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United States Securities and Exchange Commission v. Johnston

United States District Court, D. Massachusetts

March 21, 2019

United States Securities and Exchange Commission, Plaintiff,
v.
David Johnston, Defendant.

          MEMORANDUM & ORDER

          NATHANIEL M. GORTON UNITED STATES DISTRICT JUDGE

         Following an eight-day trial after which the jury found David Johnston (“Johnston” or “defendant”) liable for securities violations, the Securities and Exchange Commission (“the SEC”) has moved for final judgment. The SEC seeks an officer and director bar, disgorgement, prejudgment interest, civil penalties and a permanent injunction.

         I. Background

         In 2016, the SEC filed a complaint against defendant, alleging that Johnston, as Chief Financial Officer (“CFO”) of Aveo Pharmaceuticals (“Aveo”) engaged in a scheme to mislead Aveo investors about the pending approval by the Food and Drug Administration (“FDA”) of Aveo's flagship drug, tivozanib (“Tivo”).[1] The SEC alleged that the scheme to defraud occurred between August, 2012, and April, 2013.

         In May, 2012, Aveo representatives attended a pre-New Drug Approval (“NDA”) meeting, where the FDA 1) expressed concerns about the negative results of Tivo's overall survival data in its first clinical trial and 2) recommended that Aveo conduct a second randomized trial with respect to Tivo. Three months later, Aveo issued a press release which disclosed the negative overall survival data but did not disclose the FDA's recommendation to conduct a second clinical trial. In the meantime, Johnston and his team developed a communications strategy which emphasized that Aveo could not “speculate” as to future FDA actions, despite knowing about the FDA's recommendation. After Aveo issued its August, 2012, press release Johnston participated in several conference calls with stock analysts that obfuscated the situation.

         Shortly after its August, 2012, press release, Aveo filed its Tivo NDA with the FDA without conducting a second clinical trial. In February, 2013, FDA staff informed Aveo that the Oncologic Drugs Advisory Committee (“ODAC”) would be reviewing the sufficiency of Tivo's first clinical trial the following May. One month later, the FDA publicly disclosed that it had previously recommended that Aveo conduct a second trial for Tivo. Following the FDA's public disclosure in April, 2013, Aveo's stock price dropped by 31%. The next month, the FDA's ODAC panel rejected the adequacy of Aveo's first clinical trial by a vote of 13 to 1.

         Throughout the trial, Johnston argued that his decision not to disclose was in good faith because he relied on the corporate process in connection with Aveo's disclosures. Specifically, he referred to opinions of Aveo's outside counsel, the underwriters' counsel and internal executive committees to justify his defense. After eight days of trial, the jury returned a verdict for the SEC, finding that Johnston violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), Section 17(a)(1) of the Securities Act of 1933 (“Securities Act”) and Sections 17(a)(2) and (a)(3) of the Securities Act and Rule 13a-14 of the Exchange Act.

         II. Analysis

         A. Officer and director bar

         The SEC seeks to bar Johnston from serving as an officer and director of a public company for the aforementioned securities violations. Pursuant to 15 U.S.C. § 77t(e) and 15 U.S.C. § 78u(d)(2), district courts exercise “substantial discretion” in deciding whether to bar an individual from serving as an officer and director in a public company. SEC v. Selden, 632 F.Supp.2d 91, 96-97 (D. Mass. 2009). To that end, the Second Circuit has established six factors for determining whether an individual is “unfit”:

1) the egregiousness of the underlying securities law violation; 2) the defendant's repeat offender status; 3) the defendant's role or position when he engaged in the fraud; 4) the defendant's degree of scienter; 5) the defendant's economic stake in the violation; and 6) the likelihood that misconduct will recur.

SEC v. Patel, 61 F.3d 137, 141.

         While the Patel factors are instructive with respect to the unfitness assessment, they are not exhaustive and it is not necessary to apply all of the factors in every case. Id. In light of the Patel factors, the Court proceeds to consider whether Johnston's conduct supports imposing an officer and director bar pursuant to 15 U.S.C. § 77t(e) and 15 U.S.C. § 78u(d)(2).

         1. Egregiousness

         The SEC argues that Johnston's conduct was egregious because, as the head of Aveo's corporate communications and investor relations, he led a deceptive scheme to mislead investors by 1) omitting material information, 2) drafting scripted responses to avoid investor questions about the FDA's clinical trial recommendation and 3) continuing to engage in selective disclosure at four investor conferences. Johnston responds that a jury finding that he violated securities law does not mean that his conduct was egregious per se. Rather, he contends that lifetime bars are reserved for more serious violations such as boiler-room, pump-and-dump or pyramid schemes.

         Although Johnston as the head of Aveo's corporate communications undoubtedly led this deceptive scheme, his selective disclosure was limited to a few months, not years, and his disclosures, while materially misleading, are not so egregious as to warrant a lifetime bar. Cf. SEC v. Weed, 315 F.Supp.3d 667, 677-78 (D. Mass. 2018) (imposing a lifetime bar where the defendant played an essential role in a pump-and-dump scheme); SEC v. Selden, 632 F.Supp.2d 91, 97 (D. Mass. 2009) (finding serious violations when defendant engaged in affirmative misstatements over a period of several years). Although Johnston's violations were serious, they were not particularly flagrant.

         2. Repeat offender

         The SEC concedes that this is Johnston's first offense and Johnston, to no surprise, points to his 30-plus years of compliance with securities laws both before and after the deceptive scheme in 2012. ...


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