Volume 25 Number 1, January 2011
SECURITIES LITIGATION
The SEC’s View of the
“Reasonable” Investor as the
Irrational, Scared Investor
The Supreme Court shortly will address the
issue of materiality in the context of a Rule 10b-5
claim. In its amicus curiae brief, the SEC suggests
that investors need information, no matter how
sketchy, preliminary, or unreliable, that might indi-
cate a potential problem with a company’s products
or operations. Acceptance of such a standard would
magnify the already daunting disclosure issues con-
fronted by public companies and their counsel.
By Jared Kopel
The United States Supreme Court in recent
years has addressed in seriatim fashion the signifi-
cant elements of a private shareholder claim under
Section 10(b) of the Securities Exchange Act of
1934 (Exchange Act) and Securities and Exchange
Commission (SEC) Rule 10b-5 thereunder. Thus
the Court has addressed reliance, Stoneridge Inv.
Partners, LLC v. Scientific-Atlanta, Inc.;1 scienter,
Tellabs, Inc. v. Makor Issues & Rights, Ltd.;2 and
loss causation, Dura Pharm. Inc. v. Broudo.3 The
Court this term will address yet another element
of a Rule 10b-5 claim—materiality—in Matrixx
Initiatives, Inc. et al. v. Siracusano et al.4 The case
Jared Kopel is a securities litigation partner at Wilson Sonsini
Goodrich & Rosati, P.C. in Palo Alto, CA.
arises from a decision by the Ninth Circuit Court
of Appeals, Siracusano v. Matrixx Initiatives,
Inc.5 Oral argument before the Supreme Court
was held January 10, 2011.
As articulated by Petitioners, the question
presented in this matter is whether a plaintiff
can state a claim under Section 10(b) and Rule
10b-5 based on a pharmaceutical company’s
nondisclosure of adverse event reports (AERs)
even though the reports are not alleged to be
statistically significant.6 But lurking beneath the
surface of this seemingly narrow issue is a more
fundamental question: for purposes of deter-
mining materiality in a securities fraud action,
whether the proverbial “reasonable investor” is a
rational individual who desires and is entitled to
that information that will enable him or her to
reach an informed investment decision, or, as the
SEC appears to suggest in its amicus curiae brief,
a scared irrational individual who will flee to the
investment exits at the first whiff of any infor-
mation, no matter how sketchy, preliminary or
unreliable, that might indicate a potential prob-
lem with a company’s products or operations.
Further, the SEC argues that materiality depends
on the potential actions of third parties, such as
consumers and plaintiffs’ attorneys, rather than
the information necessary for informed decision-
making by the rational investor. Acceptance of
the SEC’s proposal by the Supreme Court would
severely magnify the already daunting disclosure
issues confronted by public companies and their
counsel.
Background
Matrixx is a pharmaceutical company that
that sells cold remedies through its wholly-owned
subsidiary, Zicam, LLC.7 During the relevant
time period, Matrixx sold Zicam Cold Remedy,
an over-the-counter cold remedy. Zicam Cold
Remedy’s active ingredient is zinc gluconate and
may be applied as a nasal spray or a gel. Zicam
Cold Remedy accounted for approximately
70 percent of Zicam’s sales during the purported
class period.
Plaintiffs alleged that in December 1999, a
neurologist called Matrixx’s customer service line
to advise that one of his patients had developed
anosmia, which is the loss of the sense of smell,
after using Zicam and that studies had indicated
potential problems with intranasal application
of zinc. In September 2002, Timothy Clarot,
Matrixx’s Vice President of Research and Devel-
opment, and one of the individual defendants,
called Miriam Linschoten, Ph.D., at the Univer-
sity of Colorado Health Sciences Center, because
one her patients had been treated for loss of smell
following use of Zicam and had complained to
Matrixx. Dr. Linschoten expressed concern that
Zicam carried no warning that it could cause
anosmia. Clarot allegedly replied that Matrixx
had received similar complaints from other cus-
tomers and that Matrixx had not conducted any
studies concerning the possible link between zinc
sulfate and the loss of smell. Subsequently, after
Dr. Linschoten provided Clarot with abstracts on
the link between zinc sulfate and the loss of smell,
Clarot asked her to participate in animal stud-
ies to be conducted by Matrixx. Dr. Linschoten
declined because she focused on human, not ani-
mal, studies.
