Cellceutix (CTIX) announced on June 8, 2016, that the U.S. District Court for the Southern District of New York has granted the motion to dismiss, with prejudice, the class action suit brought against them by plaintiff Greg Zagami and represented by The Rosen Law Firm. The 39-page written opinion by the court dismantles each and every argument presented by Rosen, citing supportive case precedent and further ordered that the claims presented have no merit, and as such, the case shall not be re-filed.
For Cellceutix, shareholders have hope that management will not allow this perceived attempt of lawsuit-based extortion to end peacefully. Rather, many feel that Cellceutix should aggressively pursue sanctions against Rosen, seek the return of all legal costs associated with the case and pressure the SEC, FBI and U.S. Postal Service to continue a vigorous investigation to determine if any communication between The Rosen Law firm, Mako Research and the lead plaintiff, Gary Zagami had occurred prior to the publishing of an article by Mako Research on August 6, 2015.
If leveraged properly, the decision by the court has the potential to limit the way the legal system can be used to exploit small companies who fall victim to providing an unnecessary defense against frivolous lawsuits. Many acquiesce to the path of least resistance and settle a case instead of undertaking a litany of costly and time-consuming legal filings, which incentivize a settlement rather than a defense. In its decision, though, the court cited extensive case precedent that admonished the "weak" claims that were made by The Rosen Law Firm. Because the court was meticulous in lining out its written decision, these well-versed precedents can be argued by the next victims faced with apparent frivolous accusations and far reaching claims of intentional deception.
In reviewing the past cases that The Rosen Law Firm has settled, it is apparent that they invoke the same method of attack on others as they used on Cellceutix. The firm relies heavily on sections 10b and 20(a) of the Securities Exchange Act alleging that a company has provided materially false and misleading financial information to shareholders.
Of the 60 cases presented on The Rosen Law Firm website under the "Recent Successes" tab, Rosen utilized Sections 10b and 20(a) of the 1934 Securities Exchange Act no less than 40 times and raked in settlements in excess of $179 million for the 60 cases listed on their website. Many of these cases were settled without trial and the preponderance of settlements were within the range of between one and two million dollars. Coincidentally, Greg Zagami, the plaintiff in the Cellceutix case also served as the lead plaintiff in another Rosen case filed against Natural Health Trends Corporation, a case that settled for $2.75 million, payable to class members after legal fees and expenses. Zagami and two other lead plaintiffs were awarded $200,000, plus interest.
Certainly, there can be no argument against some of those cases having factual validity. However, it is also fair to state that many of these companies, who were not guilty, lacked the resources to vigorously defend themselves in a costly legal battle. In the United States, the vast majority of civil actions are settled out of court and prior to trial. Estimates run as high as 90% of all civil lawsuits settled in this manner. Sadly, for small and emerging companies, a settlement of one million dollars to avoid a costly class action battle is a preferred alternative
For class action cases, an interesting study was prepared by Mayer Brown, LLP. In her study, she analyzed 148 class action cases and found some interesting results. Within her data set, she found that in the majority of cases, settlements provided little to no benefit to the plaintiff or the represented class. The predominant financial rewards went to the attorneys who represented the cases, often enriching themselves though legal fees and costs associated to the case.
Interestingly, not one of the 148 cases ended in a decision that favored the plaintiff case on an award of merit. Only 14% of the cases went beyond one year, with approximately 20 cases still pending after a four-year period, without resolution or a determination as to whether those cases had merit to continue as a class action case. Her study demonstrated that the consistent winners of any class action lawsuit are the attorneys, not the certified class. Although, as seen in Zagami vs. Natural Health Trends Corp., lead plaintiffs might have incentive as well.
It is statistics like those that have many people questioning the state of the legal system in the United States. The enormous costs and time necessary to defend against frivolous action is almost cost prohibitive to many small and emerging companies. Public companies, who often tap the capital markets for required operating funds become easy prey to unscrupulous legal firms who expose semantics in language as a legal cause.
They prey upon the inability of a company to make specific proclamations as to how much money they will earn, the exact amount of funds needed for future development and for their inability to factually predict the future of financial or clinical results. Sound absurd? Well, those are some of the precise arguments made by Rosen against Cellceutix. Thankfully, the dismissal order stopped the nonsense.
For Cellceutix, management can finally begin to focus exclusively on its clinical trials and the strategies necessary to perpetuate the studies. With the Rosen case now history, the company should have greater opportunity to engage a partner or to seek mainstream financing instead of relying on the funding agreement with Aspire Capital, which can be significantly dilutive to the outstanding share count.
There is some sentiment that Aspire is a "white knight" and is at the mercy of Cellceutix management due to their requirement to purchase shares of company stock at a time determined by Cellceutix. The reality of these stock purchase agreements is that they have historically caused a depression to the share price. Aspire has incentive to keep share prices low to mitigate potential risks, while conversely, a higher share price is at the benefit of Cellceutix. Ironically, although the two companies are working together, the two strategies do not align.
For those that see Aspire as a fair and balanced agreement, think for a moment as to whether Aspire would expose themselves to a situation whereby they could be required to purchase one million shares for $20.00 each. After all, that is what the agreement states. Cellceutix can sell stock to Aspire on a weighted average price for a stated number of trading days. Does any investor truly believe that Aspire would be so naive as to create such an unbalanced agreement? The exposure is simply too significant for Aspire to be backed against the wall and be susceptible to purchase stock due to market manipulation. They simply would not leave unmitigated exposure.
