Corporate Governance

Matrixx v. Siracusana: Revisiting the Materiality Standard (Part 6)

By J Robert Brown Jr.

The emphasis in this case on statistical significance is misleading. 

The only question is whether the information at issue is important to a reasonable investor. That in turn depends not upon the number of adverse health reports but upon the knowledge of the Company about the possible harmful effects of the drug.  To make that determination requires a consideration of the total mix of available information known to the Company and the market. 

Total mix includes information about the use of Zicam acquired from all sources.  Moreover, it requires consideration of qualitative factors.  As the Commission noted in SAB 99:

• Under the governing principles, an assessment of materiality requires that one views the facts in the context of the "surrounding circumstances," as the accounting literature puts it, or the "total mix" of information, in the words of the Supreme Court. In the context of a misstatement of a financial statement item, while the "total mix" includes the size in numerical or percentage terms of the misstatement, it also includes the factual context in which the user of financial statements would view the financial statement item. The shorthand in the accounting and auditing literature for this analysis is that financial management and the auditor must consider both "quantitative" and "qualitative" factors in assessing an item's materiality. Court decisions, Commission rules and enforcement actions, and accounting and auditing literature have all considered "qualitative" factors in various contexts.

In this case, the number of complaints about Zicam were quite small.  Of course, this is the number that plaintiffs can discern without having the benefit of discovery.  Other factors were, however, present that must be considered in determining materiality.   

First, lawsuits were filed alleging that Zicam resulted in a loss of smell.  Lawsuits must meet the requirements of Rule 11 which presumably means counsel for the plaintiffs had a non-frivilous basis for believing that the drug caused the alleged harm.  In other words, a complaint about the effect of a drug without more a coincidence.  A lawsuit requires something more than that.

Second, the product used zinc (zinc gluconate) and was put on notice that studies had linked zinc sulfate to the loss of smell.  It does not establish that Zicam caused a loss of smell.  Indeed, Matrtixx describes zinc sulfate as "a totally different compound and not in any Zicam Cold Remedy products.".  Nonetheless, in determining materiality, some assessment has to be made of the awareness by Matrixx that zinc gluconate could cause a loss of smell. 

Third, a reporter disclosed on his web site that '[t]he makers of the nationally advertised cold remedy Zicam now admit that they don't know if their nasal gel could cause loss of smell.'  This is, of course, a third party statement and it may or may not reflect exactly what officials told the reporter.  Nonetheless, it arguably reflects at least some level of uncertainty about the health effects of the durg.

In short, materiality depends upon more than the number of adverse health reports.  In ascertaining the importance of this data, it has to be considered in the context of the other facts known to the Company.  Under the total mix standard, a single adverse health report could be material if it established unequivocally (based upon other information known to the Company) that the drug was harmful. 

For the cert petition and the reply, we have posted them on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on June 24, 2010 (boomark / email).