At what point must a pharmaceutical company (or any public issuer) disclose reports of "adverse" events associated with its products in order to avoid federal securities liability? Must the company disclose after it receives only a handful of complaints out of the thousands of products sold? Or are a few anecdotal reports of problems sufficient to allow an entire class of shareholders to proceed with a multimillion-dollar lawsuit against the company for failure to disclose? As explained below, the United States Supreme Court's answer is that there is no bright-line rule and that the timing of disclosure "depends" on a host of factors.

On March 22, 2011, the Supreme Court decided Matrixx Initiatives, Inc. v. Siracusano,1 a class action brought under the federal securities antifraud provisions2 by Matrixx's shareholders based on the company's alleged failure to properly disclose that certain users of Matrixx's product Zicam Cold Remedy were reporting that the zinc-based drug could cause anosmia (a loss of the sense of smell). In upholding the Ninth Circuit's decision to allow the case to proceed past the early pleading stage, Justice Sotomayor wrote for the Court that "the materiality of adverse event reports [on pharmaceutical products] cannot be reduced to a bright-line rule." Finding that shareholders had raised sufficient claims "plausibly suggesting that reasonable investors would have viewed these particular reports as material," the Court further held that the shareholders had made a sufficiently strong showing of scienter - which means that the company acted with the required intentional or reckless state of mind in failing to disclose the adverse reports.3

The trial court originally dismissed the case, agreeing with Matrixx that the shareholders had not alleged a "statistically significant correlation between the use of Zicam and the anosmia so as to make failure to public[ly] disclose complaints . . . a material omission." Rejecting the idea that "statistical significance is the only reliable indication of causation" of product problems, the Court noted that medical experts typically rely on other evidence to establish an inference of causation, and that a lack of such statistically significant data does not necessarily doom the shareholders' claims. Assessing the materiality of adverse event reports is a "fact-specific" inquiry, and, while statistical significance (or the lack of it) is not irrelevant, courts need to look at all relevant factors.

The Court was quick to remind that there is no affirmative duty to disclose even material information, unless such disclosure is needed to make any statements already made not "misleading." The Court also stated that it did not wish to set too low a standard of materiality for fear that management would "bury the shareholders in an avalanche of trivial information" and stated that pharmaceutical manufacturers need only disclose those adverse reports that a reasonable investor would have found to have "significantly altered" the total mix of information available in the market. The mere existence of adverse reports is not enough - "[s]omething more is needed, but that something more is not limited to statistical significance and can come from the 'source, content and context of the [adverse] reports.'"

Applying its framework, the Court found that information available to Matrixx concerning Zicam was not merely "anecdotal" but "plausibly indicated a reliable causal link between Zicam and anosmia." The information included reports from medical professionals and researchers that more than ten patients had lost their sense of smell, that four product liability suits had been filed, and that two prominent researchers had presented their findings linking Zicam with anosmia. Further, the company itself had not begun a study of these complaints despite their prevalence.

Given that Zicam was Matrixx's "leading product" and accounted for 70 percent of Matrixx's overall sales, the Court found that its public statements (that revenues were going to rise 50 and then 80 percent and that reports linking Zicam to anosmia were "completely unfounded and misleading") were misleading for failing to also disclose that Matrixx had evidence of a biological link between Zicam and anosmia and that it had not conducted any studies of its own to disprove that link.

More surprising may be the Court's holding that the shareholders had pled a "strong" case that Matrixx acted with scienter, which is the intent to defraud shareholders by way of "deliberate recklessness" in its statements.4 Balancing the competing inferences of scienter, the Court found that several collective factors - including a "sufficient concern" internally about a possible causal connection, the hiring of experts to review the issue, the company's precluding the use in an independent study of the Zicam name, and, most important, statements that the company had done studies discrediting a causal connection when no such studies had in fact occurred - sufficiently indicated Matrixx's intentional or reckless behavior. Rather than electing not to disclose the adverse reports because Matrixx believed the reports to be "meaningless," the Court drew the strong inference that Matrixx did not disclose the reports because "it understood [the reports'] likely effect on the market."

What are the takeaways from the Matrixx decision for pharmaceutical companies? Most important, they must continue to track and review carefully customer complaints. Even a small number of claims may lead to securities fraud liability - it is not enough to consider the number of complaints alone in determining whether they must be disclosed. As always, carefully consider the statements that management makes, not just in public filings but also in investor calls and to the press and the market generally. Off-the-cuff statements that "our product is poised to do well" and that "our sales of the product will continue to increase in the coming year" may be considered misleading in light of the company's knowledge of the nature (and not just the extent) of customer complaints.

These warnings apply to all public issuers who manufacture consumer products. A company's knowledge of growing problems with its products - even though small in number - coupled with optimistic statements to the market generally may be misleading by omission and may also be considered intentionally fraudulent.

By refusing to draw a bright-line rule concerning adverse product reports, the Supreme Court allows shareholders the opportunity to argue that even a small number of product complaints may provide the basis to proceed with very costly litigation. While public companies defending such claims may ultimately win their securities lawsuits, the likelihood that they will do so only after costly litigation is greater.