28 March 2011
On March 22, 2011, the United States Supreme Court decided the much-anticipated case Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156. Justice Sonia Sotomayor wrote for a unanimous Court in allowing a securities fraud class action to proceed against Matrixx Initiatives, Inc. and certain executives (Matrixx), the makers of the cold remedy Zicam®. In doing so, the Supreme Court, looking to longstanding securities law, rejected the argument that statistical analyses that do not show “statistical significance” are inherently non-material.
Matrixx makes the Zicam® family of cold remedies, the active ingredient of which is zinc gluconate. According to the complaint, in 1999 and the early 2000s, clinical reports and independent research began to disclose an association between intranasal zinc gluconate and anosmia—a loss of the sense of smell. By the end of 2003, two plaintiffs had sued Matrixx for causing them to lose their sense of smell.
The plaintiffs in this case alleged that Matrixx did not disclose either the earlier suits or the clinical research and reports. In early 2004, Matrixx issued a press release emphasizing the clinical efficacy of zinc gluconate, and the absence of any clinical trial showing a connection with anosmia. However, just a few days later, Good Morning America broadcast a story highlighting the findings of a physician who had discovered more than a dozen patients suffering from anosmia after using Zicam®, and noting that by then four suits had been filed against Matrixx. Matrixx’s stock price plummeted, and a class action, predictably, ensued.
Matrixx’s principal defense was that, while it was aware of reports of adverse events associated with Zicam®, the reports were not material because they did not demonstrate a statistically significant causal link between Zicam® and anosmia. Correlation, after all, is not causation. In the absence of a statistically significant finding, Matrixx argued, the reports were not material, and thus not required to be disclosed.
There was support for the view that the absence of a statistically significant finding of causation, at least in the pharmaceutical context, can defeat the conclusion that adverse information is material. In In re Carter-Wallace, Inc. Securities Litigation, which reached the Second Circuit Court of Appeals twice,1 that court expressly held that “[d]rug companies need not disclose isolated reports of illnesses suffered by users of their drugs until those reports provide statistically significant evidence that the ill effects may be caused by—rather than randomly associated with—use of the drugs and are sufficiently serious and frequent to affect future earnings.”2 Relying in part on In re Carter-Wallace, the district court initially dismissed the case against Matrixx. The Ninth Circuit Court of Appeals reversed; this appeal to the Supreme Court followed.
On its appeal, Matrixx argued that such a bright-line rule as in In re Carter-Wallace was appropriate. The Supreme Court disagreed and rejected Matrixx’s argument, and by implication the straightforward rule expressed by the Second Circuit in In re Carter-Wallace. In doing so, the Supreme Court literally went back to Basic, relying extensively on its seminal decisions in Basic v. Levinson3 and TSC Industries, Inc. v. Northway, Inc.4 The relevant question was not whether in some scientific sense causation had been demonstrated, but whether there was a substantial likelihood that a reasonable investor would consider the information Matrixx omitted to disclose to have significantly altered the “total mix” of available information.
The Court noted that Basic itself found that any approach that designated a single fact or occurrence as always determinative of materiality would be inherently inadequate to such a fact-specific finding. In the pharmaceutical context, the Court noted that “[a] lack of statistically significant data does not mean that medical experts have no reliable basis for inferring a causal link between a drug and adverse events. . . . [M]edical experts rely on other evidence to establish an inference of causation.” Slip op. at 12. The Food and Drug Administration (FDA) also considers a variety of factors in addition to statistically significant findings in controlled clinical trials, and “sometimes acts on the basis of evidence that suggests, but does not prove, causation.” Id. at 123. The Court concluded that: “Given that medical professionals and regulators act on the basis of evidence that is not statistically significant, it stands to reason that in certain cases reasonable investors would as well.” Id. at 15. Matrixx therefore had a duty to update both its rosy earnings forecasts, and its statements describing the link between Zicam® and anosmia as “completely unfounded and misleading” in light of what it knew, or suspected, about its most important product line. Slip op. 19.
Although it rejected any bright-line test for materiality, the Court did state that the “mere existence” of “adverse event reports” does not, without more, demonstrate materiality. The materiality analysis requires consideration of omitted or misstated facts in their larger context. The Court observed that
the mere existence of reports of adverse events—which says nothing in and of itself about whether the drug is causing the adverse events—will not satisfy this [materiality] standard. Something more is needed, but that something more is not limited to statistical significance and can come from “the source, content, and context of the reports.” This contextual inquiry may reveal in some cases that reasonable investors would have viewed reports of adverse events as material even though the reports did not provide statistically significant evidence of a causal link.
Slip op. 16. Here, the plaintiffs pleaded that Zicam® had many problems besides sporadic reports of adverse effects associated with its use. The Court noted that the (not statistically significant) reports existed against a background that included a presentation on the issue to a conference of medical specialists, an FDA warning letter and information that could have informed the FDA’s judgment of whether Zicam® posed a “safety risk.”
Matrixx does not significantly alter the materiality calculus in a general sense, as it seems simply to apply the lessons of Basic and TSC Industries to the pharmaceutical context. Further, it remains accepted that adverse event reports are not enough to create a disclosure obligation, and “something more is needed.” But what that “something more” may be is left for future cases to develop. It is clear that the strong language of In re Carter-Wallace can no longer be relied upon; the mere absence of a statistically significant finding no longer will demonstrate a lack of materiality.
Finally, the Supreme Court considered whether the plaintiffs had adequately pleaded scienter under the Private Securities Litigation Reform Act (PSLRA). The Ninth Circuit had held that the plaintiffs adequately pleaded scienter by alleging “deliberate recklessness.” The Supreme Court assumed, without deciding, that this showing established scienter, and agreed that the plaintiffs’ allegations of deliberate misinformation made “the inference that Matrixx acted recklessly (or intentionally, for that matter) . . . at least as compelling, if not more compelling” than any competing inference. The question of whether recklessness satisfies the scienter requirement for claims under SEC Rule 10b-5 remains unanswered by the Supreme Court.
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||1. 220 F.3d 36 (2d Cir. 2000) and 150 F.3d 153 (1998). |
||2. 220 F.3d 40, quoting 150 F.3d at 157.|
||3. 485 U.S. 224 (1988).|
||4. 426 U.S. 438 (1976).|