On December 13, 2017, the United States Court of Appeals for the Sixth Circuit reversed the dismissal of a consolidated putative class action against Community Health Systems, Inc. (“Community”), its CEO, and CFO. Norfolk Cty. Ret. Sys. et al. v. Cmty. Health Sys., Inc. et al., No. 16-6059 (6th Cir. Dec. 13, 2017). Plaintiffs—shareholders of Community—alleged that Community and certain of its officers had violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by fraudulently inflating Community’s share price through false and misleading statements regarding Community’s operating model. Plaintiffs alleged that the value of Community’s shares fell immediately in April 2011 after a Community competitor, Tenet Healthcare Corporation, publicly disclosed in a civil complaint against Community expert analyses alleging that Community’s profits depended largely on Medicare fraud, and fell further in October 2011 after one of Community’s officers admitted to certain of Tenet’s allegations. Judge Kevin H. Sharp of the United States District Court for the Middle Division of Tennessee dismissed the putative class action complaint, finding that while plaintiffs had sufficiently pled that defendants intentionally made misleading statements, they had not adequately alleged that the misleading statements had caused plaintiffs’ losses because the disclosures came in the form of Tenet’s complaint—and was therefore regarded by the market as mere “allegations” rather than truth. The Sixth Circuit reversed.
The Sixth Circuit first considered whether the district court appropriately had dismissed certain of plaintiffs’ claims added in the amended complaint as untimely. The district court found that plaintiffs’ added claims—namely, that defendants made misleading statements from April 11, 2011 to October 26, 2011—were untimely because they were made more than two years after plaintiffs discovered them and did not “relate back” to the original claims as required under Rule 15(c) of the Federal Rules of Civil Procedure. The Sixth Circuit disagreed, finding that plaintiffs’ original complaint alleged that defendants misled investors by concealing Community’s Medicare fraud scheme, and that the amended complaint merely built upon that claim by alleging more expressly that, after Tenet filed its lawsuit, defendants engaged in a series of additional “lulling” misrepresentations that were designed to conceal the fraud’s effect. “The lulling misrepresentations thus served the same function as the earlier ones: to convince investors that Community’s revenues were sustainable when in fact they were not. All of the misrepresentations served the same fraud.” Accordingly, the Sixth Circuit held that the claims in the amended complaint were timely because they sufficiently “related back” to the original complaint and should have come as “no surprise” to defendants.
The Sixth Circuit next considered plaintiffs’ argument that the district court erred in dismissing the amended complaint for failure to state a claim. After noting that there was no dispute over the district court’s finding that the amended complaint plausibly alleged that defendants made false and misleading statements about the source of their profits, and that they did so with intent to mislead the market, the Court focused solely on whether plaintiffs had plausibly alleged that defendants’ actions caused plaintiffs’ loss. In considering loss causation, the Court emphasized that the pleading requirement “is not meant to impose a great burden upon a plaintiff” but is rather “meant to prevent disappointed shareholders from filing suit merely because their shares have lost value and then using discovery to determine whether the loss was due to fraud.” Thus, according to the Sixth Circuit, at the pleading stage a plaintiff need only provide a defendant with “some indication of the loss and the causal connection that the plaintiff has in mind.”
In analyzing the loss causation allegations, the Court considered the two disclosures that plaintiffs contend demonstrated loss causation: (i) Tenet’s complaint against Community filed in April 2011, and (ii) defendants’ October 2011 admissions that its earnings were down and that Community’s approach to Medicare played a role in that decline. Plaintiffs had alleged that the resultant stock declines after these two events—35% and 11%, respectively—were the result of this new information, but the district court had held that the third-party complaint could not reveal “truth” of new information because “complaints can reveal only allegations rather than truth.” In so holding, the district court relied on precedent from the Ninth and Eleventh Circuits, finding that mere allegations of fraud in a civil complaint or investigation are not “corrective disclosures” in the context of pleading loss causation. See Sapssov v. Health Mgmt. Assocs., Inc., 608 F. App’x 855, 863 (11th Cir. 2015) (holding that a civil suit is not a corrective disclosure to cause an adverse market reaction “because a civil suit is not proof of liability”); Loos v. Immersion Corp., 762 F.3d 880, 890 (9th Cir. 2014) (“[A]ny decline in a corporation’s share price following the announcement of an investigation can only be attributed to market speculation about whether fraud has occurred” and “cannot form the basis of a viable loss causation theory”). The Sixth Circuit disagreed, finding the proposition against complaints revealing truth to be merely a general rule, not a categorical one, and observing that “every representation of fact is in a sense an allegation, whether made in a complaint, newspaper report, press release, or under oath in a courtroom.” Noting that some allegations in all of those contexts are more credible than others, the Court found that the third-party complaint in this instance was credible because it included expert analyses that described in detail the extent to which Community’s methodology fraudulently inflated revenues. Moreover, the Court placed great significance on the fact that Community’s CFO admitted the truth of one of the complaint’s core allegations—that Community had used non-standard guidelines for determining inpatient admissions—which, taken together with the relevant allegations in the Tenet complaint, “revealed a material fact that Community had previously concealed from the market.” The Court therefore found that plaintiffs had plausibly alleged at the pleading stage that their loss was caused by the revelations in Tenet’s complaint and defendants’ subsequent partial corroboration of the complaint’s veracity. Further, as part of this loss causation determination, the Court rejected defendants’ argument that these disclosures did not convey new information because it was publicly available in the underlying data used in the expert analyses and in a whistleblower complaint that a Community employee had filed under the False Claims Act. To the contrary, the Court found that it “remains plausible that the market first learned the full extent of Community’s alleged fraud from Tenet’s complaint.” For all of these reasons, the Court reversed the dismissal of the claims and remanded the case to the district court for further proceedings.
Although this case is limited to the Sixth Circuit, it highlights that in assessing the adequacy of loss causation allegations at the pleading stage (in contrast to assessing whether falsity is alleged), some court may determine that information in the form of allegations in a related complaint may constitute true and new disclosures to the market.