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IN RE OXFORD HEALTH PLANS

May 25, 1999

IN RE OXFORD HEALTH PLANS, INC., SECURITIES LITIGATION.


The opinion of the court was delivered by: Brieant, District Judge.

MEMORANDUM & ORDER

Presently before the Court in these cases alleging securities fraud, which have been consolidated for pre-trial purposes,*fn1 is the motion pursuant to Rule 12(b)(6) and Rule 9(b), Fed.R.Civ.P., of defendant KPMG LLP ("KPMG"). KPMG seeks dismissal of the complaint against it on the ground that plaintiffs fail to meet the pleading standards of the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (the "PSLRA"). Plaintiffs filed opposition papers on February 19, 1999 and KPMG filed reply papers on April 2, 1999. A hearing was held on April 28, 1999 and decision reserved.

FACTUAL BACKGROUND

Plaintiffs are persons and entities who allegedly purchased publicly-traded securities of Oxford Health Plans, Inc. ("Oxford") during the period from November 6, 1996 through December 9, 1997 (the "Class Period"). Plaintiffs purport to bring this complaint on behalf of themselves and all others who purchased Oxford securities during the Class Period, as well as on behalf of a sub-class of all persons and entities who purchased Oxford common stock contemporaneously with sales by certain individual defendants during the Class Period.

Defendant Oxford is a managed care company that provides its members in New York, New Jersey, Pennsylvania and Connecticut, with comprehensive health care services on a prepaid basis through a network of medical service providers. The individual defendants were at all times during the Class Period officers and directors of Oxford. Defendant KPMG is a firm of certified public accountants that was Oxford's independent auditor from 1985 to 1998. KPMG conducted an audit of Oxford's financial statements for the fiscal year ended December 31, 1996, and issued a report dated February 18, 1997, opining that Oxford's 1996 financial statements were prepared in accordance with generally accepted accounting principles ("GAAP") and that KPMG's audit was conducted in accordance with generally accepted auditing standards ("GAAS").

Plaintiffs' allegations must be taken as true for purposes of this motion to dismiss. The following facts are thus taken as true: Oxford's press releases and SEC filings during the Class Period contained false or misleading information or omitted material information about the accuracy of Oxford's earnings and enrollment figures and its progress in remedying delays in billing and claims processing associated with a conversion of its computer system. Also during that time, Oxford's financial statements were in violation of GAAP. Between October 27, 1997 and December 9, 1997, Oxford revealed that delays in its ability to collect premiums negatively affected its prior membership, revenue and costs estimates. These disclosures caused the price of Oxford stock to drop substantially.

Plaintiffs allege that in auditing Oxford's 1996 financial statements, KPMG knowingly or recklessly disregarded certain evidence signaling Oxford's accounting irregularities, particularly Oxford's lack of internal controls and ineffective computer system. In so doing, KPMG violated GAAS and other auditing standards.

Specifically, plaintiffs claim that Oxford's 1996 financial statements violated GAAP and were materially misstated because:

  (i) Oxford fraudulently recognized and reported
  premium revenue; (ii) Oxford failed to adequately
  reserve for uncollectible premiums receivable; (iii)
  Oxford fraudulently accounted for its RBNP (reported
  but not paid) and IBNR (incurred but not reported)
  claims and thereby materially understated its medical
  costs payable and health care services expense; (iv)
  Oxford failed to disclose loss contingencies required
  to be disclosed by GAAP and SEC regulations; and (v)
  Oxford was unable to quantify its Class Period premium
  revenue and health care services expense. (Complaint
  ¶ 213).

Plaintiffs also allege specific violations by KPMG of GAAS General Standards of Reporting, GAAS Field Work Standards, American Institute of Certified Public Accountants ("AICPA") Auditing Standards, and AICPA Statements on Auditing Standards.

These include falsely reporting that Oxford's financial statements were prepared in accordance with GAAP; failing to conduct the audit with independence in mental attitude; conducting the audit without exercising due professional care; failing to make Oxford correct or restate allegedly fraudulent financial statements; failing to plan adequately its audit and supervise the work of assistants; failing to perform audit procedures required to assess the adequacy of Oxford's preparation of financial statements; failing to obtain sufficient understanding of Oxford's control structure and assess Oxford's control risk; failure to evaluate the effect of Oxford's computer processes on the accuracy of financial statements; failing to obtain sufficient competent evidence.

Plaintiffs also allege that there were many "red flags" indicating to KPMG that Oxford's financial reporting systems were in disarray, inherently unreliable and incapable of providing accurate financial statements. In 1996, Oxford's computer conversion was a disaster. Premiums receivable and medical costs payable were ballooning. More than half of all claims logged into Oxford's system were not paid within thirty days. In October 1996, Oracle Corporation ("Oracle"), a computer consulting company, spent two weeks at Oxford and determined that Oxford's computer system was so deficient that Oxford should stop adding functions and related data to it. In December 1996, Oxford had approximately $108 million in suspended claims but could not determine the age of these claims. Oxford was unable to determine how much money it owed to providers and thus began the extraordinary practice of making providers interest-free loans in the form of cash advances. Also, during 1996, the New York Attorney General's Office (the "NYAG") was conducting an investigation of Oxford as a result of member and provider complaints.

In May 1997, the New York State Insurance Department (the "NYSID") announced the results of an unrelated investigation of Oxford's New York subsidiaries. The NYSID had quickly determined after an investigation beginning in 1996 that Oxford's internal controls were severely deficient and had been since 1990. The NYSID concluded that Oxford had not remedied any of the internal control problems found by the NYSID in 1990. As a result of the findings made by the NYSID pursuant to the investigation, the NYSID fined Oxford three million dollars and directed that Oxford increase reserves by millions of dollars, terminate certain management personnel, including the CFO, and remove or replace the two leaders of the KPMG auditing team at Oxford. Also in 1997, Oxford took over one-half bilhon dollars in total charges relating to the fraudulent activities alleged in the Complaint. When KPMG issued its 1997 audit in early 1998, it reaffirmed the accuracy of its 1996 audit, despite the findings and directives of the NYSID.

Plaintiffs also assert that KPMG had the motive and opportunity to engage in a fraudulent scheme with Oxford because KPMG desired to maintain its competitive position in the industry and to ...


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