306 F.3d 1314 (3rd Cir. 2002), 01-4132, In re NAHC, Inc. Securities Litigation

Docket Nº:01-4132.
Citation:306 F.3d 1314
Party Name:In re NAHC, INC. SECURITIES LITIGATION Jack BRADY, Roger W. Svec, Jacob A. Salzmann, David Fisher, Chris Pietrafitta, Frank J. Siefert, Franz Schleicher, Barry Weisberg and Bruce Bardone Appellants
Case Date:October 03, 2002
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit

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306 F.3d 1314 (3rd Cir. 2002)


Jack BRADY, Roger W. Svec, Jacob A. Salzmann, David Fisher, Chris Pietrafitta, Frank J. Siefert, Franz Schleicher, Barry Weisberg and Bruce Bardone Appellants

No. 01-4132.

United States Court of Appeals, Third Circuit.

Oct. 3, 2002

Submitted under Third Circuit LAR 34.1(a) July 18, 2002.

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John F. Innelli, Michael J. Molder, Innelli and Molder, Philadelphia, PA, Mark Levine, Stull, Stull & Brody, Peter S. Linden, Kirby, McInerney & Squire, LLP, New York, NY, for Appellants, Jack Brady, Roger W. Svec, Jacob A. Salzmann, David Fisher, Chris Pietrafitta, Frank J. Siefert, Franz Schleicher, Barry Weisberg and Bruce Bardone.

Timothy C. Russell, Spector, Gadson & Rosen, P.C., Philadelphia, PA, David W.R. Wawro, Edward J. Henderson, Torys LLP, New York, NY, Mark C. Hansen, Kellogg, Huber, Hansen, Todd, & Evans, P.L.L.C., Washington, D.C., for Appellees, NAHC, Inc., John Foster, Timothy Foster, James W. McLane and Robert E. Healy, Jr.

John W. Frazier, IV, John E. Caruso, Jill Baisinger, Montgomery, McCracken, Walker & Rhoads, LLP, Philadelphia, PA, for Appellee, PriceWaterhouseCoopers.

Martin Flumenbaum, Maria T. Vullo, Robyn M. Sorid, Paul, Weiss, Rifkind, Wharton & Garrison, New York, NY, Howard M. Klein, Conrad, O'Brien, Gellman & Rohn, P.C., Philadelphia, PA, for Appellee, Wasserstein Perella & Co., Inc.

Before: McKEE, FUENTES and ALDISERT, Circuit Judges.


ALDISERT, Circuit Judge.

A number of shareholders 1 of NovaCare, Inc.'s (now known as NAHC, Inc.) ("NovaCare" or "Company") appeal from the dismissal of their consolidated amended complaint ("the Complaint") by the district court pursuant to Rule 12(b)(6), Federal Rules of Civil Procedure, and the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. §§ 78u-4 et seq. They also appeal from the court's granting of NovaCare's motion for judicial notice. Undergirding this appeal are §§ 10(b), 14(a) and 20(a) of the Securities and Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. §§ 78j(b), 78n(a) and 78t(a), and Rules 10b-5 and 14a-9 promulgated thereunder, 17 C.F.R. §§ 240.10b-5 and 240.14a-9.

The district court applied an "inquiry notice" standard to determine when the limitations period begins to run in a securities fraud action. Appellants contend that the court should have applied an actual notice standard. "We have adopted an inquiry notice standard in the context of a case brought under the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961-1968. See Mathews v. Kidder, Peabody & Co., Inc., 260 F.3d 239, 251 (3d Cir.2001). We have not, however, decided the precise standard in the context of a securities fraud claim." We do so now and conclude that the district court did not err in applying this standard and dismissing, as time-barred, the majority of Appellants' contentions. We also decide that the large number of other issues raised by Appellants were properly decided by the district court and affirm its judgment of dismissal in all respects.


NovaCare, a national provider of physical rehabilitation and employee benefits management services, operated in three

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industry segments: (1) long-term care services, consisting of physical rehabilitation services; (2) outpatient services, comprising physical rehabilitation and occupational health services ("PROH") as well as orthotic and prosthetic services ("O & P"); and (3) employee benefits management services, through a majority-owned subsidiary, NovaCare Employee Services, Inc. ("NCES"). The Company experienced substantial growth from its inception in 1985; by the end of the fiscal year ending June 30, 1998, NovaCare claimed the nation's highest market share in the long-term care and orthotic and prosthetic rehabilitation markets. It was also the nation's second largest provider of outpatient physical rehabilitation and occupational health services, and, through NCES, was the second largest employee services provider.

