On March 22, 2011, the Supreme Court of the United States issued an important opinion for life sciences companies in Matrixx Initiatives, Inc., et. al. v. Siracusano et. al., a class action securities lawsuit involving Matrixx's leading product, Zicam Cold Remedy. The Court held that a plaintiff may allege a material misstatement or omission under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 due to a company's failure to disclose medical adverse event reports even though the reports are not statistically significant.
Plaintiffs alleged that during late 2003 and early 2004 Matrixx made materially false and misleading statements regarding its Zicam Cold Remedy products. At the time, these products accounted for approximately 70% of Matrixx's revenues, and Matrixx issued optimistic forecasts that revenues and profits would increase significantly during 2004. Although Matrixx's Quarterly Report on Form 10–Q filed with the SEC in November 2003 included cautionary statements of the potential material adverse effect that could result from product liability claims "whether or not proven to be valid" and that product liability actions could materially affect Matrixx's "product branding and goodwill ... leading to reduced customer acceptance" it failed to specifically disclose that two plaintiffs had already sued Matrixx for allegedly causing them to lose their sense of smell (anosmia).
When news of dozens of adverse event reports and studies purporting to link Zicam to anosmia surfaced, as well as a report that the FDA was investigating the issue, Matrixx's stock price plummeted. It issued a press release rejecting any causal link between its products and anosmia and asserting that the safety of Zicam's active ingredient (zinc) was well established. The stock price rebounded. After additional press reports, Matrixx largely repeated its earlier press release. However, as Matrixx later acknowledged, at the time of its releases it had received reports from medical professionals that Zicam users had suffered anosmia while using the product, as well as studies of a biological link between Zicam's key ingredient and anosmia. Moreover, it had not conducted any studies of its own to prove or disprove that link. In fact, Matrixx later revealed that the available scientific evidence was insufficient to determine whether there was or was not a causal relationship between the active ingredient in its product and anosmia.
Lower Court Proceedings
Plaintiffs filed suit alleging that Matrixx failed to adequately disclose to the public the details of the adverse event reports and related allegations that the products caused consumers anosmia, as well as non-disclosure of the pending related product liability lawsuits.
In seeking to dismiss the complaint, the defense argued that the reports of drug reactions and side effects were merely "anecdotal" and thus an insufficient basis on which to provide disclosure to investors. The district court agreed, holding that the plaintiffs had failed to allege both the required material misstatement and scienter elements for Rule 10b-5 liability because they had not pled that Matrixx knew of a statistically significant relationship between use of the Zicam Cold Remedy product and the adverse events in question. The Ninth Circuit reversed and on appeal Matrixx asked the Supreme Court to adopt a bright-line test that omissions about adverse event reports could not be actionable unless plaintiffs establish a statistically significant correlation between the adverse event reports and the product in question.
The Supreme Court's Decision
In affirming the Ninth Circuit's ruling, the Supreme Court rejected a bright-line statistical significance test for materiality and reaffirmed the Federal securities law test for materiality originally set forth in TSC Industries, Inc., v. Northway, Inc., 426 U.S. 438 (1976) and Basic Inc. v. Levinson, 485 U. S. 224 (1988). Information is material if there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." In Basic the defendant allegedly made misleading statements denying that it was engaged in merger negotiations when it was, in fact, conducting preliminary negotiations. The defendant sought a bright-line rule that preliminary merger negotiations are material only once the parties reach an agreement in principle. The Court rejected this bright-line test in favor of a fact-specific inquiry, and observed that "[a]ny approach that designates a single fact or occurrence as always determinative of an inherently fact-specific finding such as materiality, must necessarily be overinclusive or underinclusive." The Basic Court explained that the proposed rule on preliminary merger negotiations, would "artificially exclud[e] from the definition of materiality information concerning merger discussions, which would otherwise be considered significant to the trading decision of a reasonable investor."
In Matrixx the defense argued that, absent statistical significance, adverse event reports provide only anecdotal evidence that the user of a drug experienced an adverse event at some point during or following the use of that drug. Matrixx argued that such anecdotal reports of adverse events associated with a company's drug products cannot be material absent a sufficient number of such reports to establish a statistically significant risk that the product is in fact causing the events. Matrixx further contended that reasonable investors would not consider such reports relevant unless they are statistically significant because only then do they "reflect a scientifically reliable basis for inferring a potential causal link between product use and the adverse event."
