to form an intent not to disclose it.” New Jersey Carpenters Pension & Annuity Funds v. Biogen IDEC Inc., 537 F.3d 35, 45 (1st Cir. 2008). In other words, a complaint is insufficient under the PSLRA if it does not contain particularized factual allegations raising a strong inference that at the time of disclosure defendants knew (or were reckless by not knowing) that their failure to provide additional information was misleading.

         Even assuming that the complaint plausibly alleges a material misrepresentation or omission, its allegations as a whole fail to clear the PSLRA’s relatively high hurdle of pleading a strong inference of scienter. In hindsight, the superficial thrombotic AEs that occurred during the ZAF-201 trial perhaps took on added significance more than two years later when a patient died during the Phase III trial. However, “[p]leading fraud by hindsight, essentially making general allegations that defendants knew earlier what later turned out badly, is not sufficient.” Ezra Charitable Trust v. Tyco Int’l, Ltd., 466 F.3d 1, 6 (1st Cir. 2006) (internal quotation marks omitted). Without the benefit of hindsight, the complaint fails to plead particularized facts demonstrating that defendants had “sufficient information at the relevant time to form an evaluation that there was a need to disclose” the “superficial” AEs, and to form an intent not to disclose them. See Biogen, 537 F.3d at 45 (emphasis added). For example, the complaint does not point to a single confidential-source allegation, internal e-mail, or any other direct evidence that would suggest Hughes knew (or was reckless in not knowing) “that there was a significant risk of thrombotic adverse events in future clinical trials of Beloranib.” (Compl. ¶ 36). Moreover, the complaint’s circumstantial allegations concerning scienter--a patchwork of scientific literature and unsuspicious insider sales--are insufficient to support a strong inference of defendants’ “conscious intent to defraud or ‘[ ] high degree of recklessness.’” ACA Fin., 512 F.3d at 58 (quoting Aldridge v. A.T. Cross Corp., 284 F.3d 72, 82 (1st Cir. 2002)).

         Accordingly, and for the reasons set forth below, defendants’ motion to dismiss will be granted.

         I. Factual Background

         Unless otherwise noted, all facts are stated as set forth in the complaint.[5]

         A. The Parties and Beloranib

         Zafgen, Inc. is based in Boston, Massachusetts. (Compl. ¶ 20).[6] Founded in 2005, Zafgen is a small biopharmaceutical company “dedicated to significantly improving the health and well-being of patients affected by obesity and complex metabolic disorders.” (Id.). Defendant Thomas E. Hughes has been Zafgen’s Chief Executive Officer since 2008. (Id. ¶ 21). Zafgen became a public company on June 19, 2014 (the first day of the class period), through an initial public offering, and its shares are traded on the NASDAQ stock exchange. (Id. ¶ 20). By the date of its IPO, Zafgen had approximately twelve full-time employees. (Id. ¶¶ 30-31).

         Beloranib, an obesity therapy, is Zafgen’s only product candidate in clinical development-that is, past the pre-clinical stage. (Id. ¶¶ 26-27). Beloranib is Zafgen’s “lead product candidate . . . [, ] a novel, first-in-class, twice-weekly subcutaneous, or SC, injection.” (Id. ¶ 26). Beloranib treats “severe obesity in two rare diseases, Prader-Willi syndrome, or PWS, and hypothalamic injury-associated obesity, or HIAO, including craniopharyngioma-associated obesity; and severe obesity in the general population.” (Id.).

         The complaint alleges that lead plaintiffs Terry Brennan, Ron Kenner, Kevin Koziatek, Vincent Rampe, and Dragon Gate Management Ltd., purchased shares of Zafgen common stock during the class period, from June 19, 2014, through October 16, 2015. (Id. ¶¶ 1, 14-18).

         B. Adverse Events During the ZAF-201 Trial

         In total, Zafgen has conducted three Phase I trials, four Phase II trials, and one Phase III trial of Beloranib for different obesity-related diseases. (Id. ¶ 28).[7] Zafgen conducted the ZAF- 201 trial (Beloranib’s Phase IIA proof-of-concept clinical trial) over twelve weeks and eight study sites from August 2012 to May 2013. (Id. ¶ 47). During the ZAF-201 trial, 160 obese patients participated, 122 of whom were treated with Beloranib. (Id.).

