High Court Again Rejects Bright Line Rule For Pleading Materiality

1. Introduction

   In Matrixx Initiatives, Inc. v. Siracusano,1 the Supreme Court recently reaffirmed its long-standing holding in Basic v. Levinson2 that there is no "bright-line rule" for determining whether information withheld from a company's public filings is material as a matter of law.3 Unwilling to allow materiality to be reduced to a test of "statistical significance," the Court held instead that assessing materiality involves a "fact-specific inquiry . . . that requires consideration of the source, content, and context of the [allegedly omitted information]."4 Thus, the Court held, while statistical significance is relevant to the inquiry, "it is not dispositive in every case."5

2. Background

   Matrixx Initiatives, Inc. ("Matrixx") is a publicly held pharmaceutical company that sells cold remedy products through its wholly-owned subsidiary Zicam, LLC. At issue in Matrixx were reports were made to Matrixx by a handful of doctors that alleged their patients had experienced complete loss of smell, or anosmia, after using Zicam Cold Remedy gel or nose spray ("Zicam"), a product which represented 70% of Matrixx's sales.6 Despite knowledge of these complaints, Matrixx told investors that Zicam was "poised for growth in the upcoming cough and cold season," that "the company had 'very strong momentum'," and it expected revenues to "be in excess of 50%, and that earnings . . . [would] be in the 25 to 30 cent range."7 During the class period, Matrixx further increased these projections, "predicting an increase in revenues of 80 percent and earnings . . . in the 33-to-38-cent range."8 Matrixx went on to issue a press release suggesting studies had discredited Zicam-anosmia claims, although it had conducted no such studies.9 When news of the doctors' reports aired on Good Morning America in February 2004, however, Matrixx stock dropped nearly 26%.10

   Plaintiffs filed a class action suit on behalf of individuals who purchased Matrixx securities between October 22, 2003 and February 6, 2004. Plaintiffs claimed that Matrixx failed to disclose the reports of a possible link between Zicam and loss of smell, rendering the statements relating to revenues and product safety made by Matrixx during the class period materially misleading in violation of §10(b) of the Securities Exchange Act and SEC Rule 10b-5.11 Defendants moved to dismiss the complaint, arguing that plaintiffs had failed to allege that the reports of Zicam-induced-anosmia represented a "statistically significant" link between Zicam and anosmia.12 Relying on decisions from the Second and Third Circuit, the district court agreed, finding the adverse event reports immaterial as a matter of law.13 Since Plaintiffs had not alleged that defendants were aware of a statistically significant link between Zicam and anosmia, the court reasoned, they had not plead facts sufficient to support a strong inference that defendants had acted with requisite scienter.14

   On appeal, the Ninth Circuit reversed, rejecting the "statistical significance standard" as contrary to the holding of the Supreme Courts in Basic.15 Warning against the adoption of a "bright-line rule," the Ninth Circuit emphasized that "courts should engage in a 'fact-specific inquiry' in assessing materiality."16 The Ninth Circuit also found that plaintiffs had properly plead scienter, holding Matrixx's failure to disclose the adverse event reports and its involvement in a related lawsuit during the class period was "an extreme departure from the standards of ordinary care."17

3. The "Statistical Significance Standard"

   On petition for a writ of certiorari, the parties in Matrixx argued over the importance of the Ninth Circuit's ruling. Matrixx suggested to the Supreme Court that the Ninth Circuit had created a circuit split by rejecting a "statistical significance standard" in conflict with First, Second, and Third Circuit precedent.18 Matrixx cited the Second Circuit's decision of In re Carter-Wallace, Inc. Securities Litigation,19 for the proposition that §10(b) claims do not exist on the basis of adverse event reports that are not statistically significant because such reports do not indicate that the product caused the adverse reaction, negating both materiality and scienter.20 Similarly, Matrixx pointed to N.J. Carpenters Pension & Annuity Funds v. Biogen IDEC Inc.,21 where the First Circuit found scienter lacking because the plaintiff had relied on statistically insignificant adverse event reports.22 Further, Matrixx explained that the Third Circuit had concluded, in Oran v. Stafford,23 that "drug companies need not disclose isolated reports of illnesses suffered by users of their drugs until those reports provide statistically significant evidence that the ill effects may be caused by . . . use of the drugs."24

   Plaintiffs argued that Matrixx's claim of a circuit split was illusory.25 They pointed out that both Carter- Wallace and Biogen were decided on a lack of scienter, and that in both cases materiality had already been assumed...