The pharmaceutical industry should cringe in horror at the U.S. Supreme Court's decision to hear a case which asks whether Matrixx (MTXX), the company that markets cold treatment Zicam, had a duty to disclose adverse event reports to shareholders even when they may not have been statistically significant. Should the court find in favor of shareholders, every single drug company in the U.S. could be affected: many would be forced to list adverse event reports, even when they believe they're trivial or frivolous, in SEC filings.
This case is a reminder to managers about the old adage about bad facts and bad law. In this case, a change to the law could be healthy for consumers and investors, but would be a headache for managers, as it would require a laborious level of transparency about the drugs they sell.
The Zicam case is brimming with bad facts -- Matrixx is one of the worst offenders in the largely unregulated, non-prescription diet-supplement business. Basically, the company is accused of not telling anyone that it had received 800 consumer complaints alleging that Zicam had robbed cold sufferers of their sense of smell.
The signs that something was wrong with Zicam occurred as early as 1999, but the company didn't explain the risks specifically to investors until March 2004, when it filed an annual report that mentioned "numerous suits" had been filed against the company. Prior to that, Matrixx had denied that anything was wrong with its product, a swab that pastes a zinc-based compound into your nose. Here's the timeline as laid out in the Appeals Court ruling that favored investors:
- December 1999: Dr. Alan Hirsch, the neurological director of the Smell & Taste Treatment and Research Foundation, called Matrixx to say that at least one of his patients had developed anosmia (lack of smell) and that other studies had indicated potential problems with "intranasal application of zinc."
- September 2002: Miriam Linschoten, Ph.D., of the University of Colorado Health Sciences Center, contacted Timothy Clarot, Matrixx's vp/R&D, because a patient had reported loss of smell. Linschoten expressed concern that Zicam contained no warning that it could cause a loss of smell.
- September 20, 2003: Dr. Bruce Jafek of the University of Colorado School of Medicine and others planned to submit a paper on 10 patients who had lost their ability to smell to the American Rhinologic Society, but "Matrixx sent a letter to Jafek stating that he did not have permission to use Matrixx's name or the names of its products" in the presentation.
- Oct. 22, 2003, onwards: Matrixx published earnings releases that didn't mention any of this activity, other than the rote general warning on litigation that all drug companies carry in their quarterly 10-Q filings.
- January 30, 2004: Dow Jones Newswires reported that the FDA was "looking into complaints" about Zicam following at least three lawsuits. The company's stock declined.
- February 2, 2004: Matrixx issued a press release saying that allegations Zicam causes loss of smell "are completely unfounded and misleading." The company threatened to sue its critics, and indeed was suing Floyd Schneider -- who had criticized the company on online investor bulletin boards -- for defamation.
- February 6, 2004: Good Morning America (!) finally discloses Jafeks' small study from 2003: "more than a dozen patients" were affected and four lawsuits had been filed, while others were being prepared.
- February 6, 2004: Matrixx issued another press release, describing the reports as "completely unfounded and misleading." The company then convened a meeting of scientists to discuss the issue.
- March 19, 2004: Matrixx filed a 10-K annual report with the SEC, stating that "numerous suits alleging that its Zicam product(s) caused anosmia had been filed."
The shareholders allege that the previous quarterly filing should have noted that several lawsuits were filed. Matrixx is arguing, narrowly, that as the adverse events weren't statistically significant in terms of Zicam's total sales, it had no duty to disclose. The shareholders are arguing that statistical significance is only one test of whether information is "material" and therefore should be disclosed. They want the court to rule that all the facts should be taken together -- including Matrixx's foot-dragging -- when courts make a decision on whether a company failed to disclose something it should have.
While Chief Justice John Roberts has led a pro-business court that may indeed rule narrowly in Matrixx's favor, his court has also favored plaintiffs against drug companies (in Wyeth v. Levine).
The broader dynamic for bosses is that the bad actions of a single irresponsible company can affect an entire industry. To put it another way, just because you're doing good deeds doesn't mean you're inoculated from punishment.