In September 2003, Dr. Linschoten, Dr. Bruce
Jafek at the University of Colorado School of
Medicine and another colleague planned to sub-
mit their findings regarding ten patients who pur-
portedly had developed anosmia following Zicam
use in a presentation to the American Rhinologic
INSIGHTS, Volume 25, Number 1, January 2011
Society. Matrixx sent a letter to Dr. Jafek refusing
permission to use Matrixx’s names or the names
of its products in the presentation, which was
made at the end of September 2003 without any
reference to Zicam.
On October 22, 2003, Matrixx issued a press
release announcing that its net sales for the third
fiscal quarter had increased by 163 percent over
the year-earlier quarter. The press release quoted
Carl Johnson, Matrixx’s CEO (and a defendant)
as stating that the Zicam brand was “poised for
growth” and that Zicam was an “efficacious prod-
uct.” On the following day, Johnson stated in an
earnings call that Matrixx’s strong results were
due to Zicam Cold Remedy offering a “unique
benefit” that reduced the duration and severity of
the common cold. Johnson stated that the com-
pany’s officers were not involved in any litigation
and denied being aware of any SEC investiga-
tion. In fact, a lawsuit alleging that Zicam caused
anosmia was filed on October 14, 2003, but was
not served until October 23, the day of the earn-
ings call.
On November 12, 2003, Matrixx filed with
the SEC its Quarterly Report on Form 10-Q,
which warned that the company could be subject
to significant liability should use or consump-
tion of its products cause injury. On January 7,
2004, Matrixx issued a press release that
upwardly revised its guidance for fiscal 2003. On
January 30, 2004, an article on the Dow Jones
Newswires reported that the Food and Drug
Administration was “looking into complaints”
that one of Matrixx’s products “may be causing
some users to lose their sense of smell” and that
three lawsuits had been filed against Matrixx by
users of Zicam Cold Remedy. Matrixx’s stock
price declined from $13.55 per share to $11.97
following this article.
In response to the Dow Jones article,
Matrixx issued a press release on February 2,
2004, stating that it was not aware of any FDA
inquiry into the safety of its products and that
2
assertions that Zicam products caused anosmia
“are completely unfounded and misleading . . .
the safety and efficacy of zinc gluconate for the
treatment of symptoms related to the common
cold have been well established.” Matrixx stated
that the population most likely to use Zicam was
already at an increased risk for anosmia because
a chief cause was the common cold. Matrixx
also asserted that the Dow Jones news article
appeared timed to interfere with a deposition of
a defendant in a defamation action brought by
Matrixx.
On February 6, 2004, a television news show
provided a report on whether Matrixx’s products
caused anosmia. The show stated that Dr. Jafek
had treated more than a dozen patients, four
lawsuits against Matrixx had been filed and oth-
ers were being prepared. Matrixx’s stock price
dropped 23.8 percent to $9.94. On the same day,
Matrixx issued a press release reaffirming the
safety and efficacy of Zicam Cold Remedy. On
March 19, 2004, Matrixx filed its Annual Report
on Form 10-K with the SEC stating that numer-
ous suits alleging that Zicam products caused
anosmia had been filed.
Plaintiffs filed their lawsuit on April 27, 2004,
alleging that Matrixx and three of its officers
violated Section 10(b) and Rule 10b-5 because
their statements between October 23, 2003, and
February 6, 2004 (the class period) had been
materially false and misleading by failing to
disclose defendants’ awareness of the significant
health risk that Zicam Cold Remedy presented to
users; that at least one lawsuit had already been
filed; and that other lawsuits were being pre-
pared. Plaintiffs also alleged that Matrixx’s finan-
cial statements filed with the SEC were false and
misleading and violated SEC rules and Generally
Accepted Accounting Principles.
Over five years later, in June 2009, the FDA
issued a warning letter to Matrixx, setting forth
the FDA’s conclusion that several Zicam Cold
Remedy products “may pose a serious risk to
3 INSIGHTS, Volume 25, Number 1, January 2011
consumers who use them.” The FDA stated that
it had received “more than 130 reports of anos-
mia” associated with the use of these products.
The district court granted defendants’ motion
to dismiss.8 The court held that “adverse infor-
mation related to the safety of a product is not
material unless such reports provide reliable
statistically significant information that a drug
is unsafe,” relying on the standard set forth in
In re Carter-Wallace, Inc. Sec. Litig.,9 (Carter-
Wallace I) and In re Carter-Wallace, Inc. Sec.
Litig.,10 (Carter-Wallace II). The district court
found that 12 user complaints were not “sta-
tistically significant.” The court also ruled that
plaintiffs had failed to plead sufficient facts estab-
lishing scienter.
Decision by Circuit Court
In reversing the district court, the Ninth Cir-
cuit rejected the statistical significance standard
to determine materiality. It cited Basic, Inc. v.
