Risk & Compliance

Is Not Telling the ‘Whole Truth’ Securities Fraud?

A jury verdict that held an ex-CFO liable for misleading investors makes clear that the SEC will take action against incomplete disclosures.
Paul Hastings LLP and Nicolas Morgan and Brian KaewertNovember 27, 2018

Does complying with company disclosure procedures and consulting with legal counsel protect public-company CFOs from liability arising from statements made in press releases and during investor conferences?

Based on a recent federal court jury verdict against David Johnston, the former CFO of Aveo Pharmaceuticals, the answer appears to be: It depends.

On Nov. 20, 2018, a jury in the U.S. District Court in Massachusetts found Aveo’s former CFO liable for federal securities fraud. The verdict highlights the obvious importance of making specific, full, and accurate disclosures to investors. More importantly for CFOs, it also highlights a vulnerability of relying on professionals and subject-matter experts for protection from SEC liability when they may not have received all of the relevant information.

Nicolas Morgan

The SEC’s case against the CFO arose out of Aveo’s 2012 disclosures regarding the Food and Drug Administration’s expressed concerns over a kidney-cancer-fighting drug, tivozanib, then in development by Aveo.

Aveo began clinical trials of tivozanib in 2010 and met with the FDA in May 2012 to discuss those trial results ahead of filing for FDA approval of the drug. In those meetings, the FDA expressed concerns about survival rates of patients on tivozanib — and recommended that Aveo undertake a second clinical trial of the drug.

Following the FDA meetings, in press releases and investor conference calls, the company disclosed that the FDA was concerned with patient survival rates, but did not disclose that the FDA had recommended the company conduct a second clinical trial.

Specifically, the company issued a press release referencing the FDA’s “concern regarding the [overall survival] trend” from the drug and stating that the company would be doing “additional analyses” to address the FDA’s concerns, without mentioning the FDA staff’s recommendation to conduct another trial.

Later, at a February 2013 conference, when a securities analyst asked the CFO whether the company had discussed potential new trials with the FDA, he replied: “We have not had any formal discussions, no.”

In March 2016, the SEC filed a lawsuit alleging securities fraud against the company and three of its former executives — the CEO, CFO, and chief medical officer. The omission of any reference to the FDA’s recommendation that the company conduct a second trial formed the basis of the SEC’s fraud claims. Aveo and the other former officers settled with the SEC, leaving Johnston as the only defendant to take his case to trial.

What role did the CFO play in connection with omission of FDA’s recommendation from Aveo’s disclosures? As would be the case at most public companies, the CFO was only one voice among many in shaping the disclosures about the FDA meetings. According to papers filed in the SEC’s lawsuit, the CFO’s duties did not include responsibility for clinical development of the drug, the design of the clinical trials, the review of clinical safety and efficacy data, the preparation and submission of regulatory filings, or communications with the FDA.

Given the CFO’s lack of formal scientific, medical, or legal training, and his lack of experience communicating with the FDA, he and the company relied on a host of internal and external subject-matter experts for guidance on the FDA review process, the meaning and import of FDA communications, and disclosure obligations regarding communications from the FDA.

Those advisers included the company’s board members, an internal disclosure committee, the CEO, the chief medical officer, the vice president of regulatory affairs, and the general counsel. Additionally, the company consulted with a number of external sources on issues relating to the FDA and disclosure, including an outside communications consultant, experienced external regulatory counsel, and perhaps most importantly, a large national law firm that advised the company on public disclosures.

However, at trial the jury didn’t hear what could have been a critical piece of evidence in the CFO’s defense: testimony from in-house and external lawyers that they had approved the omission of the FDA’s recommendation of a second trial from the company’s press releases and the CFO’s public comments.

Because the communications with the lawyers were privileged, the company — and not the CFO — controlled the privilege. So the attorneys never testified, and the CFO was permitted to testify only that he followed the company’s procedures for approving public statements, which included soliciting opinions of counsel.

The SEC countered this testimony by questioning the breadth and extent of the information provided to counsel. Johnston admitted that the law firms had reached their conclusions based on information he had provided to them.

In the end, the CFO’s defense was not enough. The jury found against him after four hours of deliberations.

By obtaining a verdict in its favor, the SEC has signaled it can and will take action against CFOs when disclosures are not full, complete, and specific. Indeed, based on this case the SEC will pursue such actions against CFOs even when they have followed company disclosure procedures and consulted internal and external subject-matter experts and counsel.

Although the overall number of SEC enforcement actions is down in 2018, the most common allegation against public-company defendants involves reporting disclosures. In such cases, CFOs and controllers are among the favorite targets when the SEC names individual defendants.

Companies and executives should diligently review their disclosure policies and procedures to ensure they are painting a complete picture in their public statements. Moreover, companies would be well-served to retain competent outside counsel to review their disclosures and should make sure counsel has all of the facts necessary to provide a well-reasoned opinion.

Reliance on internal and external subject-matter and legal experts provides the most robust defense to liability when those experts are fully-informed, particularly about potentially harmful developments.

Nicolas Morgan is a partner and Brian Kaewert an associate at the law firm Paul Hastings LLP.