Cognitive Dissonance Undercuts Deterrence in the C-Suite

HEROD(DONOTDELETE) 11/12/213:49PM

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COGNITIVEDISSONANCEUNDERCUTSDETERRENCEINTHEC-SUITE:WHYOTHERWISEETHICALFDA-DEPENDENT

MANAGERSKEEPFALLINGDOWNTHERABBITHOLEOF10(B)CLASSACTIONLITIGATION

EdwinAdlamHerod*

I.INTRODUCTIONInside or outside of the legal world, for most people, Enron,1

Madoff,2andTheranos3 all conjureup imagesof investor fraud,whitecollar crime, and executives-gone-bad. Those cases have involvedheadline-grabbingsecuritiesviolations4—amongahostofother legal, *J.D.Candidate,2022,SetonHallUniversitySchoolofLaw;B.A.,KenyonCollege.ThisCommentwouldnothavebeenpossiblewithoutthesupportandguidanceofProfessorJacob Elberg—few others would appreciate spirited discussions on the contoursbetweenincrementalismandinduction. 1 History: Famous Cases & Criminals: Enron, FED. BUREAU OF INVESTIGATIONS,https://www.fbi.gov/history/famous-cases/enron(lastvisitedOct.24,2021). 2 UnitedStatesv.BernardL.MadoffandRelatedCases,U.S.ATT’YSOFF.,S.DIST.OFN.Y.,DEP’TOFJUSTICE(June5,2020),https://www.justice.gov/usao-sdny/programs/victim-witness-services/united-states-v-bernard-l-madoff-and-related-cases [hereinafterMadoff](describingcasestatusupdatesregardingBernardMadoff). 3 BenPopken,How$9BillionStartupTheranosBlewUpandLaidoff41%,NBCNEWS(Oct.26,2016,12:45PM),https://www.nbcnews.com/business/consumer/how-9-bil-lion-blood-testing-startup-theranos-blew-n671751. 4 TheSecuritiesandExchangeCommission(SEC)filedarangeofchargesagainstall three actors listed—their managers, subsidies, and sometimes brothers—but allincluded claims under the Securities and Exchange Act of 1934, 15 U.S.C. § 78j (“§10(b)”).PressRelease,Sec.&Exch.Comm’n,SECChargesKennethL.Lay,Enron’sFormerChairman and Chief Executive Officer, with Fraud and Insider Trading (July 8, 2004),https://www.sec.gov/news/press/2004-94.htm (SEC announcing § 10(b) and Rule10b-5civilchargesagainstthe“formerChairmanandChiefExecutiveOfficerofEnronCorp”);Complaint,SECv.BernardL.Madoff,No.08-CIV-10791(S.D.N.Y.Dec.11,2008),https://www.sec.gov/litigation/complaints/2008/comp-madoff121108.pdf (SECcomplaintfiledagainstBernardL.MadoffandBernardL.MadoffInvestmentSecuritiesLLC with violations including § 10(b) and Rule 10b-5); Press Release, Sec. & Exch.Comm’n,SECChargesPeterMadoffwithFraudandFalseStatementstoRegulators(June29, 2012), https://www.sec.gov/news/press-release/2012-2012-126htm (chargingPeter Madoff—BernardMadoff’s brother—with § 10(b) and Rule 10b-5 violations);LitigationReleaseNo.24069,Sec.&Exch.Comm’n,SecuritiesandExchangeCommissionv.ElizabethHolmes,etal.(Mar.19,2018),https://www.sec.gov/litigation/litreleases/2018/lr24069.htm(SECchargingElizabethHolmes,TheranosInc,andRameshBalwaniwith§10(b)andRule10b-5violations).


608 SETONHALLLAWREVIEW [Vol.52:607

ethical, psychological, andmoral concerns. Somehave contemplatedthat these sensational scandalsmay stem from deeper psychologicalissues.5Whiletheselarge-scalefraudscapturethepublic’simaginationduetothegrandnatureofthecrimes,6theirimpactontheday-to-daysecuritieslitigationlandscapeisoutsizedbylessdramaticcases.7 Butthepublic’sfascinationwiththeselarge-scalefrauds—andwhatdrivestheactorsbehindthem—mayplacetoo largeofanonusonasmallersubsetoftheoverallproblem.

Willful fraud, and the mindsets behind it, may grab significantpublic attention, but amore elusive psychological phenomenonmaylurkbehindabroadswathofsecuritiesactions:cognitivedissonance.Cognitivedissonance,aprocessbywhichanactorcansubconsciouslydeceive herself about the quality and effect of her actions, differssignificantlyfromwillfulfraud:theactormaynotcomprehendthescopeortrajectoryofherconduct.8Understandingcognitivedissonancemayoffer insight to increasing the law’s effectiveness as a deterrent andproviding counsel a better understanding of their clients’ actions toadviseprospectivelyandretrospectively.Somescholarshavesuggestedthat cognitive dissonance has played a supporting role in largerfrauds—andisamechanismthatenablesemployeestogoalongwiththewillfullyfraudulentactsoftheiremployers.9ThisCommentwilllookbeyondtheframeworkofcognitivedissonanceasasupportingfunctiontoexaminetheeffectcognitivedissonancehaswhenittakesaleadroleinsecuritiesviolations.

With an average of $6 billion in settlements per year10 andestimates of psychopathy in the general population at under one

5 Alan Deutschman, Is Your Boss a Psychopath?, FASTCOMPANY (July 1, 2005),https://www.fastcompany.com/53247/your-boss-psychopath (Dr. Hare suggests,indirectly, that the CFO of Enron, Andrew Fastow, exhibits psychopathic behavior);Diana B. Henriques, Letters from a Sociopath, FORBES (Mar. 21, 2012, 6:00 PM),https://www.forbes.com/forbes/2012/0409/feature-bernie-madoff-prison-rewrite-letters-from-sociopath.html#666235803167 (an article about the correspondencebetween the author andBernieMadoff); JonathanStempel,Ex-TheranosCEOHolmesPutsMentalStateatIssue,tobeExaminedbyU.S.Experts,REUTERS(Sept.10,2020,12:02PM), https://www.reuters.com/article/us-theranos-holmes/ex-theranos-ceo-holmes-puts-mental-state-at-issue-to-be-examined-by-u-s-experts-idUSKBN2612Q3 (statingthatElizabethHolmes,ofTheranosInc,“mayofferevidenceshesufferedfromamentaldiseaseordefect”). 6 Seesupranotes1–3. 7 Seeinfranotes10–13andaccompanyingtext. 8 SeediscussioninfraSectionsV.A–D. 9 SeePrentice,infranote97,at431. 10 MUKESHBAJAJETAL.,ECONOMICCONSEQUENCES:THEREALCOSTSOFU.S.SECURITIESCLASSACTION LITIGATION, U.S. CHAMBER INST. FOR LEGAL REFORM 3 (Feb. 2014) [hereinafter


2021] COMMENT 609

percent,11 pinning the totality—or even a majority—of securitiesviolationsonpsychopathyandrelatedmentalillnessseemsfarfetched.Yet,thescopeoftheproblemissubstantial.Whilewecannotknowthetotalnumberofactualviolations—andthereforethescopeoftotalharmtoinvestorsandthepublic—thereisevidencethatsomecompaniesarenotmakingtheproperdisclosurestotheinvestingpublic:namely,the$6 billion in settlements per year.12 The scale here prompts animportant question: Is there truly an incredible correlation betweenmanagement and psychopathy that grossly exceeds the populationaverage,13oristhereanother,perhapsmorereasonedexplanationforthepsychologicalandethicalmindsetsthatbringcorporatemanagerstorunafoulofsecuritieslaw?

Onesectorthathasbornetheparticularbruntofsecuritiesactionsbased on the failure to make proper disclosures is the life sciencessector:twenty-fourpercentofsecuritiesclassactionsuitsin2019werefiledagainstlifesciencescompanies.14Ofparticularnotearethepubliclifesciencecorporationsonthelowercapitalizationsideofthemarket.15DuetocomplicationswithandsignificantdependenciesontheFoodand

Consequences], https://instituteforlegalreform.com/research/economic-consequences-the-real-costs-of-u-s-securities-class-action-litigation/. 11 KentA.Kiehl&MorrisB.Hoffman,TheCriminalPsychopath:History,Neuroscience,Treatment,andEconomics,51JURIMETRICS355,356n.1(2011)(indicatingone-percentofmeninthegeneral,institutionalizedpopulationandsignificantlylowerestimatesforthegeneralfemalepopulation). 12 Consequences,supranote10,at2–3. 13 SomearguethatthereisdataouttheretoshowaskewtowardsnarcissismandpsychopathyintheC-Suite,thoughthisCommentwillnotgothere,takingthetactthat,howevermuch those numbersmay vary, they do not represent amajority of theseinstances of securities violations. See Karen Landay,Psychopaths in the C-Suite?, AM.PSYCHOLOGICAL ASS’N (Oct. 15, 2018), https://www.apa.org/pubs/highlights/spotlight/issue-123 (stating that “the results donot support the idea that corporateleaderstendtohavesubstantiallyhigher levelsofpsychopathic tendencies”).ButseeJack McCullough, The Psychopathic CEO, FORBES (Dec. 9, 2019), https://www.forbes.com/sites/jackmccullough/2019/12/09/the-psychopathic-ceo (stating“[t]hereisarealchancethatatsomepointachieffinancialofficerwillbeconfrontedwithapsychopathic[CEO]”). 14 LaCroix, infra note 201; see also SECURITIES CLASS ACTION FILINGS, 2019 YEAR INREVIEW, CORNERSTONERSCH. 1 (2020), https://www.cornerstone.com/Publications/Re-ports/Securities-Class-Action-Filings-2019-Year-in-Review (stating that “[c]ompaniesintheHealthCaresectorwerethemostfrequenttargetsofnewcorefederalfilings”).Additionally,thereappearstobeariseinsecuritiesclassactionfilingsinthelifesciencessectorin2019over2018.SeeMICHELEJOHNSON,COLLEENSMITH&AMANDABETSCH,RISEINSECURITIES CLASS ACTION FILINGS IN LIFE SCIENCES SECTOR, IN VIVO 2 (2020), https://www.lw.com/thoughtLeadership/rise-securities-class-actions-life-sciences. 15 NickiLocker&LaurieB.Smilan,2019LifeSciencesSecuritiesLitigationRoundup,WILSON, SONSINI, GOODRICH, & ROSATI (Apr. 28, 2020), https://www.wsgr.com/en/in-sights/2019-life-sciences-securities-litigation-roundup.html.



Drug Administration (FDA)16 for approvals, life science companies—and their managers—are beholden to a strange array of deadlines,inspections, and notifications that ultimately makes or breaks thebusiness.17 Determiningwhenandhowtonotifyinvestorspresentsamyriadofethicaland,ultimately,legaldilemmas.18

The failure to disclose material changes to investors, eitherthrough misrepresentations or omissions, is a significant trigger forclassactionsuitsinthissector.UndertheSecuritiesandExchangeActof 1934 (SEA), companies have disclosure obligations designed toencouragetruthfuldisclosuresanddiscouragethemisrepresentationoromissionofmaterialfactstotheinvestingpublic.19Violationsofthekeystatute—SEA’sSection10(b)—are limitedbyamindset requirement:oftenthisrequiresthecourttolookatthefactsandthecircumstancessurrounding the disclosures managers and directors make to assesswhether they have the requisite scienter.20 The general internalcorporateprocesses that lead to runningafoulofSection10(b)—andthusraisingacognizableclaimofharmagainstmanagersanddirectorsonthepartof investors21—arestrangelysimilar inamyriadofcases.Whileitisoccasionallyamatterofwillfulfraudorinnocentconfusionasto the effect of an FDA notice, it is frequently a more complicated,convolutedwebofego,confusion, loyalty,andbravadothatplaysoutbetween a variety of key corporate players. Where, exactly, themanager—ormanagers—crossthelineintotherequisitescienterisnotalwaysclearbecausea slowshuffleacross the line isoftenharder tocatchinactionbutisstillanswerableinasuit.22

ThisCommentproposesthatasignificantpercentageofsecuritiesviolationsinthelifesciencesindustrymaybecausednotbywillfulfraud

16 TheFDAisaregulatoryagencythatregulatesundertheFederalFood,Drug,andCosmeticAct,21U.S.C.S.§§301–399. 17 SeeinfraSectionIII.A. 18 SeeLocker&Smilan,supranote15. 19 Itisunlawful“[t]ouseoremploy,inconnectionwiththepurchaseorsaleofanysecurityregisteredonanationalsecuritiesexchangeoranysecuritynotsoregistered,or any securities-based swap agreement[,] anymanipulative or deceptive device orcontrivance in contravention of such rules and regulations as the Commissionmayprescribe.”SeeSecuritiesandExchangeActof1934,15U.S.C.§78j(“Section10(b)”). 20 Seeinfranote41andaccompanyingtext. 21 InvestorsbringcivilclaimsunderSection10(b)oftheSEAagainstmanagersanddirectorswhocauseharmtoinvestorsthroughmisrepresentationsandomissions.See15U.S.C.§78j. 22 DonaldC.Langevoort,DisastersandDisclosures:SecuritiesFraudLiabilityintheShadowofaCorporateCatastrophe,107GEO.L.J.967,1004(2019)(statingthatmostcourtslookforaminimummensreaof“consciousdisregard”whenestablishingscienterunderaSection10(b)suit).


2021] COMMENT 611

or innocent confusion, as other scholars have theorized,23 but bycorporatecognitivedissonance.

