In March 2016, the Securities and Exchange Commission announced that AVEO Pharmaceuticals, Inc., a Massachusetts-based biopharmaceutical company, agreed, without admitting or denying the allegations, to pay $4 million to settle fraud charges alleging that AVEO and three of its officers misled investors regarding their dealings with the U.S. Food and Drug Administration. Companies and their officers can be held liable for any untrue statement of a material fact or omission to state a material fact required or necessary to make a statement not misleading.  The AVEO case serves as a cautionary reminder that when a company is telling investors about its dealings with regulators, it must be accurate and tell the whole story.

AVEO is focused on developing and commercializing cancer drugs. To date, none of its drugs have been brought to market. However, in 2012, AVEO had a drug called Tivozanib relatively far along in the FDA approval process. Tivozanib was developed with the intention of treating kidney cancer and had already undergone a clinical trial in Europe.

With that trial completed, AVEO was prepared to move forward in seeking FDA approval for Tivozanib by submitting a New Drug Application (NDA). In preparation for filing its NDA, AVEO had an initial meeting with the FDA in May 2012. At this meeting, the FDA expressed concerns about the data from Tivozanib’s clinical trial in Europe. Particularly, the FDA was concerned that although Tivozanib appeared to slow cancer’s progression in patients, the lifespan of patients taking the drug was shorter than those taking another drug already on the market. The FDA expressed its belief that a second clinical trial would likely be necessary before it could approve Tivozanib.

In the month that followed AVEO’s meeting with the FDA, AVEO conducted additional analyses of the data from the clinical trial in Europe. AVEO estimated that a second trial would cost approximately $83 million and last roughly 3 years. AVEO’s officers believed that they could explain the data that concerned the FDA without conducting a second clinical trial and avoid undue delay and expense. Ultimately, AVEO decided against conducting the second clinical trial.

In August 2012, AVEO issued a press release discussing AVEO’s progress in submitting an NDA for Tivozanib. In this press release, AVEO mentioned that the FDA was concerned about the lifespan of patients taking Tivozanib, but failed to mention that the FDA had recommended a second study be conducted or that AVEO had considered conducting such a study.

That same day, AVEO held an earnings call with investors and analysts where it discussed Tivozanib’s progress. During the call, several analysts asked officers of AVEO about the meeting with the FDA and whether the FDA had made any recommendations for getting Tivozanib approved. The officers participating in the call did not discuss the second trial recommended by the FDA, but instead said that they “can’t speculate on what the agency might want [AVEO] to do in the future.”

AVEO continued to believe that it could explain the shorter lifespans of the patients in the clinical study in Europe through certain of its analyses. Moreover, Tivozanib appeared effective at slowing the progression of cancer. Accordingly, AVEO submitted its NDA for Tivozanib in September 2012 without conducting a second clinical trial.

In January 2013, AVEO raised $53 million in a public equity offering. Approximately three months later, in April 2013, the FDA publicly disclosed its prior recommendation to AVEO to conduct a second trial for Tivozanib. That same day, AVEO’s stock price dropped 31% and roughly one month later, the FDA denied approval of Tivozanib.

Fast forward three years later: in March 2016, the SEC filed a complaint charging AVEO and three former officers with fraud for failing to disclose to investors the FDA’s recommendation that a second clinical trial be conducted. The SEC also announced that AVEO agreed to pay $4 million to settle these charges without admitting or denying the allegations in the complaint. The charges against the former officers continue. In a press release, Paul G. Levenson, Director of the SEC’s Boston Regional Office stated, “Companies must be forthcoming about their communications with regulators so investors can make informed investment decisions while knowing what challenges may lay ahead.”

Considering what to disclose – and what not to disclose – presents some of the most difficult decisions for companies. What’s “material” lacks a bright line and is instead based on decades old case law about what’s important to reasonable investors. Companies should always be careful in choosing how and when they disclose to investors communications with regulatory bodies and ensure that they are telling the whole story. Companies and their officers should strive to accurately represent their dealings with regulators, so as not to mislead investors since they can be held liable for material misstatements or omissions.

On December 4, 2015, the Fixing America’s Surface Transportation Act (the FAST Act) was signed into law. While the FAST Act primarily dealt with transportation and infrastructure improvements, it included a new subsection to Section 4 of the Securities Act of 1933. Specifically, it added Section 4(a)(7), which provides a new registration exemption for the private resale of securities. Previously, private holders of securities wishing to resell without registration had two options: (i) comply with a holding period before selling securities on a public market pursuant to Rule 144, or (ii) fall within the so-called “Section 4(a)(1½)”.

Generally, Section 5 of the Securities Act requires registration for all offers and sales of securities unless an exemption applies. Two common exemptions to registration exist under Sections 4(a)(1) and 4(a)(2) of the Securities Act. Section 4(a)(1) offers an exemption for transactions by any person other an issuer, underwriter or dealer. Section 4(a)(2) offers an exemption for transactions by an issuer that are not a public offering. However, private resales of securities fell into unclear territory. That uncertainty gave rise to the so-called “Section 4(a)(1½)”.

Section 4(a)(1½) is an exemption derived from case law and certain elements and principles of Sections 4(a)(1) and 4(a)(2). Section 4(a)(1½) essentially applies the Section 4(a)(1) exemption to a transaction with private characteristics similar to a private issuance under Section 4(a)(2). However, unlike a codified exemption, the little guidance that existed with regards to Section 4(a)(1½) was conflicted and incomplete.

Section 4(a)(7) creates more certainty by specifying the circumstances where a private resale of securities is exempt from registration. A resale of securities is exempt under Section 4(a)(7) if:

1. The purchaser is an “accredited investor” as defined by Regulation D
2. The seller, or any person acting on the seller’s behalf, refrains from any form of general solicitation or advertising
3. The seller is not the issuer or a subsidiary of the issuer
4. The seller, or any person that has been or will be paid for participating in the sale of the securities, is not qualified as a “bad actor” under Regulation D
5. The issuer is engaged in business, is not in the organizational stage or in bankruptcy or receivership, and is not a blank check, blind pool, or shell company that has no specific business plan or purpose and has not indicated that the issuer’s primary business plan is to merge or acquire an unidentified person
6. The transaction does not relate to an unsold allotment to, or a subscription or participation by, a broker or dealer as an underwriter of the securities
7. The transaction is with respect to a class of securities that has been authorized and outstanding for at least 90 days prior to the transaction
8. For securities of issuers not subject to periodic reporting and eligible to register securities under Schedule B, certain information must be provided to prospective purchasers, including financial statements prepared in accordance with generally accepted accounting principles or, for foreign issuers, International Financial Reporting Standards

Securities sold under Section 4(a)(7) are “restricted securities” under Rule 144. They are also “covered securities” within the meaning of Section 18(b) of the Securities Act, and are therefore exempt from state securities registration requirements. Further, Section 4(a)(7) does not replace Section 4(a)(1½), meaning resellers can still rely on procedures that fell under Section 4(a)(1½) if they are unable to comply with the requirements of Section 4(a)(7).