Supreme Court Increases Disclosure Burdens on Pharma Companies

By Kevin E. Noonan --

As it has done in other areas of the law recently (such as Bell Atlantic Corp. v. Twombly), the Supreme Court on Tuesday addressed the requirements for pleadings sufficient to survive a motion to dismiss a complaint for securities law violations, in Matrixx Initiatives Inc. v. Siracusano.  The Court's decision provides a reasoned basis for where it decided to draw the line for such pleadings.  However, by engaging in its penchant for "totality of the circumstances" analyses, its decision did little to clarify the behaviors pharmaceutical companies should exhibit to avoid the kinds of liability that Matrixx will be put at risk at trial.

The case involved Zicam Cold Remedy, an over-the-counter zinc gluconate formulation used to combat the common cold that was responsible for about 70% of the company's sales.  During the relevant time period, Matrixx was alleged to have become aware from several sources of a serious side effect of using Zicam, specifically anosmia or loss of the sense of smell.  In 1999, a customer service representative was told by the neurological director of the Smell & Taste Treatment and Research Foundation, Ltd. that a "cluster of patients" had suffered from anosmia after using Zicam to treat their cold symptoms (and including an individual who did not have a cold when she used the product).  Three years later, the company's Vice President for Research and Development contacted a scientist, Dr. Miriam Linschoten, at the University of Colorado Health Sciences Center after receiving a complaint about Zicam-induced anosmia, and the scientist recounted the results of "previous studies linking zinc sulfate [a different zinc-containing compound] to loss of smell."  This scientist followed up with abstracts from these studies, dating from the 1930's and 1980's that "confirmed '[z]inc's toxicity.'"  And about a year later, one of Dr. Linschoten's colleagues, Dr. Jafek, "observed 10 patients suffering from anosmia after Zicam use," and together these scientists prepared a poster for presentation at a meeting of the American Rhinologic Society.  Upon hearing of these plans, the company warned the scientists that they did not have permission to use the Matrixx company name or the names of the company's products (Zicam) and the scientists deleted this information from their poster presentation.  Shortly thereafter, two patients sued Matrixx in a products liability lawsuit based on Zicam-related anosmia; this number had increased to nine patients and four lawsuits by the end of the relevant time period in this case.

According to plaintiff/respondent investors, Matrixx reacted to these events with a series of public statements that were misleading and amounted to securities fraud.  These statements related in large part to the company's financial prospects, including estimates that "revenues 'would be up in excess of 50%'" as well as similar predictions regarding share earnings for investors.  Later, the company increased its rosy forecast to have revenues increasing by 80%.  The company acknowledged the products liability suits in required SEC filings (Form 10-Q) but did not disclose that such suits had already been filed.  In addition, the company responded to a Dow Jones Newswires story relating to reports of anosmia as a consequence of Zicam use (and the concomitant drop in share price by almost 12%) by releasing a statement that the company believed the allegations that Zicam use caused anosmia were "completely unfounded and misleading," further stating that:

In no clinical trial of intranasal zinc gluconate gel products has there been a single report of lost or di­minished olfactory function (sense of smell).  Rather, the safety and efficacy of zinc gluconate for the treatment of symptoms related to the common cold have been well established in two double-blind, placebo­controlled, randomized clinical trials.  In fact, in nei­ther study were there any reports of anosmia related to the use of this compound.  The overall incidence of adverse events associated with zinc gluconate was extremely low, with no statistically significant difference between the adverse event rates for the treated and placebo subsets.

A multitude of environmental and biologic influences are known to affect the sense of smell.  Chief among them is the common cold.  As a result, the population most likely to use cold remedy products is already at increased risk of developing anosmia.  Other common causes of olfactory dysfunction include age, nasal and sinus infections, head trauma, ana­tomical obstructions, and environmental irritants.

These statements resulted in an almost complete rebound of Matrixx's share price.  The share price plummeted even further, however, (by over one-quarter of their value) when Good Morning America aired a segment highlighting Dr. Jafek's research results relating Zicam use to anosmia and disclosing the existence of four product liability lawsuits.  Matrixx persisted in its public statements that the link between Zicam use and anosmia was without merit, and filed documents (SEC Form 8-K) that it had convened a scientific panel that had concluded that there was "insufficient scientific evidence" that Zicam affected sense of smell in users.  These statements formed the basis of plaintiff/respondents' complaint.