Cognitivedissonanceexistswhenaperson intakes twomutuallyopposingfacts.24Anindividualis,bynature,uncomfortablemaintainingopposing facts, and, therefore, the brain seeks to eliminate thisdifferential.25Thediscomfortcreatedbydissonanceisadrivingforce,like hunger, that motivates an individual to seek resolution to thediscrepancy; that resolution is called consonance.26 Dissonance iseliminatedby (1) discarding old informationor (2) distinguishing orrejectingnewfacts.27Thisprocessoccursregularlyandisanessentialmental tool for organizing new information.28 Typically, the processresolvesby leavingthe individual in internalconsonanceandrelativeharmony with objective reality.29 But when an individual reachesconsonancefalselybymanufacturingnewfacts,disregardingthescopeofnew information,orwronglydistinguishingdissonant information,thatindividualhaslostthedrivingforcetoresolvetheissueandmay,inignorance,persistinbelievinghisorhernewlymanufacturedreality.30Themore complex the new informationmay be and the smaller theobjective difference between the dissonant facts, the easier it is todistinguish the new information from the old without curing thedisconnectwithreality.31Theindividualmaynotbeconsciousorawareofthisprocessandthatmayinhibithisorherabilitytocourse-correctandavoidpotential liability.32 CognitivedissonancemaymakemanyviolatorsofSection10(b)unawareoftheirownmisstepstothepointwherethelawloseseffectivenessasadeterrent.33

23 FraudorConfusion,infranote90,at1901. 24 FESTINGER,infranote127,at3. 25 Id. 26 Id. 27 Id.at5–6. 28 Id.at4–5. 29 Ifanindividualis“moreorless”inharmonywithobjectivereality,theindividualinquestiondoesnotbelieveanyinherentfalsehoodsorfundamentallymisunderstandmaterial facts about their environment, task, or conduct. For a discussion abouteliminatingdissonance,seeid.at5. 30 By eliminating dissonance, the individual has lost the “hunger” to resolve aproblemandwillnownotseekaresolution,astheindividualfeelsasthoughtheissueisresolved.SeeFESTINGER,infranote127,at3–5. 31 SeediscussioninfraSectionsV.A–D. 32 SeeWright,infranote119. 33 In addition, systematic deterrence reducers—such as indemnification andinsurance—looktolifttheweightfrommanagersanddirectorswhomaybeconcernedaboutpotentialmalfeasance.Theindemnificationandinsuranceprovidedtodirectorsandmanagersmayreducethefinancialthreatintendedtocreatedeterrence.DavidB.Shulz, Comment, Indemnification of Directors and Officers Against Liabilities Imposed



Acommonexampleofthiseffectmayoccurinavictimofongoingfraud—such as a victim of Bernie Madoff34—who believes that theperpetratorisafriend.Butthenthevictimdiscoversnewinformationindicatingthatthevictimhasbeenmisled.Thisinformationwouldbesufficienttocauseanobjectivepersongreatconcernandlikelymotivatethemtotakeaction.Butduetocognitivedissonance,ifthepriorbeliefoffriendshipisstrongenough,itcancausethenewinformationtobedisregardedordistinguishedinsuchawaythatitlosesalleffect.Thus,thevictimisbroughtbackintoconsonance.Theresultisthatthevictimbelievesthefriendshipstillexistsandthatthenewfactwassomehow(1)false,(2)misleading,or(3)misunderstood.Thevictimhasreducedhisdissonance—andthedrivingforcetotakeaction—butremainsoutofsyncwithobjectivefact.

Rather than looking at how cognitive dissonance can enableprolongedvictimization,byaffectingthevictim,thisCommentwillturntowards how cognitive dissonance can play a role in the wrongfulconduct itself. The purpose of this Comment is to develop anunderstandingof the interactionsbetweencognitivedissonance,FDAnotifications,andsecuritiesdisclosuresto(1)focusthelawintoabetterdeterrentand(2)serveasaguideforcounselrepresentingactorsinthisspace.

Public life sciences companies have a duty to make disclosuresunder the SEA, and that duty includes refraining from omittingnecessarymaterial facts.35 But determining the timing and scope ofdisclosuremaybedifficultdue to thecomplexmulti-stepprocess lifesciencecompaniescommonlyengageinwiththeFDA:informationmaybedisbursedinsmaller-stepchanges,anditsimpactmaybeopaque.36Subsequently,thisCommentwillfocusontheeffectofsecuritieslawsinthelifesciencessector:thecombinationofthetworegulatoryschemestendstoproduceaunique,partiallyrepeatablepatternofbehaviorthathas,statistically,ledtoahigherrateofsecuritiesviolations.

OneofthekeypurposesofRule10b-5istodeterfraudulentactors,asviolationsnegatively impact investor confidence, fluidityof capital

UnderFederalSecuritiesLaws,78MARQ.L.REV.1043,1065(1995).Also,thestakesaretoohigh:over-disclosingtoinvestorscouldcutmanagersofffromtheadditionalcapitalthey require to complete the task, risking the business; the indemnification-stifledpotentialcost—andaseeminglyremotechanceofenforcement—maynotbeenoughtooffertruedeterrence.S.P.Kothari,SusanShu&PeterD.Wysocki,DoManagersWithholdBadNews?,47J.ACCT.RSCH.241,242(2009). 34 A victim who has used an investor for a long period may form a trustingrelationship.SeeMadoff,supranote2. 35 Seesupranotes19–21andaccompanyingtext. 36 Seeinfranotes61–89andaccompanyingtext.


2021] COMMENT 613

raises,andoveralleconomicgrowth.37Practitionersshouldbeawareofthe hurdles cognitive dissonance places in front of relevant clients.Changes toboth securities lawsandFDA regulations should take thepotential for cognitive dissonance into account to maximize theeffectivenessofsecurities lawasadeterrent. Thecombinationoftheengrained high-stakes of corporate management and cognitivedissonanceleadstoahighlyincentivizedactorwhoisabletorationalizeeach micro-step by employing mental tools to nullify cognitivedissonance—and thus prospectively underestimate her ownmalfeasance. This grave underestimation transforms high-stakes tohigh-risk: one now has an actor who is despondent to deterrencebecause she is unaware she is violating the law. Therefore, thisCommentproposeskeymodifications to theFDA,SEC,andcorporatechartersthatwillencourageengagementthroughouttheslow-burnofthe FDA approval process in a manner that increases beneficialdisclosuresand,bydoingso,decreaseslawsuits.

Part II of this Comment will provide background on the lawsurrounding SEC disclosures and the impact of the FDA approvalprocess on public life sciences companies. Part III will discuss thepitfalls thatpublic life science companies face indetermininghow tomake proper SEC disclosures and how to keep the investing publicapprisedof theirstatusgivenanyFDAnotifications theymayreceivewhilestilldrivinginvestmentinthecompany.PartIVwilldiscussthecommonly considered mindsets that contribute to Section 10(b)liability, such as fraud or mistake. Part V will develop a thirdpossibility—cognitive dissonance—as a mildly opaque but frequentpsychological process that may account for a thus-far unrecognizedcategoryofSection10(b)violations. PartVIwillexploreavarietyofpathsforward, includinghowthemarketandcourtscurrentlyhandlethis issue, aswell as someadditional considerations that coulddeteradditional violations. Part VII will conclude the Comment byrecommendingamixedapproachtomaximizingdeterrence.

II.BACKGROUNDForpubliccompaniesinthelifesciencesthatdependprimarilyon

approvals from the FDA to generate revenue, the intersection ofsecurities disclosure requirements and FDA notifications creates achallengingroadforcorporatemanagerstonavigate—aroadthat,with 37 See5BDISCLOSURE&REMEDIESUNDERTHESECURITIESLAWS§6:4(2011)(statingthatthepurposesofRule10b-5include“deterringviolationswhilecompensatingvictims”and“buildinginvestorconfidence”while“assuringfairness”). See infranote39foradescriptionofRule10b-5,derivedfromSection10(b).



some frequency, ends in securities litigation under the SEA’s Section10(b).38TheSEAalsocreatedtheSecuritiesandExchangeCommission(SEC), which administers and promulgates regulations, such as Rule10b-5,whichprovides additional contours to Section10(b).39 Publiccorporatedirectors andmanagers, under the SEC regulations, have aduty to disclose to the investing public “material events anduncertainties known tomanagement” thatmight reveal that publiclyreported financial information is not truly indicative of thecorporation’s condition within quarterly 10-Q and annual 10-Ksubmissions.40 Company managers are often faced with productimperfections—and subsequent related communications from theFDA—that require additional resources to overcome. Managersmayoften need to respond to these “speed bumps” by raising additionalcapital. Butsomeoftheproductimperfectionsmayeventuallyrisetomaterialissuesthat,shouldtheynotbedisclosed,exposethecompanytoliability.Thispresentsaconundrumtooperatorswhocannotfixtheproblemwithout capital but cannot raise capital if they disclose theproblem—and, frequently,when operators fail to thread this needle,classactionsecuritieslitigationoccurs.

Foracomplainttosurviveamotiontodismiss,sixfactorsmustbeproperly pleaded tomake a prima facie case—but only two of thosefactors are fertile grounds for conflict. Theplaintiffmust allege thateachdefendanthadtherequiredscienterandthatthefactsthatwereomitted ormisrepresentedwerematerial. In order for a plaintiff tosuccessfullyallegeviolationsunderSection10(b)andRule10b-5,theplaintiff must allege—particular to each defendant—that (1) thedefendant made a material misrepresentation or omission; (2) hadscienter in doing so; (3) the misrepresentation or omission had aconnectiontothepurchaseorsaleofasecuritybytheplaintiff;(4)theplaintiffreliedonsaidmisrepresentationoromission;(5)theplaintiffsuffered economic loss; and (6) therewas a causal link between themisrepresentationoromissionandtheplaintiff’seconomicloss.41The 38 15U.S.C.§78j. 39 15U.S.C.§78d(creatingtheSecuritiesandExchangeCommission). AdditionalregulationspromulgatedbytheSECunder17C.F.R.§240.10b-5(“Rule10b-5”)makeitunlawfulforcompaniestomakean“untruestatementofamaterialfactortoomittostateamaterialfactnecessaryinordertomakethestatementsmade,inthelightofthecircumstances...notmisleading.”17C.F.R.§240.10b-5(2021). 40 KatherineCohen,JosephW.Cormier&MahnuV.Davar,PredictableMateriality:Need for Common Criteria Governing Disclosure of Clinical Trial Results by Publicly-Traded Pharmaceutical Companies, 29 J.CONTEMP.HEALTHL.&POL’Y201,215 (2013)(citing17C.F.R.§229.303)[hereinafterPredictableMateriality]. 41 MatrixxInitiatives, Inc.v.Siracusano,563U.S.27,38(2011)(citingStoneridgeInv.Partners,LLCv.Scientific-Atlanta,Inc.,552U.S.148,157(2008));seealso15U.S.C.


2021] COMMENT 615

plaintiff, however, is relieved from pleading with any great detailwhetherorhowthemisrepresentationoromissionhadaconnectiontothe sale, or if the plaintiff justifiably relied on the misstatement oromission,bythe“fraudonthemarket”theory:itisenoughtosaythatthemisstatementoccurred,andtheplaintiff,subsequently,madeastocktransaction, and that therewas causation that triggeredaneconomicloss.42 Thisleaves,astheprimarychallengeforplaintiffstosurviveamotion to dismiss, alleging that the facts omitted ormisstatedwerematerial and that thedefendantshad the required scienterwhen theomissionsormisstatementsweremade.

Thereisacomplexinterplaybetweenmaterialityoffactsandthecorporatemanagers’scienter.43 Scienterrequiresthatthedefendantshave a mindset of knowledge or recklessness—this is frequentlyinterpreted by courts as a “conscious disregard” standard: thedefendant had some awareness that the behaviorwas improper, butdecided to disregard the information andmove forward despite it.44Scienterhasbeenadequatelyallegedinacomplaint“onlyifareasonableperson would deem the inference of scienter cogent and at least ascompelling as any opposing inference one could draw from the factsalleged.”45Thematerialityoffactscancircumstantiallyinformthelevelofscienterthedefendantsareaccusedofhavingactedwith.46Therefore,the determination of the materiality of facts, and any circumstantialevidence as to the knowledge or awareness of the defendants of thematerialityofthosefacts,willbehighlyprobativeastothedefendant’sscienter.

§ 78u-4. Given the relatively low bar for surviving a F.R.C.P. 12(b)(6) motion todismiss—which is theprimaryway tokeep litigationcosts low fordefendants—it isvitallyimportanttobeawareofthelinecreatedbytheCourt’sinterpretationofRule10b-5.SeeMatrixx,563U.S.at45n.12.Additionally,itmustbenotedthattheSupremeCourthasallowedthestandardofrecklessnesstobeassumedwithoutbeing“decided.”Id.at48. 42 Basicaffirmedthe“fraudonthemarket”theory,whichrelievesplaintiffsoftheburden of proving that they specifically relied upon the material omission ormisstatement in their purchase; it only requires that themisleading statement wasmadeandthatthestockpurchaseoccurred.BasicInc.v.Levinson,485U.S.224,242,247(1988). 43 ThomasM.Madden,SignificanceandtheMaterialityTautology,10J.BUS.&TECH.L.217, 225 (looking at the “close relationship” between materiality and scienter, asexploredbytheFirstCircuit). 44 Langevoort,supranote22at1004(statingthatmostcourtslookforaminimummensreaof“consciousdisregard”whenestablishingscienterundera§10(b)suit). 45 Matrixx,563U.S.at48(internalquotationsomitted). 46 Madden,supranote43(quotingMiss.Pub.Emp.’sRet.Sys.v.Bos.Sci.Corp.,549F.3d 5, 20 (1st Cir. 2011)) (“Knowingly omitting material informative is probative,althoughnotdeterminative,ofmateriality.”).



Forexample, inMatrixxv.Siracusano, theCourtdecided itwasa“cogent and compelling” inference that there was scienter when thecompanychosenottodisclosereports;itwasnotbecausetheythoughttheywereimmaterial,butratherbecausethey“understoodtheirlikelyeffect on the market.”47 Additionally, the Court, inMatrixx, made anexpress point of noting, “[m]ost significantly,” that Matrixx issued apress release referring to non-existent studies that proved itsmedication,Zicam,didnotcausetheadverseeffectsitwasaccusedofcausing.48TheindicationhereisthatthelevelofmaterialityoftheissuewillinformtheCourt’sinterpretationofthedefendant’sscienter—themoreimportantthematteristotheoperationsofthebusiness,themorelikely a manager or director is aware of the “likely effect” on themarket.49

Thispromptsamuchneededlookintomateriality:ahelpfulfirststep indeterminingmateriality for SECdisclosures is to examine theSupreme Court’s opinion in Basic v. Levinson.50 In Basic, the Courtestablished a standard that eliminated “certain information ... of‘dubioussignificance’”thatwouldriskoverwhelminginvestorswith“anavalanche of trivial information.”51 The Court tightened-up thematerialitystandardsothat,while it isstillwhat ismaterial fromtheviewpointofa“reasonableinvestor,”itrequirestheinformationtohavea“substantiallikelihood”thatitwillhave“significantlyalteredthe‘totalmix’ofinformationavailable.”52Thisatleastworkstoaccountforthefact thatany reasonable investorwould likelywant to claim thatanydetrimentalfactnotdisclosedismaterial.Butthis“totalmix”standardonly goes so far as a protection for most companies, and forpharmaceuticalswhereasingleFDAapprovalwillgravely impact thebottom line, thisdoesnotprovidea lotof leeway. The “totalmix”ofinformation for a public, small-cap pharmaceutical is informationorganized around a product line of one, two, or three products; anymeaningfulFDAfeedbackcouldjeopardizetheveryexistenceofoneofthose products—or require a significant recapitalization in order to

47 Matrixx,563U.S.at49(citingTellabs,Inc.v.MakorIssues&Rts.,Ltd.,551U.S.308,323–24(2007)). 48 Id. 49 Id. 50 SeeBasic Inc. v. Levinson,485U.S.224,231–32 (1988) (quotingTSC Indus. v.Northway,426U.S.438(1976))(holdingthatthere“mustbeasubstantial likelihoodthat the disclosure of the omitted fact would have been viewed by the reasonableinvestorashavingsignificantlyalteredthe‘totalmix’ofinformationmadeavailable”). 51 Id.at231(quotingTSCIndus.v.Northway,426U.S.438(1976)). 52 Id.at231–32(quotingTSCIndus.v.Northway,426U.S.438(1976))(emphasisadded).


