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Ciphergen Faces Class-Action Law Suit; Can Plaintiff Prove Company Was Reckless?


A class-action lawsuit filed this week against Ciphergen Biosystems alleges that the company misled shareholders when it reported second-quarter financial results in August. The suit came soon after the company disclosed that its Q2 results should not be trusted because they included improperly recorded revenues.

Though news of the suit and the disclosures that apparently triggered it, have beaten up the company's share price in recent weeks [see chart], a close look at the allegations suggests that plaintiffs could have a difficult time convincing a jury that the company misled its investors.

The suit was filed on Monday by the law firm of Kaplan Fox & Kilsheimer in the United States District Court for the Northern District of California. The day after, the Law Offices of Charles J. Piven issued a press release stating that "a securities class action was commenced" on behalf of Ciphergen shareholders. The release invited investors to contact Charles J. Piven for additional information.

These kinds of suits alleging improper revenue statements are common, and around 95 percent of them are settled out of court.

Ciphergen issued its Q2 earnings results on Aug. 8. On Nov. 7, the company abruptly announced that it had created an audit committee consisting of "external accounting advisors" to investigate around $500,000 in sales that were recorded in that period.

On Nov. 16, Ciphergen said the committee declared that the company's second-quarter earnings report should "no longer be relied upon" and should be restated. The committee also said it would investigate other past quarters for similar errors.

"To date, the [audit] investigation has identified four transactions involving instances of revenue recognition in a manner inconsistent with the company's revenue recognition policy," Ciphergen said in its Nov. 16 statement. "Based on the findings of its advisors and the progress of the investigation to date, the committee believes that these transactions resulted in improperly recognized revenue of $503,000 for the quarter ended June 30, 2005" (see ProteoMonitor 11/18/2005).

Ciphergen said that striking the $503,000 worth of revenue from its Q2 earnings would cause the net loss for the second quarter to increase by approximately $301,000, representing about 3 percent of the company's reported net loss for the quarter.

The class-action complaint alleges that during the period between Aug. 8 and Nov. 16, Ciphergen issued "a series of false and misleading statements" regarding its financial condition, causing its shares to trade at "artificially inflated levels."

"Defendants violated Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 by publicly issuing a series of false and misleading statements regarding the Company's financial condition," a statement issued by Kaplan Fox & Kilsheimer read.

The class-action complaint also notes that as a result of the audit committee's disclosures, the price of Ciphergen stock declined around 21 percent between Nov. 16 and Nov. 17.

Intentional and Reckless Misrepresentation?

Kaplan Fox & Kilsheimer refused to comment on the case. However, lawyers with securities-based class-action experience who are not involved with the Ciphergen litigation said that these kinds of suits alleging improper revenue statements are common, and that around 95 percent of them are settled out of court.

Other times, plaintiffs opt to drop their cases. For instance, last October, at least six law firms filed class-action suits against Iceland's Decode Genetics for allegedly making several "materially false and misleading statements" that artificially inflated its stock price during a 10-month period in 2003 and 2004. Six months later, those charges were universally dropped.

"In the course of litigating these things, each side will assess how strong the case is. Litigation is very expensive, so usually they settle out," one lawyer who is familiar with securities fraud cases said on the condition of anonymity because of rules governing the company for which he works.

In order to win their case, the plaintiffs' lawyers must prove that a link exists between stock prices and the company's alleged misrepresentation, the lawyer added.

"The plaintiffs would have to infer from the pattern of stock prices that [the company's] misstatement had inflated [the company's] stock prices," said Michael Klausner, a professor of corporate law at Stanford Law School.

In Ciphergen's case, its stock declined after the company released its Q2 earnings on Aug. 8, closing down 6.5 percent. The shares continued this descent, sliding a total of 18.7 percent between Aug. 8 and Nov. 4 — the last trading day before Ciphergen said it had formed its audit committee.

However, Klausner said that Ciphergen's decline in share price following its release of Q2 earnings does not necessarily mean that its share price was not inflated.

"It would be harder to prove [that shares were inflated], but [the shares] might have fallen more, and they would have to show that," he said.

Klausner also said that plaintiffs would have to show that the company's misrepresentation of earnings was "intentional" and "reckless."

"Negligence is not sufficient to make out these cases," said Klausner.

Things that will have to be looked at in Ciphergen's case include why the company first misstated its earnings, and why it restated them.

"Were they forced to restate their earnings by an analyst who discovered them on his own, or was an auditor about to discover them? These are facts and circumstances that someone has to look at," said Klausner.

There are a number of ways that a case such as Ciphergen's can be thrown out of court, lawyers noted.

"Not stating a legal claim, not sufficiently alleging something, not alleging sufficient facts to prove under existing law, [and] class not being sufficiently uniform" are all grounds for dismissing a class-action securities fraud suit, said the first attorney.

Ciphergen said it has not responded to the suit.

— Tien Shun Lee ([email protected])

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