Securities Law | Expert Legal Commentary
June 29, 2011
Matrixx Initiatives, Inc., et al. v. Siracusano: Securities Plaintiffs Can Use Inferences to Show Materiality and Scienter at the Pleading Stages
Matrixx Initiatives, Inc., et al. v. Siracusano
Josh Lawler of Zuber Lawler & Del Duca and Joel Ginsberg
The United States Supreme Court has ruled that in securities cases under §10(b) and Rule 10b–5 the requirement of the materiality of a defendant’s misrepresentations cannot be reduced to a bright-line rule. Facts giving rise to a strong inference that a defendant acted with the required state of mind are sufficient at the pleading stage. In Matrixx Initiatives, Inc., et al. v. Siracusano, decided March 22, 2011, the Court held that the material misrepresentation or omission by the defendant and scienter that are requisite elements of §10(b) and Rule 10b–5 claims did not require the shareholder plaintiffs to allege that the reports that the defendant received showed statistically significant evidence that their product caused the medical problem at issue. The Court was more flexible in its approach to materiality and scienter, considering all the evidence presented. This ruling makes it easier for plaintiffs in securities cases to get their claims past the pleading stage and to have the trier of fact decide the issues.
Defendant Matrixx manufactures a cold remedy called Zicam. Zicam is one of Matrixx’s most popular products and accounts for a large part of its profitability. Zicam is available in various forms some of which require intranasal application. Certain Zicam users complained to their physicians and to Matrixx’s customer service lines of loss of their sense of smell (a condition called anosmia) after using Zicam’s intranasal products. Independent academic research was conducted and was communicated to Matrixx. Some users filed lawsuits against Matrixx.
The current case addresses the issue of whether Matrixx failed to disclose the possible link between Zicam and anosmia that would have affected the value of Matrixx’s stock.
The plaintiffs in this case, Matrixx shareholders, filed a securities fraud class action, alleging that Matrixx violated §10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule10b–5 by failing to disclose reports of the possible link between Zicam and loss of smell, rendering statements made by Matrixx misleading. In order adequately to allege a violation of Rule 10b-5, a plaintiff must allege (1) a material misrepresentation or omission of fact, (2) scienter, (3) a connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss.
The complaint alleged that the defendants were aware of these problems because of calls to the company’s customer service representatives (by consumers and at least two doctors); because of academic research, which was communicated to the company; and because of product liability lawsuits that had been filed against the company. Relying on its own statistical research, Matrixx did not make any disclosures to shareholders or potential shareholders regarding this issue.
Matrixx moved to dismiss the complaint, arguing that respondents had not pleaded the element of a material misstatement or omission and the element of scienter.
The District Court granted Matrixx’s motion to dismiss, finding that the complaint failed to adequately allege that the omissions were material, because the complaint did not allege that the number of customer complaints was “statistically significant.”
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 the Supreme Court granted the petition.
THE SUPREME COURT’S OVERALL APPROACH
The Supreme Court held that there was no “bright line rule” requiring reports showing statistically significant evidence that Zicam caused anosmia. Rather, the Court held that the factors of materiality and scienter can be inferred in various ways. Thus the District Court erred in requiring an allegation of statistical significance to establish materiality.
STATISTICS ARE NOT THE ONLY WAY TO SHOW CAUSATION. INFERENCES ARE PERMISSIBLE
In its 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 causation.
However, the Supreme 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 Supreme Court noted that medical professionals and the FDA regularly infer a causal event between a drug and adverse event. The Supreme Court concluded that the complaint adequately alleged information linking Zicam and anosmia that would have been significant to a reasonable investor. It also held that Matrixx’s withholding of information about reports of adverse effects and about pending lawsuits by Zicam users gave rise to a strong inference of scienter.
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.”
THERE IS NO BRIGHT LINE RULE: AN ADVERSE EVENT IS MATERIAL IF IT WOULD BE SIGNIFICANT TO A REASONABLE INVESTOR
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 Supreme Court held, 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 reports.”
The Supreme Court 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 Supreme Court concluded that due to 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,” the Supreme Court wrote. The Supreme Court added the investors intend to prove that “Matrixx received information that plausibly indicated a reliable causal link between Zicam and anosmia.”
The Supreme Court also found the plaintiffs’ allegations were sufficient to satisfy the requirements for pleading scienter. The Supreme Court noted that it has not yet determined whether recklessness alone is sufficient to satisfy the scienter requirements, saving that question for another day.
As a result of the Supreme 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 most important impact of Matrixx Initiatives, Inc., et al. v. Siracusano is that it allows investors to use a combination of different sources and inferences to show materiality and scienter at the pleading stage. This will allow for more claims to reach the trier of fact which will likely result in significant pressure on defendants to settle or to face potentially large verdicts.
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