Corporate Governance

The Supreme Court, Rule 10b-5, and Matrixx v. Siracusano (Part 2)

By J Robert Brown Jr.

There was no good reason for the Supreme Court to take Matrixx. 

The case involved the materiality of Adverse Effect Reports received by the manufacture of a drug about potential side effects.  Petitioners argued that the Reports would only be material if statistically significant.  Respondents largely argued that the facts and circumstances analysis set out in Northway and Basic was the appropriate standard. 

A review of the lower courts addressing the materiality of these Reports under the conventional analysis shows that many have been dismissed, indicating that the trial courts have been adequate gatekeepers with respect to claims based upon these types of allegations.  In other words, there was no serious problem that required redress by the Supreme Court. 

Moreover, as the briefs suggest, the parties are, to some degree to be in agreement over the appropriate analysis even if they disagree on the ultimate outcome.  In the reply brief, Petitioners asserted that:

• In this case, the handful of adverse event reports ('AERs') Matrixx Initiatives, Inc. ('Matrixx') allegedly received before February 6, 2004—12-23 uncorroborated hearsay reports, over a four-year period, out of millions of units sold—did not convey any reliable information about whether Matrixx's product Zicam was causally connected to the reported event, anosmia. If Matrixx was required to disclose those few reports as material information, then materiality has no objective meaning at all, and companies will have no intelligible standard to guide their disclosure determinations.

But in fact the argument by Respondents all along (and in an amicus brief filed by Law and Business Faculty, with the author of this Post listed as Counsel of Record) was that the reports could not be viewed selectively but had to be examined in the context of all other facts and circumstances.  In other words, materiality turned not on the reports in isolation but in the context of the total mix of available information. 

Petitioners, in their reply brief, conducted a facts and circumstances analysis, arguing that the Reports, when viewed in the context of the other evidence, were not material.  As the brief stated:

• Respondents defended their complaint below, and in opposing certiorari, on the ground that the few AERs they identified in their complaint were, of themselves knew they were required to disclose to investors.  Respondents repeat that flawed argument here, but they also try a different tack, essentially rewriting their complaint to cite various Zicam that they now say suffice to establish an inference of anosmia causation reliable enough that it should have been disclosed. That argument fails as well: not only are respondents constrained by the allegations they pled, but the facts they now add— most prominently, a 1982 study of the 'olfactory mucosa of catfish' (RB7)—still fail to establish any reliable basis for inferring a causal relationship that petitioners should have disclosed.

In other words, the Reports, when considered in the context of all other factors, were not material.  This is, in short, an application of the the analysis set out in Northway/Basic.

A decision that finds the Reports immaterial as a matter of law because of the lack of statistical significance (ignoring the other facts and circumstances) will change the materiality analysis under Rule 10b-5 in a manner that favors business but harms shareholders.  Statistical significance is a bright line test that defines materiality not based upon the information important to reasonable investors but upon the convenience of those subject to the disclosure obligations under Rule 10b-5.  The fact that the SEC/Solicitor General filed a brief in the case underscores the concern over the adoption of such a standard.

With oral argument in the case tomorrow, there may be some insight into whether the majority in the decision will be the one that appeared in Stoneridge (in which case the standard is likely to be rewritten in a pro-business fashion) or the majority that appeared in Tellabs/Merck (in which case the traditional analysis will likely be reaffirmed). 

For the cert petition and the assorted amicus briefs filed in this case, including the one by the Solicitor General/SEC, go to the DU Corporate Governance web site.  For the amicus brief filed by law and business faculty, go here.

Full post as published by The Race to the Bottom on January 10, 2011 (boomark / email).