Matrixx Initiatives, Inc. v. Siracusano

Facts

D develops, manufactures, and markets over-the-counter pharmaceutical products. Its core brand of products is called Zicam. Zicam is used to treat the common cold and associated symptoms. Ps initiated this securities fraud class action against D on behalf of individuals who purchased D securities between October 22, 2003, and February 6, 2004. D had made statements relating to revenues and product safety. Ps claim that D's statements were misleading in light of reports that D had received, but did not disclose, about consumers who had lost their sense of smell (a condition called anosmia) after using Zicam. In 1999, Dr. Alan Hirsch called D's customer service line after discovering a possible link between Zicam nasal gel and a loss of smell “in a cluster of his patients.” In September 2002, Timothy Clarot, D's vice president for research and development, called Miriam Linschoten, Ph.D., at the University of Colorado Health Sciences Center after receiving a complaint from a person Linschoten was treating who had lost her sense of smell after using Zicam. Clarot informed Linschoten that D had received similar complaints from other customers. Linschoten drew Clarot's attention to “previous studies linking zinc sulfate to loss of smell.” Clarot gave her the impression that he had not heard of the studies. She asked Clarot whether Matrixx had done any studies of its own; he responded that it had not but that it had hired a consultant to review the product. Soon thereafter, Linschoten sent Clarot abstracts of the studies she had mentioned. Research from the 1930s and 1980s had confirmed “zinc's toxicity.” By September 2003, one of Linschoten's colleagues had observed 10 patients suffering from anosmia after Zicam use. Linschoten and Jafek planned to present their findings at a meeting of the American Rhinologic Society in a poster presentation entitled “Zicam Induced Anosmia.” The American Rhinologic Society posted their abstract in advance of the meeting. The presentation described in detail a 55-year-old man with previously normal taste and smell who experienced severe burning in his nose, followed immediately by a loss of smell, after using Zicam. It also reported 10 other Zicam users with similar symptoms. Clarot sent a letter to Dr. Jafek warning him that he did not have permission to use D's name or the names of its products. Dr. Jafek deleted the references to Zicam in the poster before presenting it to the American Rhinologic Society. The following month, two plaintiffs commenced a product liability lawsuit against D alleging that Zicam had damaged their sense of smell. Nine plaintiffs had filed four lawsuits. Ps allege that D made a series of public statements that were misleading in light of the foregoing information. After Dr. Jafek had presented his findings to the American Rhinologic Society, D stated that Zicam was “‘poised for growth in the upcoming cough and cold season’” and that the company had “‘very strong momentum.' D stated that revenues would “‘be up in excess of 50% and that earnings, per share for the full year [would] be in the 25 to 30 cent range.’” In January 2004, D raised its revenue guidance, predicting an increase in revenues of 80 percent and earnings per share in the 33-to-38-cent range. In its Form 10-Q in November 2003, Zicam warned of the potential “‘material adverse effect’” that could result from product liability claims, “ 'whether or not proven to be valid.' ” It stated that product liability actions could materially affect D's “‘product branding and goodwill,’” leading to reduced customer acceptance. It did not disclose that two plaintiffs had already sued D for loss of smell. On January 30, 2004, Dow Jones Newswires reported the story and that the Food and Drug Administration (FDA) was looking into complaints. D's stock fell from $13.55 to $11.97 per share after the report. D issued a press release stating the allegations are completely unfounded and misleading. No clinical trial of intranasal zinc gluconate gel products has reported 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, placebo-controlled, randomized clinical trials. D stated that 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. The day after D issued the press release, its stock price bounced back to $13.40 per share. Good Morning America highlighted Dr. Jafek's findings and reported that Dr. Jafek had discovered more than a dozen patients suffering from anosmia after using Zicam. It also noted that four lawsuits had been filed against D. The price of D stock plummeted to $9.94 per share that same day. On February 19, 2004, D filed a Form 8-K with the SEC stating that it had “‘convened a two-day meeting of physicians and scientists to review current information on smell disorders’” in response to Dr. Jafek's presentation. 'In the opinion of the panel, there is insufficient scientific evidence at this time to determine if zinc gluconate, when used as recommended, affects a person's ability to smell.’” Ps claimed that D violated § 10(b) of the Securities Exchange Act 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 D securities. D moved to dismiss Ps' 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. It held that Ps 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.” Ps failed to allege that D disbelieved its statements about Zicam's safety or that any defendants profited or attempted to profit from D's public statements. The Court of Appeals reversed. The District Court had erred in requiring an allegation of statistical significance to establish materiality and that the complaint adequately alleged “information regarding the possible link between Zicam and anosmia” that would have been significant to a reasonable investor.  It 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.

Issues

Rule of Law

Holding and Decision

Legal Analysis

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