In Focus

Supreme Court Oral Argument in Materiality Case Notes Deference Due to SEC

The U.S. Supreme Court is considering the materiality element of Rule 10b-5 for the first time in decades. Assistant U.S. Solicitor General Pratik Shah contended that the SEC is due significant deference based on its long-standing historical practice of applying the materiality standard and its special expertise with respect to what a reasonable investor would want to know. The case poses 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 (Matrixx Initiatives Inc. v. Siracusano, Doc. No. 09-1156).

Justice Elena Kagan asked about the deference to which the SEC's is entitled regarding its understanding of materiality. Shah noted that the Court, in both its earlier materiality rulings in TSC and Basic, accorded due deference to the SEC's views on the application of the materiality standard.

In those earlier cases, Shah said the Court was deferring to the views of the SEC as expressed in amicus briefs just as in this case. Shah believes that to the extent there is any ambiguity remaining in this case, the Court should defer to the SEC's views. In Basic, he said the Court not only articulated the general standard, but also laid out certain factors. In laying out those factors, the Court deferred to the SEC's brief, which outlined the factors that a reasonable investor might find relevant in the merger context. The SEC’s amicus brief lays out several factors that should bear on the materiality question in this particular context which involves adverse drug information.

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 the use of a drug and a serious adverse effect may significantly alter the behavior of consumers and regulators, the SEC explained, 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.

Shah said that for 35 years the Court's precedents have instructed that information is material for securities fraud purposes if a reasonable investor would have viewed it as having meaningfully altered the total mix of information. Under the terms of the question presented, he said, the petitioners propose to depart from that contextual inquiry in favor of a categorical rule that deems information about an adverse drug effect immaterial absent statistical significance.

Some of the justices seemed skeptical of importing the statistical significance standard into Rule 10b-5 materiality.

Kagan noted that the FDA takes action all the time with respect to drugs. It forces the withdrawal of a drug from the market or forces the relabeling of a drug on the basis of findings that are not statistically significant. In those cases, the market has a right to know the things that are going to lead the FDA to take action against a product and that are going to severely affect the product's value to the company. Kagan said that statistically significant is not a test that the FDA itself uses when it thinks about what it should regulate.

Justice Samuel Alito asked counsel for the company if there could be situations in which statistically significant evidence would not be necessary. For example, he said suppose some very distinguished physicians concluded, based on clinical trials, that there was a connection between a drug and a very serious side effect. He asked whether that could establish materiality. Counsel responded that a distinguished physician would not conclude that there is a connection unless the clinical trials reveal a statistically significant difference between what they have seen and what they would expect to see were there no association.

Justice Antonin Scalia posed a situation where Good Morning America categorically said that a drug caused a condition, but did so simply on the basis of adverse incidents without physician reports, but thousands of unreasonable investors relied upon it. Counsel said the law does not respond to irrational, unpredictable or unreasonable investors. It responds to a reasonable investor who wants accurate information. However, Chief Justice John Roberts noted that a reasonable investor is going to worry about the fact that thousands of unreasonable investors are going to dump their company stock and there is nothing unreasonable about that.

Justice Sonia Sotomayor observed that certiorari was granted on a limited question of whether in a complaint that alleges only adverse reports one can prove materiality and scienter without proving statistical importance. She noted that Kagan started with the point that the FDA does not require that. It requires the reasonable evidence of a connection, not statistical. Sotomayor added that many of the amicus briefs have done a good job of explaining why statistical importance cannot be a measure because it depends on the nature of the study at issue.

James Hamilton, Principal Analyst at Wolters Kluwer Law & Business

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In Focus

Supreme Court Oral Argument in Materiality Case Notes Deference Due to SEC

Assistant U.S. Solicitor General Pratik Shah contended that the SEC is due significant deference based on its long-standing historical practice of applying the materiality standard and its special expertise with respect to what a reasonable investor would want to know.