Supreme Court Gives Guidance on Materiality Standard Under Federal Securities Laws

In Matrixx Initiatives, Inc. v. Siracusano, the Supreme Court provided insight into how to assess the materiality of information in the context of the federal securities laws.  Applying its materiality test from Basic, Inc. v. Levinson[1], the Court considered whether a series of adverse event reports about Matrixx’s leading product, Zicam Cold Remedy, constituted material information that Matrixx should have disclosed even though those reports were not statistically significant.  The Court concluded that, in light of Matrixx’s statements about Zicam’s safety, the adverse event reports were material information.  In reaching this conclusion, the Court rejected any bright-line rule for materiality and repeated its statements from Basic that the materiality inquiry is highly fact-specific.  The Court also concluded that the plaintiffs had pleaded sufficient facts to establish a strong inference that defendants had omitted this material information either intentionally or with deliberate recklessness.  Accordingly, the Court affirmed denial of defendants’ motion to dismiss.

The Top Four Points from the Matrixx Decision

The opinion contains several important principles:

• First, the Court reaffirmed its longstanding test for materiality.  It confirmed that there is no bright-line test for materiality and that assessing materiality depends on context and involves a balance between providing investors with significant information and not burying them “in an avalanche of trivial information.”
• Second, the Court held there is no affirmative duty to disclose all material information.  A company must only disclose material information if it is necessary to prevent another statement from being misleading.  As the Court noted “[e]ven 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.”
• Third, to plead scienter, i.e., intent or knowledge of wrongdoing, with regard to omitted information, a plaintiff must show not only that defendants were aware of the omitted information, but also that they knew or were deliberately reckless as to whether it was material, i.e., that the defendants “understood [its] likely effect on the market.”
• Finally, companies should be cautious when making absolute statements.  Matrixx’s decision to issue a press release calling statements that questioned the safety of Zicam “completely unfounded and misleading” was critical to the outcome of this case in light of evidence that physicians had notified Matrixx of some adverse side effects.  A less definitive statement may not have had the same effect, and the Court may have been more sympathetic to Matrixx’s arguments that it did not make a material misrepresentation.

Summary of Opinion

The allegations in Matrixx concern Zicam Cold Remedy, Matrixx’s leading product, which accounted for approximately 70 percent of its sales. Both before and during the class period of October 2003 to February 2004, Matrixx received several reports from doctors that, after using Zicam, some consumers had suffered an “adverse event,” specifically, they had lost their sense of smell (a condition called “anosmia”). Adverse event reports, however, are not uncommon for any drug, and the reports for Zicam were not sufficiently numerous to qualify as “statistically significant.”  Zicam had also previously undergone two clinical trials with no reports of a similar side effect. Doctors, however, started to conduct research into the possible connection between Zicam and anosmia, and nine product liability lawsuits were filed. Matrixx did not disclose the existence of the adverse event reports or the lawsuits. Instead, after some initial reports about a link between Zicam and anosmia appeared in the media, Matrixx issued a press release that said that any statements that Zicam may cause anosmia “are completely unfounded and misleading.” On February 6, 2004, one of the doctors investigating Zicam appeared on Good Morning America and broadcast his observations regarding customers’ loss of a sense of smell. Matrixx’s stock price dropped significantly afterwards. Matrixx subsequently commenced studies into Zicam and anosmia, and, in 2009, the FDA issued a warning letter to Matrixx on this issue.

The district court dismissed the complaint on the grounds that plaintiffs had failed to allege a material misrepresentation or to plead facts giving rise to a strong inference of the fraudulent intent or deliberate recklessness of scienter. The district court found that the adverse event reports were not material because they did not show a statistically significant correlation between the use of Zicam and anosmia. The district court also found that there were no allegations that the defendants disbelieved Matrixx’s public statements about Zicam or that any defendant profited from Matrixx’s public statements. The court of appeals reversed, holding that information about a possible link between Zicam and anosmia would have been significant to a reasonable investor and, therefore, material, even if it was not sufficient to show a statistically significant correlation. The court of appeals also found that withholding information about the adverse event reports and lawsuits concerning Matrixx’s main product was “an extreme departure from the standards of ordinary care” and created a strong inference of scienter. The Supreme Court, in a unanimous opinion delivered by Justice Sotomayor, affirmed.

The Court reaffirmed its longstanding test for materiality in the context of the federal securities laws from Basic and TSC Industries, Inc. v. Northway, Inc.[2] Under this test, information is material if 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.” Defendants argued that to meet this standard, the adverse event reports had to be statistically significant because otherwise they would not be scientifically reliable enough for any reasonable investor to use in making an investment decision. The Court rejected this bright-line approach. The Court noted that medical researchers and, on occasions, even the FDA itself, act on evidence that is not statistically significant and, therefore, reasonable investors may also act on information that is not statistically significant.

Importantly, the Court stressed that this did not mean that a company must always disclose the existence of adverse event reports, as these reports do not necessarily mean the drug is causing the adverse event. The Court stated that “[s]omething more is needed, but that something more is not limited to statistical significance and can come from the source, content, and context of the reports.” The Court also emphasized that, even if adverse event reports are material, a company is still not required to disclose them unless it makes a statement about the product that would be misleading without their disclosure as well. The Court found that both elements were satisfied in this case: the adverse event reports did create a plausible causal relationship between Zicam and anosmia, yet Matrixx had made public statements stating that any suggestion of such a relationship was “completely unfounded and misleading.” The Court also concluded that these facts, especially the decision to issue the February 2, 2004, press release dismissing the claims about Zicam and anosmia, created a strong inference that Matrixx withheld the adverse event reports “not because it believed they were meaningless but because it understood their likely effect on the market.” This was sufficient to plead adequately scienter.

[1] 485 U.S. 224 (1988)

[2] 426 U.S. 438 (1976)

Contact Information

If you have any questions regarding this alert, please contact—