         Four thrombotic AEs of varying severity occurred during the ZAF-201 trial. (Id. ¶ 48). Third-party clinical investigators categorized two as “superficial” AEs and two as “serious” Aes. (Id. ¶ 49; Def. Ex. E at 18, 31; Def. Ex. I at 5). The two serious AEs were determined to be a pulmonary embolism and deep vein thrombosis, respectively. (Compl. ¶ 49; Def. Ex. I at 5). The two superficial AEs were determined to be “superficial thrombophlebitis.” (Compl. ¶ 49; Def. Ex. I at 5). All four AEs occurred in patients receiving Beloranib (as opposed to a placebo). (Compl. ¶ 49). The complaint does not allege that Beloranib caused those AEs, and to this date investigators have not determined a specific cause. (Def. Ex. I at 5).

         In the spring of 2014, after the ZAF-201 trial, Zafgen began to prepare for its IPO. (Compl. ¶ 52). In its April 18, 2014, SEC Form S-1, which was signed by Hughes, the company disclosed the following concerning the ZAF-201 study:

As severely obese patients are at an increased risk for cardiovascular disease, we measured systemic biomarkers of cardiovascular disease risk, including low density lipoprotein cholesterol, HDL, CRP, triglycerides and blood pressure in trial participants, to determine Beloranib’s impact on such biomarkers. The results of these biomarker measurements in this trial, as summarized below, suggest that Beloranib treatment does not increase the risk of cardiovascular disease and may be associated with reduced cardiovascular disease risk.
[Results]
There were no deaths or any [serious AEs] deemed to be possibly, probably, or definitely related to Beloranib, although there were two serious thrombotic adverse events which, while not attributed to Beloranib treatment, may point to the utility of assessment of prior history of thrombotic events in patients enrolled in subsequent trials and added vigilance for AEs related to blood clotting during future clinical trials. The most commonly reported TEAEs [treatment-emergent adverse events] were gastrointestinal disorders, mainly nausea, diarrhea, or vomiting, nervous system disorders, mainly dizziness, and psychiatric disorders, mainly insomnia, sleep disorder, or abnormal dreams. TEAEs were generally mild in severity and transient. Other frequently reported TEAEs were headaches and injection site bruising/itching, although the incidences were comparable to placebo and not observed to be dose-related.

(Id.). Zafgen repeated substantially the same disclosure in nine other filings throughout the class period. (Id. ¶¶ 55-62).

         Accordingly, “prior to October 16, 2015, [Zafgen] had not disclosed any thrombotic adverse events in clinical trials of Beloranib other than the two [serious AEs] in the ZAF-201 trial.” (Id. ¶ 54). However, the company also made the following disclosures in its Form S-1, Form 10-K for 2014, and Form 10-Qs for the second and third quarters of 2014 and first and second quarters of 2015:

Many companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in late-stage clinical trials after achieving positive results in early stage development, and we cannot be certain that we will not face similar setbacks. These setbacks have been caused by, among other things, pre-clinical findings made while clinical trials were underway or safety or efficacy observations made in clinical trials, including previously unreported adverse events.
[Serious AEs] that are not characterized by clinical investigators as possibly related to Beloranib or [serious AEs] that occur in small numbers may not be disclosed to the public until such time the various documents submitted to the FDA as part of the approval process are made public. We are unable to determine if the subsequent disclosure of [serious AEs] will have an adverse effect on our stock price.

(See, e.g., Def. Ex. E at 44-45; 51).