2021] COMMENT 617

redeveloptheproduct.53Duetothegraveimpactofthatinformation,ittends to take on a high level of importance in the overall scheme ofinformation available on the company, and it is, therefore, likely toexceedthe“totalmix”standard.54TheCourt,inMatrixx,uphelditsfact-intensiveanalysisofmaterialityinthecontextofpharmaceuticals.55

Over the last several decades, both Congress and the judicialbranchhavesoughttorefinethecontoursoftheburdensplacedonbothplaintiffs and defendants in the initial phases of Section 10(b) cases.CongressenactedthePrivateSecuritiesLitigationReformAct(“PLSRA”)in1995toreducemeritlessclassactionsecuritiesactionsbyincreasingthepleadingstandard.56Butthesesuitshavecontinued.57TheUnitedStatesSupremeCourthas,throughBasicandMatrixx,madeiteasierforplaintiffs to file these suits.58 WhileHalliburton v. EricaP. JohnFundprovideddefendantswiththeabilitytorebuttheplaintiff’spresumptionof reliance,59 other cases, likeArkansas Teacher Retirement System v.Goldman Sachs, have expanded potential liability for defendants: theSecondCircuit,inGoldmanSachs,loweredthebarnecessarytoestablishharm through an “Inflation Maintenance Theory” that allows forplaintiffstoestablishharmwithoutshowingachangeinthemarket.60

III.PITFALLSLIFESCIENCECOMPANIESFACESURROUNDINGSECDISCLOSURESWhile Section 10(b) presents challenges to various industries,

there are unique challenges to public life science companies,particularlycompaniesonthesmallercapitalizedsidethatrelyononeortwoproducts—andtheFDAtoapprovethoseproducts—toprovide

53 SeediscussioninfraSectionIII.A(discussingtheimpactofaCLR). 54 See infra note 74 for an example of FDA notifications triggering high-mediacoverageinsmall-cappharmaceuticals. 55 SeeMatrixxInitiatives,Inc.v.Siracusano,563U.S.27,39(2011). 56 Consequences,supranote10,at5. 57 Id.at7. 58 By instituting a “totalmix” approach inBasic, and then supporting that sameapproach in thecontextof lifesciencecompanies inMatrixx, theCourt increasedthelikelihoodofsmall-capitalizedpubliclifesciencecompanieshavinganychangeinoneproductbematerial.Seesupranotes42–55andaccompanyingtext.Basicalsoaffirmedthe“fraudonthemarket”theory,whicheliminatestheneedfortheplaintifftoproverelianceonthedisclosureoromission. BasicInc.v.Levinson,485U.S.224,242,247(1988). 59 HalliburtonCo.v.EricaP.JohnFund,Inc.,573U.S.258,279(2014)(holdingthatadefendantmayrebutthepresumptionofpriceimpactattheclasscertificationstage). 60 The “Inflation Maintenance Theory” operates on the assumption that, if thecompanyhadnotmade themateriallymisleadingdisclosure(oromission), thepricewouldhavedroppedearlier,andthusthepurchaserofthatstockhasoverpaid,andthatistheharm.SeeArk.TeacherRet.Sys.v.GoldmanSachsGrp.,Inc.,955F.3d254,265–66(2dCir.2020).



profitstotheirshareholders.Itisimportanttolookattwokeyelements:first, the requirements to gain—and retain—FDA approval for lifesciences products; and second, how the SECdisclosure requirementsinteractwithFDAnotifications.

A.TheFDAApprovalProcess:ATaleofInspectionsandNotificationsTheFDAapprovalprocess canvarydependingon theparticular

piece of biotechnology, traditional drug, or biologic a company isattemptingtobringtomarket.61Asanexample,thisCommentwillfocuson the application process for biologics: these are large molecule,complicatedmedicinescreatedthroughabiologicalprocess;thismeansthat thecompanycreatingthemoleculeandthesubsequentapprovalprocess is firmly tied to the manufacturing facility in which it iscreated.62WhilethisCommentwillfocusonissuesthatoccurduringtheapprovalprocessofnewbiologics,thereareotherareas,includingpost-approval actions,where similar issuesmayarisebetween companiesandtheFDArelevanttothisdiscussion.

Pharmaceutical research and development is a costly endeavor.Themeancosttobringasingledrugtomarketbetween2009and2018was$1.33billion.63 Andwhenoneaddstheadditionalmanufacturingspecifications,approvals,andlocation-commitments,biologicsarehighcostwithlowmobility,asacompany’sapprovalprocessisanchoredtothemanufacturingfacilityinwhichitchoosestorootitsbusiness.64Ifproblemspresentthemselvesdowntheroad—afteracompanyistiedto a particular facility—the sunk costs can present a major mentalobstacletoforsake.

61 Industry Frequently Asked Questions, FOOD & DRUG ADMIN. (June 26, 2018),https://www.fda.gov/industry/fda-basics-industry/industry-frequently-asked-ques-tions(offeringapprovalpathsforAnimal&VeterinaryDrugs,MedicalDevices,Radia-tion-EmittingProducts,andDrugs). 62 WhatAre“Biologics”QuestionsandAnswers,FOOD&DRUGADMIN.(Feb.6,2018),https://www.fda.gov/about-fda/center-biologics-evaluation-and-research-cber/what-are-biologics-questions-and-answers;EmilySinger,WhyisBiomanufacturingSoHard?,MIT TECH. REV. (July 15, 2011), https://www.technologyreview.com/2011/07/15/192981/why-is-biomanufacturing-so-hard/(statingthatnotonlymustthedrugitselfbeapproved,but“themanufacturingproceduremustbeapprovedaswell”). 63 Millions,infranote64. 64 Mark Terry, The Median Cost of Bringing a Drug to Market is $985 Million,According to New Study, BIOSPACE (Mar. 4, 2020) [hereinafter Millions],https://www.biospace.com/article/median-cost-of-bringing-a-new-drug-to-market-985-million/; Singer, supra note 62 (stating that not only must the drug itself beapproved,but“themanufacturingproceduremustbeapprovedaswell”).


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Companies must begin by conducting their own testing anddevelopment phase—taking an average of over eight years—rangingfrom computer modeling to microorganism and animal testing.65 Acompany must then go through the Investigational New Drug (IND)processinordertoconducthumantestingtodetermineifitsproductissafe.66 Once early human trials are complete, the company files aBiologicsLicenseApplication(BLA)withtheFDAtoindicatethattheyarereadytobringthedrugintointerstatecommerce.67TheFDAthenconducts inspections on the manufacturing facility.68 If the FDAdetermines there may be a violation of applicable law—throughinspectionofthefacility,reports,labresults,orotherfindings—theFDAwill issueaForm483 tomanagement.69 TheForm483 is “discussedwith[the]company’smanagementattheconclusionoftheinspection...[and]eachobservationisreadanddiscussedsothatthereisafullunderstandingofwhattheobservationsareandwhattheymean.”70TheFDA follows the Form 483 by sending an Establishment InspectionReport (EIR) that details the precise issues uncovered in theinspection.71ThecompanycanthensubmitaresponsetotheFDA,and

65 The Beginnings: Laboratory and Animal Studies, FOOD&DRUGADMIN. (Apr. 27,2015), https://www.fda.gov/drugs/drug-information-consumers/beginnings-labora-tory-and-animal-studies;HowDo I Go About Getting a Drug Approved?, FOOD&DRUGADMIN. (Feb. 1, 2016), https://www.fda.gov/industry/fda-basics-industry/how-do-i-go-about-getting-drug-approved. 66 Development & Approval Process (CBER), FOOD&DRUGADMIN. (June 25, 2020),https://www.fda.gov/vaccines-blood-biologics/development-approval-process-cber(stating that an “Investigational New Drug Application (IND) is a request forauthorizationfromthe[FDA]toadministeraninvestigationaldrugorbiologicalproducttohumans”);seealsoU.S.DEP’TOFHEALTH&HUM.SERVS.,FOOD&DRUGADMIN.,CTR.FORDRUGEVALUATION & RSCH. (CDER), GUIDANCE FOR INDUSTRY AND REVIEWERS: EXPLORATORY INDSTUDIES 3–4 (2006), https://www.fda.gov/media/72325/download (explaining thepurposeandscopeofanIND). 67 Development&ApprovalProcess,supranote66(citing21C.F.R.§601.2);seealsoBiologics License Applications (BLA) Process (CBER), FOOD & DRUG ADMIN.,https://www.fda.gov/vaccines-blood-biologics/development-approval-process-cber/biologics-license-applications-bla-process-cber(lastvisitedOct.24,2021). 68 See,e.g.,Mulliganv.ImpaxLab’ys,Inc.,36F.Supp.3d942,948(N.D.Cal.Apr.18,2014). Additionally,onceabiologic iscertifiedby theFDA,biennial inspectionswillcommence; therefore, a Form 483, and the subsequent string of FDA actions, cancommencelater inaproduct’s lifecycle,shouldthemanufacturingconditionschange.FOOD & DRUG ADMIN., BIOLOGIC COMPLIANCE PROGRAM 5 (2010), https://www.fda.gov/media/73834/download(lastvisitedOct.24,2021). 69 Form 483 Frequently Asked Questions, FOOD & DRUG ADMIN. (Jan. 9, 2020)[hereinafter FDA FAQ], https://www.fda.gov/inspections-compliance-enforcement-and-criminal-investigations/inspection-references/fda-form-483-frequently-asked-questions. 70 Id. 71 Id.



if the FDA finds that response lacking in regard to a violation ofregulatorysignificance, itwill issuea “WarningLetter.”72 Finally, thecompanyeitherreceivesanapprovalletter,orthecompanyreceivesaCompleteResponseLetter(CRL)—whicheffectivelydenies thedrug’sapproval.73

Therecanbeamonth-longoramanymonth-longgapbetweenthereceiptofaForm483andaCRL.74Whenacompanyiscaughtinsuchawindow, thecompany facessomedegreeofknowledgeregarding thechallengeitfacestorighttheshipaswellastheneedtofundsolutions.The FDA has a process, after a Form 483 is submitted, to allow acompany to make corrections.75 This process is essential—but alsodangerous—because, as discussed below, it is fertile earth for theinductionofcognitivedissonance76duetotheopaqueness,malleability,and, often, the small-step changes required to mend a perceivedproblem. The process, thus, creates opportunities for managers tosubconsciously self-manipulate their own understandings of theviabilityoftheproduct.

B.HowSEADisclosuresInteractwithTheFDAApprovalProcessAgainst the backdrop of securities law, when FDA-related

interactions—clinical results, positive or negative, or FDA notices—occur,howdomanagersofsmallerpubliccorporationsdeterminetheirmateriality?Negativeclinicalresultscanleadtoquestionsofmaterialityifareasonableinvestorwouldbeimpactedbyknowledgeofthatresult,ifthatresultwouldhaveagraveeffectonthe“totalmix”ofinformation

72 Mulligan, 36 F. Supp. 3d at 947–48 (quoting FOOD&DRUGADMIN., REGULATORYPROCEDURESMANUAL4.1(2012))(“TheFDA’spolicystatesthataWarningLetter‘shouldnotbeissuediftheagencyconcludesthatafirm’scorrectiveactionsareadequateandtheviolationsthatwouldhavesupportedtheletterhavebeencorrected.’”). 73 What is an FDA Complete Response Letter?, MOTLEY FOOL (Feb. 16, 2017),https://www.fool.com/knowledge-center/what-is-a-fda-complete-response-let-ter.aspx. 74 Immunomedicsisanexampleofasmall-cappublicpharmaceuticalthatendureda progression of Form 483 difficulties over many months, making multiple publicdisclosures while managing the evolving FDA notifications. See, e.g., Eric Palmer,Troubled Immunomedics NowHit with CRL for Breast Cancer Drug Candidate, FIERCEPHARMA (Jan. 18, 2019), https://www.fiercepharma.com/manufacturing/troubled-immunomedics-now-hit-crl-for-breast-cancer-mab; Odeh v. Immunomedics, Inc., No.18-17645,2020U.S.Dist.LEXIS135917,at*10–11(D.N.J.July31,2020)(receivingForm483inAugust2018andaCRLinJanuary2019). 75 WhatShouldIExpectDuringanInspection?,FOOD&DRUGADMIN.(Apr.26,2016),https://www.fda.gov/industry/fda-basics-industry/what-should-i-expect-during-in-spection. 76 SeediscussioninfraSectionV.E.


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about the business.77 But evenpositive clinical results can present aliability to the company if that result is given outsized weight incommunications and is eventually not dispositive of the product’sviability.78 Yet, the real landmine is the Form 48379—and thesubsequentthreatofaCRL80—becauseaForm483cansignifyarangeof problems (scaling from solvable to unsolvable). And, since thenumber of opportunities the FDAwill provide to correct the error isunknowable,thevalueoftheForm483canbeanunknownvariable.81A Form 483 presents a tangible problem—but a problem that canpossiblybesolved,perFDAprotocol.82Bypresentingacrypticpathwayto success—difficult to understand in scope, course, number ofpermissibleattempts,andtimetoact—aForm483noticecanopenthedoortoaslipperyslopethatcouldendinaCRL.And,notably,theroadfromtheformertothelatterhasplentyofopportunitiestorunafoulofthematerialdisclosurerequirementsalongtheway.