Levinson,11 as rejecting a bright-line rule to deter-
mine materiality “because ‘[t]he determination
[of materiality] requires delicate assessments of
the inferences a “reasonable shareholder” would
draw from a given set of facts and the significance
of those inferences to him.’”12 The Ninth Circuit
held that in relying on the statistical significance
standard to determine materiality, the district
court made a decision that should have been
left to the finder-of-fact. The court held that
plaintiffs’ allegations were “plausible on their
face” and satisfied the pleading requirements of
the Private Securities Litigation Reform Act of
1995.13
The Ninth Circuit held that scienter had been
sufficiently alleged by the allegations that defen-
dants were aware of the information indicating a
possible link between Zicam and anosmia. The
Circuit court held that viewing the complaint as
a whole, the inference of scienter was “‘cogent
and at least as compelling’ as any ‘plausible non-
culpable explanation [ ].’”14
 The Ninth Circuit denied a petition for rehear-
ing and rehearing en banc. Defendants filed a peti-
tion for a writ of certiorari on March 23, 2010,
which was granted by the Supreme Court on
June 14, 2010.15
Amicus Brief by United States
The United States, through the SEC and the
Department of Justice, filed an amicus curiae
brief in November 2010 (Amicus Brief) that sup-
ported the Respondents-Plaintiffs. The Amicus
Brief reflected the views of the SEC as the
agency that administers and enforces the federal
securities laws.16 The Amicus Brief argued that
data showing a statistically significant associa-
tion is “not essential to establish a link between
the use of a drug and an adverse event.”17 More
importantly, the SEC argued that information
suggesting a drug causes an adverse effect may
be important to a reasonable investor “even if it
does not prove that a causal link exists.”18 The
SEC stated:
[S]uch information may affect the behavior
of consumers and potential litigants, and
[the] FDA can and does take regulatory
action without evidence establishing statis-
tical significance. Because those responses
affect a product’s commercial viability, and
thus the company’s financial condition, a
reasonable investor often will want to know
about such information.19
The SEC’s position marks a radical departure
from the traditional and well-understood defi-
nition of materiality and the concept of a “rea-
sonable investor.” Information would no longer
be deemed material only when it had reached a
degree of certainty and reliability such that dis-
closure would assist a rational investor make a
well-informed investment decision. Rather, mate-
riality could encompass any information, no mat-
ter how unreliable or unconfirmed, that investors
might like to know, and which if disclosed, could
conceivably result in a drop in the stock price,
INSIGHTS, Volume 25, Number 1, January 2011
even if that decline were based on ill-informed
panic selling that did not reflect the stock’s true
long-term value.20 Companies and their counsel
would be rendered helpless in trying to ascertain
some reliable standard for determining when
information should be disclosed. Further, prema-
ture disclosure of unverified adverse information
might discourage individuals from using neces-
sary and therapeutic medicine and/or cause phy-
sicians to stop prescribing the drugs due to fear of
malpractice suits. Patients who have already been
informed of the risks associated with clinical tri-
als may decide not to participate in clinical trials
due to “anecdotal reports that may have no bear-
ing on the safety of the drug being studied.”21
The SEC acknowledged that statistical sig-
nificance “provides some indication about the
validity of a correlation between a product and
a harm,” but asserted that a determination that
certain data are not statistically significant “does
not refute an inference of causation.”22 But
that would make materiality—and the duty to
disclose—predicated on proving the negative, i.e.,
disclosure would be required absent a showing
that the drug did not cause the reported event as
opposed to providing disclosure only when there
is significant meaningful evidence that the drug is
harmful.
The SEC also noted that Petitioners them-
selves had referenced certain factors from which
causation might be inferred even in the absence
of statistically significant evidence.23 The SEC
appears to cite these factors approvingly with-
out expressly endorsing them. To the extent that
the SEC believes that the statistically significant
standard is too arbitrary, such factors could pro-
vide the framework for another materiality stan-
dard. However, the Ninth Circuit’s decision was
not based on these factors. Thus, at a minimum,
remand to the Ninth Circuit for further review
and consideration would be required.
