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March 30, 2001


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


This is a securities fraud class action brought on behalf of those who purchased or otherwise acquired the common stock or convertible debentures of Complete Management, Inc. ("CMI"). Plaintiff class alleges violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("the Exchange Act") and Rule 10b-5 promulgated thereunder. Plaintiffs further allege violations of section 11 of the Securities Act of 1933 ("the Securities Act"). The defendants include certain individuals associated with CMI's incorporation and management, the corporation's underwriters, and its accountants. Now pending are five separate motions to dismiss, pursuant to Fed.R.Civ.P. 12(b)(6), entered on behalf of various defendants or groups of defendants. For the following reasons, the motions are denied.


On December 3, 1999, Andrew Ballow, Anthony Giarletta, Carole Rothschild, Robert Siegel, Charles P. Simaz and C. Ian Sym-Smith were appointed lead plaintiffs for the class of all purchasers of the common stock or other convertible debentures of CMI between May 1, 1996 and August 13, 1998 (the "class period"). In their complaint, plaintiffs named three groups of defendants: (1) the "individual defendants", who include eight of the principals and senior managers of CMI; (2) the "underwriter defendants", who include three brokerage firms that underwrote the various public offerings of CMI stock; and (3) Arthur Andersen, LLP, ("Andersen") the accounting firm that served as CMI's independent public accountant during the class period.

1. Formation and Early Activity of CMI: December 1992 — January 1996

CMI was a physician practice management company incorporated on December 30, 1992. See Consolidated Amended Class Action Complaint ("Compl."), ¶ 4.*fn1 Four individuals, Lawrence Shields, M.D., his son Dennis Shields, Steven Rabinovici and David Jacaruso, all named as defendants in this action, founded the corporation. ¶¶ 24, 25, 28, 31. In April 1993, CMI began operations by entering into a management agreement with Greater Metropolitan Medical Services ("GMMS"). ¶ 4.

GMMS is a medical practice, founded in 1971, with offices throughout the greater New York metropolitan area. The practice primarily treats accident patients who are insured under New York's no-fault insurance laws or employees who are insured by state workers' compensation laws. ¶ 5, 11. A close relationship existed between CMI and GMMS. Defendant Lawrence Shields ("Dr. Shields"), a CMI principal and co-founder, owns 95% of GMMS. ¶ 6. Additionally, Dr. Shields's son, Dennis, was a vice-president of CMI. The management agreement between CMI and GMMS provided that CMI would be responsible for all non-medical aspects of GMMS's practice, including but not limited to office space, equipment, supplies, billing, etc. Id., ¶ 7.

Many patients insured by the no-fault and workers' compensation systems lack the financial means to pay their medical bills. Since these patients are eventually entitled to direct reimbursement by their insurance carriers, GMMS increased the volume of its business by agreeing to provide medical services subject to assignment of the patients' reimbursement rights. ¶ 5. This practice led to the creation of substantial paper assets in assigned reimbursements, as there was a significant delay between the patients' assignment of their reimbursement rights to GMMS and the eventual reimbursement to GMMS. This delay would often be as lengthy as three years, and, as will be discussed infra, the eventual reimbursement was often far from total.

GMMS leveraged these receivables in its financial relationship with CMI. Rather than pay CMI in cash for its management services, GMMS would pay CMI by assigning a portion of its accounts receivable equal to the amount owed to CMI. Id. During the first three years of operation, CMI's revenues were exclusively derived from its contract with GMMS. ¶ 7. In 1996 and 1997, CMI developed other management contracts, but GMMS remained its largest single client. Id.

However, the GMMS receivables assigned to CMI were often uncollectible. Plaintiffs allege that GMMS was nothing more than a "medical mill" that engaged in "excessive and unnecessary billings" to take advantage of the no-fault and workers' compensation systems. ¶¶ 7, 10. During the class period, some 2800 no-fault motor vehicle claims involving GMMS were refused by insurers and submitted to arbitration. Id. Such arbitrations were protracted, often taking over three years to resolve, and thus prolonged the inflated paper value of GMMS' — and consequently CMI's — receivables. ¶ 10.