Likeallpubliccompanies,public,small-capitalizedpharmaceuticalcompanieshaveadutytodisclose83intheirquarterlyForm10-Qandannual Form 10-K submissions “material events and uncertaintiesknowntomanagementthatwouldcausereportedfinancialinformation

77 PredictableMateriality, supra note84, at222–27 (discussing thematerialityofnegativeclinicaltrialresults). 78 Whenamanageroveremphasizespositiveclinicalresults,thismayhappenwhileexcludingother,lessfavorabledata—andshouldtheproduct,intheend,fail,investorsmay perceive the positive clinical results as a biased way of manipulating investorresponse. PredictableMateriality, supra note 84, at220–22 (discussing the effect ofoverstatingpositiveclinicalresults). 79 AnoticeprovidedbytheFDAthatfindsfaultsinthedrugapprovalprocessthatmustberectified.Seesupranotes67–69andaccompanyingtext. 80 A CompleteResponse Letter (CRL) is a final notice by the FDA that a drug orbiologicapplicationisdenied.SeeMOTLEYFOOL,supranote73andaccompanyingtext. 81 Seesupranotes61–64andaccompanyingtext. 82 MisleadingmandatorydisclosuresthatfollowfromaForm483are,ontheirown,insufficient to find a mandatory Form 10-K disclosure misleading. See Schaeffer v.NabrivaTherapeuticsPLC,No.19-4183,2020U.S.Dist.LEXIS78035,at*31–32(S.D.N.Y.Apr.28,2020)(citingInreDiscoveryLab’ysSec.Litig.,No.06-1820,2007U.S.Dist.LEXIS18163(E.D.Pa.Mar.15,2007)).ButaForm483“representsariskthattheFDAmaytakecorrectiveaction,...andthusacompanyisobligatedtoassesstheseriousnessoftheriskanddisclosesuchinformationtopotentialinvestorsifitalsorepresentsitisincompliancewiththeFDAregulations....”Pub.PensionFundGrp.v.KVPharm.Co.,679F.3d972,982(8thCir.2012).IfaForm483isnotlikelyto,onitsown,createliability,itcanfrequentlybeakeypieceinthebeginningofmisleadingmaterialdisclosures.See,e.g., Odeh v. Immunomedics, Inc.,No. 18-17645, 2020U.S.Dist. LEXIS135917, at *6(D.N.J.July31,2020);Mulliganv.ImpaxLab’ys,Inc.,36F.Supp.3d942,947–48(N.D.Cal.Apr.18,2014). 83 SeegenerallyStuartR.Cohn&ErinM.Swick,SittingDucksofSecuritiesClassActionLitigation:Bio-PharmasandtheNeedforImprovedEvaluationofScientificData,35DEL.J.CORP.L.911,912(2010).



nottobenecessarilyindicativeoffutureoperatingresultsoroffuturefinancial condition.”84 Additionally, should circumstances change bywayofa“reportableevent,”companiesarerequiredtodisclosematerialchangesinaForm8-K.85Finally,asynchronous“voluntarydisclosures”thatmanymanagersmake—whetheronaninvestors’call,tothemedia,or at an event—still carry the burden of not being materiallymisleading.86ItisessentialtonotethatthetimingoftheForm10-QandForm 10-K reports have no bearing whatsoever on potentialnotificationsfromtheFDA:FDAnotificationsarecorrelatedtotheBLAapplicationprocessandinspectiontiming,andtheSECnotificationsarescheduledagainstthecompany’sfiscalyear.87Thismeans,onreceiptofan FDA notification, management may already be in progress ofreleasingascheduledForm10-QorForm10-K,oravoluntaryForm8-K.Therefore,receiptofanyForm483s,EIRs,orCRLswilloftenleadtoatwo-prongdecision:(1)whatactionisrequiredtocorrectthebusinessor scientific problem? And (2) is this a material change to thebusiness—alsoknownas:MustIdisclosethis?Themoresubstantialthelevelofdifficultyrenderedbythe formerseemsto implicateahigherlikelihood of the latter; however, it is not clear when disclosure isrequired.Therefore,themanagermightlobbyfortimetoneutralizetheproblembeforemakingadisclosurethatwouldriskupsettingtheapplecart—andsubsequently losingshareholdervalueand thepotential toraiseadditionalcapital.Afterall,ifthisispartofthenatural—perhapseventypical—progressionoftheFDAapprovalprocess,isitessentialorwisetodisclose immediately? Additionally, ifdisclosuresarealreadypending,thetimingofthisnoticecanmakeitdifficulttowithdraworeditacurrentlyoutbounddisclosure.

Andarecentdisclosurethat isnowrendered incorrectcreatesasecond problem. Even providing that it may be permissible not todisclose specific information on the prior date of disclosure, thecompanymaymoveontomakeother,unrelateddisclosures.But,notonly must those disclosures not contain materially misleadinginformation,buttheycannot“omit...amaterialfactnecessaryinordertomake the statementsmade, in [ ] lightof the circumstancesunder

84 PredictableMateriality,supranote40,at215. 85 Id.at216. 86 Langevoort,supranote22,at979(statingthatmanydisclosureissuesarisefromvoluntarydisclosures). 87 SeePredictableMateriality, supra note 40, at 224–225 (discussing the duty todisclose under SEC regulations); seealso supra notes 65–75 and accompanying text(discussingtheunscheduledandunpredictableFDAprocess,inordertoinferthatthereisnocorrelationbetweenthesetwoprocesses).


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which they were made, not misleading.”88 Therefore, should thecompanymakeadisclosure,ignoringtheissueathand,itispossiblethatmakinganotherwiseneutralstatementaboutthecompanymayimplythat the “problem”—which the company is now aware of—does notexist,andtherefore,hasbeenomittedinviolationofRule10b-5.89

IV.TRADITIONALFRAMEWORKOFCORPORATEMINDSETSTHATLEADTOSECTION10(B)VIOLATIONS

Giventhedifficultiesexpressedinthesectionsabove,itcanbeeasyto see how the traditional perspectives on corporate mindsets havedwelt on two extreme ends of the spectrum:managers acting eitherfraudulentlyor innocently,duetoconfusion. ThissectionwillbrieflylookatEricSchmid’sFraudorConfusion,whichlookstobifurcatethepossiblemanagerialmindsets into two distinct categories: fraud andconfusion.90 The Note sophisticatedly proposes these two oppositepolls and then suggests a variety of solutions for each cause.91 Thissection will briefly touch on a willfully fraudulent mindset and aconfusion-driveninnocentmindset.

A.TheFrequencyofWillfulFraudWillful fraud—a term that exceeds any statutory mens rea

requirementconcerningSection10(b)—maywellexistonthemarket,butit isa“moreradicalconclusion.”92 Wecanlookatahostofcasesthroughtheages—ZZZZBest,93Enron,94HealthSouth95—anddeterminethatwillfulfraudexists.Theenormityofthescale,bothinimpactand

88 17C.F.R.§240.10b-5(2021). 89 SeeLeviev.SearsRoebuck&Co.,No.04-7643,2006U.S.Dist.LEXIS12725,at*15–16(N.D.Ill.Mar.22,2006)(statingthatomittingthefactthatmergernegotiationsweretakingplacefromanannouncementaboutastorepurchasecouldrisetoamaterialfactomissionunderRule10b-5andwasenoughtodenyamotiontodismiss). 90 EricSchmid,FraudorConfusion:APillforChronicSecuritiesLitigationinTheLifeSciencesSector,61B.C.L.REV.1899,1928(2020)[hereinafterFraudorConfusion]. 91 Id.at1901. 92 Id.at1927–28. 93 SeeInreZZZZBestSec.Litig.,864F.Supp.960,964(C.D.Cal.1994)(plaintiffsallege “[ZZZZ] Best’s glamorous aura was a sham, and that a massive fraud wasperpetratedinconnectionwiththepublictradingof[thecompany]”). 94 InreEnronCorp.Sec.,235F.Supp.2d549,637(S.D.Tex.2002)(statingthatthematerially “False andmisleading Statements” were a “deliberate failure” on Enron’spart)(emphasisadded). 95 InreHealthsouthCorp.Ins.Litig.,308F.Supp.2d1253,1259(N.D.Ala.Mar.16,2004)(“[G]uiltypleasenteredbyformerHealthSouthofficersandemployeesindicatethat much ofHealthSouth’s unprecedented growth may have been the result ofunprecedentedfraud.”).



in the array of complicit actors,96makes Enron (and frauds like it) achallengingstoryforthepublictounderstandforamultitudeofreasons,includingthatitconflictswiththerationalactortheory.97

Willfulfraudcasescommonlyappeartohaveacentralbadactororsmall group of bad actors operating knowingly. Conflicts of interestoftenmirecasesofwillfulfraud.98Forexample,inWorldCom,BernardJ. Ebbers, the CEO of WorldCom, became overleveraged when, afterengaging inmargincallswithhisWorldComstock, thepricedroppedduetoamergerdenialbytheDepartmentofJustice(DOJ).99Thefacts,asallegedbytheplaintiffs,statethatanagreementbetweenseniorstaffat the company started in 2000 when they were directed to “dowhateverwasnecessary togetWorldCom’s ‘marginsback in line.’”100WorldCommanipulateditsbookstoinflateitsearnings.101 Thisfraudpersisteduntilitunraveledin2002.102Ebberswasconflictedbetweenhisobligationstohiscompanyandsavinghimselffrompotentiallegalaction; on theotherhand,Ebber’s employees andBoardofDirectorswere conflicted between their obligations to the company and theirloyaltytoEbbers.103

While Enron’s key actors may have been actively aware of thefraudulent accounting practices they were engaging in, ProfessorRobertPrenticesuggestedthattheirdirectreportsmaynothavecomeforward to expose the fraud due to cognitive dissonance.104 Heproposedthatcognitivedissonanceallowedmanyoftheemployeeswhowerenotactingwillfullyfraudulentlytocontinuetoactinthebusinessdespite conflicting facts.105 This Comment will explore, below, howcognitivedissonancecanbeafactorintheprimaryactor’sconduct.

96 See History: Famous Cases & Criminals: Enron, FED. BUREAU OF INVESTIGATIONS,https://www.fbi.gov/history/famous-cases/enron(lastvisitedOct.24,2021). 97 RobertPrentice,Enron:ABriefBehavioralAutopsy,40AM.BUS.L.J.417,427–28(2003). 98 Crucible,infranote122,at4. 99 TroySegal,5MostPublicizedEthicsViolationsbyCEOs,INVESTOPEDIA(May9,2020),https://www.investopedia.com/financial-edge/0113/5-most-publicized-ethics-viola-tions-by-ceos.aspx. 100 InreWorldCom,Inc.Sec.Litig.,294F.Supp.2d392,402(S.D.N.Y.2003). 101 Id.at400. 102 Segal,supranote99. 103 Id. 104 Prentice,supranote97,at431. 105 Id.


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B.ConfusionAboutFDAPolicyasaDefenseLookingattheotherendofthespectrum,thereexiststhenotion

thatmanagersaremerelyconfusedbythespecificsoftheFDAapprovalprocess,andsuchconfusionleadstoincidentalfraudonthemarket.InFraud or Confusion, Schmid suggests that FDA notifications areinherently confusing, and that makes it impossible for managers, insomeinstances,tobeawareofpotentialdisclosureerrors.106

FraudorConfusionlookstoLeviv.AtossaGenetics,Inc.,107outoftheNinth Circuit, as a case involving FDA related confusion.108 In oneinstance, Atossa correctly described the FDA clearance of itsMASCTSysteminitsIPOdocuments,statingthatithadreceivedlimitedFDA-certificationforanexpresspurpose.109ButinaseparateinstanceintheIPO documents, the company described the MASCT System as fully“FDA-cleared.”110Thismadetheproductappearfurtheralongandmoreimminentlyprofitable—thecourtdescribed thisasAtossausing “lesspreciselanguage”(“IncidentTwo”).111Schmind,inFraudorConfusion,discussestheimplicationsofthisconfusionas“creat[ing]liabilit[ies]forlifesciencecompaniesthatunintentionallymisinterpretmaterialityinoneofthemostcomplex,highlyregulatedsectors.”112Schmindleavesuswitha rational concern that, scientifically, “reasonablemindsmaydiffer,” and such “disagreements could equate to misstatements ofmaterial fact under SEC regulations.”113 The issues raised inAtossa,however, were more extensive than a single misstatement. Andcuriously,allmisunderstandingsseemedtoerrinfavorofAtossa.ThisCommentwillreviewthiscase,withanewperspective,afterdiscussingcognitivedissonanceindepth.

V.CORPORATECOGNITIVEDISSONANCE:QUANTITATIVEEASINGFORMANAGERS’MINDSETS

ThisPart looksatthespectrumthatexistsbetweentheoppositepolesofconfusionandwillfulfraud.Thisgrayscalecanexistasastaticconstruct—theactorneverfullyinnocentnorwillfullyfraudulent—andit canexistasa courseofaction,over time,building toknowinglyor

106 SeeFraudorConfusion,supranote90,at1925–26. 107 Leviv.AtossaGenetics,Inc.,868F.3d784,789–90(9thCir.2017). 108 FraudorConfusion,supranote90,at1925–26. 109 Atossa,868F.3dat796. 110 Id. 111 Id. 112 FraudorConfusion,supranote90,at1926. 113 Id.



recklesslyfraudulentbehavior.C-Suite-widecognitivedissonance114isa product of groupthink115 and the individual manager or director’sdesire to eliminate conflicting inputs while maintaining forwardmomentum. The elimination of these dissonant elementsmay occurconsciouslyorunconsciously.Notably,thelessconsciousthebehavior,the more difficult the behavior is to deter. As securities laws aredesignedtodeterharmfulbehaviorsandtoremediatewhendeterrencehas failed,116 understanding how cognitive dissonance may impededeterrence is relevant to evaluating the effectiveness of existingsecuritieslaw.

