Ninth Circuit holds that failure to disclose statistically non-significant anecdotal reports of product problems may support Rule 10b-5 Liability
Our latest alert discusses a recent Ninth Circuit opinion in which the court refused to recognize the scientific concept of statistical significance as providing a bright line test for determining when complaints of drug side effects are material for securities disclosure purposes. Siracusano v. Matrixx Initiatives, Inc., No. 06-15677 (9th Cir., October 28, 2009.) The court held that even scattered anecdotal reports, or the filing of a handful of product liability lawsuits which have not yet been settled or adjudicated, may be material in the eyes of investors. Moreover, such reports may constitute sufficient notice of a potential problem so as to render misleading an issuer's categorical statement that side effect allegations are “completely unfounded.” Issuers need to be consider the impact on their disclosure obligations even of scattered anecdotal reports and other data which does not meet the test of statistical significance recognized in the scientific or medical community.
The Ninth Circuit issued an important opinion on October 28, 2009, regarding whether companies can be subject to securities fraud liability for failure to disclose product complaints that do not satisfy the test for statistical significance recognized in medical or scientific research. Siracusano v. Matrixx Initiatives, Inc., No. 06-15677 (9th Cir., October 28, 2009). The court’s decision provides an interesting contrast between the concept of materiality under the securities laws and the significance of that same information in the scientific world, complicating the life of corporate counsel for public companies. While scientists may distinguish between meaningful and non-meaningful data using tests such as statistical significance, those tests will not necessarily determine what is material under the securities laws. In addition, issuers should be cautious about denying the existence of a problem in categorical terms when anecdotal evidence exists that may be interpreted as inconsistent with such a denial.
In Siracusano, the plaintiffs alleged that Matrixx Initiatives, Inc., committed securities fraud based on its failure to disclose negative news about its anti-cold drug, Zicam. The negative news began developing around September 2003, when several anecdotal reports were made by doctors whose patients claimed they lost their sense of smell after taking the drug. The reports increased, and a number of product liability lawsuits were filed. A presentation was made at a medical conference in September regarding eleven patients who claimed they lost their sense of smell. Nevertheless, the company made generally optimistic statements about Zicam’s anticipated profitability in an earnings release and analyst call in October. Its November 10-Q referred to the risk of product liability litigation in general but did not disclose any particular lawsuit or user complaint. In early January 2004, the company projected higher earnings for the year. Later that month an article appeared in Dow Jones Newswire, which referred to three specific product liability lawsuits and suggested that the FDA was investigating Zicam’s side effects. The company fought back with a press release stating categorically that the side effect allegations were “completely unfounded and misleading,” citing two double-blind studies of the drug’s “safety and efficacy.” The press release went on to attack the journalist responsible for the story as a muckraker linked more closely to the financial markets than the medical community, and noted that the company was suing him for libel.
On February 6, 2004 (which marks the end of the class period), Good Morning America ran a feature on Zicam, disclosing the data presented at the medical conference back in September and noting that four lawsuits had now been filed. In response the company issued a press release stating that it had convened a panel of physicians to study the issues raised at the September conference. Based on the above, the plaintiff sued the issuer and two officers under Rule 10b-5.
Materiality and statistical significance
The company’s first line of defense, which was successful in the district court, was to argue that the anecdotal reports and product liability lawsuits lacked sufficient credibility to be material under the securities laws because they did not meet the test for statistical significance recognized in the scientific community. The defendants’ attempt to establish this clear line for materiality was rejected on appeal, however. The Ninth Circuit held that lack of statistical significance of such medical/scientific reports does not provide a bright line test for determining materiality. The court hearkened back to Basic, Inc. v. Levinson, 485 U.S. 224, 238-40 (1998) in which the Supreme Court likewise disappointed the hopes of corporate counsel for a bright line test as to the materiality of early-stage merger negotiations. Materiality is an intensely factual inquiry, the court stated, which must be assessed on a case-by-case basis by the trier of fact. Thus, in making disclosure decisions in the medical/scientific arena, issuers must weigh the significance to the reasonable investor of anecdotal evidence of adverse reaction reports, the filing of lawsuits by plaintiffs’ contingent fee counsel, and news reports recycling those sources, even though none of that would be considered reliable proof of causation by professionals in the fields of science or medicine.
The anecdotal side effect reports and product liability lawsuits were also relevant to the Ninth Circuit’s assessment of scienter. The court noted that by the time of the October earnings release and analyst report, which projected growing Zicam profits, the company was already aware of “fourteen complaints regarding Zicam,” made up of the eleven patients discussed at the September medical conference, one lawsuit, and a handful of other anecdotal reports. Based on this unscientific sample, the court held that plaintiff adequately pled that the company was aware of a “potential problem,” which was inconsistent with its unqualifiedly optimistic statements about Zicam. The court was also critical of the company’s November 10-Q for speaking only of a hypothetical risk of product liability claims when the company was already aware that at least one lawsuit had already been filed. The court held that the February 2, 2004, press release supported an inference of intentional misrepresentation because the company asserted that the side effect allegations in the Dow Jones Newswire article were “completely unfounded and misleading” when in fact the company was aware of anecdotal side effect reports and lawsuits. Also supporting an inference of scienter was the allegation that, at the same time the company was citing the safety and efficacy studies, the company was soliciting doctors to conduct research, telling them that the issue had not yet been studied.
The court’s ultimate conclusion was that “withholding reports of adverse effects and of lawsuits concerning the product responsible for the company’s remarkable sales increase is ‘an extreme departure from the standard of ordinary care’ and ‘presents a danger of misleading buyers or sellers.’” (Quoting from In Silicon Graphics Sec. Litig., 183 F.3d 970, 976 (9th Cir. 1999.)
The Siracusano case teaches that the concept of statistical significance, which is used in science and medicine to distinguish proof from mere speculation, cannot be relied on as a bright line test or safe harbor in the world of securities disclosure. It is also a useful reminder that, no matter how indefensible the attacks on a company or product may be on a scientific or statistical basis, an issuer needs to be careful about issuing a categorical denial that ignores anecdotal reports of which the company is aware.