The SEC emphasized that “[I]nformation sug-
gesting that a company’s product causes harm
4
may be important to an investor even if the infor-
mation does not establish that the causal link”
exists.24 The SEC stated, “[A] reasonable investor
cares about the impact undisclosed information
will have on the company’s finances and stock
price. The extent of that impact depends on the
conduct of consumers, regulators, and possible
tort plaintiffs. Because those actors may respond
in ways that hurt the company based on infor-
mation that suggests but does not prove that the
company’s product causes a particular harm,
there are many reasons why an investor would
want to be alerted to the existence of such infor-
mation.”25 Thus, according to the SEC, even if
there is no reliable evidence that the company’s
product actually caused the reported adverse
events, information concerning such events still is
material because it may cause consumers to stop
buying a product that they “perceive” as risky;
prompt regulators to conduct investigations; and
inspire plaintiffs’ lawyers to file product liability
lawsuits.26
Thus, in a breath-taking exercise of circular
reasoning, the SEC asserts that a company must
prematurely disclose information suggesting that
its products are harmful, even when such a con-
clusion has not been substantiated, because of
the potential damage that such disclosure would
cause the company, which of course is precisely
the reason militating against such disclosure.
There is also no reason to believe that the SEC’s
diluted materiality standard would apply only to
drug companies. Any company could be required
to disclose isolated, random reports that their
products cause illness or injury even when any
causal relationship has not been substantiated.27
Such a materiality standard also would under-
mine long-established authority that companies
have the right to defer disclosure of ambiguous
but potentially adverse information in order to
investigate and better understand the issue before
making what might be premature and erroneous
disclosure. As discussed below, the SEC’s views
of materiality and the “reasonable investor” devi-
ate from the Supreme Court’s landmark decisions
5 INSIGHTS, Volume 25, Number 1, January 2011
in TSC Industries, Inc. v. Northway, Inc.,28
and Basic.
The Reasonable Investor as Set Forth
in TSC Industries and Basic
The SEC, as do the litigants themselves, cite
to and quote from the Supreme Court’s decisions
in TSC Industries and Basic for the definition of
materiality in a securities case. But a review of
these decisions provides a far different view of the
“reasonable investor” than postulated by the SEC
in its Amicus Brief.
TSC Industries actually concerned disclosure
in a proxy statement and alleged violations of
Section 14(a) of the Exchange Act and Rule 14a-9
thereunder. National Industries acquired 34 per-
cent of TSC’s voting securities by a purchase from
TSC’s founder and his family. Five National nom-
inees were placed on the TSC Board of Directors.
Subsequently, the TSC Board, with the National
nominees abstaining, approved a plan to liquidate
and sell all of TSC’s assets to National in a trans-
action involving the exchange of TSC securities
for National securities. Northway, a TSC share-
holder, filed a lawsuit contending that the joint
proxy statement of TSC and National omitted
material facts relating to the degree of Nation-
al’s control over TSC and the favorability of the
proposed transaction to TSC shareholders. The
Court of Appeals had reversed the district court’s
denial of summary judgment for Northway, hold-
ing that the certain omissions were material as a
matter of law.29
In discussing whether the alleged omis-
sions were material, the Supreme Court stated
that the question of materiality is “an objective
one, involving the significance of an omitted or
misrepresented fact to a reasonable investor.”30
The Court rejected the analysis of the Court of
Appeals that material facts include “all facts
which a reasonable shareholder might consider
important.”31 Thus the Court rejected the posi-
tion now taken by the SEC that material facts
include all facts that investors may want to know
or which investors may consider to be important.
Rather, the Supreme Court held that a standard
of materiality must serve the purpose of ensuring
“disclosures by corporate management in order
to enable the shareholders to make an informed”
decision. Further, “[s]ome information is of such
dubious significance that insistence on its disclo-
sure may accomplish more harm than good.” If
the standard of materiality is set too low, “not
only may the corporation and its management
be subjected to liability for insignificant omis-
sions or misstatements, but also management’s
fear of exposing itself to substantial liability
may cause it simply to bury the shareholders
in an avalanche of trivial information a result
that is hardly conducive to informed decision-
making. Precisely these dangers are presented,
we think, by the definition of a material fact [as
that] which a reasonable shareholder might con-
sider important.”32
Utilizing this standard, the Court reversed the
decision of the Court of Appeals that informa-
tion that might have suggested market manipu-
lation in the price of National securities had to
be disclosed because such information might be
significant to shareholders even if there was no
evidence of any manipulation. The Court stated
that “if liability is to be imposed . . . upon a the-
ory that it was misleading to fail to disclose pur-
chases suggestive of market manipulation, there
must be some showing that there was in fact mar-
ket manipulation.”33 The Court remanded the
case to the Court of Appeals for further consid-
eration.