Securities laws are designed to deter harmful behaviors and toremediate when deterrence has failed.117 Remediation functions bycompensatingvictimsandreaffirmingnotionsofjustice,which,inturn,boostsconfidenceinthemarketplace.118Deterrence,byitsverynature,requiresalevelofknowledgeaboutone’sownactionspriortoorinthecourseoftheconduct.119Traditionally,mensreacreatesademarcationpointforculpability:itcanbeseenas“just”topunishthebehaviorwhenthe actor had some level of awareness, and thus, an ability to haveavoidedtheconduct.120Thismakesmensreaafocalpointforbothjustexpostremediationandprospectivedeterrence.Lookingataseriesofeventsretrospectively,itmaybepossibletofindthenecessarymensreaat the point of action. But looking at that same series of eventsprospectively—fromthevantagepointoftheactorpriortotakingtheaction—cognitive dissonancemay make it nearly impossible for anactor to understand the conduct and its consequences prior to and

114 Merriam-Websterdefines“cognitivedissonance”as“psychologicalconflictresult-ingfromincongruousbeliefsandattitudesheldsimultaneously.”CognitiveDissonance,MERRIAM-WEBSTER, https://www.merriam-webster.com/dictionary/cognitive%20dis-sonance(lastvisitedOct.24,2021). 115 Seeinfranote164andaccompanyingtext. 116 5BDISCLOSURE&REMEDIESUNDERTHESECURITIESLAWS§6:4(2011)(statingthatthepurposesofRule10b-5include“deterringviolationswhilecompensatingvictims”and“buildinginvestorconfidence”while“assuringfairness”). 117 Id. 118 Id. 119 Whenpeople lack awareness that their behavior is criminal, there is likelynodeterrent effect. See VALERIEWRIGHT, SENT’G PROJECT,DETERRENCE IN CRIMINAL JUSTICE:EVALUATINGCERTAINTY VS.SEVERITY OFPUNISHMENT 2 (2010) (stating that peoplewith a“temporarilyimpairedcapacitytoconsidertheprosandconsoftheiractions”lacktheabilitytobedeterredfromtheconduct). 120 In order to avoid conduct, onemust have self-awareness of the conduct. SeeJeffreyS.Parker,TheEconomicsofMensRea,79VA.L.REV.741,744–45(1993)(statingthatmensreaeffectivelyimposes“arequirementthatthepersonchargedpossessed,atthetimeoftheoffense,subjectiveawarenessofthe‘true’orobjectivenatureofhisorherownconduct”).


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includingthemomentof theconduct. Mensreamayonly looktothemomentofactusreus,butthemoretime,priortotheact,anactorhas,themore opportunity that actor has to choose not to do the action:hence,moreprospectiveawarenesscanaidinmaximizingthedeterrenteffect. Understandinghowthisbehaviordevelopsovertimeishighlyrelevantinmodelinghowtopreventthebehavior.

Forexample,intheframeworkofabankrobbery,thereareclear,possible steps of escalation: attaining a gun (legally or illegally);assemblingagrouptoact;walkingintoabank;andpullingouttheguninside a bank branch. Each substantial step leads to another andrequires a relatively significant choice—and thus an inferablemindset.121

In securities law,eachchoice canbemuchsmaller: forexample,stallingadisclosureforafewdaysuntilmoreinformationisavailable;notdisclosingathirdForm483whenthemanagerisconvincedsomeprogresswasmade; hosting an investors’ call and explaining away averynegativeForm483as “partof thenormalprocess;”or issuingapressreleaseexplainingthatthecompanyisstillontrackforapproval,eventhoughsomeadvisorshavesuggestedaWarningLettermaybeonitsway. Instead of a series of significant steps, the path to violatingSection10(b)beginsto lookmore likeasmoothcurve. Thepracticalresultofwhichisthatyoumayhaveaculpablemensrearetrospectively:afactfindermayreviewapatternofbehavioranddeterminethat,atthetimeof thewrongful act or omission, the individualwas exhibiting aconsciousdisregardoftheirknowndutytodisclose—andtherefore,thelawcanremediateappropriately. Butbecausethestepsareinfinitelysmaller,theeffectivenessofthelawasadeterrentdropsprecipitouslybecausetheactorwillhavedifficultydifferentiatingbetweenthestepsduetocognitivedissonance.Becauseofthisslowprogression,theactormayormaynotconsciouslyunderstandthelevelofhisorherviolation.

Therefore,thisPartwillanalyzetheeffectofcognitivedissonanceintheC-Suiteofsmall-capitalized,publiclifesciencecompaniesinordertounderstandwhereadjustmentsmaybemadeinthelaw,orviaadvicefromcounsel,thatwouldreinforcethedeterrenteffectofSection10(b).Movingforward,wewillexcludesociopaths,psychopaths,andanyotherpersonwhois“uninhibited”byatypicalsetofmoral,social,orethicallimitations.Thisis,bynomeans,tosuggestthattheC-Suiteismagicallyinsulatedfromsuchindividuals,butstatistically,wearedealingwitha

121 SeeStevenR.Morrison,TheSystemofModernCriminalConspiracy,63CATH.U.L.REV.371,408–10(2014)(discussinghowotherwiseinnocentactsmayestablishmensreaindependentlyorthroughaseriesofactionsandsubsequentinferences).



broader problem.122 First, this Part will look at how cognitivedissonance is a driving force for an individual to seek consonancethrough behavioral or belief changes. Second, this Part will discusscognitivedissonanceasasubjectivestateofmind—andadrivingforcefor self-resolution—juxtaposed against external, objective cognitivedissonance.Third,thisPartwillanalyzehowanindividualcanmaintaindissonance,despitetheinevitabledrivetoconsonance.Fourth,thisPartwilldevelopthetheorythatcognitiveeasingcanworktoeasesubjectivecognitivedissonanceatthecostof losingobjectivitybothindividuallyandasamanagementgroup.Fifth,thisPartwillanalyzehowthosetoolsapply to both the corporate environment and public life sciencecompanies.Sixth,thisPartwilltakeafreshlookatAtossa.Andlastly,thisPartwillexplainwhythisisarelevantdetermination.

A.WhatisCognitiveDissonance?For an individual, cognitive dissonance develops when new

informationconflictswithexistinginformation.123Cognitivedissonancecompels themind to eliminate or diminish the dissonance, reachingconsonance.124 Individuals lose objectivity when new, conflictinginformation is distinguished and subsumed into the former fact,eliminating internal dissonance, but establishing an objectivelyincorrectbeliefintheprocess.125CorporatecognitivedissonancemayresultinanactorhavingthenecessarymensreatobeculpableunderSection 10(b), but it inhibits the actor from recognizing the conductprospectivelyand, therefore,greatlyreduces thepotentialdeterrenceeffect.

122 See Scott Killingsworth, ‘C’ is for Crucible: Behavioral Ethics, Culture, and theBoard’sRole inC-SuiteCompliance,RANDCENTERFORCORPORATEETHICSANDGOVERNANCESYMPOSIUMWHITEPAPER SERIES, SYMPOSIUM ON “CULTURE,COMPLIANCE& THEC-SUITE:HOWEXECUTIVESANDPOLICYMAKERSCANBETTERSAFEGUARDAGAINSTMISCONDUCTATTHETOP”1(May29,2013)[hereinafterCrucible],https://ssrn.com/abstract=2271840(suggestingthat“C-Suitepsychopathsexistanddogreatdamage,buttheyarenotthesourceofmostcorporatecompliancefailures”). 123 SeeFESTINGER,infranote127,at3–4. 124 Id. 125 See Clay Halton, Cognitive Dissonance, INVESTOPEDIA (July 19, 2019), https://www.investopedia.com/terms/c/cognitive-dissonance.asp,foranexplanationofcogni-tivedissonancewithinaninvestmentsetting.


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B.CognitiveDissonanceisLikeHungerCognitivedissonance,likehunger,hasanaturaldesiretoeliminate

itself.126Cognitivedissonancefrequentlyoccurs;however,itistypicallyresolved instantaneously, placing the individual back intoconsonance.127

Forasimplisticexample,personAwastoldbypersonByesterdaythat it would be sunny today.128 Person A believes person B and,therefore,intendstogotothepark.129 Uponlookingoutthewindow,personA discovers that it is not sunny, but storming. This new factcreates dissonance; for a moment, the competing information existssimultaneouslywithinpersonA’smind—maintainingboththebeliefofthedayasitshouldhavebeenandthedaythatitappearstobe.130Buttypically,rationalityprevails,eliminatingthedissonance.131Despitethedesire to go to the park, the superior, clear facts win out over thepersonalmotivation.

Butsometimes,factsarenoteasytoreconcile.Asanalternativetotheexampleabove,onemight imagineascenariowhereavictimofasophisticated, fraudulent investment scheme might be tempted tofollowtheadage “in forapenny, in forapound,”despitediscoveringworrisome facts about their would-be defrauder. Even with clear,superior facts—for instance, a news report on the fraud—the victimmight find that many pressures—such as financial dependencies orinterpersonal relationships—deter an easy resolution of the factualdilemma. This creates persistent dissonance that the victim will beinstinctuallydrawntoeliminate,perDr.LeonFestingerabove,bringinghimselfbackintoconsonance.

The magnitude of the fact misalignment amplifies theuncomfortable dissonance. Festinger states that “[c]ognitivedissonance can be seen as an antecedent condition which leads toactivityorientedtowardsdissonancereductionjustashungerleadstoactivityorientedtowardhungerreduction.”132Eachfact,internalizedbythe individual, becomes a “cognitive element,” and the greater thesignificanceattributedtothecompetingcognitiveelements,thegreater

126 FESTINGER,infranote127,at3. 127 SeeLEONFESTINGER,ATHEORYOFCOGNITIVEDISSONANCE4–5(1957). 128 Id. 129 Id. 130 See,e.g.,id. 131 Id. 132 Id.at3.



themagnitudeofthedissonance.133 Generally,agreatermagnitudeofdissonance leads to a stronger drive to reduce or eliminate thedissonance.134

Inthecaseofourhypotheticalfraudvictim,themagnitudeofthedissonanceishighbecausetheinformationaldifferentialandthevalueoftheinformationarebothhigh.Theinformationaldifferentialishighbecausethedistancebetweenthecompetingcognitiveelementsof(1)“thispersonisafriend”and(2)“thispersonistryingtodefraudme”issignificant,andthevalueofthe informationissignificantbecausetheinformationisofatypethatwouldhaveamaterialeffectonthevictim’slife.

C.FindingConsonanceattheCostofObjectivityTherearemethods to reducedissonance constructively, keeping

the subject in alignment with the objective reality.135 This usuallyrequires an active approach: (1) changing a behavior, (2) changing abelief,or(3)changinganenvironmentalelement.136

A rational approach allows for consonance andobjective clarity.Whentheabovechangesaremaderationally—forexample,ourvictimoffraudfromabove,motivatedbythenewsreport,undertakesacourseofactiontoinvestigatetheissuetodeterminewhichofthetwobeliefsis objectively truthful—the individual can resolve the conflictinginformationbyeliminatingthefalsecognitiveelement,allowingareturntoconsonance.

But sometimes, cognitive dissonance fails the individual. ByFestinger’s model—consciously or unconsciously137—a person cancreate new facts or beliefs that reduce or eliminate the dissonance,placing them internally—psychologically—in consonance.138 When achangeinbeliefisdiscordantwithreality—whenapersondistinguishesa fact by inventing new facts or investing belief in low-quality

133 FESTINGER,supranote127,at16.A“cognitiveelement”islargelyundefinedbutconsistsoffact,impression,belief,orgroupsthereof.Seeid.at9–11. 134 Id.at18. 135 ForthepurposesofthisComment,notseekingtobecome“toophilosophical,”wewillrefertoobjectiverealityasthestandardbywhichoffenderswillbemeasuredinsuit,asopposedtotheirownsubjectivemachinations. 136 See FESTINGER, supra note 127, at 19–23 (discussing changing behavior andenvironment, and then using a literature-based hypothetical model in discussingoptionstobringapopulationbacktoobjectivity,andwhyanalternativemayprevail). 137 SeeConsciousandUnconscious,infranote143. 138 SeeFESTINGER,supranote127,at23(describinghowacommunityimaginesghostsasawaytoeliminatethecognitivedissonancecreatedbetweenabeliefinhumanity’sinherentgoodnessandadolescentmalevolence).


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information—thisreducestheindividual’sinternaldissonancebutstillleavestheindividualatoddswithobjectivereality.139

Why create new information instead of resolving thingsobjectively? Practical limitations—such as a high cost or a sunkinvestment—mayofferstrongincentivesagainstchangingabehaviorora belief.140 And environmental elements—such as the status of aproductoranFDAdecision—maybeclearandunchangeable,liketheweather at the park, but frequently environmental elements areambiguousanddifficulttonavigate, likeanagency’srecommendationor a scientific result; additionally, environment elements are oftenexternal and, therefore, inherently resistive to change.141 Finally,anotherroadblocktochangingbehavior,belief,orenvironmentisthatchangingonecognitiveelementmayplacethatelementindissonancewith another cognitive element, creating integrated resistance tochange.142

Butwhat of our victimof fraud from above? Theweight of oldinformationmaycausethevictimtoinventanewfacttodistinguishthedissonantinformation:perhapssomeoneistargetingthefraudsterwithasmearcampaign,theaccuserhasacaseofmistakenidentity,orthiswasmaliciousreporting.Thatnewfactallowsthevictimtocontinuetooperatewithoutcompromisinghisexistingbeliefs—placingthevictiminrelativeconsonance.Thepathofleastresistancemayleadthevictimto decide143 that this was “fake news,” and the defrauder has beenmalignedorslandered. Thisfraudvictimmaykeepinvesting. Totheoutsideworld,itmayseemasthoughthevictimshouldknowthetruth,butthevictimcontinuestoinvestwiththefraudster.

139 Seeid.at23(detailinghowthecreationofanewbeliefcaneliminatetheoriginaldissonance, but potentially at the cost of objective reality). Festinger discussesindividualswhomanufacturetheconceptof“ghosts”inordertodiminishtheirinternalcognitivedissonance,id.—butbyinventingghosts,theindividualshaveinherentlyputthemselvesoutofphasewithobjectivereality. 140 Seeid.at24–26(discussingresistancetochangingbehaviors). 141 Seeid.at20–21,26–27(discussingchanginganenvironmentalelementandtheresistivenatureofmakingthechange). 142 Id.at27. 143 The level at which the manufacturing of this new fact is conscious, orsubconscious,isnotnecessarilyclear:therearecompetingtheories.SeeJackAnthonyCole, Individual Differences in Conscious and Unconscious Processes in CognitiveDissonance,1–2(Aug.2004)[hereinafterConsciousandUnconscious](unpublishedPh.D.dissertation,UniversityofSouthernMississippi)(onfilewithauthor)(statingthatthestudy’s“overallresultswereconsistentwiththeDefense-mechanismmodel,”amodelwhichpoints towardsunconscious choices as thedrivingmechanism fordissonancereduction). If thesebehaviorswereentirelysubconscious, thiswouldraiseconcernsabout the applicable mens rea because the actor would not be capable of havingawarenessofhisorherownrecklessness.



