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Litigation Reform Opens Door to Freer Investor Information

Medical Device & Diagnostic Industry
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Originally published February 1996


Medical device companies may be speaking more openly about their future prospects --and the factors that might keep them from reaching their goals--because of a new law that limits the right of stockholders to sue them. The law requires that before a class action suit is filed, there must be a real basis for believing that fraud has occurred.

"Now, if you can't plead more than bad news and a stock drop, you are not going to stay in court very long," says Bruce Vanyo, chairman of the litigation department and head of the securities litigation group at Wilson, Sonsini, Goodrich, and Rosati (Palo Alto, CA).

The main feature of the new law, which took effect December 22, 1995, and applies to any case filed after that date, is to provide a safe harbor for companies making forward-looking statements. "If the statement is accompanied by meaningful cautionary statements about why the prediction might not come true, then the company will be immune from liability if it doesn't come true," Vanyo explains. "I think that will encourage a lot of companies to go out and talk about the future, so there will be a lot more information on which investors can base intelligent decisions."

Medical device companies were hit hard several years ago by class action suits that surfaced in the wake of health-care reform efforts. At the time it was common for device companies to be predicting growth of the kind that had sent their stocks skyrocketing in previous years, only to have those stocks lose half or three-quarters of their value virtually overnight as the market went south.

The stocks of companies in the technology and medical device field, Vanyo says, are especially volatile, prone to move several points on the slightest bit of good or bad news. "A lot of frivolous cases brought in the past were based on a company's predictions not coming true. If a company makes a financial projection or some other prediction and it doesn't come true, that causes disappointment in the marketplace, and the next thing you know you have a securities class action."

The new law goes a long way toward preventing such class action suits from being filed from now on. But for a time late last year, it looked like this protection would elude companies. President Clinton vetoed the Private Securities Litigation Reform Act of 1995. But on December 20, the House of Representatives voted to override the veto and two days later the Senate followed with its own override, turning the proposed legislation into law.

"In this bipartisan measure, Congress has struck a fair balance," says David Gollaher, president of the California Health Care Institute (La Jolla), an association that represents the interests of some 90 biotechnology, medical device, and pharmaceutical companies. "Shareholders' rights to sue companies that commit real fraud are fully protected. But companies will no longer be penalized for taking the risks needed to discover and develop tomorrow's medical breakthroughs. What Congress has done will help biotech and medical device firms devote precious capital resources to R&D instead of to settlements with opportunistic trial lawyers."

There are other advantages, as well. The risk of class action suits has made venture capital firms nervous about backing companies with new ideas. "In the past, some of these firms were getting sued just because they had people on the board of a company that had a bad news announcement," Vanyo notes. The protection afforded by this new law should take away some of the worry that venture capital firms have.

The new law is especially important for venture capital firms and small companies for another reason, says Dave Cleary, president of Cleary & Oxford Associates (Alexandria, VA). "Start-up companies have fewer resources in terms of legal infrastructure--in-house counsel, PR firms, and so on--and venture capital firms have a much greater share of the equity. They might own 20 to 30% of the company and, therefore, have a lot of risk," says Cleary, whose company specializes in mergers and acquisitions in the health-care industry.

But the companies most frequently victimized by class action suits have been large companies, because they have had the deepest pockets. Now, the new law promises to dramatically reduce the likelihood that such victimization will continue. "These companies have the systems in place to make sure that if they are going to make a predictive statement, they will accompany it with ample warnings and therefore satisfy the statute," Vanyo explains.--Greg Freiherr

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