Sunday, November 21, 2010

SEC Urges US Supreme Court to Reaffirm Flexible Materiality Definition under Rule 10b-5

In what will be the US Supreme Court's first pronouncement in decades on the threshold and seminal materiality element of Rule 10b-5, the SEC urges the Court to reaffirm the flexible standard hammered out in the Northway and Basic, Inc opinions that an omitted fact is ““material”” when there is a substantial likelihood that a reasonable investor would have considered it important. The SEC filed an amicus brief in a private securities fraud action posing the question of whether an investor can state a claim under Rule 10b-5 based on a pharmaceutical company’s nondisclosure of adverse event reports about a drug even though the reports are not alleged to be statistically significant. The SEC urges the Court to hold that information that a drug causes adverse effects may be material to investors even absent statistical significance. Information suggesting a causal link between use of a drug and a serious adverse effect may significantly alter the behavior of consumers and regulators, contended the SEC, even when there is no allegation of a statistically significant association. In turn, because those reactions can affect a company’’s share price reasonable investors would consider such information to be highly relevant to their investment decisions. Matrixx Initiatives Inc. v. Siracusano, Dkt. No. 09-1156.

According to the SEC, the drug company is asking the Court to depart from the settled definition of materiality refined in the 1988 Basic, Inc. v. Levinson case in favor of a categorical rule that deems information about an adverse effect associated with use of a drug immaterial unless the association is statistically significant. In the SEC's view, that rule conflicts with the standard the Supreme Court refined in Basic for two important reasons. First, evidence other than data showing a statistically significant association can suggest a causal link between use of a drug and an adverse effect. Medical researchers, courts, and FDA regularly consider multiple factors in assessing causation, especially where (as in this case) the available epidemiological data
are inconclusive. Second, a reasonable investor may consider information suggesting an adverse drug effect important even if it does not prove that the drug causes the effect. Even reports that simply suggest causation may affect the behavior of consumers, potential litigants, and FDA. Because such a reaction may affect a product’’s commercial viability, and thus the company’’s financial condition, noted the SEC, a reasonable investor often will want to know about such information.

The position urged by the company also conflicts with Supreme Court’ precedent because it establishes a rigid restriction, particularly at the pleading stage. In Basic and Northway, the Court rejected a ““bright-line”” rule both because it was too underinclusive and because the materiality inquiry requires “delicate assessments” better suited to the trier of fact.

The SEC also found unpersuasive the company's concern that indiscriminate release of adverse event reports will mislead investors The Commission pointed to statutory and regulatory requirements that drug manufacturers report those events to FDA, and FDA’’s policy of making those reports publicly available. For all drugs with an approved new drug application as well as for prescription drugs without an approved new drug application, the FDA has long required companies to report post-marketing “adverse drug experiences.”

Finally, it is the SEC's view that the company is placing a false choice before the Court of adopting a statistical significance threshold or forcing companies to disclose every report of an adverse effect to stave off liability. The choice is false, said the SEC, because application of Basic’’s materiality standard could sometimes permit a company to withhold adverse drug information. For example, a company could reasonably conclude that a single report of an adverse event from an anonymous
user, or a dozen reports of a dozen different adverse events, would not be important to a reasonable investor for a widely used drug that had undergone rigorous pre-market testing and FDA review and approval. Even if the reports of an adverse effect were more numerous or reliable, a company could reasonably conclude that they were not material if the effect was minor and transient relative to the drug’’s benefit and the drug sales did not contribute meaningfully to the company’’s revenues.

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