Friday, December 15, 2017

Allegations in another case's complaint were plausibly corrective disclosures

By Rodney F. Tonkovic, J.D.

A Sixth Circuit panel has reversed and remanded a district court's holding that a complaint in a different suit did not constitute a corrective disclosure. The district court held that claims that a medical provider illegally boosted Medicare revenues were time-barred and that the shareholders failed to adequately allege that the alleged misstatements had caused their losses. The panel reversed, finding that the new claims in an amended complaint related back to the original complaint and that it was plausible that the allegations from the other suit constituted corrective disclosures (Norfolk County Retirement System v. Community Health Care Systems, Inc., December 13, 2017, Kethledge, R.).

Community Health Systems. Community Health Systems (CHS) runs the largest for-profit hospital system in the U.S., with 131 hospitals making over $13 billion in revenue in 2011. These profits depended largely on reimbursements for treating patients covered by Medicare.

To determine whether a patient needed inpatient or outpatient care, CHS used a system written by itself, and unique to its hospitals, called the Blue Book. The Blue Book directed CHS doctors to provide inpatient services for many conditions that most other hospitals would treat as outpatient cases. Since inpatient cases require over 24 hours of constant care, Medicare pays hospitals far more for those patients than outpatient cases. During the relevant period, however, CHS, without mentioning the Blue Book, attributed its strong revenues to "synergies" and "efficiencies."

Tenet takeover. In 2011, another medical provider, Tenet Healthcare Corp., sued CHS after being made the subject of a hostile takeover attempt by CHS. Tenet alleged that CHS made statements in its SEC filings that omitted that the source of its profits was Blue Book-mandated practices that essentially defrauded Medicare by unnecessary inpatient admissions.

That suit became the basis for the action brought by Norfolk County after the complaint publicly revealed that CHS’s successful track record of increasing revenues at acquired hospitals was attributable to improper and unsustainable admission practices, according to the complaint. In response, CHS issued a press release denying the allegations. But, at the same time, CHS's CFO revealed the use of the Blue Book.

District court dismissed. The initial complaint in this case was filed in May 2011, claiming that CHS had inflated its share price through false and misleading statements. The complaint was amended twice, the last amendment raising new allegations about misrepresentations. The district court found that the newest allegations were untimely. Also, while the CHS defendants had made misleading statements, the court concluded that the shareholders failed to adequately allege that these statements had caused their losses.

Timely. On appeal, the appellate panel found that the allegations in the amended complaint were timely because they related back to those in the original complaint. According to the panel, under FRCP 15(c), the allegations, which would otherwise have been untimely, were timely because both the original and amended complaints alleged the same "general conduct" and "general wrong." That is, the original complaint alleged that CHS defrauded investors by concealing the role of the Blue Book in boosting CHS's bottom line, and the amended complaint built on that by alleging that, after the Tenet suit was filed, CHS continued to make "lulling misrepresentations that were designed to preserve the fraud’s effect."

Corrective disclosures. The panel then found that the complaint adequately alleged loss causation via corrective disclosures. The complaint plausibly alleged that the Tenet complaint, plus the admission of the use of the Blue Book by CHS's CFO, revealed the antecedent fraud to the market and caused the shareholders’ economic loss. These disclosures, plus the speed at which CHS's share price fell afterwards, made a causal link between the two at least plausible, the panel said.

CHS argued, as the district court held, that the Tenet complaint could not "reveal the truth" because complaints only contain allegations. While the panel saw some merit in that proposition as a general rule, it noted that some allegations are more credible than others. The Tenet complaint had two aspects that set it apart from most complaints: CHS's CFO admitted the truth of one of the complaints core allegations (the use of the Blue Book), and the complaint contained expert analysis of the Blue Book's effect. It was plausible, the panel concluded, that the market first learned the full extent of the alleged fraud from the Tenet complaint.

The case is No. 16-6059.

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