         C. The Patient Death and Disclosure of the Two Superficial Adverse Events

         In October 2015, Zafgen’s share price began to drop. It opened at $34.76 on October 12 and closed at $15.75 on October 13. (Compl. ¶ 63). On the morning of October 14, Zafgen announced that a patient in its ongoing Phase III trial had died. It issued a press release stating, in relevant part, as follows:

Zafgen recently learned of a patient death which occurred in the company’s ongoing double-blind, randomized, placebo-controlled Phase 3 bestPWS study of Beloranib in Prader-Willi Syndrome, a rare genetic disorder with a high rate of mortality linked to obesity and its co-morbidities. The cause of death remains unknown at this time. According to normal practice, the event was reported to the [FDA], at which point the [FDA] initiated a discussion with the company. The company is working with the [FDA] to expedite a review and understanding of this event, and to determine implications of the event on the conduct of the trial, and anticipates providing an update as its discussions with the [FDA] progress. The thoughts of the company are with the family of the patient at this time. Zafgen remains committed to ensuring the safety of all patients enrolled in its studies.

(Id. ¶ 68). Zafgen did not announce the date of the patient’s death or disclose whether the patient had been receiving Beloranib or a placebo. (Id. ¶ 69).

         Two days later, on October 16, the company issued another press release, stating that it “received verbal notice late yesterday from the [FDA] that Beloranib has been placed on partial clinical hold.” (Id. ¶ 71). That press release also stated:

As previously reported, Zafgen learned of a death in the ongoing Phase 3 bestPWS study (ZAF-311) of Beloranib in Prader-Willi Syndrome (PWS). While the cause of death remains unknown, the patient’s treatment assignment has been unblinded and it is now known that the patient was receiving Beloranib. Due to previously reported thromboembolic events in ongoing and prior clinical trials of Beloranib and the unknown nature of the death, the FDA gave verbal notice of a partial clinical hold to institute measures to ensure patient safety. Patients currently participating in the ZAF-311 study will be screened for existing thrombotic disease prior to receiving further study drug and regularly monitored through the completion of the study. Given that the study is near complete, at this time, the company expects to report top-line results in the first quarter of 2016. Similar screening and monitoring is being considered for the ongoing Phase 2b study (ZAF-203) in patients with severe obesity complicated by type 2 diabetes. The company now anticipates that the PWS Phase 3 clinical trial, ZAF-312, will be initiated after ZAF-311 is completed and a full assessment of the safety and efficacy of Beloranib is performed by the FDA.

(Id.). During an analyst conference call later that afternoon, Zafgen’s chief medical officer, Dennis Kim, stated:

In our past clinical trials, we have seen six cases of thrombotic findings of varying severity in Beloranib-treated patients[, ] including three cases of pulmonary embolism/deep vein thrombosis or DVT and one case of DVT alone. The six events were seen in approximately 400 patients treated with Beloranib for a period up to one year of treatment. We’ve had no thrombotic events in the approximately 150 patients treated with placebo.

(Id. ¶ 72). Kim added that while two of the six AEs occurred in ongoing trials, four had occurred in completed trials, and all four had occurred during the ZAF-201 trial. (Id. ¶ 73). He stated that the two previously undisclosed AEs “came from study ZAF-201, which is the same trial [for] the two events that you’re aware of. The other two events were what can be classified as minor or benign thromboembolic disease, that being superficial thrombophlebitis, which usually isn’t treated except symptomatically.” (Def. Ex. M. at 10).

         During the same October 16 call, an analyst asked when the company learned of the patient death. (Compl. ¶ 76). Hughes answered:

Patient confidentiality always matters[, ] and just to be clear, we do not, nor should we ever find out the actual identity of this patient or of their family who is still dealing with this horrible event. So, for patient confidentiality, in order to keep people from tracking into it, we can’t provide a specific date, but it was about two weeks ago[.] [T]he death we reported very promptly to [the] FDA as one would expect and that’s when our dialog with them began.
Question: So you found out and how quickly after you--how soon after you found out, you reported to FDA?
Hughes: Well, briefly within the--we’re required to do so within a week, and we certainly were well within that time horizon.

(Id.; Def. Ex. M at 11). After closing at $21.02 per share on October 15, Zafgen’s share price closed at $10.36 on October 16, the final day of the class period. (Compl. ¶ 75).

