When the Delaware Supreme Court says of a Board of Directors collectively signed a company’s Annual Statement “with hands on their ears to muffle the alarms” you can rest assured the Board was seriously negligent in fulfilling its Caremark obligations. The Court’s decision in Clovis Oncology (Clovis or ‘the company’) laid out what a plaintiff must prove to create liability for a Board under the Caremark Doctrine. Not only must a Board have oversight of a corporate compliance function it must also provide oversight of that function.
The facts are so egregious on the monitoring requirement, the entire opinion could have been the basis for the original Caremark Doctrine. As the opinion stated the Board “breached their fiduciary duties by failing to oversee the Roci clinical trial and then allowing the Company to mislead the market regarding the drug’s efficacy. These breaches, it is alleged, caused Roci to sustain corporate trauma in the form of a sudden and significant depression in market capitalization.”
Clovis had no products and no sales but only the hope of the creation, marketing and sale of a new cancer drug, Roci. Clovis “relied solely on investor capital for all operations.” The potential success for Clovis “rested largely on one of its three developmental drugs, Roci, a cancer drug designed to treat a previously- untreatable type of lung cancer. Because of the estimated $3 billion annual market for drugs of its type, Clovis expected Roci to generate large profits if Clovis could secure FDA approval for the drug and shepherd it to market.” To get Roci to market, the company had to first perform clinical trials and then submit those findings to the Food and Drug Administration (FDA).
To perform the clinical trials, Clovis used a standard, well-known drug testing protocol called RECIST. A key component of the RECIST protocol was differentiating on the reporting on confirmed results v. non-confirmed results. During the trial, Clovis deviated from the RECIST protocol by improperly calculating the efficacy measurement based on both confirmed and unconfirmed results without differentiating between the two. As a result, Clovis published inflated performance results, and included this information in raising capital in the private and public securities markets of over $500 million. Clovis also failed to properly disclose the drug’s side effects. Worse yet, Clovis made these same misrepresentations in its initial presentations to the FDA.
After its initial presentation to the FDA, the FDA requested additional information on the test results. It appears at that point the Board was made aware of significantly different results from the confirmed v. the non-confirmed categories. The stock dropped some 80% in a few days, wiping out over $1 billion in capitalization. The fallout of Clovis actions led the FDA to suspend its review of Rico, effectively ending the company’s efforts.
As noted, the Court found that the Board had made certain there was an overall compliance program. However, Caremark has a second prong which requires a Board to “monitor” its compliance program. The Court stated, “To state a claim under this prong, Plaintiffs must well-plead that a “red flag” of non- compliance waived before the Board Defendants but they chose to ignore it. In this regard, the court must remain mindful that “red flags are only useful when they are either waived in one’s face or displayed so that they are visible to the careful observer. But, as Marchand makes clear, the careful observer is one whose gaze is fixed on the company’s mission critical regulatory issues.” For the Clovis Board, the compliance oversight should have been over Roci’s trials, clinical trial protocols and related FDA regulations governing that study.
The RECIST clinical trials protocol was “the crucible in which Roci’s safety and efficacy were to be tested. Roci was Clovis’ mission critical product. And the Board knew, upon completion of the TIGER-X trial, the FDA would consider only confirmed responses when determining whether to approve Roci’s NDA per the agency’s own regulations.” Moreover, the Clovis “Board was comprised of experts and the RECIST criteria are well-known in the pharmaceutical industry. Moreover, given the degree to which Clovis relied upon it when raising capital, it is reasonable to infer the Board would have understood the concept and would have appreciated the distinction between confirmed and unconfirmed responses. The inference of Board knowledge is further enhanced by the fact the Board knew that even after FDA approval, physicians (i.e., future prescribers) would evaluate Roci based on its” clinical trials.
Mike Volkov has stated of the Clovis decision, “The Clovis Court explained that “‘Delaware Courts are more inclined to find Caremark oversight liability at the board level when the company operates in the midst of obligations imposed upon it by positive law yet fails to monitor existing compliance systems, such that a violation of law, and resulting liability, occurs.’” The Clovis Court noted that when externally imposed regulations govern a company’s mission critical operations, the board must exercise a good faith effort to implement an oversight system, which “entails a sensitivity to ‘compliance issues[s] intrinsically critical’ to the company.”
The Clovis decision is another steppingstone in the creation of duties for a Board regarding compliance. Like the Board at Blue Bell Ice Cream, the Clovis Oncology Board had but one compliance obligation. At Blue Bell Ice Cream, it was food Safety. At Clovis Oncology it was compliance around the clinical trials and reporting results of its signature product, the drug Roci. While Blue Bell Ice Cream management did not even report its food safety results to the Board, senior management at Clovis made material misrepresentations to the Board about the results of the clinal trial based upon the melding of unconfirmed results with confirmed results. This case then stands for the proposition that a Board must do more than simply accept what management says about compliance, it must monitor compliance. Here the Clovis management made material misrepresentations to the Board about the results of the clinal trial based upon the melding of unconfirmed results with confirmed results.