The Materiality Standard After Matrixx Initiatives, Inc. v. Siracusano

• Publication year: 2010

Benjamin Shook⁰

The recent, unanimous decision of the U.S. Supreme Court in Matrixx Initiatives, Inc. v. Siracusano resolved a circuit split on the materiality standard under Rule 10b-5 of the Securities Exchange Act of 1934. By affirming the Ninth Circuit, the Court re-established the materiality standard set forth twenty-three years ago in Basic Inc. v. Levinson. Although the Court relied heavily on this past decision, it did provide some guidance to pharmaceutical companies regarding the disclosure requirements of adverse event reports. With the circuit split now settled, it appears that adverse event reports, standing alone, will generally not be enough to satisfy the materiality standard. However, when in conjunction with affirmative statements concerning the safety and profitability of the drug, these adverse event reports may be material as to not make the statements made misleading. The question remains whether normal advertising of the drug would breach this threshold and require the disclosure of the adverse event reports.

I. Introduction

The United States Supreme Court's unanimous decision in Matrixx Initiatives, Inc. v. Siracusano¹ on March 22, 2011, resolved a circuit split by affirming the Ninth Circuit's standard of materiality for patient and physician reports under Rule 10b-5 of the Securities Exchange Act of 1934 ("1934 Act").² In doing so, the Court rejected the standard established by the First, Second, and Third Circuits.³ The issue arose out of patient and physician reports of adverse effects of using the over-the-counter drug Zicam.⁴ The Ninth Circuit held that the materiality of the reports under Rule 10b-5 of the 1934 Act was not dependent on the statistical significance of these complaints,⁵ contrary to holdings by the First, Second, and Third Circuit Courts.⁶

Zicam is one of the primary products sold by Matrixx Initiatives, Inc. ("Matrixx"). ⁷ It is sold in numerous forms over-the-counter for use as a cold remedy.⁸ Some of these forms are swabs and gel that contain zinc, designed for intranasal application.⁹ As early as 1999, users of these Zicam products began to experience the loss of smell.¹⁰ As a publicly traded company, Matrixx is required to comply with certain disclosure requirements of the 1934 Act.¹¹ Matrixx, as it became aware of these adverse events associated with Zicam use, did not disclose this information on its formal reports to the Securities Exchange Commission ("SEC") and affirmatively denied the validity of these events in press releases.¹² As a result, a group of shareholders brought a class action law suit against Matrixx under the anti-fraud provisions of the 1934 Act, alleging that Matrixx violated Section 10(b) and Rule 10b-5 "by failing to disclose material information regarding Zicam Cold Remedy."¹³

This Recent Development will first introduce the facts of Siracusano. Next, it will discuss the statutes and judicial precedent applicable to this case and continue with a discussion about the District Court's and Ninth Circuit's reasoning in Siracusano. Part IV will analyze the recent Supreme Court decision, and this Recent Development will conclude with a discussion of the implications of this decision going forward.

II. Matrixx Initiatives, Inc. v. Siracusano

Matrixx is a pharmaceutical company and a large distributor of cold medication.¹⁴ Zicam is one of Matrixx's main products and is sold over the counter as a cold remedy.¹⁵ Siracusano v. Matrixx is a class action law suit filed by current shareholders against Matrixx for a violation of Rule 10b-5¹⁶ of the Securities Exchange Act of 1934 regarding disclosure of material information concerning the potential adverse effects of using their pharmaceutical products.¹⁷

The complaint alleged that Matrixx, in failing to disclose the potential link between Zicam and anosmia,¹⁸ violated Section 10(b) of the 1934 Act.¹⁹ Between December 1999 and April 2004, Matrixx received various adverse event reports and became aware of at least one academic study that was conducted by researchers at the University of Colorado about patients suffering from anosmia, allegedly due to Zicam use.²⁰ During this same period, Matrixx issued several reports in various press releases and filings with the Securities Exchange Commission²¹ showing positive profit potential for the Zicam brand and denying any allegations of a connection between Zicam use and anosmia.²² In February 2004, Good Morning America reported on these potential problems associated with Zicam use and also reported that there were four product liability lawsuits pending against Matrixx alleging that Zicam use caused plaintiffs' anosmia. After this report, the Matrixx common stock price fell 23.8% in one day.²³

