In Silverberg v. Gold, et al., C.A. 7646-VCP (Dec. 31, 2013), the Court of Chancery denied defendants’ motion to dismiss a derivative action (for failure to make demand) alleging a breach of fiduciary duty based on insider trading against the directors of Dendreon Corporation, a biotechnology company which had only one commercially available drug product, Provenge, a treatment for advanced prostate cancer.  A single treatment of Provenge is administered in three separate infusions that occur approximately two weeks apart and costs $93K.  Provenge was sold using a “buy and bill” policy, whereby physicians prescribing Provenge were required to “purchase” the treatment and then receive reimbursement through Medicare, Medicaid, or private insurance companies.  This “reimbursement risk” became a key factor in the analysis of this case.

On April 29, 2010, after being developed and tested for approximately fifteen years, Provenge received FDA approval for commercial use; it launched immediately afterwards.  Fifteen months later, on August 3, 2011, after the market had closed, the Company halted trading in its securities.  At the following press release and conference calls, the Company acknowledged the significant negative impact of the “reimbursement risk” on the Company’s revenue.  A day after the Company’s August 3 announcement, Dendreon’s stock price dropped 67% and within a year, the Company undertook a restructuring and removed its CEO.  In addition, the SEC commenced a formal investigation of Dendreon.

The plaintiff filed suit alleging that the directors knew of the “reimbursement risk,” yet they failed to disclose this risk to investors, even when that risk manifested itself in the form of lower than expected sales. Instead, the defendants used this nonpublic information impermissibly to sell their shares in the company before the risk became known publicly. 

Insider Trading — a Brophy Claim

Under Delaware law, demand is excused only if plaintiff’s particularized facts “create a reasonable doubt that, as of the time the complaint is filed, the board of directors could not have properly exercised its independent and disinterested business judgment in responding to a demand.”  Here the plaintiffs argued Dendreon’s directors were not disinterested because they faced a substantial likelihood of personal liability for their conduct based on Brophy v. Cities Service Co. 70 A.2d 5 (Del. Ch. 1949) and its progeny.

A Brophy claim is an action for breach of fiduciary duty premised on a fiduciary’s insider trading.  For a plaintiff asserting a Brophy claim, to survive a motion to dismiss, the complaint must plead particularized facts sufficient to support a reasonable inference that: (1) the corporate fiduciary possessed material, nonpublic company information; and (2) the corporate fiduciary used that information improperly by making trades because the fiduciary was motivated, in whole or in part, by the substance of that information.

The Court found that, that the “reimbursement risk” information was significant because prescribing physicians would have to administer a full course of Provenge before they knew if they would be reimbursed, meaning they could not stop the treatment and mitigate their financial risk if a reimbursement problem developed.  The Court also found that the risk would be material to Dendreon’s investors because the commercial success of Provenge depends in large part on how often it is prescribed.  The Court noted that “[a]t least one reasonable inference that can be drawn from these facts is that, as of April 29, 2010 (the date the FDA approved Provenge), the Company and the Board were aware of physician reluctance, or at least the risk of it, and expected it to be an issue.”  Therefore, the Court concluded that the plaintiff had pled particularized facts sufficient to show that it is reasonably conceivable that he will be able to satisfy the first factor of a Brophy claim.

As to the second element of a Brophy claim, the plaintiff had to allege that the selling defendants, at least in part, “consciously acted to exploit” the fact that they possessed material, nonpublic information.  The Court found that during the relevant period (i.e., April 29, 2010 to July 25, 2011), defendants sold over $78 million worth of the Company’s stock.  Of that amount, over $56 million was sold within one day of the FDA approving Provenge on April 29, 2010.  And defendants large-scale disposal of stock immediately following the FDA’s approval of Provenge was accompanied by alleged facts supporting a reasonable inference that defendants knew when they sold that, at a minimum, there was a significant risk of the physician community being reluctant to prescribe Provenge because of the cost and reimbursement concerns associated with it, and that defendants did not disclose that information to the public.  For purposes of a motion to dismiss, therefore, plaintiff’s allegations were sufficient to support a reasonable inference that defendants intentionally exploited their informational advantage.  Moreover, during this time period, the Company was issuing press releases and holding conference calls with financial analysts and never mentioned the “reimbursement risk,” or that the Company was aware that such a material risk existed.

As a result, the Court found that the complaint supported a reasonable inference that defendants possessed material, nonpublic information when they sold their shares, the facts that they, among other things (1) elected to sell after the stock reached a likely high point; and (2) evidently remained silent when the Company chose not to convey that material, nonpublic information to the market, despite having multiple opportunities to do so.  These facts provided a reasonable inference of purposeful conduct which was sufficient to establish a showing of scienter under the standard applicable at this stage of the proceedings.  Thus, the motion to dismiss was denied.