To Disclose or Not to Disclose?

This June, the United States Supreme Court agreed to review Matrixx Initiatives, Inc. v. Siracusano, a case presenting the question whether securities law plaintiffs must allege statistically significant evidence of harm to survive a motion to dismiss when bringing claims against drug companies for failure to disclose adverse event reports.

The issue has been framed as a question of whether drug companies have a duty to disclose adverse event reports to investors, even when those reports do not establish statistically significant evidence that the drug may cause the events.

Although a bright line rule limiting when adverse event reports must be shared with investors could prove useful to drug and medical technology companies, negative consequences could also result. This is particularly true if the rule is not drawn carefully to avoid the automatic imputation of materiality or deceptive intent whenever there is some type of statistically significant risk calculation that could be made.

District Court Dismisses: No Materiality or Scienter

Shareholders sued Matrixx Initiatives in 2004, arguing that it violated § 10(b) of the Securities Exchange Act and SEC Rule 10b-5 by publicly affirming the safety of its nasal gel Zicam while knowing that 12 Zicam users had reported a loss of their sense of smell.

The district court granted Matrixx's motion to dismiss this case for failure to state a claim under the materiality or scienter (deceptive intent) requirements of the securities laws. The district court noted that the investors had alleged no data as to the reliability or accuracy of the user complaints, nor had they alleged that the complaints were statistically significant.

The court cited Second Circuit decisions for the proposition that when shareholders seek damages for failure to disclose adverse event reports, materiality and scienter elements require, as a matter of law, allegations that the reports were statistically significant. See In re Carter-Wallace, Inc. Securities Litigation, 150 F.3d 153 (2d Cir. 1998); In re Carter-Wallace, Inc. Securities Litigation, 220 F.3d 36 (2d Cir. 2000) (both considering reports of aplastic anemia made in connection with the study or use of the anti-epilepsy drug Felbatol). According to the Second Circuit, such a requirement ensures that the event may be caused by, rather than randomly associated with, the use of the drug.

The First and Third Circuits also have imposed statistical significance requirements in evaluating pleadings based on disclosure of adverse event reports.

In New Jersey Carpenters Pension & Annuity Funds v. Biogen Idec Inc., 537 F.3d 35 (1st Cir. 2008), the First Circuit held that Biogen could not have intentionally misled investors about a risk that Tysabri could cause opportunistic infections until the company knew there was something requiring disclosure - and that this knowledge could not arise from a few isolated reports without evidence of a causal relationship established through statistically significant findings. Id. at 44-53.

Similarly, the Third Circuit held that American Home Products did not materially and intentionally mislead investors by failing to disclose all heart valve reports it had received about users of the diet drugs Pondimin and Redux, at a time when there was no statistically significant evidence establishing a serious health risk. Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000).

Ninth Circuit Reverses: ‘Holistic' Consideration of Complaint

Despite this authority, the Ninth Circuit Court of Appeals reversed the dismissal of claims in Matrixx Initiatives, stating that the district court's reliance on the statistical significance standard was inconsistent with the Supreme Court's rejection of bright-line rules related to materiality findings, and concluding that a "holistic" consideration of the complaint supported the necessary inferences that the information was withheld intentionally. Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167 (9th Cir. 2009).

Supreme Court Grants Matrixx Petition

Matrixx filed a petition for Supreme Court review. The question presented was phrased as follows: "Whether a plaintiff can state a claim under § 10(b) of the Securities Exchange Act and SEC Rule 10b-5 based on a pharmaceutical company's nondisclosure of adverse event reports even though the reports are not alleged to be statistically significant." In support of its certiorari petition, Matrixx cited precedent from the First, Second and Third Circuits as being squarely opposed to the Ninth Circuit's refusal to require statistical significance allegations. On June 14, 2010, the Supreme Court granted the petition.

Ultimate Effect Uncertain

Drug and medical technology companies already must navigate an extensive set of rules about when and how to disclose adverse event reports to government agencies and incorporate adverse event information into product labeling. Hundreds of thousands of adverse event reports are received each year by FDA, and many of these reports do not offer complete, reliable, or accurate information.

In this context, a bright line rule introducing certainty and clarity about when these reports must be shared with investors could prove very useful.

The shaping of a disclosure rule, however, will require careful consideration. The rule should not overstate the importance of a calculation establishing significance, such that plaintiffs could allege that any statistically significant finding automatically establishes or implies materiality and intent. In other words, statistical significance may be necessary, but should not be sufficient to plead violations of the securities laws.

Further, if the statistical significance test is adopted, the necessary showing requires clarification and should carry an important and relevant scientific meaning. The Internet offers many computer programs that can generate risk numbers without good statistical data or clinical reason. The FDA's recent decision to make additional safety information available publicly also could prove to be a source of statistical data that may not be scientifically meaningful but could be used by plaintiffs. And, as has been shown in other contexts, plaintiff counsel may adapt quickly to new pleading requirements.

Stay Tuned…

Matrixx Initiatives presents an important opportunity for the adoption of stricter pleading standards in shareholder lawsuits alleging failure to disclose adverse event reports.

The Court recently has strengthened other pleading standards, in ways that have had meaningful effects on civil litigation. It remains to be seen whether and how the Court will strengthen pleading requirements in this case. Whatever the Court's holding, its decision likely will have important implications for companies that receive and evaluate adverse event reports.