The Aspire agreement is appropriate to discuss because it was perhaps the only way the company could come to terms in securing future funding draws. Similar to Ocata Therapeutics though, Cellceutix, with this lawsuit behind them, can be in a position to seek traditional methods of financing, as Ocata did when it secured Silicon Valley Bank. The agreement with Silicon Valley replaced a strikingly similar deal that Ocata management had in place with Lincoln Park Capital Fund.
Now, with the case behind them and the exposure mitigated from future class action loss, Cellceutix should seek new financial partners or mainstream outlets that are willing to lend the company money on traditional and equitable terms, relying on the recent clinical trial updates as a foundation to support a traditional funding placement.
The class action case was an obvious overhang, with many shareholders citing it as the cause for the continued pressure on the stock. But, even with the dismissal, the stock failed to gain any substantial traction on the trading day when the news was released. Volume remained at average levels and except for an early morning spike of 9%, the news of the case dismissal failed to ignite the stock to regain its price levels prior to the Mako piece and subsequent lawsuit. As I stated just a few days ago in a prior article, this case was an overhang, but not to the extent that many investors might have thought.
And although many debate my call and need of a partnership for Cellceutix, the language in the dismissal opinion clearly reiterates that management's statements in its SEC filings indicate that the company will need substantial amounts of money to fund future operations. The company itself has provided ample warning to shareholders to expect significant dilution in the near future.
But, this does not have to be the case. They have strategic options.
First, Cellceutix should aggressively request the court to provide relief for any and all damages caused by the frivolous filing. This can be through sanctions against The Rosen Law Firm.
Second, management should aggressively seek partnerships to fend off the need to dilute the outstanding share count and lessen the need to tap the Aspire equity. The Prurisol results are ripe for a partnership and taking advantage of these results are an opportunity that management should seize upon.
Subsequent to the case dismissal, the potential of a partnership becomes more likely to consummate. Now that the door to injustice has been closed, management should confidently approach potential partners and offer them an opportunity to take advantage of a $13 billion psoriasis market, offering an oral compound that has favorable comparisons to the leading drug on the market, Otezla.
This dismissal is far bigger than the share price reaction has indicated. Markets sometimes invest ahead of news, sometimes they sell the news and sometimes they digest it before bidding a stock in either direction. This dismissal, however, cannot and should not be underestimated in its importance going forward. The courts recognized the reported data as accurate and found no evidence of misleading or inaccurate statements made by management. This is extremely important as the company moves forward in its clinical trials. To have each and every claim made by Rosen dismissed by the court is a resounding victory.
Realistically, an expectation could have been plausible that at least one of the plaintiff's claims had merit, but this was not the case. The plaintiff and its representation took what many believe to be an embarrassing hit and if Cellceutix continues the fight, this case is far from over.
Just as authors use method writing in their prose, I recognize a pattern that was exposed in the Rosen filing. The use of sections 10b and 20(a) allow for a wide latitude of speculation and innuendo. Because of this, many courts have allowed even frivolous cases to move beyond an appropriate dismissal action. However, with the judge taking precise aim at Rosen in this case and providing substantial precedent in the granting of a dismissal order, the weaknesses in the Rosen model may have been exposed. (Click the hyper link above referencing the "recent successes" on the Rosen site to view the patterns and similarities.)
Going forward, companies should eagerly exploit the precedent cited by the judge, employing the will to defend themselves rather than settling quickly to avoid litigation. Regardless of whether insurance companies brunt the cost of some of these financial losses, companies should stand up to the bully pulpit that many class action law firms have enjoyed without much sanction. Litigation reform should be at the forefront of future legislative sessions. However, with the strong lobby group presented by the legal profession, significant changes are unlikely.
If at the very least, reform was legislated that required the losing party to pay all legal costs of the prevailing party, many cases, such as the case brought against Cellceutix, would never have been filed. Of the 60 cases presented on the Rosen cite, potentially millions of dollars in settlements might have been avoided. But, until such reform is enacted, small and developmental stage companies like Cellceutix remain in the cross hairs of the law firms more intent on case settlement than they are about maintaining a level of decency and integrity within the field.
Judges must be willing to adjudicate significant sanctions upon those firms that continue to file cases, which are found to have little to no merit, admonishing firms that should have the legal expertise to refrain from such frivolous attempts at settlements. Until these sanctions are handed down by the courts, the fate of unnecessary litigation will tread onward.
I applaud the Cellceutix management team for taking an aggressive stand in this case, never wavering from its commitment to shareholders or from its commitment to the science and results of its trials. It is prime opportunity to regain momentum and drive the share price higher.
It became obvious that this decision alone will not drive the share price higher. The ball is now in management's court to determine what they need to do to provide shareholder value and demonstrate that the science and data they are proving in clinical trials is as strong as the court determined it to be.
Disclaimer: Not all lawyers are bad. Not all lawyers are good. Some are ethical and some are not. This article is my opinion and does not intend to place The Rosen Law Firm in any particular category. The judge in the District Court of New York provided the best opinion about the case brought against Cellceutix. Investors should rely on that opinion.
Disclosure: I am/we are long CTIX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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