Matrixx, through a wholly owned subsidiary, develop, manufacture, and market over-the-counter pharmaceutical products. Its core brand of products is called Zicam. All of the products sold under the name Zicam are used to treat the common cold and associated symptoms. At the time of the events in question, one of Matrixx’s products was Zicam Cold Remedy, which came in several forms including nasal spray and gel.
The active ingredient in Zicam Cold Remedy was zinc gluconate. Respondents alleged that Zicam Cold Remedy accounted for approximately 70 percent of Matrixx’s sales. Respondents initiated the securities fraud class action against Matrixx on behalf of individuals who purchased Matrixx securities between October 22, 2003, and February 6, 2004. The action principally arose out of statements that Matrixx made during the class period relating to revenues and product safety. Respondents claimed that Matrixx’s statements were misleading in light of reports that Matrixx had received, but did not disclose, about consumers who had lost their sense of smell (a condition called anosmia) after using Zicam Cold Remedy.
On the basis various allegations, respondents claimed that Matrixx violated §10(b) of the Securities ExchangeAct and SEC Rule 10b–5 by making untrue statements of fact and failing to disclose material facts necessary to make the statements not misleading in an effort to maintain artificially high prices for Matrixx securities.
Matrixx moved to dismiss respondents’ complaint, arguing that they had failed to plead the elements of a material misstatement or omission and scienter. The District Court granted the motion to dismiss. Relying on In re Carter-Wallace, Inc., Securities Litigation, 220 F. 3d 36 (CA2 2000), it held that respondents had not alleged a “statistically significant correlation between the use of Zicam and anosmia so as to make failure to publicly disclose complaints and the University of Colorado study a material omission.” The District Court also held that respondents had not stated with particularity facts giving rise to a strong inference of scienter. It noted that the complaint failed to allege that Matrixx disbelieved its statements about Zicam’s safety or that any of the defendants profited or attempted to profit from Matrixx’s public statements.
The Court of Appeals reversed. 585 F. 3d 1167 (CA9 2009). It held that the District Court had erred in requiring an allegation of statistical significance to establish materiality. It concluded that the complaint adequately alleged “information regarding the possible link between Zicam and anosmia” that would have been significant to a reasonable investor. Turning to scienter, the Court of Appeals concluded that withholding reports of adverse effects of and lawsuits concerning the product responsible for the company’s remarkable sales increase is an extreme departure from the standards of ordinary care, giving rise to a strong inference of scienter.
Section 10(b) of the Securities Exchange Act make it unlawful for any person to “use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” 15 U. S. C. §78j(b). SEC Rule 10b–5 implement this provision by making it unlawful to, among other things, “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” 17 CFR §240.10b–5(b).
The Supreme Court observed that to prevail on their claim that Matrixx made material misrepresentations or omissions in violation of §10(b) and Rule 10b–5, respondents must prove “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” [Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U. S. 148, 157 (2008)]. Matrixx contended that respondents had failed to plead both the element of a material misrepresentation or omission and the element of scienter because they had not alleged that the reports received by Matrixx reflected statistically significant evidence that Zicam caused anosmia.
To prevail on a §10(b) claim, a plaintiff must show that the defendant made a statement that was “misleading as to a material fact.” In Basic, the Supreme Court held that this materiality requirement was satisfied when there was ‘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.’ Matrixx urged in the case to adopt a bright-line rule that reports of adverse events associated with a pharmaceutical company’s products cannot be material absent a sufficient number of such reports to establish a statistically significant risk that the product is in fact causing the events.
But the Supreme Court held that a lack of statistically significant data did not mean that medical experts had no reliable basis for inferring a causal link between a drug and adverse events. As Matrixx itself conceded, medical experts rely on other evidence to establish an inference of causation. Given that medical professionals and regulators act on the basis of evidence of causation that is not statistically significant, it stand to reason that in certain cases reasonable investors would as well.
The Supreme Court held that the mere existence of reports of adverse events—which say nothing in and of itself about whether the drug is causing the adverse events—will not satisfy this standard. Something more is needed, but that something more is not limited to statistical significance and can come from “the source, content, and context of the reports”. This contextual inquiry may reveal in some cases that reasonable investors would have viewed reports of adverse events as material even though the reports did not provide statistically significant evidence of a causal link. Applying Basic’s “total mix” standard in the case, the Supreme Court concluded that respondents had adequately pleaded materiality. Assuming the complaint’s allegations to be true, Matrixx received information that plausibly indicated a reliable causal link between Zicam 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 Zicam. The Supreme Court held that the allegations suffice to “raise a reasonable expectation that discovery will reveal evidence” satisfying the materiality requirement, Bell Atlantic Corp. v. Twombly, 550 U. S. 544, 556 (2007), and to “allow the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” The information provided to Matrixx by medical experts revealed a plausible causal relationship between Zicam Cold Remedy and anosmia. Consumers likely would have viewed the risk associated with Zicam (possible loss of smell) as substantially outweighing the benefit of using the product (alleviating cold symptoms), particularly in light of the existence of many alternative products on the market. Importantly, Zicam Cold Remedy allegedly accounted for 70 percent of Matrixx’s sales. Viewing the allegations of the complaint as a whole, the complaint alleged facts suggesting a significant risk to the commercial viability of Matrixx’s leading product. The Supreme Court thus affirmed the Court of Appeals’ holding that respondents adequately pleaded the element of a material misrepresentation or omission.
Matrixx also argued that respondents failed to allege facts plausibly suggesting that it acted with the required level of scienter. Under the PSLRA, a plaintiff must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U. S. C. A. §78u–4(b)(2)(A) (Feb. 2011 Supp.). This standard required courts to take into account “plausible opposing inferences.” A complaint adequately plead scienter under the PSLRA “only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.” The absence of a motive allegation, though relevant, is not dispositive.
Matrixx argued, in summary fashion, that because respondents do not allege that it knew of statistically significant evidence of causation, there was no basis to consider the inference that it acted recklessly or knowingly to be at least as compelling as the alternative inferences. But the Supreme Court held that Matrixx’s proposed bright-line rule requiring an allegation of statistical significance to establish a strong inference of scienter was just as flawed as its approach to materiality. The Supreme Court held that the inference that Matrixx acted recklessly (or intentionally, for that matter) was at least as compelling, if not more compelling, than the inference that it simply thought the reports did not indicate anything meaningful about adverse reactions. The allegations, taken collectively, gave rise to a cogent and compelling inference that Matrixx elected not to disclose the reports of adverse events not because it believed they were meaningless but because it understood their likely effect on the market. A reasonable person would deem the inference that Matrixx acted with deliberate recklessness (or even intent) at least as compelling as any opposing inference one could draw from the facts alleged. The Supreme Court thus agreed with the Court of Appeals that the respondents had adequately pleaded scienter. Thus the judgment of the Court of Appeals for the Ninth Circuit was affirmed.