In the arbitration decisions, it was frequently found that GMMS had falsified claims for medical services. Many GMMS billings were determined to be excessive, wasteful, and unnecessary. ¶¶ 9-10. Arbitrators found a number of flaws in GMMS's practice, including, among others, falsified signatures that were "obviously not by the named doctors," a majority of reports that were not signed or initialed as was required, referrals that were "excessive and unreasonable on their face," and referrals for tests and treatments that were supported by "no medical necessity". ¶ 9 (quoting arbitration decision).

Plaintiffs' complaint includes what is described as a "typical example" of an arbitration decision involving a GMMS billing assigned to CMI, which stemmed from a minor traffic accident. After an original claim of $12,065.20, GMMS was ultimately awarded only $1,196.52 in an arbitration, less than 10% of the initial claim. Id., ¶ 102. The examining physician made referrals for a number of tests, including four MRI exams at other GMMS-owned sites, which the arbitrator found to be "excessive and unreasonable on their face." Id. The entire claim, however, prior to arbitration, was considered as a GMMS receivable — and, therefore, because of the payment arrangement, as a CMI receivable.

Plaintiffs additionally allege in the complaint that a practice known as "midnight chart reviews" occurred during the class period. Id., ¶ 14f. Non-medical staff, under the direction of some of the individual defendants, would review patients' medical files and order superfluous and excessive medical tests or procedures. Id. As a result, patients were instructed to undergo medical procedures at GMMS facilities that fraudulently increased GMMS's receivables, and thus CMI's revenues. Id. In its accounting, CMI did not establish any reserve for doubtful accounts that might not be collectible, despite the track record of GMMS claims in arbitration. Id. Thus, all claims, regardless of their legitimacy, were considered as full value CMI assets once assigned to CMI by GMMS.

2. Initial Public Offering and Growth of CMI: January 1996 — July 1998

Until 1996, CMI's activities consisted solely of management services for GMMS. Through this relationship, CMI developed substantial assets in the form of the GMMS receivables assigned to it for payment. On January 4, 1996, CMI announced the completion of an initial public offering ("IPO") of 2,000,000 shares of common stock valued at $9.00 per share. ¶ 44 (hereinafter "the IPO"). Simultaneously with this offering, CMI merged with a company called Medical Management, Inc. ¶ 45. Defendants Rabinovici, Dennis Shields, and Scotti served as the top management of the newly-acquired entity. Id. The IPO was underwritten in part by defendant National Securities Corporation.

In early 1996, CMI commenced what CMI Chairman and CEO Rabinovici termed an "aggressive acquisition strategy" of purchasing physician practices that it would then manage. ¶ 45. These acquisitions would thereby expand and diversify CMI's revenue base. For example, in the April 10, 1996, Business Wire, CMI announced the acquisition of two neurological practices in New York City. ¶ 46. Plaintiffs allege that this acquisition strategy had the additional goal of attempting to reduce CMI's dependence on the artificially inflated GMMS receivables before it became apparent that those receivables were uncollectible, which would result in the certain insolvency of CMI. ¶ 47.

CMI typically structured the financing of its acquisitions in three parts: one-third cash, one-third stock, and one-third debt. ¶ 48. As a result, CMI quickly used much of the cash raised through the IPO for subsequent acquisitions, and was not obtaining sufficient cash flow from the GMMS receivables to continue operations. On May 1, 1996 — five months after the IPO — CMI announced a secondary public offering of $30 million in convertible debentures, with an interest rate of 7 to 8½ percent. Id. (quoting Reuters) (hereinafter "the September, 1996 offering"). After this announcement, CMI's stock price, which had hovered around the $9.00 per share initial offering price, rose immediately. ¶ 49. The registration statement covering the secondary offering became effective June 6, 1996. ¶ 55. These bonds had an 8 percent coupon, and were convertible into CMI common stock valued at $14 per share. Id. Once again, defendant National Securities Corporation was the underwriter of this offering. Id. In May, 1996, CMI also began trading on the American Stock Exchange, thereby gaining a heightened level of visibility. ¶ 51.

