The US Supreme Court's recent decision in Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156, (Mar. 22, 2011) (Matrixx Initiatives), marked the first time in over twenty years that the Court addressed the standard for materiality under the federal securities laws. Although there was widespread speculation that the Supreme Court might use Matrixx Initiatives as an opportunity to redefine materiality, it did not. Instead, the Court's opinion was narrowly tailored to resolve only the specific question presented: whether a pharmaceutical company's purported failure to disclose adverse events reports associated with its flagship product could be considered material even if the number of adverse events reports was itself statistically insignificant (Matrixx Initiatives at *3).

Shareholders asserted that Matrixx Initiatives and certain of its executives violated Section 10(b) of the Securities Exchange Act of 1934 when they failed to disclose reports that more than ten patients had suffered anosmia (the loss of sense of smell) after using Zicam, a cold remedy product (Matrixx Initiatives at **4-6, 12). Although Matrixx Initiatives did not view these reports as a reliable indication of causation, it had not conducted any studies of its own that disproved the purported link. When, approximately three months later, a nationally broadcast morning news program reported on the findings of one of the doctors who had sent information concerning the adverse events to Matrixx Initiatives, the Company's stock price plummeted.

Defendants argued that, as a general matter, adverse events reports associated with a pharmaceutical company's products cannot be material absent a sufficient number of reports to establish a statistically significant risk that the product is actually causing the events (Matrixx Initiatives at *8). The Court declined to adopt that bright-line rule. It reasoned that because neither medical experts nor the Food and Drug Administration limit the evidence they consider in assessing causation to statistically significant data, investors might also consider such information to be important (Matrixx Initiatives at **9-10).

Instead, the Court applied the prevailing "total mix" test, under which information is considered "material" if there is a "'substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly later the total mix of information made available." (Matrixx Initiatives at *8 (quoting Basic, Inc. v. Levinson, 485 US 224, 238 (1988))). Evaluating plaintiffs' allegations as a whole, it found that there was a substantial likelihood that a reasonable investor would have viewed the particular adverse event reports at issue to be material because the facts alleged suggested that anosmia posed a significant risk to the "commercial viability" of Zicam, which was the Company's leading product and accounted for approximately 70% of its sales (Matrixx Initiatives at *12). According to the Court, the information defendants allegedly concealed would likely have led consumers to determine that the risks associated with Zicam substantially outweighed the benefits, especially in light of the availability of many other products designed to alleviate symptoms associated with the common cold (Matrixx Initiatives).

Plaintiffs' attorneys will likely rely on Matrixx Initiatives to argue against dismissal for failure to plead materiality in securities-fraud class actions that similarly involve pharmaceutical companies and medical device manufacturers. In its opinion, however, the Court made clear that its ruling was closely tied to the facts of that particular case. It expressly warned that although it declined to adopt a bright-line rule with respect to statistical significance, its decision should not be read to suggest that "statistical significance (or the lack thereof) is irrelevant – only that it is not dispositive of every case." (Matrixx Initiatives at *10.) In addition, the Court cautioned that its application of the "total mix" test "does not mean that pharmaceutical manufacturers must disclose all reports of adverse events." (Matrixx Initiatives at *11.) To the contrary, the Court explained that "the mere existence of reports of adverse events – which says nothing in and of itself about whether the drug is causing the adverse events – will not satisfy this standard. Something more is needed . . .." Matrixx Initiatives The requirement that plaintiffs plead facts from which it can be inferred that the concealed information constituted a threat to a product's "commercial viability" likely will be a basis for distinguishing Matrixx Initiatives from most other cases.

Plaintiffs in cases against issuers outside of the life science sector will also likely try to use Matrixx Initiatives to characterise defendants' arguments as "bright-line rules" that should be rejected out of hand. Even though the Supreme Court's decision not to adopt the statistical significance test advocated by defendants in that case was context specific, all issuers should nonetheless be mindful of the holistic approach employed in Matrixx Initiatives when making decisions on disclosure.

