153 F.Supp.2d 314 (S.D.N.Y. 2001), 99 Civ. 1454, In re Complete Management Inc. Securities Litigation

• Citation: 153 F.Supp.2d 314
• Date: 30 March 2001
• Docket Number: 99 Civ. 1454 NRB.
• Parties: In re COMPLETE MANAGEMENT INC. SECURITIES LITIGATION
• Court: U.S. District Court — Southern District of New York

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153 F.Supp.2d 314 (S.D.N.Y. 2001)

In re COMPLETE MANAGEMENT INC. SECURITIES LITIGATION

No. 99 Civ. 1454 NRB.

United States District Court, S.D. New York.

March 30, 2001

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James J. Sabella, Brown and Wood, LLP, New York City, for Defendant Arthur Anderson, LLP.

Dennis J. Block, Michelle L. Roth, Cadwalader, Wickersham & Taft, New York City, for Defendants Complete Management, Inc., Steven Rabinovici, Clare A. Cardone and Dennis Shields.

Martin E. karlinsky, Camhy Karlinsky & Stein, LLP, New York City, for Defendant National Securities Corp.

Clifford Thau, Squadron, Ellenoff, Plesent & Sheinfeld, LLP, for Defendant Commonwealth Assoc.

Bernard Wincig, Law Offices of Wincig & Wincig, New York City, for Defendant Lawrence W. Shields.

Michael D. Braun, Timothy J. Burke, Stull, Stull & Broday, Los Angeles, CA, Jules Brody, Stull, Stull & Brody, New York City, Andrew M. Schatz, Jeffrey S. Nobel, Robert W. Cassot, Shatz & Nobel, P.C., Hartford, CT, Joseph H. Weiss, Weiss & Yourman, New York City, for Plaintiffs.

OPINION AND ORDER

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.

I. FACTUAL BACKGROUND

This complaint stems from the activities of a now-bankrupt medical practice management corporation, CMI, which plaintiffs

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allege made public offerings based on material false statements and omissions. In relating the facts underlying this action, we accept as true the allegations of the well-pleaded complaint, as required by Fed.R.Civ.P. 12(b)(6).

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."), ¶ 4.¹ 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.

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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.

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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...