In a unanimous March 22, 2011 opinion by Justice Sonia Sotomayor, the
U.S. Supreme Court rejected the argument of Matrixx Initiatives that adverse
product reports must be "statistically significant" in order for a
manufacturer to have an obligation to disclose the reports to investors. As a
result of the Court's decision, shareholders claims against the company for its
alleged failure to disclose reports that its Zicam cold remedy caused loss of
smell for some users will now be going forward. The Court's opinion can be
Matrixx Initiatives manufactured an internasal cold
remedy called Zicam. In April
2004, plaintiff shareholders filed a securities class action lawsuit against
Matrixx and three of its directors and officers, alleging that the defendants
were aware that numerous Zicam users experienced loss of the sense of smell.
The complaint alleges that the defendants were aware of these problems because
of calls to the company's customer service line; because of academic research,
which was communicated to the company; and because of product liability
lawsuits that had been filed against the company.
The district court granted the defendants' motion to
dismiss, finding that the complaint failed to adequately allege that the
alleged omissions were material, because the complaint did not allege that the
number of customer complaints was "statistically significant."
As discussed at greater length here,
on October 28, 2009, the Ninth Circuit reversed the district court, holding
that the district court "erred in relying on the statistical significance
standard" in concluding that the complaint did not meet the materiality
requirement. The Ninth Circuit said that a court "cannot determine as a
matter of law whether such links [between Zicam and loss of smell] was
statistically significant, because statistical significance is a matter of
fact." The defendants filed a petition for a writ of certiorari to the
U.S. Supreme Court, and as discussed here,
the Supreme Court granted the petition.
In their briefs before the U.S. Supreme Court, Matrixx
urged the Court to adopt a "bright line" test that reports of adverse
events with a pharmaceutical company's produce cannot be material absent a
sufficient number of reports to establish statistical significance. Matrixx
argued that statistical significance is the only reasonable indicator of
The Court declined to adopt the bright line test urged by
Matrixx, reasoning that such a categorical rule would "artificially
exclude evidence that would otherwise be considered significant to the trading
decision of a reasonable investor."
The Court also rejected the notion that only statistical
significance in the only reasonable indicator of causation, noting that medical
professionals and the FDA regularly infer a causal event between a drug and
adverse event. Justice Sotomayor wrote that "Given that medical
professionals and regulators regularly act on the basis of evidence of
causation that is not statistically significant, it stands to reason that in
certain cases reasonable investors would as well."
This conclusion does not however mean that pharmaceutical
companies have to disclose every adverse event. Rather, an adverse event is
material and must be disclosed, the Court said citing its standing test for
materiality, if it would "significantly alter the total mix of
information." The "mere existence" of adverse reports "will
not satisfy this standard." Rather, "something more is needed -- but
"something more" is "not limited to statistical
significance." and "can from the source, context and context of the
Justice Sotomayor reiterated, however, that absent a duty
to speak, silence cannot be the basis of securities liability. Disclosure is
only required when necessary to make previous statements 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."
Applying this total mix standard to this case, the Court
concluded that the loss of smell reports of which the plaintiffs allege the
defendants were aware, "the complaint alleges facts suggesting a
significant risk to the commercial viability of Matrixx's leading
product." "This is not a case about a handful of anecdotal reports, as
Matrixx suggests," Sotomayor wrote. She added the investors intend to
prove that "Matrixx received information that plausibly indicated a
reliable causal link between Zicam and anosmia," the medical term for a
loss of smell. At its most
basic level, the Supreme Court's decision in the Matrixx Initiatives case is
essentially just a reaffirmation of its prior case authority dealing with the
question of materiality. In particular the Court reiterated its prior statement
of the standard for materiality in the Basic, Inc. v.
Levinson case and TSC
Industries v. Northway.
"companies can control what they have to disclose under these provisions
by controlling what they say to the market "
The Court also found the plaintiffs' allegations were
sufficient to satisfy the requirements for pleading scienter. The Court noted
that it has not yet determined whether recklessness along is sufficient to
satisfy the scienter requirements, saving that question for another day.
Viewed in that light, the decision may not be all that
surprising. Just the same, there is something a little bit unexpected about
this decision. The unanimous opinion represents a clean sweep for the
plaintiffs, which given this Court's track record arguably is an unexpected
outcome. The Supreme Court has produced a number of decisions highly favorable
to defendants in recent years, and while that has not been entirely uniform
(there was the Merck decision last term for example), the Court has seemed to
have a predisposition for the defense perspective.
By rejected the proposed "bright line" test ,
the Court has relieved plaintiffs of the burden of having to come up with
sufficient facts to prove statistical significance. The lack of a bright line
test may, however, represent something of a challenge for reporting companies
going forward. Manufacturers receive "adverse event reports" in the
form of customer complaints all the time. A bright line test would have
clarified when the number of reports has reached a sufficient level that they
must be disclosed. In the absence of such a clear standard, companies will face
quite a struggle in trying to figure out what must be disclosed.
Once place companies may want to turn for guidance is the
statement in Justice Sotomayor's opinion that
This statement suggests to me that the judicious use of
precautionary disclosure may go a long way toward alleviating disclosure
Special thanks to my friends in the Securities Litigation
group at Skadden Arps for alerting me to the Matrixx Initiative decision and
for sending me a copy of their analysis of the decision (here).
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
discussed in greater detail in 1 A.A. Sommer Jr., Federal Securities
Exchange Act of 1934 § 5.04(2)(A) (Matthew Bender Rev. Ed.),
"Materiality," which can be accessed online by subscribers of lexis.com. This
treatise is also available
on the LexisNexis online store.
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