Plaintiff/respondents brought a class action lawsuit for securities fraud under Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rule 10b-5, codified at 17 C.F.R. § 240.10b.5, for actions and statements by the company made between October 22, 2003 and February 6, 2004, which were allegedly misleading based on Matrixx's knowledge of the adverse events.  The District Court dismissed, based on a failure of plaintiffs to allege a "statistically significant correlation between [Zicam use] and anosmia," which made the failure to disclose the University of Colorado study insufficient to be a material omission.  The District Court also held that plaintiffs did not plead scienter with sufficient specificity.  The Ninth Circuit reversed, holding that the District Court erred in requiring statistical significance and that Matrixx's actions constituted a "strong inference of scienter."  The Supreme Court granted certiorari and affirmed the District Court.

Writing for a unanimous Court, Justice Sotomayor started with the language of the statute, that Section 10(b), Securities and Exchange Act and SEC Rule 10b-5 made it unlawful for "any person" to "make any untrue statement of a material fact or to omit to state a material fact necessary . . . to make the statements . . . not misleading."  The standard for prevailing in a complaint for securities fraud under the statute is "'(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,'" citing Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U. S. 148, 157 (2008).  Here, Matrixx had alleged that plaintiff/respondents had not plead the material misrepresentation/omission element and the scienter element, both based on the failure to allege that Matrixx had statistically significant evidence linking Zicam use with anosmia.

The Court categorically rejected the view that a material misrepresentation/omission required this level of scientific evidence.  Citing Basic Inc. v. Levinson, 485 U. S. 224, 236 (1988), the materiality requirement can be 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 intention, according to the Court's opinion, was to enunciate a standard that would not encourage a company to "bury the shareholders in an avalanche of trivial information," which would presumably be just as harmful to an investor as a failure to disclose.  The Court cited Basic for the proposition that materiality, which is an inherently fact-specific element, should not be decided on the basis of any "single fact or occurrence," because that approach would be "necessarily [] overinclusive or underinclusive."  The Court characterized Matrixx's position as requiring a "bright-line rule" for materiality in securities fraud actions relating to adverse event reports for pharmaceuticals, i.e., to require statistically significant evidence thereof before a disclosure requirement was triggered under the securities laws.  Behind this position was the idea that "reasonable investors would not consider such [adverse event] reports relevant unless they are statistically significant," because otherwise such "anecdotal" reports could not "'reflect a scientifically reliable basis for inferring a potential causal link between product use and adverse event."

The Court in rejecting this argument asserted that under such a bright-line standard information that "would otherwise be considered significant to the trading decision of a reasonable investor" would be "artificially exclude[ed]," because such a standard "rests on the premise that statistical significance is the only reliable indication of causation."  "This premise is flawed," according to the Court, because there are "multiple factors" that medical researchers use to assess causation (citing the government's amicus curiae brief).  In some cases, statistically significant data is simply not available, such as when an adverse event is "subtle or rare," the Court states, citing an amicus brief from the Medical Researchers, or "ethical concerns" may preclude the kinds of clinical studies necessary to establish statistical significance.  The Court noted a plethora of other "relevant factors" for assessing adverse events, including "the strength of the association between the drug and the adverse effects; a temporal relationship between exposure and the adverse event; consistency across studies; biological plausibility; consideration of alternative explanations; specificity (i.e., whether the specific chemical is associated with the specific disease); the dose-response relationship; and the clinical and pathological characteristics of the event," citing defendant/petitioners and an amicus brief for the Consumer Healthcare Products Assn. et al.; these are also factors that the FDA takes into account before "taking action against pharmaceutical products" according to the Court, citing the FDA Guidance for Industry: Good Pharmacovigilance Practices and Pharmacoepidemiologic Assessment 18 (2005).  Further citing FDA standards, the opinion noted that the Agency frequently takes action (such as requiring warning labels) "as soon as there is reasonable evidence of an association of a serious hazard with a drug" without requiring that causation has been established.  Indeed, in this case the FDA issued a warning letter (in 2009) that "[a] significant and growing body of evidence substantiates that the Zicam Cold Remedy intranasal products may pose a serious risk to consumers who use them" based on evidence of 130 adverse event reports of anosmia as well as scientific journal articles.

