U.S. Supreme Court to Rule on When an AER is Material Information that Must be Disclosed to Investors

September 8, 2010

By Ricardo Carvajal

Section 10(b) of the Exchange Act and Securities and Exchange Commission (“SEC”) Rule 10b-5 prohibits “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”  To adequately allege a violation, a plaintiff must allege (among other things) that a defendant has engaged in a material representation or omission of fact, and that the defendant has done so with an intent to deceive, manipulate, or defraud – otherwise known as “scienter.”

Last fall, the 9th Circuit overturned a district court’s dismissal of a class action lawsuit alleging that Matrixx Initiatives, Inc. (“Matrixx”) violated securities laws when it failed to disclose information about possible adverse health effects of Zicam, its zinc-based cold remedy.  The district court had dismissed the complaint on the ground that plaintiffs alleged insufficient evidence to support their claim of a securities fraud violation.  In specific, the district court held that adverse event reports (“AERs”) about Zicam were not material because they were not statistically significant, and also that plaintiffs’ allegations of scienter were inadequate.  The appellate court reversed, concluding that the district court erred when it applied a statistical significance standard to determine the materiality of the AERs.  The appellate court also concluded that the inference of scienter was sufficiently strong to survive dismissal.

Matrixx appealed the 9th Circuit decision, and the Supreme Court granted certiorari in June on the question of “[w]hether 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.”  Since then, the drug, medical device, and dietary supplement industries have lined up in solid opposition to the 9th Circuit decision, as evidenced by briefs recently filed in the case by PhRMA, AdvaMed, BayBio, the Consumer Healthcare Products Association, the Council for Responsible Nutrition, and the Natural Products Association, among others (see the U.S. Supreme Court docket here and SCOTUSBlog for copies of the briefs). 

Generally, the briefs argue that the district court properly applied the statistical significance standard, and that upholding the 9th Circuit decision would have strong detrimental effects on companies, investors, and consumers.  More specifically, the briefs argue that AERs are not evidence of a causal relationship between a product and an adverse event, and that data submitted in AERs requires analysis to determine its significance.  Yet, if the 9th Circuit decision stands, companies would have little choice but to disclose all adverse event reports.  The resulting flood of information could confuse and mislead both investors and consumers.

Although most of the briefs focus on the statistical significance standard, the Washington Legal Foundation (“WLF”) filed a brief that focuses solely on the issue of scienter.  WLF argues that the facts alleged in the case do not adequately support the inference of scienter drawn by the appellate court.  Rather, those facts support the inference that Matrixx considered the AERs for Zicam to not be material – a position that Matrixx advances in its own brief.

Given the potential impact on a wide range of FDA-regulated companies, this is a case that should be watched closely.