Zafgen, Inc., is a biopharmaceutical company that sells Beloranib, an anti-obesity drug. Following the death of a clinical patient taking Beloranib and the subsequent hold placed on the drug trial by the FDA, Zafgen saw a plunge in its stock prices.

Displeased with the loss, Zafgen’s investors brought a securities fraud class action suit against the company and its chief executive officer, Dr. Thomas Hughes, pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.

The investors claimed that, because Zafgen did not disclose all of the adverse events that occurred during a clinical trial of Beloranib, Zafgen’s common stock was traded at artificially higher prices.

What are the six elements required to recover under Section 10 of the Securities Exchange Act of 1934? This case hinged on the element of scienter.

What is scienter? During the trial, the investors argued that scienter was fulfilled because the defendants “(1) knew, or were reckless in not knowing, about news and scientific articles that purportedly established a ‘link’ between Beloranib and the occurrence of thrombotic adverse event and (2) had a motive to commit securities fraud, as shown by Zafgen’s compensation structure and the ‘heavy’ insider sales that occurred before the patient death.”

Do you think this arguments holds water? Why or why not? If you do not think it does, what evidence would the investor require to successfully plead scienter?