In response to Good Morning America's report, Matrixx issued a press release stating that any link between anosmia and zinc gluconate intranasal gels, such as Zicam, was "completely unfounded and misleading."²⁴ on February 19, 2004, Matrixx ultimately filed a Form 8-K²⁵ stating that there was no sufficient evidence to support a link between Zicam use and anosmia.²⁶ However, on June 16, 2009, the Food and Drug Administration ("FDA") informed Matrixx that Zicam "may pose a serious risk to consumers."²⁷

III. Background Law

A. The 1934 Act

The 1934 Act was promulgated mainly as an investor protection statute to prevent any fraud in conjunction with the offering of securities and to increase investor awareness and confidence in securities offerings after the stock market crash of 1929.²⁸ The anti-fraud provisions of the 1934 Act are stated, in part, in Section 10(b) and further codified by the SEC in Rule 10b-5.²⁹ Under these anti-fraud provisions, a private right of action exists where the plaintiffs are shareholders and the defendant company is publicly traded and subject to the requirements of the 1934 Act.³⁰ Further, "[t]o state a claim under Section 10(b) [of the 1934 Act], 15 U.S.C. 78j(b),[³¹ ] and Rule 10b-5, 17 C.F.R. § 240.10b5,[³² ] appellants must allege: (1) a misstatement or omission (2) of material fact (3) made with scienter (4) on which Appellants relied (5) which proximately caused their injury."³³ In Siracusano, the Supreme Court resolved the issue of what constitutes a material fact under the 1934 Act as applied to pharmaceutical companies.³⁴

B. In the Courts

1. U.S. Supreme Court's Materiality Under Section 10(b) of the 1934 Act

The U.S. Supreme Court first addressed the standard for the materiality element of a Section 10(b) and Rule 10b-5 claim in Basic, Inc. v. Levinson.³⁵ Basic involved merger negotiations between two companies, and the plaintiffs in that case alleged material misrepresentations by the target company.³⁶ The target company, while in the middle of the merger discussions, made three public statements denying the negotiations and stating that they were not aware of any company developments which explained the high trading activity and prices in the company's stock.³⁷

In Basic, the Court relied on TSC Industries, Inc. v. Northway, Inc.³⁸ to establish the standard for determining materiality under Section 10(b) of the 1934 Act.³⁹ Although TSC involved Section 14(a) of the 1934 Act,⁴⁰ the Court explicitly applied the same standard of materiality under Section 10(b).⁴¹ In TSC, the Court stated that "[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote."⁴² The Basic Court further clarified that "to fulfill the materiality requirement 'there must be 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.'"⁴³

The Basic Court acknowledged that in TSC, "the Court was careful not to set too low a standard of materiality" because a lower standard could potentially "bring an overabundance of information within its reach."⁴⁴ Furthermore, the Court was specifically concerned that an overflow of trivial information into the market could obscure the truth and hinder effective decision-making.⁴⁵ Though the Supreme Court's decision in Basic was based in the context of merger negotiations, it has been applied in numerous cases and contexts since then.⁴⁶ However, because of the unique characteristics of pharmaceutical companies, this standard has been applied differently by the lower courts in these cases.

2. The Circuit Split: The Circuits' Materiality Standards Under Section 10(b) of the 1934 Act

When applying the materiality standard to pharmaceutical companies, one must turn first to the Carter-Wallace, Inc.⁴⁷ line of cases from the U.S. Court of Appeals for the Second Circuit.⁴⁸ These cases involved the use of an epilepsy drug, Felbatol, and potential side effects from its use.⁴⁹ Similar to Siracusano, in Carter-Wallace the drug manufacturer became aware that some patients developed various illnesses, such as aplastic anemia,⁵⁰ while simultaneously running advertisements in medical journals promoting the safety and effectiveness of the medication.⁵¹ During this time, Carter-Wallace was informed by physicians of "at least fifty-seven adverse medical reports relating to Felbatol, including at least six deaths and six cases of aplastic anemia."⁵² The next month, Carter-Wallace recommended the discontinuance of Felbatol treatment. Upon disclosure of this information, the company's stock prices fell almost thirty-three percent in one day.⁵³

In reaching its decision in Carter-Wallace II, the Second Circuit reasoned that since the reports received by Carter-Wallace prior to their withdrawal of the medication "did not demonstrate a statistically significant link between Felbatol and any illness,"⁵⁴ plaintiffs had failed to allege facts sufficient to meet the materiality requirement of Section 10(b) of the 1934 Act.⁵⁵ The court reasoned that Carter-Wallace had no viable grounds to question the success of Felbatol...