Supreme Court Addresses Materiality in Securities Fraud Cases
In Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156 (U.S. Mar. 22, 2011), the U.S. Supreme Court unanimously held that a plaintiff can establish the materiality (for purposes of claims under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5) of adverse events experienced by users of pharmaceutical products without showing that the incidence of harm from those adverse events was statistically significant. The Court reaffirmed the case-by-case analysis for materiality that it espoused in Basic Inc. v. Levinson, 485 U.S. 224 (1988), but it may also have signaled that the pleading of materiality is subject to the standards found in Rule 8(a) of the Federal Rules of Civil Procedure and not the heightened standards of the Private Securities Litigation Reform Act of 1995 (the "PSLRA").
Matrixx manufactures Zicam®, a product used to treat symptoms of the common cold. Beginning in 1999, Matrixx learned of a small number of incidents in which persons treated with Zicam nasal spray or gel lost their sense of smell (a condition called "anosmia").
Matrixx conducted no trials to address any alleged causal connection between Zicam and anosmia, and it stated publicly that Zicam was "poised for growth" and had "very strong momentum." Matrixx rejected allegations of a tie between Zicam and anosmia as "completely unfounded and misleading," but its stock price tumbled when Good Morning America reported that more than a dozen persons experienced anosmia after using Zicam and that four product liability lawsuits had been filed asserting a link between Zicam and anosmia. Federal class action securities fraud lawsuits followed against Matrixx and three of its executives based on their failure to disclose the adverse events linking Zicam to anosmia.
The district court dismissed the securities fraud actions, relying on rulings by the U.S. Court of Appeals for the Second Circuit in In re Carter-Wallace, Inc. Securities Litig., 150 F.3d 153 (2d Cir. 1998), and 220 F.3d 36 (2d Cir. 2000), that had embraced the "statistically significant" analysis. On appeal, the Ninth Circuit reversed, holding that the plaintiffs had sufficiently pled facts showing materiality and scienter and that there was no need to plead statistically significant ties between the use of Zicam and the onset of anosmia. Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167 (9th Cir. 2009). The Supreme Court affirmed the Ninth Circuit's decision.
The Court Rejects a Bright-Line Standard in Favor of the Basic Standard
The Court rejected Matrixx's argument for a bright-line rule that adverse event reports can be material only if there is "a sufficient number of such reports to establish a statistically significant risk that the product is in fact causing the events." The Court found the proposed bright-line rule to be inconsistent with Basic v. Levinson, in which it had held that materiality is established when 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." As in Basic, the Court expressed concern that a bright-line rule would be either overinclusive or underinclusive and would "artificially exclude information that would otherwise be considered significant to the trading decision of a reasonable investor."
The Court also observed that medical researchers and other experts, as well as the Food and Drug Administration ("FDA"), do not rely solely on statistically significant information to infer a causal link between use of a drug and adverse events. If non-statistically significant evidence is good enough for medical experts and the FDA to rely on, the Court added, then "it stands to reason that in certain cases reasonable investors would [rely on it] as well."
Non-statistically significant evidence will not always support a finding of materiality, however. An adverse event by itself does not reflect a causal link between a drug and the adverse event; therefore, disclosure of the adverse event without more would not be material to a reasonable investor. The "something more" that might be sufficient to show a causal link can come from "the source, content, and context of the reports." Finding that causal link will require a case-by-case evaluation to determine whether an investor would consider the reports of adverse events to be material. In this case, the Court agreed with the Ninth Circuit that the plaintiffs had pled enough to show the causal link necessary to satisfy the materiality element.
The Court's Language Suggests That There Is No Need to Comply With the PSLRA's Heightened Pleading Standards in Pleading Materiality
There is a split of authority among the federal appellate courts as to whether the PSLRA's heightened pleading standards apply to the element of materiality. Although the Court did not decide whether those standards apply to allegations of materiality, it held that the plaintiffs' allegations were sufficient to "raise a reasonable expectation that discovery will reveal evidence satisfying the materiality requirement and to allow the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." The Court noted, using the "plausibility" language of Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009), that medical experts had revealed to Matrixx "a plausible causal connection between Zicam Cold Remedy and anosmia."
While the Court's language does not definitively indicate how the Court would rule if directly facing the question of the appropriate pleading standard, it is notable that the Court has held that the pleading of another element of a Section 10(b) claim, "loss causation," need only meet the pleading standards applicable to Rule 8(a). See Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 346 (2005). As is true of loss causation, there is no explicit statement in the PSLRA that mandates use of a heightened pleading standard for materiality.
Conclusion: No Material Change to the Materiality Standard
Matrixx is the Supreme Court's most extensive discussion of the materiality element of a securities fraud claim in many years, but it does not change the Court's test. In rejecting a bright-line "statistical significance" standard, Matrixx is consistent with the case-by-case approach established in the Court's earlier rulings. And, to the extent the Court's language suggests that the pleading of materiality need satisfy only the Rule 8(a) standard, that result is consistent with the Court's earlier decision concerning the pleading of loss causation. Matrixx is thus most important for cutting off a new line of materiality analysis, not for any change in the Court's own materiality jurisprudence.
© 2011 Perkins Coie LLP