D.MaintainingDissonanceIndividuals can maintain states of internal dissonance under

certain circumstances. Countervailing forces—other cognitiveelementswithahighermagnitudeofdissonance—mayalsoenableanindividualtomaintainastateofcognitivedissonanceinternally,whichwouldalsobedissonantfromanobjectivethird-partyobserver.144

Lookingtoourabovevictimof investment fraud, thevictimmaynotbeabletorectifythedissonance,astheremaybeotherdissonantfacts that the new fact balances against. For instance, the originaldilemmawastheconflictbetween(1)thebeliefthatthefraudsterwasactuallyafriendwhowaslookingoutforyourbestinterests,and(2)anewsreportthatthefraudsterwas,infact,afraudster.Nowimaginethevictimhears fromhisbrotherwhosays(3) thebrothermadea lotofmoneyfromthefraudster:itworked!Andthen(4)anothercolleaguereports that the fraudster is being indicted. Now there are fourdissonant facts, somebalancing against each other. The victimmustweigh the value of each fact—the source of the information and theauthoritativequality—butthosearealsobalancedagainsttheoutcomethe victim may be reliant on seeing: not being defrauded by thefraudster. This victimmay live in anuncomfortable stateof internaldissonanceforaprolongedperiod,lookingformoreinformationto“tipthescales.”

Keepingtheaboveinmind,wehaveidentifiedtwopotentialroutestofunctioninginanobjectivelyexternalstateofcognitivedissonance:(1)significantleverageprovidedbyacompetingcognitiveelementwithgreater magnitude or (2) successfully distinguishing the dissonantelementsbygeneratingnewfactsorbeliefsorreprocessingambiguous,existing facts. From an external, impartial, third-party observer, theconclusioncanappearthesame:thesubjectisfunctioningwhilerelyingon the “truth” of two conflicting cognitive elements. But internally,frictionandself-awarenessarereducedunderthelatteroptionasthedissonanceiseliminatedorsignificantlyreduced,squashingthedriveinthesubjecttoidentifyandrectifytheproblem.Thismeansthevictimunder route one is uncomfortable and seeking resolution, while thevictimwhotakesroutetwohaseasedhisdiscomfortandhasceasedtolookforanalternativesolution.

144 SeeFESTINGER,supranote127,at27.


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E.CognitiveEasing:LeveragingInductiontoArtificiallyReduceDissonanceJust as the government uses quantitative easing to buoy the

economywhileavoidingdirecthandouts,corporatemanagerscanusecognitiveeasing toadjust factstosuit theirneedsat thetimewithoutelectingto“lie.”

Quantitativeeasingallowsthegovernmenttoprintupnewmoneyanddisburseittoabankthroughaprivatesecuritiespurchase.145Thenthatbankappliesthemoneytobusinessestoslowlybuoytheeconomy,allowingthegovernmenttoavoidtreacherouseconomicdipswithoutdirectlyaddressingtheproblem.146

Similarly, cognitive dissonance can be reduced by a form ofcognitive easing,147 allowing the brain to generate new facts—ordistinguishing features—and apply them to dissonant cognitiveelements to gently bring them into consonance.148 The higher themagnitudeof dissonance themoredifficult itwill be to ease the twoelements into consonance,149 and thus, likely, themore cognizant theactor will be of the process due to the difficulty in rectifying thedifferential. Like tension on a suspension bridge, dissonance can bemaintained when the resolution of that dissonance—consonance—comes at a cost of greater dissonance between other cognitiveelements.150

Imagine the typical manager of a public company: while thatindividualhasbeenforgedthroughthechallengingprocessofrisingtothe C-Suite, it is likely that person—like a statistically significantnumber of people—believes herself to be “psychologically normal,”

145 See Quantitative Easing, INVESTOPEDIA (Oct. 15, 2021), https://www.in-vestopedia.com/terms/q/quantitative-easing.asp. 146 Seeid. 147 “Cognitiveease”hasbeendefinedbyDanielKahnemanasastateofmentalbeingwhileengaginginasystemofthinking.SeeDANIELKAHNEMAN,THINKINGFASTANDSLOW59(2011).Here,cognitiveeasingisbeingusedwithoutattemptingtoaccessthedepthofanalysisKahnemanundertakes,butmerelytorepresentaprocessinwhichthebrainattemptstomitigatedissonance—thisisharmoniouswithKahneman’suseofthewordbutnotanchoredtoit. 148 FESTINGER,supranote127,at21–23.Thismightbeseenasrelatingto“thepathofleastresistance.” 149 See infra note 160 and accompanying text. But, notably, the greater themagnitude, the stronger the drive will be to ease the two items into consonance.FESTINGER,supranote127,at18. 150 FESTINGER,supranote127,at28–29.



valuing morality and considering herself ethical.151 So how does anormal, ethicalpersonmisrepresent facts to the investors—towhomsheowesfiduciaryduties—andthuscommitsecuritiesviolations?

A variety of psychological motivations and states can provideeasingfunctionalityandincentivestoeasenewcognitiveelements,suchasmotivatedblindness,152timepressure,153 irrationallossaversion,154andoverconfidence.155

One key mechanism behind cognitive easing is incrementalism.Incrementalism looks at the small stepspeople take, sequencedovertime, that eventually can take managers from ethical street to SECBlvd.156Scholarshavereferredtoincrementalismasthe“SlipperySlopeofDecisionMaking.”157 Therearetwokeycontributingfactorstothisprocess:(1)numbingthroughrepetitionand(2)induction.158Numbing

151 Crucible, supra note 122, at 4 (citing Max H. Bazerman & Francesca Gino,BehavioralEthics:TowardaDeeperUnderstandingofMoralJudgmentandDishonesty,8ANN.REV.L.&SOC.SCI.85,85–104(2012)). 152 Motivatedblindnesscanallowmanagerstodeveloptunnelvision,ignoringkeyfactsundertheguiseofissuesbeing“unclear,uncertain,deferred,orsimplynotintheframeofreference”ofthegivenmoment.Crucible,supranote122,at6.Notably,thisphenomenondoesnotrequiredishonestyinthesubject’sappraisalofthefactsbutcanoccurdespitegoodintentionsandconflictawareness.SeeMaxH.Bazerman&AnnE.Tenbrunsel, Ethical Breakdowns, HARV. BUS. REV. (Apr. 2011) [hereinafter EthicalBreakdowns](notingrelevantconflictsofinterestinanorganizationandsubsequentlyrelying on integrity is not, alone, sufficient “because honest people can suffer frommotivatedblindness”). 153 Thepressureofkeylaunchdates—orIPOs,capitalraises,orquarterlyreports—can greatly impede a manager’s willingness to stop and consider the full ethicalramificationsoftheiractions.SeeCrucible,supranote122,at6–7(discussingasocialexperimentwhereunhurriedpeople stopped tohelpa “groaningmancollapsed inadoorway”; sixty-threepercentof studentsdidsounder typical conditions,butundertimeconstraints,onlytenpercentstoppedtohelp). 154 Manypeopleareirrationallymotivatedtostopaloss,ratherthantoachieveanequivalent gain—and will increase their willingness to take risks or violate ethicalstandardsinordertopreventthatloss.Crucible,supranote122,at7(discussingtheeffectof“prospecttheory,”andhowitappliesintheC-Suite). 155 Overconfidencecan lead tomanagers takingonadditional risk;andwhen thatoverconfidenceisreinvigoratedby“earlysuccessinhigh-riskinitiatives,”thathindsightallowsthemanagertorecalibrate—discountingthepriorrisk—andthen“‘doubledown’onriskybusinessgoingforward.”Crucible,supranote122,at8. 156 Seeid.at5. 157 Id.at5&n.18(citingAnneE.Tenbrunsel&DavidM.Messick,EthicalFading:TheRole of Self-Deception in Unethical Behavior, 17 SOC. JUST.RSCH. 223, 228–29 (2004))(connectingincrementalism—”smallsteps”—withanarticleonthe“SlipperySlopeofDecisionMaking”). 158 AnneE.Tenbrunsel&DavidM.Messick,EthicalFading:TheRoleofSelf-DeceptioninUnethicalBehavior,17SOC.JUST.RSCH.223,228(2004)[hereinafterEthicalFading].


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occurswhen actions are repetitious, and one becomes less aware orreflectiveofthesubstanceoftheaction.159

Forexample, imagineapharmaceuticalexecutivewhoreceivesareport indicating a small percentage decrease in effectiveness. Thisexecutivemaynote that this isnotamaterialchange inefficacy. Butover time, theremaybemanyof thesereports. Inductionallows theexecutivetoperceivethesmallvariableasbeingimperceptiblydifferentfromtheoriginalvalue,andnumbness—therepeatedapplicationofthisinduction—can inhibit recognizing a growing downward trend. Thiscompoundingerrorisonlymoretroublingandlikelytooccurwhenitinvolves cryptic soft-data—such as reports, opinions, or morecomplicated, multi-vector data outputs—instead of clear numericvalues that are more likely to be discovered through diligentmonitoring.

Induction is the processwhere the humanmind is incapable ofaccounting for a small enough change in circumstances—the minddetermines that this new cognitive element is “almost identical” to aprevious cognitive element that was deemed to be acceptable andethical. Therefore, it allows the mind to accept the new cognitiveelementasbeinginalignmentwiththepriorelements.160

Theaboveforcestietogethertoallow,invaryingrecipes,objectiveindividual cognitive dissonance in the C-Suite. Once competingcognitive elements are introduced—for example, a drug will besuccessful but requires more capital (“thought 1”), and a new,perceived-to-be adverse FDA notice could, if known, jeopardize theinvestor confidence needed to raise capital (“thought 2”)—timepressureandirrational lossaversionworktoestablishanimmovableforceinthemindofthemanager.Theseincreasethemagnitudeofthedissonantcognitiveelementsexponentiallyaspressuremountsonthemanger to perform. The manager is then driven to eliminate thedissonance:thatmanagermaychangethebeliefthatacapitalraiseisrequiredorengageincognitivelyreshapingofthedissonantelementtoeliminate the conflict—either will bring these two thoughts intoconsonance.161 On the one hand, to bring these two elements into

159 EthicalFading,supranote158.Themoretimesapersonrepeatsthesameactionwithoutadverseconsequences,themorereaffirmedthatactionis;therefore,thatactionmaybecomethenewnorm,establishinganewbaselinepriortothenextinductionstep.Seeid. 160 Id. 161 See FESTINGER, supra note 127, at 19–23 (discussing changing behavior andenvironment,andthenusingaliterature-basedhypotheticalmodel,discussingoptionstobringapopulationbacktoobjectivity,andwhy,alternatively,distinguishingthefacts



consonance, the manager would have to determine that additionalfundingisnotrequired,orsecureitfromanewsource:thismaybemorecostly, less rewarding, and it requires a change in course, breakingmomentum. On the other hand, motivated blindnessmay allow themanager todiscount environmental, cognitive elements—such as thestatus of an FDA notice—as being unclear or uncertain.162 Once theenvironmental,cognitiveelementoftheFDAnoticeisdistinguishedandminimalized, it may be interpreted, through induction, as beingequivalent to a prior, insignificant update, unworthy of amandatorydisclosure.163Nowtheproblemhasbeenresolvedwithoutachangeincourse—instead,itonlyrequiredamildpsychologicaldeviation.

But how does one manager’s cognitive dissonance expand toencompasstheentireC-SuiteandtheBoardofDirectors?ThecultureofeachC-Suiteisparticularinandofitself,andoftengroupnormscansetthe“dominantreferencepointforacceptableorexpectedbehavior.”164Itisalsoessentialtonotethateachmanagerwillhavetheirownsenseofethics—somemorethanothers—whichsometimesmeansknowinglyunethical conduct-driven incrementalismmight still play a role withsome of the actors.165 Additionally, the stakes are high: even if newinformationindicatestothepersonthatpastactions—takenbythemorsomeoneelse inmanagement—mayhavebeeninerror, thepersonisnowforcedtochoosebetweensurrender—sacrificingcareerorlifestyleand potentially facing civil or criminal penalties—or trudging ahead,hopingtoeludenoticeofstockholdersandregulators.166Atsomepoint,eveniftheactorbecomesawareoftheethicalviolation,thestakesmayappeartooinsurmountabletoattempttomitigateorseekhelp,andthusrisking calling attention to the error in the process. Eitherway, theindividual isnotonlydisincentivized fromactingat that juncturebutalsofrommakingherselfawareofthescopeoftheproblemaltogether.

withnew—self-generated—informationmayprovide amoreoptimal solution to thesubject,thoughitmaybeobjectivelyinvalid). 162 Crucible,supranote122,at6. 163 SeeEthicalFading,supranote158. 164 See“groupthink,”describedinCrucible,supranote122,at9–10. 165 See supra notes 98–103 and accompanying text (discussing a willful fraudperpetratedbyonekeyactorandabettedbyotheremployeeswhomayhavehadlowermensreastatesintheirparticipation). 166 SeeCrucible,supranote122,at5–6.


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F.ApplyingCorporateCognitiveDissonancetoLifeScienceCompaniesCognitive dissonance in life science companies begins with

managementdoingexactlywhattheyaretrainedtodo:problemsolveandmaintainapositivedispositiontotheinvestorsdespiteanyspeedbumps.167Cognitivedissonanceisapplicablehereintwoprimaryways:First,cognitivedissonanceisrequiredtomaintainaseparationofself:aperson can simultaneously believe they are an ethical person, whilemakingchoicesthatescalateinethicalrisk.TheMaxH.BazermanandAnnE.TenbrunseldiscussthisphenomenoninthecontextoftheFordPintocase:

[L]ookingattheirdecisionthroughamodernlens—onethattakesintoaccountagrowingunderstandingofhowcognitivebiasesdistortethicaldecisionmaking—wecometoadifferentconclusion. We suspect that few if any of the executivesinvolvedinthePintodecisionbelievedthattheyweremakinganunethicalchoice.Why?Apparentlybecausetheythoughtofitaspurelyabusinessdecisionratherthananethicalone.168

There, the two dissonant thoughts involved the individuals’ self-perceptions as ethical beings and the knowledge that there wassignificantpotentialfordeath.BazermanandTenbrunselstatethattheexecutives decided it was a “business decision,” and thereforedistinguishablefromtheirownpersonalmoralandethicalcompass—andthismaybeseenasaversionofmotivatedblindness,169becauseitdemonstrates the mind working to eliminate the dissonance byredefiningthenatureoftheenvironmentalfact.170

167 Problem solving includes persistence and “resilience to withstand inevitablepushback from co-workers.” What Are Problem-solving Skills and Why Are TheyImportant?, CAREERBUILDER (Apr. 13, 2021), https://www.careerbuilder.com/advice/what-are-problemsolving-skills-and-why-are-they-important (a web article designedforinstructingyounger,would-be-managersonwhatittakestobeamanager);MargoReder, CEO Postings - Leveraging the Internet’s Communications Potential WhileManaging the Message to Maintain Corporate Governance Interests in InformationSecurity, Reputation and Compliance, 7DEPAULBUS.&COM. L. J. 179, 186–87 (2009)(“CEOsnecessarilyfocusoncompetition,customers,andmarketsinanefforttoachievemaximumreturnsforthecorporation.Thetemptationtoleverageadvantagesthroughanymeansavailableisnearlyirresistible.”). 168 EthicalBreakdowns,supranote152(emphasisadded). 169 Motivated blindness does not necessarily rise to the legal concept of “willfulblindness.” Motivated blindness is merely suggesting that there is an incentive toremainblindanddoesnotspecificallyspeaktoaconsciousattempttoremainblind.SeeCrucible,supranote122,at6,foradiscussionofmotivatedblindnessinbusinessethics. 170 FESTINGER, supra note 127, at 20–21 (noting that environmental cognitiveelementscanalreadybeambiguousinnature).



