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IN RE COMPLETE MANAGEMENT INC. SECURITIES LIT.
March 30, 2001
IN RE COMPLETE MANAGEMENT INC. SECURITIES LITIGATION
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 —
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.
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 —
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
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.
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 —
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.
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
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.
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".
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
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. § 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 ...