Where an individual must show that a company has misrepresented or omitted a material fact in order to claim a violation of the Securities Exchange Act, should a court apply a standard of statistical significance to determine whether the omitted or misrepresented fact is material?
Petitioners, Matrixx Initiatives Inc. and three of its officers (“Matrixx”), argue that the Ninth Circuit erred in allowing respondents, James Siracusano and other Matrixx shareholders (“Siracusano”), to sue under the Securities and Exchange Act of 1934 for Matrixx’s alleged failure to share product information with its shareholders. Specifically, Siracusano claims that Matrixx should have disclosed so-called adverse event reports that linked one of its products, Zicam Cold Remedy (“Zicam”), to anosmia, a condition that affects an individual’s ability to smell. Supreme Court precedent provides that, as part of the plaintiff’s case in showing a securities violation, the plaintiff must establish that the defendant misrepresented or omitted a material fact. In arguing that it was not required to disclose the studies, Matrixx relies on a statistical significance standard in determining whether the studies linking the drug to anosmia were material. Siracusano rejects the statistical significance standard, arguing that Matrixx should have shared such studies with investors regardless of the significance of the statistical correlation between Zicam and anosmia. The Ninth Circuit rejected the statistical significance standard and engaged in a factual analysis of Siracusano’s claims, finding that the allegations were sufficient. The Supreme Court will decide whether shareholders' ability to state a claim turns on the statistical significance of the withheld information, or whether a factual analysis is required.
Questions as Framed for the Court by the Parties
Respondents filed suit under § 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, alleging that petitioners committed securities fraud by failing to disclose "adverse event" reports-i.e., reports by users of a drug that they experienced an adverse event after using the drug. The First, Second, and Third Circuits have held that drug companies have no duty to disclose adverse event reports until the reports provide statistically significant evidence that the adverse events may be caused by, and are not simply randomly associated with, a drug's use. Expressly disagreeing with those decisions, the Ninth Circuit below rejected a statistical significance standard and allowed the case to proceed despite the lack of any allegation that the undisclosed adverse event reports were statistically significant.
The question presented is: Whether a plaintiff can state a claim under § 10(b) of the Securities Exchange Act and SEC Rule 10b-5 based on a pharmaceutical company's nondisclosure of adverse event reports even though the reports are not alleged to be statistically significant.
Between October 22, 2003 and February 6, 2004, Respondent James Siracusano bought thousands of shares in Petitioner Matrixx Initiatives Inc. (“Matrixx”). Siracusano then initiated a class action on behalf of shareholders who bought shares during that period of time, alleging that Matrixx violated the Securities and Exchange Act of 1934 by failing to disclose the potential side effects of one of its drugs, Zicam Cold Remedy ("Zicam"). In particular, Matrixx allegedly failed to disclose so-called adverse event reports (“AERs”) that indicated a possible link between the use of Zicam and anosmia, a condition involving the complete and permanent loss of smell.
The United States District Court for the District of Arizona, adopting a statistical significance standard, dismissed Siracusano’s securities fraud action for failure to state a claim, finding that the undisclosed studies were not material. The district court found instead that Siracusano provided very little evidence detailing customer complaints about the drug, and that a double-blind study conducted by Matrixx did not produce any cases linking Zicam to anosmia. The district court additionally found that Siracusano failed to show the required state of mind to plead a successful securities fraud claim, i.e., that Matrixx was deliberately reckless with regard to its failure to disclose the known relationship between Zicam and anosmia. Rather, the district court found that there was no evidence to show that Matrixx doubted the safety of Zicam or intended to benefit from making intentionally misleading public statements regarding the safety of their product.