Basic, Inc. v. Levinson concerned statements
by Basic, a publicly traded company, denying that
it was engaged in merger negotiations and that
it knew of no reason for heavy trading activity
in its stock, when in fact the company allegedly
was engaged in merger negotiations with Com-
bustion Engineering. Subsequent to the merger’s
announcement, former Basic shareholders filed a
class action lawsuit accusing Basic and its directors
INSIGHTS, Volume 25, Number 1, January 2011
of violating Section 10(b) and Rule 10b-5 because
plaintiffs purportedly sold their Basic stock at
prices that were artificially depressed as a result
of defendants’ allegedly misleading statements.
The Court of Appeals, in reversing summary
judgment for defendants, held that once Basic
made statements denying the existence of merger
discussions, even negotiations that may not have
been material became material because they made
the statements untrue.34
The Supreme Court expressly adopted the TSC
Industries materiality standard for Section 10(b)
and Rule 10b-5 actions, noting that TSC Indus-
tries “was careful not to set too low a standard
of materiality; it was concerned that a minimal
standard might bring an overabundance of infor-
mation within its reach, and lead management
‘simply to bury the shareholders in an avalanche of
trivial information . . .’” that was not “conducive
to informed decisionmaking.”35 The Court then
rejected as a standard of materiality in the merger
negotiation context the proposal that merger dis-
cussions do not become material until an “agree-
ment in principle” as to the price and structure
of the transaction has been reached between the
parties.36 Basic’s rejection of a “bright-line rule” is
unsurprisingly trumpeted by the SEC as the basis
for opposing the argument that AERs need not
be disclosed unless there is significant statistical
evidence that the drug caused the adverse event.37
However, Basic does not warrant the expansive
reading sought by the SEC.
First, the Court made clear in Basic that it
was not addressing materiality in every context,
but only “the narrow question whether informa-
tion concerning the existence and status of pre-
liminary merger discussions is significant to the
reasonable investor’s trading decision.”38 Sec-
ond, the Court rejected the standard adopted
by the Court of Appeals that Basic’s statements
denying the existence of merger discussions itself
transformed information that was not material
into material information because it made the
statements untrue. Rather, “a plaintiff must show
6
that the statements were misleading as to a mate-
rial fact. It is not enough that a statement is false
or incomplete, if the misrepresented fact is oth-
erwise insignificant.”39 Thus the mere fact that
Matrixx or its officers made statements concern-
ing projected revenue growth or the safety and
efficacy of Zicam Cold Remedy did not trigger
a duty to disclose random reports of potential
problems that had not been statistically substan-
tiated.
Third, Basic adopted a probability/magni-
tude analysis for materiality in the context of
preliminary merger negotiations. However, in
assessing the probability that a merger would
occur, the Court advised examining board reso-
lutions, instructions to investment bankers and
actual negotiations between principals.40 In other
words, the Court indicated that while an agree-
ment in principle was not required for material-
ity, there must be still significant indicia that the
event—here a merger—would occur in order
to conclude that it is probable. In Matrixx, the
analogous “event” is whether it was probable that
Zicam Cold Remedy was harmful to its users and
had caused the isolated adverse events that were
reported to the company. However, plaintiffs
failed to plead the significant indicia to support
a conclusion supporting probability that Basic
requires.
Distilling the key points of TSC Industries and
Basic lead to the following conclusions:
• Material information is that information that
would be used by an investor in making an
informed investment decision. Reaching an
“informed” investment presupposes rational,
logical investors. Thus materiality cannot be
determined by what some investors may want
to know, if the information is not conducive
to rational decisionmaking. 41
• Thus information that might be interpreted
as supporting a particular conclusion—
such as that a drug causes serious adverse
side-effects—need not be disclosed if the
7 INSIGHTS, Volume 25, Number 1, January 2011
conclusion is unsubstantiated or unverified
simply because investors might want to know
the raw information.
• Similarly, materiality must be determined
by how a rational investor would process
and analyze the information in reaching an
informed decision. Information is not mate-
rial merely because some panicky investors
would sell at the faintest hint of a potential
problem.
• Because materiality relates to how a rational
decisionmaker analyzes information, mate-
riality cannot be determined by the conduct
of third parties. In other words, information
does not become material simply because
plaintiffs’ lawyers may file strike suits or
some consumers may temporarily halt pur-
chases of the company’s products after any
unfavorable news. The rational decision-
maker presumably is aware that these devel-
opments will follow the release of any adverse
publicity but do not necessarily threaten the
company’s long-term viability or stock price
value.42
• Immaterial Information does not become
material merely because the defendants have
made statements concerning the subject
matter.
• To the extent that materiality depends on
the probability that an event will occur, there
must be significant indicia showing that the
event is probable.