Second,cognitivedissonancecanallowmanagers to,on theonehand,understandthematerialityofaprobleminordertoaffectinternaloperationalactionstoremedytheproblemwhilementallydeclaringthemateriality moot in regard to their investor-facing communications.When new, adverse information presents itself to a manager, thatmanager generally must acknowledge the severity of the issue—forexample,arelevantlegalnotice,analerttriggeredbyanemployee,oradata breach—by taking action to remedy the situation. The level ofalarmraisedheremaybeseentoinformtheseriousnesstowhichthemanagerregardsthesituation.Yet,despitetheseriousnessofactionsrequired, that manager may then be motivated to disregard theseriousness as it applies tomaterial disclosuresunder Section10(b).Objectively, one may imagine a trend to exist: if the element was aseriouselementinonecategory,itmightlikelybeofmaterialvaluetothe investors. That is not to declare that these are always identical,merelythatthisshouldraisethequestion.Butthatambiguitycreatesroomformotivatedblindnesstorepackagethedissatisfactorycognitiveelement, distinguishing it from a dangerous fact that would induceinternalcognitivedissonance.Additionally,incrementalismcanbeseenhere to allow a subject to conflate additional investigative reportsregarding an employee’s bad actions—where prior notices weredeemed immaterial to global operations—as indistinguishable frompastnotifications through inductionand, should theseactionsrepeat,numbness. This incremental “drips and drabs” way of gatheringinformationcanappear,onthesurface,tokeepthemanagerapprisedofthenecessarydetails,but,inreality,itmayreducethemanager’sabilitytocomprehendtheultimateseverityofthecalamity.Whereas,ifthefullextentoftheemployee’smaleficencewasdeliveredtothemanageratonetime, itmayhavebeensufficienttoregisterasamaterialbreach.But theslowbuildtothatsamefactpatternmayallowinductionandnumbnesstoeliminatethemanager’scognitivedissonanceandreducethemanager’sobjectivereaction.

Life science companies typically spend significantly on researchanddevelopment,sowhenproblemsarisewiththemedicationorthemanufacturingprocess,thesolutionoftenrequiresmoremoney.171Andtheproblems,atfirst,maywellbeimmaterialinregardtomandatoryinvestordisclosures.Butwhenthematerialitylineisincrediblythinandgray, it is easy to succumb to cognitive dissonance: reframing the

171 SeeMillions,supranote64.


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adversefactsintoalightmorefavorableandsolvable.172Giventhehigh-stakessituationofbeingdependentontheFDA’sapprovalofoneortwopharmaceuticalsforrevenue, it isunderstandablyeasytofindoneselffacedwithharddisclosuredecisions.

Specifically, when a Form 483 is presented to the business, theformisfairlyclearaboutwhat issuesit is indicating.173 ButtheForm483willlikelynotprescribesolutionstothoseissues.174Thisleavesamanagerwithadilemma:themanagerneedstofixtheissues—andmayneed capital to do it—but the manager, between time pressure andirrationallossaversion,willbemotivatedtoavoididentifyingtheForm483 elements as material to investors—doing so would derail thecompany’s current investor strategy and likelymake it impossible tosolvetheproblem,enteringintoadownwardspiralofpotentiallosses.Thismanagermustsimultaneouslyknowtheproblemisseriousenoughtodeployresourcestosolveitandbelieveitisnotsoseriousthatithastobereported. If thepressureof these two items isnotenough, themanager can deploy a variety of diffusion tactics to obfuscate theseverity:fromrefusingtoanticipatethepotentialbinary(andpossiblydevastating)outcomeofaCLR,todecidingthattheFDAparametersorpotentialoutcomesaretooconfusingtoreallyunderstand.Thisissteponeforincrementalism.Andoncethereispsychologicalmomentum175builtupinthemanager’smind,objectsinmotiontendtostayinmotion.

G.TakingaSecondLookatAtossawithCognitiveDissonanceinMindNow,afterreviewingcognitivedissonance in the lifescience’sC-

Suite, a fresh look at Atossa calls into question whether Schmid’sframingofthecaseasbeingdrivenby“confusion”isentirelysatisfactoryor whether cognitive dissonance might prove an alternative—if notmorelikely—explanation.

In Atossa, the Ninth Circuit reviewed a motion to dismiss thedistrictcourtgrantedinfavorofAtossaGenetics.176Thecourtaffirmed

172 Crucible, supra note 122, at 5 (“In the process of resolving that one internalconflict,[managers]havecreated,acceptedandinternalizedanideologyforjustifyingfutureinfractions,especiallyiftheyaresmallandariseinasimilarcontext.”). 173 FDAFAQ,supranote69. 174 Id. 175 James A. Fanto, Braking the Merger Momentum: Reforming Corporate LawGoverning Mega-Mergers, 49 BUFFALO L. REV. 249, 257–58 (2001) (discussingsophisticated investors being “caught up in the same psychological momentumsweeping over executives and board members” in the context of return-promisingmergersand,therefore,notfullyscrutinizingtransactions). 176 Leviv.AtossaGenetics,Inc.,868F.3d784,789–90(9thCir.2017).



in part and reversed in part.177 Atossa had two primary revenuesources:MASCTSystemandForeCYTETest.178TheMASCTSystemhadreceived a limited FDA-certification “for use in collecting NAFsamples.”179StevenQuay,Atossa’sCEO,madeastatementinaForm8-K report on December 20, 2012, that included an indication thatForeCYTE was “FDA-cleared.”180 Additionally, on News-Medical.net,QuaywasquotedassayingthatForeCYTE“hasgonethroughalloftheFDA clearance process” (“Incident One”).181 In one instance, AtossacorrectlydescribedtheFDAclearanceof itsMASCTSystemin its IPOdocuments,statingthatithadreceivedlimitedFDA-certificationforanexpresspurpose;butinaseparateinstanceintheIPOdocuments,thecompanydescribedtheMASCTSystemasbeingfully“FDA-cleared;”thismade the product appear further along and more imminentlyprofitable—the court described this as Atossa using “less preciselanguage” (“Incident Two”).182 Later, on February 25, 2013, anotherForm8-Kwasfiled,“givingnoticeoftheFDA’swarningletter.”183Butthenotice“omittedthebalanceoftheFDA’sallegedseriousconcerns”(“IncidentThree”).184Ina10-Qreport,Atossamadethestatementthatthecompanywas“‘reasonablyconfidentinitsresponses’totheFDA’swarningletter”(“IncidentFour”).185Finally,QuaystatedinaninterviewonMarch 15, 2013, that the “FDA clearance risk has been achieved”(“IncidentFive”).186

TheNinthCircuit inAtossa affirmed the district court’s decisionfrom Incident Two and Incident Four—granting the motion todismiss.187ButtheNinthCircuitreversedtheDistrictCourtonIncidentsOne,Three,andFive.188IncidentsOneandTwowereverysimilar,butwith a key distinction: Incident Two appears to have involvedmore“confusion”—theNinthCircuit stressed that the issue in the IPOwascentered around “less precise language,” as Atossa had left out a

177 Id.at790. 178 Id.at795. 179 Id.at796. 180 Id.at794. 181 Id. 182 Atossa,868F.3dat796. 183 Id.at797. 184 Id. 185 Id.at799. 186 Id.at800–01. 187 Id.at793,797,800. 188 Atossa,868F.3dat793,796,799,802–03.


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qualifying fact around the FDA clearance; IncidentOne, on the otherhand,imputedanFDAapprovalfromonekeyproducttotheother.189

Notably,whiletheremayhavebeensomeconfusionrelatedtothescope of FDA approval, or the process in which responses to FDAwarninglettersishandled,byallappearances,thedominantdriverinthis case was a series of actions that crossed the line from “merecorporate optimism” andwaltzed right into a conscious disregard ofmaterial, known facts.190 Over the course of three months, Atossa’smanagement attempted to make their product, ForeCYTE, appearfurtheralongandmoreimminentlyprofitable—itseemslikeanunlikelycoincidence that every “confused” notion about the FDA approvalprocessskewedinAtossa’sfavor.Lookingatthiscasethroughthelensofcognitivedissonance,itiseasytoimagineconvenientcognitiveeasingthatmayhaveledtothesebeneficialmisinterpretationsofFDAnotices.

H.WhyMayCognitiveDissonanceBeRelevantinTheseCases?Whenanactordoesnotunderstandthenatureofhisactions,he

cannot seek help to avoid current, prevent future, or remedy pastincidents.Thislikelymeansthatdeterrentsloseeffectbecausewhenaperson cannot understand that the very nature of their actionsmaytriggeralegalconsequence,thatdeterrentdoesnothavevaluetothatindividual.191Andthisleavesuswithakeydifferencebetweenasubjectaffected by cognitive dissonance and a subjectwho actsknowingly inordertoexploitthesystem:thepersonknowinglydoingitis,infact,self-aware of the problem and can, therefore, seek legal counsel to bestrectifythesituation.Ontheotherhand,thepersonwhoisexperiencinginternally consonant, objective cognitive dissonance isnot aware andthereforelesslikelytorealizethatsherequirescounsel,norwouldshebewilling toentertain the severityofheractions indiscussionswithcounsel.Amanagermightbethetopofherfield,supportedbyavarietyofable,intelligentpeoplewhoknowbetter,yetitisstillpossibleforherto delude herself into believing that the problem is immaterial toinvestors,despiteitsmaterialitytobusinessoperations.

Despitetheactor’sreality-distortion-field,establishingculpabilityisstillpossible. UnderSection10(b)’sscienterrequirement,asnoted

189 Id.at794,796. 190 Id.at803(internalcitationsomitted). 191 When an actor cannot anticipate the impropriety of their action, increaseddeterrentshavelittletonoeffect.SeeKaraM.McCarthy,Note,DoingTimeforClinicalCrime:TheProsecutionofIncompetentPhysiciansasanAdditionalMechanismtoAssureQualityHealthCare,28SETONHALLL.REV.569,616–17(1997)(describingatheorythatitisunjustandineffectivetoholddoctorsliableforinadvertentbadacts).



above,wemustlooktodetermineiftheactor’smensrea,atthetimeoftheconduct,rosetorecklessness.Eventhe(presently)unawareactormade choices, at the onset of the issue, to eliminate the cognitivedissonance.Giventhatthisisasophisticatedactor,withfiduciarydutiestothecompany,theinitialstateofdissonance—inconcertwiththehighstakes and knowledge of the situation—would likelymake the actor“consciouslyawareofasubstantialandunjustifiablerisk.”192Thedriveto eliminate internal cognitive dissonance relates to “a desire not toknowthereisarisk,”andindeed,“thecausingofthebeliefissomethingthepersondoeshimself,”makingtheactor,ifonlyforthatinitialfleetingmoment,culpableunderSection10(b)’sscienterrequirement.193This,however, only justifies these civil actions under the law; it does notanswerthedominatingquestion:Howdowediscouragethisbehaviorinanefforttoprotectinvestorswhiledecreasingcostlylitigation?

VI.POSSIBLEPATHSFORWARDDespite critics of class action securities litigation,194 there do

appeartobebenefits—suchasestablishingconfidenceandprotectionforinvestors,allowingindividualshareholderswhootherwiselackthemeans to bring an action to bring one, and deterring wrongful ormisleading actions by directors.195 Some suggest that the system isgenerallyworking.196

But even if the system isworking, theexpensebusinesses couldavoidmustbenoted:$6billionisspentinsettlementsperyear197—and$1billionofthatconstitutesattorney’sfees.198 Andyes,billionsmorearelosttryingtopreventexpensivelitigationorbecauseshareholdersdeflatevalue inanticipationof litigation.199 Expensive“Directorsand

192 MichaelS.Moore&HeidiM.Hurd,PunishingtheAwkward,theStupid,theWeak,and the Selfish: The Culpability of Negligence, 5 CRIM. L. & PHIL. 147, 179 (2011)[hereinafterCulpabilityofNegligence]. 193 Id.at155(emphasisadded). 194 See, e.g., John C. Coffee, Jr.,Reforming The Securities Class Action: An Essay OnDeterrenceAndItsImplementation,106COLUM.L.REV.1534,1547(2006)(“[I]tisanopenquestionastowhetherthetypicalsecuritiesclassactionsettlementactuallyproducesanynetrecovery.”). 195 SeeNicoleA.Veno,Note,ClassActionSecuritiesLawsuitsShouldSurvivetheDeathofaNamedDefendant:WhyBaillargeonv.SewellwasWronglyDecided,25QUINNIPIACPROB.L.J.408,411–12(2012). 196 BarbaraBlack,EliminatingSecuritiesFraudClassActionsUndertheRadar,2009COLUM. BUS. L. REV. 802, 806 (2009) (“[P]ost-PSLRA securities fraud class action isreasonablyeffectiveinachievingbothcompensatoryanddeterrencegoals.”). 197 Consequences,supranote10,at2–3. 198 Id. 199 Id.at3.