On appeal, the United States Court of Appeals for the Ninth Circuit held that the district court erred in its use of a statistical significance standard in determining whether Siracusano had sufficiently shown the materiality of the information withheld by Matrixx. Rather, the court held that the jury is charged with finding materiality based on an examination of the facts. The Ninth Circuit reversed the district court on the issue of materiality, finding that the facts alleged by Siracusano were sufficient to meet the standard. With regard to the state of mind requirement of securities claims, the Ninth Circuit held that while motive is relevant, a lack of motive is not necessarily fatal to a securities violation claim. The appeals court thus determined that, in light of the allegations as a whole, the inference that Matrixx failed to disclose the studies as a result of deliberate recklessness was just as compelling as the possibility that Matrixx unintentionally withheld the information.
Rule 10b-5 Violation Framework
The Securities Exchange Commission ("SEC") is authorized under the Securities Exchange Act to make such rules and regulations as are “necessary or appropriate in the public interest or for the protection of investors." The SEC created Rule 10b-5, which makes it unlawful “(a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact . . . or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. ” The Supreme Court determined that a private plaintiff, in order show a violation of Rule 10b-5, must show “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation The parties disagree about how the Court should interpret the material misrepresentation and scienter elements of the Stoneridge test.
When a company omits information, the “omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” Matrixx believes that in order for adverse event reports ("AERs") to be “material,” a plaintiff must show that they contain statistically significant evidence establishing that the product caused the adverse effect. Matrixx asserts that AERs that are not statistically significant do not reliably indicate a causal relationship between the product and condition at issue. The fact that a medical incident occurred close in time to taking a particular drug may be merely coincidence. Matrixx asserts that AERs are unreliable because they are often second or third-hand reports and simply report the presence of a condition without discussing alternative causes or showing causation. Because the AERs do not clearly demonstrate a causal effect, Matrixx claims that reasonable investors would not use the reports alone as a material basis for investment decisions. Furthermore, Matrixx alleges that if the standard for materiality is not that the reports must be statistically significant, all pharmaceutical companies will release AERs in order to avoid securities fraud lawsuits, which would in turn flood the investment market with unreliable information. However, reliable, statistically significant information that a drug causes a side effect would be potentially material to investors because of increased litigation costs, regulatory effects, and loss of market share.
Respondent James Siracusano believes that materiality should not be judged by the AERs’ statistical significance, but rather by a totality of the circumstances standard. A statistically significant standard would not be sound, Siracusano argues, because if a company received ten reports from reputable specialists which each independently came to the conclusion that the drug caused a particular side effect, these ten reports would still not be statistically significant, though they would certainly be material to investors. Siracusano argues that securities cases and other varieties of fraud cases have previously viewed “materiality” as a fact-specific inquiry for the finder of fact. Siracusano claims that many kinds of information may be material to investors, including statistically insignificant AERs, and that the securities market and its investors are sufficiently sophisticated to understand the statistical significance, or insignificance, of the adverse event reports. In particular, investors would want to know about the reports Matrixx received from nasal specialists indicating that there was a causal link between Matrixx's products and anosmia, that certain customers who lost their sense of smell did so after experiencing a burning sensation after using the product, and that customers had filed lawsuits. If these facts had been revealed to investors, the facts would have materially affected investment decisions because this type of information reveals risks of products liability lawsuits, decreased sales, and future FDA action. Siracusano believes that this type of information should be made available to investors, whether statistically significant or not, and that under the totality of the circumstances, the AERs were material to investors.
The scienter required for a violation of Rule 10b-5 is that the defendant intended to deceive, defraud, or manipulate by intentionally or deliberately recklessly making misleading or false statements. To survive a motion to dismiss, the complaint's inference of scienter must be “cogent and at least as compelling as any opposing inference one could draw from the facts alleged.” Matrixx asserts that not disclosing AERs is insufficient to infer intentional deception or manipulation because the AERs may be unreliable and do not show that the rate of anosmia among product users is statistically significant compared to the rate of anosmia within the relevant population. Matrixx claims that it is more reasonable to infer that Matrixx did not disclose the AERs because there were few reports and the reports were not reliable indicators of potential adverse effects related to the use of the products. Matrixx argues that it may be making misleading statements by actually releasing the AERs because the AERs may confuse investors who think that the reports are evidence of causation, when in fact they are unreliable and misleading.
