Supreme Court Declines To Adopt Bright Line Rule Regarding Materiality In Securities Fraud Actions

Posted on May 29, 2012


Mario Massillamany-Securities Attorney

When a securities law firm brings a securities fraud case against a defendant it must sufficiently plead all the elements of the cause of action, which include a material misstatement or omission. Recently, the United States Supreme Court was again asked by a defendant to adopt a bright line rule of what is, and is not, material in this context, and again it refused.

In the case of Matrixx Initiatives, Inc. v. Siracusano, decided on March 22, 2011, the Court was dealing with a claim for securities fraud under section 10(b) of the Securities and Exchange Act of 1934 and SEC rule 10b-5, brought against Matrixx Initiatives Inc. by a class of Plaintiffs who had purchased Matrixx stock in 2003 and 2004. The Plaintiffs alleged that Matrixx, a pharmaceutical company, failed to report information of adverse events associated with its cold relief product Zicam. Matrixx claimed that the adverse events were of a low enough statistical sampling that their failure to disclose them did not amount to a material misrepresentation or omission under 10b(b) and 10b-5. The district court granted Matrixx’s motion to dismiss, on those grounds. The Court of Appeals reversed and the Supreme Court took on the issue of whether this failure to disclose equals a securities fraud misrepresentation on appeal.

The Court applied the standard legal definition of “material misrepresentation” in securities fraud cases involving omissions which states that the materially requirement is satisfied when “there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by a reasonable investor as having significantly altered the ‘total mix’ of information made available.” Matrixx urged the court to adopt a bright-line rule that, “reports of adverse events when dealing with a pharmaceutical company’s products cannot be material absent a sufficient number of such reports to establish a statically significant risk that the product is in fact the cause of the events.” The Court declined to establish such a high standard for materiality in cases of securities fraud involving pharmaceutical products. Reasoning that medical professionals and regulators act on causational evidence that is not statistically significant, the court held that it stood to reason that a reasonable investor would do so as well. Thus instead of imposing a bright-line rule of materiality for securities fraud cases involving pharmaceutical products, the Court established that materiality should be determined on a “fact specific” basis. This means that pharmaceutical manufacturers do not have to disclose all information about a product, but they do have to disclose all information that a “reasonable investor” would view as significantly altering the “total mix” of information about the product.

Based on this standard the Court found that the Plaintiff’s had successfully pled the misrepresentation element for a fraud claim under 10(b) and 10b-5. The Plaintiffs had alleged that Matrixx ignored three reports from qualified medical professionals about at least 10 patients that had lost their sense of smell after the use of their Zicam product.  Additionally, the Plaintiffs showed that Matrixx was aware of several pre-existing and well established studies that linked the intranasal application of zinc, one of the primary ingredients of Zicam, with loss of patients’ sense of smell. The Court found that these facts easily met the “reasonable investor” test and thus the Plaintiff’s case could proceed to the merits of its securities fraud claim.

In adopting a fact specific test for dealing with the materiality of a pharmaceutical company’s omission of adverse events associated with their products the Court kept a door open to avoid excesses created by market pressures. If not for such a measure, pharmaceutical companies could bury adverse reports about their products in a sea of statistical data, denying culpability as long as those negative events were in an arbitrary statistical range. The Court noted that in this case Matrixx had done just that, ignoring the adverse events while at the same time promising investors expected future growth, in order maintain investor confidence. It is to deal with this type of corporate abuse that the fraud actions of 10(b) and 10b-5 were originated.

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