Do Small Biotechs Really Face Big Risk?
Using data from the Stanford Securities Litigation Analytics (SSLA) database, we take a closer look at the risk facing biopharma firms with market capitalization under $1 billion, and we find that the prospects these firms face with respect to securities class actions is only slightly worse than that faced by firms of comparable size in other sectors. The high volume of lawsuits is partially offset by disproportionately high dismissal rates. As a result, we show that the probability-discounted cost facing biopharma firms is not as high as apparently perceived. For a more thorough discussion of our findings, please see our companion post on the D&O Diary.
[NOTE: The charts below are interactive. Mousing over or clicking on certain chart elements will reveal more data. Each chart can also be saved as an image file by clicking the small, grey box in the upper right corner of the chart.]
Figure 1: Lawsuits Filed By Sector (2011-2017)
Figure 1: Lawsuits Filed By Sector
Figure 1 shows the filing volume of securities class actions during the period 2011 to 2017, distributed across GICS sectors. For purposes of our analysis, we refer to the “biotechnology”[1] and “pharmaceuticals”[2] sub-industries as “biopharma”[3], which ranks high with 183 lawsuits, or roughly 17% of filings over this period.[4]
Frequency and Content of Suits Against Small Biopharma Firms
Figure 2: Targeting of Firms by Sector
[NOTE: Click to switch between number and percentage of companies sued.]
Figure 2a: Companies Sued by Sector
In Figure 2, and for the remainder of this post, we focus on firms with a market cap of under $1 billion. This is the subsector of the biopharma sector that is considered particularly risky – firms engaged in drug development that are highly dependent on the outcomes of clinical trials and FDA approval. Consistent with the previous figure, the absolute volume of suits against biopharma firms is relatively high. However, when we compare targeting of firms across sectors as a percent of the publicly-traded firms in each sector, we see a reshuffling in the rankings.
Figure 3: Non-Accounting Cases Filed Against Biopharma Firms 2011 – 2017
(Types of alleged misstatements are not mutually exclusive.)
[NOTE: Click on the darker bar of each chart to drill down.]
Figure 3: Nature and Context of Allegations
Figure 3 describes the content of the 116 class actions filed against small biopharma firms. Very few cases (6%) involve allegations of accounting-related misstatements. Among the non-accounting cases, 89% involve misstatements related to drug development. Where cases do involve the drug development process, alleged misstatements relate to a firm’s general operations, the safety and efficacy of its drugs on the market, and compliance with regulatory guidelines in its facilities. Note, the percentages shown represent the subset of cases from each preceding drill-down.
Figure 4: Aggregate Disclosure Loss as Percent of Max Market Cap
Figure 4: Aggregate Disclosure Loss as Percent of Max Market Cap
On average, these lawsuits involve substantial stock drops—stock drops that are greater than those associated with alleged misstatements in suits against firms of similar size in other sectors. Figure 4 shows stock drops associated with alleged corrective disclosures.[5] Mean and median drops in biopharma cases are substantially larger than those in other cases.
Dismissal and Settlement
Figure 5: Dismissal Rate for Cases Resolved 2011-2017
Figure 5: Dismissal Rate for Resolved Cases
While the frequency of lawsuits against small biopharma firms is relatively high, the dismissal rate is also high. Between 2011 and 2017, a total of 511 cases were resolved—100 against biopharma companies and 411 against others. As shown in Figure 5, the rate of dismissal was far higher in cases against biopharma firms than in cases against non-biopharma firms—62% compared to 46%, respectively.[6] If we combine the figures for the percentage of firms sued during the 2011 to 2017 period with the percentage of resolved cases that were settled, we find that the implied rate at which biopharma and non-biopharma firms face settlements are 8% and 7% respectively over a seven-year period.[7]
Figure 6: Settlements in Raw Dollars and as a Percentage of Stock
[NOTE: Click to switch between settlements in raw dollars and as a percentage of loss.]
Figure 6a: Settlements in Dollars
Figure 6 shows settlement size in raw dollar figures and as a percentage of stock drop associated with alleged corrective disclosures. The dollar figures for mean settlements are essentially the same for biopharma cases as for other cases, but the medians are substantially different. The difference between means and medians indicates that settlements for both sets of firms are highly skewed toward higher settlements, with non-biopharma skewed more. The lower variance of biotech settlements suggests that insurers may be able to predict the cost of biotech insurance policies more accurately than they can predict others. When measured as a percentage of the stock drop associated with corrective disclosures, the means and medians are roughly similar. In fact, biotech settlements are slightly smaller.
Figure 7: Settlement Timing for Cases Resolved 2011-2017
Figure 7: Settlement Timing for Resolved Cases
SSLA’s “Settlement Timing” variable divides the litigation process into three stages: early pleading, late pleading, and discovery. Early pleading settlements are those that settle prior to a ruling on a first motion to dismiss. Late pleading settlements are those that settle after an initial motion to dismiss is granted without prejudice, and before a subsequent motion to dismiss is either granted with prejudice or denied. Discovery stage settlements are those that settle after some or all of plaintiffs’ claims survive a motion to dismiss. Figure 7 shows the timing of settlements among biopharma firms and firms of similar size in other sectors.
There is some bad news here regarding cases against small biopharma firms. Among the cases that are not dismissed, settlements tend to occur somewhat later in cases against small biopharma firms than among others. The higher rate of biopharma settlements occurring in discovery may be related to the high rate of dismissal for these suits. Defendants may tend to resist early settlements in biopharma cases in the hope of dismissal.