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Officers”insurancecoverageincreasescostburdens.200Andin2019,outof all securities class action lawsuits, twenty-four percentwere filedagainstlifesciencescompanies.201

Inordertoaddressthepeculiarsituationsthatarisewithpubliclifesciences companies, this Comment will now look at several narrowopportunities that may provide relief, deterrence, or encourageprevention,withaneye towarddiminishing theneed for classactionsecurities lawsuits by prophylactically discouraging the harmfulbehavior.Itisimportanttonotethatevenastheindustrylookstomakechanges, the courts have been altering the burdens placed on bothplaintiffs and defendants—and while there are certainly still fairprotections for the defendants, as misrepresentations continue, thecourtsrespondinoneoftheonlywaystheycan:increasingdeterrencebyallowingplaintiffactionstoprogresstothemerits.202

Inorder toapply the learnings fromabove, it seemsessential toview potential solutions in relation to how they might disrupt theslippery slope of induction that allows for individuals and teams toneutralize their internal cognitive dissonance while remainingobjectivelyoutofalignmentwithreality. Theverynatureof theFDAapprovalprocesscreatesincredibleopportunitiesforinduction,asitisrepletewith incremental, short-stepchanges. Globally, solutions thatencouragemanagers toconfront thesechangesbycausingdisruptionwould seem to offer a higher efficacy rate. The challengewill be to

200 Id.at20. 201 KevinM.LaCroix,ACloserLookat2019SecuritiesLitigationAgainstLifeSciencesCompanies, D&ODIARY (Jan. 26, 2020), https://www.dandodiary.com/2020/01/arti-cles/securities-litigation/a-closer-look-at-2019-securities-litigation-against-life-sci-ences-companies/. 202 Class action securities litigation, even a decade after the PSLR, is still seeingfluctuationsinhowcourtsbalancetheburdensontheplaintiffsanddefendantsduringtheinitialphasesofasuit.Forexample,the2010SupremeCourtrulinginHalliburtonCo.v.EricaP.JohnFund,Inc.haschangedhowdefendantsmustdealwithlosscausationpriortoclasscertification.573U.S.258,284(2014).Whileitdoescreateapresumptionof reliance, making the plaintiff’s case easier, it allows the defense to rebut thepresumptionpriortoclassactioncertification. See id.at277–79. InHalliburton, theCourtheldthatrequiringaplaintifftoproverelianceor“price-impact”createdtoohighofabarforclassactionsecuritieslitigationtobeestablished.Seeid.at267–68,278–79.The Second Circuit pushed to broaden potential plaintiffs through their expandedinflation-maintenance theory; the Supreme Court, reviewing the Second Circuit’sdecision,discussedtheinflation-maintenancetheorybutdidnotvalidate(orinvalidate)thetheory,instead,remandingthecasefortheinsufficientconsiderationofthegenericqualityofstatementsonthematerialityprong.SeeArk.Tchr.Ret.Sys.v.GoldmanSachsGrp.,Inc.,955F.3d254,258(2dCir.2020),rev’d,GoldmanSachsGrp.,Incv.Ark.Tchr.Ret.Sys.,141S.Ct.1951,1960–61(2021).AcontinuedloweringofthebarriertoenteraSection10(b)suitmayencouragecompliance,buttherearelikelyproblemswiththisasasolution.See20-4MEALEY’SLITIG.REP.:CLASSACTIONS5(2020).



determine,systematically,howtoembedtherightdisruptionpointstoelicit positive behavior changes, as opposed to generating morebureaucracy.

With that guiding principle in mind, the following sections willbrieflyidentifyafewpossible,narrowpathsforward:(1)opportunitiesforreformationstotheFDAnotificationsandguidance;(2)mandatingdisclosures, under the SEA, of any FDA notifications; (3) creating apresumption of disclosure for any—or certain enumerated—communicationsbetweentheFDAandthebusiness;and(4)creatinga“safeharbor”approachfordeterminingappropriatedisclosures.

A.ReformFDANotificationsandGuidanceThe FDA could deploy superior guidance relevant to its

notificationsand theSEAat either a global levelorwithapiecemealapproach.FraudorConfusionoffersupaversionofFDAreformtargetedatgloballyissuedguidance:

The FDA must create comprehensive guidance thatestablishes and provides examples of best disclosurepractices during the drug approval process. Such guidancewouldhelpcompaniesdeterminehowtheFDAwillrespondto a fact,which subsequently affects themateriality of thatfact. Ideally itwouldprovide strategieswherebycompaniescould effectively match the scope of their disclosure to theseverityofFDAcriticismandskepticism.203

Theabovesolutionseemsveryapplicable—andhelpful—toarationalactorwhoisnotswayedbytheeffectsofcognitivedissonance;however,takingthegloballyissuedoptionandparsingitagainsttheconceptsofcognitivedissonance,above,itischallengingtoseethisasasignificantsolutiononacase-by-casebasis.Asconsideredabove,anFDAnoticeisa formofenvironmentalelement. Environmentalelements,asnoted,areexternalandinherentlydifficulttochange.Butthemoreambiguousenvironmental elements are, the easier they become to distinguishbecause the ambiguity creates opportunities to reshape the facts.Therefore, providing clearer FDA guidance may serve to refine theresolutionofinformation,makingitmoredifficulttofalselydistinguishtheinformation.

Alternatively, the second option requires an immensereapportionmentofresourcesonthepartoftheFDA—thisseemstoomuchtoask,givenbudgetconstraints.Butperhapsanamalgamationofthese two concepts: global guidance is issued, and with it a simple

203 FraudorConfusion,supranote90,at1932(emphasisadded).


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frameworkislaidout.Forexample,theguidancewouldindicate(1)thenumberofopportunitiestocorrecttheproblemaffordedthecompany,(2) a simple color code for the severity of the issue, and (3) a cleartimeline of events—perhaps simplified, specific example timelines—then, in conjunction with the global guidance that explains theseelements, the FDA could include specific color coding and timelinerelationshipswitheachnotice.

In the context of ethical actors under the influence of cognitivedissonance, clear,boldwarnings thatmaydisrupt theregular flowofcommunicationcouldservetojartheactoroutofcomplacency.

B.MandatoryFDADisclosuresUndertheSEAAnotherpossiblepath forward is tomandateFDAdisclosures.204

Thiswouldworkbyrequiringeverycompanytodisclose,inaForm8-K,theactionlettersentbytheFDAwithinaperiodoftime(redactionsof intellectual property would be permitted).205 Deterring Fraud:MandatoryDisclosure cites three potential criticisms of this plan: (1)concernswithprotectingproprietarydata;(2)“informationoverload”for investors; and (3) concerns about themarket overreacting to thedisclosure.206Thesemaybevalidreasonsnottoexecutethisplan,but,assuming,arguendo,thattheseareirrelevant,thissolutionstillleavesaglaring flaw: it assumes that the only material information isinformation sent to the companyby the FDA, andnotmessaging thecompanysends to theFDA. As seenabove, theseaction lettersoftenform a sort of “conversation” between the company and the FDA—sometimes the conversation includes actual, verbalized dialogue, aswell.

Still,byrequiringmanagerstodisclosetheseFDAnotifications,thisworkstoeliminateoneofthekeydecisionsthatcanleadtoobjectivecognitivedissonanceinthelifesciencessector. Itdoes,however,stillleave the potential for misrepresentations or omissions in how thebusinessdisclosescommunicationsfromthebusinesstotheFDA.Ifthemandatorydisclosureschemewasextendedtorequirecommunicationsthatoccurbothways,betweenthecompanyandtheFDA,thatmaygoalong way to eliminate potential sticky points for Section 10(b)

204 Liora Sukhatme, Deterring Fraud: Mandatory Disclosure and the FDA DrugApprovalProcess,82N.Y.U.L.REV.1210,1236(2007)[hereinafterMandatory]. 205 Id.at1237. 206 Id.at1239–42.



violations.207Though,ontheflipside,thereisapotentialforincreasedbureaucracyandinformationoversaturationforinvestors.

C.PresumptionofDisclosureA variation on the mandatory disclosure approach would be to

createapresumptionofdisclosure. Thiswouldcreateapresumptionthat,every timetherewasanFDAnoticeorcommunication fromthecompanytotheFDA,thecompanyshouldhavedisclosedareasonablerendition of that communication, allowing for the removal of anyintellectualpropertyortradesecret.Ifthecompanyhascomplied,thenthe burden is on the plaintiff to show that the company clearlymisrepresented a fact—this would allow for significant protectionsagainstpotentialclaimsofmaterialomissionsunderRule10b-5,shouldcompanies comply. If a companyhasnot filed adisclosure, then theburdenwouldshiftbacktothecompanytoshowwhyadisclosurewasnot necessary. This acts as a double-edged knife, serving both as adeterrentandanopportunityforsafeharbor.

Thismaybe seenasamildversionof themandatorydisclosurescheme.Thepermissivenatureofthisplanallowsformoreflexibilityinbusinessmanagement,but,inturn,increasesthepotentialforcognitivedissonancetoenablemanagerstorunafoulofdisclosurerequirementswithout being fully aware of the misalignment. Still, this works toeliminate some bureaucracy, and potentially reduce the number ofdisclosures, versus the mandatory disclosure scheme, that wouldsaturatetheinvestors.Thesafeharboraspectofthisapproachallowsforbusinessesto,inahealthyway,takeadvantageofthislawtotheirown protection while still accomplishing the goal: deterringmisrepresentations.

D.ASpecialDisclosureCommitteeA committee designed after the Special Litigation Committee

(“SLC”)model208couldcreateasafeharboropportunityforcompanies.AnSLCcanbeformedbyimpartial,QualifiedDirectorswhocanassesswhetheraderivativesuitisappropriateagainsttheindividualdirectorsof the corporation—by using impartial Qualified Directors, the SLC

207 Thiswouldneedtoincludeanabilitytoredactsensitive,proprietaryinformationanddata. 208 See MODELBUS.CORP.ACT §§ 1.43, 7.44 (1969) (AM.BARASS’N, amended2020)(defining “Qualified Director” and the “Dismissal” power prescribed to a specialcommitteeofQualifiedDirectors).


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reduces the burden on the court system by eliminating potentiallyfrivoloussuits.209

Fashioning a Special Disclosure Committee (“SDC”) could haveclear benefits by empowering an impartial group to make finaldisclosuredecisions,and,duetotheirimpartiality,offersomelevelofsubsequentliabilityinsulation. Butgiventhattheissueshererevolvearound securities class action litigation—direct actions byshareholders—and not derivative actions, there are some keydifferences,andthus,clearalterationsthatmustbemadebetweentheSLCmodelandatheoreticalSDC.Forinstance,anSDC,unliketheSLC,wouldnotbe capableofdismissing litigation—nor should it.210 Thatbeing said, directors—and thus, Qualified Directors under theModelBusiness Corporation Act (“MBCA”)211—would still have fiduciarydutiestotheshareholders,regardlessofthedirectaction.212 Theendresult would be to create an SDC that—similar to how an auditcommittee requires at least one expert in Generally AcceptedAccounting Principles (“GAAP”)—might have at least one QualifiedDirectorwithalegalbackground—orlegalcompliancecertification—aswell as a Qualified Director who would be deemed an expert inpharmaceuticalsortheFDAapprovalprocess.EachQualifiedDirectorwouldhave(1)fiduciarydutiestotheshareholders,213(2)no“materialrelationship”214withanyofthemanagingdirectors,and(3)shouldnothavea“materialinterest”215inthefirmitself.

The SDC would function by choosing the scope of disclosureconcerning FDA notifications and company correspondencewith theFDA.Iftheproceduresarefollowedcorrectly,thenthepresumption—rebuttable by plaintiff—in any dismissal motion or class actioncertification, is that company directors did not have the requisite 209 Seeid. 210 Providingthepowerofdismissal,evenifitwerepossible,wouldlikelygivetheSDCtoomuchpowertoeliminatelawsuits. 211 SeeMODELBUS.CORP.ACT§§1.43,8.30(“[Q]ualifieddirectors”areadefinedsubsetofdirectors,anddirectorsmustoperate“ingoodfaith”and“inamannerthedirectorreasonablybelievestobeinthebestinterestsofthecorporation.”). 212 Andrew D. Shaffer, Corporate Fiduciary - Insolvent: The Fiduciary RelationshipYourCorporateLawProfessor(ShouldHave)WarnedYouAbout,8AM.BANKR.INST.L.REV.479,490n.39(2000). 213 MODELBUS.CORP.ACT§8.30;seealsoShaffer,supranote212. 214 MODELBUS.CORP.ACT§1.43(b)(1).Ifthedirectorwereotherwiseemployedbythefirmoranotherdirectororhadapersonalorfamilialrelationshipwithanotherdirector,thatwoulddisqualifythedirectorfromservinginthiscapacity.Seeid. 215 MODELBUS.CORP.ACT§1.43(b)(2).Owningsharesshouldnotprecludeadirectorfromservinghere;however,owninganamountofthefirmthat“wouldreasonablybeexpectedtoimpairtheobjectivityofthedirector’sjudgment,”id.,shoulddisqualifysuchapersonfromservinginthiscapacity.



scienter.IftheSDCproceduresarenotfollowed,thensafeharbordoesnot apply. The SDC allows a company toprotect itself and ensure itmakestheappropriatedisclosurestoinvestorsaswell.

Byplacingdisclosureauthorityinanindependentcommittee,theSDC,itwouldmigratethedecisionfrommanagerswhoareentrenchedwith the problem, giving a more objective, third party a differentvantagepointtoseethedisclosureissues.ByeliminatingsomeoftheSDC’spotentialconflictinginterests,theSDC’sprimarymotivationwillbe to make the correct disclosure decision. This could add morebureaucracy, but it also provides an opportunity for a business thatrecognizesitisinariskypositiontoprotectitselfprospectively.

VII.CONCLUSIONTheessentialtakeawayofthisCommentisthatthecombinationof

the current FDA notification process and required SEA disclosurerequirementscreateaperfect stormof circumstances thatencourageactors to obviate their cognitive dissonance by small, step-changeinduction,whichallowsmanagerstodetachthemselvesfromobjectivereality,creatingmaterialomissionsandmisstatementsalongtheway.

While cognitive dissonancemaynot preclude liability under theSEA, Section10(b), it doesdiminish thepotential for themanager toforeseepotentialconsequencesandacttoavoidsaidconsequencesbypositivelychangingtheirbehaviors.Withoutthisclearviewtocausality,the theoreticallypositive effectofdeterrence isdiminished. Offeringbusinesses additional tools, such as the safe harbor of an SDC, or apresumptive disclosure scheme, may allow businesses to be moreproactiveindefendingthesematters. CoordinatingFDAnoticesmoreclosely with SEC disclosure requirements could help to jolt somemanagers from complacency. Without adjustments to the lawssurrounding FDA notifications and the SEC disclosure requirements,small-capitalizedpublic lifesciencesectorcompanieswillcontinuetobreed opportunities for managers to, under the influence of falselyobtainedconsonance,misrepresentandomitmaterialfactstoinvestorswithoutfullycomprehendingtheirconduct.

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Cognitive Dissonance Undercuts Deterrence in the C-Suite