In a unanimous opinion authored by Justice Sotomayor, the Court disagreed. Applying a fact-based inquiry into the source, content and context of the information known to Matrixx at the time of its statements, the Court determined that the undisclosed facts were properly pleaded material omissions under Rule 10b-5. In the Court's view, rather than being a case about a handful of anecdotal reports, "[t]he information provided to Matrixx by medical experts revealed a plausible causal relationship between Zicam Cold Remedy and anosmia. Consumers likely would have viewed the risk associated with Zicam (possible loss of smell) as substantially outweighing the benefit of using the product (alleviating cold symptoms), particularly in light of the existence of many alternative products on the market. Importantly, Zicam Cold Remedy allegedly accounted for 70 percent of Matrixx's sales." The Court took the facts to suggest "a significant risk to the commercial viability of Matrixx's leading product" at a time when it was forecasting strong, continuing revenue and profitability growth. Quoting TSC Industries and Basic, the Court said that in that context "it is substantially likely that a reasonable investor would have viewed this information as having significantly altered the 'total mix' of information made available."
Thus, the Court not only applied Basic to the Matrixx facts to determine that plaintiffs had satisfied their procedural burden with respect to pleading materiality under Rule 10b-5, but it also rejected as inconsistent with Basic the defense's proposition that Rule 10b-5 requires statistically significant evidence of a causal relationship. The Court stated that Matrixx's categorical rule relating to statistical significance would "artificially exclud[e]" information that "would otherwise be considered significant to the trading decision of a reasonable investor." The Court rejected the premise underlying Matrixx's argument that evidence of statistical significance was the only reliable indication of causation with respect to important drug-related decisions. The Court further noted that the decisions of the FDA and medical professionals, as well as expert testimony in Federal court, can be made or given on the basis of a wide range of evidence and that such evidence is not limited to instances in which statistical significance has been established or causation has been proven definitively. The Court stated:
Given that medical professionals and regulators 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. As Matrixx acknowledges, adverse event reports "appear in many forms, including direct complaints by users to manufacturers, reports by doctors about reported or observed patient reactions, more detailed case reports published by doctors in medical journals, or larger scale published clinical studies." As a result, assessing the materiality of adverse event reports is a "fact-specific" inquiry. Basic … requires consideration of the source, content, and context of the reports. This is not to say that statistical significance (or the lack thereof) is irrelevant—only that it is not dispositive of every case.
Accordingly, the Court rejected the bright-line test and held that it is possible for a plaintiff to state a claim for material misrepresentation or material omission relating to the non-disclosure of adverse event reports in a fraud claim under §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 even though the reports are not alleged to be statistically significant.
Finally, the Court went on to similarly reject a bright-line statistical significance test for scienter. Given the procedural stage of the case, and thus taking the collective facts alleged by plaintiffs to be true, and applying the principles enunciated in Tellabs, Inc. v Makor Issue & Rights, Ltd., 551 U.S. 308 (2007), the Court found there to be at least as plausible a basis for inferring that Matrixx acted at least recklessly, if not intentionally, as any opposing inference that could be drawn from the facts.
Matrixx's rejection of the bright-line statistical significance test has important implications for life sciences companies. Although the Court noted that Basic's "total mix" standard does not mean that drug manufacturers must disclose all reports of adverse events and that "something more is needed," which can come from "the source, content, and context of the reports," the decision will undoubtedly increase the already intense pressure on life sciences companies with respect to disclosures about potential product liability matters. And, it seems reasonable to predict that plaintiffs may seek to base claims on the nondisclosure of adverse event reports, and that such cases may be more difficult to dismiss at the pleading stage.
In rejecting the statistical significance test for materiality and scienter, the Court generally did not break any significant new ground in its opinion. In essence, the Court confirmed that there are no "short-cuts" to good disclosure practices. It did, however, provide some helpful reminders of the limits of §10(b) and Rule 10b–5. The Court noted that these provisions do not create an affirmative duty to disclose any and all material information. Justice Sotomayor wrote that "[e]ven 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." Thus, when speaking to the investing public, companies may want to consider enhanced, specific meaningful cautionary statements and specific risk factors in their disclosures. In light of Matrixx, companies should note that rote reliance on generic risk factors may be insufficient when specific risks are known and not disclosed. In fact, life sciences companies may want to consider disclosing possible side effects of their products even where such effects cannot be proven by statistically significant scientific evidence.
Matrixx also reinforces that when faced with negative press reports, companies should be careful how they respond. The Court seized upon Matrixx's statements that concerns about the safety of Zicam were "completely unfounded and misleading" given that Matrixx was in fact already aware of medical adverse event reports and had not tested the purported causal link of its active ingredient to anosmia. Under the circumstances a more cautious statement by Matrixx might have provided some additional measure of protection.