Corporate Governance

The Supreme Court in Matrixx: Materiality and Satanic Susceptibility

By J Robert Brown Jr.

Oral argument was held today in Matrixx.  While it is hard to predict the outcome of a case from oral argument, this one seems straightforward.  Respondents will win and the Supreme Court will reject the "statistical significance" test, reaffirming the traditional Northway/Basic analysis. 

The questions directed by the Justices at Jonathan Hacker, counsel for Petitioners, cut right to the central issue over and over. 

Justice Alito asked whether there could "be some situations in which statistically significant evidence would not be necessary?" Justice Scalia essentially asked whether the issue was not the statistical significance but the facts and circumstances required under Northway.  See Transcript, at 7 ("So the -- is the question before us simply whether in isolation the adverse incidents would be enough, or is not the question whether those adverse incidents placed next to this study would be enough?").

Justice Kagan made the point that appeared in the Professors Brief:  That the test of statistical significance was not one that even the FDA used. 

• Now, as I understand it, the FDA takes action all the time as to drugs -- they force the withdrawal of a drug from the market, they force relabeling of a drug -- on the basis of findings that are not statistically significant.  Now, clearly in those cases the market has a right to  know the very things that are going to make the FDA take action against a product and that are going to severely affect the product's value to the company. Not statistical significance there.

She then added:  "And you are suggesting a test for what -- what counts as material, which is statistically significant, a test that the FDA itself doesn't use when it thinks about what it should what it should regulate."  Later in the argument, Justice Kagan gave a hypothetical that demonstrated materiality without reaching statistical significance:  millions use a contact solution and ten go blind.  Of the ten, three use the contact solution in a single eye and go blind in that eye only.  As she put it:

• This is not statistically significant. There is no way that anybody would tell that you these ten cases are statistically significant. Would you stop using that product and would a reasonable investor want to know about those ten cases?

Justice Breyer in an exasperated exchange apologized, saying that "I don't mean to take a position yet" but then took one.  "So I can't see how we can say this statistical evidence always works or always doesn't work."

It was Justice Sotomayor who pointed out what we said long ago on this Blog, that the case was a pig in a poke, breaking no new law and involving nothing more than an application of the Northway/Basic analysis.  Here is what we wrote:

• So where does this leave the Supreme Court?  It was sold a pig in a poke.  The likelihood is that the majority of justices voting for this case expected to get an opportunity to draw a bright line in connection with the analysis of materiality under Rule 10b-5 (that statistically insignificant data never qualified as material).  Instead, what they have gotten is a case that, like all of the other cases addressing materiality, turns on the "total mix" of available information.  This total mix includes not only the adverse health reports received by the Company but also the evidence of law suits, the alleged admission about the lack of knowlege about the health effects of the drug, and the apparent knowledge that there was a link between zinc sulfate and loss of smell.

Here is what Justice Sotomayor had to say:

• Counsel, you got cert granted on a limited question, and the limited question was whether in a complaint that alleges only adverse reports can you prove materiality and scienter without proving statistical importance. That's the question presented.  Justice Kagan started with the point that the FDA doesn't require that. It requires just reasonable evidence of a connection, not statistical.  Many of the amici here have done a wonderful job of explaining why statistical importance can't be a measure because it depends on the nature of the study at issue.  So given all of that -- and even in your brief, in a footnote, you answered the question by saying, no, we can't establish that rule as an absolute because there are additional factors that could prove materiality and scienter. So you've already answered the question presented.

It caused the Justice to wonder out loud what the case was even doing before the Supreme Court.  See Transcript, at 25 ("Are we down to what Justice Scalia asked you, which is: We got a no to the question: Are the facts in this case enough? I don't know why we would have granted cert on that, but you presented a different question presented."). 

Counsel for Respondents received a barrage of questions but none did any significant damage to his argument.  David Federick initially dodged a bullett that would haunt the Solicitor General.  Frederick essentially conceded that to be material the information had to have some scientific plausibility, something the Chief Justice described as a "rather significant concession." 

Nonetheless, later in the argument he deviated, interjecting the possibility that irrationally based information would be material.

• I don't mean to be evasive, but if there is a product, say, that has some link to satanic influences, and there is some reason to think that a large body of followers in an irrational way might regard there to be satanic influences on the basis of a particular product, a cautious, reasonably prudent investor might want to know that on the basis of that information that most of us would regard as irrational, might affect the stock price.

With that, the remainder of his time mostly went back and forth about the materiality of information about the practices of satan worshipers.  The Chief Justice even coined the phrase "satanic susceptibility" in one of the few moments of levity.  The issue was largely irrelevant and mostly wasted time, evidence that there was little room to challenge much of the position taken by Frederick.

Pratik A. Shah, the Assistant to the Solicitor General, was hit with the satanic line of questioning almost immediately.  This occurred in part because the Brief filed by the government gave a relatively low threshold for materiality, a standard that was accurate but unnecessary.  See Solcitor's Brief, at 17 ("Information suggesting that a company's product causes harm may be important to an investor even if the
information does not establish that the causal link more likely than not exists.").  It caused Justice Alito to querry: 

• So the government's position is that reports of adverse effects that have no scientific basis, so long as they would affect irrationally consumers, have to be disclosed, assuming the company has said we're doing well, right?

Given that the Government only needed to establish the incorrectness of the use of statistical significance, it was not necessary to push the boundaries of materiality in the other direction.

That Petitioners will lose, particularly on the materiality issue, could be seen from the use of the rebuttal time.  Counsel had three minutes and chose to use it on the scienter issue, all but ignoring the now losing argument on materiality. 

The case will not take long to write and should come out relatively quickly.  There seems to be general agreement on the Court (with little likelihood it will be a late term 5-4 decision).  The Court and the opinion will look more like Merck/Tellabs and less like Stoneridge.  

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