Unanimous decisions by the U.S. Supreme Court are rare. Even rarer are those upholding class action claims under the federal securities laws. Because of this, there is reason to be pleased with yesterday’s opinion, Matrixx Initiatives, Inc. v. Siracusano (No. 09-1156) (Mar. 22, 2011).
In the case, the Court ruled that the plaintiffs stated a claim for securities fraud based on the drug company’s failure to disclose reports of adverse events associated with its main product. The defendant, Matrixx, sells Zicam nasal spray. It had received reports associating Zicam with a condition called anosmia, the total loss of the sense of smell. At the same time as it was receiving the reports and even after being sued in product liability cases involving anosmia, the company issued public statements that Zicam was “poised for growth” during the upcoming cold season. Although the company’s SEC filings warned that product liability claims could have an adverse impact on the company, it did not reveal that such claims had in fact already been filed. After ABC’s “Good Morning America” reported a link between anosmia and Zicam, Matrixx stock took a beating.
The company moved to dismiss a class action complaint by investors who claimed that the company violated Section 10(b) of the 1934 Securities Exchange Act, and SEC Rule 10b–5 by making untrue statements of fact and failing to disclose material facts necessary to make the statements not misleading in an effort to maintain artificially high prices for Matrixx securities. The trial court granted the motion, ruling that the plaintiff’s had not alleged that there was a “statistically significant correlation” between the use of Zicam and anosmia, such that the failure to disclose the complaints was not a “material” omission. It also ruled that the plaintiffs had not alleged scienter (intent to defraud), because they had not pleaded that Matrixx disbelieved its statements about Zicam’s safety. The Court of Appeals reversed and the case went to the Supreme Court.
Justice Sotomayor wrote the Court’s opinion, which declined “to adopt a bright-line rule” about what is and is not “material”. As such, the Court refused to contrive a categorical rule that would artificially exclude information that “would otherwise be considered significant to the trading decision of a reasonable investor.” This was consistent with the position urged by the SEC, which filed an amicus brief.
The opinion also is notable in finding that the plaintiffs met the strict standards for pleading scienter. The Court held that the allegations of the complaint gave rise to a “‘cogent and compelling inference’ that Matrixx elected not to disclose the reports of adverse event not because it believed they were meaningless but because it understood their likely effect on the market.”
Comment: Any day securities class action plaintiffs don’t get kicked out of court is a good day. The refusal to draw bright line tests of materiality is a win, since bright lines tend to limit rather than expand claims. So all in all, what I hope we can call the “Zicam smell test for materiality” really is nothing to sneeze at.