The Supreme Court Reaffirms Total Mix Test for Materiality

The U.S. Supreme Court adopted the position urged by the SEC’s amicus brief, affirming its traditional test of materiality in 10b-5 actions in Matrixx Initiatives, Inc., v. Siracusano on March 22, 2011. The unanimous ruling rejected the petitioner’s contention that there should be a bright-line test for materiality in a securities fraud suit, a position that the Court also previously rejected in Basic Inc. v. Levinson.

The complaint alleges that Matrixx made false statements in 2003 about a cold remedy nasal spray, Zicam. The statements publicized the success of the nasal spray, which made Matrixx increase its earning guidance based on increased Zicam sales. However, the company had information from multiple sources showing that the nasal spray could cause loss of smell.

After several product liability suits had been filed, Matrixx continued to state that Zicam was safe and that none of the clinical trials supported findings that the nasal spray caused loss of smell. After an FDA investigation report was released, Matrixx’s share price dropped.

The District Court dismissed the original complaint holding that a pharmaceutical company is not required to disclose such reports unless they are statistically significant—consistent with precedent in the Second Circuit. However, the Ninth Circuit Court of Appeals reversed concluding that the statistically significant test was contrary to the test for materiality set forth by the Supreme Court in Basic and TSC Industries, Inc v. Northway, Inc.. In TSC and Basic, the Court articulated the “total mix” test, which sets the threshold for materiality as satisfied when there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available."

The Supreme Court affirmed the Court of Appeals, holding that “the materiality of adverse event reports cannot be reduced to a bright-line rule. Although in many cases reasonable investors would not consider reports of adverse events to be material information, respondents have alleged facts plausibly suggesting that reasonable investors would have viewed these particular reports as material.” Namely, that Zicam is Matrixx’s key product.

In its reasoning, the Supreme Court again rejected adopting a bright-line approach. Arguments in favor of a bright-line rule are based on the idea that statistical significance is the only indication of causation. However, the Court stated that lack of statistically significant data does not mean that medical experts have no reliable basis for inferring a causal link between a drug and adverse events. The Court concluded that investors may utilize a similar approach: considering context, not just statistical significance for determining causation. Similarly, the question of materiality is based on a contextual inquiry.

In Matrixx, the Court held that the total mix standard for materiality was met because Matrixx received information and reports that indicated a plausible causal link between Zicam and loss of smell. The court held this is sufficient to meet materiality at the pleading stages.

AARP AND NASAA FILE JOINT U.S. SUPREME COURT AMICUS BRIEF REGARDING §10(b) LIABILITY

Last month the AARP and the Northern American Securities Administrators, Inc. (NASAA) joined forces to file an Amicus Brief in the United States Supreme Court in Janus Capital Group, et al v. First Derivative Traders. At issue was the extent to which a person or entity must be involved in drafting false statements in order to be exposed to potential §10(b) liability. According to the Amici, the mutual fund advisers should fall within the reach of §10(b) liability because the fund's advisers were the primary actors relative to the false statements made within the prospectuses for the mutual fund.

Plaintiff's are mutual fund investors in Janus Funds. Janus Management stands accused of engaging in secret market timing deals to the detriment of the Janus Fund investors. On appeal, Janus Management argues that the Court should apply a “Direct Attribution” standard. AARP and NASAA argue that the application of this restrictive standard would allow the fund advisers to dodge liability and shift it to the Fund's innocent shareholders by simply keeping their name off the prospectus. Seems like a fairly compelling argument.

Perhaps the most interesting angle on the Brief, and the issue on appeal, is NASAA's argument that §10(b) must be afforded an expansive application and interpretation in light of the absence of an alternative state court remedy. But its primary basis for this argument is not the absence of a remedy, but the absence of a procedure – class actions. Indeed, the 1998 Securities Litigation Uniform Standards Act (“SLUSA”) imposed heavy restrictions upon the utilization of class litigation in the state courts. The Amici noted as somewhat of an after-thought the absence of a remedy as well, due to the absence of a state common law fraud-on-the-market cause of action.

The Supreme Court heard oral argument on the matter on December 7^th. A transcript or the oral argument can be retrieved by clicking here. The Amicus Brief can be reviewed by clicking here.