CMI's acquisition of physician practices and other practice management companies continued steadily during this period. ¶¶ 50, 52. The first quarter of 1996 saw increased gross and net revenues; gross revenues were approximately $5.2 million, an increase of 10% over the first quarter of 1995. ¶ 53 (quoting Business Wire). Analysts' reports in 1996 gave optimistic reviews of CMI's growth potential, based largely on the increased revenues from acquisitions, as well as on the considerable receivables from GMMS. ¶ 56. Analysts viewed these GMMS receivables as collectible debts, rather than as the bad debt that they in fact were. This view considered the GMMS receivables simply to have long collection cycles that pressured cash flow, and thereby supported the debt funding of additional acquisitions. Id. One analyst's report suggested that CMI stock deserved a strong "buy" rating because it was significantly undervalued, and might reach the price of $30 per share in six to eighteen months. Id. Plaintiffs allege that these rosy scenarios resulted from CMI management's representation to the business press that the GMMS receivables were not bad debt, but rather were collectible debts with long collection cycles.

Between June and October 1996, CMI acquired several significant medical practices and practice management companies. ¶ 58. These acquisitions included the largest occupational medical services provider in New Jersey, an 18-doctor practice with $13 million in annual revenue; two Long Island, New York medical billing and collections companies with $3 million in revenues; and a physician practice management company with a substantial thirty-year management contract in the region north of New York City, stretching up to Albany, New York. CMI also announced its intent to merge with Amedisys, a regional health care company based in Baton Rouge, Louisiana, that in the first half of 1996 posted $21.6 million in revenues.*fn2 Id.

At the end of October, 1996, CMI had once again exhausted its cash reserves. ¶ 59. On November 5, 1996, CMI filed a registration statement with the SEC for a combined stock and debt offering. Id. ("the November offering") This included 3 million shares, and $25 million in convertible subordinated debentures. Id. The offering was announced on December 6, 1996. Id., ¶ 62. The stock was issued at $13.75 per share, and the bonds were issued at an 8 percent interest rate. Id. The co-lead underwriters were defendants Commonwealth Associates and National Securities Corp. ¶¶ 63, 65.

At this time, CMI's stated revenues were at a record high; in the third quarter of 1996, stated revenues rose to $8.77 million, 85 percent higher than a year earlier. ¶ 60. CMI's 1996 annual figures were similarly record-setting; stated annual revenues reached $33 million, compared to $19 million in 1995. Earnings in 1996 were $0.68 per share, compared to 1995 earnings of $0.48 per share. ¶ 68 (quoting Business Wire).

3. CMI's Financial Difficulties and Bankruptcy: July, 1998 — 1999

CMI's stock price reached a high of $20 per share in October, 1997, and then began a steady decline. ¶ 105. In June and July of 1998, CMI's stock price began dropping significantly, reaching $3 per share in July, 1998. A Prudential Securities analyst characterized the stock's value at that time as "in something close to a free-fall of late." ¶ 104 (quoting analyst's report). In that same report, Prudential lowered its still-optimistic one-year target price for CMI shares from $24 per share to just $10 per share. Id. It was about this time that the GMMS receivables first assigned to CMI in 1994 began to complete the three-year cycle of contestation and arbitration, at which time, plaintiffs allege, it became apparent that they were uncollectible. ¶ 83.

As 1998 progressed, CMI's cash flow situation continued to worsen, new sources of funds were not apparent, and the corporation engaged in a restructuring. ¶¶ 107-08. As part of this restructuring, CMI terminated its relationship with GMMS, citing a difficulty in collecting receivables. Id. At this time, CMI took a $56.7 million charge for bad debt based on the uncollectible GMMS receivables. Id. CMI also closed some medical practice sites, relocated its headquarters, and consolidated some administrative functions such as billing. Id. CMI's net losses for the first half of 1998 were over $35 million, as compared with $3.8 million in net income for the first half of 1997. CMI's losses continued to mount as the corporation posted $26.1 million in losses in the third quarter of 1998 alone.

CMI took a second major charge for bad debt in November, 1998. At this time, the company wrote off $17.5 million in debt, including $10.1 million stemming from the collection of receivables. ¶ 109. In February, 1999, CMI announced that it had failed to pay the interest on its 8% convertible subordinated debentures that was due on the 15th of that month. ¶ 110. After the thirty-day grace period had elapsed, the corporation was in default with respect to that payment. ¶ 111. On October 12, 1999, CMI filed a petition for bankruptcy in the United States Bankruptcy Court for the Southern District of New York, under Chapter 11 of the U.S. Bankruptcy Code. ¶ 112.


