Tuesday, March 22, 2011

Supreme Court Reaffirms Historic Total Mix Test for Rule 10b-5 Materiality, Rejects Bright-Line Rule as SEC Urged

Rejecting a bright line test for Rule 10b-5 materiality, the US Supreme Court ruled unanimously that 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. Matrixx Initiatives Inc. v. Siracusano, Dkt. No. 09-1156. The Court noted that its conclusion accords with views of the SEC, as expressed in an amicus brief, that the proper balance between the need to insure adequate disclosure and the need to avoid the adverse consequences of setting too low a threshold for civil liability is entitled to consideration.

Writing for the Court, Justice Sotomayor said 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, the investors alleged facts plausibly suggesting that reasonable investors would have viewed these particular reports as material.

The Court reaffirmed the traditional test of Basic, Inc and Northway that the Rule 10b-5 materiality requirement is 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 categorical rule urged by the company here would artificially exclude information that would otherwise be considered significant to the trading decision of a reasonable investor. The company’s argument rests on the flawed premise that statistical significance is the only reliable indication of causation. As the SEC pointed out in its amicus brief, noted the Court, medical researchers consider multiple factors in assessing causation. Statistically significant data are not always available. For example, when an adverse event is subtle or rare, an inability to obtain a data set of appropriate quality or quantity may preclude a finding of statistical significance.

Applying Basic’s “total mix” standard in this case, the Court concluded that the investors adequately pleaded materiality. This is not a case about a handful of anecdotal reports, noted the Court. Assuming the complaint’s allegations to be true, as it had to, the Court noted that the company received information that plausibly indicated a reliable causal link between the drug and and anosmia. That information included reports from three medical professionals and researchers about more than 10 patients who had lost their sense of smell after using the drug.

In this case, the SEC urged 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. The SEC urged the Court to reject a bright-line rule both because it is too under inclusive and because the materiality inquiry requires delicate assessments better suited to the trier of fact.

Similarly, an amicus brief of a group of law professors said that the materiality standard set forth in Northway-Basic has proved sufficiently robust to allow courts to resolve the materiality of quantitative thresholds such as misstatements in earnings or the number of adverse event reports.

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