In a recent decision,  the Fourth Circuit considered a class action lawsuit brought by shareholders of a biopharma company, INC Research Holdings, Inc. (now Syneos Health Inc.). The shareholders had voted to approve a merger with a private company. They had high hopes for the merged entity, inflated by some optimistic projections INC Research and its executives had made. But the new company struggled and its stock price tanked.

The shareholders sued under federal securities laws, claiming INC Research and its investors misled them by failing to disclose critical, adverse facts. The Fourth Circuit disagreed, upholding the dismissal of the action. The decision highlights the importance of warnings to investors and demonstrates the requirements for an investor lawsuit based on allegedly inaccurate information.

Background to the Case

In 2017, INC Research sought to merge with another biopharma company, inVentiv. When they announced the proposed merger, the companies projected in a press release that INC Research’s adjusted earnings per share would increase in the first year following the merger.

Finalizing the merger required approval from INC Research’s shareholders. Before the vote, shareholders gathered information through written materials and earnings calls. During one earnings call, INC Research indicated that it was confident in high revenue growth in 2018. During another, INC Research told shareholders it was more optimistic than before about the combined company’s growth numbers for 2018 but that inVentiv had to close a number of deals in the second half of the year to hit its projections. Then, INC Research provided shareholders with proxy materials that recommended approval but also contained detailed cautionary language, warning investors that this was a risky undertaking and success was not guaranteed.

The shareholders voted to approve the merger. Soon after, the company’s stock price plummeted and INC Research projected roughly flat revenue growth in 2018. The change in projected revenue growth was due, in part, to inVentiv’s failure to secure any large sales contracts in 2017.

Soon after, a shareholder filed a class action lawsuit in federal court in North Carolina against INC Research, alleging INC Research violated federal securities laws, i.e., Sections 10(b) and 14(a) of the Securities Exchange Act, and various SEC rules. The shareholders also alleged that several of INC Research’s executives were also liable for those violations as “control persons” under Section 20(a) of the act.

INC Research moved to dismiss the shareholders’ claims and the district court granted the motion. The shareholders appealed.

The Fourth Circuit’s Opinion

A shareholder may bring a claim under Section 10(b), and the SEC rules under that statute, when a company or person controlling the company makes an “untrue statement of material fact” or “omits to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” For a claim to succeed, shareholders must show that the defendants intentionally or recklessly misled them.

For a shareholder’s Section 10(b) claim to survive dismissal, the shareholder must include enough specific facts in the complaint to strongly infer that the defendants intended to deceive them or created such a high risk of misleading them that INC Research must have known that it was being deceptive. The shareholders did not reach that high bar. They claimed that INC Research must have learned in due diligence that inVentiv had failed to sign large sales contracts and that those contracts were central to inVentiv’s business model. But this did not suggest anything more than negligent conduct.

The court next turned to the claim under Section 14(a). To win on a claim under that provision, a shareholder must show that the defendants issued “a proxy statement that contains false or misleading facts or omits any material fact that leaves a proxy statement false or misleading.”

The Fourth Circuit explained that because materiality is contextual, it can be negated by adequate warnings and disclaimers in proxy materials. The warnings must be specific and tailored to address the alleged misrepresentation or omission. The court noted that INC Research specifically warned investors that, among other things, the assumptions underlying their projections were uncertain and potentially flawed, its optimism was based on pipeline discussions with customers rather than finalized deals, and inVentiv had struggled to achieve profitability and might do so again. Viewed in context, the court concluded any misrepresentations were immaterial.

Takeaways From the Case

San Antonio Fire & Police Pension Fund shows that a high bar exists for investors in showing the intention or recklessness required for a Section 10(b) claim. The case also reminds public companies of the importance of including specific and tailored cautionary language in their proxy materials. In cases like this, as the Fourth Circuit put it, shareholders “have a right to be disappointed that their company’s performance did not meet its optimistic projections, but not “a right to civil remedies under federal securities law.”