On 30 March 2011, seven US Federal financial agencies (Agencies) announced a joint proposed rule to implement the provisions of Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to payment of incentive compensation at covered financial institutions with at least US$1 billion in assets (Proposed Rule). The annual report required of covered financial institutions by the Proposed Rule will be due within 90 days following the end of each covered financial institution's fiscal year.

After the Proposed Rule becomes final, each Agency will codify its own version of the rules. Agency rules will vary to accommodate differences between regulated entities, as well as varying statutory and regulatory requirements. Some highlights of the Proposed Rule include:

For more information on the Proposed Rule, see Shearman & Sterling's client publication.

On 30 March 2011, the Securities and Exchange Commission (SEC) issued proposed rules directing the national securities exchanges to adopt listing standards related to the independence of compensation committees and their selection of advisers. SEC rulemaking on these topics is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act), which prohibits national securities exchanges from listing any equity security of an issuer not in compliance with the exchange's compensation committee independence and adviser requirements. In the proposing release, the SEC also slightly revised its proxy disclosure rules related to the use of compensation consultants by compensation committees and an issuer's management.

The proposed rules generally reiterate the requirements of the Act and apply to domestic and foreign private issuers. In particular, the proposed rules direct the national securities exchanges to both:

The proposed rules do not actually establish independence standards and do not provide any safe harbors, nor do they exempt any particular relationship between compensation committee members and issuers. These topics are left to the exchanges.

There are five categories of issuers that would not be subject to the compensation committee independence requirements: controlled companies, limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act, and foreign private issuers that provide annual disclosures to shareholders of the reasons why they do not have an independent compensation committee. Exchanges may propose additional exempt issuer categories subject to SEC approval.

The Act dictates when an issuer must disclose (1) whether the compensation committee has retained or obtained the advice of a compensation consultant, (2) whether the work of the compensation consultant has raised any conflict of interest and, (3) if so, the nature of the conflict and how the conflict is being addressed. The current SEC Disclosure rules require registrants to disclose "any role of the compensation consultants in determining or recommending the amount or form of executive and director compensation." Given the similarities, the SEC elected to combine the current rules and the requirements under the Act into a single disclosure requirement that applies to all Exchange Act registrants subject to the proxy rules.

As proposed, a registrant will be required to disclose whether its compensation committee has "retained or obtained" the advice of a compensation consultant, rather than formally "engaged" one, during the registrant's last completed fiscal year. An instruction to the proposed rule clarifies that the phrase "obtained the advice" relates to whether a compensation committee has requested or received advice from a compensation consultant, regardless of whether there has been a formal engagement, a relationship with the compensation committee or management or any payment of fees.

The Act does not require that a compensation adviser actually be independent, but only that the compensation committee must consider certain independence factors when deciding to hire an adviser. These factors include:

The proposed rules include an instruction identifying the same independence factors (listed above) as a nonexclusive list of factors to be considered in determining whether there is a conflict of interest requiring disclosure. If the compensation committee determines that there is a conflict of interest, the issuer would be required to provide a clear and concise description of the specific conflict and how the issuer has addressed it; a general description of the issuer's policies and procedures on conflicts of interest would not suffice.

The SEC does not anticipate that exchange listing standards will impose any materiality or bright-line thresholds on the independence factors. In addition, the proposed rule does not require compensation committees to retain a compensation consultant or legal or other adviser, or preclude such adviser from providing other services to the issuer.

The proposed rules would require the exchanges to establish definitive procedures and compliance periods, if they do not already have adequate procedures in place, to be followed prior to delisting an issuer's securities. The listing requirements will create a safe harbor for any member of a compensation committee who ceases to be independent for reasons outside the member's reasonable control and allow the member to remain on the compensation committee until the earlier of the issuer's next annual meeting or one year from the event that caused the member to no longer be independent, as contemplated in the Reform Act.

For more information on the proposed rule, see Shearman & Sterling's client publication.