The recent U.S. Supreme Court decision in Matrixx Initiatives, Inc. v. Siracusano affects all publicly traded companies in materiality determinations.
The Court found that statistical significance alone is not required to determine whether information is material, but rather that materiality depends on a contextual analysis. In this case, the plaintiffs alleged that Matrixx violated Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, by failing to disclose a possible link between Matrixx’s leading product, Zicam Cold Remedy, and the loss of smell. This failure to disclose, plaintiffs alleged, rendered Matrixx’s statements misleading.
Between 1999 and 2004, Matrixx received reports from medical experts and researchers that indicated a possible link between Zicam use and loss of smell; four related lawsuits were also filed against the company. In October 2003, Matrixx publicly stated that it expected revenues to increase more than 50 percent. In January 2004, it indicated that it expected an 80 percent increase. At the time, Zicam was Matrixx’s leading revenue-generating product.
In January 2004, when the Food and Drug Administration said it was investigating complaints that a Matrixx over-the-counter cold medicine might be causing a loss of smell, the company issued a press release stating that allegations that intranasal Zicam products caused loss of smell were unfounded and misleading. Matrixx issued a similar press release after a Good Morning America report in February 2004.
To prevail on a claim that Matrixx made material misrepresentations or omissions in violation of Section 10(b) and Rule 10b-5, plaintiffs must demonstrate (1) a material misrepresentation or omission, (2) scienter, (3) a connection between the misrepresentation or omission and the purchase or sale of a security, (4) reliance on the misrepresentation or omission, (5) economic loss, and (6) loss causation. Only the first two factors, material misrepresentation or omission and scienter, were at issue in this case.
Matrixx argued that “adverse events associated with a pharmaceutical company’s products cannot be material absent a sufficient number of reports to establish a statistically significant risk that the product is in fact causing the events.” Absent statistical significance, Matrixx argued, such reports are only anecdotal evidence that the user experienced an adverse event.
The Supreme Court, deciding the case on March 22, 2011, rejected that argument, refusing to establish a bright-line materiality test. The test for determining materiality remains “whether a reasonable investor would have viewed the nondisclosed information as having significantly altered the total mix of information made available.” The Court clarified 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.”
The Court noted that Matrixx had reports from three medical professionals about 10 patients who experienced adverse events, had received previous studies demonstrating a biological link between intranasal application of zinc and loss of smell, and had not conducted any of its own studies. The Court also noted, in deciding that investors would likely have considered this information significant, that Zicam Cold Remedy allegedly accounted for 70 percent of Matrixx sales.
The Court concluded that the plaintiffs had adequately pleaded scienter (intent). Matrixx had hired a consultant to review the product, asked one of the complaining medical experts to participate in animal studies, convened a panel, and prevented one of the complaining medical experts from using Matrixx’s name in a presentation. Further, Matrixx issued a press release suggesting that studies confirmed that Zicam does not cause loss of smell although it had not conducted any studies related to loss of smell and the scientific evidence at the time was inconclusive. The Court determined, “Matrixx elected not to disclose the reports of adverse events not because it believed that they were meaningless but because it understood their likely effect on the market.”
The materiality analysis has always been fact-specific, but following Matrixx, it is more so, and there do not appear to be any general rules of thumb. When evaluating materiality, it is critical to consider all of the facts and circumstances. Although one or two facts may not support a determination of materiality individually, Matrixx demonstrates that, when considered in the aggregate, there may be sufficient reasons that such facts are material. This evaluation is critical for companies of all industries, not just life sciences companies. Regarding disclosure, the Court emphasized that “Section 10(b) and Rule 10b-5 do not create an affirmative duty to disclose any and all material information. Disclosure is required under these provisions only when necessary 'to make … statements made, in the light of the circumstances under which they were made, 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.”
Matrixx has significant implications for companies that make voluntary statements, such as through issuing earnings guidance or a press release related to a positive event. If a company chooses to make a voluntary statement, it may also undertake a duty to update such information, and would have to monitor changing facts and, possibly, disclose negative information. However, if the company does not voluntarily disclose information in this manner, it would have more flexibility in the timing of disclosure. Thus, a more conservative approach would be to refrain from making voluntary statements. But if a company chooses to do so, it should carefully balance the information and not overemphasize positive events.
Finally, it will be more difficult to get complaints dismissed. Plaintiffs will likely allege a broader list of facts and circumstances in an effort to show, in the aggregate, that the defendant made material misstatements or omitted material information.