In a unanimous March 22, 2011 opinion by Justice Sonia Sotomayor, the U.S. Supreme Court rejected the argument of Matrixx Initiatives that adverse product reports must be "statistically significant" in order for a manufacturer to have an obligation to disclose the reports to investors. As a result of the Court’s decision, shareholders claims against the company for its alleged failure to disclose reports that its Zicam cold remedy caused loss of smell for some users will now be going forward. The Court’s opinion can be found here.
Matrixx Initiatives manufactured an internasal cold remedy called Zicam. In April 2004, plaintiff shareholders filed a securities class action lawsuit against Matrixx and three of its directors and officers, alleging that the defendants were aware that numerous Zicam users experienced loss of the sense of smell. The complaint alleges that the defendants were aware of these problems because of calls to the company’s customer service line; because of academic research, which was communicated to the company; and because of product liability lawsuits that had been filed against the company.
The district court granted the defendants’ motion to dismiss, finding that the complaint failed to adequately allege that the alleged omissions were material, because the complaint did not allege that the number of customer complaints was "statistically significant."
As discussed at greater length here, on October 28, 2009, the Ninth Circuit reversed the district court, holding that the district court "erred in relying on the statistical significance standard" in concluding that the complaint did not meet the materiality requirement. The Ninth Circuit said that a court "cannot determine as a matter of law whether such links [between Zicam and loss of smell] was statistically significant, because statistical significance is a matter of fact." The defendants filed a petition for a writ of certiorari to the U.S. Supreme Court, and as discussed here, the Supreme Court granted the petition.
In their briefs before the U.S. Supreme Court, Matrixx urged the Court to adopt a "bright line" test that reports of adverse events with a pharmaceutical company’s produce cannot be material absent a sufficient number of reports to establish statistical significance. Matrixx argued that statistical significance is the only reasonable indicator of causation.
The Court declined to adopt the bright line test urged by Matrixx, reasoning that such a categorical rule would "artificially exclude evidence that would otherwise be considered significant to the trading decision of a reasonable investor."
The Court also rejected the notion that only statistical significance in the only reasonable indicator of causation, noting that medical professionals and the FDA regularly infer a causal event between a drug and adverse event. Justice Sotomayor wrote that "Given that medical professionals and regulators regularly act on the basis of evidence of causation that is not statistically significant, it stands to reason that in certain cases reasonable investors would as well."
This conclusion does not however mean that pharmaceutical companies have to disclose every adverse event. Rather, an adverse event is material and must be disclosed, the Court said citing its standing test for materiality, if it would "significantly alter the total mix of information." The "mere existence" of adverse reports "will not satisfy this standard." Rather, "something more is needed -- but "something more" is "not limited to statistical significance." and "can from the source, context and context of the reports."
Justice Sotomayor reiterated, however, that absent a duty to speak, silence cannot be the basis of securities liability. Disclosure is only required when necessary to make previous statements not misleading; "Even with respect to information that a reasonable investor might consider material, companies can control what they have to disclose under these provisions by controlling what they say to the market."
Applying this total mix standard to this case, the Court concluded that the loss of smell reports of which the plaintiffs allege the defendants were aware, "the complaint alleges facts suggesting a significant risk to the commercial viability of Matrixx’s leading product." "This is not a case about a handful of anecdotal reports, as Matrixx suggests," Sotomayor wrote. She added the investors intend to prove that "Matrixx received information that plausibly indicated a reliable causal link between Zicam and anosmia," the medical term for a loss of smell. At its most basic level, the Supreme Court’s decision in the Matrixx Initiatives case is essentially just a reaffirmation of its prior case authority dealing with the question of materiality. In particular the Court reiterated its prior statement of the standard for materiality in the Basic, Inc. v. Levinson case and TSC Industries v. Northway. "companies can control what they have to disclose under these provisions by controlling what they say to the market "
The Court also found the plaintiffs’ allegations were sufficient to satisfy the requirements for pleading scienter. The Court noted that it has not yet determined whether recklessness along is sufficient to satisfy the scienter requirements, saving that question for another day.
Viewed in that light, the decision may not be all that surprising. Just the same, there is something a little bit unexpected about this decision. The unanimous opinion represents a clean sweep for the plaintiffs, which given this Court’s track record arguably is an unexpected outcome. The Supreme Court has produced a number of decisions highly favorable to defendants in recent years, and while that has not been entirely uniform (there was the Merck decision last term for example), the Court has seemed to have a predisposition for the defense perspective.
By rejected the proposed "bright line" test , the Court has relieved plaintiffs of the burden of having to come up with sufficient facts to prove statistical significance. The lack of a bright line test may, however, represent something of a challenge for reporting companies going forward. Manufacturers receive "adverse event reports" in the form of customer complaints all the time. A bright line test would have clarified when the number of reports has reached a sufficient level that they must be disclosed. In the absence of such a clear standard, companies will face quite a struggle in trying to figure out what must be disclosed.
Once place companies may want to turn for guidance is the statement in Justice Sotomayor’s opinion that "companies can control what they disclosre under these provisions by controlling what they say tot he market."This statement suggests to me that the judicious use of precautionary disclosure may go a long way toward alleviating disclosure challenges.
Special thanks to my friends in the Securities Litigation group at Skadden Arps for alerting me to the Matrixx Initiative decision and for sending me a copy of their analysis of the decision (hewww.skadden.com/newsletters/Supreme_Court_Rejects_Bright_Line_Test_for_Materiality.htmlre)