Emerging Firms vs. Established Firms
Readers may recall from our June 2016 guest post on the D&O Diary, and a subsequent article in the Wall Street Journal in August 2018 with updated numbers, that we have attributed much of the increase in securities class actions over recent years to a group of three plaintiffs’ firms that we called “emerging” firms.[8] Those firms have actually been around for quite some time, but the volume of their cases, as well as their overall share of the securities class action market, have increased dramatically in recent years. On the other hand, a group of firms that we called the “established” firms—the 10 firms that served as lead counsel more than any others since 2000 and that are credited with at least five of the largest 100 securities class action settlements during that period—accounted for none of the growth in securities class action.
Figure 8: Plaintiffs’ Firms Targeting Biopharma Firms in Cases Filed 2011-2017
Figure 8: Plaintiffs’ Firms Targeting Biopharma Firms
As shown in Figure 8, the emerging firms cohort, to which we added an additional firm in 2017[9], is responsible for a disproportionately high number of shareholder class actions against small biopharma firms, and the established firms are responsible for a disproportionately small number of suits. Whereas among all securities class actions filed from 2011 to 2017, emerging and established firms have served as lead counsel in 38% and 41%, respectively, they have served as lead counsel in, respectively, 54% and 13% of cases against small biopharma firms.[10] The difference is even starker when comparing on a per firm basis. Among all securities class actions filed from 2011 to 2017, emerging firms outpace established firms by more than two to one in lead counsel appointments among all securities class actions, and by more than ten to one among cases against small biopharma firms.
The Bottom Line
The data described above show that securities class actions pose only a slightly greater danger for small biopharma firms than they do for firms of similar size in other sectors. Based on data from 2011 to 2017, the probability of being a defendant in a case that settles is approximately 1.15% and 1% per year for biopharma and non-biopharma firms, respectively.[11] The mean settlements in biopharma and non-biopharma cases are $9 million and $8.9 million, respectively. So, the probability-discounted cost facing biopharma firms is $103,500, compared to $89,000 for non-biopharma firms.
A more refined analysis might differentiate litigation risk among biopharma firms. As shown above, the likelihood of a lawsuit differs across phases of clinical trial. Perhaps stock drops and settlement sizes differ as well. The increased market share of the emerging firms raises additional questions regarding the future of biopharma cases. Perhaps the result will be earlier settlements, which would be consistent with these firms’ practice generally, which may mean smaller settlements than what we have seen over the past seven years. Additional digging into the data may well be warranted.
[1] Biotechnology (GICS code 35201010) is defined as “companies primarily engaged in the research, development, manufacturing and/or marketing of products based on genetic analysis and genetic engineering. Includes companies specializing in protein-based therapeutics to treat human diseases. Excludes companies manufacturing products using biotechnology but without a health care application.”
[2] Pharmaceuticals (GICS code 35202010) is defined as “companies engaged in the research, development or production of pharmaceuticals. Includes veterinary drugs.” While the GICS definition does not specifically say so, drugs produced by pharmaceutical firms have a chemical basis. Conversely, drugs produced by biotechnology firms have a biological basis relying on organic material.
[3] This excludes GICS sub-industry Life Sciences Tools & Services (GICS code 35203010), which is defined as “companies enabling the drug discovery, development and production continuum by providing analytical tools, instruments, consumables & supplies, clinical trial services and contract research services. This includes firms primarily servicing the pharmaceutical and biotechnology industries.”
[4] Data in Figure 1 and throughout this post are for securities class actions brought under Section 10(b) of the Securities Exchange Act, Section 11 of the Securities Act and related provisions of those laws, and exclude merger objection suits under Section 14 of the Securities Exchange Act.
[5] SSLA’s Aggregated Disclosure Loss variable aggregates the change in a firm’s market cap from one day before to one day after each corrective disclosure alleged in the plaintiffs’ last filed complaint. We collect these data for settled and dismissed cases. SSLA also computes Aggregated Disclosure Loss based upon the Plan of Allocation for settled cases.
[6] Whereas the prior data are based on cases filed between 2011 and 2017, these figures are for cases resolved during that period. These two sets of cases are overlapping but not identical. There is no basis in the data, however, to expect that as the filed cases are resolved, dismissal rates for them will differ from dismissal rates for cases resolved during this period.
[7] Our calculations are as follows. Among 557 publicly held biopharma firms, there were 116 lawsuits filed. Applying a dismissal rate of 62%, this implies that 44 cases will settle. Leaving aside the fact that some of these cases were filed against the same companies, that comes to 8% of biopharma firms over the 2011 to 2017 period. Among 3,360 publicly held non-biopharma cases, 430 cases were filed. Applying a dismissal rate of 46%, this implies that 234 will settle. That comes to 7% of non-biopharma firms. Alternatively, one could simply look at the number of settled cases during the 2011 to 2017 period. This approach yields a figure of approximately 6.6% for both biopharma and non-biopharma firms.
[8] Those three firms are Rosen Law Firm, Glancy Prongay LLP and Pomerantz LLP.
[9] Levi & Korsinsky LLP is added to that cohort here and will be added in a forthcoming report updating our 2016 report. The number of cases in which that firm served as lead counsel increased in 2015 (15 total cases), 2016 (17 cases) and 2017 (26 cases) compared to an average of 5.5 cases per year during the previous three-year period.
[10] These numbers exclude cases where lead counsel has not yet been appointed, except when the case is filed and subsequently dropped by a firm and no other related actions are filed, in which case we treat the single firm that filed the case as the lead counsel.
[11] For biopharma firms under $1 billion in market cap, there were 37 settled cases among 557 publicly traded companies. For non-biopharma firms there were 227 settled cases among 3,360 publicly traded companies. For simplicity, we do not factor into the possibility that a single firm will be sued more than once.
