On March 22, 2011, in Matrixx Initiatives, Inc. v. Siracusano, -- S.Ct. --, 2011 WL 977060 (Mar. 22, 2011), the United States Supreme Court issued a unanimous decision ruling that reports of adverse events concerning a pharmaceutical company’s product may be sufficiently “material” under the federal securities laws. Although the Court held that not every adverse report can be considered material, it declined to adopt a bright-line rule requiring evidence of the adverse event’s statistical significance. As a result of the ruling, companies that receive reports of adverse events concerning their products must carefully evaluate the reports on a case-by-case basis to determine whether there is a substantial likelihood that disclosure of these facts would be viewed by a reasonable investor as having significantly altered the total mix of information made available to the investing public.

Matrixx Initiatives, Inc. (“Matrixx”) is a manufacturer of various pharmaceutical products. Its principal product, Zicam Cold Remedy (“Zicam”), accounts for about 70 percent of its sales. Investors brought a putative class action against Matrixx and three of its executives based on its alleged failure to disclose during the period October 22, 2003 through February 6, 2004 that they had received several reports of a possible link between Zicam Cold Remedy and a condition known as anosmia, i.e., loss of smell. Matrixx publicly projected increases in revenues of between 50 and 80 percent during this period but did not disclose any of the reports linking Zicam with anosmia. When the possible link was reported by the media, Matrixx publicly denied the reports and defended the safety of Zicam even though it had not conducted research to determine whether there was any causal connection between its use and anosmia.

A federal district court initially dismissed the case, but that ruling was reversed by the Court of Appeals for the Ninth Circuit. The Supreme Court, in affirming the Ninth Circuit’s opinion, held that (i) the adverse reports received by Matrixx were sufficiently material, even without statistical significance, to the “total mix” of information available to a “reasonable investor,” and (ii) the complaint had adequately alleged a “strong inference of scienter.”

The Court held that the “mere existence” of an adverse report is not sufficient to plead materiality in a securities fraud case, but that adverse reports must be considered on a case-by-case basis, where factors such as their source, content and context are considered. Applying a bright-line rule requiring evidence of statistical significance, the Court held, would risk excluding information that would otherwise be considered significant to a reasonable investor. The Court noted, for example, that the FDA considers factors other than statistical significance in assessing causation and whether to take regulatory action. In fact, in 2009, the FDA issued a letter to Matrixx warning of the growing evidence of a link between Zicam and anosmia without citing any statistically significant data.

The Court found that the reports of adverse events concerning Zicam – including reports from three medical professionals and researchers about more than 10 patients who had lost their sense of smell after using Zicam, several complaints from Matrixx customers reporting the same issue, and several product liability lawsuits against Matrixx alleging a causal link between Zicam and anosmia – were plausible enough to indicate a possible causal link between the company’s primary revenue-generating product and a significant side effect. As a result, the Court held that the reports were material.

Similarly, the Court held that plaintiffs had adequately alleged scienter even though there was no allegation the defendants knew of statistically significant evidence of causation. Allegations that Matrixx was concerned about information it received concerning a potential causal connection between Zicam and anosmia and, in particular, the fact that Matrixx issued a press release denying the reports when the scientific evidence was inconclusive and it had not, in fact, conducted any relevant studies, when taken collectively, were sufficient, according to the Court, to establish a compelling inference that Matrixx intentionally did not disclose the adverse events reports because it believed that such disclosure would have an adverse affect on the Company’s stock price.

Notably, the Court re-affirmed that Section 10(b) of the Securities Act and Rule 10b-5 promulgated thereunder do not impose an affirmative duty to disclose all material information but, rather, require disclosure of information necessary to ensure that statements made were not misleading. As the Court held, “companies can control what they have to disclose under these provisions by controlling what they say to the market.”

As a result of the decision, public companies must carefully consider any reports of adverse events concerning their products when making public disclosures. While companies need not affirmatively disclose every such adverse report, they must assess the risks of each report, including its source, content and context, to determine whether investors would consider its findings to be material. If so, public statements that fail to disclose such risks may give rise to liability under the federal securities laws.