A. Standard on a Motion to Dismiss

For purposes of a motion to dismiss, we are required to accept as true the factual assertions in the complaint, see Zinermon v. Burch, 494 U.S. 113, 118, 110 S.Ct. 975, 108 L.Ed.2d 100 (1990); Charles W. v. Maul, 214 F.3d 350, 356 (2d. Cir. 2000). Additionally, for purposes of a Rule 12(b)(6) motion, a complaint is deemed to include any statements or documents incorporated in it by reference, see Rothman v. Gregor, 220 F.3d 81, 88 (2d. Cir. 2000), Cosmas v. Hassett, 886 F.2d 8, 13 (2d Cir. 1989), as well as publicly disclosed documents required by law to be, and that actually have been, filed with the SEC, see Rothman, 220 F.3d at 88, Cortec Industries, Inc. v. Sum Holding L.P., 949 F.2d 42, 47-48 (2d Cir. 1991).

Plaintiffs' complaint is comprised of five claims against the various defendants, brought under several provisions of the securities laws. We address each claim in turn.

B. Plaintiffs' § 10(b) Claims for False and Misleading Statements

Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, prohibit fraudulent activities in connection with securities transactions. In relevant part, § 10(b) provides that it is unlawful to:

use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulation as the Commission [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors.

15 U.S.C. § 78j(b). To implement this statute, the SEC has promulgated Rule 10b-5, which specifies what behavior the statute forbids. That rule makes it unlawful:

To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. . . .

17 C.F.R. § 240.10b-5. The Second Circuit has established that to state a claim for relief under § 10(b) and Rule 10b-5, a plaintiff must allege that each defendant "(1) made misstatements or omissions of material fact; (2) with scienter; (3) in connection with the purchase or sale of securities; (4) upon which plaintiffs relied; and (5) that plaintiffs' reliance was the proximate cause of their injury." In re IBM Corp. Sec. Litig., 163 F.3d 102, 106 (2d Cir. 1998).

Plaintiff brings § 10(b) claims against the individual defendants and Andersen. We examine these claims independently, as the applicable factual and legal contexts vary significantly.

1. Individual Defendants

Named as individual defendants are Dr. Larry Shields, Steven Rabinovici, David R. Jacaruso, Arthur L. Goldberg, Joseph M. Scott, Dennis Shields, Manus O'Donnell, and Claire A. Cardone. All of these persons were officers and/or directors of CMI, except for Dr. Shields, who was the largest individual shareholder but held no formal title. Dr. Shields's proposed grounds for dismissal were briefed separately from those of the other individual defendants, and his position as a shareholder but neither an officer nor a director presents distinct questions. Therefore, we first address the remaining individual defendants, who, for ease of reference, we will discuss collectively as the "individual defendants".

a. Pleading Scienter

Defendants' principal objection to the complaint is that plaintiffs fail to plead the state of mind required by Fed.R.Civ.P. 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA").

(i) Applicable Legal Standards

It has long been established case law that in order to state a § 10(b) claim, plaintiff must allege that defendants acted with scienter. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) (adopting the rule already applied by the Second Circuit that the Exchange Act "clearly connotes intentional misconduct" and thus a plaintiff must plead scienter.).

In 1995, Congress amended both the Securities and Exchange Acts by passing the PSLRA. See Pub.L. No. 104-67, 109 Stat. 737 (codified at scattered sections of 15 U.S.C.). In order to "curtail the filing of meritless lawsuits," the PSLRA imposed new and more stringent requirements on plaintiffs alleging securities fraud. Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir. 2000) (quoting H.R. Conf. Rep. No. 104-369, at 41 (1995)). The act codified the scienter requirement, and established a pleading standard. It states:

[I]n any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.

15 U.S.C. ยง 78u-4(b)(2). The Second Circuit concluded that through the PSLRA amendments to the securities laws, Congress "effectively raised the nationwide pleading standard to that previously existing in this circuit and no higher (with the exception of the `with particularity' requirement."). Novak, 216 F.3d at 310. Thus, the circuit has directed district courts to employ the modes of analysis established in existing precedents in determining if a Plaintiff has met his burden of pleading a "strong inference" of scienter. See id. at 311 ("[W]e hold that the PSLRA adopted our `strong ...

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