Traditionally, long-term care services had been NovaCare's core business, and in fiscal 1998, it still accounted for approximately 40% of the Company's net revenues and 60% of its operating income. By the beginning of the relevant period in May of 1998, NovaCare common stock, listed on the New York Stock Exchange, traded generally in the range of $12 to $14 per share.

The future of the long-term care services business was about to change, however. For many years, nursing homes had been reimbursed for therapy services on a cost-basis, subject to guidelines designed to ensure that costs were reasonable. On May 12, 1998, the Health Care Financing Administration ("HCFA") issued preliminary regulations implementing the Balanced Budget Act of 1997 (the "BBA"). The regulations drastically altered the method of reimbursement by Medicare and Medicaid to long-term care providers of contract therapy services, switching from reimbursement on a cost basis to reimbursement based on a per diem and specific fee schedule structure. Approximately one week following the issuance of the HCFA guidelines, 10 NovaCare executives collectively sold nearly 600,000 shares of NovaCare stock. One of the executives was Defendant T. Foster, who sold roughly $4.1 million in shares on May 20, 1998.

Following implementation of the HCFA guidelines, NovaCare reported increasingly diminished revenues for its long-term care services segment in each quarter of the 1999 fiscal year. The Balanced Budget Act's impact on NovaCare's long-term care business eventually led to a significant decline in the Company's stock price listing. It then issued a warning in its 1998 Annual Report:

Due to the extensive nature of the reimbursement changes specified by the BBA, the uncertainty regarding the application of fee schedules and an annual cap on Medicare Part B services, the effect these changes may have on the demand for services and management's inability to predict what portion of the PPS and fee schedule rates that NovaCare will be able to receive based on negotiated term of service contracts with its customers, the Company is unable to determine the impact that the BBA will have on its financial position on results of operations.

App. at 331.

On September 22, 1998, after the Company announced expectations of significant declines in first quarter earnings as a result of unanticipated delays in the transition to the new reimbursement system, the Company's stock dropped by approximately $3 per share from $7 to $4. By April 1, 1999, NovaCare was trading at $1.188. Notwithstanding the new statute's materially adverse effect on the Company's financial condition, the Company did not adjust the value of goodwill as an asset of the long-term care division in the financial

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statements on the Securities and Exchange Commission ("SEC") Form 10-K for the 1998 fiscal year (the "1998 Form 10-K") or on the SEC Forms 10-Q for the first and second quarter of the 1999 fiscal year (the "1st Quarter 10-Q" and "2nd Quarter 10-Q," respectively).

From April 1999 onwards, NovaCare began to implement a series of restructuring plans to retire its bank debt and improve its capital structure, and this ultimately resulted in the sale of all of the Company's operating lines of business. On April 5, 1999, the Company announced that it had entered into an agreement to sell its Orthotic and Prosthetic business to Hanger Orthopedic Group, Inc. for $455 million. On May 28, 1999, NovaCare announced that it had agreed to divest its long-term care services business to Chance Murphy, Inc. for only nominal consideration.

On May 30, 1999, T. Foster, McLane and Healy renegotiated their employment contracts, providing for transaction and retention bonuses tied to the sale of NCES, the sale of PROH, and the earlier of either the liquidation of the Company or June 30, 2000.

On August 16, 1999, the board of directors of NovaCare announced that it had approved a proposal to sell the PROH division and the Company's shares in NCES to satisfy the Company's outstanding debentures, and to reinvest or to liquidate and distribute to stockholders any remaining proceeds (the "Restructuring Plan"). On August 13, 1999, NovaCare filed with the SEC, and mailed to its shareholders, proxy materials announcing a special meeting for the shareholders to vote on the Restructuring Plan (the "Proxy Statement"). The Proxy Statement estimated that the proceeds available for distribution in the event of a liquidation would range from $1.76 to $3.94 per common share. On September 8, 1999, the Company announced that it had entered into an agreement, subject to shareholder approval of the Restructuring Plan, to sell its shares in NCES to an investment group at $2.50 per share, amounting to approximately $48.5 million. On September 10, the Company filed and sent additional proxy materials, which included an opinion letter by Wasserstein assessing the fairness of the NCES transaction.

On September 20, 1999, the Company filed an SEC Form 10-K for the 1999 fiscal year. The Company did not reassess its goodwill in light of the Restructuring Plan or adjust the value of goodwill as an asset in the 1999 Form 10-K's financial statements.

The shareholders of NovaCare approved the Restructuring Plan on September 21, 1999. On October 4, 1999, the Company announced that it had agreed to sell the PROH division to Select Medical Corporation ("Select Medical") for approximately $200 million in cash and debt assumption.

On November 22, 1999, the Company filed its Form 10-Q with the SEC, releasing its financial...

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