         D. Alleged Material Misrepresentations and Omissions

         The complaint alleges that defendants made three materially false misrepresentations or omissions in disclosures during the class period:

• “As severely obese patients are at an increased risk for cardiovascular disease, we measured systemic biomarkers of cardiovascular disease risk, including low density lipoprotein cholesterol, HDL, CRP, triglycerides and blood pressure in trial participants, to determine Beloranib’s impact on such biomarkers. The results of these biomarker measurements in this trial, as summarized below, suggest that Beloranib treatment does not increase the risk of cardiovascular disease and may be associated with reduced cardiovascular disease risk.[8]
• “There were no deaths or any [serious AEs] deemed to be possibly, probably, or definitely related to Beloranib . . . .”
• “[A]lthough there were two serious thrombotic adverse events which, while not attributed to Beloranib treatment, may point to the utility of assessment of prior history of thrombotic events in patients enrolled in subsequent trials and added vigilance for AEs related to blood clotting during future clinical trials. The most commonly reported TEAEs [treatment-emergent adverse events] were gastrointestinal disorders, mainly nausea, diarrhea, or vomiting, nervous system disorders, mainly dizziness, and psychiatric disorders, mainly insomnia, sleep disorder, or abnormal dreams. TEAEs were generally mild in severity and transient. Other frequently reported TEAEs were headaches and injection site bruising/itching, although the incidences were comparable to placebo and not observed to be dose-related.”

(Id. ¶ 52) (emphasis in original).

         The complaint alleges that Zafgen made those statements, using substantially the same language, in the following ten disclosures, all of which were signed by Hughes: (1) the Form S- 1 filed on April 18, 2014, for its IPO; (2) the Form S-1/A filed on April 28, 2014; (3) the Form S-1/A filed on May 2, 2014; (4) the Form S-1/A filed on June 2, 2014; (5) the Form S-1/A filed on June 5, 2014; (6) the Form 424B4 filed on June 19, 2014; (7) the Form S-1 filed on January 12, 2015, for a follow-on offering; (8) the Form S-1/A filed on January 16, 2015; (9) the Form 424B4 filed on January 23, 2015; and (10) the Form 10-K filed on March 25, 2015. (Id. ¶¶ 52, 55, 57, 59, 61).

         The complaint alleges that those disclosures were materially false misrepresentations or omissions for the following reasons:

Defendants were well aware of all adverse events relating to Beloranib from the ZAF-201 study. Having chosen to reveal two thrombotic adverse events that occurred in the ZAF-201 trial of Beloranib, to state that those events were not “deemed to be possibly, probably, or definitely related to Beloranib, ” to state that Beloranib treatment did not increase the risk of cardiovascular disease, and disclosing adverse events as minor as nausea, abnormal dreams, or itching at the injection site, defendants misled investors by failing to reveal that, in total, four thrombotic adverse events occurred in that trial among patients taking Beloranib. Defendants also failed to disclose that zero patients receiving a placebo experienced thrombotic adverse events. In the alternative, defendants omitted to disclose the material fact that they did not disclose all adverse events observed in patients taking Beloranib. By providing an extensive list of even minor adverse events-nausea, dizziness, abnormal dreams, and so on-a reasonable investor would be misled into believing that all material adverse events were revealed when, in fact, they were not.
Prior to October 16, 2015, the company had not disclosed any thrombotic adverse events in clinical trials of Beloranib other than the two events in the ZAF-201 trial described above. Therefore[, ] defendants misled investors by failing to disclose that there were four thrombotic adverse events that occurred in patients taking Beloranib in the ZAF-201 clinical trial.

(Id. ¶¶ 53-54; see also Id . ¶¶ 56, 58, 60, 62).

         According to the complaint, “all four adverse events were material for investors because the FDA considers the frequency/rate of adverse events in determining whether a drug is causing those adverse events.” (Id. ¶ 49). It further alleges that stock analysts “considered the frequency/rate of adverse thrombotic events to be material information for investors determining the value of Zafgen stock.” (Id. ¶ 50). For example, after Zafgen disclosed all of the AEs in October 2015, one analyst wrote “with six events on Beloranib and none on placebo, the imbalance is worrisome, and an association between Beloranib and thrombotic events certainly seems to be emerging.” (Id. ¶ 50(c)).

         E. Scient ...


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