Corporate Governance

Matrixx v. Siracusana: Revisiting the Materiality Standard (Part 5)

By J Robert Brown Jr.

Much of the discussion in the Petition and Opposition concerns the impact of Basic, 485 U.S. 224 (1988).  This case does have a number of similarities to that case.  

Petitioners argue that disclosure of the reports would affirmatively harm investors.  See Cert Petition, at 16 ("Requiring disclosure of every adverse report, as the court of appeals effectively did below, 'would more likely confuse, than inform, the marketplace.').  In addition, they added the argument that a finding of materiality would harm consumers.  

• Disclosing every adverse event report would also be detrimental to consumers. Because such information, no matter how carefully phrased, is likely to spawn confusion, the unfortunate effect would be to deter consumers from purchasing drugs that are needed to improve their health." 

This is a variation of the "nitwit" argument rejected in Basic.  As the Court in that case observed:

• The first rationale, and the only one connected to the concerns expressed in TSC Industries, stands soundly rejected, even by a Court of Appeals that otherwise has accepted the wisdom of the agreement-in-principle test. "It assumes that investors are nitwits, unable to appreciate -- even when told -- that mergers are risky propositions up until the closing." Disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress. We have recognized time and again, a "fundamental purpose" of the various securities acts, "was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." 

485 US at 234.  The materiality concept is not about protecting investors from their own lack of acumen but about eliminating unimportant information from the decision making process.  See Id.  ("The role of the materiality requirement is not to 'attribute to investors a child-like simplicity, an inability to grasp the probabilistic significance of negotiations,' but to filter out essentially 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."). 

Petitioners did assert that a finding of materiality would result in excessive amounts of disclosure and that this would not be "conducive" to informed decisionmaking.  As the cert petition noted: 

• To avoid these intolerable effects, a company's only safe alternative would be to provide investors with every adverse event report even though it has no reason to believe that the report casts the slightest doubt on the safety of the drug and even though it has no material significance to a reasonable investor. As the Court has recognized before, providing investors with such information 'is hardly conducive to informed decisionmaking.'

Materiality is, as the Court in Basic noted, intended to filter out information unimportant to the decision making process.  Nonetheless, it is a tough argument to make that investors will somehow be disadvantaged by a finding of materiality. 

First, a finding of materiality does not automatically mandate disclosure.  The assertion ignores the need for a duty to disclose. "Arguments based on the premise that some disclosure would be 'premature' in a sense are more properly considered under the rubric of an issuer's duty to disclose."  485 US at 235.  In other words, even if the information is material, disclosure is not automatically required.

Second, as a practical matter, the information concerning adverse health reports is unlikely to ever get to ordinary investors.  Share prices are generally influenced by analysts and institutional investors.  Moreover, it is a tough argument to make that analysis would prefer not to receive the reports.  To the extent that pharmaceutical companies had a practice of disclosing every adverse report on their web site, for example, it is unlikely that analysts would object. 

Third, it is likewise a tough argument to make that information otherwise material should not be treated that way because issuers might react by over-disclosing.  A stronger argument, frankly, is that a finding of materiality will result in reduced disclosure. 

In short, the determination of materiality does not turn on the company's response.  It turns on the importance of the information to the reasonable investor.  Most of these arguments have no bearing on that proposition.

For the cert petition and the reply, we have posted them on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on June 24, 2010 (boomark / email).