Plaintiffs seeking to assert securities fraud claims against health-care companies based on the failure to disclose adverse event reports will not be required to allege that the reports were “statistically significant,” the standard that had been articulated by a number of courts. The March 22, 2011 opinion of the Supreme Court of the United States in Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156, in so holding unani-mously, did away with the bright-line “statistical significance” standard that has been employed by the Second Circuit as well as several other federal circuits for assessing the materiality of facts alleged to have been omitted or misstated by pharmaceutical and medical device compa-nies in securities fraud claims under Section 10(b) of the 1934 Securities Exchange Act and Rule 10b-5. The Court also declined to hold that, in the absence of such statistically significant adverse event reports, a plaintiff could not meet his burden of alleging facts amounting to the strong inference of scienter required in federal securities fraud actions.1
In Matrixx Initiatives, plaintiffs brought a securities fraud lawsuit based on the failure of Matrixx Initiatives, Inc. (“Matrixx”) to disclose publicly adverse event reports submitted by various individuals who had allegedly lost their sense of smell after using Zicam, a cold remedy product manufactured by Matrixx. Zicam is a homeopathic remedy, and at the time Matrixx was under no obligation to report such inci-dents to the FDA. Plaintiffs claimed that, when information regarding the alleged effects of the drug became known, the price of Matrixx’s publicly-held shares declined.
Matrixx moved to dismiss the lawsuit on the grounds that the complaint failed to sufficiently plead materiality and scienter because the adverse event reports at issue were not alleged to be statistically significant. Applying this standard, the District Court dismissed the lawsuit, but the Court of Appeals for the Ninth Circuit reversed, an outcome the Supreme Court has now affirmed.
The Court recognized that the question of materiality is governed by the controlling standard of Basic v. Levinson, 485 U.S. 224 (1988), under which a plaintiff must show that “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 informa-tion made available.” Id. at 231-32.
Relying on Basic, the Court first rejected Matrixx’s argument that “adverse event reports that do not reveal a statistically significant increased risk of adverse events from product use are not material information.” Slip. Op. at 9. The Court reasoned that Matrixx’s argument rested on the “flawed” premise that “statistical significance is the only reliable indication of causation.” Id. at 11.
In support of this reasoning, the Court observed that “courts frequently permit expert testimony on causation based on evidence other than statistical significance,” id. at 12, and that the FDA itself assesses the safety risk of a product based on a wide range of factors, including the “temporal relationship of product use and the event” and “seriousness of the event relative to the disease being treated.” Id. at 13. The Court made clear, however, that it was not deciding any issue relating to the admissibility of expert testimony. Id. at 12.
The Court further noted that the FDA may take regula-tory action based on a mere “suspicion of causation,” as it did in sending Matrixx a warning letter regarding Zicam despite the absence statistically significant data showing a link between the product and the loss of smell. Id. at 14.
Given that medical professionals and regulators may take action based on evidence of causation that is not statistically significant, the Court reasoned that “in certain cases reasonable investors would as well.” Id. at 15. The Court thus concluded that the “categorical rule” advocated by Matrixx would “artificially exclud[e] information that would otherwise be considered significant to the trading decision of a reasonable investor,” in violation of the Basic standard. Id. at 11.
The Court emphasized that assessing the materiality of adverse event reports instead requires a “fact-specific” inquiry that “requires consideration of the source, content, and context of the reports.” Id. at 15. While statistical significance (or the lack thereof) is a relevant factor in this inquiry, the Court stressed that “it is not dispositive of every case.” Id.
The Court also declined to endorse Matrixx’s “proposed bright-line rule requiring an allegation of statistical significance to establish a strong inference of scienter.” Id. at 20. The scienter element of a securities fraud action requires plaintiffs to plead with particularity sufficient facts to raise a strong inference that an omission was made with the intent to deceive or defraud investors. Id.
Assuming, without deciding, that the scienter require-ment may be satisfied by a showing of deliberate recklessness (the standard applied below), the Court concluded that the plaintiffs in the matter had suffi-ciently pleaded scienter based on other allegations, such as Matrixx’s issuance of a press release touting studies that purportedly confirmed that Zicam did not cause the loss of smell when, in fact, no such studies had been conducted. This allegation, taken together with numerous others in the complaint, gave 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.” Id. at 21.
The Matrixx decision may well have potentially profound implications for publicly traded life sciences companies that are subject to the FDA’s adverse event reporting regime. Based on the Second Circuit’s decision and its progeny among the lower courts, life sciences compa-nies have been able to rely on statistical significance as a critical tool in determining the point at which public disclosure of adverse events was required. By rejecting statistical significance as setting a minimal threshold for disclosure, the Matrixx decision will require life sciences companies to assess the issue of potential causation and investor impact more holistically, and on a case-by-case basis.
At first glance, it might appear that the Court’s decision would require the disclosure of every adverse event report as potentially material information. In an attempt to address such concerns, the Court explicitly stated that its decision does not mandate such extensive disclosure. It rather explained that while statistical significance alone is not determinative in the materiality analysis, the “mere existence” of such adverse event reports is also not a determining factor. Slip. Op. at 16. Instead, “[s]omething more is needed” and this “some-thing more . . . can come from the source, context, and context of the [adverse event] reports” rather than from their existence alone. Id. Furthermore, the Court reiterated that under the Securities Exchange Act, companies are not required to “disclose any and all material information,” but are required to make disclosures only when they are “necessary to make statements made, in light of the circumstances under which they were made, not misleading.” Id. (citation and quotation marks omitted). Thus, “[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.” Id.
Despite these reassurances, however, life sciences companies are now faced with heavily fact-specific questions of where to draw the disclosure line in the absence of a bright-line standard. The decision will also require life sciences companies to consider whether their prior public statements have created a background against which disclosure of an adverse event report is necessary, and whether the history and pattern of adverse events was sufficiently suggestive of a possible link between the product and deleterious health effects that a reasonable investor would want to know the information. It is worth noting, however, that unlike the homeopathic product at issue in Matrixx, various regulated products, including medical devices, and (to a lesser extent) prescription drugs, are subject to public disclosure of data compiled from adverse event reports by the FDA , through online databases or other sources.
Because the over-the-counter homeopathic product at issue in Matrixx was not subject to the FDA’s adverse event reporting requirements during the period at issue in the lawsuit, the Supreme Court had no occasion to consider whether the public availability of adverse event reports disclosed by the FDA may be sufficient to defeat a securities claim based on a company’s alleged failure to independently disclose the information.