On March 22, 2011, the United States Supreme Court, in a unanimous decision written by Justice Sonia Sotomayor, stated that the “materiality” element of a claim for securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, “is satisfied when 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,’”1 and held that materiality “cannot be reduced to a bright-line rule.”2 The Court ruled that on a motion to dismiss, a court must assess – on a case by case basis – the totality of available information and not focus solely on the presence or absence of a single type of information.
In Matrixx, plaintiffs3 alleged that Matrixx Initiatives, Inc. (“Matrixx”) and three of its executives violated Section 10(b) by failing to disclose adverse event reports regarding a potential link between Matrixx’s leading product, its over-the-counter cold remedy Zicam, and anosmia (loss of the sense of smell).4 “The FDA defines an ‘[a]dverse drug experience’ as ‘[a]ny adverse event associated with the use of a drug in humans, whether or not considered drug related.’”5 Plaintiffs alleged that Matrixx’s positive statements during the class period relating to Zicam’s safety and the company’s anticipated increases in revenues were misleading in light of reports that more than ten patients had lost their sense of smell after using Zicam. Defendants moved to dismiss the complaint, arguing that plaintiffs failed to plead adequately a material misrepresentation or omission and scienter. The United States District Court for the District of Arizona granted the motion to dismiss, holding that the adverse event reports were not material because plaintiffs did not allege that they demonstrated a statistically significant causal connection between the use of Zicam and anosmia.6 The Ninth Circuit reversed, holding that the district court had erred in requiring plaintiffs to allege statistical significance to establish materiality.7 The defendants filed a petition for certiorari, which the Supreme Court granted.
Supreme Court Appeal
Prior to the Supreme Court’s decision, there was division in the federal courts regarding the appropriate standard for materiality in the context of pharmaceutical adverse event reports. The majority of the courts that addressed the issue had concluded that adverse event reports are not material unless plaintiffs can allege that there is a statistically significant causal link between the product and the adverse event.8 By contrast, the Ninth Circuit had rejected the statistical significance standard for evaluating materiality.9
In Matrixx, the Supreme Court affirmed the Ninth Circuit’s decision and rejected the defendants’ argument that there should be a bright-line test turning exclusively on the presence or absence of statistical significance for evaluating the materiality of adverse event reports. The Court explained that in its previous decision in Basic, it had rejected a bright-line rule for establishing materiality, holding that the “materiality requirement is satisfied when 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.’”10
In rejecting the notion that statistical significance is invariably required for materiality, the Supreme Court reasoned that “[g]iven 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.”11 It stated that “[a]s in Basic, Matrixx’s categorical rule would ‘artificially exclude[e]’ information that ‘would otherwise be considered significant to the trading decision of a reasonable investor.’”12 The Court held 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 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,’ supra, at 15.”13
The Supreme Court also stated that materiality is a fact-based inquiry.14 Importantly, the Court noted that “[t]his is not to say that statistical significance (or the lack thereof) is irrelevant – only that it is not dispositive of every case.”15 This suggests that the lack of statistical significance will not automatically result in dismissal of cases, but also that even when there is a statistically significant link, the failure to disclose adverse event reports still may not be material absent sufficient knowledge of a causal link between the adverse events and the drug. Central to the decision is the Court’s conclusion that materiality should be evaluated in light of all of the available information. The Court’s ruling leaves in place the possibility that the lack of statistical significance, along with other facts, may provide the basis for granting a motion to dismiss on materiality grounds and that in appropriate cases, the presence of statistical significance will not insulate a complaint from dismissal.
Notably, the Supreme Court appears to have analyzed the allegations of materiality under the relatively low “plausibility” standard of Federal Rule of Civil Procedure 8(a). It stated that “to survive a motion to dismiss, respondents need only allege ‘enough facts to state a claim to relief that is plausible on its face’” and concluded that plaintiffs in Matrixx had plausibly alleged materiality.16 However, the Court also acknowledged that, in Basic, “[w]e were careful not to set too low a standard of materiality,’ for fear that management would ‘bury the shareholders in an avalanche of trivial information.’”17
Although the Supreme Court applied the Rule 8(a) plausibility standard to allegations of materiality, there is no reason to believe that the Supreme Court abrogated Federal Rule of Civil Procedure 9(b)’s heightened standard for pleading fraud. The decision does not mention Rule 9(b) nor does it anywhere suggest that the legion of cases applying Rule 9(b)’s heightened pleading standard to materiality allegations have now been overruled.18 In addition, the Court recognized that securities fraud cases, such as the Matrixx case, are subject to the Private Securities Litigation Reform Act of 1995 (“PSLRA”), which requires a plaintiff alleging securities fraud to “‘specify each statement alleged to have been misleading, [and] the reason or reasons why the statement is misleading.’”19 The PSLRA also requires a plaintiff to “‘state with particularity facts give rise to a strong inference that the defendant acted with [scienter],’”20 which the Supreme Court has defined as “‘a mental state embracing intent to deceive, manipulate, or defraud.’”21 Post-Matrixx, securities fraud defendants should still argue that all elements of a securities fraud claim must be pled with particularity under the PSLRA and/or Rule 9(b).
Further, the Supreme Court noted that “§10(b) and Rule 10b-5 do not create an affirmative duty to disclose any and all material information.”22 Rather, there is only a duty to disclose when disclosure is required to make other statements not misleading.23 Thus, the Court instructed 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.”24
Applying the Basic “total mix” standard to the specific Matrixx facts, the Supreme Court concluded that the Matrixx plaintiffs adequately alleged materiality because they alleged that Matrixx had undisclosed “information that plausibly indicated a reliable causal link between Zicam and anosmia.”25 The Court noted that “[i]mportantly, Zicam Cold Remedy allegedly accounted for 70 percent of Matrixx’s sales” and stated that “[v]iewing the allegations of the complaint as a whole, the complaint alleges facts suggesting a significant risk to the commercial viability of Matrixx’s leading product.”26 It stated that “[w]e believe that these allegations suffice to ‘raise a reasonable expectation that discovery will reveal evidence’ satisfying the materiality requirement, Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 556 (2007), and to “allo[w] the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.’”27 The Court explained that “Matrixx had information indicating a significant risk to its leading revenue-generating product,” but made positive statements regarding Zicam’s safety and its anticipated increase in revenues.28 Thus, the Court held that the complaint sufficiently alleged a material misrepresentation or omission.29 It also held that the complaint adequately pled scienter, stating that plaintiffs’ “allegations, ‘taken collectively,’ give rise to a ‘cogent and compelling’ inference that Matrixx elected not to disclose the reports of adverse events not because it believed they were meaningless but because it understood their likely effect on the market.”30 The case will now go forward in the district court.
The Supreme Court’s decision notes that materiality is a mixed question of law and fact that must be evaluated on a case by case basis. The Court’s rejection of a bright-line test for materiality in the pharmaceutical context and more broadly does not preclude dismissal at the pleading stage for failure to properly allege the materiality of the alleged misstatement or omission. Motions to dismiss still remain a viable tool to avoid the burden of class action securities litigation, although in the wake of Matrixx, dismissal for failure to allege materiality will in some settings require more nuanced analysis of how the alleged misrepresentation fits into the total mix of information available to investors.