• Materiality requirements must consider the
impact on companies in reaching disclosure
decisions because otherwise management, in
order to avoid potential liability, will be com-
pelled to disclose even trivial information that
is not conducive to rational decisionmaking.
Not only did the Ninth Circuit’s decision
in Matrixx and the SEC’s Amicus Brief ignore
these principles, but, as discussed below, they
also ignore substantial legal authority holding
that drug companies need not disclose reports of
adverse side effects unless the reports provide sta-
tistically significant evidence of causation.
Other Decisions Support the
Statistically Significant Standard
The overwhelming weight of authority sup-
ports the statistically significant standard for
materiality, even in cases where there were
reported deaths, which is certainly far more seri-
ous than any of the reported adverse events in
Matrixx. The best known of these cases are the
two decisions by the Second Circuit Court of
Appeals in In re Carter-Wallace, Inc. Securities
Litigation. Those decisions concerned allega-
tions that Carter-Wallace made materially false
statements promoting a new anti-epileptic drug,
Felbatol, while allegedly being aware of reports
that Felbatol may have caused several deaths
from a bone-marrow failure known as aplastic
anemia. In Carter-Wallace I, the court held that
Carter-Wallace had no duty to disclose these
reports, stating that “[D]rug 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—rather than randomly associ-
ated with—use of the drugs and are sufficiently
serious and frequent to affect future earnings.”43
In Carter-Wallace II, which concerned whether
plaintiffs had sufficiently alleged scienter, the
court again held that defendants had no duty of
disclosure even though Felbatol eventually was
linked to aplastic anemia. The court stated that
“the receipt of an adverse report does not in and
of itself show a causal relationship between”
Felbatol and aplastic anemia because “[s]ome
adverse events may be expected to occur ran-
domly, especially with a drug designed to treat
people that are already ill.”44 Just as the eventual
linkage between Felbatol and aplastic anemia
could not relate back to Carter-Wallace’s state-
ments during the class period,45 neither does the
FDA’s 2009 warning concerning Zicam Cold
Remedy support a duty to disclose during the
alleged class period.
In Oran v. Stafford,46 American Home Prod-
ucts Corporation (AHP) allegedly made false
INSIGHTS, Volume 25, Number 1, January 2011
statements concerning two weight-loss drugs
when it was aware of reports that users devel-
oped heart valve abnormalities. AHP eventu-
ally withdrew these drugs from the market after
the FDA advised that 97 users had developed
abnormalities. In an opinion by then Judge (now
Justice) Alito, the court endorsed the Carter-
Wallace standard and held that because there
was no conclusive evidence establishing a causal
relationship between the weight-loss drugs
and heart valve disorders during the relevant
period, AHP’s failure to disclose the adverse
reports did not render its statements about the
inconclusiveness of the relationship materially
misleading.47
Other courts have followed the Carter-Wallace/
Oran analysis. For example, in In re Bayer AG Sec.
Litig.,48 the court held that Bayer had no duty to
disclose adverse event reports concerning an anti-
cholesterol drug until a consensus emerged among
company executives that potential dangers “were
putting the brand at risk.”49
In Detroit General Retirement System v.
Medtronic, Inc.,50 Medtronic sent a letter to phy-
sicians informing them that the company had
received reports of higher than normal failure
rates and fracturing in a medical product and
that the company was investigating the prob-
lem. The company described the nature of the
potential problem and requested feedback from
the physicians regarding the potential problem.
Such a “Dear Doctor” letter presents one poten-
tial approach for companies that have received
reports of adverse events where there is yet no
statistically meaningful evidence of a causal rela-
tionship. Nonetheless, Medtronic’s disclosure
effort did not prevent the filing of a securities
fraud class action lawsuit alleging, among other
things, that the letter to physicians was materially
false and misleading. Although the Eighth Cir-
cuit affirmed dismissal, the action showed that
even an effort at “real time” disclosure of any
potential problems, such as sought by the SEC,
still resulted in litigation.
8
Conclusion
The SEC’s materiality analysis as set forth in
its Amicus Brief disregards traditional standards
for materiality and disclosure. If adopted by the
Supreme Court, the SEC’s standard would create
innumerable problems for companies and their
counsel in determining whether to disclose iso-
lated reports that a product may cause illness or
injury before there is any statistical or other sub-
stantiation that the product is actually associated
with the illness or injury. Further, plaintiffs would
argue that stock price movements do not have to
be statistically significant in order to be material.