In view of the fact that "medical professionals and regulators act on the basis of [scientific] evidence of causation that is not statistically significant," the Court asserted that it "stands to reason" that the reasonable investor might also be able to do so.  Thus, the question of the materiality of such information, and whether it needs to be disclosed under the securities laws is "fact-specific" and requires an assessment of "the source, content and context of the reports" -- in other words, the totality of the circumstances surrounding the evidence of adverse events (designated in Basic and cited here with approval as the "total mix" standard).  The opinion noted that it does not intend to interpret the securities laws as "creating an affirmative duty to disclose any and all material information," including adverse event information but only that information that is necessary to make statements not misleading.  "Even with respect to information that a reasonable investor might consider material, companies can control what they have to disclose under these provisions by controlling what they say to the market."

Here, the Court held that plaintiff/respondents had adequately plead materiality based on the totality of the circumstances surrounding Matrixx's statements (noting in Footnote 10 that this conclusion "accords with the views of the SEC" as evidenced by the Commission's amicus brief).

The opinion turns but briefly to the question of whether plaintiff/respondents adequately plead the scienter element, noting that Matrixx argued "in summary fashion" that the absence of statistical significance was sufficient to defeat this prong of the required pleading.  The Court disagreed, stating that the inference that Matrixx acted "recklessly (or intentionally, for that matter) is 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" to Zicam administration.  The Court noted the company's actions both to investigate the alleged connection between Zicam and anosmia and to suppress this information, as well as its statements "suggested that studies had confirmed that Zicam does not cause anosmia when, in fact, it had not conducted any studies relating to anosmia and the scientific evidence at that time, according to the panel of scientists, was insufficient to determine whether Zicam did or did not cause anosmia."  The totality of these circumstances (or "[t]hese allegations 'taken collectively'") was enough for the Court to conclude that plaintiff/respondent's allegations of scienter in their pleadings were sufficient to withstand a motion to dismiss (but "[w]hether respondents can ultimately prove their allegations and establish scienter is an altogether different question").

While not an unreasonable conclusion, the Court's decision imposes additional and unpredictable burdens on pharmaceutical companies even under conditions that may on their face appear less egregious than in this case.  With regard to materiality, the "totality of the circumstances" standard replaces a scientific basis for assessing the significance of adverse events with a court's ex post facto view of what should or should not have been disclosed.  There are certainly instances where the circumstances will make such a determination readily apparent, but there will also be others where some objective standard is not only necessary but also responsible if drugs are to timely come to market.  While not discounting the deleterious consequences of some adverse events, it is not possible for any pharmaceutical to have no adverse events; the standard must take into account the frequency and severity of such adverse events in balancing the relative good with harm for any particular drug.  Statistical significance is one but not the only standard, as the Court rightly concludes, but it has the advantage of being an objective basis that can be successfully used to distinguish from the merely anecdotal.  It is foolish not to recognize that courts by necessity act well after the fact, and it is perhaps easier to assess the "totality of the circumstances" from their viewpoint.  This decision does not reach the merits, but it does illustrate that eschewing scientific standards for judicial second-guessing can be fraught with unforeseen and unnecessary dangers for pharmaceutical companies and their customers alike.

Comments

[James Demers]

All this discussion on statistical significance and scientific evidence rather misses the point, which is whether the information would be material to an INVESTOR.

As a scientist, I might conclude that the evidence is statistically insignificant, but on that same evidence I'd still sell my shares, because the information is highly relevant to their market value.

[Kevin E. Noonan]

Dear James:

Which is what the court held. And I don't disagree with the outcome here, just the dismissal of statistical significance as being a reasonable basis for Matrixx to think they didn't need to make the disclosure.

For example, what it the initial 10 people were the only 10 people in the world who had this side effect? Horrible for them (if it was permanent; the case doesn't say it was), but sufficient for the drug to be pulled from the market? After all, even with the "warning" the FDA required in 2009, what does the consumer do? Use the drug until he loses the sense of smell a little?

I don't think the court was wrong in this case. But if you read some of the other commentary out there, the take-home for many is that statistical significance is irrelevant. Which goes to far in the other direction.

Thanks for the comment.