Last week, the United States Supreme Court unanimously affirmed a prior decision of the Ninth Circuit in Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156, the latest securities case to be heard by the Court. The Supreme Court agreed with the Ninth Circuit that the plaintiffs in that case had adequately pled both materiality and a fraudulent intent or “scienter” and, thus, the defendants’ motion to dismiss plaintiffs’ claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 should have been denied by the lower court.
Plaintiffs alleged that Matrixx Initiatives, a manufacturer of over-the-counter pharmaceutical products, had violated the federal securities laws by failing to disclose reports it had received on a possible link between the use of Zicam Cold Remedy (Matrixx’s leading product) and anosmia (the loss of the sense of smell). The District Court held, inter alia, that materiality and scienter had not been plead adequately because the allegedly withheld data had not been shown to be statistically significant. The Ninth Circuit reversed.
One can always speculate as to why the Supreme Court accepts a case for review. In this instance, the Supreme Court did not alter any existing standards, but rather applied them in the context of scientific data. Many securities cases involve reporting of financial data as to which there are existing standards found in SEC regulations and/or accounting principles. There is, in contrast, no such guidance as to disclosure of scientific information. In ruling that the plaintiffs had alleged sufficient facts to plead material misstatements or an omission, the Supreme Court declined to adopt the bright-line rule put forth by the defendants, i.e., reports of adverse events related to a company’s product could never be material unless there were “a sufficient number of such reports to establish a statistically significant risk” that the company’s product is the cause of such adverse events. (Slip Op. at 10-11.) Instead, the Court invoked the longstanding rule set forth in its decision in Basic v. Levinson, 485 U.S. 224 (1988), which requires a court to examine whether 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 information made available.’ ” Id. at 231-32.
The Supreme Court reasoned that, although an event’s statistical significance may still be considered as part of the materiality analysis, it will not standing alone be determinative. Under Basic, “the materiality of adverse event reports cannot be reduced to a bright-line rule.” (Slip Op. at 1-2.) The Court explained that lower courts must continue to engage in contextual analyses to determine whether the omission of information regarding adverse event reports could be considered materially misleading. “Something more is needed, but that something more is not limited to statistical significance and can come from ‘the source, content, and context for the reports.’ ” (Slip Op. at 16.)
In a similar fashion, the Supreme Court also reaffirmed its decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), which held that courts must consider “plausible opposing inferences” with regard to whether the defendant acted with scienter. Id. at 323. In Matrixx, the Court deemed it relevant to the scienter analysis that the complaint alleged the company had withheld medical reports of potential adverse effects of the product, as well as information about several pending lawsuits. Relying on the standard articulated in Tellabs, the Court observed that allegations of scienter must be reviewed holistically and that the “complaint adequately pleads scienter under the PSLRA ‘only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.’” (Slip Op. at 20.) Although the company’s actions could be categorized as reckless, rather than intentional, the Court declined to decide whether recklessness was sufficient to establish scienter. The Court further stated that it assumed without deciding that the scienter requirement may be satisfied by a showing of “deliberate recklessness.” (Slip Op. at 20.) In finding that the plaintiffs had adequately pled scienter, the Court held that “[t]he inference that Matrixx acted recklessly . . . is at least as compelling, if not more compelling, than the inference that it simply thought the reports did not indicate anything meaningful about adverse reactions.” (Slip Op. at 21.) Even though the Court held that the allegations against the company in this case were sufficient to plead scienter, it did caution that “[w]hether respondents can ultimately prove their allegations and establish scienter [at trial] is an altogether different question.” (Slip Op. at 22.)