The SEC’s standard would require disclosure that
is not conducive to informed decisionmaking by
rational investors, and that likely would unneces-
sarily damage the company, its shareholders, and
even consumers to the extent that they ceased using
therapeutically beneficial products. The SEC’s
position is contrary to established legal authority.
To the extent that the Supreme Court concludes
that the statistically significant standard is too
rigid or arbitrary, both the SEC and Petitioners
have, as discussed above, referenced a multi-factor
test for determining materiality. However, because
that test was not the basis for the decision by the
Ninth Circuit, the case should at a minimum be
reversed and remanded for further consideration.
NOTES
1. 552 U.S. 148 (2008).
2. 551 U.S. 308 (2007).
3. 544 U.S. 336 (2005).
4. No. 09-1156.
5. 585 F.3d 1167 (9th Cir. 2009).
6. Brief for Petitioners, at page i. Respondents reject this formulation,
contending that the case does not concern adverse event reports required
by the FDA. Rather, Respondents assert that the question presented is
whether a securities-fraud complaint adequately can plead material-
ity and scienter by alleging that defendants received multiple, credible
reports from medical specialists that defendants’ cold medicine appeared
to cause serious adverse side effects. Brief for Respondents, at page i.
7. The allegations are taken from the decision by the Ninth Circuit,
585 F.3d 1167, 1170-1175.
9 INSIGHTS, Volume 25, Number 1, January 2011
8. Siracusano v. Matrixx. Initiatives, No. CV-04-0886-PHX-MHM,
2005 WL 3970117 (D. Ariz. Dec. 15, 2005).
9. 150 F.3d 153, 157 (2d Cir. 1998).
10. 220 F.3d 36 (2d Cir. 2000).
11. 485 U.S. 224 (1988).
12. Basic, 485 U.S. at 236 (quoting TSC Indus., Inc. v. Northway, Inc.,
426 U.S. 438, 450 (1976)).
13. 585 F.3d 1167, 1177-1781. The Ninth Circuit’s decision did not explain
whether defendants’ statements during the class period were affirmatively
misleading or rendered materially misleading by virtue of omitted facts.
14. 585 F.3d 1167, 1183. (Quoting Tellabs, Inc. v. Makor Issues & Rights,
Ltd., 551 U.S. 308, 324 (2007).)
15. This article concerns only materiality issues, not scienter. However,
in the absence of any materially false and misleading statements, the
lawsuit fails, and the issue of scienter is not relevant.
16. Amicus Brief at 1.
17. Amicus Brief at 12. For a discussion of the meaning of “statisti-
cally significant evidence,” see Amicus Brief at 13-15; Petitioners’ Brief
at 34-36; In re American International Group, Inc. Securities Litigation,
265 F.R.D. 157, 183-185 (S.D.N.Y. 2010). See also Dr. David Tabak
and Frederick J. Lee, “The Matrixx of Materiality and Statistical
Significance in Securities Fraud Cases,” NERA Economic Consulting
(December 20, 2010) (NERA Article) at 2-6. In general, a researcher
begins with a “null hypothesis,” i.e., that there is no relationship between
the drug and the adverse effect. The researcher then creates a “p-value,”
which is the probability of “getting data as extreme as, or more extreme
than, the actual data, given that the null hypothesis is true.” In re Ameri-
can International Group, 265 F.R.D. 157, 183. A p-value that drops below
the pre-established value means that results are considered statistically
significant. The significance level most commonly used in medical
studies is 0.05. Thus, if the p-value is less than 0.05, there is less than a
5 percent chance that the observed association between the drug and the
adverse effect would have occurred randomly and the results are deemed
statistically significant. Amicus Brief at 14.
18. Amicus Brief at 12.
19. Id. at 12-13.
20. The Amicus Curiae Brief of Baybio (Baybio Brief), a trade asso-
ciation of life science companies in Northern California, described how
Merck & Co. and Schering-Plough Corp. announced that preliminary
but unvetted results of a clinical study showed an increase risk of
cancer in patients taking the drug Vytorin. The announcement caused
significant same day declines in the companies’ stock prices. Subse-
quently, however, the study’s full results led the FDA to conclude that
it was “unlikely” that Vytorin increased the risk of cancer and the drug
remains on the market. Baybio Brief at 19.
21. Baybio Brief at 18.
22. Amicus Brief at 14.
23. Amicus Brief at 15-16 (citing Petitioners’ Brief at 44 n.22, in turn
citing Magistrini v. One Hour Martinizing Dry Cleaning, 180 F. Supp. 2d
584, 592-593 (D.N.J. 2002)). These factors included (1) the strength of the
association between the adverse event and the drug, including whether
it is statistically significant; (2) the temporal relationship between expo-
sure and the adverse event; (3) consistency across multiple studies; (4)
“biological plausibility;” (5) “consideration of alternative explanations”
for the adverse event; (6) “specificity,” i.e., whether the specific chemical
is associated with the specific disease; and (7) dose-response relationship
(whether an increase in exposure yields an increase in risk).
