On The Case

Theranos fails to win dismissal of fraud class action by ‘indirect’ investors

(Reuters) - Even if the embattled, privately-held biotech company Theranos somehow manages to persuade all of its shareholders to participate in a tender offer that requires them to release litigation claims, it will still have to face a fraud class action by “indirect” investors and their lawyers at Hagens Berman Sobol Shapiro and Robbins Geller Rudman & Dowd.

On Tuesday, U.S. Magistrate Judge Nathanael Cousins of San Jose denied Theranos’ motion to dismiss the class action, which asserts claims under common law and California’s Corporations Code. Lead plaintiffs in the case are two investors in investment funds that held Theranos shares, which were not sold on the open market.

Theranos lawyers from Wilmer Cutler Pickering Hale & Dorr and Cooley had argued that the lead plaintiffs can’t hold the company and its officers liable for securities fraud because they didn’t actually buy Theranos shares. Judge Cousins agreed with the company that plaintiffs can’t bring claims under a section of the state code that allows rescission of shares sold fraudulently. But he allowed the class to move forward with allegations under a different section, which, according to the judge, is intended to prevent fraudulent manipulation of the market. “It focuses on the actions of the seller of the securities, not the relationship between seller and buyer,” Judge Cousins said. He also found the plaintiffs had met the heightened pleading standard for fraud claims in federal court.

As I reported earlier this week, the California case is one of two suits by Theranos investors. Shareholders who bought shares directly from the company have sued in Delaware Chancery Court. Last week, they obtained a temporary restraining order barring the company from proceeding with a tender offer in which shareholders could exchange stocks for new preferred shares with enhanced rights – as long as investors agreed to release litigation claims. The Delaware plaintiffs alleged Theranos was improperly pressuring them to drop the suit.

In an email statement, Theranos lawyer Timothy Perla of Wilmer said the company is pleased that Judge Cousins dismissed part of the indirect investors’ case and that he said Theranos had “valid” concerns about the intermediary relationship between Theranos, the funds that held its shares and the indirect investors. The judge held the plaintiffs must show cause why the funds should not be joined as defendants in the case.