The United States Supreme Court recently issued a decision of importance to public companies, especially manufacturers of potentially dangerous consumer products, regarding a Plaintiff's burden in a securities fraud class action when pleading an alleged misrepresentation or omission was material. Matrixx Initiatives Inc., et al. v. Siracusano, et al., No. 09-1156 (March 22, 2011). The Court addressed a manufacturer's argument that FDA adverse event reports, which are not alleged to reveal a statistically significant causal relationship to use of the manufacturer's product, are immaterial as a matter of law. The Court rejected the company's proposed bright-line rule, stating that materiality determinations are "fact-specific" and, in the case of adverse event reports, require consideration of the source, content and context of the reports. The Court further provided interesting guidance on public disclosures. It stated that companies can control what they have to disclose under the securities laws by controlling what they say to the market.
Matrixx Initiatives, Inc. (Matrixx), is a publicly traded manufacturer of over-the-counter healthcare products such as Zicam Cold Remedy (Zicam). Zicam, a nasal spray and gel that used the active ingredient zinc gluconate, accounted for approximately 70 percent of Matrixx's sales. After Zicam's introduction to the market in 1999, Matrixx allegedly received complaints, sometimes accompanied by medical studies, linking Zicam or zinc gluconate to severe or complete loss of smell, also known as anosmia. Until February 2004, Matrixx did not publicly disclose these complaints or conduct any studies of its own to disprove that link.
Despite the signs that its biggest revenue source possibly caused anosmia, Matrixx issued several public statements between October 2003 and February 2004 which failed to disclose the evidence possibly linking Zicam to anosmia. To the contrary, Matrixx stated that Zicam was poised for growth and gave guidance predicting an increase to revenues of 80 percent. Additionally, in response to news that the FDA was looking into complaints that Zicam caused anosmia, Matrixx issued a press release on February 2, 2004, stating that any allegations connecting zinc gluconate and anosmia were "completely unfounded and misleading." Four days later, a nationally broadcast morning show reported on a doctor who found more than a dozen of his patients suffering from anosmia after using Zicam. The Matrixx share price plummeted over 25 percent that same day and several securities class action lawsuits followed.
Lower Courts' Decisions
In the class action lawsuit alleging violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, Plaintiffs alleged that Matrixx made untrue statements of fact and failed to disclose material facts -- the reports of a possible link between Zicam and ansomia -- necessary to make the statements not misleading. Matrixx moved to dismiss, contending that since there was no statistically significant correlation between Zicam and anosmia, Plaintiffs could not allege a material omission or scienter on the part of Matrixx. The U.S. District Court for the District of Arizona agreed with Matrixx. Siracusano v. Matrixx Initiatives, Inc., 2005 WL 3970117, No. CV 04-0886 PHX MHM (D. Ariz. Dec. 15, 2005). The Court of Appeals for the Ninth Circuit reversed, finding that the District Court erred in requiring an allegation of statistical significance to establish materiality and that Plaintiffs had adequately pled both materiality and scienter. Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167 (9th Cir. 2009).
Supreme Court's Decision
In a unanimous decision authored by Justice Sonia Sotomayor, the Supreme Court affirmed the Court of Appeals decision. Relying on its prior decisions in Basic Inc. v. Levinson, 485 U.S. 224 (1988) (Basic), and TSC Industries, Inc. v. Northway, Inc., 426 U.S. 736 (1976) (TSC Industries), the Court rejected Matrixx's suggested bright-line rule on the issue of materiality of nondisclosed information. Instead, the appropriate consideration was "whether a reasonable investor would have viewed the nondisclosed information as having significantly altered the total mix of information made available." The Court noted that "[a]s in Basic, Matrixx's categorical rule would artificially exclude information that would otherwise be considered significant to the trading decision of a reasonable investor." The Court stated that a lack of statistically significant data did not mean medical experts lacked an appropriate and reliable basis for inferring a causal link between a drug and adverse events. Accordingly, "it stands to reason that in certain cases reasonable investors would as well." As a result, assessing materiality would be a "fact-specific" inquiry, as decided in Basic.
In applying this "total mix" test, previously set forth in Basic and TSC Industries, the Court held that Plaintiffs had met their burden of pleading the materiality of Matrixx's omissions. It should be noted that even while declining to accept Matrixx's bright-line rule for materiality, the Court emphasized "§10(b) and Rule 10b-5(b) do not create an affirmative duty to disclose any and all material information." The mere existence of an adverse report might not be enough to require disclosure under a 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," the Court stated, citing Basic. In a more summary fashion, the Court also rejected Matrixx's argument that Plaintiffs failed to adequately plead scienter, stating, "Matrixx's proposed bright-line rule requiring an allegation of statistical significance to establish a strong inference of scienter is just as flawed as its approach to materiality."
Impact of Matrixx
In Matrixx the Court reaffirmed its "total mix" test and provided no bright-line rules to a public company regarding the possible materiality of omissions. However, it is clear that relying on something being statistically insignificant will not prevent securities fraud liability. This throws into question other accepted materiality metrics for financial information, such as the longstanding assumption that any variance under five (5) percent would not be deemed material. Now, a company must consider the significance of the adverse information in the context of all relevant information, including the company's disclosures.
In addition, the Supreme Court found it significant that this product accounted for 70 percent of Matrixx's sales. Without any bright-line comfort, companies should exercise caution in the extent and amount of their disclosures and consider disclosing less, lest they be found to be required to disclose even when the likelihood of adverse events appears small. As noted at the beginning of this Alert, companies can avoid being hung on their own petard by controlling the level of disclosures, which might thereafter require further disclosures to avoid liability.