24. Amicus Brief at 17 (emphasis added).
25. Id. at 17-18.
26. Id. at 18-21.
27. Further, the SEC’s Amicus Brief does not expressly link the duty
of disclosure to only those statements by Matrixx that specifically
addressed the safety or effectiveness of Zicam Cold Remedy. Nor does
the SEC contend that the duty to disclose AERs arose from the require-
ments under the Management Discussion and Analysis in Item 303 of
Regulation S-K. Rather, the SEC appears to suggest that the omitted
information concerning AERS rendered any Matrixx statement, regard-
less of the subject matter, materially false and misleading.
28. 426 U.S. 438 (1976).
29. See TSC Indus., 426 U.S. 438, 440-443.
30. 426 U.S. 438, 445.
31. 426 U.S. 438, 445 (citations omitted) (emphasis added).
32. 426 U.S. 438, 448-449 (emphasis in original).
33. 426 U.S. 438, 463.
34. Basic, 485 U.S. 224, 226-230.
35. 485 U.S. 224, 231.
36. 485 U.S. 224, 232-236.
37. See Amicus Brief at 25-31.
38. 485 U.S. 224, 235.
39. 485 U.S. 224, 238 (emphasis in original).
40. 485 U.S. 224, 238-239. In the context of the probability/magnitude
standard for materiality, the statistically significant evidence standard
relates only to the probability that an event has occurred, but not the
© 2011 Aspen Publishers. All Rights Reserved.
Reprinted from Insights January 2011, Volume 25, Number 1, pages 2-11,
with permission from Aspen Publishers, a Wolters Kluwer business, New York, NY,
1-800-638-8437, www.aspenpublishers.com.
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INSIGHTS, Volume 25, Number 1, January 2011
magnitude of the event. See NERA Article, at 7-8.
41. The purpose of the materiality requirement is to “filter out essen-
tially useless information that a reasonable investor would not consider
significant, even as part of a larger ‘mix’ of factors to consider in making
his investment decision.” Basic, 485 U.S. 224, 234 (citing TSC Industries,
426 U.S. at 448-449)).
42. “The role of the materiality requirement is not to ‘attribute to
investors a child-like simplicity . . . . ‘“ Basic, 485 U.S. at 234 (citation
omitted).
43. 150 F.3d 153, 157.
44. 220 F.3d 36, 41.
45. 220 F.3d 36, 41.
46. 226 F.3d 275 (3d Cir. 2000).
47. 226 F.3d 275, 283-284. Oran noted that plaintiffs had not alleged
that AHP failed to submit any required reports to the FDA. Id. at
284. Similarly, there is no allegation that Matrixx failed to submit any
required information to the FDA. Indeed, because Zicam Cold Remedy
was an over-the-counter drug, it had not needed initial FDA approval.
The SEC’s Amicus Brief conspicuously omits any reference to Oran.
Respondents attempt to distinguish Carter-Wallace and Oran by assert-
ing that those decisions did not consider the potential importance of
non-statistical information about a drug’s effects, such as case studies or
clinical opinions formed by physicians. Respondents’ Brief at 44.
48. No. 03 Civ. 1546 WHP, 2004 WL 2190357, at *7-12 (S.D.N.Y.
Sept. 30, 2004).
49. See also Detroit General Retirement Sys. v. Medtronic, Inc., 621 F.3d
800, 807 (8th Cir. 2010) (citing Carter-Wallace and Oran, holding that
medical device company did not have to disclose data concerning failure
rates of product); In re Adolor Corporation Sec. Litig., 616 F. Supp. 2d 551,
569-571 (E.D. Pa. 2009) (company had no duty to disclose allegedly nega-
tive results in clinical trials); In re Elan Corp. Sec. Litig., 543 F. Supp. 2d
187, 207-214 (S.D.N.Y. 2008) (company had no duty to disclose informa-
tion concerning possible risks of drug until statistically significant evi-
dence of causal link); In re Rigel Pharmaceuticals, Inc. Sec. Litig., No. C
09-00546 JSW, Slip op. at 14 (N.D. Cal. Aug. 24, 2010) (disagreement over
statistical analysis is not sufficient to allege a materially false statement).
50. 621 F.3d 800 (8th Cir. 2010).
10