Siracusano believes that Matrixx’s view is paternalistic because investors are sophisticated parties who are capable of understanding the statistical relevance of the AERs. . Siracusano alleges that Matrixx’s actions in a variety of contexts demonstrate that Matrixx probably was aware of the veracity of the reports, yet chose to conceal that information from investors. Siracusano points to a study conducted by a doctor and presented at a conference which demonstrated the potential side effects of Matrixx’s products, yet in response to the study, Matrixx informed the doctor that he had to remove the names of Matrixx and its products from the study and presentation. After this doctor’s study went public, Matrixx allegedly responded by declaring that scientific studies proved that its products were safe. Siracusano claims that Matrixx’s statements support a finding of the required scienter because shortly thereafter Matrixx admitted that it did not in fact know whether its products caused anosmia.
The Supreme Court will determine whether Respondent James Siracusano must show that the studies omitted by Matrixx are statistically significant, and therefore material, in order to maintain a claim under the Securities Exchange Act of 1934.
Matrixx argues that allowing securities fraud suits in such cases will compel pharmaceutical companies to disclose all of their adverse event reports (“AERs”), thereby inundating investors with a large amount of unreliable information. The Securities Industry and Financial Markets Association (“SIFMA”) and the United States Chamber of Commerce (“Chamber”) support Matrixx’s position, arguing that an absence of clear materiality standards would leave companies feeling uncertain as to the information they must disclose in order to avoid securities fraud lawsuits. Matrixx warns that disclosure of a large amount of information may make it difficult for investors to distinguish significant from unimportant information, thereby defeating the purpose of providing information in the first place.
Product Liability Advisory Council, Inc. (“PLAC”) cautions that the broad disclosure requirements proposed by the Ninth Circuit would affect not just products like Zicam, but pharmaceutical companies in general, all of which are required to submit AERs to the Food and Drug Administration (“FDA”). PLAC contends that the reporting requirements would extend to other areas of FDA regulation, including food and medical devices. PLAC additionally argues that it is even possible that the reporting requirements could extend to industries that are not monitored by the FDA. Specifically, PLAC notes that several other industries, such as the automobile and consumer products industries, use a scheme similar to the FDA monitoring system whereby they gather an over-inclusive amount of information for the purpose of making safety assessments. According to PLAC, investors would therefore be receiving a large amount of “essentially useless” information from a variety of companies, not just pharmaceutical companies.
Siracusano counters that Supreme Court precedent has rejected bright-line rules that allow pharmaceutical companies to withhold information from investors. Rather than overwhelm investors, Siracusano contends that reasonable investors would consider relevant information even if its occurrence has not reached the level of statistical significance. The federal government agrees, arguing that statistical significance is not required for investors to find information valuable to their efforts to determine the commercial viability of a product. The government notes that reasonable investors would want such information to assess the impact it could have on consumers, who may not purchase products that they deem risky, regardless of the statistical significance of the risks. Additionally, the United States notes that investors would want to know about AERs because they may increase regulatory activity, which could negatively affect product sales and increase litigation.
Additionally, the government contends that the Ninth Circuit holding would not require companies to disclose every AER. To ensure that companies do not misrepresent the safety of a product, they must disclose relevant AERs only when they make positive statements regarding the success and safety of the product. And even then, says the United States, the company is not required to disclose all relevant information, but only that which is material under a standard that evaluates the probability and magnitude of the adverse event in comparison to a broad view of the company’s activity.
Finally, SIFMA and the Chamber claim that a clear standard, such as a statistical significance analysis, is necessary to ensure a uniform evaluation of securities fraud cases among the federal circuits. SIFMA and the Chamber also argue that a clear and uniform standard of materiality will help stymie frivolous securities claims. A group of law a business professors counters that a statistical significance standard will not establish a bright-line rule because the test necessarily involves a factual inquiry, thereby creating uncertainty and litigation.
The authors would like to thank former Supreme Court Reporter of Decisions Frank Wagner for his assistance in editing this preview.